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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
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[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
or
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[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
Commission File Number: 0-22334
LODGENET ENTERTAINMENT CORPORATION
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(Exact name of Registrant as specified in its charter)
DELAWARE 46-0371161
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(State of Incorporation) (IRS Employer Identification Number)
3900 WEST INNOVATION STREET, SIOUX FALLS, SOUTH DAKOTA 57107
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(Address of Principal Executive Offices) (Zip Code)
(605) 988 - 1000
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE.
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE.
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period
that the Registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes X No .
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of the
Form 10-K or any amendment to this Form 10-K. [ ]
As of March 22, 2000, the aggregate market value of the common stock held by
non-affiliates of the Registrant was approximately $202,800,000. The number of
shares of common stock of the Registrant outstanding as of March 22, 2000 was
12,123,688 shares.
DOCUMENTS INCORPORATED BY REFERENCE - Part III of this Form 10-K is incorporated
by reference from Registrant's definitive proxy statement for the 2000 Annual
Meeting of Stockholders, which will be filed within 120 days of the fiscal year
ended December 31, 1999.
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This Report contains a total of 50 pages, excluding exhibits. The exhibit index
appears on page 26.
TABLE OF CONTENTS
Special Note Regarding Forward-Looking Statements......................................................... 1
Item 1 - Business......................................................................................... 1
Overview......................................................................................... 1
Business Strategy................................................................................ 2
Markets and Customers............................................................................ 3
Services and Products............................................................................ 3
Operations....................................................................................... 5
Competition...................................................................................... 7
Regulation....................................................................................... 9
Employees........................................................................................ 10
Item 2 - Properties....................................................................................... 10
Item 3 - Legal Proceedings................................................................................ 10
Item 4 - Submission of Matters to a Vote of Security Holders.............................................. 10
Item 5 - Market for Registrant's Common Equity and Related Stockholder Matters............................ 11
Dividends........................................................................................ 11
Stockholder Rights Plan.......................................................................... 11
Item 6 - Selected Financial Data.......................................................................... 15
Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations............ 17
Item 7A - Quantitative and Qualitative Disclosures About Market Risk...................................... 23
Item 8 - Financial Statements and Supplementary Data...................................................... 26
Item 9 - Changes In and Disagreements with Accountants on Accounting and Financial Disclosure............. 26
Item 10 - Directors and Officers of the Registrant........................................................ 26
Item 11 - Executive Compensation.......................................................................... 26
Item 12 - Security Ownership of Certain Beneficial Owners and Management.................................. 26
Item 13 - Certain Relationships and Related Transactions.................................................. 27
Item 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K................................. 27
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As used herein (unless the context otherwise requires) "LodgeNet", the
"Company" and/or the "Registrant" mean LodgeNet Entertainment Corporation and
its consolidated subsidiaries.
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PART I
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in this Annual Report on Form 10-K, including,
without limitation, statements in Item 1, including certain statements under the
headings "Overview", "Business Strategy", "Strategic Initiatives", "Services and
Products", "Operations", "Competition" and "Regulation", in Item 3 under the
heading "Legal Proceedings", and in Item 7 under the heading "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
constitute "forward-looking statements" within the meaning of the Securities Act
of 1933, as amended, and the Securities Exchange Act of 1934, as amended. When
used in this Annual Report, the words "expects," "anticipates," "estimates,"
"believes," "no assurance" and similar expressions and statements which are made
in the future tense, are intended to identify such forward-looking statements.
Such forward-looking statements involve known and unknown risks, uncertainties
and other factors, which may cause the Company's actual results, performance or
achievements to be materially different from any future results, performance or
achievements expressed or implied by such forward-looking statements. In
addition to the risks and uncertainties discussed in the foregoing sections,
such factors include, among others, the following: the impact of competition and
changes to the competitive environment for the Company's products and services,
changes in technology, reliance on strategic partners, uncertainty of
litigation, changes in government regulation and other factors detailed, from
time to time, in the Company's filings with the Securities and Exchange
Commission. These forward-looking statements speak only as of the date of this
Annual Report. The Company expressly disclaims any obligation or undertaking to
release publicly any updates or revisions to any forward-looking statements
contained herein to reflect any change in the Company's expectations with regard
thereto or any change in events, conditions or circumstances on which any such
statement is based.
ITEM 1 - BUSINESS
OVERVIEW
LodgeNet is a broadband, interactive services provider which
specializes in the delivery of interactive television and Internet access
services to the lodging industry throughout the United States, Canada and select
international markets. These services include on-demand movies,
Nintendo-Registered Trademark- video games, Internet-enhanced television,
high-speed Internet access, and other interactive television services designed
to serve the needs of the lodging industry and the traveling public. As one of
the largest companies in the industry, LodgeNet currently provides service to
761,500 rooms in more than 4,900 hotel properties. Of this base, the Company has
installed its interactive television system in more than 661,000 rooms, which
host more than 190 million guests on an annual basis.
The Company's Guest Pay interactive services are purchased by guests
on a per-view, hourly, or daily basis and include on-demand movies,
network-based Nintendo-Registered Trademark- video games, Internet-enhanced
television (which does not require a laptop for access), and high-speed
Internet access services. Guest Pay packages may also include services such
as satellite-delivered basic and premium cable television programming, and
other interactive entertainment and information services that are paid for by
the hotel and provided to guests at no charge. The Company provides its
services to various corporate-managed hotel chains such as Sheraton,
Ritz-Carlton, Harrah's Casino Hotels, Omni, Delta Hotels and Resorts,
Outrigger, La Quinta Inns, and Red Roof Inns, as well as many individual
properties flying the Marriott, Holiday Inn, Hilton, Inter-Continental,
Prince, Radisson, Westin, Doubletree, Embassy Suites, Wingate and other flags.
The growth in revenue and EBITDA ("Earnings Before Interest, Taxes,
Depreciation and Amortization") that the Company has experienced over the
past five years has primarily resulted from the rapid expansion of its Guest
Pay interactive room base. During this period, its Guest Pay room base has
grown from 185,000 at the end of 1994 to more than 661,000 as of December 31,
1999, a 29.0% compounded annual growth rate. During the same period, its
revenues and EBITDA have grown at compounded annual growth rates of 35.0% and
45.2% respectively.
The Company provides its services throughout the United States and
Canada, and in other select countries through licensing arrangements with
strategic partners. The Company's contracts are exclusive and typically have
initial, non-cancelable terms of five to seven years. The exclusive nature of
these contracts allows the Company to estimate (based on certain operating
assumptions) future revenues, cash flows and rates of return related to the
contracts prior to making a capital investment decision. The average remaining
life of the Company's existing guest pay contracts is over four years.
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The Company delivers its interactive television and Internet access
services through the use of its broadband local area network ("B-LAN-Registered
Tradmark-") system architecture. The design of this open-architecture,
UNIX-based platform enables the Company to upgrade system software to support
the introduction of new interactive services and integrate new technologies as
they become commercially available and economically viable. The Company believes
the flexibility of its broadband system architecture has enabled it to provide
innovative and creative interactive offerings to the lodging industry,
including:
- being the first in its industry to offer on demand movies (as
compared to scheduled movies that can only be watched at
predetermined times) in 100% of installed guest pay rooms,
- being the first in its industry to install and then widely deploy
network-based video games,
- being the first in its industry to utilize and then deploy in 100%
of its installed guest pay rooms an image-based menu and
purchasing protocol using on-screen graphics to market movies,
video games and other interactive television services, rather than
using simple text menus traditionally used by competitors,
- integrating technology that enables hotel guests to access and
navigate the Internet and Internet-sourced entertainment and
information through guest room televisions, and
- integrating technology that allows the Company to cost-effectively
provide plug-and-play, high-speed Internet access (at up to 50
times the speed of conventional modems) to hotel guest rooms,
business conference rooms and other meeting spaces.
The Company's predecessor commenced business in 1980 as Satellite Movie
Company, incorporated as a South Dakota corporation in February 1983, and
changed its name to LodgeNet Entertainment Corporation in September 1991. On
October 13, 1993, LodgeNet Entertainment Corporation changed its state of
incorporation from South Dakota to Delaware by merging with and into the
Company, its newly-formed Delaware subsidiary, which then adopted the LodgeNet
name. The Company's principal executive offices are located at 3900 West
Innovation Street, Sioux Falls, South Dakota 57107, (605) 988-1000.
BUSINESS STRATEGY
CONTINUE TO EXPAND THE COMPANY'S ROOM BASE. Within the Company's target
market of hotels with 75 or more rooms, the Company believes substantial
opportunity exists for continued, selective growth in its Guest Pay interactive
room base. The Company estimates that more than 400,000 rooms are presently not
served by any guest pay vendor and fit its target economic profile. The Company
also estimates that its competitors serve another 200,000 rooms under contracts
due to expire before 2001. The Company believes that the cost-effective and
flexible design of its scaleable interactive television system, together with
its expertise in installation, programming, technical support and customer
service, will allow the Company to continue to expand its interactive room base
pursuant to long term contracts. Internationally, the Company intends to
continue to expand into selected countries in Asia and Latin America and other
regions through licensing agreements with established entities in these
countries. Under these agreements, the Company does not provide any capital
investment. Instead, the Company licenses its interactive system architecture
and capabilities, sells equipment at cost plus an agreed markup and receives a
royalty based on gross revenues.
INCREASE ROOM REVENUES THROUGH EXPANSION OF INTERACTIVE SERVICES.
Having successfully transitioned 100% of its Guest Pay room base to its
interactive television platform, the Company plans to continue to increase
the revenue it realizes from each Guest Pay interactive room by expanding and
enhancing the scope of its interactive television programming and adding
Internet-based services to its installed base. The Company intends to
continue offering on-demand movies and Nintendo N64 video games ("N64") in
all new Guest Pay interactive rooms. It also plans to upgrade selected
existing systems utilizing the Super Nintendo Entertainment System ("SNES")
to the N64 platform over time as the N64 game system generates more per room
revenue than the older SNES system.
To take advantage of the explosive growth of the Internet and the
vast amount of content available on the Internet for delivery into its
interactive room base, the Company is engaged in a focused product
development effort targeted at integrating Internet-based technologies into
its interactive television system. The Company tested hardware platforms
available from various vendors, created relationships with a variety of
Internet-based content and connectivity companies, enhanced its proprietary
communications software and installed the new Internet platform into more
than 10,000 rooms as of December 31, 1999. Based on this experience, the
Company believes there are significant opportunities to generate new
interactive services revenues from usage fees charged to the guests for
Internet access through the guest room television. The Company also believes
that the more than 190
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million guests who annually stay in the guest rooms served by the Company,
represent a highly desirable target audience to which the Company can provide
access for third-party providers of content, merchandise and information
services.
In addition to its television-based Internet product development
activities, the Company has also been focused on integrating technology into its
interactive offering which would allow hotel guests with laptop computers to
connect to the Internet (without changing their system configurations) at access
speeds up to 50 times faster than conventional modems, while bypassing the
hotel's PBX system. The high-speed Internet access service can be installed into
a hotel's business conference rooms, other meeting rooms and public space as
well as at the desktop within the guest room. The Company believes that this
"managed connectivity" service may represent a significant opportunity to
generate additional new interactive revenues from usage fees charged to guests
who utilize the service or from hotels which want to provide the service as an
amenity to their guests. The Company believes that its high speed Internet
services attractively complement its existing interactive service offerings.
This combination of Internet services and interactive television capabilities,
coupled with its nationwide presence, makes the Company a convenient,
single-source from which hotels can obtain the complete range of interactive
television and Internet services.
The Company's current installed Guest Pay interactive base of more than
661,000 rooms hosts more than 190 million guests each year (based on current
average occupancy and length-of-stay data). The Company believes such guests
represent a demographic profile which a variety of advertisers may find to be
highly desirable. The Company is seeking advertising-based arrangements, such as
advertiser-supported visitor information services for specific cities, as well
as other advertising strategies to deliver targeted product or service
information directly to the consumer. The Company will evaluate these and other
opportunities as well as appropriate business models that would enable the
Company to increase the revenue generated per guest pay room.
CONTINUE TO INCREASE OPERATING MARGINS. Complementing the Company's
growth objective is its ongoing goal of increasing operating margins by reducing
direct and overhead expenses, as measured on a percentage of revenue and on a
per-installed unit basis. Over the past five years, the Company's EBITDA margin
has increased from 23.0% in 1994 to 33.2% in 1999. The Company achieved this
result through reduced per-room operating costs as it leveraged its corporate
and operating infrastructure over a larger base of installed rooms and a broader
range of interactive revenues. The Company believes that further efficiencies
can be gained as measured on a percentage of revenue as it continues to expand
its Guest Pay interactive room base and the revenues it realizes from that base
as it expands the scope of its interactive television and Internet access
offerings.
MARKETS AND CUSTOMERS
LARGE HOTEL MARKET. Historically, the Company's primary market for
Guest Pay services has been large hotels with over 150 rooms located in
metropolitan areas in the U.S. and Canada, and the Company estimates that this
market segment contains approximately 1.3 million rooms. The Company currently
provides its services to large hotels that are generally part of chains such as
Sheraton, Ritz-Carlton, Omni, Radisson, Harrah's Casino Hotels, Delta Hotels and
Resorts, Outrigger, Holiday Inn, Inter-Continental, Embassy Suites, Prince,
Westin, Hilton and Marriott. No single contract represented greater than 10% of
the Company's combined guest pay and free-to-guest revenues for the year ended
December 31, 1999.
MID-SIZE HOTEL MARKET. In 1995, LodgeNet redesigned its Guest Pay
interactive system, enabling the Company to deliver on-demand movies and
network-based video games more cost-effectively to mid-size hotels. Since 1995,
the Company has also been targeting mid-size hotels of 75 to 150 rooms as part
of its guest pay marketing strategy. Since 1995, the Company has added more than
170,000 rooms to its room base from mid-size hotels. The Company believes that
this market segment, which the Company estimates contains approximately 1.2
million rooms, has not been broadly served by the guest pay industry because
smaller average property sizes lack economies of scale. The mid-size hotel
segment represents a large and attractive market for the Company's services that
generates financial returns that meet or exceed those achieved in larger hotels.
FREE-TO-GUEST MARKET. Almost all of the approximately 3.6 million
hotel rooms in the United States are served by some form of free-to-guest
television service. Free-to-guest television typically involves a package of
basic and premium programming which the hotel purchases and provides at no
charge to its guests. These services can be purchased on a stand-alone basis or
as part of a package which includes Guest Pay interactive services.
SERVICES AND PRODUCTS
GUEST PAY INTERACTIVE SERVICES. The Company's primary source of revenue
is providing in-room, interactive television services to the lodging industry,
for which the hotel guest pays on a per-view, per-play or per-day basis. The
high-speed, two-way digital communications design of the Company's broadband
system architecture enables the Company to provide sophisticated interactive
features such as on-demand movies, network-based Nintendo video games,
Internet-enhanced television and high-
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speed Internet access services. Guest Pay packages may also include
satellite-delivered basic and premium cable television programming, and other
interactive services such as folio review, video checkout, guest surveying,
advertising and merchandising services that are paid for by the hotel and
provided to guests free of charge.
Guest Pay interactive services include in-room television viewing of
recently released major motion pictures and independent films for which a hotel
guest pays on a per-view basis. The Company's on-demand movie system allows
guests to choose from an expanded menu of video selections and individually
start the selected video at their convenience rather than restricting them to a
predetermined start time. It has been the Company's experience that rooms having
the on-demand format generate significantly greater movie revenues than
comparable rooms having only the pre-scheduled format. As of December 31, 1999,
the Company served over 661,000 Guest Pay rooms, of which 100% featured the
Company's interactive on-demand system. The Company continuously monitors
guests' entertainment selections and adjusts its programming to respond to
viewing patterns. The system also enables hotel owners to broadcast
informational and promotional messages.
In May 1993, the Company entered into a non-exclusive license agreement
with Nintendo to provide hotels with a network-based Nintendo video game playing
system. In May 1998, this agreement was revised and extended for ten years.
Pursuant to this extended agreement, Nintendo provides the Company with access
to its new Nintendo N64 video games. The Company uses its broadband system
architecture to allow guests to play the video games over the hotel's master
antenna television system. Hotel guests are charged a fee based on the amount of
time they play the video games. Presently, the Company generally charges $6.95
per hour of play. The Company had over 627,000 rooms installed with the Nintendo
video game systems as of December 31, 1999.
The revenues generated from Guest Pay interactive services at any given
property are dependent upon a number of factors: (i) the occupancy rate at the
property; (ii) the "buy rate" or percentage of occupied rooms that purchase a
movie, video games, Internet access or other interactive service offered at the
property; and (iii) the price of the movie, video game, Internet access or other
interactive service. For example, a property installed with the Company's
interactive system with a 68% occupancy rate, a buy rate of 10.5% and an $8.95
movie price will generate an average of approximately $19.40 of gross movie
revenue per installed room per month, plus additional gross revenues of $3.85
per month from video games, free-to-guest and other interactive services,
resulting in total gross revenue per room per month of $23.25, assuming an
average of 30.4 days in the month. Occupancy rates vary (a) by property based on
the property's competitive position within its marketplace, (b) over time based
on seasonal factors, and (c) as a result of changes in general economic
conditions. Buy rates generally reflect the hotel's guest mix profile, the
popularity of the available programming and the guests' other entertainment
alternatives. Buy rates also vary over time with general economic conditions.
The price charged for each programming option is established by the Company and
is set based on the guest mix profile at each property and overall economic
conditions. Movie prices are set by the Company on a title by title basis, but
generally range from $7.95 to $10.95. Prices may be higher in some locations and
for certain highly popular titles.
The cost of installation varies depending on the size of the hotel
property and the configuration of the interactive system being installed. The
average installed cost of a new on-demand movie room with video game and
general interactive services capabilities, including the headend equipment
and, in some cases, televisions, is currently approximately $355 to $365 per
room. The installed cost of a room also having Internet access on television
capabilities is $60 to $80 more. In addition to hotel commissions and
royalties paid to movie studios and other interactive content providers,
operating costs of the Guest Pay interactive systems include system
maintenance, in-room promotional and information cards, preview tapes or
discs, tape duplication, taxes, freight, insurance, personal property taxes,
data line and Internet connectivity costs.
In exchange for a contract renewal or significant contract extension
the Company typically invests from $75 to $175 per room, depending on the length
of the extended contract period and the upgrade services installed.
FREE-TO-GUEST AND OTHER SERVICES. In addition to Guest Pay interactive
services, the Company provides cable television programming for which the hotel,
rather than its guests, pays the charges. Free-to-guest services include the
satellite delivery of various programming channels through a satellite earth
station, which generally is owned or leased by the hotel, which programming is
then distributed to guest rooms over the hotel's existing master antenna system.
The hotel pays the Company a fixed monthly charge per room for each programming
channel selected and provides these channels to its guests free of charge.
Premium channels, such as HBO, Showtime and The Disney Channel, broadcast major
motion pictures and specialty programming, while non-premium channels, such as
CNN, ESPN and WTBS, broadcast news, sports and informational programs. Premium
programming suppliers typically contract only with cable companies and other
large volume subscribers, such as the Company, and will not generally provide
programming directly to individual hotel properties. The Company successfully
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competes with local cable television operators by customizing packages of
programming to provide only those channels desired by the hotel subscriber,
which typically reduces the overall cost of the services provided.
The Company also sells and leases entertainment hardware, including
satellite earth stations, televisions and off-air signal reception and
processing equipment, to the lodging industry. The Company believes that this
service complements its goal of being a full-service provider of in-room
entertainment and information services to the lodging industry.
RESIDENTIAL SERVICES. In 1996 the Company formed ResNet Communications,
Inc. ("ResNet") to extend delivery of the Company's services to the multi-family
dwelling market. In July 1998, the Company decided to merge ResNet into a
larger, independent entity. Beginning on November 30, 1998, the closing date for
the merger transaction, ResNet ceased to be a majority-owned subsidiary of the
Company. The Company received an approximate 30% equity interest in Global
Interactive Communications Corporation ("Global"), the successor to ResNet, as a
result of the merger. The Company is not actively involved in the business
activities of Global.
OPERATIONS
CONTRACTS. The Company provides its Guest Pay interactive services
under contracts with lodging properties that generally run for a term of five to
seven years. During the five years ended December 31, 1999, the average initial
term of new guest pay contracts exceeded six years. The Company's contracts
generally provide that the Company will be the exclusive provider of in-room,
on-demand television entertainment services to the hotels, permit the Company to
set prices, and allow the Company to terminate the contract and remove its
systems if the results of operation of the Company's system installed at the
hotel do not meet the Company's return on investment criteria. The contracts
also typically grant the Company a right of first refusal regarding the
provision of additional video related services to the hotel. Under these
contracts, the Company installs its system into the hotel free of charge and
retains ownership of all equipment utilized in providing its services. The terms
contained in the contracts with corporate-managed hotels in any one chain
generally are negotiated by that chain's corporate management, and the hotels
subscribe at the direction of corporate management. In the case of franchised
hotels, the contracts are generally negotiated separately with each hotel.
Typically, the hotel provides and owns the television set installed in the guest
room; however, the Company in some cases provides televisions incorporating the
Company's integrated guest pay terminal units to hotels which meet certain
economic criteria. For Guest Pay interactive services which are paid for by the
hotel guest, the hotel collects such charges, coincident with the collection of
room and other charges made by the hotel, and remits monthly to the Company. The
hotels retain a commission from such charges, which varies depending on the size
and profitability of the system and other factors. The Company generally seeks
to extend and renew hotel contracts in advance of their expiration on
substantially similar terms. The average remaining life of the Company's current
Guest Pay interactive contracts is over four years, with less than 8% of these
contracts coming up for renewal before 2001.
TECHNOLOGY, PRODUCT DEVELOPMENT AND PATENTS. The Company designs and
develops high quality interactive, multimedia entertainment and information
systems. Because such systems utilize an open architecture, UNIX-based platform
incorporating industry standard interfaces, the Company can upgrade system
software to support the introduction of new services or integrate new
technologies as they become economically viable. The Company's interactive
system incorporates the Company's scaleable proprietary broadband, local area
network system architecture with commercially manufactured, readily-available
electronic and computer components and hardware.
The Company's broadband system architecture utilizes the Company's
proprietary, two-way digital communications design to process and respond to
input commands from the viewer very rapidly. This capability enables the
Company to provide sophisticated interactive television services such as
on-demand movies, network-based Nintendo video games, Internet-enhanced
television, high-speed Internet access, and a variety of other interactive
services such as folio review, video checkout, guest surveying, advertising
and shopping services.
The Company's Guest Pay interactive systems consist of equipment
located within the guest room connected via a local-area cable distribution
network to a headend located elsewhere in the hotel. Typical in-room equipment
includes a terminal unit, a hand-held remote television control and a video game
controller. In-room equipment may also include an infra-red computer keyboard
and a desktop device which provides a high-speed Internet connection. The
in-room terminal unit may be integrated within the television set or located
behind or on top of the set. Movie programming originates from the system
headend and is transmitted to individual rooms over the hotel's master antenna
system. Video game programs are downloaded into dedicated video game processors
also located within the headend. Keystrokes and other system commands and
communications are transmitted from the room using the Company's proprietary
high-speed communications infrastructure and the video and other signals are
transmitted to the guest room over the hotel's master antenna system. The system
computer controls the delivery of the
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Guest Pay interactive services to the guest room and also automatically records
purchase transactions and billing data to the hotel's accounting system, which
automatically posts the charge to the guest's bill.
Although the Company's products are compatible with all brands of
televisions, the Company has arrangements with leading suppliers of televisions
to the lodging industry, who provide the Company with commercial televisions
into which the Company can integrate its custom-designed circuit boards.
Integration eliminates the need for an external terminal unit and costs less
than an external unit of comparable utility.
The Company designs its systems through its staff of 69 software and
hardware engineers and support personnel as of December 31, 1999. Development
activities are oriented toward the continued enhancement and cost reduction of
the Company's system and the further development of additional interactive,
multimedia entertainment and information.
It is the Company's policy to apply for patents on those product
designs which management believes may be of significance to the Company. The
Company owns eight United States patents, cross-licenses other industry-related
technologies and patent rights, and has other applications for patents pending
in the U.S. Patent and Trademark Office dealing with various aspects of the
Company's interactive multimedia systems.
The Company uses a number of registered and unregistered trademarks for
its products and services. The Company has applications for registration pending
for certain of the unregistered trademarks, and those trademarks for which the
Company has not sought registration are governed by common law and state unfair
competition laws. Because the Company believes that these trademarks are
significant to the Company's business, the Company has taken legal steps to
protect its trademarks in the past and intends to actively protect these
trademarks in the future. The Company believes that its trademarks are generally
well recognized by consumers of its products and are associated with a high
level of quality and value.
SALES AND MARKETING. The Company focuses its sales and marketing
strategies on acquiring new contracts from hotels, extending and retaining
existing contracts, and marketing the Company's Guest Pay interactive services
to the hotel guest. The Company's sales and marketing organization consisted of
53 employees as of December 31, 1999, including national account
representatives, who develop relationships with national hotel franchise
organizations and management groups, and regional sales representatives who
maintain relationships primarily with regional hotel management and ownership
organizations. The Company markets its services and products to hotels by
advertising in industry trade publications, attending industry trade shows,
direct marketing and telemarketing. Sales activities are coordinated from the
Company's headquarters.
The Company markets its services to hotel guests by means of an
interactive, image-based menu and purchasing protocol using on-screen graphics
and movie and video game promotion and programming information. In-room
marketing advertisements are designed and produced by the Company's marketing
department. The system also generates a "Welcome Channel", which appears
on-screen when the television is turned on and describes the programming and
interactive services available through the Company's system.
INSTALLATION AND SERVICE OPERATIONS. The Company believes that high
quality and consistent systems support and maintenance are essential to
competitive success in its industry. The Company's installation and service
organization consists of 281 employees in 26 locations in the United States and
Canada, as of December 31, 1999. The Company emphasizes the use of
Company-employed installation and service personnel, but also uses
Company-trained subcontractors in areas where there is not a sufficient
concentration of Company-served hotels to warrant a Company-employed service
representative. Currently, the Company's in-house installation and service
organization has responsibility for approximately 87% of the Guest Pay
interactive hotel rooms served by the Company. Service personnel are responsible
for all preventive and corrective systems maintenance. The Company's
installation personnel also prepare engineering surveys at each particular
hotel, install the Company's systems, train the hotel staff to operate the
systems and perform quality control tests.
The Company maintains a toll-free customer support hot line,
"Tech-Connect," which is monitored 24 hours a day, 365 days a year by trained
support technicians. The on-line diagnostic capability of the Company's systems
enables the Company to identify and resolve a majority of reported system
malfunctions from the Company's service control center without visiting the
hotel property. When a service visit is required, the modular design of the
Company's systems permits installation and service personnel to replace
defective components at the hotel site.
PROGRAMMING. The Company obtains non-exclusive rights to show recently
released major motion pictures from motion picture studios pursuant to a master
agreement with each studio. The license period and percentage fee for each movie
are negotiated separately, with the studio receiving a percentage of the
Company's gross revenue from the movie. For recently released
6
motion pictures, the Company typically obtains rights to exhibit the picture
while it is still in theatrical release, but prior to its release to the home
video market or for exhibition on cable television. Generally, studios make
master video tapes of their movies available for duplication sufficiently in
advance of the release dates for the lodging industry so that all of the
Company's hotels can offer the movies as of the first date they are available
for exhibition. The Company obtains independent films, most of which are
non-rated and intended for mature audiences, for a one-time flat fee that is
nominal in relation to the licensing fees paid for major motion pictures and
which permits the Company to duplicate the films as necessary to supply copies
to its hotel sites. The Company obtains its selection of Nintendo video games
pursuant to a ten year non-exclusive license agreement with Nintendo entered
into in 1998. Under the terms of the agreement, the Company pays Nintendo a
monthly fee based on the number of rooms offering Nintendo video game services.
The Company continuously monitors guests' entertainment selections and adjusts
its programming to respond to viewing patterns.
The Company obtains its basic and premium cable television programming
pursuant to multiyear license agreements generally containing automatic renewal
provisions and pays its programming suppliers a fixed, monthly fee for each room
or subscriber receiving the service. Management believes that relations with the
programming suppliers are good and expects to renew these contracts as necessary
on competitive terms.
In January 2000, the Company entered into a multi-year agreement
with DIRECTV, Inc. to make available DIRECTV -Registered Trademark-
programming to the more than 3,700 hotels and 400,000 rooms which subscribe
to LodgeNet's basic and premium cable television services. Pursuant to the
agreement, over the next year the Company will upgrade existing Primestar by
LodgeNet locations to the high-powered DIRECTV services.
SYSTEMS PRODUCTION GROUP AND EQUIPMENT SUPPLIERS. The Company contracts
directly with various electronics firms for the manufacture and assembly of
certain of its systems hardware, the design of which is controlled by the
Company. The Company has found these suppliers to be dependable and able to meet
delivery schedules on time. The Company believes that, in the event of a
termination of any of its sources, with proper notification from the supplier,
alternate suppliers could be located without incurring significant costs or
delays. Certain electronic component parts used within the Company's products
are available from a limited number of suppliers and can be subject to temporary
shortages because of general economic conditions and the demand and supply for
such component parts. If the Company were to experience a shortage of any given
electronic part, the Company believes that alternative parts could be obtained
or system design changes implemented. In such event, the Company could
experience a temporary reduction in the rate of new room installations and/or an
increase in the cost of such installations. All other components of the
Company's systems are standard commercial products, such as computers, video
cassette players, modulators and amplifiers, that are available from multiple
sources. The Company believes its anticipated growth can be accommodated through
existing suppliers.
The headend electronics are assembled at the Company's facilities for
testing prior to shipping. The Company samples the room units at the supplier's
facilities periodically for reliability. Following assembly of headend equipment
with a configuration designed specifically for a particular customer, the system
is shipped to the location, where it is installed by Company-employed
technicians or Company-trained subcontractors.
COMPETITION
The Company is the second largest provider of interactive and cable
television services to the lodging industry, currently serving over 760,000
hotel rooms. The Company's largest competitor is On Command Corporation ("OCC"),
the successor corporation resulting from the 1996 merger of SpectraVision, Inc.
and On Command Video Corporation. Based upon publicly available information, the
Company estimates that OCC currently serves approximately 956,000 hotel rooms.
The Company also competes with Hospitality Networks, SeaChange, Time Warner, Cox
Cable and GalaVu, among others. With regard to high-speed Internet
connectivity, the Company also competes with CAIS Internet, STSN, Darwin
Networks and others.
There are also a number of potential competitors that could use their
existing infrastructure to provide in-room entertainment services to the lodging
industry, including franchised and wireless cable operators, telecommunications
companies, Internet service and DBS providers. Some of these potential
competitors are already providing free-to-guest or Internet-related services to
the lodging industry and have announced plans to offer guest pay services. Some
of these companies may have substantially greater financial and other resources
than the Company, and it is possible that such competitors may develop a
technology that is more cost effective than the Company's broadband, local area
network system architecture. To respond to competition, the Company will need to
continue to enhance its in-room entertainment systems, expand its operations and
meet the increasing demands for competitive pricing, service quality and
availability of value-added product offerings.
Competition with respect to new hotel contracts centers on a variety of
factors, depending upon the features important to a particular hotel. Among the
more important factors are: (i) the features and benefits of the entertainment
systems; (ii) the quality of the vendor's technical support and maintenance
services; (iii) the financial terms and conditions of the proposed contract
(including payments to the hotel); and (iv) the ability to complete system
installation in a timely and efficient manner. In addition,
7
with respect to hotel properties already receiving in-room entertainment
services, the incumbent provider may have certain informational and installation
cost advantages as compared to outside competitors.
The Company believes that its competitive advantages include: (i) its
broadband local area network system architecture that enables the Company to
deliver a broad range of interactive features and services such as on-demand
movies, Internet-enhanced television, high speed Internet connectivity and
network-based Nintendo video games; (ii) the flexible design of the Company's
system which enables it to add enhancements or integrate new technologies and
services as they become commercially available and economically viable; (iii)
high quality customer support and nationwide field service operations; and (iv)
an experienced management team and professional and well-trained sales
organization. The Company believes that its success in securing contracts
reflects the strong competitive position of the Company's products and services.
Because of the high level of penetration in the large hotel segment of
the lodging industry already achieved by guest pay providers, most of the growth
opportunities in this market segment have typically involved securing contracts
to serve hotels that are served by a competing vendor. An incumbent provider may
have certain information and installation cost advantages as compared to outside
competitors. These circumstances have led to increasing competition for contract
renewals, particularly at hotels operated by major hotel chains. The Company
believes that certain major hotel chains have awarded contracts based primarily
on the level and nature of financial and other incentives offered by the guest
pay provider. Even if it were able to do so, the Company may not always be
willing to match the incentives provided by its competitors, some of which have
greater access to financial and other resources than the Company. Because
free-to-guest service providers generally have substantially comparable access
to the satellite delivered programming that comprises the free-to-guest
services, competition in this segment has been based primarily on price and
customer service.
While the Company believes that its broadband, local area network
system architecture is comparable or superior to the systems currently being
used by its competitors in the lodging industry, there can be no assurance that
such competitors will not develop a cost-effective system that is comparable or
superior to the Company's system. In order to broaden its market opportunities,
the Company over time has redesigned its system to permit the delivery of
on-demand movies and network-based video games to mid-size hotels of 75 to 150
rooms, a market segment the Company believes has been historically under-served
by guest pay providers. There can be no assurance that competitors will not
develop a cost-effective system that would allow them to target this market
segment. Further, there can be no assurance that the Company will continue its
current level of success in obtaining new contracts from hotels currently served
by other vendors or previously unserved, or that the Company will be able to
retain contracts with hotels it serves when those contracts expire.
Although in the free-to-guest market, the local franchised cable
operator in a hotel's market may have a substantial market presence, such
operators typically offer the hotel owner only standard packages of programming
typically developed for the residential market rather than the lodging market,
and at a fixed price per room based on all the channels provided. The Company
competes with the franchised cable operator for free-to-guest contracts by
customizing packages of programming to provide only those channels desired by
the hotel, typically reducing the overall cost per room to the hotel operator.
Competitive pressures in the guest pay and free-to-guest segments could
result in reduced market share for the Company, higher hotel commissions, lower
margins and increased expenditures for marketing, product development and
systems installation, each of which could adversely affect the Company's
financial condition and operating results.
REGULATION
TELECOMMUNICATIONS ACT OF 1996. The Telecommunications Act of
1996 (the "Act") is intended, in part, to promote substantial competition for
telephone and video services and will alter federal, state and local laws and
regulations regarding telecommunications providers and services. The Act
generally removes previous restrictions preventing cable firms, telephone
companies, long distance carriers and public utilities from entering into
certain new markets, removes many cross-ownership restrictions and modifies rate
regulations applicable to franchised cable operators. In particular, the Act
authorizes local telephone companies to provide video programming directly to
subscribers in their service areas and eliminates the requirement that "private
cable" operators serve only buildings "under common ownership, management or
control," but preserves the requirement that such operations not use closed
transmission paths to cross public rights-of-way. It is anticipated that the Act
will stimulate increased competition generally in the telecommunications and
cable industries which may adversely impact the Company. No assurance can be
given that changes in current or future laws or regulations adopted by the FCC
or state or local regulatory authorities would not have a material adverse
effect on the Company's business.
8
As a result of the Act, the Company's business may be adversely
affected by the entry of additional competitors in the multichannel video
programming distribution market. In part, the Company's competitiveness also
will depend upon the outcome of FCC rulemaking proceedings to interpret and
implement the provisions of the Act. It is not possible at this time to predict
the outcome of such rulemaking proceedings or their effect on the Company.
CABLE TELEVISION REGULATION. The Communications Act of 1934, as
amended by the Cable Communications Policy Act of 1984 (the "1984 Cable
Act"), the Cable Television Consumer Protection and Competition Act of 1992
(the "Cable Act"), and the Act, governs the regulation of "cable systems."
The law defines a "cable system" as a facility, consisting of a set of closed
transmission paths and associated signal generation, reception, and control
equipment that is designed to provide cable service which includes video
programming and which is provided to multiple subscribers within a community,
but the law exempts from that definition, among other facilities, a facility
that serves subscribers without using any public rights-of-way. The Company
constructs and operates separate headend systems at each hotel and those
systems do not use public rights-of-way. Thus, with respect to its private
guest services operations, the Company is not required to comply with many of
the FCC's rules relating to cable systems, including, among other things,
rate regulation and the requirement to obtain a franchise from local
government authorities in order to provide video services.
As a "multichannel video programming distributor" ("MVPD"), however,
the Company is subject to various provisions of the Communications Act of 1934,
as amended. Laws and regulations applicable to MVPDs generally apply to the
Company. These include laws and regulations that benefit the Company, such as
provisions that ensure the Company access to programming on fair, reasonable and
nondiscriminatory terms, as well as provisions that subject the Company to
additional requirements, such as the requirement to obtain consent from
broadcasters in order to retransmit their signals over the Company's systems.
ELECTRIC UTILITY ENTRY INTO CABLE AND TELECOMMUNICATIONS. The Act
provides that registered utility holding companies and subsidiaries may provide
telecommunications services (including cable television) notwithstanding the
Public Utility Holding Company Act. Electric utilities must establish separate
subsidiaries, known as "exempt telecommunications companies" and must apply to
the FCC for operating authority. Large utility holding companies may become
significant competitors to both cable television and other telecommunications
providers.
The foregoing does not purport to describe all present and proposed
federal, state and local regulations and legislation relating to the video
programming industry. Other existing federal, state and local laws and
regulations currently are, or may be, the subject of a variety of judicial
proceedings, legislative hearings, and administrative and legislative proposals
that could change in varying degrees, the manner in which private cable
operators and other video programming distributors operate. The Company cannot
estimate the outcome of these proceedings or their impact upon its operations at
this time.
EMPLOYEES
As of December 31, 1999, the Company had 702 employees in the United
States and Canada. None of these employees is covered by a collective bargaining
agreement. The Company has not experienced any significant labor problems and
believes that its relationship with its employees is good.
ITEM 2 - PROPERTIES
9
The Company's National Headquarters and Distribution Center, including
its principal executive offices, is located on an approximately 23 acre site in
Sioux Falls, South Dakota. Construction of the approximately $15 million
facility was completed in December 1997. The National Headquarters and
Distribution Center occupies approximately 228,500 square feet including
approximately 126,500 square feet for executive, administrative and support
functions, approximately 60,000 square feet for assembly and distribution
functions, and approximately 42,000 square feet for warehouse space. The opening
of the National Headquarters and Distribution Center allowed the Company to
consolidate all of its local operations into a single, multipurpose facility
which is designed to enhance operational efficiency and to facilitate any
necessary future expansion needs of the Company. The Company believes that the
site of its National Headquarters and Distribution Center is sufficient to
accommodate its foreseeable local operational space requirements.
The Company leases 23 facilities, in various locations, from
unaffiliated third parties. These facilities are combination warehouse/office
facilities for installation and service operations and are located throughout
the country. Each of these facilities occupies less than 3,500 square feet.
ITEM 3 - LEGAL PROCEEDINGS
The Company is subject to litigation arising in the ordinary course of
business. As of the date hereof, the Company believes the resolution of such
litigation will not have a material adverse effect upon the Company's financial
condition or results of operations.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during
the quarter ended December 31, 1999.
10
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock currently trades on the NASDAQ National
Market System ("NASDAQ NMS") under the symbol "LNET". The Company's Common Stock
began trading on the NASDAQ NMS on October 14,1993 upon the effectiveness of its
initial public offering. As of March 22, 2000 there were outstanding 12,123,688
shares of the Company's Common Stock.
The following table sets forth, for the fiscal quarters indicated, the
range of high and low sales prices of the Company's Common Stock as reported by
NASDAQ NMS.
Quarter Ended High Low
-------------------------- ----------- ----------
March 31, 1998 $12.25 $10.38
June 30, 1998 12.50 8.00
September 30, 1998 10.00 6.50
December 31, 1998 7.63 5.13
March 31, 1999 9.00 6.25
June 30, 1999 13.93 5.75
September 30, 1999 14.75 10.50
December 31, 1999 25.12 12.00
On March 22, 2000, the closing price of the Company's Common Stock, as
reported by NASDAQ NMS was $19.938. Stockholders are urged to obtain current
market quotations for the Company's Common Stock. As of March 22, 2000 there
were 146 stockholders of record of the Company with approximately 87% of the
shares held in "street name". The Company estimates that as of March 22, 2000
there were more than 2,500 stockholders of the Company.
DIVIDENDS
No dividends have been paid to date on the Common Stock of the Company.
Management of the Company does not intend to pay any cash dividends on Common
Stock of the Company in the foreseeable future, rather, it is expected that the
Company will retain earnings to finance its operations and growth. The terms and
conditions of the Company's 10.25% Senior
11
Notes and of the Company's bank credit facility both contain covenants which
restrict and limit payments or distributions in respect of the Common Stock
of the Company.
STOCKHOLDER RIGHTS PLAN
On February 28, 1997, the Board of Directors of the Company authorized
and adopted a stockholder rights plan ("Rights Plan"). The Rights Plan is
intended to maximize stockholder value by providing flexibility to the Board of
Directors in the event that an offer for the Company is received that is either
inadequate or not in the best interest of all stockholders. The Rights Plan had
been under consideration by the Board of Directors for almost a year prior to
its adoption and is in a form recommended by the Company's outside legal counsel
and financial advisors, which form is similar to that adopted by many other
public companies.
Pursuant to the Rights Plan, the Board of Directors declared a
dividend distribution of one "Right" for each outstanding share of common stock,
par value $.01 per share (the "Common Stock") of the Company to stockholders of
record at the close of business on March 10, 1997 (the "Record Date"). In
general, each Right, when exercisable, entitles the registered holder to
purchase from the Company one one-thousandth of a share of a new series of
preferred stock, designated as Series A Participating Preferred Stock, par value
$.01 per share (the "Preferred Stock"), at a price of $60.00 (the "Purchase
Price"), subject to adjustment. The terms of the Rights are set forth in a
Rights Agreement (the "Rights Agreement") between the Company and Harris Trust
and Savings Bank, as "Rights Agent". The following summary description of the
Rights and the terms of the Rights Agreement does not purport to be complete and
is qualified in its entirety by reference to the Rights Agreement incorporated
by reference as an exhibit hereto.
Initially, the Rights will be attached to all Common Stock certificates
representing shares then outstanding, and no separate Rights certificates will
be distributed. The Rights will separate from the Common Stock and a
"Distribution Date" will occur upon the earliest of (i) a public announcement
that a person, entity or group of affiliated or associated persons and/or
entities (an "Acquiring Person") has acquired, or obtained the right to acquire,
beneficial ownership of 15% or more of the outstanding shares of Common Stock,
other than as a result of repurchases of stock by the Company or certain
inadvertent actions by institutional or certain other stockholders, or (ii) ten
days (unless such date is extended by the Board of Directors ) following the
commencement of (or a public announcement of an intention to make) a tender
offer or exchange offer which would result in any person, entity or group
affiliated or associated persons and/or entities becoming an Acquiring Person.
Until the Distribution Date the Rights will be evidenced, with respect
to any of the Common Stock certificates outstanding as of the Record Date, by
such Common Stock certificate together with a Summary of Rights. The Rights
Agreement provides that, until the Distribution Date, the Rights will be
transferred with and only with Common Stock certificates. From as soon as
practicable after the Record Date and until the Distribution Date (or earlier
redemption or expiration of the Rights), new Common Stock certificates issued
after the Record Date upon transfer or new issuance of the Common Stock will
contain a notation incorporating the Rights Agreement by reference. Until the
Distribution Date (or earlier redemption or expiration of the Rights), the
surrender for transfer of any certificates for Common Stock outstanding as of
the Record Date (with or without the Summary of Rights attached) will also
constitute the transfer of the Rights associated with the Common Stock
represented by such certificate. As soon as practicable following the
Distribution Date, separate certificates evidencing the Rights ("Rights
Certificates") will be mailed to holders of record of the Common Stock as of the
close of business on the Distribution Date, and the separate Rights Certificates
alone will evidence the Rights.
The Rights are not exercisable until the Distribution Date. The Rights
will expire on the earliest of (i) February 28, 2007, (ii) consummation of a
merger transaction with a Person or group who acquired Common Stock pursuant to
a Permitted Offer (as defined below), and is offering in the merger the same
price per share and form of consideration paid in the Permitted Offer, or (iii)
redemption or exchange of the Rights by the Company as described below.
The number of Rights associated with each share of Common Stock shall
be proportionately adjusted to prevent dilution in the event of a stock dividend
on, or a subdivision, combination or reclassification of, the Common Stock. The
Purchase Price payable, and the number of shares of Preferred Stock or other
securities or property issuable, upon exercise of the Rights are subject to
adjustment from time to time to prevent dilution (i) in the event of a stock
dividend on, or a subdivision, combination or reclassification of the Preferred
Stock, (ii) upon the grant to holders of the Preferred Stock of certain rights
or warrants to subscribe for Preferred Stock, certain convertible securities or
securities having the same or more favorable rights, privileges and preferences
as the Preferred Stock at less than the current market price of the Preferred
Stock, or (iii) upon the distribution to holders of the Preferred Stock of
evidences of indebtedness or assets (excluding regular
12
quarterly cash dividends out of earning or retained earnings) or of subscription
rights or warrants (other than those referred to above). With certain
exceptions, no adjustments in the Purchase Price will be required until
cumulative adjustments require an adjustment of at least 1% in such Purchase
Price.
In the event that, after the first date of public announcement by the
Company or an Acquiring Person that an Acquiring Person has become such, the
Company is involved in a merger or other business combination transaction
(whether or not the Company is the surviving corporation) or 50% or more of the
Company's assets or earning power are sold (in one transaction or a series of
transactions), proper provision shall be made so that each holder of a Right
(other than an Acquiring Person) shall thereafter have the right to receive,
upon the exercise thereof at the then current Purchase Price, that number of
share of common stock of either the Company, in the event that it is the
surviving corporation of a merger or consolidation, or the acquiring company
(or, in the event there is more than one acquiring company, the acquiring
company receiving the greatest portion of the assets or earning power
transferred) which at the time of such transaction would have a market value of
two times the Purchase Price (such right being called the "Merger Right"). In
the event that a Person becomes the beneficial owner of 15% or more of the
outstanding shares of Common Stock (unless pursuant to a tender offer or
exchange offer for all outstanding shares of Common Stock at a price and on
terms determined prior to the date of the first acceptance of payment for any of
such shares by at least a majority of the members of the Board of Directors who
are not officers of the Company and are not Acquiring Persons or Affiliates or
Associates thereof to be both adequate and otherwise in the best interests of
the Company and its stockholders (a "Permitted Offer")), then proper provision
shall be made so that each holder of a Right will for a 60-day period (subject
to extension under certain circumstances) thereafter have the right to receive
upon exercise that number of shares of Common Stock (or, at the election of the
Company, which election may be obligatory if sufficient authorized shares of
Common Stock are not available, a combination of Common Stock, property, other
securities (e.g., Preferred Stock) and/or a reduction in the exercise price of
the Right) having a market value of two times the Purchase Price (such right
being called the "Subscription Right"). The holder of a Right will continue to
have the Merger Right whether or not such holder exercises the Subscription
Right. Notwithstanding the foregoing, upon the occurrence of any of the vents
giving rise to the exercisability of the Merger Right or the Subscription Right,
any Rights that are or were at any time after the Distribution Date owned by an
Acquiring Person shall immediately become null and void.
At any time prior to the earlier to occur of (i) a Person becoming an
Acquiring Person or (ii) the expiration of the Rights, the Company may redeem
the Rights in whole, but not in part, at a price of $.01 per Right (the
"Redemption Price"), which redemption shall be effective upon the action of the
Board of Directors. Additionally, the Company may thereafter redeem the then
outstanding Rights in whole, but not in part, at the Redemption Price (i) if
such redemption is incidental to a merger or other business combination
transaction or series of transactions involving the Company but not involving an
Acquiring Person or certain related Persons or (ii) following an event giving
rise to, and the expiration of the exercise period for, the Subscription Right
if and for as long as the Acquiring Person triggering the Subscription Right
beneficially owns securities representing less than 15% of the outstanding
shares of Common Stock and at the time of redemption there are no other
Acquiring Persons. The redemption of Rights described in the preceding sentence
shall be effective only as of such time when the Subscription Right is not
exercisable, and in any event, only after ten business days' prior notice. Upon
the effective date of the redemption of the Rights, the right to exercise the
Rights will terminate and the only right of the holders of Rights will be to
receive the Redemption Price.
Subject to applicable law, the Board of Directors, at its option, may
at any time after a Person becomes an Acquiring Person (but not after the
acquisition by such Person of 50% or more of the outstanding Common Stock),
exchange all or part of the then outstanding and exercisable Rights (except for
Rights which have become void) for shares of Common Stock at a rate of one share
of Common Stock per Right or, alternatively, for substitute consideration
consisting of cash, securities of the Company or other assets (or any
combination thereof).
The Preferred Stock purchasable upon exercise of the Rights will be
nonredeemable and junior to any other series of preferred stock the Company may
issue (unless otherwise provided in the terms of such stock). If issued, each
share of Preferred Stock will have a preferential quarterly dividend in an
amount equal to 1,000 times the dividend, if any, declared on each share of
Common Stock, but in no event less than $25.00. In the event of liquidation, the
holders of shares of Preferred Stock will receive a preferred liquidation
payment equal to the greater of $1,000.00 or 1,000 times the payment made per
share of Common Stock. Each share of Preferred Stock will have 1,000 votes,
voting together with the shares of Common Stock. The rights of the Preferred
Stock as to dividends, liquidation and voting, and in the event of mergers and
consolidations, are protected by customary antidilution provisions. Fractional
shares of Preferred Stock will be issuable; however, (i) the Company may elect
to distribute depositary receipts in lieu of such fractional share and (ii) in
lieu of fractional shares other than fractions that are multiples of one
one-thousandth of a share, an adjustment in cash will be made based on the
market price of the Preferred Stock on the last trading date prior to the date
of exercise.
13
Until a Right is exercised, the holder thereof, as such, will have no
rights as a stockholder of the Company, including, without limitation, the right
to vote or to receive dividends. The Company and the Rights Agent retain broad
authority to amend the Rights Agreement; however, following any Distribution
Date any amendment may not adversely affect the interests of holders of Rights.
14
ITEM 6 - SELECTED FINANCIAL DATA
The following is a summary of Selected Financial Data. The data should
be read in conjunction with the Company's Consolidated Financial Statements, the
notes thereto, and "Management's Discussion and Analysis of Financial Condition
and Results of Operations", all included elsewhere herein. Dollar amounts are in
thousands, except for per share and per room amounts.
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------------
1995 1996 1997 1998 1999
------------ ----------------- -------------- ---------------- ---------------
STATEMENT OF OPERATIONS DATA:
Revenues:
Guest Pay $50,758 $84,504 $116,276 $146,481 $169,850
Other 12,455 13,217 19,434 19,870 11,422
------------ ----------------- -------------- ---------------- ---------------
Total revenues 63,213 97,721 135,710 166,351 181,272
Direct costs 28,910 44,379 58,512 74,008 78,490
------------ ----------------- -------------- ---------------- ---------------
Gross profit 34,303 53,342 77,198 92,343 102,782
Operating expenses 36,741 58,428 85,262 102,282 103,460
------------ ----------------- -------------- ---------------- ---------------
Operating loss (2,438) (5,086) (8,064) (9,939) (678)
Equity in losses of unconsolidated
affiliates -- -- -- (6,550) (24,323)
Gain on sale of investments -- -- -- -- 14,739
Interest expense (4,760) (8,551) (18,837) (23,261) (27,210)
Interest income 238 308 1,836 213 1,414
------------ ----------------- -------------- ---------------- ---------------
Loss before income taxes, extraordinary
loss and cumulative effect of
accounting change (6,960) (13,329) (26,065) (39,537) (36,058)
Provision for income taxes (66) (28) (344) (375) (370)
------------ ----------------- -------------- ---------------- ---------------
Loss before extraordinary loss and
cumulative effect of accounting change (7,026) (13,357) (25,409) (39,912) (36,428)
Extraordinary loss (1) -- (3,253) -- -- --
Cumulative effect of accounting change (2) -- -- (210) -- --
------------ ----------------- -------------- ---------------- ---------------
Net loss $(7,026) $(16,610) $(25,619) $(39,912) $(36,428)
============ ================= ============== ================ ===============
Per common share (basic and diluted):
Loss before extraordinary loss and
cumulative effect of accounting change $(.96) $(1.40) $(2.25) $(3.45) $(3.05)
Extraordinary loss -- (.34) -- -- --
Cumulative effect of accounting change -- -- (.02) -- --
------------ ----------------- -------------- ---------------- ---------------
Net loss $(.96) $(1.74) $(2.27) $(3.45) $(3.05)
============ ================= ============== ================ ===============
OTHER DATA:
EBITDA (3) $15,898 $24,729 $35,696 $48,576 $60,100
EBITDA margin (3) 25.1% 25.3% 26.3% 29.2% 33.2%
Capital expenditures (4) $51,497 $84,256 $104,377 $69,660 $51,226
Depreciation and amortization 18,336 29,815 43,760 55,215 60,778
Annualized EBITDA (5) 18,246 27,290 39,090 55,536 63,152
Ratio of earnings to fixed charges (6) -- -- -- -- --
Ratio of long-term debt to
annualized EBITDA (5) 3.38x 6.58x 4.69x 4.83x 4.48x
Ratio of EBITDA to interest expense (3) 3.34x 2.89x 1.90x 2.09x 2.21x
OPERATING DATA:
Guest Pay rooms served (7)
On-demand 209,487 358,842 484,070 581,893 661,691
Scheduled 58,720 41,403 27,781 14,913 --
------------ ----------------- -------------- ---------------- ---------------
Total Guest Pay rooms 268,207 400,245 511,851 596,806 661,691
============ ================= ============== ================ ===============
Rooms with Nintendo-Registered
Trademark- game systems (7) 163,879 322,903 448,969 546,324 627,592
Rooms with Internet services (7) -- -- -- -- 10,152
Free-to-guest rooms served (7) 249,779 294,882 341,030 384,324 399,046
Total rooms served (7) (8) 388,088 516,348 613,407 703,325 761,509
Average monthly revenue per Guest Pay
room:
Movie revenue $17.08 $18.38 $17.86 $18.44 $18.62
Other interactive service revenue 2.21 2.93 3.28 3.62 3.85
------------ ----------------- -------------- ---------------- ---------------
Total $19.29 $21.31 $21.14 $22.06 $22.47
============ ================= ============== ================ ===============
15
AS OF DECEMBER 31,
-----------------------------------------------------------
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
BALANCE SHEET DATA:
Cash and cash equivalents $2,252 $86,177 $1,021 $5,240 $1,644
Total assets 125,507 279,768 260,294 306,030 305,275
Total long-term debt 61,751 179,658 183,396 268,093 282,990
Total stockholders' equity 42,726 75,552 49,579 11,774 (5,504)
- -----------
(1) Loss on early redemption of debt.
(2) Represents a charge for the effect of adopting EITF Issue 97-13 related
to accounting for certain business reengineering costs.
(3) EBITDA ("Earnings Before Interest, Taxes, Depreciation and
Amortization") is not intended to represent an alternative to net
income or cash flows from operating, financing or investing activities
(as determined in accordance with generally accepted accounting
principles) as a measure of performance. Rather, it is included herein
because EBITDA is a widely accepted financial indicator used by certain
investors and financial analysts to assess and compare companies on the
basis of operating performance. Management believes that EBITDA
provides an important additional perspective on the Company's operating
results and the Company's ability to service its long-term debt and to
fund the Company's continuing growth. EBITDA has been presented
excluding equity in losses of unconsolidated affiliates, gain on sale
of investments, and the restructuring charge for the ResNet merger in
1998.
(4) Presented as cash used for property and equipment additions and
business acquisitions.
(5) "Annualized EBITDA" represents the sum of the quarterly EBITDA for the
two most recently completed fiscal quarters multiplied by two.
(6) Earnings is defined as net loss before income taxes, extraordinary
items and fixed charges, except where capitalized. Fixed charges is
defined as the portion of rental expense under operating leases
representing interest, and interest, including amortization of debt
expense, whether expensed or capitalized. Earnings were insufficient to
cover fixed charges for the years ended December 31 by the amounts
indicated: 1995 -- $(6,960); 1996 -- $(13,329); 1997 -- $(25,065); 1998
-- $(38,799); and 1999 -- $(36,058).
(7) At end of year.
(8) Total rooms served include those rooms receiving one or more of the
Company's services, including rooms served by international licensees.
16
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
CERTAIN STATEMENTS IN THIS ANNUAL REPORT ON FORM 10-K, INCLUDING,
WITHOUT LIMITATION, STATEMENTS IN ITEM 1, INCLUDING CERTAIN STATEMENTS UNDER THE
HEADINGS "OVERVIEW", "BUSINESS STRATEGY", "STRATEGIC INITIATIVES", "SERVICES AND
PRODUCTS", "OPERATIONS", "COMPETITION" AND "REGULATION", IN ITEM 3 UNDER THE
HEADING "LEGAL PROCEEDINGS", AND IN ITEM 7 UNDER THE HEADING "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS,"
CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE SECURITIES ACT
OF 1933, AS AMENDED, AND THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. WHEN
USED IN THIS ANNUAL REPORT, THE WORDS "EXPECTS," "ANTICIPATES," "ESTIMATES,"
"BELIEVES," "NO ASSURANCE" AND SIMILAR EXPRESSIONS AND STATEMENTS WHICH ARE MADE
IN THE FUTURE TENSE, ARE INTENDED TO IDENTIFY SUCH FORWARD-LOOKING STATEMENTS.
SUCH FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES
AND OTHER FACTORS, WHICH MAY CAUSE THE COMPANY'S ACTUAL RESULTS, PERFORMANCE OR
ACHIEVEMENTS TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE OR
ACHIEVEMENTS EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. IN
ADDITION TO THE RISKS AND UNCERTAINTIES DISCUSSED IN THE FOREGOING SECTIONS,
SUCH FACTORS INCLUDE, AMONG OTHERS, THE FOLLOWING: THE IMPACT OF COMPETITION AND
CHANGES TO THE COMPETITIVE ENVIRONMENT FOR THE COMPANY'S PRODUCTS AND SERVICES,
CHANGES IN TECHNOLOGY, RELIANCE ON STRATEGIC PARTNERS, UNCERTAINTY OF
LITIGATION, CHANGES IN GOVERNMENT REGULATION AND OTHER FACTORS DETAILED, FROM
TIME TO TIME, IN THE COMPANY'S FILINGS WITH THE SECURITIES AND EXCHANGE
COMMISSION. THESE FORWARD-LOOKING STATEMENTS SPEAK ONLY AS OF THE DATE OF THIS
ANNUAL REPORT. THE COMPANY EXPRESSLY DISCLAIMS ANY OBLIGATION OR UNDERTAKING TO
RELEASE PUBLICLY ANY UPDATES OR REVISIONS TO ANY FORWARD-LOOKING STATEMENTS
CONTAINED HEREIN TO REFLECT ANY CHANGE IN THE COMPANY'S EXPECTATIONS WITH REGARD
THERETO OR ANY CHANGE IN EVENTS, CONDITIONS OR CIRCUMSTANCES ON WHICH ANY SUCH
STATEMENT IS BASED.
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH, AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO, THE CONSOLIDATED FINANCIAL STATEMENTS
OF THE COMPANY, INCLUDING THE NOTES THERETO, APPEARING ELSEWHERE HEREIN.
OVERVIEW
LodgeNet is a broadband, interactive services provider which
specializes in the delivery of interactive television and Internet access
services to the lodging industry throughout the United States, Canada and select
international markets. These services include on-demand movies, Nintendo video
games, Internet-enhanced television, high-speed Internet access, and other
interactive television services designed to serve the needs of the lodging
industry and the traveling public.
GUEST PAY INTERACTIVE SERVICES. Guest Pay interactive services are
purchased by guests on a per-view, hourly, or daily basis and include on-demand
movies, network-based Nintendo-Registered Trademark- video games, Internet
enhanced television, and high-speed Internet access services. Guest Pay packages
may also include additional services such as satellite-delivered basic and
premium cable television programming, and other interactive entertainment and
information services that are paid for by the hotel and provided to guests at no
charge. The growth that the Company has experienced has principally resulted
from its rapid expansion of Guest Pay interactive services.
The Company's Guest Pay interactive revenues depend on a number of
factors, including the number of rooms equipped with the Company's systems,
hotel occupancy rates and guest demographics, and the popularity, pricing, and
availability of programming. The primary direct costs of providing Guest Pay
interactive services are (i) license fees paid to studios for non-exclusive
distribution rights to recently-released major motion pictures, (ii) nominal
one-time license fees paid for independent films, (iii) license fees for other
interactive services, (iv) Internet connectivity costs, and (v) the commission
retained by the hotel. Guest Pay operating expenses include costs of system
maintenance and support, in-room marketing, programming delivery and
distribution, data retrieval, insurance and personal property taxes.
The Company installed its systems in the following number of rooms, net
of de-installations, during the years ended December 31:
1997 1998 1999
---------------- --------------- ---------------
Guest Pay interactive rooms 111,606 84,955 64,885
Nintendo video game rooms 126,066 97,355 81,268
Internet services rooms -- -- 10,152
17
The room installations represent increases of 27.9%, 16.6%, and 10.9%,
respectively for Guest Pay interactive rooms and 39.0%, 21.7%, and 14.9%,
respectively, for Nintendo video game rooms.
The Company's base of installed rooms was comprised as follows at December 31:
1997 1998 1999
------------------------- ------------------------- -------------------------
Rooms % Rooms % Rooms %
------------ ----------- ------------- ---------- ------------- ----------
Guest Pay rooms:
Scheduled 27,781 5.4 14,913 2.5 -- --
On-demand 484,070 94.6 581,893 97.5 661,691 100.0
------------ ----------- ------------- ---------- ------------- ----------
511,851 100.0 596,806 100.0 661,691 100.0
Nintendo video game rooms 448,969 546,324 627,592
Internet services rooms -- -- 10,152
Total rooms served, representing rooms receiving one or more of the
Company's services, including rooms served by international licensees, were as
follows at December 31:
1997 1998 1999
----------- ------------ -----------
Total rooms served 613,407 703,325 761,509
=========== ============ ===========
FREE-TO-GUEST AND OTHER SERVICES. In addition to Guest Pay interactive
services, the Company provides cable television programming for which the hotel,
rather than its guests, pays the charges. Free-to-guest services include the
satellite delivery of various programming channels through a satellite earth
station, which generally is owned or leased by the hotel. The hotel pays the
Company a fixed monthly charge per room for each programming channel provided.
The Company obtains its free-to-guest programming pursuant to multi-year
agreements and pays a monthly fee per room which varies depending on incentive
programs in effect from time to time.
To meet the needs of its hotel customers related to the Company's
service offerings, the Company provides a variety of other services to its hotel
customers including the sales of televisions, system equipment, and service
parts and labor. Results from these other services and free-to-guest services
delivered to rooms not receiving Guest Pay interactive services are included in
the "other" components of revenues and direct costs in the statements of
operations.
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1999 AND 1998
REVENUE ANALYSIS
The Company's total revenue for 1999 increased 9.0%, or $14.9 million,
in comparison to 1998. The following table sets forth the components of the
Company's revenue (in thousands) for the years ended December 31:
1998 1999
--------------------------- ---------------------------
Percent Percent
of Total of Total
Amount Revenues Amount Revenues
------------- ------------ ------------- ------------
Revenues:
Guest Pay $146,481 88.1 $169,850 93.7
Other 19,870 11.9 11,422 6.3
------------- ------------ ------------- ------------
Total $166,351 100.0 $181,272 100.0
============= ============ ============= ============
18
GUEST PAY INTERACTIVE SERVICES. Guest Pay interactive revenue increased
16.0%, or $23.4 million, in 1999 as compared to 1998. This increase is
attributable to a 13.8% increase in the average number of installed Guest Pay
rooms, all of which were installed with the Company's on-demand technology, and
to a 1.8% increase in average monthly revenue per Guest Pay room. The following
table sets forth information with respect to Guest Pay rooms for the years ended
December 31:
1998 1999
------------ -----------
Average monthly revenue per room:
Movie revenue $18.44 $18.62
Other interactive service revenue 3.62 3.85
------------ -----------
Total per Guest Pay room $22.06 $22.47
============ ===========
Average movie revenue per room increased 1.0% from 1998. This increase
was due to higher average movie prices, partially offset by lower average buy
rates and hotel occupancy levels.
Average other interactive service revenue per room increased 6.4% from
the prior year. This increase was primarily due to increased revenue from cable
television programming services, partially offset by a decrease in average
monthly video game revenue per room.
OTHER. Revenue from other sources includes revenue from free-to-guest
services provided to hotels not receiving Guest Pay services and sales of
televisions, system equipment, and service parts and labor. Additionally, in
1998, other revenue includes revenue generated by ResNet of $5.4 million. The
decrease in 1999 from the prior year of $8.5 million, or 42.7%, is primarily due
to the $5.4 million of revenue generated by ResNet in 1998. In addition, sales
declines were experienced with free-to-guest services, televisions, system
equipment, and service parts and labor.
EXPENSE ANALYSIS
DIRECT COSTS. The following table sets forth information regarding the
Company's direct costs (in thousands) and gross profit margin for the years
ended December 31:
1998 1999
------------ -----------
Direct costs:
Guest Pay $60,538 $70,632
Other 13,470 7,858
------------ -----------
$74,008 $78,490
============ ===========
Gross profit margin:
Guest Pay 58.7% 58.4%
Other 32.2% 31.2%
Composite 55.5% 56.7%
Guest Pay interactive direct costs increased 16.7% to $70.6 million in
1999 from $60.5 million in the prior year. Since Guest Pay direct costs
(primarily movie license fees, license fees for other interactive services,
Internet connectivity fees, and the commission retained by the hotel) are
primarily based on related revenue, such costs generally vary directly with
revenue. As a percentage of Guest Pay interactive revenue, direct costs
increased from 41.3% in 1998 to 41.6% in 1999. This increase is primarily the
result of slightly higher video game costs (which are incurred based on the
number of rooms receiving video game services rather than the number of game
buys) and movie license fees.
Direct costs associated with other revenue decreased $5.6 million or
41.7% in 1999 from the year earlier period. This decrease is primarily due to
$2.4 million of direct costs incurred by ResNet in 1998 and the lower volume of
sales of free-to-guest services, televisions and equipment, as previously
described. As a percentage of related revenues, other direct costs increased to
68.8% of other revenue in 1999 versus 67.8% in 1998. The resulting decrease in
gross profit margin from 32.2% in 1998 to 31.2% in 1999 is due to the fact that
the ResNet business, which generally earned a higher margin than the other
sources of other revenue, is not included in the 1999 results due to the merger
transaction previously described. This factor was partially offset by lower fees
incurred for the transport of satellite delivered free-to-guest services during
1999.
19
The Company's overall gross profit increased 11.3% in 1999 to $102.8
million on a 9.0% increase in revenues compared to 1998. The overall gross
profit margin increased to 56.7% in 1999 from 55.5% in the prior year,
reflecting a shift in sales toward the more profitable Guest Pay interactive
services (93.7% of total sales in 1999 compared to 88.1% in 1998).
OPERATING EXPENSES. The following table sets forth information in
regard to the Company's operating expenses (in thousands) for the years ended
December 31:
1998 1999
--------------------------- --------------------------
Percent Percent
of Total of Total
Amount Revenues Amount Revenues
----------- -------------- ----------- -------------
Operating expenses:
Guest Pay operations $25,167 15.1 $24,908 13.7
Selling, general and administrative 18,600 11.2 17,774 9.8
Restructuring charge 3,300 2.0 -- --
Depreciation and amortization 55,215 33.2 60,778 33.6
----------- -------------- ----------- -------------
Total operating expenses $102,282 61.5 $103,460 57.1
=========== ============== =========== =============
Guest Pay operations expenses consist of costs directly related to the
operation of systems at hotel sites. Additionally, prior to the ResNet merger,
costs incurred to operate the ResNet systems were included in Guest Pay
operations. Such costs totaled $2.9 million in 1998. Excluding the expenses
incurred to operate the systems at residential sites, expenses related to Guest
Pay operations increased 12.0%, or $2.7 million, in 1999 from $22.2 million in
the previous year. This increase is primarily attributable to the 13.8% increase
in average installed Guest Pay rooms in 1999 as compared to 1998, partially
offset by lower average operating and service expenses incurred on a per room
basis. Per average installed Guest Pay room, such expenses were $3.30 per month
in 1999 as compared to $3.35 per month in 1998.
Selling, general and administrative ("SG&A") expenses decreased 4.4% to
$17.8 million in 1999 from $18.6 million in 1998. Excluding ResNet SG&A expenses
incurred during 1998 of $1.8 million, SG&A expenses increased $955,000 or 5.7%.
As a percentage of revenue, excluding ResNet results in 1998, SG&A expenses
decreased to 9.8% of revenue in 1999 compared to 10.4% in 1998.
The $3.3 million restructuring charge recorded in 1998 represents costs
incurred related to the Company's merger of its ResNet business as previously
described. Such costs include professional services fees, employee costs, and
the write-off of certain capitalized software development costs.
Depreciation and amortization expenses increased 10.2% to $60.8 million
in 1999 from $55.2 million in the prior year. Excluding ResNet depreciation and
amortization expenses incurred during 1998 of $3.6 million, depreciation and
amortization expense increased $9.2 million or 17.8%. This increase is primarily
attributable to the increase in the number of installed Guest Pay interactive
rooms previously described, as well as the associated software costs and other
capitalized costs such as service vans, equipment and computers that are related
to the increased number of rooms in service since the prior year. Additionally,
increases in administrative and facility related assets have contributed to the
increased depreciation and amortization. As a percentage of revenue, excluding
ResNet results in 1998, depreciation and amortization expenses increased to
33.6% from 32.1% in 1998.
OPERATING LOSS. The Company's operating loss, as a result of the
factors previously described, decreased to $678,000 in 1999 from $9.9 million in
1998.
GAIN ON SALE OF INVESTMENTS. In February 1998, the Company acquired a
10% equity interest in Across Media Networks, Inc. ("AMN"), a creator and
distributor of digitally produced on-screen content for television and the
Internet. The Company also held rights to convert amounts loaned to AMN into an
additional 80% equity interest. During the third quarter of 1999, the Company
sold its interest in AMN for approximately $9.0 million, consisting of a $7.0
million note from the buyer due March 31, 2000 and a $2.0 million note from AMN
due August 31, 2002. The Company has deferred recognition of the $2.0 million
AMN note until realization is more certain. The transaction resulted in a
$7.1 million gain.
In November 1999, the Company sold its interest in 1stUp.com, a
provider of free Internet services, to CMGI, Inc. ("CMGI") in a stock-for-stock
exchange. Pursuant to the transaction, the Company received 234,332 shares of
CMGI common stock (adjusted for a 2:1 split on January 12, 2000), which are
subject to certain sale and escrow restrictions. The
20
aggregate market value of the shares was $9.8 million at the time the sales
agreement was reached. After consideration of a discount to reflect the
restrictions placed on the CMGI stock, the Company recorded a gain of $7.6
million during the fourth quarter of 1999.
EQUITY IN LOSSES OF UNCONSOLIDATED AFFILIATES. Prior to the sale of AMN
as described above, the Company recorded equity losses of $5.8 million in 1998
and $2.2 million in 1999 related to this investment. Additionally, as previously
described, the merger of ResNet with two other entities effective November 30,
1998 to form GICC resulted in the Company obtaining a 30% equity interest in
GICC. The Company's portion of GICC's net loss for 1998 was $738,000. For the
first six months of 1999, the Company recorded equity losses totaling $3.2
million. In addition, the Company recorded a $16.8 million charge in the second
quarter of 1999 to write-down its investment in GICC to estimated fair value.
Beginning with the third quarter of 1999, the Company is using the cost method
of accounting for its investment in GICC to reflect its temporary condition
resulting from the commencement of a plan by GICC management to sell its assets.
During the fourth quarter of 1999, a $2.1 million charge was recorded to further
write-down the investment in GICC to its current estimated fair value.
INTEREST EXPENSE. Interest expense increased to $27.2 million in 1999
from $23.3 million in 1998 due to increases in long-term debt to fund the
Company's continuing expansion of its business. The average principal amount of
long-term debt outstanding during 1999 was approximately $273 million (at a
weighted average interest rate of approximately 10.0%) as compared to an average
principal amount outstanding of approximately $226 million (at a weighted
average interest rate of approximately 10.3%) during 1998.
INTEREST INCOME. Interest income, earned on loans to unconsolidated
affiliates, increased to $1.4 million in 1999 from $213,000 in 1998.
EBITDA. As a result of increasing revenues from Guest Pay interactive
services, and the other factors previously described, EBITDA ("Earnings Before
Interest, Income Taxes and Depreciation and Amortization") excluding the
restructuring charge related to the ResNet merger, equity in losses of
unconsolidated affiliates, and gain on sale of investments increased 23.7% to
$60.1 million in 1999 as compared to $48.6 million in 1998. As a percentage of
total revenue, EBITDA increased to 33.2% in 1999 as compared to 29.2% in 1998.
EBITDA is not intended to represent an alternative to net income or cash flows
from operating, financing or investing activities (as determined in accordance
with generally accepted accounting principles) as a measure of performance.
Rather, it is included herein because EBITDA is a widely accepted financial
indicator used by certain investors and financial analysts to assess and compare
companies on the basis of operating performance. Management believes that EBITDA
provides an important additional perspective on the Company's operating results
and the Company's ability to service its long-term debt and to fund the
Company's continuing growth.
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1998 AND 1997
REVENUE ANALYSIS
The Company's total revenue for 1998 increased 22.6%, or $30.6 million,
in comparison to 1997. The following table sets forth the components of the
Company's revenue (in thousands) for the years ended December 31:
1997 1998
-------------------------------------------------------
Percent Percent
of Total of Total
Amount Revenues Amount Revenues
----------- -------------- ----------- ------------
Guest Pay $116,276 85.7 $146,481 88.1
Other 19,434 14.3 19,870 11.9
----------- -------------- ----------- ------------
Total $135,710 100.0 $166,351 100.0
----------- -------------- ----------- ------------
----------- -------------- ----------- ------------
21
GUEST PAY INTERACTIVE SERVICES. Guest Pay interactive revenue increased
26.0%, or $30.2 million, in 1998 from 1997. This increase is attributable to a
20.7% increase in the average number of installed Guest Pay rooms, all of which
were installed with the Company's on-demand technology, and to a 4.4% increase
in average monthly revenue per Guest Pay room. The following table sets forth
information with respect to Guest Pay rooms for the years ended December 31:
1997 1998
-------- --------
Average monthly revenue per room:
Movie revenue $17.86 $18.44
Other interactive service revenue 3.28 3.62
-------- --------
Total per Guest Pay room $21.14 $22.06
-------- --------
-------- --------
Average movie revenue per room increased 3.2% from the prior year due
to the combination of higher average buy rates and higher average movie prices,
partially offset by a decline in hotel occupancy levels.
Average other interactive service revenue per room increased 10.4% from
the prior year, primarily as a result of an increase in the number of rooms with
information and other services installed, partially offset by a decrease in
average monthly video game revenue per room.
OTHER. Revenue from other sources includes revenue from free-to-guest
services provided to hotels not receiving Guest Pay services, revenue generated
by the residential services segment (which was $5,376,000 in 1998 and $2,700,000
in 1997), and sales of televisions, system equipment, and service parts and
labor. The increase in 1998 from the prior year of $436,000 or 2.2%, is
primarily due to increased cable television revenue generated by the residential
services segment of $2.7 million, partially offset by decreased television sales
of $1.3 million, decreased sales of free-to-guest services of $642,000 and
decreased sales of system equipment.
EXPENSE ANALYSIS
DIRECT COSTS. The following table sets forth information regarding the
Company's direct costs (in thousands) and gross profit margin for the years
ended December 31:
1997 1998
--------- ---------
Direct costs:
Guest Pay $45,632 $60,538
Other 12,880 13,470
--------- ---------
$58,512 $74,008
--------- ---------
--------- ---------
Gross profit margin:
Guest Pay 60.8% 58.7%
Other 33.7% 32.2%
Composite 56.9% 55.5%
Guest Pay interactive direct costs increased 32.7% to $60.5 million in
1998 from $45.6 million in the prior year. Since Guest Pay direct costs
(primarily movie license fees, license fees for other interactive services, and
the commission retained by the hotel) are primarily based on related revenue,
such direct costs generally vary directly with revenue. As a percentage of Guest
Pay revenue, direct costs increased from 39.2% in 1997 to 41.3% in 1998. The
relative increase in Guest Pay direct costs as a percentage of revenue in 1998
as compared to the prior year is primarily the result of (i) an increase in the
percentage of revenue from cable television services which generally earn a
lower profit margin than on-demand services and (ii) higher video game costs
(which are incurred based on the number of rooms receiving video game services
rather than the number of game buys).
Direct costs associated with other revenue increased 4.6% to $13.5
million from $12.9 million in the prior year. As a percentage of related
revenues, other direct costs increased to 67.8% in 1998 from 66.3% in 1997,
reflecting the effect of decreased margin earned on free-to-guest sales due to
increased signal transport fees and decreased incentive discounts realized from
programming networks.
The Company's overall gross profit increased 19.6% in 1998 to $92.3
million on a 22.6% increase in revenues compared to 1997. The Company's overall
gross profit margin was 55.5% in 1998 and 56.9% for the prior year.
22
OPERATING EXPENSES. The following table sets forth information in
regard to the Company's operating expenses (in thousands) for the years ended
December 31:
1997 1998
--------------------------- ---------------------------
Percent Percent
of Total of Total
Amount Revenues Amount Revenues
------------ ------------ ------------ ------------
Operating expenses:
Guest Pay operations $20,785 15.3 $25,167 15.1
Selling, general and administrative 20,717 15.3 18,600 11.2
Restructuring and other charges -- -- 3,300 2.0
Depreciation and amortization 43,760 32.2 55,215 33.2
------------ ------------ ------------ ------------
Total operating expenses $85,262 62.8 $102,282 61.5
============ ============ ============ ============
Guest Pay operations expenses consist of costs directly related to the
operation of systems at the hotel sites as well as at residential sites serviced
by the residential services segment. Excluding the expenses incurred to operate
the systems at residential sites, which were $2.9 million in 1998 and $1.4
million in 1997, expenses related to Guest Pay operations increased 14.8%, or
$2.9 million, in 1998 from $19.4 million in the previous year. This increase is
primarily attributable to the 20.7% increase in average installed Guest Pay
rooms in 1998 as compared to 1997, partially offset by lower average operating
and service expenses incurred on a per room basis. Per average installed guest
pay room, such expenses were $3.35 per month in 1998 as compared to $3.52 per
month in 1997.
Selling, general and administrative expenses (including $2.2 million
and $1.8 million of expenses incurred by the residential services segment in
1998 and 1997, respectively) decreased 10.2%, or $2.1 million, in 1998 from
$20.7 million in 1997. This decrease is primarily due to reduced legal expenses
of $1.5 million resulting from the resolution of the Company's patent litigation
matters. As a percentage of revenue, general and administrative expenses
represented 11.2% of total revenue in 1998 as compared to 15.3% in 1997.
The $3.3 million restructuring and other charge recorded in 1998
represents costs incurred related to the Company's merger of its ResNet business
as previously described. Such costs include professional services fees, employee
costs, and the write-off of certain capitalized software development costs.
Depreciation and amortization expenses increased 26.2% to $55.2 million
in 1998 from $43.8 million in the prior year. This increase is primarily
attributable to the increase in the number of installed Guest Pay interactive
rooms previously described, as well as the associated software costs and other
capitalized costs such as service vans, equipment and computers that are related
to the increased number of Guest Pay interactive rooms in service since the
prior year. Additionally, increases in administrative and facility related
assets, as well as an increase of $2.1 million related to the residential
services segment ($3.6 million in 1998 compared to $1.5 million in 1997), have
contributed to the increased depreciation and amortization
OPERATING LOSS. The Company's operating loss, as a result of the
factors previously described, increased to $9.9 million in 1998 from $8.1
million in 1997.
EQUITY IN LOSSES OF UNCONSOLIDATED AFFILIATES. The Company obtained
equity interests in two entities during 1998. First, the Company acquired a 10%
interest in Across Media Networks, LLC ("AMN"), a company engaged in the
creation and distribution of digitally produced on-screen content for television
and the Internet. The Company has applied the equity method of accounting for
this investment to reflect the fact that the Company has had certain financing
obligations to AMN. Losses of $5.8 million related to this investment were
recorded in 1998. Second, as previously described, the merger of ResNet with two
other entities effective November 30, 1998 to form GICC resulted in the Company
obtaining a 30% equity interest in GICC. The Company's portion of GICC's 1998
loss was $738,000.
INTEREST EXPENSE. Interest expense increased to $23.3 million in 1998
from $18.8 million in 1997 due to increases in long-term debt to fund the
Company's continuing expansion of its business. The average principal amount of
long-term debt outstanding during 1998 was approximately $226 million (at a
weighted average interest rate of approximately 10.3%) as compared to an average
principal amount outstanding of approximately $183 million (at a weighted
average interest rate of approximately 10.3%) during 1997.
23
INTEREST INCOME. Interest income decreased from $1.8 million in 1997 to
$213,000 in 1998. The majority of the interest income earned in 1997 resulted
from short term investments of cash obtained from the $150 million note issued
in December 1996. Such cash was used to fund the growth of the Company's
business throughout 1997.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. As a result of the
issuance of EITF Issue 97-13 related to accounting for certain business
reengineering costs, the Company recorded a charge of $210,000 in 1997 to
write-off previously capitalized costs, in accordance with the new accounting
pronouncement.
EBITDA. As a result of increasing revenues from Guest Pay interactive
services, and the other factors previously described, EBITDA ("Earnings Before
Interest, Income Taxes and Depreciation and Amortization") excluding the
restructuring charge related to the ResNet merger and equity in losses of
unconsolidated affiliates increased 36.1% to $48.6 million in 1998 as compared
to $35.7 million in 1997. As a percentage of total revenue, EBITDA excluding the
restructuring charge increased to 29.2% in 1998 as compared to 26.3% in 1997.
Excluding the results of ResNet, EBITDA was $50.8 million in 1998 and $37.3
million in 1997. As a percentage of revenue, EBITDA was 31.6% in 1998 and 28.0%
in 1997, excluding the results of ResNet. EBITDA is not intended to represent an
alternative to net income or cash flows from operating, financing or investing
activities (as determined in accordance with generally accepted accounting
principles) as a measure of performance. Rather, it is included herein because
EBITDA is a widely accepted financial indicator used by certain investors and
financial analysts to assess and compare companies on the basis of operating
performance. Management believes that EBITDA provides an important additional
perspective on the Company's operating results and the Company's ability to
service its long-term debt and to fund the Company's continuing growth.
SEASONALITY
The Company's quarterly operating results are subject to fluctuation
depending upon hotel occupancy rates and other factors. Typically, occupancy
rates are higher during the second and third quarters due to seasonal travel
patterns.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the growth of the Company's business has required
substantial amounts of capital. The Company has incurred operating and net
losses due in large part to the depreciation, amortization and interest expenses
related to the capital expenditures required to expand its lodging and, prior to
1999, its residential businesses. Historically, cash flow from operations has
not been sufficient to fund the cost of expanding the Company's business and to
service existing indebtedness. During 1999, capital expenditures were $51.2
million and net cash provided by operating activities was $40.8 million. Capital
expenditures were $69.7 million during 1998 (of which approximately $14.2
million was incurred by ResNet), and net cash provided by operating activities
was $13.2 million (after the reduction of net cash used in operating activities
of $5.0 million by ResNet).
Depending on the rate of growth of its lodging business and other
factors, the Company expects to incur capital expenditures between approximately
$55 to $65 million in 2000. In addition, the Company's cash requirements during
2000 are expected to include the final $5.85 million payment to OCC on July 15,
2000 in connection with the settlement of the litigation between the Company and
OCC pursuant to the terms of the multiple cross licenses. The foregoing
statements regarding capital expenditures and cash requirements are
forward-looking statements and there can be no assurance in this regard. The
actual amount and timing of the Company's capital expenditures will vary (and
such variations could be material) depending upon the number of new contracts
for services entered into by the Company, the costs of installations and other
factors.
In February 1999, the Company amended and restated its existing bank
credit facility. This amended facility consists of a $150 million secured bank
credit facility which combines a $75 million term loan ("Term Loan") and a $75
million revolving loan facility ("Revolving Loan"). Proceeds under the Term Loan
were used to repay the $76.5 million outstanding at December 31, 1998 under the
previous revolving loan facility.
24
As previously described, effective November 30, 1998, the Company
contributed its interest in the ResNet business to GICC. During 1999, the
Company provided GICC with $1.75 million to assist in the funding of GICC's
operations while GICC management is in the process of selling its assets. A
commitment exists for the Company to provide an additional $350,000 of funding
in the first quarter of 2000.
The Company believes that its operating cash flows and borrowings
available under the Revolving Loan will be sufficient to fund the Company's
future growth as contemplated under its current business plan, depending on the
rate of the Company's growth and other factors. However, if the Company's plans
or assumptions change, if its assumptions prove to be inaccurate or if the
Company experiences unanticipated costs or competitive pressures, the Company
may be required to seek additional capital sooner than currently anticipated.
There can be no assurance that the Company will be able to obtain financing, or,
if such financing is available, that the Company will be able to obtain it on
acceptable terms. Failure to obtain additional financing, if needed, could
result in the delay or abandonment of some or all of the Company's expansion
plans.
YEAR 2000 INFORMATION
During 1998 and 1999, the Company engaged in a comprehensive review of
its internal computer systems and software and external business relationships
in regard to Year 2000 issues. The following information updates the Company's
prior disclosures related to Year 2000 matters.
STATE OF READINESS. The Company formed a project team comprised of key
members from cross-organization departments. The team's objectives were to
gather information and facilitate research on Year 2000 issues that could affect
the Company, and to take necessary actions to eliminate or minimize the impact
of such issues. Efforts focused on the computer hardware and software used both
at its in-house facilities as well as at its hotel properties. The Company
completed its research and testing of internal computer hardware in the third
quarter of 1999. Correction or replacement of hardware and software containing
Year 2000 issues was completed prior to December 31, 1999. Externally, the
Company worked to identify third party business relationships that had potential
to be impacted by the Year 2000 issue. Efforts included research and review of
such relationships, including contacting the third parties to solicit
information and assurances relating to potential Year 2000 issues and reviewing
responses. The Company has not experienced any significant Year 2000 effects
with its in-house computer systems and facilities or its systems and equipment
at its hotel customer properties.
COSTS ASSOCIATED WITH YEAR 2000. Incremental costs were comprised
primarily of costs to purchase software upgrades, hardware, external consulting
services, and subcontractor equipment installation services. The Company
incurred approximately $300,000 in aggregate out-of-pocket costs in 1998 and
1999 to complete its Year 2000 compliance program, excluding the costs of
internal staffing. Such funds were provided from the Company's bank credit
facility. The Company does not expect to incur any additional costs related to
Year 2000 issues.
RISKS ASSOCIATED WITH YEAR 2000 ISSUES. The Company is highly dependent
upon its own information technology systems and those of its suppliers and
customers. The Company's or a third party's failure to correct a material Year
2000 problem could have resulted in a failure of or interruption in the
Company's business activities and operations. Such interruptions and failures
could have materially and adversely affect the Company's results of operation,
liquidity and financial condition. No significant such failures or interruptions
have been experienced.
CONTINGENCY PLANS. The Company had prepared contingency plans for Year
2000 issues including the identification of alternate vendors and service
providers for business activities and the development of alternative systems
which could have been used to process data. The Company was not forced to
implement any of its contingency plans.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to various market risks, including potential
losses resulting from adverse changes in interest rates and foreign currency
exchange rates. The Company does not enter into derivatives or other financial
instruments for trading or speculative purposes.
INTEREST. At December 31, 1999, the Company had debt totaling $283.0
million. During the second quarter of 1999, the Company entered into interest
rate swap arrangements covering debt with a notional amount of $75 million to
effectively change the underlying debt from a variable interest rate to a fixed
interest rate for the term of the swap agreements. After giving effect to the
interest rate swap arrangements the Company had fixed rate debt of $261.5
million and variable rate debt of $21.5 million at December 31, 1999. For fixed
rate debt, interest rate changes affect the fair market value but do not impact
earnings or cash flows.
25
Conversely, for variable rate debt, interest rate changes generally do not
affect the fair market value but do impact future earnings and cash flows,
assuming other factors are held constant. Assuming other variables remain
constant (such as debt levels), a one percentage point increase in interest
rates would decrease the unrealized fair market value of the fixed rate debt by
an estimated $24.1 million. The impact on earnings and cash flow for the next
year resulting from a one percentage point increase in interest rates would be
approximately $215,000, assuming other variables remain constant.
FOREIGN CURRENCY TRANSACTIONS. A portion of the Company's revenues are
derived from the sale of Guest Pay services in Canada. The results of operations
and financial position of the Company's operations in Canada are measured in
Canadian dollars and translated into U.S. dollars. The effects of foreign
currency fluctuations in Canada are somewhat mitigated by the fact that expenses
and liabilities are generally incurred in Canadian dollars. The reported income
of the Company's Canadian subsidiary will be higher or lower depending on a
weakening or strengthening of the U.S. dollar against the Canadian dollar. In
addition, a portion of the Company's assets are based in Canada and are
translated into U.S. dollars at foreign currency exchange rates in effect as of
the end of each period. Accordingly, the Company's consolidated assets will
fluctuate depending on the weakening or strengthening of the U.S. dollar against
the Canadian dollar. A 10% increase in the 1999 level of the Canadian exchange
rate against the U.S. dollar with all other variables held constant would have
resulted in a decrease of consolidated revenue of approximately $881,000, a
decrease in the consolidated net loss of approximately $51,000, a decrease of
consolidated assets of approximately $1.4 million, and a decrease to
consolidated stockholders' equity of approximately $216,000.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See "Item 14 - Exhibits, Financial Statement Schedules and Reports on
Form 8-K" for the Company's Consolidated Financial Statements, the Notes thereto
and Schedules filed as a part of this report.
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Except as hereinafter noted, the information concerning directors and
executive officers of the Company is incorporated by reference from the sections
entitled "Executive Officers", "Election of Directors - Board of Directors and
Nominees" and "Compliance with Reporting Requirements of Section 16 of the
Exchange Act" of the Company's definitive Proxy Statement to be filed pursuant
to Regulation 14A within 120 days after the end of the last fiscal year.
ITEM 11 - EXECUTIVE COMPENSATION
Information concerning executive remuneration and transactions is
incorporated by reference from the section entitled "Beneficial Ownership of
Principal Stockholders and Management" of the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A within 120 days after the end
of the last fiscal year.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of certain beneficial owners
and management is incorporated by reference from the section entitled
"Beneficial Ownership of Principal Stockholders and Management" of the Company's
definitive Proxy Statement to be filed pursuant to Regulation 14A within 120
days after the end of the last fiscal year.
26
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions
with management is incorporated by reference from the section entitled "Certain
Transactions with Management and Others" of the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A within 120 days after the end
of the fiscal year.
PART IV
ITEM 14 -- EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES -- Reference is made to
the "Index to Consolidated Financial Statements" of LodgeNet
Entertainment Corporation, located at page F - 1 of this PART IV, for a
list of the financial statements and schedules for the year ended
December 31, 1999 included herein.
(b) REPORTS ON FORM 8-K -- During the quarter ended December 31, 1999, the
Company filed no reports on Form 8-K.
(c) EXHIBITS -- Following is a list of Exhibits filed with this report.
Exhibits 10.1, 10.2, 10.30 and 10.31 constitute management contracts.
Exhibits 10.3, 10.7, 10.8, 10.9, 10.10, 10.11, and 10.12 constitute
compensatory plans.
EXHIBIT NO.
3.1 Certificate of Incorporation of the Company (1)
3.2 By-Laws of the Registrant (1)
4.1 Registration Rights Agreement dated as of December 16, 1996, between
LodgeNet Entertainment Corporation and Morgan Stanley & Co.
Incorporated, NatWest Capital Markets Limited and Montgomery Securities
(8)
4.2 Indenture dated as of December 19, 1996, between LodgeNet Entertainment
Corporation and Marine Midland Bank, as trustee, including the form of
Senior Note (8)
4.3 Form of Senior Notes (included in Exhibit 4.2)
4.4 First Supplemental Indenture dated October 15, 1998, among LodgeNet
Entertainment Corporation and Marine Midland Bank, as trustee, to the
Indenture dated December 19, 1996 (see Exhibit 4.2)
10.1 Form of Employment Agreement between the Company and each of Tim C.
Flynn and Scott C. Petersen (1)
10.2 Form of Agreement between the Company and each of David M. Bankers,
John M. O'Haugherty, Douglas D. Truckenmiller and Steven D.
Truckenmiller (1)
10.3 LodgeNet Entertainment Corporation Stock Option Plan (as amended and
restated effective August 15, 1996)(8)
10.6 License Agreement dated May 2, 1993 between Nintendo of America, Inc.
and LodgeNet Entertainment Corporation (2)
10.7 Stock Option Agreements dated as of February 29, 1988 between the
Company and Tim C. Flynn, as extended by Extension Agreement dated as
of July 15, 1991 (2)
10.8 Stock Option Agreements dated as of February 29, 1988 between the
Company and Scott C. Petersen, as extended by Extension Agreement dated
as of July 15, 1991 (2)
10.9 Stock Option Agreement dated as of December 31, 1992 between the
Company and John M. O'Haugherty (2)
10.10 Stock Option Agreement dated as of December 31, 1992 between the
Company and David M. Bankers (2)
10.11 Form of Stock Option Agreement for Non-Employee Directors (3)
27
10.12 Form of Incentive Stock Option Agreement for Key Employees (3)
10.13 Securities Purchase Agreement, by and between LodgeNet Entertainment
Corporation, John Hancock Mutual Life Insurance Company, Allstate Life
Insurance Company, Connecticut Mutual Life Insurance and CMA Life
Insurance Company, dated as of August 9, 1995 (4)
10.14 Amendment to Securities Purchase Agreement, dated as of December 19,
1996 (8)
10.15 Form of Executive Severance Agreement between the Company and each of
Tim C. Flynn, Scott C. Petersen, Jeffrey T. Weisner, John M.
O'Haugherty, David M. Bankers, Douglas D. Truckenmiller, Steven D.
Truckenmiller and Eric R. Jacobsen; all dated of July 25, 1995 (5)
10.16 Video Services Agreement by and among GE Capital-ResCom L.P. and ResNet
Communications, Inc. and LodgeNet Entertainment Corporation dated as of
February 9, 1996 (6)+
10.17 Amended and Restated Loan Agreement by and among LodgeNet Entertainment
Corporation, the Banks Signatory thereto, National Westminster Bank
Plc, as Agent for such Banks, and National Westminster bank of Canada,
as an Issuing bank, dated December 19, 1996 (8)
10.18 Equipment Sales Agreement between ResNet Communications, Inc. and TCI
Satellite Entertainment, Inc., dated as of October 21, 1996 (7)
10.19 Subordinated Convertible Term Loan Agreement between ResNet
Communications, Inc. and TCI Satellite Entertainment, Inc., dated as of
October 21, 1996 (7)
10.20 Option Agreement between ResNet Communications, Inc. and TCI Satellite
Entertainment, Inc., dated as of October 21, 1996 (7)
10.21 Standstill Agreement between LodgeNet Entertainment Corporation and TCI
Satellite Entertainment, Inc., dated as of October 21, 1996 (7)
10.22 Stockholders' Agreement between LodgeNet Entertainment Corporation and
TCI Satellite Entertainment, Inc., dated as of October 21, 1996 (7)
10.23 Subscription Agreement between ResNet Communications, Inc. and TCI
Satellite Entertainment, Inc., dated as of October 21, 1996 (7)
10.24 First Amendment, dated October 17, 1996, to License Agreement between
Nintendo of America, Inc. and LodgeNet Entertainment Corporation (8)
10.25 Exchange Agreement, dated November 30, 1998, among Shared Technologies
Communications Corporation, Interactive Cable Systems, Inc., ResNet
Communications, LLC, ResNet Communications, Inc. and Global Interactive
Technologies Corporation (9)
10.26 Stockholders Agreement dated November 30, 1998, by and among Global
Interactive Technologies Corporation, Shared Technologies
Communications Corporation, Interactive Cable Systems, Inc. and ResNet
Communications, LLC (9)
10.27 Consent and Restructuring Agreement dated November 6, 1998, by and
among ResNet Communications, LLC, ResNet Communications, Inc., and
PrimeStar MDU (10)
10.28 Second Amended and Restated Credit Agreement dated as of February 25,
1999, by and among LodgeNet Entertainment Corporation, National
Westminster Bank Plc, BankBoston, N.A., Morgan Stanley Senior Funding,
Inc. and the Lenders Named Therein (10)
28
10.29 Confidential License Agreement for Use of Nintendo Video Game Systems
with Hotel Entertainment System, dated May 12, 1998, between LodgeNet
Entertainment Corporation and Nintendo of America Inc. + (10)
10.30 Form of Employment Agreement between the Company and Scott C. Petersen
(11)
10.31 Form of Employment Agreement between the Company and each of David M.
Bankers, John M. O'Haugherty and Jeffrey T. Weisner (11)
12.1 Statement of computation of ratios
21.1 Subsidiaries of the Company (12)
23.1 Consent of Independent Public Accountants
- -------------------
+Confidential Treatment has been requested with respect to certain portions of
these agreements.
(1) Incorporated by Reference to the Company's Amendment No. 1 to
Registration Statement on Form S-1, as filed with the Securities and
Exchange Commission, September 24, 1993.
(2) Incorporated by Reference to the company's Amendment No. 2 to
Registration Statement on Form S-1, as filed with the Securities and
Exchange Commission, October 13, 1993.
(3) Incorporated by Reference to the Annual Report on Form 10-K for the
year ended December 31, 1993, as filed with the Securities and Exchange
Commission, March 25, 1994.
(4) Incorporated by Reference to the Quarterly Report on Form 10-Q for the
quarter ended June 30, 1995, as filed with the Securities and Exchange
Commission, August 14, 1995.
(5) Incorporated by Reference to the Quarterly Report on Form 10-Q for the
quarter ended September 30, 1995, as filed with the Securities and
Exchange Commission, November 14, 1995.
(6) Incorporated by Reference to the Annual Report on Form 10-K for the
year ended December 31, 1995, as filed with the Securities and Exchange
Commission, April 1, 1996.
(7) Incorporated by Reference to TCI Satellite Entertainment, Inc.'s
Amendment No. 1 to Registration Statement on Form 10 as filed with the
Securities and Exchange Commission, October 29, 1996.
(8) Incorporated by Reference to the Annual Report on Form 10-K for the
year ended December 31, 1996, as filed with the Securities and Exchange
Commission, March 17, 1997.
(9) Incorporated by Reference to the Form 8-K as filed with the Securities
and Exchange Commission, December 15, 1998.
(10) Incorporated by Reference to the Annual Report on Form 10-K for the
year ended December 31, 1998, as filed with the Securities and Exchange
Commission, March 25, 1999.
(11) Incorporated by Reference to the Quarterly Report on Form 10-Q for the
quarter ended June 30, 1999, as filed with the Securities and Exchange
Commission, August 13, 1999.
(12) Incorporated by Reference to the Annual Report on Form 10-K for the
year ended December 31, 1997, as filed with the Securities and Exchange
Commission, March 25, 1998.
29
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized in the City of Sioux
Falls, State of South Dakota, on March 29, 2000.
LodgeNet Entertainment Corporation
By: /s/ SCOTT C. PETERSEN
-----------------------------------
Scott C. Petersen, President and
Chief Executive Officer
30
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ SCOTT C. PETERSEN President and Chief Executive March 29, 2000
- ------------------------------------ Officer, Director (Principal
Scott C. Petersen Executive Officer)
/s/ JEFFREY T. WEISNER Senior Vice President March 29, 2000
- ------------------------------------ Chief Financial Officer
Jeffrey T. Weisner (Principal Financial
Officer)
/s/ RONALD W. PIERCE Vice President and Corporate March 29, 2000
- ------------------------------------ Controller (Principal
Ronald W. Pierce Accounting Officer)
/s/ TIM C. FLYNN Chairman of the Board March 29, 2000
- ------------------------------------ and Director
Tim C. Flynn
/s/ R. DOUGLAS BRADBURY Director March 29, 2000
- ------------------------------------
R. Douglas Bradbury
/s/ LAWRENCE FLINN, JR Director March 29, 2000
- ------------------------------------
Lawrence Flinn, Jr.
/s/ RICHARD R. HYLLAND Director March 29, 2000
- ------------------------------------
Richard R. Hylland
/s/ R. F. LEYENDECKER Director March 29, 2000
- ------------------------------------
R. F. Leyendecker
31
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Public Accountants.................................. F - 2
Consolidated Balance Sheets as of December 31, 1998 and 1999.............. F - 3
Consolidated Statements of Operations -- Three Years Ended
December 31, 1999....................................................... F - 4
Consolidated Statements of Stockholders' Equity --
Three Years Ended December 31, 1999..................................... F - 5
Consolidated Statements of Cash Flows --
Three Years Ended December 31, 1999..................................... F - 6
Notes to Consolidated Financial Statements ............................... F - 7
INDEX TO FINANCIAL SCHEDULES
Report of Independent Public Accountants on Schedule...................... F -19
Schedule II -- Valuation and Qualifying Accounts.......................... F -20
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To LodgeNet Entertainment Corporation:
We have audited the accompanying consolidated balance sheets of LodgeNet
Entertainment Corporation (a Delaware corporation) and Subsidiaries as of
December 31, 1998 and 1999, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years
in the period ended December 31, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of LodgeNet Entertainment
Corporation and Subsidiaries as of December 31, 1998 and 1999, and the
results of their operations and their cash flows for each of the three years
in the period ended December 31, 1999, in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota
February 11, 2000
F-2
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands)
December 31,
-------------------------------
1998 1999
------------- -------------
Assets
Current assets:
Cash and cash equivalents $ 5,240 $ 1,644
Marketable securities -- 25,952
Accounts receivable, net 27,451 29,620
Note receivable -- 7,060
Prepaid expenses and other 6,221 2,413
------------- -------------
Total current assets 38,912 66,689
Property and equipment, net 209,437 204,334
Investments in and advances to unconsolidated affiliates 32,701 11,434
Debt issuance costs, net 6,637 8,710
Other assets, net 18,343 14,108
------------- -------------
$ 306,030 $ 305,275
============= =============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 13,705 $ 14,610
Current maturities of long-term debt 5,718 5,915
Accrued expenses 9,410 10,643
Deferred revenue 2,318 2,536
------------- -------------
Total current liabilities 31,151 33,704
Long-term debt 262,375 277,075
Minority interest in consolidated subsidiary 730 --
------------- -------------
Total liabilities 294,256 310,779
------------- -------------
Commitments and contingencies (Note 13)
Stockholders' equity (deficit):
Common stock, $.01 par value, 20,000,000 shares authorized; 11,942,387 and
11,970,852 shares outstanding at December 31,
1998 and 1999, respectively 119 120
Additional paid-in capital 123,706 124,021
Accumulated deficit (110,539) (146,967)
Accumulated other comprehensive income (loss) (1,512) 17,322
------------- -------------
Total stockholders' equity (deficit) 11,774 (5,504)
------------- -------------
$ 306,030 $ 305,275
============= =============
The accompanying notes are an integral part of these consolidated
financial statements.
F-3
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollar amounts, except per share amounts, in thousands)
Years Ended December 31,
-------------------------------------------------
1997 1998 1999
-------------- ------------- -------------
Revenues:
Guest Pay $ 116,276 $ 146,481 $ 169,850
Other 19,434 19,870 11,422
-------------- ------------- -------------
Total revenues 135,710 166,351 181,272
-------------- ------------- -------------
Direct costs:
Guest Pay 45,632 60,538 70,632
Other 12,880 13,470 7,858
-------------- ------------- -------------
Total direct costs 58,512 74,008 78,490
-------------- ------------- -------------
Gross profit 77,198 92,343 102,782
-------------- ------------- -------------
Operating expenses:
Guest Pay operations 20,785 25,167 24,908
Selling, general and administrative 20,717 18,600 17,774
Restructuring and other charges (Note 3) -- 3,300 --
Depreciation and amortization 43,760 55,215 60,778
-------------- ------------- -------------
Total operating expenses 85,262 102,282 103,460
-------------- ------------- -------------
Operating loss (8,064) (9,939) (678)
Equity in losses of unconsolidated affiliates -- (6,550) (24,323)
Gain on sale of investments -- -- 14,739
Interest expense (18,837) (23,261) (27,210)
Interest income 1,836 213 1,414
-------------- ------------- -------------
Loss before income taxes and cumulative effect
of change in accounting principle (25,065) (39,537) (36,058)
Provision for income taxes (344) (375) (370)
------------- -------------
--------------
Loss before cumulative effect of change
in accounting principle (25,409) (39,912) (36,428)
Cumulative effect of change in accounting principle
(Note 17) (210) -- --
-------------- ------------- -------------
Net loss $ (25,619) $ (39,912) $ (36,428)
============== ============= =============
Per common share (basic and diluted):
Loss before cumulative effect of change
in accounting principle $ (2.25) $ (3.45) $ (3.05)
Cumulative effect of change in accounting principle (0.02) -- --
-------------- ------------- -------------
Net loss $ (2.27) $ (3.45) $ (3.05)
-------------- ------------- -------------
Weighted average shares outstanding (basic and diluted) 11,271,064 11,579,457 11,948,660
============== ============= =============
The accompanying notes are an integral part of these consolidated
financial statements.
F-4
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollar amounts in thousands)
Accumulated
Common Stock Additional Other
---------------------------- Paid-in Accumulated Comprehensive
Shares Amount Capital Deficit Income/(Loss) Total
------------ ------------ ------------ -------------- ------------- --------
Balance, December 31, 1996 11,125,369 $111 $ 120,539 $ (45,008) $ (90) $ 75,552
Common stock option activity 196,689 2 332 -- -- 334
Comprehensive loss:
Net loss -- -- -- (25,619) --
Foreign currency
translation adjustment -- -- -- -- (609)
Comprehensive loss (26,228)
Change of interest in
subsidiary -- -- (79) -- -- (79)
------------ ------------ ------------ -------------- ------------- -----------
Balance, December 31, 1997 11,322,058 113 120,792 (70,627) (699) 49,579
Issuance of common stock 350,000 3 3,081 -- -- 3,084
Common stock option activity 270,329 3 253 -- -- 256
Comprehensive loss:
Net loss -- -- -- (39,912) --
Foreign currency
translation adjustment -- -- -- -- (813)
Comprehensive loss (40,725)
Change of interest in
subsidiary -- -- (420) -- -- (420)
------------ ------------ ------------ -------------- ------------- -----------
Balance, December 31, 1998 11,942,387 119 123,706 (110,539) (1,512) 11,774
Issuance of common stock 12,141 -- 158 -- -- 158
Common stock option activity 16,324 1 157 -- -- 158
Comprehensive loss:
Net loss -- -- -- (36,428) --
Foreign currency
translation adjustment -- -- -- -- 706
Unrealized gain on
marketable securities -- -- -- -- 18,128
Comprehensive loss (17,594)
------------ ------------ ------------ -------------- ------------- -----------
Balance, December 31, 1999 11,970,852 $ 120 $ 124,021 $ (146,967) $ 17,322 $ (5,504)
============ ============ ============ ============== ============= ===========
The accompanying notes are an integral part of these consolidated
financial statements.
F-5
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollar amounts in thousands)
Years Ended December 31,
-------------------------------------------------
1997 1998 1999
-------------- ------------- -------------
Operating activities:
Net loss $ (25,619) $ (39,912) $ (36,428)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Depreciation and amortization 43,760 55,215 60,778
Gain on sale of property and equipment -- (309) --
Gain on sale of investment -- -- (14,739)
Non-cash portion of restructuring charge -- 840 --
Equity in losses of unconsolidated affiliates -- 6,550 24,323
Change in operating assets and liabilities:
Accounts receivable (3,288) (6,157) (1,366)
Prepaid expenses and other (1,138) (2,659) 3,811
Accounts payable 1,053 (2,770) 886
Accrued expenses and deferred revenue 1,524 1,677 1,294
Other 361 768 2,223
-------------- ------------- -------------
Net cash provided by operating activities 16,653 13,243 40,782
-------------- ------------- -------------
Investing activities:
Property and equipment additions (96,290) (68,733) (51,226)
Proceeds from sale of property and equipment -- 412 --
Business acquisitions (8,087) (927) --
Investment in unconsolidated affiliates -- (8,330) (4,219)
-------------- ------------- -------------
Net cash used for investing activities (104,377) (77,578) (55,445)
-------------- ------------- -------------
Financing activities:
Proceeds from long-term debt -- 1,000 75,000
Repayment of long-term debt -- (28) (38)
Payment of license rights liability -- (5,461) (4,954)
Payment of capital lease obligations (583) (659) (577)
Borrowings under revolving credit facility 3,000 73,500 35,500
Repayments of revolving credit facility -- -- (90,500)
Debt issuance costs (141) -- (3,559)
Stock option activity 334 256 158
-------------- ------------- -------------
Net cash provided by financing activities 2,610 68,608 11,030
-------------- ------------- -------------
Effect of exchange rates on cash (42) (54) 37
-------------- ------------- -------------
Increase (decrease) in cash and cash equivalents (85,156) 4,219 (3,596)
Cash and cash equivalents at beginning of period 86,177 1,021 5,240
-------------- ------------- -------------
Cash and cash equivalents at end of period $ 1,021 $ 5,240 $ 1,644
============== ============= =============
The accompanying notes are an integral part of these consolidated
financial statements.
F-6
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- THE COMPANY
LodgeNet is a broadband, interactive services provider which specializes in
the delivery of interactive television and Internet access services to the
lodging industry throughout the United States, Canada and select
international markets. These services include on-demand movies, Nintendo
video games, Internet-enhanced television, high-speed Internet access, and
other interactive television services designed to serve the needs of the
lodging industry and the traveling public.
The Company's operating performance and outlook are strongly influenced by
such factors as hotel occupancy levels and economic conditions in the lodging
industry, the number of lodging rooms equipped with the Company's interactive
systems, hotel guest demographics, the number and type of product offerings,
the popularity and availability of programming, and competitive factors.
The rapid growth of the Company's business has required capital resources in
excess of operating cash flows. While the Company's working capital,
operating cash flows and revolving credit facility are expected to be
sufficient to fund its growth, the Company may, depending on its rate of
growth, require additional growth capital in subsequent years.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements include
the accounts of the Company and its wholly owned Canadian subsidiary.
Investments in affiliates in which the Company has significant influence, but
not effective control (generally represented by common stock ownership of at
least 20% but not more than 50%), are accounted for using the equity method
of accounting for an investment. All significant intercompany accounts and
transactions have been eliminated in consolidation.
FOREIGN CURRENCY TRANSLATION -- The assets and liabilities of the Company's
Canadian subsidiary were translated at year-end exchange rates. Income
statement items were translated at average exchange rates during the periods.
USE OF ESTIMATES -- The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions about certain matters and items. These estimates
and assumptions affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues, expenses and costs during
the reporting periods. The ultimate outcome of the matters and items may be
different from the estimates and assumptions.
LONG-LIVED ASSETS -- The Company reviews the carrying value of long-lived
assets such as property and equipment and intangible assets whenever events
or circumstances indicate that the carrying value of an asset may not be
recoverable from the estimated future cash flows expected to result from its
use and eventual disposition. In cases where undiscounted expected future
cash flows are less than the carrying value, an impairment loss is recognized
to reduce the carrying value of the asset to its estimated fair value.
F-7
PROPERTY AND EQUIPMENT -- Property and equipment is stated at cost, net of
accumulated depreciation and amortization. Installed Guest Pay and
free-to-guest systems consist of equipment and related costs of installation,
including certain payroll costs. Maintenance costs, which do not
significantly extend the useful lives of the respective assets, and repairs
are charged to operations as incurred. Depreciation of Guest Pay and
free-to-guest systems begins when such systems are installed and activated.
Depreciation of other equipment begins when such equipment is placed in
service. The Company attributes no salvage value to equipment. Depreciation
and amortization is computed using the straight-line method over the
following useful lives:
Years
------------
Buildings 30
Guest Pay systems:
System components 5 - 7
In-room equipment 2 - 5
Free-to-guest systems 5 - 7
Other equipment 3 -10
SOFTWARE DEVELOPMENT -- The Company has capitalized certain costs of
developing software for its Guest Pay systems in accordance with AICPA
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use". Capitalized costs are reported at
the lower of unamortized cost or net realizable value, and are amortized over
the system's estimated useful life, not to exceed five years. Guest Pay
system development costs capitalized were $2,100,000, $2,405,000 and
$1,554,000 during the years ended December 31, 1997, 1998 and 1999,
respectively. Amortization of such costs was $797,000, $1,138,000 and
$1,178,000 for the years ended December 31, 1997, 1998 and 1999,
respectively. The Company charged $410,000, $252,000, and $704,000 to
operations during the years ended December 31, 1997, 1998 and 1999,
respectively, related to research and development activities.
REVENUE RECOGNITION -- Revenue from the sale of Guest Pay interactive
services is recognized in the period the services are purchased by the hotel
guest. Revenue from the sale of equipment is recognized when the equipment is
shipped except for equipment requiring installation by the Company, in which
case revenue is recognized upon completion of the installation.
CONCENTRATION OF CREDIT RISKS AND CUSTOMER DATA -- The Company derives
virtually all of its revenue from entities in the lodging industry; however,
no individual customer accounted for 10% or more of total revenue in any
period presented in the accompanying consolidated statements of operations.
The allowance for doubtful accounts was $800,000 at December 31, 1998 and
1999. The provision for doubtful accounts was $820,000 in 1997, $848,000 in
1998, and $441,000 in 1999.
DERIVATIVE FINANCIAL INSTRUMENTS -- The Company has entered into interest
rate swap arrangements to manage certain exposures to fluctuations in
interest rates. The Company does not utilize these instruments for
speculative or trading purposes. Interest rate swaps generally involve the
exchange of fixed and variable rate interest payments without the exchange of
the underlying principal. Net amounts paid or received are reflected as
adjustments to interest expense.
INCOME TAXES -- The Company accounts for income taxes under the liability
method, in accordance with the requirements of Statement of Financial
Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes".
Deferred income tax assets and liabilities are computed annually for
differences between the financial statement and tax basis of assets and
liabilities. Measurement is based on enacted tax rates applicable to the
periods in which such differences are expected to reverse.
COMPREHENSIVE INCOME -- During 1998, the Company adopted SFAS No. 130,
"Reporting Comprehensive Income," which requires companies to report all
changes in equity during a period, except those resulting from investments by
owners and distributions to owners, in a financial statement for the period
in which they are recognized. The Company has chosen to disclose
comprehensive income, which is comprised of net loss, foreign currency
translation
F-8
adjustments, and unrealized gains on marketable securities available for
sale, in the consolidated statement of stockholders' equity.
EARNINGS PER SHARE COMPUTATION -- The Company follows SFAS No. 128, "Earnings
Per Share" which requires the computation and disclosure of two EPS amounts,
basic and diluted. Basic EPS is computed based only on the weighted average
number of common shares actually outstanding during the period. Diluted EPS
is computed based on the weighted average number of common shares outstanding
plus all potentially dilutive common shares outstanding during the period.
Weighted average options on 1,597,331, 1,736,333, and 1,710,796 shares of
common stock were not included in computing diluted EPS because their effects
were antidilutive for the years ended December 31, 1997, 1998, and 1999,
respectively.
STOCK-BASED COMPENSATION -- The Company measures compensation costs
associated with its stock option plans in accordance with the provisions of
Accounting Principles Board Opinion No. 25, as permitted by SFAS No. 123. The
effect of fair value based measurement of such costs on net loss and net loss
per share, in accordance with SFAS No. 123, is disclosed on a pro forma basis
in Note 15.
STATEMENTS OF CASH FLOWS -- Cash equivalents are comprised of demand deposits
and temporary investments in highly liquid securities having original
maturities of 90 days or less. Cash paid for interest was $17,828,000,
$21,633,000, and $27,081,000 during the years ended December 31, 1997, 1998,
and 1999, respectively. Equipment acquired under capital lease arrangements
totaled $1,106,000, $885,000, and $461,000 during the years ended December
31, 1997, 1998, and 1999, respectively. During 1998, non-cash activities
included the acquisition of license rights valued at $15,709,000 in exchange
for notes payable issued by the Company (see Note 13) and the issuance of
350,000 common shares valued at $3,084,000 as part of an acquisition
completed during the year (see Note 4).
EFFECT OF RECENTLY ISSUED ACCOUNTING STANDARDS -- In June 1998, the Financial
Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities". SFAS No. 133 establishes
accounting and reporting standards requiring that every derivative instrument
(including certain derivative instruments embedded in other contracts) be
recorded in the balance sheet as either an asset or liability measured at its
fair value. The statement requires that changes in the derivative's fair
value be recognized currently in earnings unless specific hedge accounting
criteria are met. Special accounting for qualifying hedges allows a
derivative's gains and losses to offset related results on the hedged item in
the income statement and requires that a company must formally document,
designate and assess the effectiveness of transactions that receive hedge
accounting. In June 1999, the FASB issued SFAS No. 137 which amended SFAS No.
133 to delay its effective date to fiscal years beginning after June 15,
2000. Accordingly, the Company plans to adopt the requirements of SFAS No.
133 effective January 1, 2001. SFAS No. 133 could increase volatility in
earnings and other comprehensive income.
RECLASSIFICATIONS -- Certain items in the consolidated financial statements
have been reclassified to conform to 1999 classifications. Such
reclassifications had no effect on previously reported net loss or
stockholders' equity.
NOTE 3 -- RESNET MERGER
Effective November 30, 1998, the operations of the Company's majority-owned
subsidiary, ResNet Communications, LLC ("ResNet"), were merged with two
non-affiliated entities to form Global Interactive Communications Corporation
("GICC"). GICC's business consists of providing cable television programming
and telecommunications services to the multi-family dwelling unit market. The
Company contributed net assets totaling $31.3 million in exchange for a 30%
equity interest in GICC and notes receivable totaling $10.8 million. The
ResNet business had sales of $5.4 million in 1998 and $2.7 million in 1997.
In connection with this transaction, the Company incurred $3.3 million of
costs during the fourth quarter of 1998 including professional services fees,
employee costs, and the write-off of certain capitalized software development
costs. These costs are reported as restructuring and other charges in the
1998 consolidated statement of operations.
NOTE 4 -- ACQUISITION
F-9
In October 1998, the Company completed the acquisition of Connect Group
Corporation ("CGC"), in exchange for consideration of approximately $4.0
million, including acquisition costs, consisting of $927,000 and 350,000
shares of LodgeNet common stock. CGC developed technology that the Company is
using to facilitate high speed Internet access to hotel guests and operators.
The acquisition has been accounted for as a purchase and the excess of the
initial consideration over the fair value of CGC's net assets of
approximately $4.0 million has been recorded as an intangible asset and is
being amortized on a straight-line basis over ten years. The pro forma
results for 1997 and 1998, assuming the transaction had been made as of the
beginning of those years, would not be materially different from reported
results.
NOTE 5 -- SALE OF INVESTMENTS
In February 1998, the Company acquired a 10% equity interest in Across Media
Networks, Inc. ("AMN"), a creator and distributor of digitally produced
on-screen content for television and the Internet. The Company also held
rights to convert amounts loaned to AMN into an additional 80% equity
interest. During the third quarter of 1999, the Company sold its interest in
AMN for consideration of approximately $9.0 million, consisting of a $7.0
million note from the buyer due March 31, 2000 and a $2.0 million note from
AMN due August 31, 2002. The Company has deferred recognition of the $2.0
million AMN note until realization is more certain. The transaction resulted
in a $7.1 million gain.
In November 1999, the Company sold its interest in 1stUp.com, a provider of
free Internet services, to CMGI, Inc. ("CMGI") in a stock-for-stock exchange.
Pursuant to the transaction, the Company received 234,332 shares of CMGI
common stock (adjusted for a 2:1 stock split on January 12, 2000), which are
subject to certain sale and escrow restrictions. The aggregate market value
of the shares was $9.8 million at the time the sales agreement was reached.
After consideration of a discount to reflect the restrictions placed on the
CMGI stock, the Company recorded a gain on this transaction of $7.6 million
during the fourth quarter of 1999.
NOTE 6 -- MARKETABLE SECURITIES
Marketable securities, consisting of the CMGI common stock described in Note
5, are classified as available for sale and recorded at current market value.
Net unrealized gains and losses on marketable securities available for sale
are credited or charged to other comprehensive income. During 1999, the
unrealized gain on marketable securities was $18.1 million. The Company has
classified this investment as a current asset since it has the intent and
ability to redeem the investment within the next year.
NOTE 7 -- FAIR VALUE OF FINANCIAL INSTRUMENTS
Estimated fair values and carrying amounts in the financial statements are as
follows at December 31 (in thousands of dollars):
1998 1999
-------------------------- --------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ----------- ----------- -----------
Assets:
Marketable securities $ -- $ -- $ 25,952 $ 25,952
Notes receivable -- -- 7,060 7,060
Liabilities:
Long-term debt 268,093 269,108 282,990 285,294
Interest rate swaps -- -- -- 2,005
Fair values were determined under the following methods: marketable securities -
quoted market prices; notes receivable - present value of projected cash flows
using current interest rates and considering credit risks and other related
business factors; long-term debt - interest rates currently available to the
Company for debt with similar terms and maturities; interest rate swaps - quoted
amount the Company would receive to terminate the swap agreements,
F-10
considering current interest rates. For certain of the Company's financial
instruments including cash and cash equivalents, accounts receivable,
accounts payable, and accrued expenses, the carrying amounts approximate fair
value due to their short maturities.
NOTE 8 -- PROPERTY AND EQUIPMENT
Property and equipment was comprised as follows at December 31 (in thousands
of dollars):
1998 1999
------------- -------------
Land, building and equipment $ 48,105 $ 55,899
Free-to-guest systems 16,237 18,111
Guest Pay systems:
Installed 259,686 292,939
System components 21,151 22,551
Software costs 8,640 9,998
------------- -------------
Total 353,819 399,498
Less - Depreciation and amortization (144,382) (195,164)
------------- -------------
Property and equipment, net $ 209,437 $ 204,334
============= =============
NOTE 9 -- INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED AFFILIATES
As described in Note 3, the Company obtained a 30% interest in GICC and notes
receivable totaling $10.8 million resulting from the November 30, 1998 merger
transaction of ResNet with two other entities. In exchange for this interest,
the Company contributed net assets totaling $31.3 million. In addition, the
Company has advanced $3.25 million to GICC under terms of secured note
agreements.
Prior to the third quarter of 1999, the Company accounted for its investment
in GICC using the equity method of accounting for an investment. The
Company's portion of GICC's net loss for 1998 was $738,000 and for the first
six months of 1999, the Company recorded equity losses totaling $3.2 million.
During the second quarter of 1999, GICC defaulted on its notes payable to the
Company. The Company recorded a $16.8 million charge in the second quarter to
write down its investment in GICC to estimated fair value. Beginning with the
third quarter of 1999, the Company is using the cost method of accounting for
its investment in GICC to reflect its temporary condition resulting from the
commencement of a plan by GICC management to sell its assets. During the
fourth quarter of 1999, a $2.1 million charge was recorded to further
write-down the investment in GICC to its current estimated fair value of
$11.4 million.
Prior to the sale of the Company's investment in AMN as described in Note 5,
the Company had recorded equity losses related to this investment of $5.8
million in 1998 and $2.2 million in 1999.
F-11
NOTE 10 -- DEBT ISSUANCE COSTS
Costs associated with the issuance of debt securities and with obtaining
credit facilities are capitalized and amortized over the term of the related
borrowing or facility. In conjunction with the amendment and restatement of
the Company's bank credit facility as described in Note 12, the Company
capitalized $3,559,000 of debt issuance costs during the year ended December
31, 1999. No debt issuance costs were incurred in 1998. Amortization of such
costs was $1,008,000 in 1997, $1,004,000 in 1998, and $1,486,000 in 1999. The
components of the debt issuance costs recorded in the balance sheets are as
follows at December 31 (in thousands of dollars):
1998 1999
------------ ------------
Debt issuance costs $ 8,960 $ 12,519
Accumulated amortization (2,323) (3,809)
------------ ------------
$ 6,637 $ 8,710
============ ============
NOTE 11 -- ACCRUED EXPENSES
Accrued expenses were comprised as follows at December 31 (in thousands of
dollars):
1998 1999
------------ ------------
Accrued taxes $ 1,345 $ 1,749
Accrued compensation 2,427 2,525
Accrued interest 3,689 3,818
Other 1,949 2,551
------------ -------------
$ 9,410 $ 10,643
============ ============
NOTE 12 -- LONG-TERM DEBT AND CREDIT FACILITIES
Long-term debt was comprised as follows at December 31 (in thousands of
dollars):
1998 1999
------------- -------------
Bank Credit Facility:
Bank term loan $ -- $ 75,000
Revolving credit facility 76,500 21,500
10.25% senior notes 150,000 150,000
11.50% senior notes 30,000 30,000
Less unamortized discount (954) (739)
Capital leases 1,326 1,000
Other 11,221 6,229
------------- -------------
268,093 282,990
Less current maturities (5,718) (5,915)
------------- -------------
$ 262,375 $ 277,075
============= =============
BANK CREDIT FACILITY -- In February 1999, the Company amended and restated
its bank credit facility, increasing the size of the facility to $150
million, comprised of a $75 million term loan and a $75 million revolving
credit facility. The $76.5 million outstanding at December 31, 1998 under the
previous revolving credit facility was repaid with proceeds from the term
loan. In addition to the $75 million term loan, the facility provides a $75
million revolving credit facility, which may be increased at the Company's
request to $100 million, subject to certain limitations. Quarterly repayments
on the term loan begin in February 2001. The revolving credit facility
matures in February 2005. Loans bear interest, payable quarterly, at the
Company's option of (1) the bank's base rate (as defined) plus a margin of
from 1.00% to 1.75%, depending on leverage as defined, or (2) the eurodollar
rate plus a margin of from 2.00% to 2.75%, depending on leverage as defined.
The margins applicable to the bank's base rate and/or the eurodollar rate
loans are subject to quarterly adjustment as defined in the agreement.
Weighted average interest rates as of December 31, 1999 were 8.44% for the
term loan and 9.11% for the revolving credit facility. The loans are secured
by a first priority security interest in all of the Company's assets. The
facility provides for the issuance of letters of
F-12
credit up to $12 million, subject to customary terms and conditions. As of
December 31, 1999, the Company had outstanding letters of credit totaling
$2.0 million.
The facility includes terms and conditions which require the maintenance of
certain financial ratios and place limitations on capital expenditures,
additional indebtedness, liens, investments, guarantees and certain payments
or distributions in respect of the common stock. As of December 31, 1999, the
Company was in compliance with all covenants, terms and conditions of the
bank credit facility.
During 1999, the Company entered into interest rate swap agreements on the
$75 million term loan to effectively change the underlying debt from a
variable interest rate to a fixed interest rate of 7.74% for the term of the
swap agreements. This reduces the Company's risk of incurring higher interest
costs in periods of rising interest rates. Interest differentials to be paid
or received as a result of the swap agreements are reflected as an adjustment
to interest expense in the related debt period.
10.25% SENIOR NOTES -- In December 1996, the Company issued $150 million of
unsecured 10.25% senior notes (the "10.25% Notes"), due December 15, 2006.
The 10.25% Notes are unsecured, rank PARI PASSU in right of payment with
future unsubordinated unsecured indebtedness and rank senior in right of
payment to all subordinated indebtedness of the Company. The 10.25% Notes
require semi-annual interest payments and contain certain restrictive
covenants. As of December 31, 1999, the Company was in compliance with all
covenants, terms, and conditions of the 10.25% Notes.
The 10.25% Notes are redeemable at the option of the Company, in whole or in
part, on or after December 15, 2001, initially at 105.125% of their principal
amount (plus accrued and unpaid interest) declining ratably to 100% of their
principal amount (plus accrued and unpaid interest) on or after December 15,
2003. In addition, at any time prior to December 15, 1999, the Company may
redeem up to 35% of the aggregate principal amount of the 10.25% Notes with
the proceeds of one or more public equity offerings.
11.50% SENIOR NOTES -- During 1995, the Company issued $30 million principal
amount of unsecured 11.50% senior notes (the "11.50% Notes"). Mandatory
annual principal payments of $6 million commence in July 2001 continuing
through July 2005. Semi-annual interest payments are required. The Company
issued a total of 480,000 warrants (see Note 16) to purchase common stock of
the Company in connection with the issuance of the 11.50% Notes and the value
of the warrants, $1.68 million, was recorded as additional paid-in capital
and shown as a discount on the 11.50% Notes. As part of the refinancing
transaction in which the 10.25% Notes were issued, the holders of the 11.50%
Notes adopted the covenants and ranking of the 10.25% Notes.
Long-term debt has the following scheduled principal maturities for the years
ended December 31 (in thousands of dollars): 2000 -- $5,915; 2001 -- $17,568;
2002 -- $23,983; 2003 -- $25,575; 2004 -- $27,563; thereafter -- $182,386.
NOTE 13 -- COMMITMENTS AND CONTINGENCIES
PROGRAMMING AGREEMENTS -- The Company, through programming agreements,
provides Guest Pay and free-to-guest programming services to the lodging
industry. These agreements provide that the Company receives monthly revenue
for such services. Such agreements contain various restrictions, including
default and termination procedures, and generally range from five to seven
years in duration. The Company has also entered into agreements with certain
networks and studios which provide their programs for redistribution. Under
these agreements, the Company pays fees which are based on revenue generated,
or on rate schedules based on the number of sites under license by the
Company. The agreements contain various restrictions, including default and
termination procedures, and generally range from three to seven years in
duration.
PURCHASE COMMITMENTS -- The Company has purchase commitments, in the ordinary
course of business, none of which are expected to result in losses.
OPERATING LEASES -- The Company has entered into certain operating leases,
which at December 31, 1998 require future minimum lease payments, as follows:
2000 --$321,000; 2001 -- $278,000; 2002 -- $218,000; 2003 -- $121,000; 2004
- -- $42,000; thereafter -- $32,000. The leases expire at dates ranging from
2000 to 2006. Rental
F-13
expense under all operating leases was $745,000, $358,000, and $436,000 for
the years ended December 31, 1997, 1998, and 1999, respectively.
LICENSE AGREEMENT -- During the third quarter of 1998, the Company entered
into an agreement with On Command Corporation ("On Command") to settle all
matters of pending litigation between the companies and enter into cross
licensing arrangements regarding the use of each of the companies' patented
technologies. The cross licensing arrangements, in consideration of the
relative fair value of the patents involved, provides for the Company to make
cash payments to On Command totaling approximately $16 million plus interest,
payable in three annual installments which commenced in September 1998. The
Company has capitalized the present value of the obligation to On Command
based on the fair value of the license rights acquired. This value is being
amortized over the remaining average lives of the underlying patents.
LEGAL PROCEEDINGS -- The Company is subject to legal proceedings and claims
arising in the ordinary course of its businesses. As of the date hereof, in
the opinion of management, the resolution of such matters is not expected to
have a material adverse effect on the Company's financial position or results
of operations.
NOTE 14 -- STOCKHOLDERS' EQUITY
PREFERRED STOCK -- There are 5,000,000 shares of preferred stock, $.01 par
value, authorized by the Company's certificate of incorporation, of which
none were outstanding at December 31, 1998 and 1999. The Board of Directors
may authorize the issuance of preferred stock, $.01 par value, in one or more
series and with rights and privileges for each issue as determined by the
Board of Directors.
STOCKHOLDER RIGHTS PLAN -- On February 28, 1997, the Board of Directors of
the Company authorized and adopted a Stockholder Rights Plan. Pursuant to the
rights plan, the Board of Directors declared a dividend distribution of one
right for each outstanding share of common stock of the Company to
stockholders of record at the close of business on March 10, 1997.
Initially, the rights will be attached to all common stock certificates and
no separate rights certificates will be distributed. The rights will separate
from the common stock and be distributed upon the occasion of (i) a public
announcement that a person, group or entity has acquired or obtained the
right to acquire 15% or more of the common stock of the Company or (ii) ten
days following the commencement of, or an announcement of the intention to
make, a tender or exchange offer which would result in a person, group or
entity becoming the holder of 15% or more of the Company's common stock. The
rights are not exercisable until distributed.
In general, each right, when exercisable, initially entitles the registered
holder to purchase from the Company one-thousandth of a share of a new series
of preferred stock, designated as Series A Participating Preferred Stock, par
value $.01, at a price of $60.00 per share. In certain other events, after
the rights have become exercisable, each right entitles the holder to
purchase for $60.00 an amount of common stock of the Company, or in certain
circumstances securities of the acquirer, having a then-current market value
of two times the exercise price of the right. The rights include
anti-dilution provisions in the event of a stock dividend, split-up or
reclassification of the common stock. The preferred stock purchasable upon
exercise of the rights will be non-redeemable and junior to any other issue
of preferred stock the Company might issue, and will include dividend and
liquidation preferences. No stockholder privileges attach to the rights until
exercised.
F-14
NOTE 15 -- STOCK OPTION PLANS
The Company has stock options plans which provide for the granting of up to
2,726,792 non-qualified or incentive stock options on the Company's common
stock. Certain officers, directors and key employees have been granted
options to purchase common stock of the Company under these plans. Options
become exercisable in accordance with vesting schedules determined by a
committee of the Board of Directors, and generally expire ten years after the
date of grant. No options had expired as of December 31, 1999, and
outstanding options expire beginning in 2001 through 2008. The following is a
summary of the stock option activity for the years ending December 31:
Weighted
Average
Options Exercise
Outstanding Price
------------- ------------
Balance at December 31, 1996 1,451,670 $ 5.79
Options granted 257,832 14.99
Options exercised (196,689) 1.08
Options forfeited/canceled (7,000) 9.06
-------------
Balance at December 31, 1997 1,505,813 7.91
Options granted 634,656 12.72
Options exercised (270,329) .81
Options forfeited/canceled (108,000) 12.84
-------------
Balance at December 31, 1998 1,762,140 10.45
Options granted 103,486 10.74
Options exercised (16,661) 9.64
Options forfeited/canceled (142,600) 11.53
-------------
Balance at December 31, 1999 1,706,365 $ 9.68
=============
The following is a summary of stock options outstanding as of December 31,
1999:
Outstanding Options Exercisable Options
-------------------------------------------------- -----------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Exercise Term Exercise Exercise
Price Range Number in Years Price Number Price
- ----------------------- ------------- -------------- ------------- ------------- -------------
$0.23 to $0.46 84,819 3.8 $ .23 84,819 .23
$2.77 to $3.23 237,022 3.6 2.89 237,022 2.89
$6.46 to $9.79 338,799 6.7 8.69 222,749 8.58
$10.38 to $13.29 834,000 7.6 11.36 518,750 11.28
$14.00 to $20.00 211,725 6.8 16.03 116,063 15.84
------------- -------------
1,706,365 6.6 $ 9.68 1,179,403 8.74
============= =============
The weighted average fair value of options granted during the year ended
December 31 was as follows:
1997 1998 1999
---------- ---------- -----------
Weighted average fair
value per option granted $ 7.13 $ 4.36 5.43
========== ========== ===========
The fair value of each option granted was estimated as of the grant date
using the Black-Scholes option valuation model under the following
assumptions: (i) dividend yield - none, (ii) weighted average risk-free
interest rate - 6.22% in 1997, 5.15% in 1998, and 5.54% in 1999; (iii)
weighted average expected life -5.0 years, and (iv) weighted average expected
volatility - 44.5% in 1997, 45.3% in 1998, and 50.7% in 1999.
F-15
The Company accounts for its stock option compensation plans in accordance
with the provisions of Accounting Principles Board Opinion No. 25.
Accordingly, because the Company's stock option plans are fixed plans and
options are issued at market value, no compensation cost has been charged to
operations for any period presented. Had compensation cost been determined in
accordance with SFAS No. 123, net loss and loss per share would have
increased, and the effect of such increases, reflected on those items on a
pro forma basis, would have been as follows for the years ended December 31
(in thousands of dollars, except per share amounts):
1997 1998 1999
------------- ------------- ------------
Net loss
As reported $ (25,619) $ (39,912) $ (36,428)
Pro forma (27,423) (42,677) (36,990)
Loss per share
As reported $ (2.27) $ (3.45) $ (3.05)
Pro forma (2.43) (3.69) (3.10)
NOTE 16 -- WARRANTS
In connection with the 1995 issuance of the 11.50% Senior Notes (see Note
12), the Company issued a total of 480,000 warrants to purchase common stock
of the Company. Each warrant entitles the holder to purchase one share of
common stock at an exercise price of $7.00 per share. The warrants include
demand registration rights and anti-dilution provisions, and such warrants
expire on July 15, 2005. The portion of the proceeds from the 1995 debt
issuance deemed attributable to the warrants was recorded as additional
paid-in capital.
NOTE 17 -- CHANGE IN ACCOUNTING PRINCIPLE
Effective in the fourth quarter of 1997, the Company adopted the provisions
of Issue No. 97-13, "Accounting for Costs Incurred in Connection with a
Consulting Contract or an Internal Project That Combines Business Process
Reengineering and Information Technology Transformation" issued by the
Emerging Issues Task Force of the FASB. This new pronouncement requires that
certain costs associated with business process reengineering activities
should be expensed as incurred rather than capitalized. As a result, the
Company recorded a $210,000 charge in the 1997 Consolidated Statement of
Operations, reflected as a cumulative effect of a change in accounting
principle, to write-off business process reengineering costs that had been
previously capitalized.
NOTE 18 -- EMPLOYEE BENEFIT PLAN
The Company sponsors a 401(k) plan covering eligible employees. The plan
provides for employer contributions based primarily on the level of employee
participation. Contribution expense for the Company was $138,000, $558,000,
and $554,000 in 1997, 1998, and 1999, respectively.
F-16
NOTE 19 -- INCOME TAXES
Loss before income taxes were as follows for the years ended December 31 (in
thousands of dollars):
1997 1998 1999
------------- ------------ -------------
Domestic $ (25,310) $ (38,698) $ (35,914)
Foreign (309) (1,214) (514)
------------- ------------ ------------
Total $ (25,619) $ (39,912) $ (36,428)
============= ============ ============
The provisions for income taxes of $344,000 in 1997, $375,000 in 1998, and
$370,000 in 1999 consist of current state taxes. Such amounts differ from
that which would be obtained by applying the statutory federal income tax
rate to loss before income taxes due primarily to changes in the valuation
allowance reflecting changes in net deferred tax assets.
Deferred income taxes reflect the impact of temporary differences between the
amounts of assets and liabilities for financial reporting purposes and
amounts used for income tax purposes. Significant components of the Company's
deferred tax assets and liabilities were as follows at December 31(in
thousands of dollars):
1998 1999
------------- -------------
Deferred tax liabilities:
Tax over book depreciation $ (2,038) $ --
Unrealized gain on marketable securities -- (6,164)
------------- -------------
(2,038) (6,164)
Deferred tax assets:
Net operating loss carryforwards 32,796 34,920
Losses of unconsolidated affiliates 2,376 7,907
Reserves and accruals 1,324 2,297
Deferred credits 788 914
Book over tax depreciation -- 1,275
Gain on sale of investment -- 665
------------- -------------
37,284 47,978
------------- -------------
Net deferred tax assets 35,246 41,814
Valuation allowance (35,246) (41,814)
------------- -------------
Net deferred taxes $ -- $ --
============= =============
The Company has net operating loss carryforwards of approximately $102 million
for federal income tax purposes. Such carryforwards expire beginning in 2001
through 2013, and federal tax regulations limit the availability and timing of
usage of carryforwards. The Company established the valuation allowance for
deferred tax assets after considering its historical financial performance,
existing deferred tax liabilities, and certain information about future years.
NOTE 20 -- RELATED PARTY TRANSACTIONS
During 1998, the Company advanced $1.9 million to two officers under the
terms of promissory notes providing for total advances of $2.0 million.
Payments on the notes were made by the officers in 1999. As of December 31,
1999, $82,000 remains outstanding due from one of the officers. Interest is
payable monthly at the rate applicable to the Company under its revolving
credit facility. The notes are secured by shares of the Company's stock held
by the officers.
F-17
NOTE 21 -- SEGMENT INFORMATION
Effective with the ResNet merger transaction described in Note 3, the Company
operates in one business segment, the distribution of entertainment and
information services to the lodging industry. The following table presents
revenues by country based on the location of the customer for the year ended
December 31 (in thousands of dollars):
1997 1998 1999
-------------- -------------- --------------
United States $ 129,484 $ 157,654 $ 171,828
Canada 5,954 7,420 8,806
Other 272 1,277 638
-------------- -------------- --------------
Total $ 135,710 $ 166,351 $ 181,272
============== ============== ==============
Long-lived assets by country based on the location of the asset were as follows
at December 31 (in thousands of dollars):
1997 1998 1999
-------------- -------------- --------------
United States $ 209,993 $ 199,067 $ 192,827
Canada 8,955 10,370 11,507
-------------- -------------- --------------
Total $ 218,948 $ 209,437 $ 204,334
============== ============== ==============
NOTE 22 -- SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following selected quarterly financial data are in thousands of dollars,
except per share data:
Quarter Quarter Quarter Quarter
Ending Ending Ending Ending
March 31, June 30, September 30, December 31,
------------- ------------- ---------------- ----------------
1998:
Revenues $ 36,347 $ 40,898 $ 45,776 $ 43,330
Gross profit 20,267 22,711 25,636 23,729
Net loss (1) (8,635) (7,548) (5,457) (18,272)
Per common share (2) $ (0.76) $ (0.65) $ (0.47) $ (1.54)
1999:
Revenues $ 41,965 $ 44,269 $ 49,640 $ 45,398
Gross profit 23,717 25,264 27,751 26,050
Net income (loss) (1) (11,027) (24,826) 2,309 (2,884)
Per common share (2): $ (0.92) $ (2.08) $ .19 $ (0.24)
(1) Net loss for the quarter ended December 31, 1998 includes a $3.3 million
restructuring charge related to the ResNet merger transaction. Net loss for
the quarter ended June 30, 1999 includes a $16.8 million charge to
write-down the investment in GICC. Net income for the quarter ended
September 30, 1999 includes a $7.1 million gain from the sale of AMN. Net
loss for the quarter ended December 31, 1999 includes a $7.6 million gain
from the sale of 1stUp.com and a $2.1 million charge to write-down the
investment in GICC.
(2) Per share amounts represent both basic and diluted earnings per share and
are computed independently for each of the quarters presented. Therefore,
the sum of such amounts may not equal the total for the year.
F-18
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE
To LodgeNet Entertainment Corporation:
We have audited, in accordance with generally accepted auditing standards,
the consolidated financial statements included in this annual report on Form
10-K, and have issued our report thereon dated February 11, 2000. Our audit
was made for the purpose of forming an opinion on those financial statements
taken as a whole. The following schedule is the responsibility of the
Company's management and is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required
to be set forth therein in relation to the basic financial statements taken
as a whole.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota
February 11, 2000
F-19
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(Dollar amounts in thousands)
Column A Column B Column C Column D Column E
- ------------------------------------------- ------------- -------------- -------------- ------------
Additions
Balance Charged to Balance
Beginning Costs and Deductions End of
Description of Period Expenses (Note 1) Period
- ------------------------------------------- ------------- -------------- -------------- ------------
Allowances deducted from related
balance sheet accounts:
Year Ended December 31, 1997:
Allowance for Doubtful Accounts $ 785 $ 820 $ 805 $ 800
Year Ended December 31, 1998:
Allowance for Doubtful Accounts $ 800 $ 848 $ 848 $ 800
Year Ended December 31, 1999:
Allowance for Doubtful Accounts $ 800 $ 441 $ 441 $ 800
(1) All deductions from reserves were for the purposes for which such
reserves were created except for the 1998 activity, which includes a
$45,000 reduction to the reserve resulting from the ResNet merger
described in Note 3.
F-20