Steinway Musical Instruments (LVB) 10-Q 2004 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

ýQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004

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

COMMISSION FILE NUMBER 001-11911

STEINWAY MUSICAL INSTRUMENTS, INC.

(Exact name of registrant as specified in its charter)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 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 such reports), and (2) has been subject to such filing requirements during the past 90 days.

Yes  ý   No  o

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

Yes  ý   Noo

Number of shares of Common Stock issued and outstanding as of August 2, 2004:	Class A	477,952
	Ordinary	7,523,595
	Total	8,001,547

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

FORM 10-Q

INDEX

PART I.	UNAUDITED FINANCIAL INFORMATION
Item 1.	Consolidated and Condensed Consolidated Financial Statements:
	Consolidated Statements of Income Three months and six months ended June 30, 2004 and June 28, 2003
	Condensed Consolidated Balance Sheets June 30, 2004 and December 31, 2003
	Consolidated Statements of Cash Flows Six months ended June 30, 2004 and June 28, 2003
	Consolidated Statement of Stockholders’ Equity Three months and six months ended June 30, 2004 and June 28, 2003
	Notes to Condensed Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures about Market Risk
Item 4.	Controls and Procedures
PART II.	OTHER INFORMATION
Item 4.	Submission of Matters to a Vote of Security Holders
Item 6.	Exhibits and Reports on Form 8-K
	Signatures

2

ITEM 1 CONSOLIDATED AND CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

Unaudited

(In Thousands Except Share and Per Share Amounts)

	Three Months Ended						Six Months Ended
	June 30, 2004			June 28, 2003			June 30, 2004			June 28, 2003
Net sales	$	83,688		$	78,035		$	173,749		$	160,544
Cost of sales	59,285			55,322			123,621			116,999
Gross Profit	24,403			22,713			50,128			43,545
Operating expenses:
Sales and marketing	10,539			10,944			21,833			21,957
General and administrative	6,399			5,535			12,413			11,489
Amortization of intangibles	255			288			546			577
Other operating expenses (income)	(3		)	136			25			308
Total operating expenses	17,190			16,903			34,817			34,331
Income from operations	7,213			5,810			15,311			9,214
Other income, net	(734		)	(712		)	(1,346		)	(1,333		)
Interest income	(591		)	(503		)	(1,228		)	(1,121		)
Interest expense	4,014			3,510			7,792			7,100
Income before income taxes	4,524			3,515			10,093			4,568
Income taxes	1,810			1,355			4,035			1,725
Net income	$	2,714		$	2,160		$	6,058		$	2,843
Earnings per share:
Basic	$	0.34		$	0.24		$	0.75		$	0.32
Diluted	$	0.33		$	0.24		$	0.72		$	0.32
Weighted average shares:
Basic	7,957,483			8,906,238			8,083,945			8,906,238
Diluted	8,340,726			8,906,238			8,436,605			8,906,252

See notes to consolidated and condensed consolidated financial statements.

3

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

Unaudited

(In Thousands)

	June 30, 2004			December 31, 2003
ASSETS:
Current assets:
Cash	$	30,323		$	42,283
Accounts, notes and leases receivable, net of allowance for bad debts of $10,044 and $9,944 in 2004 and 2003, respectively	84,653			76,403
Inventories	159,384			152,029
Prepaid expenses and other current assets	4,687			4,533
Deferred tax assets	12,974			13,022
Total current assets	292,021			288,270
Property, plant and equipment, net of accumulated depreciation of $66,223 and $63,952 in 2004 and 2003, respectively	95,912			98,937
Trademarks	10,195			10,319
Goodwill	31,275			31,665
Other intangibles, net	5,340			5,782
Other assets	15,426			10,692
TOTAL ASSETS	$	450,169		$	445,665
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt	$	10,501		$	10,638
Accounts payable	12,258			11,554
Other current liabilities	37,540			39,112
Total current liabilities	60,299			61,304
Long-term debt	213,312			185,964
Deferred tax liabilities	25,125			25,565
Other non-current liabilities	20,157			20,197
Total liabilities	318,893			293,030
Commitments and contingent liabilities
Stockholders’ equity:
Common stock	10			10
Additional paid-in capital	79,952			74,626
Retained earnings	102,778			96,720
Accumulated other comprehensive loss	(4,028		)	(2,868		)
Treasury stock, at cost	(47,436		)	(15,853		)
Total stockholders’ equity	131,276			152,635
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	450,169		$	445,665

See notes to consolidated and condensed consolidated financial statements.

4

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

(In Thousands)

	Six Months Ended
	June 30, 2004			June 28, 2003
Cash flows from operating activities:
Net income	$	6,058		$	2,843
Adjustments to reconcile net income to cash flows from operating activities:
Depreciation and amortization	5,338			5,546
Amortization of bond premium	(105		)	—
Deferred tax benefit	(218		)	(252		)
Debt issuance costs	(105		)	—
Other	(28		)	179
Changes in operating assets and liabilities:
Accounts, notes and leases receivable	(8,463		)	(11,393		)
Inventories	(9,231		)	(3,463		)
Prepaid expenses and other assets	(3,935		)	1,476
Accounts payable	753			(2,382		)
Other liabilities	(781		)	657
Cash flows from operating activities	(10,717		)	(6,789		)
Cash flows from investing activities:
Capital expenditures	(2,052		)	(1,675		)
Proceeds from disposals of fixed assets	76			—
Cash flows from investing activities	(1,976		)	(1,675		)
Cash flows from financing activities:
Borrowings under lines of credit	10,349			6,365
Repayments under lines of credit	(10,491		)	(6,121		)
Repayments of long-term debt	(3,352		)	(3,240		)
Proceeds from issuance of common stock	4,594			—
Cash flows from financing activities	1,100			(2,996		)
Effect of foreign exchange rate changes on cash	(367		)	88
Decrease in cash	(11,960		)	(11,372		)
Cash, beginning of period	42,283			19,099
Cash, end of period	$	30,323		$	7,727
Supplemental Cash Flow Information
Interest paid	$	8,488		$	7,344
Taxes paid	$	5,695		$	4,179
Non-cash transaction:
Purchase of common stock by issuance of bonds	$	31,583		$	—

See notes to consolidated and condensed consolidated financial statements.

5

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Unaudited

(In Thousands Except Share Data)

	Common Stock		Additional Paid-In Capital		Retained Earnings		Accumulated Other Comprehensive Loss			Treasury Stock			Total Stockholders’ Equity
Balance, December 31, 2003	$	10	$	74,626	$	96,720	$	(2,868	)	$	(15,853	)	$	152,635
Comprehensive income:
Net income					6,058								6,058
Foreign currency translation adjustment							(1,029		)				(1,029		)
Additional minimum pension liability, net							(146		)				(146		)
Unrealized loss on certain long-term investments, net							15						15
Total comprehensive income													4,898
Exercise of 231,835 options for shares of common stock			4,594										4,594
Tax benefit of options exercised			732										732
Purchase of 1,271,450 shares of common stock										(31,583		)	(31,583		)
Balance, June 30, 2004	$	10	$	79,952	$	102,778	$	(4,028	)	$	(47,436	)	$	131,276

See notes to consolidated and condensed consolidated financial statements.

6

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED AND CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS

JUNE 30, 2004

Unaudited

(Tabular Amounts In Thousands Except Share and Per Share Data)

(1)Basis of Presentation

The accompanying condensed consolidated financial statements of Steinway Musical Instruments, Inc. and subsidiaries (the “Company”) for the three months and six months ended June 30, 2004 andJune 28, 2003 are unaudited.  In the opinion of management, these statements have been prepared on the same basis as the audited consolidated financial statements as of and for the year ended December 31, 2003, and include all adjustments which are of a normal and recurring nature, necessary for the fair presentation of financial position, results of operations and cash flows for the interim period.  You should read the condensed consolidated financial statements in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003 filed with the Securities and Exchange Commission.  The results of operations for the three months and six months ended June 30, 2004 are not necessarily indicative of the results that may be expected for the entire year.

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

(2)Summary of Significant Accounting Policies

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

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

7

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

	Three Months Ended						Six Months Ended
	June 30, 2004			June 28, 2003			June 30, 2004			June 28, 2003
Net income, as reported	$	2,714		$	2,160		$	6,058		$	2,843
Deduct: Total stock-based employee compensation expense determined under fair-value based method for all awards, net of related tax effects	(253		)	(217		)	(507		)	(437		)
Pro forma net income	$	2,461		$	1,943		$	5,551		$	2,406
Earnings per share:
Basic - as reported	$	0.34		$	0.24		$	0.75		$	0.32
Basic - pro forma	$	0.31		$	0.22		$	0.69		$	0.27
Diluted - as reported	$	0.33		$	0.24		$	0.72		$	0.32
Diluted - pro forma	$	0.30		$	0.22		$	0.66		$	0.27

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

	Three Months Ended		Six Months Ended
	June 30, 2004	June 28, 2003	June 30, 2004	June 28, 2003
Weighted-average interest rates	1.26%	1.86%	1.26%	2.39%
Weighted-average expected life of option feature in the Purchase Plan (in years)	0.08	0.08	0.08	0.08
Weighted-average expected life of option grants (in years)	—	—	—	6
Expected volatility of underlying stock	27%	27%	27%	27%

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

	Three Months Ended				Six Months Ended
	June 30, 2004		June 28, 2003		June 30, 2004		June 28, 2003
Stock Plan	—		—		—		$	4.77
Option feature in Purchase Plan	$	4.09	$	4.78	$	4.09	$	4.78

It should be noted that the Black-Scholes option-pricing model was designed to value readily tradable options with relatively short lives and no vesting restrictions.  In addition, option valuation models require the input of highly subjective assumptions including the expected price volatility.  Because the options granted are

8

not tradable and have contractual lives of up to ten years, and because changes in the subjective input assumptions can materially affect the fair value estimate, in our opinion, the existing models do not provide a reliable measure of the fair value of the options issued under either the Stock Plan or Purchase Plan.

Earnings per Common Share – We compute basic earnings per share using the weighted-average number of common shares outstanding during each period.  Diluted earnings per common share reflects the effect of our outstanding options using the treasury stock method, except when such options would be antidilutive.

A reconciliation of the weighted-average shares used for the basic and diluted computations is as follows:

	Three Months Ended		Six Months Ended
	June 30, 2004	June 28, 2003	June 30, 2004	June 28, 2003
Weighted-average shares:
For basic earnings per share	7,957,483	8,906,238	8,083,945	8,906,238
Dilutive effect of stock options	383,243	—	352,660	14
For diluted earnings per share	8,340,726	8,906,238	8,436,605	8,906,252

All outstanding options were included in the computation of diluted net earnings per common share for the three months and six months ended June 30, 2004.  Options to purchase 1,068,400 shares of common stock at prices ranging from $14.73 to $21.94 per share and options to purchase 1,058,400 shares of common stock at prices ranging from $18.55 to $21.94 were outstanding during the three months and six months ended June 28, 2003, respectively, but were not included in the computation of diluted earnings per share because the exercise prices of the options were greater than the average market price of the common shares.

Comprehensive Income – Comprehensive income is comprised of net income, foreign currency translation adjustments, additional minimum pension liabilities, and unrealized gains and losses on certain long-term assets.  The components of accumulated other comprehensive loss are as follows:

	Foreign Currency Translation Adjustment			Gain/(Loss) on Long-term Assets		Tax Impact of Gain/(Loss) on Long-term Assets			Additional Minimum Pension Liability			Tax Impact of Additional Minimum Pension Liability		Accumulated Other Comprehensive Loss
December 31, 2003	$	1,226		$	73	$	(29	)	$	(6,853	)	$	2,715	$	(2,868	)
Activity	(1,029		)	25		(10		)	(209		)	63		(1,160		)
June 30, 2004	$	197		$	98	$	(39	)	$	(7,062	)	$	2,778	$	(4,028	)

New Accounting Pronouncements – In December 2003, the Financial Accounting Standards Board (“FASB”) revised Statement of Financial Accounting Standard (“SFAS”) No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits.”  SFAS No. 132 requires additional disclosure about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans.  This statement also requires disclosure about the types of plan assets, investment strategy, measurement dates, plan obligations, and cash flows.  SFAS No. 132 is effective for fiscal years ending after December 15, 2003. Disclosure of information about foreign plans required by this statement is effective for fiscal years ending after June 15, 2004.  Interim period disclosures for both domestic and foreign plans required by this statement are effective for periods beginning after December 15, 2003, and are included in Note 11.

9

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

(3)Inventories

	June 30, 2004		December 31, 2003
Raw materials	$	18,347	$	21,268
Work in process	49,006		50,620
Finished goods	92,031		80,141
Total	$	159,384	$	152,029

(4)Goodwill, Trademarks, and Other Intangible Assets

We ceased to record amortization expense on our goodwill and trademark assets on January 1, 2002.  We test our goodwill and trademark assets for impairment annually, or on an interim basis if events or circumstances indicate that the fair value of an asset has decreased below its carrying value.  At July 27, 2003 we evaluated our goodwill and trademark assets and determined that the fair value had not decreased below the carrying value and, accordingly, we have made no impairment adjustments.

The changes in net carrying amounts of goodwill and trademarks are as follows:

	Piano Segment			Band Segment
Goodwill:
Balance at December 31, 2003	$	23,110		$	8,555
Foreign currency translation impact	(390		)	—
Balance at June 30, 2004	$	22,720		$	8,555
Trademarks:
Balance at December 31, 2003	$	7,648		$	2,671
Foreign currency translation impact	(124		)	—
Balance at June 30, 2004	$	7,524		$	2,671

10

We also carry certain intangible assets that are amortized.  Once fully amortized, these assets are removed from both the gross and accumulated amortization balance.  These assets consist of the following:

	June 30, 2004			December 31, 2003
Gross deferred financing costs	$	8,653		$	9,293
Accumulated amortization	(3,373		)	(3,596		)
Deferred financing costs, net	$	5,280		$	5,697
Gross covenants not to compete	$	250		$	250
Accumulated amortization	(190		)	(165		)
Covenants not to compete, net	$	60		$	85

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

	Three Months Ended				Six Months Ended
	June 30, 2004		June 28, 2003		June 30, 2004		June 28, 2003
Amortization expense	$	255	$	288	$	546	$	577

The following table shows the total estimated amortization expense for 2004 and the next five succeeding fiscal years:

Estimated amortization expense:

2004	$	1,058
2005	1,002
2006	967
2007	967
2008	822
2009	472

11

(5)Other Current Liabilities

	June 30, 2004		December 31, 2003
Accrued payroll and related benefits	$	18,185	$	16,986
Current portion of pension liability	1,558		2,663
Accrued warranty expense	2,325		2,602
Accrued interest	3,237		2,706
Deferred income	4,306		4,161
Other accrued expenses	7,929		9,994
Total	$	37,540	$	39,112

Accrued warranty expense is generally recorded at the time of sale for instruments which have a warranty period ranging from five to ten years.  The accrued expense recorded is based on a percentage of sales and is adjusted periodically following an analysis of actual warranty claim activity.  Accrued warranty expense for instruments that have a warranty period of one year is recorded based on warranty return trends.

The accrued warranty expense activity for the six months ended June 30, 2004 and the year ended December 31, 2003 is as follows:

	June 30, 2004			December 31, 2003
Beginning balance	$	2,602		$	2,357
Additions	520			1,361
Claims and reversals	(774		)	(1,314		)
Foreign exchange impact	(23		)	198
Ending balance	$	2,325		$	2,602

(6)Long-Term Debt

Long-term debt consists of the following:

	June 30, 2004		December 31, 2003
Term loans	$	43,826	$	47,178
8.75% Senior Notes	174,345		145,345
Unamortized bond premium	1,709		—
Open account loans, payable on demand to a foreign bank	3,933		4,079
Total	223,813		196,602
Less current portion	10,501		10,638
Long-term debt	$	213,312	$	185,964

12

Scheduled payments of long-term debt are as follows:

	June 30, 2004
Remainder of 2004	$	7,218
2005	7,159
2006	8,315
2007	8,361
2008	16,706
Thereafter	174,345
Total	$	222,104

(7)Stockholders’ Equity

Our common stock is comprised 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 98 votes.  Holders of Ordinary common stock are entitled to one vote per share.  Class A common stock shall automatically convert to Ordinary common stock if, at any time, the Class A common stock is not owned by an original Class A holder.  The Chairman and Chief Executive Officer own 100% of the Class A common shares, representing approximately 86% of the combined voting power of the Class A common stock and Ordinary common stock.

On February 4, 2004 we purchased 1,271,450 shares of our Ordinary common stock from AIG Retirement Services, Inc. (formerly AIG SunAmerica), our largest institutional shareholder.  In exchange, we issued $29.0 million in principal amount of our 8.75% Senior Notes due 2011 under our existing indenture.  We issued these bonds at a premium of 106.3%.  This transaction resulted in an increase to our treasury stock of $31.6 million.

13

(8)Facility Rationalization Charges – Band Segment

In 2003, we began a facility rationalization project to eliminate excess manufacturing capacity in our band segment.  As part of this project, we closed our woodwind manufacturing facility in Nogales, Arizona in November 2003.  We also announced that in 2004 we would close one of our woodwind manufacturing facilities in Elkhart, Indiana and transfer that plant’s production to other company-owned facilities.  This facility was closed on April 1, 2004.  As a result of this closure, we recorded charges of $1.4 million in severance and related expenses through June 30, 2004.  We expect to incur an additional $0.1 million in severance expenses during the remainder of 2004.

The severance liability and related activity associated with the band segment’s facility rationalization project is as follows:

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

(9)Other Income, Net

	Three Months Ended						Six Months Ended
	June 30, 2004			June 28, 2003			June 30, 2004			June 28, 2003
West 57th building income	$	(1,163	)	$	(1,163	)	$	(2,326	)	$	(2,326	)
West 57th building expenses	814			814			1,628			1,628
Foreign exchange (gains) losses, net	175			(286		)	(83		)	(390		)
Miscellaneous	(560		)	(77		)	(565		)	(245		)
Other income, net	$	(734	)	$	(712	)	$	(1,346	)	$	(1,333	)

(10)Commitments and Contingent Liabilities

We are involved in certain legal proceedings 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 and incidental to the operation of our business.  While the outcome of such actions cannot be predicted with certainty, we believe that, based on our experience in dealing with these matters, their ultimate resolution will not have a material adverse impact on our business, financial condition, or results of operations.

We operated manufacturing facilities at certain locations where hazardous substances (including chlorinated solvents) were used.  We believe that an entity that formerly operated one such facility may have released hazardous substances at such location, which we leased through July 2001.  We did not contribute to

14

the release.  Further, we have a contractual indemnity from certain 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 legal proceedings will not arise in the future and that such indemnitors would make the payments described in the indemnity.

We operate other manufacturing facilities which were previously owned by Philips Electronics North America Corporation (“Philips”).  Philips agreed to indemnify us for any and all losses, damages, liabilities and claims relating to environmental matters resulting from certain activities of Philips occurring prior to December 29, 1988 (the “Environmental Indemnity Agreement”).  Philips has fully performed its obligations under the Environmental Indemnity Agreement, which terminates on December 29, 2008.  Four matters covered by the Environmental Indemnity Agreement are currently pending.  Philips has entered into Consent Orders with the Environmental Protection Agency (“EPA”) for one site and the North Carolina Department of Environment, Health and Natural Resources for a second site, whereby Philips has agreed to pay required response costs.  On October 22, 1998, we were joined as defendant in an action involving a site formerly occupied by a business we acquired in Illinois.  Philips has accepted the defense of this action pursuant to the terms of the Environmental Indemnity Agreement.  For the fourth site, the EPA has notified us it intends to carry out the final remediation itself.  The EPA estimates that this remedy has a present net cost of approximately $14.5 million. The EPA has named over 40 persons or entities as potentially responsible parties at this Elkhart, Indiana site, including four Conn-Selmer predecessor entities.  For two of these entities, which were previously owned by Philips, this matter has been tendered to Philips pursuant to the Environmental Indemnity Agreement.  Our potential liability at any of these sites is affected by several factors including, but not limited to, the method of remediation, our portion of the materials in the site relative to that of the other named parties, the number of parties participating, and the financial capabilities of the other potentially responsible parties once the relative share has been determined.  No assurance can be given, however, that additional environmental issues will not require additional, currently unanticipated investigation, assessment or remediation expenditures or that Philips will make payments that it is obligated to make under the Environmental Indemnity Agreement.

We are also continuing an existing environmental remediation program at a facility we acquired in 2000.  We currently estimate that this project will take eighteen years to complete, at a total cost of approximately $0.9 million.  We have accrued approximately $0.7 million for the estimated remaining cost of this remediation program, which represents the present value total cost using a discount rate of 5.1%.  A summary of expected payments associated with this project is as follows:

	Environmental Payments
2004	$	150
2005	63
2006	63
2007	63
2008	43
Thereafter	515
Total	$	897

The matters described above and our other liabilities and compliance costs arising under environmental laws are not expected to have a material impact on our capital expenditures, earnings or competitive position.  However, some risk of environmental liability is inherent in the nature of our current and former businesses

15

and we might, in the future, incur material costs to meet current or more stringent compliance, cleanup or other obligations pursuant to environmental laws.

(11)         Retirement Plans

We have defined benefit pension plans covering the majority of our employees, including certain employees in foreign countries.   The components of net periodic pension cost for these plans are as follows:

	Domestic Plans						Foreign Plans
	Three Months Ended						Three Months Ended
	June 30, 2004			June 28, 2003			June 30, 2004			June 28, 2003
Service cost	$	153		$	261		$	162		$	185
Interest cost	552			830			312			298
Expected return on plan assets	(743		)	(822		)	(66		)	(67		)
Amortization of prior service cost	114			189			—			—
Amortization of net loss	52			175			19			22
Net periodic benefit cost	$	128		$	633		$	427		$	438

	Domestic Plans						Foreign Plans
	Six Months Ended						Six Months Ended
	June 30, 2004			June 28, 2003			June 30, 2004			June 28, 2003
Service cost	$	439		$	352		$	329		$	354
Interest cost	1,585			1,118			634			585
Expected return on plan assets	(2,144		)	(1,108		)	(134		)	(125		)
Amortization of prior service cost	326			255			—			—
Amortization of net loss	140			236			38			32
Net periodic benefit cost	$	346		$	853		$	867		$	846

We provide postretirement health care and life insurance benefits to eligible hourly retirees and their dependents.  The components of net periodic pension cost for these benefits are as follows:

	Three Months Ended				Six Months Ended
	June 30, 2004		June 28, 2003		June 30, 2004		June 28, 2003
Service cost	$	39	$	18	$	58	$	36
Interest cost	77		35		115		70
Amortization of transition obligation	25		11		38		22
Amortization of net loss	9		4		14		8
Net postretirement benefit cost	$	150	$	68	$	225	$	136

16

We anticipate domestic pension plan contributions of approximately $3.3 million for the current year.  As of June 30, 2004 we have contributed $1.5 million to these plans.

(12)         Segment Information

We have identified two reportable segments: the piano segment and the band and orchestral instrument segment.  We consider these two segments reportable as they are managed separately and the operating results of each segment are separately reviewed and evaluated by our senior management on a regular basis.  Management and the chief operating decision maker use income from operations as a meaningful measurement of profit or loss for the segments.  Income from operations for the reportable segments includes certain corporate costs allocated to the segments based primarily on revenue, as well as intercompany profit.  Amounts reported as “Other & Elim” include those corporate costs that were not allocated to the reportable segments and the remaining intercompany profit elimination.

The following tables present information about our operating segments for the three-month and six-month periods ended June 30, 2004 and June 28, 2003:

Three months ended 2004	Piano Segment								Band Segment						Other & Elim			Consol Total
	U.S.		Germany		Other		Total		U.S.		Other		Total
Net sales to external customers	$	26,219	$	11,395	$	7,319	$	44,933	$	37,700	$	1,055	$	38,755	$	—		$	83,688
Income (loss) from operations	2,324		1,865		519		4,708		3,031		23		3,054		(549		)	7,213

Three months ended 2003	Piano Segment								Band Segment							Other & Elim			Consol Total
	U.S.		Germany		Other		Total		U.S.		Other			Total
Net sales to external customers	$	25,971	$	10,026	$	5,313	$	41,310	$	35,782	$	943		$	36,725	$	—		$	78,035
Income (loss) from operations	2,145		631		456		3,232		3,053		(16		)	3,037		(459		)	5,810

Six months ended 2004	Piano Segment								Band Segment						Other & Elim			Consol Total
	U.S.		Germany		Other		Total		U.S.		Other		Total
Net sales to external customers	$	52,960	$	21,783	$	15,907	$	90,650	$	80,881	$	2,218	$	83,099	$	—		$	173,749
Income (loss) from operations	4,576		3,421		1,671		9,668		6,820		58		6,878		(1,235		)	15,311

Six months ended 2003	Piano Segment								Band Segment						Other & Elim			Consol Total
	U.S.		Germany		Other		Total		U.S.		Other		Total
Net sales to external customers	$	46,385	$	20,028	$	10,832	$	77,245	$	81,240	$	2,059	$	83,299	$	—		$	160,544
Income (loss) from operations	2,418		1,962		1,250		5,630		4,582		47		4,629		(1,045		)	9,214

17

(13)         Summary of Guarantees

During 2001, we completed a $150.0 million 8.75% Senior Note offering.  At the end of 2002, we repurchased $4.7 million of these Senior Notes at 99.25%.  On February 4, 2004, we issued an additional $29.0 million of these Senior Notes at 106.3%.

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

The following condensed consolidating supplementary data illustrates the financial position, results of operations, and cash flows of the Guarantor Subsidiaries and the Non Guarantor Subsidiaries.  Separate complete financial statements of the respective Guarantors would not provide additional material information that would be useful in assessing the financial composition of the Guarantor Subsidiaries.  No single Guarantor Subsidiary has any significant legal restrictions on the ability of investors or creditors to obtain access to its assets in event of default on the guarantee other than its subordination to senior indebtedness.

We record investments in subsidiaries on the cost method for purposes of the supplemental consolidating presentation.  Earnings of subsidiaries are therefore not reflected in the parent company’s investment accounts and earnings.  The principal elimination entries eliminate investments in subsidiaries and intercompany balances and transactions.

18

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF INCOME

THREE MONTHS ENDED JUNE 30, 2004

Unaudited

(In Thousands)

	Issuer of Notes			Guarantor Subsidiaries			Non Guarantor Subsidiaries			Reclass/ Eliminations			Consolidated
Net sales	$	—		$	66,499		$	20,090		$	(2,901	)	$	83,688
Cost of sales	—			49,574			12,798			(3,087		)	59,285
Gross profit	—			16,925			7,292			186			24,403
Operating expenses:
Sales and marketing	—			7,472			3,067			—			10,539
General and administrative	1,465			3,423			1,511			—			6,399
Amortization of intangible assets	116			138			1			—			255
Other operating (income) expense	(886		)	577			306			—			(3		)
Total operating expenses	695			11,610			4,885			—			17,190
Income (loss) from operations	(695		)	5,315			2,407			186			7,213
Other income, net	—			(296		)	(438		)	—			(734		)
Interest income	(3,657		)	(5,568		)	(69		)	8,703			(591		)
Interest expense	3,852			8,803			62			(8,703		)	4,014
Income (loss) before income taxes	(890		)	2,376			2,852			186			4,524
Income taxes	(347		)	958			1,142			57			1,810
Net income (loss)	$	(543	)	$	1,418		$	1,710		$	129		$	2,714

19

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENT OF INCOME

THREE MONTHS ENDED JUNE 28, 2003

Unaudited

(In Thousands)

	Issuer of Notes			Guarantor Subsidiaries			Non Guarantor Subsidiaries			Reclass/ Eliminations			Consolidated
Net sales	$	—		$	63,645		$	17,160		$	(2,770	)	$	78,035
Cost of sales	—			46,665			11,362			(2,705		)	55,322
Gross profit	—			16,980			5,798			(65		)	22,713
Operating expenses:
Sales and marketing	—			7,764			3,216			(36		)	10,944
General and administrative	1,083			3,141			1,311			—			5,535
Amortization of intangible assets	113			174			1			—			288
Other operating (income) expense	(800		)	701			199			36			136
Total operating expenses	396			11,780			4,727			—			16,903
Income (loss) from operations	(396		)	5,200			1,071			(65		)	5,810
Other income, net	—			(662		)	(50		)	—			(712		)
Interest income	(3,657		)	(5,193		)	(13		)	8,360			(503		)
Interest expense	3,280			8,506			84			(8,360		)	3,510
Income (loss) before income taxes	(19		)	2,549			1,050			(65		)	3,515
Income taxes	(7		)	1,822			(438		)	(22		)	1,355
Net income (loss)	$	(12	)	$	727		$	1,488		$	(43	)	$	2,160

20

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF INCOME

SIX MONTHS ENDED JUNE 30, 2004

Unaudited

(In Thousands)

	Issuer of Notes			Guarantor Subsidiaries			Non Guarantor Subsidiaries			Reclass/ Eliminations			Consolidated
Net sales	$	—		$	139,194		$	41,146		$	(6,591	)	$	173,749
Cost of sales	—			104,107			26,190			(6,676		)	123,621
Gross profit	—			35,087			14,956			85			50,128
Operating expenses:
Sales and marketing	—			15,684			6,131			18			21,833
General and administrative	2,825			6,542			3,046			—			12,413
Amortization of intangible assets	232			312			2			—			546
Other operating (income) expense	(1,781		)	1,197			627			(18		)	25
Total operating expenses	1,276			23,735			9,806			—			34,817
Income (loss) from operations	(1,276		)	11,352			5,150			85			15,311
Other income, net	—			(653		)	(693		)	—			(1,346		)
Interest income	(7,314		)	(11,121		)	(98		)	17,305			(1,228		)
Interest expense	7,486			17,463			148			(17,305		)	7,792
Income (loss) before income taxes	(1,448		)	5,663			5,793			85			10,093
Income taxes	(564		)	2,288			2,295			16			4,035
Net income (loss)	$	(884	)	$	3,375		$	3,498		$	69		$	6,058

21

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF INCOME

SIX MONTHS ENDED JUNE 28, 2003

Unaudited

(In Thousands)

	Issuer of Notes			Guarantor Subsidiaries			Non Guarantor Subsidiaries			Reclass/ Eliminations			Consolidated
Net sales	$	—		$	132,267		$	34,223		$	(5,946	)	$	160,544
Cost of sales	—			100,761			22,071			(5,833		)	116,999
Gross profit	—			31,506			12,152			(113		)	43,545
Operating expenses:
Sales and marketing	—			16,058			5,947			(48		)	21,957
General and administrative	2,287			6,683			2,519			—			11,489
Amortization of intangible assets	226			349			2			—			577
Other operating (income) expense	(1,600		)	1,435			425			48			308
Total operating expenses	913			24,525			8,893			—			34,331
Income (loss) from operations	(913		)	6,981			3,259			(113		)	9,214
Other income, net	—			(1,197		)	(136		)	—			(1,333		)
Interest income	(7,314		)	(10,398		)	(41		)	16,632			(1,121		)
Interest expense	6,561			17,011			160			(16,632		)	7,100
Income (loss) before income taxes	(160		)	1,565			3,276			(113		)	4,568
Income taxes	(56		)	1,371			456			(46		)	1,725
Net income (loss)	$	(104	)	$	194		$	2,820		$	(67	)	$	2,843

22

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING BALANCE SHEETS

JUNE 30, 2004

Unaudited

(In Thousands)

	Issuer of Notes			Guarantor Subsidiaries			Non Guarantor Subsidiaries			Reclass/ Eliminations			Consolidated
ASSETS
Current assets:
Cash	$	—		$	(351	)	$	6,438		$	24,236		$	30,323
Accounts, notes and leases receivable, net	—			74,896			9,757			—			84,653
Inventories	—			123,454			36,976			(1,046		)	159,384
Prepaid expenses and other current assets	401			2,271			2,015			—			4,687
Deferred tax assets	—			8,168			4,806			—			12,974
Total current assets	401			208,438			59,992			23,190			292,021
Property, plant and equipment, net	161			80,386			16,317			(952		)	95,912
Investment in subsidiaries	69,643			241,488			—			(311,131		)	—
Trademarks	—			6,280			3,915			—			10,195
Goodwill	—			18,795			12,480			—			31,275
Other intangibles, net	3,170			2,166			4			—			5,340
Other assets	3,061			8,434			2,979			952			15,426
TOTAL ASSETS	$	76,436		$	565,987		$	95,687		$	(287,941	)	$	450,169
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt	$	—		$	6,568		$	3,933		$	—		$	10,501
Accounts payable	456			8,633			3,169			—			12,258
Other current liabilities	(15,054		)	38,690			14,190			(286		)	37,540
Total current liabilities	(14,598		)	53,891			21,292			(286		)	60,299
Long-term debt	176,071			13,005			—			24,236			213,312
Intercompany	(114,803		)	118,361			(3,558		)	—			—
Deferred tax liabilities	—			16,264			8,822			39			25,125
Other non-current liabilities	834			1,629			17,694			—			20,157
Total liabilities	47,504			203,150			44,250			23,989			318,893
Stockholders’ equity	28,932			362,837			51,437			(311,930		)	131,276
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	76,436		$	565,987		$	95,687		$	(287,941	)	$	450,169

23

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING BALANCE SHEETS

DECEMBER 31, 2003

Unaudited

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

24

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF CASH FLOWS

SIX MONTHS ENDED JUNE 30, 2004

Unaudited

(In Thousands)

	Issuer of Notes			Guarantor Subsidiaries			Non Guarantor Subsidiaries			Reclass/ Eliminations			Consolidated
Cash flows from operating activities:
Net income (loss)	$	(884	)	$	3,375		$	3,498		$	69		$	6,058
Adjustments to reconcile net income (loss) to cash flows from operating activities:
Depreciation and amortization	262			4,233			843			—			5,338
Amortization of bond premium	(105		)	—			—			—			(105		)
Deferred tax benefit	—			(131		)	(87		)	—			(218		)
Debt issuance costs	(105		)	—			—			—			(105		)
Other	—			(136		)	108			—			(28		)
Changes in operating assets and liabilities:
Accounts, notes and leases receivable	—			(11,642		)	3,179			—			(8,463		)
Inventories	—			(6,140		)	(3,006		)	(85		)	(9,231		)
Prepaid expenses and other assets	(1,298		)	719			(3,356		)	—			(3,935		)
Accounts payable	333			752			(332		)	—			753
Other liabilities	(511		)	(973		)	687			16			(781		)
Cash flows from operating activities	(2,308		)	(9,943		)	1,534			—			(10,717		)
Cash flows from investing activities:
Capital expenditures	(19		)	(1,568		)	(465		)	—			(2,052		)
Proceeds from disposal of fixed assets	—			76			—			—			76
Cash flows from investing activities	(19		)	(1,492		)	(465		)	—			(1,976		)
Cash flows from financing activities:
Borrowings under lines of credit	—			3,583			3,766			3,000			10,349
Repayments under lines of credit	(7		)	(6,576		)	(3,908		)	—			(10,491		)
Repayments of long-term debt	—			(3,352		)	—			—			(3,352		)
Proceeds from issuance of stock	4,594			—			—			—			4,594
Intercompany transactions	(2,260		)	5,174			(2,914		)	—			—
Cash flows from financing activities	2,327			(1,171		)	(3,056		)	3,000			1,100
Effect of exchange rate changes on cash	—			—			(367		)	—			(367		)
Increase (decrease) in cash	—			(12,606		)	(2,354		)	3,000			(11,960		)
Cash, beginning of period	—			12,255			8,792			21,236			42,283
Cash, end of period	$	—		$	(351	)	$	6,438		$	24,236		$	30,323

25

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF CASH FLOWS

SIX MONTHS ENDED JUNE 28, 2003

Unaudited

(In Thousands)

	Issuer of Notes			Guarantor Subsidiaries			Non Guarantor Subsidiaries			Reclass/ Eliminations			Consolidated
Cash flows from operating activities:
Net income (loss)	$	(104	)	$	194		$	2,820		$	(67	)	$	2,843
Adjustments to reconcile net income (loss) to cash flows from operating activities:
Depreciation and amortization	255			4,503			788			—			5,546
Deferred tax benefit	—			(130		)	(122		)	—			(252		)
Other	—			90			89			—			179
Changes in operating assets and liabilities:
Accounts, notes and leases receivable	—			(11,682		)	409			(120		)	(11,393		)
Inventories	—			(550		)	(3,026		)	113			(3,463		)
Prepaid expenses and other assets	185			1,538			(247		)	—			1,476
Accounts payable	11			(2,189		)	(282		)	78			(2,382		)
Other liabilities	353			(154		)	504			(46		)	657
Cash flows from operating activities	700			(8,380		)	933			(42		)	(6,789		)
Cash flows from investing activities:
Capital expenditures	(23		)	(1,100		)	(552		)	—			(1,675		)
Capital contribution to subsidiary	—			(513		)	513			—			—
Proceeds from disposal of fixed assets	—			—			—			—			—
Cash flows from investing activities	(23		)	(1,613		)	(39		)	—			(1,675		)
Cash flows from financing activities:
Borrowings under lines of credit	—			5,119			1,246			—			6,365
Repayments under lines of credit	(3		)	(5,119		)	(1,002		)	3			(6,121		)
Repayment of long-term debt	—			(3,240		)	—			—			(3,240		)
Intercompany transactions	(674		)	5,817			(5,185		)	42			—
Cash flows from financing activities	(677		)	2,577			(4,941		)	45			(2,996		)
Effect of exchange rate changes on cash	—			—			88			—			88
Increase (decrease) in cash	—			(7,416		)	(3,959		)	3			(11,372		)
Cash, beginning of period	—			1,166			6,736			11,197			19,099
Cash, end of period	$	—		$	(6,250	)	$	2,777		$	11,200		$	7,727

26

(13)Subsequent Events

On July 22, 2004, we entered into an agreement to acquire substantially all of the assets of G. Leblanc Corporation of Wisconsin, a high-quality band instrument manufacturer, for approximately $36.0 million.  The transaction is subject to customary closing conditions and purchase price adjustments and is expected to close in the third quarter.  We will accommodate this purchase with cash, supplemented by our existing credit facilities.

27

ITEM 2MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Tabular Amounts in Thousands Except Share and Per Share Data)

Introduction

We are a world leader in the design, manufacture, marketing, and distribution of high-quality musical instruments.  Our piano division concentrates on the high-end grand piano segment of the industry, handcrafting Steinway pianos in New York and Germany.  We also offer upright pianos and two mid-priced lines of pianos under the Boston and Essex brand names.  Moreover, we are the largest domestic producer of band and orchestral instruments and offer a complete line of brasswind, woodwind, percussion and stringed instruments and related accessories with well-known brand names such as Bach, Selmer, C.G. Conn, King, and Ludwig.  We sell our products through dealers and distributors worldwide. Our piano customer base consists of professional artists, amateur pianists, and institutions such as concert halls, universities, and music schools.  Our band and orchestral instrument customer base consists primarily of middle school and high school students, but also includes adult amateur and professional musicians.

Critical Accounting Policies

The nature of our business - the production and sale of musical instruments - is such that it rarely involves application of highly complex or subjective accounting principles.  The accounting policies that are subject to significant management estimates are those normally found in traditional businesses and include inventory reserves, accounts receivable reserves, reserves on notes receivable, and warranty reserves.  We have significant experience and data on which to base these estimates.  Historical information is adjusted for specific uncertainties, such as new product introductions, and contemporaneous information, such as price fluctuations.  Management regularly performs assessments of the underlying assumptions and believes that they provide a reasonable basis for the estimates contained in our financial statements.

Forward-Looking Statements

Certain statements contained in this document are “forward-looking statements” within the meaning of Section 21E of the Securities and Exchange Act of 1934, as amended.  These forward-looking statements represent our present expectations or beliefs concerning future events.  We caution that such statements are necessarily based on certain assumptions which are subject to risks and uncertainties which could cause actual results to differ materially from those indicated in this report.  These risk factors include, but are not limited to, the following:  changes in general economic conditions; geopolitical events; increased competition; work stoppages and slowdowns; exchange rate fluctuations; variations in the mix of products sold; market acceptance of new band instrument product and distribution strategies; ability of suppliers to meet demand; fluctuations in effective tax rates resulting from shifts in sources of income; and the ability to successfully integrate and operate acquired businesses.  Further information on these risk factors is included in our Annual Report on Form 10-K for the year ended December 31, 2003, our Final Prospectus filed in August 1996, and Registration Statement No. 333-62790 filed in June 2001, particularly in the sections entitled “Risk Factors.”  We encourage you to read those descriptions carefully.  We caution investors not to place undue reliance on the forward-looking statements contained in this report.  These statements, like all statements contained in this report, speak only as of the date of this report (unless another date is indicated) and we undertake no obligation to update or revise the statements except as required by law.

28

Results of Operations

Three Months Ended June 30, 2004 Compared to Three Months Ended June 28, 2003

	Quarter Ended								Change
	June 30, 2004				June 28, 2003				$		%
Net sales
Band	$	38,755			$	36,725			2,030		5.5
Piano	44,933				41,310				3,623		8.8
Total sales	83,688				78,035				5,653		7.2
Cost of sales
Band	29,844				27,697				2,147		7.8
Piano	29,441				27,625				1,816		6.6
Total cost of sales	59,285				55,322				3,963		7.2
Gross profit
Band	8,911			23.0%	9,028			24.6%	(117	)	(1.3	)
Piano	15,492			34.5%	13,685			33.1%	1,807		13.2
Total gross profit	24,403				22,713				1,690		7.4
	29.2%				29.1%
Operating expenses	17,190				16,903				287		1.7
Income from operations	7,213				5,810				1,403		24.1
Other income, net	(734		)		(712		)		(22	)	3.1
Net interest expense	3,423				3,007				416		13.8
									��
Income before income taxes	4,524				3,515				1,009		28.7
Income taxes	1,810			40.0%	1,355			38.5%	455		33.6
Net income	$	2,714			$	2,160			554		25.6

Overview – We are pleased with the results of our band division’s new product introduction and channel distribution strategies.  Also, our suppliers were better able to meet our order demands than in the first quarter.  On April 1, we were able to substantially complete our facility rationalization project, closing one of our woodwind manufacturing facilities and consolidating the production process into another facility.

29

The performance of our piano division also improved over the year ago quarter.  Our Asian operations continued their strong performance through the second quarter, and our domestic and European operations’ results were consistent with the prior period.

Net Sales – The increase in net sales of $5.7 million resulted in part from a 6% increase in Steinway grand unit shipments, the majority of which occurred internationally, as well as $1.4 million in benefit attributable to foreign exchange.  An increase in Boston product shipments of 12% also contributed to the sales improvement of the piano division.  Our band division sales increased 5.5% as we were able to reduce our backorder position on sourced product with many of our suppliers.  An increase in demand for our percussion instruments also contributed to the improvement.

Gross Profit – Gross profit increased $1.7 million due to the higher overall sales and improved margin performance for the piano division.  Piano margins increased from 33.1% to 34.5% due to the favorable mix towards higher margin grand units sold by our international divisions.  Domestically, the margin improvement resulting from the increased productivity at our New York factory was offset by unfavorable exchange rates on purchased product sold during the period.  Band gross margins, which deteriorated from 24.6% to 23.0%, were adversely impacted by increased freight costs attributable in part to higher fuel charges, and cash discounts offered to customers.  In this period we sold instruments which had higher costs resulting from our reduced production levels in 2003.  This also contributed to the margin decrease.

Operating Expenses – The increase in operating expenses of $0.3 million occurred principally as a result of $0.3 million from foreign currency translation.  Excluding this impact, operating expenses were consistent with the prior year.

Interest Expense and Other Income, Net – These other expenses increased $0.4 million to $2.7 million due to the additional interest expense resulting from our issuance of an additional $29.0 million in 8.75% Senior Notes in February, 2004.

Income Taxes – Our effective tax rate increased from 38.5% to 40% primarily as a result of changes in tax legislation in certain states in which we do business and the increase in the ratio of domestic income to foreign source income, which negatively impacts our ability to effectively use foreign tax credits.

30

Six Months Ended June 30, 2004 Compared to Six Months Ended June 28, 2003

	Quarter Ended								Change
	June 30, 2004				June 28, 2003				$		%
Net sales
Band	$	83,099			$	83,299			(200	)	(0.2	)
Piano	90,650				77,245				13,405		17.4
Total sales	173,749				160,544				13,205		8.2
Cost of sales
Band	64,160				65,279				(1,119	)	(1.7	)
Piano	59,461				51,720				7,741		15.0
Total cost of sales	123,621				116,999				6,622		5.7
Gross profit
Band	18,939			22.8%	18,020			21.6%	919		5.1
Piano	31,189			34.4%	25,525			33.0%	5,664		22.2
Total gross profit	50,128				43,545				6,583		15.1
	28.9%				27.1%
Operating expenses	34,817				34,331				486		1.4
Income from operations	15,311				9,214				6,097		66.2
Other income, net	(1,346		)		(1,333		)		(13	)	1.0
Net interest expense	6,564				5,979				585		9.8
Income before income taxes	10,093				4,568				5,525		121.0
Income taxes	4,035			40.0%	1,725			37.8%	2,310		133.9
Net income	$	6,058			$	2,843			3,215		113.1

Overview – Although our band division performance was constrained by some of our suppliers not being able to fully meet our short-term order demands in the beginning of the period, this was rectified by the end of the second quarter.  Our new product introduction and channel distribution strategies are being accepted by the marketplace, and most of the costs associated with training personnel in our combined production facility are behind us.

Our piano division was able to significantly improve performance over the year ago period.  Internationally, we were able to capitalize on recent improvements in the Asian economy.  Domestically, both our wholesale and our retail performance improved, as did the sales of our domestic mid-price piano lines.

31

Net Sales – The increase in net sales of $13.2 million resulted from a 13% increase in Steinway grand unit shipments, which were attributable to domestic and Asian operations.  A $3.9 million benefit attributable to foreign exchange and an increase of 23% in our domestic Boston product shipments also contributed to the improvement.  The sales results for the band division were flat for the period on a slight unit increase of 2%.  In the first half of the period, we experienced lower order rates from school music dealers and were in a backorder position on many imported products.  In the latter half of the period, school music dealer orders leveled off, and the backlog position on much of our sourced product was eliminated, enabling us to make up the sales lost in the first part of the period.

Gross Profit – Gross profit increased $6.6 million as both the piano and band segments experienced improvements in gross margins.  Piano margins increased from 33.0% to 34.4% due primarily to the increase in domestic retail sales and improved productivity in our domestic factory.  A favorable product mix sold by our European divisions also contributed to the increase.  In 2003, band gross profit was adversely impacted by $1.9 million in payments to employees in accordance with expired labor contracts and $1.3 million from work stoppages at two of our plants.  In 2004, gross profit was negatively impacted by $1.4 million in severance costs associated with the closure of one of our woodwind manufacturing facilities.  The decrease in these atypical charges resulted in the band division’s gross margin improvement from 21.6% to 22.8% for the period.  In addition, we sold instruments which had higher costs resulting from our reduced production levels in 2003, which negatively impacted our margins.  However, this was mitigated in part by the increase in sales of higher margin imported products.

Operating Expenses – The increase in operating expenses of $0.5 million occurred principally as a result of $0.8 million from foreign currency translation.  Excluding this impact, operating expenses decreased slightly, reflecting band division savings resulting from administrative staff reductions and lower sales and marketing expenses.

Interest Expense and Other Income, Net – These other expenses increased $0.6 million to $5.2 million due to the additional interest expense resulting from our issuance of an additional $29.0 million in 8.75% Senior Notes in February, 2004.

Income Taxes – Our effective tax rate is significantly impacted by our ability to utilize foreign tax credits.  The amount of such credit utilization is based on the ratio of foreign source to total income computed solely on a tax, as opposed to book, reporting basis.  As a result of the strengthening of our domestic piano and band divisions and changes in tax legislation in certain states in which we do business, our effective tax rate has increased from 37.8% to 40.0% in the current period.

32

Liquidity and Capital Resources

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

Our statements of cash flows for the six months ended June 30, 2004 and June 28, 2003 are summarized as follows:

	2004			2003			Change
Net income:	$	6,058		$	2,843		$	3,215
Changes in operating assets and liabilities	(21,657		)	(15,105		)	(7,504		)
Other adjustments to reconcile net income to cash from operating activities	4,882			5,473			(591		)
Cash flows from operating activities	(10,717		)	(6,789		)	(4,880		)
Cash flows from investing activities	(1,976		)	(1,675		)	651
Cash flows from financing activities	1,100			(2,996		)	4,096

Despite the $3.2 million increase in net income, cash flows from operating activities decreased $3.9 million.  This resulted from our use of an additional $5.8 million to normalized our inventory levels, which were comparatively low in the prior year due to strikes at our Eastlake, Ohio and La Grange, Illinois manufacturing facilities.  We also used $1.8 million to establish worker’s compensation trust accounts in order to eliminate the fees associated with the letter of credit previously used to meet this requirement.

The decrease in cash flows from investing activities of $0.3 million is primarily due to increased capital expenditures.  The increase in cash flows from financing activities of  $4.1 million resulted primarily from proceeds from stock option exercises of $4.6 million.

Borrowing Availability and Activities

Our real estate term loan, acquisition term loan and domestic seasonal borrowing requirements are accommodated through a committed credit facility with a syndicate of domestic lenders (the “Credit Facility”).  The Credit Facility provides us with a potential borrowing capacity of up to $85.0 million in revolving credit loans, based on eligible accounts receivable and inventory balances.  The acquisition term loan and revolving credit loan portions of the Credit Facility bear interest at average 30-day LIBOR plus 1.75%, and the real estate term loan bears interest at average 30-day LIBOR plus 1.5%.   The Credit facility expires on September 14, 2008.  As of June 30, 2004, there were no revolving credit loans outstanding and availability based on eligible accounts receivable and inventory balances, net of letter of credit deductions of $2.3 million, was approximately $82.7 million.  Open account loans with foreign banks also provide for borrowings by Steinway’s foreign subsidiaries of up to €17.1 million ($20.9 million at the June 30, 2004 exchange rate).  A portion of the open account loans can be converted into a maximum of £0.5 million ($0.9 million at the June 30, 2004 exchange rate) for use by our UK branch and ¥600 million ($5.5 million at the June 30, 2004 exchange rate) for use by our Japanese subsidiary.  We had $3.9 million in foreign loans outstanding as of June 30, 2004.

On February 4, 2004 we purchased 1,271,450 shares of our Ordinary common stock directly from our largest institutional shareholder.  In exchange, we issued $29.0 million in principal amount of our 8.75%

33

Senior Notes due 2011 under the existing indenture.  We issued these bonds at a premium of 106.3%.  This transaction resulted in an increase to our treasury stock of $31.6 million.

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

Our long-term financing consists primarily of $174.3 million of 8.75% Senior Notes and $43.8 million of term loans outstanding under the Credit Facility. Our debt agreements contain covenants that place certain restrictions on us, including our ability to incur additional indebtedness, to make investments in other entities and to pay cash dividends.  We were in compliance with all such covenants as of June 30, 2004.

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

On July 22, 2004, we entered into an agreement to purchase substantially all of the assets of G. Leblanc Corporation, a manufacturer of high-quality band instruments, for approximately $36.0 million.  The purchase is subject to customary closing conditions and purchase price adjustments.  Leblanc expects to generate revenues of approximately $28.0 million for 2004.  We intend to fund this acquisition with approximately $22.0 million in cash, supplemented by borrowings on our credit facility.  We expect to pay off the borrowings associated with the acquisition by the end of 2004.  We are not aware of any other trends, demands, commitments, or costs of resources that are expected to materially impact liquidity or capital resources.  Therefore, we believe that cash on hand, together with cash flows anticipated from operations and available borrowings under the Credit Facility, will be adequate to meet existing debt service requirements, fund continuing capital requirements and satisfy working capital and general corporate needs for the next twelve months.

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

34

Contractual Obligations

The following table provides a summary of our contractual obligations at June 30, 2004:

	Payments due by period
Contractual Obligations	Total		Less than 1 year		1 - 3 years		3 - 5 years		More than 5 years
Long-term debt (1)	$	222,104	$	10,501	$	16,352	$	20,906	$	174,345
Operating leases (2)	275,691		5,306		8,872		7,398		254,115
Purchase obligations (3)	11,486		11,136		236		114		—
Other long-term liabilities (4)	18,529		1,512		3,023		3,023		10,971
Total	$	527,810	$	28,455	$	28,483	$	31,441	$	439,431

Notes to Contractual Obligations:

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

(2) Approximately $258.6 million of our operating lease obligations are attributable to the ninety-nine year land lease associated with the purchase of Steinway Hall; the remainder is attributable to the leasing of other facilities and equipment.

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

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

New Accounting Pronouncements

In December 2003, the FASB revised SFAS No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits.”  SFAS No. 132 requires additional disclosure about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans.  This statement also requires disclosure about the types of plan assets, investment strategy, measurement dates, plan obligations, and cash flows.  SFAS No. 132 is effective for fiscal years ending after December 15, 2003.  Disclosure of information about foreign plans required by this statement is effective for fiscal years ending after June 15, 2004.  Interim period disclosures for both domestic and foreign plans required by this statement are effective for periods beginning after December 15, 2003, and are included in Note 11.

ITEM 3QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk associated with changes in foreign currency exchange rates and interest rates.  We mitigate our foreign currency exchange rate risk by maintaining foreign currency cash balances and holding forward foreign currency contracts.  These contracts are used as a hedge against foreign currency transactions and are not used for trading or speculative purposes.  The fair value of the forward foreign currency exchange contracts is sensitive to changes in foreign currency exchange rates.  The impact of an adverse change in foreign currency exchange rates would not be materially different than that disclosed in the our Annual Report on Form 10-K for the year ended December 31, 2003.

35

Our revolving loans and term loans bear interest at rates that fluctuate with changes in LIBOR.  As such, our interest expense on our revolving loans and term loans and the fair value of our fixed long-term debt are sensitive to changes in market interest rates.  The effect of an adverse change in market interest rates on our interest expense would not be materially different than that disclosed in our Annual Report on Form 10-K for the year ended December 31, 2003.

The majority of our long-term debt is at a fixed interest rate.  Therefore, the associated interest expense is not sensitive to fluctuations in market interest rates.  However, the fair value of our fixed interest debt would be sensitive to market rate changes.  Such fair value changes may affect our determination whether to retain, replace, or retire this debt.

ITEM 4CONTROLS AND PROCEDURES

As of the end of the period covered by this report, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Our disclosure controls and procedures are the controls and other procedures that we designed to ensure that we record, process, summarize and report in a timely manner the information we must disclose in reports that we file with or submit to the SEC. Our Chief Executive Officer and Chief Financial Officer reviewed and participated in this evaluation. Based on this evaluation the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls were effective.  In designing the Company’s disclosure controls and procedures, the Company’s management recognizes that any controls, no matter how well designed and operated, can only provide reasonable, not absolute, assurance of achieving the desired control objectives.  During the fiscal quarter covered by this report, there have not been any significant changes in our internal accounting controls or in other factors that could significantly affect those controls.

36

PART IIOTHER INFORMATION

ITEM 4SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

At the Company’s Annual Meeting of Shareholders held on May 19, 2004, the Board of Directors was re-elected in its entirety.  The votes cast for each nominee were as follows:

	For	Withheld
Kyle Kirkland	51,926,862	1,402,800
Dana D. Messina	51,946,831	1,382,831
John M. Stoner, Jr.	51,903,402	1,426,260
Bruce A. Stevens	51,907,102	1,422,560
A. Clinton Allen	52,958,361	371,301
Rudolph K. Kluiber	52,982,011	347,651
Peter McMillan	52,981,911	347,751

The proposal to ratify Deloitte & Touche to serve as the Company’s independent auditors for the fiscal year ending December 31, 2004 was approved with 53,202,982 votes cast for, 103,163 votes against, and 23,517 abstentions.

ITEM 6EXHIBITS AND REPORTS ON FORM 8-K

(a)	Exhibits
	4.1	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, Inc. with and into Conn-Selmer, Inc., as borrowers; those signatories identified as guarantors, the lenders, and GMAC Commercial Credit LLC, as administrative agent.
	31.1	Certification of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	31.2	Certification of the Principal 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
(b)	Reports on Form 8-K
	During the quarter ended June 30, 2004 we filed or furnished the following reports on
	Form 8-K:

37

On May 6, 2004, the Company filed a Current Report on Form 8-K that included a press release issued on the same date announcing its earnings for the quarter ended March 31, 2004.

38

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrants have duly caused this report to be signed on their behalf by the undersigned, thereunto duly authorized.

	STEINWAY MUSICAL INSTRUMENTS, INC.
	/s/ Dana D. Messina
	Dana D. Messina
	Director, President and Chief Executive Officer
	/s/ Dennis M. Hanson
	Dennis M. Hanson
	Senior Executive Vice President and
	Chief Financial Officer
Date: August 5, 2004

39