UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

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

Commission File Number 0-22334

LodgeNet Interactive Corporation

(Exact name of registrant as specified in its charter)

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

3900 West Innovation Street, Sioux Falls, South Dakota 57107
(Address of Principal Executive Offices)           (ZIP code)

(605) 988-1000

including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

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

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

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

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

At May 2, 2011, there were 25,155,330 shares outstanding of the Registrant’s common stock, $0.01 par value.

 

 

LodgeNet Interactive Corporation and Subsidiaries

Index

		Page
		No.
Part I. Financial Information
Item 1 — Financial Statements:
Consolidated Balance Sheets as of March 31, 2011 (Unaudited) and December 31, 2010 (Audited)			3
Consolidated Statements of Operations (Unaudited) for the Three Months Ended March 31, 2011 and 2010			4
Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended March 31, 2011 and 2010			5
Notes to Consolidated Financial Statements (Unaudited)			6
Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations			20
Item 3 — Quantitative and Qualitative Disclosures About Market Risk			41
Item 4 — Controls and Procedures			41
Part II. Other Information
Item 1 — Legal Proceedings			43
Item 1A — Risk Factors			43
Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds			43
Item 3 — Defaults Upon Senior Securities			43
Item 5 — Other Information			43
Item 6 — Exhibits			43
Signatures			44
EX-31.1
EX-31.2
EX-32

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

“LodgeNet,” “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.

Part I — Financial Information

Item 1 — Financial Statements

LodgeNet Interactive Corporation and Subsidiaries

(Dollar amounts in thousands, except share data)

		(Unaudited)				(Audited)
		March 31,				December 31,
		2011				2010
Assets
Current assets:
Cash		$	16,074			$	8,381
Accounts receivable, net			50,527				49,332
Other current assets			12,779				12,728
Total current assets			79,380				70,441
Property and equipment, net			143,544				156,917
Debt issuance costs, net			5,587				3,681
Intangible assets, net			97,033				99,005
Goodwill			100,081				100,081
Other assets			13,592				13,881
Total assets		$	439,217			$	444,006
Liabilities and Stockholders’ Deficiency
Current liabilities:
Accounts payable		$	65,064			$	60,303
Current maturities of long-term debt			10,612				4,807
Accrued expenses			19,673				22,327
Fair value of derivative instruments			5,246				10,353
Deferred revenue			20,101				23,168
Total current liabilities			120,696				120,958
Long-term debt			359,970				368,832
Other long-term liabilities			10,010				8,565
Total liabilities			490,676				498,355
Commitments and contingencies
Stockholders’ deficiency:
Preferred stock, $.01 par value, 5,000,000 shares authorized; Series B cumulative perpetual convertible, 10%, 57,500 issued and outstanding at March 31, 2011 and December 31, 2010, 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; 25,152,080 and 25,088,539 shares outstanding at March 31, 2011 and December 31, 2010, respectively			252				251
Additional paid-in capital			387,942				388,961
Accumulated deficit			(438,804	)			(437,896	)
Accumulated other comprehensive loss			(850	)			(5,666	)
Total stockholders’ deficiency			(51,459	)			(54,349	)
Total liabilities and stockholders’ deficiency		$	439,217			$	444,006

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

LodgeNet Interactive Corporation and Subsidiaries

(Dollar amounts in thousands, except share data)

		Three Months Ended
		March 31,
		2011				2010
Revenues:
Hospitality and Advertising Services		$	105,835			$	115,499
Healthcare			1,894				2,553
Total revenues			107,729				118,052
Direct costs and operating expenses:
Direct costs (exclusive of operating expenses and depreciation and amortization shown separately below):
Hospitality and Advertising Services			59,361				65,261
Healthcare			922				1,346
Operating expenses:
System operations			10,069				10,515
Selling, general and administrative			9,689				12,115
Depreciation and amortization			19,641				22,173
Restructuring charge			1,160				3
Other operating (income) expense			(14	)			5
Total direct costs and operating expenses			100,828				111,418
Income from operations			6,901				6,634
Other income and (expenses):
Interest expense			(7,671	)			(8,682	)
Loss on early retirement of debt			(158	)			(493	)
Other income			317				223
Loss before income taxes			(611	)			(2,318	)
Provision for income taxes			(297	)			(184	)
Net loss			(908	)			(2,502	)
Preferred stock dividends			(1,438	)			(1,437	)
Net loss attributable to common stockholders		$	(2,346	)		$	(3,939	)
Net loss per common share (basic and diluted)		$	(0.09	)		$	(0.17	)
Weighted average shares outstanding (basic and diluted)			25,037,122				22,746,527

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

LodgeNet Interactive Corporation and Subsidiaries

(Dollar amounts in thousands)

		Three Months Ended March 31,
		2011				2010
Operating activities:
Net loss		$	(908	)		$	(2,502	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization			19,641				22,173
Unrealized (gain) loss on derivative instruments			(745	)			659
Loss on early retirement of debt			158				493
Share-based compensation and restricted stock			414				312
Other, net			122				40
Change in operating assets and liabilities:
Accounts receivable, net			(2,667	)			(1,350	)
Other current assets			459				170
Accounts payable			4,709				10,222
Accrued expenses and deferred revenue			(2,127	)			(1,521	)
Other			178				(598	)
Net cash provided by operating activities			19,234				28,098
Investing activities:
Property and equipment additions			(4,645	)			(4,525	)
Net cash used for investing activities			(4,645	)			(4,525	)
Financing activities:
Repayment of long-term debt			(3,025	)			(45,274	)
Payment of capital lease obligations			(214	)			(287	)
Borrowings on revolving credit facility			25,000				—
Repayments of revolving credit facility			(25,000	)			—
Debt issuance costs			(2,410	)			—
Proceeds from investment in long-term debt			177				2,643
Proceeds from issuance of common stock, net of offering costs			—				13,692
Payment of dividends to preferred shareholders			(1,438	)			(1,437	)
Exercise of stock options			5				3
Net cash used for financing activities			(6,905	)			(30,660	)
Effect of exchange rates on cash			9				4
Increase (decrease) in cash			7,693				(7,083	)
Cash at beginning of period			8,381				17,011
Cash at end of period		$	16,074			$	9,928

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

LodgeNet Interactive Corporation and Subsidiaries

Note 1 — Basis of Presentation

The accompanying consolidated financial statements as of March 31, 2011, and for the three month periods ended March 31, 2011 and 2010, have been prepared by us, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “Commission”). The information furnished in the accompanying consolidated financial statements reflects all adjustments, consisting of normal recurring adjustments, which, in our opinion, are necessary for a fair statement of such financial statements.

Certain information and footnote disclosures, normally included in annual financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to the rules and regulations of the Commission. Although we believe the disclosures are adequate to make the information presented herein not misleading, it is recommended these unaudited consolidated financial statements be read in conjunction with the more detailed information contained in our Annual Report on Form 10-K for 2010, as filed with the Commission. The results of operations for the three month periods ended March 31, 2011 and 2010 are not necessarily indicative of the results of operations for the full year due to inherent seasonality within the business, among other factors.

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

Note 2 — Property and Equipment, Net

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

		March 31,				December 31,
		2011				2010
Land, building and equipment		$	112,373			$	115,031
Hotel systems			717,948				726,638
Total			830,321				841,669
Less — depreciation and amortization			(686,777	)			(684,752	)
Property and equipment, net		$	143,544			$	156,917

Note 3 — Goodwill and Other Intangible Assets

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.

Per Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 350, “Intangibles — Goodwill and Other,” 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. Effective January 1, 2011, we adopted FASB Accounting Standards Update (“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. This ASU provides that reporting units with zero or negative carrying amounts are required to perform Step 2 of the goodwill impairment test if it is more likely than not a goodwill impairment exists. In considering whether it is more likely than not an impairment loss exists, a company is required to evaluate qualitative factors, including the same factors presented in existing guidance which would trigger an interim impairment test of goodwill. Factors include a significant deterioration in market conditions, unanticipated competition, loss of key personnel and an anticipated sale of a reporting unit. If an entity determines it is more likely than not an impairment exists, Step 2 of the impairment test must be performed 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. We perform our goodwill impairment test for each reporting unit annually during the fourth quarter.

Impairment testing is not required for our finite-life intangibles unless there is a triggering event or change in circumstances which indicate the carrying value may not be recoverable, such as a significant deterioration in market conditions.

During the first quarter of 2011, we did not encounter events or circumstances which could trigger an impairment of our goodwill or intangible assets, and the adoption of the additional provisions of FASB ASC Topic 350 has not had an impact on our consolidated financial position, results of operations or cash flows.

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

						Advertising
		Hospitality				Services				Total
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
Activity during the period			—				—				—
Balance as of March 31, 2011
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 a change in circumstances, such as a significant deterioration in market conditions, warrant modifications to the carrying amount of the assets.

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

		March 31, 2011								December 31, 2010
		Carrying				Accumulated				Carrying				Accumulated
		Amount				Amortization				Amount				Amortization
Assets subject to amortization:
Acquired contracts and relationships		$	120,315			$	(25,526	)		$	120,315			$	(23,950	)
Other acquired intangibles			13,972				(12,929	)			13,956				(12,769	)
Tradenames			3,125				(2,223	)			3,124				(2,107	)
Acquired patents			5,195				(4,896	)			5,175				(4,739	)
		$	142,607			$	(45,574	)		$	142,570			$	(43,565	)

We recorded consolidated amortization expense of $2.0 million and $2.2 million, respectively, for the three months ended March 31, 2011 and 2010. We estimate total amortization expense for the nine months remaining in 2011 and the years ending December 31 as follows (dollar amounts in millions): 2011 — $5.4; 2012 — $6.8; 2013 — $6.5; 2014 — $6.4; 2015 — $6.3 and 2016 — $6.2. Actual amounts may change from such estimated amounts due to additional intangible asset acquisitions, potential impairment, accelerated amortization or other events.

Note 4 — Earnings Per Share Computation

We follow FASB ASC Topic 260, “Earnings Per Share,” which requires the computation and disclosure of two earning per share (“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. The provisions of FASB ASC Topic 260 also provide that unvested share-based payment awards which contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. We determined our outstanding shares of non-vested restricted stock are participating securities.

The following table reflects the calculation of weighted average basic and fully diluted shares for the periods ended March 31. Dollar amounts are in thousands, except share data:

		Three Months Ended
		March 31,
		2011				2010
Basic EPS:
Net loss		$	(908	)		$	(2,502	)
Preferred stock dividends			(1,438	)			(1,437	)
		$	(2,346	)		$	(3,939	)
Loss allocated to participating securities (1)			—				—
Net loss available to common stockholders		$	(2,346	)		$	(3,939	)
Weighted average shares outstanding for basic earnings per common share			25,037,122				22,746,527
Basic earnings per share		$	(0.09	)		$	(0.17	)
Diluted EPS:
Net loss		$	(908	)		$	(2,502	)
Preferred stock dividends			(1,438	)			(1,437	)
		$	(2,346	)		$	(3,939	)
Loss allocated to participating securities (1)			—				—
Net loss available to common stockholders		$	(2,346	)		$	(3,939	)
Weighted average shares outstanding for basic earnings per common share			25,037,122				22,746,527
Dilutive effect of potential shares (2)			N/A				N/A
Weighted average shares outstanding for diluted earnings per common share			25,037,122				22,746,527
Diluted earnings per share		$	(0.09	)		$	(0.17	)
Potential dilutive common shares (2)			17,251,792				17,208,201

Note 5 — Accrued Expenses

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

		March 31,				December 31,
		2011				2010
Property, sales and other taxes		$	6,410			$	6,411
Compensation			5,011				4,639
Interest			655				208
Programming related			1,467				1,782
Restructuring and reorganization			519				172
Preferred stock dividends			1,438				1,438
Purchase commitments			1,763				3,414
Other			2,410				4,263
		$	19,673			$	22,327
Note 6 — Long-term Debt and Credit Facilities
Long-term debt was comprised as follows (dollar amounts in thousands):
		March 31,				December 31,
		2011				2010
Bank Credit Facility:
Term loan		$	369,662			$	372,511
Revolving loan commitment			—				—
Capital leases			920				1,128
			370,582				373,639
Less current maturities			(10,612	)			(4,807	)
		$	359,970			$	368,832

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 loan commitment, 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 for March 31, 2011. The term loan originally bore interest at our option of (1) the bank’s base rate plus a margin of 1.00% or (2) LIBOR plus a margin of 2.00%. The term loan is collateralized by substantially all of the assets of the Company.

Effective March 22, 2011, we entered into a First Amendment (the “Amendment”) to the bank Credit Facility. The Amendment modifies certain terms of the Credit Facility, including an increase in the permitted consolidated leverage ratio, the creation of a specific preferred stock dividend payment basket and the potential to extend the term beyond its current expiration in April 2014. The restricted payment basket within the Amendment allows for dividend payments not to exceed $5,750,000 per year. The Amendment also reduces the commitments under the revolving loan commitment, increases the interest rate and required amortization and adjusts other covenants. The Company incurred $2.4 million of debt issuance costs related to certain fees and expenses in connection with this Amendment.

Under the Amendment, the $50.0 million revolving loan commitment has been reduced to $25.0 million. The Amendment also requires us to make quarterly term loan repayments of $2.5 million beginning June 30, 2011 through December 31, 2012, and $3.75 million beginning March 31, 2013 through December 31, 2013. The amended term loan and revolving loan commitment bear interest at our option of (1) the bank’s base rate plus a margin of 4.0% or (2) LIBOR plus a margin of 5.0%. In addition, a LIBOR floor of 1.5% was established under the Amendment.

The Amendment includes terms and conditions which require compliance with leverage and interest coverage covenants. As of March 31, 2011, our consolidated leverage ratio was 3.46 compared to the maximum allowable ratio of 4.00 and our consolidated interest coverage ratio was 2.76 compared to the minimum allowable ratio of 2.25. Per the Amendment, the maximum allowable consolidated leverage ratio will remain at 4.00 until September 30, 2012, when it will change to 3.75 for the quarters ending December 31, 2012 through June 30, 2013. It will then drop to 3.50 for the quarter ending September 30, 2013 until maturity. The minimum allowable consolidated interest coverage ratio will continue to be 2.25 until maturity.

The Credit Facility also requires we notify the agent upon the occurrence of a “Material Adverse Effect” prior to any draw on the Company’s revolving loan commitment, as such terms are defined and used within our bank Credit Facility. However, under the Credit Facility, the provision of such a notice is not an event of default, but if such an event occurred, it could restrict the Company’s ability to obtain additional financing under the revolving loan commitment. The original 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 of 4.97% and 5.09% (see Note 13). The term loan interest rate as of March 31, 2011 was 6.50%. The all-in weighted average interest rate for the quarter ended March 31, 2011 was 8.26%, which includes both the term loan interest rate and the difference in the swaps’ fixed interest rate versus LIBOR. The swap agreements will expire in June 2011. The Amendment does not require us to enter into any hedge agreements. As of March 31, 2011, 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 the Amendment) 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. Our ability to continue to comply with our current covenants is subject to the general economic climate and business conditions beyond our control. Although there are signs of stabilization in certain sectors of the economy, the uncertainties impacting travel and lodging, in addition to the constraints in the credit markets, consumer conservatism and other market dynamics, including technological changes, 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 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 the first quarter of 2011, we made a prepayment of $2.0 million on the term loan, along with the required payment of $1.0 million. We expensed $0.2 million of debt issuance costs related to the prepayment and the Amendment described above.

In the first quarter of 2010, we made our required quarterly payment of $1.3 million, prepaid a total of $44.0 million on the term loan, which included $13.7 million of net proceeds from the common stock offering, and expensed $0.5 million of related debt issuance costs. The common stock offering is discussed in more detail in Note 15.

The Credit Facility provides for the issuance of letters of credit up to $7.5 million, subject to customary terms and conditions. Under the terms of the Amendment, this amount was reduced from $15.0 million. As of March 31, 2011, we had outstanding letters of credit totaling $395,000, which reduce amounts available under the revolving loan commitment. During the first quarter of 2011, we borrowed $25.0 million under the revolving loan commitment and repaid the entire amount during the quarter.

Capital Leases — As of March 31, 2011, we had total capital lease obligations of $0.9 million. There was no equipment acquired under capital lease arrangements during the three months ended March 31, 2011. Our capital lease obligations consist primarily of vehicles used in our field service operations.

As of March 31, 2011, long-term debt has the following scheduled maturities for the nine months remaining in 2011 and the full years ending December 31, 2012 and after (dollar amounts in thousands):

		2011				2012				2013				2014				2015
Long-term debt		$	7,500			$	10,000			$	15,000			$	337,162			$	—
Capital leases			531				348				70				30				1
			8,031				10,348				15,070				337,192				1
Less amount representing interest on capital leases			(35	)			(19	)			(4	)			(2	)			—
		$	7,996			$	10,329			$	15,066			$	337,190			$	1

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

Note 7 — Comprehensive Income

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

		Three Months Ended
		March 31,
		2011				2010
Net loss		$	(908	)		$	(2,502	)
Other comprehensive income:
Foreign currency translation adjustment			454				595
Changes due to cash flow hedging:
Amortization of unrealized loss on interest rate swaps			448				—
Change in fair value on interest rate swaps			3,914				3,097
Other comprehensive income			4,816				3,692
Total comprehensive income		$	3,908			$	1,190

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

		March 31,				December 31,
		2011				2010
Unrealized loss on interest rate swap agreements		$	(4,480	)		$	(8,842	)
Foreign currency translation adjustment			3,630				3,176
Accumulated other comprehensive loss		$	(850	)		$	(5,666	)

Note 8 — Statements of Cash Flows

Cash is comprised of demand deposits. Cash paid for interest was $8.0 million for both the three months ended March 31, 2011 and 2010. Cash paid for taxes was $93,000 and $215,000 for the three months ended March 31, 2011 and 2010, respectively.

Note 9 — Share-Based Compensation

We account for our stock option and incentive plans under the recognition and measurement provisions of FASB ASC Topic 718, “Compensation — Stock Compensation,” which require the measurement and recognition of compensation expense for all stock-based awards based on estimated fair values, net of estimated forfeitures. Share-based compensation expense recognized in the three months ended March 31, 2011 and 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 this Topic.

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

		Three Months Ended
		March 31,
		2011				2010
Compensation cost:
Stock options		$	314			$	312
Restricted stock			100				—
Total share-based compensation expense		$	414			$	312

For the three months ended March 31, 2011 and 2010, 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 three months ended March 31, 2011, we did not grant any stock options to non-employee directors of the Company; however, we did grant 212,500 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 on our common stock; therefore, the dividend rate variable in the Black-Scholes-Merton model is zero.

Restricted Stock

For the three months ended March 31, 2011, we did not award any shares of time-based or performance-based restricted stock to our non-employee directors; however, we did award 56,250 shares of time-based restricted stock to certain officers pursuant to our 2003 Stock Option Incentive Plan. The shares will vest over four years from the date of grant, with 50% vested at the end of year three and 50% vested 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. In the first quarter of 2011, we did not issue any performance-based restricted stock to our officers.

Note 10 — Restructuring

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%. As a result of this action and our previous restructuring and reduction in force initiatives, we incurred $1.2 million of costs during the three months ended March 31, 2011, of which $1.1 million was related to our Hospitality business and $0.1 million was related to our Advertising Services business. We incurred nominal costs during the three months ended March 31, 2010. All costs are included in operating expenses on the Consolidated Statements of Operations.

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):

						Cost of closing
		Severance and				redundant
		other benefit				acquired
		related costs				facilities				Total
December 31, 2010 balance		$	35			$	137			$	172
Charges to expense			1,094				66				1,160
Cash payments			(699	)			(114	)			(813	)
March 31, 2011 balance		$	430			$	89			$	519

Note 11 — Fair Value Measurements

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

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

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

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

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

		March 31, 2011								December 31, 2010
		Carrying				Fair				Carrying				Fair
		Amount				Value				Amount				Value
Interest rate swaps - liability position		$	5,246			$	5,246			$	10,353			$	10,353
Long-term debt		$	370,582			$	355,796			$	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. 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 liabilities. Changes in fair value are recognized in other comprehensive income (loss) if the hedge is effective and in interest expense if the hedge is ineffective. We plan to hold the swap agreements to maturity. As a result of the Amendment to our Credit Facility, our swap arrangements ceased to be effective and hedge accounting was discontinued (see Note 13).

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, 2010:
Interest rate swaps — liability position		$	10,353			$	—			$	10,353			$	—
Three Months Ended March 31, 2011:
Interest rate swaps — liability position		$	5,246			$	—			$	5,246			$	—

We estimated the fair value of the interest rate swaps based on mid-market data from a third party provider. We periodically review and validate this data on an independent basis. The fair value determination also included consideration of nonperformance risk, which did not have a material impact on the fair value at March 31, 2011.

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. There was no triggering event which warranted an evaluation of impairment; therefore, there were no nonfinancial assets or liabilities measured at fair value on a non-recurring basis during the three months ended March 31, 2011.

Note 12 — 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.

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, restructuring charges, other operating income (expense), interest expense, loss on the 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 three months ended March 31 is as follows (dollar amounts in thousands):

		Three Months Ended
		March 31,
		2011				2010
Total revenues:
Hospitality		$	103,301			$	113,159
Advertising Services			2,534				2,340
Healthcare			1,894				2,553
Total		$	107,729			$	118,052
Operating profit:
Hospitality		$	31,139			$	34,494
Advertising Services			540				(222	)
Healthcare			443				345
Operating profit			32,122				34,617
Corporate			(4,434	)			(5,802	)
Depreciation and amortization			(19,641	)			(22,173	)
Restructuring charge			(1,160	)			(3	)
Other operating income (expense)			14				(5	)
Interest expense			(7,671	)			(8,682	)
Loss on early retirement of debt			(158	)			(493	)
Other income			317				223
Loss before income taxes		$	(611	)		$	(2,318	)

Note 13 — Derivative Information

We follow the provisions of FASB ASC Topic 815, “Derivatives and Hedging Activities,” which establish accounting and disclosure standards regarding a company’s derivative instruments and hedging activities.

We were required by our original 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 was to reduce the variability of cash flows associated with variable-rate loans and comply with the terms of our Credit Facility. As changes in interest rates impact future interest payments, the hedges provide an offset to the rate changes. As of March 31, 2011, we had entered into fixed rate swap agreements for $437.5 million at an average interest rate of 5.05%. The swap agreements will expire in June 2011. The Amendment to our Credit Facility does not require us to enter into any hedge agreements.

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.

With our amended Credit Facility, our interest rate swaps ceased to be effective and hedge accounting was discontinued effective March 22, 2011 and going forward, primarily related to the LIBOR floor of 1.5% as established under the Amendment. As a result, our deferred losses of $4,928,000 recorded in other comprehensive income were frozen and will be amortized into earnings over the original remaining term of the hedged transaction. All subsequent changes in the fair value of the swaps are recorded directly to interest expense. We recorded a loss of $448,000 related to the nine days of amortization in the first quarter of 2011. In addition, we recorded a gain of $1,193,000 related to the change in fair value of the interest rate swaps. The net amount of $745,000 is a non-cash gain and does not impact the amount of cash interest paid during the quarter.

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

		Contractual/						Estimated Fair
		Notional				Balance Sheet		Value
		Amount				Location		Asset				(Liability)
Year ended December 31, 2010:
Interest rate swaps		$	437,500			Current liabilities		$	—			$	(10,353	)
Three months ended March 31, 2011:
Interest rate swaps		$	437,500			Current liabilities		$	—			$	(5,246	)

The unrecognized loss for all cash flow hedges included in accumulated other comprehensive loss at March 31, 2011 and December 31, 2010 was $4.5 million and $8.8 million, respectively (see Note 7).

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

Effective Portion

Income Statement

Location of

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

Three Months Ended March 31, 2010:

Interest rate swaps

$

(2,815

)

Interest expense

$

5,253

Interest expense

$

659

Three Months Ended March 31, 2011:

Interest rate swaps

$

(89

)

Interest expense

$

4,672

Interest expense

$

(745

)

Note 14 — Perpetual Preferred Stock

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

Subject to the declaration of dividends by our Board of Directors, cumulative dividends on the preferred stock will be paid at a rate of 10% per annum of the $1,000 liquidation preference per share, starting from the date of original issue, June 29, 2009. Dividends accumulate quarterly in arrears on each January 15, April 15, July 15 and October 15, beginning on October 15, 2009. Dividend payments not to exceed $5,750,000 in any fiscal year are allowable under the restricted payment basket as defined within the Amendment to our Credit Facility.

Dividends were declared on the preferred stock by our Board of Directors and, as of March 31, 2011, 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 April 15, 2011.

Note 15 — Common Stock Offering

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

Note 16 — 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 actions for patent infringement in the U.S. District Court in Marshall, Texas, against the Company and numerous other defendants, which allege infringement of a patent issued on August 17, 2004 entitled “User Specific Automatic Data Redirection System.” On October 26, 2010, the Court issued an order staying the cases pending the final determination in the Patent Office re-examination proceeding. No material events occurred in this action during the three months ended March 31, 2011. Please refer to the description of this matter as contained in the Company’s Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 14, 2011.

Note 17 — 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 vendor’s 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. We adopted this ASU effective January 1, 2011. The adoption of this ASU did not have an impact on our consolidated results of operations or cash flows; however, 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 future periods.

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. We adopted this ASU effective January 1, 2011. The adoption of this ASU did not have an impact on our consolidated results of operations or cash flows; however, 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 future periods.

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 requires 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 was 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 were 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.

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. We adopted this ASU effective January 1, 2011. The adoption of this ASU did not have an impact on our consolidated results of operations or cash flows; however, 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 future periods.

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

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

Special Note Regarding Forward-Looking Statements

Certain statements in this report or documents incorporated herein by reference constitute “forward-looking statements.” When used in this report, the words “intends,” “expects,” “anticipates,” “estimates,” “believes,” “goal,” “no assurance” and similar expressions, and statements which are made in the future tense or refer to future events or developments, 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 elsewhere in this Report and in Item 1A of our most recent Annual Report on Form 10-K for the year ended December 31, 2010 and filed on March 14, 2011, 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 Securities and Exchange Commission.

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.

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 March 31, 2011, 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 March 31, 2011, our systems were installed in 58 healthcare facilities, representing approximately 12,700 beds, and we had an additional six facilities under contract.

In the first quarter of 2011, we successfully amended our existing bank Credit Facility, with one of the amended terms being an increase in our consolidated leverage ratio covenant to 4.00 times. This will provide us additional flexibility to invest in growth initiatives, such as partnering with our best customers as we upgrade their properties to high definition, as well as roll out our Envision platform. Envision is our next-generation, interactive television platform which connects our interactive, high-definition guest room televisions to Internet-sourced content and information. Envision will support branding, as well as a variety of interactive applications designed to assist hoteliers to increase on-premise revenues and save operating costs. We installed our first Envision system this quarter, and believe this system elevates the guest experience by presenting interactive content and information guests need while traveling. We are also continuing our market testing of VOD 2.0, which is a movie merchandising initiative with a new tiered pricing structure and on-screen look, in addition to marketing messages showcasing our access to recently released movies prior to their release to the home video market. We believe these initiatives enhance the products and services delivered to our hotel customers and their guests.

As a result of our continued diversification efforts, 45.4% of total first quarter 2011 revenue is from non-Guest Entertainment sources, driven by increases in Advertising Services, Hotel Services and System Sales and Related Services. Within our Hospitality and Advertising businesses, non-Guest Entertainment revenue per room increased 7.6% this quarter over the same period last year. Total gross margin improved 40 basis points in the first quarter of 2011, to 44.0% compared to 43.6% in the first quarter of 2010. The increase was impacted by a 110 basis point increase in Guest Entertainment gross margin. During the quarter, we also took steps to reduce and contain our cost structure, which resulted in a decrease of $2.9 million or 12.7% in operating expenses versus the prior year. With our first quarter 2011 restructuring initiative, we flattened the organization and reduced our operating costs through lower personnel expenses, while sustaining our funding of high-value product development and growth initiatives noted above.

Our total revenue for the first quarter of 2011 was $107.7 million, a decrease of $10.3 million or 8.7%, compared to the first quarter of 2010. The decrease in revenue was from Guest Entertainment and Healthcare, partially offset by increases in revenue from Advertising Services, Hotel Services and System Sales and Related Services. The decrease in Guest Entertainment revenue was driven by a decline in movie purchases and a 6.0% reduction in the average number of Guest Entertainment rooms period over period. The top five theatrical movies generated $6.2 million in revenue this quarter, which was 40.4% less than the first quarter of 2010, as poor Hollywood content continues to have a negative impact on revenue per room. Hotel Services revenue increased $0.2 million or 0.6%, to $34.7 million during the first quarter of 2011 versus the first quarter of 2010, related to price increases on cable television programming compared to the prior year. System Sales and Related Services revenue increased $0.1 million or 1.1%, to $9.7 million during the first quarter of 2011 versus the first quarter of 2010. The increase resulted from growth in network design and television installation services, offset by a reduction in broadband equipment sales. The Hotel Networks (“THN”), our advertising services subsidiary, generated $2.5 million of Advertising Services revenue during the first quarter of 2011 compared to the prior year period, an increase of $0.2 million or 8.3%. This increase was primarily the result of an increase in channel carriage revenues and advertising purchases by national advertisers on our platform. Healthcare revenue decreased $0.7 million or 25.8%, to $1.9 million during the first quarter of 2011 compared to the first quarter of 2010, driven by timing delays of certain installations.

Our total direct costs decreased $6.3 million or 9.5% period over period, to $60.3 million in the first quarter of 2011 as compared to $66.6 million in the first quarter of 2010. The decrease in total direct costs was driven by lower volume in Guest Entertainment and Hotel Services, related to decreased movie revenue and the reduction in rooms, and by rate reductions across our cost structure, related to reduced average commission rates paid to hotels and lower connectivity costs from right-sizing bandwidth and renegotiating supplier agreements. Advertising Services also experienced lower fixed costs this quarter, driven by lower satellite distribution costs versus last year. These changes improved gross margins to 44.0% for the first quarter of 2011 compared to 43.6% for the prior year period.

System operations expenses and selling, general and administrative (“SG&A”) expenses were $19.8 million in the first quarter of 2011 compared to $22.6 million in the prior year quarter. The decrease resulted primarily from a reduction in force program initiated in January 2011, which reduced our workforce by approximately 7%.

We generated $19.2 million of cash from operating activities as compared to $28.1 million in the first quarter of 2010. The decrease in cash flow from the prior year was related to favorable working capital in the prior year period due to an increase in payables. Cash used for property and equipment additions, including growth related capital, was $4.6 million in the first quarter of 2011. In March 2011, we made the required quarterly payment of $1.0 million on the term loan and also made an additional payment of $2.0 million.

Hospitality and Advertising Services Businesses

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

Guest Entertainment (includes purchases for on-demand movies, network-based video games, music and music videos and television on-demand programming). One of our main sources of revenue, generating 54.6% 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:

•		The number of rooms on our network. We can increase revenue over time by increasing the number of rooms served by our interactive television systems. Our ability to expand our room base is dependent on a number of factors, including newly constructed hotel properties and the attractiveness of our technology, service and support to hotels currently operating without an interactive television system.
•		The occupancy rate at the property. Our revenue also varies depending on hotel occupancy rates, which are subject to a number of factors, including seasonality, general economic conditions and world events, such as terrorist threats or public health issues. Occupancy rates for the properties we serve are typically higher during the second and third quarters due to seasonal travel patterns. We target higher occupancy properties in diverse demographic and geographic locations in an effort to mitigate occupancy-related risks.
•		The 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:

	•		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 more than 60% higher than our analog rooms.
	•		The popularity, timeliness and amount of content offered at the hotel. Our revenues vary, to a certain degree, with the number, timeliness and popularity of movie content available for viewing, and whether the content is presented in digital or analog format. Historically, a decrease in the availability of popular movie content has adversely impacted revenue, and the availability of high definition content has increased revenue. Although not completely within our control, we seek to program and promote the most popular available movie content and other content to maximize revenue and profitability.
	•		The price of the service purchased by the hotel guest. Generally, we control the prices charged for our products and services and manage pricing in an effort to maximize revenue and overall profitability. We establish pricing based on such things as the demographics of the property served, the popularity of the content and overall general economic conditions. Our technology enables us to measure the popularity of our content and make decisions to best position such content and optimize revenue from such content.

	•		The availability of alternative programming. We compete directly for customers with a variety of other interactive service providers, including other interactive television service providers, cable television companies, direct broadcast satellite companies, television networks and programmers, Internet service providers and portals, technology consulting and service firms, companies offering web sites which provide on-demand movies, 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.
	•		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:

•		license fees paid to major motion picture studios, which are variable and based on a percent of guest-generated revenue, for non-exclusive distribution rights of recently released major motion pictures;
•		commissions paid to our hotel customers, which are also variable and based on a percent of guest-generated revenue;
•		license fees, which are based on a percent of guest-generated revenue, for television on-demand, music, music videos, video games and sports programming; and
•		fixed monthly Internet connectivity costs.

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

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

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 March 31, 2011 and March 31, 2010, we provided advertising media services to approximately 1.2 million hotel rooms. We also deliver targeted advertising and services to more than 350,000 hotel rooms on 10 popular satellite-delivered channels.

Key Metrics:

Rooms Served

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

		March 31,
		2011				2010
Total rooms served (1)			1,797,336				1,911,842
Total Guest Entertainment rooms (2)			1,649,296				1,764,363
Total HD rooms (3)			273,309				239,984
Percent of Total Guest Entertainment rooms			16.6	%			13.6	%
Total Cable Television Programming (FTG) rooms (4)			1,013,551				1,083,837
Percent of Total Guest Entertainment rooms			61.5	%			61.4	%
Total Broadband Internet rooms (5)			171,713				200,139
Percent of Total rooms served			9.6	%			10.5	%

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 March 31:

		March 31,
		2011				2010
Net new HDTV rooms for the three months ended			2,859				8,396

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

Capital Investment Per Installed Room

The average investment per room associated with an installation can fluctuate due to 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 periods ended:

		Three Months Ended								Years Ended
		March 31,				March 31,				December 31,				December 31,
		2011				2010				2010				2009
Average cost per HD room — new installation		$	192			$	271			$	200			$	339
Average cost per HD room — conversion		$	177			$	204			$	167			$	241

The decrease in the average cost per new and converted HD rooms from 2009 to 2011 was primarily driven by lower component and overhead costs, larger average number of rooms for properties installed and hotels contributing a greater share of total installation costs through purchases of systems and equipment.

Average Revenue Per Room

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

		Three Months Ended
		March 31,
		2011				2010
Average monthly revenue per room:
Hospitality and Advertising Services
Guest Entertainment		$	11.79			$	12.99
Non-Guest Entertainment
Hotel Services			6.93				6.48
System Sales and Related Services			1.94				1.80
Advertising Services			0.51				0.44
			9.38				8.72
Total Hospitality and Advertising Services revenue per room		$	21.17			$	21.71

Our diversified revenue initiatives, including Hotel Services, Systems Sales and Related Services and Advertising Services, increased to $9.38 per room, a 7.6% increase from the prior year quarter. Total Non-Guest Entertainment revenue, including Healthcare, comprised 45.4% of total revenue during the first quarter of 2011.

Average Direct Costs Per Room

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

		Three Months Ended
		March 31,
		2011				2010
Average monthly direct costs per room:
Hospitality and Advertising Services
Guest Entertainment		$	4.59			$	5.20
Hotel Services			5.76				5.59
System Sales and Related Services			1.26				1.21
Advertising Services			0.26				0.27
Total Hospitality and Advertising Services direct costs per room		$	11.87			$	12.27

The average direct cost per Guest Entertainment room varies with revenue and, from 2010 to 2011, was driven by lower movie royalties and commissions earned by the hotels.

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:

•		revenue generated from the sale of the interactive system hardware, software license and installation services;
•		revenue from the sale and installation of DIRECTV satellite equipment and related programming;
•		revenue from recurring support agreements for interactive content, software maintenance and technical field service support, including service agreements covering cable plant, DIRECTV satellite equipment and interactive systems; and
•		revenue generated from cable plant design, modification and installation, as well as television installation services.

As of March 31, these services and solutions were installed as follows:

		2011				2010				Change				% Change
Systems installed			58				50				8				16.0	%
Beds installed			12,659				10,327				2,332				22.6	%

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 three months ended March 31:

		Three Months Ended
		March 31,
		2011				2010
Systems operations expenses		$	2.01			$	1.98
SG&A expenses			1.94				2.28
Depreciation and amortization (D&A)			3.93				4.17
Restructuring charge			0.24				—
		$	8.12			$	8.43
Systems operations as a percent of total revenue			9.3	%			8.9	%
SG&A as a percent of total revenue			9.0	%			10.3	%
D&A as a percent of total revenue			18.2	%			18.8	%
Total operating expenses as a percent of total revenue			37.6	%			38.0	%

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. The decrease in cash flow from 2010 was related to favorable working capital in the prior year period. We can manage capital expenditures by reducing the per-room installation cost of a room and by varying the number of rooms we install in any given period.

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

		Three Months Ended
		March 31,
		2011				2010
Cash provided by operating activities		$	19,234			$	28,098
Property and equipment additions			(4,645	)			(4,525	)
		$	14,589			$	23,573

Liquidity and Capital Resources

During the first three months of 2011, cash provided by operating activities was $19.2 million, and we used $4.6 million of the cash we generated for property and equipment additions. During the same period, we prepaid $2.0 million against our Credit Facility, in addition to the required quarterly payment of $1.0 million. We also used $1.4 million for preferred stock dividends. During the first three months of 2010, cash provided by operating activities was $28.1 million, and we used cash for property and equipment additions of $4.5 million. During the same period, we prepaid $44.0 million against our Credit Facility, in addition to the required quarterly payment of $1.3 million. We also used $1.4 million for the preferred stock dividend payment. The decrease in cash provided by operating activities for the first three months of 2011 compared to the first three months of 2010 was expected, due to favorable changes in working capital in the prior year period, primarily accounts payable. Cash as of March 31, 2011 was $16.1 million versus $8.4 million as of December 31, 2010.

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 underwriter’s option to purchase the additional 324,000 shares), bringing the total aggregate common stock sold to $14.9 million. Net proceeds from the issuance of common stock were $13.7 million, with offering and related costs totaling $1.2 million. The net proceeds of $13.7 million were used to reduce our debt.

Our principal sources of liquidity are our cash from operations, our cash on hand and the $25.0 million revolving loan commitment, 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 March 31, 2011, working capital was negative $41.3 million, compared to negative $50.5 million at December 31, 2010.

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.

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 loan commitment, which matures in April 2013. For the first quarter of 2011, the adjusted quarterly payment requirement was approximately $1.0 million. The term loan originally bore interest at our option of (1) the bank’s base rate plus a margin of 1.00% or (2) LIBOR plus a margin of 2.00%. The term loan is collateralized by substantially all of the assets of the Company.

Effective March 22, 2011, we entered into a First Amendment (the “Amendment”) to the bank Credit Facility. The Amendment modifies certain terms of the Credit Facility, including an increase in the permitted consolidated leverage ratio, the creation of a specific preferred stock dividend payment basket and the potential to extend the term beyond its current expiration in April 2014. The restricted payment basket within the Amendment allows for dividend payments not to exceed $5,750,000 per year. The Amendment also reduces the commitments under the revolving loan commitment, increases the interest rate and required amortization and adjusts other covenants. The Company incurred $2.4 million of debt issuance costs related to certain fees and expenses in connection with this Amendment.

Under the Amendment, the $50.0 million revolving loan commitment has been reduced to $25.0 million. The Amendment also requires us to make quarterly term loan repayments of $2.5 million beginning June 30, 2011 through December 31, 2012, and $3.75 million beginning March 31, 2013 through December 31, 2013. The amended term loan and revolving loan commitment bear interest at our option of (1) the bank’s base rate plus a margin of 4.0% or (2) LIBOR plus a margin of 5.0%. In addition, a LIBOR floor of 1.5% was established under the Amendment.

The original 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 of 4.97% and 5.09% (see Note 13 to the financial statements). The term loan interest rate as of March 31, 2011 was 6.50%. The all-in weighted average interest rate for the quarter ended March 31, 2011 was 8.26%, which includes both the term loan interest rate and the difference in the swaps’ fixed interest rate versus LIBOR. The swap agreements will expire in June 2011. The Amendment does not require us to enter into any hedge agreements. As of March 31, 2011, we were in compliance with all financial covenants required of our bank Credit Facility.

The Amendment includes terms and conditions which require compliance with leverage and interest coverage covenants.

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

		2011				2010
Actual consolidated leverage ratio (1) (3)			3.46				3.59
Maximum per covenant			4.00				3.75
Actual consolidated interest coverage ratio (2) (3)			2.76				3.22
Minimum per covenant			2.25				3.00

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

						Q3 2013
		Q4 2012				to maturity
Maximum consolidated leverage ratio			3.75				3.50
Minimum consolidated interest coverage ratio			2.25				2.25

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

In order to continue operating efficiently and expand our business, we must remain in compliance with covenants outlined in the Amendment. Our ability to remain in compliance with those covenants will depend on our ability to generate sufficient Consolidated EBITDA (a term defined in the Amendment) 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. 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 3.46 compared to the maximum allowable ratio of 4.00 for the first quarter of 2011. Our ability to continue to comply with our current covenants 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, including technological changes, 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, 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 Company’s revolving loan commitment, as such terms are defined and used within our bank Credit Facility. However, under the Credit Facility, the provision of such a notice is not an event of default, but if such an event occurred, it could restrict the Company’s ability to obtain additional financing under the revolving loan commitment. As of March 31, 2011, we are not aware of any events which would qualify under the Material Adverse Effect under the Credit Facility. The total amount of long-term debt outstanding, including the current portion, as of March 31, 2011 was $370.6 million versus $373.6 million as of December 31, 2010.

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. All of the swap agreements have been issued by Credit Suisse International.

With our amended Credit Facility, our interest rate swaps ceased to be effective and hedge accounting was discontinued effective March 22, 2011 and going forward, primarily related to the LIBOR floor of 1.5% as established under the Amendment. As a result, our deferred losses of $4,928,000 recorded in other comprehensive income were frozen and will be amortized into earnings over the original remaining term of the hedged transaction. All subsequent changes in the fair value of the swaps are recorded directly to interest expense. We recorded a loss of $448,000 related to the nine days of amortization in the first quarter of 2011. In addition, we recorded a gain of $1,193,000 related to the change in fair value of the interest rate swaps. The net amount of $745,000 is a non-cash gain and does not impact the amount of cash interest paid during the quarter.

The Credit Facility provides for the issuance of letters of credit up to $7.5 million, subject to customary terms and conditions. Under the terms of the Amendment, this amount was reduced from $15.0 million. As of March 31, 2011, we had outstanding letters of credit totaling $395,000.

Obligations and commitments as of March 31, 2011 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)		$	370,582			$	10,612			$	22,791			$	337,179			$	—
Interest on bank term loan (1)			74,955				25,626				49,069				260				—
Interest on derivative instruments (net)			5,249				5,249				—				—				—
Operating lease payments			3,010				1,161				1,339				435				75
Purchase obligations (2)			11,135				5,662				3,573				1,820				80
Minimum royalties and commissions (3)			1,202				998				204				—				—
Total contractual obligations		$	466,133			$	49,308			$	76,976			$	339,694			$	155
						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			$	—			$	—			$	—

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.

Discussion and Analysis of Results of Operations
Three Months Ended March 31, 2011 and 2010

Revenue Analysis. Total revenue for the first quarter of 2011 was $107.7 million, a decrease of $10.3 million or 8.7%, compared to the first quarter of 2010. The decrease in revenue was from Guest Entertainment and Healthcare revenues, partially offset by increases in revenue from Advertising Services, Hotel Services and System Sales and Related Services. The following table sets forth the components of our revenue (dollar amounts in thousands) for the quarter ended March 31:

		2011								2010
						Percent								Percent
						of Total								of Total
		Amount				Revenues				Amount				Revenues
Revenues:
Hospitality and Advertising Services
Guest Entertainment		$	58,922				54.6	%		$	69,082				58.5	%
Hotel Services			34,679				32.2	%			34,486				29.2	%
System Sales and Related Services			9,700				9.0	%			9,591				8.1	%
Advertising Services			2,534				2.4	%			2,340				2.0	%
Total Hospitality and Advertising Services			105,835				98.2	%			115,499				97.8	%
Healthcare			1,894				1.8	%			2,553				2.2	%
		$	107,729				100.0	%		$	118,052				100.0	%

Hospitality and Advertising Services revenue, which includes Guest Entertainment, Hotel Services, System Sales and Related Services and Advertising Services, decreased $9.7 million or 8.4%, to $105.8 million in the first quarter of 2011 compared to $115.5 million in the first quarter of 2010. Average monthly Hospitality and Advertising Services revenue per room was $21.17 in the first quarter of 2011, a decrease of 2.5% as compared to $21.71 in the prior year quarter. The following table sets forth information with respect to Hospitality and Advertising Services revenue per room for the quarter ended March 31:

		2011				2010
Average monthly revenue per room:
Hospitality and Advertising Services
Guest Entertainment		$	11.79			$	12.99
Hotel Services			6.93				6.48
System Sales and Related Services			1.94				1.80
Advertising Services			0.51				0.44
Total Hospitality and Advertising Services revenue per room		$	21.17			$	21.71

Guest Entertainment revenue, which includes on-demand entertainment such as movies, television on-demand, music and games, decreased $10.2 million or 14.7%, to $58.9 million in the first quarter of 2011 as compared to $69.1 million in the prior year quarter. On a per-room basis, monthly Guest Entertainment revenue for the first quarter of 2011 declined 9.2%, to $11.79 compared to $12.99 for the first quarter of 2010. This change in revenue per room is affected by a 6.0% reduction in the average number of rooms served period over period, some of which were low margin properties, less popular Hollywood content during the current quarter as compared to the prior year quarter, and the continued conservative consumer buying pattern of travelers. Our top five theatrical movies generated $4.2 million or 40.4%, less in revenue this quarter compared to the first quarter of 2010 and, as a result, average monthly movie revenue per room was $11.13 for the first quarter of 2011, an 8.5% reduction as compared to $12.16 per room in the prior year quarter. Non-movie Guest Entertainment revenue per room decreased 20.5% to $0.66 in the first quarter of 2011, related to decreases in television on-demand programming, music, game and television Internet revenue.

Hotel Services revenue, which includes recurring revenue from hotels for cable television programming and broadband Internet service and support, increased $0.2 million or 0.6%, to $34.7 million during the first quarter of 2011 versus $34.5 million in the first quarter of 2010. On a per-room basis, monthly Hotel Services revenue for the first quarter of 2011 increased 6.9%, to $6.93 compared to $6.48 for the first quarter of 2010. Monthly cable television programming revenue per room increased 6.9%, to $6.33 for the first quarter of 2011 as compared to $5.92 for the first quarter of 2010. These increases resulted from price increases on cable television programming over the prior year period. Recurring broadband Internet revenue per room increased 7.1%, to $0.60 for the current quarter as compared to $0.56 for the prior year quarter.

System Sales and Related Services revenue includes the sale of cable television programming equipment, broadband Internet equipment, HDTV installations and other services to hotels. For the first quarter of 2011, revenue increased $0.1 million or 1.1%, to $9.7 million as compared to $9.6 million for the first quarter of 2010. The increase was from continued growth in delivering network design and television installation services, offset by reductions in broadband equipment sales.

Advertising Services revenue consists of revenue generated by The Hotel Networks (“THN”), our advertising services subsidiary. For the first quarter of 2011, revenue increased $0.2 million or 8.3%, to $2.5 million as compared to $2.3 million in the prior year period. This increase was primarily the result of increased channel carriage revenue, where we provide cable channels to providers for the distribution of their programming, and increased advertising purchases by national advertisers on our platform.

Healthcare revenue includes the sale of interactive systems and services to healthcare facilities. Healthcare revenue decreased $0.7 million or 25.8%, to $1.9 million in the first quarter of 2011 as compared to $2.6 million for the first quarter of 2010, driven by timing delays of certain installations. During the current quarter, we installed 435 beds and two facilities compared to 1,135 beds and five facilities during the prior year period. 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 decreased $6.3 million or 9.5%, to $60.3 million in the first quarter of 2011 as compared to $66.6 million in the first quarter of 2010. Total direct costs were 56.0% of revenue for the first quarter of 2011 as compared to 56.4% in the first quarter of 2010. Direct costs related to the Hospitality and Advertising Services businesses, which include Guest Entertainment, Hotel Services, System Sales and Related Services and Advertising Services, were $59.4 million for the first quarter of 2011 compared to $65.3 million for the prior year quarter. The decrease in total direct costs was driven by lower volume and rate reductions in certain components of our cost structure. We had a lower volume of activity in Guest Entertainment, Hotel Services and System Sales and Related Services, related to decreased movie revenue and a reduction in room count. Rate reductions include reductions in the average commission rate paid to hotels and lower connectivity costs, realized from right-sizing bandwidth and renegotiating supplier agreements. Advertising Services also experienced lower fixed costs this quarter, driven by lower satellite distribution costs.

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

		2011								2010
						Percent								Percent
						of Total								of Total
		Amount				Revenues				Amount				Revenues
Operating expenses:
System operations		$	10,069				9.3	%		$	10,515				8.9	%
Selling, general and administrative			9,689				9.0	%			12,115				10.3	%
Depreciation and amortization			19,641				18.2	%			22,173				18.8	%
Restructuring charge			1,160				1.1	%			3				0.0	%
Other operating (income) expense			(14	)			0.0	%			5				0.0	%
Total operating expenses		$	40,545				37.6	%		$	44,811				38.0	%

System operations expenses decreased $0.4 million or 4.2%, to $10.1 million in the first quarter of 2011 as compared to $10.5 million in the first quarter of 2010. The decrease was driven by our reduction in force program initiated in January 2011, which reduced our workforce by approximately 7%, as well as lower property taxes and business insurance costs. As a percentage of total revenue, system operations expenses increased to 9.3% this quarter as compared to 8.9% in the first quarter of 2010. Per average installed room, system operations expenses also increased, to $2.01 per room per month compared to $1.98 in the prior year quarter.

Selling, general and administrative (“SG&A”) expenses decreased $2.4 million or 20.0%, to $9.7 million in the current quarter as compared to $12.1 million in the first quarter of 2010. The decrease was a result of our reduction in force program, as noted above, and our first quarter expense mitigation initiative. As a percentage of revenue, SG&A expenses were 9.0% in the current quarter as compared to 10.3% in the prior year quarter. SG&A expenses were $1.94 per average installed room per month for the current quarter as compared to $2.28 in the first quarter of 2010.

Depreciation and amortization expenses were $19.6 million in the first quarter of 2011 as compared to $22.2 million in the first quarter of 2010. The decline was due to the reduction in capital investments over the past several years and certain assets becoming fully depreciated. As a percentage of revenue, depreciation and amortization expenses were 18.2% in the first quarter of 2011 compared to 18.8% in the first quarter of 2010.

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%. As a result of this action and our previous restructuring and reduction in force initiatives, we incurred $1.2 million of costs during the three months ended March 31, 2011, of which $1.1 million was related to our Hospitality business and $0.1 million was related to our Advertising Services business. During the first quarter of 2010, we had nominal costs related to restructuring and workforce reduction activities. We estimate additional expenses charged to restructuring over the next 12 to 18 months, primarily reduction in force and recurring facilities expenses related to the January 2011 initiative noted above, will be in the range of $100,000 to $300,000. 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.

Operating Income. As a result of the factors described above, operating income increased to $6.9 million in the first quarter of 2011 compared to $6.6 million in the first quarter of 2010.

Interest Expense. Interest expense was $7.7 million in the current quarter versus $8.7 million in the first quarter of 2010. The outstanding balance of our debt under the Credit Facility decreased to $370.6 million in the first quarter of 2011 from $427.0 million in the first quarter of 2010. The all-in weighted average interest rate was 8.26% for the first quarter of 2011 versus 6.85% for the first quarter of 2010. Interest expense for the first quarter of 2011 included a net $745,000 non-cash interest gain related to our interest rate swap position, including a $1,193,000 gain related to the change in fair value of the swaps and $448,000 in amortization of deferred losses frozen in other comprehensive income. In the first quarter of 2010, interest expense included $659,000 of non-cash interest charges related to our interest rate swap position.

Loss on Early Retirement of Debt. During the first quarter of 2011, we made additional prepayments on the term loan totaling $2.0 million and, as a result of this prepayment and the Amendment to our Credit Facility, expensed $0.2 million of unamortized debt issuance costs. During the first quarter of 2010, we made additional prepayments on our term loan totaling $44.0 million and expensed $0.5 million of unamortized debt issuance costs.

Taxes. For the first quarter of 2011 and 2010, we incurred taxes of $297,000 and $184,000, respectively, primarily for state franchise taxes.

Net Loss. As a result of the factors described above, net loss was $0.9 million for the first quarter of 2011 compared to net loss of $2.5 million in the prior year quarter.

Critical Accounting Policies

Management’s 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 following critical policies relate to the more significant judgments and estimates used in the preparation of the financial statements:

Revenue Recognition — We recognize revenue from various sources as follows:

•		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.
•		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.
•		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 standalone 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.
•		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 standalone 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 standalone basis.

•		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.
•		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.
•		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.
•		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. The package price of the interactive system and related maintenance is fixed and determinable prior to delivery. The entire selling price of the interactive system is recognized upon installation, and is calculated using the estimated selling price on a standalone basis. The support arrangement, which includes interactive content, software maintenance and system services, is renewable upon completion of the initial year 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.

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.

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 the 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.

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

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

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 7% of our installed room base.

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 the first quarter of 2011.

Effective January 1, 2011, we adopted additional provisions of FASB ASC Topic 350, which provide that reporting units with zero or negative carrying amounts are required to perform Step 2 of the goodwill impairment test if it is more likely than not a goodwill impairment exists. During the first quarter of 2011, we did not encounter any events or circumstances which could trigger an impairment of our goodwill or intangible assets; therefore, this adoption has not had any impact on our consolidated financial position, results of operations or cash flows.

We operate in three reportable segments, Hospitality, Advertising Services and Healthcare, for which only Hospitality and Advertising Services have goodwill. FASB ASC Topic 350 requires a two-step impairment test for goodwill, to be performed annually or if a triggering event indicates the carrying value may not be recoverable. If there was such a triggering event, the first step would be to compare the carrying amount of the reporting unit’s 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 consider the income approach to be a more meaningful indicator of fair value over the use of the market and cost approaches, due to a lack of comparable companies and assets. We believe the income approach provides the best estimate of fair value and utilize a discounted cash flow analysis based on key assumptions and estimates. We would then reconcile 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.

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.

Recent Accounting Developments

See Note 17 to the financial statements.

Item 3 — 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.

At March 31, 2011, we had debt totaling $370.6 million as follows (dollar amounts in thousands):

		Carrying				Fair
		Amount				Value
Bank Credit Facility:
Term loan		$	369,662			$	354,876
Capital leases			920				920
		$	370,582			$	355,796