<PAGE>
Filed pursuant to
Rule 424(b)(4)
Registration No. 333-3586
3,200,000 SHARES
[LOGO]
COMMON STOCK
----------------
All of the shares of Common Stock offered hereby are being offered by
LodgeNet Entertainment Corporation ("LodgeNet" or the "Company").
The Common Stock is quoted on the Nasdaq National Market under the symbol
"LNET." On May 22, 1996, the last reported sale price of the Common Stock, as
reported on the Nasdaq National Market, was $13.25 per share.
THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. SEE "RISK
FACTORS" COMMENCING ON PAGE 8 OF THIS PROSPECTUS FOR INFORMATION THAT SHOULD BE
CONSIDERED BY PROSPECTIVE INVESTORS.
-----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR
ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS (1) COMPANY (2)
<S> <C> <C> <C>
Per Share................................. $13.00 $0.6825 $12.3175
Total..................................... $41,600,000 $2,184,000 $39,416,000
Total Assuming Full Exercise of Over-
Allotment Option (3)..................... $47,840,000 $2,511,600 $45,328,400
</TABLE>
(1) See "Underwriting."
(2) Before deducting expenses estimated at $567,500, which are payable by the
Company.
(3) Assuming exercise in full of the 30-day option granted by the Company to the
Underwriters to purchase up to 480,000 additional shares, on the same terms,
solely to cover over-allotments. See "Underwriting."
-------------------
The shares of Common Stock are offered by the Underwriters, subject to prior
sale, when, as and if delivered to and accepted by the Underwriters, and subject
to their right to reject orders in whole or in part. It is expected that
delivery of the Common Stock will be made in New York City on or about May 29,
1996.
-------------------
PAINEWEBBER INCORPORATED
MONTGOMERY SECURITIES
NATWEST SECURITIES LIMITED
<PAGE>
------------
THE DATE OF THIS PROSPECTUS IS MAY 23, 1996.
<PAGE>
Inside Front Cover
Photos depicting Company's products
<PAGE>
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information filed by the Company can be inspected and
copied at the public reference facilities maintained by the Commission at 450
Fifth Street, N.W., Washington, D.C. 20549, and at the Commission's Regional
Offices at Citicorp Center, 500 West Madison, Suite 1400, Chicago, Illinois
60661 and 7 World Trade Center, Suite 1300, New York, New York 10048. Copies of
such material can be obtained from the Public Reference Section of the
Commission at 450 Fifth Street, N.W., Washington D.C. 20549, at prescribed
rates.
The Company has filed with the Commission a Registration Statement under the
Securities Act of 1933, as amended (the "Securities Act"), with respect to the
Common Stock offered hereby. This Prospectus does not contain all of the
information set forth in the Registration Statement and the exhibits and
schedules thereto. For further information with respect to the Company and the
Common Stock offered hereby, reference is hereby made to such Registration
Statement, exhibits and schedules. Statements contained in this Prospectus
regarding the contents of any contract or other document are not necessarily
complete; with respect to each such contract or document filed as an exhibit to
the Registration Statement, reference is made to the exhibit for a more complete
description of the matter involved, and each such statement shall be deemed
qualified in its entirety by such reference. A copy of the Registration
Statement, including the exhibits and schedules thereto, may be inspected
without charge at the principal office of the Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549, and copies of such material may be obtained from
such office upon payment of the fees prescribed by the Commission.
-------------------
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF
THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
-------------------
IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS MAY ENGAGE IN PASSIVE
MARKET MAKING TRANSACTIONS IN THE COMMON STOCK OF THE COMPANY ON THE NASDAQ
NATIONAL MARKET IN ACCORDANCE WITH RULE 10B-6A UNDER THE SECURITIES EXCHANGE ACT
OF 1934. SEE "UNDERWRITING."
FOR UNITED KINGDOM PURCHASERS: THE COMMON STOCK MAY NOT BE OFFERED OR SOLD
IN THE UNITED KINGDOM OTHER THAN TO PERSONS WHOSE ORDINARY ACTIVITIES INVOLVE
THEM IN ACQUIRING, HOLDING, MANAGING OR DISPOSING OF INVESTMENTS, WHETHER AS
PRINCIPAL OR AGENT (EXCEPT IN CIRCUMSTANCES THAT DO NOT CONSTITUTE AN OFFER TO
THE PUBLIC WITHIN THE MEANING OF THE PUBLIC OFFERS OF SECURITIES REGULATIONS
1995 OR THE FINANCIAL SERVICES ACT 1986), AND THIS PROSPECTUS MAY ONLY BE ISSUED
OR PASSED ON TO ANY PERSON IN THE UNITED KINGDOM IF THAT PERSON IS OF A KIND
DESCRIBED IN ARTICLE 11(3) OF THE FINANCIAL SERVICES ACT 1986 (INVESTMENT
ADVERTISEMENTS) (EXEMPTIONS) ORDER 1995 OR IS A PERSON TO WHOM THE PROSPECTUS
MAY OTHERWISE LAWFULLY BE PASSED ON.
2
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND THE CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES
APPEARING ELSEWHERE IN THIS PROSPECTUS. REFERENCES IN THIS PROSPECTUS TO THE
COMPANY INCLUDE ITS PREDECESSOR AND ITS SUBSIDIARIES, UNLESS THE CONTEXT
INDICATES OTHERWISE. EXCEPT AS OTHERWISE SPECIFIED HEREIN, ALL INFORMATION IN
THIS PROSPECTUS (I) ASSUMES NO EXERCISE OF THE UNDERWRITERS' OVER-ALLOTMENT
OPTION AND (II) HAS BEEN ADJUSTED TO REFLECT AN APPROXIMATELY 21.7-FOR-ONE STOCK
SPLIT OF THE COMMON STOCK EFFECTED IN OCTOBER 1993 IN CONNECTION WITH THE
COMPANY'S INITIAL PUBLIC OFFERING. "COMMON STOCK" SHALL REFER TO SHARES OF
COMMON STOCK, $.01 PAR VALUE PER SHARE, OF THE COMPANY. THE SHARES OF COMMON
STOCK OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK. INVESTORS SHOULD CAREFULLY
CONSIDER THE INFORMATION SET FORTH UNDER "RISK FACTORS."
THE COMPANY
LodgeNet Entertainment Corporation ("LodgeNet" or the "Company") is a
specialized communications company that provides video on-demand, network-based
video games, basic and premium cable television programming and other
interactive, multimedia entertainment and information services. 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 420,000 rooms in over 2,800 hotel properties throughout the United States
and Canada. The Company recently entered into an exclusive agreement with GE
Capital-ResCom, L.P. ("GE ResCom"), an affiliate of General Electric Co., to
provide similar services in multi-family residential complexes throughout the
United States. The Company has experienced substantial growth in the number of
guest pay rooms served, total revenue and EBITDA (earnings before interest
expense, income taxes, depreciation and amortization). From 1991 through 1995,
guest pay rooms served increased from 73,415 to 268,207, revenues increased from
$19.6 million to $63.2 million and EBITDA increased from $2.9 million to $15.9
million, representing compound annual growth rates of 38.3%, 34.1% and 52.5%,
respectively. For the three months ended March 31, 1996, guest pay rooms served
increased to 300,216, revenues increased to $20.4 million and EBITDA increased
to $5.2 million, representing an increase of 49.8%, 52.1% and 68.4%,
respectively, over the same period in the prior year.
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 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 is comprised of over 3.4
million rooms, of which the Company estimates approximately 56% 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 selected countries through licensing
arrangements with strategic partners. The Company's guest pay contracts are
generally five to seven years in length. The average remaining life of the
Company's existing guest pay contracts is over four years, with only 10% of
these contracts due to expire before 1998.
In February 1996, the Company entered into an exclusive long-term agreement
with GE ResCom, a leading provider of private telecommunications services to the
multi-family housing industry, under which GE ResCom will exclusively market the
Company's interactive video and cable television services to multi-family
residential complexes throughout the United States. The Company believes there
are over 6.1 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. Subject to the terms of the agreement, GE ResCom is required to
provide the Company during the first three years of the agreement with contracts
for a minimum of 200,000 apartment units with an average term of not less than
ten years. The Company views the multi-family cable television market as
attractive due to: (i) the large market size; (ii) the portability to this
market of the technology and operating expertise developed by the Company for
the lodging market; (iii) the favorable regulatory environment available to
operators such as the Company who qualify for the "private cable" exception
(including the absence of franchise requirements, "must-carry" obligations and
rate
3
<PAGE>
regulations applicable to traditional franchised cable operators); (iv) the
exclusive long-term contracts that have customarily been available in the
multi-family residential market; and (v) the low-cost operating structure made
possible by the various services to be provided by GE ResCom.
In the lodging market, the Company's services are delivered over broadband
local-area cable networks and include Guest Scheduled-TM- on-demand movies,
network-based Super Nintendo-Registered Trademark- video games, PRIME-
STAR-Registered Trademark- digital satellite-delivered basic and premium cable
television programming, and other interactive entertainment and information
services. Guest pay services enable a guest to purchase a movie which generally
is started by the guest on-demand, rather than restricting the guest to a
predetermined start 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. Video games can
be started on-demand by a hotel guest who is charged an hourly rate for play
time. 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 interactive services by virtue of the high-speed, two-way digital
communications design of its proprietary system. 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's private cable television systems serving the multi-family
residential market will be based on technology similar to the proprietary
interactive technology deployed by the Company in the lodging market. Where
residential complexes are located in clusters, the Company may distribute its
programming content from a central location to each such apartment complex. The
Company's private cable television system will have 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. The Company may elect to provide from approximately 10 to 35
additional channels for pay-per-view, video on-demand, video games and other
interactive services, such as Internet access. The Company intends to tailor the
programming lineup at each multi-family residential complex, based on the
particular demographic profile of that complex. In addition, the Company's
private cable television systems will be addressable, enabling the Company to
remotely initiate, modify or terminate service; prevent signal theft; offer
interactive services; and respond to many other service needs.
The Company believes it is a leader in providing innovative products and
services to the lodging industry. The Company 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-TM- (an image-based menu and purchasing protocol,
utilizing pictures and graphics to replace the simple text menus traditionally
utilized by its competitors). In 1995, LodgeNet redesigned its interactive
system, enabling the Company to deliver what it believes to be 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 advanced features of its redesigned system were a principal factor in the
recent awarding by La Quinta Inns of its over 30,000-room account and Budgetel
Inns of its over 8,000-room account to the Company over incumbent competitors.
As of April 1, 1996, the Company entered into an agreement with
PRIMESTAR-Registered Trademark- Partners, L.P.
("PRIMESTAR-Registered Trademark-") which will allow 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.
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
multi-family residential private cable television market; (iii) maximize the
revenue generated per unit served by exploiting new revenue opportunities; (iv)
extend the application of the Company's proprietary technology 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.
The Company's executive offices are located at 808 West Avenue North, Sioux
Falls, South Dakota 57104, and its telephone number is (605) 330-1330.
4
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered by the Company... 3,200,000 shares
Common Stock to be outstanding after
this Offering........................ 10,559,613 shares
Use of proceeds....................... To temporarily reduce borrowings under
the Company's revolving credit facility,
to fund the continued expansion of the
Company's lodging and residential
businesses, and for working capital and
general corporate purposes.
Nasdaq National Market symbol......... LNET
</TABLE>
5
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL AND OTHER DATA
(IN THOUSANDS, EXCEPT PER SHARE, ROOM AND PER ROOM AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
----------------------------------------------------- ----------------------
1991 1992 1993 1994 1995 1995 1996
--------- --------- --------- --------- --------- --------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues............................. $ 19,550 $ 24,051 $ 31,312 $ 40,394 $ 63,213 $ 13,392 $ 20,368
Direct costs......................... 11,773 12,827 14,848 18,181 28,910 6,170 9,114
--------- --------- --------- --------- --------- --------- -----------
Gross profit......................... 7,777 11,224 16,464 22,213 34,303 7,222 11,254
Operating expenses................... 7,979 13,238 16,425 24,573 36,741 7,967 12,185
--------- --------- --------- --------- --------- --------- -----------
Operating income (loss).............. (202) (2,014) 39 (2,360) (2,438) (745) (931)
Interest expense..................... 1,918 1,783 2,096 966 4,522 735 1,922
--------- --------- --------- --------- --------- --------- -----------
Loss before income taxes and
extraordinary loss.................. (2,120) (3,797) (2,057) (3,326) (6,960) (1,480) (2,853)
Provision for income taxes........... -- -- -- -- 66 -- 20
--------- --------- --------- --------- --------- --------- -----------
Loss before extraordinary loss....... (2,120) (3,797) (2,057) (3,326) (7,026) (1,480) (2,873)
Extraordinary loss (1)............... -- -- -- 1,324 -- -- --
--------- --------- --------- --------- --------- --------- -----------
Net loss............................. (2,120) (3,797) (2,057) (4,650) (7,026) (1,480) (2,873)
Dividends on preferred stock......... 940 1,872 1,557 -- -- -- --
--------- --------- --------- --------- --------- --------- -----------
Net loss attributable to common
stock............................... $ (3,060) $ (5,669) $ (3,614) $ (4,650) $ (7,026) $ (1,480) $ (2,873)
--------- --------- --------- --------- --------- --------- -----------
--------- --------- --------- --------- --------- --------- -----------
Common Stock per share data (2):
Net loss before extraordinary
loss.............................. $ (0.42) $ (0.77) $ (0.49) $ (0.45) $ (0.95) $ (0.20) $ (0.39)
Extraordinary loss (1)............. -- -- -- (0.18) -- -- --
--------- --------- --------- --------- --------- --------- -----------
Net loss attributable to Common
Stock............................. $ (0.42) $ (0.77) $ (0.49) $ (0.63) $ (0.95) $ (0.20) $ (0.39)
--------- --------- --------- --------- --------- --------- -----------
--------- --------- --------- --------- --------- --------- -----------
Weighted average shares
outstanding (2)..................... 7,334 7,334 7,334 7,327 7,382 7,352 7,407
--------- --------- --------- --------- --------- --------- -----------
--------- --------- --------- --------- --------- --------- -----------
OTHER DATA:
EBITDA (3)........................... $ 2,941 $ 3,471 $ 7,215 $ 9,301 $ 15,898 $ 3,113 $ 5,242
EBITDA margin........................ 15.0% 14.4% 23.0% 23.0% 25.1% 23.2% 25.7%
Guest pay rooms served (4)
Scheduled.......................... 73,415 81,294 77,650 65,351 58,720 62,885 56,353
On-demand.......................... -- 21,871 59,169 119,680 209,487 137,582 243,863
--------- --------- --------- --------- --------- --------- -----------
Total guest pay rooms.............. 73,415 103,165 136,819 185,031 268,207 200,467 300,216
--------- --------- --------- --------- --------- --------- -----------
--------- --------- --------- --------- --------- --------- -----------
Rooms with Super
Nintendo-Registered Trademark- game
systems (4)......................... -- -- 225 69,806 163,879 91,346 200,388
--------- --------- --------- --------- --------- --------- -----------
--------- --------- --------- --------- --------- --------- -----------
Free-to-guest rooms served (4)....... 144,071 176,651 191,893 220,534 249,779 228,683 261,995
--------- --------- --------- --------- --------- --------- -----------
--------- --------- --------- --------- --------- --------- -----------
Total rooms served (4)(5)............ 182,537 227,697 267,171 314,184 388,088 331,529 424,089
--------- --------- --------- --------- --------- --------- -----------
--------- --------- --------- --------- --------- --------- -----------
Average monthly revenue per guest pay
room:
Movie revenue...................... $ 12.69 $ 13.00 $ 14.68 $ 15.03 $ 17.08 $ 16.64 $ 17.73
Video game/information services.... 0.24 0.27 0.39 1.01 2.21 1.73 2.35
--------- --------- --------- --------- --------- --------- -----------
$ 12.93 $ 13.27 $ 15.07 $ 16.04 $ 19.29 $ 18.37 $ 20.08
--------- --------- --------- --------- --------- --------- -----------
--------- --------- --------- --------- --------- --------- -----------
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1996
----------------------
AS
ACTUAL ADJUSTED (6)
--------- -----------
(UNAUDITED)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents............................................................... $ 14 $ 23,505
Total assets............................................................................ 139,469 162,960
Long-term debt.......................................................................... 73,133 57,775
Total stockholders' equity.............................................................. 39,900 78,749
</TABLE>
6
<PAGE>
Notes to Summary Consolidated Financial and Other Data:
(1) Extraordinary loss -- Loss on early termination of bank credit facility. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
(2) Share Data -- The net loss per common share was computed using the weighted
average number of shares outstanding and, where applicable, outstanding
warrants and options. Weighted average shares for 1993, 1994 and 1995 and
the three months ended March 31, 1995 and 1996 include the shares issued in
connection with the Company's initial public offering of Common Stock in
October 1993. Per share amounts for 1991, 1992 and 1993 reflect the effect
of cumulative dividends on preferred stock.
(3) EBITDA -- Defined as "earnings before interest expense, income taxes,
depreciation and amortization," EBITDA is not intended to represent an
alternative to net income (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 it 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) At end of period.
(5) Total rooms served include those rooms receiving one or more of the
Company's services.
(6) Adjusted to give effect to the sale by the Company of 3,200,000 shares of
Common Stock being offered by the Company at a public offering price of
$13.00 per share and the application of the estimated net proceeds therefrom
as described under "Use of Proceeds."
7
<PAGE>
RISK FACTORS
THIS PROSPECTUS CONTAINS, IN ADDITION TO HISTORICAL INFORMATION,
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S
ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN THE
FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH
DIFFERENCES INCLUDE THOSE DISCUSSED BELOW, AS WELL AS THOSE DISCUSSED ELSEWHERE
IN THIS PROSPECTUS. AN INVESTMENT IN THE SHARES OF COMMON STOCK OFFERED HEREBY
INVOLVES A HIGH DEGREE OF RISK. PROSPECTIVE INVESTORS SHOULD CONSIDER CAREFULLY
THE FOLLOWING RISK FACTORS, IN ADDITION TO THE OTHER INFORMATION PRESENTED IN
THIS PROSPECTUS, BEFORE PURCHASING THE SHARES OF COMMON STOCK OFFERED HEREBY.
DEPENDENCE ON THE LODGING INDUSTRY AND CHANGES IN VIEWING HABITS
The Company's business is closely linked to the performance of the lodging
industry. Declines in hotel occupancy or changes in the mix of hotel guests as a
result of general business, economic, seasonal and other factors can have a
significant impact on the Company's revenues. The Company's performance is also
highly sensitive to the rates at which hotel guests purchase its guest pay
services ("buy rates"). Buy rates are subject to various factors beyond the
control of the Company, including the popularity of available movies for the
Company's guest pay systems, competing free-to-guest programming and general
economic conditions. Additionally, the Company's business performance is highly
dependent upon the relative mix of major motion pictures to independently
produced, non-rated features purchased by hotel guests. The Company generally
pays licensing fees for major motion pictures based on a percentage of the
picture's gross revenues, while most independently produced features are
obtained for a flat fee that is nominal in relation to the licensing fees paid
for the major motion pictures. As a result, a shift in the viewing pattern of
hotel guests away from independently produced features, or any limitation
imposed on the offering of such features by hotels, could adversely affect the
Company's financial condition and operating results.
DEPENDENCE ON ADDITIONAL CAPITAL FOR GROWTH
The continued growth of the Company's business will require substantial
investment on a continuing basis to finance capital expenditures and related
expenses for the installation of the Company's systems in the lodging and
multi-family residential markets. Historically, cash flow generated from the
Company's operations has not been sufficient to fund the cost of expanding the
Company's business and to service related indebtedness. At least for the next
several years, the Company expects cash flow levels will not be sufficient to
support its anticipated growth. The Company will therefore require additional
financing to fund its growth. There can be no assurance that such financing will
be available or, if so, upon commercially reasonable terms. Alternatively, if
cash flows are not sufficient or financing is not available, the Company will
have to reduce growth to a level that can be supported by internally generated
cash flow. The consequences to the Company's results of operations and financial
condition of the latter course of action cannot be accurately predicted. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Financial Condition, Liquidity and Capital Resources."
HIGHLY COMPETITIVE MARKETS
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 pay-per-view service 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. 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 also target this market segment.
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.
8
<PAGE>
In addition, there are a number of potential competitors that could utilize
their existing infrastructure to provide in-room entertainment to the lodging
industry, including cable companies (including wireless cable),
telecommunications companies and direct-to-home and direct broadcast satellite
companies. Some of these potential competitors are already providing
free-to-guest services to hotels and testing video on-demand. Some of these
potential competitors have substantially greater resources than the Company.
Competitive pressures could result in reduced market share for the Company,
higher hotel commissions, narrower 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.
The provision of cable television services to the multi-family residential
market is highly competitive. The Company anticipates that the primary
competitors in each of its markets will be privately-held satellite master
antenna television operators, direct broadcast satellite providers and wireless
cable providers, as well as the local franchised cable operators. Certain of
these competitors may have substantially greater resources and experience in
this market than the Company. In addition, an incumbent provider may have
certain contractual, information or installation cost advantages over a new
provider. See "Business -- Competition."
EARLY STAGE OF BUSINESS SERVING MULTI-FAMILY RESIDENTIAL MARKET
The Company has only recently begun marketing its interactive, multimedia
cable television services to multi-family residential complexes. The Company has
no operating history in this market, and accordingly, there can be no assurance
that the Company's services will achieve market acceptance or financial returns
sufficient to justify the investment or continued operation in such market.
RISK OF TECHNOLOGICAL OBSOLESCENCE
Technology in the entertainment and communications industry is in a
continuous state of change as new technologies continue to be introduced. There
can be no guarantee that future technological advances will not result in
improved equipment or software systems that could adversely affect the Company's
business. In order to remain competitive, the Company must maintain the
programming enhancements, engineering and technical capability and flexibility
to respond to customer demands for new or improved versions of its systems and
new technological developments. The Company's continued success will depend in
part upon its ability to identify promising emerging technologies and to
develop, refine and introduce high quality services in a timely manner and on
competitive terms. Certain of the Company's competitors use or have announced
their intention to use technologies different from the Company's in providing
their guest pay or cable television services. Although the Company does not
believe that any of these competing technologies is currently superior to its
own in providing guest pay and interactive services, there can be no assurance
that the Company's assessment of the strengths, weaknesses, costs and benefits
of competing technologies has been or will be accurate.
HISTORY OF LOSSES
The Company has recorded cumulative net losses since its inception. Such
losses can be attributed principally to the interest, depreciation and
amortization expenses related to the front-end capital expenditures and related
financing incurred by the Company to develop and install its in-room
entertainment systems. Although the Company anticipates continuing to recognize
positive cash flow from operations in the future, in light of the interest,
depreciation and amortization expenses caused by the Company's historical and
expected rate of growth, net losses are expected to continue. There can be no
assurance that an increase in the number of lodging and residential customers
served by the Company or the development of additional services will result in
profitability for the Company in future years.
RISKS OF DEVELOPING NEW PRODUCTS AND MARKETS
The Company's strategy includes developing new applications for its
interactive entertainment and information technologies and pursuing markets
outside of the lodging industry. This strategy presents the risks inherent in
assessing the value of development opportunities, in committing capital in
unproven markets and in integrating and managing new technologies and
applications. Within these new markets, the Company will encounter competition
from a variety of sources that are not present in the lodging market. There can
be no assurance that the Company's new products and applications will generate
additional revenues or earnings for the Company or that the Company will
successfully penetrate these additional markets. See "Business -- Business
Strategy."
9
<PAGE>
GOVERNMENT REGULATION
The Federal Communications Commission (the "FCC") has broad jurisdiction
over the telecommunications industry. However, the Company believes its
operations comply with a statutory exemption from regulation as a "cable system"
operator under the Cable Communications Policy Act of 1984, as amended (the
"Cable Act"). As a "private cable" operator under applicable federal law, the
FCC does not directly regulate the Company's guest pay, free-to-guest, or
multi-family residential cable television activities. For example, the Company
is not subject to the franchise requirements, "must-carry" obligations and rate
regulations applicable to "cable system" operators. It is possible, however,
that laws or regulations could be adopted in the future which would impose
additional regulatory burdens on private cable operators. Private cable
operators such as the Company are, however, subject to certain regulatory
requirements. For instance, 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 can obtain all necessary retransmission consents in its markets.
On February 8, 1996, the President signed into law the Telecommunications
Act of 1996 (the "Act"). This new law 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, modifies rate
regulations applicable to franchised cable operators in the Company's markets
and establishes interconnection obligations for local exchange carriers and
other telecommunications carriers. 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 to be 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 industry. The Company cannot,
however, estimate the impact of the Act on its operations at this time. See
"Business -- Regulation."
ANTI-TAKEOVER PROVISIONS IN CHARTER, BY-LAWS AND CERTAIN AGREEMENTS
The Company's Certificate of Incorporation, By-Laws and certain agreements
contain provisions that could have the effect of making it more difficult for a
third party to acquire, or of discouraging a third party from attempting to
acquire, control of the Company. Such provisions could limit the price that
certain investors might be willing to pay in the future for shares of Common
Stock. Certain provisions in the Company's Certificate of Incorporation and
By-Laws allow the Company to issue preferred stock with rights senior to those
of the Common Stock and impose various procedural and other requirements which
could make it more difficult for stockholders to effect certain corporate
actions. See "Description of Capital Stock -- Delaware Law and Certain Charter
and By-Law Provisions." Certain of the Company's lending arrangements and its
agreement with GE ResCom contain change in control restrictions applicable to
the Company. These provisions also could have the effect of discouraging a party
from attempting to acquire control of the Company.
DEPENDENCE ON KEY PERSONNEL
The Company's success is dependent upon the continued contributions of its
senior corporate management and key employees. The loss of the services of its
key personnel could have a material adverse effect on the Company. The Company
depends on its continued ability to attract and retain highly skilled and
qualified personnel. There can be no assurance that the Company will be
successful in attracting and retaining such personnel. See "Management."
DILUTION
Purchasers of shares of Common Stock in this Offering will experience
immediate and substantial dilution. See "Dilution."
10
<PAGE>
USE OF PROCEEDS
The proceeds to the Company from the sale of the 3,200,000 shares of Common
Stock being offered by the Company are estimated to be $38.8 million ($44.8
million if the Underwriters' over-allotment option is exercised in full), at a
public offering price of $13.00 per share and after deducting estimated
underwriting discounts and commissions and offering expenses. Of the net
proceeds of this offering (the "Offering"), the Company currently anticipates
that approximately $24.8 million of such proceeds will be used to temporarily
reduce borrowings under the Company's $45 million revolving credit facility with
National Westminster Bank Plc (the "1996 Revolving Facility"), with the
remainder of the net proceeds being used to fund capital expenditures to
continue to expand the Company's lodging and residential businesses, and for
working capital and general corporate purposes. Pending such uses, the Company
intends to invest the net proceeds in highly liquid, interest-bearing
securities. As of May 22, 1996, there was approximately $24.8 million
outstanding under the 1996 Revolving Facility, which bears interest at a
variable rate determined by a formula based on the bank's prime rate or LIBOR
and the Company's total leverage (approximately 9.875% at May 22, 1996). See
Note 4 of "Notes to Consolidated Financial Statements."
DIVIDEND POLICY
No dividends have been paid to date on the Common Stock of the Company. The
Board of Directors of the Company does not intend to pay any cash dividends on
Common Stock in the foreseeable future, rather, it is expected that the Company
will retain any earnings to finance its operations and growth. In addition, the
1996 Revolving Facility and the agreements governing the issuance of the
Company's long-term debt include covenants which restrict and limit payments or
distributions in respect of the Common Stock. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Financial
Condition, Liquidity and Capital Resources."
PRICE RANGE OF COMMON STOCK
The Common Stock is quoted on the Nasdaq National Market under the symbol
"LNET." The following sets forth for the periods indicated the high and low
reported last sales price per share for the Common Stock as reported by the
Nasdaq National Market.
<TABLE>
<CAPTION>
FISCAL 1994 HIGH LOW
- -------------------------------------------------------- --------- ---------
<S> <C> <C>
First Quarter........................................... $ 15.88 $ 12.75
Second Quarter.......................................... 14.00 9.50
Third Quarter........................................... 11.00 7.25
Fourth Quarter.......................................... 8.63 6.75
<CAPTION>
FISCAL 1995
- --------------------------------------------------------
<S> <C> <C>
First Quarter........................................... $ 9.25 $ 7.00
Second Quarter.......................................... 9.00 6.75
Third Quarter........................................... 11.75 8.50
Fourth Quarter.......................................... 12.75 9.38
<CAPTION>
FISCAL 1996
- --------------------------------------------------------
<S> <C> <C>
First Quarter........................................... $ 13.75 $ 9.25
Second Quarter (through May 22, 1996)................... 14.75 12.25
</TABLE>
On May 22, 1996, the last reported sale price of the Common Stock as
reported by the Nasdaq National Market was $13.25 per share.
11
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company as of March
31, 1996, as adjusted to give effect to the sale by the Company of the 3,200,000
shares of Common Stock being offered hereby at a public offering price of $13.00
per share and the application of the estimated net proceeds therefrom as
described under "Use of Proceeds."
<TABLE>
<CAPTION>
MARCH 31, 1996
-----------------------
ACTUAL AS ADJUSTED
---------- -----------
(IN THOUSANDS)
<S> <C> <C>
Cash and cash equivalents......................... $ 14 $ 23,505
---------- -----------
---------- -----------
Long-term debt (1):
Revolving credit facility (2)................... $ 15,358 $ --
Senior notes.................................... 33,000 33,000
Senior subordinated notes, less unamortized
discount....................................... 28,455 28,455
Other........................................... 619 619
---------- -----------
77,432 62,074
Less current maturities......................... (4,299) (4,299)
---------- -----------
Total long-term debt........................ 73,133 57,775
---------- -----------
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000
shares authorized;
none outstanding............................... -- --
Common stock, $.01 par value; 20,000,000 shares
authorized;
7,359,613 outstanding, actual; 10,559,613
outstanding, as adjusted....................... 74 106
Additional paid-in capital...................... 71,262 110,079
Accumulated deficit............................. (31,436) (31,436)
---------- -----------
Total stockholders' equity.................. 39,900 78,749
---------- -----------
Total capitalization.............................. $ 113,033 $ 136,524
---------- -----------
---------- -----------
</TABLE>
- ------------
(1) See Note 3 of "Notes to Consolidated Financial Statements."
(2) See Note 4 of "Notes to Consolidated Financial Statements."
12
<PAGE>
DILUTION
The net tangible book value of the Company as of March 31, 1996 was $34.0
million, or $4.62 per share. Net tangible book value per share represents the
amount of total tangible assets less total liabilities of the Company, divided
by the number of shares of Common Stock outstanding. After giving effect to the
sale of the 3,200,000 shares of Common Stock offered by the Company hereby (at a
public offering price of $13.00 per share and after deduction of estimated
underwriting discounts and commissions and offering expenses), the pro forma net
tangible book value of the Company at March 31, 1996 would have been $72.8
million, or $6.90 per share. This represents an immediate increase in such net
tangible book value of $2.28 per share to existing stockholders and an immediate
dilution of $6.10 per share to new investors purchasing shares in this Offering.
Net tangible book value dilution per share represents the difference between the
amount per share paid by new investors purchasing shares of Common Stock in this
Offering and the pro forma net tangible book value per share of Common Stock
immediately after completion of this Offering. The following table illustrates
this per share dilution:
<TABLE>
<S> <C> <C>
Public offering price........................................ $ 13.00
---------
Net tangible book value before Offering.................... $ 4.62
Increase attributable to new investors..................... 2.28
---------
Pro forma net tangible book value after Offering............. 6.90
---------
Dilution to new investors.................................... $ 6.10
---------
---------
</TABLE>
The following table summarizes, on a pro forma basis as of March 31, 1996,
the differences between existing stockholders and new investors with respect to
the number of shares of Common Stock purchased from the Company, the total
consideration paid to the Company, and the average consideration paid per share
(based upon a public offering price of $13.00 per share and before deduction of
estimated underwriting discounts and commissions and offering expenses payable
by the Company):
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------------- --------------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------------ ----------- -------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders.......................... 7,359,613 69.7% $ 73,609,444 63.9% $ 10.00
New investors.................................. 3,200,000 30.3 41,600,000 36.1 13.00
------------ ----- -------------- -----
Total.................................... 10,559,613 100.0% $ 115,209,444 100.0%
------------ ----- -------------- -----
------------ ----- -------------- -----
</TABLE>
The foregoing table assumes no exercise of any outstanding stock options. As
of March 31, 1996, there were outstanding options to purchase an aggregate of
1,407,926 shares of Common Stock at exercise prices ranging from $0.23 to $14.75
per share. To the extent these options are exercised, there will be further
dilution to new investors. See "Management -- Stock Option Plan" and Note 7 of
"Notes to Consolidated Financial Statements."
13
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
(IN THOUSANDS, EXCEPT PER SHARE, ROOM AND PER ROOM AMOUNTS)
The statement of operations data for the five years ended December 31, 1995
and the balance sheet data as of the end of each such year have been derived
from the Consolidated Financial Statements of the Company, which have been
audited by Arthur Andersen LLP, independent public accountants. The statement of
operations and balance sheet data for the three months ended March 31, 1995 and
1996 have been derived from unaudited consolidated financial statements of the
Company but, in the opinion of the Company, include all adjustments (consisting
only of normal recurring adjustments) necessary for a fair presentation thereof.
The results for the three month period ended March 31, 1996 are not necessarily
indicative of the results to be expected for the year ending December 31, 1996.
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.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
----------------------------------------------------- --------------------
1991 1992 1993 1994 1995 1995 1996
--------- --------- --------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Guest pay........................ $ 9,019 $ 13,828 $ 21,471 $ 29,927 $ 50,758 $ 10,500 $ 17,582
Free-to-guest.................... 5,586 6,125 7,478 8,397 8,060 1,993 2,145
Other............................ 4,945 4,098 2,363 2,070 4,395 899 641
--------- --------- --------- --------- --------- --------- ---------
Total revenues..................... 19,550 24,051 31,312 40,394 63,213 13,392 20,368
Direct costs....................... 11,773 12,827 14,848 18,181 28,910 6,170 9,114
--------- --------- --------- --------- --------- --------- ---------
Gross profit....................... 7,777 11,224 16,464 22,213 34,303 7,222 11,254
Operating expenses................. 7,979 13,238 16,425 24,573 36,741 7,967 12,185
--------- --------- --------- --------- --------- --------- ---------
Operating income (loss)............ (202) (2,014) 39 (2,360) (2,438) (745) (931)
Interest expense................... 1,918 1,783 2,096 966 4,522 735 1,922
--------- --------- --------- --------- --------- --------- ---------
Loss before income taxes and
extraordinary loss................ (2,120) (3,797) (2,057) (3,326) (6,960) (1,480) (2,853)
Provision for income taxes......... -- -- -- -- 66 -- 20
--------- --------- --------- --------- --------- --------- ---------
Loss before extraordinary loss..... (2,120) (3,797) (2,057) (3,326) (7,026) (1,480) (2,873)
Extraordinary loss (1)............. -- -- -- 1,324 -- -- --
--------- --------- --------- --------- --------- --------- ---------
Net loss........................... (2,120) (3,797) (2,057) (4,650) (7,026) (1,480) (2,873)
Dividends on preferred stock....... 940 1,872 1,557 -- -- -- --
--------- --------- --------- --------- --------- --------- ---------
Net loss attributable to Common
Stock............................. $ (3,060) $ (5,669) $ (3,614) $ (4,650) $ (7,026) $ (1,480) $ (2,873)
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Common Stock per share data (2):
Net loss before extraordinary
loss............................ $ (0.42) $ (0.77) $ (0.49) $ (0.45) $ (0.95) $ (0.20) $ (0.39)
Extraordinary loss (1)........... -- -- -- (0.18) -- -- --
--------- --------- --------- --------- --------- --------- ---------
Net loss attributable to Common
Stock......................... $ (0.42) $ (0.77) $ (0.49) $ (0.63) $ (0.95) $ (0.20) $ (0.39)
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Weighted average shares outstanding
(2)............................... 7,334 7,334 7,334 7,327 7,382 7,352 7,407
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Gross profit margin................ 39.8% 46.7% 52.6% 55.0% 54.3% 53.9% 55.3%
OTHER DATA:
EBITDA (3)......................... $ 2,941 $ 3,471 $ 7,215 $ 9,301 $ 15,898 $ 3,113 $ 5,242
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
EBITDA margin...................... 15.0% 14.4% 23.0% 23.0% 25.1% 23.2% 25.7%
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Guest pay rooms served (4):
Scheduled........................ 73,415 81,294 77,650 65,351 58,720 62,885 56,353
On-demand........................ 21,871 59,169 119,680 209,487 137,582 243,863
--------- --------- --------- --------- --------- --------- ---------
Total.......................... 73,415 103,165 136,819 185,031 268,207 200,467 300,216
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Rooms with Super
Nintendo-Registered Trademark-
game systems (4).................. -- -- 225 69,806 163,879 91,346 200,388
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Free-to-guest rooms served (4)..... 144,071 176,651 191,893 220,534 249,779 228,683 261,995
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Total rooms served (4)(5).......... 182,537 227,697 267,171 314,184 388,088 331,529 424,089
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Average monthly revenue per guest
pay room:
Movie revenue.................... $ 12.69 $ 13.00 $ 14.68 $ 15.03 $ 17.08 $ 16.64 $ 17.73
Video game/information
services........................ 0.24 0.27 0.39 1.01 2.21 1.73 2.35
--------- --------- --------- --------- --------- --------- ---------
$ 12.93 $ 13.27 $ 15.07 $ 16.04 $ 19.29 $ 18.37 $ 20.08
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
</TABLE>
14
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31, 1996
----------------------------------------------------- ----------------------
AS
1991 1992 1993 1994 1995 ACTUAL ADJUSTED (7)
--------- --------- --------- --------- --------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
(UNAUDITED)
BALANCE SHEET DATA:
Cash and cash equivalents............... $ 221 $ 92 $ 12,256 $ 4,302 $ 2,252 $ 14 $ 23,505
Total assets............................ 27,566 42,238 64,300 88,265 124,712 139,469 162,960
Long-term debt.......................... 14,712 29,500 6,000 28,000 57,497 73,133 57,775
Redeemable preferred stock (6).......... 12,940 13,519 -- -- -- -- --
Total stockholders' equity (deficit).... (3,820) (7,272) 52,665 47,942 42,726 39,900 78,749
</TABLE>
- ---------------
Notes to Selected Consolidated Financial and Other Data:
(1) Extraordinary loss -- Loss on early termination of bank credit facility. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
(2) Share Data -- The net loss per common share was computed using the weighted
average number of shares outstanding and, where applicable, outstanding
warrants and options. Weighted average shares for 1993, 1994 and 1995 and
the three months ended March 31, 1995 and 1996 include the shares issued in
connection with the Company's initial public offering of Common Stock in
October 1993. Per share amounts for 1991, 1992 and 1993 reflect the effect
of cumulative dividends on preferred stock.
(3) EBITDA is not intended to represent an alternative to net income (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 it 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) At end of period.
(5) Total rooms served include those rooms receiving one or more of the
Company's services.
(6) Includes cumulative preferred dividends payable.
(7) Adjusted to give effect to the sale by the Company of 3,200,000 shares of
Common Stock being offered by the Company at a public offering price of
$13.00 per share and the application of the estimated net proceeds therefrom
as described under "Use of Proceeds."
15
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THIS PROSPECTUS CONTAINS, IN ADDITION TO HISTORICAL INFORMATION,
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S
ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN THE
FORWARD-LOOKING STATEMENTS. IN ADDITION, FIRST QUARTER RESULTS ARE NOT
NECESSARILY INDICATIVE OF THE RESULTS TO BE EXPECTED AT YEAR-END. FACTORS THAT
COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE THOSE DISCUSSED BELOW, AS
WELL AS THOSE DISCUSSED ELSEWHERE IN THIS PROSPECTUS. THE FOLLOWING SHOULD BE
READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO
INCLUDED ELSEWHERE HEREIN.
OVERVIEW
GUEST PAY SERVICES
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:
<TABLE>
<CAPTION>
1995 1994 1993
---------------------- ---------------------- ----------------------
ROOMS % ROOMS % ROOMS %
--------- ----------- --------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Scheduled............................... 58,720 21.9% 65,351 35.3% 77,650 56.8%
On-demand............................... 209,487 78.1 119,680 64.7 59,169 43.2
--------- ----- --------- ----- --------- -----
Total............................. 268,207 100.0% 185,031 100.0% 136,819 100.0%
--------- ----- --------- ----- --------- -----
--------- ----- --------- ----- --------- -----
</TABLE>
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, 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, generally ranging from 35% to 50% of gross revenues, (ii) nominal
one-time license fees paid for independent films, which are duplicated by the
Company for distribution to its operating sites, (iii) license fees for video
games and other services, and (iv) the commission retained by the hotel,
generally 10% to 15% of gross revenues, depending on the services provided and
other factors. 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 information with regard to guest pay rooms with game systems
installed as of December 31:
<TABLE>
<CAPTION>
1995 1994 1993
-------- ------- ----
<S> <C> <C> <C>
Rooms with game systems installed........................... 163,879 69,806 225
</TABLE>
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. For free-to-guest services the hotel pays the Company a fixed
monthly charge per room for each programming channel provided. Such monthly
charges range generally from $2.75 to $3.50 per room per month for premium
channels and from $0.15 to $0.85 per room per month for non-premium channels.
The Company obtains its free-to-guest programming pursuant to multi-year
agreements and pays a fixed monthly fee per
16
<PAGE>
room, which ranges generally from 75% to 80% of revenues for such services,
depending on incentive programs in effect from time to time from the programming
networks. The following table sets forth information with regard to
free-to-guest rooms installed as of December 31:
<TABLE>
<CAPTION>
1995 1994 1993
--------- --------- ---------
<S> <C> <C> <C>
Free-to-guest rooms..................... 249,779 220,534 191,893
</TABLE>
RESIDENTIAL SERVICES
In February 1996, the Company entered into an exclusive contract with GE
ResCom, under which the Company will design, install and operate interactive
cable television systems in large, multi-family residential complexes throughout
the United States. This new business is expected to have financial and
technological requirements generally similar to those of the Company's lodging
industry operations. The Company expects to begin installing systems and to
realize its first revenue from residential services in the second quarter of
1996. See "Business -- Services and Products, Multi-Family Residential
Services."
RESULTS OF OPERATIONS -- THREE MONTHS ENDED MARCH 31, 1996 AND 1995
INSTALLED ROOM BASE
During the three months ended March 31, 1996, the Company installed 32,009
new guest pay rooms, equipped 36,509 rooms with its Super
Nintendo-Registered Trademark- game system, and installed 12,216 free-to-guest
rooms. From March 31, 1995 through March 31, 1996, the Company installed 99,749
new guest pay rooms, equipped 109,042 rooms with its Super
Nintendo-Registered Trademark- game system, and installed 33,312 free-to-guest
rooms, representing increases of 49.8%, 119.4% and 14.6%, respectively. The
Company's base of installed rooms was comprised as follows at March 31:
<TABLE>
<CAPTION>
1996 1995
---------------------- ----------------------
ROOMS % ROOMS %
--------- ----------- --------- -----------
<S> <C> <C> <C> <C>
Guest pay rooms:
Scheduled................................................. 56,353 18.8% 62,885 31.4%
On-demand................................................. 243,863 81.2 137,582 68.6
--------- ----- --------- -----
300,216 100.0% 200,467 100.0%
--------- ----- --------- -----
--------- ----- --------- -----
Super Nintendo-Registered Trademark- game system rooms...... 200,388 91,346
--------- ---------
--------- ---------
Free-to-guest rooms......................................... 261,995 228,683
--------- ---------
--------- ---------
</TABLE>
REVENUE ANALYSIS
The Company's total revenues for the first quarter of 1996 increased 52.1%,
or $7.0 million, in comparison to the first quarter of 1995. The following table
sets forth the components of the Company's revenue (in thousands) for the
quarter ending March 31 (unaudited):
<TABLE>
<CAPTION>
1996 1995
----------------------- -----------------------
PERCENT PERCENT
OF TOTAL OF TOTAL
AMOUNT REVENUES AMOUNT REVENUES
--------- ------------ --------- ------------
<S> <C> <C> <C> <C>
Guest pay................................................... $ 17,582 86.3% $ 10,500 78.4%
Free-to-guest............................................... 2,145 10.5 1,993 14.9
Other....................................................... 641 3.2 899 6.7
--------- ----- --------- -----
Total revenues.......................................... $ 20,368 100.0% $ 13,392 100.0%
--------- ----- --------- -----
--------- ----- --------- -----
</TABLE>
GUEST PAY. Guest pay revenues increased 67.4%, or $7.1 million, in the
first quarter of 1996 as compared to the same quarter of 1995. This increase was
the result of (i) a 46.7% increase in the average number of installed guest pay
rooms, all of which were installed with the Company's on-demand room technology,
and (ii) a 9.3% increase in average monthly revenue per guest pay room.
17
<PAGE>
The following table sets forth information in regard to average monthly
revenue per installed guest pay room, and average movie buy rates, average movie
prices, and average hotel occupancy rates for (i) all guest pay rooms and (ii)
on-demand guest pay rooms, each for the quarter ending March 31 (unaudited):
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
Average monthly revenue per guest pay room:
Movie revenue............................................. $17.73 $16.64
Video game/information service............................ 2.35 1.73
------- -------
Total per guest pay room................................ $20.08 $18.37
------- -------
------- -------
For all guest pay rooms:
Average movie buy rates................................... 11.3% 10.7%
Average movie price....................................... $8.37 $8.19
Average hotel occupancy rate.............................. 65.9% 65.3%
For on-demand guest pay rooms:
Average movie buy rates................................... 12.4% 12.0%
Average movie price....................................... $8.41 $8.25
Average hotel occupancy rate.............................. 67.9% 67.3%
</TABLE>
Average movie revenue per room, for all guest pay rooms, was favorably
impacted in the first quarter of 1996 by a combination of higher average buy
rates and higher average movie prices, in comparison to the same quarter of the
prior 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 is attributed to a relatively more popular
selection of newly-released major motion pictures in the first quarter of 1996
as compared to the same quarter in the prior year. Movie prices in certain guest
pay rooms were increased effective February 1, 1995. The Company's movie prices
are generally $7.95 or $8.95.
Average video game and information service revenue per room, for all guest
pay rooms, increased primarily as a result of the increase in the average number
of rooms with video game services installed. On a per-room basis, average
monthly video game revenues were $1.75 and $1.27 during the quarters ended March
31, 1996 and 1995, respectively. The Company had installed its video game
service in 200,388 and 91,346 guest pay rooms as of March 31, 1996 and 1995,
respectively.
FREE-TO-GUEST. Free-to-guest revenues increased 7.6%, or $152,000, in the
first quarter of 1996 as compared to the same quarter of 1995. The comparative
increase in revenues resulted from the 14.6% increase in the number of installed
free-to-guest rooms since March 31, 1995, which installed room increase
mitigated a decline in per-room revenues resulting from a lower proportion of
rooms receiving premium services in the current period. The Company had 261,995
and 228,683 free-to-guest rooms installed at March 31, 1996 and 1995,
respectively.
OTHER. Revenue from other sources, such as the sale of televisions, system
equipment, service parts and labor, and miscellaneous free-to-guest programming
materials, decreased by $258,000, in the first quarter of 1996 as compared to
the same quarter of 1995, all of which was due to lower television sales.
18
<PAGE>
EXPENSE ANALYSIS
DIRECT COSTS. The following table sets forth information regarding the
Company's direct costs (in thousands) and gross profit margin for the quarters
ending March 31 (unaudited):
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
Direct costs:
Guest pay................................................. $ 6,839 $ 3,824
Free-to-guest............................................. 1,684 1,544
Other revenue............................................. 591 802
------- -------
Total direct costs...................................... $ 9,114 $ 6,170
------- -------
------- -------
Gross profit margin:
Guest pay................................................. 61.1% 63.6%
Free-to-guest............................................. 21.5 22.5
Other revenue............................................. 7.8 10.8
Overall (composite)....................................... 55.3 53.9
</TABLE>
Guest pay direct costs increased 78.8%, or $3.0 million, in the first
quarter of 1996 as compared to the same quarter in the prior year. Since guest
pay direct costs (i.e., 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 tend to vary directly with revenue. As a percentage
of revenue, such costs increased from 36.4% in the first quarter of 1995 to
38.9% in the first quarter of 1996. The relative increase in guest pay direct
costs (as a percentage of revenue) reflects higher movie-related costs due to
proportionately higher revenue from newly-released motion pictures,
substantially increased video game revenue in the guest pay revenue mix and
increased hotel commissions, all in the first quarter of 1996 as compared to the
same quarter in the prior year.
Free-to-guest direct costs increased 9.1% to $1.7 million in the first
quarter of 1996 from $1.5 million in the same quarter in the prior year. As a
percentage of free-to-guest revenue, free-to-guest direct costs increased to
78.5% in the first quarter of 1996 from 77.5% in the same quarter in the prior
year. The relative increase in free-to-guest direct costs (as a percentage of
revenue) resulted primarily from higher costs for non-premium programming in the
first quarter of 1996, in comparison to the same quarter in the prior year, and
to a lesser extent to a slightly higher proportion of non-premium programming in
the mix of programming services delivered.
Direct costs associated with other revenue decreased $211,000 in the first
quarter of 1996 as compared to the same quarter in the prior year. This decrease
is directly attributable to the decreased level of television sales discussed
above. As a percentage of related revenues, such direct costs increased to 92.2%
of other revenue in the first quarter versus 89.2% in the first quarter of 1995,
reflecting the effect of increased equipment sales, which have relatively low
margins, in the revenue mix for the first quarter of 1996 as compared to the
same quarter in the prior year.
The Company's overall gross profit increased 55.8%, or $4.0 million, to
$11.3 million in the first quarter of 1996 on a 52.1% increase in revenues in
comparison to the same period in the prior year. The Company's overall gross
profit margin improved to 55.3% in the first quarter of 1996, as compared to
53.9% for the same period in the prior year, primarily due to the relative
increase in the proportion of guest pay revenues in the total revenue mix
between the quarters.
19
<PAGE>
OPERATING EXPENSES. The following table sets forth information in regard to
the Company's operating expenses (in thousands) for the quarter ending March 31
(unaudited):
<TABLE>
<CAPTION>
1996 1995
------------------------ ------------------------
PERCENT PERCENT
OF TOTAL OF TOTAL
AMOUNT REVENUES AMOUNT REVENUES
--------- ------------- --------- -------------
<S> <C> <C> <C> <C>
Operating expenses:
Guest pay operations....................................... $ 3,163 15.5% $ 2,213 16.5%
Selling and marketing...................................... 742 3.7 511 3.8
General and administrative................................. 2,107 10.3 1,385 10.3
Depreciation and amortization.............................. 6,173 30.3 3,858 28.8
--------- --- --------- ---
$ 12,185 59.8% $ 7,967 59.4%
--------- --- --------- ---
--------- --- --------- ---
</TABLE>
Guest pay operations expense increased 42.9%, or $950,000, in the first
quarter of 1996 from $2.2 million in the comparable quarter of the previous
year. This increase is primarily attributable to the 46.7% increase in the
average number of installed guest pay rooms in the first quarter of 1996 as
compared to the same quarter in the prior year. Per average installed guest pay
room, such expenses averaged $3.83 per month in the first quarter of 1996 as
compared to $3.87 per month in the same quarter of 1995. The comparative
decrease on a per-room basis was primarily the result of lower service,
maintenance and support costs.
Selling and marketing expenses increased 45.2%, or $231,000, in the first
quarter of 1996 from $511,000 in the same quarter in the prior year. This
increase reflects the effect of expanded marketing and promotional activities
and an increase in the number of sales and marketing personnel. As a percentage
of revenue, such expenses represented 3.7% of revenue in the first quarter of
1996 as compared to 3.8% in the same quarter in the prior year.
General and administrative expenses increased 52.1%, or $722,000, in the
first quarter of 1996 from $1.4 million in the same quarter in the prior year
primarily reflecting higher legal and personnel related costs. As a percentage
of revenue, general and administrative expenses represented 10.3% of total
revenue in both quarters.
Depreciation and amortization expenses increased 60.0% to $6.2 million in
the first quarter of 1996 from $3.9 million in the same quarter in the prior
year. This increase is directly 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 same quarter in the prior year.
OPERATING LOSS. The Company's operating loss, as a result of the factors
previously discussed, increased to $931,000 in the first quarter of 1996 from
$745,000 in the same quarter of 1995.
INTEREST EXPENSE. Interest expense increased to $1.9 million in the first
quarter of 1996 from $735,000 in the comparable quarter of 1995 due to increases
in long-term debt to fund the Company's continuing expansion of its guest pay
services business. Long-term debt increased from $32.3 million at March 31, 1995
to approximately $73.1 million at March 31, 1996, primarily reflecting the
Company's issuance of $30 million, of 11.5% Senior Subordinated Notes in two
separate private placements during 1995, and borrowings under the Company's
revolving credit facility. Average principal amount of long-term debt
outstanding during the quarter ended March 31, 1996 was approximately $68
million (at an average interest rate of approximately 10.7%) as compared to an
average principal amount outstanding of approximately $29 million (at an average
interest rate of approximately 10.0%) during the comparable period of 1995.
NET LOSS. For the reasons previously discussed, the Company's net loss
increased to $2.9 million in the first quarter of 1996 from a net loss of $1.5
million in the same quarter in the prior year.
EBITDA. As a result of increasing revenues from guest pay services, and the
other factors previously discussed, EBITDA increased 68.4% to $5.2 million in
the first quarter of 1996 as compared to $3.1 million
20
<PAGE>
in the first quarter of 1995. EBITDA as a percentage of total revenue increased
to 25.7% in the first quarter of 1996 as compared to 23.2% in the same quarter
of 1995. EBITDA is included herein because it is a widely accepted financial
indicator used by certain investors and financial analysts to assess and compare
companies on the basis of operating performance. EBITDA is not intended to
represent an alternative to net income (as determined in accordance with
generally accepted accounting principles) as a measure of performance, but
management believes that it does provide 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, 1995 AND 1994
REVENUE ANALYSIS
The Company's total revenues increased 56.5% in 1995 as compared to 1994.
The following table sets forth the various components of the Company's total
revenue (in thousands) for the years ended December 31:
<TABLE>
<CAPTION>
1995 1994
----------------------- -----------------------
PERCENT OF PERCENT OF
TOTAL TOTAL
AMOUNT REVENUES AMOUNT REVENUES
--------- ------------ --------- ------------
<S> <C> <C> <C> <C>
Guest pay................................................... $ 50,758 80.2% $ 29,927 74.1%
Free-to-guest............................................... 8,060 12.8 8,397 20.8
Other....................................................... 4,395 7.0 2,070 5.1
--------- ----- --------- -----
Total revenues........................................ $ 63,213 100.0% $ 40,394 100.0%
--------- ----- --------- -----
--------- ----- --------- -----
</TABLE>
GUEST PAY. Guest pay revenues increased 69.6%, or $20.8 million, in 1995 as
compared to 1994. This increase is attributable to (i) an approximate 41%
increase in the average number of guest pay rooms installed during 1995 as
compared to the prior year and (ii) increases in movie and video game and
information service revenue on a per-room basis of 13.6% and 118.8%,
respectively, both as compared to 1994. Higher average buy rates and higher
average movie prices combined with higher average occupancy rates such that
average monthly movie revenues increased on a per-room basis. Video game and
information service revenues increased from approximately $1.9 million in 1994
to approximately $5.8 million in 1995, primarily as a result of the increase in
the number of rooms with video game services installed. The following table sets
forth information in regard to (i) average monthly movie revenue per installed
room, (ii) average monthly video game and information service revenue per
installed room, (iii) total average monthly revenue per installed room, (iv)
movie buy rates, (v) average movie prices, and (vi) average hotel occupancy
rates, each for the years ended December 31:
<TABLE>
<CAPTION>
1995 1994
------- -------
<S> <C> <C>
Average monthly revenue per room:
Movie revenue............................................. $17.08 $15.03
Video game/information service............................ 2.21 1.01
------- -------
Total per guest pay room.............................. $19.29 $16.04
------- -------
------- -------
For all guest pay rooms:
Average movie buy rates................................... 10.1% 9.5%
Average movie price....................................... $8.28 $7.81
Average hotel occupancy rate.............................. 69.0% 68.7%
For on-demand guest pay rooms:
Average movie buy rates................................... 11.2% 11.1%
Average movie price....................................... $8.34 $7.90
Average hotel occupancy rate.............................. 69.8% 69.9%
</TABLE>
FREE-TO-GUEST. Free-to-guest revenues decreased 4.0%, or $337,000, in 1995
as compared to the prior year. The comparative decrease is primarily
attributable to a relative decline in the proportion of free-to-guest rooms
receiving premium services.
21
<PAGE>
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 112.3%, or $2.3 million, in 1995 as compared to 1994.
This increase is directly attributable to increases in television sales between
the periods.
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:
<TABLE>
<CAPTION>
1995 1994
------- -------
<S> <C> <C>
Direct costs:
Guest pay................................................. $19,053 $10,050
Free-to-guest............................................. 6,117 6,412
Other revenue............................................. 3,740 1,719
------- -------
Total direct costs.................................... $28,910 $18,181
------- -------
------- -------
Gross profit margin:
Guest pay................................................. 62.5% 66.4%
Free-to-guest............................................. 24.1 23.6
Other revenue............................................. 14.9 17.0
Overall (composite)....................................... 54.3 55.0
</TABLE>
Guest pay direct costs increased 89.6%, or $9.0 million, in 1995 as compared
to 1994. Since guest pay direct costs, i.e. 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 tend to vary directly with revenue. As a
percentage of guest pay revenues, guest pay direct costs were 37.5% of related
revenues versus 33.6% in 1994. The relative increase in guest pay direct costs
(as a percentage of revenue) reflects higher movie-related costs due to
proportionately higher revenue from newly-released motion pictures,
substantially increased video game revenue in the guest pay revenue mix and
increased hotel commissions, as compared to 1994.
Free-to-guest direct costs decreased 4.6%, or $295,000, in 1995 compared to
the prior year, and such direct costs also decreased, as a percentage of
free-to-guest revenues, to 75.9% in 1995 from 76.4% in the prior year, primarily
due to a comparative decrease in the relative proportion of premium channels in
the programming mix, as previously mentioned.
Direct costs related to other revenue increased 117.6%, or $2.0 million, in
1995 as compared to 1994. This increase was directly attributable to the
increased level of television sales discussed above. As a percentage of other
revenue, direct costs increased to 85.1% in 1995 as compared to 83.0% in 1994
due to the relative increase in revenue from television sales, which have a
lower margin than other components of the other revenue category.
The Company's overall gross profit margin was 54.3% in 1995 as compared to
55.0% in 1994. The slight decrease is attributable to the lower guest pay gross
profit margin, and to the effect of the increased sales of televisions in the
other revenue category, both as previously discussed.
22
<PAGE>
OPERATING EXPENSES. The following table sets forth information in regard to
the Company's operating expenses (in thousands) for the years ended December 31:
<TABLE>
<CAPTION>
1995 1994
------------------------ ------------------------
PERCENT OF PERCENT OF
TOTAL TOTAL
AMOUNT REVENUES AMOUNT REVENUES
--------- ------------- --------- -------------
<S> <C> <C> <C> <C>
Operating expenses:
Guest pay operations...................................... $ 9,767 15.5% $ 7,244 17.9%
Selling and marketing..................................... 1,871 3.0 1,541 3.8
General and administrative................................ 6,767 10.7 4,127 10.2
Depreciation and amortization............................. 18,336 29.0 11,661 28.9
--------- --- --------- ---
$ 36,741 58.1% $ 24,573 60.8%
--------- --- --------- ---
--------- --- --------- ---
</TABLE>
Guest pay operations expense increased 34.8%, or $2.5 million, in 1995 as
compared to the prior year. This increase was primarily attributable to the
addition of 83,176 guest pay rooms since December 31, 1994. Per installed guest
pay room, such expenses averaged $3.71 per month during 1995 as compared to
$3.88 for 1994. Lower service and maintenance costs and lower administrative
support costs combined to offset higher property taxes, all on a per-room basis.
Selling and marketing expenses increased 21.4%, or $330,000, in 1995 as
compared to 1994, reflecting an increase in marketing and promotional activities
and the addition of sales and marketing personnel. Sales and marketing expenses
represented 3.0% of revenues in 1995 as compared to 3.8% in the prior year.
General and administrative expenses increased 64.0%, or $2.6 million, in
1995 as compared to the prior year, primarily reflecting increases in legal and
personnel-related costs. As a percentage of revenues, general and administrative
costs were 10.7% in 1995 as compared to 10.2% in 1994.
Depreciation and amortization expenses increased 57.2%, or $6.7 million, in
1995 as compared to 1994. These increases directly reflect the effect of the
approximate 45% increase in the number of installed guest pay rooms, as well as
the effect of expenditures to upgrade previously installed rooms to provide
video game and information services, and the associated software and other
capitalized costs such as service vans and equipment, computers and office
furniture, fixtures and other equipment related to the Company's continuing
expansion.
OPERATING LOSS. The Company's operating loss was $2.4 million in both 1995
and 1994.
INTEREST EXPENSE. Interest expense increased 368.1%, or $3.6 million, in
1995 as compared to 1994. The increase is directly attributable to increased
borrowing to fund the Company's continuing investments in both newly-installed
and upgraded rooms. The average amount of long-term debt outstanding during
1995, excluding amounts outstanding under the Company's revolving credit
facility, was approximately $40.6 million as compared to an average of
approximately $12.4 million during 1994. The average amount outstanding under
the revolving credit facility was approximately $2.1 million during 1995 as
compared to approximately $1.9 million in 1994.
NET LOSS. The Company's net loss increased to $7.0 million in 1995 from
$4.6 million in 1994, as a result of the foregoing factors.
EBITDA. Earnings before interest expense, income taxes and depreciation and
amortization increased 70.9%, or $6.6 million, in 1995 as compared to 1994.
EBITDA, as a percentage of total revenues, increased to 25.1% in 1995 as
compared to 23.0% in 1994.
23
<PAGE>
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1994 AND 1993
REVENUE ANALYSIS
The Company's total revenues increased 29.0% in 1994 as compared to 1993.
The following table sets forth the various components of the Company's total
revenue (in thousands) for the years ended December 31:
<TABLE>
<CAPTION>
1994 1993
----------------------- -----------------------
PERCENT OF PERCENT OF
TOTAL TOTAL
AMOUNT REVENUES AMOUNT REVENUES
--------- ------------ --------- ------------
<S> <C> <C> <C> <C>
Guest pay................................................... $ 29,927 74.1% $ 21,471 68.6%
Free-to-guest............................................... 8,397 20.8 7,478 23.9
Other....................................................... 2,070 5.1 2,363 7.5
--------- ----- --------- -----
Total revenues.......................................... $ 40,394 100.0% $ 31,312 100.0%
--------- ----- --------- -----
--------- ----- --------- -----
</TABLE>
GUEST PAY. Guest pay revenues increased 39.4%, or $8.5 million, in 1994 as
compared to 1993. This increase is primarily attributable to an approximate 34%
increase in the average number of guest pay rooms installed during 1994 as
compared to the prior year, and to a lesser extent to an increase in both movie
and video game and information service revenue on a per-room basis. Higher
average movie prices, combined with higher average occupancy rates, offset a
decline in buy rates with the result that average monthly movie revenues
increased on a per-room basis. The decline in movie buy rates was primarily the
result of a relatively less popular selection of newly-released major motion
pictures in 1994 versus 1993. Video game and information service revenues
increased from approximately $.6 million in 1993 to $1.9 million in 1994,
primarily as a result of the increase in the number of rooms with video game
services installed. The following table sets forth information in regard to (i)
average monthly movie revenue per installed room, (ii) average monthly video
game and information service revenue per installed room, (iii) total average
monthly revenue per installed room, (iv) movie buy rates, (v) average movie
prices, and (vi) average hotel occupancy rates, each for the years ended
December 31:
<TABLE>
<CAPTION>
1994 1993
------- -------
<S> <C> <C>
Average monthly revenue per room (1):
Movie revenue............................................. $15.03 $14.68
Video game/information service............................ 1.01 0.39
------- -------
Total per guest pay room................................ $16.04 $15.07
------- -------
------- -------
For all guest pay rooms:
Average movie buy rates................................... 9.5% 10.2%
Average movie price....................................... $7.81 $7.50
Average hotel occupancy rate.............................. 68.7% 65.0%
For on-demand guest pay rooms:
Average movie buy rates................................... 11.1% 13.2%
Average movie price....................................... $7.90 $7.92
Average hotel occupancy rate.............................. 69.9% 63.7%
</TABLE>
- ------------
(1) Effective December 31, 1994, the Company refined its method of calculating
average installed guest pay rooms for a period, which is the basis for
calculating "per room" revenue and expense statistics, to better reflect the
number of rooms in operation during the period being measured. Per-room
statistics for each year presented herein have been restated to conform to
the averaging convention adopted.
FREE-TO-GUEST. Free-to-guest revenues increased 12.3%, or $919,000, in 1994
as compared to the prior year. This increase was attributable to an approximate
12% increase in the average number of installed free-to-guest rooms during 1994
as compared to 1993.
24
<PAGE>
OTHER. Revenue from other sources, such as the sale of televisions, system
equipment, service parts and labor, and miscellaneous free-to-guest programming
materials, decreased by 12.4%, or $293,000, in 1994 as compared to 1993. This
decrease is directly attributable to the Company's de-emphasis of television
sales because of the relatively low profit margins associated with such sales.
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:
<TABLE>
<CAPTION>
1994 1993
------- -------
<S> <C> <C>
Direct costs:
Guest pay................................................. $10,050 $ 7,235
Free-to-guest............................................. 6,412 5,792
Other revenue............................................. 1,719 1,821
------- -------
Total direct costs...................................... $18,181 $14,848
------- -------
------- -------
Gross profit margin:
Guest pay................................................. 66.4% 66.3%
Free-to-guest............................................. 23.6 22.6
Other revenue............................................. 17.0 22.9
Overall (composite)....................................... 55.0 52.6
</TABLE>
Guest pay direct costs increased 38.9%, or $2.8 million, in 1994 as compared
to 1993. Since guest pay direct costs, i.e. studio license fees, video game
license fees and the commission retained by the hotel, are primarily based on
related revenue, such direct costs tend to vary directly with revenue. As a
percentage of guest pay revenues, guest pay direct costs were 33.6% of related
revenues versus 33.7% in 1993. The slight decline in comparison to 1993 was due
to a relatively lower proportion of revenue from newly-released major motion
pictures in 1994. The cost of a newly-released major motion picture is typically
higher, as a percentage of revenue, than that of older or independently produced
films. The relatively lower movie costs offset higher hotel commissions.
Free-to-guest direct costs increased 10.7%, or $620,000, in 1994 compared to
the prior year. This increase reflects the cost-related effect of the
free-to-guest revenue growth previously discussed, since both free-to-guest
revenue and related direct costs vary primarily as a function of the number of
rooms served. As a percentage of free-to-guest revenues, free-to-guest direct
costs decreased to 76.4% in 1994 from 77.4% in the prior year primarily due to a
comparative decrease in the relative proportion of premium channels in the
programming mix.
Direct costs related to other revenue decreased 5.6%, or $102,000, in 1994
as compared to 1993. This decrease was directly attributable to the decreased
level of sales discussed above. As a percentage of television sales and other
revenue, direct costs increased to 83.0% in 1994 as compared to 77.1% in 1993
due to a relative increase in revenue from equipment rentals, which have a lower
margin than other components of the television sales and other revenue category.
The Company's overall gross profit margin improved to 55.0% in 1994 as
compared to 52.6% in 1993 primarily due to the relative increase of the guest
pay component of the revenue mix.
25
<PAGE>
OPERATING EXPENSES. The following table sets forth information in regard to
the Company's operating expenses (in thousands) for the years ended December 31:
<TABLE>
<CAPTION>
1994 1993
------------------------ ------------------------
PERCENT OF PERCENT OF
TOTAL TOTAL
AMOUNT REVENUES AMOUNT REVENUES
--------- ------------- --------- -------------
<S> <C> <C> <C> <C>
Operating expenses:
Guest pay operations...................................... $ 7,244 17.9% $ 5,491 17.5%
Selling and marketing..................................... 1,541 3.8 1,020 3.3
General and administrative................................ 4,127 10.2 2,738 8.7
Depreciation and amortization............................. 11,661 28.9 7,176 22.9
--------- --- --------- ---
$ 24,573 60.8% $ 16,425 52.4%
--------- --- --------- ---
--------- --- --------- ---
</TABLE>
Guest pay operations expense increased 31.9%, or $1.8 million, in 1994 as
compared to the prior year. This increase was primarily attributable to the
addition of 48,212 guest pay rooms since December 31, 1993. Per installed guest
pay room, such expenses averaged $3.88 per month during 1994 as compared to
$3.85 for 1993. The slight increase on a per-room basis resulted from slightly
higher support, in-room marketing and distribution costs which offset relatively
lower maintenance and service, insurance and property tax costs.
Selling and marketing expenses increased 51.1%, or $521,000, in 1994 as
compared to 1993, reflecting an increase in sales and marketing personnel and
expanded marketing and promotional activities. Prior to the successful
completion of the Company's initial public offering of Common Stock in October
1993, the Company limited sales and marketing activities to levels consistent
with the availability of growth capital to finance the installation of rooms
already under contract for installation.
General and administrative expenses increased 50.7%, or $1.4 million, in
1994 as compared to the prior year. The increase primarily reflects the
additional insurance, legal, accounting and other costs that are a consequence
of being publicly-owned, and to a lesser extent the employment growth, and
employment-related costs, necessary to support the Company's continuing growth.
Depreciation and amortization expenses increased 62.5%, or $4.5 million, in
1994 as compared to 1993. These increases directly reflect the effect of the
increases in installed rooms previously discussed, rooms upgraded to provide
video game and information services, and the associated software, and other
capitalized costs such as service vans and equipment, computers and office
furniture, fixtures and other equipment related to the Company's continuing
expansion.
INTEREST EXPENSE. Interest expense decreased 53.9%, or $1.1 million, in
1994 as compared to 1993. The decrease is primarily attributable to decreased
borrowing under the Company's revolving facility, which offset the effect of the
Company's 9.95% Senior Notes (the "9.95% Senior Notes") which were issued on
September 15, 1994. The average amount outstanding under the revolving credit
facility during 1994 was $1.9 million as compared to an average of $21.8 million
during 1993. The average amount outstanding of the Company's 9.95% Senior Notes
was $8.2 million during 1994.
EXTRAORDINARY LOSS. On September 15, 1994, the Company issued $28 million
in principal amount of 9.95% Senior Notes, due 2003, in a private placement to
three insurance companies (see "-- Financial Condition, Liquidity and Capital
Resources"). In order that the 9.95% Senior Notes could be issued on an
unsecured basis, the Company terminated its then revolving credit facility. As a
consequence of the early termination of such revolving credit facility, the
Company recorded an extraordinary loss of $1.3 million. The one-time, non-cash
charge represented the write-off of previously incurred, unamortized debt
issuance costs relating to the terminated revolving credit facility and various
amendments thereto.
NET LOSS AND NET LOSS ON COMMON STOCK. The Company's net loss increased to
$4.6 million in 1994 from $2.1 million in 1993, as a result of the foregoing
factors. The $1.0 million increase in net loss on
26
<PAGE>
Common Stock, from $3.6 million in 1993 to $4.6 million in 1994, was mitigated
by a comparative reduction in dividends on preferred stock. Such dividends on
preferred stock were $1.6 million in 1993 versus none for 1994.
EBITDA. EBITDA increased 28.9%, or $2.1 million, in 1994 as compared to
1993. EBITDA, as a percentage of total revenues, was 23.0% in both 1994 and
1993.
SEASONALITY
The Company's quarterly operating results are subject to fluctuation
depending upon hotel occupancy rates and buy rates, among other factors.
Typically, occupancy rates are higher during the second and third quarters due
to seasonal travel patterns.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
On September 15, 1994, the Company issued $28 million, principal amount, of
9.95% Senior Notes to three insurance companies in a private placement. On April
13, 1995, the Company and the holders of the 9.95% Senior Notes amended the Note
Purchase Agreement and concurrently the Company issued $5 million, principal
amount, of 10.35% Senior Notes (the "10.35% Senior Notes"), under the Note
Purchase Agreement, in a private placement to certain holders of the 9.95%
Senior Notes (the 9.95% Senior Notes and the 10.35% Senior Notes are
collectively referred to as the "Senior Notes"). The Senior Notes are unsecured
and mature on August 1, 2003. Interest on the Senior Notes is fixed and is
payable quarterly, and mandatory annual principal payments of $4.125 million
commence August 1, 1996. The Senior Notes contain covenants 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, provide for acceleration of
principal repayment in certain circumstances, and permit early retirement of
principal subject to minimum rate of return provisions.
On August 9, 1995, the Company issued $20 million (principal amount) of
11.5% Senior Subordinated Notes due July 15, 2005 (the "Subordinated Notes") to
three insurance companies in a private placement. On October 4, 1995, the
Company issued an additional $10 million (principal amount) of such Subordinated
Notes to the same purchasers and under identical terms and conditions. The
Subordinated Notes are unsecured and bear interest at the fixed rate of 11.5%,
payable semi-annually. Mandatory annual principal payments of $6 million
commence July 15, 2001.
Net proceeds of the August 9, 1995 issue of the Subordinated Notes, net of
original issue discount and issuance-related expenses, were approximately $18.1
million, and were used to (i) repay $10.0 million outstanding under the
Company's then existing revolving facility and (ii) provide funding for capital
expenditures to expand the Company's guest pay services business. The net
proceeds from the October 4, 1995 issue of Subordinated Notes, net of original
issue discount and issuance-related expenses, were approximately $9.2 million
and provided additional capital to fund the expansion of the Company's guest pay
services business. The Subordinated Notes include covenants 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, provide for acceleration of
principal repayment in certain circumstances, and permit early retirement of
principal, subject to minimum rate of return provisions. At March 31, 1996, the
Company was in compliance with all such covenants.
The Company issued a total of 480,000 warrants to purchase Common Stock in
connection with the issuance of the Subordinated Notes. Net proceeds
attributable to the warrants were approximately $1.6 million, and provided
additional capital to fund the Company's expansion of its guest pay services
business. Each warrant permits the holder to purchase one share of Common Stock
at an exercise price of $7.00. The warrants include demand registration rights
and anti-dilution provisions and expire on July 15, 2005.
On March 11, 1996, the Company entered into the 1996 Revolving Facility with
National Westminster Bank Plc and three other banks, replacing the Company's
former revolving facility. The 1996 Revolving Facility is unsecured and amounts
thereunder bear interest at either (i) LIBOR (London Inter Bank Offered Rate)
plus from 2.00% to 2.625% or (ii) prime rate plus from 1.00% to 1.625%, both
depending on the Company's total leverage, as defined in the agreement. The
commitment under the 1996 Revolving Facility
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may be increased from $45 million to $60 million, subject to conditions
precedent. The banks' commitment under the 1996 Revolving Facility is subject to
a scheduled reduction of 15% beginning in June 1997 and annually thereafter as
follows: June 1998 - 20%; June 1999 - 20%; June 2000 - 20%; and June 2001 - 25%.
The 1996 Revolving 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 May 22,
1996, there was approximately $24.8 million outstanding under the 1996 Revolving
Facility.
The growth of the Company's business requires substantial capital investment
on a continuing basis to finance expansion of its lodging and multi-family
residential businesses. Historically, cash flow from operations has not been
sufficient to fund the cost of expanding the Company's business and to service
existing indebtedness. Capital expenditures were $51.5 million during 1995 and
net cash provided by operating activities was $15.4 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 $80 to
$90 million during 1996, and principal and interest payments on its outstanding
debt of approximately $4.3 million and $7.5 million, respectively. The Company
expects to incur capital expenditures of approximately $100 to $140 million in
1997. The actual amount and timing of the Company's capital expenditures will
vary (and such variations could be material) depending upon the number of new
contracts for services entered into by the Company, the costs of installations,
the Company's actual experience as it enters the residential and mid-size hotel
markets and other factors. The Company believes that the net proceeds from this
Offering, together with its operating cash flows, working capital and the 1996
Revolving Facility will be sufficient to fund the Company's growth for the
remainder of 1996. Depending on the Company's rate of growth, the Company
intends to seek additional financing to fund its capital expenditures for 1997.
The Company believes that such financing is available from a number of sources.
However, if such financing should not be available at reasonable cost to the
Company, the Company could modify its expansion plans and reduce its capital
expenditures necessary for the installation of the Company's systems in the
lodging and multi-family residential markets.
EFFECT OF RECENTLY ISSUED ACCOUNTING STANDARDS
Financial Accounting Standards Board Statement No. 123, "Accounting for
Stock-Based Compensation" ("Statement 123"), issued in October 1995 and
effective for fiscal years beginning after December 15, 1995, encourages, but
does not require, a fair value based method of accounting for employee stock
options or similar equity instruments. It also allows an entity to elect to
continue to measure compensation cost under Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), but requires pro
forma disclosures of net income and earnings per share as if the fair value
method of accounting had been applied.
The Company adopted Statement 123 in 1996 and elected to continue to measure
compensation cost in accordance with APB 25, as permitted under Statement 123,
and to comply with the pro forma disclosure requirements thereof. Compliance
with Statement 123 will have no impact on the Company's results of operations or
financial position because the Company's stock option plans are fixed stock
option plans, and therefore grants thereunder have no intrinsic value at the
grant date under APB 25.
Financial Accounting Standards Board Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
("Statement 121"), was issued in March 1995 and is effective for fiscal years
beginning after December 15, 1995. This statement will be applied prospectively,
and requires that impairment losses on long-lived assets be recognized when the
book value of the asset exceeds its expected undiscounted cash flows. The
Company adopted Statement 121 as of January 1, 1996 and adoption at that time
did not have a material impact on the Company's financial position or results of
operations.
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BUSINESS
OVERVIEW
LodgeNet Entertainment Corporation is a specialized communications company
that provides video on-demand, network-based video games, basic and premium
cable television programming and other interactive, multimedia entertainment and
information services. 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 420,000 rooms in over 2,800 hotel
properties throughout the United States and Canada. The Company recently entered
into an exclusive agreement with GE Capital-ResCom, L.P. ("GE ResCom"), an
affiliate of General Electric Co., to provide similar services in multi-family
residential complexes throughout the United States.
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 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 is comprised of over 3.4
million rooms, of which the Company estimates approximately 56% 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 selected countries through licensing
arrangements with strategic partners. The Company's guest pay contracts are
generally five to seven years in length. The average remaining life of the
Company's existing guest pay contracts is over four years, with only 10% of
these contracts due to expire before 1998.
On February 9, 1996, the Company entered into an exclusive long-term
agreement with GE ResCom, a leading provider of private telecommunications
services to the multi-family housing industry, under which GE ResCom will
exclusively market the Company's interactive video and cable television services
to multi-family residential complexes throughout the United States. The Company,
through its wholly-owned subsidiary, ResNet Communications, Inc. ("ResNet"),
will own the customer video service contracts and be responsible for
installation and field service operations. The Company believes there are over
6.1 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.
Subject to the terms of the agreement, GE ResCom is required to provide the
Company during the first three years of the agreement with contracts for a
minimum of 200,000 apartment units with an average term of not less than ten
years. The Company views the multi-family cable television market as attractive
due to: (i) the large market size; (ii) the portability to this market of the
technology and operating expertise developed by the Company for the lodging
market; (iii) the favorable regulatory environment available to operators such
as the Company who qualify for the "private cable" exception (including the
absence of franchise requirements, "must-carry" obligations and rate regulations
applicable to traditional franchised cable operators); (iv) the exclusive
long-term contracts that have customarily been available in the multi-family
residential market; and (v) the low-cost operating structure made possible by
the various services to be provided by GE ResCom.
In the lodging market, the Company's services are delivered over broadband
local-area cable networks and include Guest Scheduled-TM- on-demand movies,
network-based Super Nintendo-Registered Trademark- video games, PRIME-
STAR-Registered Trademark- digital satellite-delivered basic and premium cable
television programming, and other interactive entertainment and information
services. Guest pay services enable a guest to purchase a movie which generally
is started by the guest on-demand rather than restricting the guest to a
predetermined start 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. Video games can
be started on-demand by a hotel guest who is charged an hourly rate for play
time. 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 interactive services by virtue of the high-speed, two-way digital
communications design of its proprietary interactive system. 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.
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The Company's private cable television systems serving the multi-family
residential market will be based on technology similar to the proprietary
interactive technology deployed by the Company in the lodging market. Where
residential complexes are located in clusters, the Company may distribute its
programming content from a central location to each such apartment complex. The
Company's private cable television system will have 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. The Company may elect to provide from approximately 10 to 35
additional channels for pay-per-view, video on-demand, video games and other
interactive services, such as Internet access. The Company intends to tailor the
programming lineup at each multi-family residential complex, based on the
particular demographic profile of that complex. In addition, the Company's
private cable television systems will be addressable, enabling the Company to
remotely initiate, modify or terminate service; prevent signal theft; offer
interactive services; and respond to many other service needs.
The Company believes it is a leader in providing innovative products and
services to the lodging industry. The Company 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-TM- (an image-based menu and purchasing protocol,
utilizing pictures and graphics to replace the simple text menus traditionally
utilized by its competitors). In 1995, LodgeNet redesigned its interactive
system, enabling the Company to deliver what it believes to be 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 advanced features of its redesigned system were a principal factor in the
recent awarding by La Quinta Inns of its over 30,000-room account and Budgetel
Inns of its over 8,000-room account to the Company over incumbent competitors.
As of April 1, 1996, the Company entered into an agreement with
PRIMESTAR-Registered Trademark- which will allow 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.
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.
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
multi-family residential private cable television market; (iii) maximize the
revenue generated per unit served by exploiting new revenue opportunities; (iv)
extend the application of the Company's proprietary technology 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 guest rooms located in hotels having more
than 100 rooms (from the over 3.4 million guest rooms industry-wide), of which
the Company estimates approximately 600,000 are either served by the Company's
competitors under contracts due to expire before the end of 1997 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
proprietary interactive system, together with its expertise in installation,
programming, technical support and customer service.
Internationally, the Company is expanding its market into selected countries
through licensing agreements with established partners in these countries. Under
these agreements, the Company sells equipment at cost plus an agreed markup and
receives a royalty based on gross revenues. The Company's international
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partners plan to install approximately 80,000 guest rooms over the next five
years. The Company believes there may be significant additional opportunities to
enter into international strategic alliances and further exploit the Company's
technology, intellectual property and multimedia experience and capabilities.
EXPANDING INTO THE MULTI-FAMILY RESIDENTIAL MARKET. The Company believes
there are substantial opportunities to provide its services 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 over 6.1
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. As part of this strategy, on
February 9, 1996, the Company entered into an exclusive long-term agreement with
GE ResCom pursuant to which GE ResCom will exclusively market the Company's
cable television services to multi-family residential complexes throughout the
United States. The Company views the multi-family cable television market as
attractive due to: (i) the large market size; (ii) the portability to this
market of the technology and operating expertise developed by the Company for
the lodging market; (iii) the favorable regulatory environment available to
operators such as the Company who qualify for the "private cable" exception
(including the absence of franchise requirements, "must-carry" obligations and
rate regulations applicable to traditional franchised cable operators); (iv) the
exclusive long-term contracts that have customarily been available in the
multi-family residential market; and (v) the low-cost operating structure made
possible by the various services to be provided by GE ResCom.
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 on-demand movie and network-based Super
Nintendo-Registered Trademark- video game system in all new 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.
The Company's current installed guest pay base of over 300,000 rooms hosts more
than 40 million guests each year (based on current average occupancy and
length-of-stay data), which the Company believes represents over 40 million
annual opportunities to sell products and services. The Company intends to
introduce in mid-1996 the Traveler's TV Mall-TM-, a new service designed to
electronically bring consumers together with providers of merchandising and
information services. The Traveler's TV Mall-TM- will provide the Company the
opportunity to generate revenues from third-party providers of content and
services who will pay the Company for access to its consumer base, as well as
from the guests who utilize such services. The Company is evaluating other new
services, such as city-specific, advertiser-supported visitor information
services, as well as "advertorials" that deliver product information from
advertisers who seek access to the Company's consumer base due to its highly
desirable demographics.
EXPANDING INTO NEW MARKETS. The Company seeks to extend the application of
its interactive system, 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 the past three 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 15% during 1995 from $530 in 1994 to approximately $450 in 1995.
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STRATEGIC INITIATIVES
The Company has recently implemented five important strategic initiatives to
further its goal of creating a more diversified revenue base.
RESIDENTIAL ALLIANCE WITH GE RESCOM. The Company's recent agreement with GE
ResCom will extend the Company's services to multi-family residential complexes,
a market that is over three times greater than the Company's lodging market.
Subject to the terms of the agreement. GE ResCom is required to provide the
Company during the first three years of the agreement with contracts for a
minimum of 200,000 apartment units. The Company's operating plan establishes a
target of 500,000 units in five years. The actual number of units the Company
installs may vary (and such variance may be material) depending on the Company's
experience and competitive factors in this market.
PRIMESTAR-REGISTERED TRADEMARK- AGREEMENT. As of April 1, 1996, the Company
and PRIMESTAR-Registered Trademark- entered into an exclusive agreement to
provide digital satellite-delivered basic and premium television services to the
lodging industry. PRIMESTAR-Registered Trademark- is a consortium of the
nation's largest cable companies, including Tele-Communications, Inc.,
Time-Warner Cable, Comcast Cable, Continental Cablevision, Cox Cable
Communications and GE-American Communication. The Company expects that the
alliance, bringing together PRIMESTAR-Registered Trademark-'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 plans to market the new
"PRIMESTAR-Registered Trademark- by LodgeNet" service as a complement to its
interactive guest pay systems and on a stand-alone basis to mid-size hotels.
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 interactive system 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), was a significant
factor in the recent awarding by La Quinta Inns of its over 30,000-room account
and Budgetel Inns of its over 8,000-room account to the Company over incumbent
competitors. The Company believes that the mid-size hotel segment represents a
large and promising new market for the Company's services that will generate
financial returns similar to those achieved by the Company in larger
full-service hotels.
INTERNATIONAL ALLIANCES. The Company recently expanded into the
international marketplace beyond North America by entering into licensing
arrangements with strategic partners in Japan, Brazil and South Korea. The
Company's partner in Japan is ITES, an affiliate of IBM-Japan, which expects to
install LodgeNet systems in approximately 40,000 guest rooms over the next five
years. In Brazil, the Company's partner is TVA, Brazil's largest cable
television provider and a member of the Abril Group of media companies, which
intends to install the Company's system in approximately 25,000 guest rooms over
the next five years. In South Korea, the Company's partner is Gtv, a unit of the
Jinro Group, a large international industrial conglomerate, which intends to
install LodgeNet systems in approximately 15,000 guest rooms over the next five
years. Pursuant to these agreements the Company sells its equipment at cost plus
an agreed markup and receives a royalty on gross revenues.
TRAVELER'S TV MALL-TM-. The Company continued its development of the
Traveler's TV Mall-TM-, its next generation interactive multimedia service for
the lodging industry. The Traveler's TV Mall-TM- will be a forum, accessed by
the hotel guest through the in-room television, to electronically bring
consumers together with providers of merchandising and information services. As
the Traveler's TV Mall-TM-'s "developer" and manager, the Company will "rent
space" to third party content providers as well as participate in the
development and delivery of other interactive content. As part of this effort,
the Company recently announced that it
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plans to offer The Voyager's Collection-TM- on an interactive basis via the
guest room television in certain of its served rooms. The Voyager's
Collection-TM- is a merchandising service aimed at the upscale traveler
currently offered through catalogs placed in over 65,000 hotel rooms. The guest
rooms currently served by the Company's interactive entertainment and
information systems host more than 40 million guests each year, based on current
average occupancy and length-of-stay data. This represents more than 40 million
annual opportunities to reach a consumer who has on average a higher level of
income, education and occupational status than the average consumer. The Company
plans to test The Voyager's Collection-TM- service in 5 to 10 hotels in
mid-1996. Future services may include city-specific, advertiser-supported
visitor information services, as well as "advertorials" that deliver product
information from advertisers who seek access to the Company's desirable consumer
base.
MARKETS AND CUSTOMERS
LODGING MARKET. The lodging market in the United States is comprised of
over 3.4 million hotel rooms. Guest pay services were introduced in the lodging
market in the early 1970's 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 to their establishments.
LARGE HOTEL MARKET. The Company's primary market for guest pay services
has been large hotels with over 150 rooms located in metropolitan areas of North
America, 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 year ended
December 31, 1995.
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 promising new market for the Company's
services that it anticipates will generate financial returns similar to those
achieved by the Company in the large hotel market.
FREE-TO-GUEST MARKET. Almost all of the 3.4 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-Registered Trademark- will allow LodgeNet to provide digital
satellite-delivered 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 over 6.1 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 GE ResCom requires, subject
to the terms thereof, that GE ResCom provide the Company with contracts for a
minimum of 200,000 apartment units during the first three years of the
agreement.
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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 interactive system
enables the Company to provide sophisticated interactive features such as
on-demand movies, network-based Super Nintendo-Registered Trademark- 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-TM- interactive video on-demand
service, which is provided in over 80% of the Company's guest pay rooms, allows
a guest to choose from an expanded menu of video selections and individually
start the selected video at their 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. The Company currently
serves over 300,000 guest pay rooms, of which over 243,000, or 80%, feature the
Company's interactive on-demand system. The Company's original scheduled guest
pay service, which is provided in less than 20% 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.
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
interactive communications design 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 per hour of play. The Company had nearly 164,000 rooms installed
with the Super Nintendo-Registered Trademark- system by the end of 1995, and
currently provides over 200,000 rooms with video game services.
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 69% occupancy rate, a buy rate of 11.2% and an $8.95 movie price will
generate an average of $21.03 of gross movie revenue per installed room per
month, plus an average of $3.87 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 $24.90. 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 to the Company 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.
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,
ranges from $400 to $475 per room. In addition to hotel commissions and
royalties paid to movie studios, operating costs of the guest pay systems
include in-room movie schedules and information magazines that are changed
monthly, 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-
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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.
Since 1991 the Company has increased its guest pay room base from 73,415 to
over 300,000 rooms served as of March 31, 1996. During 1995, the Company
obtained contracts for more than 125,000 new guest pay rooms and installed more
than 83,000 new rooms, a 45% increase in its installed guest pay room base from
the previous year. For the year ended December 31, 1995, the Company's guest pay
services generated approximately 80.2% of the Company's total revenues and 92.4%
of its overall gross profit.
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 $0.15 - $0.85 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.
As of April 1, 1996, the Company and PRIMESTAR-Registered Trademark- entered
into an agreement to provide digital satellite-delivered basic and premium
television services to the lodging industry. The proposed alliance, bringing
together PRIMESTAR-Registered Trademark-'s digital satellite technology and the
Company's programming and marketing expertise, is expected to offer the lodging
industry a technologically superior and more flexible service, and 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-Registered Trademark-, the
Company will pay PRIMESTAR-Registered Trademark- a signal carriage fee for
providing access to the PRIMESTAR-Registered Trademark- digital satellite
signal. In connection with the PRIMESTAR-Registered Trademark- venture, 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. 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-Registered Trademark--related equipment.
Since 1990, the Company has increased its free-to-guest room base from
122,000 to over 260,000 rooms served as of March 31, 1996. During 1995, the
Company obtained contracts for over 55,000 new free-to-guest rooms and its
installed customer base grew by nearly 30,000 rooms, representing a 13% increase
from the prior year. For the year ended December 31, 1995, the Company's
free-to-guest services generated approximately 12.8% of the Company's total
revenues and 5.7% of its overall gross profit.
MULTI-FAMILY RESIDENTIAL SERVICES. The Company's multi-family residential
private cable system will have the capacity to deliver over 100 channels,
although the Company expects that the typical system will deliver approximately
35 to 50 channels of programming. The Company may elect to provide from
approximately 10 to 35 additional channels for pay-per-view, video on-demand,
video games and other interactive services, such as Internet access. The Company
intends to design a specific programming lineup for each specific multi-family
residential complex, based on the particular demographic profile of that
complex. These systems are expected to 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,
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and a bulletin board channel. Delivery of private cable television services to
multi-family residential complexes will involve technology similar to that used
in the Company's hotel systems. The hub of each multi-family residential system
is a headend, which gathers basic and premium cable television programming from
a variety of sources using a combination of satellite and off-air antennae and
then redistributes these signals throughout the apartment complex using a
broadband local-area cable network.
Through its nationwide sales organization, GE ResCom will exclusively market
ResNet's services to the owners and managers of apartment complexes. The joint
marketing plan is to offer a portfolio of products, including ResNet's cable
television services along with the private telephony, paging and other services
to be offered by GE ResCom. GE ResCom will also provide, for a fee equal to 5%
of collected revenues, the following services: (i) common sales training to
on-site property leasing agents, who will promote and sign-up subscribers for
ResNet's video services; (ii) a common customer service "hotline" through which
residents may order or modify service and make inquiries; and (iii) subscriber
billing. ResNet will own the franchise agreements with the property owners and
the video services agreements with the tenants and will be responsible for all
other operational aspects, including system design, installation, programming,
and technical field service. The Company's existing installation and field
service organizations position ResNet to operate effectively throughout the
United States wherever the GE ResCom sales force may obtain contracts.
The Company estimates that the average installed cost per unit passed for
basic and premium cable television services will range from approximately $450
to $700 (which includes a contract acquisition fee paid to GE ResCom), depending
upon whether the property is a stand-alone system or one of a cluster of nearby
properties that can receive programming via microwave transmission from a shared
headend. The Company estimates that the average cost per unit passed to add
pay-per-view movies and/or video on-demand movies to the basic cable system will
range from $30 to $130, depending on the system configuration and/or the size of
the movie library installed. The foregoing estimates of installation costs are
forward-looking in nature and actual costs could vary based on the factors
discussed elsewhere in this Prospectus.
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 owns the television set; however, the Company in some
cases includes 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, pay-per-view television entertainment services to the hotel and permit
the Company to set the movie price and terminate the contract at the Company's
sole discretion. 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 approximately 10% of these
contracts coming up for renewal before 1998.
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 will enter into and own exclusive long-term contracts with property
owners and managers to provide cable television services to multi-family
residential complexes. The length of term of such contracts
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generally runs longer than those in the lodging industry. The agreement with GE
ResCom requires that the average length of term of all contracts accepted by
ResNet be not less than 10 years. The form of agreement to be entered into with
each multi-family residential property will grant ResNet the right to provide
cable television programming and other video services, such as video on-demand,
video games, merchandising, and access to the Internet. The property owner or
manager will receive a commission generally expected to range from 6% to 12% of
subscriber revenues, depending upon the penetration rate at a particular
property.
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 communications system design with
commercially manufactured, readily available components and hardware such as
video cassette players, modulators and computers.
The Company's interactive, multimedia systems utilize 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.
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.
The Company's private cable television systems serving the multi-family
residential market will be based on technology similar to the proprietary
interactive technology deployed by the Company in the lodging market. The
Company's private cable television system will have 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. The Company may elect to provide from approximately 10 to 35
additional channels for pay-per-view, video on-demand, video games and other
interactive services, such as Internet access. The Company's interactive cable
television systems will consist of on-site satellite, off-air and/or microwave
receiving antennas and headend equipment which process and amplify the broadcast
and cable television programming signals. These signals are then transmitted to
subscribers at the property via the Company's local-area cable distribution
network. The Company plans to integrate addressable interdiction
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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. As a result, the relatively higher rate of subscriber turn-over in the
multi-family residential market represents an additional revenue stream for the
Company to be generated from "activation" and "new service" charges paid by
subscribers.
The Company designs its systems through its staff of 62 software and
hardware engineers and support personnel (as of December 31, 1995). 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 four 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 system.
The Company uses a number of trademarks for its products and services,
including "LodgeNet-TM-," "LodgeNet Entertainment-TM-," "Guest Scheduled-TM-,"
"Video Room Card-TM-," "Tech-Connect-TM-," "ResNet-TM-," "ResNet
Communications-TM-," and others. The Company has applications for registration
pending for certain of these trademarks, and those trademarks for which the
Company has not sought registration are governed by common law and state unfair
competition laws. Because the Company believes that these trademarks are
significant to the Company's business, the Company has taken legal steps to
protect its trademarks in the past and intends to actively protect these
trademarks in the future. The Company believes that its trademarks are generally
well recognized by consumers of its products and are associated with a high
level of quality and value.
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 29 employees as of December 31, 1995, 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 has established a sales
group responsible for sales and marketing of "PRIMESTAR-Registered Trademark- by
LodgeNet." 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 also markets its services to hotel guests by means of its Video
Room Card-TM-, on-screen graphics and by in-room magazines 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.
Through its nationwide sales organization, GE ResCom will exclusively market
ResNet's services to the owners and managers of apartment complexes. The joint
marketing plan is to offer a portfolio of products, including ResNet's cable
television services along with the private telephony, paging and other services
to be offered by GE ResCom. GE ResCom will also provide the following services:
(i) common sales training to on-site property leasing agents, who will promote
and sign-up subscribers for ResNet's video services; (ii) a common customer
service "hotline" through which residents may order or modify service and make
inquiries; and, (iii) subscriber billing.
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 249 installation and service personnel in 30 locations in the United
States and
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Canada, as of December 31, 1995. 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 80% 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-TM-," that 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 and
support personnel will oversee and coordinate installation crews comprised of
experienced subcontractors. Initially, ResNet will utilize field service and
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.
COMPONENT ASSEMBLY AND EQUIPMENT SUPPLIERS. The Company contracts directly
with various electronics firms for the manufacture and assembly of its systems
hardware, the design of which is controlled by the Company. The Company has
found these suppliers to be dependable and able to meet delivery schedules on
time. The Company believes that, in the event of a termination of any of its
sources, with proper notification from the supplier, alternate suppliers could
be located without incurring significant costs or delays. Certain electronic
component parts used within the Company's products are available from a limited
number of suppliers and can be subject to temporary shortages because of general
economic conditions and the demand and supply for such component parts. If the
Company were to experience a shortage of any given electronic part, the Company
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
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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 equipment with a
configuration designed specifically for a particular customer, the system is
shipped to each 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, serving over 388,000 installed hotel rooms as of December 31, 1995,
and currently over 420,000 installed rooms. The Company competes on a national
scale primarily with SpectraVision, Inc. ("SpectraVision") and On Command Video
Corporation ("OCV"), a subsidiary of Ascent Entertainment Group, Inc.
("Ascent"), and on a regional basis with certain other smaller entities. Based
upon publicly available information, management estimates that, at December 31,
1995, SpectraVision served approximately 550,000 hotel rooms and OCV served
approximately 360,000 hotel rooms. On April 19, 1996, Ascent announced that,
subject to bankruptcy court and regulatory approvals, it had reached an
agreement to acquire SpectraVision, which is currently operating under
Chapter 11 of the United States Bankruptcy Code. The proposed merger of
SpectraVision with OCV would combine two of the largest providers of cable
television services in the lodging industry based on the aggregate number of
installed rooms served. The Company currently competes against these two
companies and believes that it will be able to compete in the same manner
against a new combined entity.
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; 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 interactive system that enables the Company to deliver a broad range
of 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 the Company does not foresee significant growth over the next
several years in the number of large hotels (150 and more rooms), the Company
anticipates increasing competition in securing new contracts with major hotel
chains. The Company believes that hotels view the provision of in-room on-demand
entertainment both as a revenue source and as a competitive advantage in that
sophisticated hotel guests are increasingly demanding a greater range of quality
entertainment and information services. At the same time, 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 pay-per-view
service provider. Even if it were able to do so, the Company may not always be
willing to match the incentives provided by its competitors. The Company
believes that its success indicates that many hoteliers value product
differentiation and innovative features leading to higher guest satisfaction
over incentive-based pricing. While the Company's competitors may attempt to
gain or maintain market share at the expense of profitability, the Company
believes that its reputation as a product leader in the industry and its other
competitive advantages, together with its long-term contracts, will
substantially offset the potentially negative effect of any incentive-based
pricing by its competitors.
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In the free-to-guest programming arena, the Company competes with
SpectraVision and OCV as well as other smaller free-to-guest hotel vendors and
the various local cable television operators. Because free-to-guest service
providers generally have equal access to the satellite-delivered programming
that comprises the free-to-guest services, competition is based primarily on
price and customer service. Although local cable operators have a substantial
market presence through their residential customer base, they typically offer
the hotel subscriber only standard packages of programming at a fixed cost per
room based on all of the channels provided. The Company competes with local
cable operators 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 the PRIMESTAR-Registered Trademark- digital direct
broadcast satellite technology should enable the Company to compete more
effectively in the free-to-guest market. The Company believes that the
"PRIMESTAR-Registered Trademark- by LodgeNet" service will cost less than
current C-band satellite systems, provide a technologically superior and more
flexible service, and 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.
In addition to its current competition, there are a number of potential
competitors that could utilize their existing infrastructure to provide in-room
entertainment to the lodging industry, including cable companies (including
wireless cable), telecommunications companies, and direct-to-home and direct
broadcast satellite companies. Some of these potential competitors are already
providing free-to-guest and video on-demand services to hotels and have
substantially greater resources than the Company.
MULTI-FAMILY RESIDENTIAL MARKET. The multi-family residential market is
served by a number of private cable operators, direct broadcast satellite
providers, as well as local franchised cable operators. The Company believes
that the largest private cable competitors are ICS Communications, Inc., OpTel,
Inc. and CablePlus, none of which is a publicly reporting company. However, 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.
The Company believes that ResNet's competitive advantages will include (i)
the broad range of features and services offered by the Company's interactive
system, coupled with the advanced telephony and other services that will be
offered by GE ResCom, (ii) the Company's experience and capabilities in
conducting nationwide installation and field service operations, (iii) the
nationwide sales and marketing capabilities of GE ResCom, and (iv) the low-cost
operating structure made possible by the various services to be provided by GE
ResCom.
REGULATION
The FCC has broad jurisdiction over the telecommunications industry.
However, the Company believes its operations comply with a statutory exemption
from regulation as a "cable system" operator under the Cable Act. Operators such
as the Company that serve single buildings or serve multiple buildings without
having any closed transmission paths cross public rights-of-way are often
characterized as "private cable" operators. As a "private cable" operator under
applicable federal law, the FCC does not directly regulate the Company's guest
pay, free-to-guest, or multi-family residential cable television activities. For
example, the Company is not subject to the franchise requirements, "must-carry"
obligations and rate regulations applicable to "cable system" operators. It is
possible, however, that laws or regulations could be adopted in the future which
would impose additional regulatory burdens on private cable operators. Private
cable operators such as the Company are, however, subject to certain regulatory
requirements. For instance, 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 can obtain all necessary retransmission consents in its markets. In addition,
to the extent private cable operators use microwave or other radio
communications in their operations, they are required to obtain authorization
from the FCC, similar to other service providers.
41
<PAGE>
On February 8, 1996, the President signed into law the Act. This new law
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, modifies rate regulations applicable to franchised
cable operators in the Company's markets and establishes interconnection
obligations for local exchange carriers and other telecommunications carriers.
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 to be 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 industry. The Company cannot, however, estimate the impact of
the Act on its operations at this time.
The Company's operations may be subject to state or local laws or
ordinances. Some state or local laws or ordinances mandate that building owners
allow tenants access to franchised cable operators. In these states, private
cable operators such as the Company may not be able to enter into certain types
of exclusive arrangements with multiple dwelling unit building owners. States
and localities also retain authority in certain limited circumstances (i.e. for
public safety and health reasons) to regulate the siting of satellite earth
stations.
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. See "Risk
Factors -- Government Regulation."
EMPLOYEES
As of March 31, 1996, the Company had 463 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.
PROPERTIES
The Company's principal executive offices are leased from an unaffiliated
third party under a five-year lease which expires on December 31, 1996 and
contains an option to purchase. The Company's headquarters contains
approximately 24,000 square feet and houses its executive, administrative and
operational offices.
The Company also owns an office building (which previously served as the
Company's headquarters and is currently used in the Company's operations),
containing approximately 8,000 square feet, in Sioux Falls, South Dakota. In
addition, the Company leases from unaffiliated third parties a warehouse
(approximately 15,000 square feet) used in conjunction with its manufacturing,
installation and service activities and three other office facilities
(approximately 30,000 square feet in total) for administrative and support
staffs, all located in Sioux Falls, South Dakota. The Company leases an office
facility for sales and sales-support personnel in Dallas, Texas, and leases
eight warehouse/office facilities for its installation and service operations in
Honolulu, Hawaii; Las Vegas, Nevada; Cleveland, Ohio; Buffalo, New York; Los
Angeles and San Francisco, California; Tampa, Florida; and Toronto, Ontario,
Canada. Each of these office and/or warehouse leases is from an unaffiliated
third party and each such facility occupies less than 3,000 square feet.
42
<PAGE>
LEGAL PROCEEDINGS
On February 16, 1995, OCV filed a lawsuit in Federal District Court in
Northern California asserting patent infringement by the Company. The complaint
requests an unspecified amount of damages and injunctive relief. The Company has
carefully reviewed the allegations of infringement and is of the opinion that
the Company does not infringe on the patent and the allegations are without
merit. 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 intends to vigorously defend itself.
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 business or financial condition.
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
business or financial condition.
43
<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth information concerning the executive officers
and directors of the Company as of April 12, 1996.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------------ --- ------------------------------------
<S> <C> <C>
Tim C. Flynn........................ 46 Chairman, President and Chief
Executive Officer
Scott C. Petersen................... 40 Executive Vice President, Chief
Operating Officer and Director
Jeffrey T. Weisner.................. 48 Vice President, Finance
Eric R. Jacobsen.................... 39 Vice President, General Counsel and
Secretary
John M. O'Haugherty................. 56 Vice President, Sales
David M. Bankers.................... 38 Vice President, Systems Development
Steven D. Truckenmiller*............ 43 Vice President, Guest Pay Services
Douglas D. Truckenmiller*........... 46 Vice President and Chief Operating
Officer, ResNet
David Austad........................ 35 Director
Lawrence Flinn, Jr.................. 60 Director
Richard R. Hylland.................. 35 Director
R.F. Leyendecker.................... 50 Director
</TABLE>
- ------------
* Steven D. Truckenmiller and Douglas D. Truckenmiller are brothers.
TIM C. FLYNN founded the Company in 1980 and has been its President and
Chief Executive Officer since incorporation in 1983. Mr. Flynn is a member of
the American Hotel and Motel Association and the National Cable Television
Association. Prior to founding the Company, Mr. Flynn was involved in the
lodging and retail industries.
SCOTT C. PETERSEN joined the Company in 1987 as Senior Vice President for
Corporate and Legal Affairs, was appointed Executive Vice President and Chief
Operating Officer in 1991 and was elected a director in 1993. Prior to 1987, Mr.
Petersen acted as legal counsel to the Company as a partner in the law firm of
McFarland, Petersen and Nicholson, Sioux Falls, South Dakota. Mr. Petersen
received his Bachelor of Arts degree in economics from Dartmouth College and his
Juris Doctorate degree from Georgetown University Law Center.
JEFFREY T. WEISNER joined the Company in February 1994 as Vice President,
Finance. Mr. Weisner was Chief Financial Officer and Treasurer of Teltech
Resource Network Corporation from June 1991 to September 1993. Prior to 1991,
Mr. Weisner was Vice President, Secretary and Treasurer of CompuServe
Incorporated and in such capacity served as Chief Financial Officer and Chief
Administrative Officer for that company. Mr. Weisner is a certified public
accountant.
ERIC R. JACOBSEN joined the Company in May 1995 as Vice President and
General Counsel, and became Secretary in October 1995. Prior to joining the
Company, Mr. Jacobsen was a partner with the law firm of Manatt, Phelps &
Phillips of Los Angeles, California. Mr. Jacobsen acted as underwriters' counsel
in connection with the Company's initial public offering in October 1993 and
acted as outside legal counsel to the Company from December 1993 until joining
the Company. Mr. Jacobsen received his Juris Doctorate and Master of Business
Administration degrees from The University of Southern California.
44
<PAGE>
JOHN M. O'HAUGHERTY joined the Company in 1992 as Vice President, Sales. Mr.
O'Haugherty was Vice President for Sales and Marketing at Spectradyne, Inc., a
provider of in-room entertainment services to the lodging industry, in
Richardson, Texas from 1982 through 1989.
DAVID M. BANKERS joined the Company in 1989 as Director of Information
Systems Development and was appointed Vice President, Systems Development in
1992. Prior to joining the Company, Mr. Bankers was the Supervisor of Digital
Data Production for TGS Technology, Inc., a supplier of technical support
services for government facilities, at the Earth Resources Observation Systems
(EROS) Data Center in Sioux Falls, South Dakota. Mr. Bankers received his
Bachelor of Science and Master of Science degrees from Creighton University.
STEVEN D. TRUCKENMILLER joined the Company in 1985 as Vice President of
Technical Services. He was appointed Vice President, Technical Development in
1988 and Vice President, Guest Pay Services in 1991. Mr. Truckenmiller was a
director of the Company from 1983 to 1993.
DOUGLAS D. TRUCKENMILLER joined the Company in 1991 as Vice President for
Technical Operations. In February 1996, Mr. Truckenmiller was appointed Vice
President and Chief Operating Officer of ResNet Communications, Inc., a
wholly-owned subsidiary of the Company. From 1989 to 1991, Mr. Truckenmiller was
the President/General Manager for Heritage Cablevision of Rhode Island. Prior to
1989, he was the Senior Vice President of Engineering for Heritage
Communications, a major cable multiple systems operator based in Des Moines,
Iowa.
DAVID AUSTAD has served as a Director of the Company since 1993. Since 1988,
Mr. Austad has served as President and Chief Executive Officer of Austad Golf, a
worldwide distributor of golf equipment and apparel. In February 1996, Mr.
Austad started AGS, Inc. which owns and manages Austad Golf's retail stores.
LAWRENCE FLINN, JR. has served as a Director of the Company since 1994. Mr.
Flinn currently serves as Chairman and Chief Executive Officer of United Video
Satellite Group and has over 35 years of experience in the video and satellite
communications business.
RICHARD R. HYLLAND has served as a Director of the Company since 1990. Mr.
Hylland is a Director and Executive Vice President -- Strategic Development of
Northwestern Public Service Corporation ("NPSC"), a publicly held utility
company; President, Chief Operating Officer and a Director of Northwestern
Growth Corporation (a subsidiary of NPSC); Director of Northwestern Networks,
Inc. ("NNI") (a subsidiary of NPSC); and Vice Chairman of SYN, Inc. Mr. Hylland
joined NPSC in 1989.
R.F. LEYENDECKER has served as a Director of the Company since 1986. Mr.
Leyendecker is Vice President -- Marketing Development, NPSC; served as Vice
President -- Energy Service, NPSC from 1994 to 1996; and served as Vice
President -- Rates and Regulations, NPSC from 1987 to 1994. He was elected
Assistant Corporate Secretary of NPSC in 1993. Mr. Leyendecker also serves as a
director of NNI.
45
<PAGE>
EXECUTIVE COMPENSATION
The following table summarizes all compensation paid to the Company's Chief
Executive Officer and to the Company's four other most highly compensated
executive officers other than the Chief Executive Officer whose total annual
salary and bonus exceeded $100,000, for services rendered in all capacities to
the Company during the fiscal year ended December 31, 1995.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
--------------------------------------------- ---------------
OTHER ANNUAL STOCK
NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) COMPENSATION ($)(1) OPTIONS (#)
- ----------------------------------- --------- ----------- ----------- ------------------- ---------------
<S> <C> <C> <C> <C> <C>
Tim C. Flynn 1995 250,000 103,306 20,916 40,000
President and Chief Executive 1994 200,000 -- 15,631 22,222
Officer 1993 126,690 -- -- --
Scott C. Petersen 1995 240,000 99,174 20,165 40,000
Executive Vice President and Chief 1994 190,000 -- 14,161 21,111
Operating Officer 1993 120,833 -- -- --
John M. O'Haugherty 1995 115,000 37,510 10,408 20,000
Vice President, Sales 1994 110,000 10,000 8,547 12,222
1993 96,500 10,000 -- --
David M. Bankers 1995 105,000 34,248 10,041 20,000
Vice President, Systems 1994 95,000 -- 7,486 11,111
Development 1993 80,917 -- -- --
Douglas D. Truckenmiller (2) 1995 105,000 34,248 10,041 20,000
Vice President and Chief Operating 1994 95,000 -- 7,486 11,111
Officer, ResNet 1993 86,583 -- -- --
</TABLE>
- ---------------
(1) Reflects compensation paid to the executive officers listed above by the
Company in order for them to purchase individual supplemental insurance
coverage and other benefits.
(2) In January 1996, Mr. D. Truckenmiller was appointed Vice President and
Chief Operating Officer of ResNet. Prior to such appointment, Mr.
Truckenmiller was Vice President, Technical Operations of the Company.
EMPLOYMENT AGREEMENTS
In connection with the Company's initial public offering in October 1993,
the Company entered into an employment agreement with Mr. Flynn, dated August
16, 1993, retaining his services as the Company's President and Chief Executive
Officer. The initial term of this agreement was extended an additional year on
January 1, 1996 and will be automatically extended each January 1 thereafter
unless prior to any such date either Mr. Flynn or the Company notifies the other
of an election not to extend. The agreement may also be earlier terminated as
discussed below. Under the agreement, Mr. Flynn's salary is currently set at
$250,000 per year. In addition to his salary, Mr. Flynn is entitled to
participate in any bonus program, insurance program, stock benefit plan and
other employment benefits that may be provided by the Company from time to time
to its executive officers.
Mr. Flynn's employment may be terminated prior to the expiration of the term
of the agreement (i) automatically upon Mr. Flynn's death, disability or
retirement at age 65; (ii) by the Company at any time, with or without cause, by
action of its Board of Directors; or (iii) by Mr. Flynn or the Company within
three months after a change of control of the Company. In the event of any such
termination of employment, the following termination benefits apply: (x) for any
termination, other than for cause (including a termination due to death,
disability or retirement at age 65), the Company will pay a pro rata portion of
the maximum bonus for the then current year under any bonus program in which Mr.
Flynn may be participating at the time, unless such payment is not permitted by
the terms of the plan; and (y) for any termination by the Board of Directors
without cause, the Company will continue to pay Mr. Flynn's salary at the rate
last in effect prior to termination for the balance of the term of his
employment agreement or until his earlier death or reaching age 65, and the
Company will continue at its expense any health, disability and life insurance
coverage in
46
<PAGE>
effect immediately prior to his termination. In the event of a termination after
a change in control involving the Company, the terms of Mr. Flynn's agreement
will be superseded by the terms and conditions of the Severance Agreements
described below. The employment agreement contains a covenant by Mr. Flynn not
to compete with the Company, or to work for a competing business, for the term
of his employment and six months thereafter, provided that employment with a
cable television vendor will not be considered to be a competing business.
The Company entered into an employment agreement with Mr. Petersen, dated
August 16, 1993, retaining his services as the Company's Executive Vice
President and Chief Operating Officer. The terms of his employment agreement are
the same as those in Mr. Flynn's agreement summarized above, except that Mr.
Petersen's salary is currently set at $240,000 per year.
In July 1995, the Compensation Committee authorized the Company to enter
into agreements (the "Severance Agreements") with the Company's President and
its other executive officers, including the officers named in the Summary
Compensation Table, providing for the payment of certain compensation and other
benefits in the event of a covered termination of the executive's employment
within two years following a "change in control" involving the Company. No
compensation is payable to any executive under the Severance Agreements unless
(i) there has been a change in control and (ii) the executive's employment with
the Company shall have been terminated (including a substantial reduction in
duties or compensation, but excluding termination as a result of the death or
permanent disability of the executive or for cause or voluntary retirement). A
"change in control" is generally defined as the occurrence of any of the
following: (i) any person or group becomes the beneficial owner of securities
representing 30% or more of the voting power of the Company's outstanding
capital stock having the right to vote in the election of directors (excluding
any such transaction that is effected at an actual or implied average valuation
of less than $6.75 per share of common stock); (ii) a majority of the members of
the Board shall not for any reason be the individuals who at the beginning of
such period constitute the Board or persons nominated by such members; (iii) any
merger, consolidation or sale of all or substantially all of the assets of the
Company (meaning assets representing 30% or more of the net tangible assets of
the Company or generating 30% or more of the Company's operating cash flow),
excluding a business combination or transaction in which : (a) the stockholders
of the Company prior to such transaction continue to represent more than 70% of
the voting power of the Company immediately after giving effect to such
transaction; (b) no person or group becomes the beneficial owner of 30% or more
of the Company's voting stock; or (c) the purchase price results in an actual or
implied average valuation of less than $6.75 per share of common stock; (iv) the
adoption of any plan or proposal for the liquidation or dissolution of the
Company; or (v) the occurrence of any other event that would be required to be
reported as a change in control in response to Item 6(e) of Schedule 14A of
Regulation 14A of the Exchange Act.
Upon a covered termination, the executive is entitled to receive a lump sum
payment equal to the compensation the executive would have received over a
30-month period, a pro rata portion of any bonus the executive would have
received for the year in which such termination occurs, any stock options
previously granted to the executive will become fully vested, and the executive
will be entitled to the continuation of the insurance and other welfare benefits
then being received by such executive for a 30-month period. The Severance
Agreements contain a covenant not to compete with the Company for a period of
six months following a covered termination, and executives are not required to
mitigate any termination benefits (nor will such benefits be reduced by
compensation received from other employment). The Severance Agreements terminate
upon the earlier of: (i) five years (subject to automatic one-year extensions
unless the Board otherwise notifies the executive); (ii) the termination of the
executive's employment other than pursuant to a covered termination described
above; (iii) two years from the date of a change in control of the Company if
there has not been a covered termination; and (iv) prior to a change in control
upon the executive's ceasing to be an executive officer of the Company.
47
<PAGE>
STOCK OPTIONS
The following table contains information concerning the grant of stock
options during the fiscal year ended December 31, 1995 to the officers named in
the Summary Compensation Table.
OPTION(1) GRANTS IN FISCAL YEAR 1995
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT ASSUMED
-------------------------------------------------------------------------- ANNUAL RATES OF
PERCENT OF TOTAL STOCK PRICE
OPTIONS/SARS APPRECIATION FOR
NUMBER OF SECURITIES GRANTED TO OPTION TERM (3)
UNDERLYING OPTIONS/ EMPLOYEES IN FY EXERCISE OR BASE EXPIRATION --------------------
NAME SARS GRANTED (#)(2) 1995 (%) PRICE ($/SH) DATE 5% ($) 10% ($)
- ------------------------- --------------------- ------------------- ----------------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Tim C. Flynn............. 40,000 11.9 10.85 12/13/05 188,000 991,000
Scott C. Petersen........ 40,000 11.9 10.85 12/13/05 188,000 991,000
John M. O'Haugherty...... 20,000 5.9 10.85 12/13/05 94,000 495,500
David M. Bankers......... 20,000 5.9 10.85 12/13/05 94,000 495,500
Douglas D.
Truckenmiller........... 20,000 5.9 10.85 12/13/05 94,000 495,500
</TABLE>
- ---------------
(1) The Company has no plans pursuant to which stock appreciation rights may be
granted.
(2) The options were granted pursuant to the Company's 1993 Stock Option Plan.
The options become exercisable in four equal annual installments beginning
one year after the date of the grant.
(3) These amounts represent certain assumed rates of appreciation only. Actual
gains, if any, on stock option exercises are dependent on a variety of
factors, including market conditions and the price performance of the
Common Stock. There can be no assurance that the rates of appreciation
presented in this table can be achieved.
OPTION EXERCISES AND HOLDINGS
The following table provides information with respect to the officers named
in the Summary Compensation Table concerning the exercise of options during the
fiscal year ended December 31, 1995 and unexercised options held by such
officers as of December 31, 1995:
AGGREGATED OPTION EXERCISES IN FISCAL YEAR 1995
AND FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING OPTIONS AT IN-THE-MONEY OPTIONS AT
12/31/95 (#) 12/31/95 ($)(1)
SHARES ACQUIRED VALUE ---------------------------- ----------------------------
NAME ON EXERCISE (#) REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---------------------------- ----------------- ----------- ----------- --------------- ----------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Tim C. Flynn................ 67,865 499,000 242,229 56,666 2,445,000 --
Scott C. Petersen........... N/A N/A 351,742 55,833 2,732,000 --
John M. O'Haugherty......... N/A N/A 40,951 29,166 238,000 --
David M. Bankers............ N/A N/A 36,173 28,333 209,000 --
Douglas D. Truckenmiller.... N/A N/A 2,778 28,333 -- --
</TABLE>
- ---------------
(1) Value of unexercised "in-the-money" options is the difference between the
market price of the Common Stock on December 31, 1995 ($9.50 per share) and
the exercise price of the option, multiplied by the number of shares
subject to the option.
COMPENSATION OF DIRECTORS
Effective March 18, 1996, the Board of Directors set the compensation to be
paid to each non-employee director at $20,000 per year (payable at the Company's
option all in cash in quarterly installments or $10,000 in cash in quarterly
installments and by Common Stock with a fair market value of $10,000 on or about
July 1 of each year), $300 for each committee meeting attended and reimbursement
for travel and related expenses for attendance at Board and committee meetings.
Pursuant to the approval of the Company's stockholders at the 1996 Annual
Meeting held on May 8, 1996, non-employee directors automatically receive upon
their initial election or appointment to the Board a nonqualified stock option
to purchase 6,000 shares of Common Stock under the Company's 1993 Stock Option
Plan (the "Plan") plus an additional 6,000 options to be granted on each
anniversary of such election during the term of service.
48
<PAGE>
STOCK OPTION PLAN
The Plan, adopted by the Board of Directors and stockholders effective as of
August 16, 1993, as amended effective May 17, 1995 and May 8, 1996, provides for
the grant of (i) incentive stock options and nonqualified stock options to key
managerial employees of the Company and its subsidiaries and (ii) nonqualified
stock options to non-employee directors of the Company. The Plan provides that
the total number of shares of Common Stock that may be subject to options shall
be 1,000,000 shares (of which 436,501 shares were available for the grant of
options as of May 22, 1996).
CERTAIN TRANSACTIONS
Other than as described elswhere in this Prospectus, none of the directors
or executive officers of the Company or any subsidiary thereof, or any
associates or affiliates of any of them, is or has been indebted to the Company
at any time since the beginning of the last completed fiscal year in excess of
$60,000. None of the directors or executive officers of the Company, or any
associate or affiliate of such persons, had any material interest, direct or
indirect, in any transaction or any proposed transaction with the Company during
the past fiscal year.
49
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth the beneficial ownership of Common Stock as
of March 31, 1996 by each person known to the Company to be the record or
beneficial owner of more than five percent of the outstanding shares of Common
Stock (other than depositories holding shares of Common Stock on behalf of
brokers, dealers and others who are the record stockholders for beneficial
owners desiring to have their shares held in "street name"), by each director,
each executive officer named in the Summary Compensation Table, and by all
directors and executive officers as a group:
<TABLE>
<CAPTION>
AMOUNT AND NATURE OF
NAME AND ADDRESS OF BENEFICIAL PERCENT OF
BENEFICIAL OWNER (1) OWNERSHIP (2) CLASS (3)
- ----------------------------------------------------------------------------- ---------------------- --------------
<S> <C> <C>
Tim C. Flynn, (4) Chairman,
President and Chief Executive Officer....................................... 672,727 7.9%
Scott C. Petersen, (4)
Executive Vice President, Chief Operating Officer and Director.............. 407,725 4.8
John M. O'Haugherty, (4)
Vice President, Sales....................................................... 70,117 *
David M. Bankers, (4)
Vice President, Systems Development......................................... 64,506 *
Douglas D. Truckenmiller, (4)(5)
Vice President, Chief Operating Officer, ResNet............................. 279,343 3.3
David Austad, Director (6)................................................... 5,000 *
Lawrence Flinn, Jr., Director (6)(7)......................................... 5,000 *
Richard R. Hylland, (8)(9)
Director.................................................................... 1,041,266 12.2
R.F. Leyendecker, (8)(9)
Director.................................................................... 1,041,266 12.2
Northwestern Networks, Inc. (9).............................................. 1,041,266 12.2
Wellington Management Company (10)........................................... 615,000 7.2
Directors and Executive Officers (4)
(A group of 12 persons)..................................................... 2,978,138 35.1
</TABLE>
- ------------
* Less than 1%.
(1) Unless otherwise indicated, the address of such person is 808 West Avenue
North, Sioux Falls, South Dakota 57104.
(2) Each named person has sole voting and investment power with respect to the
shares listed, except as noted below.
(3) Shares which the person (or group) has the right to acquire within 60 days
after March 31, 1996 are deemed to be outstanding in calculating the
percentage ownership of the person (or group) but are not deemed to be
outstanding as to any other person (or group).
(4) Includes shares issuable upon the exercise of options to purchase Common
Stock as follows: Mr. Flynn, 298,895 shares; Mr. Petersen, 407,575 shares;
Mr. O'Haugherty, 70,117 shares; Mr. D. Truckenmiller, 106,111; and Mr.
Bankers, 64,506 shares; and all directors and executive officers as a group,
1,114,426 shares. Does not include 3,373 shares held in the Company's 401(k)
Plan of which Mr. Flynn and Mr. Petersen are Trustees; and for Mr. Flynn,
includes 300 shares owned by Mr. Flynn's minor children, and for Mr.
Petersen includes 150 shares owned by Mr. Petersen's minor children.
50
<PAGE>
(5) In January 1996, Mr. Truckenmiller was appointed Vice President, Chief
Operating Officer of ResNet. Prior to such appointment, Mr. Truckenmiller
was Vice President, Technical Operations of the Company.
(6) Includes 5,000 shares of Common Stock which each of Messrs. Austad and
Flinn have the right to acquire by the exercise of vested stock options.
(7) Excludes 90,000 shares held by United Video Satellite Group, Inc., a
publicly held company, for which Mr. Flinn serves as a director and as to
which he disclaims beneficial ownership.
(8) Messrs. Hylland and Leyendecker are directors of NNI, which is a subsidiary
of NPSC. The shares attributable to Messrs. Hylland and Leyendecker are as a
result of their being directors of NNI. Messrs. Hylland and Leyendecker
disclaim beneficial ownership of all such shares.
(9) The address of NNI and Messrs. Hylland and Leyendecker is 33 Third Street,
S.E., Huron, South Dakota 57350-1318; share ownership information based on
Schedule 13G filed for the year ended December 31, 1995.
(10) The address of Wellington Management Company is 75 State Street, Boston,
Massachusetts 02109; address and share ownership information based on
Schedule 13G filed for the year ended December 31, 1995.
51
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The Company's authorized capital stock consists of 20,000,000 shares of
Common Stock, par value $.01 per share, and 5,000,000 shares of Preferred Stock,
par value $.01 per share (the "Preferred Stock").
COMMON STOCK
Holders of Common Stock are entitled to one vote for each share held on all
matters submitted to a vote of stockholders and do not have cumulative voting
rights. Stockholders casting a plurality of votes of the stockholders entitled
to vote in an election of directors may elect all of the directors standing for
election. Holders of Common Stock are entitled to receive ratably such
dividends, if any, as may be declared by the Board of Directors out of funds
legally available therefor, subject to any preferential dividend rights of
Preferred Stock that may be issued at such future time or times. Upon the
liquidation, dissolution or winding up of the Company, the holders of Common
Stock are entitled to receive ratably the net assets of the Company available
after the payment of all debts and other liabilities and subject to the prior
rights of Preferred Stock that may be issued at such time. Holders of Common
Stock have no preemptive, subscription, redemption or conversion rights. The
outstanding shares of Common Stock are, and the shares of Common Stock offered
by the Company in this Offering will be, when issued and paid for, fully paid
and nonassessable. The rights, preferences and privileges of holders of Common
Stock are subject to the rights of the holders of shares of any series of
Preferred Stock which the Company may designate and issue in the future.
As of March 31, 1996, there were 7,359,613 shares of Common Stock
outstanding and held of record by approximately 260 stockholders (with
approximately 72% of the Company's outstanding shares held in "street name").
The Company estimates that as of March 31, 1996 there were more than 2,500
stockholders of the Company.
PREFERRED STOCK
The Board of Directors is authorized, subject to any limitations prescribed
by law, without further stockholder approval, to issue from time to time up to
an aggregate of 5,000,000 shares of the Company's authorized class of
undesignated Preferred Stock, in one or more series. Each such series of
Preferred Stock shall have such number of shares, designations, preferences,
powers, qualifications and special or relative rights or privileges as shall be
determined by the Board of Directors, which may include, among others, dividend
rights, voting rights, redemption and sinking fund provisions, liquidation
preferences, conversion rights and preemptive rights. No series of Preferred
Stock is currently outstanding.
The Board of Directors has the authority to issue Preferred Stock and to
determine its rights and preferences to eliminate delays associated with a
stockholder vote on specific issuances. The rights of the holders of Common
Stock will be subject to the rights of holders of any Preferred Stock issued in
the future. The issuance of Preferred Stock, while providing desirable
flexibility in connection with possible acquisitions and other corporate
purposes, could have the effect of making it more difficult for a third party to
acquire, or of discouraging a third party from acquiring, a majority of the
outstanding voting stock of the Company. The Company has no present plans to
issue any shares of Preferred Stock.
DELAWARE LAW AND CERTAIN CHARTER AND BY-LAW PROVISIONS
STAGGERED BOARD OF DIRECTORS. Pursuant to Article Sixth of the Company's
Certificate of Incorporation, the Company's Board of Directors is divided into
three classes, which are elected for three-year staggered terms. As a result, a
change in a majority of the directors of the Company cannot be effected at a
single annual meeting of stockholders. While the principal purpose of Article
Sixth is to provide continuity on the Board of Directors, the provisions could
have the effect of discouraging a third party from attempting to change the
management and policies of the Company by effecting a change in the majority of
the Board through a proxy contest.
SECTION 203 OF THE GENERAL CORPORATION LAW OF THE STATE OF DELAWARE. The
Company is subject to the provisions of Section 203 of the General Corporation
Law of the State of Delaware, which generally prohibits the Company from
engaging in a "business combination" with a person who is an "interested
52
<PAGE>
stockholder" for a period of three years after the date of the transaction in
which the person became an "interested stockholder," unless (i) the business
combination was approved by the Board of Directors of the Company before the
other party to the business combination became an interested stockholder, (ii)
upon consummation of the transaction that made it an interested stockholder, the
interested stockholder owned at least 85% of the voting stock of the Company
outstanding at the commencement of the transaction (excluding voting stock owned
by directors who are also officers), or (iii) the business combination was
approved by the Board of Directors of the Company and ratified by 66 2/3% of the
voting stock which the interested stockholder did not own. A "business
combination" includes mergers, asset sales and other transactions resulting in a
financial benefit to the interested stockholder. Subject to certain exceptions,
an "interested stockholder" is a person or entity who, together with its
affiliates and associates, owns (or within the preceding three years, owned) 15%
or more of the Company's voting stock.
NO STOCKHOLDER ACTION BY WRITTEN CONSENT; SPECIAL MEETINGS. The Company's
Certificate of Incorporation and By-Laws provide that stockholder action can be
taken only at an annual or special meeting of stockholders and prohibit
stockholder action by written consent in lieu of a meeting. The Certificate of
Incorporation and By-Laws provide that, subject to the rights of holders of any
series of Preferred Stock, special meetings of stockholders can be called only
by the President or the Board of Directors of the Company. Stockholders have no
right to call a special meeting or to require that the Board of Directors call a
special meeting of stockholders. Moreover, the business permitted to be
conducted at any special meeting of stockholders is limited to the business
brought before the meeting by or at the direction of the Board of Directors.
These provisions of the Company's Certificate of Incorporation and By-Laws
may have the effect of delaying consideration of a stockholder proposal until
the next annual meeting of stockholders, unless a special meeting is called by
the President or the Board of Directors. These provisions also would prevent the
holders of a majority of the voting power of the Company from using the written
consent procedure to take stockholder action without giving all the stockholders
of the Company entitled to vote on a particular matter the opportunity to
participate in determining such proposed action. Finally, a stockholder could
not force consideration of a proposal by stockholders over the opposition of the
Board of Directors of the Company by calling a special meeting of stockholders
prior to the time the Board believes such consideration to be appropriate.
ADVANCE NOTICE OF STOCKHOLDER NOMINEES AND STOCKHOLDER BUSINESS. The
Company's By-Laws establish an advance notice procedure for the nomination of
candidates for election as directors and the presentation of certain other
matters before an annual meeting of stockholders of the Company, other than by
or at the direction of the Board of Directors or the chairman of the meeting.
For such nominations or other business to be considered properly brought by a
stockholder before an annual meeting of stockholders of the Company, such
stockholder must have given timely prior written notice to the Secretary of the
Company of his or her intent to bring such nominations or business before the
meeting. To be timely, such notice must be received by the Secretary at least 90
days prior to the date on which, in the immediately preceding calendar year, the
annual meeting of stockholders of the Company for such year was held (provided
that if the date of the annual meeting is changed by more than 30 days from such
anniversary date, such stockholder's notice must be received by the Secretary no
later than 10 days after notice or prior public disclosure of the meeting is
first given or made to stockholders).
A stockholder notice must contain a brief description of the nomination or
business to be brought before the meeting; the name and address of the
stockholder making the notice and of any person to be nominated; a
representation that the stockholder is a holder of record of stock of the
Company entitled to vote at the meeting and intends to appear at the meeting to
bring such nomination or business before the meeting; a description of all
arrangements or understandings between the stockholder and each nominee (in the
case of a nomination) or of any material interest of the stockholder in the
business matter (in the case of other business); such other information
regarding the nominee or matter of business to be proposed as would be required
to be included in a proxy statement soliciting proxies for the election of such
nominee or approval of such other business; and, in the case of a nomination,
the consent of the nominee.
53
<PAGE>
The purpose of these procedures is to provide an orderly procedure for
conducting annual meetings of stockholders and to afford the Board of Directors
a meaningful opportunity to consider the qualifications of proposed nominees and
to inform themselves, and where appropriate to inform stockholders, in advance
of the meeting of any business proposed to be conducted at the meeting. Although
the Company's By-Laws do not give the Board of Directors any power to approve or
disapprove stockholder nominations for the election of directors or any other
business proposed by a stockholder to be conducted at an annual meeting, the
By-Laws may have the effect of precluding a nomination or the consideration of
certain business at a particular annual meeting if the proper procedures are not
followed. These procedures may also discourage or deter a third party from
conducting a solicitation of proxies to elect its own slate of directors or from
attempting to obtain control of the Company, even if the conduct of such
solicitation or such attempt might be beneficial to the Company and its
stockholders.
INDEMNIFICATION OF DIRECTORS AND OFFICERS; LIMITATION OF MONETARY
LIABILITY. Section 145 of the General Corporation Law of the State of Delaware
permits the Company to indemnify an officer, director or employee in respect of
claims made by reason of his or her status with the Company, including
stockholder derivative suits, provided he or she acted in good faith and in a
manner he or she reasonably believed to be in or not opposed to the best
interest of the Company and, with respect to any criminal act or proceeding, had
no reasonable cause to believe his or her conduct was unlawful. Expenses
incurred in the defense of any such action may be paid by the Company in advance
of final disposition upon receipt of an undertaking from the officer, director
or employee to repay the advances if there is an ultimate determination that he
or she is not entitled to be indemnified. It is the Company's general policy to
provide such indemnification to the full extent permitted by law. The Company
intends to purchase directors' and officers' liability coverage to insure its
indemnification of the Company's directors and officers.
Article Eighth of the Company's Certificate of Incorporation exonerates the
Company's directors from personal liability to the Company or its stockholders
for monetary damages for breach of the fiduciary duty of care as a director,
provided that Article Eighth does not eliminate or limit liability for any
breach of the directors' duty of loyalty for acts or omissions not in good faith
or which involve intentional misconduct or knowing violations of law, for any
improper declaration of dividends or for any transaction from which the director
derived an improper personal benefit. Article Eighth does not eliminate a
stockholder's right to seek non-monetary, equitable remedies, such as an
injunction or rescission, to redress an action taken by the directors. However,
as a practical matter, equitable remedies may not be available in all
situations, and there may be instances in which no effective remedy is
available.
The discussions of the Common Stock and Preferred Stock here and elsewhere
in this Prospectus are qualified in their entirety by reference to (i) the
Certificate of Incorporation of the Company, as amended, and the By-Laws of the
Company, copies of which have been filed as exhibits to the Registration
Statement of which this Prospectus is a part, and (ii) the applicable provisions
of Delaware law.
TRANSFER AGENT
The Transfer Agent for the Common Stock is Harris Trust and Savings Bank.
54
<PAGE>
UNDERWRITING
The underwriters named below (the "Underwriters"), for whom PaineWebber
Incorporated, Montgomery Securities and NatWest Securities Limited are acting as
representatives (the "Representatives"), have severally agreed, on the terms and
subject to the conditions set forth in the Underwriting Agreement by and among
the Company and the Underwriters (the "Underwriting Agreement"), to purchase
from the Company, and the Company has agreed to sell to the Underwriters, the
number of shares of Common Stock set forth opposite the name of such
Underwriters below:
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITERS SHARES
- --------------------------------------------- ----------
<S> <C>
PaineWebber Incorporated ................... 667,000
Montgomery Securities ...................... 667,000
NatWest Securities Limited ................. 667,000
Bear, Stearns & Co. Inc. ................... 106,500
Alex. Brown & Sons Incorporated ............ 106,500
A.G. Edwards & Sons, Inc. .................. 106,500
Furman Selz LLC ............................ 106,500
Lazard Freres & Co. LLC .................... 106,500
Oppenheimer & Co., Inc. .................... 106,500
Dain Bosworth Incorporated ................. 80,000
Gerard Klauer Mattison & Co., Inc. ......... 80,000
Ladenburg, Thalmann & Co., Inc. ............ 80,000
Miller, Johnson & Kuehn, Incorporated ...... 80,000
Pennsylvania Merchant Group, Ltd. .......... 80,000
Piper Jaffray Inc. ......................... 80,000
Unterberg Harris ........................... 80,000
----------
Total .................................. 3,200,000
----------
----------
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
to purchase the shares of Common Stock listed above are subject to certain
conditions. The Underwriting Agreement also provides that the Underwriters are
committed to purchase all of the shares of Common Stock offered hereby, if any
are purchased (without consideration of any shares that may be purchased through
the Underwriters' over-allotment option).
The Representatives have advised the Company that the Underwriters propose
to offer the shares of Common Stock to the public at the public offering price
set forth on the cover of this Prospectus and to certain dealers at such price
less a concession not in excess of $.40 per share, and that the Underwriters and
such selected dealers may reallow a concession to other dealers not in excess of
$.10 per share. After the public offering of the Common Stock, the public
offering price, the concessions to selected dealers and reallowance to other
dealers may be changed by the Representatives.
The Company has granted the Underwriters an option, exercisable during the
30-day period after the date of this Prospectus, to purchase up to an additional
480,000 shares of Common Stock at the public offering price set forth on the
cover page of this Prospectus, less the underwriting discounts and commissions.
To the extent the Underwriters exercise such option, each of the Underwriters
will become obligated, subject to certain conditions, to purchase such
percentage of such additional shares of Common Stock as is approximately equal
to the percentage of shares of Common Stock that it is obligated to purchase as
shown in the table set forth above. The Underwriters may exercise such option
only to cover over-allotments, if any, incurred in the sales of shares of Common
Stock.
The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act, or to contribute to
payments that the Underwriters may be required to make in respect thereof.
55
<PAGE>
The Company, its directors and executive officers and certain stockholders
have agreed not to offer, sell, contract to sell, or grant any option to
purchase or otherwise dispose of any shares of Common Stock owned by them prior
to the expiration of 90 days from the date of this Prospectus, except (i) for
shares of Common Stock offered hereby, (ii) with the prior written consent of
PaineWebber Incorporated, (iii) as a gift or gifts, provided the donee or donees
agree to be bound by the 90 day restriction and (iv) in the case of the Company,
for the issuance of shares of Common Stock upon the exercise of options, or the
grant of options to purchase shares of Common Stock, under the Plan.
In connection with this offering, certain Underwriters and selling group
members or their affiliates may engage in passive market making transactions in
the Common Stock on the Nasdaq National Market in accordance with Rule 10b-6A
under the Exchange Act. Passive market making consists of, among other things,
displaying bids on the Nasdaq National Market limited by the bid prices of
independent market makers and making purchases limited by such prices and
effected in response to order flow. Net purchases by a passive market maker on
each day are limited to a specified percentage of the passive market maker's
average daily trading volume in the Common Stock during a specified prior
period, and all passive market making activity must be discontinued when such
limit is reached. Passive market making may stabilize the market price of the
Common Stock at a level above that which might otherwise prevail and, if
commenced, may be discontinued at any time.
PaineWebber Incorporated served as co-manager of the Company's October 1993
initial public offering and, as partial compensation for its services, received
warrants entitling it to purchase 37,500 shares of Common Stock at an exercise
price of $16.20 per share. Such warrants expire on October 21, 1998 and, to
date, none have been exercised.
Furman Selz LLC ("Furman Selz") has performed certain financial services for
the Company for which it has received customary compensation. In connection with
the termination of certain arrangements between Furman Selz and the Company, in
addition to the shares of Common Stock to be underwritten by Furman Selz in
connection with the Offering, the Company has agreed to pay $150,000 to Furman
Selz concurrent with the consummation of the Offering, which compensation may be
deemed to be underwriters' compensation by the National Association of
Securities Dealers, Inc.
NatWest Securities Limited has from time to time in recent years performed
various investment banking and other financial advisory services for the
Company, for which it has received customary compensation. Such services
included acting as placement agent for the Company's Subordinated Notes in
August and October 1995. NatWest Securities Limited is an affiliate of National
Westminster Bank Plc, the lead agent for the Company's 1996 Revolving Facility,
which was entered into in March 1996.
NatWest Securities Limited, a United Kingdom broker-dealer and a member of
the Securities and Futures Authority Limited, has agreed that, as part of the
distribution of the Common Stock offered hereby and subject to certain
exceptions, it will not offer or sell any Common Stock within the United States,
its territories or possessions or to persons who are citizens thereof or
residents therein.
NatWest Securities Limited has also represented and agreed that (i) it has
not offered or sold and will not offer or sell any Common Stock to persons in
the United Kingdom except to persons whose ordinary activities involve them in
acquiring, holding, managing or disposing of investments (as principal or agent)
for the purposes of their businesses or otherwise in circumstances which do not
constitute an offer to the public in the United Kingdom for the purposes of the
Public Offers of Securities Regulation 1995, (ii) it has complied and will
comply with all applicable provisions of the Public Offers of Securities
Regulation 1995 and the Financial Services Act 1986 with respect to anything
done by it in relation to the Common Stock in, from or otherwise involving the
United Kingdom, and (iii) it has only issued or passed on, and will only issue
or pass on, in the United Kingdom any document received by it in connection with
the issue of the Common Stock to a person who is of a kind described in Article
8 of the Financial Services Act 1986 (Investment Advertisements) (Exemptions)
(No. 2) Order 1995 or is a person to whom the document may otherwise lawfully be
issued or passed on.
56
<PAGE>
This Offering is being made pursuant to the provisions of Article III,
Section 44(c)(8) of the Rules of Fair Practice of the National Association of
Securities Dealers, Inc.
LEGAL MATTERS
Certain legal matters with respect to the validity of the Common Stock
offered hereby will be passed upon for the Company by Pillsbury Madison & Sutro
LLP, San Francisco, California and for the Underwriters by Paul, Hastings,
Janofsky & Walker (a partnership including professional corporations), New York,
New York.
EXPERTS
The audited consolidated financial statements of LodgeNet Entertainment
Corporation and Subsidiaries as of December 31, 1994 and 1995 and for each of
the three years in the period ended December 31, 1995 and the related schedules,
included in this Prospectus and elsewhere in the Registration Statement of which
this Prospectus is a part, have been audited by Arthur Andersen LLP, independent
public accountants, as indicated in their reports with respect thereto and are
included herein and therein in reliance upon the authority of said firm as
experts in accounting and auditing.
57
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants.................................. F-2
Consolidated Balance Sheets as of December 31, 1994 and 1995 and March 31,
1996 (unaudited)......................................................... F-3
Consolidated Statements of Operations for the years ended December 31,
1993, 1994 and 1995 and the three months ended March 31, 1995 and 1996
(unaudited).............................................................. F-4
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1993, 1994 and 1995 and the three months ended March 31,
1996 (unaudited)......................................................... F-5
Consolidated Statements of Cash Flows for the years ended December 31,
1993, 1994 and 1995 and the three months ended March 31, 1995 and 1996
(unaudited).............................................................. F-6
Notes to Consolidated Financial Statements................................ F-7
</TABLE>
F-1
<PAGE>
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, 1994 and 1995, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1995. 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, 1994 and 1995, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1995, in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota
March 11, 1996
F-2
<PAGE>
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLAR AMOUNTS IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1994 1995
---------- ---------- MARCH 31,
1996
-----------
(UNAUDITED)
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents................................................. $ 4,302 $ 2,252 $ 14
Accounts receivable, net of allowance for doubtful accounts............... 7,814 11,355 14,070
Prepaid expenses and other................................................ 1,015 1,462 2,681
---------- ---------- -----------
Total current assets.................................................. 13,131 15,069 16,765
---------- ---------- -----------
Property and equipment:
Land, building and equipment.............................................. 5,813 8,976 10,450
Free-to-guest equipment................................................... 2,835 5,068 4,491
Guest pay systems:
Installed............................................................... 78,810 119,354 134,367
System components....................................................... 10,301 13,468 14,626
Software costs.......................................................... 3,215 4,078 5,075
---------- ---------- -----------
Total property and equipment.......................................... 100,974 150,944 169,009
Less -- accumulated depreciation and amortization......................... (26,289) (42,838) (48,911)
---------- ---------- -----------
Property and equipment, net............................................. 74,685 108,106 120,098
---------- ---------- -----------
Debt issuance costs, net of accumulated amortization........................ 449 1,537 2,606
---------- ---------- -----------
$ 88,265 $ 124,712 $ 139,469
---------- ---------- -----------
---------- ---------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................................... $ 9,017 $ 15,222 $ 17,446
Current maturities of long-term debt...................................... -- 4,254 4,299
Accrued expenses (Note 10)................................................ 1,652 3,434 3,089
---------- ---------- -----------
Total current liabilities............................................. 10,669 22,910 24,834
---------- ---------- -----------
Deferred revenue............................................................ 1,654 1,579 1,602
---------- ---------- -----------
Long-term debt (Note 3)..................................................... 28,000 57,497 73,133
---------- ---------- -----------
Commitments and contingencies (Note 8)
Stockholders' equity (Notes 6 and 7):
Common stock, $.01 par value, 20 million shares authorized; 7,278,748,
7,352,113 and 7,359,613 shares outstanding at December 31, 1994 and
1995 and March 31, 1996, respectively.................................. 73 74 74
Additional paid-in capital.............................................. 69,492 71,234 71,262
Accumulated deficit..................................................... (21,623) (28,582) (31,436)
---------- ---------- -----------
Total stockholders' equity.......................................... 47,942 42,726 39,900
---------- ---------- -----------
$ 88,265 $ 124,712 $ 139,469
---------- ---------- -----------
---------- ---------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
F-3
<PAGE>
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLAR AMOUNTS, EXCEPT PER SHARE AMOUNTS, IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
---------------------------------- ----------------------
1993 1994 1995 1995 1996
---------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
Guest pay...................................... $ 21,471 $ 29,927 $ 50,758 $ 10,500 $ 17,582
Free-to-guest.................................. 7,478 8,397 8,060 1,993 2,145
Other.......................................... 2,363 2,070 4,395 899 641
---------- ---------- ---------- ---------- ----------
Total revenues............................. 31,312 40,394 63,213 13,392 20,368
---------- ---------- ---------- ---------- ----------
Direct costs:
Guest pay...................................... 7,235 10,050 19,053 3,824 6,839
Free-to-guest.................................. 5,792 6,412 6,117 1,544 1,684
Other.......................................... 1,821 1,719 3,740 802 591
---------- ---------- ---------- ---------- ----------
Total direct costs......................... 14,848 18,181 28,910 6,170 9,114
---------- ---------- ---------- ---------- ----------
Gross profit..................................... 16,464 22,213 34,303 7,222 11,254
---------- ---------- ---------- ---------- ----------
Operating expenses:
Guest pay operations........................... 5,491 7,244 9,767 2,213 3,163
Selling and marketing.......................... 1,020 1,541 1,871 511 742
General and administrative..................... 2,738 4,127 6,767 1,385 2,107
Depreciation and amortization.................. 7,176 11,661 18,336 3,858 6,173
---------- ---------- ---------- ---------- ----------
Total operating expenses................... 16,425 24,573 36,741 7,967 12,185
---------- ---------- ---------- ---------- ----------
Operating income (loss).......................... 39 (2,360) (2,438) (745) (931)
Interest expense................................. 2,096 966 4,522 735 1,922
---------- ---------- ---------- ---------- ----------
Loss before income taxes and extraordinary
loss............................................ (2,057) (3,326) (6,960) (1,480) (2,853)
Provision for income taxes (Note 9).............. -- -- 66 -- 20
---------- ---------- ---------- ---------- ----------
Loss before extraordinary loss................... (2,057) (3,326) (7,026) (1,480) (2,873)
Extraordinary loss (Note 5)...................... -- 1,324 -- -- --
---------- ---------- ---------- ---------- ----------
Net loss......................................... (2,057) (4,650) (7,026) (1,480) (2,873)
Cumulative preferred dividends................... 1,557 -- -- -- --
---------- ---------- ---------- ---------- ----------
Net loss attributable to common stock............ $ (3,614) $ (4,650) $ (7,026) $ (1,480) $ (2,873)
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Per common share (Notes 1 and 6):
Loss before extraordinary loss................. $ (0.49) $ (0.45) $ (0.95) $ (0.20) $ (0.39)
Extraordinary loss............................. -- (0.18) -- -- --
---------- ---------- ---------- ---------- ----------
Net loss attributable to common stock.......... $ (0.49) $ (0.63) $ (0.95) $ (0.20) $ (0.39)
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Weighted average shares outstanding.............. 7,334,226 7,326,748 7,382,471 7,352,166 7,406,719
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
SERIES B PREFERRED
STOCK COMMON STOCK ADDITIONAL
-------------------- ----------------------- PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
--------- --------- ---------- ----------- ----------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1992.................... 3,800 $ 3,800 887,208 $ 9 $ 2,026 $ (13,107) $ (7,272)
Cumulative preferred dividends.............. (1,557) (1,557)
Conversion of preferred stock............... (3,800) (3,800) 1,121,266 11 3,789 -- --
Issuance of common stock.................... -- -- 5,265,774 53 63,653 -- 63,706
Net loss.................................... -- -- -- -- -- (2,057) (2,057)
Foreign currency translation adjustment..... -- -- -- -- -- (155) (155)
--------- --------- ---------- --- ----------- ------------ ---------
Balance, December 31, 1993.................... -- -- 7,274,248 73 69,468 (16,876) 52,665
Common stock option activity................ -- -- 4,500 -- 24 24
Net loss.................................... -- -- -- -- -- (4,650) (4,650)
Foreign currency translation adjustment..... -- -- -- -- -- (97) (97)
--------- --------- ---------- --- ----------- ------------ ---------
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 (Note 7).................... -- -- -- -- 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
Common stock option activity (unaudited).... -- -- 7,500 -- 28 -- 28
Net loss (unaudited)........................ -- -- -- -- -- (2,873) (2,873)
Foreign currency translation adjustment
(unaudited)................................ -- -- -- -- -- 19 19
--------- --------- ---------- --- ----------- ------------ ---------
Balance, March 31, 1996 (unaudited)........... -- $ -- 7,359,613 $ 74 $ 71,262 $ (31,436) $ 39,900
--------- --------- ---------- --- ----------- ------------ ---------
--------- --------- ---------- --- ----------- ------------ ---------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
---------------------------------- ----------------------
1993 1994 1995 1995 1996
---------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Operating activities:
Net loss............................................ $ (2,057) $ (4,650) $ (7,026) $ (1,480) $ (2,873)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization..................... 7,176 11,661 18,336 3,858 6,173
Extraordinary loss................................ -- 1,324 -- -- --
Change in operating assets and liabilities:
Accounts receivable............................. 9 (2,765) (3,541) (933) (2,715)
Prepaid expenses and other...................... (262) 139 (447) (315) (1,219)
Accounts payable................................ (995) 5,735 6,205 392 2,224
Accrued expenses and deferred revenue........... 352 505 1,857 32 (322)
---------- ---------- ---------- ---------- ----------
Net cash provided by operating activities............. 4,223 11,949 15,384 1,554 1,268
---------- ---------- ---------- ---------- ----------
Investing activities:
Property and equipment additions.................... (14,311) (43,521) (51,497) (8,505) (18,065)
Certificates of deposit............................. (2,008) 2,008 -- -- --
---------- ---------- ---------- ---------- ----------
Net cash used for investing activities................ (16,319) (41,513) (51,497) (8,505) (18,065)
---------- ---------- ---------- ---------- ----------
Financing activities:
Proceeds from long-term debt........................ 6,000 28,000 33,630 208 378
Debt issuance costs................................. (601) (462) (1,348) (398) (1,069)
Repayments of long-term debt........................ (212) (6,000) (89) (20) (155)
Borrowings under revolving credit facility.......... 6,500 6,500 10,000 4,200 15,358
Repayments of revolving credit facility............. (36,000) (6,500) (10,000) -- --
Proceeds from issuance of common stock.............. 63,706 -- -- -- --
Proceeds from issuance of warrants to purchase
common stock....................................... -- -- 1,680 -- --
Stock option activity............................... -- 14 63 11 28
Redemption of Series A preferred stock.............. (12,925) -- -- -- --
Payment of accumulated preferred dividends.......... (2,151) -- -- -- --
---------- ---------- ---------- ---------- ----------
Net cash provided by financing activities............. 24,317 21,552 33,936 4,001 14,540
---------- ---------- ---------- ---------- ----------
Effect of exchange rates on cash...................... (57) 58 127 (10) 19
---------- ---------- ---------- ---------- ----------
Increase (decrease) in cash and cash equivalents...... 12,164 (7,954) (2,050) (2,960) (2,238)
Cash and cash equivalents at beginning of period...... 92 12,256 4,302 4,302 2,252
---------- ---------- ---------- ---------- ----------
Cash and cash equivalents at end of period............ $ 12,256 $ 4,302 $ 2,252 $ 1,342 $ 14
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Supplemental cash flow information:
Cash paid for interest.............................. $ 2,537 $ 836 $ 3,341 $ 753 $ 2,256
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
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. The Company's operating
performance and outlook are strongly influenced by such factors as overall
occupancy levels and economic conditions in the lodging industry, the number of
rooms equipped with the Company's systems, the popularity and availability of
programming, customer buy rates and competitive factors. The Company is
dependent on third parties for the programming provided through its systems.
The Company's rapid growth has and is expected to continue to require
capital resources in excess of operating cash flows. The Company's operating
cash flows, working capital and the Revolving Credit Facility (see Note 4) are
sufficient to fund a part of the Company's growth during 1996, and the Company
is seeking additional capital financing to augment those resources. The Company
believes that such financing is available from a number of sources, however, if
such financing should not be available at reasonable cost, the Company could
modify its expansion plans and reduce capital expenditures necessary for the
installation of the Company's systems in additional hotel rooms or necessary to
upgrade existing installations.
On February 9, 1996, the Company entered into an exclusive contract with GE
Capital-ResCom, L.P., an affiliate of General Electric Co., under which ResNet
Communications, Inc., a newly formed wholly-owned subsidiary of the Company,
will install and operate private cable television systems in multi-family
residential properties nationwide.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements
include the accounts of the Company and its wholly-owned Canadian subsidiary.
All significant intercompany 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 disclosure
of contingent assets and liabilities, at the date of the financial statements,
and the reported amounts of revenues and expenses during the reporting period.
The ultimate outcome of the matters and items may be different than the
estimates and assumptions.
CASH AND CASH EQUIVALENTS -- Cash and Cash Equivalents are comprised of
demand deposits and temporary investments in highly liquid securities with an
original maturity of 90 days or less.
PROPERTY AND EQUIPMENT -- Property and Equipment is stated at cost. The
Company capitalizes certain payroll costs related to the installation of new
systems. Repairs and maintenance costs which do not significantly extend the
useful lives of the respective assets 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 items
are placed in service. For financial reporting purposes, depreciation and
amortization are computed using the straight-line method over the following
estimated useful lives of the assets:
<TABLE>
<CAPTION>
YEARS
---------
<S> <C>
Building......................................................... 19
Guest pay systems:
System components.............................................. 5 to 7
In-room equipment.............................................. 3 to 5
Free-to-guest systems............................................ 5
Other equipment.................................................. 5
</TABLE>
F-7
<PAGE>
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
GUEST PAY PRODUCT DEVELOPMENT -- The Company has capitalized certain costs
of developing software and other components of its guest pay 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 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 $423,000, $936,000 and $1,480,000 during the years ended December 31, 1993,
1994 and 1995, respectively. Amortization of such costs was $302,000, $344,000
and $455,000 for the years ended December 31, 1993, 1994 and 1995, respectively.
Guest pay system development costs capitalized during the three months ended
March 31, 1995 and 1996 were $371,000 and $425,000, respectively, and
amortization of such costs was $103,000 and $124,000, respectively.
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
$601,000, $462,000 and $1,348,000 of debt issuance costs during the years ended
December 31, 1993, 1994 and 1995, respectively. Amortization of such costs was
$237,000 in 1993; $203,000 in 1994, excluding $1,324,000 which was reflected as
an extraordinary loss resulting from the early termination of a bank revolving
credit facility during 1994 (see Note 5); and $260,000 in 1995. Accumulated
amortization was $383,000, $13,000, and $273,000 at December 31, 1993, 1994 and
1995, respectively. The Company capitalized $398,000 and $1,170,000,
respectively, during the three months ended March 31, 1995 and 1996, and
amortization of such costs during those periods was $32,000 and $101,000,
respectively. Accumulated amortization was $373,000 at March 31, 1996.
NET LOSS PER COMMON SHARE -- The net loss per common share was computed
using the weighted average number of shares outstanding and, when applicable,
outstanding warrants and options.
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. At December 31, 1993, 1994 and 1995, the Company had
recorded deferred revenues of $1,430,000, $1,654,000 and $1,579,000,
respectively, which represent reductions of the cost of programming in future
years. At March 31, 1996, the Company had recorded $1,602,000 of deferred
revenues.
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 prevailing during the
year. Translation adjustments and transaction gains and losses prior to 1993
were not material to the Company's operations.
POSTEMPLOYMENT AND POSTRETIREMENT BENEFITS -- The Company does not offer
or provide such benefits.
F-8
<PAGE>
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 $228,000 and $410,000 at December 31, 1994
and 1995, respectively, and $513,000 at March 31, 1996. The provision for
doubtful accounts was $375,000 in 1993, $226,000 in 1994, $343,000 in 1995 and
$192,000 and $154,000, respectively, during the three months ended March 31,
1995 and 1996.
FEDERAL 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."
FAIR VALUE OF FINANCIAL INSTRUMENTS -- The carrying amounts for Cash and
Cash Equivalents, Accounts Receivable, Accounts Payable and Accrued Expenses
approximate fair value due to the relatively short period to maturity of these
instruments. The fair value of Long-term debt instruments is estimated by
reference to current yields to maturity on similar instruments. The fair value
of the Warrants issued during 1995 was estimated using option valuation
techniques.
RECENTLY ISSUED ACCOUNTING STANDARDS -- Financial Accounting Standards
Board Statement No. 123, "Accounting for Stock-Based Compensation" ("Statement
123"), issued in October 1995 and effective for fiscal years beginning after
December 15, 1995, encourages, but does not require, a fair value based method
of accounting for employee stock options or similar equity instruments. It also
allows an entity to elect to continue to measure compensation cost under
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25"), but requires pro forma disclosures of net income and
earnings per share as if the fair value method of accounting had been applied.
The Company will adopt Statement 123 in 1996. While the Company is still
evaluating Statement 123, it currently expects to elect to continue to measure
compensation cost in accordance with APB 25, as permitted under Statement 123,
and to comply with the pro forma disclosure requirements thereof. If the Company
makes this election, compliance with Statement 123 will have no impact on the
Company's results of operations or financial position because the Company's
stock option plans are fixed stock option plans, and therefore grants thereunder
have no intrinsic value at the grant date under APB 25.
Financial Accounting Standards Board Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
("Statement 121"), was issued in March 1995 and is effective for fiscal years
beginning after December 15, 1995. This statement will be applied prospectively,
and requires that impairment losses on long-lived assets be recognized when the
book value of the asset exceeds its expected undiscounted cash flows. The
Company adopted Statement 121 on January 1, 1996 and adoption at that time did
not have a material impact on the Company's financial position or results of
operations.
UNAUDITED INTERIM FINANCIAL STATEMENTS -- The consolidated balance sheet
as of March 31, 1996 and the related consolidated statements of operations,
stockholders' equity and cash flows for the three month periods ended March 31,
1995 and 1996 are unaudited and are not covered by the report of independent
public accountants. However, in the opinion of management, these interim
consolidated financial statements include all adjustments (which consist only of
normal recurring adjustments) necessary to present fairly the financial
position, results of operations, and cash flows of the Company for the interim
periods and are prepared on the same basis as the audited consolidated financial
statements. The results of operations and cash flows for the unaudited three
month period ended March 31, 1996 are not necessarily indicative of the results
that may be expected for the year ending December 31, 1996.
F-9
<PAGE>
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3 -- LONG-TERM DEBT
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------- MARCH 31,
1994 1995 1996
--------- --------- -----------
<S> <C> <C> <C>
(UNAUDITED)
Revolving Credit Facility.................................. $ -- $ -- $ 15,358
Unsecured Senior Notes due August 1, 2003:
9.95% interest payable quarterly......................... 28,000 28,000 28,000
10.35% interest payable quarterly........................ -- 5,000 5,000
Unsecured Senior Subordinated Notes due July 15, 2005:
11.5% interest payable semi-annually..................... -- 30,000 30,000
Less: unamortized discount............................... -- (1,599) (1,545)
Other...................................................... -- 350 619
--------- --------- -----------
28,000 61,751 77,432
Less current maturities.................................... (4,254) (4,299)
--------- --------- -----------
$ 28,000 $ 57,497 $ 73,133
--------- --------- -----------
--------- --------- -----------
</TABLE>
Long-term debt has the following scheduled principal maturities for the five
years subsequent to December 31, 1995 (in thousands of dollars): 1996 -- $4,254;
1997 -- $4,254; 1998 -- $4,200; 1999 -- $4,132; and 2000 -- $4,125.
SENIOR NOTES -- On September 15, 1994, the Company sold $28 million,
principal amount, of 9.95% Senior Notes in a private transaction with three
insurance companies. The 9.95% Senior Notes were issued at par and mature on
August 1, 2003. Proceeds from the sale of the 9.95% Senior Notes, after issuance
expenses, were approximately $27.6 million and such proceeds were used to (i)
repay previous borrowings and (ii) to provide approximately $15.1 million of
capital for the continuing growth of the Company's guest pay services business.
On April 13, 1995, the Company and the holders of the Company's 9.95% Senior
Notes amended the Note Purchase Agreement governing such 9.95% Senior Notes and
concurrently the Company issued $5 million, principal amount, of 10.35% Senior
Notes, under the Note Purchase Agreement, in a private placement to certain
holders of the Company's 9.95% Senior Notes. The 10.35% Senior Notes were issued
at par and mature on August 1, 2003. Proceeds from the issue, after issuance
related expenses, were approximately $4.9 million, and were used to (i) repay
previous borrowings and (ii) for expansion of the Company's guest pay services
business.
SENIOR SUBORDINATED 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 to (i) 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 7) 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, is recorded in stockholders' equity and
shown as a discount on the Subordinated Notes.
Both the Senior Notes and the Senior Subordinated Notes include covenants
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 of the Company,
F-10
<PAGE>
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3 -- LONG-TERM DEBT (CONTINUED)
provide for acceleration of principal repayment in certain circumstances, and
permit early retirement of principal, subject to minimum rate of return
provisions. As of March 31, 1996, the Company was in compliance with all such
convenants.
At December 31, 1995, the estimated fair value of the Senior Notes was
approximately $37.5 million and the estimated fair value of the Subordinated
Notes was approximately $31.5 million. The fair value of the Senior Notes at
December 31, 1994 approximated their carrying value.
NOTE 4 -- REVOLVING CREDIT FACILITY AND SUBSEQUENT EVENT
On March 11, 1996, the Company entered into a $45 Million Revolving Credit
Facility (the "1996 Revolving Facility") with National Westminster Bank Plc and
three other banks, to replace a previously available $15 Million Revolving
Credit Facility. The 1996 Revolving Facility is unsecured, and amounts
outstanding thereunder bear interest at either (i) LIBOR (London Inter Bank
Offered Rate) plus 2.00% to 2.625% or (ii) Prime Rate plus 1.00% to 1.625%; both
depending on the Company's total leverage, as defined in the agreement. The
commitment under the 1996 Revolving Facility may be increased to $60 million,
subject to certain conditions, but is subject to a scheduled reduction of 15%
beginning in June 1997 and annually thereafter as follows: June 1998 -- 20%;
June 1999 -- 20%; June 2000 -- 20%; and June 2001 -- 25%. The 1996 Revolving
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 March 31, 1996, the Company
was in compliance with all such terms and conditions.
NOTE 5 -- EXTRAORDINARY LOSS ON EARLY TERMINATION OF BANK CREDIT FACILITY
In order to issue the 9.95% Senior Notes (see Note 3) on an unsecured basis,
the Company terminated its Revolving Credit and Term Loan Facility, which had
been secured by all of the Company's assets. As a consequence of the early
termination of this facility, the Company wrote off related, unamortized debt
issuance costs of $1,324,000 during 1994.
NOTE 6 -- STOCKHOLDERS' EQUITY
PREFERRED STOCK -- In 1992 the Company issued 925 shares of Series A
preferred stock to its then majority stockholder. No dividends on preferred
stock were declared in 1992. In January 1993, the number of authorized preferred
shares was increased to 20,000 and the Company issued 3,800 shares of $100 par
value ($1,000 redemption value) Series B convertible preferred stock to its then
majority stockholder in exchange for Common Stock and certain accrued dividends
on Series A preferred stock. In October 1993, all such Series B preferred shares
were converted into 1,121,266 shares of Common Stock and $2,150,751 in accrued
dividends ($594,000 and $1,556,751 applicable to and accrued in 1992 and 1993,
respectively) on preferred stock were declared and paid.
There are 5,000,000 shares of preferred stock, $.01 par value, authorized by
the Company's certificate of incorporation, of which there were none outstanding
at December 31, 1994 and 1995 and March 31, 1996. 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 -- In October 1993, the Company sold 5,175,000 shares of
Common Stock at $13.50 per share in an initial public offering. Net proceeds to
the Company, after underwriters' commissions and other expenses related to the
offering, were approximately $63.7 million.
F-11
<PAGE>
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7 -- STOCK OPTIONS AND WARRANTS
STOCK OPTIONS -- The Company has stock option plans which provide for the
granting of up to a total of 1,426,792 Nonqualified or Incentive Stock Options
on the Company's Common Stock, and certain officers, directors and key employees
have been granted options to purchase Common Stock of the Company under these
plans. Information concerning stock options is summarized for 1995, as follows:
<TABLE>
<CAPTION>
OPTION OUTSTANDING
PRICE PER BEGINNING OUTSTANDING EXERCISABLE
SHARE OF YEAR GRANTED (EXERCISED) (CANCELLED) END OF YEAR END OF YEAR
- --------- ----------- --------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
$0.23 228,579 -- (34,079) -- 194,500 194,500
$0.46 449,191 -- (39,286) -- 409,905 409,905
$2.77 173,232 -- -- -- 173,232 173,232
$3.23 71,290 -- -- -- 71,290 71,290
$13.25 5,000 -- -- -- 5,000 5,000
$14.75 10,000 -- -- (500) 9,500 4,750
$14.25 21,000 -- -- -- 21,000 10,333
$9.55 99,999 -- -- -- 99,999 25,000
$7.37 -- 72,000 -- (2,000) 70,000 --
$7.00 -- 60,000 -- -- 60,000 --
$8.25 -- 4,000 -- -- 4,000 --
$10.85 -- 200,000 -- -- 200,000 --
----------- --------- ----------- ----------- ----------- -----------
1,058,291 336,000 (73,365) (2,500) 1,318,426 894,010
----------- --------- ----------- ----------- ----------- -----------
----------- --------- ----------- ----------- ----------- -----------
</TABLE>
Options become exercisable in accordance with vesting schedules determined by a
Committee of the Board of Directors, and generally expire ten years after the
date of grant. No options had expired as of December 31, 1995 and outstanding
options expire through 2005.
During the three months ended March 31, 1996, the Company granted options
under its plans on 85,000 shares of Common Stock at an exercise price of $13.00
per share, and options were exercised on 5,000 and 2,500 shares at exercise
prices of $.23 and $7.37 per share, respectively.
WARRANTS -- In connection with the Company's initial public offering of
Common Stock 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 Subordinated Notes (see Note 3), 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
of the Company 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 has been recorded in additional paid-in
capital.
NOTE 8 -- COMMITMENTS AND CONTINGENCIES
PROGRAMMING AGREEMENTS -- The Company, through programming agreements,
provides guest pay and free-to-guest programming services to the lodging
industry. 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
F-12
<PAGE>
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8 -- COMMITMENTS AND CONTINGENCIES (CONTINUED)
rate schedules based on the number of hotel and motel rooms 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.
OPERATING LEASES -- The Company has entered into certain operating leases,
which at December 31, 1995 require future minimum lease payments, as follows (in
thousands of dollars): 1996 - $438; 1997 - $49; 1998 - $3; and none in 1999 and
2000.
LITIGATION -- On February 16, 1995, OCV filed a lawsuit in Federal
District Court in Northern California asserting patent infringement by the
Company. The complaint requests an unspecified amount of damages and injunctive
relief. The Company believes that it does not infringe on the patent and that
the allegations are without merit. The Company filed an answer and counterclaim
to the lawsuit 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 intends to vigorously defend itself.
Although the outcome of any litigation cannot be predicted with certainty, the
Company, after considering the advice of legal counsel, 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.
The Company is also subject to other litigation, arising in the ordinary
course of business. As of the date hereof, in the opinion of management, the
resolution of such other litigation will not have a material adverse effect upon
the Company's financial condition.
NOTE 9 -- INCOME TAXES
The provision for income taxes for 1995 consisted of alternative minimum
federal income taxes and State income taxes.
At December 31, 1995, the Company had net operating loss carryforwards in
excess of $29 million for Federal income tax purposes. These carryforwards
expire through 2010, although federal tax regulations limit the availability and
timing of usage of carryforwards.
Significant components of the Company's deferred tax liabilities and assets
at December 31 were as follows (in thousands of dollars):
<TABLE>
<CAPTION>
1994 1995
--------- ---------
<S> <C> <C>
Deferred tax liabilities:
Tax over book depreciation...................... $ 3,437 $ 3,777
--------- ---------
Deferred tax assets:
Net operating loss carryforwards................ 7,864 9,939
Deferred programming............................ 562 540
Other........................................... 253 345
--------- ---------
8,679 10,824
Valuation allowance............................. (5,242) (7,047)
--------- ---------
Net deferred tax assets....................... 3,437 3,777
--------- ---------
Net deferred taxes................................ $ -- $ --
--------- ---------
--------- ---------
</TABLE>
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.
F-13
<PAGE>
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10 -- ACCRUED EXPENSES
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------- MARCH 31,
1994 1995 1996
--------- --------- -----------
<S> <C> <C> <C>
(UNAUDITED)
Accrued taxes..................................... $ 521 $ 702 $ 592
Accrued compensation.............................. 660 966 659
Accrued interest.................................. 464 1,748 1,283
Other............................................. 7 18 555
--------- --------- -----------
$ 1,652 $ 3,434 $ 3,089
--------- --------- -----------
--------- --------- -----------
</TABLE>
NOTE 11 -- EVENT SUBSEQUENT TO DATE OF REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
On April 16, 1996, the Company's Board of Directors authorized the filing of
a Registration Statement with the Commission for a proposed public offering of
Common Stock. On May 21, 1996, the Company's Board of Directors appointed the
Special Pricing Committee of the Board of Directors (the "Pricing Committee")
and authorized such committee to determine the number of shares to be issued and
sold in the public offering and to set the price at which such shares are to be
sold to the Underwriters and the public. On May 22, 1996, the Pricing Committee
authorized the issuance of 3,680,000 shares (including 480,000 shares which may
be issued upon exercise of the Underwriters' over-allotment option). Costs
associated with this Offering will be charged against the proceeds of the
Offering. If for any reason this Offering is not completed, such costs will be
charged to operations.
F-14
<PAGE>
Inside Back Cover
Map depicting Company's actual and target customers
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED IN
THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION AND
REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY
OR THE UNDERWRITERS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS
BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN
OFFER TO BUY ANY SECURITIES OTHER THAN THE REGISTERED SECURITIES TO WHICH IT
RELATES. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION
OF AN OFFER TO BUY SUCH SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR
SOLICITATION IS UNLAWFUL.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information..................................................... 2
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 8
Use of Proceeds........................................................... 11
Dividend Policy........................................................... 11
Price Range of Common Stock............................................... 11
Capitalization............................................................ 12
Dilution.................................................................. 13
Selected Consolidated Financial and Other Data............................ 14
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 16
Business.................................................................. 29
Management................................................................ 44
Certain Transactions...................................................... 49
Principal Stockholders.................................................... 50
Description of Capital Stock.............................................. 52
Underwriting.............................................................. 55
Legal Matters............................................................. 57
Experts................................................................... 57
Index to Consolidated Financial Statements................................ F-1
</TABLE>
3,200,000 SHARES
[LOGO]
COMMON STOCK
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P R O S P E C T U S
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PAINEWEBBER INCORPORATED
MONTGOMERY SECURITIES
NATWEST SECURITIES LIMITED
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MAY 23, 1996
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