**UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

 

**ý****                                ****ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**FOR THEFISCAL YEAR ENDED DECEMBER 31, 2004**

 

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

 

**COMMISSION FILE NUMBER 001-11911**

 

**STEINWAY MUSICAL INSTRUMENTS,INC.**

(Exact name of registrant as specified in itscharter)

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

 

Registrant’s telephone number, including area code

**(781) 894-9770**

 

Securities registered pursuant to Section 12(b) of the Act:

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

 

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months(or for such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements during the past90 days.    Yes ý   No o

 

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

 

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

 

The aggregate marketvalue of the Common Stock held by non-affiliates of the registrant was$207,362,428 as of March 15, 2005 and $244,732,784 as of June 30,2004.

 
| Number of shares of Common Stock outstanding as of March 15,  2005: |   | Class A  |   | 477,952   |   |
|--------------------------------------------------------------------------|--------|----------|--------|-----------|--------|
|                                                                     |   | Ordinary |   | 7,555,695 |   |
|                                                                     |   | Total    |   | 8,033,647 |   |

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Part III - Items10-13 - Definitive Proxy Statement of the Registrant to be filed pursuant toRegulation 14A, Parts I-IV - Final Prospectus of the Registrant dated August 1,1996 filed pursuant to Rule 424(b).

 

 

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**NoteRegarding Forward-Looking Statements**

 

Certainstatements contained throughout this Annual Report on Form 10-K are “forward-lookingstatements” within the meaning of Section 21E of the Securities ExchangeAct of 1934, as amended.  Theseforward-looking statements represent our present expectations or beliefsconcerning future events.  We caution youthat such statements are necessarily based on certain assumptions that aresubject to risks and uncertainties, which could cause actual results to differmaterially from those indicated in this report. These risk factors include, but are not limited to, the following:changes in general economic conditions; increased competition; work stoppagesand slowdowns; exchange rate fluctuations; variations in the mix of productssold; market acceptance of new band instrument product and distributionstrategies; ability of suppliers to meet demand; and fluctuations in effectivetax rates resulting from shifts in sources of income.  We have included further information on thesefactors 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 Securities andExchange Commission (“SEC”) allows us to disclose certain information to you byreferring you to other documents we have filed with the SEC.  The information that we refer you to is “incorporatedby reference” into this Annual Report on Form 10-K.  Please read that information.

 

### **PART I**

 

### **Item 1.  Business**

 

### **Company History**

 

SteinwayMusical Instruments, Inc., through its wholly-owned subsidiaries, is a globalleader in the design, manufacture, marketing and distribution of high qualitymusical instruments.  We are the largestdomestic manufacturer of musical instruments. Whenever we refer to the “Company” or to “us,” or use the terms “we” or “our”in this annual report, we are referring to Steinway Musical Instruments, Inc.and its subsidiaries.

 

SteinwayMusical Instruments, Inc., formerly Selmer Industries, Inc., was incorporatedin 1993, at which time it purchased The Selmer Company, Inc. (“Selmer”), thelargest U.S. manufacturer of band & orchestral instruments.  In May of 1995, we purchased Steinway MusicalProperties, Inc. (“Steinway”), a manufacturer and distributor of acousticpianos.  In August of 1996, SteinwayMusical Instruments, Inc. became publicly held.

 

In September of2000, we acquired United Musical Instruments Holdings, Inc. (“UMI”), the secondlargest manufacturer of band & orchestral instruments in the U.S. and on January 1,2003 Selmer and UMI merged into Conn-Selmer, Inc. (“Conn-Selmer”).  In August of 2004, we acquired theassets of G. Leblanc Corporation, a manufacturer of high quality bandinstruments with production facilities in Wisconsin and France.

 

We area Delaware corporation with our principal executive offices located at 800South Street, Suite 305, Waltham, Massachusetts 02453, and our telephone numberis (781) 894-9770.  Through our

 

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corporatewebsite, www.steinwaymusical.com, we provide access free of charge to all ofour filings with the SEC, including our Annual Reports on Form 10-K, quarterlyreports on Form 10-Q, and current reports on Form 8-K.  These reports are available immediatelyfollowing filing with the SEC. Information contained on or connected to our website is not incorporatedby reference into this Annual Report on Form 10-K and should not be consideredpart of this report or any other filing that we make with the SEC.  Additionally, the SEC maintains an Internetsite at www.sec.gov that contains reports, proxy and information statements andother information regarding issuers that file electronically with the SEC.

 

**Financial Information by Segment and Geographic Location**

 

Informationon business segments and geographic areas in which we operated for the yearsended December 31, 2004, 2003 and 2002 is contained in Note 18 to theConsolidated Financial Statements included in this report.

 

**MusicalInstrument Industry**

 

Weoperate two reportable segments within the musical instrument industry - pianosand band & orchestral instruments.

 

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

 

During the latter half of the 1990s through 2000, the industryexperienced growth in all categories of pianos as a result of the strong U.S.economy, favorable demographics, and a general resurgence in music interests.

 

Industry piano salesdecreased in 2001 – 2003 as a result of the worldwide economic downturn.  Since Steinway realizes a majority of itsprofit from high-end grand piano sales, our results are generally more affectedby economic cycles than by industry trends. However, favorable demographics,institutional sales, and the public's continued interest in music helpedmitigate the impact of the economy on our piano business. As the U.S. economyrebounded in 2004, piano industry sales grew in all categories.

 

Market size and volumetrends are difficult to quantify for international piano markets, as there isno single source for worldwide sales data. Outside North America, our strongest market shares are in Germany, theUnited Kingdom, France and Switzerland. We believe that we hold an average grand piano market share ofapproximately 13% in these countries.

 

Outside of the UnitedStates, China and Japan are the two largest grand piano markets in theworld.  With our three piano lines, ourmarket share of grand piano units is currently 4% in Japan and less than 1% inChina.  While adverse economic conditionsin Japan have slowed our expansion in that market, the Chinese market isgrowing at a rapid pace and we continue to target this region in ourdistribution strategies.  In 2004, weopened a distribution and selection facility in Shanghai.  We believe that our long-term prospects inAsia are favorable.

 

**Band & Orchestral Instruments -**We believe that the band & orchestralinstrument market in the U.S. has historically been impacted more bydemographic trends and school budgeting than by macroeconomic cycles.  While the domestic market continued to growthrough the late 1990s, domestic supply outpaced demand. In recent years therehas been an increase in units imported into the domestic

 

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market from offshorelow-cost producers, as well as a decline in exports by domestic manufacturers.These factors have created a highly price sensitive domestic market, wheremanufacturers implemented aggressive pricing programs in an attempt to maintainmarket share positions.

 

However, we believe theoutlook for future growth remains positive. Relatively stable demographic trends and studies emphasizing theimportance of music education in a child’s development are expected tofacilitate industry growth.  We believethat parents are encouraging their children to play musical instruments inresponse to the growing number of reports that show participation in musicprograms increases a student’s ability to excel in other aspects of his or hereducation.  In addition, many school banddirectors are promoting band programs as social organizations rather than thefirst step of intensive music study.  Webelieve that focusing on the educational component of the musical instrumentindustry will help us expand our market share in the relatively flat marketexpected in the near-term.

 

**Business and Products**

 

**Piano Segment**

 

Ourpiano division concentrates on the high-end grand piano market, handcraftingSteinway pianos in New York and Germany. 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 also offerupright pianos as well as two mid-priced lines of pianos under the Boston andEssex brand names.

 

**Steinway & Sons** - We offer two premium-pricedproduct lines under the Steinway & Sons brand: grand pianos and uprightpianos.  Steinway pianos differ from allothers in design specifications, materials used and the assembly process.  Grand pianos historically have accounted forthe bulk of our production.  We offereight sizes of the grand piano ranging from the 5’1” baby grand to the largest9’ concert grand.  The smaller grands aresold to both individual and institutional customers, while the concert grandsare sold primarily to institutions. Steinway grand pianos are premium pianos in terms of quality and price,with retail prices for ebony pianos generally ranging from $38,900 to $99,900in the United States.  Limited editionpianos and pianos with exotic veneers sell for retail prices of up to $164,000.  In 2004, we sold 3,194 grand pianos, of which2,237 units were shipped from our New York facility to dealers in theAmericas.  The remaining 957 units wereshipped from our German facility primarily to Europe and Asia.

 

Ourupright pianos offer dealers a complete line of quality pianos to satisfy theneeds of institutions and other customers who are constrained by spacelimitations.  We also provide services,such as restoration, repair, replacement part sales, tuning and regulation ofpianos.  Restoration services range fromminor damage repairs to complete restorations of vintage pianos.

 

**Boston Piano Company** - Theintroduction of the Boston line in the early 1990s permitted us to compete inthe mid-price category without sacrificing quality.  Today we offer two complete lines of grandand upright pianos for the mid-priced piano market under the Boston and Essexbrand names.  With certain limitedexceptions, we allow only Steinway dealers to carry the Boston and Essex pianolines, thereby ensuring that these pianos will be marketed as complementaryproduct lines to the Steinway line. These pianos, which were designed by us and are produced by Asianmanufacturers, provide our dealers with an opportunity to realize bettermargins in this price range while capturing sales that would have otherwisegone to a competitor.  Also, these pianosprovide future Steinway grand piano customers with the opportunity to join theSteinway family of owners sooner, since our research indicates that the vast majority

 

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of Steinway customershave previously owned another piano.  TheBoston and Essex product lines also increase our business with our dealers,making us their primary supplier in many instances, since our three product linestogether offer the full spectrum of piano prices and styles.  Together the Boston and Essex product linesoffer twelve upright and grand piano sizes, with retail prices ranging from$5,200 to $39,990 in the United States.

 

**Band Segment**

 

We arethe largest domestic producer of band & orchestral instruments and offer acomplete line of brass, woodwind, percussion and string instruments withwell-known brand names.  In 2004, salesof sourced products accounted for 35% of our band division revenue.  Approximately 20% of these sales wereattributable to our new imported entry-level student woodwind and brassinstruments.

 

**Woodwind and Brass Instruments** - We manufacture piccolos, flutes,clarinets, oboes, bassoons, saxophones, trumpets, French horns, tubas, andtrombones in our manufacturing facilities in Indiana, Ohio, Wisconsin, and France. We sell student level instruments in three distinct product groupings - “good”entry-level imported instruments, “better” mid-priced instruments, which areeither imported or manufactured by us, and “best” instruments, which aremanufactured by us.  We also manufactureintermediate and professional level woodwind and brass instruments.  Sales of woodwind and brass instrumentsaccounted for 68% of our band division revenue in 2004.

 

We sell our woodwind andbrass products under the *Bach, Selmer, C.G. Conn,Leblanc, King, Armstrong, Holton, Martin, Vito, Emerson, Noblet, Artley*and*Benge*brand names.  Suggested retail pricesgenerally range from $300 to $2,500 for student instruments and from $1,000 to$10,000 for intermediate and professional instruments.  We often customize the products that we sellto professional musicians so that the product meets requested designspecifications or has certain sound characteristics.  We believe that specialization of productshelps maintain a competitive edge in quality and product design.  Our specialized woodwind and brassinstruments sell for up to $25,000.

 

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

 

**Percussion Instruments** - Wemanufacture and distribute acoustical and tuned percussion instruments,including outfit drums, marching drums, concert drums, marimbas, xylophones,vibraphones, orchestra bells, and chimes. We manufacture percussion products in North Carolina and Illinois underthe *Ludwig* and *Musser*brand names.  *Ludwig*is considered a leading brand name in acoustical drums and timpani and *Musser* has a strong market position in tuned percussionproducts.  Suggested retail prices rangefrom $500 to $5,000 for acoustical drum outfits and from $2,000 to $15,000 fortuned percussion instruments, with specialized tuned instruments purchased bysymphonies and orchestras selling for up to $20,000.  Sales of percussion instruments accounted for15% of our band division revenue in 2004.

 

**String Instruments** - We assembleand distribute violins, violas, cellos, and basses.  Products are sold under the *Glaesel, Scherl & Roth,*and *W**illiam Lewis & Son*brandnames.  Suggested retail prices generallyrange from $200 to $4,000 for student instruments and from $1,700 to $7,000 forintermediate and advanced instruments, with specialized instruments selling forup to $13,000. Components are primarily imported from Europe and Asia andassembled at our factory in Ohio.  Salesof string instruments accounted for 4% of our band division revenue in 2004.

 

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**Accessories** - We manufacture mouthpieces and distributeaccessories such as music stands, batons, mallets, straps, mutes, reeds, pads,chin rests, strings, bows, cases and instrument care products.  Sales of accessories accounted for 13% of ourband division revenue in 2004.

 

**Customers**

 

**Piano Segment**

 

Wedistribute our pianos worldwide through approximately 180 independent pianodealers who operate nearly 300 showrooms. We also sell our pianos through ten company-operated retailshowrooms:  five in the U.S. and five inEurope.  Most Steinway grand piano salesare to individuals – both professional artists and amateur pianists.  Our typical customer is between 40 and 50years old and has an intermediate to advanced level of musical skill.  He or she holds a graduate degree and reportsa household income ranging from $150,000 to over $300,000 per year.

 

We also sell pianos toinstitutions such as concert halls, conservatories, colleges, universities andmusic schools.  Nearly 20% of our 2004piano sales were to institutional customers. To date, we have designated fifty schools and conservatories worldwide as “All-Steinway Schools.”  These institutions provide their students and faculties with the best instruments possiblefor the study of music – from the practice room to the recital hall - by owningonly pianos designed by Steinway& Sons.

 

In2004, approximately 57% of piano sales were in the United States, 28% in Europeand the remaining 15% primarily in Asia. Our largest piano dealer accounted for approximately 4% of piano salesin 2004, while the top 15 accounts represented 30% of piano sales.

 

## **Band Segment**

## ** **

Band& orchestral instruments are sold to student, amateur and professionalmusicians, and institutions.  Themajority of our instruments are purchased or rented from dealers by studentsenrolled in music education programs in the U.S.  Traditionally, students join school bands ororchestras at age 10 or 11 and learn on beginner level instruments, progressingto intermediate or professional level instruments in high school orcollege.  We estimate that approximately85% of our domestic band sales are generated through educational programs.  The remaining domestic band sales are toprofessional or amateur musicians or performing groups, including orchestrasand symphonies. Student level instruments accounted for approximately 70% ofband & orchestral unit sales and approximately 40% of instrument revenuesin 2004, with advanced and professional instruments representing thebalance.  In 2004, 81% of band sales werein the United States, 9% in Europe and the remaining 10% primarily in Canadaand Asia.  Our largest band dealeraccounted for approximately 8% of band sales in 2004, while the top 15 accountsrepresented approximately 41% of band sales.

 

**Sales andMarketing**

 

### **Piano Segment**

### ** **

Wedistribute pianos primarily on a wholesale basis through approximately 180select dealers around the world.  We havesubsidiaries and dealers in both Japan and China that provide direct access tothe expansive Asian piano market. Sales to dealers accounted for approximately73% of piano segment revenue in 2004. The remaining 27% was generated fromsales made directly by us at one of our ten company-operated retail showrooms.

 

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Weemploy district sales managers whose responsibilities include developing closeworking relationships with piano dealers. These highly-experiencedprofessionals provide dealers with sales training and technical support anddevelop sales and marketing programs for the consumer and institutionalmarkets.  These sales managers are alsoresponsible for promoting the Concert and Artist and the Steinway Artistprograms described below.

 

**Concert and Artist Piano Bank****-** To ensure that all pianists, especially Steinway Artists,have a broad selection of instruments to meet their individual touch and tonalpreferences, we maintain the Concert and Artist Piano Bank.  The Piano Bank includes approximately 450instruments worldwide.  Of theseinstruments, approximately 350 are located in the United States.  In New York City alone, the Steinway concertdepartment has approximately 160 concert grands available for variousoccasions.  The remaining domestic-basedpianos are leased to dealers around the country who actively support theSteinway Artists program.  The Piano Bankpromotes our instruments in the music industry and provides management withcontinuous feedback on the quality and performance of recently producedinstruments from our most critical customer, the professional pianist.  The Piano Bank instruments are generally soldafter four years and replaced with new pianos.

 

**Steinway Artist Roster****-** Steinway Artists are world-class pianists who voluntarilyendorse Steinway & Sons by selecting the Steinway piano.  Our Steinway Artist program is unique in thatwe do not pay artists to endorse our instruments.  To become a Steinway Artist, a pianist mustnot only meet certain performance and professional criteria, he or she mustalso own a Steinway piano.  We use theserenowned artists in our marketing programs to help reinforce recognition of theSteinway brand name and its association with quality.  The Steinway Artist Roster currently includesapproximately 1,300 of the world’s finest pianists who perform on Steinwaypianos.  In return for theirendorsements, Steinway Artists are provided with access to the Piano Bankdescribed above.

 

### **Band Segment**

### ** **

Our band &orchestral, string and percussion instruments and accessories are distributedworldwide through approximately 1,800 independent musical instrument dealersand distributors.

 

In North America,we market our products through district sales managers, independent salesrepresentatives, and telemarketing representatives who are responsible forsales within assigned geographic territories. Each district sales manager isalso responsible for developing relationships with band & orchestraldirectors.  These directors represent alllevels of music educators, from those who teach elementary school childrenthrough 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 to provide newteachers 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.

 

Wealso sell our instruments through dealers and distributors located in Europeand Asia.  We use internationalrepresentatives to help market our products overseas. Dealers and distributorsin the United States and abroad are supported through incentive programs,advertising and promotional activities.

 

Wereach our customers through trade shows, educator conferences, print media,direct mail, telemarketing, the Internet and personal sales calls. We alsoactively advertise in consumer, educator and

 

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tradepublications and provide educational materials, catalogs and productspecifications to students, educators, dealers and distributors.  Our educational director travels extensively,lecturing and motivating students, educators and parents on the value of musicin a child’s development.

 

**Competition**

 

### **Piano Segment**

### ** **

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

 

Because Steinway pianos are built to last forgenerations, used Steinways are the primary competition in our marketsegment.  It is difficult to estimate thesignificance of used piano sales, since most are conducted in the privateaftermarket.  However, we have increased ouremphasis on restoration services and the procurement, refurbishment and sale ofused Steinway pianos to help us mitigate the impact of these aftermarket saleson our piano business.

 

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

 

Piano manufacturing in China has been growing at a rapid pace in recentyears.  While Chinese manufacturers havebegun producing low-priced, smaller grand pianos, a vast majority of theproduction continues to be upright pianos.

 

### **Band Segment**

### ** **

We arethe largest domestic producer of band & orchestral instruments.  We enjoy leading market shares with many ofour professional level instruments. Yamaha, a Japanese corporation, is our largest competitor.  New entrants into the domestic marketgenerally experience difficulty competing due to the need for both brandrecognition and an effective distribution system.

 

Competitionfor sales of student level instruments in the U.S. has intensified in recentyears due to the growth of offshore manufacturers.  These producers enjoy low labor costs, whichmake it possible for them to offer instruments at highly competitiveprices.  It is difficult to quantify theimpact of imported musical instruments since the majority of offshoremanufacturers do not report data through typical industry channels.

 

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**Patentsand Trademarks**

 

Steinway & Sonspioneered the development of the modern piano with over 125 patents grantedsince our founding.  While we haveseveral patents effective and pending in the United States and in severalforeign countries, we do not believe our business is materially dependent uponany single patent.

 

We also have some of themost 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 & orchestral trademarks include *Bach, Selmer, C.G. Conn, Leblanc, King, Armstrong, Ludwig, Musser,Holton, Glaesel, Scherl & Roth, Emerson, William Lewis & Son, Noblet,*and*Artley.*  We considerour trademarks to be important and valuable assets.  It is possible that the termination,expiration or infringement of one or more of our trademarks may have an adverseaffect on our business, depending on the trademark and the jurisdiction.  Accordingly, we maintain trademarkregistrations in appropriate jurisdictions on an ongoing basis and vigorouslypursue any infringement by competitors.

 

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

### ** **

Ourraw materials consist primarily of metals and woods.  A majority of these materials is sourced fromthe Americas, with the balance coming from Europe, Asia and Africa.  We acquired our sole domestic piano platemanufacturer and primary piano key maker to ensure availability of thesecomponent parts.  Component parts forstring and percussion instruments are imported from Europe and Asia.  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 2005 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 delays inavailability of product due to the lead times required by these manufacturers,we do not anticipate any material disruptions to the supply of these products.  Many of the student level band &orchestral instruments included in our “good” and “better” product groupingsare also sourced from single manufacturers. We continually scrutinize these suppliers and the quality of productsthat they manufacture for us and we believe that we have a sufficient number ofqualified suppliers to ensure availability of all offered products in theupcoming year.

 

**Labor**

 

As of December 31,2004, we employed 2,386 people, consisting of 1,795 hourly production workersand 591 salaried employees.  Of the 2,386employees, 1,842 were employed in the United States and the remaining 544 wereemployed primarily in Europe.

 

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Approximately 60% of ourworkforce in the United States is represented by labor unions.  The following table indicates the unionrepresentation and the current status of our collective bargaining agreementsin the U.S.:

 
| **Location**    | ** ** | **Union affiliation**                                                             | ** ** | **Type of  manufacturing** | ** ** | **Number of  employees** | ** ** | **Agreement  expiration** |
|-----------------|------------|-----------------------------------------------------------------------------------|------------|----------------------------|------------|--------------------------|------------|---------------------------|
| Elkhorn, WI     |       | International  Boilermakers, Iron Shipbuilder, Blacksmiths, Forgers & Helpers |       | Band instruments           |       | 71                       |       | July 19,  2005       |
| Elkhart, IN     |       | United Auto  Workers                                                              |       | Band instruments           |       | 246                      |       | April 1,  2006       |
| New York, NY    |       | United Furniture  Workers                                                         |       | Pianos                     |       | 490                      |       | December 31,  2006   |
| Springfield, OH |       | Glass, Molders,  Pottery, Plastics & Allied Workers                           |       | Piano plates               |       | 32                       |       | November 8,  2007    |
| LaGrange, IL    |       | Carpenters                                                                        |       | Percussion  instruments    |       | 38                       |       | November 16,  2007   |
| Eastlake, OH    |       | United Auto  Workers                                                              |       | Band instruments           |       | 215                      |       | February 16,  2008   |

 

In Germany, the worker’scouncil represents all employees other than management.  Nevertheless, most employment contractconditions are settled in collective bargaining agreements made between varioustrade unions and the employer organizations to which we belong. Generally,agreements are negotiated on an annual basis. The Company believes that relations with its employees and these unionsare generally good.

 

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**Item2.  Properties**

 

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

 

Thefollowing table lists our significant owned and leased facilities:

 
| **Location**               | ** ** | **Owned/  Leased** | ** ** | **Approximate  Floor Space  (Square Feet)** | ** ** | **Type of Facility and Activity Performed**                                |
|----------------------------|------------|--------------------|------------|---------------------------------------------|------------|----------------------------------------------------------------------------|
| Long Island  City, NY      |       | Owned              |       | 450,000                                     |       | Piano  manufacturing; restoration center; administrative offices; training |
| New York, NY               |       | Owned              |       | 217,000                                     |       | Piano retail  store/showroom; office rental property                       |
| Westbury, NY               |       | Leased             |       | 15,000                                      |       | Piano retail  store/showroom                                               |
| 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             |       | 6,000                                       |       | Piano retail  store/showroom                                               |
| Munich, Germany            |       | Leased             |       | 15,000                                      |       | Piano retail  store/showroom                                               |
| Berlin, Germany            |       | Leased             |       | 7,000                                       |       | Piano retail  store/showroom/service workshop                              |
| Wuppertal,  Germany        |       | Leased             |       | 27,000                                      |       | Piano key  manufacturing                                                   |
| Wilkow, Poland             |       | Owned              |       | 10,000                                      |       | Piano key  manufacturing                                                   |
| Shanghai, China            |       | Leased             |       | 12,000                                      |       | Piano  warehouse/showroom/workshop                                         |
| London, England            |       | Leased             |       | 10,000                                      |       | Piano showroom                                                             |
|                       |       | Leased             |       | 6,000                                       |       | Piano  workshop/storage                                                    |
| Tokyo, Japan               |       | Leased             |       | 9,000                                       |       | Piano selection  center; warehouse                                         |
|                       |       | Leased             |       | 2,000                                       |       | Administrative  offices                                                    |
| Eastlake, OH               |       | Owned              |       | 160,000                                     |       | Brass instrument  manufacturing                                            |
| Elkhart, IN                |       | Owned              |       | 150,000                                     |       | Brass instrument  manufacturing                                            |
|                       |       | Owned              |       | 88,000                                      |       | Woodwind  manufacturing; warehouse; office                                 |
|                       |       | Owned              |       | 77,000                                      |       | Former band  instrument manufacturing                                      |
|                       |       | Owned              |       | 81,000                                      |       | Warehouse                                                                  |
|                       |       | Owned              |       | 25,000                                      |       | Administrative  offices                                                    |
| Elkhorn, WI                |       | Owned              |       | 58,000                                      |       | Brass instrument  manufacturing                                            |
| Kenosha, WI                |       | Owned              |       | 95,000                                      |       | Woodwind  manufacturing; warehouse                                         |
|                       |       | Owned              |       | 43,000                                      |       | Brass instrument  manufacturing                                            |
| Nogales, AZ                |       | Owned              |       | 22,000                                      |       | Former woodwind  instrument manufacturing, rental property                 |
| LaGrange, IL               |       | Owned              |       | 46,000                                      |       | Percussion  instrument manufacturing                                       |
| Monroe, NC                 |       | Leased             |       | 154,000                                     |       | Drum and case  manufacturing                                               |
| Cleveland, OH              |       | Leased             |       | 62,000                                      |       | String  instrument manufacturing                                           |
| London, England            |       | Leased             |       | 8,000                                       |       | Band instrument  office; warehouse                                         |
| LaCouture  Boussey, France |       | Owned              |       | 32,000                                      |       | Woodwind  manufacturing                                                    |

 

11

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Wespent $5.2 million for capital improvements in 2004, consisting primarily offacility improvement projects related to our facility rationalization project,machinery and equipment purchases, and office equipment upgrades andreplacements.  We expect capital spendingin 2005 to be in the range of $5.0-7.0 million, relating to machinery andequipment purchases, system upgrades, and facility improvements.

 

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

 

**General**

 

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

 

### **Environmental Matters**

### ** **

Weare required to comply with various federal, state, local and foreignenvironmental laws, including those relating to discharges to air, water andland, the handling and disposal of solid and hazardous waste and the cleanup ofproperties affected by hazardous substances. Certain environmental laws, such as the Comprehensive EnvironmentalResponse, Compensation, and Liability Act, as amended, impose strict,retroactive, joint and several liability upon persons responsible for releasesof hazardous substances, which responsibility is broadly construed.

 

Weoperated manufacturing facilities at certain locations where hazardoussubstances (including chlorinated solvents) were used.  We believe that an entity that formerlyoperated one such facility may have released hazardous substances at such location,which we leased through July 2001. We did not contribute to the release. Further, we have a contractual indemnity from certain stockholders ofthis entity.  This facility is not thesubject of a legal proceeding that involves us, nor, to our knowledge, is thefacility subject to investigation. However, no assurance can be given that legal proceedings will not arisein the future and that such indemnitors would make the payments described inthe indemnity.

 

Weoperate other manufacturing facilities that were previously owned by PhilipsElectronics North America Corporation (“Philips”).  Philips agreed to indemnify us for any andall losses, damages, liabilities and claims relating to environmental mattersresulting from certain activities of Philips occurring prior to December 29,1988 (the “Environmental Indemnity Agreement”). Philips has fully performed its obligations under the EnvironmentalIndemnity Agreement, which terminates on 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 actioninvolving a 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 apresent net cost of approximately $14.5 million.  The EPA has named over 40 persons or entitiesas potentially responsible parties at this Elkhart, Indiana site, includingfour Conn-Selmer predecessor entities. For two of these entities, which werepreviously owned by Philips, this matter has been tendered to Philips pursuantto the Environmental Indemnity Agreement.  Our potential liability at any of these sitesis affected by several factors including, but not limited to, the

 

12

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methodof remediation, our portion of the materials in the site relative to the othernamed parties, the number of parties participating, and the financialcapabilities of the other potentially responsible parties once the relativeshare has been determined.  No assurancecan be given, however, that additional environmental issues will not requireother, currently unanticipated investigation, assessment or remediationexpenditures or that Philips will make payments that it is obligated to makeunder the Environmental Indemnity Agreement.

 

We arealso continuing an existing environmental remediation program at a facilityacquired in 2000.  We currently estimatethat this project will take eighteen years to complete, at a total cost ofapproximately $1.0 million.  We haveaccrued approximately $0.8 million for the estimated remaining cost of this remediationprogram, which represents the present value of the total estimated cost using adiscount rate of 4.54%.  A summary ofexpected payments associated with this project is as follows:

 
| ** ** | ** ** | **Environmental  Payments** | ** ** |
|------------|------------|-----------------------------|------------|
| 2005       |       | $                           | 237        |   |
| 2006       |       | 75                          |       |
| 2007       |       | 54                          |       |
| 2008       |       | 47                          |       |
| 2009       |       | $                           | 47         |   |
| Thereafter |       | 514                         |       |
|       |       | $                           | 974        |   |

 

In2004, we acquired manufacturing facilities for which environmental remediationprograms had already been established. Based on our current assessment, we have accrued approximately $0.8million for the cost of these remediation programs.

 

Thematters described above and our other liabilities and compliance costs arisingunder environmental laws are not expected to have a material impact on ourcapital expenditures, earnings, or competitive position.  However, some risk of environmental liabilityis inherent in the nature of our current and former business and we might, inthe future, incur material costs to meet current or more stringent compliance,cleanup, or other obligations pursuant to environmental laws.

 

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

 

No matter was submittedto a vote of our security holders during the fourth quarter of the fiscal yearended December 31, 2004.

 

13

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**PART II**

 

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

### ** **

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

 
| ** **                         | ** ** | **High**   | ** ** | **Low**    | ** ** |
|------------------------------------|------------|------------|------------|------------|------------|
| Year Ended December 31,  2004 | ** ** | ** ** | ** ** | ** ** | ** ** |
| First Quarter                      |       | $          | 33.90      |       | $          | 23.25 |   |
| Second Quarter                     |       | 36.50      |       | 32.10      |       |
| Third Quarter                      |       | 35.41      |       | 25.59      |       |
| Fourth Quarter                     |       | 29.36      |       | 26.76      |       |
|                               |       |       |       |       |       |
| 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 two classes ofcommon stock: Class A and Ordinary.  Withthe exception of disparate voting power, both classes are substantiallyidentical.  Each share of Class A commonstock 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 March 24, 2005, there were 2,925beneficial shareholders of our Ordinary common stock and two holders of recordof the Class A common stock.

 

We are restricted by theterms of our outstanding debt and financing agreements from paying cashdividends on our common stock.

 

Wepresently intend to retain earnings to reduce outstanding indebtedness and tofund the growth of our business.  Thepayment of any future dividends will be determined by the Board of Directors inlight of conditions then existing, including our results of operations,financial condition, cash requirements, restrictions in financing agreements,tax treatment of dividends, business conditions and other factors.

 

14

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### **EquityCompensation Plans**

### ** **

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

 
| **Plan Category**                                       | ** ** | **Number of securities  to be issued upon  exercise of outstanding  options, warrants and  rights** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a))** | ** ** |
|---------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                              | ** ** | **(a)**                                                                                             | ** ** | **(b)**                                                                            | ** ** | **(c)**                                                                                                                                               | ** ** |
|                                                    |       |                                                                                                |       |                                                                               |       |                                                                                                                                                  |       |
| Equity compensation plans approved by security  holders |       | 872,227                                                                                             |       |                                                                               | $19.92     |                                                                                                                                                  | 477,018    |   |
| Total                                                   |       | 872,227                                                                                             |       |                                                                               | $19.92     |                                                                                                                                                  | 477,018    |   |

 

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**Item6.  Selected Consolidated Financial Data**

 

The following table sets forth our selectedconsolidated financial data as of and for each of the five years in the periodended December 31, 2004, derived from our audited financialstatements.  The table should be read inconjunction with our consolidated financial statements, including thefootnotes, and “Management’s Discussion and Analysis of Financial Condition andResults of Operations” included elsewhere in this report.

 

(In thousands exceptshare and per share data)

 
| **Years Ended December 31,**     | ** ** | **2004 (1)** | ** ** | **2003**  | ** ** | **2002**  | ** ** | **2001**  | ** ** | **2000 (2)** | ** ** |
|---------------------------------------|------------|--------------|------------|-----------|------------|-----------|------------|-----------|------------|--------------|------------|
| **Income statement data:**            |       |         |       |      |       |      |       |      |       |         |       |
| Net sales                             |       |         | $375,034   |      |       | $337,220  |       |      | $332,297   |         |       | $352,612 |   |   | $331,698 |   |
| Gross profit                          |       | 109,133      |       | 92,553    |       | 97,151    |       | 103,521   |       | 101,688      |       |
| Income from operations                |       | 34,241       |       | 22,824    |       | 31,399    |       | 34,495    |       | 38,419       |       |
| Net income                            |       | 15,867       |       | 9,698     |       | 14,909    |       | 8,738     |       | 14,887       |       |
| Earnings per share:                   |       |         |       |      |       |      |       |      |       |         |       |
| Basic                                 |       |         | $1.97      |      |       | $1.09     |       |      | $1.68      |         |       | $0.98 |   |   | $1.67 |   |
| Diluted                               |       |         | $1.91      |      |       | $1.09     |       |      | $1.68      |         |       | $0.98 |   |   | $1.67 |   |
|                                  |       |         |       |      |       |      |       |      |       |         |       |
| **Weighted average shares:**          |       |         |       |      |       |      |       |      |       |         |       |
| Basic                                 |       | 8,046,256    |       | 8,924,578 |       | 8,877,256 |       | 8,928,000 |       | 8,921,091    |       |
| Diluted                               |       | 8,304,066    |       | 8,925,672 |       | 8,882,165 |       | 8,928,000 |       | 8,921,108    |       |
|                                  |       |         |       |      |       |      |       |      |       |         |       |
| **Balance sheet data (at year end):** |       |         |       |      |       |      |       |      |       |         |       |
| Cash                                  |       |         | $27,372    |      |       | $42,283   |       |      | $19,099    |         |       | $5,545 |   |   | $4,989 |   |
| Current assets                        |       | 308,761      |       | 288,270   |       | 267,346   |       | 254,474   |       | 263,376      |       |
| Total assets                          |       | 477,545      |       | 445,665   |       | 423,731   |       | 409,537   |       | 419,739      |       |
| Current liabilities                   |       | 72,893       |       | 61,304    |       | 53,302    |       | 49,318    |       | 56,515       |       |
| Total debt                            |       | 221,208      |       | 196,602   |       | 200,636   |       | 211,203   |       | 223,410      |       |
| Stockholders’ equity             |       | 145,553      |       | 152,635   |       | 131,208   |       | 115,773   |       | 111,190      |       |
|                                  |       |         |       |      |       |      |       |      |       |         |       |
| **Other financial data:**             |       |         |       |      |       |      |       |      |       |         |       |
| Capital expenditures                  |       | 5,186        |       | 5,462     |       | 5,604     |       | 7,141     |       | 7,890        |       |
|                                  |       |         |       |      |       |      |       |      |       |         |       |
| **Margins:**                          |       |         |       |      |       |      |       |      |       |         |       |
| Gross profit                          |       | 29.1         | %          | 27.4      | %          | 29.2      | %          | 29.4      | %          | 30.7         | %          |
| Operating                             |       | 9.1          | %          | 6.8       | %          | 9.4       | %          | 9.8       | %          | 11.6         | %          |

 

----

**Notes toSelected Consolidated Financial Data:**

 

(1)          Weacquired Leblanc in August 2004.

(2)          Weacquired UMI in September 2000.

 

16

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**Item7.  Management’s Discussion and Analysisof Financial Condition and Results of Operations (Tabular Amounts in Thousands)**

 

**Introduction**

 

Thefollowing discussion provides an assessment of the results of our operationsand liquidity and capital resources together with a brief description ofcertain accounting policies.  Accordingly, the following discussion shouldbe read in conjunction with our Consolidated Financial Statements and the Notesto Consolidated Financial Statements included within this report.

 

**Overview**

 

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

 

**PianoSegment -**Sales of our pianos are influenced by general economicconditions, demographic trends and general interest in music and the arts.  The operating results of our piano segmentare primarily affected by Steinway & Sons grand piano sales.  Given the total number of these pianos thatwe sell in any year (3,194 sold in 2004), a slight change in units sold canhave a material impact on our business and operating results.  Our results are also influenced by sales ofBoston and Essex pianos, which together represented approximately 55% of totalpiano units sold but less than 20% of total piano revenues in 2004.  Our Boston and Essex piano lines aremanufactured in Asia, each by a single manufacturer.  The ability of these manufacturers to produceand ship products to us could impact our business and operating results.  In 2004, approximately 57% of piano saleswere in the United States, 28% in Europe and the remaining 15% primarily inAsia. For the year ended December 31, 2004, our piano segment sales were$203.7 million, representing 54% of our total revenues.

 

### **Piano Outlook for2005**- We expect another successful year for our piano segment withcontinued growth in revenue.  Grossmargins should remain relatively stable as we expect somewhat higher productionlevels to offset manufacturing cost increases. We expect the higher costs of Boston inventory purchases caused byunfavorable exchange rates to be mitigated by price increases we have alreadyimplemented.  We currently havesufficient, but not excessive, manufacturing capacity to meet anticipated orincreased demand.

### ** **

**BandSegment -**Our student band instrument sales are influenced bytrends in school enrollment, general attitudes toward music and the arts andour ability to provide competitively priced products to our dealernetwork.  Management estimates that 85%of our domestic band sales are generated through educational programs.  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, our sales growth has been adverselyaffected in recent years by the abundance of competitively priced importedstudent instruments available to our dealers and their ability to purchasethese products directly from offshore sources.

 

In order to compete withthese mass-merchandised offshore instruments, we restructured our productofferings to include quality, competitively priced brand-name importedinstruments that are built to our specifications.  We now offer quality-controlled, brand-nameproducts at multiple price points through distribution channels which supportthe music education market.  Our productofferings are tailored to the needs of traditional school music dealers whoprovide full-service rental programs to beginning band

 

17

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students, as well asmusic retailers and e-commerce dealers selling directly to end consumers fromtheir stores or through the Internet.

 

Consistent with pastpatterns, beginner instruments accounted for approximately 70% of band &orchestral unit shipments and approximately 40% of band instrument revenues in2004, with advanced and professional instruments representing the balance. In2004, approximately 81% of band sales were in the United States, 9% in Europeand the remaining 10% primarily in Asia. For the year ended December 31, 2004, our band sales were $171.3million, representing 46% of our total revenues.

 

**BandOutlook for 2005 -**We continue to see shifts in the buyingpatterns of our dealers within and between our various distributionchannels.  Accordingly, pinpointing thedemand for our products at the student, institutional, and professional levels,synchronizing product availability with demand, and filling the needs of ourdistribution channels in both domestic and export markets has become far morechallenging than in the past.  Thisprocess will continue to be a major focus for us going forward.  We expect a demanding first half of the yearas we complete the integration of the Leblanc operations and product offeringsinto our business and strive to improve productivity at locations affected byour facility rationalization activities. The latter half of the year should show improvement over pastperformance, both in net sales and gross margin.  We anticipate a gradual return to moreefficient production levels and a more appropriate balance of manufactured andimported products to meet demand for the back-to-school selling season.

 

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

 

Salesto customers outside the United States represented 32% of consolidated sales in2004.  We record sales in euro, Japaneseyen, British pounds, and Chinese renminbi. In 2004, we generated 73% of ourinternational sales through our piano segment and, solely as a result offoreign exchange rate changes, piano sales increased $6.8 million. Althoughcurrency fluctuation affects international sales, it also affects cost of salesand related operating expenses. Consequently, it generally has not had amaterial impact on operating income.  Weuse financial instruments such as forward exchange contracts and currencyoptions to reduce the impact of exchange rate fluctuations on firm andanticipated cash flow exposures and certain assets and liabilities denominatedin currencies other than the functional currency of the affected division.  We do not purchase currency related financialinstruments for purposes other than exchange rate risk management.

 

**Taxes–**We are subject to U.S. income taxes as well as tax inseveral foreign jurisdictions in which we do business.  Some of these foreign jurisdictions havehigher statutory rates than the U.S.  Inaddition, certain of our operations are subject to both U.S. and foreigntaxes.  However, in such cases we receivea credit against our U.S. taxes for foreign taxes paid equal to the percentagethat such foreign income represents of the total income subject to U.S.tax.  Accordingly, our effective taxrates will vary depending on the relative proportion of foreign to U.S. incomeand the absorption of foreign tax credits in the U.S.  In 2002, we were not able to utilize foreigntax credits carried forward from prior years, but were effective at using manyof the foreign tax credits generated that period.  In 2003, we were able to utilize foreign taxcredits carried forward from prior years due to the higher proportion of ourforeign source income to overall income. In 2004, we were able to use the majority, but not all, of the foreigntax credits generated in the current period. However, because the American Jobs Creation Act of 2004

 

18

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(the “Act”) extended theforeign tax credit carryover period we were able to recognize a partial benefitfor the current year’s excess foreign tax credits.

 

The strengthening of ourdomestic piano and band businesses is expected to result in less effective useof our foreign tax credits and credit carryforwards in the upcoming year.  In addition, the states in which we dobusiness have either repealed or are likely to repeal legislation that had beenbeneficial to tax paying businesses. These events may have an adverse impact on our effective tax rate for2005.  Conversely, we expect to benefitfrom other provisions of the Act, such as the additional tax deduction providedto domestic manufacturers.  To date, wehave not fully assessed the impact of all these tax law changes but currentlyexpect our effective tax rate to increase in 2005 relative to 2004.

 

**Resultsof Operations**

FiscalYear 2004 Compared to Fiscal Year 2003

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

 

19

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

 

Ourpiano business had a very successful year. Domestic wholesale sales remainedstrong, and retail sales were bolstered by the two additional retail storesthat were fully operational for all of 2004. Our European business remained stable, while our Asian businessimproved, primarily due to our Shanghai facility being operational since spring2004.  Although sales and marketingexpenses were higher than expected, these costs were more than offset by marginimprovements due to improved production levels, efficiencies, and product mix.

 

**Net Sales –**Net sales increased $37.8 million.**** This resulted in part from a 9% increase inSteinway grand unit shipments, as well as a $6.8 million benefit attributableto foreign exchange.  The total pianosales increase of $23.9 million also reflects the increase in higher-pricedretail unit sales resulting from our additional domestic storefronts beingoperational for the full year, as well as strong wholesale shipments throughoutthe year.  Band & orchestralinstrument sales increased $13.9 million on an overall unit increase of 17%.  The band sales increase includes $9.6 millionattributable to the Leblanc acquisition, with the remainder resulting from corebusiness growth, especially professional brass and percussion****instruments.

 

**Gross Profit –****Gross profitimproved $16.6 million primarily due to the piano margin improvement from 34.2%to 37.1%.  Higher domestic productionlevels, overseas production and labor efficiencies, and improved retail saleswere the primary drivers of the increase. A shift in our international divisions’ sales mix towards higher margingrands also contributed to the improvement. Although band segment gross profit improved $2.5 million, gross marginsdeclined slightly. Atypical charges affecting margin in 2004 totaled $2.6 million,comprised primarily of severance and higher costs associated with theacquisition write-up of Leblanc inventory to fair value.  In 2003, atypical charges totaled $6.0million, including severance costs, strike costs, and inventory impairmentcharges.  Despite the reduction inatypical charges and improved margins on imported student products, grossmargins decreased slightly from 19.7% to 19.6%. This was primarily due to increased freight expenses, productioninefficiencies for some woodwind products, and reduced production levels ofcertain brass instruments.  Significantincreases in costs of raw materials such as silver and copper also adverselyaffected band gross margins.

 

**Operating Expenses –****Operating expensesincreased $5.2 million despite the $3.3 million decrease in impairment charges comparedto the prior year.  Over $3.1 million ofthis increase resulted from external costs associated with our Sarbanes-Oxleycompliance project. $2.2 million of the increase is attributable to foreignexchange, and we incurred incremental expenses of $1.4 million associated withLeblanc.  The

 

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remainderof the increase resulted primarily from increased advertising and promotionalcosts and increased bonus payments.

 

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

 

***Results of Operations***

FiscalYear 2003 Compared to Fiscal Year 2002

 
| ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Change** | ** ** |
|---------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| **For years ended December 31,** | ** ** | **2003**   | ** ** | ** ** | ** ** | **2002**   | ** ** | ** ** | ** ** | **$**      | ** ** | **%** | ** ** |
|                                  |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Net sales                             |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Band                                  |       | $          | 157,460    |       |       |       | $          | 167,708    |       |       |       | (10,248 | ) | (6.1 | ) |
| Piano                                 |       | 179,760    |       |       |       | 164,589    |       |       |       | 15,171     |       | 9.2 |   |
| Total sales                           |       | 337,220    |       |       |       | 332,297    |       |       |       | 4,923      |       | 1.5 |   |
|                                  |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Cost of sales                         |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Band                                  |       | 126,369    |       |       |       | 127,849    |       |       |       | (1,480     | )          | (1.2 | ) |
| Piano                                 |       | 118,298    |       |       |       | 107,297    |       |       |       | 11,001     |       | 10.3 |   |
| Total cost of sales                   |       | 244,667    |       |       |       | 235,146    |       |       |       | 9,521      |       | 4.0 |   |
|                                  |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Gross profit                          |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Band                                  |       | 31,091     |       | 19.7       | %          | 39,859     |       | 23.8       | %          | (8,768     | )          | (22.0 | ) |
| Piano                                 |       | 61,462     |       | 34.2       | %          | 57,292     |       | 34.8       | %          | 4,170      |       | 7.3 |   |
| Total gross profit                    |       | 92,553     |       |       |       | 97,151     |       |       |       | (4,598     | )          | (4.7 | ) |
|                                  |       | 27.4%      |       |       |       | 29.2%      |       |       |       |       |       |   |   |
|                                  |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Operating expenses                    |       | 66,771     |       |       |       | 65,752     |       |       |       | 1,019      |       | 1.5 |   |
| Facility rationalization              |       | 2,958      |       |       |       | —     |       |       |       | 2,958      |       |   |   |
| Total operating expenses              |       | 69,729     |       |       |       | 65,752     |       |       |       | 3,977      |       | 6.0 |   |
|                                  |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Income from operations                |       | 22,824     |       |       |       | 31,399     |       |       |       | (8,575     | )          | (27.3 | ) |
|                                  |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Other income, net                     |       | (3,517     | )          |       |       | (3,939     | )          |       |       | 422        |       | (10.7 | ) |
| Net interest expense                  |       | 11,945     |       |       |       | 13,279     |       |       |       | (1,334     | )          | (10.0 | ) |
|                                  |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Income before income taxes            |       | 14,396     |       |       |       | 22,059     |       |       |       | (7,663     | )          | (34.7 | ) |
|                                  |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Income tax provision                  |       | 4,698      |       | 32.6       | %          | 7,150      |       | 32.4       | %          | (2,452     | )          | (34.3 | ) |
|                                  |       |       |       |       |       |       |       |       |       |       |       |   |   |
| Net income                            |       | $          | 9,698      |       |       |       | $          | 14,909     |       |       |       | (5,211 | ) | (35.0 | ) |

 

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**Overview –****2003 was a year of transition in our bandbusiness. Our results were negatively impacted early on by strikes at two ofour plants.  We began a facilityrationalization project to reduce manufacturing space by 20% and position thebusiness to improve future margins on manufactured products.  We reduced production in order to bring downexcess manufactured inventory levels. Lastly, in October, we expanded our product line and introduced manynew, quality-controlled sourced products that have been made to ourspecifications.  We also revamped ourdistribution policy to include channels not previously utilized and now offerstep-up and professional instruments through catalogs and via the Internet.  Additionally, we now offer school musicdealers a full line of instruments, including lower-priced, brand-nameinstruments which are a favorable alternative to mass-produced, offshoreproducts.

 

Ourpiano business started out slow but recovered in the last two quarters of 2003.While Steinway & Sons’ 150th anniversary celebration causedsales and marketing expenses to increase, we believe that the additionalpublicity generated by this milestone event helped generate sales interest inthe second half of the year.  However,due to the long production cycles for Steinway pianos and the lead-timerequired for ordering sourced pianos, we were unable to match the increase indemand by year-end.

 

**Net Sales –** The increase in netsales of $4.9 million resulted from a $15.2 million improvement in piano sales,which occurred despite relatively flat Steinway grand units shipments.  The piano sales increase reflects $10.2million in benefit attributable to foreign exchange, as well as annual priceincreases and a shift in mix towards higher-priced retail units.  Band & orchestral instrument salesdecreased $10.2 million on an overall unit decrease of 12%, reflecting thedecreased 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 thesales shortfall.  These factors weremitigated in part by a shift in sales mix towards higher-priced step-up andprofessional instruments and an 11% increase in percussion unit shipments.

 

**Gross Profit –****Gross profitdecreased $4.6 million in 2003 as both the piano and band segments experienceddeteriorating gross margins.  Pianomargins decreased slightly to 34.2% despite the shift towards retail units,primarily due to the $1.4 million resulting from unfavorable foreign exchangerates on Boston inventory purchases. Gross margins for the band & orchestral segment declined to 19.7%,corresponding to a gross profit decrease of $8.8 million.  This decrease includes $1.9 million paid toemployees in accordance with the terms of expired labor contracts, and $1.3million in underabsorbed overhead and lost profit resulting from the workstoppages at two of our plants.  Inaddition, we incurred $1.2 million in inventory impairment charges and $1.7million in severance costs associated with the closure of our Nogales, Arizonawoodwind manufacturing facility and the imminent (April 2004) closure ofone of our Elkhart, Indiana woodwind manufacturing facilities.  Production levels, which were reduced at oneof our brass instrument plants in order to manage excess inventory levels, andincreased pension expenses of $1.1 million, also adversely impacted bandsegment margins in 2003.

 

**Operating Expenses –****Operating expensesincreased $4.0 million, primarily as a result of the $3.0 million of impairmentcharges taken on land, building, and equipment relating to our Nogales, Arizonaand Elkhart, Indiana woodwind manufacturing facilities.  Foreign currency translation negativelyimpacted operating expenses by $2.1 million and additional sales and marketingexpenses of over $1.0 million incurred in conjunction with Steinway & Sons’150th anniversary celebration were also a factor.  Offsetting these costs was $2.6 million insavings realized by the band segment through administrative staff reductionsand lower sales and marketing expenses.

 

***Non-operating Expenses –***Non-operatingexpenses decreased $0.9 million to $8.4 million in 2003 primarily due to lowernet interest resulting from the use of cash from operations, as opposed to lineof

 

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*credit borrowings, in the current period.  In addition, our debt buyback of $4.7 millionin December 2002 lowered interest expense by $0.4 million*.

* *

***Liquidity and Capital Resources***

* *

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

 

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

 
| **For the years ended December 31,**                                    | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income:                                                                  |       | $        | 15,867     |     | $          | 9,698    |       | $ | 14,909 |   |
| Changes in operating assets and liabilities                                  |       | (1,305   | )          | 8,350    |       | 3,813    |       |
| Other adjustments to reconcile net income to cash  from operating activities |       | 9,311    |       | 12,845   |       | 10,177   |       |
| Cash flows from operating activities                                         |       | 23,873   |       | 30,893   |       | 28,899   |       |
|                                                                         |       |     |       |     |       |     |       |
| Cash flows from investing activities                                         |       | (40,720  | )          | (5,452   | )          | (5,600   | )          |
|                                                                         |       |     |       |     |       |     |       |
| Cash flows from financing activities                                         |       | 1,019    |       | (2,767   | )          | (9,718   | )          |
|                                                                              |            |          |            |          |            |          |            |  |  |  |

 

In 2004, cash flows fromoperating activities decreased $7.0 million. This increased use of cash was caused primarily by a) a $5.4 millionrise in piano inventory levels to support our expansion in Asia; b) $3.1million in higher receivables primarily associated with band sales increases,and c) $3.4 million transferred to workers compensation and environmentaldepositary trust funds which replaced more expensive letters of creditpreviously used.  In 2003, cash flowsfrom operating activities increased $2.0 million despite the $5.2 milliondecrease in net income primarily as a result of our control over inventory,reduced manufacturing levels, and management of our accounts receivable andpayable.  In 2002, inventory and accountsreceivable management contributed $8.0 million to cash flows from operations.

 

Cash used for investingactivities of $40.7 million is primarily due to our acquisition of certainassets of G. Leblanc Corporation for $36.8 million in August 2004.  The final purchase price for the businessacquisition is subject to adjustment and has not been finalized.  Accordingly, additional cash expenditures maybe necessary.  Year over year, capitalexpenditures were relatively comparable at $5.2 million in 2004, $5.5 millionin 2003 and $5.6 million in 2002 (See Capital Expenditures discussion below.)

 

In 2004, cash provided byfinancing activities of $1.0 million resulted from stock option exercises andstock purchase plan activities totaling $5.7 million, which more than offsetthe $4.6 million in net borrowings and scheduled debt amortization on our linesof credit.  In 2003, financing activitiesconsisted primarily of scheduled debt amortization of $6.5 million, counterbalancedin part by net borrowings of $2.3 million on our foreign lines of credit.  These borrowings were made primarily tosupport an increase in working capital. In 2002, cash used for financing activities resulted from the scheduledamortization of our term loans of $6.4 million, as well as the repurchase of$4.7 million of our Senior Notes.  (SeeBorrowing Activities and Availability discussion below.)

 

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**CapitalExpenditures -**Our capital expenditures consist primarily ofmachinery and equipment purchases, system upgrades, and facilityimprovements.  In 2005, we expect ourcapital spending to be in the range of $5.0 - $7.0 million relating to factoryimprovements, equipment, process, and tooling upgrades, and machinery andequipment purchases.

 

**Seasonality-**Consistent with industry practice, we sell band instrumentsalmost entirely on credit utilizing the two financing programs describedbelow.  Due to these programs, we havelarge working capital requirements during certain times of the year when bandinstrument receivable balances reach highs of approximately $90-95 million in August andSeptember, and lesser requirements when they are at lows of approximately$70-75 million in January and February. The financing options, intended to assist dealers with the seasonalityinherent in the industry and facilitate the rent-to-own programs offered tostudents by many retailers, also allow us to match our production and deliveryschedules.  The following forms offinancing are offered to qualified band instrument dealers:

 

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

 

b)             **Note receivable financing***:* Qualified dealers may convert open accounts to a notepayable to us.  The note program isoffered in January and October and coincides with the receivabledating program.  In most instances, thenote receivable is secured by dealer inventories and receivables.

 

**OffBalance Sheet Arrangements –**In 2002**,**ourcustomers financed notes receivable with a third party, to which we had arecourse obligation under the financing agreement.  We received proceeds of$2.6 million from the financing of such notes.  In 2003, no customer receivables were subjectto such financing or recourse obligations. In 2004, certain customers of ourLeblanc subsidiary financed notes receivable with a third party, to which wehave a recourse obligation.  We receivedproceeds of $1.4 million from the customer financing of such notes.  As of December 31, 2004, the outstandingbalance on these customer notes was $3.0 million.  We have included a corresponding recourseobligation of $1.2 million in other current liabilities as of December 31,2004.  We expect the duration of ourrecourse obligation not to exceed one year. Our total maximum recourse obligation under this arrangement includesthe outstanding balance on the notes, as well as any interest or late fees thatmay be incurred by our customers.  Wereceived an indemnification from G. Leblanc Corporation in connection withour acquisition of certain of its assets and assumption of certainliabilities.  (See Note 3.)  As of December 31, 2004, we haverecognized a receivable of $0.6 million associated with thisindemnification.

 

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

 

**RetailFinancing Obligations** – Certain of our foreign retail sales were financed by our customersthrough a local bank under an arrangement that included an obligation on ourpart to repurchase pianos seized by the bank upon default of the customer. Thebuy back price is established as a percentage of the original sales price,starting at 80% in the first year and declining to 30% in the fifth year of theloan.

 

This programceased in the first quarter of 2003. Nevertheless, because our obligationcontinues until the bank is paid in full by the customer, our commitment canremain outstanding for up to 8 years – the maximum term of the consumer loan.

 

Our maximumobligation under this arrangement is estimated to be approximately €1.4 million($1.8 million at the December 31, 2004 exchange rate). To date, we have notbeen required to repurchase any pianos under this program and we believe thelikelihood of such repurchases in the future is remote. Accordingly, we havenot recognized a liability for this obligation in our financial statements.Further, in the unlikely event of a repurchase, we believe the proceedsreceived upon our resale of the piano would exceed the amount payable to thebank.

 

**Pensions and Other PostretirementBenefits -** Whendetermining the amounts to be recognized in the consolidated financialstatements related to our domestic pension and other postretirement benefits,we used a long-term rate of return on plan assets of 9%, which was developedwith input from our actuaries and our investment committee, and is consistentwith prior years.  We believe that 9% isconsistent with the historical long-term return trends on our domestic pensionassets and our expectations for future returns. The discount rate utilized for determining future pension obligationsfor our domestic plans is based on long-term bonds receiving an AA- or betterrating by a recognized rating agency. The resulting discount rate decreased from 6.50% at December 31,2003 to 6.0% at December 31, 2004.

 

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Thediscount rates and rates of returns on plan assets for our foreign pension andother postretirement benefit plans were similarly developed utilizing long-termrates of return and discount rates reasonably expected to occur in theapplicable jurisdiction.

 

**Borrowing Activities and Availability-**Our real estateterm loan, acquisition term loan, and domestic, seasonal borrowing requirementsare accommodated through a committed credit facility with a syndicate ofdomestic lenders (the “Credit Facility”). The Credit Facility provides us with a potential borrowing capacity of$85.0 million in revolving credit loans, and expires on September 14,2008. Borrowings are collateralized by our domestic accounts receivable,inventory, and fixed assets.  As of December 31,2004, there were no revolving credit loans outstanding and availability basedon eligible accounts receivable and inventory balances was approximately $82.6million, net of letters of credit. The real estate term loan is payable inmonthly installments of $0.2 million and includes interest at average 30-dayLIBOR (2.40% at December 31, 2004) plus 1.5%.  This term loan is secured by all of ourinterests in the Steinway Hall property. The acquisition term loan is repayable in monthly installments of $0.4million through August 2005 and monthly installments of $0.6 million from September 2005through September 2008.  Theacquisition term loan and revolving credit loans bear interest at average30-day LIBOR plus 1.75%.  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 alsoprovide for borrowings of up to €17.0 million ($23.1 million at December 31,2004) by Steinway’s foreign subsidiaries.

 

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

 

At December 31,2004, our total outstanding indebtedness amounted to $221.2 million, consistingof $174.3 million of 8.75% Senior Notes, $16.7 million on the real estate termloan, $22.9 million on the acquisition term loan, and $7.2 million of notespayable to foreign banks.  Cash interestpaid was $17.5 million in 2004, $14.6 million in 2003, and $15.3 million in2002. All of our debt agreements contain covenants that place certainrestrictions on us, including our ability to incur additional indebtedness, tomake investments in other entities and to pay cash dividends. We were incompliance with all such covenants as of December 31, 2004 and do notanticipate any compliance issues in 2005.

 

Ourbond indenture contains limitations, based on net income (among other things),on the amount of discretionary repurchases we may make of our Ordinary commonstock.  Our intent and ability torepurchase additional Ordinary common stock either directly from shareholdersor on the open market is directly affected by this limitation.

 

On August 12,2004 we purchased substantially all of the net assets of G. Leblanc Corporation,a manufacturer of high-quality band instruments, for $36.8 million.  The purchase price is subject to finalpurchase price adjustments.  We fundedthis acquisition with approximately $22.0 million

 

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incash, supplemented by borrowings on our credit facility, which were paid off byDecember 31, 2004.

 

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

 

We experience long production and inventory turnovercycles, which we constantly monitor since fluctuations in demand can have asignificant impact on these cycles.  Withthe exception of the Leblanc acquisition, our Credit Facility went virtuallyunused throughout the year.  Despite ourfacility rationalization project and additional interest obligations, we wereable to effectively utilize cash flow from operations to fund our debt andcapital requirements in 2004.  Lookingforward to 2005, we anticipate that both the piano and band divisions willperform consistently in the first half of the year, and band results areexpected to improve once we have sold through the higher-cost inventoryresulting from the Leblanc acquisition. Our intention is to keep our balance sheet strong by managing accountsreceivable, maintaining sufficient, but not excessive, inventory levels, andrepaying debt.  We do not have anycurrent plans or intentions that will have a material impact on our liquidityin 2005, although we may consider acquisitions that may require funding fromoperations or from our credit facilities.

 

Other than those described, we are not aware of anytrends, demands, commitments, or costs of resources that are expected tomaterially impact our liquidity or capital resources.  Accordingly, we believe that cash on hand, togetherwith cash flows anticipated from operations and available borrowings under theCredit Facility, will be adequate to meet our debt service requirements, fundcontinuing capital requirements and satisfy our working capital and generalcorporate needs through 2005.

 

**Contractual Obligations -**The following table provides a summary ofour contractual obligations at December 31, 2004.

 
| ** **                      | ** ** | **Payments due by period** | ** **    |
|---------------------------------|------------|----------------------------|---------------|
| **Contractual Obligations**     | ** ** | **Total**                  | ** **    | **Less than  1 year** | ** ** | **1 - 3 years** | ** ** | **3 - 5 years** | ** ** | **More than  5 years** | ** ** |
|                            |       |                       |          |   |   |   |   |   |   |   |   |
| Long-term debt (1)              |       | $                          |  321,057 |   | $ |  29,875 |   | $ |  47,660 |   | $ |  47,641 |   | $ |  195,881 |   |
| Operating leases (2)            |       | 273,276                    |          | 5,085 |   | 8,319 |   | 7,509 |   | 252,363 |   |
| Purchase obligations (3)        |       | 10,504                     |          | 9,951 |   | 553 |   | — |   | — |   |
| Other long-term liabilities (4) |       | 25,647                     |          | 3,469 |   | 4,479 |   | 3,217 |   | 14,482 |   |
| Total                           |       | $                          | 630,484       |   | $ | 48,380 |   | $ | 61,011 |   | $ | 58,367 |   | $ | 462,726 |   |

 

----

**Notes to Contractual Obligations:**

 

(1) Long-term debtrepresents long-term debt obligations and the fixed interest on our Notes.  The nature of our long-term debt obligationsis described more fully in the “Borrowing Availability and Activities” section of“Liquidity and Capital Resources.”

(2) Approximately$257.5 million of our operating lease obligations are attributable to theninety-nine year land lease associated with the purchase of Steinway Hall,which is described in Note 14 in the Notes to Consolidated Financial Statementsincluded within this filing; the remainder is attributable to the leasing ofother facilities and equipment.

(3) Purchaseobligations consist of firm purchase commitments for raw materials andequipment.

(4) Our otherlong-term liabilities consist primarily of the long-term portion of our pensionobligations, which are described in Note 15 in the Notes to ConsolidatedFinancial Statements included within this filing, and obligations underemployee and consultant agreements, which are described in Note 14 in the Notesto the Consolidated Financial Statements included within this filing.

 

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**Critical Accounting Estimates**

 

Theapplication of many accounting policies involves estimates and assumptions thathave a material impact on our reported results. We establish reserves for inventory, workers compensation, warrantyclaims, accounts receivable, notes receivable, (including recourse reserveswhen our customers have financed notes receivable with a third party), all ofwhich are developed using certain estimates. We have significant experience and data on which to base theseestimates.  Historical information isadjusted for specific uncertainties, such as new product introductions, andcontemporaneous information, such as price fluctuations.  We regularly perform assessments of theunderlying assumptions we use. The impairment (if any) and recoverability of long-livedassets, the selection of assumptions used to determine pension expense orincome, the allocation of purchase price for businesses acquired, and certaincomponents of our tax provision calculation, such as valuation allowances ondeferred tax assets, the ability to utilize foreign tax credits, and income taxcontingencies are based on estimates that require a greater degree ofmanagement judgment. We believe the assumptions made by management provide areasonable basis for the estimates reflected in our financial statements.

 

**RecentAccounting Pronouncements**

 

In December 2004,the Financial Accounting Standards Board (“FASB”) revised Statement ofFinancial Accounting Standards (“SFAS”) No. 123, “Share-Based Payments” (SFASNo. 123R). This accounting standard, which is effective for interim and annualperiods beginning after June 15, 2005, requires the recognition ofcompensation expense related to stock options using the fair-value method.  We plan to adopt SFAS No. 123R in the thirdquarter of 2005 using the Statement’s modified prospectiveapplication method. Based on current outstanding awards, expected participationin the Employee Stock Purchase Plan consistent with past patterns, and nosignificant changes in the number of shares of outstanding stock, we anticipate an impact on earnings ofapproximately $.06 per share in 2005.

 

In November 2004, the FASB issued SFAS No. 151,“Inventory Costs, an amendment of ARB No. 43, Chapter 4” (SFAS No. 151). Thisaccounting standard, which is effective for annual periods beginning after June 15,2005, requires that abnormal amounts of idle facility expense, freight,handling costs, and wasted materials (spoilage) should be recognized ascurrent-period charges. The adoption of SFAS No. 151 is not expected to have amaterial effect on our financial position or results or operations.

 

In December 2003, the FASB issued FASBInterpretation (“FIN”) 46R “Consolidation of Variable Interest Entities – aninterpretation of ARB No. 51” (“FIN 46R”). This interpretation, which is effective for public entities by the endof the first reporting period ending after December 15, 2003, addressesconsolidation by business enterprises of variable interest entities that havecertain characteristics.  The adoption ofFIN 46R had no impact on our financial statements.

 

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**Item7A.  Quantitative and QualitativeDisclosures About Market Risk**

 

**ForeignCurrency Risk**

 

We aresubject to market risk associated with changes in foreign currency exchangerates and interest rates.  We mitigateour cash flow exposure to foreign currency fluctuations by holding forwardforeign currency contracts.  They are notdesigned as hedges for accounting purposes.  These contracts relate primarily to intercompanytransactions and are not used for trading or speculative purposes.  The fair value of the forward foreigncurrency exchange contracts is sensitive to changes in foreign currencyexchange rates.  As of December 31,2004, a 10% negative change in foreign currency exchange rates from marketrates would decrease the fair value of the contracts by approximately $0.4million.  Gains and losses on the foreigncurrency exchange contracts are defined as the difference between the contractrate at its inception date and the current forward rate.  However, we would offset any such gains andlosses by corresponding losses and gains, respectively, on the related asset orliability.

 

**Interest Risk**

 

Ourinterest rate exposure is limited primarily to interest rate changes on ourvariable rate debt.  The Credit Facilityand term loans bear interest at rates that fluctuate with changes inLIBOR.  For the year ended December 31,2004, a hypothetical 10% increase in interest rates would have increased ourinterest expense by approximately $0.2 million. We use interest rate caps to manage a portion of our interest rate riskon foreign debt.  We have not designatedthese instruments as hedges for accounting purposes.  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.

 

Ourlong-term debt includes $174.3 million of Senior Notes with a fixed interestrate.  Accordingly, there would be noimmediate impact on our interest expense associated with these Notes due tofluctuations in market interest rates. However, based on a hypothetical 10% immediate decrease in marketinterest rates, the fair value of our Senior Notes, which would be sensitive tosuch interest rate changes, would be increased by approximately $0.7 million asof December 31, 2004.  Such fairvalue changes may affect our determination whether to retain, replace or retirethese Notes.

 

**Item8.  Financial Statements AndSupplementary Data**

 
| REPORT  OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM                                                          |   |
|-------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                              |   |
| CONSOLIDATED  FINANCIAL STATEMENTS:                                                                               |   |
| Consolidated  Statements of Income for the Years Ended December 31, 2004, 2003, and  2002                    |   |
| Consolidated Balance  Sheets as of December 31, 2004 and 2003                                                |   |
| Consolidated  Statements of Cash Flows for the Years Ended December 31, 2004, 2003,  and 2002                |   |
| Consolidated  Statements of Stockholders’ Equity for the Years Ended December 31,  2004, 2003, and 2002 |   |
| Notes to  Consolidated Financial Statements                                                                       |   |
| Schedule II  - Valuation and Qualifying Accounts                                                             |   |

 

28

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**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

To the Board of Directorsand Stockholders ofSteinway Musical Instruments, Inc.Waltham, Massachusetts

 

We have audited theaccompanying consolidated balance sheets of Steinway Musical Instruments, Inc.and subsidiaries as of December 31, 2004 and 2003, and the relatedconsolidated statements of income, stockholders’ equity, and cash flows foreach of the three years in the period ended December 31, 2004.  Our audits also included the financialstatement schedule listed in the Index at Item 15(a)(2).  These financial statements and financialstatement schedule are the responsibility of the Company’smanagement.  Our responsibility is toexpress an opinion on the financial statements and financial statement schedule basedon our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States).  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a test basis,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 our auditsprovide a reasonable basis for our opinion.

 

Inour opinion, such consolidated financial statements present fairly, in allmaterial respects, the financial position of Steinway Musical Instruments, Inc.and subsidiaries as of December 31, 2004 and 2003, and the results oftheir operations and their cash flows for each of the three years in the periodended December 31, 2004 in conformity with accounting principles generallyaccepted in the United States of America. Also, in our opinion, such financial statement schedule, when consideredin relation to the basic consolidated financial statements taken as a whole,presents fairly, in all material respects, the information set forth therein.

 

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of the Company’sinternal control over financial reporting as of December 31, 2004, basedon the criteria established in Internal Control—Integrated Framework issued bythe Committee of Sponsoring Organizations of the Treadway Commission and ourreport dated March 30, 2005 expressed an unqualified opinion on management’sassessment of the effectiveness of the Company’s internal control overfinancial reporting and an unqualified opinion on the effectiveness of theCompany’s internal control over financial reporting.

 

 
| /s/ DELOITTE & TOUCHE LLP |   |
|-------------------------------|--------|
|                          |   |
| Boston, Massachusetts         |   |
| March 30, 2005           |   |

 

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SteinwayMusical Instruments, Inc. and Subsidiaries

**CONSOLIDATED STATEMENTS OF INCOME**(In ThousandsExcept Share and Per Share Data)

 
| **For the years ended December 31,** | ** ** | **2004**  | ** ** | **2003**  | ** ** | **2002**  | ** ** |
|-------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
|                                      |       |      |       |      |       |      |       |
| Net sales                                 |       | $         | 375,034    |      | $          | 337,220   |       | $ | 332,297 |   |
| Cost of sales                             |       | 265,901   |       | 244,667   |       | 235,146   |       |
|                                      |       |      |       |      |       |      |       |
| Gross profit                              |       | 109,133   |       | 92,553    |       | 97,151    |       |
|                                      |       |      |       |      |       |      |       |
| Operating expenses:                       |       |      |       |      |       |      |       |
| Sales and marketing                       |       | 44,332    |       | 41,719    |       | 41,129    |       |
| General and administrative                |       | 29,263    |       | 23,134    |       | 22,517    |       |
| Amortization                              |       | 1,094     |       | 1,154     |       | 1,154     |       |
| Other operating expenses                  |       | 566       |       | 764       |       | 952       |       |
| Facility rationalization                  |       | (363      | )          | 2,958     |       | —    |       |
| Total operating expenses                  |       | 74,892    |       | 69,729    |       | 65,752    |       |
|                                      |       |      |       |      |       |      |       |
| Income from operations                    |       | 34,241    |       | 22,824    |       | 31,399    |       |
|                                      |       |      |       |      |       |      |       |
| Other income, net                         |       | (3,163    | )          | (3,517    | )          | (3,939    | )          |
| Interest income                           |       | (2,829    | )          | (2,175    | )          | (1,892    | )          |
| Interest expense                          |       | 16,266    |       | 14,120    |       | 15,171    |       |
|                                      |       |      |       |      |       |      |       |
| Income before income taxes                |       | 23,967    |       | 14,396    |       | 22,059    |       |
|                                      |       |      |       |      |       |      |       |
| Income tax provision                      |       | 8,100     |       | 4,698     |       | 7,150     |       |
|                                      |       |      |       |      |       |      |       |
| Net income                                |       | $         | 15,867     |      | $          | 9,698     |       | $ | 14,909 |   |
|                                      |       |      |       |      |       |      |       |
| Earnings per share - basic                |       | $         | 1.97       |      | $          | 1.09      |       | $ | 1.68 |   |
|                                      |       |      |       |      |       |      |       |
| Earnings per share - diluted              |       | $         | 1.91       |      | $          | 1.09      |       | $ | 1.68 |   |
|                                      |       |      |       |      |       |      |       |
| Weighted average shares:                  |       |      |       |      |       |      |       |
| Basic                                     |       | 8,046,256 |       | 8,924,578 |       | 8,877,256 |       |
| Diluted                                   |       | 8,304,066 |       | 8,925,672 |       | 8,882,165 |       |

 

See notes to consolidatedfinancial statements.

 

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SteinwayMusical Instruments, Inc. and Subsidiaries

**CONSOLIDATED BALANCE SHEETS**(In Thousands Except Share and Per ShareData)

 
| **December 31,**                                                                                                                             | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Assets                                                                                                                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current assets:                                                                                                                                   |       |       |       |       |       |
| Cash                                                                                                                                              |       | $          | 27,372     |       | $          | 42,283 |   |
| Accounts, notes and other receivables, net                                                                                                        |       | 88,059     |       | 76,403     |       |
| Inventories                                                                                                                                       |       | 172,346    |       | 152,029    |       |
| Prepaid expenses and other current assets                                                                                                         |       | 5,937      |       | 4,533      |       |
| Deferred tax assets                                                                                                                               |       | 15,047     |       | 13,022     |       |
| Total current assets                                                                                                                              |       | 308,761    |       | 288,270    |       |
|                                                                                                                                              |       |       |       |       |       |
| Property, plant and equipment, net                                                                                                                |       | 102,944    |       | 98,937     |       |
| Trademarks                                                                                                                                        |       | 12,325     |       | 10,319     |       |
| Goodwill                                                                                                                                          |       | 31,854     |       | 31,665     |       |
| Other intangibles, net                                                                                                                            |       | 5,290      |       | 5,782      |       |
| Other assets                                                                                                                                      |       | 16,371     |       | 10,692     |       |
|                                                                                                                                              |       |       |       |       |       |
| Total assets                                                                                                                                      |       | $          | 477,545    |       | $          | 445,665 |   |
|                                                                                                                                              |       |       |       |       |       |
| Liabilities and stockholders’ equity                                                                                                         |       |       |       |       |       |
| Current liabilities:                                                                                                                              |       |       |       |       |       |
| Current portion of long-term debt                                                                                                                 |       | $          | 14,212     |       | $          | 10,638 |   |
| Accounts payable                                                                                                                                  |       | 14,789     |       | 11,554     |       |
| Other current liabilities                                                                                                                         |       | 43,892     |       | 39,112     |       |
| Total current liabilities                                                                                                                         |       | 72,893     |       | 61,304     |       |
|                                                                                                                                              |       |       |       |       |       |
| Long-term debt                                                                                                                                    |       | 208,580    |       | 185,964    |       |
| Deferred tax liabilities                                                                                                                          |       | 26,240     |       | 25,565     |       |
| Other non-current liabilities                                                                                                                     |       | 24,279     |       | 20,197     |       |
| Total liabilities                                                                                                                                 |       | 331,992    |       | 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, 7,550,295 and 8,521,392 shares outstanding in 2004 and  2003, respectively |       | 10         |       | 10         |       |
| Additional paid-in capital                                                                                                                        |       | 81,129     |       | 74,626     |       |
| Retained earnings                                                                                                                                 |       | 112,587    |       | 96,720     |       |
| Accumulated other comprehensive loss                                                                                                              |       | (737       | )          | (2,868     | )          |
| Treasury stock, at cost (2,045,450 and 774,000  shares of Ordinary common stock in 2004 and 2003, respectively)                                   |       | (47,436    | )          | (15,853    | )          |
| Total stockholders’ equity                                                                                                                   |       | 145,553    |       | 152,635    |       |
|                                                                                                                                              |       |       |       |       |       |
| Total liabilities and stockholders’ equity                                                                                                   |       | $          | 477,545    |       | $          | 445,665 |   |

 

See notes to consolidatedfinancial statements.

 

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SteinwayMusical Instruments, Inc. and Subsidiaries

**CONSOLIDATED STATEMENTS OF CASHFLOWS******(In Thousands)

 
| **For the years ended December 31,**                                     | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Cash flows from operating activities:                                         |       |     |       |     |       |     |       |
| Net income                                                                    |       | $        | 15,867     |     | $          | 9,698    |       | $ | 14,909 |   |
| Adjustments to reconcile net income to cash flows  from operating activities: |       |     |       |     |       |     |       |
| Depreciation and amortization                                                 |       | 11,183   |       | 10,959   |       | 11,037   |       |
| Amortization of bond premium                                                  |       | (230     | )          | —   |       | —   |       |
| Facility rationalization                                                      |       | (363     | )          | 4,158    |       | —   |       |
| Deferred tax benefit                                                          |       | (2,497   | )          | (2,601   | )          | (1,194   | )          |
| Tax benefit associated with stock option exercises                            |       | 759      |       | —   |       | —   |       |
| Other                                                                         |       | 459      |       | 329      |       | 334      |       |
| Changes in operating assets and liabilities:                                  |       |     |       |     |       |     |       |
| Accounts, notes and leases receivable                                         |       | (293     | )          | 2,783    |       | 6,090    |       |
| Inventories                                                                   |       | 2,003    |       | 7,373    |       | 1,877    |       |
| Prepaid expenses and other assets                                             |       | (5,488   | )          | (857     | )          | (2,904   | )          |
| Accounts payable                                                              |       | 1,419    |       | 1,086    |       | 1,845    |       |
| Other liabilities                                                             |       | 1,054    |       | (2,035   | )          | (3,095   | )          |
| Cash flows from operating activities                                          |       | 23,873   |       | 30,893   |       | 28,899   |       |
|                                                                          |       |     |       |     |       |     |       |
| Cash flows from investing activities:                                         |       |     |       |     |       |     |       |
| Capital expenditures                                                          |       | (5,186   | )          | (5,462   | )          | (5,604   | )          |
| Proceeds from sales of fixed assets                                           |       | 1,233    |       | 10       |       | 4        |       |
| Acquisition of business, net of cash acquired                                 |       | (36,767  | )          | —   |       | —   |       |
| Cash flows from investing activities                                          |       | (40,720  | )          | (5,452   | )          | (5,600   | )          |
|                                                                          |       |     |       |     |       |     |       |
| Cash flows from financing activities:                                         |       |     |       |     |       |     |       |
| Borrowings under lines of credit                                              |       | 159,787  |       | 10,606   |       | 127,604  |       |
| Repayments under lines of credit                                              |       | (156,852 | )          | (8,316   | )          | (127,309 | )          |
| Debt issuance costs                                                           |       | (105     | )          | —   |       | —   |       |
| Repayments of long-term debt                                                  |       | (7,555   | )          | (6,512   | )          | (6,352   | )          |
| Repurchase of long-term debt                                                  |       | —   |       | —   |       | (4,655   | )          |
| Proceeds from issuance of stock                                               |       | 5,744    |       | 1,455    |       | 994      |       |
| Cash flows from financing activities                                          |       | 1,019    |       | (2,767   | )          | (9,718   | )          |
|                                                                          |       |     |       |     |       |     |       |
| Effects of foreign exchange rate changes on cash                              |       | 917      |       | 510      |       | (27      | )          |
|                                                                          |       |     |       |     |       |     |       |
| Increase (decrease) in cash                                                   |       | (14,911  | )          | 23,184   |       | 13,554   |       |
| Cash, beginning of year                                                       |       | 42,283   |       | 19,099   |       | 5,545    |       |
|                                                                          |       |     |       |     |       |     |       |
| Cash, end of year                                                             |       | $        | 27,372     |     | $          | 42,283   |       | $ | 19,099 |   |
|                                                                          |       |     |       |     |       |     |       |
| Supplemental cash flow information:                                           |       |     |       |     |       |     |       |
| Interest paid                                                                 |       | $        | 17,470     |     | $          | 14,624   |       | $ | 15,318 |   |
| Income taxes paid                                                             |       | $        | 9,623      |     | $          | 7,131    |       | $ | 11,363 |   |
|                                                                          |       |     |       |     |       |     |       |
| Non-cash transaction:                                                         |       |     |       |     |       |     |       |
| Purchase of Ordinary common stock by issuance of  bonds                       |       | $        | 31,583     |     | $          | —   |       | $ | — |   |

 

See notes to consolidatedfinancial statements.

 

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SteinwayMusical Instruments, Inc. and Subsidiaries

**CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY**(In Thousands Except Share Data)

 
| ** **                                              | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Treasury  Stock** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|---------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|------------------------------------------------------|------------|---------------------|------------|---------------------------------------|------------|
|                                                    |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Balance, January 1, 2002                           |       | $                 | 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                                | )          |
| Holding loss on marketable securities, net              |       |              |       |                             |       |                   |       | (71                                                  | )          |                |       | (71                                   | )          |
| Total comprehensive income                              |       |              |       |                             |       |                   |       |                                                 |       |                |       | 14,441                                |       |
|                                                    |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Exercise of 22,400 options for shares of common  stock  |       |              |       | 425                              |       |                   |       |                                                 |       |                |       | 425                                   |       |
| Issuance of 37,389 shares of common stock               |       |              |       | 569                              |       |                   |       |                                                 |       |                |       | 569                                   |       |
|                                                    |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| 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                                 |       |
| Holding gain on marketable securities, net              |       |              |       |                             |       |                   |       | 120                                                  |       |                |       | 120                                   |       |
| Total comprehensive income                              |       |              |       |                             |       |                   |       |                                                 |       |                |       | 19,972                                |       |
|                                                    |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Exercise of 57,900 options for shares of common  stock  |       |              |       | 953                              |       |                   |       |                                                 |       |                |       | 953                                   |       |
| Issuance of 35,209 shares of common stock               |       | 1                 |       | 501                              |       |                   |       |                                                 |       |                |       | 502                                   |       |
|                                                    |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Balance, December 31, 2003                         |       | 10                |       | 74,626                           |       | 96,720                 |       | (2,868                                               | )          | (15,853             | )          | 152,635                               |       |
| Comprehensive income:                                   |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Net income                                              |       |              |       |                             |       | 15,867                 |       |                                                 |       |                |       | 15,867                                |       |
| Foreign currency translation adjustment                 |       |              |       |                             |       |                   |       | 4,520                                                |       |                |       | 4,520                                 |       |
| Additional minimum pension liability, net               |       |              |       |                             |       |                   |       | (2,439                                               | )          |                |       | (2,439                                | )          |
| Holding gain on marketable securities, net              |       |              |       |                             |       |                   |       | 50                                                   |       |                |       | 50                                    |       |
| Total comprehensive income                              |       |              |       |                             |       |                   |       |                                                 |       |                |       | 17,998                                |       |
|                                                    |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Exercise of 267,327 options for shares of common  stock |       |              |       | 5,274                            |       |                   |       |                                                 |       |                |       | 5,274                                 |       |
| Tax benefit of options exercised                        |       |              |       | 759                              |       |                   |       |                                                 |       |                |       | 759                                   |       |
| Issuance of 33,018 shares of common stock               |       |              |       | 470                              |       |                   |       |                                                 |       |                |       | 470                                   |       |
| Purchase of 1,271,450 shares of common stock            |       |              |       |                             |       |                   |       |                                                 |       | (31,583             | )          | (31,583                               | )          |
|                                                    |       |              |       |                             |       |                   |       |                                                 |       |                |       |                                  |       |
| Balance, December 31, 2004                         |       | $                 | 10         |                             | $          | 81,129                 |       | $                                                    | 112,587    |                | $          | (737                                  | )          | $ | (47,436 | ) | $ | 145,553 |   |
|                                                         |            |                   |            |                                  |            |                        |            |                                                      |            |                     |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

See notes to consolidatedfinancial statements.

 

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SteinwayMusical Instruments, Inc. and Subsidiaries

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

YearsEnded December 31, 2004, 2003 AND 2002

(TabularAmounts in Thousands Except Share and Per Share Data)

 

**1.****              Natureof Business**

 

SteinwayMusical Instruments, Inc. and subsidiaries (the “Company”) is one of the world’sleading manufacturers of musical instruments. The Company, through its wholly-owned subsidiaries, The Steinway PianoCompany, Inc. (“Steinway”) and Conn-Selmer, Inc. (“Conn-Selmer”), manufacturesand distributes products within the musical instrument industry.  Steinway produces the highest quality pianoin the world and has one of the most highly recognized and prestigious brandnames.  Conn-Selmer is the leadingdomestic manufacturer of band & orchestral instruments and relatedaccessories, including complete lines of brass, woodwind, percussion and stringinstruments.  Selmer Paris saxophones,Bach Stradivarius trumpets, C.G. Conn French horns, King trombones and Ludwigsnare drums are considered by many to be the finest such instruments in theworld.

 

Throughout thesefinancial statements “we”, “us”, and “our” refer to Steinway MusicalInstruments, Inc. and subsidiaries taken as a whole.  We combined the operations of The SelmerCompany, Inc. (“Selmer”) and United Musical Instruments, Inc. (“UMI”) intoConn-Selmer during 2002.  The legalmerger of UMI and Selmer became effective January 1, 2003.  References to “Selmer” and “UMI” refer toevents or circumstances prior to the merger. On August 12, 2004, Conn-Selmer acquired substantially all of theassets of G. Leblanc Corporation, a high-quality band instrument manufacturerbased in Wisconsin.  See Note 3 for adiscussion of this acquisition.

 

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

 

**Principles of Consolidation** - Our consolidated financial statementsinclude the accounts of all direct and indirect subsidiaries, all ofwhich are wholly-owned.  All intercompanybalances have been eliminated in consolidation.

 

**Use of Estimates** - The preparation of financial statementsin conformity with accounting principles generally accepted in theUnited States of America necessarily requires us to make estimates andassumptions that affect the reported amounts of assets and liabilities, thedisclosure of contingent assets and liabilities at the date of the financialstatements, and the reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from those estimates.

 

**Revenue Recognition** – Generally, revenue is recognized uponshipment following receipt of a valid dealer order.  (Title and risk of loss associated withproducts sold transfers upon shipment.) Retail revenue is generally recognizedupon delivery to the customer in accordance with the customer’s purchaseagreement, and restoration revenue is recognized based on the completedcontract method.  We provide for theestimated costs of warranties, discounts and returns at the time of sale.

 

**Inventories** - Inventoriesare stated at the lower of cost, determined on a first-in, first-out basis, ormarket.

 

**Depreciation and Amortization** - Property, plant and equipment arerecorded at cost. Depreciation is provided using the straight-linemethod over the estimated useful lives of the respective assets.  Leasehold improvements are amortized usingthe straight-line method over the estimated useful lives of

 

34

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the improvements or theremaining term of the respective lease, whichever is shorter.  Estimated useful lives are as follows:

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

 

When conditions indicatea need to do so, we evaluate the recoverability of our long-lived assets bycomparing the estimated future undiscounted cash flows expected to be generatedby those assets to their carrying value. Should the assessment indicate an impairment, the affected assets arewritten down to fair value.  Assets heldfor sale are recorded at the lower of cost or net realizable value.

 

**Goodwill,Trademarks and Other Intangible Assets** - Intangible assetsother than goodwill and indefinite-lived trademarks are amortized on astraight-line basis over their estimated useful lives.  Deferred financing costs are amortized overthe repayment periods of the underlying debt. We test our goodwill and trademark assets for impairment annually or onan interim basis if events or circumstances indicate that the fair value of anasset may have decreased below its carrying value.  Should an impairment be present, the affectedasset would be adjusted to its fair value. Our annual impairment assessment is in July.  We have not recognized any impairments in theyears ended December 31, 2004, 2003, and 2002.

 

**Advertising** - Advertising costs are expensed asincurred.  Advertising expense was $7.5million for the year ended December 31, 2004, $7.7 million for theyear ended December 31, 2003 and $6.7 million for the year ended December 31,2002.

 

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

 
| **December 31,**               | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|
|                                |       |     |       |     |       |
| Accounts receivable                 |       | $        | 80,484     |     | $          | 68,459 |   |
| Notes and other receivables         |       | 20,846   |       | 19,123   |       |
|                                |       | 101,330  |       | 87,582   |       |
| Allowance for doubtful accounts     |       | (11,811  | )          | (9,944   | )          |
| Allowance for discounts and returns |       | (1,460   | )          | (1,235   | )          |
|                                |       | $        | 88,059     |     | $          | 76,403 |   |

 

**Income Taxes** - We provide for income taxes using anasset and liability approach.  We computedeferred income tax assets and liabilities annually for differencesbetween the financial statement and tax bases of assets and liabilities thatwill result in taxable or deductible amounts in the future based on enacted taxlaws and rates applicable to the periods in which the differences are expectedto affect taxable income.  We establishvaluation allowances when necessary to reduce deferred tax assets to the amountthat more likely than not will be realized.

 

35

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**Foreign Currency Translation and Remeasurement** - We translate assets and liabilities ofnon-U.S. operations into U.S. dollars at year-end rates, and revenuesand expenses at average rates of exchange prevailing during the year.  We report the resulting translationadjustments as a separate component of accumulated other comprehensive loss.  We recognize foreign currency transactiongains and losses in the consolidated statements of income as incurred.

 

**Foreign Currency Exchange Contracts** - We enter into foreign currency exchangecontracts to mitigate the risks from foreign currency fluctuations oncertain intercompany transactions.  Thesecontracts are not designated as hedging instruments for accounting purposes andare not used for trading or speculative purposes.  Gains and losses arising from fluctuations inexchange rates are recognized at the end of each reporting period.  Such gains and losses offset the foreigncurrency exchange gains or losses associated with the corresponding receivable,payable, or forecasted transaction.  Wehave credit risk to the extent the counterparties are unable to fulfill theirobligations on the foreign currency exchange contracts.  However, we enter into these contracts withreputable institutions and believe we have no significant credit risk.

 

**Stock-based Compensation** - We have an employee stock purchase plan (“PurchasePlan”) and a stock option plan (“Stock Plan”), which are described morefully in Note 13.  As currently 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.

 

Underthe intrinsic value method, compensation associated with stock awards toemployees is determined as the difference, if any, between the fair value ofthe underlying common stock on the date compensation is measured and the pricean employee must pay to exercise the award. Under the fair value method, 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 forboth the intrinsic and fair value methods is generally the date of grant.  Under the intrinsic value method, we did notrecognize any stock-based compensation expense during 2004, 2003 and 2002.  (See Recent Accounting Pronouncements below.)

 

36

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

 
| **For the years ended December 31,**                                                                                               | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                                                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income, as reported                                                                                                                 |       | $          | 15,867     |       | $          | 9,698      |       | $ | 14,909 |   |
| Deduct: Total stock-based employee compensation  expense determined under fair-value method for all awards, net of related tax  effects |       | (1,040     | )          | (836       | )          | (613       | )          |
| Pro forma net income                                                                                                                    |       | $          | 14,827     |       | $          | 8,862      |       | $ | 14,296 |   |
| Earnings per share:                                                                                                                     |       |       |       |       |       |       |       |
| As reported - Basic                                                                                                                     |       | $          | 1.97       |       | $          | 1.09       |       | $ | 1.68 |   |
| As reported - Diluted                                                                                                                   |       | $          | 1.91       |       | $          | 1.09       |       | $ | 1.68 |   |
| Pro forma - Basic                                                                                                                       |       | $          | 1.84       |       | $          | 0.99       |       | $ | 1.61 |   |
| Pro forma - Diluted                                                                                                                     |       | $          | 1.79       |       | $          | 0.99       |       | $ | 1.61 |   |

 

Thefair value of options on their grant date, including the valuation of theoption feature implicit in our Purchase Plan, was measured using theBlack-Scholes option-pricing model.  Keyweighted-average assumptions used to apply this pricing model are as follows:

 
| **For the years ended December 31,**      | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Interest rate                             |       | 1.51%    |       | 3.10%    |       | 3.48%    |       |
| Expected life of option grants (in years) |       | 1.0      |       | 5.3      |       | 5.7      |       |
| Expected volatility of underlying stock   |       | 26.6%    |       | 27.0%    |       | 25.6%    |       |

 

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

 
| **For the years ended December 31,** | ** ** | **2004** | ** **   | **2003** | ** ** | **2002**   | ** ** |
|--------------------------------------|------------|----------|--------------|----------|------------|------------|------------|
| Stock Plan                           |       | $        | —  |     | $          | 7.49  |       | $ | 6.27  |   |
| Option feature in Purchase Plan      |       | $        | 5.16    |     | $          | 4.09  |       | $ | 4.78  |   |

 

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

 

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

 

37

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

 
| **For the years ended December 31,**               | ** ** | **2004**  | ** ** | **2003**  | ** ** | **2002**  | ** ** |
|---------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
|                                                    |       |      |       |      |       |      |       |
| Weighted-average shares for basic earnings per share    |       | 8,046,256 |       | 8,924,578 |       | 8,877,256 |       |
| Dilutive effect of stock options                        |       | 257,810   |       | 1,094     |       | 4,909     |       |
| Weighted-average shares for diluted earnings per  share |       | 8,304,066 |       | 8,925,672 |       | 8,882,165 |       |

 

Alloutstanding options were included in the computation of diluted earnings percommon share for the year ended December 31, 2004.  Options to purchase 1,130,400 and 1,098,300shares of common stock at prices ranging from $18.55 to $22.67 per share wereoutstanding during the years ended December 31, 2003 and 2002,respectively, but were not included in the computation of diluted net earningsper share because the options’ exercise prices were greater than the averagemarket price of the common shares.

 

**Environmental Matters** - Potential environmental liabilities arerecorded when it is probable that a loss has been incurred and its amount canreasonably be estimated (See Note 14.)

 

**Segment Reporting** - We have two reportable segments: thepiano segment and the band & orchestral instrument segment.  We consider these two segments reportable asthey are managed separately and the operating results of each segment areseparately reviewed and evaluated by our senior management on a regularbasis.  The Company’s chief operatingdecision maker is the Chief Executive Officer.

 

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

 
| ** **                     | ** ** | **Foreign Currency  Translation  Adjustment** | ** ** | **Gain/(Loss) on  AFS  Marketable  Securities** | ** ** | **Tax Impact of  Gain/(Loss) on  AFS Marketable  Securities** | ** ** | **Additional  Minimum  Pension Liability** | ** ** | **Tax Impact of  Additional  Minimum  Pension Liability** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** |
|--------------------------------|------------|-----------------------------------------------|------------|-------------------------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------|------------|
|                           |       |                                          |       |                                            |       |                                                          |       |                                       |       |                                                      |       |                                        |       |
| Balance January 1, 2002   |       | $                                             | (11,697    | )                                               | $          | (8                                                            | )          | $                                          | 3          |                                                      | $          | (1,620                                      | )          | $ | 648 |   | $ | (12,674 | ) |
| Activity                       |       | 5,589                                         |       | (112                                            | )          | 41                                                            |       | (9,976                                     | )          | 3,990                                                     |       | (468                                        | )          |
| 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                                      |       |
| Balance December 31, 2003 |       | 1,226                                         |       | 73                                              |       | (29                                                           | )          | (6,853                                     | )          | 2,715                                                     |       | (2,868                                      | )          |
| Activity                       |       | 4,520                                         |       | 84                                              |       | (34                                                           | )          | (3,949                                     | )          | 1,510                                                     |       | 2,131                                       |       |
| Balance December 31, 2004 |       | $                                             | 5,746      |                                            | $          | 157                                                           |       | $                                          | (63        | )                                                         | $          | (10,802                                     | )          | $ | 4,225 |   | $ | (737 | ) |

 

**RecentAccounting Pronouncements** - In December 2004, the FinancialAccounting Standards Board (“FASB”) revised Statement of Financial AccountingStandards (“SFAS”) No. 123, “Share-Based Payments” (SFAS No. 123R). Thisaccounting standard, which is effective for interim and annual periodsbeginning after June 15, 2005, requires the recognition of compensationexpense related to stock options using the fair value method.  We plan to adopt SFAS No. 123R in the thirdquarter of 2005 using the modified prospective application method.Based on current outstanding awards, expected participation in

 

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the Purchase Plan consistent with past patterns, andno significant changes in the number of shares of outstanding stock, we anticipate an impact on earnings ofapproximately $.06 per share in 2005.

 

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

 

In December 2003, the FASB issued FASB Interpretation(“FIN”) 46R “Consolidation of Variable Interest Entities – an interpretation ofARB No. 51” (“FIN 46R”).  Thisinterpretation, which is effective for public entities by the end of the firstreporting period ending after December 15, 2003, addresses consolidationby business enterprises of variable interest entities that have certaincharacteristics.  The adoption of FIN 46Rhad no impact on our financial statements.

 

**Reclassifications** - Certain prior year amounts have beenreclassified to conform to the current year presentation.

 

**3.****              Acquisition**

 

OnAugust 12, 2004, we acquired substantially all of the assets and assumedthe operating liabilities of G. Leblanc Corporation (“Leblanc”) of Wisconsin, ahigh-quality band instrument manufacturer. We have included the operating results and net assets of Leblanc in ourfinancial statements since the date of acquisition.

 

Weacquired Leblanc because its line of instruments and accessories iscomplementary to our existing product lines, enabling us to gain or strengthenmarket share in certain instrument categories. Under terms of the assetpurchase agreement, the Company provisionally disbursed $37.6 million for thepurchase price, of which $4.5 million is being held in escrow pendingexpiration of the indemnification period. The final purchase price is dependent upon a calculation derived fromthe closing balance sheet which, when finalized, may result in a recovery of aportion of the initial payment, or may require an additional payment to bemade.  At December 31, 2004, theCompany recognized an expected recovery of $0.8 million of the provisionalpurchase price based on current information. We are still accumulating certain information relative to the valuationof property and other assets that may impact the final purchase priceallocation.  Accordingly, the finalpurchase price allocation may differ from the amounts presented below.  The purchase price is based on thepreliminary acquisition cost determination of $36.8 million and has beenallocated to acquired assets and assumed liabilities as of August 12, 2004as follows:

 

39

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| Inventories                          |   | $      | 20,682 |   |
|--------------------------------------|--------|--------|--------|--------|
| Receivables and other current assets |   | 12,675 |   |
| Property, plant, and equipment       |   | 6,508  |   |
| Trademarks                           |   | 1,690  |   |
| Non-compete agreements               |   | 500    |   |
| Other assets                         |   | 628    |   |
| Accounts payable                     |   | (1,450 | )      |
| Recourse reserves                    |   | (1,138 | )      |
| Environmental reserves               |   | (815   | )      |
| Other liabilities                    |   | (2,508 | )      |
|                                 |   | $      | 36,772 |   |

 

Subsequent footnotesproviding details of our significant balance sheet accounts include the impactof the Leblanc acquisition as of December 31, 2004.

 

**4.****              Inventories**

 
| **December 31,** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------|------------|----------|------------|----------|------------|
| Raw materials         |       | $        | 23,439     |     | $          | 21,268 |   |
| Work-in-process       |       | 54,612   |       | 50,620   |       |
| Finished goods        |       | 94,295   |       | 80,141   |       |
|                  |       | $        | 172,346    |     | $          | 152,029 |   |

 

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

 
| **December 31,**                          | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|
| Land                                           |       | $        | 20,276     |     | $          | 19,718 |   |
| Buildings and improvements                     |       | 69,640   |       | 65,285   |       |
| Leasehold improvements                         |       | 3,978    |       | 3,613    |       |
| Machinery, equipment and tooling               |       | 52,058   |       | 48,290   |       |
| Office furniture and fixtures                  |       | 10,692   |       | 11,294   |       |
| Concert and artist and rental pianos           |       | 15,526   |       | 13,877   |       |
| Construction-in-progress                       |       | 1,247    |       | 812      |       |
|                                           |       | 173,417  |       | 162,889  |       |
| Less accumulated depreciation and amortization |       | 70,473   |       | 63,952   |       |
|                                           |       | $        | 102,944    |     | $          | 98,937 |   |

 

Depreciation expense was $10.1 million in 2004, $9.8million in 2003, and $9.9 million in 2002. In 2003, we recognized impairment charges for certain land, building,and equipment assets of the band segment as a result of our facilityrationalization project, which is discussed more fully in Note 9.

 

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**6.****             ****Goodwill and Other IntangibleAssets**

 
| **December 31,**             | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
|                              |       |     |       |     |       |
| Amortizing intangible assets:     |       |     |       |     |       |
| Gross deferred financing costs    |       | $        | 8,627      |     | $          | 9,293 |   |
| Accumulated amortization          |       | (3,834   | )          | (3,596   | )          |
| Deferred financing costs, net     |       | $        | 4,793      |     | $          | 5,697 |   |
|                              |       |     |       |     |       |
| Gross covenants not to compete    |       | $        | 750        |     | $          | 250 |   |
| Accumulated amortization          |       | (253     | )          | (165     | )          |
| Covenants not to compete, net     |       | $        | 497        |     | $          | 85 |   |
|                              |       |     |       |     |       |
| Non-amortizing intangible assets: |       |     |       |     |       |
| Gross goodwill                    |       | $        | 38,744     |     | $          | 38,366 |   |
| Accumulated amortization          |       | (6,890   | )          | (6,701   | )          |
| Goodwill, net                     |       | $        | 31,854     |     | $          | 31,665 |   |
|                              |       |     |       |     |       |
| Gross trademarks                  |       | $        | 27,643     |     | $          | 25,059 |   |
| Accumulated amortization          |       | (15,318  | )          | (14,740  | )          |
| Trademarks, net                   |       | $        | 12,325     |     | $          | 10,319 |   |

 

The changes in the net carrying amounts of goodwilland trademarks are as follows:

 
| ** **                                   | ** ** | **Piano Segment** | ** ** | **Band Segment** | ** ** | **Total** | ** ** |
|----------------------------------------------|------------|-------------------|------------|------------------|------------|-----------|------------|
| Goodwill:                                    |       |              |       |             |       |      |       |
| Balance at December 31, 2002            |       | $                 | 20,984     |             | $          | 8,555     |       | $ | 29,539 |   |
| Foreign currency translation impact          |       | 2,126             |       | —           |       | 2,126     |       |
| Balance at December 31, 2003            |       | $                 | 23,110     |             | $          | 8,555     |       | $ | 31,665 |   |
|                                         |       |              |       |             |       |      |       |
| Balance at December 31, 2003            |       | $                 | 23,110     |             | $          | 8,555     |       | $ | 31,665 |   |
| Valuation allowance adjustment (see Note 11) |       | (822              | )          | —           |       | (822      | )          |
| Foreign currency translation impact          |       | 1,011             |       | —           |       | 1,011     |       |
| Balance at December 31, 2004            |       | $                 | 23,299     |             | $          | 8,555     |       | $ | 31,854 |   |

 

41

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| ** **                                                                   | ** ** | **Piano  Segment** | ** ** | **Band  Segment** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------|------------|-------------------|------------|-----------|------------|
| Trademarks:                                                                  |       |               |       |              |       |      |       |
| Balance at December 31, 2002                                            |       | $                  | 6,980      |              | $          | 2,671     |       | $ | 9,651 |   |
| Foreign currency translation impact                                          |       | 668                |       | —            |       | 668       |       |
| Balance at December 31, 2003                                            |       | $                  | 7,648      |              | $          | 2,671     |       | $ | 10,319 |   |
|                                                                         |       |               |       |              |       |      |       |
| Balance at December 31, 2003                                            |       | $                  | 7,648      |              | $          | 2,671     |       | $ | 10,319 |   |
| Additions based on preliminary purchase price  allocation to acquired assets |       | —             |       | 1,690             |       | 1,690     |       |
| Foreign currency translation impact                                          |       | 316                |       | —            |       | 316       |       |
| Balance at December 31, 2004                                            |       | $                  | 7,964      |              | $          | 4,361     |       | $ | 12,325 |   |

 

The weighted-averageamortization period for deferred financing costs is 9 years, and the weighted-averageamortization period of covenants not to compete is 5 years.  Thefollowing table summarizes amortization expense:

 
| **For the years ended December 31,** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Total amortization expense                |       | $        | 1,094      |     | $          | 1,154    |       | $ | 1,154 |   |
|                                           |            |          |            |          |            |          |            |  |  |  |

 

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

 
| ** **                      | ** ** | **Amount** | ** ** |
|---------------------------------|------------|------------|------------|
| Estimated amortization expense: |       |       |       |
|                            | 2005       |       | $          | 1,101 |   |
|                            | 2006       |       | 1,065      |   |
|                            | 2007       |       | 1,066      |   |
|                            | 2008       |       | 920        |   |
|                            | 2009       |       | 530        |   |
|                                 |            |            |            |  |  |

 

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

 
| **For the years ended  December 31,** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
|                                            |       |     |       |     |       |
| Intangible pension assets                       |       | $        | 2,801      |     | $          | 3,782 |   |
| Notes receivable                                |       | 7,518    |       | 4,812    |       |
| Marketable securities                           |       | 891      |       | 515      |       |
| Deposits                                        |       | 3,564    |       | 350      |       |
| Other assets                                    |       | 1,597    |       | 1,233    |       |
| Total                                           |       | $        | 16,371     |     | $          | 10,692 |   |

 

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

 
| **December 31,**                | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
|                                 |       |     |       |     |       |
| Accrued payroll and related benefits |       | $        | 18,072     |     | $          | 16,986 |   |
| Current portion of pension liability |       | 2,811    |       | 2,663    |       |
| Accrued warranty expense             |       | 2,139    |       | 2,602    |       |
| Accrued interest                     |       | 3,257    |       | 2,706    |       |
| Deferred income                      |       | 4,468    |       | 4,161    |       |
| Other accrued expenses               |       | 13,145   |       | 9,994    |       |
| Total                                |       | $        | 43,892     |     | $          | 39,112 |   |

 

Accruedwarranty expense is recorded at the time of sale for instruments that have awarranty period ranging from one to ten years. The accrued expense recorded is generally based on a percentage of salesand is adjusted periodically following an analysis of historical warrantyactivity.

 
| **For the years ended December 31,** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                      |       |     |       |     |       |     |       |
| Accrued warranty expense:                 |       |     |       |     |       |     |       |
| Beginning balance                         |       | $        | 2,602      |     | $          | 2,357    |       | $ | 2,221 |   |
| Additions                                 |       | 932      |       | 1,361    |       | 950      |       |
| Claims and reversals                      |       | (1,455   | )          | (1,314   | )          | (966     | )          |
| Foreign currency translation              |       | 60       |       | 198      |       | 152      |       |
| Ending balance                            |       | $        | 2,139      |     | $          | 2,602    |       | $ | 2,357 |   |

 

**9.****             ****Facility Rationalization – Band Segment**

 

In 2003, we began afacility rationalization project to reduce excess manufacturing capacity in ourband segment.  As part of this project,we closed our woodwind manufacturing facilities in Nogales, Arizona in November 2003.  As a result of this closing, we recordedcharges of $0.6 million in severance expenses and $1.0 million in inventorywrite-down charges as components of cost of goods sold.  We also recorded $2.1 million in impairmentcharges as a component of operating expenses.

 

In October 2003, weannounced the closure of one of our woodwind manufacturing facilities inElkhart, Indiana and our intent to transfer that plant’s production to othercompany-owned facilities.  We recordedcharges of $1.1 million in severance expenses and $0.2 million of inventorywrite-down charges as components of cost of goods sold.  We also recorded $0.9 million in relatedimpairment charges.  In 2004, we recorded$1.4 million in severance expenses, and ceased operating this facility in April 2004.  All costs associated with this closure werepaid out by December 31, 2004.

 

The accrued severanceliability activity associated with the band segment’s facility rationalizationproject for the years ended December 31, 2004 and 2003 is as follows:

 

43

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| **For the years ended December 31,**     | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|
|                                          |       |     |       |     |       |
| Facility rationalization severance liability: |       |     |       |     |       |
| Beginning balance                             |       | $        | 1,158      |     | $          | — |   |
| Additions charged to cost of sales            |       | 1,444    |       | 1,683    |       |
| Payments                                      |       | (2,575   | )          | (525     | )          |
| Reversals                                     |       | (27      | )          | —   |       |
| Ending balance                                |       | $        | —     |     | $          | 1,158 |   |

 

The impairment chargesrecorded in 2003 were reported as a separate component of operating expenseslabeled “facility rationalization” and related to buildings, land, andequipment affected by the plant closures. The impairment costs associated with the land and buildings werecalculated based on the excess of the carrying value over net realizable valuefor such assets as we planned to sell the assets.  The equipment impairment charges were basedon our ability to utilize the equipment at other facilities, or until therationalization project is complete, with remaining useful lives and associateddepreciation adjusted accordingly.

 

In 2004, we realized again of $0.1 million on the sale of equipment for which we had taken animpairment charge. In December 2004, we sold one of the Nogales, Arizonafacilities, valued at $0.7 million, for $1.0 million, resulting in a gain onsale of approximately $0.3 million.  Thesmaller facility, which has a carrying value of $0.2 million, is currentlybeing leased to a third party.  Thisfacility is classified as an asset held and used as it had been held for salefor more than a year.  We are continuingefforts to sell this property.  TheElkhart, Indiana facility, which ceased operating in April 2004, has nocarrying value.

 

The components of the$3.0 million in impairment charges recorded in 2003, and the gains resultingfrom sales of certain impaired assets in 2004, are as follows:

 
| **For the years ended December 31,** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|
|                                      |       |     |       |     |       |
| Asset category:                           |       |     |       |     |       |
| Land                                      |       | $        | —     |     | $          | 501 |   |
| Buildings                                 |       | (287     | )          | 2,202    |       |
| Equipment                                 |       | (76      | )          | 255      |       |
|                                      |       | $        | (363       | )        | $          | 2,958 |   |

 

**10.****      ****OtherIncome, Net**

 
| **For the years ended December 31,** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| West 57th Building income                 |       | $        | (4,653     | )        | $          | (4,653   | )          | $ | (4,653 | ) |
| West 57th Building expenses               |       | 3,254    |       | 3,254    |       | 3,254    |       |
| Foreign exchange (gain) loss, net         |       | (41      | )          | (815     | )          | (691     | )          |
| Miscellaneous, net                        |       | (1,723   | )          | (1,303   | )          | (1,849   | )          |
| Total                                     |       | $        | (3,163     | )        | $          | (3,517   | )          | $ | (3,939 | ) |

 

44

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**11.****       IncomeTaxes**

 

Thecomponents of the income tax provision are as follows:

 
| **For the years ended December 31,** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                      |       |     |       |     |       |     |       |
| U.S. federal:                             |       |     |       |     |       |     |       |
| Current                                   |       | $        | 2,838      |     | $          | 2,300    |       | $ | 3,896 |   |
| Deferred                                  |       | (1,990   | )          | (2,117   | )          | 7        |       |
| U.S. state and local:                     |       |     |       |     |       |     |       |
| Current                                   |       | 877      |       | 729      |       | 829      |       |
| Deferred                                  |       | (166     | )          | (177     | )          | 76       |       |
| Foreign:                                  |       |     |       |     |       |     |       |
| Current                                   |       | 6,882    |       | 4,270    |       | 3,619    |       |
| Deferred                                  |       | (341     | )          | (307     | )          | (1,277   | )          |
| Total                                     |       | $        | 8,100      |     | $          | 4,698    |       | $ | 7,150 |   |

 

The components of incomebefore income taxes are as follows:

 
| **For the years ended December 31,** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                      |       |     |       |     |       |     |       |
| U.S. operations                           |       | $        | 6,847      |     | $          | 3,860    |       | $ | 12,839 |   |
| Non-U.S. operations                       |       | 17,120   |       | 10,536   |       | 9,220    |       |
| Total                                     |       | $        | 23,967     |     | $          | 14,396   |       | $ | 22,059 |   |

 

Our incometax provision differed from that using the statutory U.S. federal rate asfollows:

 
| **For the years ended December 31,**                     | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                          |       |     |       |     |       |     |       |
| Statutory federal rate applied to income before  income taxes |       | $        | 8,388      |     | $          | 5,039    |       | $ | 7,721 |   |
| Increase (decrease) in income taxes resulting from:           |       |     |       |     |       |     |       |
| Foreign income taxes (net of federal benefit)                 |       | 1,621    |       | (2,643   | )          | 21       |       |
| State income taxes (net of federal benefit)                   |       | 773      |       | 518      |       | 391      |       |
| Other                                                         |       | (2,682   | )          | 1,784    |       | (983     | )          |
| Income tax provision                                          |       | $        | 8,100      |     | $          | 4,698    |       | $ | 7,150 |   |

 

At December 31,2004, accumulated retained earnings of non-U.S. subsidiaries totaled $5.7million.  We did not provide for U.S.income taxes or foreign withholding taxes for these subsidiaries because ourcurrent intention is to reinvest such earnings.

 

45

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The components of netdeferred taxes are as follows:

 
| **December 31,**                                        | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                         |       |     |       |     |       |
| Deferred tax assets:                                         |       |     |       |     |       |
| Uniform capitalization and reserve adjustments to  inventory |       | $        | 2,523      |     | $          | 3,527 |   |
| Allowance for doubtful accounts                              |       | 2,412    |       | 2,378    |       |
| Accrued expenses and other current assets and  liabilities   |       | 7,945    |       | 9,771    |       |
| Additional minimum pension liability                         |       | 4,225    |       | 2,715    |       |
| Net operating losses                                         |       | 4,615    |       | 2,895    |       |
| Valuation allowances on operating losses                     |       | (4,610   | )          | (2,895   | )          |
| Foreign tax credits                                          |       | 9,527    |       | 7,137    |       |
| Valuation allowances on foreign tax credits                  |       | (6,862   | )          | (6,439   | )          |
| Total deferred tax assets                                    |       | 19,775   |       | 19,089   |       |
|                                                         |       |     |       |     |       |
| Deferred tax liabilities:                                    |       |     |       |     |       |
| Pension contributions                                        |       | (2,586   | )          | (2,800   | )          |
| Fixed assets                                                 |       | (20,236  | )          | (19,227  | )          |
| Unamortized tax method change                                |       | (896     | )          | (2,748   | )          |
| Intangibles                                                  |       | (7,250   | )          | (6,857   | )          |
| Total deferred tax liabilities                               |       | (30,968  | )          | (31,632  | )          |
|                                                         |       |     |       |     |       |
| Net deferred taxes                                           |       | $        | (11,193    | )        | $          | (12,543 | ) |

 

Valuationallowances provided relate to net operating loss carryforwards and excessforeign tax credits generated over expected utilization in our tax return.  Gross state tax loss carryforwards totaled$65.2 million as of December 31, 2004 and expire in varying amounts from2005 through 2024.

 

Valuationallowances relating to the acquisition of Steinway totaled $3.3 million as of December 31,2004 and $4.3 million as of December 31, 2003.  If these valuation allowances are removed,the reversal reduces goodwill.  In 2004,we removed a portion of these valuation allowances and, as a result, we reducedgoodwill by $0.8 million.

 

During2004, the valuation allowance on foreign tax credits increased by $0.4 milliondue the generation of additional excess foreign tax credits, a portion of whichwe do not expect to be able to utilize in our future federal tax returns.  As a result of changes in certain taxlegislation which extended foreign tax credit carryover periods, our foreigntax credit carryforwards now expire in varying amounts from 2009 through 2014.  Accordingly, we were able to recognize apartial benefit of $0.9 million for the current year’s excess foreign taxcredits based on our expected utilization.

 

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**12.****      ****Long-Term Debt**

 
| **December 31,**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|
| Term loans                                               |       | $        | 39,623     |     | $          | 47,178 |   |
| 8.75% Senior Notes                                       |       | 174,345  |       | 145,345  |       |
| Unamortized bond premium                                 |       | 1,584    |       | —   |       |
| Open account loans, payable on demand to a foreign  bank |       | 7,240    |       | 4,079    |       |
| Total                                                    |       | 222,792  |       | 196,602  |       |
| Less current portion                                     |       | 14,212   |       | 10,638   |       |
| Long-term debt                                           |       | $        | 208,580    |     | $          | 185,964 |   |

 

Scheduled payments oflong-term debt as of December 31, 2004 are as follows:

 

| ** ** | ** ** | **Amount** | ** ** |
|------------|------------|------------|------------|
| 2005       |       | $          | 14,212     |   |
| 2006       |       | 8,139      |       |
| 2007       |       | 8,196      |       |
| 2008       |       | 16,316     |       |
| 2009       |       | —     |       |
| Thereafter |       | 174,345    |       |
|       |       | $          | 221,208    |   |

 

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 provides us with apotential borrowing capacity of $85.0 million in revolving credit, and expireson September 14, 2008. Borrowings are collateralized by our domesticaccounts receivable, inventory and fixed assets.  As of December 31, 2004, there were norevolving credit loans outstanding, and availability based on eligible accountsreceivable and inventory balances was approximately $82.6 million, net of outstandingletters of credit. The real estate term loan ($16.7 million at December 31,2004) is payable in monthly installments of $0.2 million and includes interestat average 30-day LIBOR (2.4% at December 31, 2004) plus 1.5%.  This term loan is secured by all of ourinterests in the Steinway Hall property. The acquisition term loan ($22.9 million at December 31, 2004) isrepayable in monthly installments of $0.4 million through August 2005 andmonthly installments of $0.6 million from September 2005 through September 2008.  The acquisition term loan and revolvingcredit loans under the Credit Facility bear interest at average 30-dayLIBOR plus 1.75%.

 

On April 19, 2001,we issued $150.0 million 8.75% Senior Notes due 2011.  In December 2002 we repurchased $4.7million of these notes at 99.25%.  In February 2004,we purchased 1,271,450 shares of our Ordinary common stock.  In exchange, we tendered $29.0 million inprincipal amount of our 8.75% Senior Notes, which we issued under our currentindenture at a premium of 106.3%.

 

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We also have certainnon-domestic credit facilities that provide for borrowings by foreign subsidiariesof up to €17.0 million ($23.1 million at the December 31, 2004 exchangerate) payable on demand. These borrowings are collateralized by most of theassets of the borrowing subsidiaries.  Aportion of the open account loans can be converted into a maximum of £0.5million ($1.0 million at the December 31, 2004 exchange rate) for use byour UK branch and ¥700 million ($6.8 million at the December 31, 2004exchange rate) for use by our Japanese subsidiary.  Demand borrowings bear interest at rates of6.70 – 7.10% for the euro loans, 5.5% for the British pound loans, and 1.265%for Japanese yen loans. Our outstanding borrowings on these loans totaled $7.2million as of December 31, 2004.  Wehave purchased two interest rate caps on a portion of those loans to mitigateour cash flow exposure to changes in interest rates.  One cap limits the base interest rate to 5%on €0.5 million ($0.7 million at the December 31, 2004 exchange rate) andexpires in 2005.  The other cap limitsthe base interest rate to 6.25% on €1.5 million ($2.1 million at the December 31,2004 exchange rate) and expires in 2005. As we have not designated these instruments as hedges for accountingpurposes, we record these instruments at fair value and recognize the change infair value in earnings.  The unrealizedgains or losses and carrying value of the caps are not material in any periodpresented.

 

All of our debtagreements contain certain financial and non-financial covenants which, amongother 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 such covenantsas of December 31, 2004.

 

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

 

Our common stock iscomprised of two classes: Class A and Ordinary.  With the exception of disparate voting power,both classes 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 Acommon stock shall automatically convert to Ordinary common stock if, at anytime, the Class A common stock is not owned by an original Class Aholder.  The Chairman and Chief ExecutiveOfficer own 100% of the Class A common shares, representing 86% of thecombined voting power of the Class A common stock and Ordinary commonstock.

 

EmployeeStock Purchase Plan - We have an employee stock purchase plan under whichsubstantially all employees may purchase Ordinary common stock throughpayroll deductions at a purchase price equal to 85% of the lower of the fairmarket values as of the beginning or end of each twelve-month offeringperiod.  Stock purchases under thePurchase Plan are limited to 5% of an employee’s annual base earnings.  Shares issued under the Purchase Plan were33,018 during 2004, 35,209 during 2003, and 37,389 during 2002.  Of the 500,000 shares originally reserved forissuance under the Purchase Plan, 243,572 shares remain available for futureissuance as of December 31, 2004.

 

StockPlan - The 1996 stock plan, as amended, provides for the granting of 1,500,000stock options (including incentive stock options and non-qualified stockoptions), stock appreciation rights and other stock awards to certain keyemployees, consultants and advisors.  Asof December 31, 2004, 1,105,673 shares of Ordinary common stock were reservedfor issuance under the Stock Plan.

 

48

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

 
| ** **                       | ** ** | **2004**                | ** ** | **2003**                                | ** ** | **2002**                | ** ** |
|----------------------------------|------------|-------------------------|------------|-----------------------------------------|------------|-------------------------|------------|
| ** **                       | ** ** | **Number  of  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Number  of  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Number  of  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| Outstanding at beginning of year |       | 1,154,747               |       | $                                       | 19.63      |                    | 1,112,447  |   | $ | 19.07 |   | 628,262 |   | $ | 19.07 |   |
| Granted                          |       | 27,825                  |       | 17.81                                   |       | 250,909                 |       | 21.16 |   | 561,174 |   | 18.80 |   |
| Exercised                        |       | (300,345                | )          | 18.65                                   |       | (93,109                 | )          | 17.26 |   | (59,789 | ) | 16.63 |   |
| Canceled, forfeited or expired   |       | (10,000                 | )          | 19.00                                   |       | (115,500                | )          | 19.06 |   | (17,200 | ) | 19.01 |   |
| Outstanding at end of year       |       | 872,227                 |       | 19.92                                   |       | 1,154,747               |       | 19.63 |   | 1,112,447 |   | 19.07 |   |
|                             |       |                    |       |                                    |       |                    |       |   |   |   |   |   |   |
| Exercisable at end of year       |       | 410,173                 |       | $                                       | 19.45      |                    | 525,100    |   | $ | 19.19 |   | 507,400 |   | $ | 19.21 |   |

 

Thefollowing table sets forth information regarding outstanding and exercisableoptions at December 31, 2004:

 
| ** **                   | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                 | ** ** |                                    |
|------------------------------|------------|-------------------------|------------|-----------------------------------------|------------|-----------------------------------------|
| **Range of Exercise Prices** | ** ** | **Number  of  Options** | ** ** | **Weighted-  Average  Remaining  Life** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Number  of  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |   |
|                         |       |                    |       |                                    |       |                                    |   |   |   |   |   |   |
| $ 14.73 - $20.75        |       |                    | 643,173    |                                    | 5.7 years  |                                    | $ | 18.94 |   | 354,673 |   | $ | 18.99 |   |   |
| $ 21.13 - $22.67        |       |                    | 219,900    |                                    | 8.6 years  |                                    | 22.60 |   | 55,500 |   | 22.39 |   |   |
| $ 25.10                 |       |                    | 9,154      |                                    | .6 years   |                                    | 25.10 |   | — |   | — |   |   |   |
|                         |       | 872,227                 |       | 6.4 years                               |       | 19.92                                   |   | 410,173 |   | 19.45 |   |   |
|                              |            |                         |            |                                         |            |                                         |  |  |  |  |  |  |  |  |  |  |

 

**14.****       Commitmentsand Contingent Liabilities**

 

**Lease Commitments** - We lease various facilities and equipmentunder non-cancelable operating lease arrangements.  These leases expire at various times through2016.  Rent expense was $5.7 million forthe year ended December 31, 2004, $4.8 million for the year ended December 31,2003, and $4.2 million for the year ended December 31, 2002.

 

In March 1999, weacquired the building that includes the Steinway Hall retail store on West 57thStreet in New York City for approximately $30.8 million.  We entered into a ninety-nine year land leaseas part of the transaction.  Annual rentpayable under the land lease is $2.2 million in the first ten years, $2.8million for the subsequent ten-year period and will be adjusted every twentyyears thereafter to the greater of the existing rent or 4% of the fair marketvalue of the land and building combined. Rent expense is being recognized on a straight-line basis over thetwenty-year period.  We also entered intoa ten-year master lease whereby all of our interest in the land and buildingwas leased back to the owner of the land. Rental expense and rental income associated with these leases wasincluded, along with other real estate costs, in Other Income, Net (see Note10).

 

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

 
| **For the years ending December 31,** | ** ** | **Lease  Payments** | ** ** | **Rental  Income** | ** ** |
|--------------------------------------------|------------|---------------------|------------|--------------------|------------|
|                                       |       |                |       |               |       |
| 2005                                       |       | $                   | 5,015      |               | $          | 4,653 |   |
| 2006                                       |       | 4,302               |       | 4,653              |       |
| 2007                                       |       | 3,877               |       | 4,653              |       |
| 2008                                       |       | 1,940               |       | 4,653              |       |
| 2009                                       |       | 1,289               |       | —             | (1)        |
| Thereafter                                 |       | 6,145               |       | —             |       |
|                                       |       | $                   | 22,568     |               | $          | 18,612 |   |
|                                            |            |                     |            |                    |            |  |  |  |

 

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(1) =In 2008, if the master lease is not renewed or replaced we would then directlyreceive the rental income from all other tenants in the building.

 

**EmploymentAgreements and Other Obligations** - We maintain employmentagreements with certain employees and consultants.  Most of these agreements have one-year termsand contain automatic renewal provisions. Our obligation under these agreements at current compensation levels isapproximately $1.2 million per year.

 

We maintain employmentagreements that expire in 2006 with both our Chairman and Chief ExecutiveOfficer.  These individuals collectivelyhold 100% of the Class A common shares, representing 86% of the combinedvoting power of the Class A common stock and Ordinary common stock.  Our total obligation under these agreementsis approximately $1.3 million. Should these agreements not be renewed in 2006,we would be obligated to pay out an additional $3.3 million.  Further, our Chairman and Chief Executive Officerhave established a limited liability corporation to which we pay reimbursementof certain rent, overhead and travel-related expenses.  These reimbursements totaled $0.2 million ineach of the years ended December 31, 2004, 2003 and 2002.  We included less than $0.1 million inaccounts payable related to these expenses in each of the years ended December31, 2004, 2003, and 2002.

 

**Notes Receivable Financed with Recourse** - In 2002, our customers financednotes receivable with a third party, to which we had a recourse obligationunder the financing agreement.  Wereceived proceeds of $2.6 million from the financing of such notes.  In 2003, no customer receivables were subjectto such financing or recourse obligations. In 2004, certain customers of our subsidiaryLeblanc financed notes receivable with a third party, to which we have arecourse obligation.  We receivedproceeds of $1.4 million from the customer financing of such notes.  As of December 31, 2004, the outstandingbalance on these customer notes was $3.0 million. We have included acorresponding recourse obligation of $1.2 million in other current liabilitiesas of December 31, 2004. We expect the duration of our recourse obligation notto exceed one year.  Our total maximumrecourse obligation under this arrangement includes the outstanding balance onthe notes, as well as any interest or late fees that may be incurred by ourcustomers. We received an indemnification from G. Leblanc Corporation inconnection with our acquisition of certain of its assets and assumption ofcertain liabilities.  (See Note 3.)  As of December 31, 2004, we haverecognized a receivable of $0.6 million associated with this indemnification.

 

**RetailFinancing Obligations**- Certain of our foreign retail saleswere financed by our customers through a local bank under an arrangement thatincluded an obligation on our part to repurchase pianos seized by the bank upondefault of the customer.  The buy backprice is established as a percentage of the original sales price, starting at80% in the first year and declining to 30% in the fifth year of the loan.

 

This program ceased inthe first quarter of 2003.  Nevertheless,because our obligation continues until the bank is paid in full by thecustomer, our commitment can remain outstanding for up to 8 years - the maximumterm of the consumer loan.

 

Our maximum obligationunder this arrangement is estimated to be approximately €1.4 million ($1.8million at the December 31, 2004 exchange rate).  To date, we have not been required torepurchase any pianos under this program and we believe the likelihood of suchrepurchase in the future is remote.  Accordinglywe have not recognized a liability for this obligation in our financialstatements.  Further, in the unlikelyevent of a repurchase, we believe the proceeds received upon our resale of thepiano would exceed the amount payable to the bank. 

 

**Legal and Environmental Matters** - We are involved in certain legalproceedings regarding environmental matters, which are described below.  Further, in the ordinary course of business,we are party to various legal actions that we believe are routine in nature andincidental to the operation of our business. While the outcome of such actions cannot be predicted with certainty, webelieve that, based

 

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on ourexperience in dealing with these matters, their ultimate resolution will nothave a material adverse impact on our business, financial condition, results ofoperations or prospects.

 

Weoperated manufacturing facilities at certain locations where hazardoussubstances (including chlorinated solvents) were used.  We believe that an entity that formerlyoperated one such facility may have released hazardous substances at suchlocation, which we leased through July 2001.  We did not contribute to the release.  Further, we have a contractual indemnity fromcertain stockholders of this 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 that legalproceedings will not arise in the future and that such indemnitors would makethe payments described in the indemnity.

 

Weoperate other manufacturing facilities that were previously owned by PhilipsElectronics North America Corporation (“Philips”).  Philips agreed to indemnify us for any andall losses, damages, liabilities and claims relating to environmental mattersresulting from certain activities of Philips occurring prior to December 29,1988 (the “Environmental Indemnity Agreement”). Philips has fully performed its obligations under the EnvironmentalIndemnity Agreement, which terminates on 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 actioninvolving a 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 apresent net cost of approximately $14.5 million.  The EPA has named over 40 persons or entitiesas potentially responsible parties at this site, which includes certainfacilities that we acquired in 2000.  Thismatter has been tendered to Philips pursuant to the Environmental IndemnityAgreement for those facilities that were acquired from Philips.  Our potential liability at any of these sitesis affected by several factors including, but not limited to, the method ofremediation, our portion of the materials in the site relative to the othernamed parties, the number of parties participating, and the financialcapabilities of the other potentially responsible parties once the relativeshare has been determined.  No assurancecan be given, however, that additional environmental issues will not requireadditional, currently unanticipated investigation, assessment or remediationexpenditures or that Philips will make payments that it is obligated to makeunder the Environmental Indemnity Agreement.

 

We arealso continuing an existing environmental remediation program at a facilityacquired in 2000.  We currently estimatethat this project will take eighteen years to complete, at a total cost ofapproximately $1.0 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

 

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discountrate of 4.54%.  A summary of expectedpayments associated with this project is as follows:

 

| ** ** | ** ** | **Environmental  Payments** | ** ** |
|------------|------------|-----------------------------|------------|
| 2005       |       |                        | $          | 237 |   |
| 2006       |       |                        | 75         |   |
| 2007       |       |                        | 54         |   |
| 2008       |       |                        | 47         |   |
| 2009       |       |                        | 47         |   |
| Thereafter |       |                        | 514        |   |
|       |       |                        | $          | 974 |   |

 

In2004, we acquired manufacturing facilities for which environmental remediationprograms had already been established.  Basedon our current assessment, we have accrued approximately $0.8 million for thecost of these remediation programs.

 

The matters describedabove and our other liabilities and compliance costs arising underenvironmental laws are not expected to have a material impact on our capitalexpenditures, earnings, or competitive position in any individual year.  However, some risk of environmental liabilityis inherent in the nature of our current and former business and we might, inthe future, incur material costs to meet current or more stringent compliance,cleanup, or other obligations pursuant to environmental laws.

 

**15.****       RetirementPlans**

 

We have defined benefitpension plans covering the majority of our employees, including certainemployees in foreign countries.  Certaindomestic hourly employees are covered by multi-employer defined benefit pensionplans to which we make contributions. These contributions totaled $1.1 million in 2004, $1.0 million in 2003and $1.0 million in 2002. The corresponding pension plan assets and liabilitiesbelong to third parties and, accordingly, are not reflected in this Note.

 

Our plan assets areinvested primarily in common stocks and fixed income securities.  We make contributions to our domestic planwith the objective of maintaining a fully funded status for the accumulatedbenefit obligation and a 90% funded status for the projected benefitobligation.  At a minimum, ourcontributions equal the amounts required by federal laws and regulations.  Foreign plans are funded in accordance withthe requirements of the regulatory bodies governing each plan.

 

EffectiveDecember 31, 2003, we amended the Steinway Salaried Pension Plan (the “SteinwayPlan”) to eliminate future years of service credit.  All distributions upon termination ofemployment will continue in the normal course under the Steinway Plan.  Since the Steinway Plan is based on years ofservice and is not impacted by salary increases, no curtailment gain or lossresulted from the amendment.

 

In December 2003,we combined all of our domestic pension plans into one plan, “The SteinwayMusical Pension Plan,” to facilitate plan monitoring and plan investmentmanagement.  We intend to establish amaster trust for this combined plan in 2005. We will continue to evaluate thisplan’s funded status and make any required minimum contributions annually.

 

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Thefollowing table sets forth the funded status and amounts recognized for ourdefined benefit pension plans:

 
| ** **                                          | ** ** | **Domestic Plans** | ** ** | **Foreign Plans** | ** ** |
|-----------------------------------------------------|------------|--------------------|------------|-------------------|------------|
| **December 31,**                               | ** ** | **2004**           | ** ** | **2003**          | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                |       |               |       |              |       |   |   |   |   |
| Change in benefit obligation:                       |       |               |       |              |       |   |   |   |   |
| Benefit obligation, beginning of year               |       | $                  | 43,987     |              | $          | 38,858 |   | $ | 24,026 |   | $ | 19,240 |   |
| Service cost                                        |       | 785                |       | 804               |       | 593 |   | 629 |   |
| Interest cost                                       |       | 2,837              |       | 2,564             |       | 1,295 |   | 1,100 |   |
| Plan participants’ contributions               |       | 13                 |       | 15                |       | 60 |   | — |   |
| Amendments                                          |       | 65                 |       | 1,841             |       | — |   | — |   |
| Actuarial (gain) loss                               |       | 3,821              |       | (715              | )          | 1,880 |   | 517 |   |
| Foreign currency exchange rate changes              |       | —             |       | —            |       | 2,059 |   | 3,550 |   |
| Curtailment gain                                    |       | (126               | )          | —            |       | — |   | — |   |
| Other                                               |       | —             |       | 2,384             |       | — |   | — |   |
| Benefits paid                                       |       | (2,506             | )          | (1,764            | )          | (1,150 | ) | (1,010 | ) |
| Benefit obligation, end of year                     |       | 48,876             |       | 43,987            |       | 28,763 |   | 24,026 |   |
|                                                |       |               |       |              |       |   |   |   |   |
| Change in plan assets:                              |       |               |       |              |       |   |   |   |   |
| Fair value of plan assets, beginning of year        |       | 42,353             |       | 27,379            |       | 3,788 |   | 3,313 |   |
| Actual return on plan assets                        |       | 5,187              |       | 6,507             |       | 352 |   | 75 |   |
| Employer contribution                               |       | 2,350              |       | 8,293             |       | 1,124 |   | 982 |   |
| Employee contributions                              |       | 13                 |       | 15                |       | 60 |   | 55 |   |
| Foreign currency exchange rate changes              |       | —             |       | —            |       | 302 |   | 373 |   |
| Other                                               |       | —             |       | 2,146             |       | — |   | — |   |
| Benefits paid                                       |       | (2,506             | )          | (1,987            | )          | (1,150 | ) | (1,010 | ) |
| Fair value of plan assets, end of year              |       | 47,397             |       | 42,353            |       | 4,476 |   | 3,788 |   |
|                                                |       |               |       |              |       |   |   |   |   |
| Funded status                                       |       | (1,479             | )          | (1,634            | )          | (24,287 | ) | (20,238 | ) |
|                                                |       |               |       |              |       |   |   |   |   |
| Unrecognized net actuarial loss                     |       | 8,656              |       | 6,596             |       | 3,623 |   | 1,605 |   |
| Unrecognized prior service cost                     |       | 2,801              |       | 3,782             |       | — |   | — |   |
| Net amount recognized                               |       | $                  | 9,978      |              | $          | 8,744 |   | $ | (20,664 | ) | $ | (18,633 | ) |
|                                                |       |               |       |              |       |   |   |   |   |
| Amounts recognized in the balance sheet consist of: |       |               |       |              |       |   |   |   |   |
| Accrued benefit cost                                |       | $                  | (1,479     | )                 | $          | (1,634 | ) | $ | (22,810 | ) | $ | (18,890 | ) |
| Intangible assets                                   |       | 2,801              |       | 3,782             |       | — |   | — |   |
| Additional minimum pension liability                |       | 8,656              |       | 6,596             |       | 2,146 |   | 257 |   |
| Net amount recognized                               |       | $                  | 9,978      |              | $          | 8,744 |   | $ | (20,664 | ) | $ | (18,633 | ) |

 

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

 
| ** **                    | ** ** | **Domestic Plans** | ** ** | **Foreign Plans** | ** ** |
|-------------------------------|------------|--------------------|------------|-------------------|------------|
| **December 31,**         | ** ** | **2004**           | ** ** | **2003**          | ** ** | **2002** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|                          |       |               |       |              |       |   |   |   |   |   |   |   |   |
| Discount rate                 |       | 6.00               | %          | 6.50              | %          | 6.75 | % | 4.85 | % | 5.52 | % | 5.53 | % |
| Rate of compensation increase |       | n/a                |       | n/a               |       | 4.0 |   | 2.49 | % | 2.88 | % | 2.75 | % |

 

53

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The weighted-averageassumptions used to determine our net periodic benefit cost are as follows:

 
| ** **                                | ** ** | **Domestic Plans** | ** ** | **Foreign Plans** | ** ** |
|-------------------------------------------|------------|--------------------|------------|-------------------|------------|
| **For the years ended December 31,** | ** ** | **2004**           | ** ** | **2003**          | ** ** | **2002** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Discount rate                             |       | 6.50%              |       | 6.75%             |       | 7.50% |   | 4.95% |   | 5.52% |   | 5.53% |   |
| Expected return  on assets                |       | 9.0                |       | 9.0               |       | 9.0 |   | 6.75 |   | 6.75 |   | 6.75 |   |
| Rate of  compensation increase            |       | n/a                |       | n/a               |       | 4.0 |   | 2.56% |   | 2.88% |   | 2.75% |   |

 

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

 
| **For the years ended December 31,** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                      |       |     |       |     |       |     |       |
| Domestic Plans:                           |       |     |       |     |       |     |       |
| Service cost                              |       | $        | 785        |     | $          | 804      |       | $ | 1,354 |   |
| Interest cost                             |       | 2,837    |       | 2,564    |       | 2,508    |       |
| Expected return on plan assets            |       | (3,820   | )          | (2,539   | )          | (3,170   | )          |
| Amortization of prior service cost        |       | 585      |       | 585      |       | 410      |       |
| Recognized actuarial loss                 |       | 269      |       | 540      |       | 5        |       |
| Other                                     |       | —   |       | 237      |       | —   |       |
| Curtailment loss                          |       | 461      |       | —   |       | 10       |       |
| Net pension expense                       |       | $        | 1,117      |     | $          | 2,191    |       | $ | 1,117 |   |
|                                      |       |     |       |     |       |     |       |
| Foreign Plans:                            |       |     |       |     |       |     |       |
| Service cost                              |       | $        | 593        |     | $          | 629      |       | $ | 574 |   |
| Interest cost                             |       | 1,295    |       | 1,100    |       | 1,054    |       |
| Expected return on plan assets            |       | (223     | )          | (189     | )          | (145     | )          |
| Net pension expense                       |       | $        | 1,665      |     | $          | 1,540    |       | $ | 1,483 |   |

 

Theprojected benefit obligation, accumulated benefit obligation, and fair value ofplan assets for pension plans with accumulated benefit obligations in excess ofplan assets were as follows:

 
| ** **                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|
| Projected benefit obligation   |       | $        | 77,639     |     | $          | 68,013 |   |
| Accumulated benefit obligation |       | 76,161   |       | 65,863   |       |
| Fair value of plan assets      |       | 51,873   |       | 46,141   |       |
|                                |            |          |            |          |            |  |  |

 

The accumulated benefitobligation for our domestic pension plans was $48.9 million in 2004 and $44.0million in 2003.  The accumulated benefitobligation for our foreign pension plans was $27.3 million in 2004 and $21.9million in 2003.

 

54

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The weighted-averageasset allocations of our invested assets held in our domestic defined benefitplans were as follows:

 
| **December 31,** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------|------------|----------|------------|----------|------------|
|                  |       |     |       |     |       |   |
| Asset category:       |       |     |       |     |       |   |
| Debt securities       |       | 37       | %          |     | 38         | % |   |
| Equity securities     |       | 61       | %          |     | 48         | % |   |
| Other                 |       | 2        | %          |     | 14         | % |   |
| Total                 |       | 100      | %          |     | 100        | % |   |

 

Domestic plan assets include 52,631 shares of theCompany’s Ordinary common stock, which was valued at $1.5 million as of December 31,2004 and $1.3 million as of December 31, 2003.  This represents less than 4% of the totalplan assets.

 

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 debt securities             |       | 5           | %          |        | 15         | % |   |
| Domestic debt securities                  |       | 20          | %          |        | 40         | % |   |

 

The objective of our investment policy is to maximize thereturn on invested assets while maintaining an appropriate level ofdiversification to minimize risk.  Ourpolicy sets forth specific criteria used in the selection and ongoingevaluation of individual fund managers.

 

Our investment committeegenerally meets on a quarterly basis with an outside registered investmentadvisor to review actual performance against relevant benchmarks, such as theS&P 500 Index.  Consistent with ourpolicy, changes in fund managers are made when a fund falls outside of our predeterminedguidelines for an extended period.

 

The investment committeereviews our domestic benefit obligations no less than annually with the objectiveof maintaining a fully funded status for the accumulated benefit obligation anda 90% funded status for the projected benefit obligation.  Whenever possible, our annual contribution isexpected to cover the short-term liquidity requirements of the plan, so as tomaintain the plan’s assets for long-term investment.  The performance goal set for the plan’sassets is to achieve a long-term rate of return no less than 8.5%.

 

For the periods ended December 31,2004 and December 31, 2003 we used an assumed long-term rate of return ondomestic plan assets of 9% and foreign plan assets of 6.75%.  These rates were developed with input fromour actuaries and our investment committee and are based on long-term rates ofreturn for the assets held.  This rate isconsistent with both previous rates we have used and the historical returntrends on our plan assets.

 

55

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Our German plans do nothold assets and pay participant benefits as incurred.  Expected 2005 benefit payments under theseplans are $1.1 million.  The domesticplan invests a small portion of its assets in a group annuity contract.  2005 benefits expected to be covered by thiscontract are $0.2 million.

 

We made contributions toour domestic pension plan of $2.4 million in 2004 and $8.3 million in 2003.Based on our funding history, we are not required to make a contribution to ourdomestic pension plan in 2005. Nevertheless, we anticipate contributing approximately $1.5 million in2005.

 

Contributions to our U.K.plan totaled $0.2 million in both 2004 and 2003.  We anticipate contributing approximately $0.2million to this plan in 2005.  Due to theunfunded status of the German plans, 2005 anticipated contributions are equalto anticipated benefit payments of $1.1 million.

 

Thedomestic and foreign pension plans expect to pay benefits in each year from2005 through 2014 as follows:

 

| ** **  | ** ** | **Domestic Plans** | ** ** | **Foreign Plans** | ** ** |
|-------------|------------|--------------------|------------|-------------------|------------|
| 2005        |       | $                  | 2,356      |              | $          | 1,332 |   |
| 2006        |       | 2,485              |       | 1,327             |       |
| 2007        |       | 2,649              |       | 1,326             |       |
| 2008        |       | 2,765              |       | 1,300             |       |
| 2009        |       | 2,924              |       | 1,307             |       |
| 2010 - 2014 |       | 16,328             |       | 7,159             |       |
|        |       | $                  | 29,507     |              | $          | 13,751 |   |

 

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

 

56

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

 
| **December 31,**                 | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|
|                                  |       |     |       |     |       |
| Change in benefit obligation:         |       |     |       |     |       |
| Benefit obligation, beginning of year |       | $        | 2,267      |     | $          | 2,014 |   |
| Service cost                          |       | 24       |       | 70       |       |
| Interest cost                         |       | 110      |       | 139      |       |
| Plan participants’ contributions |       | 63       |       | 49       |       |
| Curtailment gain                      |       | (255     | )          | —   |       |
| Actuarial (gain) loss                 |       | (393     | )          | 145      |       |
| Benefits paid                         |       | (219     | )          | (150     | )          |
| Benefit obligation, end of year       |       | 1,597    |       | 2,267    |       |
|                                  |       |     |       |     |       |
| Fair value of plan assets             |       | —   |       | —   |       |
|                                  |       |     |       |     |       |
| Funded status                         |       | (1,597   | )          | (2,267   | )          |
| Unrecognized net actuarial loss       |       | (185     | )          | 463      |       |
| Unrecognized prior service cost       |       | 311      |       | 457      |       |
| Accrued postretirement benefit cost   |       | $        | (1,471     | )        | $          | (1,347 | ) |

 

The assumedweighted-average discount rate used to determine benefit obligations as of December 31was 6.00% in 2004, 6.50% in 2003 and 6.75% in 2002.  The assumed weighted-average discount rateused to determine our net postretirement benefit cost for the years ended December 31was 6.5% in 2004, 6.75% in 2003, and 7.50% in 2002.  The annual assumed rate of increase in theper capita cost of covered health care benefits was 10.0% in 2004 and isassumed to decrease gradually to 5.50% in 2013, and remain at that levelthereafter.

 

Net postretirementbenefit costs are as follows:

 
| **For the years ended December 31,** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                      |       |     |       |     |       |     |       |
| Service cost                              |       | $        | 24         |     | $          | 70       |       | $ | 60 |   |
| Interest cost                             |       | 110      |       | 139      |       | 129      |       |
| Net loss recognition                      |       | —   |       | —   |       | —   |       |
| Amortization of prior service cost        |       | 146      |       | 62       |       | 48       |       |
| Net postretirement benefit cost           |       | $        | 280        |     | $          | 271      |       | $ | 237 |   |

 

Assumed health care costtrend rates have a significant effect on the amounts reported for the healthcare plan.  A one-percentage-point changein assumed health care cost trend rates would have the following effects:

 
| ** **                                               | ** ** | **1%  Increase** | ** ** | **1%  Decrease** | ** ** |
|----------------------------------------------------------|------------|------------------|------------|------------------|------------|
|                                                     |       |             |       |             |       |
| Effect on total of service and interest cost  components |       | $                | 6          |             | $          | (6 | ) |
| Effect on the postretirement benefit obligation          |       | 63               |       | (56              | )          |
|                                                          |            |                  |            |                  |            |  |  |

 

57

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Thedomestic postretirement health care and life insurance plan expects to paybenefits in each year from 2005 through 2014 as follows:

 
| 2005       |   | $     | 275    |   |
|------------|--------|-------|--------|--------|
| 2006       |   | 300   |   |
| 2007       |   | 310   |   |
| 2008       |   | 325   |   |
| 2009       |   | 340   |   |
| Thereafter |   | 1,560 |   |
| Total      |   | $     | 3,110  |   |

 

We sponsor 401(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 2004, $0.6 million for 2003, and $0.5 millionfor 2002.  Non-discretionary contributionsapproximated $0.4 million for the year ended December 31, 2004, $0.5million for 2003, and $0.3 million for 2002.

 

Weestablished a supplemental executive retirement plan (“SERP”) for a selectgroup of our executives who constitute a “top hat” group as defined byERISA.  Discretionary employercontributions made to this plan, as determined annually by the Board ofDirectors, are held in a Rabbi Trust (“Trust”). The SERP assets are included in our financial statements asavailable-for-sale investments within other long-term assets since the Trustpermits our creditors to access our SERP assets in the event of our insolvency(see Notes 7 and 17).  We have no otherclaims to the assets contained in the Trust. The contributions approximated $0.2 million in 2004, less than $0.1million in 2003, and $0.2 million in 2002. We anticipate making contributions of $0.2 million in 2005.

 

**16.****       ForeignCurrency Exchange Contracts**

 

One of our Germandivisions, whose functional currency is the euro, secures option and forwardcontracts for Japanese yen, British pounds, and U.S. dollars solely to mitigatecash flow exposure to currency fluctuations. At December 31, 2004, thisdivision had forward contracts to purchase $1.5 million and sell £0.9 million.These instruments had various maturity dates through July 2005.  At December 31, 2003, these divisions hadoptions and forward contracts to sell £1.8 million. These instruments hadvarious maturity dates through December 2004.  Since we do not designate these instrumentsas hedges for accounting purposes, we carry these instruments at fair value andrecognize the change in fair value in earnings. Such amounts were not materialduring the years ended December 31, 2004, 2003, or 2002.

 

**17.****       FairValues of Financial Instruments**

 

Estimatedfair values of financial instruments have been developed using appropriatemethodologies; however, considerable judgment is required to develop theseestimates.  The estimated fair value ofexisting long-term debt is based on rates currently available to us for debtwith similar terms and remaining maturities. The estimated fair value of foreign currency contracts (used to mitigatecash flow exposures) has been determined as the difference between the current forwardrate and the contract rate, multiplied by the notional amount of the contract,or upon the estimated fair value of purchased option contracts. 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.

 

58

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The net carrying value and estimated fair value of ourfinancial instruments are as follows:

 
| **December 31,**      | ** **              | **2004**   | ** **                | **2003**   | ** **              |
|----------------------------|-------------------------|------------|---------------------------|------------|-------------------------|
| ** **                 | **Net Carrying  Value** | ** ** | **Estimated  Fair Value** | ** ** | **Net Carrying  Value** | ** ** | **Estimated  Fair Value** | ** ** |
| Financial liabilities:     |                    |       |                      |       |                    |   |   |   |   |
| Long-term debt             |                    | $          | 221,208                   |       | $                       | 236,829 |   | $ | 196,602 |   | $ | 209,000 |   |
| Foreign currency contracts |                    | (98        | )                         | (98        | )                       | — |   | (78 | ) |
| Interest rate contracts    |                    | —     |                      | —     |                    | — |   | (18 | ) |
|                            |                         |            |                           |            |                         |  |  |  |  |  |  |  |  |

 

The carrying value ofaccounts, notes and other receivables, marketable equity securities, andaccounts payable approximate fair value.

 

Our marketable equitysecurities pertain to the SERP and are included as a component of other assets(see Notes 7 and 15).  Investments inmarketable equity securities are categorized as trading, available-for-sale, orheld-to-maturity.  On December 31,2004 and 2003, we had only available-for-sale securities, which are stated atfair value, with unrealized gains and losses, net of deferred taxes, reportedin accumulated other comprehensive loss. Included in accumulated other comprehensive loss were unrealized netgains of $0.1 million at December 31, 2004 and 2003.  Gross unrealized gains and losses on theseinvestments were as follows:

 
| **December 31,**      | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|
|                       |       |     |       |     |       |
| Gross unrealized gains     |       | $        | 165        |     | $          | 216 |   |
| Gross unrealized losses    |       | (81      | )          | (25      | )          |
| Net unrealized gain (loss) |       | $        | 84         |     | $          | 191 |   |

 

The cost and fair valueamounts of our marketable equity securities are as follows:

 
| **December 31,** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------|------------|----------|------------|----------|------------|
|                  |       |     |       |     |       |
| Cost                  |       | $        | 735        |     | $          | 688 |   |
| Fair value            |       | 891      |       | 760      |       |
|                       |            |          |            |          |            |  |  |

 

59

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**18.****       SegmentInformation**

 

As discussed in Note 2,we have identified two reportable segments: the piano segment and the band &orchestral instrument segment.  Weconsider these two segments reportable as they are managed separately and theoperating results of each segment are separately reviewed and evaluated by oursenior management on a regular basis.

 

Intercompany transactionsare generally recorded at an appropriate discount from comparable third-partyprices. Income from operations for the reportable segments includesintercompany profit, as well as certain corporate costs allocated to thesegments based primarily on revenue. Amounts reported as “Other & Elim” include those corporatecosts that were not allocated to the reportable segments and the remainingintercompany profit elimination.  It alsoincludes corporate assets, elimination of intercompany interest, and investmentsin subsidiaries that do not eliminate within the segments.

 

Thefollowing tables present information about our reportable segments:

 
| ** **                       | ** ** | **Piano Segment** | ** ** | **Band & Orchestral Segment** | ** ** | **Other & Elim** | ** ** | **Consolidated** | ** ** |
|----------------------------------|------------|-------------------|------------|----------------------------------------|------------|---------------------------|------------|------------------|------------|
| ** **                       | ** ** | **U.S.**          | ** ** | **Germany**                            | ** ** | **Other**                 | ** ** | **Total**        | ** ** | **U.S.** | ** ** | **Other** | ** ** | **Total** | ** ** | ** ** | ** ** |
| **2004**                         |       |              |       |                                   |       |                      |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Revenues from external customers |       | $                 | 120,387    |                                   | $          | 48,348                    |       | $                | 34,953     |   | $ | 203,688 |   | $ | 165,652 |   | $ | 5,694 |   | $ | 171,346 |   | $ | — |   | $ | 375,034 |   |
| Operating profit                 |       | 13,688            |       | 11,968                                 |       | 3,999                     |       | 29,655           |       | 7,175 |   | (156 | ) | 7,019 |   | (2,433 | ) | 34,241 |   |
| Interest income                  |       | (23               | )          | (44                                    | )          | (181                      | )          | (248             | )          | (2,581 | ) | — |   | (2,581 | ) | — |   | (2,829 | ) |
| Interest expense                 |       | 9,690             |       | 35                                     |       | 250                       |       | 9,975            |       | 25,862 |   | 3 |   | 25,865 |   | (19,574 | ) | 16,266 |   |
| Depreciation and amortization    |       | 4,427             |       | 1,369                                  |       | 348                       |       | 6,144            |       | 4,477 |   | 36 |   | 4,513 |   | 526 |   | 11,183 |   |
| Income tax provision (benefit)   |       | 3,870             |       | 3,093                                  |       | 1,336                     |       | 8,299            |       | (3,829 | ) | 61 |   | (3,768 | ) | 3,569 |   | 8,100 |   |
| Net income (loss)                |       | 1,780             |       | 9,929                                  |       | 2,878                     |       | 14,587           |       | (12,052 | ) | (177 | ) | (12,229 | ) | 13,509 |   | 15,867 |   |
| Capital expenditures             |       | 2,229             |       | 915                                    |       | 304                       |       | 3,448            |       | 1,621 |   | 44 |   | 1,665 |   | 73 |   | 5,186 |   |
| Property                         |       | 57,931            |       | 15,799                                 |       | 2,211                     |       | 75,941           |       | 25,765 |   | 1,057 |   | 26,822 |   | 181 |   | 102,944 |   |
| Total assets                     |       | 178,262           |       | 85,033                                 |       | 23,349                    |       | 286,644          |       | 371,786 |   | 11,476 |   | 383,262 |   | (192,361 | ) | 477,545 |   |
|                             |       |              |       |                                   |       |                      |       |             |       |   |   |   |   |   |   |   |   |   |   |
| **2003**                         |       |              |       |                                   |       |                      |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Revenues from external customers |       | $                 | 107,997    |                                   | $          | 47,276                    |       | $                | 24,487     |   | $ | 179,760 |   | $ | 152,914 |   | $ | 4,546 |   | $ | 157,460 |   | $ | — |   | $ | 337,220 |   |
| Operating profit                 |       | 12,018            |       | 6,784                                  |       | 2,963                     |       | 21,765           |       | 2,794 |   | 145 |   | 2,939 |   | (1,880 | ) | 22,824 |   |
| Interest income                  |       | (26               | )          | (66                                    | )          | (20                       | )          | (112             | )          | (2,063 | ) | — |   | (2,063 | ) | — |   | (2,175 | ) |
| Interest expense                 |       | 9,594             |       | 190                                    |       | 162                       |       | 9,946            |       | 24,485 |   | — |   | 24,485 |   | (20,311 | ) | 14,120 |   |
| Depreciation and amortization    |       | 4,424             |       | 1,343                                  |       | 231                       |       | 5,998            |       | 4,430 |   | 21 |   | 4,451 |   | 510 |   | 10,959 |   |
| Income tax provision (benefit)   |       | 1,038             |       | 2,806                                  |       | 1,101                     |       | 4,945            |       | (5,916 | ) | 60 |   | (5,856 | ) | 5,609 |   | 4,698 |   |
| Net income (loss)                |       | 3,139             |       | 4,581                                  |       | 1,901                     |       | 9,621            |       | (13,163 | ) | 87 |   | (13,076 | ) | 13,153 |   | 9,698 |   |
| Capital expenditures             |       | 1,790             |       | 725                                    |       | 229                       |       | 2,744            |       | 2,636 |   | — |   | 2,636 |   | 82 |   | 5,462 |   |
| Property                         |       | 58,749            |       | 14,909                                 |       | 1,721                     |       | 75,379           |       | 23,382 |   | 4 |   | 23,386 |   | 172 |   | 98,937 |   |
| Total assets                     |       | 139,855           |       | 76,307                                 |       | 16,756                    |       | 232,918          |       | 350,101 |   | 3,586 |   | 353,687 |   | (140,940 | ) | 445,665 |   |
|                             |       |              |       |                                   |       |                      |       |             |       |   |   |   |   |   |   |   |   |   |   |
| **2002**                         |       |              |       |                                   |       |                      |       |             |       |   |   |   |   |   |   |   |   |   |   |
| 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 provision (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 |   |
| Property                         |       | 60,309            |       | 12,940                                 |       | 1,469                     |       | 74,718           |       | 27,668 |   | 22 |   | 27,690 |   | 159 |   | 102,567 |   |
| Total assets                     |       | 134,418           |       | 65,726                                 |       | 13,334                    |       | 213,478          |       | 388,880 |   | 3,192 |   | 392,072 |   | (181,819 | ) | 423,731 |   |

 

60

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**19.****       Summaryof Bond Guarantees**

 

On April 19,2001, we completed a $150.0 million 8.75% Senior Note offering.  We subsequently repurchased $4.7 million ofthese notes in 2002 and issued $29.0 million of these notes in 2004.  Our payment obligations under the 8.75%Senior Notes are fully and unconditionally guaranteed on a joint and severalbasis by Conn-Selmer, Leblanc, Steinway, and certain other of our direct andindirect wholly-owned subsidiaries, each a “Guarantor” (the “GuarantorSubsidiaries”).  These subsidiariesrepresent all of our (the “Issuer”) operations conducted in the United States.

 

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

 

We record investments insubsidiaries using the cost method for purposes of the supplemental consolidatingpresentation.  Earnings of subsidiariesare therefore not reflected in our investment accounts and earnings.  The principal elimination entries eliminateinvestments in subsidiaries and intercompany balances and transactions.

 

61

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Steinway Musical Instruments, Inc. and Subsidiaries

**CONDENSEDCONSOLIDATING STATEMENTS OF INCOME**

YearEnded December 31, 2004 (In Thousands)

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

 

62

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Steinway Musical Instruments, Inc. and Subsidiaries

**CONDENSEDCONSOLIDATING STATEMENTS OF INCOME**

YearEnded December 31, 2003 (In Thousands)

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

 

63

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Steinway Musical Instruments, Inc. and Subsidiaries

**CONDENSEDCONSOLIDATING STATEMENTS OF INCOME**

YearEnded December 31, 2002 (In Thousands)

 
| ** **                        | ** ** | **Issuer  of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net sales                         |       | $                    | —     |                        | $          | 278,421                          |       | $                          | 65,065     |             | $          | (11,189 | ) | $ | 332,297 |   |
| Cost of sales                     |       | —               |       | 204,036                     |       | 42,205                           |       | (11,095                    | )          | 235,146          |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Gross profit                      |       | —               |       | 74,385                      |       | 22,860                           |       | (94                        | )          | 97,151           |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Operating expenses:               |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Sales and marketing               |       | —               |       | 31,136                      |       | 10,048                           |       | (55                        | )          | 41,129           |       |
| General and administrative        |       | 4,677                |       | 13,373                      |       | 4,467                            |       | —                     |       | 22,517           |       |
| Amortization                      |       | 452                  |       | 698                         |       | 4                                |       | —                     |       | 1,154            |       |
| Other operating (income) expense  |       | (3,204               | )          | 3,223                       |       | 878                              |       | 55                         |       | 952              |       |
| Total operating expenses          |       | 1,925                |       | 48,430                      |       | 15,397                           |       | —                     |       | 65,752           |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Income (loss) from operations     |       | (1,925               | )          | 25,955                      |       | 7,463                            |       | (94                        | )          | 31,399           |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Other income, 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 tax provision (benefit)    |       | (185                 | )          | 4,033                       |       | 3,317                            |       | (15                        | )          | 7,150            |       |
|                              |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income (loss)                 |       | $                    | (564       | )                           | $          | 10,195                           |       | $                          | 5,357      |             | $          | (79 | ) | $ | 14,909 |   |

 

64

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Steinway Musical Instruments, Inc. and Subsidiaries

**CONDENSEDCONSOLIDATING BALANCE SHEETS**

December 31,2004 (In Thousands)

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

 

65

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Steinway MusicalInstruments, Inc. and Subsidiaries

**CONDENSEDCONSOLIDATING BALANCE SHEETS**

December 31,2003 (In Thousands)

 
| ** **                                      | ** ** | **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 other receivables, 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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Steinway Musical Instruments,Inc. and Subsidiaries

**CONDENSEDCONSOLIDATING STATEMENTS OF CASH FLOWS**

YearEnded December 31, 2004 (In Thousands)

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

 

67

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Steinway MusicalInstruments, Inc. and Subsidiaries

**CONDENSEDCONSOLIDATING STATEMENTS OF CASH FLOWS**

YearEnded December 31, 2003 (In Thousands)

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

 

68

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 Steinway Musical Instruments, Inc. andSubsidiaries

**CONDENSEDCONSOLIDATING STATEMENTS OF CASH FLOWS**

YearEnded December 31, 2002 (In Thousands)

 
| ** **                                                                           | ** ** | **Issuer  Of Notes** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non  Guarantor  Subsidiaries** | ** ** | **Reclass/  Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------|------------|-----------------------------|------------|----------------------------------|------------|----------------------------|------------|------------------|------------|
| Cash flows from operating activities:                                                |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Net income (loss)                                                                    |       | $                    | (564       | )                           | $          | 10,195                           |       | $                          | 5,357      |             | $          | (79 | ) | $ | 14,909 |   |
| Adjustments to reconcile net income (loss) to cash  flows from operating activities: |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Depreciation and amortization                                                        |       | 513                  |       | 8,978                       |       | 1,546                            |       | —                     |       | 11,037           |       |
| 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 assets                                                    |       | (462                 | )          | (2,293                      | )          | (149                             | )          | —                     |       | (2,904           | )          |
| Accounts payable                                                                     |       | 14                   |       | 850                         |       | 937                              |       | 44                         |       | 1,845            |       |
| Other liabilities                                                                    |       | 1,524                |       | (2,904                      | )          | (429                             | )          | (1,286                     | )          | (3,095           | )          |
| Cash flows from operating activities                                                 |       | 1,025                |       | 23,338                      |       | 4,536                            |       | —                     |       | 28,899           |       |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Cash flows from investing activities:                                                |       |                 |       |                        |       |                             |       |                       |       |             |       |
| Capital expenditures                                                                 |       | (4                   | )          | (4,920                      | )          | (680                             | )          | —                     |       | (5,604           | )          |
| Proceeds from sales of fixed assets                                                  |       | —               |       | 4                           |       | —                           |       | —                     |       | 4                |       |
| Capital contribution to subsidiary                                                   |       | —               |       | (705                        | )          | 705                              |       | —                     |       | —           |       |
| Cash flows from investing activities                                                 |       | (4                   | )          | (5,621                      | )          | 25                               |       | —                     |       | (5,600           | )          |
|                                                                                 |       |                 |       |                        |       |                             |       |                       |       |             |       |
| 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         | )          |
| Repayment of long-term debt                                                          |       | —               |       | (6,352                      | )          | —                           |       | —                     |       | (6,352           | )          |
| Repurchase of long-term debt                                                         |       | (4,655               | )          | —                      |       | —                           |       | —                     |       | (4,655           | )          |
| 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 |   |

 

69

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**20.****       QuarterlyFinancial Data (Unaudited)**

 

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

 
| ** **                                | ** ** | **2004**           | ** ** |
|-------------------------------------------|------------|--------------------|------------|
| **For the years ended December 31,** | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|                                      |       |               |       |   |   |   |   |   |   |
| Net sales                                 |       | $                  | 90,061     |   | $ | 83,688 |   | $ | 94,653 |   | $ | 106,632 |   |
| Gross profit                              |       | 25,725             |       | 24,403 |   | 25,896 |   | 33,109 |   |
| Net income                                |       | 3,344              |       | 2,714 |   | 2,828 |   | 6,981 |   |
|                                      |       |               |       |   |   |   |   |   |   |
| Basic income per share                    |       | $                  | 0.41       |   | $ | 0.34 |   | $ | 0.35 |   | $ | 0.87 |   |
| Diluted income per share                  |       | $                  | 0.39       |   | $ | 0.33 |   | $ | 0.34 |   | $ | 0.85 |   |
|                                      |       |               |       |   |   |   |   |   |   |
| Weighted average shares:                  |       |               |       |   |   |   |   |   |   |
| Basic                                     |       | 8,210,407          |       | 7,957,483 |   | 7,998,481 |   | 8,018,655 |   |
| Diluted                                   |       | 8,519,707          |       | 8,340,726 |   | 8,282,498 |   | 8,229,775 |   |
|                                      |       |               |       |   |   |   |   |   |   |
| ** **                                | ** ** | **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 |   |

 

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SteinwayMusical Instruments, Inc. and Subsidiaries

**SCHEDULE II - VALUATION ANDQUALIFYING ACCOUNTS**(InThousands)

 
| **Year ended December 31,**                        | ** ** | **Balance at  Beginning  of Year** | ** ** | **Additions  Charged to  Costs and  Expenses** | ** ** | **Acquistions (1)** | ** ** | **Foreign  Currency  Translation  Adjustments** | ** ** | **Deductions** | ** ** | **Balance at  End of Year** | ** ** |
|----------------------------------------------------|------------|------------------------------------|------------|------------------------------------------------|------------|---------------------|------------|-------------------------------------------------|------------|----------------|------------|-----------------------------|------------|
|                                               |       |                               |       |                                           |       |                |       |                                            |       |           |       |                        |       |
| Reserves deducted from assets to which they apply: |       |                               |       |                                           |       |                |       |                                            |       |           |       |                        |       |
|                                               |       |                               |       |                                           |       |                |       |                                            |       |           |       |                        |       |
| Allowance for doubtful accounts:                   |       |                               |       |                                           |       |                |       |                                            |       |           |       |                        |       |
| 2002                                               |       | $                                  | 10,909     |                                           | $          | 242                 |       | $                                               | —     |           | $          | 91                          |       | $ | 147 |  (2) | $ | 11,389 |   |
| 2003                                               |       | 11,389                             |       | 218                                            |       | —              |       | 65                                              |       | (1,728         | )(2)       | 9,944                       |       |
| 2004                                               |       | 9,944                              |       | 848                                            |       | 1,555               |       | 39                                              |       | (575           | )          | 11,811                      |       |
|                                               |       |                               |       |                                           |       |                |       |                                            |       |           |       |                        |       |
| Inventory obsolescence:                            |       |                               |       |                                           |       |                |       |                                            |       |           |       |                        |       |
| 2002                                               |       | $                                  | 4,739      |                                           | $          | 1,644               |       | $                                               | —     |           | $          | 95                          |       | $ | (987 | ) | $ | 5,491 |   |
| 2003                                               |       | 5,491                              |       | 731                                            |       | —              |       | 126                                             |       | (633           | )          | 5,715                       |       |
| 2004                                               |       | 5,715                              |       | 1,229                                          |       | 2,703               |       | 30                                              |       | (2,103         | )          | 7,574                       |       |
|                                               |       |                               |       |                                           |       |                |       |                                            |       |           |       |                        |       |
| Reserves included in other current liabilities:    |       |                               |       |                                           |       |                |       |                                            |       |           |       |                        |       |
|                                               |       |                               |       |                                           |       |                |       |                                            |       |           |       |                        |       |
| Accrued warranty expense:                          |       |                               |       |                                           |       |                |       |                                            |       |           |       |                        |       |
| 2002                                               |       | $                                  | 2,221      |                                           | $          | 950                 |       | $                                               | —     |           | $          | 152                         |       | $ | (966 | ) | $ | 2,357 |   |
| 2003                                               |       | 2,357                              |       | 1,361                                          |       | —              |       | 198                                             |       | (1,314         | )          | 2,602                       |       |
| 2004                                               |       | 2,602                              |       | 932                                            |       | —              |       | 60                                              |       | (1,455         | )          | 2,139                       |       |
|                                               |       |                               |       |                                           |       |                |       |                                            |       |           |       |                        |       |
| Accrued environmental expense:                     |       |                               |       |                                           |       |                |       |                                            |       |           |       |                        |       |
| 2002                                               |       | $                                  | 500        |                                           | $          | 380                 |       | $                                               | —     |           | $          | —                      |       | $ | (270 | ) | $ | 610 |   |
| 2003                                               |       | 610                                |       | 267                                            |       | —              |       | —                                          |       | (87            | )          | 790                         |       |
| 2004                                               |       | 790                                |       | 135                                            |       | 815                 |       | —                                          |       | (207           | )          | 1,533                       |       |
|                                               |       |                               |       |                                           |       |                |       |                                            |       |           |       |                        |       |
| Reserve for recourse obligation on customer notes: |       |                               |       |                                           |       |                |       |                                            |       |           |       |                        |       |
| 2002                                               |       | $                                  | 849        |                                           | $          | —              |       | $                                               | —     |           |       |                        | $          | (849 | )(2) | $ | — |   |
| 2003                                               |       | —                             |       | —                                         |       | —              |       | —                                          |       | —         |       | —                      |       |
| 2004                                               |       | —                             |       | —                                         |       | 1,138               |       | —                                          |       | 21             |       | 1,159                       |       |

 

----

Note:                   (1)  Reserves recognized in connection with theLeblanc acquisition (See Note 3.)

(2)  Represents accounts written off, net ofrecoveries, and reclassifications to and from other accounts

 

71

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**Item9.  Changes in and Disagreements withAccountants on Accounting and Financial Disclosure**

 

Not applicable.

 

**Item 9A. Controls and Procedures**

 

### **DisclosureControls and Procedures**

### ** **

Our principal executive officer and our principalfinancial officer, after evaluating, together with management, theeffectiveness of the design and operation of our disclosure controls andprocedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of December 31,2004, the end of the period covered by this report, have concluded that, as ofsuch date, our disclosure controls and procedures were adequate and effectiveto ensure that material information relating to our company and ourconsolidated subsidiaries would be made known to them by others within thoseentities.

 

### **Internal Control OverFinancial Reporting**

### ** **

### **Therewere changes in our company’s internal control over financial reporting thatoccurred during the fourth quarter of 2004 which resulted from controlimprovement and remediation efforts. These changes have not materially affected, and are not likely tomaterially affect, our company’s internal control over financial reporting.**

### ** **

**MANAGEMENT’SANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING**

 

The management of Steinway Musical Instruments, Inc.and its subsidiaries (the “Company”) is responsible for establishing andmaintaining adequate internal control over financial reporting as defined inRules 13a – 15(f) and 15d – 15(f) under the Securities Exchange Act of1934.  The Company’s internal controlover financial reporting is a process designed by, or under the supervision ofthe Company’s principal executive and principal financial officers, andeffected by the Company’s board of directors, management and other personnel,to provide reasonable assurance regarding the reliability of financialreporting and the preparation of the Company’s financial statements forexternal purposes in accordance with generally accepted accountingprinciples.  Internal control overfinancial reporting includes those policies and procedures that:

 

(1)                                  pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the Company;

 

(2)                                  providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles;

 

(3)                                  providereasonable assurance that receipts and expenditures of the Company are beingmade only in accordance with authorizations of management and directors of theCompany; and

 

(4)                                  providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use or disposition of the Company’s assets that could have a materialeffect on the financial statements.

 

72

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Internal Control over financial reporting includesthe controls themselves, monitoring and internal auditing practices and actionstaken to correct deficiencies as identified.

 

Because of its inherent limitations, internalcontrol over financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

 

The Company’s management assessed the effectivenessof the Company’s internal control over financial reporting as of December 31,2004. The scope of the assessment of effectiveness of the Company’s internalcontrols over financial reporting as of December 31, 2004 did not includesuch internal controls of Leblanc, Inc., a wholly-owned subsidiary consistingof net assets purchased from G. Leblanc Corporation on August 12,2004.  Leblanc’s financial statementsinclude total assets of $36.4 million and revenues of $9.6 million, whichrepresent 8% and 3%, respectively, of the consolidated financial statementamounts as of and for the year ended December 31, 2004.  In making this assessment, the Company’smanagement used the criteria set forth by the Committee of SponsoringOrganizations of the Treadway Commission (COSO) in Internal Control -Integrated Framework.  Managementreviewed the results of its assessment with the Audit Committee of its Board ofDirectors.

 

Based on its assessment, management determined that,as of December 31, 2004, the Company’s internal control over financialreporting is effective.

 

Deloitte & Touche LLP, the independentregistered public accounting firm that audited the financial statementsincluded in this annual report has issued an attestation report on management’sassessment of the Company’s internal control over financial reporting.

 

 
| By:    | /s/                      | Dana D. Messina  |   |
|--------|--------------------------|------------------|--------|
|   | Dana D. Messina          |             |
|   | Chief Executive Officer  |
|   | March 30,  2005     |             |
|   |                     |             |
| By:    | /s/                      | Dennis M. Hanson |   |
|   | Dennis M. Hanson         |             |
|   | Chief Financial  Officer |
|   | March 30,  2005     |             |

 

73

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

To the Board of Directorsand Stockholders ofSteinway Musical Instruments, Inc.Waltham, Massachusetts

 

We have auditedmanagement’s assessment, included in the accompanying Management’s AnnualReport on Internal Control Over Financial Reporting, that Steinway MusicalInstruments, Inc. and its subsidiaries (the “Company”) maintained effectiveinternal control over financial reporting as of December 31, 2004 based oncriteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission. As described in Management’s Annual Report on Internal Control OverFinancial Reporting, management excluded from their assessment the internalcontrol over financial reporting at its Leblanc business, which was acquired onAugust 12, 2004 and whose financial statements reflect total assets andrevenues constituting 8 and 3 percent, respectively, of the relatedconsolidated financial statement amounts as of and for the year ended December 31,2004.  Accordingly, our audit did notinclude the internal control over financial reporting at Leblanc.  The Company’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financialreporting.  Our responsibility is toexpress an opinion on management’s assessment and an opinion on theeffectiveness of the Company’s internal control over financial reporting basedon our audit.

 

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects.  Our audit included obtaining an understandingof internal control over financial reporting, evaluating management’sassessment, testing and evaluating the design and operating effectiveness ofinternal control, and performing such other procedures as we considerednecessary in the circumstances.  Webelieve that our audit provides a reasonable basis for our opinions.

 

A company’s internalcontrol over financial reporting is a process designed by, or under thesupervision of, the company’s principal executive and principal financialofficers, or persons performing similar functions, and effected by the company’sboard of directors, management, and other personnel to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles.  Acompany’s internal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, in reasonabledetail, accurately and fairly reflect the transactions and dispositions of theassets of the company; (2) provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements.

 

Because of the inherentlimitations of internal control over financial reporting, including thepossibility of collusion or improper management override of controls, materialmisstatements due to error or fraud may not be prevented or detected on atimely basis.  Also, projections of anyevaluation of the effectiveness of the internal control over financialreporting to future periods are subject to the risk that the controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

 

74

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In our opinion,management’s assessment that the Company maintained effective internal controlover financial reporting as of December 31, 2004, is fairly stated, in allmaterial respects, based on the criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects,effective internal control over financial reporting as of December 31,2004, based on the criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission.

 

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated financial statements and financial statement schedule asof and for the year ended December 31, 2004 of the Company and our reportdated March 30, 2005 expressed an unqualified opinion on those financialstatements and financial statement schedule.

 

 
| /s/ DELOITTE  & TOUCHE LLP |   |
|--------------------------------|--------|
|                           |   |
| Boston,  Massachusetts         |   |
| March 30,  2005           |   |

 

75

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**Item 9B. Other Information**

 

Deloitte & Touche LLP(“Deloitte”), a member firm of Deloitte Touche Tohmatsu (“DTT”), is the Company’sindependent registered public accounting firm. Deloitte has informed the Company’s Audit Committee that during 2004 amember firm of Deloitte Touche Tohmatsu in Japan provided services related tothe Japanese Consumption Tax filings for a wholly-owned subsidiary of theCompany based in the United States of America. A Consumption Tax Representative is allowed to handle the Japanese ConsumptionTax procedures that foreign corporations or nonresidents without a fixed place ofbusiness in Japan are required to fulfill, including filing JapaneseConsumption Tax returns, responding to notices, prepare applications and paytaxes in accordance with the Japanese Consumption Tax Law.  The Company engaged the DTT member firm toperform such services.

 

The DTT member firmreceived information from Company management and calculated the Japanese ConsumptionTax on the applicable transactions for the period.  After review of the tax filing by Company management,the Company remitted taxes due to the DTT member firm, which upon notificationof receipt from the bank, remitted such funds to the tax authorities’authorized Japanese bank account.  TheDTT member firm was paid $1,400 for the completion of the tax forms andprovision of this service.  Havingcustody of the Company cash for payment to the tax authority is a relationshipthat might bear on Deloitte’s independence. The total of such receipts and disbursements during 2004 was$19,000.  Deloitte informed the Company’sAudit Committee on December 1, 2004 of this issue and immediatelydiscontinued the receipt of any tax payments from the Company.  The Audit Committee, after reviewing thefacts, determined that the service did not impair Deloitte’s independence.  Deloitte recently notified the Securities andExchange Commission of this event.

 

### **PART III**

### ** **

**Item10.  Directors and Executive Officers ofthe Registrant**

 

The information calledfor by this item is hereby incorporated by reference to the Registrant’sdefinitive Proxy Statement for the fiscal year ended December 31, 2004,which Proxy Statement will be filed with the Securities and Exchange Commissionno later than 120 days after the end of the fiscal year covered by this report.

 

**Item11.  Executive Compensation**

 

The information calledfor by this item is hereby incorporated by reference to the Registrant’sdefinitive Proxy Statement for the fiscal year ended December 31, 2004,which Proxy Statement will be filed with the Securities and Exchange Commissionno later than 120 days after the end of the fiscal year covered by this report.

 

**Item12.  Security Ownership of CertainBeneficial Owners and Management**

 

The information calledfor by this item is hereby incorporated by reference to the Registrant’sdefinitive Proxy Statement for the fiscal year ended December 31, 2004,which Proxy Statement will be filed with the Securities and Exchange Commissionno later than 120 days after the end of the fiscal year covered by this report.

 

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**Item13.  Certain Relationships and RelatedTransactions**

 

The information calledfor by this item is hereby incorporated by reference to the Registrant’sdefinitive Proxy Statement for the fiscal year ended December 31, 2004,which Proxy Statement will be filed with the Securities and Exchange Commissionno later than 120 days after the end of the fiscal year covered by this report.

 

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

### ** **

Theinformation called for by this item is hereby incorporated by reference to theRegistrant’s definitive Proxy Statement for the fiscal year ended December 31,2004, which Proxy Statement will be filed with the Securities and ExchangeCommission no later than 120 days after the end of the fiscal year covered bythis report.

 

### **PART IV**

### ** **

**Item15.  Exhibits, Financial StatementSchedules and Reports on Form 8-K**

 

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

 
|   | 1.     | Financial  Statements                                                                                             |                                                                                             |
|--------|--------|-------------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------|
|   |   |                                                                                                              |                                                                                             |
|   |   | Report  of Independent Registered Public Accounting Firm                                                          |                                                                                             |
|   |   | Consolidated  Statements of Income  Years Ended December 31, 2004, 2003, and 2002                            |                                                                                             |
|   |   | Consolidated Balance  Sheets as of December 31, 2004 and 2003                                                |                                                                                             |
|   |   | Consolidated  Statements of Cash Flows for the  Years Ended December 31, 2004, 2003, and 2002                |                                                                                             |
|   |   | Consolidated  Statements of Stockholders’ Equity for the  Years Ended December 31, 2004, 2003, and 2002 |                                                                                             |
|   |   | Notes to  Consolidated Financial Statements                                                                       |                                                                                             |
|   |   |                                                                                                              |                                                                                             |
|   | 2.     | Financial  Statement Schedules                                                                                    |                                                                                             |
|   |   |                                                                                                              |                                                                                             |
|   |   | Schedule II  - Valuation and Qualifying Accounts                                                             |                                                                                             |
|   |   |                                                                                                              |                                                                                             |
|   | 3.     | Exhibits:                                                                                                         | The Exhibits  listed below are filed as part of, or incorporated by reference into, this report. |   |
|        |        |                                                                                                                   |                                                                                                  |  |

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                       |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                                                  |
| 2.1              |       | Stock Purchase Agreement dated as of July 20,  2000, by and among Steinway Musical Instruments, Inc. and BIM Holding AG with  respect to all the capital stock of United Musical Instruments Holdings, Inc.  (8) |
| 3.1              |       | Restated  Certificate of Incorporation of Registrant (6)                                                                                                                                                              |
| 3.2              |       | Bylaws of  Registrant (4)                                                                                                                                                                                             |
| 3.3              |       | Amendment No. 1  to Bylaws of Registrant (4)                                                                                                                                                                          |
| 4.1              |       | Second Amended  and Restated Credit Agreement, dated as of September 14, 2000, among The  Selmer Company, Inc., Steinway, Inc., and United Musical Instruments USA,                                              |

 

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|   |   | 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, Inc., as borrowers; those signatories identified as guarantors,  the lenders, and GMAC Commercial Credit LLC, as administrative agent (16)                                                           |
| 4.8    |   | Seventh  Amendment to the Second Amended and Restated Credit Agreement dated as of May  26, 2004 by and among Conn-Selmer, Inc. f/k/a The Selmer Company, Inc. and  the surviving corporation of the merger of United Musical Instruments USA,  Inc. and United Musical Instrument Holdings with and into Conn-Selmer, Inc.,  Steinway, Inc., as borrowers; those signatories identified as guarantors, the  lenders, and GMAC Commercial Credit LLC, as administrative agent. (18)                                                                        |
| 4.9    |   | Eighth Amendment  to the Second Amended and Restated Credit Agreement dated as of August 11,  2004 by and among Conn-Selmer, Inc. f/k/a The Selmer Company, Inc. and the  surviving corporation of the merger of United Musical Instruments USA, Inc.  and United Musical Instruments Holdings, Inc. with and into Conn-Selmer,  Inc., Steinway, Inc., as borrowers; those signatories identified as  guarantors, the lenders, and GMAC Commercial Credit LLC, as administrative  agent.                                                              |

 

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| 4.10  |   | Registration  Rights Agreement, dated as of August 9, 1993, among Selmer Industries,  Inc. and the purchasers of certain equity securities (1)                                                                                                                      |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.11  |   | 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)                                                                                     |
| 4.12  |   | 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 (16)                                                                                                                                                                              |
| 10.17 |   | Asset Purchase  Agreement (the “Asset Purchase Agreement”) dated July 22, 2004 by and between  G. Leblanc Corporation, and Steinway Musical Instruments, Inc. (17)                                                                                             |
| 14.0  |   | Code of Ethics  and Professional Conduct                                                                                                                                                                                                                                 |
| 21.1  |   | List of  Subsidiaries of the Registrant                                                                                                                                                                                                                                  |
| 23.1  |   | Independent  Auditors’ Consent - Deloitte & Touche LLP                                                                                                                                                                                                          |
| 23.2  |   | Preferability  Letter – Deloitte & Touche LLP (16)                                                                                                                                                                                                              |
| 31.1  |   | Certification of  the Chief Executive Officer Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                            |

 

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| 31.2 |   | Certification of  the Chief Financial Officer Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                          |
|------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 32.1 |   | Certification of  the Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002  |
| 32.2 |   | Certification of  the Principal Financial Officer pursuant to 18 U.S. C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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(1)          Previouslyfiled with the Commission on February 8, 1994 as an exhibit to theRegistrant’s Registration Statement on Form S-1.

 

(2)          Previouslyfiled with the Commission on June 7, 1995 as an exhibit to the Registrant’sCurrent Report on Form 8-K.

 

(3)          Previouslyfiled with the Commission on June 7, 1995 as an exhibit to the Registrant’sRegistration Statement on Form S-4.

 

(4)          Previouslyfiled with the Commission on May 14, 1996 as an exhibit to the Registrant’sRegistration Statement on Form S-1.

 

(5)          Previouslyfiled with the Commission on July 25, 1996 as an exhibit to the Registrant’sAmendment No. 2 to Registration Statement on Form S-1.

 

(6)          Previouslyfiled with the Commission on March 27, 1997 as an exhibit to the Registrant’sAnnual Report on Form 10-K.

 

(7)          Previouslyfiled with the Commission on August 16, 1999 as an exhibit to theRegistrant’s Quarterly Report on Form 10-Q.

 

(8)          Previouslyfiled with the Commission on July 27, 2000 as an exhibit to the Registrant’sCurrent Report on Form 8-K.

 

(9)          Previouslyfiled with the Commission on September 29, 2000 as an exhibit to theRegistrant’s Current Report on Form 8-K.

 

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

 

(11)    Previouslyfiled with the Commission on November 13, 2001 as an exhibit to the Registrant’sQuarterly Report on Form 10-Q.

 

(12)    Previouslyfiled with the Commission on June 12, 2001 as an exhibit to the Registrant’sRegistration Statement on Form S-4.

 

(13)    Previouslyfiled with the Commission on March 28, 2001 as an exhibit to theRegistrant’s Annual Report on Form 10-K.

 

(14)    Previouslyfiled with the Commission on March 18, 2003 as an exhibit to theRegistrant’s Annual Report on Form 10-K.

 

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(15)    Previouslyfiled with the Commission on August 12, 2003 as an exhibit to theRegistrant’s Quarterly Report on Form 10-Q.

 

(16)    Previouslyfiled with the Commission on March 16, 2004 as an exhibit to theRegistrant’s Annual Report on Form 10-K.

 

(17)    Previouslyfiled with the Commission on July 27, 2004 as an exhibit to the Registrant’sCurrent Report on Form 8-K.

 

(18)    Previouslyfiled with the Commission on August 5, 2004 as an Exhibit to theRegistrant’s Quarterly Report on Form 10-Q.

 

(b) Reports on Form 8-K

 

On November 4, 2004the Company filed a Current Report on Form 8-K that included a press releaseissued on November 4, 2004 announcing Steinway Musical Instruments, Inc.’searnings results for the quarter and nine months ended September 30, 2004.

 

### **Signatures**

### ** **

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

 

Steinway MusicalInstruments, Inc.

 
| By:             | /s/ Dana D.  Messina |   | March 30,  2005 |   |
|-----------------|----------------------|--------|----------------------|--------|
| Dana D. Messina |                 | (Date) |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed by the following persons on behalf of the registrant and in thecapacities listed below on March 30, 2005:

 

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

 

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| /s/ Peter  McMillan     |   | Director |
|-------------------------|--------|----------|
| Peter McMillan          |   |     |
|                    |   |     |
|                    |   |     |
| /s/ A. Clinton  Allen   |   | Director |
| A. Clinton Allen        |   |     |
|                    |   |     |
|                    |   |     |
| /s/ Rudolph K.  Kluiber |   | Director |
| Rudolph K.  Kluiber     |   |     |
|                         |        |          |  |  |  |

 

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