UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number 0-22334

LodgeNet Interactive Corporation

(Exact name of registrant as specified in its charter)

Delaware		46-0371161
(State or other jurisdiction of incorporation or organization)		(I.R.S. 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)

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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

At May 3, 2010, there were 25,052,289 shares outstanding of the Registrant’s common stock, $0.01 par value.

 

 

LodgeNet Interactive Corporation and Subsidiaries

Index

			Page
			No.
Part I. Financial Information
Item 1 — Financial Statements:
Consolidated Balance Sheets (Unaudited) as of March 31, 2010 and December 31, 2009			3
Consolidated Statements of Operations (Unaudited) for the Three Months Ended March 31, 2010 and 2009			4
Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended March 31, 2010 and 2009			5
Notes to Consolidated Financial Statements (Unaudited)			6
Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations			20
Item 3 — Quantitative and Qualitative Disclosures About Market Risk			40
Item 4 — Controls and Procedures			41
Part II. Other Information
Item 1 — Legal Proceedings			42
Item 1A — Risk Factors			42
Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds			42
Item 3 — Defaults Upon Senior Securities			42
Item 5 — Other Information			42
Item 6 — Exhibits			43
Signatures			44
EX-31.1
EX-31.2
EX-32

As used herein (unless the context otherwise requires) “LodgeNet” and/or the “Registrant,” as well as the terms “we,” “us” and “our” refer to LodgeNet Interactive Corporation (f/k/a LodgeNet Entertainment Corporation) and its consolidated subsidiaries.

“LodgeNet,” “LodgeNetRX,” “On Command,” “The Hotel Networks” and the LodgeNet logo are trademarks or registered trademarks of LodgeNet Interactive Corporation. All rights reserved. All other trademarks or service marks used herein are the property of their respective owners.

Part I — Financial Information

Item 1 — Financial Statements

LodgeNet Interactive Corporation and Subsidiaries

Consolidated Balance Sheets (Unaudited)
(Dollar amounts in thousands, except share data)

		March 31,				December 31,
		2010				2009
Assets
Current assets:
Cash		$	9,928			$	17,011
Accounts receivable, net			53,193				51,706
Other current assets			9,008				9,189
Total current assets			72,129				77,906
Property and equipment, net			191,761				206,663
Debt issuance costs, net			5,159				6,005
Intangible assets, net			103,838				106,041
Goodwill			100,081				100,081
Other assets			12,104				11,658
Total assets		$	485,072			$	508,354
Liabilities and Stockholders’ Deficiency
Current liabilities:
Accounts payable		$	50,196			$	40,040
Current maturities of long-term debt			5,561				6,101
Accrued expenses			18,087				19,137
Deferred revenue			16,982				17,531
Total current liabilities			90,826				82,809
Long-term debt			421,474				463,845
Other long-term liabilities			29,999				32,687
Total liabilities			542,299				579,341
Commitments and contingencies
Stockholders’ deficiency:
Preferred stock, $.01 par value, 5,000,000 shares authorized; Series B cumulative perpetual convertible, 10%, 57,500 issued and outstanding at March 31, 2010 and December 31, 2009, respectively (liquidation preference of $1,000 per share or $57,500,000 total)			1				1
Common stock, $.01 par value, 50,000,000 shares authorized; 25,025,414 and 22,537,664 shares outstanding at March 31, 2010 and December 31, 2009, respectively			251				225
Additional paid-in capital			391,767				379,223
Accumulated deficit			(428,713	)			(426,211	)
Accumulated other comprehensive loss			(20,533	)			(24,225	)
Total stockholders’ deficiency			(57,227	)			(70,987	)
Total liabilities and stockholders’ deficiency		$	485,072			$	508,354

The accompanying notes are an integral part of these consolidated financial statements.

LodgeNet Interactive Corporation and Subsidiaries

Consolidated Statements of Operations (Unaudited)
(Dollar amounts in thousands, except share data)

		Three Months Ended
		March 31,
		2010				2009
Revenues:
Hospitality and Advertising Services		$	115,499			$	125,802
Healthcare			2,553				2,290
Total revenues			118,052				128,092
Direct costs and operating expenses:
Direct costs (exclusive of operating expenses and depreciation and amortization shown separately below):
Hospitality and Advertising Services			65,261				71,794
Healthcare			1,346				953
Operating expenses:
System operations			10,515				10,326
Selling, general and administrative			12,115				10,818
Depreciation and amortization			22,173				27,105
Restructuring charge			3				107
Other operating expense (income)			5				(132	)
Total direct costs and operating expenses			111,418				120,971
Income from operations			6,634				7,121
Other income and (expenses):
Interest expense			(8,682	)			(9,881	)
Gain on extinguishment of debt			—				9,295
Loss on early retirement of debt			(493	)			(541	)
Other income			223				175
(Loss) income before income taxes			(2,318	)			6,169
Provision for income taxes			(184	)			(211	)
Net (loss) income			(2,502	)			5,958
Preferred stock dividends			(1,437	)			—
Net (loss) income attributable to common stockholders		$	(3,939	)		$	5,958
Net (loss) income per common share (basic)		$	(0.17	)		$	0.27
Net (loss) income per common share (diluted)		$	(0.17	)		$	0.26
Weighted average shares outstanding (basic)			22,746,527				22,404,106
Weighted average shares outstanding (diluted)			22,746,527				22,423,856

The accompanying notes are an integral part of these consolidated financial statements.

LodgeNet Interactive Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)
(Dollar amounts in thousands)

		Three Months Ended March 31,
		2010				2009
Operating activities:
Net (loss) income		$	(2,502	)		$	5,958
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Depreciation and amortization			22,173				27,105
Gain on extinguishment of debt (non-cash)			—				(9,295	)
Unrealized loss on derivative instruments			659				—
Loss on early retirement of debt			493				541
Share-based compensation and restricted stock			312				271
Other, net			40				(135	)
Change in operating assets and liabilities:
Accounts receivable, net			(1,350	)			(4,449	)
Other current assets			170				730
Accounts payable			10,222				6,499
Accrued expenses and deferred revenue			(1,521	)			(6,039	)
Other			(598	)			(239	)
Net cash provided by operating activities			28,098				20,947
Investing activities:
Property and equipment additions			(4,525	)			(5,301	)
Net cash used for investing activities			(4,525	)			(5,301	)
Financing activities:
Repayment of long-term debt			(45,274	)			(8,200	)
Payment of capital lease obligations			(287	)			(523	)
Purchase of long-term debt			—				(10,750	)
Proceeds from investment in long-term debt			2,643				91
Proceeds from issuance of common stock, net of offering costs			13,692				—
Payment of dividends to preferred shareholders			(1,437	)			—
Exercise of stock options			3				—
Net cash used for financing activities			(30,660	)			(19,382	)
Effect of exchange rates on cash			4				(23	)
Decrease in cash			(7,083	)			(3,759	)
Cash at beginning of period			17,011				10,800
Cash at end of period		$	9,928			$	7,041

The accompanying notes are an integral part of these consolidated financial statements.

LodgeNet Interactive Corporation and Subsidiaries

Note 1 — Basis of Presentation

The accompanying consolidated financial statements as of March 31, 2010, and for the three month periods ended March 31, 2010 and 2009, have been prepared by us, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “Commission”). The information furnished in the accompanying consolidated financial statements reflects all adjustments, consisting of normal recurring adjustments, which, in our opinion, are necessary for a fair statement of such financial statements.

Certain information and footnote disclosures, normally included in annual financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to the rules and regulations of the Commission. Although we believe the disclosures are adequate to make the information presented herein not misleading, it is recommended these unaudited consolidated financial statements be read in conjunction with the more detailed information contained in our Annual Report on Form 10-K for 2009, as filed with the Commission. The results of operations for the three month periods ended March 31, 2010 and 2009 are not necessarily indicative of the results of operations for the full year due to inherent seasonality within the business, among other factors.

The consolidated financial statements include the accounts of LodgeNet Interactive Corporation and its subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation.

Certain amounts reported in previous periods have been reclassified to conform to the current presentation of revenue and related direct costs and operating expenses.

Note 2 — Property and Equipment, Net

Property and equipment was comprised as follows (dollar amounts in thousands):

		March 31,				December 31,
		2010				2009
Land, building and equipment		$	112,361			$	111,777
Hotel systems:
Installed system costs			626,578				630,651
Customer acquisition costs			55,977				55,889
System components			31,631				31,832
Software costs			36,803				36,497
Total			863,350				866,646
Less — depreciation and amortization			(671,589	)			(659,983	)
Property and equipment, net		$	191,761			$	206,663

Note 3 — Goodwill and Other Intangible Assets

We have three reporting units, Hospitality, Advertising Services and Healthcare, for which only the Hospitality and Advertising Services units have goodwill.

Goodwill represents the excess of cost over the fair value of net assets acquired. In 2007, we recorded goodwill in connection with the acquisitions of StayOnline, On Command and minority interest of The Hotel Networks. The product lines of both StayOnline and On Command shared the same operating and economic characteristics as our pre-acquisition product lines, and were integrated into the Hospitality operating segment. The Hospitality operating segment is one reporting unit due to the fact its components are similar and share similar characteristics.

Our goodwill is not amortized; rather, it is tested for impairment at least annually or if there is a triggering event which indicates the carrying value may not be recoverable. We perform our goodwill impairment test for each reporting unit annually during the fourth quarter. Impairment testing is not required for our finite-life intangibles unless there is a triggering event or change in circumstances which indicate the carrying value may not be recoverable, such as a significant deterioration in market conditions. During the first quarter of 2010, we did not encounter events or circumstances which could trigger an impairment of our goodwill or intangible assets.

The carrying amount of goodwill by reportable segment was as follows (dollar amounts in thousands):

						Advertising
		Hospitality				Services				Total
Balance as of December 31, 2009
Goodwill		$	92,614			$	18,679			$	111,293
Accumulated impairment losses			—				(11,212	)			(11,212	)
			92,614				7,467				100,081
Activity during the period			—				—				—
Balance as of March 31, 2010
Goodwill			92,614				18,679				111,293
Accumulated impairment losses			—				(11,212	)			(11,212	)
		$	92,614			$	7,467			$	100,081

We have intangible assets consisting of certain acquired technology, patents, trademarks, hotel contracts, customer relationships, studio agreements and licensee fees. These intangible assets have been deemed to have finite useful lives and are amortized over their current estimated useful lives, ranging from three to twenty years. We review the intangible assets for impairment when triggering events occur or change in circumstances, such as a significant deterioration in market conditions, warrant modifications to the carrying amount of the assets.

We have the following intangible assets (dollar amounts in thousands):

		March 31, 2010								December 31, 2009
		Carrying				Accumulated				Carrying				Accumulated
		Amount				Amortization				Amount				Amortization
Assets subject to amortization:
Acquired contracts and relationships		$	120,315			$	(19,213	)		$	120,315			$	(17,629	)
Other acquired intangibles			12,884				(12,374	)			12,884				(12,130	)
Tradenames			3,100				(1,759	)			3,094				(1,626	)
Acquired patents			5,155				(4,270	)			5,142				(4,009	)
		$	141,454			$	(37,616	)		$	141,435			$	(35,394	)

We recorded consolidated amortization expense of $2.2 million and $2.5 million, respectively, for the three months ended March 31, 2010 and 2009. We estimate total amortization expense for the nine months remaining in 2010 and the years ending December 31, as follows (dollar amounts in millions): 2010 — $5.9; 2011 — $7.1; 2012 — $6.6; 2013 — $6.4; 2014 — $6.3 and 2015 — $6.2. Actual amounts may change from such estimated amounts due to additional intangible asset acquisitions, potential impairment, accelerated amortization or other events.

Note 4 — Earnings Per Share Computation

We follow Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 260, “Earnings Per Share” (“EPS”), which requires the computation and disclosure of two EPS amounts, basic and diluted. Basic EPS is computed based 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. Potential common shares which have an anti-dilutive effect are excluded from diluted earnings per share.

Effective January 1, 2009, we adopted additional provisions of FASB ASC Topic 260, which provide that unvested share-based payment awards which contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. We determined our outstanding shares of non-vested restricted stock are participating securities.

The following table reflects the calculation of weighted average basic and fully diluted shares for the periods ended March 31. For the three months ended March 31, 2010, participating securities were not included in the calculations of earnings per share, as we were in a loss position and their inclusion would have been anti-dilutive. For the three months ended March 31, 2010, 17,208,201 potential dilutive common shares, which include stock options, unvested restricted stock and the conversion of preferred stock, were not included in the computation of diluted earnings per share, as we were in a loss position and their inclusion would have been anti-dilutive. For the three months ended March 31, 2009, 1,590,800 potential common shares, which include unvested restricted stock units and stock options with exercise prices greater than the average market price of our common stock, were excluded from the diluted earnings per share calculations, as their inclusion would have been anti-dilutive. Dollar amounts are in thousands, except share data:

		Three Months Ended
		March 31,
		2010				2009
Basic EPS:
Net (loss) income		$	(2,502	)		$	5,958
Preferred stock dividends			(1,437	)			—
		$	(3,939	)		$	5,958
(Loss) income allocated to participating securities			—				20
Net (loss) income available to common stockholders		$	(3,939	)		$	5,938
Weighted average shares outstanding for basic earnings per common share			22,746,527				22,404,106
Basic earnings per share		$	(0.17	)		$	0.27
Diluted EPS:
Net (loss) income		$	(2,502	)		$	5,958
Preferred stock dividends			(1,437	)			—
		$	(3,939	)		$	5,958
(Loss) income allocated to participating securities			—				20
Net (loss) income available to common stockholders		$	(3,939	)		$	5,938
Weighted average shares outstanding for basic earnings per common share			22,746,527				22,404,106
Dilutive effect of potential shares (1)			N/A				19,750
Weighted average shares outstanding for diluted earnings per common share			22,746,527				22,423,856
Diluted earnings per share		$	(0.17	)		$	0.26

Note 5 — Accrued Expenses

Accrued expenses were comprised as follows (dollar amounts in thousands):

		March 31,				December 31,
		2010				2009
Property, sales and other taxes		$	6,658			$	6,933
Compensation			5,084				4,360
Interest			118				92
Programming related			1,842				2,510
Restructuring and reorganization			506				758
Preferred stock dividends			1,437				1,437
Other			2,442				3,047
		$	18,087			$	19,137

Note 6 — Long-term Debt and Credit Facilities

Long-term debt was comprised as follows (dollar amounts in thousands):

		March 31,				December 31,
		2010				2009
Bank Credit Facility:
Bank term loan		$	425,367			$	467,998
Revolving credit facility			—				—
Capital leases			1,668				1,948
			427,035				469,946
Less current maturities			(5,561	)			(6,101	)
		$	421,474			$	463,845

Bank Credit Facility — In April 2007, we entered into a $675.0 million bank Credit Facility, comprised of a $625.0 million term loan, which matures in April 2014, and a $50.0 million revolving Credit Facility, which matures in April 2013. The term loan originally required quarterly repayments of $1,562,500, which began September 30, 2007. The required quarterly payments have been adjusted for the reduction in principal as a result of our early repayments against the loan, resulting in a quarterly payment requirement of $1,161,289. The term loan bears interest at our option of (1) the bank’s base rate plus a margin of 1.00% or (2) LIBOR plus a margin of 2.00%. The agreement provides that when our consolidated leverage ratio is below 3.25 times, the term loan bears interest at our option of (1) the bank’s base rate plus a margin of 0.75% or (2) LIBOR plus a margin of 1.75%. The term loan is collateralized by substantially all of the assets of the Company. The Credit Facility includes terms and conditions which require compliance with the leverage and interest coverage covenants. As of March 31, 2010, our consolidated leverage ratio was 3.59 compared to the maximum allowable ratio of 3.75 and our consolidated interest coverage ratio was 3.22 compared to the minimum allowable ratio of 3.00. Our maximum consolidated leverage ratio will be 3.50 starting in the third quarter of 2010 to maturity in 2014. Our minimum consolidated interest coverage ratio will continue to be 3.00 to maturity in 2014. The Credit Facility also requires we notify the agent upon the occurrence of a “Material Adverse Effect” prior to any draw on the Company’s revolving Credit Facility, as such terms are defined and used within our bank Credit Facility. However, under the Credit Facility, the provision of such a notice is not an event of default, but if such an event occurred, it could restrict the Company’s ability to obtain additional financing under the revolving Credit Facility. The Credit Facility also stipulates we enter into hedge agreements to provide at least 50% of the outstanding term loan into a fixed interest rate for a period not less than two years. We have entered into fixed rate swap agreements for $437.5 million of the outstanding term loan, with fixed interest rates ranging from 4.97% to 5.09% (see Note 14). The term loan interest rate as of March 31, 2010 was 2.30%. The aggregate weighted average interest rate for the quarter ended March 31, 2010 was 6.99%, which includes the term loan and lease interest rates and the difference in the swaps’ fixed interest rate versus LIBOR. As of March 31, 2010, we were in compliance with all financial covenants required of our bank Credit Facility.

Our ability to remain in compliance with those covenants will depend on our ability to generate sufficient Adjusted Operating Cash Flow (a term defined in our Credit Facility), to manage our level of capital investment and to continue to reduce our debt. We continue taking actions within our control to reduce our debt and remain in compliance with our debt covenants. The actions within our control include our prudent management of capital investment and operating costs and exploring other alternatives, which may include seeking an amendment to our Credit Facility, raising additional capital or reductions in our operating expenses. Our ability to continue to comply with these covenants is subject to the general economic climate and business conditions beyond our control. Although there are signs of stabilization in certain sectors of the economy, the uncertainties impacting travel and lodging, in addition to the constraints in the credit markets, consumer conservatism and other market dynamics, may continue to negatively impact our planned results and required covenants. If we are not able to remain in compliance with the debt covenants, it will likely have a significant, unfavorable impact on our business and financial condition and we may need to amend the Credit Facility to seek a waiver of the covenants. An amendment to the Credit Facility may significantly increase our interest costs, add upfront fees or modify other terms less favorable to us than we currently have in our Credit Facility. In the event our lenders will not amend or waive the covenants, the debt would be due and we would need to seek alternative financing. We cannot provide assurance we would be able to obtain alternative financing. If we were not able to secure alternative financing, this would have a substantial adverse impact on the Company.

During the first quarter of 2010, we made an additional prepayment of $44.0 million on the term loan, in addition to the required payment of $1.3 million, and we wrote off $0.5 million of related debt issuance costs. As a result of our previous repayments, our required quarterly payments have been reduced to $1.2 million, effective June 2010. In March 2010, we received net proceeds of $13.7 million from a common stock offering, which were used as part of our additional prepayment on the term loan. The common stock offering is discussed in more detail in Note 16. In March 2009, in addition to the required quarterly payment of $1.5 million, we prepaid $6.7 million on the term loan, and acquired, through our wholly-owned subsidiary, $31.5 million of outstanding debt as part of our debt reduction initiative. We recorded a gain on the extinguishment of debt of $9.3 million and wrote off $0.5 million of related debt issuance costs.

The Credit Facility provides for the issuance of letters of credit up to $15.0 million, subject to customary terms and conditions. As of March 31, 2010, we had outstanding letters of credit totaling $325,000, which reduce amounts available under the revolver. We made no borrowings against this facility during the first quarter of 2010.

Capital Leases — As of March 31, 2010, we have total capital lease obligations of $1.7 million. There was no equipment acquired under capital lease arrangements during the three months ended March 31, 2010. Our capital lease obligations consist primarily of vehicles used in our field service operations.

As of March 31, 2010, long-term debt has the following scheduled maturities for the nine months remaining in 2010 and the full years ending December 31, 2011 and after (dollar amounts in thousands):

		2010				2011				2012				2013				2014
Long-term debt		$	3,484			$	4,645			$	4,645			$	4,645			$	407,948
Capital leases			788				703				290				16				—
			4,272				5,348				4,935				4,661				407,948
Less amount representing interest on capital leases			(70	)			(46	)			(13	)			—				—
		$	4,202			$	5,302			$	4,922			$	4,661			$	407,948

We do not utilize special purpose entities or off-balance sheet financial arrangements.

Note 7 — Comprehensive Income

FASB ASC Topic 220, “Comprehensive Income,” provides standards for reporting and disclosure of comprehensive income and its components. Comprehensive income reflects the changes in equity during a period from transactions related to our interest rate swap arrangements and foreign currency translation adjustments. Comprehensive income was as follows for the periods ended March 31 (dollar amounts in thousands):

		Three Months Ended
		March 31,
		2010				2009
Net (loss) income		$	(2,502	)		$	5,958
Foreign currency translation adjustment			595				(752	)
Unrealized gain on interest rate swap agreements			3,097				2,662
Comprehensive income		$	1,190			$	7,868

Components of accumulated other comprehensive loss as shown on our Consolidated Balance Sheets were as follows (dollar amounts in thousands):

		March 31,				December 31,
		2010				2009
Unrealized loss on interest rate swap agreements		$	(23,526	)		$	(26,623	)
Foreign currency translation adjustment			2,993				2,398
Accumulated other comprehensive loss		$	(20,533	)		$	(24,225	)

Note 8 — Statements of Cash Flows

Cash is comprised of demand deposits. Cash paid for interest was $8.0 million and $9.9 million, respectively, for the three months ended March 31, 2010 and 2009. Cash paid for taxes was $215,000 and $210,000 for the three months ended March 31, 2010 and 2009, respectively.

Note 9 — Share-Based Compensation

We account for our stock option and incentive plans under the recognition and measurement provisions of FASB ASC Topic 718, “Compensation — Stock Compensation,” which require the measurement and recognition of compensation expense for all stock-based awards based on estimated fair values, net of estimated forfeitures. Share-based compensation expense recognized in the three months ended March 31, 2010 and 2009 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested, as of January 1, 2006 and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of this Topic.

The following amounts were recognized in our Consolidated Statements of Operations for share-based compensation plans for the periods ended March 31 (dollar amounts in thousands):

		Three Months Ended
		March 31,
		2010				2009
Compensation cost:
Stock options		$	312			$	170
Restricted stock			—				101
Total share based compensation expense		$	312			$	271

For the three months ended March 31, 2010, cash received from stock option exercises was $3,000 and in 2009, there was no cash received from stock option exercises. Due to our net operating loss tax position, we did not recognize a tax benefit from options exercised under the share-based payment arrangements. Cash flow from operating activities for the three months ended March 31, 2010 and 2009 included non-cash compensation expense related to stock options of $312,000 and $170,000, respectively, and included non-cash compensation expense related to restricted stock of $0 and $101,000, respectively.

Stock Options

For the three months ended March 31, 2010, we did not grant any stock options to non-employee directors of the Company; however, we did grant 321,500 stock options to certain officers and employees. The valuation methodology used to determine the fair value of the options issued during the year was the Black-Scholes-Merton option-pricing model. The Black-Scholes-Merton model requires the use of exercise behavior data and the use of a number of assumptions, including volatility of the stock price, the weighted average risk-free interest rate and the weighted average expected life of the options. We do not pay dividends; therefore, the dividend rate variable in the Black-Scholes-Merton model is zero.

Restricted Stock

For the three months ended March 31, 2010, we did not award any shares of time-based or performance-based restricted stock to our non-employee directors or officers and employees.

Note 10 — Restructuring

As a result of our previous restructuring initiatives related to our post acquisition activities, and the uncertain economy, we incurred $3,000 of costs during the three months ended March 31, 2010 and $107,000 of costs during the three months ended March 31, 2009. All costs are included in operating expenses on the Consolidated Statements of Operations.

We estimate additional expenses charged to restructuring over the next twelve to eighteen months, primarily recurring facilities expenses related to the post acquisition restructuring and reduction in force initiatives noted above, will be less than $100,000. Additional accruals and cash payments related to the restructuring activities are dependent upon execution of additional subleasing arrangements or reduction in force, which could change our expense estimates.

The above restructuring activities primarily occurred within our Hospitality and Advertising Services business. Liabilities associated with our restructuring activities to date, along with charges to expense and cash payments, were as follows (dollar amounts in thousands):

						Cost of closing
		Severance and				redundant
		other benefit				acquired
		related costs				facilities				Total
December 31, 2009 balance		$	336			$	422			$	758
Charges to expense			—				3				3
Cash payments			(164	)			(91	)			(255	)
March 31, 2010 balance		$	172			$	334			$	506

Note 11 — Fair Value Measurements

We follow the fair value measurement and disclosure provisions of FASB ASC Topic 820, “Fair Value Measurements and Disclosures,” relating to financial and nonfinancial assets and liabilities. The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. FASB ASC Topic 820 includes a fair value hierarchy, which is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on inputs to valuation techniques, which are used to measure fair value and which are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources, while unobservable inputs reflect a reporting entity’s pricing based upon their own market assumptions. The fair value hierarchy consists of the following three levels:

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.

Level 3: Unobservable inputs that are not corroborated by market data.

Financial Assets and Financial Liabilities ¾ The estimated carrying and fair values of our financial instruments in the financial statements are as follows (dollar amounts in thousands):

		March 31, 2010								December 31, 2009
		Carrying				Fair				Carrying				Fair
		Amount				Value				Amount				Value
Interest rate swaps - liability position		$	24,185			$	24,185			$	26,623			$	26,623
Long-term debt		$	427,035			$	403,639			$	469,946			$	421,976

The fair value of our long-term debt is estimated based on current interest rates for similar debt of the same remaining maturities and quoted market prices, except for capital leases, which are reported at carrying value. For our capital leases, the carrying value approximates the fair value. The fair value of the interest rate swaps (used for purposes other than trading) is the estimated amount we would have to pay to terminate the swap agreement at the reporting date.

The fair value of our long-term debt is strictly hypothetical and not indicative of what we are required to pay under the terms of our debt instruments. The fair value of the swap agreements is recognized in other long-term liabilities. Changes in fair value are recognized in other comprehensive income (loss) if the hedge is effective. We plan to hold the swap agreements to maturity.

The following table summarizes the valuation of our financial instruments by the fair value hierarchy described above as of the valuation date listed (dollar amounts in thousands):

						Quoted Prices				Significant
						in Active				Other				Significant
		Total				Markets for				Observable				Unobservable
		Fair Value				Identical Asset				Inputs				Inputs
		Measurement				(Level 1)				(Level 2)				(Level 3)
Year Ended December 31, 2009:
Interest rate swaps - liability position		$	26,623			$	—			$	26,623			$	—
Three Months Ended March 31, 2010:
Interest rate swaps - liability position		$	24,185			$	—			$	24,185			$	—

We estimated the fair value of the interest rate swaps based on mid-market data from a third party provider. We periodically review and validate this data on an independent basis. The fair value determination also included consideration of nonperformance risk, which did not have a material impact on the fair value at March 31, 2010.

Nonfinancial Assets and Nonfinancial Liabilities ¾ Certain assets and liabilities measured at fair value on a non-recurring basis could include nonfinancial assets and nonfinancial liabilities measured at fair value in the goodwill impairment tests and intangible assets and other nonfinancial long-lived assets measured at fair value for impairment assessment. There was no triggering event which warranted an evaluation of impairment; therefore, there were no nonfinancial assets or liabilities measured at fair value on a non-recurring basis during the three months ended March 31, 2010.

Note 12 — Market Conditions

Due to current economic conditions, our business could be adversely impacted by conditions affecting the lodging industry’s performance. Our results are closely linked to the performance of the lodging industry, where occupancy rates may fluctuate as a result of various factors. The percentage of occupied rooms that buy movies and other services at the property also varies over time with general economic conditions, including, but not limited to, consumer sentiment, and other factors. Reduction in hotel occupancy, resulting from the general economic environment or other changes in market conditions, such as a recession or significant slow-down in economic activity, or significant international crises, could adversely impact our business, financial condition and results of operations. The overall travel industry can be, and has been in the past, adversely affected by weaker general economic climates, geopolitical instability and concerns about public health. Factors such as the cost of fuel, airline fares and other economic conditions which result in a decrease in business or leisure travel can affect hotel occupancy and the demand for some of our products and services. Also, our goodwill and intangible assets may be impaired if market conditions deteriorate.

Note 13 — Segment Information

We operate in three reportable segments, Hospitality, Advertising Services and Healthcare. We identify our segments based upon the products and services delivered and the nature of our customer base receiving those products and services. The Hospitality business distributes entertainment, media and connectivity services to the hospitality industry. Our Advertising Services business generates revenue from the sale of advertising-based media services within our hospitality customer base, utilizing the same server based technology or by the delivery of advertising using 10 television programming channels. Our Healthcare business generates revenue from the sale of interactive system hardware, software licenses, installation services and related programming and support agreements to the healthcare market.

Our Hospitality and Advertising Services businesses provide a variety of services to hotels and/or the respective hotels’ guests. The products can include interactive video-on-demand programming, music, games, cable television programming, Internet services or advertising services, and have an analogous consumer base. All products and services are delivered through a proprietary system platform utilizing satellite delivery technology, and are geared towards the hotels and their guests.

Previously, our Advertising Services and Healthcare segments had been presented as “Other,” in one aggregated reportable segment based on relative size. Revenue and operating profit amounts reported in previous periods have been reclassified to conform to the current presentation.

Financial information related to our reportable segments for the three months ended March 31 is as follows (dollar amounts in thousands):

		Three Months Ended
		March 31,
		2010				2009
Total revenues:
Hospitality		$	113,159			$	124,041
Advertising Services			2,340				1,761
Healthcare			2,553				2,290
Total		$	118,052			$	128,092
Income (loss) before income taxes:
Hospitality		$	34,494			$	39,702
Advertising Services			(222	)			(722	)
Healthcare			345				718
Operating profit			34,617				39,698
Corporate			(5,802	)			(5,497	)
Depreciation and amortization			(22,173	)			(27,105	)
Restructuring charge			(3	)			(107	)
Other operating (expense) income			(5	)			132
Interest expense			(8,682	)			(9,881	)
Gain on extinguishment of debt			—				9,295
Loss on early retirement of debt			(493	)			(541	)
Other income			223				175
Income (loss) before income taxes		$(2,318)				$	6,169

Note 14 — Derivative Information

Effective January 1, 2009, we adopted provisions of FASB ASC Topic 815, “Derivatives and Hedging Activities.” This guidance requires additional disclosures regarding a company’s derivative instruments and hedging activities by requiring disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. It also requires disclosure of derivative features which are credit risk-related, as well as cross-referencing within the notes to the financial statements to enable financial statement users to locate important information about derivative instruments, financial performance and cash flows.

We are required by our Credit Facility to convert 50% of the outstanding term loan into a fixed interest rate for a period not less than two years. Our objective of entering into hedge transactions (or interest rate swaps) using derivative financial instruments is to reduce the variability of cash flows associated with variable-rate loans and comply with the terms of our Credit Facility. As changes in interest rates impact future interest payments, the hedges provide an offset to the rate changes. As of March 31, 2010, we had entered into fixed rate swap agreements for $437.5 million at an average interest rate of 5.05%.

In April 2007, we entered into interest rate swap agreements with notional values of $312.5 million, at a fixed rate of 5.09%, and $125.0 million, at a fixed rate of 4.97%, both of which expire in June 2011. These swap arrangements effectively change the underlying debt from a variable interest rate to a fixed interest rate for the term of the swap agreements. All of the swap agreements have been issued by Credit Suisse International. The swap agreements were designated as, and met the criteria for, cash flow hedges and are not considered speculative in nature.

Our additional payments on the Credit Facility rendered a portion of the $125.0 million notional amount swap, entered into in April 2007 and expiring in June 2011, ineffective. The ineffective portion of the change in fair value of this cash flow hedge was a loss of $659,000 for the three months ended March 31, 2010, and was recognized in interest expense in our Consolidated Statements of Operations. The charge is a non-cash charge and does not impact the amount of cash interest paid during the quarter.

A summary of the aggregate contractual or notional amounts, balance sheet location and estimated fair values of our derivative financial instruments as of March 31, 2010 is as follows (dollar amounts in thousands):

Contractual/

Estimated Fair

Notional

Balance Sheet

Value

Amount

Location

Asset

(Liability)

Interest rate swaps

$

437,500

Other long-term liabilities

$

—

$

(24,185

)

The unrecognized loss for all cash flow hedges included in accumulated other comprehensive loss at March 31, 2010 and December 31, 2009 was $23.5 million, which is net of the $0.7 million ineffective portion charged to interest expense, and $26.6 million, respectively.

A summary of the effect of cash flow hedges on our financial statements for the three months ended March 31 is as follows (dollar amounts in thousands):

Effective Portion

Income Statement

Location of

Hedge

Amount of

Gain (Loss)

Gain (Loss)

Ineffective Portion

Gain (Loss)

Reclassified From

Reclassified From

Income

Recognized

Accumulated

Accumulated

Statement

in Other

Other

Other

Location of

Hedge

Type of Cash

Comprehensive

Comprehensive

Comprehensive

Gain (Loss)

Gain (Loss)

Flow Hedge

Income

Income

Income

Recognized

Recognized

Three Months Ended March 31, 2009:

Interest rate swaps

$

7,276

Interest expense

$

(4,614

)

Interest expense

$

—

Three Months Ended March 31, 2010:

Interest rate swaps

$

8,408

Interest expense

$

(5,311

)

Interest expense

$

(659

)

Note 15 — Perpetual Preferred Stock

In June 2009, we completed our offering of 57,500 shares (inclusive of the initial purchaser’s option to purchase the additional 7,500 shares), bringing the total aggregate liquidation preference of the preferred stock sold to $57.5 million.

Subject to the declaration of dividends by our Board of Directors, cumulative dividends on the preferred stock will be paid at a rate of 10% per annum of the $1,000 liquidation preference per share, starting from the date of original issue, June 29, 2009. Dividends accumulate quarterly in arrears on each January 15, April 15, July 15 and October 15, beginning on October 15, 2009. Payments must come from funds legally available for dividend payments.

Dividends were declared on the preferred stock by our Board of Directors on April 2, 2010. As of March 31, 2010, we had $1.4 million of unpaid dividends. The dividends were recorded as a reduction to additional paid-in capital, due to our accumulated deficit balance. The dividends were paid on April 15, 2010.

Note 16 — Common Stock Offering

In March 2010, we entered into an agreement to sell 2,160,000 shares of our common stock, $0.01 par value per share, to Craig-Hallum Capital Group LLC (Underwriter), for resale to the public at a price per share of $6.00, less an underwriting discount of $0.36 per share. The Underwriter had an option to purchase up to 324,000 additional shares of common stock at the same price per share to cover overallotments. We completed our offering of 2,484,000 shares (inclusive of the Underwriter’s option to purchase the additional 324,000 shares), bringing the total aggregate common stock sold to $14.9 million. Net proceeds from the issuance of common stock were $13.7 million, with offering and related costs totaling $1.2 million.

Note 17 — Effect of Recently Issued Accounting Standards

In October 2009, the FASB issued FASB Accounting Standard Update (“ASU”) No. 2009-13, “Multiple-Deliverable Revenue Arrangements,” which is now codified under FASB ASC Topic 605, “Revenue Recognition.” This ASU establishes a selling price hierarchy for determining the selling price of a deliverable; eliminates the residual method of allocation and requires arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method; and requires a vendor determine its best estimate of selling price in a manner consistent with that used to determine the selling price of the deliverable on a standalone basis. The ASU also significantly expands the required disclosures related to a vendor’s multiple-deliverable revenue arrangements. FASB ASU No. 2009-13 is effective on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. We are evaluating the effect from the adoption of this ASU on our current and future business models. Depending on how we sell and deliver future systems and services, this ASU could have an effect on the timing of revenue recognition and our consolidated results of operations or cash flows.

In October 2009, the FASB issued FASB ASU No. 2009-14, “Certain Revenue Arrangements That Include Software Elements,” which is now codified under FASB ASC Topic 985, “Software.” This ASU changes the accounting model for revenue arrangements which include both tangible products and software elements, providing guidance on how to determine which software, if any, relating to the tangible product would be excluded from the scope of the software revenue guidance. FASB ASU No. 2009-14 is effective on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. We are evaluating the effect from the adoption of this ASU on our current and future business models. Depending on how we sell and deliver future systems and services, this ASU could have an effect on the timing of revenue recognition and our consolidated results of operations or cash flows.

In January 2010, the FASB issued FASB ASU No. 2010-06, “Improving Disclosures about Fair Value Measurements,” which is now codified under FASB ASC Topic 820, “Fair Value Measurements and Disclosures.” This ASU will require additional disclosures regarding transfers in and out of Levels 1 and 2 of the fair value hierarchy, as well as a reconciliation of activity in Level 3 on a gross basis (rather than as one net number). The ASU also provides clarification on disclosures about the level of disaggregation for each class of assets and liabilities and on disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. FASB ASU No. 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for the disclosures requiring a reconciliation of activity in Level 3. Those disclosures will be effective for interim and annual periods beginning after December 15, 2010. The adoption of the portion of this ASU effective after December 15, 2009 did not have an impact on our consolidated financial position, results of operations or cash flows. The adoption of the portion of this ASU effective after December 15, 2010 will not have a material effect on our consolidated financial position, results of operations or cash flows.

In February 2010, the FASB issued FASB ASU No. 2010-09, “Amendments to Certain Recognition and Disclosure Requirements,” which is now codified under FASB ASC Topic 855, “Subsequent Events.” This ASU includes an amendment to remove the requirement for an SEC filer to disclose a date through which subsequent events have been evaluated in both issued and revised financial statements, which include financial statements revised as a result of either correction of error or retrospective application of GAAP. If financial statements have been revised, an entity which is not an SEC filer should disclose both the date the financial statements were issued or available to be issued and the date the revised financial statements were issued or available to be issued. The ASU also includes an amendment to require an entity which is a conduit bond obligor for conduit debt securities traded in a public market to evaluate subsequent events through the date of issuance of its financial statements and must disclose that date. FASB ASU 2010-09 was effective upon issuance (February 24, 2010), except for the use of the issued date for conduit debt obligors, which is effective for interim or annual periods ending after June 15, 2010. The adoption of the portion of this ASU effective February 24, 2010 did not have an impact on our consolidated financial position, results of operations or cash flows. The adoption of the portion of this ASU effective after June 15, 2010 will not have an effect on our consolidated financial position, results of operations or cash flows.

Item 2		— Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our Consolidated Financial Statements, including the notes thereto, appearing elsewhere herein.

Special Note Regarding Forward-Looking Statements

Certain statements in this report or documents incorporated herein by reference constitute “forward-looking statements.” When used in this report, the words “intends,” “expects,” “anticipates,” “estimates,” “believes,” “goal,” “no assurance” and similar expressions, and statements which are made in the future tense or refer to future events or developments, including, without limitation, those related to rooms converted to our HD platform and repayment of debt, are intended to identify such forward-looking statements. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause the 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 elsewhere in this Report and in Item 1A of our most recent Annual Report on Form 10-K for the year ended December 31, 2009 and filed on March 12, 2010, in any prospectus supplement or any report or document incorporated herein by reference, such factors include, among others, the following:

•

the effects of economic conditions, including general financial conditions (including those represented recently by liquidity crises, government bailouts and assistance plans, bank failures and recessionary threats and developments);

	•		the economic condition of the lodging industry, which can be particularly affected by the financial conditions referenced above, as well as by high gas prices, levels of unemployment, consumer confidence, acts or threats of terrorism and public health issues;
	•		decreases in hotel occupancy, whether related to economic conditions or other causes;
	•		competition from providers of similar services and from alternative sources;
	•		changes in demand for our products and services;
	•		programming costs, availability, timeliness and quality;
	•		technological developments by competitors;
	•		developmental costs, difficulties and delays;
	•		relationships with clients and property owners;

	•		the impact of covenants contained in our credit agreement, compliance with which could adversely affect capital available for other business purposes, and the violation of which would constitute an event of default;
	•		the impact of governmental regulations;
	•		potential effects of litigation;
	•		risks of expansion into new markets and territories;
	•		risks related to the security of our data systems; and
	•		other factors detailed, from time to time, in our filings with the Securities and Exchange Commission.

Executive Overview

We are the largest provider of interactive media and connectivity solutions to the hospitality industry in the United States, Canada and Mexico. We also provide interactive television solutions in select international markets, primarily through local or regional licensees. As of March 31, 2010, we provided interactive media and connectivity solutions to approximately 1.9 million hotel rooms. In addition, we sell and maintain interactive television systems which provide on-demand patient education, information and entertainment to healthcare facilities throughout the United States. As of March 31, 2010, our system was installed in 50 healthcare facilities, representing approximately 10,300 beds.

Our operating results reflected the benefits from our diversification initiatives, which focus on non-Guest Entertainment revenue, and saw increased Hotel Services, Advertising Services and Healthcare revenue. Additionally, last year’s first quarter benefited from two significant, one-time events. These events consisted of an employee unpaid leave program, which reduced operating expenses, and the repurchase of $31.5 million of our bank debt in the open market, which contributed $9.3 million to our net income. Excluding those events, our operating expenses were flat compared to the prior year quarter, and we continue to deliver improved operating and net income metrics. Free cash flow, a non-GAAP measure which we define as cash provided by operating activities less cash used for certain investing activities, including growth-related capital, increased 50.7%, to $23.6 million in the first quarter of 2010 as compared to $15.6 million in the prior year. We reduced our long-term debt by 9.1%, or $42.9 million, in part by utilizing $13.7 million of the net proceeds from our recent equity offering. The equity proceeds will also allow us to accelerate our high-definition conversions in the second half of 2010, as we now expect to more than double the number of rooms converting to our HD platform than originally planned. As hotelier demand for this platform increases, we intend to target a select group of our existing customers for conversion in exchange for a long-term extension of our service agreement. We remain focused on the best growth opportunities to drive long-term value for our clients and shareholders.

Our total revenue for the first quarter of 2010 was $118.1 million, a decrease of $10.0 million or 7.8%, compared to the first quarter of 2009. The decrease in revenue was primarily from Guest Entertainment services and System Sales and Related Services, partially offset by increases in revenue from Hotel Services, Advertising Services and Healthcare.

Hospitality and Advertising Services revenue, which includes Guest Entertainment, Hotel Services, System Sales and Related Services and Advertising Services, decreased $10.3 million or 8.2%, to $115.5 million for the first quarter of 2010 as compared to $125.8 million for the prior year quarter. Average monthly revenue per room generated by Hospitality and Advertising Services was $21.71 for the first quarter of 2010, a decrease of 3.9% as compared to $22.58 per room in the first quarter of 2009.

Guest Entertainment revenue, which includes on-demand entertainment such as movies, games, music and other guest interactive services delivered through the television, decreased $7.4 million or 9.7%, to $69.1 million in the first quarter of 2010. Our results continued to be driven by the conservative consumer buying pattern of travelers, as average monthly Guest Entertainment revenue per room for the first quarter of 2010 declined 5.4% to $12.99 compared to $13.73 for the first quarter of 2009. Average monthly movie revenue per room was $12.16 for the first quarter of 2010, a 6.0% reduction as compared to $12.93 per room in the prior year quarter. Hotel Services revenue, which includes recurring revenue from hotels for cable television programming and broadband Internet service and support, increased $1.5 million or 4.6%, to $34.5 million during the first quarter of 2010 versus $33.0 million in the first quarter of 2009. On a per-room basis, monthly Hotel Services revenue for the first quarter of 2010 increased 9.5% to $6.48 compared to $5.92 for the first quarter of 2009. Monthly cable television programming revenue per room increased 9.8% to $5.92 for the first quarter of 2010 as compared to $5.39 for the first quarter of 2009. These increases resulted primarily from the continued installation of high definition television systems and additional cable television programming services. Recurring broadband Internet revenue per room increased to $0.56 for the first quarter of 2010 compared to $0.53 for the same period of 2009. System Sales and Related Services revenue decreased $5.0 million or 34.2%, to $9.6 million during the first quarter of 2010 versus $14.6 million in the first quarter of 2009, primarily due to a material HDTV equipment conversion contract in the first quarter of 2009, which contributed approximately $4.2 million of revenue. Advertising Services revenue, generated by The Hotel Networks (“THN”), our advertising services subsidiary, increased $0.5 million or 32.9%, to $2.3 million during the first quarter of 2010 compared to $1.8 million in the prior year period. This increase was the result of new revenue from a channel lease program.

Healthcare revenue, which includes the sale of interactive systems and services to healthcare facilities, increased $0.3 million or 11.5%, to $2.6 million during the first quarter of 2010 versus $2.3 million in the first quarter of 2009. During the current quarter, we installed five facilities representing 1,135 beds compared to six facilities representing 891 beds in the prior year period.

Total direct costs (exclusive of operating expenses and depreciation and amortization discussed separately below) were $66.6 million in the first quarter of 2010, a decrease of $6.1 million or 8.4%, as compared to $72.7 million in the first quarter of 2009. The decrease in total direct costs was primarily due to decreased system and equipment costs of $4.1 million, which vary with revenue, and decreased commissions and royalties of $2.6 million, which also vary with revenue. Partially offsetting these reductions was an increase in incremental cable television programming costs of $0.6 million, which vary with the number of rooms served and the services provided. For the first quarter of 2010, total direct costs as a percentage of revenue was 56.4% as compared to 56.8% for the first quarter of 2009.

System operations expenses and selling, general and administrative (“SG&A”) expenses were $22.6 million in the first quarter of 2010 compared to $21.1 million in the prior year quarter. As a percentage of total revenue, system operations expenses were 8.9% this quarter as compared to 8.1% in the first quarter of 2009. Per average installed room, system operations expenses increased to $1.98 per room per month this quarter as compared to $1.85 in the prior year quarter. The increases in total operating expenses were the result of a one-time benefit related to our unpaid leave program during the first quarter of 2009, which did not recur during the current quarter, higher fuel costs and increased employee health insurance benefits costs.

Despite the revenue decline, we generated $28.1 million of cash from operating activities as compared to $20.9 million in the first quarter of 2009. In March 2010, we made the required quarterly payment of $1.3 million on the Term B portion of our Credit Facility and also made an additional payment of $44.0 million. During the first quarter of 2009, we made the required Term B repayment of $1.5 million and made an additional $6.7 million Term B payment. The leverage ratio at the end of this quarter, calculated on a consolidated debt basis, was 3.59 times versus the covenant of 3.75 times. Cash as of March 31, 2010 was $9.9 million compared to $7.0 million on March 31, 2009.

Hospitality and Advertising Services Business

Our Hospitality and Advertising Services business includes television contents sold to hotels and/or the respective hotels’ guests. The products can include interactive video-on-demand (VOD), cable television programming, Internet services or advertising services, and have an analogous consumer base. All products and services are delivered through a proprietary system platform having related satellite communication technology, and are geared towards the hotels and their guests.

Guest Entertainment (includes purchases for on-demand movies, network-based video games, music and music videos and television on-demand programming). Our primary source of revenue is providing in-room, interactive guest entertainment, for which the hotel guest pays on a per-view, hourly or daily basis.

Our total guest generated revenue depends on a number of factors, including:

•

The number of rooms on our network. We can increase revenue over time by increasing the number of rooms served by our interactive television systems. Our ability to expand our room base is dependent on a number of factors, including newly constructed hotel properties and the attractiveness of our technology, service and support to hotels currently operating without an interactive television system.

•

The occupancy rate at the property. Our revenue also varies depending on hotel occupancy rates, which are subject to a number of factors, including seasonality, general economic conditions and world events, such as terrorist threats or public health issues. Occupancy rates for the properties we serve are typically higher during the second and third quarters due to seasonal travel patterns. We target higher occupancy properties in diverse demographic and geographic locations in an effort to mitigate occupancy-related risks.

•

The popularity, timeliness and amount of content offered at the hotel. Our revenues vary, to a certain degree, with the number, timeliness and popularity of movie content available for viewing, and whether the content is presented in digital or analog format. Historically, a decrease in the availability of popular movie content has adversely impacted revenue, and the availability of high definition content has increased revenue. Although not completely within our control, we seek to program and promote the most popular available movie content and other content to maximize revenue and profitability.

•

The price of the service purchased by the hotel guest. Generally, we control the prices charged for our products and services and manage pricing in an effort to maximize revenue and overall profitability. We establish pricing based on such things as the demographics of the property served, the popularity of the content and overall general economic conditions. Our technology enables us to measure the popularity of our content and make decisions to best position such content and optimize revenue from such content.

•

The availability of alternative programming. We compete directly for customers with a variety of other interactive service providers, including other interactive television service providers, cable television companies, direct broadcast satellite companies, television networks and programmers, Internet service providers and portals, technology consulting and service firms, companies offering web sites which provide on-demand movies, rental companies providing DVDs which can be viewed in properly equipped hotel rooms or on other portable viewing devices and hotels which offer in-room laptops with Internet access or other types of Internet access systems. We also compete, in varying degrees, with other leisure-time activities such as movie theaters, the Internet, radio, print media, personal computers and other alternative sources of entertainment and information.

•

Consumer sentiment. The willingness of guests to purchase our entertainment services is also impacted by the general economic environment and its impact on consumer sentiment. Historically, such impacts were not generally material to our revenue results; however, during the last half of 2008, 2009 and the first quarter of 2010, the deteriorating economic conditions did have a significant, negative impact on our revenue levels. As economic conditions improve in the future, guest purchase activity may or may not increase to the same levels previously experienced by the Company.

The primary direct costs of providing Guest Entertainment are:

•

license fees paid to major motion picture studios, which are variable and based on a percent of guest-generated revenue, for non-exclusive distribution rights of recently released major motion pictures;

•

commissions paid to our hotel customers, which are also variable and based on a percent of guest-generated revenue;

•

license fees, which are based on a percent of guest-generated revenue, for television on-demand, music, music videos, video games and sports programming; and

•

one-time license fees paid for independent films, most of which are non-rated and intended for mature audiences.

Hotel Services (includes revenue from hotels for services such as television channels and recurring broadband Internet service and support to the hotels). Another major source of our revenue is providing cable television programming and Internet services to the lodging industry, for which the hotel pays a fixed monthly fee.

•

Cable Television Programming. We offer a wide variety of satellite-delivered cable television programming paid for by the hotel and provided to guests at no charge. The cable television programming is delivered via satellite, pursuant to an agreement with DIRECTV®, and is distributed over the internal hotel network, and typically includes premium channels such as HBO and Showtime, which broadcast major motion pictures and specialty programming, as well as non-premium channels, such as CNN and ESPN. With the launch of the high-definition configuration of our interactive television system, we also began offering high-definition cable television programming to the extent available from broadcast sources and DIRECTV.

•

Broadband Internet Access, Service and Support. We also design, install and operate wired and wireless broadband Internet access systems at hotel properties. These systems control access to the Internet, provide bandwidth management tools and allow hotels to charge or provide the access as a guest amenity. Post-installation, we generate recurring revenue through the ongoing maintenance, service and call center support services to hotel properties installed by us and also to hotel properties installed by other providers. While this is a highly competitive area, we believe we have important advantages as a result of our pro-active monitoring interface with hotel systems to improve up time, existing hotel customer relationships and our nationwide field service network.

System Sales and Related Services. We also generate revenue from other products and services within the hotel and lodging industry, including sales of Internet access and other interactive television systems and equipment, cable television programming reception equipment, Internet conference services, and professional services, such as design, project management and installation services.

Advertising Services. We deliver advertising-supported media into select hotel segments, from which we earn revenue from the sale of television commercials or other marketing based programs. The demographic and professional profile of the traveler within our room base tends to have characteristics we believe may be attractive to consumer marketing organizations. By approaching guests with relevant messaging when they are in the comfort of a hotel room, free of distractions, advertisers have a prime opportunity to capture the attention of and connect with these desired consumers. In addition to market demands, our revenue is also dependent on rooms available to promote customer products and services. As of March 31, 2010, we provide advertising media services to approximately 1.2 million hotel rooms compared to 1.0 million rooms as of March 31, 2009. We also deliver targeted advertising to more than 364,000 hotel rooms on 10 popular satellite-delivered channels.

Key Metrics:

Rooms Served

One of the metrics we monitor within our Hospitality and Advertising Services business is the number of rooms we serve for our various services. As of March 31, we had the following number of rooms installed with the designated service:

		March 31,
		2010				2009
Total rooms served (1)			1,911,842				1,973,472
Total Guest Entertainment rooms (2)			1,764,363				1,849,304
Total HD rooms (3)			239,984				199,290
Percent of Total Guest Entertainment rooms			13.6	%			10.8	%
Total Cable Television Programming (FTG) rooms (4)			1,083,837				1,106,833
Percent of Total Guest Entertainment rooms			61.4	%			59.9	%
Total Broadband Internet rooms (5)			200,139				229,184
Percent of Total rooms served			10.5	%			11.6	%

High Definition Room Growth

We also track the increasing penetration of our high-definition television (HDTV) system, since rooms equipped with HDTV services typically generate higher revenue, in a stable economic environment, from Guest Entertainment and Hotel Services than rooms equipped with our other VOD systems. HDTV room growth is occurring as we install our HDTV system in newly contracted rooms and convert select rooms to the HDTV system in exchange for long-term contract extensions. We installed our systems in the following number of net new rooms and had the following total rooms installed as of March 31:

		March 31,
		2010				2009
Net new HDTV rooms for the three months ended			8,396				7,799
Total HDTV rooms installed			239,984				199,290
HDTV rooms as a percent of total Guest Entertainment rooms			13.6	%			10.8	%

HDTV rooms, including new installations and major upgrades, are equipped with high-definition capabilities.

Capital Investment Per Installed Room

The average investment per room associated with an installation can fluctuate due to the type of interactive television system installed, engineering efforts, component costs, product segmentation, cost of assembly and installation, average property size, certain fixed costs and hotel capital contributions. The following table sets forth our average installation and conversion investment cost per room on a comparable room base during the periods ended:

		Three Months Ended								Years Ended
		March 31,				March 31,				December 31,				December 31,
		2010				2009				2009				2008
Average cost per room – new installation		$	250			$	459			$	345			$	389
Average cost per room – conversion		$	204			$	357			$	235			$	295
Average cost per HD room – new installation		$	271			$	465			$	339			$	398
Average cost per HD room – conversion		$	204			$	357			$	241			$	320

The decrease in the average cost per new and converted HD rooms from 2008 to 2010 was primarily driven by a larger average room size for properties installed, lower overhead and component costs and hotels contributing a greater share of total installation costs through purchases of systems and equipment.

Average Revenue Per Room

We monitor the average revenue we generate per Hospitality and Advertising Services room. Guest Entertainment revenue can fluctuate based on several factors, including occupancy, consumer sentiment, mix of travelers, the availability of high definition and alternative programming, the popularity of movie content, the mix of services purchased and the overall economic environment. During the quarter, occupancy increased approximately 3.3% as compared to the first quarter of 2009. Hotel Services revenue can fluctuate based on the percentage of our hotels purchasing cable television programming services from us, the type of services provided at each site, as well as the number of hotels purchasing broadband service and support from us. System Sales and Related Services revenue can fluctuate based on the number of system and equipment sales, including broadband system sales. Advertising Services revenue can fluctuate based on the demand for advertising and the performance of products and services sold to business and leisure travelers, as well as the number of rooms available to promote within. The following table sets forth the components of our Hospitality and Advertising Services revenue per room for the three months ended March 31:

		2010				2009
Average monthly revenue per room:
Hospitality and Advertising Services
Guest Entertainment		$	12.99			$	13.73
Hotel Services			6.48				5.92
System Sales and Related Services			1.80				2.61
Advertising Services			0.44				0.32
Total Hospitality and Advertising Services revenue per room		$	21.71			$	22.58

Direct Costs

Guest Entertainment direct costs vary based on content license fees, the mix of Guest Entertainment products purchased and the commission earned by the hotel. Hotel Services direct costs include the cost of cable television programming and the cost of broadband Internet support services. The cost of System Sales and Related Services primarily includes the cost of the systems and equipment sold to hotels. Advertising Services direct costs include the cost of developing and distributing programming. The overall direct cost margin primarily varies based on the composition of revenue. The following table sets forth our Hospitality and Advertising Services direct expenses per room and as a percentage of related revenue during the three months ended March 31:

		Three Months Ended								Three Months Ended
		March 31, 2010								March 31, 2009
						Percent								Percent
						of Related								of Related
		Amount				Revenue				Amount				Revenue
Direct costs per room:
Hospitality and Advertising Services
Guest Entertainment		$	5.20				40.0	%		$	5.51				40.1	%
Hotel Services			5.59				86.2	%			5.24				88.6	%
System Sales and Related Services			1.21				67.5	%			1.86				71.2	%
Advertising Services			0.27				59.6	%			0.28				85.9	%
Total Hospitality and Advertising Services direct costs per room		$	12.27				56.5	%		$	12.89				57.1	%

The average direct cost per Guest Entertainment room varies with revenue and, from 2009 to 2010, was driven by the amount of commissions earned by the hotels and a change in the mix of products purchased.

Healthcare Business

The healthcare market in the United States consists of approximately 900,000 hospital beds across 5,900 facilities. We believe most hospitals currently do not have any form of interactive television services. The main interests in interactive television services include driving patient satisfaction, providing robust patient education with comprehensive reporting and operation efficiencies and cost savings for automating processes such as integrated food ordering. Our Healthcare revenue is generated through a variety of services and solutions provided to care facilities, including:

•

revenue generated from the sale of the interactive system hardware, software license and installation services;

•

revenue from the sale and installation of DIRECTV satellite equipment and related programming;

•

revenue from recurring support agreements for interactive content, software maintenance and technical field service support, including service agreements covering cable plant, DIRECTV satellite equipment and interactive systems; and

•

revenue generated from cable plant design, modification and installation, as well as television installation services.

As of March 31, 2010, we have equipped 50 healthcare facilities, or approximately 10,300 beds, with these services and solutions to improve the overall patient experience, as compared to 34 properties or approximately 7,400 beds as of March 31, 2009.

General Operations

Total Operating Expenses

We also monitor and manage the operating expenses per room. System operations expenses consist of costs directly related to the operation and maintenance of systems at hotel sites. Selling, general and administrative expenses (“SG&A”) primarily include payroll costs, stock based compensation, engineering development costs and legal, marketing, professional and compliance costs. The following table sets forth the components of our operating expenses per room for the three months ended March 31:

		Three Months Ended
		March 31,
		2010				2009
Systems operations expenses		$	1.98			$	1.85
SG&A expenses			2.28				1.94
Depreciation and amortization (D&A)			4.17				4.86
Restructuring charge			—				0.02
Other operating expense (income), net			—				(0.02	)
		$	8.43			$	8.65
Systems operations as a percent of total revenue			8.9	%			8.1	%
SG&A as a percent of total revenue			10.3	%			8.4	%
D&A as a percent of total revenue			18.8	%			21.1	%
Total operating expenses as a percent of total revenue			38.0	%			37.6	%

Special Note Regarding the Use of Non-GAAP Financial Information

To supplement our consolidated financial statements presented in accordance with accounting principles generally accepted in the United States (“GAAP”), we use free cash flow, a non-GAAP measure derived from results based on GAAP. The presentation of this additional information is not meant to be considered superior to, in isolation of, or as a substitute for, results prepared in accordance with GAAP.

We define free cash flow, a non-GAAP measure, as cash provided by operating activities less cash used for certain investing activities, including growth related capital, and consideration paid for acquisitions. Free cash flow is a key liquidity measure but should not be construed as an alternative to cash flows from operating activities or as a measure of our profitability or performance. We provide information about free cash flow because we believe it is a useful way for us, and our investors, to measure our ability to satisfy cash needs, including interest payments on our debt, taxes and capital expenditures. GAAP requires us to provide information about cash flow generated from operations. Our definition of free cash flow does not take into account our debt service requirements or other commitments. Accordingly, free cash flow is not necessarily indicative of amounts of cash which may be available to us for discretionary purposes. Our method of computing free cash flow may not be comparable to other similarly titled measures of other companies.

Free Cash Flow

One of our goals is to increase the level of free cash flow we generate. We manage our free cash flow by seeking to maximize the amount of cash we generate from our operations and managing the level of our investment activity. During the first quarter of 2010, we allocated a substantial portion of our cash flow from operations to the repayment of debt and used the balance of the cash flow for capital expenditures. We can manage capital expenditures by reducing the per-room installation cost of a room and by varying the number of rooms we install in any given period.

Levels of free cash flow are set forth in the following table (dollar amounts in thousands):

		Three Months Ended
		March 31,
		2010				2009
Cash provided by operating activities		$	28,098			$	20,947
Property and equipment additions			(4,525	)			(5,301	)
		$	23,573			$	15,646

Capital investment, including expansion capital, which we define as capital used for new room installations, is set forth in the following table (dollar amounts in thousands):

		Three Months Ended
		March 31,
		2010				2009
Expansion capital investment (1)		$	1,183			$	2,478
Renewal investment (2)			968				940
Corporate capital and minor extensions (3)			2,374				1,883
		$	4,525			$	5,301

Liquidity and Capital Resources

During the first three months of 2010, cash provided by operating activities was $28.1 million. For the first three months of 2010, we used $4.5 million of the cash we generated for property and equipment additions, including growth-related capital. During the same period, we made an additional payment of $44.0 million against the Term B portion of our Credit Facility, in addition to the required quarterly payment of $1.3 million. We also used $1.4 million for preferred stock dividends. During the first three months of 2009, cash provided by operating activities was $20.9 million. For the first three months of 2009, we used cash for property and equipment additions, including growth-related capital, of $5.3 million. During the same period, we made an additional payment of $6.7 million against the Term B portion of our Credit Facility, in addition to the required quarterly payment of $1.5 million. Cash as of March 31, 2010 was $9.9 million versus $17.0 million as of December 31, 2009.

In March 2010, we entered into an agreement to sell 2,160,000 shares of our common stock, $0.01 par value per share, to the underwriter, for resale to the public at a price per share of $6.00, less an underwriting discount of $0.36 per share. The underwriter had an option to purchase up to 324,000 additional shares of common stock at the same price per share to cover overallotments. We completed our offering of 2,484,000 shares (inclusive of the underwriter’s option to purchase the additional 324,000 shares), bringing the total aggregate common stock sold to $14.9 million. Net proceeds from the issuance of common stock were $13.7 million, with offering and related costs totaling $1.2 million. The net proceeds of $13.7 million were used to reduce our debt in the near-term, which will allow us to allocate more operating cash flow to the acceleration of converting rooms to our high-definition platform in the second half of the year.

Our principal sources of liquidity are our cash from operations, our cash on hand and the $50.0 million revolver portion of our Credit Facility, which matures in 2013. We believe our cash on hand, operating cash flow, borrowing available under the Credit Facility and availability under the shelf registration will be sufficient to fund our business and comply with our financing obligations. During 2010, we plan to continue to allocate a substantial portion of our cash flow from operations to the repayment of debt and use the balance of the cash flow for capital expenditures. As of March 31, 2010, working capital was $(18.7) million, compared to $(4.9) million at December 31, 2009.

The collectability of our receivables is reasonably assured, as supported by our broad customer base. Our interactive hotel base is well diversified in terms of (i) location; (ii) demographics; and (iii) customer contracts. We provide our services to various hotel chains, ownership groups and management companies. In accordance with our hotel contracts, monies collected by the hotel for interactive television services are held in trust on our behalf, thereby limiting our risk from hotel bankruptcies.

In order to fund our acquisitions of On Command and StayOnline, in April 2007 we entered into a $675.0 million bank Credit Facility, comprised of a $625.0 million term loan, which matures in April 2014, and a $50.0 million revolving Credit Facility, which matures in April 2013. The required quarterly payments are currently $1.2 million, and will be adjusted for any additional reduction in principal as a result of our early repayments against the loan. For the first quarter of 2010, the adjusted quarterly payment requirement was $1.3 million. The term loan bears interest at our option of (1) the bank’s base rate plus a margin of 1.00% or (2) LIBOR plus a margin of 2.00%. The agreement provides that when our consolidated leverage ratio is below 3.25 times, the term loan bears interest at our option of (1) the bank’s base rate plus a margin of 0.75% or (2) LIBOR plus a margin of 1.75%. The term loan is collateralized by substantially all of the assets of the Company. The Credit Facility includes terms and conditions which require compliance with leverage and interest coverage covenants. The Credit Facility also stipulates we enter into hedge agreements to provide at least 50% of the outstanding term loan into a fixed interest rate for a period not less than two years. We have entered into fixed rate swap agreements for $437.5 million of the outstanding term loan, with fixed interest rates ranging from 4.97% to 5.09% (see Note 14 to the financial statements). The term loan interest rate as of March 31, 2010 was 2.30%. The aggregate weighted average interest rate for the quarter ended March 31, 2010 was 6.99%, which includes the term loan and lease interest rates and the difference in the swaps’ fixed interest rate versus LIBOR. As of March 31, 2010, we were in compliance with all financial covenants required of our bank Credit Facility.

Our leverage and interest coverage ratios were as follows for the periods ended March 31:

		2010				2009
Actual consolidated leverage ratio (1) (3)			3.59				4.04
Maximum per covenant			3.75				4.25
Actual consolidated interest coverage ratio (2) (3)			3.22				3.27
Minimum per covenant			3.00				2.75

We do not utilize special purpose entities or off balance sheet financial arrangements.

Our debt covenant ratios will change in future periods as follows:

		Q3 2010
		to maturity
Maximum consolidated leverage ratio			3.50
Minimum consolidated interest coverage ratio			3.00

In order to continue operating efficiently and expand our business, we must remain in compliance with covenants outlined in our Credit Facility. Our ability to remain in compliance with those covenants will depend on our ability to generate sufficient Adjusted Operating Cash Flow (as defined in the Credit Facility), to manage our level of capital investment and to continue to reduce our debt. We continue taking actions within our control to reduce our debt and remain in compliance with our debt covenants. The actions within our control include our prudent management of capital investment and operating costs and exploring other alternatives, which may include seeking an amendment to our Credit Facility, raising additional capital or reductions in our operating expenses. We believe we are balancing the interest of our customers and our Company by reducing our capital investments, reducing our operating cost structure and aggressively reducing the level of debt. We achieved a consolidated leverage ratio of 3.59 compared to the maximum allowable ratio of 3.75 for the first quarter of 2010. Our ability to continue to comply with these covenants is subject to the general economic climate and business conditions beyond our control. We are committed to reducing our debt and are taking actions to remain in compliance with our debt covenants. Our ability to comply with these covenants depends on achieving our planned operating results and making further debt reductions. Although there are signs of stabilization in certain sectors of the economy, the uncertainties impacting travel and lodging, in addition to the constraints in the credit markets, consumer conservatism and other market dynamics, may continue to negatively impact our planned results and required covenants. If we are not able to remain in compliance with the debt covenants, it will likely have a significant, unfavorable impact on our business and financial condition and we may need to amend the Credit Facility to seek a waiver of the covenants. An amendment to the Credit Facility may significantly increase our interest costs, add upfront fees or modify other terms less favorable to us than we currently have in our Credit Facility. In the event our lenders will not amend or waive the covenants, the debt would be due and we would need to seek alternative financing. We cannot provide assurance we would be able to obtain alternative financing. If we were not able to secure alternative financing, this would have a substantial adverse impact on the Company.

The Credit Facility also requires we notify the agent upon the occurrence of a “Material Adverse Effect” prior to any draw on the Company’s revolving Credit Facility, as such terms are defined and used within our bank Credit Facility. However, under the Credit Facility, the provision of such a notice is not an event of default, but if such an event occurred, it could restrict the Company’s ability to obtain additional financing under the revolving Credit Facility. As of March 31, 2010, we are not aware of any events which would qualify under the Material Adverse Effect under the Credit Facility. The total amount of long-term debt outstanding, including the current portion, as of March 31, 2010 was $427.0 million versus $469.9 million as of December 31, 2009.

In April 2007, we entered into interest rate swap agreements with notional values of $312.5 million, at a fixed rate of 5.09%, and $125.0 million, at a fixed rate of 4.97%, both of which expire in June 2011. These swap arrangements effectively change the underlying debt from a variable interest rate to a fixed interest rate for the term of the swap agreements. The swap agreements were designated as, and met the criteria for, cash flow hedges and are not considered speculative in nature. A portion of the $125.0 million notional amount swap, entered into in April 2007 and expiring in June 2011, was rendered ineffective due to the additional payments on our term loan. The ineffective portion of the change in fair value of this cash flow hedge was a loss of $659,000 for the three months ended March 31, 2010, and was recognized in interest expense in our Consolidated Statements of Operations. All of the swap agreements have been issued by Credit Suisse International.

The Credit Facility provides for the issuance of letters of credit up to $15.0 million, subject to customary terms and conditions. As of March 31, 2010, we had outstanding letters of credit totaling $325,000.

Obligations and commitments as of March 31, 2010 were as follows (dollar amounts in thousands):

						Payments due by period
						Less than				2–3				4–5				Over
		Total				1 year				years				years				5 years
Contractual obligations:
Long-term debt(s)		$	427,035			$	5,561			$	10,034			$	411,440			$	—
Interest on bank term loan (1)			41,154				10,480				20,522				10,152				—
Interest on derivative instruments (net)			26,344				21,087				5,257				—				—
Operating lease payments			4,332				2,274				1,568				465				25
Purchase obligations (2)			6,608				4,429				1,771				408				—
Minimum royalties and commissions (3)			1,954				1,692				262				—				—
Total contractual obligations		$	507,427			$	45,523			$	39,414			$	422,465			$	25

						Amount of commitment expiration per period
						Less than				2–3				4–5				Over
		Total				1 year				years				years				5 years
Other commercial commitments:
Standby letters of credit		$	325			$	325			$	—			$	—			$	—

Seasonality

Our quarterly operating results are subject to fluctuation, depending upon hotel occupancy rates and other factors, including travel patterns and the economy. Our hotel customers typically experience higher occupancy rates during the second and third quarters, due to seasonal travel patterns and, accordingly, we historically have higher revenue and cash flow in those quarters. However, quarterly revenue can be affected by the availability of popular content during those quarters and by consumer purchasing behavior. We have no control over when new content is released or how popular it will be, or the effect of economic conditions on consumer behavior.

Market Conditions

Due to current economic conditions, our business could be adversely impacted by conditions affecting the lodging industry’s performance. Our results are closely linked to the performance of the lodging industry, where occupancy rates may fluctuate as a result of various factors. The percentage of occupied rooms that buy movies and other services at the property also varies over time with general economic conditions, including, but not limited to, consumer sentiment, and other factors. Reduction in hotel occupancy, resulting from the general economic environment or other changes in market conditions, such as a recession or significant slow-down in economic activity, or significant international crises, could adversely impact our business, financial condition and results of operations. The overall travel industry can be, and has been in the past, adversely affected by weaker general economic climates, geopolitical instability and concerns about public health. Factors such as the cost of fuel, airline fares and other economic conditions which result in a decrease in business or leisure travel can affect hotel occupancy and the demand for some of our products and services. Also, our goodwill and intangible assets may be impaired if market conditions deteriorate.

Discussion and Analysis of Results of Operations
Three Months Ended March 31, 2010 and 2009

Revenue Analysis. Total revenue for the first quarter of 2010 was $118.1 million, a decrease of $10.0 million or 7.8%, compared to the first quarter of 2009. The decrease in revenue was primarily from a decrease in Guest Entertainment and System Sales and Related Services revenue, partially offset by increases in revenue from Hotel Services, Advertising Services and Healthcare. The following table sets forth the components of our revenue (dollar amounts in thousands) for the quarter ended March 31:

		2010								2009
						Percent								Percent
						of Total								of Total
		Amount				Revenues				Amount				Revenues
Revenues:
Hospitality and Advertising Services
Guest Entertainment		$	69,082				58.5	%		$	76,488				59.7	%
Hotel Services			34,486				29.2	%			32,972				25.7	%
System Sales and Related Services			9,591				8.1	%			14,581				11.4	%
Advertising Services			2,340				2.0	%			1,761				1.4	%
Total Hospitality and Advertising Services			115,499				97.8	%			125,802				98.2	%
Healthcare			2,553				2.2	%			2,290				1.8	%
		$	118,052				100.0	%		$	128,092				100.0	%

Hospitality and Advertising Services revenue, which includes Guest Entertainment, Hotel Services, System Sales and Related Services and Advertising Services, decreased $10.3 million or 8.2%, to $115.5 million in the first quarter of 2010 compared to $125.8 million in the first quarter of 2009. Average monthly Hospitality and Advertising Services revenue per room was $21.71 in the first quarter of 2010, a decrease of 3.9% as compared to $22.58 in the prior year quarter. The following table sets forth information with respect to revenue per Hospitality and Advertising Services room for the quarter ended March 31:

		2010				2009
Average monthly revenue per room:
Hospitality and Advertising Services
Guest Entertainment		$	12.99			$	13.73
Hotel Services			6.48				5.92
System Sales and Related Services			1.80				2.61
Advertising Services			0.44				0.32
Total Hospitality and Advertising Services revenue per room		$	21.71			$	22.58

Guest Entertainment revenue, which includes on-demand entertainment such as movies, games, music and other guest interactive services delivered through the television, decreased $7.4 million or 9.7%, to $69.1 million in the first quarter of 2010 as compared to $76.5 million in the prior year quarter. On a per-room basis, monthly Guest Entertainment revenue for the first quarter of 2010 declined 5.4%, to $12.99 compared to $13.73 for the first quarter of 2009. This change in revenue per room continues to be driven by the conservative consumer buying pattern of travelers. Average monthly movie revenue per room was $12.16 for the first quarter of 2010, a 6.0% reduction as compared to $12.93 per room in the prior year quarter. Non-movie Guest Entertainment revenue per room increased 3.7% to $0.83 in the first quarter of 2010, driven by an increase in television on-demand programming.

Hotel Services revenue, which includes recurring revenue from hotels for cable television programming and broadband Internet service and support, increased $1.5 million or 4.6%, to $34.5 million during the first quarter of 2010 versus $33.0 million in the first quarter of 2009. On a per-room basis, monthly Hotel Services revenue for the first quarter of 2010 increased 9.5%, to $6.48 compared to $5.92 for the first quarter of 2009. Monthly cable television programming revenue per room increased 9.8%, to $5.92 for the first quarter of 2010 as compared to $5.39 for the first quarter of 2009. These increases resulted primarily from the continued installation of high definition television systems and additional cable television programming services. Recurring broadband Internet revenue per room was $0.56 for the first quarter of 2010 as compared to $0.53 for the first quarter of 2009.

System Sales and Related Services revenue includes the sale of cable television programming equipment, broadband Internet equipment, HDTV installations and other services to hotels. For the first quarter of 2010, revenue decreased $5.0 million or 34.2%, to $9.6 million as compared to $14.6 million for the first quarter of 2009. This decrease was due in part to the completion of a material HDTV equipment conversion contract in the first quarter of 2009, which contributed approximately $4.2 million of revenue.

Advertising Services revenue consists of revenue generated by The Hotel Networks (“THN”), our advertising services subsidiary. For the first quarter of 2010, revenue increased $0.5 million or 32.9%, to $2.3 million as compared to $1.8 million in the prior year period. This increase was the result of new revenue from a channel lease program.

Healthcare revenue includes the sale of interactive systems and services to healthcare facilities. Healthcare revenue increased $0.3 million or 11.5%, to $2.6 million in the first quarter of 2010 as compared to $2.3 million for the first quarter of 2009. During the current quarter, we installed 1,135 beds and five facilities compared to 891 beds and six facilities during the prior year period.

Direct Costs (exclusive of operating expenses and depreciation and amortization discussed separately below). Total direct costs decreased $6.1 million or 8.4%, to $66.6 million in the first quarter of 2010 as compared to $72.7 million in the first quarter of 2009. Total direct costs were 56.4% of revenue for the first quarter of 2010 as compared to 56.8% in the first quarter of 2009. Direct costs related to the Hospitality and Advertising Services business, which includes Guest Entertainment, Hotel Services, System Sales and Related Services and Advertising Services, were $65.3 million for the first quarter of 2010 compared to $71.8 million for the prior year quarter. The decrease in total direct costs was primarily related to decreases in system and equipment costs, which vary with revenue, and commissions and royalties, which also vary with revenue. The decreases were offset, in part, by an increase in incremental cable television programming costs, which vary with the number of rooms served and the services provided.

The following table sets forth the primary change drivers of total direct costs for the quarter ended March 31:

		2010				2009				Change
Direct costs as a percent of revenue (exclusive of operating expenses and depreciation and amortization discussed separately below):			56.4	%			56.8	%			(0.4	)%
Change drivers:
Hospitality and Advertising Services
Guest Entertainment											(0.5	)%
Hotel Services											2.4	%
System Sales and Related Services											(2.7	)%
Advertising Services											0.0	%
Healthcare											0.4	%
											(0.4	)%

On a weighted average basis, total direct costs decreased 40 basis points. Hospitality and Advertising Services direct costs decreased 80 basis points, primarily from a 270 basis point decrease related to the sale of professional services and equipment to hotels and a 50 basis point decrease related to movie-based Guest Entertainment revenue. These decreases were offset by a 240 basis point increase in direct costs related to lower margin cable television programming. Healthcare direct costs, primarily associated with the sale of systems and equipment to healthcare facilities, which require no capital contribution but generate a lower profit margin than our traditional Guest Entertainment products, increased 40 basis points.

Operating Expenses. The following table sets forth information in regard to operating expenses for the quarter ended March 31 (dollar amounts in thousands):

		2010								2009
						Percent								Percent
						of Total								of Total
		Amount				Revenues				Amount				Revenues
Operating expenses:
System operations		$	10,515				8.9	%		$	10,326				8.1	%
Selling, general and administrative			12,115				10.3	%			10,818				8.4	%
Depreciation and amortization			22,173				18.8	%			27,105				21.1	%
Restructuring charge			3				0.0	%			107				0.1	%
Other operating expense (income)			5				0.0	%			(132	)			(0.1	)%
Total operating expenses		$	44,811				38.0	%		$	48,224				37.6	%