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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
or
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[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
Commission File Number: 0-22334
LODGENET ENTERTAINMENT CORPORATION
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(Exact name of Registrant as specified in its charter)
DELAWARE 46-0371161
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(State of Incorporation) (IRS Employer
Identification Number)
3900 WEST INNOVATION STREET, SIOUX FALLS, SOUTH DAKOTA 57107
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(Address of Principal Executive Offices) (Zip Code)
(605) 988-1000
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE.
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.01
PAR VALUE.
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period
that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes X No .
-- --
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of the Form
10-K or any amendment to this Form 10-K. [ ]
As of March 9, 1999, the aggregate market value of the common stock held by
non-affiliates of the Registrant was approximately $87.3 million. The number of
shares of common stock of the Registrant outstanding as of March 9, 1999 was
11,942,387 shares.
DOCUMENTS INCORPORATED BY REFERENCE - Part III of this Form 10-K is incorporated
by reference from Registrant's definitive proxy statement for the 1999 Annual
Meeting of Stockholders, which will be filed within 120 days of the fiscal year
ended December 31, 1998.
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This Report contains a total of 56 pages, excluding exhibits. The Exhibit
index appears on page 27.
TABLE OF CONTENTS
Special Note Regarding Forward-Looking Statements ............................ 1
Item 1 - Business ............................................................ 1
Overview ............................................................ 1
Business Strategy ................................................... 2
ResNet Transaction .................................................. 3
Markets and Customers ............................................... 3
Services and Products ............................................... 4
Operations .......................................................... 5
Competition ......................................................... 8
Regulation .......................................................... 9
Employees ........................................................... 10
Item 2 - Properties .......................................................... 10
Item 3 - Legal Proceedings ................................................... 10
Item 4 - Submission of Matters to a Vote of Security Holders ................. 10
Item 5 - Market for Registrant's Common Equity and Related Stockholder
Matters ............................................................. 11
Dividends ........................................................... 11
Stockholder Rights Plan ............................................. 11
Item 6 - Selected Financial Data ............................................. 15
Special Note Regarding Forward-Looking Statements ............................ 17
Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations ................................. 17
Item 8 - Financial Statements and Supplementary Data ......................... 26
Item 9 - Changes In and Disagreements with Accountants on
Accounting and Financial Disclosure ................................. 26
Item 10 - Directors and Officers of the Registrant ........................... 26
Item 11 - Executive Compensation ............................................. 26
Item 12 - Security Ownership of Certain Beneficial Owners and Management ..... 26
Item 13 - Certain Relationships and Related Transactions ..................... 27
Item 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K .... 27
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As used herein (unless the context otherwise requires) "LodgeNet", the
"Company" and/or the "Registrant" mean LodgeNet Entertainment Corporation and
its consolidated subsidiaries.
LodgeNet Entertainment Corporation i Form 10-K 1998
PART I
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in this Annual Report on Form 10-K, including,
without limitation, statements in Item 1, including certain statements under the
headings "Overview", "Business Strategy", "Strategic Initiatives", "Services and
Products", "Operations", "Competition" and "Regulation", in Item 3 under the
heading "Legal Proceedings", and in Item 7 under the heading "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
constitute "forward-looking statements" within the meaning of the Securities Act
of 1933, as amended, and the Securities Exchange Act of 1934, as amended. When
used in this Annual Report, the words "expects," "anticipates," "estimates,"
"believes," "no assurance" and similar expressions and statements which are made
in the future tense, are intended to identify such forward-looking statements.
Such forward-looking statements involve known and unknown risks, uncertainties
and other factors, which may cause the Company's actual results, performance or
achievements to be materially different from any future results, performance or
achievements expressed or implied by such forward-looking statements. In
addition to the risks and uncertainties discussed in the foregoing sections,
such factors include, among others, the following: the impact of competition and
changes to the competitive environment for the Company's products and services,
changes in technology, reliance on strategic partners, uncertainty of
litigation, changes in government regulation and other factors detailed, from
time to time, in the Company's filings with the Securities and Exchange
Commission. These forward-looking statements speak only as of the date of this
Annual Report. The Company expressly disclaims any obligation or undertaking to
release publicly any updates or revisions to any forward-looking statements
contained herein to reflect any change in the Company's expectations with regard
thereto or any change in events, conditions or circumstances on which any such
statement is based.
ITEM 1 - BUSINESS
OVERVIEW
LodgeNet is a specialized communications company which provides video
on-demand, network-based Nintendo-Registered Trademark- video games, cable
television programming and other interactive entertainment and information
services to the lodging industry. The Company is the second largest provider of
these services to the lodging industry and currently serves over 4,500 hotel
properties throughout the United States and Canada. From 1992 through 1998, the
number of guest pay rooms the Company serves has grown at a compound annual rate
of 34.0%, from 73,415 to 596,806, and the Company currently serves over 596,000
Guest Pay rooms. During the same period, the Company's revenues and EBITDA
("Earnings Before Interest, Taxes, Depreciation, and Amortization") have grown
at compound annual rates of 38.0% and 55.2%, respectively, to $166.4 million and
$48.6 million in 1998.
The Company provides both Guest Pay and free-to-guest services to its
clients. Guest pay services are purchased by guests on a per-view or hourly
basis and include Guest Scheduled-SM- on-demand movies and network-based
Nintendo video games. Guest pay packages may also include additional services,
such as satellite-delivered basic and premium cable television programming, and
other interactive entertainment and information services that are paid for by
the hotel and provided to guests at no charge. Free-to-guest services typically
involve a customized package of basic and premium cable television programming.
Hotels purchase free-to-guest services from the Company and provide the services
to their guests at no charge. The Company provides its services to various
corporate-managed hotel chains such as Sheraton, Ritz-Carlton, Harrah's Casino
Hotels, Delta Hotels and Resorts, Outrigger, La Quinta Inns, and Red Roof Inns,
as well as many individual properties flying the Marriott, Holiday Inn, Hilton,
Inter-Continental, Prince, Radisson, Westin, Doubletree, Embassy Suites, Wingate
and other flags.
The Company provides its services throughout the United States and
Canada, and in other select countries through licensing arrangements with
strategic partners. The Company's contracts are exclusive and typically have
initial, non-cancelable terms of 5 to 7 years. The exclusive nature of these
contracts allows the Company to estimate (based on certain operating
assumptions) future revenues, cash flows and rates of return related to the
contracts prior to making a capital investment decision. The average remaining
life of the Company's existing guest pay contracts is over four years, with less
than 8% of these contracts due to expire before 2000.
LodgeNet Entertainment Corporation 1 Form 10-K 1998
The Company offers its interactive services by utilizing the two-way
digital communications design of its proprietary b-LAN-Registered Trademark-
system architecture. The design of this open-architecture, UNIX-based platform
enables the Company to upgrade system software to support the introduction of
new services and integrate new technologies as they become commercially
available and economically viable. The Company believes the flexibility of its
b-LAN system architecture has enabled it to provide innovative and creative
solutions to the lodging industry, including:
- achieving the industry's highest percentage of installed guest
pay rooms offering on-demand movies (as compared to scheduled
movies that can only be watched at predetermined times),
- being the first in its industry to install and widely deploy
network-based video games,
- being the first in its industry to utilize an image-based menu
and purchasing protocol using on-screen graphics to market
movies and video games, rather than using simple text menus
traditionally used by its competitors,
- installing and testing an Internet browser that enables hotel
guests to access and navigate the Internet from their guest room
television, and
- integrating and testing technology that is expected to allow the
Company to cost-effectively provide plug-and-play, high-speed
Internet access (at up to 50 times the speed of conventional
modems) to hotel guest rooms and meeting spaces.
The lodging market in the United States comprises approximately 3.6
million rooms. Due to certain economies of scale, guest pay service providers
have traditionally targeted only large hotels with over 150 rooms, which
represent a total of approximately 1.3 million rooms. In 1995, the Company
redesigned its b-LAN system, enabling it to cost-effectively deliver on-demand
movies and network-based video games to mid-size hotels of 75 to 150 rooms. As
the mid-size hotel market has been historically under-served by guest pay
providers, it represents a large (approximately 1.2 million rooms) and
attractive market for the Company's services that generates financial returns
that meet or exceed those achieved in larger hotels. Since 1995, the Company has
added more than 170,000 rooms to its room base from mid-sized hotels.
The Company's predecessor commenced business in 1980 as Satellite Movie
Company, incorporated as a South Dakota corporation in February 1983 and changed
its name to LodgeNet Entertainment Corporation in September 1991. On October 13,
1993, LodgeNet Entertainment Corporation changed its state of incorporation from
South Dakota to Delaware by merging with and into the Company, its newly-formed
Delaware subsidiary, which then adopted the LodgeNet name. The Company's
principal executive offices are located at 3900 West Innovation Street, Sioux
Falls, South Dakota 57107, (605) 988-1000.
BUSINESS STRATEGY
CONTINUE TO SELECTIVELY EXPAND THE COMPANY'S ROOM BASE. Within the
Company's target market of hotels with 75 or more rooms, the Company believes
substantial opportunity exists for continued, selective growth in its room base.
The Company estimates that more than 400,000 rooms are presently not served by
any guest pay vendor and fit its target economic profile. The Company also
estimates that its competitors serve another 200,000 rooms under contracts due
to expire before 2001. The Company believes that the cost-effective and flexible
design of its scaleable b-LAN system, together with its expertise in
installation, programming, technical support and customer service, will allow
the Company to continue to expand its room base. Based on these strengths, the
Company has increased its selectivity and is seeking higher rates of return on
new contracts. Internationally, the Company intends to continue to expand into
selected countries in Asia and Latin America and other regions through licensing
agreements with established entities in these countries. Under these agreements,
the Company does not provide any capital investment, it licenses its b-LAN
system architecture and multimedia capabilities, sells equipment at cost plus an
agreed markup and receives a royalty based on gross revenues.
MAXIMIZE REVENUE PER GUEST PAY ROOM. The Company seeks to maximize the
revenue generated by each of its installed guest pay rooms. To achieve this
strategy, the Company intends to continue to install its interactive Guest
Scheduled on-demand movie system and network-based Nintendo video game system in
all new guest pay hotel rooms. From the Company's experience, rooms with these
features generate significantly more revenue and gross profit than comparable
rooms having only the scheduled format, which allows guests to watch movies only
at predetermined times. In addition, beginning in the second quarter of 1999,
the Company intends to install the Nintendo N64 game platform in all new guest
pay rooms and upgrade selected existing guest pay rooms. The Company believes
that this platform, which will offer guests network-based access to the most
popular and advanced Nintendo video games, will generate more per room revenue
than the current Nintendo system.
LodgeNet Entertainment Corporation 2 Form 10-K 1998
To take advantage of the growth in the Internet, since mid-1997, the
Company has been developing and testing an Internet browser service that enables
a hotel guest to access and navigate the World Wide Web through the guest room
television over the Company's b-LAN system architecture. During this time, the
Company has been testing hardware platforms available from various vendors,
seeking content relationships with a wide variety of Internet sites and has been
enhancing its proprietary communications software. During the first six months
of 1999, the Company intends to expand the test of the Internet browser service.
The Company believes there may be significant opportunities to generate revenues
from usage fees charged to the guests who utilize the service as well as from
third-party providers of content, merchandise and information services who would
pay the Company for electronic access to its valuable consumer base.
In October 1998, the Company acquired the Connect Group Corporation. As
a result of this acquisition, the Company acquired technology that it is
integrating into its system which will allow hotel guests with laptop computers
to connect to the Internet (without changing their system configurations) at
access speeds up to 50 times faster than conventional modems, while bypassing
the hotel's PBX system. The Company believes that the acquired technology is
superior to and more cost efficient than other systems currently being offered
in the lodging market. The Company further believes that this "managed
connectivity" service may represent a significant opportunity to generate
revenues from usage fees charged to guests who utilize the service or from
hotels which want to provide the service as an amenity to their guests. The
Company believes that high speed Internet services will attractively complement
its existing service offerings.
The Company's current installed guest pay base of over 596,000 rooms
hosts more than 150 million guests each year (based on current average occupancy
and length-of-stay data). The Company believes such guests represent a
demographic profile which a variety of advertisers may find to be highly
desirable. For example, since November 1998, the Company has installed an
interactive in-room shopping service in over 375,000 guest rooms that enables
the guest to browse through a video version of the SkyMall-Registered Trademark-
catalog featuring quality merchandise from some of the country's leading
retailers for which the Company is paid a fixed, monthly access fee. The Company
is seeking other advertising-based arrangements, such as advertiser-supported
visitor information services for specific cities, as well as other advertising
strategies to deliver targeted product or service information directly to the
consumer. The Company will evaluate these and other opportunities as well as
appropriate business models that would enable the Company to increase the
revenue generated per guest pay room.
INCREASE OPERATING MARGINS. Complementing the Company's growth objective
is its ongoing goal of increasing operating margins by reducing direct and
overhead expenses, as measured on a percentage of revenue and on a per-installed
unit basis. The EBITDA margin from the Company's lodging business has increased
from 14.4% in 1992 to 30.5% in 1998. The Company achieved this result through
reduced per-room operating costs as it leveraged its infrastructure over a
larger base of installed rooms.
RESNET TRANSACTION
In January 1996, the Company formed ResNet Communications, Inc. ("ResNet
Inc.") to extend its b-LAN system architecture and operational expertise into
the multi-family dwelling unit ("MDU") market. Through ResNet Inc.'s majority
owned subsidiary, ResNet Communications, LLC ("ResNet LLC"), the Company
provided cable television and other interactive services to the MDU market. In
July 1998, the Company decided to merge the ResNet business into a larger, and,
it believes, more cost-effective operating entity. On November 30, 1998 (the
"Closing Date"), the Company transferred the ResNet business, consisting of net
assets totaling $31.3 million, to Global Interactive Communications Corporation
("GICC") in exchange for (i) a 30% equity interest in GICC, and (ii) notes
receivable totaling $10.8 million. In addition to its ownership of the ResNet
business, GICC holds certain cable and telephone system assets contributed by
Shared Technologies Corporation, a Delaware corporation ("STC"), and Interactive
Cable Systems, Inc., a California corporation ("ICS").
Beginning with the Closing Date, the Company will account for its
investment in GICC on the equity method of accounting for an investment. As a
result of this accounting treatment, and because the Company expects that
there is a high probability that GICC will operate at a loss for the
foreseeable future as it pursues its business plan, the Company expects to
recognize continuing losses in connection with its investment in GICC, which
losses will be reflected as "equity in losses of unconsolidated affiliates"
in the Company's operating statements. As of the date of this Report, there
is no public market for the securities of GICC, and there can be no assurance
as to when any such market may develop. The financial and operating
performance of GICC, the market acceptance for its securities and general
market conditions, among other factors, are not subject to the Company's
control and may each affect the value of the Company's investment in GICC.
On the Closing Date, ResNet Inc., STC and ICS entered into a
Stockholders Agreement providing among other things, for: (i) limitations on the
transfer of the GICC Common Stock; (ii) preemptive rights; (iii) rights of first
offer by other stockholders in the event of a sale of the GICC Common Stock by
any stockholder; (iv) tag-along-rights by other stockholders to participate in
an offer from a third party to any stockholder to purchase the GICC Common
Stock; (v) registration rights; (vi) approval rights for
LodgeNet Entertainment Corporation 3 Form 10-K 1998
sale of material assets; and (vii) the right to designate one director by a
stockholder as long as a certain level of ownership of GICC is maintained.
The Company has no continuing obligation to make any additional investments
into GICC.
MARKETS AND CUSTOMERS
LARGE HOTEL MARKET. Historically, the Company's primary market for guest
pay services has been large hotels with over 150 rooms located in metropolitan
areas in the U.S. and Canada, and the Company estimates that this market segment
contains approximately 1.3 million rooms. The Company currently provides its
services to large hotels that are generally part of chains such as Sheraton,
Ritz-Carlton, Harrah's Casino Hotels, Delta Hotels and Resorts, Outrigger,
Holiday Inn, Inter-Continental, Embassy Suites, Prince, Radisson, Westin, Hilton
and Marriott. No single contract represented greater than 10% of the Company's
combined guest pay and free-to-guest revenues for the year ended December 31,
1998.
MID-SIZE HOTEL MARKET. In 1995, LodgeNet redesigned its interactive
system, enabling the Company to deliver on-demand movies and network-based video
games more cost-effectively to mid-size hotels. Since 1995, the Company has also
been targeting mid-size hotels of 75 to 150 rooms as part of its guest pay
marketing strategy. Since 1995, the Company has added more than 170,000 rooms to
its room base for mid-size hotels. The Company believes that this market
segment, which the Company estimates contains approximately 1.2 million rooms,
has not been broadly served by the guest pay industry because smaller average
property sizes lack economies of scale. The mid-size hotel segment represents a
large and attractive market for the Company's services that generates financial
returns that meet or exceed those achieved in larger hotels.
FREE-TO-GUEST MARKET. Almost all of the approximately 3.6 million hotel
rooms in the United States are served by some form of free-to-guest television
service. Free-to-guest television typically involves a package of basic and
premium programming which the hotel purchases and provides at no charge to its
guests. These services can be purchased on a stand-alone basis or as part of a
package which includes guest pay services.
SERVICES AND PRODUCTS
GUEST PAY SERVICES. The Company's primary source of revenue is
providing in-room, interactive television services to the lodging industry,
for which the hotel guest pays on a per-view or per-play basis. The
high-speed, two-way digital communications design of the Company's
proprietary b-LAN system architecture enables the Company to provide
sophisticated interactive features such as on-demand movies and network-based
Nintendo video games. Guest pay packages also include a variety of other
interactive services, such as satellite-delivered basic and premium cable
television programming, folio review, video checkout, guest satisfaction
survey, advertising and merchandising services that are paid for by the hotel
and provided to guests free of charge.
Guest pay services include in-room television viewing of recently
released major motion pictures and independent films for which a hotel guest
pays on a per-view basis. The Company's Guest Scheduled interactive video
on-demand system allows guests to choose from an expanded menu of video
selections and individually start the selected video at their convenience rather
than restricting them to a predetermined start time. It has been the Company's
experience that rooms having the on-demand format generate significantly greater
movie revenues than comparable rooms having only the pre-scheduled format. As of
December 31, 1998, the Company served over 596,000 guest pay rooms, of which
approximately 582,000, or 97.5%, featured the Company's interactive on-demand
system. The Company's original scheduled guest pay service, which is provided in
less than 3% of the Company's guest pay rooms, offers guests a choice of up to
nine movie titles shown at predetermined times, offering a new film
approximately every half hour. The Company continuously monitors guests'
entertainment selections and adjusts its programming to respond to viewing
patterns. The system also enables hotel owners to broadcast informational and
promotional messages.
In May 1993, the Company entered into a non-exclusive license
agreement with Nintendo to provide hotels with a network-based Nintendo video
game playing system. In May 1998, this agreement was revised and extended for
ten years. Pursuant to this extended agreement, Nintendo of America, Inc.
will provide the Company with access to its new Nintendo N64 video games. As
with the Nintendo video game playing system, the Company will use its
proprietary high-speed b-LAN system architecture to allow guests to play the
video games over the hotel's master antenna television system. The Company
anticipates that it will begin deploying the Nintendo N64 video game platform
in the second quarter of 1999. Hotel guests are charged a fee based on the
amount of time they play the video games. Presently, the Company generally
charges $6.95 per hour of play. The Company had over 546,000 rooms installed
with the Nintendo video game systems as of December 31, 1998.
The revenues generated from the guest pay service are dependent upon
three factors at each location: (i) the occupancy rate at the property; (ii) the
"buy rate" or percentage of occupied rooms that buy movies or video
games/information services at the
LodgeNet Entertainment Corporation 4 Form 10-K 1998
property; and (iii) the price of the movie, video game or service. For
example, a property installed with the Company's interactive system with a
70% occupancy rate, a buy rate of 10.5% and an $8.95 movie price will
generate an average of $20.00 of gross movie revenue per installed room per
month, plus additional gross revenues of $3.60 per month from video games,
free-to-guest and other services, resulting in total gross revenue per room
per month of $23.60, assuming an average of 30.4 days in the month. Occupancy
rates vary (a) by property based on the property's competitive position
within its marketplace, (b) over time based on seasonal factors, and (c) as a
result of changes in general economic conditions. Buy rates generally reflect
the hotel's guest mix profile, the popularity of the motion pictures
available and the guests' other entertainment alternatives. Buy rates also
vary over time with general economic conditions. Movie price levels are
established by the Company and are set based on the guest mix profile at each
property and overall economic conditions. Movie prices are set by the Company
on a title by title basis, but are generally $7.95, $8.95 or $9.95. Prices
may be higher in some locations and for certain highly popular titles.
The cost of installation varies depending on the size of the hotel
property and the configuration of the system being installed. The average
installed cost of a new on-demand guest pay room with interactive and video game
services capabilities, including the headend equipment and, in some cases,
televisions, is currently approximately $375 to $385 per room. In addition to
hotel commissions and royalties paid to movie studios, operating costs of the
guest pay systems include in-room movie schedules and information cards, preview
tapes or discs, tape duplication, taxes, freight, insurance, personal property
taxes, maintenance and data line costs.
In exchange for a contract renewal or significant contract extension the
Company typically invests from $75 to $175 per room, depending on the length of
the extended contract period and the upgrade services installed.
FREE-TO-GUEST SERVICES. In addition to guest pay services, the
Company provides television programming for which the hotel, rather than its
guests, pays the charges. Free-to-guest services allow a hotel to receive one
or more satellite-distributed programming channels via a satellite earth
station. These channels are then distributed to guest rooms over the hotel's
existing master antenna system.
For free-to-guest services, the hotel pays the Company a fixed monthly
charge per room for each programming channel selected and provides these
channels to its guests free of charge. Premium channels, such as HBO, Showtime
and The Disney Channel, broadcast major motion pictures and specialty
programming, while non-premium channels, such as CNN, ESPN and WTBS, broadcast
news, sports and informational programs. Premium programming suppliers typically
contract only with cable companies and other large volume subscribers, such as
the Company, and will not generally provide programming directly to individual
hotel properties. The Company successfully competes with local cable television
operators by customizing packages of programming to provide only those channels
desired by the hotel subscriber, which typically reduces the overall cost of the
services provided.
ENTERTAINMENT HARDWARE. The Company also sells and leases entertainment
hardware, including satellite earth stations, televisions and off-air signal
reception and processing equipment, to the lodging industry. The Company
believes that this service complements its goal of being a full-service provider
of in-room entertainment and information services to the lodging industry.
OPERATIONS
CONTRACTS. The Company provides guest pay services under contracts with
lodging properties that generally run for a term of 5 to 7 years. During the
four years ended December 31, 1998, the average initial term of new guest pay
contracts exceeded 6 years. Under these contracts, the Company installs its
system into the hotel free of charge and retains ownership of all equipment
utilized in providing the service. Traditionally, the hotel provides and owns
the television set; however, the Company in some cases provides televisions
incorporating the Company's integrated guest pay terminal units to hotels which
meet certain economic criteria. The Company's contracts generally provide that
the Company will be the exclusive provider of in-room, on-demand television
entertainment services to the hotels, permit the Company to set the movie price
and allow the Company to terminate the contract if the hotel is not meeting the
Company's economic criteria. The contracts also typically grant the Company a
right of first refusal regarding the provision of additional video related
services to the hotel. The hotels collect the viewing charges from their guests
and retain a commission, which varies depending on the size and profitability of
the system and other factors. At the scheduled expiration of a contract, the
Company generally seeks to extend the contract on substantially similar terms.
The average remaining life of the Company's current guest pay contracts is over
four years, with less than 8% of these contracts coming up for renewal before
2000.
The Company typically enters into a separate contract with each hotel
for the services provided. The terms contained in the contracts with the
corporate-managed hotels in any one chain generally are negotiated by that
chain's corporate management,
LodgeNet Entertainment Corporation 5 Form 10-K 1998
and the hotels subscribe at the direction of corporate management. In the
case of franchised hotels, the contracts are generally negotiated separately
with each hotel.
TECHNOLOGY, PRODUCT DEVELOPMENT AND PATENTS. The Company designs and
develops high quality interactive, multimedia entertainment and information
systems. Because such systems utilize an open architecture, UNIX-based platform
incorporating industry standard interfaces, the Company can upgrade system
software to support the introduction of new services or integrate new
technologies as they become economically viable. The Company's interactive
system incorporates the Company's scaleable proprietary b-LAN system
architecture with commercially manufactured, readily available components and
hardware such as video cassette players, modulators and computers.
The Company's b-LAN system architecture utilizes the Company's
proprietary, two-way digital communications design to process and respond to
input commands from the viewer very rapidly. This capability enables the Company
to provide sophisticated interactive features such as network-based Nintendo
video games and on-demand movies, and a variety of other interactive services
such as folio review, video checkout, Internet browsing, guest surveying,
advertising and shopping services. The Company has installed an interactive
in-room shopping service in over 375,000 guest rooms that enables the guest to
browse through a video version of the SkyMall catalog featuring quality
merchandise from the country's leading retailers. The Company is currently
testing an Internet browser that enables the hotel guest to access and navigate
the Internet from any guest room television in the hotel, and the Company
intends to install and test the Internet browser at additional hotels over the
next several months. In October 1998, the Company acquired Connect Group
Corporation. As a result of this acquisition, the Company is integrating and
testing technology that will allow hotel guests with laptop computers to connect
to the Internet from guest or meeting rooms. Such access can be up to 50 times
faster than the speed of conventional modems and bypasses the hotel's PBX
system.
The Company's guest pay systems consist of equipment located within the
guest room connected via a local-area cable distribution network to a headend
located elsewhere in the hotel. Typical in-room equipment includes a terminal
unit, a hand-held remote control and a video game controller. The in-room
terminal unit may be integrated within the television set or located behind or
on top of the set. Movie programming originates from video cassette players
located within the headend rack and is transmitted to individual rooms over the
hotel's master antenna system. Video game programs are downloaded into dedicated
video game processors also located within the headend rack. The guest's
keystrokes are transmitted from the room to the game processor using the
Company's proprietary high-speed communications infrastructure and the video
signal produced by the game processor is transmitted to the guest room over the
hotel's master antenna system. Both movie and video game starts are controlled
automatically by the system computer. The system computer also automatically
records the purchase of a guest pay movie or video game and reports billing data
to the hotel's accounting system, which automatically posts the charge to the
guest's bill.
Although the Company's products are compatible with all brands of
televisions, the Company has arrangements with Zenith Electronics Corporation,
Phillips Consumer Electronics Company, and Sony Electronics, Inc., leading
suppliers of televisions to the lodging industry and other markets, who provide
the Company with commercial televisions into which the Company can integrate its
custom-designed circuit boards. The Company is also working with other
television manufacturers to integrate the Company's systems into their
commercial television sets. Integration eliminates the need for an external
terminal unit and costs less than an external unit of comparable utility.
The Company designs its systems through its staff of 68 software and
hardware engineers and support personnel (as of December 31, 1998). Development
activities are oriented toward the continued enhancement and cost reduction of
the Company's system and the further development of additional interactive,
multimedia entertainment and information services, such as Internet, advertising
and shopping services.
It is the Company's policy to apply for patents on those product designs
which management believes may be of significance to the Company. The Company
owns six United States patents, cross-licenses other industry-related
technologies and patent rights, and has other applications for patents pending
in the U.S. Patent and Trademark Office dealing with various aspects of the
Company's interactive multimedia systems.
The Company uses a number of registered and unregistered trademarks for
its products and services. The Company has applications for registration pending
for certain of the unregistered trademarks, and those trademarks for which the
Company has not sought registration are governed by common law and state unfair
competition laws. Because the Company believes that these trademarks are
significant to the Company's business, the Company has taken legal steps to
protect its trademarks in the past and intends to actively protect these
trademarks in the future. The Company believes that its trademarks are generally
well recognized by consumers of its products and are associated with a high
level of quality and value.
LodgeNet Entertainment Corporation 6 Form 10-K 1998
SALES AND MARKETING. The Company focuses its sales and marketing
strategies on acquiring new contracts from hotels, extending and retaining
existing contracts, and marketing the Company's guest pay and other interactive
services to the hotel guest. The Company's sales and marketing organization
consisted of 67 employees as of December 31, 1998, including national account
representatives, who develop relationships with national hotel franchise
organizations and management groups, and regional sales representatives who
maintain relationships primarily with regional hotel management and ownership
organizations. The Company markets its services and products to hotels by
advertising in industry trade publications, attending industry trade shows,
direct marketing and telemarketing. Sales activities are coordinated from the
Company's headquarters.
The Company markets its services to hotel guests by means of an
image-based menu and purchasing protocol using on-screen graphics and a movie
promotional channel which contains movie and video game programming information
and highlights the feature film selections of the month. In-room marketing
advertisements are designed and produced by the Company's marketing department.
The system also generates a "Welcome Channel", which appears on-screen when the
television is turned on and describes the programming and interactive services
available through the Company's system.
INSTALLATION AND SERVICE OPERATIONS. The Company believes that high
quality and consistent systems support and maintenance are essential to
competitive success in its industry. The Company's installation and service
organization consists of 269 employees in 28 locations in the United States and
Canada, as of December 31, 1998. The Company emphasizes the use of
Company-employed installation and service personnel, but also uses
Company-trained subcontractors in areas where there is not a sufficient
concentration of Company-served hotels to warrant a Company-employed service
representative. Currently, the Company's in-house installation and service
organization has responsibility for approximately 87% of the guest pay hotel
rooms served by the Company. Service personnel are responsible for systems
maintenance and distribution and collection of video cassettes. The Company's
installation personnel prepare site surveys to determine the type of equipment
to be installed at each particular hotel, install the Company's systems, train
the hotel staff to operate the systems and perform preliminary quality control
tests.
The Company maintains a toll-free customer support hot line,
TechConnection, which is monitored 24 hours a day by trained support
technicians. The on-line diagnostic capability of the Company's system enables
the Company to identify and resolve a majority of the reported system
malfunctions from the Company's service control center without visiting the
hotel property. When a service visit is required, the modular design of the
Company's systems permits installation and service personnel to replace
defective components at the hotel site.
PROGRAMMING. The Company obtains non-exclusive rights to show recently
released major motion pictures from motion picture studios pursuant to a master
agreement with each studio. The license period and percentage fee for each movie
are negotiated separately, with the studio receiving a percentage of the
Company's gross revenue from the movie. For recently released motion pictures,
the Company typically obtains rights to exhibit the picture after the film has
been in theaters, but prior to its release to the home video market or
exhibition on cable television. Generally, studios make master video tapes of
their movies available for duplication sufficiently in advance of the release
dates for the lodging industry so that all of the Company's hotels can offer the
movies as of the first date they are available for exhibition. The Company
obtains independent films, most of which are non-rated and intended for mature
audiences, for a one-time flat fee that is nominal in relation to the licensing
fees paid for major motion pictures and which permits the Company to duplicate
the films as necessary to supply copies to its hotel sites. The Company obtains
its selection of Nintendo video games pursuant to a ten year non-exclusive
license agreement with Nintendo entered into in 1998. Under the terms of the
agreement, the Company pays Nintendo a monthly fee based on the number of rooms
offering Nintendo video game services. The Company continuously monitors guests'
entertainment selections and adjusts its programming to respond to viewing
patterns.
The Company obtains its basic and premium cable television programming
pursuant to multi-year license agreements generally containing automatic renewal
provisions and pays its programming suppliers a fixed, monthly fee for each room
or subscriber receiving the service. Management believes that relations with the
programming suppliers are good and expects to renew these contracts as necessary
on competitive terms.
SYSTEMS PRODUCTION GROUP AND EQUIPMENT SUPPLIERS. The Company contracts
directly with various electronics firms for the manufacture and assembly of its
systems hardware, the design of which is controlled by the Company. The Company
has found these suppliers to be dependable and able to meet delivery schedules
on time. The Company believes that, in the event of a termination of any of its
sources, with proper notification from the supplier, alternate suppliers could
be located without incurring significant costs or delays. Certain electronic
component parts used within the Company's products are available from a limited
number of suppliers and can be subject to temporary shortages because of general
economic conditions and the demand and supply for such component parts. If the
Company were to experience a shortage of any given electronic part, the Company
LodgeNet Entertainment Corporation 7 Form 10-K 1998
believes that alternative parts could be obtained or system design changes
implemented. In such event, the Company could experience a temporary
reduction in the rate of new room installations and/or an increase in the
cost of such installations. All other components of the Company's systems are
standard commercial products, such as computers, video cassette players,
modulators and amplifiers, that are available from multiple sources. The
Company believes its anticipated growth can be accommodated through existing
suppliers.
The headend electronics are assembled at the Company's facilities for
testing prior to shipping. The Company samples the room units at the supplier's
facilities periodically for reliability. Following assembly of headend equipment
with a configuration designed specifically for a particular customer, the system
is shipped to the location, where it is installed by Company-employed
technicians or Company-trained subcontractors.
COMPETITION
The Company is the second largest provider of interactive and cable
television services to the lodging industry, currently serving over 700,000
hotel rooms. The Company's largest competitor is On Command Corporation ("OCC"),
the successor corporation resulting from the 1996 merger of SpectraVision, Inc.
and On Command Video Corporation. Based upon publicly available information, the
Company estimates that OCC currently serves approximately 929,000 hotel rooms.
The Company also competes with Hospitality Networks, SVI, SeaChange, Time
Warner, Cox Cable and TCI.
There are also a number of potential competitors that could use their
existing infrastructure to provide in-room entertainment services to the lodging
industry, including franchised cable operators, wireless cable operators,
telecommunications companies and DBS providers. Some of these potential
competitors are already providing free-to-guest services to the lodging industry
and have announced plans to offer guest pay services. Some of these companies
may have substantially greater financial and other resources than the Company,
and it is possible that such competitors may develop a technology that is more
cost effective than the Company's proprietary b-LAN system architecture. To
respond to competition, the Company will need to continue to enhance its in-room
entertainment systems, expand its operations and meet the increasing demands for
competitive pricing, service quality and availability of value-added product
offerings.
Competition with respect to new guest pay contracts centers on a variety
of factors, depending upon the features important to a particular hotel. Among
the more important factors are: (i) the features and benefits of the
entertainment systems; (ii) the quality of the vendor's technical support and
maintenance services; (iii) the financial terms and conditions of the proposed
contract (including payments to the hotel); and (iv) the ability to complete
system installation in a timely and efficient manner. In addition, with respect
to hotel properties already receiving in-room entertainment services, the
incumbent provider may have certain informational and installation cost
advantages as compared to outside competitors.
The Company believes that its competitive advantages include: (i) its
proprietary b-LAN system architecture that enables the Company to deliver a
broad range of interactive features and services such as on-demand movies and
network-based Nintendo video games; (ii) the flexible design of the Company's
system which enables it to add enhancements or integrate new technologies as
they become commercially available and economically viable; (iii) high quality
customer support and nationwide field service operations; and (iv) an
experienced management team and professional and well-trained sales
organization. The Company believes that its success in securing contracts
reflects the strong competitive position of the Company's products and services.
Because of the high level of penetration in the large hotel segment of
the lodging industry already achieved by guest pay providers, most of the growth
opportunities in this market segment have traditionally involved securing
contracts to serve hotels that are served by a competing vendor. An incumbent
provider may have certain information and installation cost advantages as
compared to outside competitors. These circumstances have led to increasing
competition for contract renewals, particularly at hotels operated by major
hotel chains. The Company believes that certain major hotel chains have awarded
contracts based primarily on the level and nature of financial and other
incentives offered by the guest pay provider. Even if it were able to do so, the
Company may not always be willing to match the incentives provided by its
competitors, some of which have greater access to financial and other resources
than the Company. Because free-to-guest service providers generally have
substantially comparable access to the satellite delivered programming that
comprises the free-to-guest services, competition in this segment has been based
primarily on price and customer service.
While the Company believes that its proprietary b-LAN system
architecture is comparable or superior to the systems currently being used by
its competitors in the lodging industry, there can be no assurance that such
competitors will not develop a cost-effective system that is comparable or
superior to the Company's system. In order to broaden its market opportunities,
the Company over time has redesigned its system to permit the delivery of
on-demand movies and network-based video games to
LodgeNet Entertainment Corporation 8 Form 10-K 1998
mid-size hotels of 75 to 150 rooms, a market segment the Company believes has
been historically under-served by guest pay providers. There can be no
assurance that competitors will not develop a cost-effective system that
would allow them to target this market segment. Further, there can be no
assurance that the Company will continue its current level of success in
obtaining new contracts from hotels currently served by other vendors or
previously unserved, or that the Company will be able to retain contracts
with hotels it serves when those contracts expire.
Although in the free-to-guest market the local franchised cable operator
in a hotel's market may have a substantial market presence, such operators
typically offer the hotel owner only standard packages of programming developed
for the residential market and not the lodging market, and at a fixed price per
room based on all the channels provided. The Company competes with the
franchised cable operator for free-to-guest contracts by customizing packages of
programming to provide only those channels desired by the hotel, typically
reducing the overall cost per room.
Competitive pressures in the guest pay and free-to-guest segments could
result in reduced market share for the Company, higher hotel commissions, lower
margins and increased expenditures on marketing, product development and systems
installation, each of which could adversely affect the Company's financial
condition and operating results.
REGULATION
TELECOMMUNICATIONS ACT OF 1996. The Telecommunications Act of 1996 (the
"Act") is intended, in part, to promote substantial competition for telephone
and video services and will alter federal, state and local laws and regulations
regarding telecommunications providers and services. The Act generally removes
previous restrictions preventing cable firms, telephone companies, long distance
carriers and public utilities from entering into certain new markets, removes
many cross-ownership restrictions and modifies rate regulations applicable to
franchised cable operators. In particular, the Act authorizes local telephone
companies to provide video programming directly to subscribers in their service
areas and eliminates the requirement that "private cable" operators serve only
buildings "under common ownership, management or control," but preserves the
requirement that such operations not use closed transmission paths to cross
public rights-of-way. The Act also permits franchised cable operators to offer
bulk discounts to multiple dwelling units; provided, however, that such
discounts may not constitute "predatory pricing." Prior to the adoption of the
Act, franchised cable operators were subject to a uniform rate requirement which
generally prohibited such bulk discounts. There are rulemakings and appellate
litigation resulting from Commission decisions in those rulemakings that
interpret and implement the provisions of the Act. It is anticipated that the
Act will stimulate increased competition generally in the telecommunications and
cable industries which may adversely impact the Company. No assurance can be
given that changes in current or future laws or regulations adopted by the FCC
or state or local regulatory authorities would not have a material adverse
effect on the Company's business.
As a result of the Act, the Company's business may be adversely affected
by the entry of additional competitors in the multichannel video programming
distribution market. In part, the Company's competitiveness also will depend
upon the outcome of various FCC rulemaking proceedings to interpret and
implement the provisions of the Act. It is not possible at this time to predict
the outcome of those rulemaking proceedings or their effect on the Company.
CABLE TELEVISION REGULATION. The Communications Act of 1934, as amended
by the Cable Communications Policy Act of 1984 (the "1984 Cable Act"), the Cable
Television Consumer Protection and Competition Act of 1992 (the "Cable Act"),
and the Act, governs the regulation of "cable systems." The law defines a "cable
system" as a facility, consisting of a set of closed transmission paths and
associated signal generation, reception, and control equipment that is designed
to provide cable service which includes video programming and which is provided
to multiple subscribers within a community, but the law exempts from that
definition, among other facilities, a facility that serves subscribers without
using any public rights-of-way. The Company constructs and operates separate
headend systems at each hotel or transmits cable signals from microwave
transmitters to each separate property, and those systems do not use public
rights-of-way. Thus, with respect to its private cable systems, the Company is
not required to comply with many of the FCC's rules relating to cable systems,
including, among other things, rate regulation and the requirement to obtain a
franchise from local government authorities in order to provide video services.
As a "multichannel video programming distributor" ("MVPD"), however, the
Company is subject to various provisions of the Communications Act of 1934, as
amended. Laws and regulations applicable to MVPDs generally apply to the
Company. These include laws and regulations that benefit the Company, such as
provisions that ensure the Company access to programming on fair, reasonable and
nondiscriminatory terms, as well as provisions that subject the Company to
additional requirements, such as the requirement to obtain consent from
broadcasters in order to retransmit their signals over the Company's systems.
LodgeNet Entertainment Corporation 9 Form 10-K 1998
TELEPHONE COMPANY ENTRY INTO CABLE TELEVISION. The Act allows telephone
companies to compete directly with franchised and private cable operators by
repealing the previous telephone company-cable cross-ownership ban and replacing
the FCC's video dialtone regulations with an "open video system" ("OVS") plan by
which local exchange carriers can provide cable service in their telephone
service area. The FCC has adopted regulations prohibiting an OVS operator from
discriminating among programmers and ensuring that OVS rates, terms, and
conditions for service are reasonable and nondiscriminatory. Further, those
regulations prohibit a local exchange carrier, OVS operator or its affiliates
from occupying more than one-third of a system's activated channels when demand
for channels exceeds supply, although there are no numeric limits. Additional
OVS regulations include rules governing channel sharing; extending the FCC's
sports exclusivity, network nonduplication, and syndicated exclusivity
regulations; and controlling the positioning of programmers on menus and program
guides. Local franchising authorities may require OVS operators to pay
"franchise fees" only to the extent that the OVS provides or its affiliates
provide cable services over the OVS; such fees may not exceed the franchise fees
charged to cable operators in the area, and the OVS provider may pass through
the fees as a separate subscriber bill item. OVS operators are subject to local
franchising authorities' general right-of-way management regulations.
ELECTRIC UTILITY ENTRY INTO CABLE AND TELECOMMUNICATIONS. The Act
provides that registered utility holding companies and subsidiaries may provide
telecommunications services (including cable television) notwithstanding the
Public Utility Holding Company Act. Electric utilities must establish separate
subsidiaries, known as "exempt telecommunications companies" and must apply to
the FCC for operating authority. Large utility holding companies may become
significant competitors to both cable television and other telecommunications
providers.
The foregoing does not purport to describe all present and proposed
federal, state and local regulations and legislation relating to the video
programming industry. Other existing federal, state and local laws and
regulations currently are, or may be, the subject of a variety of judicial
proceedings, legislative hearings, and administrative and legislative proposals
that could change in varying degrees, the manner in which private cable
operators and other video programming distributors operate. The Company cannot
estimate the outcome of these proceedings or their impact upon its operations at
this time.
EMPLOYEES
As of December 31, 1998, the Company had 706 employees in the United
States and Canada. None of these employees is covered by a collective bargaining
agreement. The Company has not experienced any significant labor problems and
believes that its relationship with its employees is good.
ITEM 2 - PROPERTIES
The Company's National Headquarters and Distribution Center, including
its principal executive offices, is located on an approximately 23 acre site in
Sioux Falls, South Dakota. Construction of the approximately $15 million
facility was completed in December 1997. The National Headquarters and
Distribution Center occupies approximately 228,500 square feet including
approximately 126,500 square feet for executive, administrative and support
functions, approximately 60,000 square feet for assembly and distribution
functions, and approximately 42,000 square feet for warehouse space. The opening
of the National Headquarters and Distribution Center allowed the Company to
consolidate all of its local operations into a single, multipurpose facility
which is designed to enhance operational efficiency and to facilitate any
necessary future expansion needs of the Company. The Company believes that the
site of its National Headquarters and Distribution Center is sufficient to
accommodate its foreseeable local operational space requirements.
The Company leases 19 facilities, in various locations, from
unaffiliated third parties. These facilities are combination warehouse/office
facilities for installation and service operations and are located throughout
the country. Each of these facilities occupies less than 3,500 square feet.
ITEM 3 - LEGAL PROCEEDINGS
The Company is subject to litigation arising in the ordinary course of
business. As of the date hereof, the Company believes the resolution of such
litigation will not have a material adverse effect upon the Company's financial
condition or results of operations.
LodgeNet Entertainment Corporation 10 Form 10-K 1998
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On September 30, 1998, the Company solicited the consent of the holders
of the Company's 10.25% Senior Notes Due 2006 (the "Notes") to amend the
indenture governing the Notes to
(1) Permit the Company to (i) cause ResNet Communications, Inc. ("ResNet
Inc."), a subsidiary of the Company, to contribute the operations of
its subsidiary, ResNet Communications, L.L.C. ("ResNet LLC") to a
newly-formed joint venture company, Global Interactive
Communications Corporation ("GICC"), (ii) to make up to $5 million
of additional investments in GICC, and (iii) to enter into
transactions with GICC so long as the transactions are at arm's
length and in the ordinary course of business, and
(2) Authorize the Trustee to execute and deliver a supplemental
indenture and any instrument, agreement or other document, and take
any other action reasonably requested by the Company, to effect the
proposed amendments.
Registered holders of the Notes, of record as of the close of business
on September 30, 1998, who provided their valid consent to the proposed
amendment prior to October 15, 1998, were entitled to an amount equal to $2.50
per $1,000 of principal of such holder's Notes. The holders of 100% of the
Notes, determined as of the record date for the consent solicitation, consented
to the proposed amendments to the indenture.
There were no other matters submitted to a vote of security holders
during the quarter ended December 31, 1998.
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock currently trades on the NASDAQ National
Market System ("NASDAQ NMS") under the symbol "LNET". The Company's Common Stock
began trading on the NASDAQ NMS on October 14,1993 upon the effectiveness of its
initial public offering. As of March 9, 1999 there were outstanding 11,942,387
shares of the Company's Common Stock.
The following table sets forth, for the fiscal quarters indicated, the
range of high and low sales prices of the Company's Common Stock as reported by
NASDAQ NMS.
Quarter Ended High Low
------------------ ------ ------
March 31, 1997 $17.38 $10.50
June 30, 1997 12.00 8.00
September 30, 1997 13.25 9.00
December 31, 1997 14.00 10.50
March 31, 1998 12.25 10.38
June 30, 1998 12.50 8.00
September 30, 1998 10.00 6.50
December 31, 1998 7.63 5.13
On March 9, 1999, the closing price of the Company's Common Stock, as
reported by NASDAQ NMS was $7.3125. Stockholders are urged to obtain current
market quotations for the Company's Common Stock. As of March 9, 1999 there were
164 stockholders of record of the Company with approximately 87% of the shares
held in "street name". The Company estimates that as of March 9, 1999 there were
more than 2,000 stockholders of the Company.
DIVIDENDS
No dividends have been paid to date on the Common Stock of the Company.
Management of the Company does not intend to pay any cash dividends on Common
Stock of the Company in the foreseeable future, rather, it is expected that the
Company will retain earnings to finance its operations and growth. The terms and
conditions of the Company's 10.25% Senior Notes and of the Company's bank credit
facility (See "Item 7 -- Management's Discussion and Analysis of Financial
Condition and Results of Operations" elsewhere herein) both contain covenants
which restrict and limit payments or distributions in respect of the Common
Stock of the Company.
LodgeNet Entertainment Corporation 11 Form 10-K 1998
STOCKHOLDER RIGHTS PLAN
On February 28, 1997, the Board of Directors of the Company
authorized and adopted a stockholder rights plan ("Rights Plan"). The Rights
Plan is intended to maximize stockholder value by providing flexibility to
the Board of Directors in the event that an offer for the Company is received
that is either inadequate or not in the best interest of all stockholders.
The Rights Plan had been under consideration by the Board of Directors for
almost a year prior to its adoption and is in a form recommended by the
Company's outside legal counsel and financial advisors, which form is similar
to that adopted by many other public companies.
Pursuant to the Rights Plan, the Board of Directors declared a
dividend distribution of one "Right" for each outstanding share of common
stock, par value $.01 per share (the "Common Stock") of the Company to
stockholders of record at the close of business on March 10, 1997 (the
"Record Date"). In general, each Right, when exercisable, entitles the
registered holder to purchase from the Company one one-thousandth of a share
of a new series of preferred stock, designated as Series A Participating
Preferred Stock, par value $.01 per share (the "Preferred Stock"), at a price
of $60.00 (the "Purchase Price"), subject to adjustment. The terms of the
Rights are set forth in a Rights Agreement (the "Rights Agreement") between
the Company and Harris Trust and Savings Bank, as "Rights Agent". The
following summary description of the Rights and the terms of the Rights
Agreement does not purport to be complete and is qualified in its entirety by
reference to the Rights Agreement incorporated by reference as an exhibit
hereto.
Initially, the Rights will be attached to all Common Stock
certificates representing shares then outstanding, and no separate Rights
certificates will be distributed. The Rights will separate from the Common
Stock and a "Distribution Date" will occur upon the earliest of (i) a public
announcement that a person, entity or group of affiliated or associated
persons and/or entities (an "Acquiring Person") has acquired, or obtained the
right to acquire, beneficial ownership of 15% or more of the outstanding
shares of Common Stock, other than as a result of repurchases of stock by the
Company or certain inadvertent actions by institutional or certain other
stockholders, or (ii) ten days (unless such date is extended by the Board of
Directors) following the commencement of (or a public announcement of an
intention to make) a tender offer or exchange offer which would result in any
person, entity or group affiliated or associated persons and/or entities
becoming an Acquiring Person.
Until the Distribution Date the Rights will be evidenced, with
respect to any of the Common Stock certificates outstanding as of the Record
Date, by such Common Stock certificate together with a Summary of Rights. The
Rights Agreement provides that, until the Distribution Date, the Rights will
be transferred with and only with Common Stock certificates. From as soon as
practicable after the Record Date and until the Distribution Date (or earlier
redemption or expiration of the Rights), new Common Stock certificates issued
after the Record Date upon transfer or new issuance of the Common Stock will
contain a notation incorporating the Rights Agreement by reference. Until the
Distribution Date (or earlier redemption or expiration of the Rights), the
surrender for transfer of any certificates for Common Stock outstanding as of
the Record Date (with or without the Summary of Rights attached) will also
constitute the transfer of the Rights associated with the Common Stock
represented by such certificate. As soon as practicable following the
Distribution Date, separate certificates evidencing the Rights ("Rights
Certificates") will be mailed to holders of record of the Common Stock as of
the close of business on the Distribution Date, and the separate Rights
Certificates alone will evidence the Rights.
The Rights are not exercisable until the Distribution Date. The
Rights will expire on the earliest of (i) February 28, 2007,
(ii) consummation of a merger transaction with a Person or group who acquired
Common Stock pursuant to a Permitted Offer (as defined below), and is
offering in the merger the same price per share and form of consideration
paid in the Permitted Offer, or (iii) redemption or exchange of the Rights by
the Company as described below.
The number of Rights associated with each share of Common Stock shall
be proportionately adjusted to prevent dilution in the event of a stock
dividend on, or a subdivision, combination or reclassification of, the Common
Stock. The Purchase Price payable, and the number of shares of Preferred
Stock or other securities or property issuable, upon exercise of the Rights
are subject to adjustment from time to time to prevent dilution (i) in the
event of a stock dividend on, or a subdivision, combination or
reclassification of the Preferred Stock, (ii) upon the grant to holders of
the Preferred Stock of certain rights or warrants to subscribe for Preferred
Stock, certain convertible securities or securities having the same or more
favorable rights, privileges and preferences as the Preferred Stock at less
than the current market price of the Preferred Stock, or (iii) upon the
distribution to holders of the Preferred Stock of evidences of indebtedness
or assets (excluding regular quarterly cash dividends out of earning or
retained earnings) or of subscription rights or warrants (other than those
referred to above). With certain exceptions, no adjustments in the Purchase
Price will be required until cumulative adjustments require an adjustment of
at least 1% in such Purchase Price.
LodgeNet Entertainment Corporation 12 Form 10-K 1998
In the event that, after the first date of public announcement by the
Company or an Acquiring Person that an Acquiring Person has become such, the
Company is involved in a merger or other business combination transaction
(whether or not the Company is the surviving corporation) or 50% or more of
the Company's assets or earning power are sold (in one transaction or a
series of transactions), proper provision shall be made so that each holder
of a Right (other than an Acquiring Person) shall thereafter have the right
to receive, upon the exercise thereof at the then current Purchase Price,
that number of share of common stock of either the Company, in the event that
it is the surviving corporation of a merger or consolidation, or the
acquiring company (or, in the event there is more than one acquiring company,
the acquiring company receiving the greatest portion of the assets or earning
power transferred) which at the time of such transaction would have a market
value of two times the Purchase Price (such right being called the "Merger
Right"). In the event that a Person becomes the beneficial owner of 15% or
more of the outstanding shares of Common Stock (unless pursuant to a tender
offer or exchange offer for all outstanding shares of Common Stock at a price
and on terms determined prior to the date of the first acceptance of payment
for any of such shares by at least a majority of the members of the Board of
Directors who are not officers of the Company and are not Acquiring Persons
or Affiliates or Associates thereof to be both adequate and otherwise in the
best interests of the Company and its stockholders (a "Permitted Offer")),
then proper provision shall be made so that each holder of a Right will for a
60-day period (subject to extension under certain circumstances) thereafter
have the right to receive upon exercise that number of shares of Common Stock
(or, at the election of the Company, which election may be obligatory if
sufficient authorized shares of Common Stock are not available, a combination
of Common Stock, property, other securities (e.g., Preferred Stock) and/or a
reduction in the exercise price of the Right) having a market value of two
times the Purchase Price (such right being called the "Subscription Right").
The holder of a Right will continue to have the Merger Right whether or not
such holder exercises the Subscription Right. Notwithstanding the foregoing,
upon the occurrence of any of the vents giving rise to the exercisability of
the Merger Right or the Subscription Right, any Rights that are or were at
any time after the Distribution Date owned by an Acquiring Person shall
immediately become null and void.
At any time prior to the earlier to occur of (i) a Person becoming an
Acquiring Person or (ii) the expiration of the Rights, the Company may redeem
the Rights in whole, but not in part, at a price of $.01 per Right (the
"Redemption Price"), which redemption shall be effective upon the action of
the Board of Directors. Additionally, the Company may thereafter redeem the
then outstanding Rights in whole, but not in part, at the Redemption Price
(i) if such redemption is incidental to a merger or other business
combination transaction or series of transactions involving the Company but
not involving an Acquiring Person or certain related Persons or
(ii) following an event giving rise to, and the expiration of the exercise
period for, the Subscription Right if and for as long as the Acquiring Person
triggering the Subscription Right beneficially owns securities representing
less than 15% of the outstanding shares of Common Stock and at the time of
redemption there are no other Acquiring Persons. The redemption of Rights
described in the preceding sentence shall be effective only as of such time
when the Subscription Right is not exercisable, and in any event, only after
ten business days' prior notice. Upon the effective date of the redemption of
the Rights, the right to exercise the Rights will terminate and the only
right of the holders of Rights will be to receive the Redemption Price.
Subject to applicable law, the Board of Directors, at its option, may
at any time after a Person becomes an Acquiring Person (but not after the
acquisition by such Person of 50% or more of the outstanding Common Stock),
exchange all or part of the then outstanding and exercisable Rights (except
for Rights which have become void) for shares of Common Stock at a rate of
one share of Common Stock per Right or, alternatively, for substitute
consideration consisting of cash, securities of the Company or other assets
(or any combination thereof).
The Preferred Stock purchasable upon exercise of the Rights will be
nonredeemable and junior to any other series of preferred stock the Company
may issue (unless otherwise provided in the terms of such stock). If issued,
each share of Preferred Stock will have a preferential quarterly dividend in
an amount equal to 1,000 times the dividend, if any, declared on each share
of Common Stock, but in no event less than $25.00. In the event of
liquidation, the holders of shares of Preferred Stock will receive a
preferred liquidation payment equal to the greater of $1,000.00 or 1,000
times the payment made per share of Common Stock. Each share of Preferred
Stock will have 1,000 votes, voting together with the shares of Common Stock.
The rights of the Preferred Stock as to dividends, liquidation and voting,
and in the event of mergers and consolidations, are protected by customary
antidilution provisions. Fractional shares of Preferred Stock will be
issuable; however, (i) the Company may elect to distribute depositary
receipts in lieu of such fractional share and (ii) in lieu of fractional
shares other than fractions that are multiples of one one-thousandth of a
share, an adjustment in cash will be made based on the market price of the
Preferred Stock on the last trading date prior to the date of exercise.
LodgeNet Entertainment Corporation 13 Form 10-K 1998
Until a Right is exercised, the holder thereof, as such, will have no
rights as a stockholder of the Company, including, without limitation, the
right to vote or to receive dividends. The Company and the Rights Agent
retain broad authority to amend the Rights Agreement; however, following any
Distribution Date any amendment may not adversely affect the interests of
holders of Rights.
LodgeNet Entertainment Corporation 14 Form 10-K 1998
ITEM 6 - SELECTED FINANCIAL DATA
The following is a summary of Selected Financial Data. The data
should be read in conjunction with the Company's Consolidated Financial
Statements, the notes thereto, and "Management's Discussion and Analysis of
Financial Condition and Results of Operations", all included elsewhere
herein. Dollar amounts are in thousands, except for per share and per room
amounts.
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1994 1995 1996 1997 1998
-------- -------- -------- -------- --------
STATEMENT OF OPERATIONS DATA:
Revenues:
Guest Pay $ 29,927 $ 50,758 $ 84,504 $116,276 $146,481
Free-to-guest 8,397 8,060 8,645 8,496 7,854
Other 2,070 4,395 4,572 10,938 12,016
-------- -------- -------- -------- --------
Total revenues 40,394 63,213 97,721 135,710 166,351
Direct costs 18,181 28,910 44,379 58,512 74,008
-------- -------- -------- -------- --------
Gross profit 22,213 34,303 53,342 77,198 92,343
Operating expenses 24,573 36,741 58,428 85,262 102,282
-------- -------- -------- -------- --------
Operating loss (2,360) (2,438) (5,086) (8,064) (9,939)
Equity in losses of
unconsolidated affiliates -- -- -- -- 6,550
Interest expense 966 4,522 8,243 17,001 23,048
-------- -------- -------- -------- --------
Loss before income taxes,
extraordinary loss and
cumulative effect of (3,326) (6,960) (13,329) (25,065) (39,537)
accounting change
Provision for income taxes -- 66 28 344 375
-------- -------- -------- -------- --------
Loss before extraordinary loss
and cumulative effect of
accounting change (3,326) (7,026) (13,357) (25,409) (39,912)
Extraordinary loss (1) 1,324 -- 3,253 -- --
Cumulative effect of accounting
change (2) -- -- -- 210 --
-------- -------- -------- -------- --------
Net loss $ (4,650) $ (7,026) $(16,610) $(25,619) $(39,912)
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Per common share (basic and diluted):
Loss before extraordinary
loss and cumulative
effect of accounting change $ (.45) $ (.96) $ (1.40) $ (2.25) $ (3.45)
Extraordinary loss (.18) -- (.34) -- --
Cumulative effect of
accounting change -- -- -- (.02) --
-------- -------- -------- -------- --------
Net loss $ (.63) $ (.96) $ (1.74) $ (2.27) $ (3.45)
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
OTHER DATA:
EBITDA (3) $ 9,301 $ 15,898 $ 24,729 $ 35,696 $ 48,576
EBITDA margin (3) 23.0% 25.1% 25.3% 26.3% 29.2%
Capital expenditures $ 43,521 $ 51,497 $ 84,256 $104,377 $ 69,660
Depreciation and amortization 11,661 18,336 29,815 43,760 55,215
Annualized EBITDA (4) 11,250 18,246 27,290 39,090 55,536
Ratio of earnings to fixed
charges (5) -- -- -- -- --
Ratio of long-term debt to
annualized EBITDA (4) 2.49x 3.15x 6.57x 4.67x 4.72x
Ratio of EBITDA to interest
expense (3) 9.63x 3.52x 3.00x 2.10x 2.11x
OPERATING DATA:
Guest Pay rooms served (6)
On-demand 119,680 209,487 358,842 484,070 581,893
Scheduled 65,351 58,720 41,403 27,781 14,913
-------- -------- -------- -------- --------
Total Guest Pay rooms 185,031 268,207 400,245 511,851 596,806
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Rooms with Nintendo-Registered
Trademark- game systems (6) 69,806 163,879 322,903 448,969 546,324
Free-to-guest rooms served (6) 220,534 249,779 294,882 341,030 384,324
Total rooms served (6) (7) 314,184 388,088 516,348 613,407 703,325
Average monthly revenue per
Guest Pay room:
Movie revenue $ 15.03 $ 17.08 $ 18.38 $ 17.86 $ 18.44
Video game/information
services 1.01 2.21 2.93 3.28 3.62
-------- -------- -------- -------- --------
Total $ 16.04 $ 19.29 $ 21.31 $ 21.14 $ 22.06
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
LodgeNet Entertainment Corporation 15 Form 10-K 1998
AS OF DECEMBER 31,
---------------------------------------------------
1994 1995 1996 1997 1998
------- -------- -------- -------- --------
BALANCE SHEET DATA:
Cash and cash equivalents $ 4,302 $ 2,252 $ 86,177 $ 1,021 $ 5,240
Total assets 88,265 125,507 279,768 260,294 306,030
Long-term debt 28,000 57,497 179,233 182,691 262,375
Total stockholders' equity 47,942 42,726 75,552 49,579 11,774
- ----------
(1) In 1994 -- loss on early termination of the Company's bank credit
facility of $1.3 million. In 1996 -- loss on early redemption of 9.95%
and 10.35% Senior Notes of $3.3 million. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included
elsewhere herein.
(2) Represents a charge for the effect of adopting EITF Issue 97-13 related
to accounting for certain business reengineering costs.
(3) EBITDA ("Earnings Before Interest, Taxes, Depreciation and Amortization")
is not intended to represent an alternative to net income or cash flows
from operating, financing or investing activities (as determined in
accordance with generally accepted accounting principles) as a measure
of performance. Rather, it is included herein because EBITDA is a widely
accepted financial indicator used by certain investors and financial
analysts to assess and compare companies on the basis of operating
performance. Management believes that EBITDA provides an important
additional perspective on the Company's operating results and the
Company's ability to service its long-term debt and to fund the
Company's continuing growth. EBITDA has been presented excluding equity
in losses of unconsolidated affiliates and the restructuring charge for
the ResNet merger in 1998.
(4) "Annualized EBITDA" represents the sum of the quarterly EBITDA for the
two most recently completed fiscal quarters multiplied by two.
(5) Earnings is defined as net loss before income taxes, extraordinary items
and fixed charges, except where capitalized. Fixed charges is defined as
the portion of rental expense under operating leases representing
interest, and interest, including amortization of debt expense, whether
expensed or capitalized. Earnings were insufficient to cover fixed
charges for the years ended December 31 by the amounts indicated:
1994 -- $(3,326); 1995 -- $(6,960); 1996 -- $(13,329); 1997 --
$(25,065); and 1998 -- $(38,799).
(6) At end of year.
(7) Total rooms served include those rooms receiving one or more of the
Company's services, including rooms served by international licensees.
LodgeNet Entertainment Corporation 16 Form 10-K 1998
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in this Annual Report on Form 10-K, including,
without limitation, statements in Item 1, including certain statements under
the headings "Overview", "Business Strategy", "Strategic Initiatives",
"Services and Products", "Operations", "Competition" and "Regulation", in
Item 3 under the heading "Legal Proceedings", and in Item 7 under the heading
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," constitute "forward-looking statements" within the meaning of
the Securities Act of 1933, as amended, and the Securities Exchange Act of
1934, as amended. When used in this Annual Report, the words "expects,"
"anticipates," "estimates," "believes," "no assurance" and similar
expressions and statements which are made in the future tense, are intended
to identify such forward-looking statements. Such forward-looking statements
involve known and unknown risks, uncertainties and other factors, which may
cause the Company's actual results, performance or achievements to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. In addition to the
risks and uncertainties discussed in the foregoing sections, such factors
include, among others, the following: the impact of competition and changes
to the competitive environment for the Company's products and services,
changes in technology, reliance on strategic partners, uncertainty of
litigation, changes in government regulation and other factors detailed, from
time to time, in the Company's filings with the Securities and Exchange
Commission. These forward-looking statements speak only as of the date of
this Annual Report. The Company expressly disclaims any obligation or
undertaking to release publicly any updates or revisions to any
forward-looking statements contained herein to reflect any change in the
Company's expectations with regard thereto or any change in events,
conditions or circumstances on which any such statement is based.
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH, AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO, THE CONSOLIDATED FINANCIAL
STATEMENTS OF THE COMPANY, INCLUDING THE NOTES THERETO, APPEARING ELSEWHERE
HEREIN.
OVERVIEW
LodgeNet is a specialized communications company which provides video
on-demand, network-based video games, cable television programming and other
interactive entertainment and information services to the lodging market
utilizing its proprietary b-LAN system architecture.
LODGING SERVICES
GUEST PAY SERVICES. Guest Pay services are purchased by guests on a
per-view or hourly basis and include Guest Scheduled on-demand movies and
network-based Nintendo video games. Guest Pay packages may also include
additional services such as satellite-delivered basic and premium cable
television programming, and other interactive entertainment and information
services that are paid for by the hotel and provided to guests at no charge.
The growth that the Company has experienced has principally resulted from its
rapid expansion of guest pay services, which the Company began installing in
1986. In May 1992, the Company introduced and began installing its on-demand
Guest Pay service. It has been the Company's experience that rooms featuring
the "on-demand" Guest Pay service generate significantly more revenue and
gross profit per room than comparable rooms having only the scheduled format.
The following table sets forth information in regard to Guest Pay rooms
installed as of December 31:
1996 1997 1998
----------------- ----------------- -----------------
Rooms % Rooms % Rooms %
------- ----- ------- ----- ------- -----
Scheduled 41,403 10.3 27,781 5.4 14,913 2.5
On-demand 358,842 89.7 484,070 94.6 581,893 97.5
------- ----- ------- ----- ------- -----
Total 400,245 100.0 511,851 100.0 596,806 100.0
------- ----- ------- ----- ------- -----
------- ----- ------- ----- ------- -----
The Company's Guest Pay revenues depend on a number of factors,
including the number of rooms equipped with the Company's systems, Guest Pay
buy rates, hotel occupancy rates, hotel guest demographics, the popularity,
selection and pricing of the Company's program offerings and the length of
time programming is available to the Company prior to its release to the home
video and cable television markets. The primary direct costs of providing
Guest Pay services are (i) license fees paid to studios for non-exclusive
distribution rights to recently-released major motion pictures, (ii) nominal
one-time license fees paid for independent films, (iii) license fees for
video games and other services, and (iv) the commission retained by the
hotel. Guest Pay operating expenses include costs of system maintenance and
support, in-room marketing, video tape duplication and distribution, data
retrieval, insurance and personal property taxes.
LodgeNet Entertainment Corporation 17 Form 10-K 1998
The Company provides video games and interactive multimedia
entertainment and information services including folio review, video
check-out, guest satisfaction survey, advertising, and merchandising services
through its guest pay systems. In 1993, the Company entered into a seven-year
non-exclusive license agreement with Nintendo of America, Inc. ("Nintendo")
to provide hotels with a network-based Super Nintendo-Registered Trademark-
video game playing system. During 1998, the Company entered into a new ten
year non-exclusive license agreement with Nintendo to become the first
provider of Nintendo 64 ("N64-Registered Trademark-") video games to the
lodging industry. The Company anticipates the rollout of the N64 game
technology to begin during the second quarter of 1999. The following table
sets forth the number of guest pay rooms with game systems installed as of
December 31:
1996 1997 1998
------- ------- -------
Super Nintendo-Registered Trademark-
game systems rooms 322,903 448,969 546,324
FREE-TO-GUEST SERVICES. In addition to Guest Pay services, the
Company provides cable television programming for which the hotel, rather
than its guests, pays the charges. Free-to-guest services include the
satellite delivery of various programming channels through a satellite earth
station, which generally is owned or leased by the hotel. The hotel pays the
Company a fixed monthly charge per room for each programming channel
provided. The Company obtains its free-to-guest programming pursuant to
multi-year agreements with the programmers and pays a fixed monthly fee per
room, which varies depending on incentive programs in effect from time to
time from the programming networks. In April 1996, the Company entered into
an agreement with PRIMESTAR Partners (since succeeded by PRIMESTAR, Inc.
("PRIMESTAR")) pursuant to which the Company was appointed as the exclusive
third-party provider (other than partners in PRIMESTAR and their affiliated
distributors) of the PRIMESTAR-Registered Trademark- DBS (digital direct
broadcast satellite) signal to the lodging industry. Pursuant to this
agreement, the Company pays a fee to PRIMESTAR for access to the PRIMESTAR
DBS signal, which enables the Company to provide free-to-guest digital
satellite programming to a broader segment of the lodging industry than can
be cost-effectively served with traditional C-band satellite systems. The
following table sets forth the number of free-to-guest rooms served as of
December 31:
1996 1997 1998
------- ------- -------
At hotels with Guest Pay services 178,779 246,054 288,979
At hotels with only free-to-guest services 116,103 94,976 95,345
------- ------- -------
Total rooms with free-to-guest services 294,882 341,030 384,324
------- ------- -------
------- ------- -------
RESIDENTIAL SERVICES
In January 1996, the Company formed ResNet for the purpose of
extending the Company's proprietary b-LAN system architecture and operational
expertise into the multi-family dwelling unit ("MDU") market. In October
1996, TCI Satellite Entertainment, Inc. (since succeeded by PRIMESTAR MDU,
Inc. ("PRIMESTAR MDU")), agreed to invest up to $40 million in cash and
satellite receiving equipment in ResNet in exchange for up to a 36.99%
interest in ResNet and agreed to provide ResNet with long-term PRIMESTAR DBS
signals for the MDU market on a nationwide basis.
Effective November 30, 1998, the ResNet business was merged with two
non-affiliated entities to form a new entity, Global Interactive
Communications Corporation ("GICC"). The Company has a 30% equity interest in
GICC, whose business will consist of providing cable television programming
and telecommunications services to the MDU market. The agreement between
ResNet and PRIMESTAR MDU mentioned in the preceding paragraph was terminated
in conjunction with the ResNet merger transaction.
The Company will account for its investment in GICC on the equity
method of accounting for an investment. As a result of this accounting
treatment, and because the Company expects that there is a high probability
that GICC will operate at a loss for the foreseeable future as it pursues its
business plan, the Company expects to recognize continuing losses in
connection with its investment in GICC, which losses will be reflected as
"equity in losses of unconsolidated affiliates" in the Company's operating
statements.
As of the date of this report, there is no public market for the
securities of GICC, and there can be no assurance as to when any such market
may develop. The financial and operating performance of GICC, the market
acceptance for its securities and general market conditions, among other
factors, are not subject to the Company's control and may each affect the
value of the Company's investment in GICC. The Company has no continuing
obligation to make any additional investments into GICC.
LodgeNet Entertainment Corporation 18 Form 10-K 1998
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1998 AND 1997
REVENUE ANALYSIS
The Company's total revenue for 1998 increased 22.6%, or $30.6
million, in comparison to 1997. The following table sets forth the components
of the Company's revenue (in thousands) for the years ended December 31:
1997 1998
---------------------- ----------------------
Percent Percent
of Total of Total
Amount Revenues Amount Revenues
-------- -------- -------- --------
Guest Pay $116,276 85.7 $146,481 88.1
Free-to-guest 8,496 6.3 7,854 4.7
Other 10,938 8.0 12,016 7.2
-------- -------- -------- --------
Total $135,710 100.0 $166,351 100.0
-------- -------- -------- --------
-------- -------- -------- --------
GUEST PAY SERVICES. Guest Pay revenues increased 26.0%, or $30.2
million, in 1998 as compared to 1997. This increase is attributable to a
20.7% increase in the average number of installed Guest Pay rooms, all of
which were installed with the Company's on-demand technology, and to a 4.4%
increase in average monthly revenue per Guest Pay room. The following table
sets forth information with respect to Guest Pay rooms for the years ended
December 31:
1997 1998
------ ------
Average monthly revenue per room:
Movie revenue $17.86 $18.44
Video game and other service revenue 3.28 3.62
------ ------
Total per Guest Pay room $21.14 $22.06
------ ------
------ ------
Average movie revenue per room, for all Guest Pay rooms, increased
3.2% from the prior year due to the combination of higher average buy rates
and higher average movie prices, partially offset by a decline in hotel
occupancy rates.
Average video game and other service revenue per room, for all Guest
Pay rooms, increased 10.4% from the prior year, primarily as a result of an
increase in the number of rooms with information and other services
installed, partially offset by a decrease in average monthly video game
revenue per room.
FREE-TO-GUEST SERVICES. Free-to-guest revenues decreased 7.6%, or
$642,000, in 1998 as compared to 1997. The decrease is primarily the result
of a 6.5% decrease in the average number of rooms at hotels receiving only
free-to-guest services during the period (although total rooms receiving
free-to-guest services increased 12.7%).
OTHER. Revenue from other sources includes cable television revenue
generated by the residential services segment (which was $5,376,000 in 1998
compared to $2,700,000 in 1997), revenue from international license
arrangements, and revenue from the sale of televisions, system equipment, and
service parts and labor. The increase in 1998 from the prior year of $1.1
million, or 9.9%, is primarily due to increased cable television revenue
generated by the residential services segment of $2.7 million, partially
offset by decreased television sales of $1.3 million and decreased sales of
system equipment.
LodgeNet Entertainment Corporation 19 Form 10-K 1998
EXPENSE ANALYSIS
DIRECT COSTS. The following table sets forth information regarding
the Company's direct costs (in thousands) and gross profit margin for the
years ended December 31:
1997 1998
-------- --------
Direct costs:
Guest Pay $ 45,632 $ 60,538
Free-to-guest 5,663 6,373
Other 7,217 7,097
-------- --------
$ 58,512 $ 74,008
-------- --------
-------- --------
Gross profit margin:
Guest Pay 60.8% 58.7%
Free-to-guest 33.3% 18.9%
Other 34.0% 40.9%
Composite 56.9% 55.5%
Guest Pay direct costs increased 32.7% to $60.5 million in 1998 from
$45.6 million in the prior year. Since Guest Pay direct costs (primarily studio
and other license fees, video game license fees and the commission retained by
the hotel) are primarily based on related revenue, such direct costs generally
vary directly with revenue. As a percentage of Guest Pay revenue, such costs
increased from 39.2% in 1997 to 41.3% in 1998. The relative increase in Guest
Pay direct costs as a percentage of revenue in 1998 as compared to the prior
year is primarily the result of (i) an increase in the percentage of revenue
from cable television services which generally earns a lower profit margin than
on-demand services and (ii) higher video game costs (which are incurred based on
the number of rooms receiving video game services rather than the number of game
buys).
Free-to-guest direct costs increased 12.5% to $6.4 million in 1998 from
$5.7 million in the prior year. As a percentage of free-to-guest revenue,
free-to-guest direct costs increased to 81.1% in 1998 from 66.7% in the prior
year. The relative increase in free-to-guest direct costs as a percentage of
revenue is due to increased signal carriage fees owed to PRIMESTAR under the
agreement previously described and decreased incentive discounts realized from
programming networks.
Direct costs associated with other revenue decreased 1.7% to $7.1
million from $7.2 million in the prior year. As a percentage of related
revenues, such direct costs decreased to 59.1% in 1998 from 66.0% in 1997,
reflecting the effect of (i) increased cable television revenue generated by the
residential services segment which generally earns a higher profit margin than
the other sources of other revenue, and (ii) decreased sales of televisions
which generally earn a lower profit margin than the other sources of other
revenue.
The Company's overall gross profit increased 19.6% in 1998 to $92.3
million on a 22.6% increase in revenues compared to 1997. The Company's overall
gross profit margin was 55.5% in 1998 and 56.9% for the prior year.
OPERATING EXPENSES. The following table sets forth information in
regard to the Company's operating expenses (in thousands) for the years ended
December 31:
1997 1998
--------------------- ---------------------
Percent Percent
of Total of Total
Amount Revenues Amount Revenues
-------- -------- -------- --------
Operating expenses:
Guest Pay operations $ 20,785 15.3% $ 25,167 15.1%
Selling, general and 20,717 15.3% 18,600 11.2%
administrative
Restructuring charge -- -- 3,300 2.0%
Depreciation and amortization 43,760 32.2% 55,215 33.2%
-------- -------- -------- --------
Total operating expenses $ 85,262 62.8% $102,282 61.5%
-------- -------- -------- --------
-------- -------- -------- --------
Guest Pay operations expenses consist of costs directly related to
the operation of systems at the hotel sites as well as at residential sites
serviced by the residential services segment. Excluding the expenses incurred
to operate the systems at residential
LodgeNet Entertainment Corporation 20 Form 10-K 1998
sites, which were $2.9 million in 1998 and $1.4 million in 1997, expenses
related to Guest Pay operations increased 14.8%, or $2.9 million, in 1998
from $19.4 million in the previous year. This increase is primarily
attributable to the 20.7% increase in average installed Guest Pay rooms in
1998 as compared to 1997, partially offset by lower average operating and
service expenses incurred on a per room basis. Per average installed Guest
Pay room, such expenses were $3.35 per month in 1998 as compared to $3.52 per
month in 1997.
Selling, general and administrative expenses (including $2.2 million and
$1.8 million of expenses incurred by the residential services segment in 1998
and 1997, respectively) decreased 10.2%, or $2.1 million, in 1998 from $20.7
million in 1997. This decrease is primarily due to reduced legal expenses of
$1.5 million resulting from the resolution of the Company's patent litigation
matters. As a percentage of revenue, general and administrative expenses
represented 11.2% of total revenue in 1998 as compared to 15.3% in 1997.
The $3.3 million restructuring charge recorded in 1998 represents costs
incurred related to the Company's merger of its ResNet business as previously
described. Such costs include professional services fees, employee costs, and
the write-off of certain capitalized software development costs.
Depreciation and amortization expenses increased 26.2% to $55.2 million
in 1998 from $43.8 million in the prior year. This increase is primarily
attributable to the increase in the number of installed Guest Pay and game
service equipped rooms previously described, as well as the associated software
costs and other capitalized costs such as service vans, equipment and computers
that are related to the increased number of rooms in service since the prior
year. Additionally, increases in administrative and facility related assets, as
well as an increase of $2.1 million related to the residential services segment
($3.6 million in 1998 compared to $1.5 million in 1997), have contributed to the
increased depreciation and amortization.
OPERATING LOSS. The Company's operating loss, as a result of the
factors previously described, increased to $9.9 million in 1998 from $8.1
million in 1997. Excluding the results of ResNet, the Company's operating
loss was $807,000 in 1998 and $5.0 million in 1997.
EQUITY IN LOSSES OF UNCONSOLIDATED AFFILIATES. The Company obtained
equity interests in two entities during 1998. First, the Company acquired a
10% interest in Across Media Networks, LLC ("AMN"), a company engaged in the
creation and distribution of digitally produced on-screen content for
television and the Internet. The Company has applied the equity method of
accounting for this investment to reflect the fact that the Company has had
certain financing obligations to AMN. Losses of $5.8 million related to this
investment were recorded in 1998. Second, as previously described, the merger
of ResNet with two other entities effective November 30, 1998 to form GICC
resulted in the Company obtaining a 30% equity interest in GICC. The
Company's portion of GICC's 1998 loss was $738,000.
INTEREST EXPENSE. Interest expense, net of interest income,
increased to $23.0 million in 1998 from $17.0 million in 1997 due to
increases in long-term debt to fund the Company's continuing expansion of its
business. The average principal amount of long-term debt outstanding during
1998 was approximately $236.4 million (at a weighted average interest rate of
approximately 9.9%) as compared to an average principal amount outstanding of
approximately $183.4 million (at a weighted average interest rate of
approximately 10.3%) during 1997.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. As a result of
the issuance of EITF Issue 97-13 related to accounting for certain business
reengineering costs, the Company recorded a charge of $210,000 in 1997 to
write-off previously capitalized costs, in accordance with the new accounting
pronouncement.
NET LOSS. For the reasons previously described, the Company's net
loss increased to $39.9 million in 1998 from a net loss of $25.6 million in
the prior year.
EBITDA. As a result of increasing revenues from guest pay services,
and the other factors previously described, EBITDA ("Earnings Before
Interest, Income Taxes and Depreciation and Amortization") excluding the
restructuring charge related to the ResNet merger and equity in losses of
unconsolidated affiliates increased 36.1% to $48.6 million in 1998 as
compared to $35.7 million in 1997. As a percentage of total revenue, EBITDA
excluding the restructuring charge increased to 29.2% in 1998 as compared to
26.3% in 1997. Excluding the results of ResNet, EBITDA was $50.8 million in
1998 and $37.3 million in 1997. As a percentage of revenue, EBITDA was 31.6%
in 1998 and 28.0% in 1997, excluding the results of ResNet. EBITDA is not
intended to represent an alternative to net income or cash flows from operating,
financing or investing activities (as determined in accordance with generally
accepted accounting principles) as a measure of performance. Rather, it is
included herein because EBITDA is a widely accepted financial indicator used
by certain investors and financial analysts to assess and compare
LodgeNet Entertainment Corporation 21 Form 10-K 1998
companies on the basis of operating performance. Management believes
that EBITDA provides an important additional perspective on the Company's
operating results and the Company's ability to service its long-term debt and
to fund the Company's continuing growth.
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1997 AND 1996
REVENUE ANALYSIS
The Company's total revenue for 1997 increased 38.9%, or $38.0 million,
in comparison to 1996. The following table sets forth the components of the
Company's revenue (in thousands) for the years ended December 31:
1996 1997
--------------------- ---------------------
Percent Percent
of Total of Total
Amount Revenues Amount Revenues
-------- -------- -------- --------
Guest Pay $ 84,504 86.5 $116,276 85.7
Free-to-guest 8,645 8.8 8,496 6.3
Other 4,572 4.7 10,938 8.0
-------- -------- -------- --------
Total $ 97,721 100.0 $135,710 100.0
-------- -------- -------- --------
-------- -------- -------- --------
GUEST PAY SERVICES. Guest Pay revenues increased 37.6%, or
$31.8 million, in 1997 as compared to 1996. This increase is attributable to
a 38.7% increase in the average number of installed Guest Pay rooms, all of
which were installed with the Company's on-demand technology, partially
offset by a .8% decrease in average monthly revenue per Guest Pay room. The
following table sets forth information with respect to Guest Pay rooms for
the years ended December 31:
1996 1997
------- -------
Average monthly revenue per room:
Movie revenue $ 18.38 $ 17.86
Video game and other service revenue 2.93 3.28
------- -------
Total per Guest Pay room $ 21.31 $ 21.14
------- -------
------- -------
Average movie revenue per room, for all Guest Pay rooms, decreased 2.8%
from the prior year due to the combination of lower average buy rates and lower
average hotel occupancy, partially offset by increased average movie prices and
the comparative increase in the proportion of on-demand rooms.
Average video game and other service revenue per room, for all Guest Pay
rooms, increased 11.9% from the prior year, primarily as a result of an increase
in the number of rooms with information and other services installed. Average
monthly video game revenue per room was $2.25 and $2.26 during 1997 and 1996,
respectively.
FREE-TO-GUEST SERVICES. Free-to-guest revenues decreased 1.7%, or
$149,000, in 1997 as compared to 1996. This decrease is the result of the
combination of an 18.2% decrease in the number of rooms receiving only
free-to-guest services from 1996, offset by increasing revenue per room
resulting from additional programming services taken by hotels, as well as
programming price increases.
OTHER. Revenue from other sources includes cable television revenue
generated by the residential services segment, revenue from international
license arrangements, and revenue from the sale of televisions, system
equipment, and service parts and labor. The increase in 1997 from the prior year
of $6.4 million, or 139%, is primarily due to increased cable television revenue
generated by the residential services segment of $2.4 million; increased
television sales of $1.5 million; increased sales of system equipment of
$864,000; increased service parts and labor of $450,000 and increased revenue
earned under international license arrangements of $318,000.
LodgeNet Entertainment Corporation 22 Form 10-K 1998
EXPENSE ANALYSIS
DIRECT COSTS. The following table sets forth information regarding
the Company's direct costs (in thousands) and gross profit margin for the
years ended December 31:
1996 1997
-------- --------
Direct costs:
Guest Pay $ 33,981 $ 45,632
Free-to-guest 6,784 5,663
Other 3,614 7,217
-------- --------
$ 44,379 $ 58,512
-------- --------
-------- --------
Gross profit margin:
Guest Pay 59.8% 60.8%
Free-to-guest 21.5% 33.3%
Other 21.0% 34.0%
Composite 54.6% 56.9%
Guest Pay direct costs increased 34.3% to $45.6 million in 1997 from
$34.0 million in the prior year. Since Guest Pay direct costs (primarily studio
and other license fees, video game license fees and the commission retained by
the hotel) are primarily based on related revenue, such direct costs generally
vary directly with revenue. As a percentage of Guest Pay revenue, such costs
decreased from 40.2% in 1996 to 39.2% in 1997. The relative decrease in Guest
Pay direct costs as a percentage of revenue in 1997 as compared to the prior
year is primarily the result of lower movie-related costs due to proportionately
lower revenue from newly-released motion pictures.
Free-to-guest direct costs decreased 16.5% to $5.7 million in 1997 from
$6.8 million in the prior year. As a percentage of free-to-guest revenue,
free-to-guest direct costs decreased to 66.7% in 1997 from 78.5% in the prior
year. This decrease is due to incentive discounts earned from programming
networks, partially offset by higher costs for both premium and non-premium
programming.
Direct costs associated with other revenue increased 99.7% to $7.2
million from $3.6 million in the prior year. As a percentage of related
revenues, such direct costs decreased to 66.0% in 1997 from 79.0% in 1996,
reflecting the effect of (i) increased cable television revenue generated by the
residential services segment, (ii) increased system equipment sales and revenue
from service parts and labor, both of which have higher margins than the other
sources of other revenue, and (iii) increased revenue generated under
international license arrangements.
The Company's overall gross profit increased 44.7% in 1997 to $77.2
million on a 38.9% increase in revenues compared to 1996. The Company's overall
gross profit margin was 56.9% in 1997 and 54.6% for the prior year.
OPERATING EXPENSES. The following table sets forth information in
regard to the Company's operating expenses (in thousands) for the years ended
December 31:
1996 1997
--------------------- ---------------------
Percent Percent
of Total of Total
Amount Revenues Amount Revenues
-------- -------- -------- --------
Operating expenses:
Guest Pay operations $ 15,032 15.4% $ 20,785 15.3%
Selling, general and 13,581 13.9% 20,717 15.3%
administrative
Depreciation and amortization 29,815 30.5% 43,760 32.2%
-------- -------- -------- --------
Total operating expenses $ 58,428 59.8% $ 85,262 62.8%
-------- -------- -------- --------
-------- -------- -------- --------
Guest Pay operations expenses consist of costs directly related to the
operation of systems at the hotel sites as well as at residential sites serviced
by the residential services segment. Excluding the expenses incurred to operate
the systems at residential sites, which were $1.4 million in 1997 and none in
1996, expenses related to Guest Pay operations increased 28.9%, or $4.3 million,
in 1997 from $15.0 million in the previous year. This increase is primarily
attributable to the 38.7% increase in
LodgeNet Entertainment Corporation 23 Form 10-K 1998
average installed Guest Pay rooms in 1997 as compared to 1996, partially
offset by lower average operating and service expenses incurred on a per room
basis. Per average installed guest pay room, such expenses were $3.52 per
month in 1997 as compared to $3.79 per month in 1996.
Selling, general and administrative expenses increased 52.5%, or
$7.1 million in 1997 from $13.6 million in the prior year. This increase
reflects the effect of substantially increased legal expenses, an increase in
the number of development and administrative personnel, increased
facilities-related expenses, and an increase of $1.8 million related to the
residential services segment. As a percentage of revenue, general and
administrative expenses represented 15.3% of total revenue in 1997 as
compared to 13.9% in the year earlier period.
Depreciation and amortization expenses increased 46.8% to $43.8 million
in 1997 from $29.8 million in the prior year. This increase is primarily
attributable to the increase in the number of installed Guest Pay and game
service equipped rooms previously discussed, as well as the associated software
costs and other capitalized costs such as service vans, equipment and computers
that are related to the increased number of rooms in service since the prior
year. Additionally, increases in administrative and facility related assets, as
well as an increase of $1.0 million related to the residential services segment,
have contributed to the increased depreciation and amortization.
OPERATING LOSS. The Company's operating loss, as a result of the
factors previously discussed, increased to $8.1 million in 1997 from
$5.1 million in 1996.
INTEREST EXPENSE. Interest expense, net of interest income,
increased to $17.0 million in 1997 from $8.2 million in 1996 due to increases
in long-term debt to fund the Company's continuing expansion of its
businesses. The average principal amount of long-term debt outstanding during
1997 was approximately $183.4 million (at a weighted average interest rate of
approximately 10.3%) as compared to an average principal amount outstanding
of approximately $65.4 million (at a weighted average interest rate of
approximately 10.0%) during 1996.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. As a result of
the issuance of EITF Issue 97-13 related to accounting for certain business
reengineering costs, the Company recorded a charge of $210,000 in 1997 to
write-off previously capitalized costs, in accordance with the new accounting
pronouncement.
NET LOSS. For the reasons previously discussed, the Company's net
loss increased to $25.6 million in 1997 from a net loss of $16.6 million in
the prior year.
EBITDA. As a result of increasing revenues from guest pay services,
and the other factors previously discussed, EBITDA increased 44.3% to $35.7
million in 1997 as compared to $24.7 million in 1996. EBITDA as a percentage
of total revenue increased to 26.3% in 1997 as compared to 25.3% in 1996.
SEASONALITY
The Company's quarterly operating results are subject to fluctuation
depending upon hotel occupancy rates and other factors. Typically, occupancy
rates are higher during the second and third quarters due to seasonal travel
patterns.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the growth of the Company's business has required
substantial amounts of capital. The Company has incurred operating and net
losses due in large part to the depreciation, amortization and interest
expenses related to the capital expenditures required to expand its lodging
and residential businesses. Historically, cash flow from operations has not
been sufficient to fund the cost of expanding the Company's business and to
service existing indebtedness. During 1998, capital expenditures were
$69.7 million (of which $14.2 million was incurred by ResNet) and net cash
provided by operating activities was $13.2 million (after the reduction of
net cash used in operating activities of $5.0 million from ResNet). Capital
expenditures were $104.4 million during 1997 (of which approximately
$16.8 million was incurred by ResNet), and net cash provided by operating
activities was $16.7 million (after the reduction of net cash used in
operating activities of $3.5 million from ResNet).
Depending on the rate of growth of its lodging business and other
factors, the Company expects to incur capital expenditures between approximately
$50 to $60 million in 1999. In addition, the Company's cash requirements during
1999 and 2000 are expected to include (i) payments to OCC in connection with the
settlement of the litigation between the Company and
LodgeNet Entertainment Corporation 24 Form 10-K 1998
OCC in equal amounts of $5.85 million on each of July 15, 1999 and July 15,
2000 pursuant to the terms of the multiple cross licenses and (ii) deferred
purchase payments of up to $1 million in each of 1999 and 2000 in connection
with the Company's acquisition of Connect Group Corporation. Pursuant to an
agreement reached with PRIMESTAR, the Company may purchase the 5% equity
interest in GICC currently held by PRIMESTAR during 1999, at a cash price of
up to $5.4 million in certain circumstances. The foregoing statements
regarding capital expenditures and cash requirements are forward-looking
statements and there can be no assurance in this regard. The actual amount
and timing of the Company's capital expenditures will vary (and such
variations could be material) depending upon the number of new contracts for
services entered into by the Company, the costs of installations and other
factors.
On February 25, 1999, the Company amended and restated its existing
bank credit facility. This amended facility consists of a $150 million secured
bank credit facility which combines a $75 million term loan ("Term Loan") and a
$75 million revolving loan facility ("Revolving Loan"). Proceeds under the Term
Loan were used to repay amounts outstanding under the revolving loan facility
that existed prior to the amendment and restatement. Minimum required repayments
of borrowings under the Term Loan for the respective years are (in thousands of
dollars): 2001 -- $15,000; 2002 -- $18,750; 2003 -- $18,750; 2004 -- $22,500.
As previously described, effective November 30, 1998, the Company
contributed its interest in the ResNet business to GICC. The Company has no
continuing obligation to fund any of GICC's operating and/or investing
activities. During 1998, the Company provided $19.3 million to fund ResNet's
operating and investing activities, all of which funding occurred prior to
November 30, 1998.
The Company believes that its operating cash flows and borrowings
available under the Revolving Loan will be sufficient to fund the Company's
future growth as contemplated under its current business plan, depending on the
rate of the Company's growth and other factors. However, if the Company's plans
or assumptions change, if its assumptions prove to be inaccurate or if the
Company experiences unanticipated costs or competitive pressures, the Company
may be required to seek additional capital sooner than currently anticipated.
There can be no assurance that the Company will be able to obtain financing, or,
if such financing is available, that the Company will be able to obtain it on
acceptable terms. Failure to obtain additional financing, if needed, could
result in the delay or abandonment of some or all of the Company's expansion
plans.
YEAR 2000 INFORMATION
The Company is engaged in a comprehensive review of internal computer
systems and software and external business relationships in regard to Year 2000
issues.
STATE OF READINESS. The Company has a project team comprised of key
members from cross-organization departments. The team's objectives are to
gather information and facilitate research on Year 2000 issues that could
affect the Company, and to take necessary actions to eliminate or minimize
the impact of such issues. Internally, the Company has nearly completed its
efforts to identify the computer hardware and software that is used both at
its in-house facilities as well as at its hotel properties. Research and
testing of these systems for Year 2000 compliance is underway. The Company
expects to substantially complete its research and testing of internal
computer hardware and software by the end of the second quarter of 1999.
Correction or replacement of hardware and software containing Year 2000
issues is in progress and is estimated for completion by the end of the third
quarter of 1999.
Externally, the Company is working to identify third party business
relationships that are impacted by the Year 2000 issue. Research and review of
these relationships is underway including contacting the third parties to
solicit information and assurances relating to potential Year 2000 issues and
reviewing responses. The Company expects to complete its review of third party
relationships by the end of the second quarter of 1999, although no assurance
can be given as to the Year 2000 remediation of third parties.
COSTS ASSOCIATED WITH YEAR 2000 ISSUES. Incremental costs are
expected to be comprised primarily of costs to purchase software upgrades and
hardware. Additionally, external consulting, programming and training costs
may be incurred. Estimated costs of Year 2000 compliance are not fully
determined at this time. The Company expects to incur less than $500,000 in
aggregate out-of-pocket costs in 1998 and 1999 to complete its Year 2000
compliance program, excluding the cost of internal staffing. As of
December 31, 1998, the Company has incurred out-of-pocket costs totaling
$185,000 toward Year 2000 compliance efforts. Such funds have been provided
from the Company's bank credit facility. Although the Company intends to
develop and implement, if necessary, appropriate contingency plans to
mitigate to the extent possible the effects of any Year 2000 noncompliance,
such plans may not be adequate and the cost of Year 2000 compliance may be
greater than $500,000.
LodgeNet Entertainment Corporation 25 Form 10-K 1998
RISKS ASSOCIATED WITH YEAR 2000 ISSUES. The Company is highly
dependent upon its own information technology systems and those of its
suppliers and customers. The Company's or a third party's failure to correct
a material Year 2000 problem could result in a failure of or interruption in
the Company's business activities and operations. Such interruptions and
failures could materially and adversely affect the Company's results of
operations, liquidity and financial condition. The Company's Year 2000
project is expected to reduce significantly the Company's level of
uncertainty and the possibility of significant or long-lasting interruptions
of the Company's business operations; however, the Company believes that it
is impossible to predict all of the areas in which material problems may
arise.
CONTINGENCY PLANS. The Company has not yet completed specific
contingency plans for Year 2000 issues. The Company is in the process of
identifying the most reasonably likely worst-case scenarios, so that it may
attempt to secure alternate vendors and service providers for these functions
as well as to develop alternative systems which could be used to process data.
While the Company anticipates achieving Year 2000 compliance in a timely
manner, there can be no assurance that all processes will be compliant, that
there will be no significant delay or loss of revenues, or that no material
supply sources will be interrupted. However, the Company believes that its
planning and action efforts will help reduce any loss or disruption.
MARKET RISK DISCLOSURES
The Company's bank credit facility described in Note 9 to the financial
statements as well as in Management's Discussion and Analysis of Financial
Condition and Results of Operations carries interest rate risk. Amounts borrowed
under this facility are subject to interest rates based on the lender's base
rate of either the prime interest rate or the eurodollar rate. Should the
lender's base rate change, the Company's interest expense will increase or
decrease accordingly. As of December 31, 1998, the Company had borrowed
approximately $76.5 million subject to interest rate risk. On this amount, a 1%
increase in the lender's base interest rate would cost the Company $765,000 in
additional gross interest expense on an annual basis.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See "Item 14 - Exhibits, Financial Statement Schedules and Reports on
Form 8-K" for the Company's Consolidated Financial Statements, the Notes thereto
and Schedules filed as a part of this report.
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Except as hereinafter noted, the information concerning directors and
executive officers of the Company is incorporated by reference from the sections
entitled "Executive Officers", "Election of Directors - Board of Directors and
Nominees" and "Compliance with Reporting Requirements of Section 16 of the
Exchange Act" of the Company's definitive Proxy Statement to be filed pursuant
to Regulation 14A within 120 days after the end of the last fiscal year.
ITEM 11 - EXECUTIVE COMPENSATION
Information concerning executive remuneration and transactions is
incorporated by reference from the section entitled "Beneficial Ownership of
Principal Stockholders and Management" of the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A within 120 days after the end
of the last fiscal year.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of certain beneficial owners
and management is incorporated by reference from the section entitled
"Beneficial Ownership of Principal Stockholders and Management" of the Company's
definitive Proxy Statement to be filed pursuant to Regulation 14A within 120
days after the end of the last fiscal year.
LodgeNet Entertainment Corporation 26 Form 10-K 1998
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions
with management is incorporated by reference from the section entitled "Certain
Transactions with Management and Others" of the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A within 120 days after the end
of the fiscal year.
PART IV
ITEM 14 -- EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES -- Reference is made to
the "Index to Consolidated Financial Statements" of LodgeNet
Entertainment Corporation, located at page F - 1 of this PART IV, for a
list of the financial statements and schedules for the year ended
December 31, 1998 included herein.
(b) REPORTS ON FORM 8-K -- During the quarter ended December 31, 1998, the
Company filed one report on Form 8-K, dated December 15, 1998, reporting
on the transfer of the ResNet business to GICC.
(c) EXHIBITS -- Following is a list of Exhibits filed with this report.
Exhibits 10.1 and 10.2 constitute management contracts. Exhibits 10.3,
10.7, 10.8, 10.9, 10.10, 10.11, and 10.12 constitute compensatory plans.
EXHIBIT NO.
3.1 Certificate of Incorporation of the Company (1)
3.2 By-Laws of the Registrant (1)
4.1 Registration Rights Agreement dated as of December 16, 1996, between
LodgeNet Entertainment Corporation and Morgan Stanley & Co.
Incorporated, NatWest Capital Markets Limited and Montgomery
Securities (8)
4.2 Indenture dated as of December 19, 1996, between LodgeNet Entertainment
Corporation and Marine Midland Bank, as trustee, including the form of
Senior Note (8)
4.3 Form of Senior Notes (included in Exhibit 4.2)
4.4 First Supplemental Indenture dated October 15, 1998, among LodgeNet
Entertainment Corporation and Marine Midland Bank, as trustee, to the
Indenture dated December 19, 1996 (see Exhibit 4.2)
10.1 Form of Employment Agreement between the Company and each of Tim C.
Flynn and Scott C. Petersen (1)
10.2 Form of Agreement between the Company and each of David M. Bankers, John
M. O'Haugherty, Douglas D. Truckenmiller and Steven D. Truckenmiller (1)
10.3 LodgeNet Entertainment Corporation Stock Option Plan (as amended and
restated effective August 15, 1996) (8)
10.6 License Agreement dated May 2, 1993 between Nintendo of America, Inc.
and LodgeNet Entertainment Corporation (2)
10.7 Stock Option Agreements dated as of February 29, 1988 between the
Company and Tim C. Flynn, as extended by Extension Agreement dated as of
July 15, 1991 (2)
10.8 Stock Option Agreements dated as of February 29, 1988 between the
Company and Scott C. Petersen, as extended by Extension Agreement dated
as of July 15, 1991 (2)
10.9 Stock Option Agreement dated as of December 31, 1992 between the Company
and John M. O'Haugherty (2)
10.10 Stock Option Agreement dated as of December 31, 1992 between the Company
and David M. Bankers (2)
LodgeNet Entertainment Corporation 27 Form 10-K 1998
10.11 Form of Stock Option Agreement for Non-Employee Directors (3)
10.12 Form of Incentive Stock Option Agreement for Key Employees (3)
10.13 Securities Purchase Agreement, by and between LodgeNet Entertainment
Corporation, John Hancock Mutual Life Insurance Company, Allstate Life
Insurance Company, Connecticut Mutual Life Insurance and CMA Life
Insurance Company, dated as of August 9, 1995 (4)
10.14 Amendment to Securities Purchase Agreement, dated as of December 19,
1996 (8)
10.15 Form of Executive Severance Agreement between the Company and each of
Tim C. Flynn, Scott C. Petersen, Jeffrey T. Weisner, John M.
O'Haugherty, David M. Bankers, Douglas D. Truckenmiller, Steven D.
Truckenmiller and Eric R. Jacobsen; all dated of July 25, 1995 (5)
10.16 Video Services Agreement by and among GE Capital-ResCom L.P. and ResNet
Communications, Inc. and LodgeNet Entertainment Corporation dated as of
February 9, 1996 (6)+
10.17 Amended and Restated Loan Agreement by and among LodgeNet Entertainment
Corporation, the Banks Signatory thereto, National Westminster Bank Plc,
as Agent for such Banks, and National Westminster bank of Canada, as an
Issuing bank, dated December 19, 1996 (8)
10.18 Equipment Sales Agreement between ResNet Communications, Inc. and TCI
Satellite Entertainment, Inc., dated as of October 21, 1996 (7)
10.19 Subordinated Convertible Term Loan Agreement between ResNet
Communications, Inc. and TCI Satellite Entertainment, Inc., dated as of
October 21, 1996 (7)
10.20 Option Agreement between ResNet Communications, Inc. and TCI Satellite
Entertainment, Inc., dated as of October 21, 1996 (7)
10.21 Standstill Agreement between LodgeNet Entertainment Corporation and TCI
Satellite Entertainment, Inc., dated as of October 21, 1996 (7)
10.22 Stockholders' Agreement between LodgeNet Entertainment Corporation and
TCI Satellite Entertainment, Inc., dated as of October 21, 1996 (7)
10.23 Subscription Agreement between ResNet Communications, Inc. and TCI
Satellite Entertainment, Inc., dated as of October 21, 1996 (7)
10.24 First Amendment, dated October 17, 1996, to License Agreement between
Nintendo of America, Inc. and LodgeNet Entertainment Corporation (8)
10.25 Exchange Agreement, dated November 30, 1998, among Shared Technologies
Communications Corporation, Interactive Cable Systems, Inc., ResNet
Communications, LLC, ResNet Communications, Inc. and Global Interactive
Technologies Corporation (9)
10.26 Stockholders Agreement dated November 30, 1998, by and among Global
Interactive Technologies Corporation, Shared Technologies Communications
Corporation, Interactive Cable Systems, Inc. and ResNet Communications,
LLC (9)
10.27 Consent and Restructuring Agreement dated November 6, 1998, by and among
ResNet Communications, LLC, ResNet Communications, Inc., and PrimeStar
MDU
10.28 Second Amended and Restated Credit Agreement dated as of February 25,
1999, by and among LodgeNet Entertainment Corporation, National
Westminster Bank Plc, BankBoston, N.A., Morgan Stanley Senior Funding,
Inc. and the Lenders Named Therein
LodgeNet Entertainment Corporation 28 Form 10-K 1998
10.29 Confidential License Agreement for Use of Nintendo Video Game Systems
with Hotel Entertainment System, dated May 12, 1998, between LodgeNet
Entertainment Corporation and Nintendo of America Inc. +
12.1 Statement Regarding Computation of Ratios
21.1 Subsidiaries of the Company (10)
23.1 Consent of Independent Public Accountants
- ---------
+ Confidential Treatment has been requested with respect to certain portions of
these agreements.
(1) Incorporated by Reference to the Company's Amendment No. 1 to
Registration Statement on Form S-1, as filed with the Securities and
Exchange Commission, September 24, 1993.
(2) Incorporated by Reference to the Company's Amendment No. 2 to
Registration Statement on Form S-1, as filed with the Securities and
Exchange Commission, October 13, 1993.
(3) Incorporated by Reference to the Annual Report on Form 10-K for the year
ended December 31, 1993, as filed with the Securities and Exchange
Commission, March 25, 1994.
(4) Incorporated by Reference to the Quarterly Report on Form 10-Q for the
quarter ended June 30, 1995, as filed with the Securities and Exchange
Commission, August 14, 1995.
(5) Incorporated by Reference to the Quarterly Report on Form 10-Q for the
quarter ended September 30, 1995, as filed with the Securities and
Exchange Commission, November 14, 1995.
(6) Incorporated by Reference to the Annual Report on Form 10-K for the year
ended December 31, 1995, as filed with the Securities and Exchange
Commission, April 1, 1996.
(7) Incorporated by Reference to TCI Satellite Entertainment, Inc.'s
Amendment No. 1 to Registration Statement on Form 10 as filed with the
Securities and Exchange Commission, October 29, 1996.
(8) Incorporated by Reference to the Annual Report on Form 10-K for the year
ended December 31, 1996, as filed with the Securities and Exchange
Commission, March 17, 1997.
(9) Incorporated by Reference to the Form 8-K as filed with the Securities
and Exchange Commission, December 15, 1998.
(10) Incorporated by Reference to the Annual Report on Form 10-K for the year
ended December 31, 1997, as filed with the Securities and Exchange
Commission, March 25, 1998.
LodgeNet Entertainment Corporation 29 Form 10-K 1998
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized in the City of Sioux
Falls, State of South Dakota, on March 25, 1999.
LodgeNet Entertainment Corporation
By: /s/ SCOTT C. PETERSEN
---------------------------------------
Scott C. Petersen, President and
Chief Executive Officer
LodgeNet Entertainment Corporation 30 Form 10-K 1998
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ SCOTT C. PETERSEN President and Chief Executive March 25, 1999
- ------------------------ Officer, Director (Principal
Scott C. Petersen Executive Officer)
/s/ JEFFREY T. WEISNER Senior Vice President March 25, 1999
- ------------------------ Chief Financial Officer
Jeffrey T. Weisner (Principal Financial
Officer)
/s/ RONALD W. PIERCE Vice President and Corporate March 25, 1999
- ------------------------ Controller (Principal
Ronald W. Pierce Accounting Officer)
/s/ TIM C. FLYNN Chairman of the Board March 25, 1999
- ------------------------ and Director
Tim C. Flynn
/s/ DAVID AUSTAD Director March 25, 1999
- ------------------------
David Austad
/s/ LAWRENCE FLINN, JR. Director March 25, 1999
- ------------------------
Lawrence Flinn, Jr.
/s/ RICHARD R. HYLLAND Director March 25, 1999
- ------------------------
Richard R. Hylland
/s/ R. F. LEYENDECKER Director March 25, 1999
- ------------------------
R. F. Leyendecker
LodgeNet Entertainment Corporation 31 Form 10-K 1998
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Public Accountants ................................ F - 2
Consolidated Balance Sheets as of December 31, 1997 and 1998 ............ F - 3
Consolidated Statements of Operations --
Three Years Ended December 31, 1998 ..................................... F - 4
Consolidated Statements of Stockholders' Equity --
Three Years Ended December 31, 1998 ..................................... F - 5
Consolidated Statements of Cash Flows --
Three Years Ended December 31, 1998 ..................................... F - 6
Notes to Consolidated Financial Statements .............................. F - 7
INDEX TO FINANCIAL SCHEDULES
Report of Independent Public Accountants on Schedule .................... F - 22
Schedule II -- Valuation and Qualifying Accounts ........................ F - 23
LodgeNet Entertainment Corporation F - 1 Form 10-K 1998
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To LodgeNet Entertainment Corporation:
We have audited the accompanying consolidated balance sheets of
LodgeNet Entertainment Corporation (a Delaware corporation) and Subsidiaries
as of December 31, 1997 and 1998, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years
in the period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of LodgeNet
Entertainment Corporation and Subsidiaries as of December 31, 1997 and 1998,
and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota
February 12, 1999 (except
for Note 9, as to which the
date is February 25, 1999)
LodgeNet Entertainment Corporation F - 2 Form 10-K 1998
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands)
December 31,
--------------------------
1997 1998
---------- ----------
Assets
Current assets:
Cash and cash equivalents $ 1,021 $ 5,240
Accounts receivable, net of allowance for doubtful accounts 21,835 27,586
Prepaid expenses and other 3,457 6,086
---------- ----------
Total current assets 26,313 38,912
Property and equipment, net of accumulated depreciation 218,948 209,437
Investments in and advances to unconsolidated affiliates -- 32,701
Debt issuance costs, net of accumulated amortization 7,641 6,637
Other assets, net 7,392 18,343
---------- ----------
$ 260,294 $ 306,030
---------- ----------
---------- ----------
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 16,792 $ 13,705
Current maturities of long-term debt 705 5,718
Accrued expenses 8,148 9,410
Deferred revenue 2,069 2,318
---------- ----------
Total current liabilities 27,714 31,151
Long-term debt 182,691 262,375
Minority interest in consolidated subsidiary 310 730
---------- ----------
Total liabilities 210,715 294,256
---------- ----------
Commitments and contingencies (Note 10)
Stockholders' equity:
Common stock, $.01 par value, 20,000,000 shares
authorized; 11,322,058 and
11,942,387 shares outstanding at December 31,
1997 and 1998, respectively 113 119
Additional paid-in capital 120,792 123,706
Accumulated other comprehensive loss (699) (1,512)
Accumulated deficit (70,627) (110,539)
---------- ----------
Total stockholders' equity 49,579 11,774
---------- ----------
$ 260,294 $ 306,030
---------- ----------
---------- ----------
The accompanying notes are an integral part of these
consolidated balance sheets.
LodgeNet Entertainment Corporation F - 3 Form 10-K 1998
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollar amounts, except per share amounts, in thousands)
Years Ended December 31,
---------------------------------------------------
1996 1997 1998
------------- ------------- -------------
Revenues:
Guest Pay $ 84,504 $ 116,276 $ 146,481
Free-to-guest 8,645 8,496 7,854
Other 4,572 10,938 12,016
------------- ------------- -------------
Total revenues 97,721 135,710 166,351
------------- ------------- -------------
Direct costs:
Guest Pay 33,981 45,632 60,538
Free-to-guest 6,784 5,663 6,373
Other 3,614 7,217 7,097
------------- ------------- -------------
Total direct costs 44,379 58,512 74,008
------------- ------------- -------------
Gross profit 53,342 77,198 92,343
------------- ------------- -------------
Operating expenses:
Guest Pay operations 15,032 20,785 25,167
Selling, general and administrative 13,581 20,717 18,600
Restructuring charge (Note 3) -- -- 3,300
Depreciation and amortization 29,815 43,760 55,215
------------- ------------- -------------
Total operating expenses 58,428 85,262 102,282
------------- ------------- -------------
Operating loss (5,086) (8,064) (9,939)
Equity in losses of unconsolidated affiliates -- -- 6,550
Interest expense, net 8,243 17,001 23,048
------------- ------------- -------------
Loss before income taxes, extraordinary loss, and
cumulative effect of change in accounting principle (13,329) (25,065) (39,537)
Provision for income taxes 28 344 375
------------- ------------- -------------
Loss before extraordinary loss and cumulative
effect of change in accounting principle (13,357) (25,409) (39,912)
Extraordinary loss (Note 15) 3,253 -- --
Cumulative effect of change in accounting principle
(Note 16) -- 210 --
------------- ------------- -------------
Net loss $ (16,610) $ (25,619) $ (39,912)
------------- ------------- -------------
------------- ------------- -------------
Per common share (basic and diluted):
Loss before extraordinary loss and cumulative
effect of change in accounting principle $ (1.40) $ (2.25) $ (3.45)
Extraordinary loss (0.34) -- --
Cumulative effect of change in accounting principle -- (0.02) --
------------- ------------- -------------
Net loss $ (1.74) $ (2.27) $ (3.45)
------------- ------------- -------------
------------- ------------- -------------
Weighted average shares outstanding (basic and diluted) 9,570,779 11,271,064 11,579,457
------------- ------------- -------------
------------- ------------- -------------
The accompanying notes are an integral part of these
consolidated financial statements.
LodgeNet Entertainment Corporation F - 4 Form 10-K 1998
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollar amounts in thousands)
Accumulated
Common Stock Additional Other
----------------------- Paid-in Accumulated Comprehensive
Shares Amount Capital Deficit Loss Total
---------- ------ ------------ ------------ ------------- ------------
Balance, December 31, 1995 7,352,113 $ 74 $ 71,234 $ (28,398) $ (184) $ 42,726
Issuance of common stock 3,680,000 36 44,599 -- -- 44,635
Common stock option activity 93,256 1 34 -- -- 35
Comprehensive loss:
Net loss -- -- -- (16,610) -- (16,610)
Foreign currency
translation adjustment -- -- -- -- 94 94
-----------
Comprehensive loss (16,516)
Change of interest in
subsidiary -- -- 4,672 -- -- 4,672
---------- ------ ------------ ------------ ------------- ------------
Balance, December 31, 1996 11,125,369 111 120,539 (45,008) (90) 75,552
Common stock option activity 196,689 2 332 -- -- 334
Comprehensive loss:
Net loss -- -- -- (25,619) -- (25,619)
Foreign currency
translation adjustment -- -- -- -- (609) (609)
-----------
Comprehensive loss (26,228)
Change of interest in
subsidiary -- -- (79) -- -- (79)
---------- ------ ------------ ------------ ------------- ------------
Balance, December 31, 1997 11,322,058 113 120,792 (70,627) (699) 49,579
Issuance of common stock 350,000 3 3,081 -- -- 3,084
Common stock option activity 270,329 3 253 -- -- 256
Comprehensive loss:
Net loss -- -- -- (39,912) -- (39,912)
Foreign currency
translation adjustment -- -- -- -- (813) (813)
-----------
Comprehensive loss (40,725)
Change of interest in
subsidiary -- -- (420) -- -- (420)
---------- ------ ------------ ------------ ------------- ------------
Balance, December 31, 1998 11,942,387 $ 119 $ 123,706 $ (110,539) $ (1,512) $ 11,774
---------- ------ ------------ ------------ ------------- ------------
---------- ------ ------------ ------------ ------------- ------------
The accompanying notes are an integral part of these
consolidated financial statements.
LodgeNet Entertainment Corporation F - 5 Form 10-K 1998
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollar amounts in thousands)
Years Ended December 31,
------------------------------------------
1996 1997 1998
---------- ---------- ----------
Operating activities:
Net loss $ (16,610) $ (25,619) $ (39,912)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization 29,815 43,760 55,215
Gain on sale of property and equipment -- -- (309)
Non-cash portion of extraordinary loss 434 -- --
Non-cash portion of restructuring charge -- -- 840
Equity in losses of unconsolidated affiliates -- -- 6,550
Change in operating assets and liabilities:
Accounts receivable (6,278) (3,288) (6,157)
Prepaid expenses and other (473) (1,138) (2,659)
Accounts payable 1,864 1,053 (2,770)
Accrued expenses and deferred revenue 1,433 1,524 1,677
Other (623) 361 768
---------- ---------- ----------
Net cash provided by operating activities 9,562 16,653 13,243
---------- ---------- ----------
Investing activities:
Property and equipment additions (84,256) (96,290) (68,733)
Proceeds from sale of property and equipment -- -- 412
Business acquisitions -- (8,087) (927)
Investment in unconsolidated affiliates -- -- (8,330)
Proceeds from sale of interest in subsidiary 5,396 -- --
---------- ---------- ----------
Net cash used for investing activities (78,860) (104,377) (77,578)
---------- ---------- ----------
Financing activities:
Proceeds from long-term debt 150,000 -- 1,000
Repayments of long-term debt (33,095) (583) (6,148)
Borrowings under revolving credit facility 55,958 3,000 73,500
Repayments of revolving credit facility (55,958) -- --
Debt issuance costs (7,969) (141) --
Proceeds from issuance of common stock 44,635 -- --
Stock issuance costs (477) -- --
Stock option activity 35 334 256
---------- ---------- ----------
Net cash provided by financing activities 153,129 2,610 68,608
---------- ---------- ----------
Effect of exchange rates on cash 94 (42) (54)
---------- ---------- ----------
Increase (decrease) in cash and cash equivalents 83,925 (85,156) 4,219
Cash and cash equivalents at beginning of period 2,252 86,177 1,021
---------- ---------- ----------
Cash and cash equivalents at end of period $ 86,177 $ 1,021 $ 5,240
---------- ---------- ----------
---------- ---------- ----------
The accompanying notes are an integral part of these
consolidated financial statements.
LodgeNet Entertainment Corporation F - 6 Form 10-K 1998
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- THE COMPANY
LodgeNet Entertainment Corporation ("LodgeNet" or the "Company") and its
wholly-owned Canadian subsidiary assemble, install and operate guest pay movie
systems and provide cable television programming, network-based video games and
other interactive entertainment and information systems to the lodging industry,
primarily in the United States and Canada. ResNet Communications, Inc. ("ResNet
Inc."), a wholly-owned subsidiary of the Company, was the majority owner of
ResNet Communications, LLC ("ResNet LLC") until November 30, 1998, at which time
ResNet LLC was merged with two other entities to form a new entity (see Note 3).
ResNet LLC installed and operated private cable television systems in
multi-family residential properties nationwide.
The Company's operating performance and outlook are strongly influenced
by such factors as overall occupancy levels, guest demographics, and economic
conditions in the lodging industry, the number of lodging rooms equipped with
the Company's systems, the number and type of guest pay product offerings, the
popularity and availability of programming, and competitive factors.
The rapid growth of the Company's business has required capital
resources in excess of operating cash flows. While the Company's working
capital, operating cash flows and its revolving credit facility are expected to
be sufficient to fund its growth, the Company may, depending on its rate of
growth, require additional growth capital in subsequent years.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements
include the accounts of the Company, its wholly-owned Canadian subsidiary, and
ResNet Inc. Affiliated companies in which LodgeNet does not have a controlling
interest are accounted for using the equity method. All significant
inter-company accounts and transactions have been eliminated in consolidation.
FOREIGN CURRENCY TRANSLATION -- The assets and liabilities of the
Company's Canadian subsidiary were translated at year-end exchange rates. Income
statement items were translated at average exchange rates during the periods.
USE OF ESTIMATES -- The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions about certain matters and items. These estimates
and assumptions affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities, at the date of the financial
statements; and the reported amounts of revenues, expenses and costs during the
reporting periods. The ultimate outcome of the matters and items may be
different from the estimates and assumptions.
FAIR VALUE OF FINANCIAL INSTRUMENTS -- The carrying amounts for items
comprising current assets and current liabilities approximate fair value due to
the short period to maturity of these items. The fair value of long-term debt
instruments is estimated by reference to current yields to maturity on similar
instruments or quotes where available. The fair value of the warrants issued
during 1995 was estimated using option valuation techniques.
LodgeNet Entertainment Corporation F - 7 Form 10-K 1998
PROPERTY AND EQUIPMENT -- Property and equipment is stated at cost,
including certain payroll costs related to the installation of new systems.
Maintenance costs, which do not significantly extend the useful lives of the
respective assets, and repairs are charged to operations as incurred.
Depreciation of guest pay and free-to-guest systems begins when such systems are
installed and activated. Depreciation of other equipment begins when such
equipment is placed in service. The Company attributes no salvage value to any
equipment. Depreciation and amortization are computed using the straight-line
method over the following useful lives:
Years
-----
Buildings 30
Guest Pay systems:
System components 5 - 7
In-room equipment 2 - 5
Free-to-guest systems 5 - 7
Other equipment 3 - 10
SOFTWARE DEVELOPMENT -- The Company has capitalized certain costs of
developing software for its guest pay systems in accordance with AICPA Statement
of Position 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use". Capitalized costs are reported at the lower of
unamortized cost or net realizable value, and are amortized over the system's
estimated useful life, not to exceed five years. Guest pay system development
costs capitalized were $1,616,000, $2,100,000 and $2,405,000 during the years
ended December 31, 1996, 1997 and 1998, respectively. Amortization of such costs
was $599,000, $797,000 and $1,138,000 for the years ended December 31, 1996,
1997 and 1998, respectively. The Company charged $216,000, $410,000, and
$252,000 to operations during the years ended December 31, 1996, 1997 and 1998,
respectively, related to research and development activities.
REVENUE RECOGNITION -- Revenue and related costs are recognized when
services are rendered. The Company has obtained certain programming agreements
which provide for the receipt of low-cost programming in the earlier years of
such agreements. The Company's policy is to record the costs of such programming
on a straight-line basis. During 1997, the Company entered into a new long term
agreement with a major programming source, superseding a previous programming
agreement. As a result, the recognition of approximately $1.2 million of
previously deferred programming cost reductions was accelerated in 1997. At
December 31, 1996, 1997 and 1998 the Company had recorded deferred cost
reductions relating to such agreements of $1,835,000, $450,000 and $85,000,
respectively.
CONCENTRATION OF CREDIT RISKS AND CUSTOMER DATA -- The Company has
derived virtually all of its revenue from entities in the lodging industry,
however, no individual customer accounted for 10% or more of total revenue in
any period presented in the accompanying consolidated statements of operations.
The allowance for doubtful accounts was $800,000 at December 31, 1997 and 1998.
The provision for doubtful accounts was $922,000 in 1996, $820,000 in 1997, and
$848,000 in 1998.
INCOME TAXES -- The Company accounts for income taxes under the
liability method, in accordance with the requirements of Statement of Financial
Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes". Deferred
income tax assets and liabilities are computed annually for differences between
the financial statement and tax basis of assets and liabilities. Measurement is
based on enacted tax rates applicable to the periods in which such differences
are expected to reverse.
COMPREHENSIVE INCOME -- During 1998, the Company adopted SFAS No. 130,
"Reporting Comprehensive Income" which requires companies to report all changes
in equity during a period, except those resulting from investments by owners and
distributions to owners, in a financial statement for the period in which they
are recognized. The Company has chosen to disclose comprehensive income, which
is comprised of net income and foreign currency translation adjustments, in the
consolidated statement of stockholders' equity. Comprehensive income amounts in
prior years' financial statements have been restated to conform to the
requirements of SFAS No. 130.
LodgeNet Entertainment Corporation F - 8 Form 10-K 1998
LOSS PER SHARE COMPUTATION -- During 1997, the Company adopted SFAS No.
128, "Earnings Per Share". SFAS No. 128 changes the manner in which earnings per
share ("EPS") are calculated and presented. The new standard requires the
computation and disclosure of two EPS amounts, basic and diluted. Basic EPS is
computed based only on the weighted average number of common shares actually
outstanding during the period. Diluted EPS is computed based on the weighted
average number of common shares outstanding plus all potentially dilutive common
shares outstanding during the period. Weighted average options on 1,458,839,
1,597,331, and 1,736,333 shares of common stock were not included in computing
diluted EPS because their effects were antidilutive for the years ended December
31, 1996, 1997, and 1998, respectively.
STOCK-BASED COMPENSATION -- The Company measures compensation costs
associated with its stock option plans in accordance with the provisions of
Accounting Principles Board Opinion No. 25, as permitted by SFAS No. 123. The
effect of fair value based measurement of such costs on net loss and net loss
per share, in accordance with SFAS No. 123, is disclosed on a pro forma basis in
Note 12.
STATEMENTS OF CASH FLOWS -- Cash equivalents are comprised of demand
deposits and temporary investments in highly liquid securities having original
maturities of 90 days or less. Cash paid for interest was $7,870,000,
$17,828,000, and $21,633,000 during the years ended December 31, 1996, 1997, and
1998, respectively. Equipment acquired under capital lease arrangements totaled
$1,002,000, $1,106,000, and $885,000 during the years ended December 31, 1996,
1997, and 1998, respectively. During 1998, non-cash activities included the
acquisition of license rights valued at $15,709,000 in exchange for notes
payable issued by the Company (see Note 10) and the issuance of 350,000 common
shares valued at $3,084,000 as part of an acquisition completed during the year
(see Note 4).
RECLASSIFICATIONS -- Certain items in the consolidated financial
statements have been reclassified to conform to 1998 classifications. Such
reclassifications had no effect on previously reported net loss or stockholders'
equity.
NOTE 3 -- RESNET MERGER
Effective November 30, 1998, the operations of the Company's
majority-owned subsidiary, ResNet Communications, LLC ("ResNet LLC"), were
merged with two non-affiliated entities to form a new entity, Global Interactive
Communications Corporation ("GICC"). GICC's business will consist of providing
cable television programming and telecommunications services to the multi-family
dwelling unit market. The Company contributed net assets totaling $31.3 million
in exchange for (i) a 30% equity interest in GICC, and (ii) notes receivable
totaling $10.8 million. In addition, the Company advanced GICC $1.5 million
under the terms of a secured note agreement. The notes receivable consist of
four separate instruments as follows:
SENIOR TERM NOTE - The Company loaned $1.5 million to GICC under this
note. Subject to certain extension and default provisions contained in the
agreement, the note is due May 30, 1999. Interest is charged at a rate of 10%
and is also due May 30, 1999. The note, along with GICC's other senior
indebtedness, is secured by substantially all of the assets of GICC.
JUNIOR TERM NOTE - The Company loaned $2.9 million to GICC under this
note. Subject to certain extension and default provisions contained in the
agreement, the note is due May 30, 1999. Interest is charged at a rate of 10%
and is also due May 30, 1999. The note ranks consistent with GICC's senior
indebtedness in terms of security.
CAPITAL ADVANCE NOTE - The Company loaned $3.0 million to GICC under
this note. Beginning in June 1999, four quarterly installments of $750,000 (plus
accrued interest charged at a rate of 10%) are required. The capital advance
note is subordinate to the senior and junior term notes described above.
LodgeNet Entertainment Corporation F - 9 Form 10-K 1998
CAPITAL LEASE AGREEMENT - GICC acquired equipment valued at $4.9 million
in exchange for a capital lease note. The note requires GICC to make 60 equal
monthly payments of $106,000. The note is secured by the assets subject to the
capital lease agreement.
In connection with this transaction, the Company incurred $3.3 million
of costs during the fourth quarter including professional services fees,
employee costs, and the write-off of certain capitalized software development
costs. These costs are reported as a restructuring charge in the 1998
consolidated statement of operations. The Company's interest in GICC
approximated its proportionate share of the independently appraised value of
GICC. Accordingly, no gain or loss was recognized as a result of this
transaction. As more fully described in Note 14, the Company may be required to
acquire an additional 5% of GICC in 1999.
NOTE 4 -- ACQUISITION
In October 1998, the Company completed the acquisition of Connect Group
Corporation ("CGC"), in exchange for initial consideration of approximately
$4.0 million, including acquisition costs, consisting of $927,000 and 350,000
shares of LodgeNet common stock. CGC developed technology that the Company
intends to use to provide high speed Internet access to hotel guests and
operators. The acquisition has been accounted for as a purchase and the
excess of the initial consideration over the fair value of CGC's net assets
of approximately $4.0 million has been recorded as an intangible asset and is
being amortized on a straight-line basis over 10 years. The pro forma results
for 1996, 1997 and 1998, assuming the transaction had been made as of the
beginning of those years, would not be materially different from reported
results.
In addition to the approximate $4.0 million of initial consideration,
the purchase agreement contains provisions for additional consideration to be
paid to the selling shareholders contingent on the performance of the acquired
technology in its application to the lodging industry. Depending on the
performance of the technology, as defined in the purchase agreement, the Company
may have to provide additional consideration of up to $1,000,000 on both the
first and second anniversary dates of the transaction.
NOTE 5 -- PROPERTY AND EQUIPMENT, NET
Property and equipment was comprised as follows at (in thousands of dollars):
December 31,
-------------------------
1997 1998
---------- ----------
Land, building and equipment $ 40,051 $ 48,105
Free-to-guest equipment 11,855 16,237
Cable television equipment 13,877 --
Guest pay systems:
Installed 220,778 257,980
System components 30,720 24,933
Software costs 8,053 8,640
---------- ----------
Total 325,334 355,895
Less - depreciation and (106,386) (146,458)
amortization
---------- ----------
Property and equipment, net $ 218,948 $ 209,437
---------- ----------
---------- ----------
LodgeNet Entertainment Corporation F - 10 Form 10-K 1998
NOTE 6 -- INVESTMENTS IN AFFILIATES
The Company obtained equity interests in two entities during 1998.
First, in February 1998, the Company acquired a 10% interest in Across Media
Networks, LLC ("AMN"), a company engaged in the creation and distribution of
digitally produced on-screen content for television and the Internet. The
Company has applied the equity method of accounting for this investment to
reflect the fact that the Company has had certain financing obligations to AMN.
Losses of $5.8 million related to this investment were recorded in 1998. Second,
as previously described, the merger of ResNet with two other entities effective
November 30, 1998 to form GICC resulted in the Company owning 30% of GICC. The
Company's portion of GICC's 1998 loss was $738,000.
Summarized unaudited financial information of these affiliates follows
(in thousands of dollars). The results of operations includes full year results
for AMN and results for GICC since inception on November 30, 1998.
1998
(Unaudited)
-----------
Summary Results of Operations:
Net sales $ 2,400
Gross profit $ (1,452)
Net loss $ (7,919)
Summary Balance Sheet:
Current assets $ 15,037
Non-current assets 85,796
-----------
Total assets $ 100,833
-----------
-----------
Current liabilities $ 24,566
Non-current liabilities 27,715
Stockholders' equity 48,552
-----------
Total liabilities and $ 100,833
stockholders' equity -----------
-----------
NOTE 7 -- DEBT ISSUANCE COSTS
Costs associated with the issuance of debt securities and with obtaining
credit facilities are capitalized and amortized over the term of the related
borrowing or facility. The Company capitalized $7,969,000 and $140,000 of debt
issuance costs during the years ended December 31, 1996 and 1997, respectively.
No debt issuance costs were incurred in 1998. Amortization of such costs was
$564,000 in 1996, $1,008,000 in 1997, and $1,004,000 in 1998. The 1996
amortization excludes $434,000 recorded as an extraordinary loss resulting from
the early redemption of the Company's 9.95% and 10.35% Senior Notes (see Note
15). The components of the debt issuance costs recorded in the balance sheets
are as follows (in thousands of dollars):
December 31,
----------------------
1997 1998
-------- --------
Debt issuance costs $ 8,960 $ 8,960
Accumulated (1,319) (2,323)
amortization -------- --------
$ 7,641 $ 6,637
-------- --------
-------- --------
LodgeNet Entertainment Corporation F - 11 Form 10-K 1998
NOTE 8 -- ACCRUED EXPENSES
Accrued expenses were comprised as follows at (in thousands of dollars):
December 31,
---------------------
1997 1998
------- -------
Accrued taxes $ 1,034 $ 1,345
Accrued compensation 2,567 2,427
Accrued interest 2,274 3,689
Other 2,273 1,949
------- -------
$ 8,148 $ 9,410
------- -------
------- -------
NOTE 9 -- LONG-TERM DEBT AND CREDIT FACILITIES
Long-term debt was comprised as follows at (in thousands of dollars):
December 31,
-------------------------
1997 1998
---------- ----------
Revolving Credit Facility $ 3,000 $ 76,500
10.25% Senior Notes 150,000 150,000
11.50% Senior Notes 30,000 30,000
Less - unamortized discount (1,169) (954)
Capital leases 1,565 1,326
Other -- 11,221
---------- ----------
183,396 268,093
Less current maturities (705) (5,718)
---------- ----------
$ 182,691 $ 262,375
---------- ----------
---------- ----------
REVOLVING CREDIT FACILITY -- On February 25, 1999, the Company amended
and restated its bank credit facility, increasing the size of the facility to
$150 million, comprised of a $75 million term loan and a $75 million revolving
credit facility. The $76.5 million outstanding at December 31, 1998 under the
previous revolving credit facility was repaid with proceeds from the term loan.
In addition to the $75 million term loan, the facility provides a $75 million
revolving credit facility, which may be increased at the Company's request to
$100 million, subject to certain limitations. Quarterly repayments on the term
loan begin in February 2001 and are as follows for the respective fiscal years
(in thousands of dollars): 2001 -- $15,000; 2002 -- $18,750; 2003 -- $18,750;
2004 -- $22,500. The revolving credit facility matures in February 2005. Loans
under the amended and restated facility will bear interest at the Company's
option of (1) the bank's prime rate plus a margin of from 1.00% to 1.75%,
depending on leverage as defined, or (2) the eurodollar rate plus a margin of
from 2.00% to 2.75%, depending on leverage as defined. The margins applicable to
the bank's prime rate and/or the eurodollar rate loans are subject to quarterly
adjustment as defined in the agreement. The loans will be secured by a first
priority security interest in all of the Company's assets.
The facility includes terms and conditions which require the maintenance
of certain financial ratios and place limitations on capital expenditures,
additional indebtedness, liens, investments, guarantees and certain payments or
distributions in respect of the common stock. As of December 31, 1998, the
Company was in compliance with all covenants, terms and conditions of its
previous revolving credit facility. As of the date of closing, the Company was
in compliance with all covenants, terms and conditions of the amended and
restated bank credit facility.
The amended facility provides for the issuance of letters of credit up
to $12 million, subject to customary terms and conditions. As of December 31,
1998, the Company had outstanding letters of credit totaling $6.5 million under
its previous revolving credit facility.
LodgeNet Entertainment Corporation F - 12 Form 10-K 1998
10.25% SENIOR NOTES -- In December 1996, the Company issued $150 million
of unsecured 10.25% Senior Notes (the "10.25% Notes"), due December 15, 2006.
The 10.25% Notes are unsecured, rank PARI PASSU in right of payment with future
unsubordinated unsecured indebtedness and rank senior in right of payment to all
subordinated indebtedness of the Company. The 10.25% Notes require semi-annual
interest payments and contain covenants which, among other matters, restrict the
ability of the Company to incur additional indebtedness, create liens, pay
dividends or make certain distributions in respect of its common stock; redeem
capital stock; issue or sell stock of subsidiaries in certain circumstances;
effect certain business combinations; and effect certain transactions with
affiliates or stockholders. As of December 31, 1998, the Company was in
compliance with all covenants, terms, and conditions of the 10.25% Notes.
The 10.25% Notes are redeemable at the option of the Company, in whole
or in part, on or after December 15, 2001, initially at 105.125% of their
principal amount (plus accrued and unpaid interest) declining ratably to 100% of
their principal amount (plus accrued and unpaid interest) on or after December
15, 2003. In addition, at any time prior to December 15, 1999, the Company may
redeem up to 35% of the aggregate principal amount of the 10.25% Notes with the
proceeds of one or more public equity offerings.
11.50% SENIOR NOTES -- During 1995, the Company issued $30 million
principal amount of unsecured 11.50% Senior Notes (the "11.50% Notes").
Mandatory annual principal payments of $6 million commence in July 2001
continuing through July 2005. Semi-annual interest payments are required. The
Company issued a total of 480,000 warrants (see Note 13) to purchase common
stock of the Company in connection with the issuance of the 11.50% Notes and the
value of the warrants, $1.68 million, was recorded as additional paid-in capital
and shown as a discount on the 11.50% Notes. As part of the refinancing
transaction in which the 10.25% Notes were issued, the holders of the 11.50%
Notes adopted the covenants and ranking of the 10.25% Notes.
Long-term debt has the following scheduled principal maturities for
the years ended December 31 (in thousands of dollars): 1999 -- $5,718;
2000 -- $5,778; 2001 -- $21,190; 2002 -- $24,797; 2003 -- $25,564;
thereafter -- $185,046.
At December 31, 1997 and 1998, the estimated fair value of the Company's
debt was $189.7 million and $268.0 million, respectively, which differs from the
recorded amounts of $183.4 million and $268.1 million, respectively.
NOTE 10 -- COMMITMENTS AND CONTINGENCIES
PROGRAMMING AGREEMENTS -- The Company, through programming agreements,
provides guest pay and free-to-guest programming services to the lodging and
multi-family residential unit industries. These agreements provide that the
Company receives monthly revenue for such services. Such agreements contain
various restrictions, including default and termination procedures, and
generally range from five to seven years in duration. The Company has also
entered into agreements with certain networks and studios which provide their
programs for redistribution. Under these agreements, the Company pays fees which
are based on revenue generated, or on rate schedules based on the number of
sites under license by the Company. The agreements contain various restrictions,
including default and termination procedures, and generally range from three to
five years in duration.
SIGNAL CARRIAGE AGREEMENT -- The Company and PRIMESTAR Partners, L.P.
(since succeeded by PRIMESTAR, Inc. ("PRIMESTAR") have entered into a Signal
Carriage Agreement (the "Agreement") under which, in exchange for exclusive
distribution of satellite-delivered free-to-guest programming to the lodging
industry, the Company agreed to share certain operating cash flows, as defined
in the agreement, with PRIMESTAR. Under the cash flow sharing arrangement, which
is measured on an annual basis, the Company receives the first $1.8 million of
cash flows, PRIMESTAR receives the next $1.8 million and all amounts thereafter
are shared evenly. The Company paid PRIMESTAR $207,000 under this arrangement
for the year ending December 31, 1997 and has recognized an obligation of
$781,000 for the year ending December 31, 1998. The Agreement has an initial
term of 15 years and includes various restrictions, including default and
termination provisions.
LodgeNet Entertainment Corporation F - 13 Form 10-K 1998
PURCHASE COMMITMENTS -- The Company has purchase commitments, in the
ordinary course of business, none of which are expected to result in losses.
OPERATING LEASES -- The Company has entered into certain operating
leases, which at December 31, 1998 require future minimum lease payments, as
follows (in thousands of dollars): 1999 -- $324; 2000 -- $299; 2001 -- $271;
2002 -- $163; 2003 and thereafter -- $67.
LITIGATION -- Since the first quarter of 1995, the Company has been
engaged in legal proceedings resulting from a lawsuit filed by On Command Video
Corporation ("On Command") asserting patent infringement by the Company relating
to its on-demand video system. During the third quarter of 1998, the Company
entered into an agreement with On Command to settle all matters of pending
litigation between the companies and enter into cross licensing arrangements
regarding the use of each of the companies' patented technologies. The cross
licensing arrangements, in consideration of the relative fair value of the
patents involved, provides for the Company to make cash payments to On Command
totaling approximately $16 million plus interest, payable in three annual
installments which commenced in September 1998. The Company has capitalized the
present value of the obligation to On Command based on the fair value of the
license rights acquired. The fair value of the license rights acquired will be
amortized over the remaining average lives of the underlying patents.
The Company is subject to other litigation arising in the ordinary
course of its businesses. As of the date hereof, in the opinion of management,
the resolution of such other litigation will not have a material adverse effect
on the Company's financial position or results of operations.
NOTE 11 -- STOCKHOLDERS' EQUITY
PREFERRED STOCK -- There are 5,000,000 shares of preferred stock,
$.01 par value, authorized by the Company's certificate of incorporation, of
which none were outstanding at December 31, 1996 and 1997. The Board of
Directors may authorize the issuance of preferred stock, $.01 par value, in
one or more series and with rights and privileges for each issue as
determined by the Board of Directors.
STOCKHOLDER RIGHTS PLAN -- On February 28, 1997, the Board of Directors
of the Company authorized and adopted a Stockholder Rights Plan. Pursuant to the
rights plan, the Board of Directors declared a dividend distribution of one
right for each outstanding share of common stock of the Company to stockholders
of record at the close of business on March 10, 1997.
Initially, the rights will be attached to all common stock certificates
and no separate rights certificates will be distributed. The rights will
separate from the common stock and be distributed upon the occasion of (i) a
public announcement that a person, group or entity has acquired or obtained the
right to acquire 15% or more of the common stock of the Company or (ii) ten days
following the commencement of, or an announcement of the intention to make, a
tender or exchange offer which would result in a person, group or entity
becoming the holder of 15% or more of the Company's common stock.
The rights are not exercisable until distributed.
In general, each right, when exercisable, initially entitles the
registered holder to purchase from the Company one-thousandth of a share of a
new series of preferred stock, designated as Series A Participating Preferred
Stock, par value $.01, at a price of $60.00 per share. In certain other events,
after the rights have become exercisable, each right entitles the holder to
purchase for $60.00 an amount of common stock of the Company, or in certain
circumstances securities of the acquirer, having a then-current market value of
two times the exercise price of the right. The rights include anti-dilution
provisions in the event of a stock dividend, split-up or reclassification of the
common stock. The preferred stock purchasable upon exercise of the rights will
be non-redeemable and junior to any other issue of preferred stock the Company
might issue, and will include dividend and liquidation preferences. No
stockholder privileges attach to the rights until exercised.
LodgeNet Entertainment Corporation F - 14 Form 10-K 1998
NOTE 12 -- STOCK OPTION PLANS
The Company has stock options plans which provide for the granting of up
to 2,726,792 non-qualified or incentive stock options on the Company's common
stock. Certain officers, directors and key employees have been granted options
to purchase common stock of the company under these plans. Options become
exercisable in accordance with vesting schedules determined by a committee of
the Board of Directors, and generally expire ten years after date of grant. No
options had expired as of December 31, 1998 and outstanding options expire
beginning in 2001 through 2008. The following is a summary of the stock option
activity for the years ending December 31:
Weighted
Average
Options Exercise
Outstanding Price
----------- --------
Balance at December 31, 1995 1,318,426 $ 4.21
Options granted 239,000 12.66
Options exercised (93,256) .62
Options forfeited/canceled (12,500) 8.51
----------
Balance at December 31, 1996 1,451,670 5.79
Options granted 257,832 14.99
Options exercised (196,689) 1.08
Options forfeited/canceled (7,000) 9.06
----------
Balance at December 31, 1997 1,505,813 7.91
Options granted 634,656 12.72
Options exercised (270,329) .81
Options forfeited/canceled (107,800) 12.84
----------
Balance at December 31, 1998 1,762,340 $ 10.45
----------
----------
The following is a summary of stock options outstanding as of December 31, 1998:
Outstanding Options Exercisable Options
-------------------------------- --------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Exercise Term Exercise Exercise
Price Range Number in Years Price Number Price
---------------- --------- --------- -------- ------- --------
$0.23 to $0.46 84,819 4.8 $0.23 84,819 $0.23
$2.77 to $3.23 237,022 4.6 $2.89 237,022 $2.89
$6.46 to $9.79 300,499 7.1 $8.57 176,499 $8.57
$10.38 to $13.29 724,000 8.2 $11.41 228,750 $11.38
$14.00 to $20.00 416,000 8.6 $16.51 73,875 $15.60
--------- -------
1,762,340 7.4 $10.45 800,965 $7.46
--------- -------
--------- -------
The weighted average "fair value" of options granted during the year ended
December 31 was as follows:
1996 1997 1998
------- ------- -------
Weighted average fair
value per option granted $ 6.01 $ 7.13 $ 4.36
------- ------- -------
------- ------- -------
The "fair value" of each option granted was estimated as of the grant
date using the Black-Scholes option valuation model under the following
assumptions: (i) dividend yield - none, (ii) weighted average risk-free interest
rate - 6.40% in 1996, 6.22% in 1997, 5.15% in 1998; (iii) weighted average
expected life - 5.0 years, and (iv) weighted average expected volatility - 44.0%
in 1996, 44.5% in 1997, 45.3% in 1998.
LodgeNet Entertainment Corporation F - 15 Form 10-K 1998
The Company accounts for its stock option compensation plans in
accordance with the provisions of Accounting Principles Board Opinion No. 25.
Accordingly, because the Company's stock option plans are fixed plans and
options are issued at market value, no compensation cost has been charged to
operations for any period presented. Had compensation cost been determined in
accordance with SFAS No. 123, net loss and loss per share would have
increased, and the effect of such increases, reflected on those items on a
pro forma basis, would have been as follows (in thousands of dollars, except
per share amounts):
1996 1997 1998
-------- -------- --------
Net loss
As reported $(16,610) $(25,619) $(39,912)
Pro forma (18,047) (27,423) (42,677)
Loss per share
As reported $ (1.74) $ (2.27) $ (3.45)
Pro forma (1.89) (2.43) (3.69)
NOTE 13 -- WARRANTS
In connection with the 1995 issuance of the 11.5% Senior Notes (see
Note 9), the Company issued a total of 480,000 warrants to purchase common
stock of the Company. Each warrant entitles the holder to purchase one share
of common stock at an exercise price of $7.00 per share. The warrants include
demand registration rights and anti-dilution provisions, and such warrants
expire on July 15, 2005. The portion of the proceeds from the 1995 debt
issuance deemed attributable to the warrants was recorded as additional
paid-in capital.
NOTE 14 -- SALE OF EQUITY INTEREST IN SUBSIDIARY
In October 1996, the Company and ResNet Inc. entered into agreements
with TCI Satellite Entertainment, Inc. (since succeeded by PRIMESTAR MDU,
Inc. ("PRIMESTAR")) to sell a portion of ResNet Inc. to PRIMESTAR. Under the
terms of the agreement, a 4.99% equity interest in ResNet Inc. was sold to
PRIMESTAR in exchange for $5.4 million in cash. The proceeds related to the
change in equity interest were in excess of the Company's carrying value for
its investment, and such excess, approximately $4.7 million after transaction
expenses, was reflected as a credit to paid-in capital.
In June 1997, ResNet LLC was formed and the agreements previously
entered into by PRIMESTAR and ResNet Inc. were amended, under substantially
similar terms, to reflect ResNet LLC as the operating entity of the ResNet
business.
Under a convertible note agreement (the "Convertible Note"),
PRIMESTAR had agreed to advance up to $34.6 million to ResNet LLC during the
five year period ending October 21, 2001. Use of the proceeds of the
Convertible Note were limited to the purchase of satellite receiving
equipment from PRIMESTAR. Amounts outstanding under the Convertible Note were
periodically convertible into additional equity interests in ResNet LLC. Such
conversions were mandatory, subject only to regulatory limitations on the
size of the equity interest that PRIMESTAR could hold in ResNet LLC. Under
these conversion features, PRIMESTAR had obtained rights to acquire an
additional 9.81% equity interest (incremental to the 4.99% interest acquired
in 1996) in ResNet LLC as of November 30, 1998, the date of the ResNet merger
transaction (see Note 3). Due to the regulatory limitations described above,
these rights were unable to be exercised. No amounts are due to PRIMESTAR
under this convertible note agreement at December 31, 1998.
In connection with the merger transaction described in Note 3, ResNet
LLC and PRIMESTAR agreed to terminate the convertible note agreement. The
companies further agreed that if GICC and PRIMESTAR were unable to reach
agreement by April 1, 1999 with respect to a new agreement for PRIMESTAR to
furnish GICC with nationwide access to certain satellite programming signals,
that ResNet LLC would acquire PRIMESTAR's 5%
LodgeNet Entertainment Corporation F - 16 Form 10-K 1998
equity interest in GICC that was obtained as part of the merger transaction
for $5.4 million. Consideration for this 5% interest is payable in part by
satellite receiving equipment held by the Company that was previously
purchased from PRIMESTAR. Such amount will be valued at the price paid for
the equipment by the Company. Remaining amounts to equal the $5.4 million
will be payable in cash by April 9, 1999.
NOTE 15 -- EXTRAORDINARY LOSS
Concurrently with the issuance of its 10.25% Senior Notes in 1996,
the Company redeemed its 9.95% and 10.35% Senior Notes due August 15, 2003.
As a consequence of the early redemption of the 9.95% and 10.35% Senior
Notes, the Company incurred a make-whole premium of $2,819,000 and wrote off
related, unamortized debt issuance costs of $434,000.
NOTE 16 -- CHANGE IN ACCOUNTING PRINCIPLE
Effective in the fourth quarter of 1997, the Company adopted the
provisions of Issue No. 97-13, "Accounting for Costs Incurred in Connection
with a Consulting Contract or an Internal Project That Combines Business
Process Reengineering and Information Technology Transformation" issued by
the Emerging Issues Task Force of the Financial Accounting Standards Board.
This new pronouncement requires that certain costs associated with business
process reengineering activities should be expensed as incurred rather than
capitalized. As a result, the Company recorded a $210,000 charge in the 1997
Consolidated Statement of Operations, reflected as a cumulative effect of a
change in accounting principle, to write-off business process reengineering
costs that had been previously capitalized.
NOTE 17 -- INCOME TAXES
The provisions for income taxes consisted of state income taxes. The
Company and its subsidiaries file separate federal income tax returns. At
December 31, 1998, the Company had net operating loss carry-forwards in
excess of $85 million for federal income tax purposes. Such carry-forwards
expire beginning in 2001 through 2013, and federal tax regulations limit the
availability and timing of usage of carry-forwards. Significant components of
the Company's deferred tax liabilities and assets were as follows at (in
thousands of dollars):
December 31,
-----------------------
1997 1998
-------- --------
Deferred tax liabilities:
Tax over book depreciation $ (5,207) $ (2,759)
-------- --------
Deferred tax assets:
Net operating loss carry-forwards 25,283 28,900
Reserves and accruals 1,081 1,769
Deferred programming 153 29
-------- --------
26,517 30,698
-------- --------
Net deferred tax assets 21,310 27,939
Valuation allowance (21,310) (27,939)
-------- --------
Net deferred taxes $ -- $ --
-------- --------
-------- --------
The Company established the valuation allowance for deferred tax
assets after considering its historical financial performance, existing
deferred tax liabilities, and certain information about future years.
NOTE 18 -- RELATED PARTY TRANSACTIONS
During 1998, the Company advanced $1.9 million to two officers under
the terms of promissory notes providing for total advances of $2.0 million.
The notes are payable by the officers at the earlier of (i) demand of the
Company or, (ii) November 9, 1999. Interest is payable monthly at the rate
applicable to the Company under its revolving credit facility. The notes are
secured by shares of the Company's stock held by the officers.
LodgeNet Entertainment Corporation F - 18 Form 10-K 1998
NOTE 19 -- SUBSEQUENT EVENTS
FINANCING ACTIVITIES - Effective February 25, 1999, the Company
amended and restated its bank credit facility. See Note 9 for a description
of the transaction and the terms of the credit facility.
PRIMESTAR TRANSACTION ANNOUNCEMENT - In January 1999, Hughes
Electronics Corporation ("Hughes") announced that it reached an agreement
with PRIMESTAR to acquire PRIMESTAR's digital broadcast satellite (DBS)
business and plans to combine the business with Hughes' DIRECTV unit. It was
further announced that over the next approximately two years, PRIMESTAR
subscribers will be transitioned to DIRECTV service. The Company has
approximately 200,000 lodging rooms which receive cable television
programming via the PRIMESTAR DBS technology. Management is actively pursuing
several options with respect to this matter to ensure that cable television
service to its lodging customers is not disrupted, and believes that a
transition solution will be obtained which will avoid a material adverse
impact to the Company's operations or financial position.
LodgeNet Entertainment Corporation F - 18 Form 10-K 1998
NOTE 20 -- SEGMENT INFORMATION
During 1998, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." Prior to the ResNet
merger described in Note 3, the Company's operations were classified into two
business segments, lodging and residential. The lodging segment utilizes
interactive systems designed, assembled and operated by the Company to
provide guest room entertainment, information and convenience services to the
lodging industry. The residential segment used systems designed, built and
operated by the Company to provide cable television programming and other
entertainment services to multifamily residences. The Company's operations
will not include the residential segment subsequent to the ResNet merger.
The accounting policies of the reportable segments are the same as
those described in Note 2. The company evaluates performance of its operating
segments based on operating results before depreciation and amortization,
excluding any non recurring charges. There were no intersegment sales and
transfers.
Summarized financial information concerning the Company's reportable
segments is shown in the following table (in thousands of dollars). The
information for 1997 and 1996 has been restated to conform to the 1998
presentation. The "Other" column includes corporate related items and, as it
relates to segment profit (loss), income and expense not allocated to
reportable segments.
Lodging Residential Other Total
-------- ----------- -------- --------
1996
Revenues $ 97,389 $ 332 $ - $ 97,721
Segment profit (loss) 24,552 149 (41,311) (16,610)
Total assets 274,219 5,548 - 279,767
Capital expenditures 78,738 5,518 - 84,256
1997
Revenues $133,010 $ 2,700 $ - $135,710
Segment profit (loss) 37,407 (2,055) (60,971) (25,619)
Total assets 238,869 21,425 - 260,294
Capital expenditures 87,615 16,762 - 104,377
1998
Revenues $160,975 $ 5,376 $ - $166,351
Segment profit (loss) 50,438 (2,237) (88,113) (39,912)
Total assets 306,030 - - 306,030
Capital expenditures 55,458 14,202 - 69,660
The following table presents the details of the "Other" segment profit (loss):
1996 1997 1998
------- ------- -------
Restructuring charge $ - $ - $ 3,300
Depreciation and amortization 29,815 43,760 55,215
Interest expense, net 8,243 17,001 23,048
Equity in losses of unconsolidated
affiliates - - 6,550
Extraordinary loss 3,253 - -
Cumulative effect of change in
accounting principle - 210 -
Total $41,311 $60,971 $88,113
LodgeNet Entertainment Corporation F - 19 Form 10-K 1998
The following table presents revenues by country based on the location of the
customer:
1996 1997 1998
------- -------- --------
United States $93,803 $129,484 $157,654
Canada 3,918 5,954 7,420
Other - 272 1,277
------- -------- --------
Total $97,721 $135,710 $166,351
------- -------- --------
------- -------- --------
The following table presents long-lived assets by country based on the location
of the asset:
1996 1997 1998
-------- -------- --------
United States $156,235 $209,993 $199,067
Canada 7,922 8,955 10,370
-------- -------- --------
Total $164,157 $218,948 $209,437
-------- -------- --------
-------- -------- --------
No single customer accounted for 10% or more of the Company's consolidated
revenue in 1996, 1997 or 1998.
LodgeNet Entertainment Corporation F - 20 Form 10-K 1998
NOTE 21 -- SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following selected quarterly financial data are in thousands of
dollars, except per share data:
Quarter Quarter Quarter Quarter
Ending Ending Ending Ending
March 31, June 30, September 30, December 31,
--------- -------- ------------- ------------
For 1997:
Total revenue $29,656 $ 33,132 $ 36,692 $ 36,230
Gross profit 16,839 18,794 20,961 20,604
Loss before cumulative effect
of change in accounting principle (6,679) (5,756) (5,050) (7,924)
Net loss (2) (6,679) (5,756) (5,050) (8,134)
Per common share (basic and
diluted (1):
Loss before cumulative effect
of change in accounting principle $ (0.60) $ (0.51) $ (0.45) $ (.70)
Net loss (0.60) (0.51) (0.45) (.71)
For 1998:
Total revenue $36,347 $ 40,898 $ 45,776 $ 43,330
Gross profit 20,267 22,711 25,636 23,729
Net loss (3) (8,635) (7,548) (5,457) (18,272)
Per common share (basic and
diluted) (1):
Net loss $ (0.76) $ (0.65) $ (0.47) $ (1.54)
- ----------
(1) Per share amounts are computed independently for each of the quarters
presented. Therefore, the sum of such amounts will not equal the total for
the year.
(2) The results of the quarter ended December 31, 1997 include a $210,000
charge for the effect of adopting EITF Issue 97-13 related to accounting
for certain business reengineering costs (see Note 16).
(3) The net loss for the quarter ended December 31, 1998 includes the
recognition of the $3.3 million restructuring charge related to the ResNet
transaction which occurred effective November 30, 1998. Additionally, the
$6.5 million of losses recorded from unconsolidated affiliates were
recorded in the fourth quarter. This loss is due to (i) the ResNet
transaction which resulted in the Company recording its share of GICC's
losses incurred in December, and (ii) a change in circumstances during
the fourth quarter related to the Company's investment in AMN which
resulted in the Company adopting the equity method, rather than the cost
method, of accounting for this investment.
LodgeNet Entertainment Corporation F - 21 Form 10-K 1998
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE
To LodgeNet Entertainment Corporation:
We have audited, in accordance with generally accepted auditing
standards, the consolidated financial statements included in this annual
report on Form 10-K, and have issued our report thereon dated February 12,
1999. Our audit was made for the purpose of forming an opinion on those
financial statements taken as a whole. The following schedule is the
responsibility of the Company's management and is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part
of the basic financial statements. This schedule has been subjected to the
auditing procedures applied in the audit of the basic financial statements
and, in our opinion, fairly states in all material respects the financial
data required to be set forth therein in relation to the basic financial
statements taken as a whole.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota
February 12, 1999 (except for Note 9,
as to which the date is February 25, 1999)
LodgeNet Entertainment Corporation F - 22 Form 10-K 1998
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(Dollar amounts in thousands)
Column A Column B Column C Column D Column E
- ---------------------------------- --------- ---------- ---------- --------
Additions
Balance Charged to Balance
Beginning Costs and Deductions End of
Description of Period Expenses (Note 1) Period
- ---------------------------------- --------- ---------- ---------- --------
Allowances deducted from related
balance sheet accounts:
Year Ended December 31, 1996:
Allowance for Doubtful Accounts $410 $922 $547 $785
Year Ended December 31, 1997:
Allowance for Doubtful Accounts $785 $820 $805 $800
Year Ended December 31, 1998:
Allowance for Doubtful Accounts $800 $848 $848 $800
- ----------
(1) All deductions from reserves were for the purposes for which such
reserves were created except for the 1998 activity, which includes a
$45,000 reduction to the reserve resulting from the ResNet merger
described in Note 3.
LodgeNet Entertainment Corporation F - 23 Form 10-K 1998