**UNITED STATES 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, 2005**                                                    |
|       |       |                                                                                                     |
| **o**      | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**COMMISSION FILE NUMBER 001-11911**

 

**STEINWAY MUSICAL INSTRUMENTS, INC.**

(Exact name of registrant as specified in 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  the Act: |       |
|                                                                   |       |                                          |       |
| **Title of each class**                                                | ** ** | **Name of each exchange on which registered** | ** ** |
| Ordinary Common Shares,  $.001 par value                               |       | New York Stock Exchange                       |       |

 

Securities registeredpursuant to Section 12(g) of the Act:**  None**

 

Indicateby check mark whether the registrant is a well-known seasoned issuer, asdefined in Rule 405 of the Securities Act.   Yes  o  No  ý

 

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or 15(d) of the Act.   Yes  o  No  ý

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements during the past 90 days.   Yes  ý  No  o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of the Form 10-K or anyamendment to this Form 10-K.  ý

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer.

 
| Large accelerated filer o |   | Accelerated filer ý |   | Non-accelerated filer o |
|---------------------------|--------|--------------------------|--------|-------------------------|

 

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

Yes   o  No  ý

 

Theaggregate market value of the Common Stock held by non-affiliates of theregistrant was $236,697,002 as of June 30, 2005.

 
| **Number of shares of Common Stock outstanding as of  March 24, 2006:** | ** ** | **Class A** | ** ** | **477,952**   |
|------------------------------------------------------------------------------|------------|------------------|------------|---------------|
| ** **                                                                   | ** ** | **Ordinary**     | **ý** | **7,690,858** |
| ** **                                                                   | ** ** | **Total**        | **ý** | **8,168,810** |

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Part III - Items10-14 - Definitive Proxy Statement of the Registrant to be filed pursuant toRegulation 14A, Parts I-IV - Final Prospectus of the Registrant dated August 1,1996 filed pursuant to Rule 424(b).

 

 

----

 

**NoteRegarding Forward-Looking Statements**

 

Certain statements contained throughout this AnnualReport on Form 10-K are “forward-looking statements” within the meaning ofSection 21E of the Securities Exchange Act of 1934, as amended.  These forward-looking statements representour present expectations or beliefs concerning future events.  We caution readers that such statements arenecessarily based on certain assumptions that are subject to risks anduncertainties, which could cause actual results to differ materially from thoseindicated in this report.  These riskfactors include, but are not limited to, the factors discussed in Item 1A ofthis report.  We encourage investors toread Item 1A carefully.  Undue relianceshould not be placed on the forward-looking statements contained in thisreport.  These statements, like allstatements contained in this report, speak only as of the date of this report(unless another date is indicated) and we undertake no obligation to update orrevise the statements except as required by law.

 

### **Note RegardingIncorporation By Reference**

 

The Securities and Exchange Commission (“SEC”) allowsus to disclose certain information by referring the reader to other documentswe have filed with the SEC.  Theinformation to which we refer is “incorporated by reference” into this AnnualReport on Form 10-K.  Please readthat information.

 

### **PART I**

 

### **Item 1.  Business**

 

### **Company History**

 

Steinway Musical Instruments, Inc., through itswholly owned subsidiaries, is a global leader in the design, manufacture,marketing and distribution of high quality musical instruments.  We are the largest domestic manufacturer ofmusical instruments.  Whenever we referto the “Company” or to “us,” or use the terms “we” or “our” in this annualreport, we are referring to Steinway Musical Instruments, Inc. and itssubsidiaries.

 

Steinway Musical Instruments, Inc., formerlySelmer Industries, Inc., was incorporated in 1993, at which time itpurchased The Selmer Company, Inc. (“Selmer”), the largest U.S.manufacturer of band & orchestral instruments.  In May of 1995, we purchased SteinwayMusical Properties, Inc. (“Steinway”), a manufacturer and distributor ofacoustic pianos.  In August of 1996,Steinway Musical Instruments, Inc. became publicly held.

 

In September of 2000, we acquired United MusicalInstruments Holdings, Inc. (“UMI”), the second largest manufacturer ofband & orchestral instruments in the United States and on January 1,2003 Selmer and UMI merged into Conn-Selmer, Inc. (“Conn-Selmer”).  In August of 2004,we acquired the assets of G. Leblanc Corporation, a manufacturer of highquality band instruments with production facilities in Wisconsin and France.

 

We are a Delaware corporation with our principal executiveoffices located at 800 South Street, Suite 305, Waltham, Massachusetts02453, and our telephone number is (781) 894-9770.  Through our corporate website,www.steinwaymusical.com, we provide access free of charge to all of our filingswith the SEC, including our Annual Reports on Form 10-K, quarterly reportson Form 10-Q, and current reports on Form 8-K.  These reports are available immediatelyfollowing filing with the SEC. Information contained on or connected to our website is not incorporatedby reference into this Annual

 

2

----

 

Report on Form 10-Kand should not be considered part of this report or any other filing that wemake with the SEC.  Additionally, the SECmaintains an Internet site at www.sec.gov that contains reports, proxy andinformation statements and other information regarding issuers that fileelectronically with the SEC.

 

**Financial Information by Segment and Geographic Location**

 

Information on business segments and geographic areasin which we operated for the years ended December 31, 2005, 2004 and 2003is contained in Note 17 to the Consolidated Financial Statements included inthis report.

 

**MusicalInstrument Industry**

 

We operate two reportable segments within the musicalinstrument industry: pianos and band & orchestral instruments.

### ** **

### **Pianos -**The overall piano market is comprised of two maincategories: grand pianos and upright pianos. Steinway & Sons pianoscompete in the high-end segment of the market, whereas our Boston and Essexlines compete in the mid-priced segment of the piano market.

 

During the last few years, increases in piano imports,mainly from China and Indonesia, contributed to an increase in grand piano unitsales in the United States, the world’s largest grand piano market.  While these lower-priced imports have made itpossible for more consumers to afford a piano, we believe industry revenues areon the decline as a result of lower average prices.  Since Steinway realizes the majority of itsprofit from high-end grand piano sales, our results are generally more affectedby economic cycles, demographics, and the public’s continued interest in musicthan by industry trends.  The pianomarket in China is growing at a rapid pace and is now the second largest grandpiano market outside the United States. We continue to target this region in our distribution strategies.  

 

**Band & Orchestral Instruments -**Demand forband & orchestral instruments in the domestic market has traditionallybeen more significantly impacted by factors such as demographic trends andschool budgeting rather than by macroeconomic cycles.  Recent studies have emphasized the importanceof music education in a child’s development and many school band directors arepromoting band programs as social organizations rather than the first step ofintensive music study.  We expect thisemphasis on music education and steady demographic trends to contribute to arelatively stable domestic market in the near-term.

 

In recent years, there has been an increase in unitsimported into the domestic market from offshore low-cost producers. This hascreated a highly price sensitive domestic market where manufacturers haveimplemented aggressive pricing programs in an attempt to maintain market sharepositions.  To remain competitive in thismarket, we now import some student woodwind and brass instruments, primarilyentry-level, made to our specifications. The impact of lower priced imported instruments has also led to consolidationwithin the industry, leaving Conn-Selmer, Yamaha and Jupiter as the top threeremaining competitors.

 

3

----

 

**Business and Products**

 

**Piano Segment**

 

Our piano division concentrates on the high-end grandpiano market, handcrafting Steinway pianos in New York and Germany.  The Steinway & Sons grand piano isconsidered to be the highest quality piano in the world and has one of the mostwidely recognized and prestigious brand names. We also offer upright pianos as well as two mid-priced lines of pianosunder the Boston and Essex brand names.

 

**Steinway & Sons** - Steinway pianos differ from allothers in design specifications, materials used and the assembly process.  We offertwo premium-priced product lines under the Steinway & Sons brand:grand pianos and upright pianos.  Grandpianos historically have accounted for the majority of our production.  We offer seven sizes of the grand pianoranging from the 5’1” baby grand to the largest 9’ concert grand.  The smaller grands are sold to bothindividual and institutional customers, while the concert grands are soldprimarily to institutions.  Steinwaygrand pianos are premium pianos in terms of quality and price, with retailprices for ebony pianos generally ranging from $40,600 to $103,400 in theUnited States.  Limited edition pianosand pianos with exotic veneers sell for retail prices of up to $158,200.  In 2005, we sold 3,145 grand pianos, of which 2,114 units were shippedfrom our New York facility to dealers in the Americas.  The remaining 1,031 units were shipped fromour German facility primarily to Europe and Asia.  Our upright pianos offer dealers a completeline of quality pianos to satisfy the needs of institutions and other customerswho are constrained by space limitations. We also provide services such as repair, replacement part sales, tuningand regulation of pianos, and restoration. Restoration services range fromrepairs of minor damage to complete restorations of vintage pianos.

 

**Boston Piano Company** - Weintroduced the Boston line in the early 1990s to allow us to compete in themid-price category.  Today we offer twocomplete lines of grand and upright pianos for the mid-priced piano marketunder the Boston and Essex brand names. With certain limited exceptions, we allow only Steinway dealers to carrythe Boston and Essex piano lines, thereby ensuring that these pianos will bemarketed as complementary product lines to the Steinway line.  These pianos, which were designed by us andare produced for us in Asia, provide our dealers with an opportunity to realizebetter margins in this price range while capturing sales that would haveotherwise gone to a competitor.  Also,since our research indicates that the vast majority of Steinway customers havepreviously owned another piano, Boston and Essex pianos provide future Steinwaypiano customers with the opportunity to join the Steinway family of ownerssooner.  The Boston and Essex productlines also increase our business with our dealers, making us their primarysupplier in many instances.  Together,the Boston and Essex product lines offer 13 upright and grand piano sizes, withretail prices ranging from $3,995 to $39,990 in the United States.

 

**Band Segment**

 

We are the largest domestic producer of band &orchestral instruments and offer a complete line of brass, woodwind, percussionand string instruments with well-known brand names.  We have complemented our domesticmanufacturing strategy with a sourcing strategy from Asia to remain competitivein the global marketplace.  Over the pastfew years, we have established relationships with several overseasmanufacturers to produce imported entry-level student instruments to our designspecifications.  As part of this globalmanufacturing strategy, we also began rationalizing our facilities to reducemanufacturing overhead.  We have closedtwo of our U.S. manufacturing plants, reducing our domestic manufacturing floorspace by 20%.

 

In 2005, sales of sourced products accounted for 35%of our band division revenue.

 

4

----

 

Approximately25% of these sales were from our imported entry-level student woodwind andbrass instruments.

 

**Woodwind and Brass Instruments** -We manufacture piccolos, flutes, clarinets, oboes, bassoons, saxophones,trumpets, French horns, tubas, and trombones in our manufacturing facilities inIndiana, Ohio, Wisconsin, and France.  We sell student level instruments in threedistinct product groupings: “good” entry-level imported instruments, “better”mid-priced instruments, which are either imported or manufactured by us, and “best”instruments, which are primarily manufactured by us.  In addition, we also manufacture intermediateand professional level woodwind and brass instruments.  Sales of woodwind and brass instrumentsaccounted for 70% of our band division revenue in 2005.

 

We sell our woodwind and brass products under thebrand names*Bach, Selmer, C.G. Conn, Leblanc, King, Armstrong,Holton, Martin, Yanagisawa,Vito, Emerson, Noblet, Artley*and*Benge*.  Suggested retail prices generally range from$300 to $2,500 for student instruments and from $1,000 to $10,000 forintermediate and professional instruments. We often customize the products that we sell to professional musiciansso that the product meets requested design specifications or has certain soundcharacteristics.  We believe thatspecialization of products helps maintain a competitive edge in quality andproduct design.  Our specialized woodwindand brass instruments sell for up to $27,000.

 

We are the exclusive U.S. distributor for*Yanagisawa* saxophones and *Selmer Paris* musical instruments. The *Selmer Paris*saxophone is the best selling professional saxophone in the world.  *Selmer Paris*, in turn, has exclusive distributionrights to some of our brass instruments in France.  

 

**Percussion Instruments** - Wemanufacture, source, and distribute acoustical and tuned percussioninstruments, including outfit drums, marching drums, concert drums, marimbas,xylophones, vibraphones, orchestra bells, and chimes.  We manufacture percussion products in NorthCarolina and Illinois under the *Ludwig* and *Musser* brand names.  *Ludwig* is considered a leading brand name in acousticaldrums and timpani and *Musser* has astrong market position in tuned percussion products.  Suggested retail prices range from $500 to$5,000 for acoustical drum outfits and from $2,000 to $15,000 for tunedpercussion instruments, with specialized tuned instruments purchased bysymphonies and orchestras selling for up to $20,000.  Sales of percussion instruments accounted for14% of our band division revenue in 2005.

 

**String Instruments** - We assembleand distribute violins, violas, cellos, and basses.  Products are sold under the brand names*Glaesel, Scherl & Roth,*and *W**illiam Lewis &Son*.  Suggested retail pricesgenerally range from $200 to $4,000 for student instruments and from $1,400 to$4,700 for intermediate and advanced instruments, with specialized instrumentsselling for up to $13,000. Components are primarily imported from Europe andAsia and assembled at our factory in Ohio. Sales of string instruments accounted for 3% of our band divisionrevenue in 2005.

 

**Accessories** - We manufacture mouthpieces and distributeaccessories such as music stands, batons, mallets, straps, mutes, reeds, pads,chin rests, strings, bows, cases and instrument care products.  Sales of accessories accounted for 13% of ourband division revenue in 2005.

 

5

----

 

**Customers**

 

**Piano Segment**

 

Most Steinway grand piano sales are to individuals,both professional artists and amateur pianists. Our typical customer is between 40 and 50 years old and has anintermediate to advanced level of musical skill.  He or she holds a graduate degree and reportsan annual household income over $300,000.

 

We also sell pianos to institutions such as concerthalls, conservatories, colleges, universities and music schools.  Nearly 20% of pianos sold in 2005 were toinstitutional customers.  We have aspecific program focused on increasing piano sales to music schools, as this marketsegment is typically less sensitive to economic cycles.  Institutions can earn the “All-SteinwaySchool” designation by owning primarily Steinway-designed pianos, enabling themto provide their students and faculties with the best instruments possible forthe study of music, from the practice room to the recital hall.  To date, 57 schools and conservatoriesworldwide have earned the designation “All-Steinway School.”  

 

Market size and volume trends are difficult toquantify for international piano markets, as there is no single source forworldwide sales data.  Outside the UnitedStates, our strongest market shares are in Germany, Switzerland, the UnitedKingdom, and France.  We believe that wehold an average grand piano market share of approximately 16% in thesecountries.  We also continue to expandour presence in former Eastern Bloc countries where we significantly increasedsales in 2005.

 

Outside of the United States, China is currently the secondlargest grand piano market in the world. With our three piano lines, we believe our market share of grand pianounits is currently 3% in China.  In 2004,we opened a distribution and selection facility in Shanghai.  Our unit sales in China increased over 50% in2005 and we expect a large portion of our long-term growth to come from this market.

 

In 2005, approximately 57% of piano sales were in theUnited States, 28% in Europe and the remaining 15% primarily in Asia.  Our largest piano dealer accounted forapproximately 5% of piano sales in 2005, while the top 15 accounts represented29% of piano sales.

 

## **Band Segment**

 

Band & orchestral instruments are sold tostudent, amateur and professional musicians, and institutions.  The majority of our instruments are purchasedor rented from dealers by students enrolled in music education programs in theUnited States.  Traditionally, studentsjoin school bands or orchestras at age 10 or 11 and learn on beginner levelinstruments, progressing to intermediate or professional level instruments inhigh school or college.  We estimate thatapproximately 85% of our domestic band sales are generated through educationalprograms.  The remaining domestic bandsales are to amateur or professional musicians or performing groups, includingorchestras and symphonies. Student level instruments accounted forapproximately 65% of band & orchestral unit sales and approximately40% of instrument revenues in 2005, with intermediate and professionalinstruments representing the balance.

 

Historically, over 80% of our band sales have been inthe United States.  We believe that theAsian and European markets present significant opportunities for growth due tothe quality of our instruments and the strength of our brand names.  By focusing on these markets, we increasedexports by approximately 20% during 2005.

 

In 2005, approximately 79% of band sales were in theUnited States, 8% in Europe and the remaining 13% primarily in Canada andAsia.  Our largest band dealer accountedfor approximately 6% of band sales in 2005, while the top 15 accountsrepresented approximately 40% of band sales.

 

6

----

 

**Sales andMarketing**

 

### **Piano Segment**

 

Wedistribute our pianos worldwide through approximately 185 independent dealerswho operate nearly 300 showrooms. We also sell our pianos through nine companyoperated retail showrooms: four in the United States and five in Europe.  We have subsidiaries and dealers in bothJapan and China that provide direct access to the growing Asian piano market.Sales to dealers accounted for approximately 75% of piano segment revenue in2005. The remaining 25% was generated from sales made directly by us at one ofour nine company operated retail showrooms.

 

We employ district sales managers whoseresponsibilities include developing close working relationships with pianodealers. These highly experienced professionals provide dealers with salestraining and technical support, and develop sales and marketing programs forthe consumer and institutional markets. These sales managers are also responsible for promoting the SteinwayArtist Program described below.

 

**Steinway Artist Program** -Steinway Artists are world-class pianists who voluntarily endorse Steinway &Sons by selecting the Steinway piano. Our Steinway Artist program is unique in that we do not pay artists toendorse our instruments.  To become aSteinway Artist, a pianist must not only meet certain performance andprofessional criteria, he or she must also own a Steinway piano.  We use these renowned artists in our marketingprograms to help reinforce recognition of the Steinway brand name and itsassociation with quality.  The SteinwayArtist Program currently includes approximately 1,300 of the world’s finestpianists who perform on Steinway pianos. In return for their endorsements, Steinway Artists are provided withaccess to the Concert and Artist Piano Bank.

 

**Concert and Artist Piano Bank** -To ensure that all pianists, especially Steinway Artists, have a broadselection of instruments to meet their individual touch and tonal preferences,we maintain the Concert and Artist Piano Bank. The Piano Bank includes approximately 500 instruments worldwide.  Of these instruments, approximately 375 are locatedin the United States.  In New York Cityalone, the Piano Bank includes approximately 140 concert grands available forvarious occasions.  The remainingdomestic-based pianos are leased to dealers around the country who activelysupport the Steinway Artists program. The Piano Bank promotes our instruments in the music industry and providesmanagement with continual feedback on the quality and performance of recentlyproduced instruments from our most critical customer, the professionalpianist.  The Piano Bank instruments aregenerally sold after five years and replaced with new pianos.

 

### **Band Segment**

 

Our band & orchestral, string and percussioninstruments and related accessories are distributed worldwide throughapproximately 1,700 independent musical instrument dealers and distributors.

 

In North America, we market our products throughdistrict sales managers and telemarketing representatives who are responsiblefor sales within assigned geographic territories. Each district sales manageris also responsible for developing relationships with band &orchestral 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 influencers in the choice of an instrument brand asthey will generally refer students to designated dealers for the purchase ofinstruments.

 

7

----

 

As part of our band director outreach and supportstrategy, we have developed Conn-Selmer University (“CSU”).  Originally created to help graduatingmusic education majors transition into teaching careers, we have expanded CSUto include three additional tracks: one for experienced music educators,another for music dealer representatives, and another for music business students.  We also have an educational director who travels extensively,lecturing and motivating students, educators and parents on the value of musicin a child’s development.  We believethat our well-established, long-standing relationships with influential musiceducators are an important component of our distribution strategy and that ourCSU efforts will further enhance these relationships.

 

To reach international markets, we primarily sell ourinstruments through distributors.  We reorganized our international salesstaff to include regional sales directors who have more direct contact with ourcustomers overseas.

 

We support our dealers and distributors throughincentive programs, advertising and promotional activities.  We reach ourcustomers through trade shows, educator conferences, print media, direct mail,telemarketing, the Internet and personal sales calls. We also activelyadvertise in educator and trade publications and provide educational materials,catalogs and product specifications to students, educators, dealers anddistributors.  

 

**Competition**

 

### **Piano Segment**

 

**Steinway & Sons** - The level ofcompetition our pianos face depends on the market definition.  Steinway & Sons pianos hold a uniqueposition at the top end of the grand piano market, both in terms of quality andprice.  While there are many makers ofpianos, only a few compete directly with our Steinway brand.  Other manufacturers of primarily higherpriced pianos include Bösendorfer and Fazioli.

 

Because Steinway pianos arebuilt to last for generations, used Steinways are the primary competition inour market segment.  It is difficult toestimate the significance of used piano sales, since most are conducted in theprivate aftermarket.  However, we haveincreased our emphasis on restoration services and the procurement,refurbishment and sale of used Steinway pianos to help us mitigate the impactof these aftermarket sales on our piano business.

 

**Boston Piano Company** – While ourmid-priced pianos compete with brands such as Baldwin and Schimmel, our primarycompetition has been from Japanese and Korean manufacturers such as Kawai,Yamaha and Young Chang.  By working withmanufacturers in the same geographic areas, we have been able to enjoy labor costsand manufacturing efficiencies similar to those of our primary competitorswhile offering consumers the added benefit of pianos designed by Steinway &Sons.

 

In recent years, piano manufacturing in China has beengrowing at a rapid pace.  While the vastmajority of the production continues to be upright pianos, Chinesemanufacturers have begun producing low-priced, smaller grand pianos.  In 2005, we established a relationship withPearl River Piano Group, the largest piano manufacturer in China, to buildpianos for our Essex line.  Through thisnew OEM relationship, we will be able to offer pianos priced in a considerablymore competitive price range than previously available, bringing a good measureof Steinway design benefits to a wider reach of consumers.  We expect to introduce several new Essexmodels in 2006.

 

8

----

 

### **Band Segment**

 

We are the largest domestic producer of band &orchestral instruments.  We enjoy leadingmarket shares with many of our professional level instruments.  Yamaha, a Japanese corporation, is ourlargest competitor.  New entrants intothe domestic market generally experience difficulty competing due to the needfor both brand recognition and an effective distribution system. 

 

Competition for sales of student level instruments inthe United States has intensified in recent years due to the growth of offshoremanufacturers.  These producers benefitfrom low labor costs, enabling them to offer instruments at highly competitiveprices.  It is difficult to quantify theimpact of imported musical instruments since the majority of offshoremanufacturers do not report data through industry channels.

 

**Patentsand Trademarks**

 

Steinway & Sons pioneered the development ofthe modern piano with over 125 patents granted since our founding.  While we have several patents effective andpending in the United States and in several foreign countries, we do notbelieve our business is materially dependent upon any single patent.

 

We also have some of the most well-known brand namesin the music industry.  Our pianotrademarks include *Steinway, Steinway &Sons,*the Lyre design, *Boston, Boston designed bySteinway & Sons, Heirloom Collection,**Crown Jewel Collection* and*Essex*. Our band &orchestral trademarks include *Bach, Selmer, C.G. Conn,Leblanc, King, Armstrong, Ludwig, Musser, Holton, Vito, Glaesel, Scherl &Roth, Emerson, William Lewis & Son, Noblet,*and*Artley.*  We considerour trademarks to be important and valuable assets.  It is possible that the termination,expiration or infringement of one or more of our trademarks may have an adverseaffect on our business, depending on the trademark and the jurisdiction.  Accordingly, we maintain trademarkregistrations in appropriate jurisdictions on an ongoing basis and vigorouslypursue any infringement by competitors.

 

### **Raw Materials,Component Parts, and Sourced Products**

 

Our raw materials consist primarily of metals andwoods.  The majority of these materialsis sourced from the Americas, with the balance coming from Europe, Asia andAfrica.  We acquired our sole domesticpiano plate manufacturer and primary piano key maker to ensure availability ofthese component parts.  Component partsfor string and percussion instruments are imported from Europe and Asia.  We have had adequate supplies of raw materialsand component parts in the past and do not expect any disruption to the supplyof these items during 2006 or in the future.

 

Currently, our Boston and Essex piano lines are eachsourced from a single manufacturer, as are our Selmer Paris instruments andcertain other component parts.  Althoughwe may experience delays in availability of product due to the lead timesrequired by these manufacturers, we do not anticipate any material disruptionsto the supply of these products.  Some ofour entry-level band instruments are also sourced from singlemanufacturers.  We continually scrutinizethese suppliers and the quality of products that they manufacture for us and webelieve that we have a sufficient number of qualified suppliers to ensureavailability of all offered products in the upcoming year.

 

9

----

 

**Labor**

 

As of December 31, 2005, we employed 2,443people, consisting of 1,849 hourly production workers and 594 salariedemployees.  Of the 2,443 employees, 1,884were employed in the United States and the remaining 559 were employedprimarily in Europe.

 

Approximately 60% of our workforce in the UnitedStates is represented by labor unions.  TheCompany believes that relations with its employees and most of these unions aregenerally good.  The following tableindicates the union representation and the current status of our collectivebargaining agreements in the United States:

 
| **Location**    | ** ** | **Union affiliation**                                                                              | ** ** | **Type of  manufacturing** | ** ** | **Number of  employees** | ** ** | **Agreement  expiration** | ** ** |
|-----------------|------------|---------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|---------------------------|------------|
| Elkhart, IN     |       | United Auto  Workers                                                                                    |       | Band instruments                |       | 234                           |       | April 1,  2006       |       |
| New York, NY    |       | United Furniture  Workers                                                                               |       | Pianos                          |       | 484                           |       | December 31,  2006   |       |
| Elkhart, IN     |       | United Auto  Workers                                                                                    |       | Band instruments                |       | 13                            |       | March 31,  2007      |       |
| Springfield, OH |       | Glass, Molders,  Pottery, Plastics & Allied Workers                                            |       | Piano plates                    |       | 31                            |       | November 8,  2007    |       |
| LaGrange, IL    |       | Carpenters                                                                                              |       | Percussion  instruments         |       | 34                            |       | November 16,  2007   |       |
| Eastlake, OH    |       | United Auto  Workers                                                                                    |       | Band instruments                |       | 227                           |       | February 16,  2008   |       |
| Elkhorn, WI     |       | International  Brotherhood of Boilermakers, Iron Shipbuilders, Blacksmiths, Forgers &  Helpers |       | Band instruments                |       | 67                            |       | July 20,  2008       |       |

 

We are currently in labor negotiations with the unionthat represents 234 employees at our brass instrument manufacturing plant inElkhart, Indiana.  We may not be able tocome to a new agreement before the current agreement expires on April 1,2006.  

 

In Germany, the workers’ council represents allemployees other than management. Nevertheless, most employment contract conditions are settled incollective bargaining agreements made between various trade unions and theemployer organizations to which we belong. Generally, agreements are negotiatedon an annual basis.  The Company believesthat relations with its employees and these unions are generally good.

 

10

----

 

**Item1A.  Risk Factors**

 

An investment in our company involves risk. Inaddition to the other information in this report, prospective investors shouldcarefully consider the following risks before making an investment.  The risks described below are not the onlyrisks we face.  There may be additionalrisks and uncertainties that we do not presently know of or that we currentlyconsider immaterial. All of these risks could adversely affect our business,financial condition, or results of operations.

#### ** **

#### **We operate in competitivemarkets**

 

Our success depends upon our ability to maintain ourshare of the musical instrument market by providing the best instruments atprices equal to or below our competitors providing instruments of comparablequality.  Increased competition couldlead to price reductions, fewer large sales to institutions, reduced operatingmargins and loss of market share.  Ourpiano division currently competes with companies such as Bechstein,Bösendorfer, Fazioli, Kawai and Yamaha, which also produce and market pianos atthe higher end of the market.  Because ofthe potential savings associated with buying a used instrument, as well as thedurability of the Steinway piano, a relatively large market exists for usedSteinway pianos.  It is difficult toestimate the significance of used piano sales, because most are conducted inthe private aftermarket.  However, webelieve that used Steinway pianos provide the most significant competition inthe high-end piano market.  Our band &orchestral division competes with a number of domestic and Asian manufacturersof musical instruments, including Jupiter and Yamaha.  Any of our competitors may concentrate theirresources upon efforts to compete in our markets.  In addition, Asian musical instrumentmanufacturers have made significant strides in recent years to improve theirproduct quality.  They now offer a broadrange of quality products at highly competitive prices and represent asignificant competitive challenge for us. Our failure to compete effectively could have a negative impact on ourresults of operations.

###### ** **

###### **Economic downturns and changes in consumer preferencescould adversely affect our business**

 

Our business is subject to a number of generaleconomic factors, many of which are out of our control, that may, among otherthings, result in a decrease in sales and net income. Sales of musicalinstruments are dependent in part upon discretionary consumer spending, which maybe affected by general economic conditions. For example, Steinway, which represents more than half of our net sales,sells a relatively small number of Steinway & Sons grand pianos eachyear (3,145 in 2005).  Given the smallnumber of pianos we sell, even a slight decrease in sales could adverselyaffect our profitability.  Band &orchestral sales are also dependent upon the continued interest of school-agedchildren in playing musical instruments. Any decrease in consumer spending or reduction in school-aged children’sinterest in music could result in decreased sales, which could adversely affectour business and operating results. Furthermore, terrorist activities, war or other armed conflict involvingthe United States or its interests abroad may result in a downturn in the U.Sand global economies, thus reducing spending on luxury goods and may exacerbatethe risks to our business. 

 

**We couldbe subject to work stoppages or other business interruptions as a resultof our unionized work force**

 

A significant portion of our hourly employees arerepresented by various union locals and covered by collective bargainingagreements.  These agreements containvarious expiration dates and must be renegotiated upon expiration.  A collective bargaining agreement coveringthe employees in one of our 

 

11

----

 

band manufacturing facilities in Elkhart, Indiana, expires in April 2006and another agreement covering employees in our piano manufacturing facility inNew York expires in December 2006.  We cannot assure investors thatwe will be able to reach agreements on terms that are acceptable to us, or atall.  If we are unable tonegotiate any of our collective bargaining agreements on satisfactory termsprior to expiration, we could experience disruptions in our operations.  Our most recent work stoppage occurredat two of our band & orchestral manufacturing plants in January andMarch of 2003 and lasted for approximately 13 weeks and 9 weeks,respectively.  Any future prolonged workstoppage or delay in renegotiating collective bargaining agreements couldhave a material adverse effect on our operations.  

 

**Anysignificant disruption in our supply from key suppliers could delay productionand adversely affect our sales**

 

Our Boston and Essex piano lines, our Selmer Parisinstruments, and many of our student level band & orchestralinstruments are sourced from single foreign manufacturers.  We are highly dependent on the availabilityof essential materials and purchased components from our suppliers, some ofwhich may be available only from limited resources.  Moreover, we are dependent upon theavailability of our suppliers to provide material that meets specifications,quality standards and delivery schedules. Our suppliers’ failure to provide expected raw materials or componentparts could adversely affect production schedules and profitability.

 

Although we have had adequate supplies of rawmaterials and component parts in the past, there is no assurance that we maynot experience serious interruptions in the future.  Our continued supply of materials is subjectto a number of risks including: 1) the destruction of our suppliers’ facilitiesor their distribution infrastructure; 2) work stoppages or strikes by oursuppliers’ employees; 3) the failure of our suppliers to provide materials ofthe requisite quality; 4) the failure of essential equipment at our suppliers’plants; 5) the failure or shortage of supply of raw materials to our suppliers;and 6) contractual amendments and disputes with our suppliers.  

 

We cannot assure investors that our suppliers willcontinue to provide products to us at attractive prices or at all, or that wewill be able to obtain such products in the future from these or otherproviders on the scale and within the time periods we require.  Furthermore, we cannot assure investors thatsubstitute raw materials or component parts will meet the strict specificationand quality standards we impose.  If weare not able to obtain key materials, supplies, components or sourcedinstruments on a timely basis and at affordable costs, or we experiencesignificant delays or interruptions of their supply, it could have a materialadverse effect on our business, financial condition and results of operations.

 

**We may beunable to successfully integrate acquisitions of related companies into ourbusiness**

 

We have historically acquired other businesses whoseoperations or product lines complement our existing business, including Leblancin August 2004.  We continuallyexplore new opportunities to enter into business combinations with othercompanies in order to maintain and grow our revenues and market presence.  These potential transactions with othercompanies create risks such as difficulty in assimilating the personnel,customers, technology, products and operations with our personnel, customers,technology, products and operations; disruption of our ongoing business,including loss of management focus on existing businesses; and impairment ofrelationships with existing executives, employees, customers and businesspartners.  In addition, we may not beable to identify suitable candidates for these transactions or obtain financingor otherwise make these transactions on acceptable terms.  Furthermore, the benefits that we anticipatefrom these potential transactions may not develop as expected and we cannot besure that we will recover our investment in any such strategic transaction.

 

12

----

 

**Shifts inour product mix may result in declines in our gross margins and profit levels**

 

Our gross margins vary among our product groups andhave fluctuated from quarter to quarter as a result of shifts in product mix(that is, how much of each product type we sell in any particular quarter).  The introduction of new band products,decreases in average selling prices and shifts in the proportion of studentlevel instruments to professional level instruments may cause variances in ourgross margins.  We also experiencevariances in our gross margins as a result of shifts in the proportion of ourpiano retail sales to wholesale sales, as well as changes in amounts of pianosales to territories where we realize more favorable pricing.  For example, our product sales in the formerEastern Bloc countries generally produce higher margins because most sales areat retail prices.  We expect fluctuationsin gross margins to continue in the future. 

 

**Failureof our new products to gain market acceptance may adversely affect ouroperating results**

 

New products may not achieve significant marketacceptance or generate sufficient sales to permit us to recover development,manufacturing and marketing costs associated with these products.  Achieving market acceptance for new productsmay also require substantial marketing efforts and expenditures to expandconsumer demand.  These requirementscould strain our management, financial and operational resources.  Furthermore, failure of our new products toachieve market acceptance could prevent us from maintaining our existingcustomer base, gaining new customers or expanding our markets and could have amaterial adverse effect on our business, financial condition and results ofoperations.  Additionally, pricecompetition among our various brand names may adversely affect our sales,revenues and profitability.  For example,our mid-priced Essex line of pianos may be priced lower than our Boston line,therefore potentially diminishing sales of our Boston pianos.

 

**Since wehave a limited number of facilities, any loss of use of any of our facilitiescould adversely affect our operations**

 

Our operations with respect to specific products areconcentrated in a limited number of manufacturing facilities.  Because we are heavily dependent on each ofthese facilities, our operations would be adversely affected if we experience adisruption in business at any particular facility for a prolonged period oftime because we would not have adequate substitute facilities available to us.

 

**Ouroperations may subject us to liabilities for environmental matters, the costsof which could be material**

 

Our manufacturing operations involve the use,handling, storage, treatment and disposal of materials and waste products thatmay be toxic or hazardous.  Consequently,we are subject to numerous federal, state and local environmental laws andregulations, specifically those relating to discharges to air, water and land,the handling and disposal of solid and hazardous waste and the cleanup ofproperties contaminated by hazardous substances.  Many environmental laws impose strict,retroactive, joint and several liability broadly upon owners and operators ofproperties, including with respect to environmental matters that occurred priorto the time the party became an owner or operator.  In addition, we may have liability withrespect to third-party sites to which we sent wastes for disposal in thepast.  Our potential liability at any ofthese sites is affected by many factors including, but not limited to, themethod of remediation, our portion of the hazardous substances at the siterelative to that of other responsible parties, the number of responsibleparties, the financial capabilities of other parties, and contractual rightsand obligations.

 

13

----

 

We have obligations and liability with respect to theremediation of current and former properties and third party waste disposalsites.  The liabilities and obligationsin some cases are covered by indemnification agreements and we have accrued liabilitiesfor sites where the liability is probable and can be estimated.  We cannot guarantee the indemnitors willcontinue to fund the cleanup liability or that the actual costs of cleanup willnot exceed our present accruals. Furthermore, we may be required to fund additional remedial programs inconnection with other additional current, former or future facilities.

 

Future events, such as the discovery of additionalcontamination or other information concerning past releases of hazardoussubstances at our manufacturing sites (or at sites to which we sent wastes fordisposal), changes in existing environmental laws or their interpretation, andmore rigorous efforts by regulatory authorities, may require additionalexpenditures by us to modify operations, install pollution control equipment,clean contaminated sites or curtail our operations.  These expenditures could have a materialnegative impact on our operations.

 

**We maynot be able to protect our proprietary information**

 

We rely in part on patent, trade secret, unfaircompetition, trade dress and trademark laws to protect our rights to aspects ofour business and products, including product designs, proprietary manufacturingprocesses and technologies.  The laws ofmany foreign countries do not protect proprietary rights to the same extent aslaws in the United States.  In addition,although we may have rights to a particular trademark in a given country, wemay not have similar rights to that trademark in other countries.

 

**Changesin our effective tax rates could affect future results**

 

As an international company, we are subject totaxation in the United States and various other foreign jurisdictions in whichwe do business.  Some of these foreignjurisdictions have higher statutory rates than those in the United States, andcertain of our international earnings are also taxable in the United States.  Accordingly, our effective tax rates willvary depending on the relative proportion of foreign to U.S. income andabsorption of foreign tax credits, changes in the valuation of our deferred taxassets and liabilities, and changes in tax laws.  In addition, we are subject to examination ofour income tax returns by the U.S. Internal Revenue Service and other tax authorities.  We regularly assess the likelihood of adverseoutcomes resulting from these examinations to determine the adequacy of ourincome tax reserves and expense.  Shouldactual events or results differ from our current expectations, charges orcredits to our income tax expense reserves and income tax expense may becomenecessary.  Any such adjustments couldhave a significant impact on our results of operations. 

 

**Ourforeign operations are exposed to risks associated with foreign regulations,exchange rate fluctuations, trade restrictions and political, economic andsocial instability**

 

We manufacture, market and distribute our productsworldwide.  As a result, we are subjectto the risks normally associated with foreign operations.  For example, foreign regulations may limitour ability to produce and sell some of our products or repatriate profits tothe United States.  In addition, aforeign government may impose trade or foreign exchange restrictions orincreased tariffs, which could adversely affect our operations.  Our operations may also be negativelyimpacted by political, economic and social instability in foreign countries inwhich we operate.  We are also exposed torisks associated with foreign currency fluctuations.  A strengthening of the U.S. dollar, theJapanese yen, the British pound, the Chinese yuan or the euro relative to eachother or other foreign currencies could have a negative impact on us.  Although we sometimes engage in transactionsto protect against risks associated with foreign currency fluctuations, wecannot be sure that these fluctuations will not have an adverse effect onus.  Sales outside the United Statesaccounted for approximately 33% of our net sales in 2005.

 

14

----

 

**Therequirements of complying with the Sarbanes-Oxley Act may strain our resourcesand distract management**

 

As a public company, we are subject to the reportingrequirements of the Sarbanes-Oxley Act. Sarbanes-Oxley requires that we maintain effective disclosure controlsand procedures, corporate governance standards and internal controls overfinancial reporting.  Although we devotesignificant time and resources to ensure ongoing compliance with the reportingrequirements of Sarbanes-Oxley, we can give no assurance that we will continueto meet these requirements in the future or that reportable conditions ormaterial weakness in our internal controls and procedures may not arise despiteour best efforts prevent them.  While wehave taken and continue to take all steps necessary to comply with Sarbanes-Oxley,including internal controls, our failure to meet the requirements ofSarbanes-Oxley could negatively impact our business, financial condition andresults of operations.  In addition, theeffort to comply with these obligations may divert management’s attention fromother business concerns.

 

**Messrs. Kirklandand Messina exercise significant control over us, which could adversely affect investors**

 

Mr. Kyle R. Kirkland, Chairman of the Board, and Mr. DanaD. Messina, Chief Executive Officer, hold in the aggregate 100% of our Class Acommon stock, representing approximately 86% of the voting power of our company’scapital stock.  So long as Messrs. Kirklandand Messina continue to hold a majority of the voting power, they will be able,acting together, to exercise a controlling influence over our company,including with respect to the composition of our board of directors and,through it, the direction and policies of the Company.  We cannot assure that Messrs. Kirklandand Messina will not pursue other business interests that will conflict with investors’interests.

 

**Item 1B.  Unresolved StaffComments**

 

None.

 

15

----

 

**Item2.  Properties**

 

We own most of our manufacturing and warehousingfacilities, as well as the building that includes Steinway Hall in New YorkCity.  The remaining Steinway retailstores are leased.  Substantially all ofthe domestic real estate has been pledged to secure our debt.

 

Thefollowing table lists our significant owned and leased facilities:

 
| **Location**               | ** ** | **Owned/  Leased** | ** ** | **Approximate  Floor Space  (Square Feet)** | ** ** | **Type of Facility and Activity Performed** |
|----------------------------|------------|--------------------|------------|-------------------------------------------------------|------------|----------------------------------------------------------------------|
| Long Island  City, NY      |       | Owned              |       | 450,000                                               |       | Piano  manufacturing; restoration center; administrative offices     |
| New York, NY               |       | Owned              |       | 217,000                                               |       | Piano retail  store/showroom; office rental property                 |
| Westport, CT               |       | Leased             |       | 11,000                                                |       | Piano retail  store/showroom                                         |
| Coral Gables, FL           |       | Leased             |       | 6,000                                                 |       | Piano retail  store/showroom                                         |
| Paramus, NJ                |       | Leased             |       | 4,000                                                 |       | Piano retail  store/showroom                                         |
| Springfield, OH            |       | Owned              |       | 110,000                                               |       | Piano plate  manufacturing                                           |
| Hamburg, Germany           |       | Owned              |       | 221,000                                               |       | Piano  manufacturing; executive offices                              |
|                       |       | Leased             |       | 6,000                                                 |       | Piano retail  store/showroom                                         |
| Munich, Germany            |       | Leased             |       | 15,000                                                |       | Piano retail  store/showroom                                         |
| Berlin, Germany            |       | Leased             |       | 7,000                                                 |       | Piano retail store/showroom/service  workshop                        |
| Wuppertal,  Germany        |       | Leased             |       | 27,000                                                |       | Piano key  manufacturing                                             |
| Wilkow, Poland             |       | Owned              |       | 10,000                                                |       | Piano key  manufacturing                                             |
| Shanghai, China            |       | Leased             |       | 12,000                                                |       | Piano  warehouse/showroom/workshop                                   |
| London, England            |       | Leased             |       | 10,000                                                |       | Piano showroom                                                       |
|                       |       | Leased             |       | 6,000                                                 |       | Piano  workshop/storage                                              |
| Tokyo, Japan               |       | Leased             |       | 9,000                                                 |       | Piano selection  center; warehouse                                   |
|                       |       | Leased             |       | 2,000                                                 |       | Administrative  offices                                              |
| Eastlake, OH               |       | Owned              |       | 160,000                                               |       | Brass instrument  manufacturing                                      |
| Elkhart, IN                |       | Owned              |       | 150,000                                               |       | Brass instrument  manufacturing                                      |
|                       |       | Owned              |       | 88,000                                                |       | Woodwind  manufacturing; warehouse; office                           |
|                       |       | Owned              |       | 81,000                                                |       | Warehouse                                                            |
|                       |       | Owned              |       | 25,000                                                |       | Administrative  offices                                              |
| Elkhorn, WI                |       | Owned              |       | 58,000                                                |       | Brass instrument  manufacturing                                      |
| Kenosha, WI                |       | Owned              |       | 95,000                                                |       | Woodwind  manufacturing; warehouse                                   |
| Nogales, AZ                |       | Owned              |       | 22,000                                                |       | Former woodwind  instrument manufacturing, rental property           |
| LaGrange, IL               |       | Owned              |       | 46,000                                                |       | Percussion  instrument manufacturing                                 |
| Monroe, NC                 |       | Leased             |       | 154,000                                               |       | Drum and case  manufacturing                                         |
| Cleveland, OH              |       | Leased             |       | 62,000                                                |       | String  instrument manufacturing                                     |
| London, England            |       | Leased             |       | 8,000                                                 |       | Band instrument  office; warehouse                                   |
| LaCouture  Boussey, France |       | Owned              |       | 32,000                                                |       | Woodwind  manufacturing                                              |

 

Wespent $5.0 million for capital improvements in 2005 consisting primarily ofmachinery and equipment upgrades and replacements, facility upgrades, andtelephone and computer system enhancements. We expect capital spending in 2006 to be in the range of $5.0-7.0million, relating to plant improvements, production equipment purchases, and facilityimprovements.

 

16

----

 

### **Item 3.  Legal Proceedings**

 

**General**

 

We are involved in certain legal proceedings regardingenvironmental matters, which are described below.  Further, in the ordinary course of business,we are party to various legal actions that management believes are routine innature and incidental to the operation of the 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 required to comply with various federal, state,local and foreign environmental laws, including those relating to discharges toair, water and land, the handling and disposal of solid and hazardous waste andthe cleanup of properties contaminated by hazardous substances, includingchlorinated solvents.  Our operations aresubject to environmental laws and regulations that require us to obtain andmaintain permits from regulatory authorities. Non-compliance with environmental laws and regulations or the permits wehave been issued could give rise to significant fines, penalties and othercosts.  We currently do not expect toincur material expenditures relating to environmental compliance in 2006.

 

Certain environmental laws, such as the ComprehensiveEnvironmental Response, Compensation, and Liability Act, as amended (“CERCLA”),impose strict, retroactive, joint and several liability upon personsresponsible for releases of hazardous substances, which liability is broadlyconstrued.  Under CERCLA and other laws,we may have liability for investigation and cleanup costs and other damagesrelating to our current or former properties, or third-party sites to which wesent wastes for disposal.  Our potentialliability at any of these sites is affected by many factors including, but notlimited to, the method of remediation, our portion of the hazardous substancesat the site relative to that of other parties, the number of responsibleparties, the financial capabilities of other parties, and contractual rightsand obligations.

 

In this regard, we operate certain manufacturingfacilities which were previously owned by Philips Electronics North AmericaCorporation (“Philips”).  When wepurchased these facilities, Philips agreed to indemnify us for certainenvironmental matters resulting from activities of Philips occurring prior to December 29,1988 (the “Environmental Indemnity Agreement”). To date, Philips has fully performed its obligations under theEnvironmental Indemnity Agreement, which terminates on December 29, 2008;however, we cannot assure investors that it will continue to do so in thefuture.  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.  On October 22, 1998, we were joined asdefendant in an action involving a third site formerly occupied by a businesswe acquired in Illinois.  Philips hasaccepted the defense of this action pursuant to the terms of the EnvironmentalIndemnity Agreement.  At the fourth site,which is a third-party waste disposal site, the EPA has named over 40 personsor entities as potentially responsible parties (“PRP”), including fourConn-Selmer predecessor entities.  Thefour entities have been involved as members of PRP group in the ongoingnegotiations with the site owners, the largest contributor, and the EPA in anattempt to reach a settlement and release PRP group members from furtherpotential liability.  We expect adecision on the proposed settlement to be reached within the next twelvemonths.  For two of these predecessorentities, which were previously owned by Philips, this matter has been tenderedto

 

17

----

 

Philipspursuant to the Environmental Indemnity Agreement.  With respect to the other two entities, basedon current information concerning estimated cleanup costs at the site, and ourshare of liability, we do not believe our liability will be material.

 

In addition, we arecontinuing an existing environmental remediation plan at a facility we acquiredin 2000.  We estimate our costs, whichapproximate $0.9 million, over a 15 year period.  We have accrued approximately $0.7 millionfor the estimated cost of this remediation program, which represents thepresent value total cost using a discount rate of 4.54%.  A summary of expected payments associated with thisproject is as follows:

 

| ** ** | ** ** | **Environmental  Payments** | ** ** |
|------------|------------|-----------------------------|------------|
| 2006       |       | $                           | 125        |   |
| 2007       |       | 78                          |       |
| 2008       |       | 56                          |       |
| 2009       |       | 56                          |       |
| 2010       |       | 56                          |       |
| Thereafter |       | 555                         |       |
|       |       | $                           | 926        |   |
|       |       |                        |       |

 

In 2004, we acquired two manufacturing facilities fromG. Leblanc Corporation, now Grenadilla, Inc. (“Grenadilla”), for whichenvironmental remediation plans had already been established.  In connection with the acquisition, weassumed the existing accrued liability of approximately $0.8 million for thecost of these remediation activities. Based on a review of past and ongoing investigatory and remedial work byour environmental consultants, discussions with state regulatory officials, andrecent sampling, we estimate the remaining costs of such remedial plans to be$3.1 million as of December 31, 2005. Pursuant to the purchase and sale agreement, we have soughtindemnification from Grenadilla for anticipated costs above the original estimatein the amount of $2.5 million.  We havefiled a claim against the escrow and recorded a corresponding receivable forthis amount. However, we cannot be assured that we will be able to recover suchcosts from Grenadilla.

 

Based on our past experience and currently availableinformation, the matters described above and our other liabilities andcompliance costs arising under environmental laws are not expected to have amaterial impact on our capital expenditures, earnings or competitive positionin an individual year.  However, somerisk of environmental liability is inherent in the nature of our current and formerbusinesses and we may, in the future, incur material costs to meet current ormore stringent compliance, cleanup, or other obligations pursuant toenvironmental laws.

 

### **Item 4.  Submission Of Matters To A Vote Of SecurityHolders**

 

No matters were submitted to a vote of our securityholders during the fourth quarter of the year ended December 31, 2005.

 

18

----

 

**PART II**

 

### **Item 5.  Markets for Registrant’s Common Equity andRelated Stockholder Matters**

 

        Our Ordinary common stock is traded on the New YorkStock Exchange (“NYSE”) under the “LVB” symbol. The following table sets forth,for the periods indicated, the high and low share prices of our Ordinary commonstock as reported on the NYSE.

 
| **Year Ended December 31, 2005** | ** ** | **High** | ** ** | **Low** | ** ** |
|---------------------------------------|------------|----------|------------|---------|------------|
| First Quarter                         |       | $        | 31.15      |    | $          | 26.63 |   |
| Second Quarter                        |       | 30.91    |       | 26.90   |       |
| Third Quarter                         |       | 30.35    |       | 25.50   |       |
| Fourth Quarter                        |       | 27.80    |       | 24.15   |       |
|                                       |            |          |            |         |            |  |  |

 
| **Year Ended December 31, 2004** | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------------------------------------------|------------|----------|------------|---------|------------|
| First Quarter                                        |       | $        | 33.90      |    | $          | 23.25 |   |
| Second Quarter                                       |       | 36.50    |       | 32.10   |       |
| Third Quarter                                        |       | 35.41    |       | 25.59   |       |
| Fourth Quarter                                       |       | 29.36    |       | 26.76   |       |
|                                                      |            |          |            |         |            |  |  |

 

We have two classes of common stock: Class A andOrdinary.  With the exception ofdisparate voting power, both classes are substantially identical.  Each share of Class A common stockentitles the holder to 98 votes.  Holdersof Ordinary common stock are entitled to one vote per share.  Class A common stock shall automaticallyconvert to Ordinary common stock if, at any time, the Class A common stockis not owned by an original Class A holder.  As of March 24, 2006, there were 3,546beneficial shareholders of our Ordinary common stock and two holders of recordof the Class A common stock.

 

We are restricted by the terms of our outstanding debtand financing agreements from paying cash dividends on our common stock.

 

We presently intend to retain earnings to reduceoutstanding indebtedness and to fund the growth of our business.  The payment of any future dividends will bedetermined by the Board of Directors in light of conditions then existing,including our results of operations, financial condition, cash requirements,restrictions in financing agreements, tax treatment of dividends, businessconditions and other factors.

### ** **

19

----

 

### **EquityCompensation Plans**

 

The following table setsforth the equity compensation plan information for our Employee Stock PurchasePlan and our Amended and Restated 1996 Stock Plan, which were approved bysecurity holders:

 
| **Plan Category**                                       | ** ** | **Number of securities   to be issued upon exercise of outstanding options, warrants and rights  (a)** | ** ** | **Weighted-average exercise price  of outstanding options, warrants and rights  (b)** | ** ** | **Number of securities remaining  available for future issuance under equity compensation plans (excluding  securities reflected in column (a))  (c)** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                    |       |                                                                                                   |       |                                                                                  |       |                                                                                                                                                   |       |
| Equity  compensation plans approved by security holders |       | 836,249                                                                                                |       | $                                                                                     | 20.39      |                                                                                                                                                   | 428,233    |   |
| Total                                                   |       | 836,249                                                                                                |       | $                                                                                     | 20.39      |                                                                                                                                                   | 428,233    |   |

 

20

----

 

**Item6.  Selected Consolidated Financial Data**

 

The following table sets forth our selectedconsolidated financial data as of and for each of the five years in the periodended December 31, 2005, as derived from our audited financialstatements.  The table should be read inconjunction with our consolidated financial statements, including thefootnotes, and “Management’s Discussion and Analysis of Financial Condition andResults of Operations” included elsewhere in this report.

 

(In thousands exceptshare and per share data)

 
| **Years  Ended December 31,**            | ** ** | **2005**  | ** ** | **2004 (1)** | ** ** | **2003**  | ** ** | **2002**  | ** ** | **2001**  | ** ** |
|-----------------------------------------------|------------|-----------|------------|--------------|------------|-----------|------------|-----------|------------|-----------|------------|
| **Income statement data:**                    |       |      |       |         |       |      |       |      |       |      |       |
| Net sales                                     |       | $         | 387,143    |         | $          | 375,034   |       | $         | 337,220    |      | $          | 332,297 |   | $ | 352,612 |   |
| Gross profit                                  |       | 111,534   |       | 109,133      |       | 92,553    |       | 97,151    |       | 103,521   |       |
| Income from operations                        |       | 34,837    |       | 34,241       |       | 22,824    |       | 31,399    |       | 34,495    |       |
| Net income                                    |       | 13,792    |       | 15,867       |       | 9,698     |       | 14,909    |       | 8,738     |       |
| Earnings per share:                           |       |      |       |         |       |      |       |      |       |      |       |
| Basic                                         |       | $         | 1.71       |         | $          | 1.97      |       | $         | 1.09       |      | $          | 1.68 |   | $ | 0.98 |   |
| Diluted                                       |       | $         | 1.67       |         | $          | 1.91      |       | $         | 1.09       |      | $          | 1.68 |   | $ | 0.98 |   |
|                                          |       |      |       |         |       |      |       |      |       |      |       |
| **Weighted average shares:**                  |       |      |       |         |       |      |       |      |       |      |       |
| Basic                                         |       | 8,069,721 |       | 8,046,256    |       | 8,924,578 |       | 8,877,256 |       | 8,928,000 |       |
| Diluted                                       |       | 8,265,234 |       | 8,304,066    |       | 8,925,672 |       | 8,882,165 |       | 8,928,000 |       |
|                                          |       |      |       |         |       |      |       |      |       |      |       |
| **Balance sheet data (at December 31):** |       |      |       |         |       |      |       |      |       |      |       |
| Cash                                          |       | $         | 34,952     |         | $          | 27,372    |       | $         | 42,283     |      | $          | 19,099 |   | $ | 5,545 |   |
| Current assets                                |       | 295,731   |       | 308,761      |       | 288,270   |       | 267,346   |       | 254,474   |       |
| Total assets                                  |       | 455,655   |       | 477,545      |       | 445,665   |       | 423,731   |       | 409,537   |       |
| Current liabilities                           |       | 71,881    |       | 72,893       |       | 61,304    |       | 53,302    |       | 49,318    |       |
| Total debt                                    |       | 204,692   |       | 221,208      |       | 196,602   |       | 200,636   |       | 211,203   |       |
| Stockholders’ equity                     |       | 148,830   |       | 145,553      |       | 152,635   |       | 131,208   |       | 115,773   |       |
|                                          |       |      |       |         |       |      |       |      |       |      |       |
| **Other financial data:**                     |       |      |       |         |       |      |       |      |       |      |       |
| Capital expenditures                          |       | $         | 5,004      |         | $          | 5,186     |       | $         | 5,462      |      | $          | 5,604 |   | $ | 7,141 |   |
|                                          |       |      |       |         |       |      |       |      |       |      |       |
| **Margins:**                                  |       |      |       |         |       |      |       |      |       |      |       |
| Gross profit                                  |       | 28.8      | %          | 29.1         | %          | 27.4      | %          | 29.2      | %          | 29.4      | %          |
| Operating                                     |       | 9.0       | %          | 9.1          | %          | 6.8       | %          | 9.4       | %          | 9.8       | %          |
|                                               |            |           |            |              |            |           |            |           |            |           |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)   We acquiredLeblanc in August 2004.

 

21

----

 

**Item 7. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations (Tabular Amounts in Thousands)**

 

**Introduction**

 

The following discussion provides an assessment of theresults of our operations and liquidity and capital resources together with abrief description of certain accounting policies.  Accordingly, the following discussion shouldbe read in conjunction with our Consolidated Financial Statements and the Notesto Consolidated Financial Statements included within this report.

 

**Overview**

 

We, through our operating subsidiaries, are one of theworld’s leading manufacturers of musical instruments.  Our strategy is to capitalize on our strongbrand names, leading market positions, strong distribution networks, andquality products.

 

**PianoSegment -**Sales of our pianos are influenced by generaleconomic conditions, demographic trends and general interest in music and thearts.  The operating results of our pianosegment are primarily affected by Steinway & Sons grand pianosales.  Given the total number of thesepianos that we sell in any year (3,145 sold in 2005), a slight change in unitssold can have a material impact on our business and operating results.  Our results are also influenced by sales ofBoston and Essex pianos, which together represented over 50% of total pianounits sold but less than 20% of total piano revenues in 2005.  Our Boston and Essex piano lines aremanufactured in Asia, each by a single manufacturer.  The ability of these manufacturers to produceand ship products to us could impact our business and operating results.  In2005, approximately 57% of piano sales were in the United States, 28% in Europeand the remaining 15% primarily in Asia. For the year ended December 31, 2005, our piano segment sales were $203.5million, representing 53% of our total revenues.

 

### **Piano Outlook for2006**– Overall, we expect a relatively stable year for our piano segmentwith respect to sales and gross profit. We intend to focus on reducing existing inventory levels, developing ourdistribution structure in China and implementing various manufacturingimprovement initiatives in the upcoming year. We currently have sufficient, but not excessive, manufacturing capacityto meet anticipated or increased demand.

 

**BandSegment -**Our student band instrument sales are influenced bytrends in school enrollment, general attitudes toward music and the arts, andour ability to provide competitively priced products to our dealernetwork.  Management estimates that 85%of our domestic band sales are generated through educational programs; theremainder is sales to amateur or professional musicians or performing groups,including symphonies and orchestras.  

 

Our sales growth has been adversely affected in recentyears by the abundance of competitively priced imported student instrumentsavailable to our dealers and their ability to purchase these products directlyfrom offshore sources.  In order tocompete with these mass-merchandised offshore instruments, we restructured ourproduct offerings to include quality, competitively priced brand-name importedinstruments that are built to our specifications.  We now offer quality-controlled, brand-nameproducts at multiple price points through distribution channels which supportthe music education market.  Our productofferings are tailored to the needs of traditional school music dealers whoprovide full-service rental programs to beginning band students, as well asmusic retailers and e-commerce dealers selling directly to end consumers fromtheir stores or through the Internet.  Webelieve our product offerings have helped us remain competitive at variousprice points and will continue to do so in the future.

 

22

----

 

In 2005, beginner instruments accounted forapproximately 65% of band & orchestral unit shipments andapproximately 40% of band instrument revenues, with advanced and professionalinstruments representing the balance. In 2005, approximately 79% of band saleswere in the United States, 8% in Europe and the remaining 13% primarily in Canadaand Asia.  For the year ended December 31,2005, our band sales were $183.6 million, representing 47% of our totalrevenues.

 

**Band Outlook for 2006 –**We are entering 2006 with increased ordersfor both U.S. made and sourced products and expect to see improvement in bothrevenues and gross profit in the coming year. Focused sales efforts have resulted in an expanding customer base in theU.S, particularly for percussion instruments, and in our export markets.  We are working more closely with our customersto understand their requirements so we may improve the coordination of productavailability with their needs.  We expectcontinued improvement in the flow of sourced product from our suppliers as wemonitor their capacity.  Our efforts toimprove productivity at our various facilities should continue to yield moreefficient production levels.  This,coupled with an increase in sales of sourced products, should lead to improvedmargins in 2006.

 

**Inflationand Foreign Currency Impact -**Although we cannot accuratelypredict the precise effect of inflation on our operations, we do not believethat inflation has had a material effect on sales or results of operations inrecent years.

 

Sales to customers outside the United Statesrepresented 33% of consolidated sales in 2005. We record sales in euro, Japanese yen, British pounds, and Chinese yuan.  In 2005, we generated 69% of ourinternational sales through our piano segment. Foreign exchange rate changes impacted sales by less than $1.0 millionin the current year.  Although currencyfluctuation affects international sales, it also affects cost of sales andrelated operating expenses. Consequently, it generally has not had a material impact on operatingincome.  We use financial instrumentssuch as forward exchange contracts and currency options to reduce the impact ofexchange rate fluctuations on firm and anticipated cash flow exposures andcertain assets and liabilities denominated in currencies other than thefunctional currency of the affected division. We do not purchase currency-related financial instruments for purposesother than exchange rate risk management.

 

**Taxes–**We are subject to U.S. income taxes as well as tax inseveral foreign jurisdictions in which we do business.  Some of these foreign jurisdictions havehigher statutory rates than the United States. In addition, certain of our operations are subject to both U.S. andforeign taxes.  However, in such cases wereceive a credit against our U.S. taxes for foreign taxes paid equal to thepercentage that such foreign income (as adjusted for reallocated interest) representsof the total income subject to U.S. tax. Accordingly, our effective tax rates will vary depending on the relativeproportion of foreign to U.S. income and the absorption of foreign tax creditsin the United States.  In 2003, we wereable to utilize foreign tax credits carried forward from prior years due to thehigher proportion of our foreign source income to overall income.  In 2004, we were able to use the majority, butnot all, of the foreign tax credits generated in that period.  However, because the American Jobs CreationAct of 2004 (the “Act”) extended the foreign tax credit carryover period, wewere able to recognize a partial benefit for the excess foreign tax creditsgenerated in 2004.  In 2005, we were unableto utilize approximately one third of the foreign tax credits generated in thecurrent period.  This, coupled with theincome generated in higher rate jurisdictions such as Germany, resulted in anincrease in our overall tax rate in the current year.  

 

The strengthening of our domestic piano and bandbusinesses is expected to result in less effective use of our foreign taxcredits and credit carryforwards in the upcoming year.  We also anticipate higher

 

23

----

 

pretaxincome in many of the states in which we do business.  These events may have an adverse impact onour effective tax rate for 2006.  Ouroverall tax rate will also be influenced by our ability to effectively uselosses generated in certain tax jurisdictions. 

 

**Resultsof Operations**

 

FiscalYear 2005 Compared to Fiscal Year 2004

 
| ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|--------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **For the  years ended December 31,** | ** ** | **2005**   | ** ** | ** ** | ** ** | **2004**   | ** ** | ** ** | ** ** | **$**      | ** ** | **%** | ** ** |
|                                       |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Net sales                                  |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Band                                       |       | $          | 183,626    |       |       |       | $          | 171,346    |       |       |       | 12,280 |   | 7.2 |   |
| Piano                                      |       | 203,517    |       |       |       | 203,688    |       |       |       | (171       | )          | (0.1 | ) |
| Total sales                                |       | 387,143    |       |       |       | 375,034    |       |       |       | 12,109     |       | 3.2 |   |
|                                       |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Cost of sales                              |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Band                                       |       | 146,168    |       |       |       | 137,779    |       |       |       | 8,389      |       | 6.1 |   |
| Piano                                      |       | 129,441    |       |       |       | 128,122    |       |       |       | 1,319      |       | 1.0 |   |
| Total cost of sales                        |       | 275,609    |       |       |       | 265,901    |       |       |       | 9,708      |       | 3.7 |   |
|                                       |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Gross profit                               |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Band                                       |       | 37,458     |       | 20.4%      |       | 33,567     |       | 19.6%      |       | 3,891      |       | 11.6 |   |
| Piano                                      |       | 74,076     |       | 36.4%      |       | 75,566     |       | 37.1%      |       | (1,490     | )          | (2.0 | ) |
| Total gross profit                         |       | 111,534    |       |       |       | 109,133    |       |       |       | 2,401      |       | 2.2 |   |
|                                       |       | 28.8%      |       |       |       | 29.1%      |       |       |       |       |       |   |   |
|                                       |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Operating expenses                         |       | 76,697     |       |       |       | 75,255     |       |       |       | 1,442      |       | 1.9 |   |
| Facility rationalization                   |       | —     |       |       |       | (363       | )          |       |       | 363        |       | (100.0 | ) |
| Total operating expenses                   |       | 76,697     |       |       |       | 74,892     |       |       |       | 1,805      |       | 2.4 |   |
|                                       |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Income from operations                     |       | 34,837     |       |       |       | 34,241     |       |       |       | 596        |       | 1.7 |   |
|                                       |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Other income, net                          |       | (800       | )          |       |       | (3,163     | )          |       |       | 2,363      |       | (74.7 | ) |
| Net interest expense                       |       | 13,645     |       |       |       | 13,437     |       |       |       | 208        |       | 1.5 |   |
|                                       |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Income before income taxes                 |       | 21,992     |       |       |       | 23,967     |       |       |       | (1,975     | )          | (8.2 | ) |
|                                       |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Income tax provision                       |       | 8,200      |       | 37.3%      |       | 8,100      |       | 33.8%      |       | 100        |       | 1.2 |   |
|                                       |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Net income                                 |       | $          | 13,792     |       |       |       | $          | 15,867     |       |       |       | (2,075 | ) | (13.1 | ) |

 

24

----

 

**Overview –**In 2005 wecontinued strengthening our band business. Our purchase of substantially all of the assets of G. Leblanc Corporationin August 2004 resulted in sales growth for the segment.  We merged the administrative officeoperations of Leblanc into our existing operations in May 2005, therebyeliminating duplicative administrative costs.  Production at our woodwindfacility, which was low in the early part of the year as we trained newworkers, had significantly improved by the end of the period, and we continueto experience period over period improvement in our band segment margins.  

 

Ourdomestic piano division sales decreased due to unusually high turnover in salespersonnel at the retail level, coupled with decreased demand for our BostonPiano lines. However, overall piano segment sales remained stable, primarilydue to the revenue generated by our European divisions.  Piano margins declined slightly due toinefficiencies at both piano manufacturing facilities.

 

**Net Sales –**Net sales increased $12.1 million as aresult of the increase in band division sales, which was caused primarily byincremental sales of Leblanc product through the first three quarters of2005.  Overall band unit shipmentsincreased 5.9%, due to the increase in brass and woodwind unit shipments of9.5% (the largest component of the band business).  Total piano sales remained stable at $203.5million.  Domestically, sales declined,in part due to attrition of retail sales staff in the early part of the year,as well as the 11% decrease in unit shipments of our Boston piano lines.  In the U.S., mid and lower-priced piano salesare being adversely impacted by the influx of low-priced Asian imports.  However, the shift in mix towards higherpriced units sold by our German division resulted in consistent piano segmentrevenues.

 

**Gross Profit –****Gross profitimproved $2.4 million driven by an increase in band sales and band margins.  Band margins were less affected by atypicalcharges in the current period. These costs totaled $1.6 million in 2005, andarose from the sell through of purchased Leblanc inventory, which was writtenup to fair value upon acquisition.  Inthe prior period, atypical charges totaled $2.6 million, comprised of $1.2million from the sell through of purchased Leblanc inventory, and $1.4 millionfrom severance costs associated with plant closures.  Band margins also benefited from a large,high margin sales transaction in the beginning of the fourth quarter.  Piano segment gross profit decreased $1.5million despite the beneficial sales mix towards higher margin grands sold byour German division. The adverse impact of factory inefficiencies due in partto the disruptions caused by implementing production line improvements, as wellas a larger book-to-physical inventory adjustment at our domestic pianomanufacturing facility were the primary causes of the piano margin decrease.

 

**Operating Expenses –**Operating expenses increased $1.8 million, despitethe decrease in external costs associated with Sarbanes-Oxley complianceefforts, which were approximately $1.2 million less in 2005.  The incremental operating expenses areprimarily sales and marketing, $0.9 million of which resulted from commissions associatedwith the large sales transaction described above.  Piano sales commissions also increased as aresult of the favorable performance by the German division.  In addition, this division had incrementalpublic relations and advertising costs of $0.2 million as a result of its 125thanniversary celebrations. Lastly, $0.9 million in additional operating expenseswere associated with Leblanc, and were incurred in the early part of the year,prior to the consolidation of band administrative offices.

 

**Non-operatingExpenses –** Non-operating expenses increased $2.6 million in2005.  Approximately $0.5 million of thisincrease relates to losses on extinguishment of debt, which resulted from thebuyback of $8.2 million of our 8.75% Senior Notes at 105%, and the write off ofthe corresponding deferred financing costs. A shift of $0.3 million from foreign exchange gains to foreign exchangelosses also contributed to the expense increase.  We incurred additional interest costs ofapproximately $0.2 million

 

25

----

 

due to the increase ininterest rates during the year.   Theremainder of the expense increase primarily results from reclassification ofcertain items from non-operating expenses to operating expenses.

 

**Resultsof Operations**

 

FiscalYear 2004 Compared to Fiscal Year 2003

 
| ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|----------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **For  years ended December 31,** | ** ** | **2004**   | ** ** | ** ** | ** ** | **2003**   | ** ** | ** ** | ** ** | **$**      | ** ** | **%** | ** ** |
|                                   |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Net sales                              |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Band                                   |       | $          | 171,346    |       |       |       | $          | 157,460    |       |       |       | 13,886 |   | 8.8 |   |
| Piano                                  |       | 203,688    |       |       |       | 179,760    |       |       |       | 23,928     |       | 13.3 |   |
| Total sales                            |       | 375,034    |       |       |       | 337,220    |       |       |       | 37,814     |       | 11.2 |   |
|                                   |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Cost of sales                          |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Band                                   |       | 137,779    |       |       |       | 126,369    |       |       |       | 11,410     |       | 9.0 |   |
| Piano                                  |       | 128,122    |       |       |       | 118,298    |       |       |       | 9,824      |       | 8.3 |   |
| Total cost of sales                    |       | 265,901    |       |       |       | 244,667    |       |       |       | 21,234     |       | 8.7 |   |
|                                   |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Gross profit                           |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Band                                   |       | 33,567     |       | 19.6%      |       | 31,091     |       | 19.7%      |       | 2,476      |       | 8.0 |   |
| Piano                                  |       | 75,566     |       | 37.1%      |       | 61,462     |       | 34.2%      |       | 14,104     |       | 22.9 |   |
| Total gross profit                     |       | 109,133    |       |       |       | 92,553     |       |       |       | 16,580     |       | 17.9 |   |
|                                   |       | 29.1%      |       |       |       | 27.4%      |       |       |       |       |       |   |   |
|                                   |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Operating expenses                     |       | 75,255     |       |       |       | 66,771     |       |       |       | 8,484      |       | 12.7 |   |
| Facility rationalization               |       | (363       | )          |       |       | 2,958      |       |       |       | (3,321     | )          | (112.3 | ) |
| Total operating expenses               |       | 74,892     |       |       |       | 69,729     |       |       |       | 5,163      |       | 7.4 |   |
|                                   |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Income from operations                 |       | 34,241     |       |       |       | 22,824     |       |       |       | 11,417     |       | 50.0 |   |
|                                   |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Other income, net                      |       | (3,163     | )          |       |       | (3,517     | )          |       |       | 354        |       | (10.1 | ) |
| Net interest expense                   |       | 13,437     |       |       |       | 11,945     |       |       |       | 1,492      |       | 12.5 |   |
|                                   |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Income before income taxes             |       | 23,967     |       |       |       | 14,396     |       |       |       | 9,571      |       | 66.5 |   |
|                                   |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Income tax provision                   |       | 8,100      |       | 33.8%      |       | 4,698      |       | 32.6%      |       | 3,402      |       | 72.4 |   |
|                                   |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Net income                             |       | $          | 15,867     |       |       |       | $          | 9,698      |       |       |       | 6,169 |   | 63.6 |   |

 

**Overview –**2004 was a year committed to improvement ofour band business.  We continued thefacility rationalization project started in 2003, closing one of our Elkhart,Indiana plants in April 2004 and moving production into existingfacilities.  Our redesigned distributionpolicy enabled us to grow our e-commerce, catalog, music retailer,professional, and export sales categories. Our expanded product line, which includes lower-priced, brand-namesourced instruments, has been well accepted in the marketplace, and weexperienced increases in sales of these products once we worked through productavailability issues.  However, wemaintained lower-than-normal production levels for certain products in order tomanage inventory levels, which adversely impacted margins.  We were presented with the opportunity topurchase substantially all of the assets of G. Leblanc Corporation, whichenabled us to strengthen our existing band product lines.  Leblanc faced the same excess capacity issueswe have experienced, having announced the closure of one of its manufacturingfacilities just prior to the acquisition. Accordingly, we expect our overall production rationalization activitiesto extend beyond the timeframe originally anticipated as we factor Leblanc’sproduction capabilities into our analysis.

 

26

----

 

Our piano business had a verysuccessful year. Domestic wholesale sales remained strong, and retail saleswere bolstered by the two additional retail stores that were fully operationalfor all of 2004.  Our European businessremained stable, while our Asian business improved, primarily due to ourShanghai facility being operational since spring 2004.  Although sales and marketing expenses werehigher than expected, these costs were more than offset by margin improvementsdue to improved production levels, efficiencies, and product mix.

 

**Net Sales –**Net sales increased $37.8 million.**** This resulted in part from a 9% increase inSteinway grand unit shipments, as well as a $6.8 million benefit attributableto foreign exchange.  The total pianosales increase of $23.9 million also reflects the increase in higher-pricedretail unit sales resulting from our additional domestic storefronts beingoperational for the full year, as well as strong wholesale shipments throughoutthe year.  Band & orchestralinstrument sales increased $13.9 million on an overall unit increase of17%.  The band sales increase includes$9.6 million attributable to the Leblanc acquisition, with the remainderresulting from core business growth, especially professional brass andpercussion****instruments.

 

**Gross Profit –****Gross profitimproved $16.6 million primarily due to the piano margin improvement from 34.2%to 37.1%.  Higher domestic productionlevels, overseas production and labor efficiencies, and improved retail saleswere the primary driver of the increase. A shift in our international divisions’ sales mix towards higher margingrands sold also contributed to the improvement.  Although band segment gross profit improved$2.5 million, gross margins declined slightly. Atypical charges affectingmargin in 2004 totaled $2.6 million, comprised primarily of severance andhigher costs associated with the acquisition write-up of Leblanc inventory tofair value.  In 2003, atypical chargestotaled $6.0 million, including severance costs, strike costs, and inventoryimpairment charges.  Despite thereduction in atypical charges and improved margins on imported studentproducts, gross margins decreased slightly from 19.7% to 19.6%.  This was primarily due to increased freightexpenses, production inefficiencies for some woodwind products, and reducedproduction levels of certain brass instruments. Significant increases in costs of raw materials such as silver andcopper also adversely affected band gross margins.

 

**Operating Expenses –****Operating expensesincreased $5.2 million despite the $3.3 million decrease in impairment chargestaken in the prior year.  Over $3.1million of this increase resulted from external costs associated with ourSarbanes-Oxley compliance project. $2.2 million of the increase is attributableto foreign exchange, and we incurred incremental expenses of $1.4 millionassociated with Leblanc.  The remainderof the increase resulted primarily from increased advertising and promotionalcosts and increased bonus payments.  

 

**Non-operatingExpenses –** Non-operating expenses increased $1.8 millionprimarily due to the additional interest expense resulting from our issuance of$29.0 million of 8.75% Senior Notes in February 2004.**

* *

***Liquidity and Capital Resources***

* *

We have relied primarily upon cash provided by operations,supplemented as necessary by seasonal borrowings under our domestic workingcapital line, to finance our operations, repay long-term indebtedness, financeacquisitions, and fund our capital expenditures.  Our overseas divisions, particularly in Asia,are normally in a borrowing position on their lines.  These borrowings are likely to be less than$10.0 million at any given time.  In2003, our domestic line went virtually unused for the year, in 2004, ourborrowings peaked at approximately $23.0 million, as a result of ouracquisition of the

 

27

----

 

netassets of Leblanc, and in 2005 our borrowings peaked at approximately $11.0million due to seasonal borrowings.

 

**CashFlows -**Our statements of cash flows are summarized asfollows:

 
| **For the  years ended December 31,**                                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                               |       |     |       |     |       |     |       |
| Net income:                                                                        |       | $        | 13,792     |     | $          | 15,867   |       | $ | 9,698 |   |
| Changes in operating assets and liabilities                                        |       | 6,324    |       | (1,305   | )          | 8,350    |       |
| Other adjustments to reconcile net income to cash flows  from operating activities |       | 11,313   |       | 9,311    |       | 12,845   |       |
| Cash flows from operating activities                                               |       | 31,429   |       | 23,873   |       | 30,893   |       |
|                                                                               |       |     |       |     |       |     |       |
| Cash flows from investing activities                                               |       | (5,756   | )          | (40,720  | )          | (5,452   | )          |
|                                                                               |       |     |       |     |       |     |       |
| Cash flows from financing activities                                               |       | (15,860  | )          | 1,019    |       | (2,767   | )          |
|                                                                                    |            |          |            |          |            |          |            |  |  |  |

 

In 2005, cash flows from operating activitiesincreased $7.6 million despite the increase in cash used for accounts payableof $1.9 million.  This improvement was largelydue to the increase in cash provided by inventory and receivables of $8.7million, which resulted from improved management of work-in-process inventory andreceivables collections at our band division. In 2004, cash flows from operating activities decreased $7.0million.  This resulted primarily fromworking capital changes, as inventory increased in part to support ourexpansion in Asia, and receivables increased in conjunction with band salesincreases.  Collectively, these workingcapital changes used $8.4 million more than in the prior period.  Cash transferred to workers’ compensation andenvironmental depositary trust funds (which replaced more expensive letters ofcredit previously used) also negatively impacted cash flows from operatingactivities.   In 2003, cash flows fromoperating activities of $30.9 million were driven by our control overinventory, reduced manufacturing levels, and management of our accountsreceivable and payable. 

 

The use of cash for investing activities decreased $35.0million, as $36.8 million was used to fund our acquisition of Leblanc in2004.  In 2005, cash used foracquisitions was limited to the $2.2 million final purchase price adjustmentfor Leblanc.  Capital expenditures wereslightly lower than in prior periods at $5.0 million in 2005, $5.2 million in2004, and $5.5 million in 2003.  (SeeCapital Expenditures discussion below.) The remainder of the decrease is due to the proceeds from sales of fixedassets, which provided an incremental $0.2 million in the period.  

 

In 2005, cash flows from financing activities decreased$16.9 million due in part to the $4.0 million decrease in proceeds fromissuance of stock.  In addition, werepaid approximately $1.5 million on our line borrowings in the current year,whereas borrowings provided cash of $2.9 million in the prior period.  Lastly, in December 2005, we repurchased$8.2 million of our own 8.75% Senior Notes at 105% of face value, whichresulted in a use of cash of $8.6 million. In 2004, cash provided by financing activities of $1.0 million resultedfrom stock option exercises and employee stock purchase plan activitiestotaling $5.7 million, which more than offset the $4.6 million in netborrowings and scheduled debt repayments. In 2003, financing activities consisted primarily of scheduled debt repaymentsof $6.5 million, counterbalanced in part by net borrowings of $2.3 million onour foreign lines of credit.  Theseborrowings were made primarily to support an increase in working capital.  

 

28

----

 

**CapitalExpenditures –**Our capitalexpenditures consist primarily of machinery and equipment upgrades andreplacements, facility upgrades, and telephone and computer systemenhancements.  We expect capital spendingin 2006 to be in the range of $5.0-7.0 million, relating to plant improvements,production equipment purchases, and facility improvements.

 

**Seasonality-**Consistent with industry practice, we sell band instrumentsalmost entirely on credit utilizing the two financing programs describedbelow.  Due to these programs, we have largeworking capital requirements during certain times of the year when bandinstrument receivable balances reach highs of approximately $80-85 million in August andSeptember, and lesser requirements when they are at lows of approximately $70-75million in January and February. The financing options, intended to assist dealers with the seasonalityinherent in the industry and facilitate the rent-to-own programs offered tostudents by many retailers, also allow us to match our production and deliveryschedules.  The following forms offinancing are offered to qualified band instrument dealers:

 

a)     **Receivable dating***:* Payments on purchases made from October through August ofthe following year are due in October.  Dealersare offered discounts for early payment. 

 

b)    **Note receivable financing***:* Dealers that meet certain credit qualifications mayconvert open accounts to a note payable to us.  The note program is offered primarily in October andcoincides with the receivable dating program. The terms of the notes generally include payment over a nine to twelvemonth period with interest ranging from 9-11.5%.  Interest rates are contingent upon creditratings and borrowing periods.  In certainsituations, long term arrangements for up to 36 months may be offered.  In most instances, the note receivable issecured by dealer inventories and receivables.

 

**OffBalance Sheet Arrangements –**In 2004, certain customers of ourLeblanc subsidiary financed notes receivable with a third party, to which we havea recourse obligation.  As of December 31,2005, $0.5 million of these notes remain outstanding.  We have included a corresponding recourseobligation of $0.1 million in our financial statements at period-end.  Our total maximum recourse obligation underthis arrangement includes the outstanding balance on the notes, as well as anyinterest or late fees that may be incurred by our customers. 

 

We generally do not provide extended financingarrangements to our piano dealers.  Tofacilitate long-term financing required by some dealers, we have arrangedfinancing through third-party providers. We generally provide no guarantees with respect to these arrangements.

 

**Retail Financing Obligations** – Certain of our retail sales overseas werefinanced by our customers through a local bank under an arrangement thatincluded an obligation on our part to repurchase pianos seized by the bank upondefault of the customer.  The buybackprice is established as a percentage of the original sales price, starting at80% in the first year and declining to 30% in the fifth year of the loan.

 

This program ceased in the first quarter of 2003.Nevertheless, because our obligation continues until the bank is paid in fullby the customer, our commitment can remain outstanding for up to 8 years – themaximum term of the consumer loan.

 

29

----

 

Our maximum obligation under this arrangement isestimated to be approximately €0.6 million ($0.7 million at the December 31,2005 exchange rate).  To date, we havenot been required to repurchase any pianos under this program and we believethe likelihood of such repurchases in the future is remote.  Accordingly, we have not recognized aliability for this obligation in our financial statements.  Further, in the unlikely event of arepurchase, we believe the proceeds received upon our resale of the piano wouldexceed the amount payable to the bank.

 

**Pensions and Other Postretirement Benefits-** Whendetermining the amounts to be recognized in the consolidated financialstatements related to our domestic pension and other postretirement benefits,we used a long-term rate of return on plan assets of 9%, which was developedwith input from our actuaries and our investment committee, and is consistentwith prior years.  We believe that 9% isconsistent with the historical long-term return trends on our domestic pensionassets and our expectations for future returns. The discount rate utilized fordetermining future pension obligations for our domestic plans is based onlong-term bonds receiving an AA- or better rating by a recognized ratingagency.  The resulting discount ratedecreased from 6.0% at December 31, 2004 to 5.75% at December 31, 2005.

 

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 in the applicable jurisdiction.

 

**Borrowing Activities and Availability-**Our real estateterm loan, acquisition term loan, and domestic, seasonal borrowing requirementsare accommodated through a committed credit facility with a syndicate ofdomestic lenders (the “Credit Facility”). The Credit Facility provides us with a potential borrowing capacity of$85.0 million in revolving credit loans, and expires on September 14,2008. Borrowings are collateralized by our domestic accounts receivable,inventory, and fixed assets.  As of December 31,2005, there were no revolving credit loans outstanding and availability basedon eligible accounts receivable and inventory balances was approximately $83.6million, net of letters of credit. The real estate term loan is payable inmonthly installments of $0.2 million and includes interest at average 30-dayLIBOR (2.40% at December 31, 2005) plus 1.5%.  This term loan is secured by all of ourinterests in the Steinway Hall property. The acquisition term loan was repayable in monthly installments of $0.4million through August 2005 and monthly installments of $0.6 million from September 2005through September 2008.  Theacquisition term loan and revolving credit loans bear interest at average30-day LIBOR plus 1.75%.  Subsequent toyear end, the acquisition term loan was paid in full.  All of our borrowings under the CreditFacility are secured by a first lien on our domestic inventory, receivables,and fixed assets.  Open account loanswith German banks also provide for borrowings of up to €16.5 million ($19.5million at December 31, 2005) by Steinway’s foreign subsidiaries.  An additional revolving loan providesborrowing capacity of up to ¥500 million ($4.2 million at the December 31,2005 exchange rate).

 

On April 19, 2001, we issued $150.0 million 8.75%Senior Notes due 2011.  In December 2002we repurchased $4.7 million of our Senior Notes at 99.25%.  In December 2005 we repurchased $8.2million of our Senior Notes at 105%.  In February 2004we purchased 1,271,450 shares of our Ordinary common stock directly from ourthen largest institutional shareholder. In exchange, we issued $29.0 million in principal amount of our 8.75%Senior Notes due 2011 under the existing indenture.  We issued these bonds at a premium of106.3%.  This transaction increased ourtreasury stock by $31.6 million.  

 

30

----

 

At December 31,2005, our total outstanding indebtedness amounted to $203.4 million, consistingof $166.2 million of 8.75% Senior Notes, $15.4 million on the real estate termloan, $16.6 million on the acquisition term loan, and $5.2 million of notespayable to foreign banks. Cash interest paid was $19.4 million in 2005, $17.5million in 2004, and $14.6 million in 2003. All of our debt agreements containcovenants that place certain restrictions on us, including our ability to incuradditional indebtedness, to make investments in other entities and to pay cashdividends. We were in compliance with all such covenants as of December 31,2005 and do not anticipate any compliance issues in 2006.

 

Ourbond indenture contains limitations, based on net income (among other things),on the amount of discretionary repurchases we may make of our Ordinary commonstock. Our intent and ability to repurchase additional Ordinary common stockeither directly from shareholders or on the open market is directly affected bythis limitation.

 

Wehave reserved 721,750 shares of our existing treasury stock to be utilized forthe exercise of outstanding stock options under our Amended and Restated 1996Stock Plan. These options have no impact on our cash flow or the number ofshares outstanding unless and until the options are exercised.

 

Weexperience long production and inventory turnover cycles, which we constantlymonitor since fluctuations in demand can have a significant impact on thesecycles. We were able to effectively utilize cash flow from operations to fundour debt and capital requirements and paid off our seasonal borrowings on ourdomestic line of credit. Looking forward to 2006, we anticipate that both ourpiano and band divisions will perform consistently throughout the period. Ourintention is to keep our balance sheet strong by managing accounts receivable,working to reduce inventory levels, and repaying debt.

 

Otherthan the restructuring of our long-term debt as described below, we do not haveany current plans or intentions that will have a material impact on ourliquidity in 2006, although we may consider acquisitions that may requirefunding from operations or from our credit facilities. Other than thosedescribed, we are not aware of any trends, demands, commitments, or costs ofresources that are expected to materially impact our liquidity or capitalresources. Accordingly, we believe that cash on hand, together with cash flowsanticipated from operations and available borrowings under the Credit Facility,will be adequate to meet our debt service requirements, fund continuing capitalrequirements and satisfy our working capital and general corporate needsthrough 2006.

 

**RecentEvents**

 

On February 2,2006, we repaid our acquisition term loan, which had an outstanding balance of$16.6 million as of December 31, 2005. As a result of the write-off ofassociated deferred financing costs, we recorded a loss of $1.0 million onextinguishment of this debt in the first quarter of 2006.

 

On February 23,2006 we completed a $175.0 million offering of 7% Senior Notes at 99.2435% offace value, which resulted in net proceeds to us of $170.2 million. We used$123.6 million of the proceeds to redeem $114.6 million of our 8.75% SeniorNotes (including accrued interest and associated premiums) pursuant to ourtender offer to repurchase these notes. The early retirement of these noteswill generate a net loss on extinguishment of $5.4 million in the firstquarter. This net loss is comprised primarily of $5.5 million of tender and consentpremiums paid to bondholders, as the $1.2 million of loss on write-off ofdeferred financing costs is essentially offset by the $1.3 million of gainrecorded due to our write-off of the bond premium associated with the pre-existing8.75% Senior Notes.

 

31

----

 

Weshall use the remainder of the proceeds from issuance of the 7% Senior Notes,supplemented by cash on hand, to pay outstanding debt issuance costs, such aslegal fees, and to redeem the remaining $51.6 million of 8.75% Senior Notes,which we have called at 104.375% plus accrued interest. The early retirement ofthese remaining notes, which will occur in April 2006, will generate aloss on extinguishment of $3.3 million. This loss is comprised of $2.3 millionof call premiums paid to bondholders and $1.0 million due to the write-off ofthe remaining deferred financing costs associated with the 8.75% Senior Notes.

 

Wewill record interest on both the 8.75% Senior Notes and the 7% Senior Notes forthe February – April timeframe during which both series of notes areoutstanding. This duplicate interest expense will be offset in part by interestincome on the unused debt issuance proceeds and is not expected to be materialto the financial statements. Once the duplicate interest period has passed, weexpect interest payment savings of approximately $2.3 million per year.

 

**ContractualObligations -**The following table provides a summary of ourcontractual obligations at December 31, 2005.

 
| ** **                       | ** ** | **Payments due by period** | ** ** |
|----------------------------------|------------|----------------------------|------------|
| **Contractual  Obligations**     | ** ** | **Total**                  | ** ** | **Less than  1 year** | ** ** | **1 - 3 years** | ** ** | **3 - 5 years** | ** ** | **More than  5 years** | ** ** |
|                             |       |                       |       |   |   |   |   |   |   |   |   |
| Long-term debt  (1)              |       | $                          | 289,846    |   | $ | 30,471 |   | $ | 57,288 |   | $ | 31,325 |   | $ | 170,762 |   |
| Capital leases                   |       | 66                         |       | 13 |   | 30 |   | 23 |   | — |   |
| Operating leases  (2)            |       | 268,735                    |       | 4,698 |   | 8,029 |   | 7,826 |   | 248,182 |   |
| Purchase  obligations (3)        |       | 13,367                     |       | 13,188 |   | 159 |   | 20 |   | — |   |
| Other long-term  liabilities (4) |       | 28,226                     |       | 3,932 |   | 3,716 |   | 3,369 |   | 17,209 |   |
| Total                            |       | $                          | 600,240    |   | $ | 52,302 |   | $ | 69,222 |   | $ | 42,563 |   | $ | 436,153 |   |

 

**Notesto Contractual Obligations:**

 

----

(1) Long-term debt represents long-term debtobligations, the fixed interest on our Notes, and the variable interest on ourother loans. We estimated the future variable interest obligation using theapplicable December 31, 2005 rates. The nature of our long-term debtobligations is described more fully in the “Borrowing Availability andActivities” section of “Liquidity and Capital Resources.”  Changes to our long-term debt structure whichoccurred subsequent to December 31, 2005 are described in the “Recent Events”section of “Liquidity and Capital Resources.”

 

(2) Approximately $255.4 million of our operatinglease 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) Purchase obligations consist of firm purchasecommitments for raw materials, finished goods, and equipment.

 

(4) Our other long-term liabilities consistprimarily of the long-term portion of our pension obligations, which aredescribed in Note 14 in the Notes to Consolidated Financial Statements includedwithin this filing, and obligations under employee and consultant agreements,which are described in Note 13 in the Notes to the Consolidated FinancialStatements included within this filing.

 

32

----

 

**CriticalAccounting Estimates**

 

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

 

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

 

Thesignificant accounting policies are described in Note 2 of the Notes toConsolidated Financial Statements included in the Company’s 2005 Annual Reporton Form 10-K. Not all of these significant accounting policies requiremanagement to make difficult, subjective or complex judgments or estimates.However, management considers the following estimates to be critical based onthe definition above.

 

**AccountsReceivable**

 

Weestablish reserves for accounts receivable and notes receivable (includingrecourse reserves when our customers have financed notes receivable with athird party). We review overall collectibility trends and customercharacteristics such as debt leverage, solvency, and outstanding balances inorder to develop our reserve estimates.

 

**Inventory**

 

Weestablish inventory reserves for items such as lower-of-cost-or-market andobsolescence. We review inventory levels on a detailed basis, concentrating onthe age and amounts of raw materials, work-in-process, and finished goods, aswell as recent usage and sales dates and quantities to help develop ourestimates. We also establish reserves for anticipated book-to-physicaladjustments based upon our historical level of adjustments from our annualphysical inventories. We cost our inventory using standard costs. Accordingly,variances between actual and standard that are not abnormal in nature arecapitalized into inventory and released based on calculated inventory turns.

 

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

 

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

 

**Warranty**

 

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

 

33

----

 

**Long-livedAssets**

 

Wereview long-lived assets, such as property, plant, and equipment, forimpairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable. We measure recoverabilityby comparing the carrying amount of the asset to the estimated future cashflows the asset is expected to generate.

 

Wetest our goodwill and indefinite-lived trademark assets for impairment annuallyor on an interim basis if events or circumstances indicate that the fair valueof an asset may have decreased below its carrying value. Our assessment isbased on several analyses, including multi-year cash flows and comparison of estimatedfair values to our market capitalization.

 

**Pensionsand Other Post Retirement Benefit Costs**

 

Wemake certain assumptions when calculating our benefit obligations and expenses.We base our selection of assumptions, such as discount rates and long-termrates of return, on information provided by our actuaries and investmentcommittee, current rate trends, and historical trends for our pension assetportfolio. Our benefit obligations and expenses can fluctuate significantlybased on the assumptions management selects.

 

**DeferredIncome Taxes**

 

Avaluation allowance has been recorded for certain deferred tax assets relatedto foreign tax credit carryforwards and state net operating loss carryforwards.When assessing the realizability of deferred tax assets, we consider whether itis more likely than not that the deferred tax assets will not be fully realized.The ultimate realization of these assets is dependent upon many factors,including the ratio of foreign source income to overall income and generationof sufficient future taxable income in the states for which we have losscarryforwards. When establishing or adjusting valuation allowances, we considerthese factors, as well as anticipated trends in foreign source income and taxplanning strategies which may impact future realizability of these assets.

 

**EnvironmentalLiabilities**

 

We makecertain assumptions when calculating our environmental liabilities.  We base our assumptions, such as cost andlength of time for remediation, on data provided by our environmentalconsultants, as well as information provided by regulatory authorities. We alsomake certain assumptions regarding the indemnifications we have received fromothers, including whether costs are within the scope of the indemnification,the indemnifier’s ability to perform under the agreement, and whether pastclaims have been successful.  Ourenvironmental obligations and expenses can fluctuate significantly based on management’sassumptions.

 

34

----

 

Webelieve the assumptions made by management provide a reasonable basis for theestimates reflected in our financial statements.

 

**RecentAccounting Pronouncements**

 

In December 2004,the Financial Accounting Standards Board (“FASB”) revised Statement ofFinancial Accounting Standards (“SFAS”) No. 123 and issued SFAS No. 123R,“Share-Based Payment” (SFAS No. 123R). This accounting standard, which iseffective beginning January 1, 2006, requires the recognition of compensationcost related to stock options using the fair value method. We will adopt SFAS No. 123Reffective January 1, 2006 using the modified prospective applicationmethod. Based on current outstanding awards, expected participation in thePurchase Plan consistent with past patterns, and no significant changes in thenumber of shares of outstanding stock, we anticipate an impact on basicearnings per share of approximately $0.10 - $0.12 from additional stockcompensation expense in 2006. The actual amount will be impacted by changes inthe aforementioned factors, as well as finalization of our estimated forfeiturerates and other assumptions.

 

In November 2004,the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43,Chapter 4” (SFAS No. 151). This accounting standard, which is effective for annualperiods beginning after June 15, 2005, requires that abnormal amounts ofidle facility expense, freight, handling costs, and wasted materials (spoilage)should be recognized as current period charges. The adoption of SFAS No. 151is not expected to have a material effect on our financial position or resultsof operations.

 

In June 2005,the FASB ratified Emerging Issues Task Force (“EITF”) Issue 05-05, “Accountingfor Early Retirement Programs With Specific Features (Such as Terms specifiedin Altersteilzeit Early Retirement Arrangements),” which addresses theaccounting for the transitional early retirement program in Germany. Salarycomponents of this plan should be recognized over the period from which theprogram begins until the end of the active service period. Additionally, aportion of the salary that is deferred under certain arrangements should bediscounted if payment is expected to be deferred for a period longer than oneyear. This treatment is effective for fiscal years beginning after December 15,2005. The application of EITF 05-05 is not expected to have a material impacton our financial position or results of operations.

 

35

----

 

**Item7A. Quantitative and Qualitative Disclosures About Market Risk**

 

**ForeignCurrency Risk**

 

We aresubject to market risk associated with changes in foreign currency exchangerates and interest rates. We mitigate some of our cash flow exposure to foreigncurrency fluctuations by holding forward foreign currency contracts. Thesecontracts are not designated as hedges for accounting purposes. The contractsrelate primarily to intercompany transactions and are not used for trading orspeculative purposes. The fair value of the forward foreign currency exchangecontracts is sensitive to changes in foreign currency exchange rates. As of December 31,2005, a 10% negative change in foreign currency exchange rates from marketrates would decrease the fair value of the contracts by less than $0.1 million.Gains and losses on the foreign currency exchange contracts are defined as thedifference between the contract rate at its inception date and the currentforward rate. However, we would offset any such gains and losses by correspondinglosses and gains, respectively, on the related asset or liability.

 

**InterestRisk**

 

Ourinterest rate exposure is limited primarily to interest rate changes on ourvariable rate debt. The Credit Facility and term loans bear interest at ratesthat fluctuate with changes in LIBOR or similar indices. For the year ended December 31,2005, a hypothetical 10% increase in interest rates would have increased ourinterest expense by approximately $0.2 million.

 

Ourlong-term debt includes $166.4 million of Senior Notes with a fixed interestrate. 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 interestrates, the fair value of our Senior Notes, which would be sensitive to suchinterest rate changes, would be increased by approximately $0.2 million as of December 31,2005.

 

**Item8. Financial Statements And Supplementary Data**

 

REPORT OF INDEPENDENTREGISTERED PUBLIC ACCOUNTING FIRM

 
| CONSOLIDATED  FINANCIAL STATEMENTS:                                                                               |
|-------------------------------------------------------------------------------------------------------------------|
| Consolidated Statements of  Income for the Years Ended December 31, 2005, 2004, and 2003                     |
| Consolidated Balance Sheets as of December 31,  2005 and 2004                                                |
| Consolidated Statements of  Cash Flows for the Years Ended December 31, 2005, 2004, and 2003                 |
| Consolidated Statements of  Stockholders’ Equity for the Years Ended December 31, 2005, 2004, and  2003 |
| Notes  to Consolidated Financial Statements                                                                       |

 

36

----

 

**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

To the Board of Directorsand Stockholders of

Steinway MusicalInstruments, Inc.

Waltham, Massachusetts

 

We have audited theaccompanying consolidated balance sheets of Steinway Musical Instruments, Inc.and subsidiaries as of December 31, 2005 and 2004, and the relatedconsolidated statements of income, stockholders’ equity, and cash flows foreach of the three years in the period ended December 31, 2005. Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on the financial statements based onour audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of Steinway Musical Instruments, Inc. and subsidiariesas of December 31, 2005 and 2004, and the results of their operations andtheir cash flows for each of the three years in the period ended December 31,2005, in conformity with accounting principles generally accepted in the UnitedStates of America. 

 

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2005, based on the criteria establishedin *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commissionand our report dated March 30, 2006 expressed an unqualified opinion onmanagement’s assessment of the effectiveness of the Company’s internal controlover financial reporting and an unqualified opinion on the effectiveness of theCompany’s internal control over financial reporting.

 
| /s/ DELOITTE &  TOUCHE LLP |   |
|-------------------------------------|--------|
|                                |
| Boston,  Massachusetts              |
| March 30,  2006                |

 

37

----

 

Steinway MusicalInstruments, Inc. and Subsidiaries

**CONSOLIDATEDSTATEMENTS OF INCOME**(In Thousands Except Share and Per ShareData)

 
| **For the years ended December 31,** | ** ** | **2005**  | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|-------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
|                                      |       |      |       |      |       |      |       |
| Net sales                                 |       | $         | 387,143    |      | $          | 375,034   |       | $ | 337,220 |   |
| Cost of sales                             |       | 275,609   |       | 265,901   |       | 244,667   |       |
|                                      |       |      |       |      |       |      |       |
| Gross profit                              |       | 111,534   |       | 109,133   |       | 92,553    |       |
|                                      |       |      |       |      |       |      |       |
| Operating  expenses:                      |       |      |       |      |       |      |       |
| Sales and marketing                       |       | 45,899    |       | 44,332    |       | 41,719    |       |
| General and administrative                |       | 29,200    |       | 29,263    |       | 23,134    |       |
| Amortization                              |       | 1,116     |       | 1,094     |       | 1,154     |       |
| Other operating expenses                  |       | 482       |       | 566       |       | 764       |       |
| Facility rationalization                  |       | —    |       | (363      | )          | 2,958     |       |
| Total operating  expenses                 |       | 76,697    |       | 74,892    |       | 69,729    |       |
|                                      |       |      |       |      |       |      |       |
| Income from  operations                   |       | 34,837    |       | 34,241    |       | 22,824    |       |
|                                      |       |      |       |      |       |      |       |
| Other income, net                         |       | (800      | )          | (3,163    | )          | (3,517    | )          |
| Interest income                           |       | (3,335    | )          | (2,829    | )          | (2,175    | )          |
| Interest expense                          |       | 16,980    |       | 16,266    |       | 14,120    |       |
|                                      |       |      |       |      |       |      |       |
| Income before  income taxes               |       | 21,992    |       | 23,967    |       | 14,396    |       |
|                                      |       |      |       |      |       |      |       |
| Income tax  provision                     |       | 8,200     |       | 8,100     |       | 4,698     |       |
|                                      |       |      |       |      |       |      |       |
| Net income                                |       | $         | 13,792     |      | $          | 15,867    |       | $ | 9,698 |   |
|                                      |       |      |       |      |       |      |       |
| Earnings per  share - basic               |       | $         | 1.71       |      | $          | 1.97      |       | $ | 1.09 |   |
|                                      |       |      |       |      |       |      |       |
| Earnings per  share - diluted             |       | $         | 1.67       |      | $          | 1.91      |       | $ | 1.09 |   |
|                                      |       |      |       |      |       |      |       |
| Weighted average  shares:                 |       |      |       |      |       |      |       |
| Basic                                     |       | 8,069,721 |       | 8,046,256 |       | 8,924,578 |       |
| Diluted                                   |       | 8,265,234 |       | 8,304,066 |       | 8,925,672 |       |

 

See notes to consolidatedfinancial statements.

 

38

----

 

Steinway MusicalInstruments, Inc. and Subsidiaries

**CONSOLIDATEDBALANCE SHEETS**(In Thousands Except Share and Per Share Data)

 
| **December 31,**                                                                                                                                                                                                        | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                                                                                                                                         |       |     |       |     |       |
| Assets                                                                                                                                                                                                                       |       |     |       |     |       |
| Current assets:                                                                                                                                                                                                              |       |     |       |     |       |
| Cash                                                                                                                                                                                                                         |       | $        | 34,952     |     | $          | 27,372 |   |
| Accounts, notes and other receivables, net                                                                                                                                                                                   |       | 81,880   |       | 88,059   |       |
| Inventories                                                                                                                                                                                                                  |       | 159,310  |       | 172,346  |       |
| Prepaid expenses and other current assets                                                                                                                                                                                    |       | 11,653   |       | 5,937    |       |
| Deferred tax assets                                                                                                                                                                                                          |       | 7,936    |       | 15,047   |       |
| Total current  assets                                                                                                                                                                                                        |       | 295,731  |       | 308,761  |       |
|                                                                                                                                                                                                                         |       |     |       |     |       |
| Property, plant  and equipment, net                                                                                                                                                                                          |       | 96,664   |       | 102,944  |       |
| Trademarks                                                                                                                                                                                                                   |       | 13,233   |       | 12,325   |       |
| Goodwill                                                                                                                                                                                                                     |       | 30,088   |       | 31,854   |       |
| Other  intangibles, net                                                                                                                                                                                                      |       | 4,128    |       | 5,290    |       |
| Other assets                                                                                                                                                                                                                 |       | 15,811   |       | 16,371   |       |
|                                                                                                                                                                                                                         |       |     |       |     |       |
| Total assets                                                                                                                                                                                                                 |       | $        | 455,655    |     | $          | 477,545 |   |
|                                                                                                                                                                                                                         |       |     |       |     |       |
| Liabilities and  stockholders’ equity                                                                                                                                                                                   |       |     |       |     |       |
| Current  liabilities:                                                                                                                                                                                                        |       |     |       |     |       |
| Current portion of long-term debt                                                                                                                                                                                            |       | $        | 12,977     |     | $          | 14,212 |   |
| Accounts payable                                                                                                                                                                                                             |       | 13,805   |       | 14,789   |       |
| Other current liabilities                                                                                                                                                                                                    |       | 45,099   |       | 43,892   |       |
| Total current  liabilities                                                                                                                                                                                                   |       | 71,881   |       | 72,893   |       |
|                                                                                                                                                                                                                         |       |     |       |     |       |
| Long-term debt                                                                                                                                                                                                               |       | 191,715  |       | 208,580  |       |
| Deferred tax  liabilities                                                                                                                                                                                                    |       | 15,326   |       | 26,240   |       |
| Other non-current  liabilities                                                                                                                                                                                               |       | 27,903   |       | 24,279   |       |
| Total  liabilities                                                                                                                                                                                                           |       | 306,825  |       | 331,992  |       |
|                                                                                                                                                                                                                         |       |     |       |     |       |
| Commitments and  contingent liabilities                                                                                                                                                                                      |       |     |       |     |       |
|                                                                                                                                                                                                                         |       |     |       |     |       |
| Stockholders’  equity:                                                                                                                                                                                                  |       |     |       |     |       |
| Class A common stock, $.001 par value,  5,000,000 shares authorized, 477,952 shares issued and outstanding                                                                                                              |       | —   |       | —   |       |
| Ordinary common stock, $.001 par value, 90,000,000  shares authorized, 9,680,508 and 9,595,745 shares issued in 2005 and 2004,  respectively, and 7,635,058 and 7,550,295 shares outstanding in 2005 and  2004, respectively |       | 10       |       | 10       |       |
| Additional paid-in capital                                                                                                                                                                                                   |       | 83,062   |       | 81,129   |       |
| Retained earnings                                                                                                                                                                                                            |       | 126,379  |       | 112,587  |       |
| Accumulated other comprehensive loss                                                                                                                                                                                         |       | (13,185  | )          | (737     | )          |
| Treasury stock, at cost (2,045,450 shares of Ordinary  common stock in 2005 and 2004)                                                                                                                                        |       | (47,436  | )          | (47,436  | )          |
| Total stockholders’ equity                                                                                                                                                                                              |       | 148,830  |       | 145,553  |       |
|                                                                                                                                                                                                                         |       |     |       |     |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                             |       | $        | 455,655    |     | $          | 477,545 |   |

 

See notes to consolidatedfinancial statements.

 

39

----

 

Steinway Musical Instruments, Inc.and Subsidiaries

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**(In Thousands)

 
| **For the years ended December 31,**                                     | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                          |       |     |       |     |       |     |       |
| Cash flows from  operating activities:                                        |       |     |       |     |       |     |       |
| Net income                                                                    |       | $        | 13,792     |     | $          | 15,867   |       | $ | 9,698 |   |
| Adjustments to reconcile net income to cash flows  from operating activities: |       |     |       |     |       |     |       |
| Depreciation and amortization                                                 |       | 11,267   |       | 11,183   |       | 10,959   |       |
| Amortization of bond premium                                                  |       | (252     | )          | (230     | )          | —   |       |
| Loss on extinguishment of debt                                                |       | 538      |       | —   |       | —   |       |
| Facility rationalization                                                      |       | —   |       | (363     | )          | 4,158    |       |
| Deferred tax benefit                                                          |       | (682     | )          | (2,497   | )          | (2,601   | )          |
| Tax benefit associated with stock option exercises                            |       | 170      |       | 759      |       | —   |       |
| Other                                                                         |       | 272      |       | 459      |       | 329      |       |
| Changes in operating assets and liabilities:                                  |       |     |       |     |       |     |       |
| Accounts, notes and other receivables                                         |       | 4,955    |       | (293     | )          | 2,783    |       |
| Inventories                                                                   |       | 5,488    |       | 2,003    |       | 7,373    |       |
| Prepaid expenses and other assets                                             |       | 1,189    |       | (5,488   | )          | (857     | )          |
| Accounts payable                                                              |       | (503     | )          | 1,419    |       | 1,086    |       |
| Other liabilities                                                             |       | (4,805   | )          | 1,054    |       | (2,035   | )          |
| Cash flows from  operating activities                                         |       | 31,429   |       | 23,873   |       | 30,893   |       |
|                                                                          |       |     |       |     |       |     |       |
| Cash flows from  investing activities:                                        |       |     |       |     |       |     |       |
| Capital expenditures                                                          |       | (5,004   | )          | (5,186   | )          | (5,462   | )          |
| Proceeds from sales of property, plant and equipment                          |       | 1,415    |       | 1,233    |       | 10       |       |
| Acquisition of business, net of cash acquired                                 |       | (2,167   | )          | (36,767  | )          | —   |       |
| Cash flows from  investing activities                                         |       | (5,756   | )          | (40,720  | )          | (5,452   | )          |
|                                                                          |       |     |       |     |       |     |       |
| Cash flows from  financing activities:                                        |       |     |       |     |       |     |       |
| Borrowings under lines of credit                                              |       | 188,844  |       | 159,787  |       | 10,606   |       |
| Repayments under lines of credit                                              |       | (190,297 | )          | (156,852 | )          | (8,316   | )          |
| Debt issuance costs                                                           |       | —   |       | (105     | )          | —   |       |
| Premium paid on extinguishment of debt                                        |       | (407     | )          | —   |       | —   |       |
| Repayments of long-term debt                                                  |       | (15,763  | )          | (7,555   | )          | (6,512   | )          |
| Proceeds from issuance of stock                                               |       | 1,763    |       | 5,744    |       | 1,455    |       |
| Cash flows from  financing activities                                         |       | (15,860  | )          | 1,019    |       | (2,767   | )          |
|                                                                          |       |     |       |     |       |     |       |
| Effects of  foreign exchange rate changes on cash                             |       | (2,233   | )          | 917      |       | 510      |       |
|                                                                          |       |     |       |     |       |     |       |
| Increase  (decrease) in cash                                                  |       | 7,580    |       | (14,911  | )          | 23,184   |       |
| Cash, beginning  of year                                                      |       | 27,372   |       | 42,283   |       | 19,099   |       |
|                                                                          |       |     |       |     |       |     |       |
| Cash, end of  year                                                            |       | $        | 34,952     |     | $          | 27,372   |       | $ | 42,283 |   |
|                                                                          |       |     |       |     |       |     |       |
| Supplemental  cash flow information:                                          |       |     |       |     |       |     |       |
| Interest paid                                                                 |       | $        | 19,437     |     | $          | 17,470   |       | $ | 14,624 |   |
| Income taxes paid                                                             |       | $        | 11,160     |     | $          | 9,623    |       | $ | 7,131 |   |
|                                                                          |       |     |       |     |       |     |       |
| Non-cash  transaction:                                                        |       |     |       |     |       |     |       |
| Purchase of  Ordinary common stock by issuance of bonds                       |       | $        | —     |     | $          | 31,583   |       | $ | — |   |

 

See notes to consolidatedfinancial statements.

 

40

----

 

Steinway MusicalInstruments, Inc. and Subsidiaries

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**(In Thousands Except ShareData)

 
| ** **                                              | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Treasury  Stock** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|---------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|------------------------------------------------------|------------|---------------------|------------|---------------------------------------|------------|
|                                                    |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Balance, January 1,  2003                          |       | $                 | 9          |                             | $          | 73,172                 |       | $                                                    | 87,022     |                | $          | (13,142                               | )          | $ | (15,853 | ) | $ | 131,208 |   |
|                                                    |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Comprehensive  income:                                  |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Net income                                              |       |              |       |                             |       | 9,698                  |       |                                                 |       |                |       | 9,698                                 |       |
| Foreign currency translation adjustment                 |       |              |       |                             |       |                   |       | 7,334                                                |       |                |       | 7,334                                 |       |
| Additional minimum pension liability, net               |       |              |       |                             |       |                   |       | 2,820                                                |       |                |       | 2,820                                 |       |
| Holding gain on marketable securities, net              |       |              |       |                             |       |                   |       | 120                                                  |       |                |       | 120                                   |       |
| Total  comprehensive income                             |       |              |       |                             |       |                   |       |                                                 |       |                |       | 19,972                                |       |
|                                                    |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Exercise of 57,900 options for shares of common  stock  |       |              |       | 953                              |       |                   |       |                                                 |       |                |       | 953                                   |       |
| Issuance of 35,209 shares of common stock               |       | 1                 |       | 501                              |       |                   |       |                                                 |       |                |       | 502                                   |       |
|                                                    |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Balance, December 31,  2003                        |       | 10                |       | 74,626                           |       | 96,720                 |       | (2,868                                               | )          | (15,853             | )          | 152,635                               |       |
| Comprehensive  income:                                  |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Net income                                              |       |              |       |                             |       | 15,867                 |       |                                                 |       |                |       | 15,867                                |       |
| Foreign currency translation adjustment                 |       |              |       |                             |       |                   |       | 4,520                                                |       |                |       | 4,520                                 |       |
| Additional minimum pension liability, net               |       |              |       |                             |       |                   |       | (2,439                                               | )          |                |       | (2,439                                | )          |
| Holding gain on marketable securities, net              |       |              |       |                             |       |                   |       | 50                                                   |       |                |       | 50                                    |       |
| Total  comprehensive income                             |       |              |       |                             |       |                   |       |                                                 |       |                |       | 17,998                                |       |
|                                                    |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Exercise of 267,327 options for shares of common  stock |       |              |       | 5,274                            |       |                   |       |                                                 |       |                |       | 5,274                                 |       |
| Tax benefit of options exercised                        |       |              |       | 759                              |       |                   |       |                                                 |       |                |       | 759                                   |       |
| Issuance of 33,018 shares of common stock               |       | —            |       | 470                              |       |                   |       |                                                 |       |                |       | 470                                   |       |
| Purchase of 1,271,450 shares of common stock            |       |              |       |                             |       |                   |       |                                                 |       | (31,583             | )          | (31,583                               | )          |
|                                                    |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Balance, December 31, 2004                         |       | 10                |       | 81,129                           |       | 112,587                |       | (737                                                 | )          | (47,436             | )          | 145,553                               |       |
| Comprehensive income:                                   |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Net income                                              |       |              |       |                             |       | 13,792                 |       |                                                 |       |                |       | 13,792                                |       |
| Foreign currency translation adjustment                 |       |              |       |                             |       |                   |       | (8,377                                               | )          |                |       | (8,377                                | )          |
| Additional minimum pension liability, net               |       |              |       |                             |       |                   |       | (4,105                                               | )          |                |       | (4,105                                | )          |
| Holding gain on marketable securities, net              |       |              |       |                             |       |                   |       | 34                                                   |       |                |       | 34                                    |       |
| Total comprehensive income                              |       |              |       |                             |       |                   |       |                                                 |       |                |       | 1,344                                 |       |
|                                                    |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Exercise of 64,100 options for shares of common  stock  |       |              |       | 1,244                            |       |                   |       |                                                 |       |                |       | 1,244                                 |       |
| Tax benefit of options exercised                        |       |              |       | 170                              |       |                   |       |                                                 |       |                |       | 170                                   |       |
| Issuance of 20,663 shares of common stock               |       | —            |       | 519                              |       |                   |       |                                                 |       |                |       | 519                                   |       |
|                                                    |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Balance, December 31, 2005                         |       | $                 | 10         |                             | $          | 83,062                 |       | $                                                    | 126,379    |                | $          | (13,185                               | )          | $ | (47,436 | ) | $ | 148,830 |   |

 

See notes to consolidatedfinancial statements.

 

41

----

 

Steinway MusicalInstruments, Inc. and Subsidiaries

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

Years Ended December 31,2005, 2004, AND 2003

(Tabular Amounts inThousands Except Share and Per Share Data)

 

**1.****              Nature of Business**

 

SteinwayMusical Instruments, Inc. and subsidiaries (the “Company”) is one of theworld’s leading manufacturers of musical instruments. The Company, through itswholly-owned subsidiaries, The Steinway Piano Company, Inc. (“Steinway”)and Conn-Selmer, Inc. (“Conn-Selmer”), manufactures and distributes productswithin the musical instrument industry. Steinway produces the highest qualitypiano in the world and has one of the most widely recognized and prestigiousbrand names. Conn-Selmer is the leading domestic manufacturer of band &orchestral instruments and related accessories, including complete lines ofbrass, woodwind, percussion and string instruments. Selmer Paris saxophones,Bach Stradivarius trumpets, C.G. Conn French horns, Leblanc clarinets, Kingtrombones and Ludwig snare drums are considered by many to be the finest suchinstruments in the world.

 

Throughoutthese financial statements “we”, “us”, and “our” refer to Steinway MusicalInstruments, Inc. and subsidiaries taken as a whole.

 

**2.****              SignificantAccounting Policies**

 

**Principlesof Consolidation** - Our consolidated financial statementsinclude the accounts of all direct and indirect subsidiaries, all of which arewholly-owned. All intercompany balances have been eliminated in consolidation.

 

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

 

**RevenueRecognition** – Generally, revenue for wholesale transactions isrecognized upon shipment following receipt of a valid dealer order. Retailrevenue is generally recognized upon delivery to the customer in accordancewith the customer’s purchase agreement, and restoration revenue is recognizedbased on the completed contract method. We provide for the estimated costs ofwarranties, discounts and returns at the time of revenue recognition.

 

**Inventories**- Inventories are stated at the lower of cost, determined on a first-in,first-out basis, or market.

 

42

----

 

**Depreciationand Amortization** - Property, plant and equipment are recordedat cost. Depreciation is provided using the straight-line method over theestimated useful lives of the assets. Leasehold improvements are amortizedusing 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 as follows:

 
| 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           |   |

 

Whenimpairment indicators are present, 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. Should theassessment indicate an impairment, the affected assets are written down to fairvalue. Assets held-for-sale are recorded at the lower of cost or net realizablevalue.

 

**Goodwill,Trademarks, and Other Intangible Assets** - Intangible assetsother than goodwill and indefinite-lived trademarks are amortized on astraight-line basis over their estimated useful lives. Deferred financing costsare amortized over the repayment periods of the underlying debt. We test ourgoodwill and indefinite-lived trademark assets for impairment annually or on aninterim basis if events or circumstances indicate that the fair value of anasset may have decreased below its carrying value. Should an impairment bepresent, the affected asset would be adjusted to its fair value. Our annualimpairment assessment is in July. We have not recognized any impairments forthe years ended December 31, 2005, 2004, and 2003.

 

**Advertising**- Advertising costs are expensed as incurred. Advertising expense was $7.6million for the year ended December 31, 2005, $7.5 million for the yearended December 31, 2004, and $7.7 million for the year ended December 31,2003.

 

**Accounts,notes and other receivables, net –** Accounts, notes and otherreceivables are recorded net of allowances for bad debts, discounts andreturns.

 
| **December 31,**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|
|                                |       |     |       |     |       |
| Accounts receivable                 |       | $        | 70,090     |     | $          | 80,484 |   |
| Notes and other receivables         |       | 24,113   |       | 20,846   |       |
|                                |       | 94,203   |       | 101,330  |       |
| Allowance for doubtful accounts     |       | (9,207   | )          | (11,811  | )          |
| Allowance for discounts and returns |       | (3,116   | )          | (1,460   | )          |
|                                |       | $        | 81,880     |     | $          | 88,059 |   |

 

43

----

 

A summary of the activity in the allowance for doubtful accounts is asfollows:

 
| **For the years ended December  31,**    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                     |       |     |       |     |       |     |       |
| Beginning balance                        |       | $        | 11,811     |     | $          | 9,944    |       | $ | 11,389 |   |
| Additions charged to costs and expenses  |       | 836      |       | 848      |       | 218      |       |
| Acquisitions                             |       | —   |       | 1,555    |       | —   |       |
| Foreign currency translation adjustments |       | (109     | )          | 39       |       | 65       |       |
| Deductions and reclassifications         |       | (3,331   | )          | (575     | )          | (1,728   | )          |
| Ending balance                           |       | $        | 9,207      |     | $          | 11,811   |       | $ | 9,944 |   |

 

**IncomeTaxes** - We provide for income taxes using an asset andliability approach. We compute deferred income tax assets and liabilitiesannually for differences between the financial statement and tax bases ofassets and liabilities that will result in taxable or deductible amounts in thefuture based on enacted tax laws and rates applicable to the periods in whichthe differences are expected to affect taxable income. When necessary, weestablish valuation allowances to reduce deferred tax assets to the amount thatmore likely than not will be realized.

 

**ForeignCurrency Translation and Remeasurement** - We translate assetsand liabilities of non-U.S. operations into U.S. dollars at year end rates, andrevenues and expenses at average rates of exchange prevailing during the year.We report the resulting translation adjustments as a separate component ofaccumulated other comprehensive loss. We recognize foreign currency transactiongains and losses in the consolidated statements of income as incurred.

 

**ForeignCurrency Exchange Contracts** - We enter into foreign currencyexchange contracts to mitigate the risks from foreign currency fluctuations oncertain intercompany transactions. These contracts are not designated ashedging instruments for accounting purposes, and are not used for trading orspeculative purposes. Gains and losses arising from fluctuations in exchangerates are recognized at the end of each reporting period. Such gains and lossesoffset the foreign currency exchange gains or losses associated with thecorresponding receivable, payable, or forecasted transaction. We have creditrisk to the extent the counterparties are unable to fulfill their obligationson the foreign currency exchange contracts. However, we enter into thesecontracts with reputable financial institutions and we believe we have nosignificant credit risk.

 

**Stock-basedCompensation** - We have an employee stock purchase plan (“PurchasePlan”) and a stock award plan (“Stock Plan”), which are described more fully inNote 12. As currently permitted under accounting principles generally acceptedin the United States of America, we have elected to continue to follow theintrinsic value method in accounting for our stock-based employee compensationarrangement.

 

Underthe intrinsic value method, compensation associated with stock awards toemployees is determined as the difference, if any, between the fair value ofthe underlying common stock on the date compensation is measured and the pricean employee must pay to exercise the award. Under the fair value method, theimpact of which is disclosed below, compensation associated with stock awardsto employees is determined based on the estimated fair value of the awarditself, measured using either current market data or an establishedoption-pricing model. The measurement date for employee awards for both theintrinsic and fair value methods is generally the date of grant. Under theintrinsic value method, we did not recognize any stock-based compensationexpense during 2005, 2004 and 2003. (See Recent Accounting Pronouncementsbelow.)

 

44

----

 

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.

 
| **For the years ended December 31,**                                                                                             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                                                                                  |       |     |       |     |       |     |       |
| Net income, as reported                                                                                                               |       | $        | 13,792     |     | $          | 15,867   |       | $ | 9,698 |   |
| Less: Total stock-based employee compensation  expense determined under fair-value method for all awards, net of related tax  effects |       | (933     | )          | (1,040   | )          | (836     | )          |
| Pro forma net income                                                                                                                  |       | $        | 12,859     |     | $          | 14,827   |       | $ | 8,862 |   |
| Earnings per share:                                                                                                                   |       |     |       |     |       |     |       |
| As reported - Basic                                                                                                                   |       | $        | 1.71       |     | $          | 1.97     |       | $ | 1.09 |   |
| As reported - Diluted                                                                                                                 |       | $        | 1.67       |     | $          | 1.91     |       | $ | 1.09 |   |
| Pro forma - Basic                                                                                                                     |       | $        | 1.59       |     | $          | 1.84     |       | $ | 0.99 |   |
| Pro forma - Diluted                                                                                                                   |       | $        | 1.57       |     | $          | 1.79     |       | $ | 0.99 |   |

 

Thefair value of options on their grant date, including the valuation of the optionfeature implicit in our Purchase Plan, was measured using the Black-Scholesoption-pricing model. Key weighted-average assumptions used to apply thispricing model are as follows:

 
| **For the years ended December 31,** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Interest rate                             |       | 3.79%    |       | 1.51%    |       | 3.10%    |       |
| Expected life of option grants (in years) |       | 5.6      |       | 1.0      |       | 5.3      |       |
| Expected volatility of underlying stock   |       | 25.7%    |       | 26.6%    |       | 27.0%    |       |
| Expected dividends                        |       | N/A      |       | N/A      |       | N/A      |       |

 

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

 
| **For the years ended December 31,** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Stock Plan                                |       | $        | 10.68      |     | $          | —   |       | $ | 7.49 |   |
| Purchase Plan                             |       | $        | 7.29       |     | $          | 5.16     |       | $ | 4.09 |   |

 

Itshould be noted that the Black-Scholes option-pricing model was designed tovalue readily tradable options with relatively short lives and no vestingrestrictions. In addition, option valuation models require the input of highlysubjective assumptions including the expected price volatility. Because theoptions granted are not tradable and have contractual lives of up to ten years,changes in the subjective input assumptions can materially affect the fairvalue estimate calculation.

 

**Earningsper Common Share** - Basic earnings per common share iscomputed using the weighted-average number of common shares outstanding duringeach year. Diluted earnings per common share reflects the effect of ouroutstanding options (using the treasury stock method), except when such optionswould be antidilutive.

 

45

----

 

Areconciliation of the weighted-average shares used for the basic and dilutedcomputations is as follows:

 
| **For the  years ended December 31,**              | ** ** | **2005**  | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|---------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
|                                                    |       |      |       |      |       |      |       |
| Weighted-average shares for basic earnings per share    |       | 8,069,721 |       | 8,046,256 |       | 8,924,578 |       |
| Dilutive effect of stock options                        |       | 195,513   |       | 257,810   |       | 1,094     |       |
| Weighted-average shares for diluted earnings per  share |       | 8,265,234 |       | 8,304,066 |       | 8,925,672 |       |

 

All outstanding options were included in thecomputation of diluted earnings per common share for the years ended December 31,2005 and 2004. Options to purchase 1,130,400 shares of common stock at pricesranging from $18.55 to $22.67 per share were outstanding during the year ended December 31,2003 but were not included in the computation of diluted net earnings per sharebecause the exercise prices of the options were greater than the average marketprice of the common shares.

 

**Environmental Matters** - Potential environmental liabilities arerecorded when it is probable that a loss has been incurred and its amount canreasonably be estimated. (See Note 13.)

 

**Segment Reporting** - We have two reportable segments: thepiano segment and the band & orchestral instrument segment. Weconsider these two segments reportable as they are managed separately and theoperating results of each segment are separately reviewed and evaluated by oursenior management on a regular basis. The Company’s chief operating decisionmaker is the Chief Executive Officer.

 

**ComprehensiveIncome** - Comprehensive income is comprised of net income,foreign currency translation adjustments, additional minimum pensionliabilities, and unrealized gains and losses on available-for-sale (AFS)marketable securities and is reported in the consolidated statements ofstockholders’ equity for all periods presented. The components of accumulatedother comprehensive loss are as follows:

 
| ** **                     | ** ** | **Foreign Currency   Translation   Adjustment** | ** ** | **Holding   Gain/(Loss) on  AFS   Marketable  Securities** | ** ** | **Tax Impact of  Gain/(Loss) on  AFS Marketable  Securities** | ** ** | **Additional  Minimum  Pension Liability** | ** ** | **Tax Impact of  Additional  Minimum  Pension Liability** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** |
|--------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|--------------------------------------------------------------------------|------------|---------------------------------------------|------------|
|                           |       |                                                           |       |                                                                      |       |                                                                              |       |                                            |       |                                                                     |       |                                        |       |
| Balance January 1, 2003   |       | $                                                              | (6,108     | )                                                                         | $          | (120                                                                              | )          | $                                               | 44         |                                                                     | $          | (11,596                                     | )          | $ | 4,638 |   | $ | (13,142 | ) |
| Activity                       |       | 7,334                                                          |       | 193                                                                       |       | (73                                                                               | )          | 4,743                                           |       | (1,923                                                                   | )          | 10,274                                      |       |
| Balance December 31, 2003 |       | 1,226                                                          |       | 73                                                                        |       | (29                                                                               | )          | (6,853                                          | )          | 2,715                                                                    |       | (2,868                                      | )          |
| Activity                       |       | 4,520                                                          |       | 84                                                                        |       | (34                                                                               | )          | (3,949                                          | )          | 1,510                                                                    |       | 2,131                                       |       |
| Balance December 31, 2004 |       | 5,746                                                          |       | 157                                                                       |       | (63                                                                               | )          | (10,802                                         | )          | 4,225                                                                    |       | (737                                        | )          |
| Activity                       |       | (8,377                                                         | )          | 56                                                                        |       | (22                                                                               | )          | (6,622                                          | )          | 2,517                                                                    |       | (12,448                                     | )          |
| Balance December 31, 2005 |       | $                                                              | (2,631     | )                                                                         | $          | 213                                                                               |       | $                                               | (85        | )                                                                        | $          | (17,424                                     | )          | $ | 6,742 |   | $ | (13,185 | ) |

 

**RecentAccounting Pronouncements** – In December 2004,the Financial Accounting Standards Board (“FASB”) revised Statement ofFinancial Accounting Standards (“SFAS”) No. 123 and issued SFAS No. 123R,“Share-Based Payment” (SFAS No. 123R). This accounting standard, which iseffective beginning January 1, 2006, requires the recognition ofcompensation cost related to stock options using the fair value method. We willadopt SFAS No. 123R effective January 1, 2006 using the modifiedprospective application method. Based on current outstanding awards, expectedparticipation in the Purchase Plan consistent with past patterns, and nosignificant changes in the number of shares of outstanding stock, we

 

46

----

 

anticipate an impact on basic earnings per share ofapproximately $0.10 - $0.12 from additional stock compensation expense in 2006.The actual amount will be impacted by changes in the aforementioned factors, aswell as finalization of our estimated forfeiture rates and other assumptions.

 

In November 2004, the FASB issued SFAS No. 151,“Inventory Costs, an amendment of ARB No. 43, Chapter 4”(SFAS No. 151). This accounting standard, which is effective forannual periods beginning after June 15, 2005, requires that abnormalamounts of idle facility expense, freight, handling costs, and wasted materials(spoilage) should be recognized as current-period charges. The adoption of SFASNo. 151 is not expected to have a material effect on our financialposition or results of operations.

 

In June 2005, the FASB ratified Emerging IssuesTask Force (“EITF”) Issue 05-05, “Accounting for Early Retirement Programs WithSpecific Features (Such as Terms specified in Altersteilzeit Early RetirementArrangements)” which addresses the accounting for the transitional earlyretirement program in Germany. Salary components of this plan should berecognized over the period from which the program begins until the end of theactive service period. Additionally, a portion of the salary that is deferredunder certain arrangements should be discounted if payment is expected to bedeferred for a period longer than one year. This treatment is effective forfiscal years beginning after December 15, 2005. The application of EITF 05-05is not expected to have a material impact on our financial position or resultsof operations.

 

**3.****              Acquisition**

 

On August 12, 2004, we acquired substantially allof the assets and assumed the operating liabilities of G. Leblanc Corporation (“Leblanc”)of Wisconsin, a high-quality band instrument manufacturer. We have included theoperating results and net assets of Leblanc in our financial statements sincethe date of acquisition.

 

We acquired Leblanc because its line of instrumentsand accessories is complementary to our existing product lines, enabling us togain or strengthen market share in certain instrument categories. The Companydisbursed $37.6 million for the purchase price at closing, of which $4.0million is being held in escrow pending resolution of outstanding claims. Thefinal purchase price was dependent upon a calculation derived from the closingbalance sheet, which resulted in an additional payment of $1.4 million in June 2005.The total purchase price of $38.9 million has been allocated to acquired assets

 

47

----

 

andassumed liabilities as of August 12, 2004 as follows:

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

 

We acquired a manufacturingfacility via this transaction that had been scheduled for closure by thepredecessor owner. We vacated this facility in early 2005 and did not incursignificant unaccrued costs as a result of this closure. This acquired facilityand a previously closed woodwind manufacturing facility in Elkhart, Indianawere sold in the current period for combined net proceeds of $1.0 million. Thegain on the sales was less than $0.2 million and related primarily to the closedwoodwind manufacturing facility.

 

**4.****              Inventories**

 
| **December 31,** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------|------------|----------|------------|----------|------------|
|                  |       |     |       |     |       |
| Raw materials         |       | $        | 23,218     |     | $          | 23,439 |   |
| Work-in-process       |       | 47,511   |       | 54,612   |       |
| Finished goods        |       | 88,581   |       | 94,295   |       |
|                  |       | $        | 159,310    |     | $          | 172,346 |   |

 

**5.****              Property, Plant andEquipment, Net**

 
| **December 31,**                          | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|
| Land                                           |       | $        | 19,180     |     | $          | 20,276 |   |
| Buildings and improvements                     |       | 69,004   |       | 69,640   |       |
| Leasehold improvements                         |       | 4,073    |       | 3,978    |       |
| Machinery, equipment and tooling               |       | 52,176   |       | 52,058   |       |
| Office furniture and fixtures                  |       | 10,984   |       | 10,692   |       |
| Concert and artist and rental pianos           |       | 15,829   |       | 15,526   |       |
| Construction-in-progress                       |       | 1,152    |       | 1,247    |       |
|                                           |       | 172,398  |       | 173,417  |       |
| Less accumulated depreciation and amortization |       | (75,734  | )     | (70,473  | )          |
|                                           |       | $        | 96,664     |     | $          | 102,944 |   |

 

48

----

 

Depreciation expense was $10.2 million in 2005, $10.1million in 2004 and $9.8 million in 2003.

 

**6.****              Goodwill,Trademarks, and Other Intangible Assets**

 
| **December 31,**             | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
|                              |       |     |       |     |       |
| Non-amortizing intangible assets: |       |     |       |     |       |
| Goodwill                          |       | $        | 30,088     |     | $          | 31,854 |   |
| Trademarks                        |       | $        | 13,233     |     | $          | 12,325 |   |
|                              |       |     |       |     |       |   |   |
| Amortizing intangible assets:     |       |     |       |     |       |
| Deferred financing costs          |       | $        | 8,467      |     | $          | 8,627 |   |
| Accumulated amortization          |       | (4,701   | )          | (3,834   | )          |
| Deferred financing costs, net     |       | $        | 3,766      |     | $          | 4,793 |   |
|                              |       |     |       |     |       |
| Covenants not to compete          |       | $        | 500        |     | $          | 750 |   |
| Accumulated amortization          |       | (138     | )          | (253     | )          |
| Covenants not to compete, net     |       | $        | 362        |     | $          | 497 |   |

 

The changes in the carrying amounts of goodwill andtrademarks are as follows:

 
| ** **                                   | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Total** | ** ** |
|----------------------------------------------|------------|-------------------|------------|------------------|------------|-----------|------------|
| Goodwill:                                    |       |              |       |             |       |      |       |
| Balance at January 1, 2004                   |       | $                 | 23,110     |             | $          | 8,555     |       | $ | 31,665 |   |
| Valuation allowance adjustment (see Note 10) |       | (822              | )          | —           |       | (822      | )          |
| Foreign currency translation impact          |       | 1,011             |       | —           |       | 1,011     |       |
| Balance at December 31, 2004            |       | 23,299            |       | 8,555            |       | 31,854    |       |
| Foreign currency translation impact          |       | (1,766            | )          | —           |       | (1,766    | )          |
| Balance at December 31, 2005            |       | $                 | 21,533     |             | $          | 8,555     |       | $ | 30,088 |   |

 

49

----

 
| ** **                                                                   | ** ** | **Piano  Segment** | ** ** | **Band  Segment** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------|------------|-------------------|------------|-----------|------------|
| Trademarks:                                                                  |       |               |       |              |       |      |       |
| Balance at January 1, 2004                                                   |       | $                  | 7,648      |              | $          | 2,671     |       | $ | 10,319 |   |
| Additions based on preliminary purchase price  allocation to acquired assets |       | —             |       | 1,690             |       | 1,690     |       |
| Foreign currency translation impact                                          |       | 316                |       | —            |       | 316       |       |
| Balance at December 31, 2004                                            |       | 7,964              |       | 4,361             |       | 12,325    |       |
| Additions based on purchase price allocation to  acquired assets             |       | —             |       | 1,463             |       | 1,463     |       |
| Foreign currency translation impact                                          |       | (555               | )          | —            |       | (555      | )          |
| Balance at December 31, 2005                                            |       | $                  | 7,409      |              | $          | 5,824     |       | $ | 13,233 |   |

 

The weighted-average amortization period for deferredfinancing costs is nine years, and the weighted-average amortization period ofcovenants not to compete is five years. Thefollowing table summarizes amortization expense, which includes amortization ofdeferred financing costs:

 
| **For the  years ended December 31,** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Total  amortization expense                |       | $        | 1,116      |     | $          | 1,094    |       | $ | 1,154 |   |
|                                            |            |          |            |          |            |          |            |  |  |  |

 

The following table showsthe estimated amortization expense for intangible assets for each of the fivesucceeding fiscal years:

 
| **Estimated amortization expense:** | ** ** | **Amount** | ** ** |
|-------------------------------------|------------|------------|------------|
| 2006                                |       |       | $          | 1,061 |   |
| 2007                                |       |       | 1,061      |   |
| 2008                                |       |       | 916        |   |
| 2009                                |       |       | 524        |   |
| 2010                                |       |       | 445        |   |
|                                     |            |            |            |  |  |

 

**7.****              Other Assets**

 
| **December 31,**      | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|
|                       |       |     |       |     |       |
| Intangible  pension assets |       | $        | 2,961      |     | $          | 2,801 |   |
| Notes receivable           |       | 6,067    |       | 7,518    |       |
| Marketable  securities     |       | 1,132    |       | 891      |       |
| Deposits                   |       | 4,374    |       | 3,564    |       |
| Other assets               |       | 1,277    |       | 1,597    |       |
| Total                      |       | $        | 15,811     |     | $          | 16,371 |   |

 

50

----

 

Deposits include $2.4 million of amounts set aside forpotential workers’ compensation liabilities; therefore the use of these fundsis restricted unless we replace the deposits with a letter of credit of asimilar amount.

 

**8.****              OtherCurrent Liabilities**

 
| **December 31,**                | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
|                                 |       |     |       |     |       |   |   |
| Accrued payroll and related benefits |       | $        | 17,622     |     | $          | 18,072 |   |
| Current portion of pension liability |       | 3,441    |       | 2,811    |       |
| Accrued warranty expense             |       | 1,857    |       | 2,139    |       |
| Accrued interest                     |       | 3,134    |       | 3,257    |       |
| Deferred income                      |       | 5,482    |       | 4,468    |       |
| Environmental liabilities            |       | 3,820    |       | 1,159    |       |
| Other accrued expenses               |       | 9,743    |       | 11,986   |       |
| Total                                |       | $        | 45,099     |     | $          | 43,892 |   |

 

Accrued warranty expense is recorded at the time ofsale for instruments that have a warranty period ranging from one to ten years.The accrued expense recorded is generally based on a historical warranty costsas a percentage of sales and is adjusted periodically following an analysis ofwarranty activity.

 
| **For the years ended December 31,** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                          |       |     |       |     |       |     |       |
| Accrued warranty expense:                                     |       |     |       |     |       |     |       |
| Beginning balance                                             |       | $        | 2,139      |     | $          | 2,602    |       | $ | 2,357 |   |
| Additions                                                     |       | 858      |       | 932      |       | 1,361    |       |
| Claims and reversals                                          |       | (1,045   | )          | (1,455   | )          | (1,314   | )          |
| Foreign currency translation                                  |       | (95      | )          | 60       |       | 198      |       |
| Ending balance                                                |       | $        | 1,857      |     | $          | 2,139    |       | $ | 2,602 |   |

 

**9.****              Other****Income, Net**

 
| **For the years ended December 31,** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| West 57th Building income                                     |       | $        | (4,653     | )        | $          | (4,653   | )          | $ | (4,653 | ) |
| West 57th Building expenses                                   |       | 3,269    |       | 3,254    |       | 3,254    |       |
| Foreign exchange (gain) loss, net                             |       | 271      |       | (41      | )          | (815     | )          |
| Loss on extinguishment of debt                                |       | 538      |       | —   |       | —   |       |
| Miscellaneous, net                                            |       | (225     | )          | (1,723   | )          | (1,303   | )          |
| Total                                                         |       | $        | (800       | )        | $          | (3,163   | )          | $ | (3,517 | ) |

 

51

----

 

**10.****       Income Taxes**

 

Thecomponents of the income tax provision are as follows:

 
| **For the years ended December 31,** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                          |       |     |       |     |       |     |       |
| U.S. federal:                                                 |       |     |       |     |       |     |       |
| Current                                                       |       | $        | 1,167      |     | $          | 2,838    |       | $ | 2,300 |   |
| Deferred                                                      |       | 98       |       | (1,990   | )          | (2,117   | )          |
| U.S. state and local:                                         |       |     |       |     |       |     |       |
| Current                                                       |       | 464      |       | 877      |       | 729      |       |
| Deferred                                                      |       | (171     | )          | (166     | )          | (177     | )          |
| Foreign:                                                      |       |     |       |     |       |     |       |
| Current                                                       |       | 7,251    |       | 6,882    |       | 4,270    |       |
| Deferred                                                      |       | (609     | )          | (341     | )          | (307     | )          |
| Total                                                         |       | $        | 8,200      |     | $          | 8,100    |       | $ | 4,698 |   |

 

Thecomponents of income before income taxes are as follows:

 
| **For the years ended December 31,** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                          |       |     |       |     |       |     |       |
| U.S. operations                                               |       | $        | 4,265      |     | $          | 6,847    |       | $ | 3,860 |   |
| Non-U.S. operations                                           |       | 17,727   |       | 17,120   |       | 10,536   |       |
| Total                                                         |       | $        | 21,992     |     | $          | 23,967   |       | $ | 14,396 |   |

 

Ourincome tax provision differed from that using the statutory U.S. federal rateas follows:

 
| **For the years ended December 31,** | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|---------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Statutory federal rate applied to income before income  taxes |       | $          | 7,697      |       | $          | 8,388      |       | $ | 5,039 |   |
| Increase (decrease) in income taxes resulting from:           |       |       |       |       |       |       |       |
| Foreign income taxes (net of federal benefit) (1)             |       | 1,817      |       | 1,621      |       | (2,643     | )          |
| State income taxes (net of federal benefit)                   |       | 642        |       | 773        |       | 518        |       |
| Benefit of excess foreign tax credits (2)                     |       | (938       | )          | (865       | )          | —     |       |
| Benefit of state net operating losses (3)                     |       | (562       | )          | —     |       | —     |       |
| Other                                                         |       | (456       | )          | (1,817     | )          | 1,784      |       |
| Income tax provision                                          |       | $          | 8,200      |       | $          | 8,100      |       | $ | 4,698 |   |

 

----

(1)          Includes the impact of foreign sales in excess of the U.S. Statutoryrate of 35% as well as foreign income also subject to U.S. tax, less the foreigntax credit allowed in the current year.

 

(2)          Represents the impact of excess foreign taxes eligible to offset U.S.taxes over the credit taken, less an associated valuation allowance of $938 in2005 and $865 in 2004.

 

(3)          Represents the impact of state net operating losses available to offset currentand future taxable income at the state level.

 

52

----

 

At December 31, 2005, accumulated retainedearnings of non-U.S. subsidiaries totaled $8.3 million. We did not provide forU.S. income taxes or foreign withholding taxes for these subsidiaries becauseour current intention is to reinvest such earnings for the foreseeable future.

 

The components of netdeferred taxes are as follows:

 
| **December 31,**                                        | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deferred tax assets:                                         |       |       |       |       |       |
| Uniform capitalization and reserve adjustments to  inventory |       | $          | 2,385      |       | $          | 2,523 |   |
| Allowance for doubtful accounts                              |       | 2,083      |       | 2,412      |       |
| Accrued expenses and other current assets and liabilities    |       | 7,730      |       | 7,945      |       |
| Additional minimum pension liability                         |       | 6,742      |       | 4,225      |       |
| Net operating losses                                         |       | 4,019      |       | 4,615      |       |
| Foreign tax credits                                          |       | 10,749     |       | 9,527      |       |
| Total deferred tax assets                                    |       | 33,708     |       | 31,247     |       |
|                                                         |       |       |       |       |       |
| Deferred tax liabilities:                                    |       |       |       |       |       |
| Pension contributions                                        |       | (3,332     | )          | (2,586     | )          |
| Fixed assets                                                 |       | (19,007    | )          | (20,236    | )          |
| Unamortized tax method change                                |       | (448       | )          | (896       | )          |
| Intangibles                                                  |       | (7,481     | )          | (7,250     | )          |
| Total deferred tax liabilities                               |       | (30,268    | )          | (30,968    | )          |
| Net deferred taxes before valuation allowances               |       | 3,440      |       | 279        |       |
| Valuation allowances                                         |       | (10,830    | )          | (11,472    | )          |
| Net deferred taxes                                           |       | $          | (7,390     | )          | $          | (11,193 | ) |

 

Valuation allowances relate to excess foreign taxcredits and net operating loss carryforwards generated in excess of amounts wemore likely than not expect to utilize. Gross state tax net operating loss carryforwards totaled $91.7 millionas of December 31, 2005 and expire in varying amounts from 2006 through2025.  Our foreign tax creditcarryforwards expire in varying amounts from 2009 through 2015.

 

Valuation allowances decreased $0.6 million during2005, increased $0.4 million during 2004, and decreased $5.3 million during2003.  Valuation allowances relating tothe acquisition of Steinway totaled $2.9 million as of December 31, 2005 and$3.3 million as of December 31, 2004. The difference results primarily from exchange rate fluctuations.  If these valuation allowances are removed,the reversal reduces goodwill.  In 2004,we removed a portion of these valuation allowances and, as a result, we reducedgoodwill by $0.8 million.

 

53

----

 

**11.****       Long-Term Debt**

 
| **December 31,**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|
| Term loans                                               |       | $        | 32,011     |     | $          | 39,623 |   |
| 8.75% Senior Notes                                       |       | 166,194  |       | 174,345  |       |
| Unamortized bond premium                                 |       | 1,332    |       | 1,584    |       |
| Open account loans, payable on demand to a foreign  bank |       | 5,155    |       | 7,240    |       |
| Total                                                    |       | 204,692  |       | 222,792  |       |
| Less current portion                                     |       | 12,977   |       | 14,212   |       |
| Long-term debt                                           |       | $        | 191,715    |     | $          | 208,580 |   |

 

Scheduled payments oflong-term debt as of December 31, 2005 are as follows:

 
| ** ** | ** ** | **Amount** | ** ** |
|------------|------------|------------|------------|
| 2006       |       | $          | 12,977     |   |
| 2007       |       | 7,903      |       |
| 2008       |       | 16,286     |       |
| 2009       |       | —     |       |
| 2010       |       | —     |       |
| Thereafter |       | 166,194    |       |
|       |       | $          | 203,360    |   |

 

Our real estate term loan, acquisition term loan, anddomestic, seasonal borrowing requirements are accommodated through a committedcredit facility with a syndicate of domestic lenders (the “Credit Facility”).The Credit Facility provides us with a potential borrowing capacity of $85.0million in revolving credit, and expires on September 14, 2008. Borrowingsare collateralized by our domestic accounts receivable, inventory and fixedassets. As of December 31, 2005, there were no revolving credit loansoutstanding, and availability based on eligible accounts receivable andinventory balances was approximately $83.6 million, net of outstanding lettersof credit. The real estate term loan ($15.4 million at December 31, 2005) ispayable in monthly installments of $0.2 million and includes interest ataverage 30-day LIBOR (2.4% at December 31, 2005) plus 1.5%. This term loanis secured by all of our interests in the Steinway Hall property. Theacquisition term loan ($16.6 million at December 31, 2005) was repayablein monthly installments of $0.4 million through August 2005 and monthlyinstallments of $0.6 million from September 2005 through September 2008.The acquisition term loan and revolving credit loans under the Credit Facilitybear interest at average 30-day LIBOR plus 1.75%. Subsequent to December 31,2005, the acquisition term loan was paid in full.  (See Note 19.)

 

On April 19, 2001, we issued $150.0 million 8.75%Senior Notes due 2011. In December 2002 we repurchased $4.7 million ofthese notes at 99.25%. In December 2005, we repurchased $8.2 million ofour 8.75% Senior Notes at 105%. In February 2004, we purchased 1,271,450shares of our Ordinary common stock. In exchange, we tendered $29.0 million inprincipal amount of our 8.75% Senior Notes, which we issued under our currentindenture at a premium of 106.3%. Subsequent to December 31, 2005, we refinanced our Senior Notes.  (See Note 19.)

 

54

----

 

Wealso have certain non-domestic credit facilities originating from two Germanbanks that provide for borrowings by foreign subsidiaries of up to €16.5million ($19.5 million at the December 31, 2005 exchange rate), net ofborrowing restrictions of €0.9 million ($1.1 million at the December 31,2005 exchange rate) and are payable on demand.  These borrowings arecollateralized by most of the assets of the borrowing subsidiaries.  Aportion of the loans can be converted into a maximum of £0.5 million ($0.9million at the December 31, 2005 exchange rate) for use by our U.K. branchand ¥300 million ($2.5 million at the December 31, 2005 exchange rate) foruse by our Japanese subsidiary. Our Chinese subsidiary also has the ability toconvert the equivalent of up to €1.8 million into U.S. dollars or Chinese yuan($2.1 million at the December 31, 2005 exchange rate). Euro loans bearinterest at rates of EURIBOR plus a margin determined at the time of borrowing.Margins fluctuate based on the loan amount and the borrower’s bank rating. Theremaining demand borrowings bear interest at fixed margins at rates of LIBORplus 1% for British pound loans (5.53% at December 31, 2005), LIBOR plus1% for U.S. dollar loans of our Chinese subsidiary (5.20% to 5.57% at December 31,2005), and TIBOR plus 0.875% for Japanese yen loans (0.965% at December 31,2005). We had $2.6 million outstanding as of December 31, 2005 on thesecredit facilities.

 

In January 2005,our Japanese subsidiary entered into a separate revolving loan agreement thatprovides additional borrowing capacity of up to ¥500 million ($4.2 million atthe December 31, 2005 exchange rate) based on eligible inventory balances.The revolving loan agreement bears interest at an average 30-day TIBOR rateplus 0.865% (0.955% at December 31, 2005) and expires on January 31,2010.  As of December 31, 2005, we had $2.5 million outstanding onthis revolving loan agreement.

 

All ofour debt agreements contain certain financial and non-financial covenantswhich, among other things, require the maintenance of certain financial ratiosand net worth, place certain limitations on additional borrowings and capitalexpenditures, prohibit the payment of cash dividends, and require periodicreport submissions to the lending institution or trustee. We were in compliancewith all such covenants as of December 31, 2005.

 

**12.****       Stockholders’Equity and Stock Arrangements**

 

Ourcommon stock is comprised of two classes: Class A and Ordinary. With theexception of disparate voting power, both classes are substantially identical.Each share of Class A common stock entitles the holder to 98 votes.Holders of Ordinary common stock are entitled to one vote per share. Class Acommon stock shall automatically convert to Ordinary common stock if, at anytime, the Class A common stock is not owned by an original Class Aholder. The Chairman and Chief Executive Officer own 100% of the Class Acommon shares, representing 86% of the combined voting power of the Class Acommon stock and Ordinary common stock.

 

Employee Stock Purchase Plan - We have an employeestock purchase plan under which substantially all employees may purchaseOrdinary 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. Stock purchases under the Purchase Plan arelimited to 5% of an employee’s annual base earnings. Shares issued under thePurchase Plan were 20,663 during 2005, 33,018 during 2004, and 35,209 during2003. Of the 500,000 shares originally reserved for issuance under the PurchasePlan, 222,909 shares remained available for future issuance as of December 31,2005.

 

Stock Plan - The 1996 stock plan, as amended,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 key employees, consultants and advisors.Our stock options generally have five year vesting terms and ten year optionterms. As of December 31, 2005, 1,041,573 shares of Ordinary common stockwere reserved for issuance under the Stock Plan.

 

55

----

 

Thefollowing table sets forth information regarding both the Purchase Plan and theStock Plan:

 
| ** **                       | ** ** | **2005**                | ** ** | **2004**                                | ** ** | **2003**                | ** ** |
|----------------------------------|------------|-------------------------|------------|-----------------------------------------|------------|-------------------------|------------|
| ** **                       | ** ** | **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 |       | 872,227                 |       | $                                       | 19.92      |                    | 1,154,747  |   | $ | 19.63 |   | 1,112,447 |   | $ | 19.07 |   |
| Granted                          |       | 70,985                  |       | 26.39                                   |       | 27,825                  |       | 17.81 |   | 250,909 |   | 21.16 |   |
| Exercised                        |       | (84,763                 | )          | 20.80                                   |       | (300,345                | )          | 18.65 |   | (93,109 | ) | 17.26 |   |
| Canceled, forfeited or expired   |       | (22,200                 | )          | 19.69                                   |       | (10,000                 | )          | 19.00 |   | (115,500 | ) | 19.06 |   |
| Outstanding at end of year       |       | 836,249                 |       | 20.39                                   |       | 872,227                 |       | 19.92 |   | 1,154,747 |   | 19.63 |   |
|                             |       |                    |       |                                    |       |                    |       |   |   |   |   |   |   |
| Exercisable at end of year       |       | 493,473                 |       | $                                       | 19.60      |                    | 410,173    |   | $ | 19.45 |   | 525,100 |   | $ | 19.19 |   |

 

Thefollowing table sets forth information regarding outstanding and exercisableoptions at December 31, 2005:

 
| ** **                                  | ** ** | **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** | ** ** |
|                                        |       |                         |       |                                    |       |   |   |   |   |   |   |
| $14.73 - $20.75                             |       | 568,073                      |       | 4.6 years                               |       | $ | 18.93 |   | 405,073 |   | $ | 18.97 |   |
| $21.13 - $25.42                             |       | 228,176                      |       | 7.4 years                               |       | 22.83 |   | 88,400 |   | 22.49 |   |
| $27.28                                      |       | 40,000                       |       | 9.6 years                               |       | 27.28 |   | — |   | — |   |
|                                        |       | 836,249                      |       | 5.6 years                               |       | 20.39 |   | 493,473 |   | 19.60 |   |
|                                             |            |                              |            |                                         |            |  |  |  |  |  |  |  |  |

 

**13.****       Commitmentsand Contingent Liabilities**

 

**Lease Commitments** - We lease various facilities and equipmentunder non-cancelable operating lease arrangements. These leases expireat various times through 2016. Rent expense was $5.7 million for the yearsended December 31, 2005 and 2004, and $4.8 million for the year ended December 31,2003.

 

In March 1999,we acquired the building that includes the Steinway Hall retail store on West57th Street in New York City for approximately $30.8 million. Weentered into a ninety-nine year land lease as part of the transaction. Annualrent payable under the land lease is $2.2 million in the first ten years, $2.8million for the subsequent ten-year period and will be adjusted every twentyyears thereafter to the greater of the existing rent or 4% of the fair marketvalue of the land and building combined. Rent expense is being recognized on astraight-line basis over the initial twenty-year fixed rent period. We alsoentered into a ten-year master lease whereby all of our interest in the landand building was leased back to the owner of the land. Rental expense andrental income associated with these leases was included, along with other realestate costs, in Other Income, Net (see Note 9). 

 

56

----

 

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

 

 
| **For the years ending December 31,** | ** ** | **Lease  Payments** | ** ** | **Rental  Income** | ** ** |
|----------------------------------------------------------------|------------|---------------------|------------|--------------------|------------|
| 2006                                                           |       | $                   | 4,627      |               | $          | 4,653 |   |
| 2007                                                           |       | 4,191               |       | 4,653              |       |
| 2008                                                           |       | 2,124               |       | 4,653              | (1)        |
| 2009                                                           |       | 1,273               |       | —             |       |
| 2010                                                           |       | 1,128               |       | —             |       |
| Thereafter                                                     |       | 4,755               |       | —             |       |
|                                                           |       | $                   | 18,098     |               | $          | 13,959 |   |

 

----

(1) In 2008, if themaster lease is not renewed or replaced we would then directly receive therental income from all other tenants in the building.

 

**EmploymentAgreements and Other Obligations** - We maintain employmentagreements with certain employees and consultants. Most of these agreementshave one-year terms and contain automatic renewal provisions. Our obligationunder these agreements at current compensation levels is approximately $1.8million per year.

 

We maintain employmentagreements that expire in 2006 with both our Chairman and Chief ExecutiveOfficer. These individuals collectively hold 100% of the Class A commonshares, representing 86% of the combined voting power of the Class Acommon stock and Ordinary common stock. Our total obligation under theseagreements at December 31, 2005 is approximately $0.7 million. Shouldthese agreements not be renewed in 2006, we would be obligated to pay out anadditional $3.4 million. Further, our Chairman and Chief Executive officer haveestablished a limited liability corporation to which we pay reimbursement ofcertain rent, overhead and travel-related expenses. These expenses totaled $0.2million in each of the years ended December 31, 2005, 2004, and 2003. Weincluded less than $0.1 million in accounts payable related to these expensesat December 31, 2005 and 2004.

 

**NotesReceivable Financed with Recourse** - In 2004, certaincustomers of our Leblanc subsidiary financed notes receivable with a thirdparty, to which we have a recourse obligation. As of December 31, 2005,$0.5 million of these notes remain outstanding. We have included acorresponding recourse obligation of $0.1 million in our financial statementsat December 31, 2005. Our total maximum recourse obligation under thisarrangement includes the outstanding balance on the notes, as well as anyinterest or late fees that may be incurred by our customers.

 

We generally do notprovide extended financing arrangements to our piano dealers. To facilitatelong-term financing required by some dealers, we have arranged financingthrough third-party providers. We generally provide no guarantees with respectto these arrangements.

 

**Retail Financing Obligations** – Certain of our retail sales overseaswere financed by our customers through a local bank under an arrangement thatincluded an obligation on our part to repurchase pianos seized by the bank upondefault of the customer. The buyback price is established as a percentage ofthe original sales price, starting at 80% in the first year and declining to30% in the fifth year of the loan.

 

57

----

 

This program ceased inthe first quarter of 2003. Nevertheless, because our obligation continues untilthe bank is paid in full by the customer, our commitment can remain outstandingfor up to 8 years – the maximum term of the consumer loan.

 

Our maximum obligationunder this arrangement is estimated to be approximately €0.6 million ($0.7million at the December 31, 2005 exchange rate). To date, we have not beenrequired to repurchase any pianos under this program and we believe thelikelihood of such repurchases in the future is remote. Accordingly, we havenot recognized a liability for this obligation in our financial statements.Further, in the unlikely event of a repurchase, we believe the proceedsreceived upon our resale of the piano would exceed the amount payable to thebank.

 

With limited exceptions,we do not provide extended financing arrangements to our dealers. To facilitatelong-term financing required by some dealers, we have arranged financingthrough third-party providers. We generally provide no guarantees with respectto these arrangements.

 

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

 

Certain environmentallaws, such as the Comprehensive Environmental Response, Compensation, andLiability Act, as amended (“CERCLA”), impose strict, retroactive, joint andseveral liability upon persons responsible for releases of hazardoussubstances, which liability is broadly construed. Under CERCLA and other laws,we may have liability for investigation and cleanup costs and other damagesrelating to our current or former properties, or third-party sites to which wesent wastes for disposal. Our potential liability at any of these sites isaffected by many factors including, but not limited to, the method ofremediation, our portion of the hazardous substances at the site relative tothat of other parties, the number of responsible parties, the financialcapabilities of other parties, and contractual rights and obligations.

 

In this regard, weoperate certain manufacturing facilities which were previously owned by PhilipsElectronics North America Corporation (“Philips”). When we purchased thesefacilities, Philips agreed to indemnify us for certain environmental mattersresulting from activities of Philips occurring prior to December 29, 1988(the “Environmental Indemnity Agreement”). To date, Philips has fully performedits obligations under the Environmental Indemnity Agreement, which terminateson December 29, 2008, however, we cannot assure investors that it willcontinue to do so in the future. Four matters covered by the EnvironmentalIndemnity Agreement are currently pending. Philips has entered into ConsentOrders with the Environmental Protection Agency (“EPA”) for one site and theNorth Carolina Department of Environment, Health and Natural Resources for asecond site, whereby Philips has agreed to pay required response costs. On October 22,1998, we were joined as defendant in an action involving a third site formerlyoccupied by a business we acquired in Illinois. Philips has accepted thedefense of this action pursuant to the terms of the Environmental IndemnityAgreement. At the fourth site, which is a third-party waste disposal site, theEPA has named over 40 persons or entities as potentially responsible parties (“PRP”),including four Conn-Selmer predecessor entities. The four entities have beeninvolved as members of PRP group in the ongoing negotiations with the site owners,the largest contributor, and the EPA in an attempt to reach a settlement andrelease PRP group members from further potential liability. We expect adecision on the proposed settlement to be reached within the next twelvemonths. For two

 

58

----

 

of these predecessorentities, which were previously owned by Philips, this matter has been tenderedto Philips pursuant to the Environmental Indemnity Agreement. With respect tothe other two entities, based on current information concerning estimatedcleanup costs at the site, and our share of liability, we do not believe ourliability will be material.

 

Inaddition, we are continuing an existing environmental remediation plan at afacility we acquired in 2000. We estimate our costs, which approximate $0.9million, over a 15 year period. We have accrued approximately $0.7 million forthe estimated remaining cost of this remediation program, which represents thepresent value total cost using a discount rate of 4.54%. A summary of expected payments associatedwith this project is as follows:

 
| ** ** | ** ** | **Environmental  Payments** | ** ** |
|------------|------------|-----------------------------|------------|
| 2006       |       | $                           | 125        |   |
| 2007       |       | 78                          |       |
| 2008       |       | 56                          |       |
| 2009       |       | 56                          |       |
| 2010       |       | 56                          |       |
| Thereafter |       | 555                         |       |
|       |       | $                           | 926        |   |

 

In 2004, we acquired two manufacturing facilitiesfrom G. Leblanc Corporation, now Grenadilla, Inc. (“Grenadilla”), forwhich environmental remediation plans had already been established. Inconnection with the acquisition, we assumed the existing accrued liability ofapproximately $0.8 million for the cost of these remediation activities. Basedon a review of past and ongoing investigatory and remedial work by ourenvironmental consultants, and discussions with state regulatory officials, aswell as recent sampling, we estimate the remaining costs of such remedial plansat $3.1 million. Pursuant to the purchase and sale agreement, we have soughtindemnification from Grenadilla for anticipated costs above the originalestimate in the amount of $2.5 million. We filed a claim against the escrow andrecorded a corresponding receivable for this amount in prepaid expenses andother current assets in the consolidated balance sheet. However, we cannot beassured that we will be able to recover such costs from Grenadilla.

 

Based on our past experience and currently availableinformation, the matters described above and our other liabilities andcompliance costs arising under environmental laws are not expected to have amaterial impact on our capital expenditures, earnings or competitive positionin an individual year. However, some risk of environmental liability isinherent in the nature of our current and former business and we may, in thefuture, incur material costs to meet current or more stringent compliance,cleanup, or other obligations pursuant to environmental laws.

 

59

----

 

**14.****       RetirementPlans**

 

Wehave defined benefit pension plans covering the majority of our employees,including certain employees in foreign countries. Certain domestic hourlyemployees are covered by multi-employer defined benefit pension plans to whichwe make contributions. These contributions totaled $1.1 million in 2005 and2004, and $1.0 million in 2003. The corresponding pension plan assets andliabilities belong to third parties and, accordingly, are not reflected in thisNote.

 

Ourplan assets are invested primarily in common stocks and fixed incomesecurities. We make contributions to our domestic plan with the objective ofmaintaining a fully funded status for the accumulated benefit obligation and a90% funded status for the projected benefit obligation. At a minimum, ourcontributions equal the amounts required by federal laws and regulations.Foreign plans are funded in accordance with the requirements of the regulatorybodies governing each plan.

 

EffectiveDecember 31, 2003, we amended the Steinway Salaried Pension Plan (the “SteinwayPlan”) to eliminate future years of service credit. All distributions upontermination of employment will continue in the normal course under the SteinwayPlan. Since the Steinway Plan is based on years of service and is not impactedby salary increases, no curtailment gain or loss resulted from the amendment.

 

In December 2003,we combined all of our domestic pension plans into one plan, “The SteinwayMusical Pension Plan,” to facilitate plan monitoring and plan investmentmanagement.

 

EffectiveJune 1, 2005 we established a master trust for this combined plan and wewill continue to evaluate this plan’s funded status and make any requiredminimum contributions annually.

 

60

----

 

The following table sets forth the funded status andamounts recognized for our defined benefit pension plans:

 
| ** **                                           | ** ** | **Domestic Plans** | ** ** | **Foreign Plans** | ** ** |
|------------------------------------------------------|------------|--------------------|------------|-------------------|------------|
| **December 31,**                                | ** ** | **2005**           | ** ** | **2004**          | ** ** | **2005** | ** ** | **2004** | ** ** |
| Change in benefit obligation:                        |       |               |       |              |       |   |   |   |   |
| Benefit  obligation, beginning of year               |       | $                  | 48,876     |              | $          | 43,987 |   | $ | 28,763 |   | $ | 24,026 |   |
| Service cost                                         |       | 852                |       | 785               |       | 701 |   | 593 |   |
| Interest  cost                                       |       | 2,915              |       | 2,837             |       | 1,278 |   | 1,295 |   |
| Plan  participants’ contributions               |       | 11                 |       | 13                |       | 60 |   | 60 |   |
| Amendments                                           |       | 631                |       | 65                |       | — |   | — |   |
| Actuarial  loss                                      |       | 2,294              |       | 3,821             |       | 3,712 |   | 1,880 |   |
| Foreign  currency exchange rate changes              |       | —             |       | —            |       | (3,742 | ) | 2,059 |   |
| Curtailment  gain                                    |       | —             |       | (126              | )          | — |   | — |   |
| Benefits  paid                                       |       | (2,630             | )          | (2,506            | )          | (1,185 | ) | (1,150 | ) |
| Benefit obligation, end of year                      |       | 52,949             |       | 48,876            |       | 29,587 |   | 28,763 |   |
|                                                 |       |               |       |              |       |   |   |   |   |
| Change in plan assets:                               |       |               |       |              |       |   |   |   |   |
| Fair value  of plan assets, beginning of year        |       | 47,397             |       | 42,353            |       | 4,476 |   | 3,788 |   |
| Actual  return on plan assets                        |       | 2,542              |       | 5,187             |       | 694 |   | 352 |   |
| Employer  contribution                               |       | 1,500              |       | 2,350             |       | 1,255 |   | 1,124 |   |
| Employee  contributions                              |       | 11                 |       | 13                |       | 60 |   | 60 |   |
| Foreign  currency exchange rate changes              |       | —             |       | —            |       | (510 | ) | 302 |   |
| Benefits  paid                                       |       | (2,630             | )          | (2,506            | )          | (1,185 | ) | (1,150 | ) |
| Fair value of plan assets, end of year               |       | 48,820             |       | 47,397            |       | 4,790 |   | 4,476 |   |
|                                                 |       |               |       |              |       |   |   |   |   |
| Funded status                                        |       | (4,129             | )          | (1,479            | )          | (24,797 | ) | (24,287 | ) |
|                                                 |       |               |       |              |       |   |   |   |   |
| Unrecognized net actuarial loss                      |       | 12,251             |       | 8,656             |       | 6,339 |   | 3,623 |   |
| Unrecognized prior service cost                      |       | 2,961              |       | 2,801             |       | — |   | — |   |
| Net amount recognized                                |       | $                  | 11,083     |              | $          | 9,978 |   | $ | (18,458 | ) | $ | (20,664 | ) |
|                                                 |       |               |       |              |       |   |   |   |   |
| Amounts recognized in the balance sheet  consist of: |       |               |       |              |       |   |   |   |   |
| Accrued  benefit cost                                |       | $                  | (4,129     | )                 | $          | (1,479 | ) | $ | (23,631 | ) | $ | (22,810 | ) |
| Intangible  assets                                   |       | 2,961              |       | 2,801             |       | — |   | — |   |
| Additional  minimum pension liability                |       | 12,251             |       | 8,656             |       | 5,173 |   | 2,146 |   |
| Net amount recognized                                |       | $                  | 11,083     |              | $          | 9,978 |   | $ | (18,458 | ) | $ | (20,664 | ) |

 

61

----

 

Theweighted-average assumptions used to determine our benefit obligations are asfollows:

 
| ** **                     | ** ** | **Domestic Plans** | ** ** | **Foreign Plans** | ** ** |
|--------------------------------|------------|--------------------|------------|-------------------|------------|
| **December 31,**          | ** ** | **2005**           | ** ** | **2004**          | ** ** | **2005** | ** ** | **2004** | ** ** |
|                           |       |               |       |              |       |   |   |   |   |
| Discount  rate                 |       | 5.75%              |       | 6.00%             |       | 4.21% |   | 4.85% |   |
| Rate of  compensation increase |       | n/a                |       | n/a               |       | 2.55% |   | 2.49% |   |

 

The weighted-average assumptions used to determineour net periodic benefit cost are as follows:

 
| ** **                                | ** ** | **Domestic Plans** | ** ** | **Foreign Plans** | ** ** |
|-------------------------------------------|------------|--------------------|------------|-------------------|------------|
| **For the years ended December 31,** | ** ** | **2005**           | ** ** | **2004**          | ** ** | **2003** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Discount  rate                            |       | 6.00%              |       | 6.50%             |       | 6.75% |   | 4.31% |   | 4.95% |   | 5.52% |   |
| Expected  return on assets                |       | 9.00%              |       | 9.00%             |       | 9.00% |   | 6.00% |   | 6.75% |   | 6.75% |   |
| Rate of  compensation increase            |       | n/a                |       | n/a               |       | n/a |   | 2.55% |   | 2.56% |   | 2.88% |   |

 

The components of net pension expense for the yearsended December 31 are as follows:

 
| **For the years ended December 31,** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Domestic Plans:                           |       |     |       |     |       |     |       |
| Service cost                              |       | $        | 852        |     | $          | 785      |       | $ | 804 |   |
| Interest cost                             |       | 2,915    |       | 2,837    |       | 2,564    |       |
| Expected  return on plan assets           |       | (4,221   | )          | (3,820   | )          | (2,539   | )          |
| Amortization  of prior service cost       |       | 471      |       | 585      |       | 585      |       |
| Recognized  actuarial loss                |       | 378      |       | 269      |       | 540      |       |
| Other                                     |       | —   |       | —   |       | 237      |       |
| Curtailment  loss                         |       | —   |       | 461      |       | —   |       |
| Net pension  expense                      |       | $        | 395        |     | $          | 1,117    |       | $ | 2,191 |   |
|                                      |       |     |       |     |       |     |       |
| Foreign Plans:                            |       |     |       |     |       |     |       |
| Service cost                              |       | $        | 701        |     | $          | 593      |       | $ | 629 |   |
| Interest  cost                            |       | 1,278    |       | 1,295    |       | 1,100    |       |
| Expected  return on plan assets           |       | (287     | )          | (223     | )          | (189     | )          |
| Net pension  expense                      |       | $        | 1,692      |     | $          | 1,665    |       | $ | 1,540 |   |

 

The projected benefit obligation, accumulatedbenefit obligation, and fair value of plan assets for pension plans withaccumulated benefit obligations in excess of plan assets were as follows:

 
| ** **                     | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|
| Projected benefit obligation   |       | $        | 82,536     |     | $          | 77,639 |   |
| Accumulated benefit obligation |       | 81,370   |       | 76,161   |       |
| Fair value of plan assets      |       | 53,610   |       | 51,873   |       |
|                                |            |          |            |          |            |  |  |

 

The accumulated benefit obligation for our domesticpension plans was $52.9 million in 2005 and $48.9 million in 2004. Theaccumulated benefit obligation for our foreign pension plans was $28.4 millionin 2005 and $27.3 million in 2004.

 

62

----

 

Theweighted-average asset allocations of our invested assets held in our domesticdefined benefit plans were as follows:

 
| **December 31,**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-------------------------|------------|------------|------------|------------|------------|
| ** **              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Asset category:         |       |       |       |       |       |   |
| Debt securities         |       | 35         | %          |       | 37         | % |   |
| Equity securities       |       | 58         | %          |       | 61         | % |   |
| Cash reserves and other |       | 7          | %          |       | 2          | % |   |
| Total                   |       | 100        | %          |       | 100        | % |   |

 

Domestic plan assets include 52,631 shares of theCompany’s Ordinary common stock, which was valued at $1.3 million as of December 31,2005 and $1.5 million as of December 31, 2004. This represents less than3% of the total plan assets.

 

Our investment strategy includes the following rangeof target asset allocation percentages:

 
| **Asset category:**                       | ** ** | **Minimum** | ** ** | **Maximum** | ** ** |
|-------------------------------------------|------------|-------------|------------|-------------|------------|
|                                      |       |        |       |        |       |
| Domestic equity securities                |       | 25          | %          |        | 65         | % |   |
| International and other equity securities |       | 5           | %          |        | 30         | % |   |
| International debt securities             |       | 5           | %          |        | 15         | % |   |
| Domestic debt securities                  |       | 20          | %          |        | 40         | % |   |

 

The objective of our investment policy is tomaximize the return on invested assets while maintaining an appropriate levelof diversification to manage risk. Our policy sets forth specific criteria usedin the selection and ongoing evaluation of individual funds.

 

Our investment committee generally meets on aquarterly basis with an outside registered investment advisor to review actualperformance against relevant benchmarks, such as the S&P 500 Index.Consistent with our policy, changes in funds are made when a fund falls outsideof our predetermined guidelines for an extended period.

 

The investment committee reviews our domesticbenefit obligations no less than annually with the objective of maintaining afully funded status for the accumulated benefit obligation and a 90% fundedstatus for the projected benefit obligation. Whenever possible, our annualcontribution is expected to cover the short-term liquidity requirements of theplan, so as to maintain the plan’s assets for long-term investment. Theperformance goal set for the plan’s assets is to achieve a long-term rate ofreturn no less than 8.5%.

 

For the periods ended December 31, 2005, 2004,and 2003 we used an assumed long-term rate of return on domestic plan assets of9%. For the period ended December 31, 2005, we used an assumed long-termrate of return on foreign plan assets of 6.00%. We used 6.75% as the assumedlong-term rate of return for the periods ended December 31, 2004 and 2003.These rates were developed with input from our actuaries and our investment committeeand are based on long-term rates of return for the assets

 

63

----

 

held.This rate is consistent with both previous rates we have used and thehistorical return trends on our plan assets.

 

In accordance with the requirements of localregulations, our German plans do not hold assets and pay participant benefitsas incurred. Expected 2006 benefit payments under these plans are $1.0 million.The domestic plan invests a small portion of its assets in a group annuitycontract. We expect benefits to be covered by this contract in 2006 to be $0.2million.

 

We made contributions to our domestic pension planof $1.5 million in 2005 and $2.4 million in 2004. Based on federal laws andregulations, we are not required to make a contribution to our domestic pensionplan in 2006 due to our plan’s current funded status. Nevertheless, weanticipate contributing approximately $2.0 million in 2006.

 

Contributions to our U.K. plan totaled $0.3 millionin 2005 and $0.2 million in 2004. We anticipate contributing approximately $0.2million to this plan in 2006. Due to the unfunded status of the German plans,2006 anticipated contributions are equal to anticipated benefit payments of$1.0 million.

 

The domestic and foreign pension plans expect to paybenefits in each year from 2006 through 2015 as follows:

 

| ** **  | ** ** | **Domestic Plans** | ** ** | **Foreign Plans** | ** ** |
|-------------|------------|--------------------|------------|-------------------|------------|
| 2006        |       | $                  | 2,612      |              | $          | 1,203 |   |
| 2007        |       | 2,744              |       | 1,228             |       |
| 2008        |       | 2,848              |       | 1,232             |       |
| 2009        |       | 3,016              |       | 1,276             |       |
| 2010        |       | 3,139              |       | 1,298             |       |
| 2011 - 2015 |       | 17,308             |       | 8,089             |       |
|        |       | $                  | 31,667     |              | $          | 14,326 |   |

 

We provide postretirement health care and lifeinsurance benefits to eligible hourly retirees and their dependents. The healthcare plan is contributory, with retiree contributions adjusted based on thechanges in the union contract, which is negotiated every three years. The plansare unfunded and we pay part of the health care premium and the full amount ofthe life insurance cost.

 

64

----

 

The following table sets forth the funded status ofour postretirement benefit plans and accrued postretirement benefit costreflected in our consolidated balance sheets:

 
| **December 31,**                   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-----------------------------------------|------------|------------|------------|------------|------------|
| ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Change in benefit obligation:           |       |       |       |       |       |
| Benefit  obligation, beginning of year  |       | $          | 1,597      |       | $          | 2,267 |   |
| Service cost                            |       | 47         |       | 24         |       |
| Interest  cost                          |       | 147        |       | 110        |       |
| Plan  participants’ contributions  |       | 69         |       | 63         |       |
| Curtailment  gain                       |       | —     |       | (255       | )          |
| Actuarial  (gain) loss                  |       | 1,081      |       | (393       | )          |
| Benefits  paid                          |       | (406       | )          | (219       | )          |
| Benefit  obligation, end of year        |       | 2,535      |       | 1,597      |       |
|                                    |       |       |       |       |       |
| Fair value  of plan assets              |       | —     |       | —     |       |
|                                    |       |       |       |       |       |
| Funded  status                          |       | (2,535     | )          | (1,597     | )          |
| Unrecognized  net actuarial (gain) loss |       | 849        |       | (185       | )          |
| Unrecognized  prior service cost        |       | 276        |       | 311        |       |
| Accrued  postretirement benefit cost    |       | $          | (1,410     | )          | $          | (1,471 | ) |

 

The assumed weighted-average discount rate used todetermine benefit obligations as of December 31 was 5.75% in 2005 and6.00% in 2004. The assumed weighted-average discount rate used to determine ournet postretirement benefit cost for the years ended December 31 was 6.0%in 2005, 6.50% in 2004, and 6.75% in 2003. The annual assumed rate of increasein the per capita cost of covered health care benefits was 10.0% in 2005 and isassumed to decrease gradually to 5.50% in 2015, and remain at that levelthereafter.

 

Net postretirement benefit costs are as follows:

 
| **For the years ended December 31,** | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|-------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                              |       | $          | 47         |       | $          | 24         |       | $ | 70 |   |
| Interest cost                             |       | 147        |       | 110        |       | 139        |       |
| Net loss recognition                      |       | 47         |       | —     |       | —     |       |
| Amortization of prior service cost        |       | 35         |       | 146        |       | 62         |       |
| Net postretirement benefit cost           |       | $          | 276        |       | $          | 280        |       | $ | 271 |   |

 

65

----

 

Assumed health care cost trend rates have asignificant effect on the amounts reported for the health care plan. Aone-percentage-point change in assumed health care cost trend rates would havethe following effects:

 
| ** **                                               | ** ** | **1% Increase** | ** ** | **1% Decrease** | ** ** |
|----------------------------------------------------------|------------|-----------------|------------|-----------------|------------|
|                                                     |       |            |       |            |       |
| Effect on total of service and interest  cost components |       | $               | 8          |            | $          | (7 | ) |
| Effect on the postretirement benefit  obligation         |       | 80              |       | (71             | )          |
|                                                          |            |                 |            |                 |            |  |  |

 

The domestic postretirement health care and lifeinsurance plan expects to pay benefits in each year from 2006 through 2015 asfollows:

 
| 2006       |   | $     | 305    |   |
|------------|--------|-------|--------|--------|
| 2007       |   | 335   |   |
| 2008       |   | 365   |   |
| 2009       |   | 395   |   |
| 2010       |   | 430   |   |
| Thereafter |   | 2,510 |   |
| Total      |   | $     | 4,340  |   |

 

We sponsor 401(k) retirement savings plans foreligible employees. Discretionary employer contributions, as determinedannually by the Board of Directors, are made to two of these plans andapproximated $0.6 million for 2005, 2004 and 2003. Non-discretionary contributionsapproximated $0.4 million for the year ended December 31, 2005 and 2004,and $0.5 million for 2003.

 

We established a supplemental executive retirementplan (“SERP”) for a select group of our executives who constitute a “top hat”group as defined by ERISA. Discretionary employer contributions made to thisplan, as determined annually by the Board of Directors, are held in a RabbiTrust (“Trust”). The SERP assets are included in our financial statements asavailable-for-sale investments within other long-term assets (see Notes 7 and16). The contributions approximated $0.2 million in 2005 and 2004, and lessthan $0.1 million in 2003. We anticipate making contributions of $0.2 millionin 2006.

 

**15.****      ****Foreign Currency ExchangeContracts**

 

One of our German divisions, whose functionalcurrency is the euro, secures option and forward contracts for Japanese yen,British pounds, and U.S. dollars to mitigate cash flow exposure to currencyfluctuations. At December 31, 2005, this division had forward and option contractsto purchase $0.2 million, sell $3.3 million, and sell £1.4 million. Theseinstruments had various maturity dates through January 2007. At December 31,2004, this division had forward contracts to purchase $1.5 million and sell£0.9 million. These instruments had various maturity dates through July 2005.Since we do not designate these instruments as hedges for accounting purposes,we carry these instruments at fair value and recognize the change in fair valuein earnings. Such amounts were not material during the years ended December 31,2005, 2004, or 2003.

 

66

----

 

**16.****      ****Fair Values of FinancialInstruments**

 

Estimated fair values of financial instruments havebeen developed using appropriate methodologies; however, considerable judgmentis required to develop these estimates. The estimated fair value of existinglong-term debt is based on rates currently available to us for debt withsimilar terms and remaining maturities. The estimated fair value of foreigncurrency contracts (used to mitigate cash flow exposures) has been determinedas the difference between the current forward rate and the contract rate,multiplied by the notional amount of the contract, or upon the estimated fairvalue of purchased option contracts. The estimates presented below are notnecessarily indicative of amounts that could be realized in a current marketexchange. Use of different assumptions or methodologies could have asignificant effect on these estimates.

 

Thenet carrying value and estimated fair value of certain financial instrumentsare as follows:

 
| ** **                  | ** ** | **2005**                | ** ** | **2004**                  | ** ** |
|-----------------------------|------------|-------------------------|------------|---------------------------|------------|
| **December 31,**       | ** ** | **Net Carrying  Value** | ** ** | **Estimated  Fair Value** | ** ** | **Net Carrying  Value** | ** ** | **Estimated  Fair Value** | ** ** |
| Financial liabilities:      |       |                    |       |                      |       |   |   |   |   |
| Long-term  debt             |       | $                       | 203,360    |                      | $          | 211,670 |   | $ | 221,208 |   | $ | 236,829 |   |
| Foreign  currency contracts |       | (94                     | )          | (94                       | )          | (98 | ) | (98 | ) |
|                             |            |                         |            |                           |            |  |  |  |  |  |  |  |  |

 

The carrying value of accounts, notes and otherreceivables, marketable equity securities, and accounts payable approximatefair value.

 

Our marketable equity securities pertain to the SERPand are included as a component of other assets (see Notes 7 and 14).Investments in marketable equity securities are categorized as trading,available-for-sale, or held-to-maturity. On December 31, 2005 and 2004, wehad only available-for-sale securities, which are stated at fair value, withunrealized gains (there were no unrealized losses), net of deferred taxes,reported in accumulated other comprehensive loss. There were no realized gainsor losses for the periods ended December 31, 2005, 2004, and 2003. Grossunrealized gains on these investments were as follows:

 
| **December 31,** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------|------------|----------|------------|----------|------------|
|                  |       |     |       |     |       |
| Fair value            |       | $        | 1,132      |     | $          | 891 |   |
| Cost                  |       | 919      |       | 734      |       |
| Unrealized gains      |       | $        | 213        |     | $          | 157 |   |

 

67

----

 

**17.****      ****Segment Information**

 

As discussed in Note 2, we have identified tworeportable segments: the piano segment and the band & orchestralinstrument segment. We consider these two segments reportable as they aremanaged separately and the operating results of each segment are separatelyreviewed and evaluated by our senior management on a regular basis.

 

Intercompany transactions are generally recorded ata discount from comparable third-party prices. Income from operations for thereportable segments includes intercompany profit, as well as certain corporatecosts allocated to the segments based primarily on revenue. Amounts reported as“Other & Elim” include those corporate costs that were not allocatedto the reportable segments and the remaining intercompany profit elimination.It also includes corporate assets, elimination of intercompany interest, andinvestments in subsidiaries that do not eliminate within the segments.

 

Thefollowing tables present information about our reportable segments:

 
| ** **                       | ** ** | **Piano Segment** | ** ** | **Band & Orchestral Segment** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------|------------|-------------------|------------|----------------------------------------|------------|------------|------------|------------|------------|
| ** **                       | ** ** | **U.S.**          | ** ** | **Germany**                            | ** ** | **Other**  | ** ** | **Total**  | ** ** | **U.S.** | ** ** | **Other** | ** ** | **Total** | ** ** | **Other & Elim** | ** ** | **Consolidated** | ** ** |
| **2005**                         |       |              |       |                                   |       |       |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Revenues from external customers |       | $                 | 114,803    |                                   | $          | 54,359     |       | $          | 34,355     |   | $ | 203,517 |   | $ | 176,514 |   | $ | 7,112 |   | $ | 183,626 |   | $ | — |   | $ | 387,143 |   |
| Operating profit                 |       | 10,915            |       | 14,912                                 |       | 2,842      |       | 28,669     |       | 8,710 |   | (11 | ) | 8,699 |   | (2,531 | ) | 34,837 |   |
| Interest income                  |       | (1,617            | )          | (144                                   | )          | (163       | )          | (1,924     | )          | (2,929 | ) | — |   | (2,929 | ) | 1,518 |   | (3,335 | ) |
| Interest expense                 |       | 10,788            |       | 20                                     |       | 287        |       | 11,095     |       | 26,352 |   | — |   | 26,352 |   | (20,467 | ) | 16,980 |   |
| Depreciation and amortization    |       | 4,313             |       | 1,296                                  |       | 422        |       | 6,031      |       | 4,546 |   | 135 |   | 4,681 |   | 555 |   | 11,267 |   |
| Income tax provision (benefit)   |       | 814               |       | 5,191                                  |       | 781        |       | 6,786      |       | 1,036 |   | (251 | ) | 785 |   | 629 |   | 8,200 |   |
| Net income (loss)                |       | 2,034             |       | 10,187                                 |       | 1,875      |       | 14,096     |       | (15,505 | ) | (56 | ) | (15,561 | ) | 15,257 |   | 13,792 |   |
| Capital expenditures             |       | 1,410             |       | 761                                    |       | 312        |       | 2,483      |       | 2,429 |   | — |   | 2,429 |   | 92 |   | 5,004 |   |
| Property, plant and equipment    |       | 55,904            |       | 13,514                                 |       | 2,121      |       | 71,539     |       | 23,522 |   | 1,419 |   | 24,941 |   | 184 |   | 96,664 |   |
| Total assets                     |       | 181,265           |       | 72,967                                 |       | 22,199     |       | 276,431    |       | 219,219 |   | 10,249 |   | 229,468 |   | (50,244 | ) | 455,655 |   |
|                             |       |              |       |                                   |       |       |       |       |       |   |   |   |   |   |   |   |   |   |   |
| **2004**                         |       |              |       |                                   |       |       |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Revenues from external customers |       | $                 | 120,387    |                                   | $          | 48,348     |       | $          | 34,953     |   | $ | 203,688 |   | $ | 165,652 |   | $ | 5,694 |   | $ | 171,346 |   | $ | — |   | $ | 375,034 |   |
| Operating profit                 |       | 13,688            |       | 11,968                                 |       | 3,999      |       | 29,655     |       | 7,175 |   | (156 | ) | 7,019 |   | (2,433 | ) | 34,241 |   |
| Interest income                  |       | (23               | )          | (44                                    | )          | (181       | )          | (248       | )          | (2,581 | ) | — |   | (2,581 | ) | — |   | (2,829 | ) |
| Interest expense                 |       | 9,690             |       | 35                                     |       | 250        |       | 9,975      |       | 25,862 |   | 3 |   | 25,865 |   | (19,574 | ) | 16,266 |   |
| Depreciation and amortization    |       | 4,427             |       | 1,369                                  |       | 348        |       | 6,144      |       | 4,477 |   | 36 |   | 4,513 |   | 526 |   | 11,183 |   |
| Income tax provision (benefit)   |       | 3,870             |       | 3,093                                  |       | 1,336      |       | 8,299      |       | (3,829 | ) | 61 |   | (3,768 | ) | 3,569 |   | 8,100 |   |
| Net income (loss)                |       | 1,780             |       | 9,929                                  |       | 2,878      |       | 14,587     |       | (12,052 | ) | (177 | ) | (12,229 | ) | 13,509 |   | 15,867 |   |
| Capital expenditures             |       | 2,229             |       | 915                                    |       | 304        |       | 3,448      |       | 1,621 |   | 44 |   | 1,665 |   | 73 |   | 5,186 |   |
| Property, plant and equipment    |       | 57,931            |       | 15,799                                 |       | 2,211      |       | 75,941     |       | 25,765 |   | 1,057 |   | 26,822 |   | 181 |   | 102,944 |   |
| Total assets                     |       | 178,262           |       | 85,033                                 |       | 23,349     |       | 286,644    |       | 371,786 |   | 11,476 |   | 383,262 |   | (192,361 | ) | 477,545 |   |
|                             |       |              |       |                                   |       |       |       |       |       |   |   |   |   |   |   |   |   |   |   |
| **2003**                         |       |              |       |                                   |       |       |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Revenues from external customers |       | $                 | 107,997    |                                   | $          | 47,276     |       | $          | 24,487     |   | $ | 179,760 |   | $ | 152,914 |   | $ | 4,546 |   | $ | 157,460 |   | $ | — |   | $ | 337,220 |   |
| Operating profit                 |       | 12,018            |       | 6,784                                  |       | 2,963      |       | 21,765     |       | 2,794 |   | 145 |   | 2,939 |   | (1,880 | ) | 22,824 |   |
| Interest income                  |       | (26               | )          | (66                                    | )          | (20        | )          | (112       | )          | (2,063 | ) | — |   | (2,063 | ) | — |   | (2,175 | ) |
| Interest expense                 |       | 9,594             |       | 190                                    |       | 162        |       | 9,946      |       | 24,485 |   | — |   | 24,485 |   | (20,311 | ) | 14,120 |   |
| Depreciation and amortization    |       | 4,424             |       | 1,343                                  |       | 231        |       | 5,998      |       | 4,430 |   | 21 |   | 4,451 |   | 510 |   | 10,959 |   |
| Income tax provision (benefit)   |       | 1,038             |       | 2,806                                  |       | 1,101      |       | 4,945      |       | (5,916 | ) | 60 |   | (5,856 | ) | 5,609 |   | 4,698 |   |
| Net income (loss)                |       | 3,139             |       | 4,581                                  |       | 1,901      |       | 9,621      |       | (13,163 | ) | 87 |   | (13,076 | ) | 13,153 |   | 9,698 |   |
| Capital expenditures             |       | 1,790             |       | 725                                    |       | 229        |       | 2,744      |       | 2,636 |   | — |   | 2,636 |   | 82 |   | 5,462 |   |
| Property, plant and equipment    |       | 58,749            |       | 14,909                                 |       | 1,721      |       | 75,379     |       | 23,382 |   | 4 |   | 23,386 |   | 172 |   | 98,937 |   |
| Total assets                     |       | 139,855           |       | 76,307                                 |       | 16,756     |       | 232,918    |       | 350,101 |   | 3,586 |   | 353,687 |   | (140,940 | ) | 445,665 |   |

 

68

----

 

**18.****      ****Summary of Bond Guarantees**

 

On April 19, 2001, we completed a $150.0million 8.75% Senior Note offering. We subsequently repurchased $4.7 million ofthese notes in 2002, issued $29.0 million of these notes in 2004, andrepurchased $8.2 million of these notes in December 2005. Our paymentobligations under the 8.75% Senior Notes are fully and unconditionallyguaranteed on a joint and several basis by Conn-Selmer, Leblanc, Steinway, andcertain other of our direct and indirect wholly-owned subsidiaries, each a “Guarantor”(the “Guarantor Subsidiaries”). These subsidiaries represent all of our (the “Issuer”)operations conducted in the United States.

 

The following condensed consolidating supplementarydata illustrates the composition of the combined Guarantors. Separate completefinancial statements of the respective Guarantors would not provide additionalmaterial information that would be useful in assessing the financialcomposition of the Guarantors. No single Guarantor has any significant legalrestrictions on the ability of investors or creditors to obtain access to itsassets in the event of default on the Guarantee other than its subordination tosenior indebtedness.

 

We record investments in subsidiaries using the costmethod for purposes of the supplemental consolidating presentation. Earnings ofsubsidiaries are therefore not reflected in our investment accounts andearnings. The principal elimination entries eliminate investments insubsidiaries and intercompany balances and transactions.

 

69

----

 

SteinwayMusical Instruments, Inc. and Subsidiaries

**CONDENSED CONSOLIDATING STATEMENTS OF INCOME**

YearEnded December 31, 2005 (In Thousands)

 
| ** **                        | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net sales                         |       | $                    | —     |                        | $          | 302,680                          |       | $                          | 100,759    |             | $          | (16,296 | ) | $ | 387,143 |   |
| Cost of sales                     |       | —               |       | 230,318                     |       | 61,304                           |       | (16,013                    | )          | 275,609          |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Gross profit                      |       | —               |       | 72,362                      |       | 39,455                           |       | (283                       | )          | 111,534          |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Operating expenses:               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Sales and  marketing              |       | —               |       | 32,800                      |       | 13,099                           |       | —                     |       | 45,899           |       |
| General and  administrative       |       | 7,390                |       | 15,081                      |       | 6,729                            |       | —                     |       | 29,200           |       |
| Amortization                      |       | 466                  |       | 634                         |       | 16                               |       | —                     |       | 1,116            |       |
| Other  operating (income) expense |       | (5,325               | )          | 4,280                       |       | 1,527                            |       | —                     |       | 482              |       |
| Total operating expenses          |       | 2,531                |       | 52,795                      |       | 21,371                           |       | —                     |       | 76,697           |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss) from operations     |       | (2,531               | )          | 19,567                      |       | 18,084                           |       | (283                       | )          | 34,837           |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Other (income)  expense, net      |       | 532                  |       | (1,055                      | )          | (277                             | )          | —                     |       | (800             | )          |
| Interest  income                  |       | (15,049              | )          | (24,275                     | )          | (307                             | )          | 36,296                     |       | (3,335           | )          |
| Interest  expense                 |       | 15,536               |       | 37,140                      |       | 600                              |       | (36,296                    | )          | 16,980           |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss) before income taxes |       | (3,550               | )          | 7,757                       |       | 18,068                           |       | (283                       | )          | 21,992           |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income tax provision              |       | 629                  |       | 1,836                       |       | 5,732                            |       | 3                          |       | 8,200            |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income (loss)                 |       | $                    | (4,179     | )                           | $          | 5,921                            |       | $                          | 12,336     |             | $          | (286 | ) | $ | 13,792 |   |

 

70

----

 

Steinway Musical Instruments, Inc. and Subsidiaries

**CONDENSED CONSOLIDATING STATEMENTS OF INCOME**

Year Ended December 31, 2004 (In Thousands)

 
| ** **                        | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net sales                         |       | $                    | —     |                        | $          | 298,431                          |       | $                          | 91,927     |             | $          | (15,324 | ) | $ | 375,034 |   |
| Cost of sales                     |       | —               |       | 225,872                     |       | 55,336                           |       | (15,307                    | )          | 265,901          |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Gross profit                      |       | —               |       | 72,559                      |       | 36,591                           |       | (17                        | )          | 109,133          |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Operating expenses:               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Sales and  marketing              |       | —               |       | 31,692                      |       | 12,622                           |       | 18                         |       | 44,332           |       |
| General and  administrative       |       | 8,381                |       | 14,441                      |       | 6,485                            |       | (44                        | )          | 29,263           |       |
| Amortization                      |       | 464                  |       | 626                         |       | 4                                |       | —                     |       | 1,094            |       |
| Other  operating (income) expense |       | (6,412               | )          | 5,000                       |       | 1,996                            |       | (18                        | )          | 566              |       |
| Facility rationalization  charges |       | —               |       | (363                        | )          | —                           |       | —                     |       | (363             | )          |
| Total operating expenses          |       | 2,433                |       | 51,396                      |       | 21,107                           |       | (44                        | )          | 74,892           |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss) from operations     |       | (2,433               | )          | 21,163                      |       | 15,484                           |       | 27                         |       | 34,241           |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Other (income)  expense, net      |       | (21                  | )          | (1,694                      | )          | (1,492                           | )          | 44                         |       | (3,163           | )          |
| Interest  income                  |       | (14,639              | )          | (22,736                     | )          | (225                             | )          | 34,771                     |       | (2,829           | )          |
| Interest  expense                 |       | 15,197               |       | 35,552                      |       | 288                              |       | (34,771                    | )          | 16,266           |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss) before income taxes |       | (2,970               | )          | 10,041                      |       | 16,913                           |       | (17                        | )          | 23,967           |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income tax provision (benefit)    |       | (3,247               | )          | 6,920                       |       | 4,436                            |       | (9                         | )          | 8,100            |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income (loss)                 |       | $                    | 277        |                        | $          | 3,121                            |       | $                          | 12,477     |             | $          | (8 | ) | $ | 15,867 |   |

 

71

----

 

Steinway Musical Instruments, Inc. and Subsidiaries

**CONDENSED CONSOLIDATING STATEMENTS OF INCOME**

Year Ended December 31, 2003 (In Thousands)

 
| ** **                        | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net sales                         |       | $                    | —     |                        | $          | 268,454                          |       | $                          | 79,436     |             | $          | (10,670 | ) | $ | 337,220 |   |
| Cost of sales                     |       | —               |       | 203,514                     |       | 51,673                           |       | (10,520                    | )          | 244,667          |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Gross profit                      |       | —               |       | 64,940                      |       | 27,763                           |       | (150                       | )          | 92,553           |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Operating expenses:               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Sales and marketing               |       | —               |       | 30,327                      |       | 11,474                           |       | (82                        | )          | 41,719           |       |
| General and administrative        |       | 4,694                |       | 13,259                      |       | 5,181                            |       | —                     |       | 23,134           |       |
| Amortization                      |       | 452                  |       | 698                         |       | 4                                |       | —                     |       | 1,154            |       |
| Other operating (income) expense  |       | (3,266               | )          | 2,962                       |       | 986                              |       | 82                         |       | 764              |       |
| Facility rationalization charges  |       | —               |       | 2,958                       |       | —                           |       | —                     |       | 2,958            |       |
| Total operating expenses          |       | 1,880                |       | 50,204                      |       | 17,645                           |       | —                     |       | 69,729           |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss) from operations     |       | (1,880               | )          | 14,736                      |       | 10,118                           |       | (150                       | )          | 22,824           |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Other (income) expense, net       |       | 7                    |       | (2,614                      | )          | (910                             | )          | —                     |       | (3,517           | )          |
| Interest income                   |       | (14,630              | )          | (20,895                     | )          | (86                              | )          | 33,436                     |       | (2,175           | )          |
| Interest expense                  |       | 13,125               |       | 34,079                      |       | 352                              |       | (33,436                    | )          | 14,120           |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss) before income taxes |       | (382                 | )          | 4,166                       |       | 10,762                           |       | (150                       | )          | 14,396           |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income tax provision (benefit)    |       | (134                 | )          | 865                         |       | 4,046                            |       | (79                        | )          | 4,698            |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income (loss)                 |       | $                    | (248       | )                           | $          | 3,301                            |       | $                          | 6,716      |             | $          | (71 | ) | 9,698 |   |
|                                   |            |                      |            |                             |            |                                  |            |                            |            |                  |            |  |  |  |  |  |

 

72

----

 

SteinwayMusical Instruments, Inc. and Subsidiaries

**CONDENSED CONSOLIDATING BALANCE SHEETS**

December 31,2005 (In Thousands)

 
| ** **                                     | ** ** | **Issuer  Of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                                           |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Assets:                                        |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Current assets:                                |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash                                           |       | $                    | —     |                        | $          | 48,790                           |       | $                          | 14,190     |             | $          | (28,028 | ) | $ | 34,952 |   |
| Accounts,  notes and other receivables, net    |       | —               |       | 71,702                      |       | 10,178                           |       | —                     |       | 81,880           |       |
| Inventories                                    |       | —               |       | 121,712                     |       | 39,279                           |       | (1,681                     | )          | 159,310          |       |
| Prepaid  expenses and other current assets     |       | 3,947                |       | 6,875                       |       | 831                              |       | —                     |       | 11,653           |       |
| Deferred tax  assets                           |       | —               |       | 9,267                       |       | 6,059                            |       | (7,390)                    |       | 7,936            |       |
| Total current assets                           |       | 3,947                |       | 258,346                     |       | 70,537                           |       | (37,099                    | )          | 295,731          |       |
|                                           |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Property, plant and equipment, net             |       | 184                  |       | 79,426                      |       | 17,054                           |       | —                     |       | 96,664           |       |
| Investment in subsidiaries                     |       | 69,643               |       | 115,083                     |       | —                           |       | (184,726                   | )          | —           |       |
| Trademarks                                     |       | —               |       | 9,319                       |       | 3,800                            |       | 114                        |       | 13,233           |       |
| Goodwill                                       |       | —               |       | 17,973                      |       | 12,115                           |       | —                     |       | 30,088           |       |
| Other intangibles, net                         |       | 2,341                |       | 1,718                       |       | 69                               |       | —                     |       | 4,128            |       |
| Other assets                                   |       | 4,151                |       | 9,180                       |       | 2,480                            |       | —                     |       | 15,811           |       |
| Total assets                                   |       | $                    | 80,266     |                        | $          | 491,045                          |       | $                          | 106,055    |             | $          | (221,711 | ) | $ | 455,655 |   |
|                                           |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Liabilities and stockholders’ equity      |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Current liabilities:                           |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Current  portion of long-term debt             |       | $                    | —     |                        | $          | 7,822                            |       | $                          | 5,155      |             | $          | — |   | $ | 12,977 |   |
| Accounts  payable                              |       | 464                  |       | 9,598                       |       | 3,743                            |       | —                     |       | 13,805           |       |
| Other  current liabilities                     |       | 4,876                |       | 24,608                      |       | 15,923                           |       | (308                       | )          | 45,099           |       |
| Total current liabilities                      |       | 5,340                |       | 42,028                      |       | 24,821                           |       | (308                       | )          | 71,881           |       |
|                                           |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Long-term debt                                 |       | 167,526              |       | 52,217                      |       | —                           |       | (28,028                    | )          | 191,715          |       |
| Intercompany                                   |       | (177,624             | )          | 179,433                     |       | (1,674                           | )          | (135                       | )          | —           |       |
| Deferred tax liabilities                       |       | 85                   |       | 17,768                      |       | 4,863                            |       | (7,390                     | )          | 15,326           |       |
| Other non-current liabilities                  |       | 1,132                |       | 4,161                       |       | 22,610                           |       | —                     |       | 27,903           |       |
| Total liabilities                              |       | (3,541               | )          | 295,607                     |       | 50,620                           |       | (35,861                    | )          | 306,825          |       |
|                                           |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Stockholders’ equity                      |       | 83,807               |       | 195,438                     |       | 55,435                           |       | (185,850                   | )          | 148,830          |       |
|                                           |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Total liabilites and stockholders’ equity |       | $                    | 80,266     |                        | $          | 491,045                          |       | $                          | 106,055    |             | $          | (221,711 | ) | $ | 455,655 |   |

 

73

----

 

Steinway Musical Instruments, Inc. and Subsidiaries

**CONDENSED CONSOLIDATING BALANCE SHEETS**

December 31, 2004 (In Thousands)

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

 

74

----

 

SteinwayMusical Instruments, Inc. and Subsidiaries

**CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS**

YearEnded December 31, 2005 (In Thousands)

 
| ** **                                                                           | ** ** | **Issuer  Of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
| Cash flows from operating activities:                                                |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income  (loss)                                                                   |       | $                    | (4,179     | )                           | $          | 5,921                            |       | $                          | 12,336     |             | $          | (286 | ) | $ | 13,792 |   |
| Adjustments  to reconcile net income (loss) to cash flows from operating activities: |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Depreciation  and amortization                                                       |       | 555                  |       | 8,859                       |       | 1,851                            |       | 2                          |       | 11,267           |       |
| Amortization  of bond premium                                                        |       | (252                 | )          | —                      |       | —                           |       | —                     |       | (252             | )          |
| Loss on  extinguishment of debt                                                      |       | 538                  |       | —                      |       | —                           |       | —                     |       | 538              |       |
| Deferred tax  expense (benefit)                                                      |       | 22                   |       | 971                         |       | (1,580                           | )          | (95                        | )          | (682             | )          |
| Tax benefit  associated with stock option exercises                                  |       | 170                  |       | —                      |       | —                           |       | —                     |       | 170              |       |
| Other                                                                                |       | —               |       | 339                         |       | (67                              | )          | —                     |       | 272              |       |
| Changes in  operating assets and liabilities:                                        |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Accounts,  notes and other receivables                                               |       | —               |       | 3,074                       |       | 1,881                            |       | —                     |       | 4,955            |       |
| Inventories                                                                          |       | —               |       | 4,970                       |       | 102                              |       | 416                        |       | 5,488            |       |
| Prepaid  expenses and other assets                                                   |       | (895                 | )          | 2,072                       |       | 12                               |       | —                     |       | 1,189            |       |
| Accounts  payable                                                                    |       | (213                 | )          | (1,118                      | )          | 828                              |       | —                     |       | (503             | )          |
| Other  liabilities                                                                   |       | (3,538               | )          | (3,062                      | )          | 1,697                            |       | 98                         |       | (4,805           | )          |
| Cash flows from operating activities                                                 |       | (7,792               | )          | 22,026                      |       | 17,060                           |       | 135                        |       | 31,429           |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from investing activities:                                                |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Capital  expenditures                                                                |       | (92                  | )          | (3,839                      | )          | (1,073                           | )          | —                     |       | (5,004           | )          |
| Proceeds  from sales of property, plant and equipment                                |       | —               |       | 966                         |       | 449                              |       | —                     |       | 1,415            |       |
| Acquisition  of business, net of cash acquired                                       |       | —               |       | (2,167                      | )          | —                           |       | —                     |       | (2,167           | )          |
| Cash flows from investing activities                                                 |       | (92                  | )          | (5,040                      | )          | (624                             | )          | —                     |       | (5,756           | )          |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from financing activities:                                                |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Borrowings  under lines of credit                                                    |       | —               |       | 184,785                     |       | 4,059                            |       | —                     |       | 188,844          |       |
| Repayments  under lines of credit                                                    |       | —               |       | (188,613                    | )          | (5,512                           | )          | 3,828                      |       | (190,297         | )          |
| Premium paid  on debt extinguishment                                                 |       | (407                 | )          | —                      |       | —                           |       | —                     |       | (407             | )          |
| Repayment of  long-term debt                                                         |       | (8,151               | )          | (7,612                      | )          | —                           |       | —                     |       | (15,763          | )          |
| Proceeds  from issuance of stock                                                     |       | 1,763                |       | —                      |       | —                           |       | —                     |       | 1,763            |       |
| Intercompany  dividends                                                              |       | 54,754               |       | (41,186                     | )          | (13,568                          | )          | —                     |       | —           |       |
| Intercompany  transactions                                                           |       | (40,075              | )          | 39,440                      |       | 770                              |       | (135                       | )          | —           |       |
| Cash flows from financing activities                                                 |       | 7,884                |       | (13,186                     | )          | (14,251                          | )          | 3,693                      |       | (15,860          | )          |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Effect of exchange rate changes on cash                                              |       | —               |       | —                      |       | (2,233                           | )          | —                     |       | (2,233           | )          |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Increase (decrease) in cash                                                          |       | —               |       | 3,800                       |       | (48                              | )          | 3,828                      |       | 7,580            |       |
| Cash, beginning of period                                                            |       | —               |       | 44,990                      |       | 14,238                           |       | (31,856                    | )          | 27,372           |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash, end of period                                                                  |       | $                    | —     |                        | $          | 48,790                           |       | $                          | 14,190     |             | $          | (28,028 | ) | $ | 34,952 |   |

 

75

----

 

Steinway Musical Instruments, Inc. and Subsidiaries

**CONDENSED CONSOLIDATING STATEMENTS OF CASHFLOWS**

Year Ended December 31, 2004 (In Thousands)

 
| ** **                                                                           | ** ** | **Issuer  Of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
| Cash flows from operating activities:                                                |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income  (loss)                                                                   |       | $                    | 277        |                        | $          | 3,121                            |       | $                          | 12,477     |             | $          | (8 | ) | $ | 15,867 |   |
| Adjustments  to reconcile net income (loss) to cash flows from operating activities: |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Depreciation  and amortization                                                       |       | 526                  |       | 8,904                       |       | 1,756                            |       | (3                         | )          | 11,183           |       |
| Amortization  of bond premium                                                        |       | (230                 | )          | —                      |       | —                           |       | —                     |       | (230             | )          |
| Facility  rationalization charges                                                    |       | —               |       | (363                        | )          | —                           |       | —                     |       | (363             | )          |
| Deferred tax  expense (benefit)                                                      |       | 63                   |       | 921                         |       | (2,461                           | )          | (1,020                     | )          | (2,497           | )          |
| Tax benefit  associated with stock option exercises                                  |       | 759                  |       | —                      |       | —                           |       | —                     |       | 759              |       |
| Other                                                                                |       | (7                   | )          | 292                         |       | 174                              |       | —                     |       | 459              |       |
| Changes in  operating assets and liabilities:                                        |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Accounts,  notes and other receivables                                               |       | —               |       | (1,313                      | )          | 1,020                            |       | —                     |       | (293             | )          |
| Inventories                                                                          |       | —               |       | 5,330                       |       | (3,347                           | )          | 20                         |       | 2,003            |       |
| Prepaid  expenses and other assets                                                   |       | (1,974               | )          | (2,101                      | )          | (1,413                           | )          | —                     |       | (5,488           | )          |
| Accounts  payable                                                                    |       | 554                  |       | 1,548                       |       | (683                             | )          | —                     |       | 1,419            |       |
| Other  liabilities                                                                   |       | 19,487               |       | (20,923                     | )          | 1,479                            |       | 1,011                      |       | 1,054            |       |
| Cash flows from operating activities                                                 |       | 19,455               |       | (4,584                      | )          | 9,002                            |       | —                     |       | 23,873           |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from investing activities:                                                |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Capital  expenditures                                                                |       | (73                  | )          | (3,850                      | )          | (1,263                           | )          | —                     |       | (5,186           | )          |
| Proceeds  from sales of property, plant and equipment                                |       | 9                    |       | 1,206                       |       | 18                               |       | —                     |       | 1,233            |       |
| Acquisition  of business, net of cash acquired                                       |       | —               |       | (36,859                     | )          | 92                               |       | —                     |       | (36,767          | )          |
| Cash flows from investing activities                                                 |       | (64                  | )          | (39,503                     | )          | (1,153                           | )          | —                     |       | (40,720          | )          |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from financing activities:                                                |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Borrowings  under lines of credit                                                    |       | —               |       | 193,406                     |       | 19,473                           |       | (53,092                    | )          | 159,787          |       |
| Repayments  under lines of credit                                                    |       | (24                  | )          | (140,290                    | )          | (16,538                          | )          | —                     |       | (156,852         | )          |
| Debt  issuance costs                                                                 |       | (105                 | )          | —                      |       | —                           |       | —                     |       | (105             | )          |
| Repayment of  long-term debt                                                         |       | —               |       | (7,555                      | )          | —                           |       | —                     |       | (7,555           | )          |
| Proceeds  from issuance of stock                                                     |       | 5,744                |       | —                      |       | —                           |       | —                     |       | 5,744            |       |
| Intercompany  dividends                                                              |       | —               |       | 3,667                       |       | (3,667                           | )          | —                     |       | —           |       |
| Intercompany  transactions                                                           |       | (25,006              | )          | 27,594                      |       | (2,588                           | )          | —                     |       | —           |       |
| Cash flows from financing activities                                                 |       | (19,391              | )          | 76,822                      |       | (3,320                           | )          | (53,092                    | )          | 1,019            |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Effect of exchange rate changes on cash                                              |       | —               |       | —                      |       | 917                              |       | —                     |       | 917              |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Increase (decrease) in cash                                                          |       | —               |       | 32,735                      |       | 5,446                            |       | (53,092                    | )          | (14,911          | )          |
| Cash, beginning of period                                                            |       | —               |       | 12,255                      |       | 8,792                            |       | 21,236                     |       | 42,283           |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash, end of period                                                                  |       | $                    | —     |                        | $          | 44,990                           |       | $                          | 14,238     |             | $          | (31,856 | ) | $ | 27,372 |   |

 

76

----

 

Steinway Musical Instruments, Inc. and Subsidiaries

**CONDENSED CONSOLIDATING STATEMENTS OF CASHFLOWS**

Year Ended December 31, 2003 (In Thousands)

 
| ** **                                                                           | ** ** | **Issuer  Of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
| Cash flows from operating activities:                                                |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income  (loss)                                                                   |       | $                    | (248       | )                           | $          | 3,301                            |       | $                          | 6,716      |             | $          | (71 | ) | $ | 9,698 |   |
| Adjustments  to reconcile net income (loss) to cash flows from operating activities: |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Depreciation  and amortization                                                       |       | 510                  |       | 8,854                       |       | 1,595                            |       | —                     |       | 10,959           |       |
| Facility  rationalization charges                                                    |       | —               |       | 4,158                       |       | —                           |       | —                     |       | 4,158            |       |
| Deferred tax  expense (benefit)                                                      |       | —               |       | (4,935                      | )          | 1,518                            |       | 816                        |       | (2,601           | )          |
| Other                                                                                |       | 11                   |       | 178                         |       | 140                              |       | —                     |       | 329              |       |
| Changes in  operating assets and liabilities:                                        |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Accounts,  notes and other receivables                                               |       | —               |       | 2,411                       |       | 464                              |       | (92                        | )          | 2,783            |       |
| Inventories                                                                          |       | —               |       | 6,485                       |       | 738                              |       | 150                        |       | 7,373            |       |
| Prepaid  expenses and other assets                                                   |       | (496                 | )          | (174                        | )          | (187                             | )          | —                     |       | (857             | )          |
| Accounts  payable                                                                    |       | 25                   |       | 948                         |       | 35                               |       | 78                         |       | 1,086            |       |
| Other  liabilities                                                                   |       | 197                  |       | (1,187                      | )          | (150                             | )          | (895                       | )          | (2,035           | )          |
| Cash flows from operating activities                                                 |       | (1                   | )          | 20,039                      |       | 10,869                           |       | (14                        | )          | 30,893           |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from investing activities:                                                |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Capital  expenditures                                                                |       | (82                  | )          | (4,426                      | )          | (954                             | )          | —                     |       | (5,462           | )          |
| Proceeds  from sales of property, plant and equipment                                |       | —               |       | 10                          |       | —                           |       | —                     |       | 10               |       |
| Capital  contribution to subsidiary                                                  |       | 1,370                |       | (5,083                      | )          | 3,713                            |       | —                     |       | —           |       |
| Cash flows from investing activities                                                 |       | 1,288                |       | (9,499                      | )          | 2,759                            |       | —                     |       | (5,452           | )          |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from financing activities:                                                |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Borrowings  under lines of credit                                                    |       | —               |       | 5,119                       |       | 5,487                            |       | —                     |       | 10,606           |       |
| Repayments  under lines of credit                                                    |       | (29                  | )          | (15,129                     | )          | (3,197                           | )          | 10,039                     |       | (8,316           | )          |
| Repayment of  long-term debt                                                         |       | —               |       | (6,512                      | )          | —                           |       | —                     |       | (6,512           | )          |
| Proceeds  from issuance of stock                                                     |       | 1,455                |       | —                      |       | —                           |       | —                     |       | 1,455            |       |
| Intercompany  dividends                                                              |       | —               |       | 6,194                       |       | (6,194                           | )          | —                     |       | —           |       |
| Intercompany  transactions                                                           |       | (2,713               | )          | 10,877                      |       | (8,178                           | )          | 14                         |       | —           |       |
| Cash flows from financing activities                                                 |       | (1,287               | )          | 549                         |       | (12,082                          | )          | 10,053                     |       | (2,767           | )          |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Effect of exchange rate changes on cash                                              |       | —               |       | —                      |       | 510                              |       | —                     |       | 510              |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Increase in cash                                                                     |       | —               |       | 11,089                      |       | 2,056                            |       | 10,039                     |       | 23,184           |       |
| Cash, beginning of period                                                            |       | —               |       | 1,166                       |       | 6,736                            |       | 11,197                     |       | 19,099           |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash, end of period                                                                  |       | $                    | —     |                        | $          | 12,255                           |       | $                          | 8,792      |             | $          | 21,236 |   | $ | 42,283 |   |

 

77

----

 

**19.****                              ****Subsequent Events**

 

On February 2, 2006, we repaid our acquisitionterm loan, which had an outstanding balance of $16.6 million as of December 31,2005. As a result of the write-off of associated deferred financing costs, werecorded a loss of $1.0 million on extinguishment of this debt in the firstquarter of 2006.

 

On February 23, 2006 we completed a $175.0million offering of 7% Senior Notes at 99.2435% of face value, which resultedin net proceeds to us of $170.2 million. We used $123.6 million of the proceedsto redeem $114.6 million of our 8.75% Senior Notes (including accrued interestand associated premiums) pursuant to our tender offer to repurchase thesenotes. The early retirement of these notes will generate a net loss onextinguishment of $5.4 million in the first quarter. This net loss is comprisedprimarily of $5.5 million of tender and consent premiums paid to bondholders,as the $1.2 million of loss on write-off of deferred financing costs isessentially offset by the $1.3 million of gain recorded due to our write-off ofthe bond premium associated with the pre-existing 8.75% Senior Notes.

 

We shall use the remainder of the proceeds fromissuance of the 7% Senior Notes, supplemented by cash on hand, to pay outstandingdebt issuance costs, such as legal fees, and to redeem the remaining $51.6million of 8.75% Senior Notes, which we have called at 104.375% plus accruedinterest. The early retirement of these remaining notes, which will occur in April 2006,will generate a loss on extinguishment of $3.3 million. This loss is comprisedof $2.3 million of call premiums paid to bondholders and $1.0 million due tothe write-off of the remaining deferred financing costs associated with the8.75% Senior Notes.

 

78

----

 

**20. Quarterly Financial Data (Unaudited)**

 

The net earnings for the fourth quarter of 2005 were impacted by thefollowing items which varied from our results in the first three quarters.First, we recorded a charge to cost of sales of $0.9 million based on theresults of our annual physical inventories conducted at our domestic piano andband facilities. In addition, responding to changes in our band division’sproduct line we updated our estimates for certain older product categories andincreased our lower of cost or market reserve by $0.7 million. Lastly, thefourth quarter results produced a higher than expected foreign tax creditutilization. This resulted in a reduction in our effective tax rate from the40% estimate in prior quarters to 37.3% for the full fiscal year.

 

Thefollowing is a summary of unaudited results of operations, in thousands exceptshare and per share data.

 
| ** **                                | ** ** | **2005**           | ** ** |
|-------------------------------------------|------------|--------------------|------------|
| **For the years ended December 31,** | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|                                      |       |               |       |   |   |   |   |   |   |
| Net sales                                 |       | $                  | 91,342     |   | $ | 89,761 |   | $ | 95,914 |   | $ | 110,126 |   |
| Gross profit                              |       | 25,697             |       | 26,126 |   | 27,496 |   | 32,215 |   |
| Net income                                |       | 2,598              |       | 2,418 |   | 3,743 |   | 5,033 |   |
|                                      |       |               |       |   |   |   |   |   |   |
| Basic earnings per share                  |       | $                  | 0.32       |   | $ | 0.30 |   | $ | 0.46 |   | $ | 0.62 |   |
| Diluted earnings per share                |       | $                  | 0.32       |   | $ | 0.29 |   | $ | 0.45 |   | $ | 0.61 |   |
|                                      |       |               |       |   |   |   |   |   |   |
| Weighted average shares:                  |       |               |       |   |   |   |   |   |   |
| Basic                                     |       | 8,030,879          |       | 8,052,418 |   | 8,088,022 |   | 8,107,564 |   |
| Diluted                                   |       | 8,241,196          |       | 8,276,096 |   | 8,284,461 |   | 8,254,717 |   |

 
| ** **                 | ** ** | **2004**            | ** ** |
|----------------------------|------------|---------------------|------------|
| ** **                 | ** ** | **First   Quarter** | ** ** | **Second   Quarter** | ** ** | **Third   Quarter** | ** ** | **Fourth   Quarter** | ** ** |
|                       |       |                |       |   |   |   |   |   |   |
| Net sales                  |       | $90,061             |       | $83,688 |   | $94,653 |   | $106,632 |   |
| Gross profit               |       | 25,725              |       | 24,403 |   | 25,896 |   | 33,109 |   |
| Net income                 |       | 3,344               |       | 2,714 |   | 2,828 |   | 6,981 |   |
|                       |       |                |       |   |   |   |   |   |   |
| Basic earnings per share   |       | $0.41               |       | $0.34 |   | $0.35 |   | $0.87 |   |
| Diluted earnings per share |       | $0.39               |       | $0.33 |   | $0.34 |   | $0.85 |   |
|                       |       |                |       |   |   |   |   |   |   |
| Weighted average shares:   |       |                |       |   |   |   |   |   |   |
| Basic                      |       | 8,210,407           |       | 7,957,483 |   | 7,998,481 |   | 8,018,655 |   |
| Diluted                    |       | 8,519,707           |       | 8,340,726 |   | 8,282,498 |   | 8,229,775 |   |

 

79

----

 

**Item 9. Changes in and Disagreements with Accountantson Accounting and Financial Disclosure**

 

Notapplicable.

 

**Item 9A. Controls and Procedures**

 

### **Disclosure Controls and Procedures**

 

Our principal executive officer and our principalfinancial officer, after evaluating together with management, the effectivenessof the design and operation of our disclosure controls and procedures (asdefined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of December 31,2005, the end of the period covered by this report, have concluded that, as ofsuch date, our disclosure controls and procedures were adequate and effectiveto ensure that material information relating to our Company and ourconsolidated subsidiaries would be made known to them by others within thoseentities.

 

### **Internal Control Over Financial Reporting**

###  

There were changes in our Company’s internal controlover financial reporting that occurred during the fourth quarter of 2005 whichresulted from control improvement and remediation efforts. These changes havenot materially affected, and are not likely to materially affect, our Company’sinternal control over financial reporting.

 

**MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVERFINANCIAL REPORTING**

 

Themanagement of Steinway Musical Instruments, Inc. and its subsidiaries (the“Company”) is responsible for establishing and maintaining adequate internalcontrol over financial reporting as defined in Rules 13a - 15(f) and15d - 15(f) under the Securities Exchange Act of 1934. The Company’sinternal control over financial reporting is a process designed by, or underthe supervision of, the Company’s principal executive and principal financialofficers, and effected by the Company’s board of directors, management andother personnel, to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of the Company’s financial statementsfor external purposes in accordance with generally accepted accountingprinciples. Internal control over financial reporting includes those policiesand procedures that:

 

(1)                                pertain to the maintenance of records that,in reasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the Company;

 

(2)                                provide reasonable assurance thattransactions are recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accounting principles;

 

(3)                                provide reasonable assurance that receiptsand expenditures of the Company are being made only in accordance withauthorizations of management and directors of the Company; and

 

(4)                                provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use or dispositionof the Company’s assets that could have a material effect on the financialstatements.

 

80

----

 

InternalControl over financial reporting includes the controls themselves, monitoringand internal auditing practices and actions taken to correct deficiencies asidentified.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

 

TheCompany’s management assessed the effectiveness of the Company’s internalcontrol over financial reporting as of December 31, 2005. In making thisassessment, the Company’s management used the criteria set forth by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO) in *Internal Control - Integrated Framework*. Management reviewedthe results of its assessment with the Audit Committee of its Board ofDirectors.

 

Basedon its assessment, management determined that, as of December 31, 2005,the Company’s internal control over financial reporting is effective.

 

Deloitte &Touche LLP, the independent registered public accounting firm that audited thefinancial statements included in this annual report, has issued an attestationreport on management’s assessment of the Company’s internal control overfinancial reporting.

 

 
| By:    | /s/                     | Dana D. Messina  |   |
|--------|-------------------------|------------------|--------|
|   | Dana D. Messina         |
|   | Chief Executive Officer |
|   | March 30, 2006     |
|   |                    |
|   |                    |
| By:    | /s/                     | Dennis M. Hanson |   |
|   | Dennis M. Hanson        |
|   | Chief Financial Officer |
|   | March 30, 2006     |

 

81

----

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors and Stockholders of

SteinwayMusical Instruments, Inc.

Waltham,Massachusetts

 

Wehave audited management’s assessment, included in the accompanying Management’sAnnual Report on Internal Control Over Financial Reporting, that SteinwayMusical Instruments, Inc. and its subsidiaries (the “Company”) maintainedeffective internal control over financial reporting as of December 31,2005 based on criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission. The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express an opinion on management’sassessment and an opinion on the effectiveness of the Company’s internalcontrol over financial reporting based on our audit.

 

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internalcontrol over financial reporting, evaluating management’s assessment, testingand evaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinions.

 

Acompany’s internal control over financial reporting is a process designed by,or under the supervision of, the company’s principal executive and principalfinancial officers, or persons performing similar functions, and effected bythe company’s board of directors, management, and other personnel to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles. A company’s internal control overfinancial reporting includes those policies and procedures that (1) pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permit preparationof financial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Becauseof the inherent limitations of internal control over financial reporting,including the possibility of collusion or improper management override ofcontrols, material misstatements due to error or fraud may not be prevented ordetected on a timely basis. Also, projections of any evaluation of the effectivenessof the internal control over financial reporting to future periods are subjectto the risk that the controls may become inadequate because of changes inconditions, or that the degree of compliance with the policies or proceduresmay deteriorate.

 

Inour opinion, management’s assessment that the Company maintained effectiveinternal control over financial reporting as of December 31, 2005, isfairly stated, in all material respects, based on the criteria established in *Internal Control–Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission.Also in our opinion, the Company maintained, in all material respects,effective internal control over financial reporting as of December 31,2005, based on

 

82

----

 

thecriteria established in *Internal Control–IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission.

 

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated financialstatements as of and for the year ended December 31, 2005 of the Companyand our report dated March 30, 2006 expressed an unqualified opinion onthose financial statements.

 
| /s/ DELOITTE & TOUCHE LLP |   |
|------------------------------------|--------|
|                               |
| Boston, Massachusetts              |
| March 30, 2006                |

 

83

----

 

**Item 9B. Other Information**

 

None.

 

### **PART III**

 

**Item 10. Directors and Executive Officers of theRegistrant**

 

The information called for by this item is herebyincorporated by reference to the Registrant’s definitive Proxy Statement forthe fiscal year ended December 31, 2005, which Proxy Statement will befiled with the Securities and Exchange Commission no later than 120 days afterthe end 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, 2005, which Proxy Statement will befiled with the Securities and Exchange Commission no later than 120 days afterthe end of the fiscal year covered by this report.

 

**Item 12. Security Ownership of Certain BeneficialOwners 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, 2005, which Proxy Statement will befiled with the Securities and Exchange Commission no later than 120 days afterthe end of the fiscal year covered by this report.

 

**Item 13. Certain Relationships and RelatedTransactions**

 

The information called for by this item is herebyincorporated by reference to the Registrant’s definitive Proxy Statement forthe fiscal year ended December 31, 2005, which Proxy Statement will befiled with the Securities and Exchange Commission no later than 120 days afterthe end of the fiscal year covered by this report.

 

### **Item 14. Principal Accountant Fees and Services**

###  

The information called for by this item is herebyincorporated by reference to the Registrant’s definitive Proxy Statement forthe fiscal year ended December 31, 2005, which Proxy Statement will befiled with the Securities and Exchange Commission no later than 120 days afterthe end of the fiscal year covered by this report.

 

84

----

 

### **PART IV**

###  

**Item 15. Exhibits and Financial Statement Schedules**

 

(a)                                  The following documents are filed as a partof this report:

 
| 1.     |   | Financial Statements                                               |   |                                                                                             |
|--------|--------|--------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------|
|   |   |                                                               |   |                                                                                             |
|   |   | Report  of Independent Registered Public Accounting Firm           |   |                                                                                             |
|   |   | Consolidated  Statements of Income                                 |   |                                                                                             |
|   |   | Years Ended December 31,  2005, 2004, and 2003                |   |                                                                                             |
|   |   | Consolidated  Balance Sheets as of December 31, 2005 and 2004 |   |                                                                                             |
|   |   | Consolidated  Statements of Cash Flows for the                     |   |                                                                                             |
|   |   | Years Ended December 31,  2005, 2004, and 2003                |   |                                                                                             |
|   |   | Consolidated  Statements of Stockholders’ Equity for the      |   |                                                                                             |
|   |   | Years Ended December 31,  2005, 2004, and 2003                |   |                                                                                             |
|   |   | Notes  to Consolidated Financial Statements                        |   |                                                                                             |
|   |   |                                                               |   |                                                                                             |
| 2.1    |   | Exhibits:                                                          |   | The Exhibits listed below are filed as part of, 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)                                    |

 

85

----

 
| 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 (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 (14)                                                                                                                     |
| 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 (14) |
| 4.7  |   | Sixth Amendment to the Second Amended and Restated Credit Agreement  dated as of January 31, 2004 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. and United Musical Instruments  Holdings, Inc. with and into Conn-Selmer, Inc., Steinway, Inc.,  as borrowers; those signatories identified as guarantors, the lenders, and  GMAC Commercial Credit LLC, as administrative agent (16)                                                      |
| 4.8  |   | Seventh Amendment to the Second Amended and Restated Credit Agreement  dated as of May 26, 2004 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. and United Musical Instrument  Holdings with and into Conn-Selmer, Inc., Steinway, Inc., as  borrowers; those signatories identified as guarantors, the lenders, and GMAC  Commercial Credit LLC, as administrative agent. (18)                                                                   |
| 4.9  |   | Eighth Amendment to the Second Amended and Restated Credit Agreement  dated as of August 11, 2004 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. and United Musical Instruments  Holdings, Inc. with and into Conn-Selmer, Inc., Steinway, Inc.,  as borrowers; those signatories identified as guarantors, the lenders, and  GMAC Commercial Credit LLC, as administrative agent.                                                          |
| 4.10 |   | Ninth Amendment to the Second Amended and Restated Credit Agreement  dated as of February 8, 2006 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. and United Musical Instruments Holdings, Inc. with and  into Conn-Selmer, Inc., Steinway, Inc., as borrowers; those signatories  identified as guarantors, the lenders, and GMAC Commercial Finance LLC  (successor by merger to GMAC Commercial Credit LLC), as administrative agent.                                        |
| 4.11 |   | Registration Rights Agreement, dated as of August 9, 1993, among  Selmer Industries, Inc. and the purchasers of certain equity securities  (1)                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.12 |   | 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)                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.13 |   | Indenture, dated as of February 23, 2006, among Steinway Musical  Instruments, Inc., as Issuer, the subsidiary guarantors; and the Bank of New  York Trust Company, N.A., as Trustee (22)                                                                                                                                                                                                                                                                                                                                                                                           |
| 4.14 |   | 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)                                                                                                                                                                                                                                                                                                                                                                                                                                                           |

 

86

----

 
| 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 (14)                                                                                                                                                                            |
| 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. (14)                                                                                                                    |
| 10.13 |   | Working Agreement between Conn-Selmer, Inc. and United  Automobile, Aerospace and Agriculture Implement Workers of America, Local No. 612  (15)                                                                              |
| 10.14 |   | Working Agreement between Vincent Bach Division of Conn-Selmer, Inc.  and United Automobile, Aerospace and Agricultural Implement Workers of  America Local No. 634 (15)                                                     |
| 10.15 |   | Agreement between Conn-Selmer, Inc. and U.A.W. Local 2359 (20)                                                                                                                                                                    |
| 10.16 |   | Agreement between Steinway, Inc. d/b/a Steinway & Sons  and Local 102 F.W. AFL-CIO (16)                                                                                                                                  |
| 10.17 |   | Labor Contract Agreement between Musser Division and Carpenter Local  1027 Mill-Cabinet-Industrial Division affiliate of Chicago Regional Council  of Carpenters of the United Brotherhood of Carpenters and Jointers of America  (21) |
| 10.18 |   | Labor Contract Agreement between Frank Holton Company and Local No. M94  of the International Brotherhood of Boilermakers, Iron Shipbuilders,  Blacksmiths, Forgers, and Helpers (21)                                                  |
| 10.19 |   | Asset Purchase Agreement (the “Asset Purchase Agreement”) dated July 22,2004  by and between G. Leblanc Corporation, and Steinway Musical Instruments, Inc.  (16)                                                  |
| 10.20 |   | The Deferred Compensation Incentive Plan for Steinway Musical  Instruments, Inc. effective January 1, 2001 (23)                                                                                                              |
| 10.21 |   | Summary Description of Compensation for Non-Employee Directors (24)                                                                                                                                                                    |
| 14.0  |   | Code of Ethics and Professional Conduct (19)                                                                                                                                                                                           |
| 21.1  |   | List of Subsidiaries of the Registrant                                                                                                                                                                                                 |
| 23.1  |   | Consent of Independent Registered Public Accounting Firm- Deloitte &  Touche LLP                                                                                                                                              |
| 31.1  |   | Certification of the Chief Executive Officer Pursuant to Section 302  of the Sarbanes-Oxley Act of 2002                                                                                                                           |
| 31.2  |   | Certification of the Chief Financial Officer Pursuant to Section 302  of the Sarbanes-Oxley Act of 2002                                                                                                                           |
| 32.1  |   | Certification of the Principal Executive Officer pursuant to 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002                                                                  |
| 32.2  |   | Certification of the Principal Financial Officer pursuant to 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                  |

 

___________________
| (1)    |   | Previously filed with the Commission on February 8, 1994 as an  exhibit to the Registrant’s Registration Statement on Form S-1. |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                           |
| (2)    |   | Previously filed with the Commission on June 7, 1995 as an  exhibit to the Registrant’s Current Report on   Form 8-K.           |

 

87

----

 
| (3)    |   | Previously filed with the Commission on June 7, 1995 as an  exhibit to the Registrant’s Registration Statement on Form S-4.                           |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                 |
| (4)    |   | Previously filed with the Commission on May 14, 1996 as an  exhibit to the Registrant’s Registration Statement on Form S-1.                           |
|   |   |                                                                                                                                                                 |
| (5)    |   | Previously filed with the 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 with the Commission on March 27, 1997 as an  exhibit to the Registrant’s Annual Report on   Form 10-K.                               |
|   |   |                                                                                                                                                                 |
| (7)    |   | Previously filed with the Commission on August 16, 1999 as an  exhibit to the Registrant’s Quarterly Report on Form 10-Q.                             |
|   |   |                                                                                                                                                                 |
| (8)    |   | Previously filed with the Commission on July 27, 2000 as an  exhibit to the Registrant’s Current Report on   Form 8-K.                                |
|   |   |                                                                                                                                                                 |
| (9)    |   | Previously filed with the Commission on September 29, 2000 as an  exhibit to the Registrant’s Current Report on Form 8-K.                             |
|   |   |                                                                                                                                                                 |
| (10)   |   | Previously filed with the Commission on August 14, 2001 as an  exhibit to the Registrant’s Quarterly Report on Form 10-Q.                             |
|   |   |                                                                                                                                                                 |
| (11)   |   | Previously filed with the Commission on November 13, 2001 as an  exhibit to the Registrant’s Quarterly Report on Form 10-Q.                           |
|   |   |                                                                                                                                                                 |
| (12)   |   | Previously filed with the Commission on June 12, 2001 as an exhibit  to the Registrant’s Registration Statement on Form S-4.                          |
|   |   |                                                                                                                                                                 |
| (13)   |   | Previously filed with the Commission on March 28, 2001 as an  exhibit to the Registrant’s Annual Report on   Form 10-K.                               |
|   |   |                                                                                                                                                                 |
| (14)   |   | Previously filed with the Commission on March 18, 2003 as an  exhibit to the Registrant’s Annual Report on   Form 10-K.                               |
|   |   |                                                                                                                                                                 |
| (15)   |   | Previously filed with the Commission on August 12, 2003 as an  exhibit to the Registrant’s Quarterly Report on Form 10-Q.                             |
|   |   |                                                                                                                                                                 |
| (16)   |   | Previously filed with the Commission on March 16, 2004 as an  exhibit to the Registrant’s Annual Report on   Form 10-K.                               |
|   |   |                                                                                                                                                                 |
| (17)   |   | Previously filed with the Commission on July 27, 2004 as an  exhibit to the Registrant’s Current Report on   Form 8-K.                                |
|   |   |                                                                                                                                                                 |
| (18)   |   | Previously filed with the Commission on August 5, 2004 as an exhibit to  the Registrant’s Quarterly Report on Form 10-Q.                         |
|   |   |                                                                                                                                                                 |
| (19)   |   | Previously filed with the Commission on March 31, 2005 as an exhibit  to the Registrant’s Annual Report on Form 10-K.                                           |
|   |   |                                                                                                                                                                 |
| (20)   |   | Previously filed with the Commission on May 10, 2005 as an exhibit to  the Registrant’s Quarterly Report on Form 10-Q.                                          |
|   |   |                                                                                                                                                                 |
| (21)   |   | Previously filed with the Commission on November 9, 2005 as an  exhibit to the Registrant’s Quarterly Report on Form 10-Q.                                      |
|   |   |                                                                                                                                                                 |
| (22)   |   | Previously filed with the Commission on February 27, 2006 as an  exhibit to the Registrant’s Current Report on Form 8-K.                                   |
|   |   |                                                                                                                                                                 |
| (23)   |   | Previously filed with the Commission on March 28, 2002 as an exhibit to  the Registrant’s Annual Report on Form 10-K.                                           |
|   |   |                                                                                                                                                                 |
| (24)   |   | Previously filed with the Commission on May 20, 2005 in the  Registrant’s Current Report on Form 8-K.                                                           |

 

88

----

 

**Signatures**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 
| Steinway Musical Instruments, Inc. |                      |
|-----------------------------------------|---------------------------|
|                                    |                      |
|                                    |                      |
| By:                                     |  /s/ Dana D. Messina |   | March 30, 2006 |   |
| Dana D. Messina                         | (Date)                    |
|                                         |                           |  |  |  |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed by the following persons on behalf of the registrant and in thecapacities listen below on March 16, 2006:

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

 

89

----