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 June 30, 2002.
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: 333-78571
333-78571-01
MUZAK LLC
MUZAK FINANCE CORP.
(Exact Name of Registrants as Specified in their charter)
DELAWARE 04-3433729
DELAWARE 56-2187963
(State or Other Jurisdiction of (I.R.S. Employer
Incorporated or Organization) Identification No.)
3318 LAKEMONT BLVD
FORT MILL, SC 29708
(803) 396-3000
(Address, Including Zip Code and Telephone Number including Area Code of
Registrants' Principal Executive Offices)
Indicate by check mark whether the registrants have filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days.
Yes [X] No [ ]
Muzak 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.
Muzak Finance Corp. had 100 shares of outstanding common stock as of August 14,
2002.
1
PART I-FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
MUZAK LLC
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
June 30, December 31,
2002 2001
------------------ -------------------
ASSETS
Current assets:
Cash ....................................................................... $ 317 $ 2,583
Accounts receivable, net of allowances of $1,731 and $1,943 ................ 23,353 24,313
Inventory .................................................................. 11,072 9,402
Prepaid expenses and other assets .......................................... 2,151 1,441
--------- ---------
Total current assets ................................................... 36,893 37,739
Property and equipment, net ..................................................... 113,691 118,019
Intangible assets, net .......................................................... 281,030 292,546
Deferred charges and other assets, net .......................................... 50,405 47,638
--------- ---------
Total assets ........................................................... $ 482,019 $ 495,942
========= =========
LIABILITIES AND MEMBER'S INTEREST
Current liabilities:
Current maturities of long term debt ....................................... $ 7,152 $ 6,775
Current maturities of other liabilities .................................... 4,066 4,115
Accounts payable ........................................................... 5,548 5,192
Accrued expenses ........................................................... 21,818 21,278
Advance billings ........................................................... 1,292 870
--------- ---------
Total current liabilities .............................................. 39,876 38,230
Long-term debt .................................................................. 293,021 298,284
Related party notes ............................................................. 10,000 --
Other liabilities ............................................................... 9,997 12,895
Commitments and contingencies
Member's interest:
Common units (100 issued and outstanding) ................................ 260,053 260,373
Accumulated other comprehensive loss ..................................... (94) (2,455)
Accumulated deficit ...................................................... (130,834) (111,385)
--------- ---------
Total member's interest ................................................ 129,125 146,533
--------- ---------
Total liabilities and member's interest ................................ $ 482,019 $ 495,942
========= =========
The Notes are an integral part of these consolidated financial statements.
2
MUZAK LLC
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands)
Quarter Ended Six Months Ended
------------------------------------ -------------------------------
June 30, June 30, June 30, June 30,
2002 2001 2002 2001
----------------- ------------------ ----------------- -------------
Revenues:
Music and other business services ................ $ 40,406 $ 37,113 $ 79,946 $ 73,931
Equipment and related services ................... 13,663 13,623 25,086 26,773
-------- -------- -------- --------
54,069 50,736 105,032 100,704
Cost of revenues:
Music and other business services (excluding
$10,951, $9,268, $21,736 and $17,856 of
depreciation and amortization expense) ......... 10,888 6,894 18,648 14,560
Equipment and related services ................... 11,043 10,016 20,601 18,997
-------- -------- -------- --------
21,931 16,910 39,249 33,557
-------- -------- -------- --------
32,138 33,826 65,783 67,147
Selling, general and administrative expenses .......... 17,851 17,128 35,922 35,155
Depreciation and amortization expense ................. 17,408 18,509 35,258 36,791
-------- -------- -------- --------
Loss from operations ......................... (3,121) (1,811) (5,397) (4,799)
Other income (expense):
Interest expense ................................. (7,012) (7,770) (14,759) (17,051)
Other, net ....................................... 97 (96) 116 (102)
-------- -------- -------- --------
Loss before income taxes ..................... (10,036) (9,677) (20,040) (21,952)
Income tax benefit .................................... (288) (172) (591) (609)
-------- -------- -------- --------
Net loss ..................................... $ (9,748) $ (9,505) $(19,449) $(21,343)
======== ========= ======== ========
The Notes are an integral part of these consolidated financial statements.
3
MUZAK LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
Quarter Ended Six Months Ended
--------------------- ----------------------
June 30, June 30, June 30, June 30,
2002 2001 2002 2001
--------- -------- -------- --------
CASH FLOW FROM OPERATING ACTIVITIES
Net loss .................................................................. $(9,748) $(9,505) $(19,449) $(21,343)
Adjustments to derive cash flow from continuing operating activities:
Gain (loss) on disposal of fixed assets ................................... (2) 114 (13) 109
Deferred income tax benefit ............................................... (288) (172) (591) (609)
Depreciation and amortization ............................................. 17,408 18,509 35,258 36,791
Amortization of deferred financing fees ................................... 491 390 886 780
Amortization of deferred subscriber acquisition costs ..................... 3,043 2,279 5,922 4,352
Deferred subscriber acquisition costs ..................................... (3,747) (3,956) (7,226) (7,893)
Unearned installment income ............................................... (319) (238) (737) (332)
Change in certain assets and liabilities, net of business acquisitions
Decrease (increase) in accounts receivable ............................. (25) 1,879 961 9,612
Decrease (increase) in inventory ....................................... (1,613) 1,219 (1,670) 220
Increase (decrease) in accrued interest ................................ 1,781 3,990 (2,891) 1,532
Increase (decrease) in accounts payable ................................ 373 449 (962) (4,326)
Increase (decrease) in accrued expenses ................................ 570 (982) 2,801 (568)
Increase (decrease) in advance billings ................................ (316) (406) 422 586
Other, net ............................................................. 300 (552) (135) 140
------- ------- ------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES ............................ 7,908 13,018 12,576 19,051
------- ------- ------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisitions, net of cash ................................................. -- (979) -- (979)
Capital expenditures ...................................................... (8,587) (10,384) (18,054) (21,136)
Proceeds from sale of fixed assets ........................................ 5 271 18 280
-------- ------- ------- --------
NET CASH USED IN INVESTING ACTIVITIES ................................ (8,582) (11,092) (18,036) (21,835)
-------- ------- ------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in book overdrafts .................................... 430 1,057 1,318 (2,227)
Repayments of senior credit facility ...................................... (3,347) (2,597) (3,347) (2,597)
Repayments on revolver .................................................... -- -- (10,000) --
Borrowings on revolver .................................................... 4,500 -- 8,500 8,500
Issuance of notes payable to a related party .............................. -- -- 10,000 --
Payment of interest rate protection agreement ............................. (372) -- (372) --
Repayments of capital lease obligations and other debt .................... (716) (503) (1,373) (1,081)
Payment of fees associated with the financing ............................. (18) -- (1,532) --
-------- ------- ------- --------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES ................... 477 (2,043) 3,194 2,595
-------- ------- ------- --------
NET DECREASE IN CASH ...................................................... (197) (117) (2,266) (189)
CASH, BEGINNING OF PERIOD ................................................. 514 2,940 2,583 3,012
CASH, END OF PERIOD ....................................................... $ 317 $ 2,823 $ 317 $ 2,823
======= ======= ======= ========
Significant non-cash activities:
Equity contribution from Parent ........................................... -- 33,707 -- 33,707
Capital lease obligations ................................................. 626 356 1,291 469
The Notes are an integral part of these consolidated financial statements.
4
MUZAK LLC
CONSOLIDATED STATEMENT OF CHANGES IN MEMBER'S INTEREST
(Unaudited)
(in thousands, except for units)
Accumulated
Other Total
Common Units Accumulated Comprehensive Member's
Units Dollars Deficit Loss Interest
----- ------- ----------- ------------- --------
Balance at December 31, 2001 100 $260,373 $(111,385) $(2,455) $146,533
Comprehensive Loss:
Net loss (9,701) (9,701)
Change in unrealized losses on
derivative 1,182 1,182
-------- -------- --------
Total comprehensive loss (9,701) 1,182 (8,519)
Financing fees incurred on behalf of
member (300) (300)
--- -------- --------- ------- --------
Balance at March 31, 2002 100 $260,073 $(121,086) $(1,273) $137,714
=== ======== ========= ======= ========
Comprehensive Loss:
Net loss (9,748) (9,748)
Change in unrealized losses on
derivative 1,179 1,179
--------- ------- --------
Total comprehensive loss (9,748) 1,179 (8,569)
Financing fees incurred on behalf of
member (20) (20)
--- -------- --------- ------- --------
Balance at June 30, 2002 100 $260,053 $(130,834) $ (94) $129,125
=== ======== ========= ======= ========
The Notes are an integral part of these consolidated financial statements.
5
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
Muzak LLC ("the Company"), a Delaware limited liability company, is a
wholly owned subsidiary of Muzak Holdings LLC (the "Parent"). The Company
provides business music programming to clients through its integrated nationwide
network of owned operations and franchises. All of the operating activities are
conducted through the Company and its subsidiaries.
As of June 30, 2002, ABRY Partners, LLC and its respective affiliates,
collectively own approximately 64.2% of the beneficial interests in the Parent's
voting interests.
2. BASIS OF PRESENTATION
The condensed consolidated financial statements include the accounts of the
Company and its subsidiaries: Muzak Capital Corporation, Muzak Finance
Corporation, Business Sound Inc., Electro Systems Corporation, BI Acquisition
LLC, MLP Environmental Music LLC, Audio Environments Inc., Background Music
Broadcasters Inc., Telephone Audio Productions Inc., Vortex Sound Communications
Company Inc., Music Incorporated, and Muzak Houston, Inc. All significant
intercompany items have been eliminated in consolidation.
The accompanying unaudited interim consolidated financial statements have
been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X, and accordingly, certain financial information has been
condensed and certain footnote disclosures have been omitted. Such information
and disclosures are normally included in financial statements prepared in
accordance with generally accepted accounting principles in the United States.
For further information, refer to the consolidated financial statements and
footnotes thereto included in the Muzak LLC Annual Report on Form 10-K for the
fiscal year ended December 31, 2001.
The financial statements as of June 30, 2002 and 2001 and for the three and
six months then ended are unaudited; however, in the opinion of management, such
statements include all adjustments (consisting solely of normal recurring
adjustments) necessary for a fair statement of the financial information
included herein in accordance with generally accepted accounting principles in
the United States. The preparation of consolidated financial statements in
conformity with 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 2002 presentation.
6
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
Useful June 30, December 31,
Life 2002 2001
(years) (Unaudited)
--------------------------------------------------
Equipment provided to subscribers .......................... 4-6 $ 130,626 $121,084
Capitalized installation labor ............................. 5 54,977 48,802
Equipment .................................................. 5-7 23,127 21,151
Other ...................................................... 3-30 17,060 16,248
--------- --------
225,790 207,285
Less accumulated depreciation ............................. (112,099) (89,266)
--------- --------
$ 113,691 $118,019
========= ========
Included in equipment and other at June 30, 2002 and December 31, 2001 is
$12.9 million and $11.6 million, respectively, of equipment under capital
leases, gross of accumulated depreciation of $8.1 million and $6.6 million,
respectively. Depreciation of property and equipment was $11.4 and $23.0 million
for the quarter and six months ended June 30, 2002, respectively, and $9.8
million and $19.1 million for the quarter and six months ended June 30, 2001,
respectively.
4. INTANGIBLE ASSETS
The Company adopted Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets" ("SFAS No. 142") on January 1, 2002. In
connection with the adoption of SFAS No. 142, the Company reclassified other
intangibles of $6.4 million related to trained workforce to goodwill and ceased
amortization of goodwill. During the first quarter, the Company evaluated the
useful lives of its existing intangible assets and concluded that, with the
exception of goodwill, all of its intangible assets have definite lives and that
the existing useful lives are reasonable.
SFAS No. 142 requires that goodwill be tested annually at the reporting
unit level for impairment using a two-step process. A reporting unit is the
operating segment unless, at businesses one level below the operating segment,
discrete financial information is prepared and regularly reviewed by management.
The first step is to identify a potential impairment and, in transition, this
step must be measured as of the beginning of the fiscal year. The second step of
the goodwill impairment test measures the amount of the impairment loss (also
measured as of the beginning of the fiscal year in year of transition), if any,
and must be completed by the end of the Company's fiscal year. The Company
completed its testing of goodwill in accordance with SFAS No. 142 during the
quarter ended June 30, 2002. As the fair value of goodwill exceeds the carrying
amount of goodwill, the Company did not record an impairment charge. SFAS No.
142 requires goodwill of a reporting unit to be tested for impairment on an
annual basis and between annual tests in certain circumstances.
A detailed determination of the fair value of a reporting unit may be
carried forward from one year to the next if the assets and liabilities that
make up the reporting unit have not changed significantly since the most recent
fair value determination, the most recent fair value determination resulted in
an amount that exceeded the carrying amount of the reporting unit by a
substantial margin, and based on the analysis and events that have occurred
since the most recent fair value determination, the likelihood that a current
fair value determination would be less than the current carrying amount of the
reporting unit is remote. Based on the most recent fair value determination, the
Company has elected to carry forward the detailed determination performed during
the second quarter of 2002 to 2003.
7
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Unamortized intangible assets consist of the following (in thousands):
June 30, 2002 December 31, 2001
Carrying Amount Carrying Amount
(unaudited)
--------------------------------------------
Goodwill ................................... $140,805 $137,917
Trained workforce .......................... -- 2,868
The following presents net loss exclusive of amortization of goodwill and
trained workforce (in thousands):
For the Quarter Ended June 30,
2002 2001
---------------------------------------
Net Loss ........................................ $ (9,748) $ (9,505)
Goodwill amortization ........................... -- 1,980
Trained workforce amortization .................. -- 319
-------- --------
Net Loss excluding amortization of goodwill ..... $ (9,748) $ (7,206)
======== ========
For the Six Months Ended June 30,
2002 2001
---------------------------------------
Net Loss ........................................ $(19,449) $(21,343)
Goodwill amortization ........................... -- 3,964
Trained workforce amortization .................. -- 638
-------- --------
Net Loss excluding amortization of goodwill ..... $(19,449) $(16,741)
======== ========
Amortized intangible assets consist of the following (in thousands):
June 30, 2002 December 31, 2001
(unaudited)
Useful ---------------------------------- ------------------------------------
Life Gross Carrying Accumulated Gross Carrying Accumulated
(years) Amount Amortization Amount Amortization
---------- ---------------------------------- ------------------ -----------------
Income producing contracts ...... 12 $153,955 $(40,202) $154,048 $(33,786)
License agreements .............. 20 5,082 (826) 5,082 (699)
Deferred production costs ....... 10 5,181 (946) 4,437 (701)
Trademarks ...................... 5 15,111 (9,730) 14,935 (8,219)
Non-compete agreements .......... 3-5 19,983 (16,339) 23,869 (16,560)
Other ........................... 20 10,556 (1,600) 10,778 (1,423)
-------- -------- -------- --------
$209,868 $(69,643) $213,149 $(61,388)
======== ======== ======== ========
Aggregate amortization expense was $6.0 million and $12.3 million for the
quarter and six months ended June 30, 2002, respectively, and $8.5 million and
$17.5 million for the quarter and six months ended June 30, 2001, respectively.
The estimated future aggregate amortization expense is as follows (in
thousands):
Fiscal year ending
------------------
2002 ............................... $23,163
2003 ............................... 18,285
2004 ............................... 14,986
2005 ............................... 14,150
2006 ............................... 14,117
8
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. DEFERRED CHARGES AND OTHER ASSETS, NET
Deferred charges and other assets, net, consist of the following (in
thousands):
June 30, 2002 December 31, 2001
(Unaudited)
------------- -----------------
Subscriber acquisition costs, net ................................ $38,746 $37,442
Other ............................................................ 11,659 10,196
------ ------
$50,405 $47,638
======= =======
6. ACCRUED EXPENSES
Accrued expenses are summarized below (in thousands):
June 30, 2002 December 31, 2001
(Unaudited)
------------- -----------------
Accrued interest ................................................. $ 3,602 $ 6,493
Accrued compensation and benefits ................................ 3,909 3,671
Licensing royalties ............................................. 5,125 1,897
Other ............................................................ 9,182 9,217
------- -------
$21,818 $21,278
======= =======
7. DEBT
Debt obligations consist of the following (in thousands):
June 30, 2002 December 31, 2001
(Unaudited)
------------- -----------------
Related Party Notes ............................................... $ 10,000 $ --
======== =======
Long term debt:
Revolving Loan-Senior Credit Facility ........................... $ 19,800 $ 21,300
Senior Credit Facility .......................................... 162,860 166,207
Senior Subordinated Notes ....................................... 115,000 115,000
Other ........................................................... 2,513 2,552
-------- --------
Total debt obligations ............................................ 300,173 305,059
Less current maturities ........................................... (7,152) (6,775)
-------- --------
$293,021 $298,284
======== ========
Senior Credit Facility
The Senior Credit Facility is guaranteed by the Parent, the Company and
certain 100% owned subsidiaries. The non-guarantor subsidiary is considered
minor and the consolidated amounts in the Company's financial statements are
representative of the combined guarantor's financial statements. The Amended
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.
9
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In March 2002, the Company entered into the sixth amendment under the
Senior Credit Facility, which increased its aggregate revolving loan commitment
under the Senior Credit Facility by $20.0 million, for a total commitment of
$55.0 million, and amended certain financial covenants and applicable margins.
As amended in March 2002, indebtedness under the Term Loan A and the
Revolving Loans 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 2.00% to 3.00% 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 3.00% to 4.00%.
Margins, which are subject to adjustment based on the changes in the Company's
ratio of consolidated total debt to EBITDA (i.e., earnings before interest,
taxes, depreciation, amortization, other non cash charges, and certain other
items as defined by the agreement) were 2.50% in the case of Alternate Base Rate
and 3.50% in the case of LIBOR as of June 30, 2002. 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 3.5% or (ii) LIBOR
of one, two, three, or six months, as selected by the Company plus a margin of
4.5%. The weighted average rate of interest on the Senior Credit Facility,
including the effects of the interest rate swap, if any, was 6.2% and 9.9% at
June 30, 2002 and 2001, respectively.
Senior Subordinated Notes
On March 18, 1999, the Company 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 Subordinated Notes") which mature on March
15, 2009. Interest is payable semi-annually, in arrears, on March 15 and
September 15 of each year. The Senior Subordinated Notes are general unsecured
obligations of the Company and Muzak Finance and are subordinated in right of
payment to all existing and future Senior Indebtedness of the Company and Muzak
Finance. The Senior Subordinated Notes are guaranteed by the Parent, 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. The Company's non-guarantor
subsidiary is minor and the consolidated amounts in the Company's financial
statements are representative of the combined guarantors. The indenture
governing the Senior Subordinated Notes prohibits the Company from making
certain payments such as dividends and distributions of their capital stock;
repurchases or redemptions of their capital stock, and investments (other than
permitted investments) unless certain conditions are met by the Company. After
March 15, 2004, the issuers may redeem all or part of the Notes at a redemption
price equal to 104.938% of the principal which redemption price declines to 100%
of the principal amount in 2007.
Related Party Notes
In March 2002, MEM Holdings LLC contributed $10.0 million to the Company in
the form of junior subordinated unsecured notes (the "sponsor notes"), the
proceeds of which were used to repay outstanding revolving loan balances. MEM
Holdings is a company that owns 64.2% of the voting interests in the Parent.
ABRY Broadcast Partners III and ABRY Broadcast Partners II are the beneficial
owners of MEM Holdings.
The sponsor notes accrue interest at 15% per annum; any accrued interest
not paid as of March 31, June 30, September 30 or December 31 will bear interest
at 15% per annum until such interest is paid or extinguished. The sponsor notes
are junior and subordinate to payments for the Senior Credit Facility, and the
Senior Subordinated Notes. At any time, the sponsor notes may be converted into
Class A-2 units of the Parent at the direction of MEM Holdings. If the sponsor
notes have not been repaid in full as of September 2003, the sponsor notes will
automatically be converted into Class A-2 units of the Parent.
10
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Other Debt
The Company has $2.2 million of promissory notes which, with the exception
of one, bear interest at 9.887% and mature in November 2016. The Company is
required to make interest only payments on a monthly basis through October 2006,
and principal and interest payments for the remainder of the term. The note
terms are the same for all but one of the notes. This note bears interest at 8%
with principal and interest payments due monthly until maturity in October 2006.
Liquidity
The Company's principal sources of funds will continue to be cash flows
from operations and borrowings under the senior credit facility. As of June 30,
2002, the Company had outstanding debt of $182.7 million under its senior credit
facility, with additional available borrowings of up to $35.0 million. Based
upon current and anticipated levels of operations, the Company believes that its
cash flows from operations, combined with availability under the senior credit
facility, as amended, will be adequate to meet its liquidity needs for the
foreseeable future. The Company is continuing its efforts to improve working
capital balances, while also implementing additional cost-saving initiatives,
such as more efficiently utilizing its capital resources associated with new
client locations. Overall, the Company's business plan anticipates continued
growth in new client locations and operational improvements. The Company's
future performance is subject to industry based factors such as the level of
competition in the business music industry, competitive pricing, concentrations
in and dependence on satellite delivery capabilities, rapid technological
changes, the impact of legislation and regulation, its dependence on license
agreements and other factors that are beyond its control.
Annual Maturities
Annual maturities of long-term debt obligations are as follows (in
thousands):
2002 ................................................ $ 3,388
2003 ................................................ 7,855
2004 ................................................ 27,742
2005 ................................................ 62,733
2006 ................................................ 81,700
Thereafter .......................................... 126,755
Total interest paid by the Company on all indebtedness was $4.3 million and
$16.6 million for the quarter and six months ended June 30, 2002, respectively
and $3.0 million and $13.2 million for the quarter and six months ended June 30,
2001. The weighted average interest rate on all indebtedness was 7.9% and 9.9%
as of June 30, 2002 and 2001, respectively.
Interest Rate Protection Programs
The Company had an interest rate swap agreement which terminated in April
2002. The effect of this agreement on the operating results of the Company was
to increase interest expense by $0.4 million and $1.6 million for the quarter
and six months ended June 30, 2002, respectively and $0.5 million and $0.8
million for the quarter and six months ended June 30, 2001.
11
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company entered into a three year interest rate cap on April 19, 2002,
for which it paid a premium of $0.4 million. The interest rate cap protects the
Company against LIBOR increases above 7.25% and is designated as a hedge of
interest rates. Accordingly, the derivative will be recognized on the balance
sheet at its fair value. The hedge is considered 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 will be recorded in other
comprehensive loss. The Company will amortize the premium paid for the cap over
the life of the agreement using the caplets approach and any amounts received
under the cap will be recorded as a reduction to interest expense. The fair
market value of the interest rate cap was $0.3 million as of June 30, 2002. The
fair values of interest rate caps are obtained from dealer quotes which
represents the estimated amount the Company would receive or pay to terminate
agreements taking into consideration current interest rates and creditworthiness
of the counterparties.
8. Related Party Transactions
During the six months ended June 30, 2002, the Company incurred fees of
$0.2 million under the Management and Consulting Services Agreement with ABRY
Partners. Either the Company or ABRY Partners, with the approval of the Board of
Directors of the Parent, may terminate the Management Agreement by prior written
notice to the other.
During the quarter ended March 31, 2002, the Company borrowed $10.0 million
from MEM Holdings under junior subordinated notes. At any time, the sponsor
notes may be converted into Class A-2 units of the Parent at the direction of
MEM Holdings. If the sponsor notes have not been repaid in full as of September
2003, the sponsor notes will automatically be converted into Class A-2 units of
the Parent.
As of June 30, 2002, the Parent has obligations of $60.6 million of senior
discount notes and mandatorily redeemable preferred units ("preferred units") of
$99.9 million. These obligations are not reflected in the Company's accompanying
balance sheets or income statements as the Company has no pledge of assets nor
guarantee that provides security for the Parent's obligations. Cash interest on
the senior discount notes does not accrue until March 15, 2004. Thereafter, cash
interest on the senior discount notes will accrue at a rate of 13% per annum and
will be payable in arrears on March 15 and September 15 of each year, commencing
on September 15, 2004. The preferred units accrue a preferential return of 15%
per annum, which is compounded quarterly. The Parent was in default of the unit
coverage and total leverage ratio under the Securities Purchase Agreement as of
June 30, 2002. As a result of the default, the preferred units will accrue at a
preferential return of 17% per annum as long as the default is continuing. The
Parent projects that it will be in compliance as of September 30, 2002, and
therefore, the preferred units will resume accruing at 15% per annum on October
1, 2002. The preferential return is payable in kind through October 2005, and
thereafter the 15% preferential return will be payable in cash or in kind at the
Parent's option. The Parent does not have any operations or assets other than
its ownership of Muzak. Accordingly, the Parent is dependent on distributions
from the Company in order to pay interest beginning in 2004 as discussed above.
The Company's senior credit facility and senior subordinated notes indenture
impose restrictions on its ability to make distributions to the Parent. The
senior credit facility and the senior subordinated notes indenture permit the
Company to make payments and distributions to the Parent after September 15,
2004 in an amount sufficient to permit the Parent to make cash interest payments
when due, however the senior credit facility requires that certain financial
covenant levels be met in order to make such distributions. During the six
months ended June 30, 2002, the Company incurred $0.3 million of financing fees
in conjunction with an amendment to the manditorily redeemable preferred units
agreement on behalf of the Parent. Such payment was recorded as a reduction of
the Parent's investment in the Company.
9. MUZAK FINANCE CORP.
Muzak Finance Corp. had no operating activities during the six months ended
June 30, 2002 and 2001.
12
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. 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 June
30, 2002, and likely several years thereafter. BMI contends that those fee
levels understate reasonable fee levels by as much as 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.
In October 1998, the Digital Millennium Copyright Act was enacted. The Act
provides for a statutory license from the copyright owners of master recordings
to make and use ephemeral copies of such recordings. Ephemeral copies refer to
temporary copies of master sound recordings made to enable or facilitate the
digital transmission of such recordings. The Digital Millennium Copyright Act
did not specify the rate and terms of the license. As a result, the United
States Copyright Office convened a Copyright Arbitration Royalty Panel to
recommend an ephemeral royalty rate. In February 2002, the Panel recommended an
ephemeral royalty rate of ten percent (10%) of gross proceeds applicable to the
use of ephemeral copies. That recommendation was subject to review by the
Librarian of Congress, who could have modified or adopted such recommendation.
In June 2002, the Librarian of Congress published his final decision to
adopt the Copyright Arbitration Royalty Panel's recommendation of a ten percent
(10%) ephemeral royalty rate, which covers the period from October 1998 through
the present. As a result, we are required to remit payment by October 20, 2002
for the above mentioned period.
With respect to future revenue subject to such ephemeral royalty rate, we
believe our exposure is minimal, as we believe our current satellite
technologies do not require use of ephemeral copies. Nonetheless, there can be
no assurances that the collective for the copyright owners will refrain from
investigating or otherwise challenging the applicability of the statute to our
satellite technologies.
During the quarter ended June 30, 2002, the Company increased its estimated
reserve for prior period licensing royalties and related expenses by $3.1
million to $4.0 million. This charge is recorded in cost of music and other
business services revenues.
Other Commitments
As of June 30, 2002, the Company has approximately $32.5 million in
outstanding capital expenditure commitments over a five year period. 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.
13
PART I- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
MUZAK HOLDINGS LLC
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
June 30, December 31,
2002 2001
------------ ------------
ASSETS
Current assets:
Cash......................................................................... $ 317 $ 2,583
Accounts receivable, net of allowances of $1,731 and $1,943.................. 23,353 24,313
Inventory.................................................................... 11,072 9,402
Prepaid expenses and other assets............................................ 2,151 1,441
--------- ---------
Total current assets..................................................... 36,893 37,739
Property and equipment, net....................................................... 113,691 118,019
Intangible assets, net............................................................ 281,030 292,546
Deferred charges and other assets, net............................................ 52,621 50,020
--------- ---------
Total assets............................................................. $ 484,235 $ 498,324
========= =========
LIABILITIES AND MEMBERS' INTEREST
Current liabilities:
Current maturities of long term debt......................................... $ 7,152 $ 6,775
Current maturities of other liabilities...................................... 4,066 4,115
Accounts payable............................................................. 5,548 5,192
Accrued expenses............................................................. 21,818 21,278
Advance billings............................................................. 1,292 870
--------- ---------
Total current liabilities................................................ 39,876 38,230
Long-term debt.................................................................... 353,598 355,145
Related party notes............................................................... 10,000 --
Other liabilities................................................................. 9,997 12,895
Commitments and contingencies
Manditorily redeemable preferred units............................................ 99,878 92,266
Members' interest:
Class A units.............................................................. 125,697 133,141
Class B units.............................................................. 774 1,263
Accumulated other comprehensive loss....................................... (94) (2,455)
Accumulated deficit........................................................ (155,491) (132,161)
--------- ---------
Total members' interest.................................................. (29,114) (212)
--------- ---------
Total liabilities and members' interest.................................. $ 484,235 $ 498,324
========= =========
The Notes are an integral part of these consolidated financial statements.
2
MUZAK HOLDINGS LLC
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands)
Quarter Ended Six Months Ended
----------------------------- ---------------------------
June 30, June 30, June 30, June 30,
2002 2001 2002 2001
---------- --------- --------- ---------
Revenues:
Music and other business services................. $ 40,406 $ 37,113 $ 79,946 $ 73,931
Equipment and related services.................... 13,663 13,623 25,086 26,773
---------- --------- --------- ---------
54,069 50,736 105,032 100,704
Cost of revenues:
Music and other business services (excluding
$10,951, $9,268, $21,736 and $17,856 of
depreciation and amortization expense).......... 10,888 6,894 18,648 14,560
Equipment and related services.................... 11,043 10,016 20,601 18,997
---------- --------- --------- ---------
21,931 16,910 39,249 33,557
---------- --------- --------- ---------
32,138 33,826 65,783 67,147
Selling, general and administrative expenses........... 17,851 17,128 35,922 35,155
Depreciation and amortization expense.................. 17,408 18,509 35,258 36,791
---------- --------- --------- ---------
Loss from operations.......................... (3,121) (1,811) (5,397) (4,799)
Other income (expense):
Interest expense.................................. (9,048) (9,576) (18,640) (20,492)
Other, net........................................ 97 (96) 116 (102)
---------- --------- --------- ---------
Loss before income taxes...................... (12,072) (11,483) (23,921) (25,393)
Income tax benefit..................................... (288) (172) (591) (609)
---------- --------- --------- ---------
Net loss...................................... $ (11,784) $ (11,311) $ (23,330) $ (24,784)
========== ========= ========= =========
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 Six Months Ended
-------------------- --------------------
June 30, June 30, June 30, June 30,
2002 2001 2002 2001
-------- -------- -------- --------
CASH FLOW FROM OPERATING ACTIVITIES
Net loss ................................................................. $(11,784) $(11,311) $(23,330) $(24,784)
Adjustments to derive cash flow from continuing operating activities:
Gain (loss) on disposal of fixed assets .................................. (2) 114 (13) 109
Deferred income tax benefit .............................................. (288) (172) (591) (609)
Depreciation and amortization ............................................ 17,408 18,509 35,258 36,791
Amortization of senior discount notes .................................... 1,955 1,723 3,717 3,276
Amortization of deferred financing fees .................................. 572 473 1,050 945
Amortization of deferred subscriber acquisition costs .................... 3,043 2,279 5,922 4,352
Deferred subscriber acquisition costs .................................... (3,747) (3,956) (7,226) (7,893)
Unearned installment income .............................................. (319) (238) (737) (332)
Change in certain assets and liabilities, net of business acquisitions
Decrease (increase) in accounts receivable ............................ (25) 1,879 961 9,612
Decrease (increase) in inventory ...................................... (1,613) 1,219 (1,670) 220
Increase (decrease) in accrued interest ............................... 1,781 3,990 (2,891) 1,532
Increase (decrease) in accounts payable ............................... 373 449 (962) (4,326)
Increase (decrease) in accrued expenses ............................... 570 (982) 2,801 (568)
Increase (decrease) in advance billings ............................... (316) (406) 422 586
Other, net ............................................................ 300 (552) (135) 140
-------- -------- -------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES ........................... 7,908 13,018 12,576 19,051
-------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisitions, net of cash ................................................ -- (979) -- (979)
Capital expenditures ..................................................... (8,587) (10,384) (18,054) (21,136)
Proceeds from sale of fixed assets ....................................... 5 271 18 280
-------- -------- -------- --------
NET CASH USED IN INVESTING ACTIVITIES ............................... (8,582) (11,092) (18,036) (21,835)
-------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in book overdrafts ................................... 430 1,057 1,318 (2,227)
Repayments of senior credit facility ..................................... (3,347) (2,597) (3,347) (2,597)
Repayments on revolver ................................................... -- -- (10,000) --
Borrowings on revolver ................................................... 4,500 -- 8,500 8,500
Issuance of notes payable to a related party ............................. -- -- 10,000 --
Payment of interest rate protection agreement ............................ (372) -- (372) --
Repayments of capital lease obligations and other debt ................... (716) (503) (1,373) (1,081)
Payment of fees associated with the financing ............................ (18) -- (1,532) --
-------- -------- -------- --------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITES .................. 477 (2,043) 3,194 2,595
-------- -------- -------- --------
NET DECREASE IN CASH ..................................................... (197) (117) (2,266) (189)
CASH, BEGINNING OF PERIOD ................................................ 514 2,940 2,583 3,012
CASH, END OF PERIOD ...................................................... $ 317 $ 2,823 $ 317 $ 2,823
======== ======== ======== ========
Significant non-cash activities:
Issuance of common stock in connection with conversion of sponsor notes .. -- 35,435 -- 35,435
Issuance of common stock in connection with acquisitions ................. -- 143 -- 143
Capital lease obligations ................................................ 626 356 1,291 469
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
Class A Class B Other Total
------- -------
Accumulated Comprehensive Members'
Units Dollars Units Dollars Deficit Loss Interest
----- ----- ------- ------- ---- --------
Balance, December 31, 2001 132,422 $133,141 10,526 $ 1,263 $ (132,161) $ (2,455) $ (212)
Comprehensive loss:
Net loss......................... (11,546) (11,546)
Change in unrealized losses on
derivative....................... -- 1,182 1,182
---------- -------- --------
Total comprehensive loss......... (11,546) 1,182 (10,364)
Net Issuance (repurchase) of
units............................ 470
Preferred return on preferred
units............................ -- (3,587) -- (285) -- -- (3,872)
------- -------- ------ ------- ---------- -------- --------
Balance, March 31, 2002 132,422 $129,554 10,996 $ 978 $ (143,707) $ (1,273) $(14,448)
======= ======== ====== ======= ========== ======== ========
Comprehensive loss:
Net loss......................... (11,784) (11,784)
Change in unrealized losses on
derivative....................... -- 1,179 1,179
---------- -------- --------
Total comprehensive loss......... (11,784) 1,179 (10,605)
Net Issuance (repurchase) of
units............................
Preferred return on preferred
units............................ -- (3,857) -- (204) -- -- (4,061)
------- -------- ------ ------- ---------- -------- --------
Balance, June 30, 2002 132,422 $125,697 10,996 $ 774 $ (155,491) $ (94) $(29,114)
======= ======== ====== ======= ========== ======== ========
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"), a Delaware limited
liability company, provides business music programming to clients through its
integrated nationwide network of owned operations and franchises.
As of June 30, 2002, ABRY Partners, LLC and its respective affiliates,
collectively own approximately 64.2% of the beneficial interests in the
Company's voting interests.
2. BASIS OF PRESENTATION
The condensed consolidated financial statements include the accounts of the
Company and its subsidiaries: Muzak LLC, Muzak Capital Corporation, Muzak
Holdings Finance Corporation, Muzak Finance Corporation, Business Sound Inc.,
Electro Systems Corporation, BI Acquisition LLC, MLP Environmental Music LLC,
Audio Environments Inc., Background Music Broadcasters Inc., Telephone Audio
Productions Inc., Vortex Sound Communications Company Inc., Music Incorporated,
and Muzak Houston, Inc. All significant intercompany items have been eliminated
in consolidation.
The accompanying unaudited interim consolidated financial statements have
been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X, and accordingly, certain financial information has been
condensed and certain footnote disclosures have been omitted. Such information
and disclosures are normally included in financial statements prepared in
accordance with 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, 2001.
The financial statements as of June 30, 2002 and 2001 and for the three and
six months then ended are unaudited; however, in the opinion of management, such
statements include all adjustments (consisting solely of normal recurring
adjustments) necessary for a fair statement of the financial information
included herein in accordance with generally accepted accounting principles in
the United States. The preparation of consolidated financial statements in
conformity with 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 2002 presentation.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
Useful June 30, December 31,
Life 2002 2001
(years) (Unaudited)
------------------------------------------------
Equipment provided to subscribers.......................... 4-6 $ 130,626 $ 121,084
Capitalized installation labor............................. 5 54,977 48,802
Equipment.................................................. 5-7 23,127 21,151
Other...................................................... 3-30 17,060 16,248
--------- ---------
225,790 207,285
Less accumulated depreciation............................. (112,099) (89,266)
--------- ---------
$ 113,691 $ 118,019
========= =========
Included in equipment and other at June 30, 2002 and December 31, 2001 is
$12.9 million and $11.6 million, respectively, of equipment under capital
leases, gross of accumulated depreciation of $8.1 million and $6.6 million,
respectively. Depreciation of property and equipment was $11.4 and $23.0 million
for the quarter and six months ended June 30, 2002, respectively, and $9.8
million and $19.1 million for the quarter and six months ended June 30, 2001,
respectively.
6
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. INTANGIBLE ASSETS
The Company adopted Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets" ("SFAS No. 142") on January 1, 2002. In
connection with the adoption of SFAS No. 142, the Company reclassified other
intangibles of $6.4 million related to trained workforce to goodwill and ceased
amortization of goodwill. During the first quarter, the Company evaluated the
useful lives of its existing intangible assets and concluded that, with the
exception of goodwill, all of its intangible assets have definite lives and that
the existing useful lives are reasonable.
SFAS No. 142 requires that goodwill be tested annually at the reporting unit
level for impairment using a two-step process. A reporting unit is the operating
segment unless, at businesses one level below the operating segment, discrete
financial information is prepared and regularly reviewed by management. The
first step is to identify a potential impairment and, in transition, this step
must be measured as of the beginning of the fiscal year. The second step of the
goodwill impairment test measures the amount of the impairment loss (also
measured as of the beginning of the fiscal year in year of transition), if any,
and must be completed by the end of the Company's fiscal year. The Company
completed its testing of goodwill in accordance with SFAS No. 142 during the
quarter ended June 30, 2002. As the fair value of goodwill exceeds the carrying
amount of goodwill, the Company did not record an impairment charge. SFAS No.
142 requires goodwill of a reporting unit to be tested for impairment on an
annual basis and between annual tests in certain circumstances.
A detailed determination of the fair value of a reporting unit may be
carried forward from one year to the next if the assets and liabilities that
make up the reporting unit have not changed significantly since the most recent
fair value determination, the most recent fair value determination resulted in
an amount that exceeded the carrying amount of the reporting unit by a
substantial margin, and based on the analysis and events that have occurred
since the most recent fair value determination, the likelihood that a current
fair value determination would be less than the current carrying amount of the
reporting unit is remote. Based on the most recent fair value determination, the
Company has elected to carry forward the detailed determination performed during
the second quarter of 2002 to 2003.
Unamortized intangible assets consist of the following (in thousands):
June 30, 2002 December 31, 2001
Carrying Amount Carrying Amount
(unaudited)
-------------------------------------------
Goodwill...................................... $140,805 $137,917
Trained workforce............................. -- 2,868
The following presents net loss exclusive of amortization of goodwill and
trained workforce (in thousands):
For the Quarter Ended June 30,
2002 2001
----------------------------------
Net Loss........................................ $(11,784) $ (11,311)
Goodwill amortization........................... -- 1,980
Trained workforce amortization.................. -- 319
-------- ---------
Net Loss excluding amortization of goodwill..... $(11,784) $ (9,012)
======== =========
For the Six Months Ended June 30,
2002 2001
----------------------------------
Net Loss ........................................... $(23,330) $ (24,784)
Goodwill amortization .............................. -- 3,964
Trained workforce amortization ..................... -- 638
-------- ---------
Net Loss excluding amortization of goodwill ........ $(23,330) $ (20,182)
======== =========
7
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Amortized intangible assets consist of the following (in thousands):
June 30, 2002 December 31, 2001
Useful (unaudited)
------------------------------------ ------------------------------------
Life Gross Carrying Accumulated Gross Carrying Accumulated
(years) Amount Amortization Amount Amortization
---------- ------------------------------------ ------------------------------------
Income producing contracts....... 12 $153,955 $(40,202) $ 154,048 $(33,786)
License agreements............... 20 5,082 (826) 5,082 (699)
Deferred production costs........ 10 5,181 (946) 4,437 (701)
Trademarks....................... 5 15,111 (9,730) 14,935 (8,219)
Non-compete agreements........... 3-5 19,983 (16,339) 23,869 (16,560)
Other............................ 20 10,556 (1,600) 10,778 (1,423)
-------- --------- -------- ---------
$209,868 $(69,643) $213,149 $(61,388)
======== ========= ======== =========
Aggregate amortization expense was $6.0 million and $12.3 million for the
quarter and six months ended June 30, 2002, respectively, and $8.5 million and
$17.5 million for the quarter and six months ended June 30, 2001, respectively.
The estimated future aggregate amortization expense is as follows (in
thousands):
Fiscal year ending
------------------
2002..................................... $23,163
2003..................................... 18,285
2004..................................... 14,986
2005..................................... 14,150
2006..................................... 14,117
5. DEFERRED CHARGES AND OTHER ASSETS, NET
Deferred charges and other assets, net, consist of the following (in
thousands):
June 30, December 31,
2002 2001
(Unaudited)
-------------- ---------------
Subscriber acquisition costs, net.............................. $ 38,746 $ 37,442
Other.......................................................... 13,875 12,578
-------- --------
$ 52,621 $ 50,020
======== ========
6. ACCRUED EXPENSES
Accrued expenses are summarized below (in thousands):
June 30, 2002 December 31, 2001
(Unaudited)
--------------------- --------------------
Accrued interest............................................... $ 3,602 $ 6,493
Accrued compensation and benefits.............................. 3,909 3,671
Licensing royalties........................................... 5,125 1,897
Other.......................................................... 9,182 9,217
------- -------
$21,818 $21,278
======= =======
8
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. DEBT
Debt obligations consist of the following (in thousands):
June 30, December 31,
2002 2001
(Unaudited)
------------------ -----------------
Related Party Notes .......................................... $ 10,000 $ --
======== =========
Long term debt:
Revolving Loan-Senior Credit Facility....................... $ 19,800 $ 21,300
Senior Credit Facility...................................... 162,860 166,207
Senior Discount Notes....................................... 60,577 56,861
Senior Subordinated Notes................................... 115,000 115,000
Other....................................................... 2,513 2,552
-------- ---------
Total debt obligations........................................ 360,750 361,920
Less current maturities....................................... (7,152) (6,775)
-------- ---------
$353,598 $ 355,145
======== =========
Senior Credit Facility
The Senior Credit Facility is guaranteed by the Company and certain 100%
owned subsidiaries. The non-guarantor subsidiary is considered minor and the
consolidated amounts in the Company's financial statements are representative of
the combined guarantor's financial statements. The Amended 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 March 2002, the Company entered into the sixth amendment under the Senior
Credit Facility, which increased its aggregate revolving loan commitment under
the Senior Credit Facility by $20.0 million, for a total commitment of $55.0
million, and amended certain financial covenants and applicable margins.
As amended in March 2002, indebtedness under the Term Loan A and the
Revolving Loans 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 2.00% to 3.00% 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 3.00% to 4.00%.
Margins, which are subject to adjustment based on the changes in the Company's
ratio of consolidated total debt to EBITDA (i.e., earnings before interest,
taxes, depreciation, amortization, other non cash charges, and certain other
items as defined by the agreement) were 2.50% in the case of Alternate Base Rate
and 3.50% in the case of LIBOR as of June 30, 2002. 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 3.5% or (ii) LIBOR
of one, two, three, or six months, as selected by the Company plus a margin of
4.5%. The weighted average rate of interest on the Senior Credit Facility,
including the effects of the interest rate swap, if any, was 6.2% and 9.9% at
June 30, 2002 and 2001, respectively.
9
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 Subordinated Notes") which mature on March
15, 2009. Interest is payable semi-annually, in arrears, on March 15 and
September 15 of each year. The Senior Subordinated Notes are general unsecured
obligations of the Company and Muzak Finance and are subordinated in right of
payment to all existing and future Senior Indebtedness of the Company and Muzak
Finance. The Senior Subordinated Notes are guaranteed by 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. The Company's non-guarantor subsidiary is minor and the
consolidated amounts in the Company's financial statements are representative of
the combined guarantors. The indenture governing the Senior Subordinated Notes
prohibits the Company from making certain payments such as dividends and
distributions of their capital stock; repurchases or redemptions of their
capital stock, and investments (other than permitted investments) unless certain
conditions are met by the Company. After March 15, 2004, the issuers may redeem
all or part of the Notes at a redemption price equal to 104.938% of the
principal which redemption price declines to 100% of the principal amount in
2007.
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.
Related Party Notes
In March 2002, MEM Holdings LLC contributed $10.0 million to the Company in
the form of junior subordinated unsecured notes (the "sponsor notes"), the
proceeds of which were used to repay outstanding revolving loan balances. MEM
Holdings is a company that owns 64.2% of the voting interests in the Company.
ABRY Broadcast Partners III and ABRY Broadcast Partners II are the beneficial
owners of MEM Holdings.
The sponsor notes accrue interest at 15% per annum; any accrued interest not
paid as of March 31, June 30, September 30 or December 31 will bear interest at
15% per annum until such interest is paid or extinguished. The sponsor notes are
junior and subordinate to payments for the Senior Credit Facility, and the
Senior Subordinated Notes. At any time, the sponsor notes may be converted into
Class A-2 units of the Company at the direction of MEM Holdings. If the sponsor
notes have not been repaid in full as of September 2003, the sponsor notes will
automatically be converted into Class A-2 units of the Company.
Other Debt
The Company has $2.2 million of promissory notes which, with the exception
of one, bear interest at 9.887% and mature in November 2016. The Company is
required to make interest only payments on a monthly basis through October 2006,
and principal and interest payments for the remainder of the term. The note
terms are the same for all but one of the notes. This note bears interest at 8%
with principal and interest payments due monthly until maturity in October 2006.
10
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Liquidity
The Company's principal sources of funds will continue to be cash flows
from operations and borrowings under the senior credit facility. As of June 30,
2002, the Company had outstanding debt of $182.7 million under its senior credit
facility, with additional available borrowings of up to $35.0 million. Based
upon current and anticipated levels of operations, the Company believes that its
cash flows from operations, combined with availability under the senior credit
facility, as amended, will be adequate to meet its liquidity needs for the
foreseeable future. The Company is continuing its efforts to improve working
capital balances, while also implementing additional cost-saving initiatives,
such as more efficiently utilizing its capital resources associated with new
client locations. Overall, the Company's business plan anticipates continued
growth in new client locations and operational improvements. The Company's
future performance is subject to industry based factors such as the level of
competition in the business music industry, competitive pricing, concentrations
in and dependence on satellite delivery capabilities, rapid technological
changes, the impact of legislation and regulation, its dependence on license
agreements and other factors that are beyond its control.
Annual Maturities
Annual maturities of long-term debt obligations are as follows (in
thousands):
2002........................................................ $ 3,388
2003........................................................ 7,855
2004........................................................ 27,742
2005........................................................ 62,733
2006........................................................ 81,700
Thereafter.................................................. 187,332
Total interest paid by the Company on all indebtedness was $4.3 million and
$16.6 million for the quarter and six months ended June 30, 2002 and 2001,
respectively and $3.0 million and $13.2 million for the quarter and six months
ended June 30, 2001. The weighted average interest rate on all indebtedness was
8.7% and 10.3% as of June 30, 2002 and 2001, respectively.
Interest Rate Protection Programs
The Company had an interest rate swap agreement which terminated in April
2002. The effect of this agreement on the operating results of the Company was
to increase interest expense by $0.4 million and $1.6 million for the quarter
and six months ended June 30, 2002, respectively and $0.5 million and $0.8
million for the quarter and six months ended June 30, 2001.
The Company entered into a three year interest rate cap on April 19, 2002,
for which it paid a premium of $0.4 million. The interest rate cap protects the
Company against LIBOR increases above 7.25% and is designated as a hedge of
interest rates. Accordingly, the derivative will be recognized on the balance
sheet at its fair value. The hedge is considered 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 will be recorded in other
comprehensive loss. The Company will amortize the premium paid for the cap over
the life of the agreement using the caplets approach and any amounts received
under the cap will be recorded as a reduction to interest expense. The fair
market value of the interest rate cap was $0.3 million as of June 30, 2002. The
fair values of interest rate caps are obtained from dealer quotes which
represents the estimated amount the Company would receive or pay to terminate
agreements taking into consideration current interest rates and creditworthiness
of the counterparties.
8. Manditorily Redeemable Preferred Units
On March 8, 2002, the Company entered into the second amendment to the
Securities Purchase Agreement which amended the consolidated capital expenditure
covenant for 2001 and subsequent years and allowed for an increase to
consolidated operating cash flow for amounts designated by the Company with
respect to license fees up to a certain amount. In connection with this
amendment, the Company incurred $0.3 million in fees.
11
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company was in violation of unit coverage and total leverage ratio
under the Securities Purchase Agreement as of June 30, 2002. As a result of the
default, the preferred units will accrue at a preferential return of 17% per
annum as long as the default is continuing. The Company projects that it will be
in compliance as of September 30, 2002, and therefore, the preferred units will
resume accruing at 15% per annum on October 1, 2002.
9. Related Party Transactions
During the six months ended June 30, 2002, the Company incurred fees of
$0.2 million under the Management and Consulting Services Agreement with ABRY
Partners. Either the Company or ABRY Partners, with the approval of the Board of
Directors of the Company, may terminate the Management Agreement by prior
written notice to the other.
During the quarter ended March 31, 2002, the Company borrowed $10.0 million
from MEM Holdings under junior subordinated notes. At any time, the sponsor
notes may be converted into Class A-2 units of the Company at the direction of
MEM Holdings. If the sponsor notes have not been repaid in full as of September
2003, the sponsor notes will automatically be converted into Class A-2 units of
the Company.
10. MUZAK HOLDINGS FINANCE CORP.
Muzak Holdings Finance Corp. had no operating activities during the six
months ended June 30, 2002 and 2001.
11. 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 June
30, 2002, and likely several years thereafter. BMI contends that those fee
levels understate reasonable fee levels by as much as 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.
In October 1998, the Digital Millennium Copyright Act was enacted. The Act
provides for a statutory license from the copyright owners of master recordings
to make and use ephemeral copies of such recordings. Ephemeral copies refer to
temporary copies of master sound recordings made to enable or facilitate the
digital transmission of such recordings. The Digital Millennium Copyright Act
did not specify the rate and terms of the license. As a result, the United
States Copyright Office convened a Copyright Arbitration Royalty Panel to
recommend an ephemeral royalty rate. In February 2002, the Panel recommended an
ephemeral royalty rate of ten percent (10%) of gross proceeds applicable to the
use of ephemeral copies. That recommendation was subject to review by the
Librarian of Congress, who could have modified or adopted such recommendation.
12
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In June 2002, the Librarian of Congress published his final decision to
adopt the Copyright Arbitration Royalty Panel's recommendation of a ten percent
(10%) ephemeral royalty rate, which covers the period from October 1998 through
the present. As a result, we are required to remit payment by October 20, 2002
for the above mentioned period.
With respect to future revenue subject to such ephemeral royalty rate, we
believe our exposure is minimal, as we believe our current satellite
technologies do not require use of ephemeral copies. Nonetheless, there can be
no assurances that the collective for the copyright owners will refrain from
investigating or otherwise challenging the applicability of the statute to our
satellite technologies.
During the quarter ended June 30, 2002, the Company increased its estimated
reserve for prior period licensing royalties and related expenses by $3.1
million to $4.0 million. This charge is recorded in cost of music and other
business services revenues.
Other Commitments
As of June 30, 2002, the Company has approximately $32.5 million in
outstanding capital expenditure commitments over a five year period. 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.
13
MUZAK 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 identify, complete
and integrate acquisitions, the Company's future capital requirements, the
Company's dependence on license agreements, and risks associated with general
economic conditions.
Recent Developments
General Business
In October 1998, the Digital Millennium Copyright Act was enacted. The Act
provides for a statutory license from the copyright owners of master recordings
to make and use ephemeral copies of such recordings. Ephemeral copies refer to
temporary copies of master sound recordings made to enable or facilitate the
digital transmission of such recordings. The Digital Millennium Copyright Act
did not specify the rate and terms of the license. As a result, the United
States Copyright Office convened a Copyright Arbitration Royalty Panel to
recommend an ephemeral royalty rate. In February 2002, the Panel recommended an
ephemeral royalty rate of ten percent (10%) of gross proceeds applicable to the
use of ephemeral copies. That recommendation was subject to review by the
Librarian of Congress, who could have modified or adopted such recommendation
In June 2002, the Librarian of Congress published his final decision to
adopt the Copyright Arbitration Royalty Panel's recommendation of a ten percent
(10%) ephemeral royalty rate, which covers the period from October 1998 through
the present. As a result, we are required to remit payment by October 20, 2002
for the above mentioned period.
With respect to future revenue subject to such ephemeral royalty rate, we
believe our exposure is minimal, as we believe our current satellite
technologies do not require use of ephemeral copies. Nonetheless, there can be
no assurances that the collective for the copyright owners will refrain from
investigating or otherwise challenging the applicability of the statute to our
satellite technologies.
Pan Am Sat announced the successful launch of the Galaxy IIIC satellite on
June 15, 2002. Galaxy IIIR, will co-locate with Galaxy IIIC until it is put into
service in the fall of 2002. Once the Galaxy IIIC has been successfully put into
service, the Company will explore the availability of insurance to cover
increased costs in the event of a Galaxy IIIC satellite failure.
14
MUZAK LLC
Item 2. Management's Discussion and Analysis (Continued)
During the first quarter of 2002, the Company increased its aggregate
revolver commitments under the Senior Credit Facility by $20.0 million, for a
total commitment of $55.0 million. In addition, in March 2002 the existing
equity holders, including ABRY Partners LLC, contributed $10.0 million in the
form of junior subordinated unsecured notes to the Company. The Company paid
$1.5 million in financing fees related to these transactions during the first
quarter of 2002. The increased revolver commitment and the $10.0 million from
the sponsors enhances the Company's financial flexibility and provides
sufficient liquidity to fund its organic business plan for the foreseeable
future.
Accounting Developments
The Company adopted Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets" ("SFAS No. 142") on January 1, 2002. SFAS
No. 142 requires that goodwill be tested annually at the reporting unit level
for impairment using a two-step process. A reporting unit is the operating
segment unless, at businesses one level below the operating segment, discrete
financial information is prepared and regularly reviewed by management. The
first step is to identify a potential impairment and, in transition, this step
must be measured as of the beginning of the fiscal year. The Company completed
its testing of goodwill in accordance with SFAS No. 142 during the quarter ended
June 30, 2002. As the fair value of goodwill exceeds the carrying amount of
goodwill, the Company did not record an impairment charge.
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.
Results of Operations
Set forth below are discussions of the results of operations for Muzak LLC
for the quarter and six months ended June 30, 2002 compared to the quarter and
six months ended June 30, 2001.
Revenues. Revenues were $54.1 million and $50.7 million for the quarters ended
June 30, 2002 and 2001, respectively, an increase of 6.6%. Music and other
business services revenue increased $3.3 million, or 8.9% in 2002 as compared to
the quarter ended June 30, 2001. Revenues for the six months ended June 30, 2002
increased 4.3% to $105.0 million, up $4.3 million from the comparable 2001
period. Music and other business services revenue increased $6.0 million, or
8.1% for the six months ended June 30, 2002 as compared to 2001. The growth in
music and other business services revenue is due to an increase in new client
locations, offset by a 10.4% churn rate during the twelve months ended June 30,
2002. The 2001 churn rate was higher than historical levels due to more
bankruptcies and business closures in our client base. However, our efforts on
reducing our client churn rate have contributed to a reduction in our annualized
churn rate during the six months ended June 30 of 2002 to 9.9% from 12.4% during
the first six months of 2001. During the twelve months ended June 30, 2002, we
added, net of churn of both acquisition locations and locations obtained through
our sales and marketing efforts, approximately 8,700 Audio Architecture, 3,300
Voice, and 1,400 other locations. Equipment and related services revenue was
flat for the quarter ended June 30, 2002 as compared to the quarter ended June
30, 2001 and decreased 6.3% or $1.7 million in 2002 as compared to the six
months ended June 30, 2001. This decrease is largely due to a reduction in new
store location build outs among our national chains, particularly within the
retail sector. We expect that the full year 2002 equipment and related services
revenue will be consistent with 2001 levels.
15
MUZAK LLC
Item 2. Management's Discussion and Analysis (Continued)
Cost of Revenues. Cost of revenues was $21.9 million and $16.9 million for the
quarters ended June 30, 2002 and 2001, respectively, an increase of 29.7%. Cost
of revenues increased $5.7 million for the six months ended June 30, 2002 as
compared to the six months ended June 30, 2001. During the quarter ended June
30, 2002, the Company increased its reserves for estimated prior period
licensing royalties and related expenses by $3.1 million. Excluding this
increase in reserve, total cost of revenues as a percentage of revenues was
34.7% and 33.3% for the quarters ended June 30, 2002 and 2001, respectively and
34.4% and 33.3% for the six months ended June 30, 2002 and 2001, respectively.
Excluding this increase in reserve, costs of music and other business services
revenue as a percentage of music and other business services revenue was 19.2%
and 18.6% for the quarters ended June 30, 2002 and 2001 and 19.4% and 19.7% for
the six months ended June 30, 2002 and 2001, respectively. The six month
improvement in costs of music and other business services revenue is primarily
due to the leveraging of fixed costs over a larger client base and labor savings
achieved from the use of the Company's Voice website, offset slightly by an
increase in licensing royalties and satellite expenses. The increase in the cost
of equipment and related services revenues as a percentage of revenues is due to
lower equipment and related services revenues together with a relatively fixed
technician workforce. The Company has implemented new scheduling software to
better manage and utilize its technician workforce. In addition, we experienced
an increase in certain technician related costs, such as insurance, contractual
union wage increases, and higher fuel and repair costs during the first six
months of 2002.
Selling, general and administrative expenses. Selling, general, and
administrative expenses were $17.9 million and $17.1 million for the quarters
ended June 30, 2002 and 2001, respectively and $35.9 million and $35.2 million
for the six months ended June 30, 2002 and 2001, respectively. This slight
increase is due to a $0.8 million and $1.6 million increase in amortization of
subscriber acquisition costs, a non-cash component of selling, general, and
administrative expenses for the quarter and six months ended June 30, 2002 as
compared to the 2001 period. This increase is directly related to the increase
in music and other business services revenue. Excluding the amortization of
subscriber acquisition costs, selling, general, and administrative expenses as a
percentage of revenues were 27.4% and 29.3% for the quarters ended June 30, 2002
and 2001, respectively and 28.6% and 30.6% for the six months ended June 30,
2002 and 2001, respectively. This improvement is attributable to the Company's
continued focus on controlling expenses, including travel, salaries and other
employee related expenses, telephone, and other administrative expenses. The six
months ended June 30, 2002 and 2001 include $0.5 million and $0.7 million,
respectively, of charges incurred in connection with exploring various financing
alternatives.
Depreciation and amortization expenses. Depreciation and amortization was $17.4
million and $18.5 million for the quarters ended June 30, 2002 and 2001,
respectively, a decrease of 5.9%. Depreciation and amortization was $35.3
million and $36.8 million for the six months ended June 30, 2002 and 2001,
respectively, a decrease of 4.2%. The decrease is due to the adoption of SFAS
No. 142 on January 1, 2002. In connection with the adoption, the Company ceased
amortization of goodwill on January 1, 2002. During the first six months of
2001, the Company recorded $4.6 million amortization expense related to goodwill
and trained workforce. Depreciation was $23.0 million and $19.0 million in the
six months ended June 30, 2002 and 2001, respectively. This increase is due to
increase in property and equipment in conjunction with Muzak's growth in the
number of client locations.
Interest expense. Interest expense was $7.0 million and $7.8 million for the
quarters ended June 30, 2002 and 2001, respectively, a decrease of $0.8 million,
or 9.8%. Interest expense was $14.8 million and $17.1 million for the six months
ended June 30, 2002 and 2001, respectively, a decrease of 13.4%. This decrease
is due to lower outstanding debt balances at lower interest rates during the
first six months of 2002 as compared to the 2001 comparable period. The
effective interest rate for the six months ended June 30, 2002 and 2001 was 8.7%
and 9.8%, respectively.
16
MUZAK LLC
Item 2. Management's Discussion and Analysis (Continued)
Income tax provision. Income tax benefit was $0.3 million and $0.2 million for
the quarters ended June 30, 2002 and 2001, respectively, an increase of 67.4%.
Income tax benefit was $0.6 million for the six months ended June 30, 2002 and
2001. Although Muzak is a limited liability company and is treated as a
partnership for income tax purposes, the Company has several subsidiaries that
are corporations. The income tax benefits relate to these corporate
subsidiaries.
Net Loss. The combined effect of the foregoing resulted in a net loss of $9.7
million and $19.5 million for the quarter and six months ended June 30, 2002,
respectively, compared to a net loss of $9.5 million and $21.3 million for the
comparable 2001 period.
The Company evaluates the operating performance of its business using
several measures, one of them being adjusted EBITDA (defined as earnings before
interest, income taxes (benefits), depreciation, amortization, non-cash charges
and one-time expenses). Adjusted 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 adjusted 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, however it is not
necessarily comparable to similarly titled amounts of other companies.
Three Months Ended
--------------------------------------------------------------
June 30, 2002 June 30, 2001
----------------------------- ----------------------------
Net loss .................................. $ (9,748) $ (9,505)
Depreciation and amortization ............. 17,408 18,509
Interest expense, net ..................... 6,993 7,727
Income tax benefit ........................ (288) (172)
Non Cash charges (income) ................. (78) 139
One-time expenses (a) ..................... 3,145 --
-------- --------
Adjusted EBITDA ........................... $ 17,432 $ 16,698
======== ========
Six Months Ended
----------------------------------------------------------------
June 30, 2002 June 30, 2001
----------------------------- -----------------------------
Net loss .................................. $(19,449) $(21,343)
Depreciation and amortization ............. 35,258 36,791
Interest expense, net ..................... 14,733 16,978
Income tax benefit ........................ (591) (609)
Non Cash charges (income) ................. (90) 175
One-time expenses (a) ..................... 3,684 675
-------- --------
Adjusted EBITDA ........................... $ 33,545 $ 32,667
======== ========
(a) One-time expenses were incurred in connection with exploring various
financing alternatives and increasing reserves for prior period licensing
royalties and related expenses.
Adjusted EBITDA for the quarter ended June 30, 2002 increased $0.7 million,
or 4.4% to $17.4 million from $16.7 million for the quarter ended June 30, 2001.
Adjusted EBITDA for the six months ended June 30, 2002 increased $0.9 million or
2.7% as compared to the 2001 period.
17
MUZAK LLC
Item 2. Management's Discussion and Analysis (Continued)
Liquidity and Capital Resources
Sources and Uses. Our principal sources of funds have been cash generated
from operations, borrowings under the senior credit facility, and contributions
from the sponsors. Our future need for liquidity will arise primarily from
capital expenditures for investments in new client locations and from interest
and principal payments on our indebtedness. During the six months ended June 30,
2002, $12.6 million of cash was provided by our operating activities, $18.0
million of cash was used in investing activities, and $3.2 million of cash was
provided by financing activities. Cash was primarily used during the first six
months of 2002 to make investments relating to new client locations and to make
interest payments on the senior credit facility.
We expect that our principal sources of funds will continue to be cash
flows from operations and borrowings under the senior credit facility. As of
June 30, 2002, we had outstanding debt of $182.7 million under our senior credit
facility, with additional available borrowings of up to $35.0 million. Based
upon current and anticipated levels of operations, we believe that our cash
flows from operations, combined with availability under the senior credit
facility, will be adequate to meet our liquidity needs for the foreseeable
future. We are continuing our efforts to improve working capital balances, while
also implementing additional cost-saving initiatives, such as more efficiently
utilizing our capital resources associated with new client locations. Overall,
Muzak's business plan anticipates continued growth in new client locations and
operational improvements. Our future performance is subject to industry based
factors such as the level of competition in the business music industry,
competitive pricing, concentrations in and dependence on satellite delivery
capabilities, rapid technological changes, the impact of legislation and
regulation, our dependence on license agreements and other factors that are
beyond our control.
Capital Investments. The majority of our capital expenditures are comprised
of the initial one-time investment for the installation of equipment for new
client locations. During the six months ended June 30, 2002, our total initial
investment in new client locations was $22.5 million which was comprised of
equipment and installation costs attributable to new client locations of $15.3
million and $7.2 million in sales commissions (included in operating activities
in the consolidated statement of cash flows) relating to these new locations.
The sales commissions 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. We also receive installation
revenue relating to new locations. This revenue is deferred and amortized as a
component of equipment and related services revenue over the initial contract
term of five years.
We currently anticipate that our total initial investment in new client
locations during 2002 will be approximately $50.0 million including $34.0
million of equipment and installation costs attributable to new client
locations, and $16.0 million in sales commissions relating to new client
locations. The Company is focused on reducing the initial investment associated
with new client locations through the re-use of equipment and efficiencies
gained from vendor consolidation and labor management.
We also invest in property and equipment to be used at our headquarters and
within our owned operations. Our investment for such property and equipment for
the six months ended June 30, 2002 was approximately $2.0 million, consisting of
system upgrades, furniture and fixtures, computers, equipment to replenish the
equipment exchange pool relating to our drive-thru systems client locations, and
conversions from local broadcast technology to direct broadcast satellite
transmission for existing client locations. We anticipate our investment in
property and equipment to be used at headquarters, equipment for use in the
exchange pool for servicing drive-thru systems client locations, and equipment
for conversions will be approximately $4.0 million for 2002.
18
MUZAK LLC
Item 2. Management's Discussion and Analysis (Continued)
Sensitivity to Interest Rate Changes. Due to the variable interest rates
under the senior credit facility, we are sensitive to changes in interest rates.
A 0.5% increase in each of LIBOR and the Alternate Base Rate (1.87% and 4.75%
respectively, at June 30, 2002) would impact interest costs by approximately
$0.9 million annually on the senior credit facility. The Company's interest rate
swap terminated on April 19, 2002. We entered into an interest rate cap in April
2002 as our senior credit facility requires that we maintain an agreement for
50% of the outstanding balance of the senior credit facility to limit our
interest rate exposure. The interest rate cap protects the Company against LIBOR
increases above 7.25%. To the extent, LIBOR increased above 7.25%, the Company's
exposure to increases would be limited to the unhedged portion of the senior
credit facility.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
For the period ended June 30, 2002, 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, 2001.
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
The Company filed a Form 8-K on January 14, 2002 disclosing its violation
of the maximum consolidated capital expenditures covenant of its Senior Credit
Facility for the period ending December 31, 2001 as well as the expiration of
its insurance covering increased costs in the event of a failure of PanAmSat
Corporation's Galaxy IIIR satellite. The Company filed a Form 8-K on March 29,
2002 disclosing that it has obtained a waiver of the violation of the maximum
consolidated capital expenditures covenant of its senior credit facility. In
addition, the company disclosed it has increased its revolving commitments of
its senior credit facility by $20.0 million, for a total commitment of $55.0
million.
19
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 LLC
MUZAK FINANCE CORP.
By: /s/ William A. Boyd
---------------------------------
Date: August 14, 2002 William A. Boyd
Chief Executive Officer
(Principal Executive Officer)
By: /s/ Stephen P. Villa
---------------------------------
Date: August 14, 2002 Stephen P. Villa
Chief Financial Officer
(Principal Financial
Officer and Chief
Accounting Officer)
20