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, 2000.
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
333-78571-01
MUZAK LLC
MUZAK FINANCE CORP.
(Exact Name of Registrants as Specified in their charter)
DELAWARE 04-3433729
DELAWARE 56-2187963
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporated or Organization)
3318 Lakemont Boulevard
Fort Mill, South Carolina 29708
(803) 396-3000
(Address, Including Zip Code and Telephone Number including Area Code of
Registrants' Principal Executive Offices)
5550 77 Center Drive
Suite 380
Charlotte, NC 28217
(Former Name, Former Address and Former Fiscal Year, if Changed
Since Last Report)
Indicate by check mark whether the registrants have filed 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) have been subject to
such filing requirements for the past 90 days.
Yes [ X ] No [ ]
Muzak Finance Corp meets the conditions set forth in General Instruction H(1)
(a) and (b) of Form 10-Q and is therefore filing this form with the reduced
disclosure format.
Muzak Finance Corp had 100 shares of outstanding common stock as of November 14,
2000.
<PAGE>
PART I- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
MUZAK LLC
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<S> <C> <C>
September 30, December 31,
2000 1999
(unaudited)
---------------------- ---------------------
ASSETS
Current assets:
Cash and cash equivalents.................................. $ 5,614 $ 2,275
Accounts receivable, net................................... 50,085 39,203
Inventory.................................................. 10,845 12,283
Prepaid expenses and other assets.......................... 3,009 2,304
----- -----
Total current assets................................... 69,553 56,065
Property and equipment, net..................................... 106,169 95,050
Intangible assets, net.......................................... 321,259 314,364
Deferred charges and other assets, net.......................... 41,413 28,795
------ ------
Total assets........................................... $ 538,394 $ 494,274
========== =========
LIABILITIES AND MEMBER'S INTEREST
Current liabilities:
Revolving credit facility.................................. $ 34,683 $ 25,000
Current maturities of long term debt....................... 4,432 4,197
Current maturities of other liabilities.................... 2,227 1,394
Accounts payable........................................... 17,503 15,123
Accrued expenses........................................... 19,116 34,433
Advance billings........................................... 11,994 11,171
------ ------
Total current liabilities.............................. 89,955 91,318
Long-term debt.................................................. 312,422 278,917
Related party notes............................................. 30,000 30,000
Other liabilities............................................... 18,496 9,798
Commitments and contingencies (Note 10).........................
Member's interest:
Common units (100 issued and
outstanding)............................................. 144,018 107,124
Accumulated deficit...................................... (56,497) (22,883)
-------- --------
Total member's interest................................ 87,521 84,241
------ ------
Total liabilities and member's interest................ $ 538,394 $ 494,274
========== ========
</TABLE>
The Notes to Consolidated Financial Statements are an integral part of these
consolidated financial statements.
2
<PAGE>
MUZAK LLC
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands)
<TABLE>
<S> <C> <C> <C> <C>
Quarter Ended Nine Months Ended
------------------------------------ ------------------------------------
September 30, September 30, September 30, September 30,
2000 1999 2000 1999
------------------------------------ ------------------------------------
Revenues:
Music and other business services............. $ 34,854 $ 28,328 $ 101,948 $ 62,456
Equipment and related services................ 15,005 11,927 39,622 25,468
------ ------ ------ ------
Total revenues............................ 49,859 40,255 141,570 87,924
Cost of revenues:
Music and other business services............. 7,125 6,129 22,415 13,366
Equipment and related services................ 10,838 9,259 29,493 19,981
------ ----- ------ ------
Total cost of revenues.................... 17,963 15,388 51,908 33,347
------ ------ ------ ------
Gross profit.............................. 31,896 24,867 89,662 54,577
------ ------ ------ ------
Selling, general and administrative expenses....... 16,057 13,438 46,507 28,268
Depreciation and amortization expense.............. 16,196 11,255 45,685 23,594
------ ------ ------ ------
Income (loss) from operations............. (357) 174 (2,530) 2,715
Other income (expense):
Interest expense, net......................... (10,668) (7,480) (30,600) (16,105)
Other, net.................................... (72) 154 (501) 133
------- ------- -------- --------
Loss before income taxes.................. (11,097) (7,152) (33,631) (13,257)
Income tax benefit................................. (78) -- (17) --
--------- --------- --------- ---------
Net loss.................................. $ (11,019) $ (7,152) $ (33,614) $ (13,257)
========== ========= ========== ==========
</TABLE>
The Notes to Consolidated Financial Statements are an integral part of these
consolidated financial statements.
3
<PAGE>
MUZAK LLC
CONSOLIDATED STATEMENT OF CHANGES IN MEMBER'S INTEREST
(Unaudited)
(in thousands, except for units)
<TABLE>
<S> <C> <C> <C> <C>
Total
Common Units Accumulated Member's
Outstanding Dollars Deficit Interest
---------------------------------------------------------------------
Balance at December 31, 1999....................... 100 $ 107,124 $ (22,883) $ 84,241
Additional capital contributed..................... -- 36,894 -- 36,894
Net loss .......................................... -- -- (33,614) (33,614)
----- ------------ -------- --------
Balance at September 30, 2000...................... 100 $ 144,018 $ (56,497) $ 87,521
=== ========= ========= ========
</TABLE>
The Notes to Consolidated Financial Statements are an integral part of these
consolidated financial statements.
4
<PAGE>
MUZAK LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
--------------------------- ---------------------------
September 30, September 30, September 30, September 30,
2000 1999 2000 1999
--------------------------- ---------------------------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss................................................................. $(11,019) $(7,152) $(33,614) $ (13,257)
Adjustments to derive cash flow from operating activities:
Deferred income tax benefit ............................................ (298) -- (283) --
Depreciation and amortization............................................ 16,196 11,255 45,685 23,594
Amortization of deferred financing fees.................................. 387 289 1,133 614
Deferred subscriber acquisition costs.................................... (3,062) (2,907) (9,185) (4,342)
Unearned installment income.............................................. (195) 208 (367) 208
Net change in certain assets and liabilities, net of business
acquisitions:
Increase in accounts receivable....................................... (7,459) (5,253) (10,630) (9,590)
Decrease (increase) in inventory ..................................... (560) (1,345) 634 (972)
Increase (decrease) in accrued interest............................... (2,678) (3,362) (3,096) 4,292
Increase (decrease) in accounts payable .............................. (3,293) (6,261) 2,380 (12,548)
Increase (decrease) in accrued expenses............................... 2,921 6,031 (6,112) 4,959
Increase (decrease) in advance billings............................... (310) (93) 823 1,018
Other, net............................................................ (1,801) (690) (1,626) 932
------- -------- -------- -------
NET CASH USED IN OPERATING ACTIVITIES............................... (11,171) (9,280) (14,258) (5,092)
-------- ------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisitions, net of cash................................................ -- (9,578) (34,198) (281,491)
Capital expenditures..................................................... (9,323) (8,802) (29,393) (16,824)
------- ------- -------- --------
NET CASH USED IN INVESTING ACTIVITIES............................... (9,323) (18,380) (63,591) (298,315)
------- -------- -------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of senior subordinated notes...................... -- -- -- 115,000
Proceeds from borrowings under senior credit facility.................... -- 30,000 -- 165,000
Repayments of senior credit facility..................................... -- -- (1,800) --
Net borrowing (repayment) on revolving loan.............................. -- (2,900) 9,683 16,500
Proceeds from issuance of floating rate notes............................ -- -- 36,000 --
Proceeds from interest rate swap......................................... -- -- 4,364 --
Proceeds from contributions by Parent.................................... 20,000 951 35,636 60,951
Net borrowing (repayment) of notes payable to related party.............. -- 3,000 -- (38,683)
Repayments of capital lease obligations and other debt................... (440) (2,323) (1,526) (3,140)
Payment of financing fees................................................ (421) -- (1,169) (10,164)
------- ------- ------- --------
NET CASH PROVIDED BY FINANCING ACTIVITIES........................... 19,139 28,728 81,188 305,464
------- ------- ------- -------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS..................... (1,355) 1,068 3,339 2,057
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD........................... 6,969 2,282 2,275 1,293
------- ------- ------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD................................ $ 5,614 $ 3,350 $ 5,614 $ 3,350
======= ======= ======= =======
Significant non-cash investing activities:
Equity contribution from Parent -- -- 1,258 18,723
</TABLE>
The Notes to Consolidated Financial Statements are an integral part of these
consolidated financial statements.
5
<PAGE>
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
Muzak LLC ("the Company"), a Delaware limited liability company, was
formed on August 28, 1998 as ACN Operating LLC and in October 1998 changed its
name to Audio Communications Network, LLC ("ACN"). On October 7, 1998, ACN
commenced operations with its acquisition of the independent franchisees in the
Baltimore, Charlotte, Hillsborough, Kansas City, St. Louis, Jacksonville,
Phoenix, and Fresno areas from Audio Communications Network, Inc. (the
"Predecessor Company"). On March 18, 1999, Muzak Limited Partnership ("Old
Muzak") merged with and into ACN. At the time of the merger, ACN changed its
name to Muzak LLC.
The Company is a wholly owned subsidiary of Muzak Holdings LLC (the
"Parent"), previously known as ACN Holdings, LLC. As of September 30, 2000, ABRY
Partners, LLC and its respective affiliates collectively owned approximately 66%
of the voting interests in the Parent. All of the operating activities are
conducted through the Company and its subsidiaries.
The Company derives the majority of its revenues from the sale of
business music products. The core products are Audio Architecture and Audio
Marketing. In addition, the Company produces a complementary product, Video
Imaging. The Company produces its Video Imaging product through an arrangement
with an outside vendor. These revenues are generated by clients, who pay monthly
subscription fees under noncancelable five-year contracts.
The Company also derives revenues from the sale and lease of audio
system-related products, principally sound systems and intercoms, to business
music clients and other clients. In addition, the Company sells electronic
equipment, such as proprietary tape playback equipment and other audio and video
equipment to franchisees to support the sale of business music services.
Installation, service and repair revenues consist principally of revenues from
the installation of sound systems and other equipment that is not expressly part
of a business music contract, such as paging, security and drive-through
systems. These revenues also include revenue from the installation, service and
repair of equipment installed under a business music contract. Music contract
installation revenues are deferred and recognized over the term of the
respective contracts.
2. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the
Company and its subsidiaries: Muzak Capital 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 significant
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.
For further information, refer to the consolidated financial statements and
footnotes thereto included in the Muzak LLC Annual Report on Form 10-K/A for the
fiscal year ended December 31, 1999.
The financial statements as of September 30, 2000 and September 30,
1999 and for the three and nine month periods 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 nine months
ended September 30, 1999 include operating results of ACN for the period from
January 1, 1999 to March 17, 1999, and for Muzak LLC for the period from March
18, 1999 to December 31, 1999. Results of operations for interim periods are not
necessarily indicative of results for the full year.
6
<PAGE>
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. ACQUISITIONS
As discussed in Note 1, on March 18, 1999 Old Muzak merged with and
into ACN. Under the terms of the agreement, the Company paid total consideration
of $274.2 million, which is comprised of the following: $125.5 million cash
consideration, $114.9 million consideration in the tender offer and consent
solicitation for the 10% Senior Notes due 2003 of Old Muzak, $15.9 million for
debt repayment of Old Muzak outstanding obligations, and $17.9 million of other
assumed obligations. In addition, at the time of the merger, the Company repaid
$41.7 million borrowed from ABRY Broadcast Partners by ACN in October 1998 in
connection with the acquisition of the Company's independent franchisees from
the Predecessor Company and converted $0.7 million into voting units of the
Parent.
In 1999, prior to the merger, the Company made the following
acquisitions:
On January 15, 1999, the Company acquired all of the outstanding stock of
Business Sound, Inc. for approximately $4.1 million. Business Sound was the
Company's independent franchisee for the New Orleans, Louisiana and Mobile,
Alabama areas.
On February 24, 1999, the Company acquired all of the outstanding stock of
Electro Systems for approximately $0.7 million, and assumed certain
non-recourse debt of $2.4 million. Electro Systems was the Company's
independent franchisee located in Panama City, Florida.
The Company made twenty-one acquisitions between the merger on March 18,
1999 and September 30, 2000. The table below provides information regarding
these acquisitions (in millions, except for number of Parent units).
<TABLE>
<S> <C> <C> <C> <C>
Purchase Acquired Assets Acquired Acquired
Date Price (1) Or Stock Business Markets
----------------------- ---------- ---------------------------------------- ----------------------- ------------------------
March 18,1999 $18.1 (2) Net assets of Capstar Broadcasting Independent franchisee Georgia, Florida
Corporation's independent franchisee
April 1, 1999 $0.2 Net assets of Custom On Hold Services Audio Marketing Washington
Inc.
May 1,1999 $3.2 (3) Net assets of Capstar Broadcasting Independent franchisee Nebraska
Corporation's independent franchisee
June 1, 1999 $6.9 Net assets of Advertising on Hold, Inc. Audio Marketing Florida, Georgia, North
Carolina
July 1, 1999 $0.8 Net assets of CustomTronics Sound Business Music California
July 1, 1999 $0.9 Net assets of Penobscot Broadcasting Independent franchisee Maine
Corporation
July 26, 1999 $1.3 Net assets of LaBov and Beyond, Inc. Audio Marketing Indiana
August 1, 1999 $3.5 Net assets of US West Communications Audio Marketing National
Services, Inc.'s Please Hold Promotions
September 1, 1999 $4.7 Stock of Broadcast International, Inc. Business Music National
October 1, 1999 $10.3 Net assets of Midwest Systems and Business Music Illinois, Indiana, Ohio,
Services, Inc. West Virginia
November 1, 1999 $2.9 Net assets of A & D Music, Inc. Independent franchisee Oregon
November 1, 1999 $7.9 (4) Stock of Audio Environment, Inc. and Independent franchisee California
Background Music Broadcasters Inc.
December 1, 1999 $13.2 (5) Net assets of MountainWest Audio, Inc. Independent franchisee Utah, Idaho, Washington
</TABLE>
7
<PAGE>
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. Acquisitions (Continued)
<TABLE>
<S> <C> <C> <C> <C>
Purchase Acquired Assets Acquired Acquired
Date Price (1) Or Stock Business Markets
----------------------- ---------- ---------------------------------------- ----------------------- ------------------------
February 2, 2000 $0.4 Net assets of Quincy Broadcasting Independent franchisee Illinois
Company
February 2, 2000 $0.9 Net assets of General Communications Audio Marketing Indiana, Georgia,
Corporation ("On Hold America") Florida, Ohio
February 2, 2000 $0.4 Net assets of Texas Sound Co. Ltd. Business Music Texas
February 24, 2000 $3.7 Stock of Telephone Audio Productions, Audio Marketing National
Inc.
March 24, 2000 $9.2 (6) Stock of Vortex Sound Communications Independent franchisee District of Columbia
Company, Inc.
March 31, 2000 $1.6 Net assets of Dynamic Sound Independent franchisee Nevada, California
March 31, 2000 $8.3 Stock of Muzak Houston, Inc. Independent franchisee Texas
April 11, 2000 $1.0 Net assets of Audio Plus, Inc. Independent franchisee Ohio
</TABLE>
(1) The purchase price does not include transaction costs.
(2) The Parent acquired Capstar Broadcasting Corporation's ("Capstar")
independent franchisees located in Atlanta, Albany, and Macon, Georgia,
and Ft. Myers, Florida. The total consideration was accounted for as an
equity contribution to the Company and included 13,535 Class A units of
the Parent.
(3) The Parent acquired Capstar's independent franchisee located in Omaha,
Nebraska. The total consideration was accounted for as an equity
contribution to the Company and included 2,385 Class A units of the Parent.
(4) Total purchase price included 100 Class A units of the Parent.
(5) The Company paid $3.1 million of the purchase price of Mountain West Audio,
Inc. as of December 31, 1999. In February 2000, the Company paid the
remaining purchase price, which included 456 Class A units of the Parent.
(6) Total purchase price included 802 Class A units of the Parent.
The results of operations of the acquired companies are included in the
Company's consolidated statement of operations for the periods in which they
were owned by the Company.
The acquisitions were accounted for under the purchase method of
accounting. Accordingly, the consideration was allocated to the net assets
acquired based on the fair market values at the date of acquisition. The excess
of purchase price for each acquisition over the estimated fair value of the
tangible and identifiable intangible assets acquired approximated $11.1 million
and $127.9 million for the nine months ended September 30, 2000 and the year
ended December 31, 1999, respectively, and is being amortized over a period of
twenty years on a straight-line basis.
The following presents the unaudited pro forma results assuming that
the acquisitions discussed above had occurred as of the beginning of fiscal 2000
and 1999. These pro forma results are not necessarily indicative of the results
that will occur in future periods (in thousands).
<TABLE>
Quarter Ended Nine Months Ended
September 30, 2000 September 30, 1999 September 30, 2000 September 30, 1999
------------------ ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
Revenues............................... $ 49,859 $46,986 $143,639 $133,927
Income (Loss) from operations.......... (357) 1,521 (2,200) 870
Net loss............................... (11,019) (6,913) (33,864) (23,590)
</TABLE>
8
<PAGE>
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. DEFERRED CHARGES AND OTHER ASSETS, NET
Deferred charges and other assets, net, consist of the following (in thousands):
<TABLE>
<S> <C> <C>
September 30, December 31,
2000 1999
(Unaudited)
------------------ ---------------------
Capitalized Commissions....................................... $27,154 $17,969
Other......................................................... 14,259 10,826
------ ------
$41,413 $28,795
======= =======
</TABLE>
5. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
<TABLE>
<S> <C> <C> <C>
Useful September 30, December 31,
Life 2000 1999
(years) (Unaudited)
---------- ---------------- ----------------
Equipment provided to subscribers.......................... 4-6 $ 92,672 $ 72,598
Capitalized installation labor............................. 5 27,837 18,270
Other...................................................... 3-30 25,890 22,606
--------- --------
146,399 113,474
Less accumulated depreciation.............................. (40,230) (18,424)
--------- ---------
$106,169 $ 95,050
========= =========
</TABLE>
Depreciation expense was $8.0 million and $22.0 million for the quarter and nine
months ended September 30, 2000, respectively, and $5.7 million and $11.0
million for the quarter and nine months ended September 30, 1999, respectively.
6. INTANGIBLE ASSETS
Intangible assets consist of the following (in thousands):
<TABLE>
<S> <C> <C> <C>
Useful September 30, December 31,
Life 2000 1999
(years) (Unaudited)
---------- ---------------- ----------------
Goodwill................................................. 20 $154,231 $ 143,094
Income producing contracts............................... 8-14 148,624 136,184
License agreements....................................... 20 5,082 5,082
Trademarks............................................... 5 14,895 14,866
Non-compete agreements................................... 2-7 22,286 16,401
Other.................................................... 5-20 19,556 18,430
--------- ----------
364,674 334,057
Less accumulated amortization............................ (43,415) (19,693)
--------- ----------
$321,259 $ 314,364
========= ==========
</TABLE>
Amortization expense was $8.2 million and $23.7 million for the quarter and nine
months ended September 30, 2000, respectively, and $5.6 million and $12.6
million for the quarter and nine months ended September 30, 1999, respectively.
9
<PAGE>
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. DEBT
Debt obligations consist of the following (in thousands):
<TABLE>
<S> <C> <C>
September 30, December 31,
2000 1999
(Unaudited)
------------------ ---------------------
Revolving loan- Senior Credit Facility........................ $ 34,683 $ 25,000
====== ======
Related Party Notes........................................... 30,000 30,000
====== ======
Long term debt:
Senior Credit Facility...................................... 163,200 165,000
Senior Notes................................................ 115,000 115,000
Floating Rate Notes......................................... 36,000 -
Other....................................................... 2,654 3,114
--------- ---------
Total debt obligations........................................ 316,854 283,114
Less current maturities....................................... (4,432) (4,197)
--------- ---------
$ 312,422 $ 278,917
========= =========
</TABLE>
Senior Credit Facility
In August 2000, the Company amended the Senior Credit Facility as
follows: (i) increased the additional secured indebtedness permitted from $2.5
million to $9.0 million and decreased the additional unsecured indebtedness
permitted from $5.0 million to $1.0 million; (ii) amended the interest coverage
ratio for the quarters ended June 30, 2000, September 30, 2000, and December 31,
2000 from 1.80x to 1.65x; and (iii) increased the total capital expenditures
permitted for fiscal 2000 from $32.0 million to $38.0 million. As a result of
the renegotiated EchoStar Corporation ("EchoStar") agreement (see "Recent
Developments" in Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations), the Company was in violation of certain
debt covenants as of June 30, 2000 and obtained waivers. As of September 30,
2000, the Company is in compliance with all debt covenants.
Senior Notes
On March 18, 1999, the Company together with its wholly owned
subsidiary, Muzak Finance Corp., co-issued $115.0 million in principal amount of
9 7/8% Senior Subordinated Notes ("Senior 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 Notes are general unsecured obligations of the
Company and Muzak Finance Corp., and are subordinated in right of payment to all
existing and future senior indebtedness of the Company and Muzak Finance Corp.
The Senior Notes are guaranteed by the Parent, 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. The indenture governing the Senior Notes restricts, among other
things, the Company's ability to make certain payments such as dividends and
distributions of their capital stock, repurchases or redemptions of their
capital stock, and investments (other than permitted investments).
10
<PAGE>
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. Debt (Continued)
Floating Rate Notes
In January 2000, the Company entered into an indenture for up to $50.0
million Senior Subordinated Floating Rate Notes (the "Floating Rate Notes"). As
of September 30, 2000, the Company had drawn $36.0 million of the Floating Rate
Notes and used the proceeds to fund acquisitions. The Floating Rate Notes were
redeemed at 101.50% on October 19, 2000 (See Note 12).
Indebtedness under the Floating Rate Notes bore interest at a rate
equal to 3 month LIBOR plus a margin of 5.0% for the period from January 2000
through July 31, 2000, and at a rate of 3 month LIBOR plus a margin of 7.5% for
the period from August 1, 2000 through October 19, 2000.
Related Party Notes
Related Party Notes of $30.0 million are from MEM Holdings LLC in the form
of 15% Junior Subordinated Unsecured Notes (the "ABRY Notes"). At September 30,
2000, MEM Holdings owned 66% of the voting interests in the Parent. ABRY
Broadcast Partners III and ABRY Broadcast Partners II are the beneficial owners
of MEM Holdings.
Interest Rate Protection Programs
During April 1999, the Company entered into a four year interest rate
swap agreement in which the Company effectively exchanged $100.0 million of
floating rate debt at three month LIBOR for 5.59% fixed rate debt. This
agreement was modified on January 28, 2000 resulting in an increase to 7.042%
fixed rate debt and a termination date of April 2002. The proceeds of $4.4
million from the modification are being recorded as an adjustment to interest
expense over the remaining life of the swap agreement.
This agreement is designated as a hedge of interest rates, and the
differential to be paid or received on the swap is accrued as an adjustment to
interest expense as interest rates change. The Company is exposed to credit loss
in the event of nonperformance by the other party to the swap agreement.
However, the Company does not anticipate nonperformance by the counterparty.
During the quarter and nine months ended September 30, 2000, this agreement
resulted in an increase to interest expense of approximately $0.1 million and
$0.5 million, respectively.
Annual Maturities of Debt
Annual maturities of debt obligations are as follows (in thousands):
2000.............................................$ 1,822
2001................................................ 5,181
2002................................................ 6,680
2003................................................ 7,761
2004................................................26,344
Thereafter..........................................$ 269,066
Total interest paid by the Company on all indebtedness was $12.1
million and $29.9 million for the quarter and nine months ended September 30,
2000, respectively, and $8.9 million and $11.3 million for the quarter and nine
months ended September 30, 1999, respectively. Accrued interest payable was $4.1
million and $7.2 million as of September 30, 2000 and December 31, 1999
respectively.
11
<PAGE>
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. RELATED PARTY TRANSACTIONS
The Company has a Management Agreement with ABRY Partners which
provides that the Company will pay a management fee as defined in the Management
Agreement. There were no fees incurred under the agreement during the quarters
ended September 30, 2000 and September 30, 1999. Either the Company or ABRY
Partners, with the approval of the Board of Directors of the Parent, may
terminate the Management Agreement by prior written notice to the other.
During fiscal 1999, the Company borrowed $30.0 million from MEM
Holdings under junior subordinated notes.
9. MUZAK FINANCE CORP.
Muzak Finance Corp. had no operating activities during the quarters
and nine months ended September 30, 2000 and September 30, 1999.
10. COMMITMENTS AND CONTINGENCIES
Litigation
The Company 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 the Company
believes that the resulting liability, if any, will not have a material effect
upon the Company's consolidated financial statements or liquidity.
Other Commitments
As of September 30, 2000, the Company has approximately $1.1 million in
outstanding capital expenditure commitments. The Company is the lessee under
various operating and capital leases for equipment, vehicles, satellite
capacity, and buildings for periods ranging from 2 years to 10 years.
11. NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("FAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes accounting and
reporting standards for derivative instruments and for hedging activities. FAS
No. 133 requires, among other things, that all derivative instruments be
recognized at fair value as assets or liabilities on the balance sheet and that
changes in fair value generally be recognized currently in earnings unless
specific hedge accounting criteria are met. The standard is effective for fiscal
years beginning after June 15, 2000. Financial statement impacts of adopting the
new standard depend upon the amount and nature of the future use of derivative
instruments and their relative changes in valuation over time. The Company does
not believe the adoption of FAS No. 133 will have a material impact on the
financial statements.
In December 1999, the Securities and Exchange Commission ("SEC")
issued Staff Accounting Bulletin No. 101 ("SAB No. 101") "Revenue Recognition
in Financial Statements," which addresses revenue recognition issues. SAB No.
101 summarizes the SEC's views on applying generally accepted accounting
principles to revenue recognition in financial statements. The Company has
reviewed its revenue recognition policies and has determined that they comply
with the principles as set forth in SAB No. 101. Accordingly, the adoption of
SAB No. 101 will not have a material impact on the financial position or
results of operations.
12
<PAGE>
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. SUBSEQUENT EVENTS
On October 18, 2000, the Parent completed a private placement
transaction for $85 million of preferred membership units ("preferred units").
The Parent contributed the proceeds from the financing as an equity contribution
to the Company. The Company used the contribution as follows: (i) to repay the
Revolving Loan in full; (ii) to repay the Floating Rate Notes; and (iii) to
consummate two acquisitions.
The Parent issued 85,000 preferred units and 5,489 Class A units in
connection with this transaction. The outstanding preferred units will receive a
preferential return equal to 15% per annum compounded quarterly before any
distributions are made with respect to any other common or preferred units. The
15% preferential return will be payable in kind or through accrual only through
October 18, 2005. Thereafter, the preferential return will be payable in cash or
in kind, at the Parent's option.
The preferred units may be redeemed, at any time, at the option of the
Parent, in whole or in part, at par plus accrued preferential returns upon a
liquidity event which results in either a qualified initial public offering or a
change of control. The holders may, at their option, further cause the company
to redeem all or any portion of the preferred units and the purchased Class A
units upon a change of control. All of the above redemptions are subject to a
prepayment premium of up to 5% based on a percentage of par and compliance with
certain provisions of the Parent's High Yield Notes ("Senior Discount Notes")
and the indenture governing the Company's Senior Notes ("Senior Notes").
In the absence of a liquidity event which results in either a qualified
initial public offering or a change of control, the preferred units may be
redeemed at the option of the Parent, in whole or in part, at par plus any
accrued preferential return plus a prepayment premium of up to 6% based on a
percentage of par after October 18, 2003.
The preferred units mature on October 17, 2011. The holders may, at
their option, cause the Company to redeem the preferred units at any time after
October 17, 2011.
On October 18, 2000 the Company acquired certain of the assets of Ohio
Sound and Music LLC, an Ohio limited liability company for approximately $9.4
million. Ohio Sound and Music LLC was the Company's independent franchisee
located in Cleveland, Ohio. In addition, on October 18, 2000, the Company
acquired certain of the assets of On Hold Communications Inc., a Nevada
corporation, for approximately $0.6 million. On Hold Communications Inc. was an
audio marketing business serving areas primarily in Nevada and California.
The following presents the unaudited pro forma results of the Company
for the quarter and nine months ended September 30, 2000 as if the acquisitions
discussed above occurred on January 1, 2000. These unaudited pro forma results
are not necessarily indicative of the results that will occur in future periods
(in thousands):
Quarter Ended Nine Months Ended
September 30, 2000 September 30, 2000
--------------------------------------------
Revenues...................... $50,728 $146,245
Loss from operations.......... (263) (1,799)
Net loss...................... (11,200) (34,195)
13
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MUZAK HOLDINGS LLC
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
(unaudited)
---------------------- ---------------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents.................................. $ 5,614 $ 2,275
Accounts receivable, net................................... 50,085 39,203
Inventory.................................................. 10,845 12,283
Prepaid expenses and other assets.......................... 3,009 2,304
--------- ---------
Total current assets................................... 69,553 56,065
Property and equipment, net..................................... 106,169 95,050
Intangible assets, net.......................................... 321,259 314,364
Deferred charges and other assets, net.......................... 44,207 31,836
--------- ---------
Total assets........................................... $ 541,188 $ 497,315
========= =========
LIABILITIES AND MEMBERS' INTEREST
Current liabilities:
Revolving credit facility.................................. $ 34,683 $ 25,000
Current maturities of long term debt....................... 4,432 4,197
Current maturities of other liabilities.................... 2,227 1,394
Accounts payable........................................... 17,503 15,123
Accrued expenses........................................... 19,116 34,433
Advance billings........................................... 11,994 11,171
--------- ---------
Total current liabilities.............................. 89,955 91,318
Long-term debt.................................................. 361,046 323,131
Related party notes............................................. 30,000 30,000
Other liabilities............................................... 18,496 9,798
Commitments and contingencies (Note 11).........................
Members' interest:
Class A units................................................ 107,493 70,599
Class B units................................................ 2,822 2,822
Accumulated deficit...................................... (68,624) (30,353)
--------- ---------
Total members' interest................................ 41,691 43,068
--------- ---------
Total liabilities and members' interest................ $541,188 $497,315
======== ========
</TABLE>
The Notes to Consolidated Financial Statements are an integral part of these
consolidated financial statements.
14
<PAGE>
MUZAK HOLDINGS LLC
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
----------------------------------- ---------------------------------
September 30, September 30, September 30, September 30,
2000 1999 2000 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues:
Music and other business services............. $ 34,854 $ 28,328 $ 101,948 $ 62,456
Equipment and related services................ 15,005 11,927 39,622 25,468
---------- --------- ---------- ----------
Total revenues............................ 49,859 40,255 141,570 87,924
Cost of revenues:
Music and other business services............. 7,125 6,129 22,415 13,366
Equipment and related services................ 10,838 9,259 29,493 19,981
---------- --------- ---------- ----------
Total cost of revenues.................... 17,963 15,388 51,908 33,347
---------- --------- ---------- ----------
Gross profit.............................. 31,896 24,867 89,662 54,577
---------- --------- ---------- ----------
Selling, general and administrative expenses....... 16,057 13,438 46,507 28,268
Depreciation and amortization expense.............. 16,196 11,255 45,685 23,594
---------- --------- ---------- ----------
Income (loss) from operations............. (357) 174 (2,530) 2,715
Other income (expense):
Interest expense, net......................... (12,270) (8,878) (35,257) (19,140)
Other, net.................................... (72) 154 (501) 133
---------- --------- ---------- ----------
Loss before income taxes.................. (12,699) (8,550) (38,288) (16,292)
Income tax benefit................................. (78) -- (17) --
---------- --------- ---------- ----------
Net loss.................................. $ (12,621) $ (8,550) $ (38,271) $ (16,292)
========== ========= ========== ==========
</TABLE>
The Notes to Consolidated Financial Statements are an integral part of these
consolidated financial statements.
15
<PAGE>
MUZAK HOLDINGS LLC
CONSOLIDATED STATEMENT OF CHANGES IN MEMBERS' INTEREST
(Unaudited)
(in thousands, except for units)
<TABLE>
<CAPTION>
Total
Class A Class B Accumulated Members'
Units Dollars Units Dollars Deficit Equity
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1999.......... 70,599 $ 70,599 10,281 $2,822 $ (30,353) $ 43,068
Issuance of units, net of repurchases. 20,823 36,894 2,582 -- -- 36,894
Net loss ............................. -- -- -- -- (38,271) (38,271)
------ --------- ------ ------- --------- --------
Balance at September 30, 2000......... 91,422 $ 107,493 12,863 $ 2,822 $(68,624) $41,691
====== ========= ====== ======= ========= =======
</TABLE>
The Notes to Consolidated Financial Statements are an integral part of these
consolidated financial statements.
16
<PAGE>
MUZAK HOLDINGS LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
--------------------------- ---------------------------
September 30, September 30, September 30, September 30,
2000 1999 2000 1999
------------- ------------- ------------ --------------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss................................................................. $(12,621) $(8,550) $(38,271) $ (16,292)
Adjustments to derive cash flow from operating activities:
Deferred income tax benefit.............................................. (298) -- (283) --
Depreciation and amortization............................................ 16,196 11,255 45,685 23,594
Amortization of senior discount notes.................................... 1,520 1,336 4,410 2,878
Amortization of deferred financing fees.................................. 469 351 1,380 771
Deferred subscriber acquisition costs.................................... (3,062) (2,907) (9,185) (4,342)
Unearned installment income.............................................. (195) 208 (367) 208
Net change in certain assets and liabilities, net of business
acquisitions:
Increase in accounts receivable....................................... (7,459) (5,253) (10,630) (9,590)
Decrease (increase) in inventory ..................................... (560) (1,345) 634 (972)
Increase (decrease) in accrued interest............................... (2,678) (3,362) (3,096) 4,292
Increase (decrease) in accounts payable .............................. (3,293) (6,261) 2,380 (12,548)
Increase (decrease) in accrued expenses............................... 2,921 6,031 (6,112) 4,959
Increase (decrease) in advance billings............................... (310) (93) 823 1,018
Other, net............................................................ (1,801) (690) (1,626) 932
------- ------- ------- -------
NET CASH USED IN OPERATING ACTIVITIES............................... (11,171) (9,280) (14,258) (5,092)
------- ------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisitions, net of cash................................................ -- (9,578) (34,198) (281,491)
Capital expenditures..................................................... (9,323) (8,802) (29,393) (16,824)
------- ------- ------- -------
NET CASH USED IN INVESTING ACTIVITIES............................... (9,323) (18,380) (63,591) (298,315)
------- ------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of senior subordinated notes...................... -- -- -- 115,000
Proceeds from borrowings under senior credit facility.................... -- 30,000 -- 165,000
Proceeds from issuance of senior discount notes.......................... -- -- -- 39,996
Repayments of senior credit facility..................................... -- -- (1,800) --
Net borrowing (repayment) on revolving loan.............................. -- (2,900) 9,683 16,500
Proceeds from issuance of floating rate notes............................ -- -- 36,000 --
Proceeds from interest rate swap......................................... -- -- 4,364 --
Proceeds from contributions by Members................................... 20,000 951 35,636 24,254
Net borrowing (repayment) of notes payable to related party.............. -- 3,000 -- (38,683)
Repayments of capital lease obligations and other debt................... (440) (2,323) (1,526) (3,140)
Payment of financing fees ............................................... (421) -- (1,169) (13,463)
------- ------- ------- -------
NET CASH PROVIDED BY FINANCING ACTIVITIES........................... 19,139 28,728 81,188 305,464
------- ------- ------- -------
NET INCREASE (DECREASE IN) CASH AND CASH EQUIVALENTS..................... (1,355) 1,068 3,339 2,057
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD........................... 6,969 2,282 2,275 1,293
------- ------- ------- -------
CASH AND CASH EQUIVALENTS, END OF PERIOD................................ $ 5,614 $ 3,350 $ 5,614 $ 3,350
======= ======= ======= =======
Significant non-cash investing activities:
Issuances of common stock in connection with acquisitions -- -- 1,258 21,862
</TABLE>
The Notes to Consolidated Financial Statements are an integral part of these
consolidated financial statements.
17
<PAGE>
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
Muzak Holdings LLC, together with its subsidiaries, ("the Company"),
formerly known as ACN Holdings, LLC, was formed in September 1998 pursuant to
the laws of Delaware. Muzak LLC, a wholly owned subsidiary of the Company, owns
and operates franchisees. Muzak LLC began its operations on October 7, 1998,
with the acquisition of the independent franchisees in the Baltimore, Charlotte,
Hillsborough, Kansas City, St. Louis, Jacksonville, Phoenix, and Fresno areas
from Audio Communications Network, Inc. (the "Predecessor Company"). On March
18, 1999, Muzak Limited Partnership ("Old Muzak") merged with and into Audio
Communications Network, LLC ("ACN"). At the time of the merger, ACN changed its
name to Muzak LLC.
As of September 30, 2000, ABRY Partners, LLC and its respective
affiliates collectively owned approximately 66% of the voting interests in the
Company.
The Company derives the majority of its revenues from the sale of
business music products. The core products are Audio Architecture and Audio
Marketing. In addition, the Company produces a complementary product, Video
Imaging. The Company produces its Video Imaging product through an arrangement
with an outside vendor. These revenues are generated by clients, who pay monthly
subscription fees under noncancelable five-year contracts.
The Company also derives revenues from the sale and lease of audio
system-related products, principally sound systems and intercoms, to business
music clients and other clients. In addition, the Company sells electronic
equipment, such as proprietary tape playback equipment and other audio and video
equipment to franchisees to support the sale of business music services.
Installation, service and repair revenues consist principally of revenues from
the installation of sound systems and other equipment that is not expressly part
of a business music contract, such as paging, security and drive-through
systems. These revenues also include revenue from the installation, service and
repair of equipment installed under a business music contract. Music contract
installation revenues are deferred and recognized over the term of the
respective contracts.
2. BASIS OF PRESENTATION
The 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 significant 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.
For further information, refer to the consolidated financial statements and
footnotes thereto included in the Muzak Holdings LLC Annual Report on Form 10-K
for the fiscal year ended December 31, 1999.
The financial statements as of September 30, 2000 and September 30,
1999 and for the three and nine month periods 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 nine months
ended September 30, 1999 include the operating results of ACN Holdings LLC for
the period from January 1, 1999 to March 17, 1999, and for Muzak Holdings LLC
for the period from March 18, 1999 to December 31, 1999. Results of operations
for interim periods are not necessarily indicative of results for the full year.
18
<PAGE>
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. ACQUISITIONS
As discussed in Note 1, on March 18, 1999 Old Muzak merged with and
into ACN. Under the terms of the agreement, the Company paid total consideration
of $274.2 million, which is comprised of the following: $125.5 million cash
consideration, $114.9 million consideration in the tender offer and consent
solicitation for the 10% Senior Notes due 2003 of Old Muzak, $15.9 million for
debt repayment of Old Muzak outstanding obligations, and $17.9 million of other
assumed obligations. In addition, at the time of the merger, the Company repaid
$41.7 million borrowed from ABRY Broadcast Partners by ACN in October 1998 in
connection with the acquisition of the Company's independent franchisees from
the Predecessor Company and converted $0.7 million into voting units of the
Company.
In 1999, prior to the merger, the Company made the following
acquisitions:
On January 15, 1999, the Company acquired all of the outstanding stock of
Business Sound, Inc. for approximately $4.1 million. Business Sound was the
Company's independent franchisee for the New Orleans, Louisiana and Mobile,
Alabama areas.
On February 24, 1999, the Company acquired all of the outstanding stock of
Electro Systems for approximately $0.7 million, and assumed certain
non-recourse debt of $2.4 million. Electro Systems was the Company's
independent franchisee located in Panama City, Florida.
The Company made twenty-one acquisitions between the merger on March 18,
1999 and September 30, 2000. The table below provides information regarding
these acquisitions (in millions, except for number of Company units).
<TABLE>
<CAPTION>
Purchase Acquired Assets Acquired Acquired
Date Price (1) Or Stock Business Markets
----------------------- ---------- ---------------------------------------- ----------------------- ------------------------
<S> <C> <C> <C> <C>
March 18,1999 $18.1 (2) Net assets of Capstar Broadcasting Independent franchisee Georgia, Florida
Corporation's independent franchisee
April 1, 1999 $0.2 Net assets of Custom On Hold Services Audio Marketing Washington
Inc.
May 1,1999 $3.2 (3) Net assets of Capstar Broadcasting Independent franchisee Nebraska
Corporation's independent franchisee
June 1, 1999 $6.9 Net assets of Advertising on Hold, Inc. Audio Marketing Florida, Georgia, North
Carolina
July 1, 1999 $0.8 Net assets of CustomTronics Sound Business Music California
July 1, 1999 $0.9 Net assets of Penobscot Broadcasting Independent Maine
Corporation franchisee
July 26, 1999 $1.3 Net assets of LaBov and Beyond, Inc. Audio Marketing Indiana
August 1, 1999 $3.5 Net assets of US West Communications Audio Marketing National
Services, Inc's Please Hold Promotions
September 1, 1999 $4.7 Stock of Broadcast International, Inc. Business Music National
October 1, 1999 $10.3 Net assets of Midwest Systems and Business Music Illinois, Indiana, Ohio,
Services, Inc. West Virginia
November 1, 1999 $2.9 Net assets of A & D Music, Inc. Independent franchisee Oregon
November 1, 1999 $7.9 (4) Stock of Audio Environment, Inc. and Independent franchisee California
Background Music Broadcasters Inc.
December 1, 1999 $13.2 (5) Net assets of MountainWest Audio, Inc. Independent franchisee Utah, Idaho, Washington
</TABLE>
19
<PAGE>
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. Acquisitions (Continued)
<TABLE>
<CAPTION>
Purchase Acquired Assets Acquired Acquired
Date Price (1) Or Stock Business Markets
----------------------- ---------- ---------------------------------------- ----------------------- ------------------------
<S> <C> <C> <C> <C>
February 2, 2000 $0.4 Net assets of Quincy Broadcasting Company Independent franchisee Illinois
February 2, 2000 $0.9 Net assets of General Communications Audio Marketing Indiana, Georgia,
Corporation ("On Hold America") Florida, Ohio
February 2, 2000 $0.4 Net assets of Texas Sound Co. Ltd. Business Music Texas
February 24, 2000 $3.7 Stock of Telephone Audio Productions, Audio Marketing National
Inc.
March 24, 2000 $9.2 (6) Stock of Vortex Sound Communications Independent franchisee District of Columbia
Company, Inc.
March 31, 2000 $1.6 Net assets of Dynamic Sound Independent franchisee Nevada, California
March 31, 2000 $8.3 Stock of Muzak Houston, Inc. Independent franchisee Texas
April 11, 2000 $1.0 Net assets of Audio Plus, Inc. Independent franchisee Ohio
</TABLE>
(1) The purchase price does not include transaction costs.
(2) The total purchase price included 13,535 Class A units.
(3) The total purchase price included 2,385 Class A units.
(4) Total purchase price included 100 Class A units.
(5) The Company paid $3.1 million of the purchase price of Mountain West Audio,
Inc. as of December 31, 1999. In February 2000, the Company paid the
remaining purchase price, which included 456 Class A units.
(6) Total purchase price included 802 Class A units.
The results of operations of the acquired companies are included in the
Company's consolidated statement of operations for the periods in which they
were owned by the Company.
The acquisitions were accounted for under the purchase method of
accounting. Accordingly, the consideration was allocated to the net assets
acquired based on the fair market values at the date of acquisition. The excess
of purchase price for each acquisition over the estimated fair value of the
tangible and identifiable intangible assets acquired approximated $11.1 million
and $127.9 million for the nine months ended September 30, 2000 and the year
ended December 31, 1999, respectively, and is being amortized over a period of
twenty years on a straight-line basis.
The following presents the unaudited pro forma results assuming that
the acquisitions discussed above had occurred as of the beginning of fiscal 2000
and 1999. These pro forma results are not necessarily indicative of the results
that will occur in future periods (in thousands).
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, September 30, September 30, September 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues.................................. $ 49,859 $46,986 $143,639 $133,927
Income (Loss) from operations............. (357) 1,522 (2,200) 870
Net loss.................................. (12,621) (8,312) (38,521) (27,835)
</TABLE>
20
<PAGE>
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. DEFERRED CHARGES AND OTHER ASSETS, NET
Deferred charges and other assets, net, consist of the following (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
(Unaudited)
------------------ ---------------------
<S> <C> <C>
Capitalized Commissions....................................... $27,154 $17,969
Other......................................................... 17,053 13,867
------ ------
$44,207 $31,836
======= =======
</TABLE>
5. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
Useful September 30, December 31,
Life 2000 1999
(years) (Unaudited)
---------- ------------------- -------------------
<S> <C> <C> <C>
Equipment provided to subscribers.......................... 4-6 $ 92,672 $ 72,598
Capitalized installation labor............................. 5 27,837 18,270
Other...................................................... 3-30 25,890 22,606
-------- --------
146,399 113,474
Less accumulated depreciation.............................. (40,230) (18,424)
-------- --------
$106,169 $ 95,050
======== ========
</TABLE>
Depreciation expense was $8.0 million and $22.0 million for the quarter and nine
months ended September 30, 2000, respectively, and $5.7 million and $11.0
million for the quarter and nine months ended September 30, 1999, respectively.
6. INTANGIBLE ASSETS
Intangible assets consist of the following (in thousands):
<TABLE>
<CAPTION>
Useful September 30, December 31,
Life 2000 1999
(years) (Unaudited)
---------- ------------------- -------------------
<S> <C> <C> <C>
Goodwill................................................. 20 $154,231 $ 143,094
Income producing contracts............................... 8-14 148,624 136,184
License agreements....................................... 20 5,082 5,082
Trademarks............................................... 5 14,895 14,866
Non-compete agreements................................... 2-7 22,286 16,401
Other.................................................... 5-20 19,556 18,430
-------- --------
364,674 334,057
Less accumulated amortization............................ (43,415) (19,693)
-------- --------
$321,259 $ 314,364
======== =========
</TABLE>
Amortization expense was $8.2 million and $23.7 million for the quarter and nine
months ended September 30, 2000, respectively, and $5.6 million and $12.6
million for the quarter and nine months ended September 30, 1999, respectively.
21
<PAGE>
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. DEBT
Debt obligations consist of the following (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
(Unaudited)
------------------ ---------------------
<S> <C> <C>
Revolving loan- Senior Credit Facility........................ $ 34,683 $ 25,000
========= =========
Related Party Notes........................................... 30,000 30,000
========= =========
Long term debt:
Senior Credit Facility...................................... 163,200 165,000
Senior Notes................................................ 115,000 115,000
Senior Discount Notes....................................... 48,624 44,214
Floating Rate Notes......................................... 36,000 -
Other....................................................... 2,654 3,114
--------- ---------
Total debt obligations........................................ 365,478 327,328
Less current maturities....................................... (4,432) (4,197)
--------- ---------
$ 361,046 $ 323,131
========= =========
</TABLE>
Senior Credit Facility
In August 2000, Muzak LLC amended the Senior Credit Facility as
follows: (i) increased the additional secured indebtedness permitted from $2.5
million to $9.0 million and decreased the additional unsecured indebtedness
permitted from $5.0 million to $1.0 million; (ii) amended the interest coverage
ratio for the quarters ended June 30, 2000, September 30, 2000, and December 31,
2000 from 1.80x to 1.65x; and (iii) increased the total capital expenditures
permitted for fiscal 2000 from $32.0 million to $38.0 million. As a result of
the renegotiated EchoStar Corporation ("EchoStar") agreement (see "Recent
Developments" in Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations), the Company was in violation of certain
debt covenants as of June 30, 2000 and obtained waivers. As of September 30,
2000, the Company is in compliance with all debt covenants.
Senior Notes
On March 18, 1999, Muzak LLC together with its wholly owned subsidiary,
Muzak Finance Corp., co-issued $115.0 million in principal amount of 9 7/8%
Senior Subordinated Notes ("Senior 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 Notes are general unsecured obligations of the Company and
Muzak Finance Corp., and are subordinated in right of payment to all existing
and future senior indebtedness of the Company and Muzak Finance Corp. The Senior
Notes are guaranteed by the Company, 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. The
indenture governing the Senior Notes restricts, among other things, the
Company's ability to make certain payments such as dividends and distributions
of their capital stock, repurchases or redemptions of their capital stock, and
investments (other than permitted investments).
22
<PAGE>
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. Debt (Continued)
Senior Discount Notes
On March 18, 1999, the Company together with its wholly owned
subsidiary Muzak Holdings Finance Corp., co-issued $75.0 million in principal
amount at maturity, or $39.9 million in accreted value on the issue date, of 13%
Senior Discount Notes (the "Senior Discount Notes") due March 2010. Cash
interest on the Senior Discount Notes does not accrue and is not payable prior
to March 15, 2004. The Senior Discount Notes were issued at a substantial
discount from their principal amount at maturity. 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. 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.
Floating Rate Notes
In January 2000, Muzak LLC entered into an indenture for up to $50.0
million Senior Subordinated Floating Rate Notes (the "Floating Rate Notes"). As
of September 30, 2000, Muzak LLC had drawn $36.0 million of the Floating Rate
Notes and used the proceeds to fund acquisitions. The Floating Rate Notes were
redeemed at 101.50% on October 19, 2000 (See Note 13).
Indebtedness under the Floating Rate Notes bore interest at a rate
equal to 3 month LIBOR plus a margin of 5.0% for the period from January 2000
through July 31, 2000, and at a rate of 3 month LIBOR plus a margin of 7.5% for
the period from August 1, 2000 through October 19, 2000.
Related Party Notes
Related Party Notes of $30.0 million are from MEM Holdings LLC in the
form of 15% Junior Subordinated Unsecured Notes (the "ABRY Notes"). At
September 30, 2000 MEM Holdings owned 66% of the voting interests in the
Company. ABRY Broadcast Partners III and ABRY Broadcast Partners II are the
beneficial owners of MEM Holdings.
Interest Rate Protection Programs
During April 1999, Muzak LLC entered into a four year interest rate
swap agreement in which the Company effectively exchanged $100.0 million of
floating rate debt at three month LIBOR for 5.59% fixed rate debt. This
agreement was modified on January 28, 2000 resulting in an increase to 7.042%
fixed rate debt and a termination date of April 2002. The proceeds of $4.4
million from the modification are being recorded as an adjustment to interest
expense over the remaining life of the swap agreement.
This agreement is designated as a hedge of interest rates, and the
differential to be paid or received on the swap is accrued as an adjustment to
interest expense as interest rates change. The Company is exposed to credit loss
in the event of nonperformance by the other party to the swap agreement.
However, the Company does not anticipate nonperformance by the counterparty.
During the quarter and nine months ended September 30, 2000, this agreement
resulted in an increase to interest expense of approximately $0.1 million and
$0.5 million, respectively.
23
<PAGE>
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. Debt (Continued)
Annual Maturities of Debt
Annual maturities of debt obligations are as follows (in thousands):
2000.......................................... $ 1,822
2001.......................................... 5,181
2002.......................................... 6,680
2003.......................................... 7,761
2004.......................................... 26,344
Thereafter....................................... $ 317,690
Total interest paid by the Company on all indebtedness was $12.1
million and $29.9 million for the quarter and nine months ended September 30,
2000, respectively, and $8.9 million and $11.3 million for the quarter and nine
months ended September 30, 1999, respectively. Accrued interest payable was $4.1
million and $7.2 million as of September 30, 2000 and December 31, 1999,
respectively.
8. RELATED PARTY TRANSACTIONS
The Company has a Management Agreement with ABRY Partners which
provides that the Company will pay a management fee as defined in the Management
Agreement. There were no fees incurred under the agreement during the quarters
ended September 30, 2000 and September 30, 1999. Either the Company or ABRY
Partners, with the approval of the Board of Directors of the Company, may
terminate the Management Agreement by prior written notice to the other.
During fiscal 1999, Muzak LLC borrowed $30.0 million from MEM Holdings
under junior subordinated notes.
9. MUZAK HOLDINGS FINANCE CORP.
Muzak Holdings Finance Corp. had no operating activities during the
quarters and nine months ended September 30, 2000 and September 30, 1999.
10. MEMBERS' INTEREST
Voting Units
The Company has authorized and issued Class A-1 units (Class A-1
Units). The Class A-1 Units represent a class of membership interests in the
Company and have the rights and obligations specified in the Company's Third
Amended and Restated Limited Liability Company Agreement. Each Class A-1 Unit is
entitled to voting rights equal to the percentage that such units represent of
the aggregate number of outstanding Class A and Class A-1 Units. Each Class A-1
Unit accrues a preferred return annually on the capital value of such unit at a
rate of 15% per annum. The Company cannot pay distributions (other than tax
distributions) in respect of other classes of securities (including
distributions made in connection with a liquidation) until the preferred return
and capital value of the Class A Units and Class A-1 Units are paid to each
holder thereof. In the event any residual value exists after other classes of
membership interests receive their respective priorities, holders of Class A-1
Units are entitled to participate pro rata with other holders of common units in
such residual value. As of September 30, 2000, the Company had 82,494 Class A
units outstanding and 8,928 Class A-1 units outstanding.
24
<PAGE>
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. Members' Interest (Continued)
Non Voting Units
As of September 30, 2000, the Company had 3,278 Class B-1 units
outstanding, 3,287 Class B-2 units outstanding, 3,296 Class B-3 units
outstanding, and 3,002 Class B-4 units outstanding.
11. COMMITMENTS AND CONTINGENCIES
Litigation
The Company 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 the Company
believes that the resulting liability, if any, will not have a material effect
upon the Company's consolidated financial statements or liquidity.
Other Commitments
As of September 30, 2000, the Company has approximately $1.1 million in
outstanding capital expenditure commitments. The Company is the lessee under
various operating and capital leases for equipment, vehicles, satellite
capacity, and buildings for periods ranging from 2 years to 10 years.
12. NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("FAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes accounting and
reporting standards for derivative instruments and for hedging activities. FAS
No. 133 requires, among other things, that all derivative instruments be
recognized at fair value as assets or liabilities on the balance sheet and that
changes in fair value generally be recognized currently in earnings unless
specific hedge accounting criteria are met. The standard is effective for fiscal
years beginning after June 15, 2000. Financial statement impacts of adopting the
new standard depend upon the amount and nature of the future use of derivative
instruments and their relative changes in valuation over time. The Company does
not believe the adoption of FAS No. 133 will have a material impact on the
financial statements.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 ("SAB No. 101") "Revenue Recognition in
Financial Statements," which addresses revenue recognition issues. SAB No. 101
summarizes the SEC's views on applying generally accepted accounting principles
to revenue recognition in financial statements. The Company has reviewed its
revenue recognition policies and has determined that they comply with the
principles as set forth in SAB No. 101. Accordingly, the adoption of SAB No. 101
will not have a material impact on the financial position or results of
operations.
13. SUBSEQUENT EVENTS
On October 18, 2000, the Company completed a private placement
transaction for $85 million of preferred membership units ("preferred units").
The Company used the proceeds as follows: (i) to repay the Revolving Loan in
full; (ii) to repay the Floating Rate Notes; and (iii) to consummate two
acquisitions.
25
<PAGE>
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. Subsequent Events (continued)
The Company issued 85,000 preferred units and 5,489 Class A units in
connection with this transaction. The outstanding preferred units will receive a
preferential return equal to 15% per annum compounded quarterly before any
distributions are made with respect to any other common or preferred units. The
15% preferential return will be payable in kind or through accrual only through
October 18, 2005. Thereafter, the preferential return will be payable in cash or
in kind, at the Company's option.
The preferred units may be redeemed, at any time, at the option of the
Company, in whole or in part, at par plus accrued preferential returns upon a
liquidity event which results in either a qualified initial public offering or a
change of control. The holders may, at their option, further cause the Company
to redeem all or any portion of the preferred units and the purchased Class A
units upon a change of control. All of the above redemptions are subject to a
prepayment premium of up to 5% based on a percentage of par and compliance with
certain provisions of the Company's High Yield Notes ("Senior Discount Notes")
and the indenture governing Muzak LLC's Senior Notes ("Senior Notes").
In the absence of a liquidity event which results in either a qualified
initial public offering or a change of control, the preferred units may be
redeemed at the option of the Company, in whole or in part, at par plus any
accrued preferential return plus a prepayment premium of up to 6% based on a
percentage of par after October 18, 2003.
The preferred units mature on October 17, 2011. The holders may cause,
at their option, the Company to redeem the preferred units at any time after
October 17, 2011.
On October 18, 2000 the Company acquired certain of the assets of
Ohio Sound and Music LLC, an Ohio limited liability company for approximately
$9.4 million. Ohio Sound and Music LLC was the Company's independent franchisee
located in Cleveland, Ohio. In addition, on October 18, 2000, the Company
acquired certain of the assets of On Hold Communications Inc., a Nevada
corporation, for approximately $0.6 million. On Hold Communications was an audio
marketing business serving areas primarily in Nevada and California.
The following presents the unaudited pro forma results of the Company
for the quarter and nine months ended September 30, 2000 as if the acquisitions
discussed above occurred on January 1, 2000. These unaudited pro forma results
are not necessarily indicative of the results that will occur in future periods
(in thousands):
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, 2000 September 30, 2000
------------------ ------------------
<S> <C> <C>
Revenues............................ $50,728 $146,245
Loss from operations................ (263) (1,799)
Net Loss............................ (12,527) (38,121)
</TABLE>
26
<PAGE>
MUZAK LLC
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Form 10-Q contains statements which, to the extent they are not
historical fact, constitute forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities and
Exchange Act of 1934 (the "Safe Harbor Acts"). All forward-looking statements
involve risks and uncertainties. The forward-looking statements in this Form
10-Q are intended to be subject to the safe harbor protection provided by the
Safe Harbor Acts.
Risks and uncertainties that could cause actual results to vary
materially from those anticipated in the forward-looking statements included in
this Form 10-Q include 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, as well as factors more specific to the
Company such as the Company's history of net losses, the substantial leverage of
the Company, limitations imposed by the Company's debt facilities, and changes
made in connection with the integration of operations acquired by the Company.
For a discussion of certain of these and important other factors which may
affect the Company's operations, products and markets, see the Company's
Securities and Exchange Filings, including without limitation "Business" in the
Company's Form 10-K/A for the fiscal year ended December 31, 1999 and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in the Form 10-K/A, in the Company's reports on Form 10-Q for the
fiscal quarters ended June 30, 2000, March 30, 2000 and above in this Form 10-Q
and also see the Company's other filings with the Securities and Exchange
Commission.
General
The Company is the leading provider of business music programming in
the United States based on market share. Together with its independent
franchisees, the Company serves an installed base of approximately 300,000
business locations nationwide. The Company and its independent franchisees also
sell, install and maintain audio and electronic equipment related to the
Company's business.
The Company was formed on August 28, 1998 as ACN Operating LLC and in
October of 1998 changed its name to Audio Communications Network, LLC ("ACN").
On October 7, 1998, ACN acquired the independent franchisees in the Baltimore,
Charlotte, Hillsborough, Kansas City, St. Louis, Jacksonville, Phoenix, and
Fresno areas from Audio Communications Network, Inc. (the "Predecessor Company")
for $66.8 million. On March 18, 1999, Muzak Limited Partnership ("Old Muzak")
merged with and into ACN. At the time of the merger, ACN changed its name to
Muzak LLC. Under the terms of the agreement, the Company paid total
consideration of $274.2 million, which consisted of the following: $125.5
million cash consideration, $114.9 million consideration in the tender offer and
consent solicitation for the 10% Senior Notes due 2003 of Old Muzak, $15.9
million for debt repayment of Old Muzak outstanding obligations, and $17.9
million of other general obligations. In addition, at the time of the merger,
the Company repaid $41.7 million, which included $0.9 million of interest,
borrowed from ABRY Broadcast Partners by ACN in October 1998 in connection with
the acquisition of the Company's independent franchisees from the Predecessor
Company and converted $0.7 million of interest into voting units of the Parent.
Since the merger, the Company and the Parent have acquired twenty one businesses
for total consideration of $99.4 million, which included 17,278 Class A units of
Muzak Holdings LLC ("the Parent").
In 1999, prior to the merger, the Company made the following acquisitions:
On January 15, 1999, the Company acquired all of the outstanding stock of
Business Sound Inc. for approximately $4.1 million. Business Sound was the
Company's independent franchisee for the New Orleans, Louisiana and Mobile,
Alabama areas.
On February 24, 1999, the Company acquired all of the outstanding stock of
Electro Systems for approximately $0.7 million, and assumed certain
non-recourse debt of $2.4 million. Electro Systems was the Company's
independent franchisee located in Panama City, Florida.
27
<PAGE>
MUZAK LLC
Item 2 Management's Discussion and Analysis (Continued)
The Company made twenty-one acquisitions between the merger on March 18,
1999 and September 30, 2000. The table below provides information regarding
these acquisitions (in millions, except for number of Parent units).
<TABLE>
Purchase Acquired Assets Acquired Acquired
Date Price (1) Or Stock Business Markets
------------------------- ---------- ---------------------------------------- ------------------------ -----------------------
<S> <C> <C> <C> <C>
March 18,1999 $18.1 (2) Net assets of Capstar Broadcasting Independent franchisee Georgia, Florida
Corporation's independent franchisee
April 1, 1999 $0.2 Net assets of Custom On Hold Services Audio Marketing Washington
Inc.
May 1,1999 $3.2 (3) Net assets of Capstar Broadcasting Independent franchisee Nebraska
Corporation's independent franchisee
June 1, 1999 $6.9 Net assets of Advertising on Hold, Inc. Audio Marketing Florida, Georgia, North
Carolina
July 1, 1999 $0.8 Net assets of CustomTronics Sound Business Music California
July 1, 1999 $0.9 Net assets of Penobscot Broadcasting Independent franchisee Maine
Corporation
July 26, 1999 $1.3 Net assets of LaBov and Beyond, Inc. Audio Marketing Indiana
August 1, 1999 $3.5 Net assets of US West Communications Audio Marketing National
Services, Inc.'s Please Hold Promotions
September 1, 1999 $4.7 Stock of Broadcast International, Inc. Business Music National
October 1, 1999 $10.3 Net assets of Midwest Systems and Business Music Illinois, Indiana,
Services, Inc. Ohio,
West Virginia
November 1, 1999 $2.9 Net assets of A & D Music, Inc. Independent franchisee Oregon
November 1, 1999 $7.9 (4) Stock of Audio Environment, Inc. and Independent franchisee California
Background Music Broadcasters Inc.
December 1, 1999 $13.2 (5) Net assets of MountainWest Audio, Inc. Independent franchisee Utah, Idaho, Washington
February 2, 2000 $0.4 Net assets of Quincy Broadcasting Independent franchisee Illinois
Company
February 2, 2000 $0.9 Net assets of General Communications Audio Marketing Indiana, Georgia,
Corporation ("On Hold America") Florida, Ohio
February 2, 2000 $0.4 Net assets of Texas Sound Co. Ltd Business Music Texas
February 24, 2000 $3.7 Stock of Telephone Audio Productions, Audio Marketing National
Inc.
March 24, 2000 $9.2 (6) Stock of Vortex Sound Communications Independent franchisee District of Columbia
Company, Inc.
March 31, 2000 $1.6 Net assets of Dynamic Sound Independent franchisee Nevada, California
March 31, 2000 $8.3 Stock of Muzak Houston, Inc. Independent franchisee Texas
April 11, 2000 $1.0 Net assets of Audio Plus, Inc. Independent franchisee Ohio
</TABLE>
(1) The purchase price does not include transaction costs.
(2) The Parent acquired Capstar Broadcasting Corporation's ("Capstar")
independent franchisees located in Atlanta, Albany, and Macon, Georgia,
and Ft. Myers, Florida. The total consideration was accounted for as an
equity contribution to the Company and included 13,535 Class A units of
the Parent.
(3) The Parent acquired Capstar's independent franchisee located in Omaha,
Nebraska. The total consideration was accounted for as an equity
contribution to the Company and included 2,385 Class A units of the Parent.
(4) Total purchase price included 100 Class A units of the Parent.
(5) The Company paid $3.1 million of the purchase price of Mountain West Audio,
Inc. as of December 31, 1999. In February 2000, the Company paid the
remaining purchase price, which included 456 Class A units of the Parent.
(6) Total purchase price included 802 Class A units of the Parent.
28
<PAGE>
MUZAK LLC
Item 2 Management's Discussion and Analysis (Continued)
Recent Developments
Financing
On October 18, 2000, the Parent completed a private placement
transaction for $85 million of preferred membership units ("preferred units").
The Parent contributed the proceeds from the financing as an equity contribution
to the Company. The Company used the contribution as follows: (i) to repay the
Revolving Loan in full; (ii) to repay the Floating Rate Notes; and (iii) to
consummate two acquisitions.
Acquisitions
On October 18, 2000 the Company acquired certain of the assets of Ohio
Sound and Music LLC, an Ohio limited liability company for approximately $9.4
million. Ohio Sound and Music LLC was the Company's independent franchisee
located in Cleveland, Ohio. In addition, on October 18, 2000, the Company
acquired certain of the assets of On Hold Communications Inc., a Nevada
corporation, for approximately $0.6 million. On Hold Communications was an audio
marketing business serving areas primarily in Nevada and California.
Equity Infusions
During the quarter and nine months ended September 30, 2000, the
Company received cash equity contributions of $20.0 million and $35.6 million,
respectively from its Parent. The proceeds of the equity contributions were used
to make repayments on the Senior Credit Facility and for general corporate
purposes. In October 2000, the Parent contributed the proceeds of $85 million
from the private placement of preferred membership units as an equity
contribution to the Company (see "Financing" above).
EchoStar
The Company concluded its contract negotiations with EchoStar Satellite
Corporation ("EchoStar") in August 2000. Pursuant to the terms of the parties'
new agreement, effective January 1, 2000 EchoStar no longer has a unilateral
right to cancel the distribution of the Company's programs that customers
receive via the EchoStar system. EchoStar is now obligated to distribute 60
music programs on behalf of Muzak for the entire term of the agreement. Such
agreement with EchoStar is scheduled to end in approximately 2010. In order to
secure this long-term supply agreement with EchoStar, the Company granted a
sales discount to EchoStar in connection with the broadcast of the Company's
music programming to residential customers. As a result, the Company recorded a
$1.6 million charge to costs of music and business services revenue during the
second quarter of 2000. As adjusted to reflect the economic impact of the
EchoStar renegotiation as if entered into on January 1, 2000, gross profit
reduction for the quarter ended June 30, 2000 would have been $0.8 million,
rather than $1.6 million. All other terms of the EchoStar agreement remain
substantially the same.
Revenues and Expenses
The Company derives the majority of its music and other business
services revenues from the sale of business music products. The core products
are Audio Architecture and Audio Marketing. In addition, the Company offers a
complementary product, Video Imaging. The Company's Video Imaging product is
produced through an arrangement with an outside vendor. These revenues are
generated by clients, who pay monthly subscription fees under noncancelable
five-year contracts.
29
<PAGE>
MUZAK LLC
Item 2 Management's Discussion and Analysis (Continued)
The Company also derives equipment and related services revenues from
the sale and lease of audio system-related products, principally sound systems
and intercoms, to business music clients and other clients. In addition, the
Company sells electronic equipment, such as proprietary tape playback equipment
and other audio and video equipment to franchisees to support the sale of
business music services. Installation, service and repair revenues consist
principally of revenues from the installation of sound systems and other
equipment that is not expressly part of a business music contract, such as
paging, security and drive-through systems. These revenues also include revenue
from the installation, service and repair of equipment installed under a
business music contract. Music contract installation revenues are deferred and
recognized over the term of the respective contracts.
The cost of revenues for music and other business services consists
primarily of broadcast delivery, programming and licensing associated with
providing music and other business programming to a client or a franchisee. The
cost of revenues for equipment and related services represents the purchase cost
plus handling, shipping and warranty expenses. The cost of revenues for
installation, service and repair consists primarily of service and repair labor
and installation labor associated with purchased equipment. Installation costs
associated with new client locations are capitalized and charged to depreciation
expense over the estimated life of the clients' contract.
The Company's customers typically enter into a noncancelable five-year
contract that renews automatically for at least one five-year term unless
specifically terminated at the initial contract expiration date. The average
length of service per customer is approximately 12 years. The Company typically
makes an initial one-time installation investment per location, in exchange for
recurring monthly fees. For music clients under contract with the independent
franchisees, the Company receives a net monthly royalty fee in exchange for
music programming. The Company does not incur a capital outlay for a new client
location generated by an independent franchisee.
The business music industry remains highly fragmented, with numerous
independent operators. The Company plans to pursue acquisitions of competitors
and of its independent franchisees. Through acquisitions, the Company expects to
realize cost savings by eliminating duplicative programming, distribution, sales
and marketing, and technical and other general administrative expenses.
The business music industry is influenced by the recording industry,
performing rights societies, government regulations, technological advancements,
satellite capabilities, and competition. The Company must license rights to
rerecord and distribute music and is reliant on third parties for satellite
capabilities.
Selling, general and administrative expenses include salaries,
benefits, commissions, travel, marketing materials, training and occupancy costs
associated with staffing and operating sales offices. These expenses also
include personnel and other costs in connection with the Company's headquarters
functions. Sales commissions, excluding sales commissions related to purchased
equipment, are capitalized and charged as selling, general and administrative
expense over the typical contract term of five years. If a client contract is
terminated early, the unamortized sales commission is typically recovered from
the salesperson.
Results of Operations
The Company has provided a comparison of the quarter ended September
30, 2000 to the prior year period. However, the Company did not compare the
results for the nine months ended September 30, 2000 to the prior year period as
the prior year period does not include a full nine months of operations of the
Company subsequent to the merger of Old Muzak and ACN, which occurred on March
18, 1999.
30
<PAGE>
MUZAK LLC
Item 2 Management's Discussion and Analysis (Continued)
Revenues. Total revenues for the third quarter of 2000 increased 23.9% to $49.9
million, an increase of $9.6 million from the third quarter of 1999. Music and
other business services revenue increased 23.0% in the third quarter of 2000 as
compared to the third quarter of 1999 due primarily to an increase in the number
of broadcast music and audio marketing subscribers and the acquisition of
competitors and independent franchisee's contracts. Royalty revenue remained
flat in the third quarter of 2000 as compared to the third quarter of 1999 due
to the acquisition of independent franchisees during the fourth quarter of 1999
and the nine months ended September 30, 2000.
Gross Profit. Total gross profit increased 28.3% from $24.9 million in the third
quarter of 1999 to $31.9 million in the third quarter of 2000. As a percentage
of total revenues, gross profit increased from 61.8% in the third quarter of
1999 to 63.9% in the comparable 2000 period. The improvement in the gross profit
percentage is due to growth of higher margin business services, such as
broadcast music and audio marketing.
Selling, general and administrative expenses. Selling, general, and
administrative expenses for the quarter ended September 30, 2000 increased $2.6
million, or 19.5% as compared to the quarter ended September 30, 1999. These
expenses, as a percentage of revenues, were 32.2% and 33.4% for the third
quarter of 2000 and 1999, respectively.
Depreciation and amortization expenses. Depreciation and amortization expense
increased to $16.2 million in the third quarter of 2000 from $11.3 million in
the third quarter of 1999. This increase is due to the goodwill and other
intangibles recorded as a result of the acquisitions of competitors' and
independent franchisees music and audio marketing contracts as well as the
additional capital investment associated with the growth in new subscriber
locations.
Interest expense. Interest expense, net of interest income, increased to $10.7
million in the third quarter of 2000, up 42.6% from the comparable 1999 period.
The increase is due to overall increase in debt levels, as well as an increase
in interest rates.
Income tax provision. The Company is a Limited Liability Company and is treated
as a partnership for income tax purposes. No provision for income taxes is
required by the Company as its income and expenses are taxable to or deductible
by its members. The Company's corporate subsidiaries are subject to income taxes
and account for deferred income taxes under the liability method which requires
the recognition of deferred tax assets and liabilities for the expected future
tax consequences of temporary differences between the carrying amounts and the
tax basis of assets and liabilities. For the third quarter of 2000, the income
tax benefit was $78 thousand.
Net Loss. The combined effect of the foregoing resulted in net loss of $11.0
million for the third quarter of 2000, compared to a net loss of $7.2 million
for the comparable 1999 period.
Liquidity and Capital Resources
The Company had cash and cash equivalents totaling $5.6 million and
$2.3 million at September 30, 2000 and December 31, 1999, respectively. The
Company had $39 thousand of borrowing availability under its credit agreements
as of September 30, 2000. After giving effect to the use of proceeds from the
equity contribution from the Parent in October 2000, the Company had $35 million
of borrowing availability.
31
<PAGE>
MUZAK LLC
Item 2 Management's Discussion and Analysis (Continued)
Sources and Uses of Funds
The Company's principal sources of funds are cash generated from
continuing operations, borrowings under the Senior Credit Facility, and proceeds
from equity contributions. In the quarter and nine months ended September 30,
2000, the Company received cash equity contributions of $20.0 million and $35.6
million, respectively from its Parent. The proceeds were used to pay down the
Senior Credit Facility and for general corporate purposes. Net cash used in
operating activities of the Company was $11.2 million and $14.3 million during
the quarter and nine months ended September 30, 2000, respectively.
The Company expects that its principal uses of cash flows from
operations and borrowings will be to fund acquisitions, interest and principal
payments on its indebtedness, net working capital increases and capital
expenditures associated with new client locations.
The Company believes that its cash flows from operations and borrowings
under the Revolving Loan will be sufficient to fund operations, excluding
acquisitions, through June 30, 2001. Due to continued growth in its operating
activities and the associated capital investment made in connection with new
client locations as well as the Company's strategic plan for acquisitions, the
Company may pursue additional financing within the next nine months.
At September 30, 2000, the Company has total outstanding indebtedness
of $381.5 million at an average interest rate of 10.95%. Of the total
outstanding indebtedness, $312.9 million relates to the Senior Credit Facility
and the Senior Notes.
Capital Expenditures
The Company's business generally requires capital for the installation
of equipment for new business clients. The Company also expends capital for
property and equipment to be used at headquarters and within the owned
operations. The Company currently anticipates that its capital expenditures for
fiscal 2000 will be in the range of $38.0 million to $40.0 million, which
includes approximately $5.0 million to be incurred in connection with the build
out of the Company's headquarters facility in Fort Mill, South Carolina. As of
September 30, 2000, the Company had approximately $1.1 million in remaining
capital expenditure commitments related to the new headquarters facility.
Senior Credit Facility
The Senior Credit Facility, which is guaranteed by the Parent, the
Company, and certain of its domestic subsidiaries, contains restrictive
covenants including maintenance of interest and leverage 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. Such
limitations, together with the Company's highly leveraged nature could limit the
Company's corporate and operating activities in the future, including the
implementation of future acquisitions. As a result of the renegotiated EchoStar
agreement, the Company was in violation of certain debt covenants as of June 30,
2000 and obtained a waiver. As of September 30, 2000, the Company is in
compliance with all debt covenants.
32
<PAGE>
MUZAK LLC
Item 2 Management's Discussion and Analysis (Continued)
Effective August 2, 2000, the Company, in view of the overall higher
interest rate environment and the Company's growth, amended the Senior Credit
Facility as follows: (i) increased the additional secured indebtedness permitted
from $2.5 million to $9.0 million and decreased the additional unsecured
indebtedness permitted from $5.0 million to $1.0 million; (ii) amended the
interest coverage ratio for the quarters ended June 30, 2000, September 30,
2000, and December 31, 2000 from 1.80x to 1.65x; and (iii) increased the total
capital expenditures permitted for fiscal 2000 from $32.0 million to $38.0
million. In connection with each permitted acquisition of a Muzak independent
franchisee, the amount of permitted consolidated capital expenditures for the
twelve month period after the acquisition can be increased by an amount equal to
the product of 3.5 and the total monthly music and other business services
revenue, at the time of acquisition, for each such acquired Muzak franchisee.
This increase results in permitted total capital expenditures for fiscal 2000
of $41.3 million.
Floating Rate Notes
In January 2000, the Company entered into an indenture for up to $50.0
million Senior Subordinated Floating Rate Notes (the "Floating Rate Notes"). The
Floating Rate Notes were redeemed at 101.50% on October 19, 2000.
Senior Notes
On March 18, 1999, the Company together with its wholly owned
subsidiary, Muzak Finance Corp., co-issued $115.0 million in principal amount of
Senior Subordinated Notes ("Senior 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 Notes are general unsecured obligations of the Company and
Muzak Finance Corp. and are subordinated in right of payment to all existing and
future Senior Indebtedness of the Company and Muzak Finance Corp. The Senior
Notes are guaranteed by the Parent, the Company, MLP Environmental Music LLC,
Business Sound Inc., BI Acquisition LLC, Audio Environments Inc., Background
Music Broadcasters Inc., Muzak Capital Corporation, Muzak Houston Inc.,
Telephone Audio Productions Inc., Music Incorporated, and Vortex Sound
Communications Company Inc. The indenture governing the Senior Notes restricts,
among other things, the Company's ability to make certain payments such as
dividends and distributions of their capital stock, repurchases or redemptions
of their capital stock, and investments (other than permitted investments).
Before March 15, 2002, the issuers may redeem up to 35% of the
aggregate principal amount of the Notes originally issued under the indenture at
a redemption price of 109.875% of the aggregate principal amount so redeemed,
plus accrued and unpaid interest to the redemption date, with the net proceeds
of one or more equity offerings if certain conditions are met. After March 15,
2004, the issuers may redeem all or part of the Senior Notes at a redemption
price equal to 104.938% of the principal amount, which redemption price declines
to 100% of the principal amount in 2007.
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MUZAK LLC
Item 2 Management's Discussion and Analysis (Continued)
Senior Discount Notes
On March 18, 1999, the Parent together with its wholly owned subsidiary
Muzak Holdings Finance Corp., co-issued $75.0 million in principal amount at
maturity or $39.9 million in accreted value on the issue date, of 13% Senior
Discount Notes (the "Senior Discount Notes") due 2010. Cash interest on the
Senior Discount Notes does not accrue and is not payable prior to March 15,
2004. The Senior Discount Notes were issued at a substantial discount from their
principal amount at maturity. 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. 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.
The Senior Discount Notes are general unsecured obligations of the
Parent and Muzak Holdings Finance Corp. and effectively subordinated in right of
payment to all existing and future Senior Indebtedness of the Company and Muzak
Finance Corp. The Parent is a holding company for the Company and its
subsidiaries, with no material operations of its own and only limited assets.
Muzak Holdings Finance Corp. has no operations and substantially no assets.
Accordingly, the Parent is dependent upon the distribution of the earnings of
its subsidiaries to service its debt obligations. The indenture governing the
Senior Discount Notes restricts, among other things, the ability of the Parent
and its restricted subsidiaries to make certain payments such as dividends and
distributions of their capital stock, repurchases or redemptions of their
capital stock, and investments (other than permitted investments).
Before March 15, 2002, the issuers may redeem up to 35% of the
aggregate principal amount of the Senior Discount Notes originally issued under
the indenture at a redemption price of 113% of the aggregate principal amount so
redeemed, plus accrued and unpaid interest to the redemption date, with the net
proceeds of one or more equity offerings if certain conditions are met. After
March 15, 2004, the issuers may redeem all or part of the Senior Discount Notes
at a redemption price equal to 106.5% of the principal amount, which redemption
price declines to 100% of the principal amount in 2007.
Interest Rate Exposure
Indebtedness under the Term Loan A of the Senior Credit Facility and
the revolving loans bears interest at a per annum rate equal to the Company's
choice of: (i) the Alternate Base Rate (which is the greater of prime rate and
the Federal Funds Rate plus .5%) plus a margin ranging from 1.00% to 2.00%; or
(ii) the offered rates for Eurodollar deposits ("LIBOR") of one, two, three, or
six months, as selected by the Company, plus a margin ranging from 2.0% to 3.0%.
Margins, which are subject to adjustment based on the changes in the Company's
ratio of consolidated total debt to EBITDA (i.e., earnings before interest,
taxes, interest, depreciation, amortization and other non cash charges) were
2.0% in the case of Alternate Base Rate and 3.0% in the case of LIBOR as of
September 30, 2000. Indebtedness under the Term Loan B of the Senior Credit
Facility bears interest at a per annum rate equal to the Company's choice of:
(i) the Alternate Base Rate (as described above) plus a margin of 2.5%; or (ii)
LIBOR of one, two, three, or six months, as selected by the Company plus a
margin of 3.5%. Commitment fees range from .375% to .625%.
Indebtedness under the Floating Rate Notes bore interest at a per annum
rate equal to (i) three month LIBOR plus a margin of 5.0% until July 31, 2000;
and (ii) at three month LIBOR plus a margin of 7.5% for the period beginning
August 1, 2000 through October 19, 2000.
Interest on the Senior Notes accrues at a rate of 9.875% per annum.
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. From and after March 15, 2004, interest on the
Senior Discount Notes will accrue at a rate of 13% per annum.
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MUZAK LLC
Item 2 Management's Discussion and Analysis (Continued)
Cash interest paid was $12.1 million and $29.9 million for the quarter
and nine months ended September 30, 2000, respectively and was $8.9 million and
$11.3 million for the quarter and nine months ended September 30, 1999,
respectively.
Due to the variable interest rates under the Senior Credit Facility,
the Company is sensitive to changes in interest rates. Accordingly, during April
1999, the Company entered into a four-year interest rate swap agreement in which
the Company effectively exchanged $100.0 million of floating rate debt at three
month LIBOR for 5.59% fixed rate debt. The Company modified this agreement on
January 28, 2000 resulting in an increase to 7.042% fixed rate debt and a
termination date of April 2002. Based on amounts outstanding at September 30,
2000, a .5% increase in each of LIBOR and the Alternate Base Rate (6.80% and
9.50% respectively, at September 30, 2000) would impact interest costs by
approximately $1.2 million annually on the Senior Credit Facility and the
Floating Rate Notes.
Debt Maturities
The current maturities of long-term debt primarily consist of the
current portion of the Senior Credit Facility and other miscellaneous debt. The
maturities of long-term debt of the Company's operations during the remainder of
2000 and for 2001, 2002, 2003, and 2004 are $1.8 million, $5.2 million, $6.7
million, $7.8 million, $26.3 million, respectively.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes in market risk disclosure that
affect the quantitative and qualitative disclosures since those reported in the
Company's Report on Form 10-K/A for the fiscal year ended December 31, 1999.
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings.
There have been no material developments in legal proceedings involving
the Company since those reported in the Company's Report on Form 10-K/A for
fiscal year ended December 31, 1999.
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit
Number Description
------- -----------
3.1 Third Amended and Restated Limited Liability Company Agreement of
Muzak Holdings LLC dated as of October 18, 2000. (1)
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MUZAK LLC
Item 2 Management's Discussion and Analysis (Continued)
Exhibit
Number Description
------- -----------
10.1 Amended and Restated Securityholders Agreement dated as of October
18, 2000 by and among Muzak Holdings LLC and the various parties
named therein. (1)
10.2 Securities Purchase Agreement between Muzak Holdings LLC as Issuer
and BancAmerica Capital Investors L.P. and various investors as
purchasers dated as of October 18, 2000. (1)
10.3 Second Amended and Restated Registration Rights Agreement, dated as
of October 18, 2000, by and among Muzak Holdings LLC and the parties
named therein. (1)
27.1 Financial Data Schedules of Muzak LLC.
27.2 Financial Data Schedules of Muzak Finance Corporation.
(1) Incorporated by reference to Muzak Holdings LLC's Report on
Form 10-Q for the quarter ended September 30, 2000.
(b) Reports on Form 8-K
The Company filed Form 8-K on August 22, 2000, to announce Stephen
Villa as Chief Financial Officer.
36
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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 LLC
MUZAK FINANCE CORP.
By: /s/ Stephen P. Villa
---------------------------------
Date: November 14, 2000 Stephen P. Villa
Chief Financial Officer
(Principal Financial
Officer and Chief
Accounting Officer)
By: /s/ William A. Boyd
---------------------------------
Date: November 14, 2000 William A. Boyd
President and Chief Executive Officer
(Principal Executive Officer)
37
