• 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 choir, and Finale® music notation software. We believe these innovative products that reinforce each other's features and competitiveness, will allow us to continue to achieve positive operating results. The well-established Finale family of music notation software products provides a solid base business that generates cash and has a large customer database. Music notation software is a niche business since only a small percentage of musicians ever notate music.
The first quarter of 2009 resulted in continued sales growth for SmartMusic and comparable sales for Finale products and overall, a 6% increase over first quarter 2008 net revenue was achieved. Gross margin percentages remained unchanged at 86% in the first quarter of 2009 and 86% in the first quarter of 2008 due to the amortization of software development and repertoire development relating to SmartMusic and SmartMusic Impact (Gradebook). Operating expenses increased 5% in the first quarter of 2009, primarily due to increased business systems expenses as a result of increased staffing and expansion of our systems infrastructure to support our anticipated SmartMusic growth. As a result of the factors mentioned, net loss in the first quarter of 2009 was $145,000, compared to a net loss of $149,000 for the same period last year.
We believe our greatest growth potential lies 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 titles and skill-development exercises and a web service to provide students with a compelling experience and teachers with a comprehensive solution.
SmartMusic software enhances and transforms the hours spent practicing by putting students inside a professional band, orchestra or choir so that they can hear how the music is supposed to be performed and how their part fits in. This makes practicing much more fun, 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 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 fun and productive leads to rapid student skill-development, increased student confidence, higher student retention and stronger music programs.
In April 2007, we introduced SmartMusic Impact®, a web-based grade book that is included with each teacher subscription. We are in the process of renaming this feature to SmartMusic Gradebook™ to more clearly define the capability of the product. SmartMusic Gradebook is 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. Students complete the assignment on their home computer provided that they have a SmartMusic subscription, or on a school computer equipped with SmartMusic. Submitted assignments are automatically graded and posted in the teacher's SmartMusic Gradebook thereby providing teachers with the visible means for measuring student achievement.

We have established a sales organization to focus on direct school district sales activities and introduced site licenses offering discounts for volume purchases. As of March 31, 2009 we had executed 216 site licenses, compared to 47 site licenses as of March 31, 2008.
In addition to tracking the total number of subscriptions, we track teachers who use SmartMusic as well as the number of those teachers who are using the Gradebook to deliver and manage student assignments to fifty students or more (formerly known as Impact teachers, now Gradebook teachers). As of March 31, 2009, we reported 829 Gradebook teachers compared to 498 Gradebook teachers as of March 31, 2008.
The following table illustrates our quarterly SmartMusic metrics:

                                         Mar-08            Jun-08            Sep-08            Dec-08             Mar-09
Total Subscriptions                      92,776            95,632            98,119            106,584            110,318
Educator Accounts                         8,161             8,165             9,165              9,185              9,091
Educators who have issued
assignments*                              1,159             1,282               827              1,436              1,874
Gradebook Teachers *                        498               538               247                601                829
Site Licenses                                47                97               189                212                216

* Annual statistics that restart on July 1 of each year reflecting the start of the school-year cycle

Educator accounts experienced a 20% growth rate during the 2008 fiscal year which creates the potential for sizable growth in student subscriptions. However, this growth depends upon teachers increasing their use of SmartMusic Gradebook to set up their classes, enroll students and issue frequent SmartMusic assignments. To date, there are not enough teachers that have actively utilized SmartMusic Gradebook to reflect a significant growth rate in subscriptions which has contributed to student subscriptions lagging behind our expectations.
The SmartMusic target business model is based on music educators integrating SmartMusic into their teaching and using the SmartMusic Gradebook to issue frequent assignments, which we believe would result in an increase in student subscriptions. As stated above, 1,874, or 21%, of the teachers who have purchased SmartMusic have utilized SmartMusic Gradebook, and those teachers have 107,411 students receiving SmartMusic assignments. The total student subscriptions associated with these Gradebook accounts are 46,353.
To accelerate the adoption of this target business model and address the lower-than-expected subscription rates in 2008, in the first quarter of 2009 we hired a sales director and increased the focus of our direct sales force on existing SmartMusic teachers that have not yet utilized Gradebook in their curriculum. In addition, our development efforts are focused on improving and simplifying the SmartMusic purchase processes, Gradebook class set-up, student enrollment and SmartMusic assignments. The overall objective is to make these processes easy and intuitive for both teachers and students. These product enhancements will be included in SmartMusic 2010, which is scheduled to be released prior to the back-to-school season of 2009.
In the third quarter of 2008, we began tracking new versus renewed SmartMusic subscriptions. The following table illustrates the net new SmartMusic subscription data for the quarters ended September 30, 2008, December 31, 2008 and March 31, 2009:

                                                                                                           Quarterly
 Quarter        Beginning             New             Renewed        Subscriptions      Quarter End         Net New
 End Date     Subscriptions      Subscriptions     Subscriptions         Ended         Subscriptions     Subscriptions
9/30/2008            95,632            20,347            20,017            37,877            98,119              2,487
12/31/2008           98,119            17,907            17,942            27,384           106,584              8,465
3/31/2009           106,584            10,609            12,241            19,116           110,318              3,734

We define renewed subscriptions as those subscriptions that customers purchase within the two-month period after their prior subscription ended. Because of changes to the start of school from year to year as well as fluctuations in the date that music teachers implement their curriculum, we commonly see subscribers that have a delay of up to two months in renewing their subscription. As a result, we believe that using the above definition of a

renewal more accurately reflects the renewal rate for SmartMusic subscriptions. We intend to report SmartMusic subscription renewals on a quarterly basis.
We have achieved positive cash flow from operations for the last five years, including the most recent year ended December 31, 2008. With increased revenues and, in particular, the growth in SmartMusic subscriptions, plus improvements in operational efficiency over the last few years, we feel that we can continue to achieve positive operating cash flow on an annual basis in the future. Our quarterly results will fluctuate as a result of the cyclicality of the education market. Due to the current economic conditions and concerns over school budgets, we are cautious regarding our ability to continue annual profitability. However, we have established contingency plans that will be implemented if certain revenue and cash flow objectives are not met, which we believe will be adequate to maintain positive cash flow.
In our Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2008, we identified critical accounting policies and estimates for our business that we are incorporating herein by reference.
In 2009, we began reporting results of operations by two unique reportable segments, Notation and SmartMusic. Historically, net revenue has been reported separately for these two product lines. However, direct and operating costs had not been previously assessed or reported by segment. Therefore, prior year comparative costs are not available and operating costs by segment are not discussed in this Management's Discussion and Analysis of Financial Condition and Results of Operations. For further information on segment reporting, refer to Note 6 to the financial statements appearing in Part I, Item 1 of this report.

                                                     3 Months Ended March 31,
                                           2009         2008        Incr (Decr)        %
                                           ($ in thousands)           ($ in thousands)
    Notation revenue                     $   2,528     $ 2,556              ($28 )      -1 %
    SmartMusic revenue                       1,156         882               274        31 %
    Other revenue                              158         184               (26 )     -14 %

    Net revenue                              3,842       3,622               220         6 %
    Cost of revenues                           557         507                50        10 %

    Gross profit                             3,285       3,115               170         5 %
    Percentage of net sales                     86 %        86 %

    Development expense                      1,279       1,113               166        15 %
    Selling and marketing expense            1,131       1,175               (44 )      -4 %
    General and administrative expense       1,032         985                47         5 %


    Total operating expense                  3,442       3,273               169         5 %

    Operating loss                            (157 )      (158 )               1         1 %
    Other income                                14          36               (22 )     -61 %

    Net loss before taxes                    ($143 )     ($122 )            ($21 )     -17 %
    Income tax provision                        (2 )       (27 )              25       -93 %

    Net loss                                 ($145 )     ($149 )   $           4         3 %

Comparison of the three-month period ended March 31, 2009 to the three-month period ended March 31, 2008
Net revenue. Net revenue increased 6% from $3,622,000 in the three-month period ended March 31, 2008 to $3,842,000 in the three-month period ended March 31, 2009.
Notation revenue decreased by $28,000 to $2,528,000 when comparing the three-month period ended March 31, 2009 and 2008. The first quarter of 2008 included revenue from a $133,000 Finale site license, whereas there was no comparable sale in 2009. Notation revenue decreases during the quarter were also due to a decline in our channel sales due to economic conditions. Partially offsetting this decline were sales of Finale NotePad®, which we began charging for in October 2008.
SmartMusic revenue for the quarter ended March 31, 2009, was $1,156,000, an increase of $274,000, or 31%, over the quarter ended March 31, 2008. The increase in revenue reflects the continued growth of the SmartMusic product that was originally launched in 2001 and the SmartMusic Gradebook product that was released in 2007. It also reflects the success of our SmartMusic site license program which encourages school district deployment of SmartMusic student subscriptions and our direct sales force which focuses on district level sales. As of March 31, 2008 there were 216 site licenses for SmartMusic with average subscriptions per license of 128 and average potential of 233 subscriptions per license.
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 March 31, 2009 was $912,000, an increase of $211,000, or 30%, over the three-month period ended March 31, 2008. This increase is due to the increase in the total number of subscriptions as well as a price increase in July 2008 where teacher subscriptions increased from $100 to $130 and student subscriptions increased from $25 to $30. Total unearned SmartMusic subscription revenue (deferred revenue) was $2,078,000 as of March 31, 2009, an increase of $488,000, or 31%, over the balance at March 31, 2008. Deferred SmartMusic revenue represents the future revenue to be recorded on current subscriptions.
SmartMusic has shown sustained growth since its launch. More than 9,091 schools have purchased SmartMusic, an increase of 11% over the 8,161 schools that had purchased it as of March 31, 2008. Total SmartMusic subscriptions as of March 31, 2009 number 110,318, representing a net gain of 17,542, or 19% over the March 31, 2008 subscription count of 92,776.
SmartMusic Gradebook is a web-based service that is designed to manage student assignments, recordings and grades while documenting the progress of each student and assessing student achievement. We track teachers that use SmartMusic as well as the number of those teachers who are using SmartMusic Gradebook to deliver and manage student assignments to 50 or more students (formerly Impact teachers). As of March 31, 2009, we had 829 SmartMusic Gradebook teachers with an average of 39 student subscriptions per teacher. This is an annual statistic, counting only teachers who have issued assignments to 50 or more students during a school fiscal year. Therefore, this is a gain of 829 SmartMusic Gradebook teachers during the 2008/2009 school year as the number of Gradebook teachers restarts at zero on July 1 of each year to correspond with the start of the school year. At March 31, 2008 we reported 498 Gradebook teachers with an average of 32 student subscriptions per teacher. We believe that not enough teachers have actively utilized SmartMusic Gradebook to reflect a significant growth rate in student subscriptions and we continue to focus specific marketing activities on SmartMusic and SmartMusic Gradebook, including hiring a sales director in the first quarter of 2009 and introducing training materials to teachers and students that simplify getting started with our products. Additionally we intend to increase the focus of our direct sales force on existing SmartMusic teachers that have not yet utilized the SmartMusic Gradebook in their curriculum and anticipate continued growth in the number of new subscriptions in the future.
Many SmartMusic customers, especially new customers, also purchase accessories (primarily microphones and foot pedals) that are used with the software. Revenue for the sales of accessories, included in the SmartMusic revenue category, for the quarter ended March 31, 2009 was $176,000, which was $5,000, or 3%, less than revenue of $181,000 for SmartMusic accessories in the quarter ended March 31, 2008. This decrease is due to fewer new SmartMusic subscribers in the first quarter of 2009 when compared to the first quarter of 2008. During the quarter ended March 31, 2009 total subscriptions increased 3,734, compared to an increase of 5,875 of total subscriptions during the quarter ended March 31, 2008. We increased the selling price of microphones from $15.00 to $19.95 in mid-January 2008 which partially offset the impact of the decreased volume.

Gross profit. Gross profit in the quarter ended March 31, 2009 increased by $170,000, to $3,285,000, compared to the quarter ended March 31, 2008. The increase in gross profit for the three months ended March 31, 2009 is a result of the increase in revenues offset by higher repertoire development amortization as a result of our increased repertoire in SmartMusic. Repertoire development amortization as a percentage of SmartMusic revenue was 11% for the current quarter as compared to 10% for the same quarter last year. We expect amortization related to repertoire development to increase as we continue to add repertoire to SmartMusic. Gross margin as a percentage of sales was 86% for each of the three-month periods ended March 31, 2009 and 2008.
Development expense. Development expenses increased 15% to $1,279,000, from $1,113,000, when comparing the quarters ended March 31, 2009 and 2008. 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 SmartMusic repertoire development, business systems and quality assurance. Personnel and contract labor costs increased from the first quarter of 2009 compared to the same period in 2008 due to staff increases in order to achieve numerous product development goals related to the simplification of SmartMusic user interface, enrollment and purchase processes. Additionally, in June 2008 we completed a server co-location project and expansion of our infrastructure to support our anticipated SmartMusic growth. We anticipate increased development costs due to the annualized impact of the increased headcount additions in 2008 and expenses related to our infrastructure expansion.
Selling and marketing expense. Selling and marketing expenses primarily consist of marketing, advertising and promotion expenses, business development and customer service activities and payroll. Sales and marketing expenses decreased 4% to $1,131,000 in the quarter ended March 31, 2009 compared to $1,175,000 for the quarter ended March 31, 2008. The decrease in expenses is primarily due to decreased costs related to tradeshow activities. We anticipate sales and marketing expenses for future months in 2009 to be comparable to those in 2008.
General and administrative expense. 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 5% to $1,032,000 during the first quarter of 2009 compared to $985,000 for the same period of 2008. General and administrative costs increased primarily as a result of standard annual increases in health insurance premiums, legal, accounting and consulting expenses.
Operating loss. Net loss from operations was comparable at $157,000 for the three months ended March 31, 2009 and $158,000 in the three months ended March 31, 2008. We maintained our operating performance in the first quarter due mainly to the continued performance of our SmartMusic product, offset in part by the increased development and general and administrative costs noted above, when compared to the same period last year.
The Notation segment results for the first quarter of 2009 reflects operating income of $1,447,000, the SmartMusic segment reported an operating loss of $104,000 and $1,500,000 of costs, primarily general and administrative, are not allocated by segment. Prior year comparative costs are not reported as direct and operating costs had not been previously assessed or reported by segment.
Net loss. Net loss in the first quarter of 2009 was $145,000, or $0.03 per basic and diluted share, compared to net loss of $149,000, or $0.03 per basic and diluted share, in the first quarter of 2008. The comparable net loss during the first quarter was due mainly to the same factors noted above.
Liquidity and capital resources. Net cash used by operating activities was $167,000 for the quarter ended March 31, 2009, compared to $78,000 of cash used by operating activities in the quarter ended March 31, 2008. The increase in cash used in the first quarter of 2009 compared to the same period in 2008 is primarily the result of a decline in new SmartMusic subscriptions, which reduced deferred revenue and increased working capital requirements. Net new subscriptions in the first quarter of 2009 were 3,734 compared to 5,875 in the first quarter of 2008.
Net cash used in investing activities was $299,000 for the quarter ended March 31, 2009, compared to $579,000 cash used in investing activities for the comparable quarter of 2008. The decrease is primarily due to the decrease of capitalization of software development, primarily for Repertoire Development. Our spending on Repertoire Development has declined due to reducing the overall number of titles being developed, shifting from band to orchestra titles that have fewer parts and are therefore less expensive, and moving engraving work in-house from external contractors.

Net cash used by financing activities was $15,000 in the first quarter of 2009. This is a decrease of $298,000 compared to net cash provided by financing activities of $283,000 in the first quarter of 2008. During the first quarter of 2008, $297,000 was received for stock option and warrant exercises compared to $0 in the first quarter of 2009. We expect cash provided from financing activities to be lower in 2009 due to the fact that substantially all of our outstanding warrants were exercised or expired in 2008 and the relatively low intrinsic value of options outstanding at March 31, 2009.
Cash and cash equivalents as of March 31, 2009 was $6,111,000 compared to $5,667,000 as of March 31, 2008. The increase in cash is due to our net income reported for the year ended December 31, 2008 and the increase in SmartMusic subscription revenue during the first quarter of 2009. 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 typically occur in the third or fourth quarter, and school budget cycles.
Management believes that we currently have sufficient cash to finance operations for the foreseeable future. If we do not meet our anticipated future revenue levels, management is committed to taking actions necessary to ensure the conservation of adequate cash to continue to finance our operations. Due to current economic conditions, we have established contingency plans that will be implemented if certain revenue and cash flow objectives are not met, which we believe will be adequate to maintain positive cash flow.