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

Through our operating subsidiaries, we 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 (2,001 sold in 2012), 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 74% of total piano units sold but only 21% of total piano division revenues in 2012. Our Boston piano line and our Essex piano line are each sole sourced from Asia. 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 19 to the financial statements. In 2012, our piano sales had the following geographic breakdown based on customer location: approximately 45% in the Americas, 26% in Europe, and 29% in the Asia-Pacific region. For the year ended December 31, 2012, our piano segment sales were $216.8 million, representing 61% of our total revenues.

Piano Outlook for 2013 - We anticipate improvement in both sales and gross profit in 2013, barring any severe economic problems in major markets into which we sell. We are currently manufacturing on a full production schedule, which minimizes factory inefficiencies. We have sufficient manufacturing capacity and have hired additional staffing to meet anticipated demand. However, a significant increase in demand would require more staffing and training.

Band Segment - Our student band instrument sales are influenced by trends in school enrollment, school budgeting, and our ability to provide competitively priced products to our dealer network. Management estimates that over 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.

Our offerings of sourced products 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 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 2012, student level instruments accounted for approximately 60% of band & orchestral unit shipments and approximately one-third of band instrument revenues, with intermediate and professional instruments representing the balance. In 2012, approximately 77% of band sales were in

Band Outlook for 2013 - Instrument orders are currently strong and we expect sales to continue to improve in 2013. Margins should improve due to price increases and manufacturing efficiencies. We currently have sufficient manufacturing capacity to meet anticipated or increased demand, although a significant increase in demand could require additional staffing and training.

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 47% of consolidated sales in 2012. We record sales in euro, Japanese yen, British pounds, and Chinese yuan. In 2012, we generated 77% of our international sales through our piano segment. Foreign exchange rate changes decreased reported sales by approximately $4.2 million in 2012. 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. One of these foreign jurisdictions has a higher statutory rate 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 use of foreign tax credits in the United States.

In 2012, we used $3.0 million of foreign tax credits and carried forward $4.3 million of foreign tax credits generated during the current period. In connection with our recent decision to start repatriating earnings from our operations in China, we recorded a gross tax liability of $6.5 million offset in part by related tax credits of $3.5 million. As a result of this change, we anticipate our foreign tax credit utilization will improve. Accordingly, we reversed $1.4 million of valuation allowances on these deferred tax assets. We recorded an overall effective tax rate of 37.3%, relating primarily to 2012 operations, as well as a 1.6% tax detriment associated with discrete items.

In 2011, we utilized a minimal amount of foreign tax credits and carried forward $3.7 million of foreign tax credits generated. Based on our 2011 analysis of anticipated foreign tax credit utilization, we recorded an additional $0.4 million of valuation allowances related to these deferred tax assets. Due to the low amount of taxable income, our non-deductible tax items and valuation allowances related to foreign tax credits had an abnormally large impact on our effective tax rate. As a result, we recorded an effective tax rate of 54.5%, which represents an effective tax rate of 55.9% relating primarily to 2011 operations and a 1.4% tax benefit associated with discrete items.

In 2010, we utilized 100% of the foreign tax credits generated during the year, as well as $2.9 million of credits previously generated. However, due to our expectation for prospective foreign tax credit utilization at that time, we increased our valuation allowances for foreign tax credits generated during 2006 to 2008 for a comparable amount. Accordingly, the net impact on our overall effective tax rate was nominal. Since there was a minimal net impact of discrete items such as uncertain tax positions, our overall effective tax rate of 39.0% related primarily to 2010 operations.

Fiscal Year 2012 Compared to Fiscal Year 2011

                            For the years ended December 31,                       Change
                             2012                        2011                   $          %
Net sales
Band                      $    136,905                 $ 130,715                6,190        4.7
Piano                          216,812                   215,541                1,271        0.6

Total sales                    353,717                   346,256                7,461        2.2
Cost of sales
Band                           102,302                   102,250                   52        0.1
Piano                          136,781                   138,858               (2,077 )     (1.5 )

Total cost of sales            239,083                   241,108               (2,025 )     (0.8 )
Gross profit
Band                            34,603         25.3%      28,465     21.8%      6,138       21.6
Piano                           80,031         36.9%      76,683     35.6%      3,348        4.4

Total gross profit             114,634                   105,148                9,486        9.0
                                 32.4%                     30.4%
Operating expenses              85,468                    83,728                1,740        2.1
Impairment and
facility
rationalization
charges                            566                     5,490               (4,924 )    (89.7 )

Total operating
expenses                        86,034                    89,218               (3,184 )     (3.6 )
Income from operations          28,600                    15,930               12,670       79.5
Other expense, net               3,406                     4,226                 (820 )    (19.4 )
Loss on extinguishment
of debt                              -                     2,422               (2,422 )   (100.0 )
Net interest expense             3,651                     5,698               (2,047 )    (35.9 )

Non-operating expenses           7,057                    12,346               (5,289 )    (42.8 )
Income before income
taxes                           21,543                     3,584               17,959      501.1
Income tax provision             8,033         37.3%       1,954     54.5%      6,079      311.1

Net income                $     13,510                 $   1,630               11,880      728.8

Piano division revenue is generated in three sales regions: Americas, Europe, and Asia-Pacific. Our Americas region sells Steinway pianos which are manufactured in New York. As such, factory variances are reflected in the gross profit and gross margin figures for the Americas region. Our Europe and Asia-Pacific regions both sell Steinway pianos manufactured in Germany. As such, we analyze gross profit and gross margin for the Europe and Asia-Pacific regions on a combined basis in order to appropriately reflect the impact of factory variances.

Overview - Piano division revenue increased due to strong demand in China coupled with incremental retail sales in the Americas. Gross profit also benefited from higher retail sales as well as efficiencies at our domestic piano factory. Band division revenues and gross profit improved due to strong demand for certain brass products and accessories as well as increased production and improved efficiencies at our brass instrument manufacturing plants.

Net Sales - Piano division revenue generated by our Americas region of $100.7 million was $2.5 million higher than the year-ago period despite flat Steinway grand unit shipments. Although sales to dealers were $2.0 million lower, this was more than offset by a $3.9 million increase in retail sales, most of

Band division revenue increased $6.2 million during the period. Revenue from accessories improved $3.6 million from the year-ago period. Although woodwind and brass instrument shipments were down 2%, an average selling price increase of 5% and a shift in mix towards step-up and professional brass instruments led to the increase in revenue. Increased availability of inventory produced at our Eastlake, Ohio brass instrument manufacturing facility also contributed to the revenue improvement.

Cost of Sales - Cost of sales was $2.0 million lower than the year-ago period primarily due to the piano division. In 2012, our piano factory in New York ran more efficiently than in 2011, so the increase in cost of materials was more than offset by lower labor and overhead costs. Accordingly, cost of sales by the Americas region was $0.5 million lower despite an increase in revenue. Cost of sales by our Europe and Asia divisions was $1.6 million lower due to the $1.2 million decrease in sales and favorable exchange rate impact.

Cost of sales by our band division was consistent with the year-ago period despite an increase in revenue. Although manufacturing and purchased product costs increased, the adverse impact was more than offset by a $5.6 million decrease in manufacturing inefficiencies.

Gross Profit - Gross profit was $9.5 million higher primarily due to improved sales and margins at both divisions. Piano margins generated by the Americas increased from 32.1% to 34.2%. Standard price increases and higher retail sales caused the margin improvement. Piano margins generated by the Europe and Asia-Pacific regions rose slightly from 38.5% to 39.2% due to a favorable shift in mix towards larger, higher margin Steinway grand pianos. This more than offset the impact of factory inefficiencies in Germany, which were caused by training of new workers in order to increase future production.

Gross margins generated by the band division increased from 21.8% to 25.3% in the current period. Margins benefited from increased production and greater efficiency at our brass manufacturing facilities, which were adversely impacted by the strike at our Eastlake, Ohio brass instrument manufacturing facility in 2011. This improvement more than offset the adverse impact of materials, overhead, and sourced-product costs increases. Lower pension costs of $1.1 million also contributed to the margin improvement.

Operating Expenses - Operating expenses were $1.7 million higher than the year-ago period. In 2011, the holders of our Class A common stock sold their shares to other shareholders. In conjunction with this transaction, we incurred an incremental $3.0 million in compensation expense related to the accelerated vesting of most of our stock options and all of our restricted stock and $1.1 million in legal and consulting costs. We also incurred $3.8 million of severance costs associated with the departures of our former Chairman and former Chief Executive officer.

Excluding these transaction-related charges, sales and marketing costs were $2.8 million higher than the year-ago period. This increase was due to $1.4 million in costs associated with our retail expansion as well as incremental bad debt expense of $0.7 million. Higher promotional and advertising costs were also a factor. Our general and administrative costs increased $6.9 million as 2012 includes $5.7 million of legal and consulting fees related to activities undertaken by our Board of Directors in

Impairment Charges - Impairment charges were $4.9 million lower than the year-ago period. In 2012, we incurred impairment charges related to our band division trademarks of $0.4 million and assets held for sale of $0.2 million. In 2011, we incurred impairment charges related to our band division and online music division goodwill and trademark intangible assets of $4.0 million. We also incurred impairment charges of $1.1 million associated with the long-lived assets at one of our manufacturing facilities as well as a $0.3 million impairment charge related to assets held for sale in 2011.

Non-operating Expenses - Non-operating expenses were $5.3 million less than the year-ago period. In 2011, we extinguished $85.0 million of our 7.00% Senior Notes, which resulted in a loss on extinguishment of debt of $2.4 million. As a result of the debt extinguishment, our net interest expense was $2.0 million lower in the current period. Although we incurred incremental costs associated with our West 57th Street building of $0.5 million, these were more than offset by an increase in foreign exchange gains of $0.8 million.

Results of Operations

Fiscal Year 2011 Compared to Fiscal Year 2010

                          For the years ended December 31,                        Change
                           2011                        2010                   $           %
Net sales
Band                    $    130,715                 $ 127,625                3,090          2.4
Piano                        215,541                   190,496               25,045         13.1

Total sales                  346,256                   318,121               28,135          8.8
Cost of sales
Band                         102,250                    95,569                6,681          7.0
Piano                        138,858                   126,602               12,256          9.7

Total cost of sales          241,108                   222,171               18,937          8.5
Gross profit
Band                          28,465         21.8%      32,056     25.1%     (3,591 )      (11.2 )
Piano                         76,683         35.6%      63,894     33.5%     12,789         20.0

Total gross profit           105,148                    95,950                9,198          9.6
                               30.4%                     30.2%
Operating expenses            83,728                    73,137               10,591         14.5
Impairment and
facility
rationalization
charges                        5,490                         -                5,490        100.0

Total operating
expenses                      89,218                    73,137               16,081         22.0
Income from
operations                    15,930                    22,813               (6,883 )      (30.2 )
Other expense, net             4,226                       370                3,856      1,042.2
Loss (gain) on
extinguishment of
debt                           2,422                      (104 )              2,526     (2,428.8 )
Net interest expense           5,698                     9,586               (3,888 )      (40.6 )

Non-operating
expenses                      12,346                     9,852                2,494         25.3
Income before income
taxes                          3,584                    12,961               (9,377 )      (72.3 )
Income tax provision           1,954         54.5%       5,061     39.0%     (3,107 )      (61.4 )

Net income              $      1,630                 $   7,900               (6,270 )      (79.4 )

Overview - Higher demand caused revenue at both the band and piano divisions to improve in 2011. Piano division results were significantly better with respect to revenue and gross profit due to increased Steinway grand shipments and higher production volume at both of our manufacturing facilities. Band division results were adversely impacted by a strike at our Eastlake, Ohio brass instrument manufacturing facility, which resulted in less product availability and higher factory variances.

Net Sales - Net sales increased $28.1 million primarily due to the $25.0 million improvement in piano division revenue. Domestically, Steinway grand unit shipments were 7% higher and Boston and Essex shipments were slightly higher than the year-ago period. Overall domestic sales improved $9.1 million, $4.7 of which is attributable to increased retail sales, which were bolstered by the opening of new Company-owned retail facilities in Chicago, Illinois. Overseas, Steinway grand unit shipments were 13% higher as a result of increased wholesale demand in Europe. Boston and Essex unit shipments improved by 10% due to better demand in both Europe and Asia. These increases, coupled with a $6.0 million favorable impact due to foreign exchange, were the primary cause of a $16.0 million improvement in overseas piano revenue in 2011.

Band division sales increased $3.1 million despite a total unit volume decrease of 2%. Overall woodwind and brass instrument shipments were 3% higher due to improved demand for woodwind products. Brass instrument shipments were consistent with the year-ago period even though we lost an estimated $3.4 million in brass instrument revenues due to the reduced availability of product caused by the strike at our Eastlake, Ohio facility.

Cost of Sales - Cost of sales increased at both divisions compared to the year-ago period. Cost of sales at our domestic piano division increased $4.7 million as a result of the sales improvement. Similarly, cost of sales overseas was $7.6 million higher due to the revenue increase.

Band division cost of sales increased $6.7 million, $2.0 million of which was attributable to the revenue improvement. However, increased costs on manufactured and sourced products of $2.4 million, as well as factory inefficiencies, adversely impacted costs of sales in 2011.

Gross Profit - Gross profit improved $9.2 million due to higher sales and gross margins at the piano division. Band segment gross profit deteriorated $3.6 million during the period. Gross margin for the band division decreased from 25.1% to 21.8% due to incremental unfavorable plant variances of $1.8 million primarily associated with Eastlake and $0.5 million in additional pension related charges. The remaining deterioration was due to higher material and overhead costs.

Piano segment gross profit increased $12.8 million during the period. Domestically, piano margins grew from 30.4% to 32.1% due to a shift in mix to Steinway grands sold at retail, which typically generate higher margins. In addition, the factory produced more Steinway grands, which resulted in greater factory efficiencies. Overseas piano margins grew from 36.3% to 38.5% since our factory in Germany also produced and sold more Steinway grands. This improved factory efficiency and generated higher profits.

Operating Expenses - Operating expenses were $10.6 million higher than in the year-ago period, of which $3.8 million is due to severance costs related to the departures of our former Chairman and former Chief Executive Officer and $1.8 million is incremental stock-based compensation. We also incurred $1.1 million of legal and consulting costs primarily related to the sale of Class A Common stock by our former Chairman and former Chief Executive Officer as well as activities undertaken by our Board of Directors in pursuit of strategic alternatives.

Impairment and Facility Rationalization Charges - Impairment and facility rationalization charges increased $5.5 million in the current year. We wrote down $0.3 million of trademarks and $2.7 million of goodwill associated with our online music business, $1.1 million of property, plant and equipment associated with our woodwind instrument manufacturing facility, $1.1 million related to band division trademarks and goodwill, and $0.3 million in assets held for sale by our band division. In the year-ago period we had no impairment charges.

Non-operating Expenses - Non-operating expenses were $2.5 million higher than the year-ago period for several reasons. We incurred incremental operating expenses of $2.7 million from our West 57th Street building. We expect to incur a temporary loss on this facility due to low occupancy rates. Also, our gains from foreign exchange were $0.6 million lower in 2011. We had $3.9 million in net interest saving due to the extinguishment of $85.0 million in principal of our 7.00% Senior Notes in May 2011, which resulted in a loss on extinguishment of $2.4 million.