1
- - --------------------------------------------------------------------------------
- - --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
------------------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 00-21315
ON COMMAND CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-04535194
(STATE OF INCORPORATION) (IRS EMPLOYER IDENTIFICATION NO.)
6331 SAN IGNACIO AVENUE, SAN JOSE, CALIFORNIA 95119
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 360-4500
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
Common Stock NASDAQ National Market System
Series A Common Stock Purchase Warrants NASDAQ National Market System
Series B Common Stock Purchase Warrants NASDAQ National Market System
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE
Indicate by check mark whether the Registrant (1) has 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
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by 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 Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
The aggregate market value of the Registrant's Common Stock held by
non-affiliates of the Registrant as of March 3, 1999, was $125,407,368 based
upon a price of $9.625 per share, which was the average of the bid and asked
prices of such stock on March 3, 1999, as reported on the NASDAQ National Market
Reporting System. As of March 3, 1999, there were 30,169,752 shares of the
Registrant's Common Stock issued and outstanding and 1,424,875 Series A
Warrants, 2,625,000 Series B Warrants, and 3,450,000 Series C Warrants
(non-registered) issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant's definitive proxy statement with respect to its annual
meeting of stockholders is incorporated by reference herein.
- - --------------------------------------------------------------------------------
- - --------------------------------------------------------------------------------
2
TABLE OF CONTENTS
PAGE
----
Item 1. Business
Introduction................................................ 1
General..................................................... 2
Industry Overview........................................... 2
Operating and Growth Strategies............................. 3
Services and Products....................................... 3
Sales and Marketing......................................... 5
Installation and Service Operations......................... 6
Hotel Contracts............................................. 6
Technology.................................................. 6
Suppliers................................................... 7
Integrating Operations...................................... 7
Competition................................................. 7
Regulation.................................................. 8
Patents, Trademarks, and Copyrights......................... 9
International Markets....................................... 9
Other Guest Services........................................ 9
Markets and Customers....................................... 10
Employees................................................... 10
Item 2. Properties.................................................. 10
Item 3. Legal Proceedings........................................... 11
Item 4. Submission of Matters to a Vote of Security Holders......... 11
Executive Officers of Registrant............................ 11
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters......................................... 12
Item 6. Selected Financial Data..................................... 14
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 15
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 21
Item 8. Financial Statements and Supplementary Data................. 21
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 40
Item 10. Directors and Executive Officers of the Registrant.......... 40
Item 11. Executive Compensation...................................... 40
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 40
Item 13. Certain Relationships and Related Transactions.............. 40
Item 14. Exhibits, Financial Statements, Schedules and Reports on
Form 8-K.................................................... 41
i
3
PART I
This Form 10-K may contain forward looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, which reflect On Command
Corporation's current judgment on those issues. Because such statements apply to
future events, they are subject to risks and uncertainties that could cause the
actual results to differ materially. Important factors, which could cause actual
results to differ materially, are described in the following paragraphs and are
particularly noted under Business Risks on pages 18 through 21 and the Company's
Reports on Forms 10-Q and 10-K, as filed with the Securities and Exchange
Commission. Although the Company has attempted to list some of the important
factors that may cause actual results to differ materially from those
anticipated, those factors should not be viewed as the only factors which may
affect future operating results.
ITEM 1. BUSINESS
INTRODUCTION
On Command Corporation (the "Company" or "OCC") is a Delaware corporation
formed by Ascent Entertainment Group, Inc. ("Ascent") for the purpose of (i)
effecting the merger (the "Merger") of On Command Video Corporation ("OCV"), a
majority-owned subsidiary of Ascent, with a wholly-owned subsidiary of OCC,
after which OCV became a wholly-owned subsidiary of OCC, and (ii) effecting the
acquisition (the "Acquisition") of Spectradyne, Inc., a wholly-owned subsidiary
of SpectraVision, Inc. ("Oldco"). Following the Acquisition, Spectradyne, Inc.
changed its name to SpectraVision, Inc. ("SpectraVision"). At the time of the
Merger and Acquisition, Ascent had been a majority-owned subsidiary of COMSAT
Corporation ("COMSAT"). On June 27, 1997, COMSAT consummated the distribution of
its 80.67% ownership interest in Ascent to the COMSAT shareholders on a pro-rata
basis in a transaction that was tax-free for federal income tax purposes.
The Merger and Acquisition were effective on October 8, 1996. The Merger
was accounted for using the historical book value of the assets, liabilities,
and stockholders' equity acquired from OCV in a manner similar to a pooling of
interests. The Acquisition was accounted for as a purchase using the fair value
of the assets acquired and liabilities assumed from SpectraVision. Prior to the
Merger and Acquisition (collectively hereafter, the "Acquisition"), OCC had no
significant operations other than On Command Development Corporation.
As of the closing date of the Acquisition, the stockholders of OCV received
21,750,000 of OCC Common Stock (72.5% of the initial OCC Common Stock, of which
Ascent received 17,149,766 shares). In consideration for the acquisition of the
assets and properties of SpectraVision by OCC, OCC paid $4 million in cash and
issued 8,041,618 shares of OCC common stock to the Oldco bankruptcy estate for
distribution to Oldco's creditors. Additionally, 208,382 shares were held in
reserve pursuant to the Acquisition for potential adjustments. Of these, 196,382
shares of reserve stock were subsequently distributed to the Oldco bankruptcy
estate for the benefit of Oldco's creditors with the remaining 12,000 shares
distributed to the OCV stockholders.
In connection with the Acquisition, OCC also issued warrants representing
the right to purchase a total of 7,500,000 shares of OCC Common Stock (20% of
the outstanding common stock of OCC after exercise of the warrants). The
warrants have a term of seven years and an exercise price of $15.27 per share of
OCC Common Stock. Series A warrants to purchase on a cashless basis an aggregate
of 1,425,000 shares of OCC Common Stock were issued to the former OCV
stockholders, of which Ascent received warrants to purchase 1,123,823 shares;
Series B warrants to purchase for cash an aggregate of 2,625,000 shares of OCC
Common Stock were issued to the Oldco bankruptcy estate for distribution to
creditors; and $4.0 million in cash was paid and Series C warrants to purchase
for cash an aggregate of 3,450,000 shares of OCC Common Stock were issued to
OCC's investment advisors in consideration for certain banking and advisory
services provided in connection with the Acquisition.
1
4
Unless otherwise indicated, all references to "On Command Corporation,"
"OCC" or the "Company" will include On Command Corporation and its wholly owned
subsidiaries.
GENERAL
OCC, is a holding company whose principal assets are OCV, SpectraVision,
and On Command Development Corporation, each of which operates as a separate,
wholly owned subsidiary of On Command Corporation.
OCC is the leading provider (by number of hotel rooms served) of in-room,
on-demand video entertainment and information services to the domestic lodging
industry. Currently, OCC's primary on-demand platform is the patented OCV
system, a video selection and distribution technology platform that allows hotel
guests to select at any time up to 50 motion pictures on-demand by computer
controlled television sets located in their rooms.
The OCV platform also provides for in-room viewing of free-to-guest
programming of select cable channels (such as HBO, Showtime, ESPN, CNN and
Disney Channel) and other interactive and information services. OCV primarily
provides its services under long-term contracts to hotel chains, hotel
management companies, and individually owned and franchised hotel properties,
predominantly in the deluxe, luxury, and upscale hotel categories serving
business travelers, such as Marriott, Hilton, Hyatt, Wyndham, Doubletree,
Fairmont, Embassy Suites, Four Seasons, and other select hotels. OCV has
experienced rapid growth in the past six years, increasing its base of installed
on-demand rooms from approximately 37,000 rooms at the end of 1992 to
approximately 704,000 rooms at December 31, 1998.
At December 31, 1998, approximately 86.6% of OCC's 929,000 installed rooms
were located in the United States, with the balance located primarily in Canada,
the Caribbean, Australia, Europe, and the Asia-Pacific region. In addition to
installing OCV systems in hotels served by OCV, OCV sells its systems to certain
other providers of in-room entertainment, including Hospitality Network, Inc.,
which is licensed to use OCV's system to provide on-demand, in-room
entertainment and information services to certain gaming-based, hotel properties
and MagiNet Corporation (formerly Pacific Pay Video Limited), which was
previously licensed to use OCV's system to provide on-demand in-room
entertainment in the Asia-Pacific region. OCV has terminated the MagiNet
license, which termination is being contested by MagiNet.
SpectraVision was historically a leading provider of interactive in-room
video entertainment services to the lodging industry. Founded in 1971,
SpectraVision's former parent, Oldco, originally developed and patented a system
that provides in-room television viewing of recently released major and other
motion pictures on a pay-per-view basis. SpectraVision subsequently expanded its
services to include providing pay-per-view motion pictures in an on-demand
format, delivering free-to-guest programming, and providing interactive services
that capitalized on SpectraVision's proprietary two-way communications
equipment. Like OCV, SpectraVision also provides in-room viewing of
free-to-guest programming of similar select cable channels and other interactive
services.
At December 31, 1998, SpectraVision equipment was in place in approximately
225,000 rooms, with approximately 152,000 installed rooms in the United States,
and the balance located in Canada, Asia, Europe and Mexico.
On Command Development Corporation develops technologies to be used by OCV
and SpectraVision to support and enhance OCV's and SpectraVision's operations
and to develop new applications to be marketed by OCV and SpectraVision.
INDUSTRY OVERVIEW
Providing in-room entertainment and information services to the lodging
industry includes offering pay-per-view motion pictures, free-to-guest
programming of select pay cable channels, and an increasing array of interactive
programs and information services. Pay-per-view services were introduced in the
early 1970s and have since become a standard amenity offered by many hotels to
their guests. Historically, providers of programming to hotels delivered their
content on a fixed time schedule that did not provide the hotel guest
2
5
flexibility in choosing when to watch a movie. Typically, a guest would be
offered a choice of four to eight movies, each of which would be shown once
every two to four hours. The development of video switches (including OCV's
patented video switch) has enabled providers of pay-per-view services to offer
scheduling flexibility to the viewer. Changes in technology have also led to the
ability to provide a number of on-demand interactive services such as guest
folio review, automatic checkout, survey completion, guest messaging, and video
games. The market for in-room entertainment and information is characterized as
a highly competitive environment among several industry-dedicated companies and
a number of new entrants including cable companies, telecommunications companies
and others. See "Competition".
OPERATING AND GROWTH STRATEGY
On Command Corporation's operating and growth strategy is to (i) increase
its installed hotel customer base by obtaining contracts with business and
luxury hotels and select mid-priced hotels without current service, converting
hotels currently served by other providers whose contracts are expiring, and
servicing hotels which are acquired or constructed by existing customers, (ii)
increase revenues and decrease costs in certain hotels acquired in the
SpectraVision acquisition by installing OCV technology offering greater
reliability, broader selection, and more viewing flexibility, (iii) create new
revenue sources through an expanding range of interactive and information
services offered to the lodging industry, and (iv) expand its room base in
underserved foreign markets.
Prior to the Acquisition and through 1998, OCV had experienced rapid
growth, increasing its base of installed rooms from approximately 37,000 rooms
in approximately 90 hotels at the end of 1992 to approximately 704,000 rooms in
approximately 2,496 hotels at December 1998. Conversely, SpectraVision, as a
result of financial constraints and its bankruptcy filing in June 1995,
experienced deterioration in its room base. SpectraVision's room base had
decreased from approximately 1,059,000 installed rooms December 1992 to
approximately 469,000 rooms at the time of the Acquisition.
The Acquisition also increased OCC's international base of rooms, better
positioning it to expand further into international markets, which represents an
opportunity for growth for OCC. As of December 31, 1998, approximately 13.4% of
OCC's hotel rooms served, or 124,000 rooms, are located in international
markets.
OCC has substantially completed the integration of SpectraVision's
operating systems, financial reporting, sales, marketing and management
following the Acquisition. In addition, OCC has been actively pursuing the
renewal or extension of most of these contracts with hotel customers with
SpectraVision equipment by offering these customers the opportunity to obtain
OCV on-demand pay-per-view movie service and related services. As of December
31, 1998, OCC had converted approximately 137,000 rooms previously served by
SpectraVision's systems to OCC's on-demand system. Management expects to have a
substantial majority of SpectraVision rooms converted to OCV's on-demand system
by the end of 2000.
SERVICES AND PRODUCTS
Pay-Per-View
Through its OCV and SpectraVision subsidiaries, OCC provides on-demand and,
in some cases, scheduled in-room television viewing of major motion pictures and
independent non-rated motion pictures for mature audiences, for which a hotel
guest pays on a per-view basis. Depending on the type of system installed and
the size of the hotel, guests can choose up to 50 different movies with an
on-demand system, or from eight to twelve movies with a scheduled system.
OCC obtains the non-exclusive rights to show recently released motion
pictures from major motion picture studios generally pursuant to a master
agreement with each studio. The license period and fee for each motion picture
are negotiated individually with each studio, which typically receives a
percentage of that picture's gross revenues generated by the pay-per-view
system. Typically, OCC obtains rights to exhibit major motion pictures during
the "Hotel/Motel Pay-Per-View Window," which is the time period after initial
theatrical release and before release for home video distribution or cable
television exhibition. OCC attempts to license pictures as close as possible to
motion pictures theatrical release date to benefit from the studios'
3
6
advertising and promotional efforts. OCC also obtains independent motion
pictures, most of which are non-rated and are intended for mature audiences, for
a one-time flat fee that is nominal in relation to the licensing fees paid for
major motion pictures.
OCC provides service under contracts with hotels that generally provide for
a term of five to seven years. Under these contracts, OCC installs its system
into the hotel at OCC's cost, and OCC retains ownership of all its equipment
used in providing the service. Traditionally, the hotel provides its own
televisions, however, based on certain economic evaluations, OCC may provide
televisions to hotels in exchange for other contractual consideration. OCC
undertakes a significant investment when it installs its system in a hotel
property, sometimes rewiring part of the hotel. Depending on the size of the
hotel property and the configuration of the system installed, and if televisions
are provided by the Company to the hotel property, the installation cost of a
new, on-demand system with interactive and video game services capabilities,
including the head-end equipment, averages from approximately $375 to $750 per
room. If the Company does not provide televisions to the hotel property, the
average costs are $375 to $450 per room. OCC's contracts with hotels generally
provide that OCC will be the exclusive provider of in-room, pay-per-view video
entertainment services to the hotel and generally permit OCC to set the movie
price. The hotels collect movie-viewing charges from their guests and retain a
commission equal to a percentage of the total pay-per-view revenue that varies
depending upon the size and profitability of the system. Some contracts also
require OCC to upgrade systems to the extent that new technologies and features
are introduced during the term of the contract. At the scheduled expiration of a
contract, OCC generally seeks to extend the agreement on terms that are based
upon the competitive situation in the market.
The revenue generated from OCC's pay-per-view service is dependent on the
occupancy rate at the property, the "buy rate" or percentage of occupied rooms
that buy movies or other services at the property, and the price of the movie or
service. Occupancy rates vary based on the property's location, its competitive
position within the marketplace, and, over time, based on seasonal factors and
general economic conditions. Buy rates generally reflect the hotel's guest mix
profile, the popularity of the motion pictures or services available at the
hotel, and the guests' other entertainment alternatives. Buy rates also vary
over time with general economic conditions and the business of OCC is closely
related to the performance of the business and luxury hotel segments of the
lodging industry. Movie price levels are established by OCC and are set based on
the guest mix profile at each property and overall economic conditions.
Currently, OCC's movie prices typically range from $8.95 to $9.95 for a purchase
by the hotel guest and, in certain hotels with OCV systems, $4.95 for each
subsequent purchase by the same guest on the same day. The SpectraVision
equipped hotels do not currently discount second buys. The current price for
OCC's pay-per-day service is $15.99 per day.
OCV
On Command Video(TM) On Demand System. The On Command Video System was
patented by OCV in 1992 and consists of a microprocessor controlling the
television in each room, a hand-held remote control, and a central "head-end"
video rack and system computer located elsewhere in the hotel. Programming
signals originate from video cassette players located within the head-end rack
and are transmitted to individual rooms by way of OCV's proprietary video
switching technology. Movie starts are controlled automatically by the system
computer. The system computer also records the purchase by a guest of any title
and reports billing data to the hotel's accounting system, which posts the
charge to the guest's bill.
Manual functions of the OCV equipment and system are limited to changing
videocassettes once per month and are all handled by OCC's service personnel who
also update the system's movie titles screens. OCV's information system is
capable of generating regular reports of guests' entertainment selections,
permitting OCV to adjust its programming to respond to viewing patterns. The
number of guests that can view a particular movie at the same time varies from
hotel to hotel depending upon the popularity of the movie. OCV provides more
copies of the most popular programming to hotels. The high-speed, two-way
digital communications capability of the OCV system enables OCC to provide
advanced interactive and information features, such as video games, in addition
to basic guest services such as video checkout, room service ordering and guest
satisfaction surveys. The OCV system also enables hotel owners to broadcast
informational and promotional messages and to monitor room availability.
4
7
For example, in a typical hotel with 400 rooms, the central head-end video
rack would consist of approximately 120 videocassette recorders containing up to
ten copies of the most popular movies and a total of up to 50 different titles.
The OCV system includes a computerized in-room on-screen menu that offers to
guests a list of only those movie selections available to the guest at that
time. As a result, even though the on-screen menu may not include a list of all
titles available in the particular hotel, the list includes all movies currently
available to the guest, thus eliminating the possibility of a guest being
disappointed when the guest's selection is not available. OCC markets the
full-scale OCV video-on-demand systems to business and luxury hotels.
Video NOW(TM). The Video NOW system works with the hotel's existing
televisions and telephones allowing guests to use their touch-tone telephones to
access on-demand movies and other programming and was targeted to select
midscale hotels. Beginning in 1997, OCV began to discontinue the marketing of
Video NOW systems due to the Company's development of a lower-cost, scalable,
on-demand system based substantially upon the On Command Video patented system.
SpectraVision
In comparison with OCV systems, hotels still equipped with SpectraVision
technology generally offer fewer choices if served by SpectraVision on-demand
systems, or only offer hotel guests eight movies per day at scheduled times, or
some combination thereof.
Tape-Based SpectraVision(TM). SpectraVision originated a tape-based system
which typically offers a hotel guest eight movies per day at predetermined
times.
Guest Choice(TM). In 1991, SpectraVision introduced the Guest Choice system
to provide hotel guests with on-demand viewing of videotapes based upon
proprietary equipment and software.
Digital Guest Choice(TM). In 1994, SpectraVision introduced a digital video
on-demand service, called Digital Guest Choice. The Digital Guest Choice system
provides on-demand viewing of digitally stored movies that reside on high
capacity disk arrays. While the Company is in the process of converting Digital
Guest Choice systems in the United States to its OCV on-demand systems, some
units of Digital Guest Choice equipment will continue to be used in Asia.
Free-To-Guest Services
OCC also markets free-to-guest services pursuant to which a hotel may elect
to receive one or more programming channels, such as HBO, Showtime, CNN, ESPN,
TBS, Disney Channel, Discovery Channel, and other cable networks. OCC provides
hotels free-to-guest services through a variety of arrangements, including
having the hotel pay the company a fixed monthly fee per room for each
programming channel selected or having the price of such programming included in
the Company's other offerings.
New Services. Beginning in 1997, OCC developed and selectively deployed for
market testing several new services to complement its existing offerings and
strengthen its growth strategy by creating new potential revenue sources. New
technology and services being tested by OCC include a digital server technology
and high-speed, TV-based and laptop connectivity Internet offerings. OCC is also
testing shorter and more targeted non-movie programming on a lower cost
pay-per-view basis. The initial categories of content include business,
lifestyle and kids-only. In addition, OCC is in the process of long-term testing
of a new sports category of programming that provides hotel guests with a
selection of out-of-market sports not televised nationally, or subject to local
blackout restrictions.
SALES AND MARKETING
Substantially all of OCV's growth has derived from obtaining contracts with
hotels in the United States not under contract with existing vendors or served
by other vendors as the contracts covering such hotels expired. OCC believes
that, as a result of the Acquisition, opportunities for additional growth in the
United States will be more limited than in the past. Therefore, the Company
intends to focus its strategy for obtaining
5
8
new hotel customers in international markets. The Company believes that,
relative to the United States, many international markets are underserved by the
in-room entertainment industry.
OCC's marketing efforts are primarily focused on business and leisure
hotels with approximately 150 rooms or more. Management believes that such
hotels consistently generate the highest revenues per room in the lodging
industry and have the highest potential for new service revenue growth. The
Company also targets smaller deluxe, luxury and upscale hotels and select
mid-priced hotels serving business travelers that meet its profitability
criteria. In connection with such smaller hotel segments, the Company has
recently begun to employ additional engineering development and marketing
efforts to target hotels under 150 rooms. On Command intends to continue
targeting established hotel chains, certain business and leisure hotel
management companies, and selected independent hotels.
OCC markets its services to hotel guests by means of on-screen advertising
that highlights the services and motion picture selections of the month as well
as an in-room entertainment guide distributed to more than 804,000 hotel rooms
each month. OCC believes it has been successful at renewing its hotel contracts
due to its large capital investment in wiring infrastructure of the hotel and
its high quality service record.
INSTALLATION AND SERVICE OPERATIONS
At December 31, 1998, OCC's installation and service organization consisted
of approximately 381 installation and service personnel in the United States and
Canada. OCC installation and service personnel are responsible for all of the
hotel rooms served by OCC in the United States and Canada, including system
maintenance and distribution of videocassettes. OCC's installation personnel
also prepare site surveys to determine the type of equipment to be installed at
each hotel, install systems, train the hotel staff to operate the systems, and
perform quality control tests. OCC also uses local installation subcontractors
supervised by full-time OCC personnel to install its systems.
OCC maintains a toll-free technical support hot line that is monitored 24
hours a day by trained support technicians. The on-line diagnostic capability of
the OCV and SpectraVision systems enables the technician to identify and resolve
a majority of the reported system malfunctions from OCC's service control center
without visiting the hotel property. Should a service visit be required, the
modular design of the OCV and SpectraVision systems generally permits
installation and service personnel to replace defective components at the hotel
site.
HOTEL CONTRACTS
The Company typically negotiates and enters into a separate contract with
each hotel for the services provided, except for some of the Company's large
hotel management customers, in which case the Company negotiates and enters into
a single master contract for the provision of services for all of the corporate-
managed hotels of such management company. In the case of franchised or
independently owned hotels, the contracts are generally negotiated separately
with each hotel. Existing contracts generally have a term of five or seven years
from the date the system becomes operational. At expiration, OCC typically seeks
to extend the term of the contract on terms competitive in the market. At
December 31, 1998, approximately 10% of the pay-per-view hotels served by OCC
have contracts that have expired and are on a month-to-month basis.
Approximately 8% of the pay-per-view hotels served by OCC have contracts
expiring in 1999. However, some of the SpectraVision hotel contracts, which the
Company classified internally as expired, have two-year automatic renewal
provisions under certain conditions and may continue to be in effect. As a
result, the expiration rates set forth above may overstate the actual number of
hotel contracts that are expiring.
TECHNOLOGY
OCC's product development philosophy is to design high quality
entertainment and information systems which incorporate features allowing the
Company to add system enhancements as they become commercially available and
economically viable. The high speed, two-way digital communications capability
of the OCV system enables the Company to provide advanced interactive features
such as video games in addition to basic guest services such as video checkout,
room service ordering, and guest survey.
6
9
The Company's systems incorporate proprietary communications system designs
with commercially manufactured components and hardware such as video cassette
players, televisions, amplifiers, and computers. Because the Company's systems
generally use industry standard interfaces, OCC can integrate new technologies
as they become economically viable.
SUPPLIERS
OCC contracts directly with various electronics firms for the manufacture
and assembly of its systems hardware, the design of which is controlled by On
Command Development Corporation. Historically, these suppliers have been
dependable and able to meet delivery schedules on time. The Company believes
that, in the event of a termination of any of its sources, alternate suppliers
could be located without incurring significant costs or delays. However, certain
electronic component parts used with the Company's products are available from a
limited number of suppliers and can be subject to temporary shortages because of
general economic conditions and the demand and supply for such component parts.
In addition, some of the SpectraVision systems currently installed in hotels
require a high level of service and repair. As these systems become older,
servicing replacement parts will become more difficult. If the Company were to
experience a shortage of any given electronic part, the Company believes that
alternative parts could be obtained or system design changes could be made. In
such event, the Company could experience a temporary reduction in the rate of
new installations and/or an increase in the cost of such installations.
The head-end electronics are assembled at the Company's facilities for
testing prior to shipping. Following assembly and testing of equipment designed
specifically for a particular hotel, the system is shipped to each location,
where OCC-employed and trained technicians install the system, typically
assisted by independent contractors.
For those hotels for which the Company supplies televisions, On Command
purchases such televisions from a small number of television vendors. In the
event of a significant price increase for televisions by such vendors, the
Company could face additional, unexpected capital expenditure costs.
OCC, through its OCV and SpectraVision subsidiaries, maintains direct
contractual relations with various suppliers of pay-per-view and free-to-guest
programming, including the motion picture studios and/or their domestic and
international distributors and programming networks. OCC believes its
relationships with all suppliers are good.
In addition, the Company receives satellite signal transport services for
much of its domestic cable television programming from DIRECTV, Inc. The Company
believes that its relationship with DIRECTV, Inc. is good. However, an
interruption in DIRECTV's satellite service could interfere with the Company's
ability to serve many of its hotel customers' free-to-guest cable programming
requirements.
INTEGRATING OPERATIONS
On Command Corporation has substantially completed the full integration of
its operations in support of the OCV and SpectraVision systems. Some remaining
system development and field support projects will continue into 1999. In
addition, OCC has continued to pursue the renewal or extension of certain hotel
customers with SpectraVision equipment by offering these customers the
opportunity to obtain OCV on-demand pay-per-view service and related services.
COMPETITION
In the U.S., taking into account the various providers of cable television
services, there are numerous providers of in-room video entertainment to the
lodging industry, at least three of which provide on-demand pay-per-view,
free-to-guest programming, and guest services by means of the in-room
television. Internationally, there are more companies competing in the
pay-per-view lodging industry than in the United States.
Pay-per-view, the most profitable component of the services offered,
competes for a guest's time and entertainment resources with broadcast
television, free-to-guest programming, and cable television services. In
addition, there are a number of competitors that are developing ways to use
their existing infrastructure to
7
10
provide in-room entertainment and/or information services to the lodging
industry, including cable companies (including wireless cable),
telecommunications companies, Internet and high-speed connectivity companies,
and direct-to-home and direct broadcast satellite companies. Some of these
competitors have been providing free-to-guest services to hotels and are
beginning to provide video-on-demand, Internet and high speed connectivity to
hotels.
OCC is the leading provider (by number of hotel rooms served) of in-room
video entertainment services to the United States lodging industry. OCC is also
the leading provider (by number of hotel rooms served) of in-room on-demand
video entertainment services to the lodging industry on a worldwide basis.
Domestically, OCC competes on a national scale primarily with LodgeNet
Entertainment Corporation ("LodgeNet") and on a domestic and international
regional basis with certain other smaller entities. Based on publicly available
information, OCC estimates that, at December 31, 1998, LodgeNet served
approximately 597,000 pay-per-view rooms, as of which approximately 582,000 are
equipped with on-demand service. At December 31, 1998, OCC served approximately
929,000 rooms, of which approximately 829,000 are on-demand rooms.
Competition with respect to in-room video entertainment and information
contracts centers on a variety of factors, depending upon the circumstances
important to a particular hotel. Among the more important factors are (i) the
features and benefits of the entertainment and information systems, (ii) the
quality of the vendor's technical support and maintenance services, and (iii)
the financial terms and conditions of the proposed contract. With respect to
hotel properties already receiving in-room entertainment services, the current
provider may have certain informational and installation cost advantages
compared to outside competitors.
Furthermore, while the Company is addressing the likelihood of increased
demand for Internet services in the hotel guestroom, OCC may face additional
competition in this area from traditional as well as new competitors. Some of
these competitors may be better funded from both public capital and/or private
venture capital markets and have access to additional capital resources which
OCC does not have.
OCC believes its competitive advantages include (i) technological
leadership represented by its superior on-demand capability and range of
services offered, and (ii) system reliability and high quality service. OCC
believes that its growth (including OCV's growth prior to the Acquisition)
reflects the strong competitive position of its products and services. The OCC
system offers an expansive library of on-demand movies and will allow OCC to
upgrade and add new features to the OCC system during the terms of OCC's
contracts and to obtain renewals or extensions of its contracts.
OCC also competes with local cable television operators by customizing
packages of programming to provide only those channels desired by the hotel
subscriber, which typically reduces the overall cost of the service provided.
On Command Corporation anticipates substantial competition in obtaining new
contracts with major hotel chains. The Company believes that hotels view the
provision of in-room on-demand entertainment and information both as a revenue
source and as a source of competitive advantage in that sophisticated hotel
guests are increasingly demanding a greater range of quality entertainment and
information alternatives. At the same time, OCC believes that certain major
hotel chains have awarded contracts based primarily on the level and nature of
financial and other incentives offered by the service provider. While the
Company believes its competitive advantages will enable OCC to continue to offer
financial arrangements that are attractive to hotels, its competitors may
attempt to maintain or gain market share at the expense of profitability. OCC
may not always be willing to match incentives provided by its competitors.
The communications industry is subject to rapid technological change. New
technological developments could adversely effect OCC's operations unless the
Company is able to provide equivalent services at competitive prices.
REGULATION
The Federal Communications Commission (the "FCC") has broad jurisdiction
over electronic communications. The FCC does not directly regulate the Company's
pay-per-view or free-to-guest services.
8
11
The FCC's jurisdiction also encompasses certain aspects of OCC's operations
as they related to its use of the radio frequency spectrum in certain hotels
acquired in connection with SpectraVision. SpectraVision had obtained optional
licenses from the FCC for a number of its downlink, television receive-only
satellite receivers, which are used to receive transmissions from communications
satellites in connection with its free-to-guest services. SpectraVision had also
obtained the required licenses for the microwave point-to-point relay
facilities.
On February 1, 1996, Congress passed The Telecommunications Act of 1996
(the "Telecommunications Act"), which was signed into law on February 8, 1996.
The Telecommunications Act has and will continue to alter federal, state, and
local laws and regulations for telecommunications providers and services, and
may affect On Command Corporation. There are numerous rulemakings to be
undertaken by the FCC that will interpret and implement the Telecommunications
Act. It is not possible at this time to predict the outcome of such rulemakings.
PATENTS, TRADEMARKS AND COPYRIGHTS
The Company owns a number of patents and patent licenses covering various
aspects of its pay-per-view and interactive systems. Although OCC maintains
these patents, On Command Corporation believes that the design, innovation, and
quality of its products and their relations with its customers are at least as
important, if not more so, to the maintenance and growth of the Company. The
Company also owns various trade names, trademarks, service marks, and logos used
in its businesses, which OCC intends to actively protect. In connection with the
LodgeNet litigation, the Company has licensed each other's patented technology
for five years.
INTERNATIONAL MARKETS
In addition to its operations in the fifty United States, OCC offers its
services in Canada, Mexico, Puerto Rico, the U.S. Virgin Islands, Hong Kong,
Singapore, Thailand, Australia, the Bahamas, Europe, and elsewhere in the
Asia-Pacific region.
The Company historically experienced higher international revenues and
operating cash flow per room than in the United States because of higher prices,
higher buy rates, and the general lack of programming alternatives. However, the
Company generally also incurs greater capital expenditure and operating costs
outside the United States. Additionally, the effect of the Asian economic crisis
contributed to a decline in revenues from that region. At December 31, 1998, the
Company serviced 421 hotels with a total of approximately 124,000 rooms located
outside the United States.
The competition to provide pay-per-view services to hotels is even more
dispersed in international markets, than in the United States. Expansion of
OCC's operations into foreign markets involves certain risks that are not
associated with further expansion in the United States including availability of
programming, government regulation, currency fluctuations, language barriers,
differences in signal transmission formats, local economic and political
conditions, and restriction on foreign ownership and investment. Consequently,
these risks may hinder OCC's efforts to grow its base of hotel rooms in foreign
markets.
OTHER GUEST SERVICES
In addition to entertainment services, OCC provides other guest services to
the lodging industry. Some of these services generate revenues and cash flows
that are independent of viewing levels. These services use two-way interactive
communications capability of the Company's equipment and room availability
monitoring. The hotel typically pays a fixed monthly fee for each service
selected. Among the guest services provided are video check-out, room service
ordering and guest satisfaction survey. Guest services are also currently
available in Spanish, French, and certain other foreign languages. In most
cases, the guest services are made a part of the contract for pay-per-view
services which typically runs for a term of five to seven years.
Furthermore, OCC sells systems to certain other providers of in-room
entertainment including Hospitality Network, Inc., which is licensed to use
OCV's system to provide on-demand, in-room entertainment and
9
12
information services to certain gaming-based, hotel properties and through
September 1998 MagiNet Corporation (formerly Pacific Pay Video Limited)
("MagiNet"), which was previously licensed to use OCV's system to provide
on-demand in-room entertainment in the Asia Pacific region. In September 1998,
OCV filed suit against MagiNet for violations of the license agreement between
MagiNet and OCV, and concurrently terminated MagiNet's license to use the OCV
system. MagiNet is contesting the termination and the lawsuit.
In addition, the Company is developing and testing technology that will
bring Internet and other services to hotel guests in their rooms.
MARKETS AND CUSTOMERS
On Command currently provides entertainment and information services to
hotels which are associated with major hotels chains, management companies and
independent hotels including Adam's Mark, Fairmont, Four Seasons, Hilton
(including Hilton Garden Inn), Holiday Inn, Hyatt, Loews, Marriott (including
Courtyard By Marriott, Fairfield Inn, Renaissance, Residence Inn, &
Ritz-Carlton), Omni, Patriot American Hospitality (Wyndham), Promus Hotels
(Doubletree Hotels, Embassy Suites, & Hampton Inn), Radisson, Sheraton and
Starwood Hotels & Resorts (W & Westin). OCC serves major chains and selected
other hotels throughout the United States, Canada, Mexico, the United Kingdom,
Spain, France, Australia, and the Asia-Pacific region.
The following table sets forth certain information regarding the number of
hotels and rooms served by OCC as of December 31, 1998 and 1997, respectively:
AS OF DECEMBER 31
----------------------------
1998 1997
------------ ------------
Hotels Served:
U.S. ....................................... 2,799 2,642
Non-U.S. ................................... 421 418
Rooms Served:
U.S. ....................................... 804,025 773,005
Non-U.S. ................................... 124,485 120,409
Total Room Revenue per Equipped Room (RER).... $20.76/month $19.38/month
EMPLOYEES
As of December 31, 1998, OCC employed a total of 835 persons, including 80
in engineering, 354 in domestic installation and service, 166 in domestic
manufacturing and operations, 23 in sales, 111 in management, administration and
finance, and 101 in international service and operations. During fiscal year
1998, the vast majority of research and development efforts have been performed
by the Company's employees rather than outside consultants. None of the
Company's employees is represented by a labor union. The Company has experienced
no work stoppages and believes employee relations are good.
ITEM 2. PROPERTIES
On Command Corporation currently leases its headquarters located in San
Jose, California. The headquarters contain approximately 131,000 square feet of
office, light manufacturing, and storage space. In connection with the
acquisition of SpectraVision, On Command Corporation acquired the SpectraVision
headquarters building in Richardson, Texas which contained approximately 84,000
square feet of office, light manufacturing, and storage space. OCC sold the
Richardson facility in the fourth quarter of 1997 and leased back the facility
through March 31, 1998. The Company has transferred all necessary operations to
the San Jose headquarters. In connection with the Acquisition, OCC also acquired
other leased space that housed SpectraVision's customer support operations
throughout the United States, Canada, Mexico, Puerto Rico, Hong Kong, and
Australia. The Company's properties are suitable and adequate for the Company's
business operations.
10
13
ITEM 3. LEGAL PROCEEDINGS
On September 11, 1998, OCC reached an agreement with LodgeNet Entertainment
Corporation ("LodgeNet") to settle all pending litigation between the companies.
As a result, the companies have dismissed all pending litigation between the
parties in United States Federal District Courts in California and South Dakota,
with no admission of liability by either party. The terms of the confidential
settlement include a cross-license of each company's patented technologies at
issue to the other party and a covenant not to engage in patent litigation
against the other party for a period of five years. Each company is responsible
for its own legal costs and expenses, and in connection with the multiple
cross-licenses, OCC expects to receive royalty payments, net of legal fees and
expenses, in an aggregate amount of approximately $10.8 million. OCC received
the first payment of approximately $2.9 million (net of expenses) in September
1998 and expects to receive an additional two payments of approximately $3.9
million (net of expenses) in each of July 1999 and July 2000. OCC will recognize
the additional royalty revenue as the cash payments are received.
In September 1998, OCV filed suit against MagiNet, alleging a breach by
MagiNet of a license agreement between OCV and MagiNet, and terminating the
license agreement. OCV has also demanded the payment of license fees from
MagiNet which OCC believes were due and payable under the License Agreement and
have not been paid by MagiNet. MagiNet has counter-claimed against OCV, alleging
that OCV breached the license agreement, and alleging various torts by OCV in
its relationship with MagiNet.
On Command Corporation, or its operating entities, is a defendant and may
be a potential defendant, in lawsuits and claims arising in the ordinary course
of business. While the outcomes of such claims, lawsuits, or other proceedings
cannot be predicted with certainty, management expects that such liability, to
the extent not provided for by insurance or otherwise, will not have a material
adverse effect on the financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1998.
EXECUTIVE OFFICERS OF THE REGISTRANT
In accordance with General Instruction G to the Annual Report on Form 10-K,
included herein is the following table, which sets forth the names, ages, at
March 1, 1999, and titles of executive officers of the Company, and biographical
information with respect to such officers.
NAME AGE POSITION
---- --- --------
President, Chief Operating Officer, and
Brian A.C. Steel............ 39 Director
Ronald D. Lessack........... 52 Senior Vice President, Operations
Richard C. Fenwick, Jr. .... 41 Senior Vice President, Engineering
Paul J. Milley.............. 45 Senior Vice President, Finance
Arthur M Aaron.............. 41 Acting General Counsel and Secretary
Jean A. deVera.............. 49 Senior Vice President, National Accounts
Brian A.C. Steel has been President and Chief Operating Officer of On
Command Corporation since December 1998. Prior to that appointment, Mr. Steel
was the Executive Vice President, Chief Financial Officer, and Chief Operating
Officer of On Command Corporation since September 1996 and a Director of On
Command Corporation since October 1996. Prior thereto, Mr. Steel was Executive
Vice President, Strategic Development, and Chief Financial Officer for TELE-TV,
a video services partnership among several regional telephone companies, since
August 1995. Prior to joining TELE-TV, Mr. Steel was Vice President, Strategic
Development of Pacific Telesis Enhanced Services, General Manager of Pacific
Telesis Electronic Publishing Services, and Executive Director, Corporate
Development of Pacific Telesis Group from January 1994 to July 1995. Prior to
joining Pacific Telesis, Mr. Steel was a principal in Conversion Management
Associates from January 1993 to December 1993.
11
14
Ronald D. Lessack has been Senior Vice President, Operations since December
1996 and was named Vice President, Operations of On Command Corporation in
September 1996. Prior to joining On Command Corporation, Mr. Lessack was Vice
President, Operations of OCV since January 1994. Prior to that he was self
employed as a consultant from July 1992 to February 1994, and prior to that he
was a Vice President of Watkins Johnson Co. Group.
Richard C. Fenwick, Jr. has been Senior Vice President of Engineering since
December 1996 and was named Vice President, Engineering of On Command
Corporation in September 1996. Mr. Fenwick had been Vice President, Engineering
of OCV since September 1992.
Paul J. Milley has been Senior Vice President, Finance since December 1996.
Prior thereto, Mr. Milley was Vice President and Chief Financial Officer of The
3DO Company where he worked since October 1993. Prior to joining the 3DO
company, Mr. Milley was Senior Vice President and Chief Financial Officer of
Computerland Corporation where he worked from July 1989 to September 1993.
Arthur M. Aaron has been Acting General Counsel and Secretary since April
1998. Mr. Aaron has been Vice President, Business and Legal Affairs of Ascent
Entertainment Group, Inc. since April 1995. Prior thereto, he was a General
Attorney in the office of the General Counsel of COMSAT Corporation since July
1993.
Jean A. deVera has been Senior Vice President, National Accounts of On
Command Corporation since October 1997, having been promoted from Vice
President, National Accounts, a title Ms. deVera held since September 1996.
Prior to joining On Command Corporation, Ms. deVera was Vice President, National
Accounts of OCV since January 1994. From 1977 through December 1993, Ms. deVera
held various positions at COMSAT Video Enterprises, the last of which was
Director of Sales Administration.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
On Command Corporation's Common Stock and Series A and B Warrants are
traded on the NASDAQ National Market under the symbols ONCO, ONCOW, and ONCOZ
respectively. Series C Warrants were given to an advisor to the Acquisition
transaction but were not registered for public trading. The high and low closing
prices for On Command Corporation's securities during the periods January 1,
1998 through December 31, 1998 and January 1, 1997 through December 31, 1997 are
as follows:
PRICE RANGE
--------------------
COMMON STOCK HIGH LOW
------------ -------- --------
1998:
First Quarter................................ $13.3750 $12.0000
Second Quarter............................... $14.8750 $13.0000
Third Quarter................................ $14.0000 $ 8.0000
Fourth Quarter............................... $ 9.2500 $ 6.8750
1997:
First Quarter................................ $16.0000 $10.7500
Second Quarter............................... $12.6250 $ 8.1250
Third Quarter................................ $15.2500 $10.7500
Fourth Quarter............................... $13.7500 $11.8750
12
15
PRICE RANGE
--------------------
SERIES A WARRANTS HIGH LOW
- - ----------------- -------- --------
1998:
First Quarter................................ $ 7.1250 $ 6.7500
Second Quarter............................... $ 6.0000 $ 5.5000
Third Quarter................................ $ 5.8750 $ 5.2500
Fourth Quarter............................... $ 5.7500 $ 3.5000
1997:
First Quarter................................ $ 9.5000 $ 6.2500
Second Quarter............................... $ 7.0625 $ 5.0000
Third Quarter................................ $ 6.5000 $ 5.0000
Fourth Quarter............................... $ 8.0000 $ 6.5000
PRICE RANGE
--------------------
SERIES B WARRANTS HIGH LOW
- - ----------------- -------- --------
1998:
First Quarter................................ $ 5.4375 $ 5.1250
Second Quarter............................... $ 5.1875 $ 5.0000
Third Quarter................................ $ 4.1250 $ 2.9375
Fourth Quarter............................... $ 3.0000 $ 2.0000
1997:
First Quarter................................ $ 8.7500 $ 4.2500
Second Quarter............................... $ 5.8750 $ 3.5000
Third Quarter................................ $ 6.2500 $ 4.0000
Fourth Quarter............................... $ 7.0000 $ 5.3750
As of March 3, 1999 there were 30,169,752 shares of Common Stock, 1,424,875
Series A Warrants, 2,625,000 Series B Warrants, and 3,450,000 Series C Warrants
issued and outstanding. As of March 3, 1999 there were 357 Common Stockholders,
21 Series A Warrant holders, 285 Series B Warrant holders, and 8 Series C
Warrant holders of record. The Company's Transfer Agent and Registrar is the
Bank of New York located at 101 Barclay Street, New York, New York.
Concurrent with the Acquisition transaction, the Company paid a dividend in
the amount of $10.7 million to stockholders of record as of September 18, 1996.
This dividend was distributed through the assignment to Ascent of a $8.9 million
promissory note received from Hilton Hotels Corporation and cash of $1.8 million
paid to the minority stockholders. The Company had not paid cash dividends prior
to the transaction, and any payment of such dividends in the future will depend
upon the earnings and financial position of the Company, its capital needs, and
such other factors as the Board of Directors deem appropriate.
13
16
ITEM 6. SELECTED FINANCIAL DATA
The financial data set forth below, except hotel and room data, was derived
from the audited consolidated financial statements of the Company and should be
read in connection with the Consolidated Financial Statements and related Notes
included elsewhere herein. References herein are to the financial statements and
footnotes included in Part II, Item 8 "Financial Statements and Supplementary
Data".
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1998 1997 1996(1) 1995 1994
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
INCOME STATEMENT DATA:
Total revenues.................... $238,820 $222,103 $147,469 $102,059 $ 81,609
Total direct costs of revenues.... 103,902 103,343 71,019 48,417 47,786
Total operating expenses.......... 151,068 142,166 87,770 45,091 27,976
Income (loss) from operations..... (16,150) (23,406) (11,320) 8,551 5,847
Net income (loss)(2).............. (25,966) (33,314) (14,739) 4,902 3,456
Net income (loss) applicable to
nonredeemable common stock..... (25,966) (33,314) (15,222) 4,261 2,856
Basic net income (loss) per
share.......................... (0.86) (1.11) (0.67) 0.24 0.20
Diluted net income (loss) per
share.......................... (0.86) (1.11) (0.67) 0.22 0.18
Shares used in basic per share
calculations (in thousands).... 30,150 30,081 22,625 17,554 14,022
Shares used in diluted per share
calculations (in thousands).... 30,150 30,081 22,625 19,406 15,822
CASH FLOW DATA:
Net cash provided by operating
activities..................... 53,913 53,481 42,784 41,374 20,051
Net cash used in investing
activities..................... (83,208) (88,044) (80,505) (63,693) (64,110)
Net cash provided by financing
activities..................... 30,379 35,268 42,521 14,952 47,285
OTHER DATA:
EBITDA(3)......................... $ 72,049 $ 55,578 $ 41,960 $ 37,288 $ 23,381
Cash dividends per share.......... -- -- $ 0.49 -- --
Rooms served at end of
period(4)...................... 929,000 893,000 917,000 361,000 248,000
On Demand rooms at period
end.......................... 829,000 765,000 709,000 361,000 248,000
Scheduled rooms at period
end.......................... 100,000 128,000 208,000 -- --
Hotels served at end of period.... 3,220 3,060 3,144 1,221 751
Capital expenditures(5)........... 83,208 92,307 70,545 63,693 64,110
BALANCE SHEET DATA (AT END OF
PERIOD):
Total assets...................... $402,968 $401,388 $396,538 $211,005 $138,884
Total debt........................ 163,000 133,000 98,000 15,942 1,025
Redeemable common stock........... -- -- -- 11,684 11,043
Total stockholders' equity........ 190,005 217,167 250,917 169,804 108,949
- - ---------------
(1) 1996 data reflects the acquisition of SpectraVision which was recorded using
the purchase method of accounting as defined by generally accepted
accounting principles. As such, all revenues, expenses and capital
expenditures of SpectraVision for the period October 8 through December 31,
1996, are included herein. Also included are the room and hotel counts and
the assets and liabilities of SpectraVision at December 31, 1996.
(2) 1996 data also includes $8.7 million of charges which management believes
are one-time in nature which consist of asset write-downs, reserves, and
expense accruals related to the Acquisition and integration of
SpectraVision; re-alignment of the Company's operating practices; and the
establishment of On Command Corporation as a new public company. Of the
non-recurring charges, $6.7 million affected EBITDA (see note 3). Excluding
non-recurring charges, the net loss applicable to nonredeemable common stock
for 1996 would have been $6.5 million, net loss per common and equivalent
share would have been $0.29, and EBITDA would have been $48.7 million.
(3) EBITDA represents earnings before interest, income taxes, depreciation,
amortization and other non-operating items such as gain/loss on disposal of
assets and exchange rate gain/loss. The most significant difference between
EBITDA and cash provided from operations is changes in working capital.
EBITDA
14
17
is presented because it is a widely accepted financial indicator used by
certain investors and analysts to analyze and compare companies on the basis
of operating performance. In addition, management believes EBITDA provides
an important additional perspective on the Company's operating results and
the Company's ability to service its long-term debt and fund the Company's
continuing growth. EBITDA is not intended to represent cash flows for the
period, or to depict funds available for dividends, reinvestment or other
discretionary uses. EBITDA has not been presented as an alternative to
operating income or as an indicator of operating performance and should not
be considered in isolation or as a substitute for measures of performance
prepared in accordance with generally accepted accounting principles, which
are presented in the financial statements in Item 8 and discussed in Item 7
under Liquidity and Capital Resources. See the Consolidated Financial
Statements and the Notes thereto appearing elsewhere in this document
(4) The decrease in rooms in 1997 is primarily due to the sale and termination
of certain U.S. hotel contracts, which hotels received satellite only
broadcasts of pay-per-view movies.
(5) Capital expenditures primarily include the installation of systems in new
hotels, the conversion of SpectraVision systems and upgrades made to
existing equipment in hotels.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis addresses results of operations for
the calendar years ended December 31, 1998, 1997 and 1996.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Total revenues increased $16.7 million or 7.5% to $238.8 million in 1998,
as compared to total net revenues of $222.1 million in 1997. Room revenues
increased $16.7 million or 7.9% to $227.2 million in 1998 from $210.5 million in
1997. The increase was primarily due to stronger buy rates for movies during
1998, higher total rooms during the year, and a higher percentage of total rooms
being served by higher revenue producing on-demand equipment in 1998 as compared
to 1997. Revenues during 1997 were also affected by a satellite outage in
January affecting certain SpectraVision properties and the termination and sale
of approximately 40,000 rooms during the second half of the year that were
receiving satellite only pay-per-view (PPV) movies. Video system sales and other
revenues remained relatively flat during 1998 as compared to 1997. This was due
to a lower number of video system sales to the Company's primary licensees
offset by the receipt of a $2.9 million royalty payment (net of legal fees) from
LodgeNet made during the third quarter of 1998 (see Note 14 of Notes to
Consolidated Financial Statements).
Total direct cost of revenues increased by $0.6 million or 0.5% to $103.9
million in 1998 as compared to $103.3 million in 1997. Direct costs associated
with room revenue increased $2.4 million or 2.5% to $99.0 million in 1998 from
$96.6 million in 1997, however, as a percentage of room revenue 1998 decreased
to 43.6% as compared to 45.9% in 1997. The dollar amount increase was due to
higher room revenues in 1998 as compared to 1997, while the decrease in the
percentage was due to lower feature movies royalties as a percentage of total
room revenues, and lower satellite/lease cost during 1998. Direct costs from
video system sales and other revenues decreased $1.8 million or 27.1% to $4.9
million, as compared to $6.7 million in 1997, as a result of a decline in sales
of video systems. Direct costs as a percentage of video system sales and other
revenues decreased to 42.1% in 1998 from 57.9% in 1997. The improved gross
margin was largely due to the receipt of the LodgeNet royalty payment during
1998.
Operation costs, which consist primarily of labor and material expense
required to maintain the existing equipment in hotels, decreased $2.7 million or
7.9% to $31.3 million in 1998, as compared to $34.0 million in 1997, and as a
percentage of total revenue decreased to 13.1% in 1998 from 15.3% in 1997. The
decrease was primarily due to non-recurring satellite re-deployment expenses
incurred in the first quarter of 1997 and a higher percentage of rooms using OCV
technology which is less expensive to support than SpectraVision technology.
15
18
Research and development expenses in 1998 increased $0.6 million or 9.0% to
$7.5 million as compared to $6.9 million in 1997. The higher expenses are due to
increasing efforts in the development of the Company's new products, services
and programming support.
Selling, general, and administrative expenses increased $1.8 million or
7.9% to $24.0 million in 1998, as compared to $22.3 million in 1997. The
increase is principally due to higher expenses in product management and
marketing in order to support new products and initiatives.
Depreciation and amortization expense increased $9.2 million or 11.7% to
$88.2 million in 1998 from $79.0 million in 1997, and as a percentage of total
revenue increased to 36.9% in 1998 from 35.6% in 1997. These expenses are
primarily attributable to depreciable assets associated with video systems that
generate movie revenue. The dollar increase reflects capital investments
associated with growing the Company's room base and converting SpectraVision
rooms to OCC equipment.
Interest/Other expense net increased to $10.4 million in 1998, as compared
to $9.3 million in 1997. This increase was due to the Company's greater reliance
on debt financing to continue its expansion of its installed customer base,
somewhat offset by a lower effective interest rate in 1998.
Provision for income taxes for 1998 represents tax benefits on losses in
certain foreign jurisdictions.
EBITDA increased to $72.0 million in 1998 from $55.6 million in 1997 or an
increase of 29.6%. As a percentage of revenue, EBITDA increased to 30.2% in 1998
from 25.0% in 1997. The improved EBITDA amount is primarily attributable to the
increase in revenue for 1998 as compared to 1997. With the LodgeNet royalty
payment excluded, EBITDA as a percentage of total revenue increased to 28.9% in
1998 from 25.0% in 1997.
Net loss decreased to $26.0 million in 1998 from $33.3 million in 1997 due
to the factors described above.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Total revenues increased $74.6 million or 50.6% to $222.1 million in 1997,
as compared to total net revenues of $147.5 million in 1996. Room revenues
increased $76.7 million or 57.3% to $210.5 million in 1997 from $133.8 million
in 1996. Such increase was primarily attributable to revenue generated from
rooms acquired in the SpectraVision acquisition. Revenues during 1997 were also
affected by a satellite outage in January affecting certain SpectraVision
properties and the termination and sale of approximately 40,000 rooms during the
second half of the year that were receiving satellite only pay-per-view movies.
The Company discontinued satellite distribution of movies due to poor economics
with the delivery method. Management believes these two events reduced revenue
in 1997 by approximately $3 million to $4 million. Video system sales and other
revenues decreased by $2.0 million or 15.0% to $11.6 million as compared to
$13.7 million in 1996, reflecting a slowdown in ordering of video systems from
two of the Company's primary licensees.
Total direct cost of revenues increased by $32.3 million or 45.5% to $103.3
million in 1997 as compared to $71.0 million in 1996. Direct costs associated
with room revenue increased $37.0 million or 62% to $96.6 million in 1997 as
compared to the prior year, and as a percentage of room revenue increased to
45.9% in 1997 from 44.6% in 1996. The percentage increase reflects lower
reimbursements of free-to-guest programming provided to hotels, higher royalties
on feature movies and higher hotel commission expenses on SpectraVision room
revenues. Direct costs from video system sales and other revenues decreased $4.7
million or 41.0% to $6.7 million, as compared to $11.4 million in 1996, as a
result of a decline in sales of video systems. Direct costs as a percentage of
video system sales and other revenues decreased to 57.9% in 1997 from 83.4% in
1996. The improved gross margin was largely due to higher margin on used systems
sold to Skylink and other revenues from equipment rental and video interactive
services, which have minimal direct costs.
Operation costs, which consist primarily of labor and material expense
required to maintain the existing equipment in hotels, increased $18.1 million
or 114.2% to $34.0 million in 1997, as compared to $15.9 million
16
19
in 1996, and as a percentage of total revenue increased to 15.3% in 1997 from
10.8% in 1996. The increase was primarily due to the higher field service costs
necessary to support the acquired SpectraVision equipment.
Research and development expenses in 1997 increased $2.3 million or 49.4%
to $6.9 million as compared to $4.6 million in 1996. The reason for the increase
was due to the sustaining engineering support requirement of the SpectraVision
platforms and the development of the Company's new products and services. The
increase was primarily attributable to an increase in personnel and consulting
service costs of $1.6 million.
Selling, general, and administrative expenses increased $8.3 million or
59.2% to $22.3 million in 1997, as compared to $14.0 million in 1996, primarily
due to costs to support the Company's much larger room base, including the
SpectraVision hotels, costs associated with the integration of SpectraVision's
and OCV's accounting and operational systems and higher administrative costs
associated with being a public company with an expanded international presence.
Depreciation and amortization expense increased $25.7 million or 48.2% to
$79.0 million in 1997 from $53.3 million in 1996, and as a percentage of total
revenue decreased to 35.6% in 1997 from 36.1% in 1996. These expenses are
primarily attributable to depreciable assets associated with video systems that
generate movie revenue. The dollar increase reflects capital investments
associated with growing the OCV room base and with incremental depreciation and
amortization resulting from the acquisition of SpectraVision's in room assets
and intangible assets. The percentage decrease is primarily attributable to the
lower cost basis of the acquired SpectraVision assets.
Interest/Other expense net increased to $9.3 million in 1997, as compared
to $3.3 million in 1996. This increase was due to the Company's greater reliance
on debt financing to continue its expansion of its installed customer base, debt
used to complete the acquisition of SpectraVision and the write-down of a
minority investment in MagiNet Corporation to its estimated fair value.
Provision for income taxes increased to $0.8 million in 1997 from $0.2
million in 1996, an increase of $0.6 million. The income tax expense in 1997
represents tax on income in foreign jurisdictions. The Company's international
presence grew from approximately 13,000 rooms at January 1, 1996 to
approximately 120,000 rooms at December 31, 1997 primarily due to the
SpectraVision acquisition.
Redeemable common stock accretion was eliminated in 1997 as this security
was converted to Common Stock in 1996. The accretion in 1996 was $0.5 million.
EBITDA increased to $55.6 million in 1997 from $42.0 million in 1996 or an
increase of 32.5%. As a percentage of revenue, EBITDA decreased from 28.5% in
1996 to 25.0% in 1997. The major factor in this reduction was the increase in
operation cost percentage, explained above.
Net loss increased to $33.3 million in 1997 from $14.7 million in 1996 due
to the factors described above.
LIQUIDITY AND CAPITAL RESOURCES
The primary sources of cash during 1998 were net cash from operations of
$53.9 million, and net borrowings of $30.0 million from the Company's revolving
credit facility. Cash was invested primarily for capital expenditures which
totaled $83.2 million, primarily for the installation of on-demand systems in
new hotel installations and conversions of SpectraVision equipped hotels.
The Company's principal cash requirements in 1999 are expected to include
the continued conversion of SpectraVision properties to OCV's more dependable
on-demand technology, the installation of systems in new hotels, both
domestically and abroad, and the selected deployment of the Company's new
digital technology. The Company anticipates these activities will require
capital expenditures of approximately $65.0 to $90.0 million in 1999. The
Company believes that its internally generated cash and its remaining capacity
under its credit facility will provide sufficient funding for the foreseeable
future.
17
20
REVOLVING CREDIT FACILITY
On November 24, 1997, the Company refinanced its former credit facility and
entered into an amended and restated agreement (the "Credit Facility"). Under
the amended Credit Facility, the amount available to the Company was increased
from $150.0 million to $200.0 million, and certain other terms were amended. The
Credit Facility matures in November 2002 and, subject to certain conditions, can
be renewed for two additional years. At December 31, 1998, there was $37.0
million of available borrowings under the Credit Facility, subject to certain
covenant restrictions.
LIMITATIONS ON ADDITIONAL DEBT FINANCING
On Command Corporation and Ascent entered into a Corporate Agreement, as
amended (the "Corporate Agreement"), pursuant to which OCC has agreed with
Ascent not to incur any indebtedness without Ascent's prior consent, other than
indebtedness under the Credit Facility, and indebtedness incurred in the
ordinary course of operations which together shall not exceed $182 million in
the aggregate through December 31, 1999.
FOREIGN EXCHANGE
The Company believes the risks of foreign exchange rate fluctuations on its
present operations are not material to the Company's overall financial
condition. However, should the Company's international operations continue to
grow, OCC will consider using foreign currency contracts, swap arrangements, or
other financial instruments designed to limit exposure to foreign exchange rate
fluctuations.
BUSINESS RISKS
CONTROL BY ASCENT
Ascent owned approximately 56.9% of the outstanding OCC Common Stock at
December 31, 1998. Accordingly, Ascent has the ability to control the management
and policies of On Command Corporation and the outcome of matters submitted to
the stockholders for approval, including the election of directors. In addition,
the Company and Ascent have entered into a Corporate Agreement which requires
the Company to get Ascent's approval with respect to incurring indebtedness and
issuing equity.
DEPENDENCE ON ADDITIONAL CAPITAL FOR GROWTH
The growth of On Command Corporation's business requires substantial
investment on a continuing basis to finance capital expenditures and related
expenses. Prior to the Acquisition, OCC has relied on capital provided by Ascent
and cash flow from operations to finance its growth. However, Ascent is not
obligated to provide any additional capital or debt financing to On Command
Corporation. On Command Corporation intends to use cash flow from operations and
additional borrowings (subject to the limitations discussed under "Limitations
on Additional Debt Financings") to support its growth. Whether or when On
Command Corporation can achieve cash flow levels sufficient to support its
anticipated growth cannot be accurately predicted. Unless such cash flow levels
are achieved, On Command Corporation may require additional borrowings or the
sale of debt or equity securities (subject to the limitations described under
"Limitations on Additional Debt Financings"), or some combination thereof, to
provide funding for growth or, alternatively, may have to reduce growth to a
level that can be supported by internally generated cash flow. On Command
Corporation can give no assurances with respect to the impact on the results of
operations and financial condition if On Command Corporation is required to
reduce growth to a level that can be supported by internally generated cash
flow.
THINLY TRADED STOCK IN THE PUBLIC MARKET AND POSSIBLE VOLATILITY OF STOCK PRICE
As approximately 43.1% of the outstanding On Command Common Stock, is
traded on the Nasdaq National Market as of March 3, 1999 the public market for
the OCC Common Stock and the On Command Corporation Warrants may not be subject
to an active public market which can be sustained. Further, the
18
21
stock markets may experience volatility that affects the market prices of
companies in ways unrelated to the operating performance of such companies.
These market fluctuations may adversely affect the market price of the OCC
Common Stock or Warrants.
HIGHLY COMPETITIVE IN-ROOM ENTERTAINMENT INDUSTRY
The hotel in-room entertainment industry is highly competitive. Due to the
high level of penetration in the United States lodging industry already achieved
by participants in the in-room entertainment industry and the current rate of
construction and expansion of hotel properties in the United States, most of the
growth opportunities in the in-room entertainment industry currently involve
securing contracts to serve hotels that are already being served by a competing
vendor, expanding internationally and broadening the range of services provided.
These circumstances have led to increasing competition for contract renewals,
particularly at hotels operated by major hotel chains. There can be no assurance
that On Command Corporation will obtain new contracts with hotels currently
served by other vendors or that On Command Corporation will be able to retain
contracts with the hotels served by OCV and SpectraVision when those contracts
expire. The loss by On Command Corporation of one or more of the major hotel
chain customers, such as Marriott, Hyatt, Holiday Inn or Hilton, could have a
material adverse impact on On Command Corporation's results of operations. See
"Dependence on Significant Customers." In addition, there are a number of
potential competitors that could utilize their existing infrastructure to
provide in-room entertainment to the lodging industry, including cable companies
(including wireless cable), telecommunications companies, and direct-to-home and
direct broadcast satellite companies. Some of these potential competitors
already are providing free-to-guest services to hotels and testing
video-on-demand. Some of these potential competitors have substantially greater
resources than On Command Corporation.
DEPENDENCE ON SIGNIFICANT CUSTOMERS
Marriott, Holiday Inn and Hilton accounted for approximately 24%, 11% and
10%, respectively, of On Command Corporation's revenues for the year ended
December 31, 1998. The loss of any of these customers, or the loss of a
significant number of other hotel chain customers, could have a material adverse
effect on On Command Corporation's results of operations or financial condition.
However, these customers represent both chain-owned managed hotels, as well as
franchisees. The Company often has different contracts on different terms with
the chain-owned/managed hotels, on the one hand, and with the franchisees (or
groups of franchisees), on the other.
DEPENDENCE ON PERFORMANCE OF LODGING INDUSTRY
On Command's business is closely linked to the performance of the hotel
industry in which overall occupancy has been declining recently, though not as
significantly as many of the luxury and business hotels served by OCC. Declines
in hotel occupancy as a result of general business, economic, seasonal and other
factors can have a significant adverse impact on On Command Corporation's
results of operations.
RISK OF TECHNOLOGICAL OBSOLESCENCE
Technology in the entertainment and communications industry is continuously
changing as new technologies and developments continue to be introduced. There
can be no assurance that future technological advances will not result in
improved equipment or software systems that could adversely affect On Command
Corporation's competitive position. In order to remain competitive, On Command
Corporation must maintain the programming enhancements, engineering and
technical capability and flexibility to respond to customer demands for new or
improved versions of its systems and new technological developments, and there
can be no assurance that On Command Corporation will have the financial or
technological resources to be successful in doing so.
19
22
DEPENDENCE ON KEY PERSONNEL
On Command Corporation's success will be dependent upon the contributions
of its executive officers, especially Brian A.C. Steel, its President, and Chief
Operating Officer. The loss of the services of such executive officers could
have a material adverse effect on On Command Corporation. On Command
Corporation's success also depends on its continued ability to attract and
retain highly skilled and qualified personnel. There can be no assurance that On
Command Corporation or its subsidiaries will be successful in attracting and
retaining such personnel. Mr. Steel has entered into an employment agreement
with On Command Corporation through 1999.
SEASONALITY
The business of On Command Corporation is seasonal, with higher revenues
per room realized during the summer months and lower revenues per room realized
during the winter months due to business and vacation travel patterns.
ANTI-TAKEOVER PROTECTIONS
Ascent owns approximately 56.9% of the OCC Common Stock at December 31,
1998, before giving effect to the exercise of any Warrants. Accordingly, On
Command Corporation will not be able to engage in any strategic transactions
without the approval of Ascent. Even if Ascent's interest in On Command
Corporation were reduced below such level, On Command Corporation's Certificate
of Incorporation contains certain provisions that could make it more difficult
for a third party to acquire, or discourage a third party from attempting to
acquire, control of On Command Corporation. Such provisions could limit the
price that certain investors might be willing to pay in the future for shares of
OCC Common Stock. Certain of such provisions allow On Command Corporation to
issue preferred stock with rights senior to those of the OCC Common Stock and
impose various procedural and other requirements which could make it more
difficult for stockholders to effect certain corporate actions.
PROGRAMMING
The cost to the Company to license feature movies from major movie studios
is subject to change as the major movie studios continue to negotiate for higher
royalty rates as well as higher minimum payments by the Company. Such changes
may have adverse impacts on the Company's earnings. While the Company intends to
address such trends, there can be no assurance that the Company's efforts will
prove effective.
YEAR 2000
The year 2000 issue is the result of certain computer programs being
written using two digits rather than four digits to define the application year,
such that computer programs that are date sensitive may recognize a date using
"00" as the Year 1900 rather than the Year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions or engage in normal
business activities for both the Company and its customers who rely on its
products.
The Company is actively engaged, but has not yet completed, reviewing,
correcting and testing all of the Year 2000 compliance issues. Based on the
current review and remediation, the Company has determined that it will be
required to modify or replace some of its internally developed IT software
products. The Company utilizes embedded technology in all of its hotel system
design. The Company's engineering department has completed the majority of its
evaluation process and is currently developing solutions to the Year 2000 issues
affecting the hotel systems. In addition, the Company has also determined that
it will be required to modify and/or replace certain third-party software so
that it will function properly with respect to dates in the Year 2000 and
thereafter. The Company presently believes that with the proper modifications,
the Year 2000 issue will not pose significant operational problems for the
Company or its customers.
20
23
The Company is currently on schedule to complete all Year 2000 issues by
June 1999. However, if such modifications and replacements are not made, or not
completed timely, the Year 2000 issue could have a material impact on the
Company and its customers.
The total cost to the Company for addressing its Year 2000 issues is
estimated to be less than $1 million with less than $100,000 incurred through
December 31, 1998. The costs of Year 2000 compliance and the date on which the
Company plans to complete the Year 2000 modifications are based on management's
best estimates, which were derived utilizing numerous assumptions including
third parties' Year 2000 readiness and other factors.
The Company has and will continue to have communications with its
significant suppliers and customers to determine the extent to which the Company
may be vulnerable in the event that those parties fail to properly address their
own Year 2000 issues. The Company has taken steps to monitor the progress made
by those parties, and intends to test critical system interfaces, as the Year
2000 approaches. There is some unknown level of risk based upon the compliance
issue affecting a given hotel, and generally this should be limited to a
specific hotel. Conditions that make a hotel unable to take in guests would
affect the Company's revenue. A large number of the Company's systems are
interfaced with the hotel's property management system. If this interface fails
all movie charges will require manual processing. Processes to perform this are
in place in all hotels and are occasionally utilized at times when the property
management system interface is not functioning. This typically causes a slightly
higher number of lost charges, which could be material if applied to a large
number of customers.
While the Company has not completed a formal contingency plan for the Year
2000 problem, it has evaluated several anticipated scenarios for failures
affecting both its critical business systems and hotel systems. It is
management's opinion that any of the potential scenarios can be managed by
manual means, although less efficient, while the necessary corrective action is
taken. However, there can be no guarantee that the systems of third parties on
which the Company relies will be corrected in a timely manner, that manual
processing of the Company's movie charges would be accomplished, or that the
failure to properly convert by another company would not have a material adverse
effect on the Company.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from changes in interest rates, which
could impact its results of operations and financial condition, particularly,
the Company's interest expense and cash flow. The Company does not hedge this
exposure. Revolving loans extended under the Credit Facility generally bear an
interest rate that is variable and based on the London Interbank Offering Rate
("LIBOR") and on certain operating ratios of the Company. At December 31, 1998,
the Company had $163.0 million outstanding on the Credit Facility and the
weighted average interest rate on the Credit Facility was 5.9%. Assuming no
increase or decrease in the amount outstanding, a hypothetical immediate 100
basis point increase (or decrease) in interest rates at December 31, 1998 would
increase (or decrease), the Company's annual interest expense and cash outflow
by approximately $1.6 million.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Independent Auditors' Report
Consolidated Balance Sheets at December 31, 1998 and 1997
Consolidated Statements of Operations for the years ended December 31,
1998, 1997 and 1996
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Comprehensive Loss for the years ended December
31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the years ended December 31,
1998, 1997 and 1996
Notes to the Consolidated Financial Statements
Quarterly Results of Operations for the years ended December 31, 1998 and
1997
21
24
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
On Command Corporation:
We have audited the accompanying consolidated balance sheets of On Command
Corporation (a majority-owned subsidiary of Ascent Entertainment Group, Inc.)
and subsidiaries as of December 31, 1998 and 1997, and the related consolidated
statements of operations, stockholders' equity, comprehensive loss and cash
flows for each of the three years in the period ended December 31, 1998. Our
audits also included the financial statement schedule listed in the Index at
Item 14(a)(2). 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 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 audits 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 On Command Corporation and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
Also, in our opinion, such 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.
LOGO
San Jose, California
February 3, 1999
22
25
ON COMMAND CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
ASSETS
1998 1997
--------- ---------
(IN THOUSANDS, EXCEPT
PAR VALUE AMOUNTS)
CURRENT ASSETS:
Cash and cash equivalents................................. $ 7,235 $ 6,287
Accounts receivable (less allowance for doubtful accounts
of $1,484 in 1998 and $1,630 in 1997).................. 32,167 26,827
Other current assets...................................... 2,633 1,959
-------- --------
Total current assets.............................. 42,035 35,073
VIDEO SYSTEMS, Net.......................................... 267,880 270,531
PROPERTY AND EQUIPMENT, Net................................. 11,829 7,850
GOODWILL, Net............................................... 77,674 82,049
OTHER ASSETS, Net........................................... 3,550 5,885
-------- --------
$402,968 $401,388
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 23,305 $ 20,051
Accounts payable to stockholder........................... 138 104
Accrued compensation...................................... 5,916 5,805
Other accrued liabilities................................. 11,977 9,763
Taxes payable............................................. 7,632 11,333
-------- --------
Total current liabilities......................... 48,968 47,056
OTHER ACCRUED LIABILITIES................................... 995 4,165
LONG-TERM PORTION OF REVOLVING CREDIT FACILITY.............. 163,000 133,000
-------- --------
Total liabilities................................. 212,963 184,221
COMMITMENTS AND CONTINGENCIES (Notes 7 and 14)
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; shares
authorized -- 10,000; none outstanding -- --
Common stock, $.01 par value; shares authorized -- 50,000
in 1998 and 1997; shares issued and outstanding, 30,171
in 1998 and 29,801 in 1997;
shares subscribed -- 2 in 1998 and 315 in 1997......... 302 301
Additional paid-in capital................................ 249,809 249,431
Common stock warrants..................................... 31,450 31,450
Accumulated other comprehensive loss...................... (2,539) (964)
Accumulated deficit....................................... (89,017) (63,051)
-------- --------
Total stockholders' equity........................ 190,005 217,167
-------- --------
$402,968 $401,388
======== ========
See accompanying notes to consolidated financial statements.
23
26
ON COMMAND CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996
-------- -------- --------
(IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
REVENUES:
Room revenues............................................. $227,177 $210,493 $133,813
Video systems sales/other................................. 11,643 11,610 13,656
-------- -------- --------
Total revenues (see Note 10 for related party
revenues)....................................... 238,820 222,103 147,469
-------- -------- --------
DIRECT COSTS OF REVENUES:
Room revenues............................................. 98,999 96,617 59,628
Video systems sales/other................................. 4,903 6,726 11,391
-------- -------- --------
Total direct costs of revenues.................... 103,902 103,343 71,019
-------- -------- --------
OPERATING EXPENSES:
Operations................................................ 31,301 33,993 15,870
Research and development.................................. 7,537 6,912 4,628
Selling, general and administrative....................... 24,031 22,277 13,992
Depreciation and amortization............................. 88,199 78,984 53,280
-------- -------- --------
Total operating expenses.......................... 151,068 142,166 87,770
-------- -------- --------
LOSS FROM OPERATIONS........................................ (16,150) (23,406) (11,320)
INTEREST INCOME............................................. 503 155 104
INTEREST/OTHER EXPENSE...................................... (10,428) (9,277) (3,349)
-------- -------- --------
LOSS BEFORE INCOME TAXES.................................... (26,075) (32,528) (14,565)
PROVISION (BENEFIT) FOR INCOME TAXES........................ (109) 786 174
-------- -------- --------
NET LOSS.................................................... (25,966) (33,314) (14,739)
REDEEMABLE COMMON STOCK ACCRETION........................... -- -- (483)
-------- -------- --------
NET LOSS APPLICABLE TO
NONREDEEMABLE COMMON STOCK................................ $(25,966) $(33,314) $(15,222)
======== ======== ========
BASIC AND DILUTED NET LOSS PER SHARE........................ $ (0.86) $ (1.11) $ (0.67)
======== ======== ========
SHARES USED IN BASIC AND DILUTED PER SHARE COMPUTATIONS..... 30,150 30,081 22,625
======== ======== ========
See accompanying notes to consolidated financial statements.
24
27
ON COMMAND CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
ACCUM.
COMMON STOCK ADDITIONAL COMMON OTHER RETAINED TOTAL
--------------- PAID-IN STOCK COMP. EARNINGS STOCKHOLDERS'
SHARES AMOUNT CAPITAL WARRANTS LOSS (DEFICIT) EQUITY
------ ------ ---------- -------- ------- --------- -------------
(IN THOUSANDS)
BALANCES, January 1, 1996............ 20,669 $207 $165,521 $ 840 -- $ 3,236 $169,804
Issuance of common stock and warrants
in connection with the acquisition
of SpectraVision................... 8,250 82 57,627 24,353 82,062
Exercise of stock options and
warrants........................... 1,298 13 12,319 (840) 11,492
Income tax benefit of stock option
transactions....................... 143 143
Dividends............................ 7,097 (17,751) (10,654)
Accretion of redeemable common
stock.............................. (483) (483)
Conversion of redeemable common
stock.............................. 1,166 11 12,156 12,167
Cancellation of common stock issued
and additional contribution of
assets by Ascent (see Note 10)..... (1,336) (13) 1,398 1,385
Translation adjustments.............. (260) (260)
Net loss............................. (14,739) (14,739)
------ ---- -------- ------- ------- -------- --------
BALANCES, December 31, 1996.......... 30,047 300 249,164 31,450 (260) (29,737) 250,917
Exercise of stock options............ 67 1 238 239
Issuance of common stock under ESP
plan (see Note 8).................. 2 29 29
Translation adjustment............... (704) (704)
Net loss............................. (33,314) (33,314)
------ ---- -------- ------- ------- -------- --------
BALANCES, December 31, 1997.......... 30,116 301 249,431 31,450 (964) (63,051) 217,167
Exercise of stock options............ 42 1 236 237
Issuance of common stock under ESP
plan (see Note 8).................. 15 142 142
Translation adjustment............... (1,575) (1,575)
Net loss............................. (25,966) (25,966)
------ ---- -------- ------- ------- -------- --------
BALANCES, December 31, 1998.......... 30,173 $302 $249,809 $31,450 $(2,539) $(89,017) $190,005
====== ==== ======== ======= ======= ======== ========
See accompanying notes to consolidated financial statements.
25
28
ON COMMAND CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
Net loss................................................... $(25,966) $(33,314) $(14,739)
Translation adjustments.................................... (1,575) (704) (260)
-------- -------- --------
Comprehensive loss......................................... $(27,541) $(34,018) $(14,999)
======== ======== ========
See accompanying notes to consolidated financial statements.
26
29
ON COMMAND CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(25,966) $(33,314) $(14,739)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization........................... 88,278 78,984 53,280
Deferred income taxes, net.............................. -- (47) 195
Provision for loss on long term investment.............. -- 917
(Gain)/Loss on disposal of fixed assets................. 72 (844) 64
Changes in assets and liabilities net of effects from
acquired operations:
Accounts receivable................................... (5,439) (1,584) (962)
Other current assets.................................. 7 1,420 (1,024)
Accounts payable...................................... 3,269 3,246 (5,542)
Accounts payable to stockholder....................... 34 83 (185)
Accrued compensation.................................. (121) 880 1,950
Other accrued liabilities............................. (2,735) 5,395 (3,342)
Taxes payable......................................... (3,486) (1,655) 13,089
-------- -------- --------
Net cash provided by operating activities.......... 53,913 53,481 42,784
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net cash paid in acquisition of SpectraVision............. -- -- (9,572)
Capital expenditures...................................... (83,208) (92,307) (70,545)
Proceeds from sale of property and equipment.............. -- 4,263 46
Other assets.............................................. -- -- (434)
-------- -------- --------
Net cash used in investing activities.............. (83,208) (88,044) (80,505)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings under credit facility............ 30,000 165,000 97,625
Payment of former credit facility......................... -- (130,000) --
Payment of SpectraVision debt............................. -- -- (40,000)
Proceeds from stockholders' notes payable................. -- -- 22,526
Principal payments on stockholders' notes payable......... -- -- (38,468)
Proceeds from issuance of common stock.................... 379 268 2,587
Dividends paid............................................ -- -- (1,749)
-------- -------- --------
Net cash provided by financing activities.......... 30,379 35,268 42,521
-------- -------- --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH..................... (136) (151) (23)
-------- -------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS................... 948 554 4,777
CASH AND CASH EQUIVALENTS, Beginning of year................ 6,287 5,733 956
-------- -------- --------
CASH AND CASH EQUIVALENTS, End of year...................... $ 7,235 $ 6,287 $ 5,733
======== ======== ========
SUPPLEMENTAL INFORMATION:
Cash paid for income taxes................................ $ -- $ 1,012 $ --
-------- -------- --------
Cash paid for interest.................................... $ 9,597 $ 6,832 $ 2,702
-------- -------- --------
NONCASH INVESTING AND FINANCING ACTIVITIES:
Net assets acquired from contribution agreement with
Ascent.................................................. $ -- $ -- $ 1,385
-------- -------- --------
Common stock issued for note receivable................... $ -- $ -- $ 8,905
-------- -------- --------
Reversal of accrual made in purchase price allocation..... $ -- $ 3,000 $ --
-------- -------- --------
Dividends paid through issuance of note and common stock
warrants................................................ $ -- $ -- $ 16,002
-------- -------- --------
Acquisition of SpectraVision:
Fair value of assets acquired (including intangibles of
$89,636).............................................. $ -- $ -- $155,916
Liabilities assumed..................................... -- -- (64,282)
Acquisition costs paid.................................. -- -- (5,829)
Net cash paid........................................... -- -- (3,743)
-------- -------- --------
Common stock and warrants issued........................ $ -- $ -- $ 82,062
======== ======== ========
See accompanying notes to consolidated financial statements.
27
30
ON COMMAND CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1. BASIS OF PRESENTATION
On Command Corporation (the "Company" or "OCC") is a Delaware corporation
formed by Ascent Entertainment Group, Inc. ("Ascent") for the purpose of
effecting (i) the merger (the "Merger") of On Command Video Corporation ("OCV"),
a majority-owned subsidiary of Ascent, with a wholly-owned subsidiary of OCC,
after which OCV became a wholly-owned subsidiary of OCC, and (ii) the
acquisition (the "Acquisition") of Spectradyne, Inc., a wholly-owned subsidiary
of SpectraVision, Inc. ("Oldco"). Following the Acquisition, Spectradyne, Inc.
changed its name to SpectraVision, Inc. ("SpectraVision"). Ascent had been a
majority-owned subsidiary of COMSAT Corporation ("COMSAT") and on June 27, 1997,
COMSAT consummated the distribution of its 80.67% ownership interest in Ascent
to the COMSAT shareholders on a pro-rata basis in a transaction that was
tax-free for federal income tax purposes (the "Distribution").
Effective October 8, 1996, the Merger and Acquisition were consummated. The
Merger has been accounted for using the historical book value of the assets,
liabilities and stockholders' equity acquired from OCV in a manner similar to a
pooling of interests and the Acquisition was accounted for as a purchase using
the fair value of the assets acquired and liabilities assumed from Oldco.
Accordingly, the consolidated financial statements of the Company include the
historical results of operations and cash flows of OCV as well as the acquired
operations of SpectraVision subsequent to the date of acquisition. Per share
amounts and number of shares have been restated to reflect the 2.84 shares of
OCC common stock received for every share of OCV common stock previously held.
Prior to the Merger and Acquisition, OCC had no significant operations. (See
Note 3 for additional discussion of the business combination.)
2. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND NATURE OF BUSINESS -- The Company designs, develops,
manufactures and installs proprietary video systems. The Company's primary video
system is OCV's patented video selection and distribution system that allows
hotel guests to select motion pictures on computer-controlled television sets
located in their hotel rooms at any time. The Company also provides in-room
viewing of free-to-guest programming of select cable channels and other
interactive services under long-term contracts to hotels and businesses. The
Company has operating subsidiaries or branches in the United States, Canada,
Mexico, Hong Kong, Singapore, Thailand, Australia, Spain and the United Kingdom.
All significant intercompany accounts and transactions have been eliminated.
CASH AND CASH EQUIVALENTS -- The Company considers all highly liquid debt
instruments, with insignificant interest rate risk, acquired with an original
maturity of less than three months to be cash equivalents. Cash equivalents
consist primarily of certificates of deposit and bank savings accounts.
VIDEO SYSTEMS, PROPERTY AND EQUIPMENT -- Video systems and property and
equipment are stated at cost less accumulated depreciation and amortization.
Installed video systems consist of equipment and related costs of installation
at hotel locations. Construction in progress consists of purchased and
manufactured parts of partially constructed video systems. Depreciation and
amortization are provided using the straight-line method over the shorter of the
estimated useful lives, generally three to twenty years, or lease terms. Video
Systems and equipment acquired from the SpectraVision Acquisition are being
depreciated over 36 months.
OTHER ASSETS -- Other assets consist of payments made to customers as
inducements for them to enter into contracts with the Company for the
installation of pay-per-view video systems. These assets are amortized on a
straight-line basis over the term of the contracts, five to seven years.
Additionally, other assets at December 31, 1998 and 1997 include an investment
of $348,000 in MagiNet Corporation (See Note 10 for additional discussion on
MagiNet) and approximately $610,000 and $1,283,000 at December 31, 1998 and
1997, respectively, for technology acquired in the SpectraVision Acquisition
(net of amortization recorded on
28
31
ON COMMAND CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
a straight-line basis over three years). The investment in MagiNet was reduced
by $917,000 in 1997 from an original cost of $1,265,000 due to a dilution of the
Company's ownership in MagiNet. (See Note 10 for additional discussion on
MagiNet.)
GOODWILL -- Goodwill resulted from the SpectraVision Acquisition, as
described in Note 3, and represents the excess of the aggregate purchase price
over the fair value of net assets acquired. The goodwill is being amortized over
20 years using the straight-line method. Amortization expense was $4,376,000,
$4,454,000, and $1,133,000 in 1998, 1997 and 1996, respectively.
EVALUATION OF LONG-LIVED ASSETS -- The Company evaluates the potential
impairment of long-lived assets and long-lived assets to be disposed of in
accordance with Statement of Financial Accounting Standards No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of". As of December 31, 1998 and 1997, management believes that there was not
any impairment of the Company's long-lived assets or other identifiable
intangibles.
REVENUE RECOGNITION -- The Company installs pay-per-view video systems in
hotels, generally under five-to seven-year agreements, whereby it recognizes
revenues at the time of viewing. Revenue from the sale of video systems is
recognized when the equipment is shipped, except for systems requiring
installation by the Company, which is recognized upon completion of the
installation. Revenues from video management services and royalties are
recognized when earned and payment is considered probable.
STOCK-BASED COMPENSATION -- The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with APB Opinion No.
25, Accounting for Stock Issued to Employees.
NET LOSS PER SHARE -- Basic loss per share excludes dilution and is
computed by dividing net loss applicable to nonredeemable common stock by the
weighted-average number of common shares outstanding for the period. Diluted
loss per share reflects the potential dilution that could occur if securities or
other contracts to issue common stock were exercised or converted into common
stock. Common shares equivalent are excluded from the computations in loss
periods as their effect would be antidilutive. For the years ended December 31,
1998, 1997 and 1996 approximately 10.1 million, 9.9 million and 9.7 million
equivalent dilutive securities (primarily common stock options and warrants),
respectively, have been excluded in weighted-average number of common shares
outstanding for the diluted net loss per share computation as common stock
equivalents.
FAIR VALUE OF FINANCIAL INSTRUMENTS -- The carrying amounts of cash and
cash equivalents, accounts receivable and accounts payable approximate fair
value because of the short-term maturity of these instruments. The fair value of
the revolving credit facility approximates its carrying amount based on the
current rate offered to the Company for debt of the same remaining maturities.
FOREIGN CURRENCY TRANSLATION -- For translation of its foreign currencies,
the Company has determined that the local currencies of its international
subsidiaries are the functional currencies. Assets and liabilities of the
international subsidiaries are translated at the rate of exchange in effect at
period end. Results of operations are translated at the approximate rate of
exchange in effect during the period. Translation adjustments are included
within stockholders' equity. Balances of international subsidiaries denominated
in currencies other than the functional currency are restated at the rate of
exchange at year end and any resulting gains or losses are included in the
results of operations.
USE OF ESTIMATES, CERTAIN SIGNIFICANT RISKS AND UNCERTAINTIES -- The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. Such
management estimates include the allowance for doubtful accounts receivable, the
29
32
ON COMMAND CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
estimated useful lives of video systems, property and equipment and intangible
assets, including goodwill, reducing construction in progress to its net
realizable value and the amounts of certain accrued liabilities.
The Company participates in the highly competitive in-room entertainment
industry and believes that changes in any of the following areas could have a
material adverse effect on the Company's future financial position or results of
operations: decline in hotel occupancy as a result of general business,
economic, seasonal or other factors; loss of one or more major hotel chain
customers; ability to obtain additional capital to finance capital expenditures;
ability to maintain compliance with Credit Facility covenants; ability to retain
senior management and key employees; ability to convert operational computer
software to be Year 2000 compliant; and risks of technological developments.
RECENTLY ISSUED ACCOUNTING STANDARDS -- In 1998, the Company adopted
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income," which requires an enterprise to report, by major
components and as a single total, the change in net assets during the period
from nonowner sources. Statements of comprehensive loss have been presented for
the years ended December 31, 1998, 1997 and 1996.
In 1998, the Company early adopted Statement of Position ("SOP") 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," which provides guidance on accounting for the costs of computer
software developed or obtained for internal use. In 1998, the Company
capitalized $4,100,000 of costs in accordance with this SOP.
In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," which establishes annual and interim
reporting standards for an enterprise's business segments and related
disclosures about its products, services, geographic areas and major customers.
The Company operates in one reportable segment (see Note 12).
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
requires companies to record derivatives on the balance sheet as assets or
liabilities, measured at fair value. Gains or losses resulting from changes in
the values of those derivatives would be accounted for depending on the use of
the derivative and whether it qualifies for hedge accounting. SFAS No. 133 will
be effective for the Company's fiscal year ending December 31, 2000. Management
believes that this statement will not have a significant impact on the Company's
financial position, results of operations or cash flows.
RECLASSIFICATIONS -- Certain prior year amounts have been reclassified to
conform to the current year presentation. These reclassifications had no effect
on net loss or total stockholders' equity.
3. BUSINESS COMBINATION
As discussed in Note 1, effective October 8, 1996 (the "Closing Date"), the
Company acquired all of the outstanding capital stock of SpectraVision, the
primary operating subsidiary of Oldco, together with certain other assets of
Oldco and its affiliates.
The stockholders of OCV received 21,762,000 shares of OCC common stock
(72.5% of the initial OCC common stock). In consideration for the acquisition of
the net assets and properties of SpectraVision by OCC, OCC paid $4 million in
cash and issued 8,238,000 shares of OCC common stock to the Oldco bankruptcy
estate for distribution to Oldco's creditors. Ascent owned approximately 57% of
the outstanding common stock of OCC at December 31, 1998.
In connection with the Acquisition and Merger, OCC also issued warrants
representing the right to purchase a total of 7,500,000 shares of OCC common
stock (20% of the outstanding common stock of OCC after exercise of the
warrants). The warrants have a term of seven years and an exercise price of
$15.27 per
30
33
ON COMMAND CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
share of OCC common stock. Series A warrants to purchase on a cashless basis an
aggregate of 1,425,000 shares of OCC common stock were issued to the former OCV
stockholders, of which Ascent received warrants to purchase 1,123,823 shares;
Series B warrants to purchase for cash an aggregate of 2,625,000 shares of OCC
common stock were issued to the Oldco bankruptcy estate for distribution to
creditors; and $4 million in cash was paid and Series C warrants were issued to
OCC's investment advisor to purchase for cash an aggregate of 3,450,000 shares
of OCC common stock in consideration for certain banking and advisory services
provided in connection with the transactions. The fair value of the Series A
warrants has been recognized as a dividend to the former OCV stockholders while
the fair value of Series B and Series C warrants has been accounted for as a
cost of the Acquisition. Subsequent to the Acquisition, OCC's investment advisor
obtained a seat on the Company's Board of Directors.
The Acquisition was accounted for using the purchase method of accounting.
Accordingly, a portion of the purchase price was allocated to the net assets
acquired based on their estimated fair values. The fair value of tangible assets
acquired and liabilities assumed was $66 million and $64 million, respectively.
In addition, $2 million of the purchase price was allocated to purchased
technology. The balance of the purchase price, $87.6 million, was recorded as
goodwill and is being amortized over twenty years on a straight-line basis.
The reported results of operations of the Company for the year ended
December 31, 1996 includes the operating results of SpectraVision since the date
of the Acquisition. Unaudited pro forma results of operations as if the
Acquisition had occurred at the beginning of fiscal year 1996 is as follows (in
thousands except per share amounts):
1996
--------
Total revenues.............................................. $232,817
Net loss.................................................... (25,683)
Basic and diluted net loss per share........................ (0.83)
The pro forma combination of the companies is for presentation purposes
only and is not necessarily indicative of the actual results of operations had
the Acquisition occurred on January 1, 1996.
4. VIDEO SYSTEMS
Video systems at December 31 consist of the following (in thousands):
1998 1997
--------- ---------
Installed video systems.............................. $ 459,178 $ 383,393
Construction in progress............................. 46,431 51,204
--------- ---------
505,609 434,597
Accumulated depreciation............................. (237,729) (164,066)
--------- ---------
Video systems, net................................... $ 267,880 $ 270,531
========= =========
31
34
ON COMMAND CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
5. PROPERTY AND EQUIPMENT
Property and equipment at December 31 consist of the following (in
thousands):
1998 1997
------- -------
Furniture and fixtures................................... $ 4,377 $ 4,317
Machinery, computer equipment and software............... 15,568 8,891
Buildings and leasehold improvements..................... 1,453 1,008
------- -------
21,398 14,216
Accumulated depreciation and amortization................ (9,569) (6,366)
------- -------
Property and equipment, net.............................. $11,829 $ 7,850
======= =======
6. NOTES PAYABLE
The Company currently has a $200 million credit facility (the "Credit
Facility"). The Credit Facility matures in November 2002 and, subject to certain
conditions, can be renewed for two additional years. At December 31, 1998, there
was $37 million of available borrowings under the Credit Facility, subject to
certain covenant restrictions.
Revolving loans extended under the Credit Facility bear interest at the
London Interbank Offering Rate ("LIBOR") plus a spread that may range from
0.375% to 0.75% depending on certain operating ratios of the Company. At
December 31, 1998, the weighted average interest rate on the Credit Facility was
5.9%. In addition, a fee ranging from 0.1875% to 0.25% per annum is charged on
the unused portion of the Credit Facility, depending on certain operating ratios
of the Company. The Credit Facility contains customary covenants and agreements,
most notably, the inclusion of restrictions on the Company's ability to pay
dividends or make other distributions as well as leverage and interest coverage
covenants. The Company was in compliance with such covenants at December 31,
1998.
7. COMMITMENTS
OPERATING LEASES
The Company leases its principal facilities under a noncancelable operating
lease which expires in December 2003. In addition to lease payments, the Company
is responsible for taxes, insurance and maintenance of the leased premises. The
Company also leases certain other office space and equipment. These operating
leases expire at dates ranging from 1999 to 2004.
Rental payments for the Company's principal facility were approximately
$1,553,000, $1,303,000, and $538,000 during the years ended December 31, 1998,
1997 and 1996, respectively. In 1997 and 1996 the owner of this facility was a
minority stockholder. Rental expense under all operating leases was
approximately $5,100,000, $4,400,000, and $3,892,000 for the years ended
December 31, 1998, 1997 and 1996, respectively.
32
35
ON COMMAND CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Future minimum annual payments under noncancelable operating leases at
December 31, 1998 are as follows (in thousands):
1999............................................... $ 5,884
2000............................................... 2,741
2001............................................... 1,968
2002............................................... 1,783
2003............................................... 1,773
Thereafter......................................... 893
-------
Total.............................................. $15,042
=======
The above amounts include a total of $1,580,000 of payments to be made
during 1999 for a lease that was written off during 1997.
PURCHASE COMMITMENTS
Noncancelable commitments for the purchase of video systems and office
equipment amounted to approximately $7,100,000 at December 31, 1998.
8. STOCKHOLDERS' EQUITY
COMMON STOCK SUBSCRIBED
As of December 31, 1998 and 1997, there were approximately 1,500 shares and
315,000 shares, respectively, of common stock and related warrants that had not
been issued as certain of the former OCV and the SpectraVision estate had not
yet exchanged their interest in connection with the Merger and Acquisition. Such
shares are considered to be subscribed common stock and have been included in
the earnings per share computations.
DIVIDENDS
In August 1996, OCV declared a dividend equal to the proceeds from the
exercise of the Hilton Warrants (see Note 10) to be paid to stockholders of
record as of September 18, 1996. The dividend was contingent upon the exercise
of Hilton Warrants. Accordingly, on October 7, 1996, when Hilton exercised its
warrants, a dividend was distributed to the OCV stockholders through the
assignment to Ascent of the $8.9 million promissory note received from Hilton
and cash of $1.8 million was paid to the minority stockholders.
As stated in Note 3, the fair value of the Series A warrants issued to the
former OCV stockholders has been recorded as a dividend in 1996.
STOCK OPTION PLAN
The Company adopted a stock option plan (the 1996 Plan), expiring in 2006,
under which employees may be granted incentive or nonstatutory stock options for
the purchase of common stock of the Company. In addition, restricted stock
purchases, performance awards, dividend equivalents, stock payment or
appreciation rights or deferred stock may be granted under the plan. A total of
3,000,000 shares were initially reserved for the plan.
The exercise price is set by the Company's Board of Directors. Incentive
stock options are granted at no less than fair market value on the date of
grant. Options generally expire in ten years, vest over a five-year period and
are exercisable in installments of 20% one year from the date of grant and 5%
quarterly thereafter. Unvested options are canceled upon termination of
employment.
33
36
ON COMMAND CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Under employment agreements with certain officers, 1,426,874 options were
granted in 1996 with a three-year vesting period. The shares become exercisable
as follows: 25% one year from date of grant, 25% after two years and 50% after
three years. During 1998, 1,041,562 of such options were cancelled.
1997 NON-EMPLOYEE DIRECTORS STOCK PLAN
In May 1997, the Company adopted the Company's 1997 Non-Employee Directors
Stock Plan ("Directors Plan"). The Directors Plan authorizes the granting of an
award of 400 shares of the Company's common stock and a non-qualified option to
purchase 4,000 shares of the Company's common stock (a "Director Option") to
each Independent Director on an annual basis. The aggregate number of shares of
the Company's Common Stock which may be issued upon exercise of Directors
Options granted under the Directors Plan plus the number of shares which may be
awarded pursuant to the Directors Plan will not exceed 110,000, subject to
adjustment to reflect events such as stock dividends, stock splits,
recapitalizations, mergers or reorganizations of or by the Company. In 1998,
12,000 options were granted. No options were granted in 1997.
The following is a summary of changes in shares under all of the Company's
Stock Option Plans:
OPTIONS OUTSTANDING
----------------------------
OPTIONS WEIGHTED
AVAILABLE NUMBER AVERAGE
FOR GRANT OF SHARES EXERCISE PRICE
---------- ---------- --------------
Balances, January 1, 1996 (280,500 exercisable at a
weighted-average price of $6.72).................... 263,793 453,409 $ 7.31
Additional shares authorized.......................... 2,288,478 --
Granted (weighted-average fair value of $7.33)........ (1,781,074) 1,781,074 15.60
Exercised............................................. -- (52,918) 4.62
---------- ----------
Balances, December 31, 1996 (314,345 exercisable at a
weighted-average price of $7.30).................... 771,197 2,181,565 14.14
Granted (weighted-average fair value of $3.96)........ (324,000) 324,000 11.54
Exercised............................................. -- (68,506) 5.22
Canceled.............................................. 63,250 (63,250) 12.63
---------- ----------
Balances, December 31, 1997 (814,178 exercisable at a
weighted-average fair value of $12.95).............. 510,447 2,373,809 14.09
========== ==========
Granted (weighted-average fair value of $4.62)........ (644,196) 644,196 13.22
Exercised............................................. -- (41,218) 6.00
Canceled.............................................. 1,236,312 (1,236,312) 15.26
---------- ----------
Balances, December 31, 1998........................... 1,102,563 1,740,475 $13.13
========== ==========
34
37
ON COMMAND CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Additional information regarding options outstanding as of December 31,
1998 is as follows:
OPTIONS OUTSTANDING
------------------------ OPTIONS EXERCISABLE
WEIGHTED -----------------------
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
- - --------------- ----------- ------------ -------- ----------- --------
$4.40 - 4.72 28,631 1.6 $ 4.69 28,631 $ 4.69
$5.92 - 8.80 208,236 3.3 $ 8.24 208,236 $ 8.24
$10.97 - 16.40 1,503,608 8.8 $13.96 460,446 $14.80
--------- -------
1,740,475 7.9 $13.13 697,313 $12.43
========= =======
As discussed in Note 2, the Company continues to account for its
stock-based awards using the intrinsic value method in accordance with
Accounting Principles Board No. 25, "Accounting for Stock Issued to Employees",
and its related interpretations. Accordingly, no compensation expense has been
recognized in the financial statements for employee stock arrangements, as the
exercise price of the options is not less than the fair market value of the
underlying stock at the date of grant.
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation", (SFAS No. 123) requires the disclosure of pro forma
net income and earnings per share had the Company adopted the fair value methods
as of the beginning of fiscal 1995. Under SFAS No. 123, the fair value of
stock-based awards to employees is calculated through the use of option pricing
models, even though such models were developed to estimate the fair value of
freely tradable, fully transferable options without vesting restrictions, which
significantly differ from the Company's stock option awards. These models also
require subjective assumptions, including future stock price volatility and
expected time to exercise, which greatly affect the calculated values. The
Company's calculations were made using the Black-Scholes option pricing model
with the following weighted-average assumptions for 1998, 1997 and 1996:
expected life of 5.0 years for both 1998 and 1997 grants and 5.2 years for 1996
grants; stock volatility of 25% for 1998 and 1997 grants and 43% for 1996
grants; risk free interest rates of 6%; and no dividends during the expected
term. The Company's calculations are based on a single option valuation approach
and forfeitures are recognized as they occur. If the computed fair values of the
awards had been amortized to expense over the vesting period of the awards, pro
forma net loss applicable to nonredeemable common stock would have been
approximately $28,848,000 ($0.96 per basic and diluted share) in 1998,
$37,397,000 ($1.24 per basic and diluted share) in 1997 and $16,056,000 ($0.71
per basic and diluted share) in 1996. However, the impact of outstanding
nonvested stock options granted prior to 1995 has been excluded from the pro
forma calculation; accordingly, the pro forma adjustments are not indicative of
future period pro forma adjustments, when the calculation will apply to all
applicable stock options.
EMPLOYEE STOCK PURCHASE PLAN
In August 1997, the Company adopted the Employee Stock Purchase Plan (the
"ESP Plan") which is intended to qualify under Section 423 of the Internal
Revenue Code. Under the terms of the ESP Plan, Company employees can purchase
the Company's common stock at a 10% discount from the market value on the
purchase date. As of December 31, 1998, 16,565 shares have been purchased by
Company employees.
35
38
ON COMMAND CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
SHARES RESERVED FOR FUTURE ISSUANCE
Common stock reserved for future issuance at December 31, 1998 are as
follows:
Option Plans..................................... 2,843,038
ESP Plan......................................... 163,435
Warrants......................................... 7,500,000
----------
Total............................................ 10,506,473
==========
9. INCOME TAXES
As a result of the exercise of the Hilton Warrants on October 7, 1996 (see
Note 10), Ascent's ownership in the Company fell below 80% and, accordingly, the
Company was no longer included in Ascent's consolidated tax group. The Company
has prepared its 1996 income tax provision based on inclusion in Ascent's
consolidated returns. However, the provision as calculated would approximate the
provision if prepared on a separate return basis. The current and deferred tax
expense represent the Company's separately computed tax liability.
The provision (benefit) for income taxes for the years ended December 31
consists of the following (in thousands):
1998 1997 1996
----- ---- -----
Current:
Federal................................................... $ -- $ -- $(776)
State..................................................... -- 198 257
Foreign................................................... (109) 635 498
----- ---- -----
(109) 833 (21)
Deferred:
Federal................................................... -- -- 354
State..................................................... -- -- (159)
Foreign................................................... -- (47) --
----- ---- -----
-- (47) 195
----- ---- -----
Total....................................................... $(109) $786 $ 174
===== ==== =====
The provision for income taxes differs from the amount obtained by applying
the federal statutory rate (35%) to loss before income taxes for the years ended
December 31 as follows (in thousands):
1998 1997 1996
------- -------- -------
Tax benefit computed at federal statutory rate....... $(9,126) $(11,385) $(5,097)
State tax benefit net of federal benefit............. (1,080) (1,246) (580)
Goodwill............................................. 1,750 1,750 --
Other................................................ 440 459 20
Foreign.............................................. (109) 588 498
Valuation allowance.................................. 8,016 10,620 5,333
------- -------- -------
Provision for income taxes........................... $ (109) $ 786 $ 174
======= ======== =======
36
39
ON COMMAND CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Loss before income taxes for the years ended December 31 consists of the
following (in thousands):
1998 1997 1996
-------- -------- --------
Domestic........................................... $(23,438) $(31,800) $(14,387)
Foreign............................................ (2,637) (728) (178)
-------- -------- --------
Total............................... $(26,075) $(32,528) $(14,565)
======== ======== ========
Deferred income taxes, which result from the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes, at December 31
consist of the following (in thousands):
1998 1997
-------- --------
Deferred tax assets:
Tax net operating loss and credit carryforwards........... $ 40,021 $ 27,246
Accruals not recognized for tax purposes.................. 5,413 7,752
Depreciation and amortization............................. -- 3,232
Other..................................................... 2,850 1,269
Valuation allowance....................................... (47,401) (39,385)
-------- --------
Total deferred tax assets................................... 883 114
Deferred tax liabilities:
Depreciation and amortization............................. (817) --
Other..................................................... (66) (114)
-------- --------
Total deferred tax liabilities.............................. (883) (114)
-------- --------
Net deferred tax liability.................................. $ -- $ --
======== ========
The Company has federal net operating loss carryforwards of approximately
$100,000,000, which expire beginning in 2010. However, because of the
acquisition of SpectraVision by On Command Corporation, the pre-ownership change
net operating loss carryforwards (approximately $43 million) are subject under
Section 382 of the Internal Revenue Code to an annual limitation estimated to be
approximately $6 million. In addition, the Company has state net operating loss
carryforwards of approximately $66,000,000 which expire beginning in 2000.
Certain of the state net operating loss carryforwards (approximately $7 million)
are subject to the annual limitation under Section 382. Alternative minimum tax
credit carryforwards of approximately $1,595,000 and $251,000 are available to
offset future regular federal and state tax liabilities, respectively. Research
and development tax credit carryforwards of approximately $32,000 and $382,000
are available to offset future federal and state tax liabilities, respectively.
10. RELATED PARTY TRANSACTIONS
ASCENT ENTERTAINMENT GROUP, INC.
During 1995, the Company entered into a Contribution Agreement with Ascent,
whereby the Company acquired various assets and liabilities (primarily installed
video systems and related construction in progress, accounts receivable,
deferred income taxes and other assets) from Ascent in exchange for shares of
common stock of the Company. During 1996, in connection with the aforementioned
Contribution Agreement, Ascent contributed additional assets and liabilities
with a net book value of $1,385,000 to the Company. Both of these transfers of
net assets and shares between companies under common control have been accounted
for at historical cost.
37
40
ON COMMAND CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
During 1996, the Company and Ascent entered into a Corporate Agreement, as
amended, pursuant to which the Company has agreed with Ascent not to incur any
indebtedness without Ascent's prior consent, other than indebtedness under the
Company's Credit Facility (see Note 6), and indebtedness incurred in the
ordinary course of operations which together shall not exceed $182 million
through December 31, 1999; provided, however, that such indebtedness may only be
incurred in compliance with the financial covenants contained in the Credit
Facility, with any amendments to such covenants subject to the written consent
of Ascent.
Effective October 8, 1996, the Company entered into an "Intercompany
Management Services Agreement" with Ascent under which Ascent will provide
certain management services to OCC through December 31, 1999. Services to be
provided include insurance administration, coordination and advisory services
regarding corporate financing, employee benefits administration, public
relations, and various other general corporate functions. Fees for management
services are $100,000 per month. The Company paid a total of $100,000 in
management service fees to Ascent in 1996. In 1997 and 1998, Ascent waived the
management service fees due under the Agreement. The Company had approximately
$138,000 and $104,000 in payables to Ascent at December 31, 1998 and 1997,
respectively.
HILTON HOTELS CORPORATION ("HILTON")
In July 1993, pursuant to a stock purchase agreement with Hilton, the
Company sold 1,165,993 shares of redeemable common stock at $8.80 per share. In
July 1993, in connection with the signing of a contract to provide services, the
Company issued Hilton warrants (the "Hilton Warrants") to purchase 1,165,993
shares of common stock at $9.68 per share through May 1996, increasing to $10.65
per share in June 1996 and $11.72 per share in June 1997, subject to
anti-dilution. On October 7, 1996, Hilton exercised its warrants and the Company
received proceeds of $1.8 million in cash and $8.9 million in the form of a
promissory note.
MAGINET CORPORATION
The Company also earned video system sales of approximately $83,000,
$751,000, and $4,420,000 in 1998, 1997 and 1996, respectively, and room revenues
of approximately $0, $150,000, and $524,000 in 1998, 1997 and 1996,
respectively, from MagiNet Corporation which is a related party by virtue of the
Company's preferred stock investment in this company. Accounts receivable from
MagiNet at December 31, 1998 and 1997 was approximately $40,000 and $150,000,
respectively. (See Note 2 for additional discussion).
11. CONCENTRATION OF CREDIT RISK
The Company generates the majority of its revenues from the guest usage of
proprietary video systems located in various hotels primarily throughout the
United States, Canada, Mexico, Europe, Australia and the Far East. The Company
performs periodic credit evaluations of its installed hotel locations and
generally requires no collateral while maintaining allowances for potential
credit losses. The Company invests its cash in high-credit quality institutions.
These instruments are short-term in nature and, therefore, bear minimal risk.
Marriott Corporation and its affiliates accounted for 24%, 21%, and 25% of
revenues in 1998, 1997 and 1996, respectively, while Holiday Inn Corporation
accounted for 11%, 11% and 14% of revenues in 1998, 1997 and 1996, respectively.
The Company earned revenues of approximately $22,955,000, $22,000,000, and
$18,900,000, which accounted for 10%, 10% and 13%, of total revenues in 1998,
1997 and 1996, respectively, from Hilton and its affiliates. Accounts receivable
from Hilton and its affiliates at December 31, 1998 and 1997 was approximately
$1,400,000 and $753,000, respectively.
38
41
ON COMMAND CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
12. GEOGRAPHIC OPERATING INFORMATION
The following represents total revenues for the years ended December 31,
1998, 1997 and 1996 and long-lived assets as of December 31, 1998 and 1997 by
geographic territory (in thousands):
1998 1997 1996
--------------------- --------------------- -----------
LONG- LONG-
TOTAL LIVED TOTAL LIVED TOTAL
REVENUES(*) ASSETS REVENUES(*) ASSETS REVENUES(*)
----------- ------- ----------- ------- -----------
United States.............................. 215,054 331,819 197,086 352,204 142,874
Canada..................................... 12,690 16,716 13,251 6,708 2,186
All other foreign.......................... 11,076 12,398 11,766 7,403 2,409
------- ------- ------- ------- -------
Total....................... 238,820 360,933 222,103 366,315 147,469
======= ======= ======= ======= =======
- - ---------------
* Net revenues are attributed to countries based on invoicing location of
customer.
13. EMPLOYEE BENEFIT PLAN
Qualified employees are eligible to participate in the Company's 401(k)
tax-deferred savings plan. Participants may contribute up to 20% of their
eligible earnings (to a maximum of approximately $10,000 per year) to this plan,
for which the Company, at the discretion of the Board or Directors, may make
matching contributions. Matching contributions made by the Company were
approximately $773,000, $711,000, and $1,014,000 in 1998, 1997 and 1996,
respectively.
14. LEGAL MATTERS
On September 11, 1998, OCC reached an agreement with LodgeNet Entertainment
Corporation ("LodgeNet") to settle all pending litigation between the companies.
As a result, the two providers of in-room entertainment and information services
to the lodging industry have dismissed all pending litigation between the
parties in United States Federal District Courts in California and South Dakota,
with no admission of liability by either party. The terms of the confidential
settlement include a cross-license of each company's patented technologies at
issue to the other party and a covenant not to engage in patent litigation
against the other party for a period of five years. Each company is responsible
for its own legal costs and expenses, and in connection with the multiple
cross-licenses, OCC expects to receive royalty payments net of legal fees and
expenses in an aggregate amount of approximately $10.8 million, although no
assurance can be given. OCC received the first payment of approximately $2.9
million (net of expenses) in September 1998 and expects to receive an additional
two payments of approximately $3.95 million (net of expenses) in each of July
1999 and July 2000. OCC will be recognizing the additional royalty revenue as
the cash payments are received.
In September 1998, OCV filed suit against MagiNet, alleging a breach by
MagiNet of a license agreement between OCV and MagiNet, and terminating the
license agreement. OCV has also demanded the payment of license fees from
MagiNet which OCC believes were due and payable under the License Agreement and
have not been paid by MagiNet. MagiNet has counter-claimed against OCV, alleging
that OCV breached the license agreement, and alleging various torts by OCV in
its relationship with MagiNet.
The Company is a defendant, and may be a potential defendant, in lawsuits
and claims arising in the ordinary course of its business. While the outcomes of
such claims, lawsuits, or other proceedings cannot be predicted with certainty,
management expects that such liability, to the extent not provided for by
insurance or otherwise, will not have a material adverse effect on the financial
condition of the Company.
39
42
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of unaudited quarterly results of operations for
the years ended December 31, 1998 and 1997:
DEC. 31 SEPT. 30 JUNE 30 MARCH 31
------- -------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1998:
Revenues........................................... $59,082 $62,975 $60,895 $ 55,868
Direct costs of revenue............................ 26,424 26,696 26,862 23,920
Operating expenses................................. 37,278 37,555 38,705 37,530
Loss from operations............................... (4,620) (1,276) (4,672) (5,582)
Net loss........................................... (7,076) (3,974) (7,078) (7,838)
Basic and diluted loss per share................... $ (0.23) $ (0.13) $ (0.23) $ (0.26)
1997:
Revenues........................................... $56,667 $56,985 $56,387 $ 52,064
Direct costs of revenue............................ 25,775 25,734 26,338 25,496
Operating expenses................................. 37,102 34,821 33,576 36,667
Loss from operations............................... (6,210) (3,570) (3,527) (10,099)
Net loss........................................... (9,473) (6,068) (5,817) (11,956)
Basic and diluted loss per share................... $ (0.31) $ (0.20) $ (0.19) $ (0.40)
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT
Except for the portion of Item 10 relating to Executive Officers which is
included in Part I of this Report, the information called for by Items 10
through 13 is incorporated by reference from the On Command Corporation 1999
Annual Meeting of Stockholders -- Notice and Proxy Statement -- (the "Proxy
Statement") (to be filed pursuant to Regulation 14A not later than 120 days
after the close of the fiscal year ended December 31, 1998) which meeting
involves election of directors, in accordance with General Instruction G to the
Annual Report on Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this Item 11 is hereby incorporated by reference to
the Company's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this Item 12 is hereby incorporated by reference to
the Company's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this Item 13 is hereby incorporated by reference to
the Company's Proxy Statement.
40
43
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(A)(1) FINANCIAL STATEMENTS
The following consolidated financial statements of On Command Corporation
are included in Item 8:
Independent Auditors' Report
Consolidated Balance Sheets at December 31, 1998 and 1997
Consolidated Statements of Operations for the years ended December 31,
1998, 1997 and 1996
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Comprehensive Loss for the years ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the years ended December 31,
1998, 1997 and 1996
Notes to the Consolidated Financial Statements
Quarterly Results of Operations for the years ended December 31, 1998
and 1997
(A)(2) FINANCIAL STATEMENT SCHEDULES
The following consolidated financial statement schedule of On Command
Corporation is included:
Schedule II -- Valuation Accounts
Information required by the other schedules has been presented in the
Notes to the Consolidated Financial Statement or such schedule is not
applicable and, therefore, has been omitted.
(A)(3) EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBIT
EXHIBIT
NO. DESCRIPTION
------- -----------
3.1 Certificate of Amended and Restated Certificate of
Incorporation of On Command Corporation, which is
incorporated by reference to Exhibit 3.1 of Form S-4.
3.3 Bylaws of On Command Corporation, which is incorporated by
reference to Exhibit 3.3 of Form S-4.
3.4 Amendment to Bylaws dated as of November 23, 1998.
4.1 Registration Rights Agreement by and among On Command
Corporation and the other parties named therein, which is
incorporated by reference to Exhibit 4.1 of Form S-4.
4.2 Warrant Agreement by and among On Command Corporation and
the other parties named therein, which is incorporated by
reference to Exhibit 4.2 of Form S-4.
10.1 Master Services Agreement, dated as of August 3, 1993, by
and between Marriott International, Inc., Marriott Hotel
Services, Inc. and On Command Video Corporation
(confidential treatment granted), which is incorporated by
reference to Form S-4, (Incorporated by reference to Exhibit
10.6 of the Registration statement on Form S-1 (File No.
33-98502) of Ascent Entertainment Group, Inc.).
10.2 Hilton Hotels Corporation -- On Command Video Agreement,
dated April 27, 1993, by and between Hilton Hotels
Corporation and On Command Video Corporation, which is
incorporated by reference to Exhibit 10.4 of Form S-4
(confidential treatment granted).
41
44
EXHIBIT
NO. DESCRIPTION
------- -----------
10.3* Amended and Restated Employment Agreement between On Command
Corporation and Robert Kavner, dated as of December, 1998.
10.4* Amendment to Employment Agreement between On Command
Corporation and Brian Steel, dated as of December 31, 1998.
10.5* Employment and Consulting Agreement, dated November 20,
1991, between Robert Snyder and On Command Video Corporation
which is incorporated by reference to Exhibit 10.9 of Form
S-4.
10.6 Standard Lease, dated June, 1996, between Berg & Berg
Developers, and On Command Video Corporation (Incorporated
by reference to Exhibit 10.10 of the Annual Report on Form
10-K for the year ended December 31, 1996 ("OCC 1996 Form
10-K")).
10.7 Corporate Agreement dated as of October 8, 1996, between On
Command Corporation and Ascent Entertainment Group, Inc.
(Incorporated by reference to Exhibit 10.22 of the Annual
Report on Form 10-K for the year ended December 31, 1996 at
Ascent Entertainment Group, Inc. (Commission File No.
0-27192)).
10.8* 1996 Key Employee Stock Plan (Incorporated by reference to
Exhibit 10.13 of the OCC 1996 Form 10-K).
10.9* 1997 Employee Stock Purchase Plan (Incorporated by reference
to Exhibit 4(c) of Form S-8 filed August 8, 1997).
10.10* 1997 Non-Employee Directors Stock Plan (Incorporated by
reference to Exhibit 4(d) of Form S-8 filed August 8, 1997).
10.11 First Amended and Restated Credit Agreement dated as of
November 24, 1997, between On Command Corporation and the
Lenders Named Therein and NationsBank of Texas, N.A.
10.12 Change of Control Severance Plan for Executive Officers.
21.1 Subsidiaries of On Command Corporation.
23.1 Independent Auditors' Consent.
- - ---------------
* Indicates compensatory plan or arrangement.
(B) REPORTS
No reports on Form 8-K were filed during the quarter ended December 31,
1998.
42
45
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY SAN JOSE,
STATE OF CALIFORNIA ON MARCH 27, 1999.
ON COMMAND CORPORATION
By: /s/ BRIAN A.C. STEEL
------------------------------------
Brian A.C. Steel
President
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
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE
--------- ----- --------------
/s/ BRIAN A. C. STEEL President, Chief Operating March 27,1999
- - -------------------------------------------------------- Officer, and Director
Brian A. C. Steel (Principal Executive Officer
and Financial Officer)
/s/ PAUL J. MILLEY Senior Vice President, March 27, 1999
- - -------------------------------------------------------- Finance (Principal Accounting
Paul J. Milley Officer)
/s/ JAMES A. CRONIN, III Director March 27, 1999
- - --------------------------------------------------------
James A. Cronin, III
/s/ CHARLES LYONS Chairman of the Board March 27, 1999
- - --------------------------------------------------------
Charles Lyons
/s/ GARY L. WILSON Director March 27, 1999
- - --------------------------------------------------------
Gary L. Wilson
/s/ RICHARD D. GOLDSTEIN Director March 27, 1999
- - --------------------------------------------------------
Richard D. Goldstein
/s/ J. DAVID WARGO Director March 27, 1999
- - --------------------------------------------------------
J. David Wargo
/s/ J.C. SPARKMAN Director March 27, 1999
- - --------------------------------------------------------
J.C. Sparkman
43
46
SCHEDULE II
ON COMMAND CORPORATION
VALUATION ACCOUNTS
COL. B COL. C COL. D COL. E
COL. A ------------ ------------- ---------- -------------
------ BALANCE AT ADDITIONS
BEGINNING OF ACQUIRED WITH CHARGED TO COSTS BALANCE AT
DESCRIPTION PERIOD SPECTRAVISION OR EXPENSES DEDUCTIONS END OF PERIOD
----------- ------------ ------------- ---------------- ---------- -------------
From January 1, 1998 to December 31, 1998
Deferred tax asset valuation
allowance............................ $39,385,000 -- 8,016,000 -- $47,401,000
Bad debt allowance...................... 1,630,000 -- 982,000 1,128,000 1,484,000
From January 1, 1997 to December 31, 1997
Deferred tax asset valuation
allowance............................ $28,765,000 -- 10,620,000 -- $39,385,000
Bad debt allowance...................... 629,000 -- 1,001,000 -- 1,630,000
From January 1, 1996 to December 31, 1996
Deferred tax asset valuation
allowance............................ -- 23,407,000 6,502,000 1,144,000 $28,765,000
Bad debt allowance...................... $ 100,000 1,000,000 450,000 21,000 629,000
44
47
OFFICERS
Brian A.C. Steel
President, Chief Operating Officer
and Director
Richard C. Fenwick, Jr.
Senior Vice President, Engineering
Ronald D. Lessack
Senior Vice President, Operations
Paul J. Milley
Senior Vice President, Finance
Arthur M. Aaron
Acting General Counsel and Secretary
Jean A. deVera
Senior Vice President, Account Management
DIRECTORS
Charles Lyons, Chairman
Chairman, President and Chief Executive Officer, Ascent Entertainment Group,
Inc.
Brian A.C. Steel
President, Chief Operating Officer
and Director
James A. Cronin, III
Executive Vice President, Chief Financial Officer and Chief Operating Officer
Ascent Entertainment Group, Inc.
Gary L. Wilson
Chairman, Northwest Airlines, Inc.
Richard D. Goldstein
Senior Managing Director, Alpine Capital Group
Director, US Franchise Systems, Inc;
Roberts Radio LLC; and The Berkshire Bank
J. David Wargo
President, Wargo & Company, Inc.
Director, TV Guide, Inc.
J.C. Sparkman
Director, TCI; Shaw Communications;
and Universal Electronics, Inc.
COMMON STOCK
The Company's common stock commenced trading on October 8, 1996, and is listed
on the NASDAQ National Market under the symbol ONCO.
SERIES A COMMON STOCK PURCHASE WARRANTS
The Series A Warrants commenced trading on October 8, 1996, and are listed on
the NASDAQ National Market under the ticker symbol ONCOW.
SERIES B COMMON STOCK PURCHASE WARRANTS
The Series B Warrants commenced trading on January 10, 1997, and are listed on
the NASDAQ National Market under the ticker symbol ONCOZ.
FORM 10-K AND OTHER INVESTOR INFORMATION
A copy of our Form 10-K, filed with the Securities and Exchange Commission
(SEC), is included in this report. Additional copies are available upon request.
To have your name placed on a mailing list for copies of press releases and
periodic reports to the SEC, please call or fax our corporation headquarters.
AUDITORS
Deloitte & Touche LLP
60 S. Market Street, Suite 800
San Jose, California 95113
TRANSFER AGENT
Bank of New York
101 Barclay Street (22W)
New York, New York 10286
Website Address: http://stock.bankofny.com
SHAREHOLDER SERVICES AGENT
If you have questions concerning your ownership or records, please write to:
On Command Corporation
c/o The Bank of New York
Shareholder Relations Department - 11E
PO Box 11258
Church Street Station
New York, New York 10286
E-Mail Address:
Shareowner-svcs@Email.bony.com
45
48
INDEX TO EXHIBITS
EXHIBIT
NO. DESCRIPTION
------- -----------
3.1 Certificate of Amended and Restated Certificate of
Incorporation of On Command Corporation, which is
incorporated by reference to Exhibit 3.1 of Form S-4.
3.3 Bylaws of On Command Corporation, which is incorporated by
reference to Exhibit 3.3 of Form S-4.
3.4 Amendment to Bylaws dated as of November 23, 1998.
4.1 Registration Rights Agreement by and among On Command
Corporation and the other parties named therein, which is
incorporated by reference to Exhibit 4.1 of Form S-4.
4.2 Warrant Agreement by and among On Command Corporation and
the other parties named therein, which is incorporated by
reference to Exhibit 4.2 of Form S-4.
10.1 Master Services Agreement, dated as of August 3, 1993, by
and between Marriott International, Inc., Marriott Hotel
Services, Inc. and On Command Video Corporation
(confidential treatment granted), which is incorporated by
reference to Form S-4, (Incorporated by reference to Exhibit
10.6 of the Registration statement on Form S-1 (File No.
33-98502) of Ascent Entertainment Group, Inc.).
10.2 Hilton Hotels Corporation-On Command Video Agreement, dated
April 27, 1993, by and between Hilton Hotels Corporation and
On Command Video Corporation, which is incorporated by
reference to Exhibit 10.4 of Form S-4 (confidential
treatment granted).
10.3* Amended and Restated Employment Agreement between On Command
Corporation and Robert Kavner, dated as of December, 1998.
10.4* Amendment to Employment Agreement between On Command
Corporation and Brian Steel, dated as of December 31, 1998.
10.5* Employment and Consulting Agreement, dated November 20,
1991, between Robert Snyder and On Command Video Corporation
which is incorporated by reference to Exhibit 10.9 of Form
S-4.
10.6 Standard Lease, dated June, 1996, between Berg & Berg
Developers, and On Command Video Corporation (Incorporated
by reference to Exhibit 10.10 of the Annual Report on Form
10-K for the year ended December 31, 1996 ("OCC 1996 Form
10-K")).
10.7 Corporate Agreement dated as of October 8, 1996, between On
Command Corporation and Ascent Entertainment Group, Inc.
(Incorporated by reference to Exhibit 10.22 of the Annual
Report on Form 10-K for the year ended December 31, 1996 at
Ascent Entertainment Group, Inc. (Commission File No.
0-27192)).
10.8* 1996 Key Employee Stock Plan (Incorporated by reference to
Exhibit 10.13 of the OCC 1996 Form 10-K).
10.9* 1997 Employee Stock Purchase Plan (Incorporated by reference
to Exhibit 4(c) of Form S-8 filed August 8, 1997).
10.10* 1997 Non-Employee Directors Stock Plan (Incorporated by
reference to Exhibit 4(d) of Form S-8 filed August 8, 1997).
10.11 First Amended and Restated Credit Agreement dated as of
November 24, 1997, between On Command Corporation and the
Lenders Named Therein and NationsBank of Texas, N.A.
10.12 Change of Control Severance Plan for Executive Officers.
21.1 Subsidiaries of On Command Corporation.
23.1 Independent Auditors' Consent.
- - ---------------
* Indicates compensatory plan or arrangement.
46