<PAGE> 1
As Filed with the Securities and Exchange Commission on November 12, 1998
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, 1998
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 No. 0-22815
TCI MUSIC, INC.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
State of Delaware 84-1380293
- ------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
67 Irving Place North, 4th Floor
New York, NY 10003
- ---------------------------------------- -----------------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (212) 387-7700
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
The number of shares outstanding of the Registrant's common stock as of
October 31, 1998 was 18,858,416.
<PAGE> 2
PART I - FINANCIAL STATEMENTS
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
-------------- ------------
amounts in thousands
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 5,950 $ 7,915
Trade receivables:
Unaffiliated 11,806 6,275
Related party (note 5) 2,490 2,530
Allowance for doubtful accounts (958) (563)
--------------- ----------------
13,338 8,242
Prepaid expenses and other 2,050 2,993
Equipment inventory 6,902 6,713
-------------- ----------------
Total current assets 28,240 25,863
-------------- ----------------
Investment in affiliates,
accounted for under the equity method 941 1,201
Property and equipment:
Furniture and equipment 15,587 7,024
Leasehold improvements 571 543
Studio equipment 7,839 5,599
Other equipment 2,011 1,435
-------------- ----------------
26,008 14,601
Less accumulated depreciation (5,045) (1,113)
-------------- ----------------
20,963 13,488
Intangible assets, at cost, net of accumulated amortization (note 6) 159,726 152,041
Other assets, at cost, net of accumulated amortization 4,238 2,134
-------------- ----------------
$ 214,108 $ 194,727
============== ================
</TABLE>
(continued)
I-1
<PAGE> 3
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
-------------- ----------------
amounts in thousands
<S> <C> <C>
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 2,851 $ 4,390
Accrued liabilities 13,338 10,561
Accrued loss on disposal - DMX-Europe N.V.
(notes 4 and 9) 1,469 2,827
Deferred revenue 63 186
Other notes payable (note 7) 999 3,354
Income taxes payable, related party (note 5) 1,408 1,762
-------------- ----------------
20,128 23,080
Negative investment in DMX-Europe N.V.
(notes 4 and 9) 9,058 9,058
-------------- ----------------
Total current liabilities 29,186 32,138
Debt:
Unaffiliated (note 7) 88,180 53,236
Related party, including accrued interest (note 5) 805 4,359
Deferred income taxes 187 2,811
Other liabilities (note 9) 3,158 2,357
-------------- ----------------
Total liabilities 121,516 94,901
-------------- ----------------
TCI Music, Inc. redeemable convertible preferred
stock, $.01 par value; Authorized 5,000,000
shares; Issued 1,616,591 shares in 1998 and
1,742,484 shares in 1997; $33,079,000 and
$35,490,000 liquidation preference and
redemption value in 1998 and 1997, respectively 33,986 35,588
-------------- ----------------
Stockholders' equity (note 8):
TCI Music, Inc. common stock:
Series A Common Stock, $.01 par value;
Authorized 295,000,000 shares;
Issued 18,858,416 shares in 1998 and
18,098,983 shares in 1997 189 181
Series B Common Stock, $.01 par value;
Authorized 200,000,000 shares;
Issued 62,500,000 shares 625 625
Paid-in capital 73,915 63,899
Accumulated deficit (16,230) (465)
Accumulated other comprehensive income (loss) 107 (2)
-------------- ----------------
Total stockholders' equity 58,606 64,238
-------------- ----------------
Commitments and contingencies (note 9)
$ 214,108 $ 194,727
============== ================
</TABLE>
See accompanying notes to consolidated financial statements
I-2
<PAGE> 4
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months Three Months Six Months
Ended Ended Ended Ended
September 30, September 30, September 30, June 30,
-------------------------------- ---------------- ------------------- --------------------
1998 1997 1998 1997 1997
---------------- --------------- ---------------- ------------------- --------------------
TCI Music TCI Music TCI Music TCI Music DMX
---------------- --------------- ---------------- ------------------- --------------------
(note 1) (note 1) (note 1) (note 1) (note 1)
amounts in thousands, except per share amounts
<S> <C> <C> <C> <C> <C>
Subscriber fee revenue:
Related party (notes 3 and 5) $ 7,840 $ 7,042 $ 23,919 $ 7,042 $ 4,517
Unaffiliated 5,184 3,133 14,354 3,133 4,909
----------- ----------- ----------- ---------- -----------
Total subscriber revenue 13,024 10,175 38,273 10,175 9,426
Viewer revenue 3,218 -- 8,383 -- --
Advertising revenue 3,534 -- 9,841 -- --
Other revenue 2,677 260 6,224 260 487
Revenue - DMX-Europe N.V. (note 4) -- -- -- -- 1,527
----------- ----------- ----------- ---------- -----------
Total revenue 22,453 10,435 62,721 10,435 11,440
----------- ----------- ----------- ---------- -----------
Operating costs and expenses:
Operating expenses:
Related party (note 5) 1,966 1,467 5,992 1,467 2,279
Unaffiliated 3,455 1,459 10,504 1,459 3,382
DMX-Europe N.V. (note 4) -- -- -- -- 5,412
Selling, general and administrative 14,985 2,627 41,433 2,627 7,398
Stock compensation 127 178 369 178 --
Depreciation and amortization 6,491 3,004 17,298 3,004 1,198
Writedown of inventories -- -- 1,102 -- --
Disposal of DMX-Europe N.V. (note 4) -- -- -- -- 1,738
----------- ----------- ----------- ---------- -----------
Total operating costs 27,024 8,735 76,698 8,735 21,407
----------- ----------- ----------- ---------- -----------
Operating income (loss) (4,571) 1,700 (13,977) 1,700 (9,967)
Other income (expense):
Interest expense:
Unaffiliated, net (1,531) 18 (3,843) 18 (22)
Related party (note 5) (21) (1,050) (131) (1,050) (167)
DMX-Europe N.V. (note 4) -- -- -- -- (130)
----------- ----------- ----------- ---------- -----------
(1,552) (1,032) (3,974) (1,032) (319)
Share of (losses) earnings of
affiliates (206) 78 (449) 78 109
Other, net 104 (253) 232 (253) (198)
----------- ----------- ----------- ---------- -----------
Income (loss) before income
taxes (6,225) 493 (18,168) 493 (10,375)
Income tax benefit (expense) 935 (333) 2,403 (333) --
----------- ----------- ----------- ---------- -----------
Net income (loss) $ (5,290) $ 160 $ (15,765) $ 160 $ (10,375)
Accretion of redeemable convertible
preferred stock (363) -- (1,111) -- --
----------- ----------- ----------- ---------- -----------
Net earnings (loss) attributable
to common stockholder (5,653) 160 (16,876) 160 (10,375)
=========== =========== =========== ========== ===========
Comprehensive income (loss) $ (5,196) $ 160 $ (15,656) $ 160 $ (10,328)
=========== =========== =========== ========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
I-3
<PAGE> 5
<TABLE>
<CAPTION>
Three Months Nine Months Three Months Six Months
Ended Ended Ended Ended
September 30, September 30, September 30, June 30,
-------------------------------- ---------------- ------------------- --------------------
1998 1997 1998 1997 1997
---------------- --------------- ---------------- ------------------- --------------------
TCI Music TCI Music TCI Music TCI Music DMX
---------------- --------------- ---------------- ------------------- --------------------
(note 1) (note 1) (note 1) (note 1) (note 1)
amounts in thousands, except per share amounts
<S> <C> <C> <C> <C> <C>
Net earnings (loss) attributable to
common stockholder (5,653) 160 (16,876) 160 (10,375)
=========== =========== =========== ========== ===========
Basic and diluted loss per common
share $ (.07) $ -- $ (.21) $ -- $ (.17)
=========== =========== =========== ========== ===========
Weighted average number of common
shares 81,049 77,397 81,049 77,397 59,587
=========== =========== =========== ========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
I-4
<PAGE> 6
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Consolidated Statement of Stockholders' Equity
Nine Months ended September 30, 1998
(Unaudited)
<TABLE>
<CAPTION>
Common Stock Accumulated other
--------------------- Paid in Accumulated comprehensive losses,
Series A Series B capital deficit net of taxes Total
-------- -------- -------- ----------- ---------------------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1998 $ 181 $ 625 $ 63,899 $ (465) $ (2) $ 64,238
Accretion of put option (note 2) -- -- 5,693 -- -- 5,693
Issuance of common stock 4 -- 2,725 -- -- 2,729
Conversion of Preferred Stock 4 -- 2,709 -- -- 2,713
Accretion of redeemable convertible
preferred stock -- -- (1,111) -- -- (1,111)
Foreign currency translation
adjustment -- -- -- -- 109 109
Net loss -- -- -- (15,765) -- (15,765)
-------- -------- -------- -------- ------ ---------
Balance at September 30, 1998 $ 189 $ 625 $ 73,915 $(16,230) $ 107 $ 58,606
======== ======== ======== ======== ====== =========
</TABLE>
See accompanying notes to consolidated financial statements
I-5
<PAGE> 7
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Consolidated Statement of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended Six Months Ended
September 30, September 30, June 30,
1998 1997 1997
------------------------ -------------------------- -------------------------
TCI Music TCI Music DMX
------------------------ -------------------------- -------------------------
(note 1) (note 1) (note 1)
amounts in thousands
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (15,765) $ 160 $ (10,375)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 17,298 3,004 1,627
Share of losses (earnings) of affiliates 449 (78) 41
Writedown of inventories 1,102 -- --
Loss on disposal of DMX-Europe N.V. -- -- 1,738
Stock compensation 369 178 --
Deferred income tax expense (2,077) (508) --
Changes in operating assets and
liabilities, net of acquisitions:
Trade receivables (4,246) 2,419 (915)
Prepaid expenses and other current assets 483 (794) (160)
Other assets (213) (2,269) (28)
Accounts payable, accrued liabilities
and other (3,008) (4,512) 6,156
---------- ----------- ----------
Net cash used in operating activities (5,608) (2,400) (1,916)
---------- ----------- ----------
Cash flows from investing activities:
Cash paid for acquisitions (12,590) -- --
Capital expended for property and
equipment, net (10,273) (287) (754)
Investments in affiliates (190) -- --
---------- ----------- ----------
Net cash used in investing activities (23,053) (287) (754)
---------- ----------- ----------
Cash flows from financing activities:
Borrowings from related party -- 4,233 2,517
Repayments to related party (3,553) (289) --
Decrease in income taxes payable, related party (355) -- --
Borrowing on note payable to bank 34,300 -- --
Repayment of note payable (3,696) (138) --
---------- ----------- ----------
Net cash provided by financing activities 26,696 3,806 2,517
---------- ----------- ----------
Net increase (decrease) in cash and cash equivalents (1,965) 1,119 (153)
Cash and cash equivalents, beginning of period 7,915 832 986
---------- ----------- ----------
Cash and cash equivalents, end of period $ 5,950 $ 1,951 $ 833
========== =========== ==========
</TABLE>
See accompanying notes to consolidated financial statements
I-6
<PAGE> 8
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Notes to Consolidated Financial Statements
September 30, 1998
(Unaudited)
(1) Organization
TCI Music, Inc. ("TCI Music" or the "Company") was incorporated on January 21,
1997, and on January 24, 1997 one share of TCI Music Series B common stock, $.01
par value per share ("TCI Music Series B Common Stock"), was issued to
Tele-Communications, Inc. ("TCI") for a capital contribution of $1. On July 11,
1997, DMX Inc. ("DMX") and TCI Music consummated a merger pursuant to an
Agreement and Plan of Merger, dated February 6, 1997, as amended by Amendment
One to Merger Agreement dated May 29, 1997 (the "DMX Merger Agreement"), among
DMX, TCI, TCI Music, and TCI Merger Sub ("Merger Sub"), a wholly-owned
subsidiary of TCI Music, whereby Merger Sub was merged with and into DMX (the
"DMX Merger"), with DMX as the surviving corporation, and TCI Music became the
successor registrant to DMX. The DMX Merger was deemed effective July 1, 1997
for accounting purposes. See note 3.
TCI Music has three classes of stock outstanding at September 30, 1998, the TCI
Music Series A Convertible Preferred Stock, $.01 par value per share ("TCI Music
Preferred Stock"), TCI Music Series A Common Stock, $.01 par value per share
("TCI Music Series A Common Stock") and TCI Music Series B Common Stock, $.01
par value per share. The TCI Music Series A Common Stock, the TCI Music Series B
Common Stock and the TCI Music Preferred Stock are collectively referred to as
the "TCI Music Stock". TCI beneficially owns approximately 5.2% of the
outstanding TCI Music Preferred Stock, 62.1% of the outstanding shares of TCI
Music Series A Common Stock and 100% of the outstanding shares of TCI Music
Series B Common Stock, which collectively represents approximately 86.4% of the
outstanding shares of TCI Music Stock, representing 98.2% of the voting power of
the outstanding shares of TCI Music Stock, in each case assuming conversion of
the TCI Music Preferred Stock.
Basis of Presentation
In the accompanying financial statements and in the following text, references
are made to DMX and TCI Music. The consolidated statements of operations for the
six months ended June 30, 1997 reflect the consolidated results of operations of
DMX and is referred to as "DMX" (the predecessors' operations). The financial
statements as of December 31, 1997 and September 30, 1998 and for the nine and
three months ended September 30, 1998, and for the three months ended September
30, 1997 reflect the consolidated results of operations and financial condition
of TCI Music. All significant intercompany accounts and transactions have been
eliminated for the periods presented. As a result of the DMX Merger, the
consolidated financial information for the periods after the DMX Merger are
presented on a different cost basis than that for the periods before the DMX
Merger and, therefore, are not comparable.
The accompanying interim consolidated financial statements are unaudited and, in
the opinion of management, reflect all adjustments necessary for a fair
presentation of the results for such periods. The results of operations for any
interim period are not necessarily indicative of results for the full year. The
accompanying financial information should be read in conjunction with the
audited consolidated financial statements and notes thereto included in the
Company's Annual report filed on Form 10-K for the year ended December 31, 1997.
Reclassifications
Certain reclassifications of prior period amounts have been made to conform to
the current year's reporting format.
I-7
<PAGE> 9
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Notes to Consolidated Financial Statements
September 30, 1998
(Unaudited)
Derivative Financial Instruments
The Financial Accounting Standards Board recently issued Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities," ("SFAS 133"), which is effective for all fiscal years beginning
after September 15, 1999. SFAS 133 establishes accounting and reporting
standards for derivative instruments and hedging activities by requiring that
all derivative instruments be reported as assets or liabilities and measured at
their fair values. Under SFAS 133, changes in the fair values of derivative
instruments are recognized immediately in earnings unless those instruments
qualify as hedges of the (1) fair values of existing assets, liabilities, or
firm commitments, (2) variability of cash flows of forecasted transactions, or
(3) foreign currency exposures on net investments in foreign operations. As of
September 30, 1998, the Company has not entered into any derivative contracts
nor does it hold any derivative financial instruments. The TCI right described
in note 3 is not considered a derivative instrument under SFAS 133 as it is
indexed to the price of TCI Music Series A Common Stock and is classified as a
component of additional paid in capital. Therefore, SFAS 133 will not have a
material impact on the Company's consolidated results of operations, financial
position, or cash flows.
Reporting Comprehensive Income
Effective January 1, 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
130"). The Company has reclassified its prior period consolidated balance sheet
and consolidated statement of operations to conform to the requirements of SFAS
130. SFAS 130 requires that all items which are components of comprehensive
earnings be reported in a financial statement in the period in which they are
recognized. The Company has included cumulative foreign currency translation
adjustments in other comprehensive earnings, which had been recorded directly in
stockholders' equity. Pursuant to SFAS 130, this item is reflected as a
component of other comprehensive earnings in the Company's consolidated
statements of operations and is included in accumulated other comprehensive
losses in the Company's consolidated balance sheets and statements of
stockholders' equity.
(2) Supplemental Disclosures to Consolidated Statements of Cash Flows
Cash paid for interest was $3,680,083 and $421,000 for the nine months ended
September 30, 1998 and 1997, respectively. Cash paid for taxes for periods
presented was not material.
Significant noncash investing and financing activities are as follows for the
period ended September 30, 1998 (amounts in thousands):
<TABLE>
<S> <C>
Cash paid for acquisitions:
Fair value of assets acquired $ 2,827
Net liabilities assumed (1,112)
Equity interest issued to acquired entities (2,730)
Debt issued (1,998)
Excess of cost paid over fair value of net assets acquired 15,603
-----------
Cash paid for acquisitions $ 12,590
===========
Noncash accretion of stockholders' put option (note 3) $ 5,693
===========
</TABLE>
(3) Mergers and Related Transactions
DMX Merger
In connection with the DMX Merger, TCI and TCI Music entered into a Contribution
Agreement dated July 11, 1997, as amended by the Amended and Restated
Contribution Agreement (the "Amended Contribution Agreement"). Pursuant to the
Amended Contribution Agreement: (i) TCI Music issued to TCI (as designee of
certain of its indirect subsidiaries), 62,500,000 shares of TCI Music Series B
Common Stock, and a promissory note in the amount of $40 million (repaid on
December 30, 1997), (ii) TCI is required to deliver, or cause certain of its
subsidiaries to deliver, to TCI Music monthly payments aggregating $18 million
I-8
<PAGE> 10
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Notes to Consolidated Financial Statements
September 30, 1998
(Unaudited)
annually, adjusted annually through 2017 (the "Annual TCI Payments"), which
represent revenue of certain subsidiaries of TCI that is attributable to
the distribution and sale of the DMX service to certain cable subscribers who
receive the DMX service (net of an amount equal to 10% of such revenue derived
from residential customers and license fees otherwise payable to DMX pursuant to
the Affiliation Agreement); and compensation to TCI Music and DMX for various
other rights; (iii) TCI contributed to TCI Music certain digital commercial
tuners that are not in service, and (iv) TCI granted to each stockholder of DMX
who became a stockholder of TCI Music pursuant to the DMX Merger one right (a
"TCI Right") with respect to each whole share of TCI Music Series A Common Stock
acquired by such stockholder in the DMX Merger pursuant to the terms of the
Rights Agreement among TCI, TCI Music and the Bank of New York (the "Rights
Agreement"). Each TCI Right entitled the holder to require TCI to purchase from
such holder one share of TCI Music Series A Common Stock at a purchase price of
$8.00 per share, payable at the election of TCI, in cash, a number of shares of
TCI Group Series A Common Stock, having an equivalent value or a combination
thereof, if during the one year period beginning on July 11, 1997, the effective
date of the DMX Merger, the price of TCI Music Series A Common Stock does not
equal or exceed $8.00 per share for a period of at least 20 consecutive trading
days. The TCI Rights became exercisable from July 11, 1998 through August 13,
1998. During such period, TCI Rights with respect to 7,602,483 shares of TCI
Music Series A Common Stock were exercised, and such shares were purchased by
TCI for cash. All unexercised TCI Rights expired at the close of business on
August 13, 1998. The Shares of TCI Music Series A Common Stock are quoted on the
Nasdaq SmallCap Market under the symbol "TUNE".
The merger was accounted for under the purchase method of accounting. The number
of shares of TCI Music Series A Common Stock and TCI Rights issued were based
upon DMX Common Stock ownership as of June 30, 1997. The estimated fair value of
the consideration issued to stockholders not controlled by TCI ("Unaffiliated
Stockholders") in the DMX Merger was accreted to the value of $8.00 per share
(the equivalent of $2.00 per share of DMX Common Stock) during the one-year
period beginning on the effective date of the DMX Merger. Such accretion is
reflected as an increase in excess cost with a corresponding increase to
additional paid-in capital. The TCI Rights have been fully accreted as of
September 30, 1998.
The Box Merger
Effective December 16, 1997, The Box Worldwide Inc. ("The Box") and TCI Music
consummated a merger pursuant to an Agreement and Plan of Merger, dated August
12, 1997 (the "Box Merger Agreement"), among The Box, TCI Music, and TCI Music
Acquisition Sub, Inc., a wholly-owned subsidiary of TCI Music, whereby TCI Music
Acquisition Sub, Inc. was merged into The Box (the "Box Merger"), with The Box
as the surviving corporation and a wholly-owned subsidiary of TCI Music.
Pursuant to the Box Merger Agreement, each of the 24,892,623 outstanding shares
of common stock of The Box were converted into the right to receive 0.07 of a
share of TCI Music Preferred Stock and cash in lieu of fractional shares of TCI
Music Preferred Stock. Each share of TCI Music Preferred Stock is convertible at
the option of the holder into three shares of TCI Music Series A Common Stock,
subject to certain antidilution adjustments and certain adjustments for
dividends and distributions, if any. Each share of TCI Music Preferred Stock is
entitled to vote on all matters submitted to a vote of the holders of the TCI
Music Series A Common Stock and to the number of votes equal to the number of
shares of TCI Music Series A Common Stock into which such share is convertible
as of the record date for the matter to be voted upon. The Box's 6% Convertible
Redeemable Preferred Stock, par value $.15 per share and stated value of $1.50
per share ("Box Preferred Stock"), was purchased by the Company for $2,652,000.
The shares of TCI Music Series A Common Stock into which the TCI Music Preferred
Stock is convertible are eligible for quotation on the NASDAQ SmallCap Market
under the symbol "TUNE" since the TCI Rights terminated on August 13, 1998.
The merger was accounted for under the purchase method of accounting. The
Company has performed a preliminary allocation of the purchase price to excess
cost over the fair value of net assets acquired as the net book values of The
Box's assets and liabilities were estimated to approximate their respective fair
values, and is awaiting information and evaluation at which point it will
finalize such allocation. Adjustments to the preliminary allocation are expected
to be immaterial.
I-9
<PAGE> 11
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Notes to Consolidated Financial Statements
September 30, 1998
(Unaudited)
Paradigm Merger
Effective December 31, 1997, Paradigm Music Entertainment Company ("Paradigm")
and TCI Music consummated a merger pursuant to an Agreement and Plan of Merger,
dated December 8, 1997 (the "Paradigm Merger Agreement"), among Paradigm, TCI
Music and TCI Para Merger Sub, Inc., ("TCI Para Merger Sub"), a wholly-owned
subsidiary of TCI Music, whereby TCI Para Merger Sub was merged into Paradigm
(the "Paradigm Merger"), with Paradigm as the surviving corporation and a
wholly-owned subsidiary of TCI Music.
Pursuant to the Paradigm Merger Agreement, each outstanding share of common
stock of Paradigm ("Paradigm Common Stock") was converted into the right to
receive 0.61217 of a share, and each outstanding warrant to acquire shares of
Paradigm Common Stock was converted into the right to receive, for each share of
Paradigm Common Stock underlying such warrants, 0.211878 of a share of TCI Music
Series A Common Stock and cash in lieu of fractional shares. The shares of TCI
Music Series A Common Stock issued in the Paradigm Merger became eligible for
quotation on the Nasdaq SmallCap Market under the symbol "TUNE" when the TCI
Rights terminated on August 13, 1998.
The Paradigm Merger was effective December 31, 1997 and was accounted for under
the purchase method of accounting. The estimated aggregate fair value of the TCI
Music Series A Common Stock issued in the Paradigm Merger equaled approximately
$22.3 million and has been allocated to excess cost over fair value of net
assets acquired as the net book values of Paradigm's assets and liabilities were
estimated to approximate their respective fair values. The number of shares
issued was based upon Paradigm's Common Stock ownership as of December 30, 1997.
Other Acquisitions
During the nine months ended September 30, 1998 the Company acquired owned and
operated commercial subscriber businesses. Funding for these acquisitions was
provided by borrowings from the revolving loan agreement totaling $12.6 million
and issuance of 381,754 shares of TCI Music Series A Common Stock.
(4) Investment in and Disposition of DMX-Europe N.V. and Subsidiary
On May 17, 1996, DMX consummated the merger of TCI-Euromusic, Inc. ("TCI-E"), an
indirect affiliate of TCI ("the TCI-E Merger") pursuant to the terms of the
Agreement and Plan of Merger, dated August 28, 1995, as amended on November 1,
1995 and January 17, 1996 among DMX, TCI-E and United Artists Programming
International, Inc. ("UAPI"), an indirect affiliate of TCI and owner of the
outstanding shares of TCI-E. As a result of the TCI-E Merger, DMX acquired the
remaining 49% interest in DMX-Europe N.V. ("DMX-E NV") and its subsidiary
DMX-Europe (UK) Limited ("DMX-E UK"), collectively ("DMX-E").
DMX-E ceased operation on July 1, 1997. DMX-E UK was placed into receivership on
July 1, 1997 and into liquidation on July 18, 1997. DMX-E NV, although inactive
since July 1, 1997, was placed into receivership on December 23, 1997.
Accordingly, the accompanying balance sheets as of September 30, 1998 and
December 31, 1997 and the statements of operations for the nine months and three
months ended September 30, 1998 and cash flows for the nine months ended
September 30, 1998 give effect to the deconsolidation of DMX-E.
(5) Related Party Transactions
Pursuant to an Amended and Restated Contribution Agreement between TCI and TCI
Music to be effective as of July 1, 1997 (the "Amended Contribution Agreement")
TCI is required to deliver, or cause certain of its subsidiaries to deliver, to
TCI Music monthly revenue payments aggregating $18 million annually, adjusted
annually through 2017 (the "Annual TCI Payments"). Pursuant to the Amended
Contribution Agreement, the Annual TCI payments represent (i) revenue of certain
subsidiaries of TCI that is attributable to the distribution and sale of the DMX
service to certain cable subscribers (net of an amount equal to 10% of such
revenue derived from residential customers and license fees otherwise payable to
DMX pursuant to the Affiliation Agreement) and (ii) compensation to TCI Music
I-10
<PAGE> 12
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Notes to Consolidated Financial Statements
September 30, 1998
(Unaudited)
and DMX for various other rights. During the nine months ended September 30,
1998, TCI Music recognized $15 million of subscriber fee revenue and the $1.5
million withheld by TCI was charged to operating expense pursuant to the Amended
Contribution Agreement.
Pursuant to an affiliation agreement (the "Affiliation Agreement") between
Satellite Services, Inc., a wholly-owned subsidiary of TCI ("SSI") and DMX
effective as of July 1, 1997, SSI has the non-exclusive right to distribute and
subdistribute the DMX service to commercial and residential customers for a
10-year period in exchange for licensing fees paid by SSI to DMX. Under the
Affiliation Agreement, SSI will pay an annual fee to DMX of $8,500,000 for the
initial three years, subject to adjustment annually (beginning July 1, 1998) by
the percentage change in the CPI for the prior year and for changes in the
number of subscribers, as a result of divestiture or acquisition of cable
systems. During the fourth through tenth years of the term of the Affiliation
Agreement, the annual fee will be further adjusted on a monthly basis upward or
downward, as the case may be, based on an increasing percentage of the increase
in actual number of subscribers above or below a specified number of residential
and commercial subscribers, provided that such fees cannot be reduced below a
specified minimum license fee, which minimum fee is decreased each year in years
four through ten. For the nine months ended September 30, 1998, the Company
recognized $6.4 million of licensing fees, which is included in subscriber fee
revenue, related party.
On February 6, 1997 the Company entered into a loan and security agreement with
TCI which provided the Company with $3.5 million. The loan was paid in full on
March 2, 1998.
The Company has an equipment lease with National Digital Television Center, Inc.
("NDTC"), a subsidiary of TCI, for the equipment at the studio and uplinking
facility in Littleton, Colorado with terms that extend through the year 2000, at
an interest rate of 9.5% per annum. The outstanding principal balance of the
capital lease obligation at September 30, 1998 and December 31, 1997 was
approximately $792,000 and $1,171,000, respectively. The related studio
equipment had a net book value of approximately $400,000 and $728,000 at
September 30, 1998 and December 31, 1997, respectively, and is included in
property and equipment in the accompanying consolidated balance sheets.
Additionally the Company leases certain office space and uplinking and satellite
services from NDTC. Total expenses under these leases were $3,957,000 and
$1,052,000 for the nine months ended September 30, 1998 and three months ended
September 30, 1997, respectively and are included in operating expenses, related
party.
The components of related party debt at September 30, 1998 and December 31,
1997, respectively, were as follows (amounts in thousands):
<TABLE>
<CAPTION>
Accrued
Principal Interest Total
------------ ----------- -----------
<S> <C> <C> <C>
September 30, 1998
Capital lease obligation $ 792 $ 13 $ 805
============ =========== ===========
December 31, 1997
$3.5 million equipment loan $ 3,117 $ 32 $ 3,149
Capital lease obligation 1,171 39 1,210
------------ ----------- -----------
$ 4,288 $ 71 $ 4,359
============ =========== ===========
</TABLE>
TCI Music is included in the consolidated federal income tax return of TCI.
Income tax expense or benefit for TCI Music is based on those items in the
consolidated calculation applicable to TCI Music. Intercompany tax allocation
represents an apportionment of tax expense or benefit (other than deferred
taxes) among the subsidiaries of TCI in relation to their respective amounts of
taxable earnings or losses.
I-11
<PAGE> 13
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Notes to Consolidated Financial Statements
September 30, 1998
(Unaudited)
(6) Intangible Assets
The balance of intangible assets as of September 30, 1998 principally consists
of the excess of cost over the fair value of the net assets acquired in the
acquisitions of DMX, The Box and Paradigm (see note 3). Such intangibles are
being amortized over a 10 year period.
(7) Debt
On December 30, 1997 the Company entered into a revolving loan agreement (the
"Revolving Loan Agreement") with several banks, which provides for borrowings up
to $100 million. Interest on borrowings under the agreement is tied to London
Interbank Offered Rate ("LIBOR"), plus an applicable margin dependent upon the
Company's leverage ratio, (as defined in the Revolving Loan Agreement), for the
preceding quarter or at the bank's base rate. The Revolving Loan Agreement
matures on September 30, 2005 with principal reductions beginning semi-annually
on September 30, 2000 based on a scheduled percentage of the total commitment. A
commitment fee is charged on the unborrowed portion of the Revolving Loan
Agreement commitment, $12.5 million as of September 30, 1998, ranging from .25%
to .375% based upon the leverage ratio for the preceding quarter. Included in
accrued liabilities are $294,000 and $13,000 at September 30, 1998 and December
31, 1997, respectively, of accrued interest on the revolving loan.
The Company assumed debt consisting of two auto loans, two lease obligations,
and issued nine notes payable to former owners in connection with acquisitions
made during the nine months ended September 30, 1998. The notes bearing interest
range from 5% to the Prime Rate and have a total balance of $1.6 million, of
which $986,000 is classified as current in the accompanying balance sheet as of
September 30, 1998.
In connection with the Paradigm Merger, the Company assumed debt consisting of
two bridge loans and a note payable to an individual totaling $3.3 million. The
notes bear interest at 10% per annum and were fully paid in January 1998.
The fair market value of TCI Music's debt approximated its carrying value at
September 1998.
(8) Stockholders' Equity
Stock Options and Stock Appreciation Rights
Estimates of the compensation relating to options and/or stock appreciation
rights granted to employees of TCI Music and members of the Board have been
recorded in the accompanying financial statements, but are subject to future
adjustment based upon vesting and the market value of TCI Music Series A Common
Stock and, ultimately, on the final determination of market value when the
rights are exercised. The payable or receivable arising from the compensation
related to the options and/or stock appreciation rights is included in other
liabilities.
Capital Stock
The Company has the authority to issue 500 million shares of capital stock
consisting of (i) 295 million shares of TCI Music Series A Common Stock; (ii)
200 million shares of TCI Music Series B Common Stock; and (iii) 5 million
shares of TCI Music preferred stock. The TCI Music Series A Common Stock and TCI
Music Series B Common Stock are identical except for voting and conversion
rights. Each share of TCI Music Series A Common Stock entitles the holder to one
vote and each share of TCI Music Series B Common Stock entitles the holder to
ten votes, on each matter submitted to stockholders for a vote. Each share of
TCI Music Series B Common Stock is convertible, at the option of the holder, at
any time into one share of TCI Music Series A Common Stock. The TCI Music Series
A Common Stock is not convertible into TCI Music Series B Common Stock.
I-12
<PAGE> 14
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Notes to Consolidated Financial Statements
September 30, 1998
(Unaudited)
Earnings (Loss) Per Common and Potential Common Share
Basic earnings per share ("basic EPS") is measured as the income or loss
available to common stockholders divided by the weighted average outstanding
common shares for the period. Diluted earnings per share ("diluted EPS") is
similar to basic EPS but presents the dilutive effect on a per share basis of
potential common shares as if they had been converted at the beginning of the
periods presented. Potential common shares that have an anti-dilutive effect are
excluded from diluted EPS.
The basic and diluted loss attributable to TCI Music common stockholders per
common share for the nine and three months ended September 30, 1998 were
computed by dividing the net loss, including accretion of the redeemable
preferred stock of $1,111,000 and $363,000 for the nine and three months ended
September 30, 1998, respectively, by the weighted average number of common
shares outstanding during such periods. Potential common shares were not
included in the computation of weighted average shares outstanding because their
inclusion would be antidilutive.
The basic and diluted income attributable to TCI Music common stockholders per
common share for three months ended September 30, 1997 was computed by dividing
net income by the weighted average number of common shares outstanding during
such period. Potential common shares, consisting of director and employee stock
options, were not included in the computation of weighted average shares
outstanding for diluted EPS for such period as the dilutive effect was not
significant.
The basic and diluted loss attributable to DMX was computed by dividing the net
loss attributable to DMX by the weighted average number of common shares
outstanding of DMX for the six months ended June 30, 1997. Potential common
shares were not included in the computation of weighted shares outstanding
because their inclusion would be anti-dilutive.
At September 30, 1998, there were 5.1 million potential common shares,
consisting of director and employee stock options and shares of TCI Music Series
A common stock issuable upon conversion of shares of TCI Music Preferred Stock
that could potentially dilute future EPS calculations in periods of net income.
Such potential common share amount does not take into account the assumed number
of shares that would be repurchased by TCI Music upon exercise of the director
and employee stock options. No material changes in the weighted average
outstanding shares or potential common shares occurred subsequent to September
30, 1998.
(9) Commitments and Contingencies
Year 2000
During the three months ended September 30, 1998, TCI continued its
enterprise-wide comprehensive efforts to assess and remediate its computer
systems and related software and equipment to ensure such systems, software and
equipment recognize, process and store information in the year 2000 and
thereafter. The Company's year 2000 remediation efforts include an assessment of
its most critical systems, equipment, and facilities. The Company also continued
its effort to verify the year 2000 readiness of its significant suppliers and
vendors and continued to communicate with significant business partners to
assess such partners' year 2000 status.
TCI formed a year 2000 Program Management Office (the "PMO") to organize and
manage the Company's year 2000 remediation efforts. The PMO is responsible for
overseeing, coordinating and reporting on the Company's year 2000 remediation
efforts. It is comprised of 90 member full-time staff and is accountable to
executive management of TCI.
The PMO has defined a four-phase approach to determining the year 2000 readiness
of the Company's systems, software and equipment. Such approach is expected to
provide a detailed method for tracking the evaluation, repair and testing of
Company's systems, software and equipment. Phase 1, Assessment, involves the
inventory of all systems, software and equipment and the identification of any
year 2000 issues. Phase 1 also includes the preparation of the workplans needed
for remediation. Phase 2, Remediation, involves repairing, upgrading and/or
replacing any non-compliant equipment and systems. Phase 3, Testing, involves
I-13
<PAGE> 15
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Notes to Consolidated Financial Statements
September 30, 1998
(Unaudited)
testing the Company's systems, software and equipment for year 2000 readiness,
or in certain cases, relying on test results provided to the Company. Phase 4,
Implementation, involves placing compliant systems, software and equipment into
production or service.
At September 30, 1998, Company's overall progress by phase was as follows:
<TABLE>
<CAPTION>
Percent of All
Phase Equipment/Systems in Phase*
----- ---------------------------
<S> <C>
Phase 1-Assessment 100%
Phase 2-Remediation 95%
Phase 3-Testing 4%
Phase 4-Implementation 0%
</TABLE>
- -------------------------
*Percentages do not total 100% since projects have elements in more than one
phase. For the purposes of this table, such projects have been attributed to
each applicable phase. In addition the percentages set forth above are based on
the number of projects in each phase compared to the total number of year 2000
projects.
The Company is completing an inventory of its important systems with embedded
technologies and is currently determining the correct remediation approach.
During the three months ended September 30, 1998, the Company continued its
survey of significant third-party vendors and suppliers whose systems, services
or products are important to the Company's operations. The year 2000 readiness
of such providers is critical to continued provision of Company's services. The
Company has received information that the most critical systems, services or
products supplied to the Company by third parties are either year 2000 ready or
are expected to be year 2000 ready by mid-1999. The Company is currently
developing contingency plans for systems provided by vendors who have not
responded to the Company's surveys.
In addition to the survey process described above, management of the Company has
identified its most critical supplier/vendor relationships and has instituted a
verification process to determine the vendors' year 2000 readiness. Such
verification includes, as deemed necessary, reviewing vendors' test and other
data and engaging in regular conferences with vendors' year 2000 team. The
Company is also requiring testing to validate the year 2000 compliance of
certain critical products and services and is contracting with independent
consultants to conduct such testing.
Year 2000 expenses and capital expenditures incurred in the three and nine
months ended September 30, 1998 were immaterial. Management of the Company
currently estimates the remaining costs to be not less than $600,000, bringing
the total estimated cost associated with the Company's year 2000 remediation
efforts to not less than $600,000, including the replacement cost of
noncompliant Information Technology Support ("IT") systems. Included in this
estimate is the Company's pro rata share of the $9 million in future payments to
be made by TCI pursuant to unfulfilled executory contracts or commitments with
vendors for year 2000 remediation services.
TCI is a widely distributed enterprise in which allocation of certain resources,
including IT, are decentralized. Accordingly, neither TCI nor the Company
consolidates an IT budget. Therefore, total estimated year 2000 costs as a
percentage of an IT budget are not available. There are currently no planned IT
projects being deferred due to year 2000 costs.
I-14
<PAGE> 16
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Notes to Consolidated Financial Statements (Continued)
The failure to correct a material year 2000 problem could result in an
interruption or failure of certain important business operations. There can be
no assurance that the Company's systems or the systems of other companies on
which the Company relies will be converted in time or that any such failure to
convert by the Company or other companies will not have a material adverse
effect on its financial position, results of operations or cash flows.
Lease Agreement
On July 17, 1998, DMX entered into a four year transponder lease agreement with
Microspace Communications Corporation beginning January 1, 1999 for the sublease
of transponder space on the Galaxy IIIR Ku-band satellite operated by PanAmSat
Corporation to allow DMX to deliver two channels of DMX music programming
formerly provided by 3M. The aggregate payments over the term of the lease
amount to $1.1 million.
Vendor Commitments
DMX and Scientific-Atlanta, Inc. ("S-A"), had an agreement with respect to the
manufacture, distribution and servicing of the DM-2000 tuners and DMX*DJ's.
DMX was not obligated to purchase or guarantee the purchase of any minimum
number of tuners or DMX*DJ's, and S-A was the exclusive tuner manufacturer
in the United States and Canada and earned a royalty of approximately five
percent (5%) of DMX's premium audio service revenues until August 1996. No
payments are required until DMX achieves "operating break-even", as defined in
the agreement with S-A.
I-15
<PAGE> 17
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Notes to Consolidated Financial Statements
September 30, 1998
(Unaudited)
Accrued Music Rights Royalties
DMX and The Box license rights to re-record and distribute music from a variety
of sources and pay royalties to songwriters and publishers through contracts
negotiated with performing rights societies such as the American Society of
Composers, Authors and Publishers ("ASCAP"), Broadcast Music, Inc. ("BMI") and
the Society of European Stage Authors and Composers ("SESAC"). DMX has separate
agreements with ASCAP, BMI and SESAC for residential and commercial
distribution. The Box has separate agreements with ASCAP, BMI, and various
similar international organizations. Certain of the agreements are being
negotiated on an industry wide basis mainly over new rate structures that may
require retroactive rate increases. DMX and The Box have continued to accrue
royalties that are under negotiations based on their best estimates, after
consultation with counsel and consideration of the terms and rates of the
expired contracts. The Digital Performance Right in Sound Recordings Act of 1995
("1995 Act") establishes the right of owners of the performance rights, such as
the performers and record companies, to control digital transmission of sound
recordings by means of subscription services. The 1995 Act provides a compulsory
license for noninteractive subscription services. An arbitration proceeding
before the United States Copyright Office to determine the statutory license
royalty rate to be paid under the 1995 Act by DMX and other digital music
residential subscription services on services transmitted to non-business
subscribers commenced August 2, 1996. The royalty rate will be retroactive to
February 1996. Effective May 8, 1998 the Librarian of Congress, upon
recommendation of the Register of Copyrights, issued an order setting the
royalty rate at 6.5%. The Recording Industry Association of America ("RIAA") has
appealed the order, and, DMX has been granted the right to intervene. If the
Company is required to pay a license royalty rate on a retroactive basis in
excess of 6.5% as a result of negotiations with the RIAA, no assurance can be
given that such outcome will not have a material adverse effect on the Company's
consolidated financial position, results of operations, or cash flows.
Parent Guarantees
As described in note 4, "Investment in and Disposition of DMX-Europe N.V. and
Subsidiary", DMX-E ceased operations and DMX-E UK was put into receivership on
July 1, 1997 and into liquidation proceedings on July 18, 1997. DMX-Europe N.V.
has been inactive since July 1, 1997, and was placed into receivership on
December 23, 1997. As a result, claims may be filed under the following
guarantees.
The Company has guaranteed certain contracts of DMX-E related to DMX-E's uplink
services agreement and subscriber management services agreement. To the extent
DMX-E is unable to perform under the agreements, certain creditors of DMX-E may
pursue claims against the Company under the guarantees. During the nine months
ended September 30, 1998, the company paid a $1.3 million claim to an affiliated
company under the guaranty of DMX-E's obligation in accordance with another
satellite uplink services agreement. In October 1998, the Company paid $350,000
to settle a separate claim under the guarantee of DMX-E's obligation in
accordance with another satellite uplink service agreement. Such claims are
accrued in the accompanying consolidated statement of operations of DMX for the
six months ended June 30, 1997. The Company has also guaranteed certain other
obligations of DMX-E under the Subscriber Management Services Agreement between
DMX-E and Selco Servicegesellschaft fur elektronische Kommunikation GmbH
("Selco"), and the related side letter agreement (the "Selco Agreement"). The
Company cannot estimate the amount of any potential claims at this time under
such guarantee.
DMX has received a letter from counsel for Selco requesting that DMX make a
proposal to settle claims alleged by Selco for damages in the amount of
approximately $3.5 million with respect to a guaranty by DMX of obligations of
DMX-E N.V. under the Selco Agreement. TCI Music cannot estimate or determine the
extent of any liability, based on the facts available as of the date of this
Form 10-Q, whether Selco will continue to pursue its claims and, if Selco elects
to initiate formal legal proceedings, whether DMX will be held liable for any
material amount.
I-16
<PAGE> 18
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Notes to Consolidated Financial Statements
September 30, 1998
(Unaudited)
Legal Actions
From time to time the Company may be a party to legal actions arising in the
ordinary course of business, including claims by former employees. In the
opinion of the Company's management, after consultation with counsel,
disposition of such matters are not expected to have a material adverse effect
upon the financial position, results of operations or liquidity of the Company.
(10) Proposed Merger
TCI and AT&T Corp. ("AT&T") have agreed to a merger (the "Merger") pursuant to,
and subject to the terms and conditions set forth in, the Agreement and Plan of
Restructuring and Merger, dated as of June 23, 1998. In the Merger, TCI will
become a wholly-owned subsidiary of AT&T.
In addition, TCI has announced its intention, subject to stockholder approval,
to combine the assets and businesses of Liberty Media Group and TCI Ventures
Group (the "Liberty/Ventures Combination"). Assuming the Liberty/Ventures
Combination occurs prior to the Merger, the shares of "Liberty/Ventures Stock"
to be issued in the Merger will be a newly authorized class of common stock of
AT&T which will be intended to reflect the separate performance of the
businesses and assets attributed to the "Liberty/Ventures Group." Subject to
certain asset transfers, the Liberty/Ventures Group following the Merger will be
made up of the corporations, partnerships and other entities and interests,
including TCI Music, which comprise Liberty Media Group and TCI Ventures Group
at the time of the Merger. Certain agreements to be entered into at the time of
the Merger as contemplated by the Merger Agreement will, among other things,
provide preferred vendor status to Liberty/Ventures Group for digital basic
distribution on AT&T's systems of new programming services created by
Liberty/Ventures Group and its affiliates, provide for a renewal of existing
affiliation agreements and provide for the business of the Liberty/Ventures
Group to continue to be managed following the Merger by certain members of TCI's
management who currently manage the businesses of Liberty Media Group and TCI
Ventures Group.
Consummation of the Merger is subject to the satisfaction or waiver of customary
conditions to closing, including but not limited to, the separate approvals of
the stockholders of AT&T and TCI, receipt of all necessary governmental consents
and approvals, and effectiveness of the registration statement registering the
AT&T Common Stock and Liberty/Ventures Stock to be issued to TCI stockholders in
the Merger. As a result, there can be no assurance that the Merger will be
consummated or, if the Merger is consummated, as to the date of such
consummation.
I-17
<PAGE> 19
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Management's Discussion and Analysis of
Financial Condition and Results of Operations
The following discussion and analysis provides information concerning the
results of operations and financial condition of the Company. Due to the
consummation of the DMX Merger on July 11, 1997 and the related change in fiscal
year ends by TCI Music to December 31, 1997, the results of operations include a
transition period. Accordingly, to provide a meaningful basis for comparison,
for the purpose of analysis and discussion, the nine month period ended
September 30, 1998 will be compared with the corresponding period ended
September 30, 1997, and the three month period ended September 30, 1998 will be
compared with the corresponding three month period ended September 30, 1997.
Such discussion should be read in conjunction with the accompanying consolidated
financial statements and notes thereto of the Company. Additionally, the
following discussion and analysis should be read in conjunction with
Management's Discussion and Analysis of Financial Condition and Results of
Operations and financial statements included in Part IV of the Company's Annual
Report on Form 10-K for the year ended December 31, 1997. The following
discussion focuses on material trends, risks and uncertainties affecting the
results of operations and financial condition of the Company.
Certain statements in this Quarterly Report on Form 10-Q constitute
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. In particular, some of the statements contained
under this caption are forward-looking. Such forward-looking statements involve
known and unknown risks, uncertainties and other important factors that could
cause the actual results, performance or achievements of the Company to differ
materially from future results, performance, or achievements expressed or
implied by such forward-looking statements. Such risks, uncertainties and other
factors include, among others: general economic and business conditions and
industry trends; the regulatory and competitive environment of the industries in
which the Company has interests or operations; uncertainties inherent in new
business strategies; uncertainties inherent in the changeover to year 2000,
including the Company's projected state of readiness, the projected cost of
remediation, the expected date of completion of each program or phase, the
projected worst case scenarios; and the expected contingency plans associated
with such worst case scenarios; new product launches and development plans;
rapid technological changes; development and provisions of programming for new
television and telecommunications technologies; future financial performance,
including availability, terms and deployment of capital; the ability of vendors
to deliver required equipment, software and services; availability of qualified
personnel; changes in, or failure or inability to comply with, government
regulations; changes in the nature of key strategic relationships with partners
and joint venturers; competitor responses to the Company's products and
services, and the products and services of the entities in which the Company has
interests, and the overall market acceptance of such products and services; and
the factors described under "Risk Factors" in the Company's Annual Report on
Form 10-K for the year ended December 31, 1997. These forward-looking statements
(and such risks, uncertainties and other factors) speak only as of the date of
this Report, and the Company expressly disclaims any obligation or undertaking
to disseminate any updates or revisions to any forward-looking statement
contained herein to reflect any change in the Company's expectations with regard
thereto, or any other change in events, conditions or circumstances on which any
such statement is based. Any statement contained within Management's Discussion
and Analysis of Financial Condition and Results of Operations related to year
2000 are hereby denominated as "Year 2000 Statements" within the meaning of the
Year 2000 Information and Readiness Disclosure Act.
TCI Music's assets include businesses which are principally engaged in: (i)
programming, distributing, and marketing continuous commercial-free compact
disc-quality music programming; (ii) programming, distributing, and marketing an
interactive music video television programming service; and (iii) distributing
and marketing music entertainment products through traditional and
non-traditional channels.
I-18
<PAGE> 20
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Year 2000
During the three months ended September 30, 1998, TCI continued its
enterprise-wide comprehensive efforts to assess and remediate its computer
systems and related software and equipment to ensure such systems, software and
equipment recognize, process and store information in the year 2000 and
thereafter. The Company's year 2000 remediation efforts include an assessment of
its most critical systems, equipment, and facilities. The Company also continued
its effort to verify the year 2000 readiness of its significant suppliers and
vendors and continued to communicate with significant business partners to
assess such partners' year 2000 status.
TCI formed a year 2000 Program Management Office (the "PMO") to organize and
manage the Company's year 2000 remediation efforts. The PMO is responsible for
overseeing, coordinating and reporting on the Company's year 2000 remediation
efforts. It is comprised of 90 member full-time staff and is accountable to
executive management of TCI.
The PMO has defined a four-phase approach to determining the year 2000 readiness
of the Company's systems, software and equipment. Such approach is expected to
provide a detailed method for tracking the evaluation, repair and testing of
Company's systems, software and equipment. Phase 1, Assessment, involves the
inventory of all systems, software and equipment and the identification of any
year 2000 issues. Phase 1 also includes the preparation of the work plans needed
for remediation. Phase 2, Remediation, involves repairing, upgrading and/or
replacing any non-compliant equipment and systems. Phase 3, Testing involves
testing the Company's systems, software and equipment for year 2000 readiness,
or in certain cases, relying on test results provided to the Company. Phase 4,
Implementation, involves placing compliant systems, software and equipment into
production or service.
At September 30, 1998, Company's overall progress by phase was as follows:
<TABLE>
<CAPTION>
Percent of All Expected
Phase Equipment/Systems in Phase* Completion Date
----- --------------------------- ---------------
<S> <C> <C>
Phase 1-Assessment 100% December 1998
Phase 2-Remediation 95% March 1999
Phase 3-Testing 4% June 1999
Phase 4-Implementation 0% July 1999
</TABLE>
- -------------------------
*Percentages do not total 100% since projects have elements in more than one
phase. For the purposes of this table, such projects have been attributed to
each applicable phase. In addition the percentages set forth above are based on
the number of projects in each phase compared to the total number of year 2000
projects.
The completion dates set forth above are based on the Company's current
expectations. However, due to the uncertainties inherent in year 2000
remediation, no assurances can be given as to whether such projects will be
completed on such dates.
The Company is completing an inventory of its important systems with embedded
technologies and is currently determining the correct remediation approach. The
embedded technologies assessments are expected to be completed by December of
1998.
During the three months ended September 30, 1998, the Company continued its
survey of significant third-party vendors and suppliers whose systems, services
or products are important to the Company's operations. The year 2000 readiness
of such providers is critical to continued provision of Company's services. The
Company has received information that the most critical systems, services or
products supplied to the Company by third parties are either year 2000 ready or
are expected to be year 2000 ready by mid-1999. The Company is currently
developing contingency plans for systems provided by vendors who have not
responded to the Company's surveys.
In addition to the survey process described above, management of the Company has
identified its most critical supplier/vendor relationships and has instituted a
verification process to determine the vendors' year 2000 readiness. Such
verification includes, as deemed necessary, reviewing vendors' test and other
data and engaging in regular conferences with vendors' year 2000 team. The
Company is also requiring testing to validate the year 2000 compliance of
certain critical products and services and is contracting with independent
consultants to conduct such testing.
I-19
<PAGE> 21
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Year 2000 expenses and capital expenditures incurred in the three and nine
months ended September 30, 1998 were immaterial. Management of the Company
currently estimates the remaining costs to be not less than $600,000, bringing
the total estimated cost associated with the Company's year 2000 remediation
efforts to not less than $600,000, including the replacement cost of
noncompliant Information Technology Support ("IT") systems. Included in this
estimate is the Company's pro rata share of the $9 million in future payments to
be made by TCI pursuant to unfulfilled executory contracts or commitments with
vendors for year 2000 remediation services. Although no assurances can be given,
management currently expects that (i) cash flow from operations will fund the
costs associated with year 2000 compliance and (ii) the total projected cost
associated with the Company's year 2000 program will not be material to the
Company's financial position, results of operations or cash flows.
TCI is a widely distributed enterprise in which allocation of certain resources,
including IT, are decentralized. Accordingly, neither TCI nor the Company
consolidates an IT budget. Therefore, total estimated year 2000 costs as a
percentage of an IT budget are not available. There are currently no planned IT
projects being deferred due to year 2000 costs.
The failure to correct a material year 2000 problem could result in an
interruption or failure of certain important business operations. Management
believes that its year 2000 program will significantly reduce the Company's
risks associated with the changeover to the year 2000 and has implemented
certain contingency plans to minimize the effect of any potential year 2000
related disruptions. The risks and the uncertainties discussed below and the
associated contingency plans relate to systems, software, equipment, and
services that the Company has deemed critical in regard to customer service,
business operations, financial impact or safety.
The failure of certain signal origination equipment or software could disrupt
the delivery of DMX's services to customers and could necessitate crediting
customers for failure to receive such premium services. In this event,
management expects that it will transmit repetitive programming until the
problem is resolved. Further, a failure of certain hardware and software could
disrupt the delivery of the BOX service. Management anticipates that it could
resolve the issue by manual intervention until the situation were corrected.
A failure of the services provided by billing systems service providers could
result in a loss of customer records which could result in a disruption in the
ability to bill customers for a protracted period. The Company plans to prepare
electronic backup records of its customer billing information prior to the year
2000 to allow for data recovery. In addition, the Company continues to monitor
the year 2000 readiness of its key customer billing suppliers.
Security and fire protection systems failure could leave facilities vulnerable
to intrusion and fire. The Company expects to return such systems to normal
functioning by turning the power off and then on again ("power off/on"). The
Company also plans to have additional security staff on site and plans to
implement a backup plan for communicating with local fire and police
departments. Also, certain personal computers interface and control elevators,
escalators, wireless systems, public access systems and certain telephony
systems. In the event such computers cease operating, conducting a power off/on
is expected to resume normal functioning. If a power off/on does not resume
normal functioning, management expects to resolve the problem by resetting the
computer to a pre-designated date which precedes the year 2000.
In the event that the local public utility cannot supply power, the Company
expects to supply power for a limited time to its office sites through backup
generators.
The financial impact of any or all of the above worst-case scenarios has not
been and cannot be estimated by the Company due to the numerous uncertainties
and variables associated with such scenarios.
The Company does not presently anticipate that there will be material losses
from any claims of breach of contract due to year 2000 issues.
I-20
<PAGE> 22
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
Revenue
Total revenue, increased to $62.7 million for the nine months ended September
30, 1998 from $21.9 million for the nine months ended September 30, 1997. The
$40.8 million increase was attributed to $10.1 million of revenue from sales of
DMX services to TCI's residential and commercial subscribers (the "Annual TCI
Payments") as a result of the DMX Merger and pursuant to a Contribution
Agreement dated July 11, 1997, as amended by the Amended and Restated
Contribution Agreement (the "Amended Contribution Agreement"), $18.5 million of
viewer, advertising, and other revenue from The Box as a result of The Box
Merger which was effective December 16, 1997, $2.4 million of other revenue as a
result of the Paradigm Merger which was effective December 31, 1997, and
increased subscriber revenue of $8.6 million from DMX primarily resulting from
continued growth in its residential and commercial subscriber bases and
expansion into and acquisitions of businesses in seven new markets, which
occurred in the last quarter of the fiscal year 1997 through the nine months
ended September 30, 1998. In the last quarter of the fiscal year 1997, DMX
expanded its owned and operated commercial sales business to Miami, Florida,
Atlanta, Georgia, and Phoenix, Arizona. During the nine months of 1998, DMX
acquired owned and operated operations in Massachusetts, Minnesota, Northern
California and Chicago. Additionally, DMX increased other revenue by $2.7
million primarily from equipment and installation sales attributable to the
increased subscriber base. Offsetting the increase in revenue was $1.5 million
resulting from the de-consolidation of DMX-Europe N.V. as of September 30, 1997.
Total revenue increased to $22.4 million for the three months ended September
30, 1998 from $10.4 million for the three months ended September 30, 1997. The
$12.0 million increase was attributed to $7.1 million of viewer, advertising,
and other revenue from The Box as a result of the Box Merger, $900,000 of other
revenue as a result of the Paradigm Merger, and increased subscriber revenue of
$2.8 million from DMX primarily resulting from growth in its commercial
subscriber base and expansion into new markets as described above. Additionally,
DMX increased other revenue by $1.2 million primarily from equipment and
installation sales attributable to the increased subscriber base.
Operating Expenses
Operating expenses, exclusive of DMX-E NV operating expenses of $5.4 million for
the nine months ended September 30, 1997, increased to $16.5 million for the
nine months ended September 30, 1998 from $8.6 million for the nine months ended
September 30, 1997. The $7.9 million increase was comprised of the increase in
related party operating expenses of $2.2 million, which represented fees of $1.0
million paid to TCI as compensation for services rendered in generating the
Annual TCI Payments pursuant to the Amended Contribution Agreement and The Box
payment of a related party charge for uplink and affiliated fees amounting to
$1.2 million, and an increase in operating expenses - other of $5.7 million
which represented the inclusion of The Box and Paradigm operating expenses of
$5.4 million and $600,000, respectively, and a decrease of $300,000 resulting
from a reduction in other expenses of DMX for the current period.
Operating expenses increased to $5.4 million for the three months ended
September 30, 1998 from $2.9 million for the three months ended September 30,
1997. The $2.5 million increase was comprised of The Box payment of a related
party charge of $500,000 for uplink and affiliate fees, and an increase in
operating expenses - other of $2.0 million which represented the inclusion of
the Box and Paradigm operating expenses of $2.1 million and $200,000,
respectively, and a decrease of $300,000 resulting from a reduction in other
expenses of DMX for the current period.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased to $41.4 million for the
nine months ended September 30, 1998 from $10.0 million for the nine months
ended September 30, 1997. The $31.4 million increase primarily represented
additional corporate expenses of $3.0 million as a result of expansion of the
Company, The Box and Paradigm selling, general and administrative expenses of
$16.4 million and $7.1 million, respectively, and an increase in DMX selling,
I-21
<PAGE> 23
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
general and administrative expenses of $4.9 million attributed to the increase
in personnel, occupancy and promotional expenses associated with DMX's growth in
subscriber revenues and expansion related to the commercial businesses' seven
market launch.
Selling, general and administrative expenses increased to $15.0 million for the
three months ended September 30, 1998 from $2.6 million for the three months
ended September 30, 1997. The $12.4 million increase primarily represented
additional corporate expenses of $1.1 million as a result of expansion of the
Company, The Box and Paradigm selling, general and administrative expenses of
$5.7 million and $2.6 million, respectively, and an increase in DMX selling,
general and administrative expenses of $3.0 million, attributed to the increase
in personnel, occupancy and promotional expenses associated with DMX's growth in
subscriber revenues and expansion related to the commercial businesses' seven
market launch.
Depreciation and Amortization
Depreciation and amortization expense increased to $17.3 million for the nine
months ended September 30, 1998 from $4.2 million for the nine months ended
September 30, 1997. Such increase is primarily attributable to an increase in
the balance of property and equipment and intangibles resulting from the DMX
Merger, the Box Merger, the Paradigm merger, and the acquisitions made by DMX
during 1998. Depreciation and amortization expense increased to $6.5 million for
the three months ended September 30, 1998 from $3.0 million for the three months
ended September 30, 1997. Such increase is primarily attributable to an increase
in the balance of property and equipment and intangibles resulting from the DMX
Merger, the Box Merger, the Paradigm Merger, and the acquisitions made by DMX
during 1998.
Inventory Writedown
During the second quarter of 1998, certain digital commercial tuners were
written down by $1.1 million as a result of physical inventory adjustments at
the field locations and pricing adjustments to lower of cost or market.
Operating Expenses and Disposal of DMX-E
DMX-E NV and DMX-E UK ceased operations on July 1, 1997. DMX-E UK was placed
into receivership on July 1, 1997 and into liquidation proceedings on July 18,
1997. DMX-E NV has been inactive since July 1, 1997 and entered liquidation
proceedings in December 1997. DMX-E has been de-consolidated since June 30,
1997. The loss on disposal of DMX-E of $1.7 million recorded for the nine months
ended September 30, 1997 represented the writedown of assets to their net
realizable values.
Liquidity and Capital Resources
The decrease in cash of $2.0 million for the nine months ended September 30,
1998 was the net result of funds used in operating activities of $5.6 million
and net funds provided by financing activities of $26.7 million offset by cash
used in investing activities of $23.0 million, including the growth and
acquisitions of the owned and operated commercial subscriber businesses which
expanded the DMX business into seven new markets. For additional information
concerning the cash flow of TCI Music, see the consolidated cash flow statement
included in the accompanying consolidated financial statements. A significant
portion of the Company's revenue is derived from the Annual TCI Payments. For
additional information concerning the Annual TCI Payments, see note 5 to the
accompanying consolidated financial statements. TCI Music believes that cash
provided by the Annual TCI Payments and the available capacity of $12.5 million,
pursuant to the Revolving Loan Agreement as of September 30, 1998 will provide
adequate sources of liquidity for the next year. For additional information
concerning the Revolving Loan Agreement, see note 7 to the accompanying
consolidated financial statements.
I-22
<PAGE> 24
TCI MUSIC, INC. AND SUBSIDIARIES
(A Subsidiary of Tele-Communications, Inc.)
At September 30, 1998, the Company had $87.5 million of variable-rate debt.
Accordingly, in an environment of rising interest rates, the Company expects
that it would experience an increase in interest expense.
As described in notes 4 and 9 to TCI Music's consolidated financial statements
and as discussed above, DMX-E has ceased operations on July 1, 1997. DMX-E UK
was placed into receivership on July 1, 1997 and into liquidation proceedings on
July 18, 1997. DMX-E NV entered into liquidation proceedings in December 1997.
During the nine months ended September 30, 1998, the company paid a $1.3 million
claim to an affiliated company under the guaranty of DMX-E's obligation in
accordance with a satellite uplink services agreement. Such claim is reflected
in the accompanying consolidated statement of operations for the nine months
ended September 30, 1997.
As described in note 9 to TCI Music's consolidated financial statements, the
Company accrues music rights royalties at 6.5 percent payable to Recording
Industry Association of America (RIAA). If the company is required to pay a
license royalty rate on a retroactive basis in excess of 6.5 percent as a result
of negotiations with the RIAA, no assurance can be given that such outcome will
not have a material adverse effect on the Company's consolidated financial
position, results of operations, or cash flows. For additional information
concerning other commitments and contingencies of the Company, see note 9 to the
accompanying consolidated financial statements.
I-23
<PAGE> 25
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits -
(27) TCI Music, Inc. Financial Data Schedule
(b) Reports on Form 8-K filed during the quarter ended September 30, 1998:
None.
<PAGE> 26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TCI MUSIC, INC.
Date: November 12, 1998 By: /s/ Thomas McPartland
--------------------------------------
Thomas McPartland
President and
Chief Executive Officer
Date: November 12, 1998 By: /s/ Ralph J. Sorrentino
--------------------------------------
Ralph J. Sorrentino
Executive Vice President and
Chief Financial Officer
<PAGE> 27
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------ ----------------------
(27) TCI Music, Inc. Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 5,949,735
<SECURITIES> 0
<RECEIVABLES> 14,296,534
<ALLOWANCES> 958,758
<INVENTORY> 6,901,743
<CURRENT-ASSETS> 28,239,985
<PP&E> 26,007,592
<DEPRECIATION> 5,044,731
<TOTAL-ASSETS> 214,108,210
<CURRENT-LIABILITIES> 29,186,246
<BONDS> 88,179,802
0
33,985,627
<COMMON> 813,586
<OTHER-SE> 57,792,663
<TOTAL-LIABILITY-AND-EQUITY> 214,108,210
<SALES> 62,721,067
<TOTAL-REVENUES> 62,721,067
<CGS> 0
<TOTAL-COSTS> 76,697,622
<OTHER-EXPENSES> 217,114
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,974,012
<INCOME-PRETAX> (18,167,680)
<INCOME-TAX> (2,402,769)
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (15,764,911)
<EPS-PRIMARY> .21
<EPS-DILUTED> .21
</TABLE>
