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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT PURSUANT
TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of Earliest Event Reported): February 8, 1999
MUZAK LIMITED PARTNERSHIP
MUZAK CAPITAL CORPORATION
- --------------------------------------------------------------------------------
(Exact Name of Registrants as Specified in their Charters)
DELAWARE
DELAWARE
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(State or Other Jurisdiction of Incorporation)
333-03741 13-3647593
333-03741-01 91-1722302
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(Commission File Numbers) (I.R.S. Employer Identification Nos.)
2901 THIRD AVENUE, SUITE 400
SEATTLE, WASHINGTON 98121
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(Address of Principal Executive Offices) (Zip Code)
(206) 633-3000
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(Registrants' Telephone Number, Including Area Code)
N/A
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(Former Name or Former Address, if Changed Since Last Report)
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NYFS08...:\63\64563\0011\2119\FRM2239R.550
<PAGE>
Item 5. Other Events.
ACN Cash Tender Offer and Consent Solicitation. On February 8, 1999,
Audio Communications Network, LLC ("ACN") announced that it had commenced a cash
offer for all of the outstanding 10% Senior Notes due 2003 (the "Notes") of
Muzak Limited Partnership ("Muzak") and Muzak Capital Corporation, issued
pursuant to an Indenture, dated October 2, 1996 (the "Indenture"). The
Expiration Date of the offer is 5:00 p.m., New York City time, on March 9, 1999
or such later date and time to which the offer is extended. In conjunction with
the offer, ACN also solicited consents of the registered holders of Notes to
certain proposed amendments to the Indenture. On February 22, 1999, ACN
announced that, as of 5:00 p.m., New York City time on such date, holders of
more than a majority of the Notes had tendered Notes and delivered consents in
connection with the offer and solicitation of consents.
Muzak Financial Statements. Muzak today released its financial
statements for the year ended December 31, 1997, amended to show the changes in
Subsequent Events (Note 11 of the Notes to Consolidated Financial Statements)
occurring between March 5, 1998 and February 1, 1999. The financial statements
were released in connection with the sale of Muzak pursuant to the Agreement and
Plan of Merger between Muzak, MLP Acquisition, L.P., Music Holdings Corp., ACN
Holdings, LLC and ACN, dated as of January 29, 1999.
Muzak today also released its financial statements and Management's
Discussion and Analysis for the year ended December 31, 1998.
<PAGE>
Item 7. Financial Statements, Pro Forma Financial Information and Exhibits.
(c) Exhibits
Exhibit No. Exhibit
- ----------- -------
99.1 Financial Statements for the years ended December 31, 1997,
1996 and 1995 of Muzak Limited Partnership, and Independent
Auditors' Report, as amended.
99.2 Financial Statements for the years ended December 31, 1998,
1997 and 1996 of Muzak Limited Partnership, and Independent
Auditors' Report.
99.3 Management's Discussion and Analysis for the year ended
December 31, 1998.
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 LIMITED PARTNERSHIP
(Registrant)
By: /s/ Brad D. Bodenman
----------------------------------
Date: February 25, 1999 Brad D. Bodenman
Chief Financial Officer
(Principal Financial
Officer and Chief
Accounting Officer of Muzak
Limited Partnership)
MUZAK CAPITAL CORPORATION
(Registrant)
By: /s/ Brad D. Bodenman
----------------------------------
Date: February 25, 1999 Brad D. Bodenman
Chief Financial Officer
(Principal Financial
Officer and Chief
Accounting Officer of Muzak
Limited Partnership)
<PAGE>
EXHIBIT INDEX
Exhibit No. Exhibit
- ----------- -------
99.1 Financial Statements for the years ended December 31, 1997,
1996 and 1995 of Muzak Limited Partnership, and Independent
Auditors' Report, as amended.
99.2 Financial Statements for the years ended December 31, 1998,
1997 and 1996 of Muzak Limited Partnership, and Independent
Auditors' Report.
99.3 Management's Discussion and Analysis for the year ended
December 31, 1998.
Exhibit 99.1
[LETTERHEAD OF DELOITTE & TOUCHE LLP]
INDEPENDENT AUDITORS' REPORT
General and Limited Partners
Muzak Limited Partnership
Seattle, Washington
We have audited the accompanying consolidated balance sheets of Muzak
Limited Partnership and subsidiary (the "Company") as of December 31, 1996 and
1997, and the related consolidated statements of operations, partners' capital
(deficit), and cash flows for each of the three years in the period ended
December 31, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Muzak Limited Partnership and
subsidiary as of December 31, 1996 and 1997, and their results of operations and
their cash flows for each of the three years in the period ended December 31,
1997, in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Seattle, Washington
March 5, 1998 (February 1, 1999, as to Note 11)
<PAGE>
MUZAK LIMITED PARTNERSHIP
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
December 31,
------------
1996 1997
---- ----
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents........................................... $ 25,686 $ 8,524
Accounts receivable, net of allowance for doubtful accounts of
$496 and $501.................................................... 15,600 16,790
Inventories......................................................... 3,722 3,850
Prepaid expenses.................................................... 1,607 1,400
Other............................................................... 351 1,116
---------- ----------
Total current assets............................. 46,966 31,680
Property and equipment, net............................................. 37,182 39,659
Deferred costs and intangible assets, net............................... 33,765 31,694
Other................................................................... 1,129 1,362
---------- ----------
Total assets..................................... $ 119,042 $ 104,395
========== ==========
Liabilities and Partners' Deficit
Current Liabilities:
Accounts payable $ 8,681 $ 8,435
Advance billings...................................................... 4,688 5,216
Accrued interest...................................................... 2,500 2,500
Accrued expenses...................................................... 2,423 2,556
Current portion of long-term obligation............................... 482 469
---------- ----------
Total current liabilities........................ 18,774 19,176
Long-term obligations, net of current portion........................... 100,620 100,575
Unearned installation income............................................ 3,636 4,249
Commitments and contingencies (Note 8).................................. -- --
Redeemable preferred partnership interests.............................. 6,090 6,490
Partners' Deficit:
Limited partners' interests (deficiencies)
(preference in liquidation of $8,303 and $8,841)............... 2,211 (3,597)
General partners' deficiencies........................................ (12,289) (22,498)
---------- ----------
Total partners' deficit........................................... (10,078) (26,095)
---------- ----------
Total liabilities and partners' deficit........................... $ 119,042 $ 104,395
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE>
MUZAK LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
<TABLE>
<CAPTION>
Year Ended
December 31,
----------------------------------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Revenues:
Music and other business services.......................... $ 52,489 $ 54,585 $ 59,351
Equipment sales and related services....................... 34,392 32,226 31,853
---------- ---------- ----------
Total revenues........................................ 86,881 86,811 91,204
---------- ---------- ----------
Cost of
revenues:
Music and other business services.......................... 14,465 15,263 18,502
Equipment sales and related services....................... 23,895 21,763 22,207
---------- ---------- ----------
Total cost of revenues................................ 38,360 37,026 40,709
---------- ---------- ----------
Gross profit................................................. 48,521 49,785 50,495
Selling, general and administrative expenses................. 28,496 31,659 33,464
Depreciation................................................. 9,382 10,625 10,652
Amortization................................................. 8,908 9,594 10,016
---------- ---------- ----------
Operating income (loss).............................. 1,734 (2,093) (3,637)
Interest expense............................................. (7,483) (8,112) (10,775)
Interest income.............................................. 129 438 1,017
Equity in losses of joint venture............................ -- (225) (755)
Other, net................................................... (94) (209) 715
---------- ---------- ----------
Net loss before extraordinary items.......................... (5,714) (10,201) (13,435)
Extraordinary loss on write-off of deferred financing
fees and debt discount................................... -- (3,713) --
Extraordinary gain on retirement of redeemable
preferred partnership interests.......................... -- 3,091 --
---------- ---------- ----------
Net loss................................................... (5,714) (10,823) (13,435)
Redeemable preferred return................................ (1,029) (916) (400)
---------- ---------- ----------
Net loss attributable to general and limited partners...... $ (6,743) $ (11,739) $ (13,835)
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
MUZAK LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL (DEFICIT)
(in thousands)
<TABLE>
<CAPTION>
General Partners' Class B
Interests Class A Class B Limited Preferred Class B
------------------- Limited Class A Limited Partners' Limited Partnership
Number Partners' Put/Call Partners' Subscriptions Partners' Unit
of Units Amount Interests Options Interests Receivable Interests Options
-------- ------ --------- ------- --------- ---------- --------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1994 9,101 $ 575 $ (122) $ 952 $ 171 $ (633) $ 7,000 -
Net loss (3,690) (682) (621) (721)
Payment of foreign income taxes (51) (14) (9) (12)
Preferred return on redeemable
preferred interests (665) (123) (112) (129)
Preferred return on preferred
limited partners' interests (433) (80) (73) (85) 671
Principal payments on
subscriptions receivable 259
------- -------- -------- ------- --------- -------- -------- --------
Balance, December 31, 1995 9,101 (4,264) (1,021) 137 (776) (374) 7,671
Net loss (6,973) (1,288) (1,172) (1,390)
Payment of foreign income taxes (54) (11) (9) (10)
Preferred return on redeemable
preferred interests (591) (109) (99) (117)
Preferred return on preferred
limited partners' interests (407) (75) (69) (81) 632
Principal payments on
subscriptions receivable 207
Capital contribution from noncash
incentive compensation 60
Contribution by partner 105
------- -------- -------- ------- --------- -------- -------- -------
Balance, December 31, 1996 9,101 (12,289) (2,504) (1,212) (2,269) (167) 8,303 60
Net loss (8,730) (1,593) (1,293) (1,819)
Payment of foreign income taxes (50) (1) (9) (16)
Preferred return on redeemable
preferred interests (257) (49) (48) (46)
Preferred return on preferred
limited partners' interests (367) (72) (88) (85) 612
Principal payments on
subscriptions receivable 132
Capital contribution from noncash
incentive compensation 202
Contribution by partner 2,072 (1,601)
Withdrawal by partner (805) (2,032) (74)
------- -------- -------- ------- --------- -------- -------- -------
Balance, December 31, 1997 9,101 $ (22,498) $ (4,219) $(2,650) $ (4,195) $ (1,636) $ 8,841 $ 262
======= ======== ======== ======= ========= ======== ======== =======
</TABLE>
4(a)
* Table continued on the following Page 4(b)
<PAGE>
* Table continued from the preceding Page 4(a)
<TABLE>
<CAPTION>
Total Limited
Partners' Interest Total
---------------------- ----------------------
Number Number
of Units Amount of Units Amount
-------- ------ -------- ------
<S> <C> <C> <C> <C>
Balance, December 31, 1994 8,989 $ 87,368 18,090 $ 7,943
Net loss (2,024) (5,714)
Payment of foreign income taxes (35) (86)
Preferred return on redeemable
preferred interests (364) (1,029)
Preferred return on preferred
limited partners' interests 433
Principal payments on
subscriptions receivable 259 259
-------- --------- -------- --------
Balance, December 31, 1995 8,989 5,637 18,090 1,373
Net loss (3,850) (10,823)
Payment of foreign income taxes (30) (84)
Preferred return on redeemable
preferred interests (325) (916)
Preferred return on preferred
limited partners' interests 407
Principal payments on
subscriptions receivable 207 207
Capital contribution from noncash
incentive compensation 60 60
Contribution by partner 60 105 60 105
-------- --------- -------- --------
Balance, December 31, 1996 9,049 2,211 18,150 (10,078)
Net loss (4,705) (13,435)
Payment of foreign income taxes (26) (76)
Preferred return on redeemable
preferred interests (143) (400)
Preferred return on preferred
limited partners' interests 367
Principal payments on
subscriptions receivable 132 132
Capital contribution from noncash
incentive compensation 202 202
Contribution by partner 889 471 889 471
Withdrawal by partner (1,250) (2,106) (1,250) (2,911)
-------- --------- -------- --------
Balance, December 31, 1997 8,688 $ (3,597) 17,789 $(26,095)
======== ========= ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4(b)
<PAGE>
MUZAK LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss........................................................................... (5,714) (10,823) (13,435)
Adjustments to reconcile net loss to net cash provided by operating
activities:
Provision for doubtful accounts ................................................. 810 472 20
Depreciation..................................................................... 9,382 10,625 10,652
Amortization, net of deferred financing costs.................................... 8,909 9,594 10,016
Deferred financing cost amortization............................................. 1,310 1,042 653
Equity in losses of joint venture................................................ -- 225 755
Noncash incentive compensation................................................... -- 60 202
Extraordinary loss on write-off of deferred financing fees and debt discount..... -- 3,713 --
Extraordinary gain on retirement of redeemable preferred partnership interests... -- (3,091) --
Gain on sale of territory........................................................ -- -- (757)
Loss on write-off of inventories................................................. -- -- 530
Loss on write-off of equity offering costs....................................... -- 1,353 --
Changes in operating assets and
liabilities:
Accounts receivable.............................................................. (476) (555) (2,498)
Inventories...................................................................... 597 (461) (658)
Account payable.................................................................. (1,267) 1,863 (246)
Accrued interest................................................................. (916) 834 --
Accrued expenses................................................................. 293 1,188 214
Advance billings................................................................. 194 155 528
Unearned installation income..................................................... 1,110 850 613
Other, net....................................................................... (35) 510 139
------- --------- --------
Net cash provided by operating activities.......................................... 14,197 17,554 7,328
------- --------- --------
INVESTING
ACTIVITIES
Additions to property and equipment.............................................. (8,116) (10,913) (12,639)
Additions to deferred costs and intangible assets................................ (4,641) (5,424) (6,039)
Acquisitions of businesses and ventures net of cash acquired .................... (557) -- (2,836)
Other, net....................................................................... 3 (291) 6
------- --------- --------
Net cash used in investing activities.............................................. (13,311) (16,628) (21,508)
------- --------- --------
FINANCING
ACTIVITIES
Proceeds from issuance of senior notes........................................... -- 100,000 --
Borrowings (repayment) under revolving notes payable, net........................ 3,300 (9,300) --
Principal payments on term debt.................................................. (4,111) (53,489) (92)
Payment of financing fees ....................................................... -- (5,802) --
Retirement of redeemable preferred partnership interests......................... -- (7,456) --
Payments on other long-term debt................................................. (30) (123) --
Payments under capital leases.................................................... (432) (414) (505)
Contributions by partners........................................................ 259 312 603
Withdrawal by partners........................................................... -- -- (2,911)
Other, net....................................................................... (202) (83) (77)
------- --------- --------
Net cash provided by (used in) financing activities................................ (1,216) 23,645 (2,982)
------- --------- --------
Net increase (decrease) in cash and cash equivalents............................... (330) 24,571 (17,162)
CASH AND CASH EQUIVALENTS beginning of period...................................... 1,445 1,115 25,686
------- --------- --------
CASH AND CASH EQUIVALENTS, end of period........................................... $ 1,115 $ 25,686 $ 8,524
------- --------- --------
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY AND ITS BUSINESS:
Muzak Limited Partnership (the "Company") provides business music services
and also produces, markets and sells broadcast data delivery, video, audio
marketing and in-store advertising services through a network of domestic and
international franchises and owned operations. The franchisees are charged a fee
based on their revenues, as well as certain other fees, in exchange for
broadcast music, marketing, technical and administrative support. The Company
and its franchisees also sell, install and maintain electronic equipment related
to the Company's business.
The Company's music is primarily sold for use in public areas, such as
retail establishments and restaurants, and work areas, such as business offices
and manufacturing facilities. Services are distributed through direct broadcast
satellite transmission, local broadcast transmissions and pre-recorded tapes
played on the customers' premises.
The Company is subject to certain business risks which could affect future
operations and financial performance. These risks include rapid technological
change, competitive pricing, concentrations in and dependence on satellite
delivery capabilities, and development of new services.
Public Offering
In August 1996, the general and limited partners authorized a plan for the
filing of a registration statement for the underwritten public offering of 10%
senior notes (the "Offering"). The Offering closed on October 2, 1996. A portion
of the net proceeds of the Offering were used to repay certain bank debt and
other indebtedness and to repurchase the Company's Class C redeemable preferred
partnership interest. The Company has used and will be using the remaining
portion of the net proceeds for certain strategic investments and other general
corporate purposes.
Business Acquisitions and Sales
As of September 1, 1992, the Company commenced operations in its current
form (the "Partnership") through an acquisition (the "1992 Acquisition") of
substantially all of the assets, including the right to operate under its
current name, from a predecessor partnership (the "Seller"). The 1992
Acquisition was accounted for as a purchase with the purchase price allocated to
the individual assets, based on their estimated fair values at the date of
acquisition.
On May 1, 1997, the Company sold its Spokane territory subscriber accounts
and granted the Spokane franchise to an existing franchisee of the Company for
$1.4 million. This transaction resulted in a gain of $0.8 million to the Company
which is included in other income in the consolidated statement of operations
for the year ended December 31, 1997.
6
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. THE COMPANY AND ITS BUSINESS: (CONTINUED)
On August 28, 1997, the Company acquired substantially all of the
assets of Attuned to Music, Inc. These net assets were purchased for
approximately $0.3 million. The acquisition was financed with cash remaining
from the Offering. The acquisition was accounted for as a purchase with the
purchase price allocated to the individual assets based on the fair market
values at the date of acquisition.
On September 1, 1997, the Company acquired substantially all of the assets
of Applied Sound. These assets were purchase for approximately $0.2 million. The
acquisition was financed with cash remaining from the Offering. The acquisition
was accounted for as a purchase with the purchase price allocated to the
individual assets based on the fair market values at the date of acquisition.
On October 1, 1997, the Company acquired substantially all of the assets of
Muzi-Tronic a service of Fetzer Broadcasting. These assets were purchased for
approximately $2.1 million. The acquisition was financed with cash remaining
from the Offering. The acquisition was accounted for as a purchase with the
purchase price allocated to the individual assets based on the fair market
values at the date of acquisition.
On December 23, 1997, the Company acquired substantially all of the assets
of Superior Sound. These assets were purchased for approximately $1.5 million.
The acquisition was financed with cash remaining from the Offering. The
acquisition was accounted for as a purchase with the purchase price allocated to
the individual assets based on the fair market values at the date of
acquisition.
The pro forma results of operations to reflect the above transactions have
not been disclosed as the effect on the result of operations are not considered
significant.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all
highly liquid debt instruments purchased with a maturity of three months or less
to be cash equivalents.
Cash and cash equivalents at December 31, 1996 and 1997, include commercial
paper investments of approximately $23 million and $5 million respectively. The
remaining balance of cash and cash equivalents at December 31, 1996 and 1997 is
held at various institutions throughout the United States.
7
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
Inventories
Inventories consist primarily of electronic equipment and are recorded at
the lower of cost (first-in, first-out) or market.
Property and Equipment
Property and equipment consist primarily of equipment provided to
subscribers and machinery and equipment, recorded at cost. Major renewals and
betterments are capitalized to the property accounts while replacements,
maintenance and repairs that do not improve or extend the lives of the
respective assets are expensed.
Property and equipment are depreciated on a straight-line basis over the
estimated useful lives of the related assets, ranging from five to forty years.
Assets acquired under capital leases and leasehold improvements are amortized on
a straight-line basis over the shorter of their estimated useful lives or the
term of the related leases.
Deferred Costs and Intangible Assets
Income-producing contracts, acquired through acquisitions, are being
charged to amortization expense on an accelerated method over the period of
their expected benefit of eight years. Deferred financing costs are charged to
interest expense on the effective interest method over the term of the related
agreements. Other deferred costs and intangible assets are recorded at cost and
are being charged to amortization expense over their estimated useful lives or
the period of their expected benefit ranging from five and ten years.
The carrying value of long-lived assets is reviewed on a regular basis for
the existence of facts or circumstances that may indicate that the carrying
amount is not recoverable. To date, no impairment has been indicated. Should
there be an impairment in the future, the Company will measure the impairment
based on the discounted expected future cash flows from the impaired assets.
Revenue Recognition
Revenues are recognized in the month that the services are provided. Fees
from franchisees are recognized as music revenues in the month that the
franchisee generates its revenues. Equipment and related services revenues are
recorded in the period that the installation is completed.
8
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
Advance Billings
The Company bills certain customers in advance for contracted music and
other business services. Amounts billed in advance of the service period are
deferred when billed and recognized as revenue in the period earned.
Unearned Installation Income
The Company defers recognition of income from the installation of equipment
provided to subscribers and recognizes these amounts as revenue on a
straight-line basis over the average subscriber service period.
Income Taxes
The income tax effects of all earnings or losses of the Company are passed
directly to the partners. Payment of foreign income taxes is reflected as a
reduction to the partners' capital accounts. Thus, no provision or benefit for
federal, state, local or foreign income taxes is required.
Accounting for Equity-Based Compensation
The Company measures equity-based compensation using Accounting Principles
Board Opinion Number 25 ("APB 25"), which recognizes compensation cost based on
the intrinsic value of the equity instrument when awarded.
Fair Value of Financial Instruments
The carrying amount of cash and cash equivalents approximates fair value
because of the short maturity of these instruments. The carrying amount of
long-term debt approximates $104.0 million.
European Joint Venture
In 1995, the Company entered into a joint venture agreement to provide
business music services in Europe ("Muzak Europe"). This joint venture is
accounted for using the equity method as the Company owns 50% of that venture
but does not have a controlling interest. Equity in losses of joint venture in
the accompanying consolidated statements of operations include the Company's
share of net losses. As of December 31, 1996 and 1997, the joint venture had
total assets of $7,814,000 and$7,307,000 and total liabilities of $6,662,000 and
$5,509,000 respectively. As of December 31,
9
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
1996 and 1997, the carrying value of the joint venture on the Company's books
was $800,000 and $1,100,000 respectively.
The Company uses the foreign countries' local currency as the functional
currency for its overseas operations. The translation gains and losses resulting
from the remeasurement of the foreign operations' financial statements are
insignificant.
Principles of Consolidation
The accompanying consolidated financial statements of the Company include
the accounts of the Company and its wholly owned subsidiary, Muzak Capital
Corporation. All significant intercompany accounts and transactions have been
eliminated upon consolidation.
Recent Accounting Pronouncements
The Accounting Standards Executive Committee of the American Institute of
Certified Public Accountants issued Statement of Position (SOP) 98-1, Accounting
for the Costs of Computer Software Developed or Obtained for Internal Use, on
March 4, 1998. This SOP is effective for the Company's year ended December 31,
1999 and requires certain of the Company's product research and development
expenses related to development of software for internal use to be capitalized.
The Company is currently evaluating the effects of this Statement, and
management is uncertain as to the impact of its adoption on the financial
statements, taken as a whole.
Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
10
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. PROPERTY AND EQUIPMENT, NET:
Property and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
------------
1996 1997
---- ----
<S> <C> <C>
Equipment provided to subscribers....................... $ 49,340 $ 57,393
Machinery and equipment................................. 10,745 13,129
Vehicles................................................ 3,072 3,337
Furniture and fixtures.................................. 2,260 2,546
Land and buildings...................................... 858 858
Leasehold improvements.................................. 916 865
---------- -----------
Total property and equipment............................ 67,191 78,128
Less accumulated depreciation and amortization.......... (30,009) (38,469)
---------- -----------
$ 37,182 $ 39,659
========== ===========
</TABLE>
4. DEFERRED COSTS AND INTANGIBLE ASSETS, NET:
Deferred costs and intangible assets consist of the following (in
thousands):
<TABLE>
<CAPTION>
December 31,
------------
1996 1997
---- ----
<S> <C> <C>
Income producing contracts.............................. $ 39,830 $ 42,152
Deferred subscriber acquisition costs................... 11,056 14,593
Master recording rights and deferred production costs... 9,883 12,125
Organization costs...................................... 4,432 4,501
Deferred financing costs................................ 4,423 4,341
Non-compete agreements.................................. 846 860
Other................................................... 758 811
---------- ----------
Total deferred costs and intangible assets........... 71,228 79,383
Less accumulated amortization........................... (37,463) (47,689)
---------- ----------
$ 33,765 $ 31,694
========== ==========
</TABLE>
11
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. LONG-TERM OBLIGATIONS:
Long-term obligations are summarized as follows (in thousands):
December 31,
------------
1996 1997
---- ----
Senior notes............................. $ 100,000 $ 100,000
Variable rate senior term loan........... -- --
Capital lease obligations................ 935 969
Other.................................... 167 75
---------- ----------
Total long-term obligations.......... 101,102 101,044
Less current portion..................... (482) (469)
---------- ----------
$ 100,620 $ 100,575
========== ==========
Senior Notes
The senior notes were issued as part of the Offering as discussed in Note
1. These unsecured notes bear interest at 10% and are due on October 1, 2003.
The notes require the maintenance of certain covenants that, among other things,
restrict the Company's ability to incur additional debt, as well as limit the
Company's ability to make certain investments and distributions to partners.
The Company has the option to redeem up to 35% of the senior notes during
the first three years after the Offering with the proceeds from an equity
offering, at a redemption price of 109% of the principal amount thereof, plus
accrued and unpaid interest. The entire balance of the senior notes is
redeemable at the option of the Company, in whole or in part, beginning October
1, 2000. The redemption price is 105% of par value through October 1, 2001,
102.5% through October 1, 2002, and 100% thereafter, through maturity.
Credit Agreements
The variable rate senior term loan was a $46,600,000 term loan (the "Credit
Agreement") with a group of banks for which Union Bank of Switzerland (the
"Agent Bank"), an affiliate of a limited partner, was acting as the agent. The
Credit Agreement also included a $13,000,000 revolving credit facility. The
terms of the Credit Agreement required the Company to meet certain financial
ratios and performance criteria and impose restrictions on capital spending, the
incurrence of additional debt, and distributions to partners, among other
things. Distributions to partners were limited to distributions that offset tax
liabilities to the partners resulting from the Company's taxable income.
Substantially all of the Company's assets and proceeds from certain insurance
policies were pledged as collateral under the Credit Agreement. The senior term
loan was repaid on October 2, 1996, with a portion of the net proceeds from the
Offering.
12
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. LONG-TERM OBLIGATIONS: (CONTINUED)
The fixed rate subordinated note (the "Subordinated Note") was obtained
from a group of banks that were issued options to purchase Class A limited
partnership units (the "Put/Call Units") in connection with this credit
arrangement. The value of these Put/Call Units was accounted for as debt
discount and amortized on the effective interest method over the expected term
of this note. The Subordinated Note required the Company to maintain certain
performance criteria and covenants, similar to, but less restrictive than the
Credit Agreement. Substantially all of the Company's assets and proceeds from
certain insurance policies were pledged as collateral under this agreement. This
note was repaid on October 2, 1996, with a portion of the net proceeds from the
Offering.
Interest Rates and Payments
The senior notes require semi-annual interest payments of 10%. Interest
under the Credit Agreement was paid at an interest rate based on the Agent
Bank's prime rate or LIBOR in quarterly installments. During the years ended
December 31, 1995 and 1996, the effective weighted average interest rates on
borrowings under the Credit Agreement were 11.2% and 10.9%, respectively,
including the effects of the interest rate swap agreement described below.
Interest under the Subordinated Note was paid in semi-annual installments at a
rate of 12.5%, an effective rate of 14.8%, after amortization of the debt
discount. The capital lease obligations require monthly installments of interest
at a weighted average interest rate of approximately 8.4%. Total cash paid for
interest on long-term obligations was approximately $5,760,000, $5,880,000 and
$9,972,000 for the years ended December 31, 1995, 1996 and 1997, respectively.
Future Maturities
Total future maturities of long-term obligations, including capital leases,
for the five years following December 31, 1997 are: $409,000 in 1998, $334,000
in 1999, $207,000 in 2000, $71,000 in 2001, $0 in 2002, and $100,000,000
thereafter.
Capital Leases
Assets acquired under capital leases were $489,000, $579,000 and $635,000
for the years ended December 31, 1995, 1996 and 1997, respectively. Assets
recorded under capital leases were $1,495,000 and $1,944,000 with accumulated
amortization of $522,000 and $635,000 as of December 31, 1996 and 1997,
respectively.
13
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. LONG-TERM OBLIGATIONS: (CONTINUED)
Interest Rate Hedging
The Company had entered into an interest rate swap agreement with the Agent
Bank that effectively fixed the rate on $10,000,000 of the debt under the Credit
Agreement at December 31, 1995. Net settlements were recorded in interest
expense. The interest rate swap agreement was terminated in October 1996 in
connection with the Offering.
Financing and Other Costs Paid to Related Parties
Prior to the Offering discussed in Note 1, the Agent Bank was an affiliate
of a Class A limited partner. In addition, the Subordinated Noteholder held the
Put/Call Units. During the years ended December 31, 1995, 1996 and 1997, the
Company incurred interest expense related to these credit facilities of
$7,367,000, $5,489,000, and $0, respectively. In addition, the Company paid fees
to the holders of the senior and subordinated notes payable of $122,000, $0, and
$0 in 1995, 1996 and 1997, respectively, related to amendments to the Credit
Agreement and the subordinated note agreement, as well as bank charges, legal
costs and agency fees. In addition the Company has paid board fees of $162,500
and $287,700 for services in 1996 and 1997 respectively.
6. EXTRAORDINARY ITEMS:
In conjunction with the Offering, the Company used a portion of the net
proceeds to repay the entire balance of the bank debt outstanding as of October
1, 1996. The unamortized portion of the related loan origination fees and loan
discount totaling approximately $3,713,000 were written-off as an extraordinary
loss at the time of the repayment. A portion of the net proceeds from the
Offering were also used to repurchase the Company's Class C redeemable preferred
partnership interest for $7,457,000. The recorded value of the redeemable
limited partnership interest was approximately $10,548,000, resulting in a
extraordinary gain of $3,091,000.
14
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7. BENEFIT PLANS:
Defined Contribution Plan
The Company maintains a defined contribution savings and retirement plan
(the "Benefit Plan") that covers substantially all of the Company's employees.
Under the savings portion of the Benefit Plan, eligible employees may contribute
from 1% to 14% of their compensation per year, subject to certain tax law
restrictions. The Company has the option to make a matching contribution of up
to a maximum of 100% of the first 3% and 50% of the next 3%, up to 6% of the
total base salary contributed by the employee each year. Participants are
immediately vested in their contributions as well as the Company's contributions
under the savings portion of the Benefit Plan. For the savings portion of the
Benefit Plan, the Company recorded contribution expense of $181,000, $439,000
and $660,000 for the years ended December 31, 1995, 1996 and 1997, respectively.
Contributions under the retirement portion of the Benefit Plan are
determined annually by the Company at its discretion for up to 3% of the
eligible employee's compensation. The employees vest in the retirement portion
of the Benefit Plan ratably over five years, but become fully vested in the
event of death, disability or the attainment of the age of 65. No amounts were
recorded for the years ended December 31, 1995, 1996 and 1997.
Multi-Employer Defined Contribution Plans
The Company participates in several multi-employer defined contribution
benefit plans that provide benefits to employees covered by certain labor union
contracts. The amount of expense related to contributions to these plans was
approximately $108,000, $136,000 and $138,000 for the years ended December 31,
1995, 1996 and 1997. These amounts were determined by union contract and the
Company does not administer or control the funds.
15
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. COMMITMENTS AND CONTINGENCIES:
Leases
The Company leases certain facilities and equipment under both operating
and capital leases. In addition, the Company has entered into agreements to
obtain satellite channel capacity and subsidiary communication authorization
rights for the transmission of programs to the Company's customers. Total rental
expense under operating leases was approximately $7,698,000, $7,751,000 and
$8,401,000 for the years ended December 31, 1995, 1996 and 1997, respectively.
Future annual minimum lease payments under noncancelable operating leases
for the years ended December 31 are as follows (in thousands):
1998................................ $ 7,234
1999................................ 5,920
2000................................ 5,468
2001................................ 1,569
2002................................. 1,041
Thereafter ......................... 1,647
-------
Total................................ $22,879
=======
Music Licenses
In the ordinary course of the Company's business, the Company has
agreements with various organizations for the rights to rerecord and play music
in public spaces. The expenses incurred under these agreements were
approximately $3,385,000, $3,578,000 and $4,831,000 for the years ended December
31, 1995, 1996 and 1997, respectively.
The Company's agreement with Business Music, Inc. ("BMI") expired on
December 31, 1993. The Company has entered into an interim fee structure with
BMI and is in negotiations with BMI to establish an on-going rate structure. The
interim arrangement with BMI provides for continued payments at 1993 levels and
that any settlement may be retroactive to January 1, 1994. The Company's
management does not believe that the results of these negotiations will have a
material adverse effect on the Company's financial condition or results of
operations.
Joint Venture Guarantee
The Company has agreed to make pro rata equity contributions to Muzak Europe to
the extent necessary to enable Muzak Europe to maintain minimum net worth
requirements under an outstanding
16
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. COMMITMENTS AND CONTINGENCIES: (CONTINUED)
credit facility. As of December 31, 1996 and 1997, the amount outstanding under
the credit facility was $1,744,000 and $1,519,000 respectively.
Taxes
An assessment was made against the Seller resulting from an audit performed
by the Washington State Department of Revenue for sales and use and business and
occupation taxes paid for during the period from 1987 through September 1992.
Under successor liability statutes in the state of Washington, the Company
could, if the Seller fails to pay its tax obligation, become liable for the
assessment outstanding against the Seller of approximately $1,700,000. This
assessment is under appeal by the Seller. The Seller and certain of its
affiliates have agreed to indemnify the Company for any liabilities in
connection with such assessment. The Company's management does not believe that
the assessment will have an adverse effect on the Company's financial condition
or results of operations.
Employment Agreements
During 1997, the Company entered into employment agreements with two
executive officers. Under these agreements these officers will receive a bonus
up to 50% of their annual salary if in any given 12-month period specified
performance targets are met by the Company. These agreements also contain
confidentiality covenants and non-solicitation covenants, which extend for four
and two years respectively beyond the term of the agreements.
Legal Proceedings
The Company is subject to various legal proceedings which arise in the
ordinary course of business. Company management believes none of these
proceedings, individually or in the aggregate, will have a material adverse
effect on the financial condition or results of operations of the Company.
17
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. REDEEMABLE PREFERRED PARTNERSHIP INTERESTS:
The redeemable preferred partnership interests is comprised of a Class C-1,
nonvoting preferred partnership interest that does not participate in the
Company's profits or losses. A summary of this interest and its accumulated
return by period along with a summary of a Class C, nonvoting partnership
interest, that also did not participate in the Company's profits or losses, are
as follows (in thousands):
<TABLE>
<CAPTION>
Class C Class C-1 Total
------- --------- -----
<S> <C> <C> <C>
Balance, December 31, 1994.................. $ 9,373 $ 5,320 $ 14,693
Preferred return.......................... 657 372 1,029
---------- --------- ----------
Balance, December 31, 1995.................. 10,030 5,692 15,722
Preferred return.......................... 518 398 916
Repurchase of Class C interests........... (10,548) -- (10,548)
---------- --------- ----------
Balance, December 31, 1996.................. -- 6,090 6,090
Preferred return.......................... -- 400 400
---------- --------- ----------
Balance, December 31, 1997.................. $ -- $ 6,490 $ 6,490
========== ========= ==========
</TABLE>
Class C Interest
The Class C limited partner was entitled to receive the amount of its
initial contribution of $8,000,000, plus a return of 7% compounded annually, as
discussed in Note 6. The Company repurchased the Class C limited partner's
interest with a portion of the net proceeds from the Offering in October 1996.
Class C-1 Interest
The Class C-1 limited partner is entitled to receive the amount of its
initial contribution of $5,000,000, plus a return of 7%, compounded annually,
through January 31, 2004, the date of redemption. The Class C-1 limited partner
may become, at its option, a participating partner. Upon becoming a
participating partner, the Class C-1 limited partner will forfeit any accrued
portion of the return. If it has not previously become a participating partner,
the Class C-1 limited partner is entitled to a preference in liquidation equal
to its contribution plus accumulated return. The cumulative return per unit as
of December 31, 1996 and 1997, was $0.76 and $1.04 respectively. Unless the
Class C-1 interest becomes a participating interest, a general partner may, at
its sole discretion, require the Class C-1 limited partner to exchange its
interest for a note equal to its then aggregate liquidation preference amount.
If such exchange occurs prior to the time the Class C-1 limited partner has the
opportunity to obtain participation status, the Class C-1 limited partner will
also be issued an option to acquire the participating interest on substantially
the same terms as if such exchange had not occurred. If the Class
18
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. REDEEMABLE PREFERRED PARTNERSHIP INTERESTS (CONTINUED):
C-1 limited partner has not obtained participation status, or has not exchanged
such units for notes, on or prior to January 31, 2004, the Company is required
to redeem such units for an amount equal to the Class C-1 contribution plus
accumulated return.
10. PARTNERS' CAPITAL (DEFICIT):
Partners' capital (deficit) is comprised of two general partners; Class A
limited partners and Class B limited partners; Put/Call Units, and preferred
limited partners' interests.
Put/Call Units
In connection with obtaining a fixed-rate subordinated note payable, the
Company issued an option to purchase 1,529,898 units of Class A limited
partnership interests to a lender, for an aggregate exercise price of $10. These
units are currently exercisable.
Subscriptions Receivable
Officers and key employees of the Company have acquired limited partnership
interests, a portion of which were financed with subscription notes. As of
December 31, 1996 and 1997, the Class B limited partners' capital accounts were
reduced by subscription notes receivable. Interest income on the subscriptions
receivable totaled $49,000, $27,000 and $22,000 for the years ended December 31,
1995, 1996 and 1997.
Preferred Limited Partners' Interests
The preferred limited partners' interests, do not participate in the
Company's profits or losses. Such limited partners are entitled to receive an 8%
return, compounded quarterly, on the amount of their initial contribution and
are generally entitled to a priority on distributions from the Company. At
December 31, 1996 and 1997, the return was credited to the preferred limited
partners. These limited partners are also entitled to a preference in
liquidation equal to their initial contribution plus accumulated and unpaid
return. Upon the occurrence of certain events, the units may, at the option of
the Company, be redeemed by the Company for an amount equal to the then
aggregate liquidation preference amount. The units (and any accrued and unpaid
return) may, at the option of the holder, be converted into units of Class B
limited partnership interest at any time. Cumulative per unit return as of
December 31, 1996 and 1997, was $0.33 and $0.46, respectively, and a total
aggregate return of $1,303,000 and $1,814,000, respectively.
19
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10. PARTNERS' CAPITAL (DEFICIT): (CONTINUED)
Other Limited Partners' Interests
During 1997, the Company repurchased 1,250,000 Class B limited partnership
units from eight members of former management at a unit price of $2.33 for a
total repurchase amount of $2.9 million. Seventeen new and existing members of
management purchased 889,000 units at a unit price of $2.33 per unit for a total
purchase price of $2.1 million. These purchases were substantially financed by
the Company through subscription notes from these management members bearing 7%
interest. This repurchase of partnership units in exchange for Subscription
Notes Receivable is considered a non-cash transaction for purposes of the
statement of cash flows.
Also during 1997, options to purchase 1,440,000 partnership units at prices
ranging from $1.00 to $1.75 per unit were forfeited by the separated management
members. Additionally, 26,500 options were granted to two former senior
management executives.
Management Option Plan
Certain limited partners and key employees of the Company have the ability,
under certain conditions, to exercise options to purchase units of Class B
limited partnership interests (the "Class B Interests") as established in the
management option plan (the "Option Plan").
Through October 1, 1996, the Company was authorized to grant 1,869,545
units of Class B Interests, which vested at a rate of 20% per year, based on
specific performance standards. The options did not vest prior to October 1,
1996, as these performance standards were not met.
Effective October 2, 1996, the Company amended the Option Plan (the
"Amended and Restated Option Plan") to, among other things, decrease the number
of options the Company was authorized to grant to 1,840,000 and change the
required performance standards. The options now vest according to the following
schedule: 5% of the options vest on the first anniversary of the Company's
Offering, 5% of the options vest on the second anniversary of the Company's
Offering, the remaining 90% vests ratably at each calendar year end over a
five-year period beginning January 1, 1997, and becomes exercisable if certain
performance standards are met. These options expire on October 1, 2003.
As of December 31, 1996, no options were exercisable. During 1997, 20,800
options vested and are currently exercisable at December 31, 1997. The Company
has recognized $202,000 in compensation expense for the year ended December 31,
1997 related to the portion of the options for which exercisability is not based
on performance standards. No compensation expense has been recognized for the
portion of the options which vest based on performance standards, as management,
at this time, has deemed the probability of meeting the performance standards
remote.
20
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10. PARTNERS' CAPITAL (DEFICIT): (CONTINUED)
Effective May 10, 1997 and June 1, 1997, the Board of Directors granted two
senior officers of the company a total of 1,500,000 options to purchase Class B
limited partnership units for $2.33 per unit. These options vest in equal
amounts over a three year period commencing from the grant date. Excercisability
of 60% of these options is subject to certain performance standards being met.
As of December 31, 1997 no options have vested. No compensation expense has been
recorded for these options, as management's estimate of the market value as of
December 31, 1997 and at the date of grant approximates the exercise price.
Activity under the Option Plan and option price information is as follows:
<TABLE>
<CAPTION>
Weighted
Range of Average
Number of Exercise Exercise
Options Price Price
------- ----- -----
<S> <C> <C> <C>
Outstanding, December 31, 1994............................... 1,714,545 $1.00-1.75 $ 1.06
Options granted............................................ 150,000 1.75 1.75
Options forfeited.......................................... (30,000) 1.00 1.00
----------- ------------- --------
Outstanding, December 31, 1995............................... 1,834,545 1.00--1.75 1.12
Options granted (weighted average fair value of $1.91)..... 40,000 3.00 3.00
Options forfeited.......................................... (75,000) 1.00 1.00
----------- ------------- --------
Outstanding, December 31, 1996............................... 799,545 1.00--3.00 1.16
Options granted (weighted average fair value of $0.37)..... 1,556,500 1.00--3.00 2.32
Options forfeited.......................................... (1,440,000) 1.00--1.75 1.15
----------- ------------- --------
Outstanding, December 31, 1997............................... 1,916,045 $1.00--3.00 $ 2.11
=========== ============= ========
</TABLE>
Additional information regarding options outstanding as of December 31, 1997 is
as follows:
<TABLE>
<CAPTION>
Weighted Avg.
Remaining
Range of Number Contractual Weighted Avg. Number Weighted Avg.
Exercise Prices Outstanding Life(yrs) Exercise Price Exercisable Exercise Price
- --------------- ----------- --------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$ 1.00 346,045 1.8 $ 1.00 17,300 $ 1.00
2.33 1,500,000 6.6 2.33 -- 2.33
3.00 70,000 6.0 3.00 3,500 3.00
------------- ---------- ------ --------- -------- ---------
$ 1.00-3.00 1,916,045 5.7 $ 2.11 20,800 $ 1.34
============= ========== ====== ========= ======== =========
</TABLE>
21
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10. PARTNERS' CAPITAL (DEFICIT): (CONTINUED)
Fair Value Stock Based Compensation
Statement of Financial Accounting Standard No. 123, Accounting for
Stock-Based Compensation, ("SFAS 123") requires the disclosure of the pro forma
net loss had the Company adopted the fair value method as of the beginning of
1995. The Company has calculated the pro forma net loss under SFAS 123 using a
multiple option valuation approach and certain weighted-average assumptions
deemed reasonable by management. These assumptions included, among other things,
a risk free interest rate of 5.5%, an expected life of 2 years, a partnership
unit volatility of 0.0% and no partnership distributions over the expected life.
The compensation expense which would be recognized under SFAS 123 would not be
significantly different than reported under APB 25 in 1996 and 1997. No
compensation expense would be reported in 1995 as the Option Plan was amended
which changed the terms of options granted, as described in Note 10. The impact
of these pro forma adjustments may not be indicative of future pro forma
adjustments, as various assumptions and estimates were employed and additional
awards in future years may occur.
Other Partnership Unit Options
On December 19, 1996, the Board of Directors granted a member of the Board
options to purchase 30,000 Class B limited partnership units for $3.00 per unit.
These options vest ratably over a five-year period and expire in September 2003.
No options are currently exercisable. No compensation expense has been recorded
for these options, as management's estimate of the market value was less than
the exercise price at the date of the grant.
Put Option
After September 4, 1998, a general partner and certain of the Class A
limited partners can require the Company to purchase limited partnership units
held by them at fair market value. However, such right may not be exercised if
the purchase of units would have a material adverse effect on the Company or
would be in contravention of any then existing agreement to which the Company is
a party.
Allocation of Profits and Losses
Losses are allocated among the general partners and Class A and B limited
partners based upon the total of the interests held by each individual,
including the Put/Call Units under option, as a percentage of the total of all
such interests.
22
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. SUBSEQUENT EVENTS:
During 1998, the Company acquired certain assets and assumed certain
liabilities of twelve business music distributors for a total purchase price of
approximately $21.5 million. Consideration paid was approximately $6.1 million
in cash, approximately $14.5 million in debt, and approximately $900,000 in
partnership interests. Of the total $21.5 million purchase price, $11.5 million
related to the purchase of certain assets of Music Technologies Incorporated
(MTI).
In March 1998, the Company obtained a credit facility for working capital
purposes with an initial availability of $3.0 million, increasing to $5.0
million upon the attainment of certain cash flow related targets. The credit
facility was secured by the inventories and receivables of the Company. Amounts
outstanding under the facility bore a variable rate of interest, paid quarterly,
based on the lender's prime rate or LIBOR. The terms of the credit facility
required the Company to maintain certain performance standards and covenants
that, among other things, limited the Company's capital spending and acquisition
of other business as well as the Company's ability to incur additional debt and
make distributions to partners. On December 31, 1998, all amounts outstanding
under this credit facility were repaid in conjunction with the $20 million
credit facility obtained by the Company as discussed below.
On April 16, 1998, the Company entered into an agreement with its joint
venture partner in Muzak Europe that effectively liquidated the Company's
interest in Muzak Europe in exchange for a seven-year, $800,000 promissory note,
which bears interest at eight percent (8%) per annum, and the right of the
Company to participate up to five percent (5%) of the business service revenues
of the European venture in its new role as franchisor. No gain or loss has been
recognized for this transaction.
On March 16, 1998, Muzak formed a new subsidiary, Enso Audio Imaging
Corporation (EAIC). On July 10, 1998, EAIC consummated a recapitalization and
equity financing agreement pursuant to which the shares held by the Company were
converted to 100,000 shares of series A non-voting common stock and 73,500
shares of series A voting preferred stock of EAIC, were issued to a related
party investor for a total consideration of $3.3 million, net of costs, which
represented a 42% interest. After January 5, 1999, an additional 26,250 shares
of class B preferred stock can be purchased by the related party investor for
$2.5 million if certain performance criteria is met by EAIC. No additional
shares have yet been purchased. An affiliate of the Company was issued 100
shares of super voting series C common stock which has voting rights equal to
1,000 votes per share.
23
<PAGE>
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In December 1998, the Company obtained a $20 million credit facility for
purposes of acquiring MTI and for use as working capital. The credit facility is
secured by accounts receivable and inventory. Amounts outstanding under the
credit facility will bear a variable rate of interest, to be paid monthly, based
on the Reference Rate plus 1.25%. The terms of the credit facility require the
Company to maintain certain performance standards and covenants that, among
other things, limits the Company to certain levels of indebtedness and capital
expenditures, while maintaining certain EBITDA targets.
On February 1, 1999, the Company announced that it entered into a
definitive merger agreement to be acquired by Audio Communications Network
Holdings, LLC (ACN). Under the terms of the agreement, the Company will be
merged into a subsidiary of ACN. The consummation of the merger, which is
expected to close in March 1999, is subject to a number of conditions, including
completion of ACN's financing for the transaction. Consideration paid to the
Company's current owners in the transaction will be comprised of approximately
$250 million of cash and the assumption of debt, in addition to a continuing
ownership interest in ACN. The current owners of the Company will also retain
equity interests in two unrelated Internet businesses. In conjunction with the
proposed transaction, ACN is also in the process of filing a tender offer to
purchase the Company's outstanding senior notes.
24
Exhibit 99.2
INDEPENDENT AUDITORS' REPORT
General and Limited Partners
Muzak Limited Partnership
We have audited the accompanying consolidated balance sheets of Muzak
Limited Partnership and subsidiaries (the Partnership) as of December 31, 1997
and 1998, and the related consolidated statements of operations, partners'
deficit, and cash flows for each of the three years in the period ended
December 31, 1998. These financial statements are the responsibility of the
Partnership's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Muzak Limited Partnership and
subsidiaries as of December 31, 1997 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
February 5, 1999
Seattle, Washington
F-27
<PAGE>
MUZAK LIMITED PARTNERSHIP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (in thousands)
December 31, 1997 and 1998
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents................................ $ 8,524 $ 2,971
Accounts receivable, net of allowance for doubtful ac-
counts of $501, and $1,004.............................. 16,790 21,130
Inventories.............................................. 3,850 5,790
Prepaid expenses......................................... 1,400 1,650
Other receivables........................................ 688 1,455
Other.................................................... 428 535
-------- --------
Total current assets 31,680 33,531
Property and equipment, net................................ 39,659 46,070
Deferred costs and intangible assets, net.................. 31,694 42,527
Other...................................................... 1,362 1,003
-------- --------
Total...................................................... $104,395 $123,131
======== ========
Liabilities and partners' deficit
Current liabilities:
Credit facility.......................................... $ -- $ 12,041
Accounts payable......................................... 8,435 13,118
Advance billings......................................... 5,216 5,492
Accrued interest......................................... 2,500 2,608
Accrued expenses......................................... 2,556 3,795
Current portion of long-term obligations................. 469 3,582
-------- --------
Total current liabilities.............................. 19,176 40,636
Long-term obligations, net of current portion.............. 100,575 102,790
Unearned installation income............................... 4,249 4,770
Commitments and contingencies (note 9) -- --
Redeemable preferred interests............................. 6,490 10,524
Partners' deficit:
Limited partners' deficit (preference in liquidation of
$8,841 and $9,591)...................................... (3,597) (4,427)
General partners' deficit................................ (22,498) (31,162)
-------- --------
Total partners' deficit................................ (26,095) (35,589)
-------- --------
Total.................................................. $104,395 $123,131
======== ========
</TABLE>
See notes to consolidated financial statements.
F-28
<PAGE>
MUZAK LIMITED PARTNERSHIP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands)
Years Ended December 31, 1996, 1997, and 1998
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Revenues:
Music and other business services............. $ 54,585 $ 59,351 $ 65,956
Equipment and related services................ 32,226 31,853 33,792
-------- -------- --------
Total revenues.............................. 86,811 91,204 99,748
Cost of revenues:
Music and other business services............. 15,263 18,502 19,820
Equipment and related services................ 21,763 22,207 22,689
-------- -------- --------
Total cost of revenues...................... 37,026 40,709 42,509
-------- -------- --------
Gross profit................................ 49,785 50,495 57,239
Selling, general and administrative expenses.... 31,599 33,262 34,319
Noncash incentive compensation.................. 60 202 2,217
Depreciation.................................... 10,625 10,652 9,734
Amortization.................................... 9,594 10,016 11,829
-------- -------- --------
Operating loss.............................. (2,093) (3,637) (860)
Interest expense................................ (8,112) (10,775) (11,248)
Interest income................................. 438 1,017 256
Equity in losses of joint venture............... (225) (755) (45)
Other, net...................................... (209) 715 (92)
-------- -------- --------
Net loss before extraordinary items......... (10,201) (13,435) (11,989)
Extraordinary loss on write-off of deferred fi-
nancing
fees and debt discount......................... (3,713) -- --
Extraordinary gain on retirement of redeemable
preferred partnership interests................ 3,091 -- --
-------- -------- --------
Net loss........................................ (10,823) (13,435) (11,989)
Redeemable preferred return..................... (916) (400) (619)
-------- -------- --------
Net loss attributable to general and limited
partners....................................... $(11,739) $(13,835) $(12,608)
======== ======== ========
</TABLE>
See notes to consolidated financial statements
F-29
<PAGE>
MUZAK LIMITED PARTNERSHIP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF PARTNERS' DEFICIT (in thousands)
Years Ended December 31, 1996, 1997, and 1998
<TABLE>
<CAPTION>
General partners' interest Class A Class B
-------------------------- Limited Class A Limited
Number partners' put/call partners'
of units Amount interests options interests
-------------- -------------- --------- -------- ---------
<S> <C> <C> <C> <C> <C>
Balance, January 1,
1996................... 9,101 $ (4,264) $(1,021) $ 137 $ (776)
Net loss ............. -- (6,973) (1,288) (1,172) (1,390)
Payment of foreign
income taxes......... -- (54) (11) (9) (10)
Preferred return on
redeemable preferred
partnership
interests............ -- (591) (109) (99) (117)
Preferred return on
preferred limited
partners' interests.. -- (407) (75) (69) (81)
Principal payments on
subscriptions
receivable........... -- -- -- -- --
Capital contribution
from noncash
incentive
compensation......... -- -- -- -- --
Contribution by
partner.............. -- -- -- -- 105
----------- -------------- ------- ------- -------
Balance, December 31,
1996................... 9,101 (12,289) (2,504) (1,212) (2,269)
Net loss.............. -- (8,730) (1,593) (1,527) (1,585)
Payment of foreign
income taxes......... -- (50) (10) (8) (8)
Preferred return on
redeemable preferred
partnership
interests............ -- (257) (49) (48) (46)
Preferred return on
preferred limited
partners' interests.. -- (367) (72) (88) (85)
Principal payments on
subscriptions
receivable........... -- -- -- -- --
Capital contribution
from noncash
incentive
compensation......... -- -- -- -- --
Contribution by
partner.............. -- -- -- -- 2,072
Withdrawal by
partner.............. (7) (805) -- -- (2,032)
----------- -------------- ------- ------- -------
Balance, December 31,
1997................... 9,094 (22,498) (4,228) (2,883) (3,953)
Net loss.............. -- (7,730) (1,620) (1,300) (1,339)
Payment of foreign
income taxes......... -- (40) (10) (6) (6)
Preferred return on
redeemable preferred
partnership
interests............ -- (298) (60) (48) (48)
Preferred return on
interest in EAIC
Corp. ............... -- (107) (24) (17) (17)
Preferred return on
preferred limited
partners' interests.. -- (483) (101) (83) (83)
Principal payments on
subscriptions
receivable........... -- -- -- -- --
Capital contribution
from noncash
incentive
compensation......... -- -- -- -- --
Contribution by
partner.............. -- -- 895 -- 244
Withdrawal by
partner.............. -- -- -- -- (215)
----------- -------------- ------- ------- -------
Balance, December 31,
1998................... 9,094 $(31,156) $(5,148) $(4,337) $(5,417)
=========== ============== ======= ======= =======
</TABLE>
See notes to consolidated financial statements.
F-30
<PAGE>
<TABLE>
<CAPTION>
Class B Total limited
limited Preferred partners' interests Total partners' interests
partners' limited Classs B ---------------------- ---------------------------
subscriptions partners' partnership Number Number
receivable interests unit options of units Amount of units Amount
- ------------- --------- ------------ ---------- ---------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
$ (374) $7,671 $ -- 8,989 $ 5,637 18,090 $ 1,373
-- -- -- -- (3,850) -- (10,823)
-- -- -- -- (30) -- (84)
-- -- -- -- (325) -- (916)
-- 632 -- -- 407 -- --
207 -- -- -- 207 -- 207
-- -- 60 -- 60 -- 60
-- -- -- 60 105 60 105
- ------- ------ ------ --------- ---------- ----------- -------------
(167) 8,303 60 9,049 2,211 18,150 (10,078)
-- -- -- -- (4,705) -- (13,435)
-- -- -- -- (26) -- (76)
-- -- -- -- (143) -- (400)
-- 612 -- -- 367 -- --
132 -- -- -- 132 -- 132
-- -- 202 -- 202 -- 202
(1,601) -- -- 889 471 889 471
-- (74) -- (1,250) (2,106) (1,257) (2,911)
- ------- ------ ------ --------- ---------- ----------- -------------
(1,636) 8,841 262 8,688 (3,597) 17,782 (26,095)
-- -- -- -- (4,259) -- (11,989)
-- -- -- -- (22) -- (62)
-- -- -- -- (156) -- (454)
-- -- -- -- (58) -- (165)
-- 750 -- -- 483 -- --
35 -- -- -- 35 -- 35
-- -- 2,217 -- 2,217 -- 2,217
-- -- -- 375 1,139 375 1,139
-- -- -- (100) (215) (100) (215)
- ------- ------ ------ --------- ---------- ----------- -------------
$
(1,601) $9,591 $2,479 8,963 $ (4,433) 18,057 $ (35,589)
======= ====== ====== ========= ========== =========== =============
</TABLE>
F-31
<PAGE>
MUZAK LIMITED PARTNERSHIP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Years Ended December 31, 1996, 1997, and 1998
<TABLE>
<CAPTION>
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Operating activities:
Net loss........................................ $(10,823) $(13,435) $(11,989)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Provision for doubtful accounts............... 472 620 503
Depreciation.................................. 10,625 10,652 9,734
Amortization, net of deferred financing
costs........................................ 9,594 10,016 11,829
Deferred financing cost amortization.......... 1,042 653 633
Equity in losses of joint venture............. 225 755 45
Noncash incentive compensation................ 60 202 2,217
Extraordinary loss on write-off of deferred
financing fees and debt discount............. 3,713 -- --
Extraordinary gain on retirement of redeemable
preferred partnership interests.............. (3,091) -- --
Gain on sale of territory..................... -- (757) --
Loss on write-off of equity offering costs.... 1,353 -- --
Loss on write-off of inventories.............. -- 530 --
Cash provided (used) by changes in operating
assets and liabilities, net of
effects of acquisitions:
Accounts receivable......................... (555) (2,498) (4,664)
Inventories................................. (461) (658) (1,784)
Prepaid expenses and other current assets... 130 (558) (357)
Other receivables........................... (137) (694) 688
Accounts payable............................ 1,863 (246) 4,683
Accrued interest............................ 834 -- 108
Accrued expenses............................ 1,188 214 1,239
Advance billings............................ 155 528 276
Unearned installation income................ 850 613 521
Other, net.................................. 517 697 364
-------- -------- --------
Net cash provided by operating activities.. 17,554 6,634 14,046
Investing activities:
Additions to property and equipment............. (10,913) (12,639) (12,850)
Additions to deferred costs and intangible as-
sets........................................... (5,424) (6,933) (8,576)
Acquisitions of businesses and ventures......... -- (2,836) (14,180)
Disposition of businesses and ventures.......... -- 1,588 1,081
Other, net...................................... (291) 6 --
-------- -------- --------
Net cash used by investing activities...... (16,628) (20,814) (34,525)
Financing activities:
Borrowings from credit facility................. -- -- 19,591
Payments on credit facility..................... (9,300) -- (7,550)
Proceeds from issuance of senior notes.......... 100,000 -- --
Proceeds from long-term obligations............. -- -- 248
Principal payments on long-term obligations..... (53,612) (92) (26)
Payment of financing fees....................... (5,802) -- --
Principal payments under capital leases......... (414) (505) (754)
Retirement of redeemable preferred partnership
interests...................................... (7,456) -- --
Contributions by partners....................... 312 603 279
Withdrawals by partners......................... -- (2,911) (215)
Proceeds from sale of subsidiary stock.......... -- -- 3,415
Other, net...................................... (83) (77) (62)
-------- -------- --------
Net cash provided (used) by financing ac-
tivities.................................. 23,645 (2,982) 14,926
-------- -------- --------
Net increase (decrease) in cash and cash equiva-
lents........................................... 24,571 (17,162) (5,553)
Cash and cash equivalents:
Beginning of year............................... 1,115 25,686 8,524
-------- -------- --------
End of year..................................... $ 25,686 $ 8,524 $ 2,971
======== ======== ========
</TABLE>
See notes to consolidated financial statements
F-32
<PAGE>
MUZAK LIMITED PARTNERSHIP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 1996, 1997 and 1998
NOTE 1: THE PARTNERSHIP AND ITS BUSINESS
Muzak Limited Partnership and subsidiaries (the Partnership) provides
business music services and produces, markets and sells video and audio
marketing services through a network of domestic and international independent
affiliates and owned operations. The independent affiliates are charged a fee
based on their revenues, in addition to other fees, in exchange for broadcast
music, marketing, technical and administrative support. The Partnership and its
franchisees also sell, install and maintain electronic equipment related to the
Partnership's business.
The Partnership's music services are primarily sold for use in public areas,
such as retail and restaurant establishments, and work areas, such as business
offices and manufacturing facilities. Services are distributed through direct
broadcast satellite transmission, local broadcast transmission and pre-recorded
tapes played on the customers' premises.
The Partnership is subject to certain business risks, which could affect
future operations and financial performance. These risks include rapid
technological change, competitive pricing, concentrations in and dependence on
satellite delivery capabilities, and development of new services.
Principles of consolidation: The accompanying consolidated financial
statements of the Partnership include the accounts of the Partnership, its
wholly owned subsidiaries, Muzak Capital Corporation and Enso Audio Imaging
Corporation (EAIC Corp.) (Note 10). In addition, the Partnership transferred
net assets of $869,797 consisting of purchased music to a newly formed wholly
owned subsidiary, MLP Environmental Music, LLC on December 30, 1998. All
significant inter-company accounts and transactions have been eliminated in
consolidation.
Public offering: In August 1996, the general and limited partners filed a
registration statement for the underwritten public offering of 10% senior notes
(the Offering). The Offering closed on October 2, 1996. A portion of the net
proceeds from the Offering was used to repay certain bank debt and other
indebtedness and to repurchase the Partnership's Class C redeemable preferred
partnership interest. The remainder of the net proceeds were used for certain
strategic investments and other general corporate purposes.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and cash equivalents: The Partnership considers all highly liquid debt
instruments purchased with a maturity of three months or less to be cash
equivalents. Cash and cash equivalents at December 31, 1997, included
commercial paper investments of approximately $4,900,000. There were no
commercial paper investments at December 31, 1998. The balance of cash and cash
equivalents at December 31, 1997 and 1998, is held at various institutions
throughout the United States.
Inventories: Inventories consist primarily of electronic equipment and are
recorded at the lower of cost (first-in, first-out) or market.
Property and equipment: Property and equipment consist primarily of
equipment provided to subscribers, and machinery and equipment and are recorded
at cost. Major improvements are capitalized to the property accounts while
replacements, maintenance and repairs that do not improve or extend the lives
of the respective assets are expensed.
Property and equipment are depreciated on a straight-line basis over the
estimated useful lives of the related assets, ranging from five to 40 years.
Assets acquired under capital leases and leasehold improvements are amortized
on a straight-line basis over the shorter of their estimated useful lives or
the term of the related leases.
F-33
<PAGE>
MUZAK LIMITED PARTNERSHIP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Years Ended December 31, 1996, 1997 and 1998
Deferred costs and intangible assets: Income-producing contracts, acquired
through acquisition, are being charged to amortization expense using an
accelerated method over their expected benefit period of eight years. Deferred
financing costs are charged to interest expense using the effective interest
method over the term of the related agreements. Other deferred costs and
intangible assets are recorded at cost and are being charged to amortization
expense over their estimated useful lives or the period of their expected
benefit, ranging from five to ten years.
Impairment of long-lived assets: The carrying value of long-lived assets is
reviewed on a regular basis for the existence of facts or circumstances that
may indicate that the carrying amount is not recoverable. To date, no
impairment has been indicated. Should there be impairment in the future, the
Partnership will measure the impairment based on the discounted expected future
cash flows from the impaired assets.
Revenue recognition: Revenues are recognized in the month that the related
services are provided. Fees from independent affiliates are recognized as music
revenues in the month that the independent affiliate generates its revenues.
Equipment sales and related services revenues are recorded in the period that
the installation is completed.
Advance billings: The Partnership bills certain customers in advance for
contracted music and other business services. Amounts billed in advance of the
service period are deferred when billed and recognized as revenue in the period
earned.
Unearned installation income: The Partnership defers recognition of income
from the installation of equipment provided to subscribers and recognizes these
amounts as revenue on a straight-line basis over the average subscriber service
period.
Income taxes: The income tax effects of all earnings or losses of the
Partnership are passed directly to the partners. Payment of foreign income
taxes is reflected as a reduction to the partners' capital accounts. Thus, no
provision or benefit for federal, state, local or foreign income taxes are
required.
Partnership unit options: The Partnership accounts for its partnership unit
options in accordance with Statement of Financial Accounting Standards (SFAS)
No. 123, Accounting for Stock-Based Compensation, which permits entities to
recognize as expense over the vesting period the fair value of all stock-based
awards on the date of grant. Alternatively, SFAS No. 123 also allows entities
to continue to apply the provisions of Accounting Principles Board Opinion
(APB) No. 25, Accounting for Stock Issued to Employees, and provide pro forma
net income, and pro forma earnings per share disclosures for employee stock
option grants made in 1995 and beyond as if the fair value-based method defined
in SFAS No. 123 had been applied. The Partnership has elected to continue to
apply the provisions of APB No. 25, which recognizes compensation expense based
on the intrinsic value of the equity instrument when awarded, and provide the
pro forma disclosure provisions of SFAS No. 123.
Fair value of financial instruments: The carrying amounts of cash and cash
equivalents and the revolving credit facility approximate fair value because of
the short maturity of these instruments. The fair value of the senior notes at
December 31, 1997 and 1998, approximates $105,000,000 and $104,000,000,
respectively. The carrying amount of the notes receivable and long-term
obligations other than the senior notes approximates the fair value, as the
rates are either comparable to or based on the current prime rate.
European joint venture: During 1998 the Partnership sold its interest in a
joint venture providing business music services in Europe (Muzak Europe) in
exchange for a note receivable of approximately
F-34
<PAGE>
MUZAK LIMITED PARTNERSHIP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Years Ended December 31, 1996, 1997 and 1998
$800,000, which is due in full April 2005, and a royalty based on recurring
billings beginning April 2000. No gain or loss was recorded on this
transaction. The joint venture was accounted for using the equity method, as
the Partnership owned 50% of that venture but did not have a controlling
interest. Equity in losses of joint venture in the Partnership's consolidated
statements of operations includes the Partnership's share of net losses. As of
December 31, 1997, the joint venture had total assets of $7,307,000 and total
liabilities of $5,509,000. As of December 31, 1997, the carrying value on the
Partnership's books was $1,100,000 and was included in other long-term assets.
The Partnership used the foreign country's local currency as the functional
currency for its overseas operations. The translation gains and losses
resulting from the remeasurement of the foreign operations' financial
statements are insignificant.
Comprehensive loss: The Partnership has adopted SFAS No. 130, Reporting
Comprehensive Income, which requires comprehensive income and its components to
be reported in the financial statements in the period in which they are
recognized. The Partnership has no other significant components of
comprehensive income.
New accounting pronouncements: SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, was issued in June 1998 and is effective
for all fiscal quarters of fiscal years beginning after June 15, 1999. This
standard requires an entity to recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those
instruments at fair value. The Partnership is still in the process of
evaluating the impact of this standard on their financial statements and
anticipates adopting the standard in the year ending December 31, 2000.
In March 1998, the Accounting Standards Executive Committee of the AICPA
issued Statement of Position 98-1 (SOP 98-1), Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use, which requires that
certain software costs be capitalized and amortized over the period of use. The
SOP is effective for financial statements for the fiscal years beginning after
December 15, 1998. The Partnership will adopt SOP 98-1 for the year ending
December 31, 1999. This statement is not expected to have a material effect on
the financial statements.
In April 1998, the Accounting Standards Executive Committee of the AICPA
issued SOP 98-5, Reporting on the Costs of Start-up Activities, which requires
costs of start-up activities and organization costs to be expensed as incurred.
This SOP is effective for financial statements for fiscal years beginning after
December 15, 1998. The Partnership will adopt SOP 98-5 for the year ending
December 31, 1999. This statement is not expected to have a material effect on
the financial statements; however, organization costs of approximately $272,000
will be written off.
Use of estimates in preparation of financial statements: The preparation of
financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect
the reported amount of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
Reclassifications: Certain amounts from the 1996 and 1997 financial
statements were reclassified in order to be consistent with the 1998
presentation.
F-35
<PAGE>
MUZAK LIMITED PARTNERSHIP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Years Ended December 31, 1996, 1997 and 1998
NOTE 3: Business Acquisitions and Sales
In 1997, the Partnership sold its Spokane territory subscriber accounts and
granted the Spokane franchise to an existing independent affiliate of the
Partnership for $1,400,000. This transaction resulted in a gain of $800,000 to
the Partnership, which is included in other income in the consolidated
statement of operations, for the year ended December 31, 1997.
In 1997, the Partnership acquired substantially all of the assets of four
business music providers for approximately $4,100,000. The acquisitions were
financed with cash remaining from the Offering.
In 1998, the Partnership acquired, through separate transactions,
substantially all of the net assets of twelve business music providers for a
total purchase price of approximately $20,200,000, of which approximately
$6,500,000 was paid for in cash, approximately $12,800,000 in debt incurred,
and approximately $895,000 in exchange for equity instruments at a unit price
of $3.25. Of the total purchase price, the portion related to certain assets of
Music Technologies Incorporated (MTI) was approximately $10,000,000.
As part of the acquisition of MTI, the Partnership entered into an agreement
in principle with an independent affiliate to sell a portion of the income
producing contracts obtained in the MTI acquisition. This asset of $1,455,000
has been recorded as other receivables as of December 31, 1998. In addition,
during 1998, the Partnership sold, through separate transactions, income
producing contracts to several independent affiliates for approximately
$1,081,000 in cash. No gain or loss was recognized on these sales.
For financial statement purposes, the acquisitions were accounted for as
purchases with the purchase prices allocated to the individual assets based on
the fair market values at the date of acquisition. Results of operations from
the acquired businesses are also included in the consolidated statement of
operations from the date of each respective acquisition.
The following unaudited pro forma consolidated results of operations have
been prepared as if the acquisitions made during 1998 had occurred as of the
beginning of 1997 and 1998, (in thousands):
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Pro forma amounts for the years ended December 31:
Total revenues.................................... $ 98,586 $103,841
======== ========
Net loss from continuing operations............... $(12,619) $(11,381)
======== ========
</TABLE>
The pro forma results above do not purport to be indicative of results that
would have occurred had the acquisitions been in effect for the period
presented, nor do they purport to be indicative of the results that will be
obtained in the future.
F-36
<PAGE>
MUZAK LIMITED PARTNERSHIP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Years Ended December 31, 1996, 1997 and 1998
NOTE 4: PROPERTY AND EQUIPMENT
Property and equipment at December 31 consist of the following (in
thousands):
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Equipment provided to subscribers..................... $ 57,393 $ 67,548
Machinery and equipment............................... 13,129 16,802
Vehicles.............................................. 3,337 4,034
Furniture and fixtures................................ 2,546 2,710
Land and buildings.................................... 858 858
Leasehold improvements................................ 865 992
-------- --------
Total property and equipment........................ 78,128 92,944
Less accumulated depreciation and amortization........ (38,469) (46,874)
-------- --------
$ 39,659 $ 46,070
======== ========
</TABLE>
NOTE 5: DEFERRED COSTS AND INTANGIBLE ASSETS
Deferred costs and intangible assets at December 31 consist of the following
(in thousands):
<TABLE>
<CAPTION>
1997 1998
-------- -------
<S> <C> <C>
Income producing contracts........................... $ 42,152 $54,161
Deferred subscriber acquisition costs................ 14,593 17,863
Master recording rights and deferred production
costs............................................... 12,125 15,669
Organization costs................................... 4,501 4,635
Deferred financing costs............................. 4,341 4,391
Noncompete agreements................................ 860 3,814
Goodwill............................................. 467 1,018
Trademarks........................................... 344 787
-------- -------
Total deferred costs and intangible assets......... 79,383 102,338
Less accumulated amortization........................ (47,689) (59,811)
-------- -------
$ 31,694 $42,527
======== =======
</TABLE>
NOTE 6: CREDIT FACILITY
In March 1998, the Partnership obtained a credit facility for working
capital purposes with an initial availability of $3,000,000, increasing to
$5,000,000 upon the attainment of certain cash flow related targets. In July
1998, the Partnership met the cash flow targets required to increase the
available cash to $5,000,000. The credit facility was secured by inventories
and accounts receivable of the Partnership. The outstanding balance on the
credit facility was paid in full and the facility was cancelled on December 31,
1998.
A new revolving credit facility was obtained by the Partnership in December
1998. The amount available under the facility is $20,000,000. Amounts
outstanding under the facility bear a variable rate of interest, to be paid
quarterly, based on the lender's prime rate plus 1.25%. The terms of the credit
facility require the Partnership to maintain certain performance standards and
covenants include a limit on the Partnership's capital spending and
acquisitions of other businesses, as well as the Partnership's ability to incur
additional debt and make distributions to partners. The credit facility is
secured by accounts receivable, inventories, and other assets, including
proceeds of certain insurance policies.
F-37
<PAGE>
MUZAK LIMITED PARTNERSHIP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Years Ended December 31, 1996, 1997 and 1998
As of December 31, 1998, the Partnership had approximately $12,000,000
outstanding under this credit facility. The interest rate at December 31, 1998,
was 9%. To provide collateral for a portion of the advances under the credit
facility, certain limited partners set forth a letter of credit in the amount
of $4,211,000. The Partnership has pledged to reimburse the limited partners
for related costs and fees. For the year ended December 31, 1998, no amounts
were reimbursed by the Partnership.
In September 1998, the Partnership's wholly owned subsidiary, EAIC Corp.,
obtained a credit facility. The amount available under this facility is
$750,000 and is to be used for equipment purchases. Amounts outstanding under
the facility bear a variable rate of interest to be paid at a rate equal to the
lender's prime rate plus 1% per annum. The unpaid principal balance shall be
repaid in 24 equal monthly installments of principal, plus interest, commencing
on October 1, 1999. As of December 31, 1998, EAIC Corp. had approximately
$276,000 outstanding under this credit facility. The interest rate at December
31, 1998, was 8.75%.
Total cash paid for interest on the credit facilities was approximately
$366,000 for the year ended December 31, 1998. There were no credit facilities
in 1996 or 1997.
NOTE 7: LONG-TERM OBLIGATIONS
Long-term obligations at December 31 consist of the following (in
thousands):
<TABLE>
<CAPTION>
1997 1998
--------- --------
<S> <C> <C>
Senior notes......................................... $ 100,000 $100,000
Notes payable........................................ -- 2,550
Capital lease obligations............................ 969 1,338
Other................................................ 75 2,484
--------- --------
Total long-term obligations........................ 101,044 106,372
Less current portion................................. (469) (3,582)
--------- --------
$ 100,575 $102,790
========= ========
</TABLE>
Senior notes: The senior notes were issued as part of the Offering discussed
in Note 1. These unsecured notes bear interest at 10% and are due on October 1,
2003. The notes require the maintenance of certain covenants including
restricting the Partnership's ability to incur additional debt, as well as
limiting the Partnership's ability to make certain investments and
distributions to partners. The Partnership has the option to redeem up to 35%
of the senior notes during the first three years after the Offering with the
proceeds from an equity offering, at a redemption price of 109% of the
principal amount thereof, plus accrued and unpaid interest. The entire balance
of the senior notes is redeemable at the option of the Partnership, in whole or
in part, beginning October 1, 2000. The redemption price is 105% of par value
through October 1, 2001, 102.5% through October 1, 2002, and 100% thereafter,
through maturity.
Notes payable: As part of the acquisition of MTI discussed in Note 3, the
Partnership entered into a note payable of approximately $2,550,000. The note
bears an interest rate of 14% per annum, with principal and interest payments
of $500,000 due monthly through March 31, 1999, and the balance due April 30,
1999. The Partnership has the option to extend the due date for additional
fees. The Partnership also agreed to make a deferred purchase price payment,
interest free, which is subject to adjustment. Due to the contingent nature of
this consideration and significant uncertainties related to the ultimate amount
to be paid, the Partnership has not recorded any obligation as of December 31,
1998.
F-38
<PAGE>
MUZAK LIMITED PARTNERSHIP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Years Ended December 31, 1996, 1997 and 1998
Capital leases: Assets acquired under capital leases were $579,000, $635,000
and $1,123,000 for the years ended December 31, 1996, 1997, and 1998,
respectively. Total assets recorded under capital leases were $3,337,000 and
$4,316,000 with accumulated amortization of $1,944,000 and $1,938,000 as of
December 31, 1997 and 1998, respectively.
Other long-term obligations: Pursuant to an acquisition, the Partnership
paid $510,000 in exchange for a non-compete agreement and agreed to pay seven
additional annual installments of $510,000. The Partnership has recorded this
liability of $2,187,000, using a discount rate of 14%.
Interest rates and payments: The senior notes require semi-annual interest
payments of 10%. The capital lease obligations require monthly payments of
interest at a weighted average interest rate of approximately 8%. Total cash
paid for interest on the long-term obligations was approximately $5,954,000,
$10,087,000, and $10,136,000 for the years ended December 31, 1996, 1997, and
1998, respectively.
Financing and other costs paid to related parties: During 1996, the credit
agreement with Union Bank of Switzerland (Agent Bank) and the subordinated note
were paid with part of the proceeds from the Offering discussed in Note 1. The
Agent Bank was an affiliate of a Class A limited partner. In addition, the
subordinated noteholder held the put/call units. During the year ended December
31, 1996, the Partnership incurred interest expense related to these credit
facilities of $5,489,000. The Partnership paid board fees and expenses to the
general partner and other related parties of $162,500, $287,700, and $102,000
in 1996, 1997, and 1998, respectively. In addition, $277,000 of board fees is
accrued as of December 31, 1998.
Future maturities: Total future maturities of long-term obligations,
including capital leases, for the five years following December 31, 1998, are
approximately $4,932,000 in 1999, $773,000 in 2000, $653,000 in 2001, $581,000
in 2002, $100,383,000 in 2003, and $603,000 thereafter.
NOTE 8: BENEFIT PLANS
Defined contribution plan: The Partnership maintains a defined contribution
savings and retirement plan (Benefit Plan) that covers substantially all of the
Partnership's employees. Under the savings portion of the Benefit Plan,
eligible employees may contribute from 1% to 14% of their compensation per
year, subject to certain tax law restrictions. The Partnership has the option
to make a matching contribution of up to a maximum of 100% of the first 3% and
50% of the next 3%, up to 6% of the total base salary contributed by the
employee each year. Participants are immediately vested in their contributions
as well as the Partnership's contributions under the savings portion of the
Benefit Plan. For the savings portion of the Benefit Plan, the Partnership
recorded contribution expense of $408,000, $694,000, and $609,000 for the years
ended December 31, 1996, 1997, and 1998, respectively.
Contributions under the retirement portion of the Benefit Plan are
determined annually by the Partnership at its discretion for up to 3% of the
eligible employee's compensation. The employees vest in the retirement portion
of the Benefit Plan ratably over five years, but become fully vested in the
event of death, disability or the attainment of the age of 65. No contribution
amounts were recorded for the years ended December 31, 1996, 1997, and 1998.
Multi-employer defined contribution plans: The Partnership participates in
multi-employer defined contribution benefit plans that provide benefits to
employees covered by certain labor union contracts. The amount of expense
related to contributions to these plans was approximately $136,000, $138,000
and $146,000 for the years ended December 31, 1996, 1997, and 1998,
respectively. These amounts were determined by union contract and the
Partnership does not administer or control the funds.
F-39
<PAGE>
MUZAK LIMITED PARTNERSHIP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Years Ended December 31, 1996, 1997 and 1998
NOTE 9: COMMITMENTS AND CONTINGENCIES
Leases: The Partnership leases certain facilities and equipment under both
operating and capital leases. In addition, the Partnership has entered into
agreements to obtain satellite channel capacity and subsidiary communication
authorization rights for the transmission of programs to the Partnership's
customers. Total rental expense under operating leases and rights agreements
was approximately $7,751,000, $8,401,000 and $8,712,000 for the years ended
December 31, 1996, 1997, and 1998, respectively.
Future annual minimum lease payments under noncancellable operating leases
as of December 31, 1998, are $7,451,000 in 1999, $7,080,000 in 2000, $3,019,000
in 2001, $1,963,000 in 2002, $1,459,000 in 2003 and $1,631,000 thereafter.
Music licenses: In the ordinary course of the Partnership's business, the
Partnership has agreements with various organizations for the rights to re-
record and play music in public spaces. The expenses incurred under these
agreements were approximately $3,578,000, $4,831,000 and $4,991,000 for the
years ended December 31, 1996, 1997, and 1998, respectively.
The Partnership's agreement with Business Music, Inc. (BMI) expired on
December 31, 1993. The Partnership has entered into an interim fee structure
with BMI and is in negotiations with BMI to establish an ongoing rate
structure. The interim arrangement with BMI provides for continued payments at
1993 levels. BMI has indicated that they are seeking royalty rate increases and
has asserted that this sought-after increase will be retroactive to January 1,
1994. If an agreement is not reached, BMI may seek to have the rates determined
through a court proceeding. The ultimate outcome of the negotiations is not
estimable as of December 31, 1998, and accordingly, no provision has been
recorded in the financial statements.
Taxes: During 1993, an assessment was made against the predecessor
partnership (Seller) resulting from an audit performed by the Washington State
Department of Revenue for sales and use, and business and occupation taxes paid
for during the period from 1988 through September 1992. Under successor
liability statutes in the State of Washington, the Partnership could, if the
Seller fails to pay its tax obligation, become liable for the assessment
outstanding against the Seller of approximately $1,700,000. This assessment is
under appeal by the Seller. The Seller and certain of its affiliates have
agreed to indemnify the Partnership for any liabilities in connection with such
assessment. The Partnership's management does not believe that the assessment
will have an adverse effect on the Partnership's financial condition or results
of operations.
Employment agreements: The Partnership has entered into employment
agreements with several executive officers. Under two of these agreements, the
officers will receive a bonus based upon the sales price of the Partnership
(Note 14).
Legal proceedings: The Partnership is subject to various legal proceedings
that arise in the ordinary course of business. In the opinion of management,
the outcome of these matters is not expected to have any material effect on the
consolidated financial position or results of operations of the Partnership.
NOTE 10: ENSO AUDIO IMAGING CORPORATION
On March 16, 1998, the Partnership established Enso Audio Imaging
Corporation (EAIC Corp.), to provide Internet music samples to businesses. On
July 10, 1998, EAIC Corp. consummated a recapitalization and capital financing
agreement. Pursuant to the agreement, shares held by the Partnership were
converted to 10,000,000 shares of Class B nonvoting common stock. Additionally,
73,500 shares of Series A voting
F-40
<PAGE>
MUZAK LIMITED PARTNERSHIP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Years Ended December 31, 1996, 1997 and 1998
convertible mandatorily redeemable preferred stock of EAIC Corp. were issued
to a related party investor for a total consideration of $3,415,000, net of
costs. After January 5, 1999, but prior to April 15, 1999, 26,250 shares of
Series B preferred stock could be purchased by the related party investor for
$2,500,000. In the event that certain performance criteria is met by EAIC
Corp., the related party investor is required to purchase these shares of
Series B preferred stock. EAIC Corp. has not met this criteria as of December
31, 1998.
The preferred stock has voting rights, certain liquidation features, and
accrues dividends annually at a rate of 7%. The Series A preferred stock has a
mandatory redemption requirement at the option of the holder, such that, at
any time after June 30, 2005, the holder may redeem his interest at the
greater of his original investment plus 10%, or at the fair value of the
common stock as if the preferred stock interest were converted. The cumulative
return per share as of December 31, 1998 was $2.24. The Series A preferred
stock is convertible at the option of the holder into shares of Class A voting
common stock as determined by dividing its preferential amount, which is the
original purchase price of $48 divided by an internal rate of return, by the
conversion price. The original conversion price of approximately $48 per share
will be adjusted subsequently for any additional issuances of common stock at
consideration per share less than the Class A conversion price.
An affiliate of the Partnership was issued 10,000 shares of super voting
Class C common stock which has voting rights equal to 1,000 votes per share
and is convertible to an equal number of Class A voting common stock at the
option of the holder. Further, both the Series A preferred stock and the Class
C common stock are automatically convertible to Class A voting common stock
under certain circumstances.
On August 31, 1998, the Board of Directors of EAIC Corp. authorized a 100-
to-one common stock split. All applicable share data has been retroactively
adjusted for this stock split.
NOTE 11: REDEEMABLE PREFERRED INTERESTS
The redeemable preferred interests is comprised of the following at
December 31:
<TABLE>
<CAPTION>
EAIC--Series A
Class C Class C-1 Preferred Stock Total
----------- ---------- --------------- -----------
<S> <C> <C> <C> <C>
BALANCE, January 1, 1996.. $10,030,000 $5,692,000 $ -- $15,722,000
Preferred return........ 518,000 398,000 -- 916,000
Repurchase of Class C
interests.............. (10,548,000) -- -- (10,548,000)
----------- ---------- ---------- -----------
BALANCE, December 31,
1996..................... -- 6,090,000 -- 6,090,000
Preferred return........ -- 400,000 -- 400,000
----------- ---------- ---------- -----------
BALANCE, December 31,
1997..................... -- 6,490,000 -- 6,490,000
Interest in EAIC........ -- -- 3,415,000 3,415,000
Preferred return........ -- 454,000 165,000 619,000
----------- ---------- ---------- -----------
BALANCE, December 31,
1998..................... $ -- $6,944,000 $3,580,000 $10,524,000
=========== ========== ========== ===========
</TABLE>
The Class C non-voting limited partner interests were repurchased by the
Partnership in October 1996.
The Class C-1 non-voting preferred partner interest does not participate in
the Partnership's profits or losses. The Class C-1 limited partner is entitled
to receive the amount of its initial contribution of $5,000,000, plus a return
of 7%, compounded annually, through January 31, 2004, the date of redemption.
The Class C-1 limited partner may become, at its option, a participating
partner. Upon becoming a participating partner, the Class C-1 limited partner
will forfeit any accrued portion of the return. If it has not previously
become a
F-41
<PAGE>
MUZAK LIMITED PARTNERSHIP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Years Ended December 31, 1996, 1997 and 1998
participating partner, the Class C-1 limited partner is entitled to a
preference in liquidation equal to its contribution plus accumulated return.
The cumulative return per unit as of December 31, 1997 and 1998, was $1.05 and
$1.37, respectively. At December 31, 1997 and 1998, the total number of units
outstanding, on an if-converted basis, was 1,420,368.
Unless the Class C-1 interest becomes a participating interest, a general
partner may, at its sole discretion, require the Class C-1 limited partner to
exchange its interest for a note equal to its then aggregate liquidation
preference amount. If such exchange occurs prior to the time the Class C-1
limited partner has the opportunity to obtain participation status, the Class
C-1 limited partner will also be issued an option to acquire the participating
interest on substantially the same terms as if such exchange had not occurred.
If the Class C-1 limited partner has not obtained participation status, or
has not exchanged such units for notes, on or prior to January 31, 2004, the
Partnership is required to redeem such units for an amount equal to the Class
C-1 contribution plus accumulated return.
NOTE 12: PARTNERS' DEFICIT
Partners' deficit is comprised of two general partners; Class A limited
partners, Class B limited partners, and preferred limited partners' interests;
Class A put/call units; Class B limited partner subscriptions receivable; and
Class B partnership unit options.
Class A put/call units: In connection with obtaining a fixed-rate
subordinated note payable, the Partnership issued an option to purchase
1,529,898 units of Class A limited partnership interests to a lender for an
aggregate exercise price of $10. These units are currently exercisable.
Subscriptions receivable: Officers and key employees of the Partnership have
acquired limited partnership interests, a portion of which was financed with
subscription notes. As of December 31, 1997 and 1998, the Class B limited
partners' capital accounts were reduced by subscription notes receivable.
Interest income on the subscriptions receivable totalled $27,000, $22,000, and
$94,000 for the years ended December 31, 1996, 1997, and 1998, and interest
receivable on subscription notes receivable was $16,000 and $107,000, as of
December 31, 1997 and 1998, respectively.
Preferred limited partners' interests: The preferred limited partners'
interests do not participate in the Partnership's profits or losses. Such
limited partners are entitled to receive an 8% return, compounded quarterly, on
the amount of their initial contribution and are generally entitled to a
priority on distributions from the Partnership. At December 31, 1997 and 1998,
the return was credited to the preferred limited partners. These limited
partners are also entitled to a preference in liquidation equal to their
initial contribution plus accumulated and unpaid return. Upon the occurrence of
certain events, the Partnership may, at its option, redeem the units for an
amount equal to the then aggregate liquidation preference amount. The units
(and any accrued and unpaid return) may, at the option of the holder, be
converted into units of Class B limited partnership interest at any time.
Cumulative per unit return as of December 31, 1997 and 1998, was $0.48 and
$0.68, respectively, and total aggregate return was $1,814,000 and $2,665,000,
respectively.
Other limited partners' interests: During 1997, the Partnership repurchased
1,250,000 Class B limited partnership units from eight members of former
management at a unit price of $2.33 for a total repurchase amount of
approximately $2,900,000. Seventeen new and existing members of management
purchased 889,000 units at a per unit price of $2.33 for a total purchase price
of approximately $2,100,000. The purchases were primarily financed by the
Partnership through subscription notes from the new management members and bear
F-42
<PAGE>
MUZAK LIMITED PARTNERSHIP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Years Ended December 31, 1996, 1997 and 1998
an interest rate of 7% per annum. This repurchase of partnership units in
exchange for subscription notes receivable is considered a noncash transaction
for purposes of the consolidated statements of cash flows.
Also during 1997, options to purchase 1,440,000 partnership units at prices
ranging from $1.00 to $1.75 per unit were forfeited by the separated management
members. Furthermore, 26,500 options to purchase partnership units at $1.00 per
unit were granted to two former senior manager executives.
In July 1998, the Partnership repurchased 100,000 Class B limited
partnership units at a unit price of $2.15 for a total repurchase amount of
$215,000 from a former member of management. The Partnership resold the units
at a unit price of $2.33 to current members of management.
Partnership unit options: Certain limited partners and key employees of the
Partnership have the ability, under certain conditions, to exercise options to
purchase units of Class B limited partnership interests (Class B Interests).
Through October 1, 1996, the Partnership was authorized to grant 1,869,545
units of Class B Interests, as established in the 1996 option plan (1996 Option
Plan), which vested at a rate of 20% per year, based on specific performance
standards. The options did not vest prior to October 1, 1996, as these
performance standards were not met.
Effective October 2, 1996, the Partnership amended the 1996 Option Plan
(Amended and Restated Management Option Plan) to decrease the number of options
the Partnership was authorized to grant to 1,840,000, and change the required
performance standards, along with other changes. The options now vest according
to the following schedule: 5% of the options vest on the first anniversary of
the Partnership's Offering; 5% of the options vest on the second anniversary of
the Partnership's Offering; the remaining 90% vests ratably at each calendar
year end over a five-year period beginning January 1, 1997, and become
exercisable if certain performance standards are met. These options expire on
October 1, 2003.
No compensation expense has been recorded for the options, which vest based
on the anniversary of the Offering, as management's estimate of the market
value was less than the exercise price at the date of the grant. Additionally
no compensation expense has been recognized for the remaining performance-based
options, as management, at this time, has deemed the probability of meeting the
performance standards to be remote.
Effective October 19, 1998, the Partnership granted 450,000 options, under a
new 1998 option plan, to members of management to purchase Class B limited
partnership units for $4.50 per unit. The options vest ratably over five years.
These options expire October 19, 2008. Exercisability of these options is not
based on performance standards. No compensation expense has been recorded for
these options, as management's estimate of the market value was approximately
equal to the exercise price at the date of the grant.
Other options granted: On December 19, 1996, the Board of Directors granted
a member of the Board of Directors options to purchase 30,000 Class B limited
partnership units for $3.00 per unit. These options vest ratably over a five-
year period and expire in September 2003. No material compensation expense has
been recorded for these options, as management's estimate of the market value
was less than the exercise price at the date of the grant.
Effective May 10, 1997, and June 1, 1997, the Board of Directors granted two
senior officers of the Partnership a total of 1,500,000 options to purchase
Class B limited partnership units for $2.33 per unit. These options vest in
equal amounts over a three-year period commencing from the grant date.
Exercisability of 60%
F-43
<PAGE>
MUZAK LIMITED PARTNERSHIP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Years Ended December 31, 1996, 1997 and 1998
of these options is subject to certain performance standards being met. At
December 31, 1998, it is probable the performance standards will be met. The
Partnership has recognized approximately $202,000 and $1,993,000 in
compensation expense for the years ended December 31, 1997 and 1998,
respectively.
In July 1997, the Board of Directors granted a member of the Board of
Directors options to purchase 150,000 Class B limited partnership units for
$2.33 per unit. These options vest ratably over a three-year period and expire
in July 2002. Exercisability of 60% of these options is subject to certain
performance standards being met. At December 31, 1998, it is probable the
performance standards will be met. The Partnership has recognized $-0- and
approximately $224,000 in compensation expense for the years ended December 31,
1997 and 1998, respectively.
<TABLE>
<CAPTION>
Weighted
Range of average
Number of exercise exercise
options price price
---------- ----------- --------
<S> <C> <C> <C>
Outstanding, January 1, 1996.................. 1,834,545 $1.00--1.75 $1.12
Options granted (weighted average fair value
of $1.91).................................. 40,000 3.00 3.00
Options forfeited........................... (75,000) 1.00 1.00
---------- ----------- -----
Outstanding, December 31, 1996................ 1,799,545 1.00--3.00 1.16
Options granted (weighted average fair value
of $.37)................................... 1,706,500 1.00--3.00 2.32
Options forfeited........................... (1,440,000) 1.00--1.75 1.15
---------- ----------- -----
Outstanding, December 31, 1997................ 2,066,045 1.00--3.00 2.09
Options granted (weighted average fair value
of $1.45).................................. 450,000 4.50 4.50
Options forfeited........................... (15,000) 1.00 1.00
---------- ----------- -----
Outstanding, December 31, 1998................ 2,501,045 1.00--4.50 $2.56
========== =========== =====
</TABLE>
Additional information regarding options outstanding as of December 31, 1998,
is as follows:
<TABLE>
<CAPTION>
Weighted
average Weighted Weighted
contractual average average
Exercise Number life exercise Number exercise
prices outstanding (years) price exercisable price
----------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$1.00 331,045 0.8 $1.00 33,105 $1.00
2.33 1,650,000 5.4 2.33 220,000 2.33
3.00 70,000 5.0 3.00 4,000 3.00
4.50 450,000 9.8 4.50 -- 4.50
----------- --------- --- ----- ------- -----
$1.00--4.50 2,501,045 5.6 $2.56 257,105 $2.17
=========== ========= === ===== ======= =====
</TABLE>
Fair value stock-based compensation: The Partnership has calculated the pro
forma net loss under SFAS No. 123 using a multiple option valuation approach
and certain weighted-average assumptions deemed reasonable by management. These
assumptions include a risk-free interest rate ranging from 4.5% to 4.6%, an
expected life of two to five years, a partnership unit volatility of 0.0% and
no partnership distributions over the expected life. Had compensation expense
for the stock option plans been recognized under SFAS No. 123, the
Partnership's net loss would have been adjusted to the pro forma amount for the
years ended December 31 as follows (in thousands):
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Net loss as reported................................ $(13,435) $(11,989)
======== ========
Pro forma net loss under SFAS No. 123............... $(13,599) $(12,225)
======== ========
</TABLE>
F-44
<PAGE>
MUZAK LIMITED PARTNERSHIP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Years Ended December 31, 1996, 1997 and 1998
Put options: A general partner and certain of the Class A limited partners
can require the Partnership to purchase limited partnership units held by them
at fair market value. However, such right may not be exercised if the purchase
of units would have a material adverse effect on the Partnership or would be in
contravention of any then-existing agreement to which the Partnership is a
party. These partners have not elected to exercise their redemption rights as
of December 31, 1998.
Allocation of profits and losses: Losses are allocated among the general
partners and Class A and B limited partners based upon the total of the
interests held by each individual, including the put/call units under option,
as a percentage of the total of all such interests.
NOTE 13: ENTERPRISE-WIDE INFORMATION
Management organizes its business around its independent and owned
affiliates. These operating segments have been aggregated as each segment has
similar economic characteristics and the nature of the segments, its production
processes, customers and distribution methods are similar. Information related
to the Partnership's products and services revenue is summarized for the years
ended December 31, as follows (in thousands):
<TABLE>
<CAPTION>
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Revenues:
Broadcast music...................................... $42,242 $43,761 $47,916
On-premise music..................................... 4,368 4,035 4,157
Other broadcast services............................. 1,530 1,546 1,746
Audio marketing...................................... 2,480 3,248 4,418
On-premise video..................................... 2,108 4,126 2,973
In-store advertising................................. 717 949 745
Internet music server................................ 22 359 1,678
Other................................................ 1,118 1,327 2,323
------- ------- -------
Total music and other business services............ 54,585 59,351 65,956
Equipment............................................ 21,873 21,026 22,021
Installation, service, and repair.................... 10,353 10,827 11,771
------- ------- -------
Total equipment and related services............... 32,226 31,853 33,792
------- ------- -------
Total revenue.......................................... $86,811 $91,204 $99,748
======= ======= =======
</TABLE>
NOTE 14: SUBSEQUENT EVENTS
On January 29, 1999, the Partnership entered into a definite merger
agreement to be acquired by Audio Communications Network Holdings, LLC (ACN).
Under the terms of the agreement, the Partnership will be merged into a
subsidiary of ACN. The consummation of the merger, which is expected to close
in March 1999, is subject to a number of conditions, including completion of
ACN's financing for the transaction. Under the terms of the agreement, total
consideration is approximately $245,000,000. The current partners will also
retain a minor ownership interest in the merged entity. The accounts of EAIC
Corp. are not contemplated to be part of the merger.
In the event of change of control of the Partnership, all outstanding
options to purchase partnership units will become immediately vested and
exercisable unless the performance criteria is not considered to be achievable.
Based upon the preliminary purchase price, the accelerated vesting of certain
options will likely result in a significant charge to the statement of
operations as performance criteria for these options is considered achievable.
F-45
Exhibit 99.3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
GENERAL
The Partnership derives revenues from its business services and from
the sale, installation and servicing of equipment at customer premises. The
Partnership's principal business services include broadcast music services,
on-premise music, on-premise music video, and audio marketing. Music and other
business services represented approximately 66% of total revenues in 1998.
Equipment and related revenues accounted for the remaining 34% of 1998 revenues.
A large majority of the Partnership's broadcast and on-premise music revenues
are generated from subscribers who typically execute five-year contracts at
rates ranging from $35 to $75 per month. These subscription rates typically
include the use of the Partnership's equipment at the subscriber's location. The
Partnership's independent affiliates pay royalties, including surcharges for
satellite transmission systems, to the Partnership based generally on 10% to
12.5% of adjusted music revenues, which are broadcast music revenues less
licensing payments and bad debt write-offs. Royalties received from independent
affiliates and international distributors are included in broadcast music
revenues and represented approximately 8.6% of total revenues in 1998.
On-premise music video revenues are derived from the sale of specialized
on-premise music videos targeted for certain segments of the marketplace. Audio
marketing revenues are generated primarily from the sale of customized audio
messages for use with "on-hold" telephone systems.
Equipment revenues are derived from the sale and lease of audio
system-related products, principally sound systems and intercoms, to business
music subscribers and other customers. The Partnership also sells electronic
equipment, including proprietary tape playback equipment, and other audio and
video equipment to its independent affiliates to support their business music
services. Installation, service and repair revenues consist principally of
revenues from the installation of sound systems and other equipment that is not
associated with the 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. Installation fee revenues that are related to music contracts, are
deferred and recognized over the term of the respective contracts.
Cost of revenues for business services consists primarily of broadcast,
delivery, licensing, production and programming costs associated with providing
music and other business services to a subscriber or a independent affiliates.
Cost of revenues for equipment represents the purchase cost plus handling,
shipping and warranty expenses. Cost of revenues for installation, service and
repair consists primarily of service and repair labor and labor for installation
that is not associated with new business music subscribers. Installation costs
associated with new business music subscribers are capitalized and charged to
depreciation expense over ten years.
<PAGE>
Selling, general and administrative expenses include salaries,
benefits, commissions, travel, marketing materials, training and occupancy costs
associated with staffing and operating local and national sales offices. Such
expenses also include personnel and other costs incurred in connection with the
Partnership's headquarters functions. A significant portion of commissions and
certain other selling costs are capitalized on a successful-efforts basis and
charged as amortization expense over the average contract term of five years
and, accordingly, are not reflected in selling, general and administrative
expenses. The Partnership capitalized $3.3 million, $3.8 million and $3.6
million of such costs in 1996, 1997 and 1998, respectively.
The Partnership amortizes leasehold improvements over the shorter of
the lease term or five years and deferred costs and intangible assets over lives
ranging from five to ten years. These deferred costs and intangible assets
consist of the costs associated with subscriber contracts acquired from third
parties (typically amortized on an accelerated basis over eight years),
commissions and certain other sales-related expenses (five years), the
acquisition and production costs of a music library (typically five years),
organizational expenses related to acquiring certain franchise operations (five
years) and capitalized financing costs (over the life of the loans).
The Partnership operates as a limited partnership and as such, the
income tax effects of all earnings or losses of the Partnership are passed
directly to the partners and no provision for income taxes is required.
On October 2, 1996, the Partnership and Muzak Capital Corporation
(Capital Corp.) completed the offering of $100 million aggregate principal
amount (the "Offering") of their 10% Senior Notes (the "Senior Notes"). The
Partnership adopted, as part of the Offering, a performance-based Amended and
Restated Management Option Plan (the "Amended and Restated Management Option
Plan"). Pursuant to which, the Partnership granted equity options to management
employees that vest according to the following schedule: 5% of the options vest
on the first anniversary of the Partnership's Offering; 5% of the options vest
on the second anniversary of the Partnership's Offering; the remaining 90% vests
ratably at each calendar year end over a five-year period beginning January 1,
1997, and become exercisable if certain performance standards are met. These
options expire on October 1, 2003.
No compensation expense has been recorded for the options which vest
based on the anniversary of the Offering, as management's estimate of the market
value was less than the exercise price at the date of the grant. Additionally,
no compensation expense has been recognized for the performance-based options,
as management, at this time, has deemed the probability of meeting the
performance standards to be remote.
In 1997, the Board of Directors granted two senior officers of the
Partnership and a member of the Board a total of 1,650,000 options to purchase
Class B limited partnership units for $2.33 per unit. These options vest in
equal amounts over a three-year period commencing from the grant date.
Exercisability of 60% of these options is subject to certain performance
standards being met. At December 31, 1998, it is probable the performance
standards will be met. The Partnership has recognized approximately $0.2
<PAGE>
million and $2.2 million in compensation expense for the years ended December
31, 1997 and 1998, respectively. Effective October 19, 1998, the Partnership
granted 450,000 options, under a new 1998 option plan, to members of management
to purchase Class B limited partnership units for $4.50 per unit. The options
vest ratably over 5 years. These options expire October 19, 2008. Exercisability
of these options is not based on performance standards. No compensation expense
has been recorded for these options, as management's estimate of the market
value was approximately equal to the exercise price at the date of the grant.
Capital Corp., a wholly owned subsidiary of the Partnership, was
organized on May 8, 1996, has nominal assets and conducts no business
operations. Capital Corp. has no independent operations and is dependent on the
cash flow of the Partnership to meet its sole obligation, the payment of
interest and principal on the Senior Notes when due.
EAIC Corporation (EAIC Corp.), a wholly owned subsidiary of the
Partnership, was organized on March 16, 1998. The Partnership transferred
certain assets to EAIC Corp. utilized in providing internet music samples to
businesses. On July 10, 1998, EAIC Corp. consummated a recapitalization and
capital financing agreement. Pursuant to the agreement, shares held by the
Partnership were converted to 10,000,000 shares of series A non-voting common
stock. Additionally, 73,500 shares of series A voting convertible mandatorily
redeemable preferred stock of EAIC Corp. were issued to a related party investor
for a total consideration of $3.4 million, net of costs. After January 5, 1999,
but prior to April 15, 1999, 26,250 shares of Class B preferred stock can be
purchased by the related party investor for $2.5 million. In the event that
certain performance criteria is met by EAIC Corp., the related party investor is
required to purchase these shares of Series B preferred stock. EAIC Corp. has
not met this criteria as of December 31, 1998. On August 31, 1998, the Board of
Directors of EAIC Corp. authorized a 100-to-one stock split. All applicable
share data has been retroactively adjusted for this stock split.
In addition, the Partnership transferred net assets of $0.9 million
consisting of purchased music to a newly formed, wholly owned subsidiary, MLP
Environmental Music, LLC on December 30, 1998.
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth certain financial information for the
periods presented and should be read in conjunction with the Partnership's
Financial Statements, including the Notes thereto:
<TABLE>
<CAPTION>
Year Ending December 31, Percentage Change
------------------------------------- ----------------------
1997 vs. 1998 vs.
1996 1997 1998 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
REVENUES:
Broadcast Music $42,242 $43,761 $47,916 3.6% 9.5%
On-Premise Music 4,368 4,035 4,157 (7.6)% 3.0%
Other Broadcast 1,530 1,546 1,746 1.0% 12.9%
On-Premise Video 2,108 4,126 2,973 95.7% (27.9)%
Audio Marketing 2,480 3,248 4,418 31.0% 36.0%
In-Store Advertising 717 949 745 32.4% (21.5)%
Internet Music Server 22 359 1,678 * *
Other 1,118 1,327 2,323 18.7% 75.1%
------------------------------------
Total Music and Other Business Services 54,585 59,351 65,956 8.7% 11.1%
------------------------------------
Equipment 21,873 21,026 22,021 (3.9)% 4.7%
Installation, Service & Repair 10,353 10,827 11,771 4.6% 8.7%
------------------------------------
Total Equipment Sales and Related Services 32,226 31,853 33,792 (1.2)% 6.1%
------------------------------------
Total Revenues 86,811 91,204 99,748 5.1% 9.4%
GROSS PROFIT:
Business Services 39,322 40,849 46,136 3.9% 12.9%
Equipment 10,316 10,162 12,900 (1.5)% 26.9%
Installation, Service & Repair 147 (516) (1,797) * *
------------------------------------
Total Gross Profit 49,785 50,495 57,239 1.4% 13.4%
Gross Profit Margin (1) 57.3% 55.4% 57.4%
Selling, General & Administrative 31,599 33,262 34,319 5.3% 3.2%
S,G&A Margin (2) 36.4% 36.5% 34.4%
EBITDA (3) 18,186 17,233 22,920 (5.2)% 33.0%
EBITDA Margin (4) 20.9% 18.9% 23.0%
Noncash Incentive Compensation 60 202 2,217 * *
Net Loss ($10,823) ($13,435) ($11,989) (24.1)% 10.8%
</TABLE>
- -----------------------------------
(1) Gross profit margin represents gross profit as a percentage of total
revenues.
(2) S,G&A margin represents selling, general and administrative expenses as a
percentage of total revenues.
(3) EBITDA represents earnings before interest expense, interest income, income
taxes, depreciation, amortization, other income/expense, equity in losses
of joint venture and noncash incentive compensation. EBITDA does not
represent and should not be considered as an alternative to net income or
cash flow from operations as determined by generally accepted accounting
principles. The Partnership believes that EBITDA is a meaningful measure of
performance and that it is commonly used in similar industries to analyze
and compare companies on the basis of operating performance, leverage and
liquidity. EBITDA has been adjusted for the years ending December 31, 1996
and 1997 to reflect $60,000 and $202,000, respectively, in noncash
incentive compensation to be consistent with its indenture agreement for
the $100 million Senior Notes.
(4) EBITDA margin represents EBITDA as a percentage of total revenues.
<PAGE>
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Revenues. Total revenues increased 9.4% from $91.2 million in 1997 to
$99.7 million in 1998 principally as a result of an 11.1% increase in music and
other business services revenues and a 6.1% increase in equipment sales and
related services. Music and other business services revenues increased due to an
increase in the number of broadcast music subscribers, sales growth and the
acquisition of competitors' business music contracts, combined with an increase
in the royalties paid by independent affiliates resulting from growth in the
broadcast music subscribers in the affiliate network. Music and other business
services revenues with the exception of on-premise video and in-store
advertising increased at more rapid rates than broadcast music revenues due to
the increased marketing of, and increasing customer demand for, audio marketing
services, CDI on-premise devices and promotional services, among others.
In-store advertising decreased from 1997 to 1998 primarily as a result of the
Partnership's closure of its in-store marketing group. Royalties and other fees
from independent affiliates and international distributors (included in
broadcast music revenues) accounted for $8.9 million or 9.0% of the
Partnership's revenues in 1998, compared with $8.9 million or 9.8% of the
Partnership's revenues in 1997. The continued decrease in the surcharges
assessed to independent affiliates for satellite transmission costs was offset
by increased growth in royalties related to new subscriber billing. Equipment
and installation revenues increased 4.7% and 8.7% respectively due to the
expansion of national accounts.
Gross Profit. Total gross profit increased 13.4% from $50.5 million in
1997 to $57.2 million in 1998. As a percentage of total revenues, gross profit
increased from 55.4% in 1997 to 57.4% in 1998. The improvement in gross profit
percentage in 1998 was due to growth of higher margin business services, such as
broadcast music, audio marketing and on-premise music services.
The improvement in gross profit was partially offset by approximately
$1.5 million of one-time charges related to the failure of Galaxy IV on May 19,
1998. The Galaxy IV satellite, which carries approximately 60% of the
Partnership's subscribers, had a mechanical failure that caused it to spin
uncontrollably out of orbit. This event caused additional equipment and related
services costs for labor, overtime and subcontractors to be incurred from
repointing over 100,000 satellite dishes to a new satellite, Galaxy IIIR. Gross
profit was impacted by $0.4 million of non-recurring costs related to the
conversion of competitor locations acquired during 1998. Had we not incurred
these expenses, our gross profit margin would have been 59.3% for 1998, an
increase of 17.2% over 1997.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 3.2% from $33.3 million in 1997 to $34.3
million in 1998. As a percentage of total revenues, selling, general and
administrative expenses decreased from 36.5% in 1997 to 34.4% in 1998. Selling
and marketing expenses increased 3.0% from $13.8 million in 1997 to $14.2
million in 1998, principally due to an increase in commissions paid as a result
of increased levels of sales of our business services
<PAGE>
products. In 1998, selling and marketing included non-recurring expenses of $0.5
million associated with our cost of repositioning our brand, the design and
construction of our web site and one-time printing expenses. Had we not incurred
such expenses, our selling and marketing expenses would have decreased 0.8% to
$13.6 million. General and administrative costs increased 3.3% from $19.5
million in 1997 to $20.1 million in 1998, due to transaction costs related to
the merger with ACN. However, had we not incurred these expenses, our general
and administrative costs would have only increased 0.6% to $19.6 million. If we
had not incurred the non-recurring selling and marketing expenses and the
non-recurring general and administrative costs, our 1998 selling, general and
administrative expenses as a percentage of total revenues would have been 33.4%.
Noncash Incentive Compensation. Noncash incentive compensation
increased from $0.2 million in 1997 to $2.2 million in 1998. This increase is
primarily due to the meeting of performance criteria for options issued combined
with management's estimate of the increase in value of the Partnership.
Depreciation Expense. Depreciation expense decreased 8.6% from $10.7
million in 1997 to $9.7 million in 1998, principally as a result of a reduction
of depreciation expense for five year lived assets that were fully depreciated
in 1997 related to the acquisition of the Partnership in 1992 by a group led by
Centre Capital Investors L.P. ("CCI").
Amortization Expense. Amortization expense increased 18.1% from $10.0
million in 1997 to $11.8 million in 1998. The increase in amortization expense
was due to an increase in intangibles related to the increased investment in the
expanded customer base and acquisitions of competitors' business music contracts
in 1997 and 1998.
Interest Expense. Total interest expense increased 4.4% from $10.8
million in 1997 to $11.2 million in 1998. The increase in interest expense in
1998 compared to 1997 is related to the increase in the average outstanding debt
during the year. The Partnership's total interest-bearing debt increased from
$101.0 million to $120.0 million at December 31, 1997 and 1998 respectively.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Revenues. Total revenues increased 5.1% from $86.8 million in 1996 to
$91.2 million in 1997 principally as a result of a 8.7% increase in music and
other business services revenues offset by a 1.2% decrease in equipment and
related services revenues. Music and other business services revenues increased
due to an increase in the number of broadcast music subscribers and an increase
in the royalties paid by independent affiliates resulting from an increase in
the broadcast music subscribers in the franchise network. Music and other
business services revenues (with the exception of on-premises tape sales)
increased at more rapid rates than broadcast music revenues due to the increased
marketing of, and increasing customer demand for, on-premise music video and
audio
<PAGE>
marketing services, among others. On-premise tape revenues declined due to the
Partnership's conversion of such customers to broadcast services, primarily DBS
transmission. Royalties and other fees from independent affiliates and
international distributors (included in broadcast music revenues) accounted for
$8.9 million or 9.8% of the Partnership's revenues in 1997, compared with $7.8
million or 8.9% of the Partnership's revenues in 1996. This increase is
principally due to a new surcharges assessed to independent affiliates for
satellite transmission costs. Equipment revenues decreased 3.9% as the
Partnership has continued to exit the low margin business of reselling equipment
to its independent affiliates and reduced its participation in lower margin
competitively bid equipment sales. Installation, service and repair revenues
increased 4.6% from the level generated in 1996 due to more installations and
large equipment jobs during 1997.
Gross Profit. Total gross profit increased 1.4% from $49.8 million in
1996 to $50.5 million in 1997. As a percentage of total revenues, gross profit
decreased from 57.3% in 1996 to 55.4% in 1997. Declines in gross profit as a
percentage of sales reflect a dilution of the margin percentage due to the
continued development of the Internet Music Server business and the EchoStar
residential revenues, net of EchoStar satellite costs, both of which contributed
a negative gross profit for the year. Additionally, 1997 was impacted by
approximately $0.5 million in one-time charges related to inventory writedowns.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 5.3% from $31.6 million in 1996 to $33.3
million in 1997. As a percentage of total revenues, selling, general and
administrative expenses increased from 36.4% in 1996 to 36.5% in 1997. Selling
and marketing expenses increased 19.6% from $11.5 million in 1996 to $13.8
million in 1997, principally due to an increase in sales volumes for business
services products. General and administrative costs decreased 3.0% from $20.1
million in 1996 to $19.5 million in 1997, primarily due costs associated with
the unconsummated initial public offering in the 1996 period. General and
administrative costs also include $0.8 million in non-recurring severance
charges in 1997 related to certain executive officers.
Noncash Incentive Compensation. Noncash incentive compensation
increased from $0.1 million in 1996 to $0.2 million in 1997. This increase is
primarily due to the increase in options issued combined with management's
estimate of the increase in value of the Partnership.
Depreciation Expense. Depreciation expense increased 0.2% from $10.6
million in 1996 to $10.7 million in 1997, principally as a result of an
increased investment in equipment installed at customers' premises due to an
expanded customer base and related to new investments in the EchoStar system and
the Internet MusicServer service.
Amortization Expense. Amortization expense increased 4.4% from $9.6
million in 1996 to $10.0 million in 1997. The increase in amortization expense
was due to an increase in intangibles related to the increased investment in the
expanded customer base.
<PAGE>
Interest Expense. Total interest expense increased 32.8% from $8.1
million in 1996 to $10.8 million in 1997. The increase in interest expense in
1997 compared to 1996 resulted from a full year of interest expense on the $100
million in Senior Notes issued by the Partnership in October 1996. The
Partnership's total interest-bearing debt remained constant at $101.0 million at
December 31, 1996 and 1997.
Extraordinary Items. Extraordinary items reflected nonrecurring noncash
charges from the write-off of $3.7 million of deferred financing fees, debt
discount and organizational costs and a nonrecurring gain of $3.1 million from
the retirement of a redeemable preferred limited partnership interest during
1996.
LIQUIDITY AND CAPITAL RESOURCES
The Partnership's liquidity needs have been primarily for capital
expenditures, business acquisitions, debt service and working capital. As of
December 31, 1998, the Partnership had a working capital deficit of $7.1
million, compared with a working capital surplus of $12.5 million as of December
31, 1997. This decrease in working capital for this period was due to capital
requirements to fund the additional growth in business services products as well
as the acquisition of twelve business music distributors.
The Partnership's investing activities have historically included the
acquisition and installation of on-premise customer equipment (such as satellite
dishes and receivers) and capitalized costs related to business acquisitions,
obtaining customer contracts and creating master recordings. Capital
expenditures principally related to the acquisition and installation of
on-premise equipment were $10.9 million in 1996, $12.6 million in 1997 and $12.8
million in 1998. Additions to deferred costs and intangible assets were $5.4
million in 1996, $6.0 million in 1997 and $8.6 million in 1998.
The Partnership believes that its future investing activities may
include additional acquisitions of its competitors' business music distributors
and the Partnership's independent affiliates to further its operating strategy,
as well as capital expenditures related to the acquisition and installation of
on-premise equipment and deferred customer acquisition costs.
The Partnership's primary sources of liquidity have been cash flows
from operations and proceeds from various debt instruments. Cash provided by the
Partnership's operations, adjusted for the effect of non-cash items, totaled
$14.0 million in 1998, an increase of $7.4 million over the $6.6 million
provided in 1997. The increase in cash provided by operations was primarily
attributable to a decrease in the net loss, and
<PAGE>
an increase in accounts payable, offset by an increase in accounts receivables
and inventories, related to an increase in sales volume. Net changes in the
operating assets and liabilities provided cash of $1.1 million in 1998 as
compared to utilizing of $2.6 million in 1997, due primarily to an increase in
accounts payable and accrued expenses, offset by increases in accounts
receivable and inventories.
In 1997, the Partnership sold its Spokane territory subscriber accounts
and granted the Spokane franchise to an existing independent affiliates of the
Partnership for $1.4 million. This transaction resulted in a gain of $0.8
million to the Partnership, which is included in other income in the
consolidated statement of operations, for the year ended December 31, 1997.
In 1997, the Partnership acquired substantially all of the assets of
four business music providers for approximately $4.1 million. The acquisitions
were financed with cash remaining from the Offering.
In 1998, the Partnership acquired, through separate transactions,
substantially all of the net assets of twelve business music providers for a
total purchase price of approximately $20.2 million. These acquisitions were
financed by a combination of cash, debt and approximately $0.9 million in equity
instruments. Of the total purchase price, the portion related to certain assets
of Music Technologies Incorporated (MTI) was approximately $10.0 million.
As part of the acquisition of MTI, the Partnership entered into
agreement in principle with an independent affiliate to sell a portion of the
income producing contracts obtained in the MTI acquisition. This asset of $1.4
million has been recorded as other receivables as of December 31, 1998.
The Partnership entered into a note payable of approximately $2.6
million. The note bears an interest rate of 14% per annum, with principal and
interest payments of $0.5 million due monthly through March 31, 1999, and the
balance due April 30, 1999. The Partnership has the option to extend the due
date for additional fees. The Partnership also agreed to make a deferred
purchase price payment of $1.3 million, subject to adjustment. Due to the
contingent nature of this consideration and significant uncertainties related to
the ultimate amount to be paid, the Partnership has not recorded any obligation
as of December 31, 1998.
Pursuant to an acquisition, the Partnership paid $0.5 million in
exchange for a non-compete agreement and agreed to pay seven additional annual
installments of $0.5 million. The Partnership has recorded a liability of $2.2
million using a discount rate of 14% per annum.
In March 1998, the Partnership obtained a credit facility for working
capital purposes with an initial availability of $3.0 million, increasing to
$5.0 million upon the attainment of certain cash flow related targets. In July
1998, the Partnership met the cash flow targets required to increase the
available cash to $5.0 million. The credit facility was secured by inventories
and accounts receivable of the Partnership. The outstanding
<PAGE>
balance on the credit facility was paid in full and the facility was cancelled
on December 31, 1998.
A new revolving credit facility was obtained by the Partnership in
December 1998. The amount available under the facility is $20.0 million. Amounts
outstanding under the facility bear a variable rate of interest, to be paid
quarterly, based on the lender's prime rate plus 1.25%. The terms of the credit
facility require the Partnership to maintain certain performance standards and
covenants include a limit on the Partnership's capital spending and acquisitions
of other businesses, as well as the Partnership's ability to incur additional
debt and make distributions to partners. The credit facility is secured by
accounts receivable, inventories, and other assets, including proceeds of
certain insurance policies. As of December 31, 1998, the Partnership had
approximately $12.0 million outstanding under this credit facility. The interest
rate at December 31, 1998, was 9%. As part of obtaining the credit facility,
certain limited partners were required to set forth letters of credit in the
amount of $4.2 million. The Partnership has pledged to reimburse the limited
partners for related costs and fees. For the year ended December 31, 1998, no
amounts were reimbursed by the Partnership.
In September 1998, the Partnership's wholly owned subsidiary, EAIC,
obtained a credit facility. The amount available under this facility is $0.8
million and is to be used for equipment purchases. Amounts outstanding under the
facility bear a variable rate of interest to be paid at a rate equal to the
lender's prime rate plus 1% per annum. The unpaid principal balance shall be
repaid in 24 equal monthly installments of principal, plus interest, commencing
on October 1, 1999. As of December 31, 1998, EAIC had approximately $0.3 million
outstanding under this credit facility. The interest rate at December 31, 1998,
was 8.75%.
The Senior Notes obtained in 1996 as part of the Offering, represent
unsecured senior obligations of the Partnership and Capital Corp., and are
senior in right of payment to all subordinated indebtedness and pari passu in
right of payment to all senior indebtedness. The Senior Notes mature on October
1, 2003. Interest accrues at a rate of 10% per annum and is payable
semi-annually in arrears on April 1 and October 1 to holders of record on the
immediately proceeding March 15 and September 15, respectively. A portion of the
proceeds from the Senior Notes was used to repay existing indebtedness and for
additional working capital and other corporate purposes. The remainder of the
proceeds from the Offering have been used for general corporate purposes, which
may include acquisitions of the Partnership's independent affiliates or business
music distributors of its competitors' to further its operating strategy, other
acquisitions or investment opportunities and working capital.
During 1997, the Partnership repurchased 1,250,000 limited partnership
units from eight members of former management at a unit price of $2.33 for a
total repurchase amount of $2.9 million. Seventeen existing and new members of
management purchased 899,000 units at a unit price of $2.33 per unit for a total
purchase price of $2.1 million. These purchases were financed primarily by
the Partnership through promissory notes from these management members bearing
interest at 7% per annum.
<PAGE>
During 1998, the Partnership sold its interest in a joint venture
providing business music services in Europe (Muzak Europe) in exchange for a
note receivable of approximately $0.8 million, which is due in full April 2005,
and a royalty based on recurring billings beginning April 2000. No gain or loss
was recorded on this transaction. The joint venture was accounted for using the
equity method, as the Partnership owned 50% of that venture but did not have a
controlling interest. Equity in losses of joint venture in the Partnership's
consolidated statements of operations includes the Partnership's share of net
losses. As of December 31, 1997, the joint venture had total assets of $7.3
million and total liabilities of $5.5 million. As of December 31, 1997, the
carrying value on the Partnership's books was $1.1 million and was included in
other long-term assets.
The Partnership leases certain facilities and equipment under both
operating and capital leases. In addition, the Partnership has entered into
agreements to obtain satellite channel capacity and subsidiary communication
authorization rights for the transmission of programs to the Partnership's
customers. Total rental expense under operating leases and rights' agreements
was approximately $7.8 million, $8.4 million and $8.7 million for the years
ended December 31, 1996, 1997 and 1998, respectively.
The Partnership anticipates, excluding EAIC Corp. activity, capital
expenditures, primarily related to subscriber provided equipment, of between
$10.0 million and $12.0 million in 1999 and additions to deferred costs and
intangible assets, excluding acquisitions, of between $6.0 million and $8.0
million in 1999. The level of capital expenditures and additions to deferred
costs and intangible assets are subject to a variety of factors which may cause
these expenditures to exceed the ranges set forth above.
The Partnership believes that its cash flows from operations, borrowing
availability and cash on hand will be adequate to support currently planned
business operations, capital expenditures and debt service requirements at least
through December 2000. If the Partnership engages in one or more material
acquisitions, joint ventures or alliances or other major business initiatives
requiring significant cash commitments, or incurs unanticipated expenses,
additional financing could be required.
Related to the acquisition of the Partnership of the predecessor entity
by a group led by CCI in 1992, the Washington State Department of Revenue has
levied an assessment against the Predecessor for $1.7 million in sales and use
and business and occupation taxes for the period from 1987 through September
1992. Under successor liability statutes in the State of Washington, the
Partnership could, if the predecessor entity fails to pay its tax obligation,
become liable for the assessment. The assessment is under appeal by the
predecessor entity. The seller and certain of its affiliates have agreed to
indemnify the Partnership for any liabilities in connection with such
assessments. Management does not believe that the assessment will have an
adverse effect on the Partnership's financial condition or results of
operations.
The Partnership's agreement with Business Music, Inc. (BMI) expired on
December 31, 1993. The Partnership has entered into an interim fee structure
with BMI and is in negotiations with BMI to establish an ongoing rate structure.
The interim
<PAGE>
arrangement with BMI provides for continued payments at 1993 levels. BMI has
indicated that they are seeking royalty rate increases, and has asserted that
this sought-after increase will be retroactive to January 1, 1994. If agreement
is not reached, BMI may seek to have rates determined through a court
proceeding. The ultimate outcome of the negotiations is not estimable and as a
result, no provision has been recorded in the financial statements.
On January 29, 1999, the Partnership entered into a definite merger
agreement to be acquired by Audio Communications Network Holdings, LLC (ACN).
Under the terms of the agreement, the Partnership will be merged into a
subsidiary of ACN. The consummation of the merger, which is expected to close in
March 1999, is subject to a number of conditions, including completion of ACN's
financing for the transaction. Under the terms of the agreement, total
consideration of approximately $245 million. The current partners will also
retain a minor ownership interest in the merged entity. The accounts of EAIC
Corp. are not contemplated to be part of the merger.
In the event of change of control of the Partnership, all outstanding
options to purchase partnership units will become immediately vested and
exercisable unless the performance criteria is not considered to be achievable.
Based upon the preliminary purchase price, the accelerated vesting of certain
options will likely result in a significant charge to the statement of
operations and comprehensive loss as performance criteria for these options is
considered achievable.
YEAR 2000 ISSUE
The Partnership is currently evaluating, replacing or upgrading its
computer systems in an effort to make them Year 2000 compliant, and expects to
have remediation efforts completed for its critical computer systems by the end
of the third quarter 1999. Although the Partnership assessment of its Year 2000
issues has been completed, reassessments are conducted on an ongoing basis to
provide reasonable assurance that all critical risks have been identified and
will be mitigated. While the Partnership believes all necessary work will be
completed in a timely fashion, there can be no guarantee that all systems will
be compliant by the year 2000, or that the systems of other companies and
government agencies on which the Partnership relies will be compliant.
The Partnership will use both internal and external resources to
reprogram or replace, test and implement its IT systems for Year 2000
modifications. The Partnership does not separately track the internal costs
incurred on the Year 2000 project. Such costs are principally payroll and
related costs for its internal IT personnel. The total cost of the Year 2000
project, excluding these internal costs, is estimated at $1.0 million and is
being funded through operating cash flows. Of the total estimated project cost,
the Partnership has incurred approximately $0.8 million through December 31,
1998. This amount is attributable to the purchase of new software and hardware
for the Partnership's new operating system, which was capitalized in 1997 and
1998 to be completed in 1999.
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Since 1997, the Partnership has been communicating with outside vendors
to determine their state of readiness with regard to the Year 2000 issue. The
Partnership relies on outside vendors for its non-IT systems. Based on its
assessment to date, the Partnership has no indication that any third party is
likely to experience Year 2000 non-compliance of a nature which would have a
material impact of the Partnership. However, the risk remains that outside
vendors or other third parties may not have accurately determined their state of
readiness, in which case such parties' lack of Year 2000 compliance may have a
material adverse effect on the Partnership's results of operations. The
Partnership will continue to monitor the Year 2000 compliance of third parties
with which it does business.
The Partnership believes the most likely worst-case scenarios that it
might confront with respect to the Year 2000 issues have to do with the possible
failure of third party systems over which the Partnership has no control, such
as, but not limited to, satellite, power and telephone services. The Partnership
is currently developing a specific Year 2000 contingency plan.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Financial Accounting Standard No. 133, Accounting for Derivative
Instruments and Hedging Activities, was issued in June 1998 and is effective for
all fiscal quarters of fiscal years beginning after June 15, 1999. This standard
requires an entity to recognize all derivatives as either assets or liabilities
in the statement of financial position and measure those instruments at fair
value. The Partnership is still in the process of evaluating the impact of this
standard on their financial statements and anticipates adopting this standard in
the year ending December 31, 2000.
In March 1998, the Accounting Standards Executive Committee of the
AICPA issued Statement of Position 98-1 (SOP 98-1), Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use, which requires that
certain software costs be capitalized and amortized over the period of use. The
SOP is effective for financial statements for the fiscal years beginning after
December 15, 1998. The Partnership will adopt SOP 98-1 for the year ending
December 31, 1999. This statement is not expected to have a material effect on
the financial statements.
In April 1998, the Accounting Standards Executive Committee of the
AICPA issued SOP 98-5, Reporting on the Costs of Start-up Activities, which
requires costs of start-up activities and organization costs to be expensed as
incurred. This SOP is effective for financial statements for fiscal years
beginning after December 15, 1998. The Partnership will adopt SOP 98-5 for the
year ending December 31, 1999. This statement is not expected to have a material
effect on the financial statements; however, organization costs of approximately
$272,000 will be written off.
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INFLATION AND CHANGING PRICES
Management does not believe that inflation and other changing prices
have had a significant impact on the Partnership's operations.
