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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 25, 1998
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One):
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
Commission File Number: 0-22334
LODGENET ENTERTAINMENT CORPORATION
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(Exact name of Registrant as specified in its charter)
DELAWARE 46-0371161
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(State of Incorporation) (I.R.S. Employer Identification Number)
3900 WEST INNOVATION STREET, SIOUX FALLS, SOUTH DAKOTA 57107
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(Address of Principal Executive Offices) (Zip Code)
(605) 988-1000
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE.
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.01
PAR VALUE.
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that
the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes X No .
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K. [ ]
As of March 23, 1998, the aggregate market value of the common stock held by
non-affiliates of the Registrant was approximately $109 million. The number of
shares of common stock of the Registrant outstanding as of March 23, 1998 was
11,356,358.
DOCUMENTS INCORPORATED BY REFERENCE--Part III of this From 10-K is incorporated
by reference from Registrant's definitive proxy statement for the 1998 Annual
Meeting of Stockholders which will be filed within 120 days of the fiscal year
ended December 31, 1997.
This Report contains a total of 53 pages, excluding exhibits. The exhibit
index appears on page 29.
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TABLE OF CONTENTS
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Page
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Special Note Regarding Forward-Looking Statements 1
ITEM 1 BUSINESS 1
Overview 1
Business Strategy 3
Strategic Initiatives 4
Markets and Customers 5
Services and Products 5
Operations 7
Competition 10
Regulation 11
Employees 13
ITEM 2 PROPERTIES 13
ITEM 3 LEGAL PROCEEDINGS 14
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 14
ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS 15
Dividends 15
Rights Plan 15
ITEM 6 SELECTED FINANCIAL DATA 18
Special Note Regarding Forward-Looking Statements 20
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 20
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 27
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE 27
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT 28
ITEM 11 EXECUTIVE COMPENSATION 28
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT 28
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 28
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K 29
</TABLE>
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As used herein (unless the context otherwise requires) "LodgeNet", "the
Company" and/or "the Registrant" mean LodgeNet Entertainment Corporation and
its wholly-owned subsidiaries.
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PART I
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
CERTAIN STATEMENTS IN THIS ANNUAL REPORT ON FORM 10-K, INCLUDING,
WITHOUT LIMITATION, STATEMENTS IN ITEM 1, INCLUDING CERTAIN STATEMENTS UNDER
THE HEADINGS "OVERVIEW", "BUSINESS STRATEGY", "STRATEGIC INITIATIVES",
"SERVICES AND PRODUCTS", "OPERATIONS", "COMPETITION" AND "REGULATION", IN
ITEM 3 UNDER THE HEADING "LEGAL PROCEEDINGS", AND IN ITEM 7 UNDER THE HEADING
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS," CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF
THE SECURITIES ACT OF 1933, AS AMENDED, AND THE SECURITIES EXCHANGE ACT OF
1934, AS AMENDED. WHEN USED IN THIS ANNUAL REPORT, THE WORDS "EXPECTS,"
"ANTICIPATES," "ESTIMATES," "BELIEVES," "NO ASSURANCE" AND SIMILAR
EXPRESSIONS ARE INTENDED TO IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. SUCH
FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND
OTHER FACTORS, WHICH MAY CAUSE THE COMPANY'S ACTUAL RESULTS, PERFORMANCE OR
ACHIEVEMENTS TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE
OR ACHIEVEMENTS EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. IN
ADDITION TO THE RISKS AND UNCERTAINTIES DISCUSSED IN THE FOREGOING SECTIONS,
SUCH FACTORS INCLUDE, AMONG OTHERS, THE FOLLOWING: THE IMPACT OF COMPETITION
AND CHANGES TO THE COMPETITIVE ENVIRONMENT FOR THE COMPANY'S PRODUCTS AND
SERVICES, CHANGES IN TECHNOLOGY, RELIANCE ON STRATEGIC PARTNERS, UNCERTAINTY
OF LITIGATION, CHANGES IN GOVERNMENT REGULATION AND OTHER FACTORS DETAILED,
FROM TIME TO TIME, IN THE COMPANY'S FILINGS WITH THE SECURITIES AND EXCHANGE
COMMISSION. THESE FORWARD-LOOKING STATEMENTS SPEAK ONLY AS OF THE DATE OF
THIS ANNUAL REPORT. THE COMPANY EXPRESSLY DISCLAIMS ANY OBLIGATION OR
UNDERTAKING TO RELEASE PUBLICLY ANY UPDATES OR REVISIONS TO ANY
FORWARD-LOOKING STATEMENTS CONTAINED HEREIN TO REFLECT ANY CHANGE IN THE
COMPANY'S EXPECTATIONS WITH REGARD THERETO OR ANY CHANGE IN EVENTS,
CONDITIONS OR CIRCUMSTANCES ON WHICH ANY SUCH STATEMENT IS BASED.
ITEM 1 -- BUSINESS
OVERVIEW
LodgeNet provides video on-demand, network-based video games, cable
television programming and other interactive entertainment and information
services to the lodging and multi-family dwelling unit ("MDU") markets
utilizing its proprietary broadband local-area-network ("b-LAN"-SM- ) system
architecture. Through its rapid growth, the Company has become the second
largest provider of such services to the lodging market (based on total rooms
served), currently serving over 630,000 rooms in over 4,000 hotel properties
throughout the United States, Canada, and selected international markets.
Through its subsidiary, ResNet Communications, L.L.C. ("ResNet"), the Company
is extending its b-LAN-SM- system architecture and operational expertise into
the MDU market.
LodgeNet and ResNet generally operate under exclusive long-term
contracts in the lodging and MDU markets. The Company's lodging guest pay
contracts typically have terms of 5 to 7 years and ResNet's MDU contracts
generally have terms of 8 to 12 years. The exclusive nature of these
contracts allows the Company to estimate, based on certain operating
assumptions, future revenues, cash flows and rates of return related to the
contracts prior to making a capital investment decision.
The Company has experienced substantial growth in the number of guest
pay rooms served, total revenue and earnings before interest, taxes,
depreciation and amortization ("EBITDA"). From 1991 through 1997, guest pay
rooms served increased from 73,415 to 511,851, revenues increased from $19.6
million to $135.7 million, and EBITDA increased from $2.9 million to $35.7
million.
LODGING SERVICES. The Company provides its services in the lodging
market to corporate-managed hotel chains such as ITT Sheraton, The
Ritz-Carlton Company, Harrah's Casino Hotels, Delta Hotels and Resorts,
Outrigger, La Quinta Inns, Red Roof Inns and Budgetel Inns, as well as many
individual properties flying the Marriott, Holiday Inn, Hilton,
Inter-Continental, Prince, Radisson, Westin, Doubletree, Embassy Suites, and
other flags. The lodging market in the United States comprises approximately
3.6 million rooms. The Company believes that approximately 1.9 million of
these rooms are located in the Company's target market of hotels having more
than 100 rooms. The Company provides its services under exclusive, long-term
contracts throughout the United States and Canada, and in other select
countries through licensing arrangements with strategic partners. The average
remaining life of the Company's existing guest pay contracts is over four
years, with less than 7% of these contracts due to expire before 1999.
In the lodging market, the Company's services include Guest
Scheduled-SM- on-demand movies, network-based Super Nintendo-Registered
Trademark- video games, PRIMESTAR-Registered Trademark- digital
satellite-delivered basic and premium cable television programming, and other
interactive entertainment and information services. On-demand services enable
a guest to purchase and start a movie on-demand, rather than restricting the
guest to a predetermined start time. Video games can be started on-demand by
a hotel guest who is charged an hourly rate for play time. Free-to-guest
services typically involve a customized package of basic and premium cable
television programming which the hotel purchases from the Company and
provides at no charge to guests. Other services, which are typically provided
at no charge to the guest, include guest surveys, folio review and video
checkout. The Company is able to offer its
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interactive services by virtue of the high-speed, two-way digital
communications design of its proprietary b-LAN-SM- system architecture. The
Company's open-architecture, UNIX-based platform enables the Company to
upgrade system software to support the introduction of new services or
integrate new technologies as they become commercially available and
economically viable.
The Company believes it is a leader in providing innovative products and
services to the lodging industry. The Company believes that it was the first
in the lodging market to install network-based interactive video games, the
first to install in-room printers for video checkout and other applications,
and the first to utilize a Video Room Card-SM- (an image-based menu and
purchasing protocol, utilizing pictures and graphics to replace the simple
text menus traditionally utilized by its competitors). The Company is
currently testing an Internet browser (developed in cooperation with Sun
Microsystems, Inc.) at several hotel properties that enables the hotel guest
to access and navigate the World Wide Web from any guest room television. In
1995, LodgeNet redesigned its interactive system, enabling the Company to
deliver what it believes is the first cost-effective system for on-demand
movies and network-based video games to mid-size hotels of 100 to 150 rooms,
a market segment the Company believes has been historically underserved by
guest pay providers. The Company believes that the scalability and advanced
features of its redesigned system for mid-size hotels were principal factors
in the awarding by La Quinta Inns of its over 30,000-room account, Red Roof
Inns of its over 27,000-room account and Budgetel Inns of its over 8,000-room
account to the Company over other competitors. The Company believes that the
mid-size hotel segment represents a large and attractive market for the
Company's services that will generate financial returns similar to those
achieved by the Company in larger full-service hotels. In April 1996, the
Company entered into an agreement with PRIMESTAR Partners L.P. pursuant to
which the Company was appointed as the exclusive third-party provider (other
than the partners in PRIMESTAR and their affiliated distributors) of the
PRIMESTAR-Registered Trademark- digital direct broadcast satellite ("DBS")
signal to the lodging industry. This arrangement enables the Company to
provide free-to-guest, digital satellite-delivered cable television
programming to a broader segment of the lodging industry than can be
cost-effectively served with traditional C-band satellite systems.
MULTI-FAMILY RESIDENTIAL SERVICES. In October 1996, TCI Satellite
Entertainment, Inc. ("TSAT") agreed to invest up to $40 million in ResNet in
exchange for up to a 36.99% interest in ResNet and agreed to provide ResNet
with long-term access to the PRIMESTAR-Registered Trademark- DBS signals for
the MDU market on a nationwide basis. Pursuant to a recently announced
roll-up plan, the partners in PRIMESTAR Partners, L.P. (including TSAT, Time
Warner Entertainment, Comcast Corporation, Cox Communications, MediaOne, and
GE Americom) will contribute their PRIMESTAR related assets to a newly formed
subsidiary of TSAT ("New PRIMESTAR"); and TSAT will be subsequently merged
with and into New PRIMESTAR with New PRIMESTAR as the surviving corporation
(hereinafter "PRIMESTAR"). As a result of such transactions, PRIMESTAR will
succeed to the interest of TSAT in ResNet. In March 1997, ResNet activated
its first b-LAN-SM- -enabled, video on-demand system and, at December 31,
1997, ResNet's unit base had grown to approximately 26,125 passings in 16
states through a combination of organic growth and selected acquisitions.
The Company views the MDU market as attractive due to: (i) the large
market size; (ii) the portability to this market of the Company's b-LAN-SM-
system architecture and the operating expertise developed for the lodging
market; (iii) the favorable regulatory environment available to operators
such as ResNet who qualify as "private cable" operators under applicable
federal regulations (including the absence of franchise requirements,
"must-carry" obligations and rate regulations applicable to traditional
franchised cable operators); and (iv) the exclusive long-term contracts that
have customarily been available in the MDU market.
The Company believes it is well positioned to pursue the large MDU
private cable market with its proprietary b-LAN-SM- system architecture and
the ability to offer the DBS signals provided by PRIMESTAR on a nationwide
basis. The Company believes there are approximately 6 million multi-family
residential units in the United States that are located in apartment
complexes having more than 200 units, the Company's primary market, which
represents a market more than three times as large as the Company's
traditional lodging market. The Company believes that its proprietary
b-LAN-SM- system architecture enables ResNet to offer differentiated
interactive services that allow property owners to better communicate with
and serve their tenants. In addition, the Company believes that its
experience in creating and managing a nationwide installation and field
service organization will enable ResNet to operate effectively in its markets.
ResNet's video service agreement with each property owner grants ResNet
the exclusive right and access on a long-term basis to provide video services
to tenants of the MDU complex, in return for which the owner receives a
monthly commission based on revenues. These agreements generally prohibit
the property owner from installing or marketing an alternative video system
and prohibit the owner from allowing tenants to install an antenna, satellite
or microwave dish on the exterior of the building.
ResNet's private cable television system has the capacity to deliver
over 100 channels, although the Company expects that the typical system will
deliver 35 to 50 channels of basic and premium programming, depending
principally upon the size of the property, the length of the contract and
local competitive considerations. ResNet may elect to provide approximately
10 to 35 additional channels for scheduled pay-per-view, video on-demand and
other interactive services, such as Internet access. ResNet intends to tailor
the programming lineup at each multi-family residential complex, based on the
particular demographic profile of that complex. ResNet's interactive private
cable television systems are based on the Company's proprietary b-LAN-SM-
system architecture
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and utilize the PRIMESTAR-Registered Trademark- DBS signal provided by
nationwide. ResNet's access to PRIMESTAR-Registered Trademark-'s digital
signal provides it with a more capable and cost-effective system than the
C-band systems generally used by most satellite master antenna television
("SMATV") cable operators. ResNet's private cable television system can also
utilize addressable interdiction technology, enabling ResNet to remotely
initiate, modify or terminate service, prevent signal theft and respond to
many other service needs.
ResNet intends to grow its business by (i) marketing its unique b-LAN-SM-
system architecture capabilities and the PRIMESTAR-Registered Trademark- DBS
service to large multi-state MDU property portfolios averaging at least 200
units per property, (ii) capitalizing on its reputation for quality customer
service, (iii) considering selected acquisitions of private cable operations
where the expected return on capital meets ResNet's investment criteria, and
(iv) focusing its internal sales efforts and selected acquisitions in 20 to
25 geographic clusters in order to achieve operating efficiencies.
BACKGROUND. The Company's predecessor commenced business in 1980 as
Satellite Movie Company, incorporated as a South Dakota corporation in
February 1983 and changed its name to LodgeNet Entertainment Corporation in
September 1991. On October 13, 1993, LodgeNet Entertainment Corporation
changed its state of incorporation from South Dakota to Delaware by merging
with and into the Company, its newly-formed Delaware subsidiary, which then
adopted the LodgeNet name. Interested persons may access additional
information concerning the Company and ResNet through the Company's Web Site
at: HTTP://WWW.LODGENET.COM.
BUSINESS STRATEGY
The Company's business strategy is to: (i) continue to expand its
lodging industry base of guest pay and free-to-guest rooms; (ii) expand into
the MDU private cable television market; (iii) maximize the revenue generated
per lodging room or residential unit served by exploiting new revenue
opportunities; (iv) extend the application of the Company's proprietary high
speed, two-way b-LAN-SM- system architecture and operating expertise to new
markets; and (v) enhance financial performance by increasing operating
margins and reducing the average capital invested per new unit installed.
EXPANDING THE COMPANY'S LODGING INDUSTRY FRANCHISE. The Company
believes that there are substantial opportunities for continued domestic
growth in an estimated pool of over 1.9 million rooms located in hotels
having more than 100 rooms (from the approximately 3.6 million guest rooms
industry-wide), of which the Company estimates approximately 500,000 are
either served by the Company's competitors under contracts due to expire
before the end of 1998 or are presently unserved by any movie system vendor.
The Company's marketing plan is to capitalize on the strength of its
innovative product offerings, deliverable by virtue of the high-speed,
two-way digital communications design of its scalable b-LAN-SM- system
architecture, together with its expertise in installation, programming,
technical support and customer service.
Internationally, the Company is expanding into selected countries in the
Far East, South America, Central America and other regions through licensing
agreements with established partners in these countries. Under these
agreements, the Company generally sells equipment at cost plus an agreed
markup and receives a royalty based on gross revenues. The Company believes
there are additional opportunities to enter into international strategic
alliances in other regions to exploit further the Company's proprietary
b-LAN-SM- system architecture and multimedia capabilities.
EXPANDING INTO THE MULTI-FAMILY RESIDENTIAL MARKET. The Company
believes there are substantial opportunities to provide its services in the
MDU market. The Company believes there are approximately 6 million
multi-family residential units located in apartment complexes having more
than 200 units, the Company's primary market. This represents a market that
is more than three times the size of the Company's target lodging market.
MAXIMIZING REVENUE PER UNIT. In addition, to increasing and expanding
its installed customer base, the Company also seeks to maximize the revenue
generated by each of its installed guest rooms and apartment units. In
furtherance of this strategy, the Company intends in the lodging market to
continue to install its interactive Guest Scheduledsm on-demand movie and
network-based Super Nintendo-Registered Trademark- video game system in all
new guest pay hotel rooms. From the Company's experience, rooms with this
system generate significantly more revenue and gross profit than comparable
rooms having only the scheduled format which allows guests to watch movies
only at predetermined times. The Company's current installed guest pay base
of over 527,000 rooms hosts more than 125 million guests each year (based on
current average hotel occupancy and length-of-stay data). The Company
believes there may be significant opportunities to generate revenues from
third-party providers of content and services who would pay the Company for
access to its valuable consumer base, as well as from usage fees charged to
the guests who utilize such services. The Company is currently testing an
Internet browser (developed in cooperation with Sun Microsystems, Inc.) at
several hotel properties that enables the hotel guest to access and navigate
the World Wide Web from any guest room television. The Company is reviewing
other new services, such as advertiser-supported visitor information for
specific cities, as well as "advertorials" and other "push media" strategies
to deliver targeted product or service information directly to the consumer.
The Company is evaluating these and other opportunities as well as
appropriate business models that would enable the Company to maximize the
return on its investment in these activities.
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EXPANDING INTO NEW MARKETS. The Company seeks to extend the application
of its proprietary b-LAN-SM- system architecture, products and services to an
increasingly broad range of property sizes and types. In addition to the
mid-size hotel, international lodging and multi-family residential markets,
other future potential markets may include hospitals, single-family
residences, cruise ships and educational institutions, among others.
ENHANCING FINANCIAL PERFORMANCE. Complementing the Company's growth
objective is its ongoing goal to enhance financial performance. The Company
seeks to increase its operating margins by reducing direct and overhead
expenses, as measured on a percentage of revenue and on a per-installed unit
basis. As a result of its efforts, the Company has experienced increasing
EBITDA margins during each of the past four years as it has reduced per-room
operating costs and leveraged its infrastructure over a larger base of
installed rooms. Additionally, the Company will continue its program to
reduce the average capital invested per new unit, thereby increasing its
return on investment. As a result of engineering efforts to reduce the cost
of its system, increased installation efficiencies and the ability of the
Company to negotiate guest pay contracts under which hotels are sharing a
greater percentage of the cost of installing televisions, the Company's
average investment per new guest pay room decreased from approximately $535
in 1993 to approximately $375 in 1997.
STRATEGIC INITIATIVES
The Company has implemented the following strategic initiatives to
further its goal of creating a more diversified revenue base.
EXPANSION INTO THE RESIDENTIAL MARKET. On October 21, 1996, the Company
and ResNet entered into agreements with TSAT pursuant to which TSAT acquired
a 4.99% interest in ResNet for $5.4 million (the "Stock Payment") and agreed
to provide ResNet with long-term access to a DBS signal on a nationwide
basis. In addition, TSAT agreed to advance ResNet up to $34.6 million to
purchase certain DBS reception equipment pursuant to a subordinated
convertible term loan agreement (the "TSAT Convertible Note"). The TSAT
Convertible Note has a five year term (subject to a one year extension at the
option of ResNet), is non-recourse to the Company and is payable solely in
shares of the capital stock or membership interests in ResNet. Subject to
certain vesting provisions, the TSAT Convertible Note is subject to mandatory
conversion into up to an additional 32% interest in ResNet at such time as
conversion is not restricted by Federal Communication Commission ("FCC")
regulations (as described below). As part of the transaction, TSAT was
granted an option (the "TSAT Option"), exercisable after three years, to
acquire an additional 13.00% interest in ResNet for a purchase price equal to
the fair market value of such interest at the time of exercise. ResNet and
TSAT also agreed to rights of first refusal on the sale of any interest in
ResNet and to certain standstill provisions that, among other things,
prohibit TSAT from acquiring more than 10% of the Company's outstanding
common stock or participating in any effort to influence or control the
Company's management or Board of Directors. Pursuant to a recently
announced roll-up plan, the partners in PRIMESTAR Partners L.P. (including
TSAT, Time Warner Entertainment, Comcast Corporation, Cox Communications,
MediaOne, and GE Americom) will contribute their PRIMESTAR related assets to
a newly formed subsidiary of TSAT ("New PRIMESTAR") and TSAT will be
subsequently merged with and into New PRIMESTAR with New PRIMESTAR as the
surviving corporation (hereinafter, "PRIMESTAR"). As a result of such
transactions, PRIMESTAR will succeed to the interest of TSAT in ResNet.
PRIMESTAR AGREEMENT. In April 1996, the Company and PRIMESTAR entered
into an agreement appointing the Company as the exclusive third party
provider (other than the partners in PRIMESTAR and their affiliated
distributors) of the PRIMESTAR-Registered Trademark- DBS signal to the
lodging industry. The Company expects that the alliance, bringing together
PRIMESTAR's digital satellite technology and the Company's programming and
marketing expertise, will provide the Company with a technologically superior
and more flexible service, and extend the market for free-to-guest systems to
a much broader segment of the lodging industry than can be served
cost-effectively with traditional C-band satellite systems. The Company
markets the "PRIMESTAR by LodgeNet" service as a complement to its
interactive guest pay systems and on a stand-alone basis to hotels not served
by the Company's guest pay system.
EXPANSION INTO MID-SIZE HOTEL MARKET. In addition to the large hotel
market, which traditionally has been the segment subject to the most
competition for guest pay services, the Company is now targeting mid-size
hotels of 100 to 150 rooms as part of its marketing strategy. The Company
believes that this market segment, which the Company estimates contains over
500,000 rooms, has not been broadly served by the guest pay industry because
of certain diseconomies of scale resulting from the smaller average property
size. In 1995, the Company redesigned and modified its high speed, two-way
b-LAN-SM- system architecture to permit the delivery of on-demand movies and
network-based Super Nintendo-Registered Trademark- video games more
cost-effectively to mid-size hotels. The Company believes that its ability to
deliver this full array of services (in contrast to competing systems that do
not offer network-based video games and require the guest to take the extra
step of ordering the movie purchase by telephone) and the scalability of its
system for mid-size hotels, were significant factors in the awarding by La
Quinta Inns of its over 30,000-room account, Red Roof Inns of its over
27,000-room account and Budgetel Inns of its over 8,000-room account to the
Company over other competitors. The Company believes that the mid-size hotel
segment represents a large and attractive new market for the Company's
services and expects that its scalable b-LAN-SM- system architecture will allow
it to generate financial returns similar to those achieved by the Company in
larger full-service hotels.
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INTERNET AND OTHER INTERACTIVE SERVICES. The Company is continuing the
development and implementation of an Internet browser and other interactive
services deliverable over the Company's high speed, two-way b-LAN-SM- system to
the hotel guest via the in-room television. The Company believes there may
be significant opportunities to generate revenues from third-party providers
of content, merchandise and information services who would pay the Company
for electronic access to its valuable consumer base, as well as from usage
fees charged to the guests who utilize such services. The Company has
installed an interactive in-room shopping service in over 250,000 guest rooms
that enables the guest to browse though a video version of the well known
SkyMall-Registered Trademark- catalog featuring quality merchandise from the
country's leading retailers. The Company is currently testing an Internet
browser (developed in cooperation with Sun Microsystems, Inc.) at hotel
properties that enables the hotel guest to access and navigate the World Wide
Web from any guest room television in the hotel, and the Company intends to
install and test the Internet browser at additional hotels over the next
several months. The Company is reviewing other new services, such as
advertiser-supported visitor information for specific cities, as well as
"advertorials" and other "push media" strategies to deliver targeted product
or service information directly to the consumer. The Company is evaluating
these and other opportunities as well as appropriate business models that
would enable the Company to maximize the return on its investment in these
activities.
MARKETS AND CUSTOMERS
LODGING MARKET. The lodging market in the United States comprises
approximately 3.6 million hotel rooms. Guest pay services were introduced in
the lodging market in the early 1970s and have since become a standard
amenity offered by many hotels to their guests. Virtually all hotels offer
free-to-guest services as well. In 1986, certain hotels began offering their
guests limited interactive services and in 1991, on-demand movies became
available. Guest pay services are attractive to hotel operators because they
provide an additional amenity for their guests as well as incremental revenue.
LARGE HOTEL MARKET. The Company's primary market for guest pay services
has been large hotels with over 150 rooms located in metropolitan areas in
the U.S. and Canada, and the Company estimates that this market segment
contains approximately 1.3 million rooms. The Company currently provides its
services to large hotels that are generally part of chains such as ITT
Sheraton, The Ritz-Carlton Hotel Company, Harrah's Casino Hotels, Delta
Hotels and Resorts, Outrigger, Holiday Inn, Inter-Continental, Embassy
Suites, Prince, Radisson, Westin, Hilton and Marriott. No single contract
represented greater than 10% of the Company's combined guest pay and
free-to-guest revenues for the twelve months ended December 31, 1997.
MID-SIZE HOTEL MARKET. The Company is also now targeting mid-size
hotels of 100 to 150 rooms as part of its guest pay marketing strategy. The
Company believes that this market segment, which the Company estimates
contains over 500,000 rooms, has not been broadly served by the guest pay
industry because of certain diseconomies of scale resulting from the smaller
average property size. In 1995, LodgeNet redesigned its interactive system,
enabling the Company to deliver on-demand movies and network-based video
games more cost-effectively to mid-size hotels. The Company believes that the
mid-size hotel segment represents a large and attractive new market for the
Company's services and expects that its scalable b-LAN-SM- system architecture
will allow it to generate financial returns similar to those achieved by the
Company in the large hotel market.
FREE-TO-GUEST MARKET. Almost all of the approximately 3.6 million hotel
rooms in the United States are served by some form of free-to-guest
television service. Free-to-guest television typically involves a package of
basic and premium programming which the hotel purchases and provides at no
charge to its guests. These services can be purchased on a stand-alone basis
or as part of a package which includes guest pay services. Historically, only
hotels with more than 100 rooms could generally justify the expense of buying
or leasing the large C-band satellite dish required to receive
satellite-delivered, free-to-guest services. Smaller hotels who wanted to
offer free-to-guest services generally purchased the service from local cable
operators. The Company's agreement with PRIMESTAR allows LodgeNet to provide
digital satellite-delivered free-to-guest television programming on a
cost-effective basis to hotels with as few as 50 rooms.
MULTI-FAMILY RESIDENTIAL MARKET. The Company believes that there are
substantial opportunities for growth in the multi-family residential market.
The Company believes there are approximately 26,000 apartment complexes
having more than 200 units, with an aggregate of approximately 6 million
multi-family residential units, in the 70 largest metropolitan areas in the
United States. This represents a market that is more than three times the
size of the Company's target lodging market. The Company's agreement with
PRIMESTAR will facilitate the expansion into this market by providing ResNet
with DBS equipment and access to the PRIMESTAR-Registered Trademark- DBS
signal nationwide.
SERVICES AND PRODUCTS
GUEST PAY SERVICES. The Company's primary source of revenue is
providing in-room, interactive television services to the lodging industry,
for which the hotel guest pays on a per-view or per-play basis. The
high-speed, two-way digital communications design of the Company's
proprietary b-LAN-SM- system architecture enables the Company to provide
sophisticated interactive features such as on-demand movies, network-based
Super Nintendo-Registered Trademark-
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video games, and a variety of other interactive services, such as folio
review, video checkout, in-room printers, guest surveying, advertising and
merchandising services.
Guest pay services include in-room television viewing of recently
released major motion pictures and independent films for which a hotel guest
pays on a per-view basis. The Company's Guest Scheduled-SM- interactive
video-on-demand service allows a guest to choose from an expanded menu of
video selections and individually start the selected video at the guest's
convenience rather than restricting the guest to a predetermined start time.
It has been the Company's experience that rooms having the on-demand format
generate significantly greater movie revenues than comparable rooms having
only the pre-scheduled format. As of December 31, 1997, the Company served
over 511,000 guest pay rooms, of which nearly 485,000, or approximately 95%,
featured the Company's interactive on-demand system. The Company's original
scheduled guest pay service, which is provided in approximately 5% of the
Company's guest pay rooms, offers guests a choice of up to nine movie titles
shown at predetermined times, offering a new film approximately every half
hour. The Company continuously monitors guests' entertainment selections and
adjusts its programming to respond to viewing patterns. The system also
enables hotel owners to broadcast informational and promotional messages and
to monitor room availability.
The revenue generated from the guest pay service is dependent upon three
factors at each location: (i) the occupancy rate at the property; (ii) the
"buy rate" or percentage of occupied rooms that buy movies or video
games/information services at the property; and (iii) the price of the movie,
video game or service. For example, a property installed with the Company's
interactive system with a 70% occupancy rate, a buy rate of 11.4% and an
$8.95 movie price will generate an average of $21.71 of gross movie revenue
per installed room per month, plus an average of $3.90 in additional gross
revenues per month from video games and information services (assuming 30.4
days per month), resulting in total gross revenue per room per month of
$25.61. Occupancy rates vary by property based on the property's competitive
position within its marketplace and over time based on seasonal factors and
general economic conditions. Buy rates generally reflect the hotel's guest
mix profile, the popularity of the motion pictures available and the guests'
other entertainment alternatives. Buy rates also vary over time with general
economic conditions. Movie price levels are established by the Company and
are set based on the guest mix profile at each property and overall economic
conditions. Currently, the Company's movie prices are generally $7.95 or
$8.95.
In May 1993, the Company entered into a seven-year non-exclusive license
agreement with Nintendo to provide hotels with a network-based Super
Nintendo-Registered Trademark- video game playing system. Pursuant to this
agreement, Nintendo provides the Company with access to a minimum of ten
popular Super Nintendo-Registered Trademark- video games, which selection of
games is updated periodically, and the Company uses its proprietary
high-speed, two-way b-LAN-SM- system architecture to allow guests to play the
video games over the hotel's master antenna television system. Hotel guests
are charged a fee based on the amount of time they play the video games.
Presently, the Company charges $5.95 or $6.95 per hour of play. The Company
had 448,969 rooms, approximately 87% of its guest pay rooms, installed with
the Super Nintendo-Registered Trademark-system as of December 31, 1997.
The cost of installation varies depending on the size of the hotel
property and the configuration of the system being installed. The average
installed cost of a new on-demand guest pay room with interactive and video
game services capabilities, including the headend equipment and, in some
cases, televisions, is approximately $375 to $400 per room. In addition to
hotel commissions and royalties paid to movie studios, operating costs of the
guest pay systems include preview tapes, tape duplication, taxes, freight,
insurance, personal property taxes, maintenance and data line costs. The
average cost to upgrade a room from the original scheduled guest pay system
to the on-demand system is approximately $75 to $175 per room, depending on
the size of the movie library installed in the hotel, whether video games are
provided and the configuration of the headend computer and system hardware.
FREE-TO-GUEST SERVICES. In addition to guest pay services, the Company
provides television programming for which the hotel, rather than its guests,
pays the charges. Free-to-guest services allow a hotel to receive one or more
satellite-distributed programming channels via a satellite earth station,
which are then distributed to guest rooms over the hotel's existing master
antenna system.
Traditionally, this service has required little capital expenditure by
the Company, since the earth station equipment either was provided
independently by the hotel or purchased or leased from the Company. For
free-to-guest services, the hotel pays the Company a fixed monthly charge per
room for each programming channel selected and provides these channels to its
guests free of charge. The Company generally charges $2.90 - $3.50 per room
per month for each premium channel and $.10 - $.95 per room per month for
each non-premium channel. Premium channels, such as HBO, Showtime and The
Disney Channel, broadcast major motion pictures and specialty programming,
while non-premium channels, such as CNN, ESPN and WTBS, broadcast news,
sports and informational programs. Premium programming suppliers typically
contract only with cable companies and other large volume subscribers, such
as the Company, and will not generally provide programming directly to
individual hotel properties. The Company successfully competes with local
cable television operators by customizing packages of programming to provide
only those channels desired by the hotel subscriber, which typically reduces
the overall cost of the services provided.
In April 1996, the Company and PRIMESTAR entered into an agreement to
provide digital satellite-delivered basic and premium television services to
the lodging industry. The alliance brings together
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PRIMESTAR-Registered Trademark-'s digital satellite technology and the
Company's programming and marketing expertise, will enable the Company to
offer the lodging industry a technologically superior and more flexible
service, and will extend the market for free-to-guest services to a much
broader segment of the lodging industry than can be served cost-effectively
with traditional C-band satellite systems. Pursuant to the agreement with
PRIMESTAR, the Company will pay PRIMESTAR a signal carriage fee for providing
access to the PRIMESTAR-Registered Trademark-signal. The agreement with
PRIMESTAR may be terminated by either party upon notice if certain cash flow
targets are not met during any two consecutive years. The Company is
responsible for the installation and servicing of all equipment required by
each lodging customer to receive the PRIMESTAR-Registered Trademark- digital
satellite-delivered signal. Installations began in May 1996 and approximately
78,000 rooms at 1,116 hotel properties had been installed through December
31, 1997. The Company intends to sell or lease such equipment to its
customers and is entitled to retain all revenues associated with the sale,
lease, installation and service of all such PRIMESTAR-related equipment.
MULTI-FAMILY RESIDENTIAL SERVICES. ResNet's multi-family residential
private cable system has the capacity to deliver over 100 channels, although
the typical system will deliver approximately 35 to 50 channels of
programming. ResNet may elect to provide from approximately 10 to 35
additional channels for scheduled pay-per-view, video on-demand and other
interactive services, such as Internet access. ResNet designs a specific
programming lineup for each specific multi-family residential complex, based
on the particular demographic profile of that complex. These systems include
basic programming services, such as CNN, ESPN, WTBS, TNT, The Discovery
Channel and The Weather Channel, premium programming, such as HBO and
Showtime, plus additional channels which carry local off-air stations, an
electronic programming guide, a preview channel, and a bulletin board
channel. Delivery of private cable television services to multi-family
residential complexes involves technology similar to that used in the
Company's hotel systems. The hub of each multi-family residential system is a
headend, which will gather basic and premium cable television programming
from a variety of sources using a combination of the DBS signal provided by
PRIMESTAR and off-air antennae and then redistribute these signals throughout
the apartment complex.
The Company estimates that the average installed cost per unit passed
for basic and premium cable television services is approximately $600 to
$700. The Company estimates that the average cost per unit passed to add
scheduled pay-per-view movies to the basic cable system will range from $100
to $130, depending on the system configuration. The foregoing estimates of
installation costs are forward-looking in nature and actual costs could vary
based on the factors discussed elsewhere herein.
ENTERTAINMENT HARDWARE. The Company also sells and leases entertainment
hardware, including satellite earth stations, televisions and off-air signal
reception and processing equipment, to the lodging industry. The Company
believes that this service complements its goal of being a full-service
provider of in-room entertainment and information services to the lodging
industry.
OPERATIONS
CONTRACTS. The Company provides guest pay services under contracts with
lodging properties that generally run for a term of five to seven years.
Under these contracts, the Company installs its system into the hotel free of
charge and retains ownership of all equipment utilized in providing the
service. Traditionally, the hotel provides and owns the television set;
however, the Company in some cases provides televisions incorporating the
Company's integrated guest pay terminal units to hotels which meet certain
economic criteria. The Company's contracts generally provide that the Company
will be the exclusive provider of in-room, scheduled pay-per-view or
on-demand television entertainment services to the hotels, permit the Company
to set the movie price and allow the Company to terminate the contract if the
hotel is not meeting the Company's economic criteria. The contracts also
typically grant the Company a right of first refusal regarding the provision
of additional video related services to the hotel. The hotels collect movie
viewing charges from their guests and retain a commission, generally equal to
10% to 15% of the total guest pay revenue depending upon the size and
profitability of the system. At the scheduled expiration of a contract, the
Company generally seeks to extend the contract on substantially similar
terms. The average remaining life of the Company's current guest pay
contracts is over four years, with less than 7% of these contracts coming up
for renewal before 1999.
The Company typically enters into a separate contract with each hotel
for the services provided. The terms contained in the contracts with the
corporate-managed hotels in any one chain generally are negotiated by that
chain's corporate management, and the hotels subscribe at the direction of
corporate management. In the case of franchised hotels, the contracts are
generally negotiated separately with each hotel.
ResNet enters into long-term exclusive right-of-entry contracts with
property owners and managers to provide cable television services to
multi-family residential complexes. The lengths of term of such contracts
generally run longer than those in the lodging industry. The form of
agreement to be entered into with each multi-family residential property
grants ResNet the right to provide cable television programming and other
video services, such as video on-demand, merchandising, and access to the
Internet. The property owner or manager typically receives a commission
generally from 6% to 12% of subscriber revenues, depending upon the
penetration rate at a particular property.
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TECHNOLOGY, PRODUCT DEVELOPMENT AND PATENTS. The Company designs and
develops high quality, interactive, multimedia entertainment and information
systems. Because such systems utilize an open architecture, UNIX-based
platform incorporating industry standard interfaces, the Company can upgrade
system software to support the introduction of new services or integrate new
technologies as they become economically viable. The Company's interactive
system incorporates the Company's proprietary and scalable b-LAN-SM- system
architecture with commercially manufactured, readily available components and
hardware such as video cassette players, modulators and computers.
The Company's b-LAN-SM- system architecture utilizes the Company's
proprietary high-speed, two-way digital communications design to process and
respond to keystroke commands from the viewer very rapidly. This capability
enables the Company to provide sophisticated interactive features such as
network-based Super Nintendo-Registered Trademark- video games and on-demand
movies, and a variety of other interactive services such as folio review,
video checkout, in-room printers supporting video checkout and other
applications, guest surveying, advertising and shopping services. The Company
has installed an interactive in-room shopping service in over 250,000 guest
rooms that enables the guest to browse through a video version of the well
known SkyMall-Registered Trademark- catalog featuring quality merchandise
from the country's leading retailers. The Company is currently testing an
Internet browser (developed in cooperation with Sun Microsystems, Inc.) at
hotel properties that enables the hotel guest to access and navigate the
World Wide Web from any guest room television.
In the lodging industry, the Company's guest pay systems consist of
equipment located within the guest room connected via a local-area cable
distribution network to a headend located elsewhere in the hotel. Typical
in-room equipment includes a terminal unit, a hand-held remote control and a
video game controller. The in-room terminal unit may be integrated within the
television set or located behind or on top of the set. Movie programming
originates from video cassette players located within the headend rack and is
transmitted to individual rooms over the hotel's master antenna system. Video
game programs are downloaded into dedicated video game processors also
located within the headend rack. The guest's keystrokes are transmitted from
the room to the game processor using the Company's proprietary high-speed
communications infrastructure and the video signal produced by the game
processor is transmitted to the guest room over the hotel's master antenna
system. Both movie and video game starts are controlled automatically by the
system computer. The system computer also automatically records the purchase
of a guest pay movie or video game and reports billing data to the hotel's
accounting system, which automatically posts the charge to the guest's bill.
Although the Company's products are compatible with all brands of
televisions, the Company has arrangements with Zenith Electronics
Corporation, Phillips Electronics and Sony Electronics, Inc., leading
suppliers of televisions to the lodging industry and other markets, who
provide the Company with commercial televisions into which the Company can
integrate its custom-designed circuit boards. The Company is also working
with other television manufacturers to integrate the Company's systems into
their commercial television sets. Integration eliminates the need for an
external terminal unit and costs less than an external unit of comparable
utility.
ResNet's private cable television system has the capacity to deliver
over 100 channels, although ResNet expects that the typical system will
deliver 35 to 50 channels of basic and premium programming, depending
principally upon the size of the property, the length of the contract and
local competitive considerations. ResNet may elect to provide from
approximately 10 to 35 additional channels for scheduled pay-per-view, video
on-demand and other interactive services, such as Internet access. ResNet's
interactive cable television systems utilize the Company's proprietary
b-LAN-SM- system architecture and the DBS signal provided by PRIMESTAR, off-air
and/or microwave receiving antennas and headend equipment which process and
amplify the broadcast and cable television programming signals. The Company
integrates addressable interdiction jamming technology within its proprietary
system. Addressable interdiction enables the Company to control subscriber
access to premium channels and other enhanced services through a computer
located off-site. This capability eliminates the necessity of having to
dispatch field personnel to a property to initiate, modify or terminate
service and eliminates the costs associated with damage or loss of
traditional set-top converters located in the subscriber's premises.
LodgeNet designs its systems through its staff of approximately 87
software and hardware engineers and support personnel (as of December 31,
1997). Development activities are oriented toward the continued enhancement
and cost reduction of the Company's system and the further development of
additional interactive, multimedia, entertainment and information services,
such as advertising and shopping services.
It is the Company's policy to apply for patents on those product designs
which management believes may be of significance to the Company. The Company
owns six United States patents and has other applications for patents pending
in the U.S. Patent and Trademark Office dealing with various aspects of the
Company's interactive multimedia systems.
The Company uses a number of registered and unregistered trademarks for
its products and services. The Company has applications for registration
pending for certain of the unregistered trademarks, and those trademarks for
which the Company has not sought registration are governed by common law and
state unfair competition laws. Because the Company believes that these
trademarks are significant to the Company's business, the Company has taken
legal steps to protect its trademarks in the past and intends to actively
protect these trademarks in the future.
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The Company believes that its trademarks are generally well recognized by
consumers of its products and are associated with a high level of quality and
value.
SALES AND MARKETING. The Company focuses its sales and marketing
strategies on acquiring new contracts from hotels and marketing the Company's
guest pay, video game and other interactive services to the hotel guest. The
Company's sales organization consisted of approximately 53 employees as of
December 31, 1997, including national account representatives, who develop
relationships with national hotel franchise organizations and management
groups, and regional sales representatives who maintain relationships
primarily with regional hotel management and ownership organizations. The
Company markets its services and products to hotels by advertising in
industry trade publications, attending industry trade shows, direct marketing
and telemarketing. Sales activities are coordinated from the Company's
headquarters.
The Company markets its services to hotel guests by means of its Video
Room Card-SM-, on-screen graphics and by in-room tent cards which contain movie
and video game programming information that are placed near the television
set and highlight the feature film selections of the month. In-room marketing
advertisements are designed and produced by the Company's marketing
department. The system also generates a "Welcome Channel," which appears
on-screen when the television is turned on and describes the programming and
interactive services available through the Company's system.
INSTALLATION AND SERVICE OPERATIONS. The Company believes that high
quality and consistent systems support and maintenance are essential to
competitive success in its industry. The Company's installation and service
organization consists of approximately 232 installation and service personnel
in approximately 25 locations in the United States and Canada, as of December
31, 1997. The Company emphasizes the use of Company-employed installation and
service personnel, but also uses Company-trained subcontractors in areas
where there is not a sufficient concentration of Company-served hotels to
warrant a Company-employed service representative. Currently, the Company's
in-house installation and service organization has responsibility for
approximately 87% of the guest pay hotel rooms served by the Company. Service
personnel are responsible for systems maintenance and distribution and
collection of video cassettes. The Company's installation personnel prepare
site surveys to determine the type of equipment to be installed at each
particular hotel, install the Company's systems, train the hotel staff to
operate the systems and perform preliminary quality control tests.
The Company maintains a toll-free customer support hot line,
Tech-Connect-SM-, which is monitored 24 hours a day by trained support
technicians. The on-line diagnostic capability of the Company's system
enables the Company to identify and resolve a majority of the reported system
malfunctions from the Company's service control center without visiting the
hotel property. When a service visit is required, the modular design of the
Company's systems permits installation and service personnel to replace
defective components at the hotel site.
In the multi-family residential market, ResNet installation supervisors
oversee and coordinate installation and field service crews comprised of
in-house personnel and experienced subcontractors. ResNet utilizes component
assembly resources developed by the Company for the lodging industry.
PROGRAMMING. In the lodging market, the Company obtains non-exclusive
rights to show recently released major motion pictures from motion picture
studios pursuant to a master agreement with each studio. The license period
and percentage fee for each movie are negotiated separately, with the studio
receiving a percentage, generally ranging from 35% to 50%, of the Company's
gross revenue from the movie. For recently released motion pictures, the
Company typically obtains rights to exhibit the picture after the film has
been in theaters, but prior to its release to the home video market or
exhibition on cable television. Generally, studios make master video tapes of
their movies available for duplication sufficiently in advance of the release
dates for the lodging industry so that all of the Company's hotels can offer
the movies as of the first date they are available for exhibition. The
Company obtains independent films, most of which are non-rated and intended
for mature audiences, for a one-time flat fee that is nominal in relation to
the licensing fees paid for major motion pictures and which permits the
Company to duplicate the films as necessary to supply copies to its hotel
sites. The Company continuously monitors guests' entertainment selections and
adjusts its programming to respond to viewing patterns.
The Company obtains its basic and premium cable television programming
pursuant to multi-year license agreements generally containing automatic
renewal provisions and pays its programming suppliers a fixed, monthly fee
for each room or subscriber receiving the service. Management believes that
relations with the programming suppliers are good and expects to renew these
contracts as necessary on competitive terms. The Company intends to tailor
the programming lineup at each multi-family residential complex based on the
particular demographic profile of that complex. Cable operators and
multi-channel video programming distributors such as ResNet, with certain
exceptions, are prohibited from carrying the signal of a commercial
television broadcast station without the broadcaster's "retransmission"
consent. ResNet believes it can obtain all necessary retransmission consents
in its markets. As part of its transaction with PRIMESTAR, ResNet entered
into a long-term signal availability agreement pursuant to which ResNet was
granted nationwide access to the PRIMESTAR-Registered Trademark- DBS signal.
SYSTEMS PRODUCTION GROUP AND EQUIPMENT SUPPLIERS. The Company contracts
directly with various electronics firms for the manufacture and assembly of
its systems hardware, the design of which is controlled by the Company. The
Company has found these suppliers to be dependable and able to meet delivery
schedules on time.
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The Company believes that, in the event of a termination of any of its
sources, with proper notification from the supplier, alternate suppliers
could be located without incurring significant costs or delays. Certain
electronic component parts used within the Company's products are available
from a limited number of suppliers and can be subject to temporary shortages
because of general economic conditions and the demand and supply for such
component parts. If the Company were to experience a shortage of any given
electronic part, the Company believes that alternative parts could be
obtained or system design changes implemented. In such event, the Company
could experience a temporary reduction in the rate of new room installations
and/or an increase in the cost of such installations. All other components of
the Company's systems are standard commercial products, such as video
cassette players, modulators and amplifiers, that are available from multiple
sources.
The headend electronics are assembled at the Company's facilities for
testing prior to shipping. The Company samples the room units at the
supplier's facilities periodically for reliability. Following assembly of
head-end equipment with a configuration designed specifically for a
particular customer, the system is shipped to the location, where it is
installed by Company-employed technicians or Company-trained subcontractors.
The Company believes that its anticipated growth can be accommodated through
existing suppliers.
COMPETITION
LODGING MARKET. The Company is the second largest provider (by total
number of rooms served) of interactive and cable television services to the
lodging industry, currently serving over 630,000 installed hotel rooms in
over 4,000 hotels. The Company competes on a national scale primarily with On
Command Corporation ("OCC"), the successor corporation to the merger of
SpectraVision, Inc. and On Command Video Corporation, and on a regional basis
with certain other smaller entities. Based upon publicly available
information, the Company estimates that OCC currently serves approximately
893,000 hotel rooms. The aforementioned merger combined two of the largest
providers of cable television services in the lodging industry based on the
aggregate number of rooms served. The Company historically competed against
these two companies prior to the merger and believes that it will be able to
compete in the same manner against the newly combined entity.
OCC and DirecTV, Inc. ("DirecTV") have entered into an agreement
pursuant to which OCC will deliver free-to-guest television programming using
DirecTV's DBS signal. The Company believes that its agreement with PRIMESTAR
will allow it to provide comparable services to OCC on a competitive basis.
There are also a number of potential competitors that could use their
existing infrastructure to provide in-room entertainment services to the
lodging industry, including franchised cable operators, wireless cable
operators, telecommunications companies and DBS providers. Some of these
potential competitors are already providing free-to-guest services to the
lodging industry and have announced plans to offer guest pay services,
including video on demand and Internet services. Some of these companies may
have substantially greater financial and other resources than the Company.
Competition with respect to new guest pay contracts centers on a variety
of factors, depending upon the features important to a particular hotel.
Among the more important factors are: (i) the features and benefits of the
entertainment systems; (ii) the quality of the vendor's technical support and
maintenance services; (iii) the financial terms and conditions of the
proposed contract (including payments to the hotel); and (iv) the ability to
complete system installation in a timely and efficient manner. In addition,
with respect to hotel properties already receiving in-room entertainment
services, the incumbent provider may have certain informational and
installation cost advantages as compared to outside competitors.
The Company believes that its competitive advantages include: (i) its
proprietary high speed, two-way b-LAN-SM- system architecture that enables the
Company to deliver a broad range of interactive features and services such as
on-demand movies and network-based Super Nintendo-Registered Trademark- video
games; (ii) the flexible design of the Company's system which enables it to
add enhancements or integrate new technologies as they become commercially
available and economically viable; (iii) high quality customer support and
nationwide field service operations; and (iv) an experienced management team
and professional and well-trained sales organization. The Company believes
that its success in securing contracts reflects the strong competitive
position of the Company's products and services.
Because of the high level of penetration in the large hotel segment of
the lodging industry already achieved by guest pay providers, most of the
growth opportunities in this market segment have traditionally involved
securing contracts to serve hotels that are served by a competing vendor. An
incumbent provider may have certain information and installation cost
advantages as compared to outside competitors. These circumstances have led
to increasing competition for contract renewals, particularly at hotels
operated by major hotel chains. The Company believes that certain major hotel
chains have awarded contracts based primarily on the level and nature of
financial and other incentives offered by the guest pay provider. Even if it
were able to do so, the Company may not always be willing to match the
incentives provided by its competitors, some of which have greater access to
financial and other resources than the Company. Because free-to-guest service
providers generally have substantially comparable access to the satellite
delivered programming that comprises the free-to-guest services, competition
in this segment has been based primarily on price and customer service.
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While the Company believes that its proprietary b-LAN-SM- system
architecture is comparable or superior to the systems currently being used by
its competitors in the lodging industry, there can be no assurance that such
competitors will not develop a cost-effective system that is comparable or
superior to the Company's system. In order to broaden its market
opportunities, the Company redesigned its system to permit the delivery of
on-demand movies and network-based video games to mid-size hotels of 100 to
150 rooms, a market segment the Company believes has been historically
underserved by guest pay providers. There can be no assurance that the
Company will be successful in this market segment or that competitors will
not develop a cost-effective system that would allow them to target this
market segment. Further, there can be no assurance that the Company will
continue its current level of success in obtaining new contracts from hotels
currently served by other vendors or previously unserved, or that the Company
will be able to retain contracts with hotels it serves when those contracts
expire.
Although in the free-to-guest market the local franchised cable operator
in a hotel's market may have a substantial market presence, such operators
typically offer the hotel owner only standard packages of programming
developed for the residential market and not the lodging market, and at a
fixed price per room based on all the channels provided. The Company competes
with the franchised cable operator for free-to-guest contracts by customizing
packages of programming to provide only those channels desired by the hotel,
typically reducing the overall cost per room. The Company believes that its
agreement with PRIMESTAR to deliver the PRIMESTAR-Registered Trademark- DBS
signal to the lodging industry will enable it to compete more effectively in
the free-to-guest area and to extend this market segment to smaller sized
properties that historically could not be cost-effectively served with the
more expensive traditional C-band technology.
Competitive pressures in the guest pay and free-to-guest segments could
result in reduced market share for the Company, higher hotel commissions,
lower margins and increased expenditures on marketing, product development
and systems installation, each of which could adversely affect the Company's
financial condition and operating results.
MULTI-FAMILY RESIDENTIAL MARKET. The provision of cable television
services to the MDU market is highly competitive and competition is expected
to increase. The Company anticipates that the primary competitors in each of
its markets will include SMATV operators, wireless cable operators, DBS
providers, as well as local franchised cable operators. The most substantial
competitor for ResNet in each of its markets is expected to be the local
franchised cable operator, most of whom have substantially greater resources
than the Company and ResNet. Many of ResNet's competitors also have brand
names that may be more recognizable to consumers than those of the Company
and ResNet, and that may provide such competitors certain competitive
advantages.
ResNet's success in this market will depend in large part upon its
ability to secure a significant number of long-term exclusive right-of-entry
contracts with property owners or managers. These contracts generally involve
a revenue sharing arrangement with the property owner or manager. Certain of
ResNet's competitors have significantly greater financial resources and may
offer property owners and managers more lucrative financial arrangements than
ResNet may be able or willing to offer. As residents of the high-quality MDUs
that are targeted by the Company come to expect a wider selection of cable,
interactive video and telecommunications services, property owners may be
inclined to enter into ROE contracts with companies that can offer such a
selection. Certain companies have begun to market, or have announced plans to
market, packages of services that are more extensive than those currently
offered by the Company. Increasing competition among such providers for right
of entry contracts could result in greater financial incentives being offered
to property owners, thereby adversely affecting the financial return expected
to be realized by ResNet from such contracts. The Company believes that
ResNet's competitive advantages include (i) the broad range of features and
services made possible by the Company's proprietary b-LAN-SM- system, (ii) the
Company's experience and capabilities in conducting nationwide installation
and field service operations and (iii) the availability of the
PRIMESTAR-Registered Trademark- DBS signal and related equipment provided by
PRIMESTAR at a lower cost than traditional C-band satellite signals and
equipment.
REGULATION
TELECOMMUNICATIONS ACT OF 1996. The Telecommunications Act of 1996 (the
"Act") is intended, in part, to promote substantial competition for telephone
and video services and will alter federal, state and local laws and
regulations regarding telecommunications providers and services. The Act
generally removes previous restrictions preventing cable firms, telephone
companies, long distance carriers and public utilities from entering into
certain new markets, removes many cross-ownership restrictions and modifies
rate regulations applicable to franchised cable operators. In particular, the
Act authorizes local telephone companies to provide video programming
directly to subscribers in their service areas and eliminates the requirement
that "private cable" operators serve only buildings "under common ownership,
management or control," but preserves the requirement that such operations
not use closed transmission paths to cross public rights-of-way. The Act also
permits franchised cable operators to offer bulk discounts to multiple
dwelling units; provided, however, that such discounts may not constitute
"predatory pricing." Prior to the adoption of the Act, franchised cable
operators were subject to a uniform rate requirement which generally
prohibited such bulk discounts. There are numerous rulemakings that have and
are still being undertaken by the FCC which will interpret and implement the
provisions of the Act. It is anticipated that the Act will stimulate
increased competition generally in the telecommunications and cable
industries which may adversely impact the Company. No assurance can be given
that changes in current or future laws or regulations
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<PAGE>
adopted by the FCC or state or local regulatory authorities would not have a
material adverse effect on the Company's business.
It is premature to predict the effect of the Act on the cable and
telecommunications industries in general or the Company in particular. The
Company's business may be adversely affected by the entry of additional
competitors in the multichannel video programming distribution market. In
part, the Company's competitiveness also will depend upon the outcome of
various FCC rulemaking proceedings to interpret and implement the provisions
of the Act. It is not possible at this time to predict the outcome of those
rulemaking proceedings or their effect on the Company.
CABLE TELEVISION REGULATION. The Communications Act of 1934, as amended
by the Cable Communications Policy Act of 1984 (the "1984 Cable Act"), the
Cable Television Consumer Protection and Competition Act of 1992 (the "Cable
Act"), and the Act, governs the regulation of "cable systems." The law
defines a "cable system" as a facility, consisting of a set of closed
transmission paths and associated signal generation, reception, and control
equipment that is designed to provide cable service which includes video
programming and which is provided to multiple subscribers within a community,
but the law exempts from that definition, among other facilities, a facility
that serves subscribers without using any public rights-of-way. The Company
constructs and operates separate headend systems at each hotel or MDU complex
or transmits cable signals from microwave transmitters to each separate
property, and those systems do not use public rights-of-way. Thus, with
respect to its private cable systems, the Company is not required to comply
with many of the FCC's rules relating to cable systems, including, among
other things, rate regulation and the requirement to obtain a franchise from
local government authorities in order to provide video services.
As a "multichannel video programming distributor" ("MVPD"), however, the
Company is subject to various provisions of the Communications Act of 1934,
as amended. Laws and regulations applicable to MVPDs generally apply to the
Company. These include laws and regulations that benefit the Company, such as
provisions that ensure the Company access to programming on fair, reasonable
and nondiscriminatory terms, as well as provisions that subject the Company
to additional requirements, such as the requirement to obtain consent from
broadcasters in order to retransmit their signals over the Company's systems.
CABLE AND TELEPHONE WIRING. Although the majority of the states
currently do not prohibit exclusive right-of-entry contracts, current trends
at the state and federal levels, if they continue, may render the legality of
such exclusivity provisions uncertain. Several states have enacted, and
additional states are expected to enact, mandatory access statutes that
require MDU owners to grant a cable franchisee access to its buildings in
order to offer cable services to tenants that want to receive the
franchisee's service. Although the FCC has declined to adopt a federal
mandatory access rule, this year the FCC did adopt rules that clarify the way
in which MDU owners may terminate an incumbent video provider's access to
buildings where no right to remain exists. The FCC also has initiated
rulemaking proceedings to consider, among other issues, whether to adopt a
cap on the length of exclusive contracts between video providers and MDU
owners and whether to apply cable home wiring rules to all video providers .
In addition, the FCC has initiated a rulemaking proceeding to determine
whether to prohibit restrictions against the placement on rental property of
devices designed for over-the-air reception of television broadcast signals,
multichannel multipoint distribution services, or DBS services. In a separate
rulemaking which concluded this year, the FCC declined to harmonize cable and
telephony home wiring regulations. The regulations that the FCC ultimately
adopts could affect the Company's continued ability to enter into or enforce
exclusive contracts, as well as its access to inside wiring used to provide
telephony and video programming services.
SIGNAL CARRIAGE. Private cable operators, with certain exceptions, are
prohibited from carrying the signal of a commercial television broadcast
station without the broadcaster's "retransmission" consent. If the cable
operator and the broadcaster fail to reach an agreement on terms and
conditions for retransmission, the cable operator is prohibited from carrying
the broadcaster's signal. Although there can be no assurance, the Company
believes it has obtained and will continue to obtain all necessary
retransmission consents in its markets.
CROSS-OWNERSHIP. In order to encourage competition in the provision of
video programming, the Cable Act generally prohibits a franchised cable
operator not subject to "effective competition" from holding a license for a
multichannel multipoint service or from offering SMATV service separate and
apart from any franchised cable service, in any portion of the franchise area
served by the cable operator's cable system. Under current interpretations of
FCC rules and regulations implementing the foregoing provisions, TSAT may be
prevented from acquiring a 5% or greater interest in ResNet and consequently
would be unable to exercise its conversion rights under the TSAT Convertible
Loan or the TSAT Option. TSAT is required to convert the TSAT Convertible
Loan into an equity interest in ResNet at such time as conversion would not
violate the aforementioned FCC restriction. TSAT has advised the Company that
it may seek a formal interpretive letter or waiver by the FCC with respect to
the acquisition of a further interest in ResNet.
MICROWAVE LICENSING. Where appropriate the Company's or ResNet's
systems may use 18 GHz microwave relays to link more than one hotel or MDU
complex to a single headend without using public rights-of-way. The FCC has
the power to issue, revoke, modify, and renew licenses within the radio
frequency spectrum utilized by the Company or ResNet for microwave relays.
The FCC also may approve changes in the ownership of such licenses. The
Company and ResNet have obtained all necessary FCC authorizations to operate
their microwave relays. There
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can be no assurance, however, that the Company and/or ResNet will continue to
be able to retain or obtain such authorizations in the future or that
existing authorizations will be renewed.
CABLE ENTRY INTO TELECOMMUNICATIONS. The Act declares that no state or
local laws or regulations may prohibit or have the effect of prohibiting the
ability of any entity to provide any interstate or intrastate
telecommunications service. States are authorized to impose "competitively
neutral" requirements regarding universal service, public safety and welfare,
service quality, and consumer protection. The Act further provides that the
cable operators and affiliates providing telecommunications services are not
required to obtain a separate franchise from the local franchising authority
for such services. The Act prohibits local franchising authorities from
requiring cable operators to provide telecommunications services or
facilities as a condition of a grant of a franchise, franchise renewal, or
franchise transfer, except that local franchising authorities can seek
"institutional networks" as part of franchise negotiations. The law also
provides that, when cable operators provide telecommunications services,
local franchising authorities may require reasonable, competitively neutral
compensation for management of the public rights-of-way.
TELEPHONE COMPANY ENTRY INTO CABLE TELEVISION. The Act allows telephone
companies to compete directly with franchised and private cable operators by
repealing the previous telephone company-cable cross-ownership ban and
replacing the FCC's video dialtone regulations with an "open video system"
("OVS") plan by which local exchange carriers can provide cable service in
their telephone service area. The FCC has adopted regulations prohibiting an
OVS operator from discriminating among programmers and ensuring that OVS
rates, terms, and conditions for service are reasonable and
nondiscriminatory. Further, those regulations prohibit a local exchange
carrier, OVS operator or its affiliates from occupying more than one-third of
a system's activated channels when demand for channels exceeds supply,
although there are no numeric limits. Additional OVS regulations include
rules governing channel sharing; extending the FCC's sports exclusivity,
network nonduplication, and syndicated exclusivity regulations; and
controlling the positioning of programmers on menus and program guides. Local
franchising authorities may require OVS operators to pay "franchise fees"
only to the extent that the OVS provides or its affiliates provide cable
services over the OVS; such fees may not exceed the franchise fees charged to
cable operators in the area, and the OVS provider may pass through the fees
as a separate subscriber bill item. OVS operators are subject to local
franchising authorities' general right-of-way management regulations.
ELECTRIC UTILITY ENTRY INTO CABLE AND TELECOMMUNICATIONS. The Act
provides that registered utility holding companies and subsidiaries may
provide telecommunications services (including cable television)
notwithstanding the Public Utility Holding Company Act. Electric utilities
must establish separate subsidiaries, known as "exempt telecommunications
companies" and must apply to the FCC for operating authority. Large utility
holding companies may become significant competitors to both cable television
and other telecommunications providers.
COPYRIGHT LICENSING. Both private and franchise cable systems are
subject to federal copyright licensing covering carriage of broadcast
signals. In exchange for making semi-annual payments to a federal copyright
royalty pool and meeting certain other obligations, cable operators obtain a
blanket license to retransmit broadcast signals. Bills have been introduced
in Congress over the past several years that would eliminate or modify the
cable compulsory license. Without the compulsory license, cable operators
such as the Company might need to negotiate rights from the copyright owners
for each program carried on each broadcast station in the channel lineup.
Such negotiated agreements could increase the cost to cable operators of
carrying broadcast signals. The Cable Act's retransmission consent provisions
expressly provide that retransmission consent agreements between the
television stations and cable operators do not obviate the need for cable
operators to obtain a copyright license for the programming carried on each
broadcaster's signal.
The foregoing does not purport to describe all present and proposed
federal, state and local regulations and legislation relating to the video
programming industry. Other existing federal, state and local laws and
regulations currently are, or may be, the subject of a variety of judicial
proceedings, legislative hearings, and administrative and legislative
proposals that could change in varying degrees, the manner in which private
cable operators and other video programming distributors operate. The Company
cannot estimate the outcome of these proceedings or their impact upon its
operations at this time.
EMPLOYEES
As of December 31, 1997, the Company had 739 employees in the United
States and Canada. None of these employees is covered by a collective
bargaining agreement. The Company has not experienced any significant labor
problems and believes that its relationship with its employees is good.
ITEM 2 -- PROPERTIES
The Company's National Headquarters and Distribution Center, including
its principal executive offices, are located on an approximately 23 acre site
in Sioux Falls, South Dakota. Construction of the approximately $15 million
facility was completed in December 1997. The National Headquarters and
Distribution Center occupies approximately 228,500 square feet including
approximately 116,500 square feet for executive, administrative and
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<PAGE>
support functions, approximately 60,000 square feet for assembly and
distribution functions, and approximately 42,000 square feet for warehouse
space. The opening of the National Headquarters and Distribution Center
allowed the Company to consolidate all of its local operations into a single,
multipurpose facility which is designed to enhance the operational efficiency
and to facilitate and necessary future expansion needs of the Company. The
Company believes that the site of its National Headquarters and Distribution
Center is sufficient to accommodate its foreseeable local operational space
requirements. The Company also owns an office building in Sioux Falls
containing approximately 8,000 square feet which previously served as the
Company's headquarters and which is not currently used in the Company's
operations. Such building is being offered for sale by the Company.
The Company leases sixteen facilities, in various other locations, from
unaffiliated third parties. One, located in Dallas, Texas, is an office
facility for sales and sales-support personnel. The remaining fifteen are
combination warehouse/office facilities for installation and service
operations and are located in Atlanta, Georgia; Honolulu, Hawaii; Canton,
Michigan; Golden, Colorado; Tempe, Arizona; Las Vegas, Nevada; Cleveland,
Ohio; Buffalo, New York; Los Angeles and San Francisco, California; Tampa,
Florida; Redmond, WA; Carrollton, Texas; Lombard, Illinois; and Toronto,
Ontario, Canada. Each of these facilities occupies less than 3,500 square
feet.
ITEM 3 -- LEGAL PROCEEDINGS
On February 16, 1995, OCC filed a lawsuit in Federal District Court for
the Northern District of California asserting patent infringement by the
Company relating to its on-demand video system. The complaint requests an
unspecified amount of damages and injunctive relief. The Company filed an
answer and counterclaim to the lawsuit on April 17, 1995, denying the claims,
asserting affirmative defenses and asserting a counterclaim for declaratory
relief. The Company is currently engaged in litigation with respect to this
matter and trial is expected to begin in August 1998. Based on the advice of
special patent counsel and technical experts retained by the Company, as well
as the Company's independent analysis, the Company believes that the claims
of infringement are unfounded and that OCC's patent is invalid. The Company
has and will continue to vigorously defend itself in this matter. Patent
litigation is especially complex, both as to factual allegations and the
legal interpretation of patent claims, which makes such lawsuits difficult to
assess with certainty. While the Company and its patent counsel believe that
the Company has a number of defenses available which, if properly considered,
would eliminate or minimize any liability for the Company, an unexpected
unfavorable resolution, depending on the amount and timing, could adversely
affect the Company. Although the outcome of any litigation cannot be
predicted with certainty, the Company believes that the ultimate disposition
of this matter will not have a material adverse effect on the Company's
financial condition or results of operations.
The Company is subject to other litigation arising in the ordinary
course of business. As of the date hereof, the Company believes the
resolution of such other litigation will not have a material adverse effect
upon the Company's financial condition or results of operations.
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the Company's security
holders during the fourth quarter of the Company's fiscal year ended December
31, 1997.
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PART II
ITEM 5 -- MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock currently trades on the NASDAQ National Market
System ("NASDAQ NMS") under the symbol "LNET". The Company's Common Stock
began trading on the NASDAQ NMS on October 14,1993 upon the effectiveness of
its initial public offering. As of March 23, 1998 there were outstanding
11,356,358 shares of the Company's Common Stock.
The following table sets forth, for the fiscal quarters indicated, the
range of high and low sales prices of the Company's Common Stock as reported by
NASDAQ NMS.
<TABLE>
<CAPTION>
Quarter Ended High Low
------------- ------ ------
<S> <C> <C>
March 31, 1996 $14.25 $9.00
June 30, 1996 $15.25 $11.50
September 30, 1996 $14.25 $9.75
December 31, 1996 $18.00 $11.75
March 31, 1997 $17.38 $10.50
June 30, 1997 $12.00 $8.00
September 30, 1997 $13.25 $9.00
December 31, 1997 $14.00 $10.50
</TABLE>
On March 23, 1998, the closing price of the Company's Common Stock, as
reported by NASDAQ NMS was $11.00. Stockholders are urged to obtain current
market quotations for the Company's Common Stock. As of March 23, 1998 there
were 149 stockholders of record of the Company with approximately 88% of the
shares held in "street name". The Company estimates that as of March 23, 1998
there were more than 2800 stockholders of the Company.
DIVIDENDS
No dividends have been paid to date on the Common Stock of the Company.
Management of the Company does not intend to pay any cash dividends on Common
Stock of the Company in the foreseeable future, rather, it is expected that the
Company will retain earnings to finance its operations and growth. The terms
and conditions of the Company's 10.25% Senior Notes and of the Company's
Revolving Facility (See "Item 7 -- Management's Discussion and Analysis of
Financial Condition and Results of Operations" elsewhere herein) both contain
covenants which restrict and limit payments or distributions in respect of the
Common Stock of the Company.
RIGHTS PLAN
On February 28, 1997, the Board of Directors of the Company authorized and
adopted a stockholder rights plan ("Rights Plan"). The Rights Plan is intended
to maximize stockholder value by providing flexibility to the Board of
Directors in the event that an offer for the Company is received that is either
inadequate or not in the best interest of all stockholders. The Rights Plan
had been under consideration by the Board of Directors for almost a year prior
to its adoption and is in a form recommended by the Company's outside legal
counsel and financial advisors, which form is similar to that adopted by many
other public companies.
Pursuant to the Rights Plan, the Board of Directors declared a dividend
distribution of one "Right" for each outstanding share of common stock, par
value $.01 per share (the "Common Stock") of the Company to stockholders of
record at the close of business on March 10, 1997 (the "Record Date"). In
general, each Right, when exercisable, entitles the registered holder to
purchase from the Company one one-thousandth of a share of a new series of
preferred stock, designated as Series A Participating Preferred Stock, par
value $.01 per share (the "Preferred Stock"), at a price of $60.00 (the
"Purchase Price"), subject to adjustment. The terms of the Rights are set forth
in a Rights Agreement (the "Rights Agreement") between the Company and Harris
Trust and Savings Bank, as "Rights Agent". The following summary description
of the Rights and the terms of the Rights Agreement does not purport to be
complete and is qualified in its entirety by reference to the Rights Agreement
incorporated by reference as an exhibit hereto.
Initially, the Rights will be attached to all Common Stock certificates
representing shares then outstanding, and no separate Rights certificates will
be distributed. The Rights will separate from the Common Stock and a
"Distribution Date" will occur upon the earliest of (i) a public announcement
that a person, entity or group of affiliated or associated persons and/or
entities (an "Acquiring Person") has acquired, or obtained the right to
acquire, beneficial ownership of 15% or more of the outstanding shares of
Common Stock, other than as a result of repurchases of stock by the Company or
certain inadvertent actions by institutional or certain other stockholders, or
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(ii) ten days (unless such date is extended by the Board of Directors )
following the commencement of (or a public announcement of an intention to
make) a tender offer or exchange offer which would result in any person,
entity or group affiliated or associated persons and/or entities becoming an
Acquiring Person.
Until the Distribution Date the Rights will be evidenced, with respect to
any of the Common Stock certificates outstanding as of the Record Date, by such
Common Stock certificate together with a Summary of Rights. The Rights
Agreement provides that, until the Distribution Date, the Rights will be
transferred with and only with Common Stock certificates. From as soon as
practicable after the Record Date and until the Distribution Date (or earlier
redemption or expiration of the Rights), new Common Stock certificates issued
after the Record Date upon transfer or new issuance of the Common Stock will
contain a notation incorporating the Rights Agreement by reference. Until the
Distribution Date (or earlier redemption or expiration of the Rights), the
surrender for transfer of any certificates for Common Stock outstanding as of
the Record Date (with or without the Summary of Rights attached) will also
constitute the transfer of the Rights associated with the Common Stock
represented by such certificate. As soon as practicable following the
Distribution Date, separate certificates evidencing the Rights ("Rights
Certificates") will be mailed to holders of record of the Common Stock as of
the close of business on the Distribution Date, and the separate Rights
Certificates alone will evidence the Rights.
The Rights are not exercisable until the Distribution Date. The Rights
will expire on the earliest of (i) February 28, 2007, (ii) consummation of a
merger transaction with a Person or group who acquired Common Stock pursuant to
a Permitted Offer (as defined below), and is offering in the merger the same
price per share and form of consideration paid in the Permitted Offer, or (iii)
redemption or exchange of the Rights by the Company as described below.
The number of Rights associated with each share of Common Stock shall be
proportionately adjusted to prevent dilution in the event of a stock dividend
on, or a subdivision, combination or reclassification of, the Common Stock.
The Purchase Price payable, and the number of shares of Preferred Stock or
other securities or property issuable, upon exercise of the Rights are subject
to adjustment from time to time to prevent dilution (i) in the event of a stock
dividend on, or a subdivision, combination or reclassification of the Preferred
Stock, (ii) upon the grant to holders of the Preferred Stock of certain rights
or warrants to subscribe for Preferred Stock, certain convertible securities or
securities having the same or more favorable rights, privileges and preferences
as the Preferred Stock at less than the current market price of the Preferred
Stock, or (iii) upon the distribution to holders of the Preferred Stock of
evidences of indebtedness or assets (excluding regular quarterly cash dividends
out of earning or retained earnings) or of subscription rights or warrants
(other than those referred to above). With certain exceptions, no adjustments
in the Purchase Price will be required until cumulative adjustments require an
adjustment of at least 1% in such Purchase Price.
In the event that, after the first date of public announcement by the
Company or an Acquiring Person that an Acquiring Person has become such, the
Company is involved in a merger or other business combination transaction
(whether or not the Company is the surviving corporation) or 50% or more of the
Company's assets or earning power are sold (in one transaction or a series of
transactions), proper provision shall be made so that each holder of a Right
(other than an Acquiring Person) shall thereafter have the right to receive,
upon the exercise thereof at the then current Purchase Price, that number of
share of common stock of either the Company, in the event that it is the
surviving corporation of a merger or consolidation, or the acquiring company
(or, in the event there is more than one acquiring company, the acquiring
company receiving the greatest portion of the assets or earning power
transferred) which at the time of such transaction would have a market value of
two times the Purchase Price (such right being called the "Merger Right"). In
the event that a Person becomes the beneficial owner of 15% or more of the
outstanding shares of Common Stock (unless pursuant to a tender offer or
exchange offer for all outstanding shares of Common Stock at a price and on
terms determined prior to the date of the first acceptance of payment for any
of such shares by at least a majority of the members of the Board of Directors
who are not officers of the Company and are not Acquiring Persons or Affiliates
or Associates thereof to be both adequate and otherwise in the best interests
of the Company and its stockholders (a "Permitted Offer")), then proper
provision shall be made so that each holder of a Right will for a 60-day period
(subject to extension under certain circumstances) thereafter have the right to
receive upon exercise that number of shares of Common Stock (or, at the
election of the Company, which election may be obligatory if sufficient
authorized shares of Common Stock are not available, a combination of Common
Stock, property, other securities (e.g., Preferred Stock) and/or a reduction in
the exercise price of the Right) having a market value of two times the
Purchase Price (such right being called the "Subscription Right"). The holder
of a Right will continue to have the Merger Right whether or not such holder
exercises the Subscription Right. Notwithstanding the foregoing, upon the
occurrence of any of the vents giving rise to the exercisability of the Merger
Right or the Subscription Right, any Rights that are or were at any time after
the Distribution Date owned by an Acquiring Person shall immediately become
null and void.
At any time prior to the earlier to occur of (i) a Person becoming an
Acquiring Person or (ii) the expiration of the Rights, the Company may redeem
the Rights in whole, but not in part, at a price of $.01 per Right (the
"Redemption Price"), which redemption shall be effective upon the action of the
Board of Directors. Additionally, the Company may thereafter redeem the then
outstanding Rights in whole, but not in part, at the Redemption Price (i) if
such redemption is incidental to a merger or other business combination
transaction or series of transactions involving the Company but not involving
an Acquiring Person or certain related Persons or (ii) following an event
giving rise to, and the expiration of the exercise period for, the Subscription
Right if and for as long as the
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Acquiring Person triggering the Subscription Right beneficially owns
securities representing less than 15% of the outstanding shares of Common
Stock and at the time of redemption there are no other Acquiring Persons.
The redemption of Rights described in the preceding sentence shall be
effective only as of such time when the Subscription Right is not
exercisable, and in any event, only after ten business days' prior notice.
Upon the effective date of the redemption of the Rights, the right to
exercise the Rights will terminate and the only right of the holders of
Rights will be to receive the Redemption Price.
Subject to applicable law, the Board of Directors, at its option, may at
any time after a Person becomes an Acquiring Person (but not after the
acquisition by such Person of 50% or more of the outstanding Common Stock),
exchange all or part of the then outstanding and exercisable Rights (except for
Rights which have become void) for shares of Common Stock at a rate of one
share of Common Stock per Right or, alternatively, for substitute consideration
consisting of cash, securities of the Company or other assets (or any
combination thereof).
The Preferred Stock purchasable upon exercise of the Rights will be
nonredeemable and junior to any other series of preferred stock the Company may
issue (unless otherwise provided in the terms of such stock). If issued, each
share of Preferred Stock will have a preferential quarterly dividend in an
amount equal to 1,000 times the dividend, if any, declared on each share of
Common Stock, but in no event less than $25.00. In the event of liquidation,
the holders of shares of Preferred Stock will receive a preferred liquidation
payment equal to the greater of $1,000.00 or 1,000 times the payment made per
share of Common Stock. Each share of Preferred Stock will have 1,000 votes,
voting together with the shares of Common Stock. The rights of the Preferred
Stock as to dividends, liquidation and voting, and in the event of mergers and
consolidations, are protected by customary antidilution provisions. Fractional
shares of Preferred Stock will be issuable; however, (i) the Company may elect
to distribute depositary receipts in lieu of such fractional share and (ii) in
lieu of fractional shares other than fractions that are multiples of one one-
thousandth of a share, an adjustment in cash will be made based on the market
price of the Preferred Stock on the last trading date prior to the date of
exercise.
Until a Right is exercised, the holder thereof, as such, will have no
rights as a stockholder of the Company, including, without limitation, the
right to vote or to receive dividends. The Company and the Rights Agent retain
broad authority to amend the Rights Agreement; however, following any
Distribution Date any amendment may not adversely affect the interests of
holders of Rights.
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ITEM 6 -- SELECTED FINANCIAL DATA
The following is a summary of Selected Financial Data. The data should be
read in conjunction with the Company's Consolidated Financial Statements, the
notes thereto, and "Management's Discussion and Analysis of Financial Condition
and Results of Operations", all included elsewhere herein. Dollar amounts are
in thousands, except for per share and per room amounts.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------
1993 1994 1995 1996 1997
------- ------- ------- ------- ----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Guest Pay $21,471 $29,927 $50,758 $84,504 $ 116,276
Free-to-guest 7,478 8,397 8,060 8,645 8,496
Other 2,363 2,070 4,395 4,572 10,938
------- ------- ------- ------- ----------
Total revenues 31,312 40,394 63,213 97,721 135,710
Direct costs 14,848 18,181 28,910 44,379 58,512
------- ------- ------- ------- ----------
Gross profit 16,464 22,213 34,303 53,342 77,198
Operating expenses 16,425 24,573 36,741 58,428 85,262
------- ------- ------- ------- ----------
Operating income (loss) 39 (2,360) (2,438) (5,086) (8,064)
Interest expense 2,096 966 4,522 8,243 17,001
------- ------- ------- ------- ----------
Loss before income taxes, extraordinary loss
and cumulative effect of accounting change (2,057) (3,326) (6,960) (13,329) (26,065)
Provision for income taxes -- -- 66 28 344
------- ------- ------- ------- ----------
Loss before extraordinary loss and cumulative
effect of accounting change (2,057) (3,326) (7,026) (13,357) (25,409)
Extraordinary loss (1) -- 1,324 -- 3,253 --
Cumulative effect of accounting change (2)
-- -- -- -- 210
------- ------- ------- ------- ----------
Net loss (2,057) (4,650) (7,026) (16,610) (25,619)
Cumulative preferred dividends 1,557 -- -- -- --
------- ------- ------- ------- ----------
Net loss attributable to Common Stock $(3,614) $(4,650) $(7,026) $(16,610) $(25,619)
------- ------- ------- ------- ----------
------- ------- ------- ------- ----------
OTHER DATA:
EBITDA (3) $7,215 $9,301 $15,898 $24,729 $ 35,696
EBITDA margin (3) 23.0% 23.0% 25.1% 25.3% 26.3%
Capital expenditures $14,311 $43,521 $51,497 $85,258 $ 105,483
Depreciation and amortization 7,176 11,661 18,336 29,815 43,760
Annualized EBITDA (4) 7,990 11,250 18,246 27,290 39,090
Ratio of earnings to fixed charges (5) -- -- -- -- --
Ratio of long-term debt to
annualized EBITDA (4) .75x 2.49x 3.15x 6.57x 4.67x
Ratio of EBITDA to interest expense (3) 3.44x 9.63x 3.52x 3.00x 2.10x
OPERATING DATA:
Guest Pay rooms served (6)
On-demand 59,169 119,680 209,487 358,842 484,070
Scheduled 77,650 65,351 58,720 41,403 27,781
------- ------- ------- ------- ----------
Total Guest Pay rooms 136,819 185,031 268,207 400,245 511,851
------- ------- ------- ------- ----------
------- ------- ------- ------- ----------
Rooms with Super Nintendo-Registered Trademark-
game systems (6) 225 69,806 163,879 322,903 448,969
Free-to-guest rooms served (6) 191,893 220,534 249,779 294,882 341,030
Total rooms served (6) (7) 267,171 314,184 388,088 516,348 606,827
Average monthly revenue per Guest Pay room:
Movie revenue $14.68 $15.03 $17.08 $18.38 $ 17.86
Video game/information services .39 1.01 2.21 2.93 3.28
------- ------- ------- ------- ----------
Total $15.07 $16.04 $19.29 $21.31 $ 21.14
------- ------- ------- ------- ----------
------- ------- ------- ------- ----------
</TABLE>
Page 18
<PAGE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------------------------------------
1993 1994 1995 1996 1997
------- ------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents $12,256 $ 4,302 $ 2,252 $ 86,177 $ 1,021
Total assets 64,300 88,265 125,507 279,768 260,294
Long-term debt 6,000 28,000 57,497 179,233 182,691
Total stockholders' equity 52,665 47,942 42,726 75,552 49,579
</TABLE>
___________
(1) In 1994 -- loss on early termination of the Company's bank credit facility
of $1.3 million. In 1996 -- loss on early redemption of 9.95% and 10.35%
Senior Notes of $3.3 million. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" included elsewhere
herein.
(2) Represents a charge for the effect of adopting EITF Issue 97-13 related to
accounting for certain business reengineering costs.
(3) EBITDA is not intended to represent an alternative to net income or cash
flows from operating, financing or investing activities (as determined in
accordance with generally accepted accounting principles) as a measure of
performance. Rather, it is included herein because EBITDA is a widely
accepted financial indicator used by certain investors and financial
analysts to assess and compare companies on the basis of operating
performance. Management believes that EBITDA provides an important
additional perspective on the Company's operating results and the
Company's ability to service its long-term debt and to fund the Company's
continuing growth.
(4) "Annualized EBITDA" represents the sum of the quarterly EBITDA for the two
most recently completed fiscal quarters multiplied by two.
(5) Earnings is defined as net loss before income taxes, extraordinary items
and fixed charges, except where capitalized. Fixed charges is defined as
the portion of rental expense under operating leases representing
interest, and interest, including amortization of debt expense, whether
expensed or capitalized. Earnings were insufficient to cover fixed charges
for the years ended December 31 by the amounts indicated: 1993 --
$(2,057); 1994 -- $(3,326); 1995 -- $(6,960); 1996 -- $(13,329); and 1997
$(25,065).
(6) At end of year.
(7) Total rooms served include those rooms receiving one or more of the
Company's services.
Page 19
<PAGE>
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
CERTAIN STATEMENTS IN THIS ANNUAL REPORT ON FORM 10-K, INCLUDING, WITHOUT
LIMITATION, STATEMENTS IN ITEM 1, INCLUDING CERTAIN STATEMENTS UNDER THE
HEADINGS "OVERVIEW", "BUSINESS STRATEGY", "STRATEGIC INITIATIVES", "SERVICES
AND PRODUCTS", "OPERATIONS", "COMPETITION" AND "REGULATION", IN ITEM 3 UNDER
THE HEADING "LEGAL PROCEEDINGS", AND IN ITEM 7 UNDER THE HEADING "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS,"
CONSTITUTE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE SECURITIES
ACT OF 1933, AS AMENDED, AND THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED.
WHEN USED IN THIS ANNUAL REPORT, THE WORDS "EXPECTS," "ANTICIPATES,"
"ESTIMATES," "BELIEVES," "NO ASSURANCE" AND SIMILAR EXPRESSIONS ARE INTENDED TO
IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. SUCH FORWARD-LOOKING STATEMENTS
INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS, WHICH MAY
CAUSE THE COMPANY'S ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS TO BE
MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS
EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. IN ADDITION TO THE
RISKS AND UNCERTAINTIES DISCUSSED IN THE FOREGOING SECTIONS, SUCH FACTORS
INCLUDE, AMONG OTHERS, THE FOLLOWING: THE IMPACT OF COMPETITION AND CHANGES TO
THE COMPETITIVE ENVIRONMENT FOR THE COMPANY'S PRODUCTS AND SERVICES, CHANGES IN
TECHNOLOGY, RELIANCE ON STRATEGIC PARTNERS, UNCERTAINTY OF LITIGATION, CHANGES
IN GOVERNMENT REGULATION AND OTHER FACTORS DETAILED, FROM TIME TO TIME, IN THE
COMPANY'S FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE FORWARD-
LOOKING STATEMENTS SPEAK ONLY AS OF THE DATE OF THIS ANNUAL REPORT. THE
COMPANY EXPRESSLY DISCLAIMS ANY OBLIGATION OR UNDERTAKING TO RELEASE PUBLICLY
ANY UPDATES OR REVISIONS TO ANY FORWARD-LOOKING STATEMENTS CONTAINED HEREIN TO
REFLECT ANY CHANGE IN THE COMPANY'S EXPECTATIONS WITH REGARD THERETO OR ANY
CHANGE IN EVENTS, CONDITIONS OR CIRCUMSTANCES ON WHICH ANY SUCH STATEMENT IS
BASED
ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH, AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO, THE CONSOLIDATED FINANCIAL
STATEMENTS OF THE COMPANY, INCLUDING THE NOTES THERETO, APPEARING ELSEWHERE
HEREIN.
OVERVIEW
The Company provides video on-demand, network-based video games, cable
television programming and other interactive entertainment and information
services to the lodging and multi-family residential unit markets utilizing its
proprietary B-LAN-SM- system architecture.
LODGING SERVICES
GUEST PAY SERVICES. The Company's Guest Pay services include Guest
Scheduled-SM-on-demand movies, network-based Super Nintendo-Registered
Trademark-video games and other interactive entertainment and information
services for which the hotel guest pays on a per-view or per-play basis. The
growth that the Company has experienced has principally resulted from its
rapid expansion of guest pay-per-view services, which the Company began
installing in 1986. In May 1992, the Company introduced and began installing
its on-demand guest pay service. It has been the Company's experience that
rooms featuring the "on-demand" guest pay service generate significantly more
revenue and gross profit per room than comparable rooms having only the
scheduled format. The following table sets forth information in regard to
guest pay rooms installed as of December 31:
<TABLE>
<CAPTION>
1995 1996 1997
-------------------- ------------------- ----------------------
Rooms % Rooms % Rooms %
------- ----- ------- ------ ------- -----
<S> <C> <C> <C> <C> <C> <C>
Scheduled 58,720 21.9 41,403 10.3 27,781 5.4
On-demand 209,487 78.1 358,842 89.7 484,070 94.6
------- ----- ------- ------ ------- -----
Total 268,207 100.0 400,245 100.0 511,851 100.0
------- ----- ------- ------ ------- -----
------- ----- ------- ------ ------- -----
</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, hotel guest demographics, the popularity, selection and
pricing of the Company's program offerings and the length of time programming
is available to the Company prior to its release to the home video and cable
television markets. The primary direct costs of providing guest pay services
are (i) license fees paid to studios for non-exclusive distribution rights to
recently-released major motion pictures, (ii) nominal one-time license fees
paid for independent films, (iii) license fees for video games and other
services, and (iv) the commission retained by the hotel. Guest pay operating
expenses include costs of system maintenance and support, in-room marketing,
video tape duplication and distribution, data retrieval, insurance and personal
property taxes.
The Company also provides video games and interactive multimedia
entertainment and information services through its guest pay systems. Services
include folio review, video check-out and guest satisfaction surveys. In 1993,
the Company entered into a seven-year non-exclusive license agreement with
Nintendo of America, Inc. ("Nintendo") to provide hotels with a network-based
Super Nintendo-Registered Trademark-video game playing system. The following
table sets forth the number of guest pay rooms with game systems installed as
of December 31:
<TABLE>
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Super Nintendo-Registered Trademark-
game systems rooms 163,879 322,903 448,969
</TABLE>
Page 20
<PAGE>
FREE-TO-GUEST SERVICES. In addition to guest pay services, the Company
provides cable television programming for which the hotel, rather than its
guests, pays the charges. Free-to-guest services include the satellite
delivery of various programming channels through a satellite earth station,
which generally is owned or leased by the hotel. The hotel pays the Company a
fixed monthly charge per room for each programming channel provided. Such
monthly charges range generally from $2.90 - $3.50 per room per month for
premium channels and from $.10 - $.95 per room per month for non-premium
channels. The Company obtains its free-to-guest programming pursuant to
multi-year agreements with the programmers and pays a fixed monthly fee per
room, which ranges generally from 75% to 85% of revenues for such services,
depending on incentive programs in effect from time to time from the
programming networks. In April 1996, the Company entered into an agreement
with PRIMESTAR pursuant to which the Company was appointed as the exclusive
third-party provider (other than partners in PRIMESTAR and their affiliated
distributors) of the PRIMESTAR-Registered Trademark- DBS (digital direct
broadcast satellite) signal to the lodging industry. Pursuant to this
agreement, the Company will pay a fee to PRIMESTAR for access to the PRIMESTAR
signal, which will enable the Company to provide free-to-guest digital
satellite programming to a broader segment of the lodging industry than can be
cost-effectively served with traditional C-band satellite systems. The
following table sets forth the number of free-to-guest rooms served as of
December 31:
<TABLE>
<CAPTION>
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
At hotels with Guest Pay services 129,898 178,779 246,054
At hotels with only free-to-guest services 119,881 116,103 94,976
------- ------- -------
Total rooms with free-to-guest services 249,779 294,882 341,030
------- ------- -------
------- ------- -------
</TABLE>
RESIDENTIAL SERVICES
In January 1996, the Company formed ResNet for the purpose of extending
the Company's proprietary b-LAN-SM- system architecture and operational
expertise into the Multi-family Residential Unit ("MDU") market. In October
1996, TSAT, an affiliate of TCI, agreed to invest up to $40 million in ResNet
in exchange for up to a 36.99% interest in ResNet and agreed to provide
ResNet with long-term access to DBS signals for the MDU market on a
nationwide basis.
The Company believes that the MDU business has financial and technological
requirements similar to those of the Company's lodging industry business.
ResNet began installations of its first systems during the quarter ended
September 30, 1996. The following table sets forth the number of residential
units passed as of December 31:
<TABLE>
<CAPTION>
1996 1997
------- ------
<S> <C> <C>
Residential units passed 3,087 26,125
</TABLE>
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1997 AND 1996
REVENUE ANALYSIS
The Company's total revenue for 1997 increased 38.9%, or $38.0 million, in
comparison to 1996. The following table sets forth the components of the
Company's revenue (in thousands) for the years ended December 31:
<TABLE>
<CAPTION>
1996 1997
----------------------- ---------------------
Percent Percent
of Total of Total
Amount Revenues Amount Revenues
--------- -------- --------- --------
<S> <C> <C> <C> <C>
Guest Pay $84,504 86.5 $116,276 85.7
Free-to-guest 8,645 8.8 8,496 6.3
Other 4,572 4.7 10,938 8.0
--------- -------- --------- --------
Total $97,721 100.0 $135,710 100.0
--------- -------- --------- --------
--------- -------- --------- --------
</TABLE>
Page 21
<PAGE>
GUEST PAY SERVICES. Guest Pay revenues increased 37.6%, or $31.8 million,
in 1997 as compared to 1996. This increase is attributable to a 38.7% increase
in the average number of installed guest pay rooms, all of which were installed
with the Company's on-demand technology, partially offset by a .8% decrease in
average monthly revenue per guest pay room. The following table sets forth
information with respect to guest pay rooms for the years ended December 31:
<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
Average monthly revenue per room:
Movie revenue $ 18.38 $ 17.86
Video game and other service revenue 2.93 3.28
-------- --------
Total per Guest Pay room $ 21.31 $ 21.14
-------- --------
-------- --------
For all Guest Pay rooms:
Movie buy rates 10.7% 10.3%
Average movie price $8.26 $ 8.40
Average hotel occupancy rate 69.4% 68.6%
For on-demand Guest Pay rooms:
Movie buy rates 11.4% 10.6%
Average movie price $8.28 $ 8.42
Average hotel occupancy rate 70.0% 69.0%
</TABLE>
Average movie revenue per room, for all guest pay rooms, decreased 2.8%
from the prior year due to the combination of lower average buy rates and lower
average hotel occupancy. These factors were partially offset by increased
average movie prices and by the comparative increase in the proportion of
on-demand rooms. It has been the Company's experience that buy rates are
higher in rooms featuring the on-demand service than in those rooms with the
scheduled service. The comparative decrease in buy rates, for both all and
on-demand Guest Pay rooms, is attributed to a relatively less popular selection
of newly-released major motion pictures in 1997 as compared to 1996. The
slight increase in average movie prices for both all and on-demand rooms
between the comparative periods is the result of price increases implemented at
certain hotels during 1997. The Company's movie prices were generally $7.95 or
$8.95 during the periods.
Average video game and other service revenue per room, for all guest pay
rooms, increased 11.9% from the prior year, primarily as a result of an
increase in the number of rooms with information and other services
installed. Average monthly video game revenue per room was $2.25 and $2.26
during 1997 and 1996, respectively.
FREE-TO-GUEST SERVICES. Free-to-guest revenues decreased 1.7%, or
$149,000, in 1997 as compared to 1996. This decrease is the result of the
combination of an 18.2% decrease in the number of rooms receiving only
free-to-guest services from 1996 (although total rooms receiving
free-to-guest services increased by 15.6%), offset by increasing revenue per
room resulting from additional programming services taken by hotels, as well
as programming price increases.
OTHER. Revenue from other sources includes cable television revenue
generated by the residential services segment, revenue from international
license arrangements, and revenue from the sale of televisions, system
equipment, and service parts and labor. The increase in 1997 from the prior
year of $6.4 million, or 139%, is primarily due to increased cable television
revenue generated by the residential services segment of $2.4 million;
increased television sales of $1.5 million; increased sales of system
equipment of $864,000; increased service parts and labor of $450,000 and
increased revenue earned under international license arrangements of $318,000.
EXPENSE ANALYSIS
DIRECT COSTS. The following table sets forth information regarding the
Company's direct costs (in thousands) and gross profit margin for the years
ended December 31:
<TABLE>
<CAPTION>
1996 1997
----------- ------------
<S> <C> <C>
Direct costs:
Guest Pay $ 33,981 $ 45,632
Free-to-guest 6,784 5,663
Other 3,614 7,217
----------- ------------
$ 44,379 $ 58,512
----------- ------------
----------- ------------
Gross profit margin:
Guest Pay 59.8% 60.8%
Free-to-guest 21.5% 33.3%
Other 21.0% 34.0%
Composite 54.6% 56.9%
</TABLE>
Page 22
<PAGE>
Guest Pay direct costs increased 34.3% to $45.6 million in 1997 from
$34.0 million in the prior year. Since guest pay direct costs (primarily
studio and other license fees, video game license fees and the commission
retained by the hotel) are primarily based on related revenue, such direct
costs generally vary directly with revenue. As a percentage of guest pay
revenue, such costs decreased from 40.2% in 1996 to 39.2% in 1997. The
relative decrease in guest pay direct costs as a percentage of revenue in
1997 as compared to the prior year is primarily the result of lower
movie-related costs due to proportionately lower revenue from newly-released
motion pictures.
Free-to-guest direct costs decreased 16.5% to $5.7 million in 1997 from
$6.8 million in the prior year. As a percentage of free-to-guest revenue,
free-to-guest direct costs decreased to 66.7% in 1997 from 78.5% in the prior
year. This decrease is due to incentive discounts earned from programming
networks, partially offset by higher costs for both premium and non-premium
programming.
Direct costs associated with other revenue increased 99.7% to $7.2
million from $3.6 million in the prior year. As a percentage of related
revenues, such direct costs decreased to 66.0% in 1997 from 79.0% in 1996,
reflecting the effect of (i) increased cable television revenue generated by
the residential services segment, (ii) increased system equipment sales and
revenue from service parts and labor, and (iii) increased revenue generated
under international license arrangements, all of which earn higher margins
than the other sources of other revenue.
The Company's overall gross profit increased 44.7% in 1997 to $77.2
million on a 38.9% increase in revenues compared to 1996. The Company's
overall gross profit margin was 56.9% in 1997 and 54.6% for the prior year.
OPERATING EXPENSES. The following table sets forth information in
regard to the Company's operating expenses (in thousands) for the years ended
December 31:
<TABLE>
<CAPTION>
1996 1997
-------------------- --------------------
Percent Percent
of Total of Total
Amount Revenues Amount Revenues
---------- ---------- --------- --------
<S> <C> <C> <C> <C>
Operating expenses:
Guest Pay operations $ 15,032 15.4% $ 20,785 15.3%
Selling, general and administrative 13,581 13.9% 20,717 15.3%
Depreciation and amortization 29,815 30.5% 43,760 32.2%
---------- ---------- --------- --------
Total operating expenses $ 58,428 59.8% $ 85,262 62.8%
---------- ---------- --------- --------
---------- ---------- --------- --------
</TABLE>
Guest Pay operations expenses consist of costs directly related to the
operation of systems at the hotel sites as well as at residential sites
operated by the residential services segment. Excluding the expenses
incurred to operate the systems at residential sites, which were $1.4 million
in 1997 and none in 1996, expenses related to Guest Pay operations increased
28.9%, or $4.3 million, in 1997 from $15.0 million in the previous year.
This increase is primarily attributable to the 38.7% increase in average
installed Guest Pay rooms in 1997 as compared to 1996, partially offset by
lower average operating and service expenses incurred on a per room basis.
Per average installed guest pay room, such expenses were $3.52 per month in
1997 as compared to $3.79 per month in 1996.
Selling, general and administrative expenses increased 52.5%, or 7.1
million, in 1997 from $13.6 million in the prior year. This increase
reflects the effect of a material increase in legal expenses, an increase in
the number of development and administrative personnel, increased
facilities-related expenses, and an increase of $1.8 million of expenses
related to the residential services segment. As a percentage of revenue,
selling, general and administrative expenses represented 15.3% of total
revenue in 1997 as compared to 13.9% in the year earlier period.
Depreciation and amortization expenses increased 46.8% to $43.8 million
in 1997 from $29.8 million in the prior year. This increase is primarily
attributable to the increase in the number of installed guest pay and game
service equipped rooms previously discussed, as well as the associated
software costs and other capitalized costs such as service vans, equipment
and computers that are related to the increased number of rooms in service
since the prior year. Additionally, increases in administrative and facility
related assets, as well as an increase of $1.0 million related to the
residential services segment, have contributed to the increased depreciation
and amortization.
OPERATING LOSS. The Company's operating loss, as a result of the
factors previously discussed, increased to $8.1 million in 1997 from $5.1
million in 1996.
INTEREST EXPENSE. Interest expense, net of interest income, increased
to $17.0 million in 1997 from $8.2 million in 1996 due to increases in
long-term debt to fund the Company's continuing expansion of its businesses.
The average principal amount of long-term debt outstanding during 1997 was
approximately $179.7 million (at a weighted average interest rate of
approximately 10.5%) as compared to an average principal amount outstanding
of approximately $65.4 million (at a weighted average interest rate of
approximately 10.0%) during 1996. The weighted average amount outstanding
under the revolving credit facility was approximately $250,000 during 1997 as
compared to approximately $9.4 million during 1996.
Page 23
<PAGE>
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. As a result of the
issuance of EITF Issue 97-13 related to accounting for certain business
reengineering costs, the Company recorded a charge of $210,000 to write-off
previously capitalized costs, in accordance with the new accounting
pronouncement.
NET LOSS. For the reasons previously discussed, the Company's net loss
increased to $25.6 million in 1997 from a net loss of $16.6 million in the
prior year.
EBITDA. As a result of increasing revenues from guest pay services,
and the other factors previously discussed, EBITDA ("Earnings Before
Interest, Income Taxes and Depreciation and Amortization") increased 44.3% to
$35.7 million in 1997 as compared to $24.7 million in 1996. EBITDA as a
percentage of total revenue increased to 26.3% in 1997 as compared to 25.3%
in 1996. EBITDA is not intended to represent an alternative to net income or
cash flows from operating, financing or investing activities (as determined
in accordance with generally accepted accounting principles) as a measure of
performance. Rather, it is included herein because EBITDA is a widely
accepted financial indicator used by certain investors and financial analysts
to assess and compare companies on the basis of operating performance.
Management believes that EBITDA provides an important additional perspective
on the Company's operating results and the Company's ability to service its
long-term debt and to fund the Company's continuing growth.
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1996 AND 1995
REVENUE ANALYSIS
The Company's total revenue for 1996 increased 54.6%, or $34.5 million, in
comparison to 1995. The following table sets forth the components of the
Company's revenue (in thousands) for the years ended December 31:
<TABLE>
<CAPTION>
1995 1996
------------------------- ------------------------
Percent Percent
of Total of Total
Amount Revenues Amount Revenues
----------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Guest Pay $ 50,758 80.3 $ 84,504 86.5
Free-to-guest 8,060 12.7 8,645 8.8
Other 4,395 7.0 4,572 4.7
----------- ---------- ---------- ----------
Total $ 63,213 100.0 $ 97,721 100.0
----------- ---------- ---------- ----------
----------- ---------- ---------- ----------
</TABLE>
GUEST PAY SERVICES. Guest Pay revenues increased 66.5%, or $33.7 million,
in 1996 as compared to 1995. This increase is attributable to (i) a 50.7%
increase in the average number of installed guest pay rooms, all of which were
installed with the Company's on-demand technology, and (ii) a 10.5% increase in
average monthly revenue per guest pay room. The following table sets forth
information with respect to guest pay rooms for the years ended December 31:
<TABLE>
<CAPTION>
1995 1996
--------- ---------
<S> <C> <C>
Average monthly revenue per room:
Movie revenue $ 17.08 $ 18.38
Video game and other service revenue 2.21 2.93
--------- ---------
Total per Guest Pay room $ 19.29 $ 21.31
--------- ---------
--------- ---------
For all Guest Pay rooms:
Movie buy rates 10.1% 10.7%
Average movie price $ 8.28 $ 8.26
Average hotel occupancy rate 69.0% 69.4%
For on-demand Guest Pay rooms:
Movie buy rates 11.2% 11.4%
Average movie price $ 8.34 $ 8.28
Average hotel occupancy rate 69.7% 70.0%
</TABLE>
Average movie revenue per room, for all guest pay rooms, was favorably
impacted by a combination of higher average buy rates and higher average
occupancies, all in comparison to the comparable period in the previous year,
and by the comparative increase in the proportion of on-demand rooms. It has
been the Company's experience that buy rates are higher in rooms featuring
the on-demand service than in those rooms with the scheduled service. The
comparative increase in buy rates, for both all and on-demand guest pay
rooms, is attributed to a relatively more popular selection of newly-released
major motion pictures in 1996 as compared to 1995. The slight decrease in
average movie prices for both all and on-demand rooms between the comparative
periods is the result of an increase in the proportion of limited service
hotel rooms in the installed room base, in which rooms movie prices are
generally $7.95. The Company's movie prices were generally $7.95 or $8.95
during the periods.
Page 24
<PAGE>
Average video game and other service revenue per room, for all guest pay
rooms, increased primarily as a result of the increase in the number of rooms
with video game services installed. On a per-room basis, average monthly
video game revenues were $2.26 and $1.70 during the years ended December 31,
1996 and 1995, respectively.
FREE-TO-GUEST SERVICES. Free-to-guest revenues increased 7.3%, or
$585,000, in 1996 as compared to 1995. This increase resulted from increased
programming services taken by hotels and increased programming prices,
partially offset by a 3.2% decrease in the number of rooms receiving only
free-to-guest services.
OTHER. Revenue from other sources, such as the sale of televisions,
system equipment, service parts and labor, and miscellaneous free-to-guest
programming materials, increased by $177,000, or 4.0% in 1996 as compared to
1995, all of which increase was attributable to sales of systems and
equipment to foreign licensees.
EXPENSE ANALYSIS
DIRECT COSTS. The following table sets forth information regarding the
Company's direct costs (in thousands) and gross profit margin for the years
ended December 31:
<TABLE>
<CAPTION>
1995 1996
----------- ------------
<S> <C> <C>
Direct costs:
Guest Pay $ 19,053 $ 33,981
Free-to-guest 6,117 6,784
Other 3,740 3,614
----------- ------------
$28,910 $ 44,379
----------- ------------
----------- ------------
Gross profit margin:
Guest Pay 62.5% 59.8%
Free-to-guest 24.1% 21.5%
Other 14.9% 21.0%
Composite 54.3% 54.6%
</TABLE>
Guest Pay direct costs increased 78.3%, or $14.9 million, in 1996 as
compared to the prior year. Since guest pay direct costs (primarily studio
and other license fees, video game license fees and the commission retained
by the hotel) are primarily based on related revenue, such direct costs
generally vary directly with revenue. As a percentage of guest pay revenue,
such costs increased from 37.5% in 1995 to 40.2% in 1996. The relative
increase in guest pay direct costs (as a percentage of revenue), in 1996 as
compared to the prior year, reflects higher movie-related costs due to
proportionately higher revenue from newly-released motion pictures and
substantially increased video game revenue in the guest pay revenue mix,
which increases were mitigated by a slight decrease in hotel commissions.
Free-to-guest direct costs increased 10.9% to $6.8 million in 1996 from
$6.1 million in the prior year. As a percentage of free-to-guest revenue,
free-to-guest direct costs increased to 78.5% in 1996 from 75.9% in the prior
year, primarily reflecting the effect of price increases paid for certain
programming services.
Direct costs associated with other revenue decreased 3.4%, or $126,000,
in 1996 as compared to the prior year. As a percentage of related revenues,
such direct costs decreased to 79.0% of other revenue in 1996 versus 85.1% in
1995, reflecting the effect of increased system and equipment sales, which
have slightly higher margins than the other sources of other revenue.
The Company's overall gross profit increased 55.5%, or $19.0 million, to
$53.3 million in 1996 on a 54.6% increase in revenues in comparison to the
prior year. The Company's overall gross profit margin was 54.6% in 1996 and
54.3% for the prior year.
OPERATING EXPENSES. The following table sets forth information in
regard to the Company's operating expenses (in thousands) for the years ended
December 31:
<TABLE>
<CAPTION>
1995 1996
------------------------- ------------------------
Percent Percent
of Total of Total
Amount Revenues Amount Revenues
----------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Operating expenses:
Guest Pay operations $ 9,767 15.5% $ 15,032 15.4%
Selling , general and administrative 8,638 13.7% 13,581 13.9%
Depreciation and amortization 18,336 29.0% 29,815 30.5%
----------- ---------- ---------- ----------
Total operating expenses $ 36,741 58.1% $ 58,428 59.8%
----------- ---------- ---------- ----------
----------- ---------- ---------- ----------
</TABLE>
Page 25
<PAGE>
Guest Pay operations expenses increased 53.9%, or $5.3 million, in 1996
from $9.8 million in the previous year. Such increase is primarily
attributable to the 50.7% increase in average installed Guest Pay rooms in
1996 as compared to 1995. Per average installed guest pay room, such
expenses averaged $3.79 per month in 1996 as compared to $3.71 per month in
1995, primarily reflecting increased marketing, service and support costs and
property taxes.
Selling, general and administrative expenses increased 57.2%, or $4.9
million, in 1996 from $8.6 million in the prior year. This increase reflects
the effect of substantially increased legal expenses, an increase in the
number of development, sales and administrative personnel and increased
facilities-related expenses. As a percentage of revenue, selling, general and
administrative expenses represented 13.9% of total revenue in 1996 as
compared to 13.7% in the year earlier period.
Depreciation and amortization expenses increased 62.6% to $29.8 million
in 1996 from $18.3 million in the prior year. This increase is directly
attributable to the increases in the number of installed guest pay and game
service equipped rooms previously discussed, as well as the associated
software costs and other capitalized costs such as service vans, equipment
and computers that are related to the increased number of rooms in service
since the prior year.
OPERATING LOSS. The Company's operating loss, as a result of the
factors previously discussed, increased to $5.1 million in 1996 from $2.4
million in 1995.
INTEREST EXPENSE. Interest expense increased to $8.2 million in 1996
from $4.5 million in 1995 due to increases in long-term debt to fund the
Company's continuing expansion of its businesses. Long-term debt increased
from $57.5 million at December 31, 1995 to $179.2 million at December 31,
1996, reflecting the Company's issuance of $150 million principal amount of
10.25% Senior Notes during 1996. The average principal amount of long-term
debt (excluding amounts outstanding under the revolving credit facility)
outstanding during 1996 was approximately $65.4 million (at a weighted
average interest rate of approximately 10.0%) as compared to an average
principal amount outstanding of approximately $40.6 million (at a weighted
average interest rate of approximately 10.3%) during 1995. The weighted
average amount outstanding under the revolving credit facility was
approximately $9.4 million during 1996 as compared to approximately $2.1
million in 1995.
EXTRAORDINARY LOSS. As a result of the early redemption of its 9.95% and
10.35% Senior Notes, the Company incurred a make-whole premium of approximately
$2.8 million, and wrote off unamortized debt issuance costs related to the
notes of approximately $0.4 million.
NET LOSS. For the reasons previously discussed, the Company's net loss
increased to $16.6 million in 1996 from a net loss of $7.0 million in the prior
year.
EBITDA. As a result of increasing revenues from guest pay services,
and the other factors previously discussed, EBITDA ("Earnings Before
Interest, Income Taxes and Depreciation and Amortization") increased 55.5% to
$24.7 million in 1996 as compared to $15.9 million in 1995. EBITDA as a
percentage of total revenue increased to 25.3% in 1996 as compared to 25.1%
in 1995. EBITDA is not intended to represent an alternative to net income or
cash flows from operating, financing or investing activities (as determined
in accordance with generally accepted accounting principles) as a measure of
performance. Rather, it is included herein because EBITDA is a widely
accepted financial indicator used by certain investors and financial analysts
to assess and compare companies on the basis of operating performance.
Management believes that EBITDA provides an important additional perspective
on the Company's operating results and the Company's ability to service its
long-term debt and to fund the Company's continuing growth.
SEASONALITY
The Company's quarterly operating results are subject to fluctuation
depending upon hotel occupancy rates and other factors. Typically, occupancy
rates are higher during the second and third quarters due to seasonal travel
patterns.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has incurred operating and net losses due in
large part to the depreciation, amortization and interest expenses related to
the capital required to expand its lodging and residential businesses. The
growth of the Company's business requires substantial indebtedness to finance
expansion of its lodging and multi-family residential businesses. The Company
expects that losses will increase as the Company implements its expansion
strategy. Historically, cash flow from operations has not been sufficient to
fund the cost of expanding the Company's business and to service existing
indebtedness. Capital expenditures were approximately $105.5 million during
1997, and net cash provided by operating activities was approximately $16.7
million.
Depending on the rate of growth of its lodging and residential businesses
and other factors, the Company expects to incur capital expenditures of between
approximately $75 to $85 million in 1998 and substantial amounts thereafter.
The actual amount and timing of the Company's capital expenditures will vary
(and such variations could
Page 26
<PAGE>
be material) depending upon the number of new contracts for services entered
into by the Company, the costs of installations and other factors. This a
forward-looking statement and there can be no assurance in this regard. In
addition, the Company's Revolving Credit Facility limits the amount of the
Company's annual capital expenditures to a certain base amount plus the
amounts of certain additional financing.
The Company believes that its operating cash flows and borrowings
permitted under the Revolving Credit Facility will be sufficient to fund the
Company's cash requirements for 12 to 18 months; and, the Company may increase
the Revolving Credit Facility from its present $100 to $175 million, subject to
certain conditions. However, this is a forward-looking statement and there can
be no assurance in this regard. ResNet, under its various agreements with
TSAT, may call upon TSAT to contribute up to $34.6 million of additional
capital to ResNet, which proceeds must be used for the purchase of satellite
receiving equipment. For additional information concerning the terms of the
Company's long-term debt and Revolving Credit Facility, please see Notes 7 and
8 to the Company's Consolidated Financial Statements included in this report.
The Company believes that it has various sources of financing available
in addition to borrowings under the Revolving Credit Facility, including
additional amounts of long-term indebtedness. However, if the Company's plans
or assumptions change, if its assumptions prove to be inaccurate or if the
Company experiences unanticipated costs or competitive pressures, the Company
may be required to seek additional capital sooner than currently anticipated.
There can be no assurance that the Company will be able to obtain financing,
or, if such financing is available, that the Company will be able to obtain
it on acceptable terms. Failure to obtain additional financing, if needed,
could result in the delay or abandonment of some or all of the Company's
expansion plans.
ResNet is currently at a stage of development during which it will
consume, through operating losses and capital expenditures for installations,
substantially more capital than it is capable of generating. The Company is
currently assessing alternative strategies to reduce the negative financial
impact of the operating losses and capital requirements of ResNet during its
growth phase.
YEAR 2000 INFORMATION
The Company has undertaken a comprehensive review of its computer systems
and software in regard to "year 2000" issues. Based on its review, the Company
does not anticipate any material costs or expenses, or any material adverse
effect on its operations, financial condition, products or services, or
competitive position as a result of such issues. The Company is cooperating
with its customers and suppliers to assess the extent, if any, of year 2000
issues pertaining to such third party computer systems.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See "Item 14 - Exhibits, Financial Statement Schedules and Reports on Form
8-K" for the Company's Consolidated Financial Statements, the Notes thereto and
Schedules filed as a part of this report.
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
Page 27
<PAGE>
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Except as hereinafter noted, the information concerning directors and
executive officers of the Company is incorporated by reference from the
sections entitled "Executive Officers", "Election of Directors - Board of
Directors and Nominees" and "Compliance with Reporting Requirements of Section
16 of the Exchange Act" of the Company's definitive Proxy Statement to be filed
pursuant to Regulation 14A within 120 days after the end of the last fiscal
year.
ITEM 11 - EXECUTIVE COMPENSATION
Information concerning executive remuneration and transactions is
incorporated by reference from the section entitled "Beneficial Ownership of
Principal Stockholders and Management" of the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A within 120 days after the end
of the last fiscal year.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of certain beneficial owners and
management is incorporated by reference from the section entitled "Beneficial
Ownership of Principal Stockholders and Management" of the Company's
definitive Proxy Statement to be filed pursuant to Regulation 14A within 120
days after the end of the last fiscal year.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions with
management is incorporated by reference from the section entitled "Certain
Transactions with Management and Others" of the Company's definitive Proxy
Statement to be filed pursuant to Regulation 14A within 120 days after the end
of the fiscal year.
Page 28
<PAGE>
PART IV
ITEM 14 -- EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES -- Reference is made to
the "Index to Consolidated Financial Statements" of LodgeNet Entertainment
Corporation, located at page F-1 of this PART IV, for a list of the financial
statements and schedules for the year ended December 31, 1996 included herein.
(b) None.
(c) EXHIBITS -- Following is a list of Exhibits filed with this report.
Exhibits 10.1 and 10.2 constitute management contracts. Exhibits 10.3, 10.7,
10.8, 10.9, 10.10, 10.11, and 10.12 constitute compensatory plans.
EXHIBIT NO.
<TABLE>
<CAPTION>
<S> <C>
3.1 Certificate of Incorporation of the Company (1)
3.2 By-Laws of the Registrant(1)
4.1 Registration Rights Agreement dated as of December 16, 1996, between
LodgeNet Entertainment Corporation and Morgan Stanley & Co. Incorporated,
NatWest Capital Markets Limited and Montgomery Securities (8)
4.2 Indenture dated as of December 19, 1996, between LodgeNet Entertainment
Corporation and Marine Midland Bank, as trustee, including the form of
Senior Note (8)
4.3 Form of Senior Notes (included in Exhibit 4.2)
10.1 Form of Employment Agreement between the Company and each of Tim C. Flynn
and Scott C. Petersen (1)
10.2 Form of Agreement between the Company and each of David M. Bankers, John
M. O'Haugherty, Douglas D. Truckenmiller and Steven D. Truckenmiller (1)
10.3 LodgeNet Entertainment Corporation Stock Option Plan (as amended and
restated effective August 15, 1996)(8)
10.6 License Agreement dated May 2, 1993 between Nintendo of America, Inc. and
LodgeNet Entertainment Corporation (2)
10.7 Stock Option Agreements dated as of February 29, 1988 between the Company
and Tim C. Flynn, as extended by Extension Agreement dated as of July 15,
1991 (2)
10.8 Stock Option Agreements dated as of February 29, 1988 between the Company
and Scott C. Petersen, as extended by Extension Agreement dated as of July
15, 1991 (2)
10.9 Stock Option Agreement dated as of December 31, 1992 between the Company
and John M. O'Haugherty (2)
10.10 Stock Option Agreement dated as of December 31, 1992 between the
Company and David M. Bankers (2)
10.11 Form of Stock Option Agreement for Non-Employee Directors (3)
10.12 Form of Incentive Stock Option Agreement for Key Employees (3)
10.13 Securities Purchase Agreement, by and between LodgeNet Entertainment
Corporation, John Hancock Mutual Life Insurance Company, Allstate Life
Insurance Company, Connecticut Mutual Life Insurance and CMA Life
Insurance Company, dated as of August 9, 1995 (4)
10.14 Amendment to Securities Purchase Agreement, dated as of December 19,
1996 (8)
10.15 Form of Executive Severance Agreement between the Company and each of
Tim C. Flynn, Scott C. Petersen, Jeffrey T. Weisner, John M. O'Haugherty,
David M. Bankers, Douglas D. Truckenmiller, Steven D. Truckenmiller and
Eric R. Jacobsen; all dated of July 25, 1995 (5)
10.16 Video Services Agreement by and among GE Capital-ResCom L.P. and
ResNet Communications, Inc. and LodgeNet Entertainment Corporation dated
as of February 9, 1996 (6)+
</TABLE>
Page 29
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
10.17 Amended and Restated Loan Agreement by and among LodgeNet
Entertainment Corporation, the Banks Signatory thereto, National
Westminster Bank Plc, as Agent for such Banks, and National Westminster
bank of Canada, as an Issuing bank, dated December 19, 1996 (8)
10.18 Equipment Sales Agreement between ResNet Communications, Inc. and TCI
Satellite Entertainment, Inc., dated as of October 21, 1996 (7)
10.19 Subordinated Convertible Term Loan Agreement between ResNet
Communications, Inc. and TCI Satellite Entertainment, Inc., dated as of
October 21, 1996 (7)
10.20 Option Agreement between ResNet Communications, Inc. and TCI
Satellite Entertainment, Inc., dated as of October 21, 1996 (7)
10.21 Standstill Agreement between LodgeNet Entertainment Corporation and
TCI Satellite Entertainment, Inc., dated as of October 21, 1996 (7)
10.22 Stockholders' Agreement between LodgeNet Entertainment Corporation
and TCI Satellite Entertainment, Inc., dated as of October 21, 1996 (7)
10.23 Subscription Agreement between ResNet Communications, Inc. and TCI
Satellite Entertainment, Inc., dated as of October 21, 1996 (7)
10.24 First Amendment, dated October 17, 1996, to License Agreement between
Nintendo of America, Inc. and LodgeNet Entertainment Corporation (8)
12.1 Statement of computation of ratios
21.1 Subsidiaries of the Company
23.1 Consent of Independent Public Accountants
27.1 Financial Data Schedule, Year end December 31, 1997
27.2 Financial Data Schedule, Quarterly and Year end, 1996
27.3 Financial Data Schedule, Quarterly 1997
</TABLE>
- ---------------------
+ Confidential Treatment has been requested with respect to certain portions
of these agreements.
<TABLE>
<CAPTION>
<S> <C>
(1) Incorporated by Reference to the Company's Amendment No. 1 to Registration
Statement on Form S-1, as filed with the Securities and Exchange
Commission, September 24, 1993.
(2) Incorporated by Reference to the company's Amendment No. 2 to Registration
Statement on Form S-1, as filed with the Securities and Exchange
Commission, October 13, 1993.
(3) Incorporated by Reference to the Annual Report on Form 10-K for the year
ended December 31, 1993, as filed with the Securities and Exchange
Commission, March 25, 1994.
(4) Incorporated by Reference to the Quarterly Report on Form 10-Q for the
quarter ended June 30, 1995, as filed with the Securities and Exchange
Commission, August 14, 1995.
(5) Incorporated by Reference to the Quarterly Report on Form 10-Q for the
quarter ended September 30,
1995, as filed with the Securities and Exchange Commission, November 14,
1995.
(6) Incorporated by Reference to the Annual Report on Form 10-K for the year
ended December 31, 1995, as filed with the Securities and Exchange
Commission, April 1, 1996.
(7) Incorporated by Reference to TCI Satellite Entertainment, Inc.'s Amendment
No. 1 to Registration Statement on Form 10 as filed with the Securities
and Exchange Commission, October 29, 1996.
(8) Incorporated by Reference to the Annual Report on Form 10-K for the year
ended December 31, 1996, as filed with the Securities and Exchange
Commission, March 17, 1997.
</TABLE>
Page 30
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized in the City of Sioux
Falls, State of South Dakota, on March 24, 1998.
LodgeNet Entertainment Corporation
By: /S/ TIM C. FLYNN
------------------------------
Tim C. Flynn, President and
Chief Executive Officer
Page 31
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/S/ TIM C. FLYNN President, Chief Executive March 24, 1998
- ---------------------- Officer and Director (Principal
Tim C. Flynn Executive Officer)
/S/ SCOTT C. PETERSEN Executive Vice President, March 24, 1998
- ---------------------- Chief Operating Officer,
Scott C. Petersen and Director
/S/ JEFFREY T. WEISNER Vice President - Finance, March 24, 1998
- ---------------------- (Principal Financial
Jeffrey T. Weisner and Accounting Officer)
/S/ DAVID AUSTAD Director March 24, 1998
- ----------------------
David Austad
/S/ LAWRENCE FLINN, JR. Director March 24, 1998
- ----------------------
Lawrence Flinn, Jr.
/S/ RICHARD R. HYLLAND Director March 24, 1998
- ----------------------
Richard R. Hylland
/S/ R. F. LEYENDECKER Director March 24, 1998
- ----------------------
R. F. Leyendecker
</TABLE>
Page 32
<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, 1996 and 1997................................... F - 3
Consolidated Statements of Operations -- Three Years Ended December 31, 1997................... F - 4
Consolidated Statements of Stockholders' Equity -- Three Years Ended December 31, 1997......... F - 5
Consolidated Statements of Cash Flows -- Three Years Ended December 31, 1997................... F - 6
Notes to Consolidated Financial Statements..................................................... F - 7
INDEX TO FINANCIAL SCHEDULES
Report of Independent Public Accountants on Schedule.......................................... F - 18
Schedule II -- Valuation and Qualifying Accounts.............................................. F - 19
</TABLE>
Page 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, 1996 and 1997, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years
in the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of LodgeNet
Entertainment Corporation and Subsidiaries as of December 31, 1996 and 1997,
and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota
February 25, 1998
Page F-2
<PAGE>
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
December 31,
--------------------------
1996 1997
----------- -----------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 86,177 $ 1,021
Accounts receivable, net of allowance for doubtful accounts 18,428 21,835
Prepaid expenses and other 1,935 3,457
----------- -----------
Total current assets 106,540 26,313
Property and equipment, net of accumulated depreciation 164,157 218,948
Debt issuance costs, net of accumulated amortization 8,509 7,641
Other assets, net 562 7,392
----------- -----------
$ 279,768 $ 260,294
----------- -----------
----------- -----------
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 16,775 $ 17,930
Current maturities of long-term debt 425 705
Accrued expenses 4,596 7,010
----------- -----------
Total current liabilities 21,796 25,645
Deferred revenue 2,956 2,069
Long-term debt 179,233 182,691
Minority interest in consolidated subsidiary 231 310
----------- -----------
Total liabilities 204,216 210,715
----------- -----------
Commitments and contingencies (Note 9) -- --
Stockholders' equity:
Common stock, $.01 par value, 20,000,000 shares authorized;
11,125,369 and 11,322,058 shares outstanding at December 31,
1996 and 1997, respectively 111 113
Additional paid-in capital 120,539 120,792
Accumulated deficit (45,098) (71,326)
----------- -----------
Total stockholders' equity 75,552 49,579
----------- -----------
$ 279,768 $ 260,294
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
Page F-3
<PAGE>
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollar amounts, except per share amounts, in thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1995 1996 1997
---------- ---------- -----------
<S> <C> <C> <C>
Revenues:
Guest Pay $ 50,758 $ 84,504 $ 116,276
Free-to-guest 8,060 8,645 8,496
Other 4,395 4,572 10,938
---------- ---------- -----------
Total revenues 63,213 97,721 135,710
---------- ---------- -----------
Direct costs:
Guest Pay 19,053 33,981 45,632
Free-to-guest 6,117 6,784 5,663
Other 3,740 3,614 7,217
---------- ---------- -----------
Total direct costs 28,910 44,379 58,512
---------- ---------- -----------
Gross profit 34,303 53,342 77,198
---------- ---------- -----------
Operating expenses:
Guest Pay operations 9,767 15,032 20,785
Selling, general and administrative 8,638 13,581 20,717
Depreciation and amortization 18,336 29,815 43,760
---------- ---------- -----------
Total operating expenses 36,741 58,428 85,262
---------- ---------- -----------
Operating loss (2,438) (5,086) (8,064)
Interest expense, net 4,522 8,243 17,001
---------- ---------- -----------
Loss before income taxes, extraordinary loss, and
cumulative effect of change in accounting principle (6,960) (13,329) (25,065)
Provision for income taxes 66 28 344
---------- ---------- -----------
Loss before extraordinary loss and cumulative effect of
change in accounting principle (7,026) (13,357) (25,409)
Extraordinary loss (Note 13) -- 3,253 --
Cumulative effect of change in accounting principle
(Note 3) -- -- 210
---------- ---------- -----------
Net loss $ (7,026) $ (16,610) $ (25,619)
---------- ---------- -----------
---------- ---------- -----------
Per common share (basic and diluted):
Loss before extraordinary loss and cumulative
effect of change in accounting principle $ (0.96) $ (1.40) $ (2.25)
Extraordinary loss -- (0.34) --
Cumulative effect of change in accounting principle -- -- (0.02)
---------- ---------- -----------
Net loss $ (0.96) $ (1.74) $ (2.27)
---------- ---------- -----------
---------- ---------- -----------
Weighted average shares outstanding (basic and diluted) 7,337,147 9,570,779 11,271,064
---------- ---------- -----------
---------- ---------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
Page F-4
<PAGE>
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Common Stock Additional
---------------------- Paid-in Accumulated
Shares Amount Capital Deficit Total
----------- ------- ---------- ------------ ----------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1994 7,278,748 $ 73 $ 69,492 $ (21,623) $ 47,942
Common stock option activity 73,365 1 62 -- 63
Warrants issued -- -- 1,680 -- 1,680
Net loss -- -- -- (7,026) (7,026)
Foreign currency translation adjustment -- -- -- 67 67
----------- ------- ---------- ------------ ----------
Balance, December 31, 1995 7,352,113 74 71,234 (28,582) 42,726
Issuance of common stock 3,680,000 36 44,599 -- 44,635
Common stock option activity 93,256 1 34 -- 35
Net loss -- -- -- (16,610) (16,610)
Change of interest in subsidiary -- -- 4,672 -- 4,672
Foreign currency translation adjustment -- -- -- 94 94
----------- ------- ---------- ------------ ----------
Balance, December 31, 1996 11,125,369 111 120,539 (45,098) 75,552
Common stock option activity 196,689 2 332 -- 334
Net loss -- -- -- (25,619) (25,619)
Change of interest in subsidiary -- -- (79) -- (79)
Foreign currency translation adjustment -- -- -- (609) (609)
----------- ------- ---------- ------------ ----------
Balance, December 31, 1997 11,322,058 $ 113 $ 120,792 $ (71,326) $ 49,579
----------- ------- ---------- ------------ ----------
----------- ------- ---------- ------------ ----------
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
Page F-5
<PAGE>
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
1995 1996 1997
---------- ----------- -----------
<S> <C> <C> <C>
Operating activities:
Net loss $ (7,026) $ (16,610) $ (25,619)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization 18,336 29,815 43,760
Non-cash portion of extraordinary loss -- 434 --
Minority interest -- (16) 16
Change in operating assets and liabilities:
Accounts receivable (3,541) (6,278) (3,288)
Prepaid expenses and other (447) (473) (1,138)
Accounts payable 6,205 1,864 1,053
Accrued expenses and deferred revenue 1,857 1,433 1,524
Other -- (607) 345
---------- ----------- -----------
Net cash provided by operating activities 15,384 9,562 16,653
---------- ----------- -----------
Investing activities:
Property and equipment additions (51,497) (85,258) (97,396)
Purchase of cable television operations -- -- (8,087)
Proceeds from sale of interest in subsidiary -- 5,396 --
---------- ----------- -----------
Net cash used for investing activities (51,497) (79,862) (105,483)
---------- ----------- -----------
Financing activities:
Proceeds from long-term debt 33,630 151,514 1,106
Debt issuance costs (1,348) (7,969) (141)
Stock issuance costs -- (477) --
Repayment of long-term debt (89) (33,607) (583)
Borrowings under revolving credit facility 10,000 55,958 3,000
Repayments of revolving credit facility (10,000) (55,958) --
Proceeds from issuance of common stock -- 44,635 --
Proceeds from issuance of warrants to purchase
common stock 1,680 -- --
Stock option activity 63 35 334
---------- ----------- -----------
Net cash provided by financing activities 33,936 154,131 3,716
---------- ----------- -----------
Effect of exchange rates on cash 127 94 (42)
---------- ----------- -----------
Increase (decrease) in cash and cash equivalents (2,050) 83,925 (85,156)
Cash and cash equivalents at beginning of period 4,302 2,252 86,177
---------- ----------- -----------
Cash and cash equivalents at end of period $ 2,252 $ 86,177 $ 1,021
---------- ----------- -----------
---------- ----------- -----------
Supplemental cash flow information:
Cash paid for interest $ 3,341 $ 7,870 $17,828
---------- ----------- -----------
---------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
Page 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. ResNet
Communications, Inc., a wholly-owned subsidiary of the Company, is the
majority owner of ResNet Communications, LLC (collectively "ResNet"). ResNet
installs and operates private cable television systems in multi-family
residential properties nationwide.
The Company's operating performance and outlook are strongly influenced
by such factors as overall occupancy levels, guest demographics, and economic
conditions in the lodging industry, the number of lodging rooms equipped with
the Company's systems, the number and type of guest pay product offerings,
the popularity and availability of programming, and competitive factors.
The rapid growth of the Company's businesses has and is expected to
continue to require capital resources in excess of operating cash flows.
While the Company's working capital, operating cash flows and its revolving
credit facility are expected to be sufficient to fund its growth for 1998,
the Company will likely, depending on its rate of growth, require additional
growth capital in subsequent years.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements
include the accounts of the Company, its wholly-owned Canadian subsidiary,
and ResNet. All significant inter-company accounts and transactions have
been eliminated in consolidation.
USE OF ESTIMATES -- The preparation of financial statements in
conformity with generally accepted accounting principles requires management
to make estimates and assumptions about certain matters and items. These
estimates and assumptions affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities, at the
date of the financial statements; and the reported amounts of revenues,
expenses and costs during the reporting periods. The ultimate outcome of the
matters and items may be different from the estimates and assumptions.
FAIR VALUE OF FINANCIAL INSTRUMENTS -- The carrying amounts for items
comprising current assets and current liabilities approximate fair value due
to the short period to maturity of these items. The fair value of long-term
debt instruments is estimated by reference to current yields to maturity on
similar instruments or quotes where available. The fair value of the
warrants issued during 1995 was estimated using option valuation techniques.
FOREIGN CURRENCY TRANSLATION -- The assets and liabilities of the
Company's Canadian subsidiary were translated at year-end exchange rates.
Income statement items were translated at average exchange rates during the
periods.
CASH AND CASH EQUIVALENTS -- Cash and cash equivalents are comprised of
demand deposits and temporary investments in highly liquid securities having
original maturities of 90 days or less.
PROPERTY AND EQUIPMENT -- Property and equipment is stated at cost,
including certain payroll costs related to the installation of new systems.
Maintenance costs, which do not significantly extend the useful lives of the
respective assets, and repairs are charged to operations as incurred.
Depreciation of guest pay and free-to-guest systems begins when such systems
are installed and activated. Depreciation on other equipment begins when
such equipment is placed in service. The Company attributes no salvage value
to any equipment. Depreciation and amortization are computed using the
straight-line method over the following useful lives:
<TABLE>
<CAPTION>
Years
---------
<S> <C>
Buildings 19 - 30
Guest Pay systems:
System components 5 - 7
In-room equipment 3 - 5
Cable television equipment 3 - 10
Free-to-guest systems 5
Other equipment 3 - 10
</TABLE>
Page F-7
<PAGE>
PRODUCT DEVELOPMENT -- The Company has capitalized certain costs of
developing software for its guest pay and residential systems. The
capitalization of these costs begins when a system's technological and
commercial feasibility has been established and ends when such systems are
available for use in guest pay or residential properties. Capitalized costs
are reported at the lower of unamortized costs or net realizable value, and
are amortized over the system's estimated useful life. Guest pay system
development costs capitalized were $1,480,000, $1,616,000 and $2,100,000
during the years ended December 31, 1995, 1996 and 1997, respectively.
Amortization of such costs was $455,000, $599,000 and $797,000 for the years
ended December 31, 1995, 1996 and 1997, respectively. The Company charged
$129,000, $216,000, and $410,000 to operations during the years ended
December 31, 1995, 1996 and 1997, respectively, related to research and
development activities.
REVENUE RECOGNITION -- Revenues and related costs are recognized when
the services are rendered. The Company has obtained certain programming
agreements which provide for the receipt of low-cost programming in the
earlier years of such agreements. The Company's policy is to record the
costs of such programming on a straight-line basis. During the year, the
Company entered into a new long term agreement with a major programming
source, superseding a previous programming agreement. As a result, the
recognition of approximately $1.2 million of previously deferred programming
cost reductions was accelerated. At December 31, 1995, 1996 and 1997 the
Company had recorded deferred cost reductions relating to such agreements of
$1,579,000, $1,835,000 and $450,000, respectively.
CONCENTRATION OF CREDIT RISKS AND CUSTOMER DATA -- The Company has
derived virtually all of its revenue from entities in the lodging industry,
however, no individual customer accounted for as much as 10% of total revenue
in any period presented in the accompanying consolidated statements of
operations. The allowance for doubtful accounts was $785,000 and $800,000 at
December 31, 1996 and 1997, respectively. The provision for doubtful
accounts was $343,000 in 1995, $922,000 in 1996, and $820,000 in 1997.
INCOME TAXES -- The Company accounts for income taxes under the
liability method, in accordance with the requirements of Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes".
Deferred income tax assets and liabilities are computed annually for
differences between the financial statement and tax basis of assets and
liabilities. Measurement is based on enacted tax rates applicable to the
periods in which such differences are expected to reverse.
LOSS PER SHARE COMPUTATION -- Effective in the fourth quarter of 1997,
the Company adopted Statement of Financial Accounting Standards ("SFAS") No.
128, "Earnings Per Share". SFAS No. 128 changes the manner in which earnings
per share ("EPS") are calculated and presented. The new standard requires
the computation and disclosure of two EPS amounts, basic and diluted. Basic
EPS is computed based only on the weighted average number of common shares
actually outstanding during the period. Diluted EPS is computed based on the
weighted average number of common shares outstanding plus all potentially
dilutive common shares outstanding during the period. The loss per share
amounts for 1996 and 1995 have been restated to give effect to the adoption
of SFAS No. 128. The effect of the restatement was to increase the loss per
share by $.01 in 1996 and 1995. Weighted average options on 1,121,366;
1,458,839; and 1,597,331 shares of common stock were not included in
computing diluted EPS because their effects were antidilutive for the years
ended December 31, 1995, 1996, and 1997, respectively.
STOCK-BASED COMPENSATION -- The Company measures compensation costs
associated with its stock option plans in accordance with the provisions of
Accounting Principles Board Opinion No. 25, as permitted by Statement of
Financial Accounting Standards No. 123. The effect of fair value based
measurement of such costs on net loss and net loss per share, in accordance
with Statement of Financial Accounting Standards No. 123, is disclosed on a
pro forma basis in Note 11.
RECLASSIFICATIONS -- Certain items in the consolidated financial
statements have been reclassified to conform to 1997 classifications. Such
reclassifications had no effect on previously reported net loss or
stockholders' equity.
NOTE 3 -- CHANGE IN ACCOUNTING PRINCIPLE
Effective in the fourth quarter of 1997, the Company adopted the
provisions of Issue No. 97-13, "Accounting for Costs Incurred in Connection
with a Consulting Contract or an Internal Project That Combines Business
Process Reengineering and Information Technology Transformation" issued by
the Emerging Issues Task Force of the Financial Accounting Standards Board.
This new pronouncement requires that certain costs associated with business
process reengineering activities should be expensed as incurred rather than
capitalized. As a result, the Company recorded a $210,000 charge in the 1997
Consolidated Statement of Operations, reflected as a cumulative effect of a
change in accounting principle, to write-off business process reengineering
costs that had been previously capitalized.
Page F-8
<PAGE>
NOTE 4 -- PROPERTY AND EQUIPMENT, NET
Property and equipment was comprised as follows at (in thousands of dollars):
<TABLE>
<CAPTION>
December 31,
-----------------------
1996 1997
-------- ---------
<S> <C> <C>
Land, building and equipment $ 15,914 $ 40,051
Free-to-guest equipment 7,369 11,855
Cable television equipment 5,291 13,877
Guest pay systems:
Installed 173,607 220,778
System components 23,290 30,720
Software costs 6,266 8,053
Building construction in progress 2,528 --
-------- ---------
Total 234,265 325,334
Less - depreciation and amortization (70,108) (106,386)
-------- ---------
Property and equipment, net $164,157 $ 218,948
-------- ---------
-------- ---------
</TABLE>
NOTE 5 -- DEBT ISSUANCE COSTS
Costs associated with the issuance of debt securities and with obtaining
credit facilities are capitalized and amortized over the term of the related
borrowing or facility. The Company capitalized $1,348,000, $7,969,000, and
$140,000 of debt issuance costs during the years ended December 31, 1995,
1996 and 1997, respectively. Amortization of such costs was $260,000 in
1995; $564,000 in 1996, and $1,008,000 in 1997. The 1996 amortization
excludes $434,000 recorded as an extraordinary loss resulting from the early
redemption of the Company's 9.95% and 10.35% Senior Notes (see Note 13). The
components of the debt issuance costs recorded in the balance sheets are as
follows (in thousands of dollars):
<TABLE>
<CAPTION>
December 31,
----------------------
1996 1997
------- --------
<S> <C> <C>
Debt issuance costs $8,820 $ 8,960
Accumulated amortization (311) (1,319)
------- --------
$8,509 $ 7,641
------- --------
------- --------
</TABLE>
NOTE 6 -- ACCRUED EXPENSES
Accrued expenses were comprised as follows at (in thousands of dollars):
<TABLE>
<CAPTION>
December 31,
----------------------
1996 1997
------- --------
<S> <C> <C>
Accrued taxes $ 523 $ 949
Accrued compensation 1,953 2,552
Accrued interest 2,120 2,274
Other -- 1,235
------- --------
$4,596 $7,010
------- --------
------- --------
</TABLE>
Page F-9
<PAGE>
NOTE 7 -- LONG-TERM DEBT
Long-term debt was comprised as follows at (in thousands of dollars):
<TABLE>
<CAPTION>
December 31,
-------------------------
1996 1997
--------- ----------
<S> <C> <C>
Revolving Credit Facility $ -- $ 3,000
Unsecured Senior Notes due December 15, 2006
10.25% interest payable semi-annually 150,000 150,000
Unsecured Senior Notes due July 15, 2005:
11.5% interest payable semi-annually 30,000 30,000
Less - unamortized discount (1,384) (1,169)
Capital leases 1,042 1,565
--------- ----------
179,658 183,396
Less current maturities (425) (705)
--------- ----------
$179,233 $182,691
--------- ----------
--------- ----------
</TABLE>
Long-term debt has the following scheduled principal maturities for the
years ended December 31 (in thousands of dollars): 1998 -- $705; 1999 --
$543; 2000 -- $270; 2001 -- $6,047; 2002 -- $9,000; thereafter -- $166,831.
10.25% SENIOR NOTES -- On December 19, 1996, the Company issued $150
million of unsecured 10.25% Senior Notes (the "Notes") in a private offering.
The proceeds of the Notes, which were issued at par, after placement fees and
offering expenses, were approximately $143.2 million. Approximately $31.7
million of such proceeds were used to redeem the outstanding principal
amounts of the 9.95% and 10.35% Senior Notes, $24.5 million and $4.4 million,
respectively, plus a make-whole premium, resulting from their early
redemption, of approximately $2.8 million. Approximately $20.4 million of
the proceeds was used to prepay all outstanding amounts under the Company's
revolving credit facility. The remaining proceeds of approximately $91.1
million, were invested in highly liquid, interest-bearing securities pending
their use for funding capital expenditures to expand the Company's
businesses, including approximately $15 million to construct and equip the
Company's new administrative and production facility in Sioux Falls, South
Dakota.
The Notes were issued initially to qualified institutional buyers or
other accredited investors pursuant to a registration rights agreement.
During 1997, the Notes were registered under the Securities Act of 1933 and
all the private Notes were exchanged for registered Notes. The registered
Notes contain terms and conditions identical to those of the private Notes.
The Notes are unsecured, rank PARI PASSU in right of payment with future
unsubordinated unsecured indebtedness and rank senior in right of payment to
all subordinated indebtedness of the Company. The Notes contain covenants
which, among other matters, require the Company to maintain a consolidated
leverage ratio (as defined in the indenture) of not more than 5.75 to 1
through December 15, 1999 and not more than 5.25 to 1 thereafter. The
covenants restrict the ability of the Company to incur additional
indebtedness, create liens, pay dividends or make certain distributions in
respect of its common stock; redeem capital stock; issue or sell stock of
subsidiaries in certain circumstances; effect certain business combinations;
and effect certain transactions with affiliates or stockholders.
The Notes are redeemable at the option of the Company, in whole or in
part, on or after December 15, 2001, initially at 105.125% of their principal
amount (plus accrued and unpaid interest) declining ratably to 100% of their
principal amount (plus accrued and unpaid interest) on or after December 15,
2003. In addition, at any time prior to December 15, 1999, the Company may
redeem up to 35% of the aggregate principal amount of the Notes with the
proceeds of one or more public equity offerings.
11.5% SENIOR NOTES -- During 1995, the Company issued $30 million
principal amount of 11.5% Senior Subordinated Notes due July 15, 2005 (the
"Subordinated Notes") to three insurance companies in two separate private
placements. Mandatory annual principal payments of $6 million commence July
15, 2001. Proceeds from the issuance of the Subordinated Notes, net of
original issue discount and issuance-related expenses, were approximately
$27.3 million and were used (i) to repay previous borrowings and (ii) to
provide funding for capital expenditures to expand the Company's guest pay
services business. The Company issued a total of 480,000 warrants (see Note
12) to purchase common stock of the Company in connection with the issuance
of the Subordinated Notes and the value of the warrants, $1.68 million, was
recorded in stockholders' equity and shown as a discount on the Subordinated
Notes. As part of the refinancing transaction in which the 10.25% Senior
Notes were issued, the holders of the Subordinated Notes adopted the
covenants and ranking of the 10.25% Senior Notes.
At December 31, 1996 and 1997, the estimated fair value of the 11.5%
Senior Notes was approximately $29.2 and $31.0 million, respectively. The
estimated fair value of the 10.25% Senior Notes was $150.0 and $155.3 million
at December 31, 1996 and 1997, respectively.
Page F-10
<PAGE>
NOTE 8 -- REVOLVING CREDIT FACILITY
On December 19, 1996 the Company amended and restated its revolving
credit facility with National Westminster Bank Plc, as Agent ("NatWest"), to
provide for an increase in the total lending commitments under the facility
from $60 million to $100 million. The amended facility is secured by (i) a
first priority security interest in all of the Company's and certain of its
subsidiaries tangible and intangible assets, and (ii) a guarantee by ResNet
of all amounts advanced to it by the Company. Amounts outstanding under the
amended facility bear interest at either (i) LIBOR (London Inter Bank Offered
Rate) plus from 1.25% to 2.00% or (ii) the greater of (a) the NatWest Prime
Rate plus from .25% to 1.00% or (b) the federal funds rate plus from .75% to
1.50%; depending on the Company's total leverage, as defined in the
agreement. At December 31, 1997, the interest rate on amounts outstanding
under the facility was 9.50%.
The commitment under the amended facility may be increased to $175
million, subject to the consent of NatWest, but is subject to a scheduled
reduction of 15% beginning in December 1998 and annually thereafter as
follows: December 1999 - 20%; December 2000 -20%; December 2001 - 20%; and
December 2002 - 25%. The amended facility provides for the issuance of
Letters of Credit, subject to customary terms and conditions; and includes
terms and conditions which require the maintenance of certain financial
ratios, limit the incurrence of additional indebtedness, limit the incurrence
of certain liens, limit certain payments or distributions in respect of the
Common Stock, and provide for acceleration of principal repayment in certain
circumstances. As of December 31, 1997, the Company had outstanding Standby
Letters of Credit of $1.2 million and the Company was in compliance with all
covenants, terms and conditions of the amended facility.
NOTE 9 -- COMMITMENTS AND CONTINGENCIES
PROGRAMMING AGREEMENTS -- The Company, through programming agreements,
provides guest pay and free-to-guest programming services to the lodging and
multi-family residential unit industries. These agreements provide that the
Company receives monthly revenue for such services. Such agreements contain
various restrictions, including default and termination procedures, and
generally range from five to seven years in duration. The Company has also
entered into agreements with certain networks and studios which provide their
programs for redistribution. Under these agreements, the Company pays fees
which are based on revenue generated, or on rate schedules based on the
number of sites under license by the Company. The agreements contain various
restrictions, including default and termination procedures, and generally
range from three to five years in duration.
SIGNAL CARRIAGE AGREEMENT -- The Company and PRIMESTAR Partners, L.P.
have entered into a Signal Carriage Agreement (the "Agreement") under which,
in exchange for exclusive distribution of satellite-delivered free-to-guest
programming to the lodging industry, the Company agreed to share certain
operating cash flows, as defined in the agreement, with PRIMESTAR Partners,
L.P. Under the cash flow sharing arrangement, which is measured on an annual
basis, the Company receives the first $1.8 million of cash flows, PRIMESTAR
Partners, L.P. receives the next $1.8 million and all amounts thereafter are
shared evenly. The Agreement has an initial term of 15 years and includes
various restrictions, including default and termination provisions.
PURCHASE COMMITMENTS -- The Company has purchase commitments, in the
ordinary course of business, none of which are expected to result in losses.
OPERATING LEASES -- The Company has entered into certain operating
leases, which at December 31, 1997 require future minimum lease payments, as
follows (in thousands of dollars): 1998 -- $246; 1999 -- $222; 2000 --
$200; 2001 --$179; 2002 and thereafter -- $41.
LITIGATION -- On February 16, 1995, On Command Corporation ("OCC") filed
a lawsuit in Federal District Court for the Northern District of California
asserting patent infringement by the Company relating to its on-demand video
system. The complaint requests an unspecified amount of damages and
injunctive relief. The Company filed an answer and counterclaim to the
lawsuit on April 17, 1995, denying the claims, asserting affirmative defenses
and asserting a counterclaim for declaratory relief. The Company is
currently engaged in litigation with respect to this matter and trial is
expected to begin in August 1998. Based on the advice of special patent
counsel and technical experts retained by the Company, as well as the
Company's independent analysis, the Company believes that the claims of
infringement are unfounded and that OCC's patent is invalid. The Company has
and will continue to vigorously defend itself in this matter. Patent
litigation is especially complex, both as to the factual allegations and the
legal interpretation of patent claim language, which makes such lawsuits
difficult to assess with certainty. While the Company and its patent counsel
believe that the Company has a number of defenses available which, if
properly considered, would eliminate or minimize any liability for the
Company, an unexpected unfavorable resolution, depending on the amount and
timing, could adversely affect the Company. Although the outcome of any
litigation cannot be predicted with certainty, the Company believes that the
ultimate disposition of this matter will not have a material adverse effect
on the Company's financial position or results of operations.
Page F-11
<PAGE>
The Company is subject to other litigation arising in the ordinary
course of its businesses. As of the date hereof, in the opinion of
management, the resolution of such other litigation will not have a material
adverse effect on the Company's financial position or results of operations.
NOTE 10 -- STOCKHOLDERS' EQUITY
PREFERRED STOCK -- There are 5,000,000 shares of preferred stock, $.01
par value, authorized by the Company's certificate of incorporation, of which
none were outstanding at December 31, 1996 and 1997. The Board of Directors
may authorize the issuance of preferred stock, $.01 par value, in one or more
series and with rights and privileges for each issue as determined by the
Board of Directors.
COMMON STOCK -- On May 23, 1996, the Company sold 3,200,000 shares of
common stock at $13.00 per share in a public offering. On June 10, 1996 the
Company sold an additional 480,000 shares of common stock, representing the
underwriters' exercise of their over-allotment option in accordance with the
underwriting agreement. Net proceeds from these issuances, after
underwriters' commissions and other offering-related expenses, were
approximately $44.6 million. Such proceeds were used to repay borrowings
under the Company's revolving credit facility, approximately $25.9 million,
and to provide capital for the expansion of the Company's lodging and
residential businesses.
STOCKHOLDER RIGHTS PLAN -- On February 28, 1997, the Board of Directors
of the Company authorized and adopted a Stockholder Rights Plan. Pursuant to
the rights plan, the Board of Directors declared a dividend distribution of
one right for each outstanding share of common stock of the Company to
stockholders of record at the close of business on March 10, 1997.
Initially, the rights will be attached to all common stock certificates
and no separate rights certificates will be distributed. The rights will
separate from the common stock and be distributed upon the occasion of (i) a
public announcement that a person, group or entity has acquired or obtained
the right to acquire 15% or more of the common stock of the Company or (ii)
ten days following the commencement of, or an announcement of the intention
to make, a tender or exchange offer which would result in a person, group or
entity becoming the holder of 15% or more of the Company's common stock. The
rights are not exercisable until distributed.
In general, each right, when exercisable, initially entitles the
registered holder to purchase from the Company one-thousandth of a share of a
new series of preferred stock, designated as Series A Participating Preferred
Stock, par value $.01, at a price of $60.00 per share. In certain other
events, after the rights have become exercisable, each right entitles the
holder to purchase for $60.00 an amount of common stock of the Company, or in
certain circumstances securities of the acquirer, having a then-current
market value of two times the exercise price of the right. The rights
include anti-dilution provisions in the event of a stock dividend, split-up
or reclassification of the common stock. The preferred stock purchasable
upon exercise of the rights will be non-redeemable and junior to any other
issue of preferred stock the Company might issue, and will include dividend
and liquidation preferences. No stockholder privileges attach to the rights
until exercised.
Page F-12
<PAGE>
NOTE 11 -- STOCK OPTION PLANS
The Company has stock options plans which provide for the granting of up
to 1,926,792 non-qualified or incentive stock options on the Company's common
stock. Certain officers, directors and key employees have been granted
options to purchase common stock of the company under these plans. Options
become exercisable in accordance with vesting schedules determined by a
committee of the Board of Directors, and generally expire ten years after
date of grant. No options had expired as of December 31, 1997 and
outstanding options expire beginning in 2001 through 2007. The following is
a summary of the stock option activity for the years ending December 31:
<TABLE>
<CAPTION>
1996 1997
------------------------ ----------------------
Weighted Weighted
Number Average Number Average
of Exercise of Exercise
Shares Price Shares Price
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Beginning of year 1,318,426 $4.21 1,451,670 $5.79
Granted 239,000 $12.66 253,068 $14.99
Exercised (93,256) $0.62 (191,325) $1.08
Forfeited or canceled (12,500) $8.51 (7,000) $9.06
---------- ----------
End of year 1,451,670 $5.79 1,506,413 $7.91
---------- ----------
---------- ----------
Exercisable at end of year 907,671 $2.66 971,871 $5.12
---------- ----------
---------- ----------
</TABLE>
The following is a summary of stock options outstanding as of December 31,
1997:
<TABLE>
<CAPTION>
Outstanding options Exercisable Options
------------------------------------- ----------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Exercise Term Exercise Exercise
Price Range Number in Years Price Number Price
- --------------- ----------- --------- --------- -------- ----------
<S> <C> <C> <C> <C> <C>
$0.23 to $0.46 340,892 5.8 $0.34 340,892 $0.34
$2.77 to $3.23 237,022 5.6 $2.89 237,022 $2.89
$7.00 to $9.55 250,499 7.3 $8.49 163,332 $8.75
$10.78 to $13.29 451,000 8.1 $11.87 208,750 $11.67
$14.25 to $16.71 227,000 8.7 $16.03 21,875 $14.38
--------- --------
1,506,413 7.2 $7.91 971,871 $5.12
--------- --------
--------- --------
</TABLE>
The weighted average "fair value" of options granted during the year ended
December 31 was as follows:
<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
Weighted average fair
value per option granted $ 6.01 $ 7.13
-------- --------
-------- --------
</TABLE>
The "fair value" of each option granted was estimated as of the grant
date using the Black-Scholes option valuation model under the following
assumptions: (i) dividend yield - none, (ii) weighted average risk-free
interest rate - 6.4% in 1996, 6.22% in 1997; (iii) weighted average expected
life - 5.0 years, and (iv) weighted average expected volatility - 44.0% in
1996 and 44.5% in 1997.
Page F-13
<PAGE>
The Company accounts for its stock option compensation plans in
accordance with the provisions of Accounting Principles Board Opinion No. 25.
Accordingly, because the Company's stock option plans are fixed plans and
options are issued at fair market value, no compensation cost has been
charged to operations for any period presented. Had compensation cost been
determined in accordance with Statement of Financial Accounting Standards No.
123, net loss and loss per share would have increased, and the effect of such
increases, reflected on those items on a pro forma basis, would have been as
follows (in thousands of dollars, except per share amounts):
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------
1996 1997
---------- ---------
<S> <C> <C>
Net loss
As reported $(16,610) $(25,619)
Pro forma (18,047) (27,423)
Loss per share
As reported $ (1.74) $ (2.27)
Pro forma (1.88) (2.42)
</TABLE>
NOTE 12 -- WARRANTS
In connection with the Company's initial public offering in 1993, the
Company issued warrants to purchase 75,000 shares of common stock of the
Company to the underwriters. The exercise price of such warrants is $16.20
and the warrants expire on October 14, 1998.
In connection with the 1995 issuance of the 11.5% Senior Notes (see Note
7), the Company issued a total of 480,000 warrants to purchase common stock
of the Company. Each warrant entitles the holder to purchase one share of
common stock at an exercise price of $7.00 per share. The warrants include
demand registration rights and anti-dilution provisions, and such warrants
expire on July 15, 2005. The portion of the proceeds from the 1995 debt
issuance deemed attributable to the warrants was recorded as additional
paid-in capital.
NOTE 13 -- EXTRAORDINARY LOSS
Concurrently with the issuance of its 10.25% Senior Notes in 1996, the
Company redeemed its 9.95% and 10.35% Senior Notes due August 15, 2003. As a
consequence of the early redemption of the 9.95% and 10.35% Senior Notes, the
Company incurred a make-whole premium of $2,819,000 and wrote off related,
unamortized debt issuance costs of $434,000.
NOTE 14 -- SALE OF EQUITY INTEREST IN SUBSIDIARY
On October 21, 1996, the Company and its subsidiary, ResNet, entered
into agreements with TCI Satellite Entertainment, Inc. ("TCI Satellite")
under which ResNet sold a 4.99% equity interest in ResNet to TCI Satellite in
exchange for $5.4 million in cash. The proceeds related to the change in
equity interest were in excess of the Company's carrying value for its
investment, and such excess, approximately $4.7 million after transaction
expenses, was reflected as a credit to paid-in capital. Pursuant to a signal
carriage agreement, TCI Satellite has agreed to provide ResNet with
nationwide access to certain satellite programming signals.
In addition to the aforementioned cash investment, TCI Satellite agreed
to advance up to $34.6 million to ResNet during the five year period ending
October 21, 2001, under a convertible note agreement (the "Convertible
Note"). Use of the proceeds of the Convertible Note is limited to the
purchase of satellite receiving equipment from TCI Satellite. Amounts
outstanding under the Convertible Note are periodically convertible into
additional equity interests in ResNet. Such conversions are mandatory,
subject only to regulatory limitations on the size of the equity interest
that TCI Satellite may hold in ResNet. Without regard to the amount
outstanding under the Convertible Note, and in addition to its 4.99% interest
previously described, TCI Satellite will convert its interest in the
Convertible Note into an additional 32.0% equity interest in ResNet, subject
to the regulatory limitations described above. Under these conversion
features, TCI Satellite obtained the right effective October 21, 1997 to
acquire an additional 1.30% equity interest in ResNet. Future conversion
rights into additional equity interests in ResNet are as follows: at October
21, 1998--8.51%, at October 21, 1999--11.09% and at October 21, 2000--11.10%.
The Convertible Note matures on October 21, 2001, subject to a one-year
extension at the election of ResNet. On the maturity date, if regulatory
restrictions have prohibited the aforementioned conversions, ResNet shall
issue a warrant enabling TCI Satellite to purchase the defined additional
equity interests in ResNet for the unconverted amount of the Convertible
Note. Upon issuance of the warrant, borrowings and unpaid interest under the
Note shall be cancelled and deemed repaid in full. The warrant, if and when
issued, will expire June 4, 2007.
The Convertible Note is unsecured, is not subject to prepayment, has no
recourse to the Company, and is subordinated to all present and future
borrowings by the Company to the extent that the proceeds thereof are
Page F-14
<PAGE>
advanced to ResNet. Further, the Convertible Note is subordinated to
inter-company loans or advances to ResNet by the Company. Interest accrues
(generally at TCI Satellite's average borrowing rate) on amounts outstanding
under the Convertible Note, but such interest is not paid in cash and does
not increase the equity interest into which the Convertible Note will be
mandatorily converted. Such interest accrues only until maturity or such
time as the balance of outstanding principal and accrued interest is $34.6
million, whichever is sooner. The Company, ResNet and TCI Satellite have
agreed that all amounts advanced by the Company to ResNet shall be in
accordance with an inter-company promissory note, which shall bear interest.
In connection with the aforementioned agreements, the Company has
granted TCI Satellite an option to acquire an additional 13.00% equity
interest in ResNet, first exercisable 60 days following October 21, 1999.
Such option is to be exercised in exchange for an additional cash investment
in ResNet based on ResNet's then fair market value. Such option will expire,
subject to certain limitations, coincident with the maturity of the
Convertible Note.
LIQUIDATION PREFERENCE -- The Company, ResNet and TCI Satellite have
agreed that in the event of a sale of ResNet, or a sale of substantially all
of the assets of ResNet, that (i) repayment of any inter-company loans or
advances by the Company to ResNet shall have preference to any other
distribution, (ii) that after repayment of such advances, that TCI Satellite
shall be entitled to a preferential return of its aggregate investment in
ResNet and (iii) that after the repayment of amounts in accordance with items
(i) and (ii), that any further distribution shall be determined on a
per-share basis.
On June 4, 1997, ResNet Communications, Inc. was converted to a Delaware
limited liability corporation, ResNet Communications, L.L.C.
NOTE 15 -- INCOME TAXES
The provisions for income taxes consisted of state income taxes. The
Company and its subsidiaries file separate federal income tax returns. At
December 31, 1997, the Company had net operating loss carry-forwards in
excess of $74 million for federal income tax purposes. Such carry-forwards
expire beginning in 2001 through 2012, and federal tax regulations limit the
availability and timing of usage of carry-forwards. Significant components
of the Company's deferred tax liabilities and assets were as follows at (in
thousands of dollars):
<TABLE>
<CAPTION>
December 31,
------------------------
1996 1997
--------- ---------
<S> <C> <C>
Deferred tax liabilities:
Tax over book depreciation $ (9,899) $ (5,207)
--------- ---------
Deferred tax assets:
Net operating loss carry-forwards 18,502 25,283
Deferred programming 624 153
Other 1,135 1,081
--------- ---------
20,261 26,517
--------- ---------
Net deferred tax assets 10,362 21,310
Valuation allowance (10,362) (21,310)
--------- ---------
Net deferred taxes $ -- $ --
--------- ---------
--------- ---------
</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.
Page F-15
<PAGE>
NOTE 16 -- SEGMENT INFORMATION
The Company's operations have been classified into two business
segments: lodging and residential. The lodging segment utilizes interactive
systems designed, assembled and operated by the Company to provide guest room
entertainment, information and convenience services to the lodging industry.
The residential segment uses systems designed, built and operated by the
Company to provide cable television programming and other entertainment
services to multifamily residences.
The Company's operations, prior to 1996, consisted only of lodging
operations. Summarized financial information by business segment for 1996
and 1997 is included in the table below (in thousands of dollars):
<TABLE>
<CAPTION>
1996 1997 1996 1997
--------- --------- -------- --------
<S> <C> <C> <C> <C> <C>
Revenue: Total Assets:
- ------------- ----------------
Lodging $97,389 $133,010 Lodging $143,820 $170,638
Residential 332 2,700 Residential 5,548 21,425
--------- --------- Corporate 130,400 68,231
-------- --------
$97,721 $135,710 $279,768 $260,294
--------- --------- -------- --------
--------- --------- -------- --------
Operating Depreciation and
Loss: Amortization:
- ------------- ------------------
Lodging $9,839 $18,029 Lodging $24,346 $33,172
Residential (179) (3,601) Residential 328 1,546
Corporate (14,746) (22,492) Corporate 5,141 9,042
--------- --------- -------- --------
$(5,086) $(8,064) $29,815 $43,760
--------- --------- -------- --------
--------- --------- -------- --------
Capital
Expenditures:
- --------------
Lodging $59,597 $60,096
Residental 5,518 16,762
Corporate 20,143 28,625
--------- ---------
$85,258 $105,483
--------- ---------
--------- ---------
</TABLE>
Page F-16
<PAGE>
NOTE 17 -- SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following selected quarterly financial data are in thousands of
dollars, except per share data:
<TABLE>
Caption
Quarter Quarter Quarter Quarter
Ending Ending Ending Ending
March 31, June 30, September 30, December 31,
----------- ---------- ------------- ------------
<S> <C> <C> <C> <C>
For 1996:
Total revenue $ 20,368 $ 23,202 $ 27,116 $ 27,035
Gross profit 11,254 12,780 14,425 14,883
Loss before extraordinary loss (2,873) (3,395) (1,857) (5,232)
Net loss (2,873) (3,395) (1,857) (8,485)
Per common share (basic and
diluted (1):
Loss before extraordinary loss $ (0.39) $ (0.39) $ (0.17) $ (.47)
Net loss (2) (0.39) (0.39) (0.17) (.77)
For 1997:
Total revenue $ 29,656 $ 33,132 $ 36,692 $ 36,230
Gross profit 16,839 18,794 20,961 20,604
Loss before cumulative effect of
change in accounting principle (6,679) (5,756) (5,050) (7,924)
Net loss (6,679) (5,756) (5,050) (8,134)
Per common share (basic and
diluted) (1):
Loss before cumulative effect
of change in accounting principle $ (0.60) $ (0.51) $ (0.45) $ (.70)
Net loss (3) (0.60) (0.51) (0.45) (.71)
</TABLE>
- ---------------------
(1) Per share amounts are computed independently for each of the quarters
presented. Therefore, the sum of such amounts will not equal the total
for the year.
(2) The results of the quarter ended December 31, 1996 included an
extraordinary loss of approximately $3.3 million relating to the early
retirement of debt (see Note 13).
(3) The results of the quarter ended December 31, 1997 include a $210,000
charge for the effect of adopting EITF Issue 97-13 related to accounting
for certain business reengineering costs (see Note 3).
Page F-17
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE
To LodgeNet Entertainment Corporation:
We have audited, in accordance with generally accepted auditing standards,
the consolidated financial statements included in this annual report on Form 10-
K, and have issued our report thereon dated February 25, 1998. Our audit was
made for the purpose of forming an opinion on those financial statements taken
as a whole. The following schedule is the responsibility of the Company's
management and is presented for purposes of complying with the Securities and
Exchange Commission's rules and is not part of the basic financial statements.
This schedule has been subjected to the auditing procedures applied in the
audit of the basic financial statements and, in our opinion, fairly states in
all material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota
February 25, 1998
Page F-18
<PAGE>
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Column A Column B Column C Column D Column E
- ------------------------------------ ----------- --------- --------- ---------
Additions
Charged
Balance to Balance
Beginning Costs and Deductions End of
Description of Period Expenses (Note 1) Period
- ------------------------------------ ---------- ----------- ---------- ---------
<S> <C> <C> <C> <C>
Allowances deducted from related
balance sheet accounts:
Year Ended December 31, 1995:
Allowance for Doubtful Accounts $ 228 $ 343 $ 161 $ 410
Year Ended December 31, 1996:
Allowance for Doubtful Accounts $ 410 $ 922 $ 547 $ 785
Year Ended December 31, 1997:
Allowance for Doubtful Accounts $ 785 $ 820 $ 805 $ 800
</TABLE>
- ----------------
(1) All deductions from reserves were for the purposes for which such reserves
were created.
Page F-19
<PAGE>
EXHIBIT 12.1
LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES
Statement Regarding Computation of Ratios (Unaudited)
(Dollar amounts in thousands)
Computation of Coverage of Fixed Charges
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1993 1994 1995 1996 1997
---------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Net loss $ (2,057) $ (4,650) $ (7,026) $ (16,610) $ (25,619)
Add:
Extraordinary loss (1) -- 1,324 -- 3,253 --
Cumulative effect of change
in accounting principle (2) -- -- -- -- 210
Provision for income taxes -- -- 66 28 344
Add fixed charges (3):
Interest 2,096 966 4,522 8,243 17,895
Interest portion of rentals 27 74 106 159 210
--------- ---------- ---------- ----------- ----------
Earnings available to cover
fixed charges 66 (2,286) (2,332) (4,927) (6,960)
Less fixed charges 2,123 1,040 4,628 8,402 18,105
---------- ---------- ---------- ----------- ---------
Deficiency in the coverage of
fixed charges $ (2,057) $ (3,326) $ (6,960) $ (13,329) $(25,065)
---------- ---------- ---------- ----------- ---------
---------- ---------- ---------- ----------- ---------
</TABLE>
- ---------------------------------
(1) In 1994 -- loss on early termination of the Company's then bank credit
facility. In 1996 -- loss on early redemption of the Company's 9.95% and
10.35% Senior Notes.
(2) In 1997 -- charge for the effect of adopting EITF Issue 97-13 related to
accounting for certain business reengineering costs.
(3) Fixed charges consist of interest on all indebtedness, including
amortization of debt issuance expense and capitalized interest, and
one-third of rental expense (which is estimated to represent the interest
portion thereof).
<PAGE>
EXHIBIT 21.1
SUBSIDIARIES OF THE COMPANY
LodgeNet Entertainment (Canada) Corporation, a Canadian corporation
ResNet Communications, Inc., a Delaware corporation
ResNet Communications, L.L.C., a Delaware corporation
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our reports included in this Form 10-K into the Company's previously filed
Registration Statement File No. 33-67676.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota
March 23, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF LODGENET ENTERTAINMENT CORPORATION AND ITS
SUBSIDIARIES AS OF DECEMBER 31, 1997, AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 1,021
<SECURITIES> 0
<RECEIVABLES> 21,835
<ALLOWANCES> (800)
<INVENTORY> 0
<CURRENT-ASSETS> 26,313
<PP&E> 325,334
<DEPRECIATION> (106,386)
<TOTAL-ASSETS> 260,294
<CURRENT-LIABILITIES> 25,645
<BONDS> 182,691
0
0
<COMMON> 113
<OTHER-SE> 49,466
<TOTAL-LIABILITY-AND-EQUITY> 260,294
<SALES> 135,710
<TOTAL-REVENUES> 135,710
<CGS> 58,512
<TOTAL-COSTS> 85,262
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 17,001
<INCOME-PRETAX> (25,065)
<INCOME-TAX> 344
<INCOME-CONTINUING> (25,409)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 210
<NET-INCOME> (25,619)
<EPS-PRIMARY> (2.27)
<EPS-DILUTED> 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C> <C>
<PERIOD-TYPE> YEAR 3-MOS 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1996
<PERIOD-START> JAN-01-1996 JAN-01-1996 APR-01-1996 JUL-01-1996
<PERIOD-END> DEC-31-1996 MAR-31-1996 JUN-30-1996 SEP-30-1996
<CASH> 86,177 14 10,984 2,083
<SECURITIES> 0 0 0 0
<RECEIVABLES> 19,213 14,583 15,772 18,493
<ALLOWANCES> (785) (513) (541) (784)
<INVENTORY> 0 0 0 0
<CURRENT-ASSETS> 106,540 16,765 28,386 22,446
<PP&E> 234,265 169,009 192,211 209,830
<DEPRECIATION> (70,108) (48,911) (55,443) (61,111)
<TOTAL-ASSETS> 279,768 139,469 167,611 174,368
<CURRENT-LIABILITIES> 21,796 24,834 26,671 28,193
<BONDS> 179,233 73,133 58,147 63,847
0 0 0 0
0 0 0 0
<COMMON> 111 74 110 110
<OTHER-SE> 75,441 39,826 81,020 79,166
<TOTAL-LIABILITY-AND-EQUITY> 279,768 139,469 167,611 174,368
<SALES> 97,721 20,368 23,202 27,116
<TOTAL-REVENUES> 97,721 20,368 23,202 27,116
<CGS> 44,379 9,114 10,422 12,691
<TOTAL-COSTS> 58,428 12,185 14,095 14,504
<OTHER-EXPENSES> 0 0 0 0
<LOSS-PROVISION> 0 0 0 0
<INTEREST-EXPENSE> 8,243 1,922 2,078 1,769
<INCOME-PRETAX> (13,329) (2,853) (3,393) (1,848)
<INCOME-TAX> 28 20 2 9
<INCOME-CONTINUING> (13,357) (2,873) (3,395) (1,857)
<DISCONTINUED> 0 0 0 0
<EXTRAORDINARY> 3,253 0 0 0
<CHANGES> 0 0 0 0
<NET-INCOME> (16,610) (2,873) (3,395) (1,857)
<EPS-PRIMARY> (1.74) (.39) (.39) (.17)
<EPS-DILUTED> 0 0 0 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997 DEC-31-1997
<PERIOD-START> JAN-01-1997 APR-01-1997 JUL-01-1997
<PERIOD-END> MAR-31-1997 JUN-30-1997 SEP-30-1997
<CASH> 60,416 34,436 20,070
<SECURITIES> 0 0 0
<RECEIVABLES> 21,919 22,470 23,341
<ALLOWANCES> (806) (1,000) (705)
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 84,017 62,387 46,012
<PP&E> 256,536 280,326 304,157
<DEPRECIATION> (77,999) (86,710) (96,358)
<TOTAL-ASSETS> 274,921 268,799 266,064
<CURRENT-LIABILITIES> 23,403 22,128 24,321
<BONDS> 179,304 179,454 179,460
0 0 0
0 0 0
<COMMON> 111 112 114
<OTHER-SE> 68,827 63,200 58,206
<TOTAL-LIABILITY-AND-EQUITY> 274,921 268,799 266,064
<SALES> 29,656 33,132 36,692
<TOTAL-REVENUES> 29,656 33,132 36,692
<CGS> 12,817 14,338 15,731
<TOTAL-COSTS> 19,444 20,228 21,362
<OTHER-EXPENSES> 0 0 0
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 4,064 4,302 4,638
<INCOME-PRETAX> (6,669) (5,736) (5,039)
<INCOME-TAX> 10 20 11
<INCOME-CONTINUING> (6,679) (5,756) (5,050)
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> (6,679) (5,756) (5,050)
<EPS-PRIMARY> (.60) (.51) (.45)
<EPS-DILUTED> 0 0 0
</TABLE>
