Steinway Musical Instruments (LVB) 10-Q 2011 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2011

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

COMMISSION FILE NUMBER 001-11911

STEINWAY MUSICAL INSTRUMENTS, INC.

(Exact name of registrant as specified in its charter)

DELAWARE	35-1910745
(State or Other Jurisdiction of	(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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No  o

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

Large accelerated filer o	Accelerated filer x
Non-accelerated filer o	Smaller reporting company o
(Do not check if a smaller reporting company)

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 November 4, 2011:  12,357,499

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

FORM 10-Q

INDEX

PART I	FINANCIAL STATEMENTS
Item 1.	Condensed Consolidated Unaudited Financial Statements:
	Condensed Consolidated Statements of Operations Three and nine months ended September 30, 2011 and 2010	3
	Condensed Consolidated Balance Sheets September 30, 2011 and December 31, 2010	4
	Condensed Consolidated Statements of Cash Flows Nine months ended September 30, 2011 and 2010	5
	Condensed Consolidated Statement of Stockholders’ Equity Nine months ended September 30, 2011	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	29
Item 4.	Controls and Procedures	30
PART II.	OTHER INFORMATION
Item 6.	Exhibits	30
	Signatures	31

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PART IFINANCIAL STATEMENTS

ITEM 1CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Unaudited

(In Thousands Except Share and Per Share Amounts)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Net sales	$	89,755		$	83,261		$	251,627		$	230,052
Cost of sales	63,783			60,066			176,783			163,370
Gross profit	25,972			23,195			74,844			66,682
Operating expenses:
Sales and marketing	10,689			9,587			32,470			29,756
General and administrative	9,269			7,768			29,321			22,096
Other operating (income) expenses	(230		)	46			3			172
Facility rationalization and impairment charges	5,142			—			5,361			—
Total operating expenses	24,870			17,401			67,155			52,024
Income from operations	1,102			5,794			7,689			14,658
Other expense (income), net	1,886			110			3,132			(699		)
Net loss (gain) on extinguishment of debt	—			—			2,422			(104		)
Interest income	(255		)	(241		)	(943		)	(985		)
Interest expense	1,266			2,705			5,794			8,303
Total non-operating expenses	2,897			2,574			10,405			6,515
(Loss) income before income taxes	(1,795		)	3,220			(2,716		)	8,143
Income tax (benefit) provision	(717		)	1,655			(1,096		)	3,598
Net (loss) income	$	(1,078	)	$	1,565		$	(1,620	)	$	4,545
(Loss) earnings per share:
Basic	$	(0.09	)	$	0.13		$	(0.13	)	$	0.40
Diluted	$	(0.09	)	$	0.13		$	(0.13	)	$	0.39
Weighted average shares:
Basic	12,334,155			12,055,741			12,188,889			11,503,013
Diluted	12,334,155			12,098,871			12,188,889			11,559,335

See notes to condensed consolidated financial statements.

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STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

Unaudited

(In Thousands)

	September 30,			December 31,
	2011			2010
Assets
Current assets:
Cash	$	41,221		$	119,811
Accounts, notes, and other receivables, net of allowances of $11,875 and $12,265 in 2011 and 2010, respectively	49,724			42,385
Inventories	140,333			144,500
Prepaid expenses and other current assets	16,208			10,513
Deferred tax assets	11,493			11,419
Total current assets	$	258,979		$	328,628
Property, plant and equipment, net of accumulated depreciation of $115,212 and $110,983 in 2011 and 2010, respectively	85,290			86,404
Trademarks	13,880			14,981
Goodwill	23,112			26,023
Other intangibles, net	2,540			4,028
Other assets	17,301			16,144
Long-term deferred tax assets	9,176			8,886
Total assets	$	410,278		$	485,094
Liabilities and stockholders’ equity
Current liabilities:
Debt	$	649		$	2,462
Accounts payable	12,234			12,141
Other current liabilities	33,723			39,181
Total current liabilities	46,606			53,784
Long-term debt	77,351			152,048
Deferred tax liabilities	3,762			3,761
Pension and other postretirement benefit liabilities	36,965			38,366
Other non-current liabilities	8,356			8,511
Total liabilities	173,040			256,470
Commitments and contingent liabilities
Stockholders’ equity:
Common stock	14			14
Additional paid-in capital	160,764			154,404
Retained earnings	132,276			134,209
Accumulated other comprehensive loss	(11,132		)	(12,935		)
Treasury stock, at cost	(44,684		)	(47,068		)
Total stockholders’ equity	237,238			228,624
Total liabilities and stockholders’ equity	$	410,278		$	485,094

See notes to condensed consolidated financial statements.

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STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

(In Thousands)

	Nine Months Ended September 30,
	2011			2010
Cash flows from operating activities:
Net (loss) income	$	(1,620	)	$	4,545
Adjustments to reconcile net income to cash flows from operating activities:
Depreciation and amortization	6,544			7,302
Net loss (gain) on extinguishment of debt	2,422			(104		)
Facility rationalization and impairment charges	5,361			—
Stock-based compensation expense	3,514			1,109
(Excess benefit) tax deficiency from stock-based awards	(261		)	64
Tax benefit from stock option exercises	398			4
Deferred tax benefit	(333		)	(1,257		)
Recovery of doubtful accounts	(211		)	(63		)
Other	504			66
Changes in operating assets and liabilities:
Accounts, notes and other receivables	(7,650		)	(8,296		)
Inventories	3,520			6,353
Prepaid expenses and other assets	(6,708		)	(324		)
Accounts payable	(140		)	2,990
Other liabilities	(4,482		)	(1,275		)
Cash flows from operating activities	858			11,114
Cash flows from investing activities:
Capital expenditures	(4,118		)	(1,841		)
Payment for acquisition and contingent consideration for previous acquisition	(3,289		)	(353		)
Other	18			108
Cash flows from investing activities	(7,389		)	(2,086		)
Cash flows from financing activities:
Borrowings under lines of credit	16,607			870
Repayments under lines of credit	(8,470		)	(335		)
Repayments of long-term debt, net of premium or discount	(86,488		)	(5,633		)
Proceeds from issuance of common stock	4,519			28,197
Purchase of treasury stock	—			(349		)
Excess benefit (tax deficiency) from stock-based awards	261			(64		)
Cash flows from financing activities	(73,571		)	22,686
Effect of foreign exchange rate changes on cash	1,512			(1,373		)
(Decrease) increase in cash	(78,590		)	30,341
Cash, beginning of period	119,811			65,873
Cash, end of period	$	41,221		$	96,214
Supplemental Cash Flow Information:
Interest paid	$	8,823		$	12,268
Income taxes paid	$	5,427		$	6,395

See notes to condensed consolidated financial statements.

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STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Unaudited

(In Thousands Except Option and Share Data)

	Common Stock		Additional Paid-In Capital		Retained Earnings			Accumulated Other Comprehensive Loss			Treasury Stock			Total Stockholders’ Equity
Balance, January 1, 2011	$	14	$	154,404	$	134,209		$	(12,935	)	$	(47,068	)	$	228,624
Comprehensive income:
Net loss:					(1,620		)							(1,620		)
Foreign currency translation adjustment								1,803						1,803
Total comprehensive income														183
Exercise of 226,300 options for shares of common stock	—		1,860		(313		)				2,384			3,931
Tax benefit of options exercised			398											398
Stock-based compensation			3,514											3,514
Issuance of 35,487 shares of common stock	—		588											588
Balance, September 30, 2011	$	14	$	160,764	$	132,276		$	(11,132	)	$	(44,684	)	$	237,238

See notes to condensed consolidated financial statements.

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STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

Unaudited

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

(1)           Basis of Presentation

The accompanying condensed consolidated financial statements of Steinway Musical Instruments, Inc. and subsidiaries (the “Company”) for the three and nine months ended September 30, 2011 and 2010 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, 2010, 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 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, 2010 filed with the Securities and Exchange Commission (“SEC”). The results of operations for the three and nine months ended September 30, 2011 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

Our significant accounting policies were described in Note 2 to our audited Consolidated Financial Statements included in our 2010 Annual Report on Form 10-K for the fiscal year ended December 31, 2010. There have been no significant changes in our accounting policies during 2011.

Recent Accounting Pronouncements — Certain amendments to Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements,” become effective for us for fiscal years beginning after December 15, 2011. These amendments include a consistent definition of fair value, enhanced disclosure requirements for “Level 3” fair value adjustments and other changes to required disclosures.

In June 2011, ASC 220, “Comprehensive Income,” was amended and will become effective for us for fiscal years beginning after December 15, 2011. These amendments require us to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. As a result of the amendment, the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity is eliminated.

In September 2011, ASC 350, “Intangibles-Goodwill and Others,” was amended to simplify the assessment of goodwill impairment and will become effective for us for fiscal years beginning after December 15, 2011. The amended guidance allows us to do an initial qualitative assessment of relative events and circumstances to determine if fair value of a reporting unit is more likely than not less than its carrying value, prior to performing the two-step quantitative goodwill impairment test.

We will comply with the requirements of these amendments when the amendments are effective. None of these amendments are expected to have a material impact on our financial statements.

(3)           Earnings per Common Share

 We compute earnings per share using the weighted-average number of common shares outstanding during each period. Diluted earnings per common share reflects the dilutive impact of shares subscribed under the Employee Stock Purchase Plan (“Purchase Plan”) and effect of our outstanding options and restricted stock using the treasury stock method, except when such items would be antidilutive.

The following table presents the calculation of basic and diluted earnings per share:

	Three Months Ended September 30,					Nine Months Ended September 30,
	2011			2010		2011			2010
Numerator:
Net (loss) income	$	(1,078	)	$	1,565	$	(1,620	)	$	4,545
Denominator:
Weighted-average common shares outstanding - basic	12,334,155			12,055,741		12,188,889			11,503,013
Dilutive effect of stock-based compensation plans	—			43,130		—			56,322
Weighted-average common shares outstanding - diluted	12,334,155			12,098,871		12,188,889			11,559,335
Net (loss) income per share - basic	$	(0.09	)	$	0.13	$	(0.13	)	$	0.40
Net (loss) income per share - diluted	$	(0.09	)	$	0.13	$	(0.13	)	$	0.39

Since we incurred a loss for the three and nine month periods ended September 30, 2011, we did not include any of the 837,926 options to purchase shares of common stock or the right to purchase 3,864 shares under our employee stock

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purchase plan in the computation of diluted earnings per share because their impact would have been antidilutive. We did not include 745,176 outstanding options to purchase shares of common stock in the computation of diluted earnings per share for the three and nine months ended September 30, 2010 because generally their exercise prices were more than the average market price of our common shares and they are therefore antidilutive.

(4)           Accumulated Other Comprehensive (Loss) Income

Accumulated other comprehensive loss is comprised of foreign currency translation adjustments and pension and other postretirement benefits. The components of accumulated other comprehensive loss are as follows:

	September 30,			December 31,
	2011			2010
Accumulated other comprehensive loss:
Foreign currency translation adjustment	$	5,543		$	3,740
Pension and other postretirement benefits	(16,675		)	(16,675		)
Total accumulated other comprehensive loss	$	(11,132	)	$	(12,935	)

The components of comprehensive (loss) income are as follows:

	Three Months Ended September 30,					Nine Months Ended September 30,
	2011			2010		2011			2010
Comprehensive (loss) income:
Net (loss) income:	$	(1,078	)	$	1,565	$	(1,620	)	$	4,545
Foreign currency translation adjustment	(3,220		)	6,319		1,803			(2,894		)
Pension and other postretirement benefits, net	—			—		—			83
Tax impact of pension and postretirement benefits	—			—		—			(23		)
Total comprehensive (loss) income	$	(4,298	)	$	7,884	$	183		$	1,711

(5)           Inventories

	September 30,		December 31,
	2011		2010
Raw materials	$	18,277	$	18,091
Work-in-process	34,895		34,493
Finished goods	87,161		91,916
Total inventory	$	140,333	$	144,500

Finished goods inventory was impacted by the final purchase price allocation of $0.6 million relating to our acquisition of assets associated with a piano retail store in Chicago, Illinois. This acquisition was not material to our financial condition or results of operations.

(6)           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. Goodwill and indefinite-lived trademarks are not amortized but are subject to impairment testing. We conduct our annual impairment test on July 31st each year, and also when events and circumstances indicate that the fair value of any of our reporting units may be below the unit’s carrying value. We consider our band division, music education business, piano division, and our online music business to be separate reporting units.

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Our assessment is based on a comparison of net book value to estimated fair values primarily using an income approach. For purposes of the income approach, fair value is determined based on the present value of estimated future cash flows, discounted at an appropriate risk-adjusted rate. We make assumptions about the amount and timing of future expected cash flows, terminal value growth rates and appropriate discount rates. The amount and timing of future cash flows within our discounted cash flow analysis is based on our most recent operational budgets, long range strategic plans and other estimates. The terminal value growth rate is used to calculate the value of cash flows beyond the last projected period in our analysis and reflects our best estimates for stable, perpetual growth of our reporting units. We use estimates of market participant weighted-average costs of capital as a basis for determining the discount rates to apply to our reporting units future expected cash flows, adjusted for the risks and uncertainty inherent in our industry generally and in our internally developed forecasts. We also use a market approach against which we benchmark the results of our income approach to ensure that the results are appropriate.

Our annual impairment testing date of July 31st was selected to coincide with the timing of our fall budgeting and planning process, which provides multi-year cash flows that are used to conduct our annual impairment testing. This date also enables us to have insight into the back-to-school selling season results for our band and music education businesses. The multi-year cash flow projections for our band and music education businesses resulted in reductions in revenue growth assumptions and lower profit margins, both of which have a significant impact on our discounted cash flow models. Our revenue and gross profit assumptions were impacted in part by recent changes made to certain product lines, including the redesign of certain student woodwind instruments and the discontinuation of sourcing some components and reversion to in-house manufacturing in order to ensure supply and quality. These changes have resulted in increased costs, which we expect to cause lower margins despite price increases which we implemented on July 1, 2011. As a result, we recorded a $0.9 million charge to trademarks and wrote off $0.2 million of goodwill associated with the band division’s music education business. In connection with completing the impairment analysis for the band division’s reporting units, we also evaluated the recoverability of its long-lived assets. The results of this analysis are discussed in Note 9.

The multi-year cash flow forecast associated with our online music business also showed deterioration in revenue and growth assumptions due to recent decreases in order volume and declining market trends in the compact disc industry. Music consumers are increasingly using other delivery methods such as digital downloading and streaming as preferred methods of obtaining music, both of which require additional investment. As a result, our future anticipated cash flows for this business were reduced and our associated goodwill and trademarks were determined to be impaired. Accordingly, we recorded a $2.7 million charge to goodwill and a $0.3 million charge to trademarks associated with to our online music business during the period.

All impairment charges were taken as a component of operating expenses. Analyses of other intangible assets, including the remaining piano division trademarks and piano division goodwill indicated no impairment. No other events or circumstances occurred subsequent to our annual impairment test which would have indicated that these assets may be impaired.

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

	Piano			Band			Total
Goodwill:
Balance, January 1, 2011	$	25,823		$	200		$	26,023
Impairment charge	(2,727		)	(200		)	(2,927		)
Foreign currency translation impact	16			—			16
Balance, September 30, 2011	$	23,112		$	—		$	23,112
Trademarks:
Balance, January 1, 2011	$	9,157		$	5,824		$	14,981
Impairment charge	(255		)	(850		)	(1,105		)
Foreign currency translation impact	4			—			4
Balance, September 30, 2011	$	8,906		$	4,974		$	13,880

Our cumulative impairment losses are $8.8 million associated with band division goodwill, $0.9 million related to band division trademarks, $2.7 million attributable to online music business goodwill, and $1.2 million associated with online music business trademarks.

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

	September 30, 2011			December 31, 2010
Gross deferred financing costs	$	3,932		$	6,170
Accumulated amortization	(2,623		)	(3,542		)
Deferred financing costs, net	$	1,309		$	2,628
Gross non-compete agreements	$	250		$	250
Accumulated amortization	(169		)	(131		)
Non-compete agreements, net	$	81		$	119
Gross customer relationships	$	748		$	524
Accumulated amortization	(312		)	(283		)
Customer relationships, net	$	436		$	241
Gross website and developed technology	$	2,176		$	2,176
Accumulated amortization	(1,462		)	(1,136		)
Website and developed technology, net	$	714		$	1,040
Total gross other intangibles	$	7,106		$	9,120
Accumulated amortization	(4,566		)	(5,092		)
Total other intangibles, net	$	2,540		$	4,028

We wrote off $1.0 million of deferred financing costs during the nine months ended September 30, 2011, primarily due to the redemption of $85.0 million of our 7.00% Senior Notes, which is discussed more fully in Note 8. The weighted-average amortization period for deferred financing costs is six years, and the weighted-average amortization period for all other amortizable intangibles is approximately five years. The remaining weighted-average amortization period for deferred financing costs is approximately three years and the remaining weighted-average amortization period for all other amortizable intangibles is approximately two years. Total amortization expense, which includes amortization of deferred financing costs, is as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Amortization expense	$	263	$	300	$	840	$	911

The following table shows the total estimated amortization expense for the remainder of 2011 and beyond:

Remainder of 2011	$	261
2012	1,038
2013	691
2014	302
2015	217
Thereafter	31
Total	$	2,540

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(7)           Other Current Liabilities

Our other current liabilities consist of the following:

	September 30, 2011		December 31, 2010
Accrued payroll and related benefits	$	12,727	$	11,428
Current portion of pension and other postretirement benefit liabilities	1,253		1,306
Accrued warranty expense	1,348		1,510
Accrued interest	430		3,549
Deferred income	9,263		9,652
Income and other taxes payable	263		358
Other accrued expenses	8,439		11,378
Total	$	33,723	$	39,181

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 nine months ended September 30, 2011 and 2010, and the year ended December 31, 2010 is as follows:

	September 30, 2011			September 30, 2010			December 31, 2010
Beginning balance	$	1,510		$	1,553		$	1,553
Additions	948			587			894
Claims and reversals	(1,114		)	(665		)	(896		)
Foreign currency translation impact	4			(26		)	(41		)
Ending balance	$	1,348		$	1,449		$	1,510

(8)           Debt

On May 2, 2011 we redeemed $85.0 million of our 7.00% Senior Notes at 101.75% of principal plus accrued interest pursuant to a call we issued on April 1, 2011. We recorded a net loss on extinguishment of debt of $2.4 million during the second quarter of 2011. This net loss consists of the following:

Premiums paid pursuant to the call	$	1,488
Deferred financing costs write-off	706
Bond discount write-off	228
Net loss on extinguishment of debt	$	2,422

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Our outstanding debt consists of the following:

	September 30, 2011			December 31, 2010
7.00% Senior Notes	$	67,506		$	152,506
Unamortized bond discount	(155		)	(458		)
Domestic line of credit	10,000			—
Overseas lines of credit	649			2,462
Total	78,000			154,510
Less: current portion	649			2,462
Long-term debt	$	77,351		$	152,048

Scheduled repayments of outstanding debt as of September 30, 2011 are as follows:

Remainder of 2011	$	649
2012	—
2013	—
2014	67,506
2015	10,000
Total	$	78,155

(9)Facility Rationalization and Impairment Charges — Band Segment

As discussed in Note 6, our band division had an indicator of impairment when we conducted our annual impairment testing. As a result, we were required to conduct a detailed analysis of our long-lived assets to determine whether their recoverability was impaired. Recoverability of these assets is determined by comparing forecasted undiscounted net cash flows for the asset groups to their respective carrying values. Our woodwind manufacturing facility in Elkhart, Indiana produces primarily student instruments, which typically generate lower margins. Despite the implementation of price increases on July 1, the recent change from using certain sourced components to manufacturing these components in-house has resulted in anticipated reduction in future gross margins. We believe these margins are insufficient to recover the book value of the property, plant, and equipment associated with that production. Accordingly, we recorded a $1.1 million impairment charge related to property, plant, and equipment as a component of operating expenses during the third quarter of 2011.

During the second quarter of 2011, we determined that the book value of our former manufacturing facility in Elkhorn, Wisconsin exceeded the fair value. Accordingly, we recorded a facility impairment charge of $0.2 million as a component of operating expenses. This facility, which has a remaining book value of less than $0.1 million, is included in other assets and is being held for sale.

Our real estate and equipment assets were valued using either quoted prices for specific assets or management-estimated market prices for similar assets.

During the first quarter of 2012, we intend to close our tuned percussion instrument manufacturing facility located in LaGrange, Illinois and consolidate the production into our other percussion facility in Monroe, North Carolina. As a result of this pending closure, we recorded charges of $0.4 million in severance and related expenses during the first quarter of 2011 as a component of cost of goods sold. We currently do not expect to incur any additional severance expenses during the remainder of 2011.

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The severance liability and related activity associated with this plant closure is as follows:

Facility rationalization severance liability:
Balance at January 1, 2011	$	—
Additions charged to cost of sales	417
Payments	—
Balance, September 30, 2011	$	417

Although our plant closure process has yet to be completed, we do not expect impairment charges or equipment relocation costs, if any, to be material.

(10)         Fair Values of Financial Instruments

Our financial instruments, which are recorded at fair value, consist primarily of foreign currency contracts and marketable equity securities. We assess the inputs used to measure fair value using the following three-tier hierarchy, which indicates the extent to which inputs used are observable in the market.

Level 1	Valuation is based upon unadjusted quoted prices for identical instruments traded in active markets.
Level 2	Valuation is based upon quoted prices for identical or similar instruments such as interest rates, foreign currency exchange rates, commodity rates and yield curves, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3	Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions include management’s own judgments about the assumptions market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques. (We do not have any assets or liabilities carried at Level 3 fair value.)

We value our foreign currency contracts using internal and third-party models with observable inputs, including currency forward and spot prices, volatility factors, and net present value factors. Estimated fair value has been determined as the difference between the current forward rate and the contract rate, multiplied by the notional amount of the contract, or upon the estimated fair value of purchased option contracts.

The following table presents information about our assets and liabilities measured at fair value on a recurring basis as of September 30, 2011 and December 31, 2010 and the fair value hierarchy of the valuation techniques we utilized. We classify these assets and liabilities as either short term or long term based on maturity or anticipated realization dates.

	September 30, 2011		December 31, 2010
Financial assets:
Trading securities(1) - Level 1	$	1,559	$	1,758
Foreign currency contracts(2) - Level 2	363		216
	$	1,922	$	1,974
Financial liabilities:
Foreign currency contracts(2) - Level 2	$	868	$	447

(1)Our trading securities pertain to the Supplemental Executive Retirement Plan (“SERP”) and are held in a Rabbi Trust. We record a corresponding liability for the same amount in our financial statements, which represents our obligation to SERP participants.

(2)Our foreign currency contracts pertain to obligations or potential obligations to purchase or sell euros, pounds, U.S. dollars, and yen under various forward and option contracts.

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We base the estimated fair value of our debt on institutional quotes currently available to us. The historical cost, net carrying value, and estimated fair value are as follows:

	September 30, 2011				December 31, 2010
	Net Carrying Value		Estimated Fair Value		Net Carrying Value		Estimated Fair Value
Financial liabilities:
Debt	$	78,000	$	75,877	$	154,510	$	156,208

The carrying values of accounts, notes and other receivables, and accounts payable approximate fair value.

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

Our common stock was previously comprised of two classes: Class A and Ordinary. With the exception of disparate voting power, both classes were substantially identical. Each share of Class A common stock entitled the holder to 98 votes. Holders of Ordinary common stock are entitled to one vote per share. On June 2, 2011 our Chairman and Chief Executive Officer sold all of their Class A common stock to other shareholders. Once the Class A stock was no longer held by its former shareholders, it was converted into Ordinary common stock. This eliminated the 80% voting power previously held by our Chairman and Chief Executive Officer.

Stockholder Rights Plan — During the third quarter of 2011, we adopted a Stockholder Rights Plan under which stockholders will receive rights to purchase shares of a new series of preferred stock. The rights will be distributed to all stockholders of record of the Company’s common stock as of October 7, 2011. To effect the plan, the Board of Directors declared a dividend of one right on each outstanding share of the Company’s common stock. The rights become exercisable if any person or group acquires 10% or more (or, in certain instances, 35% or more) of our common stock.

If the rights become exercisable, each right will initially entitle the holder to acquire one one-hundredth (1/100) of a share of a new series of preferred stock at an exercise price of $75 per right. In addition, under certain circumstances, the rights will entitle the holders (other than the person or group triggering the rights) to buy shares of our common stock with a cumulative market value of two times the exercise price at a 50% discount off the then current price. Because the rights of any person or group acquiring the specified ownership percentage become void, that person or group would be subject to significant dilution in their holdings.

Until the rights become exercisable, they will not have any impact on our shares outstanding. The rights will expire on September 26, 2021, unless extended or earlier redeemed or exchanged by us pursuant to the terms of the plan.

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 400,000 shares of common stock for issuance under this plan.

Stock Plans - The 2006 Stock Plan provides for the granting of 1,000,000 stock options (including incentive stock options and non-qualified stock options), stock appreciation rights, restricted shares and other stock awards to certain key employees, consultants and advisors. Our stock options generally have five-year vesting terms and ten-year option terms. Our restricted shares have three-year vesting terms, except upon a change in control, when they would vest immediately.

Our 1996 Stock Plan has expired but still has vested options outstanding. We reached our registered share limitation in early 2007, and had previously reserved 721,750 treasury stock shares to issue under this plan. We have since issued 225,274 shares of treasury stock to cover options exercised, with 229,876 remaining options outstanding. Since in most instances the average cost of the treasury stock exceeded the price of the options exercised, the difference between the proceeds received and the average cost of the treasury stock issued resulted in a reduction of retained earnings. The reduction to retained earnings associated with options exercised during the three and nine months ended September 30, 2011 was $0.2 million and $0.3 million, respectively. This reduction was $0.1 million for the three and nine months ended September 30, 2010.

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The compensation cost and the income tax benefit recognized for these plans are as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Compensation cost included in:
Basic income per share	$	0.01	$	0.03	$	0.22	$	0.08
Diluted income per share	$	0.01	$	0.02	$	0.22	$	0.08
Stock-based compensation expense	113		368		3,514		1,109
Income tax benefit	26		66		877		201

In connection with the sale of Class A common stock mentioned above, vesting of most of the unvested stock options under our Stock Plan was accelerated. As a result, we incurred $2.2 million of stock-based compensation expense during the second quarter of 2011.

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 the expected life of the option, as our options are not readily tradable.

There were no options granted during the three and nine months ended September 30, 2011. Key assumptions used to apply this pricing model to the Stock Plan for the three and nine months ended September 30, 2010 are as follows:

	Three Months Ended	Nine Months Ended
	September 30, 2010	September 30, 2010
Risk-free interest rate	2.3%	2.3%
Weighted-average expected life of option feature (in years)	7.2	7.2
Expected volatility of underlying stock	33.8%	33.8%
Expected dividends	n/a	n/a
Weighted-average fair value of option feature	$7.93	$7.93

During the nine months ended September 30, 2011, we granted 40,000 restricted shares with a fair value of $19.89 per share. As a result of the sale of Class A common stock, the vesting of these shares was accelerated and we recognized an associated compensation cost of $0.7 million during the second quarter of 2011.

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The following table sets forth information regarding the Stock Plans:

	Number of Options		Weighted- Average Exercise Price		Weighted- Average Remaining Contract Life (in years)	Aggregate Intrinsic Value
Outstanding, January 1, 2011	1,086,886		$	20.60
Granted	—		—
Exercised	(226,300	)	17.37
Forfeited	(22,660	)	29.39
Outstanding, September 30, 2011	837,926		$	21.24	5.6	$	2,941
Exercisable, September 30, 2011	750,186		$	21.80	5.4	$	2,323

The total intrinsic value of the options exercised during the three and nine month periods ended September 30, 2011 was $1.0 million and $2.0 million, respectively. The total intrinsic value of the options exercised during the three and nine month periods ended September 30, 2010 was nominal. As of September 30, 2011, there was $0.5 million of unrecognized compensation cost related to nonvested share-based compensation arrangements. This compensation is expected to be recognized over a weighted-average period of 2.6 years. Cash received from option exercises under the Stock Plans for the three and nine month periods ended September 30, 2011 was $2.3 million and $3.9 million, respectively.

The following tables set forth information regarding the Purchase Plan:

	Three Months Ended September 30,		Nine Months Ended September 30,
	2011	2010	2011	2010
Risk-free interest rate	0.2%	0.4%	0.3%	0.4%
Weighted-average expected life of option feature (in years)	1.0	1.0	1.0	1.0
Expected volatility of underlying stock	28.5%	28.1%	28.3%	28.0%
Expected dividends	n/a	n/a	n/a	n/a
Weighted-average fair value of option feature	$6.03	$3.77	$5.19	$3.09

	Number of Options		Weighted- Average Exercise Price		Remaining Contract Life (in years)	Aggregate Intrinsic Value
Outstanding, January 1, 2011	15,709		$	16.58
Shares subscribed	24,796		17.85
Exercised	(35,487	)	16.58
Forfeited	(1,154	)	16.59
Outstanding, September 30, 2011	3,864		$	24.70	0.8	$	12

Cash received from shares issued under the Purchase Plan for the three and nine month periods ended September 30, 2011 was $0.6 million.

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(12)Other Expense (Income), Net

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
West 57th Street building income	$	(572	)	$	(915	)	$	(1,827	)	$	(4,308	)
West 57th Street building expense	1,708			1,687			5,078			5,148
Foreign exchange loss (gain), net	456			(403		)	(194		)	(1,116		)
Miscellaneous, net	294			(259		)	75			(423		)
Other expense (income), net	$	1,886		$	110		$	3,132		$	(699	)

Our building on West 57th Street in New York City is managed by an outside company. West 57th Street building income includes all rent and other income attributable to the property; West 57th Street building expense includes the land lease, real estate taxes, depreciation, and other building costs. Since we utilize a portion of the leasable space for our own retail store, we have allocated a ratable portion of the building expenses to sales and marketing expenses.

(13)         Commitments and Contingent Liabilities

We are involved in certain legal proceedings regarding environmental matters, which were previously disclosed in our 2010 Annual Report on Form 10-K. 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.

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

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(14)         Retirement Plans

We have defined benefit pension plans covering many 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 Plan						Foreign Plans
	Three Months Ended September 30,						Three Months Ended September 30,
	2011			2010			2011			2010
Service cost	$	91		$	87		$	162		$	133
Interest cost	812			864			448			424
Expected return on plan assets	(1,125		)	(1,048		)	(105		)	(89		)
Amortization of prior service cost (credit)	28			28			(13		)	(13		)
Amortization of net loss	542			489			29			48
Net periodic pension cost	$	348		$	420		$	521		$	503

	Domestic Plan						Foreign Plans
	Nine Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Service cost	$	272		$	262		$	484		$	452
Interest cost	2,438			2,592			1,337			1,285
Expected return on plan assets	(3,275		)	(3,145		)	(317		)	(256		)
Amortization of prior service cost (credit)	85			84			(39		)	(26		)
Amortization of net loss	1,626			1,467			87			128
Net periodic pension cost	$	1,146		$	1,260		$	1,552		$	1,583

We were not required to make any contributions to our domestic pension plan in 2011. We have made payments of $2.6 million to this plan as of September 30, 2011, but do not anticipate making any more contributions this year. Our anticipated contributions to the pension plan of our U.K. subsidiary approximate $0.7 million for the current year. As of September 30, 2011, we have made contributions of $0.6 million to this plan. The pension plans of our German entities do not hold any assets and use operating cash to pay participant benefits as they become due. Expected 2011 benefit payments under these plans are $1.2 million, of which $0.9 million was paid through September 30, 2011.

We provide postretirement life insurance benefits to a limited number of certain eligible hourly retirees and their dependents. The activity in this plan is not material to the condensed consolidated financial statements.

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(15)         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. We have included the results of our online music division within the “U.S. Piano Segment” as we believe its results are not material and its products and customer base are most correlated with piano operations. 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” contain 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 and nine months ended September 30, 2011 and 2010:

Three Months Ended 2011	Piano Segment									Band Segment						Other &			Consol
	U.S.			Germany		Other		Total		U.S.		Europe		Total		Elim			Total
Net sales to external customers	$	25,854		$	13,229	$	12,020	$	51,103	$	37,376	$	1,276	$	38,652	$	—		$	89,755
Income (loss) from operations	(1,581		)	3,250		1,159		2,828		37		144		181		(1,907		)	1,102

Three Months Ended 2010	Piano Segment								Band Segment						Other &			Consol
	U.S.		Germany		Other		Total		U.S.		Europe		Total		Elim			Total
Net sales to external customers	$	22,064	$	11,792	$	11,144	$	45,000	$	36,978	$	1,283	$	38,261	$	—		$	83,261
Income (loss) from operations	1,311		1,001		1,152		3,464		3,263		129		3,392		(1,062		)	5,794

Nine Months Ended 2011	Piano Segment								Band Segment						Other &			Consol
	U.S.		Germany		Other		Total		U.S.		Europe		Total		Elim			Total
Net sales to external customers	$	70,721	$	43,003	$	35,139	$	148,863	$	99,366	$	3,398	$	102,764	$	—		$	251,627
Income (loss) from operations	438		7,240		3,650		11,328		1,985		313		2,298		(5,937		)	7,689

Nine Months Ended 2010	Piano Segment								Band Segment						Other &			Consol
	U.S.		Germany		Other		Total		U.S.		Europe		Total		Elim			Total
Net sales to external customers	$	62,270	$	34,457	$	32,571	$	129,298	$	97,402	$	3,352	$	100,754	$	—		$	230,052
Income (loss) from operations	1,890		4,086		3,125		9,101		7,805		286		8,091		(2,534		)	14,658

(16)         Subsequent Events

On October 20, 2011 the workers at our Eastlake, Ohio brass instrument manufacturing facility notified us that they have ended the strike that began on July 26, 2011. The union at this plant subsequently accepted our last contract offer, which includes freezing the defined benefit plan, the impact of which is currently being calculated and will be recognized during the fourth quarter of 2011.

On October 24, 2011 our Chief Executive Officer stepped down from his operating position. As a result, we will incur a $2.7 million separation charge during the fourth quarter of 2011.

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ITEM 2	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	(Tabular Amounts in Thousands Except Percentages, 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 Steinway upright pianos and two mid-priced lines of pianos under the Boston and Essex brand names. We are also an online retailer of classical music. Through our band division, we are the largest domestic producer of band and orchestral instruments and offer a complete line of brass, woodwind, percussion and string instruments and related accessories with well-known brand names such as Bach, Selmer, C.G. Conn, Leblanc, King, and Ludwig. We sell our products through dealers and distributors worldwide. Our piano customer base consists of professional artists, amateur pianists, and institutions such as concert halls, universities, and music schools. Our band and orchestral instrument customer base consists primarily of middle school and high school students, but also includes adult amateur and professional musicians.

Critical Accounting Policies and Estimates

The Securities and Exchange Commission (“SEC”) has issued disclosure guidance for “critical accounting policies and estimates.” The SEC defines “critical accounting policies and estimates” 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 condensed 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 2010 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 and estimates based on the definition above.

Accounts Receivable

We establish reserves for accounts receivable and notes receivable. 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 at both our piano and band divisions has been generated by our top fifteen 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 a 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, 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 account for 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. Abnormal costs are expensed in the period in which they occur.

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Workers’ Compensation and Self-Insured Health Claims

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

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 or asset group may not be recoverable. We measure recoverability by comparing the carrying amount of the asset or asset group to the estimated future cash flows the asset or asset group is expected to generate.

We establish long-lived intangible assets based on estimated fair values, and amortize finite-lived intangibles over their estimated useful lives. 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. We determine our reporting units by first identifying our operating segments, and then assess whether any components of these segments constitute a business for which discrete financial information is available and where segment management regularly reviews the operating results of that component. We aggregate components within a reporting unit that have similar economic characteristics.

Our assessment is based on a comparison of net book value to estimated fair values primarily using an income approach. For purposes of the income approach, fair value is determined based on the present value of estimated future cash flows, discounted at an appropriate risk-adjusted rate. We make assumptions about the amount and timing of future expected cash flows, terminal value growth rates and appropriate discount rates. The amount and timing of future cash flows within our discounted cash flow analysis is based on our most recent operational budgets, long range strategic plans and other estimates. The terminal value growth rate is used to calculate the value of cash flows beyond the last projected period in our analysis and reflects our best estimates for stable, perpetual growth of our reporting units. We use estimates of market participant weighted-average costs of capital as a basis for determining the discount rates to apply to our reporting units’ future expected cash flows, adjusted for the risks and uncertainty inherent in our industry generally and in our internally developed forecasts. We also use a market approach against which we benchmark the results of our income approach to ensure the results are appropriate.

Pensions and Other Postretirement 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

We record valuation allowances for certain deferred tax assets related to foreign tax credit carryforwards and 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 jurisdictions 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.

When appropriate, a liability has been recorded for uncertain tax positions. When analyzing these positions, we consider the probability of various outcomes which could result from examination, negotiation, or settlement with various taxing authorities. The final outcome on these positions could differ significantly from our original estimates due to the following: expiring statutes of limitations; availability of detailed historical data; results of audits or examinations conducted by taxing authorities or agents that vary from management’s anticipated results; identification of new tax contingencies; release of applicable administrative tax guidance; management’s decision to settle or appeal assessments; the rendering of court decisions affecting our estimates of tax liabilities; or other factors.

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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 condensed consolidated 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; reductions in school budgets; increased competition; ability of dealers to obtain financing; exchange rate fluctuations; variations in the mix of products sold; market acceptance of new products, ability of suppliers to meet demand; concentration of credit risk; ability to maximize return on NY real estate; and fluctuations in effective tax rates resulting from shifts in sources of income. 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, 2010. 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.

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Results of Operations

Three Months Ended September 30, 2011 Compared to Three Months Ended September 30, 2010

	Three Months Ended September 30,							Change
	2011				2010			$		%
Net sales
Band	$	38,652			$	38,261		391		1.0
Piano	51,103				45,000			6,103		13.6
Total sales	89,755				83,261			6,494		7.8
Cost of sales
Band	30,795				29,259			1,536		5.2
Piano	32,988				30,807			2,181		7.1
Total cost of sales	63,783				60,066			3,717		6.2
Gross profit
Band	7,857			20.3%	9,002		23.5%	(1,145	)	(12.7	)
Piano	18,115			35.4%	14,193		31.5%	3,922		27.6
Total gross profit	25,972				23,195			2,777		12.0
	28.9%				27.9%
Operating expenses	19,728				17,401			2,327		13.4
Impairment charges	5,142				—			5,142		100.0
Income from operations	1,102				5,794			(4,692	)	(81.0	)
Other expense (income), net	1,886				110			1,776		1,614.5
Net interest expense	1,011				2,464			(1,453	)	(59.0	)
Non-operating expenses	2,897				2,574			323		12.5
(Loss) income before income taxes	(1,795		)		3,220			(5,015	)	(155.7	)
Income tax (benefit) provision	(717		)	39.9%	1,655		51.4%	(2,372	)	(143.3	)
Net (loss) income	$	(1,078	)		$	1,565		(2,643	)	(168.9	)

Overview — Piano division revenues and gross profits improved significantly as a result of increased shipments of Steinway grand units. Band division revenues were stable despite lost sales due to the strike at our Eastlake, Ohio brass instrument manufacturing facility. Band division gross margins deteriorated due to higher material and overhead costs and inefficiencies associated with the strike at our Eastlake plant.

Our fall budgeting and planning process provides multi-year cash flow projections which we use to conduct our annual impairment testing of intangible assets. Recent decreases in order volume and declining market trends in the compact disc industry, coupled with other factors, caused us to lower sales expectations for our online music business. As a result, our future anticipated cash flows for this business were reduced and our goodwill and trademarks were determined to be impaired. Accordingly, we recorded a $2.7 million impairment charge to goodwill and $0.3 million impairment charge to trademarks associated with our online music business during the period.

Similarly, the multi-year cash flow projections for our band division, which were adversely impacted by increased costs, particularly at our woodwind manufacturing facility, indicated an impairment of that division’s assets. As a result, we recorded impairment charges of $2.2 million related to band division intangible assets and property, plant and equipment.

Net Sales — Domestic piano division revenues improved $3.8 million as a result of a 6% increase in Steinway grand unit shipments and a 16% increase in Boston and Essex piano unit shipments. Overseas piano division revenues were $2.3 million higher

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due to better wholesale demand in Europe as well as $1.8 million attributable to foreign currency exchange rates. Overseas Steinway grand unit shipments increased 5% and Boston and Essex piano line shipments were on par with the year-ago period.

Despite a strike at our Eastlake, Ohio brass instrument manufacturing facility, band division revenues were up $0.4 million. We implemented planned price increases on July 1, which more than offset the estimated $2.3 million in lost revenue attributable to the strike. However, overall unit shipments were down 4% compared to the year-ago period.

Gross Profit— Gross profit was $2.8 million higher due to better sales and margins at our piano divisions.  Domestic piano division gross margins increased from 29.9% to 30.3% as production increases and the resultant factory efficiencies more than offset the $0.4 million increased costs on our Boston and Essex piano lines. Overseas piano division margins went from 33.1% to 40.7% due to factory efficiencies and lower overhead spending.

Negative production variances of $0.8 million caused by the strike at our Eastlake, Ohio brass instrument manufacturing facility, as well as higher material and overhead costs, caused the band division margin to drop from 23.5% to 20.3% during the period.

Operating Expenses— Operating expenses increased $2.3 million during the period. Sales and marketing costs increased $1.1 million largely due to advertising and promotional expenses, as well as commissions and bonuses incurred by the piano division. General and administrative costs increased $1.5 million primarily due to the $1.1 million of severance costs associated with the departure of our former Chairman in July 2011.

Impairment Charges — In the current period, we incurred impairment charges related to our band division and online music division goodwill and trademark intangible assets of $4.0 million. We also incurred impairment charges associated with the long-lived assets at our woodwind instrument manufacturing facility. These charges totaled $1.1 million. We did not incur any impairment charges in the year-ago period.

Non-operating Expenses — Non-operating expenses were $0.3 million higher than the year-ago period. In May we extinguished $85.0 million of our 7.00% Senior Notes, which enabled us to lower our net interest expense by $1.5 million during the period. However, this savings was offset by unrealized foreign exchange losses of $0.5 million versus unrealized gains of $0.4 million in the year-ago period. Also, the deterioration in Supplemental Executive Retirement Plan assets of $0.4 million adversely impacted non-operating expenses. Lastly, increased expenses associated with our West 57th Street building, which were $0.4 million higher than the year-ago period were also a factor. We expect to continue to incur temporary losses in the near term on this facility due to low occupancy rates.

Income Taxes — We recorded an income tax benefit of $0.7 million, reflecting our anticipated annual effective income tax rate of 38.9% associated with current year income, as well as uncertain tax positions and discrete items. The combination of these items resulted in an effective tax rate of 39.9% for the period. The rate of 51.4% in the year-ago period reflected an anticipated annual effective income tax rate of 43.7% as well as uncertain tax positions and discrete items.

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Nine Months Ended September 30, 2011 Compared to Nine Months Ended September 30, 2010

	Nine Months Ended September 30,								Change
	2011				2010				$		%
Net sales
Band	$	102,764			$	100,754			2,010		2.0
Piano	148,863				129,298				19,565		15.1
Total sales	251,627				230,052				21,575		9.4
Cost of sales
Band	79,809				75,993				3,816		5.0
Piano	96,974				87,377				9,597		11.0
Total cost of sales	176,783				163,370				13,413		8.2
Gross profit
Band	22,955			22.3%	24,761			24.6%	(1,806	)	(7.3	)
Piano	51,889			34.9%	41,921			32.4%	9,968		23.8
Total gross profit	74,844				66,682				8,162		12.2
	29.7%				29.0%
Operating expenses	61,794				52,024				9,770		18.8
Impairment charges	5,361				—				5,361		100.0
Income from operations	7,689				14,658				(6,969	)	(47.5	)
Other expense (income), net	3,132				(699		)		3,831		(548.1	)
Net loss (gain) on extinguishment of debt	2,422				(104		)		2,526		(2,428.8	)
Net interest expense	4,851				7,318				(2,467	)	(33.7	)
Non-operating expenses	10,405				6,515				3,890		59.7
(Loss) income before income taxes	(2,716		)		8,143				(10,859	)	(133.4	)
Income tax (benefit) provision	(1,096		)	40.4%	3,598			44.2%	(4,694	)	(130.5	)
Net (loss) income	$	(1,620	)		$	4,545			(6,165	)	(135.6	)

Overview — Although band division revenues increased, higher material and overhead costs, production inefficiencies related to the strike at one of our brass instrument manufacturing facilities, and severance associated with a pending plant closure adversely impacted gross profits. Piano division revenues and gross profits increased primarily as a result of greatly improved demand for Steinway grand units worldwide and more efficient production at both of our piano factories.

Income from operations was negatively impacted by incremental legal, consulting, and stock-based compensation costs associated with the Class A common stock transaction which occurred during the second quarter of 2011. Also, we recorded intangible asset impairment charges of $4.0 million and property, plant, and equipment impairment charges of $1.3 million during the period, which adversely impacted our results.

Net Sales — Domestic piano division revenues increased $8.5 million primarily as a result of a 15% increase in Steinway grand unit shipments. A 5% increase in Boston and Essex piano shipments also contributed to the revenue improvement. Overseas, strong wholesale demand drove a 12% increase in Steinway grand unit shipments which more than offset an 8% decrease in Boston and Essex piano unit shipments. This, coupled with a favorable foreign exchange rate impact of $5.4 million caused overseas piano division revenues to increase $11.1 million.

Despite a slight (2%) decrease in overall unit shipments, band division revenues increased $2.0 million due to strong demand for brass and woodwind instruments, which offset weaker percussion and string instrument revenues.

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Gross Profit— Gross profit increased $8.2 million due to improved sales and margins from the piano division. Gross margins at the band division dropped from 24.6% to 22.3% in the current period. Higher material and overhead costs,  as well as $0.8 million of inefficiencies related to the strike at our Eastlake plant and severance charges of $0.4 million associated with a pending plant closure adversely impacted the margin.

Piano margins improved from 32.4% to 34.9%. Domestic piano margins grew from 29.8% to 32.2% due to factory efficiencies and increased Steinway grand unit sales, which typically generate higher margins. Overseas piano margins improved from 34.9% to 37.3% due to higher factory throughput and favorable variances.

Operating Expenses— Operating expenses increased $9.8 million, of which $2.2 million is incremental stock-based compensation and $0.8 million is legal and consulting costs primarily associated with the Class A common stock transaction mentioned above. We also incurred $1.1 million in severance charges related to the departure of our former Chairman.

Marketing, advertising, commissions, and promotional expenses increased $2.6 million. General and administrative costs increased $3.3 million due to increased wages, benefits, headcount, legal, and consulting costs. Wages and benefits increased in part due to the reinstatement to full salaries for staff members that took pay cuts and the resumption of annual merit increases. Also, selling, general, and administrative expenses were adversely impacted by $1.2 million due to foreign currency exchange rate changes.

Impairment Charges — In the current period, we incurred impairment charges related to our band division and online music division goodwill and trademark intangible assets of $4.0 million. We also incurred impairment charges associated with the long-lived assets at one current and one former manufacturing facility. These charges totaled $1.3 million. We did not incur any impairment charges in the year-ago period.

Non-operating Expenses — Non-operating expenses increased $3.9 million primarily due to a shift from gain on extinguishment of debt to loss on extinguishment of debt of $2.5 million. This loss relates to our redemption of $85.0 million of our 7.00% Senior Notes in May, which generated an interest savings of $2.5 million during the period. Foreign exchange gains were $0.9 million lower than the year-ago period, and we incurred incremental expenses of $2.4 million from our West 57th Street building, both of which increased non-operating expenses. We expect to continue to incur temporary losses on our West 57th Street building due to low occupancy rates.

Income Taxes — We recorded an income tax benefit of $1.1 million, reflecting our anticipated annual effective income tax rate of 38.9% associated with current year income, as well as uncertain tax positions and discrete items. The combination of these items resulted in an effective tax rate of 40.4% for the period. The rate of 44.2% in the year-ago period reflected an anticipated annual effective income tax rate of 43.7% as well as uncertain tax positions and discrete items.

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Liquidity and Capital Resources

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

Our statements of cash flows for the nine months ended September 30, 2011 and 2010 are summarized as follows:

	2011			2010			Change
Net (loss) income:	$	(1,620	)	$	4,545		$	(6,165	)
Changes in operating assets and liabilities	(15,460		)	(552		)	(14,908		)
Other adjustments to reconcile net (loss) income to cash from operating activities	17,938			7,121			10,817
Cash flows from operating activities	858			11,114			(10,256		)
Cash flows from investing activities	(7,389		)	(2,086		)	(5,303		)
Cash flows from financing activities	(73,571		)	22,686			(96,257		)

Cash flows from operating activities decreased $10.3 million from the year-ago period. Cash generated by inventory was $2.8 million lower in the current period as a result of higher production levels at many plants. We used $6.4 million more for prepaids and other assets due to prepaid income taxes, real estate taxes, and expenses associated with our West 57th Street building. We used $6.3 million more for accounts payable, pension, accrued expenses, primarily due to shifts in spending patterns, which have returned to normal levels.

Cash flows from investing activities resulted in the use of an additional $5.3 million primarily due to the payment of $2.7 million in additional consideration associated with the acquisition of our online music business, as well as $0.6 million paid to acquire assets of a piano retail store in Chicago, Illinois. Higher capital expenditures of $2.3 million were also a factor as capital expenditures were abnormally low in 2010. In 2011, we expect capital expenditures for the full year to be in the range of $5.0 to $6.0 million.

Cash flows from financing activities decreased by $96.3 million compared to the year-ago period. We spent an incremental $80.9 million to extinguish a significant portion of our 7.00% Senior Notes. This was partially offset by incremental cash provided by borrowings of $7.6 million. Also, in the prior period, we generated $28.2 million through stock sales, compared to $4.5 million in the current period.

Borrowing Activities and Availability — We have a domestic credit facility with a syndicate of lenders (the “Credit Facility”) with a potential borrowing capacity of $100.0 million in revolving credit loans, which expires on October 5, 2015. It provides for periodic borrowings at either London Interbank Offering Rate (“LIBOR”) plus a range from 1.75% to 2.25%, or as-needed borrowings at an alternate base rate, plus a range from 0.75% to 1.25%; both ranges depend upon borrowing availability at the time of borrowing. The Credit Facility is collateralized by our domestic accounts receivable, inventory, and certain property, plant and equipment. As of September 30, 2011 we had $10.0 million outstanding on this Credit Facility and $80.9 million of availability, net of borrowing restrictions.

We also have certain non-domestic credit facilities originating from two German banks that provide for borrowings by foreign subsidiaries of up to €16.4 million ($22.0 million at the September 30, 2011 exchange rate), net of borrowing restrictions of €1.6 million ($2.1 million at the September 30, 2011 exchange rate) which are payable either December 31, 2011 or in April 2012. 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 £0.9 million ($1.4 million at the September 30, 2011 exchange rate) for use by our U.K. branch and ¥300 million ($3.9 million at the September 30, 2011 exchange rate) for use by our Japanese subsidiary. Our Chinese subsidiary also has the ability to convert the equivalent of up to €2.5 million into U.S. dollars or Chinese yuan ($3.3 million at the September 30, 2011 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 rates of LIBOR plus 0.8% for British pound loans, LIBOR plus 1.0% for U.S. dollar loans of our Chinese subsidiary, and Tokyo Interbank Offered Rate (“TIBOR”) plus 1.6% for Japanese yen loans. We had nothing outstanding as of September 30, 2011 on these credit facilities.

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Our Japanese subsidiary also maintains a separate revolving loan agreement that provides additional borrowing capacity of up to ¥300 million ($3.9 million at the September 30, 2011 exchange rate). The revolving loan agreement bears interest at an average 30-day TIBOR rate plus 0.9% (outstanding borrowings at 1.1% at September 30, 2011) and expires on June 30, 2012. As of September 30, 2011, we had $0.6 million outstanding on this revolving loan agreement.

At September 30, 2011, our total outstanding indebtedness amounted to $78.2 million, consisting of $67.5 million of our 7.00% Senior Notes due March 1, 2014, $10.0 million outstanding on our Credit Facility, and $0.6 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 repurchase 7.00% Senior Notes, to make investments in other entities, and limitations on cash dividend payments. We were in compliance with all such covenants as of September 30, 2011 and do not anticipate any compliance issues in the future. 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. In May 2008 we announced a share repurchase program, which permits us to make discretionary purchases of up to $25.0 million of our Ordinary common stock. To date, we have repurchased 102,127 shares and approximately $22.5 million remains authorized for repurchases under this program. We did not make any repurchases during the three and nine months ended September 30, 2011. We repurchased 21,827 shares for $0.3 million during the three months ended September 30, 2010.

We experience long production and inventory turnover cycles, which we constantly monitor since fluctuations in demand can have a significant impact on these cycles. In normal economic conditions, we are able to effectively utilize cash flow from operations to fund our debt and capital requirements and pay off borrowings on our domestic line of credit. We intend to manage accounts receivable and credit risk, and control inventory levels by monitoring purchases and production schedules. Our intention is to manage cash outflow and maintain sufficient operating cash on hand to meet short-term requirements. We indefinitely reinvest earnings of our foreign operations. This indefinite reinvestment does not have a material impact on our liquidity.

Other than those described above, we do not have any current plans or intentions that will have a material impact on our liquidity in 2011, 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 regular capital requirements and satisfy our working capital and general corporate needs for the next twelve months.

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Contractual Obligations - The following table provides a summary of our contractual obligations at September 30, 2011.

	Payments due by period
	Total		Less than 1 year		1 - 3 years		3 - 5 years		More than 5 years
Contractual Obligations
Long-term debt(1)	$	90,382	$	5,581	$	74,601	$	10,200	$	—
Capital leases	10		4		6		—		—
Operating leases(2)	254,728		6,249		9,795		8,403		230,281
Purchase obligations(3)	30,908		30,887		21		—		—
Other long-term liabilities(4)	47,731		7,131		4,535		3,972		32,093
Total	$	423,759	$	49,852	$	88,958	$	22,575	$	262,374

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 September 30, 2011 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 $241.3 million of our operating lease obligations are attributable to the land lease associated with the purchase of Steinway Hall, which has eighty-six years remaining. The rest is attributable to the leasing of other facilities and equipment.
(3)	Purchase obligations consist of firm purchase commitments for raw materials, finished goods, and service agreements.
(4)	Our other long-term liabilities consist primarily of the long-term portion of our pension obligations, which are described in Note 14 in the Notes to Condensed Consolidated Financial Statements included within this filing and obligations under employee and consultant agreements. We have not included $0.3 million of liabilities relating to uncertain tax positions within this schedule due to the uncertainty of the payment date, if any.

Recent Accounting Pronouncements

Certain amendments to Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements,” become effective for us for fiscal years beginning after December 15, 2011. These amendments include a consistent definition of fair value, enhanced disclosure requirements for “Level 3” fair value adjustments and other changes to required disclosures.

In June 2011, ASC 220, “Comprehensive Income,” was amended and will become effective for us for fiscal years beginning after December 15, 2011. These amendments require us to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. As a result of the amendment, the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity is eliminated.

In September 2011, ASC 350, “Intangibles-Goodwill and Others,” was amended to simplify the assessment of goodwill impairment and will become effective for us for fiscal years beginning after December 15, 2011. The amended guidance allows us to do an initial qualitative assessment of relative events and circumstances to determine if fair value of a reporting unit is more likely than not less than its carrying value, prior to performing the two-step quantitative goodwill impairment test.

We will comply with the requirements of these amendments when the amendments are effective. None of these amendments are expected to have a material impact on our financial statements.

ITEM 3QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk associated with changes in foreign currency exchange rates and interest rates. We mitigate a portion of our foreign currency exchange rate risk by maintaining foreign currency cash balances and holding option and forward foreign currency contracts. They are not designated as hedges for accounting purposes. These contracts relate primarily to intercompany transactions and are not used for trading or speculative purposes. The fair value of the option and forward foreign currency exchange contracts is sensitive to changes in foreign currency exchange rates. The impact of an adverse change in foreign currency exchange rates would not be materially different than that disclosed in our Annual Report on Form 10-K for the year ended December 31, 2010.

Our revolving loans bear interest at rates that fluctuate with changes in the Prime Rate, Federal Funds Rate, LIBOR, TIBOR, and EURIBOR. As such, our interest expense on our revolving 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, 2010.

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.

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ITEM 4CONTROLS AND PROCEDURES

Our principal executive officer and our principal financial officer, after evaluating together with management the design and operation of our disclosure controls and procedures, have concluded that our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) were effective as of September 30, 2011, the end of the period covered by this report. In designing disclosure controls and procedures, 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, internal control over financial reporting.

PART IIOTHER INFORMATION

ITEM 6EXHIBITS

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
101.INS	XBRL Instance Document*
101.SCH	XBRL Taxonomy Extension Schema Document*
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document*
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document*
101.LAB	XBRL Taxonomy Extension Label Linkbase Document*
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document*

*Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

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SIGNATURES

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/ Michael T. Sweeney
	Michael T. Sweeney
	President and Chief Executive Officer
	/s/ Dennis M. Hanson
	Dennis M. Hanson
	Senior Executive Vice President and
	Chief Financial Officer
Date: November 9, 2011

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