-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UygsqFKqZQzah5KdclfmbAQ2cY7mBNoYFO8tQttkKPHlqONkXk33zqrJmH1enSTs yNQCNG9M9Pe5HP3KKZcCIQ== 0001047469-98-011480.txt : 19980326 0001047469-98-011480.hdr.sgml : 19980326 ACCESSION NUMBER: 0001047469-98-011480 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980325 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: LODGENET ENTERTAINMENT CORP CENTRAL INDEX KEY: 0000911002 STANDARD INDUSTRIAL CLASSIFICATION: CABLE & OTHER PAY TELEVISION SERVICES [4841] IRS NUMBER: 460371161 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22334 FILM NUMBER: 98573275 BUSINESS ADDRESS: STREET 1: 808 WEST AVE N CITY: SIOUX FALLS STATE: SD ZIP: 57104 BUSINESS PHONE: 6053301330 MAIL ADDRESS: STREET 1: 808 WEST AVE N CITY: SIOUX FALLS STATE: SD ZIP: 57104 FORMER COMPANY: FORMER CONFORMED NAME: LNET INC DATE OF NAME CHANGE: 19930820 10-K 1 10-K AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 25, 1998 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One): [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 Commission File Number: 0-22334 LODGENET ENTERTAINMENT CORPORATION ------------------------------------------------------ (Exact name of Registrant as specified in its charter) DELAWARE 46-0371161 ------------------------ --------------------------------------- (State of Incorporation) (I.R.S. Employer Identification Number) 3900 WEST INNOVATION STREET, SIOUX FALLS, SOUTH DAKOTA 57107 ----------------------------------------------------------------- (Address of Principal Executive Offices) (Zip Code) (605) 988-1000 ------------------------------------------------------ (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: NONE. Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.01 PAR VALUE. Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No . --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. [ ] As of March 23, 1998, the aggregate market value of the common stock held by non-affiliates of the Registrant was approximately $109 million. The number of shares of common stock of the Registrant outstanding as of March 23, 1998 was 11,356,358. DOCUMENTS INCORPORATED BY REFERENCE--Part III of this From 10-K is incorporated by reference from Registrant's definitive proxy statement for the 1998 Annual Meeting of Stockholders which will be filed within 120 days of the fiscal year ended December 31, 1997. This Report contains a total of 53 pages, excluding exhibits. The exhibit index appears on page 29. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- TABLE OF CONTENTS -----------------
Page Special Note Regarding Forward-Looking Statements 1 ITEM 1 BUSINESS 1 Overview 1 Business Strategy 3 Strategic Initiatives 4 Markets and Customers 5 Services and Products 5 Operations 7 Competition 10 Regulation 11 Employees 13 ITEM 2 PROPERTIES 13 ITEM 3 LEGAL PROCEEDINGS 14 ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 14 ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 15 Dividends 15 Rights Plan 15 ITEM 6 SELECTED FINANCIAL DATA 18 Special Note Regarding Forward-Looking Statements 20 ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 20 ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 27 ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 27 ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT 28 ITEM 11 EXECUTIVE COMPENSATION 28 ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 28 ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 28 ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K 29
- ------------------------ As used herein (unless the context otherwise requires) "LodgeNet", "the Company" and/or "the Registrant" mean LodgeNet Entertainment Corporation and its wholly-owned subsidiaries. Page i 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 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 provides video on-demand, network-based video games, cable television programming and other interactive entertainment and information services to the lodging and multi-family dwelling unit ("MDU") markets utilizing its proprietary broadband local-area-network ("b-LAN"-SM- ) system architecture. Through its rapid growth, the Company has become the second largest provider of such services to the lodging market (based on total rooms served), currently serving over 630,000 rooms in over 4,000 hotel properties throughout the United States, Canada, and selected international markets. Through its subsidiary, ResNet Communications, L.L.C. ("ResNet"), the Company is extending its b-LAN-SM- system architecture and operational expertise into the MDU market. LodgeNet and ResNet generally operate under exclusive long-term contracts in the lodging and MDU markets. The Company's lodging guest pay contracts typically have terms of 5 to 7 years and ResNet's MDU contracts generally have terms of 8 to 12 years. The exclusive nature of these contracts allows the Company to estimate, based on certain operating assumptions, future revenues, cash flows and rates of return related to the contracts prior to making a capital investment decision. The Company has experienced substantial growth in the number of guest pay rooms served, total revenue and earnings before interest, taxes, depreciation and amortization ("EBITDA"). From 1991 through 1997, guest pay rooms served increased from 73,415 to 511,851, revenues increased from $19.6 million to $135.7 million, and EBITDA increased from $2.9 million to $35.7 million. LODGING SERVICES. The Company provides its services in the lodging market to corporate-managed hotel chains such as ITT Sheraton, The Ritz-Carlton Company, Harrah's Casino Hotels, Delta Hotels and Resorts, Outrigger, La Quinta Inns, Red Roof Inns and Budgetel Inns, as well as many individual properties flying the Marriott, Holiday Inn, Hilton, Inter-Continental, Prince, Radisson, Westin, Doubletree, Embassy Suites, and other flags. The lodging market in the United States comprises approximately 3.6 million rooms. The Company believes that approximately 1.9 million of these rooms are located in the Company's target market of hotels having more than 100 rooms. The Company provides its services under exclusive, long-term contracts throughout the United States and Canada, and in other select countries through licensing arrangements with strategic partners. The average remaining life of the Company's existing guest pay contracts is over four years, with less than 7% of these contracts due to expire before 1999. In the lodging market, the Company's services include Guest Scheduled-SM- on-demand movies, network-based Super Nintendo-Registered Trademark- video games, PRIMESTAR-Registered Trademark- digital satellite-delivered basic and premium cable television programming, and other interactive entertainment and information services. On-demand services enable a guest to purchase and start a movie on-demand, rather than restricting the guest to a predetermined start time. Video games can be started on-demand by a hotel guest who is charged an hourly rate for play time. Free-to-guest services typically involve a customized package of basic and premium cable television programming which the hotel purchases from the Company and provides at no charge to guests. Other services, which are typically provided at no charge to the guest, include guest surveys, folio review and video checkout. The Company is able to offer its Page 1 interactive services by virtue of the high-speed, two-way digital communications design of its proprietary b-LAN-SM- system architecture. The Company's open-architecture, UNIX-based platform enables the Company to upgrade system software to support the introduction of new services or integrate new technologies as they become commercially available and economically viable. The Company believes it is a leader in providing innovative products and services to the lodging industry. The Company believes that it was the first in the lodging market to install network-based interactive video games, the first to install in-room printers for video checkout and other applications, and the first to utilize a Video Room Card-SM- (an image-based menu and purchasing protocol, utilizing pictures and graphics to replace the simple text menus traditionally utilized by its competitors). The Company is currently testing an Internet browser (developed in cooperation with Sun Microsystems, Inc.) at several hotel properties that enables the hotel guest to access and navigate the World Wide Web from any guest room television. In 1995, LodgeNet redesigned its interactive system, enabling the Company to deliver what it believes is the first cost-effective system for on-demand movies and network-based video games to mid-size hotels of 100 to 150 rooms, a market segment the Company believes has been historically underserved by guest pay providers. The Company believes that the scalability and advanced features of its redesigned system for mid-size hotels were principal factors in the awarding by La Quinta Inns of its over 30,000-room account, Red Roof Inns of its over 27,000-room account and Budgetel Inns of its over 8,000-room account to the Company over other competitors. The Company believes that the mid-size hotel segment represents a large and attractive market for the Company's services that will generate financial returns similar to those achieved by the Company in larger full-service hotels. In April 1996, the Company entered into an agreement with PRIMESTAR Partners L.P. pursuant to which the Company was appointed as the exclusive third-party provider (other than the partners in PRIMESTAR and their affiliated distributors) of the PRIMESTAR-Registered Trademark- digital direct broadcast satellite ("DBS") signal to the lodging industry. This arrangement enables the Company to provide free-to-guest, digital satellite-delivered cable television programming to a broader segment of the lodging industry than can be cost-effectively served with traditional C-band satellite systems. MULTI-FAMILY RESIDENTIAL SERVICES. In October 1996, TCI Satellite Entertainment, Inc. ("TSAT") agreed to invest up to $40 million in ResNet in exchange for up to a 36.99% interest in ResNet and agreed to provide ResNet with long-term access to the PRIMESTAR-Registered Trademark- DBS signals for the MDU market on a nationwide basis. Pursuant to a recently announced roll-up plan, the partners in PRIMESTAR Partners, L.P. (including TSAT, Time Warner Entertainment, Comcast Corporation, Cox Communications, MediaOne, and GE Americom) will contribute their PRIMESTAR related assets to a newly formed subsidiary of TSAT ("New PRIMESTAR"); and TSAT will be subsequently merged with and into New PRIMESTAR with New PRIMESTAR as the surviving corporation (hereinafter "PRIMESTAR"). As a result of such transactions, PRIMESTAR will succeed to the interest of TSAT in ResNet. In March 1997, ResNet activated its first b-LAN-SM- -enabled, video on-demand system and, at December 31, 1997, ResNet's unit base had grown to approximately 26,125 passings in 16 states through a combination of organic growth and selected acquisitions. The Company views the MDU market as attractive due to: (i) the large market size; (ii) the portability to this market of the Company's b-LAN-SM- system architecture and the operating expertise developed for the lodging market; (iii) the favorable regulatory environment available to operators such as ResNet who qualify as "private cable" operators under applicable federal regulations (including the absence of franchise requirements, "must-carry" obligations and rate regulations applicable to traditional franchised cable operators); and (iv) the exclusive long-term contracts that have customarily been available in the MDU market. The Company believes it is well positioned to pursue the large MDU private cable market with its proprietary b-LAN-SM- system architecture and the ability to offer the DBS signals provided by PRIMESTAR on a nationwide basis. The Company believes there are approximately 6 million multi-family residential units in the United States that are located in apartment complexes having more than 200 units, the Company's primary market, which represents a market more than three times as large as the Company's traditional lodging market. The Company believes that its proprietary b-LAN-SM- system architecture enables ResNet to offer differentiated interactive services that allow property owners to better communicate with and serve their tenants. In addition, the Company believes that its experience in creating and managing a nationwide installation and field service organization will enable ResNet to operate effectively in its markets. ResNet's video service agreement with each property owner grants ResNet the exclusive right and access on a long-term basis to provide video services to tenants of the MDU complex, in return for which the owner receives a monthly commission based on revenues. These agreements generally prohibit the property owner from installing or marketing an alternative video system and prohibit the owner from allowing tenants to install an antenna, satellite or microwave dish on the exterior of the building. ResNet's private cable television system has the capacity to deliver over 100 channels, although the Company expects that the typical system will deliver 35 to 50 channels of basic and premium programming, depending principally upon the size of the property, the length of the contract and local competitive considerations. ResNet may elect to provide approximately 10 to 35 additional channels for scheduled pay-per-view, video on-demand and other interactive services, such as Internet access. ResNet intends to tailor the programming lineup at each multi-family residential complex, based on the particular demographic profile of that complex. ResNet's interactive private cable television systems are based on the Company's proprietary b-LAN-SM- system architecture Page 2 and utilize the PRIMESTAR-Registered Trademark- DBS signal provided by nationwide. ResNet's access to PRIMESTAR-Registered Trademark-'s digital signal provides it with a more capable and cost-effective system than the C-band systems generally used by most satellite master antenna television ("SMATV") cable operators. ResNet's private cable television system can also utilize addressable interdiction technology, enabling ResNet to remotely initiate, modify or terminate service, prevent signal theft and respond to many other service needs. ResNet intends to grow its business by (i) marketing its unique b-LAN-SM- system architecture capabilities and the PRIMESTAR-Registered Trademark- DBS service to large multi-state MDU property portfolios averaging at least 200 units per property, (ii) capitalizing on its reputation for quality customer service, (iii) considering selected acquisitions of private cable operations where the expected return on capital meets ResNet's investment criteria, and (iv) focusing its internal sales efforts and selected acquisitions in 20 to 25 geographic clusters in order to achieve operating efficiencies. BACKGROUND. 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. Interested persons may access additional information concerning the Company and ResNet through the Company's Web Site at: HTTP://WWW.LODGENET.COM. BUSINESS STRATEGY The Company's business strategy is to: (i) continue to expand its lodging industry base of guest pay and free-to-guest rooms; (ii) expand into the MDU private cable television market; (iii) maximize the revenue generated per lodging room or residential unit served by exploiting new revenue opportunities; (iv) extend the application of the Company's proprietary high speed, two-way b-LAN-SM- system architecture and operating expertise to new markets; and (v) enhance financial performance by increasing operating margins and reducing the average capital invested per new unit installed. EXPANDING THE COMPANY'S LODGING INDUSTRY FRANCHISE. The Company believes that there are substantial opportunities for continued domestic growth in an estimated pool of over 1.9 million rooms located in hotels having more than 100 rooms (from the approximately 3.6 million guest rooms industry-wide), of which the Company estimates approximately 500,000 are either served by the Company's competitors under contracts due to expire before the end of 1998 or are presently unserved by any movie system vendor. The Company's marketing plan is to capitalize on the strength of its innovative product offerings, deliverable by virtue of the high-speed, two-way digital communications design of its scalable b-LAN-SM- system architecture, together with its expertise in installation, programming, technical support and customer service. Internationally, the Company is expanding into selected countries in the Far East, South America, Central America and other regions through licensing agreements with established partners in these countries. Under these agreements, the Company generally sells equipment at cost plus an agreed markup and receives a royalty based on gross revenues. The Company believes there are additional opportunities to enter into international strategic alliances in other regions to exploit further the Company's proprietary b-LAN-SM- system architecture and multimedia capabilities. EXPANDING INTO THE MULTI-FAMILY RESIDENTIAL MARKET. The Company believes there are substantial opportunities to provide its services in the MDU market. The Company believes there are approximately 6 million multi-family residential units located in apartment complexes having more than 200 units, the Company's primary market. This represents a market that is more than three times the size of the Company's target lodging market. MAXIMIZING REVENUE PER UNIT. In addition, to increasing and expanding its installed customer base, the Company also seeks to maximize the revenue generated by each of its installed guest rooms and apartment units. In furtherance of this strategy, the Company intends in the lodging market to continue to install its interactive Guest Scheduledsm on-demand movie and network-based Super Nintendo-Registered Trademark- video game system in all new guest pay hotel rooms. From the Company's experience, rooms with this system 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. The Company's current installed guest pay base of over 527,000 rooms hosts more than 125 million guests each year (based on current average hotel occupancy and length-of-stay data). The Company believes there may be significant opportunities to generate revenues from third-party providers of content and services who would pay the Company for access to its valuable consumer base, as well as from usage fees charged to the guests who utilize such services. The Company is currently testing an Internet browser (developed in cooperation with Sun Microsystems, Inc.) at several hotel properties that enables the hotel guest to access and navigate the World Wide Web from any guest room television. The Company is reviewing other new services, such as advertiser-supported visitor information for specific cities, as well as "advertorials" and other "push media" strategies to deliver targeted product or service information directly to the consumer. The Company is evaluating these and other opportunities as well as appropriate business models that would enable the Company to maximize the return on its investment in these activities. Page 3 EXPANDING INTO NEW MARKETS. The Company seeks to extend the application of its proprietary b-LAN-SM- system architecture, products and services to an increasingly broad range of property sizes and types. In addition to the mid-size hotel, international lodging and multi-family residential markets, other future potential markets may include hospitals, single-family residences, cruise ships and educational institutions, among others. ENHANCING FINANCIAL PERFORMANCE. Complementing the Company's growth objective is its ongoing goal to enhance financial performance. The Company seeks to increase its operating margins by reducing direct and overhead expenses, as measured on a percentage of revenue and on a per-installed unit basis. As a result of its efforts, the Company has experienced increasing EBITDA margins during each of the past four years as it has reduced per-room operating costs and leveraged its infrastructure over a larger base of installed rooms. Additionally, the Company will continue its program to reduce the average capital invested per new unit, thereby increasing its return on investment. As a result of engineering efforts to reduce the cost of its system, increased installation efficiencies and the ability of the Company to negotiate guest pay contracts under which hotels are sharing a greater percentage of the cost of installing televisions, the Company's average investment per new guest pay room decreased from approximately $535 in 1993 to approximately $375 in 1997. STRATEGIC INITIATIVES The Company has implemented the following strategic initiatives to further its goal of creating a more diversified revenue base. EXPANSION INTO THE RESIDENTIAL MARKET. On October 21, 1996, the Company and ResNet entered into agreements with TSAT pursuant to which TSAT acquired a 4.99% interest in ResNet for $5.4 million (the "Stock Payment") and agreed to provide ResNet with long-term access to a DBS signal on a nationwide basis. In addition, TSAT agreed to advance ResNet up to $34.6 million to purchase certain DBS reception equipment pursuant to a subordinated convertible term loan agreement (the "TSAT Convertible Note"). The TSAT Convertible Note has a five year term (subject to a one year extension at the option of ResNet), is non-recourse to the Company and is payable solely in shares of the capital stock or membership interests in ResNet. Subject to certain vesting provisions, the TSAT Convertible Note is subject to mandatory conversion into up to an additional 32% interest in ResNet at such time as conversion is not restricted by Federal Communication Commission ("FCC") regulations (as described below). As part of the transaction, TSAT was granted an option (the "TSAT Option"), exercisable after three years, to acquire an additional 13.00% interest in ResNet for a purchase price equal to the fair market value of such interest at the time of exercise. ResNet and TSAT also agreed to rights of first refusal on the sale of any interest in ResNet and to certain standstill provisions that, among other things, prohibit TSAT from acquiring more than 10% of the Company's outstanding common stock or participating in any effort to influence or control the Company's management or Board of Directors. Pursuant to a recently announced roll-up plan, the partners in PRIMESTAR Partners L.P. (including TSAT, Time Warner Entertainment, Comcast Corporation, Cox Communications, MediaOne, and GE Americom) will contribute their PRIMESTAR related assets to a newly formed subsidiary of TSAT ("New PRIMESTAR") and TSAT will be subsequently merged with and into New PRIMESTAR with New PRIMESTAR as the surviving corporation (hereinafter, "PRIMESTAR"). As a result of such transactions, PRIMESTAR will succeed to the interest of TSAT in ResNet. PRIMESTAR AGREEMENT. In April 1996, the Company and PRIMESTAR entered into an agreement appointing the Company as the exclusive third party provider (other than the partners in PRIMESTAR and their affiliated distributors) of the PRIMESTAR-Registered Trademark- DBS signal to the lodging industry. The Company expects that the alliance, bringing together PRIMESTAR's digital satellite technology and the Company's programming and marketing expertise, will provide the Company with a technologically superior and more flexible service, and extend the market for free-to-guest systems to a much broader segment of the lodging industry than can be served cost-effectively with traditional C-band satellite systems. The Company markets the "PRIMESTAR by LodgeNet" service as a complement to its interactive guest pay systems and on a stand-alone basis to hotels not served by the Company's guest pay system. EXPANSION INTO MID-SIZE HOTEL MARKET. In addition to the large hotel market, which traditionally has been the segment subject to the most competition for guest pay services, the Company is now targeting mid-size hotels of 100 to 150 rooms as part of its marketing strategy. The Company believes that this market segment, which the Company estimates contains over 500,000 rooms, has not been broadly served by the guest pay industry because of certain diseconomies of scale resulting from the smaller average property size. In 1995, the Company redesigned and modified its high speed, two-way b-LAN-SM- system architecture to permit the delivery of on-demand movies and network-based Super Nintendo-Registered Trademark- video games more cost-effectively to mid-size hotels. The Company believes that its ability to deliver this full array of services (in contrast to competing systems that do not offer network-based video games and require the guest to take the extra step of ordering the movie purchase by telephone) and the scalability of its system for mid-size hotels, were significant factors in the awarding by La Quinta Inns of its over 30,000-room account, Red Roof Inns of its over 27,000-room account and Budgetel Inns of its over 8,000-room account to the Company over other competitors. The Company believes that the mid-size hotel segment represents a large and attractive new market for the Company's services and expects that its scalable b-LAN-SM- system architecture will allow it to generate financial returns similar to those achieved by the Company in larger full-service hotels. Page 4 INTERNET AND OTHER INTERACTIVE SERVICES. The Company is continuing the development and implementation of an Internet browser and other interactive services deliverable over the Company's high speed, two-way b-LAN-SM- system to the hotel guest via the in-room television. The Company believes there may be significant opportunities to generate revenues from third-party providers of content, merchandise and information services who would pay the Company for electronic access to its valuable consumer base, as well as from usage fees charged to the guests who utilize such services. The Company has installed an interactive in-room shopping service in over 250,000 guest rooms that enables the guest to browse though a video version of the well known SkyMall-Registered Trademark- catalog featuring quality merchandise from the country's leading retailers. The Company is currently testing an Internet browser (developed in cooperation with Sun Microsystems, Inc.) at hotel properties that enables the hotel guest to access and navigate the World Wide Web 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. The Company is reviewing other new services, such as advertiser-supported visitor information for specific cities, as well as "advertorials" and other "push media" strategies to deliver targeted product or service information directly to the consumer. The Company is evaluating these and other opportunities as well as appropriate business models that would enable the Company to maximize the return on its investment in these activities. MARKETS AND CUSTOMERS LODGING MARKET. The lodging market in the United States comprises approximately 3.6 million hotel rooms. Guest pay services were introduced in the lodging market in the early 1970s and have since become a standard amenity offered by many hotels to their guests. Virtually all hotels offer free-to-guest services as well. In 1986, certain hotels began offering their guests limited interactive services and in 1991, on-demand movies became available. Guest pay services are attractive to hotel operators because they provide an additional amenity for their guests as well as incremental revenue. LARGE HOTEL MARKET. 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 ITT Sheraton, The Ritz-Carlton Hotel Company, 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 twelve months ended December 31, 1997. MID-SIZE HOTEL MARKET. The Company is also now targeting mid-size hotels of 100 to 150 rooms as part of its guest pay marketing strategy. The Company believes that this market segment, which the Company estimates contains over 500,000 rooms, has not been broadly served by the guest pay industry because of certain diseconomies of scale resulting from the smaller average property size. 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. The Company believes that the mid-size hotel segment represents a large and attractive new market for the Company's services and expects that its scalable b-LAN-SM- system architecture will allow it to generate financial returns similar to those achieved by the Company in the large hotel market. 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. Historically, only hotels with more than 100 rooms could generally justify the expense of buying or leasing the large C-band satellite dish required to receive satellite-delivered, free-to-guest services. Smaller hotels who wanted to offer free-to-guest services generally purchased the service from local cable operators. The Company's agreement with PRIMESTAR allows LodgeNet to provide digital satellite-delivered free-to-guest television programming on a cost-effective basis to hotels with as few as 50 rooms. MULTI-FAMILY RESIDENTIAL MARKET. The Company believes that there are substantial opportunities for growth in the multi-family residential market. The Company believes there are approximately 26,000 apartment complexes having more than 200 units, with an aggregate of approximately 6 million multi-family residential units, in the 70 largest metropolitan areas in the United States. This represents a market that is more than three times the size of the Company's target lodging market. The Company's agreement with PRIMESTAR will facilitate the expansion into this market by providing ResNet with DBS equipment and access to the PRIMESTAR-Registered Trademark- DBS signal nationwide. 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-SM- system architecture enables the Company to provide sophisticated interactive features such as on-demand movies, network-based Super Nintendo-Registered Trademark- Page 5 video games, and a variety of other interactive services, such as folio review, video checkout, in-room printers, guest surveying, advertising and merchandising services. 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-SM- interactive video-on-demand service allows a guest to choose from an expanded menu of video selections and individually start the selected video at the guest's convenience rather than restricting the guest 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, 1997, the Company served over 511,000 guest pay rooms, of which nearly 485,000, or approximately 95%, featured the Company's interactive on-demand system. The Company's original scheduled guest pay service, which is provided in approximately 5% 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 and to monitor room availability. The revenue generated from the guest pay service is 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 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 11.4% and an $8.95 movie price will generate an average of $21.71 of gross movie revenue per installed room per month, plus an average of $3.90 in additional gross revenues per month from video games and information services (assuming 30.4 days per month), resulting in total gross revenue per room per month of $25.61. Occupancy rates vary by property based on the property's competitive position within its marketplace and over time based on seasonal factors and 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. Currently, the Company's movie prices are generally $7.95 or $8.95. In May 1993, the Company entered into a seven-year non-exclusive license agreement with Nintendo to provide hotels with a network-based Super Nintendo-Registered Trademark- video game playing system. Pursuant to this agreement, Nintendo provides the Company with access to a minimum of ten popular Super Nintendo-Registered Trademark- video games, which selection of games is updated periodically, and the Company uses its proprietary high-speed, two-way b-LAN-SM- system architecture to allow guests to play the video games over the hotel's master antenna television system. Hotel guests are charged a fee based on the amount of time they play the video games. Presently, the Company charges $5.95 or $6.95 per hour of play. The Company had 448,969 rooms, approximately 87% of its guest pay rooms, installed with the Super Nintendo-Registered Trademark-system as of December 31, 1997. 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 approximately $375 to $400 per room. In addition to hotel commissions and royalties paid to movie studios, operating costs of the guest pay systems include preview tapes, tape duplication, taxes, freight, insurance, personal property taxes, maintenance and data line costs. The average cost to upgrade a room from the original scheduled guest pay system to the on-demand system is approximately $75 to $175 per room, depending on the size of the movie library installed in the hotel, whether video games are provided and the configuration of the headend computer and system hardware. 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, which are then distributed to guest rooms over the hotel's existing master antenna system. Traditionally, this service has required little capital expenditure by the Company, since the earth station equipment either was provided independently by the hotel or purchased or leased from the Company. 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. The Company generally charges $2.90 - $3.50 per room per month for each premium channel and $.10 - $.95 per room per month for each non-premium channel. 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. In April 1996, the Company and PRIMESTAR entered into an agreement to provide digital satellite-delivered basic and premium television services to the lodging industry. The alliance brings together Page 6 PRIMESTAR-Registered Trademark-'s digital satellite technology and the Company's programming and marketing expertise, will enable the Company to offer the lodging industry a technologically superior and more flexible service, and will extend the market for free-to-guest services to a much broader segment of the lodging industry than can be served cost-effectively with traditional C-band satellite systems. Pursuant to the agreement with PRIMESTAR, the Company will pay PRIMESTAR a signal carriage fee for providing access to the PRIMESTAR-Registered Trademark-signal. The agreement with PRIMESTAR may be terminated by either party upon notice if certain cash flow targets are not met during any two consecutive years. The Company is responsible for the installation and servicing of all equipment required by each lodging customer to receive the PRIMESTAR-Registered Trademark- digital satellite-delivered signal. Installations began in May 1996 and approximately 78,000 rooms at 1,116 hotel properties had been installed through December 31, 1997. The Company intends to sell or lease such equipment to its customers and is entitled to retain all revenues associated with the sale, lease, installation and service of all such PRIMESTAR-related equipment. MULTI-FAMILY RESIDENTIAL SERVICES. ResNet's multi-family residential private cable system has the capacity to deliver over 100 channels, although the typical system will deliver approximately 35 to 50 channels of programming. ResNet may elect to provide from approximately 10 to 35 additional channels for scheduled pay-per-view, video on-demand and other interactive services, such as Internet access. ResNet designs a specific programming lineup for each specific multi-family residential complex, based on the particular demographic profile of that complex. These systems include basic programming services, such as CNN, ESPN, WTBS, TNT, The Discovery Channel and The Weather Channel, premium programming, such as HBO and Showtime, plus additional channels which carry local off-air stations, an electronic programming guide, a preview channel, and a bulletin board channel. Delivery of private cable television services to multi-family residential complexes involves technology similar to that used in the Company's hotel systems. The hub of each multi-family residential system is a headend, which will gather basic and premium cable television programming from a variety of sources using a combination of the DBS signal provided by PRIMESTAR and off-air antennae and then redistribute these signals throughout the apartment complex. The Company estimates that the average installed cost per unit passed for basic and premium cable television services is approximately $600 to $700. The Company estimates that the average cost per unit passed to add scheduled pay-per-view movies to the basic cable system will range from $100 to $130, depending on the system configuration. The foregoing estimates of installation costs are forward-looking in nature and actual costs could vary based on the factors discussed elsewhere herein. 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 five to seven 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, scheduled pay-per-view or 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 movie viewing charges from their guests and retain a commission, generally equal to 10% to 15% of the total guest pay revenue depending upon the size and profitability of the system. 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 7% of these contracts coming up for renewal before 1999. 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, 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. ResNet enters into long-term exclusive right-of-entry contracts with property owners and managers to provide cable television services to multi-family residential complexes. The lengths of term of such contracts generally run longer than those in the lodging industry. The form of agreement to be entered into with each multi-family residential property grants ResNet the right to provide cable television programming and other video services, such as video on-demand, merchandising, and access to the Internet. The property owner or manager typically receives a commission generally from 6% to 12% of subscriber revenues, depending upon the penetration rate at a particular property. Page 7 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 proprietary and scalable b-LAN-SM- system architecture with commercially manufactured, readily available components and hardware such as video cassette players, modulators and computers. The Company's b-LAN-SM- system architecture utilizes the Company's proprietary high-speed, two-way digital communications design to process and respond to keystroke commands from the viewer very rapidly. This capability enables the Company to provide sophisticated interactive features such as network-based Super Nintendo-Registered Trademark- video games and on-demand movies, and a variety of other interactive services such as folio review, video checkout, in-room printers supporting video checkout and other applications, guest surveying, advertising and shopping services. The Company has installed an interactive in-room shopping service in over 250,000 guest rooms that enables the guest to browse through a video version of the well known SkyMall-Registered Trademark- catalog featuring quality merchandise from the country's leading retailers. The Company is currently testing an Internet browser (developed in cooperation with Sun Microsystems, Inc.) at hotel properties that enables the hotel guest to access and navigate the World Wide Web from any guest room television. In the lodging industry, 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 Electronics 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. ResNet's private cable television system has the capacity to deliver over 100 channels, although ResNet expects that the typical system will deliver 35 to 50 channels of basic and premium programming, depending principally upon the size of the property, the length of the contract and local competitive considerations. ResNet may elect to provide from approximately 10 to 35 additional channels for scheduled pay-per-view, video on-demand and other interactive services, such as Internet access. ResNet's interactive cable television systems utilize the Company's proprietary b-LAN-SM- system architecture and the DBS signal provided by PRIMESTAR, off-air and/or microwave receiving antennas and headend equipment which process and amplify the broadcast and cable television programming signals. The Company integrates addressable interdiction jamming technology within its proprietary system. Addressable interdiction enables the Company to control subscriber access to premium channels and other enhanced services through a computer located off-site. This capability eliminates the necessity of having to dispatch field personnel to a property to initiate, modify or terminate service and eliminates the costs associated with damage or loss of traditional set-top converters located in the subscriber's premises. LodgeNet designs its systems through its staff of approximately 87 software and hardware engineers and support personnel (as of December 31, 1997). 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 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 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. Page 8 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. SALES AND MARKETING. The Company focuses its sales and marketing strategies on acquiring new contracts from hotels and marketing the Company's guest pay, video game and other interactive services to the hotel guest. The Company's sales organization consisted of approximately 53 employees as of December 31, 1997, 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 its Video Room Card-SM-, on-screen graphics and by in-room tent cards which contain movie and video game programming information that are placed near the television set and highlight 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 approximately 232 installation and service personnel in approximately 25 locations in the United States and Canada, as of December 31, 1997. 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, Tech-Connect-SM-, 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. In the multi-family residential market, ResNet installation supervisors oversee and coordinate installation and field service crews comprised of in-house personnel and experienced subcontractors. ResNet utilizes component assembly resources developed by the Company for the lodging industry. PROGRAMMING. In the lodging market, 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, generally ranging from 35% to 50%, 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 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. The Company intends to tailor the programming lineup at each multi-family residential complex based on the particular demographic profile of that complex. Cable operators and multi-channel video programming distributors such as ResNet, with certain exceptions, are prohibited from carrying the signal of a commercial television broadcast station without the broadcaster's "retransmission" consent. ResNet believes it can obtain all necessary retransmission consents in its markets. As part of its transaction with PRIMESTAR, ResNet entered into a long-term signal availability agreement pursuant to which ResNet was granted nationwide access to the PRIMESTAR-Registered Trademark- DBS signal. 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. Page 9 The Company believes that, in the event of a termination of any of its sources, with proper notification from the supplier, alternate suppliers could be located without incurring significant costs or delays. Certain electronic component parts used within the Company's products are available from a limited number of suppliers and can be subject to temporary shortages because of general economic conditions and the demand and supply for such component parts. If the Company were to experience a shortage of any given electronic part, the Company believes that alternative parts could be obtained or system design changes implemented. In such event, the Company could experience a temporary reduction in the rate of new room installations and/or an increase in the cost of such installations. All other components of the Company's systems are standard commercial products, such as video cassette players, modulators and amplifiers, that are available from multiple sources. 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 head-end 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. The Company believes that its anticipated growth can be accommodated through existing suppliers. COMPETITION LODGING MARKET. The Company is the second largest provider (by total number of rooms served) of interactive and cable television services to the lodging industry, currently serving over 630,000 installed hotel rooms in over 4,000 hotels. The Company competes on a national scale primarily with On Command Corporation ("OCC"), the successor corporation to the merger of SpectraVision, Inc. and On Command Video Corporation, and on a regional basis with certain other smaller entities. Based upon publicly available information, the Company estimates that OCC currently serves approximately 893,000 hotel rooms. The aforementioned merger combined two of the largest providers of cable television services in the lodging industry based on the aggregate number of rooms served. The Company historically competed against these two companies prior to the merger and believes that it will be able to compete in the same manner against the newly combined entity. OCC and DirecTV, Inc. ("DirecTV") have entered into an agreement pursuant to which OCC will deliver free-to-guest television programming using DirecTV's DBS signal. The Company believes that its agreement with PRIMESTAR will allow it to provide comparable services to OCC on a competitive basis. 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, including video on demand and Internet services. Some of these companies may have substantially greater financial and other resources than the Company. 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 high speed, two-way b-LAN-SM- system architecture that enables the Company to deliver a broad range of interactive features and services such as on-demand movies and network-based Super Nintendo-Registered Trademark- 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. Page 10 While the Company believes that its proprietary b-LAN-SM- 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 redesigned its system to permit the delivery of on-demand movies and network-based video games to mid-size hotels of 100 to 150 rooms, a market segment the Company believes has been historically underserved by guest pay providers. There can be no assurance that the Company will be successful in this market segment or 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. The Company believes that its agreement with PRIMESTAR to deliver the PRIMESTAR-Registered Trademark- DBS signal to the lodging industry will enable it to compete more effectively in the free-to-guest area and to extend this market segment to smaller sized properties that historically could not be cost-effectively served with the more expensive traditional C-band technology. 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. MULTI-FAMILY RESIDENTIAL MARKET. The provision of cable television services to the MDU market is highly competitive and competition is expected to increase. The Company anticipates that the primary competitors in each of its markets will include SMATV operators, wireless cable operators, DBS providers, as well as local franchised cable operators. The most substantial competitor for ResNet in each of its markets is expected to be the local franchised cable operator, most of whom have substantially greater resources than the Company and ResNet. Many of ResNet's competitors also have brand names that may be more recognizable to consumers than those of the Company and ResNet, and that may provide such competitors certain competitive advantages. ResNet's success in this market will depend in large part upon its ability to secure a significant number of long-term exclusive right-of-entry contracts with property owners or managers. These contracts generally involve a revenue sharing arrangement with the property owner or manager. Certain of ResNet's competitors have significantly greater financial resources and may offer property owners and managers more lucrative financial arrangements than ResNet may be able or willing to offer. As residents of the high-quality MDUs that are targeted by the Company come to expect a wider selection of cable, interactive video and telecommunications services, property owners may be inclined to enter into ROE contracts with companies that can offer such a selection. Certain companies have begun to market, or have announced plans to market, packages of services that are more extensive than those currently offered by the Company. Increasing competition among such providers for right of entry contracts could result in greater financial incentives being offered to property owners, thereby adversely affecting the financial return expected to be realized by ResNet from such contracts. The Company believes that ResNet's competitive advantages include (i) the broad range of features and services made possible by the Company's proprietary b-LAN-SM- system, (ii) the Company's experience and capabilities in conducting nationwide installation and field service operations and (iii) the availability of the PRIMESTAR-Registered Trademark- DBS signal and related equipment provided by PRIMESTAR at a lower cost than traditional C-band satellite signals and equipment. 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 numerous rulemakings that have and are still being undertaken by the FCC which will 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 Page 11 adopted by the FCC or state or local regulatory authorities would not have a material adverse effect on the Company's business. It is premature to predict the effect of the Act on the cable and telecommunications industries in general or the Company in particular. 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 MDU complex 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. CABLE AND TELEPHONE WIRING. Although the majority of the states currently do not prohibit exclusive right-of-entry contracts, current trends at the state and federal levels, if they continue, may render the legality of such exclusivity provisions uncertain. Several states have enacted, and additional states are expected to enact, mandatory access statutes that require MDU owners to grant a cable franchisee access to its buildings in order to offer cable services to tenants that want to receive the franchisee's service. Although the FCC has declined to adopt a federal mandatory access rule, this year the FCC did adopt rules that clarify the way in which MDU owners may terminate an incumbent video provider's access to buildings where no right to remain exists. The FCC also has initiated rulemaking proceedings to consider, among other issues, whether to adopt a cap on the length of exclusive contracts between video providers and MDU owners and whether to apply cable home wiring rules to all video providers . In addition, the FCC has initiated a rulemaking proceeding to determine whether to prohibit restrictions against the placement on rental property of devices designed for over-the-air reception of television broadcast signals, multichannel multipoint distribution services, or DBS services. In a separate rulemaking which concluded this year, the FCC declined to harmonize cable and telephony home wiring regulations. The regulations that the FCC ultimately adopts could affect the Company's continued ability to enter into or enforce exclusive contracts, as well as its access to inside wiring used to provide telephony and video programming services. SIGNAL CARRIAGE. Private cable operators, with certain exceptions, are prohibited from carrying the signal of a commercial television broadcast station without the broadcaster's "retransmission" consent. If the cable operator and the broadcaster fail to reach an agreement on terms and conditions for retransmission, the cable operator is prohibited from carrying the broadcaster's signal. Although there can be no assurance, the Company believes it has obtained and will continue to obtain all necessary retransmission consents in its markets. CROSS-OWNERSHIP. In order to encourage competition in the provision of video programming, the Cable Act generally prohibits a franchised cable operator not subject to "effective competition" from holding a license for a multichannel multipoint service or from offering SMATV service separate and apart from any franchised cable service, in any portion of the franchise area served by the cable operator's cable system. Under current interpretations of FCC rules and regulations implementing the foregoing provisions, TSAT may be prevented from acquiring a 5% or greater interest in ResNet and consequently would be unable to exercise its conversion rights under the TSAT Convertible Loan or the TSAT Option. TSAT is required to convert the TSAT Convertible Loan into an equity interest in ResNet at such time as conversion would not violate the aforementioned FCC restriction. TSAT has advised the Company that it may seek a formal interpretive letter or waiver by the FCC with respect to the acquisition of a further interest in ResNet. MICROWAVE LICENSING. Where appropriate the Company's or ResNet's systems may use 18 GHz microwave relays to link more than one hotel or MDU complex to a single headend without using public rights-of-way. The FCC has the power to issue, revoke, modify, and renew licenses within the radio frequency spectrum utilized by the Company or ResNet for microwave relays. The FCC also may approve changes in the ownership of such licenses. The Company and ResNet have obtained all necessary FCC authorizations to operate their microwave relays. There Page 12 can be no assurance, however, that the Company and/or ResNet will continue to be able to retain or obtain such authorizations in the future or that existing authorizations will be renewed. CABLE ENTRY INTO TELECOMMUNICATIONS. The Act declares that no state or local laws or regulations may prohibit or have the effect of prohibiting the ability of any entity to provide any interstate or intrastate telecommunications service. States are authorized to impose "competitively neutral" requirements regarding universal service, public safety and welfare, service quality, and consumer protection. The Act further provides that the cable operators and affiliates providing telecommunications services are not required to obtain a separate franchise from the local franchising authority for such services. The Act prohibits local franchising authorities from requiring cable operators to provide telecommunications services or facilities as a condition of a grant of a franchise, franchise renewal, or franchise transfer, except that local franchising authorities can seek "institutional networks" as part of franchise negotiations. The law also provides that, when cable operators provide telecommunications services, local franchising authorities may require reasonable, competitively neutral compensation for management of the public rights-of-way. 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. COPYRIGHT LICENSING. Both private and franchise cable systems are subject to federal copyright licensing covering carriage of broadcast signals. In exchange for making semi-annual payments to a federal copyright royalty pool and meeting certain other obligations, cable operators obtain a blanket license to retransmit broadcast signals. Bills have been introduced in Congress over the past several years that would eliminate or modify the cable compulsory license. Without the compulsory license, cable operators such as the Company might need to negotiate rights from the copyright owners for each program carried on each broadcast station in the channel lineup. Such negotiated agreements could increase the cost to cable operators of carrying broadcast signals. The Cable Act's retransmission consent provisions expressly provide that retransmission consent agreements between the television stations and cable operators do not obviate the need for cable operators to obtain a copyright license for the programming carried on each broadcaster's signal. 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, 1997, the Company had 739 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, are 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 116,500 square feet for executive, administrative and Page 13 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 the operational efficiency and to facilitate and 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 also owns an office building in Sioux Falls containing approximately 8,000 square feet which previously served as the Company's headquarters and which is not currently used in the Company's operations. Such building is being offered for sale by the Company. The Company leases sixteen facilities, in various other locations, from unaffiliated third parties. One, located in Dallas, Texas, is an office facility for sales and sales-support personnel. The remaining fifteen are combination warehouse/office facilities for installation and service operations and are located in Atlanta, Georgia; Honolulu, Hawaii; Canton, Michigan; Golden, Colorado; Tempe, Arizona; Las Vegas, Nevada; Cleveland, Ohio; Buffalo, New York; Los Angeles and San Francisco, California; Tampa, Florida; Redmond, WA; Carrollton, Texas; Lombard, Illinois; and Toronto, Ontario, Canada. Each of these facilities occupies less than 3,500 square feet. ITEM 3 -- LEGAL PROCEEDINGS On February 16, 1995, OCC filed a lawsuit in Federal District Court for the Northern District of California asserting patent infringement by the Company relating to its on-demand video system. The complaint requests an unspecified amount of damages and injunctive relief. The Company filed an answer and counterclaim to the lawsuit on April 17, 1995, denying the claims, asserting affirmative defenses and asserting a counterclaim for declaratory relief. The Company is currently engaged in litigation with respect to this matter and trial is expected to begin in August 1998. Based on the advice of special patent counsel and technical experts retained by the Company, as well as the Company's independent analysis, the Company believes that the claims of infringement are unfounded and that OCC's patent is invalid. The Company has and will continue to vigorously defend itself in this matter. Patent litigation is especially complex, both as to factual allegations and the legal interpretation of patent claims, which makes such lawsuits difficult to assess with certainty. While the Company and its patent counsel believe that the Company has a number of defenses available which, if properly considered, would eliminate or minimize any liability for the Company, an unexpected unfavorable resolution, depending on the amount and timing, could adversely affect the Company. Although the outcome of any litigation cannot be predicted with certainty, the Company believes that the ultimate disposition of this matter will not have a material adverse effect on the Company's financial condition or results of operations. The Company is subject to other litigation arising in the ordinary course of business. As of the date hereof, the Company believes the resolution of such other litigation will not have a material adverse effect upon the Company's financial condition or results of operations. ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of the Company's security holders during the fourth quarter of the Company's fiscal year ended December 31, 1997. Page 14 PART II ITEM 5 -- MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock currently trades on the NASDAQ National Market System ("NASDAQ NMS") under the symbol "LNET". The Company's Common Stock began trading on the NASDAQ NMS on October 14,1993 upon the effectiveness of its initial public offering. As of March 23, 1998 there were outstanding 11,356,358 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, 1996 $14.25 $9.00 June 30, 1996 $15.25 $11.50 September 30, 1996 $14.25 $9.75 December 31, 1996 $18.00 $11.75 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
On March 23, 1998, the closing price of the Company's Common Stock, as reported by NASDAQ NMS was $11.00. Stockholders are urged to obtain current market quotations for the Company's Common Stock. As of March 23, 1998 there were 149 stockholders of record of the Company with approximately 88% of the shares held in "street name". The Company estimates that as of March 23, 1998 there were more than 2800 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 Revolving 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. 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 Page 15 (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. 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 Page 16 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. 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. Page 17 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, ------------------------------------------------------------------- 1993 1994 1995 1996 1997 ------- ------- ------- ------- ---------- STATEMENT OF OPERATIONS DATA: Revenues: Guest Pay $21,471 $29,927 $50,758 $84,504 $ 116,276 Free-to-guest 7,478 8,397 8,060 8,645 8,496 Other 2,363 2,070 4,395 4,572 10,938 ------- ------- ------- ------- ---------- Total revenues 31,312 40,394 63,213 97,721 135,710 Direct costs 14,848 18,181 28,910 44,379 58,512 ------- ------- ------- ------- ---------- Gross profit 16,464 22,213 34,303 53,342 77,198 Operating expenses 16,425 24,573 36,741 58,428 85,262 ------- ------- ------- ------- ---------- Operating income (loss) 39 (2,360) (2,438) (5,086) (8,064) Interest expense 2,096 966 4,522 8,243 17,001 ------- ------- ------- ------- ---------- Loss before income taxes, extraordinary loss and cumulative effect of accounting change (2,057) (3,326) (6,960) (13,329) (26,065) Provision for income taxes -- -- 66 28 344 ------- ------- ------- ------- ---------- Loss before extraordinary loss and cumulative effect of accounting change (2,057) (3,326) (7,026) (13,357) (25,409) Extraordinary loss (1) -- 1,324 -- 3,253 -- Cumulative effect of accounting change (2) -- -- -- -- 210 ------- ------- ------- ------- ---------- Net loss (2,057) (4,650) (7,026) (16,610) (25,619) Cumulative preferred dividends 1,557 -- -- -- -- ------- ------- ------- ------- ---------- Net loss attributable to Common Stock $(3,614) $(4,650) $(7,026) $(16,610) $(25,619) ------- ------- ------- ------- ---------- ------- ------- ------- ------- ---------- OTHER DATA: EBITDA (3) $7,215 $9,301 $15,898 $24,729 $ 35,696 EBITDA margin (3) 23.0% 23.0% 25.1% 25.3% 26.3% Capital expenditures $14,311 $43,521 $51,497 $85,258 $ 105,483 Depreciation and amortization 7,176 11,661 18,336 29,815 43,760 Annualized EBITDA (4) 7,990 11,250 18,246 27,290 39,090 Ratio of earnings to fixed charges (5) -- -- -- -- -- Ratio of long-term debt to annualized EBITDA (4) .75x 2.49x 3.15x 6.57x 4.67x Ratio of EBITDA to interest expense (3) 3.44x 9.63x 3.52x 3.00x 2.10x OPERATING DATA: Guest Pay rooms served (6) On-demand 59,169 119,680 209,487 358,842 484,070 Scheduled 77,650 65,351 58,720 41,403 27,781 ------- ------- ------- ------- ---------- Total Guest Pay rooms 136,819 185,031 268,207 400,245 511,851 ------- ------- ------- ------- ---------- ------- ------- ------- ------- ---------- Rooms with Super Nintendo-Registered Trademark- game systems (6) 225 69,806 163,879 322,903 448,969 Free-to-guest rooms served (6) 191,893 220,534 249,779 294,882 341,030 Total rooms served (6) (7) 267,171 314,184 388,088 516,348 606,827 Average monthly revenue per Guest Pay room: Movie revenue $14.68 $15.03 $17.08 $18.38 $ 17.86 Video game/information services .39 1.01 2.21 2.93 3.28 ------- ------- ------- ------- ---------- Total $15.07 $16.04 $19.29 $21.31 $ 21.14 ------- ------- ------- ------- ---------- ------- ------- ------- ------- ----------
Page 18
AS OF DECEMBER 31, ---------------------------------------------------- 1993 1994 1995 1996 1997 ------- ------- -------- -------- -------- BALANCE SHEET DATA: Cash and cash equivalents $12,256 $ 4,302 $ 2,252 $ 86,177 $ 1,021 Total assets 64,300 88,265 125,507 279,768 260,294 Long-term debt 6,000 28,000 57,497 179,233 182,691 Total stockholders' equity 52,665 47,942 42,726 75,552 49,579
___________ (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 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. (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: 1993 -- $(2,057); 1994 -- $(3,326); 1995 -- $(6,960); 1996 -- $(13,329); and 1997 $(25,065). (6) At end of year. (7) Total rooms served include those rooms receiving one or more of the Company's services. Page 19 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 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 The Company provides video on-demand, network-based video games, cable television programming and other interactive entertainment and information services to the lodging and multi-family residential unit markets utilizing its proprietary B-LAN-SM- system architecture. LODGING SERVICES GUEST PAY SERVICES. The Company's Guest Pay services include Guest Scheduled-SM-on-demand movies, network-based Super Nintendo-Registered Trademark-video games and other interactive entertainment and information services for which the hotel guest pays on a per-view or per-play basis. The growth that the Company has experienced has principally resulted from its rapid expansion of guest pay-per-view 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:
1995 1996 1997 -------------------- ------------------- ---------------------- Rooms % Rooms % Rooms % ------- ----- ------- ------ ------- ----- Scheduled 58,720 21.9 41,403 10.3 27,781 5.4 On-demand 209,487 78.1 358,842 89.7 484,070 94.6 ------- ----- ------- ------ ------- ----- Total 268,207 100.0 400,245 100.0 511,851 100.0 ------- ----- ------- ------ ------- ----- ------- ----- ------- ------ ------- -----
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. The Company also provides video games and interactive multimedia entertainment and information services through its guest pay systems. Services include folio review, video check-out and guest satisfaction surveys. 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. The following table sets forth the number of guest pay rooms with game systems installed as of December 31: 1995 1996 1997 ------- ------- ------- Super Nintendo-Registered Trademark- game systems rooms 163,879 322,903 448,969
Page 20 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. Such monthly charges range generally from $2.90 - $3.50 per room per month for premium channels and from $.10 - $.95 per room per month for non-premium channels. 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 ranges generally from 75% to 85% of revenues for such services, 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 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 will pay a fee to PRIMESTAR for access to the PRIMESTAR signal, which will enable 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:
1995 1996 1997 ------- ------- ------- At hotels with Guest Pay services 129,898 178,779 246,054 At hotels with only free-to-guest services 119,881 116,103 94,976 ------- ------- ------- Total rooms with free-to-guest services 249,779 294,882 341,030 ------- ------- ------- ------- ------- -------
RESIDENTIAL SERVICES In January 1996, the Company formed ResNet for the purpose of extending the Company's proprietary b-LAN-SM- system architecture and operational expertise into the Multi-family Residential Unit ("MDU") market. In October 1996, TSAT, an affiliate of TCI, agreed to invest up to $40 million in ResNet in exchange for up to a 36.99% interest in ResNet and agreed to provide ResNet with long-term access to DBS signals for the MDU market on a nationwide basis. The Company believes that the MDU business has financial and technological requirements similar to those of the Company's lodging industry business. ResNet began installations of its first systems during the quarter ended September 30, 1996. The following table sets forth the number of residential units passed as of December 31:
1996 1997 ------- ------ Residential units passed 3,087 26,125
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 --------- -------- --------- -------- --------- -------- --------- --------
Page 21 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 -------- -------- -------- -------- For all Guest Pay rooms: Movie buy rates 10.7% 10.3% Average movie price $8.26 $ 8.40 Average hotel occupancy rate 69.4% 68.6% For on-demand Guest Pay rooms: Movie buy rates 11.4% 10.6% Average movie price $8.28 $ 8.42 Average hotel occupancy rate 70.0% 69.0%
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. These factors were partially offset by increased average movie prices and by the comparative increase in the proportion of on-demand rooms. It has been the Company's experience that buy rates are higher in rooms featuring the on-demand service than in those rooms with the scheduled service. The comparative decrease in buy rates, for both all and on-demand Guest Pay rooms, is attributed to a relatively less popular selection of newly-released major motion pictures in 1997 as compared to 1996. The slight increase in average movie prices for both all and on-demand rooms between the comparative periods is the result of price increases implemented at certain hotels during 1997. The Company's movie prices were generally $7.95 or $8.95 during the periods. 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 (although total rooms receiving free-to-guest services increased by 15.6%), 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. 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%
Page 22 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, and (iii) increased revenue generated under international license arrangements, all of which earn higher margins than the other sources of other revenue. 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 administrative 13,581 13.9% 20,717 15.3% 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 operated 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 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 a material increase in legal expenses, an increase in the number of development and administrative personnel, increased facilities-related expenses, and an increase of $1.8 million of expenses related to the residential services segment. As a percentage of revenue, selling, 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 $179.7 million (at a weighted average interest rate of approximately 10.5%) 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. The weighted average amount outstanding under the revolving credit facility was approximately $250,000 during 1997 as compared to approximately $9.4 million during 1996. Page 23 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 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 ("Earnings Before Interest, Income Taxes and Depreciation and Amortization") 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. 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 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, 1996 AND 1995 REVENUE ANALYSIS The Company's total revenue for 1996 increased 54.6%, or $34.5 million, in comparison to 1995. The following table sets forth the components of the Company's revenue (in thousands) for the years ended December 31:
1995 1996 ------------------------- ------------------------ Percent Percent of Total of Total Amount Revenues Amount Revenues ----------- ---------- ---------- ---------- Guest Pay $ 50,758 80.3 $ 84,504 86.5 Free-to-guest 8,060 12.7 8,645 8.8 Other 4,395 7.0 4,572 4.7 ----------- ---------- ---------- ---------- Total $ 63,213 100.0 $ 97,721 100.0 ----------- ---------- ---------- ---------- ----------- ---------- ---------- ----------
GUEST PAY SERVICES. Guest Pay revenues increased 66.5%, or $33.7 million, in 1996 as compared to 1995. This increase is attributable to (i) a 50.7% increase in the average number of installed guest pay rooms, all of which were installed with the Company's on-demand technology, and (ii) a 10.5% 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:
1995 1996 --------- --------- Average monthly revenue per room: Movie revenue $ 17.08 $ 18.38 Video game and other service revenue 2.21 2.93 --------- --------- Total per Guest Pay room $ 19.29 $ 21.31 --------- --------- --------- --------- For all Guest Pay rooms: Movie buy rates 10.1% 10.7% Average movie price $ 8.28 $ 8.26 Average hotel occupancy rate 69.0% 69.4% For on-demand Guest Pay rooms: Movie buy rates 11.2% 11.4% Average movie price $ 8.34 $ 8.28 Average hotel occupancy rate 69.7% 70.0%
Average movie revenue per room, for all guest pay rooms, was favorably impacted by a combination of higher average buy rates and higher average occupancies, all in comparison to the comparable period in the previous year, and by the comparative increase in the proportion of on-demand rooms. It has been the Company's experience that buy rates are higher in rooms featuring the on-demand service than in those rooms with the scheduled service. The comparative increase in buy rates, for both all and on-demand guest pay rooms, is attributed to a relatively more popular selection of newly-released major motion pictures in 1996 as compared to 1995. The slight decrease in average movie prices for both all and on-demand rooms between the comparative periods is the result of an increase in the proportion of limited service hotel rooms in the installed room base, in which rooms movie prices are generally $7.95. The Company's movie prices were generally $7.95 or $8.95 during the periods. Page 24 Average video game and other service revenue per room, for all guest pay rooms, increased primarily as a result of the increase in the number of rooms with video game services installed. On a per-room basis, average monthly video game revenues were $2.26 and $1.70 during the years ended December 31, 1996 and 1995, respectively. FREE-TO-GUEST SERVICES. Free-to-guest revenues increased 7.3%, or $585,000, in 1996 as compared to 1995. This increase resulted from increased programming services taken by hotels and increased programming prices, partially offset by a 3.2% decrease in the number of rooms receiving only free-to-guest services. OTHER. Revenue from other sources, such as the sale of televisions, system equipment, service parts and labor, and miscellaneous free-to-guest programming materials, increased by $177,000, or 4.0% in 1996 as compared to 1995, all of which increase was attributable to sales of systems and equipment to foreign licensees. 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:
1995 1996 ----------- ------------ Direct costs: Guest Pay $ 19,053 $ 33,981 Free-to-guest 6,117 6,784 Other 3,740 3,614 ----------- ------------ $28,910 $ 44,379 ----------- ------------ ----------- ------------ Gross profit margin: Guest Pay 62.5% 59.8% Free-to-guest 24.1% 21.5% Other 14.9% 21.0% Composite 54.3% 54.6%
Guest Pay direct costs increased 78.3%, or $14.9 million, in 1996 as compared to 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 37.5% in 1995 to 40.2% in 1996. The relative increase in guest pay direct costs (as a percentage of revenue), in 1996 as compared to the prior year, reflects higher movie-related costs due to proportionately higher revenue from newly-released motion pictures and substantially increased video game revenue in the guest pay revenue mix, which increases were mitigated by a slight decrease in hotel commissions. Free-to-guest direct costs increased 10.9% to $6.8 million in 1996 from $6.1 million in the prior year. As a percentage of free-to-guest revenue, free-to-guest direct costs increased to 78.5% in 1996 from 75.9% in the prior year, primarily reflecting the effect of price increases paid for certain programming services. Direct costs associated with other revenue decreased 3.4%, or $126,000, in 1996 as compared to the prior year. As a percentage of related revenues, such direct costs decreased to 79.0% of other revenue in 1996 versus 85.1% in 1995, reflecting the effect of increased system and equipment sales, which have slightly higher margins than the other sources of other revenue. The Company's overall gross profit increased 55.5%, or $19.0 million, to $53.3 million in 1996 on a 54.6% increase in revenues in comparison to the prior year. The Company's overall gross profit margin was 54.6% in 1996 and 54.3% 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:
1995 1996 ------------------------- ------------------------ Percent Percent of Total of Total Amount Revenues Amount Revenues ----------- ---------- ---------- ---------- Operating expenses: Guest Pay operations $ 9,767 15.5% $ 15,032 15.4% Selling , general and administrative 8,638 13.7% 13,581 13.9% Depreciation and amortization 18,336 29.0% 29,815 30.5% ----------- ---------- ---------- ---------- Total operating expenses $ 36,741 58.1% $ 58,428 59.8% ----------- ---------- ---------- ---------- ----------- ---------- ---------- ----------
Page 25 Guest Pay operations expenses increased 53.9%, or $5.3 million, in 1996 from $9.8 million in the previous year. Such increase is primarily attributable to the 50.7% increase in average installed Guest Pay rooms in 1996 as compared to 1995. Per average installed guest pay room, such expenses averaged $3.79 per month in 1996 as compared to $3.71 per month in 1995, primarily reflecting increased marketing, service and support costs and property taxes. Selling, general and administrative expenses increased 57.2%, or $4.9 million, in 1996 from $8.6 million in the prior year. This increase reflects the effect of substantially increased legal expenses, an increase in the number of development, sales and administrative personnel and increased facilities-related expenses. As a percentage of revenue, selling, general and administrative expenses represented 13.9% of total revenue in 1996 as compared to 13.7% in the year earlier period. Depreciation and amortization expenses increased 62.6% to $29.8 million in 1996 from $18.3 million in the prior year. This increase is directly attributable to the increases 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. OPERATING LOSS. The Company's operating loss, as a result of the factors previously discussed, increased to $5.1 million in 1996 from $2.4 million in 1995. INTEREST EXPENSE. Interest expense increased to $8.2 million in 1996 from $4.5 million in 1995 due to increases in long-term debt to fund the Company's continuing expansion of its businesses. Long-term debt increased from $57.5 million at December 31, 1995 to $179.2 million at December 31, 1996, reflecting the Company's issuance of $150 million principal amount of 10.25% Senior Notes during 1996. The average principal amount of long-term debt (excluding amounts outstanding under the revolving credit facility) outstanding during 1996 was approximately $65.4 million (at a weighted average interest rate of approximately 10.0%) as compared to an average principal amount outstanding of approximately $40.6 million (at a weighted average interest rate of approximately 10.3%) during 1995. The weighted average amount outstanding under the revolving credit facility was approximately $9.4 million during 1996 as compared to approximately $2.1 million in 1995. EXTRAORDINARY LOSS. As a result of the early redemption of its 9.95% and 10.35% Senior Notes, the Company incurred a make-whole premium of approximately $2.8 million, and wrote off unamortized debt issuance costs related to the notes of approximately $0.4 million. NET LOSS. For the reasons previously discussed, the Company's net loss increased to $16.6 million in 1996 from a net loss of $7.0 million in the prior year. EBITDA. As a result of increasing revenues from guest pay services, and the other factors previously discussed, EBITDA ("Earnings Before Interest, Income Taxes and Depreciation and Amortization") increased 55.5% to $24.7 million in 1996 as compared to $15.9 million in 1995. EBITDA as a percentage of total revenue increased to 25.3% in 1996 as compared to 25.1% in 1995. 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 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. 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 Company has incurred operating and net losses due in large part to the depreciation, amortization and interest expenses related to the capital required to expand its lodging and residential businesses. The growth of the Company's business requires substantial indebtedness to finance expansion of its lodging and multi-family residential businesses. The Company expects that losses will increase as the Company implements its expansion strategy. Historically, cash flow from operations has not been sufficient to fund the cost of expanding the Company's business and to service existing indebtedness. Capital expenditures were approximately $105.5 million during 1997, and net cash provided by operating activities was approximately $16.7 million. Depending on the rate of growth of its lodging and residential businesses and other factors, the Company expects to incur capital expenditures of between approximately $75 to $85 million in 1998 and substantial amounts thereafter. The actual amount and timing of the Company's capital expenditures will vary (and such variations could Page 26 be material) depending upon the number of new contracts for services entered into by the Company, the costs of installations and other factors. This a forward-looking statement and there can be no assurance in this regard. In addition, the Company's Revolving Credit Facility limits the amount of the Company's annual capital expenditures to a certain base amount plus the amounts of certain additional financing. The Company believes that its operating cash flows and borrowings permitted under the Revolving Credit Facility will be sufficient to fund the Company's cash requirements for 12 to 18 months; and, the Company may increase the Revolving Credit Facility from its present $100 to $175 million, subject to certain conditions. However, this is a forward-looking statement and there can be no assurance in this regard. ResNet, under its various agreements with TSAT, may call upon TSAT to contribute up to $34.6 million of additional capital to ResNet, which proceeds must be used for the purchase of satellite receiving equipment. For additional information concerning the terms of the Company's long-term debt and Revolving Credit Facility, please see Notes 7 and 8 to the Company's Consolidated Financial Statements included in this report. The Company believes that it has various sources of financing available in addition to borrowings under the Revolving Credit Facility, including additional amounts of long-term indebtedness. 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. ResNet is currently at a stage of development during which it will consume, through operating losses and capital expenditures for installations, substantially more capital than it is capable of generating. The Company is currently assessing alternative strategies to reduce the negative financial impact of the operating losses and capital requirements of ResNet during its growth phase. YEAR 2000 INFORMATION The Company has undertaken a comprehensive review of its computer systems and software in regard to "year 2000" issues. Based on its review, the Company does not anticipate any material costs or expenses, or any material adverse effect on its operations, financial condition, products or services, or competitive position as a result of such issues. The Company is cooperating with its customers and suppliers to assess the extent, if any, of year 2000 issues pertaining to such third party computer systems. 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. Page 27 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. 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. Page 28 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, 1996 included herein. (b) None. (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) 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) 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)+
Page 29
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) 12.1 Statement of computation of ratios 21.1 Subsidiaries of the Company 23.1 Consent of Independent Public Accountants 27.1 Financial Data Schedule, Year end December 31, 1997 27.2 Financial Data Schedule, Quarterly and Year end, 1996 27.3 Financial Data Schedule, Quarterly 1997
- --------------------- + 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.
Page 30 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 24, 1998. LodgeNet Entertainment Corporation By: /S/ TIM C. FLYNN ------------------------------ Tim C. Flynn, President and Chief Executive Officer Page 31 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/ TIM C. FLYNN President, Chief Executive March 24, 1998 - ---------------------- Officer and Director (Principal Tim C. Flynn Executive Officer) /S/ SCOTT C. PETERSEN Executive Vice President, March 24, 1998 - ---------------------- Chief Operating Officer, Scott C. Petersen and Director /S/ JEFFREY T. WEISNER Vice President - Finance, March 24, 1998 - ---------------------- (Principal Financial Jeffrey T. Weisner and Accounting Officer) /S/ DAVID AUSTAD Director March 24, 1998 - ---------------------- David Austad /S/ LAWRENCE FLINN, JR. Director March 24, 1998 - ---------------------- Lawrence Flinn, Jr. /S/ RICHARD R. HYLLAND Director March 24, 1998 - ---------------------- Richard R. Hylland /S/ R. F. LEYENDECKER Director March 24, 1998 - ---------------------- R. F. Leyendecker
Page 32 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, 1996 and 1997................................... F - 3 Consolidated Statements of Operations -- Three Years Ended December 31, 1997................... F - 4 Consolidated Statements of Stockholders' Equity -- Three Years Ended December 31, 1997......... F - 5 Consolidated Statements of Cash Flows -- Three Years Ended December 31, 1997................... F - 6 Notes to Consolidated Financial Statements..................................................... F - 7 INDEX TO FINANCIAL SCHEDULES Report of Independent Public Accountants on Schedule.......................................... F - 18 Schedule II -- Valuation and Qualifying Accounts.............................................. F - 19
Page F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To LodgeNet Entertainment Corporation: We have audited the accompanying consolidated balance sheets of LodgeNet Entertainment Corporation (a Delaware corporation) and Subsidiaries as of December 31, 1996 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. 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, 1996 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Minneapolis, Minnesota February 25, 1998 Page F-2 LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollar amounts in thousands)
December 31, -------------------------- 1996 1997 ----------- ----------- Assets Current assets: Cash and cash equivalents $ 86,177 $ 1,021 Accounts receivable, net of allowance for doubtful accounts 18,428 21,835 Prepaid expenses and other 1,935 3,457 ----------- ----------- Total current assets 106,540 26,313 Property and equipment, net of accumulated depreciation 164,157 218,948 Debt issuance costs, net of accumulated amortization 8,509 7,641 Other assets, net 562 7,392 ----------- ----------- $ 279,768 $ 260,294 ----------- ----------- ----------- ----------- Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 16,775 $ 17,930 Current maturities of long-term debt 425 705 Accrued expenses 4,596 7,010 ----------- ----------- Total current liabilities 21,796 25,645 Deferred revenue 2,956 2,069 Long-term debt 179,233 182,691 Minority interest in consolidated subsidiary 231 310 ----------- ----------- Total liabilities 204,216 210,715 ----------- ----------- Commitments and contingencies (Note 9) -- -- Stockholders' equity: Common stock, $.01 par value, 20,000,000 shares authorized; 11,125,369 and 11,322,058 shares outstanding at December 31, 1996 and 1997, respectively 111 113 Additional paid-in capital 120,539 120,792 Accumulated deficit (45,098) (71,326) ----------- ----------- Total stockholders' equity 75,552 49,579 ----------- ----------- $ 279,768 $ 260,294 ----------- ----------- ----------- -----------
The accompanying notes are an integral part of these consolidated balance sheets. Page F-3 LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Dollar amounts, except per share amounts, in thousands)
Years Ended December 31, ---------------------------------------- 1995 1996 1997 ---------- ---------- ----------- Revenues: Guest Pay $ 50,758 $ 84,504 $ 116,276 Free-to-guest 8,060 8,645 8,496 Other 4,395 4,572 10,938 ---------- ---------- ----------- Total revenues 63,213 97,721 135,710 ---------- ---------- ----------- Direct costs: Guest Pay 19,053 33,981 45,632 Free-to-guest 6,117 6,784 5,663 Other 3,740 3,614 7,217 ---------- ---------- ----------- Total direct costs 28,910 44,379 58,512 ---------- ---------- ----------- Gross profit 34,303 53,342 77,198 ---------- ---------- ----------- Operating expenses: Guest Pay operations 9,767 15,032 20,785 Selling, general and administrative 8,638 13,581 20,717 Depreciation and amortization 18,336 29,815 43,760 ---------- ---------- ----------- Total operating expenses 36,741 58,428 85,262 ---------- ---------- ----------- Operating loss (2,438) (5,086) (8,064) Interest expense, net 4,522 8,243 17,001 ---------- ---------- ----------- Loss before income taxes, extraordinary loss, and cumulative effect of change in accounting principle (6,960) (13,329) (25,065) Provision for income taxes 66 28 344 ---------- ---------- ----------- Loss before extraordinary loss and cumulative effect of change in accounting principle (7,026) (13,357) (25,409) Extraordinary loss (Note 13) -- 3,253 -- Cumulative effect of change in accounting principle (Note 3) -- -- 210 ---------- ---------- ----------- Net loss $ (7,026) $ (16,610) $ (25,619) ---------- ---------- ----------- ---------- ---------- ----------- Per common share (basic and diluted): Loss before extraordinary loss and cumulative effect of change in accounting principle $ (0.96) $ (1.40) $ (2.25) Extraordinary loss -- (0.34) -- Cumulative effect of change in accounting principle -- -- (0.02) ---------- ---------- ----------- Net loss $ (0.96) $ (1.74) $ (2.27) ---------- ---------- ----------- ---------- ---------- ----------- Weighted average shares outstanding (basic and diluted) 7,337,147 9,570,779 11,271,064 ---------- ---------- ----------- ---------- ---------- -----------
The accompanying notes are an integral part of these consolidated financial statements. Page F-4 LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Dollar amounts in thousands)
Common Stock Additional ---------------------- Paid-in Accumulated Shares Amount Capital Deficit Total ----------- ------- ---------- ------------ ---------- Balance, December 31, 1994 7,278,748 $ 73 $ 69,492 $ (21,623) $ 47,942 Common stock option activity 73,365 1 62 -- 63 Warrants issued -- -- 1,680 -- 1,680 Net loss -- -- -- (7,026) (7,026) Foreign currency translation adjustment -- -- -- 67 67 ----------- ------- ---------- ------------ ---------- Balance, December 31, 1995 7,352,113 74 71,234 (28,582) 42,726 Issuance of common stock 3,680,000 36 44,599 -- 44,635 Common stock option activity 93,256 1 34 -- 35 Net loss -- -- -- (16,610) (16,610) Change of interest in subsidiary -- -- 4,672 -- 4,672 Foreign currency translation adjustment -- -- -- 94 94 ----------- ------- ---------- ------------ ---------- Balance, December 31, 1996 11,125,369 111 120,539 (45,098) 75,552 Common stock option activity 196,689 2 332 -- 334 Net loss -- -- -- (25,619) (25,619) Change of interest in subsidiary -- -- (79) -- (79) Foreign currency translation adjustment -- -- -- (609) (609) ----------- ------- ---------- ------------ ---------- Balance, December 31, 1997 11,322,058 $ 113 $ 120,792 $ (71,326) $ 49,579 ----------- ------- ---------- ------------ ---------- ----------- ------- ---------- ------------ ----------
The accompanying notes are an integral part of these consolidated financial statements. Page F-5 LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollar amounts in thousands)
Years Ended December 31, ----------------------------------------- 1995 1996 1997 ---------- ----------- ----------- Operating activities: Net loss $ (7,026) $ (16,610) $ (25,619) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization 18,336 29,815 43,760 Non-cash portion of extraordinary loss -- 434 -- Minority interest -- (16) 16 Change in operating assets and liabilities: Accounts receivable (3,541) (6,278) (3,288) Prepaid expenses and other (447) (473) (1,138) Accounts payable 6,205 1,864 1,053 Accrued expenses and deferred revenue 1,857 1,433 1,524 Other -- (607) 345 ---------- ----------- ----------- Net cash provided by operating activities 15,384 9,562 16,653 ---------- ----------- ----------- Investing activities: Property and equipment additions (51,497) (85,258) (97,396) Purchase of cable television operations -- -- (8,087) Proceeds from sale of interest in subsidiary -- 5,396 -- ---------- ----------- ----------- Net cash used for investing activities (51,497) (79,862) (105,483) ---------- ----------- ----------- Financing activities: Proceeds from long-term debt 33,630 151,514 1,106 Debt issuance costs (1,348) (7,969) (141) Stock issuance costs -- (477) -- Repayment of long-term debt (89) (33,607) (583) Borrowings under revolving credit facility 10,000 55,958 3,000 Repayments of revolving credit facility (10,000) (55,958) -- Proceeds from issuance of common stock -- 44,635 -- Proceeds from issuance of warrants to purchase common stock 1,680 -- -- Stock option activity 63 35 334 ---------- ----------- ----------- Net cash provided by financing activities 33,936 154,131 3,716 ---------- ----------- ----------- Effect of exchange rates on cash 127 94 (42) ---------- ----------- ----------- Increase (decrease) in cash and cash equivalents (2,050) 83,925 (85,156) Cash and cash equivalents at beginning of period 4,302 2,252 86,177 ---------- ----------- ----------- Cash and cash equivalents at end of period $ 2,252 $ 86,177 $ 1,021 ---------- ----------- ----------- ---------- ----------- ----------- Supplemental cash flow information: Cash paid for interest $ 3,341 $ 7,870 $17,828 ---------- ----------- ----------- ---------- ----------- -----------
The accompanying notes are an integral part of these consolidated financial statements. Page F-6 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 satellite-delivered, free-to-guest programming, interactive games and multimedia entertainment, and guest information systems to the lodging industry, primarily in the United States and Canada. ResNet Communications, Inc., a wholly-owned subsidiary of the Company, is the majority owner of ResNet Communications, LLC (collectively "ResNet"). ResNet installs and operates 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 businesses has and is expected to continue to require 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 for 1998, the Company will likely, 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. All significant inter-company accounts and transactions have been eliminated in consolidation. 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. 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. CASH AND CASH EQUIVALENTS -- Cash and cash equivalents are comprised of demand deposits and temporary investments in highly liquid securities having original maturities of 90 days or less. 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 on 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 19 - 30 Guest Pay systems: System components 5 - 7 In-room equipment 3 - 5 Cable television equipment 3 - 10 Free-to-guest systems 5 Other equipment 3 - 10
Page F-7 PRODUCT DEVELOPMENT -- The Company has capitalized certain costs of developing software for its guest pay and residential systems. The capitalization of these costs begins when a system's technological and commercial feasibility has been established and ends when such systems are available for use in guest pay or residential properties. Capitalized costs are reported at the lower of unamortized costs or net realizable value, and are amortized over the system's estimated useful life. Guest pay system development costs capitalized were $1,480,000, $1,616,000 and $2,100,000 during the years ended December 31, 1995, 1996 and 1997, respectively. Amortization of such costs was $455,000, $599,000 and $797,000 for the years ended December 31, 1995, 1996 and 1997, respectively. The Company charged $129,000, $216,000, and $410,000 to operations during the years ended December 31, 1995, 1996 and 1997, respectively, related to research and development activities. REVENUE RECOGNITION -- Revenues and related costs are recognized when the 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 the year, 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. At December 31, 1995, 1996 and 1997 the Company had recorded deferred cost reductions relating to such agreements of $1,579,000, $1,835,000 and $450,000, 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 as much as 10% of total revenue in any period presented in the accompanying consolidated statements of operations. The allowance for doubtful accounts was $785,000 and $800,000 at December 31, 1996 and 1997, respectively. The provision for doubtful accounts was $343,000 in 1995, $922,000 in 1996, and $820,000 in 1997. INCOME TAXES -- The Company accounts for income taxes under the liability method, in accordance with the requirements of Statement of Financial Accounting Standards 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. LOSS PER SHARE COMPUTATION -- Effective in the fourth quarter of 1997, the Company adopted Statement of Financial Accounting Standards ("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. The loss per share amounts for 1996 and 1995 have been restated to give effect to the adoption of SFAS No. 128. The effect of the restatement was to increase the loss per share by $.01 in 1996 and 1995. Weighted average options on 1,121,366; 1,458,839; and 1,597,331 shares of common stock were not included in computing diluted EPS because their effects were antidilutive for the years ended December 31, 1995, 1996, and 1997, 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 Statement of Financial Accounting Standards No. 123. The effect of fair value based measurement of such costs on net loss and net loss per share, in accordance with Statement of Financial Accounting Standards No. 123, is disclosed on a pro forma basis in Note 11. RECLASSIFICATIONS -- Certain items in the consolidated financial statements have been reclassified to conform to 1997 classifications. Such reclassifications had no effect on previously reported net loss or stockholders' equity. NOTE 3 -- 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. Page F-8 NOTE 4 -- PROPERTY AND EQUIPMENT, NET Property and equipment was comprised as follows at (in thousands of dollars):
December 31, ----------------------- 1996 1997 -------- --------- Land, building and equipment $ 15,914 $ 40,051 Free-to-guest equipment 7,369 11,855 Cable television equipment 5,291 13,877 Guest pay systems: Installed 173,607 220,778 System components 23,290 30,720 Software costs 6,266 8,053 Building construction in progress 2,528 -- -------- --------- Total 234,265 325,334 Less - depreciation and amortization (70,108) (106,386) -------- --------- Property and equipment, net $164,157 $ 218,948 -------- --------- -------- ---------
NOTE 5 -- DEBT ISSUANCE COSTS Costs associated with the issuance of debt securities and with obtaining credit facilities are capitalized and amortized over the term of the related borrowing or facility. The Company capitalized $1,348,000, $7,969,000, and $140,000 of debt issuance costs during the years ended December 31, 1995, 1996 and 1997, respectively. Amortization of such costs was $260,000 in 1995; $564,000 in 1996, and $1,008,000 in 1997. 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 13). The components of the debt issuance costs recorded in the balance sheets are as follows (in thousands of dollars):
December 31, ---------------------- 1996 1997 ------- -------- Debt issuance costs $8,820 $ 8,960 Accumulated amortization (311) (1,319) ------- -------- $8,509 $ 7,641 ------- -------- ------- --------
NOTE 6 -- ACCRUED EXPENSES Accrued expenses were comprised as follows at (in thousands of dollars):
December 31, ---------------------- 1996 1997 ------- -------- Accrued taxes $ 523 $ 949 Accrued compensation 1,953 2,552 Accrued interest 2,120 2,274 Other -- 1,235 ------- -------- $4,596 $7,010 ------- -------- ------- --------
Page F-9 NOTE 7 -- LONG-TERM DEBT Long-term debt was comprised as follows at (in thousands of dollars):
December 31, ------------------------- 1996 1997 --------- ---------- Revolving Credit Facility $ -- $ 3,000 Unsecured Senior Notes due December 15, 2006 10.25% interest payable semi-annually 150,000 150,000 Unsecured Senior Notes due July 15, 2005: 11.5% interest payable semi-annually 30,000 30,000 Less - unamortized discount (1,384) (1,169) Capital leases 1,042 1,565 --------- ---------- 179,658 183,396 Less current maturities (425) (705) --------- ---------- $179,233 $182,691 --------- ---------- --------- ----------
Long-term debt has the following scheduled principal maturities for the years ended December 31 (in thousands of dollars): 1998 -- $705; 1999 -- $543; 2000 -- $270; 2001 -- $6,047; 2002 -- $9,000; thereafter -- $166,831. 10.25% SENIOR NOTES -- On December 19, 1996, the Company issued $150 million of unsecured 10.25% Senior Notes (the "Notes") in a private offering. The proceeds of the Notes, which were issued at par, after placement fees and offering expenses, were approximately $143.2 million. Approximately $31.7 million of such proceeds were used to redeem the outstanding principal amounts of the 9.95% and 10.35% Senior Notes, $24.5 million and $4.4 million, respectively, plus a make-whole premium, resulting from their early redemption, of approximately $2.8 million. Approximately $20.4 million of the proceeds was used to prepay all outstanding amounts under the Company's revolving credit facility. The remaining proceeds of approximately $91.1 million, were invested in highly liquid, interest-bearing securities pending their use for funding capital expenditures to expand the Company's businesses, including approximately $15 million to construct and equip the Company's new administrative and production facility in Sioux Falls, South Dakota. The Notes were issued initially to qualified institutional buyers or other accredited investors pursuant to a registration rights agreement. During 1997, the Notes were registered under the Securities Act of 1933 and all the private Notes were exchanged for registered Notes. The registered Notes contain terms and conditions identical to those of the private Notes. The 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 Notes contain covenants which, among other matters, require the Company to maintain a consolidated leverage ratio (as defined in the indenture) of not more than 5.75 to 1 through December 15, 1999 and not more than 5.25 to 1 thereafter. The covenants 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. The 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 Notes with the proceeds of one or more public equity offerings. 11.5% SENIOR NOTES -- During 1995, the Company issued $30 million principal amount of 11.5% Senior Subordinated Notes due July 15, 2005 (the "Subordinated Notes") to three insurance companies in two separate private placements. Mandatory annual principal payments of $6 million commence July 15, 2001. Proceeds from the issuance of the Subordinated Notes, net of original issue discount and issuance-related expenses, were approximately $27.3 million and were used (i) to repay previous borrowings and (ii) to provide funding for capital expenditures to expand the Company's guest pay services business. The Company issued a total of 480,000 warrants (see Note 12) to purchase common stock of the Company in connection with the issuance of the Subordinated Notes and the value of the warrants, $1.68 million, was recorded in stockholders' equity and shown as a discount on the Subordinated Notes. As part of the refinancing transaction in which the 10.25% Senior Notes were issued, the holders of the Subordinated Notes adopted the covenants and ranking of the 10.25% Senior Notes. At December 31, 1996 and 1997, the estimated fair value of the 11.5% Senior Notes was approximately $29.2 and $31.0 million, respectively. The estimated fair value of the 10.25% Senior Notes was $150.0 and $155.3 million at December 31, 1996 and 1997, respectively. Page F-10 NOTE 8 -- REVOLVING CREDIT FACILITY On December 19, 1996 the Company amended and restated its revolving credit facility with National Westminster Bank Plc, as Agent ("NatWest"), to provide for an increase in the total lending commitments under the facility from $60 million to $100 million. The amended facility is secured by (i) a first priority security interest in all of the Company's and certain of its subsidiaries tangible and intangible assets, and (ii) a guarantee by ResNet of all amounts advanced to it by the Company. Amounts outstanding under the amended facility bear interest at either (i) LIBOR (London Inter Bank Offered Rate) plus from 1.25% to 2.00% or (ii) the greater of (a) the NatWest Prime Rate plus from .25% to 1.00% or (b) the federal funds rate plus from .75% to 1.50%; depending on the Company's total leverage, as defined in the agreement. At December 31, 1997, the interest rate on amounts outstanding under the facility was 9.50%. The commitment under the amended facility may be increased to $175 million, subject to the consent of NatWest, but is subject to a scheduled reduction of 15% beginning in December 1998 and annually thereafter as follows: December 1999 - 20%; December 2000 -20%; December 2001 - 20%; and December 2002 - 25%. The amended facility provides for the issuance of Letters of Credit, subject to customary terms and conditions; and includes terms and conditions which require the maintenance of certain financial ratios, limit the incurrence of additional indebtedness, limit the incurrence of certain liens, limit certain payments or distributions in respect of the Common Stock, and provide for acceleration of principal repayment in certain circumstances. As of December 31, 1997, the Company had outstanding Standby Letters of Credit of $1.2 million and the Company was in compliance with all covenants, terms and conditions of the amended facility. NOTE 9 -- 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. 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 Partners, L.P. 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 Partners, L.P. receives the next $1.8 million and all amounts thereafter are shared evenly. The Agreement has an initial term of 15 years and includes various restrictions, including default and termination provisions. 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, 1997 require future minimum lease payments, as follows (in thousands of dollars): 1998 -- $246; 1999 -- $222; 2000 -- $200; 2001 --$179; 2002 and thereafter -- $41. LITIGATION -- On February 16, 1995, On Command Corporation ("OCC") filed a lawsuit in Federal District Court for the Northern District of California asserting patent infringement by the Company relating to its on-demand video system. The complaint requests an unspecified amount of damages and injunctive relief. The Company filed an answer and counterclaim to the lawsuit on April 17, 1995, denying the claims, asserting affirmative defenses and asserting a counterclaim for declaratory relief. The Company is currently engaged in litigation with respect to this matter and trial is expected to begin in August 1998. Based on the advice of special patent counsel and technical experts retained by the Company, as well as the Company's independent analysis, the Company believes that the claims of infringement are unfounded and that OCC's patent is invalid. The Company has and will continue to vigorously defend itself in this matter. Patent litigation is especially complex, both as to the factual allegations and the legal interpretation of patent claim language, which makes such lawsuits difficult to assess with certainty. While the Company and its patent counsel believe that the Company has a number of defenses available which, if properly considered, would eliminate or minimize any liability for the Company, an unexpected unfavorable resolution, depending on the amount and timing, could adversely affect the Company. Although the outcome of any litigation cannot be predicted with certainty, the Company believes that the ultimate disposition of this matter will not have a material adverse effect on the Company's financial position or results of operations. Page F-11 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 10 -- STOCKHOLDERS' EQUITY PREFERRED STOCK -- There are 5,000,000 shares of preferred stock, $.01 par value, authorized by the Company's certificate of incorporation, of which none were outstanding at December 31, 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. COMMON STOCK -- On May 23, 1996, the Company sold 3,200,000 shares of common stock at $13.00 per share in a public offering. On June 10, 1996 the Company sold an additional 480,000 shares of common stock, representing the underwriters' exercise of their over-allotment option in accordance with the underwriting agreement. Net proceeds from these issuances, after underwriters' commissions and other offering-related expenses, were approximately $44.6 million. Such proceeds were used to repay borrowings under the Company's revolving credit facility, approximately $25.9 million, and to provide capital for the expansion of the Company's lodging and residential businesses. 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. Page F-12 NOTE 11 -- STOCK OPTION PLANS The Company has stock options plans which provide for the granting of up to 1,926,792 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, 1997 and outstanding options expire beginning in 2001 through 2007. The following is a summary of the stock option activity for the years ending December 31:
1996 1997 ------------------------ ---------------------- Weighted Weighted Number Average Number Average of Exercise of Exercise Shares Price Shares Price --------- --------- --------- --------- Beginning of year 1,318,426 $4.21 1,451,670 $5.79 Granted 239,000 $12.66 253,068 $14.99 Exercised (93,256) $0.62 (191,325) $1.08 Forfeited or canceled (12,500) $8.51 (7,000) $9.06 ---------- ---------- End of year 1,451,670 $5.79 1,506,413 $7.91 ---------- ---------- ---------- ---------- Exercisable at end of year 907,671 $2.66 971,871 $5.12 ---------- ---------- ---------- ----------
The following is a summary of stock options outstanding as of December 31, 1997:
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 $0.46 340,892 5.8 $0.34 340,892 $0.34 $2.77 to $3.23 237,022 5.6 $2.89 237,022 $2.89 $7.00 to $9.55 250,499 7.3 $8.49 163,332 $8.75 $10.78 to $13.29 451,000 8.1 $11.87 208,750 $11.67 $14.25 to $16.71 227,000 8.7 $16.03 21,875 $14.38 --------- -------- 1,506,413 7.2 $7.91 971,871 $5.12 --------- -------- --------- --------
The weighted average "fair value" of options granted during the year ended December 31 was as follows:
1996 1997 -------- -------- Weighted average fair value per option granted $ 6.01 $ 7.13 -------- -------- -------- --------
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 - 6.4% in 1996, 6.22% in 1997; (iii) weighted average expected life - 5.0 years, and (iv) weighted average expected volatility - 44.0% in 1996 and 44.5% in 1997. Page F-13 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 fair market value, no compensation cost has been charged to operations for any period presented. Had compensation cost been determined in accordance with Statement of Financial Accounting Standards 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):
Year Ended December 31, ------------------------ 1996 1997 ---------- --------- Net loss As reported $(16,610) $(25,619) Pro forma (18,047) (27,423) Loss per share As reported $ (1.74) $ (2.27) Pro forma (1.88) (2.42)
NOTE 12 -- WARRANTS In connection with the Company's initial public offering in 1993, the Company issued warrants to purchase 75,000 shares of common stock of the Company to the underwriters. The exercise price of such warrants is $16.20 and the warrants expire on October 14, 1998. In connection with the 1995 issuance of the 11.5% Senior Notes (see Note 7), 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 13 -- 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 14 -- SALE OF EQUITY INTEREST IN SUBSIDIARY On October 21, 1996, the Company and its subsidiary, ResNet, entered into agreements with TCI Satellite Entertainment, Inc. ("TCI Satellite") under which ResNet sold a 4.99% equity interest in ResNet to TCI Satellite 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. Pursuant to a signal carriage agreement, TCI Satellite has agreed to provide ResNet with nationwide access to certain satellite programming signals. In addition to the aforementioned cash investment, TCI Satellite agreed to advance up to $34.6 million to ResNet during the five year period ending October 21, 2001, under a convertible note agreement (the "Convertible Note"). Use of the proceeds of the Convertible Note is limited to the purchase of satellite receiving equipment from TCI Satellite. Amounts outstanding under the Convertible Note are periodically convertible into additional equity interests in ResNet. Such conversions are mandatory, subject only to regulatory limitations on the size of the equity interest that TCI Satellite may hold in ResNet. Without regard to the amount outstanding under the Convertible Note, and in addition to its 4.99% interest previously described, TCI Satellite will convert its interest in the Convertible Note into an additional 32.0% equity interest in ResNet, subject to the regulatory limitations described above. Under these conversion features, TCI Satellite obtained the right effective October 21, 1997 to acquire an additional 1.30% equity interest in ResNet. Future conversion rights into additional equity interests in ResNet are as follows: at October 21, 1998--8.51%, at October 21, 1999--11.09% and at October 21, 2000--11.10%. The Convertible Note matures on October 21, 2001, subject to a one-year extension at the election of ResNet. On the maturity date, if regulatory restrictions have prohibited the aforementioned conversions, ResNet shall issue a warrant enabling TCI Satellite to purchase the defined additional equity interests in ResNet for the unconverted amount of the Convertible Note. Upon issuance of the warrant, borrowings and unpaid interest under the Note shall be cancelled and deemed repaid in full. The warrant, if and when issued, will expire June 4, 2007. The Convertible Note is unsecured, is not subject to prepayment, has no recourse to the Company, and is subordinated to all present and future borrowings by the Company to the extent that the proceeds thereof are Page F-14 advanced to ResNet. Further, the Convertible Note is subordinated to inter-company loans or advances to ResNet by the Company. Interest accrues (generally at TCI Satellite's average borrowing rate) on amounts outstanding under the Convertible Note, but such interest is not paid in cash and does not increase the equity interest into which the Convertible Note will be mandatorily converted. Such interest accrues only until maturity or such time as the balance of outstanding principal and accrued interest is $34.6 million, whichever is sooner. The Company, ResNet and TCI Satellite have agreed that all amounts advanced by the Company to ResNet shall be in accordance with an inter-company promissory note, which shall bear interest. In connection with the aforementioned agreements, the Company has granted TCI Satellite an option to acquire an additional 13.00% equity interest in ResNet, first exercisable 60 days following October 21, 1999. Such option is to be exercised in exchange for an additional cash investment in ResNet based on ResNet's then fair market value. Such option will expire, subject to certain limitations, coincident with the maturity of the Convertible Note. LIQUIDATION PREFERENCE -- The Company, ResNet and TCI Satellite have agreed that in the event of a sale of ResNet, or a sale of substantially all of the assets of ResNet, that (i) repayment of any inter-company loans or advances by the Company to ResNet shall have preference to any other distribution, (ii) that after repayment of such advances, that TCI Satellite shall be entitled to a preferential return of its aggregate investment in ResNet and (iii) that after the repayment of amounts in accordance with items (i) and (ii), that any further distribution shall be determined on a per-share basis. On June 4, 1997, ResNet Communications, Inc. was converted to a Delaware limited liability corporation, ResNet Communications, L.L.C. NOTE 15 -- 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, 1997, the Company had net operating loss carry-forwards in excess of $74 million for federal income tax purposes. Such carry-forwards expire beginning in 2001 through 2012, 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, ------------------------ 1996 1997 --------- --------- Deferred tax liabilities: Tax over book depreciation $ (9,899) $ (5,207) --------- --------- Deferred tax assets: Net operating loss carry-forwards 18,502 25,283 Deferred programming 624 153 Other 1,135 1,081 --------- --------- 20,261 26,517 --------- --------- Net deferred tax assets 10,362 21,310 Valuation allowance (10,362) (21,310) --------- --------- 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. Page F-15 NOTE 16 -- SEGMENT INFORMATION The Company's operations have been 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 uses systems designed, built and operated by the Company to provide cable television programming and other entertainment services to multifamily residences. The Company's operations, prior to 1996, consisted only of lodging operations. Summarized financial information by business segment for 1996 and 1997 is included in the table below (in thousands of dollars):
1996 1997 1996 1997 --------- --------- -------- -------- Revenue: Total Assets: - ------------- ---------------- Lodging $97,389 $133,010 Lodging $143,820 $170,638 Residential 332 2,700 Residential 5,548 21,425 --------- --------- Corporate 130,400 68,231 -------- -------- $97,721 $135,710 $279,768 $260,294 --------- --------- -------- -------- --------- --------- -------- -------- Operating Depreciation and Loss: Amortization: - ------------- ------------------ Lodging $9,839 $18,029 Lodging $24,346 $33,172 Residential (179) (3,601) Residential 328 1,546 Corporate (14,746) (22,492) Corporate 5,141 9,042 --------- --------- -------- -------- $(5,086) $(8,064) $29,815 $43,760 --------- --------- -------- -------- --------- --------- -------- -------- Capital Expenditures: - -------------- Lodging $59,597 $60,096 Residental 5,518 16,762 Corporate 20,143 28,625 --------- --------- $85,258 $105,483 --------- --------- --------- ---------
Page F-16 NOTE 17 -- SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) The following selected quarterly financial data are in thousands of dollars, except per share data: Caption Quarter Quarter Quarter Quarter Ending Ending Ending Ending March 31, June 30, September 30, December 31, ----------- ---------- ------------- ------------ For 1996: Total revenue $ 20,368 $ 23,202 $ 27,116 $ 27,035 Gross profit 11,254 12,780 14,425 14,883 Loss before extraordinary loss (2,873) (3,395) (1,857) (5,232) Net loss (2,873) (3,395) (1,857) (8,485) Per common share (basic and diluted (1): Loss before extraordinary loss $ (0.39) $ (0.39) $ (0.17) $ (.47) Net loss (2) (0.39) (0.39) (0.17) (.77) 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 (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 (3) (0.60) (0.51) (0.45) (.71)
- --------------------- (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, 1996 included an extraordinary loss of approximately $3.3 million relating to the early retirement of debt (see Note 13). (3) 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 3). Page F-17 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 25, 1998. 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 25, 1998 Page F-18 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 Charged Balance 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, 1995: Allowance for Doubtful Accounts $ 228 $ 343 $ 161 $ 410 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
- ---------------- (1) All deductions from reserves were for the purposes for which such reserves were created. Page F-19 EX-12.1 2 EXHIBIT 12.1 EXHIBIT 12.1 LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES Statement Regarding Computation of Ratios (Unaudited) (Dollar amounts in thousands) Computation of Coverage of Fixed Charges - -------------------------------------------------------------------------------
1993 1994 1995 1996 1997 ---------- ----------- ---------- ----------- ----------- Net loss $ (2,057) $ (4,650) $ (7,026) $ (16,610) $ (25,619) Add: Extraordinary loss (1) -- 1,324 -- 3,253 -- Cumulative effect of change in accounting principle (2) -- -- -- -- 210 Provision for income taxes -- -- 66 28 344 Add fixed charges (3): Interest 2,096 966 4,522 8,243 17,895 Interest portion of rentals 27 74 106 159 210 --------- ---------- ---------- ----------- ---------- Earnings available to cover fixed charges 66 (2,286) (2,332) (4,927) (6,960) Less fixed charges 2,123 1,040 4,628 8,402 18,105 ---------- ---------- ---------- ----------- --------- Deficiency in the coverage of fixed charges $ (2,057) $ (3,326) $ (6,960) $ (13,329) $(25,065) ---------- ---------- ---------- ----------- --------- ---------- ---------- ---------- ----------- ---------
- --------------------------------- (1) In 1994 -- loss on early termination of the Company's then bank credit facility. In 1996 -- loss on early redemption of the Company's 9.95% and 10.35% Senior Notes. (2) In 1997 -- charge for the effect of adopting EITF Issue 97-13 related to accounting for certain business reengineering costs. (3) Fixed charges consist of interest on all indebtedness, including amortization of debt issuance expense and capitalized interest, and one-third of rental expense (which is estimated to represent the interest portion thereof). EX-21.1 3 EXHIBIT 21.1 EXHIBIT 21.1 SUBSIDIARIES OF THE COMPANY LodgeNet Entertainment (Canada) Corporation, a Canadian corporation ResNet Communications, Inc., a Delaware corporation ResNet Communications, L.L.C., a Delaware corporation EX-23.1 4 EXHIBIT 23.1 EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included in this Form 10-K into the Company's previously filed Registration Statement File No. 33-67676. ARTHUR ANDERSEN LLP Minneapolis, Minnesota March 23, 1998 EX-27.1 5 EXHIBIT 27.1
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED FINANCIAL STATEMENTS OF LODGENET ENTERTAINMENT CORPORATION AND ITS SUBSIDIARIES AS OF DECEMBER 31, 1997, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 1,021 0 21,835 (800) 0 26,313 325,334 (106,386) 260,294 25,645 182,691 0 0 113 49,466 260,294 135,710 135,710 58,512 85,262 0 0 17,001 (25,065) 344 (25,409) 0 0 210 (25,619) (2.27) 0
EX-27.2 6 EXHIBIT 27.2
5 1,000 YEAR 3-MOS 3-MOS 3-MOS DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1996 JAN-01-1996 JAN-01-1996 APR-01-1996 JUL-01-1996 DEC-31-1996 MAR-31-1996 JUN-30-1996 SEP-30-1996 86,177 14 10,984 2,083 0 0 0 0 19,213 14,583 15,772 18,493 (785) (513) (541) (784) 0 0 0 0 106,540 16,765 28,386 22,446 234,265 169,009 192,211 209,830 (70,108) (48,911) (55,443) (61,111) 279,768 139,469 167,611 174,368 21,796 24,834 26,671 28,193 179,233 73,133 58,147 63,847 0 0 0 0 0 0 0 0 111 74 110 110 75,441 39,826 81,020 79,166 279,768 139,469 167,611 174,368 97,721 20,368 23,202 27,116 97,721 20,368 23,202 27,116 44,379 9,114 10,422 12,691 58,428 12,185 14,095 14,504 0 0 0 0 0 0 0 0 8,243 1,922 2,078 1,769 (13,329) (2,853) (3,393) (1,848) 28 20 2 9 (13,357) (2,873) (3,395) (1,857) 0 0 0 0 3,253 0 0 0 0 0 0 0 (16,610) (2,873) (3,395) (1,857) (1.74) (.39) (.39) (.17) 0 0 0 0
EX-27.3 7 EXHIBIT 27.3
5 1,000 3-MOS 3-MOS 3-MOS DEC-31-1997 DEC-31-1997 DEC-31-1997 JAN-01-1997 APR-01-1997 JUL-01-1997 MAR-31-1997 JUN-30-1997 SEP-30-1997 60,416 34,436 20,070 0 0 0 21,919 22,470 23,341 (806) (1,000) (705) 0 0 0 84,017 62,387 46,012 256,536 280,326 304,157 (77,999) (86,710) (96,358) 274,921 268,799 266,064 23,403 22,128 24,321 179,304 179,454 179,460 0 0 0 0 0 0 111 112 114 68,827 63,200 58,206 274,921 268,799 266,064 29,656 33,132 36,692 29,656 33,132 36,692 12,817 14,338 15,731 19,444 20,228 21,362 0 0 0 0 0 0 4,064 4,302 4,638 (6,669) (5,736) (5,039) 10 20 11 (6,679) (5,756) (5,050) 0 0 0 0 0 0 0 0 0 (6,679) (5,756) (5,050) (.60) (.51) (.45) 0 0 0
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