-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, MeSKPT9wF+Vj6ZzpHEan1JVgSVLSLO47qscKv6jhEvHwBnuaBGAfzeRKEC+ks9G5 Nojg246LLQSjaol4Dsos0g== 0000912057-96-010781.txt : 19960525 0000912057-96-010781.hdr.sgml : 19960525 ACCESSION NUMBER: 0000912057-96-010781 CONFORMED SUBMISSION TYPE: 424B4 PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 19960524 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: LODGENET ENTERTAINMENT CORP CENTRAL INDEX KEY: 0000911002 STANDARD INDUSTRIAL CLASSIFICATION: COMMUNICATION SERVICES, NEC [4899] IRS NUMBER: 460371161 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 424B4 SEC ACT: 1933 Act SEC FILE NUMBER: 333-03586 FILM NUMBER: 96572308 BUSINESS ADDRESS: STREET 1: 808 WEST AVENUE NORTH CITY: SIOUX FALLS STATE: SD ZIP: 57104 BUSINESS PHONE: 6053301330 MAIL ADDRESS: STREET 1: 808 WEST AVE N CITY: SIOUX FALLS STATE: SD ZIP: 57104 FORMER COMPANY: FORMER CONFORMED NAME: LNET INC DATE OF NAME CHANGE: 19930820 424B4 1 424B4 Filed pursuant to Rule 424(b)(4) Registration No. 333-3586 3,200,000 SHARES [LOGO] COMMON STOCK ---------------- All of the shares of Common Stock offered hereby are being offered by LodgeNet Entertainment Corporation ("LodgeNet" or the "Company"). The Common Stock is quoted on the Nasdaq National Market under the symbol "LNET." On May 22, 1996, the last reported sale price of the Common Stock, as reported on the Nasdaq National Market, was $13.25 per share. THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS" COMMENCING ON PAGE 8 OF THIS PROSPECTUS FOR INFORMATION THAT SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS. ----------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
UNDERWRITING PRICE TO DISCOUNTS AND PROCEEDS TO PUBLIC COMMISSIONS (1) COMPANY (2) Per Share................................. $13.00 $0.6825 $12.3175 Total..................................... $41,600,000 $2,184,000 $39,416,000 Total Assuming Full Exercise of Over- Allotment Option (3)..................... $47,840,000 $2,511,600 $45,328,400
(1) See "Underwriting." (2) Before deducting expenses estimated at $567,500, which are payable by the Company. (3) Assuming exercise in full of the 30-day option granted by the Company to the Underwriters to purchase up to 480,000 additional shares, on the same terms, solely to cover over-allotments. See "Underwriting." ------------------- The shares of Common Stock are offered by the Underwriters, subject to prior sale, when, as and if delivered to and accepted by the Underwriters, and subject to their right to reject orders in whole or in part. It is expected that delivery of the Common Stock will be made in New York City on or about May 29, 1996. ------------------- PAINEWEBBER INCORPORATED MONTGOMERY SECURITIES NATWEST SECURITIES LIMITED ------------ THE DATE OF THIS PROSPECTUS IS MAY 23, 1996. Inside Front Cover Photos depicting Company's products AVAILABLE INFORMATION The Company is subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance therewith files reports, proxy statements and other information with the Securities and Exchange Commission (the "Commission"). Such reports, proxy statements and other information filed by the Company can be inspected and copied at the public reference facilities maintained by the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the Commission's Regional Offices at Citicorp Center, 500 West Madison, Suite 1400, Chicago, Illinois 60661 and 7 World Trade Center, Suite 1300, New York, New York 10048. Copies of such material can be obtained from the Public Reference Section of the Commission at 450 Fifth Street, N.W., Washington D.C. 20549, at prescribed rates. The Company has filed with the Commission a Registration Statement under the Securities Act of 1933, as amended (the "Securities Act"), with respect to the Common Stock offered hereby. This Prospectus does not contain all of the information set forth in the Registration Statement and the exhibits and schedules thereto. For further information with respect to the Company and the Common Stock offered hereby, reference is hereby made to such Registration Statement, exhibits and schedules. Statements contained in this Prospectus regarding the contents of any contract or other document are not necessarily complete; with respect to each such contract or document filed as an exhibit to the Registration Statement, reference is made to the exhibit for a more complete description of the matter involved, and each such statement shall be deemed qualified in its entirety by such reference. A copy of the Registration Statement, including the exhibits and schedules thereto, may be inspected without charge at the principal office of the Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, and copies of such material may be obtained from such office upon payment of the fees prescribed by the Commission. ------------------- IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. ------------------- IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK OF THE COMPANY ON THE NASDAQ NATIONAL MARKET IN ACCORDANCE WITH RULE 10B-6A UNDER THE SECURITIES EXCHANGE ACT OF 1934. SEE "UNDERWRITING." FOR UNITED KINGDOM PURCHASERS: THE COMMON STOCK MAY NOT BE OFFERED OR SOLD IN THE UNITED KINGDOM OTHER THAN TO PERSONS WHOSE ORDINARY ACTIVITIES INVOLVE THEM IN ACQUIRING, HOLDING, MANAGING OR DISPOSING OF INVESTMENTS, WHETHER AS PRINCIPAL OR AGENT (EXCEPT IN CIRCUMSTANCES THAT DO NOT CONSTITUTE AN OFFER TO THE PUBLIC WITHIN THE MEANING OF THE PUBLIC OFFERS OF SECURITIES REGULATIONS 1995 OR THE FINANCIAL SERVICES ACT 1986), AND THIS PROSPECTUS MAY ONLY BE ISSUED OR PASSED ON TO ANY PERSON IN THE UNITED KINGDOM IF THAT PERSON IS OF A KIND DESCRIBED IN ARTICLE 11(3) OF THE FINANCIAL SERVICES ACT 1986 (INVESTMENT ADVERTISEMENTS) (EXEMPTIONS) ORDER 1995 OR IS A PERSON TO WHOM THE PROSPECTUS MAY OTHERWISE LAWFULLY BE PASSED ON. 2 PROSPECTUS SUMMARY THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED INFORMATION AND THE CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES APPEARING ELSEWHERE IN THIS PROSPECTUS. REFERENCES IN THIS PROSPECTUS TO THE COMPANY INCLUDE ITS PREDECESSOR AND ITS SUBSIDIARIES, UNLESS THE CONTEXT INDICATES OTHERWISE. EXCEPT AS OTHERWISE SPECIFIED HEREIN, ALL INFORMATION IN THIS PROSPECTUS (I) ASSUMES NO EXERCISE OF THE UNDERWRITERS' OVER-ALLOTMENT OPTION AND (II) HAS BEEN ADJUSTED TO REFLECT AN APPROXIMATELY 21.7-FOR-ONE STOCK SPLIT OF THE COMMON STOCK EFFECTED IN OCTOBER 1993 IN CONNECTION WITH THE COMPANY'S INITIAL PUBLIC OFFERING. "COMMON STOCK" SHALL REFER TO SHARES OF COMMON STOCK, $.01 PAR VALUE PER SHARE, OF THE COMPANY. THE SHARES OF COMMON STOCK OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK. INVESTORS SHOULD CAREFULLY CONSIDER THE INFORMATION SET FORTH UNDER "RISK FACTORS." THE COMPANY LodgeNet Entertainment Corporation ("LodgeNet" or the "Company") is a specialized communications company that provides video on-demand, network-based video games, basic and premium cable television programming and other interactive, multimedia entertainment and information services. Through its rapid growth, the Company has become the second largest provider of such services to the lodging market (based on total rooms served), currently serving over 420,000 rooms in over 2,800 hotel properties throughout the United States and Canada. The Company recently entered into an exclusive agreement with GE Capital-ResCom, L.P. ("GE ResCom"), an affiliate of General Electric Co., to provide similar services in multi-family residential complexes throughout the United States. The Company has experienced substantial growth in the number of guest pay rooms served, total revenue and EBITDA (earnings before interest expense, income taxes, depreciation and amortization). From 1991 through 1995, guest pay rooms served increased from 73,415 to 268,207, revenues increased from $19.6 million to $63.2 million and EBITDA increased from $2.9 million to $15.9 million, representing compound annual growth rates of 38.3%, 34.1% and 52.5%, respectively. For the three months ended March 31, 1996, guest pay rooms served increased to 300,216, revenues increased to $20.4 million and EBITDA increased to $5.2 million, representing an increase of 49.8%, 52.1% and 68.4%, respectively, over the same period in the prior year. The Company provides its services in the lodging market to corporate-managed hotel chains such as ITT Sheraton, The Ritz-Carlton Company, Harrah's Casino Hotels, Delta Hotels and Resorts, Outrigger, La Quinta Inns and Budgetel Inns, as well as many individual properties flying the Marriott, Holiday Inn, Hilton, Inter-Continental, Prince, Radisson, Westin, Doubletree, Embassy Suites, and other flags. The lodging market in the United States is comprised of over 3.4 million rooms, of which the Company estimates approximately 56% are located in the Company's target market of hotels having more than 100 rooms. The Company provides its services under exclusive, long-term contracts throughout the United States and Canada, and in other selected countries through licensing arrangements with strategic partners. The Company's guest pay contracts are generally five to seven years in length. The average remaining life of the Company's existing guest pay contracts is over four years, with only 10% of these contracts due to expire before 1998. In February 1996, the Company entered into an exclusive long-term agreement with GE ResCom, a leading provider of private telecommunications services to the multi-family housing industry, under which GE ResCom will exclusively market the Company's interactive video and cable television services to multi-family residential complexes throughout the United States. The Company believes there are over 6.1 million multi-family residential units in the United States that are located in apartment complexes having more than 200 units, the Company's primary market. Subject to the terms of the agreement, GE ResCom is required to provide the Company during the first three years of the agreement with contracts for a minimum of 200,000 apartment units with an average term of not less than ten years. The Company views the multi-family cable television market as attractive due to: (i) the large market size; (ii) the portability to this market of the technology and operating expertise developed by the Company for the lodging market; (iii) the favorable regulatory environment available to operators such as the Company who qualify for the "private cable" exception (including the absence of franchise requirements, "must-carry" obligations and rate 3 regulations applicable to traditional franchised cable operators); (iv) the exclusive long-term contracts that have customarily been available in the multi-family residential market; and (v) the low-cost operating structure made possible by the various services to be provided by GE ResCom. In the lodging market, the Company's services are delivered over broadband local-area cable networks and include Guest Scheduled-TM- on-demand movies, network-based Super Nintendo-Registered Trademark- video games, PRIME- STAR-Registered Trademark- digital satellite-delivered basic and premium cable television programming, and other interactive entertainment and information services. Guest pay services enable a guest to purchase a movie which generally is started by the guest on-demand, rather than restricting the guest to a predetermined start time. Free-to-guest services typically involve a customized package of basic and premium cable television programming which the hotel purchases from the Company and provides at no charge to guests. Video games can be started on-demand by a hotel guest who is charged an hourly rate for play time. Other services, which are typically provided at no charge to the guest, include guest surveys, folio review and video checkout. The Company is able to offer its interactive services by virtue of the high-speed, two-way digital communications design of its proprietary system. The Company's open-architecture, UNIX-based platform enables the Company to upgrade system software to support the introduction of new services or integrate new technologies as they become commercially available and economically viable. The Company's private cable television systems serving the multi-family residential market will be based on technology similar to the proprietary interactive technology deployed by the Company in the lodging market. Where residential complexes are located in clusters, the Company may distribute its programming content from a central location to each such apartment complex. The Company's private cable television system will have the capacity to deliver over 100 channels, although the Company expects that the typical system will deliver 35 to 50 channels of basic and premium programming, depending principally upon the size of the property, the length of the contract and local competitive considerations. The Company may elect to provide from approximately 10 to 35 additional channels for pay-per-view, video on-demand, video games and other interactive services, such as Internet access. The Company intends to tailor the programming lineup at each multi-family residential complex, based on the particular demographic profile of that complex. In addition, the Company's private cable television systems will be addressable, enabling the Company to remotely initiate, modify or terminate service; prevent signal theft; offer interactive services; and respond to many other service needs. The Company believes it is a leader in providing innovative products and services to the lodging industry. The Company was the first in the lodging market to install network-based interactive video games, the first to install in-room printers for video checkout and other applications, and the first to utilize a Video Room Card-TM- (an image-based menu and purchasing protocol, utilizing pictures and graphics to replace the simple text menus traditionally utilized by its competitors). In 1995, LodgeNet redesigned its interactive system, enabling the Company to deliver what it believes to be the first cost-effective system for on-demand movies and network-based video games to mid-size hotels of 100 to 150 rooms -- a market segment the Company believes has been historically underserved by guest pay providers. The Company believes that the advanced features of its redesigned system were a principal factor in the recent awarding by La Quinta Inns of its over 30,000-room account and Budgetel Inns of its over 8,000-room account to the Company over incumbent competitors. As of April 1, 1996, the Company entered into an agreement with PRIMESTAR-Registered Trademark- Partners, L.P. ("PRIMESTAR-Registered Trademark-") which will allow the Company to provide free-to-guest, digital satellite-delivered cable television programming to a broader segment of the lodging industry than can be cost-effectively served with traditional C-band satellite systems. The Company's business strategy is to: (i) continue to expand its lodging industry base of guest pay and free-to-guest rooms; (ii) expand into the multi-family residential private cable television market; (iii) maximize the revenue generated per unit served by exploiting new revenue opportunities; (iv) extend the application of the Company's proprietary technology and operating expertise to new markets; and (v) enhance financial performance by increasing operating margins and reducing the average capital invested per new unit installed. The Company's executive offices are located at 808 West Avenue North, Sioux Falls, South Dakota 57104, and its telephone number is (605) 330-1330. 4 THE OFFERING Common Stock offered by the Company... 3,200,000 shares Common Stock to be outstanding after this Offering........................ 10,559,613 shares Use of proceeds....................... To temporarily reduce borrowings under the Company's revolving credit facility, to fund the continued expansion of the Company's lodging and residential businesses, and for working capital and general corporate purposes. Nasdaq National Market symbol......... LNET
5 SUMMARY CONSOLIDATED FINANCIAL AND OTHER DATA (IN THOUSANDS, EXCEPT PER SHARE, ROOM AND PER ROOM AMOUNTS)
THREE MONTHS ENDED YEAR ENDED DECEMBER 31, MARCH 31, ----------------------------------------------------- ---------------------- 1991 1992 1993 1994 1995 1995 1996 --------- --------- --------- --------- --------- --------- ----------- (UNAUDITED) STATEMENT OF OPERATIONS DATA: Revenues............................. $ 19,550 $ 24,051 $ 31,312 $ 40,394 $ 63,213 $ 13,392 $ 20,368 Direct costs......................... 11,773 12,827 14,848 18,181 28,910 6,170 9,114 --------- --------- --------- --------- --------- --------- ----------- Gross profit......................... 7,777 11,224 16,464 22,213 34,303 7,222 11,254 Operating expenses................... 7,979 13,238 16,425 24,573 36,741 7,967 12,185 --------- --------- --------- --------- --------- --------- ----------- Operating income (loss).............. (202) (2,014) 39 (2,360) (2,438) (745) (931) Interest expense..................... 1,918 1,783 2,096 966 4,522 735 1,922 --------- --------- --------- --------- --------- --------- ----------- Loss before income taxes and extraordinary loss.................. (2,120) (3,797) (2,057) (3,326) (6,960) (1,480) (2,853) Provision for income taxes........... -- -- -- -- 66 -- 20 --------- --------- --------- --------- --------- --------- ----------- Loss before extraordinary loss....... (2,120) (3,797) (2,057) (3,326) (7,026) (1,480) (2,873) Extraordinary loss (1)............... -- -- -- 1,324 -- -- -- --------- --------- --------- --------- --------- --------- ----------- Net loss............................. (2,120) (3,797) (2,057) (4,650) (7,026) (1,480) (2,873) Dividends on preferred stock......... 940 1,872 1,557 -- -- -- -- --------- --------- --------- --------- --------- --------- ----------- Net loss attributable to common stock............................... $ (3,060) $ (5,669) $ (3,614) $ (4,650) $ (7,026) $ (1,480) $ (2,873) --------- --------- --------- --------- --------- --------- ----------- --------- --------- --------- --------- --------- --------- ----------- Common Stock per share data (2): Net loss before extraordinary loss.............................. $ (0.42) $ (0.77) $ (0.49) $ (0.45) $ (0.95) $ (0.20) $ (0.39) Extraordinary loss (1)............. -- -- -- (0.18) -- -- -- --------- --------- --------- --------- --------- --------- ----------- Net loss attributable to Common Stock............................. $ (0.42) $ (0.77) $ (0.49) $ (0.63) $ (0.95) $ (0.20) $ (0.39) --------- --------- --------- --------- --------- --------- ----------- --------- --------- --------- --------- --------- --------- ----------- Weighted average shares outstanding (2)..................... 7,334 7,334 7,334 7,327 7,382 7,352 7,407 --------- --------- --------- --------- --------- --------- ----------- --------- --------- --------- --------- --------- --------- ----------- OTHER DATA: EBITDA (3)........................... $ 2,941 $ 3,471 $ 7,215 $ 9,301 $ 15,898 $ 3,113 $ 5,242 EBITDA margin........................ 15.0% 14.4% 23.0% 23.0% 25.1% 23.2% 25.7% Guest pay rooms served (4) Scheduled.......................... 73,415 81,294 77,650 65,351 58,720 62,885 56,353 On-demand.......................... -- 21,871 59,169 119,680 209,487 137,582 243,863 --------- --------- --------- --------- --------- --------- ----------- Total guest pay rooms.............. 73,415 103,165 136,819 185,031 268,207 200,467 300,216 --------- --------- --------- --------- --------- --------- ----------- --------- --------- --------- --------- --------- --------- ----------- Rooms with Super Nintendo-Registered Trademark- game systems (4)......................... -- -- 225 69,806 163,879 91,346 200,388 --------- --------- --------- --------- --------- --------- ----------- --------- --------- --------- --------- --------- --------- ----------- Free-to-guest rooms served (4)....... 144,071 176,651 191,893 220,534 249,779 228,683 261,995 --------- --------- --------- --------- --------- --------- ----------- --------- --------- --------- --------- --------- --------- ----------- Total rooms served (4)(5)............ 182,537 227,697 267,171 314,184 388,088 331,529 424,089 --------- --------- --------- --------- --------- --------- ----------- --------- --------- --------- --------- --------- --------- ----------- Average monthly revenue per guest pay room: Movie revenue...................... $ 12.69 $ 13.00 $ 14.68 $ 15.03 $ 17.08 $ 16.64 $ 17.73 Video game/information services.... 0.24 0.27 0.39 1.01 2.21 1.73 2.35 --------- --------- --------- --------- --------- --------- ----------- $ 12.93 $ 13.27 $ 15.07 $ 16.04 $ 19.29 $ 18.37 $ 20.08 --------- --------- --------- --------- --------- --------- ----------- --------- --------- --------- --------- --------- --------- -----------
MARCH 31, 1996 ---------------------- AS ACTUAL ADJUSTED (6) --------- ----------- (UNAUDITED) BALANCE SHEET DATA: Cash and cash equivalents............................................................... $ 14 $ 23,505 Total assets............................................................................ 139,469 162,960 Long-term debt.......................................................................... 73,133 57,775 Total stockholders' equity.............................................................. 39,900 78,749
6 Notes to Summary Consolidated Financial and Other Data: (1) Extraordinary loss -- Loss on early termination of bank credit facility. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." (2) Share Data -- The net loss per common share was computed using the weighted average number of shares outstanding and, where applicable, outstanding warrants and options. Weighted average shares for 1993, 1994 and 1995 and the three months ended March 31, 1995 and 1996 include the shares issued in connection with the Company's initial public offering of Common Stock in October 1993. Per share amounts for 1991, 1992 and 1993 reflect the effect of cumulative dividends on preferred stock. (3) EBITDA -- Defined as "earnings before interest expense, income taxes, depreciation and amortization," EBITDA is not intended to represent an alternative to net income (as determined in accordance with generally accepted accounting principles) as a measure of performance. Rather, it is included herein because EBITDA is a widely accepted financial indicator used by certain investors and financial analysts to assess and compare companies on the basis of operating performance. Management believes that it provides an important additional perspective on the Company's operating results and the Company's ability to service its long-term debt and to fund the Company's continuing growth. (4) At end of period. (5) Total rooms served include those rooms receiving one or more of the Company's services. (6) Adjusted to give effect to the sale by the Company of 3,200,000 shares of Common Stock being offered by the Company at a public offering price of $13.00 per share and the application of the estimated net proceeds therefrom as described under "Use of Proceeds." 7 RISK FACTORS THIS PROSPECTUS CONTAINS, IN ADDITION TO HISTORICAL INFORMATION, FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE THOSE DISCUSSED BELOW, AS WELL AS THOSE DISCUSSED ELSEWHERE IN THIS PROSPECTUS. AN INVESTMENT IN THE SHARES OF COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. PROSPECTIVE INVESTORS SHOULD CONSIDER CAREFULLY THE FOLLOWING RISK FACTORS, IN ADDITION TO THE OTHER INFORMATION PRESENTED IN THIS PROSPECTUS, BEFORE PURCHASING THE SHARES OF COMMON STOCK OFFERED HEREBY. DEPENDENCE ON THE LODGING INDUSTRY AND CHANGES IN VIEWING HABITS The Company's business is closely linked to the performance of the lodging industry. Declines in hotel occupancy or changes in the mix of hotel guests as a result of general business, economic, seasonal and other factors can have a significant impact on the Company's revenues. The Company's performance is also highly sensitive to the rates at which hotel guests purchase its guest pay services ("buy rates"). Buy rates are subject to various factors beyond the control of the Company, including the popularity of available movies for the Company's guest pay systems, competing free-to-guest programming and general economic conditions. Additionally, the Company's business performance is highly dependent upon the relative mix of major motion pictures to independently produced, non-rated features purchased by hotel guests. The Company generally pays licensing fees for major motion pictures based on a percentage of the picture's gross revenues, while most independently produced features are obtained for a flat fee that is nominal in relation to the licensing fees paid for the major motion pictures. As a result, a shift in the viewing pattern of hotel guests away from independently produced features, or any limitation imposed on the offering of such features by hotels, could adversely affect the Company's financial condition and operating results. DEPENDENCE ON ADDITIONAL CAPITAL FOR GROWTH The continued growth of the Company's business will require substantial investment on a continuing basis to finance capital expenditures and related expenses for the installation of the Company's systems in the lodging and multi-family residential markets. Historically, cash flow generated from the Company's operations has not been sufficient to fund the cost of expanding the Company's business and to service related indebtedness. At least for the next several years, the Company expects cash flow levels will not be sufficient to support its anticipated growth. The Company will therefore require additional financing to fund its growth. There can be no assurance that such financing will be available or, if so, upon commercially reasonable terms. Alternatively, if cash flows are not sufficient or financing is not available, the Company will have to reduce growth to a level that can be supported by internally generated cash flow. The consequences to the Company's results of operations and financial condition of the latter course of action cannot be accurately predicted. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Financial Condition, Liquidity and Capital Resources." HIGHLY COMPETITIVE MARKETS Because of the high level of penetration in the large hotel segment of the lodging industry already achieved by guest pay providers, most of the growth opportunities in this market segment have traditionally involved securing contracts to serve hotels that are served by a competing vendor. An incumbent provider may have certain information and installation cost advantages as compared to outside competitors. These circumstances have led to increasing competition for contract renewals, particularly at hotels operated by major hotel chains. The Company believes that certain major hotel chains have awarded contracts based primarily on the level and nature of financial and other incentives offered by the pay-per-view service provider. Even if it were able to do so, the Company may not always be willing to match the incentives provided by its competitors, some of which have greater access to financial and other resources than the Company. In order to broaden its market opportunities, the Company redesigned its system to permit the delivery of on-demand movies and network-based video games to mid-size hotels of 100 to 150 rooms, a market segment the Company believes has been historically underserved by guest pay providers. There can be no assurance that the Company will be successful in this market segment or that competitors will not also target this market segment. There can be no assurance that the Company will continue its current level of success in obtaining new contracts from hotels currently served by other vendors or previously unserved, or that the Company will be able to retain contracts with hotels it serves when those contracts expire. 8 In addition, there are a number of potential competitors that could utilize their existing infrastructure to provide in-room entertainment to the lodging industry, including cable companies (including wireless cable), telecommunications companies and direct-to-home and direct broadcast satellite companies. Some of these potential competitors are already providing free-to-guest services to hotels and testing video on-demand. Some of these potential competitors have substantially greater resources than the Company. Competitive pressures could result in reduced market share for the Company, higher hotel commissions, narrower margins and increased expenditures on marketing, product development and systems installation, each of which could adversely affect the Company's financial condition and operating results. The provision of cable television services to the multi-family residential market is highly competitive. The Company anticipates that the primary competitors in each of its markets will be privately-held satellite master antenna television operators, direct broadcast satellite providers and wireless cable providers, as well as the local franchised cable operators. Certain of these competitors may have substantially greater resources and experience in this market than the Company. In addition, an incumbent provider may have certain contractual, information or installation cost advantages over a new provider. See "Business -- Competition." EARLY STAGE OF BUSINESS SERVING MULTI-FAMILY RESIDENTIAL MARKET The Company has only recently begun marketing its interactive, multimedia cable television services to multi-family residential complexes. The Company has no operating history in this market, and accordingly, there can be no assurance that the Company's services will achieve market acceptance or financial returns sufficient to justify the investment or continued operation in such market. RISK OF TECHNOLOGICAL OBSOLESCENCE Technology in the entertainment and communications industry is in a continuous state of change as new technologies continue to be introduced. There can be no guarantee that future technological advances will not result in improved equipment or software systems that could adversely affect the Company's business. In order to remain competitive, the Company must maintain the programming enhancements, engineering and technical capability and flexibility to respond to customer demands for new or improved versions of its systems and new technological developments. The Company's continued success will depend in part upon its ability to identify promising emerging technologies and to develop, refine and introduce high quality services in a timely manner and on competitive terms. Certain of the Company's competitors use or have announced their intention to use technologies different from the Company's in providing their guest pay or cable television services. Although the Company does not believe that any of these competing technologies is currently superior to its own in providing guest pay and interactive services, there can be no assurance that the Company's assessment of the strengths, weaknesses, costs and benefits of competing technologies has been or will be accurate. HISTORY OF LOSSES The Company has recorded cumulative net losses since its inception. Such losses can be attributed principally to the interest, depreciation and amortization expenses related to the front-end capital expenditures and related financing incurred by the Company to develop and install its in-room entertainment systems. Although the Company anticipates continuing to recognize positive cash flow from operations in the future, in light of the interest, depreciation and amortization expenses caused by the Company's historical and expected rate of growth, net losses are expected to continue. There can be no assurance that an increase in the number of lodging and residential customers served by the Company or the development of additional services will result in profitability for the Company in future years. RISKS OF DEVELOPING NEW PRODUCTS AND MARKETS The Company's strategy includes developing new applications for its interactive entertainment and information technologies and pursuing markets outside of the lodging industry. This strategy presents the risks inherent in assessing the value of development opportunities, in committing capital in unproven markets and in integrating and managing new technologies and applications. Within these new markets, the Company will encounter competition from a variety of sources that are not present in the lodging market. There can be no assurance that the Company's new products and applications will generate additional revenues or earnings for the Company or that the Company will successfully penetrate these additional markets. See "Business -- Business Strategy." 9 GOVERNMENT REGULATION The Federal Communications Commission (the "FCC") has broad jurisdiction over the telecommunications industry. However, the Company believes its operations comply with a statutory exemption from regulation as a "cable system" operator under the Cable Communications Policy Act of 1984, as amended (the "Cable Act"). As a "private cable" operator under applicable federal law, the FCC does not directly regulate the Company's guest pay, free-to-guest, or multi-family residential cable television activities. For example, the Company is not subject to the franchise requirements, "must-carry" obligations and rate regulations applicable to "cable system" operators. It is possible, however, that laws or regulations could be adopted in the future which would impose additional regulatory burdens on private cable operators. Private cable operators such as the Company are, however, subject to certain regulatory requirements. For instance, private cable operators, with certain exceptions, are prohibited from carrying the signal of a commercial television broadcast station without the broadcaster's "retransmission" consent. If the cable operator and the broadcaster fail to reach an agreement on terms and conditions for retransmission, the cable operator is prohibited from carrying the broadcaster's signal. Although there can be no assurance, the Company believes it can obtain all necessary retransmission consents in its markets. On February 8, 1996, the President signed into law the Telecommunications Act of 1996 (the "Act"). This new law will alter federal, state and local laws and regulations regarding telecommunications providers and services. The Act generally removes previous restrictions preventing cable firms, telephone companies, long distance carriers and public utilities from entering into certain new markets, removes many cross-ownership restrictions, modifies rate regulations applicable to franchised cable operators in the Company's markets and establishes interconnection obligations for local exchange carriers and other telecommunications carriers. In particular, the Act authorizes local telephone companies to provide video programming directly to subscribers in their service areas and eliminates the requirement that "private cable" operators serve only buildings "under common ownership, management or control," but preserves the requirement that such operations not use closed transmission paths to cross public rights-of-way. The Act also permits franchised cable operators to offer bulk discounts to multiple dwelling units; provided, however, that such discounts may not constitute "predatory pricing." Prior to the adoption of the Act, franchised cable operators were subject to a uniform rate requirement which generally prohibited such bulk discounts. There are numerous rulemakings to be undertaken by the FCC which will interpret and implement the provisions of the Act. It is anticipated that the Act will stimulate increased competition generally in the telecommunications industry. The Company cannot, however, estimate the impact of the Act on its operations at this time. See "Business -- Regulation." ANTI-TAKEOVER PROVISIONS IN CHARTER, BY-LAWS AND CERTAIN AGREEMENTS The Company's Certificate of Incorporation, By-Laws and certain agreements contain provisions that could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, control of the Company. Such provisions could limit the price that certain investors might be willing to pay in the future for shares of Common Stock. Certain provisions in the Company's Certificate of Incorporation and By-Laws allow the Company to issue preferred stock with rights senior to those of the Common Stock and impose various procedural and other requirements which could make it more difficult for stockholders to effect certain corporate actions. See "Description of Capital Stock -- Delaware Law and Certain Charter and By-Law Provisions." Certain of the Company's lending arrangements and its agreement with GE ResCom contain change in control restrictions applicable to the Company. These provisions also could have the effect of discouraging a party from attempting to acquire control of the Company. DEPENDENCE ON KEY PERSONNEL The Company's success is dependent upon the continued contributions of its senior corporate management and key employees. The loss of the services of its key personnel could have a material adverse effect on the Company. The Company depends on its continued ability to attract and retain highly skilled and qualified personnel. There can be no assurance that the Company will be successful in attracting and retaining such personnel. See "Management." DILUTION Purchasers of shares of Common Stock in this Offering will experience immediate and substantial dilution. See "Dilution." 10 USE OF PROCEEDS The proceeds to the Company from the sale of the 3,200,000 shares of Common Stock being offered by the Company are estimated to be $38.8 million ($44.8 million if the Underwriters' over-allotment option is exercised in full), at a public offering price of $13.00 per share and after deducting estimated underwriting discounts and commissions and offering expenses. Of the net proceeds of this offering (the "Offering"), the Company currently anticipates that approximately $24.8 million of such proceeds will be used to temporarily reduce borrowings under the Company's $45 million revolving credit facility with National Westminster Bank Plc (the "1996 Revolving Facility"), with the remainder of the net proceeds being used to fund capital expenditures to continue to expand the Company's lodging and residential businesses, and for working capital and general corporate purposes. Pending such uses, the Company intends to invest the net proceeds in highly liquid, interest-bearing securities. As of May 22, 1996, there was approximately $24.8 million outstanding under the 1996 Revolving Facility, which bears interest at a variable rate determined by a formula based on the bank's prime rate or LIBOR and the Company's total leverage (approximately 9.875% at May 22, 1996). See Note 4 of "Notes to Consolidated Financial Statements." DIVIDEND POLICY No dividends have been paid to date on the Common Stock of the Company. The Board of Directors of the Company does not intend to pay any cash dividends on Common Stock in the foreseeable future, rather, it is expected that the Company will retain any earnings to finance its operations and growth. In addition, the 1996 Revolving Facility and the agreements governing the issuance of the Company's long-term debt include covenants which restrict and limit payments or distributions in respect of the Common Stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Financial Condition, Liquidity and Capital Resources." PRICE RANGE OF COMMON STOCK The Common Stock is quoted on the Nasdaq National Market under the symbol "LNET." The following sets forth for the periods indicated the high and low reported last sales price per share for the Common Stock as reported by the Nasdaq National Market.
FISCAL 1994 HIGH LOW - -------------------------------------------------------- --------- --------- First Quarter........................................... $ 15.88 $ 12.75 Second Quarter.......................................... 14.00 9.50 Third Quarter........................................... 11.00 7.25 Fourth Quarter.......................................... 8.63 6.75 FISCAL 1995 - -------------------------------------------------------- First Quarter........................................... $ 9.25 $ 7.00 Second Quarter.......................................... 9.00 6.75 Third Quarter........................................... 11.75 8.50 Fourth Quarter.......................................... 12.75 9.38 FISCAL 1996 - -------------------------------------------------------- First Quarter........................................... $ 13.75 $ 9.25 Second Quarter (through May 22, 1996)................... 14.75 12.25
On May 22, 1996, the last reported sale price of the Common Stock as reported by the Nasdaq National Market was $13.25 per share. 11 CAPITALIZATION The following table sets forth the capitalization of the Company as of March 31, 1996, as adjusted to give effect to the sale by the Company of the 3,200,000 shares of Common Stock being offered hereby at a public offering price of $13.00 per share and the application of the estimated net proceeds therefrom as described under "Use of Proceeds."
MARCH 31, 1996 ----------------------- ACTUAL AS ADJUSTED ---------- ----------- (IN THOUSANDS) Cash and cash equivalents......................... $ 14 $ 23,505 ---------- ----------- ---------- ----------- Long-term debt (1): Revolving credit facility (2)................... $ 15,358 $ -- Senior notes.................................... 33,000 33,000 Senior subordinated notes, less unamortized discount....................................... 28,455 28,455 Other........................................... 619 619 ---------- ----------- 77,432 62,074 Less current maturities......................... (4,299) (4,299) ---------- ----------- Total long-term debt........................ 73,133 57,775 ---------- ----------- Stockholders' equity: Preferred stock, $.01 par value; 5,000,000 shares authorized; none outstanding............................... -- -- Common stock, $.01 par value; 20,000,000 shares authorized; 7,359,613 outstanding, actual; 10,559,613 outstanding, as adjusted....................... 74 106 Additional paid-in capital...................... 71,262 110,079 Accumulated deficit............................. (31,436) (31,436) ---------- ----------- Total stockholders' equity.................. 39,900 78,749 ---------- ----------- Total capitalization.............................. $ 113,033 $ 136,524 ---------- ----------- ---------- -----------
- ------------ (1) See Note 3 of "Notes to Consolidated Financial Statements." (2) See Note 4 of "Notes to Consolidated Financial Statements." 12 DILUTION The net tangible book value of the Company as of March 31, 1996 was $34.0 million, or $4.62 per share. Net tangible book value per share represents the amount of total tangible assets less total liabilities of the Company, divided by the number of shares of Common Stock outstanding. After giving effect to the sale of the 3,200,000 shares of Common Stock offered by the Company hereby (at a public offering price of $13.00 per share and after deduction of estimated underwriting discounts and commissions and offering expenses), the pro forma net tangible book value of the Company at March 31, 1996 would have been $72.8 million, or $6.90 per share. This represents an immediate increase in such net tangible book value of $2.28 per share to existing stockholders and an immediate dilution of $6.10 per share to new investors purchasing shares in this Offering. Net tangible book value dilution per share represents the difference between the amount per share paid by new investors purchasing shares of Common Stock in this Offering and the pro forma net tangible book value per share of Common Stock immediately after completion of this Offering. The following table illustrates this per share dilution: Public offering price........................................ $ 13.00 --------- Net tangible book value before Offering.................... $ 4.62 Increase attributable to new investors..................... 2.28 --------- Pro forma net tangible book value after Offering............. 6.90 --------- Dilution to new investors.................................... $ 6.10 --------- ---------
The following table summarizes, on a pro forma basis as of March 31, 1996, the differences between existing stockholders and new investors with respect to the number of shares of Common Stock purchased from the Company, the total consideration paid to the Company, and the average consideration paid per share (based upon a public offering price of $13.00 per share and before deduction of estimated underwriting discounts and commissions and offering expenses payable by the Company):
SHARES PURCHASED TOTAL CONSIDERATION ------------------------- --------------------------- AVERAGE PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE ------------ ----------- -------------- ----------- ------------- Existing stockholders.......................... 7,359,613 69.7% $ 73,609,444 63.9% $ 10.00 New investors.................................. 3,200,000 30.3 41,600,000 36.1 13.00 ------------ ----- -------------- ----- Total.................................... 10,559,613 100.0% $ 115,209,444 100.0% ------------ ----- -------------- ----- ------------ ----- -------------- -----
The foregoing table assumes no exercise of any outstanding stock options. As of March 31, 1996, there were outstanding options to purchase an aggregate of 1,407,926 shares of Common Stock at exercise prices ranging from $0.23 to $14.75 per share. To the extent these options are exercised, there will be further dilution to new investors. See "Management -- Stock Option Plan" and Note 7 of "Notes to Consolidated Financial Statements." 13 SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA (IN THOUSANDS, EXCEPT PER SHARE, ROOM AND PER ROOM AMOUNTS) The statement of operations data for the five years ended December 31, 1995 and the balance sheet data as of the end of each such year have been derived from the Consolidated Financial Statements of the Company, which have been audited by Arthur Andersen LLP, independent public accountants. The statement of operations and balance sheet data for the three months ended March 31, 1995 and 1996 have been derived from unaudited consolidated financial statements of the Company but, in the opinion of the Company, include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation thereof. The results for the three month period ended March 31, 1996 are not necessarily indicative of the results to be expected for the year ending December 31, 1996. The data should be read in conjunction with the Company's Consolidated Financial Statements, the notes thereto, and "Management's Discussion and Analysis of Financial Condition and Results of Operations," all included elsewhere herein.
THREE MONTHS ENDED YEAR ENDED DECEMBER 31, MARCH 31, ----------------------------------------------------- -------------------- 1991 1992 1993 1994 1995 1995 1996 --------- --------- --------- --------- --------- --------- --------- (UNAUDITED) STATEMENT OF OPERATIONS DATA: Revenues: Guest pay........................ $ 9,019 $ 13,828 $ 21,471 $ 29,927 $ 50,758 $ 10,500 $ 17,582 Free-to-guest.................... 5,586 6,125 7,478 8,397 8,060 1,993 2,145 Other............................ 4,945 4,098 2,363 2,070 4,395 899 641 --------- --------- --------- --------- --------- --------- --------- Total revenues..................... 19,550 24,051 31,312 40,394 63,213 13,392 20,368 Direct costs....................... 11,773 12,827 14,848 18,181 28,910 6,170 9,114 --------- --------- --------- --------- --------- --------- --------- Gross profit....................... 7,777 11,224 16,464 22,213 34,303 7,222 11,254 Operating expenses................. 7,979 13,238 16,425 24,573 36,741 7,967 12,185 --------- --------- --------- --------- --------- --------- --------- Operating income (loss)............ (202) (2,014) 39 (2,360) (2,438) (745) (931) Interest expense................... 1,918 1,783 2,096 966 4,522 735 1,922 --------- --------- --------- --------- --------- --------- --------- Loss before income taxes and extraordinary loss................ (2,120) (3,797) (2,057) (3,326) (6,960) (1,480) (2,853) Provision for income taxes......... -- -- -- -- 66 -- 20 --------- --------- --------- --------- --------- --------- --------- Loss before extraordinary loss..... (2,120) (3,797) (2,057) (3,326) (7,026) (1,480) (2,873) Extraordinary loss (1)............. -- -- -- 1,324 -- -- -- --------- --------- --------- --------- --------- --------- --------- Net loss........................... (2,120) (3,797) (2,057) (4,650) (7,026) (1,480) (2,873) Dividends on preferred stock....... 940 1,872 1,557 -- -- -- -- --------- --------- --------- --------- --------- --------- --------- Net loss attributable to Common Stock............................. $ (3,060) $ (5,669) $ (3,614) $ (4,650) $ (7,026) $ (1,480) $ (2,873) --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Common Stock per share data (2): Net loss before extraordinary loss............................ $ (0.42) $ (0.77) $ (0.49) $ (0.45) $ (0.95) $ (0.20) $ (0.39) Extraordinary loss (1)........... -- -- -- (0.18) -- -- -- --------- --------- --------- --------- --------- --------- --------- Net loss attributable to Common Stock......................... $ (0.42) $ (0.77) $ (0.49) $ (0.63) $ (0.95) $ (0.20) $ (0.39) --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Weighted average shares outstanding (2)............................... 7,334 7,334 7,334 7,327 7,382 7,352 7,407 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Gross profit margin................ 39.8% 46.7% 52.6% 55.0% 54.3% 53.9% 55.3% OTHER DATA: EBITDA (3)......................... $ 2,941 $ 3,471 $ 7,215 $ 9,301 $ 15,898 $ 3,113 $ 5,242 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- EBITDA margin...................... 15.0% 14.4% 23.0% 23.0% 25.1% 23.2% 25.7% --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Guest pay rooms served (4): Scheduled........................ 73,415 81,294 77,650 65,351 58,720 62,885 56,353 On-demand........................ 21,871 59,169 119,680 209,487 137,582 243,863 --------- --------- --------- --------- --------- --------- --------- Total.......................... 73,415 103,165 136,819 185,031 268,207 200,467 300,216 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Rooms with Super Nintendo-Registered Trademark- game systems (4).................. -- -- 225 69,806 163,879 91,346 200,388 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Free-to-guest rooms served (4)..... 144,071 176,651 191,893 220,534 249,779 228,683 261,995 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Total rooms served (4)(5).......... 182,537 227,697 267,171 314,184 388,088 331,529 424,089 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- Average monthly revenue per guest pay room: Movie revenue.................... $ 12.69 $ 13.00 $ 14.68 $ 15.03 $ 17.08 $ 16.64 $ 17.73 Video game/information services........................ 0.24 0.27 0.39 1.01 2.21 1.73 2.35 --------- --------- --------- --------- --------- --------- --------- $ 12.93 $ 13.27 $ 15.07 $ 16.04 $ 19.29 $ 18.37 $ 20.08 --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
14
DECEMBER 31, MARCH 31, 1996 ----------------------------------------------------- ---------------------- AS 1991 1992 1993 1994 1995 ACTUAL ADJUSTED (7) --------- --------- --------- --------- --------- --------- ----------- (UNAUDITED) BALANCE SHEET DATA: Cash and cash equivalents............... $ 221 $ 92 $ 12,256 $ 4,302 $ 2,252 $ 14 $ 23,505 Total assets............................ 27,566 42,238 64,300 88,265 124,712 139,469 162,960 Long-term debt.......................... 14,712 29,500 6,000 28,000 57,497 73,133 57,775 Redeemable preferred stock (6).......... 12,940 13,519 -- -- -- -- -- Total stockholders' equity (deficit).... (3,820) (7,272) 52,665 47,942 42,726 39,900 78,749
- --------------- Notes to Selected Consolidated Financial and Other Data: (1) Extraordinary loss -- Loss on early termination of bank credit facility. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." (2) Share Data -- The net loss per common share was computed using the weighted average number of shares outstanding and, where applicable, outstanding warrants and options. Weighted average shares for 1993, 1994 and 1995 and the three months ended March 31, 1995 and 1996 include the shares issued in connection with the Company's initial public offering of Common Stock in October 1993. Per share amounts for 1991, 1992 and 1993 reflect the effect of cumulative dividends on preferred stock. (3) EBITDA is not intended to represent an alternative to net income (as determined in accordance with generally accepted accounting principles) as a measure of performance. Rather, it is included herein because EBITDA is a widely accepted financial indicator used by certain investors and financial analysts to assess and compare companies on the basis of operating performance. Management believes that it provides an important additional perspective on the Company's operating results and the Company's ability to service its long-term debt and to fund the Company's continuing growth. (4) At end of period. (5) Total rooms served include those rooms receiving one or more of the Company's services. (6) Includes cumulative preferred dividends payable. (7) Adjusted to give effect to the sale by the Company of 3,200,000 shares of Common Stock being offered by the Company at a public offering price of $13.00 per share and the application of the estimated net proceeds therefrom as described under "Use of Proceeds." 15 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THIS PROSPECTUS CONTAINS, IN ADDITION TO HISTORICAL INFORMATION, FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. IN ADDITION, FIRST QUARTER RESULTS ARE NOT NECESSARILY INDICATIVE OF THE RESULTS TO BE EXPECTED AT YEAR-END. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE THOSE DISCUSSED BELOW, AS WELL AS THOSE DISCUSSED ELSEWHERE IN THIS PROSPECTUS. THE FOLLOWING SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED ELSEWHERE HEREIN. OVERVIEW GUEST PAY SERVICES The growth that the Company has experienced has principally resulted from its rapid expansion of guest pay-per-view services, which the Company began installing in 1986. In May 1992, the Company introduced and began installing its on-demand guest pay service. It has been the Company's experience that rooms featuring the "on-demand" guest pay service generate significantly more revenue and gross profit per room than comparable rooms having only the scheduled format. The following table sets forth information in regard to guest pay rooms installed as of December 31:
1995 1994 1993 ---------------------- ---------------------- ---------------------- ROOMS % ROOMS % ROOMS % --------- ----------- --------- ----------- --------- ----------- Scheduled............................... 58,720 21.9% 65,351 35.3% 77,650 56.8% On-demand............................... 209,487 78.1 119,680 64.7 59,169 43.2 --------- ----- --------- ----- --------- ----- Total............................. 268,207 100.0% 185,031 100.0% 136,819 100.0% --------- ----- --------- ----- --------- ----- --------- ----- --------- ----- --------- -----
The Company's guest pay revenues depend on a number of factors, including the number of rooms equipped with the Company's systems, guest pay buy rates, hotel occupancy rates, the popularity, selection and pricing of the Company's program offerings and the length of time programming is available to the Company prior to its release to the home video and cable television markets. The primary direct costs of providing guest pay services are (i) license fees paid to studios for non-exclusive distribution rights to recently-released major motion pictures, generally ranging from 35% to 50% of gross revenues, (ii) nominal one-time license fees paid for independent films, which are duplicated by the Company for distribution to its operating sites, (iii) license fees for video games and other services, and (iv) the commission retained by the hotel, generally 10% to 15% of gross revenues, depending on the services provided and other factors. Guest pay operating expenses include costs of system maintenance and support, in-room marketing, video tape duplication and distribution, data retrieval, insurance and personal property taxes. The Company also provides video games and interactive multimedia entertainment and information services through its guest pay systems. Services include folio review, video check-out and guest satisfaction surveys. In 1993 the Company entered into a seven-year non-exclusive license agreement with Nintendo of America, Inc. ("Nintendo") to provide hotels with a network-based Super Nintendo-Registered Trademark- video game playing system. The following table sets forth information with regard to guest pay rooms with game systems installed as of December 31:
1995 1994 1993 -------- ------- ---- Rooms with game systems installed........................... 163,879 69,806 225
FREE-TO-GUEST SERVICES In addition to guest pay services, the Company provides cable television programming for which the hotel, rather than its guests, pays the charges. Free-to-guest services include the satellite delivery of various programming channels through a satellite earth station, which generally is owned or leased by the hotel. For free-to-guest services the hotel pays the Company a fixed monthly charge per room for each programming channel provided. Such monthly charges range generally from $2.75 to $3.50 per room per month for premium channels and from $0.15 to $0.85 per room per month for non-premium channels. The Company obtains its free-to-guest programming pursuant to multi-year agreements and pays a fixed monthly fee per 16 room, which ranges generally from 75% to 80% of revenues for such services, depending on incentive programs in effect from time to time from the programming networks. The following table sets forth information with regard to free-to-guest rooms installed as of December 31:
1995 1994 1993 --------- --------- --------- Free-to-guest rooms..................... 249,779 220,534 191,893
RESIDENTIAL SERVICES In February 1996, the Company entered into an exclusive contract with GE ResCom, under which the Company will design, install and operate interactive cable television systems in large, multi-family residential complexes throughout the United States. This new business is expected to have financial and technological requirements generally similar to those of the Company's lodging industry operations. The Company expects to begin installing systems and to realize its first revenue from residential services in the second quarter of 1996. See "Business -- Services and Products, Multi-Family Residential Services." RESULTS OF OPERATIONS -- THREE MONTHS ENDED MARCH 31, 1996 AND 1995 INSTALLED ROOM BASE During the three months ended March 31, 1996, the Company installed 32,009 new guest pay rooms, equipped 36,509 rooms with its Super Nintendo-Registered Trademark- game system, and installed 12,216 free-to-guest rooms. From March 31, 1995 through March 31, 1996, the Company installed 99,749 new guest pay rooms, equipped 109,042 rooms with its Super Nintendo-Registered Trademark- game system, and installed 33,312 free-to-guest rooms, representing increases of 49.8%, 119.4% and 14.6%, respectively. The Company's base of installed rooms was comprised as follows at March 31:
1996 1995 ---------------------- ---------------------- ROOMS % ROOMS % --------- ----------- --------- ----------- Guest pay rooms: Scheduled................................................. 56,353 18.8% 62,885 31.4% On-demand................................................. 243,863 81.2 137,582 68.6 --------- ----- --------- ----- 300,216 100.0% 200,467 100.0% --------- ----- --------- ----- --------- ----- --------- ----- Super Nintendo-Registered Trademark- game system rooms...... 200,388 91,346 --------- --------- --------- --------- Free-to-guest rooms......................................... 261,995 228,683 --------- --------- --------- ---------
REVENUE ANALYSIS The Company's total revenues for the first quarter of 1996 increased 52.1%, or $7.0 million, in comparison to the first quarter of 1995. The following table sets forth the components of the Company's revenue (in thousands) for the quarter ending March 31 (unaudited):
1996 1995 ----------------------- ----------------------- PERCENT PERCENT OF TOTAL OF TOTAL AMOUNT REVENUES AMOUNT REVENUES --------- ------------ --------- ------------ Guest pay................................................... $ 17,582 86.3% $ 10,500 78.4% Free-to-guest............................................... 2,145 10.5 1,993 14.9 Other....................................................... 641 3.2 899 6.7 --------- ----- --------- ----- Total revenues.......................................... $ 20,368 100.0% $ 13,392 100.0% --------- ----- --------- ----- --------- ----- --------- -----
GUEST PAY. Guest pay revenues increased 67.4%, or $7.1 million, in the first quarter of 1996 as compared to the same quarter of 1995. This increase was the result of (i) a 46.7% increase in the average number of installed guest pay rooms, all of which were installed with the Company's on-demand room technology, and (ii) a 9.3% increase in average monthly revenue per guest pay room. 17 The following table sets forth information in regard to average monthly revenue per installed guest pay room, and average movie buy rates, average movie prices, and average hotel occupancy rates for (i) all guest pay rooms and (ii) on-demand guest pay rooms, each for the quarter ending March 31 (unaudited):
1996 1995 ------- ------- Average monthly revenue per guest pay room: Movie revenue............................................. $17.73 $16.64 Video game/information service............................ 2.35 1.73 ------- ------- Total per guest pay room................................ $20.08 $18.37 ------- ------- ------- ------- For all guest pay rooms: Average movie buy rates................................... 11.3% 10.7% Average movie price....................................... $8.37 $8.19 Average hotel occupancy rate.............................. 65.9% 65.3% For on-demand guest pay rooms: Average movie buy rates................................... 12.4% 12.0% Average movie price....................................... $8.41 $8.25 Average hotel occupancy rate.............................. 67.9% 67.3%
Average movie revenue per room, for all guest pay rooms, was favorably impacted in the first quarter of 1996 by a combination of higher average buy rates and higher average movie prices, in comparison to the same quarter of the prior year, and by the comparative increase in the proportion of on-demand rooms. It has been the Company's experience that buy rates are higher in rooms featuring the on-demand service than in those rooms with the scheduled service. The comparative increase in buy rates is attributed to a relatively more popular selection of newly-released major motion pictures in the first quarter of 1996 as compared to the same quarter in the prior year. Movie prices in certain guest pay rooms were increased effective February 1, 1995. The Company's movie prices are generally $7.95 or $8.95. Average video game and information service revenue per room, for all guest pay rooms, increased primarily as a result of the increase in the average number of rooms with video game services installed. On a per-room basis, average monthly video game revenues were $1.75 and $1.27 during the quarters ended March 31, 1996 and 1995, respectively. The Company had installed its video game service in 200,388 and 91,346 guest pay rooms as of March 31, 1996 and 1995, respectively. FREE-TO-GUEST. Free-to-guest revenues increased 7.6%, or $152,000, in the first quarter of 1996 as compared to the same quarter of 1995. The comparative increase in revenues resulted from the 14.6% increase in the number of installed free-to-guest rooms since March 31, 1995, which installed room increase mitigated a decline in per-room revenues resulting from a lower proportion of rooms receiving premium services in the current period. The Company had 261,995 and 228,683 free-to-guest rooms installed at March 31, 1996 and 1995, respectively. OTHER. Revenue from other sources, such as the sale of televisions, system equipment, service parts and labor, and miscellaneous free-to-guest programming materials, decreased by $258,000, in the first quarter of 1996 as compared to the same quarter of 1995, all of which was due to lower television sales. 18 EXPENSE ANALYSIS DIRECT COSTS. The following table sets forth information regarding the Company's direct costs (in thousands) and gross profit margin for the quarters ending March 31 (unaudited):
1996 1995 ------- ------- Direct costs: Guest pay................................................. $ 6,839 $ 3,824 Free-to-guest............................................. 1,684 1,544 Other revenue............................................. 591 802 ------- ------- Total direct costs...................................... $ 9,114 $ 6,170 ------- ------- ------- ------- Gross profit margin: Guest pay................................................. 61.1% 63.6% Free-to-guest............................................. 21.5 22.5 Other revenue............................................. 7.8 10.8 Overall (composite)....................................... 55.3 53.9
Guest pay direct costs increased 78.8%, or $3.0 million, in the first quarter of 1996 as compared to the same quarter in the prior year. Since guest pay direct costs (i.e., studio and other license fees, video game license fees and the commission retained by the hotel) are primarily based on related revenue, such direct costs tend to vary directly with revenue. As a percentage of revenue, such costs increased from 36.4% in the first quarter of 1995 to 38.9% in the first quarter of 1996. The relative increase in guest pay direct costs (as a percentage of revenue) reflects higher movie-related costs due to proportionately higher revenue from newly-released motion pictures, substantially increased video game revenue in the guest pay revenue mix and increased hotel commissions, all in the first quarter of 1996 as compared to the same quarter in the prior year. Free-to-guest direct costs increased 9.1% to $1.7 million in the first quarter of 1996 from $1.5 million in the same quarter in the prior year. As a percentage of free-to-guest revenue, free-to-guest direct costs increased to 78.5% in the first quarter of 1996 from 77.5% in the same quarter in the prior year. The relative increase in free-to-guest direct costs (as a percentage of revenue) resulted primarily from higher costs for non-premium programming in the first quarter of 1996, in comparison to the same quarter in the prior year, and to a lesser extent to a slightly higher proportion of non-premium programming in the mix of programming services delivered. Direct costs associated with other revenue decreased $211,000 in the first quarter of 1996 as compared to the same quarter in the prior year. This decrease is directly attributable to the decreased level of television sales discussed above. As a percentage of related revenues, such direct costs increased to 92.2% of other revenue in the first quarter versus 89.2% in the first quarter of 1995, reflecting the effect of increased equipment sales, which have relatively low margins, in the revenue mix for the first quarter of 1996 as compared to the same quarter in the prior year. The Company's overall gross profit increased 55.8%, or $4.0 million, to $11.3 million in the first quarter of 1996 on a 52.1% increase in revenues in comparison to the same period in the prior year. The Company's overall gross profit margin improved to 55.3% in the first quarter of 1996, as compared to 53.9% for the same period in the prior year, primarily due to the relative increase in the proportion of guest pay revenues in the total revenue mix between the quarters. 19 OPERATING EXPENSES. The following table sets forth information in regard to the Company's operating expenses (in thousands) for the quarter ending March 31 (unaudited):
1996 1995 ------------------------ ------------------------ PERCENT PERCENT OF TOTAL OF TOTAL AMOUNT REVENUES AMOUNT REVENUES --------- ------------- --------- ------------- Operating expenses: Guest pay operations....................................... $ 3,163 15.5% $ 2,213 16.5% Selling and marketing...................................... 742 3.7 511 3.8 General and administrative................................. 2,107 10.3 1,385 10.3 Depreciation and amortization.............................. 6,173 30.3 3,858 28.8 --------- --- --------- --- $ 12,185 59.8% $ 7,967 59.4% --------- --- --------- --- --------- --- --------- ---
Guest pay operations expense increased 42.9%, or $950,000, in the first quarter of 1996 from $2.2 million in the comparable quarter of the previous year. This increase is primarily attributable to the 46.7% increase in the average number of installed guest pay rooms in the first quarter of 1996 as compared to the same quarter in the prior year. Per average installed guest pay room, such expenses averaged $3.83 per month in the first quarter of 1996 as compared to $3.87 per month in the same quarter of 1995. The comparative decrease on a per-room basis was primarily the result of lower service, maintenance and support costs. Selling and marketing expenses increased 45.2%, or $231,000, in the first quarter of 1996 from $511,000 in the same quarter in the prior year. This increase reflects the effect of expanded marketing and promotional activities and an increase in the number of sales and marketing personnel. As a percentage of revenue, such expenses represented 3.7% of revenue in the first quarter of 1996 as compared to 3.8% in the same quarter in the prior year. General and administrative expenses increased 52.1%, or $722,000, in the first quarter of 1996 from $1.4 million in the same quarter in the prior year primarily reflecting higher legal and personnel related costs. As a percentage of revenue, general and administrative expenses represented 10.3% of total revenue in both quarters. Depreciation and amortization expenses increased 60.0% to $6.2 million in the first quarter of 1996 from $3.9 million in the same quarter in the prior year. This increase is directly attributable to the increase in the number of installed guest pay and game service equipped rooms previously discussed as well as the associated software costs and other capitalized costs such as service vans, equipment and computers that are related to the increased number of rooms in service since the same quarter in the prior year. OPERATING LOSS. The Company's operating loss, as a result of the factors previously discussed, increased to $931,000 in the first quarter of 1996 from $745,000 in the same quarter of 1995. INTEREST EXPENSE. Interest expense increased to $1.9 million in the first quarter of 1996 from $735,000 in the comparable quarter of 1995 due to increases in long-term debt to fund the Company's continuing expansion of its guest pay services business. Long-term debt increased from $32.3 million at March 31, 1995 to approximately $73.1 million at March 31, 1996, primarily reflecting the Company's issuance of $30 million, of 11.5% Senior Subordinated Notes in two separate private placements during 1995, and borrowings under the Company's revolving credit facility. Average principal amount of long-term debt outstanding during the quarter ended March 31, 1996 was approximately $68 million (at an average interest rate of approximately 10.7%) as compared to an average principal amount outstanding of approximately $29 million (at an average interest rate of approximately 10.0%) during the comparable period of 1995. NET LOSS. For the reasons previously discussed, the Company's net loss increased to $2.9 million in the first quarter of 1996 from a net loss of $1.5 million in the same quarter in the prior year. EBITDA. As a result of increasing revenues from guest pay services, and the other factors previously discussed, EBITDA increased 68.4% to $5.2 million in the first quarter of 1996 as compared to $3.1 million 20 in the first quarter of 1995. EBITDA as a percentage of total revenue increased to 25.7% in the first quarter of 1996 as compared to 23.2% in the same quarter of 1995. EBITDA is included herein because it is a widely accepted financial indicator used by certain investors and financial analysts to assess and compare companies on the basis of operating performance. EBITDA is not intended to represent an alternative to net income (as determined in accordance with generally accepted accounting principles) as a measure of performance, but management believes that it does provide an important additional perspective on the Company's operating results and the Company's ability to service its long-term debt and to fund the Company's continuing growth. RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1995 AND 1994 REVENUE ANALYSIS The Company's total revenues increased 56.5% in 1995 as compared to 1994. The following table sets forth the various components of the Company's total revenue (in thousands) for the years ended December 31:
1995 1994 ----------------------- ----------------------- PERCENT OF PERCENT OF TOTAL TOTAL AMOUNT REVENUES AMOUNT REVENUES --------- ------------ --------- ------------ Guest pay................................................... $ 50,758 80.2% $ 29,927 74.1% Free-to-guest............................................... 8,060 12.8 8,397 20.8 Other....................................................... 4,395 7.0 2,070 5.1 --------- ----- --------- ----- Total revenues........................................ $ 63,213 100.0% $ 40,394 100.0% --------- ----- --------- ----- --------- ----- --------- -----
GUEST PAY. Guest pay revenues increased 69.6%, or $20.8 million, in 1995 as compared to 1994. This increase is attributable to (i) an approximate 41% increase in the average number of guest pay rooms installed during 1995 as compared to the prior year and (ii) increases in movie and video game and information service revenue on a per-room basis of 13.6% and 118.8%, respectively, both as compared to 1994. Higher average buy rates and higher average movie prices combined with higher average occupancy rates such that average monthly movie revenues increased on a per-room basis. Video game and information service revenues increased from approximately $1.9 million in 1994 to approximately $5.8 million in 1995, primarily as a result of the increase in the number of rooms with video game services installed. The following table sets forth information in regard to (i) average monthly movie revenue per installed room, (ii) average monthly video game and information service revenue per installed room, (iii) total average monthly revenue per installed room, (iv) movie buy rates, (v) average movie prices, and (vi) average hotel occupancy rates, each for the years ended December 31:
1995 1994 ------- ------- Average monthly revenue per room: Movie revenue............................................. $17.08 $15.03 Video game/information service............................ 2.21 1.01 ------- ------- Total per guest pay room.............................. $19.29 $16.04 ------- ------- ------- ------- For all guest pay rooms: Average movie buy rates................................... 10.1% 9.5% Average movie price....................................... $8.28 $7.81 Average hotel occupancy rate.............................. 69.0% 68.7% For on-demand guest pay rooms: Average movie buy rates................................... 11.2% 11.1% Average movie price....................................... $8.34 $7.90 Average hotel occupancy rate.............................. 69.8% 69.9%
FREE-TO-GUEST. Free-to-guest revenues decreased 4.0%, or $337,000, in 1995 as compared to the prior year. The comparative decrease is primarily attributable to a relative decline in the proportion of free-to-guest rooms receiving premium services. 21 OTHER. Revenue from other sources, such as the sale of televisions, system equipment, service parts and labor, and miscellaneous free-to-guest programming materials, increased by 112.3%, or $2.3 million, in 1995 as compared to 1994. This increase is directly attributable to increases in television sales between the periods. EXPENSE ANALYSIS DIRECT COSTS. The following table sets forth information regarding the Company's direct costs (in thousands) and gross profit margin for the years ended December 31:
1995 1994 ------- ------- Direct costs: Guest pay................................................. $19,053 $10,050 Free-to-guest............................................. 6,117 6,412 Other revenue............................................. 3,740 1,719 ------- ------- Total direct costs.................................... $28,910 $18,181 ------- ------- ------- ------- Gross profit margin: Guest pay................................................. 62.5% 66.4% Free-to-guest............................................. 24.1 23.6 Other revenue............................................. 14.9 17.0 Overall (composite)....................................... 54.3 55.0
Guest pay direct costs increased 89.6%, or $9.0 million, in 1995 as compared to 1994. Since guest pay direct costs, i.e. studio and other license fees, video game license fees and the commission retained by the hotel, are primarily based on related revenue, such direct costs tend to vary directly with revenue. As a percentage of guest pay revenues, guest pay direct costs were 37.5% of related revenues versus 33.6% in 1994. The relative increase in guest pay direct costs (as a percentage of revenue) reflects higher movie-related costs due to proportionately higher revenue from newly-released motion pictures, substantially increased video game revenue in the guest pay revenue mix and increased hotel commissions, as compared to 1994. Free-to-guest direct costs decreased 4.6%, or $295,000, in 1995 compared to the prior year, and such direct costs also decreased, as a percentage of free-to-guest revenues, to 75.9% in 1995 from 76.4% in the prior year, primarily due to a comparative decrease in the relative proportion of premium channels in the programming mix, as previously mentioned. Direct costs related to other revenue increased 117.6%, or $2.0 million, in 1995 as compared to 1994. This increase was directly attributable to the increased level of television sales discussed above. As a percentage of other revenue, direct costs increased to 85.1% in 1995 as compared to 83.0% in 1994 due to the relative increase in revenue from television sales, which have a lower margin than other components of the other revenue category. The Company's overall gross profit margin was 54.3% in 1995 as compared to 55.0% in 1994. The slight decrease is attributable to the lower guest pay gross profit margin, and to the effect of the increased sales of televisions in the other revenue category, both as previously discussed. 22 OPERATING EXPENSES. The following table sets forth information in regard to the Company's operating expenses (in thousands) for the years ended December 31:
1995 1994 ------------------------ ------------------------ PERCENT OF PERCENT OF TOTAL TOTAL AMOUNT REVENUES AMOUNT REVENUES --------- ------------- --------- ------------- Operating expenses: Guest pay operations...................................... $ 9,767 15.5% $ 7,244 17.9% Selling and marketing..................................... 1,871 3.0 1,541 3.8 General and administrative................................ 6,767 10.7 4,127 10.2 Depreciation and amortization............................. 18,336 29.0 11,661 28.9 --------- --- --------- --- $ 36,741 58.1% $ 24,573 60.8% --------- --- --------- --- --------- --- --------- ---
Guest pay operations expense increased 34.8%, or $2.5 million, in 1995 as compared to the prior year. This increase was primarily attributable to the addition of 83,176 guest pay rooms since December 31, 1994. Per installed guest pay room, such expenses averaged $3.71 per month during 1995 as compared to $3.88 for 1994. Lower service and maintenance costs and lower administrative support costs combined to offset higher property taxes, all on a per-room basis. Selling and marketing expenses increased 21.4%, or $330,000, in 1995 as compared to 1994, reflecting an increase in marketing and promotional activities and the addition of sales and marketing personnel. Sales and marketing expenses represented 3.0% of revenues in 1995 as compared to 3.8% in the prior year. General and administrative expenses increased 64.0%, or $2.6 million, in 1995 as compared to the prior year, primarily reflecting increases in legal and personnel-related costs. As a percentage of revenues, general and administrative costs were 10.7% in 1995 as compared to 10.2% in 1994. Depreciation and amortization expenses increased 57.2%, or $6.7 million, in 1995 as compared to 1994. These increases directly reflect the effect of the approximate 45% increase in the number of installed guest pay rooms, as well as the effect of expenditures to upgrade previously installed rooms to provide video game and information services, and the associated software and other capitalized costs such as service vans and equipment, computers and office furniture, fixtures and other equipment related to the Company's continuing expansion. OPERATING LOSS. The Company's operating loss was $2.4 million in both 1995 and 1994. INTEREST EXPENSE. Interest expense increased 368.1%, or $3.6 million, in 1995 as compared to 1994. The increase is directly attributable to increased borrowing to fund the Company's continuing investments in both newly-installed and upgraded rooms. The average amount of long-term debt outstanding during 1995, excluding amounts outstanding under the Company's revolving credit facility, was approximately $40.6 million as compared to an average of approximately $12.4 million during 1994. The average amount outstanding under the revolving credit facility was approximately $2.1 million during 1995 as compared to approximately $1.9 million in 1994. NET LOSS. The Company's net loss increased to $7.0 million in 1995 from $4.6 million in 1994, as a result of the foregoing factors. EBITDA. Earnings before interest expense, income taxes and depreciation and amortization increased 70.9%, or $6.6 million, in 1995 as compared to 1994. EBITDA, as a percentage of total revenues, increased to 25.1% in 1995 as compared to 23.0% in 1994. 23 RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1994 AND 1993 REVENUE ANALYSIS The Company's total revenues increased 29.0% in 1994 as compared to 1993. The following table sets forth the various components of the Company's total revenue (in thousands) for the years ended December 31:
1994 1993 ----------------------- ----------------------- PERCENT OF PERCENT OF TOTAL TOTAL AMOUNT REVENUES AMOUNT REVENUES --------- ------------ --------- ------------ Guest pay................................................... $ 29,927 74.1% $ 21,471 68.6% Free-to-guest............................................... 8,397 20.8 7,478 23.9 Other....................................................... 2,070 5.1 2,363 7.5 --------- ----- --------- ----- Total revenues.......................................... $ 40,394 100.0% $ 31,312 100.0% --------- ----- --------- ----- --------- ----- --------- -----
GUEST PAY. Guest pay revenues increased 39.4%, or $8.5 million, in 1994 as compared to 1993. This increase is primarily attributable to an approximate 34% increase in the average number of guest pay rooms installed during 1994 as compared to the prior year, and to a lesser extent to an increase in both movie and video game and information service revenue on a per-room basis. Higher average movie prices, combined with higher average occupancy rates, offset a decline in buy rates with the result that average monthly movie revenues increased on a per-room basis. The decline in movie buy rates was primarily the result of a relatively less popular selection of newly-released major motion pictures in 1994 versus 1993. Video game and information service revenues increased from approximately $.6 million in 1993 to $1.9 million in 1994, primarily as a result of the increase in the number of rooms with video game services installed. The following table sets forth information in regard to (i) average monthly movie revenue per installed room, (ii) average monthly video game and information service revenue per installed room, (iii) total average monthly revenue per installed room, (iv) movie buy rates, (v) average movie prices, and (vi) average hotel occupancy rates, each for the years ended December 31:
1994 1993 ------- ------- Average monthly revenue per room (1): Movie revenue............................................. $15.03 $14.68 Video game/information service............................ 1.01 0.39 ------- ------- Total per guest pay room................................ $16.04 $15.07 ------- ------- ------- ------- For all guest pay rooms: Average movie buy rates................................... 9.5% 10.2% Average movie price....................................... $7.81 $7.50 Average hotel occupancy rate.............................. 68.7% 65.0% For on-demand guest pay rooms: Average movie buy rates................................... 11.1% 13.2% Average movie price....................................... $7.90 $7.92 Average hotel occupancy rate.............................. 69.9% 63.7%
- ------------ (1) Effective December 31, 1994, the Company refined its method of calculating average installed guest pay rooms for a period, which is the basis for calculating "per room" revenue and expense statistics, to better reflect the number of rooms in operation during the period being measured. Per-room statistics for each year presented herein have been restated to conform to the averaging convention adopted. FREE-TO-GUEST. Free-to-guest revenues increased 12.3%, or $919,000, in 1994 as compared to the prior year. This increase was attributable to an approximate 12% increase in the average number of installed free-to-guest rooms during 1994 as compared to 1993. 24 OTHER. Revenue from other sources, such as the sale of televisions, system equipment, service parts and labor, and miscellaneous free-to-guest programming materials, decreased by 12.4%, or $293,000, in 1994 as compared to 1993. This decrease is directly attributable to the Company's de-emphasis of television sales because of the relatively low profit margins associated with such sales. EXPENSE ANALYSIS DIRECT COSTS. The following table sets forth information regarding the Company's direct costs (in thousands) and gross profit margin for the years ended December 31:
1994 1993 ------- ------- Direct costs: Guest pay................................................. $10,050 $ 7,235 Free-to-guest............................................. 6,412 5,792 Other revenue............................................. 1,719 1,821 ------- ------- Total direct costs...................................... $18,181 $14,848 ------- ------- ------- ------- Gross profit margin: Guest pay................................................. 66.4% 66.3% Free-to-guest............................................. 23.6 22.6 Other revenue............................................. 17.0 22.9 Overall (composite)....................................... 55.0 52.6
Guest pay direct costs increased 38.9%, or $2.8 million, in 1994 as compared to 1993. Since guest pay direct costs, i.e. studio license fees, video game license fees and the commission retained by the hotel, are primarily based on related revenue, such direct costs tend to vary directly with revenue. As a percentage of guest pay revenues, guest pay direct costs were 33.6% of related revenues versus 33.7% in 1993. The slight decline in comparison to 1993 was due to a relatively lower proportion of revenue from newly-released major motion pictures in 1994. The cost of a newly-released major motion picture is typically higher, as a percentage of revenue, than that of older or independently produced films. The relatively lower movie costs offset higher hotel commissions. Free-to-guest direct costs increased 10.7%, or $620,000, in 1994 compared to the prior year. This increase reflects the cost-related effect of the free-to-guest revenue growth previously discussed, since both free-to-guest revenue and related direct costs vary primarily as a function of the number of rooms served. As a percentage of free-to-guest revenues, free-to-guest direct costs decreased to 76.4% in 1994 from 77.4% in the prior year primarily due to a comparative decrease in the relative proportion of premium channels in the programming mix. Direct costs related to other revenue decreased 5.6%, or $102,000, in 1994 as compared to 1993. This decrease was directly attributable to the decreased level of sales discussed above. As a percentage of television sales and other revenue, direct costs increased to 83.0% in 1994 as compared to 77.1% in 1993 due to a relative increase in revenue from equipment rentals, which have a lower margin than other components of the television sales and other revenue category. The Company's overall gross profit margin improved to 55.0% in 1994 as compared to 52.6% in 1993 primarily due to the relative increase of the guest pay component of the revenue mix. 25 OPERATING EXPENSES. The following table sets forth information in regard to the Company's operating expenses (in thousands) for the years ended December 31:
1994 1993 ------------------------ ------------------------ PERCENT OF PERCENT OF TOTAL TOTAL AMOUNT REVENUES AMOUNT REVENUES --------- ------------- --------- ------------- Operating expenses: Guest pay operations...................................... $ 7,244 17.9% $ 5,491 17.5% Selling and marketing..................................... 1,541 3.8 1,020 3.3 General and administrative................................ 4,127 10.2 2,738 8.7 Depreciation and amortization............................. 11,661 28.9 7,176 22.9 --------- --- --------- --- $ 24,573 60.8% $ 16,425 52.4% --------- --- --------- --- --------- --- --------- ---
Guest pay operations expense increased 31.9%, or $1.8 million, in 1994 as compared to the prior year. This increase was primarily attributable to the addition of 48,212 guest pay rooms since December 31, 1993. Per installed guest pay room, such expenses averaged $3.88 per month during 1994 as compared to $3.85 for 1993. The slight increase on a per-room basis resulted from slightly higher support, in-room marketing and distribution costs which offset relatively lower maintenance and service, insurance and property tax costs. Selling and marketing expenses increased 51.1%, or $521,000, in 1994 as compared to 1993, reflecting an increase in sales and marketing personnel and expanded marketing and promotional activities. Prior to the successful completion of the Company's initial public offering of Common Stock in October 1993, the Company limited sales and marketing activities to levels consistent with the availability of growth capital to finance the installation of rooms already under contract for installation. General and administrative expenses increased 50.7%, or $1.4 million, in 1994 as compared to the prior year. The increase primarily reflects the additional insurance, legal, accounting and other costs that are a consequence of being publicly-owned, and to a lesser extent the employment growth, and employment-related costs, necessary to support the Company's continuing growth. Depreciation and amortization expenses increased 62.5%, or $4.5 million, in 1994 as compared to 1993. These increases directly reflect the effect of the increases in installed rooms previously discussed, rooms upgraded to provide video game and information services, and the associated software, and other capitalized costs such as service vans and equipment, computers and office furniture, fixtures and other equipment related to the Company's continuing expansion. INTEREST EXPENSE. Interest expense decreased 53.9%, or $1.1 million, in 1994 as compared to 1993. The decrease is primarily attributable to decreased borrowing under the Company's revolving facility, which offset the effect of the Company's 9.95% Senior Notes (the "9.95% Senior Notes") which were issued on September 15, 1994. The average amount outstanding under the revolving credit facility during 1994 was $1.9 million as compared to an average of $21.8 million during 1993. The average amount outstanding of the Company's 9.95% Senior Notes was $8.2 million during 1994. EXTRAORDINARY LOSS. On September 15, 1994, the Company issued $28 million in principal amount of 9.95% Senior Notes, due 2003, in a private placement to three insurance companies (see "-- Financial Condition, Liquidity and Capital Resources"). In order that the 9.95% Senior Notes could be issued on an unsecured basis, the Company terminated its then revolving credit facility. As a consequence of the early termination of such revolving credit facility, the Company recorded an extraordinary loss of $1.3 million. The one-time, non-cash charge represented the write-off of previously incurred, unamortized debt issuance costs relating to the terminated revolving credit facility and various amendments thereto. NET LOSS AND NET LOSS ON COMMON STOCK. The Company's net loss increased to $4.6 million in 1994 from $2.1 million in 1993, as a result of the foregoing factors. The $1.0 million increase in net loss on 26 Common Stock, from $3.6 million in 1993 to $4.6 million in 1994, was mitigated by a comparative reduction in dividends on preferred stock. Such dividends on preferred stock were $1.6 million in 1993 versus none for 1994. EBITDA. EBITDA increased 28.9%, or $2.1 million, in 1994 as compared to 1993. EBITDA, as a percentage of total revenues, was 23.0% in both 1994 and 1993. SEASONALITY The Company's quarterly operating results are subject to fluctuation depending upon hotel occupancy rates and buy rates, among other factors. Typically, occupancy rates are higher during the second and third quarters due to seasonal travel patterns. FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES On September 15, 1994, the Company issued $28 million, principal amount, of 9.95% Senior Notes to three insurance companies in a private placement. On April 13, 1995, the Company and the holders of the 9.95% Senior Notes amended the Note Purchase Agreement and concurrently the Company issued $5 million, principal amount, of 10.35% Senior Notes (the "10.35% Senior Notes"), under the Note Purchase Agreement, in a private placement to certain holders of the 9.95% Senior Notes (the 9.95% Senior Notes and the 10.35% Senior Notes are collectively referred to as the "Senior Notes"). The Senior Notes are unsecured and mature on August 1, 2003. Interest on the Senior Notes is fixed and is payable quarterly, and mandatory annual principal payments of $4.125 million commence August 1, 1996. The Senior Notes contain covenants which require the maintenance of certain financial ratios, limit the incurrence of additional indebtedness, limit the incurrence of certain liens, limit certain payments or distributions in respect of the Common Stock, provide for acceleration of principal repayment in certain circumstances, and permit early retirement of principal subject to minimum rate of return provisions. On August 9, 1995, the Company issued $20 million (principal amount) of 11.5% Senior Subordinated Notes due July 15, 2005 (the "Subordinated Notes") to three insurance companies in a private placement. On October 4, 1995, the Company issued an additional $10 million (principal amount) of such Subordinated Notes to the same purchasers and under identical terms and conditions. The Subordinated Notes are unsecured and bear interest at the fixed rate of 11.5%, payable semi-annually. Mandatory annual principal payments of $6 million commence July 15, 2001. Net proceeds of the August 9, 1995 issue of the Subordinated Notes, net of original issue discount and issuance-related expenses, were approximately $18.1 million, and were used to (i) repay $10.0 million outstanding under the Company's then existing revolving facility and (ii) provide funding for capital expenditures to expand the Company's guest pay services business. The net proceeds from the October 4, 1995 issue of Subordinated Notes, net of original issue discount and issuance-related expenses, were approximately $9.2 million and provided additional capital to fund the expansion of the Company's guest pay services business. The Subordinated Notes include covenants which require the maintenance of certain financial ratios, limit the incurrence of additional indebtedness, limit the incurrence of certain liens, limit certain payments or distributions in respect of the Common Stock, provide for acceleration of principal repayment in certain circumstances, and permit early retirement of principal, subject to minimum rate of return provisions. At March 31, 1996, the Company was in compliance with all such covenants. The Company issued a total of 480,000 warrants to purchase Common Stock in connection with the issuance of the Subordinated Notes. Net proceeds attributable to the warrants were approximately $1.6 million, and provided additional capital to fund the Company's expansion of its guest pay services business. Each warrant permits the holder to purchase one share of Common Stock at an exercise price of $7.00. The warrants include demand registration rights and anti-dilution provisions and expire on July 15, 2005. On March 11, 1996, the Company entered into the 1996 Revolving Facility with National Westminster Bank Plc and three other banks, replacing the Company's former revolving facility. The 1996 Revolving Facility is unsecured and amounts thereunder bear interest at either (i) LIBOR (London Inter Bank Offered Rate) plus from 2.00% to 2.625% or (ii) prime rate plus from 1.00% to 1.625%, both depending on the Company's total leverage, as defined in the agreement. The commitment under the 1996 Revolving Facility 27 may be increased from $45 million to $60 million, subject to conditions precedent. The banks' commitment under the 1996 Revolving Facility is subject to a scheduled reduction of 15% beginning in June 1997 and annually thereafter as follows: June 1998 - 20%; June 1999 - 20%; June 2000 - 20%; and June 2001 - 25%. The 1996 Revolving Facility provides for the issuance of letters of credit, subject to customary terms and conditions, and includes terms and conditions which require the maintenance of certain financial ratios, limit the incurrence of additional indebtedness, limit the incurrence of certain liens, limit certain payments or distributions in respect of the Common Stock, and provide for acceleration of principal repayment in certain circumstances. As of May 22, 1996, there was approximately $24.8 million outstanding under the 1996 Revolving Facility. The growth of the Company's business requires substantial capital investment on a continuing basis to finance expansion of its lodging and multi-family residential businesses. Historically, cash flow from operations has not been sufficient to fund the cost of expanding the Company's business and to service existing indebtedness. Capital expenditures were $51.5 million during 1995 and net cash provided by operating activities was $15.4 million. Depending on the rate of growth of its lodging and residential businesses and other factors, the Company expects to incur capital expenditures of between approximately $80 to $90 million during 1996, and principal and interest payments on its outstanding debt of approximately $4.3 million and $7.5 million, respectively. The Company expects to incur capital expenditures of approximately $100 to $140 million in 1997. The actual amount and timing of the Company's capital expenditures will vary (and such variations could be material) depending upon the number of new contracts for services entered into by the Company, the costs of installations, the Company's actual experience as it enters the residential and mid-size hotel markets and other factors. The Company believes that the net proceeds from this Offering, together with its operating cash flows, working capital and the 1996 Revolving Facility will be sufficient to fund the Company's growth for the remainder of 1996. Depending on the Company's rate of growth, the Company intends to seek additional financing to fund its capital expenditures for 1997. The Company believes that such financing is available from a number of sources. However, if such financing should not be available at reasonable cost to the Company, the Company could modify its expansion plans and reduce its capital expenditures necessary for the installation of the Company's systems in the lodging and multi-family residential markets. EFFECT OF RECENTLY ISSUED ACCOUNTING STANDARDS Financial Accounting Standards Board Statement No. 123, "Accounting for Stock-Based Compensation" ("Statement 123"), issued in October 1995 and effective for fiscal years beginning after December 15, 1995, encourages, but does not require, a fair value based method of accounting for employee stock options or similar equity instruments. It also allows an entity to elect to continue to measure compensation cost under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), but requires pro forma disclosures of net income and earnings per share as if the fair value method of accounting had been applied. The Company adopted Statement 123 in 1996 and elected to continue to measure compensation cost in accordance with APB 25, as permitted under Statement 123, and to comply with the pro forma disclosure requirements thereof. Compliance with Statement 123 will have no impact on the Company's results of operations or financial position because the Company's stock option plans are fixed stock option plans, and therefore grants thereunder have no intrinsic value at the grant date under APB 25. Financial Accounting Standards Board Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("Statement 121"), was issued in March 1995 and is effective for fiscal years beginning after December 15, 1995. This statement will be applied prospectively, and requires that impairment losses on long-lived assets be recognized when the book value of the asset exceeds its expected undiscounted cash flows. The Company adopted Statement 121 as of January 1, 1996 and adoption at that time did not have a material impact on the Company's financial position or results of operations. 28 BUSINESS OVERVIEW LodgeNet Entertainment Corporation is a specialized communications company that provides video on-demand, network-based video games, basic and premium cable television programming and other interactive, multimedia entertainment and information services. Through its rapid growth, the Company has become the second largest provider of such services to the lodging market (based on total rooms served), currently serving over 420,000 rooms in over 2,800 hotel properties throughout the United States and Canada. The Company recently entered into an exclusive agreement with GE Capital-ResCom, L.P. ("GE ResCom"), an affiliate of General Electric Co., to provide similar services in multi-family residential complexes throughout the United States. The Company provides its services in the lodging market to corporate-managed hotel chains such as ITT Sheraton, The Ritz-Carlton Company, Harrah's Casino Hotels, Delta Hotels and Resorts, Outrigger, La Quinta Inns and Budgetel Inns, as well as many individual properties flying the Marriott, Holiday Inn, Hilton, Inter-Continental, Prince, Radisson, Westin, Doubletree, Embassy Suites, and other flags. The lodging market in the United States is comprised of over 3.4 million rooms, of which the Company estimates approximately 56% are located in the Company's target market of hotels having more than 100 rooms. The Company provides its services under exclusive, long-term contracts throughout the United States and Canada, and in other selected countries through licensing arrangements with strategic partners. The Company's guest pay contracts are generally five to seven years in length. The average remaining life of the Company's existing guest pay contracts is over four years, with only 10% of these contracts due to expire before 1998. On February 9, 1996, the Company entered into an exclusive long-term agreement with GE ResCom, a leading provider of private telecommunications services to the multi-family housing industry, under which GE ResCom will exclusively market the Company's interactive video and cable television services to multi-family residential complexes throughout the United States. The Company, through its wholly-owned subsidiary, ResNet Communications, Inc. ("ResNet"), will own the customer video service contracts and be responsible for installation and field service operations. The Company believes there are over 6.1 million multi-family residential units in the United States that are located in apartment complexes having more than 200 units, the Company's primary market. Subject to the terms of the agreement, GE ResCom is required to provide the Company during the first three years of the agreement with contracts for a minimum of 200,000 apartment units with an average term of not less than ten years. The Company views the multi-family cable television market as attractive due to: (i) the large market size; (ii) the portability to this market of the technology and operating expertise developed by the Company for the lodging market; (iii) the favorable regulatory environment available to operators such as the Company who qualify for the "private cable" exception (including the absence of franchise requirements, "must-carry" obligations and rate regulations applicable to traditional franchised cable operators); (iv) the exclusive long-term contracts that have customarily been available in the multi-family residential market; and (v) the low-cost operating structure made possible by the various services to be provided by GE ResCom. In the lodging market, the Company's services are delivered over broadband local-area cable networks and include Guest Scheduled-TM- on-demand movies, network-based Super Nintendo-Registered Trademark- video games, PRIME- STAR-Registered Trademark- digital satellite-delivered basic and premium cable television programming, and other interactive entertainment and information services. Guest pay services enable a guest to purchase a movie which generally is started by the guest on-demand rather than restricting the guest to a predetermined start time. Free-to-guest services typically involve a customized package of basic and premium cable television programming which the hotel purchases from the Company and provides at no charge to guests. Video games can be started on-demand by a hotel guest who is charged an hourly rate for play time. Other services, which are typically provided at no charge to the guest, include guest surveys, folio review and video checkout. The Company is able to offer its interactive services by virtue of the high-speed, two-way digital communications design of its proprietary interactive system. The Company's open-architecture, UNIX-based platform enables the Company to upgrade system software to support the introduction of new services or integrate new technologies as they become commercially available and economically viable. 29 The Company's private cable television systems serving the multi-family residential market will be based on technology similar to the proprietary interactive technology deployed by the Company in the lodging market. Where residential complexes are located in clusters, the Company may distribute its programming content from a central location to each such apartment complex. The Company's private cable television system will have the capacity to deliver over 100 channels, although the Company expects that the typical system will deliver 35 to 50 channels of basic and premium programming, depending principally upon the size of the property, the length of the contract and local competitive considerations. The Company may elect to provide from approximately 10 to 35 additional channels for pay-per-view, video on-demand, video games and other interactive services, such as Internet access. The Company intends to tailor the programming lineup at each multi-family residential complex, based on the particular demographic profile of that complex. In addition, the Company's private cable television systems will be addressable, enabling the Company to remotely initiate, modify or terminate service; prevent signal theft; offer interactive services; and respond to many other service needs. The Company believes it is a leader in providing innovative products and services to the lodging industry. The Company was the first in the lodging market to install network-based interactive video games, the first to install in-room printers for video checkout and other applications, and the first to utilize a Video Room Card-TM- (an image-based menu and purchasing protocol, utilizing pictures and graphics to replace the simple text menus traditionally utilized by its competitors). In 1995, LodgeNet redesigned its interactive system, enabling the Company to deliver what it believes to be the first cost-effective system for on-demand movies and network-based video games to mid-size hotels of 100 to 150 rooms -- a market segment the Company believes has been historically underserved by guest pay providers. The Company believes that the advanced features of its redesigned system were a principal factor in the recent awarding by La Quinta Inns of its over 30,000-room account and Budgetel Inns of its over 8,000-room account to the Company over incumbent competitors. As of April 1, 1996, the Company entered into an agreement with PRIMESTAR-Registered Trademark- which will allow the Company to provide free-to-guest, digital satellite-delivered cable television programming to a broader segment of the lodging industry than can be cost-effectively served with traditional C-band satellite systems. The Company's predecessor commenced business in 1980 as Satellite Movie Company, incorporated as a South Dakota corporation in February 1983 and changed its name to LodgeNet Entertainment Corporation in September 1991. On October 13, 1993, LodgeNet Entertainment Corporation changed its state of incorporation from South Dakota to Delaware by merging with and into the Company, its newly-formed Delaware subsidiary, which then adopted the LodgeNet name. BUSINESS STRATEGY The Company's business strategy is to: (i) continue to expand its lodging industry base of guest pay and free-to-guest rooms; (ii) expand into the multi-family residential private cable television market; (iii) maximize the revenue generated per unit served by exploiting new revenue opportunities; (iv) extend the application of the Company's proprietary technology and operating expertise to new markets; and (v) enhance financial performance by increasing operating margins and reducing the average capital invested per new unit installed. EXPANDING THE COMPANY'S LODGING INDUSTRY FRANCHISE. The Company believes that there are substantial opportunities for continued domestic growth in an estimated pool of over 1.9 million guest rooms located in hotels having more than 100 rooms (from the over 3.4 million guest rooms industry-wide), of which the Company estimates approximately 600,000 are either served by the Company's competitors under contracts due to expire before the end of 1997 or are presently unserved by any movie system vendor. The Company's marketing plan is to capitalize on the strength of its innovative product offerings, deliverable by virtue of the high-speed, two-way digital communications design of its proprietary interactive system, together with its expertise in installation, programming, technical support and customer service. Internationally, the Company is expanding its market into selected countries through licensing agreements with established partners in these countries. Under these agreements, the Company sells equipment at cost plus an agreed markup and receives a royalty based on gross revenues. The Company's international 30 partners plan to install approximately 80,000 guest rooms over the next five years. The Company believes there may be significant additional opportunities to enter into international strategic alliances and further exploit the Company's technology, intellectual property and multimedia experience and capabilities. EXPANDING INTO THE MULTI-FAMILY RESIDENTIAL MARKET. The Company believes there are substantial opportunities to provide its services in the multi-family residential market. The Company believes there are approximately 26,000 apartment complexes having more than 200 units, with an aggregate of over 6.1 million multi-family residential units, in the 70 largest metropolitan areas in the United States. This represents a market that is more than three times the size of the Company's target lodging market. As part of this strategy, on February 9, 1996, the Company entered into an exclusive long-term agreement with GE ResCom pursuant to which GE ResCom will exclusively market the Company's cable television services to multi-family residential complexes throughout the United States. The Company views the multi-family cable television market as attractive due to: (i) the large market size; (ii) the portability to this market of the technology and operating expertise developed by the Company for the lodging market; (iii) the favorable regulatory environment available to operators such as the Company who qualify for the "private cable" exception (including the absence of franchise requirements, "must-carry" obligations and rate regulations applicable to traditional franchised cable operators); (iv) the exclusive long-term contracts that have customarily been available in the multi-family residential market; and (v) the low-cost operating structure made possible by the various services to be provided by GE ResCom. MAXIMIZING REVENUE PER UNIT. In addition to increasing and expanding its installed customer base, the Company also seeks to maximize the revenue generated by each of its installed guest rooms and apartment units. In furtherance of this strategy, the Company intends in the lodging market to continue to install its interactive on-demand movie and network-based Super Nintendo-Registered Trademark- video game system in all new hotel rooms. From the Company's experience, rooms with this system generate significantly more revenue and gross profit than comparable rooms having only the scheduled format. The Company's current installed guest pay base of over 300,000 rooms hosts more than 40 million guests each year (based on current average occupancy and length-of-stay data), which the Company believes represents over 40 million annual opportunities to sell products and services. The Company intends to introduce in mid-1996 the Traveler's TV Mall-TM-, a new service designed to electronically bring consumers together with providers of merchandising and information services. The Traveler's TV Mall-TM- will provide the Company the opportunity to generate revenues from third-party providers of content and services who will pay the Company for access to its consumer base, as well as from the guests who utilize such services. The Company is evaluating other new services, such as city-specific, advertiser-supported visitor information services, as well as "advertorials" that deliver product information from advertisers who seek access to the Company's consumer base due to its highly desirable demographics. EXPANDING INTO NEW MARKETS. The Company seeks to extend the application of its interactive system, products and services to an increasingly broad range of property sizes and types. In addition to the mid-size hotel, international lodging and multi-family residential markets, other future potential markets may include hospitals, single-family residences, cruise ships and educational institutions, among others. ENHANCING FINANCIAL PERFORMANCE. Complementing the Company's growth objective is its ongoing goal to enhance financial performance. The Company seeks to increase its operating margins by reducing direct and overhead expenses, as measured on a percentage of revenue and on a per-installed unit basis. As a result of its efforts, the Company has experienced increasing EBITDA margins during the past three years as it has reduced per-room operating costs and leveraged its infrastructure over a larger base of installed rooms. Additionally, the Company will continue its program to reduce the average capital invested per new unit, thereby increasing its return on investment. As a result of engineering efforts to reduce the cost of its system, increased installation efficiencies and the ability of the Company to negotiate guest pay contracts under which hotels are sharing a greater percentage of the cost of installing televisions, the Company's average investment per new guest pay room decreased 15% during 1995 from $530 in 1994 to approximately $450 in 1995. 31 STRATEGIC INITIATIVES The Company has recently implemented five important strategic initiatives to further its goal of creating a more diversified revenue base. RESIDENTIAL ALLIANCE WITH GE RESCOM. The Company's recent agreement with GE ResCom will extend the Company's services to multi-family residential complexes, a market that is over three times greater than the Company's lodging market. Subject to the terms of the agreement. GE ResCom is required to provide the Company during the first three years of the agreement with contracts for a minimum of 200,000 apartment units. The Company's operating plan establishes a target of 500,000 units in five years. The actual number of units the Company installs may vary (and such variance may be material) depending on the Company's experience and competitive factors in this market. PRIMESTAR-REGISTERED TRADEMARK- AGREEMENT. As of April 1, 1996, the Company and PRIMESTAR-Registered Trademark- entered into an exclusive agreement to provide digital satellite-delivered basic and premium television services to the lodging industry. PRIMESTAR-Registered Trademark- is a consortium of the nation's largest cable companies, including Tele-Communications, Inc., Time-Warner Cable, Comcast Cable, Continental Cablevision, Cox Cable Communications and GE-American Communication. The Company expects that the alliance, bringing together PRIMESTAR-Registered Trademark-'s digital satellite technology and the Company's programming and marketing expertise, will provide the Company with a technologically superior and more flexible service, and extend the market for free-to-guest systems to a much broader segment of the lodging industry than can be served cost-effectively with traditional C-band satellite systems. The Company plans to market the new "PRIMESTAR-Registered Trademark- by LodgeNet" service as a complement to its interactive guest pay systems and on a stand-alone basis to mid-size hotels. EXPANSION INTO MID-SIZE HOTEL MARKET. In addition to the large hotel market which traditionally has been the segment subject to the most competition for guest pay services, the Company is now targeting mid-size hotels of 100 to 150 rooms as part of its marketing strategy. The Company believes that this market segment, which the Company estimates contains over 500,000 rooms, has not been broadly served by the guest pay industry because of certain diseconomies of scale resulting from the smaller average property size. In 1995, the Company redesigned and modified its interactive system to permit the delivery of on-demand movies and network-based Super Nintendo-Registered Trademark- video games more cost-effectively to mid-size hotels. The Company believes that its ability to deliver this full array of services (in contrast to competing systems that do not offer network-based video games and require the guest to take the extra step of ordering the movie purchase by telephone), was a significant factor in the recent awarding by La Quinta Inns of its over 30,000-room account and Budgetel Inns of its over 8,000-room account to the Company over incumbent competitors. The Company believes that the mid-size hotel segment represents a large and promising new market for the Company's services that will generate financial returns similar to those achieved by the Company in larger full-service hotels. INTERNATIONAL ALLIANCES. The Company recently expanded into the international marketplace beyond North America by entering into licensing arrangements with strategic partners in Japan, Brazil and South Korea. The Company's partner in Japan is ITES, an affiliate of IBM-Japan, which expects to install LodgeNet systems in approximately 40,000 guest rooms over the next five years. In Brazil, the Company's partner is TVA, Brazil's largest cable television provider and a member of the Abril Group of media companies, which intends to install the Company's system in approximately 25,000 guest rooms over the next five years. In South Korea, the Company's partner is Gtv, a unit of the Jinro Group, a large international industrial conglomerate, which intends to install LodgeNet systems in approximately 15,000 guest rooms over the next five years. Pursuant to these agreements the Company sells its equipment at cost plus an agreed markup and receives a royalty on gross revenues. TRAVELER'S TV MALL-TM-. The Company continued its development of the Traveler's TV Mall-TM-, its next generation interactive multimedia service for the lodging industry. The Traveler's TV Mall-TM- will be a forum, accessed by the hotel guest through the in-room television, to electronically bring consumers together with providers of merchandising and information services. As the Traveler's TV Mall-TM-'s "developer" and manager, the Company will "rent space" to third party content providers as well as participate in the development and delivery of other interactive content. As part of this effort, the Company recently announced that it 32 plans to offer The Voyager's Collection-TM- on an interactive basis via the guest room television in certain of its served rooms. The Voyager's Collection-TM- is a merchandising service aimed at the upscale traveler currently offered through catalogs placed in over 65,000 hotel rooms. The guest rooms currently served by the Company's interactive entertainment and information systems host more than 40 million guests each year, based on current average occupancy and length-of-stay data. This represents more than 40 million annual opportunities to reach a consumer who has on average a higher level of income, education and occupational status than the average consumer. The Company plans to test The Voyager's Collection-TM- service in 5 to 10 hotels in mid-1996. Future services may include city-specific, advertiser-supported visitor information services, as well as "advertorials" that deliver product information from advertisers who seek access to the Company's desirable consumer base. MARKETS AND CUSTOMERS LODGING MARKET. The lodging market in the United States is comprised of over 3.4 million hotel rooms. Guest pay services were introduced in the lodging market in the early 1970's and have since become a standard amenity offered by many hotels to their guests. Virtually all hotels offer free-to-guest services as well. In 1986, certain hotels began offering their guests limited interactive services and in 1991, on-demand movies became available. Guest pay services are attractive to hotel operators because they provide an additional amenity for their guests as well as incremental revenue to their establishments. LARGE HOTEL MARKET. The Company's primary market for guest pay services has been large hotels with over 150 rooms located in metropolitan areas of North America, and the Company estimates that this market segment contains approximately 1.3 million rooms. The Company currently provides its services to large hotels that are generally part of chains such as ITT Sheraton, The Ritz-Carlton Hotel Company, Harrah's Casino Hotels, Delta Hotels and Resorts, Outrigger, Holiday Inn, Inter-Continental, Embassy Suites, Prince, Radisson, Westin, Hilton and Marriott. No single contract represented greater than 10% of the Company's combined guest pay and free-to-guest revenues for the year ended December 31, 1995. MID-SIZE HOTEL MARKET. The Company is also now targeting mid-size hotels of 100 to 150 rooms as part of its guest pay marketing strategy. The Company believes that this market segment, which the Company estimates contains over 500,000 rooms, has not been broadly served by the guest pay industry because of certain diseconomies of scale resulting from the smaller average property size. In 1995, LodgeNet redesigned its interactive system, enabling the Company to deliver on-demand movies and network-based video games more cost-effectively to mid-size hotels. The Company believes that the mid-size hotel segment represents a large and promising new market for the Company's services that it anticipates will generate financial returns similar to those achieved by the Company in the large hotel market. FREE-TO-GUEST MARKET. Almost all of the 3.4 million hotel rooms in the United States are served by some form of free-to-guest television service. Free-to-guest television typically involves a package of basic and premium programming which the hotel purchases and provides at no charge to its guests. These services can be purchased on a stand-alone basis or as part of a package which includes guest pay services. Historically, only hotels with more than 100 rooms could generally justify the expense of buying or leasing the large C-band satellite dish required to receive satellite-delivered, free-to-guest services. Smaller hotels who wanted to offer free-to-guest services generally purchased the service from local cable operators. The Company's agreement with PRIMESTAR-Registered Trademark- will allow LodgeNet to provide digital satellite-delivered television programming on a cost-effective basis to hotels with as few as 50 rooms. MULTI-FAMILY RESIDENTIAL MARKET. The Company believes that there are substantial opportunities for growth in the multi-family residential market. The Company believes there are approximately 26,000 apartment complexes having more than 200 units, with an aggregate of over 6.1 million multi-family residential units, in the 70 largest metropolitan areas in the United States. This represents a market that is more than three times the size of the Company's target lodging market. The Company's agreement with GE ResCom requires, subject to the terms thereof, that GE ResCom provide the Company with contracts for a minimum of 200,000 apartment units during the first three years of the agreement. 33 SERVICES AND PRODUCTS GUEST PAY SERVICES. The Company's primary source of revenue is providing in-room, interactive television services to the lodging industry, for which the hotel guest pays on a per-view or per-play basis. The high-speed, two-way digital communications design of the Company's proprietary interactive system enables the Company to provide sophisticated interactive features such as on-demand movies, network-based Super Nintendo-Registered Trademark- video games, and a variety of other interactive services, such as folio review, video checkout, in-room printers, guest surveying, advertising and merchandising services. Guest pay services include in-room television viewing of recently released major motion pictures and independent films for which a hotel guest pays on a per-view basis. The Company's Guest Scheduled-TM- interactive video on-demand service, which is provided in over 80% of the Company's guest pay rooms, allows a guest to choose from an expanded menu of video selections and individually start the selected video at their convenience rather than restricting the guest to a predetermined start time. It has been the Company's experience that rooms having the on-demand format generate significantly greater movie revenues than comparable rooms having only the pre-scheduled format. The Company currently serves over 300,000 guest pay rooms, of which over 243,000, or 80%, feature the Company's interactive on-demand system. The Company's original scheduled guest pay service, which is provided in less than 20% of the Company's guest pay rooms, offers guests a choice of up to nine movie titles shown at predetermined times, offering a new film approximately every half hour. The Company continuously monitors guests' entertainment selections and adjusts its programming to respond to viewing patterns. The system also enables hotel owners to broadcast informational and promotional messages and to monitor room availability. In May 1993, the Company entered into a seven-year non-exclusive license agreement with Nintendo to provide hotels with a network-based Super Nintendo-Registered Trademark- video game playing system. Pursuant to this agreement, Nintendo provides the Company with access to a minimum of ten popular Super Nintendo-Registered Trademark- video games, which selection of games is updated periodically, and the Company uses its proprietary high-speed interactive communications design to allow guests to play the video games over the hotel's master antenna television system. Hotel guests are charged a fee based on the amount of time they play the video games. Presently, the Company charges $5.95 per hour of play. The Company had nearly 164,000 rooms installed with the Super Nintendo-Registered Trademark- system by the end of 1995, and currently provides over 200,000 rooms with video game services. The revenue generated from the guest pay service is dependent upon three factors at each location: (i) the occupancy rate at the property; (ii) the "buy rate" or percentage of occupied rooms that buy movies or video games/information services at the property; and (iii) the price of the movie, video game or service. For example, a property installed with the Company's interactive system with a 69% occupancy rate, a buy rate of 11.2% and an $8.95 movie price will generate an average of $21.03 of gross movie revenue per installed room per month, plus an average of $3.87 in additional gross revenues per month from video games and information services (assuming 30.4 days per month), resulting in total gross revenue per room per month of $24.90. Occupancy rates vary by property based on the property's competitive position within its marketplace and over time based on seasonal factors and general economic conditions. Buy rates generally reflect the hotel's guest mix profile, the popularity of the motion pictures available to the Company and the guests' other entertainment alternatives. Buy rates also vary over time with general economic conditions. Movie price levels are established by the Company and are set based on the guest mix profile at each property and overall economic conditions. Currently, the Company's movie prices are generally $7.95 or $8.95. The cost of installation varies depending on the size of the hotel property and the configuration of the system being installed. The average installed cost of a new on-demand guest pay room with interactive and video game services capabilities, including the headend equipment and, in some cases, televisions, ranges from $400 to $475 per room. In addition to hotel commissions and royalties paid to movie studios, operating costs of the guest pay systems include in-room movie schedules and information magazines that are changed monthly, preview tapes, tape duplication, taxes, freight, insurance, personal property taxes, maintenance and data line costs. The average cost to upgrade a room from the original scheduled guest pay system to the on- 34 demand system is approximately $75 to $175 per room, depending on the size of the movie library installed in the hotel, whether video games are provided and the configuration of the headend computer and system hardware. Since 1991 the Company has increased its guest pay room base from 73,415 to over 300,000 rooms served as of March 31, 1996. During 1995, the Company obtained contracts for more than 125,000 new guest pay rooms and installed more than 83,000 new rooms, a 45% increase in its installed guest pay room base from the previous year. For the year ended December 31, 1995, the Company's guest pay services generated approximately 80.2% of the Company's total revenues and 92.4% of its overall gross profit. FREE-TO-GUEST SERVICES. In addition to guest pay services, the Company provides television programming for which the hotel, rather than its guests, pays the charges. Free-to-guest services allow a hotel to receive one or more satellite-distributed programming channels via a satellite earth station, which are then distributed to guest rooms over the hotel's existing master antenna system. Traditionally, this service has required little capital expenditure by the Company, since the earth station equipment either was provided independently by the hotel or purchased or leased from the Company. For free-to-guest services, the hotel pays the Company a fixed monthly charge per room for each programming channel selected and provides these channels to its guests free of charge. The Company generally charges $2.90 - $3.50 per room per month for each premium channel and $0.15 - $0.85 per room per month for each non-premium channel. Premium channels, such as HBO, Showtime and The Disney Channel, broadcast major motion pictures and specialty programming, while non-premium channels, such as CNN, ESPN and WTBS, broadcast news, sports and informational programs. Premium programming suppliers typically contract only with cable companies and other large volume subscribers, such as the Company, and will not generally provide programming directly to individual hotel properties. The Company successfully competes with local cable television operators by customizing packages of programming to provide only those channels desired by the hotel subscriber, which typically reduces the overall cost of the services provided. As of April 1, 1996, the Company and PRIMESTAR-Registered Trademark- entered into an agreement to provide digital satellite-delivered basic and premium television services to the lodging industry. The proposed alliance, bringing together PRIMESTAR-Registered Trademark-'s digital satellite technology and the Company's programming and marketing expertise, is expected to offer the lodging industry a technologically superior and more flexible service, and extend the market for free-to-guest services to a much broader segment of the lodging industry than can be served cost-effectively with traditional C-band satellite systems. Pursuant to the agreement with PRIMESTAR-Registered Trademark-, the Company will pay PRIMESTAR-Registered Trademark- a signal carriage fee for providing access to the PRIMESTAR-Registered Trademark- digital satellite signal. In connection with the PRIMESTAR-Registered Trademark- venture, the Company is responsible for the installation and servicing of all equipment required by each lodging customer to receive the PRIMESTAR-Registered Trademark- digital satellite-delivered signal. The Company intends to sell or lease such equipment to its customers and is entitled to retain all revenues associated with the sale, lease, installation and service of all such PRIMESTAR-Registered Trademark--related equipment. Since 1990, the Company has increased its free-to-guest room base from 122,000 to over 260,000 rooms served as of March 31, 1996. During 1995, the Company obtained contracts for over 55,000 new free-to-guest rooms and its installed customer base grew by nearly 30,000 rooms, representing a 13% increase from the prior year. For the year ended December 31, 1995, the Company's free-to-guest services generated approximately 12.8% of the Company's total revenues and 5.7% of its overall gross profit. MULTI-FAMILY RESIDENTIAL SERVICES. The Company's multi-family residential private cable system will have the capacity to deliver over 100 channels, although the Company expects that the typical system will deliver approximately 35 to 50 channels of programming. The Company may elect to provide from approximately 10 to 35 additional channels for pay-per-view, video on-demand, video games and other interactive services, such as Internet access. The Company intends to design a specific programming lineup for each specific multi-family residential complex, based on the particular demographic profile of that complex. These systems are expected to include basic programming services, such as CNN, ESPN, WTBS, TNT, The Discovery Channel and The Weather Channel, premium programming, such as HBO and Showtime, plus additional channels which carry local off-air stations, an electronic programming guide, a preview channel, 35 and a bulletin board channel. Delivery of private cable television services to multi-family residential complexes will involve technology similar to that used in the Company's hotel systems. The hub of each multi-family residential system is a headend, which gathers basic and premium cable television programming from a variety of sources using a combination of satellite and off-air antennae and then redistributes these signals throughout the apartment complex using a broadband local-area cable network. Through its nationwide sales organization, GE ResCom will exclusively market ResNet's services to the owners and managers of apartment complexes. The joint marketing plan is to offer a portfolio of products, including ResNet's cable television services along with the private telephony, paging and other services to be offered by GE ResCom. GE ResCom will also provide, for a fee equal to 5% of collected revenues, the following services: (i) common sales training to on-site property leasing agents, who will promote and sign-up subscribers for ResNet's video services; (ii) a common customer service "hotline" through which residents may order or modify service and make inquiries; and (iii) subscriber billing. ResNet will own the franchise agreements with the property owners and the video services agreements with the tenants and will be responsible for all other operational aspects, including system design, installation, programming, and technical field service. The Company's existing installation and field service organizations position ResNet to operate effectively throughout the United States wherever the GE ResCom sales force may obtain contracts. The Company estimates that the average installed cost per unit passed for basic and premium cable television services will range from approximately $450 to $700 (which includes a contract acquisition fee paid to GE ResCom), depending upon whether the property is a stand-alone system or one of a cluster of nearby properties that can receive programming via microwave transmission from a shared headend. The Company estimates that the average cost per unit passed to add pay-per-view movies and/or video on-demand movies to the basic cable system will range from $30 to $130, depending on the system configuration and/or the size of the movie library installed. The foregoing estimates of installation costs are forward-looking in nature and actual costs could vary based on the factors discussed elsewhere in this Prospectus. ENTERTAINMENT HARDWARE. The Company also sells and leases entertainment hardware, including satellite earth stations, televisions and off-air signal reception and processing equipment, to the lodging industry. The Company believes that this service complements its goal of being a full-service provider of in-room entertainment and information services to the lodging industry. OPERATIONS CONTRACTS. The Company provides guest pay services under contracts with lodging properties that generally run for a term of five to seven years. Under these contracts, the Company installs its system into the hotel free of charge and retains ownership of all equipment utilized in providing the service. Traditionally, the hotel owns the television set; however, the Company in some cases includes televisions incorporating the Company's integrated guest pay terminal units to hotels which meet certain economic criteria. The Company's contracts generally provide that the Company will be the exclusive provider of in-room, pay-per-view television entertainment services to the hotel and permit the Company to set the movie price and terminate the contract at the Company's sole discretion. The contracts also typically grant the Company a right of first refusal regarding the provision of additional video related services to the hotel. The hotels collect movie viewing charges from their guests and retain a commission, generally equal to 10% to 15% of the total guest pay revenue depending upon the size and profitability of the system. At the scheduled expiration of a contract, the Company generally seeks to extend the contract on substantially similar terms. The average remaining life of the Company's current guest pay contracts is over four years, with approximately 10% of these contracts coming up for renewal before 1998. The Company typically enters into a separate contract with each hotel for the services provided. The terms contained in the contracts with the corporate-managed hotels in any one chain generally are negotiated by that chain's corporate management, and the hotels subscribe at the direction of corporate management. In the case of franchised hotels, the contracts are generally negotiated separately with each hotel. ResNet will enter into and own exclusive long-term contracts with property owners and managers to provide cable television services to multi-family residential complexes. The length of term of such contracts 36 generally runs longer than those in the lodging industry. The agreement with GE ResCom requires that the average length of term of all contracts accepted by ResNet be not less than 10 years. The form of agreement to be entered into with each multi-family residential property will grant ResNet the right to provide cable television programming and other video services, such as video on-demand, video games, merchandising, and access to the Internet. The property owner or manager will receive a commission generally expected to range from 6% to 12% of subscriber revenues, depending upon the penetration rate at a particular property. TECHNOLOGY, PRODUCT DEVELOPMENT AND PATENTS. The Company designs and develops high quality interactive, multimedia entertainment and information systems. Because such systems utilize an open architecture, UNIX-based platform incorporating industry standard interfaces, the Company can upgrade system software to support the introduction of new services or integrate new technologies as they become economically viable. The Company's interactive system incorporates the Company's proprietary communications system design with commercially manufactured, readily available components and hardware such as video cassette players, modulators and computers. The Company's interactive, multimedia systems utilize the Company's proprietary high-speed, two-way digital communications design to process and respond to keystroke commands from the viewer very rapidly. This capability enables the Company to provide sophisticated interactive features such as network-based Super Nintendo-Registered Trademark- video games and on-demand movies, and a variety of other interactive services such as folio review, video checkout, in-room printers supporting video checkout and other applications, guest surveying, advertising and shopping services. In the lodging industry, the Company's guest pay systems consist of equipment located within the guest room connected via a local-area cable distribution network to a headend located elsewhere in the hotel. Typical in-room equipment includes a terminal unit, a hand-held remote control and a video game controller. The in-room terminal unit may be integrated within the television set or located behind or on top of the set. Movie programming originates from video cassette players located within the headend rack and is transmitted to individual rooms over the hotel's master antenna system. Video game programs are downloaded into dedicated video game processors also located within the headend rack. The guest's keystrokes are transmitted from the room to the game processor using the Company's proprietary high-speed communications infrastructure and the video signal produced by the game processor is transmitted to the guest room over the hotel's master antenna system. Both movie and video game starts are controlled automatically by the system computer. The system computer also automatically records the purchase of a guest pay movie or video game and reports billing data to the hotel's accounting system, which automatically posts the charge to the guest's bill. Although the Company's products are compatible with all brands of televisions, the Company has arrangements with Zenith Electronics Corporation, Phillips Electronics and Sony Electronics, Inc., leading suppliers of televisions to the lodging industry and other markets, who provide the Company with commercial televisions into which the Company can integrate its custom-designed circuit boards. The Company is also working with other television manufacturers to integrate the Company's systems into their commercial television sets. Integration eliminates the need for an external terminal unit and costs less than an external unit of comparable utility. The Company's private cable television systems serving the multi-family residential market will be based on technology similar to the proprietary interactive technology deployed by the Company in the lodging market. The Company's private cable television system will have the capacity to deliver over 100 channels, although the Company expects that the typical system will deliver 35 to 50 channels of basic and premium programming, depending principally upon the size of the property, the length of the contract and local competitive considerations. The Company may elect to provide from approximately 10 to 35 additional channels for pay-per-view, video on-demand, video games and other interactive services, such as Internet access. The Company's interactive cable television systems will consist of on-site satellite, off-air and/or microwave receiving antennas and headend equipment which process and amplify the broadcast and cable television programming signals. These signals are then transmitted to subscribers at the property via the Company's local-area cable distribution network. The Company plans to integrate addressable interdiction 37 jamming technology within its proprietary system. Addressable interdiction enables the Company to control subscriber access to premium channels and other enhanced services through a computer located off-site. This capability eliminates the necessity of having to dispatch field personnel to a property to initiate, modify or terminate service and eliminates the costs associated with damage or loss of traditional set-top converters located in the subscriber's premises. As a result, the relatively higher rate of subscriber turn-over in the multi-family residential market represents an additional revenue stream for the Company to be generated from "activation" and "new service" charges paid by subscribers. The Company designs its systems through its staff of 62 software and hardware engineers and support personnel (as of December 31, 1995). Development activities are oriented toward the continued enhancement and cost reduction of the Company's system and the further development of additional interactive, multimedia entertainment and information services, such as advertising and shopping services. It is the Company's policy to apply for patents on those product designs which management believes may be of significance to the Company. The Company owns four United States patents and has other applications for patents pending in the U.S. Patent and Trademark Office dealing with various aspects of the Company's interactive multimedia system. The Company uses a number of trademarks for its products and services, including "LodgeNet-TM-," "LodgeNet Entertainment-TM-," "Guest Scheduled-TM-," "Video Room Card-TM-," "Tech-Connect-TM-," "ResNet-TM-," "ResNet Communications-TM-," and others. The Company has applications for registration pending for certain of these trademarks, and those trademarks for which the Company has not sought registration are governed by common law and state unfair competition laws. Because the Company believes that these trademarks are significant to the Company's business, the Company has taken legal steps to protect its trademarks in the past and intends to actively protect these trademarks in the future. The Company believes that its trademarks are generally well recognized by consumers of its products and are associated with a high level of quality and value. SALES AND MARKETING. The Company focuses its sales and marketing strategies on acquiring new contracts from hotels and marketing the Company's guest pay, video game and other interactive services to the hotel guest. The Company's sales organization consisted of 29 employees as of December 31, 1995, including national account representatives, who develop relationships with national hotel franchise organizations and management groups, and regional sales representatives who maintain relationships primarily with regional hotel management and ownership organizations. The Company has established a sales group responsible for sales and marketing of "PRIMESTAR-Registered Trademark- by LodgeNet." The Company markets its services and products to hotels by advertising in industry trade publications, attending industry trade shows, direct marketing and telemarketing. Sales activities are coordinated from the Company's headquarters. The Company also markets its services to hotel guests by means of its Video Room Card-TM-, on-screen graphics and by in-room magazines which contain movie and video game programming information that are placed near the television set and highlight the feature film selections of the month. In-room marketing advertisements are designed and produced by the Company's marketing department. The system also generates a "Welcome Channel," which appears on-screen when the television is turned on and describes the programming and interactive services available through the Company's system. Through its nationwide sales organization, GE ResCom will exclusively market ResNet's services to the owners and managers of apartment complexes. The joint marketing plan is to offer a portfolio of products, including ResNet's cable television services along with the private telephony, paging and other services to be offered by GE ResCom. GE ResCom will also provide the following services: (i) common sales training to on-site property leasing agents, who will promote and sign-up subscribers for ResNet's video services; (ii) a common customer service "hotline" through which residents may order or modify service and make inquiries; and, (iii) subscriber billing. INSTALLATION AND SERVICE OPERATIONS. The Company believes that high quality and consistent systems support and maintenance are essential to competitive success in its industry. The Company's installation and service organization consists of 249 installation and service personnel in 30 locations in the United States and 38 Canada, as of December 31, 1995. The Company emphasizes the use of Company-employed installation and service personnel, but also uses Company-trained subcontractors in areas where there is not a sufficient concentration of Company-served hotels to warrant a Company-employed service representative. Currently, the Company's in-house installation and service organization has responsibility for approximately 80% of the guest pay hotel rooms served by the Company. Service personnel are responsible for systems maintenance and distribution and collection of video cassettes. The Company's installation personnel prepare site surveys to determine the type of equipment to be installed at each particular hotel, install the Company's systems, train the hotel staff to operate the systems and perform preliminary quality control tests. The Company maintains a toll-free customer support hot line, "Tech-Connect-TM-," that is monitored 24 hours a day by trained support technicians. The on-line diagnostic capability of the Company's system enables the Company to identify and resolve a majority of the reported system malfunctions from the Company's service control center without visiting the hotel property. When a service visit is required, the modular design of the Company's systems permits installation and service personnel to replace defective components at the hotel site. In the multi-family residential market, ResNet installation supervisors and support personnel will oversee and coordinate installation crews comprised of experienced subcontractors. Initially, ResNet will utilize field service and component assembly resources developed by the Company for the lodging industry. PROGRAMMING. In the lodging market, the Company obtains non-exclusive rights to show recently released major motion pictures from motion picture studios pursuant to a master agreement with each studio. The license period and percentage fee for each movie are negotiated separately, with the studio receiving a percentage, generally ranging from 35% to 50%, of the Company's gross revenue from the movie. For recently released motion pictures, the Company typically obtains rights to exhibit the picture after the film has been in theaters, but prior to its release to the home video market or exhibition on cable television. Generally, studios make master video tapes of their movies available for duplication sufficiently in advance of the release dates for the lodging industry so that all of the Company's hotels can offer the movies as of the first date they are available for exhibition. The Company obtains independent films, most of which are non-rated and intended for mature audiences, for a one-time flat fee that is nominal in relation to the licensing fees paid for major motion pictures and which permits the Company to duplicate the films as necessary to supply copies to its hotel sites. The Company continuously monitors guests' entertainment selections and adjusts its programming to respond to viewing patterns. The Company obtains its basic and premium cable television programming pursuant to multi-year license agreements generally containing automatic renewal provisions and pays its programming suppliers a fixed, monthly fee for each room or subscriber receiving the service. Management believes that relations with the programming suppliers are good and expects to renew these contracts as necessary on competitive terms. The Company intends to tailor the programming lineup at each multi-family residential complex based on the particular demographic profile of that complex. Cable operators and multi-channel video programming distributors such as ResNet, with certain exceptions, are prohibited from carrying the signal of a commercial television broadcast station without the broadcaster's "retransmission" consent. ResNet believes it can obtain all necessary retransmission consents in its markets. COMPONENT ASSEMBLY AND EQUIPMENT SUPPLIERS. The Company contracts directly with various electronics firms for the manufacture and assembly of its systems hardware, the design of which is controlled by the Company. The Company has found these suppliers to be dependable and able to meet delivery schedules on time. The Company believes that, in the event of a termination of any of its sources, with proper notification from the supplier, alternate suppliers could be located without incurring significant costs or delays. Certain electronic component parts used within the Company's products are available from a limited number of suppliers and can be subject to temporary shortages because of general economic conditions and the demand and supply for such component parts. If the Company were to experience a shortage of any given electronic part, the Company believes that alternative parts could be obtained or system design changes implemented. In such event, the Company could experience a temporary reduction in the rate of new room 39 installations and/or an increase in the cost of such installations. All other components of the Company's systems are standard commercial products, such as video cassette players, modulators and amplifiers, that are available from multiple sources. The headend electronics are assembled at the Company's facilities for testing prior to shipping. The Company samples the room units at the supplier's facilities periodically for reliability. Following assembly of equipment with a configuration designed specifically for a particular customer, the system is shipped to each location, where it is installed by Company-employed technicians or Company-trained subcontractors. The Company believes that its anticipated growth can be accommodated through existing suppliers. COMPETITION LODGING MARKET. The Company is the second largest provider (by total number of rooms served) of interactive and cable television services to the lodging industry, serving over 388,000 installed hotel rooms as of December 31, 1995, and currently over 420,000 installed rooms. The Company competes on a national scale primarily with SpectraVision, Inc. ("SpectraVision") and On Command Video Corporation ("OCV"), a subsidiary of Ascent Entertainment Group, Inc. ("Ascent"), and on a regional basis with certain other smaller entities. Based upon publicly available information, management estimates that, at December 31, 1995, SpectraVision served approximately 550,000 hotel rooms and OCV served approximately 360,000 hotel rooms. On April 19, 1996, Ascent announced that, subject to bankruptcy court and regulatory approvals, it had reached an agreement to acquire SpectraVision, which is currently operating under Chapter 11 of the United States Bankruptcy Code. The proposed merger of SpectraVision with OCV would combine two of the largest providers of cable television services in the lodging industry based on the aggregate number of installed rooms served. The Company currently competes against these two companies and believes that it will be able to compete in the same manner against a new combined entity. Competition with respect to new guest pay contracts centers on a variety of factors, depending upon the features important to a particular hotel. Among the more important factors are: (i) the features and benefits of the entertainment systems; (ii) the quality of the vendor's technical support and maintenance services; (iii) the financial terms and conditions of the proposed contract; and (iv) the ability to complete system installation in a timely and efficient manner. In addition, with respect to hotel properties already receiving in-room entertainment services, the incumbent provider may have certain informational and installation cost advantages as compared to outside competitors. The Company believes that its competitive advantages include: (i) its proprietary interactive system that enables the Company to deliver a broad range of features and services such as on-demand movies and network-based Super Nintendo-Registered Trademark- video games; (ii) the flexible design of the Company's system which enables it to add enhancements or integrate new technologies as they become commercially available and economically viable; (iii) high quality customer support and nationwide field service operations; and (iv) an experienced management team and professional and well-trained sales organization. The Company believes that its success in securing contracts reflects the strong competitive position of the Company's products and services. Because the Company does not foresee significant growth over the next several years in the number of large hotels (150 and more rooms), the Company anticipates increasing competition in securing new contracts with major hotel chains. The Company believes that hotels view the provision of in-room on-demand entertainment both as a revenue source and as a competitive advantage in that sophisticated hotel guests are increasingly demanding a greater range of quality entertainment and information services. At the same time, the Company believes that certain major hotel chains have awarded contracts based primarily on the level and nature of financial and other incentives offered by the pay-per-view service provider. Even if it were able to do so, the Company may not always be willing to match the incentives provided by its competitors. The Company believes that its success indicates that many hoteliers value product differentiation and innovative features leading to higher guest satisfaction over incentive-based pricing. While the Company's competitors may attempt to gain or maintain market share at the expense of profitability, the Company believes that its reputation as a product leader in the industry and its other competitive advantages, together with its long-term contracts, will substantially offset the potentially negative effect of any incentive-based pricing by its competitors. 40 In the free-to-guest programming arena, the Company competes with SpectraVision and OCV as well as other smaller free-to-guest hotel vendors and the various local cable television operators. Because free-to-guest service providers generally have equal access to the satellite-delivered programming that comprises the free-to-guest services, competition is based primarily on price and customer service. Although local cable operators have a substantial market presence through their residential customer base, they typically offer the hotel subscriber only standard packages of programming at a fixed cost per room based on all of the channels provided. The Company competes with local cable operators by customizing packages of programming to provide only those channels desired by the hotel, typically reducing the overall cost per room. The Company believes that the PRIMESTAR-Registered Trademark- digital direct broadcast satellite technology should enable the Company to compete more effectively in the free-to-guest market. The Company believes that the "PRIMESTAR-Registered Trademark- by LodgeNet" service will cost less than current C-band satellite systems, provide a technologically superior and more flexible service, and extend the market for free-to-guest services to a much broader segment of the lodging industry than can be served cost-effectively with traditional C-band satellite systems. In addition to its current competition, there are a number of potential competitors that could utilize their existing infrastructure to provide in-room entertainment to the lodging industry, including cable companies (including wireless cable), telecommunications companies, and direct-to-home and direct broadcast satellite companies. Some of these potential competitors are already providing free-to-guest and video on-demand services to hotels and have substantially greater resources than the Company. MULTI-FAMILY RESIDENTIAL MARKET. The multi-family residential market is served by a number of private cable operators, direct broadcast satellite providers, as well as local franchised cable operators. The Company believes that the largest private cable competitors are ICS Communications, Inc., OpTel, Inc. and CablePlus, none of which is a publicly reporting company. However, the most substantial competitor for ResNet in each of its markets is expected to be the local franchised cable operator, most of whom have substantially greater resources than the Company. The Company believes that ResNet's competitive advantages will include (i) the broad range of features and services offered by the Company's interactive system, coupled with the advanced telephony and other services that will be offered by GE ResCom, (ii) the Company's experience and capabilities in conducting nationwide installation and field service operations, (iii) the nationwide sales and marketing capabilities of GE ResCom, and (iv) the low-cost operating structure made possible by the various services to be provided by GE ResCom. REGULATION The FCC has broad jurisdiction over the telecommunications industry. However, the Company believes its operations comply with a statutory exemption from regulation as a "cable system" operator under the Cable Act. Operators such as the Company that serve single buildings or serve multiple buildings without having any closed transmission paths cross public rights-of-way are often characterized as "private cable" operators. As a "private cable" operator under applicable federal law, the FCC does not directly regulate the Company's guest pay, free-to-guest, or multi-family residential cable television activities. For example, the Company is not subject to the franchise requirements, "must-carry" obligations and rate regulations applicable to "cable system" operators. It is possible, however, that laws or regulations could be adopted in the future which would impose additional regulatory burdens on private cable operators. Private cable operators such as the Company are, however, subject to certain regulatory requirements. For instance, private cable operators, with certain exceptions, are prohibited from carrying the signal of a commercial television broadcast station without the broadcaster's "retransmission" consent. If the cable operator and the broadcaster fail to reach an agreement on terms and conditions for retransmission, the cable operator is prohibited from carrying the broadcaster's signal. Although there can be no assurance, the Company believes it can obtain all necessary retransmission consents in its markets. In addition, to the extent private cable operators use microwave or other radio communications in their operations, they are required to obtain authorization from the FCC, similar to other service providers. 41 On February 8, 1996, the President signed into law the Act. This new law will alter federal, state and local laws and regulations regarding telecommunications providers and services. The Act generally removes previous restrictions preventing cable firms, telephone companies, long distance carriers and public utilities from entering into certain new markets, removes many cross-ownership restrictions, modifies rate regulations applicable to franchised cable operators in the Company's markets and establishes interconnection obligations for local exchange carriers and other telecommunications carriers. In particular, the Act authorizes local telephone companies to provide video programming directly to subscribers in their service areas, and eliminates the requirement that "private cable" operators serve only buildings "under common ownership, management or control," but preserves the requirement that such operations not use closed transmission paths to cross public rights-of-way. The Act also permits franchised cable operators to offer bulk discounts to multiple dwelling units; provided, however, that such discounts may not constitute "predatory pricing." Prior to the adoption of the Act, franchised cable operators were subject to a uniform rate requirement which generally prohibited such bulk discounts. There are numerous rulemakings to be undertaken by the FCC which will interpret and implement the provisions of the Act. It is anticipated that the Act will stimulate increased competition generally in the telecommunications industry. The Company cannot, however, estimate the impact of the Act on its operations at this time. The Company's operations may be subject to state or local laws or ordinances. Some state or local laws or ordinances mandate that building owners allow tenants access to franchised cable operators. In these states, private cable operators such as the Company may not be able to enter into certain types of exclusive arrangements with multiple dwelling unit building owners. States and localities also retain authority in certain limited circumstances (i.e. for public safety and health reasons) to regulate the siting of satellite earth stations. The foregoing does not purport to describe all present and proposed federal, state and local regulations and legislation relating to the video programming industry. Other existing federal, state and local laws and regulations currently are, or may be, the subject of a variety of judicial proceedings, legislative hearings, and administrative and legislative proposals that could change in varying degrees, the manner in which private cable operators and other video programming distributors operate. The Company cannot estimate the outcome of these proceedings or their impact upon its operations at this time. See "Risk Factors -- Government Regulation." EMPLOYEES As of March 31, 1996, the Company had 463 employees in the United States and Canada. None of these employees is covered by a collective bargaining agreement. The Company has not experienced any significant labor problems and believes that its relationship with its employees is good. PROPERTIES The Company's principal executive offices are leased from an unaffiliated third party under a five-year lease which expires on December 31, 1996 and contains an option to purchase. The Company's headquarters contains approximately 24,000 square feet and houses its executive, administrative and operational offices. The Company also owns an office building (which previously served as the Company's headquarters and is currently used in the Company's operations), containing approximately 8,000 square feet, in Sioux Falls, South Dakota. In addition, the Company leases from unaffiliated third parties a warehouse (approximately 15,000 square feet) used in conjunction with its manufacturing, installation and service activities and three other office facilities (approximately 30,000 square feet in total) for administrative and support staffs, all located in Sioux Falls, South Dakota. The Company leases an office facility for sales and sales-support personnel in Dallas, Texas, and leases eight warehouse/office facilities for its installation and service operations in Honolulu, Hawaii; Las Vegas, Nevada; Cleveland, Ohio; Buffalo, New York; Los Angeles and San Francisco, California; Tampa, Florida; and Toronto, Ontario, Canada. Each of these office and/or warehouse leases is from an unaffiliated third party and each such facility occupies less than 3,000 square feet. 42 LEGAL PROCEEDINGS On February 16, 1995, OCV filed a lawsuit in Federal District Court in Northern California asserting patent infringement by the Company. The complaint requests an unspecified amount of damages and injunctive relief. The Company has carefully reviewed the allegations of infringement and is of the opinion that the Company does not infringe on the patent and the allegations are without merit. The Company filed an answer and counterclaim to the lawsuit on April 17, 1995, denying the claims, asserting affirmative defenses and asserting a counterclaim for declaratory relief. The Company is currently engaged in litigation with respect to this matter and intends to vigorously defend itself. Although the outcome of any litigation cannot be predicted with certainty, the Company believes that the ultimate disposition of this matter will not have a material adverse effect on the Company's business or financial condition. The Company is subject to other litigation arising in the ordinary course of business. As of the date hereof, the Company believes the resolution of such other litigation will not have a material adverse effect upon the Company's business or financial condition. 43 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The following table sets forth information concerning the executive officers and directors of the Company as of April 12, 1996.
NAME AGE POSITION - ------------------------------------ --- ------------------------------------ Tim C. Flynn........................ 46 Chairman, President and Chief Executive Officer Scott C. Petersen................... 40 Executive Vice President, Chief Operating Officer and Director Jeffrey T. Weisner.................. 48 Vice President, Finance Eric R. Jacobsen.................... 39 Vice President, General Counsel and Secretary John M. O'Haugherty................. 56 Vice President, Sales David M. Bankers.................... 38 Vice President, Systems Development Steven D. Truckenmiller*............ 43 Vice President, Guest Pay Services Douglas D. Truckenmiller*........... 46 Vice President and Chief Operating Officer, ResNet David Austad........................ 35 Director Lawrence Flinn, Jr.................. 60 Director Richard R. Hylland.................. 35 Director R.F. Leyendecker.................... 50 Director
- ------------ * Steven D. Truckenmiller and Douglas D. Truckenmiller are brothers. TIM C. FLYNN founded the Company in 1980 and has been its President and Chief Executive Officer since incorporation in 1983. Mr. Flynn is a member of the American Hotel and Motel Association and the National Cable Television Association. Prior to founding the Company, Mr. Flynn was involved in the lodging and retail industries. SCOTT C. PETERSEN joined the Company in 1987 as Senior Vice President for Corporate and Legal Affairs, was appointed Executive Vice President and Chief Operating Officer in 1991 and was elected a director in 1993. Prior to 1987, Mr. Petersen acted as legal counsel to the Company as a partner in the law firm of McFarland, Petersen and Nicholson, Sioux Falls, South Dakota. Mr. Petersen received his Bachelor of Arts degree in economics from Dartmouth College and his Juris Doctorate degree from Georgetown University Law Center. JEFFREY T. WEISNER joined the Company in February 1994 as Vice President, Finance. Mr. Weisner was Chief Financial Officer and Treasurer of Teltech Resource Network Corporation from June 1991 to September 1993. Prior to 1991, Mr. Weisner was Vice President, Secretary and Treasurer of CompuServe Incorporated and in such capacity served as Chief Financial Officer and Chief Administrative Officer for that company. Mr. Weisner is a certified public accountant. ERIC R. JACOBSEN joined the Company in May 1995 as Vice President and General Counsel, and became Secretary in October 1995. Prior to joining the Company, Mr. Jacobsen was a partner with the law firm of Manatt, Phelps & Phillips of Los Angeles, California. Mr. Jacobsen acted as underwriters' counsel in connection with the Company's initial public offering in October 1993 and acted as outside legal counsel to the Company from December 1993 until joining the Company. Mr. Jacobsen received his Juris Doctorate and Master of Business Administration degrees from The University of Southern California. 44 JOHN M. O'HAUGHERTY joined the Company in 1992 as Vice President, Sales. Mr. O'Haugherty was Vice President for Sales and Marketing at Spectradyne, Inc., a provider of in-room entertainment services to the lodging industry, in Richardson, Texas from 1982 through 1989. DAVID M. BANKERS joined the Company in 1989 as Director of Information Systems Development and was appointed Vice President, Systems Development in 1992. Prior to joining the Company, Mr. Bankers was the Supervisor of Digital Data Production for TGS Technology, Inc., a supplier of technical support services for government facilities, at the Earth Resources Observation Systems (EROS) Data Center in Sioux Falls, South Dakota. Mr. Bankers received his Bachelor of Science and Master of Science degrees from Creighton University. STEVEN D. TRUCKENMILLER joined the Company in 1985 as Vice President of Technical Services. He was appointed Vice President, Technical Development in 1988 and Vice President, Guest Pay Services in 1991. Mr. Truckenmiller was a director of the Company from 1983 to 1993. DOUGLAS D. TRUCKENMILLER joined the Company in 1991 as Vice President for Technical Operations. In February 1996, Mr. Truckenmiller was appointed Vice President and Chief Operating Officer of ResNet Communications, Inc., a wholly-owned subsidiary of the Company. From 1989 to 1991, Mr. Truckenmiller was the President/General Manager for Heritage Cablevision of Rhode Island. Prior to 1989, he was the Senior Vice President of Engineering for Heritage Communications, a major cable multiple systems operator based in Des Moines, Iowa. DAVID AUSTAD has served as a Director of the Company since 1993. Since 1988, Mr. Austad has served as President and Chief Executive Officer of Austad Golf, a worldwide distributor of golf equipment and apparel. In February 1996, Mr. Austad started AGS, Inc. which owns and manages Austad Golf's retail stores. LAWRENCE FLINN, JR. has served as a Director of the Company since 1994. Mr. Flinn currently serves as Chairman and Chief Executive Officer of United Video Satellite Group and has over 35 years of experience in the video and satellite communications business. RICHARD R. HYLLAND has served as a Director of the Company since 1990. Mr. Hylland is a Director and Executive Vice President -- Strategic Development of Northwestern Public Service Corporation ("NPSC"), a publicly held utility company; President, Chief Operating Officer and a Director of Northwestern Growth Corporation (a subsidiary of NPSC); Director of Northwestern Networks, Inc. ("NNI") (a subsidiary of NPSC); and Vice Chairman of SYN, Inc. Mr. Hylland joined NPSC in 1989. R.F. LEYENDECKER has served as a Director of the Company since 1986. Mr. Leyendecker is Vice President -- Marketing Development, NPSC; served as Vice President -- Energy Service, NPSC from 1994 to 1996; and served as Vice President -- Rates and Regulations, NPSC from 1987 to 1994. He was elected Assistant Corporate Secretary of NPSC in 1993. Mr. Leyendecker also serves as a director of NNI. 45 EXECUTIVE COMPENSATION The following table summarizes all compensation paid to the Company's Chief Executive Officer and to the Company's four other most highly compensated executive officers other than the Chief Executive Officer whose total annual salary and bonus exceeded $100,000, for services rendered in all capacities to the Company during the fiscal year ended December 31, 1995. SUMMARY COMPENSATION TABLE
LONG-TERM ANNUAL COMPENSATION COMPENSATION --------------------------------------------- --------------- OTHER ANNUAL STOCK NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) COMPENSATION ($)(1) OPTIONS (#) - ----------------------------------- --------- ----------- ----------- ------------------- --------------- Tim C. Flynn 1995 250,000 103,306 20,916 40,000 President and Chief Executive 1994 200,000 -- 15,631 22,222 Officer 1993 126,690 -- -- -- Scott C. Petersen 1995 240,000 99,174 20,165 40,000 Executive Vice President and Chief 1994 190,000 -- 14,161 21,111 Operating Officer 1993 120,833 -- -- -- John M. O'Haugherty 1995 115,000 37,510 10,408 20,000 Vice President, Sales 1994 110,000 10,000 8,547 12,222 1993 96,500 10,000 -- -- David M. Bankers 1995 105,000 34,248 10,041 20,000 Vice President, Systems 1994 95,000 -- 7,486 11,111 Development 1993 80,917 -- -- -- Douglas D. Truckenmiller (2) 1995 105,000 34,248 10,041 20,000 Vice President and Chief Operating 1994 95,000 -- 7,486 11,111 Officer, ResNet 1993 86,583 -- -- --
- --------------- (1) Reflects compensation paid to the executive officers listed above by the Company in order for them to purchase individual supplemental insurance coverage and other benefits. (2) In January 1996, Mr. D. Truckenmiller was appointed Vice President and Chief Operating Officer of ResNet. Prior to such appointment, Mr. Truckenmiller was Vice President, Technical Operations of the Company. EMPLOYMENT AGREEMENTS In connection with the Company's initial public offering in October 1993, the Company entered into an employment agreement with Mr. Flynn, dated August 16, 1993, retaining his services as the Company's President and Chief Executive Officer. The initial term of this agreement was extended an additional year on January 1, 1996 and will be automatically extended each January 1 thereafter unless prior to any such date either Mr. Flynn or the Company notifies the other of an election not to extend. The agreement may also be earlier terminated as discussed below. Under the agreement, Mr. Flynn's salary is currently set at $250,000 per year. In addition to his salary, Mr. Flynn is entitled to participate in any bonus program, insurance program, stock benefit plan and other employment benefits that may be provided by the Company from time to time to its executive officers. Mr. Flynn's employment may be terminated prior to the expiration of the term of the agreement (i) automatically upon Mr. Flynn's death, disability or retirement at age 65; (ii) by the Company at any time, with or without cause, by action of its Board of Directors; or (iii) by Mr. Flynn or the Company within three months after a change of control of the Company. In the event of any such termination of employment, the following termination benefits apply: (x) for any termination, other than for cause (including a termination due to death, disability or retirement at age 65), the Company will pay a pro rata portion of the maximum bonus for the then current year under any bonus program in which Mr. Flynn may be participating at the time, unless such payment is not permitted by the terms of the plan; and (y) for any termination by the Board of Directors without cause, the Company will continue to pay Mr. Flynn's salary at the rate last in effect prior to termination for the balance of the term of his employment agreement or until his earlier death or reaching age 65, and the Company will continue at its expense any health, disability and life insurance coverage in 46 effect immediately prior to his termination. In the event of a termination after a change in control involving the Company, the terms of Mr. Flynn's agreement will be superseded by the terms and conditions of the Severance Agreements described below. The employment agreement contains a covenant by Mr. Flynn not to compete with the Company, or to work for a competing business, for the term of his employment and six months thereafter, provided that employment with a cable television vendor will not be considered to be a competing business. The Company entered into an employment agreement with Mr. Petersen, dated August 16, 1993, retaining his services as the Company's Executive Vice President and Chief Operating Officer. The terms of his employment agreement are the same as those in Mr. Flynn's agreement summarized above, except that Mr. Petersen's salary is currently set at $240,000 per year. In July 1995, the Compensation Committee authorized the Company to enter into agreements (the "Severance Agreements") with the Company's President and its other executive officers, including the officers named in the Summary Compensation Table, providing for the payment of certain compensation and other benefits in the event of a covered termination of the executive's employment within two years following a "change in control" involving the Company. No compensation is payable to any executive under the Severance Agreements unless (i) there has been a change in control and (ii) the executive's employment with the Company shall have been terminated (including a substantial reduction in duties or compensation, but excluding termination as a result of the death or permanent disability of the executive or for cause or voluntary retirement). A "change in control" is generally defined as the occurrence of any of the following: (i) any person or group becomes the beneficial owner of securities representing 30% or more of the voting power of the Company's outstanding capital stock having the right to vote in the election of directors (excluding any such transaction that is effected at an actual or implied average valuation of less than $6.75 per share of common stock); (ii) a majority of the members of the Board shall not for any reason be the individuals who at the beginning of such period constitute the Board or persons nominated by such members; (iii) any merger, consolidation or sale of all or substantially all of the assets of the Company (meaning assets representing 30% or more of the net tangible assets of the Company or generating 30% or more of the Company's operating cash flow), excluding a business combination or transaction in which : (a) the stockholders of the Company prior to such transaction continue to represent more than 70% of the voting power of the Company immediately after giving effect to such transaction; (b) no person or group becomes the beneficial owner of 30% or more of the Company's voting stock; or (c) the purchase price results in an actual or implied average valuation of less than $6.75 per share of common stock; (iv) the adoption of any plan or proposal for the liquidation or dissolution of the Company; or (v) the occurrence of any other event that would be required to be reported as a change in control in response to Item 6(e) of Schedule 14A of Regulation 14A of the Exchange Act. Upon a covered termination, the executive is entitled to receive a lump sum payment equal to the compensation the executive would have received over a 30-month period, a pro rata portion of any bonus the executive would have received for the year in which such termination occurs, any stock options previously granted to the executive will become fully vested, and the executive will be entitled to the continuation of the insurance and other welfare benefits then being received by such executive for a 30-month period. The Severance Agreements contain a covenant not to compete with the Company for a period of six months following a covered termination, and executives are not required to mitigate any termination benefits (nor will such benefits be reduced by compensation received from other employment). The Severance Agreements terminate upon the earlier of: (i) five years (subject to automatic one-year extensions unless the Board otherwise notifies the executive); (ii) the termination of the executive's employment other than pursuant to a covered termination described above; (iii) two years from the date of a change in control of the Company if there has not been a covered termination; and (iv) prior to a change in control upon the executive's ceasing to be an executive officer of the Company. 47 STOCK OPTIONS The following table contains information concerning the grant of stock options during the fiscal year ended December 31, 1995 to the officers named in the Summary Compensation Table. OPTION(1) GRANTS IN FISCAL YEAR 1995
POTENTIAL REALIZABLE INDIVIDUAL GRANTS VALUE AT ASSUMED -------------------------------------------------------------------------- ANNUAL RATES OF PERCENT OF TOTAL STOCK PRICE OPTIONS/SARS APPRECIATION FOR NUMBER OF SECURITIES GRANTED TO OPTION TERM (3) UNDERLYING OPTIONS/ EMPLOYEES IN FY EXERCISE OR BASE EXPIRATION -------------------- NAME SARS GRANTED (#)(2) 1995 (%) PRICE ($/SH) DATE 5% ($) 10% ($) - ------------------------- --------------------- ------------------- ----------------- ----------- --------- --------- Tim C. Flynn............. 40,000 11.9 10.85 12/13/05 188,000 991,000 Scott C. Petersen........ 40,000 11.9 10.85 12/13/05 188,000 991,000 John M. O'Haugherty...... 20,000 5.9 10.85 12/13/05 94,000 495,500 David M. Bankers......... 20,000 5.9 10.85 12/13/05 94,000 495,500 Douglas D. Truckenmiller........... 20,000 5.9 10.85 12/13/05 94,000 495,500
- --------------- (1) The Company has no plans pursuant to which stock appreciation rights may be granted. (2) The options were granted pursuant to the Company's 1993 Stock Option Plan. The options become exercisable in four equal annual installments beginning one year after the date of the grant. (3) These amounts represent certain assumed rates of appreciation only. Actual gains, if any, on stock option exercises are dependent on a variety of factors, including market conditions and the price performance of the Common Stock. There can be no assurance that the rates of appreciation presented in this table can be achieved. OPTION EXERCISES AND HOLDINGS The following table provides information with respect to the officers named in the Summary Compensation Table concerning the exercise of options during the fiscal year ended December 31, 1995 and unexercised options held by such officers as of December 31, 1995: AGGREGATED OPTION EXERCISES IN FISCAL YEAR 1995 AND FISCAL YEAR-END OPTION VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED UNDERLYING OPTIONS AT IN-THE-MONEY OPTIONS AT 12/31/95 (#) 12/31/95 ($)(1) SHARES ACQUIRED VALUE ---------------------------- ---------------------------- NAME ON EXERCISE (#) REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ---------------------------- ----------------- ----------- ----------- --------------- ----------- --------------- Tim C. Flynn................ 67,865 499,000 242,229 56,666 2,445,000 -- Scott C. Petersen........... N/A N/A 351,742 55,833 2,732,000 -- John M. O'Haugherty......... N/A N/A 40,951 29,166 238,000 -- David M. Bankers............ N/A N/A 36,173 28,333 209,000 -- Douglas D. Truckenmiller.... N/A N/A 2,778 28,333 -- --
- --------------- (1) Value of unexercised "in-the-money" options is the difference between the market price of the Common Stock on December 31, 1995 ($9.50 per share) and the exercise price of the option, multiplied by the number of shares subject to the option. COMPENSATION OF DIRECTORS Effective March 18, 1996, the Board of Directors set the compensation to be paid to each non-employee director at $20,000 per year (payable at the Company's option all in cash in quarterly installments or $10,000 in cash in quarterly installments and by Common Stock with a fair market value of $10,000 on or about July 1 of each year), $300 for each committee meeting attended and reimbursement for travel and related expenses for attendance at Board and committee meetings. Pursuant to the approval of the Company's stockholders at the 1996 Annual Meeting held on May 8, 1996, non-employee directors automatically receive upon their initial election or appointment to the Board a nonqualified stock option to purchase 6,000 shares of Common Stock under the Company's 1993 Stock Option Plan (the "Plan") plus an additional 6,000 options to be granted on each anniversary of such election during the term of service. 48 STOCK OPTION PLAN The Plan, adopted by the Board of Directors and stockholders effective as of August 16, 1993, as amended effective May 17, 1995 and May 8, 1996, provides for the grant of (i) incentive stock options and nonqualified stock options to key managerial employees of the Company and its subsidiaries and (ii) nonqualified stock options to non-employee directors of the Company. The Plan provides that the total number of shares of Common Stock that may be subject to options shall be 1,000,000 shares (of which 436,501 shares were available for the grant of options as of May 22, 1996). CERTAIN TRANSACTIONS Other than as described elswhere in this Prospectus, none of the directors or executive officers of the Company or any subsidiary thereof, or any associates or affiliates of any of them, is or has been indebted to the Company at any time since the beginning of the last completed fiscal year in excess of $60,000. None of the directors or executive officers of the Company, or any associate or affiliate of such persons, had any material interest, direct or indirect, in any transaction or any proposed transaction with the Company during the past fiscal year. 49 PRINCIPAL STOCKHOLDERS The following table sets forth the beneficial ownership of Common Stock as of March 31, 1996 by each person known to the Company to be the record or beneficial owner of more than five percent of the outstanding shares of Common Stock (other than depositories holding shares of Common Stock on behalf of brokers, dealers and others who are the record stockholders for beneficial owners desiring to have their shares held in "street name"), by each director, each executive officer named in the Summary Compensation Table, and by all directors and executive officers as a group:
AMOUNT AND NATURE OF NAME AND ADDRESS OF BENEFICIAL PERCENT OF BENEFICIAL OWNER (1) OWNERSHIP (2) CLASS (3) - ----------------------------------------------------------------------------- ---------------------- -------------- Tim C. Flynn, (4) Chairman, President and Chief Executive Officer....................................... 672,727 7.9% Scott C. Petersen, (4) Executive Vice President, Chief Operating Officer and Director.............. 407,725 4.8 John M. O'Haugherty, (4) Vice President, Sales....................................................... 70,117 * David M. Bankers, (4) Vice President, Systems Development......................................... 64,506 * Douglas D. Truckenmiller, (4)(5) Vice President, Chief Operating Officer, ResNet............................. 279,343 3.3 David Austad, Director (6)................................................... 5,000 * Lawrence Flinn, Jr., Director (6)(7)......................................... 5,000 * Richard R. Hylland, (8)(9) Director.................................................................... 1,041,266 12.2 R.F. Leyendecker, (8)(9) Director.................................................................... 1,041,266 12.2 Northwestern Networks, Inc. (9).............................................. 1,041,266 12.2 Wellington Management Company (10)........................................... 615,000 7.2 Directors and Executive Officers (4) (A group of 12 persons)..................................................... 2,978,138 35.1
- ------------ * Less than 1%. (1) Unless otherwise indicated, the address of such person is 808 West Avenue North, Sioux Falls, South Dakota 57104. (2) Each named person has sole voting and investment power with respect to the shares listed, except as noted below. (3) Shares which the person (or group) has the right to acquire within 60 days after March 31, 1996 are deemed to be outstanding in calculating the percentage ownership of the person (or group) but are not deemed to be outstanding as to any other person (or group). (4) Includes shares issuable upon the exercise of options to purchase Common Stock as follows: Mr. Flynn, 298,895 shares; Mr. Petersen, 407,575 shares; Mr. O'Haugherty, 70,117 shares; Mr. D. Truckenmiller, 106,111; and Mr. Bankers, 64,506 shares; and all directors and executive officers as a group, 1,114,426 shares. Does not include 3,373 shares held in the Company's 401(k) Plan of which Mr. Flynn and Mr. Petersen are Trustees; and for Mr. Flynn, includes 300 shares owned by Mr. Flynn's minor children, and for Mr. Petersen includes 150 shares owned by Mr. Petersen's minor children. 50 (5) In January 1996, Mr. Truckenmiller was appointed Vice President, Chief Operating Officer of ResNet. Prior to such appointment, Mr. Truckenmiller was Vice President, Technical Operations of the Company. (6) Includes 5,000 shares of Common Stock which each of Messrs. Austad and Flinn have the right to acquire by the exercise of vested stock options. (7) Excludes 90,000 shares held by United Video Satellite Group, Inc., a publicly held company, for which Mr. Flinn serves as a director and as to which he disclaims beneficial ownership. (8) Messrs. Hylland and Leyendecker are directors of NNI, which is a subsidiary of NPSC. The shares attributable to Messrs. Hylland and Leyendecker are as a result of their being directors of NNI. Messrs. Hylland and Leyendecker disclaim beneficial ownership of all such shares. (9) The address of NNI and Messrs. Hylland and Leyendecker is 33 Third Street, S.E., Huron, South Dakota 57350-1318; share ownership information based on Schedule 13G filed for the year ended December 31, 1995. (10) The address of Wellington Management Company is 75 State Street, Boston, Massachusetts 02109; address and share ownership information based on Schedule 13G filed for the year ended December 31, 1995. 51 DESCRIPTION OF CAPITAL STOCK The Company's authorized capital stock consists of 20,000,000 shares of Common Stock, par value $.01 per share, and 5,000,000 shares of Preferred Stock, par value $.01 per share (the "Preferred Stock"). COMMON STOCK Holders of Common Stock are entitled to one vote for each share held on all matters submitted to a vote of stockholders and do not have cumulative voting rights. Stockholders casting a plurality of votes of the stockholders entitled to vote in an election of directors may elect all of the directors standing for election. Holders of Common Stock are entitled to receive ratably such dividends, if any, as may be declared by the Board of Directors out of funds legally available therefor, subject to any preferential dividend rights of Preferred Stock that may be issued at such future time or times. Upon the liquidation, dissolution or winding up of the Company, the holders of Common Stock are entitled to receive ratably the net assets of the Company available after the payment of all debts and other liabilities and subject to the prior rights of Preferred Stock that may be issued at such time. Holders of Common Stock have no preemptive, subscription, redemption or conversion rights. The outstanding shares of Common Stock are, and the shares of Common Stock offered by the Company in this Offering will be, when issued and paid for, fully paid and nonassessable. The rights, preferences and privileges of holders of Common Stock are subject to the rights of the holders of shares of any series of Preferred Stock which the Company may designate and issue in the future. As of March 31, 1996, there were 7,359,613 shares of Common Stock outstanding and held of record by approximately 260 stockholders (with approximately 72% of the Company's outstanding shares held in "street name"). The Company estimates that as of March 31, 1996 there were more than 2,500 stockholders of the Company. PREFERRED STOCK The Board of Directors is authorized, subject to any limitations prescribed by law, without further stockholder approval, to issue from time to time up to an aggregate of 5,000,000 shares of the Company's authorized class of undesignated Preferred Stock, in one or more series. Each such series of Preferred Stock shall have such number of shares, designations, preferences, powers, qualifications and special or relative rights or privileges as shall be determined by the Board of Directors, which may include, among others, dividend rights, voting rights, redemption and sinking fund provisions, liquidation preferences, conversion rights and preemptive rights. No series of Preferred Stock is currently outstanding. The Board of Directors has the authority to issue Preferred Stock and to determine its rights and preferences to eliminate delays associated with a stockholder vote on specific issuances. The rights of the holders of Common Stock will be subject to the rights of holders of any Preferred Stock issued in the future. The issuance of Preferred Stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from acquiring, a majority of the outstanding voting stock of the Company. The Company has no present plans to issue any shares of Preferred Stock. DELAWARE LAW AND CERTAIN CHARTER AND BY-LAW PROVISIONS STAGGERED BOARD OF DIRECTORS. Pursuant to Article Sixth of the Company's Certificate of Incorporation, the Company's Board of Directors is divided into three classes, which are elected for three-year staggered terms. As a result, a change in a majority of the directors of the Company cannot be effected at a single annual meeting of stockholders. While the principal purpose of Article Sixth is to provide continuity on the Board of Directors, the provisions could have the effect of discouraging a third party from attempting to change the management and policies of the Company by effecting a change in the majority of the Board through a proxy contest. SECTION 203 OF THE GENERAL CORPORATION LAW OF THE STATE OF DELAWARE. The Company is subject to the provisions of Section 203 of the General Corporation Law of the State of Delaware, which generally prohibits the Company from engaging in a "business combination" with a person who is an "interested 52 stockholder" for a period of three years after the date of the transaction in which the person became an "interested stockholder," unless (i) the business combination was approved by the Board of Directors of the Company before the other party to the business combination became an interested stockholder, (ii) upon consummation of the transaction that made it an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the Company outstanding at the commencement of the transaction (excluding voting stock owned by directors who are also officers), or (iii) the business combination was approved by the Board of Directors of the Company and ratified by 66 2/3% of the voting stock which the interested stockholder did not own. A "business combination" includes mergers, asset sales and other transactions resulting in a financial benefit to the interested stockholder. Subject to certain exceptions, an "interested stockholder" is a person or entity who, together with its affiliates and associates, owns (or within the preceding three years, owned) 15% or more of the Company's voting stock. NO STOCKHOLDER ACTION BY WRITTEN CONSENT; SPECIAL MEETINGS. The Company's Certificate of Incorporation and By-Laws provide that stockholder action can be taken only at an annual or special meeting of stockholders and prohibit stockholder action by written consent in lieu of a meeting. The Certificate of Incorporation and By-Laws provide that, subject to the rights of holders of any series of Preferred Stock, special meetings of stockholders can be called only by the President or the Board of Directors of the Company. Stockholders have no right to call a special meeting or to require that the Board of Directors call a special meeting of stockholders. Moreover, the business permitted to be conducted at any special meeting of stockholders is limited to the business brought before the meeting by or at the direction of the Board of Directors. These provisions of the Company's Certificate of Incorporation and By-Laws may have the effect of delaying consideration of a stockholder proposal until the next annual meeting of stockholders, unless a special meeting is called by the President or the Board of Directors. These provisions also would prevent the holders of a majority of the voting power of the Company from using the written consent procedure to take stockholder action without giving all the stockholders of the Company entitled to vote on a particular matter the opportunity to participate in determining such proposed action. Finally, a stockholder could not force consideration of a proposal by stockholders over the opposition of the Board of Directors of the Company by calling a special meeting of stockholders prior to the time the Board believes such consideration to be appropriate. ADVANCE NOTICE OF STOCKHOLDER NOMINEES AND STOCKHOLDER BUSINESS. The Company's By-Laws establish an advance notice procedure for the nomination of candidates for election as directors and the presentation of certain other matters before an annual meeting of stockholders of the Company, other than by or at the direction of the Board of Directors or the chairman of the meeting. For such nominations or other business to be considered properly brought by a stockholder before an annual meeting of stockholders of the Company, such stockholder must have given timely prior written notice to the Secretary of the Company of his or her intent to bring such nominations or business before the meeting. To be timely, such notice must be received by the Secretary at least 90 days prior to the date on which, in the immediately preceding calendar year, the annual meeting of stockholders of the Company for such year was held (provided that if the date of the annual meeting is changed by more than 30 days from such anniversary date, such stockholder's notice must be received by the Secretary no later than 10 days after notice or prior public disclosure of the meeting is first given or made to stockholders). A stockholder notice must contain a brief description of the nomination or business to be brought before the meeting; the name and address of the stockholder making the notice and of any person to be nominated; a representation that the stockholder is a holder of record of stock of the Company entitled to vote at the meeting and intends to appear at the meeting to bring such nomination or business before the meeting; a description of all arrangements or understandings between the stockholder and each nominee (in the case of a nomination) or of any material interest of the stockholder in the business matter (in the case of other business); such other information regarding the nominee or matter of business to be proposed as would be required to be included in a proxy statement soliciting proxies for the election of such nominee or approval of such other business; and, in the case of a nomination, the consent of the nominee. 53 The purpose of these procedures is to provide an orderly procedure for conducting annual meetings of stockholders and to afford the Board of Directors a meaningful opportunity to consider the qualifications of proposed nominees and to inform themselves, and where appropriate to inform stockholders, in advance of the meeting of any business proposed to be conducted at the meeting. Although the Company's By-Laws do not give the Board of Directors any power to approve or disapprove stockholder nominations for the election of directors or any other business proposed by a stockholder to be conducted at an annual meeting, the By-Laws may have the effect of precluding a nomination or the consideration of certain business at a particular annual meeting if the proper procedures are not followed. These procedures may also discourage or deter a third party from conducting a solicitation of proxies to elect its own slate of directors or from attempting to obtain control of the Company, even if the conduct of such solicitation or such attempt might be beneficial to the Company and its stockholders. INDEMNIFICATION OF DIRECTORS AND OFFICERS; LIMITATION OF MONETARY LIABILITY. Section 145 of the General Corporation Law of the State of Delaware permits the Company to indemnify an officer, director or employee in respect of claims made by reason of his or her status with the Company, including stockholder derivative suits, provided he or she acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the best interest of the Company and, with respect to any criminal act or proceeding, had no reasonable cause to believe his or her conduct was unlawful. Expenses incurred in the defense of any such action may be paid by the Company in advance of final disposition upon receipt of an undertaking from the officer, director or employee to repay the advances if there is an ultimate determination that he or she is not entitled to be indemnified. It is the Company's general policy to provide such indemnification to the full extent permitted by law. The Company intends to purchase directors' and officers' liability coverage to insure its indemnification of the Company's directors and officers. Article Eighth of the Company's Certificate of Incorporation exonerates the Company's directors from personal liability to the Company or its stockholders for monetary damages for breach of the fiduciary duty of care as a director, provided that Article Eighth does not eliminate or limit liability for any breach of the directors' duty of loyalty for acts or omissions not in good faith or which involve intentional misconduct or knowing violations of law, for any improper declaration of dividends or for any transaction from which the director derived an improper personal benefit. Article Eighth does not eliminate a stockholder's right to seek non-monetary, equitable remedies, such as an injunction or rescission, to redress an action taken by the directors. However, as a practical matter, equitable remedies may not be available in all situations, and there may be instances in which no effective remedy is available. The discussions of the Common Stock and Preferred Stock here and elsewhere in this Prospectus are qualified in their entirety by reference to (i) the Certificate of Incorporation of the Company, as amended, and the By-Laws of the Company, copies of which have been filed as exhibits to the Registration Statement of which this Prospectus is a part, and (ii) the applicable provisions of Delaware law. TRANSFER AGENT The Transfer Agent for the Common Stock is Harris Trust and Savings Bank. 54 UNDERWRITING The underwriters named below (the "Underwriters"), for whom PaineWebber Incorporated, Montgomery Securities and NatWest Securities Limited are acting as representatives (the "Representatives"), have severally agreed, on the terms and subject to the conditions set forth in the Underwriting Agreement by and among the Company and the Underwriters (the "Underwriting Agreement"), to purchase from the Company, and the Company has agreed to sell to the Underwriters, the number of shares of Common Stock set forth opposite the name of such Underwriters below:
NUMBER OF UNDERWRITERS SHARES - --------------------------------------------- ---------- PaineWebber Incorporated ................... 667,000 Montgomery Securities ...................... 667,000 NatWest Securities Limited ................. 667,000 Bear, Stearns & Co. Inc. ................... 106,500 Alex. Brown & Sons Incorporated ............ 106,500 A.G. Edwards & Sons, Inc. .................. 106,500 Furman Selz LLC ............................ 106,500 Lazard Freres & Co. LLC .................... 106,500 Oppenheimer & Co., Inc. .................... 106,500 Dain Bosworth Incorporated ................. 80,000 Gerard Klauer Mattison & Co., Inc. ......... 80,000 Ladenburg, Thalmann & Co., Inc. ............ 80,000 Miller, Johnson & Kuehn, Incorporated ...... 80,000 Pennsylvania Merchant Group, Ltd. .......... 80,000 Piper Jaffray Inc. ......................... 80,000 Unterberg Harris ........................... 80,000 ---------- Total .................................. 3,200,000 ---------- ----------
The Underwriting Agreement provides that the obligations of the Underwriters to purchase the shares of Common Stock listed above are subject to certain conditions. The Underwriting Agreement also provides that the Underwriters are committed to purchase all of the shares of Common Stock offered hereby, if any are purchased (without consideration of any shares that may be purchased through the Underwriters' over-allotment option). The Representatives have advised the Company that the Underwriters propose to offer the shares of Common Stock to the public at the public offering price set forth on the cover of this Prospectus and to certain dealers at such price less a concession not in excess of $.40 per share, and that the Underwriters and such selected dealers may reallow a concession to other dealers not in excess of $.10 per share. After the public offering of the Common Stock, the public offering price, the concessions to selected dealers and reallowance to other dealers may be changed by the Representatives. The Company has granted the Underwriters an option, exercisable during the 30-day period after the date of this Prospectus, to purchase up to an additional 480,000 shares of Common Stock at the public offering price set forth on the cover page of this Prospectus, less the underwriting discounts and commissions. To the extent the Underwriters exercise such option, each of the Underwriters will become obligated, subject to certain conditions, to purchase such percentage of such additional shares of Common Stock as is approximately equal to the percentage of shares of Common Stock that it is obligated to purchase as shown in the table set forth above. The Underwriters may exercise such option only to cover over-allotments, if any, incurred in the sales of shares of Common Stock. The Company has agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act, or to contribute to payments that the Underwriters may be required to make in respect thereof. 55 The Company, its directors and executive officers and certain stockholders have agreed not to offer, sell, contract to sell, or grant any option to purchase or otherwise dispose of any shares of Common Stock owned by them prior to the expiration of 90 days from the date of this Prospectus, except (i) for shares of Common Stock offered hereby, (ii) with the prior written consent of PaineWebber Incorporated, (iii) as a gift or gifts, provided the donee or donees agree to be bound by the 90 day restriction and (iv) in the case of the Company, for the issuance of shares of Common Stock upon the exercise of options, or the grant of options to purchase shares of Common Stock, under the Plan. In connection with this offering, certain Underwriters and selling group members or their affiliates may engage in passive market making transactions in the Common Stock on the Nasdaq National Market in accordance with Rule 10b-6A under the Exchange Act. Passive market making consists of, among other things, displaying bids on the Nasdaq National Market limited by the bid prices of independent market makers and making purchases limited by such prices and effected in response to order flow. Net purchases by a passive market maker on each day are limited to a specified percentage of the passive market maker's average daily trading volume in the Common Stock during a specified prior period, and all passive market making activity must be discontinued when such limit is reached. Passive market making may stabilize the market price of the Common Stock at a level above that which might otherwise prevail and, if commenced, may be discontinued at any time. PaineWebber Incorporated served as co-manager of the Company's October 1993 initial public offering and, as partial compensation for its services, received warrants entitling it to purchase 37,500 shares of Common Stock at an exercise price of $16.20 per share. Such warrants expire on October 21, 1998 and, to date, none have been exercised. Furman Selz LLC ("Furman Selz") has performed certain financial services for the Company for which it has received customary compensation. In connection with the termination of certain arrangements between Furman Selz and the Company, in addition to the shares of Common Stock to be underwritten by Furman Selz in connection with the Offering, the Company has agreed to pay $150,000 to Furman Selz concurrent with the consummation of the Offering, which compensation may be deemed to be underwriters' compensation by the National Association of Securities Dealers, Inc. NatWest Securities Limited has from time to time in recent years performed various investment banking and other financial advisory services for the Company, for which it has received customary compensation. Such services included acting as placement agent for the Company's Subordinated Notes in August and October 1995. NatWest Securities Limited is an affiliate of National Westminster Bank Plc, the lead agent for the Company's 1996 Revolving Facility, which was entered into in March 1996. NatWest Securities Limited, a United Kingdom broker-dealer and a member of the Securities and Futures Authority Limited, has agreed that, as part of the distribution of the Common Stock offered hereby and subject to certain exceptions, it will not offer or sell any Common Stock within the United States, its territories or possessions or to persons who are citizens thereof or residents therein. NatWest Securities Limited has also represented and agreed that (i) it has not offered or sold and will not offer or sell any Common Stock to persons in the United Kingdom except to persons whose ordinary activities involve them in acquiring, holding, managing or disposing of investments (as principal or agent) for the purposes of their businesses or otherwise in circumstances which do not constitute an offer to the public in the United Kingdom for the purposes of the Public Offers of Securities Regulation 1995, (ii) it has complied and will comply with all applicable provisions of the Public Offers of Securities Regulation 1995 and the Financial Services Act 1986 with respect to anything done by it in relation to the Common Stock in, from or otherwise involving the United Kingdom, and (iii) it has only issued or passed on, and will only issue or pass on, in the United Kingdom any document received by it in connection with the issue of the Common Stock to a person who is of a kind described in Article 8 of the Financial Services Act 1986 (Investment Advertisements) (Exemptions) (No. 2) Order 1995 or is a person to whom the document may otherwise lawfully be issued or passed on. 56 This Offering is being made pursuant to the provisions of Article III, Section 44(c)(8) of the Rules of Fair Practice of the National Association of Securities Dealers, Inc. LEGAL MATTERS Certain legal matters with respect to the validity of the Common Stock offered hereby will be passed upon for the Company by Pillsbury Madison & Sutro LLP, San Francisco, California and for the Underwriters by Paul, Hastings, Janofsky & Walker (a partnership including professional corporations), New York, New York. EXPERTS The audited consolidated financial statements of LodgeNet Entertainment Corporation and Subsidiaries as of December 31, 1994 and 1995 and for each of the three years in the period ended December 31, 1995 and the related schedules, included in this Prospectus and elsewhere in the Registration Statement of which this Prospectus is a part, have been audited by Arthur Andersen LLP, independent public accountants, as indicated in their reports with respect thereto and are included herein and therein in reliance upon the authority of said firm as experts in accounting and auditing. 57 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- Report of Independent Public Accountants.................................. F-2 Consolidated Balance Sheets as of December 31, 1994 and 1995 and March 31, 1996 (unaudited)......................................................... F-3 Consolidated Statements of Operations for the years ended December 31, 1993, 1994 and 1995 and the three months ended March 31, 1995 and 1996 (unaudited).............................................................. F-4 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1993, 1994 and 1995 and the three months ended March 31, 1996 (unaudited)......................................................... F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1993, 1994 and 1995 and the three months ended March 31, 1995 and 1996 (unaudited).............................................................. F-6 Notes to Consolidated Financial Statements................................ F-7
F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To LodgeNet Entertainment Corporation: We have audited the accompanying consolidated balance sheets of LodgeNet Entertainment Corporation (a Delaware corporation) and Subsidiaries as of December 31, 1994 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of LodgeNet Entertainment Corporation and Subsidiaries as of December 31, 1994 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Minneapolis, Minnesota March 11, 1996 F-2 LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLAR AMOUNTS IN THOUSANDS) ASSETS
DECEMBER 31, ---------------------- 1994 1995 ---------- ---------- MARCH 31, 1996 ----------- (UNAUDITED) Current assets: Cash and cash equivalents................................................. $ 4,302 $ 2,252 $ 14 Accounts receivable, net of allowance for doubtful accounts............... 7,814 11,355 14,070 Prepaid expenses and other................................................ 1,015 1,462 2,681 ---------- ---------- ----------- Total current assets.................................................. 13,131 15,069 16,765 ---------- ---------- ----------- Property and equipment: Land, building and equipment.............................................. 5,813 8,976 10,450 Free-to-guest equipment................................................... 2,835 5,068 4,491 Guest pay systems: Installed............................................................... 78,810 119,354 134,367 System components....................................................... 10,301 13,468 14,626 Software costs.......................................................... 3,215 4,078 5,075 ---------- ---------- ----------- Total property and equipment.......................................... 100,974 150,944 169,009 Less -- accumulated depreciation and amortization......................... (26,289) (42,838) (48,911) ---------- ---------- ----------- Property and equipment, net............................................. 74,685 108,106 120,098 ---------- ---------- ----------- Debt issuance costs, net of accumulated amortization........................ 449 1,537 2,606 ---------- ---------- ----------- $ 88,265 $ 124,712 $ 139,469 ---------- ---------- ----------- ---------- ---------- ----------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.......................................................... $ 9,017 $ 15,222 $ 17,446 Current maturities of long-term debt...................................... -- 4,254 4,299 Accrued expenses (Note 10)................................................ 1,652 3,434 3,089 ---------- ---------- ----------- Total current liabilities............................................. 10,669 22,910 24,834 ---------- ---------- ----------- Deferred revenue............................................................ 1,654 1,579 1,602 ---------- ---------- ----------- Long-term debt (Note 3)..................................................... 28,000 57,497 73,133 ---------- ---------- ----------- Commitments and contingencies (Note 8) Stockholders' equity (Notes 6 and 7): Common stock, $.01 par value, 20 million shares authorized; 7,278,748, 7,352,113 and 7,359,613 shares outstanding at December 31, 1994 and 1995 and March 31, 1996, respectively.................................. 73 74 74 Additional paid-in capital.............................................. 69,492 71,234 71,262 Accumulated deficit..................................................... (21,623) (28,582) (31,436) ---------- ---------- ----------- Total stockholders' equity.......................................... 47,942 42,726 39,900 ---------- ---------- ----------- $ 88,265 $ 124,712 $ 139,469 ---------- ---------- ----------- ---------- ---------- -----------
The accompanying notes are an integral part of these consolidated balance sheets. F-3 LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLAR AMOUNTS, EXCEPT PER SHARE AMOUNTS, IN THOUSANDS)
THREE MONTHS ENDED YEAR ENDED DECEMBER 31, MARCH 31, ---------------------------------- ---------------------- 1993 1994 1995 1995 1996 ---------- ---------- ---------- ---------- ---------- (UNAUDITED) Revenues: Guest pay...................................... $ 21,471 $ 29,927 $ 50,758 $ 10,500 $ 17,582 Free-to-guest.................................. 7,478 8,397 8,060 1,993 2,145 Other.......................................... 2,363 2,070 4,395 899 641 ---------- ---------- ---------- ---------- ---------- Total revenues............................. 31,312 40,394 63,213 13,392 20,368 ---------- ---------- ---------- ---------- ---------- Direct costs: Guest pay...................................... 7,235 10,050 19,053 3,824 6,839 Free-to-guest.................................. 5,792 6,412 6,117 1,544 1,684 Other.......................................... 1,821 1,719 3,740 802 591 ---------- ---------- ---------- ---------- ---------- Total direct costs......................... 14,848 18,181 28,910 6,170 9,114 ---------- ---------- ---------- ---------- ---------- Gross profit..................................... 16,464 22,213 34,303 7,222 11,254 ---------- ---------- ---------- ---------- ---------- Operating expenses: Guest pay operations........................... 5,491 7,244 9,767 2,213 3,163 Selling and marketing.......................... 1,020 1,541 1,871 511 742 General and administrative..................... 2,738 4,127 6,767 1,385 2,107 Depreciation and amortization.................. 7,176 11,661 18,336 3,858 6,173 ---------- ---------- ---------- ---------- ---------- Total operating expenses................... 16,425 24,573 36,741 7,967 12,185 ---------- ---------- ---------- ---------- ---------- Operating income (loss).......................... 39 (2,360) (2,438) (745) (931) Interest expense................................. 2,096 966 4,522 735 1,922 ---------- ---------- ---------- ---------- ---------- Loss before income taxes and extraordinary loss............................................ (2,057) (3,326) (6,960) (1,480) (2,853) Provision for income taxes (Note 9).............. -- -- 66 -- 20 ---------- ---------- ---------- ---------- ---------- Loss before extraordinary loss................... (2,057) (3,326) (7,026) (1,480) (2,873) Extraordinary loss (Note 5)...................... -- 1,324 -- -- -- ---------- ---------- ---------- ---------- ---------- Net loss......................................... (2,057) (4,650) (7,026) (1,480) (2,873) Cumulative preferred dividends................... 1,557 -- -- -- -- ---------- ---------- ---------- ---------- ---------- Net loss attributable to common stock............ $ (3,614) $ (4,650) $ (7,026) $ (1,480) $ (2,873) ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Per common share (Notes 1 and 6): Loss before extraordinary loss................. $ (0.49) $ (0.45) $ (0.95) $ (0.20) $ (0.39) Extraordinary loss............................. -- (0.18) -- -- -- ---------- ---------- ---------- ---------- ---------- Net loss attributable to common stock.......... $ (0.49) $ (0.63) $ (0.95) $ (0.20) $ (0.39) ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Weighted average shares outstanding.............. 7,334,226 7,326,748 7,382,471 7,352,166 7,406,719 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
The accompanying notes are an integral part of these consolidated financial statements. F-4 LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DOLLAR AMOUNTS IN THOUSANDS)
SERIES B PREFERRED STOCK COMMON STOCK ADDITIONAL -------------------- ----------------------- PAID-IN ACCUMULATED SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL --------- --------- ---------- ----------- ----------- ------------ --------- Balance, December 31, 1992.................... 3,800 $ 3,800 887,208 $ 9 $ 2,026 $ (13,107) $ (7,272) Cumulative preferred dividends.............. (1,557) (1,557) Conversion of preferred stock............... (3,800) (3,800) 1,121,266 11 3,789 -- -- Issuance of common stock.................... -- -- 5,265,774 53 63,653 -- 63,706 Net loss.................................... -- -- -- -- -- (2,057) (2,057) Foreign currency translation adjustment..... -- -- -- -- -- (155) (155) --------- --------- ---------- --- ----------- ------------ --------- Balance, December 31, 1993.................... -- -- 7,274,248 73 69,468 (16,876) 52,665 Common stock option activity................ -- -- 4,500 -- 24 24 Net loss.................................... -- -- -- -- -- (4,650) (4,650) Foreign currency translation adjustment..... -- -- -- -- -- (97) (97) --------- --------- ---------- --- ----------- ------------ --------- Balance, December 31, 1994.................... -- -- 7,278,748 73 69,492 (21,623) 47,942 Common stock option activity................ -- -- 73,365 1 62 -- 63 Warrants issued (Note 7).................... -- -- -- -- 1,680 -- 1,680 Net loss.................................... -- -- -- -- -- (7,026) (7,026) Foreign currency translation adjustment..... -- -- -- -- -- 67 67 --------- --------- ---------- --- ----------- ------------ --------- Balance, December 31, 1995.................... -- -- 7,352,113 74 71,234 (28,582) 42,726 Common stock option activity (unaudited).... -- -- 7,500 -- 28 -- 28 Net loss (unaudited)........................ -- -- -- -- -- (2,873) (2,873) Foreign currency translation adjustment (unaudited)................................ -- -- -- -- -- 19 19 --------- --------- ---------- --- ----------- ------------ --------- Balance, March 31, 1996 (unaudited)........... -- $ -- 7,359,613 $ 74 $ 71,262 $ (31,436) $ 39,900 --------- --------- ---------- --- ----------- ------------ --------- --------- --------- ---------- --- ----------- ------------ ---------
The accompanying notes are an integral part of these consolidated financial statements. F-5 LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLAR AMOUNTS IN THOUSANDS)
THREE MONTHS ENDED YEAR ENDED DECEMBER 31, MARCH 31, ---------------------------------- ---------------------- 1993 1994 1995 1995 1996 ---------- ---------- ---------- ---------- ---------- (UNAUDITED) Operating activities: Net loss............................................ $ (2,057) $ (4,650) $ (7,026) $ (1,480) $ (2,873) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization..................... 7,176 11,661 18,336 3,858 6,173 Extraordinary loss................................ -- 1,324 -- -- -- Change in operating assets and liabilities: Accounts receivable............................. 9 (2,765) (3,541) (933) (2,715) Prepaid expenses and other...................... (262) 139 (447) (315) (1,219) Accounts payable................................ (995) 5,735 6,205 392 2,224 Accrued expenses and deferred revenue........... 352 505 1,857 32 (322) ---------- ---------- ---------- ---------- ---------- Net cash provided by operating activities............. 4,223 11,949 15,384 1,554 1,268 ---------- ---------- ---------- ---------- ---------- Investing activities: Property and equipment additions.................... (14,311) (43,521) (51,497) (8,505) (18,065) Certificates of deposit............................. (2,008) 2,008 -- -- -- ---------- ---------- ---------- ---------- ---------- Net cash used for investing activities................ (16,319) (41,513) (51,497) (8,505) (18,065) ---------- ---------- ---------- ---------- ---------- Financing activities: Proceeds from long-term debt........................ 6,000 28,000 33,630 208 378 Debt issuance costs................................. (601) (462) (1,348) (398) (1,069) Repayments of long-term debt........................ (212) (6,000) (89) (20) (155) Borrowings under revolving credit facility.......... 6,500 6,500 10,000 4,200 15,358 Repayments of revolving credit facility............. (36,000) (6,500) (10,000) -- -- Proceeds from issuance of common stock.............. 63,706 -- -- -- -- Proceeds from issuance of warrants to purchase common stock....................................... -- -- 1,680 -- -- Stock option activity............................... -- 14 63 11 28 Redemption of Series A preferred stock.............. (12,925) -- -- -- -- Payment of accumulated preferred dividends.......... (2,151) -- -- -- -- ---------- ---------- ---------- ---------- ---------- Net cash provided by financing activities............. 24,317 21,552 33,936 4,001 14,540 ---------- ---------- ---------- ---------- ---------- Effect of exchange rates on cash...................... (57) 58 127 (10) 19 ---------- ---------- ---------- ---------- ---------- Increase (decrease) in cash and cash equivalents...... 12,164 (7,954) (2,050) (2,960) (2,238) Cash and cash equivalents at beginning of period...... 92 12,256 4,302 4,302 2,252 ---------- ---------- ---------- ---------- ---------- Cash and cash equivalents at end of period............ $ 12,256 $ 4,302 $ 2,252 $ 1,342 $ 14 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Supplemental cash flow information: Cash paid for interest.............................. $ 2,537 $ 836 $ 3,341 $ 753 $ 2,256 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
The accompanying notes are an integral part of these consolidated financial statements. F-6 LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 -- THE COMPANY LodgeNet Entertainment Corporation ("LodgeNet" or the "Company") and its wholly-owned Canadian subsidiary assemble, install and operate guest pay movie systems and provide satellite-delivered, free-to-guest programming, interactive games and multimedia entertainment, and guest information systems to the lodging industry, primarily in the United States and Canada. The Company's operating performance and outlook are strongly influenced by such factors as overall occupancy levels and economic conditions in the lodging industry, the number of rooms equipped with the Company's systems, the popularity and availability of programming, customer buy rates and competitive factors. The Company is dependent on third parties for the programming provided through its systems. The Company's rapid growth has and is expected to continue to require capital resources in excess of operating cash flows. The Company's operating cash flows, working capital and the Revolving Credit Facility (see Note 4) are sufficient to fund a part of the Company's growth during 1996, and the Company is seeking additional capital financing to augment those resources. The Company believes that such financing is available from a number of sources, however, if such financing should not be available at reasonable cost, the Company could modify its expansion plans and reduce capital expenditures necessary for the installation of the Company's systems in additional hotel rooms or necessary to upgrade existing installations. On February 9, 1996, the Company entered into an exclusive contract with GE Capital-ResCom, L.P., an affiliate of General Electric Co., under which ResNet Communications, Inc., a newly formed wholly-owned subsidiary of the Company, will install and operate private cable television systems in multi-family residential properties nationwide. NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements include the accounts of the Company and its wholly-owned Canadian subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation. USE OF ESTIMATES -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions about certain matters and items. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. The ultimate outcome of the matters and items may be different than the estimates and assumptions. CASH AND CASH EQUIVALENTS -- Cash and Cash Equivalents are comprised of demand deposits and temporary investments in highly liquid securities with an original maturity of 90 days or less. PROPERTY AND EQUIPMENT -- Property and Equipment is stated at cost. The Company capitalizes certain payroll costs related to the installation of new systems. Repairs and maintenance costs which do not significantly extend the useful lives of the respective assets are charged to operations as incurred. Depreciation of guest pay and free-to-guest systems begins when such systems are installed and activated. Depreciation on other equipment begins when such items are placed in service. For financial reporting purposes, depreciation and amortization are computed using the straight-line method over the following estimated useful lives of the assets:
YEARS --------- Building......................................................... 19 Guest pay systems: System components.............................................. 5 to 7 In-room equipment.............................................. 3 to 5 Free-to-guest systems............................................ 5 Other equipment.................................................. 5
F-7 LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) GUEST PAY PRODUCT DEVELOPMENT -- The Company has capitalized certain costs of developing software and other components of its guest pay systems. The capitalization of these costs begins when a system's technological and commercial feasibility has been established and ends when such systems are available for use in guest pay properties. Capitalized costs are reported at the lower of unamortized costs or net realizable value, and are amortized over the system's estimated useful life. Guest pay system development costs capitalized were $423,000, $936,000 and $1,480,000 during the years ended December 31, 1993, 1994 and 1995, respectively. Amortization of such costs was $302,000, $344,000 and $455,000 for the years ended December 31, 1993, 1994 and 1995, respectively. Guest pay system development costs capitalized during the three months ended March 31, 1995 and 1996 were $371,000 and $425,000, respectively, and amortization of such costs was $103,000 and $124,000, respectively. DEBT ISSUANCE COSTS -- Costs associated with the issuance of debt securities and with obtaining credit facilities are capitalized and amortized over the term of the related borrowing or facility. The Company capitalized $601,000, $462,000 and $1,348,000 of debt issuance costs during the years ended December 31, 1993, 1994 and 1995, respectively. Amortization of such costs was $237,000 in 1993; $203,000 in 1994, excluding $1,324,000 which was reflected as an extraordinary loss resulting from the early termination of a bank revolving credit facility during 1994 (see Note 5); and $260,000 in 1995. Accumulated amortization was $383,000, $13,000, and $273,000 at December 31, 1993, 1994 and 1995, respectively. The Company capitalized $398,000 and $1,170,000, respectively, during the three months ended March 31, 1995 and 1996, and amortization of such costs during those periods was $32,000 and $101,000, respectively. Accumulated amortization was $373,000 at March 31, 1996. NET LOSS PER COMMON SHARE -- The net loss per common share was computed using the weighted average number of shares outstanding and, when applicable, outstanding warrants and options. REVENUE RECOGNITION -- Revenues and related costs are recognized when the services are rendered. The Company has obtained certain programming agreements which provide for the receipt of low-cost programming in the earlier years of such agreements. The Company's policy is to record the costs of such programming on a straight-line basis. At December 31, 1993, 1994 and 1995, the Company had recorded deferred revenues of $1,430,000, $1,654,000 and $1,579,000, respectively, which represent reductions of the cost of programming in future years. At March 31, 1996, the Company had recorded $1,602,000 of deferred revenues. FOREIGN CURRENCY TRANSLATION -- The assets and liabilities of the Company's Canadian subsidiary were translated at year-end exchange rates. Income statement items were translated at average exchange rates prevailing during the year. Translation adjustments and transaction gains and losses prior to 1993 were not material to the Company's operations. POSTEMPLOYMENT AND POSTRETIREMENT BENEFITS -- The Company does not offer or provide such benefits. F-8 LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) CONCENTRATION OF CREDIT RISKS AND CUSTOMER DATA -- The Company has derived virtually all of its revenue from entities in the lodging industry, however, no individual customer accounted for as much as 10% of total revenue in any period presented in the accompanying consolidated statements of operations. The allowance for doubtful accounts was $228,000 and $410,000 at December 31, 1994 and 1995, respectively, and $513,000 at March 31, 1996. The provision for doubtful accounts was $375,000 in 1993, $226,000 in 1994, $343,000 in 1995 and $192,000 and $154,000, respectively, during the three months ended March 31, 1995 and 1996. FEDERAL INCOME TAXES -- The Company accounts for income taxes under the liability method, in accordance with the requirements of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." FAIR VALUE OF FINANCIAL INSTRUMENTS -- The carrying amounts for Cash and Cash Equivalents, Accounts Receivable, Accounts Payable and Accrued Expenses approximate fair value due to the relatively short period to maturity of these instruments. The fair value of Long-term debt instruments is estimated by reference to current yields to maturity on similar instruments. The fair value of the Warrants issued during 1995 was estimated using option valuation techniques. RECENTLY ISSUED ACCOUNTING STANDARDS -- Financial Accounting Standards Board Statement No. 123, "Accounting for Stock-Based Compensation" ("Statement 123"), issued in October 1995 and effective for fiscal years beginning after December 15, 1995, encourages, but does not require, a fair value based method of accounting for employee stock options or similar equity instruments. It also allows an entity to elect to continue to measure compensation cost under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), but requires pro forma disclosures of net income and earnings per share as if the fair value method of accounting had been applied. The Company will adopt Statement 123 in 1996. While the Company is still evaluating Statement 123, it currently expects to elect to continue to measure compensation cost in accordance with APB 25, as permitted under Statement 123, and to comply with the pro forma disclosure requirements thereof. If the Company makes this election, compliance with Statement 123 will have no impact on the Company's results of operations or financial position because the Company's stock option plans are fixed stock option plans, and therefore grants thereunder have no intrinsic value at the grant date under APB 25. Financial Accounting Standards Board Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("Statement 121"), was issued in March 1995 and is effective for fiscal years beginning after December 15, 1995. This statement will be applied prospectively, and requires that impairment losses on long-lived assets be recognized when the book value of the asset exceeds its expected undiscounted cash flows. The Company adopted Statement 121 on January 1, 1996 and adoption at that time did not have a material impact on the Company's financial position or results of operations. UNAUDITED INTERIM FINANCIAL STATEMENTS -- The consolidated balance sheet as of March 31, 1996 and the related consolidated statements of operations, stockholders' equity and cash flows for the three month periods ended March 31, 1995 and 1996 are unaudited and are not covered by the report of independent public accountants. However, in the opinion of management, these interim consolidated financial statements include all adjustments (which consist only of normal recurring adjustments) necessary to present fairly the financial position, results of operations, and cash flows of the Company for the interim periods and are prepared on the same basis as the audited consolidated financial statements. The results of operations and cash flows for the unaudited three month period ended March 31, 1996 are not necessarily indicative of the results that may be expected for the year ending December 31, 1996. F-9 LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 3 -- LONG-TERM DEBT
DECEMBER 31, -------------------- MARCH 31, 1994 1995 1996 --------- --------- ----------- (UNAUDITED) Revolving Credit Facility.................................. $ -- $ -- $ 15,358 Unsecured Senior Notes due August 1, 2003: 9.95% interest payable quarterly......................... 28,000 28,000 28,000 10.35% interest payable quarterly........................ -- 5,000 5,000 Unsecured Senior Subordinated Notes due July 15, 2005: 11.5% interest payable semi-annually..................... -- 30,000 30,000 Less: unamortized discount............................... -- (1,599) (1,545) Other...................................................... -- 350 619 --------- --------- ----------- 28,000 61,751 77,432 Less current maturities.................................... (4,254) (4,299) --------- --------- ----------- $ 28,000 $ 57,497 $ 73,133 --------- --------- ----------- --------- --------- -----------
Long-term debt has the following scheduled principal maturities for the five years subsequent to December 31, 1995 (in thousands of dollars): 1996 -- $4,254; 1997 -- $4,254; 1998 -- $4,200; 1999 -- $4,132; and 2000 -- $4,125. SENIOR NOTES -- On September 15, 1994, the Company sold $28 million, principal amount, of 9.95% Senior Notes in a private transaction with three insurance companies. The 9.95% Senior Notes were issued at par and mature on August 1, 2003. Proceeds from the sale of the 9.95% Senior Notes, after issuance expenses, were approximately $27.6 million and such proceeds were used to (i) repay previous borrowings and (ii) to provide approximately $15.1 million of capital for the continuing growth of the Company's guest pay services business. On April 13, 1995, the Company and the holders of the Company's 9.95% Senior Notes amended the Note Purchase Agreement governing such 9.95% Senior Notes and concurrently the Company issued $5 million, principal amount, of 10.35% Senior Notes, under the Note Purchase Agreement, in a private placement to certain holders of the Company's 9.95% Senior Notes. The 10.35% Senior Notes were issued at par and mature on August 1, 2003. Proceeds from the issue, after issuance related expenses, were approximately $4.9 million, and were used to (i) repay previous borrowings and (ii) for expansion of the Company's guest pay services business. SENIOR SUBORDINATED NOTES -- During 1995, the Company issued $30 million (principal amount) of 11.5% Senior Subordinated Notes due July 15, 2005 (the "Subordinated Notes") to three insurance companies in two separate private placements. Mandatory annual principal payments of $6 million commence July 15, 2001. Proceeds from the issuance of the Subordinated Notes, net of original issue discount and issuance-related expenses, were approximately $27.3 million and were used to (i) repay previous borrowings and (ii) to provide funding for capital expenditures to expand the Company's guest pay services business. The Company issued a total of 480,000 Warrants (see Note 7) to purchase Common Stock of the Company in connection with the issuance of the Subordinated Notes and the value of the Warrants, $1.68 million, is recorded in stockholders' equity and shown as a discount on the Subordinated Notes. Both the Senior Notes and the Senior Subordinated Notes include covenants which require the maintenance of certain financial ratios, limit the incurrence of additional indebtedness, limit the incurrence of certain liens, limit certain payments or distributions in respect of the Common Stock of the Company, F-10 LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 3 -- LONG-TERM DEBT (CONTINUED) provide for acceleration of principal repayment in certain circumstances, and permit early retirement of principal, subject to minimum rate of return provisions. As of March 31, 1996, the Company was in compliance with all such convenants. At December 31, 1995, the estimated fair value of the Senior Notes was approximately $37.5 million and the estimated fair value of the Subordinated Notes was approximately $31.5 million. The fair value of the Senior Notes at December 31, 1994 approximated their carrying value. NOTE 4 -- REVOLVING CREDIT FACILITY AND SUBSEQUENT EVENT On March 11, 1996, the Company entered into a $45 Million Revolving Credit Facility (the "1996 Revolving Facility") with National Westminster Bank Plc and three other banks, to replace a previously available $15 Million Revolving Credit Facility. The 1996 Revolving Facility is unsecured, and amounts outstanding thereunder bear interest at either (i) LIBOR (London Inter Bank Offered Rate) plus 2.00% to 2.625% or (ii) Prime Rate plus 1.00% to 1.625%; both depending on the Company's total leverage, as defined in the agreement. The commitment under the 1996 Revolving Facility may be increased to $60 million, subject to certain conditions, but is subject to a scheduled reduction of 15% beginning in June 1997 and annually thereafter as follows: June 1998 -- 20%; June 1999 -- 20%; June 2000 -- 20%; and June 2001 -- 25%. The 1996 Revolving Facility provides for the issuance of Letters of Credit, subject to customary terms and conditions; and includes terms and conditions which require the maintenance of certain financial ratios, limit the incurrence of additional indebtedness, limit the incurrence of certain liens, limit certain payments or distributions in respect of the Common Stock, and provide for acceleration of principal repayment in certain circumstances. As of March 31, 1996, the Company was in compliance with all such terms and conditions. NOTE 5 -- EXTRAORDINARY LOSS ON EARLY TERMINATION OF BANK CREDIT FACILITY In order to issue the 9.95% Senior Notes (see Note 3) on an unsecured basis, the Company terminated its Revolving Credit and Term Loan Facility, which had been secured by all of the Company's assets. As a consequence of the early termination of this facility, the Company wrote off related, unamortized debt issuance costs of $1,324,000 during 1994. NOTE 6 -- STOCKHOLDERS' EQUITY PREFERRED STOCK -- In 1992 the Company issued 925 shares of Series A preferred stock to its then majority stockholder. No dividends on preferred stock were declared in 1992. In January 1993, the number of authorized preferred shares was increased to 20,000 and the Company issued 3,800 shares of $100 par value ($1,000 redemption value) Series B convertible preferred stock to its then majority stockholder in exchange for Common Stock and certain accrued dividends on Series A preferred stock. In October 1993, all such Series B preferred shares were converted into 1,121,266 shares of Common Stock and $2,150,751 in accrued dividends ($594,000 and $1,556,751 applicable to and accrued in 1992 and 1993, respectively) on preferred stock were declared and paid. There are 5,000,000 shares of preferred stock, $.01 par value, authorized by the Company's certificate of incorporation, of which there were none outstanding at December 31, 1994 and 1995 and March 31, 1996. The Board of Directors may authorize the issuance of preferred stock, $.01 par value, in one or more series and with rights and privileges for each issue as determined by the Board of Directors. COMMON STOCK -- In October 1993, the Company sold 5,175,000 shares of Common Stock at $13.50 per share in an initial public offering. Net proceeds to the Company, after underwriters' commissions and other expenses related to the offering, were approximately $63.7 million. F-11 LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 7 -- STOCK OPTIONS AND WARRANTS STOCK OPTIONS -- The Company has stock option plans which provide for the granting of up to a total of 1,426,792 Nonqualified or Incentive Stock Options on the Company's Common Stock, and certain officers, directors and key employees have been granted options to purchase Common Stock of the Company under these plans. Information concerning stock options is summarized for 1995, as follows:
OPTION OUTSTANDING PRICE PER BEGINNING OUTSTANDING EXERCISABLE SHARE OF YEAR GRANTED (EXERCISED) (CANCELLED) END OF YEAR END OF YEAR - --------- ----------- --------- ----------- ----------- ----------- ----------- $0.23 228,579 -- (34,079) -- 194,500 194,500 $0.46 449,191 -- (39,286) -- 409,905 409,905 $2.77 173,232 -- -- -- 173,232 173,232 $3.23 71,290 -- -- -- 71,290 71,290 $13.25 5,000 -- -- -- 5,000 5,000 $14.75 10,000 -- -- (500) 9,500 4,750 $14.25 21,000 -- -- -- 21,000 10,333 $9.55 99,999 -- -- -- 99,999 25,000 $7.37 -- 72,000 -- (2,000) 70,000 -- $7.00 -- 60,000 -- -- 60,000 -- $8.25 -- 4,000 -- -- 4,000 -- $10.85 -- 200,000 -- -- 200,000 -- ----------- --------- ----------- ----------- ----------- ----------- 1,058,291 336,000 (73,365) (2,500) 1,318,426 894,010 ----------- --------- ----------- ----------- ----------- ----------- ----------- --------- ----------- ----------- ----------- -----------
Options become exercisable in accordance with vesting schedules determined by a Committee of the Board of Directors, and generally expire ten years after the date of grant. No options had expired as of December 31, 1995 and outstanding options expire through 2005. During the three months ended March 31, 1996, the Company granted options under its plans on 85,000 shares of Common Stock at an exercise price of $13.00 per share, and options were exercised on 5,000 and 2,500 shares at exercise prices of $.23 and $7.37 per share, respectively. WARRANTS -- In connection with the Company's initial public offering of Common Stock in 1993, the Company issued warrants to purchase 75,000 shares of Common Stock of the Company to the underwriters. The exercise price of such warrants is $16.20 and the warrants expire on October 14, 1998. In connection with the 1995 issuance of Subordinated Notes (see Note 3), the Company issued a total of 480,000 Warrants to purchase Common Stock of the Company. Each Warrant entitles the holder to purchase one share of Common Stock of the Company at an exercise price of $7.00 per share. The Warrants include demand registration rights and anti-dilution provisions, and such Warrants expire on July 15, 2005. The portion of the proceeds from the 1995 debt issuance deemed attributable to the Warrants has been recorded in additional paid-in capital. NOTE 8 -- COMMITMENTS AND CONTINGENCIES PROGRAMMING AGREEMENTS -- The Company, through programming agreements, provides guest pay and free-to-guest programming services to the lodging industry. These agreements provide that the Company receives monthly revenue for such services. Such agreements contain various restrictions, including default and termination procedures, and generally range from five to seven years in duration. The Company has also entered into agreements with certain networks and studios which provide their programs for redistribution. Under these agreements, the Company pays fees which are based on revenue generated or on F-12 LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 8 -- COMMITMENTS AND CONTINGENCIES (CONTINUED) rate schedules based on the number of hotel and motel rooms under license by the Company. The agreements contain various restrictions, including default and termination procedures, and generally range from three to five years in duration. OPERATING LEASES -- The Company has entered into certain operating leases, which at December 31, 1995 require future minimum lease payments, as follows (in thousands of dollars): 1996 - $438; 1997 - $49; 1998 - $3; and none in 1999 and 2000. LITIGATION -- On February 16, 1995, OCV filed a lawsuit in Federal District Court in Northern California asserting patent infringement by the Company. The complaint requests an unspecified amount of damages and injunctive relief. The Company believes that it does not infringe on the patent and that the allegations are without merit. The Company filed an answer and counterclaim to the lawsuit denying the claims, asserting affirmative defenses and asserting a counterclaim for declaratory relief. The Company is currently engaged in litigation with respect to this matter and intends to vigorously defend itself. Although the outcome of any litigation cannot be predicted with certainty, the Company, after considering the advice of legal counsel, believes that the ultimate disposition of this matter will not have a material adverse effect on the Company's financial position or results of operations. The Company is also subject to other litigation, arising in the ordinary course of business. As of the date hereof, in the opinion of management, the resolution of such other litigation will not have a material adverse effect upon the Company's financial condition. NOTE 9 -- INCOME TAXES The provision for income taxes for 1995 consisted of alternative minimum federal income taxes and State income taxes. At December 31, 1995, the Company had net operating loss carryforwards in excess of $29 million for Federal income tax purposes. These carryforwards expire through 2010, although federal tax regulations limit the availability and timing of usage of carryforwards. Significant components of the Company's deferred tax liabilities and assets at December 31 were as follows (in thousands of dollars):
1994 1995 --------- --------- Deferred tax liabilities: Tax over book depreciation...................... $ 3,437 $ 3,777 --------- --------- Deferred tax assets: Net operating loss carryforwards................ 7,864 9,939 Deferred programming............................ 562 540 Other........................................... 253 345 --------- --------- 8,679 10,824 Valuation allowance............................. (5,242) (7,047) --------- --------- Net deferred tax assets....................... 3,437 3,777 --------- --------- Net deferred taxes................................ $ -- $ -- --------- --------- --------- ---------
The Company established the valuation allowance for deferred tax assets after considering its historical financial performance, existing deferred tax liabilities and certain information about future years. F-13 LODGENET ENTERTAINMENT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 10 -- ACCRUED EXPENSES
DECEMBER 31, -------------------- MARCH 31, 1994 1995 1996 --------- --------- ----------- (UNAUDITED) Accrued taxes..................................... $ 521 $ 702 $ 592 Accrued compensation.............................. 660 966 659 Accrued interest.................................. 464 1,748 1,283 Other............................................. 7 18 555 --------- --------- ----------- $ 1,652 $ 3,434 $ 3,089 --------- --------- ----------- --------- --------- -----------
NOTE 11 -- EVENT SUBSEQUENT TO DATE OF REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS On April 16, 1996, the Company's Board of Directors authorized the filing of a Registration Statement with the Commission for a proposed public offering of Common Stock. On May 21, 1996, the Company's Board of Directors appointed the Special Pricing Committee of the Board of Directors (the "Pricing Committee") and authorized such committee to determine the number of shares to be issued and sold in the public offering and to set the price at which such shares are to be sold to the Underwriters and the public. On May 22, 1996, the Pricing Committee authorized the issuance of 3,680,000 shares (including 480,000 shares which may be issued upon exercise of the Underwriters' over-allotment option). Costs associated with this Offering will be charged against the proceeds of the Offering. If for any reason this Offering is not completed, such costs will be charged to operations. F-14 Inside Back Cover Map depicting Company's actual and target customers - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION AND REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE REGISTERED SECURITIES TO WHICH IT RELATES. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY SUCH SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL. ------------------- TABLE OF CONTENTS
PAGE ---- Available Information..................................................... 2 Prospectus Summary........................................................ 3 Risk Factors.............................................................. 8 Use of Proceeds........................................................... 11 Dividend Policy........................................................... 11 Price Range of Common Stock............................................... 11 Capitalization............................................................ 12 Dilution.................................................................. 13 Selected Consolidated Financial and Other Data............................ 14 Management's Discussion and Analysis of Financial Condition and Results of Operations............................................................... 16 Business.................................................................. 29 Management................................................................ 44 Certain Transactions...................................................... 49 Principal Stockholders.................................................... 50 Description of Capital Stock.............................................. 52 Underwriting.............................................................. 55 Legal Matters............................................................. 57 Experts................................................................... 57 Index to Consolidated Financial Statements................................ F-1
3,200,000 SHARES [LOGO] COMMON STOCK ------------------- P R O S P E C T U S ------------------- PAINEWEBBER INCORPORATED MONTGOMERY SECURITIES NATWEST SECURITIES LIMITED ------------ MAY 23, 1996 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- -----END PRIVACY-ENHANCED MESSAGE-----