<PAGE>
UNITED STATES
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 QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
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)
----------------------------------------------------
(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 November 1, 1999, there were 11,956,852 shares outstanding of the
Registrant's common stock, $0.01 par value.
<PAGE>
LODGENET ENTERTAINMENT CORPORATION
INDEX
<TABLE>
<CAPTION>
Page
No.
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1 -- Financial Statements:
Consolidated Balance Sheets as of December 31, 1998 and September 30, 1999 (Unaudited)............. 3
Consolidated Statements of Operations (Unaudited) for
the Three and Nine Months Ended September 30, 1998 and 1999.................................... 4
Consolidated Statements of Cash Flows (Unaudited) for
the Nine Months Ended September 30, 1998 and 1999.............................................. 5
Notes to Consolidated Financial Statements......................................................... 6
Item 2 -- Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................................................... 9
Item 3-- Quantitative and Qualitative Disclosures About Market Risk..................................... 19
PART II. OTHER INFORMATION
Item 1-- Legal Proceedings.............................................................................. 20
Item 2-- Changes in Securities and Use of Proceeds...................................................... 20
Item 3-- Defaults Upon Senior Securities................................................................ 20
Item 4-- Submission of Matters to a Vote of Security Holders............................................ 20
Item 5-- Other Information.............................................................................. 20
Item 6-- Exhibits and Reports on Form 8-K............................................................... 20
SIGNATURES.............................................................................................. 21
</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, AND STATEMENTS WHICH ARE MADE IN THE FUTURE TENSE, ARE INTENDED TO
IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. SUCH FORWARD-LOOKING STATEMENTS
INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS, WHICH MAY
CAUSE THE COMPANY'S ACTUAL 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.
2
<PAGE>
PART I -- FINANCIAL INFORMATION
ITEM 1 -- FINANCIAL STATEMENTS
LODGENET ENTERTAINMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
December 31, September 30,
1998 1999
---------------- ----------------
(Unaudited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 5,240 $ 2,104
Accounts receivable, net of allowance for doubtful accounts 27,586 29,460
Prepaid expenses and other 6,086 11,340
---------------- ----------------
Total current assets 38,912 42,904
Property and equipment, net of accumulated depreciation 209,437 205,928
Investments in and advances to unconsolidated affiliates 32,701 13,568
Debt issuance costs, net of accumulated amortization 6,637 9,107
Other assets, net 18,343 14,748
---------------- ----------------
$ 306,030 $ 286,255
================ ================
Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
Accounts payable $ 13,705 $ 15,031
Accrued expenses and other 9,410 14,325
Current maturities of long-term debt 5,718 5,899
Deferred revenue 2,318 2,475
---------------- ----------------
Total current liabilities 31,151 37,730
Long-term debt 262,375 268,934
Minority interest in consolidated subsidiary 730 730
---------------- ----------------
Total liabilities 294,256 307,394
---------------- ----------------
Commitments and contingencies
Stockholders' equity (deficit):
Common stock, $.01 par value, 20,000,000 shares authorized;
11,942,387 and 11,944,711 shares outstanding at
December 31, 1998 and September 30, 1999, respectively 119 119
Additional paid-in capital 123,706 123,764
Accumulated other comprehensive loss (1,512) (939)
Accumulated deficit (110,539) (144,083)
---------------- ----------------
Total stockholders' equity (deficit) 11,774 (21,139)
---------------- ----------------
$ 306,030 $ 286,255
================ ================
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
3
<PAGE>
LODGENET ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- ---------------------------------
1998 1999 1998 1999
--------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Revenues:
Guest Pay $ 40,952 $ 46,508 $ 108,702 $ 126,956
Other 4,824 3,132 14,319 8,918
-------------- -------------- -------------- --------------
Total revenues 45,776 49,640 123,021 135,874
-------------- -------------- -------------- --------------
Direct costs:
Guest Pay 16,974 19,415 44,724 52,106
Other 3,166 2,474 9,683 7,036
-------------- -------------- -------------- --------------
Total direct costs 20,140 21,889 54,407 59,142
-------------- -------------- -------------- --------------
Gross profit 25,636 27,751 68,614 76,732
-------------- -------------- -------------- --------------
Operating expenses:
Guest Pay operations 6,496 6,447 18,879 18,345
Selling, general and administrative 4,513 4,291 14,300 12,850
Depreciation and amortization 13,955 15,235 39,941 44,541
-------------- -------------- -------------- --------------
Total operating expenses 24,964 25,973 73,120 75,736
-------------- -------------- -------------- --------------
Operating income (loss) 672 1,778 (4,506) 996
Equity in losses of unconsolidated affiliates -- -- -- (22,217)
Gain on sale of investment -- 7,095 -- 7,095
Interest expense (6,066) (6,882) (16,938) (20,360)
Interest income 19 424 111 1,205
Provision for income taxes (82) (106) (308) (263)
-------------- -------------- -------------- --------------
Net income (loss) $ (5,457) $ 2,309 $ (21,641) $ (33,544)
============== ============== ============== ==============
Basic earnings per common share $ (0.47) $ .19 $ (1.88) $ (2.81)
Average basic common shares outstanding 11,552,345 11,944,691 11,485,466 11,943,163
Diluted earnings per common share $ (0.47) $ .19 $ (1.88) $ (2.81)
Average diluted common shares outstanding 11,552,345 12,426,986 11,485,466 11,943,163
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
4
<PAGE>
LODGENET ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
------------------------------------
1998 1999
---------------- ----------------
<S> <C> <C>
Operating activities:
Net loss $ (21,641) $ (33,544)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Depreciation and amortization 39,941 44,541
Gain on sale of property and equipment (309) --
Gain on sale of investment -- (7,095)
Equity in losses of unconsolidated affiliates -- 22,217
Change in operating assets and liabilities:
Accounts receivable (7,639) (1,089)
Prepaid expenses and other (954) 1,853
Accounts payable (2,321) 1,311
Accrued expenses and other 3,640 4,765
Other 745 2,074
---------------- ----------------
Net cash provided by operating activities 11,462 35,033
---------------- ----------------
Investing activities:
Property and equipment additions (54,979) (37,871)
Proceeds from sale of property and equipment 412 --
Investment in unconsolidated affiliates (6,819) (3,364)
---------------- ----------------
Net cash used for investing activities (61,386) (41,235)
---------------- ----------------
Financing activities:
Proceeds from long-term debt 1,802 75,000
Repayment of long-term debt (512) (29)
Payment on license rights liability (5,461) (4,954)
Repayment of capital lease obligations -- (430)
Borrowings under revolving credit facility 55,500 19,000
Repayments of revolving credit facility -- (82,000)
Debt issuance costs -- (3,559)
Stock option activity 238 --
---------------- ----------------
Net cash provided by financing activities 51,567 3,028
---------------- ----------------
Effect of exchange rates on cash (53) 38
---------------- ----------------
Increase (decrease) in cash and cash equivalents 1,590 (3,136)
Cash and cash equivalents at beginning of period 1,021 5,240
---------------- ----------------
Cash and cash equivalents at end of period $ 2,611 $ 2,104
================ ================
Supplemental cash flow information:
Cash paid for interest $ 13,147 $ 17,165
================ ================
Noncash investing and financing activity:
License rights acquired by incurring liability $ 15,709 $ --
================ ================
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
5
<PAGE>
LODGENET ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 -- Basis of Presentation
The accompanying consolidated financial statements as of September 30,
1999, and for the three and nine month periods ended September 30, 1998 and
1999, 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 1998, as filed with the Commission. The results of
operations for the three and nine month periods ended September 30, 1999 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, September 30,
1998 1999
----------------- ----------------
<S> <C> <C>
Land, building and equipment $ 48,105 $ 54,310
Free-to-guest equipment 16,237 17,790
Guest pay systems:
Installed 257,980 283,692
System components 24,933 25,376
Software costs 8,640 9,604
---------------- ----------------
Total 355,895 390,772
Less - depreciation and amortization (146,458) (184,844)
---------------- ----------------
Property and equipment, net $ 209,437 $ 205,928
================ ================
</TABLE>
6
<PAGE>
Note 3 -- Investment in Affiliate
The Company obtained a 30% interest in Global Interactive
Communications Corporation ("GICC") resulting from the November 30, 1998 merger
transaction of the Company's majority owned subsidiary, ResNet Communications,
LLC with two other entities. GICC's business consists of providing cable
television programming and telecommunications services to the multi-family
dwelling unit market. The Company recorded losses totaling $3.2 million for the
first six months of 1999 to reflect its 30% equity interest in GICC's losses.
Additionally, during the second quarter of 1999, the Company recorded a charge
of $16.8 million to write-down its investment in GICC to estimated fair value.
Beginning with the third quarter of 1999, the Company will use the cost method
of accounting for its investment in GICC to reflect its temporary condition
resulting from the commencement of a plan by GICC management to sell its assets.
Note 4 -- Financing Transaction
On February 25, 1999, the Company amended and restated its bank credit
facility (the "Bank Facility"), increasing the capacity of the Bank Facility to
$150 million, comprised of a $75 million term loan and a $75 million revolving
credit facility. The $76.5 million outstanding at December 31, 1998 under the
previous revolving credit facility was repaid with proceeds from the term loan.
In addition to the $75 million term loan, the Bank Facility provides a $75
million revolving credit facility, which may be increased at the Company's
request to $100 million, subject to certain limitations. Quarterly repayments on
the term loan begin in February 2001 and are as follows for the respective
fiscal years (in thousands of dollars): 2001 -- $15,000; 2002 -- $18,750; 2003
- -- $18,750; 2004 -- $22,500. The revolving credit facility matures in February
2005. Loans under the Bank Facility bear interest at the Company's option of (1)
the bank's prime rate plus a margin of from 1.00% to 1.75%, or (2) the
eurodollar rate plus a margin of from 2.00% to 2.75%; both depending on leverage
as defined. The margins applicable to the bank's prime rate and/or the
eurodollar rate loans are subject to quarterly adjustment as defined in the
agreement.
The Bank Facility includes terms and conditions which require the
maintenance of certain financial ratios and place certain limitations on capital
expenditures, investments, additional indebtedness, liens, guarantees, and
certain payments or distributions in respect of common stock of the Company.
Loans under the Bank Facility are secured by a first priority security interest
in all of the Company's assets. As of September 30, 1999, $13.5 million was
outstanding under the revolving credit facility, and the Company was in
compliance with all covenants, terms and conditions of the Bank Facility.
Note 5 -- Gain on Sale of Investment
In February 1998, the Company acquired a 10% equity interest in Across
Media Networks, Inc. ("AMN"), a creator and distributor of digitally produced
on-screen content for television and the internet. The Company also held rights
to convert amounts loaned to AMN into an additional 80% equity interest. During
the third quarter of 1999, the Company sold its interest in AMN for
consideration of $9.25 million, consisting of a $7.2 million note from the buyer
due March 31, 2000 and a $2.05 million note from AMN due August 31, 2002. The
Company has deferred recognition of the $2.05 million AMN note until realization
is more certain. The transaction resulted in immediate recognition of a $7.1
million gain.
Note 6 -- Comprehensive Income
Effective January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income". This statement established standards for reporting and
disclosure of comprehensive income and its components. Comprehensive income
reflects the change in equity of a business enterprise during a period from
transactions and other events and circumstances from non-owner sources. For the
Company, comprehensive income primarily represents net income adjusted for
foreign currency translation adjustments. Comprehensive income (in thousands of
dollars) was $2,375 for the quarter ended September 30, 1999 as compared to a
comprehensive loss of $5,857 for the quarter ended September 30, 1998. For the
nine months ended September 30, 1999 and 1998, comprehensive loss was $32,971
and $22,368, respectively.
7
<PAGE>
Note 7 -- Reclassification
Beginning in 1999, the Company has chosen to reflect the results of its
free-to-guest business within the "other" components of revenues and direct
costs in the statements of operations. Accordingly, the statement of operations
for the three and nine months ended September 30, 1998 includes these
reclassifications to conform to the 1999 presentation. These changes had no
impact on total revenues, direct costs or net loss for the period.
Note 8 -- Effect of Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities". SFAS No. 133 establishes
accounting and reporting standards requiring that every derivative instrument
(including certain derivative instruments embedded in other contracts) be
recorded in the balance sheet as either an asset or liability measured at its
fair value. The statement requires that changes in the derivative's fair value
be recognized currently in earnings unless specific hedge accounting criteria
are met. Special accounting for qualifying hedges allows a derivative's gains
and losses to offset related results on the hedged item in the income statement
and requires that a company must formally document, designate and assess the
effectiveness of transactions that receive hedge accounting. In June 1999, the
FASB issued SFAS No. 137 which amended SFAS No. 133 to delay its effective date
to fiscal quarters beginning after June 15, 2000. Accordingly, the Company plans
to adopt the requirements of SFAS No. 133 in the third quarter of 2000. SFAS No.
133 could increase volatility in earnings and other comprehensive income.
Note 9 -- Subsequent Event
Effective November 4, 1999, the Company sold its interest in 1stUp.com,
a provider of free internet services, to CMGI, Inc. ("CMGI") in a
stock-for-stock exchange. Pursuant to the transaction, the Company received
117,166 shares of CMGI common stock, which shares are subject to certain sale
and escrow restrictions. The aggregate market value of the shares was $9.8
million at the time the sales agreement was reached. After consideration of a
discount to reflect the restrictions placed on the CMGI stock, the Company
expects to record a gain of approximately $7.6 million during the fourth quarter
of 1999.
8
<PAGE>
ITEM 2 -- 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.
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, AND STATEMENTS WHICH ARE MADE IN THE FUTURE TENSE, ARE INTENDED TO
IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. SUCH FORWARD-LOOKING STATEMENTS
INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS, WHICH MAY
CAUSE THE COMPANY'S ACTUAL 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.
OVERVIEW
LodgeNet is a specialized communications company which provides video
on-demand, network-based video games, high-speed internet access, cable
television programming and other interactive entertainment and information
services to the lodging industry utilizing its B-LAN-Registered Trademark- open
system architecture.
GUEST PAY SERVICES. Guest Pay services are purchased by guests on a
per-view or hourly basis and include Guest Scheduled-SM- on-demand movies and
network-based Nintendo-Registered Trademark- video games. Guest Pay packages
may also include additional services such as satellite-delivered basic and
premium cable television programming, and other interactive entertainment and
information services that are paid for by the hotel and provided to guests at
no charge. The growth that the Company has experienced has principally
resulted from its rapid expansion of Guest Pay services, which the Company
began installing in 1986. In May 1992, the Company introduced and began
installing its on-demand Guest Pay service. It has been the Company's
experience that rooms featuring the on-demand Guest Pay service generate
significantly more revenue and gross profit per room than comparable rooms
having only the scheduled format.
The 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,
programming delivery and distribution, data retrieval, insurance and personal
property taxes.
The Company provides video games and interactive multimedia
entertainment and information services including folio review, video
checkout, guest satisfaction survey, advertising and merchandising services
through its Guest Pay systems. In 1993, the Company entered into a seven-year
non-exclusive license agreement with Nintendo of America, Inc. ("Nintendo")
to provide hotels with a network-based Super Nintendo-Registered Trademark-
video game playing system. During 1998, the Company entered into a new,
ten-year non-exclusive license agreement with Nintendo to become the first
provider of Nintendo 64 ("N64-Registered Trademark-") video games to the
lodging industry. The Company began the rollout of the N64 game technology to
its Guest Pay rooms during the second quarter of 1999.
9
<PAGE>
During the three months and twelve months ended September 30, 1999, the
Company installed its systems in the following number of rooms, net of
de-installations:
Three Months Twelve Months
Ended Ended
September 30, 1999 September 30, 1999
---------------------- ----------------------
Guest Pay rooms 16,214 70,519
====================== ======================
Nintendo game system rooms 21,808 67,947
====================== ======================
The room installations for the twelve months ended September 30, 1999
represent increases of 12.2% for Guest Pay and 12.8% for Nintendo, over the room
bases at September 30, 1998.
The Company's base of installed rooms was comprised as follows at September 30:
1998 1999
----------------------- -----------------------
Rooms % Rooms %
------------ -------- ------------ --------
Guest Pay rooms:
Scheduled 16,403 2.8 6,784 1.0
On-demand 562,578 97.2 642,716 99.0
----------- ------- ------------ -------
578,981 100.0 649,500 100.0
============ ======== ============ ========
Nintendo game system rooms 530,194 598,141
============ ============
Total rooms served, representing rooms receiving one or more of the
Company's services, including rooms served by international licensees, were as
follows at September 30:
1998 1999
------------ ------------
Total rooms served 683,390 750,287
============ ============
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.
Results from free-to-guest services delivered to rooms not receiving Guest Pay
services are included in the "other" components of revenues and direct costs in
the statements of operations.
RESIDENTIAL SERVICES. Effective November 30, 1998, the operations of
the Company's majority-owned subsidiary, ResNet Communications, LLC ("ResNet")
were merged with two non-affiliated entities to form a new entity, Global
Interactive Communications Corporation ("GICC"). The Company has a 30% equity
interest in GICC. GICC's business consists of providing cable television
programming and telecommunications services to the multi-family dwelling unit
market. Prior to the third quarter of 1999, the Company accounted for its
investment in GICC using the equity method of accounting for an investment,
recording losses totaling $3.2 million for its share of GICC's losses for the
six months ending June 30, 1999. Additionally, during the second quarter of
1999, the Company recorded a charge of $16.8 million to write-down its
investment in GICC to estimated fair value. Beginning with the third quarter of
1999, the Company will use the cost method of accounting for its investment in
GICC to reflect its temporary condition resulting from the commencement of a
plan by GICC management to sell its assets.
10
<PAGE>
DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1999
REVENUE ANALYSIS
The Company's total revenue for the third quarter of 1999 increased
8.4%, or $3.9 million, in comparison to the third quarter of 1998. The following
table sets forth the components of the Company's revenue (in thousands) for the
quarter ending September 30:
1998 1999
--------------------------- -----------------------------
Percent Percent
of Total of Total
Amount Revenue Amount Revenue
------------ ----------- ------------- -----------
Guest Pay $ 40,952 89.5 $ 46,508 93.7
Other 4,824 10.5 3,132 6.3
------------ ----------- ------------- -----------
Total $ 45,776 100.0 $ 49,640 100.0
============ =========== ============= ===========
GUEST PAY SERVICES. Guest Pay revenue increased 13.6%, or $5.6 million,
in the third quarter of 1999 in comparison to the same quarter of 1998. This
increase was attributable to a 13.3% increase in the average number of installed
Guest Pay rooms and a .3% increase 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 September 30:
1998 1999
----------- ------------
Average monthly revenue per room:
Movie revenue $ 19.79 $ 19.71
Video game and other service revenue 4.38 4.53
----------- ------------
Total per Guest Pay room $ 24.17 $ 24.24
=========== ============
Average movie revenue per Guest Pay room decreased .4% in the third
quarter of 1999 compared to the same quarter of 1998. This decrease was due to
lower average buy rates partially offset by higher average movie prices.
Average video game and other service revenue per Guest Pay room
increased 3.4% primarily as a result of increased revenue per Guest Pay room
from cable television programming services, partially offset by a decrease in
average monthly video game revenue per room.
OTHER. Revenue from other sources includes revenue from free-to-guest
services provided to hotels not receiving Guest Pay services and sales of
televisions, system equipment, and service parts and labor. Additionally, in
1998, other revenue includes revenue generated by ResNet. The decrease in the
third quarter of 1999 from the third quarter of 1998 of $1.7 million or 35.1%,
is primarily due to $1.6 million of revenue generated by ResNet in the third
quarter of 1998. In addition, sales of televisions and system equipment were
lower in the third quarter of 1999 from the year earlier quarter.
11
<PAGE>
EXPENSE ANALYSIS
DIRECT COSTS. The following table sets forth information in regard to
the Company's direct costs (in thousands) and gross profit margin for the
quarter ending September 30:
1998 1999
------------ -----------
Direct costs:
Guest Pay $ 16,974 $ 19,415
Other 3,166 2,474
------------ -----------
$ 20,140 $ 21,889
============ ===========
Gross profit margin:
Guest Pay 58.6% 58.3%
Other 34.4% 21.0%
Composite 56.0% 55.9%
Guest Pay direct costs increased 14.4%, or $2.4 million, in the third
quarter of 1999 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 costs tend
to vary directly with revenue. As a percentage of revenue, such costs increased
from 41.4% in the third quarter of 1998 to 41.7% in the current quarter,
primarily due to a slight increase in studio and video game license fees.
Direct costs associated with other revenue decreased $692,000 or 21.9%
in the third quarter of 1999 from the year earlier quarter. This decrease is
primarily due to $713,000 of direct costs incurred by ResNet in the second
quarter of 1998 and the lower volume of television and equipment sales
previously described. As a percentage of related revenues, direct costs
increased to 79.0% of other revenue in the current quarter versus 65.6% in the
third quarter of 1998. The resulting decrease in gross profit margin from 34.4%
in the third quarter of 1998 to 21.0% in the current quarter is due to the fact
that the ResNet business, which generally earned a higher margin than the other
sources of other revenue, is not included in the 1999 results due to the merger
transaction previously described.
The Company's overall gross profit increased 8.3%, or $2.1 million, to
$27.8 million in the third quarter of 1999 on an 8.4% increase in revenues in
comparison to the same period of the prior year. The Company's overall gross
profit margin decreased to 55.9% in the current quarter from 56.0% in the year
earlier quarter.
OPERATING EXPENSES. The following table sets forth information in
regard to the Company's operating expenses for the quarter ending September 30
(dollar amounts in thousands):
<TABLE>
<CAPTION>
1998 1999
--------------------------- ---------------------------
Percent Percent
of Total of Total
Amount Revenues Amount Revenues
------------ ----------- ----------- -----------
<S> <C> <C> <C> <C>
Operating expenses:
Guest Pay operations $ 6,496 14.2 $ 6,447 13.0
Selling, general and administrative 4,513 9.9 4,291 8.6
Depreciation and amortization 13,955 30.5 15,235 30.7
------------ ----------- ----------- -----------
Total operating expenses $ 24,964 54.6 $ 25,973 52.3
============ =========== =========== ===========
</TABLE>
Guest Pay operations expenses consist of costs directly related to the
operation of systems at the hotel sites. Additionally, prior to the ResNet
merger, costs incurred to operate the ResNet systems were included in Guest Pay
operations. Such costs totaled $799,000 in the third quarter of 1998. Excluding
the expenses incurred to operate the systems at residential sites, expenses
related to Guest Pay operations increased 13.2%, or $750,000 in the third
quarter of 1999 compared to the year earlier quarter. This increase is
attributable to the 13.3% increase in average installed
12
<PAGE>
Guest Pay rooms in the third quarter of 1999 as compared to the year earlier
quarter. Per average installed Guest Pay room, such expenses were $3.36 per
month in the third quarter of 1999 and 1998.
Selling, general and administrative expenses decreased 4.9%, or
$222,000 in the third quarter of 1999 compared to the year earlier quarter. The
decrease is due in part to the ResNet merger as $436,000 of selling, general and
administrative expenses were incurred by ResNet in the third quarter of 1998. As
a percentage of revenue, such expenses were 8.6% in the current quarter as
compared to 9.9% in the year earlier quarter.
Depreciation and amortization expenses increased 9.2% to $15.2 million
in the third quarter of 1999 from $14.0 million in the year earlier quarter.
This increase is attributable to the increases in the number of installed Guest
Pay rooms, associated software and other capitalized costs such as service vans,
equipment and computers that are related to the increased number of rooms in
service since the year-earlier quarter. This increase was partially offset by
the ResNet merger as ResNet depreciation and amortization during the third
quarter of 1998 was $1.0 million.
OPERATING INCOME. As a result of the factors previously described, the
Company generated operating income of $1.8 million in the third quarter of 1999
compared to $672,000 in the same quarter of 1998.
GAIN ON SALE OF INVESTMENT. In February 1998, the Company acquired a
10% equity interest in Across Media Networks, Inc. ("AMN"), a creator and
distributor of digitally produced on-screen content for television and the
internet. The Company also held rights to convert amounts loaned to AMN into an
additional 80% equity interest. During the third quarter of 1999, the Company
sold its interest in AMN for consideration of $9.25 million, consisting of a
$7.2 million note from the buyer due March 31, 2000 and a $2.05 million note
from AMN due August 31, 2002. The Company has deferred recognition of the $2.05
million AMN note until realization is more certain. The transaction resulted in
immediate recognition of a $7.1 million gain.
INTEREST EXPENSE. Interest expense increased to $6.9 million in the
current quarter from $6.1 million in the year earlier quarter due to increases
in long-term debt to fund the Company's continuing expansion of its business.
Total debt increased from $250.4 million at September 30, 1998 to $274.8 million
at September 30, 1999. Average principal amount of long-term debt outstanding
during the quarter ended September 30, 1999 was approximately $276 million (at
an average interest rate of approximately 10.0%) as compared to an average
principal amount outstanding of approximately $232 million (at an average
interest rate of approximately 10.4%) during the third quarter of 1998.
INTEREST INCOME. Interest income, earned on loans to unconsolidated
affiliates, increased to $424,000 in the third quarter of 1999 from $19,000 in
the same period of 1998.
NET INCOME (LOSS). For the reasons previously described, the Company
generated net income of $2.3 million during the third quarter of 1999 as
compared to a net loss of $5.5 million in the third quarter of 1998.
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") excluding the gain on
sale of investment increased 16.3% to $17.0 million in the third quarter of 1999
as compared to $14.6 million in the third quarter of 1998. EBITDA as a
percentage of total revenues was 34.3% in the current quarter as compared to
32.0% in the same quarter of 1998. 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.
13
<PAGE>
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1999
REVENUE ANALYSIS
The Company's total revenue for the nine months ended September 30,
1999 increased 10.4%, or $12.9 million, in comparison to the nine months ended
September 30, 1998. The following table sets forth the components of the
Company's revenue for the nine months ended September 30 (dollar amounts in
thousands):
1998 1999
----------------------------- -----------------------------
Percent Percent
of Total of Total
Amount Revenue Amount Revenue
------------- ------------ ------------- -----------
Guest Pay $ 108,702 88.4 $ 126,956 93.4
Other 14,319 11.6 8,918 6.6
------------ ----------- ------------ -----------
Total $ 123,021 100.0 $ 135,874 100.0
============= ============ ============= ===========
GUEST PAY REVENUE. Guest Pay revenue increased 16.8%, or $18.3 million,
in the first nine months of 1999 in comparison to the same period of 1998. This
increase was the result of a 14.6% increase in the average number of installed
Guest Pay rooms and a 1.9% increase 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 nine months ending September 30:
1998 1999
----------- ------------
Average monthly revenue per room:
Movie revenue $ 18.57 $ 18.77
Video game and other service revenue 3.70 3.93
---------- -----------
Total per Guest Pay room $ 22.27 $ 22.70
=========== ============
Average movie revenue per room increased 1.1% in the first nine months
of 1999 compared to the same period of 1998. This increase was due to higher
average movie prices, partially offset by lower average buy rates and hotel
occupancy levels.
Average video game and other service revenue per room increased 6.2%
primarily as a result of increased revenue per Guest Pay room from cable
television programming services, partially offset by a decrease in average
monthly video game revenue per room.
OTHER REVENUE. Revenue from other sources includes revenue from
free-to-guest services provided to hotels not receiving Guest Pay services and
sales of televisions, system equipment, and service parts and labor.
Additionally, in 1998, other revenue includes revenue generated by ResNet. The
decrease in the first nine months of 1999 from the same period of 1998 of $5.4
million or 37.7%, is primarily due to $4.2 million of revenue generated by
ResNet in the first nine months of 1998. In addition, sales of televisions and
system equipment were lower in the first nine months of 1999 from the year
earlier period.
14
<PAGE>
EXPENSE ANALYSIS
DIRECT COSTS. The following table sets forth information in regard to
the Company's direct costs and gross profit margin for the nine months ending
September 30 (dollar amounts in thousands):
1998 1999
------------ -----------
Direct costs:
Guest Pay $ 44,724 $ 52,106
Other 9,683 7,036
----------- ----------
$ 54,407 $ 59,142
============ ===========
Gross profit margin:
Guest Pay 58.9% 59.0%
Other 32.4% 21.1%
Composite 55.8% 56.5%
Guest Pay direct costs increased 16.5%, or $7.4 million, in the first
nine months of 1999 as compared to the first nine months of 1998. 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
costs tend to vary directly with revenue. As a percentage of revenue, such costs
decreased from 41.1% during the first nine months of 1998 to 41.0% during the
same period of 1999. This decrease is primarily due to a slight decrease in
commissions earned by the hotels and increased margin earned on cable television
programming services provided to Guest Pay rooms.
Direct costs associated with other revenue decreased $2.6 million or
27.3% in the first nine months of 1999 from the year earlier period. This
decrease is primarily due to $1.9 million of direct costs incurred by ResNet in
the first nine months of 1998 and the lower volume of television and equipment
sales previously described. As a percentage of related revenues, direct costs
increased to 78.9% of other revenue in the current nine month period versus
67.6% in the same period of 1998. The resulting decrease in gross profit margin
from 32.4% in the first nine months of 1998 to 21.1% in the first nine months of
1999 is due to the fact that the ResNet business, which generally earned a
higher margin than the other sources of other revenue, is not included in the
1999 results due to the merger transaction previously described.
The Company's overall gross profit increased 11.8%, or $8.1 million, to
$76.7 million in the first nine months of 1999 on a 10.4% increase in revenues
in comparison to the same period of the prior year. The Company's overall gross
profit margin was 56.5% in the current nine month period, as compared to the
year earlier 55.8%.
OPERATING EXPENSES. The following table sets forth information in
regard to the Company's operating expenses for the nine months ending
September 30 (dollar amounts in thousands):
<TABLE>
<CAPTION>
1998 1999
--------------------------- ---------------------------
Percent Percent
of Total of Total
Amount Revenues Amount Revenues
------------ ----------- ----------- -----------
<S> <C> <C> <C> <C>
Operating expenses:
Guest Pay operations $ 18,879 15.3% $ 18,345 13.5%
Selling, general and administrative 14,300 11.6% 12,850 9.5%
Depreciation and amortization 39,941 32.5% 44,541 32.8%
------------ ----------- ----------- -----------
Total operating expenses $ 73,120 59.4% $ 75,736 55.8%
============ =========== =========== ===========
</TABLE>
Guest Pay operations expenses consist of costs directly related to the
operation of systems at the hotel sites. Additionally, prior to the ResNet
merger, costs incurred to operate the ResNet systems were included in Guest Pay
operations. Such costs totaled $2.3 million in the first nine months of 1998.
Excluding the expenses incurred to
15
<PAGE>
operate the systems at residential sites, expenses related to Guest Pay
operations increased 10.4%, or $1.7 million in the first nine months of 1999
compared to the year earlier period. This increase is primarily attributable to
the 14.6% increase in average installed Guest Pay rooms in the current period as
compared to the year earlier period, partially offset by lower average operating
and service expenses incurred on a per room basis. Per average installed Guest
Pay room, such expenses were $3.28 per month in the current period as compared
to $3.40 per month in the prior year period.
Selling, general and administrative expenses decreased 10.1%, or $1.5
million in the first nine months of 1999 compared to the year earlier period.
This decrease is primarily due to the ResNet merger as $1.5 million of selling,
general and administrative expenses were incurred by ResNet in the first nine
months of 1998. As a percentage of revenue, such expenses were 9.5% in the
current period as compared to 11.6% in the year earlier period.
Depreciation and amortization expenses increased 11.5% to $44.5 million
in the first nine months of 1999 from $39.9 million in the year earlier period.
This increase is attributable to the increases in the number of installed Guest
Pay rooms, associated software and other capitalized costs such as service vans,
equipment and computers that are related to the increased number of rooms in
service since the year-earlier period. This increase was partially offset by the
ResNet merger as ResNet depreciation and amortization during the first nine
months of 1998 was $2.8 million.
OPERATING INCOME (LOSS). As a result of the factors previously
described, the Company generated operating income of $996,000 in the first nine
months of 1999 compared to an operating loss of $4.5 million in the same period
of 1998.
EQUITY IN LOSSES OF UNCONSOLIDATED AFFILIATES. During 1998, the Company
acquired a 10% interest in Across Media Networks, LLC ("AMN"), a company engaged
in the creation and distribution of digitally produced on-screen content for
television and the internet. Prior to the second quarter of 1999, the Company
had applied the equity method of accounting for this investment to reflect the
fact that the Company had certain financing obligations to AMN. Losses of $2.2
million related to this investment were recorded in the first quarter of 1999.
During the second quarter of 1999, AMN was able to secure other financing
resources eliminating the Company's obligation to provide future financing.
Accordingly, the Company discontinued the use of the equity method of accounting
for this investment and, as such, no further equity losses have been recorded.
Additionally, as previously described, the merger of ResNet with two other
entities effective November 30, 1998 to form GICC resulted in the Company
obtaining a 30% equity interest in GICC. The Company's portion of GICC's net
losses for the first six months of 1999 totaled $3.2 million. In addition, the
Company recorded a $16.8 million charge in the second quarter of 1999 to
write-down its investment in GICC to estimated fair value. Beginning with the
third quarter of 1999, the Company will use the cost method of accounting for
its investment in GICC to reflect its temporary condition resulting from the
commencement of a plan by GICC management to sell its assets.
GAIN ON SALE OF INVESTMENT. In February 1998, the Company acquired a
10% equity interest in Across Media Networks, Inc. ("AMN"), a creator and
distributor of digitally produced on-screen content for television and the
internet. The Company also held rights to convert amounts loaned to AMN into an
additional 80% equity interest. During the third quarter of 1999, the Company
sold its interest in AMN for consideration of $9.25 million, consisting of a
$7.2 million note from the buyer due March 31, 2000 and a $2.05 million note
from AMN due August 31, 2002. The Company has deferred recognition of the $2.05
million AMN note until realization is more certain. The transaction resulted in
immediate recognition of a $7.1 million gain.
INTEREST EXPENSE. Interest expense increased to $20.4 million in the
current nine month period from $16.9 million in the year earlier period due to
increases in long-term debt to fund the Company's continuing expansion of its
business. Total debt increased from $250.4 million at September 30, 1998 to
$274.8 million at September 30, 1999. Average principal amount of long-term debt
outstanding during the nine months ended September 30, 1999 was approximately
$270 million (at an average interest rate of approximately 10.1%) as compared to
an average principal amount outstanding of approximately $215 million (at an
average interest rate of approximately 10.5%) during the first nine months of
1998.
16
<PAGE>
INTEREST INCOME. Interest income, earned on loans to unconsolidated
affiliates, increased to $1.2 million in the third quarter of 1999 from $111,000
in the same period of 1998.
NET LOSS. For the reasons previously described, the Company's net loss
increased to $33.5 million in the first nine months of 1999 from a net loss of
$21.6 million in the same period of the prior year.
EBITDA. As a result of increasing revenues from Guest Pay services, and
the other factors previously described, EBITDA increased 28.5% to $45.5 million
in the first nine months of 1999 as compared to $35.4 million in the first nine
months of 1998. EBITDA as a percentage of total revenue was 33.5% in the current
nine month period as compared to 28.8% in the same period of 1998. 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 growth of the Company's business has required
substantial amounts of capital. The Company has incurred operating and net
losses due in large part to the depreciation, amortization and interest expenses
related to the capital required to expand its lodging and residential
businesses. Historically, cash flow from operations has not been sufficient to
fund the cost of expanding the Company's business and to service existing
indebtedness. During 1998, capital expenditures were $69.7 million (of which
$14.2 million was incurred by ResNet) and net cash provided by operating
activities was $13.2 (after the reduction of net cash used in operating
activities of $5.0 million by ResNet). During the first nine months of 1999,
capital expenditures were $37.9 million as compared to $55.0 million in the
first nine months of 1998, and net cash provided by operating activities was
$35.0 million as compared to $11.5 million in the same period of 1998.
Depending on the rate of growth of its lodging business and other
factors, the Company expects to incur capital expenditures of approximately $10
million during the remainder of 1999. In addition, the Company's cash
requirements during 2000 are expected to include the payment to OCC of $5.85
million on July 15, 2000 pursuant to the terms of the multiple cross licenses
and may include deferred purchase payments of up to $2 million in connection
with the Company's acquisition of Connect Group Corporation in 1998. The
foregoing statements regarding capital expenditures and cash requirements are
forward-looking statements and there can be no assurance in this regard. The
actual amount and timing of the Company's capital expenditures will vary (and
such variations could be material) depending upon the number of new contracts
for services entered into by the Company, the costs of installations and other
factors.
On February 25, 1999, the Company amended and restated its existing
bank credit facility. This amended facility (the "Bank Facility") consists of a
$150 million secured credit facility which combines a $75 million term loan (the
"Term Loan") and a $75 million revolving loan facility (the "Revolving Loan").
Proceeds under the Term Loan were used to repay amounts outstanding under the
revolving loan facility that existed prior to the amendment and restatement.
Minimum required prepayments of borrowings under the Term Loan for the
respective years are (in thousands of dollars): 2001 -- $15,000; 2002 --
$18,750; 2003 -- $18,750; 2004 -- $22,500. The Bank Facility includes covenants
which require the maintenance of certain financial ratios and which impose
certain limitations on such matters as the incurrence of additional indebtedness
and payments in respect of common stock of the Company, among others. As of
September 30, 1999, the Company was in compliance with all such covenants.
17
<PAGE>
As previously described, effective November 30, 1998 the Company
contributed its interest in the ResNet business to GICC. The Company has no
continuing obligation to fund any of GICC's operating and/or investing
activities. During 1998, the Company provided $19.3 million to fund ResNet's
operating and investing activities, all of which funding occurred prior to
November 30, 1998.
The Company believes that its operating cash flows and borrowings
available under its revolving credit facility will be sufficient to fund the
Company's future growth as contemplated under its current business plan,
depending on the rate of the Company's growth and other factors. However, if the
Company's plans or assumptions change, if its assumptions prove to be inaccurate
or if the Company experiences unanticipated costs or competitive pressures, the
Company may be required to seek additional capital. There can be no assurance
that the Company will be able to obtain financing, if additional long-term
financing should be required, or, if such financing is available, that the
Company will be able to obtain it on acceptable terms. Failure to obtain
additional financing, if needed, could result in the delay or abandonment of
some or all of the Company's expansion plans.
YEAR 2000 INFORMATION
The Company has engaged in a comprehensive review of its internal
computer systems and software and external business relationships in regard to
Year 2000 issues.
STATE OF READINESS. The Company has a project team comprised of key
members from cross-organization departments. The team's objectives are to gather
information and facilitate research on Year 2000 issues that could affect the
Company, and to take necessary actions to eliminate or minimize the impact of
such issues. Internally the Company has completed its efforts to identify the
computer hardware and software that is used both at its in-house facilities as
well as at its hotel properties. Research and testing of these systems for Year
2000 compliance is near completion. The Company has substantially completed its
research and testing of internal computer hardware and software as of the end of
the third quarter of 1999. Correction or replacement of hardware and software
containing Year 2000 issues is near completion and will be completed during the
fourth quarter of 1999.
Externally, the Company continues to work to identify third party
business relationships that are impacted by the Year 2000 issue. Research and
review of these relationships, including contacting the third parties to solicit
information and assurances relating to potential Year 2000 issues and reviewing
responses, is substantially complete. The Company expects to complete its review
of third party relationships during the fourth quarter of 1999, although no
assurance can be given as to the Year 2000 remediation of third parties.
COSTS ASSOCIATED WITH YEAR 2000. Incremental costs are expected to be
comprised primarily of costs to purchase software upgrades and hardware.
Additionally, external consulting, programming and training costs may be
incurred. The Company expects to incur less than $500,000 in aggregate
out-of-pocket costs in 1998 and 1999 to complete its Year 2000 compliance
program, excluding the costs of internal staffing. As of September 30, 1999 the
Company has incurred out-of-pocket costs totaling approximately $300,000 toward
Year 2000 compliance efforts. Such funds have been provided from the Company's
bank credit facility. Although the Company intends to develop and implement, if
necessary, appropriate contingency plans to mitigate to the extent possible the
effects of any Year 2000 noncompliance, such plans may not be adequate and the
cost of Year 2000 compliance may be greater than $500,000.
RISKS ASSOCIATED WITH YEAR 2000 ISSUES. The Company is highly dependent
upon its own information technology systems and those of its suppliers and
customers. The Company's or a third party's failure to correct a material Year
2000 problem could result in a failure of or interruption in the Company's
business activities and operations. Such interruptions and failures could
materially and adversely affect the Company's results of operation, liquidity
and financial condition. The Company's Year 2000 project is expected to reduce
significantly the Company's level of uncertainty and the possibility of
significant or long-lasting interruptions of the Company's business operations;
however, the Company believes that it is impossible to predict all of the areas
in which material problems may arise.
18
<PAGE>
CONTINGENCY PLANS. The Company continues to prepare contingency plans
for Year 2000 issues. The Company is in the process of identifying the most
reasonably likely worst-case scenarios, so that it may attempt to secure
alternate vendors and service providers for these functions as well as to
develop alternative systems which could be used to process data. Contingency
plans are expected to be completed during the fourth quarter of 1999.
While the Company anticipates achieving Year 2000 compliance in a
timely manner, there can be no assurance that all processes will be compliant,
that there will be no significant delay or loss of revenues, or that no material
supply sources will be interrupted. However, the Company believes that its
planning and action efforts will help reduce any loss or disruption.
ITEM 3 -- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to various market risks, including potential
losses resulting from adverse changes in interest rates and foreign currency
exchange rates. The Company does not enter into derivatives or other financial
instruments for trading or speculative purposes.
INTEREST. At September 30, 1999, the Company had debt totaling $274.8
million. During the second quarter of 1999, the Company entered into interest
rate swap arrangements covering debt with a notional amount of $75 million to
effectively change the underlying debt from a variable interest rate to a fixed
interest rate for the term of the swap agreements. After giving effect to the
interest rate swap arrangements the Company had fixed rate debt of $261.3
million and variable rate debt of $13.5 million at September 30, 1999. For fixed
rate debt, interest rate changes affect the fair market value but do not impact
earnings or cash flows. Conversely, for variable rate debt, interest rate
changes generally do not affect the fair market value but do impact future
earnings and cash flows, assuming other factors are held constant. Assuming
other variables remain constant (such as debt levels), a one percentage point
increase in interest rates would decrease the unrealized fair market value of
the fixed rate debt by an estimated $24.2 million. The impact on earnings and
cash flow for the next year resulting from a one percentage point increase in
interest rates would be approximately $135,000, assuming other variables remain
constant.
FOREIGN CURRENCY TRANSACTIONS. A minor portion of the Company's
revenues are derived from the sale of Guest Pay services in Canada. The results
of operations and financial position of the Company's operations in Canada are
measured in Canadian dollars and translated into U.S. dollars. The effects of
foreign currency fluctuations in Canada are somewhat mitigated by the fact that
expenses are generally incurred in Canadian dollars. The reported income of the
Company's Canadian subsidiary will be higher or lower depending on a weakening
or strengthening of the U.S. dollar against the Canadian dollar. In addition, a
minor portion of the Company's assets are based in Canada and are translated
into U.S. dollars at foreign currency exchange rates in effect as of the end of
each period, with the impact of such translation reflected within the Company's
consolidated stockholders' equity. Accordingly, the Company's consolidated
stockholders' equity will fluctuate depending on the weakening or strengthening
of the U.S. dollar against the Canadian dollar. The Company manages its
potential adverse currency fluctuation risk by conducting the majority of its
Canadian operations in Canadian dollars.
19
<PAGE>
PART II -- OTHER INFORMATION
ITEM 1 -- LEGAL PROCEEDINGS
The Company is subject to litigation arising in the ordinary course of
business. As of the date hereof, the Company believes the resolution of such
litigation will not have a material adverse effect upon the Company's financial
condition or results of operations.
ITEM 2 -- CHANGES IN SECURITIES AND USE OF PROCEEDS
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:
None.
B. REPORTS ON FORM 8-K:
The Company filed no Reports on Form 8-K during the quarter ended
September 30, 1999.
20
<PAGE>
LODGENET ENTERTAINMENT CORPORATION
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: November 8, 1999 /s/ SCOTT C. PETERSEN
-----------------------------------------------
Scott C. Petersen
President and Chief Executive Officer
(Principal Executive Officer)
Date: November 8, 1999 /s/ JEFFREY T. WEISNER
-----------------------------------------------
Jeffrey T. Weisner
Senior Vice President, Chief Financial Officer
(Principal Financial Officer)
Date: November 8, 1999 /s/ RONALD W. PIERCE
-----------------------------------------------
Ronald W. Pierce
Vice President, Corporate Controller
(Principal Accounting Officer)
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
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0
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