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 March 31, 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 May 15,
2002.
1
PART I- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
MUZAK LLC
CONSOLIDATED BALANCE SHEETS
(in thousands)
March 31, December 31,
2002 2001
(unaudited)
--------------- ---------------
ASSETS
Current assets:
Cash ...................................................................... $ 514 $ 2,583
Accounts receivable, net of allowances of $1,760 and $1,943 ............... 23,328 24,313
Inventory ................................................................. 9,459 9,402
Prepaid expenses and other assets ......................................... 1,889 1,441
--------- ---------
Total current assets .................................................. 35,190 37,739
Property and equipment, net .................................................... 116,266 118,019
Intangible assets, net ......................................................... 286,654 292,546
Deferred charges and other assets, net ......................................... 49,820 47,638
--------- ---------
Total assets .......................................................... $ 487,930 $ 495,942
========= =========
LIABILITIES AND MEMBER'S INTEREST
Current liabilities:
Current maturities of long term debt ...................................... $ 6,775 $ 6,775
Current maturities of other liabilities ................................... 4,057 4,115
Accounts payable .......................................................... 4,745 5,192
Accrued expenses .......................................................... 19,138 21,278
Advance billings .......................................................... 1,608 870
--------- ---------
Total current liabilities ............................................. 36,323 38,230
Long-term debt ................................................................. 292,265 298,284
Related party notes ............................................................ 10,000 --
Other liabilities .............................................................. 11,628 12,895
Commitments and contingencies
Member's interest:
Common units (100 issued and
outstanding) ............................................................ 260,073 260,373
Accumulated other comprehensive loss .................................... (1,273) (2,455)
Accumulated deficit ..................................................... (121,086) (111,385)
--------- ---------
Total member's interest ............................................... 137,714 146,533
--------- ---------
Total liabilities and member's interest ............................... $ 487,930 $ 495,942
========= =========
The Notes are an integral part of these consolidated financial statements.
2
MUZAK LLC
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands)
Quarter Quarter
Ended Ended
March 31, March 31,
2002 2001
-------------- -------------
Revenues:
Music and other business services ......................................... $ 39,540 $ 36,818
Equipment and related services ............................................ 11,423 13,150
-------- ----------
50,963 49,968
Cost of revenues:
Music and other business services (excluding $10,785 and $8,588 of
depreciation and amortization expense) .................................. 7,760 7,666
Equipment and related services ............................................ 9,558 8,981
-------- ----------
17,318 16,647
-------- ----------
33,645 33,321
Selling, general and administrative expenses ................................... 18,071 18,027
Depreciation and amortization expense .......................................... 17,850 18,282
-------- ----------
Loss from operations .................................................. (2,276) (2,988)
Other income (expense):
Interest expense .......................................................... (7,747) (9,281)
Other, net ................................................................ 19 (6)
-------- ----------
Loss before income taxes .............................................. (10,004) (12,275)
Income tax benefit ............................................................ (303) (437)
-------- ----------
Net loss .............................................................. $ (9,701) $ (11,838)
======== ==========
The Notes are an integral part of these consolidated financial statements.
3
MUZAK LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
Quarter Ended Quarter Ended
March 31, March 31,
2002 2001
------------- -------------
CASH FLOW FROM OPERATING ACTIVITIES
Net loss ....................................................................... $ (9,701) $(11,838)
Adjustments to derive cash flow from continuing operating activities:
Gain on disposal of fixed assets ............................................... (11) (5)
Deferred income tax benefit .................................................... (303) (437)
Depreciation and amortization .................................................. 17,850 18,282
Amortization of deferred financing fees ........................................ 395 390
Amortization of deferred subscriber acquisition costs .......................... 2,879 2,073
Deferred subscriber acquisition costs .......................................... (3,479) (3,937)
Unearned installment income .................................................... (418) (94)
Change in certain assets and liabilities, net of business acquisitions
Decrease in accounts receivable ............................................. 986 7,759
Increase in inventory ....................................................... (57) (999)
Decrease in accrued interest ................................................ (4,672) (2,458)
Decrease in accounts payable ................................................ (1,335) (4,775)
Increase (decrease) in accrued expenses ..................................... 2,231 (147)
Increase in advance billings ................................................ 738 992
Other, net .................................................................. (435) 1,046
-------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES ................................. 4,668 5,852
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures ........................................................... (9,467) (10,571)
Proceeds from sale of fixed assets ............................................. 13 9
-------- --------
NET CASH USED IN INVESTING ACTIVITIES ..................................... (9,454) (10,562)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in book overdrafts ......................................... 888 (3,284)
Repayments under revolver ...................................................... (10,000) --
Borrowings under revolver ...................................................... 4,000 8,500
Issuance of notes payable to a related party ................................... 10,000 --
Repayments of capital lease obligations and other debt ......................... (657) (578)
Payment of financing fees ...................................................... (1,514) --
-------- --------
NET CASH PROVIDED BY FINANCING ACTIVITES .................................. 2,717 4,638
-------- --------
NET DECREASE IN CASH ........................................................... (2,069) (72)
CASH, BEGINNING OF PERIOD ...................................................... 2,583 3,012
-------- --------
CASH, END OF PERIOD ............................................................ $ 514 $ 2,940
======== ========
Significant non-cash activities:
Capital lease obligations ...................................................... $ 665 $ 113
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
========= ========= ========= ========= =========
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 March 31, 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 March 31, 2002 and March 31, 2001 and for the
quarters 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 March 31, December 31,
Life 2002 2001
(years) (Unaudited)
--------------------------------------------------
Equipment provided to subscribers ........................... 4-6 $ 126,115 $ 121,084
Capitalized installation labor .............................. 5 52,107 48,802
Equipment ................................................... 5-7 21,815 21,151
Other ....................................................... 3-30 16,954 16,248
--------- ---------
216,991 207,285
Less accumulated depreciation .............................. (100,725) (89,266)
--------- --------
$ 116,266 $ 118,019
========= =========
Included in equipment and other at March 31, 2002 and December 31, 2001 is
$4.8 million and $5.0 million, respectively of equipment under capital leases,
net of accumulated depreciation of $7.5 million and $6.6 million, respectively.
Depreciation of property and equipment was $11.6 million and $9.3 million for
the quarters ended March 31, 2002 and 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 for impairment using
a two-step process. 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.
However, the Company has six months from the date of adoption to complete the
first step. 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. Any impairment loss resulting from the transitional impairment
tests in 2002 will be reflected as a cumulative effect of a change in accounting
principle. The Company is still in the process of evaluating its goodwill and
has not yet determined what effect these impairment tests, or what additional
effects SFAS No. 142, will have on its financial statements.
7
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Amortized intangible assets consist of the following (in thousands):
March 31, 2002 December 31, 2001
(unaudited)
Useful ------------------------------------ ------------------------------------
Life Gross Carrying Accumulated Gross Carrying Accumulated
(years) Amount Amortization Amount Amortization
---------- ------------------------------------ -------------------------------------
Income producing contracts ....... 12 $153,994 $(36,995) $154,048 $(33,786)
License agreements ............... 20 5,082 (762) 5,082 (699)
Deferred production costs ........ 10 4,813 (819) 4,437 (701)
Trademarks ....................... 5 15,104 (8,975) 14,935 (8,219)
Non-compete agreements ........... 3-5 19,983 (14,653) 23,869 (16,560)
Other ............................ 20 10,556 (1,466) 10,778 (1,423)
-------- --------- -------- ---------
$209,532 $(63,670) $213,149 $(61,388)
======== ========= ======== =========
Aggregate amortization expense was $6.3 million and $9.0 million for the
quarters ended March 31, 2002 and 2001, respectively.
The estimated future aggregate amortization expense is as follows (in
thousands):
Fiscal year ending
------------------
2002 ............................................. $ 23,184
2003 ............................................. 18,299
2004 ............................................. 15,000
2005 ............................................. 14,161
2006 ............................................. 14,110
Unamortized intangible assets consist of the following (in thousands):
March 31, 2002 December 31, 2001
Carrying Amount Carrying Amount
(unaudited)
--------------------- ---------------------
Goodwill ......................................... $ 140,792 $ 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 March 31,
2002 2001
------------------- -----------------
Net Loss $(9,701) $(11,838)
Goodwill amortization -- 1,984
Trained workforce amortization -- 319
-------- ---------
Net Loss excluding amortization of goodwill $(9,701) $ (9,535)
======== =========
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):
March 31, December 31,
2002 2001
(Unaudited)
-------------- -------------
Subscriber acquisition costs, net ............ $ 38,042 $ 37,442
Other ........................................ 11,778 10,196
-------- --------
$ 49,820 $ 47,638
======== ========
6. ACCRUED EXPENSES
Accrued expenses are summarized below (in thousands):
March 31, 2002 December 31, 2001
(Unaudited)
------------------------------------
Accrued interest .......................... $ 1,820 $ 6,493
Accrued compensation and benefits ......... 5,003 3,671
Other ..................................... 12,315 11,114
------- -------
$19,138 $21,278
======= =======
7. DEBT
Debt obligations consist of the following (in thousands):
March 31, December 31,
2002 2001
(Unaudited)
-------------- ---------------
Related Party Notes ................................. $ 10,000 $ --
======== =========
Long term debt:
Revolving Loan-Senior Credit Facility ............. $ 15,300 $ 21,300
Senior Credit Facility ............................ 166,207 166,207
Senior Subordinated Notes ......................... 115,000 115,000
Other ............................................. 2,533 2,552
-------- ---------
Total debt obligations .............................. 299,040 305,059
Less current maturities ............................. (6,775) (6,775)
-------- ---------
$292,265 $ 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 March 31, 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, was 9.21% and 9.47% at March
31, 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 $2.4 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 March 31,
2002, the Company had outstanding debt of $181.5 million under its senior credit
facility, with additional available borrowings of up to $39.7 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 reduce accounts
receivable and inventory balances, while implementing additional cost-saving
initiatives. 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 ........................................... $ 6,755
2003 ........................................... 7,855
2004 ........................................... 27,742
2005 ........................................... 58,233
2006 ........................................... 81,699
Thereafter ..................................... 126,756
Total interest paid by the Company on all indebtedness was $12.3 million
and $10.2 million for the quarters ended March 31, 2002 and 2001, respectively.
The weighted average interest rate on all indebtedness was 9.65% and 10.07% for
the quarters ended March 31, 2002 and 2001, respectively.
Interest Rate Protection Programs
The effect of the Company's interest rate swap agreement on the
operating results of the Company was to increase interest expense by $1.2
million and $0.3 million for the quarters ended March 31, 2002 and 2001,
respectively. This agreement terminated on April 19, 2002.
The fair value of the interest rate swap agreement was a loss of
approximately $1.3 million as of March 31, 2002. The fair values of interest
rate swaps 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.
11
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Subsequent to quarter end, the Company entered into a three year interest
rate cap on April 19, 2002, for which we 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.
8. Related Party Transactions
During the quarter ended March 31, 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 March 31, 2002, the Parent has obligations of $58.6 million of senior
discount notes and mandatorily redeemable preferred units ("preferred units") of
$96.1 million. During the first quarter of 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. 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 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.
9. MUZAK FINANCE CORP.
Muzak Finance Corp. had no operating activities during the quarters ended
March 31, 2002 and 2001.
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.
12
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 March
31, 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 for digital copies granted from the copyright
owner of the master 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, and such Panel published a report that was released in February 2002.
The Panel recommended an ephemeral royalty rate of ten percent (10%) of
gross proceeds applicable to the use of ephemeral copies of copyrighted
recordings. That recommendation is now subject to the review of the Librarian of
Congress, who can either modify or adopt such recommendation. Upon publication
of the Librarian's determination in the Federal Register, such determination may
further be appealed to the United States Court of Appeals for the District of
Columbia Circuit.
Since a final determination has yet to be published by the Librarian of
Congress and an appeal of any such final determination may arise after such
publication, we cannot currently predict what the ultimate ephemeral royalty
rate or license terms are likely to be. As a result, we cannot predict the
extent of our exposure for retroactive royalty payments dating back to October
1998 under the Digital Millennium Copyright Act. However with respect to future
revenue, 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, the Record Industry
Association of America, will refrain from investigating or otherwise challenging
the applicability of the statute to our satellite technologies.
Other Commitments
As of March 31, 2002, the Company has approximately $32.4 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)
March 31, December 31,
2002 2001
(unaudited)
-------------- ---------------
ASSETS
Current assets:
Cash ............................................................. $ 514 $ 2,583
Accounts receivable, net of allowances of $1,760 and $1,943 ...... 23,328 24,313
Inventory ........................................................ 9,459 9,402
Prepaid expenses and other assets ................................ 1,889 1,441
----------- -----------
Total current assets ......................................... 35,190 37,739
Property and equipment, net ........................................... 116,266 118,019
Intangible assets, net ................................................ 286,654 292,546
Deferred charges and other assets, net ................................ 52,118 50,020
----------- -----------
Total assets ................................................. $ 490,228 $ 498,324
=========== ===========
LIABILITIES AND MEMBERS' INTEREST
Current liabilities:
Current maturities of long term debt ............................. $ 6,775 $ 6,775
Current maturities of other liabilities .......................... 4,057 4,115
Accounts payable ................................................. 4,745 5,192
Accrued expenses ................................................. 19,138 21,278
Advance billings ................................................. 1,608 870
----------- -----------
Total current liabilities .................................... 36,323 38,230
Long-term debt ........................................................ 350,887 355,145
Related party notes ................................................... 10,000 --
Other liabilities ..................................................... 11,628 12,895
Commitments and contingencies
Mandatorily redeemable preferred units ................................ 95,838 92,266
Members' Interest:
Class A units .................................................. 129,554 133,141
Class B units .................................................. 978 1,263
Accumulated other comprehensive loss ........................... (1,273) (2,455)
Accumulated deficit ............................................ (143,707) (132,161)
----------- -----------
Total members' interest ...................................... (14,448) (212)
----------- -----------
Total liabilities and members' interest ...................... $ 490,228 $ 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 Quarter
Ended Ended
March 31, March 31,
2002 2001
--------- ---------
Revenues:
Music and other business services ....................................... $ 39,540 $ 36,818
Equipment and related services .......................................... 11,423 13,150
--------- --------
50,963 49,968
Cost of revenues:
Music and other business services (excluding $10,785 and $8,588 of
depreciation and amortization expense)................................. 7,760 7,666
Equipment and related services .......................................... 9,558 8,981
--------- --------
17,318 16,647
--------- --------
33,645 33,321
Selling, general and administrative expenses ................................. 18,071 18,027
Depreciation and amortization expense ........................................ 17,850 18,282
--------- --------
Loss from operations ................................................. (2,276) (2,988)
Other income (expense):
Interest expense ........................................................ (9,592) (10,916)
Other, net .............................................................. 19 (6)
--------- --------
Loss before income taxes ............................................ (11,849) (13,910)
Income tax benefit .......................................................... (303) (437)
--------- --------
Net loss ............................................................ $ (11,546) $(13,473)
========= ========
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 Quarter Ended
March 31, March 31,
2002 2001
---------------- -----------------
CASH FLOW FROM OPERATING ACTIVITIES
Net loss ...................................................................... $ (11,546) $ (13,473)
Adjustments to derive cash flow from continuing operating activities:
Gain on disposal of fixed assets .............................................. (11) (5)
Deferred income tax benefit ................................................... (303) (437)
Depreciation and amortization ................................................. 17,850 18,282
Amortization of senior discount notes ......................................... 1,762 1,553
Amortization of deferred financing fees ....................................... 478 472
Amortization of deferred subscriber acquisition costs ......................... 2,879 2,073
Deferred subscriber acquisition costs ......................................... (3,479) (3,937)
Unearned installment income ................................................... (418) (94)
Change in certain assets and liabilities, net of business acquisitions
Decrease in accounts receivable ............................................ 986 7,759
Increase in inventory ...................................................... (57) (999)
Decrease in accrued interest ............................................... (4,672) (2,458)
Decrease in accounts payable ............................................... (1,335) (4,775)
Increase (decrease) in accrued expenses .................................... 2,231 (147)
Increase in advance billings ............................................... 738 992
Other, net ................................................................. (435) 1,046
---------- ----------
NET CASH PROVIDED BY OPERATING ACTIVITIES ................................ 4,668 5,852
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures .......................................................... (9,467) (10,571)
Proceeds from sale of fixed assets ............................................ 13 9
---------- ----------
NET CASH USED IN INVESTING ACTIVITIES .................................... (9,454) (10,562)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in book overdrafts ........................................ 888 (3,284)
Repayments under revolver ..................................................... (10,000) --
Borrowings under revolver ..................................................... 4,000 8,500
Issuance of notes payable to a related party .................................. 10,000 --
Repayments of capital lease obligations and other debt ........................ (657) (578)
Payment of financing fees ..................................................... (1,514) --
---------- ----------
NET CASH PROVIDED BY FINANCING ACTIVITES ................................. 2,717 4,638
---------- ----------
NET DECREASE IN CASH .......................................................... (2,069) (72)
CASH BEGINNING OF PERIOD ...................................................... 2,583 3,012
---------- ----------
CASH END OF PERIOD ............................................................ $ 514 $ 2,940
========== ==========
Significant non-cash activities:
Capital lease obligations ..................................................... $ 665 $ 113
The Notes are an integral part of these consolidated financial statements.
4
MUZAK HOLDINGS LLC
CONSOLIDATED STATEMENTS OF CHANGES IN
MEMBERS' INTEREST AND COMPREHENSIVE LOSS
(In thousands, except for units)
Class A Class B Accumulated
------- ------- 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)
--------
Issuance 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)
======== ========= ======= ======== ========= ========= ========
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 March 31, 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 March 31, 2002 and March 31, 2001 and for
the quarters 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 HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
Useful March 31, December 31,
Life 2002 2001
(years) (Unaudited)
-------------------------------------------
Equipment provided to subscribers ......................... 4-6 $ 126,115 $ 121,084
Capitalized installation labor ............................ 5 52,107 48,802
Equipment ................................................. 5-7 21,815 21,151
Other ..................................................... 3-30 16,954 16,248
--------- ---------
216,991 207,285
Less accumulated depreciation ............................ (100,725) (89,266)
--------- ---------
$ 116,266 $ 118,019
========= =========
Included in equipment and other at March 31, 2002 and December 31, 2001 is
$4.8 million and $5.0 million, respectively of equipment under capital leases,
net of accumulated depreciation of $7.5 million and $6.6 million, respectively.
Depreciation of property and equipment was $11.6 million and $9.3 million for
the quarters ended March 31, 2002 and 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 for impairment using
a two-step process. 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.
However, the Company has six months from the date of adoption to complete the
first step. 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. Any impairment loss resulting from the transitional impairment
tests in 2002 will be reflected as a cumulative effect of a change in accounting
principle. The Company is still in the process of evaluating its goodwill and
has not yet determined what effect these impairment tests, or what additional
effects SFAS No. 142, will have on its financial statements.
7
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Amortized intangible assets consist of the following (in thousands):
March 31, 2002 December 31, 2001
(unaudited)
Useful ------------------------------------ ------------------------------------
Life Gross Carrying Accumulated Gross Carrying Accumulated
(years) Amount Amortization Amount Amortization
---------- ------------------ ----------------- ------------------------------------
Income producing contracts ........ 12 $153,994 $(36,995) $ 154,048 $ (33,786)
License agreements ................ 20 5,082 (762) 5,082 (699)
Deferred production costs ......... 10 4,813 (819) 4,437 (701)
Trademarks ........................ 5 15,104 (8,975) 14,935 (8,219)
Non-compete agreements ............ 3-5 19,983 (14,653) 23,869 (16,560)
Other ............................. 20 10,556 (1,466) 10,778 (1,423)
-------- --------- --------- ---------
$209,532 $(63,670) $ 213,149 $ (61,388)
======== ========= ========= =========
Aggregate amortization expense was $6.3 million and $9.0 million for the
quarters ended March 31, 2002 and 2001, respectively.
The estimated future aggregate amortization expense is as follows (in
thousands):
Fiscal year ending:
2002 ...................................... $23,184
2003 ...................................... 18,299
2004 ...................................... 15,000
2005 ...................................... 14,161
2006 ...................................... 14,110
Unamortized intangible assets consist of the following (in thousands):
March 31, 2002 December 31, 2001
Carrying amount Carrying amount
(unaudited)
------------------- -----------------
Goodwill .............................................. $140,792 $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 March 31,
2002 2001
-------------------------------------
Net Loss ........................................... $ (11,546) $ (13,473)
Goodwill amortization .............................. -- 1,984
Trained workforce amortization ..................... -- 319
--------- ---------
Net Loss excluding amortization of goodwill ........ $ (11,546) $ (11,170)
========= =========
8
MUZAK HOLDINGS 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):
March 31, December 31,
2002 2001
(Unaudited)
------------------ ------------------
Subscriber acquisition costs, net................................ $ 38,042 $ 37,442
Other ........................................................... 14,076 12,578
--------- ----------
$ 52,118 $ 50,020
========= ==========
6. ACCRUED EXPENSES
Accrued expenses are summarized below (in thousands):
March 31, 2002 December 31, 2001
(Unaudited)
------------------ ------------------
Accrued interest ................................................... $ 1,820 $ 6,493
Accrued compensation and benefits .................................. 5,003 3,671
Other .............................................................. 12,315 11,114
--------- ----------
$ 19,138 $ 21,278
========= =========
7. DEBT
Debt obligations consist of the following (in thousands):
March 31, December 31,
2002 2001
(Unaudited)
------------------ ------------------
Related Party Notes ............................................. $ 10,000 $ --
========= =========
Long term debt:
Revolving Loan-Senior Credit Facility ......................... $ 15,300 $ 21,300
Senior Credit Facility ........................................ 166,207 166,207
Senior subordinated notes ..................................... 115,000 115,000
Senior discount notes ......................................... 58,622 56,861
Other ......................................................... 2,533 2,552
--------- ----------
Total debt obligations .......................................... 357,662 361,920
Less current maturities ......................................... (6,775) (6,775)
--------- ----------
$ 350,887 $ 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.
9
MUZAK HOLDINGS 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 March 31, 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, was 9.21% and 9.47% at March
31, 2002 and 2001, respectively.
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.
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.
10
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Other Debt
The Company has $2.4 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 March 31,
2002, the Company had outstanding debt of $181.5 million under its senior credit
facility, with additional available borrowings of up to $39.7 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 reduce accounts
receivable and inventory balances, while implementing additional cost-saving
initiatives. 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 .............................................. $ 6,755
2003 .............................................. 7,855
2004 .............................................. 27,742
2005 .............................................. 58,233
2006 .............................................. 81,699
Thereafter ........................................ 185,378
Total interest paid by the Company on all indebtedness was $12.3 million
and $10.2 million for the quarters ended March 31, 2002 and 2001, respectively.
The weighted average interest rate on all indebtedness was 10.27% and 10.46% for
the quarters ended March 31, 2002 and 2001, respectively.
Interest Rate Protection Programs
The effect of the Company's interest rate swap agreement on the operating
results of the Company was to increase interest expense by $1.2 million and $0.3
million for the quarters ended March 31, 2002 and 2001, respectively. This
agreement terminated on April 19, 2002.
The fair value of the interest rate swap agreement was a loss of
approximately $1.3 million as of March 31, 2002. The fair values of interest
rate swaps 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.
11
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Subsequent to quarter end, the Company entered into a three year interest
rate cap on April 19, 2002, for which we 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.
8. Mandatorily 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.
9. Related Party Transactions
During the quarter ended March 31, 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
quarters ended March 31, 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.
12
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 March
31, 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 for digital copies granted from the copyright
owner of the master 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, and such Panel published a report that was released in February 2002.
The Panel recommended an ephemeral royalty rate of ten percent (10%) of
gross proceeds applicable to the use of ephemeral copies of copyrighted
recordings. That recommendation is now subject to the review of the Librarian of
Congress, who can either modify or adopt such recommendation. Upon publication
of the Librarian's determination in the Federal Register, such determination may
further be appealed to the United States Court of Appeals for the District of
Columbia Circuit.
Since a final determination has yet to be published by the Librarian of
Congress and an appeal of any such final determination may arise after such
publication, we cannot currently predict what the ultimate ephemeral royalty
rate or license terms are likely to be. As a result, we cannot predict the
extent of our exposure for retroactive royalty payments dating back to October
1998 under the Digital Millennium Copyright Act. However with respect to future
revenue, 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, the Record Industry
Association of America, will refrain from investigating or otherwise challenging
the applicability of the statute to our satellite technologies.
Other Commitments
As of March 31, 2002, the Company has approximately $32.4 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
During the first quarter, the Company explored various financing
alternatives to fund continuing growth. As a result, 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. Accordingly, the Company has decided not to pursue other contemplated
forms of financing at this time and recorded $0.5 million in expenses associated
with the exploratory efforts mentioned above.
General
Muzak is the leading provider of business music programming in the United
States based on market share. We believe that, together with our franchisees, we
have a market share of approximately 60% of the estimated number of U.S.
business locations currently subscribing to business music programming. Together
with our franchisees, we have nationwide coverage and serve an installed base of
approximately 340,000 client locations.
Results of Operations
Set forth below are discussions of the results of operations for Muzak LLC
for the quarter ended March 31, 2002 compared to the quarter ended March 31,
2001.
Revenues. Revenues were $51.0 million and $50.0 million for the quarters ended
March 31, 2002 and 2001, respectively, an increase of 2.0%. Music and other
business services revenue increased $2.7 million, or 7.4% in 2002 as compared to
the quarter ended March 31, 2001. The growth in music and other business
services revenue is due to an increase in new client locations , offset by a
10.7% churn rate during the twelve months ended March 31, 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
first quarter of 2002 to 10.0% from 12.7% in the first quarter of 2001. During
the twelve months ended March 31, 2002, we added, net of churn of both
acquisition locations
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MUZAK LLC
Item 2. Management's Discussion and Analysis (Continued)
and locations obtained through our sales and marketing efforts, 11,017 Audio
Architecture, 2,397 Voice, and 1,413 other locations. Equipment and related
services revenue decreased 13.1% or $1.7 million in 2002 as compared to the
quarter ended March 31, 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.
Cost of Revenues. Cost of revenues was $17.3 million and $16.6 million for the
quarters ended March 31, 2002 and 2001, respectively, an increase of 4.0%. Total
cost of revenues as a percentage of revenues was 34.0% and 33.3% for the
quarters ended March 31, 2002 and 2001, respectively. Costs of music and other
business services revenue as a percentage of music and other business services
revenue was 19.6% and 20.8% for the quarters ended March 31, 2002 and 2001,
respectively. The 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. 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. 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 quarter
of 2002.
Selling, general and administrative expenses. Selling, general, and
administrative expenses were $18.1 million and $18.0 million for the quarters
ended March 31, 2002 and 2001, respectively. This slight increase is due to a
$0.8 million increase in amortization of subscriber acquisition costs, a
non-cash component of selling, general, and administrative expenses. 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
28.8% and 30.6% for the quarters ended March 31, 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 quarters ended March 31, 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 $17.9
million and $18.3 million for the quarters ended March 31, 2002 and 2001,
respectively, a decrease of 2.4%. 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 quarter of 2001,
the Company recorded $2.3 million amortization expense related to goodwill and
trained workforce. Depreciation was $11.6 million and $9.3 million in the
quarters ended March 31, 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 $7.7 million and $9.3 million for the
quarters ended March 31, 2002 and 2001, respectively, a decrease of $1.5
million, or 16.5%. This decrease is due to lower outstanding debt balances at
lower interest rates during the first quarter of 2002 as compared to the first
quarter of 2001.
Income tax provision. Income tax benefit was $0.3 million and $0.4 million for
the quarters ended March 31, 2002 and 2001, respectively, a decrease of 30.7%.
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 for the quarter ended March 31, 2002, compared to a net loss of $11.8
million for the comparable 2001 period.
15
MUZAK LLC
Item 2. Management's Discussion and Analysis (Continued)
The Company evaluates the operating performance of its business using
several measures, one of them being 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
-----------------------------------------------------------
March 31, 2002 March 31, 2001
----------------------- ------------------------
Net loss ................................ $ (9,701) $ (11,838)
Depreciation and amortization ........... 17,850 18,282
Interest expense, net ................... 7,740 9,251
Income Tax benefit ...................... (303) (437)
Non Cash charges (income) ............... (12) 36
One-time expenses (a) ................... 539 675
--------- ---------
Adjusted EBITDA ......................... $ 16,113 $ 15,969
========= =========
(a) One-time expenses were incurred in connection with exploring various
financing alternatives.
Adjusted EBITDA for the quarter ended March 31, 2002 increased $0.1
million, or 0.9% to $16.1 million from $16.0 million for the quarter ended March
31, 2001.
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 quarter ended March 31,
2002, $4.7 million of cash was provided by our operating activities, $9.5
million of cash was used in investing activities, and $2.7 million of cash was
provided by financing activities. Cash was primarily used during the first
quarter 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
March 31, 2002, we had outstanding debt of $181.5 million under our senior
credit facility, with additional available borrowings of up to $39.7 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 reduce accounts receivable and
inventory balances and are committed to reducing our up front investment
(equipment, commissions, and technician labor) associated with new client
locations through the re-use of equipment, drop shipping equipment to customer
locations, and the efficient use of our technician workforce through our
automated technician labor scheduling system, among other initiatives. 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.
16
MUZAK LLC
Item 2. Management's Discussion and Analysis (Continued)
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 quarter ended March 31, 2002, our total initial
investment in new client locations was $11.5 million which was comprised of
equipment and installation costs attributable to new client locations of $8.0
million and $3.5 million in sales commissions (included in cash provided by
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 $52.0 million including $36.0
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 first quarter of 2002 was approximately $1.1 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 $3.0 million for 2002.
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 (1.99% and 4.75%
respectively, at March 31, 2002) would impact interest costs by approximately
$0.4 million annually on the senior credit facility. The Company's interest rate
swap terminated on April 19, 2002. We entered into a new interest rate
protection agreement 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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
For the period ended March 31, 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.
17
MUZAK LLC
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit
Number Description
- ------ -----------
(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.
18
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: May 15, 2002 William A. Boyd
Chief Executive Officer
(Principal Executive Officer)
By: /s/ Stephen P. Villa
---------------------------------
Date: May 15, 2002 Stephen P. Villa
Chief Financial Officer
(Principal Financial
Officer and Chief
Accounting Officer)
19