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EX-12.1 - EX-12.1 - LODGENET INTERACTIVE CORP | c63489exv12w1.htm |
EX-21.1 - EX-21.1 - LODGENET INTERACTIVE CORP | c63489exv21w1.htm |
EX-31.1 - EX-31.1 - LODGENET INTERACTIVE CORP | c63489exv31w1.htm |
EX-23.1 - EX-23.1 - LODGENET INTERACTIVE CORP | c63489exv23w1.htm |
EX-31.2 - EX-31.2 - LODGENET INTERACTIVE CORP | c63489exv31w2.htm |
EX-32.1 - EX-32.1 - LODGENET INTERACTIVE CORP | c63489exv32w1.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One)
þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Fiscal Year Ended December 31, 2010
or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND 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 of Incorporation) | (IRS Employer Identification Number) |
3900 West Innovation Street, Sioux Falls, South Dakota 57107
(Address of Principal Executive Offices) (Zip Code)
(Address of Principal Executive Offices) (Zip Code)
(605) 988 1000
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
|
Common Stock, $.01 par value. Registered on the NASDAQ Global Select Market |
|
Securities registered pursuant to Section 12(g) of the Act:
|
None. |
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ | |||
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ | |||
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ | |||
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. |
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 Act). Yes o No þ | |||
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrants most recently completed second fiscal quarter. $87,708,006 |
The number of shares of common stock of the Registrant outstanding as of March 7, 2011, was
25,152,080 shares.
DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrants definitive proxy statement for
the 2011 Annual Meeting of Stockholders, which will be filed within 120 days of the fiscal year
ended December 31, 2010, are incorporated by reference in Part III of this Form 10-K.
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Table of Contents
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, On Command, The Hotel Networks, eSUITE 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.
Table of Contents
PART I
Item 1 Business
Overview
We are the largest provider of interactive media and connectivity solutions to the hospitality
industry in the United States, Canada and Mexico. Our primary offerings include guest-paid
entertainment, such as on-demand movies, and hotel-paid services, including cable television
programming and Internet access services. As of December 31, 2010, we provided interactive and
media networks and connectivity solutions to approximately 1.8 million hotel rooms in North America
and provide our hospitality solutions in select international markets, primarily through local or
regional licensees. In addition, we also have a growing presence in the healthcare market, where
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
December 31, 2010, our systems were installed in 56 healthcare facilities, representing
approximately 12,200 beds, and we had an additional six facilities under contract.
The interactive media and connectivity solutions we offer the hospitality industry generally
include a wide range of guest-paid entertainment options, including movies, games, music and
on-demand television programming delivered through the television. We refer to these offerings as
Guest Entertainment content, which guests typically purchase on a per-view, hourly or daily basis.
We also provide services for which hotels pay us a monthly service fee, which we refer to as Hotel
Services. These offerings include cable television programming and broadband Internet, as well as
video, Internet and technical support services. We also sell broadband Internet and interactive
television systems and equipment to hotels, including related professional design, project
management and installation services. These services are reported under System Sales and Related
Services. Through The Hotel Networks (THN), we deliver advertising-supported media into select
segments of our interactive television room base, from which we earn revenue from the sale of
television commercials or other marketing-based programs.
We have master agreements with many of the leading hotel franchising organizations, which provide a
framework of the key terms, conditions and content which we will offer their franchisees. We then
enter into long-term contracts with the owners or operators of the individual hotels, which
typically have a term of five to seven years. In addition, to ensure we have quality entertainment
content for our hotel partners and their guests, we have agreements with the major movie studios
and other content distributors, such as DIRECTV®, to ensure continued and timely access to the
latest and most popular movie titles and cable channels.
In the healthcare industry, we generate revenue from the sale of interactive television system
hardware, software license and installation services. Additionally, we earn recurring revenues
from the sale of on-demand and television entertainment content, patient education content,
software maintenance and technical support services.
In June 2010, we unveiled our next generation, interactive television platform, called Envision,
which connects our interactive, high-definition guest room televisions to Internet-sourced content
and information. Envision will support extensive branding, as well as a variety of interactive
applications designed to assist hoteliers to increase on-premise revenues and save operating costs.
In addition, Envision will enhance the guest experience by allowing guests to easily and
conveniently perform a variety of functions, such as purchasing local event tickets and hotel
branded merchandise, reserving tee times and making restaurant reservations. We believe Envision
represents a new revenue growth opportunity for us, as it enables new subscription and
transactional-based revenues. We deployed our initial Envision system in January 2011.
Competitive Strengths
Leading Market Position. We are the largest provider of interactive television systems to the
hospitality industry and estimate we have an approximately 85% share of the hospitality VOD-served
market, reaching over 500 million travelers annually. We focus on the mid-scale through luxury
hotel segment, where we believe demand for our content and services is strongest. Our existing
installed base of rooms enables us to achieve attractive economies of scale for both content
distribution as well as new product and technology development.
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Table of Contents
Long-term relationships. We maintain master agreements with many of the leading hotel franchising
organizations in North America, and have individual five to seven year contracts with over 9,000
individual hotel properties executed by their specific ownership or management companies. Our
long-term contracts create recurring revenues for the Company, enabling us to reasonably predict
the rates of return on our property-based capital investments. We have been a trusted distribution
partner of many of the major Hollywood movie studios since the early 1980s, and have expanded our
distribution relationships to include leading cable television channels and distributors such as
HBO and DIRECTV. Our contracts with the major motion picture studios provide us with access to the
latest Hollywood content prior to its release to the home video market. We also offer hoteliers
and their guests access to special content, such as our Hotel SportsNETSM programming,
where guests can access sporting event coverage from the NFL, NHL, NBA, ESPN and College Sports TV
(CSTV) even if they are away from their home team market. We believe no other competitor matches
the duration and breadth of our relationships with the major entertainment content providers.
Proprietary, interactive high-definition platform. We believe we operate the most advanced
interactive television distribution network in our industry. Our interactive system connects each
individual hotel room television to a digital server located within the hotel, where content is
stored and continuously updated via our satellite distribution network. We began deploying the
high-definition (HD) configuration of our interactive television system in 2005 and we currently
have our HD interactive television system installed in over 270,000 rooms from our 1.7 million
interactive television room base. These HD rooms generate significantly more revenue per room per
month than our average systems, providing an attractive rate of return on our capital investment.
We believe increasing the size of our HD room base represents a significant opportunity for the
Company to improve the guest room experience, enhance our hotel customer relationships and increase
our per-room revenues. Additionally, it creates the foundation upon which we will introduce our
new Envision software applications.
Increasingly Diversified Revenue Streams. We have steadily diversified our revenue streams beyond
our traditional business of in-room on-demand entertainment. Our diversified revenues have grown
from approximately 20% in 2006 to more than 40% of our total revenue for 2010, as we have been
successful in growing our Hotel Services revenues, including cable television programming and
Internet access, as well as entering the targeted advertising and healthcare markets. We currently
provide cable television programming to over 1.0 million hotel rooms and broadband Internet access
services to approximately 180,000 hotel rooms, both of which are contracted on a per room, per
month fee basis. We also provide advertisers opportunities to target the attractive, but hard to
reach, traveler demographic through our THN subsidiary, where nationally programmed commercials are
replaced with ads targeted at the business and vacation traveler demographic. Additionally, we
have our eSUITE interactive television solution installed in 56 hospitals as of December 31, 2010.
Free Cash Flow Generation. We have increased the amount of free cash generated by our business
over the past several years, by reducing our operating costs, decreasing the number of rooms and
the amount of capital we invest per HD room we install or upgrade, reducing our interest cost and
managing our working capital. For the year ended December 31, 2010, we generated approximately
$80.0 million of free cash flow, prior to paying down debt. Our free cash flow is expected to
enable us to continue to upgrade existing rooms to HD systems in return for contract extensions, as
well as invest in new products and target new markets.
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Business Strategy
Our goal is to continue to expand and enhance our position as the leading provider of interactive
media and connectivity solutions to the hospitality and healthcare industries in the United States,
Canada and Mexico. To accomplish our goal, we intend to pursue the following strategies:
Capitalize on the favorable economics of and demand for our HD system. We can improve the in-room
television experience by providing hotel guests with a greatly enhanced viewing experience through
our high-definition, interactive television system; and our agreement to install these systems in
rooms enables us to extend our hotel contracts for an incremental five to seven years. We have HD
systems installed in over 270,000 hotel rooms, representing approximately 16% of our installed room
base. Rooms equipped with our HD systems are generating approximately 60% greater per-room revenue
for us than our rooms installed with analog technology. The higher revenue performance is driven
by 1) a lift in Guest Entertainment revenue within our HD rooms, 2) a higher penetration of
LodgeNet-provided HD cable programming within HD rooms and 3) the mix of converted rooms are from
generally higher chain scale properties. Our return on investment and payback has significantly
improved, as the cost of installing a room with our HD technology has decreased by nearly 50% since
2008.
Leverage our installed base of over 1.8 million hotel rooms to continue to introduce new products
and services. Our installed base of 1.8 million hotel rooms gives us the scale to launch new
product innovations, such as enhanced Internet access services and on-demand television
programming, as well as targeted advertising through our THN subsidiary. We will begin deploying
our next generation Envision software into our room base in 2011. Envision will provide hotel
guests access to a number of Internet-sourced, traveler centric applications designed to enhance
and automate the hotel guest experience, such as purchasing local event tickets and hotel branded
merchandise, making restaurant reservations and viewing content streamed from the Internet.
Envision will enable hotels to provide additional services to their guests from which we expect to
earn recurring subscription revenues, which will not fluctuate with occupancy or consumer buying
patterns.
Maintain strong relationships with our hotel, studio and technology partners. We seek to continue
to be a value added partner for hoteliers by delivering industry leading content and applications
for use within their operations. By providing customized promotional and informational content, we
facilitate the brand promotion and customer loyalty initiatives of our hotelier partners; and our
interactive services, including in-room check out and several of our new Envision applications, are
designed to help hotels reduce costs and streamline their own operations while enhancing the guest
experience. We expect to continue to be an attractive distribution channel for studios and select
technology providers, as we believe our in-room movie sales provide a high-margin revenue
opportunity for the studios and attractive technology implementation opportunities for our
technology providers.
Successfully continue to grow our healthcare business. We believe we are in the early stages of
penetrating this large and attractive market, as we serve approximately 1% of the existing hospital
beds in the United States. We believe there are strong underlying growth drivers for us in the
healthcare market due to growing demand for healthcare services and the increasing focus by
hospitals on interactive patient education.
Focus on free cash flow generation. We have increased free cash flow generation during 2010 by
over 20% compared to 2009. We accomplished this by prudently managing our capital deployment,
controlling costs, efficiently managing our working capital and deleveraging our balance sheet.
Since the end of 2008, we have reduced our consolidated outstanding debt from $588.5 million to
$373.6 million.
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The following table presents selected operations data for the period 2006 through 2010. In
2007, LodgeNet acquired the assets of StayOnline, Inc. and the stock of Ascent Entertainment Group,
Inc., which owned 100% of the capital stock of On Command Corporation. These acquisitions
substantially increased our Hospitality room base and affected our financial results for 2007.
Dollar amounts are in thousands, except for room data:
Year Ended December 31, | ||||||||||||||||||||
2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||
Financial Highlights: |
||||||||||||||||||||
Revenue |
$ | 452,172 | $ | 484,492 | $ | 533,879 | $ | 485,588 | $ | 288,213 | ||||||||||
Operating income (loss) |
23,410 | 21,692 | (5,071 | ) | (4,236 | ) | 26,932 | |||||||||||||
Depreciation and amortization (1) |
83,236 | 100,309 | 124,060 | 116,378 | 66,311 | |||||||||||||||
Share-based compensation and restricted stock |
1,762 | 1,724 | 2,275 | 1,737 | 1,677 | |||||||||||||||
Net (loss) income |
(11,685 | ) | (10,155 | ) | (48,418 | ) | (65,172 | ) | 1,841 | |||||||||||
Net (loss) income attributable to common stockholders |
$ | (17,435 | ) | $ | (13,269 | ) | $ | (48,418 | ) | $ | (65,172 | ) | $ | 1,841 | ||||||
Selected Operations Data: |
||||||||||||||||||||
Hospitality |
||||||||||||||||||||
Total rooms served (2) |
1,829,712 | 1,909,323 | 1,977,015 | 1,962,090 | 1,052,025 | |||||||||||||||
Total Guest Entertainment rooms (3) (8) |
1,680,322 | 1,779,979 | 1,866,353 | 1,860,720 | 1,004,937 | |||||||||||||||
Total High Definition rooms (4) (8) |
270,384 | 231,588 | 191,491 | 84,327 | 23,502 | |||||||||||||||
Percentage of Total Guest Entertainment rooms |
16.1 | % | 13.0 | % | 10.3 | % | 4.5 | % | 2.3 | % | ||||||||||
Total Television Programming (FTG) rooms (5) (8) |
1,030,437 | 1,087,860 | 1,105,754 | 1,068,256 | 535,777 | |||||||||||||||
Percentage of Total Guest Entertainment rooms |
61.3 | % | 61.1 | % | 59.2 | % | 57.4 | % | 53.3 | % | ||||||||||
Total Broadband Internet rooms (6) (8) |
178,047 | 201,936 | 229,003 | 218,860 | 37,686 | |||||||||||||||
Advertising |
||||||||||||||||||||
Total Advertising and Media Services rooms (7) (8) |
1,173,808 | 1,207,465 | 893,738 | 716,219 | | |||||||||||||||
Healthcare |
||||||||||||||||||||
Total hospitals installed |
56 | 45 | 28 | 20 | 11 | |||||||||||||||
Total beds installed |
12,224 | 9,192 | 6,543 | 4,387 | 2,162 |
(1) | Includes amortization of acquired intangibles. | |
(2) | Total rooms served include rooms receiving one or more of our services, including rooms served by international licensees. The increase from 2006 to 2007 is due primarily to the addition of the On Command room base of approximately 830,000 rooms. | |
(3) | Guest Entertainment rooms are equipped with our interactive television systems. | |
(4) | High Definition rooms are equipped with high-definition video-on-demand capabilities. | |
(5) | Television programming (which we refer to as free-to-guest or FTG) rooms receiving basic or premium television programming. | |
(6) | Represents rooms receiving high-speed Internet service. The increase from 2006 to 2007 is due to the addition of the StayOnline and On Command room bases of approximately 137,000 and 12,000 rooms, respectively. | |
(7) | Includes rooms receiving satellite-delivered and server-based channels. | |
(8) | Included in total rooms served. |
We define free cash flow, a non-GAAP measure, as cash provided by operating activities less cash
used for certain investing activities. 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.
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Table of Contents
Overview of Markets Served
HOSPITALITY AND ADVERTISING SERVICES
In the hospitality market, we provide our interactive media and connectivity solutions to hotel
customers and their guests throughout the United States, Canada and Mexico, and through licensing
arrangements with companies in other select countries. Our hospitality business is focused on:
Guest Entertainment services, which includes products guests purchase on a pay-per-view or similar
basis; Hotel Services, which includes the cable television programming and broadband Internet
service we provide to hotels; System Sales and Related Services, which includes the sale of cable
television equipment, broadband Internet equipment and HDTV installations; and Advertising
Services, which consists of the sale of advertising directed to hotel guests and carriage services
to programming providers by THN. Except for Guest Entertainment and Advertising Services, our
other services are sold directly to hotels and do not involve guest purchases. Our strategy is to
maximize our traditional Guest Entertainment business, primarily through the expansion of HDTV
rooms, while we develop new products and services, such as our newly-introduced Envision product,
to grow diversified, new revenue within our Hotel Services and System Sales and Related Services
over time. Many of our potential diversified revenue sources are focused on products and services
which require limited capital investment by us; however, certain of our potential diversified
revenue sources may require significant capital investment.
Markets and Customers
Diversified Customer Base. The primary market for our interactive media solutions is the mid-size
and large hotel segments within the United States, Canada and Mexico. We believe our hotel base is
well diversified in terms of location, demographics and customer contracts. As of December 31,
2010, no single state or province accounted for more than 8% of the hotel properties served by us.
We provide our services to various hotel chains, ownership groups and management companies
representing some of the finest hotels in the world, including Marriott International, Inc. (J.W.
Marriott, Ritz-Carlton, Renaissance, Courtyard by Marriott, Fairfield Inn & Suites, Residence Inn,
Springhill Suites and Towne Place Suites); Hilton Worldwide (Hilton, Doubletree, Embassy Suites,
Hampton Inn & Suites, Hilton Garden Inn, Homewood Suites, Conrad Hotels & Resorts and The Waldorf
Astoria Collection); Starwood Hotels & Resorts (aloft, Element, Westin, W Hotels, Sheraton, Four
Points by Sheraton and The Luxury Collection); Hyatt Hotels Corporation (Andaz, Hyatt, Hyatt
Regency, Park Hyatt and Hyatt Place); Four Seasons, Fairmont; Harrahs; Kimpton Hotels &
Restaurants; Wyndham Hotels & Resorts (Wyndham, Wyndham Garden, Wingate by Wyndham); Gaylord
Hotels; Omni Hotels; Loews Hotels, Outrigger; Grand Casino; Felcor; Interstate; John Q. Hammons,
Davidson Hotels, Winegardner & Hammons; Las Vegas Sands Corporation (Venetian Resort Hotel Casino,
Four Seasons Hotel Macau, Sands Macau Hotel, Venetian Macau Resort Hotel); and Sage Hospitality, as
well as many independent properties. During 2010, our two largest brands covered by master
services agreements, Hilton Worldwide and Marriott International, represented approximately 18.9%
and 16.3%, respectively, of our consolidated revenue. Properties owned and operated by Hilton
accounted for approximately 1.3% of consolidated revenue, as most of the hotels served under the
Hilton agreement are owned by independent franchisees. Marriott does not own any of the properties
served under the Marriott agreement. The properties are all owned by independent franchisees.
Each property is subject to an individual long-term property level agreement. No other master
service agreement accounted for more than 10% of our consolidated revenue. Additionally, our room
base is geographically diversified, which mitigates our reliance on any one geographic sector.
We also provide services in select international markets through licensing arrangements with
companies in these areas. Under these arrangements, we sell the equipment and license our
interactive television system and technologies to the licensee and receive a royalty based on gross
revenue. We intend to continue to expand in selected countries in Asia, South America, Europe and
other regions. Financial information related to our domestic and international operations is
included in Note 16 of the Consolidated Financial Statements.
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Products and Services
Guest Entertainment
Approximately 60% of our revenue within the hospitality market comes from the sale of on-demand
entertainment content, which the hotel guest buys on a per-view, hourly or daily basis. We design,
develop and operate interactive television systems installed at hotel properties, and it is through
these systems our Guest Entertainment revenues are generated.
Our interactive television systems provide a broad array of guest entertainment and other
interactive services, including:
Ø | on-demand movies; | ||
Ø | on-demand television programming; | ||
Ø | on-demand digital music programming; | ||
Ø | daily subscription sports programming; | ||
Ø | on-screen controls which allow the guest more viewing control and flexibility; and | ||
Ø | interactive guest marketing and merchandising capabilities. |
The vast majority of these systems are owned by us, although, in some cases, hotels purchase the
systems from us. The interactive system connects each individual hotel room to a server, referred
to as the headend, located within the hotel. Because of the flexible and modular design of the
system architecture, we can typically upgrade our software and hardware to support the introduction
of new interactive services and integrate new technologies as they become commercially available
and economically viable.
In 2005, we began deploying an HD configuration of our digital system, which allows the delivery of
a variety of high-definition programming services to guest rooms. The HD configuration uses the
same content management and satellite distribution network as our standard digital system; however,
in the HD system, the content is sent in a digital format from the headend server to a commercial,
in-room digital television. In our standard digital systems, the content is sent to the in-room
television using an analog transport technology. The HD system utilizes the
Pro:IdiomTM premium content copy protection technology to enable LodgeNet-served hotels
to display HD premium satellite and video-on-demand entertainment licensed by satellite programmers
and movie studios. Our experience has been that rooms with HD systems generate higher average
monthly per-room revenue than non-HD rooms. Accordingly, we actively converted analog rooms to
HDTVs beginning in 2006. The rate of HD conversions has been reduced recently, as hotels have
deferred their purchase of high-definition televisions and we have reduced the amount of capital
allocated to installation activities. However, we expect the number of rooms served with our HD
system will expand significantly during the next several years, as we utilize our free cash flow
for new HD installations and system upgrades. Our goal is to have HDTV installed in more than 50%
of our room base over the next three to four years.
The Guest Entertainment revenues generated from our interactive television services are dependent
upon a number of factors, including:
Ø | the number of rooms equipped with our interactive television system; | ||
Ø | the range of interactive and HD television content and services offered at each hotel; | ||
Ø | the popularity, amount and timeliness of content offered, as well as the popularity and availability of other entertainment alternatives; | ||
Ø | the profile of the guest at each property; | ||
Ø | the price of the service purchased by the hotel guest; | ||
Ø | the occupancy rate at the property; and | ||
Ø | general economic conditions and consumer sentiment. |
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Increasing the number of rooms served by our interactive television system is dependent on a number
of factors, including the amount of capital we elect to allocate to installation activities, the
desirability of our technology, new hotel construction and the number of hotels which choose to
purchase a system from us. Revenues vary with the number, availability and popularity of major
motion pictures and the guests other entertainment alternatives. The price charged for each
interactive programming option is established by us and is segmented according to the guest mix
profile at each property and overall economic conditions. Movie prices are set on a title-by-title
basis and may be higher in some locations and for more popular titles. In addition, our content
management systems allow us to refresh interactive menus; promote different products and different
titles to different demographics; and change pricing of our products, selection and promotions
based on time-of-day or day-of-week, among other marketing efforts to the guest. Our systems allow
us to measure guests entertainment selections and we adjust our programming and the pricing of the
programming to respond to viewing patterns. Occupancy rates vary by property based on the
propertys competitive position within its marketplace, seasonality factors and as a result of
changes in general economic conditions. Typically, occupancy rates are higher during the second
and third quarters due to seasonal travel patterns, and these quarters typically generate our
strongest financial results.
Hotel Contracts. We provide our interactive television services under contracts with lodging
properties, which generally are for a term of five to seven years. Our contracts typically require
that we will be the exclusive provider of in-room, on-demand television entertainment services to
the hotels, permit us to set prices for the interactive services, and allow us to terminate the
contract and remove our system if the results of operations do not meet our return on investment
criteria. Under these contracts, we generally install our interactive television network in the
hotel and retain ownership of all equipment utilized in providing our services (except for the
television sets and other in-room equipment, which are paid for by the hotels). The length of each
agreement is determined based on a number of factors, including the revenue potential of the hotel,
the amount of capital we are investing in the equipment and other considerations. A term of five
to seven years is generally adequate to assure we receive the expected return on our invested
capital and, to the extent this is not the case, we generally require the hotel to contribute a
portion of the capital required. In cases where the hotel customer contributes to the capital
costs of the system, the term and other provisions of the agreement may be modified from those set
forth above; however, the terms will be designed to meet our return on investment criteria. When a
property level agreement is for a period of less than five years, the individual property generally
must contribute most, if not all, of the required capital. We also offer, to certain hotel
customers who would not otherwise qualify for the installation of our systems using our capital, or
who desire to exercise greater control over content and pricing, the opportunity to purchase our
systems combined with long-term service maintenance and content agreements with us.
While a separate service agreement is executed with each property, we also enter into master
agreements which govern the terms on which services will be rendered to the properties affiliated
with various hotel brands. Historically, these master agreements gave us status as a preferred
provider for the term of the agreements and specified the terms on which our systems would be made
available to all properties affiliated with the brands covered by the agreements and established
standards which required franchise properties to install certain types of systems. While such
agreements were beneficial in that they required any hotels owned or managed by the brands to
execute hotel level agreements and authorized (but did not require) franchised hotels to sign
property level agreements, they also typically specified the financial terms of all agreements with
the affiliated brands and required systems be made available on the contracted terms without regard
for the return on investment for a particular property. Increasingly, franchisors have exhibited a
reluctance to enforce brand standards and, in some cases, have eliminated such standards
altogether, particularly in economy or limited service properties. Existing master agreements also
created problems for management groups which owned properties affiliated with a number of brands
and faced conflicting contract requirements specified by the various existing master agreements.
In order to address these issues, beginning in 2008, we changed our approach to major brand
relations by moving to standard pricing terms for the largest brands, with the understanding we
could adjust pricing terms periodically, and limited our obligation to install systems in
properties which did not meet specified minimum performance criteria. It is expected all master
agreements in the future will be consistent with this new model.
While we consider master agreements to be desirable, such master agreements no longer assure a
guaranteed amount of business, and thus are not a substitute for property level agreements.
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For the on-demand programming which is purchased by the hotel guest, the hotel collects such
charges on our behalf, along with the collection of room and other charges made by the hotel guest,
and the hotel remits funds to us on a monthly basis. The hotel retains a commission for such
services, which varies depending on the size and profitability of the system and other factors. We
generally seek to extend and renew hotel contracts in advance of their expiration. Over the last
five years, we have de-installed from 2% to 6% of our installed base per year. During 2010, we
de-installed approximately 109,000 rooms, or approximately 6% of our installed base.
De-installations typically reflect certain sites electing not to continue to provide on-demand
programming to their guests or our decision not to renew contracts at select properties, primarily
limited service and extended stay properties, as the revenue generated at these properties
frequently does not meet our payback criteria.
Hotel Services, System Sales and Related Services and Other Diversified Revenue
One of our principal business goals is to diversify our sources of revenue by the following
products and services:
Television Programming. We offer a wide variety of satellite-delivered television programming paid
for by the hotel and provided to guests at no charge. The television programming is delivered via
satellite through DIRECTV, pursuant to an agreement, and distributed to guest rooms 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 our HD system, we also began offering high-definition television
programming to the extent available from broadcast sources and DIRECTV.
The television programming is generally provided under contracts with hotel properties which
generally run for the same period as the interactive television contract for a given property. The
hotel pays a fixed fee per room per month for this programming, which in turn is provided to the
guest without charge. We categorize this recurring revenue as Hotel Services revenue. We also
generate revenue through the sales of the system equipment necessary to provide this service to the
hotels. This revenue is categorized as revenue from System Sales and Related Services.
Broadband Internet System Sales, 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, allow hotels to charge or provide the access as a guest amenity and provide
bandwidth management tools. We generate revenue through the sale and installation of the equipment
and we provide 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 existing hotel
customer relationships, our expertise in integrating and customizing connectivity solutions for
hospitality, our nationwide field service network and a 24-hour call center to support calls from
hotel customers.
Contracts for broadband Internet access services to hotels generally have terms of three to four
years. Pursuant to these agreements, the hotel pays us a fixed fee per room per month for
providing 24-hour help desk services to their guests having questions about accessing the Internet.
In some cases, we also enter into technical service agreements, for which the hotel pays an
incremental fixed fee per room per month. We also provide technical service under an hourly
service charge arrangement. We categorize the recurring monthly revenue as Hotel Services revenue
and the revenue from equipment sales as revenue from System Sales and Related Services.
System Sales and Related Services. In addition to the sale of Internet connectivity systems and
satellite television reception equipment to our hotel customers, we also generate revenue from the
sale of interactive television systems to our international licensees. We also offer hotel
properties which do not meet our economic and/or demographic profile, or wish to accelerate the
installation of their system, the opportunity to purchase our interactive television system. We
then program, operate and maintain the system and receive a percentage of revenue generated from
Guest Entertainment purchases. We categorize the revenue generated from these sales as System
Sales and Related Services. Our Professional Solutions Group provides services to hotels such as
system planning, technical installations, project management and support services, primarily
focused on high-definition television and low voltage wiring installations. Generally, the
Professional Solutions Group quotes and sells its services on a project-by-project basis.
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Hospitality Operations and Structure
Sales and Marketing. For the hospitality market, we focus our sales and marketing strategies on
acquiring new contracts from hotels, extending and retaining existing contracts, and marketing our
interactive services to hotel brands, management companies, ownership groups and individual hotels.
Our sales organization includes national account representatives, who develop relationships with
national hotel brands, and regional sales representatives, who maintain relationships primarily
with franchise organizations and management groups, regional hotel management and ownership
organizations. We market our services and products to hotels by advertising in industry trade
publications, attending industry trade conferences, trade shows and direct marketing. Sales
activities are coordinated from our headquarters. Given our long operating history and reputation
for service and innovation, we believe we are well recognized in the market among our existing and
potential customers.
We market our services to hotel guests through a variety of means, including an interactive,
image-based menu and purchasing protocol using on-screen graphics, promotions and programming
information. Our system also generates a Welcome Channel, which appears on-screen when the
television is turned on and describes the programming and interactive services available through
our system. Our systems also generally have a promotion channel located within the television
lineup which presents movie trailers and other information about the services available on the
system.
Installation Operations. Once a contract has been signed with a hotel, our installation personnel
prepare engineering surveys for each site, install our systems, train the site staff to operate the
systems and perform quality control tests. Due to our geographically diversified customer base, we
have determined it is usually more cost effective to utilize subcontracted installation teams,
which are managed and coordinated by our in-house installation employees. We work closely with our
company-trained subcontractors and have a separate quality control department to regularly monitor
quality standards.
Service Operations. We believe high quality and consistent systems support and maintenance are
essential to our continued competitive success. We emphasize the use of company-employed service
personnel operating from locations throughout the United States, Canada and Mexico, but also use
company-trained subcontractors in areas where there is not a sufficient concentration of
company-served hotels to warrant a company-employed service representative. Service personnel are
responsible for all preventive and corrective systems maintenance. Our service organization is
also utilized to support our broadband Internet systems.
We maintain a toll-free customer support hot line, which is staffed 24 hours a day, 365 days a
year. The on-line diagnostic capability of our systems enables us to identify and resolve most of
reported system service issues from our service control center without visiting the hotel. When a
service visit is required, the modular design of our systems permits service personnel to replace
only those components which are defective at the site.
Component Suppliers. We contract directly with various electronics firms for the manufacturing and
assembly of certain system hardware, the design of which is controlled by us. We have found these
suppliers to be dependable and generally able to meet delivery schedules on time. We believe, in
the event of a termination of any of our sources, with proper notification from the supplier,
alternate suppliers could be located without incurring significant costs or delays. Certain
electronic component parts used within our products are available from a limited number of
suppliers and can be subject to temporary shortages because of general economic conditions and the
demand and supply for such component parts. If we were to experience a shortage of any given
electronic part, we believe alternative parts could be obtained or system design changes
implemented. In such event, we could experience a temporary reduction in the rate of new
installations or conversions to high definition and/or an increase in the cost of such
installations. All other components of our systems are standard commercial products, such as
computers, hard drives, routers, modulators and amplifiers, which are available from multiple
sources. We believe our anticipated growth can be accommodated through existing suppliers.
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Programming. We obtain non-exclusive rights to show recently released major motion pictures from
motion picture studios pursuant to an agreement with each studio, which is typically two to three
years in length. The royalty rate for each movie is predetermined, with the studio receiving a
percentage of the gross revenue from the movie. For recently released motion pictures, we
typically obtain rights to exhibit the picture while it is still in theatrical release and prior to
its release to the home video market or for exhibition on cable television. For our television
on-demand programming, we obtain the rights to exhibit television on-demand content for which we
pay a predetermined percentage of gross revenue or a one-time fixed fee. In addition, we
distribute satellite-delivered cable television programming, including HD format programming,
through an agreement with DIRECTV. We also have agreements with certain other select television
programming providers, such as HBO. We pay our television programming providers a fixed, monthly
fee for each room or subscriber receiving the service. We believe our relationships with the
television programming suppliers are good and expect to renew these contracts as necessary on
competitive terms. We obtain independent films, most of which are non-rated and intended for
mature audiences, for a one-time fixed fee. We also obtain non-exclusive rights to digital music
content, through an agreement with one of our subsidiaries, whereby we pay a predetermined
percentage of the gross revenue from the music service. We obtain our selection of Nintendo® video
games pursuant to a non-exclusive license agreement with Nintendo, which expires in May 2013.
Under the terms of the agreement, we pay a monthly fee equal to a percent of revenue generated from
the sale of Nintendo video game services. For our Hotel SportsNETSM programming, we
obtained the rights to exhibit sporting event content from the NFL, NHL, NBA, ESPN and College
Sports TV (CSTV), for which we pay a predetermined percentage of gross revenue.
Technology, Product Development, and Patents. We design and develop our own interactive
television systems. Because such systems utilize an open architecture design incorporating industry
standard interfaces, historically we have been able to upgrade system software to support the
introduction of new services or integrate new technologies as they become economically viable. Our
interactive television system incorporates commercially manufactured, off-the-shelf electronic and
computer components and hardware.
Our system architecture utilizes a proprietary, two-way digital communications design to process
and respond in real time to input commands from guests through the television in each guest room.
This capability, combined with our menus and guest interface screens, enables us to provide guests
with sophisticated interactive television services which include: on-demand movies with pause,
skip, forward, back and save functionality; network-based video games; music services; on-demand
television programming; and a variety of other interactive services. Our system also interfaces
with the hotel systems, allowing guests to review room charges, check out, take guest surveys and
view interactive information about the hotel and its services.
Our interactive television systems consist of equipment located within the guest room and
associated equipment required for the generation, reception, storage, transmission, amplification
and modulation of signals located elsewhere in the hotel. Typical in-room equipment includes a
terminal unit and a hand-held television remote control. For those properties equipped with the
digital systems, in-room equipment may also include an infrared computer keyboard or a video game
controller. Video and music programming originates from the system headend and is transmitted to
individual rooms over the hotels coax-based (RF) or Internet Protocol (IP) Local Area Network.
Video game programs are downloaded into dedicated video game processors also located within the
headend. Keystrokes and other system commands and communications are transmitted from the room
using our proprietary communications infrastructure and the video and other signals are transmitted
to the guest room over the network. The system computer controls the delivery of the interactive
services to the guest room and also records purchase transactions and billing data to the hotels
accounting system, which posts the charge to the guests bill.
In addition, we are continuing to develop and integrate technologies which enable us to deliver
high-definition television and Internet-sourced content to our hotels and their guests. These
developments extend our digital platform with new technology, including specially-equipped digital
televisions and set-top or set-back boxes which are able to receive RF signals or IP video data and
decrypt and decode this digital content and render menus in the guestroom. These HD systems are
contrasted with our traditional systems, which deliver an analog signal to the room from either a
digital storage device or analog tape-based storage. The digital content is encrypted to protect
the rights of content owners, who consider this protection when granting us distribution rights.
Our new digital video and IP solutions leverage our current headend-based platform and our
industry-leading content management and distribution technology, providing scalability, reliability
and lower costs than many other models.
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Our content management systems allow us to refresh interactive menus, by brand or even down to a
specific property level, if desired; promote different products and titles to different
demographics; and change pricing of our products, selection and promotions based on time-of-day or
day-of-week, among other marketing efforts to the guest.
At those properties where we have sold broadband Internet systems, we offer a selection of
technology systems, which consist of commercial off-the-shelf networking equipment used to provide
wired and wireless connections to guests computers. To support these systems, we have our own
proprietary Visitor Based Network (VBN) software, which manages connections between the guest and
the Internet, and also offer solutions which use licensed VBN software. The connection to the
Internet is provided by either the hotel or an Internet Service Provider contracted by us.
Our policy is to apply for patents on those product designs which management believes may be of
significance to our business. We currently hold 19 United States and foreign patents, and have
other applications for patents pending, which pertain to various aspects of our interactive
systems. We also license industry-related technology from third parties.
Advertising and Media Services
THN provides a platform to create and generate revenue for our Company through paid advertising or
sponsorships. THNs primary business is presenting advertisers with the opportunity to target
attractive demographic groups, such as business professionals, affluent consumers and travelers.
These mobile professionals represent a coveted demographic to many marketers, and THN provides a
set of programs to reach this audience. In 2010, THN had advertisers from industries such as
insurance, pharmaceutical, automotive, travel, financial services, technology, consumer goods and
telecommunications.
THN provides traditional television advertising, place-based digital advertising and promotional
marketing solutions focused on business-class and upscale hotels. We believe 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. This is accomplished through three primary program offerings:
1) | Traditional Television Advertising. The THN Superblock consists of a package of 10 cable networks broadcast through THNs private satellite network. Based on the agreement THN has with most of these networks, THN has 100% of the national and local commercials available across these networks, which is then sold to advertisers in a block format. | ||
2) | Video-On-Demand/Interactive Advertising. THN offers two approaches to interactive advertising. Freeviews is an on-demand advertising program which enables guests to choose from a variety of advertiser-sponsored content within the interactive television menu, which they can view free of charge. Interactive Channels is a program which allows marketers to promote their products or brands on an interactive, linear channel located within the standard free television lineup, from which guests can then telescope into content stored on the interactive television server. Freeviews and Interactive Channel content categories include target areas such as golf, travel, technology, health, fitness, and music. These programs are also Nielsen rated, so we can demonstrate to advertisers their ad impressions are being delivered. | ||
3) | Programming Carriage Services. Network, cable and content companies value the branding and sampling hotel broadcast distribution provides to a large and important demographic. Both satellite and server channels can provide programming trial, which research shows leads to a significant viewership conversion when guests return home. |
Sales and Marketing. We focus our sales and marketing activities on selling advertising time and
sponsorship opportunities to consumer brands and their representative advertising agencies. Our
sales organization calls on clients and the full array of agencies, from promotional, out-of-home
(OOH) and interactive agencies to broadcast planners and buyers. Additionally, we market our
company and services through trade publications, various web sites and industry conferences.
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Installation and Service Operations. We utilize both internal installation personnel and
subcontractors to install contracted equipment and services to hotels. We also utilize the
Hospitality field service operations and customer support services to provide high quality and
consistent system support and maintenance for the systems deployed in the hotels. The satellite
uplink and distribution of our networks is provided via contract with third party providers, with
ad insertion and trafficking provided by an in-house team based in New York City.
Programming. Additionally, we market customized content and programming to hotels in both a linear
channel and on-demand format. This includes packages of traditional cable programming, as well as
proprietary content we source or produce ourselves. In some cases, we are able to collect
distribution fees from content partners due to the marketing exposure generated through our hotel
networks.
Technology and Product Development. THN leverages the technology and product development of the
other LodgeNet divisions, as well as develops innovative, advertising-specific applications. THN
also has dedicated resources for promotional development, interactive programming and new media.
HEALTHCARE
We sell a variety of products to acute care and specialty hospitals, including eSUITE, an
interactive television solution which provides innovative ways for hospitals to educate, entertain
and engage their patients. Revenue is generated from the sale of system hardware, software
licenses and professional services. Additionally, we earn recurring revenues from the sale of
on-demand movies and television content, patient education videos, software maintenance and
technical support services. eSUITE is built on the same system architecture used in Hospitality,
with additional enhancements needed to meet the unique needs of the healthcare environment,
including patient education applications and clinical system integrations. Contract terms are
typically for five years, with many sites implementing services in phases, providing future growth
opportunities. Systems are sold through both direct sales and sales agents who have established
relationships with healthcare facilities.
As of December 31, 2010, we had 56 facilities installed with our interactive television system.
Healthcare Market and Customers
The healthcare market in the United States consists of over 940,000 hospital beds across 5,800
facilities. We believe most hospitals currently do not have any form of interactive television
services. Customers who have purchased systems from us represent some of the most highly regarded
hospitals and health systems in the United States, including Brigham and Womens Hospital in
Boston, Massachusetts; The University of Texas MD Anderson Cancer Center in Houston; Childrens
Pittsburgh, part of UPMC Health System; Baylor Plano/Baylor Heart in Texas; Kaiser
Oakland/Sunnyside in California; The University of Chicago Northshore Hospital; and Cedars-Sinai
Medical Center in Los Angeles, California.
The primary reasons hospitals purchase interactive television systems are to increase patient
satisfaction, to improve clinical outcomes and to increase operational efficiencies.
Recently, significant focus has been placed on healthcare reform, which is intended to improve the
quality of care, while promoting efficiencies in delivery and containing costs. Hospitals looking
to meet the requirements of the four Medicare payment reform initiatives will be best served by
adopting a patient engagement strategy which employs the use of technology; is implemented within
the inpatient environment, with follow-up care across the care continuum; is effective at
motivating patients to play an active role in their own care; and can reach all patients, including
the most vulnerable. eSUITE meets all of these requirements. Our solution provides critical
information in a video format, which drives comprehension, while dynamic automation promotes
operational efficiencies and robust integrations provide the ability to track and report on patient
viewing and comprehension. eSUITE is a powerful engagement tool which meets current requirements,
while providing a strong foundation which can be built upon to meet future needs.
Interactive television systems are most commonly purchased when a new hospital is under
construction, in conjunction with a renovation project or at the time a facility is migrating to
flat-panel televisions. Often times, hospitals try to leverage their facility investments to
provide greater patient satisfaction and enhanced patient experiences.
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Healthcare Market Services and Products
LodgeNet Healthcare offers care facilities a variety of solutions, including the following:
Ø | eSUITE, an interactive television system which includes specialized applications and integrated services; | ||
Ø | professional services including cable plant design, modification and installation, as well as television installation services; | ||
Ø | DIRECTV satellite equipment sales and programming; | ||
Ø | digital signage and messaging solutions; and | ||
Ø | service agreements covering cable plant, DIRECTV, television and interactive system support. |
Additional applications delivered through our interactive television system include:
Ø | custom welcome channel; | ||
Ø | safety videos; | ||
Ø | hospital information channel; | ||
Ø | digital healthcare open channel; | ||
Ø | relaxation channel; | ||
Ø | music channels; | ||
Ø | interactive games; | ||
Ø | interactive information about the hospital and its services; | ||
Ø | interactive information about a patients care team and schedule; |
Ø | assigned education application enables care providers to assign specific videos to patients based on their diagnoses; includes ability to track viewing and comprehension and the ability to chart the information in the patients electronic medical record; | ||
Ø | patient request application allows patients to submit common requests through the television directly to the person responsible for fulfillment, allowing nursing staff to focus on patient care; | ||
Ø | patient feedback surveys designed to capture and build in-service recovery so patient issues can be identified and addressed by the care staff while the patient is still in the hospital; | ||
Ø | retail promotions for revenue-generating services such as outpatient pharmacy, home medical equipment, health clubs and other outreach/continuum of care services; and | ||
Ø | meal ordering application provides information on diet types and allows patients to order meals based on diagnosis and allergies. |
Sales and Marketing. In the healthcare market, we focus our sales and marketing strategy on the
acquisition of new care facility contracts, while increasing awareness of our eSUITE solution. Our
sales organization consists of internal direct sales and third-party sales/lead referral agents
with care facility relationships. Marketing efforts include direct mail campaigns, print ads in
trade publications, digital/online promotions, tradeshows, summits and public relation tactics
including press releases, webinars and whitepapers.
Installation and Service Operations. We utilize both internal personnel and subcontractors to
install contracted equipment and services to individual healthcare facilities. To manage the cost
and quality of our installations, we assemble the systems at our corporate headquarters and utilize
the same group of subcontractors who install our Hospitality interactive systems. We also utilize
the Hospitality field service operations and customer support services to provide high quality and
consistent system support and maintenance for the systems deployed in healthcare facilities.
Programming. We sell programming to healthcare facilities using various third-party distributors.
We obtain the rights to show major motion pictures, which are typically offered to patients at no
charge, as well as patient education content, pursuant to non-exclusive programming agreements.
These agreements are typically three to five years in length, with programming royalties based on
the number of beds at each healthcare facility receiving services. In addition, we also utilize
our existing relationships with DIRECTV for television programming and Nintendo for video game
services.
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Technology and Product Development. We generally leverage the technology and product development
utilized in the Hospitality market to provide solutions and services to healthcare facilities, with
limited modifications and customizations.
Competition
Hospitality
Based on the number of hotels and rooms served, we are the worlds largest provider of interactive
media and connectivity solutions to hotels. Competitors for media and connectivity services
include, but are not limited to:
Ø | other interactive television service providers, such as Hospitality Networks, Inc. (a wholly-owned subsidiary of Cox Communications, Inc.), NXTV, Kool Connect, SuiteLinq, Guest-Tek, iBAHN, Tivus, Roomlinx and international providers, such as Acentic, MagiNet and Quadriga; | ||
Ø | other providers of basic and premium television programming, such as Charter Communications, Comcast, Cox Cable, Dish Network, DIRECTV, Time Warner, BulkTV, Televue, Tangerine Global and World Cinema; | ||
Ø | television networks and programmers, such as ABC, NBC, CBS, FOX, HBO, and Showtime; | ||
Ø | other broadband Internet service providers, such as iBAHN, Guest-Tek, EthoStream, SuperClick, Comcast, Time Warner, Verizon, AT&T, Wi-Fi Venue Services, Influx, Xeta and T-Mobile; and | ||
Ø | companies which offer in-room computers with Internet access or other types of Internet access systems. |
Other indirect competition for guest attention and revenue include: television programming;
portable media devices such as MP3 players, iPods® and DVD players; other devices such as laptop
computers and cell phones; devices, such as iPads®, which can access web content; websites which
offer on-demand videos, television programs and movies; and other forms of entertainment and
information such as newspapers, magazines and books, concerts, sporting events and movie theaters.
Given the high level of innovation in communications technology, we expect to continue to confront
new sources of competition.
A number of potential competitors, including those identified above, could use their existing
infrastructure to provide in-room entertainment services to the hospitality industry. Some of
these potential competitors are already providing guest entertainment, television programming or
Internet-related services to the hospitality industry. Some of these companies have substantially
greater financial and other resources than we do, and it is possible such competitors may develop a
technology which is more cost effective than ours. To respond to competition, we will need to
continue to enhance our interactive systems, expand our operations and meet the increasing demands
for competitive pricing, service quality and availability of value-added product offerings.
Competition with respect to hotel contracts centers on a variety of factors, depending upon the
features important to a particular hotel. Among the more important factors are:
Ø | the features and benefits of the service offering, and Internet or interactive system; | ||
Ø | the quality of the vendors technical support and maintenance services; | ||
Ø | the financial terms and conditions of the proposed contract, including commissions to the hotel or capital cost of the system; and | ||
Ø | the ability to complete system installation in a timely and efficient manner. |
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In addition, with respect to hotel properties already receiving in-room entertainment or high-speed
Internet services, the incumbent provider may have certain informational and installation cost
advantages as compared to outside competitors. We believe our competitive advantages include:
Ø | the size of our existing customer base; | ||
Ø | our history of innovation; | ||
Ø | our diverse client base; | ||
Ø | our technically-innovative high definition platform; | ||
Ø | our digital platform; | ||
Ø | our flexible interactive television system; | ||
Ø | our content management system; and | ||
Ø | our field service group, which is, we believe, the largest technical services group focused on the hospitality industry. |
We believe our past success in securing contracts reflects the strong competitive position of our
products and services. While we believe our system architecture is comparable or superior to the
systems currently being used by our competitors in the hospitality industry, our competitors may
develop cost effective systems comparable or superior to ours. Also, we may not be able to
continue our current level of success in obtaining new contracts from hotels currently served by
other providers or previously un-served, and we may not be able to retain contracts with hotels we
serve when our contracts expire.
In the basic and premium television programming market, the local franchised cable operator in a
hotels market may have a substantial market presence. Such operators generally offer the hotel
owner only standard packages of programming, typically developed for the residential market rather
than the hospitality market, and at a fixed price per room based on all the channels provided. We
compete with the franchised cable operator for basic and premium programming contracts by
customizing packages of programming to provide only those channels desired by the hotel, typically
reducing the overall cost per room to the hotel operator.
Competitive pressures in the interactive television, basic and premium television programming and
broadband Internet access segments could result in reduced market share for us, higher hotel
commissions, lower margins and increased expenditures for marketing, product development and
systems installation, each of which could adversely affect our financial condition and operating
results.
Advertising and Media Services
THN occupies a unique niche in the advertising industry, providing commercial branding and
promotional programs targeted towards hotel guests based on our hotel relationships and
distribution network. This consumer group, which contains many affluent and business travelers,
represents an important, and at times, elusive, target for many companies and brands. Advertisers
do have other options when considering how to best reach and engage with these potential consumers.
Although there are but a few known in-hotel competitors which offer programs such as sampling
and public space digital advertising, there are many others which target travelers and the business
community in other ways. This includes:
Ø | Airport Advertising: Place-based OOH media found in airports, represented by companies such as Viacom, CBS Outdoor and JC Decaux; | ||
Ø | Airline Advertising: Television programming supported with commercials during flight, tray-top ads and ad-supported in-flight magazines and airline sampling programs, represented by companies such as IdeaCast and Brand Connections; and | ||
Ø | Office Advertising: Place-based digital media in office buildings, office elevators, etc., represented by companies such as Wall Street Journal, Captivate Media and others. |
More generally, we compete against the full array of media and marketing services companies. This
includes television broadcasters and cable companies, such as FOX, CBS, NBC, ABC, CNN, and ESPN.
It also includes magazine and web publishers, especially those focused on travelers, affluent and
business markets. These broader media companies offer superior reach, but are generally not as
targeted as THNs advertising programs.
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We believe our competitive advantages include:
Ø | significant experience in the hotel space, with well established hotel relationships; | ||
Ø | ability to leverage the LodgeNet field support and technical infrastructure; | ||
Ø | broad array of advertising options, including hotel television media, VOD media and in-room promotion; | ||
Ø | hotel television media which is Nielsen monitored, rated and guaranteed for advertisers; | ||
Ø | ideal environmental factors for ad receptivity no DVRs, few distractions, comfortable setting; | ||
Ø | consumer engagement which is both long and of a high quality; | ||
Ø | ability to integrate our marketing programs combining media with promotion; | ||
Ø | sophisticated technology allowing telescoping, where consumers can click from a linear commercial to an interactive ad menu; and | ||
Ø | large size of our existing customer base. |
Healthcare
Main competitors in the healthcare market include, but are not limited to:
Ø | other interactive patient care providers, such as GetWell Network, Skylight and Allen Technologies; | ||
Ø | companies which primarily sell or lease television sets and also offer some phone and television-based interactive services, which include TVRC and TeleHealth; and | ||
Ø | other providers of basic and premium television programming, such as Charter Communications, Comcast, Cox Cable, Dish Network, DIRECTV and Time Warner. |
We believe our competitive advantages include:
Ø | our significant experience from thirty years of service in the lodging sector; | ||
Ø | the technical reliability of our solution; | ||
Ø | our nationwide service and support organization; | ||
Ø | our ability to leverage features from our lodging systems to efficiently customize and deploy new solutions to healthcare facilities; | ||
Ø | our ability to provide our services over existing cable infrastructure; | ||
Ø | our access to HD content with Pro:IdiomTM encryption technology; | ||
Ø | our understanding of interactive television and guest ease-of-use; | ||
Ø | our ability to assign content to specific patients through multiple mediums and track behaviors; and | ||
Ø | our ability to integrate to third-party systems for patient information, as well as reporting of viewing and end-user behaviors. |
Regulation
Hospitality
Cable Television Regulation. The Communications Act of 1934, as amended by the Cable
Communications Policy Act of 1984, the Cable Television Consumer Protection and Competition Act of
1992, and the Telecommunications Act of 1996, (collectively, the Communications Act) governs the
regulation of cable systems. The law defines a cable system as a facility, consisting of a set
of closed transmission paths and associated signal generation, reception and control equipment,
which is designed to provide cable service, including video programming, and which is provided to
multiple subscribers within a community, but the law exempts from that definition, among other
facilities, a facility which serves subscribers without using any public rights-of-way. We
construct and operate separate headend systems at each hotel and those systems do not use public
rights-of-way. Consequently, we are not required to comply with many of the Federal Communication
Commissions (FCC) rules relating to cable systems, including, among other things, rate
regulation and the requirement to obtain a franchise from local government authorities in order to
provide video services.
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The FCC rules define a multi-channel video programming distributor as a person such as, but not
limited to, a cable operator, a multi-channel multipoint distribution service, a direct broadcast
satellite service, or a television receive-only satellite program distributor, who make available
for purchase, multiple channels of video programming. We may be considered to be a multi-channel
multipoint distribution service. As such, we may be subject to various provisions of the
Communications Act. The Communications Act includes laws and regulations which would benefit our
operations, such as provisions which ensure our access to programming on fair, reasonable and
nondiscriminatory terms, as well as provisions which may subject us to additional requirements,
such as the requirement to obtain consent from broadcasters in order to retransmit their signal
over our systems.
Broadband Internet Access. The FCC has classified high-speed Internet access as an interstate
information service as defined by the Communications Act. To date, the FCC has not imposed any
regulations on information service providers, although it may do so in the future.
As part of our revenue diversification effort, we have begun to serve as a conduit for personal
information to third-party credit card processors, service partners and others. The handling of
such personal information requires we comply with a variety of federal, state and industry
requirements governing the use and protection of such information, including, but not limited to,
Federal Trade Commission (FTC) consumer protection regulations and Payment Card Industry (PCI)
data security standards.
Healthcare
The Health Insurance Portability and Accountability Act (HIPAA) addresses the security and
privacy of health data. The privacy and security rules promulgated under HIPAA apply only to
covered entities health plans, healthcare clearinghouses and healthcare providers. If
LodgeNet enters into a contract with a healthcare facility which makes it a business associate, or
a company which performs functions or activities involving the use or disclosure of protected
health information on behalf of a covered entity, LodgeNet must comply with the terms and
conditions of such contract, which will require LodgeNet to appropriately safeguard the
confidentiality, integrity and availability of the protected health information it receives or
transmits on behalf of the covered entity.
The foregoing does not purport to describe all present and proposed federal, state and local
regulations and legislation relating to our business. Other existing federal, state and local laws
and regulations currently are, or may be, the subject of a variety of judicial proceedings,
legislative hearings and administrative and legislative proposals which could change in varying
degrees the manner in which private cable operators, other video programming distributors and
Internet service providers operate. We cannot predict the outcome of these proceedings or their
impact upon our operations at this time.
Employees
As of December 31, 2010, we had 1,049 employees in the United States, Canada and Mexico. We have
not experienced any significant labor problems and believe our relationships with our employees are
good.
Corporate Information and Web Site Access to SEC Filings
We are a Delaware corporation with our principal executive offices located at 3900 West Innovation
Street, Sioux Falls, South Dakota 57107. Our telephone number is (605) 988-1000.
Our web site address is http://www.lodgenet.com. We make our Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q and Current Reports on Form 8-K, including all amendments to those reports,
available free of charge on our web site as soon as reasonably practicable after such material is
electronically filed with or furnished to the Securities and Exchange Commission (SEC).
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Item 1A Risk Factors
We experienced sustained revenue decline and net losses in 2010, 2009 and 2008. If we are not
profitable in the long-term or do not generate sustained levels of free cash flow, a non-GAAP
measure which we define as cash provided by operating activities less cash used for investing
activities, it could have a harmful effect on our results of operations and business. We reported
net losses of $11.7 million, $10.2 million and $48.4 million for the fiscal years ended December
31, 2010, 2009 and 2008, respectively. With regard to free cash flow, we generated $79.9 million,
$64.8 million and $25.4 million for the fiscal years ended December 31, 2010, 2009 and 2008,
respectively. Our financial results and amount of free cash flow for the fiscal year 2011 and
beyond will be dependent to a significant degree on general economic conditions and our ability to
successfully execute our business plan.
Our business is generally impacted by conditions affecting the hospitality industrys performance.
Our results are generally connected to the performance of the hospitality industry, where occupancy
rates may fluctuate resulting from various factors. Reduction in hotel occupancy and consumer buy
rates resulting from business, economic or other events, such as generally weak economic
conditions, significant international crises, acts of terrorism, war or public health issues,
adversely impacts our business, financial condition and results of operations. The general
economic conditions over the last several years have adversely affected the hotel industry and our
business. The overall travel industry and consumer buying pattern can be, has been in the past
and/or currently is, adversely affected by weaker general economic climates, consumer sentiment,
geopolitical instability and concerns about public health.
Our revenue is dependent on factors beyond our control, including the currently recovering economy,
reduced business travel and reduced consumer spending. Generally, our revenue is dependent on the
timely availability of content, including popular major motion pictures, the occupancy rate of each
hotel property served, the percentage of occupied rooms buying movies or other services at the
property and the price of the services. Occupancy rates vary based on the propertys location, its
competitive position within the marketplace, seasonal factors, economic conditions, the level of
business travel, changes in travel patterns due to public health concerns, the threat of terrorism,
wars and other international crises and other factors outside of our control. Occupancy rates are
usually higher during the summer and lower during winter. The percentage of occupied rooms buying
movies or other services at the property generally reflects the hotels guest mix profile, the
popularity and seasonality of movies, the availability of HD content, other services available at
the hotel and the guests other entertainment alternatives. The percentage of occupied rooms
buying movies and other services at the property also varies over time with general economic
conditions. Over the past three years, and due to the negative economic conditions and reduced
business travel, our revenue has been negatively impacted by lower purchases and lower hotel
occupancy rates. The average monthly revenue per-room we generated from Guest Entertainment
decreased from $16.38 in 2008 to $12.41 in 2010. Because many factors described above are out of
our control, we may not be able to control the negative trends we have recently reported in our
revenue.
We operate in a very competitive business environment and competition could reduce our revenue and
our cash flow. Our business is primarily reliant on our Guest Entertainment and Hotel Services
revenues, which are highly competitive. If we are unable to compete effectively with large
diversified entertainment service providers and large technology service providers who have
substantially greater resources than we have, our operating margins and market share could be
reduced and the growth of our business inhibited. In particular, we compete directly for customers
with a variety of other media service providers, including other interactive television service
providers, high definition television services, local cable providers and 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, movie downloads, rental companies providing DVDs which can be viewed in properly equipped
hotel rooms or on other portable viewing devices, including iPads, and hotels which offer in-room
laptops with Internet access or other types of Internet access systems.
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A continuing trend toward business combinations and alliances in both the domestic and foreign
entertainment service industries may create significant new competitors for us. Many of these
combined entities could have resources greater than ours. These combined entities may provide
bundled packages of programming, delivery and other services which compete directly with the
products we offer. Our competitors may also offer services sooner and at more competitive rates
than we do. We may need to reduce our prices or license additional programming to remain
competitive, and we may be unable to sustain future price levels as competition increases. Our
failure to achieve or sustain market acceptance of our offered services at desired pricing levels
could impair our ability to generate free cash flow, which could harm our business.
Diversification activities may not be successful. We have sought to diversify our business and
decrease reliance on revenue from Guest Entertainment offerings. These activities have included
sales of systems to healthcare facilities, the sale of advertising within the hospitality market,
the sale of media systems and services to hotels and the sale of in-room broadband Internet access.
We may pursue additional markets in the future which we consider to be complementary to our other
businesses. In addition, we are also working to create new diversified revenue streams within the
hospitality market, primarily from our new Envision applications. However, the diversification
into areas in which we do not have the same experience as our traditional business, including, but
not limited to, our Envision applications, involves a variety of risks, such as increased capital
expenditures and diversion of limited resources and personnel from our traditional business, as
well as managements time and attention. In addition, our newer business activities may generate
lower margins than our Guest Entertainment offerings and may require significant levels of capital
to grow successfully. Furthermore, we may not be able to market these new businesses successfully,
for any number of reasons. Accordingly, we may not be successful in developing and growing these
new revenue streams.
Our revenue could be affected if our hotel customers decide to eliminate certain services we
provide or restrict the types of content offered at their hotels. The size of our room base, our
revenue, profitability and cash flow could be negatively impacted if a significant number of
franchisors determine video-on-demand or other services we provide would no longer be preferred by
certain hotel franchising companies. In addition, certain franchisors may decide to no longer
include content offerings such as mature content films. Our revenue, profitability and cash flow
could be adversely affected if a significant number of franchisors or hotel properties make such
decisions.
We may not have adequate capital resources to support our business, which could have a harmful
effect on our business and prospects. We may have insufficient capital resources to support our
business if our cash from operations decreases or our capital expenditure or working capital
requirements increase, whether as a result of product development efforts, changes in technology or
otherwise, and we are unable to access financing on acceptable terms. This would have the
following adverse impacts on our business and prospects, among others:
Ø | we may modify our business plan and adjust or delay capital spending necessary to expand or maintain our customer base or to continue to deploy our HD systems and other technological advances throughout our installed room base; | ||
Ø | we may lose a substantial number of customers if we delay or limit our capital investments; | ||
Ø | we may have insufficient capital to make payments on our outstanding indebtedness as they become due; | ||
Ø | we may have to delay or limit our product development and diversification activities; and | ||
Ø | we may be required to seek additional capital through additional equity or debt financings, asset sales, collaborative arrangements or other sources, which may not be available to us on a timely basis, if at all, or may not be available on acceptable terms. |
We may have to incur significant capital expenditures in order to adapt to technological change.
The television-based interactive service industry has been, and is likely to continue to be,
subject to:
Ø | rapid and significant technological change, including continuing developments in technology, which do not presently have widely accepted standards; and | ||
Ø | frequent introductions of new services and alternative technologies, including new technologies for providing high-definition television and providing Internet content. |
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New technologies may emerge which may be superior to, or may not be compatible with, some of our
current technologies, which may require us to make significant capital expenditures to remain
competitive. In particular, we expect to incur capital expenditures for high-definition television
platforms in our hotel properties. Many of our competitors, including cable and Internet service
providers, may have greater financial and technical resources to adapt to and capitalize on any
such technological changes more effectively than we can. Our future success will depend, in part,
on our ability to anticipate and adapt to technological changes and to offer, on a timely basis,
services which meet customer demands and evolving industry standards. In part, we rely on third
parties for the development of, and access to, communications and network technology. As a result,
we may be unable to obtain access to new technology on a timely basis or on satisfactory terms. If
we fail to adapt successfully to any technological change or obsolescence, or fail to obtain access
to important technologies, our revenues and business could be harmed.
Opportunities to expand our installed customer room base may be limited, so we may be unable to
grow our revenue. While new hotel construction and hotel expansions offer an opportunity to expand
our customer base, increases in un-served rooms due to the addition of new hotel rooms in any given
year are generally not substantial and are impacted by general economic conditions. Additionally,
we may be limited by certain financial constraints or choose not to make capital or other
expenditures, which would adversely affect growth if our cash management strategy calls for us to
conserve available resources. Even if we are willing to make such expenditures, we may not be
successful in our efforts to further expand our installed customer room base. These circumstances
may limit our ability to expand our installed room base, which in turn could limit our ability to
grow revenue.
We may not be successful in renewing hotel properties to long-term contracts, which may reduce our
revenue. We have rooms in our renewal window where we generally seek to extend and renew hotel
contracts. We may not be successful in renewing a portion of those rooms due to the hotel electing
not to continue to provide our services to their guests and replacing our interactive television
services with high-definition television programming only or a different interactive television
services provider. We have experienced a higher level of de-installation activities during 2010,
where we de-installed approximately 109,000 rooms, or approximately 6% of our installed base. Over
the last five years, we have de-installed from 2% to 6% of our installed base per year.
New technologies, including the growth of wireless devices, roll out of 4G technologies and
expansion of digital distribution of content in our markets, may increase competition and result in
a decrease in our revenue. Another major source of competition is the increasing popularity of
personal wireless devices, such as iPads and smart phones, all of which may occupy hotel guests
time and make them less likely to purchase our Guest Entertainment services. The increasing
availability of content on such devices, the improved video quality of the content on such devices
and faster wireless delivery speeds may make hotel guests less likely to purchase Guest
Entertainment services. Our success can depend on new product development. The entertainment and
communications industry is ever-changing as new technologies are introduced. Advances in
technology, such as new video formats, downloading or alternative methods of product delivery and
distribution channels, such as the Internet, or certain changes in consumer behavior driven by
these or other technologies and methods of delivery, could have a negative effect on our business.
While we mitigate risks by continually designing, engineering and developing products and systems
which can be upgraded to support new services or integrated with new technologies as they become
economically viable, there can be no assurance we will continue to be successful in these efforts.
The deployment of high-definition television (HDTV) and the introduction of new technologies,
such as Internet Protocol television (IPTV), into the hospitality market could accelerate the
convergence of broadcast, telecommunications, Internet and other media and could result in material
changes in the economics, regulations, intellectual property usage and technical platforms on which
our business relies. Video-on-demand has been introduced over the Internet, as high-speed
broadband access has greatly increased the speed and quality of viewing content, including the
on-going rollout of 4G technology, enabling the viewing of feature-length movies on personal
computers or Internet-connected television. These changes could lower cost barriers for our
competitors desiring to enter into, or expand their presence in, the television-based interactive
services business. Increased competition may adversely affect our business including the scale,
source and volatility of our revenue streams, cost structures and cash flow, and may require us to
significantly change our operations.
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Our revenue may be adversely affected by a reduction or elimination of the time between our receipt
of movies and the movies being made available to the home market. We receive our movies directly
from movie studios and the timing is at the studios discretion. Historically, we have received
movies prior to their being more broadly distributed via movie rental or retail stores. We believe
this window of release has yielded a competitive advantage, as hotel guests have been able to
view movies in the hotel rooms prior to being able to rent or purchase them for home viewing.
Recently, this advance window of release has been reduced by certain studios and a further
reduction or elimination of this advance window of release could adversely affect our revenue. In
addition, if a studio delays release of a movie to us in a manner inconsistent with past practices,
we may not be able to generate as much revenue from such movie as we could have with an earlier
release date.
If we fail to develop new products, services and product enhancements, our business and prospects
could be harmed. We have a continuing product development program designed to develop new products
and services and to enhance and improve existing products and services. The successful development
of products, services and product enhancements is subject to numerous risks, both known and
unknown, including:
Ø | unanticipated delays; | ||
Ø | access to capital; | ||
Ø | budget overruns; | ||
Ø | technical problems; and | ||
Ø | customer acceptance. |
These difficulties could result in the abandonment or substantial change in the design, development
and commercialization of these new products or product enhancements.
Given the uncertainties inherent with product development and introduction, we cannot assure any
given product development efforts will be successful on a timely basis, within budget or at all.
Our failure to develop new products, services and product enhancements on a timely basis or within
budget could harm our business and prospects. In addition, there is no assurance any new product,
service or product enhancement will be attractive to hotels and/or the hotel guests.
Our business could be harmed if we are unable to protect our proprietary technology. We rely
primarily on a combination of trade secrets, patents, copyright and trademark laws and
confidentiality procedures to protect our technology. Despite these precautions, unauthorized
third parties may infringe, copy, or reverse engineer portions of our technology. We do not know
if current or future patent applications will be issued within the scope of claims sought, if at
all, or whether any patent issued will be challenged or invalidated. In addition, we have applied,
or plan to apply for, corresponding patents and patent applications in several foreign countries
for some of our existing patents and patent applications. There is a risk these patent
applications will not provide significant protection for our products and technology. Our
competitors may independently develop similar technology our patents do not cover. In addition,
because patent applications in the United States can provide patent protection from the date of
filing but are not publicly disclosed until approximately 18 months after the patent application
has been filed, other patent applications may have been filed in those previous 18 months which
relate to our technology and of which we are unaware. Moreover, there is a risk foreign
intellectual property laws will not protect our intellectual rights to the same extent as United
States intellectual property laws. In the absence of significant patent protection, we may be
vulnerable to competitors who attempt to copy our products, processes or technology, which could
harm our business.
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If our products or services employ technology which infringes the proprietary rights of others, we
may be subject to infringement claims, forced to pay certain fees to license technology or be
required to stop selling our products. Our business could be harmed if we infringe upon the
intellectual property rights of others. We have been notified in the past, and may be in the
future, that we may be infringing intellectual property rights possessed by third parties. If any
such claims are asserted, we may seek to enter into royalty or licensing agreements. There is a
risk in these situations no license will be available or a license will not be available on
reasonable terms, precluding our use of the applicable technology. Alternatively, we may decide to
litigate such claims or to design around the patented technology. These actions could be costly
and would divert the efforts and attention of our management and technical personnel. A successful
claim of infringement against us or our failure or inability to license infringed or similar
technology could damage our business to the extent we are required to pay substantial monetary
damages or if, as a result of a successful claim, we are unable to sell our products or services
without redeveloping them or are otherwise forced to incur significant additional expense. As a
result, any infringement claims by third parties or claims for indemnification by customers
resulting from infringement claims, whether or not proven to be true, may harm our business and
prospects.
We are dependent on others for our programming content and increases in our costs or license fees
to obtain such programming could reduce our cash flow and profitability. Our guest room
programming content is provided primarily by movie studios, major television networks and other
providers, aggregators and distributors of entertainment content. We currently pay each of these
parties a fee for the right to distribute their programming in our installed guest rooms. In the
future, we may be exposed to volatile or increased programming costs which may adversely affect our
operating results. Our entertainment content providers may demand higher royalty rates or higher
minimum payments than we are currently paying or may defer making their content available to us.
We do not have a formal agreement with some of our content providers and, therefore, content from
these providers may not be available in the future on terms which are acceptable to us, or at all.
Increased licensing fees would also negatively impact our operating results.
The lack of quality programming or a change in available content could reduce our profitability and
cash flows. Our profitability and cash flow is dependent on our ability to provide quality and
popular programming to our hotel guests. We currently provide hotel guests major movies we obtain
from movie studios. The quality and popularity of major movies available at any given time and
from year to year can vary widely. Generally, the more popular titles at the box office will also
be more popular with hotel guests. We also provide hotel guests independent films, most of which
are non-rated and intended for mature audiences, music services and Nintendo video games. Our
ability to be profitable and generate positive cash flow depends upon our ability to provide
content for which hotel guests are willing to pay. However, we cannot predict the future
popularity or quality of the movies, music, games or other content we provide or may provide in the
future. If, for any reason, such content became less popular than it is currently, or is not made
available to us for distribution on a timely basis, our business could be adversely impacted. In
addition, if any significant portion of the content we provide to hotel guests were to become
unavailable, for reasons which could include licensing difficulties, governmental regulation or
issues of public standards, our business could be adversely impacted. In addition, any negative
publicity, lawsuit or boycotts by opponents of the mature-themed programming content could have a
negative impact on the willingness of the hospitality industry to offer such content to guests,
which, in turn, could have a detrimental effect on our revenues and ability to achieve stated
business goals.
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Federal, state, local and foreign legislation and regulation may negatively impact our business and
growth. We may be classified as a multi-channel video programming distributor, and thus may be
subject to various provisions of the Communications Act of 1934, as amended by the Cable
Communications Policy Act of 1984, the Cable Television Consumer Protection and Competition Act of
1992 and the Telecommunications Act of 1996, and the regulations promulgated under those acts. In
addition, the Internet-based services offered by us may be affected by various laws and
governmental regulations. While there are currently few laws or regulations directly regarding
access to or commerce on commercial online services, new laws and regulations are under debate by
federal and local lawmakers and may be adopted. The adoption of such laws or regulations in the
future may slow the growth of commercial online services and the Internet, which may cause a
decline for our Internet-based services and products or have other adverse effects on our business.
In addition, any legislative or regulatory changes restricting content which may be delivered over
our systems, particularly mature content, could significantly reduce our revenue and operating
income. Federal, state, local and foreign laws and regulations are, or may be, the subject of a
variety of judicial, administrative and legislative hearings and proceedings which could change, in
varying degrees, the regulatory classification applicable to us and the manner in which we are
regulated. We cannot predict the outcome of these proceedings or the impact on our operations at
this time.
If our hotel customers become dissatisfied with our service, they may elect not to renew certain
products or services with us or elect to terminate service agreements, which could have an adverse
affect on our ability to maintain or grow our revenue. In the event our customers become
dissatisfied with the scope or capability of our products or services, or the level of funding we
are willing or able to allocate to hotel-based investments, they may elect not to renew certain
products or services, such as video-on-demand, upon expiration or terminate their existing
agreements with us. The loss of these products or services or a loss of any significant number of
hotel customers could have a detrimental effect on our operations and financial condition.
Our data systems could fail or their security could be compromised, and we will increasingly be
handling personal data requiring our compliance with a variety of regulations. Our business
operations depend on the reliability of sophisticated data systems. Any failure of these systems,
or any breach of our systems security measures, could adversely affect our operations, at least
until our data can be restored and/or the breaches remediated. Historically, virtually all
purchases made by hotel guests using our systems were posted to the guests hotel folio. As a
result, we did not receive, store or process personal information in conjunction with business
transactions governed by government and industry privacy and security requirements, such as credit
card transactions. As our revenue diversification efforts increase, we have, to a limited extent,
begun to serve as a conduit for personal information to third-party credit processors, service
partners and others, and it is likely we will do so more regularly. The handling of such personal
information requires we comply with a variety of federal, state and industry requirements governing
the use and protection of such information, including, but not limited to, FTC consumer protection
regulations and Payment Card Industry (PCI) data security standards and, for the Healthcare
division, the requirements of the Health Insurance Policy Portability Act (HIPPA) and regulations
thereunder. While we believe we have taken the steps necessary to assure compliance with all
applicable regulations and have made necessary changes to our data systems, any failure of these
systems or any breach of the security of these systems could adversely affect our operations and
expose us to increased cost, liability for lost personal information and increased regulatory
obligations.
Many of our key functions are concentrated in a single location, and a natural disaster could
seriously impact our ability to operate. Our IT systems, production, inventory control systems,
executive offices and finance/accounting functions, among others, are primarily centralized in our
Sioux Falls, SD facility. A natural disaster, such as a tornado, could seriously disrupt our
ability to continue or resume normal operations for some period of time. While we have certain
business continuity plans in place, no assurances can be given as to how quickly we would be able
to resume operations and how long it may take to return to normal operations. We may experience
business interruptions and could incur substantial losses beyond what may be covered by applicable
insurance policies, and may experience a loss of customers, vendors and employees during the
recovery period.
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Our significant level of debt and interest payment obligations may impair our financial condition,
limit our ability to compete, expose us to interest rate risk to the extent of our variable-rate
debt and prevent us from meeting our financial obligations. As of December 31, 2010, we had $373.6
million of consolidated debt. Subject to restrictions in our Credit Facility and instruments
governing our current and future debt securities, we may also incur additional amounts of debt for
working capital, capital expenditures and other purposes. This substantial level of indebtedness
could have important consequences, including the following:
Ø | make it more difficult for us to satisfy our financial obligations and dividend payments required on our outstanding preferred stock; | ||
Ø | require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness and dividend payments required on our outstanding preferred stock, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes; | ||
Ø | limit our ability to borrow additional funds to expand our business or alleviate liquidity constraints; | ||
Ø | limit our ability to refinance all or a portion of our indebtedness on or before maturity; | ||
Ø | limit our ability to pursue potential acquisitions; | ||
Ø | increase our vulnerability to general adverse economic and industry conditions; | ||
Ø | increase our cost of borrowing; | ||
Ø | limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; and | ||
Ø | place us at a competitive disadvantage relative to companies which have proportionately less indebtedness. |
Covenants under our Credit Facility may restrict our future operations and adverse consequences
could result in the event of non-compliance. Our current Credit Facility contains covenants which
may restrict our ability to finance future operations or capital needs or to engage in other
business activities. Future borrowing instruments, such as credit facilities and indentures, if
any, are also likely to contain restrictive covenants and may require us to pledge assets as
security under those future arrangements. The terms of our current Credit Facility, including
financial covenants, restrict, among other things, our ability and the ability of our subsidiaries
to:
Ø | incur, assume or permit to exist additional indebtedness, guaranty obligations or hedging arrangements; | ||
Ø | declare or pay certain dividends or make other payments on, redeem or repurchase our capital stock; make loans and investments or repay subordinated indebtedness; | ||
Ø | engage in sale-leaseback transactions; | ||
Ø | enter into transactions with affiliates; | ||
Ø | sell assets; | ||
Ø | create or suffer to exist liens; | ||
Ø | create restrictions on dividend and other payments to us from our subsidiaries; | ||
Ø | change the nature of the business we conduct; and | ||
Ø | issue or sell stock of subsidiaries; and engage in a merger, sale or consolidation. |
Events beyond our control, including changes in general economic and business conditions, as well
as our financial performance, may adversely affect our business. In addition, the Credit Facility
contains certain financial ratio and financial condition covenants. Such changes in general
economic and business conditions, or our financial performance, may affect our ability to meet
those financial ratios and financial conditions tests and to otherwise remain in compliance with
the requirements of our Credit Facility and other material agreements. A breach of any of these
covenants would result in a default under the applicable debt instrument or agreement. In that
event, the amounts under the applicable agreement could be declared immediately due and payable, or
require us to amend the Credit Facility, resulting in significantly higher annual interest expense,
and such a default may cause a default under some of our material agreements. As a result of these
covenants and restrictions, we are limited in how to conduct our business and we may be unable to
compete effectively, to meet our customer demands for installations or service or take advantage of
new business opportunities.
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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 Consolidated EBITDA (a term defined in
our Credit Facility) and to manage our capital investment and debt levels. We are currently
pursuing an amendment of our Credit Facility, which may increase our interest costs, require
upfront fees and modify certain other terms which will be less favorable than we currently have.
If we are not able to remain in compliance with our current debt covenants and our lenders will not
amend or waive covenants with which we are not in compliance, the debt would be due, we would not
be able to satisfy our financial obligations and we would need to seek alternative financing. If
we were not able to secure alternative financing, this would have a substantial adverse impact on
the Company and our ability to continue our operations.
The price of our common stock may be subject to volatility. As of December 31, 2010, a substantial
portion of our common stock was held by a limited number of institutional investors, and the amount
of capital stock held by non-institutional holders is believed to be limited. This concentration
of ownership may limit the amount of stock available for sale or purchase at any particular time,
and may result in significant increases or decreases in the price of our common stock due to
factors which may not reflect the market as a whole or our economic condition or results of
operations.
Item 1B Unresolved Staff Comments
None.
Item 2 Properties
Our headquarters, including our distribution center and principal executive offices, are located in
Sioux Falls, South Dakota. Our owned facility is used for executive, administrative and support
functions; assembly and distribution; and warehouse space. We believe our facility will be
sufficient to accommodate foreseeable local operational space requirements.
We lease 28 facilities, in various locations, from unaffiliated third parties. These facilities
include offices for our subsidiaries and combination warehouse/office facilities for our
installation and service operations, and are located throughout the United States, Canada and
Mexico.
Item 3 Legal Proceedings
We are subject to litigation arising in the ordinary course of business. As of the date hereof, we
believe the resolution of such litigation will not have a material adverse effect upon our
financial condition, results of operations or cash flows.
On July 11, 2008, LinkSmart Wireless Technology, LLC, a California limited liability company based
in Pasadena, California, filed several actions for patent infringement in the U.S. District Court
in Marshall, Texas. The suits allege the Company and numerous other defendants infringe a patent
issued on August 17, 2004, entitled User Specific Automatic Data Redirection System. All pending
cases have been consolidated. The complaint does not specify an amount in controversy. The
Company believes it does not infringe the patent in question, has filed responsive pleadings and is
vigorously defending the action. The suit is in the discovery stage. The U.S. Patent and
Trademark Office has undertaken a re-examination of the patent which is the subject of this suit,
and issued a preliminary finding that the patent is invalid. On June 30, 2010, the Court, through
the Magistrate Judge, issued a Memorandum Opinion and Order (the Markman Order), which construed
certain disputed terms in the patent at issue in the case. The plaintiff and several defendants
have filed objections with the Court for review of various portions of the Order. On July 1, 2010,
the Magistrate Judge issued a report and recommendation that the Court grant the motion of the
defendants for summary judgment with respect to claims 15, 16, 17, 19, 22 and 23 of the patent on
grounds that such claims in the patent are indefinite and invalid. The plaintiff has filed
objections with the Court for review of report and recommendation regarding summary judgment. On
October 26, 2010, the Court issued an order staying the case pending the final determination in the
Patent Office re-examination proceeding.
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On November 17, 2009, Nomadix, Inc., a Delaware corporation based in Newbury Park, California,
filed an action for patent infringement in the U.S. District Court in Los Angeles, California. The
suit alleged the Company and its subsidiaries On Command Corporation and LodgeNet StayOnline, Inc.
infringed five patents. The complaint also asserted claims against a number of other defendants,
including Hewlett-Packard Company, Wayport, Inc., Ibahn Corporation, Guest-Tek Interactive
Entertainment Ltd. and Guest-Tek Entertainment Inc., Aruba Networks, Inc., Superclick, Inc. and
Superclick Networks, Inc. On May 21, 2010, the plaintiff filed an amended complaint asserting
infringement of a patent issued on March 30, 2010 entitled Systems and Methods for Providing
Dynamic Network Authorization, Authentication and Accounting. The Company filed a responsive
pleading denying such allegations. This action and a related patent infringement action filed by
the Company against Nomadix in the U.S. District Court for South Dakota were settled as of December
31, 2010. In connection with the settlement, the parties entered into a patent license agreement
and a strategic technology alliance which includes a number of ordinary course commercial
agreements, including agreements pursuant to which the Company will be able to offer various
hardware and software developed by Nomadix and its affiliates in the United States, Canada and
Mexico, and Nomadix and its affiliates will be able to offer hardware and software developed by the
Company in various countries served by such entities.
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PART II
Item 5 Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities
Our common stock currently trades on the NASDAQ Global Select Market (NASDAQ Exchange) under the
symbol LNET. Our common stock began trading on the NASDAQ Exchange on October 14, 1993 upon the
effectiveness of our initial public offering. As of March 7, 2011, there were outstanding
25,152,080 shares of common stock.
The following table sets forth, for the fiscal quarters indicated, the range of high and low sales
prices of our common stock as reported by NASDAQ:
Quarter Ended | High | Low | Quarter Ended | High | Low | |||||||||||||
March 31, 2010
|
7.38 | 4.96 | March 31, 2009 | 1.73 | 0.50 | |||||||||||||
June 30, 2010
|
7.41 | 3.61 | June 30, 2009 | 5.99 | 1.50 | |||||||||||||
September 30, 2010
|
4.50 | 2.32 | September 30, 2009 | 7.75 | 3.11 | |||||||||||||
December 31, 2010
|
4.48 | 2.14 | December 31, 2009 | 7.77 | 4.26 |
On March 7, 2011, the closing price of our common stock, as reported by NASDAQ Exchange, was $3.13.
Stockholders are urged to obtain current market quotations for our common stock. As of March 7,
2011, we have 106 stockholders of record with approximately 98.6% of the shares held in street
name. We estimate that as of March 7, 2011, we had 4,051 beneficial owners of our common stock.
We have 5,000,000 shares of preferred stock authorized at $0.01 par value per share, of which
57,500 10% Series B cumulative perpetual convertible shares were issued and outstanding as of
December 31, 2010, with a liquidation preference of $1,000 per share.
Performance Graph
The following graph compares the percentage change in the Companys cumulative total stockholder
return on its common stock with (i) the cumulative total return of the NASDAQ Market Index and (ii)
the cumulative total return of all companies (the Peer Group) with the same four-digit standard
industrial code (SIC) as the Company (SIC 4841 Cable and Other Pay Television Services) over
the period from January 1, 2005 through December 31, 2010, The graph assumes an initial investment
of $100 in each of the Company, the NASDAQ Market Index and the Peer Group and reinvestment of
dividends. The Company did not declare or pay any dividends on its common stock in 2010. The
graph is not necessarily indicative of future price performance.
This graph shall not be deemed incorporated by reference by any general statement incorporating by
reference this Annual Report on Form 10-K into any filing under the Securities Act or under the
Exchange Act, except to the extent the Company specifically incorporates this information by
reference, and shall not otherwise be deemed filed under such Acts.
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Issuer Purchases of Equity Securities
During 2010, we did not repurchase any shares of our common stock.
Dividends
No dividends have been paid to date on our common stock. The terms and conditions of our bank
Credit Facility contain covenants, which restrict and limit payments or distributions in respect of
our common stock.
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, and as of December 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 preferred stock dividends were paid on January 18, 2011.
Stockholder Rights Plan
In February 2008, we adopted a stockholder rights plan (the 2008 Rights Plan), which was approved
by the stockholders at the Annual Meeting on May 14, 2008. The rights plan is intended to maximize
stockholder value by providing flexibility to the Board of Directors in the event an offer for
LodgeNet is received which is either inadequate or not in the best interest of all stockholders.
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The following is a summary of the material terms of the 2008 Rights Plan. The statements below are
only a summary, and we refer you to the full text of the 2008 Rights Plan, which was filed as an
exhibit to Form 8-A filed with the SEC on March 3, 2008. Each statement in this summary is
qualified in its entirety by this reference.
General
Under the terms of the 2008 Rights Plan, each share of common stock outstanding has one Right
attached to it, so the purchase of a share of common stock is also a purchase of the attached
Right. Certificates representing the Companys common stock also represent the attached Rights.
The Rights are not currently exercisable or separately tradable.
After the Distribution Date, which is described below, each Right will become separately tradable
and initially will entitle the holder to purchase from the Company one one-thousandth of a share of
Series A Participating Preferred Stock (the Preferred Shares) at a price of $60.00 (the Purchase
Price), subject to adjustment. Each one one-thousandth of a Preferred Share has rights roughly
equivalent to one share of common stock. If certain circumstances occur as discussed below, the
Rights would instead entitle their holders to purchase common stock of the Company or an acquirer.
Assuming the Plan is approved by the stockholders every three years, the Rights will expire at the
close of business on February 28, 2017 (the Final Expiration Date).
Events Causing Exercisability and Separate Transferability
A Distribution Date will occur and the Rights will become exercisable and separately tradable
upon the earlier of:
(1) | the first public announcement a person or group (other than the Company, any subsidiary, or a benefit plan of the Company or its subsidiaries), has acquired, or obtained the right to acquire, except under limited circumstances, beneficial ownership of 20 percent or more of the outstanding common stock; or | ||
(2) | the close of business on the tenth business day (or such later date as the Companys Board of Directors may determine) after the commencement of, or a public announcement of, an intention to commence (which tender offer is not terminated within such ten business days), a tender or exchange offer the consummation of which would result in a person or group becoming an Acquiring Person (as defined in the following). |
Generally, a person or group whose acquisition of common stock causes a Distribution Date pursuant
to clause (1) above (including pursuant to the completion of a tender or exchange offer described
in (2)) is an Acquiring Person. As soon as practicable following the Distribution Date, separate
Right certificates will be mailed to holders of record of the common stock as of the close of
business on the Distribution Date.
Events Causing Adjustment of the Shares Acquirable Upon Exercise of the Purchase Price
Generally, if any person becomes an Acquiring Person, each holder of a Right, other than the
Acquiring Person (and any affiliates and certain transferees), will then have the right to receive,
upon exercise and payment to the Company of the Purchase Price, instead of one one-thousandth of a
Preferred Share, the number of shares of Company common stock having an average market value equal
to two times the Purchase Price. Any Rights beneficially owned by any Acquiring Person (or any
affiliate or certain transferees) will be null and void. In other words, the Rights holders, other
than the Acquiring Person and certain others, may at that time purchase Company common stock at a
50 percent discount.
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Alternatively, in the event that, after the first public announcement, a person or group has become
an Acquiring Person, the Company is a party to a merger, statutory share exchange or sale of more
than 50 percent of the Companys assets or earning power in a transaction with an Acquiring Person
or certain specified related parties or in which all holders of Company common stock are not
treated alike, then each holder of a Right (except Rights which have been voided as set forth
previously) shall have the right to receive, upon exercise and payment to the Company of the
Purchase Price, instead of one one-thousandth of a Preferred Share, common shares of the acquiring
or surviving company having an average market value equal to two times the Purchase Price. In
other words, the Rights holders, other than the Acquiring Person and certain others, may at that
time purchase the acquiring or surviving companys common shares at a 50 percent discount.
The Purchase Price payable and the number of shares issuable upon exercise of the Rights are
subject to adjustment, from time to time, to prevent dilution upon the occurrence of specified
events affecting the Preferred Shares. The number of outstanding Rights and the Purchase Price are
also subject to adjustment in the event of a stock dividend on the common stock payable in common
stock or subdivisions or combinations of the common stock occurring before the Distribution Date.
Redemption of the Rights
At any time before a person becomes an Acquiring Person, the Board may redeem the Rights in whole,
but not in part, at a price of $0.01 per Right (the Redemption Price), payable in cash or common
stock. The Board may also redeem the Rights for a limited time after 60 days after the later of
the date a person or group becomes an Acquiring Person and the effective date of a registration
statement under the Securities Act of 1933 with respect to securities issuable upon exercise of the
Rights.
In addition, if the Company receives a Qualified Offer (as defined in the following paragraph),
the Rights may be redeemed by the stockholders if approved by the holders of at least a majority of
the outstanding common stock at a special meeting of stockholders called to vote on a resolution
accepting the Qualified Offer and to authorize the redemption of the Rights pursuant to the
provisions of the Agreement. The special meeting must be held within 90 business days after the
Company receives a request from stockholders to hold such a meeting. If a resolution to redeem the
Rights is approved at the special meeting (or if the special meeting is not held on or before the
90th business day after receipt of the request for a meeting), it will become effective
immediately prior to the consummation of any Qualified Offer consummated within 60 days after the
earlier of the special meeting or the 90th business day after receipt of a request for a
special meeting of shareholders.
A Qualified Offer is a tender offer for all outstanding common stock not already beneficially
owned by the person making the offer which meets all of the following conditions:
Ø | the same per share price is offered for all shares, and such price per share is greater than the highest closing price for the common stock during the 12 month period immediately preceding the date on which the offer is commenced, represents a reasonable premium above the average of the closing prices for the five trading days immediately preceding the date on which the offer is commenced, is at least 80 percent cash (with any non-cash consideration consisting of common stock of the offeror), and is to be paid upon consummation of the offer; | ||
Ø | if the consideration offered includes shares of common stock of the offeror, the offeror is a publicly owned United States corporation and its common stock is traded on either the New York Stock Exchange or The NASDAQ Stock Market (NASDAQ), no further stockholder approval is required to issue such common stock, no other class of voting stock of the offeror is outstanding, and the offeror shall permit the Companys investment banking firm and legal counsel to have access to such offerors books, records, management, accountants and other advisers for the purpose of permitting such investment banking firm and such legal counsel to conduct a due diligence review to permit such investment banking firm to be able to render a fairness opinion with respect to the consideration being offered; the offer is accompanied by written financing commitments and/or the offeror has on hand cash or cash equivalents for the full amount of all financing necessary to consummate the offer and follow-on merger; |
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Ø | the offer is subject to a non-waivable condition that a minimum of 90 percent of the outstanding common stock (other than those owned by the offeror) will be tendered and not withdrawn as of the offers expiration date; | ||
Ø | the offer by its terms remains open for at least 60 business days and at least 10 business days after the date of any special meeting of shareholders called under the redemption provisions, plus 15 business days after any change in price or after any bona fide alternative offer for a higher consideration is made; | ||
Ø | the offer is accompanied by a written opinion of a nationally recognized investment banking firm stating the price to be paid to holders pursuant to the offer is fair and including any written presentation of such firm showing the analysis and range of values underlying such conclusion; | ||
Ø | on or before the date the offer is commenced, such person makes an irrevocable written commitment to the Company (1) to acquire, within five business days following completion of the offer, all shares of common stock not beneficially owned by such person at the same cash price per share as paid in the offer, (2) not to amend its offer to reduce the price or otherwise change the terms in a way which is adverse to tendering shareholders, and (3) if the offer is not consummated, such person will not make another offer for the common stock within one year if at least 85 percent of the common stock not owned by such person has not been tendered; and | ||
Ø | the offer is subject only to the conditions specified in the definition and usual and customary terms and conditions, and is not subject to any financing, funding or similar condition, nor to any condition relating to completion of or satisfaction with any due diligence or similar investigation. |
Amendments
The 2008 Rights Plan may be amended by the Board before the Distribution Date without the consent
of the Rights holders. After the Distribution Date, the Rights Plan may be amended by the Board to
cure any ambiguity, to correct or supplement any provision which may be defective or inconsistent
with any other provision, to make changes which do not adversely affect the interests of holders of
Rights (excluding the interests of any Acquiring Person) or, subject to certain limitations, to
shorten or lengthen any time period under the Rights Plan (other than a time period governing
redemption at a time when the Rights are not redeemable).
Term
The 2008 Rights Plan expires on the date of our 2011 Annual Meeting of Shareholders unless an
extension is ratified for an additional three years.
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Item 6 Selected Financial Data
The following is a summary of the Statement of Operations and other data derived from the audited
financial statements. The data should be read in conjunction with our Consolidated Financial
Statements, the notes thereto, and Managements Discussion and Analysis of Financial Condition and
Results of Operations, all included elsewhere herein. Dollar amounts are in thousands, except
share data and per room amounts:
Year Ended December 31, | ||||||||||||||||||||
2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||
Select Financial Data: |
||||||||||||||||||||
Revenues: |
||||||||||||||||||||
Hospitality and Advertising Services |
$ | 443,654 | $ | 476,658 | $ | 527,810 | $ | 481,111 | $ | 285,939 | ||||||||||
Healthcare |
8,518 | 7,834 | 6,069 | 4,477 | 2,274 | |||||||||||||||
Total revenues |
452,172 | 484,492 | 533,879 | 485,588 | 288,213 | |||||||||||||||
Income (loss) from operations |
23,410 | 21,692 | (5,071 | ) | (4,236 | ) | 26,932 | |||||||||||||
Net (loss) income |
(11,685 | ) | (10,155 | ) | (48,418 | ) | (65,172 | ) | 1,841 | |||||||||||
Preferred stock dividends |
(5,750 | ) | (3,114 | ) | | | | |||||||||||||
Net (loss) income attributable to common stockholders |
$ | (17,435 | ) | $ | (13,269 | ) | $ | (48,418 | ) | $ | (65,172 | ) | $ | 1,841 | ||||||
Net (loss) income per common share (basic and diluted) |
$ | (0.71 | ) | $ | (0.59 | ) | $ | (2.16 | ) | $ | (3.00 | ) | $ | 0.10 | ||||||
Other Data: |
||||||||||||||||||||
Investing activities: |
||||||||||||||||||||
Capital expenditures (1) |
$ | 21,825 | $ | 21,341 | $ | 64,407 | $ | 79,097 | $ | 48,268 | ||||||||||
Average cost per room new HD installation |
$ | 200 | $ | 339 | $ | 398 | $ | 460 | $ | 438 | ||||||||||
Average Hospitality and Advertising Services revenue per room |
$ | 21.29 | $ | 21.73 | $ | 23.69 | $ | 21.76 | $ | 23.72 |
As of December 31, | ||||||||||||||||||||
2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||
Balance Sheet Data: |
||||||||||||||||||||
Cash and cash equivalents |
$ | 8,381 | $ | 17,011 | $ | 10,800 | $ | 25,569 | $ | 22,795 | ||||||||||
Total assets |
$ | 444,006 | $ | 508,354 | $ | 589,786 | $ | 693,823 | $ | 263,209 | ||||||||||
Total debt |
$ | 373,639 | $ | 469,946 | $ | 588,520 | $ | 624,594 | $ | 270,169 | ||||||||||
Total stockholders deficiency |
$ | (54,349 | ) | $ | (70,987 | ) | $ | (128,748 | ) | $ | (48,242 | ) | $ | (58,122 | ) |
Year Ended December 31, | ||||||||||||||||||||
2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||
Statement of Cash Flows Data: |
||||||||||||||||||||
Cash provided by operating activities |
$ | 101,706 | $ | 86,172 | $ | 89,853 | $ | 58,869 | $ | 72,301 | ||||||||||
Property and equipment additions |
(21,825 | ) | (21,341 | ) | (64,407 | ) | (79,097 | ) | (48,268 | ) | ||||||||||
79,881 | 64,831 | 25,446 | (20,228 | ) | 24,033 | |||||||||||||||
Cash used for acquisition and other activities, net |
| | | (354,177 | ) | (2,336 | ) | |||||||||||||
$ | 79,881 | $ | 64,831 | $ | 25,446 | $ | (374,405 | ) | $ | 21,697 | ||||||||||
(1) | Presented as cash used for property and equipment additions as reported in the Statement of Cash Flows. |
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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, are
intended to identify such forward-looking statements. Such forward-looking statements are subject
to risks, uncertainties and other factors which 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 in Item 1A of this Annual Report on Form 10-K for the year ended December 31, 2010, in
any prospectus supplement or any report or document incorporated herein by reference, such factors
include, among others, the following:
Ø | the effects of general economic and financial conditions; | ||
Ø | the economic condition of the hospitality industry, which can be particularly affected by general economic and financial conditions, as well as by factors such as high gas prices, levels of unemployment, consumer confidence, acts or threats of terrorism and public health issues; | ||
Ø | decreases in hotel occupancy, whether related to economic conditions or other causes; | ||
Ø | competition from providers of similar services and from alternative sources; | ||
Ø | changes in demand for our products and services; | ||
Ø | programming costs, availability, timeliness and quality; | ||
Ø | technological developments by competitors; | ||
Ø | developmental costs, difficulties and delays; | ||
Ø | relationships with clients and property owners; | ||
Ø | the impact of covenants contained in our credit agreement, compliance with which could adversely affect capital available to finance growth, and the violation of which would constitute an event of default; | ||
Ø | changes to government laws and regulations and industry compliance standards; | ||
Ø | potential effects of litigation; | ||
Ø | risks of expansion into new markets and territories; | ||
Ø | risks related to the security of our data systems; and | ||
Ø | other factors detailed, from time to time, in our filings with the SEC. |
These forward-looking statements speak only as of the date of this report. We expressly disclaim
any obligation or undertaking to release publicly any updates or revisions to any forward-looking
statements contained herein to reflect any change in our expectations with regard thereto or any
change in events, conditions or circumstances on which any such statement is based.
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Item 7 Managements 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.
Executive Overview
We are the largest provider of interactive media and connectivity solutions to the hospitality
industry in the United States, Canada and Mexico. Our primary offerings include guest-paid
entertainment, such as on-demand movies, and hotel-paid services, including cable television
programming and Internet access services. As of December 31, 2010, we provided interactive and
media networks and connectivity solutions to approximately 1.8 million hotel rooms in North America
and provide our hospitality solutions in select international markets, primarily through local or
regional licensees. In addition, we also have a growing presence in the healthcare market, where
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
December 31, 2010, our systems were installed in 56 healthcare facilities, representing
approximately 12,200 beds, and we had an additional six facilities under contract.
Our video-on-demand served room base consists of 1.7 million hotel rooms in approximately 9,000 of
the best hotels throughout the United States, Canada and Mexico, and our business strategy is
focused unlocking the full value those rooms represent. We believe there is substantial value
beyond the returns we are generating from our current analog base, and converting that base to high
definition (HD) represents a significant and proven opportunity. Rooms with our HD system
generated approximately 60% more revenue than rooms installed with analog technology. The higher
revenue performance is driven by 1) a lift in Guest Entertainment revenue within our HD rooms, 2) a
higher penetration of LodgeNet-provided HD cable programming within HD rooms and 3) the mix of
converted rooms are from generally higher chain scale properties. Another highlight of our HD
system is the rapid decline in the amount of capital we invest to equip a room with HD, as we
leverage the technology cost curve and benefit from ongoing operating efficiencies. During the
last year, we have seen a 41.0% decrease in the cost to install a new HD room, from an average of
$339 in 2009 to $200 for 2010. In addition, we believe Envision, our next generation, interactive
television platform, will create additional revenues from Internet-sourced and other interactive
applications, information and entertainment. We successfully installed our first Envision system
in January 2011.
Our total revenue for 2010 was $452.2 million, a decrease of $32.3 million or 6.7%, compared to
2009. The decrease in revenue came mainly from a decrease in Guest Entertainment revenue, as well
as from System Sales and Related Services, partially offset by increases in revenue from Hotel
Services, Advertising Services and Healthcare. Guest Entertainment revenue decreased $37.2 million
or 12.6% in 2010, resulting from an 8.0% reduction in revenue on a per installed room basis, in
addition to a 5.0% reduction in the average number of rooms served over the prior year period.
Hotel Services revenue increased $4.5 million or 3.4% for 2010. This increase resulted from price
changes and higher priced programming packages purchased by hotels as they install high-definition
television systems. System Sales and Related Services decreased $3.3 million or 7.8% in 2010. The
decrease was primarily driven by a decline in broadband equipment sales. The Hotel Networks
(THN), our advertising services subsidiary, generated $9.9 million of Advertising Services
revenue during 2010 compared to $6.9 million in the prior year, an increase of $3.0 million or
42.7%. This increase was primarily the result of an increase in carriage services revenue.
Healthcare revenue increased $0.7 million or 8.7%, to $8.5 million during 2010 versus $7.8 million
in 2009.
Total direct costs were $254.0 million in 2010, a decrease of $19.9 million or 7.3%, as compared to
$273.9 million in 2009. The decrease in total direct costs was primarily due to decreased
commissions and content royalties, lower system and equipment costs and a reduction in recurring
connectivity and other Internet support costs. Advertising Services experienced lower fixed costs
in 2010 as well, due to lower satellite distribution costs. Partially offsetting these reductions
was an increase in television programming costs, which vary with the increased revenue and the
services provided. These changes improved gross margins to 43.8% in 2010 compared to 43.5% for the
prior year.
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System operations expenses and selling, general and administrative (SG&A) expenses were $91.1
million in 2010 compared to $88.1 million in 2009. The increase was driven by debt issuance costs
of $0.7 million related to financing options, higher legal fees, service and maintenance costs,
travel, higher fuel costs and business development costs.
We generated $101.7 million of cash from operating activities during 2010, as compared to $86.2
million in 2009. The increase was primarily from the increase of our accounts payable balance. A
portion of this working capital increase is expected to reverse in 2011. Cash used for property
and equipment additions, including growth related capital, was $21.8 million in 2010. During the
year, we also used the cash generated from operations to pay the required term loan principal
repayments of $4.6 million and made $96.8 million of additional payments. We achieved our final
covenant step-down during the third quarter of 2010, and ended the year with a leverage ratio (as
defined on page 42), calculated on a consolidated debt basis, of 3.43 times compared to the
covenant of 3.50 times.
Hospitality and Advertising Services Business
Guest Entertainment (includes purchases for on-demand movies, network-based video games, music and
music videos and television on-demand programming). One of our main sources of revenue, generating
57.2% of total 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:
Ø | 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. | ||
Ø | 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. | ||
Ø | The buy rate of hotel guests. This is impacted by a number of issues, some of which are not under our control. Specific issues impacting buy rate include: |
Ø | The number of rooms equipped with our high-definition (HD) systems. We can increase revenue by increasing the number of HD rooms served. Our ability to expand our HD room base is dependent on a number of factors, including availability of capital resources from the hotels and us to invest in HD televisions and equipment. We are focused on accelerating the installation of our HD systems as hotels increase their purchase of HD televisions, since the revenue generated from the digital quality experience within our installed HD rooms is approximately 60% higher than our analog rooms. | ||
Ø | 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. | ||
Ø | 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. |
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Ø | 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, movie downloads, 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. | ||
Ø | 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, since the last half of 2008, economic conditions have had 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:
Ø | 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; | ||
Ø | commissions paid to our hotel customers, which are also variable and based on a percent of guest-generated revenue; | ||
Ø | 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 | ||
Ø | 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.
Ø | 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. | ||
Ø | Broadband Internet Service and Support. We also design, install and operate wired and wireless broadband Internet systems at hotel properties. These systems control access to the Internet, provide bandwidth management tools and allow hotels to charge guests 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 or through a revenue-share model in which hotel guests pay for broadband Internet and we pay a commission to our hotel customers. While this is a highly competitive area, we believe we have important advantages as a result of our proactive 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 broadband Internet 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.
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Advertising Services. We deliver advertising-supported media into select hotel segments, from
which we earn revenue from the sale of television commercials, channel access 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 December 31, 2010
and December 31, 2009, we provided advertising media services to approximately 1.2 million hotel
rooms. We also deliver targeted advertising and services to approximately 360,000 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 with our various services. As of December 31, we had the following number
of rooms installed with the designated service:
2010 | 2009 | 2008 | ||||||||||
Total rooms served (1) |
1,829,712 | 1,909,323 | 1,977,015 | |||||||||
Total Guest Entertainment rooms (2) |
1,680,322 | 1,779,979 | 1,866,353 | |||||||||
Total HD rooms (3) |
270,384 | 231,588 | 191,491 | |||||||||
Percent of Total Guest Entertainment rooms |
16.1 | % | 13.0 | % | 10.3 | % | ||||||
Total Cable Television Programming (FTG) rooms
(4) |
1,030,437 | 1,087,860 | 1,105,754 | |||||||||
Percent of Total Guest Entertainment rooms |
61.3 | % | 61.1 | % | 59.2 | % | ||||||
Total Broadband Internet rooms (5) |
178,047 | 201,936 | 229,003 | |||||||||
Percent of Total rooms served |
9.7 | % | 10.6 | % | 11.6 | % |
(1) | Total rooms served include rooms receiving one or more of our services, including rooms served by international licensees. | |
(2) | Guest Entertainment rooms, of which 87.7% are digital, receive one or more Guest Entertainment services, such as movies, video games, music or other interactive and advertising services. | |
(3) | HD rooms are equipped with high-definition capabilities. | |
(4) | Cable television programming (FTG) rooms receive basic or premium cable television programming. | |
(5) | Represents rooms receiving high-speed Internet service. |
High Definition Room Growth
We also track the penetration of our high-definition television (HDTV) system, since rooms
equipped with HDTV services typically generate higher revenue from Guest Entertainment and Hotel
Services than rooms equipped with our standard-definition VOD systems. HDTV room growth occurs as
we install our HDTV system in newly contracted rooms or convert certain existing rooms to the HDTV
system in exchange for contract extensions. The installation of an HDTV system typically requires
a capital investment by both the Company and the hotel operator. HDTV growth has been constrained
by reduced hotel capital spending budgets, given the negative impact of the economy on the
hospitality industry. We are prepared to increase capital investment levels and work jointly with
our best hotel customers to continue the rollout of high-definition systems within the operating
and capital plans of the hotels and the Company. We installed our HDTV systems in the following
number of net new rooms as of December 31:
2010 | 2009 | 2008 | ||||||||||
Net new HDTV rooms |
38,633 | 40,097 | 105,099 |
HDTV rooms, including new installations and major upgrades, are equipped with high-definition
capabilities.
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Capital Investment Per Installed Room
The average investment per room associated with an installation can fluctuate due to engineering
efforts, component costs, product segmentation, cost of assembly and installation, average number
of rooms for properties installed, certain fixed costs and hotel capital contributions. The
following table sets forth our average installation and conversion investment cost per room during
the years ended December 31:
2010 | 2009 | 2008 | ||||||||||
Average cost per HD room new installation |
$ | 200 | $ | 339 | $ | 398 | ||||||
Average cost per HD room conversion |
$ | 167 | $ | 241 | $ | 320 |
The decrease in the average cost per new and converted HD rooms from 2008 to 2010 was primarily
driven by lower component and overhead costs, larger average number of rooms for properties
installed, hotels contributing a greater share of total installation costs through purchases of
systems and equipment and engineering efforts.
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.
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 systems 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 years ended
December 31:
2010 | 2009 | 2008 | ||||||||||
Average monthly revenue per room: |
||||||||||||
Hospitality and Advertising Services |
||||||||||||
Guest Entertainment |
$ | 12.41 | $ | 13.49 | $ | 16.38 | ||||||
Hotel Services |
6.53 | 6.00 | 5.45 | |||||||||
System Sales and Related Services |
1.88 | 1.93 | 1.50 | |||||||||
Advertising Services |
0.47 | 0.31 | 0.36 | |||||||||
Total Hospitality and Advertising
Services revenue per room |
$ | 21.29 | $ | 21.73 | $ | 23.69 | ||||||
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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
direct costs of System Sales and Related Services primarily include 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 for the years ended December 31:
2010 | 2009 | 2008 | ||||||||||
Direct costs per room: |
||||||||||||
Hospitality and Advertising Services |
||||||||||||
Guest Entertainment |
$ | 4.85 | $ | 5.41 | $ | 6.40 | ||||||
Hotel Services |
5.64 | 5.24 | 4.99 | |||||||||
System Sales and Related Services |
1.25 | 1.39 | 1.12 | |||||||||
Advertising Services |
0.25 | 0.27 | 0.32 | |||||||||
Total Hospitality and Advertising Services direct costs per room |
$ | 11.99 | $ | 12.31 | $ | 12.83 | ||||||
The average direct cost per Guest Entertainment room varies with revenue and, from 2008 to 2010,
was driven by lower commissions earned by the hotels and offset by a change in the mix of movie
products purchased.
Healthcare Business
The healthcare market in the United States consists of over 940,000 hospital beds across 5,800
facilities. We believe most hospitals currently do not have any form of interactive television
services. The primary reasons hospitals purchase interactive television systems are to increase
patient satisfaction, to improve clinical outcomes and to increase operational efficiencies. Our
Healthcare revenue is generated through a variety of services and solutions provided to care
facilities, including:
Ø | revenue generated from the sale of the interactive system hardware, software license and installation services; | ||
Ø | revenue from the sale and installation of DIRECTV satellite equipment and related programming; | ||
Ø | 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 | ||
Ø | revenue generated from cable plant design, modification and installation, as well as television installation services. |
As of December 31, 2010, we equipped 56 healthcare facilities, or approximately 12,200 beds, with
these services and solutions to improve the overall patient experience, as compared to 45
properties or approximately 9,200 beds as of December 31, 2009.
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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, share 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
years ended December 31:
2010 | 2009 | 2008 | ||||||||||
System operations expenses |
$ | 2.06 | $ | 1.94 | $ | 2.60 | ||||||
SG&A expenses |
2.31 | 2.07 | 2.37 | |||||||||
Depreciation and amortization (D&A) |
4.00 | 4.58 | 5.57 | |||||||||
Goodwill impairment charge |
| | 0.50 | |||||||||
Restructuring charge |
0.02 | 0.02 | 0.23 | |||||||||
Other operating income (1) |
(0.01 | ) | | (0.05 | ) | |||||||
$ | 8.38 | $ | 8.61 | $ | 11.22 | |||||||
System operations as a percent of total revenue |
9.5 | % | 8.8 | % | 10.8 | % | ||||||
SG&A as a percent of total revenue |
10.6 | % | 9.4 | % | 9.9 | % | ||||||
D&A as a percent of total revenue |
18.4 | % | 20.7 | % | 23.3 | % | ||||||
Total operating expenses as a percent of total revenue |
38.6 | % | 39.0 | % | 46.9 | % |
(1) | Other operating income for 2008 includes net proceeds received from insurance related to business interruption and property damage claims associated with Hurricane Katrina. |
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. 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
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 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.
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Levels of free cash flow are set forth in the following table (dollar amounts in thousands):
2010 | 2009 | 2008 | ||||||||||
Cash provided by operating activities |
$ | 101,706 | $ | 86,172 | $ | 89,853 | ||||||
Property and equipment additions |
(21,825 | ) | (21,341 | ) | (64,407 | ) | ||||||
$ | 79,881 | $ | 64,831 | $ | 25,446 | |||||||
Liquidity and Capital Resources
We ended the year with cash of $8.4 million and were in compliance with all of the Credit Facility
covenants. For the year, cash provided by operating activities was $101.7 million. In 2010, we
used $21.8 million of the cash we generated for property and equipment additions. During 2010, we
made additional payments of $96.8 million against our Credit Facility, in addition to the scheduled
quarterly payments of $4.6 million. We also utilized $5.8 million for preferred stock dividends.
During 2009, cash provided by operating activities was $86.2 million. During 2009, we used $21.3
million for property and equipment additions and made additional payments of $85.4 million against
our Credit Facility, including proceeds from our preferred stock offering, in addition to the
scheduled quarterly payments of $5.7 million. We used $1.7 million for preferred stock dividends
in 2009.
In March 2010, we entered into an agreement to sell 2,160,000 shares of our common stock to the
underwriter, for resale to the public. The underwriter had an option to purchase up to 324,000
additional shares of common stock to cover overallotments. We completed our offering of 2,484,000
shares (inclusive of the underwriters 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 June 2009, we entered into a purchase agreement to sell 50,000 shares of our 10% Series B
Cumulative Perpetual Convertible Preferred Stock, $0.01 par value per share, with a liquidation
preference of $1,000 per share. The initial purchaser was also granted a 30-day option to purchase
up to an additional 7,500 shares of the preferred stock to cover overallotments. We completed our
offering of 57,500 shares (inclusive of the initial purchasers option to purchase the additional
7,500 shares), bringing the total aggregate liquidation preference of the preferred stock sold to
$57.5 million. Net proceeds from the issuance of preferred stock were $53.7 million, with offering
and related costs totaling $3.8 million.
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 potential availability
under the shelf registration will be sufficient to fund our business and comply with our financing
obligations. We plan to allocate a portion of our future cash flow from operations to the
repayment of debt, as necessary, and to the expansion of our high-definition room base. As of
December 31, 2010, working capital was negative $50.5 million, compared to negative $4.9 million at
December 31, 2009. The change was primarily from the increase of our accounts payable balance. A
portion of this working capital increase is expected to reverse in 2011. The change was also
driven by the fair value of derivative instruments liability becoming short term as our interest
rate swaps expire in June 2011.
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 location, demographics and
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.
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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 approximately $1.0 million, and will be adjusted for any reduction
in principal as a result of our early repayments against the loan. For the fourth quarter of 2010,
the adjusted quarterly payment requirement was $1.1 million. The term loan bears interest at our
option of (1) the banks 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 banks 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 stipulated 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 currently have two outstanding fixed rate swap agreements for
$437.5 million, with fixed interest rates ranging from 4.97% to 5.09% (see Note 9 to the
Consolidated Financial Statements). The term loan interest rate as of December 31, 2010 was 2.31%.
The all-in weighted average interest rate as of December 31, 2010 was 7.36%, which includes both
the term loan interest rate and the difference in the swaps fixed interest rate versus LIBOR,
including any ineffective portion of the hedge. As of December 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 years ended December 31:
2010 | 2009 | 2008 | ||||||||||
Actual consolidated leverage ratio (1) (3) |
3.43 | 3.82 | 4.30 | |||||||||
Maximum per covenant |
3.50 | 4.00 | 4.50 | |||||||||
Actual consolidated interest coverage ratio (2)
(3) |
3.19 | 3.23 | 3.22 | |||||||||
Minimum per covenant |
3.00 | 2.75 | 2.50 |
(1) | Our maximum consolidated leverage ratio is the total amount of all indebtedness of the Company, determined on a consolidated basis in accordance with GAAP, divided by operating income exclusive of depreciation and amortization and adjusted (plus or minus) for certain other miscellaneous cash items, non-cash items and non-recurring items, as defined by the terms of the bank Credit Facility. | |
(2) | Our minimum consolidated interest coverage ratio is a function of operating income exclusive of depreciation and amortization and adjusted (plus or minus) for certain other miscellaneous cash items, non-cash items and non-recurring items divided by interest expense, as defined by the terms of the bank Credit Facility. | |
(3) | Maximum consolidated leverage ratio and minimum consolidated interest coverage ratios are defined terms of the bank Credit Facility and are presented here to demonstrate compliance with the covenants in our Credit Facility, as noncompliance with such covenants could have a material adverse effect on us. |
Per the bank Credit Facility, our maximum consolidated leverage ratio of 3.50 and minimum
consolidated interest coverage ratio of 3.00 continue to maturity in 2014.
We do not utilize special purpose entities or off balance sheet financial arrangements.
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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 Consolidated EBITDA (a term defined in
our Credit Facility) and to manage our capital investment and debt levels. We continue taking
actions within our control to manage our debt level and remain in compliance with our debt
covenants. The actions within our control include our prudent management of capital investment,
working capital and operating costs and exploring other alternatives, which include seeking an
amendment to our Credit Facility. We are currently pursuing an amendment of our Credit Facility,
which may increase our interest costs, require upfront fees and modify certain other terms which
will be less favorable than we currently have. If we are not able to remain in compliance with our
current debt covenants and our lenders will not amend or waive covenants with which we are not in
compliance, the debt would be due, we would not be able to satisfy our financial obligations and we
would need to seek alternative financing. If we were not able to secure alternative financing,
this would have a substantial adverse impact on the Company and our ability to continue our
operations.
We achieved a consolidated leverage ratio of 3.43 compared to the maximum allowable of 3.50 for the
fourth quarter of 2010. Our ability to continue to comply with our current covenants, as well as
any revised covenants resulting from an amendment to our Credit Facility, is subject to the general
economic climate and business conditions beyond our control. Additionally, our ability to comply
with these covenants depends on achieving our planned operating results and making further debt
reductions, as necessary. 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 our
current debt covenants, or the revised covenants in the event we are successful in amending our
Credit Facility, it will likely have a significant, unfavorable impact on our business and
financial condition.
The Credit Facility also requires we notify the agent upon the occurrence of a Material Adverse
Effect prior to any draw on the Companys 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 Companys
ability to obtain additional financing under the revolving Credit Facility. As of December 31,
2010, we are not aware of any events which would qualify as a Material Adverse Effect under the
Credit Facility. The total amount of long-term debt outstanding, including the current portion, as
of December 31, 2010 was $373.6 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
$1.5 million for the year ended December 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 December 31, 2010, we had outstanding letters of credit
totaling $395,000.
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Obligations and commitments as of December 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) |
$ | 373,639 | $ | 4,807 | $ | 8,591 | $ | 360,241 | $ | | ||||||||||
Interest on bank term loan (1) |
29,464 | 9,210 | 17,981 | 2,273 | | |||||||||||||||
Interest on derivative instruments (net) |
10,435 | 10,435 | | | | |||||||||||||||
Operating lease payments |
2,967 | 1,440 | 1,307 | 220 | | |||||||||||||||
Purchase obligations (2) |
10,509 | 4,886 | 3,688 | 1,840 | 95 | |||||||||||||||
Minimum royalties and commissions (3) |
1,499 | 1,019 | 480 | | | |||||||||||||||
Total contractual obligations |
$ | 428,513 | $ | 31,797 | $ | 32,047 | $ | 364,574 | $ | 95 | ||||||||||
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 |
$ | 395 | $ | 395 | $ | | $ | | $ | | ||||||||||
(1) | Interest payments are estimates based on current LIBOR and scheduled debt amortization. | |
(2) | Consists of open purchase orders and commitments. | |
(3) | In connection with our programming-related agreements, we may guarantee minimum royalties for specific periods or by individual programming content. See Note 10 to the Consolidated Financial Statements. |
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.
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Results of Operations Years Ended December 31, 2010 and 2009
Revenue Analysis. Total revenue for 2010 was $452.2 million, a decrease of $32.3 million or 6.7%,
compared to 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 Hotel Services,
Advertising Services and Healthcare revenue. The following table sets forth the components of our
revenue (dollar amounts in thousands) for the years ended December 31:
2010 | 2009 | |||||||||||||||
Percent | Percent | |||||||||||||||
of Total | of Total | |||||||||||||||
Amount | Revenues | Amount | Revenues | |||||||||||||
Revenues: |
||||||||||||||||
Hospitality and Advertising Services |
||||||||||||||||
Guest Entertainment |
$ | 258,617 | 57.2 | % | $ | 295,817 | 61.1 | % | ||||||||
Hotel Services |
136,089 | 30.1 | % | 131,559 | 27.2 | % | ||||||||||
System Sales and Related Services |
39,081 | 8.6 | % | 42,367 | 8.7 | % | ||||||||||
Advertising Services |
9,867 | 2.2 | % | 6,915 | 1.4 | % | ||||||||||
Total Hospitality and Advertising Services |
443,654 | 98.1 | % | 476,658 | 98.4 | % | ||||||||||
Healthcare |
8,518 | 1.9 | % | 7,834 | 1.6 | % | ||||||||||
$ | 452,172 | 100.0 | % | $ | 484,492 | 100.0 | % | |||||||||
Hospitality and Advertising Services revenue, which includes Guest Entertainment, Hotel Services,
System Sales and Related Services and Advertising Services, decreased $33.0 million or 6.9%, to
$443.7 million in 2010 compared to $476.7 million in 2009. Average monthly Hospitality and
Advertising Services revenue per room was $21.29 for 2010, a decrease of 2.0% as compared to $21.73
per room in the prior year. The following table sets forth information with respect to Hospitality
and Advertising Services revenue per room for the years ended December 31:
2010 | 2009 | |||||||
Average monthly revenue per room: |
||||||||
Hospitality and Advertising Services |
||||||||
Guest Entertainment |
$ | 12.41 | $ | 13.49 | ||||
Hotel Services |
6.53 | 6.00 | ||||||
System Sales and Related Services |
1.88 | 1.93 | ||||||
Advertising Services |
0.47 | 0.31 | ||||||
Total Hospitality and Advertising Services revenue per room |
$ | 21.29 | $ | 21.73 | ||||
Guest Entertainment revenue, which includes on-demand entertainment such as movies, television
on-demand, music and games, decreased $37.2 million or 12.6%, to $258.6 million in 2010 as compared
to $295.8 million in 2009. On a
per-room basis, monthly Guest Entertainment revenue for 2010 declined 8.0%, to $12.41 compared to
$13.49 for 2009. We had a 5.0% reduction in the average number of rooms served year over year,
some of which were low margin properties. Average monthly movie revenue per room was $11.60 for
2010, an 8.4% reduction as compared to $12.66 per room in the prior year. The decline in revenue
per room was driven by the continued conservative consumer buying pattern and a low penetration of
high-definition services across our 1.7 million Guest Entertainment rooms. Non-movie Guest
Entertainment revenue per room decreased 2.4%, to $0.81 for 2010, driven by reductions in games and
television Internet purchases, partially offset by an increase in on-demand television purchases.
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Hotel Services revenue, which includes recurring revenue from hotels for cable television
programming and broadband Internet service and support, increased $4.5 million or 3.4%, to $136.1
million during 2010 versus $131.6 million in 2009. On a per-room basis, monthly Hotel Services
revenue for 2010 increased 8.8%, to $6.53 compared to $6.00 for 2009. Monthly cable television
programming revenue per room increased 9.0%, to $5.96 for 2010 as compared to $5.47 for 2009.
These increases resulted from price changes and higher priced programming packages purchased by
hotels as they install high-definition television systems. Recurring broadband Internet revenue
per room for 2010 increased to $0.57 versus $0.53 for 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
2010, revenue decreased $3.3 million or 7.8%, to $39.1 million as compared to $42.4 million for
2009. The decrease was driven by a decline in broadband equipment sales.
Advertising Services revenue consists of revenue generated by The Hotel Networks (THN), our
advertising services subsidiary acquired as part of the On Command acquisition. Revenue increased
$3.0 million or 42.7%, to $9.9 million during 2010 as compared to $6.9 million for 2009. This
increase was primarily the result of increased carriage services revenue, where we provide cable
channels to providers for the distribution of their programming, and other general advertising.
Healthcare revenue includes the sale of interactive systems and services to healthcare facilities.
Healthcare revenue increased by $0.7 million or 8.7%, to $8.5 million for 2010 versus $7.8 million
in 2009, primarily from recurring service and maintenance agreement revenues. During 2010, we
installed 12 facilities and 3,045 beds compared to 17 facilities and 2,659 beds in 2009. We have
six signed healthcare contracts in our backlog waiting for installation.
Direct Costs (exclusive of operating expenses and depreciation and amortization discussed
separately below). Total direct costs were $254.0 million in 2010, a decrease of $19.9 million or
7.3%, as compared to $273.9 million in 2009. Total direct costs were 56.2% of revenue for 2010 as
compared to 56.5% for 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 $249.7 million for 2010 compared to $270.0 million in 2009. The
decrease in total direct costs was primarily related to decreases in hotel commissions and content
royalties, lower system and equipment costs and a reduction in recurring connectivity and other
Internet support costs. Advertising Services had lower costs during 2010 due to lower satellite
distribution costs. These decreases were partially offset by an increase in television programming
costs, which vary with the increased revenue and the services provided.
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Operating Expenses. The following table sets forth information in regard to operating expenses for
the years ended December 31 (dollar amounts in thousands):
2010 | 2009 | |||||||||||||||
Percent | Percent | |||||||||||||||
of Total | of Total | |||||||||||||||
Amount | Revenues | Amount | Revenues | |||||||||||||
Operating expenses: |
||||||||||||||||
System operations |
$ | 42,940 | 9.5 | % | $ | 42,605 | 8.8 | % | ||||||||
Selling, general and
administrative (1) |
48,151 | 10.6 | % | 45,494 | 9.4 | % | ||||||||||
Depreciation and amortization |
83,236 | 18.4 | % | 100,309 | 20.7 | % | ||||||||||
Restructuring charge (2) |
421 | 0.1 | % | 603 | 0.1 | % | ||||||||||
Other operating income |
(21 | ) | 0.0 | % | (126 | ) | 0.0 | % | ||||||||
Total operating expenses |
$ | 174,727 | 38.6 | % | $ | 188,885 | 39.0 | % | ||||||||
(1) | 2010 SG&A expenses include $0.7 million of debt issuance costs related to the marketing of a high-yield offering, which we did not pursue. | |
(2) | Restructuring costs are defined as costs associated with the closing, disposal or exit of certain duplicate facilities or operations, including termination benefits and costs to consolidate facilities or relocate employees, and costs associated with a reduction in force, including termination benefits. The Company will not realize future benefits from these costs. |
System operations expenses increased $0.3 million or 0.8%, to $42.9 million in 2010 as compared to
$42.6 million in 2009. The increase was driven primarily by higher fuel costs. As a percentage of
total revenue, system operations expenses increased to 9.5% this year as compared to 8.8% in the
prior year. Per average installed room, system operations expenses also increased, to $2.06 per
room per month for 2010 compared to $1.94 for 2009.
Selling, general and administrative (SG&A) expenses increased $2.7 million or 5.8%, to $48.2
million in 2010 as compared to $45.5 million in 2009. As a percentage of revenue, SG&A expenses
were 10.6% in the current year compared to 9.4% in the prior year. SG&A expenses were $2.31 per
average installed room per month in 2010 compared to $2.07 in 2009. The increases resulted from
debt issuance costs related to financing options, higher legal fees, service and maintenance costs,
travel and business development costs.
Depreciation and amortization expenses were $83.2 million in 2010 as compared to $100.3 million in
2009. The decline was due to the reduction in capital investments over the past two years and
certain assets becoming fully depreciated. As a percentage of revenue, depreciation and
amortization expenses were 18.4% in 2010 compared to 20.7% in 2009.
During 2010, we incurred costs of $421,000 related to our workforce reduction initiatives, while we
had costs of $603,000 in 2009.
Operating Income. As a result of the factors described above, operating income increased to $23.4
million in 2010 as compared to $21.7 million in the prior year.
Interest Expense. Interest expense was $33.5 million in the current year versus $38.1 million in
2009. The decrease resulted from the change in the weighted average outstanding balance of our
debt under the Credit Facility, to $423.9
million at December 31, 2010 from $535.0 million at December 31, 2009. The all-in weighted average
interest rate increased to 7.36% for the current year versus 6.97% for 2009. Interest expense for
2010 included $1.5 million of non-cash interest charges related to our interest rate swap position;
there were no such charges included for 2009.
Gain on Extinguishment of Debt. During 2009, we acquired $31.5 million of our outstanding debt as
part of a debt reduction initiative, at 70.5% of par value, and recorded a gain on extinguishment
of the debt of $9.3 million. The acquisition was made through a wholly-owned subsidiary, a
permitted investment under our Credit Facility.
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Loss on Early Retirement of Debt. In 2010, we made additional payments on our term loan totaling
$96.8 million and wrote off $1.1 million of unamortized debt issuance costs. During 2009, we made
additional payments of $85.4 million on our term loan and wrote off $1.5 million of unamortized
debt issuance costs associated with the early retirement of our debt.
Other Income (Expense). During 2010, we recorded $0.3 million of other income, including interest
income. In 2009, we recorded a total of $0.7 million of other expense. This consisted of an
investment loss of $1.4 million related to our 2007 investment of $5.0 million in a high-speed
Internet service provider, due to continued softness in certain markets, and $0.7 million of other
income, including interest income.
Taxes. During 2010, we incurred state franchise taxes of $0.8 million. For 2009, we also incurred
state franchise taxes of $0.8 million.
Net Loss. As a result of the factors described above, net loss was $11.7 million for 2010 compared
to a net loss of $10.2 million in the prior year.
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Results of Operations Years Ended December 31, 2009 and 2008
Revenue Analysis. Total revenue for 2009 was $484.5 million, a decrease of $49.4 million or 9.3%,
compared to 2008. The decrease was driven by lower Guest Entertainment and Advertising Services
revenues, partially offset by increases in revenue from Hotel Services, System Sales and Related
Services and Healthcare.
Hospitality and Advertising Services revenue, which includes Guest Entertainment, Hotel Services,
System Sales and Related Services and Advertising Services, decreased $51.1 million or 9.7%, to
$476.7 million in 2009 compared to $527.8 million in 2008. Average monthly Hospitality and
Advertising Services revenue per room was $21.73 for 2009, a decrease of 8.3% as compared to $23.69
in the prior year. Guest Entertainment revenue decreased $69.2 million or 18.9%, to $295.8 million
in 2009 as compared to $365.0 million in 2008. Hotel Services revenue, from cable television
programming and broadband Internet service and support, increased $10.1 million or 8.2%, to $131.6
million during 2009 versus $121.5 million in 2008. System Sales and Related Services revenue,
including cable television equipment, broadband Internet equipment, HDTV installations and other
services to hotels, increased $9.0 million or 26.7%, to $42.4 million for 2009 as compared to $33.4
million for 2008. Advertising Services revenue consists of revenue generated by our advertising
subsidiary, and decreased $1.0 million or 12.3%, to $6.9 million during 2009 as compared to $7.9
million in 2008.
Healthcare revenue, which includes the sale of interactive systems and services to healthcare
facilities, increased $1.7 million or 29.1%, to $7.8 million during 2009 as compared to $6.1
million for 2008.
Direct costs (exclusive of operating expenses and depreciation and amortization discussed
separately below). Total direct costs were $273.9 million, or 56.5% of revenue, in 2009, a
decrease of $15.1 million as compared to $289.0 million, or 54.1% of revenue, in 2008. The change
in cost as a percentage of revenue was due to a change in the mix of products or services sold year
over year, driven by the increased percentage of revenue generated by cable television programming
and system sales, which generally have lower margins than our Guest Entertainment revenues.
Operating Expenses. System operations expenses decreased $15.3 million or 26.4%, to $42.6 million
in 2009 as compared to $57.9 million in 2008. Selling, general and administrative (SG&A)
expenses decreased $7.3 million or 13.8%, to $45.5 million in 2009 as compared to $52.8 million in
2008. These decreases were due to the expected synergies from our post-merger consolidation of
certain duplicative general and administrative expenses and our labor expense reduction initiatives
implemented during 2008 and 2009. Depreciation and amortization expenses were $100.3 million in
2009 as compared to $124.1 million in 2008. As a percentage of revenue, depreciation and
amortization expenses were 20.7% in 2009 compared to 23.3% in 2008.
In 2008, due to the erosion of the capital markets and the economy in general, we incurred a
goodwill and purchased intangibles impairment charge of $11.2 million, related to Advertising
Services, and recorded a write down of $0.6 million related to On Command purchased intangibles.
See Note 6 to the Consolidated Financial Statements.
During 2009, we incurred restructuring costs of approximately $680,000 related to facility
consolidation, partially offset by unused severance benefits of approximately $77,000. During
2008, we incurred costs of $5.0 million related to post-acquisition restructuring activities.
Other operating income for 2008 included proceeds of $815,000 from insurance related to business
interruption and property damage claims associated with Hurricane Katrina.
Operating Income (Loss). As a result of the factors described above, operating income was $21.7
million in 2009 as compared to an operating loss of $(5.1) million in 2008.
Interest Expense. Interest expense was $38.1 million in 2009 versus $42.6 million in 2008. The
decrease resulted from the change in the weighted average outstanding balance of our debt under our
Credit Facility, to $535.0 million at December 31, 2009 from $616.7 million at December 31, 2008.
The all-in weighted average interest rate increased to 6.97% for 2009 versus 6.78% for 2008.
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Gain on Extinguishment of Debt. During 2009, we acquired $31.5 million of our outstanding debt as
part of a debt reduction initiative, at 70.5% of par value, and recorded a gain on extinguishment
of the debt of $9.3 million. The acquisition was made through a wholly-owned subsidiary, a
permitted investment under our Credit Facility. In 2008, we acquired $2.9 million of outstanding
debt at 50.0% of par value and recorded a gain on the extinguishment of debt of $1.4 million.
Loss on Early Retirement of Debt. During 2009, we made additional payments of $85.4 million on our
term loan and wrote off $1.5 million of unamortized debt issuance costs associated with the early
retirement of our debt. During 2008, we made additional payments of $27.5 million on our term loan
and wrote off $0.4 million of unamortized debt issuance costs.
Other Expense. In 2009, we recorded a total of $0.7 million of other expense, which included an
investment loss of $1.4 million related to our 2007 investment in a high-speed Internet service
provider, offset by $0.7 million of other income, including interest income. In 2008, we recorded
a total of $0.9 million of other expense, including an investment loss of $0.6 million related to
our investment in the Internet service provider, and $0.3 million of other expense, net of interest
income.
Taxes. During 2009, we incurred state franchise taxes of $0.8 million. For 2008, we also incurred
state franchise taxes of $0.8 million.
Net Loss. As a result of the factors described above, net loss was $10.2 million for 2009 compared
to a net loss of $48.4 million in the prior year.
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Critical Accounting Policies
Managements discussion and analysis of financial condition and results of operations are based
upon our financial statements, which have been prepared in conformity with accounting principles
generally accepted in the United States of America. Our primary cost drivers are predetermined
rates, such as hotel commissions; license fees paid for major motion pictures and other content or
one-time fixed fees for independent films; and cable television programming costs. However, the
preparation of financial statements requires us to make estimates and assumptions which affect the
reported amounts of assets and liabilities and the reported amounts of revenues and expenses during
the reporting period. We base our estimates on historical experience and on various other
assumptions we believe to be reasonable based upon the available information. The critical
policies related to the more significant judgments and estimates used in the preparation of the
financial statements are further discussed within the Notes of the financial statements as follows:
Ø | Revenue Recognition footnote #2 | ||
Ø | Goodwill and Other Intangible Assets footnote #6 | ||
Ø | Restructuring footnote #14 |
Recent Accounting Developments
In October 2009, the Financial Accounting Standards Board (FASB) issued FASB Accounting Standards
Update (ASU) No. 2009-13, Multiple-Deliverable Revenue Arrangements, which is now codified
under FASB Accounting Standards Codification (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 vendors multiple-deliverable revenue
arrangements. FASB ASU No. 2009-13 was 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. 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
was 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. 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 April 2010, the FASB issued FASB ASU No. 2010-17, Milestone Method of Revenue Recognition,
which is now codified under FASB ASC Topic 605, Revenue Recognition. This ASU provides guidance
on defining a milestone and determining when it may be appropriate to apply the milestone method of
revenue recognition for research and development transactions. Consideration which is contingent
upon achievement of a milestone in its entirety can be recognized as revenue in the period in which
the milestone is achieved only if the milestone meets all criteria to be considered substantive. A
milestone should be considered substantive in its entirety, and an individual milestone may not be
bifurcated. An arrangement may include more than one milestone, and each milestone should be
evaluated individually to determine if it is substantive. FASB ASU No. 2010-17 was effective on a
prospective basis for milestones achieved in fiscal years (and interim periods within those years)
beginning on or after June 15, 2010, with early adoption permitted. 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.
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In December 2010, the FASB issued FASB ASU No. 2010-28, When to Perform Step 2 of the Goodwill
Impairment Test for Reporting Units with Zero or Negative Carrying Amounts, which is now codified
under FASB ASC Topic 350, Intangibles Goodwill and Other. This ASU provides amendments to
Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts.
For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test
if it is more likely than not a goodwill impairment exists. When determining whether it is more
likely than not an impairment exists, an entity should consider whether there are any adverse
qualitative factors, such as a significant deterioration in market conditions, indicating an
impairment may exist. FASB ASU No. 2010-28 is effective for fiscal years (and interim periods
within those years) beginning after December 15, 2010. Early adoption is not permitted. Upon
adoption of the amendments, an entity with reporting units having carrying amounts which are zero
or negative is required to assess whether is it more likely than not the reporting units goodwill
is impaired. If the entity determines impairment exists, the entity must perform Step 2 of the
goodwill impairment test for that reporting unit or units. Step 2 involves allocating the fair
value of the reporting unit to each asset and liability, with the excess being implied goodwill.
An impairment loss results if the amount of recorded goodwill exceeds the implied goodwill. Any
resulting goodwill impairment should be recorded as a cumulative-effect adjustment to beginning
retained earnings in the period of adoption. We have reporting units with negative carrying value
and are evaluating the effect from the adoption of this ASU. Depending on market conditions or
other qualitative factors, this ASU could have a material effect on our consolidated results of
operations.
Item 7A Quantitative and Qualitative Disclosures About Market Risk |
We are exposed to various market risks, including potential losses resulting from adverse changes
in interest rates and foreign currency exchange rates. We do not enter into derivatives or other
financial instruments for trading or speculative purposes.
Interest. At December 31, 2010, we had debt totaling $373.6 million, as follows (dollar amounts in
thousands):
Carrying | Fair | |||||||
Amount | Value | |||||||
Bank Credit Facility: |
||||||||
Bank term loan |
$ | 372,511 | $ | 348,298 | ||||
Capital leases |
1,128 | 1,128 | ||||||
$ | 373,639 | $ | 349,426 | |||||
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. In addition, 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.
We have two 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. The
term loan interest rate as of December 31, 2010 was 2.31% and the capital lease interest rate was
7.14%. Our all-in weighted average interest rate, which includes both the term loan interest rate
and the difference in the swaps fixed interest rate versus LIBOR, for the year ended December 31,
2010, was 7.36%, compared to 6.97% for the year ended December 31, 2009. After giving effect to
the interest rate swap arrangements, we had fixed rate debt of $373.6 million and no variable rate
debt, as the total swap amount was greater than our term loan amount at December 31, 2010. For
fixed rate debt, interest rate fluctuations affect the fair market value but do not impact earnings
or cash flows, if effective. Conversely, for variable rate debt, interest rate fluctuations
generally do not affect the fair market value but do impact future earnings and cash flows,
assuming other factors are held constant. There would be no impact on earnings and cash flow for
the next year resulting from a one percentage point increase to interest rates, assuming other
variables
remain constant. Upon expiration of the interest rate swaps in June 2011, a one percentage point
increase to interest rates, assuming other variables remain constant, would impact second half 2011
earnings and cash flow by approximately $1.9 million.
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Economic Condition and Consumer Confidence. Our results are generally connected to the performance
of the lodging industry, where occupancy rates may fluctuate resulting from various factors.
Reduction in hotel occupancy and consumer buy rates, resulting from business, general economic or
other events, such as a recession in the United States, significant international crises, acts of
terrorism, war or public health issues, could adversely impact our business, financial condition
and results of operations. The overall travel industry and consumer buying pattern can be, and has
been in the past, adversely affected by weaker general economic climates, geopolitical instability
and concerns about public health.
Foreign Currency Transactions. A portion of our revenue is derived from the sale of Guest
Entertainment services in Canada and Mexico. The results of operations and financial position of
our operations in Canada and Mexico are measured in their local currencies and translated into U.S.
dollars. The effects of foreign currency fluctuations in Canada and Mexico are somewhat mitigated
by the fact expenses and liabilities are generally incurred in the local currency. The reported
income of our Canadian and Mexican subsidiaries will be higher or lower depending on a weakening or
strengthening of the U.S. dollar against the local currency. Additionally, a portion of our assets
are based in Canada and Mexico and are translated into U.S. dollars at foreign currency exchange
rates in effect as of the end of each period. Accordingly, our consolidated assets will fluctuate
depending on the weakening or strengthening of the U.S. dollar against the local currency.
Item 8 Financial Statements and Supplementary Data |
See Item 15 Exhibits and Financial Statement Schedules for LodgeNets Consolidated Financial
Statements, the Notes thereto and Schedules filed as a part of this report.
Item 9 Changes In and Disagreements with Accountants on Accounting and Financial Disclosure |
None.
Item 9A Controls and Procedures |
Evaluation of Disclosure Controls and Procedures. Based on their evaluation as of the end of the
period covered by this Annual Report on Form 10-K, the Chief Executive Officer and Chief Financial
Officer have concluded the disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) of the Securities Exchange Act of 1934) are effective to ensure information required to
be disclosed by us in reports we file or submit under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the time periods specified in Securities and
Exchange Commission rules and forms. Additionally, our disclosure controls and procedures were
also effective in ensuring information required to be disclosed in our Exchange Act reports is
accumulated and communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, to allow timely decisions regarding required disclosures.
Managements report on internal control over financial reporting. Our management is responsible
for establishing and maintaining adequate internal control over financial reporting, as defined in
Rule 13a-15(f) of the Securities Exchange Act of 1934. Our internal control over financial
reporting is a process designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. Our internal control over financial reporting
includes those policies and procedures which (i) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and dispositions of assets; (ii)
provide reasonable assurance transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting principles, and our receipts
and expenditures are being made only in accordance with authorizations of our management and
directors; and (iii) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of our assets, which could have a material effect on
the financial statements.
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Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk controls may become inadequate because of changes in conditions, or the degree
of compliance with the policies or procedures may deteriorate.
Management has assessed our internal control over financial reporting in relation to criteria
described in Internal Control Integrated Framework, issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this assessment, using those criteria, we
concluded that, as of December 31, 2010, our internal control over financial reporting was
effective.
PricewaterhouseCoopers LLP, an independent registered public accounting firm, has audited the
Companys internal control over financial reporting as of December 31, 2010, as stated in their
report appearing on page F-2 of this Annual Report on Form 10-K.
Changes in Internal Control over Financial Reporting. There was no change in our internal control
over financial reporting during the quarter ended December 31, 2010 which has materially affected,
or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B Other Information |
None.
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PART III
Item 10 Directors, Executive Officers and Corporate Governance
The information concerning our directors and executive officers is incorporated by reference from
the sections entitled Executive Officers, Election of Directors Board of Directors and
Nominees and Compliance with Reporting Requirements of Section 16 of the Exchange Act of our
definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days after the end of
the last fiscal year.
Information concerning Audit Committee membership and the Audit Committees designated financial
expert is incorporated by reference from the sections entitled Election of Directors Corporate
Governance and Committees of the Board of DirectorsCommittees and Audit Committee Report of
our definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days after the end
of the last fiscal year.
We have adopted a written code of business conduct and ethics, which applies to all employees,
including the principal executive officer, principal financial officer and accounting officer,
controller or persons performing similar functions and all members of the Board of Directors. The
policies are found on our web site, which is http://www.lodgenet.com.
The charters of our Audit Committee, Governance and Nominating Committee and Compensation Committee
may also be found on our website.
Item 11 Executive Compensation
Information concerning executive remuneration and transactions is incorporated by reference from
the sections entitled Election of Directors Director Compensation, Election of Directors
Executive Compensation, Report of the Compensation Committee on Executive Compensation and
Performance Graph of our definitive Proxy Statement to be filed pursuant to Regulation 14A within
120 days after the end of the last fiscal year.
Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
Information concerning security ownership of certain beneficial owners and management is
incorporated by reference from the section entitled About the Annual Meeting Who are the
largest owners of LodgeNets stock and how much stock do our directors and executive officers own?
of our definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days after the
end of the last fiscal year. Information concerning securities authorized for issuance under
equity compensation plans is incorporated by reference from the section entitled Equity
Compensation Plan Information of our definitive Proxy Statement to be filed pursuant to Regulation
14A within 120 days after the end of the last fiscal year. We do not know of any arrangement which
could, at a subsequent date, result in a change of control.
Item 13 Certain Relationships and Related Transactions, and Director Independence
Information concerning certain relationships and related transactions with management is
incorporated by reference from the section entitled Certain Transactions with Management and
Others of our definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days
after the end of the fiscal year.
Item 14 Principal Accountant Fees and Services
The information concerning principal accountant fees and services is incorporated by reference from
the section entitled Audit Committee Report of our definitive Proxy Statement to be filed
pursuant to Regulation 14A within 120 days after the end of the last fiscal year.
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PART IV
Item 15 Exhibits and Financial Statement Schedules
Consolidated Financial Statements and Schedules Reference is made to the Index to
Consolidated Financial Statements of LodgeNet Interactive Corporation, located at page F 1 of
this PART IV, for a list of the financial statements and schedules for the year ended December 31,
2010, included herein.
Exhibits Following is a list of Exhibits filed with this report. Exhibits 10.17 through
10.24 constitute management contracts. Exhibits 10.1, 10.2, 10.3, 10.7, 10.8, 10.9, 10.10, and
10.11 constitute compensatory plans.
If you would like a copy of any of the Exhibits listed herein, please submit a written request to
LodgeNet Interactive Corporation, Attention: Corporate Secretary, 3900 West Innovation Street,
Sioux Falls, South Dakota, 57107-7002, telephone (605) 988-1000, and we will provide you with such
Exhibit(s) upon the payment of a nominal fee, such fee being limited to the expenses incurred by us
in providing you with the requested Exhibit(s).
Exhibit No.
3.1 | Certificate of Incorporation of LodgeNet (1) |
|||
3.2 | Restated By-Laws of the Registrant (2) |
|||
3.3 | Amendment No. 1 to Restated Certificate of Incorporation of LodgeNet (3) |
|||
3.4 | Certificate of Ownership and Merger merging LodgeNet Interactive Corporation into LodgeNet
Entertainment Corporation (4) |
|||
4.1 | Rights Agreement dated as of February 28, 2008 between LodgeNet Interactive Corporation and
Computershare Investor Services, LLC (5) |
|||
4.2 | Certificate of Designations for 10% Series B Cumulative Perpetual Convertible Preferred Stock
(6) |
|||
10.1 | LodgeNet Interactive Corporation Stock Option Plan (as amended and restated effective May 9,
2001) (7) |
|||
10.2 | 1993 Plan Form of Stock Option Agreement for Non-Employee Directors (8) |
|||
10.3 | 1993 Plan Form of Incentive Stock Option Agreement for Key Employees (8) |
|||
10.4 | Master Services Agreement between Hilton Worldwide and LodgeNet Interactive Corporation dated
October 9, 2000 (9) |
|||
10.5 | Amendment To Master Services Agreement dated August 2, 2002 by and between Hilton Worldwide
and LodgeNet Interactive Corporation (10) |
|||
10.6 | Hilton LodgeNet Agreement dated August 2, 2002 by and between Hilton Worldwide and LodgeNet
Interactive Corporation (11) |
|||
10.7 | LodgeNet Interactive Corporation 2003 Stock Option and Incentive Plan (12) |
|||
10.8 | 2003 Plan Form of Stock Option Agreement for Non-Employee Directors (13) |
|||
10.9 | 2003 Plan Form of Incentive Stock Option Agreement for Key Employees (14) |
|||
10.10 | Form of Restricted Stock Agreement for Time-Based Vesting (15) |
56
Table of Contents
10.11 | Form of Restricted Stock Agreement for Performance-Based Vesting (16) |
|||
10.16 | $675,000,000 Credit Agreement dated as of April 4, 2007 among LodgeNet Entertainment
Corporation, as Borrower, Credit Suisse Securities (USA) LLC as Syndication Agent, U.S. Bank
National Association as Documentation Agent, and Bear Stearns Corporate Lending Inc. as
Administrative Agent (17) |
|||
10.17 | Second Amended and Restated Employment Agreement dated as of January 29, 2008 between
LodgeNet Interactive Corporation and Scott C. Petersen (18) |
|||
10.18 | Executive Employment Agreement dated as of January 29, 2008 between LodgeNet Interactive
Corporation and David M. Bankers (19) |
|||
10.19 | Executive Employment Agreement dated as of January 29, 2008 between LodgeNet Interactive
Corporation and James G. Naro (20) |
|||
10.20 | Executive Employment Agreement dated as of January 29, 2008 between LodgeNet Interactive
Corporation and Steven R. Pofahl (21) |
|||
10.21 | Executive Employment Agreement dated as of January 29, 2008 between LodgeNet Interactive
Corporation and Gary H. Ritondaro (22) |
|||
10.22 | Executive Employment Agreement dated as of February 4, 2008 between LodgeNet Interactive
Corporation and Derek S. White (23) |
|||
10.23 | Executive Employment Agreement dated as of August 27, 2008 between LodgeNet Interactive
Corporation and Scott E. Young (24) |
|||
10.24 | Executive Employment Agreement dates as of February 25, 2010 between LodgeNet Interactive
Corporation and Frank P. Elsenbast (25) |
|||
12.1 | Statement Regarding Computation of Ratios |
|||
21.1 | Subsidiaries of the Company |
|||
23.1 | Consent of Independent Registered Public Accounting Firm |
|||
31.1 | Rule 13a-14(a)/15d-14(a) Certifications of Chief Financial Officer |
|||
31.2 | Rule 13a-14(a)/15d-14(a) Certifications of Chief Executive Officer |
|||
32.1 | Section 1350 Certifications |
| Confidential Treatment has been requested with respect to certain portions of this agreement. | |
(1) | Incorporated by Reference to LodgeNets Amendment No. 1 to Registration Statement on Form S-1, as filed with the Securities and Exchange Commission, September 24, 1993. (File No. 033-67676). | |
(2) | Incorporated by Reference to Exhibit 3.2 to LodgeNets Current Report on Form 8-K dated November 17, 2008. | |
(3) | Incorporated by Reference to Exhibit 10.37 to LodgeNets Quarterly Report on Form 10-Q for the quarter ended September 30, 2001. |
57
Table of Contents
(4) | Incorporated by Reference to Exhibit 3.1 to LodgeNets Current Report on Form 8-K as filed with the Securities and Exchange Commission on January 15, 2008. | |
(5) | Incorporated by Reference to Exhibit 4.6 to LodgeNets Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 14, 2008. | |
(6) | Incorporated by Reference to Exhibit 3.1 to LodgeNets Current Report on Form 8-K as filed with the Securities and Exchange Commission on June 29, 2009. | |
(7) | Incorporated by Reference to Exhibit 99.1 to LodgeNets Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on March 27, 2002. | |
(8) | Incorporated by Reference to Exhibit 10.13 and 10.14 to LodgeNets Annual Report on Form 10-K for the year ended December 31, 1993. | |
(9) | Incorporated by Reference to Exhibit 10.32 to LodgeNets Quarterly Report on Form 10-Q for the quarter ended September 30, 2000. | |
(10) | Incorporated by Reference to Exhibit 10.2 to LodgeNets Current Report on Form 8-K as filed with the Securities and Exchange Commission on August 15, 2002. | |
(11) | Incorporated by Reference to Exhibit 10.1 to LodgeNets Current Report on Form 8-K as filed with the Securities and Exchange Commission on August 15, 2002. | |
(12) | Incorporated by Reference to Annex 2 of LodgeNets Definitive Proxy Statement dated March 30, 2006. | |
(13) | Incorporated by Reference to Exhibit 10.26 to LodgeNets Annual Report on Form 10-K for the year ended December 31, 2003. | |
(14) | Incorporated by Reference to Exhibit 10.27 to LodgeNets Annual Report on Form 10-K for the year ended December 31, 2003. | |
(15) | Incorporated by Reference to Exhibit 10.25 to LodgeNets Annual Report on Form 10-K for the year ended December 31, 2005. | |
(16) | Incorporated by Reference to Exhibit 10.26 to LodgeNets Annual Report on Form 10-K for the year ended December 31, 2005. | |
(17) | Incorporated by Reference to Exhibit 10.1 to LodgeNets Current Report on Form 8-K dated April 4, 2007. | |
(18) | Incorporated by Reference to Exhibit 10.17 to LodgeNets Annual Report on Form 10-K for the year ended December 31, 2007. | |
(19) | Incorporated by Reference to Exhibit 10.18 to LodgeNets Annual Report on Form 10-K for the year ended December 31, 2007. | |
(20) | Incorporated by Reference to Exhibit 10.19 to LodgeNets Annual Report on Form 10-K for the year ended December 31, 2007. | |
(21) | Incorporated by Reference to Exhibit 10.20 to LodgeNets Annual Report on Form 10-K for the year ended December 31, 2007. | |
(22) | Incorporated by Reference to Exhibit 10.21 to LodgeNets Annual Report on Form 10-K for the year ended December 31, 2007. |
58
Table of Contents
(23) | Incorporated by Reference to Exhibit 10.22 to LodgeNets Annual Report on Form 10-K for the year ended December 31, 2007. | |
(24) | Incorporated by Reference to Exhibit 10.1 to LodgeNets Current Report on Form 8-K as filed with the Securities Exchange Commission on September 2, 2008. | |
(25) | Incorporated by Reference to Exhibit 10.1 to LodgeNets Current Report on Form 8-K as filed with the Securities Exchange Commission on March 2, 2010. |
59
Table of Contents
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
LodgeNet has duly caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized in the City of Sioux Falls, State of South Dakota, on March 14, 2011.
LodgeNet Interactive Corporation | ||||
By: | /s/ Scott C. Petersen | |||
Scott C. Petersen, | ||||
President, Chief Executive Officer and
Chairman of the Board of Directors |
||||
Pursuant to the requirements of the Securities Exchange Act of 1934, LodgeNet has duly caused this
report to be signed on its behalf by the undersigned, and in the capacities indicated, on March 14,
2011.
Signature | Title | Date | ||
/s/ Scott C. Petersen
|
President, Chief Executive Officer and Chairman of the Board of Directors (Principal Executive Officer) | March 14, 2011 | ||
/s/ Frank P. Elsenbast
|
Senior Vice President Chief Financial Officer (Principal Financial & Accounting Officer) |
March 14, 2011 | ||
/s/ Martin L. Abbott
|
Director | March 14, 2011 | ||
/s/ R. Douglas Bradbury
|
Director | March 14, 2011 | ||
/s/ John E. Haire
|
Director | March 14, 2011 | ||
/s/ J. Scott Kirby
|
Director | March 14, 2011 | ||
/s/ R. F. Leyendecker
|
Director | March 14, 2011 | ||
/s/ Vikki I. Pachera
|
Director | March 14, 2011 | ||
/s/ Edward L. Shapiro
|
Director | March 14, 2011 | ||
/s/ Scott H. Shlecter
|
Director | March 14, 2011 |
60
Table of Contents
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
LodgeNet Interactive Corporation and Subsidiaries
Index to Consolidated Financial Statements
Page | ||||
F - 2 | ||||
F - 3 | ||||
F - 4 | ||||
F - 5 | ||||
F - 6 | ||||
F - 7 | ||||
Index to Financial Schedules |
||||
F - 34 |
F - 1
Table of Contents
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of
LodgeNet Interactive Corporation
LodgeNet Interactive Corporation
In our opinion, the accompanying consolidated balance sheets and the related consolidated
statements of operations, of stockholders equity and of cash flows present fairly, in all material
respects, the financial position of LodgeNet Interactive Corporation and its subsidiaries at
December 31, 2010 and December 31, 2009, and the results of their operations and their cash flows
for each of the three years in the period ended December 31, 2010 in conformity with accounting
principles generally accepted in the United States of America. In addition, in our opinion, the
financial statement schedule listed in the accompanying index presents fairly, in all materials
respects, the information set forth therein when read in conjunction with the related consolidated
financial statements. Also in our opinion, the Company maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2010, based on criteria
established in Internal Control Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Companys management is responsible for these
financial statements and financial statement schedule, for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of internal control over
financial reporting, which is stated in Managements Report on Internal Control Over Financial
Reporting within the 2010 Annual Report to Shareholders. Our responsibility is to express opinions
on these financial statements, on the financial statement schedule, and on the Companys internal
control over financial reporting based on our integrated audits. We conducted our audits in
accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audits to obtain reasonable assurance about
whether the financial statements are free of material misstatement and whether effective internal
control over financial reporting was maintained in all material respects. Our audits of the
financial statements included examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles used and significant
estimates made by management, and evaluating the overall financial statement presentation. Our
audit of internal control over financial reporting included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness exists, and testing
and evaluating the design and operating effectiveness of internal control based on the assessed
risk. Our audits also included performing such other procedures as we considered necessary in the
circumstances. We believe that our audits provide a reasonable basis for our opinions.
A companys internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles. A
companys internal control over financial reporting includes those policies and procedures that (i)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of management and directors of the company;
and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the companys assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.
PricewaterhouseCoopers LLP
Minneapolis, Minnesota
March 14, 2011
Minneapolis, Minnesota
March 14, 2011
F - 2
Table of Contents
LodgeNet Interactive Corporation and Subsidiaries
Consolidated Balance Sheets
(Dollar amounts in thousands, except share data)
Consolidated Balance Sheets
(Dollar amounts in thousands, except share data)
December 31, | December 31, | |||||||
2010 | 2009 | |||||||
Assets |
||||||||
Current assets: |
||||||||
Cash |
$ | 8,381 | $ | 17,011 | ||||
Accounts receivable, net |
49,332 | 51,706 | ||||||
Other current assets |
12,728 | 9,189 | ||||||
Total current assets |
70,441 | 77,906 | ||||||
Property and equipment, net |
156,917 | 206,663 | ||||||
Debt issuance costs, net |
3,681 | 6,005 | ||||||
Intangible assets, net |
99,005 | 106,041 | ||||||
Goodwill |
100,081 | 100,081 | ||||||
Other assets |
13,881 | 11,658 | ||||||
Total assets |
$ | 444,006 | $ | 508,354 | ||||
Liabilities and Stockholders Deficiency |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 60,303 | $ | 40,040 | ||||
Current maturities of long-term debt |
4,807 | 6,101 | ||||||
Accrued expenses |
22,327 | 19,137 | ||||||
Fair value of derivative instruments |
10,353 | | ||||||
Deferred revenue |
23,168 | 17,531 | ||||||
Total current liabilities |
120,958 | 82,809 | ||||||
Long-term debt |
368,832 | 463,845 | ||||||
Fair value of derivative instruments |
| 26,623 | ||||||
Other long-term liabilities |
8,565 | 6,064 | ||||||
Total liabilities |
498,355 | 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 December 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;
25,088,539 and 22,537,664 shares outstanding at December 31, 2010
and December 31, 2009, respectively |
251 | 225 | ||||||
Additional paid-in capital |
388,961 | 379,223 | ||||||
Accumulated deficit |
(437,896 | ) | (426,211 | ) | ||||
Accumulated other comprehensive loss |
(5,666 | ) | (24,225 | ) | ||||
Total stockholders deficiency |
(54,349 | ) | (70,987 | ) | ||||
Total liabilities and stockholders deficiency |
$ | 444,006 | $ | 508,354 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
F - 3
Table of Contents
LodgeNet Interactive Corporation and Subsidiaries
Consolidated Statements of Operations
(Dollar amounts in thousands, except share data)
Consolidated Statements of Operations
(Dollar amounts in thousands, except share data)
Years Ended December 31, | ||||||||||||
2010 | 2009 | 2008 | ||||||||||
Revenues: |
||||||||||||
Hospitality and Advertising Services |
$ | 443,654 | $ | 476,658 | $ | 527,810 | ||||||
Healthcare |
8,518 | 7,834 | 6,069 | |||||||||
Total revenues |
452,172 | 484,492 | 533,879 | |||||||||
Direct costs and operating expenses: |
||||||||||||
Direct costs (exclusive of operating expenses and
depreciation and amortization shown separately below): |
||||||||||||
Hospitality and Advertising Services |
249,745 | 269,997 | 285,835 | |||||||||
Healthcare |
4,290 | 3,918 | 3,132 | |||||||||
Operating expenses: |
||||||||||||
System operations |
42,940 | 42,605 | 57,853 | |||||||||
Selling, general and administrative |
48,151 | 45,494 | 52,775 | |||||||||
Depreciation and amortization |
83,236 | 100,309 | 124,060 | |||||||||
Goodwill impairment charge |
| | 11,212 | |||||||||
Restructuring charge |
421 | 603 | 5,047 | |||||||||
Other operating income |
(21 | ) | (126 | ) | (964 | ) | ||||||
Total direct costs and operating expenses |
428,762 | 462,800 | 538,950 | |||||||||
Income (loss) from operations |
23,410 | 21,692 | (5,071 | ) | ||||||||
Other income and (expenses): |
||||||||||||
Interest expense |
(33,537 | ) | (38,092 | ) | (42,551 | ) | ||||||
Gain on extinguishment of debt |
| 9,292 | 1,446 | |||||||||
Loss on early retirement of debt |
(1,050 | ) | (1,537 | ) | (448 | ) | ||||||
Other income (expense) |
326 | (747 | ) | (945 | ) | |||||||
Loss before income taxes |
(10,851 | ) | (9,392 | ) | (47,569 | ) | ||||||
Provision for income taxes |
(834 | ) | (763 | ) | (849 | ) | ||||||
Net loss |
(11,685 | ) | (10,155 | ) | (48,418 | ) | ||||||
Preferred stock dividends |
(5,750 | ) | (3,114 | ) | | |||||||
Net loss attributable to common stockholders |
$ | (17,435 | ) | $ | (13,269 | ) | $ | (48,418 | ) | |||
Net loss per common share (basic and diluted) |
$ | (0.71 | ) | $ | (0.59 | ) | $ | (2.16 | ) | |||
Weighted average shares outstanding (basic and diluted) |
24,454,796 | 22,439,325 | 22,372,475 | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
F - 4
Table of Contents
LodgeNet Interactive Corporation and Subsidiaries
Consolidated Statements of Stockholders Deficiency and Comprehensive Income (Loss)
(Dollar amounts in thousands, except share data)
Consolidated Statements of Stockholders Deficiency and Comprehensive Income (Loss)
(Dollar amounts in thousands, except share data)
Accumulated | ||||||||||||||||||||||||||||||||||||||||
Additional | Other | |||||||||||||||||||||||||||||||||||||||
Preferred Stock | Common Stock | Treasury Stock | Paid-in | Accumulated | Comprehensive | |||||||||||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | Shares | Amount | Capital | Deficit | (Loss)/Income | Total | |||||||||||||||||||||||||||||||
Balance, December 31, 2007 |
| $ | | 22,969,775 | $ | 230 | 60,000 | $ | (1,075 | ) | $ | 330,405 | $ | (367,638 | ) | $ | (10,164 | ) | $ | (48,242 | ) | |||||||||||||||||||
Common stock option exercises |
| | 100 | | | | 1 | | | 1 | ||||||||||||||||||||||||||||||
Purchase of treasury stock |
| | | | 470,000 | (4,662 | ) | | | | (4,662 | ) | ||||||||||||||||||||||||||||
Retirement of treasury stock |
| | (350,000 | ) | (3 | ) | (350,000 | ) | 2,912 | (2,909 | ) | | | | ||||||||||||||||||||||||||
Share-based compensation |
| | | | | | 1,185 | | | 1,185 | ||||||||||||||||||||||||||||||
Restricted stock |
| | 44,289 | | | | 1,090 | | | 1,090 | ||||||||||||||||||||||||||||||
Other |
| | | | | | (32 | ) | | | (32 | ) | ||||||||||||||||||||||||||||
Comprehensive loss: |
||||||||||||||||||||||||||||||||||||||||
Net loss |
| | | | | | | (48,418 | ) | | ||||||||||||||||||||||||||||||
Foreign currency
translation adjustment |
| | | | | | | | (6,196 | ) | ||||||||||||||||||||||||||||||
Unrealized loss on
interest rate swap agreements |
| | | | | | | | (23,474 | ) | ||||||||||||||||||||||||||||||
Comprehensive loss |
| | | | | | | | | (78,088 | ) | |||||||||||||||||||||||||||||
Balance, December 31, 2008 |
| $ | | 22,664,164 | $ | 227 | 180,000 | $ | (2,825 | ) | $ | 329,740 | $ | (416,056 | ) | $ | (39,834 | ) | $ | (128,748 | ) | |||||||||||||||||||
Common stock option exercises |
| | 3,000 | | | | 1 | | | 1 | ||||||||||||||||||||||||||||||
Retirement of treasury stock |
| | (180,000 | ) | (2 | ) | (180,000 | ) | 2,825 | (2,823 | ) | | | | ||||||||||||||||||||||||||
Preferred stock issuance |
57,500 | 1 | | | | | 53,695 | | | 53,696 | ||||||||||||||||||||||||||||||
Preferred stock dividends |
| | | | | | (3,114 | ) | | | (3,114 | ) | ||||||||||||||||||||||||||||
Share-based compensation |
| | | | | | 1,057 | | | 1,057 | ||||||||||||||||||||||||||||||
Restricted stock |
| | 50,500 | | | | 667 | | | 667 | ||||||||||||||||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||||||||||||||
Net loss |
| | | | | | | (10,155 | ) | | ||||||||||||||||||||||||||||||
Foreign currency
translation adjustment |
| | | | | | | | 1,861 | |||||||||||||||||||||||||||||||
Unrealized gain on
interest rate swap agreements |
| | | | | | | | 13,748 | |||||||||||||||||||||||||||||||
Comprehensive income |
| | | | | | | | | 5,454 | ||||||||||||||||||||||||||||||
Balance, December 31, 2009 |
57,500 | $ | 1 | 22,537,664 | $ | 225 | | $ | | $ | 379,223 | $ | (426,211 | ) | $ | (24,225 | ) | $ | (70,987 | ) | ||||||||||||||||||||
Common stock option exercises |
| | 17,000 | | | | 48 | | | 48 | ||||||||||||||||||||||||||||||
Common stock issuance |
| | 2,484,000 | 25 | | | 13,633 | | | 13,658 | ||||||||||||||||||||||||||||||
Preferred stock dividends |
| | | | | | (5,750 | ) | | | (5,750 | ) | ||||||||||||||||||||||||||||
Share-based compensation |
| | | | | | 1,281 | | | 1,281 | ||||||||||||||||||||||||||||||
Restricted stock |
| | 49,875 | 1 | | | 480 | | | 481 | ||||||||||||||||||||||||||||||
Warrants issued |
| | | | | | 46 | | | 46 | ||||||||||||||||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||||||||||||||
Net loss |
| | | | | | | (11,685 | ) | | ||||||||||||||||||||||||||||||
Foreign currency
translation adjustment |
| | | | | | | | 778 | |||||||||||||||||||||||||||||||
Unrealized gain on
interest rate swap agreements |
| | | | | | | | 17,781 | |||||||||||||||||||||||||||||||
Comprehensive income |
| | | | | | | | | 6,874 | ||||||||||||||||||||||||||||||
Balance, December 31, 2010 |
57,500 | $ | 1 | 25,088,539 | $ | 251 | | $ | | $ | 388,961 | $ | (437,896 | ) | $ | (5,666 | ) | $ | (54,349 | ) | ||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
F - 5
Table of Contents
LodgeNet Interactive Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Dollar amounts in thousands)
Consolidated Statements of Cash Flows
(Dollar amounts in thousands)
Years Ended December 31, | ||||||||||||
2010 | 2009 | 2008 | ||||||||||
Operating activities: |
||||||||||||
Net loss |
$ | (11,685 | ) | $ | (10,155 | ) | $ | (48,418 | ) | |||
Adjustments to reconcile net loss to net cash provided
by operating activities: |
||||||||||||
Depreciation and amortization |
83,236 | 100,309 | 124,060 | |||||||||
Gain on extinguishment of debt (non-cash) |
| (9,292 | ) | (1,446 | ) | |||||||
Unrealized loss on derivative instruments |
1,511 | | | |||||||||
Goodwill impairment charge |
| | 11,212 | |||||||||
Loss on early retirement of debt |
1,050 | 1,537 | 448 | |||||||||
Share-based compensation and restricted stock |
1,762 | 1,724 | 2,275 | |||||||||
Gain due to insurance proceeds |
| | (815 | ) | ||||||||
Insurance proceeds related to business interruption |
| | 815 | |||||||||
Other, net |
304 | 588 | 576 | |||||||||
Change in operating assets and liabilities: |
||||||||||||
Accounts receivable, net |
2,571 | 12,385 | 9,030 | |||||||||
Other current assets |
(1,063 | ) | 1,173 | 2,030 | ||||||||
Accounts payable |
21,410 | (5,713 | ) | (5,454 | ) | |||||||
Accrued expenses and deferred revenue |
4,268 | (4,981 | ) | (5,720 | ) | |||||||
Other |
(1,658 | ) | (1,403 | ) | 1,260 | |||||||
Net cash provided by operating activities |
101,706 | 86,172 | 89,853 | |||||||||
Investing activities: |
||||||||||||
Property and equipment additions |
(21,825 | ) | (21,341 | ) | (64,407 | ) | ||||||
Net cash used for investing activities |
(21,825 | ) | (21,341 | ) | (64,407 | ) | ||||||
Financing activities: |
||||||||||||
Repayment of long-term debt |
(101,408 | ) | (91,109 | ) | (33,760 | ) | ||||||
Payment of capital lease obligations |
(1,031 | ) | (1,437 | ) | (1,365 | ) | ||||||
Borrowings on revolving credit facility |
45,000 | | 30,000 | |||||||||
Repayments of revolving credit facility |
(45,000 | ) | | (30,000 | ) | |||||||
Purchase of long-term debt |
| (23,685 | ) | | ||||||||
Proceeds from investment in long-term debt |
5,921 | 5,410 | | |||||||||
Purchase of treasury stock |
| | (4,662 | ) | ||||||||
Proceeds from issuance of common stock, net of offering costs |
13,658 | | | |||||||||
Proceeds from issuance of preferred stock, net of offering costs |
| 53,696 | | |||||||||
Payment of dividends to preferred shareholders |
(5,750 | ) | (1,677 | ) | | |||||||
Exercise of stock options |
49 | 2 | | |||||||||
Proceeds from issuance of stock warrants |
46 | | | |||||||||
Net cash used for financing activities |
(88,515 | ) | (58,800 | ) | (39,787 | ) | ||||||
Effect of exchange rates on cash |
4 | 180 | (428 | ) | ||||||||
(Decrease) increase in cash |
(8,630 | ) | 6,211 | (14,769 | ) | |||||||
Cash at beginning of period |
17,011 | 10,800 | 25,569 | |||||||||
Cash at end of period |
$ | 8,381 | $ | 17,011 | $ | 10,800 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
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Note 1 The Company
We are the largest provider of interactive media and connectivity solutions to the hospitality
industry in the United States, Canada and Mexico. Our primary offerings include guest-paid
entertainment, such as on-demand movies, and hotel-paid services, including cable television
programming and Internet access services. As of December 31, 2010, we provided interactive and
media networks and connectivity solutions to approximately 1.8 million hotel rooms in North America
and provide our hospitality solutions in select international markets, primarily through local or
regional licensees. In addition, we also have a growing presence in the healthcare market, where
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
December 31, 2010, our systems were installed in 56 healthcare facilities, representing
approximately 12,200 beds, and we had an additional six facilities under contract.
Our operating performance and outlook are strongly influenced by such factors as hotel occupancy
levels, general economic conditions in the lodging industry, the number of hotel rooms equipped
with our interactive systems, hotel guest demographics, the number and type of product offerings,
the popularity and availability of programming and competitive factors, as well as the effect of
general economic conditions on consumer spending practices.
Note 2 Summary of Significant Accounting Policies
Revenue Recognition We recognize revenue from various sources as follows:
Ø | Guest Entertainment Services. Our primary source of revenue is from providing in-room, interactive television services to the lodging industry, which the hotel guest typically purchases on a per-view, hourly or daily basis. These services include on-demand movies, on-demand games, music and music videos, Internet on television and television on-demand. We recognize revenue from the sale of these guest entertainment services in the period in which such services are sold to the hotel guest and when collection is reasonably assured. Persuasive evidence of a purchase exists through a guest buy transaction recorded on our system. No future performance obligations exist with respect to these types of services once they have been provided to the hotel guest. The prices related to our products or services are fixed or determinable prior to delivery of the products or services. |
Ø | Cable Television Programming Services. We generate revenue from the sale of basic and premium cable television programming to individual hotels. In contrast to Guest Entertainment services, where the hotel guest is charged directly for the service, we charge the hotel for our cable television programming services. We recognize revenue from the sale of cable television programming services in the period in which such services are sold and when collection is reasonably assured. We establish the prices charged to each hotel and no future performance obligations exist on programming which has been provided to the hotel. Persuasive evidence of an arrangement exists through our long-term contract with each hotel. We also have advance billings from one month to three months for certain basic and premium programming services where the revenue is deferred and recognized in the periods which services are provided. |
Ø | Broadband Service and Support. We provide ongoing maintenance, service and call center support services to hotel properties installed by us and also to hotel properties installed by other providers. In addition, we provide, in some cases, the hotel property with the portal to access the Internet. We receive monthly service fees from such hotel properties for our maintenance services and Internet access. We recognize the service fee ratably over the term of the contract. The prices for these services are fixed and determinable prior to delivery of the service. The fair value of these services is known due to objective and reliable evidence from contracts and stand-alone sales. Under the service agreement, which includes maintenance and Internet access, we recognize revenue ratably over the term of the maintenance and service contract, typically three years. |
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Table of Contents
Ø | Broadband System Sales. We provide broadband Internet access through the sale and installation of equipment. Revenue from the sale and installation of this equipment is recognized when the equipment is installed. The delivery and installation of the equipment are concurrent. In addition, this equipment, which can be acquired from other manufacturers or retailers, has stand-alone value to the customer. The software used within these systems can also be supplied by other vendors unrelated to us. Equipment prices are fixed and determinable prior to delivery and are based on objective and reliable sales evidence from a stand-alone basis. |
Ø | Hotel System Sales and Support. We also market and sell our guest entertainment interactive systems to hotels, along with recurring support for interactive content, software maintenance and technical field service, for a fixed fee. Revenue from the sale and installation of the interactive system, including the operating software, is deferred and recognized over the term of the contract, generally five years, due to inseparable proprietary software elements. The multiple elements are not separable because the proprietary software is required to operate the system and we do not license or sell the software separately under this business model. The interactive system prices are fixed and determinable prior to delivery. Revenue from this arrangement, which includes equipment, operating software, interactive content and maintenance services, is recognized ratably over the term of the related contract. |
Ø | Other Cable Television Programming Systems and Equipment Sales and Services. We generate revenues from the sale and installation of cable television programming systems (i.e. DIRECTV satellite systems); from the installation of master antenna (MATV) equipment, including wiring, at the hotel; and from the sale of miscellaneous system equipment or services, such as in-room terminals, television remotes or other media devices, along with service parts and labor. Prices for the equipment or services are fixed and determinable prior to delivery. The equipment is not proprietary and can be supplied by other vendors. These sales are not made under multiple element arrangements and we recognize the revenue when the equipment is delivered or service (repair or installation) has been performed. No future performance obligation exists on an equipment sale or on a repair service which has been provided. |
Ø | Advertising and Media Services. We generate revenue from the sale of advertising-based media services within our hospitality media and connectivity businesses through our wholly-owned subsidiary, The Hotel Networks, and server-based channels within our interactive room base. Advertising-based media services include traditional television advertising, video-on-demand or interactive advertising, programming carriage services and channel access services. The Hotel Networks delivers targeted advertising to hotel rooms on, or sells programming providers access to, 10 satellite-delivered channels, known as the SuperBlock, which include MSNBC, CNBC, FOX News and The Weather Channel. In addition to the satellite platform, we generate revenue from server-based channels and other interactive and location-based applications which can be delivered by our interactive television platform. Advertising revenue is recognized, net of agency commissions, when advertisements are broadcast or ratably over a contracted advertising period and when collection is reasonably assured. We establish the prices charged to each advertiser and no future performance obligations exist on advertising which has been broadcast. Persuasive evidence of an arrangement exists through our contracts with each advertiser. |
Ø | Healthcare System Sales and Support. We provide our interactive television infrastructure and content to the healthcare industry. We generate revenue from two sources: 1) the sale and installation of system equipment and 2) support agreements with the facility to provide software maintenance, programming and system maintenance for one year. Historically, revenue from the sale and installation of our interactive system was recognized ratably over the one-year maintenance period after the equipment was installed. The contracted system hardware, installation and maintenance elements were not separable during this start-up phase due to insufficient vendor specific objective evidence (VSOE) of fair value. The package price of the interactive system and related maintenance is fixed and determinable prior to delivery. Upon completion of the initial year, the support arrangement, which includes interactive content, software maintenance and system services, is renewable and is recognized ratably over the term of the related contract. The hospital is under no obligation to contract with us for the support arrangement. They may contract with other providers and utilize the equipment and software installed by us. We attained 100% renewal activity for maintenance services, therefore establishing VSOE of the fair value of maintenance services. The entire selling price of the interactive system is recognized upon installation using the residual method. |
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Principles of Consolidation The consolidated financial statements include the accounts of
LodgeNet Interactive Corporation and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
Foreign Currency Translation The assets and liabilities of our Canadian and Mexican subsidiaries
were translated at year-end exchange rates. Statement of operations items were translated at
average exchange rates for each month. The translation adjustments are reported as a component of
other comprehensive income. The gains or losses on the intercompany accounts between LodgeNet and
its foreign subsidiaries, resulting from transactions occurring in foreign currencies, are included
in the Consolidated Statements of Operations. The gains or losses on intercompany accounts of a
long-term investment nature are reported as a component of other comprehensive income.
Use of Estimates The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires management to make estimates
and assumptions which affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements, and the reported amounts
of revenues, expenses and costs during the reporting periods. Actual results could differ from
those estimates.
Long-Lived Assets We review the carrying value of long-lived assets, such as property and
equipment and intangible assets, whenever events or circumstances indicate the carrying value of an
asset may not be recoverable from the estimated future cash flows expected to result from its use
and eventual disposition. In cases where undiscounted expected future cash flows are less than the
carrying value, an impairment loss is recognized to reduce the carrying value of the asset to its
estimated fair value.
Property and Equipment Our property and equipment is stated at cost, net of accumulated
depreciation and amortization. Installed hotel systems consist of equipment and related costs of
installation, including certain payroll costs, sales commissions and customer acquisition costs
directly related to the successful acquisition of hotel contracts. Maintenance costs, which do not
significantly extend the useful lives of the respective assets, and repair costs are charged to
system operations expense as incurred. We begin depreciating hotel systems when such systems are
installed and activated. Depreciation of other equipment begins when such equipment is placed in
service. We attribute no salvage value to equipment, and depreciation and amortization are
computed using the straight-line method over the following useful lives:
Years | ||||
Buildings |
30 | |||
Hotel systems |
1 1/2 7 | |||
Other equipment |
3 10 |
Allowance for System Removal We de-install properties through the course of normal operations
due to a number of factors, including: poor revenue performance, hotel bankruptcy or collection
issues, hotel closings and change in service provider. We regularly evaluate our backlog of
properties scheduled for de-installation and record a provision for estimated system removal costs.
The costs incurred as a result of de-installation include the labor to de-install the system, as
well as unamortized installation costs. Over the last five years, de-installation activity was in
a range of 2% to 6% of our installed room base.
Allowance for Excess or Obsolete System Components We regularly evaluate component levels to
ascertain build requirements based on our backlog and service requirements based on our current
installed base. When a certain system component becomes obsolete due to technological changes, and
it is determined the component cannot be utilized within our current installed base, we record a
provision through depreciation for excess and obsolete components, based on estimated forecasts of
product demand and service requirements. Additionally, we have components held primarily for
resale, and if the component is not an active item for our assembly or service inventory, we record
a provision through cost of sales related to that product. We make every effort to ensure the
accuracy of our forecasts of service requirements and future production; however, any significant
unanticipated changes in demand or technological advances could have an impact on the value of system components
and reported operating results.
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Goodwill Impairment We account for goodwill and other intangible assets under FASB ASC Topic
350, Intangibles Goodwill and Other. Under FASB ASC Topic 350, purchased goodwill is not
amortized; rather, it is tested for impairment annually. We perform our goodwill impairment test
for each reporting unit during the fourth quarter. Impairment testing could occur more frequently
if 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. We did not encounter
such triggering events during 2010.
We have three reporting units, Hospitality, Advertising Services and Healthcare, for which only the
Hospitality and Advertising Services units have goodwill. FASB ASC Topic 350 requires a two-step
impairment test for goodwill. The first step is to compare the carrying amount of the reporting
units net assets to the fair value of the reporting unit. Fair value measurements must take into
consideration the principal or most advantageous market, the highest and best use, the valuation
technique and incorporate market participant assumptions. Valuation techniques to be used to
measure fair value are the market approach, income approach and/or cost approach, and must be based
on market participant assumptions. We considered the use of the market and cost approaches but,
due to a lack of comparable companies and assets, these approaches would not provide meaningful
indications of fair value. We determined the income approach provides the best estimate of fair
value and utilized a discounted cash flow analysis based on key assumptions and estimates. We then
reconciled the aggregate reporting units fair values to their indicated market capitalization.
Key assumptions used to determine fair value include projections of revenue and cost data, capital
spending, growth and operating earnings, factored for certain economic conditions. Certain costs
within the reporting units are fixed in nature; therefore, changes in revenue which exceed or fall
below the fixed cost threshold would have an effect on cash flow and recoverability of goodwill.
If the fair value of the reporting unit exceeds the carrying value, no further evaluation is
required and no impairment loss is recognized. If the carrying amount exceeds the fair value, then
the second step must be completed, which involves allocating the fair value of the reporting unit
to each asset and liability, with the excess being implied goodwill. An impairment loss occurs if
the amount of the recorded goodwill exceeds the implied goodwill. We are required to record such
impairment losses as a component of income from continuing operations.
As of December 31, 2010, our Hospitality segments fair value was significantly in excess of its
carrying value. The fair value was $189.6 million versus our negative carrying value of $(53.5)
million. Our Advertising units fair value of $23.0 million also exceeded its negative carrying
value of $(0.9) million as of December 31, 2010.
The determination of fair value requires us to make significant estimates and assumptions. These
estimates may differ from actual results due to inherent uncertainty, such as deterioration in
market conditions, prohibiting expected revenue recovery levels. Our revenue is closely linked to
the performance of products and services sold to business and leisure travelers. A significant
slow-down in economic activities could adversely impact our business, financial condition, results
of operations and cash flows. Consequently, our goodwill may be impaired if the market conditions
deteriorate or the capital market erodes. We believe there are no current impacts to our reporting
units.
Intangible Assets In accordance with FASB ASC Topics 350, Intangibles Goodwill and Other,
and 360, Property, Plant, and Equipment, we evaluate the remaining useful lives of our intangible
assets with finite lives, and review for impairment when triggering events occur or change in
circumstances warrant modifications to the carrying amount of the assets. These triggering events
or circumstances include a significant deterioration in market conditions. We periodically
evaluate the reasonableness of the useful lives of the intangible assets:
Years | ||||
Hotel contracts and relationships |
10 20 | |||
Tradenames |
7 | |||
Acquired technologies, rights and patents |
2 10 | |||
Content agreements and relationships |
4 |
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Software Developed for Internal Use We have capitalized certain costs of developing internal use
software for our Guest Entertainment systems in accordance with FASB ASC Topic 350, Intangibles
Goodwill and Other. This requires capitalization of qualifying costs incurred during the
softwares application development stage and to expense as incurred costs incurred during the
preliminary project and post implementation/operation stages. We evaluate the remaining useful
lives of our intangible assets with finite lives, and review for impairment when triggering events
occur or change in circumstances warrant modifications to the carrying amount of the assets. We
capitalized internal system development costs of $3.3 million, $1.5 million and $2.5 million during
the years ended December 31, 2010, 2009 and 2008, respectively. Amortization of such costs was
$2.8 million, $3.7 million and $4.8 million during the years ended December 31, 2010, 2009 and
2008, respectively.
Software Developed for Sale We have capitalized certain costs of developing software for sale
for our free-to-guest, broadband and healthcare systems in accordance with FASB ASC Topic 985,
Software. This requires capitalization of qualifying costs incurred after the establishment of
technological feasibility and to expense costs incurred prior to that point as research and
development. Capitalized costs are reported at the lower of unamortized cost or net realizable
value, and are amortized to direct costs based on current and future revenue, with an annual
minimum equal to the straight-line amortization over the remaining estimated economic life. We
capitalized system development for sale costs of approximately $613,000, $893,000 and $840,000
during the years ended December 31, 2010, 2009 and 2008, respectively. Amortization of such costs
was approximately $415,000, $181,000 and $0 during the years ended December 31, 2010, 2009 and
2008, respectively.
Research and Development Costs Research and development costs related to our software
development activities are expensed as incurred. We charged research and development activities of
$567,000, $512,000 and $630,000 to operating expense during the years ended December 31, 2010, 2009
and 2008, respectively.
Concentration of Credit Risks and Customer Data We derive most of our revenue from entities in
the lodging industry. During 2010, hotels owned, managed or franchised by Hilton Worldwide
(Hilton) and by Marriott International, Inc. (Marriott) represented approximately 18.9% and
16.3%, respectively, of our consolidated revenue. The Hilton-owned properties account for
approximately 7.0% of total properties operating under the Hilton brand within our room base. In
2000, we signed a master services agreement with Hilton to install, on an exclusive basis, our
interactive television system in all Hilton-owned properties and to be the exclusive recommended
provider of choice for its managed and franchised properties. In 2008, the Hilton master services
agreement was extended through December 31, 2009, and is currently on month-to-month terms as we
negotiate a new agreement with current management, which we expect to finalize in 2011. We also
have a master agreement with Marriott which allows us to distribute our services to hotel rooms
owned or managed by Marriott. In addition, we have the opportunity to enter into agreements to
provide our services to additional hotel rooms franchised by Marriott. The master agreement with
Marriott expires on the date when the last contract that is entered into under the master agreement
with a hotel owned or managed by Marriott expires. The loss of any of these hotel chain customers,
or the loss of a significant number of other hotel chain customers, could have a material adverse
effect on our results of operations, cash flows and financial condition. No other customers
account for more than 10% of our total revenue.
Significant Vendors We obtain most of our basic and premium cable television programming
pursuant to an agreement with DIRECTV, which expires on January 1, 2020. Following this
expiration, the agreement will renew for two successive one-year terms, unless we or DIRECTV
provide notice of non-renewal prior to the end of the current term. We pay only for the selected
programming provided to a hotel. The loss of this vendor could limit our ability to provide such
programming to our customers and impact our results of operations, cash flows and financial
condition.
Allowance for Doubtful Accounts We determine the estimate of the allowance for doubtful accounts
considering several factors, including historical experience, aging of the accounts receivable, bad
debt recoveries and contract terms between the hotel and us. In accordance with our hotel
contracts, monies collected by the hotel for interactive television services are held in trust on
our behalf. Collectability is reasonably assured as supported by our credit check process, nominal
write-off history and broad customer base. Our interactive hotel base is well diversified in terms
of location, demographics and customer contracts. If the financial condition of a hotel chain or
group of hotels were to deteriorate and reduce the ability to remit our monies, we may be required
to increase our allowance by recording additional bad debt expense. The allowance for doubtful
accounts was $409,000, $652,000 and $553,000 at December 31, 2010, 2009 and 2008, respectively.
F - 11
Table of Contents
Derivative Financial Instruments We follow FASB ASC Topic 815, Derivative and Hedging
Activities, which establishes accounting and reporting standards requiring every derivative
instrument (including certain derivative instruments embedded in other contracts) be recorded in
the balance sheet as either an asset or liability measured at its fair value. The statement
requires changes in the derivatives fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Accounting for qualifying hedges allows a derivatives gains
and losses to offset related results on the hedged item and requires we must formally document,
designate and assess the effectiveness of transactions receiving hedge accounting. See Note 9.
Income Taxes We account for income taxes under the liability method, in accordance with the
requirements of FASB ASC Topic 740, Income Taxes. Deferred income tax assets and liabilities are
computed annually for differences between the financial statement and tax basis of assets and
liabilities. Measurement is based on enacted tax rates applicable to the periods in which such
differences are expected to reverse. Valuation allowances are established when necessary to reduce
deferred tax assets to the amount expected to be realized. FASB ASC Topic 740 also prescribes a
recognition threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return. In instances where a
company has taken or expects to take a tax position in its tax return, and the company believes it
is more likely than not such tax position will be upheld by the relevant taxing authority, the
company may record a benefit for such tax position in its consolidated financial statements.
Comprehensive Income (Loss) We follow FASB ASC Topic 220, Comprehensive Income, which requires
companies to report all changes in equity during a period, except those resulting from investments
by owners and distributions to owners, in a financial statement for the period in which they are
recognized. Total comprehensive income (loss) is disclosed in the Consolidated Statements of
Stockholders Deficiency and Comprehensive Income (Loss) and includes net loss and other
comprehensive income (loss), which is comprised of unrealized gains (losses) on interest rate swap
agreements and foreign currency translation adjustments. Comprehensive income (loss) was as
follows for the years ended December 31 (dollar amounts in thousands):
2010 | 2009 | 2008 | ||||||||||
Net loss |
$ | (11,685 | ) | $ | (10,155 | ) | $ | (48,418 | ) | |||
Foreign currency translation adjustment |
778 | 1,861 | (6,196 | ) | ||||||||
Unrealized gain (loss) on interest rate swap agreements |
17,781 | 13,748 | (23,474 | ) | ||||||||
Comprehensive income (loss) |
$ | 6,874 | $ | 5,454 | $ | (78,088 | ) | |||||
Components of accumulated other comprehensive income (loss), as shown on our Consolidated Balance
Sheets, were as follows (dollar amounts in thousands):
Unrealized | ||||||||||||
(Loss) Gain on | Foreign | Accumulated | ||||||||||
Interest Rate | Currency | Other | ||||||||||
Swap | Translation | Comprehensive | ||||||||||
Agreements | Adjustment | Loss | ||||||||||
Balance, December 31, 2007 |
$ | (16,897 | ) | $ | 6,733 | $ | (10,164 | ) | ||||
Change during period |
(23,474 | ) | (6,196 | ) | (29,670 | ) | ||||||
Balance, December 31, 2008 |
(40,371 | ) | 537 | (39,834 | ) | |||||||
Change during period |
13,748 | 1,861 | 15,609 | |||||||||
Balance, December 31, 2009 |
(26,623 | ) | 2,398 | (24,225 | ) | |||||||
Change during period |
17,781 | 778 | 18,559 | |||||||||
Balance, December 31, 2010 |
$ | (8,842 | ) | $ | 3,176 | $ | (5,666 | ) | ||||
Treasury Stock We account for treasury stock under the cost method and include it as a component
of stockholders deficiency within our Consolidated Balance Sheets. Accordingly, we include the
cash payment to acquire the treasury stock as a component of financing activities within our
Consolidated Statements of Cash Flows. Effective in the fourth quarter of 2007, we began to
repurchase shares of common stock as treasury stock. A total of 530,000 shares were repurchased.
In March 2008, we retired 350,000 shares, with the remaining 180,000 shares retired in March 2009.
There is no treasury stock at December 31, 2010.
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Earnings Per Share Computation We calculate earnings per share (EPS) in accordance with FASB
ASC Topic 260, Earnings Per Share, 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 containing 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. All earnings per common share
data for periods prior to January 1, 2009 have been retrospectively adjusted to conform to the new
computation method.
The following table reflects the calculation of weighted average basic and fully diluted shares for
the periods ended December 31. Dollar amounts are in thousands, except share data:
2010 | 2009 | 2008 | ||||||||||
Basic EPS: |
||||||||||||
Net loss |
$ | (11,685 | ) | $ | (10,155 | ) | $ | (48,418 | ) | |||
Preferred stock dividends |
(5,750 | ) | (3,114 | ) | | |||||||
$ | (17,435 | ) | $ | (13,269 | ) | $ | (48,418 | ) | ||||
Loss allocated to participating securities (1) |
| | | |||||||||
Net loss available to common stockholders |
$ | (17,435 | ) | $ | (13,269 | ) | $ | (48,418 | ) | |||
Weighted average shares outstanding for basic
earnings per common share |
24,454,796 | 22,439,325 | 22,372,475 | |||||||||
Basic earnings per share |
$ | (0.71 | ) | $ | (0.59 | ) | $ | (2.16 | ) | |||
Diluted EPS: |
||||||||||||
Net loss |
$ | (11,685 | ) | $ | (10,155 | ) | $ | (48,418 | ) | |||
Preferred stock dividends |
(5,750 | ) | (3,114 | ) | | |||||||
$ | (17,435 | ) | $ | (13,269 | ) | $ | (48,418 | ) | ||||
Loss allocated to participating securities (1) |
| | | |||||||||
Net loss available to common stockholders |
$ | (17,435 | ) | $ | (13,269 | ) | $ | (48,418 | ) | |||
Weighted average shares outstanding for basic
earnings per common share |
24,454,796 | 22,439,325 | 22,372,475 | |||||||||
Dilutive effect of potential shares (2) |
N/A | N/A | N/A | |||||||||
Weighted average shares outstanding for diluted
earnings per common share |
24,454,796 | 22,439,325 | 22,372,475 | |||||||||
Diluted earnings per share |
$ | (0.71 | ) | $ | (0.59 | ) | $ | (2.16 | ) | |||
Potential dilutive common shares (2) |
17,062,267 | 17,029,401 | 1,710,718 |
(1) | For the years ended December 31, 2010, 2009 and 2008, participating securities, which do not participate in losses, 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. | |
(2) | For the years ended December 31, 2010, 2009 and 2008, potential dilutive common shares, which include stock options, unvested restricted stock, warrants 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. |
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Table of Contents
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 year ended December 31, 2010 includes 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 FASB ASC Topic 718. Share-based compensation expense recognized
in the years ended December 31, 2009 and 2008 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.
Statements of Cash Flows Cash is comprised of demand deposits. Cash paid for interest was $31.9
million, $38.1 million and $42.4 million for the years ended December 31, 2010, 2009 and 2008,
respectively. Cash paid for taxes, primarily state franchise tax, was $856,000, $929,000 and
$759,000 during the years ended December, 2010, 2009 and 2008, respectively.
Effect of Recently Issued Accounting Standards In October 2009, the FASB issued FASB 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 vendors multiple-deliverable revenue arrangements. FASB ASU No. 2009-13 was
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. 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
was 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. 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, as well as the portion of the ASU effective after December 15, 2010, did not have an impact
on our consolidated financial position, results of operations or cash flows.
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In April 2010, the FASB issued FASB ASU No. 2010-17, Milestone Method of Revenue Recognition,
which is now codified under FASB ASC Topic 605, Revenue Recognition. This ASU provides guidance
on defining a milestone and determining when it may be appropriate to apply the milestone method of
revenue recognition for research and development transactions. Consideration which is contingent
upon achievement of a milestone in its entirety can be recognized as revenue in the period in which
the milestone is achieved only if the milestone meets all criteria to be considered substantive. A
milestone should be considered substantive in its entirety, and an individual milestone may not be
bifurcated. An arrangement may include more than one milestone, and each milestone should be
evaluated individually to determine if it is substantive. FASB ASU No. 2010-17 was effective on a
prospective basis for milestones achieved in fiscal years (and interim periods within those years)
beginning on or after June 15, 2010, with early adoption permitted. If an entity elects early
adoption, and the period of adoption is not the beginning of its fiscal year, the entity should
apply this ASU retrospectively from the beginning of the year of adoption. Entities may also elect
to adopt the amendments retrospectively for all prior periods. 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 December 2010, the FASB issued FASB ASU No. 2010-28, When to Perform Step 2 of the Goodwill
Impairment Test for Reporting Units with Zero or Negative Carrying Amounts, which is now codified
under FASB ASC Topic 350, Intangibles Goodwill and Other. This ASU provides amendments to
Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts.
For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test
if it is more likely than not a goodwill impairment exists. When determining whether it is more
likely than not an impairment exists, an entity should consider whether there are any adverse
qualitative factors, such as a significant deterioration in market conditions, indicating an
impairment may exist. FASB ASU No. 2010-28 is effective for fiscal years (and interim periods
within those years) beginning after December 15, 2010. Early adoption is not permitted. Upon
adoption of the amendments, an entity with reporting units having carrying amounts which are zero
or negative is required to assess whether is it more likely than not the reporting units goodwill
is impaired. If the entity determines impairment exists, the entity must perform Step 2 of the
goodwill impairment test for that reporting unit or units. Step 2 involves allocating the fair
value of the reporting unit to each asset and liability, with the excess being implied goodwill.
An impairment loss results if the amount of recorded goodwill exceeds the implied goodwill. Any
resulting goodwill impairment should be recorded as a cumulative-effect adjustment to beginning
retained earnings in the period of adoption. We are evaluating the effect from the adoption of
this ASU. Depending on market conditions or other qualitative factors, this ASU could have a
material effect on our consolidated results of operations.
In December 2010, the FASB issued FASB ASU No. 2010-29, Disclosure of Supplementary Pro Forma
Information for Business Combinations, which is now codified under FASB ASC Topic 805, Business
Combinations. A public entity is required to disclose pro forma data for business combinations
occurring during the current reporting period. This ASU provides amendments to clarify the
acquisition date to be used when reporting the pro forma financial information when comparative
financial statements are presented and improves the usefulness of the pro forma revenue and
earnings disclosures. If a public company presents comparative financial statements, the entity
should disclose revenue and earnings of the combined entity as though the business combination(s)
which occurred during the current year had occurred as of the beginning of the comparable prior
annual reporting period only. The supplemental pro forma disclosures required are also expanded to
include a description of the nature and amount of material, nonrecurring pro forma adjustments
directly attributable to the business combination included in the reported pro forma revenue and
earnings. FASB ASU No. 2010-29 is effective on a prospective basis for business combinations for
which the acquisition date is on or after the beginning of the first annual reporting period
beginning on or after December 15, 2010, with early adoption permitted. The adoption of this ASU
will not have a material effect on our consolidated financial position, results of operations or
cash flows.
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Note 3 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 entitys 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 which are corroborated by market
data.
Level 3: Unobservable inputs which are not corroborated by market data.
Financial Assets and Financial Liabilities The estimated carrying and fair values of our
financial instruments in the financial statements are as follows at December 31 (dollar amounts in
thousands):
2010 | 2009 | |||||||||||||||
Carrying | Fair | Carrying | Fair | |||||||||||||
Amount | Value | Amount | Value | |||||||||||||
Interest rate swaps -
liability position |
$ | 10,353 | $ | 10,353 | $ | 26,623 | $ | 26,623 | ||||||||
Long-term debt |
$ | 373,639 | $ | 349,426 | $ | 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 our current and 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. As a result of our additional payments on the Credit Facility, a portion of our swap
arrangements was rendered ineffective (see Note 9).
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 | $ | | ||||||||
Year Ended December 31, 2010: |
||||||||||||||||
Interest rate swaps -
liability position |
$ | 10,353 | $ | | $ | 10,353 | $ | |
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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 December 31, 2010.
Nonfinancial Assets and Nonfinancial Liabilities 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.
In 2009, as a result of the general economy and reduced profitability, our cost method investment
in a high-speed Internet service provider with a carrying amount of $4.4 million was written down
to its Level 3 fair value of $3.0 million, resulting in an impairment charge of $1.4 million.
There was no impairment charge incurred during the year ended December 31, 2010.
Note 4 Property and Equipment, Net
Property and equipment was comprised as follows at December 31 (dollar amounts in thousands):
2010 | 2009 | |||||||
Land, building and equipment |
$ | 115,031 | $ | 111,777 | ||||
Hotel systems |
726,638 | 754,869 | ||||||
Total |
841,669 | 866,646 | ||||||
Less depreciation and amortization |
(684,752 | ) | (659,983 | ) | ||||
Property and equipment, net |
$ | 156,917 | $ | 206,663 | ||||
We recorded depreciation and amortization expense for property, plant and equipment of $73.8
million, $89.5 million and $110.7 million during the years ended December 31, 2010, 2009 and 2008,
respectively.
Note 5 Debt Issuance Costs
Costs associated with the issuance of debt securities and with obtaining credit facilities are
capitalized and amortized over the term of the related borrowing or facility. No costs were
capitalized during the years ended December 31, 2010, 2009 or 2008. Unamortized debt issuance
costs of $1.1 million, $1.5 million and $0.4 million were written off in 2010, 2009 and 2008,
respectively (see Note 8). Amortization of the debt issuance costs was $1.3 million in 2010, $1.6
million in 2009 and $1.8 million in 2008. Debt issuance costs recorded in the balance sheets are
as follows at December 31 (dollar amounts in thousands):
2010 | 2009 | |||||||
Debt issuance costs |
$ | 9,705 | $ | 10,754 | ||||
Accumulated amortization |
(6,024 | ) | (4,749 | ) | ||||
$ | 3,681 | $ | 6,005 | |||||
Note 6 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 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.
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Our goodwill is not amortized; rather, it is tested for impairment 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.
In our 2008 test, we determined goodwill within our Advertising reporting unit was impaired,
resulting in a goodwill impairment charge of $11.2 million, which was recognized in the fourth
quarter of 2008. This charge reduced goodwill recorded in connection with acquisitions made in
2007, but did not impact our cash flow or debt covenants.
In our 2009 test, we determined there was no impairment.
In our 2010 test, we determined there was no impairment. As of December 31, 2010, our Hospitality
segments fair value was significantly in excess of carrying value. The fair value was $189.6
million versus our negative carrying value of $(53.5) million. Our Advertising units fair value
of $23.0 million also exceeded its negative carrying value of $(0.9) million as of December 31,
2010. Key assumptions used to determine the reporting units fair values include projections of
revenue and cost data, capital spending, growth and operating earnings, factored for certain
economic conditions. Certain costs within the reporting units are fixed in nature; therefore,
changes in revenue which exceed or fall below the fixed cost threshold would have an effect on cash
flow and recoverability of goodwill. Our revenue is closely linked to the performance of products
and services sold to business and leisure travelers. A significant slow-down in economic
activities could adversely impact our business, financial condition, results of operations and cash
flows. Consequently, our goodwill may be impaired if the market conditions deteriorate or the
capital market erodes.
The carrying amount of goodwill by reportable segment for the years ended December 31, 2010, 2009
and 2008 was as follows (dollar amounts in thousands):
Advertising | ||||||||||||
Hospitality | Services | Total | ||||||||||
Balance as of December 31, 2008 |
||||||||||||
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 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 December 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 2 to 20 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.
In 2008, we recorded a write-down of $0.6 million related to the On Command studio programming
agreements. The impairment charge was primarily driven by the erosion of the general economy and
capital markets and their impact on our Hospitality business. There was no impairment charges
recorded in either 2010 or 2009.
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We have the following intangible assets at December 31 (dollar amounts in thousands):
2010 | 2009 | |||||||||||||||
Carrying | Accumulated | Carrying | Accumulated | |||||||||||||
Amount | Amortization | Amount | Amortization | |||||||||||||
Assets subject to amortization: |
||||||||||||||||
Acquired contracts and
relationships |
$ | 120,315 | $ | (23,950 | ) | $ | 120,315 | $ | (17,629 | ) | ||||||
Other acquired intangibles |
13,956 | (12,769 | ) | 12,884 | (12,130 | ) | ||||||||||
Tradenames |
3,124 | (2,107 | ) | 3,094 | (1,626 | ) | ||||||||||
Acquired patents |
5,175 | (4,739 | ) | 5,142 | (4,009 | ) | ||||||||||
$ | 142,570 | $ | (43,565 | ) | $ | 141,435 | $ | (35,394 | ) | |||||||
We recorded consolidated amortization expense of $8.2 million, $9.2 million and $11.6 million,
respectively, for the years ended December 31, 2010, 2009 and 2008. We estimate total amortization
expense for the years ending December 31, as follows (dollar amounts in millions): 2011 $7.5;
2012 $6.8; 2013 $6.5; 2014 $6.4 and 2015 $6.3. Actual amounts may change from such
estimated amounts due to additional intangible asset acquisitions, potential impairment,
accelerated amortization or other events.
Note 7 Accrued Expenses
Accrued expenses were comprised as follows at December 31 (dollar amounts in thousands):
2010 | 2009 | |||||||
Property, sales and other taxes |
$ | 6,411 | $ | 6,933 | ||||
Compensation |
4,639 | 4,360 | ||||||
Interest |
208 | 92 | ||||||
Programming related |
1,782 | 2,139 | ||||||
Restructuring and reorganization |
172 | 758 | ||||||
Preferred stock dividends |
1,438 | 1,437 | ||||||
Purchase commitments |
3,414 | 371 | ||||||
Other |
4,263 | 3,047 | ||||||
$ | 22,327 | $ | 19,137 | |||||
Note 8 Long-term Debt and Credit Facilities
Long-term debt was comprised as follows at December 31 (dollar amounts in thousands):
2010 | 2009 | |||||||
Bank Credit Facility: |
||||||||
Bank term loan |
$ | 372,511 | $ | 467,998 | ||||
Revolving credit facility |
| | ||||||
Capital leases |
1,128 | 1,948 | ||||||
373,639 | 469,946 | |||||||
Less current maturities |
(4,807 | ) | (6,101 | ) | ||||
$ | 368,832 | $ | 463,845 | |||||
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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 $1,024,892. The term loan bears interest at our
option of (1) the banks 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 banks 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 December 31, 2010, our consolidated leverage ratio
was 3.43 compared to the maximum allowable of 3.50 and our consolidated interest coverage ratio was
3.19 compared to the minimum allowable of 3.00. Our maximum consolidated leverage ratio will
continue to be 3.50 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 Companys 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 Companys ability to obtain additional financing under the
revolving Credit Facility. The Credit Facility also stipulated 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 currently have two outstanding fixed rate swap agreements for $437.5 million,
with fixed interest rates ranging from 4.97% to 5.09% (see Note 9). The term loan interest rate as
of December 31, 2010 was 2.31%. The all-in weighted average interest rate for the year ended
December 31, 2010 was 7.36%, which includes both the term loan interest rate and the difference in
the swaps fixed interest rate versus LIBOR, including any ineffective portion of the hedge. As of
December 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 Consolidated EBITDA (a term defined in our Credit Facility) and to manage our capital
investment and debt levels. We continue taking actions within our control to manage our debt level
and remain in compliance with our debt covenants. The actions within our control include our
prudent management of capital investment, working capital and operating costs and exploring other
alternatives, which include seeking an amendment to our Credit Facility. Our ability to continue
to comply with our current covenants, as well as any revised covenants resulting from an amendment
to our Credit Facility, 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. We are currently pursuing an amendment of our Credit Facility,
which may increase our interest costs, require upfront fees and modify certain other terms which
will be less favorable than we currently have. If we are not able to remain in compliance with our
current debt covenants and our lenders will not amend or waive covenants with which we are not in
compliance, the debt would be due, we would not be able to satisfy our financial obligations and we
would need to seek alternative financing. If we were not able to secure alternative financing,
this would have a substantial adverse impact on the Company and our ability to continue our
operations.
During 2010, we made additional payments totaling $96.8 million on the term loan, in addition to
the required payments of $4.6 million, and we wrote off $1.1 million of related debt issuance
costs. As a result of our previous repayments, our required quarterly payments have been reduced.
During 2009, we made additional payments totaling $85.4 million on the term loan, including the
required $27.7 million from our preferred stock offering, in addition to the required payments of
$5.7 million, and we wrote off $1.5 million of related debt issuance costs.
During 2009, as part of our debt reduction initiative, we acquired, through a wholly-owned
subsidiary as a permitted investment under our Credit Facility, $31.5 million of our outstanding
debt at 70.5% of par value and recorded a gain on the extinguishment of debt of $9.3 million.
Under our Credit Facility, we can make permitted investments, as defined by the Credit Facility, of
up to $25.0 million.
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The Credit Facility provides for the issuance of letters of credit up to $15.0 million, subject to
customary terms and conditions. As of December 31, 2010, we had outstanding letters of credit
totaling $395,000, which reduce amounts available under the revolver. During 2010, we borrowed
$45.0 million under the revolving portion of the Credit Facility and repaid the entire amount
during the year.
Capital Leases As of December 31, 2010, we have total capital lease obligations of $1.1 million.
Equipment acquired under capital lease arrangements totaled $0.2 million, $0.2 million and $1.9
million during the years ended December 31, 2010, 2009 and 2008, respectively.
Long-term debt has the following scheduled annual maturities for the years ended December 31
(dollar amounts in thousands):
2011 | 2012 | 2013 | 2014 | 2015 | ||||||||||||||||
Long-term debt |
$ | 4,100 | $ | 4,100 | $ | 4,100 | $ | 360,211 | $ | | ||||||||||
Capital leases |
762 | 346 | 69 | 29 | 1 | |||||||||||||||
4,862 | 4,446 | 4,169 | 360,240 | 1 | ||||||||||||||||
Less amount representing
interest on capital leases |
(55 | ) | (18 | ) | (4 | ) | (2 | ) | | |||||||||||
$ | 4,807 | $ | 4,428 | $ | 4,165 | $ | 360,238 | $ | 1 | |||||||||||
We do not utilize special purpose entities or off-balance sheet financial arrangements.
Note 9 Derivative Information
We follow the provisions of FASB ASC Topic 815, Derivatives and Hedging Activities, which
establish accounting and disclosure standards regarding a companys derivative instruments and
hedging activities.
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 December 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
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 $1.5 million for the year ended
December 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.
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Table of Contents
A summary of the aggregate contractual or notional amounts, balance sheet location and estimated
fair values of our derivative financial instruments are as follows (dollar amounts in thousands):
Contractual/ | Estimated Fair | |||||||||||||||
Notional | Balance Sheet | Value | ||||||||||||||
Amount | Location | Asset | (Liability) | |||||||||||||
Year ended December
31, 2009: |
||||||||||||||||
Interest rate swaps |
$ | 437,500 | Long-term liabilities | $ | | $ | (26,623 | ) | ||||||||
Year ended December
31, 2010: |
||||||||||||||||
Interest rate swaps |
$ | 437,500 | Current liabilities | $ | | $ | (10,353 | ) |
The unrecognized loss for all cash flow hedges included in accumulated other comprehensive loss at
December 31, 2010 and December 31, 2009 was $8.8 million, which is net of the $1.5 million
ineffective portion charged to interest expense, and $26.6 million, respectively (see Note 2
Comprehensive Income (Loss) discussion).
A summary of the effect of cash flow hedges on our financial statements for the years ended
December 31 is as follows (dollar amounts in thousands):
Effective Portion | ||||||||||||||||||||
Income Statement | ||||||||||||||||||||
Location of | ||||||||||||||||||||
Amount of | Swap Interest | Swap Interest | ||||||||||||||||||
Gain (Loss) | Reclassified From | Reclassified From | ||||||||||||||||||
Recognized | Accumulated | Accumulated | Ineffective Portion | |||||||||||||||||
in Other | Other | Other | Income | |||||||||||||||||
Type of Cash | Comprehensive | Comprehensive | Comprehensive | Statement | Amount | |||||||||||||||
Flow Hedge | Income | Income | Income | Location | Recognized | |||||||||||||||
Year Ended December 31, 2009: |
||||||||||||||||||||
Interest rate swaps |
$ | (7,877 | ) | Interest expense | $ | 21,625 | Interest expense | $ | | |||||||||||
Year Ended December 31, 2010: |
||||||||||||||||||||
Interest rate swaps |
$ | (4,632 | ) | Interest expense | $ | 20,902 | Interest expense | $ | 1,511 |
Note 10 Commitments and Contingencies
Programming Agreements We obtain non-exclusive rights to show recently released major motion
pictures from motion picture studios pursuant to an agreement with each studio, which is typically
two to five years in length. The royalty rate for each movie is predetermined, with the studio
receiving a percentage of the gross revenue from the movie. For our television on-demand
programming, we obtain rights to release television on-demand content, for which we pay a
predetermined percentage of gross revenue or a one-time fixed fee. In addition, we obtain
non-exclusive rights to cable or premium television programming through an agreement with a third
party provider, whereby we pay a fixed monthly fee. We obtain independent films, most of which are
non-rated and intended for mature audiences, for a one-time fixed fee. We also have rights to
digital music content through our wholly-owned subsidiary. We obtain our selection of Nintendo
video games pursuant to a non-exclusive license agreement with Nintendo. Under the terms of the
agreement, we pay a monthly fee based on revenue generated from Nintendo video game services. For
our Hotel SportsNETSM programming, we obtain the rights to exhibit on-demand sporting
event content for which we pay a predetermined percentage of gross revenue, subject to a minimum
guarantee. These agreements contain various restrictions, including default and termination
procedures.
Minimum Guarantees In connection with our programming-related agreements, we may guarantee
minimum royalties for specific periods or by individual programming content. Generally, our
programming contracts are two to five years in length. The unpaid balance of programming-related
minimum guarantees, reflected as a liability in our Consolidated Balance Sheet as of December 31,
2010, was approximately $1.2 million. At December 31, 2010, our obligations for
programming-related guarantees and purchase commitments aggregated to approximately $12.0 million,
including the amount noted above.
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Operating Leases We have entered into certain operating leases which, at December 31, 2010,
require future minimum lease payments as follows: 2011 $1.4 million; 2012 $0.8 million; 2013
$0.5 million; 2014 $0.2 million; and 2015 $0.1 million. The leases, which relate to
combination warehouse/office facilities for installation and service operations, expire at dates
ranging from 2011 to 2015. Rental expense under all operating leases was $2.0 million, $2.0
million and $2.6 million for the years ended December 31, 2010, 2009 and 2008, respectively.
Legal Proceedings We are subject to litigation arising in the ordinary course of business. We
believe the resolution of such litigation will not have a material adverse effect upon our
financial condition, results of operations or cash flows.
On July 11, 2008, LinkSmart Wireless Technology, LLC, a California limited liability company based
in Pasadena, California, filed several actions for patent infringement in the U.S. District Court
in Marshall, Texas. The suits allege the Company and numerous other defendants infringe a patent
issued on August 17, 2004, entitled User Specific Automatic Data Redirection System. All pending
cases have been consolidated. The complaint does not specify an amount in controversy. The
Company believes it does not infringe the patent in question, has filed responsive pleadings and is
vigorously defending the action. The suit is in the discovery stage. The U.S. Patent and
Trademark Office has undertaken a re-examination of the patent which is the subject of this suit,
and issued a preliminary finding that the patent is invalid. On June 30, 2010, the Court, through
the Magistrate Judge, issued a Memorandum Opinion and Order (the Markman Order), which construed
certain disputed terms in the patent at issue in the case. The plaintiff and several defendants
have filed objections with the Court for review of various portions of the Order. On July 1, 2010,
the Magistrate Judge issued a report and recommendation that the Court grant the motion of the
defendants for summary judgment with respect to claims 15, 16, 17, 19, 22 and 23 of the patent on
grounds that such claims in the patent are indefinite and invalid. The plaintiff has filed
objections with the Court for review of report and recommendation regarding summary judgment. On
October 26, 2010, the Court issued an order staying the case pending the final determination in the
Patent Office re-examination proceeding.
On November 17, 2009, Nomadix, Inc., a Delaware corporation based in Newbury Park, California,
filed an action for patent infringement in the U.S. District Court in Los Angeles, California. The
suit alleged the Company and its subsidiaries On Command Corporation and LodgeNet StayOnline, Inc.
infringed five patents. The complaint also asserted claims against a number of other defendants,
including Hewlett-Packard Company, Wayport, Inc., Ibahn Corporation, Guest-Tek Interactive
Entertainment Ltd. and Guest-Tek Entertainment Inc., Aruba Networks, Inc., Superclick, Inc. and
Superclick Networks, Inc. On May 21, 2010, the plaintiff filed an amended complaint asserting
infringement of a patent issued on March 30, 2010 entitled Systems and Methods for Providing
Dynamic Network Authorization, Authentication and Accounting. The Company filed a responsive
pleading denying such allegations. This action and a related patent infringement action filed by
the Company against Nomadix in the U.S. District Court for South Dakota were settled as of December
31, 2010. In connection with the settlement, the parties entered into a patent license agreement
and a strategic technology alliance which includes a number of ordinary course commercial
agreements, including agreements pursuant to which the Company will be able to offer various
hardware and software developed by Nomadix and its affiliates in the United States, Canada and
Mexico, and Nomadix and its affiliates will be able to offer hardware and software developed by the
Company in various countries served by such entities.
Note 11 Stockholders Equity
Perpetual Preferred Stock The Board of Directors may authorize the issuance of preferred stock,
$.01 par value, in one or more series and with rights and privileges for each issue as determined
by the Board of Directors. In June
2009, we entered into a purchase agreement with Merrill Lynch, Pierce, Fenner & Smith Incorporated,
initial purchaser, to sell 50,000 shares of our 10% Series B Cumulative Perpetual Convertible
Preferred Stock, $0.01 par value per share, with a liquidation preference of $1,000 per share. The
initial purchaser was also granted a 30-day option to purchase up to an additional 7,500 shares of
the preferred stock to cover overallotments. We completed our offering of 57,500 shares (inclusive
of the initial purchasers option to purchase the additional 7,500 shares), bringing the total
aggregate liquidation preference of the preferred stock sold to $57.5 million. Net proceeds from
the issuance of preferred stock were $53.7 million, with offering and related costs totaling $3.8
million.
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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.
Dividend payments must come from funds available under the restricted payment basket as defined
within our Credit Facility agreement. In the event funds are not available and the restricted
basket has been exhausted, we would not be able to pay these dividends in cash. Under these
circumstances, the Company would be required to pay accumulated and unpaid dividends upon
conversion. Additionally, the preferred shareholders would receive a conversion rate approximately
10% higher than the original conversion rate.
Dividends were declared on the preferred stock by our Board of Directors, and as of December 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. These dividends were paid on
January 18, 2011.
The preferred stock is convertible at any time, at the option of the holder, at an initial
conversion rate of 264.5503 shares of common stock per share of preferred stock, equal to an
initial conversion price of $3.78 per share. This represents a conversion premium of approximately
10%, based on the closing bid price of $3.43 per share of common stock on June 23, 2009.
On or prior to July 15, 2014, we may elect to convert some or all of the preferred stock into
shares of common stock, if the closing price of our common stock has exceeded 150% of the
conversion price for at least 20 of the 30 consecutive trading days ending the trading day before
our notice of the conversion. If we elect to convert any preferred stock on or prior to July 15,
2014, we will also make a payment on the preferred stock, in cash or shares of common stock, equal
to the aggregate amount of dividends which would have accumulated and become payable through and
including July 15, 2014, less any dividends already paid on the preferred stock.
After July 15, 2014, we may elect to convert some or all of the preferred stock into shares of
common stock, if the closing price of our common stock has exceeded 125% of the conversion price
for at least 20 of the 30 consecutive trading days ending the trading day before our notice of the
conversion. If we elect to convert any preferred stock after July 15, 2014, we will make an
additional payment on the preferred stock, in cash or shares of common stock, for all accumulated
and unpaid dividends to and including the conversion date.
If the holder elects to convert their shares of preferred stock in connection with a fundamental
change, as defined, (such as a merger or acquisition) which occurs on or prior to July 14, 2014, we
will increase the conversion rate of the preferred stock surrendered for conversion. In addition,
upon a fundamental change when the stock price of the common stock is less than $3.43 per share
(the closing bid price as of June 23, 2009), the holder may require us to convert some or all of
the preferred stock at a conversion rate equal to the liquidation preference, plus all accumulated
and unpaid dividends, divided by 97.5% of the market price of our common stock, subject to a cap on
the aggregate number of shares of common stock to be issued.
Common Stock 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 to cover overallotments. We completed our offering of 2,484,000 shares (inclusive of the
Underwriters 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.
Share Repurchase Program In December 2007, our Board of Directors authorized a stock repurchase
program of up to $15.0 million, the full amount currently permitted under our Credit Facility.
During 2007, we repurchased 60,000 shares at a cost of $1.0 million (an average price of $17.91 per
share). During 2008, we repurchased 470,000 shares at a cost of $4.7 million (an average price of
$9.92 per share) and $9.3 million remained available under the plan for share repurchases. We
retired 350,000 of the repurchased shares in March 2008 and the remaining 180,000 repurchased
shares in March 2009.
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Stockholder Rights Plan In February 2008, we adopted a stockholder rights plan, which was
approved by the stockholders at the Annual Meeting on May 14, 2008. The rights plan is intended to
maximize stockholder value by providing flexibility to the Board of Directors in the event an offer
for LodgeNet is received which is either inadequate or not in the best interest of all
stockholders.
Warrants In October 2010, we issued a warrant to a professional services company, granting it
the right to purchase up to 25,000 shares of our common stock at a price of $3.75 per share.
Proceeds from the issuance were $46,000. The warrant became exercisable on the date the
professional services were delivered to us in January 2011. The warrant includes anti-dilution
provisions and expires on October 15, 2013.
Note 12 Stock Option Plans
The LodgeNet Interactive Corporation 2003 Stock Option and Incentive Plan (the 2003 Plan)
provides for the award of incentive stock options, non-qualified stock options, restricted stock,
stock appreciation rights and phantom stock units. The stockholders approved and adopted this plan
at the 2003 Annual Meeting and approved an amendment to the plan at the Annual Meeting in May of
2006. As of December 31, 2010, there were 2,600,000 shares authorized under this plan and 579,596
shares available for grant. In addition to the stock option and restricted stock awards currently
outstanding under the 2003 Plan, we have stock options outstanding under previously approved plans,
which are inactive.
Certain officers, directors and key employees have been awarded restricted stock and options to
purchase common stock of LodgeNet under the 2003 Plan and other prior plans. Stock options issued
under the plans have an exercise price equal to the fair market value, as defined by the terms of
the plan, on the date of grant. The stock options become exercisable in accordance with vesting
schedules determined by the Compensation Committee of the Board of Directors, and expire ten years
after the date of grant. Restrictions applicable to restricted stock lapse based either on
performance or service conditions as determined by the Compensation Committee of the Board of
Directors.
We measure and recognize compensation expense for all stock-based awards based on estimated fair
values, net of estimated forfeitures. Share-based compensation expense recognized in 2010 includes
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 FASB ASC Topic 718,
Compensation Stock Compensation. Share-based compensation expense recognized in 2009 and 2008
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 years ended December 31 (dollar amounts in thousands):
2010 | 2009 | 2008 | ||||||||||
Compensation Cost: |
||||||||||||
Stock options |
$ | 1,281 | $ | 1,057 | $ | 1,185 | ||||||
Restricted stock |
481 | 667 | 1,090 | |||||||||
Total share-based compensation expense |
$ | 1,762 | $ | 1,724 | $ | 2,275 | ||||||
For the years ended December 31, 2010, 2009 and 2008, the cash received from stock option exercises
was nominal. Due to our net operating loss tax position, we did not recognize a tax benefit from
options exercised under the share-based payment arrangements. The amounts presented in the table
above are included as non-cash compensation in our cash flow from operating activities.
Stock Options
For the year ended December 31, 2010, we granted 40,000 stock options to non-employee directors of
the Company and granted 351,500 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.
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The risk-free interest rate assumption is based upon observed interest rates on zero coupon U.S.
Treasury bonds whose maturity period is appropriate for the term of our stock options and is
calculated by using the average monthly yield equivalent to the options expected term.
The volatility assumption is measured as the fluctuation or movement of the Companys stock price
over a time period corresponding to the expected life of the option. We calculate volatility as
the annualized standard deviation of the natural logarithms of relative stock prices over the
options expected term and is based on monthly historical stock prices through the month preceding
the grant date.
The expected life of stock options granted to employees and non-employee directors represents the
weighted average period those options are expected to remain outstanding and is based on analysis
of historical behavior of employees and non-employee director option holders.
Share-based compensation expense recognized in our results for the years ended December 31, 2010,
2009, and 2008 is based on awards ultimately expected to vest and has been reduced for estimated
forfeitures. Our forfeiture rates were estimated based on our historical experience.
The weighted average fair value of options granted and the assumptions used in the
Black-Scholes-Merton model during the years ended December 31 are set forth in the table below:
2010 | 2009 | 2008 | ||||||||||
Weighted average fair value of options granted |
$ | 4.23 | $ | 1.61 | $ | 5.32 | ||||||
Dividend yield |
0.0 | % | 0.0 | % | 0.0 | % | ||||||
Weighted average risk-free interest |
4.2 | % | 4.3 | % | 4.4 | % | ||||||
Weighted average expected volatility |
93.0 | % | 72.0 | % | 45.4 | % | ||||||
Weighted average expected life employee |
5.25 years | 5.25 years | 5.25 years | |||||||||
Weighted average expected life officers |
5.75 years | 5.75 years | 5.75 years | |||||||||
Weighted average expected life
non-employee director |
8.00 years | 8.00 years | 8.00 years |
The following is a summary of the stock option activity for the years ended December 31:
Weighted | ||||||||||||||||
Weighted | Average | |||||||||||||||
Average | Remaining | Aggregate | ||||||||||||||
Exercise | Term | Intrinsic | ||||||||||||||
Options | Price | in Years | Value | |||||||||||||
Outstanding, December 31, 2007 |
1,165,450 | $ | 18.96 | |||||||||||||
Granted |
371,500 | 11.32 | ||||||||||||||
Exercised |
(100 | ) | 10.24 | |||||||||||||
Forfeited/canceled |
(124,500 | ) | 17.27 | |||||||||||||
Outstanding, December 31, 2008 |
1,412,350 | 17.10 | ||||||||||||||
Granted |
291,500 | 2.23 | ||||||||||||||
Exercised |
(3,000 | ) | 0.70 | |||||||||||||
Forfeited/canceled |
(18,550 | ) | 19.28 | |||||||||||||
Outstanding, December 31, 2009 |
1,682,300 | 14.48 | ||||||||||||||
Granted |
391,500 | 5.50 | ||||||||||||||
Exercised |
(17,000 | ) | 2.65 | |||||||||||||
Forfeited/canceled |
(394,050 | ) | 16.59 | |||||||||||||
Outstanding, December 31, 2010 |
1,662,750 | $ | 11.99 | 5.8 | $ | 568,450 | ||||||||||
Options exercisable, December
31, 2010 |
1,019,299 | $ | 15.16 | 4.2 | $ | 138,815 | ||||||||||
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The aggregate intrinsic value in the table above represents the difference between the closing
stock price on December 31, 2010 and the exercise price, multiplied by the number of in-the-money
options which would have been received by the option holders had all option holders exercised their
options on December 31, 2010. The total intrinsic value of options exercised for the years ended
December 31, 2010, 2009 and 2008 was nominal.
The fair value of options vested during the years ended December 31, 2010, 2009, and 2008 was
approximately $1,145,000, $1,105,000, and $783,000, respectively.
For the year ended December 31, 2010, 281,550 vested options to purchase shares with a weighted
average exercise price of $20.65 expired. The remaining outstanding share options expire in 2011
through 2020. For the year ended December 31, 2009, 17,050 vested option to purchases shares with
a weighted average exercise price of $18.76 expired, and for the year ended December 31, 2008,
31,000 vested options to purchase shares with a weighted average exercise price of $11.35 expired.
Restricted Stock
For the years ended December 31, 2010, and 2008, we awarded 20,000 and 26,000 shares of time-based
restricted stock, respectively, to certain officers pursuant to our 2003 Stock Option and Incentive
Plan. We did not award any shares for the year ended December 31, 2009. The shares vest over four
years from the date of grant, with 50% vested at the end of year three and 50% at the end of year
four. The fair value of the restricted stock is equal to the fair market value, as defined by the
terms of the 2003 Plan, on the date of grant and is amortized ratably over the vesting period.
For the years ended December 31, 2010, 2009, and 2008, we awarded 76,000, 87,500 and 35,000 shares
of time-based restricted stock, respectively, to our non-employee directors pursuant to our 2003
Stock Option and Incentive Plan. The shares vested 50% at the date of grant and 50% on the
one-year anniversary of the date of grant. The fair value of the restricted stock is equal to the
fair market value, as defined by the terms of the 2003 Plan, on the date of grant and is amortized
50% at the date of grant and 50% ratably over the one year vesting period.
We recorded the following amounts in our Consolidated Statements of Operations related to
restricted stock for the years ended December 31 (dollar amounts in thousands):
2010 | 2009 | 2008 | ||||||||||
Compensation cost restricted stock: |
||||||||||||
Time-based vesting |
$ | 481 | $ | 667 | $ | 595 | ||||||
Performance-based vesting |
| | 495 | |||||||||
Total share-based compensation expense restricted stock |
$ | 481 | $ | 667 | $ | 1,090 | ||||||
A summary of the status of restricted stock and changes as of December 31, 2010 is set forth below:
Time Based | Performance Based | |||||||||||||||
Weighted | Weighted | |||||||||||||||
Average | Average | |||||||||||||||
Restricted | Grant-date | Restricted | Grant-date | |||||||||||||
Stock | Fair Value | Stock | Fair Value | |||||||||||||
Outstanding, beginning of period |
93,875 | $ | 12.60 | 1,084 | $ | 31.10 | ||||||||||
Granted |
96,000 | 5.61 | | | ||||||||||||
Vested |
(97,750 | ) | 7.53 | | | |||||||||||
Forfeited/canceled |
(8,125 | ) | 18.91 | (459 | ) | 31.10 | ||||||||||
Outstanding, end of period |
84,000 | $ | 9.90 | 625 | $ | 31.10 | ||||||||||
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Table of Contents
Unrecognized Compensation Expense
As of December 31, 2010, unrecorded compensation costs related to awards issued under our various
share-based compensation plans are as follows (dollar amounts in thousands):
Weighted average | ||||||||
December 31, | recognition period | |||||||
2010 | (months) | |||||||
Unrecognized compensation cost: |
||||||||
Stock options, net of expected forfeitures |
$ | 1,667 | 27.1 | |||||
Restricted stock time based vesting |
246 | 14.7 | ||||||
Restricted stock performance based vesting |
| | ||||||
Total unrecognized compensation cost |
$ | 1,913 | ||||||
Note 13 Employee Benefit Plans
We sponsor defined contribution plans covering eligible employees. The plans provide for employer
contributions based on the level of employee participation. In response to the current and
anticipated economic uncertainties, in November 2008 we implemented an expense reduction program,
which included, among other things, the suspension of the 401(k) corporate matching contribution.
Therefore, our contribution expense for both 2010 and 2009 was $0, and our contribution expense for
2008, prior to the suspension, was $1.3 million. The 401(k) corporate matching contribution
continues to be suspended for 2011.
Note 14 Restructuring
As a result of our post-acquisition activities, we incurred nominal restructuring costs during the
years ended December 31, 2010 and 2009, while we incurred restructuring costs of approximately $3.2
million during the year ended December 31, 2008. Restructuring expenses for 2010 consisted of
approximately $33,000 related to the consolidation or closure of acquired facilities.
Restructuring expenses for 2009 consisted of approximately $386,000 related to the consolidation or
closure of acquired facilities and a reduction of approximately $419,000 in employee severance
costs, due to unused outplacement services and insurance benefits. Restructuring expenses for 2008
consisted of $1.4 million in employee severance, $1.6 million in redundant acquired facility
consolidation and $0.2 million of other restructuring costs. All restructuring costs are included
in operating expenses on the Consolidated Statements of Operations. Employee severance costs
relate to the phase out of duplicate general and administrative functions. Redundant facility
expenses related to the consolidation of certain leased offices and corporate systems
infrastructure, including the early termination of a support agreement.
In the fourth quarter of 2008, we implemented an expense reduction program in response to the
economic uncertainties, which included a reduction in our general workforce and the closing of our
Atlanta call center location and two ancillary offices. The reduction in force resulted in a
decrease in our employee base by approximately 20%. As a result of the reduction in force and the
facilities closure, we incurred approximately $327,000 of severance-related costs and approximately
$61,000 of consolidation or closure of facilities costs during the year ending December 31, 2010.
We incurred approximately $342,000 of severance-related costs and $294,000 of consolidation or
closure of facilities costs during the year ended December 31, 2009. Reduction in force costs for
2008 consisted of $1.9 million of severance-related costs. All reduction in force costs are
included in operating expenses on the Consolidated Statements of Operations.
In January 2011, we initiated a reduction in force program to gain operating efficiencies by
reorganizing departments and reducing layers of management. The reduction in force program reduced
our workforce by approximately 7%.
We estimate additional expenses charged to restructuring over the next twelve to eighteen months,
primarily reduction in force initiatives and recurring facilities expenses related to the
post-acquisition restructuring noted above, will be in the range of $0.9 million to $1.3 million.
Additional accruals and cash payments related to the restructuring activities are dependent upon
reduction in force or subleasing arrangements, which could change our expense estimates.
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Table of Contents
The above restructuring activities primarily occurred within our Hospitality and Advertising
Services businesses. Liabilities associated with our restructuring activities to date, along with
charges to expense and cash payments, were as follows (dollar amounts in thousands):
Severance and other | Cost of closing | |||||||||||||||
benefit related | redundant acquired | |||||||||||||||
costs | facilities | Other | Total | |||||||||||||
December 31, 2007 balance |
$ | 5,289 | $ | 485 | $ | | $ | 5,774 | ||||||||
Charges to expense |
3,277 | 1,587 | 183 | 5,047 | ||||||||||||
Cash payments |
(6,570 | ) | (1,632 | ) | (183 | ) | (8,385 | ) | ||||||||
December 31, 2008 balance |
1,996 | 440 | $ | | 2,436 | |||||||||||
Charges to expense |
(77 | ) | 680 | | 603 | |||||||||||
Cash payments |
(1,583 | ) | (698 | ) | | (2,281 | ) | |||||||||
December 31, 2009 balance |
336 | 422 | $ | | 758 | |||||||||||
Charges to expense |
327 | 94 | | 421 | ||||||||||||
Cash payments |
(628 | ) | (379 | ) | | (1,007 | ) | |||||||||
December 31, 2010 balance |
$ | 35 | $ | 137 | $ | | $ | 172 | ||||||||
Note 15 Income Taxes
The (loss) gain before income taxes was as follows for the years ended December 31 (dollar amounts
in thousands):
2010 | 2009 | 2008 | ||||||||||
Domestic |
$ | (12,512 | ) | $ | (11,401 | ) | $ | (48,578 | ) | |||
Foreign |
1,661 | 2,009 | 1,009 | |||||||||
Total |
$ | (10,851 | ) | $ | (9,392 | ) | $ | (47,569 | ) | |||
The provision for income taxes varies from the federal statutory rate applied to total income as
follows for the years ended December 31 (dollar amounts in thousands):
2010 | 2009 | 2008 | ||||||||||
Federal income tax (benefit) computed at
statutory rate (35%) |
$ | (3,798 | ) | $ | (3,287 | ) | $ | (16,652 | ) | |||
State income taxes, net of federal benefit |
463 | 353 | 466 | |||||||||
Impairment charge |
| 479 | 3,924 | |||||||||
Other non-deductible items |
384 | 60 | 124 | |||||||||
Other |
| | | |||||||||
Net change to valuation allowance, excluding
change due to acquisitions |
3,785 | 3,158 | 12,987 | |||||||||
Provision for income taxes |
$ | 834 | $ | 763 | $ | 849 | ||||||
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Table of Contents
The provision for income taxes was as follows for the years ended December 31 (dollar amounts in
thousands):
2010 | 2009 | 2008 | ||||||||||
Current: |
||||||||||||
Federal |
$ | | $ | | $ | | ||||||
State |
713 | 543 | 642 | |||||||||
Foreign |
121 | 220 | 207 | |||||||||
834 | 763 | 849 | ||||||||||
Deferred: |
||||||||||||
Federal |
$ | | $ | | $ | | ||||||
State |
| | | |||||||||
Foreign |
| | | |||||||||
| | | ||||||||||
Total income tax expense |
$ | 834 | $ | 763 | $ | 849 | ||||||
Deferred income taxes, which result from the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and the amounts used
for income tax purposes, consist of the following at December 31 (dollar amounts in thousands):
2010 | 2009 | 2008 | ||||||||||
Deferred tax assets: |
||||||||||||
Tax net operating loss and tax credit
carryforwards |
$ | 227,804 | $ | 220,979 | $ | 204,466 | ||||||
Capital loss carryforwards |
| | | |||||||||
Reserves and accruals |
3,195 | 2,320 | 2,854 | |||||||||
Net deferred revenue |
7,356 | 5,766 | 5,753 | |||||||||
Book over tax depreciation/amortization |
| | | |||||||||
Other tax assets |
9,811 | 10,690 | 9,457 | |||||||||
Valuation allowance |
(237,848 | ) | (221,665 | ) | (201,104 | ) | ||||||
Total deferred tax assets |
10,318 | 18,090 | 21,426 | |||||||||
Deferred tax liabilities: |
||||||||||||
Reserves and accruals |
| | | |||||||||
Tax over book depreciation/amortization |
(10,318 | ) | (18,090 | ) | (21,426 | ) | ||||||
Total deferred tax liabilities |
(10,318 | ) | (18,090 | ) | (21,426 | ) | ||||||
Net deferred tax liability |
$ | | $ | | $ | | ||||||
We evaluated the realization of deferred tax assets and reduced the carrying amount of these
deferred tax assets by a valuation allowance. We considered various factors when assessing the
future realization of our deferred tax assets, including our recent cumulative earnings experience
by taxing jurisdiction, expectations of future taxable income, the carryforward periods available
to us for tax reporting purposes and other relevant factors. Significant judgment is required in
making this assessment.
Our
valuation allowance increased $16.2 million in 2010. This
increase was primarily due to book depreciation and amortization in
excess of tax depreciation and amortization, an increase in federal
and state net operating losses and other book-to-tax differences.
In 2008, we reported an acquired valuation allowance of $51.8 million for the deductible temporary
differences, operating loss or tax credit carryforwards as a result of a 2007 acquisition. If this
valuation allowance is recognized in the future by elimination of the acquired valuation allowance
of $51.8 million, it shall reduce income tax expense.
F - 30
Table of Contents
At December 31, 2010, we had net operating loss carryforwards for United States federal income tax
purposes aggregating approximately $552.6 million and $470.2 million for United States state and
local income tax purposes. There were also approximately $5.4 million of Canadian federal net
operating loss carryforwards. At December 31, 2010, combined federal alternative minimum tax
credit carryforwards and foreign tax credits totaled $0.6 million, available to offset future
regular tax liabilities. A portion of these loss carryforwards expire each year unless utilized.
Tax loss carryforwards expiring in the next five years are as follows (dollar amounts in
thousands): 2011 $16,526; 2012 $15,968; 2013 $0; 2014 $0 and 2015 $0.
Current federal and state tax laws include substantial restrictions on the utilization of net
operating losses and tax credits in the event of an ownership change of a corporation.
Accordingly, our ability to utilize net operating losses and tax
credit carryforwards generated may be limited as a result of such ownership change, as defined.
Effective January 1, 2007, the Company adopted additional provisions now codified under FASB ASC
Topic 740, Income Taxes, which clarified the accounting for uncertainty in income taxes
recognized in a companys financial statements and prescribed a recognition threshold and
measurement attribute for the financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return. In instances where a company has taken or expects
to take a tax position in its tax return, and the company believes it is more likely than not such
tax position will be upheld by the relevant taxing authority, the company may record a benefit for
such tax position in its consolidated financial statements. We are not currently under audit in
any income tax jurisdiction and have not signed any extensions to extend the statute of limitations
to complete an audit. The Companys tax returns remain open for all tax years after 2005 and,
therefore, may be subject to audit in future periods.
The impact increase (decrease) on our Consolidated Balance Sheets as of December 31, 2010 due
to the adoption of the additional provisions of FASB ASC Topic 740 is as follows (dollars amounts
in thousands):
Beginning | Ending | |||||||||||||||
Balance | Additions | Deductions | Balance | |||||||||||||
Year Ended December 31, 2009: |
||||||||||||||||
Uncertain Tax Benefit |
$ | 581 | $ | | $ | (19 | ) | $ | 562 | |||||||
Year Ended December 31, 2010: |
||||||||||||||||
Uncertain Tax Benefit |
$ | 562 | $ | | $ | (72 | ) | $ | 490 |
Due to our net operating loss position, the unrecognized tax benefit has the effect of reducing our
deferred tax asset and related valuation allowance. The total amount of unrecognized tax benefits
which, if recognized, would affect the effective tax rate at December 31, 2010, is $490,000.
Unrecognized tax benefits were reduced in 2009 and 2010 by $19,000 and $72,000, respectively, as a
result of a tax position taken and the expiration of statutory periods of assessment. We recognize
interest and penalties related to unrecognized tax benefits in tax expense.
Note 16 Segment Information
We operate in three reportable segments, Hospitality, Advertising Services and Healthcare. We
organize and manage 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 interactive and media
network solutions 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.
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Previously, our Advertising Services and Healthcare segments had been presented as Other, in
one aggregated reportable segment based on relative size. Revenue, operating profit, capital
expenditures and total asset amounts reported in previous periods have been reclassified to conform
to the current presentation.
The accounting policies of the segments are the same as those described in the summary of
significant accounting policies, except certain expenses are not allocated to the segments. These
unallocated expenses are corporate overhead, depreciation and amortization expenses, impairment and
restructuring charges, other operating income (expense), interest expense, gains and losses on the
extinguishment and early retirement of debt, other income (expense) and income tax expense. We
evaluate segment performance based upon operating profit and loss before the aforementioned
expenses.
Financial information related to our reportable segments for the years ended December 31 is as
follows (dollar amounts in thousands):
2010 | 2009 | 2008 | ||||||||||
Total revenue: |
||||||||||||
Hospitality |
$ | 433,787 | $ | 469,743 | $ | 519,922 | ||||||
Advertising Services |
9,867 | 6,915 | 7,888 | |||||||||
Healthcare |
8,518 | 7,834 | 6,069 | |||||||||
Total |
$ | 452,172 | $ | 484,492 | $ | 533,879 | ||||||
Operating profit: |
||||||||||||
Hospitality |
$ | 128,879 | $ | 146,714 | $ | 167,104 | ||||||
Advertising Services |
769 | (2,894 | ) | (3,412 | ) | |||||||
Healthcare |
2,070 | 1,903 | 957 | |||||||||
Operating profit |
131,718 | 145,723 | 164,649 | |||||||||
Corporate |
(24,672 | ) | (23,245 | ) | (30,365 | ) | ||||||
Depreciation and amortization |
(83,236 | ) | (100,309 | ) | (124,060 | ) | ||||||
Goodwill impairment charge |
| | (11,212 | ) | ||||||||
Restructuring charge |
(421 | ) | (603 | ) | (5,047 | ) | ||||||
Other operating income |
21 | 126 | 964 | |||||||||
Interest expense |
(33,537 | ) | (38,092 | ) | (42,551 | ) | ||||||
Gain on extinguishment of debt |
| 9,292 | 1,446 | |||||||||
Loss on early retirement of debt |
(1,050 | ) | (1,537 | ) | (448 | ) | ||||||
Other income (expense) |
326 | (747 | ) | (945 | ) | |||||||
Loss before income taxes |
$ | (10,851 | ) | $ | (9,392 | ) | $ | (47,569 | ) | |||
Capital expenditures: |
||||||||||||
Hospitality |
$ | 16,834 | $ | 17,433 | $ | 53,422 | ||||||
Advertising Services |
166 | 214 | 169 | |||||||||
Healthcare |
247 | 249 | 207 | |||||||||
Corporate |
4,578 | 3,445 | 10,609 | |||||||||
Total |
$ | 21,825 | $ | 21,341 | $ | 64,407 | ||||||
Total assets: |
||||||||||||
Hospitality |
$ | 406,085 | $ | 468,609 | $ | 542,862 | ||||||
Advertising Services |
13,746 | 11,728 | 11,943 | |||||||||
Healthcare |
633 | 616 | 565 | |||||||||
Corporate |
23,542 | 27,401 | 34,416 | |||||||||
Total |
$ | 444,006 | $ | 508,354 | $ | 589,786 | ||||||
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Table of Contents
The following table presents revenues by country based on the location of the customer for the
years ended December 31 (dollar amounts in thousands):
2010 | 2009 | 2008 | ||||||||||
United States |
$ | 423,883 | $ | 456,167 | $ | 497,860 | ||||||
Canada |
24,804 | 24,992 | 31,327 | |||||||||
Mexico |
2,414 | 1,952 | 2,973 | |||||||||
Other |
1,071 | 1,381 | 1,719 | |||||||||
Total |
$ | 452,172 | $ | 484,492 | $ | 533,879 | ||||||
Property and equipment by country based on the location of the assets were as follows at December
31 (dollar amounts in thousands):
2010 | 2009 | 2008 | ||||||||||
United States |
$ | 142,713 | $ | 188,805 | $ | 254,077 | ||||||
Canada |
9,826 | 13,218 | 14,791 | |||||||||
Mexico |
4,378 | 4,640 | 4,962 | |||||||||
Total |
$ | 156,917 | $ | 206,663 | $ | 273,830 | ||||||
Note 17 Selected Quarterly Financial Data (Unaudited)
The following selected quarterly financial data are in thousands of dollars, except share data:
Quarter | Quarter | Quarter | Quarter | |||||||||||||
Ended | Ended | Ended | Ended | |||||||||||||
March 31, | June 30, | September 30, | December 31, | |||||||||||||
2009 |
||||||||||||||||
Revenues |
$ | 128,092 | $ | 121,982 | $ | 121,122 | $ | 113,296 | ||||||||
Net income (loss) |
5,958 | (5,213 | ) | (4,982 | ) | (5,918 | ) | |||||||||
Net income (loss) attributable to common
stockholders |
5,958 | (5,245 | ) | (6,627 | ) | (7,355 | ) | |||||||||
Per common share (basic) |
$ | 0.27 | $ | (0.23 | ) | $ | (0.30 | ) | $ | (0.33 | ) | |||||
Per common share (diluted) |
0.26 | (0.23 | ) | (0.30 | ) | (0.33 | ) | |||||||||
2010 |
||||||||||||||||
Revenues |
$ | 118,052 | $ | 113,071 | $ | 113,794 | $ | 107,255 | ||||||||
Net loss |
(2,502 | ) | (3,145 | ) | (1,674 | ) | (4,364 | ) | ||||||||
Net loss attributable to common stockholders |
(3,940 | ) | (4,582 | ) | (3,111 | ) | (5,802 | ) | ||||||||
Per common share (basic and diluted) |
$ | (0.17 | ) | $ | (0.18 | ) | $ | (0.12 | ) | $ | (0.23 | ) |
F - 33
Table of Contents
LodgeNet Interactive Corporation and Subsidiaries
Schedule II Valuation and Qualifying Accounts
(Dollar amounts in thousands)
(Dollar amounts in thousands)
Additions | Additions | |||||||||||||||||||
Balance | Charged to | Related to | Balance | |||||||||||||||||
Beginning | Costs and | Other | End of | |||||||||||||||||
Description | of Period | Expenses | Accounts | Deductions | Period | |||||||||||||||
Allowances deducted from related
balance sheet accounts: |
||||||||||||||||||||
Year Ended December 31, 2008: |
||||||||||||||||||||
Allowance for Excess or Obsolete
System Components |
$ | 675 | $ | 513 | $ | | $ | 620 | $ | 568 | ||||||||||
Allowance for Doubtful Accounts |
432 | 844 | | 723 | 553 | |||||||||||||||
Allowance for System Removal |
422 | 3,157 | | 2,314 | 1,265 | |||||||||||||||
Deferred Tax Valuation Allowance |
197,232 | | 18,308 | 14,436 | 201,104 | |||||||||||||||
Year Ended December 31, 2009: |
||||||||||||||||||||
Allowance for Excess or Obsolete
System Components |
$ | 568 | $ | 776 | $ | | $ | 499 | $ | 845 | ||||||||||
Allowance for Doubtful Accounts |
553 | 536 | | 437 | 652 | |||||||||||||||
Allowance for System Removal |
1,265 | 2,641 | | 3,010 | 896 | |||||||||||||||
Deferred Tax Valuation Allowance |
201,104 | | 20,561 | | 221,665 | |||||||||||||||
Year Ended December 31, 2010: |
||||||||||||||||||||
Allowance for Excess or Obsolete
System Components |
$ | 845 | $ | 1,163 | $ | | $ | 811 | $ | 1,197 | ||||||||||
Allowance for Doubtful Accounts |
652 | 636 | | 879 | 409 | |||||||||||||||
Allowance for System Removal |
896 | 4,399 | | 4,301 | 994 | |||||||||||||||
Deferred Tax Valuation Allowance |
221,665 | | 16,183 | | 237,848 |
F - 34