UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-K

 

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

 

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004

 

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 Incorporation or Organization)		(I.R.S. Employer Identification No.)
800 South Street, Suite 305, Waltham, Massachusetts		02453
(Address of Principal Executive Offices)		(Zip Code)

 

Registrant’s telephone number, including area code

(781) 894-9770

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class		Name of each exchange on which registered
Ordinary Common Shares, $.001 par value		New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act:  None

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements during the past 90 days.    Yes ý   No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K.  ý

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes ý   No o

 

The aggregate market value of the Common Stock held by non-affiliates of the registrant was $207,362,428 as of March 15, 2005 and $244,732,784 as of June 30, 2004.

 

Number of shares of Common Stock outstanding as of March 15, 2005:		Class A		477,952
		Ordinary		7,555,695
		Total		8,033,647

 

DOCUMENTS INCORPORATED BY REFERENCE

 

 

Note Regarding Forward-Looking Statements

 

Certain statements contained throughout this Annual Report on Form 10-K are “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended.  These forward-looking statements represent our present expectations or beliefs concerning future events.  We caution you that such statements are necessarily based on certain assumptions that 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; increased competition; work stoppages and slowdowns; exchange rate fluctuations; variations in the mix of products sold; market acceptance of new band instrument product and distribution strategies; ability of suppliers to meet demand; and fluctuations in effective tax rates resulting from shifts in sources of income.  We have included further information on these factors in our Final Prospectus filed in August 1996 and in Registration Statement No. 333-62790 filed in June 2001, particularly in the sections entitled “Risk Factors.”  We encourage you to read those descriptions carefully.  We caution investors not to place undue reliance on the forward-looking statements contained in this report.  These statements, like all statements contained in this report, speak only as of the date of this report (unless another date is indicated) and we undertake no obligation to update or revise the statements except as required by law.

 

Note Regarding Incorporation By Reference

 

The Securities and Exchange Commission (“SEC”) allows us to disclose certain information to you by referring you to other documents we have filed with the SEC.  The information that we refer you to is “incorporated by reference” into this Annual Report on Form 10-K.  Please read that information.

 

PART I

 

Item 1.  Business

 

Company History

 

Steinway Musical Instruments, Inc., through its wholly-owned subsidiaries, is a global leader in the design, manufacture, marketing and distribution of high quality musical instruments.  We are the largest domestic manufacturer of musical instruments.  Whenever we refer to the “Company” or to “us,” or use the terms “we” or “our” in this annual report, we are referring to Steinway Musical Instruments, Inc. and its subsidiaries.

 

Steinway Musical Instruments, Inc., formerly Selmer Industries, Inc., was incorporated in 1993, at which time it purchased The Selmer Company, Inc. (“Selmer”), the largest U.S. manufacturer of band & orchestral instruments.  In May of 1995, we purchased Steinway Musical Properties, Inc. (“Steinway”), a manufacturer and distributor of acoustic pianos.  In August of 1996, Steinway Musical Instruments, Inc. became publicly held.

 

In September of 2000, we acquired United Musical Instruments Holdings, Inc. (“UMI”), the second largest manufacturer of band & orchestral instruments in the U.S. and on January 1, 2003 Selmer and UMI merged into Conn-Selmer, Inc. (“Conn-Selmer”).  In August of 2004, we acquired the assets of G. Leblanc Corporation, a manufacturer of high quality band instruments with production facilities in Wisconsin and France.

 

We are a Delaware corporation with our principal executive offices located at 800 South Street, Suite 305, Waltham, Massachusetts 02453, and our telephone number is (781) 894-9770.  Through our

 

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corporate website, www.steinwaymusical.com, we provide access free of charge to all of our filings with the SEC, including our Annual Reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K.  These reports are available immediately following filing with the SEC.  Information contained on or connected to our website is not incorporated by reference into this Annual Report on Form 10-K and should not be considered part of this report or any other filing that we make with the SEC.  Additionally, the SEC maintains an Internet site at www.sec.gov that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC.

 

Financial Information by Segment and Geographic Location

 

Information on business segments and geographic areas in which we operated for the years ended December 31, 2004, 2003 and 2002 is contained in Note 18 to the Consolidated Financial Statements included in this report.

 

Musical Instrument Industry

 

We operate two reportable segments within the musical instrument industry - pianos and band & orchestral instruments.

 

Pianos - The overall piano market is comprised of two main categories: grand pianos and upright pianos. Steinway & Sons pianos compete in the high-end segment of the market, whereas our Boston and Essex lines compete in the mid-priced segment of the piano market.

 

During the latter half of the 1990s through 2000, the industry experienced growth in all categories of pianos as a result of the strong U.S. economy, favorable demographics, and a general resurgence in music interests.

 

Industry piano sales decreased in 2001 – 2003 as a result of the worldwide economic downturn.  Since Steinway realizes a majority of its profit from high-end grand piano sales, our results are generally more affected by economic cycles than by industry trends. However, favorable demographics, institutional sales, and the public's continued interest in music helped mitigate the impact of the economy on our piano business. As the U.S. economy rebounded in 2004, piano industry sales grew in all categories.

 

Market size and volume trends are difficult to quantify for international piano markets, as there is no single source for worldwide sales data.  Outside North America, our strongest market shares are in Germany, the United Kingdom, France and Switzerland.  We believe that we hold an average grand piano market share of approximately 13% in these countries.

 

Outside of the United States, China and Japan are the two largest grand piano markets in the world.  With our three piano lines, our market share of grand piano units is currently 4% in Japan and less than 1% in China.  While adverse economic conditions in Japan have slowed our expansion in that market, the Chinese market is growing at a rapid pace and we continue to target this region in our distribution strategies.  In 2004, we opened a distribution and selection facility in Shanghai.  We believe that our long-term prospects in Asia are favorable.

 

Band & Orchestral Instruments - We believe that the band & orchestral instrument market in the U.S. has historically been impacted more by demographic trends and school budgeting than by macroeconomic cycles.  While the domestic market continued to grow through the late 1990s, domestic supply outpaced demand. In recent years there has been an increase in units imported into the domestic

 

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market from offshore low-cost producers, as well as a decline in exports by domestic manufacturers. These factors have created a highly price sensitive domestic market, where manufacturers implemented aggressive pricing programs in an attempt to maintain market share positions.

 

However, we believe the outlook for future growth remains positive.  Relatively stable demographic trends and studies emphasizing the importance of music education in a child’s development are expected to facilitate industry growth.  We believe that parents are encouraging their children to play musical instruments in response to the growing number of reports that show participation in music programs increases a student’s ability to excel in other aspects of his or her education.  In addition, many school band directors are promoting band programs as social organizations rather than the first step of intensive music study.  We believe that focusing on the educational component of the musical instrument industry will help us expand our market share in the relatively flat market expected in the near-term.

 

Business and Products

 

Piano Segment

 

Our piano division concentrates on the high-end grand piano market, handcrafting Steinway pianos in New York and Germany.  The Steinway & Sons grand piano is considered to be the highest quality piano in the world and has one of the most widely recognized and prestigious brand names.  We also offer upright pianos as well as two mid-priced lines of pianos under the Boston and Essex brand names.

 

Steinway & Sons - We offer two premium-priced product lines under the Steinway & Sons brand: grand pianos and upright pianos.  Steinway pianos differ from all others in design specifications, materials used and the assembly process.  Grand pianos historically have accounted for the bulk of our production.  We offer eight sizes of the grand piano ranging from the 5’1” baby grand to the largest 9’ concert grand.  The smaller grands are sold to both individual and institutional customers, while the concert grands are sold primarily to institutions.  Steinway grand pianos are premium pianos in terms of quality and price, with retail prices for ebony pianos generally ranging from $38,900 to $99,900 in the United States.  Limited edition pianos and pianos with exotic veneers sell for retail prices of up to $164,000.  In 2004, we sold 3,194 grand pianos, of which 2,237 units were shipped from our New York facility to dealers in the Americas.  The remaining 957 units were shipped from our German facility primarily to Europe and Asia.

 

Our upright pianos offer dealers a complete line of quality pianos to satisfy the needs of institutions and other customers who are constrained by space limitations.  We also provide services, such as restoration, repair, replacement part sales, tuning and regulation of pianos.  Restoration services range from minor damage repairs to complete restorations of vintage pianos.

 

Boston Piano Company - The introduction of the Boston line in the early 1990s permitted us to compete in the mid-price category without sacrificing quality.  Today we offer two complete lines of grand and upright pianos for the mid-priced piano market under the Boston and Essex brand names.  With certain limited exceptions, we allow only Steinway dealers to carry the Boston and Essex piano lines, thereby ensuring that these pianos will be marketed as complementary product lines to the Steinway line.  These pianos, which were designed by us and are produced by Asian manufacturers, provide our dealers with an opportunity to realize better margins in this price range while capturing sales that would have otherwise gone to a competitor.  Also, these pianos provide future Steinway grand piano customers with the opportunity to join the Steinway family of owners sooner, since our research indicates that the vast majority

 

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of Steinway customers have previously owned another piano.  The Boston and Essex product lines also increase our business with our dealers, making us their primary supplier in many instances, since our three product lines together offer the full spectrum of piano prices and styles.  Together the Boston and Essex product lines offer twelve upright and grand piano sizes, with retail prices ranging from $5,200 to $39,990 in the United States.

 

Band Segment

 

We are the largest domestic producer of band & orchestral instruments and offer a complete line of brass, woodwind, percussion and string instruments with well-known brand names.  In 2004, sales of sourced products accounted for 35% of our band division revenue.  Approximately 20% of these sales were attributable to our new imported entry-level student woodwind and brass instruments.

 

Woodwind and Brass Instruments - We manufacture piccolos, flutes, clarinets, oboes, bassoons, saxophones, trumpets, French horns, tubas, and trombones in our manufacturing facilities in Indiana, Ohio, Wisconsin, and France.  We sell student level instruments in three distinct product groupings - “good” entry-level imported instruments, “better” mid-priced instruments, which are either imported or manufactured by us, and “best” instruments, which are manufactured by us.  We also manufacture intermediate and professional level woodwind and brass instruments.  Sales of woodwind and brass instruments accounted for 68% of our band division revenue in 2004.

 

We sell our woodwind and brass products under the Bach, Selmer, C.G. Conn, Leblanc, King, Armstrong, Holton, Martin, Vito, Emerson, Noblet, Artley and Benge brand names.  Suggested retail prices generally range from $300 to $2,500 for student instruments and from $1,000 to $10,000 for intermediate and professional instruments.  We often customize the products that we sell to professional musicians so that the product meets requested design specifications or has certain sound characteristics.  We believe that specialization of products helps maintain a competitive edge in quality and product design.  Our specialized woodwind and brass instruments sell for up to $25,000.

 

We are the exclusive U.S. distributor for Yanagisawa saxophones and Selmer Paris musical instruments. The Selmer Paris saxophone is the largest selling professional saxophone in the world.  Selmer Paris, in turn, has exclusive distribution rights to some of our woodwind and brass products in France.

 

Percussion Instruments - We manufacture and distribute acoustical and tuned percussion instruments, including outfit drums, marching drums, concert drums, marimbas, xylophones, vibraphones, orchestra bells, and chimes.  We manufacture percussion products in North Carolina and Illinois under the Ludwig and Musser brand names.  Ludwig is considered a leading brand name in acoustical drums and timpani and Musser has a strong market position in tuned percussion products.  Suggested retail prices range from $500 to $5,000 for acoustical drum outfits and from $2,000 to $15,000 for tuned percussion instruments, with specialized tuned instruments purchased by symphonies and orchestras selling for up to $20,000.  Sales of percussion instruments accounted for 15% of our band division revenue in 2004.

 

String Instruments - We assemble and distribute violins, violas, cellos, and basses.  Products are sold under the Glaesel, Scherl & Roth, and William Lewis & Son brand names.  Suggested retail prices generally range from $200 to $4,000 for student instruments and from $1,700 to $7,000 for intermediate and advanced instruments, with specialized instruments selling for up to $13,000. Components are primarily imported from Europe and Asia and assembled at our factory in Ohio.  Sales of string instruments accounted for 4% of our band division revenue in 2004.

 

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Accessories - We manufacture mouthpieces and distribute accessories such as music stands, batons, mallets, straps, mutes, reeds, pads, chin rests, strings, bows, cases and instrument care products.  Sales of accessories accounted for 13% of our band division revenue in 2004.

 

Customers

 

Piano Segment

 

We distribute our pianos worldwide through approximately 180 independent piano dealers who operate nearly 300 showrooms.  We also sell our pianos through ten company-operated retail showrooms:  five in the U.S. and five in Europe.  Most Steinway grand piano sales are to individuals – both professional artists and amateur pianists.  Our typical customer is between 40 and 50 years old and has an intermediate to advanced level of musical skill.  He or she holds a graduate degree and reports a household income ranging from $150,000 to over $300,000 per year.

 

We also sell pianos to institutions such as concert halls, conservatories, colleges, universities and music schools.  Nearly 20% of our 2004 piano sales were to institutional customers.  To date, we have designated fifty schools and conservatories worldwide as “All-Steinway Schools.”  These institutions provide their students and faculties with the best instruments possible for the study of music – from the practice room to the recital hall - by owning only pianos designed by Steinway & Sons.

 

In 2004, approximately 57% of piano sales were in the United States, 28% in Europe and the remaining 15% primarily in Asia.  Our largest piano dealer accounted for approximately 4% of piano sales in 2004, while the top 15 accounts represented 30% of piano sales.

 

Band Segment

 

Band & orchestral instruments are sold to student, amateur and professional musicians, and institutions.  The majority of our instruments are purchased or rented from dealers by students enrolled in music education programs in the U.S.  Traditionally, students join school bands or orchestras at age 10 or 11 and learn on beginner level instruments, progressing to intermediate or professional level instruments in high school or college.  We estimate that approximately 85% of our domestic band sales are generated through educational programs.  The remaining domestic band sales are to professional or amateur musicians or performing groups, including orchestras and symphonies. Student level instruments accounted for approximately 70% of band & orchestral unit sales and approximately 40% of instrument revenues in 2004, with advanced and professional instruments representing the balance.  In 2004, 81% of band sales were in the United States, 9% in Europe and the remaining 10% primarily in Canada and Asia.  Our largest band dealer accounted for approximately 8% of band sales in 2004, while the top 15 accounts represented approximately 41% of band sales.

 

Sales and Marketing

 

Piano Segment

 

We distribute pianos primarily on a wholesale basis through approximately 180 select dealers around the world.  We have subsidiaries and dealers in both Japan and China that provide direct access to the expansive Asian piano market. Sales to dealers accounted for approximately 73% of piano segment revenue in 2004. The remaining 27% was generated from sales made directly by us at one of our ten company-operated retail showrooms.

 

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We employ district sales managers whose responsibilities include developing close working relationships with piano dealers. These highly-experienced professionals provide dealers with sales training and technical support and develop sales and marketing programs for the consumer and institutional markets.  These sales managers are also responsible for promoting the Concert and Artist and the Steinway Artist programs described below.

 

Concert and Artist Piano Bank - To ensure that all pianists, especially Steinway Artists, have a broad selection of instruments to meet their individual touch and tonal preferences, we maintain the Concert and Artist Piano Bank.  The Piano Bank includes approximately 450 instruments worldwide.  Of these instruments, approximately 350 are located in the United States.  In New York City alone, the Steinway concert department has approximately 160 concert grands available for various occasions.  The remaining domestic-based pianos are leased to dealers around the country who actively support the Steinway Artists program.  The Piano Bank promotes our instruments in the music industry and provides management with continuous feedback on the quality and performance of recently produced instruments from our most critical customer, the professional pianist.  The Piano Bank instruments are generally sold after four years and replaced with new pianos.

 

Steinway Artist Roster - Steinway Artists are world-class pianists who voluntarily endorse Steinway & Sons by selecting the Steinway piano.  Our Steinway Artist program is unique in that we do not pay artists to endorse our instruments.  To become a Steinway Artist, a pianist must not only meet certain performance and professional criteria, he or she must also own a Steinway piano.  We use these renowned artists in our marketing programs to help reinforce recognition of the Steinway brand name and its association with quality.  The Steinway Artist Roster currently includes approximately 1,300 of the world’s finest pianists who perform on Steinway pianos.  In return for their endorsements, Steinway Artists are provided with access to the Piano Bank described above.

 

Band Segment

 

Our band & orchestral, string and percussion instruments and accessories are distributed worldwide through approximately 1,800 independent musical instrument dealers and distributors.

 

In North America, we market our products through district sales managers, independent sales representatives, and telemarketing representatives who are responsible for sales within assigned geographic territories. Each district sales manager is also responsible for developing relationships with band & orchestral directors.  These directors represent all levels of music educators, from those who teach elementary school children through those involved at the college and professional levels. These individuals are the primary influencers in the choice of an instrument brand.  Band directors will generally refer students to designated dealers for the purchase of instruments.  As part of our music director outreach and support strategy, we have developed Conn-Selmer University to provide new teachers with the tools and instruction to excel in the music education environment.  We believe that our well-established, long-standing relationships with these influential music educators are an important component of our distribution strategy.

 

We also sell our instruments through dealers and distributors located in Europe and Asia.  We use international representatives to help market our products overseas. Dealers and distributors in the United States and abroad are supported through incentive programs, advertising and promotional activities.

 

We reach our customers through trade shows, educator conferences, print media, direct mail, telemarketing, the Internet and personal sales calls. We also actively advertise in consumer, educator and

 

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trade publications and provide educational materials, catalogs and product specifications to students, educators, dealers and distributors.  Our educational director travels extensively, lecturing and motivating students, educators and parents on the value of music in a child’s development.

 

Competition

 

Piano Segment

 

Steinway & Sons - The level of competition our pianos face depends on the market definition.  Steinway & Sons pianos hold a unique position at the top end of the grand piano market, both in terms of quality and price.  While there are many makers of pianos, only a few compete directly with our Steinway brand.  Other manufacturers of primarily higher priced pianos include Bösendorfer and Fazioli.

 

Because Steinway pianos are built to last for generations, used Steinways are the primary competition in our market segment.  It is difficult to estimate the significance of used piano sales, since most are conducted in the private aftermarket.  However, we have increased our emphasis on restoration services and the procurement, refurbishment and sale of used Steinway pianos to help us mitigate the impact of these aftermarket sales on our piano business.

 

Boston Piano Company – While our mid-priced pianos compete with brands such as Baldwin and Schimmel, our primary competition is from Japanese and Korean manufacturers such as Kawai, Yamaha and Young Chang.  By working with manufacturers in the same geographic areas, we are able to enjoy labor costs and manufacturing efficiencies similar to those of our primary competitors while offering consumers the added benefit of pianos designed by Steinway & Sons.

 

Piano manufacturing in China has been growing at a rapid pace in recent years.  While Chinese manufacturers have begun producing low-priced, smaller grand pianos, a vast majority of the production continues to be upright pianos.

 

Band Segment

 

We are the largest domestic producer of band & orchestral instruments.  We enjoy leading market shares with many of our professional level instruments.  Yamaha, a Japanese corporation, is our largest competitor.  New entrants into the domestic market generally experience difficulty competing due to the need for both brand recognition and an effective distribution system.

 

Competition for sales of student level instruments in the U.S. has intensified in recent years due to the growth of offshore manufacturers.  These producers enjoy low labor costs, which make it possible for them to offer instruments at highly competitive prices.  It is difficult to quantify the impact of imported musical instruments since the majority of offshore manufacturers do not report data through typical industry channels.

 

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Patents and Trademarks

 

Steinway & Sons pioneered the development of the modern piano with over 125 patents granted since our founding.  While we have several patents effective and pending in the United States and in several foreign countries, we do not believe our business is materially dependent upon any single patent.

 

We also have some of the most well-known brand names in the music industry.  Our piano trademarks include Steinway, Steinway & Sons, the Lyre design, Boston, Boston designed by Steinway & Sons, Heirloom Collection, and Essex. Our band & orchestral trademarks include Bach, Selmer, C.G. Conn, Leblanc, King, Armstrong, Ludwig, Musser, Holton, Glaesel, Scherl & Roth, Emerson, William Lewis & Son, Noblet, and Artley.  We consider our trademarks to be important and valuable assets.  It is possible that the termination, expiration or infringement of one or more of our trademarks may have an adverse affect on our business, depending on the trademark and the jurisdiction.  Accordingly, we maintain trademark registrations in appropriate jurisdictions on an ongoing basis and vigorously pursue any infringement by competitors.

 

Raw Materials, Component Parts, and Sourced Products

 

Our raw materials consist primarily of metals and woods.  A majority of these materials is sourced from the Americas, with the balance coming from Europe, Asia and Africa.  We acquired our sole domestic piano plate manufacturer and primary piano key maker to ensure availability of these component parts.  Component parts for string and percussion instruments are imported from Europe and Asia.  We have had adequate supplies of raw materials and component parts in the past and do not expect any disruption to the supply of these items during 2005 or in the future.

 

Our Boston and Essex piano lines are each sourced from a single manufacturer, as are our Selmer Paris instruments and certain other component parts.  Although we may experience delays in availability of product due to the lead times required by these manufacturers, we do not anticipate any material disruptions to the supply of these products.  Many of the student level band & orchestral instruments included in our “good” and “better” product groupings are also sourced from single manufacturers.  We continually scrutinize these suppliers and the quality of products that they manufacture for us and we believe that we have a sufficient number of qualified suppliers to ensure availability of all offered products in the upcoming year.

 

Labor

 

As of December 31, 2004, we employed 2,386 people, consisting of 1,795 hourly production workers and 591 salaried employees.  Of the 2,386 employees, 1,842 were employed in the United States and the remaining 544 were employed primarily in Europe.

 

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Approximately 60% of our workforce in the United States is represented by labor unions.  The following table indicates the union representation and the current status of our collective bargaining agreements in the U.S.:

 

Location		Union affiliation		Type of manufacturing		Number of employees		Agreement expiration
Elkhorn, WI		International Boilermakers, Iron Shipbuilder, Blacksmiths, Forgers & Helpers		Band instruments		71		July 19, 2005
Elkhart, IN		United Auto Workers		Band instruments		246		April 1, 2006
New York, NY		United Furniture Workers		Pianos		490		December 31, 2006
Springfield, OH		Glass, Molders, Pottery, Plastics & Allied Workers		Piano plates		32		November 8, 2007
LaGrange, IL		Carpenters		Percussion instruments		38		November 16, 2007
Eastlake, OH		United Auto Workers		Band instruments		215		February 16, 2008

 

In Germany, the worker’s council represents all employees other than management.  Nevertheless, most employment contract conditions are settled in collective bargaining agreements made between various trade unions and the employer organizations to which we belong. Generally, agreements are negotiated on an annual basis.  The Company believes that relations with its employees and these unions are generally good.

 

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Item 2.  Properties

 

We own most of our manufacturing and warehousing facilities, as well as the building that includes Steinway Hall in New York City.  The remaining Steinway retail stores are leased.  Substantially all of the domestic real estate has been pledged to secure our debt.

 

The following table lists our significant owned and leased facilities:

 

Location		Owned/ Leased		Approximate Floor Space (Square Feet)		Type of Facility and Activity Performed
Long Island City, NY		Owned		450,000		Piano manufacturing; restoration center; administrative offices; training
New York, NY		Owned		217,000		Piano retail store/showroom; office rental property
Westbury, NY		Leased		15,000		Piano retail store/showroom
Westport, CT		Leased		11,000		Piano retail store/showroom
Coral Gables, FL		Leased		6,000		Piano retail store/showroom
Paramus, NJ		Leased		4,000		Piano retail store/showroom
Springfield, OH		Owned		110,000		Piano plate manufacturing
Hamburg, Germany		Owned		221,000		Piano manufacturing; executive offices; training
		Leased		6,000		Piano retail store/showroom
Munich, Germany		Leased		15,000		Piano retail store/showroom
Berlin, Germany		Leased		7,000		Piano retail store/showroom/service workshop
Wuppertal, Germany		Leased		27,000		Piano key manufacturing
Wilkow, Poland		Owned		10,000		Piano key manufacturing
Shanghai, China		Leased		12,000		Piano warehouse/showroom/workshop
London, England		Leased		10,000		Piano showroom
		Leased		6,000		Piano workshop/storage
Tokyo, Japan		Leased		9,000		Piano selection center; warehouse
		Leased		2,000		Administrative offices
Eastlake, OH		Owned		160,000		Brass instrument manufacturing
Elkhart, IN		Owned		150,000		Brass instrument manufacturing
		Owned		88,000		Woodwind manufacturing; warehouse; office
		Owned		77,000		Former band instrument manufacturing
		Owned		81,000		Warehouse
		Owned		25,000		Administrative offices
Elkhorn, WI		Owned		58,000		Brass instrument manufacturing
Kenosha, WI		Owned		95,000		Woodwind manufacturing; warehouse
		Owned		43,000		Brass instrument manufacturing
Nogales, AZ		Owned		22,000		Former woodwind instrument manufacturing, rental property
LaGrange, IL		Owned		46,000		Percussion instrument manufacturing
Monroe, NC		Leased		154,000		Drum and case manufacturing
Cleveland, OH		Leased		62,000		String instrument manufacturing
London, England		Leased		8,000		Band instrument office; warehouse
LaCouture Boussey, France		Owned		32,000		Woodwind manufacturing

 

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We spent $5.2 million for capital improvements in 2004, consisting primarily of facility improvement projects related to our facility rationalization project, machinery and equipment purchases, and office equipment upgrades and replacements.  We expect capital spending in 2005 to be in the range of $5.0-7.0 million, relating to machinery and equipment purchases, system upgrades, and facility improvements.

 

Item 3.  Legal Proceedings

 

General

 

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

 

Environmental Matters

 

We are required to comply with various federal, state, local and foreign environmental laws, including those relating to discharges to air, water and land, the handling and disposal of solid and hazardous waste and the cleanup of properties affected by hazardous substances.  Certain environmental laws, such as the Comprehensive Environmental Response, Compensation, and Liability Act, as amended, impose strict, retroactive, joint and several liability upon persons responsible for releases of hazardous substances, which responsibility is broadly construed.

 

We operated manufacturing facilities at certain locations where hazardous substances (including chlorinated solvents) were used.  We believe that an entity that formerly operated one such facility may have released hazardous substances at such location, which we leased through July 2001.  We did not contribute to the release.  Further, we have a contractual indemnity from certain stockholders of this entity.  This facility is not the subject of a legal proceeding that involves us, nor, to our knowledge, is the facility subject to investigation.  However, no assurance can be given that legal proceedings will not arise in the future and that such indemnitors would make the payments described in the indemnity.

 

We operate other manufacturing facilities that were previously owned by Philips Electronics North America Corporation (“Philips”).  Philips agreed to indemnify us for any and all losses, damages, liabilities and claims relating to environmental matters resulting from certain activities of Philips occurring prior to December 29, 1988 (the “Environmental Indemnity Agreement”).  Philips has fully performed its obligations under the Environmental Indemnity Agreement, which terminates on December 29, 2008.  Four matters covered by the Environmental Indemnity Agreement are currently pending.  Philips has entered into Consent Orders with the Environmental Protection Agency (“EPA”) for one site and the North Carolina Department of Environment, Health and Natural Resources for a second site, whereby Philips has agreed to pay required response costs.  On October 22, 1998, we were joined as defendant in an action involving a site formerly occupied by a business we acquired in Illinois.  Philips has accepted the defense of this action pursuant to the terms of the Environmental Indemnity Agreement.  For the fourth site, the EPA has notified us it intends to carry out the final remediation itself.  The EPA estimates that this remedy has a present net cost of approximately $14.5 million.  The EPA has named over 40 persons or entities as potentially responsible parties at this Elkhart, Indiana site, including four Conn-Selmer predecessor entities. For two of these entities, which were previously owned by Philips, this matter has been tendered to Philips pursuant to the Environmental Indemnity Agreement.  Our potential liability at any of these sites is affected by several factors including, but not limited to, the

 

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method of remediation, our portion of the materials in the site relative to the other named parties, the number of parties participating, and the financial capabilities of the other potentially responsible parties once the relative share has been determined.  No assurance can be given, however, that additional environmental issues will not require other, currently unanticipated investigation, assessment or remediation expenditures or that Philips will make payments that it is obligated to make under the Environmental Indemnity Agreement.

 

We are also continuing an existing environmental remediation program at a facility acquired in 2000.  We currently estimate that this project will take eighteen years to complete, at a total cost of approximately $1.0 million.  We have accrued approximately $0.8 million for the estimated remaining cost of this remediation program, which represents the present value of the total estimated cost using a discount rate of 4.54%.  A summary of expected payments associated with this project is as follows:

 

		Environmental Payments
2005		$	237
2006		75
2007		54
2008		47
2009		$	47
Thereafter		514
		$	974

 

In 2004, we acquired manufacturing facilities for which environmental remediation programs had already been established.  Based on our current assessment, we have accrued approximately $0.8 million for the cost of these remediation programs.

 

The matters described above and our other liabilities and compliance costs arising under environmental laws are not expected to have a material impact on our capital expenditures, earnings, or competitive position.  However, some risk of environmental liability is inherent in the nature of our current and former business and we might, in the future, incur material costs to meet current or more stringent compliance, cleanup, or other obligations pursuant to environmental laws.

 

Item 4.  Submission Of Matters To A Vote Of Security Holders

 

No matter was submitted to a vote of our security holders during the fourth quarter of the fiscal year ended December 31, 2004.

 

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PART II

 

Item 5.  Markets For Registrant’s Common Equity and Related Stockholder Matters

 

Our Ordinary common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “LVB”.  The following table sets forth, for the periods indicated, the high and low share prices of our Ordinary common stock as reported on the NYSE.

 

		High			Low
Year Ended December 31, 2004
First Quarter		$	33.90		$	23.25
Second Quarter		36.50			32.10
Third Quarter		35.41			25.59
Fourth Quarter		29.36			26.76
Year Ended December 31, 2003
First Quarter		$	16.60		$	14.25
Second Quarter		16.25			12.30
Third Quarter		18.20			15.27
Fourth Quarter		24.70			16.85

 

We have two classes of common stock: Class A and Ordinary.  With the exception of disparate voting power, both classes are substantially identical.  Each share of Class A common stock entitles the holder to 98 votes.  Holders of Ordinary common stock are entitled to one vote per share.  Class A common stock shall automatically convert to Ordinary common stock if, at any time, the Class A common stock is not owned by an original Class A holder.  As of March 24, 2005, there were 2,925 beneficial shareholders of our Ordinary common stock and two holders of record of the Class A common stock.

 

We are restricted by the terms of our outstanding debt and financing agreements from paying cash dividends on our common stock.

 

We presently intend to retain earnings to reduce outstanding indebtedness and to fund the growth of our business.  The payment of any future dividends will be determined by the Board of Directors in light of conditions then existing, including our results of operations, financial condition, cash requirements, restrictions in financing agreements, tax treatment of dividends, business conditions and other factors.

 

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Equity Compensation Plans

 

The following table sets forth the equity compensation plan information for our Employee Stock Purchase Plan and our Amended and Restated 1996 Stock Plan, which were approved by security holders:

 

Plan Category		Number of securities to be issued upon exercise of outstanding options, warrants and rights		Weighted-average exercise price of outstanding options, warrants and rights			Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
		(a)		(b)			(c)
Equity compensation plans approved by security holders		872,227			$19.92		477,018
Total		872,227			$19.92		477,018

 

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Item 6.  Selected Consolidated Financial Data

 

The following table sets forth our selected consolidated financial data as of and for each of the five years in the period ended December 31, 2004, derived from our audited financial statements.  The table should be read in conjunction with our consolidated financial statements, including the footnotes, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report.

 

(In thousands except share and per share data)

 

Years Ended December 31,		2004 (1)			2003			2002			2001			2000 (2)
Income statement data:
Net sales			$375,034			$337,220			$332,297			$352,612			$331,698
Gross profit		109,133			92,553			97,151			103,521			101,688
Income from operations		34,241			22,824			31,399			34,495			38,419
Net income		15,867			9,698			14,909			8,738			14,887
Earnings per share:
Basic			$1.97			$1.09			$1.68			$0.98			$1.67
Diluted			$1.91			$1.09			$1.68			$0.98			$1.67
Weighted average shares:
Basic		8,046,256			8,924,578			8,877,256			8,928,000			8,921,091
Diluted		8,304,066			8,925,672			8,882,165			8,928,000			8,921,108
Balance sheet data (at year end):
Cash			$27,372			$42,283			$19,099			$5,545			$4,989
Current assets		308,761			288,270			267,346			254,474			263,376
Total assets		477,545			445,665			423,731			409,537			419,739
Current liabilities		72,893			61,304			53,302			49,318			56,515
Total debt		221,208			196,602			200,636			211,203			223,410
Stockholders’ equity		145,553			152,635			131,208			115,773			111,190
Other financial data:
Capital expenditures		5,186			5,462			5,604			7,141			7,890
Margins:
Gross profit		29.1		%	27.4		%	29.2		%	29.4		%	30.7		%
Operating		9.1		%	6.8		%	9.4		%	9.8		%	11.6		%

 

Notes to Selected Consolidated Financial Data:

 

(1)          We acquired Leblanc in August 2004.

(2)          We acquired UMI in September 2000.

 

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Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations (Tabular Amounts in Thousands)

 

Introduction

 

The following discussion provides an assessment of the results of our operations and liquidity and capital resources together with a brief description of certain accounting policies.  Accordingly, the following discussion should be read in conjunction with our Consolidated Financial Statements and the Notes to Consolidated Financial Statements included within this report.

 

Overview

 

We, through our operating subsidiaries, are one of the world’s leading manufacturers of musical instruments.  Our strategy is to capitalize on our strong brand names, leading market positions, strong distribution networks, and quality products.

 

Piano Segment - Sales of our pianos are influenced by general economic conditions, demographic trends and general interest in music and the arts.  The operating results of our piano segment are primarily affected by Steinway & Sons grand piano sales.  Given the total number of these pianos that we sell in any year (3,194 sold in 2004), a slight change in units sold can have a material impact on our business and operating results.  Our results are also influenced by sales of Boston and Essex pianos, which together represented approximately 55% of total piano units sold but less than 20% of total piano revenues in 2004.  Our Boston and Essex piano lines are manufactured in Asia, each by a single manufacturer.  The ability of these manufacturers to produce and ship products to us could impact our business and operating results.  In 2004, approximately 57% of piano sales were in the United States, 28% in Europe and the remaining 15% primarily in Asia. For the year ended December 31, 2004, our piano segment sales were $203.7 million, representing 54% of our total revenues.

 

Piano Outlook for 2005 - We expect another successful year for our piano segment with continued growth in revenue.  Gross margins should remain relatively stable as we expect somewhat higher production levels to offset manufacturing cost increases.  We expect the higher costs of Boston inventory purchases caused by unfavorable exchange rates to be mitigated by price increases we have already implemented.  We currently have sufficient, but not excessive, manufacturing capacity to meet anticipated or increased demand.

 

Band Segment - Our student band instrument sales are influenced by trends in school enrollment, general attitudes toward music and the arts and our ability to provide competitively priced products to our dealer network.  Management estimates that 85% of our domestic band sales are generated through educational programs.  Our school instrument business is correlated to the number of school children in the United States, which has peaked and is expected to remain relatively stable over the next few years.  However, our sales growth has been adversely affected in recent years by the abundance of competitively priced imported student instruments available to our dealers and their ability to purchase these products directly from offshore sources.

 

In order to compete with these mass-merchandised offshore instruments, we restructured our product offerings to include quality, competitively priced brand-name imported instruments that are built to our specifications.  We now offer quality-controlled, brand-name products at multiple price points through distribution channels which support the music education market.  Our product offerings are tailored to the needs of traditional school music dealers who provide full-service rental programs to beginning band

 

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students, as well as music retailers and e-commerce dealers selling directly to end consumers from their stores or through the Internet.

 

Consistent with past patterns, beginner instruments accounted for approximately 70% of band & orchestral unit shipments and approximately 40% of band instrument revenues in 2004, with advanced and professional instruments representing the balance. In 2004, approximately 81% of band sales were in the United States, 9% in Europe and the remaining 10% primarily in Asia.  For the year ended December 31, 2004, our band sales were $171.3 million, representing 46% of our total revenues.

 

Band Outlook for 2005 - We continue to see shifts in the buying patterns of our dealers within and between our various distribution channels.  Accordingly, pinpointing the demand for our products at the student, institutional, and professional levels, synchronizing product availability with demand, and filling the needs of our distribution channels in both domestic and export markets has become far more challenging than in the past.  This process will continue to be a major focus for us going forward.  We expect a demanding first half of the year as we complete the integration of the Leblanc operations and product offerings into our business and strive to improve productivity at locations affected by our facility rationalization activities.  The latter half of the year should show improvement over past performance, both in net sales and gross margin.  We anticipate a gradual return to more efficient production levels and a more appropriate balance of manufactured and imported products to meet demand for the back-to-school selling season.

 

Inflation and Foreign Currency Impact - Although we cannot accurately predict the precise effect of inflation on our operations, we do not believe that inflation has had a material effect on sales or results of operations in recent years.

 

Sales to customers outside the United States represented 32% of consolidated sales in 2004.  We record sales in euro, Japanese yen, British pounds, and Chinese renminbi. In 2004, we generated 73% of our international sales through our piano segment and, solely as a result of foreign exchange rate changes, piano sales increased $6.8 million. Although currency fluctuation affects international sales, it also affects cost of sales and related operating expenses. Consequently, it generally has not had a material impact on operating income.  We use financial instruments such as forward exchange contracts and currency options to reduce the impact of exchange rate fluctuations on firm and anticipated cash flow exposures and certain assets and liabilities denominated in currencies other than the functional currency of the affected division.  We do not purchase currency related financial instruments for purposes other than exchange rate risk management.

 

Taxes – We are subject to U.S. income taxes as well as tax in several foreign jurisdictions in which we do business.  Some of these foreign jurisdictions have higher statutory rates than the U.S.  In addition, certain of our operations are subject to both U.S. and foreign taxes.  However, in such cases we receive a credit against our U.S. taxes for foreign taxes paid equal to the percentage that such foreign income represents of the total income subject to U.S. tax.  Accordingly, our effective tax rates will vary depending on the relative proportion of foreign to U.S. income and the absorption of foreign tax credits in the U.S.  In 2002, we were not able to utilize foreign tax credits carried forward from prior years, but were effective at using many of the foreign tax credits generated that period.  In 2003, we were able to utilize foreign tax credits carried forward from prior years due to the higher proportion of our foreign source income to overall income.  In 2004, we were able to use the majority, but not all, of the foreign tax credits generated in the current period.  However, because the American Jobs Creation Act of 2004

 

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(the “Act”) extended the foreign tax credit carryover period we were able to recognize a partial benefit for the current year’s excess foreign tax credits.

 

The strengthening of our domestic piano and band businesses is expected to result in less effective use of our foreign tax credits and credit carryforwards in the upcoming year.  In addition, the states in which we do business have either repealed or are likely to repeal legislation that had been beneficial to tax paying businesses.  These events may have an adverse impact on our effective tax rate for 2005.  Conversely, we expect to benefit from other provisions of the Act, such as the additional tax deduction provided to domestic manufacturers.  To date, we have not fully assessed the impact of all these tax law changes but currently expect our effective tax rate to increase in 2005 relative to 2004.

 

Results of Operations

Fiscal Year 2004 Compared to Fiscal Year 2003

 

												Change
For years ended December 31,		2004					2003					$		%
Net sales
Band		$	171,346				$	157,460				13,886		8.8
Piano		203,688					179,760					23,928		13.3
Total sales		375,034					337,220					37,814		11.2
Cost of sales
Band		137,779					126,369					11,410		9.0
Piano		128,122					118,298					9,824		8.3
Total cost of sales		265,901					244,667					21,234		8.7
Gross profit
Band		33,567			19.6%		31,091			19.7%		2,476		8.0
Piano		75,566			37.1%		61,462			34.2%		14,104		22.9
Total gross profit		109,133					92,553					16,580		17.9
		29.1		%			27.4		%
Operating expenses		75,255					66,771					8,484		12.7
Facility rationalization		(363		)			2,958					(3,321	)	(112.3	)
Total operating expenses		74,892					69,729					5,163		7.4
Income from operations		34,241					22,824					11,417		50.0
Other income, net		(3,163		)			(3,517		)			354		(10.1	)
Net interest expense		13,437					11,945					1,492		12.5
Income before income taxes		23,967					14,396					9,571		66.5
Income tax provision		8,100			33.8%		4,698			32.6%		3,402		72.4
Net income		$	15,867				$	9,698				6,169		63.6

 

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Overview – 2004 was a year committed to improvement of our band business.  We continued the facility rationalization project started in 2003, closing one of our Elkhart, Indiana plants in April 2004 and moving production into existing facilities.  Our redesigned distribution policy enabled us to grow our e-commerce, catalog, music retailer, professional, and export sales categories.  Our expanded product line, which includes lower-priced, brand-name sourced instruments, has been well accepted in the marketplace, and we experienced increases in sales of these products once we worked through availability issues.  However, we maintained lower-than-normal production levels for certain products in order to manage inventory levels, which adversely impacted margins.  We were presented with the opportunity to purchase substantially all of the assets of G. Leblanc Corporation, which enabled us to strengthen our existing band product lines.  Leblanc faces the same excess capacity issues we have experienced, announcing the closure of one of its manufacturing facilities just prior to the acquisition.  Accordingly, we expect our overall production rationalization activities to extend beyond the timeframe originally anticipated as we factor Leblanc’s production capabilities into our analysis.

 

Our piano business had a very successful year. Domestic wholesale sales remained strong, and retail sales were bolstered by the two additional retail stores that were fully operational for all of 2004.  Our European business remained stable, while our Asian business improved, primarily due to our Shanghai facility being operational since spring 2004.  Although sales and marketing expenses were higher than expected, these costs were more than offset by margin improvements due to improved production levels, efficiencies, and product mix.

 

Net Sales – Net sales increased $37.8 million.  This resulted in part from a 9% increase in Steinway grand unit shipments, as well as a $6.8 million benefit attributable to foreign exchange.  The total piano sales increase of $23.9 million also reflects the increase in higher-priced retail unit sales resulting from our additional domestic storefronts being operational for the full year, as well as strong wholesale shipments throughout the year.  Band & orchestral instrument sales increased $13.9 million on an overall unit increase of 17%.  The band sales increase includes $9.6 million attributable to the Leblanc acquisition, with the remainder resulting from core business growth, especially professional brass and percussion instruments.

 

Gross Profit – Gross profit improved $16.6 million primarily due to the piano margin improvement from 34.2% to 37.1%.  Higher domestic production levels, overseas production and labor efficiencies, and improved retail sales were the primary drivers of the increase.  A shift in our international divisions’ sales mix towards higher margin grands also contributed to the improvement.  Although band segment gross profit improved $2.5 million, gross margins declined slightly. Atypical charges affecting margin in 2004 totaled $2.6 million, comprised primarily of severance and higher costs associated with the acquisition write-up of Leblanc inventory to fair value.  In 2003, atypical charges totaled $6.0 million, including severance costs, strike costs, and inventory impairment charges.  Despite the reduction in atypical charges and improved margins on imported student products, gross margins decreased slightly from 19.7% to 19.6%.  This was primarily due to increased freight expenses, production inefficiencies for some woodwind products, and reduced production levels of certain brass instruments.  Significant increases in costs of raw materials such as silver and copper also adversely affected band gross margins.

 

Operating Expenses – Operating expenses increased $5.2 million despite the $3.3 million decrease in impairment charges compared to the prior year.  Over $3.1 million of this increase resulted from external costs associated with our Sarbanes-Oxley compliance project. $2.2 million of the increase is attributable to foreign exchange, and we incurred incremental expenses of $1.4 million associated with Leblanc.  The

 

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remainder of the increase resulted primarily from increased advertising and promotional costs and increased bonus payments.

 

Non-operating Expenses – Non-operating expenses increased $1.8 million primarily due to the additional interest expense resulting from our issuance of $29.0 million of 8.75% Senior Notes in February 2004.

 

Results of Operations

Fiscal Year 2003 Compared to Fiscal Year 2002

 

												Change
For years ended December 31,		2003					2002					$		%
Net sales
Band		$	157,460				$	167,708				(10,248	)	(6.1	)
Piano		179,760					164,589					15,171		9.2
Total sales		337,220					332,297					4,923		1.5
Cost of sales
Band		126,369					127,849					(1,480	)	(1.2	)
Piano		118,298					107,297					11,001		10.3
Total cost of sales		244,667					235,146					9,521		4.0
Gross profit
Band		31,091			19.7	%	39,859			23.8	%	(8,768	)	(22.0	)
Piano		61,462			34.2	%	57,292			34.8	%	4,170		7.3
Total gross profit		92,553					97,151					(4,598	)	(4.7	)
		27.4%					29.2%
Operating expenses		66,771					65,752					1,019		1.5
Facility rationalization		2,958					—					2,958
Total operating expenses		69,729					65,752					3,977		6.0
Income from operations		22,824					31,399					(8,575	)	(27.3	)
Other income, net		(3,517