**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, 2003**                                               |
|       |   |                                                                                          |
| **o**      |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**COMMISSION FILE NUMBER 001-11911**

 

**STEINWAYMUSICAL INSTRUMENTS, INC.**

(Exact name of registrant asspecified in its charter)

 

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

 

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

 

Securities registered pursuant to Section12(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 registered pursuant to Section12(g) of the Act:  **None**

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be 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 to suchfiling requirements during the past 90 days.   Yes ý    No o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not be contained,to the best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of the Form 10-K or anyamendment to this Form 10-K.  ý

 

The aggregate market value of the Common Stock held by non-affiliatesof the registrant was $200,772,583 as of February 27, 2004 and $123,738,394 asof June 28, 2003.

 

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

 

Number of shares of Common Stock outstanding as of February 27, 2004:

 
| Class A  |   | 477,952   |   |
|----------|--------|-----------|--------|
| Ordinary |   | 7,333,742 |   |
| Total    |   | 7,811,694 |   |

 

Documents incorporated byreference:  Part III - Items 10-13 - Definitive Proxy Statement ofthe Registrant to be filed pursuant to Regulation 14A, Parts I-IV - FinalProspectus of the Registrant dated August 1, 1996 filed pursuant to Rule424(b).

 

 

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**NOTE REGARDINGFORWARD-LOOKING STATEMENTS**

 

Certain statements contained throughout this Annual Report on Form 10-Kare “forward-looking statements” within the meaning of Section 21E of theSecurities Exchange Act of 1934, as amended. These forward-looking statements represent our present expectations orbeliefs concerning future events.  Wecaution you that such statements are necessarily based on certain assumptions whichare subject to risks and uncertainties, which could cause actual results todiffer materially from those indicated in this report.  These risk factors include, but are notlimited to, the following: changes in general economic conditions; increased competition;work stoppages and slowdowns; exchange rate fluctuations; variations in the mixof products sold; market acceptance of new band instrument product anddistribution strategies; ability of suppliers to meet demand; and fluctuationsin effective tax rates resulting from shifts in sources of income.  We have included further information onthese factors in our Final Prospectus filed in August 1996 and in RegistrationStatement No. 333-62790 filed in June 2001, particularly in the sectionsentitled “Risk Factors.”  We encourageyou to read those descriptions carefully. We caution investors not to place undue reliance on the forward-lookingstatements contained in this report. These statements, like all statements contained in this report, speakonly as of the date of this report (unless another date is indicated) and weundertake no obligation to update or revise the statements except as requiredby law.

 

### **NOTE REGARDINGINCORPORATION BY REFERENCE**

 

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

 

**PARTI**

 

**ITEM1                   BUSINESS**

 

**Introduction**

 

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

 

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

 

The legalmerger of The Selmer Company, Inc. (“Selmer”) and United Musical Instruments,Inc. (“UMI”) into Conn-Selmer became effective on January 1, 2003. Referencesto “Selmer” and “UMI” refer to events or circumstances prior to the merger.

 

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Our principalexecutive offices are located at 800 South Street, Suite 305, Waltham,Massachusetts, 02453.  Our primarytelephone number is 781-894-9770, and our Internet website is located atwww.steinwaymusical.com.  All of ourfilings with the SEC, including our annual reports on Form 10-K, quarterlyreports on Form 10-Q, and current reports on Form 8-K, are available free ofcharge, immediately upon filing, through the Investor Relations page on ourwebsite.  Additionally, the SECmaintains an Internet site at www.sec.gov that contains reports, proxy andinformation statements and other information regarding issuers that file withthe SEC.

 

We haveadopted a Code of Ethics and Professional Conduct to provide guidance to ourdirectors, officers and employees on matters of business ethics and conduct,including compliance standards, business conduct, conflicts of interest, andidentification, reporting, and resolution of issues.  We have posted this Code, along with our Corporate GovernanceGuidelines and our Audit Committee Charter, on our website.  This information will be made available inprint to any shareholder who requests it.

 

Please notethat information contained on or connected to our website is not incorporatedby reference into this annual report on Form 10-K and should not be consideredpart of this report or any other filing that we make with the SEC.

 

**Financial Informationby Segment and Geographic Location**

 

Our revenues from external customers, operating profit, total assets,and financial information by geographic area for the last three years for ourpiano and band segments can be found in Note 17 to the consolidated financialstatements included in this filing.

 

**Business andProducts**

 

We are organized into two reportable segments – pianos and band andorchestral instruments.  Our pianodivision concentrates on the high-end grand piano market, handcrafting Steinwaypianos in New York and Germany.  We alsooffer upright pianos as well as two mid-priced lines of pianos under the Bostonand Essex brand names.  Moreover, we arethe largest domestic producer of band and orchestral instruments and offer acomplete line of brasswind, woodwind, percussion and stringed instruments andrelated accessories with well known brand names such as *Bach, C.G. Conn,**King,*and *Ludwig*.

 

The Steinway & Sons grand piano is considered to be the highestquality piano in the world and has one of the most widely recognized andprestigious brand names.  We sell ourpianos worldwide through approximately 170 independent piano dealers and tencompany-operated retail showrooms including those located in New York, London,and Munich.  In 2003, approximately 57%of piano sales were in the United States, 28% in Europe and the remaining 15%primarily in Asia.

 

Our band andorchestral division holds the leading domestic market share in the majority ofour product lines*.*  Instruments aremade by a highly-skilled workforce at our manufacturing facilities in Indiana,Ohio, North Carolina, and Illinois, and sold through approximately 1,800 independentdealers and distributors.  We also sellcertain student instruments that are made to our specifications by overseasmanufacturers.  Beginner instrumentsaccounted for 70% of band and orchestral unit sales and 43% of instrumentrevenues in 2003, with advanced and professional instruments representing thebalance.  In 2003, approximately 84% ofband sales were in the United States, 8% in Europe and the remaining 8%primarily in Asia.

 

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We offer pianos, band and orchestral instruments and services throughthe following subsidiaries and operating divisions:

 

*Steinway & Sons* offers two premium-priced productlines: grand pianos and upright pianos. Steinway pianos differ from all others in design specifications,materials used and the assembly process. Grand pianos historically have accounted for the bulk of Steinway’sproduction.  We offer eight sizes of thegrand piano ranging from the 5’1” baby grand to the largest 9’ concertgrand.  The smaller grands are sold toboth individual and institutional customers, while the concert grands are soldprimarily to institutions.  Steinwaygrand pianos are premium pianos in terms of quality and price, with retailprices generally ranging from $37,400 to $96,100 in the United States.  In 2003, we sold 2,928 grand pianos, ofwhich 1,988 units were shipped from our New York facility to dealers in Northand Latin America.  The remaining 940 unitswere shipped from our German facility to various countries in Europe and Asia.

 

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

 

*Boston Piano Company*offers two complete lines of grand and upright pianos for the mid-priced pianomarket under the Boston and Essex brand names. These pianos, which were designed by us and are produced by Asianmanufacturers, provide our dealers with anopportunity to realize better margins in this price range while capturing salesthat would have otherwise gone to a competitor.  These pianos provide future Steinway grand piano customers withthe opportunity to join the Steinway family of owners sooner, since ourresearch indicates that the vast majority of Steinway customers have previouslyowned another piano.  The product linesalso increase our business with our dealers, making us the dealer’s primarysupplier in many instances, since our three product lines together offer thefull spectrum of piano prices and styles. The Boston and Essex product lines together offer twelve upright andgrand piano sizes, with retail prices ranging from $4,910 to $37,720 in theUnited States.

 

*The BandInstrument Division*manufactures brasswind and woodwind instruments, including piccolos, flutes,clarinets, oboes, bassoons, saxophones, trumpets, French horns, tubas, andtrombones at facilities in Elkhart, Indiana, and Eastlake, Ohio.  We also manufacture mouthpieces, distributeaccessories (oils, lubricants, polishes, stands, batons, straps, mutes andreeds), and distribute some imported student instruments which are made to ourspecifications.  We sell products underthe *Bach,Selmer, C.G. Conn, King, Armstrong,* and *Emerson* brand names to student, amateurand professional musicians. Suggested retail prices generally range from $595to $1,700 for student instruments and from $1,000 to $8,600 for step-up andprofessional instruments.  We oftencustomize the products that we sell to professional musicians so that theproduct meets requested design specifications or has certain soundcharacteristics. We believe that specialization of products helps maintain acompetitive edge in quality and product design.

 

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

 

*The PercussionDivision*manufactures and distributes acoustical and tuned percussion instruments,including outfit drums, marching drums, concert drums, marimbas, xylophones,vibraphones, orchestra bells, chimes, mallets and accessories.  We manufacture percussion products inMonroe, North Carolina and LaGrange, Illinois under the *Ludwig* and *Musser*brand names.  *Ludwig* is considered aleading brand name in acoustical drums and timpani and *Musser* has a strong marketposition in tuned percussion products.

 

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Suggestedretail prices range from $550 to $4,600 for acoustical drum outfits and from$1,800 to $17,000 for tuned percussion instruments.

 

*The StringedInstrument Division*manufactures and distributes violins, violas, cellos, basses, and accessories(bridges, covers, mutes, pads, chin rests, rosins, strings, bows, cases andinstrument care products).  Products aresold under the *Glaesel, Scherl & Roth,*and *W**illiam Lewis & Son*brand names.  Suggested retail prices generally range from$200 to $2,200 for student instruments and from $1,100 to $11,000 forintermediate and advanced instruments. Components are primarily imported fromEurope and Asia and assembled at our factory in Cleveland, Ohio.

 

**Customers**

 

Our core piano customer base consists of professional artists andamateur pianists, as well as institutions such as concert halls,conservatories, colleges, universities and music schools.  Most Steinway grand piano sales are toindividuals.  These individuals aretypically over 35 years old, have household income ranging from $150,000 to$300,000 per year and have a serious interest in music.  Sales to institutional customers havehistorically represented a larger portion of international revenue thandomestic revenue.  Over the past severalyears, we have introduced several unique marketing programs designed toincrease institutional sales in the United States.  As a result, domestic unit shipments to institutions increasednearly 2% in 2002 and another 1% in 2003 and they now represent 18% of domesticunit sales. Our largest piano dealer accounted for approximately 4% of pianosales in 2003, while the top 15 accounts represented 27% of piano sales.

 

The majority of our band instruments are purchased or rented fromdealers by students enrolled in music education programs.  Traditionally, students join school bands ororchestras at age 10 or 11 and learn on beginner level instruments, progressingto advanced or professional level instruments in high school or college.  We estimate that approximately 85% of ourdomestic band sales are generated through educational programs.  The remaining domestic band sales are toprofessional or amateur musicians or performing groups, including orchestrasand symphonies.  Our largest band dealeraccounted for approximately 9% of band sales in 2003, while the top 15 accountsrepresented approximately 34% of sales.

 

**Sales and Marketing**

 

*Pianos.*We distribute pianos primarily on a wholesale basisthrough approximately 170 select dealers around the world.  We have subsidiaries and dealers in bothJapan and China that provide direct access to the expansive Asian piano market.Sales to dealers accounted for approximately 84% of piano segment revenue in2003. The remaining 16% was generated from sales made directly by us at one ofour ten company-operated retail locations.

 

We employ district sales managers, whose responsibilities includedeveloping close working relationships with domestic and international pianodealers. These highly experienced professionals provide sales training andtechnical support to dealers, as well as developing appropriate sales andmarketing programs for the consumer and institutional markets.  These sales managers are also responsiblefor promoting the Piano Bank and the Steinway Artists programs described below.

 

*The Concertand Artist Piano Bank.*  To ensure that all pianists,especially Steinway Artists, have a broad selection of instruments to meettheir individual touch and tonal preferences, we maintain the Concert andArtist Piano Bank (the “Piano Bank”). The Piano Bank includes approximately 400 instruments worldwide.  Of these instruments, approximately 300 arelocated in the United States.  In NewYork City alone, the Steinway concert department has approximately 100 concertgrands available for various

 

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occasions.  The balance of the domestic-based pianos isleased to dealers around the country who actively support the Steinway Artistsprogram.  In addition to promoting ourinstruments in the music industry, the Piano Bank provides continuous feedbackon the quality and performance of recently produced instruments from our mostcritical customer, the professional pianist. The Piano Bank instruments are generally sold after five years andreplaced with new pianos.

 

*Steinway Artists.*  Foryears, we have successfully used renowned artists in our marketingprograms.  This technique has helpedreinforce recognition of the Steinway brand name and its association withquality.  The “Steinway Artists” programis the endorsement of Steinway & Sons by world-class pianists whovoluntarily select the Steinway piano. It is unique in that we do not payartists to endorse our instruments.  Tobecome a Steinway Artist, a pianist must not only meet certain performance andprofessional criteria, he or she must also own a Steinway piano.  The Steinway Artist roster currentlyincludes approximately 1,300 of the world’s finest pianists who perform onSteinway pianos.  In return for theirendorsements, Steinway Artists are provided with access to the Piano Bankdescribed above.

 

*Distribution,Sales and Marketing of the Boston and Essex Piano Lines.*  TheBoston and Essex piano lines are targeted at the mid-priced segment of themarket.  The lines provide both abroader product offering for dealers and entry-level products for futureSteinway grand piano customers. With certain limited exceptions, we allow onlySteinway dealers to carry the Boston and Essex piano lines, thereby ensuringthat these pianos will be marketed as complementary product lines.  Increased traffic generated by these pianoscreates current and future customers for Steinway.  We do not believe that the availability of lower-priced Bostonand Essex alternatives has negatively impacted the sales of Steinway & Sonspianos.  These lines benefit from the“spillover” effect created by the marketing efforts supporting the mainSteinway product line.

 

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

 

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

 

We also sellour products through dealers and distributors located in each major countryoutside of the United States. International representatives help market our products to these dealersand distributors. Dealers and distributors in the United States and abroad aresupported through incentive programs, advertising and promotional activities.

 

The primarymethods of reaching customers are trade shows, educator conferences, printmedia, direct mail, telemarketing, the Internet and personal sales calls. Wealso actively advertise in consumer, educator and trade magazines andpublications and provide educational materials, catalogs and productspecifications to students, educators, dealers and distributors.  In addition, our representatives attend

 

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several trade shows andeducator conferences each year, which provide opportunities to interactdirectly with customers.  Moreover, our educationaldirector travels extensively, lecturing and motivating students, educators andparents on the value of music in a child’s development.

 

**Musical InstrumentIndustry**

 

*Pianos.*The overallpiano industry is comprised of three main categories: high-end grand pianos,mid/low-end grand pianos, and upright pianos. From the middle through the end of the 1990s, the industry experiencedgrowth in all categories of pianos. The introduction of the Boston line in the early1990s permitted us to compete in the mid-price category without sacrificingquality.   In recent years the industryhas been impacted by the worldwide economic downturn.  Although piano sales were adversely affected, favorabledemographics, institutional sales, and the public’s continued interest in musichelped mitigate the impact of the economy. Of late, economic indicators have improved, and we expect a favorableimpact on our business as the economy rebounds.

 

Market sizeand volume trends are difficult to quantify for international markets, as thereis no single source for worldwide sales data. Our strongest international markets outside the Americas are Germany,Japan, the United Kingdom, France and Switzerland.

 

Outside of theUnited States, China and Japan are the two largest piano markets in the world,with Japan representing the second largest grand piano market.  With our three piano lines, our marketshare, based on grand piano units, is currently 4% in Japan, compared to anaverage market share of approximately 8% in other major markets.  While adverse economic conditions in some ofthe Asian markets have slowed our expansion, other markets, such as China, aregrowing at a rapid pace.  We continue totarget this region in our distribution strategies and have appointed apresident of Asian operations whose responsibilities include growthinitiatives, strategic activities, and manufacturing relationships.  We have also established a distribution andselection facility in Shanghai.  Webelieve that our long-term prospects in Asia are favorable.

 

*Band and Orchestral Instruments. *We believe that the band andorchestral instrument industry in the U.S. has historically been impacted moreby demographic trends and school budgeting than by macroeconomic cycles.  While the domestic market continued to growthrough the late 1990s, domestic supply has outpaced demand. In recent yearsthere has been an increase in units imported into the domestic market fromoffshore low-cost producers, as well as a decline in exports by domesticmanufacturers. These factors have created a highly price sensitive domesticmarket, where manufacturers implemented aggressive pricing programs in anattempt to maintain market share positions.

 

However, we believe the outlook for future growth remainspositive.  Relatively stable demographictrends and studies emphasizing the importance of music education in a child’sdevelopment are expected to facilitate industry growth.  We believe that parents are encouragingtheir children to play musical instruments in response to the growing number ofreports that show participation in music programs increases a student’s abilityto excel in other aspects of his or her education.  In addition, many school band directors are promoting band programsas social organizations rather than the first step of intensive musicstudy.   We believe that focusing on theeducational component of the musical instrument industry will help us expandour market share in the relatively flat market expected in the near-term.

 

**Competition**

 

Few manufacturerscompete directly with Steinway & Sons pianos, both in terms of quality andprice.  We believe that used Steinwaypianos provide the primary competition in our market segment.

 

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Because of the potentialsavings associated with buying a used Steinway piano, as well as the durabilityof the instrument, a large market exists for used Steinways.  It is difficult to estimate the significanceof used piano sales, since most are conducted in the private aftermarket.  However, our increased emphasis onrestoration services and the procurement, refurbishment and sales of usedSteinway pianos has helped us mitigate the impact of these aftermarket sales.

 

We are thelargest domestic producer of band and orchestral instruments.  New entrants into the domestic marketexperience difficulty competing with us due to the long learning curve inherentin the production of musical instruments, the high quality standards set by themarket, cost of tooling, significant capital requirements, and need for bothbrand recognition and an effective distribution system.  However, offshore musical instrumentmanufacturers present an ever-increasing level of competition for us, primarilybecause their labor costs are so low. They now offer a broad range of products at highly competitive prices.

 

It isdifficult to quantify the impact of imported musical instruments since themajority of offshore manufacturers do not report data through typical industrychannels, if at all.  However, it isclear from our research and the sales deterioration we’ve experienced thatthere is increased competition from offshore sources.  Furthermore, many non-traditional musical instrument retailerssuch as superstores and wholesale clubs have recently decided to sell theseoffshore products.  Currently we do notknow what long-term impact, if any, these non-traditional retailers will haveon the marketplace or whether they will continue to grow at the expense of thetraditional music retailers.

 

Recognizing thecompetition from these imported products, in October 2003 we expanded ourproduct line to include three distinct student product groupings, offeringsourced instruments made to our specifications at prices comparable to that ofoffshore manufacturers. We now offer “good” entry-level imported instruments,“better” mid-priced instruments, which are either imported or manufactured byus, and “best” instruments, which are manufactured by us.

 

**Patents andTrademarks**

 

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

 

We also havesome of the most well-known brand names in the music industry.  Our piano trademarks include *Steinway,Steinway & Sons,*the Lyre design, *Boston, Boston designed by Steinway& Sons, Heirloom Collection,*and*Essex*. Our band and orchestral trademarksinclude *Bach,Selmer, C.G. Conn, King, Armstrong, Ludwig, Musser, Glaesel, Scherl & Roth,William Lewis & Son, Emerson,* and*Artley.*  We consider our trademarks to be importantand valuable assets.  It is possiblethat the termination, expiration or infringement of one or more of ourtrademarks may have an adverse affect on our business, depending on thetrademark and the jurisdiction. Accordingly, we maintain trademark registrations in appropriatejurisdictions on an ongoing basis and vigorously pursue any infringement bycompetitors.

 

### **Raw Materials, ComponentParts, and Sourced Products**

 

Our rawmaterials consist primarily of metals and woods, the majority of which aresourced from the Americas, with the balance coming from Europe, Asia andAfrica.  We have made strategicacquisitions of our sole domestic piano plate manufacturer and primary pianokey maker to ensure

 

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availability of these componentparts.  In addition, component parts areimported from Europe and Asia for stringed and percussion instruments.  We have had adequate supplies of rawmaterials and component parts in the past and do not expect any disruption tothe supply of these items during 2004 or in the future.

 

Our Boston andEssex piano lines are each sourced from a single manufacturer, as are ourSelmer Paris instruments and certain other component parts.  Although we may experience slight delays inavailability of product due to the lead times required by these manufacturers,we do not anticipate any material disruptions to the supply of theseproducts.  Additionally, many of theband and orchestral instruments included in our expanded product line are alsosourced from single manufacturers. Although we continuously scrutinize these suppliers and the quality ofproducts that they manufacture to our specifications, we currently cannotaccurately predict these manufacturers’ ability to react to changes in orderquantities.   We expect availability ofthese sourced products to have some impact on results in the first half of 2004until we are able to pinpoint anticipated demand and reconcile it with oursuppliers’ required lead times. However, we believe that we have a sufficient number of qualifiedsuppliers to ensure availability of all offered products in the upcoming year.

 

**Manufacturing Process**

 

We manufacturea majority of the musical instruments that we sell. The manufacturing processinvolves essentially two main production phases: the production of component partsand instrument assembly.  Employeesperform various forming, drilling, and cutting operations during the partsproduction phase.  Skilled workersassemble component parts, creating the instruments.  Each instrument is tested or tuned and regulated to ourspecifications.  The manufacturingprocess for our band instruments typically takes approximately two months,whereas the manufacturing process for pianos takes nine months to a year.

 

Historically,we have maintained a fairly constant production schedule for band andorchestral instruments in order to minimize labor disruptions and to keepwork-in-process inventories relatively stable. However, in the last two years we have implemented periodic shutdowns ofselected manufacturing facilities in each segment of our business.  We utilize this process in order to controlinventory levels while maintaining a skilled workforce.

 

**Labor**

 

As of December31, 2003, we employed 2,283 people, consisting of 1,702 hourly productionworkers and 581 salaried employees.  Ofthe 2,283 employees, 1,783 were employed in the United States and the remaining500 were employed primarily in Europe.

 

Other thanmanagement, employees in Germany are represented by the workers’ council.  Nevertheless, most employment contract conditionsare settled in collective bargaining agreements made between various tradeunions and the employer organizations to which we belong. Generally, agreementsare negotiated on an annual basis.

 

Approximately66% of our workforce in the United States is represented by labor unions.  Collective bargaining agreements coveringthese employees were negotiated at various dates throughout 2003.  During the negotiation process for theseagreements, employees at our LaGrange, Illinois and Eastlake, Ohio plants, respectively,initiated work stoppages in an attempt to obtain improved contract offers.  However, we were eventually able tosuccessfully negotiate all agreements. In October 2003 we

 

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announced the pending closureof one of our Elkhart, Indiana woodwind manufacturing facilities.  In March 2004 the labor union at thisfacility voted unanimously to accept the shutdown agreement.

 

**ITEM2                   PROPERTIES**

 

We own most ofour manufacturing and warehousing facilities, as well as the building thatincludes Steinway Hall in New York City. The remaining Steinway retail stores are leased.  Substantially all of the domestic realestate has been pledged to secure our debt.

 

The following table lists oursignificant owned and leased facilities:

 
| **Location**       |   | **Owned/Leased** |   | **Approximate  Floor Space  (Square Feet)** |   | **Type of  Facility and Activity Performed**                               |   |
|--------------------|--------|------------------|--------|---------------------------------------------|--------|----------------------------------------------------------------------------|--------|
| New York, NY       |   | Owned            |   | 450,000                                     |   | Piano manufacturing; restoration center; administrative offices;  training |   |
|               |   | 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; training                           |   |
|               |   | Leased           |   | 7,000                                       |   | 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                                      |   | Warehouse/showroom/workshop                                                |   |
| London, England    |   | Leased           |   | 10,000                                      |   | Piano showroom                                                             |   |
|               |   | Leased           |   | 6,000                                       |   | Piano workshop/storage                                                     |   |
| Tokyo, Japan       |   | Leased           |   | 9,000                                       |   | Selection center; warehouse                                                |   |
|               |   | Leased           |   | 2,000                                       |   | Administrative offices                                                     |   |
| Eastlake, OH       |   | Owned            |   | 160,000                                     |   | Brasswind manufacturing                                                    |   |
| Elkhart, IN        |   | Owned            |   | 150,000                                     |   | Brasswind manufacturing                                                    |   |
|               |   | Owned            |   | 88,000                                      |   | Woodwind manufacturing; warehouse; office                                  |   |
|               |   | Owned            |   | 77,000                                      |   | Woodwind manufacturing (to be closed in 2004)                              |   |
|               |   | Owned            |   | 81,000                                      |   | Warehouse                                                                  |   |
|               |   | Owned            |   | 25,000                                      |   | Administrative offices                                                     |   |
| Nogales, AZ        |   | Owned            |   | 67,000                                      |   | Former band instrument manufacturing, held for sale                        |   |
|               |   | Owned            |   | 22,000                                      |   | Former band 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                                      |   | Stringed instrument manufacturing                                          |   |
| London, England    |   | Leased           |   | 8,000                                       |   | Band instrument office; warehouse                                          |   |

 

We spent $5.5 million for capital improvements in 2003,consisting primarily of leasehold improvement projects related to our new pianoretail stores, machinery and equipment purchases, and

 

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office equipment upgrades andreplacements.  We expect capitalspending in 2004 to be in the range of $5.5-6.5 million, relating to machineryand equipment purchases, system upgrades, and facility improvements.

 

**ITEM3                   LEGALPROCEEDINGS**

 

We areinvolved in certain legal proceedings regarding environmental matters, whichare described below.  Further, in theordinary course of business, we are party to various legal actions thatmanagement believes are routine in nature and incidental to the operation ofthe business.  While the outcome of suchactions 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 or resultsof operations or prospects.

 

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

 

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

 

We operateother manufacturing facilities that were previously owned by PhilipsElectronics North America Corporation (“Philips”).  Philips agreed to indemnify us for any and all losses, damages,liabilities and claims relating to environmental matters resulting from certainactivities of Philips occurring prior to December 29, 1988 (the “EnvironmentalIndemnity Agreement”).  Philips hasfully performed its obligations under the Environmental Indemnity Agreement,which terminates on December 29, 2008.  Fourmatters covered by the Environmental Indemnity Agreement are currently pending.  Philips has entered into Consent Orders withthe Environmental Protection Agency (“EPA”) for one site and the North CarolinaDepartment of Environment, Health and Natural Resources for a second site,whereby Philips has agreed to pay required response costs.  On October 22, 1998, we were joined asdefendant in an action involving a site formerly occupied by a business weacquired in Illinois.  Philips hasaccepted the defense of this action pursuant to the terms of the EnvironmentalIndemnity Agreement.  For the fourthsite, the EPA has notified us it intends to carry out the final remediationitself.  The EPA estimates that thisremedy has a present net cost of approximately $14.5 million.  The EPA has named over 40 persons orentities as potentially responsible parties at this site, which includescertain facilities that we acquired in 2000. This matter has been tendered to Philips pursuant to the EnvironmentalIndemnity Agreement for those facilities that were acquired from Philips.  Our potential liability at any of thesesites is affected by several factors including, but not limited to, the methodof remediation, our portion of the materials in the site relative to the othernamed parties, the number of parties participating, and the financial capabilitiesof the other potentially responsible parties once the relative share has beendetermined.  No assurance can be given,however, that additional environmental issues will not require

 

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additional, currentlyunanticipated investigation, assessment or remediation expenditures or thatPhilips will make payments that it is obligated to make under the EnvironmentalIndemnity Agreement.

 

We are alsocontinuing an existing environmental remediation program at a facility acquiredin 2000.  We currently estimate thatthis project will take eighteen years to complete, at a total cost ofapproximately $1.2 million.  We haveaccrued approximately $0.8 million for the estimated remaining cost of thisremediation program, which represents the present value of the total estimatedcost using a discount rate of 5.0%.  Asummary of expected payments associated with this project is as follows:

 

|       |   | **Environmental  Payments** |   |
|------------|--------|-----------------------------|--------|
| 2004       |   | $                           | 217    |   |
| 2005       |   | 81                          |   |
| 2006       |   | 81                          |   |
| 2007       |   | 81                          |   |
| 2008       |   | 56                          |   |
| Thereafter |   | 673                         |   |
| Total      |   | $                           | 1,189  |   |

 

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

 

**ITEM4                   SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

No matter wassubmitted to a vote of our security holders during the fourth quarter of thefiscal year ended December 31, 2003.

 

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**PART II**

 

**ITEM 5****                                                        MARKETFOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS**

 

Our ordinarycommon stock is traded on the New York Stock Exchange (“NYSE”) under the symbol“LVB”.  The following table sets forth,for the periods indicated, the high and low sales prices per share of ourordinary common stock as reported on the NYSE.

 
|                                |   | **High** |   | **Low** |   |
|-------------------------------------|--------|----------|--------|---------|--------|
|                                |   |     |   |    |   |
| Fiscal Year Ended December 31, 2002 |   |     |   |    |   |
| First Quarter                       |   | $        | 20.85  |    | $      | 15.49 |   |
| Second Quarter                      |   | 23.83    |   | 18.88   |   |
| Third Quarter                       |   | 22.44    |   | 15.00   |   |
| Fourth Quarter                      |   | 19.19    |   | 15.25   |   |
|                                |   |     |   |    |   |
| Fiscal Year Ended December 31, 2003 |   |     |   |    |   |
| First Quarter                       |   | $        | 16.60  |    | $      | 14.25 |   |
| Second Quarter                      |   | 16.25    |   | 12.30   |   |
| Third Quarter                       |   | 18.20    |   | 15.27   |   |
| Fourth Quarter                      |   | 24.70    |   | 16.85   |   |

 

We have twoclasses of common stock: Class A and Ordinary. With the exception of disparate voting power, both classes aresubstantially identical.  Each share ofClass A common stock entitles the holder to 98 votes.  Holders of Ordinary common stock are entitled to one vote pershare.  Class A common stock shallautomatically convert to Ordinary common stock if, at any time, the Class Acommon stock is not owned by an original Class A holder.  As of February 2, 2004, there were 2,207holders of record of our Ordinary common stock and two holders of record of theClass A common stock.

 

We arerestricted by the terms of our outstanding debt and financing agreements frompaying cash dividends on our common stock, and we may, in the future, enterinto loan or other agreements that restrict the payment of cash dividends onthe common stock.

 

We presentlyintend to retain earnings to reduce outstanding indebtedness and to fund thegrowth of our business.  The payment ofany future dividends will be determined by the Board of Directors in light ofconditions then existing, including our results of operations, financialcondition, cash requirements, restrictions in financing agreements, taxtreatment of dividends, business conditions and other factors.

 

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### **Equity Compensation Plans**

 

The following table sets forth the equity compensation plan informationfor our Employee Stock Purchase Plan and our Amended and Restated 1996 StockPlan, which were approved by security 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 |   | 1,154,747                                                                                                |   | $19.63                                                                                  |   | 494,843                                                                                                                                                    |   |
|                                                   |   |                                                                                                     |   |                                                                                    |   |                                                                                                                                                       |   |
| Total                                                  |   | 1,154,747                                                                                                |   | $19.63                                                                                  |   | 494,843                                                                                                                                                    |   |

 

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**ITEM6                   SELECTEDCONSOLIDATED FINANCIAL DATA**

 

The followingtable sets forth our selected consolidated financial data as of and for each ofthe five years ended December 31, 2003, 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 except share and  per share information)**                    |     | **Years Ended December 31,** |         |
|-------------------------------------------------------------------------------|----------|------------------------------|--------------|
|                                                                          | **1999** |                         | **2000 (1)** |   | **2001** |   | **2002** |   | **2003** |   |
| **Income statement data:**                                                    |     |                         |         |   |   |   |   |   |   |   |   |
| Net  sales                                                                    |     | $                            | 304,636      |   | $ | 331,698 |   | $ | 352,612 |   | $ | 332,297 |   | $ | 337,220 |   |
| Gross  profit                                                                 |     | 100,748                      |         | 101,688 |   | 103,521 |   | 97,151 |   | 92,553 |   |
| Income  from operations                                                       |     | 41,140                       |         | 38,419 |   | 34,495 |   | 31,399 |   | 22,824 |   |
| Net  income                                                                   |     | 17,345                       |         | 14,887 |   | 8,738 |   | 14,909 |   | 9,698 |   |
| Earnings  per share:                                                          |     |                         |         |   |   |   |   |   |   |   |   |
| Basic                                                                         |     | $                            | 1.88         |   | $ | 1.67 |   | $ | 0.98 |   | $ | 1.68 |   | $ | 1.09 |   |
| Diluted                                                                       |     | $                            | 1.87         |   | $ | 1.67 |   | $ | 0.98 |   | $ | 1.68 |   | $ | 1.09 |   |
|                                                                          |     |                         |         |   |   |   |   |   |   |   |   |
| **Weighted average shares:**                                                  |     |                         |         |   |   |   |   |   |   |   |   |
| Basic                                                                         |     | 9,213,145                    |         | 8,921,091 |   | 8,928,000 |   | 8,877,256 |   | 8,924,578 |   |
| Diluted                                                                       |     | 9,277,798                    |         | 8,921,108 |   | 8,928,000 |   | 8,882,165 |   | 8,925,672 |   |
|                                                                          |     |                         |         |   |   |   |   |   |   |   |   |
| **Balance sheet data (at year end):**                                         |     |                         |         |   |   |   |   |   |   |   |   |
| Cash                                                                          |     | $                            | 4,664        |   | $ | 4,989 |   | $ | 5,545 |   | $ | 19,099 |   | $ | 42,283 |   |
| Current  assets                                                               |     | 171,954                      |         | 263,376 |   | 254,474 |   | 267,346 |   | 288,270 |   |
| Total  assets                                                                 |     | 309,641                      |         | 419,739 |   | 409,537 |   | 423,731 |   | 445,665 |   |
| Current  liabilities                                                          |     | 44,959                       |         | 56,515 |   | 49,318 |   | 53,302 |   | 61,304 |   |
| Total  debt                                                                   |     | 140,080                      |         | 223,410 |   | 211,203 |   | 200,636 |   | 196,602 |   |
| Stockholders’  equity                                                    |     | 98,202                       |         | 111,190 |   | 115,773 |   | 131,208 |   | 152,635 |   |
|                                                                          |     |                         |         |   |   |   |   |   |   |   |   |
| **Other financial data:**                                                     |     |                         |         |   |   |   |   |   |   |   |   |
| EBITDA  (2)/net interest expense                                              |     | 4.1x                         |         | 3.4x |   | 3.0x |   | 3.5x |   | 3.9x |   |
| Capital  expenditures (3)                                                     |     | 5,399                        |         | 7,890 |   | 7,141 |   | 5,604 |   | 5,462 |   |
|                                                                          |     |                         |         |   |   |   |   |   |   |   |   |
| **Margins:**                                                                  |     |                         |         |   |   |   |   |   |   |   |   |
| Gross  profit                                                                 |     | 33.1                         | %            | 30.7 | % | 29.4 | % | 29.2 | % | 27.4 | % |
| EBITDA  (2)                                                                   |     | 18.0                         | %            | 16.3 | % | 14.2 | % | 14.0 | % | 13.7 | % |
|                                                                          |     |                         |         |   |   |   |   |   |   |   |   |
| **Reconciliation from cash flows from operating activities   to EBITDA (2):** |     |                         |         |   |   |   |   |   |   |   |   |
| Cash  flows from operating activities                                         |     | $                            | 15,372       |   | $ | 13,265 |   | $ | 28,877 |   | $ | 31,048 |   | $ | 31,876 |   |
| Changes  in operating assets and liabilities                                  |     | 11,786                       |         | 10,662 |   | (2,265 | ) | (5,962 | ) | (9,333 | ) |
| Income  taxes, net of deferred tax benefit                                    |     | 14,479                       |         | 12,789 |   | 7,164 |   | 8,344 |   | 7,299 |   |
| Net  interest expense                                                         |     | 13,276                       |         | 16,110 |   | 16,731 |   | 13,279 |   | 11,945 |   |
| Other                                                                         |     | (91                          | )            | (234 | ) | (425 | ) | (334 | ) | (329 | ) |
| Non-recurring,  infrequent, or unusual charges                                |     | —                       |         | 1,490 |   | — |   | — |   | 4,844 |   |
| EBITDA  (2)                                                                   |     | $                            | 54,822       |   | $ | 54,082 |   | $ | 50,082 |   | $ | 46,375 |   | $ | 46,302 |   |

 

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**Notes to SelectedConsolidated Financial Data:**

 

(1)          We acquired UMI in September 2000.

(2)          We use the non-GAAP measurement EBITDA, whichwe define as earnings before net interest expense, income taxes, depreciationand amortization, adjusted to exclude non-recurring, infrequent or unusualitems.  We use EBITDA because it isuseful to management and investors as a measure of core operating performance.  We also believe EBITDA is helpful indetermining our ability to meet future debt service, capital expenditures andworking capital requirements.  Inaddition, certain of our debt covenants are based primarily upon calculationsusing EBITDA and we use EBITDA as the primary measure for determining bonusesfor our managers.  However, EBITDAshould not be construed as a substitute for operating income or a betterindicator of liquidity than cash flows from operating activities, which aredetermined in accordance with GAAP.

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

 

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**ITEM 7****                                                        MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

**(Tabular Amounts in Thousands Except Shareand Per Share Data)**

 

**Introduction**

 

The followingdiscussion provides an assessment of the results of our operations andliquidity and capital resources together with a brief description of certainaccounting policies.  Accordingly, thefollowing discussion should be read in conjunction with our ConsolidatedFinancial Statements and the Notes to Consolidated Financial Statementsincluded within this filing.

 

**Overview**

 

We, throughour operating subsidiaries, are one of the world’s leading manufacturers ofmusical instruments.  Our strategy is tocapitalize on our strong brand names, leading market positions, strongdistribution networks, and quality products.

 

**PianoSegment**

 

Sales of ourpianos are influenced by general economic conditions, demographic trends andgeneral interest in music and the arts. The operating results of our piano segment are primarily affected bySteinway & Sons grand piano sales. Given the total number of these pianos that we sell in any year (2,928sold in 2003), a slight change in units sold can have a material impact on ourbusiness and operating results.  Ourresults are also influenced by sales of Boston and Essex pianos, which togetherrepresented approximately 50% of total piano units sold and approximately 20%of total piano revenues in 2003.  OurBoston and Essex piano lines are manufactured in Asia, each by a singlemanufacturer.  The ability of these manufacturersto produce and ship products to us could materially impact our business andoperating results.  In 2003,approximately 57% of piano sales were in the United States, 28% in Europe andthe remaining 15% primarily in Asia. For theyear ended December 31, 2003, our piano segment sales were $179.8 million,representing 53% of our total revenues.

 

### **Piano Outlook for 2004**

 

We expect a successful year for our piano segment due to recent orderpatterns and indications of a stronger economy.  Gross margins are expected to remain stable as we return tonormal production levels in our domestic manufacturing facility and reap thebenefits of having two new retail stores open for the full year.  We expect these factors to offset the highercosts of Boston inventory purchases caused by unfavorable exchange rates.  We currently have sufficient, but notexcessive, manufacturing capacity to meet anticipated or increased demand.

 

**BandSegment**

 

Our studentband instrument sales are influenced by trends in school enrollment and generalattitudes toward music and the arts. Management estimates that 85% of ourdomestic band sales are generated through educational programs.  Our school instrument business is correlatedto the number of school children in the United States, which has peaked and isexpected to remain relatively stable over the next few years.  However, the correlation has been adverselyaffected in recent years by two factors: limited school budget resources and the resultant negative impact onschool music program funding, and the abundance of competitively-pricedimported student instruments.

 

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In order to compete with these mass-merchandised offshore instruments,we restructured our product line in 2003. Our product offerings now includequality, competitively-priced brand-name imported instruments that are built toour specifications.  We also began afacility rationalization project to eliminate excess manufacturing space andthe corresponding overhead.  We believethese changes were necessary for us to remain competitive in the bandinstrument market.

 

Consistentwith past patterns, beginner instruments accounted for 70% of band andorchestral unit shipments and 43% of instrument revenues in 2003, with advancedand professional instruments representing the balance. In 2003, approximately84% of band sales were in the United States, 8% in Europe and the remaining 8%primarily in Asia.  For the year ended December 31, 2003, our bandsales were $157.5 million, representing 47% of our total revenues.

 

**Band Outlook for 2004**

 

We expect a challengingfirst half of the year as we complete our facility rationalization project,pinpoint the demand for our recently introduced sourced products, andsynchronize product availability with demand. We expect the latter half of the year to show improvement over pastperformance, both in net sales and gross margin, since we will have workedthrough excess inventories, returned to more efficient production levels, andexpect to have the appropriate balance of manufactured and imported products tomeet demand for the back-to-school selling season.  We believe that providing quality-controlled, brand-name productsat multiple pricepoints via distribution channels which support the musiceducation market will prove to be a successful strategy for the long-termgrowth of this segment of our business.

 

**Inflation and Foreign Currency Impact**

 

Although wecannot accurately predict the precise effect of inflation on our operations, wedo not believe that inflation has had a material effect on sales or results ofoperations in recent years.

 

Sales tocustomers outside the United States represent approximately 30% of consolidatedsales, with international piano sales accounting for approximately 75% of theseinternational sales.  A significantportion of international piano sales originate from our German manufacturingfacility, resulting in sales, cost of sales and related operating expensesdenominated in Euros. While currency translation has affected internationalsales, cost of sales and related operating expenses, it has not had a materialimpact on operating income.  We usefinancial instruments such as forward exchange contracts and currency optionsto reduce the impact of exchange rate fluctuations on firm and anticipated cashflow exposures and certain assets and liabilities denominated in currenciesother than the functional currency of the affected division.  We do not purchase currency relatedfinancial instruments for purposes other than exchange rate risk management.

 

**Taxes**

 

Our effectivetax rates vary depending on the relative proportion of foreign to U.S. incomeand the absorption of foreign tax credits in the U.S.  In 2001, the costs associated with our debt extinguishment, whichwere absorbed domestically, caused an increase in the proportion of our foreignsource income, allowing us to utilize foreign tax credits carried forward fromprior years.  In 2002, we were not ableto utilize foreign tax credits carried forward from prior years. However, withthe overall effective German rates on par with the U.S. rates, the shifttowards income generated from the German divisions allowed us to better utilizeour current foreign tax credits.  In2003, we were once again able to

 

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utilize foreign tax creditscarried forward from prior years due to the higher proportion of our foreignsource income to overall income.

 

Thestrengthening of our domestic piano and band businesses is expected to resultin less effective use of our foreign tax credits and credit carryforwards inthe upcoming year.  In addition, thestates in which we do business are either repealing legislation that had beenbeneficial to tax paying businesses, or have promulgated more restrictive taxlegislation in an effort to boost tax revenues and eliminate statedeficits.  These events will have anegative impact on our effective tax rate for 2004.  Accordingly, we expect our 2004 effective tax rate to approximate40%.

 

**Results of Operations**

 

*Fiscal Year 2003Compared to Fiscal Year 2002*

 
|                              |   | **Year Ended December 31,** |    |   |   | **Change** |   |
|-----------------------------------|--------|-----------------------------|---------|--------|--------|------------|--------|
|                              |   | **2002**                    |    |   |   | **2003**   |   |   |   | **$** |   | **%** |   |
|                              |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Net  sales                        |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Band                              |   | $                           | 167,708 |   |   |       | $      | 157,460 |   |   |   | (10,248 | ) | (6.1 | ) |
| Piano                             |   | 164,589                     |    |   |   | 179,760    |   |   |   | 15,171 |   | 9.2 |   |
| Total  sales                      |   | 332,297                     |    |   |   | 337,220    |   |   |   | 4,923 |   | 1.5 |   |
|                              |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Cost  of sales                    |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Band                              |   | 127,849                     |    |   |   | 126,369    |   |   |   | (1,480 | ) | (1.2 | ) |
| Piano                             |   | 107,297                     |    |   |   | 118,298    |   |   |   | 11,001 |   | 10.3 |   |
| Total  cost of sales              |   | 235,146                     |    |   |   | 244,667    |   |   |   | 9,521 |   | 4.0 |   |
|                              |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Gross  profit                     |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Band                              |   | 39,859                      |    | 23.8%  |   | 31,091     |   | 19.7% |   | (8,768 | ) | (22.0 | ) |
| Piano                             |   | 57,292                      |    | 34.8%  |   | 61,462     |   | 34.2% |   | 4,170 |   | 7.3 |   |
| Total  gross profit               |   | 97,151                      |    |   |   | 92,553     |   |   |   | (4,598 | ) | (4.7 | ) |
|                              |   | 29.2%                       |    |   |   | 27.4%      |   |   |   |   |   |   |   |
|                              |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Operating  expenses               |   | 65,752                      |    |   |   | 66,771     |   |   |   | 1,019 |   | 1.5 |   |
| Facility  rationalization charges |   | —                      |    |   |   | 2,958      |   |   |   | 2,958 |   |   |   |
| Total  operating expenses         |   | 65,752                      |    |   |   | 69,729     |   |   |   | 3,977 |   | 6.0 |   |
|                              |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Income  from operations           |   | 31,399                      |    |   |   | 22,824     |   |   |   | (8,575 | ) | (27.3 | ) |
|                              |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Other  income, net                |   | (3,939                      | )       |   |   | (3,517     | )      |   |   | 422 |   | (10.7 | ) |
| Net  interest expense             |   | 13,279                      |    |   |   | 11,945     |   |   |   | (1,334 | ) | (10.0 | ) |
|                              |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Income  before income taxes       |   | 22,059                      |    |   |   | 14,396     |   |   |   | (7,663 | ) | (34.7 | ) |
|                              |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Income  taxes                     |   | 7,150                       |    |   |   | 4,698      |   |   |   | (2,452 | ) | (34.3 | ) |
|                              |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Net  income                       |   | $                           | 14,909  |   |   |       | $      | 9,698 |   |   |   | (5,211 | ) | (35.0 | ) |

 

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*Overview –*2003 was a year of transition in our band business. Our results werenegatively impacted early on by strikes at two of our plants.  We began a facility rationalization projectto reduce manufacturing space by 20% and improve future margins on manufacturedproducts.  We reduced production inorder to bring down excess manufactured inventory levels.  Lastly, in October, we expanded our productline and introduced many new, quality-controlled sourced products that havebeen made to our specifications.  Wealso revamped our distribution policy to include channels not previously utilizedand now offer step-up and professional instruments through catalogs and via theInternet.  Additionally, we now offerschool music dealers a full line of instruments, including lower-priced,brand-name instruments which are a favorable alternative to mass-produced,offshore products.   We expect thisstrategy to positively impact the latter half of 2004.

 

Our piano business started out slow butrecovered in the last two quarters of 2003. While Steinway & Sons’ 150thanniversary celebration caused sales and marketing expenses to increase, we believethat the additional publicity generated by this milestone event helped generatesales interest in the second half of the year. However, due to the long production cycles for Steinway pianos and thelead-time required for ordering sourced pianos, we were unable to match theincrease in demand by year-end. Nevertheless, we believe that the increase in orders for bothmanufactured and sourced products is a positive indicator for 2004.

 

*Change in Accounting Principle -*Prior toOctober 1, 2003, we used the first-in, first-out (“FIFO”) method of costinginventory for approximately 75% of our inventories, with the cost of theremaining inventories determined using the last-in, first-out (“LIFO”)method.   Effective October 1, 2003, wedecided to conform our method of costing inventory by adopting the FIFO methodfor all inventories.  We believe theFIFO method is preferable as the FIFO method better matches current costs withcurrent revenues and provides a more meaningful presentation of our financialposition by reflecting more recent costs in the balance sheet.   In addition, as we rationalize ourfacilities, combine manufacturing processes, and increase the use of outsourcedproduct in our offerings, the use of a consistent method across all ourinventories will enable us to better allocate resources and avoid significantcosts that would likely be incurred to segregate and track inventory onseparate methods that may flow through a single manufacturing facility.

 

In accordancewith generally accepted accounting principles, the change in accountingprinciple has been applied by retroactively restating prior years consolidatedfinancial statements.  The change inaccounting resulted in a reduction of net income reported in 2001 of $2.6million ($0.29 per share) and a reduction in retained earnings of $4.6 millionas of December 31, 2001.  The change didnot have a material effect on our 2002 or 2003 income statements.

 

*Net Sales –* Theincrease in net sales of $4.9 million resulted from a $15.2 million improvementin piano sales, which occurred despite relatively flat Steinway grand unitsshipments.  The piano sales increasereflects $10.2 million in benefit attributable to foreign exchange, as well asannual price increases and a shift in mix towards higher-priced retailunits.  Band and orchestral instrumentsales decreased $10.2 million on an overall unit decrease of 12%, reflectingthe decreased demand for higher cost beginner instruments.  The delay in availability of productresulting from the union strikes at our LaGrange, Illinois and Eastlake, Ohioplants (settled in March and May, respectively) also contributed to the salesshortfall.  These factors were mitigatedin part by a shift in sales mix towards higher-priced step-up and professionalinstruments and an 11% increase in percussion unit shipments.

 

*Gross Profit –*Gross profit decreased $4.6 million in 2003 as both the piano and bandsegments experienced deteriorating gross margins.  Piano margins decreased slightly to 34.2% despite the shifttowards retail units, primarily due to the $1.4 million resulting fromunfavorable foreign exchange rates

 

19

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onBoston inventory purchases.  Grossmargins for the band and orchestral segment declined to 19.7%, corresponding toa gross profit decrease of $8.8 million. This decrease includes $1.9 million paid to employees in accordance withthe terms of expired labor contracts, and $1.3 million in underabsorbedoverhead and lost profit resulting from the work stoppages at two of ourplants.  In addition, we incurred $1.2million in inventory impairment charges and $1.7 million in severance costsassociated with the closure of our Nogales, Arizona woodwind manufacturingfacility and the imminent (April 2004) closure of one of our Elkhart, Indianawoodwind manufacturing facilities.  Production levels, which were reduced at one of our brasswind plants inorder to manage excess inventory levels, and increased pension expenses of $1.1million, also adversely impacted band segment margins in 2003.

 

*Operating Expenses –*Operating expenses increased $4.0 million,primarily as a result of the $3.0 million of impairment charges taken on land,building, and equipment relating to our Nogales, Arizona and Elkhart, Indianawoodwind manufacturing facilities. Foreign currency translation negatively impacted operating expenses by$2.1 million and additional sales and marketing expenses of over $1.0 millionincurred in conjunction with Steinway & Sons’ 150th anniversarycelebration were also a factor. Offsetting these costs was $2.6 million in savings realized by the bandsegment through administrative staff reductions and lower sales and marketingexpenses.

 

*Non-operating Expenses*–Non-operating expenses decreased $0.9 million to $8.4 million in 2003 primarilydue to lower net interest resulting from the use of cash from operations, asopposed to line of credit borrowings, in the current period.  In addition, our debt buyback of $4.7million in December 2002 lowered interest expense by $0.4 million.

 

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***Resultsof Operations***

 

*Fiscal Year 2002 Compared to Fiscal Year 2001*

 
|                        |   | **Year Ended December 31,** |    |   |   | **Change** |   |
|-----------------------------|--------|-----------------------------|---------|--------|--------|------------|--------|
|                        |   | **2001**                    |    |   |   | **2002**   |   |   |   | **$** |   | **%** |   |
|                        |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Net  sales                  |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Band                        |   | $                           | 183,646 |   |   |       | $      | 167,708 |   |   |   | (15,938 | ) | (8.7 | ) |
| Piano                       |   | 168,966                     |    |   |   | 164,589    |   |   |   | (4,377 | ) | (2.6 | ) |
| Total  sales                |   | 352,612                     |    |   |   | 332,297    |   |   |   | (20,315 | ) | (5.8 | ) |
|                        |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Cost  of sales              |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Band                        |   | 139,379                     |    |   |   | 127,849    |   |   |   | (11,530 | ) | (8.3 | ) |
| Piano                       |   | 109,712                     |    |   |   | 107,297    |   |   |   | (2,415 | ) | (2.2 | ) |
| Total  cost of sales        |   | 249,091                     |    |   |   | 235,146    |   |   |   | (13,945 | ) | (5.6 | ) |
|                        |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Gross  profit               |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Band                        |   | 44,267                      |    | 24.1%  |   | 39,859     |   | 23.8% |   | (4,408 | ) | (10.0 | ) |
| Piano                       |   | 59,254                      |    | 35.1%  |   | 57,292     |   | 34.8% |   | (1,962 | ) | (3.3 | ) |
| Total  gross profit         |   | 103,521                     |    |   |   | 97,151     |   |   |   | (6,370 | ) | (6.2 | ) |
|                        |   | 29.4%                       |    |   |   | 29.2%      |   |   |   |   |   |   |   |
|                        |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Operating  expenses         |   | 64,771                      |    |   |   | 64,598     |   |   |   | (173 | ) | (0.3 | ) |
| Amortization                |   | 4,255                       |    |   |   | 1,154      |   |   |   | (3,101 | ) | (72.9 | ) |
| Total  operating expenses   |   | 69,026                      |    |   |   | 65,752     |   |   |   | (3,274 | ) | (4.7 | ) |
|                        |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Income  from operations     |   | 34,495                      |    |   |   | 31,399     |   |   |   | (3,096 | ) | (9.0 | ) |
|                        |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Other  income, net          |   | (1,778                      | )       |   |   | (3,939     | )      |   |   | (2,161 | ) | 121.5 |   |
| Net  interest expense       |   | 16,731                      |    |   |   | 13,279     |   |   |   | (3,452 | ) | (20.6 | ) |
| Debt  extinguishment costs  |   | 6,612                       |    |   |   | —     |   |   |   | (6,612 | ) |   |   |
|                        |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Income  before income taxes |   | 12,930                      |    |   |   | 22,059     |   |   |   | 9,129 |   | 70.6 |   |
|                        |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Income  taxes               |   | 4,192                       |    |   |   | 7,150      |   |   |   | 2,958 |   | 70.6 |   |
|                        |   |                        |    |   |   |       |   |   |   |   |   |   |   |
| Net  income                 |   | $                           | 8,738   |   |   |       | $      | 14,909 |   |   |   | 6,171 |   | 70.6 |   |

 

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*Overview –*2002 was a difficult year for our band business. We ran our factoriesat lower production levels to bring output more in line with current demand asa short-term solution for our manufacturing overcapacity.  Foreign competition continued to put pricingpressure on domestic band instrument manufacturers.  Dealers continued to have excess inventories, and were reluctantto order additional instruments unless enticed by discounting.  Lastly, state budget cuts negativelyimpacted band programs in many communities, causing a reduction in our schoolbid business.  We recognized the needfor long-term strategic changes in order to remain competitive in theindustry.  We restructured the companytowards year-end, combining Selmer and UMI, and initiated the strategicplanning process designed to produce fundamental changes necessary to ensurethe long-term growth of this segment of our business.

 

Our piano business remained relatively stabledespite worldwide economic conditions. We experienced growth in mid-priced piano market demand, which helpedstabilize sales.  We reduced productionlevels at our New York and German factories to manage working capital. We wereable to increase domestic production mid-year and overseas production towardsyear-end in response to positive sales results.

 

*Net Sales –* Thedecrease in net sales of $20.3 million occurred despite a $6.1 million (7%)revenue increase in the fourth quarter, which was attributable to pianosales.  Our domestic piano sales wereless impacted by the weakened economy than our sales in Europe and Asia.  Domestic Steinway grand unit shipmentsdecreased only 9% as compared to the 16% decrease in our grand unit shipments overseas.  Our lower-priced Boston piano lines faredmuch better, experiencing a domestic unit increase of 16% in 2002.  As a result, domestic piano revenuesremained relatively stable year over year. The band and orchestral instrument sales decrease of $15.9 millionresulted from a unit decrease of 13% and more competitive pricing strategies oncertain instruments, which was partially offset by a shift in sales mix towardshigher-priced step-up and professional instruments.

 

*Gross Profit* – Grossprofit decreased $6.4 million due to deterioration in both the piano and bandgross margins. Piano margins decreased to 34.8% due to periodic factoryshutdowns, which were taken in response to the slowing economy.  These shutdowns enabled us to controlinventory levels while retaining our skilled workforce.  A decrease in production days at ouroverseas manufacturing facility had an unfavorable impact of approximately $1.6million, but was mitigated by the favorable exchange rates on the Bostonproduct line inventories.  Band segmentmargins decreased slightly to 23.8% due to reduced production, which was at orbelow 2001 levels in virtually all of our plants, as well as manufacturinginefficiencies resulting from layoffs and staff retraining requirements at oneof our plants.

 

*Operating Expenses* –Operating expenses decreased $3.3 million primarily due to the $3.1 milliondecrease in our amortization expense resulting from the cessation ofamortization of our goodwill and trademark assets following the implementationof Statement of Financial Accounting Standard (“SFAS”) No. 142.  Increases in general and administrativecosts associated with consulting and severance costs were more than offset bythe $1.1 million decrease in sales and marketing expenses year over year.

 

*Non-operating Expenses –* Non-operating expenses decreased $12.2million to $9.3 million in 2002 due to the absence of $6.6 million of debtextinguishment costs, which were incurred in the prior year.  These costs were attributable to our long-termdebt refinancing in April 2001. Exclusive of these costs, non-operating expenses decreased $5.6million.  This was due to the $3.5million decrease in net interest expense resulting from the significantdecrease in borrowings on our domestic revolving loan as compared to 2001.  Foreign exchange gains of $0.7 millioncompared to foreign exchange losses of $0.8 million in 2001 also contributed tothe reduction of non-operating expenses in the current period*.*

 

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**Liquidityand Capital Resources**

 

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

 

**Cash Flows**

 

Our statements of cash flows for the years ended December 31 aresummarized as follows:

 
|                                                                         |   | **2001** |   | **2002** |   | **2003** |   |
|------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Net  income:                                                                 |   | $        | 8,738  |     | $      | 14,909   |   | $ | 9,698 |   |
| Changes  in operating assets and liabilities                                 |   | 2,265    |   | 5,962    |   | 9,333    |   |
| Other  adjustments to reconcile net income to cash from operating activities |   | 17,874   |   | 10,177   |   | 12,845   |   |
| Cash  flows from operating activities                                        |   | 28,877   |   | 31,048   |   | 31,876   |   |
|                                                                         |   |     |   |     |   |     |   |
| Cash  flows from investing activities                                        |   | (7,988   | )      | (7,749   | )      | (6,435   | )      |
|                                                                         |   |     |   |     |   |     |   |
| Cash  flows from financing activities                                        |   | (20,411  | )      | (9,718   | )      | (2,767   | )      |
|                                                                              |        |          |        |          |        |          |        |  |  |  |

 

The 2003 increase in cash flows from operating activities of $0.9million occurred despite the $5.2 million decrease in net income primarily as aresult of our continued control of inventory as well as effective management ofour accounts receivable and payable. Together, these amounts contributed $11.2 million to cash flows fromoperating activities in 2003, as compared to $9.8 million in 2002 and $6.9 millionin 2001.

 

Cash used ininvesting activities consists primarily of capital expenditures of $7.1 millionin 2001, $5.6 million in 2002, and $5.5 million in 2003 (see CapitalExpenditures discussion below).  Cashused in financing activities in 2001 resulted from the debt restructuringactivities we completed to ensure long-term financing at favorable rates,including the issuance of $150.0 million 8.75% Senior Notes, our redemption of$110.0 million in 11% Senior Subordinated Notes, and repayment of our domesticline of credit with the additional Senior Note proceeds.  In 2002, cash used for financing activitiesresulted from the scheduled amortization of our term loans of $6.4 million, aswell as the repurchase of $4.7 million of our Senior Notes.  In 2003, domestic financing activity consistedprimarily of scheduled debt amortization of $6.5 million.  This was partially offset by net borrowingson our foreign lines of credit of $2.3 million, which were made primarily foroperating cash and inventory purchases. (See Borrowing Activities and Availability discussion below.)

 

**Capital Expenditures**

 

Our capital expenditures consist primarily of machinery and equipmentpurchases, and office equipment upgrades and replacements, as well as leaseholdimprovement projects related to our new retail stores in 2003. We expect ourcapital spending in 2004 to be in the range of $5.5-6.5 million, relating tomachinery and equipment purchases, system upgrades, and facility improvements.

 

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**Seasonality**

 

Consistentwith industry practice, we sell band instruments almost entirely on creditutilizing the two financing programs described below.  Due to these programs, we have large working capital requirementsduring certain times of the year when band instrument receivable balances reachhighs of approximately $75-80 million in August and September, and lesserrequirements when they are at lows of approximately $60-65 million in Januaryand February.  The financing options, intendedto assist dealers with the seasonality inherent in the industry and tofacilitate the rent-to-own programs offered to students by many retailers, alsoallow us to match our production and delivery schedules.  The following forms of financing are offeredto qualified band instrument dealers:

 

a)              *Receivable dating:* Payments on purchasesmade from January through August are due in October.  Payments on purchases made from September to December are due inJanuary.  Dealers are offered discountsfor early payment.

 

b)             *Note receivable financing:* Qualifieddealers may convert open accounts to a note payable to us.  The note program is offered in January andOctober and coincides with the receivable dating program.  In most instances, the note receivable issecured by dealer inventories and receivables.

 

### **Off Balance SheetArrangements**

 

Prior toAugust 2002, we sold notes receivable on a recourse basis to a financingcompany.  The financing company had theoption to purchase up to $18.0 million of our notes receivable.  We received proceeds from the sale of suchnotes of approximately $12.7 million in 2001 and $2.6 million in 2002.  Outstanding balances on these notes were$6.7 million as of December 31, 2001. We have retained these notes receivable since August 2002.

 

Unlike many ofour competitors in the piano industry, with limited exceptions, we do notprovide extended financing arrangements to our dealers.  To facilitate long-term financing requiredby some dealers, we have arranged financing through third-party providers.  We generally provide no guarantees withrespect to these arrangements.

 

**Pensions and Other Postretirement Benefits**

 

During 2003,we amended one of our plans to eliminate future years of service credit underthe plan and combined all of our domestic pension plans into one plan tofacilitate plan monitoring and plan investment management.  When determining the amounts to berecognized in the consolidated financial statements related to our domesticpension and other post retirement benefits, we used a long-term rate of returnon plan assets of 9%, which was developed with input from our actuaries and ourinvestment committee, and is consistent with previous rates we have used.  We believe that 9% is representative of thelong-term rate of return that we may expect from our domestic pensionassets.  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 6.75% to 6.50% at December 31, 2003.

 

The discountrates and rates of returns on plan assets for our foreign pension and otherpostretirement benefit plans were similarly developed utilizing long-term ratesof return and discount rates reasonably expected to occur.

 

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**Borrowing Activities and Availability**

 

Our realestate term loan, acquisition term loan, and domestic, seasonal borrowingrequirements are accommodated through a committed credit facility with a syndicateof domestic lenders (the “Credit Facility”). The Credit Facility, which was amended and restated to accommodate the$150.0 million bond offering completed on April 19, 2001, provides us with apotential borrowing capacity of $85.0 million in revolving credit loans, andexpires on September 14, 2008. Borrowings are collateralized by our domesticaccounts receivable, inventory, and fixed assets.  As of December 31, 2003, there were no revolving credit loansoutstanding and availability based on eligible accounts receivable andinventory balances was approximately $82.0 million, net of letters of credit.The real estate term loan is payable in monthly installments of $0.2 millionand includes interest at average 30-day LIBOR (1.12% at December 31, 2003) plus1.5%.  This term loan is secured by allof our interests in the Steinway Hall property.  The acquisition term loan is repayable in monthly installments of$0.4 million for the first five years and monthly installments of $0.6 millionin years six through eight.  Theacquisition term loan and revolving credit loans bear interest at average30-day LIBOR plus 1.75%.  All of ourborrowings under the Credit Facility are secured by a first lien on ourdomestic inventory, receivables, and fixed assets.  Open account loans with foreign banks also provide for borrowingsof up to €17.6 million ($22.1 million at December 31, 2003) by Steinway’sforeign subsidiaries.

 

On April 19,2001, we completed a $150.0 million 8.75% Senior Note offering.  The proceeds of this offering were used toredeem $110.0 million of previously outstanding Senior Subordinated Notes, withthe balance used to pay down the Credit Facility.  The early retirement of the Senior Subordinated Notes, which wereredeemed on June 1, 2001 at 102.75% of the principal amount, generated a debtextinguishment charge of approximately $6.6 million, and a related tax benefitof $2.7 million.  On December 18, 2002we repurchased $4.7 million of our Senior Notes at 99.25%.

 

At December31, 2003, our total outstanding indebtedness amounted to $196.6 million,consisting of $145.3 million of 8.75% Senior Notes, $18.2 million on the realestate term loan, $29.0 million on the acquisition term loan, and $4.1 millionof notes payable to foreign banks.  Cashinterest paid was $19.1 million in 2001, $15.3 million in 2002, and $14.6million in 2003. All of our debt agreements contain covenants that placecertain restrictions on us, including our ability to incur additionalindebtedness, to make investments in other entities and to pay cash dividends.We were in compliance with all such covenants as of December 31, 2003 and donot anticipate any compliance issues in 2004.

 

Our sharerepurchase program authorizes us to make discretionary repurchases of ourOrdinary common stock on the open market up to a limit of $25.0 million.  Repurchased shares are held as treasuryshares to be used for corporate purposes. We have reserved 721,750 shares of our existing treasury stock to beutilized for the issuance of stock options under our Amended and Restated 1996Stock Plan.  These options have noimpact on our cash flow or number of shares outstanding unless and until theyare exercised.  In 2001, we repurchased114,600 shares at a cost of $1.9 million. We did not repurchase any shares in 2002 or 2003.

 

Subsequent toDecember 31, 2003, we amended our Credit Facility to accommodate a large stockrepurchase.  On February 4, 2004 werepurchased 1,271,450 shares of Ordinary common stock directly from our largestinstitutional shareholder.  In exchange,we tendered $29.0 million in principal amount of our 8.75% Senior Notes due2011, which were issued under the existing indenture.  We issued our bonds at a premium of 106.3%.  This transaction resulted in an increase toour treasury stock of $31.6 million.

 

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

 

We experiencelong production and inventory turnover cycles, which we constantly monitorsince fluctuations in demand can have a significant impact on thesecycles.  Our Credit Facility wentvirtually unutilized throughout the year since we effectively managed ourinventory levels and accounts receivable and were able to maximize cash flowsfrom operations despite strikes, facility rationalization costs, and lower netincome in the current period.  Lookingforward to 2004, we anticipate a stable year for the piano division and achallenging first half of the year for the band division as we implement ourproduct expansion and distribution strategy. We will continue to focus on keeping our balance sheet strong bymanaging accounts receivable, maintaining sufficient, but not excessive,inventory levels, and repaying debt.  Weexpect to have an incremental interest liability of $2.5 million as a result ofthe additional $29.0 million in bonds issued in February 2004.  However, we do not expect that this willhave a material impact on our liquidity in 2004.

 

Other thanthose described, we are not aware of any trends, demands, commitments, or costsof resources that are expected to materially impact our liquidity or capitalresources.  Accordingly, we believe thatcash on hand, together with cash flows anticipated from operations andavailable borrowings under the Credit Facility, will be adequate to meet ourdebt service requirements, fund continuing capital requirements and satisfy ourworking capital and general corporate needs through 2004.

 

**Contractual Obligations**

 

The following table provides asummary of our contractual obligations at December 31, 2003.

 
|                             |   | **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)              |   | $                          | 196,602 |   | $ | 10,638 |   | $ | 15,512 |   | $ | 25,107 |   | $ | 145,345 |   |
| Operating  leases (2)            |   | 276,026                    |    | 4,955 |   | 8,579 |   | 6,874 |   | 255,618 |   |
| Purchase  obligations (3)        |   | 4,838                      |    | 4,523 |   | 210 |   | 105 |   | — |   |
| Other  long-term liabilities (4) |   | 18,723                     |    | 1,512 |   | 3,023 |   | 3,023 |   | 11,165 |   |
| Total                            |   | $                          | 496,189 |   | $ | 21,628 |   | $ | 27,324 |   | $ | 35,109 |   | $ | 412,128 |   |

 

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**Notes to Contractual Obligations:**

 

(1) The nature of our long-term debt obligations is described morefully in the “Borrowing Availability and Activities” section of “Liquidity andCapital Resources.”

(2) Approximately $259.7 million of our operating lease obligations areattributable to the ninety-nine year land lease associated with the purchase ofSteinway Hall, which is described in Note 13 in the Notes to ConsolidatedFinancial Statements included within this filing; the remainder is attributableto the leasing of other facilities and equipment.

(3) Purchase obligations consist of firm purchase commitments for rawmaterials and equipment.

(4) Our other long-term liabilities consist primarily of pensionobligations, which are described in Note 14 in the Notes to ConsolidatedFinancial Statements included within this filing.

 

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**Critical Accounting Policies**

 

The nature ofour business - the production and sale of musical instruments - is such that itrarely involves application of highly complex or subjective accountingprinciples.  The accounting policiesthat are subject to significant management estimates are those normally foundin traditional businesses and include inventory reserves, accounts receivablereserves, reserves on notes receivable (including recourse reserves when noteshad been sold to third parties), and warranty reserves.  We have significant experience and data onwhich to base these estimates. Historical information is adjusted for specific uncertainties, such asnew product introductions, and contemporaneous information, such as pricefluctuations.  We regularly performassessments of the underlying assumptions and believe that they provide areasonable basis for the estimates contained in our financial statements.

 

**New AccountingPronouncements**

 

In April 2003,the Financial Accounting Standards Board (“FASB”) issued SFAS No. 149,“Amendment of Statement 133 on Derivative Instruments and Hedging Activities.”SFAS No. 149 amends SFAS No. 133 to conform and incorporate derivativeimplementation issues and subsequently issued accounting guidance. SFAS No. 149clarifies under what circumstances a contract with an initial net investmentmeets the characteristic of a derivative, and clarifies when a derivativecontains a financing component that warrants special reporting in the statementof cash flows.  SFAS No. 149 also amendsother existing pronouncements, resulting in more consistent reporting ofcontracts that are derivatives in their entirety or that contain embeddedderivatives that warrant special accounting. The adoption of SFAS No. 149 didnot have a material effect on our financial position, results of operations orcash flows.

 

In May 2003,the FASB issued SFAS No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity.” SFAS No. 150 establishesstandards for how an issuer classifies and measures certain freestandingfinancial instruments with characteristics of both liabilities and equity. Theadoption of SFAS No. 150 did not have a material effect on our financialposition, results of operations or cash flows.

 

In December2003, the FASB revised SFAS No. 132, “Employers’ Disclosures about Pensions andOther Postretirement Benefits.”  SFASNo. 132 requires additional disclosure about the assets, obligations, cashflows, and net periodic benefit cost of defined benefit pension plans and otherdefined benefit postretirement plans. This statement also requires disclosure about the types of plan assets,investment strategy, measurement dates, plan obligations, and cash flows.  SFAS No. 132 is effective for fiscal yearsending after December 15, 2003.  Interimperiod disclosures required by this statement are effective for periodsbeginning after December 15, 2003. Disclosure of information about foreign plans required by this statementis effective for fiscal years ending after June 15, 2004.

 

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

 

We are subjectto market risk associated with changes in foreign currency exchange rates andinterest rates.  We mitigate our foreigncurrency exchange rate risk by holding forward foreign currency contracts.  These contracts are used as a hedge againstintercompany transactions and are not used for trading or speculativepurposes.  The fair value of the forwardforeign currency exchange contracts is sensitive to changes in foreign currencyexchange rates.  As of December 31,2003, a 10% negative change in foreign currency exchange rates from marketrates would decrease the fair value of the contracts by approximately $0.3million.  Gains and losses on theforeign currency exchange contracts are defined as the difference between thecontract rate at its inception date and the current exchange rate.  However, we would offset any such gains andlosses by corresponding losses and gains, respectively, on the related hedgedasset or liability.

 

Our interestrate exposure is limited primarily to interest rate changes on our variablerate debt.  The Credit Facility and termloans bear interest at rates that fluctuate with changes in LIBOR.  For the year ended December 31, 2003, ahypothetical 10% increase in interest rates would have increased our interestexpense by approximately $0.1 million. We use interest rate caps to manage interest rate risk on foreign debt.  The carrying value of the caps is notmaterial and a 10% change in interest rates would not have a material effect onthe fair value of the caps.

 

Our long-termdebt includes $145.3 million of Senior Notes with a fixed interest rate.  Accordingly, there would be no immediateimpact on our interest expense associated with these Notes due to fluctuationsin market interest rates.  However,based on a hypothetical 10% immediate decrease in market interest rates, thefair value of our Senior Notes, which would be sensitive to such interest ratechanges, would be increased by approximately $0.6 million as of December 31,2003.  Such fair value changes mayaffect our determination whether to retain, replace or retire these Notes.

 

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3299-1-bc.doc -ConsolidatedStatementsOfStockholders

**ITEM 8****                   FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

 
| INDEPENDENT AUDITORS’ REPORT   |
|-------------------------------------|
|                                |
| CONSOLIDATED  FINANCIAL STATEMENTS: |
|                                |
|                                | Consolidated Statements of Income for the  Years Ended December 31, 2001, 2002, and 2003 |
|                                | Consolidated Balance Sheets as of December 31, 2002 and 2003 |
|                                | Consolidated Statements of Cash Flows for  the Years Ended December 31, 2001, 2002, and 2003 |
|                                | Consolidated Statements of Stockholders’  Equity for the Years Ended December 31, 2001, 2002, and 2003 |
|                                | Notes to Consolidated Financial Statements |
|                                | Schedule II - Valuation and Qualifying  Accounts |

 

29

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**INDEPENDENT AUDITORS’REPORT**

 

To the Board of Directors and Stockholders ofSteinway Musical Instruments, Inc.:

 

 

We have audited theaccompanying consolidated balance sheets of Steinway Musical Instruments, Inc.and subsidiaries as of December 31, 2002 and 2003, and the related consolidatedstatements of income, stockholders’ equity, and cash flows for each of thethree years in the period ended December 31, 2003.  Our audits also included the financial statement schedule listedin the Index at Item 15(a)(1).  Thesefinancial statements and financial statement schedule are the responsibility ofthe Company’s management.  Ourresponsibility is to express an opinion on the financial statements andfinancial statement schedule based on our audits.

 

We conducted our audits inaccordance with auditing standards generally accepted in the United States ofAmerica.  Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation.  We believe that ouraudits provide a reasonable basis for our opinion.

 

In our opinion, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of Steinway Musical Instruments, Inc. and subsidiaries as ofDecember 31, 2002 and 2003, and the results of their operations and their cashflows for each of the three years in the period ended December 31, 2003 inconformity with accounting principles generally accepted in the United Statesof America.  Also, in our opinion, suchfinancial statement schedule, when considered in relation to the basic consolidatedfinancial statements taken as a whole, presents fairly, in all materialrespects, the information set forth therein.

 

As discussed in Note 2, in 2002the Company changed its methods of accounting for goodwill and trademarks toconform to Statement of Financial Accounting Standard (“SFAS”) No. 142, anddebt extinguishment costs to conform to SFAS No. 145.

 

As discussed in Note 2, in 2003the Company changed its method of accounting for certain inventories from thelast-in, first-out method to the first-in, first-out method and retroactivelyrestated the 2001 and 2002 consolidated financial statements for the change.

 

 
| /s/  DELOITTE & TOUCHE LLP |   |
|-------------------------------------|--------|
|                                |
| Boston,  Massachusetts              |
| March 12,  2004                     |

 

30

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**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOMEYEARS ENDED DECEMBER 31, 2001, 2002, AND 2003(In Thousands Except Share and Per Share Data)**

 
|                                   |   | **2001**  |    | **2002**  |   | **2003**  |   |
|----------------------------------------|--------|-----------|---------|-----------|--------|-----------|--------|
|                                   |   |      |    |      |   |      |   |
| Net sales                              |   | $         | 352,612 |      | $      | 332,297   |   | $ | 337,220 |   |
| Cost of sales                          |   | 249,091   |    | 235,146   |   | 244,667   |   |
|                                   |   |      |    |      |   |      |   |
| Gross profit                           |   | 103,521   |    | 97,151    |   | 92,553    |   |
|                                   |   |      |    |      |   |      |   |
| Operating expenses:                    |   |      |    |      |   |      |   |
| Sales and marketing                    |   | 42,251    |    | 41,129    |   | 41,719    |   |
| General and administrative             |   | 21,909    |    | 22,517    |   | 23,134    |   |
| Amortization                           |   | 4,255     |    | 1,154     |   | 1,154     |   |
| Other operating expenses               |   | 611       |    | 952       |   | 764       |   |
| Facility rationalization charges       |   | —    |    | —    |   | 2,958     |   |
| Total operating expenses               |   | 69,026    |    | 65,752    |   | 69,729    |   |
|                                   |   |      |    |      |   |      |   |
| Income from operations                 |   | 34,495    |    | 31,399    |   | 22,824    |   |
|                                   |   |      |    |      |   |      |   |
| Other income, net                      |   | (1,778    | )       | (3,939    | )      | (3,517    | )      |
| Interest income                        |   | (2,306    | )       | (1,892    | )      | (2,175    | )      |
| Interest expense                       |   | 19,037    |    | 15,171    |   | 14,120    |   |
| Debt extinguishment costs              |   | 6,612     |    | —    |   | —    |   |
|                                   |   |      |    |      |   |      |   |
| Income before income taxes             |   | 12,930    |    | 22,059    |   | 14,396    |   |
|                                   |   |      |    |      |   |      |   |
| Income taxes                           |   | 4,192     |    | 7,150     |   | 4,698     |   |
|                                   |   |      |    |      |   |      |   |
| Net income                             |   | $         | 8,738   |      | $      | 14,909    |   | $ | 9,698 |   |
|                                   |   |      |    |      |   |      |   |
| Earnings per share - basic and diluted |   | $         | 0.98    |      | $      | 1.68      |   | $ | 1.09 |   |
|                                   |   |      |    |      |   |      |   |
| Weighted average shares:               |   |      |    |      |   |      |   |
| Basic                                  |   | 8,928,000 |    | 8,877,256 |   | 8,924,578 |   |
| Diluted                                |   | 8,928,000 |    | 8,882,165 |   | 8,925,672 |   |

 

See notes to consolidatedfinancial statements.

 

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**STEINWAY MUSICALINSTRUMENTS, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**DECEMBER 31, 2002 AND2003**

**(In Thousands ExceptShare and Per Share Data)**

 
|                                                                                                                                              |   | **December  31,  2002** |    | **December  31,  2003** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|-------------------------|--------|
| ASSETS                                                                                                                                            |   |                    |    |                    |   |
| Current assets:                                                                                                                                   |   |                    |    |                    |   |
| Cash                                                                                                                                              |   | $                       | 19,099  |                    | $      | 42,283 |   |
| Accounts, notes and leases receivable, net  of allowance for bad debts of  $11,389 and $9,944 in 2002 and 2003, respectively                      |   | 77,421                  |    | 76,403                  |   |
| Inventories                                                                                                                                       |   | 155,843                 |    | 152,029                 |   |
| Prepaid expenses and other current assets                                                                                                         |   | 5,227                   |    | 4,533                   |   |
| Deferred tax assets                                                                                                                               |   | 9,756                   |    | 13,022                  |   |
| Total current assets                                                                                                                              |   | 267,346                 |    | 288,270                 |   |
|                                                                                                                                              |   |                    |    |                    |   |
| Property, plant and equipment, net                                                                                                                |   | 102,567                 |    | 98,937                  |   |
| Trademarks                                                                                                                                        |   | 9,651                   |    | 10,319                  |   |
| Goodwill                                                                                                                                          |   | 29,539                  |    | 31,665                  |   |
| Other intangibles, net                                                                                                                            |   | 6,936                   |    | 5,782                   |   |
| Other assets                                                                                                                                      |   | 7,692                   |    | 10,692                  |   |
|                                                                                                                                              |   |                    |    |                    |   |
| TOTAL ASSETS                                                                                                                                      |   | $                       | 423,731 |                    | $      | 445,665 |   |
|                                                                                                                                              |   |                    |    |                    |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                         |   |                    |    |                    |   |
| Current liabilities:                                                                                                                              |   |                    |    |                    |   |
| Current portion of long-term debt                                                                                                                 |   | $                       | 8,055   |                    | $      | 10,638 |   |
| Accounts payable                                                                                                                                  |   | 9,888                   |    | 11,554                  |   |
| Other current liabilities                                                                                                                         |   | 35,359                  |    | 39,112                  |   |
| Total current liabilities                                                                                                                         |   | 53,302                  |    | 61,304                  |   |
|                                                                                                                                              |   |                    |    |                    |   |
| Long-term debt                                                                                                                                    |   | 192,581                 |    | 185,964                 |   |
| Deferred tax liabilities                                                                                                                          |   | 22,709                  |    | 25,565                  |   |
| Other non-current liabilities                                                                                                                     |   | 23,931                  |    | 20,197                  |   |
| Total liabilities                                                                                                                                 |   | 292,523                 |    | 293,030                 |   |
|                                                                                                                                              |   |                    |    |                    |   |
| 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, 8,428,286  and 8,521,392 shares outstanding in 2002 and 2003, respectively |   | 9                       |    | 10                      |   |
| Additional paid-in capital                                                                                                                        |   | 73,172                  |    | 74,626                  |   |
| Retained earnings                                                                                                                                 |   | 87,022                  |    | 96,720                  |   |
| Accumulated other comprehensive loss                                                                                                              |   | (13,142                 | )       | (2,868                  | )      |
| Treasury stock, at cost (774,000 shares of  Ordinary common stock)                                                                                |   | (15,853                 | )       | (15,853                 | )      |
| Total stockholders’ equity                                                                                                                   |   | 131,208                 |    | 152,635                 |   |
|                                                                                                                                              |   |                    |    |                    |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                   |   | $                       | 423,731 |                    | $      | 445,665 |   |

 

See notes to consolidatedfinancial statements.

 

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**STEINWAY MUSICALINSTRUMENTS, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**YEARS ENDED DECEMBER31, 2001, 2002 AND 2003**

**(In Thousands)**

 
|                                                                          |   | **2001** |   | **2002** |   | **2003** |   |
|-------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Cash flows from operating activities:                                         |   |     |   |     |   |     |   |
| Net income                                                                    |   | $        | 8,738  |     | $      | 14,909   |   | $ | 9,698 |   |
| Adjustments to reconcile net income to cash  flows from operating activities: |   |     |   |     |   |     |   |
| Depreciation and amortization                                                 |   | 13,803   |   | 11,037   |   | 10,959   |   |
| Facility rationalization charges                                              |   | —   |   | —   |   | 4,158    |   |
| Debt extinguishment costs                                                     |   | 6,612    |   | —   |   | —   |   |
| Deferred tax benefit                                                          |   | (2,972   | )      | (1,194   | )      | (2,601   | )      |
| Other                                                                         |   | 431      |   | 334      |   | 329      |   |
| Changes in operating assets and  liabilities:                                 |   |     |   |     |   |     |   |
| Accounts, notes and leases receivable                                         |   | 9,864    |   | 6,090    |   | 2,783    |   |
| Inventories                                                                   |   | 457      |   | 1,877    |   | 7,373    |   |
| Prepaid expenses and other current assets                                     |   | (2,533   | )      | (755     | )      | 126      |   |
| Accounts payable                                                              |   | (3,440   | )      | 1,845    |   | 1,086    |   |
| Other current liabilities                                                     |   | (2,083   | )      | (3,095   | )      | (2,035   | )      |
| Cash flows from operating activities                                          |   | 28,877   |   | 31,048   |   | 31,876   |   |
|                                                                          |   |     |   |     |   |     |   |
| Cash flows from investing activities:                                         |   |     |   |     |   |     |   |
| Capital expenditures                                                          |   | (7,141   | )      | (5,604   | )      | (5,462   | )      |
| Proceeds from disposals of fixed assets                                       |   | 243      |   | 4        |   | 10       |   |
| Changes in other assets                                                       |   | (1,090   | )      | (2,149   | )      | (983     | )      |
| Cash flows from investing activities                                          |   | (7,988   | )      | (7,749   | )      | (6,435   | )      |
|                                                                          |   |     |   |     |   |     |   |
| Cash flows from financing activities:                                         |   |     |   |     |   |     |   |
| Borrowings under lines of credit                                              |   | 309,161  |   | 127,604  |   | 10,606   |   |
| Repayments under lines of credit                                              |   | (354,762 | )      | (127,309 | )      | (8,316   | )      |
| Proceeds from long-term debt                                                  |   | 150,000  |   | —   |   | —   |   |
| Repayments of long-term debt                                                  |   | (118,847 | )      | (6,352   | )      | (6,512   | )      |
| Repurchase of long-term debt                                                  |   | —   |   | (4,655   | )      | —   |   |
| Debt issuance costs                                                           |   | (4,516   | )      | —   |   | —   |   |
| Proceeds from issuance of stock                                               |   | 454      |   | 994      |   | 1,455    |   |
| Purchases of treasury stock                                                   |   | (1,901   | )      | —   |   | —   |   |
| Cash flows from financing activities                                          |   | (20,411  | )      | (9,718   | )      | (2,767   | )      |
|                                                                          |   |     |   |     |   |     |   |
| Effects of foreign exchange rate changes on  cash                             |   | 78       |   | (27      | )      | 510      |   |
|                                                                          |   |     |   |     |   |     |   |
| Increase in cash                                                              |   | 556      |   | 13,554   |   | 23,184   |   |
| Cash, beginning of year                                                       |   | 4,989    |   | 5,545    |   | 19,099   |   |
|                                                                          |   |     |   |     |   |     |   |
| Cash, end of year                                                             |   | $        | 5,545  |     | $      | 19,099   |   | $ | 42,283 |   |
|                                                                          |   |     |   |     |   |     |   |
| Supplemental Cash Flow Information                                            |   |     |   |     |   |     |   |
| Interest paid                                                                 |   | $        | 19,120 |     | $      | 15,318   |   | $ | 14,624 |   |
| Income taxes paid                                                             |   | $        | 10,337 |     | $      | 11,363   |   | $ | 7,131 |   |

 

See notes to consolidatedfinancial statements.

 

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**STEINWAY MUSICALINSTRUMENTS, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’EQUITY**

**FOR THE YEARS ENDEDDECEMBER 31, 2001, 2002 AND 2003**

**(In Thousands ExceptShare Data)**

 
|                                                   |   | **Common  Stock** |   | **Additional  Paid-In  Capital** |   | **Retained  Earnings** |   | **Accumulated  Other  Comprehensive  Loss** |   | **Treasury  Stock** |   | **Total  Stockholders’  Equity** |   |
|--------------------------------------------------------|--------|-------------------|--------|----------------------------------|--------|------------------------|--------|---------------------------------------------|--------|---------------------|--------|---------------------------------------|--------|
|                                                   |   |              |   |                             |   |                   |   |                                        |   |                |   |                                  |   |
| Balance, January 1, 2001                               |   | $                 | 9      |                             | $      | 71,724                 |   | $                                           | 63,375 |                | $      | (9,966                                | )      | $ | (13,952 | ) | $ | 111,190 |   |
| Comprehensive income:                                  |   |              |   |                             |   |                   |   |                                        |   |                |   |                                  |   |
| Net income                                             |   |              |   |                             |   | 8,738                  |   |                                        |   |                |   | 8,738                                 |   |
| Foreign currency translation adjustment                |   |              |   |                             |   |                   |   | (1,852                                      | )      |                |   | (1,852                                | )      |
| Additional minimum pension liability, net              |   |              |   |                             |   |                   |   | (851                                        | )      |                |   | (851                                  | )      |
| Unrealized loss on certain long-term  investments, net |   |              |   |                             |   |                   |   | (5                                          | )      |                |   | (5                                    | )      |
| Total comprehensive income                             |   |              |   |                             |   |                   |   |                                        |   |                |   | 6,030                                 |   |
|                                                   |   |              |   |                             |   |                   |   |                                        |   |                |   |                                  |   |
| Issuance of 29,549 shares of common stock              |   |              |   | 454                              |   |                   |   |                                        |   |                |   | 454                                   |   |
|                                                   |   |              |   |                             |   |                   |   |                                        |   |                |   |                                  |   |
| Purchase of 114,600 shares of common stock             |   |              |   |                             |   |                   |   |                                        |   | (1,901              | )      | (1,901                                | )      |
|                                                   |   |              |   |                             |   |                   |   |                                        |   |                |   |                                  |   |
| Balance, December 31, 2001                             |   | 9                 |   | 72,178                           |   | 72,113                 |   | (12,674                                     | )      | (15,853             | )      | 115,773                               |   |
|                                                   |   |              |   |                             |   |                   |   |                                        |   |                |   |                                  |   |
| Comprehensive income:                                  |   |              |   |                             |   |                   |   |                                        |   |                |   |                                  |   |
| Net income                                             |   |              |   |                             |   | 14,909                 |   |                                        |   |                |   | 14,909                                |   |
| Foreign currency translation adjustment                |   |              |   |                             |   |                   |   | 5,589                                       |   |                |   | 5,589                                 |   |
| Additional minimum pension liability, net              |   |              |   |                             |   |                   |   | (5,986                                      | )      |                |   | (5,986                                | )      |
| Unrealized loss on certain long-term  investments, net |   |              |   |                             |   |                   |   | (71                                         | )      |                |   | (71                                   | )      |
| Total comprehensive income                             |   |              |   |                             |   |                   |   |                                        |   |                |   | 14,441                                |   |
|                                                   |   |              |   |                             |   |                   |   |                                        |   |                |   |                                  |   |
| Issuance of 59,789 shares of common stock              |   |              |   | 994                              |   |                   |   |                                        |   |                |   | 994                                   |   |
|                                                   |   |              |   |                             |   |                   |   |                                        |   |                |   |                                  |   |
| Balance, December 31, 2002                             |   | 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                                 |   |
| Unrealized gain on certain long-term  investments, net |   |              |   |                             |   |                   |   | 120                                         |   |                |   | 120                                   |   |
| Total comprehensive income                             |   |              |   |                             |   |                   |   |                                        |   |                |   | 19,972                                |   |
|                                                   |   |              |   |                             |   |                   |   |                                        |   |                |   |                                  |   |
| Issuance of 93,109 shares of common stock              |   | 1                 |   | 1,454                            |   |                   |   |                                        |   |                |   | 1,455                                 |   |
| Balance, December 31, 2003                             |   | $                 | 10     |                             | $      | 74,626                 |   | $                                           | 96,720 |                | $      | (2,868                                | )      | $ | (15,853 | ) | $ | 152,635 |   |

 

See notes to consolidatedfinancial statements.

 

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**STEINWAY MUSICALINSTRUMENTS, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**YEARS ENDED DECEMBER31, 2001, 2002 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 its wholly-owned subsidiaries, The SteinwayPiano Company, Inc. (“Steinway”) and Conn-Selmer, Inc. (“Conn-Selmer”),manufactures and distributes products within the musical instrumentindustry.  Steinway produces the highestquality piano in the world and has one of the most highly recognized andprestigious brand names.  Conn-Selmer isthe leading domestic manufacturer of band and orchestral instruments andrelated accessories, including complete lines of brasswind, woodwind,percussion and stringed instruments. Selmer Paris saxophones, Bach Stradivarius trumpets, C.G. Conn Frenchhorns, King trombones and Ludwig snare drums are considered by many to be thefinest such instruments in the world.

 

Throughoutthese financial statements “we”, “us”, and “our” refer to Steinway MusicalInstruments, Inc. and subsidiaries taken as a whole.  We combined the operations of The Selmer Company, Inc. (“Selmer”)and United Musical Instruments, Inc. (“UMI”) into Conn-Selmer during 2002.  The legal merger of UMI and Selmer becameeffective January 1, 2003.  Referencesto “Selmer” and “UMI” refer to events or circumstances prior to the merger.

 

**(2)****      Summary of SignificantAccounting Policies**

 

*Principles of Consolidation* - Our consolidated financialstatements include the accounts of all direct and indirect subsidiaries, all ofwhich are wholly-owned.  Allintercompany balances have been eliminated in consolidation.

 

*Use of Estimates* -The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America necessarilyrequires us to make estimates and assumptions that affect the reported amountsof assets and liabilities, the disclosure of contingent assets and liabilitiesat the date of the financial statements, and the reported amounts of revenuesand expenses during the reporting period. Actual results could differ from those estimates.

 

*Revenue Recognition*- Revenue is recognized upon shipment following receipt of a valid customerorder.   Title and risk of lossassociated with products sold transfers upon shipment to customers. We providefor the estimated costs of warranties, discounts and returns at the time ofsale.

 

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

 

*Change in Accounting Principle -*Prior toOctober 1, 2003, we used the first-in, first-out (“FIFO”) method of costinginventory for approximately 75% of our inventories, with the cost of theremaining inventories determined using the last-in, first-out (“LIFO”)method.   Effective October 1, 2003, wedecided to conform our method of costing inventory by adopting the FIFO methodfor all inventories.  We believe theFIFO method is preferable as the FIFO method better matches current costs withcurrent revenues and provides a more meaningful presentation of our financialposition by reflecting more recent costs in the balance sheet.  In addition, as we rationalize ourfacilities, combine manufacturing processes, and increase the use of outsourcedproduct in our offerings (as described further in Note 8), the use of a 

 

35

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consistent method across all our inventorieswill enable us to better allocate resources and avoid significant costs thatwould likely be incurred to segregate and track inventory on separate methodsthat may flow through a single manufacturing facility.

 

In accordancewith generally accepted accounting principles, the change in accountingprinciple has been applied by retroactively restating prior years consolidatedfinancial statements.  The change inaccounting resulted in a reduction of net income reported in 2001 of $2.6million ($0.29 per share) and a reduction in retained earnings of $4.6 millionas of December 31, 2001.  The change didnot have a material effect on our 2002 or 2003 income statements.

 

*Depreciation and Amortization*- Property, plant and equipment are recorded at cost or, in the case of assetsacquired through business combinations, at fair value. Depreciation is providedusing the straight-line method over the estimated useful lives of therespective assets.  Leaseholdimprovements are amortized using the straight-line method over the estimateduseful lives of the improvements or the remaining term of the respective lease,whichever is shorter.  Estimated usefullives 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    |   |

 

Whenconditions indicate a need to evaluate recoverability, we evaluate therecoverability of our long-lived assets by comparing the estimated futureundiscounted cash flows expected to be generated by those assets to theircarrying value.  Should the assessmentindicate an impairment, the affected assets are written down to fair value.

 

*Goodwill, Trademarks and Other IntangibleAssets*-**Intangibleassets other than goodwill and trademarks are amortized on a straight-linebasis over their estimated useful lives. Deferred financing costs are amortized over the repayment periods of theunderlying debt.  This approximates theeffective interest method.  Prior to 2002,goodwill was amortized on a straight-line basis over 40 years, and trademarksacquired were recorded at appraised value and amortized on a straight-linebasis over 10 years.  We ceased torecord amortization expense on our goodwill and trademark assets on January 1,2002.  We test our goodwill andtrademark assets for impairment annually or on an interim basis if events orcircumstances indicate that the fair value of an asset has decreased below itscarrying value.  Should an impairment bepresent, the affected asset would be written down to its fair value.  At January 1, 2002, July 27, 2002, and July26, 2003 we evaluated our goodwill and trademark assets and determined that thefair value had not decreased below the carrying value and, accordingly, we havemade no impairment adjustments.

 

*Advertising*-Advertising costs are expensed as incurred. Advertising expense was $8.3 million for the year ended December 31,2001, $6.7 million for the year ended December 31, 2002, and $7.7 million forthe year ended December 31, 2003.

 

*Income Taxes -*Weprovide for income taxes using an asset and liability approach.  We compute deferred income tax assets andliabilities annually for differences between the financial statement and taxbases of assets and liabilities that will result in taxable or deductibleamounts in the future based on enacted tax laws and rates applicable to theperiods in which the differences are expected to affect taxable income.  We establish valuation allowances whennecessary to reduce deferred tax assets to the 

 

36

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amount expected to berealized.  Income taxes is the taxpayable or refundable for the period plus or minus the change in deferred taxassets and liabilities during the period.

 

*Foreign Currency Translation*- We translate assets and liabilities of non-U.S. operations into U.S. dollarsat year-end rates, and revenues and expenses at average rates of exchangeprevailing during the year.  We reportthe resulting translation adjustments as a separate component of comprehensiveincome.  We recognize foreign currencytransaction gains and losses in the consolidated statements of income asincurred.

 

*Foreign Currency Exchange Contracts*- We enter into foreign currency exchange contracts as a hedge against risksinherent in foreign currency transactions. These contracts are not used for trading or speculative purposes.  Gains and losses arising from fluctuationsin exchange rates are recognized at the end of each reporting period.  Such gains and losses offset the foreigncurrency exchange gains or losses associated with the hedged receivable orpayable.  We have credit risk to theextent the counterparties are unable to fulfill their obligations on theforeign currency exchange contracts. However, we enter into these contracts with reputable institutions andbelieve we have no significant credit risk.

 

*Stock-based Compensation* - We have an employee stock purchaseplan (“Purchase Plan”) and a stock option plan (“Stock Plan”), which are describedmore fully in Note 12.  As permittedunder accounting principles generally accepted in the United States of America,we have elected to continue to follow the intrinsic value method in accountingfor our stock-based employee compensation arrangement.

 

Under theintrinsic value method, compensation associated with stock awards to employeesis determined as the difference, if any, between the fair value of theunderlying common stock on the date compensation is measured and the price anemployee must pay to exercise the award. Under the fair value method, the impact of which is disclosed below,compensation associated with stock awards to employees is determined based onthe estimated fair value of the award itself, measured using either currentmarket data or an established option pricing model.  The measurement date for employee awards for both the intrinsicand fair value methods is generally the date of grant.   Under the intrinsic value method, we didnot recognize any stock-based compensation expense during 2001, 2002, or 2003.

 

The following table illustratesthe effect on net income and earnings per share if we had applied the fairvalue method to measure stock-based employee compensation.

 
|                                                                                                                                    |   | **Years  Ended December 31** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                                                                                    |   | **2001**                     |   | **2002** |   | **2003** |   |
|                                                                                                                                    |   |                         |   |   |   |   |   |
| Net income, as reported                                                                                                                 |   | $                            | 8,738  |   | $ | 14,909 |   | $ | 9,698 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair-value method for all awards, net  of related tax effects |   | (715                         | )      | (613 | ) | (836 | ) |
| Pro forma net income                                                                                                                    |   | $                            | 8,023  |   | $ | 14,296 |   | $ | 8,862 |   |
| Earnings per share:                                                                                                                     |   |                         |   |   |   |   |   |
| As reported Basic and Diluted                                                                                                           |   | $                            | 0.98   |   | $ | 1.68 |   | $ | 1.09 |   |
| Pro forma Basic and Diluted                                                                                                             |   | $                            | 0.90   |   | $ | 1.61 |   | $ | 0.99 |   |

 

37

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The fair value of options ontheir grant date, including the valuation of the option feature implicit in ourPurchase Plan, was measured using the Black-Scholes option-pricing model.  Key assumptions used to apply this pricingmodel are as follows:

 
|                                                |   | **2001** |   | **2002** |   | **2003** |   |
|-----------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Weighted-average interest rate                      |   | 3.57%    |   | 3.48%    |   | 3.10%    |   |
| Range of expected life of option grants (in  years) |   | 1 to 6   |   | 1 to 6   |   | 1 to 6   |   |
| Expected volatility of underlying stock             |   | 25.5%    |   | 25.6%    |   | 27.0%    |   |

 

The weighted-average fair valueof options on their grant date is as follows:

 
|                            |   | **2001** |   | **2002** |   | **2003** |   |
|---------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Stock Plan                      |   | $        | — |     | $      | 6.27     |   | $ | 7.49 |   |
| Option feature in Purchase Plan |   | $        | 4.48   |     | $      | 4.78     |   | $ | 4.09 |   |

 

It should benoted that the Black-Scholes option-pricing model was designed to value readilytradable options with relatively short lives and no vesting restrictions.  In addition, option valuation models requirethe input of highly subjective assumptions including the expected pricevolatility.  Because the options grantedare not tradable and have contractual lives of up to ten years, and becausechanges in the subjective input assumptions can materially affect the fairvalue estimate, in management’s opinion the existing models do not provide areliable measure of the fair value of the options issued under either the StockPlan or Purchase Plan.

 

*Earnings per Common Share*- Basic earnings per common share is computed using the weighted-average numberof common shares outstanding during each year. Diluted earnings per common share reflects the effect of our outstandingoptions (using the treasury stock method), except when such options would beantidilutive.

 

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

 
|                                                    |   | **2001**  |   | **2002**  |   | **2003**  |   |
|---------------------------------------------------------|--------|-----------|--------|-----------|--------|-----------|--------|
|                                                    |   |      |   |      |   |      |   |
| Weighted-average shares for basic earnings  per share   |   | 8,928,000 |   | 8,877,256 |   | 8,924,578 |   |
| Dilutive effect of stock options                        |   | —    |   | 4,909     |   | 1,094     |   |
| Weighted-average shares for diluted  earnings per share |   | 8,928,000 |   | 8,882,165 |   | 8,925,672 |   |

 

Options topurchase 612,400, 1,098,300, and 1,130,400 shares of Ordinary common stock atprices ranging from $18.55 to $22.67 per share were outstanding during theyears ended December 31, 2001, 2002, and 2003, respectively, but were notincluded in the computation of diluted net earnings per share because theoptions’ exercise prices were greater than the average market price of thecommon shares.

 

*Environmental Matters*-Potential environmental liabilities are recorded when it is probable that aloss has been incurred and its amount can reasonably be estimated (see Note13).

 

*Segment Reporting* - We have two reportable segments:the piano segment and the band and orchestral instrument segment.  We consider these two segments reportable asthey are managed 

 

38

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separately and the operatingresults of each segment are separately reviewed and evaluated by our seniormanagement on a regular basis.

 

C*omprehensiveIncome -*Comprehensive income is comprised of net income, foreigncurrency translation adjustments, additional minimum pension liabilities, andunrealized gains and losses on certain long-term assets and is reported in theconsolidated statements of stockholders’ equity for all periods presented.  The components of accumulated other comprehensiveloss are as follows:

 
|                              |   | **Foreign  Currency  Translation  Adjustment** |   | **Gain/(Loss)  on  Long-term  Assets** |   | **Tax Impact  of  Gain/(Loss) on  Long-term Assets** |   | **Additional  Minimum  Pension Liability** |   | **Tax Impact  of  Additional  Minimum  Pension Liability** |   | **Accumulated  Other  Comprehensive  Loss** |   |
|-----------------------------------|--------|------------------------------------------------|--------|----------------------------------------|--------|------------------------------------------------------|--------|--------------------------------------------|--------|------------------------------------------------------------|--------|---------------------------------------------|--------|
|                              |   |                                           |   |                                   |   |                                                 |   |                                       |   |                                                       |   |                                        |   |
| Beginning balance January 1, 2001 |   | $                                              | (9,845 | )                                      | $      | —                                               |   | $                                          | — |                                                       | $      | (121                                        | )      | $ | — |   | $ | (9,966 | ) |
| Activity                          |   | (1,852                                         | )      | (8                                     | )      | 3                                                    |   | (1,499                                     | )      | 648                                                        |   | (2,708                                      | )      |
| Ending balance December 31, 2001  |   | (11,697                                        | )      | (8                                     | )      | 3                                                    |   | (1,620                                     | )      | 648                                                        |   | (12,674                                     | )      |
| Activity                          |   | 5,589                                          |   | (112                                   | )      | 41                                                   |   | (9,976                                     | )      | 3,990                                                      |   | (468                                        | )      |
| Ending balance December 31, 2002  |   | (6,108                                         | )      | (120                                   | )      | 44                                                   |   | (11,596                                    | )      | 4,638                                                      |   | (13,142                                     | )      |
| Activity                          |   | 7,334                                          |   | 193                                    |   | (73                                                  | )      | 4,743                                      |   | (1,923                                                     | )      | 10,274                                      |   |
| Ending balance December 31, 2003  |   | $                                              | 1,226  |                                   | $      | 73                                                   |   | $                                          | (29    | )                                                          | $      | (6,853                                      | )      | $ | 2,715 |   | $ | (2,868 | ) |

 

*New Accounting Pronouncements -*InApril 2003, the Financial Accounting Standards Board (“FASB”) issued Statementof Financial Accounting Standard (“SFAS”) No. 149, “Amendment of Statement 133on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends SFAS No.133 to conform and incorporate derivative implementation issues andsubsequently issued accounting guidance. SFAS No. 149 clarifies under whatcircumstances a contract with an initial net investment meets thecharacteristic of a derivative, and clarifies when a derivative contains afinancing component that warrants special reporting in the statement of cashflows.  SFAS No. 149 also amends otherexisting pronouncements, resulting in more consistent reporting of contractsthat are derivatives in their entirety or that contain embedded derivativesthat warrant special accounting. The adoption of SFAS No. 149 did not have amaterial effect on our financial position, results of operations or cash flows.

 

In May 2003,the FASB issued SFAS No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity.” SFAS No. 150 establishesstandards for how an issuer classifies and measures certain freestandingfinancial instruments with characteristics of both liabilities and equity. Theadoption of SFAS No. 150 did not have a material effect on our financialposition, results of operations or cash flows.

 

In December2003, the FASB revised SFAS No. 132, “Employers’ Disclosures about Pensions andOther Postretirement Benefits.”  SFASNo. 132 requires additional disclosure about the assets, obligations, cashflows, and net periodic benefit cost of defined benefit pension plans and otherdefined benefit postretirement plans. This statement also requires disclosure about the types of plan assets,investment strategy, measurement dates, plan obligations, and cash flows.  SFAS No. 132 is effective for fiscal yearsending after December 15, 2003.  Interimperiod disclosures required by this statement are effective for periodsbeginning after December 15, 2003. Disclosure of information about foreign plans 

 

39

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required by this statement iseffective for fiscal years ending after June 15, 2004.  The required disclosures are included inNote 14.

 

*Reclassifications -*Certainprior year amounts have been reclassified to conform to the current yearpresentation.

 

**(3)****      Inventories**

 
|            |   | **December  31,** |    |
|-----------------|--------|-------------------|---------|
|            |   | **2002**          |    | **2003** | ** ** |
| Raw materials   |   | $                 | 21,568  |   | $ | 21,268 |   |
| Work in process |   | 56,019            |    | 50,620 |   |
| Finished goods  |   | 78,256            |    | 80,141 |   |
| Total           |   | $                 | 155,843 |   | $ | 152,029 |   |

 

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

 
|                                            |   | **December  31,** |    |
|-------------------------------------------------|--------|-------------------|---------|
|                                            |   | **2002**          |    | **2003** |   |
| Land                                            |   | $                 | 18,902  |   | $ | 19,718 |   |
| Buildings and improvements                      |   | 66,002            |    | 65,285 |   |
| Leasehold improvements                          |   | 2,349             |    | 3,613 |   |
| Machinery, equipment and tooling                |   | 47,229            |    | 48,290 |   |
| Office furniture and fixtures                   |   | 8,702             |    | 11,294 |   |
| Concert and artist and rental pianos            |   | 12,811            |    | 13,877 |   |
| Construction in progress                        |   | 1,723             |    | 812 |   |
|                                            |   | 157,718           |    | 162,889 |   |
| Less accumulated depreciation and  amortization |   | 55,151            |    | 63,952 |   |
| Total                                           |   | $                 | 102,567 |   | $ | 98,937 |   |

 

We recognized impairment charges for certain land, building, andequipment assets of the band segment as a result of our facility rationalizationproject, which is discussed more fully in Note 8.

 

40

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**(5)****           Goodwilland Other Intangible Assets**

 

Goodwilland other intangible assets as of December 31, 2002 and 2003 are as follows:

 
|                           |   | **2002** |   | **2003** |   |
|--------------------------------|--------|----------|--------|----------|--------|
| Amortized intangible assets:   |   |     |   |     |   |
| Gross deferred financing costs |   | $        | 10,751 |     | $      | 9,293 |   |
| Accumulated amortization       |   | (3,951   | )      | (3,596   | )      |
| Deferred financing costs, net  |   | $        | 6,800  |     | $      | 5,697 |   |
|                           |   |     |   |     |   |
| Gross covenants not to compete |   | $        | 750    |     | $      | 250 |   |
| Accumulated amortization       |   | (614     | )      | (165     | )      |
| Covenants not to compete, net  |   | $        | 136    |     | $      | 85 |   |
|                           |   |     |   |     |   |
| Unamortized intangible assets: |   |     |   |     |   |
| Gross goodwill                 |   | $        | 35,841 |     | $      | 38,366 |   |
| Accumulated amortization       |   | (6,302   | )      | (6,701   | )      |
| Goodwill, net                  |   | $        | 29,539 |     | $      | 31,665 |   |
|                           |   |     |   |     |   |
| Gross trademarks               |   | $        | 23,176 |     | $      | 25,059 |   |
| Accumulated amortization       |   | (13,525  | )      | (14,740  | )      |
| Trademarks, net                |   | $        | 9,651  |     | $      | 10,319 |   |

 

Thechanges in the net carrying amounts of goodwill and trademarks are as follows:

 
|                                |   | **Piano  Segment** |   | **Band &  Orchestral  Segment** |   |
|-------------------------------------|--------|--------------------|--------|-------------------------------------|--------|
| Goodwill:                           |   |               |   |                                |   |
| Balance at December 31, 2001        |   | $                  | 19,362 |                                | $      | 8,555 |   |
| Foreign currency translation impact |   | 1,622              |   | —                              |   |
| Balance at December 31, 2002        |   | $                  | 20,984 |                                | $      | 8,555 |   |
|                                |   |               |   |                                |   |
| Balance at December 31, 2002        |   | $                  | 20,984 |                                | $      | 8,555 |   |
| Foreign currency translation impact |   | 2,126              |   | —                              |   |
| Balance at December 31, 2003        |   | $                  | 23,110 |                                | $      | 8,555 |   |

 

41

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|                                |   | **Piano  Segment** |   | **Band &  Orchestral  Segment** |   |
|-------------------------------------|--------|--------------------|--------|-------------------------------------|--------|
| Trademarks:                         |   |               |   |                                |   |
| Balance at December 31, 2001        |   | $                  | 6,471  |                                | $      | 2,671 |   |
| Foreign currency translation impact |   | 509                |   | —                              |   |
| Balance at December 31, 2002        |   | $                  | 6,980  |                                | $      | 2,671 |   |
|                                |   |               |   |                                |   |
| Balance at December 31, 2002        |   | $                  | 6,980  |                                | $      | 2,671 |   |
| Foreign currency translation impact |   | 668                |   | —                              |   |
| Balance at December 31, 2003        |   | $                  | 7,648  |                                | $      | 2,671 |   |

 

The weighted averageamortization period for deferred financing costs is 6.30 years, and theweighted average amortization period of covenants not to compete is 5.0years.  The following table summarizes amortization expense for the years endingDecember 31:

 
|                           |   | **2001** |   | **2002** |   | **2003** |   |
|--------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                           |   |     |   |     |   |     |   |
| Aggregate amortization expense |   | $        | 4,255  |     | $      | 1,154    |   | $ | 1,154 |   |
|                                |        |          |        |          |        |          |        |  |  |  |

 

The amortization periods for other intangible assets range from five toten years.  The following table showsthe estimated amortization expense for these assets for each of the fivesucceeding fiscal years:

 

| **Estimated amortization expense:** |   | **Amount** |   |
|-------------------------------------|--------|------------|--------|
| 2004                                |   | $          | 594    |   |
| 2005                                |   | 535        |   |
| 2006                                |   | 500        |   |
| 2007                                |   | 500        |   |
| 2008                                |   | 356        |   |
|                                     |        |            |        |  |

 

42

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Had SFAS No. 142 been in effectprior to January 1, 2002, our reported net income and income per share wouldhave been as follows:

 
|                                |   | **Year Ended  December 31, 2001** |   |
|-------------------------------------|--------|-----------------------------------|--------|
|                                |   |                              |   |
| Net income                          |   | $                                 | 8,738  |   |
| Goodwill amortization               |   | 857                               |   |
| Trademark amortization, net of tax  |   | 1,453                             |   |
| Adjusted net income                 |   | $                                 | 11,048 |   |
|                                |   |                              |   |
| Basic and diluted income per share: |   |                              |   |
| Net income                          |   | $                                 | 0.98   |   |
| Goodwill amortization               |   | 0.10                              |   |
| Trademark amortization              |   | 0.16                              |   |
| Adjusted net income                 |   | $                                 | 1.24   |   |

 

**(6)****           OtherAssets**

 
|               |   | **December  31,** |   |
|--------------------|--------|-------------------|--------|
|               |   | **2002**          |   | **2003** |   |
| Intangible pension |   | $                 | 2,526  |   | $ | 3,782 |   |
| Notes receivable   |   | 3,967             |   | 4,812 |   |
| Other assets       |   | 1,199             |   | 2,098 |   |
| Total              |   | $                 | 7,692  |   | $ | 10,692 |   |

 

**(7)****           OtherCurrent Liabilities**

 
|                                 |   | **December  31,** |   |
|--------------------------------------|--------|-------------------|--------|
|                                 |   | **2002**          |   | **2003** |   |
| Accrued payroll and related benefits |   | $                 | 15,287 |   | $ | 16,986 |   |
| Current portion of pension liability |   | 4,111             |   | 2,663 |   |
| Accrued warranty expense             |   | 2,357             |   | 2,602 |   |
| Accrued interest                     |   | 2,720             |   | 2,706 |   |
| Deferred income                      |   | 3,536             |   | 4,161 |   |
| Income and other taxes payable       |   | (702              | )      | 1,889 |   |
| Other accrued expenses               |   | 8,050             |   | 8,105 |   |
| Total                                |   | $                 | 35,359 |   | $ | 39,112 |   |

 

Accruedwarranty expense is generally recorded at the time of sale for instruments thathave a warranty period ranging from five to ten years.  The accrued expense recorded is based on apercentage of sales and is adjusted periodically following an analysis ofhistorical warranty activity.  Accruedwarranty expense for instruments that have a warranty period of one year isrecorded based on warranty return trends.

 

43

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The accrued warranty expenseactivity for the years ended December 31, 2001, 2002 and 2003 is as follows:

 
|                      |   | **2001** |   | **2002** |   | **2003** |   |
|---------------------------|--------|----------|--------|----------|--------|----------|--------|
| Accrued warranty expense: |   |     |   |     |   |     |   |
| Beginning balance         |   | $        | 2,355  |     | $      | 2,221    |   | $ | 2,357 |   |
| Additions                 |   | 932      |   | 950      |   | 1,361    |   |
| Claims and reversals      |   | (1,022   | )      | (966     | )      | (1,314   | )      |
| Foreign exchange impact   |   | (44      | )      | 152      |   | 198      |   |
| Ending balance            |   | $        | 2,221  |     | $      | 2,357    |   | $ | 2,602 |   |

 

**(8)****           FacilityRationalization Charges – Band Segment**

 

We closed ourwoodwind manufacturing facility in Nogales, Arizona and eliminatedapproximately 90 positions in November 2003. As a result of this closing, werecorded charges of $0.6 million in severance expenses and $1.0 million ininventory write-down charges as components of cost of goods sold.  We also recorded $2.1 million in impairmentcharges as a component of operating expenses.

 

On October 3,2003, we announced that we will be closing one of our woodwind manufacturingfacilities in Elkhart, Indiana and transferring that plant’s production toother company-owned facilities.  Thisclosure will impact approximately 100 employees and we expect to complete thisproject in the second quarter of 2004. As a result of this imminent closure, we recorded charges of $1.1million in severance expenses and $0.2 million of inventory write-down chargesas components of cost of goods sold.  Wealso recorded $0.9 million in related impairment charges. We anticipateincurring an additional $1.1 million in severance expenses in 2004, which willnegatively impact our first and second quarter results.

 

Oncecompleted, we expect to have incurred $2.8 million in severance expenses, $1.2million in inventory write-down charges, and $3.0 million in asset impairmentcharges as a result of this facility rationalization project.

 

The accrued severance liabilityactivity associated with the band segment’s facility rationalization projectfor the year ended December 31, 2003 is as follows:

 
|                                           |   | **2003** |   |
|------------------------------------------------|--------|----------|--------|
| Facility rationalization severance  liability: |   |     |   |
| Beginning balance                              |   | $        | — |   |
| Additions charged to cost of sales             |   | 1,683    |   |
| Payments                                       |   | (525     | )      |
| Ending balance                                 |   | $        | 1,158  |   |

 

The impairmentcharges were reported as a separate component of operating expenses labeled“facility rationalization charges” and relate to buildings, land, and equipmentaffected by the plant closures.  Theimpairment costs associated with the land and buildings were calculated basedon the excess of the carrying value over net realizable value for suchassets.  The equipment impairmentcharges 

 

44

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were based on our ability toutilize the equipment at other facilities, or until the rationalization projectis complete, with remaining useful lives and associated depreciation adjustedaccordingly.  The components of the $3.0million in aggregate impairment charges for the year ended December 31, 2003are as follows:

 

| **Asset category:** |   | **Impairment  Charge** |   |
|---------------------|--------|------------------------|--------|
|                |   |                   |   |
| Land                |   | $                      | 501    |   |
| Buildings           |   | 2,202                  |   |
| Equipment           |   | 255                    |   |
|                |   | $                      | 2,958  |   |

 

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

 
|                              |   | **Years  Ended December 31,** |   |
|-----------------------------------|--------|-------------------------------|--------|
|                              |   | **2001**                      |   | **2002** |   | **2003** |   |
|                              |   |                          |   |   |   |   |   |
| West 57th Building income         |   | $                             | (4,653 | ) | $ | (4,653 | ) | $ | (4,653 | ) |
| West 57th Building expenses       |   | 3,254                         |   | 3,254 |   | 3,254 |   |
| Foreign exchange (gain) loss, net |   | 791                           |   | (691 | ) | (815 | ) |
| Miscellaneous, net                |   | (1,170                        | )      | (1,849 | ) | (1,303 | ) |
| Total                             |   | $                             | (1,778 | ) | $ | (3,939 | ) | $ | (3,517 | ) |

 

45

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**(10)****         IncomeTaxes**

 

Thecomponents of the provision for income taxes are as follows:

 
|                  |   | **Years  Ended December 31,** |   |
|-----------------------|--------|-------------------------------|--------|
|                  |   | **2001**                      |   | **2002** |   | **2003** |   |
| U.S. Federal:         |   |                          |   |   |   |   |   |
| Current               |   | $                             | 1,811  |   | $ | 3,896 |   | $ | 2,300 |   |
| Deferred              |   | (2,086                        | )      | 7 |   | (2,117 | ) |
| U.S. State and local: |   |                          |   |   |   |   |   |
| Current               |   | 674                           |   | 829 |   | 729 |   |
| Deferred              |   | (45                           | )      | 76 |   | (177 | ) |
| Foreign:              |   |                          |   |   |   |   |   |
| Current               |   | 4,679                         |   | 3,619 |   | 4,270 |   |
| Deferred              |   | (841                          | )      | (1,277 | ) | (307 | ) |
| Total                 |   | $                             | 4,192  |   | $ | 7,150 |   | $ | 4,698 |   |

 

The components of income beforeincome taxes are as follows:

 
|                |   | **Years  Ended December 31,** |   |
|---------------------|--------|-------------------------------|--------|
|                |   | **2001**                      |   | **2002** |   | **2003** |   |
|                |   |                          |   |   |   |   |   |
| U.S. operations     |   | $                             | 2,527  |   | $ | 12,839 |   | $ | 3,860 |   |
| Non-U.S. operations |   | 10,403                        |   | 9,220 |   | 10,536 |   |
| Total               |   | $                             | 12,930 |   | $ | 22,059 |   | $ | 14,396 |   |

 

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

 
|                                                            |   | **Years  Ended December 31,** |   |
|-----------------------------------------------------------------|--------|-------------------------------|--------|
|                                                            |   | **2001**                      |   | **2002** |   | **2003** |   |
| Statutory federal rate applied to earnings  before income taxes |   | $                             | 4,526  |   | $ | 7,721 |   | $ | 5,039 |   |
| Increase (decrease) in income taxes  resulting from:            |   |                          |   |   |   |   |   |
| Foreign income taxes (net of federal  benefit)                  |   | (590                          | )      | 21 |   | (2,643 | ) |
| State income taxes (net of federal benefit)                     |   | 325                           |   | 391 |   | 518 |   |
| Other                                                           |   | (69                           | )      | (983 | ) | 1,784 |   |
| Income taxes                                                    |   | $                             | 4,192  |   | $ | 7,150 |   | $ | 4,698 |   |

 

At December31, 2003, accumulated retained earnings of non-U.S. subsidiaries totaled $4.4million.  We did not provide for U.S.income taxes or foreign withholding taxes for these subsidiaries because wecurrently expect that such earnings will be reinvested indefinitely.

 

46

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The components of net deferredtaxes are as follows:

 
|                                                       |   | **December  31,** |    |
|------------------------------------------------------------|--------|-------------------|---------|
|                                                       |   | **2002**          |    | **2003** |   |
| Deferred tax assets:                                       |   |              |    |   |   |
| Uniform capitalization adjustment to  inventory            |   | $                 | 3,044   |   | $ | 3,527 |   |
| Allowance for doubtful accounts                            |   | 2,859             |    | 2,378 |   |
| Accrued expenses and other current assets  and liabilities |   | 6,831             |    | 9,771 |   |
| Additional minimum pension liability                       |   | 4,638             |    | 2,715 |   |
| Foreign tax credits                                        |   | 12,226            |    | 7,137 |   |
| Valuation allowances                                       |   | (11,709           | )       | (6,439 | ) |
| Total deferred tax assets                                  |   | 17,889            |    | 19,089 |   |
|                                                       |   |              |    |   |   |
| Deferred tax liabilities:                                  |   |              |    |   |   |
| Pension contributions                                      |   | (1,040            | )       | (2,800 | ) |
| Fixed assets                                               |   | (19,729           | )       | (19,227 | ) |
| LIFO reserve for tax (Note 2)                              |   | (3,005            | )       | (2,748 | ) |
| Intangibles                                                |   | (7,068            | )       | (6,857 | ) |
| Total deferred tax liabilities                             |   | (30,842           | )       | (31,632 | ) |
|                                                       |   |              |    |   |   |
| Net deferred taxes                                         |   | $                 | (12,953 | ) | $ | (12,543 | ) |

 

Valuationallowances provided relate to excess foreign tax credits generated overexpected credit utilization in our federal tax return.  Valuation allowances relating to theacquisition of Steinway totaled $3.9 million as of December 31, 2002 and $4.3million as of December 31, 2003.  Shouldthe related tax benefits be recognized in the future, the effect of removingthe valuation allowances associated with the acquisition of Steinway would be areduction in goodwill. During 2002, the valuation allowance increased by $0.9million due to the generation of additional excess foreign tax credits.  During 2003, the valuation allowance decreasedby $5.3 million in connection with the use and reduction of our foreign taxcredits generated in prior years. Foreign tax credit carryforwards expire invarying amounts through 2007.

 

47

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**(11)****         Long-Term Debt**

 

Long-term debt consists of thefollowing:

 
|                                                     |   | **December  31,** |    |
|----------------------------------------------------------|--------|-------------------|---------|
|                                                     |   | **2002**          |    | **2003** |   |
|                                                     |   |              |    |   |   |
| Term loans                                               |   | $                 | 53,690  |   | $ | 47,178 |   |
| 8.75% Senior Notes                                       |   | 145,345           |    | 145,345 |   |
| Open account loans, payable on demand to a  foreign bank |   | 1,601             |    | 4,079 |   |
| Total                                                    |   | 200,636           |    | 196,602 |   |
| Less current portion                                     |   | 8,055             |    | 10,638 |   |
| Long-term debt                                           |   | $                 | 192,581 |   | $ | 185,964 |   |

 

Scheduled maturities oflong-term debt as of December 31, 2003 are as follows:

 

|       |   | **Amount** |    |
|------------|--------|------------|---------|
|       |   |       |    |
| 2004       |   | $          | 10,638  |   |
| 2005       |   | 7,179      |    |
| 2006       |   | 8,333      |    |
| 2007       |   | 8,376      |    |
| 2008       |   | 16,731     |    |
| Thereafter |   | 145,345    |    |
| Total      |   | $          | 196,602 |   |

 

Our realestate term loan, acquisition term loan, and domestic, seasonal borrowingrequirements are accommodated through a committed credit facility with asyndicate of domestic lenders (the “Credit Facility”).  The Credit Facility, which was amended andrestated to accommodate the $150.0 million bond offering completed on April 19,2001, provides us with a potential borrowing capacity of $85.0 million inrevolving credit, and expires on September 14, 2008. Borrowings arecollateralized by our domestic accounts receivable, inventory and fixedassets.  As of December 31, 2003, therewere no revolving credit loans outstanding, and availability based on eligibleaccounts receivable and inventory balances was approximately $82.0 million, netof letters of credit. The real estate term loan ($18.2 million at December 31,2003) is payable in monthly installments of $0.2 million and includes interestat average 30-day LIBOR (1.12% at December 31, 2003) plus 1.5%.  This term loan is secured by all of ourinterests in the Steinway Hall property. The acquisition term loan ($29.0 million at December 31, 2003) isrepayable in monthly installments of $0.4 million for the first five years andmonthly installments of $0.6 million in years six through eight.  The acquisition term loan and revolvingcredit loans under the Credit Facility bear interest at average 30-day LIBORplus 1.75%.

 

On April 19,2001, we completed a $150.0 million 8.75% Senior Note offering.  The proceeds of this offering were used to redeem$110.0 million of previously outstanding Senior Subordinated Notes, with thebalance used to pay down the Credit Facility. The early retirement of the Senior Subordinated Notes, which wereredeemed on June 1, 2001 at 102.75% of the principal amount, generated a debtextinguishment charge of approximately $6.6 million, and a related tax benefitof $2.7 million.  On December 18, 2002we repurchased $4.7 million of our Senior Notes at 99.25%.

 

48

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The openaccount loans provide for borrowings by foreign subsidiaries of up to €17.6million  ($22.1 million at the December31, 2003 exchange rate) payable on demand. A portion of the open account loans can be converted into a maximum of£0.5 million ($0.9 million at the December 31, 2003 exchange rate) for use byour UK branch and ¥600 million ($5.6 million at the December 31, 2003 exchangerate) for use by our Japanese subsidiary. Demand borrowings bear interest at rates of 6.70 - 7.10% for the Euroloans and 1.265% for Japanese yen loans. We have purchased two interest rate caps on a portion of thoseloans.  One cap limits the base interestrate to 5% on  €1.5 million ($1.9million at the December 31, 2003 exchange rate) declining to €0.5 million ($0.6million at the December 31, 2003 exchange rate) in 2004.  The other cap limits the base interest rateto 6.25% on €1.5 million ($1.9 million at the December 31, 2003 exchange rate)and expires in 2005.  The unrealizedgains or losses and carrying value of the caps are not material in any periodpresented.

 

All of ourdebt agreements contain certain financial and non-financial covenants which,among other things, require the maintenance of certain financial ratios and networth, 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 compliance with all suchcovenants as of December 31, 2003.

 

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

 

Our commonstock is comprised of two classes: Class A and Ordinary.  With the exception of disparate votingpower, both classes are substantially identical.  Each share of Class A common stock entitles the holder to 98votes.  Holders of Ordinary common stockare entitled to one vote per share. Class A common stock shall automatically convert to Ordinary commonstock if, at any time, the Class A common stock is not owned by an original ClassA holder.  The Chairman and Chief ExecutiveOfficer own 100% of the Class A common shares, representing approximately 85%of the combined voting power of the Class A common stock and Ordinary commonstock.

 

*Employee Stock Purchase Plan*- We have an employee stock purchase plan under which substantially allemployees may purchase Ordinary common stock through payroll deductions at apurchase price equal to 85% of the lower of the fair market values as of thebeginning or end of each twelve-month offering period.  Stock purchases under the Purchase Plan arelimited to 5% of an employee’s annual base earnings.  Shares issued under the Purchase Plan were 29,549 during 2001,37,389 during 2002, and 35,209 during 2003. Of the 500,000 shares originally reserved for issuance under thePurchase Plan, 276,590 shares remain available for future issuance as ofDecember 31, 2003.

 

*Stock Plan* - The1996 stock plan, as amended, provides for the granting of 1,500,000 stockoptions (including incentive stock options and non-qualified stock options),stock appreciation rights and other stock awards to certain key employees,consultants and advisors.  As ofDecember 31, 2003, Ordinary common stock reserved for issuance under the StockPlan was 1,373,000 shares.

 

49

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The following table sets forthinformation regarding both the Purchase Plan and the Stock Plan:

 
|                             |   | **2001**                |   | **2002**                                |   | **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 |   | 632,398                 |   | $                                       | 19.09  |                    | 628,262 |   | $ | 19.07 |   | 1,112,447 |   | $ | 19.07 |   |
| Granted                          |   | 31,813                  |   | 15.30                                   |   | 561,174                 |    | 18.80 |   | 250,909 |   | 21.16 |   |
| Exercised                        |   | (29,549                 | )      | 15.38                                   |   | (59,789                 | )       | 16.63 |   | (93,109 | ) | 17.26 |   |
| Canceled, forfeited or expired   |   | (6,400                  | )      | 19.00                                   |   | (17,200                 | )       | 19.01 |   | (115,500 | ) | 19.06 |   |
| Outstanding at end of year       |   | 628,262                 |   | 19.07                                   |   | 1,112,447               |    | 19.07 |   | 1,154,747 |   | 19.63 |   |
|                             |   |                    |   |                                    |   |                    |    |   |   |   |   |   |   |
| Exercisable at end of year       |   | 502,300                 |   | $                                       | 19.17  |                    | 507,400 |   | $ | 19.21 |   | 525,100 |   | $ | 19.19 |   |

 

The following table sets forthinformation regarding outstanding and exercisable options at December 31, 2003:

 
|                         |   | **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** |   |
|                         |   |                     |    |                                    |      |   |   |   |   |   |   |
| $14.23                       |   |                     | 14,347  |                                    | .6 years  |   | $ | 14.23 |   | — |   | $ | — |   |
| $14.73 -  $20.75             |   |                     | 896,900 |                                    | 6.0 years |   | 18.94 |   | 487,100 |   | 18.99 |   |
| $21.13 -  $22.67             |   |                     | 243,500 |                                    | 9.1 years |   | 22.51 |   | 38,000 |   | 21.66 |   |
|                         |   | 1,154,747                |    | 6.6 years                               |      | 19.63 |   | 525,100 |   | 19.19 |   |
|                              |        |                          |         |                                         |           |  |  |  |  |  |  |  |  |  |

 

**(13) Commitments and Contingent Liabilities**

 

*Lease Commitments* -We lease various facilities and equipment under non-cancelable operating leasearrangements.  These leases expire atvarious times through 2016 with various renewal options.  Rent expense was $4.0 million for the yearended December 31, 2001, $4.2 million for the year ended December 31, 2002, 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.  We entered into a ninety-nine year landlease as part of the transaction. Annual rent payable under the land lease is $2.2 million in the firstten years, $2.8 million for the subsequent ten-year period and will be adjustedevery twenty years thereafter to the greater of the existing rent or 4% of thefair market value of the land and building combined.  We also entered into a ten-year master lease whereby all of ourinterest in the land and building was leased back to the owner of theland.  Rental expense and rental incomeassociated with these leases was included, along with other real estate costs,in Other Income, Net (see Note 9).

 

50

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Future minimumlease payments for our non-cancelable operating leases, excluding the landlease discussed above, and future rental income under the master lease for theyears ending December 31 are as follows:

 
|       |   | **Lease  Payments** |   | **Rental  Income** |   |
|------------|--------|---------------------|--------|--------------------|--------|
| 2004       |   | $                   | 4,885  |               | $      | 4,653 |   |
| 2005       |   | 4,499               |   | 4,653              |   |
| 2006       |   | 3,940               |   | 4,653              |   |
| 2007       |   | 3,523               |   | 4,653              |   |
| 2008       |   | 1,636               |   | 4,653              |   |
| Thereafter |   | 6,765               |   | —             |   |
| Total      |   | $                   | 25,248 |               | $      | 23,265 |   |

 

*Employment Agreements -*Wemaintain employment agreements with certain employees.  Most of these agreements have one-year termsand contain automatic renewal provisions. Our obligation under these agreements at current compensation levels isapproximately $1.4 million per year.

 

Additionally,we maintain employment agreements that expire in 2006 with both our Chairmanand Chief Executive Officer.  Theseindividuals collectively hold 100% of the Class A common shares, representingapproximately 85% of the combined voting power of the Class A common stock andOrdinary common stock.  Our totalobligation under these agreements is approximately $1.9 million.

 

*Notes Receivable Sold with Recourse*- Prior to August 2002, we sold notes receivable on a recourse basis to a financingcompany.  The financing company had theoption of purchasing up to $18.0 million of our notes receivable.  We received proceeds from the sale of suchnotes of $2.6 million during the year ended December 31, 2002.  We have retained these notes receivablesince August 2002.

 

*Legal and**EnvironmentalMatters* - We are involved in certain legal proceedings regardingenvironmental matters, which are described below.  Further, in the ordinary course of business, we are party tovarious legal actions that we believe are routine in nature and incidental tothe operation of our business.  Whilethe outcome of such actions cannot be predicted with certainty, we believethat, based on our experience in dealing with these matters, their ultimateresolution will not have a material adverse impact on our business, financialcondition, results of operations or prospects.

 

We operatedmanufacturing facilities at certain locations where hazardous substances(including chlorinated solvents) were used. We believe that an entity that formerly operated one such facility mayhave released hazardous substances at such location, which we leased throughJuly 2001.  We did not contribute to therelease.  Further, we have a contractualindemnity from certain stockholders of this entity.  This facility is not the subject of a legal proceeding thatinvolves us, nor, to our knowledge, is the facility subject toinvestigation.  However, no assurancecan be given that legal proceedings will not arise in the future and that suchindemnitors would make the payments described in the indemnity.

 

We operateother manufacturing facilities that were previously owned by PhilipsElectronics North America Corporation (“Philips”).  Philips agreed to indemnify us for any and all losses, damages,liabilities and claims relating to environmental matters resulting from certainactivities of Philips occurring prior to December 29, 1988 (the “EnvironmentalIndemnity Agreement”).  Philips hasfully performed its obligations under the Environmental Indemnity Agreement,which terminates on 

 

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December 29, 2008.  Four matters covered by the EnvironmentalIndemnity Agreement are currently pending. Philips has entered into Consent Orders with the EnvironmentalProtection Agency (“EPA”) for one site and the North Carolina Department ofEnvironment, Health and Natural Resources for a second site, whereby Philipshas agreed to pay required response costs. On October 22, 1998, we were joined as defendant in an action involvinga site formerly occupied by a business we acquired in Illinois.  Philips has accepted the defense of thisaction pursuant to the terms of the Environmental Indemnity Agreement.  For the fourth site, the EPA has notified usit intends to carry out the final remediation itself.  The EPA estimates that this remedy has a present net cost ofapproximately $14.5 million.  The EPAhas named over 40 persons or entities as potentially responsible parties atthis site, which includes certain facilities that we acquired in 2000.  This matter has been tendered to Philipspursuant to the Environmental Indemnity Agreement for those facilities thatwere acquired from Philips.  Ourpotential liability at any of these sites is affected by several factors including,but not limited to, the method of remediation, our portion of the materials inthe site relative to the other named parties, the number of partiesparticipating, and the financial capabilities of the other potentiallyresponsible parties once the relative share has been determined.  No assurance can be given, however, thatadditional environmental issues will not require additional, currentlyunanticipated investigation, assessment or remediation expenditures or thatPhilips will make payments that it is obligated to make under the EnvironmentalIndemnity Agreement.

 

We are alsocontinuing an existing environmental remediation program at a facility acquiredin 2000.  We currently estimate thatthis project will take eighteen years to complete, at a total cost ofapproximately $1.2 million.  We haveaccrued approximately $0.8 million for the estimated remaining cost of thisremediation program, which represents the present value of the total estimatedcost using a discount rate of 5.0%.  Asummary of expected payments associated with this project is as follows:

 
|       |   | **Environmental  Payments** |   |
|------------|--------|-----------------------------|--------|
| 2004       |   |                        | $      | 217 |   |
| 2005       |   |                        | 81     |   |
| 2006       |   |                        | 81     |   |
| 2007       |   |                        | 81     |   |
| 2008       |   |                        | 56     |   |
| Thereafter |   |                        | 673    |   |
| Total      |   |                        | $      | 1,189 |   |

 

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**(14)****         RetirementPlans**

 

We havedefined benefit pension plans covering the majority of our employees, includingcertain employees in foreign countries. Certain domestic hourly employees are covered by multi-employer definedbenefit pension plans to which we make contributions.  These contributions totaled $1.1 million in 2001, $1.0 million in2002, and $1.0 million in 2003. The corresponding pension plan assets andliabilities belong to third parties and, accordingly, are not reflected in thisNote.  Our plan assets are investedprimarily in common stocks and fixed income securities.  We make contributions generally at leastequal to the minimum amounts required by federal laws and regulations.  Foreign plans are funded in accordance withthe requirements of the regulatory bodies governing each plan.  

 

EffectiveDecember 31, 2002, we amended the Selmer Salaried Pension Plan (the “SelmerPlan”) to eliminate further years of service credit.  All distributions upon termination of employment will continue inthe normal course under the Selmer Plan. Due to the amendment, no new participants have been added to the SelmerPlan after December 31, 2002.  Theamendment resulted in a curtailment loss of less than $0.1 million.

 

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

 

In December2003, we combined all of our domestic pension plans into one plan, “TheSteinway Musical Pension Plan,” to facilitate plan monitoring and planinvestment management.  We intend toestablish a master trust for this combined plan in 2004. We will continue toevaluate this plan’s funded status and make any required minimum contributionsannually.

 

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The following table sets forththe funded status and amounts recognized for our defined benefit pension plansas of December 31, 2002 and 2003:

 
|                                                 |   | **Domestic  Plans** |    | **Foreign  Plans** |   |
|------------------------------------------------------|--------|---------------------|---------|--------------------|--------|
|                                                 |   | **2002**            |    | **2003**           |   | **2002** |   | **2003** |   |
| Change in benefit obligation:                        |   |                |    |               |   |   |   |   |   |
| Benefit obligation, beginning of year                |   | $                   | 34,189  |               | $      | 38,858 |   | $ | 16,252 |   | $ | 19,240 |   |
| Service cost                                         |   | 1,354               |    | 804                |   | 574 |   | 629 |   |
| Interest cost                                        |   | 2,508               |    | 2,564              |   | 1,054 |   | 1,100 |   |
| Plan participants’ contributions                |   | 24                  |    | 15                 |   | — |   | — |   |
| Amendments                                           |   | (1,392              | )       | 1,841              |   | 9 |   | — |   |
| Actuarial (gain) loss                                |   | 3,977               |    | (715               | )      | (453 | ) | 512 |   |
| Actuarial adjustment                                 |   | —              |    | —             |   | — |   | 5 |   |
| Foreign currency exchange rate changes               |   | —              |    | —             |   | 2,623 |   | 3,550 |   |
| Other                                                |   | —              |    | 2,384              |   | — |   | — |   |
| Benefits paid                                        |   | (1,802              | )       | (1,764             | )      | (819 | ) | (1,010 | ) |
| Benefit obligation, end of year                      |   | 38,858              |    | 43,987             |   | 19,240 |   | 24,026 |   |
|                                                 |   |                |    |               |   |   |   |   |   |
| Change in plan assets:                               |   |                |    |               |   |   |   |   |   |
| Fair value of plan assets, beginning of  year        |   | 29,987              |    | 27,379             |   | 3,013 |   | 3,313 |   |
| Return on plan assets                                |   | (3,406              | )       | 6,507              |   | (72 | ) | 75 |   |
| Employer contribution                                |   | 2,576               |    | 8,293              |   | 819 |   | 982 |   |
| Employee contributions                               |   | 24                  |    | 15                 |   | 54 |   | 55 |   |
| Foreign currency exchange rate changes               |   | —              |    | —             |   | 318 |   | 373 |   |
| Other                                                |   | —              |    | 2,146              |   | — |   | — |   |
| Benefits paid                                        |   | (1,802              | )       | (1,987             | )      | (819 | ) | (1,010 | ) |
| Fair value of plan assets, end of year               |   | 27,379              |    | 42,353             |   | 3,313 |   | 3,788 |   |
|                                                 |   |                |    |               |   |   |   |   |   |
| Funded status                                        |   | (11,479             | )       | (1,634             | )      | (15,927 | ) | (20,238 | ) |
|                                                 |   |                |    |               |   |   |   |   |   |
| Unrecognized net actuarial loss                      |   | 11,596              |    | 6,596              |   | 888 |   | 1,605 |   |
| Unrecognized prior service cost                      |   | 2,526               |    | 3,782              |   | — |   | — |   |
| Net amount recognized                                |   | $                   | 2,643   |               | $      | 8,744 |   | $ | (15,039 | ) | $ | (18,633 | ) |
|                                                 |   |                |    |               |   |   |   |   |   |
| Amounts recognized in the balance sheet  consist of: |   |                |    |               |   |   |   |   |   |
| Accrued benefit cost                                 |   | $                   | (11,479 | )                  | $      | (1,634 | ) | $ | (15,039 | ) | $ | (18,890 | ) |
| Intangible asset                                     |   | 2,526               |    | 3,782              |   | — |   | — |   |
| Additional minimum pension liability                 |   | 11,596              |    | 6,596              |   | — |   | 257 |   |
| Net amount recognized                                |   | $                   | 2,643   |               | $      | 8,744 |   | $ | (15,039 | ) | $ | (18,633 | ) |

 

The weighted-averageassumptions used to determine our benefit obligations at December 31 are asfollows:

 
|                          |   | **Domestic  Plans** |   | **Foreign  Plans** |   |
|-------------------------------|--------|---------------------|--------|--------------------|--------|
|                          |   | **2001**            |   | **2002**           |   | **2003** |   | **2001** |   | **2002** |   | **2003** |   |
|                          |   |                |   |               |   |   |   |   |   |   |   |   |   |
| Discount rate                 |   | 7.50%               |   | 6.75%              |   | 6.50% |   | 5.75, 6.5% |   | 5.5, 5.7% |   | 5.5, 5.6% |   |
| Rate of compensation increase |   | 4.0                 |   | 4.0                |   | n/a |   | 2.5, 4.5 |   | 2.5, 4.0 |   | 2.5, 4.4 |   |

 

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The weighted-averageassumptions used to determine our net periodic benefit cost for the years endedDecember 31 are as follows:

 
|                          |   | **Domestic  Plans** |   | **Foreign  Plans** |   |
|-------------------------------|--------|---------------------|--------|--------------------|--------|
|                          |   | **2001**            |   | **2002**           |   | **2003** |   | **2001** |   | **2002** |   | **2003** |   |
|                          |   |                |   |               |   |   |   |   |   |   |   |   |   |
| Discount rate                 |   | 7.50%               |   | 7.50%              |   | 6.75% |   | 5.75, 6.5% |   | 5.5, 5.7% |   | 5.5, 5.6% |   |
| Expected return on assets     |   | 9.0                 |   | 9.0                |   | 9.0 |   | 6.75 |   | 6.75 |   | 6.75 |   |
| Rate of compensation increase |   | 4.0                 |   | 4.0                |   | n/a |   | 2.5, 4.5 |   | 2.5, 4.0 |   | 2.5, 4.4 |   |

 

The components of net pensionexpense for the years ended December 31 are as follows:

 
|                               |   | **2001** |   | **2002** |   | **2003** |   |
|------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Domestic Plans:                    |   |     |   |     |   |     |   |
| Service cost                       |   | $        | 1,284  |     | $      | 1,354    |   | $ | 804 |   |
| Interest cost                      |   | 2,342    |   | 2,508    |   | 2,564    |   |
| Expected return on plan assets     |   | (2,897   | )      | (3,170   | )      | (2,539   | )      |
| Amortization of prior service cost |   | 407      |   | 410      |   | 585      |   |
| Recognized actuarial (gain) loss   |   | (142     | )      | 5        |   | 540      |   |
| Other                              |   | —   |   | —   |   | 237      |   |
| Curtailment loss                   |   | —   |   | 10       |   | —   |   |
| Net pension expense                |   | $        | 994    |     | $      | 1,117    |   | $ | 2,191 |   |
|                               |   |     |   |     |   |     |   |
| Foreign Plans:                     |   |     |   |     |   |     |   |
| Service cost                       |   | $        | 534    |     | $      | 574      |   | $ | 629 |   |
| Interest cost                      |   | 930      |   | 1,054    |   | 1,100    |   |
| Actuarial adjustment               |   | —   |   | —   |   | 5        |   |
| Expected return on plan assets     |   | (177     | )      | (145     | )      | (194     | )      |
| Net pension expense                |   | $        | 1,287  |     | $      | 1,483    |   | $ | 1,540 |   |

 

The projectedbenefit obligation, accumulated benefit obligation, and fair value of planassets for pension plans with accumulated benefit obligations in excess of planassets were as follows:

 
|                           |   | **2002** |   | **2003** |   |
|--------------------------------|--------|----------|--------|----------|--------|
| Projected benefit obligation   |   | $        | 58,098 |     | $      | 68,013 |   |
| Accumulated benefit obligation |   | 55,945   |   | 65,863   |   |
| Fair value of plan assets      |   | 30,692   |   | 46,141   |   |
|                                |        |          |        |          |        |  |  |

 

Theaccumulated benefit obligation for our domestic pension plans was $38.9 millionin 2002 and $44.0 million in 2003.

 

We providepostretirement health care and life insurance benefits to eligible hourlyretirees and their dependents.  Thehealth care plan is contributory, with retiree contributions adjusted everythree years as part of a union contract. The plans are unfunded and we pay partof the health care premium and the full amount of the life insurance cost.

 

The following table sets forththe funded status of our postretirement benefit plans and accruedpostretirement benefit cost reflected in our consolidated balance sheets as ofDecember 31:

 

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|                                  |   | **2002** |   | **2003** |   |
|---------------------------------------|--------|----------|--------|----------|--------|
| Change in benefit obligation:         |   |     |   |     |   |
| Benefit obligation, beginning of year |   | $        | 1,770  |     | $      | 2,014 |   |
| Service cost                          |   | 60       |   | 70       |   |
| Interest cost                         |   | 129      |   | 139      |   |
| Plan participants’ contributions |   | 45       |   | 49       |   |
| Actuarial loss                        |   | 124      |   | 145      |   |
| Benefits paid                         |   | (114     | )      | (150     | )      |
| Benefit obligation, end of year       |   | 2,014    |   | 2,267    |   |
|                                  |   |     |   |     |   |
| Fair value of plan assets             |   | —   |   | —   |   |
|                                  |   |     |   |     |   |
| Funded status                         |   | (2,014   | )      | (2,267   | )      |
| Unrecognized net actuarial loss       |   | 335      |   | 463      |   |
| Unrecognized prior service cost       |   | 503      |   | 457      |   |
| Accrued postretirement benefit cost   |   | $        | (1,176 | )        | $      | (1,347 | ) |

 

The assumedweighted-average discount rate used to determine benefit obligations as ofDecember 31 was 7.50% in 2001, 6.75% in 2002, and 6.50% in 2003.  The assumed weighted-average discount rateused to determine our net postretirement benefit cost as of December 31 was7.75% in 2001, 7.50% in 2002, and 6.75% in 2003.  The annual assumed rate of increase in the per capita cost ofcovered health care benefits is 7.0% in 2003 and is assumed to decreasegradually to 5.50% in 2006, and remain at that level thereafter.

 

Net postretirement benefitcosts are as follows:

 
|                                  |   | **Years  Ended December 31,** |   |
|---------------------------------------|--------|-------------------------------|--------|
|                                  |   | **2001**                      |   | **2002** |   | **2003** |   |
| Service cost                          |   | $                             | 57     |   | $ | 60 |   | $ | 70 |   |
| Interest cost                         |   | 124                           |   | 129 |   | 139 |   |
| Net loss recognition                  |   | 1                             |   | — |   | — |   |
| Amortization of transition obligation |   | 45                            |   | 48 |   | 62 |   |
| Net postretirement benefit cost       |   | $                             | 227    |   | $ | 237 |   | $ | 271 |   |

 

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

 
|                                                     |   | **1%  Increase** |   | **1%  Decrease** |   |
|----------------------------------------------------------|--------|------------------|--------|------------------|--------|
|                                                     |   |             |   |             |   |
| Effect on total of service and interest  cost components |   | $                | 16     |             | $      | (14 | ) |
| Effect on the postretirement benefit  obligation         |   | 134              |   | (113             | )      |
|                                                          |        |                  |        |                  |        |  |  |

 

56

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The weighted-average assetallocations of our invested assets held in our domestic defined benefit plansat December 31 were as follows:

 
|              |   | **2002** |   | **2003** |   |
|-------------------|--------|----------|--------|----------|--------|
| Asset category:   |   |     |   |     |   |
| Debt securities   |   | 41%      |   | 38%      |   |
| Equity securities |   | 52%      |   | 48%      |   |
| Other             |   | 7%       |   | 14%      |   |
| Total             |   | 100%     |   | 100%     |   |

 

Our investment strategyincludes the following range of target asset allocation percentages:

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

 

During 2002,we updated our pension asset investment policy, conducted a review andredistribution of our investment assets in accordance with that policy, andreviewed past portfolio performance and future performance expectations for ourpension assets.  We amended one of ourplans to eliminate future years of service credit under the plan.  A similar amendment was effected for anotherplan in 2003.

 

The objectiveof our investment policy is to maximize the return on invested assets whilemaintaining an appropriate level of diversification to minimize risk.  Our policy sets forth specific criteria usedin the selection and ongoing evaluation of individual fund managers.

 

Our investmentcommittee generally meets on a quarterly basis with an outside registeredinvestment advisor to review actual performance against relevant benchmarks,such as the S&P 500 Index. Consistent with our policy, changes in fund managers are made when afund falls outside of our predetermined guidelines for an extended period.

 

The investmentcommittee reviews our benefit obligations no less than annually with theobjective of maintaining a fully-funded status for the accumulated benefitobligation and a 90% funded status for the projected benefit obligation.  Whenever possible, our annual contributionis expected to cover the short-term liquidity requirements of the plans, so asto maintain the plans’ assets for long-term investment.  The performance goal set for the plans’assets is to achieve a long-term rate of return no less than 8.5%.

 

For theperiods ended December 31, 2002 and December 31, 2003 we used an assumedlong-term rate of return on plan assets of 9%. This rate was developed with input from our actuaries and our investmentcommittee and is based on long-term rates of return for the assets held, andreturn assumptions of entities with comparable investment portfolios.  This rate is consistent with both previousrates we have used and the historical return trends on our plan assets.

 

57

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In December2003, we made an additional contribution of $5.0 million to our domesticpension plans.  Based on our fundinghistory, we are not required to make a contribution to our domestic pensionplans in 2004.  Nevertheless, weanticipate contributing approximately $ 3.3 million in 2004.

 

The SteinwayMusical Pension Plan expects to pay benefits in each year from 2004 through2013 as follows:

 
|       |   | **Amount** |   |
|------------|--------|------------|--------|
|       |   |       |   |
| 2004       |   | $          | 2,135  |   |
| 2005       |   | 2,310      |   |
| 2006       |   | 2,477      |   |
| 2007       |   | 2,704      |   |
| 2008       |   | 2,894      |   |
| Thereafter |   | 17,036     |   |
| Total      |   | $          | 29,556 |   |

 

We sponsor401(k) retirement savings plans for eligible employees.  Discretionary employer contributions, asdetermined annually by the Board of Directors, are made to two of these plansand approximated $0.6 million for 2001, $0.5 million for 2002, and $0.6 millionfor 2003.  Non-discretionary contributionsapproximated $0.3 million for the years ended December 31, 2001 and 2002, and$0.5 million for the year ended December 31, 2003.

 

We establisheda supplemental executive retirement plan (“SERP”) for a select group of ourexecutives who constitute a “top hat” group as defined by ERISA.  Discretionary employer contributions made tothis plan, as determined annually by the Board of Directors, are held in aRabbi Trust.  The SERP assets areincluded in our financial statements as available-for-sale investments withinother long-term assets since the Trust permits our creditors to access our SERPassets in the event of our insolvency (see Notes 6 and 16).  We have no other claims to the assetscontained in the Trust.  Thecontributions approximated $0.3 million in 2001, $0.2 million in 2002, and lessthan $0.1 million in 2003.

 

**(15)****         ForeignCurrency Exchange Contracts**

 

Our Germandivisions, whose functional currency is the Euro, secure options and forwardscontracts for Japanese yen and British pounds solely to manage currencyfluctuations.  At December 31, 2002,these divisions had forward contracts to sell £2.3 million. These instrumentshad various maturity dates through March 2004. At December 31, 2003, these divisions have options and forward contractsto sell  £1.8 million. These instrumentshave various maturity dates through December 2004.

 

**(16)****         FairValues of Financial Instruments**

 

Estimated fairvalues of financial instruments have been developed using appropriatemethodologies; however, considerable judgment is required to develop theseestimates.  Accordingly, the estimatespresented below are not necessarily indicative of amounts that could berealized in a current market exchange. Use of different assumptions or methodologies could have a significanteffect on these estimates.  The netcarrying value and estimated fair value of our financial instruments are asfollows at December 31:

 

58

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|                       |   | **2002**                 |    | **2003**                   |   |
|----------------------------|--------|--------------------------|---------|----------------------------|--------|
|                       |   | **Net  Carrying  Value** |    | **Estimated  Fair  Value** |   | **Net  Carrying  Value** |   | **Estimated  Fair  Value** |   |
| Financial liabilities:     |   |                     |    |                       |   |   |   |   |   |
| Long-term debt             |   | $                        | 200,636 |                       | $      | 201,087 |   | $ | 196,602 |   | $ | 209,000 |   |
| Foreign currency contracts |   | —                   |    | (106                       | )      | — |   | (78 | ) |
|                            |        |                          |         |                            |        |  |  |  |  |  |  |  |  |

 

The estimatedfair value of existing long-term debt is based on rates currently available tous for debt with similar terms and remaining maturities.

 

The estimatedfair value of foreign currency contracts (used for hedging purposes) has beendetermined as the difference between the current spot rate and the contractrate, multiplied by the notional amount of the contract, or upon the estimatedfair value of purchased option contracts.

 

The carryingamounts of cash, marketable equity securities, accounts payable, and accounts,notes and leases receivable approximate fair value because of the short maturityof these instruments.

 

Investments inmarketable equity securities are categorized as trading, available-for-sale, orheld-to-maturity.  On December 31, 2002and 2003, we had only available-for-sale securities, which are stated at fairvalue, with unrealized gains and losses, net of deferred taxes, reported instockholders’ equity.  Included inaccumulated other comprehensive loss were unrealized net losses of $0.1 millionat December 31, 2002 and unrealized net gains of $0.1 million at December 31, 2003.Gross unrealized gains and losses on these investments were as follows:

 
|                       |   | **December  31,** |   |
|----------------------------|--------|-------------------|--------|
|                       |   | **2002**          |   | **2003** |   |
|                       |   |              |   |   |   |
| Gross unrealized gains     |   | $                 | 87     |   | $ | 216 |   |
| Gross unrealized losses    |   | (208              | )      | (25 | ) |
| Net unrealized gain (loss) |   | $                 | (121   | ) | $ | 191 |   |

 

Our marketable equitysecurities pertain to the SERP and are included as a component of other assets(see Notes 6 and 14).  The cost and fairvalue amounts of these securities are as follows:

 
|       |   | **December  31,** |   |
|------------|--------|-------------------|--------|
|       |   | **2002**          |   | **2003** |   |
|       |   |              |   |   |   |
| Cost       |   | $                 | 486    |   | $ | 688 |   |
| Fair value |   | 360               |   | 760 |   |
|            |        |                   |        |  |  |  |  |

 

59

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**(17)****         SegmentInformation**

 

As discussedin Note 2, we have identified two reportable segments: the piano segment andthe band and orchestral instrument segment. We consider these two segments reportable as they are managed separatelyand the operating results of each segment are separately reviewed and evaluatedby our senior management on a regular basis.

 

The accountingpolicies of each segment are the same as those described in Note 2.  Intercompany transactions are generallyrecorded at cost plus a negotiated markup. 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 allocated to the reportablesegments and the remaining intercompany profit elimination.

 

The following tables presentinformation about our operating segments:

 
|                             |   | **Piano  Segment** |    | **Band and  Orchestral Segment** |   | **Other  &  Elim** |   | **Consol  Total** |   |
|----------------------------------|--------|--------------------|---------|----------------------------------|--------|------------------------|--------|-------------------|--------|
| **2001**                         |   | **U.S.**           |    | **Germany**                      |   | **Other**              |   | **Total**         |   | **U.S.** |   | **Other** |   | **Total** |   |   |   |
| Revenues from external customers |   | $                  | 105,726 |                             | $      | 41,144                 |   | $                 | 22,096 |   | $ | 168,966 |   | $ | 179,067 |   | $ | 4,579 |   | $ | 183,646 |   | $ | — |   | $ | 352,612 |   |
| Operating profit                 |   | 10,190             |    | 6,124                            |   | 4,176                  |   | 20,490            |   | 15,339 |   | 119 |   | 15,458 |   | (1,453 | ) | 34,495 |   |
| Interest income                  |   | (38                | )       | (44                              | )      | (37                    | )      | (119              | )      | (2,187 | ) | — |   | (2,187 | ) | — |   | (2,306 | ) |
| Interest expense                 |   | 10,767             |    | 273                              |   | 189                    |   | 11,229            |   | 27,654 |   | — |   | 27,654 |   | (19,846 | ) | 19,037 |   |
| Depreciation and amortization    |   | 5,872              |    | 2,366                            |   | 205                    |   | 8,443             |   | 4,968 |   | 17 |   | 4,985 |   | 375 |   | 13,803 |   |
| Income tax expense (benefit)     |   | (478               | )       | 2,246                            |   | 1,588                  |   | 3,356             |   | (4,127 | ) | 3 |   | (4,124 | ) | 4,960 |   | 4,192 |   |
| Net income (loss)                |   | (1,434             | )       | 4,068                            |   | 2,435                  |   | 5,069             |   | (8,758 | ) | 63 |   | (8,695 | ) | 12,364 |   | 8,738 |   |
| Capital expenditures             |   | 2,566              |    | 651                              |   | 107                    |   | 3,324             |   | 3,629 |   | 1 |   | 3,630 |   | 187 |   | 7,141 |   |
| Total assets                     |   | 138,336            |    | 54,785                           |   | 10,499                 |   | 203,620           |   | 395,314 |   | 3,214 |   | 398,528 |   | (192,611 | ) | 409,537 |   |
|                             |   |               |    |                             |   |                   |   |              |   |   |   |   |   |   |   |   |   |   |   |
|                             |   | **Piano Segment**  |    | **Band and Orchestral Segment**  |   | **Other &  Elim**  |   | **Consol  Total** |   |
| **2002**                         |   | **U.S.**           |    | **Germany**                      |   | **Other**              |   | **Total**         |   | **U.S.** |   | **Other** |   | **Total** |   |   |   |
| Revenues from external customers |   | $                  | 105,842 |                             | $      | 38,431                 |   | $                 | 20,316 |   | $ | 164,589 |   | $ | 163,265 |   | $ | 4,443 |   | $ | 167,708 |   | $ | — |   | $ | 332,297 |   |
| Operating profit                 |   | 13,392             |    | 5,294                            |   | 2,650                  |   | 21,336            |   | 11,923 |   | 65 |   | 11,988 |   | (1,925 | ) | 31,399 |   |
| Interest income                  |   | (37                | )       | (34                              | )      | (17                    | )      | (88               | )      | (1,804 | ) | — |   | (1,804 | ) | — |   | (1,892 | ) |
| Interest expense                 |   | 9,417              |    | 179                              |   | 154                    |   | 9,750             |   | 24,104 |   | — |   | 24,104 |   | (18,683 | ) | 15,171 |   |
| Depreciation and amortization    |   | 4,495              |    | 1,295                            |   | 231                    |   | 6,021             |   | 4,483 |   | 20 |   | 4,503 |   | 513 |   | 11,037 |   |
| Income tax expense (benefit)     |   | 1,924              |    | 2,400                            |   | 1,009                  |   | 5,333             |   | (2,568 | ) | 77 |   | (2,491 | ) | 4,308 |   | 7,150 |   |
| Net income (loss)                |   | 3,968              |    | 3,882                            |   | 1,691                  |   | 9,541             |   | (7,566 | ) | 161 |   | (7,405 | ) | 12,773 |   | 14,909 |   |
| Capital expenditures             |   | 2,095              |    | 665                              |   | 15                     |   | 2,775             |   | 2,825 |   | — |   | 2,825 |   | 4 |   | 5,604 |   |
| Total assets                     |   | 134,418            |    | 65,726                           |   | 13,334                 |   | 213,478           |   | 388,880 |   | 3,192 |   | 392,072 |   | (181,819 | ) | 423,731 |   |
|                             |   |               |    |                             |   |                   |   |              |   |   |   |   |   |   |   |   |   |   |   |
|                             |   | **Piano Segment**  |    | **Band and Orchestral Segment**  |   | **Other &  Elim**  |   | **Consol  Total** |   |
| **2003**                         |   | **U.S.**           |    | **Germany**                      |   | **Other**              |   | **Total**         |   | **U.S.** |   | **Other** |   | **Total** |   |   |   |
| 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 expense (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 |   |
| Total assets                     |   | 139,855            |    | 76,307                           |   | 16,756                 |   | 232,918           |   | 350,101 |   | 3,586 |   | 353,687 |   | (140,940 | ) | 445,665 |   |

 

60

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**(18)****         Summary of Merger andGuarantees**

 

On May 25,1995, Selmer acquired Steinway pursuant to an Agreement and Plan of Mergerdated as of April 11, 1995.  Thetotal purchase price of approximately $104.0 million, including fees andexpenses, was funded by our available cash balances and Selmer’s issuance of$105.0 million of 11% Senior Subordinated Notes (the “Notes”) due 2005.  An additional $5.0 million of Notes wereissued in exchange for the existing 10% Subordinated notes outstanding at thattime.

 

On April 19, 2001, we completed a $150.0 million 8.75% Senior Noteoffering.  The proceeds of the offeringwere used to redeem all of the existing 11% Senior Subordinated Notes, with thebalance paying down the revolving credit facility.

 

Our payment obligations under the 8.75% Senior Notes are fully andunconditionally guaranteed on a joint and several basis by Selmer, Steinway,UMI and certain other of our direct and indirect wholly-owned subsidiaries,each a “Guarantor” (the “Guarantor Subsidiaries”).  These subsidiaries represent all of our (the “Issuer”) operationsconducted in the United States.

 

The following condensed consolidating supplementary data illustratesthe composition of the combined Guarantors. Separate complete financial statements of the respective Guarantorswould not provide additional material information that would be useful inassessing the financial composition of the Guarantors.  No single Guarantor has any significantlegal restrictions on the ability of investors or creditors to obtain access toits assets in event of default on the Guarantee other than its subordination tosenior indebtedness.

 

We record investments in subsidiaries using the cost method forpurposes of the supplemental consolidating presentation.  Earnings of subsidiaries are therefore notreflected in our investment accounts and earnings.  The principal elimination entries eliminate investments insubsidiaries and intercompany balances and transactions.

 

61

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**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATINGSTATEMENTS OF INCOME**

**YEARENDED DECEMBER 31, 2001**

**(InThousands)**

 
|                               |   | **Issuer********of Notes** |   | **Guarantor********Subsidiaries** |   | **Non********Guarantor********Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|------------------------------------|--------|----------------------------|--------|-----------------------------------|--------|----------------------------------------------|--------|----------------------------|--------|------------------|--------|
|                               |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Net  sales                         |   | $                          | — |                              | $      | 292,168                                      |   | $                          | 70,670 |             | $      | (10,226 | ) | $ | 352,612 |   |
| Cost  of sales                     |   | —                     |   | 216,005                           |   | 43,724                                       |   | (10,638                    | )      | 249,091          |   |
| Gross  profit                      |   | —                     |   | 76,163                            |   | 26,946                                       |   | 412                        |   | 103,521          |   |
|                               |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Operating  expenses:               |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Sales  and marketing               |   | —                     |   | 32,186                            |   | 10,185                                       |   | (120                       | )      | 42,251           |   |
| General  and administrative        |   | 4,299                      |   | 13,210                            |   | 4,660                                        |   | (260                       | )      | 21,909           |   |
| Amortization                       |   | 315                        |   | 2,862                             |   | 1,078                                        |   | —                     |   | 4,255            |   |
| Other  operating (income) expense  |   | (3,163                     | )      | 2,556                             |   | 838                                          |   | 380                        |   | 611              |   |
| Total  operating expenses          |   | 1,451                      |   | 50,814                            |   | 16,761                                       |   | —                     |   | 69,026           |   |
|                               |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Income  (loss) from operations     |   | (1,451                     | )      | 25,349                            |   | 10,185                                       |   | 412                        |   | 34,495           |   |
|                               |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Other  income, net                 |   | (229                       | )      | (1,184                            | )      | (365                                         | )      | —                     |   | (1,778           | )      |
| Interest  income                   |   | (9,929                     | )      | (20,089                           | )      | (81                                          | )      | 27,793                     |   | (2,306           | )      |
| Interest  expense                  |   | 7,947                      |   | 38,421                            |   | 462                                          |   | (27,793                    | )      | 19,037           |   |
| Debt  extinguishment costs         |   | 1,216                      |   | 5,396                             |   | —                                       |   | —                     |   | 6,612            |   |
|                               |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Income  (loss) before income taxes |   | (456                       | )      | 2,805                             |   | 10,169                                       |   | 412                        |   | 12,930           |   |
|                               |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Income  taxes                      |   | (250                       | )      | 477                               |   | 3,822                                        |   | 143                        |   | 4,192            |   |
|                               |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Net  income (loss)                 |   | $                          | (206   | )                                 | $      | 2,328                                        |   | $                          | 6,347  |             | $      | 269 |   | $ | 8,738 |   |

 

62

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**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATING STATEMENTS OF INCOME**

**YEARENDED DECEMBER 31, 2002**

**(InThousands)**

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

 

63

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**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATING STATEMENTS OF INCOME**

**YEARENDED DECEMBER 31, 2003**

**(InThousands)**

 
|                               |   | **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  taxes                      |   | (134                       | )      | 865                               |   | 4,046                                        |   | (79                        | )      | 4,698            |   |
|                               |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Net  income (loss)                 |   | $                          | (248   | )                                 | $      | 3,301                                        |   | $                          | 6,716  |             | $      | (71 | ) | 9,698 |   |
|                                    |        |                            |        |                                   |        |                                              |        |                            |        |                  |        |  |  |  |  |  |

 

64

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**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATINGBALANCE SHEETS**

**DECEMBER 31,2002**

**(InThousands)**

 
|                                            |   | **Issuer********of Notes** |   | **Guarantor********Subsidiaries** |   | **Non********Guarantor********Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|-------------------------------------------------|--------|----------------------------|--------|-----------------------------------|--------|----------------------------------------------|--------|----------------------------|--------|------------------|--------|
|                                            |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| ASSETS                                          |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Current assets:                                 |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Cash                                            |   | $                          | — |                              | $      | 1,871                                        |   | $                          | 6,031  |             | $      | 11,197 |   | $ | 19,099 |   |
| Accounts, notes and leases receivable, net      |   | —                     |   | 65,690                            |   | 11,809                                       |   | (78                        | )      | 77,421           |   |
| Inventories                                     |   | —                     |   | 126,535                           |   | 30,289                                       |   | (981                       | )      | 155,843          |   |
| Prepaid expenses and other current assets       |   | 643                        |   | 3,678                             |   | 906                                          |   | —                     |   | 5,227            |   |
| Deferred tax assets                             |   | —                     |   | 8,890                             |   | 5,036                                        |   | (4,170                     | )      | 9,756            |   |
| Total current assets                            |   | 643                        |   | 206,664                           |   | 54,071                                       |   | 5,968                      |   | 267,346          |   |
|                                            |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Property, plant and equipment, net              |   | 159                        |   | 87,980                            |   | 14,428                                       |   | —                     |   | 102,567          |   |
| Investment in subsidiaries                      |   | 71,143                     |   | 255,666                           |   | —                                       |   | (326,809                   | )      | —           |   |
| Trademarks                                      |   | —                     |   | 6,280                             |   | 3,371                                        |   | —                     |   | 9,651            |   |
| Goodwill                                        |   | —                     |   | 18,795                            |   | 10,744                                       |   | —                     |   | 29,539           |   |
| Other intangibles, net                          |   | 3,749                      |   | 3,178                             |   | 9                                            |   | —                     |   | 6,936            |   |
| Other assets                                    |   | 865                        |   | 6,393                             |   | 434                                          |   | —                     |   | 7,692            |   |
| TOTAL ASSETS                                    |   | $                          | 76,559 |                              | $      | 584,956                                      |   | $                          | 83,057 |             | $      | (320,841 | ) | $ | 423,731 |   |
|                                            |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY       |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Current liabilities:                            |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Current portion of long-term debt               |   | $                          | — |                              | $      | 6,454                                        |   | $                          | 1,601  |             | $      | — |   | $ | 8,055 |   |
| Accounts payable                                |   | 98                         |   | 6,933                             |   | 2,935                                        |   | (78                        | )      | 9,888            |   |
| Other current liabilities                       |   | (14,195                    | )      | 40,654                            |   | 13,343                                       |   | (4,443                     | )      | 35,359           |   |
| Total current liabilities                       |   | (14,097                    | )      | 54,041                            |   | 17,879                                       |   | (4,521                     | )      | 53,302           |   |
|                                            |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Long-term debt                                  |   | 145,398                    |   | 35,986                            |   | —                                       |   | 11,197                     |   | 192,581          |   |
| Intercompany                                    |   | (109,830                   | )      | 105,963                           |   | 3,867                                        |   | —                     |   | —           |   |
| Deferred tax liabilities                        |   | —                     |   | 16,164                            |   | 6,545                                        |   | —                     |   | 22,709           |   |
| Other non-current liabilities                   |   | 252                        |   | 9,458                             |   | 14,221                                       |   | —                     |   | 23,931           |   |
| Total liabilities                               |   | 21,723                     |   | 221,612                           |   | 42,512                                       |   | 6,676                      |   | 292,523          |   |
|                                            |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Stockholders’ equity                       |   | 54,836                     |   | 363,344                           |   | 40,545                                       |   | (327,517                   | )      | 131,208          |   |
|                                            |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY |   | $                          | 76,559 |                              | $      | 584,956                                      |   | $                          | 83,057 |             | $      | (320,841 | ) | $ | 423,731 |   |

 

65

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**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATING BALANCE SHEETS**

**DECEMBER 31,2003**

**(InThousands)**

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

 

66

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**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATINGSTATEMENTS OF CASH FLOWS**

**YEARENDED DECEMBER 31, 2001**

**(InThousands)**

 
|                                                                                 |   | **Issuer********of Notes** |   | **Guarantor********Subsidiaries** |   | **Non********Guarantor********Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|--------------------------------------------------------------------------------------|--------|----------------------------|--------|-----------------------------------|--------|----------------------------------------------|--------|----------------------------|--------|------------------|--------|
| Cash  flows from operating activities:                                               |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Net  income (loss)                                                                   |   | $                          | (206   | )                                 | $      | 2,328                                        |   | $                          | 6,347  |             | $      | 269 |   | $ | 8,738 |   |
| Adjustments  to reconcile net income (loss) to cash flows from operating activities: |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Depreciation  and amortization                                                       |   | 373                        |   | 10,842                            |   | 2,588                                        |   | —                     |   | 13,803           |   |
| Early  extinguishment of debt                                                        |   | 1,216                      |   | 5,396                             |   | —                                       |   | —                     |   | 6,612            |   |
| Deferred  tax expense (benefit)                                                      |   | —                     |   | 328                               |   | (1,682                                       | )      | (1,618                     | )      | (2,972           | )      |
| Other                                                                                |   | 4                          |   | 216                               |   | 211                                          |   | —                     |   | 431              |   |
| Changes  in operating assets and liabilities:                                        |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Accounts,  notes and leases receivable                                               |   | —                     |   | 10,077                            |   | (335                                         | )      | 122                        |   | 9,864            |   |
| Inventories                                                                          |   | —                     |   | 2,562                             |   | (1,693                                       | )      | (412                       | )      | 457              |   |
| Prepaid  expenses and other current assets                                           |   | (298                       | )      | (1,214                            | )      | (370                                         | )      | (651                       | )      | (2,533           | )      |
| Accounts  payable                                                                    |   | (58                        | )      | (3,217                            | )      | (43                                          | )      | (122                       | )      | (3,440           | )      |
| Other  current liabilities                                                           |   | 502                        |   | (8,608                            | )      | 3,614                                        |   | 2,409                      |   | (2,083           | )      |
| Cash  flows from operating activities                                                |   | 1,533                      |   | 18,710                            |   | 8,637                                        |   | (3                         | )      | 28,877           |   |
|                                                                                 |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Cash  flows from investing activities:                                               |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Capital  expenditures                                                                |   | (187                       | )      | (6,195                            | )      | (759                                         | )      | —                     |   | (7,141           | )      |
| Proceeds  from disposals of fixed assets                                             |   | —                     |   | 243                               |   | —                                       |   | —                     |   | 243              |   |
| Changes  in other assets                                                             |   | (5                         | )      | (1,088                            | )      | —                                       |   | 3                          |   | (1,090           | )      |
| Capital  contribution to subsidiary                                                  |   | —                     |   | (419                              | )      | 419                                          |   | —                     |   | —           |   |
| Cash  flows from investing activities                                                |   | (192                       | )      | (7,459                            | )      | (340                                         | )      | 3                          |   | (7,988           | )      |
|                                                                                 |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Cash  flows from financing activities:                                               |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Borrowings  under lines of credit                                                    |   | —                     |   | 303,430                           |   | 5,731                                        |   | —                     |   | 309,161          |   |
| Repayments  under lines of credit                                                    |   | (165                       | )      | (346,996                          | )      | (8,245                                       | )      | 644                        |   | (354,762         | )      |
| Proceeds  from issuance of long-term debt                                            |   | 150,000                    |   | —                            |   | —                                       |   | —                     |   | 150,000          |   |
| Repayment  of long-term debt                                                         |   | —                     |   | (118,497                          | )      | (350                                         | )      | —                     |   | (118,847         | )      |
| Debt  issuance costs                                                                 |   | (4,516                     | )      | —                            |   | —                                       |   | —                     |   | (4,516           | )      |
| Proceeds  from issuance of stock                                                     |   | 454                        |   | —                            |   | —                                       |   | —                     |   | 454              |   |
| Purchase  of treasury stock                                                          |   | (1,901                     | )      | —                            |   | —                                       |   | —                     |   | (1,901           | )      |
| Intercompany  dividends                                                              |   | —                     |   | 3,801                             |   | (3,801                                       | )      | —                     |   | —           |   |
| Intercompany  transactions                                                           |   | (145,213                   | )      | 146,102                           |   | (889                                         | )      | —                     |   | —           |   |
| Cash  flows from financing activities                                                |   | (1,341                     | )      | (12,160                           | )      | (7,554                                       | )      | 644                        |   | (20,411          | )      |
|                                                                                 |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Effect  of exchange rate changes on cash                                             |   | —                     |   | —                            |   | 78                                           |   | —                     |   | 78               |   |
|                                                                                 |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Increase  (decrease) in cash                                                         |   | —                     |   | 909                               |   | 821                                          |   | 644                        |   | 556              |   |
| Cash,  beginning of period                                                           |   | —                     |   | 2,581                             |   | 2,408                                        |   | —                     |   | 4,989            |   |
|                                                                                 |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Cash,  end of period                                                                 |   | $                          | — |                              | $      | 1,672                                        |   | $                          | 3,229  |             | $      | 644 |   | $ | 5,545 |   |

 

67

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**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATING STATEMENTS OF CASH FLOWS**

**YEARENDED DECEMBER 31, 2002**

**(InThousands)**

 
|                                                                                 |   | **Issuer********of Notes** |   | **Guarantor********Subsidiaries** |   | **Non********Guarantor********Subsidiaries** |   | **Reclass/  Eliminations** |   | **Consolidated** |   |
|--------------------------------------------------------------------------------------|--------|----------------------------|--------|-----------------------------------|--------|----------------------------------------------|--------|----------------------------|--------|------------------|--------|
| Cash flows from operating activities:                                                |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Net income (loss)                                                                    |   | $                          | (564   | )                                 | $      | 10,195                                       |   | $                          | 5,357  |             | $      | (79 | ) | $ | 14,909 |   |
| Adjustments to reconcile net income (loss) to cash flows  from operating activities: |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Depreciation and amortization                                                        |   | 513                        |   | 8,978                             |   | 1,546                                        |   | —                     |   | 11,037           |   |
| Early extinguishment of debt                                                         |   | —                     |   | —                            |   | —                                       |   | —                     |   | —           |   |
| Deferred tax expense (benefit)                                                       |   | —                     |   | (687                              | )      | (1,778                                       | )      | 1,271                      |   | (1,194           | )      |
| Other                                                                                |   | —                     |   | 161                               |   | 173                                          |   | —                     |   | 334              |   |
| Changes in operating assets and liabilities:                                         |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Accounts, notes and leases receivable                                                |   | —                     |   | 6,484                             |   | (350                                         | )      | (44                        | )      | 6,090            |   |
| Inventories                                                                          |   | —                     |   | 2,554                             |   | (771                                         | )      | 94                         |   | 1,877            |   |
| Prepaid expenses and other current assets                                            |   | (380                       | )      | (226                              | )      | (149                                         | )      | —                     |   | (755             | )      |
| Accounts payable                                                                     |   | 14                         |   | 850                               |   | 937                                          |   | 44                         |   | 1,845            |   |
| Other current liabilities                                                            |   | 1,524                      |   | (2,904                            | )      | (429                                         | )      | (1,286                     | )      | (3,095           | )      |
| Cash flows from operating activities                                                 |   | 1,107                      |   | 25,405                            |   | 4,536                                        |   | —                     |   | 31,048           |   |
|                                                                                 |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Cash flows from investing activities:                                                |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Capital expenditures                                                                 |   | (4                         | )      | (4,920                            | )      | (680                                         | )      | —                     |   | (5,604           | )      |
| Proceeds from disposals of fixed assets                                              |   | —                     |   | 4                                 |   | —                                       |   | —                     |   | 4                |   |
| Changes in other assets                                                              |   | (82                        | )      | (2,067                            | )      | —                                       |   | —                     |   | (2,149           | )      |
| Capital contribution to subsidiary                                                   |   | —                     |   | (705                              | )      | 705                                          |   | —                     |   | —           |   |
| Cash flows from investing activities                                                 |   | (86                        | )      | (7,688                            | )      | 25                                           |   | —                     |   | (7,749           | )      |
|                                                                                 |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Cash flows from financing activities:                                                |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Borrowings under lines of credit                                                     |   | 33                         |   | 121,848                           |   | 5,723                                        |   | —                     |   | 127,604          |   |
| Repayments under lines of credit                                                     |   | —                     |   | (132,434                          | )      | (5,428                                       | )      | 10,553                     |   | (127,309         | )      |
| Proceeds from issuance of long-term debt                                             |   | —                     |   | —                            |   | —                                       |   | —                     |   | —           |   |
| Repayment of long-term debt                                                          |   | —                     |   | (6,352                            | )      | —                                       |   | —                     |   | (6,352           | )      |
| Repurchase of long-term debt                                                         |   | (4,655                     | )      | —                            |   | —                                       |   | —                     |   | (4,655           | )      |
| Debt issuance costs                                                                  |   | —                     |   | —                            |   | —                                       |   | —                     |   | —           |   |
| Proceeds from issuance of stock                                                      |   | 994                        |   | —                            |   | —                                       |   | —                     |   | 994              |   |
| Intercompany dividends                                                               |   | —                     |   | 787                               |   | (787                                         | )      | —                     |   | —           |   |
| Intercompany transactions                                                            |   | 2,607                      |   | (2,072                            | )      | (535                                         | )      | —                     |   | —           |   |
| Cash flows from financing activities                                                 |   | (1,021                     | )      | (18,223                           | )      | (1,027                                       | )      | 10,553                     |   | (9,718           | )      |
|                                                                                 |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Effect of exchange rate changes on cash                                              |   | —                     |   | —                            |   | (27                                          | )      | —                     |   | (27              | )      |
|                                                                                 |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Increase (decrease) in cash                                                          |   | —                     |   | (506                              | )      | 3,507                                        |   | 10,553                     |   | 13,554           |   |
| Cash, beginning of period                                                            |   | —                     |   | 1,672                             |   | 3,229                                        |   | 644                        |   | 5,545            |   |
|                                                                                 |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Cash, end of period                                                                  |   | $                          | — |                              | $      | 1,166                                        |   | $                          | 6,736  |             | $      | 11,197 |   | $ | 19,099 |   |

 

68

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**STEINWAY MUSICAL INSTRUMENTS, INC. ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATING STATEMENTS OF CASH FLOWS**

**YEARENDED DECEMBER 31, 2003**

**(InThousands)**

 
|                                                                                 |   | **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 leases receivable                                                |   | —                     |   | 2,411                             |   | 464                                          |   | (92                        | )      | 2,783            |   |
| Inventories                                                                          |   | —                     |   | 6,485                             |   | 738                                          |   | 150                        |   | 7,373            |   |
| Prepaid expenses and other current assets                                            |   | (630                       | )      | 767                               |   | (11                                          | )      | —                     |   | 126              |   |
| Accounts payable                                                                     |   | 25                         |   | 948                               |   | 35                                           |   | 78                         |   | 1,086            |   |
| Other current liabilities                                                            |   | 197                        |   | (1,187                            | )      | (150                                         | )      | (895                       | )      | (2,035           | )      |
| Cash flows from operating activities                                                 |   | (135                       | )      | 20,980                            |   | 11,045                                       |   | (14                        | )      | 31,876           |   |
|                                                                                 |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Cash flows from investing activities:                                                |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| Capital expenditures                                                                 |   | (82                        | )      | (4,426                            | )      | (954                                         | )      | —                     |   | (5,462           | )      |
| Proceeds from disposals of fixed assets                                              |   | —                     |   | 10                                |   | —                                       |   | —                     |   | 10               |   |
| Changes in other assets                                                              |   | 1,504                      |   | (6,024                            | )      | 3,537                                        |   | —                     |   | (983             | )      |
| Cash flows from investing activities                                                 |   | 1,422                      |   | (10,440                           | )      | 2,583                                        |   | —                     |   | (6,435           | )      |
|                                                                                 |   |                       |   |                              |   |                                         |   |                       |   |             |   |
| 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 (decrease) 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 |   |

 

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**(19)****         QuarterlyFinancial Data (Unaudited)**

 

The following is a summary of unaudited results of operations (inthousands except share and per share data) for the years endedDecember 31, 2002 and 2003.

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

 
|                      |   | **Year Ended December 31, 2003** | ** ** |
|---------------------------|--------|---------------------------------------|------------|
|                      |   | **First********Quarter**              |       | **Second********Quarter** | ** ** | **Third********Quarter** | ** ** | **Fourth********Quarter** | ** ** |
|                      |   |                                  |       |   |   |   |   |   |   |
| Net  sales                |   | $                                     | 82,509     |   | $ | 78,035 |   | $ | 82,546 |   | $ | 94,130 |   |
| Gross  profit             |   | 20,832                                |       | 22,713 |   | 22,891 |   | 26,117 |   |
| Net  income               |   | 683                                   |       | 2,160 |   | 1,838 |   | 5,017 |   |
|                      |   |                                  |       |   |   |   |   |   |   |
| Basic  income per share   |   | $                                     | 0.08       |   | $ | 0.24 |   | $ | 0.21 |   | $ | 0.56 |   |
| Diluted  income per share |   | $                                     | 0.08       |   | $ | 0.24 |   | $ | 0.21 |   | $ | 0.55 |   |
|                      |   |                                  |       |   |   |   |   |   |   |
| Weighted  average shares: |   |                                  |       |   |   |   |   |   |   |
| Basic                     |   | 8,906,238                             |       | 8,906,238 |   | 8,930,613 |   | 8,955,178 |   |
| Diluted                   |   | 8,906,418                             |       | 8,906,238 |   | 8,931,709 |   | 9,039,770 |   |

 

**(20)****         SubsequentEvents**

 

On February 4, 2004 we repurchased 1,271,450 shares of ourOrdinary common stock from AIG Retirement Services, Inc. (formerly AIGSunAmerica), our largest institutional shareholder.  In exchange, we tendered $29.0 million in principal amount of our8.75% Senior Notes due 2011, which were issued under our existingindenture.  We issued our bonds at a premiumof 106.3%.  This transaction resulted inan increase to our treasury stock of $31.6 million.

 

In the event that this transaction had been completed prior toDecember 31, 2003, pro forma earnings per share would have been $1.27 forthe year ended December 31, 2003.

 

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**STEINWAYMUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES**

**SCHEDULE II- VALUATION AND QUALIFYING ACCOUNTS**

**(InThousands)**

 
|                                                |   | **Balance at********Beginning********of Year** |   | **Additions  Charged to********Costs and  Expenses** |   | **Foreign  Currency  Translation  Adjustments** |   | **Deductions** |      | **Balance at  End of Year** |   |
|-----------------------------------------------------|--------|------------------------------------------------|--------|------------------------------------------------------|--------|-------------------------------------------------|--------|----------------|-----------|-----------------------------|--------|
|                                                |   |                                           |   |                                                 |   |                                            |   |           |      |                        |   |
| Reserves  deducted from assets to which they apply: |   |                                           |   |                                                 |   |                                            |   |           |      |                        |   |
|                                                |   |                                           |   |                                                 |   |                                            |   |           |      |                        |   |
| Allowance  for doubtful accounts:                   |   |                                           |   |                                                 |   |                                            |   |           |      |                        |   |
| Year  ended December 31, 2001                  |   | $                                              | 11,377 |                                                 | $      | 362                                             |   | $              | (38       | )                           | $      | (792 | )(1) | $ | 10,909 |   |
| Year  ended December 31, 2002                  |   | 10,909                                         |   | 242                                                  |   | 91                                              |   | 147            |  (1) | 11,389                      |   |
| Year  ended December 31, 2003                  |   | 11,389                                         |   | 218                                                  |   | 65                                              |   | (1,728         | )(1)      | 9,944                       |   |
|                                                |   |                                           |   |                                                 |   |                                            |   |           |      |                        |   |
| Inventory  obsolescence:                            |   |                                           |   |                                                 |   |                                            |   |           |      |                        |   |
| Year  ended December 31, 2001                  |   | $                                              | 3,954  |                                                 | $      | 1,086                                           |   | $              | (25       | )                           | $      | (276 | ) | $ | 4,739 |   |
| Year  ended December 31, 2002                  |   | 4,739                                          |   | 1,644                                                |   | 95                                              |   | (987           | )         | 5,491                       |   |
| Year  ended December 31, 2003                  |   | 5,491                                          |   | 731                                                  |   | 126                                             |   | (633           | )         | 5,715                       |   |
|                                                |   |                                           |   |                                                 |   |                                            |   |           |      |                        |   |
| Reserves  included in other current liabilities:    |   |                                           |   |                                                 |   |                                            |   |           |      |                        |   |
|                                                |   |                                           |   |                                                 |   |                                            |   |           |      |                        |   |
| Accrued  warranty expense:                          |   |                                           |   |                                                 |   |                                            |   |           |      |                        |   |
| Year  ended December 31, 2001                  |   | $                                              | 2,355  |                                                 | $      | 932                                             |   | $              | (44       | )                           | $      | (1,022 | ) | $ | 2,221 |   |
| Year  ended December 31, 2002                  |   | 2,221                                          |   | 950                                                  |   | 152                                             |   | (966           | )         | 2,357                       |   |
| Year  ended December 31, 2003                  |   | 2,357                                          |   | 1,361                                                |   | 198                                             |   | (1,314         | )         | 2,602                       |   |
|                                                |   |                                           |   |                                                 |   |                                            |   |           |      |                        |   |
| Accrued  environmental expense:                     |   |                                           |   |                                                 |   |                                            |   |           |      |                        |   |
| Year  ended December 31, 2001                  |   | $                                              | 500    |                                                 | $      | 90                                              |   | $              | —    |                        | $      | (90 | ) | $ | 500 |   |
| Year  ended December 31, 2002                  |   | 500                                            |   | 380                                                  |   | —                                          |   | (270           | )         | 610                         |   |
| Year  ended December 31, 2003                  |   | 610                                            |   | 267                                                  |   | —                                          |   | (87            | )         | 790                         |   |
|                                                |   |                                           |   |                                                 |   |                                            |   |           |      |                        |   |
| Reserves  for notes sold with recourse:             |   |                                           |   |                                                 |   |                                            |   |           |      |                        |   |
| Year  ended December 31, 2001                  |   | $                                              | 1,103  |                                                 | $      | —                                          |   |           |      | $                           | (254   | ) | $ | 849 |   |
| Year  ended December 31, 2002                  |   | 849                                            |   | —                                               |   |                                            |   | (849           | )(1)      | —                      |   |
| Year  ended December 31, 2003                  |   | —                                         |   |                                                 |   |                                            |   |           |      | —                      |   |

 

----

Note:      (1)           Represents accountswritten off, net of recoveries, and reclassifications to and from otheraccounts

 

71

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**ITEM 9****                   CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

Not applicable.

 

**ITEM 9A**                **CONTROLS AND PROCEDURES**

 

Disclosure controls and procedures

 

Under the direction of our Chief Executive Officer and Chief FinancialOfficer, we evaluated our disclosure controls and procedures and internalcontrol over financial reporting and concluded that (i) our disclosure controlsand procedures were effective as of December 31, 2003 and (ii) no changein internal control over financial reporting occurred during the quarter endedDecember 31, 2003 that has materially affected, or is reasonably likely tomaterially affect, such internal control over financial reporting.

 

**PARTIII**

 

**ITEM 10****                DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT**

 

The information called for by this item is hereby incorporated byreference to the Registrant’s definitive Proxy Statement for the fiscal yearended December 31, 2003, which Proxy Statement will be filed with theSecurities and Exchange Commission no later than 120 days after the end of thefiscal year covered by this report.

 

**ITEM 11****                EXECUTIVECOMPENSATION**

 

The information called for by this item is hereby incorporated byreference to the Registrant’s definitive Proxy Statement for the fiscal yearended December 31, 2003, which Proxy Statement will be filed with theSecurities and Exchange Commission no later than 120 days after the end of thefiscal year covered by this report.

 

72

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**ITEM 12****                SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

The information called for by this item is hereby incorporated byreference to the Registrant’s definitive Proxy Statement for the fiscal yearended December 31, 2003, which Proxy Statement will be filed with theSecurities and Exchange Commission no later than 120 days after the end of thefiscal year covered by this report.

 

**ITEM 13****                CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

The information called for by this item is hereby incorporated byreference to the Registrant’s definitive Proxy Statement for the fiscal yearended December 31, 2003, which Proxy Statement will be filed with theSecurities and Exchange Commission no later than 120 days after the end of thefiscal year covered by this report.

 

**ITEM 14****                PRINCIPALACCOUNTANT FEES AND SERVICES**

 

The information called for by this item is hereby incorporated byreference to the Registrant’s definitive Proxy Statement for the fiscal yearended December 31, 2003, which Proxy Statement will be filed with theSecurities and Exchange Commission no later than 120 days after the end of thefiscal year covered by this report.

 

**PARTIV**

 

**ITEM 15****                EXHIBITS,FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K**

 

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

 
|   |   |                                                               |   |
|--------|--------|--------------------------------------------------------------------|--------|
| (1)    |   | Financial Statements                                               |   |
|   |   |                                                               |   |
|   |   | Independent Auditors’ Report                                  |   |
|   |   | Consolidated Statements of Income                                  |   |
|   |   | Years Ended December 31, 2001, 2002, and 2003                 |   |
|   |   | Consolidated Balance Sheets as of  December 31, 2002 and 2003 |   |
|   |   | Consolidated Statements of Cash Flows for the                      |   |
|   |   | Years Ended December 31, 2001, 2002, and 2003                 |   |
|   |   | Consolidated Statements of Stockholders’  Equity for the      |   |
|   |   | Years Ended December 31, 2001, 2002,  and 2003                |   |
|   |   | Notes to Consolidated Financial Statements                         |   |
|   |   |                                                               |   |
| (2)    |   | Financial Statement Schedules                                      |   |
|   |   |                                                               |   |
|   |   | Schedule II - Valuation and Qualifying  Accounts              |   |

 

73

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

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

 

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|   |   | Inc., as borrowers; those signatories identified as guarantors, the  lenders, and GMAC Commercial Credit LLC, as administrative agent.                                                                                                                                              |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.8    |   | Registration Rights Agreement, dated as of August 9, 1993, among  Selmer Industries, Inc. and the purchasers of certain equity securities  (1)                                                                                                                            |
| 4.9    |   | 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)                                                                                           |
| 4.10   |   | Exchange Registration Rights agreement, dated as of May 25, 1995, by  and among The Selmer Company, Inc., Selmer Industries, Inc., Steinway Musical  Properties, Inc., Steinway, Inc., Boston Piano Company, Inc. and Donaldson,  Lufkin  & Jenrette Corporation  (2) |
| 10.1   |   | Employment Agreement, dated May 8, 1989, between Steinway Musical  Properties, Inc. and Thomas Kurrer   (3)                                                                                                                                                                    |
| 10.2   |   | Employment Agreement, dated as of May 1, 1995, between Steinway  Musical Properties, Inc. and Bruce Stevens   (3)                                                                                                                                                              |
| 10.3   |   | Employment Agreement Renewal and Amendment dated January 1, 1997  by and between Steinway Musical Instruments, Inc. and Bruce Stevens  (6)                                                                                                                                |
| 10.4   |   | Employment Agreement, dated as of May 1, 1995, between Steinway  Musical Properties, Inc. and Dennis Hanson   (3)                                                                                                                                                              |
| 10.5   |   | Employment Agreement Renewal and Amendment dated January 1, 1997  by and between Steinway Musical Instruments, Inc. and Dennis Hanson  (6)                                                                                                                                |
| 10.6   |   | Employment Agreement, dated as of January 4, 1999, between the  Registrant and Dana Messina  (7)                                                                                                                                                                          |
| 10.7   |   | Employment Agreement, dated as of January 4, 1999, between the  Registrant and Kyle Kirkland  (7)                                                                                                                                                                         |
| 10.8   |   | Environmental Indemnification and Non-Competition Agreement, dated as  of August 9, 1993, between The Selmer Company, Inc. and Philips  Electronics North American Corporation   (1)                                                                                      |
| 10.9   |   | Distribution Agreement, dated November 1, 1952, by and between  H. & A. Selmer, Inc. and Henri Selmer & Cie  (1)                                                                                                                                                  |
| 10.10  |   | Amended and Restated 1996 Stock Plan of the Registrant (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 (15)                                                                                                                                                                                                                      |
| 10.16  |   | Agreement between Steinway, Inc. d/b/a Steinway & Sons and Local  102 F.W. AFL-CIO                                                                                                                                                                                              |
| 21.1   |   | List of Subsidiaries of the Registrant                                                                                                                                                                                                                                              |
| 23.1   |   | Independent Auditors’ Consent - Deloitte & Touche LLP                                                                                                                                                                                                                      |
| 23.2   |   | Preferability Letter – 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                                                                                                                                                                        |

 

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

 

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(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 onJune 7, 1995 as an exhibit to the Registrant’s Current Report on Form 8-K.

 

(3)     Previously filed with the Commission onJune 7, 1995 as an exhibit to the Registrant’s Registration Statement onForm 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 onJuly 25, 1996 as an exhibit to the Registrant’s Amendment No. 2 toRegistration Statement on Form S-1.

 

(6)     Previously filed with the Commission onMarch 27, 1997 as an exhibit to the Registrant’s Annual Report on Form10-K.

 

(7)     Previously filed with the Commission onAugust 16, 1999 as an exhibit to the Registrant’s Quarterly Report on Form10-Q.

 

(8)     Previously filed with the Commission onJuly 27, 2000 as an exhibit to the Registrant’s Current Report on Form8-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 onAugust 14, 2001 as an exhibit to the Registrant’s Quarterly Report on Form10-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 onJune 12, 2001 as an exhibit to the Registrant’s Registration Statement onForm 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 onMarch 18, 2003 as an Exhibit to the Registrant’s Annual Report on Form10-K.

 

(15)   Previously filed with the Commission onAugust 12, 2003 as an Exhibit to the Registrant’s Quarterly Report onForm 10-Q.

 

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(b)           Reportson Form 8-K

 

On October 3, 2003 the Company filed a Current Report on Form 8-Kthat included a press release issued on October 3, 2003 announcing thedecision to close its woodwind manufacturing facility in Elkhart, Indiana andto transfer production to other company-owned facilities.

 

On October 8, 2003 the Company filed a Current Report on Form 8-Kannouncing that Standard and Poor’s Ratings Services had lowered its corporatecredit rating from ‘BB’ to ‘BB-’ and its seniored unsecured rating from ‘BB-’to ‘B+’.  The ratings were removed fromCreditWatch, where they were placed on April 1, 2003.  The Outlook reported by Standard and Poor’swas stable.

 

On October 28, 2003 the Company filed a Current Report on Form 8-Kthat included a press release issued on October 28, 2003 announcing itsearnings for the quarter and nine months ended September 27, 2003.

 

 

SIGNATURES

 

 

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

 

 
|                | STEINWAY MUSICAL INSTRUMENTS, INC. |
|---------------------|------------------------------------|
|                |                               |
|                |                               |   |
| March 12, 2004 | By:                                | /s/ Dana D. Messina |   |
| (Date)              |                               | Dana D. Messina |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed by the following persons on behalf of theregistrant and in the capacities and on the dates indicated:

 
| **Signature**              |   | **Title**                                     |   |                |
|----------------------------|--------|-----------------------------------------------|--------|---------------------|
|                       |   |                                          |   |                |
| /s/  Dana D. Messina  |   | Director and Chief Executive Officer          |   | March 12, 2004 |
| Dana D. Messina            |   | (Principal Executive Officer)                 |   |                |
|                       |   |                                          |   |                |
| /s/  Dennis M. Hanson |   | Chief Financial Officer                       |   | March 12, 2004 |
| Dennis M. Hanson           |   | (Principal Financial and  Accounting Officer) |   |                |
|                       |   |                                          |   |                |
| /s/  Kyle R. Kirkland |   | Chairman of the Board                         |   | March 12, 2004 |
| Kyle R. Kirkland           |   |                                          |   |                |

 

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| /s/  John M. Stoner, Jr. |   | Director |   | March 12, 2004 |
|-------------------------------|--------|----------|--------|---------------------|
| John M. Stoner, Jr.           |   |     |   |                |
|                          |   |     |   |                |
| /s/  Bruce A. Stevens    |   | Director |   | March 12, 2004 |
| Bruce A. Stevens              |   |     |   |                |
|                          |   |     |   |                |
| /s/  Peter McMillan      |   | Director |   | March 12, 2004 |
| Peter McMillan                |   |     |   |                |
|                          |   |     |   |                |
| /s/  A. Clinton Allen    |   | Director |   | March 12, 2004 |
| A. Clinton Allen              |   |     |   |                |
|                          |   |     |   |                |
| /s/ Rudolph K. Kluiber        |   | Director |   | March 12, 2004 |
| Rudolph K. Kluiber            |   |     |   |                |

 

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