Exhibit 99.3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
GENERAL
The Partnership derives revenues from its business services and from
the sale, installation and servicing of equipment at customer premises. The
Partnership's principal business services include broadcast music services,
on-premise music, on-premise music video, and audio marketing. Music and other
business services represented approximately 66% of total revenues in 1998.
Equipment and related revenues accounted for the remaining 34% of 1998 revenues.
A large majority of the Partnership's broadcast and on-premise music revenues
are generated from subscribers who typically execute five-year contracts at
rates ranging from $35 to $75 per month. These subscription rates typically
include the use of the Partnership's equipment at the subscriber's location. The
Partnership's independent affiliates pay royalties, including surcharges for
satellite transmission systems, to the Partnership based generally on 10% to
12.5% of adjusted music revenues, which are broadcast music revenues less
licensing payments and bad debt write-offs. Royalties received from independent
affiliates and international distributors are included in broadcast music
revenues and represented approximately 8.6% of total revenues in 1998.
On-premise music video revenues are derived from the sale of specialized
on-premise music videos targeted for certain segments of the marketplace. Audio
marketing revenues are generated primarily from the sale of customized audio
messages for use with "on-hold" telephone systems.
Equipment revenues are derived from the sale and lease of audio
system-related products, principally sound systems and intercoms, to business
music subscribers and other customers. The Partnership also sells electronic
equipment, including proprietary tape playback equipment, and other audio and
video equipment to its independent affiliates to support their business music
services. Installation, service and repair revenues consist principally of
revenues from the installation of sound systems and other equipment that is not
associated with the business music contract, such as paging, security and
drive-through systems. These revenues also include revenue from the
installation, service and repair of equipment installed under a business music
contract. Installation fee revenues that are related to music contracts, are
deferred and recognized over the term of the respective contracts.
Cost of revenues for business services consists primarily of broadcast,
delivery, licensing, production and programming costs associated with providing
music and other business services to a subscriber or a independent affiliates.
Cost of revenues for equipment represents the purchase cost plus handling,
shipping and warranty expenses. Cost of revenues for installation, service and
repair consists primarily of service and repair labor and labor for installation
that is not associated with new business music subscribers. Installation costs
associated with new business music subscribers are capitalized and charged to
depreciation expense over ten years.
Selling, general and administrative expenses include salaries,
benefits, commissions, travel, marketing materials, training and occupancy costs
associated with staffing and operating local and national sales offices. Such
expenses also include personnel and other costs incurred in connection with the
Partnership's headquarters functions. A significant portion of commissions and
certain other selling costs are capitalized on a successful-efforts basis and
charged as amortization expense over the average contract term of five years
and, accordingly, are not reflected in selling, general and administrative
expenses. The Partnership capitalized $3.3 million, $3.8 million and $3.6
million of such costs in 1996, 1997 and 1998, respectively.
The Partnership amortizes leasehold improvements over the shorter of
the lease term or five years and deferred costs and intangible assets over lives
ranging from five to ten years. These deferred costs and intangible assets
consist of the costs associated with subscriber contracts acquired from third
parties (typically amortized on an accelerated basis over eight years),
commissions and certain other sales-related expenses (five years), the
acquisition and production costs of a music library (typically five years),
organizational expenses related to acquiring certain franchise operations (five
years) and capitalized financing costs (over the life of the loans).
The Partnership operates as a limited partnership and as such, the
income tax effects of all earnings or losses of the Partnership are passed
directly to the partners and no provision for income taxes is required.
On October 2, 1996, the Partnership and Muzak Capital Corporation
(Capital Corp.) completed the offering of $100 million aggregate principal
amount (the "Offering") of their 10% Senior Notes (the "Senior Notes"). The
Partnership adopted, as part of the Offering, a performance-based Amended and
Restated Management Option Plan (the "Amended and Restated Management Option
Plan"). Pursuant to which, the Partnership granted equity options to management
employees that vest according to the following schedule: 5% of the options vest
on the first anniversary of the Partnership's Offering; 5% of the options vest
on the second anniversary of the Partnership's Offering; the remaining 90% vests
ratably at each calendar year end over a five-year period beginning January 1,
1997, and become exercisable if certain performance standards are met. These
options expire on October 1, 2003.
No compensation expense has been recorded for the options which vest
based on the anniversary of the Offering, as management's estimate of the market
value was less than the exercise price at the date of the grant. Additionally,
no compensation expense has been recognized for the performance-based options,
as management, at this time, has deemed the probability of meeting the
performance standards to be remote.
In 1997, the Board of Directors granted two senior officers of the
Partnership and a member of the Board a total of 1,650,000 options to purchase
Class B limited partnership units for $2.33 per unit. These options vest in
equal amounts over a three-year period commencing from the grant date.
Exercisability of 60% of these options is subject to certain performance
standards being met. At December 31, 1998, it is probable the performance
standards will be met. The Partnership has recognized approximately $0.2
million and $2.2 million in compensation expense for the years ended December
31, 1997 and 1998, respectively. Effective October 19, 1998, the Partnership
granted 450,000 options, under a new 1998 option plan, to members of management
to purchase Class B limited partnership units for $4.50 per unit. The options
vest ratably over 5 years. These options expire October 19, 2008. Exercisability
of these options is not based on performance standards. No compensation expense
has been recorded for these options, as management's estimate of the market
value was approximately equal to the exercise price at the date of the grant.
Capital Corp., a wholly owned subsidiary of the Partnership, was
organized on May 8, 1996, has nominal assets and conducts no business
operations. Capital Corp. has no independent operations and is dependent on the
cash flow of the Partnership to meet its sole obligation, the payment of
interest and principal on the Senior Notes when due.
EAIC Corporation (EAIC Corp.), a wholly owned subsidiary of the
Partnership, was organized on March 16, 1998. The Partnership transferred
certain assets to EAIC Corp. utilized in providing internet music samples to
businesses. On July 10, 1998, EAIC Corp. consummated a recapitalization and
capital financing agreement. Pursuant to the agreement, shares held by the
Partnership were converted to 10,000,000 shares of series A non-voting common
stock. Additionally, 73,500 shares of series A voting convertible mandatorily
redeemable preferred stock of EAIC Corp. were issued to a related party investor
for a total consideration of $3.4 million, net of costs. After January 5, 1999,
but prior to April 15, 1999, 26,250 shares of Class B preferred stock can be
purchased by the related party investor for $2.5 million. In the event that
certain performance criteria is met by EAIC Corp., the related party investor is
required to purchase these shares of Series B preferred stock. EAIC Corp. has
not met this criteria as of December 31, 1998. On August 31, 1998, the Board of
Directors of EAIC Corp. authorized a 100-to-one stock split. All applicable
share data has been retroactively adjusted for this stock split.
In addition, the Partnership transferred net assets of $0.9 million
consisting of purchased music to a newly formed, wholly owned subsidiary, MLP
Environmental Music, LLC on December 30, 1998.
RESULTS OF OPERATIONS
The following table sets forth certain financial information for the
periods presented and should be read in conjunction with the Partnership's
Financial Statements, including the Notes thereto:
Year Ending December 31, Percentage Change
------------------------------------- ----------------------
1997 vs. 1998 vs.
1996 1997 1998 1996 1997
---- ---- ---- ---- ----
REVENUES:
Broadcast Music $42,242 $43,761 $47,916 3.6% 9.5%
On-Premise Music 4,368 4,035 4,157 (7.6)% 3.0%
Other Broadcast 1,530 1,546 1,746 1.0% 12.9%
On-Premise Video 2,108 4,126 2,973 95.7% (27.9)%
Audio Marketing 2,480 3,248 4,418 31.0% 36.0%
In-Store Advertising 717 949 745 32.4% (21.5)%
Internet Music Server 22 359 1,678 * *
Other 1,118 1,327 2,323 18.7% 75.1%
------------------------------------
Total Music and Other Business Services 54,585 59,351 65,956 8.7% 11.1%
------------------------------------
Equipment 21,873 21,026 22,021 (3.9)% 4.7%
Installation, Service & Repair 10,353 10,827 11,771 4.6% 8.7%
------------------------------------
Total Equipment Sales and Related Services 32,226 31,853 33,792 (1.2)% 6.1%
------------------------------------
Total Revenues 86,811 91,204 99,748 5.1% 9.4%
GROSS PROFIT:
Business Services 39,322 40,849 46,136 3.9% 12.9%
Equipment 10,316 10,162 12,900 (1.5)% 26.9%
Installation, Service & Repair 147 (516) (1,797) * *
------------------------------------
Total Gross Profit 49,785 50,495 57,239 1.4% 13.4%
Gross Profit Margin (1) 57.3% 55.4% 57.4%
Selling, General & Administrative 31,599 33,262 34,319 5.3% 3.2%
S,G&A Margin (2) 36.4% 36.5% 34.4%
EBITDA (3) 18,186 17,233 22,920 (5.2)% 33.0%
EBITDA Margin (4) 20.9% 18.9% 23.0%
Noncash Incentive Compensation 60 202 2,217 * *
Net Loss ($10,823) ($13,435) ($11,989) (24.1)% 10.8%
- -----------------------------------
(1) Gross profit margin represents gross profit as a percentage of total
revenues.
(2) S,G&A margin represents selling, general and administrative expenses as a
percentage of total revenues.
(3) EBITDA represents earnings before interest expense, interest income, income
taxes, depreciation, amortization, other income/expense, equity in losses
of joint venture and noncash incentive compensation. EBITDA does not
represent and should not be considered as an alternative to net income or
cash flow from operations as determined by generally accepted accounting
principles. The Partnership believes that EBITDA is a meaningful measure of
performance and that it is commonly used in similar industries to analyze
and compare companies on the basis of operating performance, leverage and
liquidity. EBITDA has been adjusted for the years ending December 31, 1996
and 1997 to reflect $60,000 and $202,000, respectively, in noncash
incentive compensation to be consistent with its indenture agreement for
the $100 million Senior Notes.
(4) EBITDA margin represents EBITDA as a percentage of total revenues.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Revenues. Total revenues increased 9.4% from $91.2 million in 1997 to
$99.7 million in 1998 principally as a result of an 11.1% increase in music and
other business services revenues and a 6.1% increase in equipment sales and
related services. Music and other business services revenues increased due to an
increase in the number of broadcast music subscribers, sales growth and the
acquisition of competitors' business music contracts, combined with an increase
in the royalties paid by independent affiliates resulting from growth in the
broadcast music subscribers in the affiliate network. Music and other business
services revenues with the exception of on-premise video and in-store
advertising increased at more rapid rates than broadcast music revenues due to
the increased marketing of, and increasing customer demand for, audio marketing
services, CDI on-premise devices and promotional services, among others.
In-store advertising decreased from 1997 to 1998 primarily as a result of the
Partnership's closure of its in-store marketing group. Royalties and other fees
from independent affiliates and international distributors (included in
broadcast music revenues) accounted for $8.9 million or 9.0% of the
Partnership's revenues in 1998, compared with $8.9 million or 9.8% of the
Partnership's revenues in 1997. The continued decrease in the surcharges
assessed to independent affiliates for satellite transmission costs was offset
by increased growth in royalties related to new subscriber billing. Equipment
and installation revenues increased 4.7% and 8.7% respectively due to the
expansion of national accounts.
Gross Profit. Total gross profit increased 13.4% from $50.5 million in
1997 to $57.2 million in 1998. As a percentage of total revenues, gross profit
increased from 55.4% in 1997 to 57.4% in 1998. The improvement in gross profit
percentage in 1998 was due to growth of higher margin business services, such as
broadcast music, audio marketing and on-premise music services.
The improvement in gross profit was partially offset by approximately
$1.5 million of one-time charges related to the failure of Galaxy IV on May 19,
1998. The Galaxy IV satellite, which carries approximately 60% of the
Partnership's subscribers, had a mechanical failure that caused it to spin
uncontrollably out of orbit. This event caused additional equipment and related
services costs for labor, overtime and subcontractors to be incurred from
repointing over 100,000 satellite dishes to a new satellite, Galaxy IIIR. Gross
profit was impacted by $0.4 million of non-recurring costs related to the
conversion of competitor locations acquired during 1998. Had we not incurred
these expenses, our gross profit margin would have been 59.3% for 1998, an
increase of 17.2% over 1997.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 3.2% from $33.3 million in 1997 to $34.3
million in 1998. As a percentage of total revenues, selling, general and
administrative expenses decreased from 36.5% in 1997 to 34.4% in 1998. Selling
and marketing expenses increased 3.0% from $13.8 million in 1997 to $14.2
million in 1998, principally due to an increase in commissions paid as a result
of increased levels of sales of our business services
products. In 1998, selling and marketing included non-recurring expenses of $0.5
million associated with our cost of repositioning our brand, the design and
construction of our web site and one-time printing expenses. Had we not incurred
such expenses, our selling and marketing expenses would have decreased 0.8% to
$13.6 million. General and administrative costs increased 3.3% from $19.5
million in 1997 to $20.1 million in 1998, due to transaction costs related to
the merger with ACN. However, had we not incurred these expenses, our general
and administrative costs would have only increased 0.6% to $19.6 million. If we
had not incurred the non-recurring selling and marketing expenses and the
non-recurring general and administrative costs, our 1998 selling, general and
administrative expenses as a percentage of total revenues would have been 33.4%.
Noncash Incentive Compensation. Noncash incentive compensation
increased from $0.2 million in 1997 to $2.2 million in 1998. This increase is
primarily due to the meeting of performance criteria for options issued combined
with management's estimate of the increase in value of the Partnership.
Depreciation Expense. Depreciation expense decreased 8.6% from $10.7
million in 1997 to $9.7 million in 1998, principally as a result of a reduction
of depreciation expense for five year lived assets that were fully depreciated
in 1997 related to the acquisition of the Partnership in 1992 by a group led by
Centre Capital Investors L.P. ("CCI").
Amortization Expense. Amortization expense increased 18.1% from $10.0
million in 1997 to $11.8 million in 1998. The increase in amortization expense
was due to an increase in intangibles related to the increased investment in the
expanded customer base and acquisitions of competitors' business music contracts
in 1997 and 1998.
Interest Expense. Total interest expense increased 4.4% from $10.8
million in 1997 to $11.2 million in 1998. The increase in interest expense in
1998 compared to 1997 is related to the increase in the average outstanding debt
during the year. The Partnership's total interest-bearing debt increased from
$101.0 million to $120.0 million at December 31, 1997 and 1998 respectively.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Revenues. Total revenues increased 5.1% from $86.8 million in 1996 to
$91.2 million in 1997 principally as a result of a 8.7% increase in music and
other business services revenues offset by a 1.2% decrease in equipment and
related services revenues. Music and other business services revenues increased
due to an increase in the number of broadcast music subscribers and an increase
in the royalties paid by independent affiliates resulting from an increase in
the broadcast music subscribers in the franchise network. Music and other
business services revenues (with the exception of on-premises tape sales)
increased at more rapid rates than broadcast music revenues due to the increased
marketing of, and increasing customer demand for, on-premise music video and
audio
marketing services, among others. On-premise tape revenues declined due to the
Partnership's conversion of such customers to broadcast services, primarily DBS
transmission. Royalties and other fees from independent affiliates and
international distributors (included in broadcast music revenues) accounted for
$8.9 million or 9.8% of the Partnership's revenues in 1997, compared with $7.8
million or 8.9% of the Partnership's revenues in 1996. This increase is
principally due to a new surcharges assessed to independent affiliates for
satellite transmission costs. Equipment revenues decreased 3.9% as the
Partnership has continued to exit the low margin business of reselling equipment
to its independent affiliates and reduced its participation in lower margin
competitively bid equipment sales. Installation, service and repair revenues
increased 4.6% from the level generated in 1996 due to more installations and
large equipment jobs during 1997.
Gross Profit. Total gross profit increased 1.4% from $49.8 million in
1996 to $50.5 million in 1997. As a percentage of total revenues, gross profit
decreased from 57.3% in 1996 to 55.4% in 1997. Declines in gross profit as a
percentage of sales reflect a dilution of the margin percentage due to the
continued development of the Internet Music Server business and the EchoStar
residential revenues, net of EchoStar satellite costs, both of which contributed
a negative gross profit for the year. Additionally, 1997 was impacted by
approximately $0.5 million in one-time charges related to inventory writedowns.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 5.3% from $31.6 million in 1996 to $33.3
million in 1997. As a percentage of total revenues, selling, general and
administrative expenses increased from 36.4% in 1996 to 36.5% in 1997. Selling
and marketing expenses increased 19.6% from $11.5 million in 1996 to $13.8
million in 1997, principally due to an increase in sales volumes for business
services products. General and administrative costs decreased 3.0% from $20.1
million in 1996 to $19.5 million in 1997, primarily due costs associated with
the unconsummated initial public offering in the 1996 period. General and
administrative costs also include $0.8 million in non-recurring severance
charges in 1997 related to certain executive officers.
Noncash Incentive Compensation. Noncash incentive compensation
increased from $0.1 million in 1996 to $0.2 million in 1997. This increase is
primarily due to the increase in options issued combined with management's
estimate of the increase in value of the Partnership.
Depreciation Expense. Depreciation expense increased 0.2% from $10.6
million in 1996 to $10.7 million in 1997, principally as a result of an
increased investment in equipment installed at customers' premises due to an
expanded customer base and related to new investments in the EchoStar system and
the Internet MusicServer service.
Amortization Expense. Amortization expense increased 4.4% from $9.6
million in 1996 to $10.0 million in 1997. The increase in amortization expense
was due to an increase in intangibles related to the increased investment in the
expanded customer base.
Interest Expense. Total interest expense increased 32.8% from $8.1
million in 1996 to $10.8 million in 1997. The increase in interest expense in
1997 compared to 1996 resulted from a full year of interest expense on the $100
million in Senior Notes issued by the Partnership in October 1996. The
Partnership's total interest-bearing debt remained constant at $101.0 million at
December 31, 1996 and 1997.
Extraordinary Items. Extraordinary items reflected nonrecurring noncash
charges from the write-off of $3.7 million of deferred financing fees, debt
discount and organizational costs and a nonrecurring gain of $3.1 million from
the retirement of a redeemable preferred limited partnership interest during
1996.
LIQUIDITY AND CAPITAL RESOURCES
The Partnership's liquidity needs have been primarily for capital
expenditures, business acquisitions, debt service and working capital. As of
December 31, 1998, the Partnership had a working capital deficit of $7.1
million, compared with a working capital surplus of $12.5 million as of December
31, 1997. This decrease in working capital for this period was due to capital
requirements to fund the additional growth in business services products as well
as the acquisition of twelve business music distributors.
The Partnership's investing activities have historically included the
acquisition and installation of on-premise customer equipment (such as satellite
dishes and receivers) and capitalized costs related to business acquisitions,
obtaining customer contracts and creating master recordings. Capital
expenditures principally related to the acquisition and installation of
on-premise equipment were $10.9 million in 1996, $12.6 million in 1997 and $12.8
million in 1998. Additions to deferred costs and intangible assets were $5.4
million in 1996, $6.0 million in 1997 and $8.6 million in 1998.
The Partnership believes that its future investing activities may
include additional acquisitions of its competitors' business music distributors
and the Partnership's independent affiliates to further its operating strategy,
as well as capital expenditures related to the acquisition and installation of
on-premise equipment and deferred customer acquisition costs.
The Partnership's primary sources of liquidity have been cash flows
from operations and proceeds from various debt instruments. Cash provided by the
Partnership's operations, adjusted for the effect of non-cash items, totaled
$14.0 million in 1998, an increase of $7.4 million over the $6.6 million
provided in 1997. The increase in cash provided by operations was primarily
attributable to a decrease in the net loss, and
an increase in accounts payable, offset by an increase in accounts receivables
and inventories, related to an increase in sales volume. Net changes in the
operating assets and liabilities provided cash of $1.1 million in 1998 as
compared to utilizing of $2.6 million in 1997, due primarily to an increase in
accounts payable and accrued expenses, offset by increases in accounts
receivable and inventories.
In 1997, the Partnership sold its Spokane territory subscriber accounts
and granted the Spokane franchise to an existing independent affiliates of the
Partnership for $1.4 million. This transaction resulted in a gain of $0.8
million to the Partnership, which is included in other income in the
consolidated statement of operations, for the year ended December 31, 1997.
In 1997, the Partnership acquired substantially all of the assets of
four business music providers for approximately $4.1 million. The acquisitions
were financed with cash remaining from the Offering.
In 1998, the Partnership acquired, through separate transactions,
substantially all of the net assets of twelve business music providers for a
total purchase price of approximately $20.2 million. These acquisitions were
financed by a combination of cash, debt and approximately $0.9 million in equity
instruments. Of the total purchase price, the portion related to certain assets
of Music Technologies Incorporated (MTI) was approximately $10.0 million.
As part of the acquisition of MTI, the Partnership entered into
agreement in principle with an independent affiliate to sell a portion of the
income producing contracts obtained in the MTI acquisition. This asset of $1.4
million has been recorded as other receivables as of December 31, 1998.
The Partnership entered into a note payable of approximately $2.6
million. The note bears an interest rate of 14% per annum, with principal and
interest payments of $0.5 million due monthly through March 31, 1999, and the
balance due April 30, 1999. The Partnership has the option to extend the due
date for additional fees. The Partnership also agreed to make a deferred
purchase price payment of $1.3 million, subject to adjustment. Due to the
contingent nature of this consideration and significant uncertainties related to
the ultimate amount to be paid, the Partnership has not recorded any obligation
as of December 31, 1998.
Pursuant to an acquisition, the Partnership paid $0.5 million in
exchange for a non-compete agreement and agreed to pay seven additional annual
installments of $0.5 million. The Partnership has recorded a liability of $2.2
million using a discount rate of 14% per annum.
In March 1998, the Partnership obtained a credit facility for working
capital purposes with an initial availability of $3.0 million, increasing to
$5.0 million upon the attainment of certain cash flow related targets. In July
1998, the Partnership met the cash flow targets required to increase the
available cash to $5.0 million. The credit facility was secured by inventories
and accounts receivable of the Partnership. The outstanding
balance on the credit facility was paid in full and the facility was cancelled
on December 31, 1998.
A new revolving credit facility was obtained by the Partnership in
December 1998. The amount available under the facility is $20.0 million. Amounts
outstanding under the facility bear a variable rate of interest, to be paid
quarterly, based on the lender's prime rate plus 1.25%. The terms of the credit
facility require the Partnership to maintain certain performance standards and
covenants include a limit on the Partnership's capital spending and acquisitions
of other businesses, as well as the Partnership's ability to incur additional
debt and make distributions to partners. The credit facility is secured by
accounts receivable, inventories, and other assets, including proceeds of
certain insurance policies. As of December 31, 1998, the Partnership had
approximately $12.0 million outstanding under this credit facility. The interest
rate at December 31, 1998, was 9%. As part of obtaining the credit facility,
certain limited partners were required to set forth letters of credit in the
amount of $4.2 million. The Partnership has pledged to reimburse the limited
partners for related costs and fees. For the year ended December 31, 1998, no
amounts were reimbursed by the Partnership.
In September 1998, the Partnership's wholly owned subsidiary, EAIC,
obtained a credit facility. The amount available under this facility is $0.8
million and is to be used for equipment purchases. Amounts outstanding under the
facility bear a variable rate of interest to be paid at a rate equal to the
lender's prime rate plus 1% per annum. The unpaid principal balance shall be
repaid in 24 equal monthly installments of principal, plus interest, commencing
on October 1, 1999. As of December 31, 1998, EAIC had approximately $0.3 million
outstanding under this credit facility. The interest rate at December 31, 1998,
was 8.75%.
The Senior Notes obtained in 1996 as part of the Offering, represent
unsecured senior obligations of the Partnership and Capital Corp., and are
senior in right of payment to all subordinated indebtedness and pari passu in
right of payment to all senior indebtedness. The Senior Notes mature on October
1, 2003. Interest accrues at a rate of 10% per annum and is payable
semi-annually in arrears on April 1 and October 1 to holders of record on the
immediately proceeding March 15 and September 15, respectively. A portion of the
proceeds from the Senior Notes was used to repay existing indebtedness and for
additional working capital and other corporate purposes. The remainder of the
proceeds from the Offering have been used for general corporate purposes, which
may include acquisitions of the Partnership's independent affiliates or business
music distributors of its competitors' to further its operating strategy, other
acquisitions or investment opportunities and working capital.
During 1997, the Partnership repurchased 1,250,000 limited partnership
units from eight members of former management at a unit price of $2.33 for a
total repurchase amount of $2.9 million. Seventeen existing and new members of
management purchased 899,000 units at a unit price of $2.33 per unit for a total
purchase price of $2.1 million. These purchases were financed primarily by
the Partnership through promissory notes from these management members bearing
interest at 7% per annum.
During 1998, the Partnership sold its interest in a joint venture
providing business music services in Europe (Muzak Europe) in exchange for a
note receivable of approximately $0.8 million, which is due in full April 2005,
and a royalty based on recurring billings beginning April 2000. No gain or loss
was recorded on this transaction. The joint venture was accounted for using the
equity method, as the Partnership owned 50% of that venture but did not have a
controlling interest. Equity in losses of joint venture in the Partnership's
consolidated statements of operations includes the Partnership's share of net
losses. As of December 31, 1997, the joint venture had total assets of $7.3
million and total liabilities of $5.5 million. As of December 31, 1997, the
carrying value on the Partnership's books was $1.1 million and was included in
other long-term assets.
The Partnership leases certain facilities and equipment under both
operating and capital leases. In addition, the Partnership has entered into
agreements to obtain satellite channel capacity and subsidiary communication
authorization rights for the transmission of programs to the Partnership's
customers. Total rental expense under operating leases and rights' agreements
was approximately $7.8 million, $8.4 million and $8.7 million for the years
ended December 31, 1996, 1997 and 1998, respectively.
The Partnership anticipates, excluding EAIC Corp. activity, capital
expenditures, primarily related to subscriber provided equipment, of between
$10.0 million and $12.0 million in 1999 and additions to deferred costs and
intangible assets, excluding acquisitions, of between $6.0 million and $8.0
million in 1999. The level of capital expenditures and additions to deferred
costs and intangible assets are subject to a variety of factors which may cause
these expenditures to exceed the ranges set forth above.
The Partnership believes that its cash flows from operations, borrowing
availability and cash on hand will be adequate to support currently planned
business operations, capital expenditures and debt service requirements at least
through December 2000. If the Partnership engages in one or more material
acquisitions, joint ventures or alliances or other major business initiatives
requiring significant cash commitments, or incurs unanticipated expenses,
additional financing could be required.
Related to the acquisition of the Partnership of the predecessor entity
by a group led by CCI in 1992, the Washington State Department of Revenue has
levied an assessment against the Predecessor for $1.7 million in sales and use
and business and occupation taxes for the period from 1987 through September
1992. Under successor liability statutes in the State of Washington, the
Partnership could, if the predecessor entity fails to pay its tax obligation,
become liable for the assessment. The assessment is under appeal by the
predecessor entity. The seller and certain of its affiliates have agreed to
indemnify the Partnership for any liabilities in connection with such
assessments. Management does not believe that the assessment will have an
adverse effect on the Partnership's financial condition or results of
operations.
The Partnership's agreement with Business Music, Inc. (BMI) expired on
December 31, 1993. The Partnership has entered into an interim fee structure
with BMI and is in negotiations with BMI to establish an ongoing rate structure.
The interim
arrangement with BMI provides for continued payments at 1993 levels. BMI has
indicated that they are seeking royalty rate increases, and has asserted that
this sought-after increase will be retroactive to January 1, 1994. If agreement
is not reached, BMI may seek to have rates determined through a court
proceeding. The ultimate outcome of the negotiations is not estimable and as a
result, no provision has been recorded in the financial statements.
On January 29, 1999, the Partnership entered into a definite merger
agreement to be acquired by Audio Communications Network Holdings, LLC (ACN).
Under the terms of the agreement, the Partnership will be merged into a
subsidiary of ACN. The consummation of the merger, which is expected to close in
March 1999, is subject to a number of conditions, including completion of ACN's
financing for the transaction. Under the terms of the agreement, total
consideration of approximately $245 million. The current partners will also
retain a minor ownership interest in the merged entity. The accounts of EAIC
Corp. are not contemplated to be part of the merger.
In the event of change of control of the Partnership, all outstanding
options to purchase partnership units will become immediately vested and
exercisable unless the performance criteria is not considered to be achievable.
Based upon the preliminary purchase price, the accelerated vesting of certain
options will likely result in a significant charge to the statement of
operations and comprehensive loss as performance criteria for these options is
considered achievable.
YEAR 2000 ISSUE
The Partnership is currently evaluating, replacing or upgrading its
computer systems in an effort to make them Year 2000 compliant, and expects to
have remediation efforts completed for its critical computer systems by the end
of the third quarter 1999. Although the Partnership assessment of its Year 2000
issues has been completed, reassessments are conducted on an ongoing basis to
provide reasonable assurance that all critical risks have been identified and
will be mitigated. While the Partnership believes all necessary work will be
completed in a timely fashion, there can be no guarantee that all systems will
be compliant by the year 2000, or that the systems of other companies and
government agencies on which the Partnership relies will be compliant.
The Partnership will use both internal and external resources to
reprogram or replace, test and implement its IT systems for Year 2000
modifications. The Partnership does not separately track the internal costs
incurred on the Year 2000 project. Such costs are principally payroll and
related costs for its internal IT personnel. The total cost of the Year 2000
project, excluding these internal costs, is estimated at $1.0 million and is
being funded through operating cash flows. Of the total estimated project cost,
the Partnership has incurred approximately $0.8 million through December 31,
1998. This amount is attributable to the purchase of new software and hardware
for the Partnership's new operating system, which was capitalized in 1997 and
1998 to be completed in 1999.
Since 1997, the Partnership has been communicating with outside vendors
to determine their state of readiness with regard to the Year 2000 issue. The
Partnership relies on outside vendors for its non-IT systems. Based on its
assessment to date, the Partnership has no indication that any third party is
likely to experience Year 2000 non-compliance of a nature which would have a
material impact of the Partnership. However, the risk remains that outside
vendors or other third parties may not have accurately determined their state of
readiness, in which case such parties' lack of Year 2000 compliance may have a
material adverse effect on the Partnership's results of operations. The
Partnership will continue to monitor the Year 2000 compliance of third parties
with which it does business.
The Partnership believes the most likely worst-case scenarios that it
might confront with respect to the Year 2000 issues have to do with the possible
failure of third party systems over which the Partnership has no control, such
as, but not limited to, satellite, power and telephone services. The Partnership
is currently developing a specific Year 2000 contingency plan.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Financial Accounting Standard No. 133, Accounting for Derivative
Instruments and Hedging Activities, was issued in June 1998 and is effective for
all fiscal quarters of fiscal years beginning after June 15, 1999. This standard
requires an entity to recognize all derivatives as either assets or liabilities
in the statement of financial position and measure those instruments at fair
value. The Partnership is still in the process of evaluating the impact of this
standard on their financial statements and anticipates adopting this standard in
the year ending December 31, 2000.
In March 1998, the Accounting Standards Executive Committee of the
AICPA issued Statement of Position 98-1 (SOP 98-1), Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use, which requires that
certain software costs be capitalized and amortized over the period of use. The
SOP is effective for financial statements for the fiscal years beginning after
December 15, 1998. The Partnership will adopt SOP 98-1 for the year ending
December 31, 1999. This statement is not expected to have a material effect on
the financial statements.
In April 1998, the Accounting Standards Executive Committee of the
AICPA issued SOP 98-5, Reporting on the Costs of Start-up Activities, which
requires costs of start-up activities and organization costs to be expensed as
incurred. This SOP is effective for financial statements for fiscal years
beginning after December 15, 1998. The Partnership will adopt SOP 98-5 for the
year ending December 31, 1999. This statement is not expected to have a material
effect on the financial statements; however, organization costs of approximately
$272,000 will be written off.
INFLATION AND CHANGING PRICES
Management does not believe that inflation and other changing prices
have had a significant impact on the Partnership's operations.