10-Q 1 a2158272z10-q.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2005 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT For the transition period from ________ to ___________ Commission File No.: 33-55254-447 TOUCHTUNES MUSIC CORPORATION (Exact name of registrant as specified in its charter) NEVADA 87-0485304 (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 1800 E. SAHARA AVENUE SUITE 107 LAS VEGAS, NEVADA 89104 (Address of principal executive offices) (702) 792-7405 (Registrant's telephone number) Indicate by a check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes _X_ No ___ Indicate by a check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes__ No _X_. State the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date: AS OF MAY 13, 2005, 14,827,394 SHARES OF CLASS A VOTING COMMON STOCK WERE OUTSTANDING. TOUCHTUNES MUSIC CORPORATION INDEX

PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS The accompanying unaudited financial statements for the quarter ended March 31, 2005 have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all information and notes necessary for a complete presentation of financial position, results of operations, cash flows and stockholders' equity for the quarter then ended, in conformity with generally accepted accounting principles in the United States. In the opinion of management, all adjustments considered necessary for a fair presentation of the results of operations and financial position have been included and all such adjustments are of a normal recurring nature. Operating results for the quarter ended March 31, 2005 are not necessarily indicative of the results that can be expected for the fiscal year ending December 31, 2005. For further information, refer to the financial statements and the notes thereto included in the Annual Report for TouchTunes Music Corporation (the "Company") on Form 10-K, for the fiscal year ended December 31, 2004. Note that all dollar amounts set forth in this quarterly report on Form 10-Q are in United States dollars, except where otherwise indicated, and references herein to "dollars" or "$" are to United States dollars and references to "CDN" are to Canadian dollars. TOUCHTUNES MUSIC CORPORATION FINANCIAL STATEMENTS (UNAUDITED) MARCH 31, 2005 CONSOLIDATED BALANCE SHEETS

1 TOUCHTUNES MUSIC CORPORATION CONSOLIDATED BALANCE SHEETS [CONT'D]

SEE ACCOMPANYING NOTES. * Note: The balance sheet as at December 31, 2004 has been derived from the financial statements at that date but does not include all of the information and notes required by generally accepted accounting principles in the United States for complete financial statements. 2 TOUCHTUNES MUSIC CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (UNAUDITED)

SEE ACCOMPANYING NOTES. 3 TOUCHTUNES MUSIC CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

SEE ACCOMPANYING NOTES. 4 TOUCHTUNES MUSIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) March 31, 2005 [In U.S. dollars] 1. ORGANIZATION AND OPERATIONS OF THE COMPANY TouchTunes Music Corporation (the "Company") is involved in the digital distribution of interactive music to music-on-demand applications. The first such music-on-demand application developed by the Company were its digital jukeboxes (the "Digital Jukeboxes"), which utilize digitally compressed audio technology to distribute music titles through a proprietary distribution network. The Company is also developing its technology for other music-on-demand applications. 2. BASIS OF FINANCIAL STATEMENT PRESENTATION The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States. The consolidated financial statements at March 31, 2005 and for the three-month periods ended March 31, 2005 and 2004, are unaudited and reflect all adjustments (consisting only of normal recurring accruals) which are, in the opinion of management, necessary for a fair presentation of the Company's financial position and operating results for the interim periods in accordance with accounting principles generally accepted in the U.S. for interim financial statements. Accordingly, these interim consolidated financial statements do not include all information and footnotes required by generally accepted accounting principles for complete financial statements. These consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto, together with management's discussion and analysis of financial condition and results of operations, contained in the Company's Annual Report on Form 10-K, for the fiscal year ended December 31, 2004. The results of operations for the three-month period ended March 31, 2005 are not necessarily indicative of the results for the fiscal year ending December 31, 2005 or any other future periods. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary TouchTunes Digital Jukebox, Inc. ("TouchTunes Digital"). All significant inter-company balances and transactions since acquisition of control have been eliminated on consolidation. 3. WARRANTY PROVISION The change in the warranty provision recorded in the Company's balance sheet for the relevant periods was as follows:

5 4. BASIC AND DILUTED NET LOSS PER SHARE The calculation of basic and diluted net loss per share for the periods ended March 31 are as follows:

The impact of the conversion of 12,843,960 shares of Series A preferred stock, voting and participating ("Series A Preferred Stock"), into 38,531,880 shares of Class A voting common stock ("Common Stock") and 8,888,889 shares of Series B preferred stock, voting and participating ("Series B Preferred Stock"), into 40,000,000 shares of Common Stock are included in the weighted average common shares outstanding, using the as-if-converted method, to compute the basic and diluted net loss per share because they have characteristics similar to the Common Stock. The options and warrants to purchase the Company's Common Stock, were not included in the computation of the diluted net loss per share as the effect would be anti-dilutive. 5. BANK INDEBTEDNESS AND LONG-TERM DEBT The Company's bank indebtedness consists of an operating line of credit (the "Line of Credit") of $4,000,000. The collateralization provided to the bank by the Company on the Line of Credit and the loans described below is in the form of charges on past, present and future assets of the Company. The Line of Credit bears interest at the U.S. prime rate of the bank plus 1.50%, representing a rate of 7.75% as at March 31, 2005 (December 31, 2004 - 7.25%). The Line of Credit is also collateralized by a first charge on moveable property in the amount of $5,160,000 and by a certificate of guarantee issued by Export Development Canada covering 50 percent of the net loss risk. The Company has obtained an extension of the Line of Credit to April 30, 2006. Long-term debt consists of the following:

6 Long-term debt as at March 31, 2005 consists of a music advance term loan facility (the "Music Advance Term Loan") with National Bank of Canada (the "Bank"). The Music Advance Term Loan represents, in the aggregate, $2,000,000 and was entered into in January 2004 for purposes of financing the recoupable advances made to certain music providers. The security provided to the Bank by the Company was in the form of charges on past, present and future assets of the Company. The Music Advance Term Loan bears interest at the U.S. base rate of the Bank plus 2%, representing a rate of 8.25% as at March 31, 2005 (December 31, 2004 - 7.75%). The Music Advance Term Loan is also collateralized by a certificate of guarantee issued by La Financiere du Quebec covering 50% of the net loss risk and a charge on moveable property in the amount of $ 2,400,000. The Music Advance Term Loan is repayable over the term of the respective music agreements financed, ranging from one year to five years. The Company also has available a new term loan facility ("Revolving Credit Term Loan") in an amount of up to an aggregate of $2,000,000. The Revolving Credit Term Loan was entered into in December 2004 for purposes of financing certain of the Company's products sold to its customers. The security provided to the Bank by the Company was in the form of charges on past, present and future assets of the Company. The Revolving Credit Term Loan bears interest at the US base rate of the Bank plus 4.5%, representing a rate of 10.75% as at March 31, 2005. The Revolving Credit Term Loan is also collateralized by a certificate of guarantee issued by Export Development Canada covering 50% of the net loss risk and a second charge on moveable property in the amount of $2,400,000. At March 31, 2005, the Company had not drawn any funds on this loan. The agreements between the Company and the Bank governing the Music Advance Term Loan, the Revolving Credit Term Loan and the Line of Credit contain financial covenants including requirements that the Company maintain a minimum stockholders' equity, as defined in the agreement, of $8,000,000, and a minimum debt to equity ratio of 1.5 to 1. As at March 31, 2005, the Company satisfied these covenants. The principal payments of long-term debt are as follows:

6. NOTES PAYABLE In October 2003, the Company entered into a loan facility with a lender under which the Company could borrow up to a maximum of $1,500,000 for purposes of financing the sale of one of the Company's products, Tune Central. The security provided to the lender is a first ranking security in the Tune Centrals financed by the lender. The loan bears interest at the rate of 9.5% and must be repaid over a period of twelve months. 7. STOCK OPTIONS Options granted under the Plan are exercisable for a period of ten years, except for options granted to stockholders beneficially owning 5% or more of the Company's Common Stock, which are exercisable over a period of five years. On March 31, 2005, an aggregate of 1,970,256 shares of Common Stock were 7 reserved for future issuance under the Plan. The Plan was approved by stockholders on February 8, 2001. On September 17, 2004, the Board of Directors voted unanimously to amend the exercise price on all outstanding stock options issued under the Plan to $0.40 therefore these stock options issued under the Plan will be subject to variable stock option plan accounting. The Company accounts for options granted to employees and directors under the Plan using APB No.25, under which no compensation cost has been recognized for stock options granted. Had compensation cost for these stock options been determined consistent with SFAS No. 123, the Company's pro forma loss per common share would have been as follows:

The fair value of options at the date of grant was estimated using the Black-Scholes pricing model with the following weighted average assumptions.

8. PROPOSED TRANSACTION The Company filed with the Securities and Exchange Commission a preliminary Schedule 13E-3 Transaction Statement with respect to a going private transaction (the "Proposed Transaction") and a preliminary Schedule 14A Proxy Statement soliciting a stockholders vote on the Proposed Transaction. In connection with the Proposed Transaction, the Company intends to effect a reverse stock split of Common Stock at a ratio of one to 2,000. Once the Schedule 13E-3 Transaction Statement and Schedule 14A Proxy Statement are approved by the SEC and are in definitive form, the Company will mail copies to all of its stockholders, describing all of the material terms of the Proposed Transaction, and currently intends to effect the Proposed Transaction as soon as possible thereafter. 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE DISCUSSION AND ANALYSIS BELOW CONTAINS TREND ANALYSIS AND OTHER FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"). WORDS SUCH AS "ANTICIPATES", "EXPECTS", "INTENDS", "PLANS", "BELIEVES", "SEEKS", "ESTIMATES", VARIATIONS OF SUCH WORDS AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. THESE STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND ARE SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND ASSUMPTIONS THAT ARE DIFFICULT TO PREDICT. THEREFORE, ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE EXPRESSED OR FORECASTED IN ANY SUCH FORWARD-LOOKING STATEMENTS AS A RESULT OF A NUMBER OF FACTORS, WHICH ARE NOT WITHIN THE COMPANY'S CONTROL. The following discussion and analysis should be read in conjunction with the Company's consolidated financial statements, including the notes thereto, contained in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2004. Note that all dollar amounts set forth in this quarterly report on Form 10-Q are in United States dollars, except where otherwise indicated, and references herein to "dollars" or "$" are to United States dollars and references to "CDN" are to Canadian dollars. BACKGROUND AND OVERVIEW The Company was a development-stage company until September 1998. Prior to September 1998, the Company's financial resources were used to finance the development of its digital jukeboxes (the "Digital Jukeboxes"), which utilize digitally compressed audio technology to distribute music titles securely through a proprietary distribution network. Revenues since September 1998 have been generated from sales and leases of the Digital Jukeboxes to jukebox operators in the United States, as well as from the music service contracts associated with such sales and leases of the Digital Jukeboxes. As at March 31, 2005, the Company had delivered a total of 11,149 Digital Jukeboxes as compared with 8,235 Digital Jukeboxes delivered as at March 31, 2004. Management intends to continue its development activities in applying its technologies to other music-on-demand products and applications to other industries. The Company plays over 26 million songs to an estimated audience of approximately 5 million people each month. Management expects the base of installed Digital Jukeboxes to continue to grow, thereby increasing the number of plays and the audience exposure. This growth is expected to establish the Digital Jukeboxes as a significant promotional medium for record labels and their artists. Total assets of the Company were approximately $16,490,000 at March 31, 2005, a decrease of approximately $2,073,000 from December 31, 2004. This decrease was primarily due to a decrease in trade accounts receivable of approximately $662,000 and a decrease in inventory of approximately $1,546,000. These decreases were in part offset by an increase in cash, which was primarily attributable to an increase in the collection of trade accounts receivable. Total liabilities of the Company also decreased as compared to December 31, 2004, from approximately $8,113,000 to $6,804,000 at March 31, 2005. This is primarily due to repayments on the Company's Music Advance Term Loan and notes payable totaling approximately $622,000. In addition, the Company paid income taxes of approximately $172,000 and recorded a decrease in accounts payable and accrued liabilities. 9 RESULTS OF OPERATIONS FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2005 COMPARED TO THE THREE-MONTH PERIOD ENDED MARCH 31, 2004 The Company recorded a net loss of approximately $763,000 for the three-month ("first quarter 2005") period ended March 31, 2005 as compared to a net loss of approximately $58,000 for the corresponding three-month period ended March 31, 2004 ("first quarter 2004"). REVENUES Revenues from the sale of Digital Jukeboxes increased by approximately $1,591,000 from approximately $4,343,000 for the first quarter 2004 to $5,934,000 for the first quarter 2005. For promotional purposes the Company has reduced the retail selling price of its Digital Jukeboxes, including Tune Central, to $6,295 as compared to the comparative 2004 retail selling price of $7,990 for a Rhapsody model and $7,685 for a Maestro model, including Tune Central. The Company shipped 1,053 Digital Jukeboxes in the first quarter of 2005 as compared to 555 for the first quarter of 2004. The increase in revenues from the sale of Digital Jukeboxes is attributable to the increased unit sales offset by the impact of the aforementioned retail price reduction. In addition, the Company had a backlog of orders for in excess of 400 digital Jukeboxes as at March 31, 2005. Music service revenues grew to approximately $5,092,000 for the first quarter 2005 as compared with approximately $3,516,000 for the first quarter 2004. This increase in music service revenues resulted from an increase in the total number of Digital Jukeboxes and the installation of Tune Centrals on the Company's network, which generate recurring music service revenues. Digital Jukebox leasing and financing revenues increased to approximately $407,000 for the first quarter 2005 as compared to $360,000 for the first quarter 2004. This increase is attributable to the sale of Tune Centrals, which the Company has leased to customers, offset by a reduction in leasing and financing revenues on Digital Jukeboxes as many of these leases reach the expiration of their term. COST OF JUKEBOX REVENUES The cost of jukebox revenues increased by approximately $2,693,000, or 82%, from approximately $3,292,000 in the first quarter 2004 to approximately $5,985,000 during the first quarter 2005. The increase in cost of jukebox revenues is due to an increase in the number of Digital Jukeboxes and Tune Centrals sold in the period as compared to the first quarter 2004. COST OF MUSIC REVENUES The cost of music revenues increased by approximately $398,000 or 34%, from approximately $1,160,000 for the three-month period ended March 31, 2004 to approximately $1,558,000 for the three-month period ended March 31, 2005. The increase in the number of Digital Jukeboxes and Tune Centrals sold has resulted in an increase in the number of plays on the Company's network, thereby resulting in an increase in the royalties paid to music labels and publishers. GENERAL AND ADMINISTRATIVE EXPENSES General and administrative expenses decreased by approximately $52,000 or 4%, from approximately $1,228,000 in the first quarter 2004 to approximately $1,176,000 in the first quarter 2005. This decrease is principally attributable to a decrease in professional fees and the recording of interest revenue on the amount receivable from Ecast, Inc. offset by higher staff-related costs to support increased sales growth. RESEARCH AND DEVELOPMENT EXPENSES Research and development expenses increased by approximately $174,000, or 19%, from approximately $935,000 in the first quarter 2004 to approximately $1,109,000 in the first quarter 2005. 10 This increase in research and development expenses is due to higher staff-related costs in connection with the ongoing development and design of new products. SALES AND MARKETING EXPENSES Sales and marketing expenses increased by approximately $760,000, or 67%, from approximately $1,129,000 in the first quarter 2004 to approximately $1,889,000 in the first quarter 2005. This increase is mainly due to two factors. Firstly an increase in commissions paid to the Company's distributors of approximately $391,000 and secondly, commissions paid to the Company's salespeople as a result of the overall increase in unit sales of Digital Jukeboxes and Tune Centrals. In addition, the Company spent approximately $175,000 more in marketing and promotional costs in the first quarter 2005 as compared to the first quarter 2004 to support its sales growth. INTEREST EXPENSE Interest expense decreased by approximately $52,000, or 58%, from approximately $89,000 in the first quarter 2004 to approximately $37,000 in the first quarter 2005. This decrease is primarily due to the elimination of interest expense on the Company's Jukebox Term Loan which was repaid in March 2004 and the reduction in use of the Company's Line of Credit, offset by interest on the Company's Music Advance Term. DEPRECIATION AND AMORTIZATION EXPENSE Depreciation and amortization expense increased by approximately $24,000, or 7%, from approximately $360,000 in the first quarter 2004 to approximately $384,000 in the first quarter 2005. This increase is primarily attributable to an increase in depreciation expense due to Tune Centrals which are leased to the Company's customers and recorded as capital assets. FOREIGN EXCHANGE LOSSES The Company experienced a foreign exchange loss of approximately $57,000 during the first quarter 2005 as compared to a foreign exchange loss of approximately $141,000 during the first quarter of 2004. Foreign exchange gains or losses result from the Company paying certain expenditures in currencies other than the United States dollar. The main foreign currency in which the Company's wholly-owned subsidiary, TouchTunes Digital Jukebox, Inc., transacts is the Canadian dollar. SEASONALITY The Company has experienced lower sales volume during the summer vacation period of June, July and August, as well as during national holiday periods. These seasonal fluctuations may result in significant decreases in the Company's results of operations and have material adverse effects on its financial condition. LIQUIDITY AND CAPITAL RESOURCES The following table summarizes selected financial data (amounts in thousands):

11 The Company believes that existing funds, cash generated from operations and existing sources of and access to financing are adequate to satisfy its working capital, capital expenditure and debt service requirements for the foreseeable future. The Company's funding has come principally from a group of three investors: Societe Innovatech du Grand Montreal, CDP Capital Technologies (formerly known as CDP Sofinov) and CDP Capital Communications (formerly known as Capital Communications CDPQ Inc.). To date, they have collectively invested approximately $43,000,000 in the Company, which has provided the Company with sufficient capital resources to finance its start-up activities and to commence commercial operations. Financing arrangements with the National Bank of Canada (the "Bank") are another significant source of funding for the Company's operations. The Company has a Line of Credit available from the Bank of $4,000,000. The interest rate on the Line of Credit is the Bank's U.S. base rate plus 1.5%. The Line of Credit is secured by a first charge on the past, present and future assets of the Company and is collateralized by a certificate of guarantee issued by Export Development Canada covering 50% of the net loss risk and a charge on moveable property in the amount of $5,160,000. The Company has negotiated an extension of the Line of Credit to April 30, 2006. In January 2004, the Company entered into a Music Advance Term Loan with the Bank for an aggregate $2,000,000 for purposes of financing the recoupable advances made to certain music providers. The Term Loan bears interest at the U.S. base rate of the Bank plus 3%, representing a rate of 9.25% as at March 31, 2005. The Music Advance Term Loan is also collateralized by a certificate of guarantee issued by La Financiere du Quebec covering 50% of the net loss risk and a charge on moveable property in the amount of $2,400,000. The Music Advance Term Loan is repayable over the term of the respective music agreements financed, ranging from one to five years. The Music Advance Term Loan is secured by a lien on the past, present and future assets of the Company. The Company also has available a term loan facility ("Revolving Credit Term Loan") in an amount of up to an aggregate of $2,000,000. The Revolving Credit Term Loan was entered into in December 2004 for purposes of financing certain of the Company's products sold to its customers. The security provided to the Bank by the Company was in the form of charges on past, present and future assets of the Company. The Revolving Credit Term Loan bears interest at the US base rate of the Bank plus 4.5%, representing a rate of 10.75% as at March 31, 2005. The Revolving Credit Term Loan is also collateralized by a certificate of guarantee issued by Export Development Canada covering 50% of the net loss risk and a second charge on moveable property in the amount of $2,400,000. At March 31, 2005 the Company had not drawn on this Facility. The agreements as amended between the Company and the National Bank of Canada governing the Music Advance Term Loan, the Revolving Credit Term Loan and the Line of Credit contain financial covenants including requirements that the Company maintains a minimum net stockholders' equity, as defined in the agreement, of $8,000,000 and a minimum debt to equity ratio of 1.5 to 1. As at March 31, 2005, the Company satisfied all of its covenants. The Company has contractual obligations totaling approximately $2,033,000. These relate to payments due under the Company's long-term debt obligations described above, notes payable and operating leases. The operating leases are primarily related to office space. 12

(1) Refers to "less than 1 year" from April 1, 2005. (2) Refers to "more than 1 year" from April 1, 2005. (3) Refers to Music Advance Term Loan. The Company filed with the Securities and Exchange Commission a preliminary Schedule 13E-3 Transaction Statement with respect to a going private transaction (the "Proposed Transaction") and a preliminary Schedule 14A Proxy Statement soliciting a stockholders vote on the Proposed Transaction. In connection with the Proposed Transaction, the Company intends to effect a reverse stock split of Common Stock at a ratio of one to 2,000. Once the Schedule 13E-3 Transaction Statement and Schedule 14A Proxy Statement are approved by the SEC and are in definitive form, the Company will mail copies to all of its stockholders, describing all of the material terms of the Proposed Transaction, and currently intends to effect the Proposed Transaction as soon as possible thereafter. The Company expects the cost of acquiring the partial shares, after the proposed reverse stock split, to be approximately $360,000. The Company expects to finance this from its existing financial resources. Cash Flows The following table summarizes the Company's cash flow activity (amounts in thousands):

OPERATING Cash provided by operating activities has been and is expected to be the Company's primary recurring source of funds (see Consolidated Statement of Cash Flows). INVESTING Purchase of property, plant and equipment during the three-month period ended March 31, 2005 decreased from approximately $623,000 in the first quarter of 2004 to $103,000 in the first quarter of 2005 due to the discontinuance of the Company's Tune Central leasing program. During the first quarter 2004, the Company also incurred costs totaling approximately $411,000 relating to the settlement of the E-Cast, Inc. litigation. FINANCING The Company repaid long-term debt totaling approximately $622,000 in the first quarter 2005 as compared to approximately $996,000 in the first quarter 2004. The Company did not draw on any of its existing credit facilities in the first quarter 2005 as compared to approximately $1,600,000 of long-term debt and $532,000 of notes payable which were drawn in the first quarter 2004. 13 SUMMARY OF CRITICAL ACCOUNTING POLICIES ALLOWANCE FOR DOUBTFUL ACCOUNTS - METHODOLOGY The Company evaluates the collectibility of accounts receivable based on a combination of factors. In circumstances where the Company is aware of a specific customer's inability to meet its financial obligations (e.g., bankruptcy filings, substantial downgrading of credit scores), the Company records a specific reserve for bad debts against amounts due to reduce the net recognized receivable to the amount the Company reasonably believes will be collected. For all other customers, the Company recognizes reserves for bad debts based on the length of time the receivables are past due based on the Company's historical experience and the Company's specific experience with that customer. If circumstances change (i.e., higher than expected defaults or an unexpected material adverse change in a major customer's ability to meet its financial obligations to the Company), the Company's estimates of the recoverability of amounts due could be reduced by a material amount. WARRANTY PROVISION - METHODOLOGY The Company provides warranties on all jukeboxes sold or leased for a period of 2 to 5 years. Estimated costs for warranties are provided based upon management's best estimate. The adequacy of the warranty provision is reviewed regularly in light of the Company's past experience and expectation of costs to be incurred and adjusted accordingly. REVENUE RECOGNITION Jukebox sales are recognized when the jukebox is shipped to the customers. The Company further provides for the estimated cost of product warranties as described above. Shipping and handling costs are included in the cost of jukebox revenues and direct operating costs. Revenues generated from music service contracts and operating leases are recognized as the services are performed. RISK FACTORS The following items are representative of the risks, uncertainties and assumptions that could affect the outcome of the forward looking statements. The risks described below are not the only ones facing the Company. Additional risks we are not presently aware of or that we currently believe are immaterial may also impair our business operations. WE HAVE HAD LOSSES, AND WE CANNOT ASSURE FUTURE PROFITABILITY. We reported net income for fiscal year 2004 and operating losses for fiscal years 2000, 2001, 2002 and 2003 and the three-month period ended March 31, 2005. We cannot be assured that we will operate profitably, and if we do not, we may not be able to meet our debt service requirements, working capital requirements, capital expenditure plans, acquisition or other cash needs. Our inability to meet those needs could have a material adverse effect on our business, results of operations and financial condition. Our credit facilities contain certain covenants and financial tests that limit the way we conduct business. Our credit facilities contain various covenants limiting our ability to incur or guarantee additional indebtedness, pay dividends and make other distributions, make investments and other restricted payments, make capital expenditures and sell assets. These covenants may prevent us from raising additional financing, competing effectively or taking advantage of new business opportunities. Under our credit facilities, we are also required to maintain specified financial ratios and satisfy certain financial tests. If we cannot comply with these covenants or meet these ratios and other tests, it could result in a default under our credit facility, and unless we are able to negotiate an amendment, forbearance or waiver, we could be required to repay all amounts then outstanding, which could have a material adverse effect on our business, results of operations and financial condition. 14 Borrowings under our credit facilities also are secured by liens on substantially all of our assets and the assets of our subsidiary. If we are in default under one of these credit facilities, the lender could foreclose upon all or substantially all of our assets and the assets of our subsidiary. We cannot assure you that we will generate sufficient cash flow to repay our indebtedness, and we further cannot assure you that, if the need arises, we will be able to obtain additional financing or to refinance our indebtedness on terms acceptable to us, if at all. Any such failure to obtain financing could have a material adverse effect on our business, results of operations and financial condition. We do not own the rights to the music we offer under our music and service agreements. These rights are obtained through license agreements with music label companies, music publishing companies and performing rights societies. There can be no assurances that the Company will be able to renew existing arrangements with record label companies and publishing companies for the use of their music. If we are unable to renew these agreements, it could have a material adverse effect on our business results of operations and financial condition. We rely on a few major distributors. A small number of distributors account for a significant percentage of our jukebox sales revenues. We do not have long-term agreements with any of these distributors. We cannot be assured that we will continue to maintain favorable relationships with these distributors or that they will not be adversely affected by economic conditions. If any of these distributors reduces or cancels a significant order, it could have a material adverse effect on our business, results of operations and financial condition. Our revenues and results of operations are vulnerable to currency fluctuations. We report our revenues and results of operations in US dollars, but a significant portion of our expenses is incurred outside of the United States. Our principal currency exposure is between Canadian and US dollars, although this exposure is partially mitigated through the entering into forward foreign exchange contracts. The Company has not designated its forward exchange contracts as a hedge and accordingly records the derivatives at their fair value on the consolidated balance sheet with the corresponding gains or losses included with foreign exchange loss in the consolidated statement of operations. We cannot accurately predict the impact of future exchange rate fluctuations between the Canadian dollar and the US dollar or other foreign currencies on revenues and operating margins, and fluctuations could have a material adverse effect on our business, results of operations and financial condition. IF WE FAIL TO MAINTAIN AN EFFECTIVE SYSTEM OF INTERNAL CONTROLS OR FAIL TO IMPLEMENT CHANGES TO ADDRESS REPORTABLE CONDITIONS, WE MAY NOT BE ABLE TO REPORT OUR FINANCIAL RESULTS ACCURATELY. Effective internal controls are necessary for us to provide reliable financial reports. We may in the future discover, areas of our internal controls that need improvement. PROTECTING AND DEFENDING AGAINST INTELLECTUAL PROPERTY CLAIMS MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS. Our ability to compete depends, in part, upon successful protection of our intellectual property. We attempt to protect proprietary and intellectual property rights through available patent and trademark laws. Despite these precautions, existing patent and trademark laws afford only limited practical protection in certain countries. As a result, it may be possible for unauthorized third parties to copy our applications which could have a material adverse effect on our business, results of operations and financial condition. Litigation may also be necessary in the future to enforce our intellectual property rights, to protect our trade secrets, or to determine the validity and scope of the proprietary rights of others or to defend against claims or infringement or invalidity. As such, litigation could result in substantial costs and the diversion of resources and could have a material adverse effect on our business, results of operations and financial condition. We cannot assure you that infringement or invalidity claims will not materially adversely affect our business, results of operations and financial condition. Regardless of the validity or the success of the assertion of these claims, we could incur significant costs and diversion of resources in enforcing our intellectual property rights or in defending against such claims, which could have a material adverse effect on our business, results of operations and financial condition. 15 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK AND SUPPLEMENTARY DATA CURRENCY RATE RISK MANAGEMENT Market risks relating to our operations result primarily from changes in foreign currency exchange rates. As part of our overall risk management program, we evaluate and manage our exposure to changes in currency exchange risks on an ongoing basis. Hedges and derivative financial instruments will be used in the future, within guidelines approved or to be approved by the Board of Directors for counterpart exposure, limits and hedging practices, in order to manage our currency exposure. We have no intention of entering into financial derivative contracts, other than to hedge a specific financial risk. Currency Rate Risk We incur certain operating and manufacturing costs in Canada and are subject to market risks resulting from fluctuations in foreign currency exchange rates. Our principal currency exposure is between Canadian and US dollars. We also enter into forward foreign exchange contracts. The Company has not designated its forward foreign exchange contracts as a hedge and accordingly records the derivatives at their fair value on the consolidated balance sheet with the corresponding gains or losses included with foreign exchange loss in the consolidated statement of operations. These forward exchange contracts do not subject us to risk from exchange rate movements because gains and losses on the contracts offset losses and gains on the transactions being hedged. As at March 31, 2005, the Company had contract to sell US $2.5 million in exchange for CDN dollars over a period to June 1, 2005 at a weighted average exchange rate of CDN $1.1734. The company has recorded a foreign currency loss of approximately $71,000 in respect of these contracts in its financial results for the three-month period ended March 31, 2005. These contracts are entered into with a major financial institution as counterparty. The Company is exposed to credit loss in the event of nonperformance by the counterparty, which is limited to the cost of replacing the contracts, at current market rates. The company does not require collateral or other security to support these contracts. We currently intend to continue to enter into such contracts to hedge against future material foreign currency exchange rate risks. ITEM 4. CONTROLS AND PROCEDURES The Company's Chief Executive Officer and Chief Financial Officer have concluded, based on their evaluation as of March 31, 2005 that the Company's disclosure controls and procedures (as defined in Rule 13a-15 of the Exchange Act) are effective in ensuring that all material information required to be disclosed in this quarterly report has been made known to them in a timely fashion. There have been no significant changes in the Company's internal controls or in other factors, or any corrective actions with regard to significant deficiencies and material weaknesses that could significantly affect these controls subsequent to the date of their evaluation. PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. The exhibits listed on the Index of Exhibits of this quarterly report are included in this filing or incorporated herein by reference to other filings, as specified in the Index of Exhibits. b. The Company has filed the following report on Form 8-K for the three month period ended March 31, 2005: Form 8-K dated March 12, 2005, announcing the resignation of Marc Ferland from his position as a Director of the Company and as Chairman of the Company's Audit Committee and a member of the Company's Compensation and Strategic Committees. 16 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. TOUCHTUNES MUSIC CORPORATION Dated: May 16, 2005 By: /s/ John Perrachon ----------------------- John Perrachon Chief Executive Officer, President and Director Dated: May 16, 2005 By: /s/ Matthew Carson ------------------ Matthew Carson Vice President Finance and Chief Financial Officer (Principal Financial Officer) 17

TOUCHTUNES MUSIC CORP 10-Q