Muzak 10-Q 2004 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2004

Or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             .

Commission File Number:	333-78573
	333-78573-01
	333-78571
	333-78571-01

MUZAK HOLDINGS LLC

MUZAK HOLDINGS FINANCE CORP

MUZAK LLC

MUZAK FINANCE CORP

(Exact Name of Registrants as Specified in their charter)

DELAWARE	04-3433730
DELAWARE	04-3433728
DELAWARE	04-3433729
DELAWARE	56-2187963
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)

3318 LAKEMONT BLVD.

FORT MILL, SC 29708

(803) 396-3000

(Address, Including Zip Code and Telephone Number including Area Code of Registrants’ Principal Executive Offices)

Indicate by check mark whether the registrants have filed all documents and reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrants are accelerated filers (as defined in Rule 12b-2 of the Securities and Exchange Act of 1934)    Yes  ¨    No  x

Muzak Holdings Finance Corp. and Muzak Finance Corp. meet the conditions set forth in General Instruction H (1) (a) and (b) of Form 10-Q and are therefore filing this form with the reduced disclosure format.

PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

MUZAK HOLDINGS LLC

CONSOLIDATED BALANCE SHEETS

(in thousands)

	September 30, 2004			December 31, 2003
	(unaudited)
ASSETS
Current assets:
Cash	$	1,261		$	2,284
Accounts receivable, net of allowances of $3,593 and $1,580		32,108			29,579
Inventory		17,849			15,016
Prepaid expenses and other assets		4,120			3,974
Total current assets		55,338			50,853
Property and equipment, net		103,038			108,591
Goodwill		140,805			140,805
Intangible assets, net		102,873			113,129
Deferred subscriber acquisition costs, net		46,517			46,208
Deferred charges and other assets, net		14,407			15,646
Total assets	$	462,978		$	475,232
LIABILITIES AND MEMBERS’ INTEREST (DEFICIENCY)
Current liabilities:
Accounts payable	$	6,673		$	6,528
Accrued expenses		24,417			21,311
Current portion of other liabilities		4,006			3,711
Current maturities of long term debt		99			94
Advance billings		1,699			1,084
Total current liabilities		36,894			32,728
Long-term debt		425,219			411,424
Other liabilities		9,124			9,461
Mandatorily redeemable preferred units		148,479			129,691
Commitments and contingencies
Members’ Interest (deficiency):
Class A units		77,900			96,688
Accumulated deficit		(234,638	)		(204,760	)
Total members’ interest (deficiency)		(156,738	)		(108,072	)
Total liabilities and members’ interest (deficiency)	$	462,978		$	475,232

The Notes are an integral part of these consolidated financial statements.

2

MUZAK HOLDINGS LLC

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands)

	Quarter Ended						Nine Months Ended
	September 30, 2004			September 30, 2003			September 30, 2004			September 30, 2003
Revenues:
Music and other business services	$	46,365		$	43,965		$	137,604		$	129,995
Equipment and related services		15,341			15,384			44,345			43,627
		61,706			59,349			181,949			173,622
Cost of revenues:
Music and other business services (excluding $11,139, $10,393, $33,534, and $32,300 of depreciation and amortization expense)		9,387			8,173			26,547			23,893
Equipment and related services		14,457			12,100			39,815			35,355
		23,844			20,273			66,362			59,248
		37,862			39,076			115,587			114,374
Selling, general and administrative expenses		22,118			20,038			64,676			59,958
Depreciation and amortization expense		15,182			15,338			46,376			47,776
Income from operations		562			3,700			4,535			6,640
Other income (expense):
Interest expense		(10,974	)		(10,302	)		(32,920	)		(28,766	)
Other, net		38			36			40			131
Loss from extinguishment of debt		—			—			(1,663	)		(3,694	)
Loss before income taxes		(10,374	)		(6,566	)		(30,008	)		(25,689	)
Income tax benefit		(56	)		(7	)		(130	)		(54	)
Net loss	$	(10,318	)	$	(6,559	)	$	(29,878	)	$	(25,635	)

The Notes are an integral part of these consolidated financial statements.

3

MUZAK HOLDINGS LLC

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

	Nine Months Ended
	September 30, 2004			September 30, 2003
CASH FLOW FROM OPERATING ACTIVITIES
Net loss	$	(29,878	)	$	(25,635	)
Adjustments to derive cash flow from operating activities:
Loss on extinguishment of debt		1,663			3,694
Gain on disposal of fixed assets		(88	)		(37	)
Deferred income tax benefit		(184	)		(501	)
Depreciation and amortization		46,376			47,776
Amortization of senior discount notes and senior notes		1,575			5,672
Amortization of deferred financing fees		1,965			1,864
Amortization of deferred subscriber acquisition costs		12,904			11,562
Deferred subscriber acquisition costs		(13,411	)		(14,614	)
Unearned installment income		(161	)		(26	)
Change in certain assets and liabilities
Increase in accounts receivable		(918	)		(1,539	)
Increase in inventory		(3,755	)		(3,192	)
Decrease in accounts payable		(579	)		(645	)
Increase in accrued expenses		3,864			3,602
Increase in advance billings		615			640
Other, net		(276	)		(4,781	)
NET CASH PROVIDED BY OPERATING ACTIVITIES		19,712			23,840
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures for property and equipment		(27,388	)		(30,317	)
Capital expenditures for intangibles		(1,448	)		(1,201	)
Proceeds from sale of fixed assets		91			50
NET CASH USED IN INVESTING ACTIVITIES		(28,745	)		(31,468	)
CASH FLOWS FROM FINANCING ACTIVITIES
Decrease in book overdrafts		(138	)		(2,459	)
Proceeds from issuance of Term Loan B		35,000			—
Proceeds from issuance of Senior Notes		—			218,869
Repayments of senior credit facility		—			(159,514	)
Repayments on revolver		—			(31,000	)
Borrowings on revolver		10,000			17,400
Repurchase of Senior discount notes		(33,670	)		(14,440	)
Repayment of notes payable to a related party		—			(10,000	)
Termination of interest rate protection agreement		—			4
Repayments of capital lease obligations and other debt		(2,112	)		(1,702	)
Payment of fees associated with financing		(1,070	)		(8,918	)
NET CASH PROVIDED BY FINANCING ACTIVITIES		8,010			8,240
NET INCREASE (DECREASE) IN CASH		(1,023	)		612
CASH, BEGINNING OF PERIOD		2,284			1,781
CASH, END OF PERIOD	$	1,261		$	2,393
Significant non-cash activities:
Capital lease obligations	$	2,005		$	1,214

The Notes are an integral part of these consolidated financial statements.

4

MUZAK HOLDINGS LLC

CONSOLIDATED STATEMENTS OF CHANGES IN

MEMBERS’ INTEREST (DEFICIENCY)

(Unaudited)

(in thousands, except for units)

	Class A					Class B				Accumulated Deficit			Total Members’ Interest
	Units		Dollars			Units		Dollars
Balance, December 31, 2003	132,422		$	96,688		14,537		$	—	$	(204,760	)	$	(108,072	)
Net loss											(29,878	)		(29,878	)
Forfeiture of Class B units						(396	)		—					—
Preferred return on preferred units				(18,788	)									(18,788	)
Balance, September 30, 2004	132,422	��	$	77,900		14,141		$	—	$	(234,638	)	$	(156,738	)

The Notes are an integral part of these consolidated financial statements.

5

MUZAK HOLDINGS LLC

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

1. Organization

Muzak Holdings LLC (and its subsidiaries (the “Company”)) was formed in September 1998 pursuant to the laws of the state of Delaware. The Company, through its subsidiaries, provides business music programming to clients through its integrated nationwide network of owned operations and franchises. All of the operating activities are conducted through the Company’s subsidiaries.

As of September 30, 2004, ABRY Partners, LLC and its respective affiliates, collectively own 64.2% of the beneficial interests in the Company’s voting interests.

2. Basis of Presentation

The consolidated financial statements include the accounts of the Company and its subsidiaries: Muzak LLC, Muzak Capital Corporation, Muzak Holdings Finance Corporation, Muzak Finance Corporation, Business Sound Inc., Electro Systems Corporation, BI Acquisition LLC, MLP Environmental Music LLC, Audio Environments Inc., Background Music Broadcasters Inc., Telephone Audio Productions Inc., Vortex Sound Communications Company Inc., Music Incorporated, and Muzak Houston, Inc. All significant intercompany items have been eliminated in consolidation.

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X, and accordingly, certain financial information has been condensed and certain footnote disclosures have been omitted. Such information and disclosures are normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States. For further information, refer to the consolidated financial statements and footnotes thereto included in the Muzak Holdings LLC Annual Report on Form 10-K for the fiscal year ended December 31, 2003 which can be found at www.sec.gov.

The financial statements as of September 30, 2004 and September 30, 2003 and for the quarters and nine months then ended are unaudited; however, in the opinion of management, such statements include all adjustments (consisting solely of normal recurring adjustments) necessary for a fair statement of the financial information included herein in accordance with generally accepted accounting principles in the United States. The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. Results of operations for interim periods are not necessarily indicative of results for the full year.

3. Property and Equipment

Property and equipment consists of the following (in thousands):

	Useful Life (years)	September 30, 2004 (Unaudited)			December 31, 2003
Equipment provided to subscribers	5	$	174,495		$	161,275
Capitalized installation labor	5		86,897			76,900
Equipment	5-7		33,840			29,875
Other	3-30		21,442			20,478
			316,674			288,528
Less accumulated depreciation			(213,636	)		(179,937	)
		$	103,038		$	108,591

Included in equipment and other at September 30, 2004 and December 31, 2003 is $17.1 million and $15.0 million, respectively, of equipment under capital leases, gross of accumulated depreciation of $11.9 million and $10.3 million, respectively. Depreciation of property and equipment was $11.5 million and $34.6 million for the quarter and nine months ended September 30, 2004 and was $10.8 million and $33.7 million for the quarter and nine months ended September 30, 2003, respectively.

6

MUZAK HOLDINGS LLC

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

4. Intangible Assets

Unamortized intangible assets consist of the following (in thousands):

	September 30, 2004		December 31, 2003
	Carrying Amount		Carrying Amount
	(unaudited)
Goodwill	$	140,805	$	140,805

Amortized intangible assets consist of the following (in thousands):

		September 30, 2004					December 31, 2003
	Useful Life (years)	Gross Carrying Amount		Accumulated Amortization			Gross Carrying Amount		Accumulated Amortization
		(unaudited)
Income producing contracts	12	$	153,900	$	(69,062	)	$	153,900	$	(59,442	)
License agreements	20		5,082		(1,398	)		5,082		(1,207	)
Deferred production costs	10		8,755		(2,513	)		7,354		(1,901	)
Trademarks	5		15,231		(15,071	)		15,184		(14,274	)
Non-compete agreements	3-5		275		(257	)		541		(445	)
Purchased music	20		10,831		(2,900	)		10,831		(2,494	)
		$	194,074	$	(91,201	)	$	192,892	$	(79,763	)

Aggregate amortization expense was $3.6 million and $11.7 million for the quarter and nine months ended September 30, 2004 and $4.6 million and $14.1 million for the quarter and nine months ended September 30, 2003, respectively.

The estimated future aggregate amortization expense is as follows (in thousands):

Fiscal year ending
2004 (remaining three months)	$	3,661
2005		14,583
2006		14,532
2007		14,506
2008		14,498

5. Accrued Expenses

Accrued expenses are summarized below (in thousands):

	September 30, 2004		December 31, 2003
	(Unaudited)
Accrued interest	$	9,330	$	6,292
Accrued compensation and benefits		3,533		2,347
Rebates payable to affiliates		2,459		2,747
Licensing royalties		4,661		3,818
Other		4,434		6,107
	$	24,417	$	21,311

7

MUZAK HOLDINGS LLC

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

6. Debt

Debt obligations consist of the following (in thousands):

	September 30, 2004			December 31, 2003
	(Unaudited)
Long term debt:
Revolving Loan-Senior Credit Facility	$	30,000		$	20,000
Term Loan B- Senior Credit Facility		35,000			—
Senior notes		219,083			218,962
Senior subordinated notes		115,000			115,000
Senior discount notes		24,245			55,496
Other		1,990			2,060
Total debt obligations		425,318			411,518
Less current maturities		(99	)		(94	)
	$	425,219		$	411,424

Senior Credit Facility

On November 9, 2004, the Company amended the following aspects of its Senior Credit Facility: (i) amended financial covenants for the third quarter of 2004 and prospectively to make such covenants less restrictive (ii) revised the maturity dates of the revolver and its $35.0 million term loan facility (“Term Loan B”) to May 2007 and November 2007, respectively, (iii) increased Term Loan B margins to 4.25% in the case of Eurodollar loans and 3.25% in the case of Base Rate Loans (iv) amended the definition of consolidated EBITDA to exclude up to $1.9 million in restructuring charges, and (v) reduced the revolving commitment from $60.0 million to $55.0 million. We estimate that we will incur approximately $0.2 million in financing fees during the fourth quarter of 2004 in connection with this amendment.

On May 10, 2004, the Company amended its Senior Credit Facility to include a Term Loan B in the amount of $35.0 million payable in quarterly installments beginning June 30, 2006 until final maturity on November 21, 2007, as amended. The proceeds of the term loan were used to repurchase $32.7 million in aggregate outstanding principal amount of the Company’s 13% Senior Discount Notes due 2010 and to pay associated interest and expenses. The Company recorded a loss on extinguishment of debt of $1.7 million in connection with this transaction. The loss on extinguishment of debt is comprised of $1.0 million premium paid on the repurchase and $0.7 million write off of deferred financing fees. We incurred financing fees of $1.4 million in connection with this transaction, $1.1 million of which were paid during the nine months ended September 30, 2004. The fees are included in Deferred charges and other assets, net, on the balance sheet. In conjunction with this transaction, on March 10, 2004, the Company received a consent from its Senior Credit Facility lenders to incur this additional indebtedness.

On March 9, 2004, the Company received a waiver of and amended certain of its financial covenants under the Senior Credit Facility to reflect the financial impact of the 2003 Telstar 4 satellite disruption as well as the disposition of the closed circuit television product line (“CCTV”) (See Note 13 for more disclosure on this disposition). In conjunction with the amendment, the Company incurred $0.1 million in fees. These fees are included within Deferred charges and other assets, net on the balance sheet.

As of September 30, 2004, the Company had $30.0 million outstanding under its revolver and $1.7 million outstanding letters of credit.

The Senior Credit Facility, as amended, contains restrictive covenants including the maintenance of interest, total leverage, and fixed charge ratios and various other restrictive covenants, which are customary for such facilities. In addition, the Company is generally prohibited from incurring additional indebtedness, incurring liens, paying dividends or making other restricted payments, consummating asset sales, entering into transactions with affiliates, merging or consolidating with any other person or selling, assigning, transferring, leasing, conveying, or otherwise disposing of assets. Additionally, the Senior Credit Facility contains default provisions that are customary for such facilities including those provisions that are subjective in nature. Absent the waiver and amendment obtained on November 9, 2004, the Company would have been in violation of its financial covenants as of September 30, 2004.

Indebtedness under the revolver bears interest at a per annum rate equal to the Company’s choice of (i) Base Rate (which is the highest of prime rate and the Federal Funds Rate plus .5%) plus a margin ranging from 2.00% to 2.75% or (ii) the offered rates for Eurodollar deposits (“LIBOR”) of one, two, three, six, nine, or twelve months, as selected by the Company, plus a margin ranging from 3.25% to 4.00%. The margins are subject to adjustment based on changes in the Company’s ratio of consolidated total debt to EBITDA (i.e., earnings before interest, taxes, depreciation and amortization and certain other charges as

8

MUZAK HOLDINGS LLC

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

defined in the agreement) and were 2.75% and 4.00% in the case of Base Rate and LIBOR, respectively as of September 30, 2004. As of September 30, 2004, the average interest rate on the revolver was 5.72%. Indebtedness under the Term Loan B bears interest at a per annum rate equal to the Company’s choice of (i) the Base Rate (as described above) plus a margin of 3.25% or (ii) LIBOR of one, two, three, six, nine, or twelve months, as selected by the Company, plus a margin of 4.25%. As of September 30, 2004, the interest rate on the Term Loan B was 5.21%.

Senior Notes

Muzak LLC together with its wholly owned subsidiary, Muzak Finance Corp., has $220.0 million in principal amount of 10% Senior Notes (“Senior Notes”) which mature on February 15, 2009. Interest is payable semi-annually, in arrears, on May 15 and November 15 of each year. The Senior Notes are general unsecured obligations of Muzak LLC and Muzak Finance Corp. and are subordinate to existing and future secured debt and are senior to Muzak LLC’s existing Senior Subordinated Notes. The Senior Notes are guaranteed by the Company and certain of the Company’s direct and indirect subsidiaries (See Note 12). The indenture governing the Senior Notes prohibits the Company from making certain payments such as dividends and distributions of capital stock; repurchases or redemptions of capital stock, and investments (other than permitted investments) unless certain conditions are met by the Company. After February 15, 2006, the issuers may redeem all or part of the Senior Notes at a redemption price equal to 105.0% of the principal which redemption price declines to 100% of the principal amount in 2008. The Company is in default of consolidated leverage ratio under the indenture governing the Senior Notes as of September 30, 2004. However, the Company may incur permitted indebtedness as defined in the indenture governing the Senior Notes, which includes borrowings under its revolving loan. The Company expects to be in compliance with consolidated leverage ratio in the fourth quarter of 2004.

Senior Subordinated Notes

Muzak LLC together with its wholly owned subsidiary, Muzak Finance Corp., has $115.0 million in principal amount of 9 ⁷/8% Senior Subordinated Notes (“Senior Subordinated Notes”) which mature on March 15, 2009. Interest is payable semi-annually, in arrears, on March 15 and September 15 of each year. The Senior Subordinated Notes are general unsecured obligations of the Muzak LLC and Muzak Finance Corp and are subordinated in right of payment to all existing and future Senior Indebtedness of Muzak LLC and Muzak Finance Corp. The Senior Subordinated Notes are guaranteed by the Company and certain of the Company’s direct and indirect subsidiaries (See Note 12). The indenture governing the Senior Subordinated Notes prohibits Muzak LLC from making certain payments such as dividends and distributions of their capital stock; repurchases or redemptions of their capital stock, and investments (other than permitted investments) unless certain conditions are met by Muzak LLC. As of March 15, 2004, the issuers may redeem all or part of the Notes at a redemption price equal to 104.938% of the principal which redemption price declines to 100% of the principal amount in 2007. The Company is in default of consolidated leverage ratio under the indenture governing the Senior Subordinated Notes as of September 30, 2004. However, the Company may incur permitted indebtedness, as defined in the indenture governing the Senior Subordinated Notes, which includes borrowings under its revolving loan. The Company expects to be in compliance with consolidated leverage ratio in the fourth quarter of 2004.

Senior Discount Notes

The Company together with its wholly owned subsidiary Muzak Holdings Finance Corp. has $24.2 million in principal amount of 13% Senior Discount Notes (the “Senior Discount Notes”) due March 2010. The Senior Discount Notes were fully accreted as of March 15, 2004 and the first interest payment was made on September 15, 2004. From and after March 15, 2004, interest began accruing at a rate of 13% per annum. Interest is payable semi-annually in arrears on each March 15 and September 15 to holders of record of the Senior Discount Notes at the close of business on the immediately preceding March 1 and September 1. Muzak Holdings LLC does not have any operations or assets other than its ownership of Muzak LLC. Accordingly, Muzak Holdings LLC is dependent upon distributions from Muzak LLC in order to pay interest. Muzak LLC’s senior credit facility, senior notes, and senior subordinated notes indentures impose restrictions on its ability to make distributions to Muzak Holdings LLC. The senior credit facility, the senior notes, and subordinated notes indentures permit Muzak LLC to make payments and distributions to Muzak Holdings LLC on and after September 15, 2004 in an amount sufficient to permit Muzak Holdings LLC to make cash interest payments when due, however the senior credit facility requires that certain financial covenant levels be met in order to make such distributions.

The proceeds of the term loan in May 2004 were used to repurchase $32.7 million in aggregate outstanding principal amount of the Company’s 13% Senior Discount Notes due 2010 and to pay associated interest and expenses. The Company recorded a loss on extinguishment of debt of $1.7 million in connection with this transaction. The loss on extinguishment of debt is comprised of $1.0 million premium paid on the repurchase and $0.7 million write off of deferred financing fees.

Other Debt

Muzak LLC assumed $2.4 million of promissory notes in connection with an acquisition in 1999. All of the notes, with the exception of one, aggregating $1.8 million, bear interest at 9.9% and mature in November 2016. Muzak LLC is required to make interest only payments on a monthly basis through October 2006, and principal and interest payments for the remainder of the term. The note terms are the same for all but one of the notes. This note bears interest at 8% with principal and interest payments due monthly until maturity in October 2006.

9

MUZAK HOLDINGS LLC

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Liquidity

During 2004, we expect that our primary source of funds will be cash flows from operations and our secondary source to be from borrowings under the senior credit facility. As of September 30, 2004, we had outstanding debt of $30.0 million under our $55.0 million senior credit facility, as amended. As of the date of this filing, we have full availability to the undrawn revolving commitment. Availability under our senior credit facility is subject to achieving a leverage ratio less than the leverage financial covenant established for the applicable quarter.

Based upon current and anticipated levels of operations, we believe that our cash flows from operations, combined with availability under the senior credit facility, will be adequate to meet our liquidity needs for at least the next twelve months. Our future performance is subject to industry based factors such as the level of competition in the business music industry, competitive pricing, concentrations in and dependence on satellite delivery capabilities, rapid technological changes, the impact of legislation and regulation, our dependence on license agreements and other factors that are beyond our control.

Annual Maturities

Annual maturities of long-term debt obligations are as follows (in thousands):

2004 (remaining three months)	$	24
2005		101
2006		110
2007		65,118
2008		131
Thereafter	$	360,751

The Annual maturities schedule includes the principal amount of the Senior Notes which mature in 2009.

Total interest paid by the Company on all indebtedness was $8.3 million and $26.7 million for the quarter and nine months ended September 30, 2004, respectively, and was $6.1 million and $16.3 million for the quarter and nine months ended September 30, 2003, respectively.

Interest Rate Protection Programs

In August 2003, the Company entered into an interest rate swap agreement in which the Company effectively exchanged $220.0 million of fixed rate debt at 10.0% for six month LIBOR plus 7.95%. The swap agreement, entered into to mitigate our interest costs associated with the Senior Notes, covers an eighteen month period ending November 2004. In accordance with Statement of Financial Accounting Standard No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (“SFAS 133”), the swap agreement is recorded at its fair value of $8 thousand in the consolidated balance sheet as of September 30, 2004 and included in prepaid expenses and other assets. The Company has fixed the rate for the November 2004 payment date such that the Company will receive $8 thousand on November 15, 2004. Because the swap agreement is not designated as a hedge under SFAS 133, changes in fair value of the swap have been recorded as an adjustment to interest expense during the nine months ended September 30, 2004, resulting in a $0.4 million reduction to interest expense.

7. Mandatorily Redeemable Preferred Units

The Company was in violation of unit coverage ratio and leverage ratio under the Securities Purchase Agreement as of September 30, 2004 and has been in default of unit coverage ratio since June 2003 and in default of leverage ratio since December 2003. As a result of the default, the preferred units accrue at a preferential return of 17% per annum as long as the default is continuing. The Company is projecting to be out of compliance with the unit coverage ratio (the ratio of consolidated operating cash flow to the sum of consolidated interest expense plus the aggregate Series A preferred return, as more specifically defined in the Securities Purchase Agreement) for the foreseeable future and to be out of compliance with leverage ratio for the next twelve months. As a result of non-compliance with unit coverage ratio and leverage ratio for four consecutive quarters (a Class B default and a Class A default under the Securities Purchase Agreement, respectively), two of the three preferred unit holders were each entitled to be designated as either a Class B or Class A Director, although neither party has elected to so designate a Class B or Class A Director. As such, the number of Class B Directors and Class A Directors remains unchanged at six and three directors, respectively. The same two preferred unit holders will each be entitled to designate a Class A Director until such time as the Company complies with the leverage coverage ratio. If the Company is still in default of unit coverage ratio at the time that the Company complies with the leverage coverage ratio, the same two preferred unit holders would each still be entitled to designate a Class B Director.

10

MUZAK HOLDINGS LLC

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The foregoing defaults do not result in a cross default under the Senior Credit Facility or the indentures governing the Senior Notes, the Senior Subordinated Notes, and the Senior Discount Notes.

8. Related Party Transactions

During the nine months ended September 30, 2004, the Company accrued $0.3 million of fees payable to ABRY Partners. These fees were incurred for services rendered in connection with the issuance of the Term Loan B.

During the nine months ended September 30, 2004, the Company repurchased an aggregate principal amount of $0.2 million of Senior Discount Notes from Mr. William A. Boyd, the Company’s Chairman Emeritus and a Director of the Board of Directors. The Company recorded a gain of $9 thousand on this transaction which is included within loss on extinguishment of debt.

9. Muzak Holdings Finance Corp. and Muzak Finance Corp.

Muzak Holdings Finance Corp. and Muzak Finance Corp. had no operating activities during the quarter and nine months ended September 30, 2004 and 2003.

10. Commitments and Contingencies

Indemnification

Muzak’s Limited Liability Company Agreement dated as of March 18, 1999, as amended, provides for indemnification of directors and officers, including advancement of reasonable attorney’s fees and other expenses, in connection with all claims, liabilities and expenses arising out of the management of Muzak’s affairs. Such indemnification obligations are limited to the extent Muzak’s assets are sufficient to cover such obligations. Muzak carries directors and officers insurance that covers such exposure for indemnification up to certain limits. As of September 30, 2004, we had accrued $50,000 to cover indemnification.

Litigation

The Company is involved in various claims and lawsuits arising out of the normal conduct of its business. Although the ultimate outcome of these legal proceedings cannot be predicted with certainty, the management of the Company believes that the resulting liability, if any, will not have a material effect upon the Company’s consolidated financial statements or liquidity.

The industry-wide agreement between business music providers and BMI expired in December 1993. Since this time we have been operating under an interim agreement pursuant to which we have continued to pay royalties at the 1993 rates. Business music providers and BMI have been attempting to negotiate the terms of a new agreement and we have been involved in a rate court proceeding, initiated by BMI in Federal Court in New York regarding music license fees payable to BMI. The Company and BMI have advanced their conversations toward reaching a new five-year music license agreement, culminating in a recent agreement in principle. The Company anticipates that a final license agreement will be executed prior to the end of the fourth quarter of 2004 and that such agreement will result in higher license fees to BMI than we have incurred in the past.

The industry-wide agreement between business music providers and ASCAP expired in May 1999. The Company began negotiations with ASCAP in June 1999, and has continued to pay ASCAP royalties at the 1999 rates. The agreement between business music providers and ASCAP allowed either party to pursue a rate court proceeding in federal court in New York to seek a court determined reasonable rate if a mutually acceptable rate was not obtained by November 29, 2002. ASCAP notified the Company that it would pursue such rate court proceeding and on January 29, 2003 made an application to the court to commence such a proceeding. Discovery in the proceeding has commenced and is not yet completed. The Company cannot predict what the terms of the new ASCAP agreement with business music providers will be or when agreements will be reached.

In the quarter and nine months ended September 30, 2004, the Company paid $3.0 million and $8.3 million, respectively, in royalties to ASCAP, BMI and to SESAC. In the quarter and nine months ended September 30, 2003, the Company paid $2.2 million and $6.6 million, respectively in royalties to ASCAP, BMI, and to SESAC. Increases in the fees we must pay under these agreements could adversely affect our operating margin, and, therefore, our results of operations. The Company has not accrued any material amounts in connection with potential retroactive rate increases.

In October 1998, the Digital Millennium Copyright Act was enacted. The Act provides for a statutory license from the copyright owners of master recordings to make and use ephemeral copies of such recordings. Ephemeral copies refer to temporary copies of master sound recordings made to enable or facilitate the digital transmission of such recordings. The Digital Millennium Copyright Act did not specify the rate and terms of the license. As a result, the United States Copyright Office convened a Copyright Arbitration Royalty Panel to recommend an ephemeral royalty rate. In February 2002, the Panel recommended an ephemeral royalty rate of ten percent (10%) of gross proceeds applicable to the use of ephemeral copies. That recommendation was subject to review by the Librarian of Congress, who could have modified or adopted such recommendation.

11

MUZAK HOLDINGS LLC

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

In June 2002, the Librarian of Congress published his final decision to adopt the Copyright Arbitration Royalty Panel’s recommendation of a ten percent (10%) ephemeral royalty rate, which covers the period from October 1998 through December 31, 2002. As required by such determination, we accrued the royalties owed and remitted payment on October 20, 2002 for royalties payable. The United States Copyright Office is in the process of extending the foregoing ten percent (10%) ephemeral royalty rate to cover the period January 1, 2003 through December 31, 2004.

With respect to future revenue subject to such ephemeral royalty rate, we believe our exposure is minimal, as the Company believes its current satellite technologies do not require use of ephemeral copies. Nonetheless, there can be no assurances that the collective for the copyright owners will refrain from investigating or otherwise challenging the applicability of the statute to our satellite technologies.

During the quarter ended September 30, 2004, the Company increased its reserve for licensing royalties by $0.8 million.

Other Commitments

As of September 30, 2004, the Company has approximately $28.9 million in outstanding capital expenditure commitments covering a four-year period. The Company is the lessee under various operating and capital leases for equipment, vehicles, satellite capacity, and buildings.

11. Restructuring Charges

To reduce operating costs and gain efficiencies in resource utilization, the Company recently reorganized into five functional areas: Sales, Operations, Administration, Customer Service, and Product and Marketing. In conjunction with this realignment, the Company centralized the administrative function and certain aspects of operations at its home office. As a result, the Company recorded $0.1 million and $0.8 million of severance and related benefits in selling, general, and administrative expenses during the quarter and nine months ended September 30, 2004. Accordingly, the following table provides a summary of the accrued liability for severance charges (in thousands):

	Employee Severance
Q2 2004 Charges	$	694
Cash payments		(156	)
Accrued liability as of June 30, 2004	$	538
Q3 2004 Charges	$	107
Cash payments		(461	)
Accrued liability as of September 30, 2004	$	184

Employee severance-related costs include the elimination of administrative, sales, operations, and product fulfillment positions. The Company expects to pay the remaining liability in the fourth quarter of 2004.

12. Guarantors

The following schedules set forth condensed consolidating financial information as required by Rule 3-10 of Securities and Exchange Commission Regulation S-X for the quarter and nine months ended September 30, 2004 and 2003 for (1) Muzak Holdings, LLC, (2) Muzak LLC, a co-issuer of the Senior Notes and Senior Subordinated Notes, (3) Muzak Finance Corp., a co-issuer of the Senior Notes and Senior Subordinated Notes and a wholly-owned subsidiary of Muzak LLC, and (4) on a combined basis, the subsidiary guarantors of the Senior Notes and Senior Subordinated Notes which include MLP Environmental Music, LLC, Business Sound, Inc., BI Acquisition LLC, Audio Environments, Inc., Background Music Broadcasters, Inc., Muzak Capital Corporation, Telephone Audio Productions, Inc., Muzak Houston, Inc., Vortex Sound Communications Company, Inc., and Music Incorporated, and a subsidiary that is not a guarantor of the Senior Subordinated Notes. The guarantor subsidiaries are direct and indirect wholly-owned subsidiaries of Muzak Holdings, LLC and have fully and unconditionally, jointly and severally, guaranteed the Senior Notes and Senior Subordinated Notes of Muzak LLC and Muzak Finance Corp. Muzak Holdings, LLC has also fully and unconditionally, jointly and severally, guaranteed the Senior Notes and Senior Subordinated Notes. The subsidiary that does not guarantee the Senior Notes and Senior Subordinated Notes represents less than 3% of consolidated total assets, members’ interest, revenues, loss before income taxes and cash flow from operating activities. Therefore, the non-guarantor subsidiary information is not separately presented in the tables below but rather is included in the column labeled “Guarantor Subsidiaries”.

12

MUZAK HOLDINGS LLC

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

CONDENSED CONSOLIDATING BALANCE SHEETS AS OF SEPTEMBER 30, 2004

(unaudited) (In thousands)

	Muzak Holdings LLC (“Parent”)			Muzak LLC (Co-issuer)		Muzak Finance Corp (Co-issuer)			Guarantor Subsidiaries*		Eliminations			Consolidated
ASSETS
Current assets:
Cash	$	—		$	1,261	$	—		$	—	$	—		$	1,261
Accounts receivable, net		—			31,405		—			703		—			32,108
Inventories		—			17,849		—			—		—			17,849
Prepaid expenses and other assets		—			4,120		—			—		—			4,120
Total current assets		—			54,635		—			703		—			55,338
Property and equipment, net		—			102,679		—			359		—			103,038
Intangible assets, net		—			220,904		—			22,774		—			243,678
Deferred subscriber acquisition costs and other assets, net		477			60,439		7,236			8		(7,236	)		60,924
Advances to/from subsidiaries		—			—		—			2,347		(2,347	)		—
Investment in subsidiaries		15,640			21,368		—			—		(37,008	)		—
Total assets	$	16,117		$	460,025	$	7,236		$	26,191	$	(46,591	)	$	462,978
LIABILITIES AND MEMBERS’ INTEREST (DEFICIENCY)
Current liabilities:
Accounts payable	$	—		$	6,509	$	—		$	164	$	—		$	6,673
Accrued expenses		131			23,169		8,723			1,117		(8,723	)		24,417
Current portion of other liabilities		—			4,006		—			—		—			4,006
Current maturities of long term debt		—			—		—			99		—			99
Advanced billings		—			1,699		—			—		—			1,699
Total current liabilities		131			35,383		8,723			1,380		(8,723	)		36,894
Long-term debt		24,245			399,083		334,083			1,891		(334,083	)		425,219
Other liabilities		—			7,572		—			1,552		—			9,124
Advances to/from subsidiaries		—			2,347		—			—		(2,347	)		—
Mandatorily redeemable preferred units		148,479			—		—			—		—			148,479
Members’ interest (deficiency)		(156,738	)		15,640		(335,570	)		21,368		298,562			(156,738	)
Total liabilities and members’ interest (deficiency)	$	16,117		$	460,025	$	7,236		$	26,191	$	(46,591	)	$	462,978

* Also includes non-guarantor which is “minor” as defined by Rule 3-10 of Regulation S-X.

13

MUZAK HOLDINGS LLC

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2004

(unaudited) (In thousands)

	Muzak Holdings LLC (“Parent”)			Muzak LLC (Co-issuer)			Muzak Finance Corp (Co-issuer)			Guarantor Subsidiaries*			Eliminations		Consolidated
Revenues
Music and other business services	$	—		$	45,081		$	—		$	1,284		$	—	$	46,365
Equipment and related services		—			15,341			—			—			—		15,341
		—			60,422			—			1,284			—		61,706
Cost of Revenues
Music and other business services		—			8,955			—			432			—		9,387
Equipment and related services		—			14,457			—			—			—		14,457
		—			23,412			—			432			—		23,844
		—			37,010			—			852			—		37,862
Selling, general & administrative		—			21,827			—			291			—		22,118
Management Fee		—			(257	)		—			257			—		—
Depreciation & amortization expense		—			14,687			—			495			—		15,182
Income (Loss) from Operations		—			753			—			(191	)		—		562
Other income (expense)
Interest expense		(815	)		(10,131	)		(8,339	)		(28	)		8,339		(10,974	)
Other, net		—			33			—			5			—		38
Equity in earnings of subsidiaries		(17,842	)		(158	)		—			—			18,000		—
Loss before income taxes		(18,657	)		(9,503	)		(8,339	)		(214	)		26,339		(10,374	)
Income tax benefit		—			—			—			(56	)		—		(56	)
Net loss	$	(18,657	)	$	(9,503	)	$	(8,339	)	$	(158	)	$	26,339	$	(10,318	)

* Also includes non-guarantor which is “minor” as defined by Rule 3-10 of Regulation S-X.

14

MUZAK HOLDINGS LLC

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004

(unaudited) (In thousands)

	Muzak Holdings LLC (“Parent”)			Muzak LLC (Co-issuer)			Muzak Finance Corp (Co-issuer)			Guarantor Subsidiaries*			Eliminations		Consolidated
Revenues
Music and other business services	$	—		$	133,564		$	—		$	4,040		$	—	$	137,604
Equipment and related services		—			44,345			—			—			—		44,345
		—			177,909			—			4,040			—		181,949
Cost of Revenues
Music and other business services		—			25,158			—			1,389			—		26,547
Equipment and related services		—			39,815			—			—			—		39,815
		—			64,973			—			1,389			—		66,362
		—			112,936			—			2,651			—		115,587
Selling, general & administrative		—			63,932			—			744			—		64,676
Management Fee		—			(808	)		—			808			—		—
Depreciation & amortization expense		—			44,891			—			1,485			—		46,376
Income (Loss) from Operations		—			4,921			—			(386	)		—		4,535
Other income (expense)
Interest expense		(3,945	)		(28,828	)		(25,017	)		(147	)		25,017		(32,920	)
Other, net		—			39			—			1			—		40
Loss on extinguishment of debt		(1,663	)		—			—			—			—		(1,663	)
Equity in earnings of subsidiaries		(49,287	)		(402	)		—			—			49,689		—
Loss before income taxes		(54,895	)		(24,270	)		(25,017	)		(532	)		74,706		(30,008	)
Income tax benefit		—			—			—			(130	)		—		(130	)
Net loss	$	(54,895	)	$	(24,270	)	$	(25,017	)	$	(402	)	$	74,706	$	(29,878	)

* Also includes non-guarantor which is “minor” as defined by Rule 3-10 of Regulation S-X.

15

MUZAK HOLDINGS LLC

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004

(unaudited) (In thousands)

	Muzak Holdings LLC (“Parent”)			Muzak LLC (Co-issuer)			Muzak Finance Corp (Co-issuer)		Guarantor Subsidiaries*			Eliminations		Consolidated
CASH FLOWS FROM OPERATING ACTIVITIES:
Net cash provided by operating activities	$	131		$	18,422		$	—	$	1,159		$	—	$	19,712
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of fixed assets		—			91			—		—			—		91
Capital expenditures (for property, plant & equipment and intangibles)		—			(28,836	)		—		—			—		(28,836	)
Net cash used in investing activities		—			(28,745	)		—		—			—		(28,745	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Change in book overdrafts		—			(138	)		—		—			—		(138	)
Repurchase of senior discount notes		(33,670	)		—			—		—			—		(33,670	)
Borrowings under revolving credit loan		—			10,000			—		—			—		10,000
Proceeds from Term Loan B		—			35,000			—		—			—		35,000
Repayment of capital lease obligations and other debt		—			(2,043	)		—		(69	)		—		(2,112	)
Payment of financing fees		—			(1,070	)		—		—			—		(1,070	)
Advances to/from subsidiaries		33,539			(32,449	)		—		(1,090	)		—		—
Net cash provided by (used in) financing activities		(131	)		9,300			—		(1,159	)		—		8,010
NET DECREASE IN CASH		—			(1,023	)		—		—			—		(1,023	)
CASH, BEGINNING OF PERIOD		—			2,284			—		—			—		2,284
CASH, END OF PERIOD	$	—		$	1,261		$	—	$	—		$	—	$	1,261

* Also includes non-guarantor which is “minor” as defined by Rule 3-10 of Regulation S-X.

16

MUZAK HOLDINGS LLC

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

CONDENSED CONSOLIDATING BALANCE SHEETS AS OF DECEMBER 31, 2003

(In thousands)

	Muzak Holdings LLC (Parent)			Muzak LLC (Co- issuer)		Muzak Finance Corp (Co- issuer)			Combined Guarantor Subsidiaries*		Eliminations			Consolidated
ASSETS
Current assets:
Cash	$	—		$	2,284	$	—		$	—	$	—		$	2,284
Accounts receivable, net		—			28,568		—			1,011		—			29,579
Inventories		—			15,016		—			—		—			15,016
Prepaid expenses and other assets		—			3,974		—			—		—			3,974
Total current assets		—			49,842		—			1,011		—			50,853
Property and equipment, net		—			107,876		—			715		—			108,591
Intangible assets, net		—			230,032		—			23,902		—			253,934
Deferred subscriber acquisition costs and other assets, net		1,306			60,539		8,485			9		(8,485	)		61,854
Advances to/from subsidiaries		—					—			1,259		(1,259	)		—
Investment in subsidiaries		75,809			21,770		—			—		(97,579	)		—
Total assets	$	77,115		$	470,059	$	8,485		$	26,896	$	(107,323	)	$	475,232
LIABILITIES AND MEMBERS’ INTEREST (DEFICIENCY)
Current liabilities:
Accounts payable	$	—		$	6,281	$	—		$	247	$	—		$	6,528
Accrued expenses		—			20,240		6,062			1,071		(6,062	)		21,311
Current maturity of other liabilities		—			3,711		—			—		—			3,711
Current maturities of long term debt		—					—			94		—			94
Advance billings		—			1,084		—			—		—			1,084
Total current liabilities		—			31,316		6,062			1,412		(6,062	)		32,728
Long-term debt		55,496			353,962		333,962			1,966		(333,962	)		411,424
Other liabilities		—			7,713		—			1,748		—			9,461
Advances to/from subsidiaries		—			1,259		—					(1,259	)		—
Mandatorily redeemable preferred units		129,691			—		—			—		—			129,691
Members’ interest (deficiency)		(108,072	)		75,809		(331,539	)		21,770		233,960			(108,072	)
Total liabilities and members’ interest (deficiency)	$	77,115		$	470,059	$	8,485		$	26,896	$	(107,323	)	$	475,232

* Also includes non-guarantor which is “minor” as defined by Rule 3-10 of Regulation S-X.

17

MUZAK HOLDINGS LLC

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Condensed Consolidating Statements of Operations for the Three Months ended September 30, 2003

(unaudited) (In thousands)

	Muzak Holdings LLC (“Parent”)			Muzak LLC (Co-issuer)			Muzak Finance Corp (Co-issuer)			Guarantor Subsidiaries*			Eliminations		Consolidated
Revenues
Music and other business services	$	—		$	42,681		$	—		$	1,284		$	—	$	43,965
Equipment and related services		—			15,384			—			—			—		15,384
		—			58,065			—			1,284			—		59,349
Cost of Revenues
Music and other business services		—			7,757			—			416			—		8,173
Equipment and related services		—			12,100			—			—			—		12,100
		—			19,857			—			416			—		20,273
		—			38,208			—			868			—		39,076
Selling, general & administrative		—			19,747			—			291			—		20,038
Management Fee		—			(255	)		—			255			—		—
Depreciation & amortization expense		—			14,892			—			446			—		15,338
Loss from Operations		—			3,824			—			(124	)		—		3,700
Other income (expense)
Interest expense		(1,743	)		(8,506	)		(2,839	)		(53	)		2,839		(10,302	)
Other, net		—			36			—			—			—		36
Equity in earnings of subsidiary		(7,655	)		(170	)		—			—			7,825		—
Loss before income taxes		(9,398	)		(4,816	)		(2,839	)		(177	)		10,664		(6,566	)
Income tax benefit		—			—			—			(7	)		—		(7	)
Net loss	$	(9,398	)	$	(4,816	)	$	(2,839	)	$	(170	)	$	10,664	$	(6,559	)

* Includes a non-guarantor subsidiary which is considered to be “minor” as defined by Rule 3-10 of regulation S-X

18

MUZAK HOLDINGS LLC

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Condensed Consolidating Statements of Operations for the Nine Months ended September 30, 2003

(unaudited) (In thousands)

	Muzak Holdings LLC (“Parent”)			Muzak LLC (Co-issuer)			Muzak Finance Corp (Co-issuer)			Guarantor Subsidiaries*			Eliminations		Consolidated
Revenues
Music and other business services	$	—		$	125,487		$	—		$	4,508		$	—	$	129,995
Equipment and related services		—			43,627			—			—			—		43,627
		—			169,114			—			4,508			—		173,622
Cost of Revenues
Music and other business services		—			22,359			—			1,534			—		23,893
Equipment and related services		—			35,355			—			—			—		35,355
		—			57,714			—			1,534			—		59,248
		—			111,400			—			2,974			—		114,374
Selling, general & administrative		—			58,949			—			1,009			—		59,958
Management Fee		—			(900	)		—			900			—		—
Depreciation & amortization expense		—			45,855			—			1,921			—		47,776
Loss from Operations		—			7,496			—			(856	)		—		6,640
Other income (expense)
Interest expense		(5,837	)		(22,768	)		(8,517	)		(161	)		8,517		(28,766	)
Other, net		—			131			—			—			—		131
Extraordinary Loss		1,384			(5,078	)		—			—			—		(3,694	)
Equity in earnings of subsidiaries		(29,699	)		(963	)		—			—			30,662		—
Loss before income taxes		(34,152	)		(21,182	)		(8,517	)		(1,017	)		39,179		(25,689	)
Income tax benefit		—			—			—			(54	)		—		(54	)
Net loss	$	(34,152	)	$	(21,182	)	$	(8,517	)	$	(963	)	$	39,179	$	(25,635	)

* Includes a non-guarantor subsidiary which is considered to be “minor” as defined by Rule 3-10 of regulation S-X

19

MUZAK HOLDINGS LLC

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Condensed Consolidating Statements of Cash Flows for the Nine Months ended September 30, 2003

(unaudited) (In thousands)

	Muzak Holdings LLC (“Parent”)			Muzak LLC (Co-issuer)			Muzak Finance Corp (Co-issuer)		Guarantor Subsidiaries*			Eliminations		Consolidated
CASH FLOWS FROM OPERATING ACTIVITIES:
Net cash provided by operating activities	$	—		$	22,515		$	—	$	1,325		$	—	$	23,840
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of other business, net of cash acquired		—			—			—		—			—		—
Proceeds from sale of fixed assets		—			50			—		—			—		50
Capital expenditures (for property, plant & equipment and intangibles)		—			(31,518	)		—		—			—		(31,518	)
Net cash used in investing activities		—			(31,468	)		—		—			—		(31,468	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Change in book overdrafts		—			(2,459	)		—		—			—		(2,459	)
Proceeds from Senior note offering		—			218,869			—		—			—		218,869
Paydown of senior credit facility		—			(159,514	)		—		—			—		(159,514	)
Paydown of senior discount notes		(14,440	)		—			—		—			—		(14,440	)
Repayments under revolving credit loan		—			(31,000	)		—		—			—		(31,000	)
Borrowings under revolving credit loan		—			4,700			—		—			—		4,700
Borrowings under new revolving credit loan		—			12,700			—		—			—		12,700
Repayment on note payable to related party		—			(10,000	)		—		—			—		(10,000	)
Proceeds from sale of interest rate protection agreement		—			4			—		—			—		4
Repayments of capital lease obligations and other debt		—			(1,638	)		—		(64	)		—		(1,702	)
Payment of financing fees		—			(8,918	)		—		—			—		(8,918	)
Advances to/from subsidiaries		14,440			(13,179	)		—		(1,261	)		—		—
Net cash provided by/(used in) financing activities		—			9,565			—		(1,325	)		—		8,240
NET INCREASE IN CASH		—			612			—		—			—		612
CASH, BEGINNING OF PERIOD		—			1,781			—		—			—		1,781
CASH, END OF PERIOD	$	—		$	2,393		$	—	$	—		$	—	$	2,393

* Includes a non-guarantor subsidiary which is considered to be “minor” as defined by Rule 3-10 of Regulation S-X

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MUZAK HOLDINGS LLC

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)

13. Closed Circuit Television Systems Disposition

During 2003, the Company sold, installed, and maintained a closed circuit television systems product line. The Company made the decision to focus on this product line in late 2002 and made an investment in sales, administrative, and operational resources to support its growth. Significant resources would have continued to be required to address the ever increasing sophistication and complexity of technology and related product offerings in the CCTV marketplace. In light of the anticipated demands and complexities of this product line, we made a strategic decision to reallocate our capital resources and management efforts to our core products and services and exit the CCTV product line in late 2003. On February 25, 2004, we obtained a Consent and Waiver for the disposition of our CCTV product line from the existing lenders of the Senior Credit Facility and on March 1, 2004, sold the related inventory and recurring customer contracts to a third party for $2.0 million in notes receivable. As of the date of this filing, the purchaser is in default of scheduled payments totaling $1.0 million. Due to the continuing default in payments during the third quarter, the Company determined that the receivable was impaired and recorded a $0.6 million impairment charge to properly reflect the receivable at its estimated fair market value as of September 30, 2004. In addition, the Company and the purchaser are discussing revising the terms of the payment schedule of the notes. In conjunction with the sale, the Company disposed of inventory totaling $0.9 million, accounts receivable of $0.2 million, and other assets and liabilities relating to the CCTV product line of $0.9 million, net. The Company did not record a gain or loss on the original transaction.

14. Recent Accounting Pronouncements

In January 2003 the FASB issued FASB Interpretation (“FIN”) No. 46, Consolidation of Variable Interest Entities. In December 2003, the FASB issued FIN No. 46 (Revised) (“FIN 46-R”) to address certain FIN 46 implementation issues. This interpretation clarifies the application of Accounting Research Bulletin (“ARB”) No. 51, Consolidated Financial Statements for companies that have interests in entities that are Variable Interest Entities (VIE) as defined under FIN 46. According to this interpretation, if a company has an interest in a VIE and is at risk for a majority of the VIE’s expected losses or receives a majority of the VIE’s expected gains it shall consolidate the VIE. FIN 46-R also requires additional disclosures by primary beneficiaries and other significant variable interest holders. This interpretation was effective no later than the end of the first interim or reporting period ending after March 15, 2004. We have assessed all of the criteria established in FIN 46-R to determine if our franchisee relationships qualify as a variable interest entities, and thus would need to be consolidated. We have concluded that our franchisee relationships do not qualify as variable interest entities, and therefore, the adoption of the provisions of this interpretation did not have a material effect on the Company’s Consolidated Financial Statements.

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MUZAK HOLDINGS LLC

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Form 10-Q includes forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Some of these statements can be identified by terms and phrases such as “anticipate”, “believe”, “intend”, “expect”, “could”, “may”, “will” and similar expressions and include references to assumptions that the Company believes are reasonable and relate to our future prospects, developments and business strategies. Forward-looking statements involve risks and uncertainties, including, but not limited to those related to the Company’s substantial leverage and debt service requirements, restrictions imposed by the terms of the Company’s indebtedness, the Company’s history of net losses, the Company’s dependence on satellite delivery of its products, the Company’s ability to integrate acquisitions, future capital requirements, the impact of competition and technological change, the availability of cost-effective programming, the impact of legislation and regulation, risks associated with the effect of general economic conditions and the other factors discussed in the Company’s filings with the Securities and Exchange Commission. Actual results could differ materially from these forward-looking statements. The Company undertakes no obligation to update these forward-looking statements.

Recent Developments

On November 9, 2004, the Company amended the following aspects of its Senior Credit Facility: (i) amended financial covenants for the third quarter of 2004 and prospectively to make such covenants less restrictive (ii) revised the maturity dates of the revolver and its $35.0 million term loan facility (“Term Loan B”) to May 2007 and November 2007, respectively, (iii) increased Term Loan B margins to 4.25% in the case of Eurodollar loans and 3.25% in the case of Base Rate Loans (iv) amended the definition of consolidated EBITDA to exclude up to $1.9 million in restructuring charges, and (v) reduced the revolving commitment from $60.0 million to $55.0 million. In connection with this amendment, we expect to incur financing fees of approximately $0.2 million.

During the third quarter we reorganized the Company into five functional areas: Sales, Operations, Administration, Customer Service, and Product and Marketing. Under Financial Accounting Standard Board’s (“FASB”) Statement of Financial Accounting Standard No. 131, “Disclosures about Segments of an Enterprise and Related Information,” the Company will continue to report one operating segment. In conjunction with this realignment, effective August 2, 2004, the Company completed the centralization of the administrative function and certain aspects of operations, such as purchasing and scheduling, at the home office. The Company estimates total charges of $1.9 million associated with severance and other termination benefits, relocation costs, duplicate salaries, and facility requirements. In accordance with generally accepted accounting principles (“GAAP”), $0.8 million and $0.9 million were recorded in the quarters ended June 30, 2004 and September 30, 2004, respectively. These charges are included within selling, general, and administrative expenses. We have recently made certain modifications to the reorganization plan to ensure that we can achieve efficiencies in each of the primary functions. Although synergies and cost savings of approximately $1.8 million to $2.5 million are expected on an annualized basis, these modifications and an increase in overtime during this transitional period have delayed the realization of the projected savings.

In August 2004, the Company and Broadcast Music, Inc. (“BMI”) advanced their conversations toward reaching a new five-year music license agreement, culminating in a recent agreement in principle. The Company anticipates that a final license agreement will be executed prior to the end of the fourth quarter of 2004 and that such agreement will result in higher license fees to BMI than we have incurred in the past.

On May 10, 2004, we amended our Senior Credit Facility to include a $35.0 million term loan facility. The proceeds of the term loan were used to repurchase $32.7 million in aggregate outstanding principal amount of the Company’s 13% Senior Discount Notes due 2010 and to pay associated expenses. The Term loan facility ranks pari passu with the Company’s existing revolving loan and will mature on November 21, 2007.

On April 30, 2004, Julianna Hill and Randall Mays, both of Clear Channel Communications Inc., stepped down as Class B Directors of the Company. Ms. Hill and Mr. Mays will continue to participate in discussions as guests of the Board of Directors.

Effective April 19, 2004, Lon Otremba has been named Chief Executive Officer. Mr. Otremba joined Muzak in September of 2003 as President and will continue to serve in this capacity in addition to his new role as Chief Executive Officer.

Effective March 15, 2004, Mr. Bill Boyd stepped down as Chief Executive Officer of Muzak and will serve as the Company’s Chairman Emeritus. This role will include serving on the board of directors of the Company, along with rendering certain executive services including managing relationships within the franchise community, certain client accounts, and other external business relationships.

On March 10, 2004, the Company received a consent from its Senior Credit Facility lenders to incur additional indebtedness under a term loan, the proceeds of which were used to repurchase a portion of the Company’s 13% Senior Discount Notes.

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MUZAK HOLDINGS LLC

On March 9, 2004, the Company received a waiver of and amended certain of its financial covenants under the Senior Credit Facility.

On February 25, 2004, the Company obtained a consent and waiver for the disposition of its CCTV inventory and recurring customer contracts from the existing lenders of the Senior Credit Facility.

Recent Accounting Pronouncements

In January 2003 the FASB issued FASB Interpretation (“FIN”) No. 46, Consolidation of Variable Interest Entities. In December 2003, the FASB issued FIN No. 46 (Revised) (“FIN 46-R”) to address certain FIN 46 implementation issues. This interpretation clarifies the application of Accounting Research Bulletin (“ARB”) No. 51, Consolidated Financial Statements for companies that have interests in entities that are Variable Interest Entities (VIE) as defined under FIN 46. According to this interpretation, if a company has an interest in a VIE and is at risk for a majority of the VIE’s expected losses or receives a majority of the VIE’s expected gains it shall consolidate the VIE. FIN 46-R also requires additional disclosures by primary beneficiaries and other significant variable interest holders. This interpretation was effective no later than the end of the first interim or reporting period ending after March 15, 2004. We have assessed all of the criteria established in FIN 46-R to determine if our franchisee relationships qualify as a variable interest entities, and thus would need to be consolidated. We have concluded that our franchisee relationships do not qualify as variable interest entities, and therefore, the adoption of the provisions of this interpretation did not have a material effect on the Company’s Consolidated Financial Statements.

General

The Company is the leading provider of business music programming in the United States based on market share. We believe that, together with our franchisees, we have a market share of approximately 60% of the estimated number of U.S. business locations currently subscribing to business music programming.

Results of Operations

Set forth below are discussions of the results of operations for Muzak Holdings LLC for the quarter and nine months ended September 30, 2004 compared to the quarter and nine months ended September 30, 2003.

Revenues.Revenues were $61.7 million and $181.9 million for the quarter and nine months ended September 30, 2004 and were $59.3 million and $173.6 million for the quarter and nine months ended September 30, 2003, respectively. These increases in revenues represent increases of 4.0% and 4.8% for the quarter and nine months ended September 30, 2004 compared to the 2003 periods. Music and other business services revenue increased $2.4 million, or 5.5% in 2004 as compared to the quarter ended September 30, 2003 and increased 5.9% for the nine month period as compared to 2003. The growth in music and other business services revenue is due to an increase in new client locations at consistent prices, offset by a 10.2% cancellation rate during the nine months ended September 30, 2004. During the twelve months ended September 30, 2004, we added, net of cancellations, 6,500 Audio Architecture, 5,000 Voice, and 500 other locations. The number of new client locations added during the third quarter was negatively impacted by the centralization of the scheduling function and the resulting learning curve for the new employees performing this function. The third quarter and nine month cancellation rate is consistent with the prior year cancellation rate.

Equipment and related services revenue was flat for the quarter ended September 30, 2004 as compared to the 2003 period and up 1.6% on a year on year basis. The flat equipment and labor revenue for the quarter and the marginally higher equipment and labor revenue for the nine months as compared to the prior year was expected due to the sale of our CCTV product line on March 1, 2004. We did not record any equipment and labor revenues from this product line during 2004. As such, the increase of 1.6% is solely from the sale of system related products, such as sound systems, that support our core products as well as non-music related equipment, such as drive-thru systems.

Cost of Revenues.Cost of revenues was $23.8 million and $66.4 million for the quarter and nine months ended September 30, 2004, respectively, and was $20.3 million and $59.2 million for the quarter and nine months ended September 30, 2003, respectively. The increase in cost of revenues was 17.6% and 12.0% for the quarter and nine months ended September 30, 2004 as compared to the 2003 comparable periods. Costs of music and other business services revenue as a percentage of music and other business services revenue was 20.2% and 19.3% for the quarter and nine months ended September 30, 2004 and was 18.6% and 18.4% for the quarter and nine months ended September 30, 2003. In light of the current status with the performing rights societies, the Company increased its reserve for licensing royalties by $0.8 million during the third quarter of 2004. Excluding this increase of $0.8 million in reserves for licensing royalties in the third quarter of 2004, costs of music and other business service revenue as a percentage of music and other business services revenue was 18.6% and 18.7% for the quarter and nine months ended September 30, 2004. The remaining increase of 0.1% or $0.4 million in cost of music revenue is primarily due to an increase in amounts owed to licensing collectives and record companies as a result of more clients opting to receive our service via an on-premise device as well as to an increase in amounts payable for licensing royalties based on a detailed review of the amounts owed to the licensing collectives conducted in late 2003.

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MUZAK HOLDINGS LLC

Costs of equipment and related services revenue as a percentage of equipment and related services revenue was 94.2% and 89.8% for the quarter and nine months ended September 30, 2004 and was 78.7% and 81.0% for the quarter and nine months ended September 30, 2003, respectively. The increase in costs as a percentage of revenues for the nine month period is comprised as follows: (i) 2.5% is due to lower new client installations resulting in excess installation labor capacity base (ii) 2.1% is due to equipment sales at lower margins (iii) 3.5% is attributable to higher salaries and related benefits for our technicians and (iv) 0.7% is due to increases in the cost of gasoline. The third quarter degradation as compared to 2003 is largely due to the same factors as for the nine month period. However, the reduction in new client locations due to implementation challenges associated with the centralization of the scheduling function and the learning curve for the new employees performing this function was primarily in the third quarter. The lower equipment margin is due to the sale of the music receiving equipment that we typically provide as part of the music service. Although these sales were at lower profit margins, we secured numerous client locations for our recurring revenue service. In addition, a larger portion of our overall equipment sales was comprised of the sale of drive-thru systems to the quick service restaurant industry during 2004, which carry lower margins than our typical equipment sales. We have approximately 400 technicians, who travel throughout the day to client locations, and therefore gasoline increases have impacted the costs associated with installations and service calls. Lastly, the third quarter and nine months of 2003 include a credit for an insurance receivable of $0.9 million to offset costs incurred to repoint satellite dishes as a result of the Telestar IV satellite failure on September 19, 2003.

Selling, general and administrative expenses. Selling, general, and administrative expenses were $22.1 million and $64.7 million for the quarter and nine months ended September 30, 2004 and were $20.0 million and $60.0 million for the quarter and nine months ended September 30, 2003. Amortization of deferred subscriber acquisition costs, a non-cash component of selling, general, and administrative expenses increased $0.2 million and $1.3 million for the quarter and nine months ended September 30, 2004 as compared to the 2003 periods. This increase is directly related to the increase in music and other business services revenue. The remaining increases of $1.9 million and $3.4 million for the quarter and nine months is due primarily to costs associated with the Company’s reorganization and an impairment of a receivable. Included within selling, general and administrative expenses in the quarter and nine months are $0.9 million and $1.7 million, respectively, of severance and related benefits associated with our centralization efforts. On March 1, 2004, the Company sold the inventory and recurring customer contracts of its CCTV product line to a third party for $2.0 million in notes receivable. Due to the continuing default in payments during the third quarter, the Company determined that the receivable was impaired and recorded a $0.6 million impairment charge in the third quarter of 2004 to properly reflect the receivable as at its estimated fair market value as of September 30, 2004. The remaining increase is due to higher bad debt expense, professional fees, insurance premiums and our investment in sales automation tools. Due to the centralization of all administrative functions and the learning curve of new employees performing the billing and collection functions, we have experienced a 1% increase in bad debt expense as a percentage of revenues in 2004 as compared to 2003. These increases are offset by reductions in sales and administrative workforces during the fourth quarter of 2003 of approximately $2.5 million on an annualized basis.

Depreciation and amortization expenses. Depreciation and amortization expense was $15.2 million and $46.4 million for the quarter and nine months ended September 30, 2004 and was $15.4 million and $47.8 million for the quarter and nine months ended September 30, 2003. The decrease of $0.3 million for the quarter ended September 30, 2004 over the 2003 period is comprised of a $0.7 million increase in depreciation of fixed assets and a $1.0 million decrease in amortization of intangibles. The increase in depreciation is due to capital expenditures relating to new client locations and the decrease in amortization is due to several trademarks and non-compete agreements becoming fully amortized during the period beginning July 2003 through September 2004. The $1.5 million decrease in depreciation and amortization for the nine months ended September 30, 2004 as compared to the 2003 period is comprised of an increase of $0.9 million in depreciation and a $2.4 million decrease in amortization. The $2.4 million decrease in amortization is due to several trademarks and non-compete agreements becoming fully amortized.

Interest expense.Interest expense increased 6.5% and 14.4% for the quarter and nine months ended September 30, 2004 as compared to the 2003 periods. The nine month increase is due to the issuance of our 10% Senior Notes and repayment of our Old Senior Credit Facility in May 2003. The Old Senior Credit Facility bore interest rates at the Company’s choice of LIBOR or the Base Rate plus a margin, based on the Company’s leverage ratio. The third quarter of 2004 increase as compared to the 2003 period is due to higher overall indebtedness. The effective interest rate for the quarter and nine months ended September 30, 2004 was 9.7% and 9.6%, respectively, and was 9.8% and 9.1% for the quarter and nine months ended September 30, 2003, respectively. In May 2004, the Company issued $35.0 million in term loans and used the proceeds to repurchase $32.7 million in aggregate principal amount of the Company’s 13% Senior Discount Notes. The exchange of 13% debt for LIBOR plus 4.25% debt will result in a reduction to interest expense of approximately $2.0 million per annum.

Loss on extinguishment of debt. The $1.7 million loss on extinguishment of debt for the 2004 periods is due to the repurchase of $32.7 million in aggregate principal amount of the Company’s 13% Senior Discount notes at a premium of $1.0

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MUZAK HOLDINGS LLC

million and the write off of related deferred financing fees. The $3.7 million loss on extinguishment of debt for the 2003 periods was recorded in connection with the issuance of 10% Senior Notes due 2009 and is comprised of a $5.2 million write off of deferred financing fees related to the then existing Senior Credit Facility, $0.4 million reclassification of other comprehensive loss to earnings, offset by a $1.9 million gain on the repurchase of $18.1 million principal amount of Senior Discount Notes.

Net Loss.Net loss increased 57.3% and 16.6% for the quarter and nine months ended September 30, 2004, respectively, as compared to the 2003 periods due to the reasons cited above.

Liquidity and Capital Resources

The Company evaluates liquidity using several measures, one of them being EBITDA (defined as earnings before interest, income taxes (benefits), depreciation, and amortization). EBITDA is not intended to be a liquidity measure that should be regarded as an alternative to, or more meaningful than, cash flow from operations as a measure of liquidity, as determined in accordance with generally accepted accounting principles, known as GAAP. However, management believes that EBITDA is a meaningful measure of the cash flows available to invest in new client locations and to service its debt obligations. Further, management believes that EBITDA is commonly used in similar industries to analyze and compare companies on the basis of leverage and liquidity; however it is not necessarily comparable to similarly titled amounts of other companies. The following table provides a reconciliation of cash flows from operations to EBITDA.

	Three Months Ended
	September 30, 2004			September 30, 2003
Cash flows provided by operating activities	$	4,134		$	11,820
Interest expense net of amortization		10,254			7,967
Change in working capital		857			(1,772	)
Current tax expense		10			55
Change in unearned installation revenue		86			24
Amortization of deferred subscriber acquisition costs		(4,226	)		(4,075	)
Deferred subscriber acquisition costs		4,643			5,017
Gain on disposal of fixed assets		21			29
EBITDA	$	15,779		$	19,065
	Nine Months Ended
	September 30, 2004			September 30, 2003
Cash flows provided by operating activities	$	19,712		$	23,840
Loss on early extinguishment of debt		(1,663	)		(3,694	)
Interest expense net of amortization		29,369			21,205
Change in working capital		1,049			5,957
Current tax expense		53			408
Change in unearned installation revenue		161			26
Amortization of deferred subscriber acquisition costs		(12,904	)		(11,562	)
Deferred subscriber acquisition costs		13,411			14,614
Gain on disposal of fixed assets		88			37
EBITDA	$	49,276		$	50,831

Our principal sources of funds have historically been cash generated from operations and borrowings under the senior credit facility.

        Cash generated from operations has been negatively impacted by severance and related payments and the effects of the temporary business disruption resulting from our recently completed reorganization. One of the primary reasons for the reorganization was to structure our Company such that we can gain greater efficiencies in how we utilize our resources. We believe the reorganization will result in the employment of best practices, a reduction in operating costs, and greater efficiencies in every functional area. However, due to the relocation of our administrative function and certain aspects of the operations function to the home office in the third quarter, we have experienced transitional challenges in deploying our technicians to client sites and managing our accounts receivable balances. We are working through the challenges and making revisions to processes as necessary. As such, we believe that cash flows from operations will begin to reflect the benefits of the reorganization within the next twelve months. We borrowed $6.0 million and $10.0 million under our revolving credit facility in the quarter and nine months ended September 30, 2004, respectively.

The cash generated from operations was primarily used during the nine months ended September 30, 2004 to make investments relating to new client locations and to make interest payments on our indebtedness. Interest payments have increased as compared to the prior year, due to the senior discount notes becoming fully accreted in March 2004, as well to an overall increase in indebtedness.

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MUZAK HOLDINGS LLC

Our future need for liquidity will arise primarily from capital expenditures for investments in new client locations and from interest payments on our indebtedness. The following table summarizes contractual obligations and commitments at September 30, 2004 (in thousands).

	Payments due by Period
	Remaining 3 months 2004		2005		2006		2007		2008		After 2008		Total
Long-term debt	$	24	$	101	$	110	$	65,118	$	131	$	360,751	$	426,235
Interest		12,009		40,950		40,942		39,778		36,666		21,707		192,052
Capital lease obligations		804		2,837		1,436		793		31		3		5,904
Operating leases		2,453		8,794		8,050		7,585		7,064		35,607		69,553
Unconditional purchase obligations		3,180		7,611		6,336		6,169		6,102		509		29,907
Total Contractual Cash Obligations	$	18,470	$	60,293	$	56,874	$	119,443	$	49,994	$	418,577	$	723,651

The majority of our unconditional purchase obligations relate to a purchase commitment for receivers used in installing new client locations. The majority of our capital expenditures are comprised of the initial one-time investment for the installation of equipment for new client locations. During the nine months ended September 30, 2004, our total initial investment in new client locations was $36.0 million, which was comprised of equipment and installation costs attributable to new client locations of $22.6 million and $13.4 million in subscriber acquisition costs (included in cash provided by operating activities in the consolidated statement of cash flows) relating to these new locations. The subscriber acquisition costs are capitalized and are amortized as a component of selling, general and administrative expenses over the initial contract term. We also receive installation revenue relating to new locations. This revenue is deferred and amortized as a component of equipment and related services revenue over the initial contract term.

We also invest in property and equipment to be used at our headquarters and within our owned operations as well as incur equipment and installation costs relating to conversions from one delivery platform to another delivery platform. Our investment for such investments for the nine months ended September 30, 2004 was approximately $4.8 million, consisting of equipment to replenish the equipment exchange pool relating to our drive-thru systems client locations, equipment and labor costs for conversions, system upgrades, furniture and fixtures, and computers. We used existing receivers for the majority of these conversions, but incurred installation costs and costs associated with procuring satellite dishes.

We currently anticipate that our total initial investment in new client locations during 2004 will be approximately $48.4 million including $30.0 million of equipment and installation costs attributable to new client locations, and $18.4 million in sales commissions relating to new client locations. The Company is focused on reducing the initial investment associated with new client locations through the re-use of equipment and efficiencies gained from vendor consolidation and labor management. In addition, we anticipate our investment in property and equipment to be used at headquarters, equipment for use in the exchange pool for servicing drive-thru systems client locations, and equipment for conversions will be approximately $6.2 million during 2004.

On November 9, 2004, the Company amended its financial covenants and certain other aspects of its Senior Credit Facility. The Company believes that the revised covenant levels provide the Company ample flexibility and liquidity for the next twelve months.

Interest Rate Protection Agreements. As a result of the issuance of the 10% Senior Notes in May 2003 and the relating application of such proceeds, a large portion of the Company’s indebtedness bears interest at fixed rates. Accordingly, in August 2003, the Company entered into an interest rate swap agreement in which the Company effectively exchanged $220.0 million of fixed rate debt at 10.0% for six month LIBOR plus 7.95%. The swap agreement, entered into to mitigate our interest costs associated with the Senior Notes, ends in November 2004.

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MUZAK HOLDINGS LLC

Item 3. Quantitative and Qualitative Disclosures About Market Risk

For the period ended September 30, 2004, the Company experienced a decline in the fair market values of its debt. As of December 31, 2003, the carrying value and the fair value of the Company’s debt were $411.5 million and $418.0 million, respectively. As of September 30, 2004, the carrying value and the fair value of the Company’s debt were $425.3 million and $365.8 million, respectively. As the majority of the Company’s debt is fixed rate debt, the Company has not experienced a material change in cash flows associated with its debt obligations.

Item 4. Controls and Procedures

Under the direction of our Chief Executive Officer and Chief Financial Officer, we evaluated our disclosure controls and procedures and internal control over financial reporting and concluded that (i) our disclosure controls and procedures were effective as of September 30, 2004, and (ii) no change in internal control over financial reporting occurred during the quarter ended September 30, 2004, that has materially affected, or is reasonably likely to materially affect, such internal control over financial reporting.

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MUZAK HOLDINGS LLC

PART II—OTHER INFORMATION

ITEM 5. Legal Proceedings.

The Company and BMI have advanced their conversations toward reaching a new five-year music license agreement, culminating in a recent agreement in principle. The Company anticipates that a final license agreement will be executed prior to the end of the fourth quarter of 2004.

As reported in the Company’s report on Form 10-K for the fiscal year ended December 31, 2003, ASCAP had notified the Company that ASCAP would pursue a rate court proceeding in federal court in New York and on January 29, 2003, made an application to the court to commence such a proceeding. The impact of this rate court proceeding is more fully described in the Company’s report on Form 10-K.

Other than the Company’s progress on conversations with BMI regarding license fees, there have been no material developments in legal proceedings involving the Company since those reported in the Company’s Report on Form 10-K for fiscal year ended December 31, 2003.

ITEM 6. Exhibits.

(a) Exhibits

10.1 First Amendment to the Amended and Restored Credit Agreement dated as of May 10, 2004 among Muzak Holdings LLC, Muzak LLC as Borrower, the lenders from time to time parties thereto, Bear Stearns and Co. Inc. and Lehman Brothers Inc., as Joint Lead Arrangers and Joint Bookrunners, Lehman Commercial Paper Inc., Fleet National Bank and GECC Capital Markets Groups Inc., as Co-Syndication Agents, General Electric Capital Corporation, as Documentation Agent and Collateral Agent and Bear Stearns Corporate Lending Inc., as Administrative Agent.

31.1 Certification of Chief Executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 Certification of Chief Financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrants have duly caused this report to be signed on their behalf by the undersigned thereunto duly authorized.

	MUZAK HOLDINGS LLC MUZAK HOLDINGS FINANCE CORP. MUZAK LLC MUZAK FINANCE CORP
	By:	/S/ Lon E. Otremba
Date: November 15, 2004		Lon E. Otremba Chief Executive Officer (Principal Executive Officer)
	By:	/S/ STEPHEN P. VILLA
Date: November 15, 2004		Stephen P. Villa Chief Financial Officer (Principal Financial Officer and Chief Accounting Officer)

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