STEINWAY MUSICAL INSTRUMENTS INC - FORM 10-Q

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EX-31.1 - EX-31.1 - STEINWAY MUSICAL INSTRUMENTS INC	a10-17339_1ex31d1.htm
EX-32.2 - EX-32.2 - STEINWAY MUSICAL INSTRUMENTS INC	a10-17339_1ex32d2.htm
EX-32.1 - EX-32.1 - STEINWAY MUSICAL INSTRUMENTS INC	a10-17339_1ex32d1.htm
EX-31.2 - EX-31.2 - STEINWAY MUSICAL INSTRUMENTS INC	a10-17339_1ex31d2.htm

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 SEPTEMBER 30, 2010

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 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 o 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, 2010:

	Class A	477,952
	Ordinary	11,576,660
	Total	12,054,612

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

FORM 10-Q

INDEX

PART I	FINANCIAL STATEMENTS

Item 1.	Condensed Consolidated Financial Statements:

	Condensed Consolidated Statements of Operations Three and nine months ended September 30, 2010 and 2009	3

	Condensed Consolidated Balance Sheets September 30, 2010 and December 31, 2009	4

	Condensed Consolidated Statements of Cash Flows Nine months ended September 30, 2010 and 2009	5

	Condensed Consolidated Statement of Stockholders’ Equity Nine months ended September 30, 2010	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	29

PART II.	OTHER INFORMATION

Item 6.	Exhibits	29

	Signatures	30

PART I FINANCIAL STATEMENTS

ITEM 1 CONDENSED 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,
	2010			2009			2010			2009
Net sales	$	83,261		$	82,634		$	230,052		$	224,738
Cost of sales	60,066			59,229			163,370			163,826

Gross profit	23,195			23,405			66,682			60,912

Operating expenses:
Sales and marketing	9,587			9,638			29,756			30,118
General and administrative	7,768			7,491			22,096			22,860
Other	46			145			172			347
Impairment charges	—			976			—			976
Total operating expenses	17,401			18,250			52,024			54,301

Income from operations	5,794			5,155			14,658			6,611

Other expense (income), net	110			(223		)	(699		)	(1,034		)
Net gain on extinguishment of debt	—			—			(104		)	(3,434		)
Interest income	(241		)	(320		)	(985		)	(1,302		)
Interest expense	2,705			2,954			8,303			8,974
Total non-operating expenses	2,574			2,411			6,515			3,204

Income before income taxes	3,220			2,744			8,143			3,407

Income tax provision	1,655			2,107			3,598			2,385

Net income	$	1,565		$	637		$	4,545		$	1,022

Earnings per share:
Basic	$	0.13		$	0.07		$	0.40		$	0.12
Diluted	$	0.13		$	0.07		$	0.39		$	0.12

Weighted average shares:
Basic	12,055,741			8,581,343			11,503,013			8,549,287
Diluted	12,098,871			8,583,320			11,559,335			8,551,885

See notes to condensed consolidated financial statements.

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

Unaudited

(In Thousands)

	September 30,			December 31,
	2010			2009
Assets
Current assets:
Cash	$	96,214		$	65,873
Accounts, notes, and other receivables, net of allowances of $13,554 and $13,643 in 2010 and 2009, respectively	52,383			45,073
Inventories	149,300			158,030
Prepaid expenses and other current assets	13,504			13,499
Deferred tax assets	11,582			11,431
Total current assets	$	322,983		$	293,906

Property, plant and equipment, net of accumulated depreciation of $110,161 and $105,744 in 2010 and 2009, respectively	85,850			89,538
Trademarks	15,064			15,284
Goodwill	23,365			24,063
Other intangibles, net	3,427			4,183
Other assets	14,102			12,663
Long-term deferred tax assets	11,485			10,153

Total assets	$	476,276		$	449,790

Liabilities and stockholders’ equity
Current liabilities:
Debt	$	1,198		$	537
Accounts payable	12,908			9,764
Other current liabilities	34,322			36,395
Total current liabilities	48,428			46,696

Long-term debt	152,012			157,703
Deferred tax liabilities	7,088			7,124
Pension and other postretirement benefit liabilities	36,022			35,766
Other non-current liabilities	5,558			6,005
Total liabilities	249,108			253,294

Commitments and contingent liabilities

Stockholders’ equity:
Common stock	14			12
Additional paid-in capital	154,053			125,192
Retained earnings	130,854			126,415
Accumulated other comprehensive loss	(10,685		)	(7,851		)
Treasury stock, at cost	(47,068		)	(47,272		)
Total stockholders’ equity	227,168			196,496

Total liabilities and stockholders’ equity	$	476,276		$	449,790

See notes to condensed consolidated financial statements.

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

(In Thousands)

	Nine Months Ended September 30,
	2010			2009
Cash flows from operating activities:
Net income	$	4,545		$	1,022
Adjustments to reconcile net income to cash flows from operating activities:
Depreciation and amortization	7,302			7,845
Net gain on extinguishment of debt	(104		)	(3,434		)
Intangible asset impairment	—			976
Stock-based compensation expense	1,109			890
Excess tax benefits from stock-based awards	64			—
Tax benefit from stock option exercises	4			—
Deferred tax (benefit) expense	(1,257		)	169
Provision for (recovery of) doubtful accounts	(63		)	1,302
Other	66			(181		)
Changes in operating assets and liabilities:
Accounts, notes and other receivables	(8,296		)	674
Inventories	6,353			(1,244		)
Prepaid expenses and other assets	(324		)	2,026
Accounts payable	2,990			(3,724		)
Other liabilities	(1,275		)	(7,790		)
Cash flows from operating activities:	11,114			(1,469		)

Cash flows from investing activities:
Capital expenditures	(1,841		)	(2,996		)
Other	108			24
Acquisition of businesses, net of cash acquired	(353		)	(820		)
Cash flows from investing activities	(2,086		)	(3,792		)

Cash flows from financing activities:
Borrowings under lines of credit	870			231,793
Repayments under lines of credit	(335		)	(214,552		)
Repayments of long-term debt, net of discount	(5,633		)	(7,280		)
Proceeds from issuance of common stock	28,197			605
Purchase of treasury stock	(349		)	—
Excess tax benefits from stock-based awards	(64		)	—
Cash flows from financing activities	22,686			10,566

Effect of foreign exchange rate changes on cash	(1,373		)	569

Change in cash	30,341			5,874
Cash, beginning of period	65,873			44,380
Cash, end of period	$	96,214		$	50,254

Supplemental Cash Flow Information:
Interest paid	$	12,268		$	13,482
Income taxes paid	$	6,395		$	4,139

See notes to condensed consolidated financial statements.

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

CONDENSED 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, 2010	$	12	$	125,192	$	126,415		$	(7,851	)	$	(47,272	)	$	196,496

Comprehensive income:
Net income					4,545									4,545
Foreign currency translation adjustments								(2,894		)				(2,894		)
Changes in pension and other postretirement benefits, net								60						60
Total comprehensive income														1,711
Exercise of 23,850 options for shares of common stock	—		2		(106		)				553			449
Tax benefit of options exercised			4											4
Stock-based compensation			1,109											1,109
Issuance of 1,756,821 shares of common stock	2		27,746											27,748
Purchase of 21,827 shares of common stock											(349		)	(349		)
Balance, September 30, 2010	$	14	$	154,053	$	130,854		$	(10,685	)	$	(47,068	)	$	227,168

See notes to condensed consolidated financial statements.

STEINWAY MUSICAL INSTRUMENTS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS

SEPTEMBER 30, 2010

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, 2010 and 2009 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, 2009, 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, 2009 filed with the Securities and Exchange Commission (“SEC”). The results of operations for the three and nine months ended September 30, 2010 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 condensed consolidated financial statements include the accounts of all direct and indirect subsidiaries, all of which are wholly owned, including the piano (“Steinway”), band (“Conn-Selmer”), and online music (“Arkiv”) divisions. 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.

We provide reserves for potential payments of tax to various tax authorities related to uncertain tax positions and other issues. Reserves related to uncertain tax positions are based on a determination of whether and how much of a tax benefit taken in our tax filings or positions is more likely than not to be realized, assuming that the matter in question will be raised by the tax authorities. Potential interest and penalties associated with such uncertain tax positions are recorded as a component of income tax expense. We believe appropriate provisions for outstanding issues have been made.

Income tax-related interest and penalties are reported as a component of income tax expense. We file income tax returns at the U.S. federal, state, and local levels, as well as in several foreign jurisdictions. With few exceptions, our returns are no longer subject to examinations for years before 2006.

There were no material changes to the liability for uncertain tax positions in the first nine months of 2010. Although we believe our tax estimates are appropriate, the final determination of tax audits and any related litigation could result in changes in our estimates.

Stock-based Compensation - We record compensation cost on a straight-line basis over the award’s requisite service period for all share-based awards granted. We estimate the fair value of our stock option awards (less estimated forfeitures) and employee stock purchase plan rights on the date of grant using the Black-Scholes option valuation model.

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 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 September 30,		Nine Months Ended September 30,
	2010	2009	2010	2009
Weighted-average shares:
For basic earnings per share	12,055,741	8,581,343	11,503,013	8,549,287
Dilutive effect of stock-based compensation plans	43,130	1,977	56,322	2,598
For diluted earnings per share	12,098,871	8,583,320	11,559,335	8,551,885

We did not include any of the 1,141,016 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, 2009 because generally their exercise prices were more than the average market price of our common shares, and therefore 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 they were antidilutive.

Accumulated Other Comprehensive Loss - 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,
	2010			2009
Accumulated other comprehensive loss:
Foreign currency translation adjustment	$	4,386		$	7,280
Pension and other postretirement benefits	(15,071		)	(15,131		)
Total accumulated other comprehensive loss	$	(10,685	)	$	(7,851	)

The components of comprehensive income are as follows:

	Three Months Ended September 30,					Nine Months Ended September 30,
	2010		2009			2010			2009
Comprehensive income:
Net income	$	1,565	$	637		$	4,545		$	1,022
Foreign currency translation adjustment	6,319		2,576			(2,894		)	3,690
Pension and other postretirement benefits	—		3,655			83			3,655
Tax impact of pension and postretirement benefits	—		(1,462		)	(23		)	(1,462		)
Total comprehensive income	$	7,884	$	5,406		$	1,711		$	6,905

Recent Accounting Pronouncements - In March 2010, the Financial Accounting Standards Board issued new guidance which clarifies the scope exception for embedded credit related derivatives. We were required to comply with this new standard as of July 1, 2010 and it did not have a material impact on our financial statements.

(3) Inventories

	September 30,		December 31,
	2010		2009
Raw materials	$	17,213	$	18,413
Work-in-process	35,960		42,121
Finished goods	96,127		97,496
Total inventory	$	149,300	$	158,030

(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 performed our annual goodwill and intangible asset impairment test as of July 31, 2010 given the timing of our fall budgeting and planning process, which provides multi-year cash flows used to conduct our annual impairment testing of intangible assets. Our analyses of band division trademarks and piano division goodwill and trademarks did not indicate any impairment; therefore, no charge was taken against those assets. 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, 2010	$	24,063		$	—	$	24,063
Foreign currency translation impact	(698		)	—		(698		)
Balance, September 30, 2010	$	23,365		$	—	$	23,365

Trademarks:
Balance, January 1, 2010	$	9,460		$	5,824	$	15,284
Foreign currency translation impact	(220		)	—		(220		)
Balance, September 30, 2010	$	9,240		$	5,824	$	15,064

We have previously recorded cumulative impairment losses of $8.6 million associated with band division goodwill and $1.0 million associated with online music business trademarks.

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, 2010			December 31, 2009
Gross deferred financing costs	$	5,286		$	5,333
Accumulated amortization	(3,411		)	(3,135		)
Deferred financing costs, net	$	1,875		$	2,198

Gross non-compete agreements	$	250		$	250
Accumulated amortization	(119		)	(81		)
Non-compete agreements, net	$	131		$	169

Gross customer relationships	$	525		$	506
Accumulated amortization	(254		)	(166		)
Customer relationships, net	$	271		$	340

Gross website and developed technology	$	2,176		$	2,176
Accumulated amortization	(1,026		)	(700		)
Website and developed technology, net	$	1,150		$	1,476

Total gross other intangibles	$	8,237		$	8,265
Accumulated amortization	(4,810		)	(4,082		)
Other intangibles, net	$	3,427		$	4,183

Our band division purchased a music education business in August 2010. We are in the process of conducting the valuation assessment of acquired assets but do not expect the result to be material to our intangible assets.

Deferred financing costs increased $0.2 million due to the renegotiation of our domestic credit agreement, which was in process as of September 30, 2010. Deferred financing costs were also affected by the purchase of $5.8 million of our Senior Notes in May and June 2010. These repurchases are described more fully in Note 6. The weighted-average amortization period for deferred financing costs is seven years, and the weighted-average amortization period for all other amortizable intangibles is approximately five years. Total amortization expense, which includes amortization of deferred financing costs, is as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
Amortization expense	$	300	$	328	$	911	$	995

The following table shows the total estimated amortization expense for the remainder of 2010 and beyond:

Remainder of 2010	$	307
2011	1,182
2012	1,066
2013	717
2014	121
Thereafter	34
Total	$	3,427

(5) Other Current Liabilities

Our other current liabilities consist of the following:

	September 30, 2010		December 31, 2009
Accrued payroll and related benefits	$	11,320	$	9,326
Current portion of pension and other postretirement benefit liabilities	1,235		1,456
Accrued warranty expense	1,449		1,553
Accrued interest	876		3,675
Deferred income	8,041		7,210
Environmental liabilities	2,233		2,377
Income and other taxes payable	2,038		3,383
Other accrued expenses	7,130		7,415
Total	$	34,322	$	36,395

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, 2010 and 2009, and the year ended December 31, 2009 is as follows:

	September 30, 2010			September 30, 2009			December 31, 2009
Beginning balance	$	1,553		$	1,451		$	1,451
Additions	587			570			945
Claims and reversals	(665		)	(610		)	(865		)
Foreign currency translation impact	(26		)	35			22
Ending balance	$	1,449		$	1,446		$	1,553

(6) Long-Term Debt

Our long-term debt consists of the following:

	September 30, 2010			December 31, 2009
Senior Notes	$	152,506		$	158,326
Unamortized bond discount	(494		)	(623		)
Overseas lines of credit	1,198			537
Total	153,210			158,240
Less: current portion	1,198			537
Long-term debt	$	152,012		$	157,703

Scheduled repayments of long-term debt as of September 30, 2010 are as follows:

Remainder of 2010	$	1,198
2011	—
2012	—
2013	—
2014	152,506
Total	$	153,704

During the second quarter of 2010, we repurchased $5.8 million of our Senior Notes at prices ranging from 95.0% to 98.0% plus interest. As a result, we recorded a net gain on extinguishment of debt of $0.1 million. A summary of the transactions is as follows:

Principal repurchased	$	5,820
Less:
Cash paid	(5,633		)
Write-off of deferred financing costs	(64		)
Write-off of bond discount	(19		)
Net gain on extinguishment of debt	$	104

(7) 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 models with observable inputs, including currency forward and spot prices. 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, 2010 and December 31, 2009 and the fair value hierarchy of the valuation techniques we utilized.

	September 30, 2010		December 31, 2009
Financial assets:
Trading securities(1) - Level 1	$	1,661	$	1,623
Foreign currency contracts(2) - Level 2	87		82
	$	1,748	$	1,705

Financial liabilities:
Foreign currency contracts(2) - Level 2	$	112	$	3

(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 contracts.

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, 2010				December 31, 2009
	Net Carrying Value		Estimated Fair Value		Net Carrying Value		Estimated Fair Value
Financial liabilities:
Debt	$	153,210	$	155,229	$	158,240	$	144,218

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

(8) 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. Each share of Class A common stock shall automatically convert to Ordinary common stock if, at any time, that share of Class A common stock is not owned by an original Class A holder. In March 2010 Samick Musical Instruments Co., Ltd. (“Samick”) exercised its right to purchase 1,700,000 shares of our ordinary common stock at a price of $16.00 per share, which resulted in a cash payment to us of $27.2 million. As of September 30, 2010 our Chairman and our Chief Executive Officer collectively owned 100% of the Class A common shares, representing approximately 80% 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 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 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 1996 Stock Plan has expired but still has vested and unvested 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 122,674 shares of treasury stock to cover options exercised, with 337,876 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. This reduction was $0.1 million for the nine months ended September 30, 2010. There were no stock option exercises during the three and nine months ended September 30, 2009.

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
Compensation cost included in:
Basic income per share	$	0.03	$	0.03	$	0.08	$	0.09
Diluted income per share	$	0.02	$	0.03	$	0.08	$	0.09
Stock-based compensation expense	368		328		1,109		890
Income tax benefit	66		51		201		136

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.

Key assumptions used to apply this pricing model to the Stock Plan are as follows:

	Three Months Ended September 30,		Nine Months Ended September 30,
	2010	2009	2010	2009
Risk-free interest rate	2.3%	3.1%	2.3%	3.1%
Weighted-average expected life of option feature (in years)	7.2	7.4	7.2	7.4
Expected volatility of underlying stock	33.8%	32.6%	33.8%	32.6%
Expected dividends	n/a	n/a	n/a	n/a
Weighted-average fair value	$7.93	$4.70	$7.93	$4.70

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, 2010	1,129,276		$	20.61
Granted	10,000		19.62
Exercised	(23,850	)	18.79
Forfeited	(18,400	)	22.71
Outstanding, September 30, 2010	1,097,026		$	20.60	6.4	$	2,157

Exercisable, September 30, 2010	588,846		$	22.27	4.8	$	435

The total intrinsic value of the options exercised during the three and nine month periods ended September 30, 2010 was nominal. There were no options exercised during the three and nine months ended September 30, 2009. As of September 30, 2010, there was $3.2 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 3.2 years. Cash received from option exercises under the Stock Plans for the nine month period ended September 30, 2010 was $0.4 million.

The following tables set forth information regarding the Purchase Plan:

	Three Months Ended September 30,		Nine Months Ended September 30,
	2010	2009	2010	2009
Risk-free interest rate	0.4%	1.9%	0.4%	2.0%
Weighted-average expected life of option feature (in years)	1.0	1.0	1.0	1.0
Expected volatility of underlying stock	28.1%	25.8%	28.0%	25.7%
Expected dividends	n/a	n/a	n/a	n/a
Weighted-average fair value of option feature	$3.77	$5.97	$3.09	$6.12

	Number of Options		Weighted- Average Exercise Price		Remaining Contract Life (in years)	Aggregate Intrinsic Value (in whole $)
Outstanding, January 1, 2010	24,382		$	9.65
Granted	39,509		10.66
Exercised	(56,821	)	9.65
Forfeited	(1,285	)	9.65
Outstanding, September 30, 2010	5,785		$	16.58	0.8	$	4,512

(9) Other Expense (Income), Net

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
West 57th Street building income	$	(915	)	$	(1,552	)	$	(4,308	)	$	(4,610	)
West 57th Street building expense	1,687			1,214			5,148			3,400
Foreign exchange (gain) loss, net	(403		)	541			(1,116		)	890
Miscellaneous, net	(259		)	(426		)	(423		)	(714		)
Other expense (income), net	$	110		$	(223	)	$	(699	)	$	(1,034	)

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; and 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.

(10) Commitments and Contingent Liabilities

We are involved in certain legal proceedings regarding environmental matters, which are described below. Further, in the ordinary course of business, we are party to various legal actions that we believe are routine in nature and incidental to the operation of our business. While the outcome of such actions cannot be predicted with certainty, we believe that, based on our experience in dealing with these matters, their ultimate resolution will not have a material adverse impact on our business, financial condition, 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.

We are continuing an existing environmental remediation plan at a facility we acquired in 2000 and subsequently sold. We expect to pay these costs, which approximate $0.6 million, over an 11-year period. We have accrued approximately $0.5 million for the 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
Remainder of 2010	$	31
2011	61
2012	61
2013	61
2014	61
Thereafter	362
Total	$	637

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 periodic sampling, we estimate the remaining costs of such remedial plans to be $1.7 million. Pursuant to the purchase and sale agreement, we sought indemnification from Grenadilla for anticipated costs above the original estimate. We filed a claim against the escrow and recorded a corresponding receivable for this amount in prepaid expenses and other current assets in our consolidated balance sheet. Based on the current estimated costs of remediation, this receivable totaled $2.1 million as of September 30, 2010. We have reached an agreement with Grenadilla whereby related environmental costs are paid directly out of the escrow. Currently, the escrow balance exceeds our receivable balance. Should the escrow be reduced to zero, we would seek further indemnification from Grenadilla for these additional costs. However, we cannot be assured that we will be able to recover such costs.

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 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.

In May 2008 we acquired 100% of the membership interest in ArkivMusic, LLC, an online retailer of classical music. Under the purchase agreement, we are obligated to pay an amount equal to 5% of the net operating profits of Arkiv, if any, in 2010, the sum of which is not to exceed $2.5 million. The final purchase price is dependent upon a calculation derived from the 2010 net operating profits which, when finalized, is expected to result in an additional payment between $1.0 and $1.9 million. Since the final net operating profits for 2010 cannot be calculated until year end, we have not recorded any liability or additional purchase price associated with this acquisition but expect to do so in the fourth quarter of 2010.

(11) Retirement Plans

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

	Domestic Plan						Foreign Plans
	Three Months Ended September 30,						Three Months Ended September 30,
	2010			2009			2010			2009
Service cost	$	87		$	83		$	133		$	144
Interest cost	864			852			424			438
Expected return on plan assets	(1,048		)	(921		)	(89		)	(67		)
Amortization of prior service cost (credit)	28			36			(13		)	—
Amortization of net loss	489			575			48			2
Curtailment loss	—			241			—			—
Net periodic pension cost	$	420		$	866		$	503		$	517

	Domestic Plan						Foreign Plans
	Nine Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Service cost	$	262		$	276		$	452		$	418
Interest cost	2,592			2,574			1,285			1,276
Expected return on plan assets	(3,145		)	(2,667		)	(256		)	(207		)
Amortization of prior service cost (credit)	84			139			(26		)	—
Amortization of net loss	1,467			1,830			128			6
Curtailment loss	—			241			—			—
Net periodic pension cost	$	1,260		$	2,393		$	1,583		$	1,493

On April 1, 2010, we amended our U.K. pension plan prospectively to both limit active participants’ annual increases in pensionable salary and reduce the rate at which participants accrue final benefits. We remeasured the plan’s benefit obligation, plan assets and net periodic pension cost as a result of the plan amendment. Assumptions utilized are as follows:

	Benefit Obligation		Net Periodic Pension Cost
	April 1,	January 1,	April 1,	January 1,	Weighted-
	2010	2010	2010	2010	Average
Discount rate	5.50%	5.80%	5.50%	5.80%	5.62%
Expected return on assets	n/a	n/a	5.30%	5.30%	5.30%
Rate of compensation increase	3.80%	4.80%	3.80%	4.80%	4.20%

The decrease in our long-term pension benefit obligation was more than offset by an increase in our actuarial loss due to the change in valuation assumptions when the plan was remeasured. The plan amendment resulted in a gross decrease in our pension benefit obligation of $0.6 million through recognition of a prior service credit, which will be amortized over a period of 12 years. On a net basis, our long term pension benefit obligation increased by less than $0.1 million and our accumulated other comprehensive loss decreased by $0.1 million, net of tax.

We provide postretirement health care and life insurance benefits to a limited number of certain eligible hourly retirees and their dependents. As a result of terminating one of our collective bargaining agreements in 2009, we have a limited number of participants receiving health care benefits under this plan. Once these participants reach age sixty-five and are eligible for Medicare, no postretirement health care benefits will be provided. We will continue to provide life insurance benefits for eligible retirees. During 2010, we made a settlement payment of $0.1 million associated with this plan. This payment had no material impact on the plan. The components of net periodic postretirement benefit cost for these benefits are as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Service cost	$	3		$	1		$	8		$	4
Interest cost	10			13			31			49
Amortization of prior service credit	(29		)	(23		)	(86		)	(49		)
Recognized loss	—			—			6			—
Net periodic postretirement benefit cost (benefit)	$	(16	)	$	(9	)	$	(41	)	$	4

Based on federal laws and regulations, we are not required to make a contribution to our domestic pension plan in 2010. We made a payment of less than $0.1 million to this plan during the period and are currently evaluating what additional amount, if any, we will contribute to this plan in 2010. Our anticipated contributions to the pension plan of our U.K. subsidiary approximate $0.8 million for the current year. As of September 30, 2010, 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 2010 benefit payments under these plans are $1.2 million, of which $0.9 million was paid through September 2010.

(12) 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, 2010 and 2009:

	Piano Segment								Band Segment						Other &			Consol
Three Months Ended 2010	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

	Piano Segment									Band Segment						Other &			Consol
Three Months Ended 2009	U.S.			Germany		Other		Total		U.S.		Europe		Total		Elim			Total
Net sales to external customers	$	21,123		$	12,535	$	11,275	$	44,933	$	36,173	$	1,528	$	37,701	$	—		$	82,634
Income (loss) from operations	(1,314		)	1,639		1,675		2,000		3,858		210		4,068		(913		)	5,155

	Piano Segment								Band Segment						Other &			Consol
Nine Months Ended 2010	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

	Piano Segment									Band Segment						Other &			Consol
Nine Months Ended 2009	U.S.			Germany		Other		Total		U.S.		Europe		Total		Elim			Total
Net sales to external customers	$	57,739		$	36,363	$	30,510	$	124,612	$	96,483	$	3,643	$	100,126	$	—		$	224,738
Income (loss) from operations	(3,956		)	5,380		2,896		4,320		4,797		406		5,203		(2,912		)	6,611

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 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 2009 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, 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 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.

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.

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 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. Our assessment is based on several analyses, including a comparison of net book value to estimated fair values, market capitalization, and multi-year cash flows.

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 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 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 considered not more likely than not to be realized, 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; or the rendering of court decisions affecting our estimates of tax liabilities; as well as other factors.

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 employee stock purchase plan (“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; reductions in school budgets; increased competition; work stoppages and slowdowns; ability to successfully consolidate band manufacturing; impact of dealer consolidations on orders; 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 lease office space; 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, 2009. 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 September 30, 2010 Compared to Three Months Ended September 30, 2009

	Three Months Ended September 30,							Change
	2010			2009				$		%
Net sales
Band	$	38,261		$	37,701			560		1.5
Piano	45,000			44,933				67		0.1
Total sales	83,261			82,634				627		0.8

Cost of sales
Band	29,259			28,284				975		3.4
Piano	30,807			30,945				(138	)	(0.4	)
Total cost of sales	60,066			59,229				837		1.4

Gross profit
Band	9,002		23.5%	9,417			25.0%	(415	)	(4.4	)
Piano	14,193		31.5%	13,988			31.1%	205		1.5
Total gross profit	23,195			23,405				(210	)	(0.9	)
	27.9%			28.3%

Operating expenses	17,401			17,274				127		0.7
Impairment charges	—			976				(976	)	(100.0	)
Income from operations	5,794			5,155				639		12.4

Other expense (income), net	110			(223		)		333		(149.3	)
Net interest expense	2,464			2,634				(170	)	(6.5	)
Non-operating expenses	2,574			2,411				163		6.8

Income before income taxes	3,220			2,744				476		17.3

Income tax provision	1,655		51.4%	2,107			76.8%	(452	)	(21.5	)

Net income	$	1,565		$	637			928		145.7

Overview — Piano division revenue and profits remained stable over the year-ago period. Band division sales improved due to an 11% increase in overall unit shipments. However, band margins declined due to production inefficiencies.

Net Sales — Domestic piano division revenues increased $0.9 million as a result of an 11% increase in Steinway grand unit shipments, which more than offset the impact of a 3% decrease in mid-priced piano line shipments. Overseas Steinway grand unit shipments decreased 11% compared to the year-ago period. However, mid-priced piano line shipments improved 33%, reducing the overseas sales deterioration to $0.9 million.

Band division revenues were $0.6 million higher as a result of improved orders and shipments of student instruments which were needed by dealers to meet greater back-to-school selling season demand. Promotional incentives on select professional brass inventory models also contributed to the revenue improvement.

Gross Profit — Gross profit decreased slightly ($0.2 million) due to reduced production schedules at the band division, which were altered in an effort to control inventory levels. The resulting unabsorbed overhead, coupled with certain cash discount and sales program costs, caused the band margin decrease from 25.0% to 23.5%.

Piano margins improved from 31.1% to 31.5%. Although overseas piano margins dropped from 35.5% to 33.1%, domestic piano margins increased from 26.2% to 29.9%. While the production at our overseas piano factory increased, margins deteriorated due to higher cost on certain mid-priced pianos. Domestic piano margins were favorably impacted by steadier production schedules, which improved factory efficiency. A domestic shift in mix towards retail units also helped improve the margins.

Operating Expenses— Operating expenses were consistent with the year-ago period. Sales and marketing expenses decreased $0.1 million as the decrease in bad debt expense of $0.7 million was mostly offset by higher commissions, marketing, and promotional expenses. General and administrative costs were $0.3 million higher because of consulting and professional service fees.

Impairment Charges — There were no impairment charges in the current period, whereas trademarks associated with our online music division were impaired $1.0 million in the year-ago period.

Non-operating Expenses — Non-operating expenses increased $0.2 million despite a $0.9 million shift from foreign exchange losses to foreign exchange gains during the period. This $1.1 million deterioration is primarily attributable to a shift from net income to net expense from our West 57th Street building. We expect to incur a temporary loss on this facility until we have leased the remaining available space to new tenants. Net interest expense was $0.2 million lower as the decrease in interest income associated with customer financed receivables at the band division was more than offset by lower interest expense due to lower outstanding borrowings.

Income Taxes — We recorded an income tax expense of $1.7 million, reflecting our anticipated annual effective income tax rate of 43.7% 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 51.4% for the period. The rate of 76.8% in the year-ago period reflected an anticipated annual effective income tax rate of 48.0% as well as uncertain tax positions and discrete items.

Nine Months Ended September 30, 2010 Compared to Nine Months Ended September 30, 2009

	Nine Months Ended September 30,								Change
	2010				2009				$		%
Net sales
Band	$	100,754			$	100,126			628		0.6
Piano	129,298				124,612				4,686		3.8
Total sales	230,052				224,738				5,314		2.4

Cost of sales
Band	75,993				77,635				(1,642	)	(2.1	)
Piano	87,377				86,191				1,186		1.4
Total cost of sales	163,370				163,826				(456	)	(0.3	)

Gross profit
Band	24,761			24.6%	22,491			22.5%	2,270		10.1
Piano	41,921			32.4%	38,421			30.8%	3,500		9.1
Total gross profit	66,682				60,912				5,770		9.5
	29.0%				27.1%

Operating expenses	52,024				53,325				(1,301	)	(2.4	)
Impairment charges	—				976				(976	)	(100.0	)
Income from operations	14,658				6,611				8,047		121.7

Other income, net	(699		)		(1,034		)		335		(32.4	)
Net gain on extinguishment of debt	(104		)		(3,434		)		3,330		(97.0	)
Net interest expense	7,318				7,672				(354	)	(4.6	)
Non-operating expenses	6,515				3,204				3,311		103.3

Income before income taxes	8,143				3,407				4,736		139.0

Income tax provision	3,598			44.2%	2,385			70.0%	1,213		50.9

Net income	$	4,545			$	1,022			3,523		344.7

Overview — Piano division revenue improved primarily due to increased domestic demand for our products. Piano margins were better due to more efficient production at both manufacturing facilities. Band division sales improved, as the reluctance of dealers to place orders early in the year was offset by improved orders and shipments in the second and third quarter. Band margins improved due to more normal production schedules and better production efficiencies than in the year-ago period.

Net Sales — Domestic piano division revenues were $4.5 million (8%) higher due to a combination of a 6% increase in Steinway grand units, stronger retail sales, and a shift in mix from lower priced upright pianos to higher priced grand pianos. Price increases, which were implemented at the beginning of the year, were also a factor. Despite a 6% decrease in Steinway grand unit shipments, overseas revenues increased slightly ($0.2) million supported by an improvement in sales by our divisions in Asia. Overseas mid-priced piano line shipments rose 35% due in part to improved availability of certain models.

Band division revenues increased $0.6 million as a result of improved sales of percussion instrument units, which increased 26%. Woodwind and brass instrument unit shipments were flat, as lower orders and shipment in the first quarter were offset by improvements in the second and third quarters.

Gross Profit — Gross profit improved significantly due to higher margins at both the piano and band divisions. Domestically, piano margins increased from 25.6% to 29.8% due to changes in production schedules, which bolstered factory efficiency, as well as better retail sales, which generate higher margins. However, overseas margins went from 35.3% to 34.8%. Improvements in factory efficiency in the latter part of the period only partially offset a shift in shipments to lower margin territories in the early part of 2010, as well as the adverse impact of foreign exchange rates and higher mid-priced piano costs.

The band division’s gross margin improved from 22.5% to 24.6% during the period. Higher production levels in the first half of 2010 resulted in improved overhead absorption and lower factory variances.

Operating Expenses — Operating expenses decreased $1.3 million. Sales and marketing expenses decreased $0.4 million primarily due to lower bad debt expense of $1.4 million, which was partially offset by costs associated with commissions, marketing, and promotional costs as well as incremental retail sales personnel. General and administrative costs were $0.8 million lower as a result of cost saving measures implemented during 2009 and lower compensation related costs.

Impairment Charges — There were no impairment charges in the current period, whereas trademarks associated with our online music division were impaired $1.0 million in the year-ago period.

Non-operating Expenses — Non-operating expenses increased $3.3 million due to the reduction in net gains on extinguishment of debt of the same amount. The benefit of a shift from foreign exchange losses to foreign exchange gains of $2.0 million was offset by a shift from net income to net expense of approximately the same amount from our West 57th Street building.

Income Taxes — We recorded an income tax expense of $3.6 million, reflecting our anticipated annual effective income tax rate of 43.7% associated with current year income, as well as 0.5% due to discrete items and uncertain tax positions. The combination of these items resulted in an effective tax rate of 44.2% for the period. The rate of 70.0% in the year-ago period reflected an anticipated effective income tax rate of 48.0% related to income for that period, and 22.0% relating to uncertain tax positions and discrete items.

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, 2010 and 2009 are summarized as follows:

	2010			2009			Change
Net income:	$	4,545		$	1,022		$	3,523
Changes in operating assets and liabilities	(552		)	(10,058		)	9,506
Other adjustments to reconcile net income to cash from operating activities	7,121			7,567			(446		)
Cash flows from operating activities	11,114			(1,469		)	12,583

Cash flows from investing activities	(2,086		)	(3,792		)	1,706

Cash flows from financing activities	22,686			10,566			12,120

Cash flows from operating activities improved $12.6 million over the year-ago period. Although the sales increase caused a shift from source to use of cash for accounts receivable of $9.0 million, we also used $7.6 million less for inventory since the sales improvement helped reduce our finished goods levels. We generated $13.4 million more from accounts

payable and accrued expenses in the current period. In 2009, we had implemented cost cutting measures to conserve cash and reduce expenditures. In 2010, spending has returned to normal levels.

Cash flows from investing activities decreased $1.7 million primarily due to the reduction in capital expenditures of $1.2 million. We expect capital expenditures for the full year to be in the range of $3.0 to $4.0 million.

Cash flows from financing activities increased $12.1 million as we generated $28.2 million through stock sales in 2010. Also, we did not use our domestic line of credit in 2010, so cash provided by borrowings was $16.7 million lower than the year-ago period.

Borrowing Activities and Availability — As of September 30, 2010, there was nothing outstanding on our former domestic credit facility. Shortly after September 30, 2010, we entered into a new 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.

We also have certain non-domestic credit facilities originating from two German banks that provide for borrowings by foreign subsidiaries of up to €16.1 million ($22.0 million at the September 30, 2010 exchange rate), net of borrowing restrictions of €1.9 million ($2.6 million at the September 30, 2010 exchange rate) which are payable 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 £0.8 million ($1.4 million at the September 30, 2010 exchange rate) for use by our U.K. branch and ¥300 million ($3.6 million at the September 30, 2010 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 ($3.4 million at the September 30, 2010 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 1.4% for Japanese yen loans. We had nothing outstanding as of September 30, 2010 on these credit facilities.

Our Japanese subsidiary also maintains a separate revolving loan agreement that provides additional borrowing capacity of up to ¥500 million ($6.0 million at the September 30, 2010 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, 2010) and expires on January 31, 2011. As of September 30, 2010, we had $1.2 million outstanding on this revolving loan agreement.

At September 30, 2010, our total outstanding indebtedness amounted to $153.7 million, consisting of $152.5 million of our 7.00% Senior Notes due March 1, 2014 and $1.2 million of notes payable to foreign banks. We repurchased $5.8 million of our Senior Notes during the nine months ended September 30, 2010. We may consider additional repurchases or restructuring of our Senior Note debt in the future, contingent upon cash availability and the trading and call prices of our Senior Notes.

All of our debt agreements contain covenants that place certain restrictions on us, including our ability to incur additional indebtedness, to repurchase 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, 2010 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 repurchased 21,827 shares for $0.3 million during the three months ended September 30, 2010. We did not make any repurchases in 2009.

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 seasonal borrowings on our domestic line of credit. While we anticipate the remainder of 2010 to be challenging, we do not expect any adverse impact in our liquidity as we had

over $95.0 million in cash as of September 30, 2010. We intend to manage accounts receivable and credit risk, and control inventory levels by monitoring purchases and production schedules. We have also reduced headcount, minimized non-critical expenditures, and forgone wage increases and discretionary benefit program contributions. Our intention is to manage cash outflow and maintain sufficient operating cash on hand to meet short-term requirements.

We do not have any current plans or intentions that will have a material adverse impact on our liquidity in 2010, 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.

Contractual Obligations - The following table provides a summary of our contractual obligations at September 30, 2010.

	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)	$	190,191	$	11,886	$	21,351	$	156,954	$	—
Capital leases	11		10		1		—		—
Operating leases(2)	257,448		5,830		9,842		8,239		233,537
Purchase obligations(3)	31,045		30,317		728		—		—
Other long-term liabilities(4)	40,057		3,687		4,117		3,984		28,269
Total	$	518,752	$	51,730	$	36,039	$	169,177	$	261,806

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, 2010 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 $244.1 million of our operating lease obligations are attributable to the land lease associated with the purchase of Steinway Hall, which has eighty seven 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 11 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

In March 2010, the Financial Accounting Standards Board issued new guidance which clarifies the scope exception for embedded credit related derivatives. We were required to comply with this new standard as of July 1, 2010 and it did not have a material impact on our financial statements.

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, 2009.

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, 2009.

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

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, 2010, 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 II OTHER INFORMATION

ITEM 6 EXHIBITS

31.1 Certification of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2 Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1 Certification of the Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2 Certification of the Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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/ 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: November 5, 2010

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