UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended September 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 Identification No.)
Incorporated or Organization)
3318 LAKEMONT BLVD
FORT MILL, SC 29708
(803) 396-3000
(Address, Including Zip Code and Telephone Number including Area Code of
Registrants' Principal Executive Offices)
Indicate by check mark whether the registrants have filed all documents and
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days.
Yes [X] No [_]
Muzak 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 November
14, 2002.
1
PART I-FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
MUZAK LLC
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
September 30, December 31,
2002 2001
-------------- ---------------
ASSETS
Current assets:
Cash ........................................................... $ 1,599 $ 2,583
Accounts receivable, net of allowances of $1,719 and $1,943 .... 27,113 24,313
Inventory ...................................................... 11,238 9,402
Prepaid expenses and other assets .............................. 2,091 1,441
------------- -------------
Total current assets ....................................... 42,041 37,739
Property and equipment, net ......................................... 110,721 118,019
Intangible assets, net .............................................. 275,737 292,546
Deferred charges and other assets, net .............................. 49,594 47,638
------------- -------------
Total assets ............................................... $ 478,093 $ 495,942
============= =============
LIABILITIES AND MEMBER'S INTEREST
Current liabilities:
Current maturities of long term debt ........................... $ 7,153 $ 6,775
Current maturities of other liabilities ........................ 3,993 4,115
Accounts payable ............................................... 6,545 5,192
Accrued expenses ............................................... 19,545 21,278
Advance billings ............................................... 1,382 870
------------- -------------
Total current liabilities .................................. 38,618 38,230
Long-term debt ...................................................... 295,999 298,284
Related party notes ................................................. 10,000 --
Other liabilities ................................................... 9,884 12,895
Commitments and contingencies
Member's interest:
Common units (100 issued and outstanding) .................... 260,053 260,373
Accumulated other comprehensive loss ......................... (197) (2,455)
Accumulated deficit .......................................... (136,264) (111,385)
------------- -------------
Total member's interest .................................... 123,592 146,533
------------- -------------
Total liabilities and member's interest .................... $ 478,093 $ 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 Nine Months Ended
---------------------------------- ----------------------------------
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
---------------- ---------------- --------------- ---------------
Revenues:
Music and other business services .............. $ 41,177 $ 37,851 $ 121,123 $ 111,782
Equipment and related services ................. 14,989 12,675 40,075 39,448
------------- -------------- ------------ ------------
56,166 50,526 161,198 151,230
Cost of revenues:
Music and other business services (excluding
$11,196, $9,550, $32,932, and $27,406 of
depreciation and amortization expense) ...... 7,780 7,396 26,428 21,956
Equipment and related services ................ 11,873 10,519 32,474 29,516
------------- -------------- ------------ ------------
19,653 17,915 58,902 51,472
------------- -------------- ------------ ------------
36,513 32,611 102,296 99,758
Selling, general and administrative expenses ....... 17,931 16,402 53,853 51,557
Depreciation and amortization expense .............. 17,567 19,287 52,825 56,078
------------- ------------- ------------ ------------
Income (loss) from operations ............. 1,015 (3,078) (4,382) (7,877)
Other income (expense):
Interest expense .............................. (6,829) (7,431) (21,588) (24,482)
Other, net .................................... 76 (99) 192 (201)
------------- ------------- ------------ ------------
Loss before income taxes .................. (5,738) (10,608) (25,778) (32,560)
Income tax provision (benefit) ..................... (308) 109 (899) (500)
------------- ------------- ------------ ------------
Net loss .................................. $ (5,430) $ (10,717) $ (24,879) $ (32,060)
============= ============= ============ ============
The Notes are an integral part of these consolidated financial statements.
3
MUZAK LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
Quarter Ended Nine Months Ended
---------------------------------- --------------------------------
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
--------------- --------------- --------------- ---------------
CASH FLOW FROM OPERATING ACTIVITIES
Net loss ..................................................... $ (5,430) $ (10,717) $ (24,879) $ (32,060)
Adjustments to derive cash flow from continuing operating
activities:
Loss (gain) on disposal of fixed assets ...................... (17) 10 (30) 119
Deferred income tax benefit .................................. (308) (142) (899) (751)
Depreciation and amortization ................................ 17,567 19,287 52,825 56,078
Amortization of deferred financing fees ...................... 491 391 1,377 1,170
Amortization of deferred subscriber acquisition costs ........ 3,260 2,478 9,182 6,830
Deferred subscriber acquisition costs ........................ (3,619) (4,027) (10,845) (11,920)
Unearned installment income .................................. (316) (216) (1,053) (548)
Change in certain assets and liabilities, net of business
acquisitions
Decrease (increase) in accounts receivable ................ (3,760) 610 (2,799) 10,222
Decrease (increase) in inventory .......................... (166) 806 (1,836) 1,026
Decrease in accrued interest .............................. (2,807) (2,802) (5,698) (1,269)
Decrease in accounts payable .............................. (722) (353) (1,684) (4,679)
Increase (decrease) in accrued expenses ................... 1,434 162 4,544 (406)
Increase (decrease) in advance billings ................... 90 (292) 512 294
Other, net ................................................ 495 (471) 51 633
------------ ------------ ---------- ----------
NET CASH PROVIDED BY OPERATING ACTIVITIES ............... 6,192 4,724 18,768 24,739
------------ ------------ ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisitions, net of cash .................................... -- -- -- (979)
Capital expenditures ......................................... (8,646) (8,327) (26,700) (30,427)
Proceeds from sale of fixed assets ........................... 22 11 40 291
------------ ------------ ---------- ----------
NET CASH USED IN INVESTING ACTIVITIES ................... (8,624) (8,316) (26,660) (31,115)
------------ ------------ ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in book overdrafts ....................... 1,719 (3,093) 3,037 (5,320)
Repayments of senior credit facility ......................... -- -- (3,347) (2,597)
Repayments on revolver ....................................... -- -- (10,000) --
Borrowings on revolver ....................................... 3,000 7,500 11,500 16,000
Issuance of notes payable to a related party ................. -- -- 10,000 --
Payment of interest rate protection agreement ................ -- -- (372) --
Repayments of capital lease obligations and other debt ....... (662) (662) (2,035) (1,743)
Financing fees paid on behalf of member ...................... (50) -- (50) --
Payment of fees associated with the financing ................ (293) -- (1,825) --
------------ ------------ ---------- ----------
NET CASH PROVIDED BY FINANCING ACTIVITES ............... 3,714 3,745 6,908 6,340
------------ ------------ ---------- ----------
NET INCREASE (DECREASE) IN CASH .............................. 1,282 153 (984) (36)
CASH, BEGINNING OF PERIOD .................................... 317 2,823 2,583 3,012
CASH, END OF PERIOD .......................................... $ 1,599 $ 2,976 $ 1,599 $ 2,976
============ ============ ========== ==========
Significant non-cash activities:
Equity contribution from Parent .............................. -- -- -- 33,707
Capital lease obligations .................................... 662 963 1,953 1,432
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
====== ======== ========== ======== =========
Comprehensive Loss:
Net loss (5,430) (5,430)
Change in unrealized losses on
derivative (103) (103)
--------- -------- ---------
Total comprehensive loss (5,430) (103) (5,533)
------ -------- --------- -------- ---------
Balance at September 30, 2002 100 $260,053 $(136,264) $ (197) $ 123,592
====== ======== ========== ======== =========
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 September 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 September 30, 2002 and 2001 and for the
three and nine 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. This Form
10-Q and the Form 10-Q for the three and six months ended June 30, 2002 can be
found on the Company's website, www.muzak.com.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
Useful September 30, December 31,
Life 2002 2001
(years) (Unaudited)
--------- -------------- -------------
Equipment provided to subscribers .......... 4-6 $ 135,004 $ 121,084
Capitalized installation labor ............. 5 57,740 48,802
Equipment .................................. 5-7 23,944 21,151
Other ...................................... 3-30 17,766 16,248
------------ ------------
234,454 207,285
Less accumulated depreciation .............. (123,733) (89,266)
------------ ------------
$ 110,721 $ 118,019
============ ============
6
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Included in equipment and other at September 30, 2002 and December 31, 2001
is $13.7 million and $11.6 million, respectively, of equipment under capital
leases, gross of accumulated depreciation of $8.8 million and $6.6 million,
respectively. Depreciation of property and equipment was $11.8 million and $34.8
million for the quarter and nine months ended September 30, 2002, respectively,
and $10.5 million and $29.6 million for the quarter and nine months ended
September 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.
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.
Unamortized intangible assets consist of the following (in thousands):
September 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):
(unaudited)
For the Quarter Ended September 30,
2002 2001
------------------------------------------
Net Loss ...................................... $ (5,430) $(10,717)
Goodwill amortization .... .................... -- 1,984
Trained workforce amortization ................ -- 319
-------- --------
Net Loss excluding amortization of goodwill ... $ (5,430) $ (8,414)
======== ========
(unaudited)
For the Nine Months Ended September 30,
2002 2001
-------------------------------------------
Net Loss ...................................... $(24,879) $(32,060)
Goodwill amortization ......................... -- 5,948
Trained workforce amortization ................ -- 957
-------- --------
Net Loss excluding amortization of goodwill ... $(24,879) $(25,155)
======== ========
7
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Amortized intangible assets consist of the following (in thousands):
September 30, 2002
Useful (unaudited) December 31, 2001
---------------------------------- ---------------------------------
Life Gross Carrying Accumulated Gross Carrying Accumulated
(years) Amount Amortization Amount Amortization
---------- ---------------------------------- ---------------------------------
Income producing contracts ...... 12 $ 153,955 $ (43,410) $ 154,048 $ (33,786)
License agreements .............. 20 5,082 (889) 5,082 (699)
Deferred production costs ....... 10 5,593 (1,092) 4,437 (701)
Trademarks ...................... 5 15,123 (10,486) 14,935 (8,219)
Non-compete agreements .......... 3-5 19,983 (17,787) 23,869 (16,560)
Other ........................... 20 10,683 (1,823) 10,778 (1,423)
------------ ------------ ------------- -----------
$ 210,419 $ (75,487) $ 213,149 $ (61,388)
============ ============ ============= ===========
Aggregate amortization expense was $5.7 million and $18.0 million for the
quarter and nine months ended September 30, 2002, respectively, and $8.8 million
and $26.3 million for the quarter and nine months ended September 30, 2001,
respectively.
The estimated future aggregate amortization expense is as follows (in
thousands):
Fiscal year ending
------------------
2002 ............................ $23,229
2003 ............................ 18,379
2004 ............................ 15,079
2005 ............................ 14,240
2006 ............................ 14,189
5. DEFERRED CHARGES AND OTHER ASSETS, NET
Deferred charges and other assets, net, consist of the following (in
thousands):
September 30,
2002 December 31,
(Unaudited) 2001
---------------- --------------------
Subscriber acquisition costs, net ....... $ 39,105 $ 37,442
Other ................................... 10,489 10,196
-------- ---------
$ 49,594 $ 47,638
======== =========
8
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. DEBT
Debt obligations consist of the following (in thousands):
September 30,
2002 December 31,
(Unaudited) 2001
----------------- -------------
Related Party Notes .......................... $ 10,000 $ --
========= =========
Long term debt:
Revolving Loan-Senior Credit Facility ...... $ 22,800 $ 21,300
Senior Credit Facility ..................... 162,860 166,207
Senior Subordinated Notes .................. 115,000 115,000
Other ...................................... 2,492 2,552
--------- ---------
Total debt obligations ....................... 303,152 305,059
Less current maturities ...................... (7,153) (6,775)
--------- ---------
$ 295,999 $ 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, 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 2.75% in the case of Alternate Base Rate
and 3.75% in the case of LIBOR as of September 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 6.1% and
9.3% at September 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.
9
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
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 September
30, 2002, the Company had outstanding debt of $185.7 million under its senior
credit facility, with additional available borrowings of up to $32.0 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
through December 2004. 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.
10
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Annual Maturities
Annual maturities of long-term debt obligations are as follows (in
thousands):
2002 ........................................................ $ 3,368
2003 ........................................................ 7,855
2004 ........................................................ 27,742
2005 ........................................................ 65,733
2006 ........................................................ 81,700
Thereafter .................................................. 126,754
Total interest paid by the Company on all indebtedness was $8.6 million and
$25.2 million for the quarter and nine months ended September 30, 2002,
respectively and $10.1 million and $23.3 million for the quarter and nine months
ended September 30, 2001. The weighted average interest rate on all indebtedness
was 7.8% and 9.5% as of September 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 $1.6 million for the nine months ended September
30, 2002 and $0.8 million and $1.6 million for the quarter and nine months ended
September 30, 2001, respectively.
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 $0.2 million as of September 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.
7. Related Party Transactions
During the nine months ended September 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 September 30, 2002, the Parent has obligations of $62.5 million of
senior discount notes and mandatorily redeemable preferred units ("preferred
units") of $104.7 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
11
MUZAK LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
default, the preferred units accrue at a preferential return of 17% per annum as
long as the default is continuing. The Parent was in compliance as of September
30, 2002, and therefore, the preferred units resumed 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 nine months ended September 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.
8. MUZAK FINANCE CORP.
Muzak Finance Corp. had no operating activities during the nine months
ended September 30, 2002 and 2001.
9. COMMITMENTS AND CONTINGENCIES
Litigation
The Company is involved in various claims and lawsuits arising out of the
normal conduct of its business. Although the ultimate outcome of these legal
proceedings cannot be predicted with certainty, the management of the Company
believes that the resulting liability, if any, will not have a material effect
upon the Company's consolidated financial statements or liquidity.
The industry wide agreement between business music providers and Broadcast
Music Inc. ("BMI") expired in December 1993. Since this time the Company has
been operating under an interim agreement pursuant to which the Company has
continued to pay royalties at the 1993 rates. Business music providers and BMI
have been negotiating the terms of a new agreement. The Company is involved in a
rate court proceeding, initiated by BMI in Federal Court in New York. At issue
are the music license fees payable by the Company and its owned operations as
well as licensed independent franchisees to BMI. The period from which such
"reasonable" license fees are payable covers the period January 1, 1994 to
September 30, 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. If the parties fail to
progress in their negotiations toward a mutually acceptable rate by November 29,
2002, either party can pursue a rate court proceeding in federal court in New
York to seek a court determined reasonable rate.
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 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 required by such determination, we remitted payment on 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 nine months ended September 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 September 30, 2002, the Company has approximately $28.4 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)
(unaudited)
September 30, December 31,
2002 2001
------------- ------------
ASSETS
Current assets:
Cash .......................................................... $ 1,599 $ 2,583
Accounts receivable, net of allowances of $1,719 and $1,943 ... 27,113 24,313
Inventory ..................................................... 11,238 9,402
Prepaid expenses and other assets ............................. 2,091 1,441
---------- ----------
Total current assets ...................................... 42,041 37,739
Property and equipment, net ...................................... 110,721 118,019
Intangible assets, net ........................................... 275,737 292,546
Deferred charges and other assets, net ........................... 51,728 50,020
---------- ----------
Total assets .............................................. $ 480,227 $ 498,324
========== ==========
LIABILITIES AND MEMBERS' INTEREST
Current liabilities:
Current maturities of long term debt .......................... $ 7,153 $ 6,775
Current maturities of other liabilities ....................... 3,993 4,115
Accounts payable .............................................. 6,545 5,192
Accrued expenses .............................................. 19,545 21,278
Advance billings .............................................. 1,382 870
---------- ----------
Total current liabilities ................................. 38,618 38,230
Long-term debt ................................................... 358,529 355,145
Related party notes .............................................. 10,000 --
Other liabilities ................................................ 9,884 12,895
Commitments and contingencies
Manditorialy redeemable preferred units .......................... 104,683 92,266
Members' interest:
Class A units ................................................. 121,261 133,141
Class B units ................................................. 406 1,263
Accumulated other comprehensive loss .......................... (197) (2,455)
Accumulated deficit ........................................... (162,957) (132,161)
---------- ----------
Total members' interest ................................... (41,487) (212)
---------- ----------
Total liabilities and members' interest ................... $ 480,227 $ 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 Nine Months Ended
------------------------------ -----------------------------
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
------------- ------------- ------------- -------------
Revenues:
Music and other business services ............... $ 41,177 $ 37,851 $ 121,123 $ 111,782
Equipment and related services .................. 14,989 12,675 40,075 39,448
--------- --------- --------- ---------
56,166 50,526 161,198 151,230
Cost of revenues:
Music and other business services (excluding
$11,196, $9,550, $32,932, and $27,406 of
depreciation and amortization expense) ........ 7,780 7,396 26,428 21,956
Equipment and related services .................. 11,873 10,519 32,474 29,516
--------- --------- --------- ---------
19,653 17,915 58,902 51,472
--------- --------- --------- ---------
36,513 32,611 102,296 99,758
Selling, general and administrative expenses ......... 17,931 16,402 53,853 51,557
Depreciation and amortization expense ................ 17,567 19,287 52,825 56,078
--------- --------- --------- ---------
Income (loss) from operations ............... 1,015 (3,078) (4,382) (7,877)
Other income (expense):
Interest expense ................................ (8,865) (9,236) (27,505) (29,728)
Other, net ...................................... 76 (99) 192 (201)
--------- --------- --------- ---------
Loss before income taxes .................... (7,774) (12,413) (31,695) (37,806)
Income tax provision (benefit) ....................... (308) 109 (899) (500)
--------- --------- --------- ---------
Net loss .................................... $ (7,466) $ (12,522) $ (30,796) $ (37,306)
========= ========= ========= =========
The Notes are an integral part of these consolidated financial statements.
3
MUZAK HOLDINGS LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
Quarter Ended Nine Months Ended
----------------------------- -----------------------------
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
------------- ------------- ------------- -------------
CASH FLOW FROM OPERATING ACTIVITIES
Net loss ............................................................ $ (7,466) $(12,522) $(30,796) $(37,306)
Adjustments to derive cash flow from continuing operating activities:
Loss (gain) on disposal of fixed assets ............................. (17) 10 (30) 119
Deferred income tax benefit ......................................... (308) (142) (899) (751)
Depreciation and amortization ....................................... 17,567 19,287 52,825 56,078
Amortization of senior discount notes ............................... 1,953 1,723 5,669 4,999
Amortization of deferred financing fees ............................. 575 473 1,625 1,417
Amortization of deferred subscriber acquisition costs ............... 3,260 2,478 9,182 6,830
Deferred subscriber acquisition costs ............................... (3,619) (4,027) (10,845) (11,920)
Unearned installment income ......................................... (316) (216) (1,053) (548)
Change in certain assets and liabilities, net of business
acquisitions
Decrease (increase) in accounts receivable ....................... (3,760) 610 (2,799) 10,222
Decrease (increase) in inventory ................................. (166) 806 (1,836) 1,026
Decrease in accrued interest ..................................... (2,807) (2,802) (5,698) (1,269)
Decrease in accounts payable ..................................... (722) (353) (1,684) (4,679)
Increase (decrease) in accrued expenses .......................... 1,434 162 4,544 (406)
Increase (decrease) in advance billings .......................... 90 (292) 512 294
Other, net ....................................................... 494 (471) 51 633
-------- -------- -------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES ...................... 6,192 4,724 18,768 24,739
-------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisitions, net of cash ........................................... -- -- -- (979)
Capital expenditures ................................................ (8,646) (8,327) (26,700) (30,427)
Proceeds from sale of fixed assets .................................. 22 11 40 291
-------- -------- -------- --------
NET CASH USED IN INVESTING ACTIVITIES .......................... (8,624) (8,316) (26,660) (31,115)
-------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in book overdrafts .............................. 1,719 (3,093) 3,037 (5,320)
Repayments of senior credit facility ................................ -- -- (3,347) (2,597)
Repayments on revolver .............................................. -- -- (10,000) --
Borrowings on revolver .............................................. 3,000 7,500 11,500 16,000
Issuance of notes payable to a related party ........................ -- -- 10,000 --
Payment of interest rate protection agreement ....................... -- -- (372) --
Repayments of capital lease obligations and other debt .............. (662) (662) (2,035) (1,743)
Payment of fees associated with the financing ....................... (343) -- (1,875) --
-------- -------- -------- --------
NET CASH PROVIDED BY FINANCING ACTIVITES ...................... 3,714 3,745 6,908 6,340
-------- -------- -------- --------
NET INCREASE (DECREASE) IN CASH ..................................... 1,282 153 (984) (36)
CASH, BEGINNING OF PERIOD ........................................... 317 2,823 2,583 3,012
CASH, END OF PERIOD ................................................. $ 1,599 $ 2,976 $ 1,599 $ 2,976
======== ======== ======== ========
Significant non-cash activities:
Issuance of common stock in connection with conversion of
sponsor notes ....................................................... -- -- -- 35,435
Issuance of common stock in connection with acquisitions ............ -- -- -- 143
Capital lease obligations ........................................... 662 963 1,953 1,432
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)
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)
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)
======= ========= ======= ========= ========= ======== =========
Comprehensive loss:
Net loss ............................... (7,466) (7,466)
Change in unrealized losses on
derivative ............................. -- (103) (103)
--------- -------- ---------
Total comprehensive loss ............... (7,466) (103) (7,569)
Net Issuance (repurchase) of units ..... (297)
Preferred return on preferred units .... -- (4,436) -- (368) -- -- (4,804)
------- --------- ------- --------- --------- -------- ---------
Balance, September 30, 2002 132,422 $ 121,261 10,699 $ 406 $(162,957) $ (197) $ (41,487)
======= ========= ======= ========= ========= ======== =========
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 September 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 September 30, 2002 and 2001 and for the
three and nine 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 September 30, December 31,
Life 2002 2001
(years) (Unaudited)
-----------------------------------------
Equipment provided to subscribers .... 4-6 $ 135,004 $ 121,084
Capitalized installation labor ....... 5 57,740 48,802
Equipment ............................ 5-7 23,944 21,151
Other ................................ 3-30 17,766 16,248
--------- ---------
234,454 207,285
Less accumulated depreciation ....... (123,733) (89,266)
--------- ---------
$ 110,721 $ 118,019
========= =========
6
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Included in equipment and other at September 30, 2002 and December 31, 2001
is $13.7 million and $11.6 million, respectively, of equipment under capital
leases, gross of accumulated depreciation of $8.8 million and $6.6 million,
respectively. Depreciation of property and equipment was $11.8 million and $34.8
million for the quarter and nine months ended September 30, 2002, respectively,
and $10.5 million and $29.6 million for the quarter and nine months ended
September 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.
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.
Unamortized intangible assets consist of the following (in thousands):
September 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):
(unaudited)
For the Quarter Ended September 30,
2002 2001
-----------------------------------
Net Loss ...................................... $ (7,466) $ (12,522)
Goodwill amortization ......................... -- 1,984
Trained workforce amortization ................ -- 319
--------- ---------
Net Loss excluding amortization of goodwill ... $ (7,466) $ (10,219)
========= =========
(unaudited)
For the Nine Months Ended September 30,
2002 2001
---------------------------------------
Net Loss ..................................... $ (30,796) $ (37,306)
Goodwill amortization ........................ -- 5,948
Trained workforce amortization ............... -- 957
--------- ---------
Net Loss excluding amortization of goodwill .. $ (30,796) $ (30,401)
========= =========
7
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Amortized intangible assets consist of the following (in thousands):
September 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 $(43,410) $ 154,048 $ (33,786)
License agreements ............... 20 5,082 (889) 5,082 (699)
Deferred production costs ........ 10 5,593 (1,092) 4,437 (701)
Trademarks ....................... 5 15,123 (10,486) 14,935 (8,219)
Non-compete agreements ........... 3-5 19,983 (17,787) 23,869 (16,560)
Other ............................ 20 10,683 (1,823) 10,778 (1,423)
-------- -------- --------- ---------
$210,419 $(75,487) $ 213,149 $ (61,388)
======== ======== ========= =========
Aggregate amortization expense was $5.7 million and $18.0 million for the
quarter and nine months ended September 30, 2002, respectively, and $8.8 million
and $26.3 million for the quarter and nine months ended September 30, 2001,
respectively.
The estimated future aggregate amortization expense is as follows (in
thousands):
Fiscal year ending
------------------
2002 ................................. $23,229
2003 ................................. 18,379
2004 ................................. 15,079
2005 ................................. 14,240
2006 ................................. 14,189
5. DEFERRED CHARGES AND OTHER ASSETS, NET
Deferred charges and other assets, net, consist of the following (in
thousands):
September 30, December 31,
2002 2001
(Unaudited)
----------- --------
Subscriber acquisition costs, net ........ $ 39,105 $ 37,442
Other .................................... 12,623 12,578
-------- --------
$ 51,728 $ 50,020
======== ========
8
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. DEBT
Debt obligations consist of the following (in thousands):
September 30, December 31,
2002 2001
(Unaudited)
----------- ---------
Related Party Notes ......................... $ 10,000 $ --
======== =========
Long term debt:
Revolving Loan-Senior Credit Facility ..... $ 22,800 $ 21,300
Senior Credit Facility .................... 162,860 166,207
Senior Discount Notes ..................... 62,530 56,861
Senior Subordinated Notes ................. 115,000 115,000
Other ..................................... 2,492 2,552
-------- ---------
Total debt obligations ...................... 365,682 361,920
Less current maturities ..................... (7,153) (6,775)
-------- ---------
$358,529 $ 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, 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 2.75% in the case of Alternate Base Rate
and 3.75% in the case of LIBOR as of September 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 6.1% and
9.3% at September 30, 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 Muzak LLC and Muzak Finance and are subordinated in right of
payment to all existing and future Senior Indebtedness of Muzak LLC and Muzak
Finance.
9
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Senior Subordinated Notes are guaranteed by the Company, MLP Environmental
Music LLC, Business Sound Inc., BI Acquisition LLC, Audio Environments Inc.,
Background Music Broadcasters Inc., Muzak Capital Corporation, Telephone Audio
Productions Inc., Muzak Houston Inc., Vortex Sound Communications Company Inc.,
and Music Incorporated. 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. Under certain
default scenarios, the sponsor notes are junior and subordinate to payments for
the Senior Credit Facility, the Senior Subordinated Notes, and the Senior
Discount 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.
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 September
30, 2002, the Company had outstanding debt of $185.7 million under its senior
credit facility, with additional available borrowings of up to $32.0 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
through December 2004. 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
10
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 .................................... $ 3,368
2003 .................................... 7,855
2004 .................................... 27,742
2005 .................................... 65,733
2006 .................................... 81,700
Thereafter .............................. 189,284
Total interest paid by the Company on all indebtedness was $8.6 million
and $25.2 million for the quarter and nine months ended September 30, 2002,
respectively and $10.1 million and $23.3 million for the quarter and nine months
ended September 30, 2001. The weighted average interest rate on all indebtedness
was 8.7% and 10.0% as of September 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 $1.6 million for the nine months ended September
30, 2002 and $0.8 million and $1.6 million for the quarter and nine months ended
September 30, 2001, respectively.
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 $0.2 million as of September 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.
7. 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.
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 accrued at a preferential return of 17% per annum
during the quarter ended September 30, 2002. The Company is in compliance as of
September 30, 2002, and therefore, the preferred units are accruing at 15% per
annum beginning on October 1, 2002.
11
MUZAK HOLDINGS LLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. Related Party Transactions
During the nine months ended September 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.
9. MUZAK HOLDINGS FINANCE CORP.
Muzak Holdings Finance Corp. had no operating activities during the nine
months ended September 30, 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.
The industry wide agreement between business music providers and
Broadcast Music Inc. ("BMI") expired in December 1993. Since this time the
Company has been operating under an interim agreement pursuant to which the
Company has continued to pay royalties at the 1993 rates. Business music
providers and BMI have been negotiating the terms of a new agreement. The
Company is involved in a rate court proceeding, initiated by BMI in Federal
Court in New York. At issue are the music license fees payable by the Company
and its owned operations as well as licensed independent franchisees to BMI. The
period from which such "reasonable" license fees are payable covers the period
January 1, 1994 to September 30, 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. If the parties fail to
progress in their negotiations toward a mutually acceptable rate by November 29,
2002, either party can pursue a rate court proceeding in federal court in New
York to seek a court determined reasonable rate.
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 required by such determination, we remitted payment on 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 nine months ended September 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 September 30, 2002, the Company has approximately $28.4 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.
This Form 10-Q and the Form 10-Q for the three and six months ended June
30, 2002 can be found on the Company's website, www.muzak.com.
Recent Developments
General Business
Pan Am Sat announced the successful launch of the Galaxy IIIC satellite on
June 15, 2002. Galaxy IIIC is now operating in the same orbital slot formerly
occupied by Galaxy IIIR, and the transition to Galaxy IIIC has been a seamless
one for the Company's clients. While the Company believes that Galaxy IIIC is
operating within all performance and design specifications, the Company's risk
management strategy continues to be to explore the availability of insurance to
cover increased costs in the event of a Galaxy IIIC satellite failure.
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 required by such determination, we remitted payment on 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
current satellite technologies.
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,
14
MUZAK LLC
Item 2. Management's Discussion and Analysis (Continued)
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 $1.8 million in financing fees related to these transactions during
the nine months ended September 30, 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. 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 nine months ended September 30, 2002 compared to the quarter
and nine months ended September 30, 2001.
Revenues. Revenues were $56.2 million and $50.5 million for the quarters ended
September 30, 2002 and 2001, respectively, an increase of 11.2%. Music and other
business services revenue increased $3.3 million, or 8.8% and equipment and
related services revenue increased $2.3 million, or 18.3% in 2002 as compared to
the quarter ended September 30, 2001. Revenues for the nine months ended
September 30, 2002 increased 6.6% to $161.2 million, up $10.0 million from the
comparable 2001 period. Music and other business services revenue increased $9.3
million, or 8.4% and equipment and related services revenue increased $0.6
million, or 1.6% for the nine months ended September 30, 2002 as compared to
2001. The increase in music and other business services revenue is due to a
growth in new client locations at consistent prices, offset by a 10.4% churn
rate during the twelve months ended September 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 nine months
ended September 30, 2002 to 10.0% from 11.8% during the first nine months of
2001. During the twelve months ended September 30, 2002, we added, net of churn,
approximately 8,200 Audio Architecture, 3,900 Voice, and 1,400 other locations.
Due to an expected further reduction in new store location build outs among our
national chains in 2002, particularly within the retail sector, the Company
committed resources and renewed its focus on system sales such as sound systems,
noise masking, drive-thru systems, and closed circuit television as a means to
replace this expected reduction in equipment and labor revenues. The significant
increase in equipment and related services revenue for the quarter ended
September 30, 2002 as compared to the quarter ended September 30, 2001 is a
direct result of this focus. We expect the full year 2002 equipment and related
services revenue will slightly exceed the 2001 levels.
Cost of Revenues. Cost of revenues was $19.7 million and $17.9 million for the
quarters ended September 30, 2002 and 2001, respectively, an increase of 9.7%.
Cost of revenues increased $7.4 million for the nine months ended September 30,
2002 as compared to the nine months ended September 30, 2001. During the nine
months
15
MUZAK LLC
Item 2. Management's Discussion and Analysis (Continued)
ended September 30, 2002, the Company increased its reserves for estimated prior
period licensing royalties and related expenses by $3.1 million. Excluding this
increase in the reserve in 2002, costs of music and other business services
revenue as a percentage of music and other business services revenue was 18.9%
and 19.5% for the quarters ended September 30, 2002 and 2001 and 19.2% and 19.6%
for the nine months ended September 30, 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, despite an increase in
licensing royalties and satellite expenses. Costs of equipment and related
services as a percentage of revenues was 79.2% and 83.0% for the quarters ended
September 30, 2002 and 2001 and 81.0% and 74.8% for the nine months ended
September 30, 2002 and 2001. The increase in the cost of equipment and related
services revenues as a percentage of revenues for the nine months ended
September 30, 2002 as compared to the 2001 period is due to the relatively fixed
technician workforce and an increase in certain technician related costs, such
as insurance, contractual union wage increases, and higher fuel and repair
costs, despite lower equipment and related services revenue during the first
half of 2002. The cost of equipment and related services revenues as a
percentage of revenues in the third quarter of 2002 decreased as compared to the
2001 period due to lower equipment and related services revenues in the 2001
period as well as disruptions in the Company's technician work force's ability
to install new client locations in the days following September 11, 2001. The
improvement is also attributable to the Company's focus on efficient management
of its labor technician costs. The Company fully implemented its scheduling
software in June 2002, which is designed to better manage and utilize internal
and external labor resources. The Company expects to continue to achieve savings
from the efficient management of its labor resources which will be offset
slightly by the increase in certain technician related costs such as contractual
union wage increases and insurance.
Selling, general and administrative expenses. Selling, general, and
administrative expenses were $17.9 million and $16.4 million for the quarters
ended September 30, 2002 and 2001, respectively and $53.9 million and $51.6
million for the nine months ended September 30, 2002 and 2001, respectively.
This increase is partially due to a $0.8 million and $2.4 million increase in
amortization of subscriber acquisition costs, a non-cash component of selling,
general, and administrative expenses for the quarter and nine months ended
September 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 26.1% and 27.6% for the
quarters ended September 30, 2002 and 2001, respectively and 27.4% and 29.1% for
the nine months ended September 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 nine months ended September
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 $17.6
million and $19.3 million for the quarters ended September 30, 2002 and 2001,
respectively, a decrease of 8.9%. Depreciation and amortization was $52.8
million and $56.1 million for the nine months ended September 30, 2002 and 2001,
respectively, a decrease of 5.8%. 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 nine months of
2001, the Company recorded $6.9 million amortization expense related to goodwill
and trained workforce. Depreciation was $34.8 million and $29.6 million in the
nine months ended September 30, 2002 and 2001, respectively. This increase is
due to the increase in property and equipment in conjunction with Muzak's growth
in the number of client locations.
Interest expense. Interest expense was $6.8 million and $7.4 million for the
quarters ended September 30, 2002 and 2001, respectively, a decrease of $0.6
million, or 8.1%. Interest expense was $21.6 million and $24.5
16
MUZAK LLC
Item 2. Management's Discussion and Analysis (Continued)
million for the nine months ended September 30, 2002 and 2001, respectively, a
decrease of 11.8%. This decrease is due to lower interest rates during the first
nine months of 2002 as compared to the 2001 comparable period as well as to the
termination of the interest rate swap. The effective interest rate for the nine
months ended September 30, 2002 and 2001 was 7.8% and 9.5%, respectively.
Income tax provision. Income tax benefit was $0.3 million for the quarter ended
September 30, 2002 and the income tax provision for the quarter ended September
30, 2001 was $0.1 million. Income tax benefit was $0.9 million and $0.5 million
for the nine months ended September 30, 2002 and 2001, respectively. 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 $5.4
million and $24.9 million for the quarter and nine months ended September 30,
2002, respectively, compared to a net loss of $10.7 million and $32.1 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
(unaudited)
----------------------------------------------------------
September 30, 2002 September 30, 2001
----------------------------- ----------------------------
Net loss ............................... $ (5,430) $ (10,717)
Depreciation and amortization .......... 17,567 19,287
Interest expense, net .................. 6,820 7,420
Income tax provision (benefit) ......... (308) 109
Non Cash charges (income) .............. (67) 110
---------- ----------
Adjusted EBITDA ........................ $ 18,582 $ 16,209
========== ==========
Nine Months Ended
(unaudited)
----------------------------------------------------------
September 30, 2002 September 30, 2001
----------------------------- ----------------------------
Net loss ............................... $ (24,879) $ (32,060)
Depreciation and amortization .......... 52,825 56,078
Interest expense, net .................. 21,553 24,398
Income tax benefit ..................... (899) (500)
Non Cash charges (income) .............. (157) 285
One-time expenses (a) .................. 3,684 675
--------- ---------
Adjusted EBITDA ........................ $ 52,127 $ 48,876
========= =========
(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 September 30, 2002 increased $2.4
million, or 14.6% to $18.6 million from $16.2 million for the quarter ended
September 30, 2001. Adjusted EBITDA for the nine months ended September 30, 2002
increased $3.3 million or 6.7% 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 nine months ended
September 30, 2002, $18.8 million of cash was provided by our operating
activities, $26.7 million of cash was used in investing activities, and $6.9
million of cash was provided by financing activities. Cash was primarily used
during the first nine 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 September
30, 2002, we had outstanding debt of $185.7 million under our senior credit
facility, with additional available borrowings of up to $32.0 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 through December 2004. 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 steady growth in new client locations,
operational improvements, and increases in equipment and related services
revenue. Muzak strives to fund both investments in new client locations and
interest and principal payments primarily through cash generated from operations
rather than through borrowings under the senior credit facility. Currently,
Muzak is funding investments in new client locations through cash generated from
operations but is borrowing under its senior credit facility for partial
interest and principal payments. 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 nine months ended September 30, 2002, our total
initial investment in new client locations was $33.1 million which was comprised
of equipment and installation costs attributable to new client locations of
$22.2 million and $10.9 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 $47.0 million including $32.0
million of equipment and installation costs attributable to new client
locations, and $15.0 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 nine months ended September 30, 2002 was approximately $3.3 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 $4.8 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 (1.82% and 4.75%
respectively, at September 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.
Certification Under the Sarbanes-Oxley Act. The certification by the
Company's chief executive officer and the chief financial officer of this report
on Form 10-Q, as required by Section 906 of the Sarbanes-Oxley Act of 2002 (18
U.S.C. Section 1350), accompanies this report to the Securities and Exchange
Commission as additional correspondence.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
For the period ended September 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.
Item 4. Controls and Procedures
Within 90 days prior to the date of this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and the Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure and control procedures. Based upon that evaluation, the
Chief Executive Officer and the Chief Financial Officer concluded that the
Company's disclosure and control procedures are effective. There were no
significant changes in the Company's internal controls or in other factors that
could significantly affect these subsequent to the date of their evaluation.
19
MUZAK LLC
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
10.1 Executive Employment Agreement dated as of November 5, 2002,
among Muzak Holdings LLC, Muzak LLC, and Stephen P. Villa
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.
20
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: November 14, 2002 William A. Boyd
Chief Executive Officer
(Principal Executive Officer)
By: /s/ Stephen P. Villa
---------------------------------
Date: November 14, 2002 Stephen P. Villa
Chief Financial Officer
(Principal Financial Officer and Chief
Accounting Officer)
21
Muzak LLC
Section 302 Certifications
Certification of the Chief Financial Officer
I, Stephen P. Villa,Chief Financial Officer of Muzak LLC certify that:
1. I have reviewed this quarterly report on Form 10-Q of Muzak LLC;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I, are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors (or persons performing the equivalent
function):
(a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
November 14, 2002
Stephen P. Villa
Chief Financial Officer
22
Muzak LLC
Section 302 Certifications
Certification of the Chief Executive Officer
I, William A. Boyd,Chief Executive Officer of Muzak LLC certify that:
1. I have reviewed this quarterly report on Form 10-Q of Muzak LLC;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I, are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors (or persons performing the equivalent
function):
(a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
November 14, 2002
William A. Boyd
Chief Executive Officer
23