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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,
2003.
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from _________ to
__________.
Commission file number: 333-78571-02
333-78573-01
333-78571
333-78571-05
MUZAK HOLDINGS LLC
MUZAK HOLDINGS FINANCE CORP
MUZAK LLC
MUZAK FINANCE CORP
(Exact Name of Registrants as Specified in their charter)
DELAWARE 04-3433730
DELAWARE 04-3433728
DELAWARE 04-3433729
DELAWARE 56-2187963
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporated or Organization)
3318 LAKEMONT BLVD
FORT MILL, SC 29708
(803) 396-3000
(Address, Including Zip Code and Telephone Number including Area Code of
Registrants' Principal Executive Offices)
Indicate by check mark whether the registrant has filed (1) all documents and
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
registrants were 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 is an accelerated filer (as
defined in the Exchange Act Rule 12-b-2). Yes ( ) No (X)
On November 13, 2003, there were 146,958 membership units of Muzak Holdings LLC
outstanding. There is no established trading market for the membership units.
PART I- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
MUZAK HOLDINGS LLC
CONSOLIDATED BALANCE SHEETS
(in thousands)
September 30, December 31,
2003 2002
(unaudited)
---------------- ---------------
ASSETS
Current assets:
Cash $ 2,393 $ 1,781
Accounts receivable, net of allowances of $1,862 and $1,708 28,070 26,531
Inventory 14,593 11,401
Prepaid expenses and other assets. 4,352 1,719
--------------- ---------------
Total current assets 49,408 41,432
Property and equipment, net 108,839 110,889
Intangible assets, net 257,864 270,756
Deferred subscriber acquisition costs, net 44,464 41,410
Deferred charges and other assets, net 15,470 11,759
--------------- ---------------
Total assets $ 476,045 $ 476,246
=============== ===============
LIABILITIES AND MEMBERS' INTEREST
Current liabilities:
Accounts payable $ 6,945 $ 10,049
Accrued expenses 21,556 18,304
Current maturities of other liabilities 2,852 2,924
Current maturities of long term debt 417 7,855
Advance billings 1,680 1,040
--------------- ---------------
Total current liabilities 33,450 40,172
Long-term debt 402,428 359,914
Related party notes -- 10,000
Other liabilities 9,565 10,215
Manditorily redeemable preferred units 123,887 109,114
Commitments and contingencies
Total liabilities 569,330 529,415
Members' interest:
Class A units 102,493 117,167
Class B units -- 97
Accumulated other comprehensive loss -- (290)
Accumulated deficit (195,778) (170,143)
--------------- ---------------
Total members' interest (93,285) (53,169)
--------------- ---------------
Total liabilities and members' interest $ 476,045 $ 476,246
=============== ===============
The Notes are an integral part of these consolidated financial statements.
2
MUZAK HOLDINGS LLC
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands)
Quarter Ended Nine Months Ended
--------------------------- ---------------------------
September 30, September 30, September 30, September 30,
2003 2002 2003 2002
------------- ------------- ------------- -------------
Revenues:
Music and other business services $ 43,965 $ 41,177 $ 129,995 $ 121,123
Equipment and related services. 15,384 14,989 43,627 40,075
------------ ------------ ------------ ------------
59,349 56,166 173,622 161,198
Cost of revenues:
Music and other business services
(excluding $10,393, $11,196, $32,300 and
$32,932 of depreciation and amortization
expense). 8,173 7,780 23,893 26,428
Equipment and related services. 12,100 11,873 35,355 32,474
------------ ------------ ------------ ------------
20,273 19,653 59,248 58,902
------------ ------------ ------------ ------------
39,076 36,513 114,374 102,296
Selling, general and administrative
expenses. 20,038 17,931 59,958 53,853
Depreciation and amortization expense. 15,338 17,567 47,776 52,825
------------ ------------ ------------ ------------
Income (loss) from operations. 3,700 1,015 6,640 (4,382)
Other income (expense):
Interest expense. (10,302) (8,865) (28,766) (27,505)
Other, net. 36 76 131 192
Loss from extinguishment of debt -- -- (3,694) --
------------ ------------ ------------ ------------
Loss before income taxes (6,566) (7,774) (25,689) (31,695)
Income tax benefit (7) (308) (54) (899)
------------ ------------ ------------ ------------
Net loss. $ (6,559) $ (7,466) $ (25,635) $ (30,796)
============ ============ ============ ============
The Notes are an integral part of these consolidated financial statements.
3
MUZAK HOLDINGS LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
Nine Months Ended
--------------------------------
September 30, September 30,
2003 2002
-------------------------------
CASH FLOW FROM OPERATING ACTIVITIES
Net loss $ (25,635) $ (30,796)
Adjustments to derive cash flow from continuing operating
activities:
Loss on extinguishment of debt 3,694 --
Gain on disposal of fixed assets (37) (30)
Deferred income tax benefit (501) (997)
Depreciation and amortization 47,776 52,825
Amortization of senior discount notes and senior notes 5,672 5,669
Amortization of deferred financing fees 1,864 1,625
Amortization of deferred subscriber acquisition costs 11,562 9,182
Deferred subscriber acquisition costs (14,614) (10,845)
Unearned installment income (26) (1,053)
Change in certain assets and liabilities
Increase in accounts receivable (1,539) (2,799)
Increase in inventory (3,192) (1,836)
Decrease in accounts payable (645) (1,684)
Increase (decrease) in accrued expenses 3,602 (1,154)
Increase in advance billings 640 512
Other, net (4,781) 149
-------------- --------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 23,840 18,768
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (31,518) (26,700)
Proceeds from sale of fixed assets 50 40
-------------- --------------
NET CASH USED IN INVESTING ACTIVITIES (31,468) (26,660)
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in book overdrafts (2,459) 3,037
Proceeds from issuance of Senior Notes 218,869 --
Repayments of senior credit facility (159,514) (3,347)
Repayments on revolver (31,000) (10,000)
Borrowings on revolver 17,400 11,500
Repurchase of Senior discount notes (14,440) --
Issuance (repayment) of notes payable to a related party (10,000) 10,000
Termination (purchase) of interest rate protection agreement 4 (372)
Repayments of capital lease obligations and other debt (1,702) (2,035)
Payment of fees associated with financing (8,918) (1,875)
-------------- --------------
NET CASH PROVIDED BY FINANCING ACTIVITES 8,240 6,908
-------------- --------------
NET INCREASE (DECREASE) IN CASH 612 (984)
CASH, BEGINNING OF PERIOD 1,781 2,583
CASH, END OF PERIOD $ 2,393 $ 1,599
============== ==============
Significant non-cash activities:
Capital lease obligations $ 1,214 $ 1,953
The Notes are an integral part of these consolidated financial statements.
4
MUZAK HOLDINGS LLC
CONSOLIDATED STATEMENT OF CHANGES IN MEMBERS' INTEREST
(Unaudited)
(in thousands, except for units)
Class A Class B Accumulated
--------------------- ------------------- Other Total
Accumulated Comprehensive Members'
Units Dollars Units Dollars Deficit Loss Interest
--------- ---------- -------- --------- ----------- ------------- ----------
Balance, December 31, 2002 132,422 $ 117,167 11,419 $ 97 $ (170,143) $ (290) $ (53,169)
Comprehensive loss:
Net loss (25,635) (25,635)
Current period change in value of
derivative -- (78) (78)
Reclassification to earnings -- 368 368
---------- ------------ ---------
Total comprehensive loss (25,635) 290 (25,345)
Net Issuance of Units 3,117 -- --
Preferred return on preferred units -- (14,674) -- (97) -- -- (14,771)
--------- --------- -------- -------- ---------- ------------ ---------
Balance, September 30, 2003 132,422 $ 102,493 14,536 $ -- $ (195,778) $ -- $ (93,285)
========= ========= ======== ======== ========== ============ =========
The Notes are an integral part of these consolidated financial statements.
5
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
Muzak Holdings LLC ("the Company"), previously known as ACN Holdings, LLC,
was formed in September 1998 pursuant to the laws of the state of Delaware. The
Company, through its subsidiaries, provides business music programming to
clients through its integrated nationwide network of owned operations and
franchises. All of the operating activities are conducted through the Company's
subsidiaries.
As of September 30, 2003, ABRY Partners, LLC and its respective affiliates,
collectively own approximately 64.2% of the beneficial interests in the
Company's voting interests.
2. BASIS OF PRESENTATION
The condensed consolidated financial statements include the accounts of the
Company and its subsidiaries: Muzak LLC, Muzak Capital Corporation, Muzak
Holdings Finance Corporation, Muzak Finance Corporation, Business Sound Inc.,
Electro Systems Corporation, BI Acquisition LLC, MLP Environmental Music LLC,
Audio Environments Inc., Background Music Broadcasters Inc., Telephone Audio
Productions Inc., Vortex Sound Communications Company Inc., Music Incorporated,
and Muzak Houston, Inc. All intercompany items have been eliminated in
consolidation.
The accompanying unaudited interim consolidated financial statements have
been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X, and accordingly, certain financial information has been
condensed and certain footnote disclosures have been omitted. Such information
and disclosures are normally included in financial statements prepared in
accordance with generally accepted accounting principles in the United States.
The financial statements as of September 30, 2003 and 2002 and for the
three and nine months then ended are unaudited; however, in the opinion of
management, such statements include all adjustments (consisting solely of normal
recurring adjustments) necessary for a fair statement of the financial
information included herein in accordance with generally accepted accounting
principles in the United States. The preparation of consolidated financial
statements in conformity with generally accepted accounting principles in the
United States requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the consolidated financial statements and
reported amounts of revenues and expenses during the period. Actual results
could differ from those estimates. Results of operations for interim periods are
not necessarily indicative of results for the full year.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
Useful September 30, December 31,
Life 2003 2002
(years) (Unaudited)
----------------------------------
Equipment provided to subscribers 4-6 $ 155,449 $ 140,604
Capitalized installation labor 5 73,268 62,007
Equipment 5-7 29,031 25,716
Other 3-30 20,076 18,321
------------ -----------
277,824 246,648
Less accumulated depreciation (168,985) (135,759)
------------ -----------
$ 108,839 $ 110,889
============ ===========
Included in equipment and other at September 30, 2003 and December 31, 2002
is $14.9 million and $13.8 million, respectively, of equipment under capital
leases, gross of accumulated depreciation of $11.2 million and $9.5 million,
respectively. Depreciation of property and equipment was $10.8 million and $33.7
million for the quarter and nine months ended September 30, 2003, respectively,
and $11.8 million and $34.8 million for the quarter and nine months ended
September 30, 2002, respectively.
6
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. INTANGIBLE ASSETS
Unamortized intangible assets consist of the following (in thousands):
September 30, 2003 December 31, 2002
Carrying Amount Carrying Amount
(unaudited)
--------------------- ----------------------
Goodwill................... $140,805 $140,805
Amortized intangible assets consist of the following (in thousands):
September 30, 2003 December 31, 2002
(unaudited)
Useful ------------------------------------ ------------------------------------
Life Gross Carrying Accumulated Gross Carrying Accumulated
(years) Amount Amortization Amount Amortization
---------- ------------------ ----------------- ------------------ -----------------
Income producing contracts....... 12 $153,900 $(56,235) $ 153,956 $(46,617)
License agreements............... 20 5,082 (1,143) 5,082 (953)
Deferred production costs........ 10 7,011 (1,717) 5,780 (1,232)
Trademarks....................... 5 15,163 (13,515) 15,136 (11,242)
Non-compete agreements........... 3-5 591 (459) 7,468 (6,211)
Other............................ 20 10,741 (2,360) 10,741 (1,957)
--------- --------- --------- ---------
$ 192,488 $ (75,429) $ 198,163 $ (68,212)
========= ========= ========= =========
The decrease in non-compete agreements is due to several of the Company's
non-compete agreements becoming fully amortized during 2003. Accordingly, the
non-compete agreements have been removed from the balance sheet. Aggregate
amortization expense was $4.6 million and $14.1 million for the quarter and nine
months ended September 30, 2003, respectively, and $5.7 million and $18.0
million for the quarter and nine months ended September 30, 2002, respectively.
The estimated future aggregate amortization expense is as follows (in
thousands):
Fiscal year ending
------------------
2003 (remaining three months)............ $4,372
2004..................................... 15,207
2005..................................... 14,368
2006..................................... 14,317
2007..................................... 14,291
5. ACCRUED EXPENSES
Accrued expenses are summarized below (in thousands):
September 30, 2003 December 31, 2002
(Unaudited)
----------------------- -----------------------
Accrued interest............................................... $ 8,539 $ 3,427
Accrued compensation and benefits.............................. 3,021 3,178
Licensing royalties........................................... 4,015 4,054
Other.......................................................... 5,981 7,645
--------- ---------
$ 21,556 $ 18,304
========= =========
7
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
6. DEBT
Debt obligations consist of the following (in thousands):
September 30, December 31,
2003 2002
(Unaudited)
---------------- ----------------
Related Party Notes .......................................... $ -- $ 10,000
================ ================
Long term debt:
Revolving Loan-Senior Credit Facility....................... $ 12,700 $ 26,300
Senior Credit Facility...................................... -- 159,514
Senior Notes................................................ 218,923 --
Senior Subordinated Notes................................... 115,000 115,000
Senior Discount Notes....................................... 53,815 64,484
Other....................................................... 2,407 2,471
---------------- ----------------
Total debt obligations........................................ 402,845 367,769
Less current maturities....................................... (417) (7,855)
---------------- ----------------
$ 402,428 $ 359,914
================ ================
As discussed below, on May 20, 2003, Muzak LLC completed a private placement
for $220.0 million principal amount of 10% Senior Notes due 2009 ("Senior
Notes"). The proceeds were used to repay the revolving loan, Term Loan A, and
Term Loan B under our then existing Senior Credit Facility ("Old Senior Credit
Facility"), related party notes, and to purchase a portion of the outstanding
Senior Discount Notes. We incurred financing fees of $10.5 million in connection
with this transaction, $8.9 million of which were paid during the second and
third quarters of 2003. The fees are included in Deferred charges and other
assets, net, on the balance sheet. In addition, we wrote off $5.2 million of
financing fees relating to the Old Senior Credit facility. This charge is
included in loss on extinguishment of debt for the nine months ended September
30, 2003.
Revolving Loan- Senior Credit Facility
In connection with the private placement of Senior Notes, the Company
replaced its Old Senior Credit Facility with a New Senior Secured Credit
Facility maturing on May 20, 2008. The new Senior Credit Facility is a revolving
loan with borrowing availability of up to $60.0 million, a portion of which is
available for the issuance of letters of credit. As of September 30, 2003, the
Company had $12.7 million outstanding under its revolver, $0.9 million letters
of credit outstanding and $27.5 million of borrowing availability.
The New Senior Credit facility is guaranteed by certain of our direct and
indirect subsidiaries and is secured by a first priority security interest
in (i) substantially all of our tangible and intangible assets and (ii) our
capital stock and the capital stock of our subsidiaries. The non-guarantor
subsidiary is minor and the consolidated amounts in the Company's financial
statements are representative of the combined guarantor's financial statements.
The Senior Credit Facility contains restrictive covenants including the
maintenance of interest, total leverage, and fixed charge ratios and various
other restrictive covenants, which are customary for such facilities. In
addition, the Company is generally prohibited from incurring additional
indebtedness, incurring liens, paying dividends or making other restricted
payments, consummating asset sales, entering into transactions with affiliates,
merging or consolidating with any other person or selling, assigning,
transferring, leasing, conveying, or otherwise disposing of assets. The Company
was in compliance with these covenants as of September 30, 2003. The Company's
financial covenants become increasingly restrictive during the term of the New
Senior Credit Facility and the Company is continually monitoring projected
compliance with such covenants. In order to achieve such compliance, the Company
is analyzing its entire cost structure and expects to make adjustments in such
cost structure during the remainder of 2003 and 2004. Additionally, the Company
is assessing the financial impact of lost business revenues during the satellite
disruption on covenant compliance.
8
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Indebtedness under the revolver bears interest at a per annum rate equal to
the Company's choice of (i) Base Rate (which is the highest of prime rate and
the Federal Funds Rate plus .5%) plus a margin ranging from 2.00% to 2.75% or
(ii) the offered rates for Eurodollar deposits ("LIBOR") of one, two, three,
six, nine, or twelve months, as selected by the Company, plus a margin ranging
from 3.25% to 4.00%. Margins are fixed from May 20, 2003 until December 31,
2003, and were 2.75% and 4.00% in the case of Base Rate and Libor, respectively,
as of September 30, 2003. Subsequent to December 31, 2003, the margins will be
subject to adjustment based on changes in the Company's ratio of consolidated
total debt to EBITDA (i.e, earnings before interest, taxes, depreciation and
amortization and certain other charges as defined in the agreement). As of
September 30, 2003, the interest rate on the revolver was 5.1%.
Senior Notes
On May 20, 2003, Muzak LLC together with its wholly owned subsidiary, Muzak
Finance Corp., co-issued $220.0 million in principal amount of 10% Senior Notes
which mature on February 15, 2009. Interest is payable semi-annually, in
arrears, on May 15 and November 15 of each year. The Senior Notes are general
unsecured obligations of Muzak LLC and Muzak Finance and are subordinate to
existing and future secured debt and are senior to Muzak LLC's existing Senior
Subordinated Notes. The Senior Notes are guaranteed by the Company and certain
of the Company's direct and indirect subsidiaries (See Note 7). The indenture
governing the Senior Notes prohibits the Company from making certain payments
such as dividends and distributions of capital stock; repurchases or redemptions
of capital stock, and investments (other than permitted investments) unless
certain conditions are met by the Company. After February 15, 2006, the issuers
may redeem all or part of the Senior Notes at a redemption price equal to 105.0%
of the principal which redemption price declines to 100% of the principal amount
in 2008.
Senior Subordinated Notes
Muzak LLC together with its wholly owned subsidiary, Muzak Finance Corp.,
has $115.0 million in principal amount of 9 7/8% Senior Subordinated Notes
("Senior Subordinated Notes") which mature on March 15, 2009. Interest is
payable semi-annually, in arrears, on March 15 and September 15 of each year.
The Senior Subordinated Notes are general unsecured obligations of the Muzak LLC
and Muzak Finance and are subordinated in right of payment to all existing and
future Senior Indebtedness of the Muzak LLC and Muzak Finance. The Senior
Subordinated Notes are guaranteed by the Company and certain of the Company's
direct and indirect subsidiaries (See Note 7). The indenture governing the
Senior Subordinated Notes prohibits the Company from making certain payments
such as dividends and distributions of capital stock; repurchases or redemptions
of capital stock, and investments (other than permitted investments) unless
certain conditions are met by the Company. After March 15, 2004, the issuers may
redeem all or part of the Senior Subordinated Notes at a redemption price equal
to 104.938% of the principal which redemption price declines to 100% of the
principal amount in 2007.
Senior Discount Notes
The Company together with its wholly owned subsidiary, Muzak Holdings
Finance Corp., has $56.9 million in principal amount at maturity, or $30.4
million in accreted value on the issue date, of 13% Senior Discount Notes (the
"Senior Discount Notes") due March 2010. Accreted value on the Senior Discount
Notes was $53.8 million and $64.5 million as of September 30, 2003 and December
31, 2002, respectively. Until March 15, 2004, the Senior Discount Notes will
accrete in value such that the accreted value on March 15, 2004 will equal the
principal amount at maturity of the Senior Discount Notes. Cash interest on the
Senior Discount Notes is not payable prior to March 15, 2004. From and after
March 15, 2004, interest on the Senior Discount Notes will accrue at a rate of
13% per annum. Interest will be payable semi-annually in arrears on each March
15 and September 15, commencing September 15, 2004, to holders of record of the
Senior Discount Notes at the close of business on the immediately preceding
March 1 and September 1. Muzak Holdings LLC does not have any operations or
assets other than its ownership of Muzak LLC. Accordingly, Muzak Holdings LLC is
dependent upon distributions from Muzak LLC in order to pay interest beginning
in 2004 as discussed above. Muzak LLC's Senior Credit Facility, Senior Notes,
and Senior Subordinated Notes indenture impose restrictions on its ability to
make distributions to Muzak Holdings LLC. The Senior Credit Facility, Senior
Notes, and the Senior Subordinated Notes indenture permit Muzak LLC to make
payments and distributions to Muzak Holdings LLC on and after September 15, 2004
in an amount sufficient to permit Muzak Holdings LLC to make cash interest
payments when due, however the New Senior Credit Facility requires that certain
financial covenant levels be met in order to make such distributions.
9
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
A portion of the proceeds from the issuance of Senior Notes were used to
purchase an aggregate principal amount of $18.1 million of the Company's Senior
Discount Notes due 2010. We recorded a gain on extinguishment of debt of $1.9
million in connection with this transaction. This gain is included in loss on
extinguishment of debt for the nine months ended September 30, 2003.
Related Party Notes
In March 2002, Muzak LLC borrowed an aggregate amount of $10.0 million from
MEM Holdings LLC in the form of junior subordinated unsecured notes (the
"sponsor notes"), the proceeds of which were used to repay outstanding revolving
loan balances. MEM Holdings is a company that owns 64.2% of the voting interests
in the Company. ABRY Broadcast Partners III and ABRY Broadcast Partners II are
the beneficial owners of MEM Holdings.
The sponsor notes accrued interest at 15% per annum from March 2002 through
May 20, 2003. These notes and accrued interest, which collectively totaled $11.9
million as of May 20, 2003, were repaid in conjunction with the private
placement of Senior Notes.
Other Debt
The Company assumed $2.4 million of promissory notes in connection with an
acquisition in 1999. All of the notes, with the exception of one, aggregating
$1.8 million as of September 30, 2003, bear interest at 9.9% and mature in
November 2016. The Company is required to make interest only payments on a
monthly basis through October 2006, and principal and interest payments for the
remainder of the term. The note terms are the same for all but one of the notes.
This note, $0.3 million as of September 30, 2003, bears interest at 8% with
principal and interest payments due monthly until maturity in October 2006.
Liquidity
During 2003, the Company's principal sources of funds will be cash flows
from operations and borrowings under the New Senior Credit Facility. As of
September 30, 2003, the Company had outstanding debt of $12.7 million under its
New Senior Credit Facility, with additional available borrowings of up to $27.5
million. The financing transaction eliminated our Old Senior Credit Facility and
extended 98% of our debt maturities to 2009 and beyond. Based upon our current
capital structure and current and anticipated levels of operations, the Company
believes that its cash flows from operations, combined with availability under
the senior credit facility, will be adequate to meet its liquidity needs for the
foreseeable future. We strive to fund both investments in new client locations
and interest payments primarily through cash generated from operations rather
than through borrowings under the New Senior Credit Facility; nonetheless, we
expect to borrow under our revolver during the remainder of 2003. The Company is
continuing its efforts to improve working capital balances, increase
efficiencies of its technician workforce, and decrease the up front capital
investment associated with a new client location. Overall, the Company's
business plan anticipates continued growth in new client locations and
operational improvements. The Company's future performance is subject to
industry based factors such as the level of competition in the business music
industry, competitive pricing, concentrations in and dependence on satellite
delivery capabilities, rapid technological changes, the impact of legislation
and regulation, its dependence on license agreements and other factors that are
beyond its control.
Annual Maturities
Annual maturities of long-term debt obligations are as follows (in
thousands):
2003 (remaining three months)............................... $ 347
2004........................................................ 94
2005........................................................ 101
2006........................................................ 110
2007........................................................ 118
Thereafter.................................................. 406,287
The Annual maturities schedule includes the principal amount of the Senior
Notes and Senior Discount Notes which mature in 2009 and 2010, respectively.
10
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Total interest paid by the Company on all indebtedness was $6.1 million and
$16.3 million for the quarter and nine months ended September 30, 2003,
respectively and $8.6 million and $25.2 million for the quarter and nine months
ended September 30, 2002, respectively. The weighted average interest rate on
all indebtedness was 9.7% and 8.7% as of September 30, 2003 and 2002,
respectively.
Interest Rate Protection Programs
On January 28, 2000, the Company entered into an interest rate swap
agreement in which the Company effectively exchanged $100.0 million of floating
rate debt at three month LIBOR for 7.042% fixed rate debt. The interest rate
swap agreement terminated on April 19, 2002. The effect of this interest rate
protection agreement on the operating results of the Company was to increase
interest expense by $1.6 million for the nine months ended September 30, 2002.
The Company entered into a three year interest rate cap on April 19, 2002,
for which it paid a premium of $0.4 million. The interest rate cap protected the
Company against LIBOR increases above 7.25% and was designated as a hedge of
interest rates. An interest rate protection agreement was required by the
Company's Old Senior Credit Facility and this interest rate cap was terminated
on May 20, 2003, in conjunction with the repayment of the Old Senior Credit
Facility. The Company received $4 thousand in proceeds for the sale of this
interest rate cap, and reclassified $368 thousand from other comprehensive loss
to earnings. This charge has been recorded in loss on extinguishment of debt.
In August 2003, the Company entered into an interest rate swap agreement in
which the Company effectively exchanged $220.0 million of fixed rate debt at
10.0% for six month LIBOR plus 7.95%. The swap agreement, entered into to
mitigate its interest costs associated with its Senior Notes, covers an eighteen
month period ending November 2004. In accordance with Statement of Financial
Accounting Standard No. 133 ", "Accounting for Derivative Instruments and
Hedging Activities," ("SFAS 133"), the swap agreement is recorded at its fair
value in the consolidated balance sheet as of September 30, 2003 and included in
Prepaid expenses and other assets. Because the swap agreement is not designated
as a hedge under SFAS 133, changes in fair value of the swap have been recorded
as an adjustment to interest expense during the quarter ended September 30,
2003, resulting in a $0.8 million reduction to interest expense.
Fair Value of Financial Instruments
The estimated fair values of the Company's debt as of September 30, 2003
and December 31, 2002 were $395.7 million and $329.9 million, respectively. The
fair value of the Senior Notes, Senior Subordinated Notes, and the Senior
Discount Notes are based upon quoted market price. The fair value of the other
long-term debt of the Company approximates the carrying value as it bears
interest at variable rates.
7. GUARANTORS
The following schedules set forth condensed consolidating financial
information as required by Rule 3-10 of Securities and Exchange Commission
Regulation S-X for the quarter and nine months ended September 30, 2003 and 2002
for (1) Muzak Holdings, LLC, (2) Muzak LLC, a co-issuer of the Senior
Subordinated Notes and the Senior Notes, (3) Muzak Finance Corp., a co-issuer of
the Senior Subordinated Notes and the Senior Notes and a wholly-owned subsidiary
of Muzak LLC, and (4) on a combined basis, the subsidiary guarantors of the
Senior Subordinated Notes and the Senior Notes which include MLP Environmental
Music, LLC, Business Sound, Inc., BI Acquisition LLC, Audio Environments, Inc.,
Background Music Broadcasters, Inc., Muzak Capital Corporation, Telephone Audio
Productions, Inc., Muzak Houston, Inc., Vortex Sound Communications Company,
Inc., and Music Incorporated, and a subsidiary that is not a guarantor of the
Senior Subordinated Notes and the Senior Notes. The guarantor subsidiaries are
direct and indirect wholly-owned subsidiaries of Muzak Holdings, LLC and have
fully and unconditionally, jointly and severally, guaranteed the Senior
Subordinated Notes and the Senior Notes of Muzak LLC and Muzak Finance Corp.
Muzak Holdings, LLC has also fully and unconditionally, jointly and severally,
guaranteed the Senior Subordinated Notes and the Senior Notes. The subsidiary
that does not guarantee the Senior Subordinated Notes and the Senior Notes
represents less than 3% of consolidated total assets, members' interest,
revenues, loss before income taxes and cash flow from operating activities.
Therefore, the non-guarantor subsidiary information is not separately presented
in the tables below but rather is included in the column labeled "Guarantor
Subsidiaries".
11
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Condensed Consolidating Balance Sheets as of September 30, 2003
(In thousands) (unaudited)
Muzak Muzak
Holdings Muzak Finance
LLC LLC Corp Guarantor
("Parent") (Co-issuer) (Co-issuer) Subsidiaries* Eliminations Consolidated
------------ ----------- ----------- -------------- ------------ -------------
ASSETS
Current assets:
Cash $ -- $ 2,393 $ -- $ -- $ -- $ 2,393
Accounts receivable, net -- 27,049 -- 1,021 -- 28,070
Inventories -- 14,593 -- -- -- 14,593
Prepaid expenses and other assets -- 4,352 -- -- -- 4,352
----------- ---------- ---------- ------------- ----------- ------------
Total current assets -- 48,387 -- 1,021 -- 49,408
Property and equipment, net -- 108,005 -- 834 -- 108,839
Intangible assets, net -- 233,586 -- 24,278 -- 257,864
Deposits and other assets, net 1,370 58,556 1,864 8 (1,864) 59,934
Advances in/due from subsidiary -- -- -- 983 (983) --
Investment in Subsidiary 83,047 21,370 -- -- (104,417) --
----------- ---------- ---------- ------------- ----------- ------------
Total assets $ 84,417 $ 469,904 $ 1,864 $ 27,124 $ (107,264) $ 476,045
=========== ========== ========== ============= =========== ============
LIABILITIES AND MEMBERS' INTEREST
Current liabilities:
Accounts payable $ -- $ 6,685 $ -- $ 260 $ -- $ 6,945
Accrued expenses -- 20,348 473 1,208 (473) 21,556
Current portion of other liabilities -- 2,852 -- -- -- 2,852
Current maturities of long term debt -- 325 -- 92 -- 417
Advanced billings -- 1,680 -- -- -- 1,680
----------- ---------- ---------- ------------- ----------- ------------
Total current liabilities -- 31,890 473 1,560 (473) 33,450
Long-term debt 53,815 346,623 115,000 1,990 (115,000) 402,428
Related party notes -- -- -- -- -- --
Other liabilities -- 7,361 -- 2,204 -- 9,565
Advances in/due from subsidiary -- 983 -- -- (983) --
Preferred Stock 123,887 -- -- -- -- 123,887
Members' interest/Shareholders equity (93,285) 83,047 (113,609) 21,370 9,192 (93,285)
----------- ---------- ---------- ------------- ----------- ------------
Total liabilities and members'
interest $ 84,417 $ 469,904 $ 1,864 $ 27,124 $ (107,264) $ 476,045
=========== ========== ========== ============= =========== ============
- ------------------
* Includes a non-guarantor subsidiary which is considered to be "minor" as
defined by Rule 3-10 of Regulation S-X
12
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Condensed Consolidating Statements of Operations for the Quarter ended
September 30, 2003 (In thousands) (unaudited)
Muzak Muzak
Holdings Muzak Finance
LLC LLC Corp Guarantor
("Parent") (Co-issuer) (Co-issuer) Subsidiaries* Eliminations Consolidated
------------ ----------- ----------- -------------- ------------ -------------
Revenues
Music and other business services $ -- $ 42,681 $ -- $ 1,284 $ -- $ 43,965
Equipment and related services -- 15,384 -- -- -- 15,384
----------- ---------- ---------- ------------- ----------- ------------
-- 58,065 -- 1,284 -- 59,349
Cost of Revenues
Music and other business services -- 7,757 -- 416 -- 8,173
Equipment and related services -- 12,100 -- -- -- 12,100
----------- ---------- ---------- ------------- ----------- ------------
-- 19,857 -- 416 -- 20,273
----------- ---------- ---------- ------------- ----------- ------------
-- 38,208 -- 868 -- 39,076
----------- ---------- ---------- ------------- ----------- ------------
Selling, general & administrative -- 19,747 -- 291 -- 20,038
Depreciation & amortization expense -- 14,892 -- 446 -- 15,338
----------- ---------- ---------- ------------- ----------- ------------
Income from Operations -- 3,569 -- 131 -- 3,700
Other income (expense)
Interest expense (1,743) (8,506) (2,839) (53) 2,839 (10,302)
Other, net -- 36 -- -- -- 36
Management Fee -- 255 -- (255) -- --
Equity in earnings of subsidiary** (4,816) (170) -- -- 4,986 --
----------- ---------- ---------- ------------- ----------- ------------
Loss before income taxes (6,559) (4,816) (2,839) (177) 7,825 (6,566)
Income tax benefit -- -- -- (7) -- (7)
----------- ---------- ---------- ------------- ----------- ------------
Net loss $ (6,559) $ (4,816) $ (2,839) $ (170) $ 7,825 $ (6,559)
=========== ========== ========== ============= =========== ============
- ------------------
* Includes a non-guarantor subsidiary which is considered to be "minor" as
defined by Rule 3-10 of regulation S-X
** Amount excludes the net loss of Muzak Finance Corp (which is a wholly-owned
subsidiary of Muzak LLC) as the interest expense recorded by Muzak Finance
Corp, which relates solely to the Senior Subordinated Notes, is also
reflected in Muzak LLC's results of operations due to both of these entities
being co-issuers of the Senior Subordinated Notes. Muzak Finance Corp has no
results of operations other than the interest expense on the Senior
Subordinated Notes.
13
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Condensed Consolidating Balance Sheets as of December 31, 2002
(In thousands)
Muzak Muzak
Holdings Muzak Finance Combined
LLC LLC Corp Guarantor
(Parent) (Co-issuer) (Co-issuer) Subsidiaries* Eliminations Consolidated
------------ ----------- ----------- -------------- ------------ -------------
Assets
Current assets:
Cash $ -- $ 1,781 $ -- $ -- $ -- $ 1,781
Accounts receivable, net -- 25,298 -- 1,233 -- 26,531
Inventories -- 11,401 -- -- -- 11,401
Prepaid expenses and other assets -- 1,719 -- -- -- 1,719
------------ ----------- ----------- -------------- ------------ -------------
Total current assets -- 40,199 -- 1,233 -- 41,432
Property and equipment, net -- 109,699 -- 1,190 -- 110,889
Intangible assets, net -- 244,913 -- 25,843 -- 270,756
Deferred subscriber acquisition
costs and other assets, net 2,050 51,114 2,177 5 (2,177) 53,169
Advances to/from subsidiaries -- 62 -- -- (62) --
Investment in subsidiaries 118,379 22,333 -- -- (140,712) --
------------ ----------- ----------- -------------- ------------ -------------
Total assets $ 120,429 $ 468,320 $ 2,177 $ 28,271 $ (142,951) $ 476,246
------------ ----------- ----------- -------------- ------------ -------------
Liabilities and Members' Interest
Current liabilities:
Accounts payable $ -- $ 10,002 $ -- $ 47 $ -- $ 10,049
Accrued expenses -- 17,267 3,312 1,037 (3,312) 18,304
Current maturity of other
liabilities -- 2,924 -- -- -- 2,924
Current maturities of long term
debt -- 7,769 -- 86 -- 7,855
Advance billings -- 1,040 -- -- -- 1,040
------------ ----------- ----------- -------------- ------------ -------------
Total current liabilities -- 39,002 3,312 1,170 (3,312) 40,172
Long-term debt 64,484 293,371 115,000 2,059 (115,000) 359,914
Related party notes -- 10,000 -- -- -- 10,000
Other liabilities -- 7,568 -- 2,647 -- 10,215
Advances to/from subsidiaries -- -- -- 62 (62) --
Mandatorily redeemable preferred units 109,114 -- -- -- -- 109,114
Members' interest/Shareholder equity (53,169) 118,379 (116,135) 22,333 (24,577) (53,169)
------------ ----------- ----------- -------------- ------------ -------------
Total liabilities and members'
interest $ 120,429 $ 468,320 $ 2,177 $ 28,271 $ (142,951) $ 476,246
------------ ----------- ----------- -------------- ------------ -------------
- ------------------
* Includes a non-guarantor subsidiary which is considered to be "minor" as
defined by Rule 3-10 of Regulation S-X.
14
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Condensed Consolidating Statements of Operations for the Quarter ended
September 30, 2002 (In thousands) (unaudited)
Muzak Muzak
Holdings Muzak Finance
LLC LLC Corp Guarantor
("Parent") (Co-issuer) (Co-issuer) Subsidiaries* Eliminations Consolidated
------------ ----------- ----------- -------------- ------------ -------------
Revenues
Music and other business services $ -- $ 39,698 $ -- $ 1,479 $ -- $ 41,177
Equipment and related services -- 14,989 -- -- -- 14,989
----------- ---------- ---------- ------------- ----------- ------------
-- 54,687 -- 1,479 -- 56,166
Cost of Revenues
Music and other business services -- 7,575 -- 205 -- 7,780
Equipment and related services -- 11,873 -- -- -- 11,873
----------- ---------- ---------- ------------- ----------- ------------
-- 19,448 -- 205 -- 19,653
----------- ---------- ---------- ------------- ----------- ------------
-- 35,239 -- 1,274 -- 36,513
----------- ---------- ---------- ------------- ----------- ------------
Selling, general & administrative -- 17,753 -- 178 -- 17,931
Depreciation & amortization expense -- 16,581 -- 986 -- 17,567
----------- ---------- ---------- ------------- ----------- ------------
Income from Operations -- 905 -- 110 -- 1,015
Other income (expense)
Interest expense (2,036) (6,823) (2,839) (6) 2,839 (8,865)
Other, net -- 76 -- -- -- 76
Management Fee -- 1,181 -- (1,181) -- --
Equity in earnings of subsidiary** (5,430) (769) -- -- 6,199 --
----------- ---------- ---------- ------------- ----------- ------------
Loss before income taxes (7,466) (5,430) (2,839) (1,077) 9,038 (7,774)
Income tax benefit -- -- -- (308) -- (308)
----------- ---------- ---------- ------------- ----------- ------------
Net loss $ (7,466) $ (5,430) $ (2,839) $ (769) $ 9,038 $ (7,466)
=========== ========== ========== ============= =========== ============
- ------------------
* Includes a non-guarantor subsidiary which is considered to be "minor" as
defined by Rule 3-10 of regulation S-X ** Amount excludes the net loss of
Muzak Finance Corp (which is a wholly-owned subsidiary of Muzak LLC) as the
interest expense recorded by Muzak Finance Corp, which relates solely to the
Senior Subordinated Notes, is also reflected in Muzak LLC's results of
operations due to both of these entities being co-issuers of the Senior
Subordinated Notes. Muzak Finance Corp has no results of operations other
than the interest expense on the Senior Subordinated Notes.
15
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Condensed Consolidating Statements of Operations for the Nine Months ended
September 30, 2003
(In thousands) (unaudited)
Muzak Muzak
Holdings Muzak Finance
LLC LLC Corp Guarantor
("Parent") (Co-issuer) (Co-issuer) Subsidiaries* Eliminations Consolidated
------------ ----------- ----------- -------------- ------------ -------------
Revenues
Music and other business services $ -- $ 125,487 $ -- $ 4,508 $ -- $ 129,995
Equipment and related services -- 43,627 -- -- -- 43,627
----------- ---------- ---------- ------------- ----------- ------------
-- 169,114 -- 4,508 -- 173,622
Cost of Revenues
Music and other business services -- 22,359 -- 1,534 -- 23,893
Equipment and related services -- 35,355 -- -- -- 35,355
----------- ---------- ---------- ------------- ----------- ------------
-- 57,714 -- 1,534 -- 59,248
----------- ---------- ---------- ------------- ----------- ------------
-- 111,400 -- 2,974 -- 114,374
----------- ---------- ---------- ------------- ----------- ------------
Selling, general & administrative -- 58,949 -- 1,009 -- 59,958
Depreciation & amortization expense -- 45,855 -- 1,921 -- 47,776
----------- ---------- ---------- ------------- ----------- ------------
Income from Operations -- 6,596 -- 44 -- 6,640
Other income (expense)
Interest expense (5,837) (22,768) (8,517) (161) 8,517 (28,766)
Other, net -- 131 -- -- -- 131
Extraordinary Loss 1,384 (5,078) -- -- -- (3,694)
Management Fee -- 900 -- (900) -- --
Equity in earnings of subsidiaries** (21,182) (963) -- -- 22,145 --
----------- ---------- ---------- ------------- ----------- ------------
Loss before income taxes (25,635) (21,182) (8,517) (1,017) 30,662 (25,689)
Income tax benefit -- -- -- (54) -- (54)
----------- ---------- ---------- ------------- ----------- ------------
Net loss $ (25,635) $ (21,182) $ (8,517) $ (963) $ 30,662 $ (25,635)
=========== ========== ========== ============= =========== ============
- ------------------
* Includes a non-guarantor subsidiary which is considered to be "minor" as
defined by Rule 3-10 of regulation S-X
** Amount excludes the net loss of Muzak Finance Corp (which is a wholly-owned
subsidiary of Muzak LLC) as the interest expense recorded by Muzak Finance
Corp, which relates solely to the Senior Subordinated Notes, is also
reflected in Muzak LLC's results of operations due to both of these entities
being co-issuers of the Senior Subordinated Notes. Muzak Finance Corp has no
results of operations other than the interest expense on the Senior
Subordinated Notes.
16
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Condensed Consolidating Statements of Operations for the Nine Months ended
September 30, 2002 (In thousands) (unaudited)
Muzak Muzak
Holdings Muzak Finance
LLC LLC Corp Guarantor
("Parent") (Co-issuer) (Co-issuer) Subsidiaries* Eliminations Consolidated
------------ ----------- ----------- -------------- ------------ -------------
Revenues
Music and other business services $ -- $ 115,823 $ -- $ 5,300 $ -- $ 121,123
Equipment and related services -- 40,075 -- -- -- 40,075
----------- ---------- ---------- ------------- ----------- ------------
-- 155,898 -- 5,300 -- 161,198
Cost of Revenues
Music and other business services -- 25,568 -- 860 -- 26,428
Equipment and related services -- 32,474 -- -- -- 32,474
----------- ---------- ---------- ------------- ----------- ------------
-- 58,042 -- 860 -- 58,902
----------- ---------- ---------- ------------- ----------- ------------
-- 97,856 -- 4,440 -- 102,296
----------- ---------- ---------- ------------- ----------- ------------
Selling, general & administrative -- 53,269 -- 584 -- 53,853
Depreciation & amortization expense -- 49,334 -- 3,491 -- 52,825
----------- ---------- ---------- ------------- ----------- ------------
Income (loss) from Operations -- (4,747) -- 365 -- (4,382)
Other income (expense)
Interest expense (5,917) (21,570) (8,517) (18) 8,517 (27,505)
Other, net -- 192 -- -- -- 192
Management Fee -- 4,148 -- (4,148) -- --
Equity in earnings of subsidiary** (24,879) (2,902) -- -- 27,781 --
----------- ---------- ---------- ------------- ----------- ------------
Loss before income taxes (30,796) (24,879) (8,517) (3,801) 36,298 (31,695)
Income tax benefit -- -- -- (899) -- (899)
----------- ---------- ---------- ------------- ----------- ------------
Net loss $ (30,796) $ (24,879) $ (8,517) $ (2,902) $ 36,298 $ (30,796)
=========== ========== ========== ============= =========== ============
- ------------------
* Includes a non-guarantor subsidiary which is considered to be "minor" as
defined by Rule 3-10 of regulation S-X
** Amount excludes the net loss of Muzak Finance Corp (which is a wholly-owned
subsidiary of Muzak LLC) as the interest expense recorded by Muzak Finance
Corp, which relates solely to the Senior Subordinated Notes, is also
reflected in Muzak LLC's results of operations due to both of these entities
being co-issuers of the Senior Subordinated Notes. Muzak Finance Corp has no
results of operations other than the interest expense on the Senior
Subordinated Notes.
17
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Condensed Consolidating Statements of Cash Flows for the Nine Months ended
September 30, 2003 (In thousands) (unaudited)
Muzak Muzak
Holdings Muzak Finance
LLC LLC Corp Guarantor
("Parent") (Co-issuer) (Co-issuer) Subsidiaries* Eliminations Consolidated
------------ ----------- ----------- -------------- ------------ -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net cash provided by operating
activities $ -- $ 22,515 $ -- $ 1,325 $ -- $ 23,840
----------- ---------- ---------- ------------- ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of fixed assets -- 50 -- -- -- 50
Capital expenditures (for property,
plant & equipment and intangibles) -- (31,518) -- -- -- (31,518)
----------- ---------- ---------- ------------- ----------- ------------
Net cash used in investing
activities -- (31,468) -- -- -- (31,468)
----------- ---------- ---------- ------------- ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Change in book overdrafts -- (2,459) -- -- -- (2,459)
Proceeds from Senior note offering -- 218,869 -- -- -- 218,869
Repayments of senior credit facility -- (159,514) -- -- -- (159,514)
Repayments of senior discount notes (14,440) -- -- -- -- (14,440)
Repayments under revolving credit
loan -- (31,000) -- -- -- (31,000)
Borrowings under revolving credit
loan -- 17,400 -- -- -- 17,400
Repayment on note payable to related
party -- (10,000) -- -- -- (10,000)
Proceeds from sale of interest rate
protection agreement -- 4 -- -- -- 4
Repayments of capital lease
obligations and other debt -- (1,638) -- (64) -- (1,702)
Payment of financing fees -- (8,918) -- -- -- (8,918)
Advances to/from subsidiaries 14,440 (13,179) -- (1,261) -- --
----------- ---------- ---------- ------------- ----------- ------------
Net cash provided by/(used in)
financing activities -- 9,565 -- (1,325) -- 8,240
----------- ---------- ---------- ------------- ----------- ------------
NET INCREASE IN CASH -- 612 -- -- -- 612
CASH, BEGINNING OF PERIOD -- 1,781 -- -- -- 1,781
=========== ========== ========== ============= =========== ============
CASH, END OF PERIOD $ -- $ 2,393 $ -- $ -- $ -- $ 2,393
=========== ========== ========== ============= =========== ============
- ------------------
* Includes a non-guarantor subsidiary which is considered to be "minor" as
defined by Rule 3-10 of Regulation S-X
18
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Condensed Consolidating Statements of Cash Flows for the Nine Months ended
September 30, 2002 (In thousands) (unaudited)
Muzak Muzak
Holdings Muzak Finance
LLC LLC Corp Guarantor
("Parent") (Co-issuer) (Co-issuer) Subsidiaries* Eliminations Consolidated
------------ ----------- ----------- -------------- ------------ -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net cash provided by/(used in) operating
activities $ -- $ 18,968 $ -- $ (200) $ -- $ 18,768
----------- ---------- ---------- ------------- ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of fixed assets -- 40 -- -- -- 40
Capital expenditures (for property,
plant & equipment and intangibles) -- (26,700) -- -- -- (26,700)
----------- ---------- ---------- ------------- ----------- ------------
Net cash used in investing activities -- (26,660) -- -- -- (26,660)
----------- ---------- ---------- ------------- ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Change in book overdrafts -- 3,037 -- -- -- 3,037
Borrowings under revolver -- 11,500 -- -- -- 11,500
Repayments under revolver -- (10,000) -- -- -- (10,000)
Repayments of senior credit facility -- (3,347) -- -- -- (3,347)
Proceeds from issuance of note payable
to related party 10,000 10,000
Payment of interest rate protection
agreement -- (372) -- -- -- (372)
Repayments of capital lease and other
debt -- (1,976) -- (59) -- (2,035)
Payment of fees associated with
financing -- (1,875) -- -- -- (1,875)
Advances to/from subsidiaries -- (259) -- 259 -- --
----------- ---------- ---------- ------------- ----------- ------------
Net cash provided by financing
activities -- 6,708 -- 200 -- 6,908
----------- ---------- ---------- ------------- ----------- ------------
NET DECREASE IN CASH -- (984) -- -- -- (984)
CASH, BEGINNING OF PERIOD -- 2,583 -- -- -- 2,583
=========== ========== ========== ============= =========== ============
CASH, END OF PERIOD $ -- $ 1,599 $ -- $ -- $ -- $ 1,599
=========== ========== ========== ============= =========== ============
- ------------------
* Includes a non-guarantor subsidiary which is considered to be "minor" as
defined by Rule 3-10 of Regulation S-X
19
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. MANDATORILY REDEEMABLE PREFERRED UNITS
The Company was in violation of unit coverage ratio under the
Securities Purchase Agreement as of September 30, 2003 and June 30, 2003. As a
result of the default, the preferred units will accrue at a preferential return
of 17% per annum as long as the default is continuing. The Company is projecting
to be out of compliance with the unit coverage ratio (the ratio of consolidated
operating cash flow to the sum of consolidated interest expense plus the
aggregate Series A Preferred return, as more specifically defined in the
Securitires Purchase Agreement) for the foreseeable future. Failure to comply
with unit coverage ratio for four consecutive quarters results in an increase in
the authorized number of Class B Directors from eight to ten. The Class B
Directors so designated will be entitled to serve until such time as the Company
complies with the unit coverage ratio. The number of Class A directors will
remain unchanged at three directors, each of whom has three votes. The Class A
directors are comprised of representatives from ABRY Partners, and therefore
ABRY Partners will remain in control of the board of directors. The foregoing
default does not result in a change of voting control or a cross default under
the New Senior Credit Facility or the indentures governing the Senior Notes, the
Senior Subordinated Notes, and the Senior Discount Notes. The Company was in
compliance with all other financial covenants under the Securities Purchase
Agreement as of September 30, 2003.
9. MUZAK HOLDINGS FINANCE CORP. AND MUZAK FINANCE CORP.
Muzak Holdings Finance Corp. and Muzak Finance Corp. had no operating
activities during the nine months ended September 30, 2003 and 2002.
10. RECENTLY ISSUED ACCOUNTING STANDARDS
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
Consolidation of Variable Interest Entities, which addresses the consolidation
of business enterprises (variable interest entities), to which the usual
condition of consolidation, a controlling financial interest, does not apply. As
defined in FIN 46, variable interests are contractual, ownership or other
interests in an entity that change with changes in the entity's net asset value.
Variable interests in an entity may arise from financial instruments, service
contracts, guarantees, leases or other arrangements with the variable interest
entity. An entity that will absorb a majority of the variable interest entity's
expected losses or expected residual returns, as defined in FIN 46, is
considered the primary beneficiary of the variable interest entity. The primary
beneficiary must include the variable interest entity's assets, liabilities and
results of operations in its consolidated financial statements. FIN 46 is
immediately effective for all variable interest entities created after January
31, 2003.
As amended by FASB Staff Position ("FSP") No. FIN 46-6, FIN 46 is effective
for variable interests in a VIE created before February 1, 2003 at the end of
the first interim or annual period ending after December 15, 2003. FIN 46
may be applied prospectively with a cumulative-effect adjustment as of the date
on which it is first applied or by restating previously issued financial
statements for one or more years with a cumulative-effect adjustment as of the
beginning of the first year restated. The Company will adopt FIN 46 in the
fourth quarter of 2003.
The FASB is currently proposing modifications and issuing FSPs that change
and clarify FIN 46. These modifications and FSPs, when finalized, could
impact the Company's analysis of the applicability of FIN 46 to entities that
are franchisees of the Company. The Company has no equity ownership interests in
its franchisees and none of the Company's franchisees have been consolidated in
the Company's third quarter financial statements. The Company will continue to
monitor and analyze developments regarding FIN 46 that would impact its
applicability to its franchisees.
The Emerging Issued Task Force has issued EITF 00-21 "Revenue
Arrangements with Multiple Deliverables" (EITF 00-21) which is effective for
revenue arrangements entered into in fiscal periods beginning after June 15,
2003. EITF 00-21 addresses certain aspects of the accounting by a vendor for
arrangements under which it will perform multiple revenue-generating activities.
The Company adopted EITF 00-21 during the third quarter of 2003 and concluded
that it is accounting for its arrangements under which it performs multiple
revenue-generating activities in accordance with EITF 00-21. As such, there is
no financial impact from this adoption.
11. COMMITMENTS AND CONTINGENCIES
Litigation
Muzak LLC is involved in various claims and lawsuits arising out of the
normal conduct of its business. Although the ultimate outcome of these legal
proceedings cannot be predicted with certainty, the management of Muzak LLC
believes that the resulting liability, if any, will not have a material effect
upon Muzak LLC's consolidated financial statements or liquidity.
20
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Music Licenses
The industry-wide agreement between business music providers and BMI expired
in December 1993. Since this time we have been operating under an interim
agreement pursuant to which we have continued to pay royalties at the 1993
rates. Business music providers and BMI have been negotiating the terms of a new
agreement. We are involved in a rate court proceeding, initiated by BMI in
Federal Court in New York. At issue are the music license fees payable to BMI.
The period from which such "reasonable" license fees are payable covers the
period January 1, 1994 to September 30, 2003, and likely several years
thereafter. BMI contends that those fee levels understate reasonable fee levels
by as much as 100%. We are vigorously contesting BMI's assessment. The Company
believes the eventual court ruling setting final fees for the period covered
will require retroactive adjustment, upward or downward, likely back to January
1, 1994, and possibly will also entail payment of pre-judgment interest.
Discovery in the proceeding has commenced and is not yet completed. As of the
date hereof, a trial date had not been set.
The industry-wide agreement between business music providers and ASCAP
expired in May 1999. The Company began negotiations with ASCAP in June 1999, and
has continued to pay ASCAP royalties at the 1999 rates. The agreement between
business music providers and ASCAP allowed either party to pursue a rate court
proceeding in federal court in New York to seek a court determined reasonable
rate if a mutually acceptable rate was not obtained by November 29, 2002. ASCAP
notified the Company that it would pursue such rate court proceeding and on
January 29, 2003 made an application to the court to commence such a proceeding.
Discovery in the proceeding has commenced and is not yet completed. In the
interim, the Company and DMX Music, Inc. have requested the rate court's
assistance in exploring and determining alternative licensing and royalty
structures in order to establish flexible and competitive alternatives to
ASCAP's traditional "blanket license".
The Company cannot predict what the terms of the new BMI or ASCAP agreements
with business music providers will be or when agreements will be reached,
although BMI and ASCAP have indicated that they are seeking royalty rate
increases and a retroactive royalty rate increase. As of September 30, 2003, the
Company has not accrued any amounts in connection with any such potential
retroactive rate increases. In the third quarter and nine months of 2003, the
Company incurred $2.2 million and $6.6 million, respectively, in royalties to
ASCAP, BMI and to SESAC. In the third quarter and nine months of 2002, the
Company incurred $2.2 million and $6.5 million, respectively, in royalties to
ASCAP, BMI and to SESAC. These amounts exclude the increase in the estimated
reserve for prior period licensing royalties as discussed below. Increases in
the fees we must pay under these agreements could adversely affect our operating
margin, and, therefore, our results of operations.
In October 1998, the Digital Millennium Copyright Act was enacted. The Act
provides for a statutory license from the copyright owners of master recordings
to make and use ephemeral copies of such recordings. Ephemeral copies refer to
temporary copies of master sound recordings made to enable or facilitate the
digital transmission of such recordings. The Digital Millennium Copyright Act
did not specify the rate and terms of the license. As a result, the United
States Copyright Office convened a Copyright Arbitration Royalty Panel to
recommend an ephemeral royalty rate. In February 2002, the Panel recommended an
ephemeral royalty rate of ten percent (10%) of gross proceeds applicable to the
use of ephemeral copies. That recommendation was subject to review by the
Librarian of Congress, who could have modified or adopted such recommendation.
In June 2002, the Librarian of Congress published his final decision
to adopt the Copyright Arbitration Royalty Panel's recommendation of a ten
percent (10%) ephemeral royalty rate, which covers the period from October 1998
through December 31, 2002. As required by such determination, we remitted
payment on October 20, 2002 for royalties payable for the period from October
28, 1998 through August 31, 2002. The United States Copyright Office is in the
process of extending the foregoing ten percent (10%) ephemeral royalty rate to
cover the period January 1, 2003 through December 31, 2004.
With respect to future revenue subject to such ephemeral royalty rate, we
believe our exposure is minimal, as the Company believes its current satellite
technologies do not require use of ephemeral copies. Nonetheless, there can be
no assurances that the collective for the copyright owners will refrain from
investigating or otherwise challenging the applicability of the statute to our
satellite technologies.
During the nine months ended September 30, 2002, the Company increased its
estimated reserve for prior period licensing royalties and related expenses by
$3.1 million. This charge was recorded in cost of music and other business
services revenues. This accrual was not made in connection with a potential
retroactive rate increase for BMI or ASCAP.
21
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
As of September 30, 2003, our reserve for prior period licensing royalties
and related expenses was $2.9 million.
Other Commitments
As of September 30, 2003, the Company has approximately $26.6 million in
outstanding capital expenditure commitments covering a three-year period. The
Company is the lessee under various operating and capital leases for equipment,
vehicles, satellite capacity, and buildings.
12. RELATED PARTY TRANSACTIONS
During the nine months ended September 30, 2003, the Company accrued $1.2
million of fees payable to ABRY Partners. These fees were incurred under the
Management and Consulting Services Agreement with ABRY Partners and for services
rendered in connection with the private placement of Senior Notes.
The Company repaid $10.0 million sponsor notes to MEM Holdings in
conjunction with the private placement of Senior Notes during the quarter ended
June 30, 2003.
13. SATELLITE DISRUPTION
On September 19, 2003, TelStar 4, the satellite that provides the
signal for certain of the Company's client locations experienced a technical
malfunction. The Company secured comparable transponder capacity through
Microspace Communications on AMC-1, a digital satellite of SES Americom. The
Company successfully restored service, which required re-pointing of satellite
dishes, to all client locations by September 28, 2003. The Company has insurance
that provides $1.5 million of coverage for its re-pointing costs and submitted a
claim in early November for the total amount of coverage. As of September 30,
2003, $1.3 million of the insurance claim was recorded in prepaid expenses and
other assets on the balance sheet. The Company expects the uninsured costs
associated with the re-pointing of dishes to be minimal. However, The Company
was required to dedicate installation and service resources to the re-pointing
efforts and, as a result, delay normal course installations and service calls.
The Company expects to incur additional costs to perform such service calls and
installations. The Company is still assessing the fourth quarter financial
impact of the lost revenues and additional costs. In addition, the Company is in
the process of securing insurance for AMC-I and believes it will be able to
secure comparable coverage during the fourth quarter of 2003.
22
MUZAK HOLDINGS LLC
Item 2. Management's Discussion and Analysis
This Form 10-Q includes forward-looking statements made pursuant to the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995. Some
of these statements can be identified by terms and phrases such as "anticipate",
"believe", "intend", "expect", "could", "may", "will" and similar expressions
and include references to assumptions that the Company believes are reasonable
and relate to our future prospects, developments and business strategies.
Forward-looking statements involve risks and uncertainties, including, but not
limited to those related to the Company's substantial leverage and debt service
requirements, restrictions imposed by the terms of the Company's indebtedness,
the Company's history of net losses, the Company's dependence on satellite
delivery of its products and on license agreements, the Company's ability to
integrate acquisitions, future capital requirements, the impact of competition
and technological change, the availability of cost-effective programming, the
impact of legislation and regulation, risks associated with the effect of
general economic conditions and the other factors discussed in the Company's
filings with the Securities and Exchange Commission. Actual results could differ
materially from these forward-looking statements. The Company undertakes no
obligation to update these forward-looking statements.
Recent Developments
On November 4, 2003, the Board of Directors of the Company increased the
number of Class B Directors from five to eight. The new Class B Directors are
Lon Otremba, President of the Company, and Rob MacInnis and Hilary Kaiser, both
of ABRY Partners.
On October 1, 2003, the Company announced it had successfully restored
service to all of its client locations following the Telestar 4 satellite
disruption on September 19, 2003. On September 19, 2003, TelStar 4, the
satellite that provides the signal for certain of the Company's client locations
experienced a technical malfunction. The Company secured comparable transponder
capacity through Microspace Communications on AMC-1, a digital satellite of SES
Americom. The Company has insurance that provides $1.5 million of coverage for
its re-pointing costs and submitted a claim in early November for the total
amount of coverage. As of September 30, 2003, $1.3 million of the insurance
claim was recorded in prepaid expenses and other assets on the balance sheet.
The Company expects the uninsured costs associated with the re-pointing of
dishes to be minimal. However, The Company was required to dedicate installation
and service resources to the re-pointing efforts and, as a result, delay normal
course installations and service calls. The company expects to incur additional
costs to perform such service calls and installations. The Company is still
assessing the fourth quarter financial impact of the lost revenues and
additional costs. In addition, the Company is in the process of securing
insurance for AMC-1 and believes it will be able to secure comparable coverage
during the fourth quarter of 2003.
On September 29, 2003, the Company announced that Lon Otremba has joined the
Company as its President. Most recently, he was Executive Vice President of
America Online's Interactive Marketing Group, where he was responsible for
developing and leading the short and long-term strategy and operations for AOL's
advertising and e-commerce business turnaround. In addition, Bill Boyd has been
named Chairman of the Board.
On May 20, 2003, Muzak LLC completed a private placement for $220 million
principal amount of 10% Senior Notes due 2009. The Company used the proceeds to
repay its Old Senior Credit Facility, sponsor notes and to repurchase a portion
of its Senior Discount Notes.
Recently Issued Accounting Standards
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
Consolidation of Variable Interest Entities, which addresses the consolidation
of business enterprises (variable interest entities), to which the usual
condition of consolidation, a controlling financial interest, does not apply. As
defined in FIN 46, variable interests are contractual, ownership or other
interests in an entity that change with changes in the entity's net asset value.
Variable interests in an entity may arise from financial instruments, service
contracts, guarantees, leases or other arrangements with the variable interest
entity. An entity that will absorb a majority of the variable interest entity's
expected losses or expected residual returns, as defined in FIN 46, is
considered the primary beneficiary of the variable interest entity. The primary
beneficiary must include the variable interest entity's assets, liabilities and
results of operations in its consolidated financial statements. FIN 46 is
immediately effective for all variable interest entities created after January
31, 2003.
As amended by FASB Staff Position ("FSP") No. FIN 46-6, FIN 46 is effective
for variable interests in a VIE created before February 1, 2003 at the
end of the first interim or annual period ending after December 15, 2003. FIN 46
may be applied prospectively with a cumulative-effect adjustment as of the date
on which it is first applied or by restating previously issued financial
statements for one or more years with a cumulative-effect adjustment as of the
beginning of the first year restated. The Company will adopt FIN 46 in the
fourth quarter of 2003.
The FASB is currently proposing modifications and issuing FSPs that change
and clarify FIN 46. These modifications and FSPs, when finalized, could
impact the Company's analysis of the applicability of FIN 46 to entities that
are franchisees of the Company. The Company has no equity ownership interests in
its franchisees and none of the Company's franchisees have been consolidated in
the Company's third quarter financial statements. The Company will continue to
monitor and analyze developments regarding FIN 46 that would impact its
applicability to its franchisees.
23
MUZAK HOLDINGS LLC
Item 2. Management's Discussion and Analysis
The Emerging Issued Task Force has issued EITF 00-21 "Revenue Arrangements
with Multiple Deliverables" (EITF 00-21) which is effective for revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. EITF
00-21 addresses certain aspects of the accounting by a vendor for arrangements
under which it will perform multiple revenue-generating activities. The Company
adopted EITF 00-21 during the third quarter of 2003 and concluded that it is
accounting for its arrangements under which it performs multiple
revenue-generating activities in accordance with EITF 00-21. As such, there is
no financial impact from this adoption.
General
Muzak is the leading provider of business music programming in the United
States based on market share. We believe that, together with our franchisees, we
have a market share of approximately 60% of the estimated number of U.S.
business locations currently subscribing to business music programming.
Results of Operations
Set forth below are discussions of the results of operations for Muzak
Holdings LLC for the quarter and nine months ended September 30, 2003 compared
to the quarter and nine months ended September 30, 2002.
Revenues. Revenues were $59.3 million and $56.2 million for the quarters
ended September 30, 2003 and 2002, respectively, an increase of 5.7% and were
$173.6 million and $161.2 million for the nine months ended September 30, 2003
and 2002, respectively, an increase of 7.7%. Music and other business services
revenue increased $2.8 million, or 6.8% in 2003 as compared to the quarter ended
September 30, 2002 and increased $8.9 million or 7.3% during the nine months
ended September 30, 2003 as compared to the 2002 period. As the price of new
client locations is consistent with prior years, the growth in music and other
business services revenue is due to an increase in new client locations, offset
by a 10.3% cancellation rate during the twelve months ended September 30, 2003.
As a result of our efforts on reducing the client cancellation rate, we
experienced a 9.8% cancellation rate in the nine months ended September 30, 2003
as compared to 10.0% in the 2002 period. During the twelve months ended
September 30, 2003, we added, net of cancellations, 10,300 Audio Architecture,
5,000 Voice, and 1,700 other locations. Equipment and related services revenues
increased $0.4 million and $3.6 million for the quarter and nine months ended
September 30, 2003, respectively, versus the comparable 2002 periods. The 8.9%
increase for the nine months reflects our targeted efforts to develop our
equipment sales such as sound systems, noise masking, closed circuit television,
and drive thru systems. Our targeted efforts include dedicating resources in the
form of product specialists to facilitate this sales process.
Cost of revenues. Cost of revenues were $20.3 million and $19.7 million for
the quarters ended September 30, 2003 and 2002, respectively, an increase of
$0.6 million. Costs of music and other business services for the nine months
ended September 30, 2002 includes a $3.1 million charge relating to an increase
in reserves for prior period licensing royalties and related expenses. Excluding
this charge, cost of music and other business services revenues as a percentage
of revenues was 18.6% and 18.9% for the quarters ended September 30, 2003 and
2002, respectively, and was 18.4% and 19.2% for the nine months ended September
30, 2003 and 2002, respectively. The decrease in cost of revenues as a
percentage of revenues is due to the leveraging of the fixed cost infrastructure
including costs such as satellite space, and music programming as well as from
efficiencies achieved from our muzakvoice.com website. Costs of equipment and
related services revenue as a percentage of revenues decreased to 78.7% in the
third quarter of 2003 from 79.2% in the third quarter of 2002 and was flat at
81.0% for the nine months ended September 30, 2003 and 2002. The decrease in
costs as a percentage of revenues in the third quarter is due to more efficient
use of our technician workforce coupled with equipment and service revenues at
improved margins. The costs associated with re-pointing of receivers due to the
satellite disruption during the third quarter of 2003 of $0.9 million have been
removed from the income statement and are recorded as a receivable from our
insurance carrier which is included in prepaid expenses and other assets on the
balance sheet as of September 30, 2003.
24
MUZAK HOLDINGS LLC
Item 2. Management's Discussion and Analysis
Selling, general, and administrative expenses. Selling, general, and
administrative expenses were $20.0 million and $17.9 million in the quarters
ended September 30, 2003 and 2002, respectively, an increase of $2.1 million.
Selling, general, and administrative expenses were $60.0 million and $53.9
million in the nine months ended September 30, 2003 and 2002, respectively, an
increase of $6.1million or 11.3%. A portion of these increases is due to a $0.8
million and $2.4 million increase in the quarter and nine months ended September
30, 2003, respectively, in amortization of subscriber acquisition costs, a
non-cash component of selling, general, and administrative expenses. This
increase is directly related to the increase in music and other business
services revenue. The remaining increases of $1.3 million and $3.7 million for
the quarter and nine months ended September 30, 2003, respectively, is due to
higher commissions on equipment and related services revenues, increased
overhead expenses such as insurance premiums, and an increase in sales support
positions. The nine months ended September 30, 2002 includes a $0.5 million
charge incurred in connection with exploring various financing alternatives.
Costs associated with the satellite disruption of $0.3 million have been
removed from the income statement and are recorded as a receivable from our
insurance carrier which is included in prepaid expenses and other assets on the
balance sheet as of September 30, 2003.
Depreciation and amortization expenses. Depreciation and amortization was
$15.3 million and $17.6 million for the quarters ended September 30, 2003 and
2002, respectively, and $47.8 million and $52.8 million for the nine months
ended September 30, 2003 and 2002, respectively. The decrease from the 2002 to
the 2003 period is primarily due to several of our non-compete agreements
becoming fully amortized in the fourth quarter of 2002.
Interest expense. Interest expense was $10.3 million and $8.9 million for
the quarters ended September 30, 2003 and 2002, respectively, an increase of
$1.4 million. This increase is due to the issuance of our 10% Senior Notes and
the repayment of our Old Senior Credit Facility. The Old Senior Credit facility
bore interest at the Company's choice of LIBOR or the Base Rate plus a margin,
based on the Company's leverage ratio. This increase is offset by a $0.8 million
reduction in interest expense due to our interest rate swap agreement. The
effective interest rate for the quarters ended September 30, 2003 and 2002 was
9.8% and 8.9% respectively. Interest expense was $28.8 million and $27.5 million
and the effective interest rate was 9.1% and 9.3% for the nine months ended
September 30, 2003 and 2002, respectively.
Loss on extinguishment of debt. Loss on extinguishment of debt was $3.7
million for the nine months ended September 30, 2003. This loss was recorded in
connection with the issuance of 10% Senior Notes due 2009 and is comprised of a
$5.2 million write off of financing fees related to the Old Senior Credit
Facility, $0.4 million reclassification other comprehensive loss to earnings,
offset by a $1.9 million gain on the repurchase of $18.1 million principal
amount of Senior Discount Notes.
Income tax provision. Income tax benefit decreased $0.3 million from $0.3
million in the third quarter 2002, respectively, and was $54 thousand and $0.9
million in the nine months ended September 30, 2003 and 2002, respectively.
Although the Company is a limited liability company and is treated as a
partnership for income tax purposes, the Company has several subsidiaries that
are corporations. The income tax provision (benefit) relates to these corporate
subsidiaries.
Net Loss. The combined effect of the foregoing resulted in a net loss of
$6.6 million for the quarter ended September 30, 2003 compared to a net loss of
$7.5 million for the comparable 2002 period and a net loss of $25.6 million for
the nine months ended September 30, 2003 compared to a net loss of $30.8 million
for the nine months ended September 30, 2002.
Liquidity and Capital Resources
Sources and Uses. During 2003, our principal sources of funds have
been cash generated from operations, borrowings under our revolver, and the
issuance of our Senior Notes due 2009. During the nine months ended September
30, 2003, $23.8 million of cash was provided by operating activities, $31.5
million of cash was used in investing activities, and $8.2 million was provided
by financing activities. Cash was primarily used during the nine months ended
September 30, 2003 to make investments relating to new client locations, to make
interest payments, and to repay certain existing indebtedness and pay costs
associated with financing efforts. In addition, we experienced a use of cash due
to working capital increases in the nine months ended September 30, 2003
primarily due to a purchase commitment for our Encompass receivers, as well as
to an increase in receivables associated with the increase in revenues. We have
maintained consistent days sales outstanding in 2002 and 2003 at approximately
43 days. Our success at re-using equipment for new client installations and
conversions has contributed to the increase in inventory balances. We are
committed to improving working capital balances.
25
MUZAK HOLDINGS LLC
Item 2. Management's Discussion and Analysis
We expect that our principal sources of funds will continue to be cash flows
from operations and borrowings under the New Senior Credit Facility. As of
September 30, 2003, we had outstanding debt of $12.7 million under our New
Senior Credit Facility, with additional available borrowings of up to $27.5
million. The financing transaction eliminated our amortizing old Senior Credit
Facility and extended 98% of our debt maturities to 2009 and beyond. Based upon
our capital structure and current and anticipated levels of operations, we
believe that our cash flows from operations, combined with availability under
the New Senior Credit Facility, will be adequate to meet our liquidity needs for
the foreseeable future.
We are focused on improving working capital balances, efficiently utilizing
our capital resources associated with new client locations, and identifying and
implementing cost savings initiatives in all areas of the business. Overall, our
business plan anticipates continued growth in new client locations, operational
improvements, and increases in equipment and related services revenue. We strive
to fund both investments in new client locations and interest payments primarily
through cash flows from operations rather than through borrowings under the New
Senior Credit Facility; nonetheless, we expect to borrow under our revolver
during the remainder of 2003. Our future performance is subject to industry
based factors such as the level of competition in the business music industry,
competitive pricing, concentrations in and dependence on satellite delivery
capabilities, rapid technological changes, the impact of legislation and
regulation, our dependence on license agreements and other factors that are
beyond our control.
The Company evaluates liquidity using several measures, one of them being
EBITDA (defined as earnings before interest, income taxes (benefits),
depreciation, and amortization). EBITDA is not intended to be a liquidity
measure that should be regarded as an alternative to, or more meaningful than,
cash flow from operations as a measure of liquidity, as determined in accordance
with generally accepted accounting principles, known as GAAP. However,
management believes that EBITDA is a meaningful measure of the cash flows
available to invest in new client locations and to service its debt obligations.
Further, management believes that EBITDA is commonly used in similar industries
to analyze and compare companies on the basis of leverage and liquidity; however
it is not necessarily comparable to similarly titled amounts of other companies.
The following table provides a reconciliation of cash flows from operations to
EBITDA for the quarter and nine months ended September 30, 2003 and 2002. (in
thousands)
Three Months Ended
-------------------------
September September
30, 2003 30, 2002
----------- -----------
Cash flows provided by operating activities $ 11,820 $ 6,192
Interest expense net of amortization 7,383 6,329
Change in working capital (1,188) 5,437
Current tax expense 55 --
Change in unearned installation revenue 24 316
Amortization of deferred subscriber
acquisition costs (4,075) (3,260)
Deferred subscriber acquisition costs 5,017 3,619
Gain on disposal of fixed assets 29 17
---------- ----------
EBITDA $ 19,065 $ 18,650
========== ==========
26
MUZAK HOLDINGS LLC
Item 2. Management's Discussion and Analysis
Nine Months Ended
-------------------------
September September
30, 2003 30, 2002
----------- -----------
Cash flows provided by operating activities $ 23,840 $ 18,768
Loss on extinguishment of debt (3,694) --
Interest expense net of amortization 20,621 20,177
Change in working capital 6,596 6,838
Current tax expense 353 73
Change in unearned installation revenue 26 1,053
Amortization of deferred subscriber
acquisition costs (11,562) (9,182)
Deferred subscriber acquisition costs 14,614 10,845
Gain on disposal of fixed assets 37 30
---------- ----------
EBITDA $ 50,831 $ 48,602
========== ==========
Capital Investments. The majority of our capital expenditures are comprised
of the initial one-time investment for the installation of equipment for new
client locations. During the quarter ended September 30, 2003, our total initial
investment in new client locations was $13.4 million which was comprised of
equipment and installation costs attributable to new client locations of $8.4
million and $5.0 million in sales commissions (included in cash provided by
operating activities in the consolidated statement of cash flows) relating to
these new locations. During the nine months ended September 30, 2003, our total
initial investment in new client locations was $39.9 million which was comprised
of equipment and installation costs attributable to new client locations of
$25.3 million and $14.6 million in sales commissions. The sales commissions are
capitalized and are amortized as a component of selling, general and
administrative expenses over the initial contract term of five years. We also
receive installation revenue relating to new locations. This revenue is deferred
and amortized as a component of equipment and related services revenue over the
initial contract term of five years.
We currently anticipate that our total initial investment in new client
locations during 2003 will be approximately $53.2 million including $33.7
million of equipment and installation costs attributable to new client
locations, and $19.5 million in sales commissions relating to new client
locations. These levels are higher than 2002 because of the anticipated increase
in new client locations in 2003. We are focused on reducing the initial
investment associated with new client locations through the re-use of equipment
and efficiencies gained from vendor consolidation and technician labor
management.
We also invest in property and equipment to be used at our headquarters and
within our owned operations. Our investment for such property and equipment for
the quarter and nine months ended September 30, 2003 was approximately $2.1
million and $5.0 million, respectively consisting of system upgrades, furniture
and fixtures, computers, equipment to replenish the equipment exchange pool
relating to our drive-thru systems client locations, and conversions from local
broadcast technology to direct broadcast satellite transmission for existing
client locations. We anticipate our investment in property and equipment to be
used at headquarters, equipment for use in the exchange pool for servicing
drive-thru systems client locations, and equipment for conversions will be
approximately $5.8 million for 2003.
Contractual Obligations. The following table summarizes contractual
obligations and commitments as of September 30, 2003(in thousands).
Payments due by Period
------------------------------------------------------------------------
Remaining
3 months
2003 2004 2005 2006 2007 After 2007 Total
------------------------------------------------------------------------
Long-term debt $347 $94 $101 $110 $118 $406,287 $407,057
Interest 11,297 38,178 41,872 41,864 41,855 43,136 218,202
Capital lease obligations 542 1,972 1,461 570 228 -- 4,773
Operating leases 2,306 8,722 5,521 4,388 4,148 23,966 49,051
Unconditional purchase obligations 4,072 9,679 6,062 5,733 1,092 -- 26,638
------------------------------------------------------------------------
Total Contractual Cash Obligations $18,564 $58,645 $55,017 $52,665 $47,441 $473,389 $705,721
========================================================================
27
MUZAK HOLDINGS LLC
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Exposure
On May 20, 2003, Muzak LLC completed a private placement for $220 million
principal amount of 10% Senior Notes due 2009. The Company used the proceeds to
repay its Old Senior Credit Facility, sponsor notes and to repurchase a portion
of its Senior Discount Notes. This financing transaction extended 98% of its
debt maturities to 2009 and beyond. As a result of the financing, all of the
Company's debt is fixed with the exception of its revolving loan under our New
Senior Credit Facility. In order to mitigate its interest costs, in August 2003,
the Company entered into an interest rate swap agreement in which the Company
effectively exchanged $220.0 million of fixed rate debt at 10.0% for six month
LIBOR plus 7.95%. The swap agreement covers an eighteen month period ending
November 2004. As such, the Company's exposure to market risk for changes in
interest rates relates primarily to its revolving loan and its interest rate
swap agreement. The interest exposure for the variable debt is currently indexed
to LIBOR of one, two, three, six, nine, or twelve months as selected by us, or
the Alternate Base Rate.
The table below provides information about our debt obligations and
interest rate protection agreement. For debt obligations, the table presents
principal cash flows and related weighted average interest rates by expected
maturity dates. For interest rate protection agreements, the table presents
notional amounts and weighted average interest rates by expected (contractual)
maturity dates. Weighted average variable interest rates are based on implied
LIBOR in the yield curve at the reporting date. The principal cash flows are in
thousands.
Expected Maturity Date
----------------------------------------------------------
2003 2004 2005 2006 2007 Thereafter Total
---------- --------- --------- --------- --------- ----------- --------
Debt:
Fixed rate ($US) $ 347 $ 94 $ 101 $ 110 $ 118 $ 393,587 $ 394,357
Average interest rate 10.4% 10.4% 10.4% 10.4% 10.4% 10.4%
Variable rate ($US) $ - $ - $ - $ - $ - 12,700 $ 12,700
Average interest rate 5.2% 5.9% 7.2% 8.2% 8.6% 9.5%
Interest Rate Derivatives:
Interest Rate Swap ($US Notional) $ 220,000
Variable Rate 9.1% 9.8%
Item 4. Controls and Procedures
Within 90 days prior to the date of this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and the Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures. Based upon that evaluation, the
Chief Executive Officer and the Chief Financial Officer concluded that the
Company's disclosure controls and procedures are effective. There were no
significant changes in the Company's internal controls or in other factors that
could significantly affect these subsequent to the date of their evaluation.
28
MUZAK HOLDINGS LLC
PART II--OTHER INFORMATION
ITEM 1. Legal Proceedings.
As reported in the Company's annual report on Form 10-K for the fiscal
year ended December 31, 2002, ASCAP had notified the Company that ASCAP would
pursue a rate court proceeding in federal court in New York and on January 29,
2003, made an application to the court to commence such a proceeding. Discovery
in the proceeding has commenced and is not yet completed. In the interim, the
Company and DMX Music, Inc. have requested the rate court's assistance in
exploring and determining alternative licensing and royalty structures in order
to establish flexible and competitive alternatives to ASCAP's traditional
"blanket license". The impact of this rate court proceeding and the pending rate
court proceeding with BMI are more fully described in the Company's report on
Form 10-K and the commitments and contingencies footnote to the consolidated
financial statements. There have been no material developments in legal
proceedings involving the Company since those reported in the Company's Report
on Form 10-K for fiscal year ended December 31, 2002.
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
10.1 Executive Employment Agreement, dated as of September 29, 2003, among
Muzak Holdings LLC, Muzak LLC, and Lon Otremba
10.2 Incentive Unit Agreement, dated as of October 28, 2003, among Muzak
Holdings LLC, Lon Otremba, and ABRY Broadcast Partners III
10.3 Amendment to the Executive Employment agreement dated as of November 4,
2003 among Muzak Holdings LLC, Muzak LLC, and Stephen Villa
31.1 Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Executive Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
The Company filed a Form 8-K on September 29, 2003 under Item 5, "Other
Events" announcing that Lon Otremba has joined the Company as its President. In
addition, Bill Boyd has been named Chairman of the Board.
The Company filed a Form 8-K on September 19, 2003 under Item 5, "Other
Events" disclosing the Telestar 4 satellite disruption and attainment of
comparable transponder capacity on AMC-1, a digital satellite of SES Americom.
Muzak LLC filed a Form 8-K on August 14, 2003 under Item 5, "Other Events"
stating that Muzak LLC is not required to file separate financial statements and
has made the decision to cease filing separate financial statements as of the
quarter ended March 31, 2003 due to the time and expenses involved with such
filing.
29
MUZAK HOLDINGS LLC
The Company furnished a Form 8-K on August 7, 2003 under Item 12,
"Disclosure of Results of Operations and Financial Conditions". The Form 8-K
included the company's second quarter financial results press release, which was
furnished as Exhibit 99.1 to the Form 8-K.
30
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrants have duly caused this report to be signed on their behalf by the
undersigned thereunto duly authorized.
MUZAK HOLDINGS LLC
By: /s/ William A. Boyd
---------------------------------
Date: November 14, 2003 William A. Boyd
Chief Executive Officer
(Principal Executive Officer)
By: /s/ Stephen P. Villa
---------------------------------
Date: November 14, 2003 Stephen P. Villa
Chief Financial Officer
(Principal Financial
Officer and Chief
Accounting Officer)
31