SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549


                                    FORM 10-K


[x]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934 (No Fee Required)  For the fiscal year ended
         December 31, 1996
                                       or

[_]      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934 (No Fee Required)  For the transition period
         from ___________ to ___________


                              Commission file numbers:  333-03741
                                                        333-03741-01

                            MUZAK LIMITED PARTNERSHIP
                            MUZAK CAPITAL CORPORATION
           (Exact Name of Registrants as Specified in their charters)

           DELAWARE                                       13-3647593
           DELAWARE                                       91-1722302
(State or Other Jurisdiction of
 Incorporation or Organization)          (I.R.S. Employer Identification Nos.)

                          2901 THIRD AVENUE, SUITE 400
                                SEATTLE, WA 98121
                                 (206) 633-3000
            (Address, Including Zip Code, and Telephone Number,
        Including Area Code, of Registrants' Principal Executive Offices)
        Securities registered pursuant to Section 12(b) of the Act: None.
        Securities registered pursuant to Section 12(g) of the Act: None.

Indicate by check mark whether the registrants: (1) have filed all 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 [_]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrants' knowledge, in definitive proxy or information statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [x].

On March 28, 1997 there were 19,579,831 units of partnership interests of Muzak
Limited Partnership outstanding.

None of the voting securities of Muzak Capital Corporation are held by
non-affiliates.

Muzak Capital Corporation meets the conditions set forth in General Instruction
(I)(1)(a) and (b) of Form 10-K and is therefore filing this form with the
reduced disclosure format.

                         APPLICABLE ONLY TO REGISTRANTS
                       INVOLVED IN BANKRUPTCY PROCEEDINGS
                        DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrants have filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [_] No [_]

APPLICABLE ONLY TO CORPORATE REGISTRANTS: On March 28, 1997, Muzak Capital
Corporation had outstanding 100 shares of Common Stock, par value $ 0.01 per
share, which is the registrant's only class of common stock.

                   DOCUMENTS INCORPORATED BY REFERENCE: None.
================================================================================


<PAGE>
                            MUZAK LIMITED PARTNERSHIP
                            MUZAK CAPITAL CORPORATION


                                      INDEX
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<CAPTION>

                                                                                                               Page
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Part I

         Item 1.    Business................................................................................     3
         Item 2.    Properties..............................................................................    11
         Item 3.    Legal Proceedings.......................................................................    11
         Item 4.    Submission of Matters to a Vote of Security Holders.....................................    11

Part II

         Item 5.    Market for Registrants' Common Equity and Related Stockholder Matters...................    12
         Item 6.    Selected Financial Data.................................................................    12
         Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations...    14
         Item 8.    Financial Statements and Supplementary Data.............................................    22
         Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure....    47

Part III

         Item 10.   Directors and Executive Officers of the Registrants.....................................    48
         Item 11.   Executive Compensation..................................................................    51
         Item 12.   Security Ownership of Certain Beneficial Owners and Management..........................    56
         Item 13.   Certain Relationships and Related Transactions..........................................    57

Part IV

         Item 14.   Exhibits, Financial Statement Schedules and Reports on Form 8-K.........................    57

         Signatures   ......................................................................................    60

</TABLE>


         The Registrants will furnish a copy of any exhibit to this Form 10-K
upon the payment of a fee equal to the Registrant's reasonable expense in
furnishing such exhibits.

                                       2
<PAGE>


FORWARD-LOOKING STATEMENTS

         When used in this Annual Report on Form 10-K or future filings by the
Company, as defined below, and Capital Corp., as defined below, with the
Securities and Exchange Commission, in the Company's and Capital Corp.'s press
releases or other public communications, or in oral statements made with the
approval of an authorized executive officer, the words or phrases "will likely
result," "are expected to," "will continue," "is anticipated," "estimate,"
"project" or similar expressions are intended to identify "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. The Company and Capital Corp. wish to caution readers not to place
undue reliance on any such forward-looking statements, which speak only as of
the date made, and to advise readers that various factors, including rapid
technological change, competitive pricing, concentrations in and dependence on
satellite delivery capabilities and development of new services could affect the
Company's and Capital Corp.'s financial performance and could cause the
Company's and Capital Corp.'s actual results for future periods to differ
materially from those anticipated or projected.

         The Company and Capital Corp. do not undertake and specifically
disclaim any obligation to update any forward-looking statements to reflect the
occurrence of anticipated or unanticipated events or circumstances after the
date of such statements.


                                     PART I

ITEM 1.            BUSINESS.


GENERAL

         Muzak Limited Partnership (the "Company") is the leading provider of
business music in the United States, based on the number of customer locations
served. As of December 31, 1996, the Company and its franchisees served
approximately 188,000 business customer locations in the United States,
representing a market share of approximately 50% of the estimated number of
domestic business customer locations currently served by business music
providers and approximately twice the estimated number of business customer
locations served by its nearest competitor. In addition to providing business
music, the Company also provides in-home CD quality music to EchoStar Satellite
Corporation ("EchoStar") subscribers. As of December 31, 1996, the number of
EchoStar subscribers receiving this service totaled over 300,000. Revenues from
the in-home music service accounted for less than 1.0% of revenues in 1996.
Through a network of distributors, the Company also provides business music to
subscribers outside the United States. In addition, the Company offers its
business customers a range of non-music services, including broadcast data
delivery, video, audio marketing and in-store advertising services, and sells,
installs and services related equipment.

         The Company markets business music in a variety of formats, including
(i) its well-known proprietary Environmental Music(R) (or "background" music)
and (ii) over 100 "foreground" music formats ranging from top-of-the-charts hits
to contemporary jazz, country music and classical music. Environmental Music(R),
which is principally comprised of instrumental versions of popular songs that
have been adapted and re-recorded by the Company, is generally used in business

                                       3
<PAGE>

offices and manufacturing facilities to improve employee concentration and
reduce stress. Foreground music, consisting principally of original artist
recordings, is most commonly used in public areas, such as restaurants and
retail establishments, primarily as a sales enhancement tool. The Company
distributes 60 of its channels by broadcast media (principally direct broadcast
satellite ("DBS") transmission) and supplies the balance to subscribers
principally in the form of long-playing audio tapes.

         Since 1992, the total number of domestic business customer locations
served by the Company and its franchisees has grown from 144,000 to 188,000.
Over the same period, the Company's total revenues and EBITDA have grown from
$54.5 million and $10.0 million in 1992, respectively, to $86.8 million and
$18.1 million in 1996, respectively, and the Company's net losses from
operations have decreased from approximately $2.6 million in 1992 to
approximately $2.1 million in 1996.

         Muzak Capital Corporation ("Capital Corp."), a wholly-owned subsidiary
of the Company, has nominal assets and does not conduct any operations.

BUSINESS MUSIC SERVICES

     MUSIC FORMATS

         The Company conducts on-going research into the effects of music on
human behavior to create proprietary music formats designed to have a favorable
impact on listeners. These music formats cover a wide range of musical tastes.

         The Company's best-selling format, Environmental Music(R), is a unique
blend of completely instrumental music and is principally comprised of versions
of popular songs that have been adapted and re-recorded by the Company
("covers"), music that has been composed and recorded exclusively for inclusion
in the Environmental Music(R) program ("originals"), and some commercially
available recordings. The Environmental Music(R) format is generally used in
business offices and manufacturing facilities to improve employee concentration
and reduce stress. The Environmental Music(R) library consists of approximately
30,000 recordings owned by the Company, of which approximately 5,000 are
actively used at any given time. The Company updates the library periodically,
adding approximately 1,000 new selections each year.

         Foreground music, consisting principally of original artist recordings,
is most commonly used in public areas, such as restaurants and retail
establishments, primarily as a sales enhancement tool. The Company's most
popular foreground music product, FM-1(R), features moderate tempo, original
artist recordings of familiar adult contemporary favorites. With its broad
appeal, FM-1(R) is second to the Environmental Music(R) channel in the total
number of business subscriber locations served and is the Company's most
widely-used format in the restaurant and retail markets. FM-1(R) features a
broad range of popular artists from the last 30 years, with an emphasis on
current popular music.

         Including Environmental Music(R) and FM-1(R), the Company has developed
over 60 other foreground music formats for broadcast transmission and over 100
different tape-based formats of music targeted to the specialized business needs
of subscribers with more focused customer demographics.

                                       4
<PAGE>

     DISTRIBUTION SYSTEMS

         Satellite transmission is the Company's primary delivery medium for its
business and residential programs. The Company's business music programs are
distributed to business subscribers through its medium-powered DBS system, the
EchoStar high-powered DBS system, local broadcast technology and tape-based
formats. The Company also uses its medium-powered DBS system to distribute these
programs to its franchisees for local broadcasting to the franchisees'
subscribers.

         The Company leases transponder capacity from Microspace Communication
Corporation ("Microspace"), which also provides facilities for the uplink of the
Company's signals to Microspace's transponder. Microspace, in turn, leases its
transponder capacity on satellites operated by third parties, including the
Galaxy IV satellite operated by Hughes Communications Galaxy Inc. ("Hughes"), on
which a majority of the Company's DBS signals are transmitted. The term of the
Company's principal transponder lease with Microspace for the Galaxy IV
satellite runs through the life of that satellite (which is expected to continue
through 2004). Microspace may terminate its agreements with the Company if the
Company materially breaches its obligations thereunder or if any governmental
restriction results in a sustained interruption of the Company's performance
thereunder. Microspace also is entitled to terminate its agreements with the
Company immediately upon termination of its underlying agreement with Hughes.

         In April 1996, the Company began offering high-powered DBS transmission
service to business and EchoStar residential customers through the EchoStar
satellite system. High-powered DBS systems utilize satellite dishes as small as
18 inches in diameter. The Company expanded its music services offered on the
EchoStar satellite system in mid-February 1997, when an additional 2.4 megahertz
of transponder capacity on EchoStar's second satellite became available for use
by the Company. Pursuant to its agreement with EchoStar, the Company pays
EchoStar a fee for uplink transmission and use of the uplink facility, and
EchoStar pays the Company a programming fee for each residential music customer.

OTHER SERVICES

     NON-MUSIC BROADCAST SERVICES

         The Company offers a variety of non-music services to its
medium-powered DBS business music subscribers that complement its music
services. These services are generally "bundled" and marketed in conjunction
with the Company's business music services. These services include AdParting(R)
(customized audio messages interspersed in business music), broadcast data
delivery (one-way data broadcasting on customer specific networks) and custom
business television services (custom video programs broadcasted to subscriber
locations).

     ON-PREMISE MUSIC VIDEO-ZTV(R)

         The Company programs, duplicates on videotape and sells its proprietary
ZTV(R) on-premise music video service to subscribers, allowing subscribers to
create an "MTV(R)-type" environment for their customers through specially
programmed, long-playing videotapes. The ZTV(R) taped music videos are produced
and shipped directly from the Company's production

                                       5
<PAGE>

facilities to subscriber locations. Subscribers currently using the ZTV(R)
service include Macy's, Bloomingdale's, Radio Shack, Oshman's Sporting Goods and
Rent-A-Center.

     AUDIO MARKETING

         The Company creates, produces and records spoken messages for use with
"on-hold" business telephone systems, AdParting(R) broadcasts and other forms of
in-store messaging and advertising.

     IN-STORE ADVERTISING

         The Company markets in-store "point of purchase" audio and video
advertising and merchandising services for transmission primarily through its
medium-powered DBS system. The Company has established an industry-specific
network (SuperLink(R)) of grocery wholesalers and wholesaler-supplied retailers
and sells time on the network to advertisers seeking to deliver a message
simultaneously to multiple locations in the network.

INTERNET SERVICES

         The Company has recently developed and begun operating its Internet
MusicServerSM service. The MusicServerSM service permits music retailers and
others to offer visitors to their websites access to digitized 30-second samples
from the Company's library of recorded music. This service, which permits, among
other things, a consumer to preview recordings offered for sale by a retailer,
currently is being provided to, among others, CDnow!, an on-line retailer of
compact discs and audio cassettes, Tower Records and Microsoft.

EQUIPMENT AND RELATED SERVICES

         The Company sells or leases various audio system-related products,
principally sound systems and intercoms to its business music subscribers and
other customers. The Company also sells electronic equipment, principally DBS
receivers and dishes as well as proprietary tape playback equipment, to its
franchisees to support their business music services business. All the equipment
is manufactured by third parties, although some items bear the Muzak(R) brand
name. Revenues from equipment and related services accounted for 40% of the
Company's revenues in 1995 and 37% of such revenues in 1996.

         The Company and its franchisees also sell, install and maintain
non-music related equipment, such as intercoms and paging systems, for use by
their business music subscribers and other customers. Although the maintenance
of program-receiving equipment provided to business music subscribers is
typically included as part of the overall music subscription fee, installation
and maintenance of audio or other equipment not directly related to reception of
the Company's business music service is provided on a contractual or
time-and-materials basis. Labor rates and charges for installation and service
vary by location and are determined by the Company or its franchisee. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
                                       6
<PAGE>

MARKETING

     COMPANY SALES OFFICES

         The Company has 35 local sales offices in the United States, including
sales offices in seven of the top ten U.S. markets (the greater metropolitan
areas of New York, Los Angeles, Chicago, San Francisco, Boston, Dallas and
Detroit). These 35 sales offices accounted for approximately 72% of the
Company's revenues in each of 1995 and 1996. In addition, the Company has three
additional offices including one national sales office, one office which deals
exclusively with on-premise music video services and one office which deals
exclusively with in-store advertising.

     FRANCHISEES

         The Company has 81 franchisees serving 138 separate territories in the
United States. Each franchisee has exclusive responsibility for sales in its
territory, except for sales to national accounts, sales of in-store advertising
services and on-premise music video services. The Company designs and produces
literature, customer and training videos and sales materials for use by its
franchisees. The Company also conducts sales training for its franchisees' sales
personnel.

         Under the standard form of the franchise agreement, franchisees pay the
Company (i) a monthly fee based on the number of business locations within the
specified territory, (ii) a monthly royalty equal to 10% of billings for
broadcast business music services (subject to certain deductions and
adjustments) and (iii) additional amounts for non-music broadcast services and
on-premise tape services. In addition, franchisees pay a variable surcharge of
billings to customers for medium-powered DBS service and high-powered DBS
services in the franchisee's territory. Franchisees are also responsible for
paying performing rights fees in connection with the provision of services in
their territories.

         Revenues from the sale of other broadcast business services are shared
between the Company and its franchisees, and the Company receives, determined by
service type, 50% or 60% of these revenues in lieu of royalty payments.
Franchisees also pay a monthly fee for use of various additional non-music and
other music broadcast services offered by the Company.

     NATIONAL SALES PROGRAM

         The Company has established a national sales program to market its
services more effectively to subscribers with numerous locations in various
territories, including those served by franchisees, and to address the needs of
these subscribers for uniform service and centralized billing for all of their
locations. Subscribers with 50 or more locations operating in four or more
territories are deemed to be "national accounts." The national sales program
includes a committee of representatives of the Company and its franchisees that
oversees the pricing and other material terms for national account subscriber
contracts. The Company, through its Seattle headquarters, coordinates the
servicing of national accounts by its franchisees and allocates revenues from
national accounts among the participating franchisees. The national sales office
is comprised of 9 salespeople and is supported by additional customer service
personnel. At December 31, 1996, the Company and its franchisees had national
accounts representing approximately 68,000 business subscriber locations (of
which approximately 41,000 were franchisee subscriber locations), including
those of Taco Bell, McDonald's, Burger King, Bob

                                       7
<PAGE>

Evans, Boston Markets, Crate & Barrel, Kroger, Staples, Hallmark and Wal-Mart.
None of the Company's national accounts represents more than 3% of the Company's
consolidated revenues, and the Company's top five national accounts represent in
the aggregate less than 10% of consolidated revenues.

     INTERNATIONAL SALES

         The Company has agreements with 15 international distributors and
franchisees in 10 countries outside the United States, including Canada, Mexico,
Japan, Argentina and Australia. These distributors and franchisees either pay
royalties to the Company based on their sales of business music services or a
flat fee based on the number of subscribers they serve. Royalties and other fees
from international sales accounted for approximately 2% of the Company's
revenues in 1996.

         The Company, through a joint venture ("Muzak Europe"), has been
offering business music and non-music services via satellite transmission since
1995 and is seeking to establish relationships with key distributors throughout
Europe. In addition, Muzak Europe recently acquired German and Belgian
distributors.

COMPETITION

         The Company's principal direct competitors in providing business music
services are AEI Music Network, Inc. ("AEI") of Seattle, Washington, and 3M
Sound and Communications, an affiliate of Minnesota Mining and Manufacturing
Corporation. The Company competes with a number of local independent providers
of business music. In addition, certain companies, such as DMX, Inc. and Cable
Radio Associates L.P., market and sell commercial-free music programming over
cable to residential cable television subscribers and have launched DBS services
aimed at business users. No assurance can be given that such competition will
not attract customers to whom the Company markets its services, including its
existing customers. In broadcast data delivery, video, audio marketing and
in-store advertising services, the Company faces competition from numerous
companies using broadcast as well as other delivery systems to provide similar
business services.

         There are numerous methods by which programming, such as the Company's
business music services, broadcast data delivery, video, audio marketing and
in-store advertising services, can be delivered by existing and future
competitors, including various forms of DBS services, wireless cable and fiber
optic cable and digital compression over existing telephone lines. Many
competitors or potential competitors with access to these delivery technologies
have substantially greater financial, technical, personnel and other resources
than the Company. In addition, the larger communications industry of which the
Company is a part is undergoing significant and rapid change, including the
development of new services, delivery systems and interactive technologies. In
addition, the recently enacted Telecommunications Act of 1996 (the
"Telecommunication Act") may increase competition in the markets in which the
Company operates. The Telecommunications Act resulted in comprehensive changes
to the regulatory environment for the telecommunications industry as a whole.
The legislation permits telephone companies to enter certain broadcast services
businesses. The entry of telephone companies into such businesses, with greater
access to capital and other resources, could provide significant competition to
the Company. In addition, the legislation affords relief to DBS transmission

                                       8

<PAGE>

providers by exempting them from local restrictions on small-size reception
antennae and preempting the authority of local governments to impose certain
taxes. The Company cannot reasonably predict how the Federal Communications
Commission ("FCC") will enforce the rules and policies promulgated under the
Telecommunications Act, or the effect of such rules and policies on competition
in the market for the Company's services.

         Internationally, the Company competes with AEI and a number of regional
business music providers, some of whom have substantially greater financial,
technical, personnel and other resources than the Company.

         The Company competes on the basis of service and system quality,
versatility and flexibility, the variety of its music formats, the availability
of its broadcast data and other non-music services and, to a lesser extent,
price. Even though it is seldom the lowest-priced provider of business music in
any territory, the Company believes that it can compete effectively on all these
bases due to the widespread recognition of the Muzak(R) name, its nationwide
sales and service infrastructure, the quality and variety of its music
programming and its multiple delivery systems. However, no assurance can be
given that the Company will be able to compete successfully with its existing or
potential new competitors or maintain or increase its current market share, that
it will be able to use, or compete effectively with competitors that adopt, new
delivery methods and technologies, or that discoveries or improvements in the
communications, media and entertainment industries will not render obsolete some
or all of the technologies or delivery systems currently relied upon by the
Company.

MUSIC LICENSES

         Most music is copyrighted and the Company is required to enter into
license agreements to rerecord and play music in public spaces. The Company has
various types of licensing agreements and arrangements with major rights owners
and organizations to permit the production and distribution of its business
music, including (i) master performance licensing agreements with the American
Society of Composers, Authors and Publishers ("ASCAP"), Broadcast Music, Inc.
("BMI") and the Society of European Stage Authors and Composers ("SESAC") that
permit public performance of copyrighted music in a customer's location, (ii)
mechanical licensing agreements under which the Company receives rights to
rerecord and make copies of copyrighted music and (iii) licensing agreements
with record companies that allow the Company to produce, advertise and
distribute to its on-premise tape subscribers audio tapes containing original
artist recordings.

         The Company's agreement with ASCAP expires on May 31, 1999. During
1996, the Company paid ASCAP fees aggregating approximately $2.8 million. The
Company's agreement with BMI expired on December 31, 1993 and its agreement with
SESAC expired on December 31, 1995. The Company has entered into an interim fee
structure with BMI and is in negotiations with BMI and SESAC with respect to new
agreements. The interim fee structure with BMI has been in place on an ongoing
month-to-month basis since the expiration of the underlying agreement, and
provides for continued payments at 1993 levels. The BMI license extension
stipulates that any settlement relating to ongoing fees may be retroactive to
January 1, 1994. Negotiations on a new contract with BMI began in early 1994 and
at this time it is not known when negotiations will be completed. The Company
discontinued use of SESAC licensed material upon expiration of the underlying
agreement. Negotiations on a new contract with

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SESAC began in mid-1995 and it is not known when these negotiations will be
completed. During 1996, the Company paid BMI and SESAC fees aggregating
approximately $956,000 and $7,000, respectively. The Company's total fees in the
aggregate for mechanical licenses, original artist recording
licenses and licensing agreements with record companies were approximately
$460,000 for 1996.

GOVERNMENT REGULATION

         The Company is subject to the regulatory authority of the United States
government and the governments of other countries in which it provides services
to subscribers. The business prospects of the Company could be adversely
affected by the adoption of new laws, policies or regulations that modify the
present regulatory environment. The Company currently provides music services in
a few areas in the United States through 928 to 960 megahertz radio broadcast
frequencies, which are licensed by the FCC. Additionally, the satellites on
which the Company transmits its DBS services in the United States are licensed
by the FCC. If the FCC authorizations for any of these satellites are revoked or
are not extended, the Company would be required to seek alternative satellite
facilities. Laws, regulations and policy, or changes therein, in other countries
could adversely affect the Company's existing services or restrict the growth of
the Company's business in these countries.

         The Digital Recordings Act of 1995 (the "Digital Recordings Act") was
enacted into law on November 1, 1995. The Digital Recordings Act amends U.S.
copyright law to provide sound recording owners with an exclusive performance
right in sound recordings that are performed through digital transmissions. The
Digital Recordings Act provides a compulsory license for non-interactive
subscription services, but does not provide a compulsory license for interactive
services (where the listener selects a musical piece based upon a menu or
schedule). As music services to or within a business are specifically exempted
from the provisions of the Digital Recordings Act, the digital performance right
does not apply to the Company's traditional business music services (whether
analog or digital). However, to the extent the Company provides digital music
services to residential customers, via satellite or other broadcast delivery or
via the Internet or other digital means, the Digital Recordings Act would
require the payment of additional royalties.

EMPLOYEES

         At December 31, 1996, the Company had 751 full-time and part-time
employees, of whom 192 held sales and marketing positions, 179 held
administrative positions and 380 held technical and service positions. A total
of 81 of the Company's technical and service personnel are covered by nine union
contracts with the International Brotherhood of Electrical Workers ("IBEW"). The
IBEW contracts have currently effective terms that expire on dates ranging from
February 28, 1997 to May 31, 1999. All of the IBEW contracts provide for
successive automatic one-year renewals, unless a notice of renegotiation or
termination is given prior to the end of the then-effective term. The Company
anticipates that some of the contracts may be renegotiated as their current
terms expire. The Company believes its relationships with its employees and the
IBEW are good.

                                       10

<PAGE>

ITEM 2.            PROPERTIES.


         The Company's headquarters in Seattle, Washington, consisting of
approximately 43,300 square feet, 32 of its 35 local and its three national
sales offices, which occupy an aggregate of approximately 150,000 square feet,
as well as office and satellite uplink facilities at Raleigh, North Carolina and
Cheyenne, Wyoming and two warehouses in Seattle, are leased. The Company's total
lease payments related to these premises during 1996 were approximately $2.5
million. In addition, the Company owns office and warehouse facilities,
aggregating approximately 21,000 square feet, in Buffalo, New York, Irving,
Texas and Peoria, Illinois. The Company considers its facilities to be adequate
to meet its current and reasonably foreseeable needs.


ITEM 3.            LEGAL PROCEEDINGS.


         The Company is subject to various proceedings arising in the ordinary
course of business, none of which, individually or in the aggregate, is expected
to have a material adverse effect on the Company's financial condition, results
of operations or liquidity.


ITEM 4.            SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.


         None.

                                       11
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                                     PART II

ITEM 5.            MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
                   STOCKHOLDER MATTERS.

         The Company is a privately-held company. There is no established public
trading market for its securities.


ITEM 6.            SELECTED FINANCIAL DATA.
<TABLE>
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                                                            PREDECESSOR(1)                 THE COMPANY
                                                            --------------   --------------------------------------------------
                                                               EIGHT         FOUR
                                                               MONTHS        MONTHS
                                                               ENDED         ENDED
                                                               AUG. 31,      DEC. 31,            YEAR ENDED DECEMBER 31,
                                                                                          -------------------------------------
                                                               1992          1992         1993     1994(2)     1995     1996(3)
                                                             --------------  ----------  --------  --------   ------    -------
<S>                                                            <C>          <C>         <C>       <C>       <C>         <C>


          STATEMENT OF OPERATIONS DATA:
          Revenues:
             Music and other business services..................   $ 23,771    $ 12,039  $ 36,800  $ 50,410   $ 52,489  $ 54,585
             Equipment and related services.....................     12,102       6,602    21,741    33,006     34,392    32,226
                                                                   -------------------------------------------------------------
                  Total revenues................................     35,873      18,641    58,541    83,416     86,881    86,811
                                                                   -------------------------------------------------------------
          Cost of revenues:
             Music and other business services..................      6,420       3,249    10,611    13,685     14,465    15,263
             Equipment and related services.....................      9,513       5,235    16,756    23,413     23,895    21,763
                                                                    ------------------------------------------------------------
                  Total cost of revenues........................     15,933       8,484    27,367    37,098     38,360    37,026
                                                                    ------------------------------------------------------------
          Gross profit..........................................     19,940      10,157    31,174    46,318     48,521    49,785
          Selling, general & administrative expenses(3).........     14,230       5,846    19,603    28,699     28,496    31,659
          Depreciation..........................................      3,990       1,349     4,349     8,211      9,382    10,625
          Amortization..........................................      5,005       2,259     6,942     9,622      8,909     9,594
                                                                    ------------------------------------------------------------
          Operating income (loss)...............................     (3,285)        703       280      (214)     1,734    (2,093)
          Interest expense......................................      3,639       1,228     3,785     6,990      7,483     8,112
          Other (income) expense, net...........................       (949)        (57)      (30)      (21)       (35)       (4)
                                                                    ------------------------------------------------------------
          Net income (loss) before extraordinary items..........     (5,975)       (468)   (3,475)   (7,183)    (5,714)  (10,201)
                                                                     -----------------------------------------------------------

             Extraordinary loss on write off of deferred                 --          --        --        --         --    (3,713)
              financing fees and debt discount..................
             Extraordinary gain on retirement of redeemable
              preferred partnership interests...................         --          --        --        --         --     3,091
                                                                    ------------------------------------------------------------
                Net loss......................................      (5,975)       (468)   (3,475)   (7,183)    (5,714)   (10,823)
        Redeemable preferred returns..........................         --        (188)     (572)     (933)    (1,029)       (916)
                                                                    -----------------------------------------------------------
        Net loss attributable to general and limited partners.   $ (5,975)  $    (656) $ (4,047) $ (8,116)  $ (6,743)  $ (11,739)
                                                                 ===============================================================

        OTHER INFORMATION:
        Gross profit margin(4)................................      55.6%       54.5%     53.3%     55.5%      55.8%     57.3%
        EBITDA(5).............................................   $  5,710    $  4,311  $ 11,571  $ 17,619   $ 20,025  $ 18,126
        Capital expenditures(6)...............................      5,034       3,628     8,235    13,804     12,757    16,337
        Ratio of earnings to fixed charges(7).................         --          --        --        --         --        --

</TABLE>
<TABLE>
<CAPTION>
                                                           PREDECESSOR                  THE COMPANY
                                                           ------------    ------------------------------------------------
                                                                   AT         AT
                                                                AUG. 31.   DEC. 31.              AT DECEMBER 31,
                                                                  1992       1992      1993    1994(2)     1995      1996
<S>                                                         <C>        <C>        <C>       <C>        <C>       <C>

       BALANCE SHEET DATA:
       Total assets..........................................   $ 58,837  $ 66,598    $66,294 $103,092   $96,439   $119,042
       Total long-term obligations, including current portion     37,889    36,218     35,022   56,833    53,005    101,102
       Redeemable preferred partnership interests............         --     8,188      8,760   14,693    15,722      6,090
       Partners' capital (deficit)...........................      7,284    12,199      8,047    7,943     1,373    (10,078)

(footnotes to table on following page)
                                       12


<PAGE>
<FN>

(footnotes to table on preceding page)

---------------
(1)      The Company was formed in September 1992 by Centre Capital Investors
         L.P., a private investment partnership of which Centre Partners L.P. is
         the general partner, to acquire substantially all of the assets and
         business of the Company from a predecessor entity (the "Predecessor").

(2)      Includes the results of Comcast Sound Communications Inc. ("Comcast")
         from January 31, 1994. See "Management's Discussion and Analysis of
         Financial Condition and Results of Operations."

(3)      In 1996, selling, general and administrative expenses included a fourth
         quarter write-off of $1.4 million related to an unconsummated initial
         public offering of the Company's equity securities.

(4)      Gross profit margin represents gross profit as a percentage of total
         revenues.

(5)      EBITDA represents earnings before interest expense, income taxes,
         depreciation, amortization and other income/expense. EBITDA does not
         represent and should not be considered as an alternative to net income
         or cash flow from operations as determined by generally accepted
         accounting principles. The Company, however, believes that EBITDA
         provides useful information regarding a company's ability to service
         and/or incur additional indebtedness.

(6)      Includes additions to property and equipment and additions to deferred
         costs and intangible assets.

(7)      For purposes of computing the ratio of earnings to fixed charges,
         earnings include net loss attributable to general and limited partners,
         redeemable preferred returns and interest expense, including that
         portion of lease expense attributable to interest costs. Fixed charges
         consist of preferred returns and interest expense, including that
         portion of lease expense attributable to interest costs. Earnings were
         insufficient to cover fixed charges by $6.0 million, $0.7 million, $4.0
         million, $8.1 million, $6.7 million, and $11.7 million for the
         eight-month period ended August 31, 1992, four-month period ended
         December 31, 1992, and the years ended December 31, 1993, 1994, 1995
         and 1996, respectively.
</FN>
</TABLE>

                                       13

<PAGE>


ITEM 7.            MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                   AND RESULTS OF OPERATIONS.


GENERAL

         The Company operates as a limited partnership and as such, the income
tax effects of all earnings or losses of the Company are passed directly to the
partners and no provision for income taxes is required.

         In January 1994, the Partnership acquired the assets of its largest
franchisee, Comcast, for approximately $33.0 million (the "Comcast
Acquisition"). Operating results in 1994 include eleven months of Comcast
operations, while operating results in 1995 and 1996 include a full year of
Comcast operations. The former Comcast operations represented approximately 28%
of the Company's revenues in 1995 and 29% of the Company's revenues in 1996.
Following the Comcast Acquisition, the Company eliminated redundant
administrative and field operations, resulting in annualized net savings
estimated by the Company to be approximately $1.8 million, the majority of which
was realized immediately.

         The Company derives revenues from its business services and from the
sale, installation and servicing of customer premises equipment. The Company's
principal business services include broadcast music services, on-premise tapes,
on-premise music video, audio marketing and in-store advertising. Business
services represented approximately 63% of total revenues in 1996. Equipment and
related revenues accounted for the remaining 37% of 1996 revenues. A large
majority of the Company's broadcast and on-premise tape revenues are generated
from subscribers who typically execute five-year contracts at rates ranging from
$35 to $75 per month. These subscription rates typically include the provision
of the Company's equipment for use at the subscriber's location. Royalties
received from franchisees and international distributors are included in
broadcast music revenues and represented approximately 8.9% of total revenues in
1996. The Company's franchisees pay royalties, including surcharges for
satellite transmission systems, to the Company based generally on 10% to 12.5%
of adjusted music revenues, which are broadcast music revenues less licensing
payments and bad debt write-offs. In-store advertising revenues are generated
from the sale of advertising for delivery to certain subscribers. On-premise
music video revenues are derived from the sale of specialized on-premise music
videos targeted for certain segments of the marketplace. Audio marketing
revenues are generated primarily from the sale of customized audio messages for
use with "on-hold" telephone systems. The Company also provides other broadcast
business services, including AdParting(R), data delivery services, custom
business television and other music-related services.

         Equipment revenues are derived from the sale or lease of audio
system-related products, principally sound systems and intercoms, to business
music subscribers and other customers. The Company also sells electronic
equipment, principally DBS receivers and dishes, as well as proprietary tape
playback equipment, audio and video equipment to its franchisees to support
their business music services. Installation, service and repair revenues consist
principally of revenues from the installation of sound systems and other
equipment that is not expressly part of a business music contract, such as
paging, security and drive-through systems. These revenues also include revenue
from the installation, service and repair of equipment installed under a
business music contract. Music contract installation revenues are deferred and
recognized over the term of the respective contracts.

                                       14

<PAGE>

         Cost of revenues for business services consists primarily of broadcast,
delivery, manufacturing, licensing and research costs associated with providing
music and other business services to a subscriber or a franchisee. Cost of
revenues for equipment represents the purchase cost plus handling, shipping and
warranty expenses. Cost of revenues for installation, service and repair
consists primarily of service and repair labor and labor for installation that
is not associated with new business music subscribers. Installation costs
associated with new business music subscribers are capitalized and charged to
depreciation expense over ten years.

         Selling, general and administrative expenses include salaries,
benefits, commissions, travel, marketing materials, training and occupancy costs
associated with staffing and operating local and national sales offices. Such
expenses also include personnel and other costs in connection with the Company's
headquarters functions. A significant portion of commissions and certain other
selling costs are capitalized on a successful-efforts basis and charged as
amortization expense over the average contract term of five years and,
accordingly, are not reflected in selling, general and administrative expenses.
The Company capitalized $2.8 million, $3.2 million and $3.3 million of such
costs in 1994, 1995 and 1996, respectively. The Company amortizes leasehold
improvements over the shorter of the lease term or five years and deferred costs
and intangible assets over lives ranging from two and one-half to ten years.
These deferred costs and intangible assets consist of the costs associated with
subscriber contracts acquired from third parties (typically amortized on an
accelerated basis over eight years), commissions and certain other sales related
expenses (five years), the acquisition and production costs of a music library
(typically five years), organizational expenses related to acquiring certain
franchise operations (five years) and capitalized financing costs (over the life
of the loans).

         On October 2, 1996, the Company and Capital Corp. completed the
offering of $100 million aggregate principal amount (the "Offering") of their
10% Senior Notes due 2003 (the "Senior Notes"). The Senior Notes represent
unsecured senior obligations of the Company and Capital Corp., and are senior in
right of payment to all subordinated indebtedness and pari passu in right of
payment to all senior indebtedness. The Senior Notes mature on October 1, 2003.
Interest accrues at a rate of 10% per annum and is payable semi-annually in
arrears on April 1 and October 1 to holders of record on the immediately
preceding March 15 and September 15, respectively. A portion of the proceeds
from the Senior Notes was used to repay existing indebtedness and for additional
working capital and other corporate purposes.

         In 1996, the Company adopted, as part of the Offering, a
performance-based Amended and Restated Management Option Plan (the "Amended and
Restated Option Plan") that replaces an option plan implemented in connection
with the acquisition by the Company of substantially all of the assets and
business of the Company (the "1992 Acquisition") from a predecessor entity (the
"Predecessor"). The options granted under the Amended and Restated Option Plan
represent the same proportionate equity interest and carry equivalent exercise
prices as the options granted under the original plan. The Company had not been
required to record non-cash compensation expense for the original plan because
those options were not deemed exercisable. Non-cash compensation expense is
determined with respect to options under the Amended and Restated Option Plan
based on the difference between the exercise price and the fair value of the
partnership units. Such expense is recognized from that date to the date the
options actually become exercisable and is recorded as part of the Company's
operating income (loss). The Company recorded $60,000 as non-cash compensation
expense related to this plan in the fourth quarter of 1996.

                                       15

<PAGE>
         Capital Corp., a wholly-owned subsidiary of the Company was organized
on May 8, 1996, has nominal assets and conducts no business operations. Capital
Corp. has no independent operations and is dependent on the cash flow of the
Company to meet its sole obligation, the payment of interest and principal on
the Senior Notes when due.

RESULTS OF OPERATIONS

         The following table sets forth certain financial information for the
periods presented and should be read in conjunction with the Company's Financial
Statements, including the Notes thereto:
<TABLE>
<CAPTION>

                                                                             PERCENTAGE CHANGE
                                                                             -----------------
                                                    YEAR ENDED DECEMBER 31,
                                                    -----------------------
                                                                             1995 VS  1996 VS
                                                    1994(1)  1995     1996     1994    1995
                                                            (DOLLARS IN THOUSANDS)
<S>                                             <C>      <C>      <C>       <C>     <C>

Revenues:
   Business services:
     Broadcast music.............................. $39,519 $40,664   $42,242   2.9%    3.9%
     On-premise tapes.............................   5,434   4,895     4,368  (9.9)  (10.8)
     Other broadcast..............................   1,227   1,403     1,530  14.3     9.1
     On-premise music video.......................   1,257   1,741     2,108  38.5    21.1
     Audio marketing..............................   1,615   2,027     2,480  25.5    22.3
     In-store advertising.........................     814     913       717  12.2   (21.5)
     Other........................................     544     846     1,140  55.5    34.8
                                                   -------  ------     -----
       Total music and other business services....  50,410  52,489    54,585   4.1     4.0
                                                   -------  ------    ------
Equipment.........................................  23,060  23,901    21,873   3.6    (8.5)
Installation, service and repair..................   9,946  10,491    10,353   5.5    (1.3)
                                                    ------  ------    ------
   Total equipment and related services...........  33,006  34,392    32,226   4.2    (6.3)
                                                    ------  ------    ------
   Total revenues.................................  83,416  86,881    86,811   4.2    (0.1)
Gross profit:
   Business services..............................  36,725  38,024    39,322   3.5     3.4
   Equipment......................................   9,596  10,450    10,316   8.9    (1.3)
   Installation, services and repair..............     (3)      47       147  --       --
                                                    ------  ------    ------
     Total gross profit...........................  46,318  48,521    49,785   4.8     2.6
Gross profit(2)...................................   55.5%   55.8%     57.3%
Selling, general and administrative expenses...... $28,699 $28,496   $31,659  (0.7)   11.1
S, G&A margin(3)..................................   34.4%   32.8%     36.5%
EBITDA(4)......................................... $17,619 $20,025   $18,126  13.7    (9.5)
EBITDA margin(5)..................................   21.1%   23.0%     20.9%
Net loss.......................................... $(7,183)$(5,714)  $(10,823)  --     --

<FN>
----------------
(1)  Includes the results of Comcast from January 3, 1994.
(2)  Gross profit margin represents gross profit as a percentage of total
     revenues.
(3)  S,G&A margin represents selling, general and administrative expenses as a
     percentage of total revenues.
(4)  EBITDA represents earnings before interest expense, income taxes,
     depreciation, amortization and other income/expense. EBITDA does not
     represent and should not be considered as an alternative to net income or
     cash flow from operations as determined by generally accepted accounting
     principles. The Company, however, believes that EBITDA provides useful
     information regarding a company's ability to service and/or incur
     additional indebtedness.
(5)  EBITDA margin represents EBITDA as a percentage of total revenues.

</FN>
</TABLE>

YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995

         Revenues. Total revenues decreased 0.1% from $86.9 million in 1995 to
$86.8 million in 1996 principally as a result of a 6.3% decrease in equipment
and related services offset by a 4.0% increase in business services revenues.
Business services revenues increased due to an increase in the number of
broadcast music subscribers and an increase in the royalty surcharges paid by
franchisees for DBS services. Business services revenues (with the exception of
on-premises tape sales) increased at more rapid rates than broadcast music
revenues due to the increased marketing of, and increasing customer demand for,
on-premise music video and audio marketing services, among others. On-premise
tape revenues declined due to the Company's conversion of such customers to
broadcast services, primarily DBS transmission. In-store advertising revenues

                                       16
<PAGE>

decreased 21.5% principally due to sales to a single customer in 1995 that did
not continue into 1996. Royalties and other fees from franchisees and
international distributors (included in broadcast music revenues) accounted for
$7.8 million or 8.9% of the Company's revenues in 1996, compared with $6.9
million or 7.9% of the Company's revenues in 1995 due to growth in the number of
customer locations being served and additional surcharges assessed to
franchisees for satellite transmission costs. Equipment revenues decreased 8.5%
as the Company maintained its focus on higher margin sales and reduced its
participation in lower margin competitively bid equipment sales. Installation,
service and repair revenues decreased 1.3% from the level generated in 1995 due
to fewer installations and large equipment jobs during 1996.

         Gross Profit. Total gross profit increased 2.6% from $48.5 million in
1995 to $49.8 million in 1996. As a percentage of total revenues, gross profit
increased from 55.8% in 1995 to 57.3% in 1996. The improvement in the gross
profit percentage in 1996 was due to growth in higher margin business services,
such as broadcast music, audio marketing and on-premise music video services,
and improved equipment margins.

         Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 11.1% from $28.5 million in 1995 to $31.7
million in 1996. As a percentage of total revenues, selling, general and
administrative expenses increased from 32.8% in 1995 to 36.5% in 1996. Selling
and marketing expenses increased 7.5% from $10.7 million in 1995 to $11.5
million in 1996, primarily attributable to an increase in the salesforce.
General and administrative costs increased 13.3% from $17.8 million in 1995 to
$20.1 million in 1996, primarily due to additional personnel to support
centralization of local and national sales office services and consulting
expenses for the Internet MusicServerSM and EchoStar projects, partially offset
by lower bad debt expense. General and administrative costs also include $1.4
million in expense write-offs in the fourth quarter of 1996 related to an
unconsummated public offering of equity securities.

         Depreciation Expense. Depreciation expense increased 13.3% from $9.4
million in 1995 to $10.6 million in 1996, principally as a result of an
increased investment in equipment installed at customers' premises due to an
expanded customer base and related to new investments in the EchoStar system and
the Internet MusicServerSM service.

         Amortization Expense. Amortization expense increased 7.7% from $8.9
million in 1995 to $9.6 million in 1996. The increase in amortization expense
was due to an increase in intangibles related to the increased investment in the
expanded customer base.

         Interest Expense. Total interest expense increased 8.4% from $7.5
million in 1995 to $8.1 million in 1996. The increase in interest expense in
1996 compared to 1995 resulted from the $100 million in Senior Notes issued by
the Company in October 1996. As a result, the Company's total interest-bearing
debt increased from $62.3 million to $101.1 million from 1995 to 1996.

         Extraordinary Items. Extraordinary items reflected nonrecurring noncash
charges from the write-off of $3.7 million of deferred financing fees, debt
discount and organizational costs and a nonrecurring gain of $3.1 million from
the retirement of a redeemable preferred limited partnership interest during the
fourth quarter of 1996.

                                       17

<PAGE>

YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994

         Revenues. Total revenues increased 4.2% from $83.4 million in 1994 to
$86.9 million in 1995 principally as a result of a 4.1% increase in business
services revenues and a 4.2% increase in equipment and related revenues.
Business services revenues increased due to an increase in the number of
broadcast music subscribers, offset partially by a reduction in the royalty
surcharges paid by franchisees for DBS services. Other business services
revenues, with the exception of on-premise tape sales, increased at more rapid
rates than broadcast music revenues due to the increased marketing of, and
increasing customer demand for, video, audio messaging, and AdParting(R)
services, among others. On-premise tape revenues declined due to the Company's
conversion of such customers to broadcast services, primarily DBS transmission.
Royalties and other fees from franchisees and international distributors
(included in broadcast music revenues) accounted for $6.9 million or 7.9% of the
Company's revenues in 1995, compared with $6.8 million or 8.2% of the Company's
revenues in 1994 due to growth in the number of customer locations being served,
partially offset by a planned reduction in DBS surcharges. Equipment revenues
increased 3.6% as a result of an increase in leased equipment subscribers.
Installation, service and repair revenues increased 5.5% primarily related to
large job revenue increases. In-store advertising revenues increased 12.2%,
principally due to sales to a single customer in the first quarter of 1995,
which did not continue into the last three quarters of the year.

         Gross Profit. Total gross profit increased 4.8% from $46.3 million in
1994 to $48.5 million in 1995. As a percentage of total revenues, gross profit
increased slightly from 55.5% in 1994 to 55.8% in 1995. The improvement in the
gross profit percentage in 1995 was due to growth in higher margin business
services, such as broadcast music, audio marketing and on-premise music video
services, and improved equipment margins.

         Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased 0.7% from $28.7 million in 1994 to $28.5
million in 1995. As a percentage of total revenues, selling, general and
administrative expenses declined from 34.4% in 1994 to 32.8% in 1995. Selling
and marketing expenses declined 5.1% from $11.3 million in 1994 to $10.7 million
in 1995. This decline was primarily attributable to a reduction in local sales
offices' administrative and operating support personnel, reduced costs of new
product and service research, a decrease in promotional expenses and lower sales
award costs, offset somewhat by higher non-capitalized selling costs. General
and administrative costs increased 2.1% from $17.4 million in 1994 to $17.8
million in 1995, primarily due to relocation and expansion of the headquarters
office, additional personnel to support centralization of local and national
sales office services, higher bad debt expense and consulting expenses for the
Internet MusicServerSM and EchoStar projects. These increased expenses were
partially offset by a decrease in bonuses accrued and expenses incurred in 1994
in connection with an unconsummated financing.

         Depreciation Expense. Depreciation expense increased 14.3% from $8.2
million in 1994 to $9.4 million in 1995, principally as a result of an increased
investment in equipment installed at customers' premises due to an expanded
customer base, and twelve months of depreciation of the assets acquired in the
Comcast Acquisition in 1995 compared to eleven months in 1994.

         Amortization Expense. Amortization expense decreased 7.4% from $9.6
million in 1994 to $8.9 million in 1995. The decline in amortization expense was
due to the final amortization in early 1995 of music acquired in the 1992
Acquisition.

                                       18

<PAGE>

         Interest Expense. Total interest expense increased 7.1% from $7.0
million in 1994 to $7.5 million in 1995. The increase in interest expense in
1995 as compared to 1994 was the result of increased borrowing as well as an
increase in the effective weighted average interest rate under the Company's
existing term loan and revolving credit facility from 10.0% in 1994 to 11.2% in
1995.

LIQUIDITY AND CAPITAL RESOURCES

         The Company's liquidity needs have been primarily for capital
expenditures, business acquisitions, debt service and working capital. As of
December 31, 1996, the Company had a working capital surplus of $28.2 million
compared with a working capital deficit of $7.4 million as of December 31, 1995.
This increase in net working capital for this period was due principally to an
increase in cash associated with the Offering of $100 million in Senior Notes in
October 1996.

         The Company's investing activities, excluding the Comcast Acquisition,
have historically included the purchase of on-premise customer equipment (such
as satellite dishes and receivers) and certain capitalized deferred costs
related to business acquisitions, obtaining customer contracts and creating
master recordings. Capital expenditures were $9.5 million in 1994, $8.1 million
in 1995, and $10.9 million in 1996. Additions to deferred costs were $4.3
million in 1994, $4.6 million in 1995, and $5.4 million in 1996. The Company
believes that its future investing activities may include acquisitions of the
Company's franchisees to further its operating strategy and other acquisitions
in addition to these capital expenditures and deferred customer and music
acquisition costs.

         The Company's primary sources of liquidity have been cash flows from
operations and borrowings. Cash provided by the Company's operations, adjusted
for the effect of non-cash items, totaled $17.6 million in 1996, an increase of
$3.4 million over the $14.2 million provided in 1995, due primarily to changes
in working capital. Net changes in the operating assets and liabilities utilized
cash of $4.4 million in 1996 as compared to utilizing cash of $500,000 in 1995.
The change in operating assets and liabilities was primarily attributable to an
increase in accounts payable and accrued expenses.

         A portion of the proceeds from the Offering of the Senior Notes were
used to pay off the Company's outstanding debt under a term loan and revolving
credit facility provided by Union Bank of Switzerland, New York Branch ("UBS"),
and other lenders and subordinated bank debt provided by Barclays Bank PLC, New
York Branch ("Barclays"), and retire a redeemable preferred partnership interest
of the Company. The remainder of the proceeds from the Offering will be used for
general corporate purposes, which may include acquisitions of the Company's
franchisees to further its operating strategy, other acquisitions or investment
opportunities and working capital. During the fourth quarter of 1996, the
Company reported an extraordinary loss of approximately $3.7 million on the
write-off of deferred financing fees and debt discount in connection with the
extinguishment of the bank debt. In addition, an extraordinary gain of
approximately $3.1 million was recorded as a result of the retirement of certain
redeemable preferred partnership units of the Company.

         On March 17, 1997, the Company accepted an offer, subject to due
diligence, from an interested party, to buy the Company's Spokane, Washington
franchise for $1.4 million.

                                       19

<PAGE>

         The Company leases certain facilities under both operating and capital
leases. Total lease payments for 1996 under noncancelable leases were $7.8
million. Minimum annual lease payments for 1997 under noncancelable leases are
$5.0 million.

         The Company anticipates capital expenditures of between $9.0 and $10.0
million in 1997 and additions to deferred costs and intangible assets of between
$5.0 and $6.0 million in 1997. The level of capital expenditures and additions
to deferred costs and intangible assets are subject to a variety of factors
which may cause these expenditures to exceed the ranges set forth above.

         The Company believes that subsequent to the Offering, its cash flows
from operations, borrowing availability and cash on hand will be adequate to
support currently planned business operations, capital expenditures and debt
service requirements at least through December 1998. If the Company engages in
one or more material acquisitions, joint ventures or alliances or other major
business initiatives requiring significant cash commitments, or incurs
unanticipated expenses, additional financing could be required.

         The 1992 Acquisition of the business of the Predecessor by Centre
Capital Investors L.P. ("CCI") and certain members of the Company's management
provides for contingent earn-out payments ("Earn-Out Payments") of between $5.0
million to $24.0 million to the Predecessor if certain performance measures are
achieved in the five years following the transaction. The minimum performance
requirement for the $5.0 million Earn-Out Payment requires the Company to
achieve a cumulative performance target (as defined in the acquisition
documents) over the five-year period ending August 31, 1997. The Company
believes that the minimum performance target triggering an Earn-Out Payment will
not be reached.

         The Washington State Department of Revenue has levied an assessment
against the Predecessor for $1.7 million in sales and use and business and
occupation taxes for the period from 1987 through September 1992. Under
successor liability statutes in the State of Washington, the Company could, if
the Predecessor fails to pay its tax obligation, become liable for the
assessment. The assessment is under appeal by the Predecessor. The Company has
the right to offset any future payments from the Company to the Predecessor if
the Predecessor fails to pay its tax obligation. The Seller and certain of its
affiliates have agreed to indemnify the Company for any liabilities in
connection with such assessments. Management does not believe that the
assessment will have an adverse effect on the Company's financial condition or
results of operations.

                                       20

<PAGE>

INFLATION AND CHANGING PRICES

         Management does not believe that inflation and other changing prices
have had a significant impact on the Company's operations.

                                       21
<PAGE>

ITEM 8.            FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

<TABLE>
<CAPTION>

         INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE

<S>                                                                                                      <C>
                                                                                                             PAGE
MUZAK LIMITED PARTNERSHIP
     Independent Auditors' Report.........................................................................      23
     Consolidated Balance Sheets as of December 31, 1995 and 1996.........................................      24
     Consolidated Statements of Operations for the years ended December 31, 1994,
       1995 and 1996......................................................................................      25
     Consolidated Statements of Partners' Capital (Deficit) for the years ended December 31,
       1994, 1995 and 1996................................................................................      26
     Consolidated Statements of Cash Flows for the years ended December 31, 1994,
       1995 and 1996......................................................................................      27
     Notes to Financial Statements........................................................................      28

MUZAK CAPITAL CORPORATION
     Independent Auditors' Report.........................................................................      44
     Balance Sheets as of May 8, 1996 (date of inception)and December 31, 1996............................      45
     Note to Financial Statements.........................................................................      46

FINANCIAL STATEMENT SCHEDULE - MUZAK LIMITED PARTNERSHIP
     Valuation and Qualifying Accounts Schedule II (Reg 210.12-09)........................................      47

</TABLE>

                                       22
<PAGE>

                          INDEPENDENT AUDITORS' REPORT




General and Limited Partners
Muzak Limited Partnership
Seattle, Washington

         We have audited the accompanying consolidated balance sheets of Muzak
Limited Partnership and subsidiary (the "Company") as of December 31, 1995 and
1996, and the related consolidated statements of operations, partners' capital
(deficit), and cash flows for each of the three years in the period ended
December 31, 1996. Our audits also included the financial statement schedule
listed in the Index at Item 8 of Form 10-K. These financial statements and
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
the financial statement schedule based on our audits.

         We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

         In our opinion, such consolidated financial statements present fairly,
in all material respects, the financial position of Muzak Limited Partnership
and subsidiary as of December 31, 1995 and 1996, and their results of operations
and their cash flows for each of the three years in the period ended December
31, 1996 in conformity with generally accepted accounting principles. Also, in
our opinion, the financial statement schedule, when considered in relation to
the basic financial statements, taken as a whole, presents fairly in all
material respects the information set forth therein.



Deloitte & Touche LLP
Seattle, Washington


February 28, 1997
(March 17, 1997, as to Note 11)

                                       23

<PAGE>

                            MUZAK LIMITED PARTNERSHIP

                           CONSOLIDATED BALANCE SHEETS
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                                   DECEMBER 31,
                                                                          --------------------------------
                                                                              1995               1996

                                     ASSETS
                                    -------
<S>                                                                     <C>                 <C>

CURRENT ASSETS:
     Cash and cash equivalents ...................................          $   1,115          $   25,686
     Accounts receivable, net of allowance for doubtful accounts
         of $632 and $496.........................................             15,534              15,600
     Inventories..................................................              3,473               3,722
     Prepaid expenses.............................................              1,543               1,607
     Other........................................................                357                 351
                                                                            ---------          ----------
         Total current assets.....................................             22,022              46,966

Property and equipment, net.......................................             36,586              37,182
Deferred costs and intangible assets, net.........................             36,706              33,765
Other    .........................................................              1,125               1,129
                                                                            ---------          ----------
         Total assets.............................................          $  96,439            $119,042
                                                                            =========            ========

                   LIABILITIES AND PARTNERS' CAPITAL (DEFICIT)
                   -------------------------------------------

CURRENT LIABILITIES:
     Revolving credit facility....................................          $   9,300          $       --
     Accounts payable.............................................              6,818               8,681
     Advance billings.............................................              4,533               4,688
     Accrued interest.............................................              1,312               2,500
     Accrued expenses.............................................              1,590               2,423
     Current portion of long-term obligations.....................              5,911                 482
                                                                            ---------          ----------
         Total current liabilities................................             29,464              18,774

Long-term obligations, net of current portion.....................             47,094             100,620
Unearned installation income......................................              2,786               3,636
Commitments and contingencies (Note 8)............................                 --                  --
Redeemable preferred partnership interests........................             15,722               6,090

PARTNERS' CAPITAL (DEFICIT):
     Limited partners' interests..................................              5,637               2,211
     General partners' interests (deficiencies)...................             (4,264)            (12,289)
                                                                            ---------          ----------
         Total partners' capital (deficit)........................              1,373             (10,078)
                                                                            ---------          ----------
         Total liabilities and partners' capital (deficit)........          $  96,439            $119,042
                                                                            =========            ========
</TABLE>


   The accompanying notes are an intergral part of these financial statements


                                       24
<PAGE>


                            MUZAK LIMITED PARTNERSHIP

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>

                                                                             YEAR ENDED DECEMBER 31,
                                                                     ---------------------------------------
                                                                       1994             1995           1996

<S>                                                               <C>            <C>             <C>

Revenues:

  Music and other business services..........................       $   50,410       $   52,489      $   54,585
  Equipment and related services.............................           33,006           34,392          32,226
                                                                    ----------       ----------      ----------
     Total revenues..........................................           83,416           86,881          86,811
                                                                    ----------       ----------      ----------
Cost of revenues:

  Music and other business services..........................           13,685           14,465          15,263
  Equipment and related services.............................           23,413           23,895          21,763
                                                                    ----------       ----------      ----------
     Total cost of revenues..................................           37,098           38,360          37,026
                                                                    ----------       ----------      ----------
     Gross profit............................................           46,318           48,521          49,785

Selling, general and administrative expenses.................           28,699           28,496          31,659
Depreciation.................................................            8,211            9,382          10,625
Amortization.................................................            9,622            8,909           9,594
                                                                    ----------       ----------      ----------
     Operating income (loss).................................             (214)           1,734          (2,093)

Other income (expense)
   Interest expense..........................................           (6,990)          (7,483)         (8,112)
   Interest income...........................................              103              129             438
   Equity in losses of joint venture.........................               --               --            (225)
   Other expense ............................................              (82)             (94)           (209)
                                                                    ----------       ----------      ----------
                                                                        (6,969)          (7,448)         (8,108)
Loss before extraordinary items..............................           (7,183)          (5,714)        (10,201)
  Extraordinary loss on write-off of deferred financing fees
    and debt discount........................................               --               --          (3,713)
  Extraordinary gain on retirement of redeemable preferred
    partnership interests....................................               --               --           3,091
                                                                    ----------       ----------      ----------
  Net loss...................................................           (7,183)          (5,714)        (10,823)
  Redeemable preferred returns...............................             (933)          (1,029)           (916)
                                                                    ----------       ----------      ----------
  Net loss attributable to general and limited partners......       $   (8,116)      $   (6,743)     $  (11,739)
                                                                    ==========       ==========      ==========

</TABLE>

   The accompanying notes are an integral part of these financial statements

                                       25

<PAGE>


                            MUZAK LIMITED PARTNERSHIP

             CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL (DEFICIT)
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>

                                                                      CLASS B
                      GENERAL PARTNERS' CLASS A             CLASS B   LIMITED     PREFERRED  CLASS B        TOTAL LIMITED
                         INTERESTS      LIMITED   CLASS A   LIMITED   PARTNERS'    LIMITED   PARTNERSHIP PARTNERS' INTERESTS  TOTAL
                      ----------------                                                                   ------------------ ------
                        NUMBER         PARTNERS'  PUT/CALL PARTNERS' SUBSCRIPTIONS PARTNERS'  UNIT   NUMBER         NUMBER
                          OF   AMOUNT  INTERESTS  OPTIONS  INTERESTS RECEIVABLE  INTERESTS  OPTIONS OF UNITS AMOUNT OF UNITS AMOUNT
                         UNITS


<S>                    <C>     <C>     <C>    <C>      <C>         <C>        <C>        <C>     <C>       <C>      <C>      <C>

Balance, January 1, 1994 9,101 $ 6,044   $ 888  $   624   $1,058     $(567)     $   --  $  --     4,326  $2,003   13,427    $ 8,047
  Net loss..............        (4,802)   (887)    (561)    (933)                                        (2,381)             (7,183)
  Payment of foreign
    income taxes . . . .           (43)     (8)      (5)      (8)                                           (21)                (64)
   Preferred return on
    redeemable preferred
    interests ..........          (624)   (115)     (73)    (121)                                          (309)               (933)

  Contributions by
    partners ..........                             967      175      (246)      7,000            4,663   7,896    4,663      7,896
  Principal payments on
    subscriptions
    receivable ..........                                              180                                  180                 180
                         ------ -------   -----  -------   ------     -----      ------          -------  ------  -------    -------

Balance, December 31,
  1994.................. 9,101     575    (122)     952      171      (633)      7,000     --     8,989   7,368   18,090      7,943
    Net loss.............       (3,690)   (682)    (621)    (721)                                        (2,024)             (5,714)
  Payment of foreign
    income taxes.......            (51)    (14)      (9)     (12)                                           (35)                (86)
  Preferred return on
    redeemable preferred
    interests...........          (665)   (123)    (112)    (129)                                          (364)             (1,029)
  Preferred return on
    preferred limited
    partners' interests.          (433)    (80)     (73)     (85)                  671                      433                 --
  Principal payments on
    subscriptions
    receivable..........                                               259                                  259                 259
                         -----  -------  -------    ---     -----     -----      -----  -----     -----   -----   ------      -----
Balance, December 31,
1995.................... 9,101  (4,264)  (1,021)    137     (776)     (374)      7,671     --     8,989   5,637   18,090      1,373
  Net loss..............        (6,973)  (1,288) (1,172)  (1,390)                                        (3,850)            (10,823)
  Payment of foreign
    income taxes.......            (54)    (11)      (9)     (10)                                           (30)                (84)
  Preferred return on
    redeemable preferred
    interests...........          (591)   (109)     (99)    (117)                                          (325)               (916)
  Preferred return on
    preferred limited
    partners' interests.          (407)    (75)     (69)     (81)                  632                      407                  --
 Principal payments on
    subscriptions
    receivable..........                                               207                                  207                 207
 Capital contribution
    from noncash
    incentive
    compensation......                                                                     60                60                  60
 Contribution by
    partner........                                          105                                     60     105       60        105
                          ----  -------   -----  -------   ------     -----      ------  -----   -------  ------  -------      ----

Balance, December 31,
   1996........        9,101 $(12,289) $(2,504) $(1,212) $(2,269)    $(167)     $8,303   $ 60     9,049  $2,211   18,150   $(10,078)
                      ======  ========  ======= ======   =======     ======     ======   =====  =======  ======  =======    ========

</TABLE>

   The accompanying notes are an integral part of these financial statements



                                       26

<PAGE>
                            MUZAK LIMITED PARTNERSHIP
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>


                                                                                YEAR ENDED DECEMBER 31,
                                                                          ------------------------------------
                                                                          1994           1995            1996
<S>                                                                 <C>           <C>              <C>

OPERATING ACTIVITIES
  Net loss.......................................................     $ (7,183)       $ (5,714)        $(10,823)
  Adjustments to reconcile net loss to net cash provided by operating
    activities:
        Provision for doubtful accounts..........................          610             810              472
      Depreciation...............................................        8,211           9,382           10,625
      Amortization, net of deferred financing costs..............        9,622           8,909            9,594
      Deferred financing cost amortization.......................        1,159           1,310`           1,042
      Equity in losses of joint venture..........................           --              --              225
      Noncash incentive compensation.............................           --              --               60
      Extraordinary loss on write-off of deferred financing fees
        and debt discount........................................           --              --            3,713
      Extraordinary gain on retirement of redeemable preferred
        partnership interests....................................           --              --           (3,091)
      Loss on write-off of equity offering costs.................           --              --            1,353
  Changes in operating assets and liabilities:
      Accounts receivable........................................       (1,890)           (476)            (555)
      Inventories................................................         (259)            597             (461)
      Accounts payable...........................................        1,970          (1,267)           1,863
      Accrued interest...........................................          371            (916)             834
      Accrued expenses...........................................          827             293            1,188
      Advance billings...........................................        1,200             194              155
      Unearned installation income...............................        1,099           1,110              850
      Other, net.................................................          (79)            (35)             510
                                                                      --------        --------       ----------
      Net cash provided by operating activities..................       15,658          14,197           17,554
                                                                      --------        --------       ----------

INVESTING ACTIVITIES
  Additions to property and equipment............................       (9,531)         (8,116)         (10,913)
  Additions to deferred costs and intangible assets..............       (4,273)         (4,641)          (5,424)
  Acquisitions of businesses and ventures, net of cash acquired .      (33,294)           (557)              --
  Other, net.....................................................           52               3             (291)
                                                                      --------        --------       ----------
      Net cash used in investing activities......................      (47,046)        (13,311)         (16,628)
                                                                      --------        --------       ----------
FINANCING ACTIVITIES
  Proceeds from issuance of senior notes ........................           --              --          100,000
  Borrowings (repayment) under revolving notes payable, net......        2,250           3,300           (9,300)
  Borrowings on term debt........................................       34,034              --               --
  Principal payments on term debt................................      (11,500)         (4,111)         (53,489)
  Payment of financing fees......................................           --              --           (5,802)
  Retirement of redeemable preferred partnership interests ......           --              --           (7,456)
  Payments on other long-term debt...............................         (986)            (30)            (123)
  Payments under capital leases..................................         (413)           (432)            (414)
  Contributions by partners......................................        8,076             259              312
  Other, net.....................................................          (64)           (202)             (83)
                                                                      --------        --------       ----------
      Net cash provided by (used in) financing activities........       31,397          (1,216)          23,645
                                                                      --------        --------       ----------
      Net increase (decrease) in cash and cash equivalents.......            9            (330)          24,571
CASH AND CASH EQUIVALENTS, beginning of period...................        1,436           1,445            1,115
                                                                      --------        --------      -----------
CASH AND CASH EQUIVALENTS, end of period.........................     $  1,445        $  1,115      $    25,686
                                                                      ========        ========      ===========
</TABLE>
 The accompanying notes are an integral part of these financial statements

                                     27

<PAGE>


                            MUZAK LIMITED PARTNERSHIP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.      THE COMPANY AND ITS BUSINESS:

         Muzak Limited Partnership (the "Company") provides business music
services and also produces, markets and sells broadcast data delivery, video,
audio marketing and in-store advertising services through a network of domestic
and international franchises and owned operations. The franchisees are charged a
fee based on their revenues, as well as certain other fees, in exchange for
broadcast music, marketing, technical and administrative support. The Company
and its franchisees also sell, install and maintain electronic equipment related
to the Company's business.

         The Company's music is primarily sold for use in public areas, such as
retail establishments and restaurants, and work areas, such as business offices
and manufacturing facilities. Services are distributed through direct broadcast
satellite transmission, local broadcast transmissions and pre-recorded tapes
played on the customers' premises.

         The Company is subject to certain business risks which could affect
future operations and financial performance. These risks include rapid
technological change, competitive pricing, concentrations in and dependence on
satellite delivery capabilities, and development of new services.

     BUSINESS ACQUISITIONS

         As of September 1, 1992, the Company commenced operations in its
current form (the "Partnership") through an acquisition (the "1992 Acquisition")
of substantially all of the assets, including the right to operate under its
current name, from a predecessor partnership (the "Seller"). The 1992
Acquisition was accounted for as a purchase with the purchase price allocated to
the individual assets, based on their estimated fair values at the date of
acquisition.

         On January 31, 1994, the Company acquired substantially all the net
assets of Comcast Sound Communications, Inc. ("Comcast"), previously the
Company's largest franchisee. The net assets were acquired for approximately $33
million, including a $5 million redeemable preferred partnership interest issued
to Comcast and closing costs. The acquisition was financed through additional
bank borrowings and the contribution of certain assets by Comcast in exchange
for a redeemable preferred partnership interest. The transaction was accounted
for as a purchase with the purchase price allocated to the individual assets
based on the fair values at the date of acquisition.

     PUBLIC OFFERING

         In August 1996, the general and limited partners authorized a plan for
the filing of a registration statement for the underwritten public offering of
10% senior notes (the "Offering"). The Offering closed on October 2, 1996. A
portion of the net proceeds of the Offering were used to repay certain bank debt
and other indebtedness and to repurchase the Company's Class C redeemable
preferred partnership interest. The Company anticipates using the remaining
portion of the net proceeds for certain strategic investments and other general
corporate purposes.

                                       28

<PAGE>

                           MUZAK LIMITED PARTNERSHIP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

     CASH AND CASH EQUIVALENTS

         For purposes of the statements of cash flows, the Company considers all
highly liquid debt instruments purchased with a maturity of three months or less
to be cash equivalents.

         Cash and cash equivalents at December 31, 1996 include approximately
$23 million of commercial paper. The remaining balance of cash and cash
equivalents at December 31, 1996 and the entire balance at December 31, 1995 is
held at various institutions throughout the United States.

     INVENTORIES

         Inventories consist primarily of electronic equipment and are recorded
at the lower of cost (first-in, first-out) or market.

     PROPERTY AND EQUIPMENT

         Property and equipment consist primarily of equipment provided to
subscribers and machinery and equipment, recorded at cost. Major renewals and
betterments are capitalized to the property accounts while replacements,
maintenance and repairs that do not improve or extend the lives of the
respective assets are expensed.

         Property and equipment are depreciated on a straight-line basis over
the estimated useful lives of the related assets, ranging from five to forty
years. Assets acquired under capital leases and leasehold improvements are
amortized on a straight-line basis over the shorter of their estimated useful
lives or the term of the related leases.

     DEFERRED COSTS AND INTANGIBLE ASSETS

         Income-producing contracts, acquired through acquisitions, are being
charged to amortization expense on an accelerated method over the period of
their expected benefit of eight years. Deferred financing costs are charged to
interest expense on the effective interest method over the term of the related
agreements. Other deferred costs and intangible assets are recorded at cost and
are being charged to amortization expense over their estimated useful lives or
the period of their expected benefit ranging from two and one-half to ten years.

         The carrying value of long-lived assets is reviewed on a regular basis
for the existence of facts or circumstances that may indicate that the carrying
amount is not recoverable. To date, no impairment has been indicated. Should
there be an impairment in the future, the Company will measure the impairment
based on the discounted expected future cash flows from the impaired assets.


                                       29

<PAGE>


                            MUZAK LIMITED PARTNERSHIP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, (CONTINUED):

     REVENUE RECOGNITION

         Revenues are recognized in the month that the services are provided.
Fees from franchisees are recognized as music revenues in the month that the
franchisee generates its revenues. Equipment and related services revenues are
recorded in the period that the installation is completed.

     ADVANCE BILLINGS

         The Company bills certain customers in advance for contracted music and
other business services. Amounts billed in advance of the service period are
deferred when billed and recognized as revenue in the period earned.

     UNEARNED INSTALLATION INCOME

         The Company defers recognition of income from the installation of
equipment provided to subscribers and recognizes these amounts as revenue on a
straight-line basis over the average subscriber service period.

     INCOME TAXES

         The income tax effects of all earnings or losses of the Company are
passed directly to the partners. Payment of foreign income taxes is reflected as
a reduction to the partners' capital accounts. Thus, no provision or benefit for
federal, state, local or foreign income taxes is required.

     ACCOUNTING FOR EQUITY-BASED COMPENSATION

         The Company, as allowed, continues to measure equity-based compensation
using Accounting Principles Board Opinion Number 25 ("APB 25"), which recognizes
compensation cost based on the intrinsic value of the equity instrument when
awarded.

         Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation, ("SFAS 123") requires the disclosure of the pro forma
net loss had the Company adopted the fair value method as of the beginning of
1995. The Company has calculated the pro forma net loss under SFAS 123 using a
multiple option valuation approach and certain weighted-average assumptions
deemed reasonable by management. These assumptions included, among other things,
a risk free interest rate of 5.0%, an expected life of 2 years, a partnership
unit volatility of 0.001% and no partnership distributions over the expected
life. The compensation expense which would be recognized under SFAS 123 would
not be significantly different than reported under APB 25 in 1996. No
compensation expense would be reported in 1995 as the management option plan was
amended which changed the terms of options granted, as described in Note 10. The
impact of these pro forma adjustments may not be indicative of future pro forma
adjustments, as various assumptions and estimates were employed and additional
awards in future years may occur.

                                       30

<PAGE>

                            MUZAK LIMITED PARTNERSHIP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


2.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, (CONTINUED):

     FAIR VALUE OF FINANCIAL INSTRUMENTS

         The carrying amount of cash and cash equivalents approximates fair
value because of the short maturity of these instruments. The carrying amount of
long-term debt approximates fair value for the same or similar issues available
to the Company for debt with similar remaining maturities.

     EUROPEAN JOINT VENTURE

         In 1995, the Company entered into a joint venture agreement to provide
business music services in Europe ("Muzak Europe"). This joint venture is
accounted for using the equity method as the Company owns 50% of that venture
but does not have a controlling interest. Equity in losses of joint venture in
the accompanying consolidated statements of operations include the Company's
share of net losses. As of December 31, 1996, the joint venture had total assets
of $7,814,000 and total liabilities of $6,662,000. As of December 31, 1996, the
carrying value of the joint venture on the Company's books was $800,000.

         The Company uses the foreign countries' local currency as the
functional currency for its overseas operations. The translation gains and
losses resulting from the remeasurement of the foreign operations' financial
statements are insignificant.

     PRINCIPLES OF CONSOLIDATION

         The accompanying consolidated financial statements of the Company
include the accounts of the Company and its wholly owned subsidiary, Muzak
Capital Corporation. All significant intercompany accounts and transactions have
been eliminated upon consolidation.

     USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS

         The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.

     RECLASSIFICATIONS

         Certain reclassifications have been made to the 1995 balances to
conform to the classifications used in 1996. These reclassifications had no
effect on net loss attributable to general and limited partners or partners'
capital (deficit) as previously reported.

                                       31

<PAGE>


                            MUZAK LIMITED PARTNERSHIP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>

3.       PROPERTY AND EQUIPMENT, NET:

         Property and equipment consist of the following (in thousands):

                                                                             DECEMBER 31,
                                                                         ----------------------
                                                                        1995              1996

      <S>                                                         <C>             <C>

         Equipment provided to subscribers.....................      $  42,847         $  49,340
         Machinery and equipment...............................          7,628            10,745
         Vehicles..............................................          2,872             3,072
         Furniture and fixtures................................          2,133             2,260
         Land and buildings....................................            858               858
         Leasehold improvements................................            833               916
                                                                      ---------         ---------

             Total property and equipment......................         57,171            67,191
         Less--accumulated depreciation and amortization.......        (20,585)          (30,009)
                                                                     ---------         ---------
                                                                     $  36,586         $  37,182
                                                                     =========         =========

</TABLE>

<TABLE>
<CAPTION>

4.       DEFERRED COSTS AND INTANGIBLE ASSETS, NET:

         Deferred costs and intangible assets consist of the following (in
         thousands):
                                                                             DECEMBER 31,
                                                                        ----------------------
                                                                        1995              1996

       <S>                                                        <C>              <C>

          Income producing contracts............................      $ 39,826         $  39,830
          Deferred subscriber acquisition costs.................         7,784            11,056
          Master recording rights and deferred production costs.         7,770             9,883
          Organization costs....................................         5,783             4,432
          Deferred financing costs..............................         4,454             4,423
          Non-compete agreements................................           846               846
          Other.................................................           702               758
                                                                      --------         ---------
              Total deferred costs and intangible assets........        67,165            71,228
          Less--accumulated amortization........................       (30,459)          (37,463)
                                                                      --------         ---------
                                                                      $ 36,706         $  33,765
                                                                      ========         =========

</TABLE>

         During 1996, the Company capitalized $1,353,000 of expenses associated
with an initial underwritten public offering of its equity securities. In August
1996, the Company postponed the equity offering. These deferred financing costs
were charged to selling, general and administrative expenses in the fourth
quarter.

                                       32

<PAGE>

                            MUZAK LIMITED PARTNERSHIP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


5.       LONG-TERM OBLIGATIONS:

         Long-term obligations are summarized as follows (in thousands):
<TABLE>
<CAPTION>

                                                                             DECEMBER 31,
                                                                       -----------------------

                                                                        1995              1996

       <S>                                                         <C>             <C>

          Senior notes..........................................      $     --         $ 100,000
          Variable rate senior term loan........................        40,989                --
          Fixed rate subordinated note, net of unamortized
            discount of $1,536..................................        10,964                --
          Capital lease obligations.............................           762               935
          Other.................................................           290               167
                                                                      --------         ---------
              Total long-term obligations.......................        53,005           101,102
          Less--current portion.................................        (5,911)             (482)
                                                                      --------         ---------
                                                                      $ 47,094         $ 100,620
                                                                      ========         =========
</TABLE>

     SENIOR NOTES

         The senior notes were issued as part of the Offering as discussed in
Note 1. These unsecured notes bear interest at 10% and are due on October 1,
2003. The notes require the maintenance of certain covenants that, among other
things, require the Company to meet a certain fixed-charge ratio, restrict
the Company's ability to incur additional debt, as well as limit the Company's
ability to make certain investments and distributions to partners.
The Company is in compliance with these covenants at December 31, 1996.

         The Company has the option to redeem up to 35% of the senior notes
during the first three years after the Offering with the proceeds from an equity
offering, at a redemption price of 109% of the principal amount thereof, plus
accrued and unpaid interest. The entire balance of the senior notes is
redeemable at the option of the Company, in whole or in part, beginning October
1, 2000. The redemption price is 105% of par value through October 1, 2001,
102.5% through October 1, 2002, and 100% thereafter, through maturity.

     CREDIT AGREEMENTS

         The variable rate senior term loan was a $46,600,000 term loan (the
"Credit Agreement") with a group of banks for which Union Bank of Switzerland
(the "Agent Bank"), an affiliate of a limited partner, was acting as the agent.
The Credit Agreement also included a $13,000,000 revolving credit facility. The
terms of the Credit Agreement required the Company to meet certain financial
ratios and performance criteria and impose restrictions on capital spending, the
incurrence of additional debt, and distributions to partners, among other
things. Distributions to partners were limited to distributions that offset tax
liabilities to the partners resulting from the Company's taxable income.
Substantially all of the Company's assets and proceeds from certain insurance
policies were pledged as collateral under the Credit Agreement. The senior term
loan was repaid on October 2, 1996, with a portion of the net proceeds from the
Offering.

                                       33

<PAGE>


                            MUZAK LIMITED PARTNERSHIP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


5.       LONG-TERM OBLIGATIONS, (CONTINUED):

         The fixed rate subordinated note (the "Subordinated Note") was obtained
from a group of banks that were issued options to purchase Class A limited
partnership units (the "Put/Call Units") in connection with this credit
arrangement. The value of these Put/Call Units was accounted for as debt
discount and amortized on the effective interest method over the expected term
of this note until it was repaid in October 1996 with a portion of the net
proceeds from the Offering. The Subordinated Note required the Company to
maintain certain performance criteria and covenants, similar to, but less
restrictive than the Credit Agreement. Substantially all of the Company's assets
and proceeds from certain insurance policies were pledged as collateral under
this agreement.

     INTEREST RATES AND PAYMENTS

         The senior notes require semi-annual interest payments of 10%. Interest
under the Credit Agreement was paid at an interest rate based on the Agent
Bank's prime rate or LIBOR in quarterly installments. During the years ended
December 31, 1994, 1995 and 1996, the effective weighted average interest rates
on borrowings under the Credit Agreement were 10.0%, 11.2%, and 10.9%,
respectively, including the effects of the interest rate swap agreement
described below. Interest under the Subordinated Note was paid in semi-annual
installments at a rate of 12.5%, an effective rate of 14.8%, after amortization
of the debt discount. The capital lease obligations require monthly installments
of interest at a weighted average interest rate of approximately 8.4%. Total
cash paid for interest on long-term obligations was approximately $5,460,000,
$5,760,000 and $5,880,000 for the years ended December 31, 1994, 1995 and 1996,
respectively.

     FUTURE MATURITIES

         Total future maturities of long-term obligations, including capital
leases, for the five years following December 31, 1996 are: $482,000 in 1997,
$293,000 in 1998, $226,000 in 1999, $83,000 in 2000, $8,000 in 2001, and
$100,010,000 thereafter.

     CAPITAL LEASES

         Assets acquired under capital leases were $460,000, $489,000 and
$579,000 for the years ended December 31, 1994, 1995 and 1996, respectively.
Assets recorded under capital leases were $1,141,000 and $1,495,000 with
accumulated amortization of $307,000 and $522,000 as of December 31, 1995 and
1996, respectively.

     INTEREST RATE HEDGING

         The Company had entered into an interest rate swap agreement with the
Agent Bank that effectively fixed the rate on $10,000,000 of the debt under the
Credit Agreement at December 31, 1995. Net settlements were recorded in interest
expense. The interest rate swap agreement was terminated in October 1996 in
connection with the Offering.


                                       34

<PAGE>
                            MUZAK LIMITED PARTNERSHIP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


5.       LONG-TERM OBLIGATIONS, (CONTINUED):

     FINANCING COSTS PAID TO RELATED PARTIES

         Prior to the Offering discussed in Note 1, the Agent Bank was an
affiliate of a Class A limited partner. In addition, the Subordinated Noteholder
held the Put/Call Units. During the years ended December 31, 1994, 1995 and
1996, the Company incurred interest expense related to these credit facilities
of $6,888,000, $7,367,000, and $5,489,000, respectively. Of these amounts,
$1,336,000 and $0 are accrued at December 31, 1995 and 1996, respectively. In
addition, the Company paid fees to the holders of the senior and subordinated
notes payable of $1,943,000, $122,000, and $0 in 1994, 1995 and 1996,
respectively, related to amendments to the Credit Agreement and the subordinated
note agreement, as well as bank charges, legal costs and agency fees. During the
year ended December 31, 1994, the Company paid the general partner $474,000 for
its efforts related to obtaining the Company's credit facilities and acquiring
Comcast.

6.       EXTRAORDINARY ITEMS:

         In conjunction with the Offering, the Company used a portion of the net
proceeds to repay the entire balance of the bank debt outstanding as of October
1, 1996. The unamortized portion of the related loan origination fees and loan
discount totaling approximately $3,713,000 were written-off as an extraordinary
loss at the time of the repayment. A portion of the net proceeds from the
Offering were also used to repurchase the Company's Class C redeemable preferred
partnership interest for $7,457,000. The recorded value of the redeemable
limited partnership interest was approximately $10,548,000, resulting in a
extraordinary gain of $3,091,000.


7.       BENEFIT PLANS:

     DEFINED CONTRIBUTION PLAN

         The Company maintains a defined contribution savings and retirement
plan (the "Benefit Plan") that covers substantially all of the Company's
employees. Under the savings portion of the Benefit Plan, eligible employees may
contribute from 1% to 14% of their compensation per year, subject to certain tax
law restrictions. The Company has the option to make a matching contribution of
up to a maximum of 100% of the first 3% and 50% of the next 3%, up to 6% of the
total base salary contributed by the employee each year. Participants are
immediately vested in their contributions as well as the Company's contributions
under the savings portion of the Benefit Plan. For the savings portion of the
Benefit Plan, the Company recorded contribution expense of $170,000, $181,000
and $439,000 for the years ended December 31, 1994, 1995 and 1996, respectively.

         Contributions under the retirement portion of the Benefit Plan are
determined annually by the Company at its discretion for up to 3% of the
eligible employee's compensation. The employees vest in the retirement portion
of the Benefit Plan ratably over five years, but become fully vested in the
event of death, disability or the attainment of the age of 65. The Company
recorded $260,000 of contribution expense related to the retirement portion of
the Benefit Plan for the year ended December 31, 1994. No amounts were recorded
for the years ended December 31, 1995 and 1996.

                                       35

<PAGE>
                           MUZAK LIMITED PARTNERSHIP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7.       BENEFIT PLANS, (continued):

     MULTI-EMPLOYER DEFINED CONTRIBUTION PLANS

         The Company participates in several multi-employer defined contribution
benefit plans that provide benefits to employees covered by certain labor union
contracts. The amount of expense related to contributions to these plans was
approximately $110,000, $108,000 and $136,000 for the years ended December 31,
1994, 1995 and 1996. These amounts were determined by union contract and the
Company does not administer or control the funds.

                                       36

<PAGE>


                            MUZAK LIMITED PARTNERSHIP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


8.       COMMITMENTS AND CONTINGENCIES:

     LEASES

         The Company leases certain facilities and equipment under both
operating and capital leases. In addition, the Company has entered into
agreements to obtain satellite channel capacity and subsidiary communication
authorization rights for the transmission of programs to the Company's
customers. Total rental expense under operating leases was approximately
$6,384,000, $7,698,000 and $7,751,000 for the years ended December 31, 1994,
1995 and 1996, respectively.

         Future annual minimum lease payments under noncancelable operating
leases for the years ended December 31 are as follows (in thousands):


          1997............................................      $ 4,962
          1998............................................        4,075
          1999............................................        3,322
          2000............................................        2,983
          2001............................................        1,229
          Thereafter......................................        1,578
                                                                -------
          Total...........................................      $18,149
                                                                =======

     MUSIC LICENSES

         In the ordinary course of the Company's business, the Company has
agreements with various organizations for the rights to rerecord and play music
in public spaces. The expenses incurred under these agreements were
approximately $3,971,000, $3,385,000 and $3,578,000 for the years ended December
31, 1994, 1995 and 1996, respectively.

     JOINT VENTURE GUARANTEE

         The Company has agreed to make pro rata equity contributions to Muzak
Europe to the extent necessary to enable Muzak Europe to maintain minimum net
worth requirements under an outstanding credit facility. As of December 31,
1996, the amount outstanding under the credit facility was $1,744,000.

     CONTINGENT PURCHASE CONSIDERATION

         The 1992 asset purchase agreement, as amended ("Purchase Agreement"),
provides for contingent payments to the Seller if certain performance levels are
achieved in the five years following the closing of the 1992 Acquisition. If the
performance levels are achieved, the Company will owe the Seller additional
purchase prices of $5 million to $24 million. Any such payments, if earned, will
be allocated to the assets acquired or, if applicable, recorded as additional
purchased assets. No amounts have been paid or accrued as of December 31, 1995
or 1996 pursuant to this provision, as the possibility of obtaining the required
performance objectives has been deemed remote by management.

                                       37

<PAGE>

                            MUZAK LIMITED PARTNERSHIP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


8.       COMMITMENTS AND CONTINGENCIES,(continued):

     TAXES

         An assessment was made against the Seller resulting from an audit
performed by the Washington State Department of Revenue for sales and use and
business and occupation taxes paid for during the period from 1987 through
September 1992. Under successor liability statutes in the state of Washington,
the Company could, if the Seller fails to pay its tax obligation, become liable
for the assessment outstanding against the Seller of approximately $1,700,000.
This assessment is under appeal by the Seller. The Seller and certain of its
affiliates have agreed to indemnify the Company for any liabilities in
connection with such assessment. The Company's management does not believe that
the assessment will have an adverse effect on the Company's financial condition
or results of operations.

     EMPLOYMENT AGREEMENTS

         The Company has five-year employment agreements with certain senior
executive officers. These five-year agreements, expiring August 31, 1997,
provide certain benefits to the officers if involuntarily terminated by the
Company. As of December 31, 1995 and 1996, no amounts have been accrued related
to these agreements.

     LEGAL PROCEEDINGS

         The Company is subject to various legal proceedings which arise in the
ordinary course of business. Company management believes none of these
proceedings, individually or in the aggregate, will have a material adverse
effect on the financial condition or results of operations of the Company.

                                       38

<PAGE>

9.       REDEEMABLE PREFERRED PARTNERSHIP INTERESTS:

         As of December 31, 1996, the redeemable preferred partnership interests
is comprised of a Class C-1, nonvoting preferred partnership interest that does
not participate in the Company's profits or losses. A summary of this interest
and its accumulated return by period along with a summary of a Class C,
nonvoting partnership interest, that also did not participate in the Company's
profits or losses, are as follows (in thousands):




                            MUZAK LIMITED PARTNERSHIP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9.       REDEEMABLE PREFERRED PARTNERSHIP INTERESTS, (continued):
<TABLE>
<CAPTION>

                                                                     CLASS C          CLASS C-1          TOTAL
      <S>                                                         <C>              <C>               <C>

          Balance, January 1, 1994.............................      $  8,760          $     --         $  8,760
             Class C-1 contribution............................            --             5,000            5,000
             Preferred return..................................           613               320              933
                                                                     --------          --------         --------
          Balance, December 31, 1994...........................         9,373             5,320           14,693
             Preferred return..................................           657               372            1,029
                                                                     --------          --------         --------
          Balance, December 31, 1995...........................        10,030             5,692           15,722
             Preferred return..................................           518               398              916
             Repurchase of Class C interests...................       (10,548)               --          (10,548)
                                                                     --------          --------          -------
          Balance, December 31, 1996...........................      $     --          $  6,090         $  6,090
                                                                     ========          ========         ========
</TABLE>

     CLASS C INTEREST

         The Class C limited partner was entitled to receive the amount of its
initial contribution of $8,000,000, plus a return of 7% compounded annually, as
discussed in Note 6. The Company repurchased the Class C limited partner's
interest with a portion of the net proceeds from the Offering in October 1996.

<PAGE>

     CLASS C-1 INTEREST

         The Class C-1 limited partner is entitled to receive the amount of its
initial contribution of $5,000,000, plus a return of 7%, compounded annually,
through January 31, 2004, the date of redemption. The Class C-1 limited partner
may become, at its option, a participating partner. Upon becoming a
participating partner, the Class C-1 limited partner will forfeit any accrued
portion of the return. If it has not previously become a participating partner,
the Class C-1 limited partner is entitled to a preference in liquidation equal
to its contribution plus accumulated return. Unless the Class C-1 interest
becomes a participating interest, a general partner may, at its sole discretion,
require the Class C-1 limited partner to exchange its interest for a note equal
to its then aggregate liquidation preference amount. If such exchange occurs
prior to the time the Class C-1 limited partner has the opportunity to obtain
participation status, the Class C-1 limited partner will also be issued an
option to acquire the participating interest on substantially the same terms as
if such exchange had not occurred. If the Class C-1 limited partner has not
obtained participation status, or has not exchanged such units for notes, on or
prior to January 31, 2004, the Company is required to redeem such units for an
amount equal to the Class C-1 contribution plus accumulated return.

10.      PARTNERS' CAPITAL (DEFICIT):

         Partners' capital (deficit) is comprised of two general partners; Class
A limited partners and Class B limited partners; Put/Call Units, and; preferred
limited partners' interests.

                                       40

<PAGE>

                            MUZAK LIMITED PARTNERSHIP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

10.      PARTNERS' CAPITAL (DEFICIT), (continued):

     PUT/CALL UNITS

         In connection with obtaining the fixed-rate subordinated note payable,
the Company issued an option to purchase 1,529,898 units of Class A limited
partnership interests to a lender, for an aggregate exercise price of $10. These
units are currently exercisable. The estimated value of the Put/Call Units was
recorded as a debt discount and is being amortized as an adjustment to interest
expense over the expected term of the related debt obligation until it was
repaid in October, 1996.

     SUBSCRIPTIONS RECEIVABLE

         Officers and key employees of the Company have acquired limited
partnership interests, a portion of which were financed with subscription notes.
As of December 31, 1995 and 1996, the Class B limited partners' capital accounts
were reduced by subscription notes receivable. Interest income on the
subscriptions receivable totaled $51,000, $49,000 and $27,000 for the years
ended December 31, 1994, 1995 and 1996.

     PREFERRED LIMITED PARTNERS' INTERESTS

         The preferred limited partners' interests, which were issued on
November 4, 1994, do not participate in the Company's profits or losses. Such
limited partners are entitled to receive an 8% return, compounded quarterly, on
the amount of their initial contribution and are generally entitled to a
priority on distributions from the Company. At December 31, 1995 and 1996, the
return was credited to the preferred limited partners. These limited partners
are also entitled to a preference in liquidation equal to their initial
contribution plus accumulated and unpaid return. Upon the occurrence of certain
events, the units may, at the option of the Company, be redeemed by the Company
for an amount equal to the then aggregate liquidation preference amount. The
units (and any accrued and unpaid return) may, at the option of the holder, be
converted into units of Class B limited partnership interest at any time.

     MANAGEMENT OPTION PLAN

         Certain limited partners and key employees of the Company have the
ability, under certain conditions, to exercise options to purchase units of
Class B limited partnership interests (the "Class B Interests") as established
in the management option plan (the "Option Plan").

         Through October 1, 1996, the Company could grant 1,869,545 units of
Class B Interests, that vested at a rate of 20% per year, based on specific
performance standards. The options did not vest prior to October 1, 1996, as
these performance standards were not met.

         Effective October 2, 1996, the Company amended the Option Plan (the
"Amended and Restated Option Plan") to, among other things, decrease the number
of options the Company could grant to 1,840,000 and change the required
performance standards. The options now vest according to the following schedule:
5% of the options vest on the first anniversary of the Company's Offering, 5% of
the options vest on the second anniversary of the Company's Offering, the
remaining 90% vests

                                       41


<PAGE>

                            MUZAK LIMITED PARTNERSHIP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

10.      PARTNERS' CAPITAL (DEFICIT), (continued):

ratably at each calendar year end over a five-year period beginning January 1,
1997, and becomes exercisable if certain performance standards are met. All
options expire on October 1, 2003.

         Activity under the Option Plan and option price information is as
follows:
<TABLE>
<CAPTION>
                                                                                                    WEIGHTED
                                                         NUMBER OF OPTIONS       RANGE OF            AVERAGE
                                                                              EXERCISE PRICE     EXERCISE PRICE

<S>                                                        <C>            <C>                     <C>

Outstanding, January 1, 1994.........................        1,634,545            $1.00                 1.00
   Options granted...................................          165,000          1.50-1.75               1.60
   Options forfeited.................................          (85,000)           1.00                  1.00
                                                           -----------      -------------            -------

Outstanding, December 31, 1994.......................        1,714,545          1.00-1.75               1.06
   Options granted...................................          150,000            1.75                  1.75
   Options forfeited.................................          (30,000)           1.00                  1.00
                                                           -----------      -------------            -------

Outstanding, December 31, 1995.......................        1,834,545          1.00-1.75               1.12
   Options granted...................................           40,000            3.00                  3.00
   Options forfeited.................................          (75,000)           1.00                  1.00
                                                           -----------      -------------            -------

Outstanding, December 31, 1996.......................        1,799,545         $1.00-3.00            $  1.16
                                                           ===========      =============            =======

</TABLE>

         As of December 31, 1996, no options are currently exercisable. The
Company has recognized $60,000 in compensation expense for the year ending
December 31, 1996 related to the portion of the options that are exercisable
automatically under the Amended and Restated Option Plan. No compensation
expense has been recognized for the portion of the options which vest based on
performance standards, as management, at this time, has deemed the probability
of meeting the performance standards remote.

     OTHER PARTNERSHIP UNIT OPTIONS

         On December 19, 1996, the Board of Directors granted a member of the
Board 30,000 options to purchase Class B limited partnership units for
$3.00/unit. These options vest ratably over a five-year period and expire in
September 2003. No options are currently exercisable. At December 31, 1996, no
compensation expense has been recorded for these options, as management's
estimate of the market value approximates the exercise price. This member was
also offered the right to purchase up to 200,000 additional Class B limited
partnership units at $3.00 per unit.

     PUT OPTION

         After September 4, 1998, a general partner and certain of the Class A
limited partners can require the Company to purchase limited partnership units
held by them at fair market value. However, such right may not be exercised if
the purchase of units would have a material adverse effect

                                       42
<PAGE>

                            MUZAK LIMITED PARTNERSHIP

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

10.      PARTNERS' CAPITAL (DEFICIT), (continued):

on the Company or would be in contravention of any then existing agreement to
which the Company is a party.

     ALLOCATION OF PROFITS AND LOSSES

         Losses are allocated among the general partners and Class A and B
limited partners based upon the total of the interests held by each individual,
including the Put/Call Units under option, as a percentage of the total of all
such interests.

11.      SUBSEQUENT EVENT:

         On March 17, 1997, the Company accepted an offer, subject to due
diligence, from an interested party, to buy the Company's Spokane, Washington
franchise for $1.4 million.

                                       43

<PAGE>



                          INDEPENDENT AUDITORS' REPORT

Board of Directors
Muzak Capital Corporation
Seattle, Washington

         We have audited the accompanying balance sheets of Muzak Capital
Corporation (the "Company") as of May 8, 1996 (date of inception) and December
31, 1996. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

         We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

         In our opinion, such financial statements present fairly, in all
material respects, the financial position of Muzak Capital Corporation as of May
8, 1996 (date of inception) and December 31, 1996 in conformity with generally
accepted accounting principles.



Deloitte & Touche LLP
Seattle, Washington


February 28, 1997

                                       44

<PAGE>

                            MUZAK CAPITAL CORPORATION

                                 BALANCE SHEETS

<TABLE>
<CAPTION>

                                                                            MAY 8, 1996
                                                                             (DATE OF        DECEMBER 31,
                                                                             INCEPTION)          1996
                                                                             ---------           ----
<S>                                                                        <C>               <C>

ASSETS
   Cash......................................................................  $  1              $   1
                                                                               ====              =====

STOCKHOLDER'S EQUITY
   Preferred Stock--authorized 10,000,000 shares of $0.01 par value each;
    no shares issued and outstanding.........................................  $ --              $  --
   Common Stock--authorized 30,000,000 shares of $0.01 par value each; 100
   shares issued and outstanding.............................................     1                  1
                                                                               ----              -----

   Total.....................................................................  $  1              $   1
                                                                               ====              =====
</TABLE>

                                       45
<PAGE>

                            MUZAK CAPITAL CORPORATION

                          NOTE TO FINANCIAL STATEMENTS

         Muzak Capital Corporation (the "Company") (formerly Muzak, Inc.), a
wholly-owned subsidiary of Muzak Limited Partnership ("MLP"), was formed on May
8, 1996. The Company filed a registration statement along with MLP for the
underwritten offering of senior notes of which the Company and MLP are
co-issuers. The offering closed in October 1996. The Company is dependent upon
results of operations and cash flow of MLP to meet debt service obligations of
the senior notes. No activity has occurred from May 8, 1996 (date of inception)
through December 31, 1996; therefore, statements of operations and cash flows
have not been included herein.

                                       46
<PAGE>


                            MUZAK LIMITED PARTNERSHIP
                        VALUATION AND QUALIFYING ACCOUNTS
                          SCHEDULE II (REG. 210.12-09)


<TABLE>
<CAPTION>

                                                                   ADDITIONS          DEDUCTIONS
                                                         ------------------------
                                           BALANCE AT    CHARGED TO    CHARGED TO    WRITE-OFFS,     BALANCE
                                            BEGINNING     COSTS AND       OTHER        NET OF       AT END OF
               DESCRIPTION                  OF PERIOD     EXPENSES     ACCOUNTS(a)   RECOVERIES      PERIOD

<S>                                       <C>          <C>           <C>          <C>            <C>

JANUARY 1 THROUGH DECEMBER 31, 1996
Allowance for Doubtful Accounts.......      $632,000      $472,000                    ($608,000)    $496,000
                                            ========      ========                    ==========    ========
JANUARY 1 THROUGH DECEMBER 31, 1995
Allowance for Doubtful Accounts.......      $736,000      $810,000                    ($914,000)    $632,000
                                            ========      ========                    ==========    ========
JANUARY 1 THROUGH DECEMBER 31, 1994
Allowance for Doubtful Accounts.......      $558,000      $610,000      $359,000      ($791,000)    $736,000
                                            ========      ========      ========      ==========    ========
<FN>
-----------------

(a)   Related to 1/31/94 Comcast Acquisition

</FN>
</TABLE>

                                      47

<PAGE>


ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE.


         None.


                                       48


<PAGE>



                                    PART III

ITEM 10.           DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.


         The Board of Directors of Music Holdings Corp. ("Music Holdings"), an
affiliate of Centre Partners and the general partner of MLP Acquisition L.P.
("MLP Acquisition"), the managing general partner of the Company, functions as
the governing body of the Company. MLP Acquisition was organized to act as
managing general partner of the Company, MLP Administration Corp. ("MLP
Administration") was organized to act as the administrative general partner of
the Company, and Music Holdings was organized to act as the general partner of
MLP Acquisition. MLP Acquisition, MLP Administration and Music Holdings are not
involved in any investment activities and have no independent operations, except
the business operations of the Issuers. Executive officers of the Company also
act as officers of Capital Corp., but do not receive additional compensation for
such services.

DIRECTORS, EXECUTIVE OFFICERS AND OTHER SENIOR MANAGEMENT PERSONNEL

         Certain information is set forth below concerning (i) executive
officers and other members of senior management of the Company and (ii)
directors of Music Holdings as of March 1, 1997:
<TABLE>
<CAPTION>

                     NAME                         AGE                     POSITION WITH THE COMPANY

<S>                                            <C>    <C>

Directors and Executive Officers:
John R. Jester................................... 56     President and Chief Executive Officer and a Director
James F. Harrison................................ 50     Senior Vice President, Sales and Marketing
Kirk A. Collamer................................. 44     Vice President and Chief Financial Officer
Thomas J. Gentry................................. 61     Vice President and General Manager, DBS Division
William A. Boyd.................................. 55     Chairman of the Board
Paul F. Balser................................... 55     Director
Mark E. Jennings................................. 34     Director
Bruce G. Pollack................................. 37     Director

Other Senior Management Personnel:
Wallace R. Borgeson.............................. 52     Vice President, Centralized Operations
Bruce B. Funkhouser.............................. 47     Vice President, Programming and Licensing
L. Dale Stewart.................................. 50     Vice President, Operations - DBS
Jack D. Craig.................................... 62     Vice President, Affiliate Sales and Development
Richard Chaffee.................................. 53     Vice President, Owned Affiliate Operations
Roger C. Fairchild............................... 48     Vice President, Marketing
J. Gary Henderson................................ 43     President, In-Store Marketing Group

</TABLE>

         John R. Jester has been a Director of Music Holdings, an affiliate of
Centre Partners and the general partner of MLP Acquisition, the managing general
partner of the Company, since September 1992, and has been President and Chief
Executive Officer of the Company and its predecessors since January 1988. Prior
to joining the Predecessor, Mr. Jester served from 1985 to 1987 as President of
US West Information Systems. From 1983 to 1985, Mr. Jester was President of
Executone Inc. Prior to that, Mr. Jester held various financial and management
positions with Contel Corporation, ITT

                                       49

<PAGE>

Corporation and C & P of Maryland, Inc. Mr. Jester currently serves as a
director of Montana Power Company.

         James F. Harrison has been Senior Vice President for Sales and
Marketing of the Company and the Predecessor since March 1988. Prior to joining
the Predecessor, Mr. Harrison served from 1986 to 1987 as President of Telegence
Corporation, a start-up data communications manufacturer. From 1985 to 1986, Mr.
Harrison was Vice President of Marketing with US West Information Systems. From
1983 to 1984, Mr. Harrison was Vice President of Business Market Development for
Contel Corporation's unregulated businesses. From 1981 to 1982, he was head of
Communications Marketing Division at Wang Laboratories, Inc., and from 1976 to
1980, Mr. Harrison was PBX Systems Engineering and Development Supervisor and
Member of the Technical Staff for Human Factors Research with Bell Laboratories,
Inc.

         Kirk A. Collamer, a certified public accountant, was Vice President of
Finance and Administration and Chief Financial Officer of the Company from
August 1995 through March 14, 1997, at which time Mr. Collamer resigned from
these positions. Prior to joining the Company, Mr. Collamer served from July
1990 to July 1995 as Vice President of Finance at Ameritech Corporation for its
Enhanced Business Services division and Chief Financial Officer of its New
Zealand subsidiary. Prior to that time, Mr. Collamer held a variety of financial
and accounting positions with Jack Daniel Distillery/Brown-Forman Corporation,
Aladdin Industries, Inc. and Arthur Andersen LLP.

         Thomas J. Gentry has been Vice President and General Manager of the DBS
Division of the Company and the Predecessor since June 1988. Prior to joining
the Predecessor, Mr. Gentry served from 1985 to 1987 as President and Chief
Executive Officer of SkySwitch Satellite Communications. Mr. Gentry has over 30
years of experience in telecommunications and satellite communications with
Westinghouse Defense Group, COMSAT Corporation, Western Union and Contel A.S.C.

         Paul F. Balser has been a Director of Music Holdings since September
1992. Mr. Balser was a partner of Centre Partners from 1986 until August 1995.
In August 1995, Mr. Balser resigned as an officer of the managing general
partner of Centre Partners to become a founding partner of Generation Capital
Partners L.P., a newly organized private investment partnership. From 1982 to
1986, Mr. Balser was a Managing Director and a member of the Board of Directors
of J. Henry Schroeder Corp. Mr. Balser currently serves as a director of Kansas
City Southern Industries, Inc. (NYSE), The Carbide/Graphite Group, Inc.
(Nasdaq), The Quarton Group-Publishers, Inc., Scientific Games Holdings Corp.
(Nasdaq) and Jeepers! Inc.

         William A. Boyd has been the Chairman of the Board of Music Holdings
since February 1997 and a Director of Music Holdings since August 1996. From
September 1995 to August 1996, Mr. Boyd was a private investor. From 1982 to
September 1995, Mr. Boyd was owner and president of the largest franchisee of
the Company. Mr. Boyd was President of the Independent Affiliate Organization
from 1994 to 1995 and from 1986 to 1987. Mr. Boyd was also President of the
Company's Owned Affiliate division in 1987. Prior to owning a franchise, Mr.
Boyd held various positions with the Predecessor.

         Mark E. Jennings has been a Director of Music Holdings since September
1992. Through August 1995, Mr. Jennings was a partner of Centre Partners where
he has been employed since 1987. In August 1995, Mr. Jennings resigned as an
officer of the managing general partner of Centre Partners to become a founding
partner of Generation Capital Partners L.P. From 1986 to 1987, Mr.

                                       50

<PAGE>

Jennings was employed at Goldman, Sachs & Co. in its Corporate Finance
Department. Mr. Jennings currently serves as a director of Snyder
Communications, Inc. (NYSE), Scientific Games Holdings Corp. (Nasdaq), Jeepers!
Inc. and Johnny Rockets Group, Inc.

         Bruce G. Pollack has been a Director of Music Holdings since September
1995. Mr. Pollack is a partner of Centre Partners, which he joined in January
1991, and is a Managing Director of Centre Partners Management LLC, which was
formed in December 1995 to manage investments on behalf of Centre Capital
Investors II, L.P. and affiliated entities. From 1988 to June 1991, Mr. Pollack
was an officer and director of RSG Partners, Inc. and its predecessors, and from
1985 to 1988, Mr. Pollack was an officer of TSG Holdings, Inc. Mr. Pollack
currently serves as a director of Fire Arms Trading Systems, Inc. (Nasdaq),
Johnny Rockets Group, Inc., The Quarton Group-Publishers, Inc., Jeepers! Inc.
and Victory Holdings Corp.

         Wallace R. Borgeson has been Vice President of Centralized Operations
of the Company since August 1995. From April 1990 to August 1995, Mr. Borgeson
served as Vice President of Finance and Administration of the Company and the
Predecessor. From 1988 to 1990, Mr. Borgeson was the Chief Financial Officer of
Hickory Farms, Inc., and from 1971 to 1988, he served in various capacities with
Wurlitzer Company, most recently as Chief Financial Officer.

         Bruce B. Funkhouser has been Vice President of Programming and
Licensing of the Company and the Predecessor since October 1987. From 1983 to
1987, Mr. Funkhouser served as Programming and Production Manager for YesCo,
Inc., which was merged with a predecessor to the Predecessor in 1986. Prior to
1983, Mr. Funkhouser was a record company owner and producer, former
broadcasting manager and on-air talent and Professor of Communications at
Bellevue Community College. He is a member of The American Federation of
Television and Radio Artists and The National Academy of Recording Arts and
Sciences.

         L. Dale Stewart has been Vice President of Operations - DBS of the
Company since February 1997. From November 1987 to February 1997, Mr. Stewart
was Vice President of Operations and Engineering of the Company and its
Predecessor. From 1986 to 1987, Mr. Stewart was Acting General Manager and
Operations Manager at the Predecessor's New York City office. From 1984 to 1986,
Mr. Stewart was General Manager of the Corpus Christi, Texas franchise, and
prior to that he worked for the franchisee in San Antonio, Texas.

         Jack D. Craig has been Vice President, Affiliate Sales and Development
of the Company and the Predecessor since September 1988. From 1983 to 1988, Mr.
Craig was Vice President, Dealer Sales for AEI. From 1979 to 1983, Mr. Craig was
Marketing/Sales Manager for Aiphone Corporation, a leading intercom
manufacturer. Prior to joining Aiphone Corporation, Mr. Craig served as Vice
President/Account Supervisor for 11 years with J. Walter Thompson Advertising.

         Richard Chaffee has been Vice President, Owned Affiliate Operations of
the Company and the Predecessor since July 1987. Since joining a predecessor to
the Predecessor in 1968, Mr. Chaffee has served in both local sales offices and
franchisee operations in New York, Boston, Chicago, Minneapolis and Charlotte,
primarily as Chief Engineer and Operations Manager.

         Roger C. Fairchild has been Vice President, Marketing of the Company
since February 1997. From December 1993 to February 1997, Mr. Fairchild was Vice
President, Owned Affiliate Sales and Market Development of the Company. From
January 1991 to December 1993, Mr. Fairchild provided consulting services to the
Company and the Predecessor through Strategic Growth Advisory, a marketing and
business development

                                       51

<PAGE>

consultancy. From 1989 to 1991, Mr. Fairchild was President of a start-up voice
processing equipment manufacturer. From 1988 to 1989, Mr. Fairchild was Director
of Marketing for ADC Telecommunications, Inc., a $175 million growth-stage
telecommunications manufacturer. From 1983 to 1988, Mr. Fairchild served as a
vice president of operations and marketing for a US West Information Systems
subsidiary.

         J. Gary Henderson has been President of the In-Store Marketing Group of
the Company since December 1993. From April 1991 to November 1993, Mr. Henderson
was a private investor. From 1986 to April 1991, Mr. Henderson was Executive
Vice President and Chief Marketing Officer of POP Radio Corporation. From 1982
to 1986, Mr. Henderson was Account Director for Actmedia, Inc.

         There are no family relationships among the directors and executive
officers of the Company.

ITEM 11.           EXECUTIVE COMPENSATION.


         The following table sets forth information concerning the compensation
of the Company's Chief Executive Officer and to each of the Company's four other
most highly compensated executive officers (together with the Chief Executive
Officer, the "Named Executive Officers") for services in all capacities rendered
to the Company and its subsidiaries for the years 1994, 1995 and 1996.

<TABLE>
<CAPTION>

                           SUMMARY COMPENSATION TABLE
                           ---------------------------
                               ANNUAL COMPENSATION
                        ---------------------------------

                                                               OTHER ANNUAL
NAME AND PRINCIPAL POSITION     YEAR     SALARY    BONUS(1)    COMPENSATION     ALL OTHER COMPENSATION (2)
---------------------------     ----     ------    --------    ------------     -------------------------

<S>                          <C>      <C>        <C>       <C>                      <C>
John R. Jester,                 1996    $220,000                                       $4,996
  President and Chief           1995    $213,725                                       $2,310
  Executive Officer             1994    $207,500                                       $2,310

James F. Harrison,              1996    $178,000   $11,000                             $4,676
  Senior Vice President,        1995    $172,750                                       $2,310
  Sales & Marketing             1994    $167,700                                       $2,310

Kirk A. Collamer                1996    $163,018   $ 5,000    60,504                   $3,328
  Vice President and            1995    $ 66,667              69,436
  Chief Financial Officer(3)

John A. Neal,                   1996    $160,000   $11,000                             $3,633
  Vice President, Owned         1995    $155,000                                       $1,744
  Operations(4)                 1994    $150,000                                       $2,310

Thomas J. Gentry,               1996    $157,000   $11,000                             $4,710
  Vice President and            1995    $152,000                                       $1,995
  General Manager, DBS          1994    $147,600                                       $1,937
Division

<FN>

(1)  Bonuses in respect of services rendered in 1994 and 1995 were determined
     and paid in 1995 and 1996, respectively. No bonuses will be awarded to
     Named Executive Officers with respect to services rendered in 1996.
(2)  Consists of contributions by the Company to a defined contribution 401(k)
     plan.
(3)  Mr. Collamer served as an executive officer beginning in August 1995. Mr.
     Collamer resigned his positions as Vice President and Chief Financial
     Officer effective March 14, 1997. As of the filing of this Form 10-K, his
     positions as Vice President and Chief Financial Officer have not been
     filled.
(4)  Mr. Neal resigned his position as Vice President, Owned Operations
     effective January 31, 1997. As of the filing of this Form 10K, his position
     as Vice President, Owned Operations has not been filled.
</FN>
</TABLE>

                                       52

<PAGE>
<TABLE>
<CAPTION>



                        OPTION GRANTS IN LAST FISCAL YEAR
                                                                                           Potential Realizable Value At Assumed
                                                                                                 Annual Rates of Unit Price
                                           Individual Grants                                           Appreciation For
                                                                                                          Option Term
 ----------------------------------------------------------------------------------------  --------------------------------------
                     Number of    Percent of Total
                    Securities    Options Granted  Exercise or Base
               Underlying Option  To Employees In     Price         Market-Price   Expiration
        Name       Granted (#)    Fiscal Year      ($/Unit)           on Date       Date                    5%($)       10%($)
        (a)         (b)               (c)              (d)            of Grant       (e)         0%           (f)          (g)
-------------  -----------------  ---------------  ---------------  ------------   ----------  -------     ---------    -------

<S>                <C>                  <C>           <C>       <C>         <C>           <C>           <C>          <C>

John R. Jester,        325,000             18.1%         $1.00     $3.00        10/2003       650,000      $749,938     $854,750
  President and
Chief
   Executive Officer
James F. Harrison,     205,000             11.4%         $1.00     $3.00        10/2003       410,000      $473,038     $539,150
  Senior Vice
President,
   Sales & Marketing
Kirk A. Collamer,      150,000              8.3%         $1.75     $3.00        10/2003       187,500      $233,625     $282,000
  Vice President and
  Chief Financial
Officer
John A. Neal           140,000              7.8%         $1.00     $3.00        10/2003       280,000      $323,050     $368,200
  Vice President,
Owned
  Operations
Thomas J. Gentry,      140,000              7.8%         $1.00     $3.00        10/2003       280,000      $323,050     $368,200
  Vice President and
  General Manager,
DBS
  Division
</TABLE>

               AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND
                              FY-END OPTION VALUES


<TABLE>
<CAPTION>
                                                                Number Of Securities Underlying
                                                                          Unexercised        Value Of Unexercised In-The
                                                                           Options At            Money Options
                                                                      Fiscal Year-End (#)        At Fiscal Year-End ($)
         Name              Units Acquired       Value Realized   Exercisable/Unexercisable   Exercisable/Unexercisable
                          On Exercise (#)           ($)
---------------------    -------------------    --------------   -------------------------   ---------------------------
<S>                         <C>                  <C>                     <C>                      <C>

John R. Jester,                        0                    0                 0/325,000               0/650,000
  President and Chief
   Executive Officer
James F. Harrison,                     0                    0                 0/205,000               0/410,000
  Senior Vice President,
   Sales & Marketing
Kirk A. Collamer,                $60,000             $105,000                 0/150,000               0/187,500
  Vice President and
  Chief Financial Officer
John A. Neal                           0                    0                 0/140,000               0/280,000
  Vice President, Owned
  Operations
Thomas J. Gentry,                      0                    0                 0/140,000               0/280,000
  Vice President and
  General Manager, DBS
  Division

</TABLE>

DIRECTORS' COMPENSATION

         Directors of Music Holdings, the general partner of the managing
partner of the Company, who are also employees of the Company receive no
remuneration for services as members of the Board or any committee of the Board.
Directors who are not employed by the Company receive an annual retainer of
$20,000 plus $3,000 for each meeting of the Board attended, except in the case
of the Centre Partners designees, who receive an annual retainer of $50,000, in
each case plus reimbursement of expenses. See "Certain Relationships and Related
Transactions."

CONTRACTS, TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL ARRANGEMENTS

         Effective August 31, 1992, the Company entered into five-year
employment agreements with each of John R. Jester, President and Chief Executive
Officer of the Company, and James F. Harrison, Senior Vice President of the
Company. Under his employment agreement, Mr. Jester currently receives an annual
base salary of $220,000, subject to cost of living adjustments. Under his
employment agreement, Mr. Harrison currently receives an annual base salary of
$178,000, subject to cost of living adjustments. Mr. Jester receives a bonus
equal to 50% of his annual base salary if in any given 12 month fiscal period,
the Company achieves a specified performance target, which for the 12 months
ended December 31, 1996 was not reached. If the target is not reached, the Board
of Directors may nonetheless award Mr. Jester a bonus in an amount and on the
terms determined by the Board of Directors (which amount shall not exceed 50% of
his annual base salary). Each of the agreements also provides for a severance
payment equal to the annual base salary and pro rata bonus in the event of
termination due to disability or death during the term of employment. Both
employment agreements also contain confidentiality covenants and
non-solicitation covenants which extend for five and two years, respectively,
beyond the term of the agreements.

                                       53

<PAGE>

         The Company can terminate either agreement without further liability in
case of the officer's fraud against, or embezzlement from, the Company,
indictment or conviction of a felony or misdemeanor having a material adverse
effect on the Company or material failure to discharge his duties. In addition,
the Company can terminate the agreements if there is a material uncured default
under the Company's credit agreements or if the Company's cumulative performance
level is less than 80% of the cumulative target projected for any month;
provided that in either such case the Company is required to pay a severance
payment equal to, in the case of Mr. Jester, his annual base salary plus a
pro-rated bonus, or, in the case of Mr. Harrison, his annual base salary. The
Company may otherwise terminate the agreements for any reason during their terms
by paying a severance payment equal to the lesser of (i) two times the
then-effective annual base salary and (ii) the amount of compensation to which
Mr. Jester or Mr. Harrison, as the case may be, would be entitled to receive
between the date of termination and the fifth anniversary of the employment
agreement had the agreement in question not been terminated; but in no event
less than one year's annual base salary at the then effective rate. Mr. Jester
would also be entitled to receive a pro-rated bonus if cumulative performance
targets exceed projections for the twelve-month period preceding such
termination.

AMENDED AND RESTATED OPTION PLAN

         In August 1992, the Company adopted, and issued options under, the
Company's Management Option Plan (the "Original Option Plan"). As part of the
Offering, the Company adopted the performance-based Amended and Restated Option
Plan to replace the Original Option Plan, which was terminated upon consummation
of the Offering. At the time of the adoption of the Amended and Restated Option
Plan, the total number of outstanding options granted under the Amended and
Restated Option Plan was the same under the Original Option Plan. The purchase
price of the units of partnership interest issuable upon exercise of each option
granted pursuant to the Amended and Restated Option Plan are the same as the
exercise prices of the options granted under the Original Option Plan.

         The Amended and Restated Option Plan provides for the granting of
options to purchase an aggregate of 1,840,000 units of partnership interest
which were granted to 23 existing senior management members at an average
exercise price of $1.12 per unit in substitution of the outstanding options held
by such members of senior management under the Original Option Plan. Options
granted under the Amended and Restated Option Plan are not intended to qualify
as "incentive stock options" within the meaning of Section 422A of the Internal
Revenue Code of 1986, as amended (the "Code").

         Options granted under the Amended and Restated Option Plan are
non-transferable, except by will, the laws of descent and distribution, or
pursuant to a qualified domestic relations order. As a condition to the exercise
of any option under the Amended and Restated Option Plan, the optionee is

                                       54
<PAGE>

required to become party to the Company's partnership agreement. Options granted
under the Amended and Restated Option Plan expire seven years from the date of
grant.

SENIOR MANAGEMENT INCENTIVE PLAN

         In January 1996, the Company adopted the Senior Management Incentive
Plan (the "Incentive Plan"), to provide for annual incentive awards to senior
executives of the Company. The Incentive Plan will be administered by the
Compensation Committee. Initially, there will be eleven participants in the
Incentive Plan, including Messrs. Jester, Harrison, Collamer and Gentry.

         Annual incentive awards under the Incentive Plan will be based on the
achievement by the Company of target levels of three distinct measures: EBITDA,
operating cash flow (as defined in the Incentive Plan) and revenue growth in a
calendar year. The annual incentives for participants may range from no award
(if minimum target levels are not reached) to a maximum of 43% (if maximum
target levels are reached) of base salary in effect at the end of a plan year.
No awards will be made under the Incentive Plan unless the minimum target level
for EBITDA is reached, regardless of the performance levels for the other
measurements. The Incentive Plan was first effective for the 1996 plan year.

         If a participant's employment is terminated during a plan year, a
pro-rated bonus may be awarded at the discretion of the Compensation Committee.
Performance target levels may be modified, at the discretion of the Compensation
Committee, for significant transactions, such as acquisitions, divestitures or
development projects.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

         Executive compensation decisions are made by the Board of Directors of
Music Holdings, which consists of Messrs. Balser, Boyd, Jennings, Jester and
Pollack.

         Paul F. Balser and Mark E. Jennings are limited partners of MLP and
prior to August 1995 were officers of Park Road Corporation ("Park Road"), the
managing general partner of Centre Partners. Bruce G. Pollack, a director of
Music Holdings, is a limited partner of MLP and is an officer and director of
Park Road.

         In 1996, the Company paid to Centre Partners $162,500 for services
provided by the Centre Partners designees during 1995 and 1996.

BENEFIT PLAN

         The Company maintains a 401(k) defined contribution savings and
retirement plan (the "Benefit Plan") that covers substantially all of the
Company's employees, including certain Named Executive Officers. Under the
Benefit Plan's savings portion, eligible employees may contribute from 1% to 14%
of their compensation per year, subject to certain tax law restrictions. The
Company may make a matching contribution of up to a maximum of 100% of the first
3% and 50% of the next 3%, up to 6% of the total base salary contributed by the
employee each year. The Company's contributions under the retirement portion of
the Benefit Plan are determined annually by the Company, but may not exceed 3%
of the eligible employee's annual compensation. Benefit Plan participants are
immediately vested in their contributions as well as the Company's
contributions.

                                       55
<PAGE>


ITEM 12.        SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.


         The following table sets forth certain information with respect to the
beneficial ownership of the Company as of the date hereof, by (i) each
interestholder known by the Company to beneficially own more than five percent
of the Company, (ii) each director of the general partner of the managing
general partner of the Company, (iii) the Named Executive Officers and (iv) all
directors of the general partner of the managing general partner of the Company
and executive officers of the Company as a group. The following table excludes
units of partnership interest issuable upon the exercise of options under the
Company's Amended and Restated Option Plan. Except pursuant to applicable
community property laws or as otherwise noted below, each of the owners
identified in the table has sole voting and investment power with respect to the
partnership interests beneficially owned by such person.
<TABLE>
<CAPTION>

                                                                                    NUMBER OF
                                                                                   PARTNERSHIP
                                                                                    INTERESTS
                   NAME AND ADDRESS OF BENEFICIAL OWNER                                                   PERCENT
<S>                                                                               <C>                  <C>

Centre Partners L.P.(1)
   30 Rockefeller Plaza
   Suite 5050
   New York, NY 10020....................................................
                                                                                     12,229,976            62.5%
UBS Capital LLC
   299 Park Avenue
   34th Floor
   New York, NY 10171....................................................
                                                                                      1,747,574             8.9
Comcast Corporation(2)
   1500 Market Street
   Philadelphia, PA 19102................................................             1,429,933             7.3
Barclays Bank PLC
   600 Fifth Avenue
   New York, NY 10023....................................................             1,358,617             6.9
John R. Jester...........................................................               367,143             1.9
James F. Harrison........................................................               217,143             1.1
Thomas J. Gentry.........................................................               158,571             0.8
John A. Neal.............................................................               175,000             0.9
Kirk A. Collamer.........................................................                60,000             0.3
Paul F. Balser...........................................................                     *(3)            * (3)
Mark E. Jennings.........................................................                     *(3)            * (3)
Bruce G. Pollack.........................................................                     *(4)            * (4)
All directors and executive officers as a group (8 persons)..............               977,857(5)          5.0 (5)
<FN>

*Less than 1%.
----------------------
(1)  Includes partnership interests held by MLP, of which Centre Partners is the
     general partner. Centre Partners may be deemed to be indirectly controlled,
     through Park Road, the managing general partner of Centre Partners, by
     Lester Pollack, a Managing Director of Lazard Freres & Co. LLC, an
     underwriter of this Offering, and the father of Bruce G. Pollack, a
     director of the general partner of the managing general partner of the
     Company.
(2)  The Class C-1 Limited Partnership Interest beneficially owned by Comcast
     Corporation is a preferred limited partnership interest convertible into an
     equivalent number of shares of common stock in the event of the
     incorporation of the Company. See "Description of the Partnership
     Agreement."
(3)  Excludes partnership interests held by Centre Partners and MLP.  Messrs.
     Balser and Jennings are limited partners of MLP and prior to August 1995
     were officers of Park Road.  Each disclaims beneficial ownership of such
     partnership interests.

                                       56

<PAGE>

(4)   Excludes partnership interests held by Centre Partners and MLP.  Mr.
      Pollack is a limited partner of MLP and is an officer and director of
      Park Road.  He disclaims beneficial ownership of such partnership
      interests.
(5)   Excludes partnership interests held by Centre Partners and MLP.
</FN>
</TABLE>

ITEM 13.           CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.


         For the year ended December 31, 1996, the Company incurred interest
expense and related fees of approximately $5.5 million in connection with the
UBS term loan and revolving credit facility and the Barclays subordinated debt
facility. The outstanding senior indebtedness and outstanding subordinated
indebtedness was repaid in full with the proceeds of the Offering. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."

         Directors of Music Holdings, the general partner of the managing
partner of the Company, who are also employees of the Company receive no
remuneration for services as members of the Board or any committee of the Board.
Directors who are not employed by the Company receive an annual retainer of
$20,000 plus $3,000 for each meeting of the Board attended, except in the case
of the Centre Partners designees, who receive an annual retainer of $50,000, in
each case plus reimbursement of expenses. See "Directors and Executive Officers
of the Registrant -- Directors' Compensation."

ITEM 14.       EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.


          (a)  The following documents are filed as part of this report:

          (1)  Financial Statements

               Audited financial statements and supplementary data required by
               this item are presented and listed in Part II, Item 8.

          (2)  Financial Statement Schedule

               A financial statement schedule required to be filed as part of
               this report is presented in Part II, Item 8.

          (3)  Exhibits

EXHIBIT
NO.      .........                              DESCRIPTION

3.1      --   Certificate of Incorporation of Capital Corp. (b)
3.2      --   By-Laws of Capital Corp. (b)
3.3      --   Certificate of Amendment to the Certificate of Incorporation of
              Capital Corp. (b)
3.4      --   Third Amended and Restated Agreement of Limited Partnership of
              Muzak Limited Partnership (formerly, MLP Operating, L.P.), dated
              as of November 4, 1994, as amended (b)
4.1      --   Indenture, dated as of October 2, 1996, among the Registrants
              and First Trust National Association, as trustee, in respect of
              the Registrants' 10% Senior Notes due 2003 (b)
4.2      --   Form of Senior Note (included in the form of Indenture filed as
              Exhibit 4.2 above) (b)
                                       57

<PAGE>

10.1     --   Asset Purchase Agreement dated as of March 11, 1992, among Muzak
              Limited Partnership, Field/Muzak Inc., The Field Corporation and
              MLP Operating, L.P., as amended by Muzak Limited Partnership's
              letters dated April 22, 1992, August 6, 1992 and August 20, 1992,
              Amendment No. 1 dated as of June 26, 1992, Amendment No. 2, dated
              July 31, 1992 and Amendment No. 3, dated as of August 26, 1992 (b)
10.2    --    Asset Purchase Agreement and Contribution Agreement dated as of
              November 24, 1993 among Comcast Corporation, et al. and Muzak
              Limited Partnership (b)
10.3    --    Amended and Restated Credit Agreement dated as of September 4,
              1992, as amended as of October 22, 1992 and as of December 15,
              1993; and as amended and restated as of January 31, 1994 among
              Muzak Limited Partnership, Union Bank of Switzerland, New York
              Branch, Internationale Nederlanden (U.S.) Capital Corporation and
              the other Lenders parties thereto and Union Bank of Switzerland,
              New York Branch, as Agent; as amended by Waiver and Agreement
              dated as of February 10, 1994; Waiver and Amendment No. 1 dated as
              of October 31, 1994; Waiver and Amendment No. 2 dated as of
              November 2, 1994; Amendment No. 3 and Consent dated as of November
              4, 1994; Amendment No. 4 to Amended and Restated Credit Agreement
              dated as of November 17,1994; Waiver dated January 10, 1995;
              Waiver dated as of July 31, 1995; Amendment No. 5 to Amended and
              Restated Credit Agreement dated as of November 7, 1995; and Waiver
              dated as of April 1, 1996 (b)
10.4    --    Amended and Restated Term Notes issued as of September 4, 1992,
              amended and restated as of January 31, 1994 (b)
10.5    --    Subordinated Loan Agreement dated as of September 4, 1992, as
              amended, between Muzak Limited Partnership and Barclays Bank PLC,
              New York Branch (b)
10.6    --    Option Agreement dated as of September 4, 1992 between Muzak
              Limited Partnership and Barclays Bank PLC, New York Branch (b)
10.7    --    Uplink Facility Agreement dated as of December 28, 1995 between
              EchoStar Satellite Corporation and Muzak Limited Partnership (b)
10.8    --    DBS Programming Affiliation Agreement dated as of December 28,
              1995 between EchoStar Satellite Corporation and Muzak Limited
              Partnership (b)
10.9    --    Video Programming Sales Agent Agreement dated as of December 28,
              1995 between EchoStar Satellite Corporation and Muzak Limited
              Partnership (b)
10.10   --    Form of Muzak(R) Participating Affiliate Agreement (b)
10.11   --    Third and Board Office Lease dated June 8, 1994, between Martin
              Selig and Muzak Limited Partnership (b)
10.12   --    ASCAP License (b)
10.13   --    Joint Venture Agreement dated August 2, 1995 between
              Muzak Limited Partnership and Alcas Holdings B.V. (b)
10.14   --    Muzak(R) Master Affiliate Agreement (Mexico) dated March 1, 1992
              between Muzak Limited Partnership and Audioplan S.A. (b)
10.15   --    Muzak(R)Master Affiliate Agreement (Canada) dated August 30, 1990
              between Muzak Limited Partnership and Chum Limited, as amended (b)
10.16   --    FCC Licenses (b)
10.17   --    Form of License Agreement (New Franchise Agreement), as amended
              (b)
10.18   --    Form of Music Services Agreement (b)
10.19   --    Form of Multi-Territory Account Service Agreement (b)
10.20   --    Form of Sales of Adjunct Services and Form of Muzak Adjunct
              Services Subscriber Agreement (b)
10.21   --    Transponder Lease Agreement dated December 9, 1993 between
              Microspace Communications Corporation and Muzak Limited
              Partnership (b)
10.22   --    Transmission Lease Agreement dated January 31, 1995 between
              Microspace Communications Corporation and Muzak and Limited
              Partnership (b)
10.23   --    Transponder Lease Agreement dated January 31, 1995 between
              Microspace Communications Corporation and Muzak Limited
              Partnership (b)
10.24   --    Transponder Lease Agreement dated April 27, 1995 between
              Microspace Communications Corporation and Muzak Limited
              Partnership (b)
10.25   --    Transponder Lease Agreement dated July 5, 1995 between Microspace
              Communications Corporation and Muzak Limited Partnership (b)

                                       58
<PAGE>

10.26   --    Transponder Lease Agreement dated April 29, 1996 between
              Microspace Communications Corporation and Muzak Limited
              Partnership (b)
10.27   --    Agreement to Provide Telecommunications Service dated August 8 and
              9, 1995 between Keystone Communications Corporation and Muzak
              Limited Partnership (b)
10.28   --    Sales Agreement and License dated September 28, 1995 between
              Mainstream Data, Inc. and Muzak Limited Partnership (b)
10.29   --    Muzak Limited Partnership Tempo Savings and Retirement Plan (b)
10.30   --    Muzak Limited Partnership Tempo Savings and Retirement Trust (b)
10.31   --    Muzak Limited Partnership Management Incentive Plan (b)
10.32   --    Muzak Limited Partnership Management Option Plan (b)
10.35   --    Employment Agreement dated August 31, 1992 of John R. Jester (b)
10.36   --    Employment Agreement dated August 31, 1992 of James F.
              Harrison (b)
10.37   --    Employment Letter dated July 7, 1995 of Kirk A. Collamer (b)
10.38   --    Amended and Restated Management Option Plan (b)
12      --    Statement of Computations of Ratios of Earnings to Fixed
              Charges (a)
21      --    List of Subsidiaries of the Registrants  (b)
27      --    Financial Data Schedules (a)

-----------------
(a)  Filed herewith
(b)  Previously filed as Exhibits to Registration Statement No.'s 333-03741 and
     333-03741-01 filed with the Securities and Exchange Commission.


(b)  Reports on Form 8-K
     -------------------
     None

                                       59

<PAGE>


                                   SIGNATURES

         Pursuant to the requirements of Section 13 or 15(d) of the Securities
and Exchange Act of 1934, the registrants have duly caused this report to be
signed on their behalf by the undersigned, thereunto duly authorized.

                             MUZAK LIMITED PARTNERSHIP
                             (Registrant)

                             By:        MLP ACQUISITION L.P.
                                --------------------------------
                                        Managing General Partner

                             By:        MUSIC HOLDINGS CORP.
                                --------------------------------
                                             General Partner

                             By:            /s/  John R. Jester
                                 -------------------------------
                                                 John R. Jester
                                                    President

                             MUZAK CAPITAL CORPORATION
                             (Registrant)

March 27, 1997               By:           /s/  John R. Jester
                                 --------------------------------
                                                John R. Jester
                                        President and Chief Executive Officer

         Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrants and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>


                SIGNATURE                                         TITLE                                      DATE
                ---------                                         -----                                      ----
<S>                                         <C>                                                  <C>

        /S/ JOHN R. JESTER                      President and Chief Executive Officer                   March 27, 1997
------------------------------------------
            JOHN R. JESTER                      Officer (Principal Executive Officer,
                                                Principal Financial Officer and
                                                Principal Accounting Officer), of
                                                the Company and Capital Corp. and Director
                                                of Music Holdings and Capital Corp.

           /s/ WILLIAM A. BOYD                  Chairman of the Board of Music                          March 27, 1997
------------------------------------------
               WILLIAM A. BOYD                  Holdings and Capital Corp.

           /s/ PAUL F. BALSER                   Director of Music Holdings and                          March 27, 1997
------------------------------------------
               PAUL F. BALSER                   Capital Corp.

          /s/ BRUCE G. POLLACK                  Director of Music Holdings and.                         March 27, 1997
------------------------------------------
              BRUCE G. POLLACK                  Capital Corp.

          /s/ MARK E. JENNINGS                  Director of Music Holdings and                          March 27, 1997
------------------------------------------
              MARK E. JENNINGS                  Capital Corp.


</TABLE>

                                       60
<PAGE>

                                 EXHIBIT INDEX

EXHIBIT NO.                                 DESCRIPTION


3.1      --   Certificate of Incorporation of Capital Corp. (b)
3.2      --   By-Laws of Capital Corp. (b)
3.3      --   Certificate of Amendment to the Certificate of Incorporation of
              Capital Corp. (b)
3.4      --   Third Amended and Restated Agreement of Limited Partnership of
              Muzak Limited Partnership (formerly, MLP Operating, L.P.), dated
              as of November 4, 1994, as amended (b)
4.1      --   Indenture, dated as of October 2, 1996, among the Registrants
              and First Trust National Association, as trustee, in respect of
              the Registrants' 10% Senior Notes due 2003 (b)
4.2      --   Form of Senior Note (included in the form of Indenture filed as
              Exhibit 4.2 above) (b)
10.1     --   Asset Purchase Agreement dated as of March 11, 1992, among Muzak
              Limited Partnership, Field/Muzak Inc., The Field Corporation and
              MLP Operating, L.P., as amended by Muzak Limited Partnership's
              letters dated April 22, 1992, August 6, 1992 and August 20, 1992,
              Amendment No. 1 dated as of June 26, 1992, Amendment No. 2, dated
              July 31, 1992 and Amendment No. 3, dated as of August 26, 1992 (b)
10.2    --    Asset Purchase Agreement and Contribution Agreement dated as of
              November 24, 1993 among Comcast Corporation, et al. and Muzak
              Limited Partnership (b)
10.3    --    Amended and Restated Credit Agreement dated as of September 4,
              1992, as amended as of October 22, 1992 and as of December 15,
              1993; and as amended and restated as of January 31, 1994 among
              Muzak Limited Partnership, Union Bank of Switzerland, New York
              Branch, Internationale Nederlanden (U.S.) Capital Corporation and
              the other Lenders parties thereto and Union Bank of Switzerland,
              New York Branch, as Agent; as amended by Waiver and Agreement
              dated as of February 10, 1994; Waiver and Amendment No. 1 dated as
              of October 31, 1994; Waiver and Amendment No. 2 dated as of
              November 2, 1994; Amendment No. 3 and Consent dated as of November
              4, 1994; Amendment No. 4 to Amended and Restated Credit Agreement
              dated as of November 17,1994; Waiver dated January 10, 1995;
              Waiver dated as of July 31, 1995; Amendment No. 5 to Amended and
              Restated Credit Agreement dated as of November 7, 1995; and Waiver
              dated as of April 1, 1996 (b)
10.4    --    Amended and Restated Term Notes issued as of September 4, 1992,
              amended and restated as of January 31, 1994 (b)
10.5    --    Subordinated Loan Agreement dated as of September 4, 1992, as
              amended, between Muzak Limited Partnership and Barclays Bank PLC,
              New York Branch (b)
10.6    --    Option Agreement dated as of September 4, 1992 between Muzak
              Limited Partnership and Barclays Bank PLC, New York Branch (b)
10.7    --    Uplink Facility Agreement dated as of December 28, 1995 between
              EchoStar Satellite Corporation and Muzak Limited Partnership (b)
10.8    --    DBS Programming Affiliation Agreement dated as of December 28,
              1995 between EchoStar Satellite Corporation and Muzak Limited
              Partnership (b)
10.9    --    Video Programming Sales Agent Agreement dated as of December 28,
              1995 between EchoStar Satellite Corporation and Muzak Limited
              Partnership (b)
10.10   --    Form of Muzak(R) Participating Affiliate Agreement (b)
10.11   --    Third and Board Office Lease dated June 8, 1994, between Martin
              Selig and Muzak Limited Partnership (b)
10.12   --    ASCAP License (b)
10.13   --    Joint Venture Agreement dated August 2, 1995 between
              Muzak Limited Partnership and Alcas Holdings B.V. (b)
10.14   --    Muzak(R) Master Affiliate Agreement (Mexico) dated March 1, 1992
              between Muzak Limited Partnership and Audioplan S.A. (b)
10.15   --    Muzak(R)Master Affiliate Agreement (Canada) dated August 30, 1990
              between Muzak Limited Partnership and Chum Limited, as amended (b)
10.16   --    FCC Licenses (b)
10.17   --    Form of License Agreement (New Franchise Agreement), as amended
              (b)
10.18   --    Form of Music Services Agreement (b)
10.19   --    Form of Multi-Territory Account Service Agreement (b)
10.20   --    Form of Sales of Adjunct Services and Form of Muzak Adjunct
              Services Subscriber Agreement (b)
10.21   --    Transponder Lease Agreement dated December 9, 1993 between
              Microspace Communications Corporation and Muzak Limited
              Partnership (b)
10.22   --    Transmission Lease Agreement dated January 31, 1995 between
              Microspace Communications Corporation and Muzak and Limited
              Partnership (b)

                                       61
<PAGE>


10.23   --    Transponder Lease Agreement dated January 31, 1995 between
              Microspace Communications Corporation and Muzak Limited
              Partnership (b)
10.24   --    Transponder Lease Agreement dated April 27, 1995 between
              Microspace Communications Corporation and Muzak Limited
              Partnership (b)
10.25   --    Transponder Lease Agreement dated July 5, 1995 between Microspace
              Communications Corporation and Muzak Limited Partnership (b)
10.26   --    Transponder Lease Agreement dated April 29, 1996 between
              Microspace Communications Corporation and Muzak Limited
              Partnership (b)
10.27   --    Agreement to Provide Telecommunications Service dated August 8 and
              9, 1995 between Keystone Communications Corporation and Muzak
              Limited Partnership (b)
10.28   --    Sales Agreement and License dated September 28, 1995 between
              Mainstream Data, Inc. and Muzak Limited Partnership (b)
10.29   --    Muzak Limited Partnership Tempo Savings and Retirement Plan (b)
10.30   --    Muzak Limited Partnership Tempo Savings and Retirement Trust (b)
10.31   --    Muzak Limited Partnership Management Incentive Plan (b)
10.32   --    Muzak Limited Partnership Management Option Plan (b)
10.35   --    Employment Agreement dated August 31, 1992 of John R. Jester (b)
10.36   --    Employment Agreement dated August 31, 1992 of James F.
              Harrison (b)
10.37   --    Employment Letter dated July 7, 1995 of Kirk A. Collamer (b)
10.38   --    Amended and Restated Management Option Plan (b)
12      --    Statement of Computations of Ratios of Earnings to Fixed
              Charges(a)
21      --    List of Subsidiaries of the Registrants  (b)
27      --    Financial Data Schedules (a)

-----------------
(a)  Filed herewith
(b)  Previously filed as Exhibits to Registration Statement No.'s 333-03741 and
     333-03741-01 filed with the Securities and Exchange Commission.

                                       62