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 (2,589 sold in 2008), 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 70% of total piano units sold and 22% of total piano revenues in 2008. Our Boston piano line and many of our Essex piano models are sourced from Asia by single manufacturers. The ability of these manufacturers to produce and ship products to us could impact our business and operating results. A breakdown of sales by our divisions and their geographic location can be found in Note 18 to the financial statements. In 2008, our piano sales had the following geographic breakdown based on customer location: approximately 42% in the United States, 32% in Europe, 7% in Japan, 7% in China, and the remaining 12% primarily in other Asian countries. For the year ended December 31, 2008, our piano segment sales were $228.4 million, representing 59% of our total revenues.

Piano Outlook for 2009 - Overall, we expect a difficult year for our piano segment with respect to sales and gross profit. We anticipate the domestic market will be more challenging than that overseas, although the continued strengthening of the euro could have an adverse impact on international sales. We intend to focus on aligning production and sales so as not to build excess inventory, reducing expenses, and assisting our dealers through the current U.S. credit crisis without undue risk to receivable collectibility. We currently have sufficient 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 75% of our domestic band sales are generated through educational programs; the remainder is to amateur or professional musicians or performing groups, including symphonies and orchestras.

With respect to sourced products, in recent years we expanded our offerings to include quality, competitively priced instruments that have our brand names and are built to our specifications. Our product offerings are tailored to the needs of traditional school music dealers who provide full-service rental programs to beginning band students, as well as music retailers and e-commerce dealers selling directly to end consumers from their stores or through the Internet. We believe our product offerings have helped us remain competitive at various price points and will continue to do so in the future.

In 2008, beginner instruments accounted for approximately 60% of band & orchestral unit shipments and approximately 35% of band instrument revenues, with intermediate and professional

instruments representing the balance. In 2008, approximately 75% of band sales were in the United States, 12% in Europe and the remaining 13% primarily in Japan and Canada. For the year ended December 31, 2008, our band sales were $159.0 million, representing 41% of our total revenues.

Band Outlook for 2009 - We expect a challenging year for our band division since order volume has decreased. Some of our dealers have been adversely impacted by the credit crisis. In an effort to increase their cash flow, these dealers are working to repair or resell existing inventory instead of ordering new product. We have also eliminated some order and purchasing incentive programs, which will be beneficial to our margin, but has caused orders to shift to later in the season. We have completed most of our facility rationalization project, and have reduced production of certain instruments so as not to build excess inventory. We have made some headcount reductions and will continue to reduce expenses. Similar to the piano division, we are helping our dealers through the current U.S. credit crisis without undue risk to receivable collectibility. We currently have sufficient manufacturing capacity to meet anticipated or increased demand.

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 44% of consolidated sales in 2008. We record sales in euro, Japanese yen, British pounds, and Chinese yuan. In 2008, we generated 77% of our international sales through our piano segment. Foreign exchange rate changes impacted sales favorably by approximately $5.5 million in the current year. Although currency fluctuations affect international sales, they also affect cost of sales and related operating expenses. Consequently, they generally have 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 United States. 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 (as adjusted for reallocated interest) 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 United States.

In 2006, we were unable to utilize any of the foreign tax credits generated as we incurred a loss from operations subject to U.S. tax due to our debt restructuring costs and the strike at one of our brass instrument plants. Based on the extended carryforward period, the impact of an anticipated reduction in the German tax rates in 2008, and other tax planning strategies, we recognized the full benefit for the excess foreign tax credits generated in the period. The overall effective tax rate of (75.3%) in 2006 differs from the statutory rate primarily due to foreign taxes that are not creditable against U.S. taxes, permanent differences between book and tax income and expenses, and state taxes. The overall effective rate is also a function of the insignificant level of loss before income taxes, for which a small change in any amount results in a large percentage change in effective tax rate.

In 2007, we recognized a benefit of approximately $0.3 million due to the reduction in German tax rates and were able to use a majority, but not all, of our foreign tax credits. We carried forward $1.7 million of credits, and recognized the full benefit for the excess foreign tax credits generated. However, our rate was adversely impacted by approximately $0.6 million of taxes, penalties, and

interest associated with uncertain tax positions. Accordingly, our overall effective tax rate was 39.5% in 2007.

In 2008, we were able to use approximately 60% of the foreign tax credits generated during the year. We recognized a benefit of $0.9 million for the excess foreign tax credits generated, net of reserves, which were recorded based on our recent historical foreign tax credit usage trends and anticipated ratios of foreign source income to domestic income in the future. Our rate was beneficially impacted by $1.1 million in reduction of taxes, interest, and penalties associated with uncertain tax positions that have been settled. Accordingly, our overall effective tax rate was 37.7% in 2008. Excluding the impact of any addition to or resolution of uncertain tax positions, we anticipate an overall effective rate of 38% to 40% for 2009.

Results of Operations

Fiscal Year 2008 Compared to Fiscal Year 2007

                                 For the years ended December 31,                           Change
                                2008                           2007                      $           %
Net sales
    Band                     $    159,047                    $ 171,124                 (12,077 )      (7.1 )
    Piano                         228,366                      235,190                  (6,824 )      (2.9 )

Total sales                       387,413                      406,314                 (18,901 )      (4.7 )
Cost of sales
    Band                          124,752                      136,870                 (12,118 )      (8.9 )
    Piano                         147,371                      145,958                   1,413         1.0

Total cost of sales               272,123                      282,828                 (10,705 )      (3.8 )
Gross profit
    Band                           34,295          21.6%        34,254     20.0%            41         0.1
    Piano                          80,995          35.5%        89,232     37.9%        (8,237 )      (9.2 )

Total gross profit                115,290                      123,486                  (8,196 )      (6.6 )
                                    29.8%                        30.4%
Operating expenses                 84,220                       88,156                  (3,936 )      (4.5 )
Facility rationalization
and
    impairment charges              9,877                          128                   9,749     7,616.4

Total operating expenses           94,097                       88,284                   5,813         6.6
Income from operations             21,193                       35,202                 (14,009 )     (39.8 )
Other income, net                    (536 )                        (59 )                  (477 )     808.5
Gain on extinguishment of
debt                                 (636 )                          -                    (636 )     100.0
Net interest expense                9,218                        9,771                    (553 )      (5.7 )

Income before income
taxes                              13,147                       25,490                 (12,343 )     (48.4 )
Income tax provision                4,961          37.7%        10,080     39.5%        (5,119 )     (50.8 )

Net income                   $      8,186                    $  15,410                  (7,224 )     (46.9 )

Overview - The facility rationalization project at our band division is complete, and production at closed plants has been moved into existing plants. However, the U.S. economic crisis adversely impacted fourth quarter band revenues, since dealers only ordered products that they could resell quickly. Nevertheless, margins improved despite the $0.9 million incurred due to plant closures.

Our fall budgeting and planning process provides multi-year cash flow projections which we use to conduct our annual impairment testing of intangible assets. Recent decreases in order volume, the adverse impact of unavailable sourced products, delays in producing new product lines, and recent economic events, coupled with other factors, caused us to lower sales expectations. As a result, our future anticipated cash flows at the band division were reduced and our goodwill was determined to be impaired. Accordingly, we recorded an $8.6 million charge during the period to fully write off this asset. Analyses of band division trademarks and other assets during the fall indicated no other impairment, so no further charges have been taken. Our analysis of the piano division's intangible assets in the fall indicated no impairment charge was required. We performed an update of our analysis as of December 31, 2008 due to current economic conditions. No other impairments were noted.

Net Sales - Net sales decreased $18.9 million which is attributable to both band and domestic piano division performance. Band division revenues decreased $12.1 million, virtually all of which was caused by the 38% decrease in brass and woodwind unit shipments in the fourth quarter. This was mitigated by a shift towards higher priced intermediate and professional level instruments and improved percussion instrument sales. Piano revenue, which included $5.0 million of online music retail sales, deteriorated $6.8 million due to the $8.2 million decrease in domestic piano revenues. Steinway grand unit shipments decreased 16% and mid-priced piano line shipments decreased 8% domestically as demand fell at both the wholesale and retail level. Overseas piano sales improved $1.3 million, which includes $5.5 million in foreign currency translation. Steinway grand unit shipments were 10% lower, although mid-priced piano line shipments remained stable.

Gross Profit - Gross profit fell $8.2 million due to lower domestic piano sales and margins. Although we incurred $0.9 million in severance and other charges associated with the facility rationalization project, band gross profit was consistent due to the $2.4 million reduction in pension and retirement benefit costs. Unabsorbed overhead and production variances were also lower than in 2007.

Piano segment gross profit dropped $8.2 million primarily due to the decline in domestic piano sales. The overseas margin remained unchanged from the prior period at 41.3%. Domestically, margins dropped from 34.5% to 28.9% due to the 25% reduction in production, which was implemented in order to control inventory levels. The absence of a higher margin limited edition piano, lower margins on mid-priced piano shipments due to unfavorable exchange rates, and higher physical inventory adjustments, which were atypically favorable in 2007, were also factors in the margin deterioration.

Operating Expenses - Operating expenses were $3.9 million lower primarily due to the $1.7 million reduction in bad debt expense. Advertising expenses, salaries, commissions, and professional fees also decreased.

Facility rationalization and impairment charges - Facility rationalization and impairment charges of $9.9 million are comprised of $8.6 million associated with the write off of goodwill discussed above and $1.3 million in facility impairment charges at band locations that have been closed or sold.

Non-operating Expenses - Non-operating expenses decreased $1.7 million due to the $0.6 million gain on extinguishment of $5.8 million of our Notes. A $0.6 million shift from foreign exchange losses to foreign exchange gains also contributed to the improvement. Lower legal fees associated with the West 57th street building were offset by losses on our Supplemental Executive Retirement Plan assets.

Results of Operations

Fiscal Year 2007 Compared to Fiscal Year 2006

                                  For the years ended December 31,                           Change
                                 2007                           2006                     $           %
Net sales
    Band                      $    171,124                    $ 170,426                    698          0.4
    Piano                          235,190                      214,194                 20,996          9.8

Total sales                        406,314                      384,620                 21,694          5.6
Cost of sales
    Band                           136,870                      138,745                 (1,875 )       (1.4 )
    Piano                          145,958                      138,468                  7,490          5.4

Total cost of sales                282,828                      277,213                  5,615          2.0
Gross profit
    Band                            34,254          20.0%        31,681     18.6%        2,573          8.1
    Piano                           89,232          37.9%        75,726     35.4%       13,506         17.8

Total gross profit                 123,486                      107,407                 16,079         15.0
                                     30.4%                        27.9%
Operating expenses                  85,842                       79,879                  5,963          7.5
Provision for doubtful
accounts                             2,442                        9,150                 (6,708 )      (73.3 )

Total operating expenses            88,284                       89,029                   (745 )       (0.8 )
Income from operations              35,202                       18,378                 16,824         91.5
Other income, net                      (59 )                     (2,170 )                2,111        (97.3 )
Loss on extinguishment of
debt                                     -                        9,674                 (9,674 )     (100.0 )
Net interest expense                 9,771                       11,255                 (1,484 )      (13.2 )

Income (loss) before
income taxes                        25,490                         (381 )               25,871     (6,790.3 )
Income tax provision                10,080          39.5%           287     (75.3 )%     9,793      3,412.2

Net income (loss)             $     15,410                    $    (668 )               16,078     (2,406.9 )

Overview - By the end of 2007 our band business recovered from the strike at our Elkhart, Indiana brass instrument manufacturing facility, as production of intermediate and professional level instruments surpassed pre-strike levels. This beneficially impacted revenues and gross margins. However, the sales and margin improvements were partially offset by reduced order volumes caused by dealer consolidations.

Despite a slight decrease in domestic piano revenues, our piano division sales improved significantly due to the increase in overseas demand for Steinways and the re-launched Essex line of pianos. Piano margins improved, largely due to the higher ratio of overseas product to domestic product sold, as our overseas piano division typically earns higher margins.

Net Sales - Net sales increased $21.7 million, virtually all of which is attributable to piano division performance. Despite the 11% decrease in overall band unit shipments, which was largely due to

reduced demand for percussion and string instruments, band revenues increase slightly ($0.7 million) for the year. Sales of intermediate and professional level brass instruments, which are higher priced than student level instruments, caused the revenue improvement. Total piano sales improved $21.0 million to $235.2 million in 2007. Domestic sales deteriorated $1.3 million despite a 17% increase in mid-priced piano shipments, due to a 12% decrease in Steinway grand unit shipments. The increase in Steinway grand unit shipments of 9% and mid-priced piano line shipments of 84% overseas drove a revenue increase of $22.3 million, which includes $8.0 million in foreign currency translation.

Gross Profit - Gross profit improved $16.1 million due to improved sales and margins at both the piano and band divisions. Band gross profit was beneficially impacted by the Elkhart, Indiana brass instrument manufacturing facility's improved production of intermediate and professional level instruments, which exceeded pre-strike levels by year end. This more than offset the impact of unabsorbed overhead and production variances due to reduced production levels at some of our plants, which we experienced due to dealer consolidations and reduced order volume.

Piano segment gross profit increased $13.5 million primarily due to the improvement in sales. Gross margins benefited from the ratio of overseas division product to domestic product sold, as the overseas divisions typically have higher margins. Domestically, margins improved from 30.5% to 34.5% due to sales of higher margin limited edition pianos and lower-than-anticipated physical inventory adjustments.

Operating Expenses - Operating expenses decreased $0.7 million compared to 2006. Our provision for doubtful accounts decreased from $9.2 million to $2.4 million, but remained higher than normal due to the at-risk receivables of two of our piano division dealers. (In 2006, provision for doubtful accounts was exceptionally high due to the bankruptcy of two large band division customers.) Sales and marketing expenses increased $2.8 million in correlation with revenue. This was largely due to advertising and promotional activities at our overseas divisions, as well as cost associated with the introduction of a limited edition piano by our domestic division. Administrative costs, including legal, overseas bonuses, recruiting and relocation activities, and salaries increased $1.9 million. Other operating expenses increased $1.1 million, partially due to the $0.5 million reserve recorded against a $2.0 million escrowed deposit relating to a terminated asset purchase agreement. We also recognized a $0.1 million write down of property associated with the pending closure of our Kenosha, Wisconsin woodwind instrument manufacturing plant.

Non-operating Expenses - Non-operating expenses decreased $9.0 million largely due to the absence of $9.7 million in loss on extinguishment of debt, which we recorded in 2006 as a result of our Senior Note refinancing and repayment of our term loans. Other income, net decreased $2.1 million due to $1.1 million in legal fees associated with the West 57th Street building, as well as a $0.9 million shift from foreign exchange gains to foreign exchange losses.

Net interest expense decreased $1.5 million compared to 2006. The impact of the $0.9 million decrease in interest income, which was due to lower average cash balances, was more than offset by the $2.4 million decrease in interest expense as a result of our debt restructuring activities in the prior year.

Liquidity and Capital Resources

We have relied primarily upon cash provided by operations, supplemented as necessary by seasonal borrowings under our working capital lines, to finance our operations, repay or repurchase long-term indebtedness, finance acquisitions, and fund our capital expenditures. Our overseas divisions, particularly in Asia, are normally in a borrowing position on their lines. These borrowings are likely to be less than $10.0 million at any given time. In 2006, our domestic borrowings reached $13.9 million, due to the repayment of our term loan in September. In 2007, domestic borrowings peaked at

$28.9 million, due to the dividend we issued in March 2007, coupled with seasonal borrowings and the semi-annual interest payment on our bonds. In 2008, our domestic line went virtually unused until the fourth quarter, when we borrowed $30.0 million to ensure short-term liquidity. We paid down $15.0 million of that balance prior to December 31, 2008.

Cash Flows - Our statements of cash flows are summarized as follows:

       For the years ended December 31,            2008        2007        2006
       Net income (loss):                        $   8,186   $  15,410   $    (668 )
         Changes in operating assets and
         liabilities                               (21,988 )     8,297       8,607
         Other adjustments to reconcile net
         income (loss) to cash flows from
         operating activities                       20,773      10,358      21,281

       Cash flows from operating activities          6,971      34,065      29,220
       Cash flows from investing activities         (7,655 )    (4,760 )    (3,798 )
       Cash flows from financing activities          9,084     (23,217 )   (31,978 )

In 2008, cash flows from operating activities decreased $27.1 million. Cash used for inventory increased $24.5 million due to the band division, which experienced a $12.1 million reduction in sales, virtually all of which occurred in the fourth quarter. Also, cash used for liability related items increased $17.7 million due to large pension contributions, tax related payments, and reductions in employee benefit and deferred income accruals. These items exceed the positive impact of cash provided by accounts receivable, which increased $14.1 million largely due to more stringent credit criteria at the band division, and the $9.9 million increase in non-cash adjustments, which are added back to cash flows from operating activities.

In 2007, cash flows from operating activities increased $4.8 million due to the $16.1 million shift from net loss to net income. This more than offset the decrease in non-cash adjustments which are added back to cash flows from operating activities. These adjustments were abnormally high in 2006 due to the large provision for doubtful accounts and the loss on extinguishment of debt. Cash provided by inventory decreased $2.9 million, as we continued to carry excess inventory at our domestic piano division.

In 2006, cash flows from operating activities, which decreased $2.2 million, were impacted by many factors. While the decrease in net income was the largest factor, that amount included many expense items which are added back in adjustments to cash flows from operating activities. Cash provided by inventory increased $2.2 million due to increased piano sales combined with reduced production at our Elkhart brass instrument facility. Cash used by accounts receivable increased $5.8 million due to increased sales and extended payment terms offered as part of the Essex re-launch promotional activities and an increase in our band division aged receivable balance.

Cash flows from operating activities were also impacted by the $1.4 million purchase of securities (which are classified as trading) for our supplemental executive retirement plan ("SERP"). This purchase was funded by the sale of existing SERP securities and is described below. We realized gains of $0.2 million on the sale of these securities. Realized gains on the newly purchased securities were less than $0.1 million for the year ended December 31, 2006.

In 2008, cash used for investing activities increased $2.9 million due to our acquisitions of Arkiv and Clickpoint, which are discussed in Note 3 of the Notes to the Consolidated Financial Statements. In 2007, cash used for investing . . .