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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                         to                     

0-26192

(Commission File Number)

 

 

MAKEMUSIC, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Minnesota     41-1716250
(State or Other Jurisdiction of     (I.R.S. Employer
Incorporation or Organization)     Identification No.)

7615 Golden Triangle Drive, Suite M

Eden Prairie, Minnesota 55344-3848

(Address of principal executive offices)

(952) 937-9611

(Registrant’s telephone number, including area code)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x     No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨     No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: As of October 27, 2011 there were 4,932,020 shares of Common Stock outstanding.

 

 

 


Table of Contents

MakeMusic, Inc.

INDEX

          Page No.
   PART I. FINANCIAL INFORMATION   
Item 1    Condensed Financial Statements    3
   Condensed Balance Sheets September 30, 2011 and December 31, 2010    3
   Condensed Statements of Operations Three and nine-month periods ended September 30, 2011 and 2010    4
   Condensed Statements of Cash Flows Nine-month periods ended September 30, 2011 and 2010    5
   Notes to Condensed Financial Statements    6
Item 2    Management’s Discussion and Analysis of Financial Condition and Results of Operations    11
Item 4    Controls and Procedures    18
   PART II. OTHER INFORMATION   
Item 1    Legal Proceedings    19
Item 2    Unregistered Sales of Equity Securities and Use of Proceeds    19
Item 3    Defaults Upon Senior Securities    19
Item 4    (Removed and Reserved)    19
Item 5    Other Information    19
Item 6    Exhibits    20
   Signatures    21
   Exhibit Index    22

 

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Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Condensed Financial Statements.

MakeMusic, Inc.

Condensed Balance Sheets

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

     September 30,
2011
(Unaudited)
    December 31,
2010
 

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 9,881      $ 11,532   

Accounts receivable (net of allowance of $8 and $20 in 2011 and 2010, respectively)

     1,743        1,238   

Inventories

     335        201   

Deferred income taxes, net

     2,786        2,786   

Prepaid expenses and other current assets

     328        252   
  

 

 

   

 

 

 

Total current assets

     15,073        16,009   

Property and equipment, net

     389        342   

Capitalized software products, net

     2,245        2,424   

Goodwill

     3,630        3,630   

Long term deferred income taxes, net

     422        214   

Other non-current assets

     1        2   
  

 

 

   

 

 

 

Total assets

   $ 21,760      $ 22,621   
  

 

 

   

 

 

 

Liabilities and Shareholders’ Equity

    

Current liabilities:

    

Current portion of capital lease obligations

   $ 6      $ 25   

Accounts payable

     398        489   

Accrued compensation

     647        1,372   

Other accrued expenses

     303        307   

Post contract support

     150        150   

Reserve for product returns

     369        380   

Current portion of deferred revenue

     4,090        3,603   
  

 

 

   

 

 

 

Total current liabilities

     5,963        6,326   

Capital lease obligations, net of current portion

     —          4   

Deferred revenue, net of current portion

     140        96   

Shareholders’ equity:

    

Common stock, $0.01 par value:

    

Authorized shares – 10,000,000 Issued and outstanding shares – 4,927,868 and 4,895,983 in 2011 and 2010, respectively

     49        49   

Additional paid-in capital

     66,784        66,632   

Accumulated deficit

     (51,176     (50,486
  

 

 

   

 

 

 

Total shareholders’ equity

     15,657        16,195   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 21,760      $ 22,621   
  

 

 

   

 

 

 

See Notes to Condensed Financial Statements

 

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Table of Contents

MakeMusic, Inc.

Condensed Statements of Operations

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

(Unaudited)

     3 Months      9 Months  
     Ended September 30,      Ended September 30,  
     2011     2010      2011     2010  

Notation revenue

   $ 1,647      $ 2,704       $ 5,653      $ 7,734   

SmartMusic revenue

     2,158        1,825         5,459        4,572   
  

 

 

   

 

 

    

 

 

   

 

 

 

NET REVENUE

     3,805        4,529         11,112        12,306   

COST OF REVENUES

     783        778         1,911        2,000   
  

 

 

   

 

 

    

 

 

   

 

 

 

GROSS PROFIT

     3,022        3,751         9,201        10,306   

OPERATING EXPENSES:

         

Development expenses

     971        1,336         3,271        4,060   

Selling and marketing expenses

     1,384        1,225         3,632        3,459   

General and administrative expenses

     907        769         3,004        2,685   

Patent litigation expense

     —          —           225        —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Total operating expenses

     3,262        3,330         10,132        10,204   
  

 

 

   

 

 

    

 

 

   

 

 

 

INCOME (LOSS) FROM OPERATIONS

     (240     421         (931     102   

Other, net

     38        16         91        56   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income (loss) before income tax

     (202     437         (840     158   

Income tax expense (benefit)

     3        196         (150     82   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income (loss)

   $ (205   $ 241       $ (690   $ 76   
  

 

 

   

 

 

    

 

 

   

 

 

 

Income (Loss) per common share:

         

Basic

   $ (0.04   $ 0.05       $ (0.14   $ 0.02   

Diluted

   $ (0.04   $ 0.05       $ (0.14   $ 0.02   

Weighted average common shares outstanding:

         

Basic

     4,908,829        4,867,663         4,884,755        4,818,383   

Diluted

     4,908,829        4,974,772         4,884,755        4,923,507   

See Notes to Condensed Financial Statements

 

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Table of Contents

MakeMusic, Inc.

Condensed Statements of Cash Flows

(In thousands of U.S. dollars)

(Unaudited)

     9 Months  
     Ended
September 30,
 
     2011     2010  

Cash flows from operating activities

    

Net income (loss)

   $ (690   $ 76   

Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:

    

Depreciation and amortization

     826        758   

Gain on disposal of assets

     —          (1

Deferred income taxes, net

     (208     79   

Share based compensation

     356        325   

Net changes in operating assets and liabilities:

    

Accounts receivable

     (505     (184

Inventories

     (134     38   

Prepaid expenses and other current assets

     (76     (69

Accounts payable

     (91     (90

Accrued expenses and product returns

     (722     (202

Deferred revenue

     531        477   
  

 

 

   

 

 

 

Net cash (used in) provided by operating activities

     (713     1,207   

Cash flows from investing activities

    

Purchases of property and equipment

     (239     (93

Proceeds from disposal of property and equipment

     —          1   

Capitalized development and other intangibles

     (453     (367
  

 

 

   

 

 

 

Net cash (used in) investing activities

     (692     (459

Cash flows from financing activities

    

Proceeds from stock options exercised

     87        167   

Payments on redemption of stock options

     (18     —     

Repurchase of common stock

     (291     —     

Principal payments on capital leases

     (24     (45
  

 

 

   

 

 

 

Net cash (used in) provided by financing activities

     (246     122   
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     (1,651     870   

Cash and cash equivalents, beginning of period

     11,532        8,943   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 9,881      $ 9,813   
  

 

 

   

 

 

 

Supplemental disclosure of cash flow information

    

Interest paid

   $ 1      $ 4   

Income taxes paid

     124        99   

See Notes to Condensed Financial Statements

 

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Table of Contents

MakeMusic, Inc.

Notes to Condensed Financial Statements

(Unaudited)

Note1 Accounting Policies.
Note 1   Accounting Policies. The information furnished in this report is unaudited but reflects all adjustments that are necessary, in the opinion of management, for a fair statement of the results for the interim period. The operating results for three and nine months ended September 30, 2011 are not necessarily indicative of the operating results to be expected for the full fiscal year. In preparing the accompanying financial statements, management has evaluated subsequent events and has determined no additional events have occurred that require disclosure. The Company believes that although the disclosures contained herein are adequate to prevent the information presented from being misleading, these statements should be read in conjunction with the Company’s most recent Form 10-K.

Accounting Pronouncements. In September 2009, the FASB issued ASU No. 2009-13, “Revenue Recognition (ASC 605): Multiple-Deliverable Revenue Arrangements — a consensus of the FASB Emerging Issues Task Force,” which addresses the accounting for multiple-deliverable arrangements to enable vendors to account for products or services separately rather than as a combined unit and requires expanded revenue recognition policy disclosures. This amendment addresses how to separate deliverables and how to measure and allocate arrangement consideration to one or more units of accounting. Our adoption of ASU No. 2009-13, effective January 1, 2011, had no impact on our consolidated financial condition or results of operations.

Note2 Net Income (Loss) Per Share.
Note 2   Net Income (Loss) Per Share. Net loss per share was calculated by dividing the net loss by the weighted average number of shares outstanding during the period. The effect of options and warrants of 355,496 and 251,660, respectively, for the three and nine-month periods ended September 30, 2011 are excluded because the effect is anti-dilutive. Net income per share was calculated by dividing the net income by the weighted average number of shares outstanding during the period. The effect of options and warrants of 345,376 and 334,713, respectively, for the three and nine-month periods ended September 30, 2010 are excluded because the effect is anti-dilutive. The following table summarizes the dilutive effect on shares of stock included in calculating earnings per share for the three-month and nine-month periods ended September 30, 2011 and 2010:

 

     Three Months Ended
September 30
     Nine Months Ended
September 30
 
     2011      2010      2011      2010  

Weighted-average common shares outstanding

     4,908,829         4,867,663         4,884,755         4,818,383   

Dilutive effect of stock options and warrants

     —           107,109         —           105,124   

Equivalent average common shares outstanding – diluted

     4,908,829         4,974,772         4,884,755         4,923,507   
Note3 Income Tax Expense.
Note 3   Income Tax Expense. We account for income taxes using the asset and liability method. We estimate our income taxes in each of the jurisdictions in which we operate and account for income taxes payable as part of the preparation of our financial statements. This process involves estimating our actual current tax expense as well as assessing temporary differences resulting from differing treatment of items, such as depreciation and amortization, for financial and tax reporting purposes. These differences result in deferred tax assets and liabilities, which are included in our balance sheet to the extent deemed realizable. We assess the likelihood that, and the extent to which, our deferred tax assets will be realized and establish a valuation allowance to reduce deferred tax assets to an amount for which realization is more likely than not. If we increase or decrease a valuation allowance in a given period, then we must increase or decrease the tax provision in our statements of income.

We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority.

 

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Table of Contents

As of September 30, 2011 and September 30, 2010, there are no open positions for which the unrecognized tax benefits will significantly increase or decrease during the next twelve months. Additionally, tax years still open for examination by Federal and major state agencies as of September 30, 2011 are 2006-2010.

As of December 31, 2010, we had U.S. net operating loss carry-forwards of approximately $14,721,000, Minnesota net operating loss carry-forwards of $5,868,000, and research and development tax credits of $1,191,000 and Minnesota research and development tax credits of $514,000. The losses and tax credits are carried forward for federal and state corporate income taxes and may be used to reduce future taxes.

Significant management judgment is required in determining any valuation allowance recorded against our net deferred tax assets. During 2010, we maintained our policy established in the fourth quarter of 2009of recording a deferred tax asset representing tax on three years of forecasted income. We continue to believe that this policy is prudent, as the likelihood of technological and industry developments limit our ability to forecast income beyond three years. Due to uncertainties related to our ability to utilize the balance of our deferred tax assets, as of September 30, 2011 we have maintained a valuation allowance of $5,690,000. The additional future potential decrease of the valuation allowance is dependent on our future ability to realize the deferred tax assets that are affected by our future profitability. Should the remaining $5,690,000 valuation allowance be reversed in the future, a liability of $3,175,000 would have to be established for uncertain tax positions.

We recorded a cumulative income tax benefit of $150,000 for the nine months ended September 30, 2011, and income tax expense of $3,000 for the three months ended September 30, 2011. The three-month period ended September 30, 2011 includes an income tax benefit of $55,000 for the current period, and an income tax expense true-up of $58,000 for the tax year ended December 31, 2010, related to an accounting method change. After taking into account the prior year true-up, the effective tax rate for the nine month period ended September 30, 2011 was 17.85%. We recorded income tax expense of $82,000 and $196,000 for the cumulative nine-month and quarterly three-month comparable periods in 2010, respectively. In addition, future utilization of NOL carry-forwards is subject to certain limitations under Section 382 of the Internal Revenue Code. This section generally relates to a 50 percent change in ownership of a company over a three-year period. The acquisition of additional shares by a greater than 5% shareholder in January 2007 resulted in an “ownership change” under Section 382. Accordingly, our ability to use NOL’s in the future may be limited.

Note4 Stock-Based Compensation.
Note 4   Stock-Based Compensation. The MakeMusic, Inc. 2003 Equity Incentive Plan (the “2003 Plan”), as amended, reserves a total of 1,500,000 shares of our common stock for issuance under stock options, restricted stock, performance awards and stock appreciation rights. The 2003 Plan is administered by the Compensation Committee of the Board of Directors, which recommends to the Board persons eligible to receive awards and the number of shares and/or options subject to each award, the terms, conditions, performance measures, and other provisions of the award. Readers should refer to Note 5 of our financial statements on Form 10-K for the fiscal year ended December 31, 2010 for additional information related to our stock-based compensation plans.

We measure stock-based compensation cost at the grant date based on the fair value of the award and recognize the compensation expense over the requisite service period, which is generally the vesting period. For the three months ended September 30, 2011 and 2010, we recognized $75,000 and $108,000, respectively, and for the nine months ended September 30, 2011 and 2010, we recognized $293,000 and $325,000, respectively, of expense related to stock based compensation.

Stock Options

We use the Black-Scholes option pricing model to estimate the fair value of stock-based awards with the weighted average assumptions noted in the following table.

 

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Table of Contents
     September 30,     September 30,  
     2011     2010  

Black-Scholes Model:

    

Risk-free interest rate

     1.15     1.98

Expected life, in years

     4.3        4.4   

Expected volatility

     69.85     79.30

Dividend yield

     0.00     0.00

Expected volatility is based on the historical volatility of our share price in the period prior to option grant equivalent to the expected life of the options. The expected term is based on management’s estimate of when the option will be exercised which is generally consistent with the vesting period. The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

Equity Award Activity

The following table represents stock option and restricted stock activity under the 2003 Plan for the nine months ended September 30, 2011:

 

     Shares
Reserved
for Future
Grant
    2003 Plan
Restricted Shares
     Plan Option
Shares
    Weighted
Average
Option
Exercise
Price
     Weighted
Average
Remaining
Contract
Life
 

At December 31, 2010

     361,103        80,049         504,536      $ 5.51      

Authorized

     —          —           —          

Granted

     (294,214     65,381         228,833      $ 4.97      

Expired

     103,664        —           (103,664   $ 6.00      

Cancelled

     24,504        —           (24,504   $ 3.99      

Exercised

     —          —           (40,178   $ 3.87      
  

 

 

   

 

 

    

 

 

      

At September 30, 2011

     195,057        145,430         565,023      $ 5.38         4.7 Years   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Outstanding Exercisable at September 30, 2011

          228,622      $ 6.05         3.0 Years   
       

 

 

   

 

 

    

 

 

 

At September 30, 2011 the aggregate intrinsic value of options outstanding was $117,000, and the aggregate intrinsic value of options exercisable was $76,000.

At September 30, 2011 there was $499,000 of unrecognized compensation cost related to unvested share-based option payments which is expected to be recognized over a weighted-average period of 2.2 years. At September 30, 2011 there was $237,000 of unrecognized compensation cost related to the issuance of restricted stock which is expected to be recognized over a weighted-average period of 1.75 years.

 

Note 5   Segment Reporting.

MakeMusic reports results of operations by two unique reportable segments, Notation and SmartMusic.

The Notation segment includes the design, development and sales and marketing of music notation software in the Finale family of products.

 

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Table of Contents

The SmartMusic segment includes the design, development, amortization of capitalized song title development and sales and marketing of the subscription-based SmartMusic product line and related accessories.

The remaining activities are included in “Other.” These are unallocated expenses which include costs related to business systems, marketing and general and administrative that are not directly attributable to a particular segment. Unallocated expenses are reported in the reconciliation of the segment totals to consolidated totals as “Other” items.

Segment assets or other balance sheet information are not prepared or presented to management. Therefore, information relating to segment assets is not presented.

The following table presents results of operations by reportable segment:

 

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Table of Contents
     For the 3 Months Ended September 30, 2011     For the 9 Months Ended September 30, 2011  
     Notation     SmartMusic     Other     Total     Notation     SmartMusic     Other     Total  

NET REVENUE

   $ 1,647      $ 2,158      $ —        $ 3,805      $ 5,653      $ 5,459      $ —        $ 11,112   

COST OF REVENUES

     128        655        —          783        392        1,519        —          1,911   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

GROSS PROFIT

     1,519        1,503        —          3,022        5,261        3,940        —          9,201   

Percentage of Net Revenue

     92     70     0     79     93     72     0     83

OPERATING EXPENSES:

                

Development expenses

     442        290        239        971        1,419        1,053        799        3,271   

Selling and marketing expenses

     411        666        307        1,384        1,216        1,655        761        3,632   

General and administrative expenses

     17        25        865        907        59        61        2,884        3,004   

Patent litigation expense

     —          —          —          —          —          —          225        225   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Operating Expenses

     870        981        1,411        3,262        2,694        2,769        4,669        10,132   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income/(Loss) from Operations

     649        522        (1,411     (240     2,567        1,171        (4,669     (931

Other Income/(Expense)

     —          —          38        38        —          —          91        91   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income/(Loss) Before Income Tax

     649        522        (1,373     (202     2,567        1,171        (4,578     (840

Income tax expense/(benefit)

     —          —          3        3        —          —          (150     (150
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME/(LOSS)

   $ 649      $ 522      ($ 1,376   ($ 205   $ 2,567      $ 1,171      ($ 4,428   ($ 690
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     For the 3 Months Ended September 30, 2010     For the 9 Months Ended September 30, 2010  
     Notation     SmartMusic     Other     Total     Notation     SmartMusic     Other     Total  

NET REVENUE

   $ 2,704      $ 1,825      $ —        $ 4,529      $ 7,734      $ 4,572      $ —        $ 12,306   

COST OF REVENUES

     197        581        —          778        621        1,379        —          2,000   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

GROSS PROFIT

     2,507        1,244        —          3,751        7,113        3,193        —          10,306   

Percentage of Net Revenue

     93     68     0     83     92     70     0     84

OPERATING EXPENSES:

                

Development expenses

     610        481        245        1,336        1,766        1,531        763        4,060   

Selling and marketing expenses

     481        437        307        1,225        1,408        1,263        788        3,459   

General and administrative expenses

     16        23        730        769        62        49        2,574        2,685   

Patent litigation expense

     —          —          —          —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Operating Expenses

     1,107        941        1,282        3,330        3,236        2,843        4,125        10,204   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income/(Loss) from Operations

     1,400        303        (1,282     421        3,877        350        (4,125     102   

Other Income/(Expense)

     —          —          16        16        —          —          56        56   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income/(Loss) Before Income Tax

     1,400        303        (1,266     437        3,877        350        (4,069     158   

Income tax expense/(benefit)

     —          —          196        196        —          —          82        82   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME/(LOSS)

   $ 1,400      $ 303      ($ 1,462   $ 241      $ 3,877      $ 350      ($ 4,151   $ 76   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Note 6   Goodwill.

Goodwill represents the cost in excess of fair value of the tangible and identified intangible assets of businesses acquired. In accordance with ASC 350, Intangibles – Goodwill and Other, (formerly SFAS 142) goodwill is not amortized but rather is reviewed for impairment annually in the fourth quarter of MakeMusic’s fiscal year, or more often if indicators of impairment exist.

 

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Note 7   Subsequent Events.

None.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Executive Overview

MakeMusic’s mission is to develop and market solutions that transform how music is composed, taught, learned and performed. This is accomplished by:

 

   

Providing integrated technology, content and web services to enhance and expand how music is taught, learned and prepared for performance.

 

   

Providing music education content developers with a technology-enriched publishing platform that leverages their copyrighted assets while simultaneously increasing the content and value of the SmartMusic library.

 

   

Offering software solutions for engraving and electronically distributing sheet music.

MakeMusic develops and markets two product lines, SmartMusic® learning software for band, jazz ensemble, orchestra and voice and Finale® music notation software. We believe these innovative products reinforce each other’s features and competitiveness. The well-established Finale family of music notation software products provides a solid base business that serves a large customer base and generates consistent revenue through sales of new products, annual upgrades and trade-up campaigns. Our innovative technology enables the creation, learning and performance of music and our unparalleled products makes us the leader in our industry.

For the first nine months of 2011, net revenues for MakeMusic were $11,112,000 which was $1,194,000 less than revenue of $12,306,000 reported in the first nine months 2010. SmartMusic revenue grew 19% due to our year-over-year subscription growth from 158,574 to 176,352 and price increases implemented in the third quarter of 2010, from $130 to $140 for teacher subscriptions and from $30 to $36 for student subscriptions. Notation revenue decreased 27% due to reductions in both our sales to distribution partners and our direct sales. We attribute these decreases to the timing of our annual Finale update release. This year’s update was released in October 2011, as compared to last year’s release of Finale 2011 in June 2010. We anticipate improvement in the fourth quarter of 2011 on a year-over-year basis on our total Finale sales due to the early October release although total year sales will still be impacted by the later release. Gross margin percentages were comparable at 83% in 2011 and 84% in 2010.

Operating expenses during the first nine months of 2011 were comparable to the same period in 2010. Selling and marketing expenses increased due to expansion in our direct educational sales force, which were offset by reductions in direct marketing expenses relating to the later timing of our Finale 2012 release. General and administrative expenses increased primarily due to recruiting initiatives for our Chief Executive Officer position, which was completed with the appointment of Karen van Lith on June 13, 2011, and accrued severance expenses relating to the departure of our former interim Chief Executive Officer. We also incurred expenses of approximately $225,000 relating to a patent infringement settlement, which were accrued in the first quarter of 2011 and paid in the second quarter of 2011. Development expenses decreased primarily because our open Chief Technology Officer position and other open development positions resulted in lower personnel costs. The Chief Technology Officer position was filled in August 2011 and one of the open development positions was filled in September 2011.

Our net loss before taxes in the first nine months of 2011 was $840,000 compared to net income before taxes of $158,000 in 2010. The tax benefit in first nine months of 2011 was $150,000 compared to tax expense of $82,000 in the first nine months of 2010. As a result of the factors mentioned, we reported net loss of approximately $690,000 in the first nine months of 2011 compared to net income of $76,000 in the first nine months of 2010.

We believe there is growth potential with SmartMusic, a subscription-based product directed toward the very large and constantly renewing market of music students and their teachers. SmartMusic combines a software application, a library of thousands of music titles, skill-development exercises and a web service to provide students with a compelling experience and teachers with the realistic means to document the progress of every student.

SmartMusic software enhances and transforms the hours spent practicing by putting students inside a professional band or orchestra so that they can hear how the music is supposed to be performed and how their part fits in. This makes practicing much more engaging, causing students to practice longer and more often. SmartMusic provides access to an ever-increasing library of band, jazz ensemble and orchestra literature. Each title includes

 

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individual part assignments authored by respected educators, thereby providing music teachers with a time-saving solution for preparing selections for their next performance. SmartMusic also offers a rich variety of effective practice tools that make practice time more efficient and productive. The combination of making practice time more engaging and productive leads to rapid student skill-development, increased student confidence, higher student retention, and stronger music programs. SmartMusic 2012 introduced new vocal and site-reading technology and included site-singing exercises which can be assessed for both pitch and rhythm. Choral directors and general music teachers now have access to the same award-winning interactive technology that has been available to band and orchestra directors.

SmartMusic Gradebook is a web-based grade book designed to manage student assignments, grades, and recordings while documenting the progress of each student and assessing student achievement. This provides music educators (and students) with exciting new possibilities to assist in developing strong music programs and complying with accountability requirements. SmartMusic Gradebook enables teachers to easily send assignments to each of their students. Submitted assignments are automatically graded and posted in the teacher’s SmartMusic Gradebook thereby providing teachers with the visible means for measuring student achievement.

In July of 2011, we announced a mobile application called SmartMusic InboxTM. SmartMusic Inbox is a free application for both Android and Apple platforms. SmartMusic teachers can now listen to and grade assignments at any time and at any place. Additionally, in the second quarter of 2011, development was completed on SmartMusic 2012 which includes new vocal capabilities as well as other product enhancements.

We believe that our technological investments in SmartMusic have created a digital pipeline between our growing subscriber base of more than 176,000 and the music publishers who provide SmartMusic content. This growing platform is a strategic asset for MakeMusic.

The following table illustrates our quarterly SmartMusic metrics:

 

     Jun-10      Sep-10      Dec-10      Mar-11      Jun-11      Sep-11  

Total Subscriptions

     143,095         158,574         162,189         164,836         173,295         176,352   

Subscriptions purchased during quarter

     18,722         69,947         46,496         25,246         24,487         74,550   

Educator Accounts

     9,073         9,312         9,402         9,727         9,633         9,744   

Our educational sales organization focuses on direct school district sales aimed at the 17,000 schools who match our ideal demographic profile. We sell site agreements that provide discounts for volume purchases. We increased the size of our educational sales force from 5 to 7 and our marketing staff from 8 to 9 in 2010 to strengthen our strategic sales and marketing initiatives. During the first nine months of 2011, we further increased our education sales force to 13.

The following tables illustrate the total net new SmartMusic educator subscriptions for each quarter during the year ended December 31, 2010 and for the quarters ended March 31, 2011, June 30, 2011 and September 30, 2011:

Educators:

 

Quarter End
Date
  Beginning
Subscriptions
    New
Subscriptions
    Renewed
Subscriptions
    Renewal
Rate
    Subscriptions
Ended
    Quarter End
Subscriptions
    Quarterly
Net New
Subscriptions
 
3/31/2010     11,667        728        2,087        80     2,606        11,876        209   
6/30/2010     11,876        500        1,837        72     2,561        11,652        (224
9/30/2010     11,652        1,434        3,440        87     3,932        12,594        942   
12/31/2010     12,594        873        2,192        66     3,299        12,360        (234
3/31/2011     12,360        741        2,026        77     2,618        12,509        149   
6/30/2011     12,509        742        2,232        86     2,591        12,892        383   
9/30/2011     12,892        1,420        3,957        80     4,972        13,297        405   

 

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We define renewed subscriptions as those subscriptions that educators purchase within the two-month period after their prior subscription ended. Because of changes to the start of school from year to year, fluctuations in the date that music teachers implement their curriculum, and promotional programs that encourage early renewals, the majority of subscribers renew their subscriptions within approximately a two- month window of the anniversary date of their previous subscription rather than exactly on the anniversary date. As a result, we believe that using the above definition of a renewal more accurately reflects the renewal rate for SmartMusic subscriptions.

The educator renewal rate was impacted in the third quarter by subscriptions renewed early in the second quarter. The educator renewal rate for the third quarter of 2011 was 80% compared to 86% in the second quarter of 2011.

We have achieved positive cash flow from operations for the last six years, including the most recent year ended December 31, 2010. Our quarterly results will fluctuate as a result of the seasonality of the education market and timing of our product releases. Our operating cash flow was negatively impacted in the nine months ended September 30, 2011 as compared to the nine months ended September 30, 2010 due to the timing of our Finale 2012 release. Due to current economic conditions and school budgets constraints, we remain cautious regarding our future financial projections. However, given the release of Finale 2012 in early October 2011 and with continued growth in SmartMusic subscriptions, we expect to achieve positive operating cash flow in 2011.

In our Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2010, we identified critical accounting policies and estimates for our business that we are incorporating herein by reference.

Results of Operations

Comparison of the three- and nine-month periods ended September 30, 2011 to the three- and nine-month periods ended September 30, 2010

Net Revenue ($ in thousands)

 

     3 Months Ended September 30,     9 Months Ended September 30,  
     2011      2010      Incr
(Decr)
    %     2011      2010      Incr
(Decr)
    %  

Notation

   $ 1,647       $ 2,704       $ (1,057     -39   $ 5,653       $ 7,734       $ (2,081     -27

SmartMusic

     2,158         1,825         333        18     5,459         4,572         887        19
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 3,805       $ 4,529       $ (724     -16   $ 11,112       $ 12,306       $ (1,194     -10
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Net revenue decreased 16% when comparing the three months ended September 30, 2011 and 2010 and decreased 10% when comparing the nine months ended September 30, 2011 and 2010.

Notation revenue decreased by $1,057,000, to $1,647,000, when comparing the three months ended September 30, 2011 and 2010 and by $2,081,000, to $5,653,000, when comparing the nine months ended September 30, 2011 and 2010. Decreases during the comparative results for the quarter and for the nine months ended September 30, 2011 were due to the timing of our annual Finale update release and lower sales through our Japan distributor.

SmartMusic revenue for the three months ended September 30, 2011 was $2,158,000, an increase of $333,000, or 18%, over the three months ended September 30, 2010 and increased $887,000, or 19% to $5,459,000, when comparing the nine months ended September 30, 2011 and 2010. The increase in revenue for the three and nine months ended September 30, 2011 is due to the growth of total SmartMusic subscriptions and price increases implemented in the third quarter of 2010. We attribute the increase in our SmartMusic subscriptions to our site agreement program, which encourages school district deployment of SmartMusic student subscriptions at a discounted rate.

SmartMusic is sold to schools, students and music organization members on a subscription basis. Revenue for these subscriptions is recognized over the life of the subscription which is typically 12 months. Total earned SmartMusic subscription revenue for the three-month period ended September 30, 2011 was $1,615,000, an increase of $360,000, or 29%, over the three-month period ended September 30, 2010. Total earned SmartMusic subscription revenue for the nine-month period ended September 30, 2011 was $4,535,000, an increase of $973,000, or 27%, over the nine-month period ended September 30, 2010. The increases for the three and nine-month periods ended

 

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September 30, 2011 compared to the same periods in 2010 were due to the increase in the total number of subscriptions and the 2010 price increases. Total unearned SmartMusic subscription revenue (deferred revenue) was $4,002,000 as of September 30, 2011, an increase of $692,000, or 21%, over the balance at September 30, 2010 and an increase of $369,000, or 10%, compared to the balance of $3,633,000 at December 31, 2010. The increase from year-end 2010 is due to our historical trend where the majority of subscriptions purchases and renewals typically occur in the fall back-to-school season. Deferred SmartMusic revenue represents the future revenue to be recorded on current subscriptions and fluctuates based on new subscription sales, the total number of subscriptions and the remaining life of those subscriptions.

SmartMusic has shown sustained growth since its launch. More than 9,744 educators have purchased SmartMusic, an increase of 5% over the 9,312 educators that had purchased it as of September 30, 2010. Total SmartMusic subscriptions as of September 30, 2011 number 176,352, representing a net gain of 17,778, or 11%, over the September 30, 2010 subscription count of 158,574.

We recorded $410,000 of revenue for the sales of SmartMusic accessories (primarily microphones) for the three months ended September 30, 2011, which was an increase of $2,000, or 1%, from the revenue of $408,000 for SmartMusic accessories for the three months ended September 30, 2010. Revenue for the sales of SmartMusic accessories for the nine months ended September 30, 2011 was $680,000, which was an increase of $6,000, or 1%, from $674,000 of SmartMusic accessories revenue in the nine months ended September 30, 2010.

Gross Profit ($ in thousands)

 

     3 Months Ended September 30,     9 Months Ended September 30,  
     2011      2010      Incr
(Decr)
    %     2011      2010      Incr
(Decr)
    %  

Notation

   $ 1,519       $ 2,507       $ (988     -39   $ 5,261       $ 7,113       $ (1,852     -26

SmartMusic

     1,503         1,244         259        21     3,940         3,193         747        23
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 3,022       $ 3,751       $ (729     -19   $ 9,201       $ 10,306         (1,105     -11
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Gross profit in the three months ended September 30, 2011 decreased by $729,000, to $3,022,000, compared to the three months ended September 30, 2010. Gross profit for Notation decreased by $988,000, to $1,519,000, for the three months ended September 30, 2011 compared to the three months ended September 30, 2010 due to the decrease in notation revenue attributed to the later release of Finale 2012. Gross profit for SmartMusic increased by $259,000, to $1,503,000, for the three months ended September 30, 2011 compared to the three months ended September 30, 2010 due to the increase in SmartMusic revenue. Gross profit in the nine months ended September 30, 2011 decreased by $1,105,000, to $9,201,000, compared to the nine months ended September 30, 2010. Gross profit for Notation decreased $1,852,000, to $5,261,000, for the nine months ended September 30, 2011 compared to the same period in 2010 due to the decrease in notation revenue. Gross profit for SmartMusic increased $747,000, to $3,940,000, for the nine months ended September 30, 2011 compared to the same period in 2010 due to the increase in SmartMusic revenue.

Cost of revenue includes product costs, royalties paid to publishers, amortization of capitalized software development costs for repertoire and SmartMusic Gradebook software development costs, shipping, and credit card fees. Capitalized SmartMusic repertoire added into SmartMusic is amortized over a five-year period and repertoire development amortization as a percentage of SmartMusic revenue was 12% for each of the nine month periods ended September 30, 2011 and 2010. We expect amortization related to repertoire development to increase as we continue to add repertoire to SmartMusic. Gross margins as a percentage of sales decreased to 79% for the three months ended September 30, 2011 compared to 83% for the three months ended September 30, 2010. Gross margins were generally comparable at 83% and 84%, respectively, for the nine months ended September 30, 2011 and 2010.

Development expense ($ in thousands)

 

     3 Months Ended September 30,     9 Months Ended September 30,  
     2011      2010      Incr
(Decr)
    %     2011      2010      Incr
(Decr)
    %  

Notation

   $ 442       $ 610       $ (168     -28   $ 1,419       $ 1,766       $ (347     -20

SmartMusic

     290         481         (191     -40     1,053         1,531         (478     -31

Other

     239         245         (6     -2     799         763         36        5
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 971       $ 1,336       $ (365     -27   $ 3,271       $ 4,060       $ (789     -19
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

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Development expenses decreased 27% to $971,000, from $1,336,000, when comparing the three months ended September 30, 2011 and 2010. Development expenses decreased 19% to $3,271,000, from $4,060,000, when comparing the nine months ended September 30, 2011 and 2010. Development expenses consist primarily of internal payroll, payments to independent contractors and related expenses for the development and maintenance of our Finale notation, SmartMusic and SmartMusic Gradebook products as well as non-capitalized SmartMusic repertoire development, business systems and quality assurance. The decrease in development expenses for Notation and SmartMusic was primarily due to reduced personnel costs relating to the open Chief Technology Officer position which was filled in August 2011 and other open development positions. Accrued bonuses are also lower in 2011 due to year-to-date financial results. SmartMusic consulting expenses were also lower in 2011 due to completion in 2010 of upgrades to the SmartMusic user-interface design. In addition, expenses for SmartMusic repertoire development decreased slightly during the three and nine-month periods ended September 30, 2011 compared to the same periods in 2010, despite an increase to the number of titles released. During the nine months ended September 30, 2011, 289 new SmartMusic large ensemble band, jazz ensemble, and orchestra titles with pre-authored assignments were released, compared to 48 new titles in the nine months ended September 30, 2010. There were 96 new titles released during the three months ended September 30, 2011 and no titles released during the quarter ended September 30, 2010. There were 2,800 large ensemble titles as of September 30, 2011.

Selling and marketing expense ($ in thousands)

 

     3 Months Ended September 30,     9 Months Ended September 30,  
     2011      2010      Incr
(Decr)
    %     2011      2010      Incr
(Decr)
    %  

Notation

   $ 411       $ 481       $ (70     -15   $ 1,216       $ 1,408       $ (192     -14

SmartMusic

     666         437         229        52     1,655         1,263         392        31

Other

     307         307         0        0     761         788         (27     -3
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 1,384       $ 1,225       $ 159        13   $ 3,632       $ 3,459       $ 173        5
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Selling and marketing expenses primarily consist of marketing, advertising and promotion expenses, business development and customer service activities and payroll. Sales and marketing expenses increased 13% to $1,384,000 for the three months ended September 30, 2011 compared to $1,225,000 for the three months ended September 30, 2010. Selling and marketing expenses increased 5%, to $3,632,000, during the nine months ended September 30, 2011, compared to $3,459,000 for the nine months ended September 30, 2010. Notation selling and marketing expenses decreased primarily due to reduced personnel costs relating to incentive compensation allocated to notation and direct marketing expenses tied to the later release of Finale 2012. SmartMusic selling and marketing expenses increased due to increases to our educational sales force to achieve our strategic sales and marketing initiatives for SmartMusic.

General and administrative expense ($ in thousands)

 

     3 Months Ended September 30,     9 Months Ended September 30,  
     2011      2010      Incr
(Decr)
     %     2011      2010      Incr
(Decr)
    %  

Notation

   $ 17       $ 16       $ 1         6   $ 59       $ 62       $ (3     -5

SmartMusic

     25         23         2         9     61         49         12        24

Other

     865         730         135         18     2,884         2,574         310        12
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 907       $ 769       $ 138         18   $ 3,004       $ 2,685       $ 319        12
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

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General and administrative expenses consist primarily of payroll and related expenses for executive and administrative personnel, professional services, facility costs, amortization of certain intangible assets with finite lives, bad debt and other general corporate expenses. General and administrative expenses increased by 18% to $907,000 during the three months ended September 30, 2011 compared to $769,000 for the same period of 2010. General and administrative expenses increased by 12% to $3,004,000 during the nine months ended September 30, 2011, compared to $2,685,000 for the same period of 2010. The increase in other general and administrative costs primarily resulted from recruiting our Chief Executive Officer. We also accrued severance costs relating to the departure of the former interim Chief Executive Officer. Partially offsetting these increases is a reduction in accrued bonus expenses in 2011 due to year-to-date financial results.

Patent litigation expense

We reached a confidential settlement with Uniloc USA, Inc. and Uniloc Singapore Private Limited in April 2011, which resulted in patent litigation costs of $225,000 during the nine months ended September 30, 2011. The circumstances related to the settlement are described in more detail in this Quarterly Report under Part II, Item 1, “Legal Proceedings.” There were no comparable expenses during the nine months ended September 30, 2010.

Income/(Loss) from operations ($ in thousands)

 

     3 Months Ended September 30,     9 Months Ended September 30,  
     2011     2010     Incr
(Decr)
    %     2011     2010     Incr
(Decr)
    %  

Notation

   $ 649      $ 1,400      $ (751     -54   $ 2,567      $ 3,877      $ (1,310     -34

SmartMusic

     522        303        219        72     1,171        350        821        235

Other

     (1,411     (1,282     (129     10     (4,669     (4,125     (544     13
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   ($ 240   $ 421      $ (661     -157   $ (931   $ 102      $ (1,033     -1013
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income from operations decreased by $661,000, to a net loss of $240,000 for the three months ended September 30, 2011, compared to net income of $421,000 in the three months ended September 30, 2010. Net income from operations decreased by $1,033,000, to a net loss of $931,000 for the nine months ended September 30, 2011 compared to net income of $102,000 in the nine months ended September 30, 2010.The notation segment operating results for the nine months ended September 30, 2011 reflects a decrease in income from operations due to the later release of Finale 2012, offset by decreased development and selling and marketing expenses. SmartMusic income from operations improved due to increased SmartMusic revenue and lower expenses. The increased loss in other operations was primarily due to expenses relating to our search and appointment of our Chief Executive Officer, the April 2011 patent litigation settlement and the increase in unallocated sales and marketing expenses.

Net Loss

Net loss in the three months ended September 30, 2011 was $205,000, or $0.04 per basic and diluted share, compared to net income of $241,000, or $0.05 per basic and diluted share, in the three months ended September 30, 2010. Net loss for the nine months ended September 30, 2011 was $690,000, or $0.14 per basic and diluted share, compared to net income of $76,000, or $0.02 per basic and diluted share, in the same period of 2010. The increase in net loss in the nine months ended September 30, 2011 was primarily due to lower notation revenues, patent litigation expenses and increased general and administrative fees related to recruiting our Chief Executive Officer. There were no comparable legal accruals or settlements or recruiting expenses in the first nine months of 2010. The net tax expense was $3,000 in the three months ended September 30, 2011 and a net tax benefit of $150,000 for the nine months ended September 30, 2011, compared to a net tax expense of $196,000 and $82,000, respectively, for the three and nine months ended September 30, 2010. A net tax benefit was recorded in 2011 due to our year-to-date loss.

Liquidity and capital resources

Net cash used in operating activities was $713,000 for the nine months ended September 30, 2011, compared to $1,207,000 of cash provided by operating activities during the nine months ended September 30, 2010. The increase in cash used in the first nine months of 2011 compared to the same period in 2010 was primarily due to lower net income from operations, which resulted from lower Notation revenue and an increase in cash used for working capital.

 

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Net cash used in investing activities was $692,000 for the nine months ended September 30, 2011, compared to $459,000 cash used in investing activities for the comparable period in 2010. The increase was primarily due to purchases of capital items relating to our facility expansion as a part of our lease renewal and the increase in capitalization of software development, primarily for repertoire development. Our total spending on repertoire development decreased slightly from $521,000 during the nine months ended September 30, 2010 to $510,000 during the nine months ended September 30, 2011. However, the amount capitalized increased from $367,000 during the nine months ended September 30, 2010 to $453,000 during the nine months ended September 30, 2011 due to the overall number of titles being developed and less time spent on non-title related activities.

Net cash used in financing activities was $246,000 in the nine months ended September 30, 2011 compared to $122,000 of cash provided by financing activities during the nine months ended September 30, 2010. The increase in cash used in financing primarily consisted of $291,000 used to repurchase company shares under the Stock Repurchase Program which was announced in November 2010. The Stock Repurchase Program was discontinued effective May 6, 2011.

Cash and cash equivalents as of September 30, 2011 was $9,881,000 compared to $11,532,000 as of December 31, 2010. The decrease in cash is due to our net loss incurred during the nine months ended September 30, 2011 due to the later Finale release. Our quarterly revenues and operating cash flows are typically seasonal, with the first and second quarters being historically lower than the third and fourth quarters. This seasonal pattern is primarily due to timing of the upgrade releases of Finale, which in recent years has occurred in the second or third quarters, and school budget cycles and the timing of school purchases.

Our cash flow was negatively impacted in the second and third quarters of 2011 due to the timing of our Finale 2012 release. However, given the release of Finale 2012 in early fourth quarter, we expect to achieve positive operating cash flow in 2011. We expect that our revenues and, in particular, continued growth in SmartMusic subscriptions, will yield sufficient cash to finance our operations for the next twelve months.

 

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Item 4. Controls and Procedures.

(a) Evaluation of disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covering this report. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed in the reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms and that our disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

(b) Changes in internal controls. There were no changes in our internal controls over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

Forward Looking and Cautionary Statements

The preceding discussion and analysis should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report. Management’s Discussion and Analysis may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements provide current expectations or forecasts of future events and can be identified by the use of terminology such as “believe,” “estimate,” “expect,” “intend,” “may,” “could,” “will,” “anticipate,” and similar words or expressions. The forward-looking statements in this report generally relate to our expectations and beliefs regarding: the synergies that exist between our two product lines; future operating results, cash flows from operations, revenue growth from new SmartMusic subscriptions, and the impact of the later release of Finale 2012 on our fourth quarter and fiscal year revenue; development activities and investments; our target business model, future subscription growth for SmartMusic and our ability to leverage the SmartMusic platform; expansion of SmartMusic repertoire and the impact on amortization; marketing and sales efforts; the impact of our patent litigation settlement; and the adequacy of capital resources. Forward-looking statements cannot be guaranteed and actual results may vary materially due to the uncertainties and risks, known and unknown, associated with such statements. MakeMusic cautions investors that many important factors have affected, and in the future could affect our actual results of operations and cause such results to differ materially from those anticipated in forward-looking statements made in this release and elsewhere by MakeMusic or on its behalf. These factors include, but are not limited to: unforeseen capital demands; the market acceptance of Finale, SmartMusic, SmartMusic Gradebook and other products; the success of our direct sales efforts; the success of our product development efforts; the maintenance of strategic partnerships and customer relationships; our ability to license titles from music publishers; the effectiveness of, and our ability to implement, our target business model; our ability to execute strategic development plans with respect to our notation and SmartMusic segments; our ability to attract and integrate qualified personnel; the limited and fluctuating sales of certain of our products; the intense competition that we face; the rapid technological changes and obsolescence in software industry, including our ability to release timely product upgrades that are responsive to such changes; our dependence on key personnel and the proprietary nature of our technology; other general business and economic conditions (including changes to discretionary spending by schools and students); and those factors described from time to time in our reports to the Securities and Exchange Commission (including our Annual Report on Form 10-K). It is not possible to foresee or identify all factors that could cause actual results to differ from expected or historic results. As such, investors should not consider any list of such factors to be an exhaustive statement of all of the risks, uncertainties or potentially inaccurate assumptions that investors should take into account when making investment decisions. Shareholders and other readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date on which they are made. We do not intend to update publicly or revise any forward-looking statements.

 

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

As previously disclosed, on September 14, 2010, a complaint was filed against us by Uniloc USA, Inc. and Uniloc Singapore Private Limited (collectively “Uniloc”) in the United States District Court for the Eastern District of Texas. The complaint alleged infringement of Uniloc’s patent for securely registering software and other digital media to prevent illicit copying and software piracy and seeks a permanent injunction. In addition, Uniloc sought compensatory damages in an unspecified amount, and interest, costs and expenses associated with the litigation. We are one of approximately 120 companies that have been similarly sued by Uniloc. We entered into a confidential settlement with Uniloc on April 28, 2011, pursuant to which we incurred expenses of approximately $225,000. As part of the settlement, we received a license to the patent in question. We do not expect the settlement to have a material impact on our business, financial condition, or results of operations.

In the ordinary course of business, we may be party to additional legal actions, proceedings, or claims. Corresponding costs are accrued when it is reasonably possible that loss will be incurred and the amount can be precisely or reasonably estimated. We are not aware of any actual or threatened litigation that would have a material adverse effect on our financial condition or results of operations.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Unregistered Sales of Equity Securities

There were no sales of unregistered equity securities during the quarter ended September 30, 2011.

Issuer Purchases of Equity Securities

There were no stock repurchases during the quarter ended September  30, 2011.

Item 3. Defaults Upon Senior Securities.

None.

I tem 4. (Removed and Reserved).

Item 5. Other Information.

On June 13, 2011, upon our appointment of Karen van Lith to the position of Chief Executive Officer, we accepted the resignation of Jeffrey Koch from his position of Interim Chief Executive Officer. The terms of Mr. Koch’s employment as Interim Chief Executive Officer were governed by an Employment Agreement dated November 10, 2010. In connection with Mr. Koch’s resignation, and consistent with the terms of his Employment Agreement, we entered into a Separation Agreement and Release (the “Separation Agreement”) with Mr. Koch on July 8, 2011. The terms of the Separation Agreement provide that Mr. Koch will receive $93,864.98 in separation pay, equal to his base salary through the first anniversary of his appointment to the position of Interim Chief Executive Officer, and pro-rated cash and equity incentive awards for the portion of the fiscal year that he served. Mr. Koch was also entitled to receive payment for accrued paid time off.

On July 28, 2011, our Board of Directors approved amendments to the Governance Committee Policies for Director Qualifications and Shareholder Communications (the “Policies”) to ensure the Policies remain consistent with our Bylaws (the “Bylaws”), which were amended on the same date. The Polices provide that a shareholder who wishes to nominate one or more directors must provide a written recommendation to the Secretary of MakeMusic within the timeframe provided by the Bylaws, whether or not the nominating shareholder intends such nominees to be included in MakeMusic’s proxy statement. To be eligible to make a nomination, a shareholder must own shares at the time the shareholder provides notice of the nomination to the Secretary and at the time of the annual meeting of shareholders at which the nominee or nominees will stand for election. The notice of nomination must include the name and address of the shareholder making the nomination and the class and number of shares such shareholder owns. With respect to each nominee, the shareholder should include the nominee’s name, age, business address, residence address, current principal occupation, five-year employment history (with organization names and a description of the employer’s business), the number of shares beneficially owned by the nominee, and whether such

 

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nominee can read and understand basic financial statements. The notice of nomination should also include a description of the nominee’s experience and character traits that cause him or her to be suitable for Board membership, and, if desired, an explanation of why the shareholder believes that the nominee would make a meaningful contribution to the Board.

Item 6. Exhibits.

See the attached exhibit index.

 

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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 the undersigned thereunto duly authorized.

    MAKEMUSIC, INC.
Date: November 14, 2011     By:   /s/    Karen T. van Lith
      Karen T. van Lith, Chief Executive Officer
      (Principal Executive Officer)
    By:   /s/    Karen L. VanDerBosch
      Karen L.VanDerBosch, Chief Financial Officer and Chief Operating Officer
      (Principal Financial Officer and Principal Operating Officer)

 

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EXHIBIT INDEX

Form 10-Q

The quarterly period ended September 30, 2011

 

 

Exhibit No.   Description
10.1*   Separation Agreement by and between MakeMusic, Inc. and Jeffrey Koch dated July 8, 2011
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.
101**   The following materials from this report, formatted in XBRL (Extensible Business Reporting Language), are filed herewith: (i) condensed balance sheets, (ii) condensed statement of operations, (iii) condensed statements of cash flows, and (iv) the notes to the condensed financial statements.

 

* Filed herewith.

 

** Pursuant to Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be deemed part of a registration statement, prospectus or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filings.

 

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