**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

 

**FORM 10-Q**

** **

**ý****                                ****QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For the quarterly period ended March 31, 2003**

** **

**OR**

** **

**o****                                ****TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For the transition period from                      to                      **

** **

**CommissionFile Number:  00-21315**

** **

**ON COMMAND CORPORATION**

(Exact name of Registrant as specified in its charter)

 

| **Delaware**                                              |   | **77-0435194**                       |
|-----------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of                           |   | (I.R.S. Employer Identification No.) |
| incorporation or organization)                            |   |                                 |
|                                                      |   |                                 |
| **4610 South Ulster Street, 6th Floor  Denver, Colorado** |   | **80237**                            |
| (Address of principal executive offices)                  |   | (Zip Code)                           |

 

Registrant’s telephone number, including area code: **(720) 873-3200**

 

Indicate bycheck mark whether the registrant is an accelerated filer (as described in  Rule 12(b)-2 of the Securities ExchangeAct).  oYes ý No

 

Indicate bycheck mark whether the Registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days ýYes o No

 

The number ofshares outstanding of the Registrant’s Common Stock as of May 1, 2003 was30,858,340 shares.

 

 

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**ON COMMAND CORPORATION**

(An Indirect Consolidated Subsidiary of Liberty Media Corporation)

Condensed Consolidated Balance Sheets

(unaudited)

 
|                                                    |   | **March 31,**               |    | **December  31,** |   |
|---------------------------------------------------------|--------|-----------------------------|---------|-------------------|--------|
|                                                    |   | **2003**                    |    | **2002**          |   |
|                                                    |   | **(amounts  in thousands)** |    |
| Assets                                                  |   |                        |    |              |   |
| Current assets:                                         |   |                        |    |              |   |
| Cash and cash equivalents                               |   | $                           | 3,036   |              | $      | 4,501 |   |
| Accounts receivable, net                                |   | 30,531                      |    | 33,525            |   |
| Other current assets                                    |   | 3,245                       |    | 3,461             |   |
| Total current assets                                    |   | 36,812                      |    | 41,487            |   |
|                                                    |   |                        |    |              |   |
| Property and  equipment:                                |   |                        |    |              |   |
| Video systems                                           |   |                        |    |              |   |
| In service                                              |   | 675,156                     |    | 668,697           |   |
| Construction in progress                                |   | 35,290                      |    | 37,511            |   |
|                                                    |   | 710,446                     |    | 706,208           |   |
| Support equipment, vehicles and leasehold  improvements |   | 26,231                      |    | 26,245            |   |
|                                                    |   | 736,677                     |    | 732,453           |   |
| Accumulated depreciation                                |   | (467,901                    | )       | (457,482          | )      |
|                                                    |   | 268,776                     |    | 274,971           |   |
|                                                    |   |                        |    |              |   |
| Goodwill                                                |   | 65,580                      |    | 65,580            |   |
|                                                    |   |                        |    |              |   |
| Other assets, net                                       |   | 14,691                      |    | 14,444            |   |
|                                                    |   |                        |    |              |   |
| Total assets                                            |   | $                           | 385,859 |              | $      | 396,482 |   |
|                                                    |   | (continued)                 |    |

 

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**ON COMMAND CORPORATION**

(An Indirect Consolidated Subsidiary of Liberty Media Corporation)

Condensed Consolidated Balance Sheets

(unaudited)

 

(continued)

 
|                                                                                                                                 |   | **March 31,**               |    | **December  31,** |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|---------|-------------------|--------|
|                                                                                                                                 |   | **2003**                    |    | **2002**          |   |
|                                                                                                                                 |   | **(amounts  in thousands)** |    |
| Liabilities and Stockholders’ Deficit                                                                                           |   |                        |    |              |   |
| Current liabilities:                                                                                                                 |   |                        |    |              |   |
| Accounts payable                                                                                                                     |   | $                           | 21,596  |              | $      | 28,689 |   |
| Accounts payable to parent (note 5)                                                                                                  |   | 1,191                       |    | 1,906             |   |
| Accrued compensation                                                                                                                 |   | 5,545                       |    | 6,433             |   |
| Sales, use and property tax liabilities                                                                                              |   | 4,693                       |    | 4,585             |   |
| Other accrued liabilities                                                                                                            |   | 7,243                       |    | 7,987             |   |
| Current portion of debt (note 4)                                                                                                     |   | 833                         |    | 833               |   |
|                                                                                                                                 |   |                        |    |              |   |
| Total current liabilities                                                                                                            |   | 41,101                      |    | 50,433            |   |
|                                                                                                                                 |   |                        |    |              |   |
| Long-term debt (note 4)                                                                                                              |   | 265,695                     |    | 261,946           |   |
| Other long-term liabilities                                                                                                          |   | 223                         |    | 496               |   |
| Total liabilities                                                                                                                    |   | 307,019                     |    | 312,875           |   |
|                                                                                                                                 |   |                        |    |              |   |
| Minority interest in consolidated  subsidiary                                                                                        |   | 245                         |    | 259               |   |
|                                                                                                                                 |   |                        |    |              |   |
| Redeemable securities:                                                                                                               |   |                        |    |              |   |
| Mandatorily redeemable preferred stock                                                                                               |   | 100,110                     |    | 97,848            |   |
| Common stock subject to repurchase  obligation (note 7)                                                                              |   | 2,333                       |    | 2,333             |   |
| Total redeemable securities                                                                                                          |   | 102,443                     |    | 100,181           |   |
|                                                                                                                                 |   |                        |    |              |   |
| Stockholders’ deficit:                                                                                                          |   |                        |    |              |   |
| Preferred stock, $.01 par value; shares  authorized – 10,000,000; shares issued and outstanding – 98,500 in 2003 and  2002 |   | —                      |    | —            |   |
| Common stock, $.01 par value; shares  authorized - 150,000,000; shares issued – 30,977,840 in 2003 and 30,973,989  in 2002      |   | 310                         |    | 310               |   |
| Additional paid-in capital                                                                                                           |   | 297,566                     |    | 299,398           |   |
| Accumulated other comprehensive loss                                                                                                 |   | (2,478                      | )       | (4,533            | )      |
| Accumulated deficit                                                                                                                  |   | (292,585                    | )       | (285,777          | )      |
|                                                                                                                                 |   | 2,813                       |    | 9,398             |   |
| Common stock held in treasury, at cost  (119,500 shares in 2003 and 2002)                                                            |   | (1,344                      | )       | (1,344            | )      |
| Note receivable from stockholder (note 5)                                                                                            |   | (25,317                     | )       | (24,887           | )      |
| Total stockholders’ deficit                                                                                                     |   | (23,848                     | )       | (16,833           | )      |
|                                                                                                                                 |   |                        |    |              |   |
| Commitments and contingencies (notes 6 and  7)                                                                                       |   |                        |    |              |   |
|                                                                                                                                 |   |                        |    |              |   |
| Total liabilities and stockholders’ deficit                                                                                     |   | $                           | 385,859 |              | $      | 396,482 |   |

 

See accompanying notes tocondensed consolidated financial statements.

 

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**ON COMMAND CORPORATION**

(An Indirect Consolidated Subsidiary of Liberty Media Corporation)

Condensed Consolidated Statements of Operations

(unaudited)

 
|                                                                          |   | **Three  Months Ended  March 31,** |   |
|-------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                          |   | **2003**                           |   | **2002** |   |
|                                                                          |   | **(amounts  in thousands)**        |   |
| Net revenue:                                                                  |   |                               |   |   |   |
| Net room revenue                                                              |   | $                                  | 54,754 |   | $ | 54,254 |   |
| System and equipment sales and other                                          |   | 1,966                              |   | 3,129 |   |
| Total net revenue                                                             |   | 56,720                             |   | 57,383 |   |
|                                                                          |   |                               |   |   |   |
| Direct costs of net revenue:                                                  |   |                               |   |   |   |
| Content fees, commissions and other in-room  services                         |   | 27,386                             |   | 27,884 |   |
| System, equipment and other costs                                             |   | 862                                |   | 1,380 |   |
| Total costs of net revenue                                                    |   | 28,248                             |   | 29,264 |   |
|                                                                          |   |                               |   |   |   |
| Direct margin (exclusive of other operating  expenses shown separately below) |   | 28,472                             |   | 28,119 |   |
|                                                                          |   |                               |   |   |   |
| Other operating expenses:                                                     |   |                               |   |   |   |
| Operations support                                                            |   | 6,062                              |   | 6,506 |   |
| Research and development                                                      |   | 1,083                              |   | 957 |   |
| Selling, general and administrative (note  5)                                 |   | 5,576                              |   | 5,542 |   |
| Depreciation and amortization                                                 |   | 18,963                             |   | 20,131 |   |
| Asset impairments and other charges                                           |   | 325                                |   | 1,829 |   |
| Total other operating expenses                                                |   | 32,009                             |   | 34,965 |   |
|                                                                          |   |                               |   |   |   |
| Loss from operations                                                          |   | (3,537                             | )      | (6,846 | ) |
|                                                                          |   |                               |   |   |   |
| Interest expense                                                              |   | (3,353                             | )      | (3,606 | ) |
| Other income, net                                                             |   | 170                                |   | 482 |   |
|                                                                          |   |                               |   |   |   |
| Loss before income taxes                                                      |   | (6,720                             | )      | (9,970 | ) |
|                                                                          |   |                               |   |   |   |
| Income tax expense                                                            |   | (88                                | )      | (43 | ) |
|                                                                          |   |                               |   |   |   |
| Net loss                                                                      |   | (6,808                             | )      | (10,013 | ) |
|                                                                          |   |                               |   |   |   |
| Dividends on mandatorily redeemable  preferred stock                          |   | (2,262                             | )      | (2,054 | ) |
|                                                                          |   |                               |   |   |   |
| Net loss attributable to common  stockholders                                 |   | $                                  | (9,070 | ) | $ | (12,067 | ) |
|                                                                          |   |                               |   |   |   |
| Basic and diluted net loss per common share  (note 2)                         |   | $                                  | (0.29  | ) | $ | (0.39 | ) |
|                                                                          |   |                               |   |   |   |
| Basic and diluted weighted average number  of common shares outstanding       |   | 30,858                             |   | 30,892 |   |

 

See accompanying notes tocondensed consolidated financial statements.

 

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**ON COMMAND CORPORATION**

(An Indirect Consolidated Subsidiary of Liberty Media Corporation)

Condensed Consolidated Statements of Comprehensive Loss

(unaudited)

 
|                                                 |   | **Three  Months Ended  March 31,** |       |
|------------------------------------------------------|--------|------------------------------------|------------|
|                                                 |   | **2003**                           |       | **2002** |   |
|                                                 |   | **(amounts  in thousands)**        | ** ** |
|                                                 |   |                               |       |   |   |
| Net loss                                             |   | $                                  | (6,808     | ) | $ | (10,013 | ) |
| Foreign currency translation adjustment,  net of tax |   | 2,055                              |       | (71 | ) |
|                                                 |   |                               |       |   |   |
| Comprehensive loss                                   |   | $                                  | (4,753     | ) | $ | (10,084 | ) |

 

See accompanying notes tocondensed consolidated financial statements.

 

I-4

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**ON COMMAND CORPORATION**

(An Indirect Consolidated Subsidiary of Liberty Media Corporation)

Condensed Consolidated Statement of Stockholders’ Deficit

Three Months Ended March 31, 2003

(unaudited)

 
|                                                 |   | **Preferred  stock**       |   | **Common  stock** |   | **Additional  paid-in  Capital** |   | **Accumulated  other  comprehensive  loss** |    | **Accumulated  deficit** |   | **Treasury  stock** |   | **Note  receivable  from  stockholder** |     | **Total  stockholders’  deficit** |   |
|------------------------------------------------------|--------|----------------------------|--------|-------------------|--------|----------------------------------|--------|---------------------------------------------|---------|--------------------------|--------|---------------------|--------|-----------------------------------------|----------|----------------------------------------|--------|
|                                                 |   | **(amounts in thousands)** |   |
| Balance at December 31, 2002                         |   | $                          | — |              | $      | 310                              |   | $                                           | 299,398 |                     | $      | (4,533              | )      | $                                       | (285,777 | )                                      | $      | (1,344 | ) | $ | (24,887 | ) | $ | (16,833 | ) |
| Net loss                                             |   | —                     |   | —            |   | —                           |   | —                                      |    | (6,808                   | )      | —              |   | —                                  |     | (6,808                                 | )      |
| Other comprehensive income                           |   | —                     |   | —            |   | —                           |   | 2,055                                       |    | —                   |   | —              |   | —                                  |     | 2,055                                  |   |
| Interest on stockholder note (note 5)           |   | —                     |   | —            |   | 430                              |   | —                                      |    | —                   |   | —              |   | (430                                    | )        | —                                 |   |
| Dividends on mandatorily redeemable  preferred stock |   | —                     |   | —            |   | (2,262                           | )      | —                                      |    | —                   |   | —              |   | —                                  |     | (2,262                                 | )      |
| Balance at March 31, 2003                            |   | $                          | — |              | $      | 310                              |   | $                                           | 297,566 |                     | $      | (2,478              | )      | $                                       | (292,585 | )                                      | $      | (1,344 | ) | $ | (25,317 | ) | $ | (23,848 | ) |
|                                                      |        |                            |        |                   |        |                                  |        |                                             |         |                          |        |                     |        |                                         |          |                                        |        |  |  |  |  |  |  |  |  |  |  |

 

See accompanying notes tocondensed consolidated financial statements.

 

I-5

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**ON COMMAND CORPORATION**

(An Indirect Consolidated Subsidiary of Liberty Media Corporation)

Condensed Consolidated Statements of Cash Flows

(unaudited)

 
|                                                                             |   | **Three  Months Ended March 31,** |   |
|----------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                             |   | **2003**                          |   | **2002** |   |
|                                                                             |   | **(amounts  in thousands)**       |   |
|                                                                             |   | **(note 3)**                      |   |
| Cash flows from operating activities:                                            |   |                              |   |   |   |
| Net loss                                                                         |   | $                                 | (6,808 | ) | $ | (10,013 | ) |
| Adjustments to reconcile net loss to net  cash provided by operating activities: |   |                              |   |   |   |
| Depreciation and amortization                                                    |   | 18,963                            |   | 20,131 |   |
| Payments of restructuring costs                                                  |   | (273                              | )      | (480 | ) |
| Asset impairments and other charges                                              |   | 325                               |   | 1,829 |   |
| Other non-cash items                                                             |   | 287                               |   | 196 |   |
| Changes in assets and liabilities:                                               |   |                              |   |   |   |
| Accounts receivable                                                              |   | 3,137                             |   | (2,062 | ) |
| Other assets                                                                     |   | 521                               |   | 630 |   |
| Accounts payable                                                                 |   | (6,431                            | )      | (527 | ) |
| Accounts payable to parent                                                       |   | (833                              | )      | (37 | ) |
| Accrued compensation                                                             |   | (869                              | )      | 246 |   |
| Sales, use and property tax liabilities                                          |   | 81                                |   | (362 | ) |
| Other accrued liabilities                                                        |   | (762                              | )      | 818 |   |
|                                                                             |   |                              |   |   |   |
| Net cash provided by operating activities                                        |   | 7,338                             |   | 10,369 |   |
|                                                                             |   |                              |   |   |   |
| Cash flows from investing activities:                                            |   |                              |   |   |   |
| Capital expenditures                                                             |   | (11,998                           | )      | (12,440 | ) |
| Cost investments                                                                 |   | —                            |   | (1,716 | ) |
|                                                                             |   |                              |   |   |   |
| Net cash used in investing activities                                            |   | (11,998                           | )      | (14,156 | ) |
|                                                                             |   |                              |   |   |   |
| Cash flows from financing activities:                                            |   |                              |   |   |   |
| Borrowings of debt                                                               |   | 4,000                             |   | 7,000 |   |
| Repayments of debt                                                               |   | (251                              | )      | (270 | ) |
| Payment of deferred financing costs                                              |   | (550                              | )      | — |   |
| Proceeds from issuance of common and  preferred stock                            |   | —                            |   | 31 |   |
|                                                                             |   |                              |   |   |   |
| Net cash provided by financing activities                                        |   | 3,199                             |   | 6,761 |   |
|                                                                             |   |                              |   |   |   |
| Effect of exchange rate changes on cash                                          |   | (4                                | )      | (29 | ) |
|                                                                             |   |                              |   |   |   |
| Net increase (decrease) in cash and cash  equivalents                            |   | (1,465                            | )      | 2,945 |   |
|                                                                             |   |                              |   |   |   |
| Cash and cash equivalents, beginning of  period                                  |   | 4,501                             |   | 2,869 |   |
|                                                                             |   |                              |   |   |   |
| Cash and cash equivalents, end of period                                         |   | $                                 | 3,036  |   | $ | 5,814 |   |

 

See accompanying notes tocondensed consolidated financial statements.

 

I-6

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**ON COMMAND CORPORATION**

(An Indirect Consolidated Subsidiary of Liberty Media Corporation)

Notes to Condensed Consolidated Financial Statements

 

March 31, 2003

(unaudited)

 

(1)                                  BasisOf Presentation

 

On CommandCorporation is a Delaware corporation formed in July 1996 by Ascent EntertainmentGroup, Inc. (“Ascent”).  Ascent is thecontrolling stockholder of On Command Corporation (together with itsconsolidated subsidiaries, “On Command” or the “Company”). On March 28, 2000,Liberty Media Corporation (“Liberty”) closed a cash tender offer for the commonstock of Ascent and thereby obtained control of the Company.  On June 8, 2000, Liberty completed a mergerwith Ascent pursuant to which Ascent became an indirect, wholly-ownedsubsidiary of Liberty.  The portion ofLiberty’s cost to acquire Ascent that is attributable to the Company has notbeen reflected in the accompanying condensed consolidated financial statementsof the Company due to the fact that a significant percentage of the Company’scommon stock (“Company Common Stock”) is owned by stockholders other thanLiberty.  In April 2002, LibertySatellite & Technology, Inc., (“LSAT”), a majority-owned subsidiary ofLiberty, acquired 100% of the common equity of Ascent.  At March 31, 2003, LSAT, through itsownership interest in Ascent, owned approximately 74% of the outstandingCompany Common Stock and 100% of certain series of the Company’s preferredstock, which ownership interests collectively represented approximately 80% ofthe voting power associated with On Command’s common and preferred securities.

 

The Companydevelops, assembles and operates proprietary video systems. The Company’sprimary distribution system allows hotel guests to select, on an on-demandbasis, motion pictures on computer-controlled television sets located in theirhotel rooms. The Company also provides in-room viewing of select cable channelsand other interactive services under long-term contracts to hotels. Theseinteractive services include video games, Internet offerings, digital music andvarious hotel and guest services. At March 31, 2003, the Company’s primaryoperating subsidiaries or branches were located in the United States, Canadaand Mexico.

 

These interimcondensed consolidated financial statements are unaudited. In the opinion ofmanagement, all adjustments (consisting only of normal recurring accruals) havebeen made which are necessary to present fairly the financial position of theCompany as of March 31, 2003, as well as the results of its operations for thethree months ended March 31, 2003 and 2002. The results of operations for anyinterim period are not necessarily indicative of the results for the entireyear. These condensed consolidated financial statements should be read inconjunction with the consolidated financial statements and related notesthereto included in the Company’s December 31, 2002 Annual Report on Form 10-K.

 

Thepreparation of consolidated financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent liabilities, as well asthe reported amounts of revenue and expenses. Significant estimates areinvolved in determining the allowance for doubtful accounts receivable, assetimpairments, the estimated useful lives of property and equipment andintangible assets, and the amounts of certain accrued liabilities. Actualresults may  vary significantly fromthese estimates.

 

Certain priorperiod amounts have been reclassified for comparability with the 2003presentation.

 

 

I-7

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(2)                                  Earnings(Loss) Per Common Share

 

The loss percommon share for the three months ended March 31, 2003 and 2002 is based on30,858,000 and 30,892,000 weighted average shares outstanding during therespective periods.  Potential commonshares were not included in the computation of diluted earnings per sharebecause their inclusion would be anti-dilutive.  At March 31, 2003 and 2002, the number of potential dilutivecommon shares was approximately 19,966,000 and 20,933,000, respectively.  Such potential common shares consist ofstock options to acquire shares of Company Common Stock, warrants andconvertible securities.  The foregoingpotential common share amount does not take into account the assumed number ofshares that may be repurchased by the Company upon the exercise of stockoptions.

 

(3)                                  SupplementalDisclosures to Consolidated Statements of Cash Flows

 

Cash paid forinterest was $3,209,000 and $2,848,000 during the three months ended March 31,2003 and 2002, respectively.  Cash paidfor income taxes was not significant during these periods.

 

(4)                                  Debt

 

Debt issummarized as follows (amounts in thousands):

 
|                         |   | **March 31,  2003** |    | **December  31,  2002** |   |
|------------------------------|--------|---------------------|---------|-------------------------|--------|
|                         |   |                |    |                    |   |
| Revolving Credit Facility(a) |   | $                   | 265,633 |                    | $      | 261,633 |   |
| Capital lease obligations    |   | 895                 |    | 1,146                   |   |
|                         |   | 266,528             |    | 262,779                 |   |
| Less current portion         |   | (833                | )       | (833                    | )      |
|                         |   | $                   | 265,695 |                    | $      | 261,946 |   |

 

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(a)               TheCompany’s revolving credit facility, as amended, (the “Revolving CreditFacility”) provided for aggregate borrowings of $275,000,000 at March 31,2003.  Borrowings under the RevolvingCredit Facility are due and payable in July 2004.  The Company had $9,367,000 of remaining availability under theRevolving Credit Facility at March 31, 2003. The Company’s ability to draw additional funds under the RevolvingCredit Facility is subject to the Company’s continued compliance withapplicable financial covenants.

 

Revolvingloans extended under the Revolving Credit Facility bear interest at the LondonInterbank Offered Rate (“LIBOR”) plus a spread that may range from 1.10% to2.75% depending on certain operating ratios of the Company (3.82% effectiveborrowing rate at March 31, 2003).  Inaddition, a facility fee ranging from 0.15% to 0.50% per annum is charged onthe Revolving Credit Facility, depending on certain operating ratios of theCompany.  The Revolving Credit Facilitycontains customary covenants and agreements, most notably the inclusion ofrestrictions on the Company’s ability to pay dividends or make otherdistributions, and restrictions on the Company’s ability to make capitalexpenditures.  In addition, the Companyis required to maintain leverage and interest coverage ratios.  The Company was in compliance with

 

I-8

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such covenantsat March 31, 2003.  Substantially all ofthe Company’s assets are pledged as collateral for borrowings under theRevolving Credit Facility.

 

On March 28,2003, the Company and its bank lenders amended the Revolving CreditFacility  to postpone until June 30,2003 the step down of the leverage ratio covenant of its Revolving CreditFacility from 4.25 to 3.50. Accordingly, the maximum leverage ratio permittedunder the Revolving Credit Facility at March 31, 2003 was 4.25, and theCompany’s actual leverage ratio was 4.00 as of such date.  On April 17, 2003, the Company and its bank lenders executed an Amended andRestated Credit Agreement.  The closingof the Amended and Restated Credit Agreement is contingent upon thecontribution of $40,000,000 by Liberty to the Company to be used to repayprincipal due, and permanently reduce lender commitments, pursuant to theAmended and Restated Credit Agreement. However, Liberty has no obligation to make any contribution to theCompany, and there can be no assurance that any such contribution will bemade.  The terms of any potentialLiberty contribution (including the securities or other consideration to be receivedby Liberty in exchange for such contribution) have not yet been agreedupon.  After the proposed reduction oflender commitments, the Amended and Restated Credit Agreement would constitutea $235,000,000 senior secured credit facility, consisting of a $50,000,000revolving credit facility and a $185,000,000 term loan facility.  The term loan would be subject to scheduledamortizations commencing September 30, 2003, and both facilities would matureon December 31, 2007.

 

Although theCompany is in compliance with the leverage ratio covenant of its existingRevolving Credit Facility at March 31, 2003, the Company believes that it willbe out of compliance with such covenant at June 30, 2003 if the closing of theAmended and Restated Credit Agreement does not occur by that date.  If the Amended and Restated Credit Agreementhas not closed by June 30, 2003, the Company anticipates that it will request afurther amendment to its existing Revolving Credit Facility to postpone thestep down of the leverage ratio covenant. It is uncertain if the Company’s lenders would agree to such a furtheramendment and what terms might be imposed by the lenders in connection withsuch further amendment.  In the eventthat the closing of the Amended and Restated Credit Agreement does not occur bythe date that the leverage ratio is reduced to 3.50, the Company anticipatesthat a default would occur under the Revolving Credit Facility.  Upon the occurrence of a default, if leftuncured, the bank lenders would have various remedies, including terminatingtheir revolving loan commitment, declaring all outstanding loan amountsincluding interest immediately due and payable, and exercising their rightsagainst their collateral, which consists of substantially all the Company’s assets.  No assurance can be given that the Amendedand Restated Credit Agreement will close. In addition, if the Amended and Restated Credit Agreement does notclose, no assurance can be given that the Company will be able to successfullyrestructure or refinance its existing Revolving Credit Facility on termsacceptable to the Company, or that the Company will be able to avoid a defaultunder its existing Revolving Credit Facility. In light of the uncertainties with respect to the restructuring of theRevolving Credit Facility, the Company’s independent auditors included anexplanatory paragraph in their audit report on the December 31, 2002consolidated financial statements of the Company stating in part that “TheCompany is seeking to restructure the debt facility and such restructuring iscontingent on certain events, which raises substantial doubt about theCompany’s ability to continue as a going concern.”

 

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(5)                                  RelatedParty Transactions

 

Liberty allocatescertain general and administrative expenses to the Company.  Although there are no written agreementswith Liberty for these allocations, the Company believes the amounts to bereasonable.  Allocations from Libertyaggregated $37,000 for each of the three month periods ended March 31, 2003 and2002, and such amounts are included in selling, general and administrativeexpense in the accompanying condensed consolidated statements ofoperations.  In addition, the Companyreimburses Liberty for certain expenses, including various insurance premiums,paid by Liberty on behalf of the Company. Amounts owed to Liberty pursuant to these arrangements ($1,191,000 atMarch 31, 2003) are non-interest bearing.

 

In 2002, OnCommand entered into a short-term agreement with Ascent Media Group, Inc., aconsolidated subsidiary of Liberty, (“Ascent Media”) pursuant to which AscentMedia supplied On Command with uplink and satellite transport services at acost of $180,000 through March 31, 2003. On March 24, 2003, the parties executed a Content Preparation andDistribution Services Agreement that will provide for uplink and satellitetransport services for a monthly fee of $36,000, subject to adjustment, for aperiod of five years, beginning on April 1, 2003.  This agreement also provides for Ascent Media to supply OnCommand with content preparation services at a negotiated rate for a period offive years at On Command’s request. On Command has also entered into anagreement dated April 1, 2003 with a wholly-owned subsidiary of Ascent Mediafor the installation by such subsidiary of satellite equipment at On Command’sdownlink sites at hotels for a fee of $500 per installation completed.

 

On August 8,2000, the Company issued 13,500 shares of the Company’s Series A, $.01 ParValue Convertible Participating Preferred Stock (“Series A Preferred Stock”),to the former Chairman and Chief Executive Officer of the Company in exchangefor a $21,080,000 promissory note and a $13,500 cash payment.  The promissory note is secured by the SeriesA Preferred Stock or proceeds thereon and the former Chairman and ChiefExecutive Officer’s personal obligations under such promissory note are limitedto 25% of the principal amount of the note plus accrued interest thereon.  The note, which may not be prepaid, is dueand payable on August 1, 2005, and interest on the note accrues at a rate of 7%per annum, compounded quarterly.

 

(6)                                  SignificantCustomers

 

During thethree months ended March 31, 2003, hotels owned, managed or franchised by MarriottInternational, Inc. (“Marriott”), Hilton Hotels Corporation (“Hilton”), SixContinents Hotels, Inc. (“Six Continents”), Hyatt Hotel Corporation (“Hyatt”),and Starwood Hotels and Resorts Worldwide, Inc. (“Starwood”) accounted for 32%,15%, 11%, 7% and 7%, respectively, of the Company’s total net roomrevenue.   Accordingly, hotels owned,managed or franchised by the Company’s five largest hotel chain customersaccounted for 72% of the Company’s total net room revenue during the threemonths ended March 31, 2003.  The lossof any of these hotel chain customers, or the loss of a significant number ofother hotel chain customers, could have a material adverse effect on theCompany’s results of operations and financial condition.

 

On March 21,2001, the Company and Marriott entered into a definitive master agreementspursuant to which the Company distributes its services in hotel rooms owned ormanaged by Marriott.  In addition, theCompany has the opportunity to enter into agreements to provide its services toadditional hotel rooms franchised by Marriott. The master agreement with Marriott expires in 2008.  At March 31,

 

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2003, OnCommand provided entertainment services to approximately 166,000 rooms thatwere owned or managed by Marriott, and approximately 94,000 rooms that werefranchised by Marriott.

 

On Command’smaster contract with Hilton expired in April 2000, and in October 2000, Hiltonannounced that it would not be renewing such master contract.  As a result, hotels owned, managed orfranchised by Hilton are currently subject to a master contract between Hiltonand a competitor of the Company. Accordingly, the Company anticipates that hotels owned by Hilton willnot renew their contracts as they expire. However, hotels that are managed or franchised by Hilton are notprecluded from renewing their contracts with the Company, and, although noassurance can be given, the Company anticipates that certain of those hotelswill choose to renew.  At March 31,2003, the Company provided service to approximately 121,000 rooms in 523 hotelsthat are owned, managed or franchised by Hilton.  The majority of these rooms are located in managed or franchisedhotels that are not owned by Hilton. Through March 31, 2003, the Company’s contracts with 75 of theaforementioned 523 hotels (19,000 rooms) had expired and service to thesehotels is currently provided under monthly or other short-term renewals.  The Company’s individual contracts with theremaining 448 Hilton hotels (102,000 rooms) expire at various dates through2010, with 53% of those rooms expiring by 2005.  Since January 2002, the Company has entered into new contracts,or renewed existing contracts, with respect to 8,400 rooms that were franchisedby Hilton, and 2,600 rooms that were managed by Hilton. The net room revenuederived from hotels that were owned, managed, or franchised by Hilton decreased17% during the three months ended March 31, 2003, as compared to thecorresponding prior year period. Over time, the Company anticipates that therevenue it derives from hotels that are owned, managed or franchised by Hiltonwill continue to decrease.  However, dueto the uncertainties involved, the Company is currently unable to predict theamount and timing of the revenue decreases.

 

The Companydoes not have master contracts with either Starwood or Six Continents, and theCompany’s master contract with Hyatt provides for the simultaneous expirationof the Company’s contractual relationships with all of the individual hotelsthat are subject to the Hyatt master contract as of December 31, 2004.  At March 31, 2003, the Company providedentertainment services to approximately 176,000 rooms in hotels that are owned,managed or franchised by Starwood or Six Continents.  Agreements with respect to approximately 51% of such Starwood andSix Continents rooms have already expired, or will expire by December 31,2004.  At March 31, 2003, approximately38,000 or 60% of the Company’s Starwood rooms were located in Sheraton or FourPoints hotels that, depending on whether such hotels are owned, managed orfranchised by Starwood, may be covered by a master contract with a competitorof the Company upon the expiration of such hotels’ contracts with the Company.  The Company is actively pursuing masteragreements with Hyatt and Six Continents, and with Starwood with respect to theStarwood brands that are not already covered by a competitor’s contract.

 

In certaincases, the Company is also pursuing direct contractual relationships withindividual hotels that are owned, managed or franchised by these hotelchains.  No assurance can be given thatthe Company will be successful in executing master or individual hotelcontracts.  However, the Company expectsthat, regardless of the expiration dates of master contracts or individualcontracts with hotels, the Company will continue to be the provider of in-roomentertainment services for individual hotels that are not under contract untilsuch time as a competitor’s equipment can be installed.

 

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(7)                                  Commitmentsand Contingencies

 

In connectionwith a first quarter 2001 acquisition of a 7.5% interest in e-ROOM CORPORATION(“e-ROOM”) and the settlement of certain litigation, the Company agreed thate-ROOM would have the option during the 15 day period beginning on March 1,2003 to cause the Company to repurchase all, but not less than all, of the275,000 shares of Company Common Stock issued to e-ROOM at a price of $15 pershare.  During the fourth quarter of2002, the Company repurchased 119,500 of such shares for an aggregate price of$1,344,000 or $11.25 per share.  The$448,000 excess of the repurchase obligation, calculated at $15 per share, overthe aggregate price paid to repurchase such shares has been reflected as anadjustment to net loss attributable to common stockholders in the Company’sconsolidated statements of operations for the year ended December 31,2002.  In connection with thistransaction, the parties agreed to postpone until March 1, 2004 the date onwhich the Company can be required to repurchase 119,500 of the remaining sharessubject to repurchase.  The Company isnot precluded from repurchasing such shares at an earlier date.  The repurchase price for such shares will be$15 per share, plus an adjustment factor calculated from March 1, 2003 to thedate of repurchase, at a rate of 8% per annum. On March 1, 2003, the date on which the remaining 36,000 shares willfirst become subject to repurchase by the Company was postponed until March 1,2004.  The repurchase price for suchshares will remain at $15 per share.

 

On February28, 2001, the Company acquired a controlling interest in Hotel Digital Network,Inc. (“Hotel Digital Network”).   Inconnection with such acquisition, the Company entered into a stockholdersagreement (the “HDN Stockholders Agreement”) with the then controllingstockholder of Hotel Digital Network (the “HDN Stockholder”).  The HDN Stockholders Agreement provided theHDN Stockholder with the right during each of the 30-day periods beginning onMarch 1, 2003 and 2004 to require the Company to exchange shares of CompanyCommon Stock for all, but not less than all, of the Hotel Digital Networkcommon shares held by the HDN Stockholder. On March 20, 2003, the HDNStockholder exercised such right, and in May 2003, the Company acquired all ofthe HDN Stockholder’s interests in HDN common stock for cash and certain otherconsideration, which in the aggregate was not material to the Company’s financialcondition.  Such acquisition, which didnot require the issuance of any shares of Company Common Stock, represented thefinal settlement of the Company’s purchase obligation under the HDNStockholders Agreement.

 

The Company isa party to affiliation agreements with programming suppliers.  Pursuant to certain of these agreements, theCompany is committed to distribute such suppliers’ programming on its videosystems.  Additionally, certain of theseagreements provide for minimum payments and per room rates that escalate as thenumber of rooms receiving programming decreases.

 

In certaincases, the Company has entered into master contracts whereby the Company hasagreed to purchase televisions and/or provide capital assistance and, to alesser extent, provide television maintenance services to hotels during therespective terms of the applicable contracts.

 

The Companyhas received a series of letters from Acacia Media Technologies Corporation(“Acacia”) regarding a portfolio of patents owned by Acacia.  Acacia has alleged that its patents covercertain activities performed by the Company and has proposed that the Companytake a license under those patents.  TheCompany is reviewing Acacia’s patents and believes there are substantialarguments that Acacia’s claims lack merit.

 

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The Companyhas contingent liabilities related to legal proceedings and other mattersarising in the ordinary course of business. Although it is reasonably possible the Company may incur losses uponconclusion of such matters, an estimate of any loss or range of loss cannot bemade.  In the opinion of management, itis expected that amounts, if any, which may be required to satisfy such contingencieswill not be material in relation to the accompanying condensed consolidatedfinancial statements.

 

(8)                                  StockCompensation

 

The Companyapplies the intrinsic value-based method of accounting prescribed by AccountingPrinciples Board Opinion No. 25, *Accountingfor Stock Issued to Employees*, (“APB Opinion No. 25”) and relatedinterpretations, to account for its fixed plan stock options.  Under this method, compensation expense forstock options or awards that are fixed generally is required to be recognizedover the vesting period only if the current market price of the underlyingstock exceeds the exercise price on the date of grant.  Statement of Financial Accounting StandardsNo. 123, *Accounting for Stock-BasedCompensation*, (“Statement 123”) established accounting anddisclosure requirements using a fair value-based method of accounting forstock-based employee compensation plans. As allowed by Statement 123, the Company has elected to continue toapply the intrinsic value-based method of accounting prescribed by APB OpinionNo. 25, and has adopted the disclosure requirements of Statement 123, asamended by Statement of Financial Accounting Standards No. 148, *Accounting for Stock-Based Compensation — Transitionand Disclosure — An Amendment of FASB Statement No. 123*.  The following table illustrates the effectson net loss and loss per share if the Company had applied the fair valuerecognition provisions of Statement 123 to stock-based employee compensation(amounts in thousands except per share amounts).

 
|                                                                         |   | **Three  months ended March 31,** |    |
|------------------------------------------------------------------------------|--------|-----------------------------------|---------|
|                                                                         |   | **2003**                          |    | **2002** |   |
|                                                                         |   |                              |    |   |   |
| Net loss, as reported                                                        |   | $                                 | (6,808  | ) | $ | (10,013 | ) |
| Stock compensation expense determined under  fair value method, net of taxes |   | (1,204                            | )       | (1,346 | ) |
| Pro forma net loss                                                           |   | $                                 | (8,012  | ) | $ | (11,359 | ) |
| Pro forma net loss applicable to common  shareholders                        |   | $                                 | (10,274 | ) | $ | (13,413 | ) |
|                                                                         |   |                              |    |   |   |
| Loss per share:                                                              |   |                              |    |   |   |
| Basic and diluted - as reported                                              |   | $                                 | (0.29   | ) | $ | (0.39 | ) |
| Basic and diluted - pro forma                                                |   | $                                 | (0.33   | ) | $ | (0.43 | ) |

 

(9)                                  SubsequentEvents

 

On April 2,2003, the Company announced that it received an expression of interest fromLiberty regarding the possibility of Liberty acquiring all the issued andoutstanding shares of the Company that Liberty (through its subsidiaries) doesnot already own.  As proposed by Liberty,the Company’s stockholders would receive 0.0787 of a share of Liberty MediaCorporation Series A common stock for each share of On Command common stockheld.  The transaction would be taxableto the Company’s stockholders.

 

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On Command’sBoard of Directors has established a committee of independent directors toconsider the overture by Liberty.  Thecommittee has engaged independent legal counsel and financial advisors and hasauthority, among other things, to review and evaluate the terms and conditionsof the proposed transaction, to determine whether the proposed transaction isin the best interests of the Company and its public stockholders, to negotiatewith Liberty, and  to accept, reject, ormodify the proposed transaction.  Any transactionbetween the Company and Liberty would be subject to negotiation, execution anddelivery of definitive documentation relating thereto and any closingconditions provided for in such documentation.

 

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Management’sDiscussion And Analysis Of Financial Condition And Results Of Operations

 

General

 

The followingdiscussion and analysis provides information concerning the financial conditionand results of operations of the Company and should be read in conjunction withthe accompanying condensed consolidated financial statements of the Company, aswell as the Company’s Annual Report on Form 10-K for the year ended December31, 2002.

 

Certainstatements in this Quarterly Report on Form 10-Q constitute forward-lookingstatements within the meaning of the Private Securities Litigation Reform Actof 1995.  Such forward-lookingstatements involve known and unknown risks, uncertainties and other importantfactors that could cause the actual results, performance, or achievements of OnCommand, or industry results, to differ materially from future results,performance, or achievements expressed or implied by such forward-lookingstatements.  Such risks, uncertainties andother factors include, among others:

 

•                  General economicand business conditions, and trends in the travel and entertainment industries;

•                  Trends in hoteloccupancy rates and business and leisure travel patterns, including thepotential impacts that wars, actual or threatened terrorist attacks andnational security responses thereto, contagious diseases such as severe acuterespiratory syndrome, or other events might have on such occupancy rates andtravel patterns;

•                  Uncertaintiesinherent in the Company’s efforts to renew or enter into agreements onacceptable terms with its significant hotel chain customers and their owned,managed and franchised hotels;

•                  The Company’sability to access quality movies, programming networks and other content onacceptable terms;

•                  The regulatoryand competitive environment of the industry in which On Command operates;

•                  The potentialimpact that any negative publicity, lawsuits, or boycotts by opponents ofmature-themed programming content distributed by the Company could have on thewillingness of hotel industry participants to deliver such content to guests;

•                  The potentialfor increased government regulation and enforcement actions, and the potentialfor changes in laws that would restrict or otherwise inhibit the Company’sability to make mature-themed programming content available over its videosystems;

•                  Uncertaintiesinherent in new business strategies such as the Company’s recent efforts toexpand its target market to include smaller hotels;

•                  Competitivethreats posed by rapid technological changes;

•                  The development,provision and marketing of new platforms and services, and customer acceptance,usage rates, and profitability of such platforms and services;

•                  Uncertaintiesinherent in the Company’s efforts to improve future operating results byincreasing revenue and decreasing costs;

•                  Uncertaintiesinherent in the Company’s efforts to effectively manage capital expenditures;

•                  Uncertaintiesinherent in the Company’s ability to execute planned upgrades of its videosystems, including uncertainties associated with operational, economic andother factors;

•                  The ability ofvendors to deliver required equipment, software and services;

•                  Availability ofqualified personnel;

•                  Competitorresponses to On Command’s products and services, and the overall market acceptanceof such products and services;

•                  Uncertaintiesinherent in the ability of On Command to satisfy the closing conditions of theAmended and Restated Credit Agreement (including the required $40,000,000equity contribution 

 

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from Liberty)on a timely basis and, if not satisfied, the ability of On Command torestructure or refinance the Revolving Credit Facility; and

•                  Other factorsdiscussed in this Report.

 

Theseforward-looking statements (and such risks, uncertainties and other factors)speak only as of the date of this Report, and On Command expressly disclaimsany obligation or undertaking to disseminate any updates or revisions to anyforward-looking statement contained herein, to reflect any change in OnCommand’s expectations with regard thereto, or any other changes in events,conditions, or circumstances on which any such statement is based.

 

MaterialChanges in Results of Operations

 

Revenue

 

Revenueconsists primarily of fees collected from hotels for in-room services providedto hotel guests by the Company. Services provided by the Company to hotel guests include pay-per-viewmovies, free-to-guest television programming, video games, Internet service,short subject products and digital music. The Company also earns revenue from the sale of video and music systemsto third parties and the sale of video equipment to hotels.  The Company’s total net revenue during thethree months ended March 31, 2003 and 2002 was $56,720,000 and $57,383,000,respectively.

 

Net roomrevenue increased $500,000 or less than 1% during the three months ended March31, 2003, as compared to the corresponding prior year period.  The increase in net room revenue during the2003 period is attributable to the net effect of (i) a decrease attributable toa lower volume of pay-per-view buys; (ii) an increase attributable to higher average rates for certainpay-per-view products; (iii) a $1,000,000 increase in the aggregate revenuederived from short subject, digital music and television-based Internetproducts; and (iv) a $715,000 increase in free-to-guest programmingrevenue.  The Company believes that thedecrease in pay-per-view buys is attributable to the combined effect of (i) adecrease in buy rates for  certainpay-per-view products, (ii) a decrease in occupancy rates (as further discussedbelow), and (iii) a reduction in the average number of rooms served by theCompany.  The 4.4% decline in theaverage number of rooms served by the Company during the 2003 period isattributable to (i) the sale of the Company's European operations; (ii)the loss of rooms to competitors; and (iii) the discontinuance of service tocertain non-profitable hotels.

 

Overall hoteloccupancy rates, as reported by Smith Travel Research, declined 1.1% during thethree months ended March 31, 2003, as compared to the corresponding prior yearperiod.  In addition, occupancy ratesfor hotels in the top 25 markets, as reported by Smith Travel Research, declined1.0% over the same period.  Since theCompany derives a significant portion of its revenue from hotels located in thetop 25 markets, the Company believes that the occupancy rate for this segmentis the best indicator of the impact changes in hotel occupancy are having onthe Company’s business.  Hotel occupancyrates are outside of the Company’s control, and changes in hotel occupancyrates can have a significant impact on the Company’s results of operations.

 

During thethree months ended March 31, 2003, hotels owned, managed or franchised byMarriott, Hilton, Six Continents, Hyatt, and Starwood accounted for 32%, 15%,11%, 7% and 7%, respectively, of the Company’s total net room revenue.   Accordingly, hotels owned, managed orfranchised by the Company’s five largest hotel chain customers accounted for72% of the Company’s total net room revenue during the three months ended March31, 2003.  The loss of any of thesehotel chain customers, or the loss of a significant number of other hotel chaincustomers, could have a material adverse effect on the Company’s results ofoperations and financial condition. For additional information concerning theCompany’s 

 

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relationships with itssignificant customers, see note 6 to the accompanying condensed consolidatedfinancial statements.

 

System andequipment sales and other revenue decreased $1,163,000 or 37.2% during thethree months ended March 31, 2003, as compared to the corresponding prior yearperiod.  Such decrease is primarilyattributable to the net effect of (i) a $674,000 decrease in sales of theCompany’s music systems; and (ii) a $407,000 decrease in sales of the Company’svideo systems and equipment. The decrease in music systems sales is largelyattributable to the Company’s efforts to convert its primary music systemcustomer to a software-based music system from a hardware-based music system.The Company expects to initiate sales of its software-based music systems tothis customer during the third quarter of 2003.  As a result, the Company expects that it will not realizesignificant revenue from the sale of hardware-based music systems during 2003and future periods, and that the revenue to be derived from the sale of itssoftware-based music systems during 2003 will be significantly lower than therevenue derived from music system sales during 2002 due to lower sales volumesand lower per unit sales prices.

 

Direct Costs

 

Direct costsconsist primarily of fees paid to movie and other content providers, hotelcommissions, direct costs associated with the Company’s Internet product, andcosts associated with video and music systems sold to other providers, andvideo equipment sold to hotels.

 

Content fees,commissions and other in-room service costs decreased $498,000 or 1.8% during thethree months ended March 31, 2003, as compared to the corresponding prior yearperiod. Such decrease represents the net effect of individually insignificantchanges in the components of this line item. Free-to-guest programming costsremained relatively constant during the 2003 and 2002 periods as higher ratesfrom programmers were offset by cost savings resulting from the optimization ofcertain channel line-ups and changes in certain distribution agreements. In theaggregate, content fees, commissions and other in-room service costsrepresented 50.0% and 51.4% of total net room revenue during the 2003 and 2002periods, respectively. Certain of the Company’s content fees and other in-roomservice costs do not vary with room revenue and occupancy rates.

 

System,equipment and other costs decreased $518,000 or 37.5% during 2003, as comparedto 2002.  The majority of such decreaseis attributable to lower costs as a result of lower system and equipment sales,as described above.

 

The Company isa party to various agreements with programming suppliers that permit theCompany to distribute movies and programming networks.  The Company expects that the cost of suchmovies and programming networks will increase in future periods as contractsexpire and renewals are negotiated. Certain of the Company’s contracts with hotel customers limit the amountof any cost increases that can be passed on to any such hotels.  Any cost increases that the Company is notable to pass on to its customers would result in increased pressure on theCompany’s operating margins.

 

Operations Support

 

Operationssupport expense includes the labor, materials and overhead costs associatedwith the repair, maintenance and support of video systems and other roomservice equipment.  Operations supportexpense decreased $444,000 or 6.8% during the three months ended March 31,2003, as compared to the corresponding prior year period.  Such decrease represents the net effect ofindividually insignificant changes in the components of this line item.

 

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Research and Development

 

Research anddevelopment expense increased $126,000 or 13.2% during the three months endedMarch 31, 2003, as compared to the corresponding prior year period.  The increase is primarily attributable tocontract labor associated with the launch of the Company’s satellitedistribution system.

 

Selling, General and Administrative

 

Selling,general and administrative expense increased $34,000 or less than 1% during thethree months ended March 31, 2003, as compared to the corresponding prior yearperiod. Such increase is attributable to the net effect of (i) higher laborcosts, (ii) lower bad debt expense, and (iii) various other individuallyinsignificant changes in the components of this line item. The decrease in baddebt expense is largely attributable to the collection of a receivable that hadbeen fully reserved in a prior period. The percentage of total net revenue thatis represented by selling, general and administrative expense was 9.8% and 9.7%during the 2003 and 2002 periods, respectively.

 

Depreciation and Amortization

 

Depreciationand amortization expense decreased $1,168,000 or 5.8% during the three monthsended March 31, 2003, as compared to the corresponding prior year period.  Such decrease represents the net effect ofreductions to the Company’s depreciable asset base that were only partiallyoffset by increases attributable to capital expenditures.  The decrease in the Company’s depreciableasset base is attributable to (i) assets becoming fully depreciated, and (ii)asset dispositions.

 

Asset Impairment and Other Charges

 

The Companyrecorded impairment charges of $325,000 and $1,829,000 during the three monthsended March 31, 2003 and 2002, respectively. The 2002 amount includes a loss of $1,411,000 relating to a transaction in which certain equipment wastransferred to STSN, Inc. (“STSN”).  The Company also recorded other charges aggregating $325,000 and$418,000 during the 2003 and 2002 periods, respectively.  Such charges are comprised of amountsrelated to obsolete materials and equipment, and losses on various dispositionsof property and equipment, and other assets.

 

Interest Expense

 

Interestexpense decreased $253,000 or 7.0% during the three months ended March 31,2003, as compared to the corresponding prior year period.  The decrease in interest expense isattributable to a lower weighted average interest rate and a decrease inweighted average borrowings outstanding under the Revolving Credit Facility.

 

Income Taxes

 

The Company’sincome tax expense of $88,000 and $43,000 during the three months ended March31, 2003 and 2002, respectively, represents taxes in certain foreign, state andlocal jurisdictions.  The Company’sreported income tax expense differs from the expected benefit that would resultby applying the statutory rates to the Company’s pre-tax losses primarilybecause the Company is only able to realize income tax benefits for financialreporting purposes to the extent that the Company generates taxable income, orto the extent that tax benefits (i) represent refunds due to the Company or(ii) offset recorded income tax liabilities. 

 

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For financial reportingpurposes, all of the Company’s income tax liabilities had been fully offset byincome tax benefits at March 31, 2003 and 2002, respectively.

 

Net Loss

 

As a result ofthe factors described above, the Company’s net loss decreased from $10,013,000during the 2002 period to $6,808,000 during the 2003 period.  The Company is attempting to improve itsoperating results by increasing revenue while containing, and whereverpossible, reducing expenses and capital expenditures.  Specifically, the Company plans to increase revenue by (i) developingand, to the extent economically feasible, implementing new technologies thatwill enhance the Company’s ability to manage its existing products and/or allowthe Company to introduce new or more technologically advanced systems orproducts; (ii) retaining existing hotel customers and selectively increasingthe number of rooms in the Company’s traditional target market (generallyhotels with 150 or more rooms);  (iii)expanding the Company’s target market by marketing the MiniMateTM platform tosmaller hotels (generally hotels with less than 150 rooms) and lower cost hotelsand (iv) selectively increasing prices. In addition, the Company expects to continue to focus on all availableopportunities to reduce or contain costs for the foreseeable future.  In this regard, the Company believes vendorand customer relationships, outsourcing, and new technologies, are among theareas that will provide opportunities for cost reduction and containment during2003 and future periods.  The Companyintends to contain and reduce capital expenditures by continuing its efforts tomanage and deploy capital with a view towards improving the Company’s return onits capital expenditures. The Company cannot presently predict the amount ofincreased revenue, decreased costs or other benefits that might result from itsefforts to improve operating results.  Furthermore, the Company’s ability to accomplish its operatingobjectives is dependent to a degree on hotel occupancy rates and other factorsoutside of its control.  No assurancecan be given that the Company will be able to significantly increase itsrevenue base or reduce its expenses or capital expenditures.   To the extent that changes in hoteloccupancy rates impact the Company’s revenue base, the Company will notexperience proportionate changes in its expenses since many of the Company’sexpenses do not vary with hotel occupancy rates.

 

Material Changes in Financial Condition

 

During thethree months ended March 31, 2003, the Company used $7,338,000 of cash providedby operating activities, $3,199,000 of cash provided by financing activitiesand a $1,465,000 decrease in cash and cash equivalents to fund the $11,998,000used by its investing activities.  Foradditional information, see the accompanying condensed consolidated statementsof cash flows.

 

At March 31,2003, the Company’s Revolving Credit Facility, as amended, provided foraggregate borrowings of $275,000,000. Borrowings under the Revolving Credit Facility are due and payable inJuly 2004.  The Company had $9,367,000of remaining availability under the Revolving Credit Facility at March 31,2003.  The Company’s ability to drawadditional funds under the Revolving Credit Facility is subject to theCompany’s continued compliance with applicable financial covenants.

 

Revolvingloans extended under the Revolving Credit Facility bear interest at LIBOR plusa spread that may range from 1.10% to 2.75% depending on certain operatingratios of the Company (3.82% effective borrowing rate at March 31, 2003).  In addition, a facility fee ranging from0.15% to 0.50% per annum is charged on the Revolving Credit Facility, dependingon certain operating ratios of the Company. The Revolving Credit Facility contains customary covenants andlimitations, most notably the inclusion of restrictions on the Company’sability to pay dividends or make other distributions, and restrictions on theCompany’s ability to make capital expenditures.  In addition, the Company is required to maintain leverage andinterest coverage ratios.  The Companywas in compliance with such covenants at March 31, 2003.  Substantially all of the Company’s assetsare pledged as collateral for borrowings under the Revolving Credit Facility.

 

On March 28,2003, the Company and its bank lenders amended the Revolving Credit Facility topostpone until June 30, 2003 the step down of the leverage ratio covenant ofits Revolving Credit Facility from 4.25 to 3.50. Accordingly, the maximumleverage ratio permitted under the Revolving Credit Facility at March 31, 2003was 4.25, and the Company’s actual leverage ratio was 4.00 as of suchdate.  On April 17, 2003, the Companyand its bank lenders executed an Amended and Restated Credit Agreement.  The closing of the Amended and RestatedCredit Agreement is contingent upon the contribution of $40,000,000 by Libertyto the Company to be used to repay principal due, and permanently reduce lendercommitments, pursuant to the Amended and Restated Credit Agreement.  However, Liberty has no obligation to makeany contribution to the Company, and there can be no assurance that any suchcontribution will be made.  The 

 

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terms of any potential Libertycontribution (including the securities or other consideration to be received byLiberty in exchange for such contribution) have not yet been agreed upon.  After the proposed reduction of lendercommitments, the Amended and Restated Credit Agreement would constitute a$235,000,000 senior secured credit facility, consisting of a $50,000,000revolving credit facility and a $185,000,000 term loan facility.  The term loan would be subject to scheduledamortizations commencing September 30, 2003, and both facilities would matureon December 31, 2007.

 

Although theCompany is in compliance with the leverage ratio covenant of its existingRevolving Credit Facility at March 31, 2003, the Company believes that it willbe out of compliance with such covenant at June 30, 2003 if the closing of theAmended and Restated Credit Agreement does not occur by that date.  If the Amended and Restated Credit Agreementhas not closed by June 30, 2003, the Company anticipates that it will request afurther amendment to its existing Revolving Credit Facility to postpone thestep down of the leverage ratio covenant. It is uncertain if the Company’s lenders would agree to such a furtheramendment and what terms might be imposed by the lenders in connection withsuch further amendment.  In the eventthat the closing of the Amended and Restated Credit Agreement does not occur bythe date that the leverage ratio is reduced to 3.50, the Company anticipatesthat a default would occur under the Revolving Credit Facility.  Upon the occurrence of a default, if leftuncured, the bank lenders would have various remedies, including terminatingtheir revolving loan commitment, declaring all outstanding loan amountsincluding interest immediately due and payable, and exercising their rightsagainst their collateral, which consists of substantially all the Company’sassets.  No assurance can be given thatthe Amended and Restated Credit Agreement will close.  In addition, if the Amended and Restated Credit Agreement doesnot close, no assurance can be given that the Company will be able tosuccessfully restructure or refinance its existing Revolving Credit Facility onterms acceptable to the Company, or that the Company will be able to avoid adefault under it existing Revolving Credit Facility.  In light of the uncertainties with respect to the restructuringof the Revolving Credit Facility, the Company’s independent auditors includedan explanatory paragraph in their audit report on the December 31, 2002consolidated financial statements of the Company stating in part that “TheCompany is seeking to restructure the debt facility and such restructuring iscontingent on certain events, which raises substantial doubt about theCompany’s ability to continue as a going concern.”

 

During 2001,the Company issued to Ascent Entertainment Group, Inc. (“Ascent”) Series BCumulative Redeemable Preferred Stock, par value $.01 per share (the “Series BPreferred Stock”), Series C Cumulative Redeemable Preferred Stock, par value$.01 per share (the “Series C Preferred Stock”) and Series D CumulativeConvertible Redeemable Preferred Stock, par value $.01 per share (“Series DPreferred Stock”) in exchange for aggregate net cash proceeds of $84,942,000.  The Series B Preferred Stock, Series CPreferred Stock and Series D Preferred Stock are classified as mandatorilyredeemable preferred stock within the accompanying condensed consolidatedbalance sheet due to the fact that, under certain circumstances and subject tocertain restrictions contained in the Revolving Credit Facility, Ascent couldrequire the Company to redeem such mandatorily redeemable preferred stock.  Ascent has informed the Company that itcurrently does not intend to redeem any portion of the liquidation value of theSeries B Preferred Stock, Series C 

 

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Preferred Stock, or Series DPreferred Stock.   Accumulated andunpaid dividends on the Company’s Series B Preferred Stock, Series C PreferredStock and Series D Preferred Stock aggregated $15,168,000 at March 31,2003.  Such dividends have been added tothe liquidation preference of the applicable preferred stock issuance since theCompany has not paid any cash dividends since issuance.  The Company does not intend to pay cashdividends on any of its preferred stock issuances for the foreseeable future.

 

In connectionwith a first quarter 2001 acquisition of a 7.5% interest in e-ROOM and thesettlement of certain litigation, the Company agreed that e-ROOM would have theoption during the 15 day period beginning on March 1, 2003 to cause the Companyto repurchase all, but not less than all, of the 275,000 shares of CompanyCommon Stock that had been issued to e-ROOM in such transaction, at a price of$15 per share.  During the fourthquarter of 2002, the Company repurchased 119,500 of such shares for anaggregate price of $1,344,000 or $11.25 per share.  The $448,000 excess of the repurchase obligation, calculated at$15 per share, over the aggregate price paid to repurchase such shares has beenreflected as an adjustment to net loss attributable to common stockholders inthe Company’s consolidated statements of operations for the year ended December31, 2002.  In connection with thistransaction, the parties agreed to postpone until March 1, 2004 the date onwhich the Company can be required to repurchase 119,500 of the remaining sharessubject to repurchase.  The Company isnot precluded from repurchasing such shares at an earlier date.  The repurchase price for such shares will be$15 per share, plus an adjustment factor calculated from March 1, 2003 to thedate of repurchase, at a rate of 8% per annum. On March 1, 2003, the date on which the remaining 36,000 shares willfirst become subject to repurchase by the Company was postponed until March 1,2004.  The repurchase price for suchshares will remain at $15 per share.

 

Historically,the Company has required external financing to fund the cost of installing andupgrading video systems in hotels. However, during 2002 the Company was able to manage its operations andcapital expenditures such that the Company was able to rely on internallygenerated funds and existing sources of liquidity to finance its installationand upgrade activities.  During 2003 andfuture periods, the Company intends to continue to focus its efforts onincreasing revenue while containing, and wherever possible, reducing expensesand capital expenditures.  The Companyexpects that it will be able to rely on cash provided by operations, existingavailability under the Revolving Credit Facility, and existing cash and cashequivalent balances to fund its capital expenditures and other anticipatedliquidity requirements during 2003.To the extent that the Company were toexperience a revenue shortfall or any other unfavorable variance from its 2003operating plan, the Company would seek to reduce expenses and/or capitalexpenditures to compensate for any such shortfall or unfavorable variance.   Accordingly, the Company believes, althoughno assurance can be given, that it will not require additional sources ofliquidity to fund its capital expenditures and anticipated liquidityrequirements during 2003. Notwithstanding the foregoing, the Company anticipates that it willrequire a $40,000,000 equity contribution from Liberty in order to satisfy oneof the closing conditions of its Amended and Restated Credit Agreement, andthat it would require additional external financing to (i) fund any significantnew growth initiatives or unanticipated liquidity requirements; or (ii)refinance the Revolving Credit Facility, if the Amended and Restated CreditAgreement does not close on a timely basis (as discussed above).  No assurance can be given that the Companywill not be required to seek external financing during 2003, and if externalfinancing is required, no assurance can be given that any such financing wouldbe available on terms acceptable to the Company or at all.

 

Item 3.  Quantitative and Qualitative DisclosuresAbout Market Risk

 

The Company isexposed to market risk from changes in interest rates, which could impact itsresults of operations and financial condition, particularly the Company’sinterest expense and cash flow.  TheCompany does not hedge this exposure. Revolving loans extended under the Revolving Credit Facility generallybear interest at a variable rate based on LIBOR and certain operating ratios ofthe Company.  At March 31, 2003, theoutstanding borrowings under the Revolving Credit Facility were$265,633,000.  Exclusive of facilityfees, 

 

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the effective borrowing rate onamounts outstanding under the Revolving Credit Facility was 3.82% at March 31,2003.  Assuming no increase or decreasein the amount outstanding, a hypothetical 1% increase (or decrease) in interestrates at March 31, 2003 would increase (or decrease) the Company’s annualinterest expense and cash outflow by approximately $2,656,000.

 

The Company’sforeign operations are located primarily in Canada and Mexico. The Companybelieves the risks of foreign exchange rate fluctuations on its presentoperations are not material to the Company’s overall financial condition.  However, the Company will consider usingforeign currency contracts, swap arrangements, or other financial instrumentsdesigned to limit exposure to foreign exchange rate fluctuations, if deemedprudent.

 

Item 4.  Controls and Procedures

 

The Company’sChief Executive Officer and Chief Financial Officer (the “Executives”)conducted an evaluation of the effectiveness of the design and operation of theCompany’s disclosure controls and procedures, as defined in Exchange Act Rule13d-14(c), as of a date within 90 days prior to the filing of this quarterlyreport on Form 10-Q.  Based on thisevaluation, the Executives concluded that the Company’s disclosure controls andprocedures were effective as of the date of that evaluation.  There have been no significant changes inthe Company’s disclosure controls and procedures or in other factors that couldsignificantly affect these controls subsequent to the date on which theExecutives completed their evaluation.

 

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PART II - OTHER INFORMATION

 

Item 1.    Legal Proceedings

 

Litigation

 

There are no material changesto pending legal proceedings to which the Company is a party or to which any ofits property is subject, except as follows:

 

Shareholder Litigation  On April 2, 2003, the Company announced thatit had received an expression of interest from Liberty regarding thepossibility of acquiring all the issued and outstanding shares of On Commandnot already owned by affiliates of Liberty. As proposed by Liberty, On Command stockholders would receive 0.0787 ofa share of Liberty Media Corporation Series A common stock for each share of OnCommand common stock held.  On April 11,2003, one purported class action styled *RaymondGavilan v. On Command Corporation, et al*., C.A. No. 20252 was filedon behalf of the stockholders of the Company other than Liberty and thedefendants, in the Court of Chancery in New Castle County, Delaware  (the “Action”).  The Action names as defendants in addition to Liberty and theCompany, current directors Kenneth G. Carroll, William R. Fitzgerald, Paul A.Gould, Mark K. Hammond, Gary S. Howard, Christopher Sophinos, and J. DavidWargo, as well as Peter Kern, a former director.  Certain of the Company’s officers were also named asdefendants.  The Action asserts, amongother things, that the offer made by Liberty was the product of unfair dealingby Liberty and its representatives on the Company’s Board of Directors and doesnot offer the public stockholders of the Company fair value for theirshares.  The plaintiff seeks injunctiverelief to prevent consummation of the offer made by Liberty, and if thetransaction with Liberty is consummated, an order rescinding the transaction orrescissory damages.  The Companybelieves that the claims are without merit.

 

Item 6.    Exhibits and Reports on Form 8-K

 

(A)          Exhibits

 
| 10.1   |   | Content  Preparation and Distribution Services Agreement by and between Ascent Media  Group, Inc. and On Command Video Corporation. |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                |
| 99.1   |   | Certification  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 filed herewith.                                            |

 

 

(B)           Reports on Form 8-K filed during the quarter ended March31, 2003:

 
| **Date Filed**     |   | **Items Reported** |   | **Financial Statements Filed** |
|--------------------|--------|--------------------|--------|--------------------------------|
|               |   |               |   |                           |
| February 10,  2003 |   | Item 5             |   | None                           |

 

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(C)           SIGNATURES

 

Pursuant tothe requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 
|                     | ON COMMAND  CORPORATION |
|--------------------------|-------------------------|
|                     |                    |
|                     |                    |   |
| Date:  May 15, 2003 | By:                     | /s/  Bernard G. Dvorak |
|                     |                    | Bernard G.  Dvorak |
|                     |                    | Senior Vice  President, Chief Financial Officer and Treasurer |
|                     |                    | (Principal  Accounting and Financial Officer) |
|                          |                         |  |  |

 

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**CERTIFICATION**

 

I, Christopher Sophinos,certify that:

 

1. I have reviewed thisquarterly report on Form 10-Q of On Command Corporation;

 

2. Based on my knowledge, thisquarterly report does not contain any untrue statement of a material fact oromit to state a material fact necessary to make the statements made, in lightof the circumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3. Based on my knowledge, thefinancial statements, and other financial information included in thisquarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4. The registrant’s othercertifying officer and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and we have:

 

a) designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b) evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c) presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5. The registrant’s othercertifying officer and I have disclosed, based on our most recent evaluation,to the registrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent function):

 

a) allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b) any fraud,whether or not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6. The registrant’s othercertifying officer and I have indicated in this quarterly report whether or notthere were significant changes in internal controls or in other factors thatcould significantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

 
| Date:  May 15, 2003               |   |
|----------------------------------------|--------|
|                                   |   |
| /s/  Christopher Sophinos              |   |
| Christopher  Sophinos                  |   |
| President  and Chief Executive Officer |   |
| (Principal  Executive Officer)         |   |
|                                        |        |  |

 

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**CERTIFICATION**

 

I, Bernard G. Dvorak, certifythat:

 

1. I have reviewed thisquarterly report on Form 10-Q of On Command Corporation;

 

2. Based on my knowledge, thisquarterly report does not contain any untrue statement of a material fact oromit to state a material fact necessary to make the statements made, in lightof the circumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3. Based on my knowledge, thefinancial statements, and other financial information included in thisquarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4. The registrant’s othercertifying officer and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and we have:

 

a) designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b) evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c) presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5. The registrant’s othercertifying officer and I have disclosed, based on our most recent evaluation,to the registrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent function):

 

a) allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b) any fraud,whether or not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6. The registrant’s othercertifying officer and I have indicated in this quarterly report whether or notthere were significant changes in internal controls or in other factors thatcould significantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

 
| Date:  May 15, 2003                                      |
|---------------------------------------------------------------|
|                                                          |
| /s/ Bernard  G. Dvorak                                        |   |
| Bernard G.  Dvorak                                            |
| Senior Vice President,  Chief Financial Officer and Treasurer |
| (Principal  Accounting and Financial Officer)                 |

 

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**EXHIBIT INDEX**

 

| Exhibits |                                                                                                                                |
|----------|-------------------------------------------------------------------------------------------------------------------------------------|
|     |                                                                                                                                |
| 10.1     | Content  Preparation and Distribution Services Agreement by and between Ascent Media  Group, Inc. and On Command Video Corporation. |
|     |                                                                                                                                |
| 99.1     | Certification  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 filed herewith.                                            |

 

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