Steinway Musical Instruments 10Q 2006 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006

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 x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o

Accelerated filer x

Non-accelerated filer o

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

Yes o No x

Number of shares of Common Stock issued and outstanding as of August 6, 2006:	Class A	477,952
	Ordinary	7,884,152
	Total	8,362,104

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 Operations Three months and six months ended June 30, 2006 and June 30, 2005

	Condensed Consolidated Balance Sheets June 30, 2006 and December 31, 2005

	Consolidated Statements of Cash Flows Six months ended June 30, 2006 and June 30, 2005

	Consolidated Statement of Stockholders’ Equity Six months ended June 30, 2006

	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

ITEM 1 CONSOLIDATED AND CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Unaudited
(In Thousands Except Share and Per Share Amounts)

	Three Months Ended June 30,						Six Months Ended June 30,
	2006			2005			2006			2005
Net sales	$	92,423		$	89,761		$	187,617		$	181,103
Cost of sales	69,274			63,635			138,476			129,280

Gross profit	23,149			26,126			49,141			51,823

Operating expenses:
Sales and marketing	11,063			11,049			22,733			22,182
Provision for doubtful accounts	4,505			83			4,562			222
General and administrative	7,811			6,960			16,189			13,935
Amortization of intangible assets	197			284			426			566
Other operating (income) expenses	(32		)	23			115			133
Total operating expenses	23,544			18,399			44,025			37,038

(Loss) income from operations	(395		)	7,727			5,116			14,785

Other (income) expense, net	(695		)	33			(1,446		)	(406		)
Loss on extinguishment of debt	3,063			—			9,674			—
Interest income	(880		)	(723		)	(2,607		)	(1,693		)
Interest expense	4,032			4,389			8,507			8,528
Total non-operating expenses	5,520			3,699			14,128			6,429

(Loss) income before income taxes	(5,915		)	4,028			(9,012		)	8,356

Income tax (benefit) provision	(5,054		)	1,610			(6,309		)	3,340

Net (loss) income	$	(861	)	$	2,418		$	(2,703	)	$	5,016

(Loss) earnings per share:
Basic	$	(0.10	)	$	0.30		$	(0.33	)	$	0.62
Diluted	$	(0.10	)	$	0.29		$	(0.33	)	$	0.61

Weighted average shares:
Basic	8,331,652			8,052,418			8,242,011			8,041,649
Diluted	8,331,652			8,276,096			8,242,011			8,259,070

See notes to consolidated and condensed consolidated financial statements.

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
Unaudited
(In Thousands)

	June 30, 2006			December 31, 2005

Assets
Current assets:
Cash	$	21,118		$	34,952
Accounts, notes and other receivables, net of allowances of $18,899 and $12,323 in 2006 and 2005, respectively	90,307			81,880
Inventories	155,284			159,310
Prepaid expenses and other current assets	11,669			11,653
Deferred tax assets	18,383			7,936
Total current assets	296,761			295,731

Property, plant and equipment, net of accumulated depreciation of $81,306 and $75,734 in 2006 and 2005, respectively	96,448			96,664
Trademarks	13,540			13,233
Goodwill	31,062			30,088
Other intangibles, net	4,623			4,128
Other assets	15,661			15,811

Total assets	$	458,095		$	455,655

Liabilities and stockholders’ equity
Current liabilities:
Current portion of long-term debt	$	5,960		$	12,977
Accounts payable	15,222			13,805
Other current liabilities	47,131			45,099
Total current liabilities	68,313			71,881

Long-term debt	187,544			191,715
Deferred tax liabilities	15,823			15,326
Other non-current liabilities	30,443			27,903
Total liabilities	302,123			306,825

Commitments and contingent liabilities

Stockholders’ equity:
Common stock	10			10
Additional paid-in capital	88,804			83,062
Retained earnings	123,676			126,379
Accumulated other comprehensive loss	(9,082		)	(13,185		)
Treasury stock, at cost	(47,436		)	(47,436		)
Total stockholders’ equity	155,972			148,830

Total liabilities and stockholders’ equity	$	458,095		$	455,655

See notes to consolidated and condensed consolidated financial statements.

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
(In Thousands)

	Six Months Ended June 30,
	2006			2005
Cash flows from operating activities:
Net (loss) income	$	(2,703	)	$	5,016
Adjustments to reconcile net (loss) income to cash flows from operating activities:
Depreciation and amortization	5,439			5,739
Amortization of bond discount	57			—
Amortization of bond premium	(42		)	(126		)
Loss on extinguishment of debt	9,674			—
Stock-based compensation expense	566			—
Excess tax benefits from stock-based awards	(417		)	—
Tax benefit from stock option exercises	917			99
Deferred tax benefit	(10,227		)	(279		)
Provision for doubtful accounts	4,562			222
Other	(85		)	(118		)
Changes in operating assets and liabilities:
Accounts, notes and other receivables	(11,582		)	(3,443		)
Inventories	6,020			(13,145		)
Prepaid expenses and other assets	(423		)	2,821
Accounts payable	1,014			(1,097		)
Other liabilities	1,619			(5,786		)
Cash flows from operating activities	4,389			(10,097		)

Cash flows from investing activities:
Capital expenditures	(2,565		)	(2,349		)
Proceeds from disposals of property, plant and equipment	331			1,353
Cash flows from investing activities	(2,234		)	(996		)

Cash flows from financing activities:
Borrowings under lines of credit	37,401			70,708
Repayments under lines of credit	(37,779		)	(64,200		)
Debt issuance costs	(4,145		)	—
Proceeds from issuance of debt	173,676			—
Repayments of long-term debt	(183,331		)	(4,090		)
Premium paid on extinguishment of debt	(7,740		)	—
Proceeds from issuance of common stock	4,259			656
Excess tax benefits from stock-based awards	417			—
Cash flows from financing activities	(17,242		)	3,074

Effect of foreign exchange rate changes on cash	1,253			(1,611		)

Decrease in cash	(13,834		)	(9,630		)
Cash, beginning of period	34,952			27,372

Cash, end of period	$	21,118		$	17,742

Supplemental Cash Flow Information
Interest paid	$	7,163		$	9,517
Taxes paid	$	3,249		$	6,694

See notes to consolidated and condensed consolidated financial statements.

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, 2006	$	10	$	83,062	$	126,379		$	(13,185	)	$	(47,436	)	$	148,830
Comprehensive loss:
Net loss					(2,703		)							(2,703		)
Foreign currency translation adjustment								4,111						4,111
Holding loss on marketable securities, net								(8		)				(8		)
Total comprehensive income														1,400
Exercise of options for 221,973 shares of common stock	—		4,259											4,259
Stock-based compensation			566											566
Tax benefit of options exercised			917											917
Balance, June 30, 2006	$	10	$	88,804	$	123,676		$	(9,082	)	$	(47,436	)	$	155,972

See notes to consolidated and condensed consolidated financial statements.

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED AND CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
JUNE 30, 2006
Unaudited
(Tabular Amounts In Thousands Except Share, Per Share, Option, and Per Option 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 months and six months ended June 30, 2006 and 2005 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, 2005, 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. We encourage you to read the consolidated and condensed consolidated financial statements in conjunction with the risk factors, consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 filed with the Securities and Exchange Commission (“SEC”). The results of operations for the three months and six months ended June 30, 2006 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”). 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 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 award plan (“Stock Plan”). Prior to January 1, 2006, we used the intrinsic-value method of accounting for our stock-based employee compensation arrangements. Effective January 1, 2006, we adopted Statement of Financial Accounting Standard (SFAS) No. 123R, “Share-Based Payment” using the modified prospective application method. Under this transition method, we are required to record

compensation cost for all awards granted after the date of adoption and for the unvested portion of the previously granted awards that remain outstanding at the date of adoption. We are not required to restate prior period results.

(Loss) Earnings per Common Share - We compute basic (loss) earnings per share using the weighted-average number of common shares outstanding during each period. Diluted (loss) 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,
	2006	2005	2006	2005
Weighted-average shares:
For basic earnings per share	8,331,652	8,052,418	8,242,011	8,041,649
Dilutive effect of stock options	—	223,678	—	217,421
For diluted earnings per share	8,331,652	8,276,096	8,242,011	8,259,070

We did not include 628,200 outstanding options to purchase shares of common stock in the computation of diluted loss per common share for the three and six months ended June 30, 2006 because their impact would have been antidilutive. 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 because the exercise prices of the outstanding options were less than the average market price of our common shares.

Accumulated Other Comprehensive Income (Loss) - Comprehensive income (loss) is comprised of 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 on AFS Securities			Tax Impact of Unrealized Holding Gain on AFS Securities			Additional Minimum Pension Liability			Tax Impact of Additional Minimum Pension Liability		Accumulated Other Comprehensive Loss

Balance, January 1, 2006	$	(2,631	)	$	213		$	(85	)	$	(17,424	)	$	6,742	$	(13,185	)
Activity	4,111			(13		)	5			—			—		4,103
Balance, June 30, 2006	$	1,480		$	200		$	(80	)	$	(17,424	)	$	6,742	$	(9,082	)

Recent Accounting Pronouncements - In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48 (“FIN48”), “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109.” FIN 48 clarifies the recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years

beginning after December 15, 2006. We are evaluating the impact that this statement will have on our financial position or result of operations.

Reclassification—We have reclassified our prior year provision for doubtful accounts and related cash flow effects to conform to the current year presentation. The provision for doubtful accounts was included in operating expenses within “Sales and marketing” in the prior year. The cash flow effects of changes in the provision for doubtful accounts were included in the “Other” line item on our prior year cash flow.

(3) Inventories

	June 30, 2006		December 31, 2005
Raw materials	$	20,504	$	23,218
Work-in-process	43,953		47,511
Finished goods	90,827		88,581
	$	155,284	$	159,310

(4) 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. The changes in carrying amounts of goodwill and trademarks are as follows:

	Piano Segment		Band Segment		Total
Goodwill:
Balance, January 1, 2006	$	21,533	$	8,555	$	30,088
Foreign currency translation impact	974		—		974
Balance, June 30, 2006	$	22,507	$	8,555	$	31,062

Trademarks:
Balance, January 1, 2006	$	7,409	$	5,824	$	13,233
Foreign currency translation impact	307		—		307
Balance, June 30, 2006	$	7,716	$	5,824	$	13,540

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, 2006			December 31, 2005

Gross deferred financing costs	$	5,260		$	8,467
Accumulated amortization	(949		)	(4,701		)
Deferred financing costs, net	$	4,311		$	3,766

Gross covenants not to compete	$	500		$	500
Accumulated amortization	(188		)	(138		)
Covenants not to compete, net	$	312		$	362

The change in gross deferred financing costs and related accumulated amortization during the six months ended June 30, 2006 is primarily attributable to the write-off of the assets associated with our term loan which we repaid, the extinguishment of our 8.75% Senior Notes, and the recording of a new deferred financing costs associated with the issuance of our 7.00% Senior Notes. These events are described more fully in Note 6.

The weighted-average amortization period for deferred financing costs is 8 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,
	2006		2005		2006		2005

Amortization expense	$	197	$	284	$	426	$	566

The following table shows the total estimated amortization expense for 2006 and the next five succeeding fiscal years:

Estimated amortization expense:	Amount

2006	$	809
2007	766
2008	730
2009	598
2010	519
2011	515

(5) Other Current Liabilities

	June 30, 2006		December 31, 2005
Accrued payroll and related benefits	$	18,564	$	17,622
Current portion of pension liability	3,813		3,441
Accrued warranty expense	1,894		1,857
Accrued interest	4,356		3,134
Deferred income	5,402		5,482
Environmental liabilities	3,719		3,820
Other accrued expenses	9,383		9,743
Total	$	47,131	$	45,099

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 ratio of warranty costs to sales based on our warranty history and is adjusted periodically following an analysis of actual warranty claims.

The accrued warranty expense activity for the six months ended June 30, 2006 and 2005, and the year ended December 31, 2005 is as follows:

	June 30, 2006			June 30, 2005			December 31, 2005
Beginning balance	$	1,857		$	2,139		$	2,139
Additions	534			542			858
Claims and reversals	(550		)	(480		)	(1,045		)
Foreign currency translation impact	53			(81		)	(95		)
Ending balance	$	1,894		$	2,120		$	1,857

(6) Long-Term Debt

During the six months ended June 30, 2006, we significantly restructured our long-term debt. We repaid our larger, higher interest term loan, which had an outstanding balance of $16.6 million at December 31, 2005. We also issued $175.0 million of 7.00% Senior Notes and extended a tender offer to purchase the $166.2 million of our outstanding 8.75% Senior Notes. We issued our new 7.00% Senior Notes at 99.2435%, and received proceeds of $170.2 million, net of associated fees. We used the proceeds from this issuance to extinguish $114.6 million of the 8.75% Senior Notes pursuant to our tender offer in the first quarter of 2006. The remaining proceeds, supplemented by borrowings on our line of credit, were used to exercise our right to call the remaining $51.6 million of 8.75% Senior Notes on April 17, 2006. As a result of these activities, our long-term debt at June 30, 2006 consists of the following:

	June 30, 2006
Term loans	$	14,874
7.00% Senior Notes	175,000
Unamortized bond discount	(1,267		)
Open account loans, payable on demand	4,897
Total	193,504
Less: current portion	(5,960		)
Long-term debt	$	187,544

In conjunction with our debt restructuring activities, we recorded a net loss on extinguishment of debt of $9.7 million in the period ended June 30, 2006, which consists of the following:

	June 30, 2006
Deferred financing costs write-off - term loan	$	977
Deferred financing costs write-off - 8.75% Senior Notes	2,247
Premiums pursuant to the tender offer and call	7,740
Bond premium write-off	(1,290		)
Total net loss on extinguishment of debt	$	9,674

Scheduled payments of long-term debt are as follows:

	June 30, 2006
Remainder of 2006	$	5,415
2007	1,107
2008	13,249
2009	—
2010	—
Thereafter	175,000
Total	$	194,771

(7) Stockholders’ Equity and Stock-based Compensation Arrangements

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. As of June 30, 2006 our Chairman and Chief Executive Officer owned 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.

Employee Stock Purchase Plan - We have an employee stock purchase plan under which substantially all employees may purchase Ordinary common stock through payroll deductions at a purchase price equal to 85% of the lower of the fair market values as of the beginning or end of each twelve-month offering period. Stock purchases under the Purchase Plan are limited to 5% of an employee’s annual base earnings. We have reserved 500,000 shares for issuance under this plan and we may grant options to purchase shares up to ten years from the plan’s commencement. This plan expired on July 31, 2006. Our stockholders approved a new Purchase Plan effective August 1, 2006 during our annual stockholders meeting. The characteristics of the plan were not changed. Our Board of Directors has authorized an aggregate of 400,000 shares of common stock for issuance under this plan.

Stock Plan - The 1996 stock plan, as amended, provides for the granting of up to 1,500,000 stock options (including incentive stock options and non-qualified stock options), stock appreciation rights and other stock awards to certain key employees, consultants and advisors through July 31, 2006. Our stock options generally have five year vesting terms and ten year option terms. Upon option exercise, we issue shares of Ordinary common stock, and we will continue to issue shares until we have reached our registered share limitation. At that time, we will issue shares out of treasury stock. We have reserved 721,750 treasury stock shares under the 1996 stock plan for this purpose. Our stockholders approved a new “2006 Stock Plan” effective August 1, 2006 during our annual stockholders meeting. The characteristics of the plan were not changed. Our Board of Directors has authorized an aggregate of 1,000,000 shares of common stock for issuance under this plan.

Effective January 1, 2006, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment” to account for our stock compensation arrangements, using the modified prospective application transition method. Accordingly, we did not restate the results of prior periods. Prior to January 1, 2006, we applied Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and did not recognize any compensation expense associated with employee stock options because the exercise price was equal to the market price at the date of option grant. SFAS No. 123R requires that stock-based compensation cost be recognized over the period from the date of grant to the date when the award is no longer contingent upon the employee providing additional service.

As of June 30, 2006, the compensation cost that has been charged against income for these plans was $0.3 million and $0.6 million for the three and six months ended June 30, 2006, respectively. The income tax benefit recognized in the income statement for share-based compensation arrangements was less than $0.1 million for the three and six months ended June 30, 2006. Basic and diluted loss per share includes $0.03 and $0.06 of stock-based compensation cost for the three and six months ended June 30, 2006, respectively.

The following table illustrates the effect on net income and earnings per share as if we had applied the fair value method of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation” (SFAS 123), prior to January 1, 2006:

	Three Months Ended June 30, 2005			Six Months Ended June 30, 2005

Net income, as reported	$	2,418		$	5,016
Deduct: Total stock-based employee compensation expense determined under fair-value based method for all awards, net of related tax effects of $35 and $71 for the three and six months ended June 30, 2005, respectively	(220		)	(472		)

Pro forma net income	$	2,198		$	4,544

Earnings per share:
Basic - as reported	$	0.30		$	0.62
Basic - pro forma	$	0.27		$	0.57

Diluted - as reported	$	0.29		$	0.61
Diluted - pro forma	$	0.27		$	0.56

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. The risk-free interest rate is based on the weighted-average of U.S. Treasury rates over the expected life of the stock option or the contractual life of the option feature in the Purchase Plan. The expected life of a stock option is based on historical data of similar option holders. We have segregated our employees into two groups based on historical exercise and termination behavior. The expected life of the option feature in the Purchase Plan is the same as its contractual life. Expected volatility is based on historical volatility of our stock over its expected life, as our options are not readily tradable.

Key assumptions used to apply this pricing model to the option feature in the Purchase Plan are as follows:

	Three Months Ended June 30,		Six Months Ended June 30,
	2006	2005	2006	2005
Risk-free interest rate	3.80%	2.04%	3.80%	2.04%
Weighted-average expected life of option feature in the Purchase Plan (in years)	1.00	1.00	1.00	1.00
Expected volatility of underlying stock	22.79%	26.83%	22.79%	26.83%

The weighted average fair value of the option feature in the Purchase Plan is as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
	2006		2005		2006		2005
Option feature in Purchase Plan	$	7.25	$	7.33	$	7.25	$	7.33

There were no stock option awards issued during the six months ended June 30, 2005. During the six months ended June 30, 2006, we granted stock options awards and applied a risk-free interest rate of 4.98%, a weighted-average expected life in years of 7.12, and an expected volatility of 24.43% to the Black-Scholes option-pricing model. The weighted average fair value of options granted during the three and six months ended June 30, 2006 was $10.95.

The following table sets forth information regarding the Purchase Plan:

	Number of Options		Weighted- Average Exercise Price		Remaining Contractual Life (in years)
Outstanding at January 1, 2006	9,476		$	25.42
Shares subscribed	11,203		25.42
Exercised	—		—
Canceled	(1,238	)	25.42
Outstanding at June 30, 2006	19,441		$	25.42	0.1

The following table sets forth information regarding the Stock Plan:

	Number of Options		Weighted- Average Exercise Price		Remaining Contractual Life (in years)	Aggregate Intrinsic Value (not in 000s)
Outstanding at January 1, 2006	826,773		$	20.33
Granted	25,000		27.66
Exercised	(221,973	)	19.19
Forfeited	(1,600	)	19.04
Outstanding at June 30, 2006	628,200		$	21.03	6.7	$	2,395,321

Exercisable at June 30, 2006	273,500		$	19.89	5.9	$	1,269,879

The total intrinsic value of the options exercised during the six months ended June 30, 2006 and 2005 was $2.6 million and $0.3 million, respectively.

As of June 30, 2006, there was $1.9 million of unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Stock Plan. This compensation cost is expected to be recognized over a period of 2.4 years.

As reported in the statement of cash flows, cash received from option exercises under the Stock Plan for the period ended June 30, 2006 was $4.3 million. SFAS No. 123R requires that cash flows from tax benefits resulting from tax deductions in excess of the compensation cost recognized for stock-based awards under a fair value basis (excess tax benefits) be classified as a cash flow from financing activities. Prior to the adoption of SFAS No. 123R, such excess tax benefits were classified as operating cash flows. Accordingly, $0.9 million of tax benefit from stock option exercises is presented as a cash inflow from operating activities and $0.4 million of excess tax benefits has been classified as an outflow from operating activities and an inflow from financing activities in the statement of cash flows.

(8) Other (Income) Expense, Net

	Three Months Ended June 30,						Six Months Ended June 30,
	2006			2005			2006			2005

West 57th building income	$	(1,163	)	$	(1,163	)	$	(2,327	)	$	(2,327	)
West 57th building expenses	820			816			1,638			1,631
Foreign exchange (gains) losses, net	(322		)	457			(672		)	442
Miscellaneous	(30		)	(77		)	(85		)	(152		)
Other (income) expense, net	$	(695	)	$	33		$	(1,446	)	$	(406	)

(9) 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, results of operations or prospects.

Certain environmental laws, such as the Comprehensive Environmental Response, Compensation, and Liability Act, as amended (“CERCLA”), impose strict, retroactive, joint and several liability upon persons responsible for releases of hazardous substances, which liability is broadly construed. Under CERCLA and other laws, we may have liability for investigation and cleanup costs and other damages relating to our current or former properties, or third-party sites to which we sent wastes for disposal. Our potential liability at any of these sites is affected by many factors including, but not limited to, the method of remediation, our portion of the hazardous substances at the site relative to that of other parties, the number of responsible parties, the financial capabilities of other parties, and contractual rights and obligations.

In this regard, we operate certain manufacturing facilities which were previously owned by Philips Electronics North America Corporation (“Philips”). When we purchased these facilities, Philips agreed to indemnify us for certain environmental matters resulting from activities of Philips occurring prior to December 29, 1988 (the “Environmental Indemnity Agreement”). To date, Philips has fully performed its obligations under the Environmental Indemnity Agreement, which terminates on December 29, 2008; however, we cannot provide assurance that it will continue to do so in the future. 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 third 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. At the fourth site, which is a third-party waste disposal site, the EPA has named over 40 persons or entities as potentially responsible parties (“PRP”), including four Conn-Selmer predecessor entities. The four entities have been involved as members of PRP group in the ongoing negotiations with the site owners, the largest contributor, and the EPA in an attempt to reach a settlement and release PRP group members from further potential liability. We expect a decision on the proposed settlement to be reached within the next six to twelve months. For two of these predecessor entities, which were previously owned by Philips, this matter has been tendered to Philips pursuant to the Environmental Indemnity Agreement. With respect to the other two entities, based on current information concerning estimated cleanup costs at the site, and our share of liability, we do not believe our liability will be material.

In addition, we are continuing an existing environmental remediation plan at a facility we acquired in 2000. We estimate our costs, which approximate $0.9 million, over a 15 year period. 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 4.54%.

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

	Environmental Payments
2006	$	62
2007	84
2008	56
2009	56
2010	56
Thereafter	555
	$	869

In 2004, we acquired two manufacturing facilities from G. Leblanc Corporation, now Grenadilla, Inc. (“Grenadilla”), for which environmental remediation plans had already been established. In connection with the acquisition, we assumed the existing accrued liability of approximately $0.8 million for the cost of these remediation activities. Based on a review of past and ongoing investigatory and remedial work by our environmental consultants, and discussions with state regulatory officials, as well as recent sampling, we estimate the remaining costs of such remedial plans at $3.1 million. Pursuant to the purchase and sale agreement, we have sought indemnification from Grenadilla for anticipated costs above the original estimate in the amount of $2.5 million. We filed a claim against the escrow and recorded a corresponding receivable for this amount in prepaid expenses and other current assets in the consolidated balance sheet. However, we cannot be assured that we will be able to recover such costs from Grenadilla.

Based on our past experience and currently available information, 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 an individual year. However, some risk of environmental liability is inherent in the nature of our current and former business and we may, in the future, incur material costs to meet current or more stringent compliance, cleanup, or other obligations pursuant to environmental laws.

(10) 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,
	2006			2005			2006			2005
Service cost	$	190		$	126		$	215		$	171
Interest cost	690			566			366			330
Expected return on plan assets	(1,018		)	(782		)	(77		)	(73		)
Amortization of prior service cost	105			76			—			—
Amortization of net loss	146			114			—			1
Net periodic benefit cost	$	113		$	100		$	504		$	429

	Domestic Plans						Foreign Plans
	Six Months Ended June 30,						Six Months Ended June 30,
	2006			2005			2006			2005
Service cost	$	433		$	252		$	422		$	339
Interest cost	1,475			1,132			717			655
Expected return on plan assets	(2,169		)	(1,564		)	(151		)	(148		)
Amortization of prior service cost	215			152			—			—
Amortization of net loss	322			228			—			1
Net periodic benefit cost	$	276		$	200		$	988		$	847

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

	Three Months Ended June 30,				Six Months Ended June 30,
	2006		2005		2006		2005
Service cost	$	13	$	9	$	25	$	20
Interest cost	34		29		68		65
Amortization of transition obligation	8		10		17		23
Amortization of net loss	12		—		25		—
Net postretirement benefit cost	$	67	$	48	$	135	$	108

Based on federal laws and regulations, we are not required to make a contribution to our domestic pension plan in 2006 and, through June 30, 2006, we have not made any contributions to this plan. Nevertheless, we expect to contribute approximately $1.5 million to our domestic pension plan in the current year. Our anticipated contributions to the pension plan of our U.K. subsidiary approximate $0.2 million for the current year. As of June 30, 2006, we have made contributions of $0.1 million to this plan. The pension plans of our German subsidiaries do not hold any assets and pay participant benefits as incurred. Expected 2006 benefit payments under these plans are $1.1 million. For the six months ended June 30, 2006, we have made benefit payments of $0.5 million under these plans.

(11) Segment Information

We have identified two reportable segments: the piano segment and the band & 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 months and six months ended June 30, 2006 and 2005:

Three months ended 2006	Piano Segment								Band Segment								Other			Consol
	U.S.		Germany		Other		Total		U.S.			Europe		Total			& Elim			Total
Net sales to external customers	$	29,912	$	14,436	$	7,316	$	51,664	$	38,958		$	1,801	$	40,759		$	—		$	92,423
Income (loss) from operations	2,246		3,528		284		6,058		(5,933		)	46		(5,887		)	(566		)	(395		)

Three months ended 2005	Piano Segment								Band Segment							Other			Consol
	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

Six months ended 2006	Piano Segment								Band Segment									Other			Consol
	U.S.		Germany		Other		Total		U.S.			Europe			Total			& Elim			Total
Net sales to external customers	$	54,567	$	24,124	$	15,101	$	93,792	$	90,216		$	3,609		$	93,825		$	—		$	187,617
Income (loss) from operations	2,669		5,107		733		8,509		(1,653		)	(40		)	(1,693		)	(1,700		)	5,116

Six months ended 2005	Piano Segment								Band Segment							Other			Consol
	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

(12) Summary of Guarantees

Our payment obligations under our 7.00% 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 either 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 had 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.

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2006
Unaudited
(In Thousands)

	Issuer of Notes			Guarantor Subsidiaries			Non Guarantor Subsidiaries			Reclass/ Eliminations			Consolidated

Net sales	$	—		$	71,063		$	24,327		$	(2,967	)	$	92,423
Cost of sales	—			57,023			15,250			(2,999		)	69,274

Gross profit	—			14,040			9,077			32			23,149

Operating expenses:
Sales and marketing	—			7,957			3,106			—			11,063
Provision for doubtful accounts	—			4,480			25			—			4,505
General and administrative	1,755			4,240			1,816			—			7,811
Amortization of intangible assets	137			57			3			—			197
Other operating (income) expense	(1,326		)	951			343			—			(32		)
Total operating expenses	566			17,685			5,293			—			23,544

(Loss) income from operations	(566		)	(3,645		)	3,784			32			(395		)

Other income, net	—			(618		)	(77		)	—			(695		)
Loss on extinguishment of debt	3,063			—			—			—			3,063
Interest income	(4,796		)	(764		)	(86		)	4,766			(880		)
Interest expense	3,318			5,342			138			(4,766		)	4,032
Total non-operating expenses	1,585			3,960			(25		)	—			5,520

(Loss) income before income taxes	(2,151		)	(7,605		)	3,809			32			(5,915		)

Income tax (benefit) provision	(6,156		)	(548		)	1,637			13			(5,054		)

Net (loss) income	$	4,005		$	(7,057	)	$	2,172		$	19		$	(861	)

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF OPERATIONS
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	—			7,644			3,405			—			11,049
Provision for doubtful accounts	—			75			8			—			83
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

(Loss) income from operations	(790		)	5,391			3,137			(11		)	7,727

Other income, 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
Total non-operating expenses	189			3,409			101			—			3,699

(Loss) income before income taxes	(979		)	1,982			3,036			(11		)	4,028

Income tax (benefit) provision	354			(36		)	1,299			(7		)	1,610

Net (loss) income	$	(1,333	)	$	2,018		$	1,737		$	(4	)	$	2,418

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2006
Unaudited
(In Thousands)

	Issuer of Notes			Guarantor Subsidiaries			Non Guarantor Subsidiaries			Reclass/ Eliminations			Consolidated

Net sales	$	—		$	148,401		$	44,380		$	(5,164	)	$	187,617
Cost of sales	—			115,455			28,238			(5,217		)	138,476

Gross profit	—			32,946			16,142			53			49,141

Operating expenses:
Sales and marketing	—			16,658			6,075			—			22,733
Provision for doubtful accounts	—			4,541			21			—			4,562
General and administrative	4,227			8,472			3,490			—			16,189
Amortization of intangible assets	275			145			6			—			426
Other operating (income) expense	(2,802		)	2,151			766			—			115
Total operating expenses	1,700			31,967			10,358			—			44,025

(Loss) income from operations	(1,700		)	979			5,784			53			5,116

Other income, net	(16		)	(1,197		)	(233		)	—			(1,446		)
Loss on extinguishment of debt	8,697			977			—			—			9,674
Interest income	(9,774		)	(2,198		)	(165		)	9,530			(2,607		)
Interest expense	7,223			10,537			277			(9,530		)	8,507
Total non-operating expenses	6,130			8,119			(121		)	—			14,128

(Loss) income before income taxes	(7,830		)	(7,140		)	5,905			53			(9,012		)

Income tax (benefit) provision	(8,490		)	(503		)	2,663			21			(6,309		)

Net (loss) income	$	660		$	(6,637	)	$	3,242		$	32		$	(2,703	)

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF OPERATIONS
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	—			15,779			6,403			—			22,182
Provision for doubtful accounts	—			258			(36		)	—			222
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

(Loss) income from operations	(1,627		)	10,510			5,844			58			14,785

Other income, net	(8		)	(474		)	76			—			(406		)
Loss on extinguishment of debt	—			—			—			—			—
Interest income	(7,332		)	(12,262		)	(161		)	18,062			(1,693		)
Interest expense	7,714			18,721			155			(18,062		)	8,528
Total non-operating expenses	374			5,985			70			—			6,429

(Loss) income before income taxes	(2,001		)	4,525			5,774			58			8,356

Income tax (benefit) provision	891			(66		)	2,464			51			3,340

Net (loss) income	$	(2,892	)	$	4,591		$	3,310		$	7		$	5,016

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS
JUNE 30, 2006
Unaudited
(In Thousands)

	Issuer of Notes			Guarantor Subsidiaries		Non Guarantor Subsidiaries			Reclass/ Eliminations			Consolidated
ASSETS
Current assets:
Cash	$	—		$	42,278	$	14,894		$	(36,054	)	$	21,118
Accounts, notes and other receivables, net	—			81,250		9,057			—			90,307
Inventories	—			112,109		43,928			(753		)	155,284
Prepaid expenses and other current assets	3,535			6,684		1,450			—			11,669
Deferred tax assets	9,444			9,882		6,447			(7,390		)	18,383
Total current assets	12,979			252,203		75,776			(44,197		)	296,761

Property, plant and equipment, net	216			77,775		18,457			—			96,448
Investment in subsidiaries	69,643			115,054		(2,082		)	(182,615		)	—
Trademarks	—			9,319		4,221			—			13,540
Goodwill	—			17,973		13,089			—			31,062
Other intangibles, net	3,964			596		63			—			4,623
Other assets	4,424			8,379		2,858			—			15,661
TOTAL ASSETS	$	91,226		$	481,299	$	112,382		$	(226,812	)	$	458,095

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt	$	—		$	1,063	$	4,897		$	—		$	5,960
Accounts payable	399			11,018		3,805			—			15,222
Other current liabilities	5,969			25,205		16,244			(287		)	47,131
Total current liabilities	6,368			37,286		24,946			(287		)	68,313

Long-term debt	173,733			49,865		—			(36,054		)	187,544
Intercompany	(180,512		)	178,894		1,520			98			—
Deferred tax liabilities	80			17,698		5,435			(7,390		)	15,823
Other non-current liabilities	1,356			4,269		24,818			—			30,443
Total liabilities	1,025			288,012		56,719			(43,633		)	302,123

Stockholders’ equity	90,201			193,287		55,663			(183,179		)	155,972

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	91,226		$	481,299	$	112,382		$	(226,812	)	$	458,095

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEETS
DECEMBER 31, 2005
Unaudited
(In Thousands)

	Issuer Of Notes			Guarantor Subsidiaries		Non Guarantor Subsidiaries			Reclass/ Eliminations			Consolidated

ASSETS
Current assets:
Cash	$	—		$	48,790	$	14,190		$	(28,028	)	$	34,952
Accounts, notes and other receivables, net	—			71,702		10,178			—			81,880
Inventories	—			121,712		39,279			(1,681		)	159,310
Prepaid expenses and other current assets	3,947			6,875		831			—			11,653
Deferred tax assets	—			9,267		6,059			(7,390		)	7,936
Total current assets	3,947			258,346		70,537			(37,099		)	295,731

Property, plant and equipment, net	184			79,426		17,054			—			96,664
Investment in subsidiaries	69,643			115,083		—			(184,726		)	—
Trademarks	—			9,319		3,800			114			13,233
Goodwill	—			17,973		12,115			—			30,088
Other intangibles, net	2,341			1,718		69			—			4,128
Other assets	4,151			9,180		2,480			—			15,811
TOTAL ASSETS	$	80,266		$	491,045	$	106,055		$	(221,711	)	$	455,655

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt	$	—		$	7,822	$	5,155		$	—		$	12,977
Accounts payable	464			9,598		3,743			—			13,805
Other current liabilities	4,876			24,608		15,923			(308		)	45,099
Total current liabilities	5,340			42,028		24,821			(308		)	71,881

Long-term debt	167,526			52,217		—			(28,028		)	191,715
Intercompany	(177,624		)	179,433		(1,674		)	(135		)	—
Deferred tax liabilities	85			17,768		4,863			(7,390		)	15,326
Other non-current liabilities	1,132			4,161		22,610			—			27,903
Total liabilities	(3,541		)	295,607		50,620			(35,861		)	306,825

Stockholders’ equity	83,807			195,438		55,435			(185,850		)	148,830

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	80,266		$	491,045	$	106,055		$	(221,711	)	$	455,655

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES
CONSOLIDATING STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2006
Unaudited
(In Thousands)

	Issuer of Notes			Guarantor Subsidiaries			Non Guarantor Subsidiaries			Reclass/ Eliminations			Consolidated
Cash flows from operating activities:
Net (loss) income	$	660		$	(6,637	)	$	3,242		$	32		$	(2,703	)
Adjustments to reconcile net (loss) income to cash flows from operating activities:
Depreciation and amortization	319			4,202			918			—			5,439
Amortization of bond discount	57			—			—			—			57
Amortization of bond premium	(42		)	—			—			—			(42		)
Loss on extinguishment of debt	8,697			977			—			—			9,674
Stock-based compensation expense	208			323			35			—			566
Excess tax benefits from stock-based awards	(417		)	—			—			—			(417		)
Tax benefit from stock option exercises	917			—			—			—			917
Deferred tax benefit	(9,449		)	(685		)	(93		)	—			(10,227		)
Provision for doubtful accounts	—			4,541			21			—			4,562
Other	—			(82		)	(3		)	—			(85		)
Changes in operating assets and liabilities:
Accounts, notes and other receivables	—			(13,269		)	1,687			—			(11,582		)
Inventories	—			8,939			(2,641		)	(278		)	6,020
Prepaid expenses and other assets	132			172			(727		)	—			(423		)
Accounts payable	(66		)	1,277			(197		)	—			1,014
Other liabilities	1,317			705			(424		)	21			1,619
Cash flows from operating activities	2,333			463			1,818			(225		)	4,389

Cash flows from investing activities:
Capital expenditures	(76		)	(2,138		)	(351		)	—			(2,565		)
Proceeds from disposal of fixed assets	—			327			4			—			331
Cash flows from investing activities	(76		)	(1,811		)	(347		)	—			(2,234		)

Cash flows from financing activities:
Borrowings under lines of credit	—			34,746			10,681			(8,026		)	37,401
Repayments under lines of credit	—			(26,720		)	(11,059		)	—			(37,779		)
Debt issuance costs	(4,145		)	—			—			—			(4,145		)
Proceeds from issuance of debt	173,676			—			—			—			173,676
Repayments of long-term debt	(166,194		)	(17,137		)	—			—			(183,331		)
Premium paid on extinguishment of debt	(7,740		)	—			—			—			(7,740		)
Proceeds from issuance of common stock	4,259			—			—			—			4,259
Excess tax benefits from stock-based awards	417			—			—			—			417
Intercompany transactions	(2,530		)	3,947			(1,642		)	225			—
Cash flows from financing activities	(2,257		)	(5,164		)	(2,020		)	(7,801		)	(17,242		)

Effect of exchange rate changes on cash	—			—			1,253			—			1,253

(Decrease) increase in cash	—			(6,512		)	704			(8,026		)	(13,834		)
Cash, beginning of year	—			48,790			14,190			(28,028		)	34,952

Cash, end of period	$	—		$	42,278		$	14,894		$	(36,054	)	$	21,118

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 (loss) income	$	(2,892	)	$	4,591		$	3,310		$	7		$	5,016
Adjustments to reconcile net (loss) income to cash flows from operating activities:
Depreciation and amortization	275			4,488			976			—			5,739
Amortization of bond premium	(126		)	—			—			—			(126		)
Tax benefit from stock option exercises	99			—			—			—			99
Deferred tax benefit	(13		)	(122		)	(144		)	—			(279		)
Provision for doubful accounts	—			258			(36		)	—			222
Other	—			(160		)	42			—			(118		)
Changes in operating assets and liabilities:
Accounts, notes and other receivables	—			(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

ITEM 2	MANAGEMENT’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. We are also 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 Policies

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

Management is required to make certain estimates and assumptions during the preparation of the consolidated financial statements. These estimates and assumptions impact the reported amount of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial statements. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary. Actual results could differ from those estimates.

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

Accounts Receivable

We establish reserves for accounts receivable and notes receivable (including recourse reserves when our customers have financed notes receivable with a third party). We review overall collectibility trends and customer characteristics such as debt leverage, solvency, and outstanding balances in order to develop our reserve estimates. Historically, a large portion of our sales have been generated by our top 15 customers. As a result, we experience some inherent concentration of credit risk in our accounts receivable due to its composition and the relative proportion of large customer receivables to the total. This is especially true at our band division, which characteristically has the majority of our consolidated accounts receivable balance. We consider the credit health and solvency of our customers when developing our receivable reserve estimates.

Inventory

We establish inventory reserves for items such as lower-of-cost-or-market and obsolescence. We review inventory levels on a detailed basis, concentrating on the age and amounts of raw materials, work-in-process, and finished goods, as well as recent usage and sales dates and quantities to help develop our estimates. Ongoing changes in our business strategy, including a shift from batch processing to single piece production flow, coupled with increased offshore sourcing, could affect our ability to realize the current cost of our inventory, and are considered by management when developing our estimates. We also establish reserves for anticipated book-to-physical adjustments based upon our historical level of adjustments from our annual physical inventories. We cost our inventory using standard costs. Accordingly, variances between actual and standard costs that are not abnormal in nature are capitalized into inventory and released based on calculated inventory turns.

Workers’ Compensation and Self-Insured Health Claims

We establish workers’ compensation and self-insured health claims reserves based on our trend analysis of data provided by third party administrators regarding historical claims and anticipated future claims.

Warranty

We establish reserves for warranty claims based on our analysis of historical claims data, recent claims trends, and the various lengths of time for which we warranty our products.

Long-lived Assets

We review long-lived assets, such as property, plant, and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We measure recoverability by comparing the carrying amount of the asset to the estimated future cash flows the asset is expected to generate.

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 may have decreased below its carrying value. Our assessment is based on several analyses, including multi-year cash flows and comparison of estimated fair values to our market capitalization.

Pensions and Other Post Retirement Benefit Costs

We make certain assumptions when calculating our benefit obligations and expenses. We base our selection of assumptions, such as discount rates and long-term rates of return, on information provided by our actuaries, investment advisors, investment committee, current rate trends, and historical trends for our pension asset portfolio. Our benefit obligations and expenses can fluctuate significantly based on the assumptions management selects.

Income Taxes

Our effective tax rate at an interim period is based upon an estimate of expected foreign source income to U.S. income and our corresponding ability to utilize foreign tax credits effectively. We consider shifts in sources of income when developing our estimated effective tax rate.

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

Stock-based Compensation

We grant stock-based compensation awards which generally vest over a specified period. When determining the fair value of stock options and subscriptions to purchase shares under the Purchase Plan, we use the Black-Scholes option valuation model, which requires input of certain management assumptions, including dividend yield, expected volatility, risk-free interest rate, expected life of stock options granted during the period, and the life applicable to the Purchase Plan subscriptions. The estimated fair value of the options and subscriptions to purchase shares, and the resultant stock-based compensation expense can fluctuate based on the assumptions used by management.

Environmental Liabilities

We make certain assumptions when calculating our environmental liabilities. We base our selection of assumptions, such as cost and length of time for remediation, on data provided by our environmental consultants, as well as information provided by regulatory authorities. We also make certain assumptions regarding the indemnifications we have received from others, including whether remediation costs are within the scope of the indemnification, the indemnifier’s ability to perform under the agreement, and whether past claims have been successful. Our environmental obligations and expenses can fluctuate significantly based on management’s assumptions.

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 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 Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2005. 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.

Results of Operations

Three Months Ended June 30, 2006 Compared to Three Months Ended June 30, 2005

	Three Months Ended June 30,							Change
	2006				2005			$		%

Net sales
Band	$	40,759			$	43,368		(2,609	)	(6.0	)
Piano	51,664				46,393			5,271		11.4
Total sales	92,423				89,761			2,662		3.0

Cost of sales
Band	35,324				33,709			1,615		4.8
Piano	33,950				29,926			4,024		13.4
Total cost of sales	69,274				63,635			5,639		8.9

Gross profit
Band	5,435			13.3%	9,659		22.3%	(4,224	)	(43.7	)
Piano	17,714			34.3%	16,467		35.5%	1,247		7.6
Total gross profit	23,149				26,126			(2,977	)	(11.4	)
	25.0%				29.1%

Operating expenses	23,544				18,399			5,145		28.0

(Loss) income from operations	(395		)		7,727			(8,122	)	(105.1	)

Other (income) expense, net	(695		)		33			(728	)	(2,206.1	)
Loss on extinguishment of debt	3,063				—			3,063		100.0
Net interest expense	3,152				3,666			(514	)	(14.0	)
Non-operating expenses	5,520				3,699			1,821		49.2

(Loss) income before income taxes	(5,915		)		4,028			(9,943	)	(246.8	)

Income tax (benefit) provision	(5,054		)	85.4%	1,610		40.0%	(6,664	)	(413.9	)

Net (loss) income	$	(861	)		$	2,418		(3,279	)	(135.6	)

Overview - Sales at our piano division improved significantly during the quarter. We re-launched our Essex piano line in June 2006 and received a positive response from our dealers. Our domestic piano operations experienced increases in both wholesale and retail sales volume, and our overseas operations remained stable with sales and margins on par with the year-ago period. Band division revenues and gross profit were negatively impacted by the strike at our Elkhart, Indiana brass instrument manufacturing facility. While professional brass instrument sales were adversely affected by the strike, improved sales of student level instruments and percussion product helped to offset its impact. We are actively working towards resolving the strike.

Net Sales - The increase in net sales of $2.7 million resulted from improved performance in the piano segment. Piano sales increased $5.3 million or 11% due primarily to a 15% increase in total domestic units shipped. A special promotional program was offered to domestic dealers in conjunction with the Essex re-launch that helped drive a $3.1 million increase in Steinway grand pianos sold at wholesale. Overseas piano sales increased $1.2 million primarily due to continued wholesale demand in the European market. Band division sales decreased $2.6 million due primarily to an estimated $4.9 million in lower shipments caused by the strike at our Elkhart brass instrument facility. The strike impact was partially offset by a $1.5 million increase in sales of percussion instruments and a $1.2 million increase in sales of student instruments generated through promotional programs targeted towards available inventory.

Gross Profit - Gross profit decreased $3.0 million driven by a decrease in our band division gross profit of $4.2 million. An estimated $3.0 million was due to the strike at the Elkhart brass instrument facility consisting of an estimated $1.8 million in lost profit and $1.2 million in unabsorbed overhead. We also adjusted our inventory reserves upward by $2.3 million to properly reflect the net realizable value of our inventory. The increase in reserves resulted from the streamlining of our product offering and our on going migration from batch processing to one-piece production flow. These two initiatives have helped reduced our raw material and work in process inventory over the past year and increased our exposure to excess and obsolete inventory. The decrease in band division gross profit was somewhat offset by $0.5 million in lower charges associated with the Leblanc inventory step-up and reduced medical costs. The piano segment gross profit increased $1.2 million primarily due to increased sales volume. This increase was offset by unabsorbed overhead of $0.4 million from a one week shutdown at our domestic manufacturing facility and increased cash discounts due to the special promotional program offered to domestic dealers associated with the Essex re-launch.

Operating Expenses - Operating expenses increased $5.1 million due largely to an increase of $4.4 million in our provision for doubtful accounts. This increase in reserve primarily resulted from the bankruptcy of one of our major band division customers in July 2006. The re-launch of our Essex line increased operating expenses $0.4 million and the remaining increase of $0.3 million is attributable to stock based compensation.

Non-operating Expenses - Non-operating expenses increased $1.8 million due to the loss on extinguishment of debt of $3.1 million resulting from the call of our remaining $51.6 million of 8.75% Senior Notes. This loss was comprised of $2.3 in call premiums and $0.8 million write-off of bond related deferred financing fees and was partially offset by an increase in other income.

Other income, net increased $0.7 million due to foreign exchange gains. Net interest expense decreased $0.5 million due to a reduced interest rate on outstanding Senior Notes from 8.75% to 7.00%.

Income Taxes - Our effective rate has increased from the year ago period due to the significant shift in the ratio of foreign source income to worldwide income. This shift is due largely to the adverse impact of the loss on extinguishment of our 8.75% Senior Notes, the additional reserve charges taken in the second quarter, and the estimated loss in income due to the strike at our Elkhart brass facility. We anticipate that virtually all of our consolidated income for the year will be derived from subsidiaries which are taxed both domestically and in their local country. Accordingly, we expect to generate significantly more foreign taxes than we will be able to utilize as credits against U.S. tax liabilities and our higher effective rate reflects this double taxation. Although we continue to investigate acceptable tax planning strategies in an effort to reduce our rate, we currently expect our effective tax rate for 2006 to be 70%.

Results of Operations

Six Months Ended June 30, 2006 Compared to Six Months Ended June 30, 2005

	Period Ended June 30,								Change
	2006				2005				$		%

Net sales
Band	$	93,825			$	90,935			2,890		3.2
Piano	93,792				90,168				3,624		4.0
Total sales	187,617				181,103				6,514		3.6

Cost of sales
Band	76,329				71,523				4,806		6.7
Piano	62,147				57,757				4,390		7.6
Total cost of sales	138,476				129,280				9,196		7.1

Gross profit
Band	17,496			18.6%	19,412			21.3%	(1,916	)	(9.9	)
Piano	31,645			33.7%	32,411			35.9%	(766	)	(2.4	)
Total gross profit	49,141				51,823				(2,682	)	(5.2	)
	26.2%				28.6%

Operating expenses	44,025				37,038				6,987		18.9

Income from operations	5,116				14,785				(9,669	)	(65.4	)

Other income, net	(1,446		)		(406		)		(1,040	)	256.2
Loss on extinguishment of debt	9,674				—				9,674		100.0
Net interest expense	5,900				6,835				(935	)	(13.7	)
Non-operating expenses	14,128				6,429				7,699		119.8

(Loss) income before income taxes	(9,012		)		8,356				(17,368	)	(207.9	)

Income tax (benefit) provision	(6,309		)	70.0%	3,340			40.0%	(9,649	)	(288.9	)

Net (loss) income	$	(2,703	)		$	5,016			(7,719	)	(153.9	)

Overview - Sales at our piano and band divisions increased during the period. The piano division’s improved domestic Steinway sales at both retail and wholesale offset a decrease in domestic Boston product sales. Piano division margin deteriorated due to plant shutdown at our domestic manufacturing facility. Band division unit volume and sales increased despite the impact of the strike at our Elkhart brass instrument facility. Band margin improvements made during the first quarter were more than offset during the second quarter by unabsorbed overhead from the strike, higher inventory reserves and additional sales discounts.

Net Sales - The increase in net sales of $6.5 million was driven by increases in both our band and piano divisions. The increase in band division sales of $2.9 million was driven by an increase in student woodwind product and percussion instruments. Availability of student woodwind product and the introduction of new percussion product into existing channels and entry into new channels helped to support this growth. First quarter promotions geared towards professional and step-up brass instruments offset an estimated $4.9 million impact of the strike at our Elkhart brass instruments facility during the second quarter. Our piano division sales increase of $3.6 million was driven by a $2.5 million increase in domestic Steinway grand sales at wholesale, boosted by a sales incentive offered to dealers as part of the June Essex re-launch. Domestic Steinway grand piano sales at retail increased $1.5 million based on a 15% increase in unit shipments, which helped to offset a decrease of $0.9 million in domestic Boston product sales to dealers. Total overseas piano sales increased $0.8 million as an overall 11% increase in unit shipments was partially offset by an unfavorable foreign currency translation of $1.8 million.

Gross Profit - Gross profit decreased by $2.7 million from deterioration in both the band and piano division margins. Our band division gross margin declined from 21.3% to 18.6% as a result of a $2.3 million charge to inventory reserves during the second quarter and a $1.3 million increase in cash discounts. The majority of sales growth experienced during the period resulted from customers utilizing cash discounts. Gross margin was also negatively impacted by the strike at the Elkhart brass instrument facility during the second quarter. The deterioration was minimized by $1.1 million in lower charges associated with Leblanc inventory step-up. The band gross profit also benefited from increased sales, a reduction in property taxes, and reduced medical costs. Our piano division gross profit decreased $0.8 million, despite increased sales, as a result of three weeks of production shutdown at our domestic piano manufacturing facility resulting in $1.3 million of unabsorbed overhead.

Operating Expenses - Operating expenses increased $7.0 million due largely to an increase of $4.3 million in our provision for doubtful accounts. Stock based compensation cost for the period was $0.6 million, legal fees at our band division increased $0.6 million, and bonus expense increased $0.5 million. Operating expense associated with the re-launch of our Essex line, recruiting, and commissions accounted for the remaining increase.

Non-operating Expenses - Non-operating expenses increased $7.7 million due largely to the loss on extinguishment of debt of $9.7 million resulting from the refinancing of our 8.75% Senior Notes and the early repayment of our acquisition term loan. This net loss was comprised of $7.7 million in premiums paid to bondholders, the write-off of term loan related deferred financing fees of $1.0, and the write-off of bond related deferred financing fees of $2.2 million, which were offset in part by the write-off of bond premium of $1.3 million.

Other income, net increased $1.0 million due to foreign exchange gains. Net interest expense decreased $0.9 million due to the reduction in interest rates on our outstanding Senior Notes from 8.75% to 7.00% for a portion of the period.�� The remaining decrease was due to interest earned for two months on $51.6 million in residual proceeds from the issuance of our 7.00% Senior Notes.

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, 2006 and 2005 are summarized as follows:

	2006			2005			Change
Net (loss) income:	$	(2,703	)	$	5,016		$	(7,719	)
Changes in operating assets and liabilities	(3,352		)	(20,650		)	17,298
Other adjustments to reconcile net (loss) income to cash from operating activities	10,444			5,537			4,907
Cash flows from operating activities	4,389			(10,097		)	14,486

Cash flows from investing activities	(2,234		)	(996		)	(1,238		)

Cash flows from financing activities	(17,242		)	3,074			(20,316		)

Cash flows generated from operating activities increased $14.5 million due to changes in working capital accounts. Cash provided by inventory increased $19.2 million due to increased domestic sales, combined with reduced production at both our Elkhart brass instrument facility and our domestic piano manufacturing facility. Cash used for accounts receivable increased $8.1 million primarily as a result of increased sales. An increase in our band division aged receivable balance and improved June sales by our domestic piano division were also factors behind the change.

The use of cash for investing activities increased $1.2 million despite consistent capital expenditures each period, as we benefited from an additional $1.0 million of proceeds from disposals of property in the prior period.

Cash used by financing activities increased $20.3 million due to our bond refinancing, which generated proceeds of $173.7 million, offset by the extinguishment of $166.2 million of our 8.75% Senior Note debt and the repayment of our acquisition term loan of $16.6 million. Premiums paid on the extinguishment of debt of $7.7 million and costs related to the transaction of $4.1 million also offset our bond refinancing proceeds. Additional proceeds from the issuance of stock contributed $3.6 million in

the current period; however $7.2 million of net borrowings on our domestic revolver and $4.1 million in debt repayments in the prior period offset any cash proceeds received from the stock issuance.

Borrowing Activities and Availability - During the period we restructured our long-term debt and issued $175.0 million of 7.00% Senior Notes due 2014. We used the proceeds from this issuance to repay $114.6 million of the 8.75% Senior Notes pursuant to our tender offer. The remaining proceeds, supplemented by borrowings on our line of credit, were used to exercise our right to call the remaining $51.6 million of 8.75% Senior Notes. This resulted in a loss on extinguishment of $8.7 million, comprised of $7.7 million in premiums paid to existing holders of 8.75% Senior Notes, $1.3 million of bond premium write-off, and $2.3 million in the write-off of associated deferred financing costs. We recorded interest on both the 8.75% Senior Notes and the 7.00% Senior Notes for the February - April timeframe during which both series of notes were outstanding. This double interest expense was partially offset by interest income on the unused debt issuance proceeds during the first quarter, and is not material to our liquidity. We expect interest payment savings of approximately $2.3 million per year based on the difference in interest rates on the Senior Notes.

Our real estate 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 $85.0 million in revolving credit loans, and expires on September 14, 2008. Borrowings are collateralized by our domestic accounts receivable, inventory, and fixed assets. As of June 30, 2006, there were no revolving credit loans outstanding and availability based on eligible accounts receivable and inventory balances was approximately $83.6 million, net of letters of credit. The real estate term loan is payable in monthly installments of $0.2 million and includes interest at average 30-day London Interbank Offered Rate (“LIBOR”) (5.23% at June 30, 2006) plus 1.5%. This term loan is secured by all of our interests in the Steinway Hall property. The acquisition term loan was repaid during the first quarter of 2006. All of our borrowings under the Credit Facility are secured by a first lien on our domestic inventory, receivables, and fixed assets.

We also have certain non-domestic credit facilities originating from two German banks that provide for borrowings by foreign subsidiaries of up to €17.7 million ($22.7 million at the June 30, 2006 exchange rate), net of borrowing restrictions of €0.7 million ($0.9 million at the June 30, 2006 exchange rate) and are payable on demand. These borrowings are collateralized by most of the assets of the borrowing subsidiaries. A portion of the loans can be converted into a maximum of £0.5 million ($0.9 million at the June 30, 2006 exchange rate) for use by our U.K. branch and ¥300 million ($2.6 million at the June 30, 2006 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. dollars or Chinese yuan ($2.3 million at the June 30, 2006 exchange rate). Euro loans bear interest at rates of Euro Interbank Offered Rate (“EURIBOR”) plus a margin determined at the time of borrowing. Margins fluctuate based on the loan amount and the borrower’s bank rating. The remaining demand borrowings bear interest at fixed margins at rates of LIBOR plus 1% for British pound loans (6.5% at June 30, 2006), LIBOR plus 1% for U.S. dollar loans of our Chinese subsidiary (6.1% to 6.3% at June 30, 2006), and Tokyo Interbank Offered Rate (“TIBOR”) plus 0.8% for Japanese yen loans (1.0% at June 30, 2006). We had $1.8 million outstanding as of June 30, 2006 on these credit facilities.

Our Japanese subsidiary also maintains a separate revolving loan agreement that provides additional borrowing capacity of up to ¥460 million ($4.0 million at the June 30, 2006 exchange rate) based on eligible inventory balances. The revolving loan agreement bears interest at an average 30-day TIBOR rate plus 0.8% (1.0% at June 30, 2006) and expires on January 31, 2010. As of June 30, 2006, we had $3.1 million outstanding on this revolving loan agreement.

At June 30, 2006, our total outstanding indebtedness amounted to $194.8 million, consisting of $175.0 million of 7.00% Senior Notes, $14.9 million on the real estate term loan, and $4.9 million of notes payable to foreign banks.

All of 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, 2006 and do not anticipate any compliance issues in 2006.

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. Our intent and ability to repurchase additional Ordinary common stock either directly from shareholders or on the open market is directly affected by this limitation.

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. As of June 30, 2006, we estimate 530,350 shares of reserved treasury stock will be utilized. These options have no impact on our cash flow or the number of shares outstanding unless and until the options are exercised.

We experience long production and inventory turnover cycles, which we constantly monitor since fluctuations in demand can have a significant impact on these cycles. We were able to effectively utilize cash flow from operations to fund our capital requirements and pay off our seasonal borrowings on our domestic line of credit.

Three weeks of additional shutdown at our domestic piano manufacturing facility and the strike at the Elkhart brass instrument facility has had an adverse impact on operations, however, we do not anticipate any material changes to liquidity as a result of these events.

Other than the restructuring of our long-term debt as described above, we do not have any current plans or intentions that will have a material impact on our liquidity in 2006, although we may consider acquisitions that may require funding from operations or from our credit facilities. Other than those described, we are not aware of any trends, demands, commitments, or costs of resources that are expected to materially impact our liquidity or capital resources. Accordingly, 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 our debt service requirements, fund continuing capital requirements and satisfy our working capital and general corporate needs through 2006.

Contractual Obligations - The following table provides a summary of our contractual obligations at June 30, 2006.

	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)	$	290,766	$	19,251	$	39,348	$	24,500	$	207,667
Capital leases	59		13		31		15		—
Operating leases (2)	267,559		5,098		8,102		7,940		246,419
Purchase obligations (3)	16,028		15,857		157		14		—
Other long-term liabilities (4)	30,220		3,651		3,539		3,357		19,673
Total	$	604,632	$	43,870	$	51,177	$	35,826	$	473,759

Notes to Contractual Obligations:

(1) Long-term debt represents long-term debt obligations, the fixed interest on our Notes, and the variable interest on our other loans. We estimated the future variable interest obligation using the applicable June 30, 2006 rates. The nature of our long-term debt obligations, including changes to our long-term debt structure, is described more fully in the “Borrowing Availability and Activities” section of “Liquidity and Capital Resources.”

(2) Approximately $254.3 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, finished goods, and equipment.

(4) Our other long-term liabilities consist primarily of the long-term portion of our pension obligations, which are described in Note 10 in the Notes to Consolidated Financial Statements included within this filing, and obligations under employee and consultant agreements.

Recent Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109.” FIN 48 clarifies the recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are evaluating the impact that this statement will have on our financial position or results of operations.

ITEM 3 QUANTITATIVE 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 our Annual Report on Form 10-K for the year ended December 31, 2005.

Our revolving loans and term loans bear interest at rates that fluctuate with changes in LIBOR, TIBOR, and EURIBOR. 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, 2005.

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 4 CONTROLS 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 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 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II OTHER INFORMATION

ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

At the Company’s Annual Meeting of Shareholders held on May 17, 2006, the Board of Directors was re-elected in its entirety. The votes cast for each nominee were as follows:

	For	Withheld

Kyle Kirkland	51,909,466	2,274,021
Dana D. Messina	51,916,558	2,266,929
John M. Stoner, Jr.	51,487,375	2,696,112
Bruce A. Stevens	51,904,430	2,279,057
A. Clinton Allen	53,929,479	254,008
Rudolph K. Kluiber	53,929,479	254,008
Peter McMillan	53,937,230	246,257

The proposal to ratify Deloitte & Touche LLP to serve as the Company’s independent registered public accounting firm for the fiscal year ending December 31, 2006 was approved with 54,155,110 votes cast for, 28,277 against, and 100 abstentions.

The proposal to approve the Company’s 2006 Stock Compensation Plan effective August 1, 2006 was approved with 50,126,079 votes cast for, 2,102,753 against, 416,894 abstentions, and 1,537,761 withheld. The 2006 stock plan is identical to the existing 1996 stock plan except our Board of Directors has authorized an aggregate of 1,000,000 shares of common stock for issuance under this plan.

The proposal to approve the Company’s 2006 Employee Stock Purchase Plan effective August 1, 2006 was approved with 52,157,591 votes cast for, 71,243 against, 416,892 abstentions, and 1,537,761 withheld. The new plan is identical to the existing plan except our Board of Directors has authorized an aggregate of 400,000 shares of common stock for issuance under this plan.

ITEM 6 EXHIBITS

(i) Exhibits

	4.1	Tenth Amendment and consent to the Second Amended and Restated Credit Agreement dated as of May 1, 2006 by and among Conn-Selmer, Inc. f/k/a The Selmer Company, Inc. and surviving corporation of the merger of United Musical Instruments USA, Inc. and United Instruments Holdings with and into Conn-Selmer, Inc., Steinway, Inc., as borrowers; those signatories identified as guarantors, the lenders, and GMAC Commercial Finance LLC (successor by merger to GMAC Commercial Credit LLC), as administrative agent.

	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

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, 2006

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Steinway Musical Instruments (LVB) Inactive 10-Q2006 Q2 Quarterly report

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