**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-QSB**

 

**(Mark One)**
| **ý** |   | **Quarterly  report under Section 13 or 15(d) of the Securities Exchange Act of 1934**                                          |   |   |
|------------|--------|---------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|       |   | **For the quarterly period ended June 30,  2004**                                                                               |   |   |
|       |   |                                                                                                                            |   |   |
| **o**      |   | **Transition  report under Section 13 or 15(d) of the Exchange Act**                                                            |   |   |
|       |   | **For the transition period  from               To** |   |   |
|       |   |                                                                                                                            |   |   |
|       |   | **Commission file  number               0-26192**    |   |   |

 

**MakeMusic! Inc.**

(Exact Name of Small Business Issuer asSpecified in its Charter)

 

| **Minnesota**                                                                        |   | **41-1716250**                        |
|--------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization)                      |   | (I.R.S. Employer  Identification No.) |
|                                                                                 |   |                                  |
| **6210 Bury Drive  Eden Prairie, Minnesota 55346-1718**                              |
| (Address of Principal Executive Offices)                                             |
|                                                                                 |
| **(952) 937-9611**                                                                   |
| (Issuer’s Telephone Number, Including Area  Code)                               |
|                                                                                 |   |                                  |
|                                                                                 |   |                                  |
| (Former Name, Former Address and Former  Fiscal Year,  if Changed Since Last Report) |

 

Check whether the issuer:  (1) filed all reports required to be filedby Section 13 or 15(d) of the Exchange Act during the past 12 months (or for suchshorter 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  ý  No  o

 

Asof July 21, 2004, there were 3,381,321 shares of Common Stock outstanding.

 

Transitional Small Business Disclosure Format (check one):

 

Yes  o  No  ý

 

 

----

 

**MakeMusic!Inc.**

 

**INDEX**

 
|    | **PART I.  FINANCIAL INFORMATION**                                                                   |   |
|---------|-----------------------------------------------------------------------------------------------------------|--------|
|    |                                                                                                      |   |
| Item 1. | Condensed Consolidated Financial Statements                                                               |   |
|    |                                                                                                      |   |
|    | Condensed Consolidated Balance Sheets  June 30, 2004 and December 31, 2003                                |   |
|    |                                                                                                      |   |
|    | Condensed Consolidated Statement of  Operations  Three and six-month periods ended June 30, 2004 and 2003 |   |
|    |                                                                                                      |   |
|    | Condensed Consolidated Statement of Cash  Flows  Six-month periods ended June 30, 2004 and 2003           |   |
|    |                                                                                                      |   |
|    | Notes to Condensed Consolidated Financial  Statements                                                     |   |
|    |                                                                                                      |   |
| Item 2. | Management’s Discussion and Analysis or  Plan of Operation.                                          |   |
|    |                                                                                                      |   |
| Item 3. | Controls and Procedures                                                                                   |   |
|    |                                                                                                      |   |
|    | **PART II.  OTHER INFORMATION**                                                                      |   |
|    |                                                                                                      |   |
| Item 6. | Exhibits and Reports on Form 8-K                                                                          |   |
|    |                                                                                                      |   |
|    | Signatures                                                                                                |   |
|    |                                                                                                      |   |
|    | Exhibit  Index                                                                                            |   |
|    |                                                                                                      |   |

 

2

----

 

**PART I**

 

**ITEM1.  CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

 

**MakeMusic! Inc.**

**Condensed Consolidated Balance Sheets**

*(In thousands of U.S. dollars)*

 
|                                                              |   | **June 30,  2004** |       | **December 31,  2003** |   |
|-------------------------------------------------------------------|--------|--------------------|------------|------------------------|--------|
|                                                              |   | **(unaudited)**    |       | **(Note)**             |   |
| **Assets**                                                        |   |               | ** ** |                   |   |
| Current assets:                                                   |   |               | ** ** |                   |   |
| Cash and cash equivalents                                         |   | **$**              | **1,784**  | ** **             | $      | 1,467 |   |
| Accounts receivable, net                                          |   | **783**            | ** ** | 494                    |   |
| Inventories                                                       |   | **262**            | ** ** | 273                    |   |
| Value added tax receivable                                        |   | **36**             | ** ** | 32                     |   |
| Prepaid expenses and other current assets                         |   | **141**            | ** ** | 175                    |   |
| Total current assets                                              |   | **3,006**          | ** ** | 2,441                  |   |
| Property and equipment, net                                       |   | **244**            | ** ** | 280                    |   |
| Goodwill, net                                                     |   | **3,630**          | ** ** | 3,630                  |   |
| Capitalized software products                                     |   | **493**            | ** ** | 599                    |   |
| Intangible assets, net                                            |   | **1,259**          | ** ** | 1,718                  |   |
| Other non-current assets                                          |   | **112**            | ** ** | 88                     |   |
| **Total assets**                                                  |   | **$**              | **8,744**  | ** **             | $      | 8,756 |   |
|                                                              |   |               | ** ** |                   |   |
| **Liabilities and shareholders’ equity**                     |   |               | ** ** |                   |   |
| Current liabilities:                                              |   |               | ** ** |                   |   |
| Accounts payable                                                  |   | **$**              | **394**    | ** **             | $      | 417 |   |
| Accrued compensation                                              |   | **908**            | ** ** | 798                    |   |
| Accrued expenses and other current  liabilities                   |   | **325**            | ** ** | 353                    |   |
| Current portion of long-term debt and  capital leases obligations |   | **6**              | ** ** | 57                     |   |
| Reserve for product returns                                       |   | **377**            | ** ** | 355                    |   |
| Deferred revenue                                                  |   | **607**            | ** ** | 660                    |   |
| Total current liabilities                                         |   | **2,617**          | ** ** | 2,640                  |   |
|                                                              |   |               | ** ** |                   |   |
| Capital lease obligations, net of current  portion                |   | **19**             | ** ** | 21                     |   |
|                                                              |   |               | ** ** |                   |   |
| Shareholders’ equity:                                        |   |               | ** ** |                   |   |
| Common stock                                                      |   | **34**             | ** ** | 34                     |   |
| Additional paid-in capital                                        |   | **61,570**         | ** ** | 61,553                 |   |
| Accumulated deficit                                               |   | **(55,417**        | **)**      | (55,339                | )      |
| Deferred compensation                                             |   | **(79**            | **)**      | (153                   | )      |
| Total shareholders’ equity                                   |   | **6,108**          | ** ** | 6,095                  |   |
| Total liabilities and shareholders’ equity                   |   | **$**              | **8,744**  | ** **             | $      | 8,756 |   |

 

**NOTE:**   TheBalance Sheet at December 31, 2003 has been derived from the audited financialstatements at that date but does not reflect all of the information andfootnotes required by accounting principles generally accepted in the UnitedStates for complete financial statements.

 

3

----

 

**MakeMusic! Inc.**

**Condensed Consolidated Statements of Operations**

*(In thousands of U.S. dollars,except per share data)*

(Unaudited)

 
|                                       |   | **Quarter  Ended June 30,** |       | **Six Months  Ended June 30,** |     |
|--------------------------------------------|--------|-----------------------------|------------|--------------------------------|----------|
| **2004**                                   |   | **2003**                    | **2004**   |                           | **2003** |
|                                       |   |                        | ** ** |                           |     |   | ** ** |   | ** ** |
| NET REVENUE                                |   | **$**                       | **2,403**  | ** **                     | $        | 1,378 |   | **$** | **5,598** | ** ** | $ | 3,035 |   |
|                                       |   |                        | ** ** |                           |     |   | ** ** |   |   |
| COST OF REVENUES                           |   | **510**                     | ** ** | 322                            |     | **1,024** | ** ** | 704 |   |
|                                       |   |                        | ** ** |                           |     |   | ** ** |   |   |
| GROSS PROFIT                               |   | **1,893**                   | ** ** | 1,056                          |     | **4,574** | ** ** | 2,331 |   |
|                                       |   |                        | ** ** |                           |     |   | ** ** |   |   |
| OPERATING EXPENSES:                        |   |                        | ** ** |                           |     |   | ** ** |   |   |
| Website development expenses               |   | **141**                     | ** ** | 141                            |     | **282** | ** ** | 209 |   |
| Content and product development expenses   |   | **452**                     | ** ** | 535                            |     | **946** | ** ** | 1,091 |   |
| Selling and marketing expenses             |   | **894**                     | ** ** | 782                            |     | **1,779** | ** ** | 1,823 |   |
| General and administrative expenses        |   | **935**                     | ** ** | 980                            |     | **1,753** | ** ** | 1,984 |   |
|                                       |   |                        | ** ** |                           |     |   | ** ** |   |   |
| Total operating expenses                   |   | **2,422**                   | ** ** | 2,438                          |     | **4,760** | ** ** | 5,107 |   |
|                                       |   |                        | ** ** |                           |     |   | ** ** |   |   |
| LOSS FROM OPERATIONS                       |   | **(529**                    | **)**      | (1,382                         | )        | **(186** | **)** | (2,776 | ) |
|                                       |   |                        | ** ** |                           |     |   | ** ** |   |   |
| Interest income/(expense), net             |   | **3**                       | ** ** | (6                             | )        | **2** | ** ** | (732 | ) |
| Other income/(expense), net                |   | **98**                      | ** ** | (76                            | )        | **108** | ** ** | (76 | ) |
| Net (loss)/income before income tax        |   | **(428**                    | **)**      | (1,464                         | )        | **(76** | **)** | (3,584 | ) |
|                                       |   |                        | ** ** |                           |     |   | ** ** |   |   |
| Income Tax                                 |   | **—**                  | ** ** | —                         |     | **(2** | **)** | (2 | ) |
| Net loss                                   |   | **$**                       | **(428**   | **)**                          | $        | (1,464 | ) | **$** | **(78** | **)** | $ | (3,586 | ) |
|                                       |   |                        | ** ** |                           |     |   | ** ** |   | ** ** |
| Basic and diluted loss per common share    |   | **$**                       | **(0.13**  | **)**                          | $        | (0.44 | ) | **$** | **(0.02** | **)** | $ | (1.18 | ) |
|                                       |   |  

               |       |                           |     |   |   |   |   |
| Weighted average common shares outstanding |   | **3,366,297**               | ** ** | 3,356,330                      |     | **3,361,368** | ** ** | 3,042,016 |   |

 

4

----

**MakeMusic! Inc.**

**Condensed Consolidated Statements of Cash Flows**

*(In thousands of U.S. dollars)*

(Unaudited)

 
|                                                                         |   | **Six Months  Ended June 30,** |       |
|------------------------------------------------------------------------------|--------|--------------------------------|------------|
|                                                                         |   | **2004**                       |       | **2003** |   |
| **Operating activities**                                                     |   |                           | ** ** |   |   |
| Net loss                                                                     |   | **$**                          | **(78**    | **)** | $ | (3,586 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |   |                           | ** ** |   |   |
| Amortization of intangible assets                                            |   | **672**                        | ** ** | 647 |   |
| Depreciation and amortization of property  and equipment                     |   | **99**                         | ** ** | 242 |   |
| Amortization of deferred compensation                                        |   | **75**                         | ** ** | 80 |   |
| Interest on bridge loan and discount                                         |   | **—**                     | ** ** | 718 |   |
| Issuance of stock options and warrants for  services                         |   | **5**                          | ** ** | 2 |   |
| Foreign currency translation loss recorded                                   |   | **—**                     | ** ** | 145 |   |
| Increase (decrease) in cash from:                                            |   |                           | ** ** |   |   |
| Accounts receivable                                                          |   | **(288**                       | **)**      | 52 |   |
| Inventories                                                                  |   | **10**                         | ** ** | 24 |   |
| Prepaid expenses and other current assets                                    |   | **3**                          | ** ** | 34 |   |
| Accounts payable                                                             |   | **(22**                        | **)**      | (393 | ) |
| Accrued liabilities and product returns                                      |   | **102**                        | ** ** | (132 | ) |
| Deferred revenue                                                             |   | **(53**                        | **)**      | 190 |   |
| Net cash provided (used) by operating  activities                            |   | **525**                        | ** ** | (1,977 | ) |
|                                                                         |   |                           | ** ** |   |   |
| **Net cash used by investing activities**                                    |   |                           | ** ** |   |   |
| Purchases of property  & equipment                                  |   | **(63**                        | **)**      | (67 | ) |
| Capitalized development and other  intangibles                               |   | **(104**                       | **)**      | (74 | ) |
| Net cash used by investing activities                                        |   | **(167**                       | **)**      | (141 | ) |
|                                                                         |   |                           | ** ** |   |   |
| **Net cash (used) provided by financing  activities**                        |   |                           | ** ** |   |   |
| Issuance of shares                                                           |   | **12**                         | ** ** | 2,120 |   |
| Payments on revolving note payable, net                                      |   | **—**                     | ** ** | 22 |   |
| Payments on long-term debt and capital  leases                               |   | **(53**                        | **)**      | 5 |   |
| Net cash (used) provided by financing  activities                            |   | **(41**                        | **)**      | 2,147 |   |
|                                                                         |   |                           | ** ** |   |   |
| Net increase in cash and cash equivalents                                    |   | **317**                        | ** ** | 29 |   |
| Cash and cash equivalents, beginning of  period                              |   | **1,467**                      | ** ** | 1,469 |   |
| Cash and cash equivalents, end of period                                     |   | **$**                          | **1,784**  | ** ** | $ | 1,498 |   |
|                                                                         |   |                           | ** ** |   |   |
| **Supplemental disclosure of cash flow  information**                        |   |                           | ** ** |   |   |
| Interest paid                                                                |   | **$**                          | **2**      | ** ** | $ | 23 |   |

 

5

----

 

**MakeMusic! Inc.**

** **

## **Notesto Condensed Consolidated Financial Statements**

 

## **(Unaudited)**

 

Note 1                       **AccountingPolicies.  **The information furnished in this report isunaudited but reflects all adjustments that are necessary, in the opinion ofmanagement, for a fair statement of the results for the interim period.  The operating results for the six monthsended June 30, 2004 are not necessarily indicative of the operating results tobe expected for the full fiscal year. These statements should be read in conjunction with the Company’s mostrecent Annual Report on Form 10-KSB.

 

Note 2                       **Private Financing****.  **On March 3, 2003, the Company announced that it had completed a privateplacement of $3,015,000, which was approved by shareholders on February 24,2003.  Of this amount, $750,000represented proceeds received upon the sale of convertible bridge loans onSeptember 30, 2002.  According to thebridge loan agreement, holders of bridge loans were entitled to receive:  (i) warrants (“Original Warrants”) topurchase one additional share of common stock for each converted share for$0.10 if a private placement of at least $1.0 million was not completed byMarch 31, 2003; or (ii) warrants to purchase one additional share of commonstock for each converted share for $0.50 per share if the requisite privateplacement was completed prior to March 31, 2003.  In 2002, the value attributed to the Original Warrants wasrecorded as a debt discount and additional paid-in capital

 

Upon completion of the private placement, and concurrent bridge loanconversion into 325,251 shares of common stock, the Company issued warrants(“Conversion Warrants”) to holders of bridge loans to purchase shares of commonstock for $0.50 per share.  These eventsresulted in $706,000 of interest expense being recorded in the quarter ended March31, 2003.  Of this amount, $356,000 wasrecorded to recognize the value attributed to the Conversion Warrants upontheir issuance and $350,000 was recorded to amortize in full the discountoriginally recorded (and remaining unamortized) on the bridge loan relating totheir beneficial conversion feature.

 

In addition to the 325,251 shares issued to the bridge loan holders,707,823 shares were issued for the $2.265 million received from investors atthe full private placement price of $3.20. As of June 30, 2004, 3,376,986 shares of common stock were issued andoutstanding.

 

6

----

 

Note 3                       **Net****Loss PerShare.  **Net loss per share was calculated bydividing the net loss by the weighted average number of shares outstandingduring the period.  The following tablesummarizes the shares of stock included in calculating earnings per share forthe quarters and six months ended June 30, 2004 and 2003 in accordance withFASB Statement 128 (“FAS 128”), *Earnings perShare*:

 
|                                                        |   | **Quarter  Ended   June 30,** |     | **Six Months  Ended  June 30,** |     |
|-------------------------------------------------------------|--------|-------------------------------|----------|---------------------------------|----------|
| **2004**                                                    |   | **2003**                      | **2004** |                            | **2003** |
| Weighted-average common shares outstanding                  |   | 3,366,297                     |     | 3,356,330                       |     | 3,361,368 |   | 3,042,016 |   |
| Dilutive effect of stock options and  warrants              |   | —                        |     | —                          |     | — |   | — |   |
| Equivalent average common shares outstanding – diluted |   | 3,366,297                     |     | 3,356,330                       |     | 3,361,368 |   | 3,042,016 |   |

 

The effect of options and warrants are excluded from earnings per sharebecause their effect would be anti-dilutive. The computation of dilutive loss per share excluded anti-dilutive stockoptions and warrants to purchase 501,462 and 274,977 shares as of June 30, 2004and 2003 respectively.

 

Note 4                       **Income Tax (Expense)Benefit.  **The Company did not record a provision forincome tax in the three or six months periods ended June 30, 2004 due to thefact the company recorded net losses for such periods.  The only income tax expense recorded in thesix months ended June 30, 2004 was for minimum state income tax payments.  Due to the uncertainty regarding therealization of our Federal deferred income tax assets and specifically the netoperating loss carry-forwards, we have recorded a valuation allowance againstour income tax benefit for 2003.

 

7

----

Note 5                       **Stock Options and Warrants.      **The Company accounts for stock options underAccounting Principles Board Opinion No. 25, under which the excess, ifany, of the quoted market price at the date of grant over the amount anemployee must pay to acquire the stock is recognized as compensation expense.  The following table displays pro forma netincome and earnings per share as if the fair value based method of accountinghad been applied, as required by Statement of Financial Accounting StandardsNo. 123, *Accounting for Stock-BasedCompensation* and Statement of Accounting Standards No. 148, *Accounting for Stock-Based**Compensation – Transition and Disclosure*:

 
|                                      |   | **Quarter  Ended June 30,** |       | **Six Months  Ended June 30,** |     |
|-------------------------------------------|--------|-----------------------------|------------|--------------------------------|----------|
| **2004**                                  |   | **2003**                    | **2004**   |                           | **2003** |
| (In thousands, except per share data)     |
| Net loss:                                 |   |                        | ** ** |                           |     |   | ** ** |   |   |
| Net loss as reported                      |   | **$**                       | **(428**   | **)**                          | $        | (1,464 | ) | **$** | **(78** | **)** | $ | (3,586 | ) |
| Stock compensation recorded under APB 25  |   | **36**                      | ** ** | 45                             |     | **75** | ** ** | 91 |   |
| Stock compensation recorded under FAS 123 |   | **(118**                    | **)**      | (89                            | )        | **(214** | **)** | (167 | ) |
| Pro forma net loss                        |   | **$**                       | **(510**   | **)**                          | $        | (1,508 | ) | **$** | **(217** | **)** | $ | (3,662 | ) |
| Basic and diluted net loss per share:     |   |                        | ** ** |                           |     |   | ** ** |   |   |
| As reported                               |   | **$**                       | **(0.13**  | **)**                          | $        | (0.44 | ) | **$** | **(0.02** | **)** | $ | (1.18 | ) |
| Pro forma                                 |   | **$**                       | **(0.15**  | **)**                          | $        | (0.45 | ) | **$** | **(0.06** | **)** | $ | (1.20 | ) |

 

**ITEM2.****                                         MANAGEMENT’SDISCUSSION AND ANALYSIS OR PLAN OF  OPERATION**

 

### **Executive Overview**

 

Weare a world leader in music education technology with a mission to enhance andtransform the experience of making, teaching and learning music.  Among our leading products are Finale®, theworld’s best-selling music notation software, and SmartMusic®, the completemusic practice system that features Intelligent Accompaniment® and the world’slargest interactive accompaniment library.

 

For over a decade,Finale has been the world’s best-selling music notation software.  We believe it has transformed the veryprocess by which composers, arrangers, musicians, teachers, students andpublishers create, edit, audition, print and publish musical scores.  In the world of music software, Finale isthe equivalent of Adobe® PageMaker® or Adobe®Illustrator® – it is what musicians use for page layout of sheetmusic.

 

We have traditionallyderived a substantial portion of our revenues from marketing and selling Finaleand its related notation products, which generally are sold throughout theworld in nine languages.  These productscontinue to provide revenue through regular upgrade releases and customerrenewal in the education market.  Wecontinue to work on developing their full potential internationally.

 

8

----

 

Our continued focus ondeveloping our market opportunities and providing positive operating cash flowto the company has resulted in four consecutive quarters of positive operatingcash flow and growing revenues. The release of Finale 2004 for Macintosh inJanuary 2004, the first version of Finale to be compliant with Macintosh OS X,and the overall sales of Finale 2004 for both Macintosh and Windows, as well asan upgrade release of our PrintMusic® software product, have helpedthe company to be operating cash positive in the first six months of 2004.  Historically, the third and fourth quartershave provided better cash flow due to the annual release of the Finale upgradeand educational customers purchasing products based on the school-yearcalendar.

 

SmartMusic®is a complete, interactive, computer-based practice system for woodwinds, brassplayers, vocalists and strings. SmartMusic enhances and transforms the process of practicing music byaccompanying musicians while they practice – following their spontaneous tempochanges like a human accompanist. Offered through subscription, SmartMusic gives musicians access to alibrary of more than 25,000 professionally performed and recordedaccompaniments

 

We expect SmartMusic toact as our growth engine to take us beyond our traditional strength in notationsoftware.  With its recurring revenues,SmartMusic is an important part of our business with a subscription-based modelthat leverages relationships with music educators and their students.  We expect alliances with industry leadingpartners such as Hal Leonard, Conn-Selmer, and Berklee School of Music to helpprovide substantial growth opportunities for the remainder of 2004 and into thefuture.  While it is difficult topredict the volume increase these alliances may produce, we are confident thatwe will be ready for the growth these relationships may present.

 

With Finale andSmartMusic, we have the marketing and development platform for building agrowing business in music education software. We are exploring opportunities to introduce our existing products intonew geographic markets through our existing distribution partners and newrelationships.  We are also exploringopportunities to develop and launch new products based on our core musiceducation technologies:  the editing,display, printing and playback of music notation, pitch recognition,assessment, recording, and Intelligent Accompaniment.

 

As of June 30, 2004, losses from operations have resulted in anaccumulated deficit of $55,417,000.

 

In our Form 10KSB filed with the Securities and Exchange Commission forthe year ended December 31, 2003, we identified critical accounting policiesand estimates for our business.

### ** **

9

----

 

### **Results of Operations**

 

The following tablesummarizes key operating information for the six months ended June 30, 2004 and2003.

 
|                                     |   | **Quarter  Ended June 30,** |   | **Six Months  Ended June 30,** |   |
|------------------------------------------|--------|-----------------------------|--------|--------------------------------|--------|
|                                     |   | **2004**                    |   | **2003**                       |   | **%   Chg** |   | **2004** |   | **2003** |   | **%   Chg** |   |
| Notation revenue                         |   | $                           | 2,163  |                           | $      | 1,262 |   | 71 |   | $ | 5,157 |   | $ | 2,797 |   | 84 |   |
| SmartMusic revenue                       |   | 202                         |   | 113                            |   | 79 |   | 399 |   | 231 |   | 73 |   |
| Other revenue                            |   | 38                          |   | 3                              |   | 1,167 |   | 42 |   | 7 |   | 500 |   |
| Net revenue                              |   | 2,403                       |   | 1,378                          |   | 74 |   | 5,598 |   | 3,035 |   | 84 |   |
| Cost of revenues                         |   | 510                         |   | 322                            |   | 58 |   | 1,024 |   | 704 |   | 45 |   |
| Gross profit                             |   | 1,893                       |   | 1,056                          |   | 79 |   | 4,574 |   | 2,331 |   | 96 |   |
| Percentage of net sales                  |   | 78.8                        | %      | 76.6                           | %      |   |   | 81.7 | % | 76.8 | % |   |   |
|                                     |   |                        |   |                           |   |   |   |   |   |   |   |   |   |
| Website development expense              |   | 141                         |   | 141                            |   | 0 |   | 282 |   | 209 |   | 35 |   |
| Content and product development expenses |   | 452                         |   | 535                            |   | (16 | ) | 946 |   | 1,091 |   | (13 | ) |
| Selling and marketing expense            |   | 894                         |   | 782                            |   | 14 |   | 1,779 |   | 1,823 |   | (2 | ) |
| General and administrative expense       |   | 935                         |   | 980                            |   | (5 | ) | 1,753 |   | 1,984 |   | (12 | ) |
| Total operating expense                  |   | 2,422                       |   | 2,438                          |   | (1 | ) | 4,760 |   | 5,107 |   | (7 | ) |
| Operating income (loss)                  |   | (529                        | )      | (1,382                         | )      | 62 |   | (186 | ) | (2,776 | ) | 93 |   |
| Other income (expense)                   |   | 101                         |   | (82                            | )      | 223 |   | 108 |   | (810 | ) | 113 |   |
| Net income (loss)                        |   | $                           | (428   | )                              | $      | (1,464 | ) | 71 |   | $ | (78 | ) | $ | (3,586 | ) | 98 |   |

 

***For the periods ended June 30, 2004 comparedto the period ended June 30, 2003.***

 

***Net Revenues.***  The increase in notation revenue is due tothe 2004 releases of our Finale and PrintMusic software products.  Finale 2004 has been our best sellingrelease for both the Windows and Macintosh versions.  Also, Finale 2004 for Macintosh, the first version of Finale thatis compatible with the Macintosh OS X operating system, was released in January2004 compared to a July 2002 release of Finale 2003 for Macintosh.  Finale sales customarily are highest uponrelease of a new version, and sales decline throughout the year until the nextrelease.  PrintMusic sales were $288,000in the quarter ended June 30, 2004 and $520,000 for the six months ended June30, 2004.  This is $148,000 and$170,000, respectively, greater than the corresponding periods of 2003.  In May of 2004, we released our firstupgrade of PrintMusic in two years.  Forthe trailing twelve months ended June 30, 2004, revenues from the Finale familyof products were $9,047,000.  Thisrepresents growth of 29% over the corresponding trailing twelve-month period ayear earlier, which is higher than our historical annual growth trends forFinale software.

 

In addition, revenue forour SmartMusic subscription service, which was launched in November 2001 forschools and June 2002 for home users, continues to grow.  SmartMusic revenue for the second quarter endedJune 30, 2004 increased by 79% over the second quarter of 

 

10

----

 

the prior year on the strength of subscriptiongrowth.  Total SmartMusic revenueincludes revenue from the subscription service as well as the sale ofaccessories such as microphones. Revenue for the prior year also includes sales of SmartMusicapplications and accompaniments. Applications and accompaniments are no longer being sold separately withSmartMusic being distributed exclusively as monthly or annual subscriptions.

 

The total number ofSmartMusic subscriptions as of June 30, 2004 was more than 25,000, generatingan annual run rate (total revenue to be earned on subscriptions over atwelve-month period) of $725,000, which represents a 33% increase over theannual run rate as of December 31, 2003 and a 94% increase over the run rate asof June 30, 2003.

 

SmartMusic subscriptionsand revenues fall into three main categories: schools, school-sponsored homes, and regular home subscriptions.  As of June 30, 2004, we had:

 

•                  Morethan 2,500 schools subscribing to the SmartMusic service with over 7,560subscriptions.  This is a net increaseof approximately 380 schools and 1,760 subscriptions since December 31, 2003.  These schools’ subscriptions correspond toannual subscription revenue of $285,000 to be recognized over the subscriptionperiod, of which $67,000 was recorded as revenue in the quarter ended June 30,2004.

•                  Morethan 460 schools participating in the school-sponsored home subscriptionprogram, for a total of 16,550 school-sponsored home subscriptions generatingannual revenue of $285,000 as of June 30, 2004, with $61,000 recorded in thequarter ended June 30, 2004.  This is anincrease of approximately 130 schools and 6,150 school-sponsored homesubscriptions since December 31, 2003.

•                  More than 1,600 regularhome subscribers with annual revenue of $155,000, approximately 350 more thanat December 31, 2003, with$36,000 recorded asrevenue in the quarter ended June 30, 2004.

 

Deferred SmartMusicsubscription revenue coming from the subscription programs, to be recognizedover the balance of the current subscription period, was $400,000 as of June30, 2004 compared to $200,000 at June 30, 2003, an increase of $200,000, or100%.  Deferred SmartMusic revenuerepresents the revenue yet to be recorded on current subscriptions.  This differs from the $725,000 run rate,which is the total revenue for twelve months on all combined monthly and annualsubscriptions that are held by customers as of June 30, 2004, because deferredrevenue includes only annual subscriptions and is only for the portion of theyear remaining until the subscription period ends.  The run rate does not include any forecasts of new customers, butgives the annual revenue assuming that we maintain our current customers attheir current subscription level.  Webelieve that the presentation of the annual run rate provides usefulinformation to investors regarding the success of the subscription program bydisclosing the amount of revenue that is earned on an annual basis from allcurrent customers, as opposed to deferred revenue that shows only a portion ofrevenue or quarterly posted revenue that is historical information.  These financial measures should beconsidered in addition to, and not a substitute for, financial measuresprepared in accordance with GAAP.

 

We expect that theeffects of partnerships with Hal Leonard and Conn-Selmer, both of whom aredistributing SmartMusic with their products, will begin to take effect and addto our customer base over the course of the 2004-5 academic year.

 

***Gross Profit. ***Grossprofit of $1,893,000 for the quarter ended June 30, 2004 was $837,000, or 79%,greater than the quarter ended June 30, 2003. Gross profit of $4,574,000 for the six-month period ended June 30, 2004was $2,243,000, or 97%, greater than the six-month period ended June 30,2003.  These increases are due to theincreased revenues described above. Gross

 

11

----

 

margins as a percentage of sales were higherthan the corresponding 2003 periods because most of the revenue increase wasgenerated by Finale, a relatively high margin product.

 

***Website DevelopmentExpenses.*** Website development expenses consist primarily of expenses related toimprovement of the design and development of additional features for the Finaleand SmartMusic websites and other underlying technology infrastructure.

 

***Content and ProductDevelopment Expenses.***  Content and product development expenses consist primarily ofinternal payroll and payments to third parties for the development and ongoingmaintenance of Finale notation products and the SmartMusic subscription productand accompaniment library.  We have reducedpayroll and contract expenses from the second quarter of the prior year.  We will continue to develop upgrades of theFinale family of products on a regular basis for the Macintosh and Windowsplatforms as well as upgrades to the SmartMusic application.

 

***Selling and Marketing Expenses.***  The increase in sales and marketing expensefor the second quarter ended June 30, 2004 is directly related to the successof Finale sales.  Sales incentivebonuses have been higher due the additional sales achieved in the six-monthperiod.  This has been offset by expensereductions due to the consolidation of SmartMusic marketing in Minneapolis withthe closing of the France office as of April 30, 2003 as well as the timing ofdirect marketing expenses.

 

***General and Administrative Expenses.***General and administrative expenses consist primarily of payroll and relatedexpenses for executive and administrative personnel, professional servicesexpenses relating to financing activities, amortization of certain intangibleassets with definite lives, and other general corporate expenses.  The decreases primarily relate to expensereductions resulting from the closing of our France operations.

 

***Net Loss from Operations***.  We recorded a net loss from operations of$529,000 for the quarter ended June 30, 2004, compared with a net operatingloss of $1,382,000 for the quarter ended June 30, 2003.  Year-to-date, our operating loss is 93% lessthan the year-to-operating loss as of June 30, 2003.  The higher gross profit due to higher Finale and PrintMusic salesmade up the most significant improvement in operating earnings.

 

***Net Income (Loss)***.  We recorded a net loss of $428,000, or $0.13per basic and diluted share, for the quarter ended June 30, 2004 compared to anet loss of $1,464,000, or $0.44 per basic and diluted share, for the quarterended June 30, 2003.  For the six monthsended June 30, 2004, net loss of $78,000, or $0.02 per share, is $3,508,000less than the net loss of $3,586,000, or $1.18 per share in the same period of2003.  In addition to the improvement innet loss resulting from the increased revenues, 2003 six-month results alsoinclude $706,000 of interest expense relating to the conversion of bridge loandebt into equity in the quarter ended March 31, 2003 (see Note 2).

 

12

----

 

***Liquidity and Capital Resources*****.**  Net cash provided by operating activitieswas $525,000 for the six months ended June 30, 2004, compared to $1,977,000 ofcash used for operating activities in the six months ended June 30, 2003.  The increase in operating cash is providedby the decrease in the net loss resulting from the higher sales level.  The amount of the decrease due to highersales is partially offset by a reduction in non-cash expenses, particularly a$718,000 non-cash interest expense in 2003 related to the conversion of bridgeloan debt to equity (see Note 2).  Inaddition, accounts receivable increased by $288,000 for the six months endedJune 30, 2004, $340,000 more than the first six months of the prior year due toincreases in dealer sales from the Finale release.  In total, cash increased by $317,000 for the six months endingJune 30, 2004 in comparison to an increase of $29,000 for the six months endedJune 30, 2003.  A private financingcompleted in March 2003 yielded $2,120,000 in cash, net of related costs.  There has been no additional financing inthe first six months of 2004.

 

We have significantlyimproved operating cash flow over the last several quarters and the secondquarter of 2004 is our fourth consecutive quarter of positive operating cashflow.  The company’s quarterly revenuesare normally cyclical, with the first and second quarters being historicallylower than the third and fourth quarters. The cyclical nature is mainly due to the timing of Finale family upgradereleases, which typically occur in the third or fourth quarter.  However, with the later than normal releaseof Finale 2004 for Macintosh (in January 2004), the continued strong sales ofFinale 2004 for both Windows and Macintosh, and the release of a new version ofPrintMusic, revenues in the first and second quarters of 2004 were higher thanhistorical trends.   Based on the recenttrend of increasing operating cash, the growth of SmartMusic subscriptions, andthe planned summer release of Finale 2005, the Company expects to achievepositive cash flow for the year 2004. If we do not meet our anticipated revenue levels due to a significantlylater than anticipated release or a decrease in demand for our products,management is committed to expense reductions in sales and marketing and otherareas as necessary to ensure the conservation of adequate cash to continue tofinance operations.  If further expensereductions do not offset the decrease in revenue, we may have to seekadditional financing.  However,management believes that the company has sufficient cash to finance operationsfor the foreseeable future.

 

**ITEM3.  CONTROLS AND PROCEDURES**

 

(a)               *Evaluation of disclosure controls and procedures*.  After evaluating the effectiveness of theCompany’s “disclosure controls and procedures” (as defined in the SecuritiesExchange Act of 1934 (“Exchange Act”) Rules 13a-14 and 15d-14) as of the end ofthe period covered by this quarterly report, our chief executive officer andacting principal financial and accounting officer, with the participation ofthe Company’s management, have concluded that the Company’s disclosure controlsand procedures are effective to ensure that information that is required to bedisclosed by the Company in reports that it files under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the rules of the Securities and Exchange commission.

 

(b)              *Changes in internal controls*.  There were no changes in our internalcontrols over financial reporting that occurred during the period covered bythis report that have materially affected, or are reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

 

13

----

 

***CautionaryStatements***

 

*This report may containforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995. Forward-looking statements provide currentexpectations or forecasts of future events and can be identified by the use ofterminology such as “believe,” “estimate,” “expect,” “intend,” “may,” “could,”“will,” and similar words or expressions. Our forward-looking statements inthis report generally relate to our ability to generate positive cash flow, ourexpectations regarding increasing sales, the timing of product updates,sufficiency of and ability to obtain additional capital, product development,market introduction and sales efforts. Forward-looking statements cannot be guaranteed and actual results mayvary materially due to the uncertainties and risks, known and unknown,associated with such statements.  Wecaution investors that many important factors have affected, and in the futurecould affect, our actual results of operations and cause such results to differmaterially from those anticipated in forward-looking statements made in thisrelease and elsewhere by us or on our behalf. These factors include, but are not limited to, our possible need for andability to obtain additional capital; the market acceptance of our products;our dependence upon new product development effort; our dependence on releasingannual Finale upgrades; the success of our Internet business; maintaininglicense agreements with a limited number of publishers; the limited and fluctuatingsales of certain of our products; the intense competition we face; the rapidtechnological changes and obsolescence in our industry; the changinggovernmental regulation we may face; the risks of doing businessinternationally; our dependence on key personnel and the proprietary nature ofour technology; the market volatility of our stock; potential market delisting;other general business and economic conditions; and those risks described fromtime to time in our reports to the Securities and Exchange Commission(including our Annual Report on Form 10-KSB). It is not possible to foresee or identify all factors that could causeactual results to differ from expected or historic results.  As such, investors should not consider anylist of such factors to be an exhaustive statement of all of the risks,uncertainties or potentially inaccurate assumptions that investors should takeinto account when making investment decisions. Shareholders and other readers are cautioned not to place undue relianceon forward-looking statements, which speak only as of the date on which theyare made.  We undertake no obligation toupdate publicly or revise any forward-looking statements.*

 

 

## **PART II.  OTHER INFORMATION**

 

**Item6.****                     Exhibitsand Reports on Form 8-K.**

 

(a)  **Exhibits:**  See the attached exhibit index.

 

(b)  **Reports on Form 8-K:**  On May 5, 2004, an 8-K was furnishedpursuant to Item 12 announcing financial results for the quarter ended March31, 2004.

 

On May 19, 2004, an 8-K was filed containing a press release announcingthe resignation of Sean Lafleur as Chief Executive Officer and the naming ofChief Financial Officer Bill Wolff as the new Chief Executive Officer.

 

14

----

 

**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
| Date August 4, 2004 | MAKEMUSIC INC.                                                                               |
|---------------------|----------------------------------------------------------------------------------------------|
|                |                                                                                         |
|                | By:                                                                                          | /s/ William R. Wolff |   |
|                | William R. Wolff, Chief Executive Officer  (Principal Executive Officer)                     |
|                |                                                                                         |   |
|                | And:                                                                                         | /s/ Michael L. Liston |   |
|                | Michael L. Liston, Corporate Controller  (Acting Principal Financial and Accounting Officer) |

 

15

----

**EXHIBITINDEX**

 

**Form10-QSB**

 

**Quarterended June 30, 2004**

 
| **Exhibit  No.** |   | **Description**                                                                                      |
|------------------|--------|------------------------------------------------------------------------------------------------------|
| **31.1**         |   | Certification of Chief Executive Officer pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002. |
|             |   |                                                                                                 |
| **31.2**         |   | Certification of Corporate Controller pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.    |
|             |   |                                                                                                 |
| **32.1**         |   | Certification of Chief Executive Officer Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002. |
|             |   |                                                                                                 |
| **32.2**         |   | Certification of Corporate Controller Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.    |

 

16

----