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)
MUZAK LIMITED PARTNERSHIP
CONSOLIDATED BALANCE SHEETS
(in thousands)
December 31,
------------
1996 1997
---- ----
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
========== ==========
The accompanying notes are an integral part of these financial statements.
2
MUZAK LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
Year Ended
December 31,
----------------------------------------------
1995 1996 1997
---- ---- ----
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)
========== ========== ==========
The accompanying notes are an integral part of these financial statements.
3
MUZAK LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL (DEFICIT)
(in thousands)
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
-------- ------ --------- ------- --------- ---------- --------- -------
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
======= ======== ======== ======= ========= ======== ======== =======
4(a)
* Table continued on the following Page 4(b)
* Table continued from the preceding Page 4(a)
Total Limited
Partners' Interest Total
---------------------- ----------------------
Number Number
of Units Amount of Units Amount
-------- ------ -------- ------
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)
======== ========= ======== ========
The accompanying notes are an integral part of these financial statements.
4(b)
MUZAK LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
-----------------------
1995 1996 1997
---- ---- ----
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
------- --------- --------
The accompanying notes are an integral part of these financial statements.
5
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
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
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
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
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
MUZAK LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. PROPERTY AND EQUIPMENT, NET:
Property and equipment consist of the following (in thousands):
December 31,
------------
1996 1997
---- ----
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
========== ===========
4. DEFERRED COSTS AND INTANGIBLE ASSETS, NET:
Deferred costs and intangible assets consist of the following (in
thousands):
December 31,
------------
1996 1997
---- ----
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
========== ==========
11
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
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
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
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
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
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
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):
Class C Class C-1 Total
------- --------- -----
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
========== ========= ==========
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
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
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
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:
Weighted
Range of Average
Number of Exercise Exercise
Options Price Price
------- ----- -----
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
=========== ============= ========
Additional information regarding options outstanding as of December 31, 1997 is
as follows:
Weighted Avg.
Remaining
Range of Number Contractual Weighted Avg. Number Weighted Avg.
Exercise Prices Outstanding Life(yrs) Exercise Price Exercisable Exercise Price
- --------------- ----------- --------- -------------- ----------- --------------
$ 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
============= ========== ====== ========= ======== =========
21
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
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
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