Back to GetFilings.com
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
================================================================================
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
================================================================================
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
or
================================================================================
[ ] 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
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
DELAWARE 46-0371161
(State of Incorporation) (IRS Employer Identification Number)
3900 WEST INNOVATION STREET, SIOUX FALLS, SOUTH DAKOTA 57107
------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(605) 988 - 1000
----------------------------------------------------
(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 __ .
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 23, 2001, the aggregate market value of the common stock held by
non-affiliates of the Registrant was approximately $158,500,000 based on the
March 23, 2001 closing price of $14.00. The number of shares of common stock
of the Registrant outstanding as of March 23, 2001 was 12,212,439 shares.
DOCUMENTS INCORPORATED BY REFERENCE - Portions of the 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,
2000, are incorporated by reference in Part III of this Form 10-K.
TABLE OF CONTENTS
Item 1 - Business.........................................................................................1
Overview.........................................................................................1
Markets and Customers............................................................................2
Services and Products............................................................................2
Operations.......................................................................................4
Competition......................................................................................6
Business Strategy................................................................................7
Regulation.......................................................................................8
Employees........................................................................................9
Item 2 - Properties.......................................................................................9
Item 3 - Legal Proceedings................................................................................9
Item 4 - Submission of Matters to a Vote of Security Holders..............................................9
Item 5 - Market for Registrant's Common Equity and Related Stockholder Matters............................10
Dividends........................................................................................10
Stockholder Rights Plan..........................................................................10
Item 6 - Selected Financial Data..........................................................................12
Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations............14
Item 7A - Quantitative and Qualitative Disclosures About Market Risk......................................23
Item 8 - Financial Statements and Supplementary Data......................................................23
Item 9 - Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.............23
Item 10 - Directors and Officers of the Registrant........................................................23
Item 11 - Executive Compensation..........................................................................24
Item 12 - Security Ownership of Certain Beneficial Owners and Management..................................24
Item 13 - Certain Relationships and Related Transactions..................................................24
Item 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K.................................24
- ----------------------
As used herein (unless the context otherwise requires) "LodgeNet", the
"Company" and/or the "Registrant" mean LodgeNet Entertainment Corporation and
its consolidated subsidiaries.
i
PART I
ITEM 1 - BUSINESS
OVERVIEW
LodgeNet is an interactive services provider specializing in the
delivery of interactive television and Internet access services to the
lodging industry. Utilizing broadband technology, the Company provides
services throughout the United States, Canada and select international
markets. These services include on-demand movies, music and music videos,
Nintendo(R) 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. LodgeNet currently provides
service to 806,100 rooms in more than 5,100 hotel properties. The Company has
installed its interactive television system in more than 725,000 of those
rooms, which host more than 250 million guests on an annual basis.
The Company's interactive services are purchased by guests on a
per-view, hourly, or daily basis and include on-demand movies, network-based
Nintendo video games, music and music videos, Internet-enhanced television
(which does not require a laptop for access), and high-speed Internet access
services (referred to by the Company as Guest Pay interactive services).
Service packages may also include 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 (referred to by the Company as free-to-guest services). The
Company provides its services to various corporate-managed hotel chains such
as Hilton, Doubletree, Embassy Suites, Sheraton, Ritz-Carlton, Harrah's
Casino Hotels, Omni, Delta Hotels and Resorts, Outrigger, La Quinta Inns,
Wingate, Homewood Suites, Hampton Inns and Red Roof Inns, as well as many
individual properties using the Marriott, Holiday Inn, Inter-Continental,
Prince, Radisson, Westin and other trade names.
The growth in revenue and operating cash flow that the Company has
experienced over the past five years has primarily resulted from the rapid
expansion of the number of rooms installed with the Company's services. During
this period, the number of hotel rooms receiving the Company's Guest Pay
services has grown from 400,000 at the end of 1996 to more than 725,000 as of
December 31, 2000.
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 Company delivers its interactive television and Internet access
services through a system which it has designed. The system, which it refers to
as B-LAN(R), has the ability to transmit more information and images than was
commonly possible just a few years ago, because it utilizes greater transmittal
capacity, commonly referred to as bandwidth. The system is also referred to as a
local area network because it ties together numerous hotel rooms to a server
located in the hotel. Because the Company's system is based on the UNIX
operating system, the Company can upgrade its 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 system 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 guest rooms with Company
provided services,
- 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 guest rooms with Company provided services, menus which use
images rather than text to display movies, video games and other
interactive services available to guests,
- 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 high-speed Internet access (at up to 50 times the speed of
conventional modems) to hotel guest rooms, hotel business
conference rooms and other hotel meeting spaces.
1
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.
MARKETS AND CUSTOMERS
LARGE HOTEL MARKET. Historically, the Company's primary market for its
services has been large hotels with over 150 rooms located in metropolitan areas
in the U.S. and Canada. Based on industry sources, the Company estimates that
this market segment contains approximately 1.7 million rooms. The Company
currently provides its services to large hotels that are generally part of
chains such as Hilton, Doubletree, Embassy Suites, Sheraton, Ritz-Carlton, Omni,
Radisson, Harrah's Casino Hotels, Delta Hotels and Resorts, Outrigger, Holiday
Inn, Inter-Continental, Prince, Westin and Marriott. No single contract
represented greater than 10% of the Company's revenue for the year ended
December 31, 2000.
MID-SIZE HOTEL MARKET. In 1995, LodgeNet redesigned its 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 marketing
strategy and has added more than 198,000 rooms to its room base from mid-size
hotels. Based on industry sources, the Company estimates that this market
segment contains approximately 1.4 million rooms, and has historically been
underserved by the Company's industry because smaller average property sizes
generally 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. Some form of free-to-guest television service is
available to almost all of the approximately 3.9 million hotel rooms in the
United States. Free-to-guest television service 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.
INTERNATIONAL MARKET. The Company also provides services in other
select international countries, primarily countries located in Central and
South America, through licensing arrangements with established entities in
these countries. Under the arrangements, the Company does not provide any
capital investment. Instead, the Company sells equipment and licenses its
interactive architecture and technologies to the licensee and receives a
royalty based on gross revenue. Financial information related to the
Company's geographic operations is included in the Company's consolidated
financial statements.
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-speed Internet access services. Guest Pay
packages may also include satellite-delivered basic and premium cable television
programming which are paid for by the hotel and provided to guests free of
charge, and other interactive services such as review of room charges and video
checkout, guest surveying, advertising and merchandising services.
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, 2000,
the Company served over 725,000 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 Nintendo N64 video system and games. The Company uses its broadband
system architecture to allow guests to play the video games over the hotel's
master antenna television
2
system. Hotel guests are charged a fee based on the amount of time they play the
video games. The Company had over 697,000 rooms installed with the Nintendo
video game systems as of December 31, 2000.
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 game, 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 purchased by the hotel guest. For example, a property
installed with the Company's interactive system with a 68% occupancy rate, a buy
rate of 10% and an $8.95 movie price will generate an average of approximately
$18.50 of gross movie revenue per installed room per month, plus additional
gross revenues of $4.00 per month from video games, free-to-guest and other
interactive services, resulting in total gross revenue per room per month of
$22.50, assuming an average of 30.4 days in the month. Occupancy rates vary by
property based on the property's competitive position within its marketplace,
over time based on seasonal factors, and as a result of changes in general
economic conditions. Typically, occupancy rates are higher during the second and
third quarters due to seasonal travel patterns. 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 and may be higher in some locations and for certain
highly popular titles.
The cost of installing the Company's interactive system in a hotel
varies depending on the size of the hotel property and the configuration of the
interactive system being installed. The average installed cost of an interactive
system that includes on-demand movies, video games and general interactive
services capabilities is currently approximately $360 per room. The installation
of Internet access on television capabilities generally adds $60 to $80 more per
room. Installation costs include equipment that is located in one location
within the hotel and controls the overall operation of the Company's system in
each room (referred to by the Company as a headend location), in-room equipment
and labor and overhead costs. 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, preview tapes
or discs, tape duplication, taxes, freight, insurance, personal property taxes,
data line and Internet connectivity costs.
Upon 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. Programming is delivered via satellite
and 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
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 provides a variety of other services to its hotel
customers including the sale of system equipment and service parts and labor.
The Company believes that these services complement its goal of being a
full-service provider of in-room entertainment and information services to the
lodging industry.
INNMEDIA, LLC. In October of 2000, the Company entered into an
arrangement with Hilton Hotels Corporation to form and equally own a new
broadband, interactive media company, InnMedia LLC, to offer hotel guests new
and innovative interactive television content such as high speed Internet
access through the television as well as customized hotel and guest
information. Under this arrangement, InnMedia will supply Internet portal and
interactive television content to the Company for distribution to Hilton and
to other hotels installed with the Company's broadband, interactive system.
InnMedia will report the operations of these activities and will pay LodgeNet
a fee for use of LodgeNet's system.
RESIDENTIAL SERVICES. In 1996 the Company formed ResNet Communications,
Inc. 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, the successor to ResNet, as a result of
the merger. The Company is not actively involved in the business activities of
Global.
3
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, 2000, 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 guest, and the hotel 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 approximately four years
with less than 11% of these contracts coming up for renewal before 2002.
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
review of room charges and 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 infrared computer keyboard and
a desktop device which provides a high-speed Internet connection. 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 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.
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 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 also
licenses industry related technology from third parties.
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.
4
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 includes
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. 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 emphasizes the use of
Company-employed installation and service personnel residing in 23 locations
throughout the United States and Canada, 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 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 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 only
those components which are defective 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 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(R) programming to the
properties it services.
5
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 generally
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.
COMPETITION
Based on the number of hotel rooms served, the Company is the second
largest provider of interactive television services to the lodging industry,
currently serving over 825,000 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 977,000 hotel rooms. The Company also competes
with Hospitality Networks, SeaChange, AOL Time Warner, Cox Cable and
InRoomVideo among others. With regard to high-speed Internet connectivity,
the Company also competes with CAIS Internet, STSN and many 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 digital broadcast service 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 commissions to the hotel); and (iv) the ability to complete system
installation in a timely and efficient manner. In addition, 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 field service operations; and (iv) an
experienced management team and well-trained professional 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. 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
6
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 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.
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 350,000 rooms are
presently not served by any guest pay vendor and fit its target economic
profile. 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.
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, through
its relationship with InnMedia LLC, adding Internet on television based
services to its installed base. The Company intends to continue offering
on-demand movies, Nintendo N64 video games and digital music services in all
new Guest Pay interactive rooms. It also plans to upgrade selected existing
systems to provide digital movies, digital music, N64 games and Interaction
television 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 telephone system. The high-speed Internet access service can be
installed into a hotel's business conference rooms, other hotel 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
7
combination of Internet services and interactive television capabilities,
coupled with its broad presence in the United States and Canada, makes the
Company a convenient, single-source from which hotels can obtain the complete
range of interactive television and Internet services.
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 has reduced
per-room operating costs as it spread its expenses related to corporate overhead
and operating infrastructure over a larger base of installed rooms, as well as a
broader range of revenue generating sources. The Company believes that further
efficiencies can be achieved as it continues to expand the number of installed
rooms and the scope of its interactive television and Internet access offerings.
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.
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 Cable Television Consumer
Protection and Competition Act of 1992, and the Telecommunications 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, however, the Company
is subject to various provisions of the Communications Act. 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
8
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, 2000, the Company had 769 employees in the United
States and Canada, none of which are 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
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 United States and include one location in Canada. Each of these facilities
occupies less than 3,500 square feet.
The Company's headquarters, including its distribution center and
principal executive offices, is located in Sioux Falls, South Dakota. The
facility 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
facility in 1997 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 its facility is sufficient to accommodate its
foreseeable local operational space requirements.
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, 2000.
9
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 23, 2001 there were outstanding
12,212,439 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, 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
March 31, 2000 26.75 18.56
June 30, 2000 27.25 17.50
September 30, 2000 29.25 21.13
December 31, 2000 29.00 11.88
On March 23, 2001, the closing price of the Company's Common Stock, as
reported by NASDAQ NMS was $14.00. Stockholders are urged to obtain current
market quotations for the Company's Common Stock. As of March 23, 2001 there
were 133 stockholders of record of the Company with approximately 87% of the
shares held in "street name". The Company estimates that as of March 23, 2001
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 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 Company adopted a stockholder 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.
Under the rights plan, the Board of Directors declared a dividend
distribution of one right for each outstanding share of common stock to
stockholders of record at the close of business on March 10, 1997. Each right,
when exercisable, entitles the registered holder to purchase one one-thousandth
of a share of a new series of Series A Participating Preferred Stock, at a price
of $60.00.
Initially, the rights are "attached" to the common stock and trade with
the common stock. They separate from the common stock if a person or group
acquires 15% or more of the outstanding shares of common stock or a public
announcement of a tender offer or exchange offer is made which would result in
someone becoming the owner of 15% or more of the outstanding common stock.
Following a separation, the rights become exercisable, are separately tradable
and the Company will mail separate rights certificates to stockholders.
The rights expire on the earliest of February 28, 2007, the date of the
consummation of a merger with a person who acquired common stock with the
approval of the Board of Directors or the redemption of the rights by the
Company.
10
The number of rights are adjusted to prevent dilution in the event of a
stock split or stock dividend. The purchase price, and the number of shares of
preferred stock issuable upon exercise of the rights, are also adjusted for
stock splits and dividends, as well as for other events, including the issuance
of preferred stock at less than the market price or the distribution of Company
assets to preferred stockholders.
If the Company is acquired without the approval of the directors who
are neither officers of the Company nor related to the acquirer, the rights
become exercisable for shares of common stock of the acquiring company with a
market value of two times the exercise price. If there is merely an acquisition
of at least 15% of the common stock of the Company without such approval, the
rights become exercisable for common stock with a market value of two times the
exercise price
Prior to a 15% acquisition or the expiration of the rights, the Company
may redeem the rights at a price of $.01 per right. The rights are also
redeemable in connection with a merger or other similar transaction not
involving a 15% acquirer or if the acquier has acquired less than 15% and there
are no other acquirers.
In addition, the Board of Directors may, after a 15% acquisition (but
less than a 50% acquisition), exchange the rights for shares of common stock on
a one for one basis or for cash or other assets or securities of the Company.
If issued, the preferred stock will be nonredeemable and junior to any
other series of preferred stock the Company may issue, but will have a
preferential quarterly dividend equal to 1,000 times the dividend, if any,
declared on each share of common stock, but not less than $25.00 and, in the
event of liquidation of the Company, a preferred liquidation preference equal to
the greater of $1,000 or 1,000 times the payment per share of common stock. Each
share of preferred stock will have 1,000 votes and will vote together with the
common stock.
Until a right is exercised, the holder will have no rights as a
stockholder of the Company. The Company and the rights agent have broad
discretion to amend the Rights Agreement governing the rights; however,
following a separation, no amendment may adversely affect the rights holders.
11
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,
------------------------------------------------------------------------------------
1996 1997 1998 1999 2000
-------------- -------------- -------------- -------------- --------------
STATEMENT OF OPERATIONS DATA:
Revenues:
Guest Pay $ 84,504 $ 116,276 $ 146,481 $ 169,850 $ 186,718
Other 13,217 19,434 19,870 11,422 10,099
-------------- -------------- -------------- -------------- --------------
Total revenue 97,721 135,710 166,351 181,272 196,817
Direct costs 44,379 58,512 74,008 78,490 82,450
-------------- -------------- -------------- -------------- --------------
Gross profit 53,342 77,198 92,343 102,782 114,367
Operating expenses 58,428 85,262 102,282 103,460 112,073
-------------- -------------- -------------- -------------- --------------
Operating income (loss) (5,086) (8,064) (9,939) (678) 2,294
Gain on sale of investments -- -- -- 14,739 --
Investment losses -- -- (6,550) (24,323) (13,593)
Interest expense (8,551) (18,837) (23,261) (27,210) (27,809)
Interest income 308 1,836 213 1,414 419
-------------- -------------- -------------- -------------- --------------
Loss before income taxes, extraordinary
loss and cumulative effect of
accounting change (13,329) (26,065) (39,537) (36,058) (38,689)
Provision for income taxes (28) (344) (375) (370) (325)
-------------- -------------- -------------- -------------- --------------
Loss before extraordinary loss and
cumulative effect of accounting change (13,357) (25,409) (39,912) (36,428) (39,014)
Extraordinary loss (1) (3,253) -- -- -- --
Cumulative effect of accounting change
(2) -- (210) -- -- --
-------------- -------------- -------------- -------------- --------------
Net loss $ (16,610) $ (25,619) $ (39,912) $ (36,428) $ (39,014)
============== ============== ============== ============== ==============
Per common share (basic and diluted):
Loss before extraordinary loss and
cumulative effect of accounting change $ (1.40) $ (2.25) $ (3.45) $ (3.05) $ (3.21)
Extraordinary loss (.34) -- -- -- --
Cumulative effect of accounting
change -- (.02) -- -- --
-------------- -------------- -------------- -------------- --------------
Net loss $ (1.74) $ (2.27) $ (3.45) $ (3.05) $ (3.21)
============== ============== ============== ============== ==============
OTHER DATA:
EBITDA (3) $ 24,729 $ 35,696 $ 48,576 $ 60,100 $ 67,764
EBITDA margin (3) 25.3% 26.3% 29.2% 33.2% 34.4%
Capital expenditures (4) $ 84,256 $ 104,377 $ 69,660 $ 51,226 $ 60,195
Depreciation and amortization 29,815 43,760 55,215 60,778 65,470
Ratio of earnings to fixed charges (5) -- -- -- -- --
Ratio of total long-term debt to
EBITDA (3) 7.27x 5.14x 5.52x 4.71x 4.29x
Ratio of EBITDA to interest expense (3) 2.89x 1.90x 2.09x 2.21x 2.44x
OPERATING DATA:
Guest Pay rooms served (6)
On-demand 358,842 484,070 581,893 661,691 725,075
Scheduled 41,403 27,781 14,913 -- --
-------------- -------------- -------------- -------------- --------------
Total Guest Pay rooms 400,245 511,851 596,806 661,691 725,075
============== ============== ============== ============== ==============
Rooms with Nintendo(R)game systems (6) 322,903 448,969 546,324 627,592 697,703
Rooms with Internet services (6) -- -- -- 10,152 31,502
Free-to-guest rooms served (6) 294,882 341,030 384,324 399,046 405,977
Total rooms served (6) (7) 516,348 613,407 703,325 761,509 806,112
Average monthly revenue per Guest Pay
room:
Movie revenue $ 18.38 $ 17.86 $ 18.44 $ 18.62 $18.19
Other interactive service revenue 2.93 3.28 3.62 3.85 4.27
-------------- -------------- -------------- -------------- --------------
Total $21.31 $ 21.14 $ 22.06 $ 22.47 $22.46
============== ============== ============== ============== ==============
12
AS OF DECEMBER 31,
---------------------------------------------------------
1996 1997 1998 1999 2000
---- ---- ---- ---- ----
BALANCE SHEET DATA:
Cash and cash equivalents $ 86,177 $ 1,021 $ 5,240 $ 1,644 $ 4,059
Total assets 279,768 260,294 306,030 305,275 281,605
Total long-term debt 179,658 183,396 268,093 282,990 290,659
Total stockholders' equity (deficit) 75,552 49,579 11,774 (5,504) (36,426)
YEAR ENDED DECEMBER 31,
---------------------------------------------------------
1996 1997 1998 1999 2000
---- ---- ---- ---- ----
STATEMENT OF CASH FLOWS DATA:
Cash provided by operating activities $ 9,562 $ 16,653 $ 13,243 $ 40,782 $ 41,180
Cash used for investing activities (78,860) (104,377) (77,578) (55,445) (50,248)
Cash provided by financing activities 153,129 2,610 68,608 11,030 11,510
(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 consists of earnings before interest, income taxes,
depreciation, amortization and other non-operating income or expenses.
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, and is not representative of funds
available for discretionary use due to the Company's financing
obligations. EBITDA, as defined by the Company, may not be calculated
consistently among other companies reporting similarly titled measures.
EBITDA is included herein because it 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.
(4) Presented as cash used for property and equipment additions and
business acquisitions as reported in the Statement of Cash Flows.
(5) 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: 1996 --
$(13,329); 1997 -- $(25,065); 1998 -- $(38,799); 1999 -- $(36,058); and
2000 -- $(38,689).
(6) At end of year.
(7) Total rooms served include those rooms receiving one or more of the
Company's services, including rooms served by international licensees.
13
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". 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 THE
CONSOLIDATED FINANCIAL STATEMENTS OF THE COMPANY, INCLUDING THE NOTES THERETO,
APPEARING ELSEWHERE HEREIN.
OVERVIEW
LodgeNet is a broadband, interactive services provider specializing 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(R) 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:
1998 1999 2000
------------ ------------ ------------
Guest Pay interactive rooms 84,955 64,885 63,384
Nintendo video game rooms 97,355 81,268 70,111
Internet services rooms -- 10,152 21,350
14
The net room installations represent increases of 16.6%, 10.9%, and
9.6%, respectively for Guest Pay interactive rooms and 21.7%, 14.9%, and 11.2%,
respectively, for Nintendo video game rooms. De-installation activity is
generally less than 2% of the installed number of rooms.
The Company's base of installed rooms was comprised as follows at December 31:
1998 1999 2000
----------------------- ----------------------- ------------------------
ROOMS % ROOMS %
----------- ------- ----------- ------- ----------- --------
Guest Pay rooms:
Scheduled 14,913 2.5 -- -- -- --
On-demand 581,893 97.5 661,691 100.0 725,075 100.0
----------- ------- ----------- ------- ----------- --------
596,806 100.0 661,691 100.0 725,075 100.0
Nintendo video game rooms 546,324 627,592 697,703
Internet services rooms -- 10,152 31,502
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:
1998 1999 2000
------------ ------------ ------------
Total rooms served 703,325 761,509 806,112
============ ============ ============
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 sale of system equipment and service parts and labor.
Results from these 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.
RESIDENTIAL SERVICES. Effective November 30, 1998, the operations of
the Company's majority-owned subsidiary, ResNet Communications, LLC, 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,
which were included in the "other" component of revenues in the statements of
operations.
INNMEDIA LLC. During the fourth quarter of 2000, the Company entered
into an arrangement with Hilton Hotels Corporation to form a new broadband,
interactive media company, InnMedia LLC, to offer hotel guests new and
innovative interactive television content such as high speed Internet access
through the television as well as customized hotel and guest information. Under
this arrangement, InnMedia will supply Internet portal and interactive
television content to Hilton and other hotels using LodgeNet's broadband,
interactive system. InnMedia will report the operations of these activities, of
which LodgeNet and Hilton will equally share, and will pay LodgeNet a fee for
use of LodgeNet's system. The arrangement includes $5 million financing
commitments from both LodgeNet and Hilton to fund start-up and near-term
operational costs. InnMedia is expected to begin delivery of content and
services during the third quarter of 2001.
15
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 2000 AND 1999
REVENUE ANALYSIS
The Company's total revenue for 2000 increased 8.6%, or $15.5 million,
in comparison to 1999. The following table sets forth the components of the
Company's revenue (in thousands) for the years ended December 31:
1999 2000
--------------------------- ---------------------------
PERCENT PERCENT
OF TOTAL OF TOTAL
AMOUNT REVENUES AMOUNT REVENUES
------------ ----------- ----------- -----------
Revenues:
Guest Pay $169,850 93.7 $186,718 94.9
Other 11,422 6.3 10,099 5.1
------------ ----------- ----------- -----------
Total $181,272 100.0 $196,817 100.0
============ =========== =========== ===========
GUEST PAY INTERACTIVE SERVICES. Guest Pay interactive service revenue
increased 9.9%, or $16.9 million, in 2000 as compared to 1999. This increase is
primarily due to a 10.0% increase in the average number of installed Guest Pay
rooms. The following table sets forth information with respect to revenue per
Guest Pay room for the years ended December 31:
1999 2000
----------- ------------
Average monthly revenue per room:
Movie revenue $ 18.62 $ 18.19
Other interactive service revenue 3.85 4.27
----------- ------------
Total per Guest Pay room $ 22.47 $ 22.46
=========== ============
Average movie revenue per room decreased 2.3% from 1999 due to a
relatively less popular selection of major motion pictures during 2000 compared
to the prior year. This factor contributed to a decline in the average buy rate
of movies by hotel guests, which was partially offset by higher prices charged
for movies and slightly higher hotel occupancy levels.
Average other interactive service revenue per room increased 10.9% from
the prior year. This increase was primarily due to (i) increased per room
revenue from Internet services resulting from increased penetration of Internet
services into Guest Pay rooms, an expanded selection of revenue generating
Internet services, and increasing interest in Internet services from hotel
guests; and (ii) increased revenue from cable television programming services
resulting from decreased incentive credits granted to hotels and increases in
the number of cable television programming channels supplied by hotels to their
guests.
OTHER. Revenue from other sources includes revenue from free-to-guest
services provided to hotels not receiving Guest Pay services and sales of system
equipment and service parts and labor. The 11.6%, or $1.3 million, decrease in
other revenue is primarily due to a $1.1 million decrease in revenue from
free-to-guest services provided to hotels not receiving Guest Pay services. This
was the result of a decline in the number of rooms receiving such services as
the Company has chosen to not pursue the renewal of certain contracts as they
expire, in certain cases where a technology upgrade (which would result in
additional capital investment by the Company) is needed.
16
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:
1999 2000
------------ -----------
Direct costs:
Guest Pay $ 70,632 $ 76,586
Other 7,858 5,864
------------ -----------
$ 78,490 $ 82,450
============ ===========
Gross profit margin:
Guest Pay 58.4% 59.0%
Other 31.2% 41.9%
Composite 56.7% 58.1%
Guest Pay interactive direct costs increased 8.4% to $76.6 million in
2000 from $70.6 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 service revenue, direct costs
decreased from 41.6% in 1999 to 41.0% in 2000. The resulting increase in the
gross profit margin from 58.4% to 59.0% is primarily the result of:
(i) decreased license fees relative to movie revenue due to an
increase in sales of independent movies versus major motion
pictures as the license fees for independent movies are
significantly less than those charged for major motion pictures;
(ii) decreased video game license fees as the structure for license
fees with Nintendo is such that incremental rooms are incurring
license fees at lower rates resulting in an overall lower rate as
the Company adds rooms;
(iii) decreased commissions paid to the hotel on video game sales as
commission rates on the newer N64 game offering have been lower
than those on the Super Nintendo product;
(iv) decreased programming costs relative to cable television
programming revenue due to more favorable programming rates
resulting from the Company's conversion to DIRECTV from PRIMESTAR
during 2000.
These factors were partially offset by a shift in the mix of Guest Pay
revenue from the higher margin revenue source of movies to the lower margin
revenue source of cable television programming services.
Direct costs associated with other revenue decreased $2.0 million or
25.4% in 2000 from the year earlier period, primarily due to the decrease in
free-to-guest services provided to hotels not receiving Guest Pay services as
described in the revenue analysis above. As a percentage of related revenues,
other direct costs decreased to 58.1% of other revenue in 2000 versus 68.8% in
1999. The resulting increase in gross profit margin from 31.2% in 1999 to 41.9%
in 2000 is due to (i) the benefit of one-time incentives of $800,000 earned from
a vendor and (ii) a shift in the mix of other revenue to higher margin sources
from the lower margin source of free-to-guest services.
The Company's overall gross profit increased 11.3% in 2000 to $114.4
million on an 8.6% increase in revenue compared to 1999. The overall gross
profit margin increased to 58.1% in 2000 from 56.7% in the prior year,
reflecting the improved margin for both Guest Pay and other revenue as described
above, and due to a shift in sales toward the more profitable Guest Pay
interactive services (94.9% of total sales in 2000 compared to 93.7% in 1999)
from other revenue sources.
17
OPERATING EXPENSES. The following table sets forth information in regard to the
Company's operating expenses (in thousands) for the years ended December 31:
1999 2000
--------------------------- ---------------------------
PERCENT PERCENT
OF TOTAL OF TOTAL
AMOUNT REVENUES AMOUNT REVENUES
------------ ----------- ----------- -----------
Operating expenses:
Guest Pay operations $ 24,908 13.7 $ 27,356 13.9
Selling, general and administrative 17,774 9.8 19,247 9.8
Depreciation and amortization 60,778 33.6 65,470 33.3
------------ ----------- ----------- -----------
Total operating expenses $103,460 57.1 $112,073 56.9
============ =========== =========== ===========
Guest Pay operations expenses, consisting of costs directly related to
the operation of systems at hotel sites, increased 9.8%, or $2.4 million, in
2000 from the prior year. This increase is primarily attributable to the 10.0%
increase in average installed Guest Pay rooms in 2000 as compared to 1999. Per
average installed Guest Pay room, such expenses were $3.29 per month in 2000
compared to $3.30 per month in 1999.
Selling, general and administrative expenses increased 8.3% to $19.2
million in 2000 from $17.8 million in 1999. This increase is primarily due to
increased payroll and related expenses such as training, and increased
advertising and facilities costs. As a percentage of revenue, SG&A expenses were
9.8% in 2000 and 1999.
Depreciation and amortization expenses increased 7.7% to $65.5 million
in 2000 from $60.8 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 rooms in service since the prior year. As a
percentage of revenue, depreciation and amortization expenses decreased to 33.3%
in 2000 from 33.5% in 1999.
OPERATING INCOME (LOSS). The Company generated operating income of $2.3
million compared to an operating loss of $678,000 in 1999, primarily due to
increased revenue from Guest Pay interactive services and increased gross profit
margin, as described above.
GAIN ON SALES OF INVESTMENTS. During the third quarter of 1999, the
Company sold its interest in Across Media Networks, Inc. ("AMN"), a creator and
distributor of digitally produced on-screen content for television and the
Internet, for approximately $9.0 million. 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 which were 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 of $7.6
million during the fourth quarter of 1999.
INVESTMENT LOSSES. Global Interactive Communications Corporation - 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. Beginning with the third quarter of 1999, the Company
began 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. The Company periodically reviews its remaining
investment in GICC for realization and recognizes write-downs if estimated
proceeds from GICC's asset sales are not expected to exceed the Company's
recorded investment balance. During 1999, write-downs totaling $18.8 million
were recorded to write-down the investment in GICC to estimated fair value.
During the fourth quarter of 2000, a $4.2 million write-down was recorded to
reduce the investment to its estimated fair value of $3.5 million.
Across Media Networks - Prior to the sale of AMN as described above,
the Company recorded equity losses of $2.2 million in 1999 related to this
investment.
Marketable Securities - During the fourth quarter of 2000, the Company
recorded losses on its investment in CMGI common stock (described above related
to the sale of 1stUp.com) of $6.4 million reflecting a market value decline in
the
18
securities, which was deemed to be permanent. The recorded value of this
investment was $1.4 million as of December 31, 2000.
InnMedia LLC - As previously described, InnMedia was formed by LodgeNet
and Hilton during the fourth quarter of 2000. The Company has a 50% equity
interest in InnMedia and recorded losses under the equity method of accounting
for an investment of $3.0 million during the fourth quarter. A significant
portion of these losses represent one-time start-up and organizational-type
costs.
INTEREST EXPENSE. Interest expense increased to $27.8 million in 2000
from $27.2 million in 1999 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 2000 was approximately $282 million (at a
weighted average interest rate of approximately 9.9%) as compared to an average
principal amount outstanding of approximately $273 million (at a weighted
average interest rate of approximately 10.0%) during 1999.
INTEREST INCOME. Interest income decreased to $419,000 in 2000 from
$1.4 million in 1999 due to decreased loans to unconsolidated affiliates.
EBITDA. EBITDA (defined by the Company as earnings before interest,
income taxes, depreciation, amortization and other non-operating income or
expenses) increased 12.8% to $67.8 million in 2000 as compared to $60.1 million
in 1999. This increase is primarily due to a 10.0% increase in the average
number of installed rooms receiving Guest Pay interactive services and the
related increase in Guest Pay revenue, as well as increased gross profit earned
on Guest Pay revenue and other revenue as described above. As a percentage of
total revenue, EBITDA increased to 34.4% in 2000 as compared to 33.2% in 1999.
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, and is not representative of funds available for discretionary use
due to the Company's financing obligations. EBITDA, as defined by the Company,
may not be calculated consistently among other companies reporting similarly
titled measures. EBITDA is included herein because it 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.
19
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
============ =========== =========== ===========
GUEST PAY INTERACTIVE SERVICES. Guest Pay interactive service 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 and to a 1.9% increase in average monthly revenue per Guest Pay room. The
following table sets forth information with respect to revenue per Guest Pay
room 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. The decrease in other revenue in 1999 from the prior year of
$8.5 million, or 42.5%, 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 and sales of system equipment and service parts.
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
20
percentage of Guest Pay interactive service revenue, direct costs increased from
41.3% in 1998 to 41.6% in 1999. The resulting decrease in the gross profit
margin from 58.7% to 58.4% is primarily the result of slightly higher license
fees for movies and video games.
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 and sales of system equipment and service parts,
as previously described.
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) from other
sources of revenue.
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 and other 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 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 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 10.1% 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 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 decreased to $678,000 in
1999 from $9.9 million in 1998. This is due to increased revenue from Guest Pay
interactive services, improved gross profit margin, and lower Guest Pay
operating and SG&A expenses, as described above.
GAIN ON SALE OF INVESTMENTS. During the third quarter of 1999, the
Company sold its interest in Across Media Networks, Inc. ("AMN") for
approximately $9.0 million. The transaction resulted in a $7.1 million gain.
21
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 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 of $7.6
million during the fourth quarter of 1999.
INVESTMENT LOSSES. 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. EBITDA (defined by the Company as earnings before interest,
income taxes, depreciation, amortization and other non-operating income or
expenses) increased 23.7% to $60.1 million in 1999 as compared to $48.6 million
in 1998. This increase is primarily due to a 13.8% increase in the average
number of installed rooms receiving Guest Pay interactive services and the
related increase in Guest Pay revenue, as well as increased gross profit and
lower Guest Pay operations and SG&A expenses, as described above. As a
percentage of total revenue, EBITDA increased to 33.2% in 1999 as compared to
29.2% in 1998.
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 required to expand its business. Historically, cash flow
from operations has not been sufficient to fund the cost of expanding the
Company's business and to service existing indebtedness. For 1999, capital
expenditures were $51.2 million and net cash provided by operating activities
was $40.8 million. For 2000, capital expenditures were $60.2 million and net
cash provided by operating activities was $41.2 million. Depending on the rate
of growth of its business and other factors, the Company expects to incur
capital expenditures between $70 to $80 million in 2001, as contemplated under
its 2001 business plan. The Company's cash requirements for 2001 are expected to
include $21.6 million of payments for principal maturities of long-term debt. In
addition, the Company has committed up to $5 million of financing to InnMedia
LLC, of which the Company funded $1 million in the fourth quarter of 2000. The
Company also has a $13.3 million net working capital deficit as of December 31,
2000.
As of December 31, 2000, the Company has $41 million available for
borrowing under its $75 million revolving credit facility. The Company believes
that its operating cash flows and borrowings available under the revolving
credit facility will be sufficient to fund the Company's future growth and
financing obligations for approximately nine months, as contemplated under its
2001 business plan. The Company may increase the revolving credit facility to
$100 million, subject to certain conditions.
The Company is presently analyzing various sources to obtain additional
long-term financing in addition to the revolving credit facility, and believes
that such amounts will be obtained to support the Company's growth objectives.
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
22
obtain it on acceptable terms. Failure to obtain additional financing could
result in the delay or abandonment of some or all of the Company's expansion
plans, which would reduce the level of capital expenditures anticipated for 2001
as described above. 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.
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, 2000, the Company had debt totaling $290.7
million. The Company has interest rate swap arrangements covering debt with a
notional amount of $109 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 $281.7 million and variable rate debt of $9.0
million at December 31, 2000. For fixed rate debt, interest rate changes affect
the fair market value but do not impact earnings or cash flows. 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 $26.6
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 $90,000
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. No significant foreign currency fluctuations occurred
during 2000 to materially impact consolidated results of operations or financial
condition.
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.
23
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.
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, 2000 included herein.
(b) REPORTS ON FORM 8-K -- On October 18, 2000, the Company filed a Form
8-K reporting on the Company's agreement with Hilton Hotels
Corporation.
(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 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)
24
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)
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 and Steven D. Truckenmiller; 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)
25
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)
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)
10.32 Master Services Agreement between Hilton Hotels Corporation and
LodgeNet Entertainment Corporation dated October 9, 2000 + (12)
10.33 Warrant to Purchase Common Stock of LodgeNet Entertainment Corporation
dated October 9, 2000(12)
10.34 InnMedia LLC Operating Agreement effective as of October 9, 2000(12)
12.1 Statement of computation of ratios
21.1 Subsidiaries of the Company (13)
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 Company's 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 Company's 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 Company's 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 Company's 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 the Company's Form 10
as filed with the Securities and Exchange Commission, October 29,
1996.
(8) Incorporated by Reference to the Company's Annual Report on Form 10-K
for the year ended December 31, 1996, as filed with the Securities
and Exchange Commission, March 17, 1997.
26
(9) Incorporated by Reference to the Company's Form 8-K as filed with the
Securities and Exchange Commission, December 15, 1998.
(10) Incorporated by Reference to the Company's 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 Company's 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 Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 2000, as filed with
the Securities and Exchange Commission, November 14, 2000.
(13) Incorporated by Reference to the Company's Annual Report on Form 10-K
for the year ended December 31, 1997, as filed with the Securities
and Exchange Commission, March 25, 1998.
27
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, 2001.
LodgeNet Entertainment Corporation
By: /s/ Scott C. Petersen,
---------------------------------------
Scott C. Petersen,
President, Chief Executive Officer and
Chairman of the Board of Directors
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Company has duly caused this report to be signed on its behalf by the
undersigned, and in the capacities indicated, on March 29, 2001.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Scott C. Petersen President, Chief Executive Officer March 29, 2001
- ----------------------------- and Chairman of the Board of
Scott C. Petersen Directors (Principal Executive Officer)
/s/ Gary H. Ritondaro Senior Vice President March 29, 2001
- ----------------------------- Chief Financial Officer
Gary H. Ritondaro (Principal Financial
Officer)
/s/ Ronald W. Pierce Vice President and Corporate March 29, 2001
- ----------------------------- Controller (Principal
Ronald W. Pierce Accounting Officer)
/s/ R. Douglas Bradbury Director March 29, 2001
- -----------------------------
R. Douglas Bradbury
/s/ Lawrence Flinn, Jr. Director March 29, 2001
- -----------------------------
Lawrence Flinn, Jr.
/s/ Richard R. Hylland Director March 29, 2001
- -----------------------------
Richard R. Hylland
/s/ R. F. Leyendecker Director March 29, 2001
- -----------------------------
R. F. Leyendecker
28
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, 1999 and 2000.............................................. F - 3
Consolidated Statements of Operations -- Three Years Ended December 31, 2000...............................F - 4
Consolidated Statements of Stockholders' Equity (Deficit) -- Three Years Ended December 31, 2000...........F - 5
Consolidated Statements of Cash Flows -- Three Years Ended December 31, 2000...............................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, 1999 and 2000, and the related consolidated statements of
operations, stockholders' equity (deficit) and cash flows for each of the three
years in the period ended December 31, 2000. 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 auditing standards generally accepted
in the United States. 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, 1999 and 2000, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2000, in conformity with accounting principles
generally accepted in the United States.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota
February 9, 2001
F-2
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands)
DECEMBER 31,
-------------------------------
1999 2000
------------- -------------
Assets
Current assets:
Cash and cash equivalents $ 1,644 $ 4,059
Marketable securities 25,952 1,398
Accounts receivable, net 29,620 26,553
Note receivable 7,060 --
Prepaid expenses and other 2,413 3,610
------------- -------------
Total current assets 66,689 35,620
Property and equipment, net 204,334 224,927
Investments in and advances to unconsolidated affiliates 11,434 3,500
Debt issuance costs, net 8,710 7,121
Other assets, net 14,108 10,437
------------- -------------
$ 305,275 $ 281,605
============= =============
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable $ 14,610 $ 12,671
Current maturities of long-term debt 5,915 21,563
Accrued expenses and other 10,643 11,988
Deferred revenue 2,536 2,713
------------- -------------
Total current liabilities 33,704 48,935
Long-term debt 277,075 269,096
------------- -------------
Total liabilities 310,779 318,031
------------- -------------
Commitments and contingencies (Note 9)
Stockholders' deficit:
Common stock, $.01 par value, 20,000,000 shares authorized; 11,970,852 and
12,212,039 shares outstanding at December 31,
1999 and 2000, respectively 120 122
Additional paid-in capital 124,021 150,663
Accumulated deficit (146,967) (185,981)
Accumulated other comprehensive income (loss) 17,322 (1,230)
------------- -------------
Total stockholders' deficit (5,504) (36,426)
------------- -------------
$ 305,275 $ 281,605
============= =============
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,
-------------------------------------------------
1998 1999 2000
-------------- ------------- -------------
Revenues:
Guest Pay $ 146,481 $ 169,850 $ 186,718
Other 19,870 11,422 10,099
-------------- ------------- -------------
Total revenues 166,351 181,272 196,817
-------------- ------------- -------------
Direct costs:
Guest Pay 60,538 70,632 76,586
Other 13,470 7,858 5,864
-------------- ------------- -------------
Total direct costs 74,008 78,490 82,450
-------------- ------------- -------------
Gross profit 92,343 102,782 114,367
-------------- ------------- -------------
Operating expenses:
Guest Pay operations 25,167 24,908 27,356
Selling, general and administrative 18,600 17,774 19,247
Restructuring and other charges (Note 3) 3,300 -- --
Depreciation and amortization 55,215 60,778 65,470
-------------- ------------- -------------
Total operating expenses 102,282 103,460 112,073
-------------- ------------- -------------
Operating income (loss) (9,939) (678) 2,294
Gain on sales of investments -- 14,739 --
Investment losses (6,550) (24,323) (13,593)
Interest expense (23,261) (27,210) (27,809)
Interest income 213 1,414 419
-------------- ------------- -------------
Loss before income taxes (39,537) (36,058) (38,689)
Provision for income taxes (375) (370) (325)
-------------- ------------- -------------
Net loss $ (39,912) $ (36,428) $ (39,014)
============== ============= =============
Per common share (basic and diluted):
Net loss $ (3.45) $ (3.05) $ (3.21)
============== ============= =============
Weighted average shares outstanding (basic and diluted) 11,579,457 11,948,660 12,145,109
============== ============= =============
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(Dollar amounts in thousands)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
---------------------------- PAID-IN ACCUMULATED COMPREHENSIVE
SHARES AMOUNT CAPITAL DEFICIT INCOME/(LOSS) TOTAL
------------ ------------ ------------ -------------- ------------- -----------
Balance, December 31, 1997 11,322,058 $ 113 $ 120,792 $ (70,627) $ (699) $ 49,579
Common stock option activity 350,000 3 3,081 -- -- 3,084
Issuance of common stock 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)
Common stock option activity 241,187 2 2,326 -- -- 2,328
Short-swing profits (Note 10) -- -- 2,468 -- -- 2,468
Warrants issued (Note 12) -- -- 21,848 -- -- 21,848
Comprehensive loss:
Net loss -- -- -- (39,014) --
Foreign currency
translation adjustment -- -- -- -- (424)
Unrealized loss on
marketable securities -- -- -- -- (18,128)
Comprehensive loss (57,566)
------------ ------------ ------------ -------------- ------------- -----------
Balance, December 31, 2000 12,212,039 $ 122 $ 150,663 $ (185,981) $ (1,230) $ (36,426)
============ ============ ============ ============== ============= ===========
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,
-------------------------------------------------
1998 1999 2000
-------------- ------------- -------------
Operating activities:
Net loss $ (39,912) $ (36,428) $ (39,014)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Depreciation and amortization 55,215 60,778 65,470
Gain on sale of property and equipment (309) -- --
Gain on sales of investments -- (14,739) --
Investment losses 6,550 24,323 13,593
Non-cash portion of restructuring charge 840 -- --
Change in operating assets and liabilities:
Accounts receivable (6,157) (1,366) 3,011
Prepaid expenses and other (2,659) 3,811 (1,948)
Accounts payable (2,770) 886 (1,926)
Accrued expenses and deferred revenue 1,677 1,294 296
Other 768 2,223 1,698
-------------- ------------- -------------
Net cash provided by operating activities 13,243 40,782 41,180
-------------- ------------- -------------
Investing activities:
Property and equipment additions (68,733) (51,226) (60,195)
Proceeds from (investment in) affiliates (8,330) (4,219) 2,747
Proceeds from sale of investment -- -- 7,200
Proceeds from sale of property and equipment 412 -- --
Business acquisitions (927) -- --
-------------- ------------- -------------
Net cash used for investing activities (77,578) (55,445) (50,248)
-------------- ------------- -------------
Financing activities:
Proceeds from long-term debt 1,000 75,000 --
Repayment of long-term debt (28) (38) (39)
Payment of license rights liability (5,461) (4,954) (5,294)
Payment of capital lease obligations (659) (577) (453)
Borrowings under revolving credit facility 73,500 35,500 23,000
Repayments of revolving credit facility -- (90,500) (10,500)
Debt issuance costs -- (3,559) --
Stock option activity 256 158 2,328
Short-swing profits (Note 10) -- -- 2,468
-------------- ------------- -------------
Net cash provided by financing activities 68,608 11,030 11,510
-------------- ------------- -------------
Effect of exchange rates on cash (54) 37 (27)
-------------- ------------- -------------
Increase (decrease) in cash and cash equivalents 4,219 (3,596) 2,415
Cash and cash equivalents at beginning of period 1,021 5,240 1,644
-------------- ------------- -------------
Cash and cash equivalents at end of period $ 5,240 $ 1,644 $ 4,059
============== ============= =============
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 specializing 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 and is expected to continue to
require capital resources in excess of operating cash flows. The Company
believes that its operating cash flows and borrowings available under its
revolving credit facility will be sufficient to fund the Company's growth plans,
as contemplated under its current business plan, for approximately nine months.
The Company is currently seeking additional capital to support its growth plans
in subsequent periods. Failure to obtain additional capital could result in the
delay or abandonment of some or all of the Company's growth plans.
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
accounting principles generally accepted in the United States 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
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 $2,405,000, $1,554,000 and $2,818,000 during the years
ended December 31, 1998, 1999 and 2000, respectively, and amortization of such
costs was $1,138,000, $1,178,000 and $1,445,000, respectively. The Company
charged $252,000, $704,000, and $507,000 to operations for each of the years
presented related to research and development activities.
REVENUE RECOGNITION -- In December 1999, the SEC staff released Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB 101"). SAB
101 provides interpretive guidance on the recognition, presentation and
disclosures of revenue in the financial statements effective for all
transactions beginning January 1, 2000. Adoption of SAB 101 did not materially
impact the Company's revenue recognition policies.
Revenue from the sale of interactive television services is recognized in the
period the services are provided. Revenue from the sale of system equipment and
service parts and labor is recognized when the equipment is delivered or the
service has been provided. Deferred revenue consists of advance billings for
certain interactive television services that are recognized in the periods that
services are provided.
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, 1999 and 2000. The provision for
doubtful accounts was $848,000 in 1998, $441,000 in 1999, and $340,000 in 2000.
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
F-8
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
adjustments, and unrealized gains (losses) 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 1,736,333, 1,710,796, and 1,912,991 shares of common stock
and warrants on 480,000, 480,000, and 823,000 shares of common stock were not
included in computing diluted EPS because their effects were antidilutive for
each of the years presented.
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 11.
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 $21,633,000, $27,081,000, and
$27,879,000 during the years ended December 31, 1998, 1999, and 2000,
respectively. Equipment acquired under capital lease arrangements totaled
$885,000, $461,000, and $957,000 during the years ended December 31, 1998, 1999,
and 2000, 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 9) and the issuance of 350,000 common
shares valued at $3,084,000 as part of an acquisition completed during the year
(see Note 3). During 2000, the Company issued 2.1 million stock purchase
warrants valued at $21,848,000 to Hilton Hotels Corporation (Hilton) (see Note
12) to acquire rights to deliver interactive television services in Hilton
hotels.
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 and requires that a
company must formally document, designate and assess the effectiveness of
transactions that receive hedge accounting. SFAS No. 133 will impact the
Company, beginning January 1, 2001, by requiring that its interest rate swap
agreements be recorded on the balance sheet as an asset or liability measured at
fair value. The effective portion of the resulting gain or loss will be reported
as a component of other comprehensive income and reclassified into earnings in
the same period during which the hedged interest payments affect earnings. If
SFAS No. 133 was required to be applied to the interest rate swap arrangements
in place at December 31, 2000, changes in the fair value of the contract would
increase liabilities by approximately $1.3 million with an offsetting amount
recorded in accumulated other comprehensive income.
RECLASSIFICATIONS -- Certain items in the consolidated financial statements have
been reclassified to conform to 2000 classifications. Such reclassifications had
no effect on previously reported net loss or stockholders' deficit.
F-9
NOTE 3 -- INVESTMENT ACTIVITIES
RESNET MERGER/GICC INVESTMENT - 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. 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. The ResNet business
contributed sales of $5.4 million in 1998.
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 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 1999 and
2000, the Company advanced $2.1 million to GICC under terms of secured note
agreements to assist GICC in meeting its operating cash needs while GICC's
assets were being sold. Subsequent write-downs to estimated fair value of $2.1
million in the fourth quarter of 1999 and $4.2 million in the fourth quarter of
2000 were recorded. During 2000, the Company received cash distributions
totaling $4.1 million related to GICC's asset sales.
ACROSS MEDIA NETWORKS - In February 1998, the Company acquired an equity
interest in Across Media Networks, Inc. ("AMN"), a creator and distributor of
digitally produced on-screen content for television and the Internet. During the
third quarter of 1999, the Company sold its interest in AMN in exchange for
notes receivable of approximately $9.0 million, consisting of a $7.0 million
note from the buyer which was paid in 2000 and a $2.0 million note from AMN due
August 31, 2002. The transaction resulted in a $7.1 million gain. Prior to the
sale of AMN, the Company recorded equity losses related to this investment of
$2.2 million in 1999.
1STUP.COM/CMGI MARKETABLE SECURITIES - 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 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.
The CMGI marketable securities 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 these securities was $18.1 million.
In 2000, market value declines in these securities resulted in unrealized losses
that offset the unrealized gain from 1999 and, in the fourth quarter of 2000,
the Company recorded a charge to the income statement of $6.4 million to
consider the market value decline as permanent.
CONNECT GROUP - 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 was 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 was recorded as an intangible asset and is being amortized on a
straight-line basis over ten years. The pro forma results for 1998, assuming the
transaction had been made as of the beginning of the year, would not be
materially different from reported results.
F-10
INNMEDIA LLC - During the fourth quarter of 2000, the Company entered into an
arrangement with Hilton to form a new broadband, interactive media company,
InnMedia LLC, to offer hotel guests new and innovative interactive television
content such as high speed Internet access through the television as well as
customized hotel and guest information. Under this arrangement, InnMedia will
supply Internet portal and interactive television content to Hilton and other
hotels using LodgeNet's broadband, interactive system. InnMedia will report the
operations of these activities, of which LodgeNet and Hilton will equally share,
and will pay LodgeNet a fee for use of LodgeNet's system. The arrangement
includes $5 million financing commitments from both LodgeNet and Hilton to fund
start-up and near-term operational costs. InnMedia is expected to begin delivery
of content and services during the third quarter of 2001. The Company recorded
losses under the equity method of accounting for an investment of $3.0 million
during the fourth quarter. A significant portion of these losses represent
one-time start-up and organizational-type costs.
NOTE 4 -- 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):
1999 2000
--------------------------- ---------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
------------ ----------- ----------- -----------
Assets (Liabilities):
Marketable securities $ 25,952 $ 25,952 $ 1,398 $ 1,398
Notes receivable 7,060 7,060 -- --
Interest rate swaps -- 2,005 -- (1,287)
Long-term debt (282,990) (285,294) (290,659) (286,868)
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 - quoted market prices (if available) or
interest rates currently available to the Company for debt with similar terms
and maturities; interest rate swaps - quoted amount the Company would receive
(pay) to terminate the swap agreements, 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 5 -- PROPERTY AND EQUIPMENT
Property and equipment was comprised as follows at December 31 (in thousands of
dollars):
1999 2000
------------- -------------
Land, building and equipment $ 55,899 $ 62,432
Free-to-guest systems 18,111 20,175
Guest Pay systems:
Installed 292,939 349,313
System components 22,551 24,565
Software costs 9,998 12,816
------------- -------------
Total 399,498 469,301
Less - Depreciation and amortization (195,164) (244,374)
------------- -------------
Property and equipment, net $ 204,334 $ 224,927
============= =============
F-11
NOTE 6 -- 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 described in Note 8, the Company capitalized $3,559,000 of
additional debt issuance costs during the year ended December 31, 1999. No debt
issuance costs were incurred in 2000. Amortization of such costs was $1,004,000
in 1998, $1,486,000 in 1999, and $1,589,000 in 2000. The components of the debt
issuance costs recorded in the balance sheets are as follows at December 31 (in
thousands of dollars):
1999 2000
------------ ------------
Debt issuance costs $ 12,519 $ 12,519
Accumulated amortization (3,809) (5,398)
------------ ------------
$ 8,710 $ 7,121
============ ============
NOTE 7 -- ACCRUED EXPENSES
Accrued expenses were comprised as follows at December 31 (in thousands of
dollars):
1999 2000
------------ ------------
Accrued taxes $ 1,749 $ 2,294
Accrued compensation 2,525 2,396
Accrued interest 3,818 3,748
Other 2,551 3,550
------------ ------------
$ 10,643 $ 11,988
============ ============
NOTE 8 -- LONG-TERM DEBT AND CREDIT FACILITIES
Long-term debt was comprised as follows at December 31 (in thousands of
dollars):
1999 2000
------------- -------------
Bank Credit Facility:
Bank term loan $ 75,000 $ 75,000
Revolving credit facility 21,500 34,000
10.25% senior notes 150,000 150,000
11.50% senior notes 30,000 30,000
Less unamortized discount (739) (523)
Capital leases 1,000 1,287
Other 6,229 895
------------- -------------
282,990 290,659
Less current maturities (5,915) (21,563)
------------- -------------
$ 277,075 $ 269,096
============= =============
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
(which may be increased 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, 2000 were 8.81% for the term
loan and 8.67% 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 credit up to $12 million, subject to
customary terms and conditions. As of December 31, 2000, the Company had
outstanding letters of credit totaling $2.0 million.
F-12
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, 2000, the
Company was in compliance with all covenants, terms and conditions of the bank
credit facility.
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,
2000, 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.
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 12) 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): 2001 -- $21,563; 2002 -- $25,161;
2003 -- $25,805; 2004 -- $28,652; 2005 -- $40,000; thereafter -- $149,478.
NOTE 9 -- 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, 2000, require future minimum lease payments, as follows: 2001 --
$325,000; 2002 -- $267,000; 2003 -- $161,000; 2004 -- $73,000; 2005 -- $24,000;
thereafter -- $16,000. The leases expire at dates ranging from 2001 to 2006.
Rental expense under all operating leases was $358,000, $436,000, and $474,000
for the years ended December 31, 1998, 1999, and 2000, 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, provided for the Company to make cash payments to On
Command totaling approximately $16 million plus interest, payable in three
annual installments which commenced in 1998 and ended in 2000. The Company has
capitalized the present value of the obligation to
F-13
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,
which as of December 31, 2000, range from six to nine years.
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 10 -- 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, 1999 and 2000. 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.
SHORT-SWING PROFITS -- During 2000, the Company received approximately $2.5
million from a shareholder in settlement of a potential short-swing profit
liability under section 16(b) of the Securities Exchange Act of 1934, resulting
from certain trading activity of the Company's common stock by the shareholder.
This amount was recorded as paid-in capital in stockholders' equity.
F-14
NOTE 11 -- 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, 2000, 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, 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
Options granted 830,624 19.73
Options exercised (241,187) 9.67
Options forfeited/canceled (21,800) 18.35
-------------
Balance at December 31, 2000 2,274,002 $ 13.32
=============
The following is a summary of stock options outstanding as of December 31, 2000:
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 83,303 2.8 $ .23 83,303 $ .23
$2.77 to $3.23 203,022 2.6 2.87 203,022 2.87
$6.46 to $9.79 252,477 5.9 8.79 205,527 8.86
$10.38 to $13.77 753,250 6.7 11.41 581,750 11.37
$14.00 to $24.89 981,950 5.1 19.21 186,300 17.90
------------- -------------
2,274,002 5.4 $ 13.32 1,259,902 $ 9.82
============= =============
The weighted average fair value of options granted during the year ended
December 31 was as follows:
1998 1999 2000
---------- ---------- -----------
Weighted average fair
value per option granted $ 4.36 $ 5.43 $ 10.71
========== ========== ===========
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 - 5.15% in
1998, 5.54% in 1999, and 6.15% in 2000; (iii) weighted average expected life -
5.0 years, and (iv) weighted average expected volatility - 45.3% in 1998, 50.7%
in 1999, and 54.6% in 2000.
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):
1998 1999 2000
------------- ------------- -------------
Net loss
As reported $ (39,912) $ (36,428) $ (39,014)
Pro forma (42,677) (36,990) (47,592)
Loss per share
As reported $ (3.45) $ (3.05) $ (3.21)
Pro forma (3.69) (3.10) (3.92)
NOTE 12 -- WARRANTS
In connection with the 1995 issuance of the 11.50% Senior Notes (see Note 8),
the Company issued 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 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.
On October 9, 2000, the Company entered into an agreement with Hilton to provide
LodgeNet's interactive television services into Hilton's owned, leased and joint
venture hotels in the United States. Under terms of the agreement, Hilton was
issued a warrant granting it the right to purchase up to 2.1 million shares of
LodgeNet common stock over the next seven years at a price of $20.44 per share.
1.5 million warrant shares relate to hotels owned or operated by Hilton and
vested immediately. The remaining 600,000 warrant shares relate to hotels
franchised through Hilton and will vest on a per room basis as LodgeNet obtains
contracts for delivery of services to these hotels. The Company followed EITF
96-18 to account for the warrants issued. The fair value of the 1.5 million
warrant shares was estimated at $21.8 million using the Black-Sholes valuation
method and was recorded as contract acquisition costs within fixed assets and
credited to additional paid-in capital. The 600,000 warrant shares will be
measured and similarly accounted for upon delivery of the related room
contracts.
NOTE 13 -- EMPLOYEE BENEFIT PLANS
The Company sponsors defined contribution plans covering eligible employees. The
plans provide for employer contributions based primarily on the level of
employee participation. Contribution expense for the Company was $558,000,
$567,000, and $635,000 in 1998, 1999, and 2000, respectively.
NOTE 14 -- INCOME TAXES
Loss before income taxes was as follows for the years ended December 31 (in
thousands of dollars):
1998 1999 2000
------------- ------------ -------------
Domestic $ (38,825) $ (35,572) $ (38,669)
Foreign (712) (486) (20)
------------- ------------ -------------
Total $ (39,537) $ (36,058) $ (38,689)
============= ============ ============
The provisions for income taxes of $375,000 in 1998, $370,000 in 1999, and
$325,000 in 2000 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.
F-16
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):
1999 2000
------------- -------------
Deferred tax liabilities:
Unrealized gain on marketable securities $ (6,164) $ --
------------- -------------
Deferred tax assets:
Net operating loss carryforwards 34,920 37,481
Losses of unconsolidated affiliates 7,907 10,345
Reserves and accruals 2,297 2,282
Deferred credits 914 922
Book over tax depreciation 1,275 7,419
Unrealized loss on marketable securities -- 2,185
Gain on sale of investment 665 665
------------- -------------
47,978 61,299
------------- -------------
Net deferred tax assets 41,814 61,299
Valuation allowance (41,814) (61,299)
------------- -------------
Net deferred taxes $ -- $ --
============= =============
The Company has net operating loss carryforwards of approximately $110 million
for federal income tax purposes. Such carryforwards expire beginning in 2002
through 2015, 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 15 -- RELATED PARTY TRANSACTIONS
The Company has advanced $1.2 million to a former officer as of December 31,
2000, under the terms of a promissory note providing for total advances of $1.5
million. 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 officer.
NOTE 16 -- 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):
1998 1999 2000
-------------- -------------- --------------
United States $ 157,654 $ 171,828 $ 185,721
Canada 7,420 8,806 9,800
Other 1,277 638 1,296
============== ============== ==============
Total $ 166,351 $ 181,272 $ 196,817
============== ============== ==============
Long-lived assets by country based on the location of the asset were as follows
at December 31 (in thousands of dollars):
1998 1999 2000
-------------- -------------- --------------
United States $ 199,067 $ 192,827 $ 213,933
Canada 10,370 11,507 10,994
============== ============== ==============
Total $ 209,437 $ 204,334 $ 224,927
============== ============== ==============
F-17
NOTE 17 -- 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,
------------- ------------- ----------------- ----------------
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)
2000:
Revenues $ 47,733 $ 48,129 $ 52,894 $ 48,061
Gross profit 27,377 27,966 31,460 27,564
Net loss (1) (7,682) (6,539) (4,144) (20,649)
Per common share (2): $ (.64) $ (.54) $ (.34) $ (1.69)
(1) 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. Net loss for the quarter ended December 31, 2000
includes a $4.2 million charge to write-down the investment in GICC, equity
losses of $3.0 million from InnMedia and losses on CMGI common stock
totaling $6.4 million.
(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 auditing standards generally accepted in the
United States, the consolidated financial statements included in this annual
report on Form 10-K, and have issued our report thereon dated February 9, 2001.
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 9, 2001
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, 1998:
Allowance for Doubtful Accounts $ 800 $ 848 $ 848 $ 800
Year Ended December 31, 1999:
Allowance for Doubtful Accounts $ 800 $ 441 $ 441 $ 800
Year Ended December 31, 2000:
Allowance for Doubtful Accounts $ 800 $ 336 $ 336 $ 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