UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------------
FORM 10-Q
-------------------------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2001.
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 for the transition period from ______ to _______.
Commission file number: 333-78573
333-78573-01
MUZAK HOLDINGS LLC
MUZAK HOLDINGS FINANCE CORP.
(Exact Name of Registrants as Specified in their charter)
DELAWARE 04-3433730
DELAWARE 04-3433728
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporated or Organization)
3318 LAKEMONT BLVD
FORT MILL, SC 29708
(803) 396-3000
(Address, Including Zip Code and Telephone Number including Area Code of
Registrants' Principal Executive Offices)
Indicate by check mark whether the registrants have filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days.
Yes [ X ] No [ ]
Muzak Holdings Finance Corp. meets the conditions set forth in General
Instruction H (1) (a) and (b) of Form 10-Q and is therefore filing this form
with the reduced disclosure format.
PART I- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
MUZAK HOLDINGS LLC
CONSOLIDATED BALANCE SHEETS
(in thousands, except for units)
September 30, December 31,
2001 2000
(unaudited)
-------------------- ------------------
ASSETS
Current assets:
Cash and cash equivalents ..................................................... $ 2,976 $ 3,012
Accounts receivable, net of allowances of $3,018 and $4,066 ................... 27,844 38,847
Inventory ..................................................................... 10,061 11,082
Prepaid expenses and other assets ............................................. 2,389 2,548
--------- ---------
Total current assets ...................................................... 43,270 55,489
Property and equipment, net ........................................................ 114,892 114,571
Intangible assets, net ............................................................. 300,822 324,544
Deferred charges and other assets, net ............................................. 50,335 45,471
--------- ---------
Total assets .............................................................. $ 509,319 $ 540,075
========= =========
LIABILITIES AND MEMBERS' INTEREST
Current liabilities:
Revolving credit facility ..................................................... $ 20,000 $ 4,000
Current maturities of long term debt .......................................... 6,024 5,281
Current maturities of other liabilities ....................................... 3,900 3,776
Accounts payable .............................................................. 4,499 14,498
Accrued expenses .............................................................. 17,597 19,541
Advance billings .............................................................. 2,404 2,096
--------- ---------
Total current liabilities ................................................. 54,424 49,192
Long-term debt ..................................................................... 335,490 333,890
Related party notes ................................................................ -- 27,000
Other liabilities .................................................................. 14,106 17,993
Commitments and contingencies (Note 7)
Manditorily redeemable preferred units.............................................. 88,451 79,762
Member's interest:
Class A units ............................................................... 136,675 110,680
Class B units ............................................................... 1,530 2,522
Accumulated other comprehensive loss ........................................ (3,087) --
Accumulated deficit ......................................................... (118,270) (80,964)
--------- ---------
Total members' interest ................................................... 16,848 32,238
--------- ---------
Total liabilities and members' interest ................................... $509,319 $ 540,075
========= =========
The notes are an integral part of these consolidated financial statements.
2
MUZAK HOLDINGS LLC
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands)
Quarter Ended Nine Months Ended
------------------------------------ ------------------------------------
September 30, September 30, September 30, September 30,
2001 2000 2001 2000
----------------- ------------------ ----------------- -----------------
Revenues:
Music and other business services .............. $37,851 $ 34,854 $ 111,782 $ 101,948
Equipment and related services ................. 12,675 15,005 39,448 39,622
---------- --------- ---------- ----------
50,526 49,859 151,230 141,570
Cost of revenues:
Music and other business services
(excluding $9,550, $7,870, $27,406 and
$21,757 of depreciation and
amortization expenses) ........................ 7,396 7,125 21,956 22,415
Equipment and related services ................. 10,519 10,838 29,516 29,493
---------- --------- ---------- ----------
17,915 17,963 51,472 51,908
---------- --------- ---------- ----------
Selling, general and administrative expenses ........ 16,402 16,057 51,557 46,507
Depreciation and amortization expenses .............. 19,287 16,196 56,078 45,685
---------- --------- ---------- ----------
Loss from operations ....................... (3,078) (357) (7,877) (2,530)
Other expense:
Interest expense, net .......................... (9,226) (12,270) (29,644) (35,257)
Other, net ..................................... (110) (72) (285) (501)
---------- --------- ---------- ----------
Loss before income taxes ................... (12,414) (12,699) (37,806) (38,288)
Income tax provision (benefit) ...................... 109 (78) (500) (17)
---------- --------- ---------- ----------
Net loss ................................... $ (12,523) $(12,621) $ (37,306) $ (38,271)
========== ========= ========== ==========
The notes are an integral part of these consolidated financial statements.
3
MUZAK HOLDINGS LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
Quarter Ended Nine Months Ended
--------------------------- -------------------------
September September September September
30, 30, 30, 30,
2001 2000 2001 2000
-------------------------- ------------ -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ............................................................... $ (12,523) $ (12,621) $ (37,306) $ (38,271)
Adjustments to derive cash flow from continuing operating activities:
Loss on disposal of fixed assets ....................................... 10 -- 119 --
Deferred income tax (benefit) provision ................................ (142) (298) (751) (283)
Depreciation and amortization .......................................... 19,287 16,196 56,078 45,685
Amortization of deferred financing fees ................................ 473 469 1,417 1,380
Amortization of senior discount notes .................................. 1,723 1,520 4,999 4,410
Amortization of deferred subscriber acquisition costs .................. 2,478 1,634 6,830 4,112
Deferred subscriber acquisition costs .................................. (4,027) (4,696) (11,920) (13,297)
Unearned installment income ............................................ (216) (195) (548) (367)
Change in certain assets and liabilities, net of business acquisitions
Decrease (increase) in accounts receivable .......................... 610 (6,882) 10,222 (10,318)
Decrease (increase) in inventory .................................... 806 (560) 1,026 634
Decrease in accrued interest ........................................ (2,801) (2,678) (1,269) (3,096)
Increase (decrease) in accounts payable ............................. (353) (2,391) (4,679) 8,637
Decrease (increase) in accrued expenses ............................. 162 2,921 (406) (6,112)
Increase (decrease) in advance billings ............................. (292) (887) 294 511
Other, net .......................................................... (1,149) (1,801) (1,009) (1,626)
---------- ---------- ---------- ----------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES ............... 4,046 (10,269) 23,097 (8,001)
---------- ---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisitions, net of cash .............................................. -- (109) (979) (34,593)
Capital expenditures ................................................... (7,649) (9,214) (28,785) (28,998)
Proceeds from sale of fixed assets ..................................... 11 -- 291 --
---------- ---------- ---------- ----------
NET CASH USED IN INVESTING ACTIVITIES ............................. (7,638) (9,323) (29,473) (63,591)
---------- ---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Decrease in book overdrafts ............................................ (3,093) (902) (5,320) (6,257)
Repayments of senior credit facility ................................... -- -- (2,597) (1,800)
Net borrowing on revolver .............................................. 7,500 -- 16,000 9,683
Proceeds from issuance of floating rate notes .......................... -- -- -- 36,000
Proceeds from interest rate swap ....................................... -- -- -- 4,364
Proceeds from contributions by members .................................. -- 20,000 -- 35,636
Repayments of capital lease obligations and other debt ................. (662) (440) (1,743) (1,526)
Payment of fees associated with the financing .......................... -- (421) -- (1,169)
---------- ---------- ---------- ----------
NET CASH PROVIDED BY FINANCING ACTIVITIES ......................... 3,745 18,237 6,340 74,931
---------- ---------- ---------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ................... 153 (1,355) (36) 3,339
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ......................... 2,823 6,969 3,012 2,275
---------- ---------- ---------- ----------
CASH AND CASH EQUIVALENTS, END OF PERIOD ............................... $2,976 $5,614 $2,976 $5,614
========== ========== ========== ==========
The notes are an integral part of these consolidated financial statements.
4
MUZAK HOLDINGS LLC
CONSOLIDATED STATEMENT OF CHANGES IN MEMBERS' INTEREST
(Unaudited)
(in thousands, except for units)
Accumulated
Current Year Other Total
Comprehensive Class A Class B Accumulated Comprehensive Members'
Loss Units Dollars Units Dollars Deficit Loss Interest
------------- ---------- --------- ------- --------- ----------- ------------- --------
Balance at December 31, 2000 ........ -- 96,910 $110,680 12,810 $ 2,522 $ (80,964) -- $32,238
Comprehensive loss:
Net loss ............................ (37,306) (37,306) (37,306)
Unrealized loss on derivative ....... (3,087) (3,087) (3,087)
----------
(40,393)
Issuance of units ................... 35,512 35,512 (876) 10 35,522
Preferred return on preferred units . -- (9,517) -- (1,002) -- -- (10,519)
---------- --------- ------- ------- ---------- -------- --------
Balance at September 30, 2001 ....... 132,422 $136,675 11,934 $1,530 $(118,270) $(3,087) $16,848
========== ========= ======= ======= ========== ======== =========
The notes are an integral part of these consolidated financial statements.
5
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
Muzak Holdings LLC and its subsidiaries ("the Company") was formed in
September 1998 pursuant to the laws of Delaware. Muzak LLC, a wholly owned
subsidiary of the Company, provides business music programming, music and
marketing on hold, and in-store messaging to clients through its integrated
nationwide network of owned operations and franchises. As of September 30, 2001,
ABRY Partners, LLC and its respective affiliates collectively own approximately
64% of the voting interests in the Company.
2. BASIS OF PRESENTATION
The condensed consolidated financial statements include the accounts of
the Company and its subsidiaries: Muzak LLC, Muzak Capital Corporation, Muzak
Finance Corporation, Muzak Holdings Finance Corporation, Business Sound Inc.,
Electro Systems Corporation, BI Acquisition LLC, MLP Environmental Music LLC,
Audio Environments Inc., Background Music Broadcasters Inc., Telephone Audio
Productions Inc., Vortex Sound Communications Company Inc., Music Incorporated,
and Muzak Houston, Inc. All significant intercompany items have been eliminated
in consolidation.
The accompanying unaudited interim consolidated financial statements
have been prepared in accordance with the instructions to Form 10-Q and Rule
10-01 of Regulation S-X, and accordingly, certain financial information has been
condensed and certain footnote disclosures have been omitted. Such information
and disclosures are normally included in financial statements prepared in
accordance with generally accepted accounting principles in the United States.
For further information, refer to the consolidated financial statements and
footnotes thereto included in the Muzak Holdings LLC Annual Report on Form 10-K
for the fiscal year ended December 31, 2000.
The financial statements as of September 30, 2001 and September 30,
2000 and for the three and nine month periods then ended are unaudited; however,
in the opinion of management, such statements include all adjustments
(consisting solely of normal recurring adjustments) necessary for a fair
statement of the financial information included herein in accordance with
generally accepted accounting principles in the United States. The preparation
of consolidated financial statements in conformity with generally accepted
accounting principles in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and reported amounts of revenues and expenses during the
period. Actual results could differ from those estimates. Results of operations
for interim periods are not necessarily indicative of results for the full year.
Certain prior year items have been reclassified to conform with the
2001 presentation. Prior year accounts receivable and advance billings balances
have been reduced by the amounts invoiced, but not received, in advance of the
service period. Book overdrafts have been reclassified as a financing activity
on the statement of cash flows.
6
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
Useful September 30, December 31,
Life 2001 2000
(years) (Unaudited)
-------- --------------- --------------
Equipment provided to client locations ...................... 4-6 $ 114,353 $ 99,305
Capitalized installation labor .............................. 5 44,864 33,341
Equipment ................................................... 5-7 17,727 16,945
Other ....................................................... 3-30 15,826 13,832
--------- ---------
192,770 163,423
Less accumulated depreciation .............................. (77,878) (48,852)
--------- ---------
$ 114,892 $ 114,571
========= =========
Depreciation expense was $10.5 million and $29.6 million for the
quarter and nine months ended September 30, 2001, respectively, and $8.0 million
and $22.0 million for the quarter and nine months ended September 30, 2000,
respectively.
4. INTANGIBLE ASSETS
Intangible assets consist of the following (in thousands):
Useful September 30, December 31,
Life 2001 2000
(years) (Unaudited)
-------- --------------- --------------
Goodwill .................................................... 20 $158,484 $ 158,172
Income producing contracts .................................. 8-14 154,044 153,485
License agreements .......................................... 20 5,082 5,082
Deferred production costs ................................... 10 4,192 3,166
Trademarks .................................................. 5 14,935 14,979
Non-compete agreements ...................................... 2-7 24,869 24,604
Other ....................................................... 5-20 17,166 17,024
-------- ---------
378,772 376,512
Less accumulated amortization ............................... (77,950) (51,968)
-------- ---------
$300,822 $ 324,544
======== =========
Amortization expense was $8.8 million and $26.3 million for the quarter
and nine months ended September 30, 2001, respectively, and $8.2 million and
$23.7 million for the quarter and nine months ended September 30, 2000,
respectively.
7
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. DEBT
Debt obligations consist of the following (in thousands):
September 30, December 31,
2001 2000
(Unaudited)
------------- ------------
Revolving loan- Senior Credit Facility ...................... $ 20,000 $ 4,000
======== ========
Related Party Notes ......................................... $ -- $ 27,000
======== ========
Long term debt:
Senior Credit Facility .................................... $168,803 $171,400
Senior Subordinated Notes ................................. 115,000 115,000
Senior Discount Notes ..................................... 55,138 50,139
Other ..................................................... 2,573 2,632
-------- --------
Total debt obligations ...................................... 341,514 339,171
Less current maturities ..................................... (6,024) (5,281)
-------- --------
$335,490 $333,890
======== ========
Senior Credit Facility
The Senior Credit Facility is guaranteed by the Company and certain
100% owned subsidiaries. The non-guarantor subsidiary is minor and the
consolidated amounts in the Company's financial statements are representative of
the combined guarantors. The Senior Credit Facility contains restrictive
covenants including maintenance of interest, senior and total leverage and fixed
charge ratios and various other restrictive covenants which are customary for
such facilities. In addition, the Company is generally prohibited from incurring
additional indebtedness, incurring liens, paying dividends or making other
restricted payments, consummating asset sales, entering into transactions with
affiliates, merging or consolidating with any other person or selling,
assigning, transferring, leasing, conveying, or otherwise disposing of assets.
On May 15, 2001 the Company entered into the fifth amendment in which, among
other things, the parties amended the interest coverage ratios for the quarter
ended March 31, 2001 and with respect to future periods.
The Senior Credit Facility consists of two term loan facilities (Term
Loan A and Term Loan B) and a revolving loan. Amounts outstanding on the Term
Loan A and Term Loan B loans were $25.9 million and $142.9 million,
respectively, as of September 30, 2001. The Company had $14.8 million of
borrowing availability under its revolving loan as of September 30, 2001.
Availability under the revolving loan has been reduced by outstanding letters of
credit of $0.2 million. The Company believes that the cash flows from operations
and current borrowing availability will be sufficient to fund operations and
investments associated with client locations through June 30, 2002. However, the
Company continues to explore various financing alternatives, which would provide
necessary liquidity for future organic growth and acquisitions.
Indebtedness under the Term Loan A and the Revolving Loan bear
interest at a per annum rate equal to the Company's choice of (i) the Alternate
Base Rate (which is the highest of prime rate and the Federal Funds Rate plus
.5%) plus a margin ranging from 1.50% to 2.50%; or (ii) the offered rates for
Eurodollar deposits ("LIBOR") of one, two, three, or six months, as selected by
the Company, plus a margin ranging from 2.50% to 3.50%. Margins, which are
subject to adjustment based on the changes in the Company's ratio of
consolidated total debt to Adjusted EBITDA (i.e., earnings before interest,
taxes, depreciation, amortization and other non cash charges) were 2.0% in the
case of Alternate Base Rate and 3.0% in the case of LIBOR as of September 30,
2001. Indebtedness under the Term Loan B bears interest at a per annum rate
equal to the Company's choice of (i) the Alternate Base Rate (as described
above) plus a margin of 3.0%; or (ii) LIBOR of one, two, three, or six months,
as selected by the Company plus a margin of 4.0%. The weighted average rate of
interest on the Senior Credit Facility, including the effects of the interest
rate swap, was 9.3% at September 30, 2001.
8
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. Debt (Continued)
Related Party Notes
On May 9, 2001 and May 24, 2001, $20.0 million and $7.0 million,
respectively, of the Related Party Notes borrowed from MEM Holdings LLC, as well
as $5.0 million and $1.7 million, respectively, of accrued interest, converted
into Class A units of the Company. MEM Holdings owns 64% of the voting interests
in the Company as of September 30, 2001. ABRY Broadcast Partners III and ABRY
Broadcast Partners II are the beneficial owners of MEM Holdings.
Senior Subordinated Notes
On March 18, 1999, Muzak LLC together with its wholly owned subsidiary,
Muzak Finance Corp., co-issued $115.0 million in principal amount of 9 7/8%
Senior Subordinated Notes ("Senior Notes") which mature on March 15, 2009.
Interest is payable semi-annually, in arrears, on March 15 and September 15 of
each year. The Senior Notes are general unsecured obligations of Muzak LLC and
Muzak Finance Corp. and are subordinated in right of payment to all existing and
future Senior Indebtedness of Muzak LLC and Muzak Finance Corp. The Senior Notes
are guaranteed by the Company, MLP Environmental Music LLC, Business Sound Inc.,
BI Acquisition LLC, Audio Environments Inc., Background Music Broadcasters Inc.,
Muzak Capital Corporation, Telephone Audio Productions Inc., Muzak Houston Inc.,
Vortex Sound Communications Company Inc., and Music Incorporated. Muzak LLC's
non-guarantor subsidiary is minor and the consolidated amounts in the Company's
financial statements are representative of the combined guarantors financial
statements. The indenture governing the Senior Notes prohibits Muzak LLC from
making certain payments such as dividend and distributions of their capital
stock, repurchases or redemptions of their capital stock, and investments (other
than permitted investments) unless certain conditions are met by Muzak LLC.
Before March 15, 2002, the issuers may redeem up to 35% of the aggregate
principal amount of the Senior Notes originally issued under the indenture at a
redemption price of 109.875% of the aggregate principal amount so redeemed, plus
accrued and unpaid interest to the redemption date, with the net proceeds of one
or more equity offerings if certain conditions are met. After March 15, 2004,
the issuers may redeem all or part of the Senior Notes at a redemption price
equal to 104.938% of the principal which redemption price declines to 100% of
the principal amount in 2007.
Senior Discount Notes
On March 18, 1999, the Company together with its wholly owned
subsidiary Muzak Holdings Finance Corp., co-issued $75.0 million in principal
amount at maturity, or $39.9 million in accreted value on the issue date, of 13%
Senior Discount Notes (the "Senior Discount Notes") due March 2010. Cash
interest on the Senior Discount Notes does not accrue and is not payable prior
to March 15, 2004. The Senior Discount Notes were issued at a substantial
discount from their principal amount at maturity. Until March 15, 2004, the
Senior Discount Notes will accrete in value such that the accreted value on
March 15, 2004 will equal the principal amount at maturity of the Senior
Discount Notes. From and after March 15, 2004, interest on the Senior Discount
Notes will accrue at a rate of 13% per annum. Interest will be payable
semi-annually in arrears on each March 15 and September 15, commencing September
15, 2004, to holders of record of the Senior Discount Notes at the close of
business on the immediately preceding March 1 and September 1.
9
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. Debt (Continued)
Annual Maturities of Debt
Annual maturities of debt obligations are as follows (in thousands):
2001 (remainder of the year) ................ $ 2,618
2002 ........................................ 6,773
2003 ........................................ 7,855
2004 ........................................ 27,742
2005 ........................................ 62,933
Thereafter ....................................... 253,593
Total interest paid by the Company on all indebtedness was $10.1
million and $23.3 million for the quarter and nine months ended September 30,
2001, respectively. Total interest paid by the Company on all indebtedness was
$12.1 million and $29.9 million for the quarter and nine months ended September
30, 2000. Accrued interest payable was $4.0 million and $5.2 million as of
September 30, 2001 and December 31, 2000, respectively.
Interest Rate Swap Agreements
At September 30, 2001, the Company had in effect one interest rate swap
agreement required by its Senior Credit Facility, with a notional amount of
$100.0 million. Muzak's interest rate swap agreement requires Muzak to pay a
fixed rate and receive a floating rate, thereby creating fixed rate debt. The
agreement is designated as a hedge of interest rates, and the differential to be
paid or received on the swap is recorded as an adjustment to interest expense.
The fair value of the interest rate swap agreement representing the cash the
Company would pay to settle the agreement, was approximately $3.1 million at
September 30, 2001. There were no amounts of hedge ineffectiveness related to
the Company's interest rate swap and no gains or losses were excluded from the
assessment of hedge effectiveness. During the quarter and nine months ended
September 30, 2001, the interest rate swap agreement resulted in an increase to
interest expense of approximately $0.8 million and $1.6 million, respectively.
6. MUZAK HOLDINGS FINANCE CORP.
Muzak Holdings Finance Corp. had no operating activities during the
quarter and nine months ended September 30, 2001.
7. COMMITMENTS AND CONTINGENCIES
Litigation
The Company is involved in various claims and lawsuits arising out of
the normal conduct of its business. Although the ultimate outcome of these legal
proceedings cannot be predicted with certainty, the management of the Company
believes that the resulting liability, if any, will not have a material effect
upon the Company's consolidated financial statements or liquidity.
The industry wide agreement between business music providers and
Broadcast Music Inc. ("BMI") expired in December 1993. Since this time the
Company has been operating under an interim agreement pursuant to which the
Company has continued to pay royalties at the 1993 rates. Business music
providers and BMI have been negotiating the terms of a new agreement. The
Company is involved in a rate court proceeding, initiated by BMI in Federal
Court in New York. At issue are the music license fees payable by the Company
and its owned operations as well as licensed independent franchisees to BMI. The
period from which such "reasonable" license fees are payable covers the period
January 1, 1994 to September 30, 2001, and likely several years thereafter. BMI
contends that those fee levels understate reasonable fee levels by as much as
10
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. Commitments and Contingencies (Continued)
100%. The Company vigorously contests BMI's assessment. The eventual court
ruling setting final fees for the period covered will require retroactive
adjustment, upward or downward, likely back to January 1, 1994, and possibly
will also entail payment of pre-judgment interest. Discovery in the proceeding
has commenced and is not yet completed. A trial date has not been set.
The industry wide agreement between business music providers and
American Society of Composers, Authors and Publishers ("ASCAP") expired in May
1999. Negotiations between ASCAP and the Company began in June 1999, and the
Company has continued to pay ASCAP royalties at the 1999 rates.
Other Commitments
As of September 30, 2001, the Company had approximately $32.0 million
in outstanding capital expenditure commitments for equipment provided to client
locations over a five year period and other commitments of $0.7 million. The
Company is the lessee under various operating and capital leases for equipment,
vehicles, satellite capacity, and buildings for periods ranging from 2 years to
15 years. On January 1, 2001, the Company entered into a 17 year commitment to
lease additional transponder space from Microspace.
8. RECENTLY ISSUED ACCOUNTING STANDARDS
Accounting for the Impairment or Disposal of Long-Lived Assets
In October 2001, FASB issued Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets". This Statement supersedes SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and the
accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions". This Statement retains the
requirements of SFAS No. 121 to recognize an impairment loss only if the
carrying amount of a long-lived asset is not recoverable from its undiscounted
cash flows and to measure an impairment loss as the difference between the
carrying amount and the fair value of the asset. However, this standard removes
goodwill from its scope and revises the approach for evaluating impairment. The
Company is evaluating the impact of the adoption of SFAS No. 144, but does not
expect that implementation of this standard will have a significant financial
impact.
Accounting for Asset Retirement Obligations
In August 2001, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 143, "Accounting for
Asset Retirement Obligations" ("SFAS No. 143"). This Statement addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated legal obligations of
such asset retirement costs. The Company does not expect that implementation of
this standard will have a significant financial impact.
Business Combinations and Goodwill and Other Intangible Assets
In July 2001, the FASB issued Statement of Financial Accounting
Standards No. 141, "Business Combinations" ("SFAS No.141") and Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("SFAS No. 142"). SFAS No. 141 requires that all business combinations be
accounted for under the purchase method. The statement further requires separate
recognition of intangible assets that meet one of two criteria. The statement
applies to all business combinations initiated after June 30, 2001.
11
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. Recently Issued Accounting Standards (Continued)
SFAS No. 142 requires that an intangible asset that is acquired shall be
initially recognized and measured based on its fair value. The statement also
provides that goodwill should not be amortized, but should be tested for
impairment annually, or more frequently if circumstances indicate potential
impairment, through a comparison of fair value to its carrying amount. Existing
goodwill will continue to be amortized through the remainder of 2001 at which
time amortization will cease and the Company will perform a transitional
goodwill impairment test. Adoption of SFAS No. 142 will have a material impact
on the Company's financial statements, due to the fact that goodwill
amortization is a significant non-cash expense. Goodwill amortization expense
for the quarter and nine months ended September 30,2001 was $2.0 million and
$5.9 million, respectively. While goodwill impairment charges may occur in
future periods, the Company is currently evaluating the impact of the new
accounting standards on existing goodwill and other intangible assets. SFAS No.
142 is effective for fiscal periods beginning after December 15, 2001.
Derivatives and Hedging Activities
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS
No. 133"). Subsequently, SFAS No. 133 was amended by the issuance of Statement
of Accounting Standards No. 137 and Statement of Accounting Standards No. 138.
The Company adopted SFAS No. 133, as amended, on January 1, 2001.
The Company uses a derivative financial instrument for purposes other than
trading, such as hedging for long-term debt and does so to reduce its exposure
to fluctuations in interest rates, as dictated by its Senior Credit Facility.
The Company's derivative is recognized on the balance sheet at its fair value.
The hedge is 100% effective for exposures to interest rate fluctuations. As a
result of the 100% effectiveness of the hedge, changes in the fair value of the
derivative are recorded each period in other comprehensive loss.
Comprehensive Income
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income", ("SFAS No. 130") requires the display of comprehensive
income or loss and its components as part of the Company's full set of financial
statements. Comprehensive income or loss is comprised of net income or loss and
other comprehensive income or loss. Other comprehensive income or loss includes
certain changes in equity that are excluded from net income, such as translation
adjustments and unrealized holding gains and losses on available-for-sale
marketable securities and certain derivative instruments, net of tax.
Prior to January 1, 2001, the Company did not have any transactions that
qualified as comprehensive income or loss. Upon adoption of SFAS No. 133, on
January 1, 2001, the Company recorded other comprehensive loss to recognize at
fair value a derivative that is designated as a cash flow hedging instrument,
which is comprised of unrealized losses related to the Company's interest rate
swap of $1.6 million. This unrealized loss increased by $1.5 million during the
nine months ended September 30, 2001 and the cumulative unrealized losses on the
Company's interest rate swap was $3.1 million as of September 30, 2001.
12
MUZAK HOLDINGS LLC
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Form 10-Q contains statements which, to the extent they are not
historical fact, constitute forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities and
Exchange Act of 1934 (the "Safe Harbor Acts"). All forward-looking statements
involve risks and uncertainties. The forward-looking statements in this Form
10-Q are intended to be subject to the safe harbor protection provided by the
Safe Harbor Acts.
Risks and uncertainties that could cause actual results to vary
materially from those anticipated in the forward-looking statements included in
this Form 10-Q include, but are not limited to, industry-based factors such as
the level of competition in the business music industry, competitive pricing,
concentrations in and dependence on satellite delivery capabilities, rapid
technological changes, the impact of legislation and regulation, as well as
factors more specific to the Company such as the substantial leverage and debt
service requirements, limitations imposed by the Company's debt facilities, the
Company's history of net losses, and the Company's ability to integrate
acquisitions, the Company's ability to obtain future financings to fund internal
growth, the Company's future capital requirements, the Company's dependence on
license agreements, and risks associated with economic conditions generally.
General
Muzak is the leading provider of business music programming in the
United States based on market share. We believe that, together with our
franchisees, we have a market share of approximately 60% of the estimated number
of U.S. business locations currently subscribing to business music programming.
Together with our franchisees, we have nationwide coverage and serve an
installed base of approximately 335,000 client locations.
Recent Developments
As announced on October 10, 2001, Stephen Villa has been named Chief
Operating Officer. In addition, he will serve as a Class B Director of the
Company. He joined Muzak in September 2000 as Chief Financial Officer and will
continue to serve in such capacity in addition to his role as Chief Operating
Officer. Steve succeeds Joseph Koff, who has left Muzak to pursue other
opportunities. Joe served as President and Chief Operating Officer of Muzak from
April 2000 to October 2001. With Joe's departure, the position of President has
been eliminated.
Results of Operations
Set forth below are discussions of the results of operations for Muzak
Holdings LLC for the quarter and nine months ended September 30, 2001 compared
to the quarter and nine months ended September 30, 2000.
Revenues. Total revenues for the third quarter of 2001 increased 1.3% to $50.5
million from the third quarter of 2000. Total revenues for the nine months ended
September 30, 2001 increased 6.8% to $151.2 million, up $9.7 million from the
comparable 2000 period. Music and other business services revenue increased 8.6%
and 9.6% for the quarter and nine months ended September 30, 2001, respectively,
as compared to the prior year comparable periods. Music and other business
services revenue increases are due to Muzak's growth in both Audio Marketing and
Audio Architecture clients resulting from both internal growth and acquisitions,
as well as the expansion of Muzak's drive-thru systems business. During the
twelve months ended September 30, 2001, through our sales and marketing efforts,
we added, net of churn, 17,000 Audio Architecture clients, 7,000 Audio
Marketing, and 2,200 other client locations, including drive-thru. The revenue
increase from client growth is partially offset by the loss of revenues due to
the renegotiated EchoStar agreement. During the nine months ended September 30,
2000, the Company recorded approximately $1.6 million of revenues under the
previous EchoStar agreement, whereas no revenues were recorded during the nine
months ended September 30, 2001
13
MUZAK HOLDINGS LLC
Item 2 Management's Discussion and Analysis (Continued)
under the new agreement. Equipment and related services revenue decreased 15.5%
to $12.7 million from the third quarter of 2000. This decrease is primarily due
to less capital spending associated with a reduction in new location store build
outs within the retail sector. Equipment and related services revenue was flat
for the nine months ended September 30, 2001 as compared to the nine months
ended September 30, 2000.
Cost of Revenues. Cost of revenues was $17.9 million for the quarters ended
September 30, 2001 and 2000. Cost of revenues for the nine months ended
September 30, 2001 decreased $0.4 million to $51.5 million as compared to the
same 2000 period. Cost of revenues, as a percentage of revenues was 35.5% and
36.0% for the quarters ended September 30, 2001 and 2000, respectively, and
34.0% and 36.7% for the nine months ended September 30, 2001 and September 30,
2000, respectively. This improvement is due to the leveraging of fixed costs
over a larger client base resulting from internal growth and headcount
reductions taken in the second half of 2000, as well as a $1.6 million charge in
the second quarter of 2000 recorded in connection with the renegotiated EchoStar
Agreement.
Selling, general and administrative expenses. Selling, general, and
administrative expenses were $16.4 million and $16.1 million for the quarters
ended September 30, 2001 and 2000, respectively, an increase of 2.1%. For the
nine months ended September 30, 2001, selling, general and administrative
expenses were $51.6 million, compared to $46.5 million in the comparable 2000
period. This increase is attributable to the one-time expenses of $0.7 million
recorded in the first quarter of 2001 related to the postponement of the senior
subordinated notes offering, as well as expenses associated with growth in
revenues. Amortization of deferred subscriber acquisition costs, a non-cash
component of selling, general, and administrative expenses, was $2.5 million and
$1.6 million for the quarters ended September 30, 2001 and 2000, respectively.
Excluding the amortization of deferred subscriber acquisition costs, selling,
general, and administrative expenses as a percentage of revenues were 27.6% and
28.9% for the quarters ended September 30, 2001 and 2000, respectively.
Depreciation and amortization expenses. Depreciation and amortization was $19.3
million and $16.2 million for the quarters ended September 30, 2001 and 2000,
respectively, an increase of 19.1%. Depreciation and amortization was $56.1
million and $45.7 million for the nine months ended September 30, 2001 and
September 30, 2000, respectively. This increase is due to the increase in
property and equipment in conjunction with Muzak's growth in the number of
client locations resulting from internal growth and acquisitions and the
increase in intangibles related to the acquisitions consummated in 2000.
Interest expense. Interest expense, net of interest income, was $9.2 million and
$12.3 million for the quarters ended September 30, 2001 and 2000, respectively,
a decrease of 24.8%. Interest expense, net of interest income, decreased $5.6
million, or 15.9%, to $29.6 million for the nine months ended September 30, 2001
as compared to the nine months ended September 30, 2000. The decrease in
interest expense is due to lower borrowing levels, as a result of the conversion
of related party notes to equity during the second quarter of 2001, as well as a
decrease in interest rates during 2001.
Income tax provision. The income tax provision (benefit) was $0.1 million and
($78) thousand for the quarters ended September 30, 2001 and 2000, respectively.
Muzak is a limited liability company and is treated as a partnership for income
tax purposes.
Net Loss. The combined effect of the foregoing resulted in a net loss of $12.5
million for the quarter ended September 30, 2001, compared to a net loss of
$12.6 million for the comparable 2000 period.
14
MUZAK HOLDINGS LLC
Item 2 Management's Discussion and Analysis (Continued)
The Company evaluates the operating performance of its business using
several measures, one of them being EBITDA (defined as earnings before
interest, income taxes (benefits), depreciation and amortization). EBITDA is not
intended to be a performance measure that should be regarded as an alternative
to, or more meaningful than, either operating income or net income as an
indicator of operating performance or cash flow as a measure of liquidity, as
determined in accordance with generally accepted accounting principles, known as
GAAP. However, management believes that EBITDA is a meaningful measure of
performance and that it is commonly used in similar industries to analyze and
compare companies on the basis of operating performance, leverage and liquidity;
nonetheless it is not necessarily comparable to similarly titled amounts of
other companies. Adjusted EBITDA represents EBITDA adjusted for one time
expenses and non cash charges. Adjusted EBITDA is calculated as follows:
Three Months Ended
----------------------------------------------------------------
September 30, 2001 September 30, 2000
----------------------------- -----------------------------
Net loss .......................................... $ (12,523) $ (12,621)
Depreciation and amortization ..................... 19,287 16,196
Interest .......................................... 9,226 12,270
Tax provision (benefit)............................ 109 (78)
Non Cash charges................................... 110 72
---------- ---------
Adjusted EBITDA.................................... $ 16,209 $ 15,839
========== =========
Nine Months Ended
---------------------------------------------------------------
September 30, 2001 September 30, 2000
------------------------------ ----------------------------
Net loss .......................................... $ (37,306) $ (38,271)
Depreciation and amortization ..................... 56,078 45,685
Interest........................................... 29,644 35,257
Tax provision (benefit)............................ (500) (17)
Non Cash charges................................... 285 501
One time expenses (a).............................. 675 --
---------- ---------
Adjusted EBITDA.................................... $ 48,876 $ 43,155
========== =========
(a) One-time expenses of $0.7 million recorded in the first quarter of 2001
related to the postponement of the senior subordinated notes offering.
Adjusted EBITDA for the quarter ended September 30, 2001 increased $0.4
million, or 2.3% to $16.2 million from $15.8 million for the quarter ended
September 30, 2000 and for the nine months ended September 30, 2001 increased
$5.7 million, or 13.3% to $48.9 million from $43.2 million for the same period
in 2000.
Liquidity and Capital Resources
During the nine month period ending September 30, 2001, our principal
sources of funds have been cash generated from operations and borrowings under
the revolving credit facility. Cash provided from operations, before deferred
subscriber acquisition costs, was $8.1 million and $35.0 million in the quarter
and nine months ended September 30 2001, respectively, an increase of $13.6
million and $29.7 million over the comparable periods of 2000. The increase in
cash provided by operations is due to improvements in working capital balances,
particularly accounts receivable balances. During the nine months ended
September 30, 2001, cash was used to make investments in new client locations,
interest and principal payments, the acquisition of Sound of Music, and for
general corporate purposes.
15
MUZAK HOLDINGS LLC
Item 2 Management's Discussion and Analysis (Continued)
We expect that our principal uses of funds provided by operations and
borrowings will be the funding of growth in new client locations, interest and
principal payments, and working capital requirements. The Company continues to
explore various financing alternatives, which would provide necessary liquidity
for future organic growth and acquisitions. However, the Company believes that
the cash flows from operations and current borrowing availability will be
sufficient to fund operations and investments associated with new client
locations through June 30, 2002.
Capital Investments. The majority of our capital expenditures are comprised of
the initial investment for the installation of equipment for new client
locations. During the nine months ended September 30, 2001, the total initial
investment in new client locations and investments in existing client locations
due to adding additional services was $36.4 million, which was comprised of
equipment and installation costs attributable to new client locations of $24.5
million and $11.9 million in deferred subscriber acquisition costs relating to
these new locations or additional services. The deferred subscriber acquisition
costs are capitalized in deferred charges and other assets, net, and are
amortized as a component of selling, general, and administrative expenses over
the initial contract term of five years. If a client's contract terminates
early, the unamortized deferred subscriber acquisition costs are typically
recovered. Also, we typically receive installation revenue relating to new
client locations. This revenue is deferred and amortized as a component of
equipment and related services over the initial contract term of five years.
We currently anticipate that our total initial investment in new client
locations for the remainder of fiscal 2001 will be approximately $10.5 million,
including $6.6 million of equipment and installation costs attributable to new
client locations, and $3.9 million in deferred subscriber acquisition costs
relating to new client locations.
Debt Maturities. The current maturities of long-term debt primarily consist of
the current portion of the senior credit facility and other miscellaneous debt.
The maturities of long-term debt of our operations as of September 30, 2001
during the remainder of 2001 and 2002, 2003, 2004, 2005, and thereafter are $2.6
million, $6.8 million, $7.9 million, $27.7 million, $62.9 million, and $253.6
million, respectively.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
For the period ended September 30, 2001, the Company did not experience
any material changes in market risk disclosure that affect the quantitative and
qualitative disclosures presented in the 10-K.
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings.
There have been no material developments in legal proceedings involving
the Company since those reported in the Company's Report on Form 10-K for fiscal
year ended December 31, 2000.
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
(b) Reports on Form 8-K
During the quarter ended September 30, 2001, the Company filed no
reports on Form 8-K. However, on October 10, 2001, the Company filed an 8-K
announcing Stephen Villa as Chief Operating Officer.
16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrants have duly caused this report to be signed on their behalf by the
undersigned thereunto duly authorized.
MUZAK HOLDINGS LLC
MUZAK FINANCE CORP.
By: /s/ William A. Boyd
---------------------------------
Date: November 14, 2001 William A. Boyd
Chief Executive Officer
(Principal Executive Officer)
By: /s/ Stephen P. Villa
---------------------------------
Date: November 14, 2001 Stephen P. Villa
Chief Operating Officer
(Principal Financial
Officer and Chief
Accounting Officer)
17