**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-QSB**

 

**(MarkOne)**
| **ý** |   | **Quarterly report under Section 13 or 15(d) of the  Securities Exchange Act of 1934 For the quarterly period ended March 31,  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 as Specified inits 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 filed by Section 13 or15(d) of the Exchange Act during the past 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 

Yes    ý  No    o

 

As of April 30, 2004, there were3,357,480 shares of Common Stock outstanding.

 

Transitional Small BusinessDisclosure Format (check one):

 

Yes    o  No    ý

 

 

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**MakeMusic! Inc.**

 

**INDEX**

 
|    | **PART I.  FINANCIAL INFORMATION**                                                                 |   |
|---------|---------------------------------------------------------------------------------------------------------|--------|
|    |                                                                                                    |   |
| Item 1. | Condensed  Consolidated Financial Statements                                                            |   |
|    |                                                                                                    |   |
|    | Condensed Consolidated Balance Sheets  March 31, 2004 and December 31, 2003                   |   |
|    |                                                                                                    |   |
|    | Condensed  Consolidated Statement of Operations  Three-month periods ended March 31, 2004 and 2003 |   |
|    |                                                                                                    |   |
|    | Condensed  Consolidated Statement of Cash Flows  Three-month periods ended March 31, 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 2. | Changes in Securities                                                                                   |   |
|    |                                                                                                    |   |
| Item 6. | Exhibits and Reports  on Form 8-K                                                                       |   |
|    |                                                                                                    |   |
|    | Signatures                                                                                              |   |
|    |                                                                                                    |   |
|    | Exhibit Index                                                                                           |   |

 

2

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**PARTI**

 

**ITEM 1.****  CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

**MakeMusic! Inc.Condensed Consolidated Balance Sheets***(In thousands of U.S. dollars)*

 
|                                                              |   | **March 31,  2004** |       | **December 31,  2003** |       |
|-------------------------------------------------------------------|--------|--------------------------|------------|-----------------------------|------------|
|                                                              |   | **(unaudited)**          |       | **(Note)**                  | ** ** |
| **Assets**                                                        |   |                     |       |                        |       |
| Current  assets:                                                  |   |                     | ** ** |                        |       |
| Cash  and cash equivalents                                        |   | **$**                    | **1,564**  | ** **                  | $          | 1,467 |   |
| Accounts  receivable, net                                         |   | **655**                  | ** ** | 494                         |       |
| Inventories                                                       |   | **240**                  | ** ** | 273                         |       |
| Value  added tax receivable                                       |   | **33**                   | ** ** | 32                          |       |
| Prepaid  expenses and other current assets                        |   | **157**                  | ** ** | 175                         |       |
| Total  current assets                                             |   | **2,649**                | ** ** | 2,441                       |       |
| Property  and equipment, net                                      |   | **253**                  | ** ** | 280                         |       |
| Goodwill,  net                                                    |   | **3,630**                | ** ** | 3,630                       |       |
| Capitalized  software products                                    |   | **524**                  | ** ** | 599                         |       |
| Intangible  assets, net                                           |   | **1,489**                | ** ** | 1,718                       |       |
| Other  non-current assets                                         |   | **107**                  | ** ** | 88                          |       |
| **Total  assets**                                                 |   | **$**                    | **8,652**  | ** **                  | $          | 8,756 |   |
|                                                              |   |                     | ** ** |                        |       |
| **Liabilities  and shareholders’ equity**                    |   |                     | ** ** |                        |       |
| Current  liabilities:                                             |   |                     | ** ** |                        |       |
| Accounts  payable                                                 |   | **$**                    | **227**    | ** **                  | $          | 417 |   |
| Accrued  compensation                                             |   | **652**                  | ** ** | 798                         |       |
| Accrued  expenses and other current liabilities                   |   | **349**                  | ** ** | 353                         |       |
| Current  portion of long-term debt and capital leases obligations |   | **1**                    | ** ** | 57                          |       |
| Reserve  for product returns                                      |   | **344**                  | ** ** | 355                         |       |
| Deferred  revenue                                                 |   | **574**                  | ** ** | 660                         |       |
| Total  current liabilities                                        |   | **2,147**                | ** ** | 2,640                       |       |
|                                                              |   |                     | ** ** |                        |       |
| Capital  lease obligations, net of current portion                |   | **20**                   | ** ** | 21                          |       |
|                                                              |   |                     | ** ** |                        |       |
| Shareholders’  equity:                                       |   |                     | ** ** |                        |       |
| Common  stock                                                     |   | **34**                   | ** ** | 34                          |       |
| Additional  paid-in capital                                       |   | **61,555**               | ** ** | 61,553                      |       |
| Accumulated  deficit                                              |   | **(54,989**              | **)**      | (55,339                     | )          |
| Deferred  compensation                                            |   | **(115**                 | **)**      | (153                        | )          |
| Total  shareholders’ equity                                  |   | **6,485**                | ** ** | 6,095                       |       |
| Total  liabilities and shareholders’ equity                  |   | **$**                    | **8,652**  | ** **                  | $          | 8,756 |   |

 

**NOTE:**  The Balance Sheet atDecember 31, 2003 has been derived from the audited financial statementsat that date but does not reflect all of the information and footnotes requiredby accounting principles generally accepted in the United States for completefinancial statements.

 

3

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**MakeMusic! Inc.Condensed Consolidated Statements of Operations**

(In thousands ofU.S. dollars, except share and per share data)

(Unaudited)

 
|                                         |   | **Quarter  Ended March 31** |       |
|----------------------------------------------|--------|----------------------------------|------------|
|                                         |   | **2004**                         |       | **2003** |   |
| NET  REVENUE                                 |   | **$**                            | **3,195**  | ** ** | $ | 1,658 |   |
|                                         |   |                             | ** ** |   |   |
| COST  OF REVENUES                            |   | **514**                          | ** ** | 383 |   |
|                                         |   |                             | ** ** |   |   |
| GROSS  PROFIT                                |   | **2,681**                        | ** ** | 1,275 |   |
|                                         |   |                             | ** ** |   |   |
| OPERATING  EXPENSES:                         |   |                             | ** ** |   |   |
| Website  development expenses                |   | **141**                          | ** ** | 67 |   |
| Content  and product development expenses    |   | **494**                          | ** ** | 557 |   |
| Selling  and marketing expenses              |   | **885**                          | ** ** | 1,041 |   |
| General  and administrative expenses         |   | **818**                          | ** ** | 1,003 |   |
|                                         |   |                             | ** ** |   |   |
| Total  operating expenses                    |   | **2,338**                        | ** ** | 2,668 |   |
|                                         |   |                             | ** ** |   |   |
| INCOME  (LOSS) FROM OPERATIONS               |   | **343**                          | ** ** | (1,393 | ) |
|                                         |   |                             | ** ** |   |   |
| Interest  expense, net                       |   | **(1**                           | **)**      | (726 | ) |
| Other  income                                |   | **10**                           | ** ** | — |   |
| Net  income (loss) before income tax         |   | **352**                          | ** ** | (2,119 | ) |
|                                         |   |                             | ** ** |   |   |
| Income  tax                                  |   | **(2**                           | **)**      | (2 | ) |
| Net  income (loss)                           |   | **$**                            | **350**    | ** ** | $ | (2,121 | ) |
|                                         |   |                             | ** ** |   |   |
| Income  (loss) per common share:             |   |                             | ** ** |   |   |
| Basic                                        |   | **$**                            | **0.10**   | ** ** | $ | (0.78 | ) |
| Diluted                                      |   | **$**                            | **0.09**   | ** ** | $ | (0.78 | ) |
|                                         |   |                             | ** ** |   |   |
| Weighted  average common shares outstanding: |   |                             | ** ** |   |   |
| Basic                                        |   | **3,356,330**                    | ** ** | 2,724,209 |   |
| Diluted                                      |   | **3,814,016**                    | ** ** | 2,724,209 |   |

 

4

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**MakeMusic! Inc.**

**Condensed Consolidated Statements of Cash Flows***(In thousands of U.S. dollars)*(Unaudited)

 
|                                                                         |   | **Quarter  Ended March 31,** |       |
|------------------------------------------------------------------------------|--------|-----------------------------------|------------|
|                                                                         |   | **2004**                          |       | **2003** |   |
| **Operating activities**                                                     |   |                              | ** ** |   |   |
| Net  income (loss)                                                           |   | **$**                             | **350**    | ** ** | $ | (2,121 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities: |   |                              | ** ** |   |   |
| Amortization  of intangible assets                                           |   | **352**                           | ** ** | 319 |   |
| Depreciation  and amortization of property and equipment                     |   | **52**                            | ** ** | 137 |   |
| Amortization  of deferred compensation                                       |   | **38**                            | ** ** | 39 |   |
| Restructuring                                                                |   | **—**                        | ** ** | (137 | ) |
| Interest  on bridge loan and discount                                        |   | **—**                        | ** ** | 718 |   |
| Issuance  of stock options and warrants for services                         |   | **2**                             | ** ** | 1 |   |
| Increase  (decrease) in cash from:                                           |   |                              | ** ** |   |   |
| Accounts  receivable                                                         |   | **(160**                          | **)**      | (107 | ) |
| Inventories                                                                  |   | **33**                            | ** ** | (12 | ) |
| Prepaid  expenses and other current assets                                   |   | **(4**                            | **)**      | 50 |   |
| Accounts  payable                                                            |   | **(190**                          | **)**      | (95 | ) |
| Accrued  liabilities and product returns                                     |   | **(160**                          | **)**      | (267 | ) |
| Deferred  revenue                                                            |   | **(87**                           | **)**      | 88 |   |
| Net  cash provided (used) by operating activities                            |   | **226**                           | ** ** | (1,387 | ) |
|                                                                         |   |                              | ** ** |   |   |
| **Net cash used by investing activities**                                    |   |                              | ** ** |   |   |
| Purchases  of property  & equipment                                 |   | **(25**                           | **)**      | (8 | ) |
| Capitalized  development and other intangibles                               |   | **(47**                           | **)**      | (28 | ) |
| Net  cash used by investing activities                                       |   | **(72**                           | **)**      | (36 | ) |
|                                                                         |   |                              | ** ** |   |   |
| **Net cash provided (used) by financing activities**                         |   |                              | ** ** |   |   |
| Issuance  of shares                                                          |   | **—**                        | ** ** | 2,120 |   |
| Payments  on revolving note payable, net                                     |   | **—**                        | ** ** | (89 | ) |
| Payments  on long-term debt and capital leases                               |   | **(57**                           | **)**      | (11 | ) |
| Net  cash (used) provided by financing activities                            |   | **(57**                           | **)**      | 2,020 |   |
|                                                                         |   |                              | ** ** |   |   |
| Effect  of exchange rate changes on cash                                     |   | **—**                        | ** ** | (41 | ) |
| Net  increase in cash and cash equivalents                                   |   | **97**                            | ** ** | 556 |   |
| Cash  and cash equivalents, beginning of period                              |   | **1,467**                         | ** ** | 1,469 |   |
| Cash  and cash equivalents, end of period                                    |   | **$**                             | **1,564**  | ** ** | $ | 2,025 |   |
|                                                                         |   |                              | ** ** |   |   |
| **Supplemental disclosure of cash flow information**                         |   |                              |       |   |   |
| Interest  paid                                                               |   | **$**                             | **1**      | ** ** | $ | 9 |   |

 

5

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**MakeMusic!Inc.**

 

## **Notes to CondensedConsolidated Financial Statements**

 

## **(Unaudited)**

 

Note 1                         **AccountingPolicies.**** **The information furnished inthis report is unaudited but reflects all adjustments that are necessary, inthe opinion of management, for a fair statement of the results for the interimperiod.  The operating results for thethree months ended March 31, 2004 are not necessarily indicative of theoperating results to be expected for the full fiscal year.  These statements should be read inconjunction with the Company’s most recent Annual Report on Form 10-KSB.

 

Note 2                         **Private Financing****. **On March 3,2003, the Company announced that it had completed a private placement of$3,015,000, which was approved by shareholders on February 24, 2003.  Of this amount, $750,000 representedproceeds received upon the sale of convertible bridge loans onSeptember 30, 2002.  According tothe bridge 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 ofcommon stock for each converted share for $0.50 per share if the requisiteprivate placement was completed prior to March 31, 2003.  In 2002, the value attributed to theOriginal Warrants was recorded as a debt discount and additional paid-incapital

 

Upon completion of theprivate placement, and concurrent bridge loan conversion into 325,251 shares ofcommon stock, the Company issued warrants (“Conversion Warrants”) to holders ofbridge loans to purchase shares of common stock for $0.50 per share.  These events resulted in $706,000 ofinterest expense being recorded in the quarter ended March 31, 2003.  Of this amount, $356,000 was recorded torecognize the value attributed to the Conversion Warrants upon their issuanceand $350,000 was recorded to amortize in full the discount originally recorded(and remaining unamortized) on the bridge loan relating to their beneficialconversion feature.

 

In addition to the325,251 shares issued to the bridge loan holders, 707,823 shares were issuedfor the $2.265 million received from investors at the full private placementprice of $3.20.  As of March 31,2004, 3,356,330 shares of common stock were issued and outstanding.

 

6

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Note 3                         **Income**(**loss) Per Common Share.**    The following table summarizes the sharesof stock included in calculating earnings per share for the quarters endedMarch 31, 2004 and 2003 in accordance with FASB Statement 128 (“FAS 128”),*Earnings per Share*:

 
|                                                         |   | **Quarter  Ended March 31,** |   |
|--------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                         |   | **2004**                          |   | **2003** |   |
| Weighted-average  common shares outstanding                  |   | 3,356,330                         |   | 2,724,209 |   |
| Dilutive  effect of stock options and warrants               |   | 457,686                           |   | 0 |   |
| Equivalent  average common shares outstanding – diluted |   | 3,814,016                         |   | 2,724,209 |   |

 

The Company had a netloss for the quarter ended March 31, 2003, so the effect of stock optionsand warrants would be anti-dilutive.

 

Under the provisions ofFAS 128, basic earnings per share are based on the weighted average number ofcommon shares outstanding during each period. In computing diluted earnings per share, the number of common sharesoutstanding is increased by common stock options and warrants with exerciseprices lower than the average market prices during the period and reduced bythe number of shares that could be repurchased with the proceeds from theexercised options and warrants.

 

Note 4                         **Income Tax(Expense) Benefit. ** The Company did not record a provision forincome tax in the quarter ended March 31, 2004 because of the availabilityof net operating loss carry-forwards from prior years.  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

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Note 5                         **StockOptions and Warrants. **TheCompany accounts for stock options under Accounting Principles Board OpinionNo. 25, under which the excess, if any, of the quoted market price at thedate of grant over the amount an employee must pay to acquire the stock isrecognized as compensation expense.  Thefollowing table displays pro forma net income and earnings per share as if thefair value based method of accounting had been applied, as required byStatement of Financial Accounting Standards No. 123, *Accounting for Stock-Based Compensation*and Statement ofAccounting Standards No. 148, *Accounting forStock-Based Compensation – Transition and Disclosure*:  

 
|                                      |   | **Quarter  Ended March 31,**          |       |
|-------------------------------------------|--------|--------------------------------------------|------------|
|                                      |   | **2004**                                   |       | **2003** |   |
|                                      |   | **(In  thousands, except per share date)** |       |
| Net  income (loss):                       |   |                                       | ** ** |   |   |
| Net  income (loss) as reported            |   | **$**                                      | **350**    | ** ** | $ | (2,121 | ) |
| Stock  compensation recorded under APB 25 |   | **39**                                     | ** ** | 46 |   |
| Stock  compensation under FAS 123         |   | **(96**                                    | **)**      | (79 | ) |
| Pro  forma net income (loss)              |   | **$**                                      | **293**    | ** ** | $ | (2,154 | ) |
|                                      |   |                                       |       |   |   |   |   |
| Income  (loss) per share:                 |   |                                       | ** ** |   |   |
| Basic                                     |   |                                       | ** ** |   |   |
| As  reported                              |   | **$**                                      | **0.10**   | ** ** | $ | (0.78 | ) |
| Pro  forma                                |   | **$**                                      | **0.09**   | ** ** | $ | (0.79 | ) |
| Diluted                                   |   |                                       | ** ** |   |   |
| As  reported                              |   | **$**                                      | **0.09**   | ** ** | $ | (0.78 | ) |
| Pro  forma                                |   | **$**                                      | **0.08**   | ** ** | $ | (0.79 | ) |

 

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

 

### **ExecutiveOverview**

 

We area world leader in music education technology whose mission is 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, Finalehas been the world’s best-selling music notation software. It has transformedthe very process by which composers, arrangers, musicians, teachers, studentsand publishers 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.

 

8

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We have traditionallyderived revenues from the development, marketing, and sales of Finale and itsrelated notation products that are accepted throughout the world and in ninelanguages as market leaders.  Theseproducts continue to provide revenue through regular upgrade releases andcustomer renewal in the education market. We continue to work on developing their full potential internationally.

 

Our continued focus ondeveloping our market opportunities and providing positive operating cash flowto the company has resulted in three consecutive quarters of positive operatingcash flow and growing revenues. The first quarter of 2004 was profitable due tothe release of the Macintosh version of the 2004 Finale product in the firstquarter, and the continued growth of SmartMusic revenues. Although the firstquarter is traditionally a slower quarter for the company, the timing of theMacintosh release and the continued strength of the Windows version of the 2004Finale software gives us confidence that we can achieve our goal of beingoperating cash flow positive for 2004.

 

SmartMusic® isa 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 20,000 professionally performed and recordedaccompaniments

 

Weexpect SmartMusic to act as our growth engine to take us beyond our traditionalstrength in notation software.  With itsrecurring revenues, SmartMusic is an important part of our business from thesubscription-based model that leverages relationships with music educators andtheir students.  We expect allianceswith industry leading partners such as Hal Leonard, Conn-Selmer, and BerkleeSchool of Music to help provide substantial growth opportunities in 2004 andinto the future.  While it is difficultto predict the volume increase these alliances may produce, we are confidentthat we will be ready for the growth these relationships may present.

 

WithFinale and SmartMusic, we have the marketing and development platform forbuilding a growing business in music education software.  We are exploring opportunities to introduceour existing products into new geographic markets through our existingdistribution partners and new relationships. We are also exploring opportunities to develop and launch new productsbased on our core music education technologies:  the editing, display, printing and playback of music notation,pitch recognition, assessment, recording, and Intelligent Accompaniment.

 

As of March 31,2004, losses from operations have resulted in an accumulated deficit of$54,989,000.

 

In our Form 10KSB filedwith the Securities and Exchange Commission for the year endedDecember 31, 2003, we identified critical accounting policies andestimates for our business.

 

9

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### **Resultsof Operations**

 

Thefollowing table summarizes key operating information for the quarters endedMarch 31, 2004 and 2003.

 
|                                      |   | **March 31** |   |     |   |             |   |
|-------------------------------------------|--------|-------------------|--------|----------|--------|------------------|--------|
|                                      |   | **2004**          |   | **2003** |   | **Incr  (Decr)** |   | **%** |   |
| Notation  revenue                         |   | $                 | 2,997  |     | $      | 1,535            |   | $ | 1,462 |   | 95 |   |
| SmartMusic  revenue                       |   | 194               |   | 118      |   | 76               |   | 64 |   |
| Other  revenue                            |   | 4                 |   | 5        |   | (1               | )      | (20 | ) |
| Net  revenue                              |   | 3,195             |   | 1,658    |   | 1,537            |   | 93 |   |
| Cost  of revenues                         |   | 514               |   | 383      |   | 131              |   | 34 |   |
| Gross  profit                             |   | 2,681             |   | 1,275    |   | 1,406            |   | 110 |   |
| Percentage  of net sales                  |   | 83.9              | %      | 76.9     | %      |             |   |   |   |
|                                      |   |              |   |     |   |             |   |   |   |
| Website  development expense              |   | 141               |   | 67       |   | 74               |   | 110 |   |
| Content  and product development expenses |   | 494               |   | 557      |   | (63              | )      | (11 | ) |
| Selling  and marketing expense            |   | 885               |   | 1,041    |   | (156             | )      | (15 | ) |
| General  and administrative expense       |   | 818               |   | 1,003    |   | (185             | )      | (18 | ) |
| Total  operating expense                  |   | 2,338             |   | 2,668    |   | (330             | )      | (12 | ) |
| Operating  income (loss)                  |   | 343               |   | (1,393   | )      | 1,736            |   | 125 |   |
| Other  income (expense)                   |   | 7                 |   | (728     | )      | 735              |   | 101 |   |
| Net  income (loss)                        |   | $                 | 350    |     | $      | (2,121           | )      | $ | 2,471 |   | 117 |   |

 

***For the periodended March 31, 2004 compared to the period ended March 31, 2003.***

 

***Net Revenues.*** The increase in notation revenue is due to the release of Finale 2004for Macintosh® in January of 2004; Finale 2003 for Macintoshwas released in July 2002.  Finalesales customarily are highest upon release of a new version, and sales declinethroughout the year until the next release. Sales of Finale 2004 for Macintosh were particularly high because it isthe first version of Finale to be compatible with the Macintosh OS X operatingsystem.  For the twelve months endedMarch 31, 2004, revenues from the Finale family of products were $8,151,000.  This represents growth of 14% over thecorresponding period a year earlier, which is higher than our historical annualgrowth trends for Finale software.

 

Inaddition, revenue for our SmartMusic subscription service, which was launchedin November 2001 for schools and June 2002 for home users, continuesto grow.  Revenue increased by 76% overthe first quarter of 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.

 

10

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Thetotal number of SmartMusic subscriptions as of March 31, 2004 was morethan 22,000, generating an annual run rate (total revenue to be earned onsubscriptions over a twelve-month period) of $648,000, which represents a 19%increase over the annual run rate as of December 31, 2003 and a 93%increase over the run rate as of March 31, 2003.

 

SmartMusicsubscriptions and revenues fall into three main categories:  schools, school-sponsored homes, and regularhome subscriptions.  As ofMarch 31, 2004, we had:

 

•                  More than 2,330 schools subscribing to the SmartMusicservice with over 7,060 subscriptions. This is a net increase of approximately 210 schools and 1,260subscriptions since December 31, 2003. These schools’ subscriptions correspond to annual subscription revenueof $253,000 to be recognized over the subscription period, of which $62,000 wasrecorded as revenue in the quarter ended March 31, 2004.

•                  More than 400 schools participating in the school-sponsoredhome subscription program, for a total of 13,500 school-sponsored homesubscriptions generating annual revenue of $256,000 as of March 31, 2004,with $48,000 recorded in the quarter ended March 31, 2004.  This is an increase of approximately 70 schoolsand 3,100 school-sponsored home subscriptions since December 31, 2003.

•                  More than 1,480 regular home subscriberswith annual revenue of $139,000, approximately 230 more than atDecember 31, 2003.  $28,000 was recorded as revenue in the quarter ended March 31,2004.

 

DeferredSmartMusic subscription revenue coming from the subscription programs, to berecognized over the balance of the current subscription period, was $378,000 asof March 31, 2004 compared to $216,000 at March 31, 2003, an increaseof $162,000, or 75%.

 

Managementexpects the SmartMusic revenues will continue to grow but that such growth mayslow somewhat as the current academic year ends, before accelerating againafter the summer as the new school year begins.  Management expects that the effects of the partnerships with HalLeonard and Conn-Selmer, both of whom are distributing SmartMusic with theirproducts, will begin to take effect over the course of the 2004-5 academicyear.

 

***Gross Profit. ***Grossprofit of $2,681,000 for the quarter ended March 31, 2004 was $1,406,000,or 110%, greater than the quarter ended March 31, 2003.  The increase is due to the increasedrevenues described above.  Gross marginas a percentage of sales was higher than the first quarter of 2003 because therevenue increase was generated by Finale, a relatively high margin product.

 

***Website Development Expenses.***  Website development expenses consistprimarily of expenses related to improvement of the design and development ofadditional features for the Finale and SmartMusic websites and other underlyingtechnology infrastructure.

 

***Content and Product Development Expenses.***  Content and product development expensesconsist primarily of internal payroll and payments to third parties for thedevelopment and ongoing maintenance of Finale notation products and theSmartMusic subscription product and accompaniment library.  We have reduced payroll and contractexpenses from the first quarter of the prior year.  We will continue to develop upgrades of the Finale family ofproducts on a regular basis for the Macintosh and Windows platforms as well asupgrades to the SmartMusic application.

 

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***Selling and Marketing Expenses.*** The decrease in sales and marketing expense is related to theconsolidation of SmartMusic marketing in Minneapolis with the closing of theFrance office as of April 30, 2003 as well as the timing of trade shows,primarily a major European trade show completed in April 2004 that washeld earlier in the year in 2003.

 

***General and Administrative Expenses.*** General and administrative expensesconsist primarily of payroll and related expenses for executive andadministrative personnel, professional services expenses relating to financingactivities, amortization of certain intangible assets with definite lives, andother general corporate expenses.  Thedecrease primarily relates to actual expense reductions as a result of theclosing of the Company’s France operations.

 

***Net Loss from Operations***. We recorded net income from operations of $343,000 for the quarter endedMarch 31, 2004, compared with a net loss of $1,393,000 for the quarterended March 31, 2003.  Higher grossprofit of $1,406,000 due to the Finale release and a $330,000 decrease inoperating expenses made up the most significant improvement in operatingearnings.

 

***Interest Expense, Net.*** We had interest expense of $1,000 in the quarter endedMarch 31, 2004 compared to $726,000 in the quarter ended March 31,2003.  The majority of the prior yearinterest expense was a non-cash charge for warrants and beneficial conversionfeatures of the bridge loan debt that was converted to equity upon the privateplacement financing completed in the quarter ended March 31, 2003 (seeNote 2 to the financial statements).

 

***Net Income (Loss)***. We recorded net income of $350,000, or $0.10 per basic share and $0.09per diluted share, for the quarter ended March 31, 2004 compared to a netloss of $2,121,000, or $0.78 per basic and diluted share, for the quarter endedMarch 31, 2003.

 

***Liquidity and Capital Resources*****.**  Net cash provided by operating activitieswas $226,000 for the three months ended March 31, 2004 compared to$1,387,000 of cash used for operating activities in the three months endedMarch 31, 2003.  The increase inoperating cash is provided by the income earned during the quarter offset byincreases in receivables and payments on accounts payable and accruedexpenses.  Accounts receivable increasedby $160,000 in the quarter ended December 31, 2004, $53,000 more than theincrease in the first quarter of the prior year due to increases in dealersales from the Finale release.  $190,000of accounts payable were paid down in the first quarter of 2004, $95,000 morethan in the first quarter of 2003; a large portion of this was from $77,000 ofcredits on customer accounts as of December 31, 2003, a higher than usualtotal due to prepayments for Finale 2004 for Macintosh, which was shipped inthe the first quarter of 2004.  Accruedexpenses and the reserve for product returns were reduced by $160,000 in thequarter ended March 31, 2004, $107,000 less than the reduction in thequarter ended March 31, 2003.  Thelower reduction in accrued expenses is primarily due to a lower balance as ofyear-end due to the closing of the France office in 2003.  Deferred revenue decreased by $87,000 in thequarter ended March 31, 2004 compared to an increase of $88,000 in thesame quarter of the prior year.  Thecurrent year decrease relates to the release of Finale 2004 for Macintosh, whichresulted in shipping products that were billed and deferred in the prior year.

 

Intotal, cash increased by $97,000 in the quarter ending March 31, 2004 incomparison to an increase of $556,000 in the quarter ended March 31,2003.  A private financing completed inMarch 2003 yielded $2,120,000 in cash, net of related costs.  There has been no cash received throughfinancing in the first quarter of 2004.

 

Wehave significantly improved operating cash flow over the last several quartersand the first quarter of 2004 is our third consecutive quarter of positiveoperating cash flow.  Historically,

 

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operating cashperformance has been lowest in the first and second quarters, with the thirdand fourth quarter showing better cash results due to the notation productrelease cycle and the cyclical impact of schools related to the school yearcalendar.  Based on the recent trend ofincreasing operating cash, the growth of SmartMusic subscriptions, and theplanned summer release of Finale 2005, the Company expects to achieve positivecash flow for the year 2004.  If we donot meet our anticipated revenue levels due to a significantly later thananticipated release or a decrease in demand for our products, management iscommitted to expense reductions in sales and marketing and other areas asnecessary to ensure the conservation of adequate cash to continue to financeoperations.  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.

 

**ITEM 3.****  CONTROLS AND PROCEDURES**

 

(a)*  Evaluationof disclosure controls and procedures*.  After evaluating the effectives of the Company’s “disclosurecontrols and procedures” (as defined in the Securities Exchange Act of 1934(“Exchange Act”) Rules 13a-14 and 15d-14) as of the end of the period coveredby this quarterly report, our chief executive office and chief financialofficer, with the participation of the Company’s management, have concludedthat the Company’s disclosure controls and procedures are effective to ensurethat information that is required to be disclosed by the Company in reportsthat it files under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the rules of the Securities andExchange commission.

 

(b)*  Changes ininternal controls*.  Therewere no changes in our internal controls over financial reporting that occurredduring the period covered by this report that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

***Cautionary Statements***

 

*This report may contain forward-lookingstatements within the meaning of the Private Securities Litigation Reform Actof 1995. Forward-looking statements provide current expectations or forecastsof future events and can be identified by the use of terminology such as“believe,” “estimate,” “expect,” “intend,” “may,” “could,” “will,” and similarwords or expressions. Our forward-looking statements in this release generallyrelate to our growth strategy and expectations, our business goals, the futureof the SmartMusic program, release of annual Finale upgrades, sufficiency ofand ability to obtain additional capital, product development, marketintroductions, 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 andfluctuating sales of certain of our products; the intense competition we face;the rapid technological 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;*

 

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*potential market delisting; othergeneral business and economic conditions; and those risks described from timeto time in our reports to the Securities and Exchange Commission (including ourAnnual Report on Form 10-KSB).  It isnot possible to foresee or identify all factors that could cause actual resultsto differ from expected or historic results. As such, investors should not consider any list of such factors to be anexhaustive statement of all of the risks, uncertainties or potentiallyinaccurate assumptions that investors should take into account when makinginvestment decisions.  Shareholders and otherreaders are cautioned not to place undue reliance on forward-lookingstatements, which speak only as of the date on which they are made.  We undertake no obligation to updatepublicly or revise any forward-looking statements.*

 

## **PART  II. OTHER INFORMATION**

 

**Item2.****                     Changesin Securities: **In February 2003, the Company issued1,033,074 additional shares of common stock in a private placement.  Of this amount, 707,823 shares were issuedat a price of $3.20, together with warrants to purchase on equal number ofshares at $3.20 per share.  The remaining325,251 shares were issued at a price of $2.40 per share to holders of bridgeloans issued in September 2002 that were converted concurrent with theprivate placement, together with warrants to purchase an equal number of sharesat $0.50 per share.  The privateplacement was made in reliance upon exemptions from registration set forth inSection 4(2) of the Securities Act of 1933, as amended (the “Act”), andRegulation D adopted pursuant to the Act.

 

**Item 6.****                       Exhibitsand Reports on Form 8-K.**

 

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

 

(b)  **Reports on Form 8-K:**  On February 12, 2004, a Form 8-K wasfiled containing a press release announcing the appointment of Bill Wolff asChief Operating Officer in addition to his responsibilities as Chief FinancialOfficer.

 

On March 29, 2004,an 8-K was filed announcing financial results for the year endedDecember 31, 2003.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
| Date May 7, 2004 | MAKEMUSIC INC.                                |
|------------------|-----------------------------------------------|
|             |                                          |
|             |                                          |
|             | By:                                           | /s/ Philip Sean Lafleur |   |
|             | Philip Sean Lafleur,  Chief Executive Officer |
|             |                                          |
|             |                                          |
|             | And:                                          | /s/ William R. Wolff |   |
|             | William R. Wolff, Chief  Financial Officer    |
|                  |                                               |  |  |  |

 

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### **EXHIBIT INDEX**

 

**Form 10-QSB**

 

**Quarter endedMarch 31, 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 Chief  Financial Officer 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 Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002. |

 

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