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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, 1997
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, 1998, was $167,616,737 based
upon a price of $13.188 per share, which was the average of the bid and asked
prices of such stock on March 3, 1998, as reported on the NASDAQ National Market
Reporting System. As of March 3, 1998, there were 29,850,208 shares of the
Registrant's Common Stock issued and outstanding and 1,424,875 Series A
Warrants, 2,529,803 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.
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TABLE OF CONTENTS
Page
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Item 1. Business
Introduction 1
General 1
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 6
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 13
Item 6. Selected Financial Data 14
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15
Item 8. Financial Statements and Supplementary Data 21
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 41
Item 10. Directors and Officers of the Registrant 41
Item 11. Executive Compensation 41
Item 12. Security Ownership of Certain Beneficial Owners
and Management 41
Item 13. Certain Relationships and Related Transactions 41
Item 14. Exhibits, Financial Statements, Schedules and 41
Reports on Form 8-K
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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.
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 allocated 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.
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, a Delaware corporation, 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.
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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 from 20 to 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 the
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, and Four Seasons, and to other select hotels. OCV has
experienced rapid growth in the past four years, increasing its base of
installed on-demand rooms from approximately 37,000 rooms at the end of 1992 to
approximately 576,000 rooms at December 31, 1997.
At December 31, 1997, approximately 86.6% of OCC's 893,000 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 has been licensed to use OCV's system to provide on-demand
in-room entertainment in the Asia-Pacific region.
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, 1997, SpectraVision equipment was in place in
approximately 317,000 rooms, with approximately 233,000 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 major motion pictures, free-to-guest
programming of select pay cable channels, and an increasing array of interactive
programs and information. Pay-per-view services were introduced in the early
1970's 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 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 a few industry-dedicated companies, as well as new entrants.
OPERATING AND GROWTH STRATEGY
In October 1996, OCC acquired the assets and certain liabilities of
SpectraVision, at the time the second largest provider of in-room, on-demand
entertainment and
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information services to the domestic lodging industry. The Acquisition enhanced
OCC's position as the leading provider of on-demand in-room entertainment and
information services to the lodging industry and approximately doubled the
number of installed rooms served by OCC.
On Command Corporation's current 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 1997, 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 576,000 rooms in
approximately 2,078 hotels at December 1997. 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 as 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, 1997, approximately 13.4% of
OCC's hotel rooms served, or 120,000 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, 1997, OCC converted approximately 67,000 rooms from SpectraVision's
scheduled system 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 from 20 to 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
a motion picture's theatrical release date to benefit from the studios'
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
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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.
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.
For example, in a typical hotel with 400 rooms, the central head-end
video rack would consist of approximately 120 video cassette 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 available to the guest at that particular time, 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 NOWO(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. During 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.
During 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 an Internet
offering. OCC is also testing shorter and more targeted non-movie programming on
a lower cost pay-per-view basis. The
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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.
SpectraVision
By 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 Theater(TM). Guest Theater systems use digital satellite delivery
technology that was introduced in 1993. The SpectraVision Guest Theater service
was discontinued during 1997 due to the loss of the AT&T Telstar 401 satellite
that occurred in January 1997.
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 new
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, WTBS, 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.
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. On
Command Corporation 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 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 luxury
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 with guestrooms under 150 rooms. On Command intends to
continue targeting established hotel chains, certain business and luxury 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. 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.
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INSTALLATION AND SERVICE OPERATIONS
At December 31, 1997, OCC's installation and service organization
consisted of approximately 355 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, 1997, approximately 4.5% of the pay-per-view hotels
served by OCC have contracts that have expired and are on a month-to-month
basis. Approximately 7.4% of the pay-per-view hotels served by OCC have
contracts expiring in 1998. 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.
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.
In 1993, SpectraVision, through its parent company Oldco, entered into
an agreement with Electronic Data Systems Corporation ("EDS") to install a
satellite-based digital movie delivery system to replace its existing
tape-based delivery systems. Upon completing the Acquisition, OCC entered into
a new agreement with EDS for the continued delivery of the satellite-delivered
service for up to 45 months after the closing of the Acquisition. On January
11, 1997, OCC experienced an interruption in the EDS satellite-delivered
service caused by the loss of AT&T's Telstar 401 satellite. Of the 950
SpectraVision hotels affected, approximately 410 hotels continued to provide
limited pay-per-view services through alternate disk or tape-based systems. The
Company then entered into a six-month agreement with Hughes Network Systems for
transponder capacity on a GE Americom Communications, Inc. satellite to resume
the satellite service through July 1997. Thereafter, OCC transferred its
remaining approximately 26,500 satellite served rooms, along with certain other
rooms that did not meet OCC's target customer profile, to Skylink Cinema
Corporation ("Skylink").
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
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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 it is installed by OCC-employed and trained technicians, 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, except for Showtime Networks Inc.,
("Showtime") which is disputing OCV's performance of the contract with Showtime
in connection with OCV's termination of scheduled satellite pay-per-view
service. [Supreme Court of the State of New York, County of New York, Index No.
95-600849]. Showtime is currently installed in approximately 3.4% of OCC's room
base.
In addition, the Company receives satellite signal transport services
for much of its domestic cable television programming from DIRECTV, Inc. While
the Company believes that its relationship with DIRECTV, Inc. is good, 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 largely 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 1998. 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 two 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 potential competitors that could use their
existing infrastructure to provide in-room entertainment and/or information
services 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 are already providing
free-to-guest services to hotels and testing video-on-demand.
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 or private
venture capital markets and have access to additional capital resources which
OCC does not have.
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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, 1997, LodgeNet served
approximately 512,000 pay-per-view rooms, as of which approximately 484,000 are
equipped with on-demand service. At December 31, 1997, OCC served approximately
893,000 rooms, of which approximately 765,000 are on-demand rooms.
Competition with respect to new pay-per-view 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.
On Command Corporation 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 over the previous three
years) 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 the
pay-per-view 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 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
informational 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 pay-per-view 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 On Command Corporation's
operations unless it 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 On Command
Corporation's pay-per-view or free-to-guest services. However, the FCC's
jurisdiction does encompass certain aspects of On Command Corporation's
operations as they related to the offering of satellite-delivered pay-per-view
movies during the first portion of 1997.
The FCC's jurisdiction also encompasses certain aspects of On Command
Corporation'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.
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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.
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 on average experiences 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. At December 31, 1997, the Company serviced 420 hotels
with a total of 120,000 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 information
services to certain gaming-based, hotel properties and MagiNet Corporation
(formerly Pacific Pay Video Limited), which has been licensed to use OCC's
system to provide on-demand in-room entertainment in the Asia Pacific region and
at December 31, 1997, provided service to approximately 75,800 rooms.
In addition, the Company is developing and testing technology that will
bring Internet and other services to hotel guests in their rooms.
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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, DoubleTree (Promus), Embassy Suites,
Fairmont, Four Seasons, Hilton, Holiday Inn, Hyatt, Loews, Marriott (including
Courtyard Inn, Fairfield Inn & Residence Inn), Omni, Patriot American,
Renaissance, Starwood Lodging, Westin and Wyndham. 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, 1997 and 1996,
respectively:
As of December 31
-------------------------------
1997 1996
---- ----
Hotels Served:
U.S. 2,642 2,706
Non-U.S. 418 438
Rooms Served: (1)
U.S. 773,005 801,952
Non-U.S 120,409 115,663
Revenue per Equipped $18.19/month $20.87/month
Room (RER) (2)
(1) The decrease in rooms in 1997 is primarily due to the sale and
termination of certain U.S. hotel contracts, which hotels featured
pay-per-view movies by means of satellite transmission only.
(2) The decline in RER in 1997 is due to SpectraVision equipped hotels
having a lower RER than OCV rooms and OCC's inclusion of twelve months
of SpectraVision RER results for 1997, versus including only three
months of SpectraVision RER results for 1996.
EMPLOYEES
As of December 31, 1997, OCC employed a total of 773 persons, including
61 in engineering, 332 in domestic installation and service, 180 in domestic
manufacturing and operations, 10 in sales, 97 in management, administration,
finance, and 93 in international service and operations. During fiscal year
1997, 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 will complete the closure of the Richardson
facility in March 1998 and transfer necessary operations to the San Jose
headquarters at that time. 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.
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ITEM 3. LEGAL PROCEEDINGS
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 1997.
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, 1998, and titles of executive officers of the Company, and
biographical information with respect to such officers.
Name Age Position
---- --- --------
Robert M. Kavner 54 President, Chief Executive Officer, and
Director
Brian A.C. Steel 38 Executive Vice President, Chief Financial
Officer, Chief Operating Officer, and
Director
Ronald D. Lessack 51 Senior Vice President, Operations
Richard C. Fenwick, Jr. 40 Senior Vice President, Engineering
Paul J. Milley 44 Senior Vice President, Finance
Jill E. Fishbein 36 Senior Vice President, Legal, General
Counsel, and Secretary
Jean A. deVera 48 Senior Vice President, National Accounts
Robert M. Kavner has been President, Chief Executive Officer, and
Director of On Command Corporation since September 1996. Prior thereto, Mr.
Kavner was a principal in Kavner & Associates, a consulting firm for media and
communication companies. From June 1994 through September 1995, Mr. Kavner was
an Executive Vice President of Creative Artists Agency, Inc. Prior to joining
Creative Artists Agency, Mr. Kavner was Executive Vice President of AT&T Corp.
("AT&T") and Chief Executive Officer of AT&T's Multimedia Products and Services
Group. He was also a member of AT&T's Management Executive Committee. From 1992
to 1994, Mr. Kavner was Group Executive for Communications Products Group of
AT&T. From 1988 to 1991, Mr. Kavner was President of AT&T's Data Systems Group.
Mr. Kavner is also a director of the Fleet Financial Corp. and Earthlink
Networks, Inc.
Brian A.C. Steel has been 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. From
June 1986 to December 1992, Mr. Steel was employed by Shearson Lehman Brothers
Inc. as Senior Vice President, Real Estate Merchant Banking Group and First Vice
President, E.F. Hutton Properties.
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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.
Jill E. Fishbein has been Senior Vice President, Legal, General Counsel
and Secretary since December 1996. Ms. Fishbein was Vice President, General
Counsel, and Secretary of Network General Corporation from October 1994 through
December 1996. Prior to joining Network General Corporation, Ms. Fishbein was
Legal Counsel at Electronic Arts Inc. from April 1992 to September 1994.
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.
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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,
1997 through December 31, 1997 and October 8, 1996 through December 31, 1996 are
as follows:
Price Range
----------------------
Common Stock High Low
------------ -------- --------
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
1996:
Fourth Quarter (since October 8, 1996) $25.2500 $15.6250
Price Range
-----------------------
Series A Warrants High Low
----------------- --------- ---------
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
1996:
Fourth Quarter (since October 8, 1996) $ 10.5000 $ 7.1250
Price Range
-----------------------
Series B Warrants High Low
----------------- --------- ---------
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
1996:
Fourth Quarter (since October 8, 1996) $ 6.7500 $ 6.7500
As of March 3, 1998 there were 29,850,208 shares of Common Stock, 1,424,875
Series A Warrants, 2,529,803 Series B Warrants, and 3,450,000 Series C Warrants
issued and outstanding. As of March 3, 1998 there were 340 Common Stockholders,
34 Series A Warrant holders, 253 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.
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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,
1997 1996(1) 1995 1994 1993
--------- --------- --------- --------- ---------
(Dollars in thousands, except per share data)
INCOME STATEMENT DATA:
Total revenues ..................... $ 222,103 $ 147,469 $ 102,059 $ 81,609 $ 30,204
Total direct costs of revenues ..... 103,343 71,019 48,417 47,786 12,912
Total operating expenses ........... 142,166 87,770 45,091 27,976 14,955
Income (loss) from operations ...... (23,406) (11,320) 8,551 5,847 2,337
Net income (loss) (2) .............. (33,314) (14,739) 4,902 3,456 1,358
Net income (loss) applicable to
nonredeemable common stock ..... (33,314) (15,222) 4,261 2,856 1,179
Basic net income (loss) per share .. (1.11) (0.67) 0.24 0.20 0.12
Diluted net income (loss) per share (1.11) (0.67) 0.22 0.18 0.11
Shares used in basic per share
calculations (in thousands) .... 30,081 22,625 17,554 14,022 9,939
Shares used in diluted per share
calculations (in thousands) .... 30,081 22,625 19,406 15,822 11,065
CASH FLOW DATA:
Net cash provided by operating
activities ...................... 53,523 42,784 41,374 20,051 11,760
Net cash used in investing
activities ...................... (87,533) (80,505) (63,693) (64,110) (56,123)
Net cash provided by financing
activities ...................... 35,268 42,521 14,952 47,285 47,541
OTHER DATA:
EBITDA (3) ......................... $ 55,578 $ 41,960 $ 37,288 $ 23,381 $ 10,157
Cash dividends per share ........... -- 0.49 -- -- --
Rooms served at end of period (4) .. 893,000 917,000 361,000 248,000 124,000
On Demand rooms at period end .. 765,000 709,000 361,000 248,000 124,000
Scheduled rooms at period end .. 128,000 208,000 -- -- --
Hotels served at end of period ..... 3,062 3,144 1,221 751 272
Capital expenditures (5) ........... 91,307 70,545 63,693 64,110 56,153
BALANCE SHEET DATA (AT END OF PERIOD):
Total assets ....................... $ 401,388 $ 396,538 $ 211,005 $ 138,884 $ 92,363
Total debt ......................... 133,000 98,000 15,942 1,025 1,842
Redeemable common stock ............ -- -- 11,684 11,043 10,443
Total stockholders' equity ......... 217,167 250,917 169,804 108,949 67,817
(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, installation backlog, 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 effected
EBITDA (see note 3). Excluding non-
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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 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 includes 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, 1997, 1996, and
1995.
RESULTS OF OPERATIONS
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 revenues of $147.5 million in
1996. Movie revenues increased $76.7 million or 57.3% to $210.5 million
in 1997 from $133.8 million in 1996. The increase was primarily
attributable to movie 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
(PPV) movies. The Company discontinued satellite distribution of movies
due to the high costs of this 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 movie revenue increased $37.0 million or
62% to $96.6 million in 1997 as compared to the prior year, and as a
percentage of movie revenue increased to 45.9% in 1997 from 44.6% in
1996. The percentage increase reflects a lower recovery of free-to-guest
programming costs from 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.
Operations 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 in 1996, and as a percentage of total revenue increased to 15.3%
in 1997 from 10.8% in 1996. The increase is primarily due to the higher
field service costs necessary to support the acquired SpectraVision
equipment, the
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SpectraVision spare part depot used to refurbish SpectraVision equipment, and
expenses associated with the satellite outage, as previously discussed.
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 is due to the engineering support requirement of the existing
SpectraVision platforms and the development of the Company's new digital
technologies. The increase consisted of 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.
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
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 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 has not recorded
a tax benefit in 1997 from the net operating losses generated in that year
because it has established a valuation allowance against its otherwise
recognizable net deferred tax assets at December 31, 1997, due to the
uncertainty surrounding the reliability of these benefits in future tax returns.
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 percent of revenue, EBITDA decreased from 28.5% in
1996 to 25.0% in 1997. The major factor in this reduction was the increase in
operations, research and development, and selling, general and administrative
expenses, explained above.
Net loss increased to $33.3 million in 1997 from $14.7 million in 1996
due to the factors described above.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Total revenues increased $45.4 million or 44.5% to $147.5 million in
1996, as compared to total revenues of $102.1 million in 1995. Movie revenues
increased $59.3 million or 79.7% from previous year. Such increase was primarily
attributable to movie revenue generated from rooms acquired from SpectraVision
($21.4 million); increasing number of OCV's installed on-demand rooms of 466,000
in 1996, as compared to 361,000 in 1995; and, to a lesser degree, a selected
price increase by OCV. Video system sales and other revenues decreased by $13.9
million or 50.5% to $13.7 million as compared to $27.6 million in 1995. The
decrease was primarily the result of the elimination of the low margin video
system sales to Ascent following Ascent's contribution to OCV of Ascent's hotel
video assets (the "Contribution") pursuant to the Contribution Agreement (see
Note 11 to the Consolidated financial statements). The Contribution also
resulted in the elimination of the revenue from video management services from
Ascent which totaled $4.2 million in 1995.
Total direct cost of revenues increased $22.6 million or 46.7% to $71.0
million in 1996, as compared to $48.4 million in 1995. Direct costs associated
with movie revenue increased $35.6 million or 147.9% to $59.6 million in 1996 as
compared to prior year, and as a percentage of movie revenue increased to 44.6%
in 1996 from 32.3% in 1995. The dollar increase was attributable to the
acquisition of SpectraVision ($9.9 million) and
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increased number of rooms serviced by OCV. The percentage decrease was due to
lower margins on SpectraVision rooms, increased free-to-guest costs, increased
property tax expense and slightly declining revenue on a per room basis at OCV.
Direct costs from video system sales and other revenues decreased $13.0 million
or 53.2% to $11.4 million, as compared to $24.4 million in 1995. The decrease
was the result of elimination of video system sales and video management service
to Ascent described above.
Operations costs, which consist primarily of labor and material expense
required to maintain the existing on-demand equipment, increased $6.8 million or
75.3% to $15.9 million, as compared to $9.1 million in 1995, and as a percentage
of total revenue increased to 10.8% in 1996 from 8.9% in 1995. The increase is
primarily due to the additional labor and material necessary to maintain the
growing volume of installed on-demand equipment, and higher field service costs
to support the acquired SpectraVision equipment.
Research and development expenses increased $2.0 million or 75.2% to
$4.6 million as compared to $2.6 million in 1995, as a result of the Company's
continuing commitment to maintain and enhance existing products, develop new
products, and create commonality with SpectraVision's video systems.
Selling, general, and administrative expenses increased to $14.0 million
in 1996 from $3.1 million in 1995, an increase of $10.9 million. The increase is
primarily due to higher levels of business activity; increased facility costs
resulting from the addition of the former SpectraVision headquarters in
Richardson, Texas; non-recurring costs including transaction and integration
costs associated with the acquisition of SpectraVision, employee relocation and
severance costs (including former SpectraVision employees), and the relocation
of Company headquarters to San Jose, California. Non-recurring costs account for
approximately $3.2 million of the increase.
Depreciation and amortization expense increased $24.5 million or 85.4%
to $53.3 million in 1996 from $28.7 million in 1995, and as a percentage of
total revenue increased to 36.1% in 1996 from 28.2% in 1995. The increase is
primarily due to capital investments associated with installing on-demand
service in hotel rooms ($13.4 million), the acquisition of assets in 1995 from
Ascent under the Contribution Agreement ($5.7 million), and the acquisition of
SpectraVision ($5.2 million).
Interest/Other expense net increased to $3.3 million in 1996, as
compared to $0.4 million in 1995. This increase is due to the company's greater
reliance on debt financing to continue the expansion of its installed customer
base, and debt used to complete the acquisition of SpectraVision.
Provision for income taxes decreased to $0.2 million in 1996 from $3.3
million in 1995, a decrease of $3.1 million or 94.7%. The decrease was primarily
due to the net loss in 1996 offset by higher foreign taxes resulting from the
acquisition of SpectraVision. The Company has not recorded a tax benefit in 1996
from the net operating losses generated in that year because it has established
a valuation allowance against its otherwise recognizable net deferred tax assets
at December 31, 1996, due to the uncertainty surrounding the realization of
these benefits in future tax returns.
Redeemable common stock accretion decreased to $0.5 million in 1996 from
$0.6 million in 1995, reflecting a decrease of $0.1 million or 24.6%. Concurrent
with the Merger and Acquisition, the Redeemable Common Stock was converted to
common stock of the Company. Therefore, accretion was recorded for a partial
year in 1996 compared to a full year in 1995.
EBITDA increased to $42.0 million in 1996 from $37.3 million in 1995,
reflecting an increase of $4.7 million or 12.5%. EBITDA, as a percentage of
total revenue, decreased to 28.5% in 1996 from 36.5% in 1995. Eliminating
non-recurring adjustments, EBITDA totaled $48.7 million in 1996 or 33% of total
revenues. The reduced percentage is primarily due to the higher operating costs
currently associated with the SpectraVision business, higher free-to-guest
costs, and higher administrative expense necessary to operate as a public
company.
Net income (loss) decreased to a net loss of $14.7 million in 1996 from
net income of $4.9 million in 1995 due to the factors described above.
SEASONALITY
The Company's business is expected to be seasonal where revenues are
influenced principally by hotel occupancy rates and the "buy rate" or percentage
of occupied rooms at hotels that buy movies or other services at the property.
Higher revenues are generally realized during the summer months and lower
revenues realized during the winter months due to business and vacation travel
patterns which impact the lodging industry's occupancy rates.
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Buy rates generally reflect the hotel's guest demographic mix, the popularity of
the motion picture or services available at the hotel and the guests' other
entertainment alternatives.
LIQUIDITY AND CAPITAL RESOURCES
The primary sources of cash during 1997 were cash from operations of
$53.5 million, and net borrowings of $35.0 million from the Company's revolving
credit facility. Cash was expended primarily for capital expenditures which
totaled $92.3 million, primarily for the installation of on-demand systems and
the conversion of SpectraVision systems in hotels.
The Company's principal cash requirements in 1998 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 1998. The
Company believes that its internally generated cash and its remaining capacity
under its Credit Facility will provide sufficient funding for the foreseeable
future.
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") with
NationsBank of Texas, N.A. (NationsBank). 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, 1997, there was $67.0 million of available
borrowings under the Credit Facility, subject to certain covenant restrictions.
See Note 6 in the Notes to Consolidated Financial Statements appearing elsewhere
in this document.
LIMITATIONS ON ADDITIONAL DEBT FINANCING
On Command and Ascent entered into a Corporate Agreement, as amended
(the "Corporate Agreement") pursuant to which OCC has agreed, among other
things, not to incur any indebtedness without Ascent's prior written consent,
other than indebtedness under the Credit Facility, and indebtedness incurred in
the ordinary course of operations, which together shall not exceed $140 million
through December 31, 1997. Subsequent to December 31, 1997, the Corporate
Agreement was amended to increase the OCC indebtedness limit to $157 million
through December 31, 1998.
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.
INTEREST RATES AND INFLATION
Fluctuations in interest rates and inflation have not had a material
effect on the operations of the Company to date. However, if management believes
the direction of future interest rates pose a significant risk to the operations
of the Company, it will consider using interest rate contracts, swap
arrangements, or other financial instruments designed to limit exposure to
interest rate fluctuations.
BUSINESS RISKS
CONTROL BY ASCENT
Ascent owned approximately 57.2% of the outstanding OCC Common Stock at
December 31, 1997. 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.
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RESTRICTIONS ON DEBT AND EQUITY FINANCINGS
Pursuant to the Corporate Agreement entered into between Ascent and On
Command Corporation, as amended, On Command Corporation has agreed, among other
things, not to incur any indebtedness without Ascent's prior written consent,
other than indebtedness under the Credit Facility and indebtedness incurred in
the ordinary course of operations, which together shall not exceed $157 million
in the aggregate, and not to issue any equity security without the prior written
consent of Ascent. Restrictions on On Command Corporation's ability to incur
additional debt and equity could adversely affect On Command Corporation's plans
for growth, its ability to develop new products and technologies and its ability
to meet its liquidity needs.
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, OCV relied on capital provided by COMSAT and
Ascent and cash flow from operations to finance its growth. On Command
Corporation intends to use cash flow from operations and additional borrowings
(subject to the limitations discussed under "Restrictions on Debt Financings")
to support its growth. Whether or when On Command Corporation can achieve
intended cash flow levels sufficient to completely 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
"Restrictions on 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.
INTEGRATION OF OCV AND SPECTRAVISION BUSINESSES
While the Company has substantially completed the integration of
SpectraVision's operating systems, financial reporting, sales, marketing and
management, certain information systems require further integration and a
significant portion of the installed base of hotel rooms acquired in the
SpectraVision acquisition remains to be converted to OCC's on-demand technology.
Management expects that this conversion process, which is scheduled to be
completed by the end of 2000, will result in financial improvement due to
increased revenues attributable to OCV system's on-demand capabilities and
reduced system downtime, as well as lower field service costs. There can be no
assurance that the conversion process will be completed on schedule or that the
desired financial improvements will be realized. The inability to complete the
conversion process on schedule and realize such financial improvements could
have a material adverse effect on the financial condition or results of
operations of OCC.
THINLY TRADED STOCK IN THE PUBLIC MARKET AND POSSIBLE VOLATILITY OF STOCK PRICE
As approximately 42.8 % of the outstanding On Command Common Stock, is
traded on the NASDAQ Stock Market as of March 3, 1998, 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 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 OCC 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 OCC of one or more of the major hotel chain customers, such as Marriott
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),
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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. Furthermore, particularly in the provision of Internet services
to the hotel guest, the Company anticipates that it will face competition from
traditional in-room entertainment competitors as well as new competitors, some
of whom may have access to additional capital resources that OCC does not have.
DEPENDENCE ON SIGNIFICANT CUSTOMERS
Hotels affiliated with Marriott, Holiday Inn and Hilton accounted for
approximately 21%, 11% and 10%, respectively, of On Command Corporation's
revenues for the year ended December 31, 1997. 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
The business of On Command is closely linked to the performance of the
hotel industry in which occupancy rates have recently been near their all-time
high. 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.
TECHNOLOGICAL DEVELOPMENTS
Technology in the entertainment, information 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. However,
there can be no assurance the Company will be successful in developing new
technology and systems or in enhancing existing technology and systems or that
new or enhanced technology and systems, including but not limited to On
Command's digital and Internet access technologies will timely meet market
requirements. The Company has, from time to time, experienced delays in
introducing new technology and there can be no assurance that On Command
Corporation will have the financial or technological resources to be successful
in its future introductions of new technology.
DEPENDENCE ON KEY PERSONNEL
On Command Corporation's success will be dependent upon the
contributions of its executive officers, especially Robert M. Kavner, its
President and Chief Executive Officer and Brian A.C. Steel, its Executive Vice
President, Chief Financial Officer 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. Messrs. Kavner and
Steel have entered into employment agreements with On Command Corporation.
SEASONALITY
The Company's business is expected to be seasonal where revenues are
influenced principally by hotel occupancy rates and the "buy rate" or percentage
of occupied rooms at hotels that buy movies or other services at the property.
Higher revenues are generally realized during the summer months and lower
revenues realized during the winter months due to business and vacation travel
patterns which impact the lodging industry's occupancy rates. Buy rates
generally reflect the hotel's guest demographic mix, the popularity of the
motion picture or services available at the hotel and the guests' other
entertainment alternatives.
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PROGRAMMING
The cost to the Company to license feature movies from major motion
picture studios is subject to change as the major motion picture studios
continue to negotiate for higher royalty rates and higher minimum payments by
the Company, as well as a shorter Hotel/Motel Pay-Per-View Window. Such changes
may have adverse impacts on the Company's earnings. In addition the Company has
experienced periods of, and may continue to experience periods of, slight
declines in its movie buy-rates. While the Company is taking measures to address
such trends, there can be no assurance that the Company's efforts will prove
effective. In addition, as the Company tests and begins marketing of new
programming alternatives for guests, there can be no assurance that such
programming will timely meet market requirements.
YEAR 2000
The Company has developed preliminary plans to address the possible exposure
related to the impact on its computer systems of the Year 2000. Key financial
information and operational and product systems have been assessed and plans
have been developed to address systems modifications required by December 31,
1999. The financial impact of making the required systems changes is not
expected to be material to the Company's consolidated financial position,
results of operations, or cash flow. In addition, the Company will be
communicating with others with whom it does significant business, including but
not limited to its suppliers and hotel customers, to determine their Year 2000
compliance readiness and the extent to which the Company is vulnerable to any
third party Year 2000 issues. However, there can be no guarantee that the
systems of other companies on which the Company's systems rely will be timely
converted, or that a failure to convert by another company, or a conversion that
is incompatible with the Company's systems, would not have a material adverse
effect on the Company.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Independent Auditors' Report
Consolidated Balance Sheets at December 31, 1997 and 1996
Consolidated Statements of Operations for the years ended December 31, 1997,
1996, and 1995
Consolidated Statements of Stockholders' Equity for the years ended December 31,
1997, 1996, and 1995
Consolidated Statements of Cash Flows for the years ended December 31, 1997,
1996, and 1995
Notes to the Consolidated Financial Statements
Quarterly Results of Operations for the years ended December 31, 1997 and 1996
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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, 1997 and 1996, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1997. 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, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997 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.
DELOITTE & TOUCHE LLP
San Jose, California
February 4, 1998
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ON COMMAND CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996 (IN THOUSANDS, EXCEPT PAR VALUE AMOUNTS)
- - ------------------------------------------------------------------------------------------------------
1997 1996
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 6,287 $ 5,733
Accounts receivable (less allowance for doubtful accounts of $1,630 in 1997
and $629 in 1996) 26,827 25,328
Other current assets 1,959 3,718
Deferred income taxes -- 1,593
--------- ---------
Total current assets 35,073 36,372
VIDEO SYSTEMS, Net 270,531 250,600
PROPERTY AND EQUIPMENT, Net 7,850 11,037
GOODWILL, Net 82,049 89,503
OTHER ASSETS, Net 5,885 9,374
--------- ---------
$ 401,388 $ 396,886
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 20,051 $ 16,823
Accounts payable to stockholder 104 21
Accrued compensation 5,805 4,931
Other accrued liabilities 9,763 6,859
Income taxes payable 2,113 6,970
Other taxes payable 9,002 8,807
Current portion of revolving credit facility -- 48,000
--------- ---------
Total current liabilities 46,838 92,411
OTHER ACCRUED LIABILITIES 4,165 1,700
LONG-TERM PORTION OF REVOLVING CREDIT FACILITY 133,000 50,000
DEFERRED INCOME TAXES 218 1,858
--------- ---------
Total liabilities 184,221 145,969
COMMITMENTS AND CONTINGENCIES -- --
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; shares authorized - 10,000; none outstanding -- --
Common stock, $.01 par value; shares authorized - 50,000 in 1997 and 1996;
shares issued and outstanding, 29,801 in 1997 and 29,087 in 1996;
shares subscribed -315 in 1996 and 960 in 1996 301 300
Additional paid-in capital 249,431 249,164
Common stock warrants 31,450 31,450
Cumulative translation adjustments (964) (260)
Accumulated deficit (63,051) (29,737)
--------- ---------
Total stockholders' equity 217,167 250,917
--------- ---------
$ 401,388 $ 396,886
========= =========
See accompanying notes to consolidated financial statements.
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ON COMMAND CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- - -----------------------------------------------------------------------------------------------------
1997 1996 1995
REVENUES:
Movie revenues $ 210,493 $ 133,813 $ 74,464
Video systems sales/Other 11,610 13,656 27,595
--------- --------- ---------
Total revenues (see Note 11 for related party revenues) 222,103 147,469 102,059
--------- --------- ---------
DIRECT COSTS OF REVENUES:
Movie revenues 96,617 59,628 24,052
Video systems sales 6,726 11,391 24,365
--------- --------- ---------
Total direct costs of revenues 103,343 71,019 48,417
--------- --------- ---------
OPERATING EXPENSES:
Operations 33,993 15,870 9,054
Research and development 6,912 4,628 2,642
Selling, general and administrative 22,277 13,992 3,118
Settlement of litigation -- -- 1,540
Depreciation and amortization 78,984 53,280 28,737
--------- --------- ---------
Total operating expenses 142,166 87,770 45,091
--------- --------- ---------
INCOME (LOSS) FROM OPERATIONS (23,406) (11,320) 8,551
INTEREST INCOME 155 104 61
INTEREST/OTHER EXPENSE (9,277) (3,349) (413)
--------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES (32,528) (14,565) 8,199
PROVISION FOR INCOME TAXES 786 174 3,297
--------- --------- ---------
NET INCOME (LOSS) (33,314) (14,739) 4,902
REDEEMABLE COMMON STOCK ACCRETION -- (483) (641)
--------- --------- ---------
NET INCOME (LOSS) APPLICABLE TO
NONREDEEMABLE COMMON STOCK $ (33,314) $ (15,222) $ 4,261
========= ========= =========
BASIC NET INCOME (LOSS) PER SHARE $ (1.11) $ (0.67) $ 0.24
========= ========= =========
DILUTED NET INCOME (LOSS) PER SHARE $ (1.11) $ (0.67) $ 0.22
========= ========= =========
SHARES USED IN BASIC PER SHARE COMPUTATIONS 30,081 22,625 17,554
========= ========= =========
SHARES USED IN DILUTED PER SHARE COMPUTATIONS 30,081 22,625 19,406
========= ========= =========
See accompanying notes to consolidated financial statements.
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ON COMMAND CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (IN THOUSANDS)
- - ---------------------------------------------------------------------------------------------------------------------------------
COMMON STOCK ADDITIONAL COMMON CUMULATIVE RETAINED TOTAL
--------------- PAID-IN STOCK TRANSLATION EARNINGS STOCKHOLDERS'
SHARES AMOUNT CAPITAL WARRANTS ADJUSTMENTS (DEFICIT) EQUITY
BALANCES, December 31, 1994 15,326 153 108,981 840 - (1,025) 108,949
Common stock issued in connection
with contribution agreement with
Ascent (see Note 11) 5,337 53 56,486 56,539
Exercise of stock options 6 1 34 35
Income tax benefit of
stock option transactions 20 20
Accretion of redeemable common stock (641) (641)
Net income 4,902 4,902
------ ----- --------- -------- -------- --------- ---------
BALANCES, December 31, 1995 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 11) (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
====== ===== ========= ======== ======== ========= =========
See accompanying notes to consolidated financial statements.
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ON COMMAND CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (IN THOUSANDS)
- - ---------------------------------------------------------------------------------------------------------------------
1997 1996 1995
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (33,314) $ (14,739) $ 4,902
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 78,984 53,280 28,737
Deferred income taxes, net (47) 195 4,506
Provision for loss on long term investment 917
(Gain)/Loss on disposal of fixed assets (844) 64 232
Changes in assets and liabilities net of effects
from acquired operations:
Accounts receivable (1,584) (962) 3,959
Accounts receivable from stockholder -- -- 4,500
Other current assets 1,420 (1,024) (499)
Accounts payable 3,246 (5,542) (3,235)
Accounts payable to stockholder 83 (185) (2,900)
Accrued compensation 880 1,950 (355)
Other accrued liabilities 5,395 (2,771) 159
Income taxes payable (1,855) 4,282 1,746
Other taxes payable 200 8,807 --
Deferred revenue (571) (378)
--------- --------- ---------
Net cash provided by operating activities 53,481 42,784 41,374
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net cash paid in acquisition of SpectraVision -- (9,572) --
Capital expenditures (92,307) (70,545) (63,693)
Proceeds from sale of property and equipment 4,263 46 --
Other assets -- (434) --
--------- --------- ---------
Net cash used in investing activities (88,044) (80,505) (63,693)
--------- --------- -------