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MMUS > SEC Filings for MMUS > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for MAKEMUSIC, INC.

Form 10-Q for MAKEMUSIC, INC.


13-Nov-2012

Quarterly Report


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, notation and SmartMusic, that reinforce each other's features and competitiveness. The notation product line includes the well-established Finale® family of music notation software products which are utilized by music colleges and composers around the world in the creation of music scores. Finale serves a large and stable customer base, and generates revenue through sales of new version releases. Also included in the notation product line is MusicXML™, the industry standard open format for notation software and Garritan TM sound sample libraries.

SmartMusic® is a subscription-based product directed toward the very large and constantly renewing market of music students and music teachers. SmartMusic combines a software application with a library of thousands of music titles and skill-development exercises. It provides students and musicians with a compelling practice or audition experience and music teachers with the efficiency and effectiveness to reach more students and assess student achievement and growth.

In the fourth quarter of 2011, we announced the acquisition of select assets of Recordare, LLC and the acquisition of Garritan Corporation. We believe these acquisitions provide new products, technology, brands and employees that are complementary to MakeMusic and provide growth and technology opportunities for the future.

Our first nine months of 2012 resulted in a growth in sales for MakeMusic. Overall, net revenue increased 17% during the first nine months of 2012 as compared to the first nine months of 2011. SmartMusic revenue grew 15% due to our year over year subscription growth from 176,352 subscriptions to 201,838 subscriptions. Notation revenue increased 20% primarily due to added sales of Garritan sound libraries, resulting from the acquisition of Garritan Corporation, and sales of Finale 2012 due to the timing of our release cycle. This increase was offset by lower sales of Finale PrintMusic as this product has not been updated since September 2010. Additionally, there were lower sales of Finale NotePad compared to the first nine months of 2011 because we began offering the product as a free download effective with the release of Finale NotePad 2012 on February 15, 2012. Gross margin percentages were generally comparable at 84% in the first nine months of 2012 and 83% in the first nine months of 2011.

Operating expenses increased in the first nine months of 2012 across all operating categories. Development expenses were greater primarily due to personnel costs resulting from the addition of the Chief Technology Officer position, which was open until August of 2011, and added personnel and development costs to support technology initiatives, the addition of the Garritan sound libraries and MusicXML technologies. Selling and marketing expenses increased as a result of the planned expansion of our direct sales force, expanded product management capabilities, re-branding and company-wide strategic sales and marketing initiatives. General and administrative expenses increased primarily due to increased legal and consulting fees relating to the Tax Asset Protection Plan that became effective February 21, 2012, increased accounting fees for reporting requirements relating to the acquisition of Garritan Corporation, expenses relating to the departure of our Chief Executive Officer in June 2012 including legal fees and accrued severance expenses, and expenses relating to the financial and legal advisory services for the


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Special Committee's evaluation of strategic alternatives (the "Strategic Alternatives"). The Strategic Alternatives evaluation includes, but is not limited to, evaluation of the proposal from our largest shareholder, Launch Equity Partners, LLC, other potential strategic transactions to realize the long-term value of the Company, or continuing as an independent, public company with the Company's current growth plans. In the first nine months of 2011, we incurred expenses of $225,000 relating to a patent infringement settlement. There were no comparable expenses in the first nine months of 2012.

Our net loss before taxes in the first nine months of 2012 was $3,718,000 compared to $840,000 in 2011. The tax benefit in the first nine months of 2012 was $1,320,000 compared to $150,000 in the first nine months of 2011. As a result of the factors mentioned, we reported net loss of $2,398,000 in the first nine months of 2012 compared to net loss of $690,000 in the first nine months of 2011.

We believe there is growth potential with SmartMusic software, an interactive music teaching, practicing and learning solution for band, orchestra and vocal programs. SmartMusic is subscription-based software for use in the classroom and in the student's home. SmartMusic 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 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.

Teachers use the SmartMusic Gradebook™ capability of the educator's subscription to issue assignments to students, receive completed assignments from students, assess student achievement, and manage student records. Music teachers are challenged to reach all of their students in the way they passionately desire. The SmartMusic technology allows teachers to be more efficient and effective, allowing them to affect more of their students in ways they never imagined. SmartMusic also addresses the increasing desire and need of administrators to document the assessment of student's achievement. Assessment standards have become topics of intense interest at the level of state education administrators and MakeMusic is becoming recognized as providing the technology that allows them to accomplish their goals. Students also find that SmartMusic is a more satisfying and helpful way to practice and learn to sing or play a musical instrument. SmartMusic allows practice to be more engaging and rewarding, which results in the acceleration of students' growth and achievement.

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.

In July of 2011, we released a mobile application called SmartMusic InboxTM. SmartMusic Inbox is a free application for both Android and iOS platforms for mobile use by SmartMusic teachers that enables them to listen and grade assignments with ease and mobility.

We believe that our technological investments in SmartMusic have created a digital pipeline between our growing subscriber base of more than 200,000 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:

                                             Sep-11        Dec-11        Mar-12        June-12       Sep-12
Total Subscriptions                           176,352       178,609       183,331       185,968       201,838
Subscriptions purchased during quarter         74,550        51,003        24,738        12,738        47,699
Educator Accounts                               9,744        10,544        11,326        11,201        12,565

Our educational sales organization focuses on direct school district sales in the United States and Canada, aiming at the 17,000 schools who match our ideal demographic profile. We increased the size of our educational sales force from 7 to 13 in 2011 to strengthen our strategic sales initiatives. During the first nine months of 2012, we hired a sales executive to lead our sales and business development initiatives.


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The following table illustrates the total net new SmartMusic educator subscriptions for each quarter during the year ended December 31, 2011 and the quarters ended March 31, 2012, June 30, 2012 and September 30, 2012:

                                                                                                                                         Quarterly
                      Beginning              New               Renewed          Renewal        Subscriptions        Quarter End           Net New
Quarter End Date    Subscriptions       Subscriptions       Subscriptions        Rate              Ended           Subscriptions       Subscriptions
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
12/31/2011                  13,297                 894               2,616            79 %              3,327              13,480                 183
3/31/2012                   13,480                 878               2,067            76 %              2,726              13,699                 219
6/30/2012                   13,699                 675               2,033            76 %              2,662              13,745                  46
9/30/2012                   13,745               1,614               4,752            86 %              5,515              14,596                 851

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 educator subscriptions. In the third quarter of 2012, the educator renewal rate was 86%. This is an improvement from a renewal rate of 76% in each of the first and second quarters of 2012 and is comparable to the renewal rate in the second quarter of 2011. During the second quarter of 2011, we implemented a subscription promotion for our customers that provided for a 15-month subscription for the price of 12 months. We believe that some SmartMusic customers not only renewed early as a result of this promotion but also increased the number of subscriptions purchased during that period. The subscriptions renewed in the second quarter of 2011 under the 15-month subscription promotion renewed during the third quarter of 2012.

In 2012, we are focused on four strategic initiatives that include enhancing our technology architecture, extending our core product value into new product innovations and platforms, developing new and leveraging existing distribution channels and strengthening our marketing strategy focusing on our brand promise. We are making investments in each of these initiatives to provide anticipated growth opportunities in the future.

We have achieved positive cash flow from operations for the last seven years, including the most recent year ended December 31, 2011. Our quarterly results will fluctuate as a result of the seasonality of the education market and timing of our Finale release cycle. Due to current economic conditions, concerns over school budgets and our planned strategic investments, we are cautious regarding our future financial projections. We expect increased revenues and, in particular, growth in SmartMusic subscriptions and sound library sales from the acquisition of Garritan Corporation. However, our investments in our operations and technology have and will continue to result in reduction in cash balances during 2012.

In our Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2011, we identified critical accounting policies and estimates for our business that we are incorporating herein by reference.


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Results of Operations

Comparison of the three and nine-month periods ended September 30, 2012 to the three and nine-month periods ended September 30, 2011

Net Revenue ($ in thousands)



                      3 Months Ended September 30,                    9 Months Ended September 30,
                  2012        2011        Incr        %          2012         2011        Incr        %
   Notation     $  2,377     $ 1,647     $   730       44 %    $  6,766     $  5,653     $ 1,113       20 %
   SmartMusic      2,438       2,158         280       13 %       6,273        5,459         814       15 %

   Total        $  4,815     $ 3,805     $ 1,010       27 %    $ 13,039     $ 11,112     $ 1,927       17 %

Net revenue for the three months ended September 30, 2012 increased 27% compared to net revenue for the three months ended September 30, 2011 and increased 17% when comparing the nine months ended September 30, 2012 and 2011.

Notation revenue increased by $730,000, to $2,377,000, when comparing the three-month periods ended September 30, 2012 and 2011 and by $1,113,000, to $6,766,000, when comparing the nine months ended September 30, 2012 and 2011. Sales of Finale in the third quarter of 2012 were higher than the comparable quarter of 2011 as customers anticipated the release of the new product version in October 2011 which slowed sales in the third quarter of last year. Other increases during the 2012 quarter included $216,000 of added Garritan sound libraries sales due to the acquisition of Garritan Corporation in December 2011. These increases were partially offset by lower Finale PrintMusic sales as this product has not been updated since September 2010. Additionally, Finale NotePad sales are lower when compared to the third quarter of 2011 because we began offering the product as a free download effective with the release of Finale NotePad 2012 on February 15, 2012. Increases during the nine months ended September 30, 2012 were primarily due to increased direct Finale sales and $699,000 added sales of Garritan sound libraries resulting from the acquisition of Garritan Corporation. This increase was offset by lower sales of Finale PrintMusic and Finale NotePad compared to the nine months ended September 30, 2011.

SmartMusic revenue for the three months ended September 30, 2012 was $2,438,000, an increase of $280,000, or 13%, over the three months ended September 30, 2011 and an increase of $814,000, or 15%, to $6,273,000, when comparing the nine months ended September 30, 2012 and 2011. The increase in revenue is primarily due to the growth of total SmartMusic subscriptions. SmartMusic subscriptions have increased due in part to our direct sales force which focuses on district-level sales. During the third quarter of 2012, we also began selling SmartMusic subscriptions and accessories through a dealer channel. Revenue for 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, 2012 was $1,835,000, an increase of $221,000, or 14%, over the three-month period ended September 30, 2011. Total earned SmartMusic subscription revenue for the nine-month period ended September 30, 2012 was $5,330,000, an increase of $795,000, or 18%, over the nine-month period ended September 30, 2011.This increase was due to the increase in the total number of subscriptions and average sales price per subscription. Total unearned SmartMusic subscription revenue (deferred revenue), including deferred subscription sales to our dealer channel, was $4,900,000 as of September 30, 2012, an increase of $898,000, or 22%, over the balance at September 30, 2011 and an increase of $615,000, or 14%, compared to the balance of $4,285,000 at December 31, 2011. Deferred SmartMusic revenue represents the future revenue to be recorded on current subscriptions and fluctuates based on new subscription sales, subscriptions sold to our music instrument dealer channel, the total number of subscriptions and the remaining life of those subscriptions. We experience seasonal fluctuations in deferred SmartMusic revenue due to the majority of subscriptions purchased during the fall back-to-school season.

SmartMusic has shown sustained growth since its launch. The number of educators who had purchased SmartMusic as of September 30, 2012 was 12,565, an increase of 29% over the 9,744 educators that had purchased it as of September 30, 2011. Total SmartMusic subscriptions as of September 30, 2012 number 201,838, representing a net gain of 25,486, or 14%, over the September 30, 2011 subscription count of 176,352.

Many SmartMusic customers, especially new customers, also purchase accessories (primarily microphones) that are used with the software. Revenue for the sales of accessories, included in the SmartMusic revenue category, for the quarter ended September 30, 2012 was $475,000, which was an increase of $65,000, or 16%, from the


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revenue of $410,000 for SmartMusic accessories in the quarter ended September 30, 2011. Revenue for the sales of SmartMusic accessories for the nine months ended September 30, 2012 was $739,000, which was an increase of $60,000, or 9%, from $679,000 of SmartMusic accessories revenue in the nine months ended September 30, 2011. This increase is primarily due to an increase in the number of net new subscriptions added during the three and nine months ended September 30, 2012 as compared to the number of net new subscriptions added during the same periods of the prior year and sales of accessories to our dealer channel in the third quarter of 2012.

Gross profit ($ in thousands)

                       3 Months Ended September 30,                   9 Months Ended September 30,
                   2012          2011       Incr       %          2012        2011        Incr        %
    Notation     $   2,218      $ 1,522     $ 696       46 %    $  6,259     $ 5,261     $   998       19 %
    SmartMusic       1,744        1,500       244       16 %       4,698       3,940         758       19 %

    Total        $   3,962      $ 3,022     $ 940       31 %    $ 10,957     $ 9,201     $ 1,756       19 %

Gross profit in the three months ended September 30, 2012 increased by $940,000, to $3,962,000, compared to the three months ended September 30, 2011. Gross profit for notation increased by $696,000, to $2,218,000, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011 primarily due to the increase in notation revenue attributed to increased Finale sales and the acquisition of Garritan Corporation. Gross profit for SmartMusic increased by $244,000, to $1,744,000, for the three months ended September 30, 2012 compared to the three months ended September 30, 2011 due to the increase in SmartMusic revenue. Gross profit in the nine months ended September 30, 2012 increased by $1,756,000, to $10,957,000, compared to the nine months ended September 30, 2011. Gross profit for notation increased $998,000, to $6,259,000 for the nine months ended September 30, 2012 compared to the same period in 2011 primarily due to the increase in notation revenue attributed to increased Finale sales and the acquisition of Garritan Corporation. Gross profit for SmartMusic increased $758,000, to $4,698,000 for the nine months ended September 30, 2012 compared to the same period in 2011 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 and Garritan software development costs, shipping, and credit card fees. Capitalized SmartMusic repertoire is amortized over a five-year period. Repertoire development amortization as a percentage of SmartMusic revenue was 13% for the nine months ended September 30, 2012 and 12% for the nine months ended September 30, 2011. Total gross margins as a percentage of sales were 82% and 79%, respectively, for the three months ended September 30, 2012 and 2011 and 84% and 83%, respectively, for the nine-month periods ended September 30, 2012 and 2011. Gross margins for notation as a percentage of sales were generally comparable at 93% and 92%, respectively, for the three-month periods ended September 30, 2012 and 2011 and were 93% for each of the nine months ended September 30, 2012 and 2011. Gross margins for SmartMusic as a percentage of sales were 72% and 70%, respectively, for the three months ended September 30, 2012 and 2011 and were 75% and 72%, respectively, for the nine months ended September 30, 2012 and 2011. We expect future gross margins as a percentage of sales to remain generally comparable with historical levels.

Development expense ($ in thousands)

                       3 Months Ended September 30,                   9 Months Ended September 30,
                   2012        2011       Incr         %          2012        2011        Incr        %
    Notation     $     725     $ 442     $   283        64 %    $  2,254     $ 1,419     $   835       59 %
    SmartMusic         790       290         500       172 %       2,097       1,053       1,044       99 %
    Other              456       239         217        91 %       1,106         799         307       38 %

    Total        $   1,971     $ 971     $ 1,000       103 %    $  5,457     $ 3,271     $ 2,186       67 %

Development expenses increased 103% to $1,971,000, from $971,000, when comparing the three months ended September 30, 2012 and 2011. Development expenses increased 67% to $5,457,000, from $3,271,000, when comparing the nine months ended September 30, 2012 and 2011. Development expenses consist primarily of internal payroll, payments to independent contractors and related expenses for the development and maintenance of our Finale notation, Garritan sound libraries, MusicXML, SmartMusic and SmartMusic Gradebook products, as well as non-capitalized SmartMusic repertoire development, business systems and quality assurance. Notation development expenses increased due to personnel costs relating to the Chief Technology Officer position, which was open until August of 2011, mobile application development and added personnel and contractor costs to support our technology


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architecture modernization and the Garritan sound libraries and MusicXML technologies. SmartMusic development expenses increased primarily due to personnel costs relating to the Chief Technology Officer position and contract labor to support our strategic developments. During the quarter ended September 30, 2012, 129 new SmartMusic large ensemble band, jazz ensemble, and orchestra titles with pre-authored assignments were released, as compared to no new large ensemble titles released in the quarter ended September 30, 2011. A total of 3,280 large ensemble titles are available in SmartMusic as of September 30, 2012.

Selling and marketing expense ($ in thousands)

                       3 Months Ended September 30,                   9 Months Ended September 30,
                   2012          2011       Incr       %          2012        2011        Incr        %
    Notation     $     588      $   407     $ 181       44 %    $  1,791     $ 1,216     $   575       47 %
    SmartMusic         822          670       152       23 %       2,286       1,655         631       38 %
    Other              436          307       129       42 %       1,028         761         267       35 %

    Total        $   1,846      $ 1,384     $ 462       33 %    $  5,105     $ 3,632     $ 1,473       41 %

Selling and marketing expenses primarily consist of marketing, advertising and promotion expenses, business development, product management and customer service activities and payroll. Sales and marketing expenses increased 33%, to $1,846,000, for the three months ended September 30, 2012 compared to $1,384,000 for the three months ended September 30, 2011. Selling and marketing expenses increased 41%, to $5,105,000, during the nine months ended September 30, 2012, compared to $3,632,000 for the nine months ended September 30, 2011. Notation selling and marketing expenses increased primarily due to company-wide strategic marketing initiatives, Garritan product promotions and expanded product management capabilities. SmartMusic selling and marketing expenses increased due to increased personnel relating to our direct sales organization, expanded product management capabilities and strategic sales and marketing initiatives for SmartMusic. Other selling expenses increased primarily due to website, company-wide branding and social media investments.

General and administrative expense ($ in thousands)

                       3 Months Ended September 30,                     9 Months Ended September 30,
                                          Incr                                            Incr
                 2012         2011       (Decr)         %         2012        2011       (Decr)         %
  Notation     $       5      $  16     $    (11 )      -69 %    $    39     $    59     $   (20 )      -34 %
  SmartMusic          27         27            0          0 %         53          61          (8 )      -13 %
  Other            1,091        864          227         26 %      4,085       2,884       1,201         42 %

  Total        $   1,123      $ 907     $    216         24 %    $ 4,177     $ 3,004     $ 1,173         39 %

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 24% to $1,123,000 during the three months ended September 30, 2012 compared to $907,000 for the same period of 2011. General and administrative expenses increased by 39% to $4,177,000 during the nine months ended September 30, 2012, compared to $3,004,000 for the same period of 2011. Other . . .

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