<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X ] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
FOR THE PERIOD ENDED MARCH 31, 1998
Commission File Number 0-22334
LODGENET ENTERTAINMENT CORPORATION
----------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 46-0371161
---------------------------------- -----------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number )
3900 WEST INNOVATION STREET, SIOUX FALLS, SOUTH DAKOTA 57107
-----------------------------------------------------------------------
(Address of Principal Executive Offices) (ZIP code)
(605) 988-1000
----------------------------------
(Registrant's telephone number,
including area code)
808 WEST AVENUE NORTH, SIOUX FALLS, SOUTH DAKOTA 57104
--------------------------------------------------------
(Former name, former address and
former fiscal year, if changed since last report)
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 .
----- -----
At May 11, 1998, there were 11,545,531 shares outstanding of the
Registrant's common stock, $0.01 par value.
THIS REPORT CONTAINS A TOTAL OF 15 PAGES
<PAGE>
Lodgenet Entertainment Corporation Form 10-Q
LODGENET ENTERTAINMENT CORPORATION
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
Page
No.
<S> <C>
PART I. FINANCIAL INFORMATION
- ------------------------------
Item 1 -- Financial Statements:
Consolidated Balance Sheets as of December 31, 1997 and March 31, 1998(Unaudited). . . . . . 3
Consolidated Statements of Operations (Unaudited) for
the Three Months Ended March 31, 1997 and 1998. . . . . . . . . . . . . . . . . . . . . . 4
Consolidated Statements of Cash Flows (Unaudited) for
the Three Months Ended March 31, 1997 and 1998. . . . . . . . . . . . . . . . . . . . . . 5
Notes to Consolidated Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . . . 6
Item 2 -- Management's Discussion and Analysis of the Results of Operations. . . . . . . . . . . . 8
PART II. OTHER INFORMATION
- ---------------------------
Item 1 -- Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Item 2 -- Changes in Securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Item 3 -- Defaults Upon Senior Securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Item 4 -- Submission of Matters to a Vote of Security Holders. . . . . . . . . . . . . . . . . . . 14
Item 5 -- Other Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Item 6 -- Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
- ----------
</TABLE>
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS -- CERTAIN STATEMENTS IN
THIS QUARTERLY REPORT ON FORM 10-Q 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 QUARTERLY
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 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 THIS QUARTERLY REPORT, 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 QUARTERLY
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.
- ----------
As used herein (unless the context otherwise requires) "LodgeNet", "the
Company" and/or "the Registrant" means LodgeNet Entertainment Corporation and
its majority-owned subsidiaries.
March 31, 1998 Page 2
<PAGE>
LodgeNet Entertainment Corporation Form 10-Q
PART I -- FINANCIAL INFORMATION
LODGENET ENTERTAINMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
December 31, March 31,
1997 1998
------------ -----------
Assets (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 1,021 $ 840
Accounts receivable, net of allowance for doubtful accounts 21,835 22,120
Prepaid expenses and other 3,457 4,148
------------ -----------
Total current assets 26,313 27,108
Property and equipment, net of accumulated depreciation 218,948 225,751
Debt issuance costs, net of accumulated amortization 7,641 7,393
Other assets, net 7,392 11,760
------------ -----------
$ 260,294 $ 272,012
------------ -----------
------------ -----------
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 17,930 $ 12,703
Current maturities of long-term debt 705 736
Accrued expenses 7,010 9,537
------------ -----------
Total current liabilities 25,645 22,976
Deferred revenue 2,069 2,334
Long-term debt 182,691 205,224
Minority interest in consolidated subsidiary 310 310
------------ -----------
Total liabilities 210,715 230,844
------------ -----------
Commitments and contingencies
Stockholders' equity:
Common stock, $.01 par value, 20,000,000 shares authorized;
11,322,058 shares outstanding at December 31, 1997 and
11,533,031 shares outstanding at March 31, 1998 113 115
Additional paid-in capital 120,792 120,937
Accumulated deficit (71,326) (79,884)
------------ -----------
Total stockholders' equity 49,579 41,168
------------ -----------
$ 260,294 $ 272,012
------------ -----------
------------ -----------
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
March 31, 1998 Page 3
<PAGE>
LodgeNet Entertainment Corporation Form 10-Q
LODGENET ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(Dollar amounts, except per share amounts, in thousands)
<TABLE>
<CAPTION>
Three Months Ended March 31,
------------------------------
1997 1998
------------ ------------
<S> <C> <C>
Revenues:
Guest Pay $ 25,567 $ 31,849
Free-to-guest 2,166 2,061
Other 1,923 2,437
------------ ------------
Total revenues 29,656 36,347
------------ ------------
Direct costs:
Guest Pay 9,726 13,071
Free-to-guest 1,735 1,545
Other 1,356 1,464
------------ ------------
Total direct costs 12,817 16,080
------------ ------------
Gross profit 16,839 20,267
------------ ------------
Operating expenses:
Guest Pay operations 4,693 6,137
Selling, general and administrative 5,056 4,826
Depreciation and amortization 9,695 12,578
------------ ------------
Total operating expenses 19,444 23,541
------------ ------------
Operating loss (2,605) (3,274)
Interest expense, net 4,064 5,210
Provision for income taxes 10 151
------------ ------------
Net loss $ (6,679) $ (8,635)
------------ ------------
------------ ------------
Per common share (basic and diluted):
Net loss $ (0.60) $ (0.76)
------------ ------------
------------ ------------
Weighted average shares outstanding 11,209,124 11,356,675
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
March 31, 1998 Page 4
<PAGE>
LodgeNet Entertainment Corporation Form 10-Q
LODGENET ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Three Months Ended March 31,
------------------------------
1997 1998
------------ ------------
<S> <C> <C>
Operating activities:
Net loss $ (6,679) $ (8,635)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Depreciation and amortization 9,695 12,578
Change in operating assets and liabilities:
Accounts receivable (2,633) (275)
Prepaid expenses and other (553) (607)
Accounts payable (1,574) (5,229)
Accrued expenses and deferred revenue 3,117 2,794
Other (465) (136)
------------ ------------
Net cash provided by operating activities 908 490
------------ ------------
Investing activities:
Property and equipment additions (22,305) (18,772)
Purchase of cable television operations (4,562) --
Investment in unconsolidated affiliate -- (4,662)
------------ ------------
Net cash used for investing activities (26,867) (23,434)
------------ ------------
Financing activities:
Proceeds from long-term debt 238 1,204
Repayment of long-term debt (106) (88)
Borrowings under revolving credit facility -- 21,500
Stock option activity 86 147
------------ ------------
Net cash provided by financing activities 218 22,763
------------ ------------
Effect of exchange rates on cash (20) --
------------ ------------
Decrease in cash and cash equivalents (25,761) (181)
Cash and cash equivalents at beginning of period 86,177 1,021
------------ ------------
Cash and cash equivalents at end of period $ 60,416 $ 840
------------ ------------
------------ ------------
Supplemental cash flow information:
Cash paid for interest $ 1,076 $ 1,743
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
March 31, 1998 Page 5
<PAGE>
LodgeNet Entertainment Corporation Form 10-Q
LODGENET ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 -- Basis of Presentation
The accompanying consolidated financial statements as of March 31,
1998, and for the three month periods ended March 31, 1997 and 1998, have
been prepared by LodgeNet Entertainment Corporation (the "Company"), without
audit, pursuant to the rules and regulations of the Securities and Exchange
Commission (the "Commission"). The information furnished in the accompanying
consolidated financial statements reflects all adjustments, consisting only
of normal recurring adjustments, which, in the opinion of management, are
necessary for a fair presentation of such financial statements.
Certain information and footnote disclosures, normally included in
financial statements prepared in accordance with generally accepted
accounting principles, have been condensed or omitted pursuant to the rules
and regulations of the Commission. Although the Company believes that the
disclosures are adequate to make the information presented herein not
misleading, it is recommended that these unaudited consolidated financial
statements be read in conjunction with the more detailed information
contained in the Company's Annual Report on Form 10-K for 1997, as filed with
the Commission. The results of operations for the three month period ended
March 31, 1998 are not necessarily indicative of the results of operations
for the full year.
The consolidated financial statements include the accounts of LodgeNet
Entertainment Corporation and its majority-owned subsidiaries. All
significant inter-company accounts and transactions have been eliminated in
consolidation.
Note 2 -- Property and Equipment, Net
Property and equipment was comprised as follows at (in thousands of dollars):
<TABLE>
<CAPTION>
December 31, March 31,
1997 1998
------------ ---------
<S> <C> <C>
Land, building and equipment $ 40,051 $ 42,878
Free-to-guest equipment 11,855 12,937
Cable television equipment 13,877 16,873
Guest pay systems:
Installed 220,778 232,758
System components 30,720 29,199
Software costs 8,053 8,581
------------ ---------
Total 325,334 343,226
Less - depreciation and amortization (106,386) (117,475)
------------ ---------
Property and equipment, net $ 218,948 $ 225,751
------------ ---------
------------ ---------
</TABLE>
Note 3 -- Loss Per Share Computation
Effective in the fourth quarter of 1997, the Company adopted Statement
of Financial Accounting Standard ("SFAS") No. 128, "Earnings Per Share".
SFAS No. 128 changed 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 amount for
the three months ended March 31, 1997 has been restated from $(.59) per share
to $(.60) per share to give effect to the adoption of SFAS No. 128.
March 31, 1998 Page 6
<PAGE>
LodgeNet Entertainment Corporation Form 10-Q
Note 4 -- Effect of Recently Issued Accounting Standards
In March 1998, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of
Position ("SOP") 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use". SOP 98-1 provides guidance on the
accounting for the costs of computer software developed or obtained for
internal use and provides guidance for determining whether computer software
is for internal use. The SOP is effective for financial statements for
fiscal years beginning after December 15, 1998. The Company has reviewed its
accounting for computer software development costs and believes that the
adoption of SOP 98-1 will not have a material effect on the Company's
financial condition or results of operations.
March 31, 1998 Page 7
<PAGE>
LodgeNet Entertainment Corporation Form 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 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.
FREE-TO-GUEST SERVICES. In addition to guest pay services, the Company
provides cable television programming for which the hotel, rather than its
guests, pays the charges. Free-to-guest services include the satellite
delivery of various programming channels through a satellite earth station,
which generally is owned or leased by the hotel. The hotel pays the Company
a fixed monthly charge per room for each programming channel provided. The
Company obtains its free-to-guest programming pursuant to multi-year
agreements with the programmers and pays a fixed monthly fee per room which
varies depending on incentive programs in effect from time to time from the
programming networks. In April 1996, the Company entered into an agreement
with PRIMESTAR pursuant to which the Company was appointed as the exclusive
third-party provider (other than partners in PRIMESTAR and their affiliated
distributors) of the PRIMESTAR-Registered Trademark- DBS (digital direct
broadcast satellite) signal to the lodging industry. Pursuant to this
agreement, the Company pays a fee to PRIMESTAR for access to the PRIMESTAR
signal, which enables the Company to provide free-to-guest digital satellite
programming to a broader segment of the lodging industry than can be
cost-effectively served with traditional C-band satellite systems.
March 31, 1998 Page 8
<PAGE>
LodgeNet Entertainment Corporation Form 10-Q
The Company installed its systems in the following number of rooms, net
of de-installations, for the following periods ended March 31, 1998:
<TABLE>
<CAPTION>
Three Twelve
Months Months
Ended Ended
-------- --------
<S> <C> <C>
Guest Pay Rooms 21,753 100,908
-------- --------
-------- --------
Nintendo Game System Rooms 25,795 115,908
-------- --------
-------- --------
Free-to-Guest Rooms 15,016 55,442
-------- --------
-------- --------
</TABLE>
The room installations for the twelve months ended March 31, 1998
represent increases of 23.3% for Guest Pay, 32.3% for Nintendo, and 18.4% for
free-to-guest, over the room bases at March 31, 1997.
The Company's base of installed rooms was comprised as follows at March 31:
<TABLE>
<CAPTION>
1997 1998
----------------- -----------------
Rooms % Rooms %
--------- ------ --------- ------
<S> <C> <C> <C> <C>
Guest Pay Rooms:
Scheduled 38,182 8.8 24,476 4.6
On-demand 394,514 91.2 509,128 95.4
--------- ------ --------- ------
432,696 100.0 533,604 100.0
--------- ------ --------- ------
--------- ------ --------- ------
Nintendo game system rooms 359,036 474,944
--------- ---------
--------- ---------
Free-to-guest rooms:
At hotels with Guest Pay services 202,214 260,258
At hotels with only free-to-guest services 98,390 95,788
--------- ---------
300,604 356,046
--------- ---------
--------- ---------
</TABLE>
RESIDENTIAL SERVICES
In January 1996, the Company formed ResNet Communications, L.L.C.
("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, TCI Satellite, 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 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.
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 March 31:
1997 1998
------- -------
Residential units passed 15,528 28,718
------- -------
------- -------
March 31, 1998 Page 9
<PAGE>
LodgeNet Entertainment Corporation Form 10-Q
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1997 AND 1998
REVENUE ANALYSIS
The Company's total revenue for the first quarter of 1998 increased
22.6%, or $6.7 million, in comparison to the first quarter of 1997. The
following table sets forth the components of the Company's revenue for the
quarter ending March 31 (dollar amounts in thousands):
<TABLE>
<CAPTION>
1997 1998
------------------------ ------------------------
Percent Percent
of Total of Total
Amount Revenue Amount Revenue
---------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Guest Pay $ 25,567 86.2 $ 31,849 87.6
Free-to-guest 2,166 7.3 2,061 5.7
Other 1,923 6.5 2,437 6.7
---------- ----------- ---------- ----------
Total $ 29,656 100.0 $ 36,347 100.0
---------- ----------- ---------- ----------
---------- ----------- ---------- ----------
</TABLE>
GUEST PAY REVENUE -- Guest Pay revenue increased 24.6%, or $6.3 million, in
the first quarter of 1998 in comparison to the same quarter of 1997. This
increase was primarily the result of a 26.3% increase in the average number
of installed Guest Pay rooms, partially offset by a slight decline in average
monthly revenue per room. The following table sets forth information in
regard to average monthly revenue per installed Guest Pay room for the
quarter ending March 31:
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Average monthly revenue per room:
Movie revenue $ 17.64 $ 17.34
Video game and other service revenue 3.04 3.06
-------- --------
Total per Guest Pay room $ 20.68 $ 20.40
-------- --------
-------- --------
</TABLE>
Average movie revenue per room was impacted by lower average buy rates
attributable to a relatively less popular selection of newly-released major
motion pictures in the current quarter as compared to the year earlier
quarter.
Average video game and other service revenue per room increased
primarily as a result of the increase in the number of rooms with information
and other services installed, partially offset by a decrease in average
monthly video game revenue per room.
FREE-TO-GUEST REVENUE -- Free-to-guest revenue decreased 4.8%, or
$105,000, in the first quarter of 1998 as compared to the same quarter of
1997. This decrease is primarily the result of a 2.6% decrease in the number
of rooms receiving only free-to-guest services from the first quarter of 1997
(although total rooms receiving free-to-guest services increased by 18.4%).
OTHER REVENUE -- 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 the first
quarter of 1998 from the first quarter of 1997 of $514,000 or 26.7%, is
primarily due to increased cable television revenue generated by the
residential services segment of $952,000, partially offset by a decrease in
sales of televisions and system equipment.
March 31, 1998 Page 10
<PAGE>
LodgeNet Entertainment Corporation Form 10-Q
EXPENSE ANALYSIS
DIRECT COSTS -- The following table sets forth information in regard to the
Company's direct costs and gross profit margin for the quarter ending March 31
(dollar amounts in thousands):
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Direct costs:
Guest Pay $ 9,726 $ 13,071
Free-to-guest 1,735 1,545
Other 1,356 1,464
-------- --------
$ 12,817 $ 16,080
-------- --------
-------- --------
Gross profit margin:
Guest Pay 62.0% 59.0%
Free-to-guest 19.9% 25.0%
Other 29.5% 39.9%
Composite 56.8% 55.8%
</TABLE>
Guest Pay direct costs increased 34.4%, or $3.3 million, in the first
quarter of 1998 as compared to the year earlier quarter. Since Guest Pay
direct costs (primarily studio license fees, video game license fees and the
commission retained by the hotel) are primarily based on related revenue,
such direct costs tend to vary directly with revenue. As a percentage of
revenue, such costs increased from 38.0% in the first quarter of 1997 to
41.0% in the current quarter. The increase in Guest Pay direct costs as a
percentage of revenue reflects higher video game costs (which are incurred
based on the number of rooms receiving video game services rather than the
number of game buys) as well as slight increases in studio license fees and
commissions paid to the hotels.
Free-to-guest direct costs decreased 11.0% or $190,000 in the first
quarter of 1998 as compared to the year earlier quarter. As a percentage of
free-to-guest revenue, free-to-guest direct costs decreased to 75.0% from
80.1% in the year-earlier quarter. The decrease in free-to-guest direct
costs as a percentage of revenue resulted from a shift of certain
free-to-guest rooms, which have historically incurred direct costs higher
than the average free-to-guest room, from the free-to-guest revenue component
to the Guest Pay revenue component in the first quarter of 1998.
Direct costs associated with other revenue increased $108,000 or 8.0% in
the first quarter of 1998 from the year earlier quarter. As a percentage of
related revenues, such direct costs decreased to 60.1% of other revenue in
the current quarter versus 70.5% in the first quarter of 1997, primarily
reflecting the effect of the increased cable television revenue previously
described, which generally earns a higher margin than the other sources of
other revenue.
The Company's overall gross profit increased 20.4%, or $3.4 million, to
$20.3 million in the first quarter of 1998 on a 22.6% increase in revenues in
comparison to the same period in the prior year. The Company's overall gross
profit margin was 55.8% in the current quarter, as compared to the year
earlier 56.8%.
OPERATING EXPENSES -- The following table sets forth information in
regard to the Company's operating expenses for the quarter ending March 31
(dollar amounts in thousands):
<TABLE>
<CAPTION>
1997 1998
------------------------ ------------------------
Percent Percent
of Total of Total
Amount Revenue Amount Revenue
---------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Operating expenses:
Guest Pay operations $ 4,693 15.8% $ 6,137 16.9%
Selling, general and administrative 5,056 17.0% 4,826 13.3%
Depreciation and amortization 9,695 32.7% 12,578 34.6%
---------- ----------- ---------- ----------
Total operating expenses $ 19,444 65.5% $ 23,541 64.8%
---------- ----------- ---------- ----------
---------- ----------- ---------- ----------
</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
serviced by the residential services segment. Excluding the expenses
incurred to operate the systems at residential sites, which were $746,000 in
the first quarter of 1998 and $142,000 in the first quarter of 1997, expenses
related to Guest Pay operations increased 18.5%, or $840,000 in the first
quarter of 1998 compared to the year earlier quarter. This increase is
primarily attributable to the 26.3% increase in average installed Guest Pay
rooms in the first quarter of 1998 as compared to the year earlier quarter,
partially offset by lower average operating and service expenses incurred on
a per room basis. Per average installed Guest Pay room,
March 31, 1998 Page 11
<PAGE>
LodgeNet Entertainment Corporation Form 10-Q
such expenses were $3.45 per month in the first quarter of 1998 as compared
to $3.79 per month in the first quarter of 1997.
Selling, general and administrative expenses decreased 4.5%, or $230,000
in the first quarter of 1998 compared to the year earlier quarter. The
decrease reflects a reduction in litigation and facilities-related expenses.
As a percentage of revenue, such expenses were 13.3% in the current quarter
as compared to 17.0% in the year earlier quarter.
Depreciation and amortization expenses increased 29.7% to $12.6 million
in the first quarter of 1998 from $9.7 million in the year earlier quarter.
This increase is directly attributable to the increases in the number of
installed Guest Pay rooms and ResNet units, associated software and other
capitalized costs such as service vans, equipment and computers that are
related to the increased number of rooms and units in service since the
year-earlier quarter. ResNet depreciation and amortization was $803,000 in
the first quarter of 1998 compared to $189,000 in the year earlier quarter.
OPERATING LOSS -- The Company's operating loss, as a result of the
factors previously discussed, was $(3.3) million in the current quarter as
compared to $(2.6) million in the same quarter of 1997.
INTEREST EXPENSE -- Interest expense, net of interest income, increased
to $5.2 million in the current quarter from $4.1 million in the comparable
quarter of 1997, primarily due to decreased interest income and increases in
long-term debt to fund the Company's continuing expansion of its business.
Interest income decreased from $855,000 in the first quarter of 1997 to
$7,000 in the first quarter of 1998 due to the use of proceeds from previous
borrowings to fund the Company's expansion. Long-term debt increased from
$179.8 million at March 31, 1997 to $206.0 million at March 31, 1998.
Average principal amount of long-term debt outstanding during the quarter
ended March 31, 1998 was approximately $195 million (at an average interest
rate of approximately 10.5%) as compared to an average principal amount
outstanding of approximately $180 million (at an average interest rate of
approximately 10.5%) during the comparable period of 1997.
NET LOSS -- For the reasons previously discussed, the Company's net loss
increased to $(8.6) million in the first quarter of 1998 from a net loss of
$(6.7) million in the same quarter a year earlier.
EBITDA -- As a result of increasing revenues from Guest Pay services,
and the other factors previously described, EBITDA (defined as "earnings
before interest, income taxes, depreciation and amortization") increased
31.2% to $9.3 million in the first quarter of 1998 as compared to $7.1
million in the first quarter of 1997. EBITDA as a percentage of total
revenues was 25.6% in the current quarter as compared to 23.9% in the same
quarter of 1997. EBITDA is included herein because it is a widely accepted
financial indicator used by certain investors and financial analysts to
assess and compare companies on the basis of operating performance. EBITDA
is not intended to represent an alternative to net income (as determined in
accordance with generally accepted accounting principles) as a measure of
performance, but management believes that it does provide an important
additional perspective on the Company's operating results and the Company's
ability to service its long-term debt and to fund the Company's continuing
growth.
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 calendar 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. During the first quarter of 1998, capital
expenditures were approximately $18.8 million and net cash provided by
operating activities was $490,000.
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 $50 to $60 million during the remainder
of 1998 and substantial amounts thereafter. The actual amount and timing of
the Company's capital expenditures will vary (and such variations could be
material) depending upon the number of new contracts for services entered
into by the Company, the costs of installations and other factors. This a
forward-looking statement and there can be no
March 31, 1998 Page 12
<PAGE>
LodgeNet Entertainment Corporation Form 10-Q
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 9 to 15 months; and, the Company may increase
the Revolving Credit Facility from its present $100 million 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 TCI Satellite, may call upon TCI Satellite to contribute up
to $34.6 million of additional capital to ResNet, which proceeds must be used
for the purchase of satellite receiving equipment.
The Company believes that it has various sources of financing in
alternative to borrowings under the Revolving Credit Facility, including
additional amounts of long-term indebtedness, and the Company expects to seek
additional long-term financing during 1998. 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.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS -- CERTAIN STATEMENTS IN
THIS QUARTERLY REPORT ON FORM 10-Q 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 QUARTERLY
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 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 THIS QUARTERLY REPORT, 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 QUARTERLY
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.
March 31, 1998 Page 13
<PAGE>
LodgeNet Entertainment Corporation Form 10-Q
PART II -- OTHER INFORMATION
ITEM 1 -- 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 allegation 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.
From time to time, the Company is subject to other litigation arising in
the ordinary course of business. As of the date hereof, in the opinion of
management, the resolution of such other litigation will not have a material
adverse effect upon the Company's business or financial condition.
ITEM 2 -- CHANGES IN SECURITIES
Not applicable.
ITEM 3 -- DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5 -- OTHER INFORMATION
Not applicable.
ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K
A. EXHIBITS:
Not applicable.
B. REPORTS ON FORM 8-K:
The Company filed no Reports on Form 8-K during the three months
ended March 31, 1998.
March 31, 1998 Page 14
<PAGE>
LodgeNet Entertainment Corporation Form 10-Q
LODGENET ENTERTAINMENT CORPORATION
FORM 10-Q
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LODGENET ENTERTAINMENT CORPORATION
-----------------------------------------------------
(Registrant)
Date: May 13, 1998 /S/ TIM C. FLYNN
-----------------------------------------------------
Tim C. Flynn
President and Chief Executive Officer
(Principal Executive Officer)
Date: May 13, 1998 /S/ JEFFREY T. WEISNER
-----------------------------------------------------
Jeffrey T. Weisner
Vice President - Finance
(Principal Financial and Accounting Officer)
March 31, 1998 Page 15
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