Steinway Musical Instruments (LVB) 10-Q 2005 Q2 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER 001-11911

STEINWAY MUSICAL INSTRUMENTS, INC.

(Exact name of registrant as specified in its charter)

DELAWARE	35-1910745
(State or Other Jurisdiction of	(I.R.S. Employer
Incorporation or Organization)	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    No o

Number of shares of Common Stock issued and outstanding as of August 2, 2005:	Class A	477,952
	Ordinary	7,606,998
	Total	8,084,950

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, 2005 and June 30, 2004
	Condensed Consolidated Balance Sheets
	June 30, 2005 and December 31, 2004
	Consolidated Statements of Cash Flows
	Six months ended June 30, 2005 and June 30, 2004
	Consolidated Statement of Stockholders’ Equity
	Six months ended June 30, 2005
	Notes to Consolidated and 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
	Signatures

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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 June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
Net sales	$	89,761		$	83,688		$	181,103		$	173,749
Cost of sales	63,635			59,285			129,280			123,621
Gross profit	26,126			24,403			51,823			50,128
Operating expenses:
Sales and marketing	11,132			10,539			22,404			21,833
General and administrative	6,960			6,399			13,935			12,413
Amortization of intangible assets	284			255			566			546
Other operating expenses	23			(3		)	133			25
Total operating expenses	18,399			17,190			37,038			34,817
Income from operations	7,727			7,213			14,785			15,311
Other (income) expense, net	33			(734		)	(406		)	(1,346		)
Interest income	(723		)	(591		)	(1,693		)	(1,228		)
Interest expense	4,389			4,014			8,528			7,792
Income before income taxes	4,028			4,524			8,356			10,093
Income tax provision	1,610			1,810			3,340			4,035
Net income	$	2,418		$	2,714		$	5,016		$	6,058
Earnings per share:
Basic	$	0.30		$	0.34		$	0.62		$	0.75
Diluted	$	0.29		$	0.33		$	0.61		$	0.72
Weighted average shares:
Basic	8,052,418			7,957,483			8,041,649			8,083,945
Diluted	8,276,096			8,340,726			8,259,070			8,436,605

See notes to consolidated and condensed consolidated financial statements.

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STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

Unaudited

(In Thousands)

	June 30, 2005			December 31, 2004
ASSETS
Current assets:
Cash	$	17,742		$	27,372
Accounts, notes and other receivables, net of allowances of $11,980 and $13,271 in 2005 and 2004, respectively	90,354			88,059
Inventories	179,872			172,346
Prepaid expenses and other current assets	3,675			5,937
Deferred tax assets	14,636			15,047
Total current assets	306,279			308,761
Property, plant and equipment, net of accumulated depreciation of $71,675 and $70,473 in 2005 and 2004, respectively	98,739			102,944
Trademarks	13,318			12,325
Goodwill	30,355			31,854
Other intangibles, net	4,816			5,290
Other assets	14,530			16,371
TOTAL ASSETS	$	468,037		$	477,545
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt	$	13,794		$	14,212
Accounts payable	13,299			14,789
Other current liabilities	37,403			43,892
Total current liabilities	64,496			72,893
Long-term debt	210,887			208,580
Deferred tax liabilities	25,260			26,240
Other non-current liabilities	22,588			24,279
Total liabilities	323,231			331,992
Commitments and contingent liabilities
Stockholders’ equity:
Common stock	10			10
Additional paid-in capital	81,884			81,129
Retained earnings	117,603			112,587
Accumulated other comprehensive loss	(7,255		)	(737		)
Treasury stock, at cost	(47,436		)	(47,436		)
Total stockholders’ equity	144,806			145,553
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	468,037		$	477,545

See notes to consolidated and condensed consolidated financial statements.

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STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

(In Thousands)

	Six Months Ended June 30,
	2005			2004
Cash flows from operating activities:
Net income	$	5,016		$	6,058
Adjustments to reconcile net income to cash flows from operating activities:
Depreciation and amortization	5,739			5,338
Amortization of bond premium	(126		)	(105		)
Deferred tax benefit	(279		)	(218		)
Tax benefit from stock option exercises	99			732
Other	104			(28		)
Changes in operating assets and liabilities:
Accounts, notes and other receivables	(3,443		)	(8,463		)
Inventories	(13,145		)	(9,231		)
Prepaid expenses and other assets	2,821			(3,935		)
Accounts payable	(1,097		)	753
Other liabilities	(5,786		)	(1,513		)
Cash flows from operating activities	(10,097		)	(10,612		)
Cash flows from investing activities:
Capital expenditures	(2,349		)	(2,052		)
Proceeds from disposals of fixed assets	1,353			76
Cash flows from investing activities	(996		)	(1,976		)
Cash flows from financing activities:
Borrowings under lines of credit	70,708			10,349
Repayments under lines of credit	(64,200		)	(10,491		)
Debt issuance costs	—			(105		)
Repayments of term loan debt	(4,090		)	(3,352		)
Proceeds from issuance of common stock	656			4,594
Cash flows from financing activities	3,074			995
Effect of foreign exchange rate changes on cash	(1,611		)	(367		)
Decrease in cash	(9,630		)	(11,960		)
Cash, beginning of year	27,372			42,283
Cash, end of period	$	17,742		$	30,323
Supplemental Cash Flow Information
Interest paid	$	9,517		$	8,488
Taxes paid	$	6,694		$	5,695
Non-cash transaction:
Purchase of common stock by issuance of bonds	$	—		$	31,583

See notes to consolidated and condensed consolidated financial statements.

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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, January 1, 2005	$	10	$	81,129	$	112,587	$	(737	)	$	(47,436	)	$	145,553
Comprehensive income:
Net income					5,016								5,016
Foreign currency translation adjustment							(6,499		)				(6,499		)
Unrealized holding loss on marketable securities, net							(19		)				(19		)
Total comprehensive income													(1,502		)
Exercise of 33,640 options for shares of common stock			656										656
Tax benefit of options exercised			99										99
Balance, June 30, 2005	$	10	$	81,884	$	117,603	$	(7,255	)	$	(47,436	)	$	144,806

See notes to consolidated and condensed consolidated financial statements.

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STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED AND CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS

JUNE 30, 2005

Unaudited

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

(1)Basis of Presentation

The accompanying consolidated and condensed consolidated financial statements of Steinway Musical Instruments, Inc. and subsidiaries (the “Company”) for the three and six months ended June 30, 2005 and 2004 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, 2004, 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 periods.  You should read the consolidated and 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 year ended December 31, 2004 filed with the Securities and Exchange Commission (“SEC”).  The results of operations for the three and six months ended June 30, 2005 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.

Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America necessarily requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Income Taxes - We provide for income taxes using an asset and liability approach.  We compute deferred income tax assets and liabilities annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income.  We establish valuation allowances when necessary to reduce deferred tax assets to the amount that more likely than not will be realized.

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

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United States of America, we have elected to continue to follow the intrinsic value method in accounting for our stock-based employee compensation arrangements.

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 June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
Net income, as reported	$	2,418		$	2,714		$	5,016		$	6,058
Deduct: Total stock-based employee compensation expense determined under fair-value based method, net of related tax effects	(220		)	(253		)	(472		)	(507		)
Pro forma net income	$	2,198		$	2,461		$	4,544		$	5,551
Earnings per share:
Basic - as reported	$	0.30		$	0.34		$	0.62		$	0.75
Basic - pro forma	$	0.27		$	0.31		$	0.57		$	0.69
Diluted - as reported	$	0.29		$	0.33		$	0.61		$	0.72
Diluted - pro forma	$	0.27		$	0.30		$	0.56		$	0.67

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.  There were no stock option awards during the three and six months ended June 30, 2005 and 2004.

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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 June 30,		Six Months Ended June 30,
	2005	2004	2005	2004
Weighted-average shares:
For basic earnings per share	8,052,418	7,957,483	8,041,649	8,083,945
Dilutive effect of stock options	223,678	383,243	217,421	352,660
For diluted earnings per share	8,276,096	8,340,726	8,259,070	8,436,605

All outstanding options were included in the computation of diluted net earnings per common share for the three and six months ended June 30, 2005 and 2004 because the exercise prices of the options were less than the average market price of our common shares.

Accumulated Other Comprehensive Income (Loss) – Accumulated other comprehensive income (loss) is comprised of net income, foreign currency translation adjustments, additional minimum pension liabilities, and unrealized gains and losses on available-for-sale (“AFS”) marketable securities.  The components of accumulated other comprehensive loss are as follows:

	Foreign Currency Translation Adjustment			Unrealized Holding Gain/(Loss) on AFS Securities			Tax Impact of Unrealized Holding Gain/(Loss) on AFS Securities			Additional Minimum Pension Liability			Tax Impact of Additional Minimum Pension Liability		Accumulated Other Comprehensive Loss
Balance, January 1, 2005	$	5,746		$	157		$	(63	)	$	(10,802	)	$	4,225	$	(737	)
Activity	(6,499		)	(32		)	13			—			—		(6,518		)
Balance, June 30, 2005	$	(753	)	$	125		$	(50	)	$	(10,802	)	$	4,225	$	(7,255	)

Recent Accounting Pronouncements – In December 2004, the Financial Accounting Standards Board (“FASB”) revised Statement of Financial Accounting Standards (“SFAS”) No. 123 and issued SFAS No. 123R, “Share-Based Payments” (SFAS No. 123R). This accounting standard, which was originally effective for interim and annual periods beginning after June 15, 2005, requires the recognition of compensation expense related to stock options using the fair value method.  In April 2005, the SEC revised the first required compliance date to fiscal years beginning after June 15, 2005.  We plan to adopt SFAS No. 123R in the first quarter of 2006 using the modified prospective application method. Based on current outstanding awards, expected participation in the Purchase Plan consistent with past patterns, and no significant changes in the number of shares of outstanding stock, we anticipate an impact on earnings of approximately $0.11 per basic share in additional stock compensation expense in 2006.  The actual amount will be impacted by changes in the aforementioned factors.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4” (SFAS No. 151). This accounting standard, which is effective for annual periods beginning after June 15, 2005, requires that abnormal amounts of idle facility expense, freight, handling

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costs, and wasted materials (spoilage) should be recognized as current-period charges. The adoption of SFAS No. 151 is not expected to have a material effect on our financial position or results of operations.

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

(3)Acquisitions

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

We acquired Leblanc because its line of instruments and accessories is complementary to our existing product lines, enabling us to gain or strengthen market share in certain instrument categories. The Company disbursed $37.6 million for the purchase price at closing, of which $3.9 million is being held in escrow pending expiration of an indemnification period.  The final purchase price was dependent upon a calculation derived from the closing balance sheet, which resulted in an additional payment of $1.4 million in June 2005.  The total purchase price of $38.9 million has been allocated to acquired assets and assumed liabilities as of August 12, 2004 as follows:

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

We acquired a manufacturing facility via this transaction that had been scheduled for closure by the predecessor owner.  We vacated this facility in early 2005 and did not incur significant costs as a result of this closure.  This acquired facility and a previously closed woodwind manufacturing facility in Elkhart, Indiana were sold in the current period for combined net proceeds of $1.0 million.  The gain on the sales was less than $0.2 million and related primarily to the closed woodwind manufacturing facility.

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(4)Inventories

	June 30, 2005		December 31, 2004
Raw materials	$	22,595	$	23,439
Work in process	53,795		54,612
Finished goods	103,482		94,295
Total	$	179,872	$	172,346

(5)Goodwill, Trademarks, and Other Intangible Assets

Intangible assets other than goodwill and indefinite-lived trademarks are amortized on a straight-line basis over their estimated useful lives.  Deferred financing costs are amortized over the repayment periods of the underlying debt.  We test our goodwill and indefinite-lived 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.  Our annual impairment assessment is in July.  The changes in carrying amounts of goodwill and trademarks are as follows:

	Piano Segment			Band Segment		Total
Goodwill:
Balance, January 1, 2005	$	23,299		$	8,555	$	31,854
Foreign currency translation impact	(1,499		)	—		(1,499		)
Balance, June 30, 2005	$	21,800		$	8,555	$	30,355
Trademarks:
Balance, January 1, 2005	$	7,964		$	4,361	$	12,325
Additions based on purchase price allocation to acquired assets	—			1,463		1,463
Foreign currency translation impact	(470		)	—		(470		)
Balance, June 30, 2005	$	7,494		$	5,824	$	13,318

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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, 2005			December 31, 2004
Gross deferred financing costs	$	8,717		$	8,627
Accumulated amortization	(4,323		)	(3,834		)
Deferred financing costs, net	$	4,394		$	4,793
Gross covenants not to compete	$	750		$	750
Accumulated amortization	(328		)	(253		)
Covenants not to compete, net	$	422		$	497

The weighted-average amortization period for deferred financing costs is 9 years, and the weighted-average amortization period of covenants not to compete is 5 years.  Total amortization expense, which includes amortization of deferred financing costs, is as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
	2005		2004		2005		2004
Amortization expense	$	284	$	255	$	566	$	546

The following table shows the total estimated amortization expense for 2005 and the next five succeeding fiscal years:

Estimated amortization expense:

2005	$	1,117
2006	1,084
2007	1,084
2008	939
2009	548
2010	468

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(6)Other Current Liabilities

	June 30, 2005		December 31, 2004
Accrued payroll and related benefits	$	19,152	$	18,072
Current portion of pension liability	2,876		2,811
Accrued warranty expense	2,120		2,139
Accrued interest	3,284		3,257
Deferred income	4,465		4,468
Other accrued expenses	5,506		13,145
Total	$	37,403	$	43,892

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

The accrued warranty expense activity for the six months ended June 30, 2005 and 2004, and the year ended December 31, 2004 is as follows:

	June 30, 2005			June 30, 2004			December 31, 2004
Beginning balance	$	2,139		$	2,602		2,602
Additions	542			520			932
Claims and reversals	(480		)	(774		)	(1,455	)
Foreign currency translation impact	(81		)	(23		)	60
Ending balance	$	2,120		$	2,325		2,139

(7)Long-Term Debt

Long-term debt consists of the following:

	June 30, 2005		December 31, 2004
Term loans	$	35,533	$	39,623
8.75% Senior Notes	174,345		174,345
Unamortized bond premium	1,458		1,584
Domestic line of credit	7,238		—
Open account loans, payable on demand	6,107		7,240
Total	224,681		222,792
Less: current portion	13,794		14,212
Long-term debt	$	210,887	$	208,580

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Scheduled payments of long-term debt are as follows:

	June 30, 2005
Remainder of 2005	$	9,802
2006	7,997
2007	8,071
2008	23,008
2009	—
Thereafter	174,345
Total	$	223,223

(8)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.  At June 30, 2005 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.

(9) Other (Income) Expense, Net

	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
West 57th building income	$	(1,163	)	$	(1,163	)	$	(2,327	)	$	(2,326	)
West 57th building expense	816			814			1,631			1,628
Foreign exchange (gains) losses, net	457			175			442			(83		)
Miscellaneous	(77		)	(560		)	(152		)	(565		)
Other (income) expense, net	$	33		$	(734	)	$	(406	)	$	(1,346	)

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(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 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 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

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4.1%.  A summary of expected payments associated with this project is as follows:

	Environmental Payments
2005	156
2006	80
2007	54
2008	47
2009	47
Thereafter	514
Total	$	898

In 2004, we acquired manufacturing facilities for which environmental remediation programs had already been established.  Based on our current assessment, we have accrued approximately $0.7 million for the cost of these remediation programs.  Should the liability increase, we are able to seek a claim against the escrow, which has a remaining balance of approximately $3.9 million and is available until February 2006.

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 in any individual year.  However, some risk of environmental liability is inherent in the nature of our current and former business 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 Germany and the U.K.   The components of net periodic pension cost for these plans are as follows:

	Domestic Plans						Foreign Plans
	Three Months Ended June 30,						Three Months Ended June 30,
	2005			2004			2005			2004
Service cost	$	126		$	153		$	171		$	162
Interest cost	566			552			330			312
Expected return on plan assets	(782		)	(743		)	(73		)	(66		)
Amortization of prior service cost	76			114			—			—
Amortization of net loss	114			52			1			19
Net periodic benefit cost	$	100		$	128		$	429		$	427

16

	Domestic Plans						Foreign Plans
	Six Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
Service cost	$	252		$	439		$	339		$	329
Interest cost	1,132			1,585			655			634
Expected return on plan assets	(1,564		)	(2,144		)	(148		)	(134		)
Amortization of prior service cost	152			326			—			—
Amortization of net loss	228			140			1			38
Net periodic benefit cost	$	200		$	346		$	847		$	867

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 June 30,				Six Months Ended June 30,
	2005		2004		2005		2004
Service cost	$	9	$	39	$	20	$	58
Interest cost	29		77		65		115
Amortization of transition obligation	10		25		23		38
Amortization of net loss	—		9		—		14
Net postretirement benefit cost	$	48	$	150	$	108	$	225

We anticipate domestic pension plan contributions of approximately $1.5 million for the current year.  As of June 30, 2005 we have not yet made a contribution to this plan.  Our anticipated contributions to the pension plan of our U.K. subsidiary approximate $0.2 million for the current year.  As of June 30, 2005, we have made contributions of less than $0.2 million to this plan.  The pension plans of our German subsidiaries do not hold any assets and pay participant benefits as incurred.  Expected 2005 benefit payments under these plans are $0.8 million.  For the three and six months ended June 30, 2005, we have made benefit payments of $0.5 million under 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.

17

The following tables present information about our operating segments for the three and six month periods ended June 30, 2005 and 2004:

	Piano Segment								Band Segment							Other			Consol
Three months ended 2005	U.S.		Germany		Other		Total		U.S.		Europe			Total		& Elim			Total
Net sales to external customers	$	25,489	$	13,739	$	7,165	$	46,393	$	41,767	$	1,601		$	43,368	$	—		$	89,761
Income (loss) from operations	1,872		3,142		271		5,285		3,449		(217		)	3,232		(790		)	7,727

	Piano Segment								Band Segment						Other			Consol
Three months ended 2004	U.S.		Germany		Other		Total		U.S.		Europe		Total		& Elim			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

	Piano Segment								Band Segment							Other			Consol
Six months ended 2005	U.S.		Germany		Other		Total		U.S.		Europe			Total		& Elim			Total
Net sales to external customers	$	51,406	$	24,053	$	14,709	$	90,168	$	87,518	$	3,417		$	90,935	$	—		$	181,103
Income (loss) from operations	4,350		5,348		822		10,520		6,163		(271		)	5,892		(1,627		)	14,785

	Piano Segment								Band Segment						Other			Consol
Six months ended 2004	U.S.		Germany		Other		Total		U.S.		Europe		Total		& Elim			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

(13) Summary of Guarantees

Our payment obligations under our 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, 2005

Unaudited

(In Thousands)

	Issuer of Notes			Guarantor Subsidiaries			Non Guarantor Subsidiaries			Reclass/ Eliminations			Consolidated
Net sales	$	—		$	70,113		$	23,403		$	(3,755	)	$	89,761
Cost of sales	—			52,435			14,944			(3,744		)	63,635
Gross profit	—			17,678			8,459			(11		)	26,126
Operating expenses:
Sales and marketing	—			7,719			3,413			—			11,132
General and administrative	1,891			3,557			1,512			—			6,960
Amortization of intangible assets	116			162			6			—			284
Other operating (income) expense	(1,217		)	849			391			—			23
Total operating expenses	790			12,287			5,322			—			18,399
Income (loss) from operations	(790		)	5,391			3,137			(11		)	7,727
Other (income) expense, net	—			(58		)	91			—			33
Interest income	(3,667		)	(6,312		)	(71		)	9,327			(723		)
Interest expense	3,856			9,779			81			(9,327		)	4,389
Income (loss) before income taxes	(979		)	1,982			3,036			(11		)	4,028
Income tax provision (benefit)	354			(36		)	1,299			(7		)	1,610
Net income (loss)	$	(1,333	)	$	2,018		$	1,737		$	(4	)	$	2,418

19

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 tax provision (benefit)	(347		)	958			1,142			57			1,810
Net income (loss)	$	(543	)	$	1,418		$	1,710		$	129		$	2,714

20

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF INCOME

SIX MONTHS ENDED JUNE 30, 2005

Unaudited

(In Thousands)

	Issuer of Notes			Guarantor Subsidiaries			Non Guarantor Subsidiaries			Reclass/ Eliminations			Consolidated
Net sales	$	—		$	144,716		$	44,366		$	(7,979	)	$	181,103
Cost of sales	—			109,002			28,315			(8,037		)	129,280
Gross profit	—			35,714			16,051			58			51,823
Operating expenses:
Sales and marketing	—			16,037			6,367			—			22,404
General and administrative	3,662			7,169			3,104			—			13,935
Amortization of intangible assets	233			324			9			—			566
Other operating (income) expense	(2,268		)	1,674			727			—			133
Total operating expenses	1,627			25,204			10,207			—			37,038
Income (loss) from operations	(1,627		)	10,510			5,844			58			14,785
Other (income) expense, net	(8		)	(474		)	76			—			(406		)
Interest income	(7,332		)	(12,262		)	(161		)	18,062			(1,693		)
Interest expense	7,714			18,721			155			(18,062		)	8,528
Income (loss) before income taxes	(2,001		)	4,525			5,774			58			8,356
Income tax provision (benefit)	891			(66		)	2,464			51			3,340
Net income (loss)	$	(2,892	)	$	4,591		$	3,310		$	7		$	5,016

21

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 tax provision (benefit)	(564		)	2,288			2,295			16			4,035
Net income (loss)	$	(884	)	$	3,375		$	3,498		$	69		$	6,058

22

 STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING BALANCE SHEETS

JUNE 30, 2005

Unaudited

(In Thousands)

	Issuer of Notes			Guarantor Subsidiaries		Non Guarantor Subsidiaries		Reclass/ Eliminations			Consolidated
ASSETS
Current assets:
Cash	$	—		$	37,288	$	13,419	$	(32,965	)	$	17,742
Accounts, notes and leases receivable, net	—			80,696		9,658		—			90,354
Inventories	—			136,594		44,485		(1,207		)	179,872
Prepaid expenses and other current assets	458			1,908		1,309		—			3,675
Deferred tax assets	—			9,705		4,931		—			14,636
Total current assets	458			266,191		73,802		(34,172		)	306,279
Property, plant and equipment, net	214			80,929		17,596		—			98,739
Investment in subsidiaries	69,643			248,346		—		(317,989		)	—
Trademarks	—			9,319		3,885		114			13,318
Goodwill	—			17,973		12,382		—			30,355
Other intangibles, net	2,705			2,028		83		—			4,816
Other assets	3,296			8,185		3,049		—			14,530
TOTAL ASSETS	$	76,316		$	632,971	$	110,797	$	(352,047	)	$	468,037
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt	$	—		$	7,687	$	6,107	$	—		$	13,794
Accounts payable	233			9,806		3,260		—			13,299
Other current liabilities	2,777			20,633		14,253		(260		)	37,403
Total current liabilities	3,010			38,126		23,620		(260		)	64,496
Long-term debt	175,803			68,049		—		(32,965		)	210,887
Intercompany	(132,701		)	130,965		1,736		—			—
Deferred tax liabilities	50			18,731		6,479		—			25,260
Other non-current liabilities	1,045			1,939		19,604		—			22,588
Total liabilities	47,207			257,810		51,439		(33,225		)	323,231
Stockholders’ equity	29,109			375,161		59,358		(318,822		)	144,806
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	76,316		$	632,971	$	110,797	$	(352,047	)	$	468,037

23

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING BALANCE SHEETS

DECEMBER 31, 2004

Unaudited

(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

24

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONSOLIDATING STATEMENTS OF CASH FLOWS

SIX MONTHS ENDED JUNE 30, 2005

Unaudited

(In Thousands)

	Issuer of Notes			Guarantor Subsidiaries			Non Guarantor Subsidiaries			Reclass/ Eliminations			Consolidated
Cash flows from operating activities:
Net income (loss)	$	(2,892	)	$	4,591		$	3,310		$	7		$	5,016
Adjustments to reconcile net income (loss) to cash flows from operating activities:
Depreciation and amortization	275			4,488			976			—			5,739
Amortization of bond premium	(126		)	—			—			—			(126		)
Deferred tax benefit	(13		)	(122		)	(144		)	—			(279		)
Tax benefit from stock option exercises	99			—			—			—			99
Other	—			98			6			—			104
Changes in operating assets and liabilities:
Accounts, notes and leases receivable	—			(6,149		)	2,706			—			(3,443		)
Inventories	—			(9,471		)	(3,616		)	(58		)	(13,145		)
Prepaid expenses and other assets	360			3,365			(904		)	—			2,821
Accounts payable	(444		)	(910		)	257			—			(1,097		)
Other liabilities	(2,688		)	(2,578		)	(571		)	51			(5,786		)
Cash flows from operating activities	(5,429		)	(6,688		)	2,020			—			(10,097		)
Cash flows from investing activities:
Capital expenditures	(75		)	(1,720		)	(554		)	—			(2,349		)
Proceeds from disposal of fixed assets	—			954			399			—			1,353
Cash flows from investing activities	(75		)	(766		)	(155		)	—			(996		)
Cash flows from financing activities:
Borrowings under lines of credit	—			69,664			2,153			(1,109		)	70,708
Repayments under lines of credit	—			(61,317		)	(2,883		)	—			(64,200		)
Repayments of term-loan debt	—			(4,090		)	—			—			(4,090		)
Proceeds from issuance of stock	656			—			—			—			656
Intercompany transactions	4,848			(4,505		)	(343		)	—			—
Cash flows from financing activities	5,504			(248		)	(1,073		)	(1,109		)	3,074
Effect of exchange rate changes on cash	—			—			(1,611		)	—			(1,611		)
Decrease in cash	—			(7,702		)	(819		)	(1,109		)	(9,630		)
Cash, beginning of year	—			44,990			14,238			(31,856		)	27,372
Cash, end of period	$	—		$	37,288		$	13,419		$	(32,965	)	$	17,742

25

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		)
Tax benefit from stock option exercises	732			—			—			—			732
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	(1,243		)	(973		)	687			16			(1,513		)
Cash flows from operating activities	(2,203		)	(9,943		)	1,534			—			(10,612		)
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		)
Debt issuance costs	(105		)	—			—			—			(105		)
Repayments of term loan 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	(2,222		)	(1,171		)	(3,056		)	3,000			995
Effect of exchange rate changes on cash	—			—			(367		)	—			(367		)
Increase (decrease) in cash	—			(12,606		)	(2,354		)	3,000			(11,960		)
Cash, beginning of year	—			12,255			8,792			21,236			42,283
Cash, end of period	$	—		$	(351	)	$	6,438		$	24,236		$	30,323

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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 brass, woodwind, percussion and string instruments and related accessories with well-known brand names such as Bach, Selmer, C.G. Conn, Leblanc, 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 Estimates

The application of many accounting policies involves estimates and assumptions that have a material impact on our reported results.  We establish reserves for inventory, workers’ compensation, warranty claims, accounts receivable, notes receivable, (including recourse reserves when our customers have financed notes receivable with a third party), all of which are developed using certain estimates.  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.  We regularly perform assessments of the underlying assumptions we use. The impairment (if any) and recoverability of long-lived assets, the selection of assumptions used to determine pension expense or income, the allocation of purchase price for businesses acquired, and certain components of our tax provision calculation, such as valuation allowances on deferred tax assets, the ability to utilize foreign tax credits, and income tax contingencies are based on estimates that require a greater degree of management judgment. We believe the assumptions made by management provide a reasonable basis for the estimates reflected 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, 2004, 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

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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.

Results of Operations

Three Months Ended June 30, 2005 Compared to Three Months Ended June 30, 2004

	Quarter Ended June 30,						Change
	2005			2004			$		%
Net sales
Band	$	43,368		$	38,755		4,613		11.9
Piano	46,393			44,933			1,460		3.2
Total sales	89,761			83,688			6,073		7.3
Cost of sales
Band	33,709			29,844			3,865		13.0
Piano	29,926			29,441			485		1.6
Total cost of sales	63,635			59,285			4,350		7.3
Gross profit
Band	9,659		22.3%	8,911		23.0%	748		8.4
Piano	16,467		35.5%	15,492		34.5%	975		6.3
Total gross profit	26,126			24,403			1,723		7.1
	29.1%			29.2%
Operating expenses	18,399			17,190			1,209		7.0
Income from operations	7,727			7,213			514		7.1
Other (income) expense, net	33			(734		)	767		(104.5	)
Net interest expense	3,666			3,423			243		7.1
Income before income taxes	4,028			4,524			(496	)	(11.0	)
Income taxes	1,610		40.0%	1,810		40.0%	(200	)	(11.0	)
Net income	$	2,418		$	2,714		(296	)	(10.9	)

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Overview – The increase in band division revenue in the current period resulted primarily from Leblanc instruments. Also, this period we were better able to align our shipments of new sourced products and certain domestically produced woodwind instruments with orders received for these items. We had increased production staff at our woodwind manufacturing facility in early 2005 to help us better meet the demand for instruments produced at that location. Although production inefficiencies resulting from training personnel at our woodwind facility continued during the period, these were more than offset by lower employee benefit costs.  As a result, overall band operating profit improved over the prior period.

Domestic piano revenues were consistent with the prior year, and overseas piano revenue increased primarily due to strong wholesale volume.  Margins improved due to increased sales volume of higher margin wholesale units, and overall piano operating profit improved over the prior period.

Net Sales – The increase in net sales of $6.1 million resulted from improved performance in both the piano and band segments.  Although overall Steinway grand unit shipments were off 3% from the prior year, piano division sales increased $1.5 million.  This improvement was driven by an 11% increase in overseas Steinway grand unit shipments and strong wholesale volume at our European operations.  In addition, the annual sales price increase on Steinway products and price increase on Boston products mitigated the decrease in overall unit shipments of 2%. We were not able to fill all orders received for certain woodwind instruments, particularly flutes, due to the production inefficiencies resulting from the training of new production workers at our woodwind manufacturing facility. Despite this, band segment revenues increased $4.6 million on an overall unit increase of 4%.  This increase was fueled by Leblanc product sales of $5.4 million, which resulted in a brass and woodwind unit increase of 13% for the period.

Gross Profit – Gross profit improved $1.7 million driven by piano margin improvements and band sales volume improvements.  Despite flat retail sales, piano margins increased from 34.5% to 35.5% due to strong wholesale demand in higher margin European territories. Band gross margins declined from 23.0% to 22.3% in the period.  This decrease resulted from charges of $0.6 million that arose from the turn through of Leblanc inventory, which was written up to fair value. Although the production inefficiencies at our woodwind manufacturing plant adversely impacted band margins, this was offset by reduced employee medical costs during the period.

Operating Expenses – Operating expenses increased $1.2 million, $0.3 million of which is due to incremental costs associated with Leblanc.  Approximately $0.4 million of the increase is due to a shift in external costs associated with Sarbanes-Oxley compliance efforts into the current period.  These costs were concentrated in the third and fourth quarters in the prior year.  The remainder is attributable to increased sales and marketing costs, primarily associated with promotional efforts.

Interest Expense and Other Income, Net – These other expenses increased $1.0 million to $3.7 million due primarily to certain reclassifications, an increase in foreign exchange losses of $0.3 million, and $0.2 million in additional interest expense.  Higher domestic interest expense resulted from the rise in interest rates, as well as our use of the domestic line in the current period.

Income Taxes – Our effective tax rate of 40% is consistent with the prior comparative period.

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Six Months Ended June 30, 2005 Compared to Six Months Ended June 30, 2004

	Period Ended June 30,						Change
	2005			2004			$		%
Net sales
Band	$	90,935		$	83,099		7,836		9.4
Piano	90,168			90,650			(482	)	(0.5	)
Total sales	181,103			173,749			7,354		4.2
Cost of sales
Band	71,523			64,160			7,363		11.5
Piano	57,757			59,461			(1,704	)	(2.9	)
Total cost of sales	129,280			123,621			5,659		4.6
Gross profit
Band	19,412		21.3%	18,939		22.8%	473		2.5
Piano	32,411		35.9%	31,189		34.4%	1,222		3.9
Total gross profit	51,823			50,128			1,695		3.4
	28.6%			28.9%
Operating expenses	37,038			34,817			2,221		6.4
Income from operations	14,785			15,311			(526	)	(3.4	)
Other income, net	(406		)	(1,346		)	940		(69.8	)
Net interest expense	6,835			6,564			271		4.1
Income before income taxes	8,356			10,093			(1,737	)	(17.2	)
Income taxes	3,340		40.0%	4,035		40.0%	(695	)	(17.2	)
Net income	$	5,016		$	6,058		(1,042	)	(17.2	)

Overview – Sales of Leblanc instruments drove the band division’s revenue improvement for the period.  Sales of other band instruments were lower as demand for newly introduced sourced-product models and certain woodwind instruments exceeded amounts available for shipment. We expect the production disruptions caused by training new personnel at the woodwind manufacturing facility to taper off in the third quarter.  These production disruptions also adversely impacted band gross margins.

Although piano sales were relatively flat for the period, piano division operating profit improved, primarily as a result of gross margin improvements.

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Net Sales – The increase in net sales of $7.4 million was driven by the increase in band sales.  Piano division sales were relatively consistent with the prior period as the strong European wholesale performance in the latter part of the period essentially offset the $1.4 million decrease in domestic retail sales in the first quarter.  Steinway grand unit shipments, as well as overall unit shipments, decreased 3% over the prior period.  However, standard price increases on Steinway and Boston product helped mitigate the impact of lower shipments.  Our band division sales increased $7.8 million as a result of incremental Leblanc product sales of $11.4 million.  In the first part of the period, orders for certain new sourced product models as well as certain domestically manufactured clarinets and flutes exceeded amounts we had available for shipment. The availability of sourced products and clarinets improved in the latter part of the period, mitigating the revenue shortfall in these categories.

Gross Profit – Gross profit improved $1.7 million, fueled by the improvement in piano division margins.    Piano margins increased from 34.4% to 35.9% despite lower retail sales due to wholesale shipments to high-margin territories by our European operations, as well as a shift in domestic sales mix toward larger, higher margin Steinway grand units. Increased production levels at our German manufacturing facility and lower domestic overhead expenses in the first part of the period also contributed to the margin improvement.  Band gross margins declined from 22.8% to 21.3% in the period.  Atypical charges affecting margin in 2005 totaled $1.3 million, comprised of charges from the turn through of Leblanc inventory, which was written up to fair value.  Atypical charges affecting margin in 2004 included $1.4 million in severance costs associated with the closure of one of our woodwind manufacturing facilities.  Despite the decrease in atypical charges, gross margins declined primarily as a result of the factory disruptions caused by production ramp-up efforts and new workforce training at our domestic woodwind manufacturing facility.

Operating Expenses – Operating expenses increased $2.2 million, primarily due to incremental costs of $0.9 million associated with Leblanc, the majority of which was incurred in the first part of the period.  Approximately $0.6 million of the increase is due to a shift in external costs associated with ongoing compliance efforts to the current period.  In 2004, the majority of costs were incurred in the latter half of the year.  The remainder is primarily attributable to increased sales and marketing costs associated with promotional efforts and commissions incurred by the piano division.

Interest Expense and Other Income, Net – These other expenses increased $1.2 million to $6.4 million due the $0.5 million shift from foreign currency gains to foreign currency losses during the period.  Increased domestic interest expense due to the rise in interest rates, our increased bond debt ($29.0 million issued in February 2004), and borrowings on the domestic line of credit resulted in $0.3 million of the increase.  The remainder is due to the reclassification of certain items.

Income Taxes – Our effective tax rate of 40% is consistent with the prior comparative period.

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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, 2005 and 2004 are summarized as follows:

	2005			2004			Change
Net income:	$	5,016		$	6,058		$	(1,042	)
Changes in operating assets and liabilities	(20,650		)	(22,389		)	1,739
Other adjustments to reconcile net income to cash from operating activities	5,537			5,719			(182		)
Cash flows from operating activities	(10,097		)	(10,612		)	515
Cash flows from investing activities	(996		)	(1,976		)	980
Cash flows from financing activities	3,074			995			2,079

Although net income decreased $1.0 million, cash used for operating activities was $0.5 million lower during the period. Having established and funded new workers’ compensation trust accounts in the prior period, cash used for such assets decreased significantly.  Cash used for band division accounts receivable also decreased significantly during the period as collections improved.

The use of cash for investing activities decreased $1.0 million as proceeds of $1.4 million from the sale of certain acquired assets, including one manufacturing facility in Wisconsin, more than offset the increase in capital expenditures of $0.3 million.  Cash flows from financing activities increased $2.1 million during the period due to increased borrowings on the domestic line of credit.  These borrowings more than offset the $3.9 million decrease in cash generated from stock option exercises.

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, 2005 there was $7.2 million in revolving credit loans outstanding, and remaining availability based on eligible accounts receivable and inventory balances was approximately $75.4 million net of letters of credit of $2.3 million.  We also have certain non-domestic credit facilities originating from two German banks that provide for borrowings by foreign subsidiaries of up to €16.5 million ($20.0 million at the June 30, 2005 exchange rate), net of borrowing restrictions of €0.9 million ($1.1 million at the June 30, 2005 exchange rate) and are payable on demand.  These borrowings are collateralized by most of the assets of the borrowing subsidiaries.  A portion of the open account loans can be converted into a maximum of £0.5 million ($0.9 million at the June 30, 2005 exchange rate) for use by our U.K. branch and ¥300 million ($2.7 million at the June 30, 2005 exchange rate) for use by our Japanese subsidiary. Our Chinese subsidiary also has the ability to convert the equivalent of up to €1.8 million into U.S.

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dollars or Chinese renminbi ($2.2 million at the June 30, 2005 exchange rate).  We had $1.6 million outstanding as of June 30, 2005 on these credit facilities.  In January 2005, our Japanese subsidiary entered into a separate revolving loan agreement that provides additional borrowing capacity of up to ¥500 million ($4.5 million at the June 30, 2005 exchange rate) based on eligible inventory balances. The revolving loan agreement bears interest at an average 30-day Tokyo Interbank Offered Rate (“TIBOR”)(0.08% as of June 30, 2005) plus 0.875% and expires on January 31, 2010.  As of June 30, 2005, we had $4.5 million outstanding on this revolving loan agreement.

On February 4, 2004 we purchased 1,271,450 shares of our Ordinary common stock directly from our then 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 of 106.3%.  This transaction increased our treasury stock by $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 2004 stock repurchase, we had approached the limitation.  Although our availability under these limitations has increased over time as we have earned income, 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 $7.2 million in revolving credit loans and $35.5 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, 2005.

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.

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Contractual Obligations

The following table provides a summary of our contractual obligations at June 30, 2005:

	Payments due by period
Contractual Obligations	Total		Less than 1 year		1 - 3 years		3 - 5 years		More than 5 years
Long-term debt (1)	$	313,935	$	29,457	$	47,249	$	50,485	$	186,744
Operating leases (2)	270,990		4,831		8,430		7,537		250,192
Purchase obligations (3)	12,686		12,442		244		—		—
Other long-term liabilities (4)	23,371		3,571		3,947		3,208		12,645
Total	$	620,982	$	50,301	$	59,870	$	61,230	$	449,581

Notes to Contractual Obligations:

(1)	Long-term debt represents long-term debt obligations and the fixed interest on our Notes. 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 $256.4 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 tooling.
(4)	Other long-term liabilities consist primarily of the long-term portion of our pension obligations and obligations under employee and consultant agreements.

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) revised Statement of Financial Accounting Standards (“SFAS”) No. 123, and issued SFAS No. 123R, “Share-Based Payments” (SFAS No. 123R). This accounting standard, which was originally effective for interim and annual periods beginning after June 15, 2005, requires the recognition of compensation expense related to stock options using the fair value method.  In April 2005, the SEC revised the first required compliance date to fiscal years beginning after June 15, 2005.  We plan to adopt SFAS No. 123R in the first quarter of 2006 using the modified prospective application method. Based on current outstanding awards, expected participation in the Purchase Plan consistent with past patterns, and no significant changes in the number of shares of outstanding stock, we anticipate an impact on earnings of approximately $0.11 per basic share in additional stock compensation expense in 2006. The actual amount will be impacted by changes in the aforementioned factors.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4” (SFAS No. 151). This accounting standard, which is effective for 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 current-period charges. The adoption of SFAS No. 151 is not expected to have a material effect on our financial position or results of operations.

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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 a portion of our foreign currency exchange rate risk by maintaining foreign currency cash balances and holding option and forward foreign currency contracts.  They are not designated as hedges for accounting purposes.  These contracts relate primarily to intercompany transactions and are not used for trading or speculative purposes.  The fair value of the option and 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, 2004.

Our revolving loans and term loans bear interest at rates that fluctuate with changes in LIBOR and TIBOR.  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, 2004.

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 decision 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

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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 and procedures 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 quarter covered by this report, there were no significant changes in our internal controls other than those related to the integration of the Leblanc business, purchased in 2004, into our pre-existing internal control structure.  During the most recent quarter, we consolidated the majority of the Leblanc business processes into the Conn-Selmer processes and internal controls.  These changes have not materially affected, and are not reasonably likely to materially affect, the Company’s internal control over financial reporting.

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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, 2005, the Board of Directors was re-elected in its entirety.  The votes cast for each nominee were as follows:

	For	Withheld
Kyle Kirkland	52,065,800	2,122,101
Dana D. Messina	51,817,295	2,370,606
John M. Stoner, Jr.	51,796,347	2,391,554
Bruce A. Stevens	51,797,417	2,390,484
A. Clinton Allen	53,989,545	198,356
Rudolph K. Kluiber	53,993,044	194,857
Peter McMillan	53,993,045	194,856

The proposal to ratify Deloitte & Touche to serve as the Company’s independent auditors for the fiscal year ending December 31, 2005 was approved with 54,140,162 votes cast for, 45,274 against, and 2,465 abstentions.

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ITEM 6EXHIBITS

(i)Exhibits

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

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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has 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 9, 2005

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