##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 
 FORM 10-KSB ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004 Commission File No.: 0-26192 MakeMusic!
Inc.
  Minnesota
(State or other jurisdiction of
incorporation or organization)
    
    41-1716250
(IRS Employer
Identification Number)
 6210 Bury Drive, Eden Prairie, Minnesota 55346-1718
(Address of principal executive offices)(Zip Code)
Issuers telephone number, including area code: (952) 937-9611 Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock Check whether the Issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of
the Exchange Act during the past 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 for the past
90 days.Yes þ Noo Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B
contained herein, and no disclosure will be contained, to the best of Registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB.
þ Issuers revenues for its most recent fiscal year: $11,240,000 The aggregate market value of the Common Stock held by non-affiliates of the Registrant as of March
8, 2005 was approximately $13,137,735 based upon the closing price of the Registrants Common Stock
on such date. There were 3,419,464 shares of Common Stock outstanding as of March 8, 2005. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrants definitive Proxy
Statement for its 2005 Annual Meeting are incorporated by reference into Part III. Transitional Small Business
Disclosure Format (check one). Yes
o Noþ




---



TABLE OF CONTENTS Page No.PART I
    
    
    2Item 1.
    
    Description of Business
    
    
    2Item 2.
    
    Description of Property
    
    
    11Item 3.
    
    Legal Proceedings
    
    
    11Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    11PART II
    
    
    12Item 5.
    
    Market for Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities
    
    
    12Item 6.
    
    Managements Discussion and Analysis or Plan of Operation
    
    
    12Item 7.
    
    Financial Statements
    
    
    18Item 8.
    
    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    
    
    40Item 8A.
    
    Controls and Procedures
    
    
    40Item 8B.
    
    Other Information
    
    
    40PART III
    
    
    41Item 9.
    
    Directors and Executive Officers of the Registrant
    
    
    41Item 10.
    
    Executive Compensation
    
    
    41Item 11.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    
    
    42Item 12.
    
    Certain Relationships and Related Transactions
    
    
    42Item 13.
    
    Exhibits
    
    
    42Item 14.
    
    Principal Accountant Fees and Services
    
    
    42Restated Articles of Incorporation as AmendedForm of Incentive Stock Option AgreementForm of Nonqualified Stock Option AgreementForm of Restricted Stock AgreementConsent of McGladrey & Pullen LLPConsent of Ernst & Young LLPCertification by CEO Pursuant to Section 302Certification by CFO Pursuant to Section 302Certification by CEO Pursuant to Section 906Certification by CFO Pursuant to Section 906
  1




---



##### Table of Contents



PART I 
 ITEM 1. DESCRIPTION OF BUSINESS General MakeMusic! Inc., a Minnesota corporation, is a world leader in music education technology
whose mission is to enhance and transform the experience of making, teaching and learning music.
Among its leading products are SmartMusic®, the complete music practice system that features
Intelligent Accompaniment® and the worlds largest interactive accompaniment library and Finale®,
the worlds best-selling music notation software. SmartMusic is a complete, interactive, computer-based practice system for woodwinds, brass
players, vocalists and strings. SmartMusic enhances and transforms the process of practicing music
by accompanying musicians while they practice  following their spontaneous tempo changes like a
human accompanist. Offered through subscription, SmartMusic gives musicians access to a library of
more than 30,000 professionally performed and recorded accompaniments and more than 50,000
exercises. For over a decade, Finale has been the worlds best-selling music notation software. It has
transformed the process by which composers, arrangers, musicians, teachers, students and publishers
create, edit, audition, print and publish musical scores. In the world of music software, Finale
is the equivalent of Adobe® PageMaker® or Adobe® Illustrator®  it is what musicians use for page
layout of sheet music. Strategy MakeMusic! works with teachers and publishers in a proactive collaboration to meet the needs
of active music makers and to develop products for them. The long-term leadership established by
our Finale software with music educators internationally provides MakeMusic! with credibility in
the marketplace to capitalize on the development of SmartMusic and other new products. The worldwide market for products and services sold to student, hobbyist and professional
musicians is estimated by the Company to be approximately $15.5 billion, with music software as one
of its fastest-growing segments. As music educators and parents search for ways to make student
practicing more fun and productive, MakeMusic! is building on its current leadership position to
become a key driver in the future of music education. Possessing many key technologies that can be
combined and expanded upon, in a cost-effective manner, we believe we are uniquely positioned to
offer continuous innovation to music makers. MakeMusics business strategy is characterized by the following principles: Focus on meeting the needs of a highly influential niche market.By focusing on providing
superior, long-lasting solutions for music educators, MakeMusic! gains exceptional access to the
larger market of student and hobbyist musicians at the lowest possible cost. Deliver high-quality patented technologies and licensed content.The complexity of the
notation and Intelligent Accompaniment technologies at the core of MakeMusics products represent a
significant barrier to entry to competition. Furthermore, we hold licenses to a major library of
music, adding to this barrier. Capitalize on fundamental shifts in the marketplace.MakeMusics products support two shifts
that are leading to long-term growth opportunities: its products support the adoption of the
digital lifestyle in which music is a market driver; and its products provide the building blocks
that meet the demand for quantification and assessment tools in the evolving e-learning market for
music education. Leverage an extensive customer database for targeted and personalized direct marketing.With
an active database of nearly a half-million musicians, MakeMusic! is able to target, personalize
and develop each customers buying potential in an optimal fashion. Supporting this initiative,
MakeMusics management has gained operational experience in world-class customer relationship
management businesses. 2




---



##### Table of Contents



Grow the SmartMusic business through the leveraged support of music educators.MakeMusic!
introduced an annual subscription for teachers late in 2001 and a monthly subscription for home
users in the spring of 2002. In October 2002, we launched the school-sponsored home subscription
program, allowing schools to sponsor their students home use of SmartMusic at substantial
discounts. Maintain and strengthen Finale market leadership and revenues.Finale music notation software
is accepted worldwide as the industry standard. We will seek to maintain Finale revenues by
continuing to introduce innovative upgrades to its products. MakeMusic! intends to grow revenues
by expanding coverage throughout the world and more aggressively pursuing the marketing of products
outside the U.S. Partner with leading industry players.MakeMusic! is continuing to pursue and expand
strategic alliances with entities that have the marketing power and capital resources to fully
exploit SmartMusics potential around the world. We will also pursue alliances that enhance our
technology base into complementary music and educational markets. Already, we have forged key
strategic relationships with: McGraw-Hill, the largest music textbook publisher; Hal Leonard
Corporation, the largest sheet music publishing company; Conn-Selmer, the largest manufacturer of
band and orchestral instruments and accessories in the United States; and Berklee College of Music,
the worlds premier learning lab for the music of today. Grow the business step by step.MakeMusic! currently has sufficient capital necessary to
continue the product development and marketing efforts necessary to grow our business. We are
planning to continue business development with attention to careful cash management while
continuing to grow revenues with a view to attaining profitability as soon as possible. Products SmartMusic.SmartMusic® is a complete, interactive, computer-based music system that
transforms and modernizes the way a musician practices by providing human-like accompaniment in a
wide range of musical styles performed by orchestras, jazz trios, rock bands, and other musical
ensembles. Its key innovation, the patented Intelligent Accompaniment®, enables SmartMusic to
listen to a musician as he sings or plays and follow his spontaneous tempo changes. In addition,
SmartMusic allows the user to start playing at any point in a musical piece, repeat
difficult-to-play segments, change instrumentation, adjust the degree to which the accompaniment
follows the musician, control tempo, transpose the music into any key, play with or without repeats
or designate sections of the music to cut. The software also includes self-assessment features and
allows the user to record his performance and send it by e-mail. The prototype technology upon
which the SmartMusic system is based was patented by Carnegie Mellon University and licensed to us.
We then significantly enhanced the prototype technology with our own proprietary technology and
additional patented features, producing a marketable product. SmartMusic is a unique product that
has won numerous awards as well as the support of world-class musicians such as Wynton Marsalis,
James Galway, Dawn Upshaw and others. Via a subscription, schools, students and hobbyists have access to over 30,000 licensed
accompaniments including elementary band methods, classical, jazz, pop, rock, movie, theater, and
holiday titles. We have entered into license agreements with top music publishers to produce
synthesized versions of musical arrangements for use with SmartMusic. We have also received the
exclusive rights from certain major publishers to all solo classical works for voice, woodwinds,
brass, percussion, strings and keyboard for the purpose of musical accompaniment products, which
respond in real time to the musician. We have developed our accompaniment selection based on a
review of the most frequently performed titles in American academic solo contests as well as
popular titles of sheet music sold at retail in the United States. In the future, we plan to
continue expansion of our library of accompaniments to cover a broad spectrum of musical genres,
instruments and skill levels as well as international preferences for music performance. Further,
users of our notation software (see below) can create their own accompaniments, which can be played
by SmartMusic subscribers. In addition, SmartMusic users have access to a selection of accompaniments to more than 50,000
skill-development exercises based on scales, intervals, arpeggios and twisters. The products also
feature warm-up exercises for vocalists, the ability to insert tempo changes with variations in
speed, and the ability to insert breath marks and cues to wait for a particular tone. These
variables can be saved with the music, creating a personally
customized version of the accompaniment. SmartMusic provides accompaniments for band and
string instruments as well as vocalists. 3




---



##### Table of Contents



We launched our website www.smartmusic.com and started to market SmartMusic on a
licensed subscription basis to schools in the United States in December 2001 with a decreasing
price scale ranging from $90 per year for the first subscription down to $20 per year for the
fourth and subsequent subscriptions. The home subscription program, priced at $9.95 per month or $90 per year, was launched in
spring 2002. In response to teachers requests to have an offer which would encourage all their
students to use SmartMusic at home, we developed and launched our school-sponsored home
subscription program in October 2002, which allows participating students to buy a subscription for
$20 per year as long as the school signs up at least 10 students. The students can get their
subscription directly from the www.smartmusic.com website using a code generated by their teachers.
In 2005, we plan to expand the ability to generate codes beyond teachers to include organizations
of musicians. We believe that the SmartMusic subscription-based revenue model, with its recurring
stream of revenues, offers a significant opportunity to increase profitability. We also sell a
packaged box Subscription Starter Kit through dealers, that includes a one-year subscription plus a
vocal and instrumental microphone for a suggested retail price of $119.95. Finale notation family.We believe we are a market leader in music notation software with our
Finale family of products for use with Macintosh® and Windows® PC operating systems. Music
notation software enables a musician to enter musical data into a computer using either the
computer keyboard, a MIDI- (Musical Instrument Digital Interface) equipped electronic music
keyboard or other MIDI-equipped instruments and contemporaneously display the data on a computer
screen as a musical score. The dramatic improvements in speed and flexibility provided by programs
like Finale software have made such software the dominant method for composers, arrangers,
publishers and music teachers to create printed music. The Finale product is generally recognized as one of the most powerful and comprehensive
notation software products in the world. Finale music notation software has a suggested retail
price of $600. Finale software is differentiated from other music notation software by its breadth
and depth of features, including patented capabilities such as its hyperscribe feature.
HyperScribe® allows users to freely play music with varying tempos via a MIDI keyboard while the
software interpolates the rhythms and accurately notates the music in real time. We also produce an Academic/Theological Edition of the Finale product that is sold exclusively
to schools, teachers, college students and religious institutions at a suggested retail price of
$300. This edition has also been a key source of revenue and registered user base growth for us
and represents a market that is continually being replenished with new student users. The product is currently translated into German, French, Spanish, Italian and Japanese.
Related manuals are currently available in German, French, Spanish, Italian, Swedish, Dutch and
Japanese. We believe the international market is a key growth opportunity as computer penetration
increases worldwide. The Finale® Allegro® product, a value priced version of the powerful Finale music notation
software product, was introduced in 1993. The Allegro music notation software product retails for
$199 and contains a subset of the notation tools contained in the Finale product. With extensive
MIDI capabilities, Allegro is targeted to an audience that may not read music but needs to create
lead sheets for other musicians, and is therefore known as, the MIDI Users Choice for Music
Notation. In October 2002, we introduced Finale® Guitar, a value priced version of Finale for guitar
players that retails for $99.95. The newest addition to our award-winning Finale music notation
software line offers powerful new features for guitarists and fretted instrument players, as well
as file compatibility with Finale. Special features just for the guitar include TAB notation
features that allow users to enter music in a traditional staff and see it displayed automatically
in a TAB staff or vice versa, an extensive library of special symbols and shapes used with notation
for standard guitar or any of the more than fifty fretted instruments Finale Guitar supports, and a
feature that allows users to input notes with a MIDI guitar and see instant TAB notation. Finale® PrintMusic!®, an entry-level, yet powerful music notation software product retails for
$69.95 and contains a subset of the notation tools contained in the Finale and Finale Allegro
products. Finale PrintMusic!, introduced in 1999, allows us to offer an entry-level product to the
retail customer, thereby expanding the base of registered users and increasing the potential for
sales of notation software upgrades. This product is targeted to a broader audience in the
education and general consumer marketplace. 4




---



##### Table of Contents



Finale® NotePad® is a downloadable freeware introduction to the Finale notation family. As of
December 31, 2004, there are 1,067,500 unique users of Finale NotePad with over 1,600,000 total
downloads of NotePad products. Late in 2002, we introduced Finale® NotePad® Plus, an upgraded version of NotePad available
for customers to download for $24.95. NotePad Plus turns any standard MIDI file into sheet music.
Whether using MIDI files from a persons own sequencer or accessing the thousands of available
Internet MIDI files, NotePad Plus is a cost-effective route to converting playback files into sheet
music. Synergy Between Product Lines From a technology perspective, there are considerable synergies between the SmartMusic
business and the Finale notation business. This is because the products benefit from shared
technologies. The Finale notation technology, for example, is used within SmartMusic to display
sheet music, exercises, beginning band method songs, etc. It is this same technology that puts red
and green notes on the screen to show SmartMusic students what they did wrong and how to do it
right. Similarly, the SmartMusic pitch recognition technology is used within Finale in its
MicNotator® feature, which allows Finale users to enter notes by simply playing an acoustic
instrument into a microphone. Indeed, the synergistic integration between SmartMusic and Finale
notation products represents a significant differentiator for our notation products in the
marketplace. Likewise, the ability to effortlessly create SmartMusic repertoire using the Finale
product is a major benefit for SmartMusic customers. More important than the technology synergies, however, are the market and customer synergies.
We estimate that Finale is well-established in over 30,000 schools, all of which are targets for
SmartMusic. The school decision-makers, teachers, know and respect Finale and are willing to learn
about new products from MakeMusic! Similarly, the Finale channels of distribution are anxious to
build upon their continuing Finale sales with new products from MakeMusic! Technology Infrastructure The MakeMusic! Inc. data center is operated internally, offering extensive uptime and
connectivity to the Internet backbone via dual dedicated T1 connections provided by Qwest®. For
maximum reliability, all our servers utilize redundant arrays of independent disks for information
backup as well as redundant power. We are currently utilizing Compaq®, SUN® and Cisco® hardware
solutions running under Microsoft Windows® and Solaris® platforms. Web services are run on
Microsoft IIS® and Apache® servers. A combination of Microsoft SQL® and Oracle® are used for
database applications. Our entire network is monitored twenty-four hours a day, seven days a week
and is fully scalable and upgradeable for future growth. www.smartmusic.com.The SmartMusic website distributes our SmartMusic subscription
product and SmartMusic accessories. www.finalemusic.com.The Finale website promotes notation products and e-commerce
with mail-order fulfillment and also downloads of Finale NotePad and Finale® NotePad® Plus. www.makemusic.com.The MakeMusic! website includes information on the Company and
both its notation and SmartMusic products. It provides links to www.smartmusic.com and
www.finalemusic.com for people wanting to make purchases of the Companys products. Marketing, Sales and Distribution SmartMusic.MakeMusic! believes its future revenue growth will be driven by its proprietary,
patented product SmartMusic, the worlds first computer software that is a complete music practice
system. SmartMusic features its award-winning Intelligent Accompaniment technology and the worlds
largest library of interactive music accompaniments. The market for SmartMusic is large, with at-home use being the biggest potential market.
There are over 100,000 school buildings in the U.S. that have nearly 15 million students enrolled
in band, orchestra and choir programs. The school-sponsored home subscription offering encourages
teachers to be advocates to students and parents for SmartMusic at home. Our expanding
subscription sales model is likely to result 5




---



##### Table of Contents



in increased profit margins because of a recurring
stream of revenues and cash flow, depending on the rate at which schools will adopt the SmartMusic
system and on our success in establishing long-term customer relationships with the SmartMusic
subscribers. We plan to focus on adoption and customer satisfaction to leverage the
school-sponsored home subscription model. MakeMusic! intends to utilize a variety of marketing channels to achieve the best mix for
profitable growth. In the United States and Canada, SmartMusic is being marketed by traditional
direct mail, e-marketing, member-get-member initiatives, trade show exposure at over 40 state music
educator conferences and advertising in targeted print media. We are also recruiting experienced
music educators to join our educator support system (ESS), through which they help us reach their
fellow music educators. In addition, we have developed SmartMusic Intelligent Accompaniment software for Hal Leonards
Essential Elements®, the worlds best-selling method books for beginning band students.
This is part of a strategic partnership with Hal Leonard Corporation, the worlds largest sheet
music publisher. This relationship is very important because students usually start to play in a
school band in the fifth grade. In the United States alone, there are approximately 2.5 million
fifth graders starting band every year. If many of these students have a successful experience
starting out with SmartMusic, they will likely become users of other MakeMusic! products, including
Finale software and new products introduced in the future. As a result of a special marketing and
licensing agreement, Hal Leonard offers SmartMusic in its Essential Elements book 1 for both band
and orchestra students, reaching approximately 1 million students per year. Students receive a
free trial offer giving them access to accompaniments to the first half of the book; and they will
receive an offer to purchase access to the second half of the book as well as to become regular
subscribers thereafter. Though the primary distribution for SmartMusic subscriptions is via the
www.smartmusic.com website (linked with www.makemusic.com, and
www.finalemusic.com), we also have a network of education dealers and distributors
supporting the Subscription Starter Kit of SmartMusic designed for sale at retail. Distributors
service the music instrument retailers, college bookstore and educational software markets. We are
also working with key dealers to implement a beginning band instrument rental opportunity. A future marketing strategy is to deploy SmartMusic at key partner sites that already have
customers frequenting their sites. SmartMusic creates the opportunity to strengthen their music
makers community while sharing in the revenues from recurring SmartMusic subscription fees.
Offering SmartMusic is extremely easy for a partner site since we project SmartMusic onto their
site from our own servers and handle all transactions including back office functions. The international marketplace in Europe, Latin/South America and Asia is significantly larger
than the North American market. Chinas increasing participation in global trade and improved
western relations is anticipated to soon open up the single largest market for music software
technology like SmartMusic. In Europe, distributors in key territories including the United
Kingdom and Germany are currently marketing SmartMusic. The Subscription Starter Kit will assist
in expanding their efforts. The majority of SmartMusics worldwide exposure is driven by successes
in the efforts of ESS members and our own web-based initiatives and presence to date. We also intend to continue to deepen the integration with notation technology. Finale notation family.In the United States and Canada, the Finale family of notation
products is sold by a group of channel-specific distributors in the musical instrument and
educational channels. Finale is also marketed to educational institutions and specialty retailers
on a direct basis. Repeat business is driven by direct marketing to registered users for product
upgrades and trade-ups. Internationally, Finale notation products are represented by one or more key distributors in
32 overseas territories, primarily in Europe and Japan. Available in six different languages,
Finale generates approximately 20% of its sales over 125 countries abroad. We believe the
international markets present an additional opportunity for future growth. Music makers can also utilize Finale software to create accompaniments for use with
SmartMusic. A Finale file is simply saved as a SmartMusic accompaniment and becomes part of the
Intelligent Accompaniment system. This interplay provides MakeMusic! with cross-marketing
opportunities between Finale and SmartMusic users and products. 6




---



##### Table of Contents



We believe we can significantly build on our Finale notation software business by continuously
expanding the installed base of users, regularly providing them with upgrades, broadening retail
distribution, producing additional international versions of the products and establishing the
products as a means for electronic transmission of music. Finale upgrades were introduced on both
the Windows® platform and Macintosh® platform in each of the last eight years. Starting with
Finale 2005, released in 2004, all Finale products now operate on both Windows and Macintosh
platforms. Product Development We intend to continue to expand our current product offerings by developing products for new
applications and markets. Website.Website development expense consists of expenses required for design and development
of the MakeMusic, SmartMusic and FinaleMusic websites and underlying technology infrastructure.
These expenses primarily include personnel costs and payments to third-party service vendors. All
of our websites are maintained and updated on a regular basis. In addition, we plan to refine the SmartMusic Internet subscription model and further develop
its distribution capabilities on other Internet websites. Content and product.Content and product development consists primarily of internal payroll
and payments to third parties for the development and ongoing maintenance of notation products and
the SmartMusic subscription software. We continue to create additional SmartMusic accompaniments to be included with our
subscriptions. Procedures have been created to synthesize classical music and mark music
sequences. Additionally, we have automated some of the process and developed a technical
specification that is used to standardize both quality and process. We have maintained our competitive position in the music notation marketplace in part by
focusing our improvement efforts over the past nine years on developing upgrades of the Finale
product on a regular basis for the Macintosh and Windows platforms. We expect to make annual
releases of such upgrades. The remainder of the Finale family of products is updated periodically. We intend to continue developing music education products with our proprietary music
technologies. Competition We believe we are well positioned in music technology markets and benefit from strong barriers
to entry for new competitors in our business niches because of our 1) proprietary music notation,
Intelligent Accompaniment and music education software; 2) extensive library of licensed content;
3) credibility in the music education marketplace; and 4) relationships with major industry
partners. We know of no other musical accompaniment product for band instruments, string
instruments, and vocalists that responds to the musician with the exception of In Concert by
Cakewalk, which is an interactive product for MIDI keyboards. We expect that SmartMusic products
will also compete with conventional music accompaniment products by Music Minus One by MMO Music
Group, Inc. and MTS 120 by Roland Corporation. These products offer students the ability to play
along with prerecorded songs. They differ from the SmartMusic product in that they do not
automatically adjust in real time to the musicians changes in tempo and they do not provide
graphical assessment. We believe our SmartMusic system is unique because this product listens to
the musician and adjusts accordingly. The notation market is highly competitive and continues to have competitors such as Steinberg,
Sibelius Software LTD, and Voyetra Inc. Competitive factors in marketing the SmartMusic and Finale products include product features,
quality, brand recognition, ease of use, merchandising, access to distribution channels, retail
shelf space and price. We believe we compete effectively in these areas. In addition, a
competitive advantage is that both product lines benefit from shared technologies. For example,
the SmartMusic pitch recognition technology is used within Finale in its MicNotator feature,
allowing Finale users to enter notes by simply playing an acoustic instrument into a microphone. 7




---



##### Table of Contents



Patents We have licensed, from Carnegie Mellon University (CMU) on a worldwide basis for the life of
the patent, the use of the U.S. patent that covers the automated accompaniment that listens to and
follows tempo changes from a live performance. We have further developed this technology and
patented additional features. We have obtained five additional patents that protect improvements
to the user control of the software and that contain certain aspects of the repertoire file which
enhance the following capabilities of the software: enhancements to the algorithms, accompaniment
controls and repertoire data files and miscellaneous interface features of the product. As a
result of the additional patented features we have developed and continuing development of an
extensive library of repertoire over the next several years, we do not believe that SmartMusic will
be materially affected by the expiration of the CMU patent in 2005. Our Finale product is covered by three separate patents, which protect the data structure, the
ability to enter music into the product by tapping tempo with a pedal device or computer keyboard,
and the method of automatically assigning guitar fingerboards to a notated chord. These patents
are licensed from Wenger Corporation on a royalty-free, exclusive, worldwide basis for the life of
the patents. Trademarks We own the registered trademarks in the United States for Allegro®, Coda®, Finale®, Finale
Allegro®, Finale NotePad®, Finale PrintMusic! ®, HyperScribe®, Intelligent Accompaniment®,
Intonation Trainer®, MakeMusic!® , MicNotator®, Net4Music®, Practice Studio®, SmartMusic®,
SmartMusic Accompaniments®, SmartMusic Studio®, and The Art of Music Notation®. In addition, the
names Coda®, Finale®, Intelligent Accompaniment®, Net4Music®, SmartMusic® and The Art of Music
Notation® have been protected in some foreign countries. We have applied for trademark
registration in the U.S. for FinaleScript, M!, Finale SongWriter, FPA, Finale Performance
Assessment, and Human Playback. In addition to our own registered trademarks, this report
contains references to trademarks owned by third parties. Manufacturing Printing of user manuals, packaging, and the manufacture of related materials are performed to
our specifications by outside subcontractors. We currently use two subcontractors to perform
standard copying and assembling services, including copying product software CD-ROM disks, and
assembling the product manuals, disks and other product literature into packages. If either of our
subcontractors is unable to perform, there are many alternative vendors that we could use for this
service. Employees As of December 31, 2004, MakeMusic! employed 69 full-time employees. We believe our relations
with employees are good. None of our employees are covered by a collective bargaining agreement.
In addition, we rely on independent contractors to help develop our repertoire or products. We
have little difficulty contracting with these individuals and believe that our relationships with
them are good. Should we have difficulty securing the services of such persons in the future, it
could adversely affect operations. Available Information All reports filed electronically by MakeMusic! with the Securities and Exchange Commission
(SEC), including its annual reports on Form 10-KSB, quarterly reports on Form 10-QSB, current
reports on Form 8-K, proxy and information statements, other information and amendments to those
reports filed (if applicable), are accessible at no cost by contacting the investor relations
department at MakeMusic! These filings are also accessible on the SECs website at
www.sec.gov. The public may read and copy any materials filed by the Company with the SEC
at the SECs Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may
also obtain information for the Public Reference Room by calling the SEC at 1-800-SEC-0330. 8




---



##### Table of Contents



Cautionary Statements The Private Securities Litigation Reform Act of 1995 (the Reform Act) provides a safe harbor
for forward-looking statements made by us or on our behalf. We have made, and may continue to
make, various written or verbal forward-looking statements with respect to business and financial
matters, including statements contained in this document, other filings with the Securities and
Exchange Commission, and reports to stockholders. Forward-looking statements provide current
expectations or forecasts of future events and can be identified by the use of terminology such as
believe, estimate, expect, intend, may, could, will and similar words or expressions. Our forward-looking statements generally relate to our growth strategy, financial results,
product development and sales efforts. Forward-looking statements cannot be guaranteed and actual
results may vary materially due to the uncertainties and risks, known and unknown, associated with
such statements. We undertake no obligation to update any forward-looking statements. We wish to
caution investors that the following important factors, among others, in some cases have affected
and in the future could affect our actual results of operations and cause such results to differ
materially from those anticipated in forward-looking statements made in this document and elsewhere
by or on our behalf. It is not possible to foresee or identify all factors that could cause actual
results to differ from expected or historic results. As such, investors should not consider any
list of such factors to be an exhaustive statement of all risks, uncertainties or potentially
inaccurate assumptions. While we currently believe that we have sufficient capital, we may have other capital needs.
We achieved positive operating cash flow in 2004 and expect it to continue to be positive in the
future, provided we continue to increase revenue and manage expenses. If we do not maintain
positive cash flow, we will need additional capital to continue to operate the business.
Additional capital may be needed if there is a significant change in our business plan or operating
results. There is no assurance that additional capital will be available on terms favorable to us
or at all. We are dependent upon our new product development efforts.Additional development work is required to increase the breadth of our SmartMusic business and the accompaniment repertoire for SmartMusic. There can be no assurance that our timetable for any of our development plans will be achieved, that sufficient development resources will be available or that development efforts will be successful. We are dependent upon our Internet business.We are dependent on the Internet to activate our SmartMusic subscriptions and secure our licensed content. We also utilize the Internet as one of our order-processing channels. A number of uncertainties relate to the Internet aspects of our business. If we experience problems developing and maintaining our Internet operations, our sales, operating results and financial condition could be adversely affected. We are dependent upon obtaining and maintaining license agreements with music publishers, of which there are a limited number.The world market for music license rights is highly concentrated among a limited number of publishers. We have entered into license agreements with leading music publishers that provide access to certain musical titles for accompaniment development. Many of our contracts with major publishers are not exclusive, which means that similar agreements may be made with competitors or that the publishers themselves may sell the same titles. While we believe that our relationships with these publishers are good, there can be no assurance that we will be able to maintain or expand these relationships. The lack of a sufficient number and variety of musical arrangements would greatly limit the ability to market our products and services. Certain of our products have limited and fluctuating sales.Sales of our SmartMusic subscription products have not achieved, and may not achieve, significant levels. Further, Internet sales have fluctuated, as have sales of Finale products, which are historically higher following the release of product upgrades. We believe that results of operations may fluctuate as a result of, among other things, the purchasing cycle of the education market and the timing of releases of new products and product upgrades. Certain states have had education funding cuts, which could potentially negatively impact sales of academic products to the education market. We have incurred operating losses in the past and may continue to incur losses in the near future.We have incurred operating losses since inception, and may continue to incur such losses in the near future. Such losses will include non-cash expenses due to the amortization of intangible assets recorded as a result of the reverse merger transaction with Net4Music S.A. in 2000. In order to continue to develop our business and planned product and service offerings, we will be required to devote additional amounts of capital to development and marketing efforts, among other things. There can be no assurance that we will ever operate profitably or provide an economic return to the investors. 9




---



##### Table of Contents



We face intense competition.While competition for SmartMusic is relatively limited, there
can be no assurance that others, such as large electronic and musical instrument manufacturers,
will not enter this market. Competition for our notation products could potentially adversely
impact future sales levels. Our ability to continue to compete effectively will be substantially
dependent upon our ability to continue to improve our product offerings and Internet resources. If
such improvements and development efforts do not materialize as intended, we may lose our ability
to differentiate our products from those of our competitors. In addition, increasing competition
in the music software market could cause prices to fall and the volume of transactions to decline,
either of which could adversely affect our business, operating results and financial condition. Rapid technological changes and obsolescence may adversely affect our business.We operate in
an industry greatly affected by technological changes. While we are not currently aware of any
significant technological changes that may affect our current technology base, continued
advancements in computer software, hardware and network designs and formats may impact our ability
to effectively maintain our Internet-based sales efforts in a workable and user-friendly format.
The proprietary technology we use to protect access to our licensed files may be effective for only
a limited period by reason of technological change. We must, therefore, devote new resources to
improve or modify this security system, which is a critical aspect of our ability to establish and
maintain relationships with music publishers. While we currently believe that we have sufficient
resources to address technological changes that may affect our business, there can be no assurance
that any such technological changes will not prove too much for us to overcome in a cost-effective
manner. Additional government regulation of the Internet may impair our ability to fully develop and
utilize the Internet as a marketing and distribution medium.Today, there are relatively few
enacted laws specifically directed toward online services, and the applicability and scope of such
laws is still uncertain, as court interpretations are few. Currently, we do not believe their
impact materially affects the nature of our Internet operations. Applicability to the Internet of
existing laws governing issues such as property ownership, copyrights and other intellectual
property issues, taxation, libel, obscenity and personal privacy is uncertain. In addition,
because our services are accessible worldwide, foreign jurisdictions may claim that we are required
to comply with their laws. Laws regulating Internet companies outside of the U.S. may be less
favorable than those in the U.S. Compliance with foreign laws may require us to change our business practices or restrict our
service offerings to an extent that may damage our financial results. Further, changes to existing
laws or the passage of new laws affecting the Internet could directly affect the way we do
business, create uncertainty on the Internet, reduce
demand for our services, increase the cost of doing business, or otherwise harm our business.
Our failure to comply with domestic or foreign laws could also subject us to penalties ranging from
fines to bans on our ability to offer our services. We are dependent upon certain key personnel.We are highly dependent on a limited number of
key management, including Bill Wolff and John Paulson, and key technical personnel. The loss of
key personnel, or inability to hire and retain qualified personnel, could have an adverse effect on
our business, financial condition and results of operations. We are dependent upon proprietary technology and cannot assure protection of such technology.
There can be no assurance that our proprietary technology will provide us with significant
competitive advantages, that other companies will not develop substantially equivalent technology
or that we will be able to protect our technologies. We could incur substantial costs in seeking
enforcement of our patents or in defending ourselves against patent infringement claims by others.
Further, there can be no assurance that we will be able to obtain or maintain patent protection in
the markets in which we intend to offer products. International development plans are subject to numerous risks.There can be no guarantee that
our international expansion efforts will be successful or that we will be able to offset the cost
of the resources allocated to such efforts. Moreover, we could be faced with the risks inherent in
any international development, such as unpredictable changes in export restrictions, barriers and
customs rates; currency risks; the difficulty of managing foreign operations; the differences in
technological standards, payment terms and labor laws and practices among countries; collection
problems; political instabilities; seasonal reductions in business; and unforeseen taxes. Such
risk factors could harm our international operations and, therefore, our business, operating
results and financial condition. 10




---



##### Table of Contents



The market price of our stock may experience volatility.We cannot speculate as to the future
market price of our Common Stock. Our Common Stock has experienced, and may continue to
experience, significant price volatility due to a number of factors, including fluctuations in
operating results, changes in market perspectives for our products, developments in our industry,
and general market conditions that may be unrelated to our performance. 
 ITEM 2. DESCRIPTION OF PROPERTY The Minnesota location leases approximately 12,150 square feet of office and warehouse space
at 6210 Bury Drive, Eden Prairie, Minnesota 55346. Rent and maintenance payments for the remainder
of the lease are approximately $125,000 on an annual basis and the lease expires April 30, 2006.
We lease an office in Paris with approximately 600 square feet at 32, Avenue Duquesne, 75007 Paris,
France, for current annual net rent of approximately $18,000. We may opt out of the Paris lease
effective September 1, 2005. We also lease approximately 200 square feet of space for a sales
office in Lyon, France for annual rent of approximately $10,000 with a commitment to lease the
property through June of 2005. 
 ITEM 3. LEGAL PROCEEDINGS In the ordinary course of business, we may be party to legal actions, proceedings or claims.
Corresponding costs are accrued when it is more likely than not that loss will be incurred and the
amount can be precisely or reasonably estimated. We are currently participating in negotiations to
settle a case with a small French sheet music publisher that claimed wrongful termination of a
contract. We believe that the case is without merit, but have accrued $27,000 for a possible
settlement. The Company is not aware of any threatened litigation that would have a material
adverse effect on its financial condition or results of operations. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 11




---



##### Table of Contents



PART II 
  ITEM 5.
    MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES There were no sales of unregistered securities during the year ended December 31, 2004. On November 17, 2004, former director Francois Duliege, exercised a warrant to purchase 21,673
shares of common stock of MakeMusic! Inc. at an exercise price of $0.50 per share for a total
purchase price of $10,836.50. This transaction is exempt from registration pursuant to Section
4(2) under the Securities Act of 1933, as amended. Our common stock trades on The Nasdaq SmallCap Market under the symbol MMUS. The following
table sets forth the high and low sales prices of our common stock for the periods set forth: 2004
    
    
    2003High
    
    
    Low
    
    
    High
    
    
    LowFirst Quarter
    
    $
    3.70
    
    
    $
    2.45
    
    
    $
    2.90
    
    
    $
    1.50Common
    
    
    Second Quarter
    
    
    4.40
    
    
    
    2.50
    
    
    
    2.85
    
    
    
    1.60Stock
    
    
    Third Quarter
    
    
    3.94
    
    
    
    3.00
    
    
    
    2.59
    
    
    
    1.65Fourth Quarter
    
    
    5.95
    
    
    
    3.06
    
    
    
    3.10
    
    
    
    1.58
 As of December 31, 2004, there were approximately 1,500 shareholders including approximately
1,325 beneficial owners. We have never paid cash dividends on any of its securities. We currently
intend to retain any earnings for use in operations and do not anticipate paying cash dividends in
the foreseeable future. 
 ITEM 6. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION Executive Overview MakeMusic! intends to achieve significant growth as a worldwide leader in music education
software. We have traditionally derived revenue through the development, marketing and sales of
our notation software products, accepted as market leaders around the world and in six languages.
These products continue to grow through regular upgrade releases and natural renewal in the
education market. We are also working on developing their full potential internationally. SmartMusic, our complete practice software system, is expected to be a growth engine that
takes us beyond our strength in notation software. SmartMusic is becoming a very important part of
our business with recurring revenue from the subscription-based model that leverages our
relationships with music educators and their students. We continue to fine-tune the model to
ensure strong acceptance of the SmartMusic subscription service. Due to alliances with industry
leading partners such as Hal Leonard and Conn-Selmer, we expect to see substantial growth
opportunities in 2005 and in future years. While it is difficult to predict the volume increase
these alliances may generate, we are confident that we will be ready for the challenges this growth
may present. With Finale and SmartMusic, we believe we have the platforms for building a growing business
in music education software. We are exploring opportunities to introduce our existing products
into new geographic markets through existing distribution partners and new relationships. We are
also exploring opportunities to develop and launch new products based on our core music education
technologies: the editing, display, printing and playback of music notation, pitch recognition,
assessment, recording, and Intelligent Accompaniment. After two years of streamlining the business and cutting costs, we were able to achieve
positive cash flow in the year ended December 31, 2004. With increased revenues and, in
particular, the growth in SmartMusic subscriptions, plus our improvements in efficiency over the
last few years, we feel that we can achieve positive
operating cash flow in the future. In spite of tight budgets in the school systems, we are
confident that we can continue to move toward profitability due to our improvements in operations,
established customer base, and partnerships with education providers. 12




---



##### Table of Contents



Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in conformity with U.S. generally accepted
accounting principles. The preparation of these financial statements requires management to make
significant estimates and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of revenues and expenses during the
periods presented. We believe that the following are some of the more critical judgment areas in
the application of our accounting policies that currently affect our financial condition and
results of operations: Revenue recognition.Software revenue is recognized in accordance with the American Institute
of Certified Public Accountants (AICPA) Statement of Position (SOP) 97-2, Software Revenue
Recognition, when all of the following conditions are met: there is evidence of an agreement with
the customer (normally a purchase order), delivery has occurred, the total sales price is fixed and
determinable, collectibility is probable and any uncertainties with regard to customer acceptance
are insignificant. If a customer is entitled to a pending upgrade, revenue is deferred until
delivery of the upgrade. For any sales that include a right of return, we track return history and
record a reduction to revenue for the estimated return amount in accordance with Financial
Accounting Standards Board (FASB) Statement 48 (FAS 48), Revenue Recognition When a Right of
Return Exists. SmartMusic subscription sales are deferred and amortized to revenue on a pro-rated
monthly basis over the life of the subscription. Allowance for doubtful accounts.Our distribution in domestic and international markets
through independent dealers and distributors concentrates relatively large amounts of receivables
in relatively few customer accounts; however, none are greater than 10% of the total. Most
international customers pay for the product in U.S. dollars prior to shipment; domestic dealers and
distributors that do not prepay are granted payment terms and credit limits based on credit checks
and account history. We have successfully done business with most of our dealers and distributors
for many years and have a history of minimal uncollectible accounts. Any sales directly to home
users are prepaid and schools submit purchase orders for purchases. The Company records a monthly
accrual for potential non-payments, which has historically been sufficient to cover uncollected
accounts. Financial conditions in international markets can change very quickly and our allowance
for doubtful accounts cannot anticipate all potential changes. Inventory Valuation.Inventories are stated at the lower of cost or market, cost being
determined on a weighted average cost method. We record a provision to adjust slow-moving and
obsolete inventories to the lower of cost or market based on historical experience and current
product demand. The carrying value of inventory is evaluated at least quarterly and adjusted as
needed. Licensing reserves.Our business requires licensing rights to certain technologies and songs
that will be used in our product. Many publishers require advance payments in order to license
their property, which we booked as prepaid royalties. We periodically analyze the prepayments to
estimate the likelihood that we will fully realize the value for the amounts paid in advance for
royalties on each song. A reserve is booked against the prepaid royalty asset to estimate the
amount that may not be realized. Capitalized Software Costs.Costs incurred in the development of software products are
capitalized in accordance with the FASB Statement 86 (FAS 86), Accounting for the Costs of
Computer Software to Be Sold, Leased, or Otherwise Marketed, which requires the capitalization of
certain software development costs incurred after technological feasibility is established.
Technological feasibility is established when all planning and testing activities are completed.
Capitalization of computer software costs shall cease when the product is available for general
release to customers. We capitalize the costs of producing additional repertoire to be included
with the SmartMusic product and, upon release of a song, amortize the costs over the estimated life
of the song, not to exceed three years. Annual development of notation products consists of
maintenance costs and are expenses as incurred. Post Contract Support.We account for software maintenance in accordance with FAS 86,
Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed, which
states when the sales price of a product includes customer support for several periods and the
price of that support is not separately stated, the estimated related costs should be accrued in
the same period that the sales price is recognized. We provide unlimited, free technical support
to our customers and, therefore, accrue an estimated cost of future support in the period of sale. 13




---



##### Table of Contents



Impairment of goodwill.We review goodwill for potential impairment at least annually or when
events or changes in circumstances indicate the carrying value of goodwill may be impaired.
Utilizing a discounted cash flow model as well as an analysis of our market value as determined by
the stock market, we assess whether the assets carrying value is fully recoverable. The
assessment of potential impairment requires certain judgments and estimates by us, including the
determination of an event indicating impairment, the future cash flows to be generated by the
asset, risks associated with those cash flows, and the Companys discount rate to be utilized. If
actual results are not consistent with our assumptions, we may be exposed to a goodwill impairment
charge that could be material. Deferred tax assets.We have U.S. net operating loss carryforwards of approximately $21.5
million, including approximately $7.1 million related to the inactive MakeMusic! SA division, and
tax credits of approximately $644,000. The losses and tax credits are carried forward for U.S. and
state corporate income taxes and can be used to reduce future taxes. At December 31, 2004, we had
net deferred tax assets totaling approximately $9.2 million. Since we could not conclude that this
asset is more likely than not to be realized we have recorded a valuation allowance against it for
its full amount. Results of Operations The following table summarizes key operating information for the years ended December 31, 2004
and 2003. % ofDecember 31
    
    
    Increase
    
    
    Net2004
    
    
    2003
    
    
    (Decrease)
    
    
    Revenue(In thousands)Notation revenue
    
    $
    10,162
    
    
    $
    6,688
    
    
    $
    3,474
    
    
    
    52SmartMusic revenue
    
    
    1,002
    
    
    
    585
    
    
    
    417
    
    
    
    71Other revenue
    
    
    76
    
    
    
    84
    
    
    
    (8
    )
    
    
    (10
    )Net revenue
    
    
    11,240
    
    
    
    7,357
    
    
    
    3,883
    
    
    
    53Cost of revenue
    
    
    2,054
    
    
    
    1,750
    
    
    
    304
    
    
    
    17Gross profit
    
    
    9,186
    
    
    
    5,607
    
    
    
    3,579
    
    
    
    64Percentage of net sales
    
    
    81.7
    %
    
    
    76.2
    %Website development expenses
    
    
    564
    
    
    
    470
    
    
    
    94
    
    
    
    20Content and product
development expenses
    
    
    2,125
    
    
    
    1,947
    
    
    
    178
    
    
    
    9Selling and marketing expenses
    
    
    3,634
    
    
    
    3,605
    
    
    
    29
    
    
    
    1General and administrative
expenses
    
    
    3,489
    
    
    
    3,881
    
    
    
    (392
    )
    
    
    (10
    )Total operating expenses
    
    
    9,812
    
    
    
    9,903
    
    
    
    (91
    )
    
    
    (1
    )Operating loss
    
    
    (626
    )
    
    
    (4,296
    )
    
    
    3,670
    
    
    
    85Interest income
    
    
    12
    
    
    
    17
    
    
    
    (5
    )
    
    
    (29
    )Interest expense
    
    
    (2
    )
    
    
    (778
    )
    
    
    776
    
    
    
    (100
    )Forgiveness of debt
    
    
    
    
    
    
    542
    
    
    
    (542
    )
    
    
    (100
    )Other income, net
    
    
    108
    
    
    
    54
    
    
    
    54
    
    
    
    100Income tax expense
    
    
    (2
    )
    
    
    (1
    )
    
    
    (1
    )
    
    
    100Net loss
    
    $
    (510
    )
    
    $
    (4,462
    )
    
    $
    3,952
    
    
    
    88
 14




---



##### Table of Contents



Year ended December 31, 2004 compared to the year ended December 31, 2003 Net revenue.The increase in notation revenue from the prior year is primarily due to the
release of Finale 2004 for Macintosh in January 2004. Historically, this version would have been
released in August of 2003, shortly after Finale 2004 for Windows was released. However, it was
not released until January 2004 due to additional programming required to make it compliant with
the Macintosh OS X operating system. In addition, overall sales of the Finale 2004 release were
strong compared to previous versions because of the market acceptance of the product. Finale 2005
was released in August 2004 for both Windows and Macintosh platforms. We also released PrintMusic
2004 in the year ended December 31, 2004, which was the first upgrade to PrintMusic in two years
and resulted in a $404,000, or 55%, increase in PrintMusic sales. The increase in SmartMusic revenue reflects the growth of the SmartMusic subscription system
that was originally launched in November 2001. SmartMusic is now an Internet-based product, sold
to home and educational customers on a subscription basis, typically with a subscription life of 12
months for educational institutions and one month to one year for home users. The annual
SmartMusic school-sponsored home subscription was introduced in October 2002. Revenue for annual
subscription sales is recognized over the life of the subscription. Total earned SmartMusic
revenue for the year ended December 31, 2004 was $1,002,000, an increase of $417,000, or 71%, over
the year ended December 31, 2003. Total unearned SmartMusic subscription revenue was $565,000 as
of December 31, 2004, an increase of $262,000, or 86%, over the balance at December 31, 2003.
Unearned subscription revenue is included in deferred revenue on the balance sheet. We are
currently focusing on growing our subscription business and anticipate the current trend to
continue. The SmartMusic subscription service has shown continual growth since its November 2001 launch.
It has been purchased by more than 3,290 schools with greater than 9,640 current subscriptions at
December 31, 2004, an increase of 66% over the 5,800 subscriptions as of December 31, 2003. School
subscription revenue of $277,000 was recorded in the financial statements in the year ended
December 31, 2004. The home subscription program was launched in June 2002. As of December 31,
2004, we had over 2,050 active home subscriptions resulting in revenues of $150,000 for the year
ended December 31, 2004. This is a 64% increase in home subscriptions over the end of the prior
year. Our school-sponsored home subscription program was introduced September 2002 and had over
680 schools participating for a total of over 22,750 home users as of December 31, 2004, 119% more
than the 10,400 subscriptions on December 31, 2003. Revenue of $289,000 was recognized through
this program in the year ended December 31, 2004. As of year-end 2004, total SmartMusic school
subscriptions, school-sponsored home subscriptions and home subscriptions had an annual run rate of
$946,000, which is 74% higher than the annual run rate of $545,000 at December 31, 2003. The
annual run rate is the total revenue earned on all subscriptions on a 12-month basis. It gives an
indication of the total revenue generated over the life of the subscriptions by maintaining the
current level of subscriptions, as opposed to the reported revenue, which reflects revenue only for
the past months, and deferred revenue, which includes revenue for only future months. Many SmartMusic subscription customers also purchase microphones and foot pedals (accessories)
that are used with the software. Revenue for the sales of accessories for the year ended December
31, 2004 (included in total SmartMusic revenue of $1,002,000) was $286,000, which was $68,000, or
31%, greater than revenue of $218,000 for SmartMusic accessories in the year ended December 31,
2003. Gross profit.Gross profit was higher than the prior year primarily due to the increase in
revenues. Cost of revenue includes product costs, royalties paid to publishers, amortization of
capitalized notation, repertoire and SmartMusic software development costs, and credit card fees. Gross margin as a percent of sales for the year ended December 31, 2004 was 5.5 percentage
points higher than the year ended December 31, 2003. The higher percentage is primarily a product
of the increase in revenues due to a significant portion of fixed costs in cost of revenues. Cost of sales includes period costs, such as amortization of intangible assets that resulted from
the reverse merger in 2000. Also, the increase in revenue was primarily in Finale and SmartMusic
subscription sales, which are relatively high margin products. Website development.Current year website development expense consists primarily of expenses
related to improvement of the design and development of additional features for the Finale and
SmartMusic website and other underlying technology infrastructure. Personnel resources had been
reduced in 2003 due to the closing of our
operations in France. During the year ended December 31, 2004 additional personnel were
added in Minneapolis to update and maintain our websites. All costs incurred in 2004 related to
website development have been expensed. 15




---



##### Table of Contents



Content and product development.Content and product development expenses consist primarily
of Finale notation and SmartMusic product development as well as SmartMusic repertoire development.
Personnel costs increased from the prior year due to staff increases in order to reach numerous
product development goals. A significant portion of the content development expenditures related
to additional repertoire have been capitalized and are being amortized over their estimated useful
life of 3 years. Selling and marketing expenses.Selling and marketing expenses primarily consist of
marketing, advertising and promotion expenses, business development and customer service activities
and payroll. There were no significant increases in selling and marketing expenses year over year. General and administrative expenses.General and administrative expenses consist primarily of
payroll and related expenses for executive and administrative personnel, professional services,
facility costs, amortization of certain intangible assets with definite lives, and other general
corporate expenses. The decrease relates to expense reductions resulting from the closing of the
France location effective April 30, 2003 and a reduction in software depreciation because the ERP
system reached full depreciation in June of 2003. Interest income and expense, net.Net interest was $10,000 in income for the year ended
December 31, 2004 compared to $761,000 in interest expense for the year ended December 31, 2003.
The majority of the prior year interest expense was a non-cash charge for warrants and beneficial
conversion features of the bridge loan debt that was converted to equity upon the private placement
financing completed in the quarter ended March 31, 2003 (see Note 5 to the financial statements).
Interest income in the year ended December 31, 2004 is interest earned on savings and marketable
securities. Gain on Forgiveness of Debt.In September 2003, we received formal forgiveness of debt from
ANVAR, a French administrative organization that extends loans to companies to develop new
business. The debt forgiveness resulted in recognition of non-operating income of $542,000 during
the third quarter of 2003. Other Income.In 2004, we received a $100,000 cancellation payment from a partner that
canceled a contract for which we had performed a portion of our responsibility. Income tax.Due to operating losses, we recorded minimum taxes for the years ended December
31, 2004 and 2003. The total tax recorded was $2,000 and $1,000 in the years ended December 31,
2004 and 2003, respectively. Because the Company could not determine that it is more likely than
not that the operating loss carryforwards will be utilized there is no tax benefit for the losses
reflected in the financial statements. Liquidity and capital resources.Net cash provided by operating activities totaled $1,030,000
for the year ended December 31, 2004 compared to $1,690,000 of net cash used in operating
activities for the year ended December 31, 2003. The increase in cash provided in 2004 is
attributed to the revenue increases. When the net loss for 2004 is netted against non-cash items such as depreciation,
amortization, impairment of intangibles, non-cash interest, and the forgiveness of the ANVAR debt,
the lower net loss for the year ended December 31, 2004 provided $3,394,000 more in operating cash
than the year ended December 31, 2003. This improvement was offset by a $241,000 greater increase
in accounts receivable in 2004 than in 2003, as well as increases in inventory and prepaid expenses
using $232,000 more cash than in 2003. Deferred revenue provided $37,000 in operating cash in
2004, compared to $482,000 in 2003. The change can be attributed to a deferred revenue balance at
December 31, 2003 that was high due to deferrals for Finale 2004 for Macintosh that were owed to
customers that had prior purchases of Finale for Macintosh. In 2004, increases in accounts payable
and accrued expenses provided $448,000 more in cash than in 2003. Cash used in investing activities was $288,000 in the year ended December 31, 2004 compared to
$303,000 in the year ended December 31, 2003. Current year expenditures were $156,000 for
purchases of property and equipment and $132,000 for capitalization of software development,
primarily for SmartMusic repertoire. 16




---



##### Table of Contents



Cash provided by financing activities was $1,985,000 less in the year ended December 31, 2004
than the $1,991,000 provided in the year ended December 31, 2003 as there were no significant
issuances of common stock in 2004. The current year includes $63,000 net proceeds from the
issuance of shares offset by payments on debt and capital leases of $57,000. We have significantly increased cash flows over the last several quarters. Actual operating
cash usage is typically highest in the first and second quarters, with the third quarter using the
least cash or producing positive cash flow. These quarterly fluctuations are created by the
notation product release cycle and the cyclical impact of sales to schools related to the school
year calendar. Our 2004 cash inflows did not follow the usual pattern because the release of
Finale 2004 for Macintosh in January helped to drive positive cash flow for all four quarters of
2004. Management expects to achieve positive cash flow into the foreseeable future. If we do not
meet our anticipated revenue levels due to a significantly later than anticipated product release
or a decrease in demand for our products, management is committed to expense reductions as
necessary to ensure adequate cash levels remain to continue funding operations. If further expense
reductions do not offset this decrease in revenue, we may have to seek additional financing. There
can be no assurances, however, that such financing will be available under attractive terms or at
all. As of December 31, 2004, the Company had cash and cash equivalents of $2,215,000. New Accounting Pronouncements.Refer to Note 3 in the audited financial statements. 17




---



##### Table of Contents



ITEM 7. FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders
MakeMusic! Inc.
Eden Prairie, Minnesota We have audited the accompanying consolidated balance sheet of MakeMusic! Inc. and
subsidiaries, as of December 31, 2004 and the related consolidated statements of operations,
shareholders equity and cash flows for the year then ended. These consolidated financial
statements are the responsibility of the Companys management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit. We conducted our audits in accordance with the auditing standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a reasonable basis for our
opinion. In our opinion, the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of MakeMusic! Inc. and subsidiaries as of December
31, 2004 and the consolidated results of their operations and their cash flows for the year then
ended, in conformity with accounting principles generally accepted in the United States. /s/ McGladrey & Pullen LLP Minneapolis, Minnesota
March 5, 2005 18




---



##### Table of Contents



Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders
MakeMusic! Inc. We have audited the accompanying consolidated balance sheet of MakeMusic! Inc. and
subsidiaries, as of December 31, 2003 and the related consolidated statements of operations,
shareholders equity and cash flows for the year then ended. These consolidated financial
statements are the responsibility of the Companys management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a reasonable basis for our
opinion. In our opinion, the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of MakeMusic! Inc. and subsidiaries as of December
31, 2003 and the consolidated results of their operations and their cash flows for the year then
ended, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Minneapolis, Minnesota
March 5, 2004 19




---



##### Table of Contents



MakeMusic! Inc.
Consolidated Balance Sheets(In thousands of U.S. dollars, except share and per share data) December 312004
    
    
    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    2,215
    
    
    $
    1,467Accounts receivable (net of allowance of $38 and $41 as of
December 31, 2004 and 2003, respectively)
    
    
    830
    
    
    
    494Inventories
    
    
    332
    
    
    
    273Prepaid expenses and other current assets
    
    
    241
    
    
    
    207Total current assets
    
    
    3,618
    
    
    
    2,441Property and equipment, net
    
    
    250
    
    
    
    280Capitalized software products, net
    
    
    347
    
    
    
    599Goodwill, net
    
    
    3,630
    
    
    
    3,630Intangible assets, net
    
    
    725
    
    
    
    1,718Other non-current assets
    
    
    83
    
    
    
    88Total assets
    
    $
    8,653
    
    
    $
    8,756Liabilities and shareholders equityCurrent liabilities:Current portion of long-term debt and capital lease obligations
    
    $
    6
    
    
    $
    57Accounts payable
    
    
    494
    
    
    
    417Accrued compensation
    
    
    1,024
    
    
    
    798Other accrued liabilities
    
    
    402
    
    
    
    353Reserve for product returns
    
    
    203
    
    
    
    355Deferred revenue
    
    
    697
    
    
    
    660Total current liabilities
    
    
    2,826
    
    
    
    2,640Capital lease obligations, net of current portion
    
    
    16
    
    
    
    21Shareholders equity:Common stock, $0.01 par value:Authorized shares  6,500,000 (including 1,500,000 undesignated)Issued and outstanding shares  3,419,464 and 3,356,330
in 2004 and 2003, respectively
    
    
    34
    
    
    
    34Additional paid-in capital
    
    
    61,626
    
    
    
    61,553Accumulated deficit
    
    
    (55,849
    )
    
    
    (55,339
    )Deferred compensation
    
    
    
    
    
    
    (153
    )Total shareholders equity
    
    
    5,811
    
    
    
    6,095Total liabilities and shareholders equity
    
    $
    8,653
    
    
    $
    8,756
 See accompanying notes. 20




---



##### Table of Contents



MakeMusic! Inc.
Consolidated Statements of Operations(In thousands of U.S. dollars, except share and per share data) Year ended December 312004
    
    
    2003Net revenue
    
    $
    11,240
    
    
    $
    7,357Cost of revenue
    
    
    2,054
    
    
    
    1,750Gross profit
    
    
    9,186
    
    
    
    5,607Operating expensesWebsite development
    
    
    564
    
    
    
    470Content and product development
    
    
    2,125
    
    
    
    1,947Selling and marketing
    
    
    3,634
    
    
    
    3,605General and administrative
    
    
    3,489
    
    
    
    3,8819,812
    
    
    
    9,903Loss from operations
    
    
    (626
    )
    
    
    (4,296
    )Interest income
    
    
    12
    
    
    
    17Interest expense
    
    
    (2
    )
    
    
    (778
    )Forgiveness of debt
    
    
    
    
    
    
    542Other income, net
    
    
    108
    
    
    
    54Net loss before income tax
    
    
    (508
    )
    
    
    (4,461
    )Income tax
    
    
    (2
    )
    
    
    (1
    )Net Loss
    
    $
    (510
    )
    
    $
    (4,462
    )Basic and diluted loss per common share
    
    $
    (0.15
    )
    
    $
    (1.39
    )Weighted average common shares outstanding  basic and diluted
    
    
    3,374,618
    
    
    
    3,200,465
 See accompanying notes. 21




---



##### Table of Contents



MakeMusic! Inc.
Consolidated Statement of Shareholders Equity(In thousands of U.S. dollars, except share data) AccumulatedCommon Stock
    
    
    Additional
    
    
    
    
    
    
    
    
    
    
    Other
    
    
    ShareholdersTotal
    
    
    
    
    
    
    Paid-In
    
    
    Accumulated
    
    
    Deferred
    
    
    Comprehensive
    
    
    EquityShares
    
    
    Amount
    
    
    Capital
    
    
    Deficit
    
    
    Compensation
    
    
    Income
    
    
    (Deficit)Balance at December 31,
2002
    
    
    2,168,860
    
    
    
    22
    
    
    
    58,278
    
    
    
    (50,877
    )
    
    
    (595
    )
    
    
    (73
    )
    
    
    6,755Shares related to put and
call agreements and
reverse acquisition with
Coda
    
    
    147,985
    
    
    
    2
    
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Sale of common stock
    
    
    1,033,074
    
    
    
    10
    
    
    
    2,869
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,879Warrants issued to bridge
loan investors
    
    
    
    
    
    
    
    
    
    
    355
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    355Issuance of stock, stock
options and warrants for
services
    
    
    6,411
    
    
    
    
    
    
    
    99
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    99Warrants for loan interest
    
    
    
    
    
    
    
    
    
    
    29
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29Amortization of deferred
compensation
    
    
    
    
    
    
    
    
    
    
    (75
    )
    
    
    
    
    
    
    442
    
    
    
    
    
    
    
    367Comprehensive loss:Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,462
    )
    
    
    
    
    
    
    
    
    
    
    (4,462
    )Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    73
    
    
    
    73Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,389
    )Balance at December 31,
2003
    
    
    3,356,330
    
    
    
    34
    
    
    
    61,553
    
    
    
    (55,339
    )
    
    
    (153
    )
    
    
    0
    
    
    
    6,095Exercise of stock options
and warrants
    
    
    63,134
    
    
    
    
    
    
    
    62
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    62Issuance of stock, stock
options and warrants for
services
    
    
    
    
    
    
    
    
    
    
    11
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11Amortization of deferred
compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    153
    
    
    
    
    
    
    
    153Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (510
    )
    
    
    
    
    
    
    
    
    
    
    (510
    )Balance at December 31,
2004
    
    
    3,419,464
    
    
    $
    34
    
    
    $
    61,626
    
    
    $
    (55,849
    )
    
    $
    
    
    
    $
    0
    
    
    $
    5,811
 See accompanying notes. 22




---



##### Table of Contents



MakeMusic! Inc.
Consolidated Statements of Cash Flows(In thousands of U.S. dollars) Year ended December 312004
    
    
    2003Operating activitiesNet loss
    
    $
    (510
    )
    
    $
    (4,462
    )Adjustments to reconcile net loss to net cash provided
by (used in) operating activities:Amortization of intangible assets
    
    
    1,310
    
    
    
    1,354Depreciation and amortization of property and equipment
    
    
    186
    
    
    
    372Impairment of intangible assets
    
    
    78
    
    
    
    Amortization of deferred compensation
    
    
    153
    
    
    
    367Interest expense and debt related warrants
    
    
    
    
    
    
    735Issuance of stock, options and warrants for services
    
    
    11
    
    
    
    99Forgiveness of debt
    
    
    
    
    
    
    (542
    )Foreign currency translation loss recorded
    
    
    
    
    
    
    115Increase (decrease) in cash from:Accounts receivable
    
    
    (336
    )
    
    
    (94
    )Inventories
    
    
    (59
    )
    
    
    51Prepaid expenses and other current assets
    
    
    (34
    )
    
    
    83Accounts payable
    
    
    77
    
    
    
    (234
    )Accrued liabilities and product returns
    
    
    121
    
    
    
    (16
    )Deferred revenue
    
    
    37
    
    
    
    482Net cash provided by (used in) operating activities
    
    
    1,034
    
    
    
    (1,690
    )Investing activitiesPurchases of property and equipment
    
    
    (156
    )
    
    
    (105
    )Capitalized software development and other intangibles
    
    
    (132
    )
    
    
    (198
    )Net cash used in investing activities
    
    
    (288
    )
    
    
    (303
    )Financing activitiesCash proceeds from issuance of shares
    
    
    62
    
    
    
    2,129Proceeds from long-term debt
    
    
    
    
    
    
    500Payments on debt and capital leases
    
    
    (60
    )
    
    
    (638
    )Net cash provided by financing activities
    
    
    2
    
    
    
    1,991Net increase (decrease) in cash and cash equivalents
    
    
    748
    
    
    
    (2
    )Cash and cash equivalents, beginning of year
    
    
    1,467
    
    
    
    1,469Cash and cash equivalents, end of year
    
    $
    2,215
    
    
    $
    1,467Supplemental disclosure of cash flow informationInterest paid
    
    $
    2
    
    
    $
    60Income taxes paid
    
    $
    2
    
    
    $
    1Non-cash transactions:Acquisition of equipment with a capital lease
    
    $
    
    
    
    $
    19Conversion of notes payable for common stock
    
    $
    
    
    
    $
    750
 See accompanying notes. 23




---



##### Table of Contents



Notes to Consolidated Financial Statements 1. Description of Business The Company develops and markets proprietary music technology products under the Finale® and
SmartMusic® brands that enhance music learning and composition, increase productivity and make
practicing and performing music fun. The Companys innovative products provide easy-to-use,
efficient alternatives to traditional practice, education and composition techniques. Software
product sales are made through traditional distribution channels and the Companys websites. 2. Summary of Significant Accounting Policies Consolidation The consolidated financial statements include the accounts of MakeMusic! Inc., or
Predecessors, and its majority-owned subsidiaries MakeMusic! S.A. and Net4Music, Inc. (New York).
All significant intercompany accounts and transactions have been eliminated in consolidation. As
of April 30, 2003, the MakeMusic! SA subsidiary was closed and all operations were consolidated
into MakeMusic! Inc. Foreign Currency Translation Assets and liabilities denominated in foreign currency are translated at the exchange rate as
of the balance sheet date. Income statement and cash flow amounts are translated using the average
exchange rates throughout the period. Since the closing of MakeMusic! SA in 2003, immaterial
translation adjustments of balance sheet accounts resulting from fluctuations in exchange rates are
recorded as operating expenses during the period of the change in the exchange rate. Prior to
closing MakeMusic! SA, translation adjustments of balance sheet accounts were recorded as a
component of Accumulated Other Comprehensive Income in shareholders equity. Upon the closing of
MakeMusic! SA, the assets and liabilities giving rise to the Accumulated Other Comprehensive Income
were either settled or transferred to MakeMusic! Inc. and denominated in US dollars. Revenue Recognition Revenue for notation products is recognized when goods are shipped or delivered. SmartMusic
subscription revenue is recognized over the life of the subscription. Software revenue is
primarily derived from the sale of off the shelf products, easily installed and used by the
customer. Software revenue is recognized in accordance with the AICPA SOP 97-2, Software Revenue
Recognition, when all of the following conditions are met: there is evidence of an agreement with
the customer (normally a purchase order), delivery has occurred, the total sales price is fixed and
determinable, collectibility is probable and any uncertainties with regard to customer acceptance
are insignificant. Customers are entitled to a free upgrade if the Company launches a new version of a software
product within a specified period after a customer originally purchased their software. In this
event, the Company defers a portion of the sale price applicable to the upgrade for products sold
within the upgrade replacement window until such time that the upgrade is shipped. In the year ended December 31, 2003, the Company entered certain arrangements with customers
in which the customer was entitled to receive products including both Finale for Windows and Finale
for Macintosh OS X, which was not available until the Finale 2004 for Macintosh version was
released in January 2004. The Company shipped Finale for Windows when the order was placed, but
deferred all revenue until shipping Finale 2004 for Macintosh in 2004. When a new version of Finale is released, dealers retain the right to return any unsold
versions of the prior release in exchange for an equal number of units of the updated version of
the product that is returned. The Company tracks the history of these returns and defers revenue
based on the expected return rate until the new product is released, at which time the product may
be exchanged for the new version. 24




---



##### Table of Contents



2. Summary of Significant Accounting Policies (Continued) Shipping and handling charges are accounted for in accordance with EITF No. 00-10, Accounting
for Shipping and Handling Fees and Costs, with all charges to customers for shipping and handling
included in revenue and costs in cost of revenue. Revenue for the years ended December 31, 2004
and 2003 include $500,000 and $327,000 of shipping and handling revenue, respectively. Cost of
revenue for the years ended December 31, 2004 and 2003 include $394,000 and $255,000 of shipping
expense, respectively. Net Loss Per Share Basic and diluted net loss per share was computed by dividing the net loss by the weighted
average number of common shares outstanding during the year. The effect of options and warrants
are excluded in both years as their effect is anti-dilutive. Weighted average shares used in the calculation of net loss per share are as follows: 2004
    
    
    2003Weighted average common shares outstanding
    
    
    3,374,618
    
    
    
    3,166,002Weighted average effect of common shares
issuable under put and call arrangements
    
    
    
    
    
    
    34,462Net weighted average common shares
    
    
    3,374,618
    
    
    
    3,200,465Net Loss
    
    $
    (510,000
    )
    
    $
    (4,462,000
    )Basic and diluted loss per common share
    
    $
    (0.15
    )
    
    $
    (1.39
    )
 Segment Reporting The Company operates in one industry segment, the design, development, support and marketing
of application software solutions to music educators, music makers and the music publishing
industry. Product distribution is carried out via the Internet as well as a variety of strategic
partnerships and distribution networks to many foreign countries. See Note 11 for geographic data. Cash and Cash Equivalents Cash equivalents consist of money market instruments with original maturities of 360 days or
less. Cash equivalents are recorded at cost, which approximates fair value. Fair Value of Financial Instruments At December 31, 2004, and 2003, the carrying values of current financial instruments such as
cash and cash equivalents, accounts receivable, accounts payable, other current assets, accrued
liabilities and other current liabilities, as well as capital lease obligations, approximated their
market values, based on the short-term maturities of these instruments. Accounts Receivable Accounts receivable are recorded for all credit sales at the time the product is shipped to
the customer. Credit terms for dealers and distributors are generally net 30 days and are granted
on analysis of dealer references and customer history. Schools submit purchase orders for all
shipments with payment due in 30 days. Sales to home users are paid in advance with a credit card
or prepayment with the order. Payments not received within the agreed upon terms are considered
past due. 25




---



##### Table of Contents



2. Summary of Significant Accounting Policies (Continued) The Company maintains an allowance for doubtful accounts based on bad debt history and
analysis of specific past due accounts. Analysis of the customers ability to pay includes contact
through statements, e-mail, and telephone as well as consideration of the customers payment
history. If the analysis indicates any customers are unlikely to pay, the account will be written
off against the allowance for doubtful accounts and the account sent to collections. Inventories Inventories are stated at the lower of weighted average cost or market and consist of finished
products and components, net of a reserve for obsolescence. Property and Equipment Property and equipment are stated at their acquisition costs net of accumulated depreciation.
Depreciation is computed by using the straight-line method over the estimated useful lives of the
purchased software (three years), computer equipment (three years), and furniture (five years). Property and equipment held under capital leases are capitalized and depreciated over the
useful life of the asset, in case of a contractual option to buy, or over the residual life of the
lease contract. Capitalized Software Products Capitalized software products consist of expenditures to develop software products for sale,
including repertoire software and website development. Website development.Costs incurred in the development of the Companys website are
capitalized in accordance with the Emerging Issues Task Force (EITF) No. 00-02, Accounting for
Web Site Development Costs. Application development stage costs are capitalized and amortized on a
straight-line basis over the useful life of the website, which is estimated at three years. The
estimated useful life is based on planned or expected significant modifications of the site in
response to the rapid rate of change in the Internet industry and technology in general. No costs
relating to the SmartMusic website were capitalized in 2004 or 2003 as the website was running and
costs incurred were for maintenance. Website development expenses in the Statement of Operations are primarily non-capitalized
development costs and the amortization costs of capitalized expenses, as well as costs dedicated to
site maintenance and minor improvements. Costs of preliminary studies of the functional analysis
and website post-implementation costs are expensed as incurred. Content and product development.Costs incurred in the development of software products are
capitalized in accordance FAS 86, Accounting for the Costs of Computer Software to Be Sold, Leased,
or Otherwise Marketed. The Company periodically evaluates whether events and circumstances have
occurred that indicate the remaining balance of software development expenses may not be
recoverable. The costs incurred in the development of repertoire software are also capitalized in
accordance with the FAS 86. As of December 31, 2004 and 2003, the Company had capitalized, net of
amortization and reserves, $334,000 and $441,000, respectively, of costs related to the development
of repertoire software. The capitalized amount represents costs of producing product masters for
new songs as technological feasibility had been established by the selling of previous titles.
When a title is available for release, expenditures related to that title are no longer capitalized
and the capitalized cost of the title is amortized over a three year period using the straight-line
method. The Company periodically evaluates whether events and circumstances have occurred that
indicate the remaining balance of repertoire development costs may not be recoverable. In the year
ended December 31, 2003, the Company determined that impairment had occurred related to some titles
and $40,000 was recorded as a current year expense. No additional impairment was required in the
year ended December 31, 2004. 26




---



##### Table of Contents



2. Summary of Significant Accounting Policies (Continued) Goodwill Goodwill represents the cost in excess of fair value of the tangible and identified intangible
assets of businesses acquired. In accordance with FASB Statement 142 (FAS 142), Goodwill and
Other Intangible Assets, goodwill is not amortized but rather reviewed for impairment annually in
the fourth quarter, or more often if indicators of impairment exist (see Note 4). Other Intangible Assets Other intangible assets consist primarily of the identifiable intangible assets acquired in
the 2000 reverse merger between Coda Music Technology Inc. and Net4Music S.A. (see Note 4) and
include the value of the notation and SmartMusic software products, amortized over five years; Coda
trade name, amortized over ten years; Coda website, amortized over three years; distributor/dealer
network, amortized over five years; and customer lists, amortized over five years. The Coda
website reached full amortization in October of 2003 and the fully amortized costs were written
off. In the year ended December 31, 2004, an impairment charge of $78,000 was taken for the
remaining book value of the Coda trade name, which is no longer used by the Company. Patents and trademarks Costs associated with obtaining patents, trademarks and Internet domain names are capitalized.
These costs are being amortized from three to ten years depending on their estimated useful lives
and are included in other assets on the balance sheet. Costs of maintaining patents and trademarks
after acquisition are expensed as incurred. Impairment of Long-Lived Assets The Company reviews the long-lived assets for impairment when events or changes in
circumstances indicate that the carrying amount of an asset may not be recoverable. If impairment
indicators are present and the estimated undiscounted cash flows are less than the carrying value
of the assets, the carrying value is reduced to the estimated fair value as measured by the
discounted cash flows. Leases Leases are capitalized in accordance with FASB Statement 13, Accounting for Leases, which
specifies that in a lease that transfers the benefits and risks inherent in the ownership of
property to the lessee, the lessee should account for the lease as the acquisition of an asset and
the incurrence of a liability. The Company includes the capital lease assets in its property and
equipment and records the liability as capital lease obligations, a liability on the balance sheet. Income Taxes Deferred taxes are provided on a liability method whereby deferred tax assets are recognized
for deductible temporary differences and operating loss or tax credit carry-forwards and deferred
tax liabilities are recognized for taxable temporary differences. Temporary differences are the
differences between the amounts of assets and liabilities recorded for income tax and financial
reporting purposes. Deferred tax assets are reduced by a valuation allowance when management
determines that it is more likely than not that some portion or all of the deferred tax assets will
not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in
tax laws and tax rates on the date of enactment. 27




---



##### Table of Contents



2. Summary of Significant Accounting Policies (Continued) Stock-Based Compensation The Company accounts for stock options under Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations in accounting for its plans.
Under this method, compensation expense is recognized for the amount by which the market price of
the common stock on the date of grant exceeds the exercise price of an option. In the years ended
December 31, 2004 and 2003, we recorded compensation expense of $153,000 and $367,000,
respectively, in the statement of operations. The fair value of grants to our employees and
directors was estimated at the grant date using the Black-Scholes method with the following
assumptions for 2004 and 2003: no expected dividend yield; risk-free interest rates of 3.25% and
3.71%, respectively; expected lives of 4 to 7 years; and estimated volatility of 61 and 90 percent
based on recent history of the Companys stock price. Had compensation cost for these options been
determined consistent with the fair value method of SFAS No. 123, Accounting for Stock-Based
Compensation, the net loss and loss per share would have been increased to the following pro forma
amounts: December 31,2004
    2003(In thousands)Net loss:Net loss as reported
    
    $
    (510
    )
    
    $
    (4,462
    )Stock compensation recorded under APB 25
    
    
    153
    
    
    
    367Stock compensation under FAS 123
    
    
    (429
    )
    
    
    (391
    )Proforma net loss
    
    $
    (786
    )
    
    $
    (4,486
    )Basic and diluted loss per share:As reported
    
    $
    (0.15
    )
    
    $
    (1.39
    )Pro forma
    
    $
    (0.23
    )
    
    $
    (1.40
    )
 In December 2004, the Financial Accounting Standards Board (FASB) published FASB Statement
No. 123 (revised 2004), Share-Based Payment (FAS 123(R) or the Statement). FAS 123(R)
requires that the compensation cost relating to share-based payment transactions, including grants
of employee stock options, be recognized in financial statements. That cost will be measured based
on the fair value of the equity or liability instruments issued. FAS 123(R) covers a wide range of
share-based compensation arrangements including stock options, restricted share plans,
performance-based awards, share appreciation rights, and employee share purchase plans. FAS 123(R)
is a replacement of FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes
APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related interpretive guidance
(APB 25). The effect of the Statement will be to require entities to measure the cost of employee
services received in exchange for stock options based on the grant-date fair value of the award,
and to recognize the cost over the period the employee is required to provide services for the
award. FAS 123(R) permits entities to use any option-pricing model that meets the fair value
objective in the Statement. The Company will be required to apply FAS 123(R) as of the beginning of its first interim
period that begins after December 15, 2005, which will be the year ending December 31, 2006. FAS
123(R) allows two methods for determining the effects of the transition: the modified prospective
transition method and the modified retrospective method of transition. Under the modified
prospective transition method, an entity would use the fair value based accounting method for all
employee awards granted, modified, or settled after the effective date. As of the effective date,
compensation cost related to the nonvested portion of awards outstanding as of that date would be
based on the grant-date fair value of those awards as calculated under the original provisions of
Statement No. 123; that is, an entity would not remeasure the grant-date fair value estimate of the
unvested portion of awards granted prior to the effective date. An entity will have the further
option to either apply the Statement to only the quarters in the period of adoption and subsequent
periods, or apply the Statement to all quarters in the fiscal year of adoption Under the modified
retrospective method of transition, an entity would revise its previously issued financial
statements to recognize employee compensation cost for prior periods presented in accordance with
the original provisions of Statement No. 123. 28




---



##### Table of Contents



The Company has not yet completed its study of the transition methods or made any decisions
about how it will adopt FAS 123(R). However, the pro forma net income effect of using the fair
value method for the past two fiscal years is presented in the table above. The pro forma
compensation costs presented in the table above and in prior filings for the Company have been
calculated using a Black-Scholes option pricing model and may not be indicative of amounts which
should be expected in future years. No decisions have been made as to which option-pricing model
is most appropriate for the Company for future awards. Use of Estimates Preparation of the Companys consolidated financial statements requires management to make
estimates and assumptions that affect reported amounts of assets and liabilities and related
revenues and expenses. Actual results could differ from those estimates. Advertising and Promotion Product costs for promotional samples are classified in the statement of operations as sales
and marketing expense. Costs associated with the purchase of tradeshow booths and equipment are
included in capitalized property and equipment and depreciated over their useful lives. All other
advertising costs are expensed as incurred. Sales and marketing expenses include advertising
expense of $812,000 and $730,000 for the years ended December 31, 2004 and 2003, respectively. Reclassifications Certain amounts in the 2003 consolidated balance sheet and notes have been reclassified to
conform with the 2004 presentation. 3. New Accounting Pronouncements In November 2004, FASB issued FASB Statement 151, Inventory Costs. This statement amends
Accounting Research Bulletin No. 43, Inventory Pricing, to clarify the accounting for abnormal
amounts of idle facility expense, freight, handling costs, and waster material. It also requires
that allocation of fixed production overhead to the costs of conversion be based on the normal
capacity of production facilities. The Company does not expect FAS 151 to have a material impact
on its financial position or results of operations. In December 2004, FASB issued FASB Statement 153, Exchanges of Nonmonetary Assets, which
amended APB Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive
assets. The Company does not engage in nonmonetary exchanges and does not expect to in the future,
so this statement is not expected to have a material impact on the Companys financial position or
results of operations. 4. Supplemental Balance Sheet Information Inventories Inventories consist of the following: December 31,2004
    2003(In thousands)Components
    
    $
    308
    
    
    $
    240Finished goods
    
    
    97
    
    
    
    93Reserve for obsolescence
    
    
    (73
    )
    
    
    (60
    )$
    332
    
    
    $
    273
 29




---



##### Table of Contents



Property and Equipment Property and equipment are as follows: December 31,2004
    
    
    2003(In thousands)Computer equipment and software
    
    $
    2,003
    
    
    $
    1,899Office furniture and other
    
    
    607
    
    
    
    5552,610
    
    
    
    2,454Less accumulated depreciation
    
    
    (2,360
    )
    
    
    (2,174
    )$
    250
    
    
    $
    280
 The Company has financed some of its equipment through capital lease contracts. Property and
equipment includes $19,000 of assets held as capital leases as of December 31, 2004 and 2003.
Accumulated depreciation of capital lease assets at December 31, 2004 and 2003 was $8,000 and
$2,000, respectively. Capitalized Software Products Capitalized software products are the capitalized expenditures for creating software for sale
and are as follows: December 31,2004
    
    
    2003(In thousands)Software translation
    
    $
    125
    
    
    $
    110SmartMusic website
    
    
    461
    
    
    
    461Repertoire development
    
    
    677
    
    
    
    1,8451,263
    
    
    
    2,416Less accumulated depreciation and amortization
    
    
    (916
    )
    
    
    (1,817
    )$
    347
    
    
    $
    599
 Amortization expense related to the capitalized software was $223,000 and $141,000 in the
years ended December 31, 2004 and 2003, respectively. The remaining $347,000 is scheduled to be
amortized over three years on a straight line basis. Goodwill Goodwill of $3,630,000, net of amortization prior to the adoption of FAS 142, resulted from
the reverse merger of Net4Music S.A. with Coda in 2000. On an annual basis, the Company analyzes
the value of goodwill by comparing the Companys market value to its book equity to determine if
any impairment has occurred and utilizes a discounted cash flow model and market analysis to
determine the amount of impairment, if any. The analyses completed for the years ending December
31, 2004 and 2003 indicated no impairment had occurred in either year. 30




---



##### Table of Contents



4. Supplemental Balance Sheet Information (Continued) Intangible Assets Intangible assets are as follows: December 31,2004
    
    
    2003(In thousands)Distributor/dealer network
    
    $
    1,440
    
    
    $
    1,440Software products
    
    
    2,304
    
    
    
    2,304Customer lists
    
    
    780
    
    
    
    780Other intangible assets
    
    
    
    
    
    
    130Total gross value
    
    
    4,524
    
    
    
    4,654Less accumulated amortization
    
    
    (3,799
    )
    
    
    (2,936
    )$
    725
    
    
    $
    1,718
 The Company has removed all references in its advertising and literature to Coda Music
Technologies or the Coda division of MakeMusic. Therefore, the Coda Trade Name intangible asset
was deemed to have no future value and the remaining balance of $78,000 was written off during the
year ended December 31, 2004. Amortization expense related to the intangible assets was $916,000 and $1,001,000 in the years
ended December 31, 2004 and 2003, respectively. The remaining $725,000 is scheduled to be
amortized in full during 2005. Other Non-current Assets Other non-current assets consist of the following: December 31,2004
    
    
    2003(In thousands)Patents and trademarks
    
    $
    40
    
    
    $
    50Prepaid royalties
    
    
    43
    
    
    
    38$
    83
    
    
    $
    88
 Accrued Expenses and Other Current Liabilities Accrued expenses and other current liabilities are as follows: December 31,2004
    
    
    2003(In thousands)Accrued Compensation
    
    $
    1,024
    
    
    $
    798Accrued royalties
    
    
    29
    
    
    
    27Accrued post contract technical support
    
    
    175
    
    
    
    125Other
    
    
    198
    
    
    
    201$
    1,426
    
    
    $
    1,151
 31




---



##### Table of Contents



4. Supplemental Balance Sheet Information (Continued) Deferred Revenue Deferred revenue is primarily comprised of the unearned portion of SmartMusic subscriptions
lasting more than one month, deferrals of Finale notation revenue for free upgrades due to
customers purchasing finale prior to release of a new version, deposits for commission on sheet
music revenue sold by partners that received referrals from the MakeMusic! websites, and deposits
for royalties earned from partners incorporating MakeMusic! products into their sales items. December 31,2004
    
    
    2003(In thousands)Deferred SmartMusic subscription revenue
    
    $
    565
    
    
    $
    303Deferred notation revenue
    
    
    38
    
    
    
    303Deposits
    
    
    94
    
    
    
    54$
    697
    
    
    $
    660
 In the year ended December 31, 2003, the Company entered into a contract for a distributor to
sell Finale site licenses throughout the province of Ontario, Canada. The contract called for the
distributor to receive Finale 2004 for Macintosh OS X at no additional charge when it was released.
All revenue related to this contract, $165,000, was deferred until delivery of Finale 2004 for
Macintosh OS X. Delivery occurred and the revenue was recorded in the year ended December 31,
2004. 5. Debt Conditional Advance from ANVAR In the year ended December 31, 2003, the Company received forgiveness of a loan from the
Agence Nationale pour la Valorisation de la Recherche (ANVAR), a French state-owned institution
dedicated to the financing of research and development activities of French companies. The
reduction in debt of $542,000, based on the US dollar value of the loan at the time of forgiveness,
was recorded to other income in 2003. Bridge Loans On March 3, 2003, the Company announced that it had completed a $3,015,000 private placement
of common stock, which was approved by shareholders on February 24, 2003. Of this amount, $750,000
represented proceeds received upon the sale of convertible bridge loans on September 30, 2002. Net
of expenses, the private placement yielded $2,129,000 in the year ended December 31, 2003.
According to the bridge loan agreement, holders of bridge loans were entitled to receive: (i)
warrants (Original Warrants) to purchase one additional share of common stock for $0.10 for each
converted share if a private placement of at least $1.0 million was not completed by March 31,
2003; or (ii) warrants to purchase one additional share of common stock for each converted share
for $0.50 per share if the requisite private placement was completed prior to March 31, 2003. The aforementioned private placement was completed on March 3, 2003. The bridge loan was
converted into 325,251 shares of common stock, and the Company issued warrants (Conversion
Warrants) to holders of bridge loans to purchase shares of common stock for $0.50 per share.
These events resulted in $706,000 of interest expense being recorded in the year ended December 31,
2003. Of this amount, $355,000 was recorded to recognize the value attributed to the Conversion
Warrants upon their issuance and $350,000 was recorded to amortize in full a discount recorded on
the bridge loan relating to the beneficial conversion feature. In addition to the 325,251 shares issued to the bridge loan holders, 707,823 shares of common
stock were issued for the $2,265,000 received from investors at the full private placement price of
$3.20. 32




---



##### Table of Contents



5. Debt (Continued) Line of Credit On March 18, 2004, the Company executed a $500,000 line of credit agreement with a bank. The
line of credit is secured by cash, has an interest rate equal to the current Libor rate + 1.9% and
matures on April 30, 2005. As of December 31, 2004, the Company had no outstanding amounts on the
line of credit. Short-Term Note Payable Effective July 17, 2003, the Company entered into a loan and investment agreement whereby,
effective September 1, 2003, it could borrow between $500,000 and $1,000,000 at its discretion.
The Company received $500,000 from this loan on September 11, 2003. Interest accrued at an annual
rate of twenty percent calculated on a 360-day year and was paid in the form of warrants to
purchase 24,100 shares of its common stock with an expiration date of March 11, 2005 and an
exercise price of $2.30. The Company recorded $29,000 in interest expense in the year ended
December 31, 2003 related to this note. The note was paid in full on December 23, 2003. Convertible Bonds In September 1996, MakeMusic! S.A. issued 9,000 convertible bonds to EUREFI for a total of
137,000 Euros ($172,000 USD at the December 31, 2003 exchange rate) in order to reinforce its
equity and finance its growth. These bonds were originally convertible by the holder, seven bonds
giving a right to four shares of MakeMusic! SA common stock, from January 1, 2000 through the term
of the debt at December 31, 2003. However, in 1999 the Company reached an agreement with EUREFI
that they would not exercise the conversion right. Interest of 6% per year on the debt was payable
each half-year at June 30 and December 31. Final payment on the last 3,000 bonds was made in
January 2004 for 46,000 euros, or $50,000. 6. Shareholders Equity On January 3, 2003, the Companys Board of Directors authorized a one-for-ten reverse stock
split effective January 16, 2003. All earnings per common share amounts, references to common
stock, warrant and stock option plan data and stockholders equity amounts have been restated. In February 2003, the Company sold, pursuant to a private placement, 1,033,074 shares of its
common stock. Bridge loan holders were issued 325,251 shares of its common stock at a price of
$2.40 per share and 707,823 shares were issued at a price of $3.20 per share for total proceeds of
$3,015,000. Net of expenses, the total cash received from the private placement was $2,879,000.
In addition, bridge loan investors received warrants to purchase 325,251 common shares, exercisable
for five years at $.50 per share. Private placement investors received warrants to purchase
707,823 shares exercisable for five years at $3.20 per share. Management and employees purchased
52,014 shares. Reverse Merger In connection with the October 19, 2000 reverse merger, certain MakeMusic! S.A. shareholders
and option and warrant holders retained their common stock interests in MakeMusic! S.A. with a put
and call agreement permitting conversion of those shares at any time within five years into
MakeMusic! Inc. common stock at the same conversion ratio applicable at the acquisition date.
During 2003, 189,723 shares were put to the Company and converted to 147,985 MakeMusic! Inc.
shares. There were no remaining shares of put and call stock as of December 31, 2003. In 2000, the Company granted options to purchase 58,500 options at prices between $16.41 and
$26.26 per share when the fair value of the Companys stock was $28.10, resulting in deferred
compensation of approximately $493,000. The purchase price of the reverse merger included the fair
value of all vested Coda Music Technology options. The intrinsic value of all unvested Coda
options was approximately $433,000 and recorded as additional deferred compensation. The balance
of the deferred compensation was amortized to compensation expense over the remaining vesting
period. Compensation expense amortized for the years ended December 31, 2004 and 2003 was
$153,000 and $367,000, respectively. There is no unamortized balance of deferred compensation as
of December 31, 2004. 33




---



##### Table of Contents



Stock Options and Warrants Prior to the reverse merger, MakeMusic! S.A. had granted options and warrants in 2000 to
employees, directors, external consultants and licensors. In connection with the reverse
acquisition, certain option and warrant holders converted their rights into the Companys options
or warrants based on the acquisition conversion rate of .78 and under the same terms as their
original rights. The remaining option and warrant holders retained their right to purchase
MakeMusic! S.A. shares with a put and call agreement, which would convert to MakeMusic! Inc. shares
at a rate of .78. The following table summarizes the MakeMusic! S.A. options and warrants under
put and call agreements: Weighted-AverageYear
    
    Ordinary Shares
    
    
    Exercise PriceBalance at December 31, 2001
    
    
    155,089
    
    
    Euro 11.461Canceled
    
    
    (8,000
    )
    
    Euro 16.769Balance at December 31, 2002
    
    
    147,089
    
    
    Euro 11.172Canceled
    
    
    (89,540
    )
    
    Euro  8.300Forfeited
    
    
    (42,000
    )
    
    Euro 16.769Balance at December 31, 2003
    
    
    15,549
    
    
    Euro 12.588Forfeited
    
    
    (15,549
    )
    
    Euro 12.588Balance at December 31, 2004
    
    
    0
 The Company has a stock option plan pursuant to which options for up to 750,000 shares of its
common stock may be issued to its key employees and directors. The options generally may not
exceed ten years and are granted at prices that must be at least equal to the stocks fair market
value at the grant date. The Companys previous stock option plan expired September 28, 2002,
which allowed up to 267,500 shares of its common stock to be issued to key employees and directors.
The options vest over periods up to six years and are granted at prices that must be at least
equal to the stocks fair market value at the grant date. The Company also has granted non-plan, nonqualified stock options to certain of its directors,
European employees and consultants. These options vest over periods of up to five years and have
been granted at prices at least equal to the stocks fair market value at the grant date. 34




---



##### Table of Contents



6. Shareholders Equity (Continued) In connection with the reverse merger, all acquired stock options remained outstanding under
their original terms. The following table summarizes the Companys stock option awards: Weighted-Shares Reserved
    
    
    
    
    
    
    Non-Plan
    
    
    Average Exercisefor Grant
    
    
    Plan Options
    
    
    Options
    
    
    PriceMakeMusic! Options Outstanding
at December 31, 2002
    
    
    65,656
    
    
    
    199,110
    
    
    
    24,261
    
    
    $
    16.54Prior Plan Expired
    
    
    (65,656
    )
    
    
    
    
    
    
    New Plan
    
    
    750,000
    
    
    
    
    
    
    
    Granted
    
    
    (661,970
    )
    
    
    661,970
    
    
    
    1,312
    
    
    
    2.29Forfeited
    
    
    
    
    
    
    (7,650
    )
    
    
    (21,141
    )
    
    
    16.93Expired
    
    
    
    
    
    
    (11,850
    )
    
    
    
    
    
    
    14.73Outstanding at December 31, 2003
    
    
    88,030
    
    
    
    841,580
    
    
    
    4,432
    
    
    
    5.38Granted
    
    
    (120,000
    )
    
    
    120,000
    
    
    
    
    
    
    
    3.56Expired
    
    
    
    
    
    
    (8,100
    )
    
    
    (1,193
    )
    
    
    9.95Forfeited
    
    
    49,350
    
    
    
    (71,500
    )
    
    
    
    
    
    
    6.06Cancelled
    
    
    79,439
    
    
    
    (79,439
    )
    
    
    
    
    
    
    2.27Exercised
    
    
    
    
    
    
    (17,620
    )
    
    
    
    
    
    
    2.27Outstanding at December 31, 2004
    
    
    96,819
    
    
    
    784,921
    
    
    
    3,239
    
    
    
    5.37
 The weighted-average fair value of options granted during 2004 and 2003 was $3.56 and $1.78,
respectively. The following summarizes information about stock options outstanding at December 31, 2004: Options Outstanding
    
    
    Options ExercisableOutstanding at
    
    
    
    
    
    
    Weighted-
    
    
    
    
    
    
    Weighted-Range of
    
    December 31,
    
    
    Weighted-Average
    
    
    Average Exercise
    
    
    Exercisable at
    
    
    Average ExerciseExercise Prices
    
    2004
    
    
    Remaining Term
    
    
    Price
    
    
    December 31, 2004
    
    
    Price$2.27  $3.50
    
    
    545,680
    
    
    5.11 years
    
    $
    2.34
    
    
    
    131,325
    
    
    $
    2.363.51  10.00
    
    
    100,900
    
    
    5.32 years
    
    
    4.20
    
    
    
    13,652
    
    
    
    6.5910.01  20.00
    
    
    92,660
    
    
    3.44 years
    
    
    13.17
    
    
    
    71,580
    
    
    
    14.0120.01  40.00
    
    
    48,920
    
    
    2.03 years
    
    
    26.82
    
    
    
    43,923
    
    
    
    27.07Total
    
    
    788,160
    
    
    4.75 years
    
    $
    5.37
    
    
    
    260,480
    
    
    $
    9.95
 In August 2001, the Company issued 6,500 options to purchase common stock at $7.50 to third
parties in exchange for advisory and promotional services. Of these options, 4,000 vested
immediately and the remaining 2,500 shares vest over 60 months as advisory services are received.
In connection with these issuances the Company has recognized expenses of $1,245 and $700, for 2004
and 2003, respectively. As the remaining options vest the Company will recognize additional
expenses. In October 2001, the Company issued warrants to purchase 15,000 shares of common stock at
$6.60 to a third party in exchange for advisory and promotional services. The warrants vest over
60 months. During 2004 and 2003, the Company has recognized expenses in the amount of $9,697 and
$5,800, respectively, in relation to the vested portion of warrants. As the remaining warrants
vest the Company will recognize additional expenses. In September 2001, in connection with a private placement, the Company issued warrants to
purchase 229,840 shares of its common stock at $6.60 per share, expiring in September of 2005. 35




---



##### Table of Contents



6. Shareholders Equity (Continued) Total warrants of 1,324,139 are outstanding at December 31, 2004, of which 1,318,139 are
exercisable at a weighted average exercise price of $3.18. The warrants expire as follows: 2005 
256,947; 2008  987,560; 2010  15,083; 2011  15,000; 2013  49,549. 7. Commitments Capital Lease Obligations Future minimum lease payments under capital lease obligations due for the years ending
December 31 are as follows (in thousands): 2005
    
    $
    72006
    
    
    72007
    
    
    72008
    
    
    3Total minimum lease payments
    
    
    24Less amount representing interest
    
    

    2Present value of net minimum lease payments
    
    
    22Less current portion
    
    
    6Long-term portion
    
    $
    16
 Operating Leases The Company leases office and warehouse space and certain equipment under operating leases
into 2007. Total future minimum lease payments under these leases as of December 31, 2004 are as
follows (in thousands): 2005
    
    $
    1622006
    
    
    622007
    
    
    7Total
    
    $
    231
 Obligations for operating leases beyond 2004 relate to the Company offices and telephone
equipment. Rent expense for the years ended December 31, 2004 and 2003 was $140,000 and $160,000,
respectively. Licensing and Exclusivity Agreements The Company has entered into license and exclusivity agreements that require payments based on
sales of its software products and accompaniments. Payments to licensors are included in cost of
sales in the consolidated statement of operations and were $86,000 and $120,000 for the years ended
December 31, 2004 and 2003, respectively. Minimum royalties related to significant licensors are as follows (in thousands): 2005
    
    $
    582006
    
    
    20Total
    
    $
    78
 8. 401(k) Savings Plan The Company has a 401(k) savings plan for the benefit of qualified U.S. employees. Under the
plan, qualified employees may elect to defer up to 80% of their compensation, subject to a limit
determined by the Internal Revenue Service. The Company, at the discretion of the Board of
Directors, may elect to make additional contributions. The Company made no contributions to the
plan in 2004 or 2003. 36




---



##### Table of Contents



9. Income Taxes Loss before income taxes includes the following components: December 31,2004
    
    
    2003(In thousands)France
    
    $
    
    
    
    $
    (443
    )United States
    
    
    (508
    )
    
    
    (4,018
    )$
    (508
    )
    
    $
    (4,461
    )
 The tax effects of temporary differences at an assumed effective annual rate of 38% are shown
in the following table: December 31,2004
    
    
    2003(In thousands)Loss carryforwards
    
    $
    8,311
    
    
    $
    8,169Research and development credits
    
    
    645
    
    
    
    572Inventory
    
    
    105
    
    
    
    158Depreciation and amortization
    
    
    176
    
    
    
    265Other accruals
    
    
    464
    
    
    
    547Valuation allowance for deferred tax assets
    
    
    (9,257
    )
    
    
    (8,841
    )Net deferred tax assets
    
    
    444
    
    
    

    870Deferred tax liability:Software development costs
    
    
    169
    
    
    
    209Intangible assets
    
    
    275
    
    
    
    661Total deferred tax liabilities
    
    
    444
    
    
    
    870Net deferred taxes
    
    $
    
    
    
    $
    
 Realization of deferred tax assets is dependent upon the generation of sufficient future
taxable income. Management has determined that sufficient uncertainty exists regarding the
realizability of the net deferred tax assets and, accordingly, has fully reserved the net deferred
tax assets. A reconciliation of the income tax benefit computed using the U.S. statutory rate (34%) to the
effective income tax expense included in the statement of operations is as follows: December 31,2004
    
    
    2003(In thousands)Income tax benefit computed at the statutory rate
    
    $
    (174
    )
    
    $
    (1,367
    )State tax benefit, net of calculated federal income tax effects
    
    
    (22
    )
    
    
    (173
    )Unused tax loss carryforwards and valuation reserve
    
    
    122
    
    
    
    1,385Permanent differences
    
    
    72
    
    
    
    156Effective income tax expense
    
    $
    2
    
    
    $
    1
 37




---



##### Table of Contents



9. Income Taxes (Continued) Net Operating Losses At December 31, 2004, the Company had net operating loss carryforwards (NOLs) and research and
development credit carryforwards which may be used to offset otherwise future taxable income with
the following expiration dates: Research andNet Operating Loss
    
    
    Development CreditsU.S.
    
    
    U.S.2007
    
    
    219
    
    
    
    132008
    
    
    825
    
    
    
    722009
    
    
    1,586
    
    
    
    902010
    
    
    2,128
    
    
    
    472011
    
    
    2,192
    
    
    
    432012
    
    
    1,736
    
    
    
    382018
    
    
    770
    
    
    
    462019
    
    
    1,472
    
    
    
    362020
    
    
    4,414
    
    
    
    2021
    
    
    3,037
    
    
    
    722022
    
    
    1,375
    
    
    
    1162023
    
    
    2,117
    
    
    
    72$
    21,871
    
    
    $
    645
 Included in the U.S. NOLs are those of MakeMusic! S.A.s now inactive subsidiary with federal
and state NOLs of approximately $7.1 million, which begin to expire in 2019. These loss
carryforwards can generally only be used by the entity that has generated the corresponding tax
losses. At December 31, 2004, approximately $9.5 million of the Companys NOLs have a full valuation
allowance that, if and when realized, will result in a reduction of goodwill associated with the
Coda reverse merger. Section 382 of the Internal Revenue Code restricts the annual utilization of
these NOLs incurred prior to a change in ownership. Such a change in ownership occurred in
connection with the Coda reverse merger, thereby potentially restricting the NOLs available to the
Company. The Company has yet to determine whether any limitation on these NOLs exists at December
31, 2004. The Companys subsidiary in New York had also generated approximately $4.6 million in
NOLs that may also be subject to Section 382 limitations due to the significant changes in control
of Net4Music S.A. There can be no assurance that certain of the Companys NOLs will be available
for use in the future. 10. Litigation In the ordinary course of business, the Company may be party to legal actions, proceedings or
claims. Corresponding costs are accrued when it is probable that a loss will be incurred and the
amount can be precisely or reasonably estimated. The Company is currently participating in
negotiations to settle a case with a French sheet music publisher that claimed wrongful termination
of a contract. The Company believes that this case is without merit but has accrued $27,000 for a
potential settlement. We are not aware of any other threatened litigation that would have a
material effect on the Companys financial condition or results of operations. 11. Segment and Geographic Data The Company operates in one industry segment: the design, development, support and marketing
of application solutions to music educators, music makers and the music publishing industry. The
Company provides the technologies, products and services to optimize the entire music-maker supply
chain. 38




---



##### Table of Contents



The geographic distribution of the Companys revenue and long-lived assets are summarized in
the following table: December 31,2004
    
    
    2003(In thousands)Net sales:North America
    
    $
    9,216
    
    
    $
    5,825Europe
    
    
    1,289
    
    
    
    1,019Other foreign countries
    
    
    735
    
    
    
    513$
    11,240
    
    
    $
    7,357Long-lived assets:North America
    
    $
    5,032
    
    
    $
    6,293Europe
    
    
    3
    
    
    
    22$
    5,035
    
    
    $
    6,315
 12. Liquidity Net cash provided by operating activities was $1,034,000 for the year ended December 31, 2004
compared to $1,690,000 used by operating activities for the year ended December 31, 2003. The
Company had positive cash flow in 2004 for the first time since the 2000 reverse merger of Coda
Music Technology and Net4Music. This was the result of efforts to significantly reduce expenses
and increase revenues. The Company expects to continue to earn positive operating cash in the
foreseeable future, but not necessarily every quarter. If the Company does not meet its
anticipated revenue levels due to a significantly later than anticipated Notation product release
or a decrease in demand for its products, management is committed to expense reductions in sales,
marketing and other areas as necessary to ensure adequate cash levels remain to continue funding
operations. If further expense reductions do not offset such a decrease in revenue, the Company
may have to seek additional financing. 39




---



##### Table of Contents



ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On August 30, 2004, Ernst & Young LLP resigned as the Companys independent public accountants
and on September 13, 2004, the Companys Board of Directors and Audit Committee retained McGladrey
& Pullen, LLP to be their independent public accountants, which was previously reported in a Form
8-K which was filed on September 2, 2004. 
 ITEM 8A. CONTROLS AND PROCEDURES Our Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the
Companys disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
as of the end of the period covering this report. Based on this evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that our disclosure controls and procedures are
effective to provide reasonable assurance that information required to be disclosed by the Company
in the reports that it files or submits under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified by the Securities and Exchange Commissions rules
and forms. Changes in Internal Controls There were no changes in the Companys internal control over financial reporting that occurred
during the fourth quarter that have materially affected, or are reasonably likely to materially
affect, the Companys internal control over financial reporting. 
 ITEM 8B. OTHER INFORMATION All information required to be reported in a report on Form 8-K during the fourth quarter of
the year covered by this report has been reported. 40




---



##### Table of Contents



PART III 
 ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The names and ages of the executive officers of the Company and their positions and offices
presently held are as follows: Name
    
    Age
    
    PositionWilliam R. Wolff
    
    
    47
    
    
    Chief Executive OfficerJohn W. Paulson
    
    
    57
    
    
    PresidentAlan Shuler
    
    
    57
    
    
    Vice President and Chief Financial Officer
 William R. Wolffjoined the Company as Chief Financial Officer, Secretary, and Treasurer in
October 2003 and became Chief Executive Officer on June 9, 2004. Wolff began his career as a
financial analyst at Control Data Corporation. He subsequently held a variety of leadership
positions in start-up and growth software companies, including Springboard Software, where he was
Controller and CFO and responsible for the Companys public reporting. He later served for eight
years as Chief Executive Officer of Open Systems Holdings Corporation, an accounting systems
company. For the six years prior to joining MakeMusic! he was Chief Executive Officer of CrossUSA,
an innovative systems outsourcing company. Mr. Wolff also serves on the Board of Directors of a
local IT Services Company, Instrumental Inc. John W. Paulson, founder of the Company, has served as director, Chairman and CEO from 1990 to
2000 and continues to serve as President and director. From 1982 to 1990, Mr. Paulson was Chairman
and CEO of Springboard Software, Inc., a publicly held company he founded to develop and market
educational consumer software products. Prior to founding Springboard, Mr. Paulson was a public
school music teacher for nine years. He has a Master of Arts in Music Education from the Eastman
School of Music, is a published composer and has performed as a professional musician for more than
10 years. Mr. Paulson has served on the Board of Directors of the National Association of Music
Merchants, the Wenger Corporation and the St. Paul Chamber Orchestra. Alan G. Shulerjoined the Company as Vice President and Chief Financial Officer in October
2004. Shuler has more than 30 years of experience at large and small public and private companies
having spent the past twelve years as Vice President and Chief Financial Officer of Datakey, Inc.,
a public company that produces software and semiconductor-based smart card systems for Internet and
network security and single sign-on solutions with sophisticated password management. He
previously held leadership positions with FSI International, Inc., where he was Senior VP Finance &
Administration & CFO and Carlson Companies, Inc., where he was President and CEO of the North
American Financial Division. Mr. Shuler holds a BS in Business/Engineering from the University of
Idaho and an MBA in Accounting from Santa Clara University. The other information required by Item 9 relating to directors, compliance with Section 16(a)
of the Exchange Act, and code of ethics is incorporated herein by reference to the sections labeled
Election of Directors, Section 16(a) Beneficial Ownership Reporting Compliance, and Code of
Ethics, that appear in the Companys definitive Proxy Statement for its 2005 Annual Meeting of
Shareholders. 
 ITEM 10. EXECUTIVE COMPENSATION The information required by Item 10 is incorporated herein by reference to the section labeled
Executive Compensation that appears in the Companys definitive Proxy Statement for its 2005
Annual Meeting of Shareholders. 41




---



##### Table of Contents



ITEM 11.
    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS The information required by Item 11 regarding security ownership is incorporated herein by
reference to the sections labeled Principal Shareholders and Management Shareholdings that appear
in the Companys definitive Proxy Statement for its 2005 Annual Meeting of Shareholders. The following table provides information concerning the Companys equity compensation plans as
of December 31, 2004. Number of securities remainingNumber of securities to be
    
    
    
    Weighted average
    
    
    
    available for future issuanceissued upon exercise of
    
    
    
    exercise price of
    
    
    
    under equity compensationoutstanding options,
    
    
    
    outstanding options,
    
    
    
    plans (excluding securitieswarrants and rights
    
    
    
    warrants and rights
    
    
    
    reflected in column (a))(a)
    
    
    
    (b)
    
    
    
    (c)Equity compensation
plans approved by
security holders
    
    
    
    784,921
    
    
    
    $
    5.35
    
    
    
    
    96,819Equity compensation
plans not approved
by security holders
    
    
    
    3,239
    (1)
    
    
    $
    32.80
    
    
    
    NoneTotals
    
    
    
    788,160
    
    
    
    $
    5.37
    
    
    
    
    96,819
   (1)
    
    Options issued to consultants in 2000 for services rendered. 
 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 12 is incorporated by reference to the section labeled
Certain Transactions that appears in the Companys definitive Proxy Statement for its 2005 Annual
Meeting of Shareholders. 
 ITEM 13. EXHIBITS See Exhibit Index immediately following the certifications to this Form 10-KSB. 
 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by Item 14 is incorporated by reference to the section labeled
Independent Registered Public Accounting Firm, Audit Fees that appears in the Companys
definitive Proxy Statement for its 2005 Annual Meeting of Shareholders. 42




---



##### Table of Contents



SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant has caused this
Report to be signed on its behalf by the undersigned, thereunto duly authorized. MakeMusic! Inc.Dated: March 22, 2005
    
    By:
    
    /s/ William R. WolffWilliam R. Wolff, Chief Executive Officer
 In accordance with the Exchange Act, this Report has been signed by the following persons on
behalf of the Registrant and in the capacities and on the dates indicated. (Power of Attorney) Each person whose signature appears below constitutes and appoints WILLIAM R. WOLFF and ALAN
G. SHULER as true and lawful attorneys-in-fact and agents, each acting alone, with full power of
substitution and resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any or all amendments to this Annual Report on Form 10-KSB and to file the
same, with all exhibits thereto, and other documents in connection therewith, with the Securities
and Exchange Commission, granting unto said attorneys-in-fact and agents, each acting alone, full
power and authority to do and perform each and every act and thing requisite and necessary to be
done in and about the premises, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all said attorneys-in-fact and agents, each acting alone,
or his substitute or substitutes, may lawfully do or cause to be done by virtue thereof. Signature and Title
    
    Date/s/ William R. Wolff
    
    March 22, 2005William R. Wolff, Chairman of the Board and Chief
Executive Officer (principal executive officer)/s/ John W. PaulsonMarch 22, 2005John W. Paulson, President and Director/s/ Alan ShulerMarch 22, 2005Alan Shuler, Chief Financial Officer (principal financial
and accounting officer)/s/ Philip Sean LafleurMarch 22, 2005Philip Sean Lafleur/s/ Philippe AubertMarch 22, 2005Philippe Aubert, Director/s/ John C. BergstromMarch 22, 2005John C. Bergstrom, Director/s/ Ronald B. RaupMarch 22, 2005Ronald B. Raup, Director
 43




---



##### Table of Contents



Signature and Title
    
    DateMartin Velasco, Director/s/ John R. WhisnantMarch 22, 2005John R. Whisnant, DirectorBenson K. Whitney, Director
 44




---



##### Table of Contents



MAKEMUSIC! INC. 
 EXHIBIT INDEX
FOR
FORM 10-KSB FOR 2004 FISCAL YEAR
 ExhibitNumber
    
    Description2.1
    
    Stock Purchase Agreement, dated August 11, 2000, by and among the Registrant,
Net4Music S.A. and certain shareholders of Net4Music S.A.  incorporated by
reference to Exhibit 2.1 to the Registrants Registration Statement on Form S-4,
Reg. No. 333-436602.2
    
    Put and Call Agreement entered into by the Registrant and certain shareholders
and option and warrant holders of Net4Music S.A.  incorporated by reference to
Exhibit 2.2 to the Registrants Registration Statement on Form S-4, Reg. No.
333-436602.3
    
    Shareholder Voting Agreement entered into by the Registrant and certain
shareholders of the Registrantincorporated by reference to Exhibit 2.3 to the
Registrants Registration Statement on Form S-4, Reg. No. 333-436603.1
    
    Restated Articles of Incorporation as amended3.2
    
    Bylawsincorporated by reference to Exhibit 3.2 to the Registrants Form SB-2
Registration Statement, Reg. No. 33-92212C10.1
    
    Lease dated October 23, 1992 between the Registrant and Jorandcor,
Inc.incorporated by reference to Exhibit 10.1 to the Registrants Form SB-2
Registration Statement, Reg. No. 33-92212C10.2*
    
    1992 Stock Option Planincorporated by reference to Exhibit 10.3 to the
Registrants Form SB-2 Registration Statement, Reg. No. 33-92212C10.3
    
    License Agreement dated June 10, 1992 between the Registrant and Carnegie Mellon
University, including Amendments 1 and 2incorporated by reference to Exhibit
10.11 to the Registrants Form SB-2 Registration Statement, Reg. No. 33-92212C10.4
    
    License Agreement dated December 31, 1992 between the Registrant and Wenger
Corporationincorporated by reference to Exhibit 10.12 to the Registrants Form
SB-2 Registration Statement, Reg. No. 33-92212C10.5*
    
    Form of Nonqualified Stock Option Agreement for Options Granted Outside the 1992
Stock Option Planincorporated by reference to Exhibit 10.13 to the Registrants
Form SB-2 Registration Statement, Reg. No. 33-92212C10.6
    
    Educational Software Distribution Agreement dated July 26, 1991 between the
Registrant and The Douglas Stewart Companyincorporated by reference to Exhibit
10.17 to the Registrants Form SB-2 Registration Statement, Reg. No. 33-92212C10.7
    
    Amendment No. 3 to License Agreement between the Registrant and Carnegie Mellon
University dated August 28, 1996  incorporated by reference to Exhibit 10.1 to
the Registrants 10-QSB for the quarter ended September 30, 199610.8
    
    Second Amendment to Lease by and between Jorandcor, Inc. and the
Registrantincorporated by reference to Exhibit 10.14 to the Registrants Form
10-KSB for the year ended December 31, 199710.9
    
    Amendment No. 4 to License Agreement between the Registrant and Carnegie Mellon
University dated December 30, 1998  incorporated by reference to Exhibit 10.10
to the Registrants Form 10-KSB for the year ended December 31, 1998
 45




---



##### Table of Contents



ExhibitNumber
    
    Description10.10
    
    Third Amendment to Lease by and between Jorandcor, Inc. and the Registrant 
incorporated by reference to Exhibit 10.1 to the Registrants Form 10-QSB for the
quarter ended March 31, 200010.11*
    
    Employment Agreement dated October 19, 2000 between the Registrant and John W.
Paulson  incorporated by reference to Exhibit 10.15 to the Registrants Form
10-KSB for the year ended December 31, 200010.12
    
    Fourth Amendment dated December 11, 2001 to Lease by and between Jorandcor, Inc.
and the Registrant  incorporated by reference to exhibit 10.12 to the
Registrants Form 10-KSB for the year ended December 31, 2002.10.13*
    
    Employment Agreement dated September 1, 2002 between MakeMusic! Inc. and Philip
Sean Lafleur  incorporated by reference to exhibit 10.13 to the Registrants
Form 10-KSB for the year ended December 31, 2002.10.14
    
    Fifth Amendment, dated January 23, 2003, to Lease by and between Jorandcor, Inc.
and the Registrant  incorporated by reference to exhibit 10.14 to the
Registrants Form 10-KSB for the year ended December 31, 2002.10.15
    
    MakeMusic! 2003 warrant for private placement at $3.20 issued February 28, 2003
with list of amounts purchased by directors, officers and principal shareholders
 incorporated by reference to exhibit 10.15 to the Registrants Form 10-KSB for
the year ended December 31, 2002.10.16
    
    MakeMusic! 2003 warrant for private placement at $0.50 issued February 28, 2003
with list of amounts purchased by directors, officers and principal shareholders
 incorporated by reference to exhibit 10.16 to the Registrants Form 10-KSB for
the year ended December 31, 2002.10.17*
    
    MakeMusic! 2003 Equity Incentive Plan, incorporated by reference to exhibit 10.17
to the Registrants Form 10-KSB for the year ended December 31, 2003.10.18*
    
    Employment Agreement dated June 9, 2004 between the Registrant and William R.
Wolff  incorporated by reference to Exhibit 10.18 to the Registrants Form
10-QSB for the quarter ended September 30, 2004.10.19*
    
    Transition Agreement and Release dated November 22, 2004 between the Registrant
and Philip Sean Lafleur  incorporated by reference to Exhibit 99.1 to the
Registrants Form 8-K filed on November 24, 2004.10.20*
    
    Board Compensation Plan effective October 1, 2004  December 31, 2005 between the
Registrant and all board members that do not represent more than 5% of
shareholders or are not otherwise compensated by the Company  incorporated by
reference to Exhibit 10.1 to the Registrants Form 8-K filed on February 8, 2005.10.21*
    
    Form of Incentive Stock Option Agreement under the MakeMusic! 2003 Equity
Incentive Plan10.22*
    
    Form of Nonqualified Stock Option Agreement under the MakeMusic! 2003 Equity
Incentive Plan10.23*
    
    Form of Restricted Stock Agreement under the MakeMusic! 2003 Equity Incentive Plan21
    
    Subsidiaries of the Registrant: Net4Music (New York) Inc.23.1
    
    Consent of McGladrey & Pullen LLP, independent registered public accounting firm23.2
    
    Consent of Ernst & Young LLP, independent registered public accounting firm
 46




---



##### Table of Contents



ExhibitNumber
    
    Description24
    
    Power of Attorney (included on the Signatures page of this Form 10-KSB)31.1
    
    Certification by Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.31.2
    
    Certification by Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32.1
    
    Certification by Chief Executive Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.32.2
    
    Certification by Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
   *
    
    Indicates a management contract or compensatory plan or arrangement required to be filed as an
exhibit to this Form 10-KSB. 47