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Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

X  ]  Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended March 31, 2012

 

or

 

[       ]  Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from                          to                        

 

Commission File Number 0-22334

 

LodgeNet Interactive Corporation

(Exact name of registrant as specified in its charter)

 

Delaware

 

46-0371161

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification Number)

 

3900 West Innovation Street, Sioux Falls, South Dakota 57107

(Address of Principal Executive Offices)                 (ZIP code)

 

(605) 988-1000

(Registrant’s telephone number,

including area code)

 

 

 

 

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes   X No      

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  X    No      

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

 

Large accelerated filer      

Accelerated filer X

Non-accelerated filer      

Smaller reporting company    

 

 

(Do not check if a smaller reporting company)

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes        No  X  

 

At May 3, 2012, there were 25,347,609 shares outstanding of the registrant’s common stock, $0.01 par value.

 



Table of Contents

 

LodgeNet Interactive Corporation and Subsidiaries

 

Index

 

 

Page

 

No.

 

 

Part I. Financial Information

 

 

Item 1 — Financial Statements:

 

Consolidated Balance Sheets as of March 31, 2012 (Unaudited) and December 31, 2011 (Audited)

3

Consolidated Statements of Operations (Unaudited) for the Three Months Ended March 31, 2012 and 2011

4

Consolidated Statements of Comprehensive Income (Unaudited) for the Three Months Ended March 31, 2012 and 2011

5

Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended March 31, 2012 and 2011

6

Notes to Consolidated Financial Statements (Unaudited)

7

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations

20

Item 3 — Quantitative and Qualitative Disclosures About Market Risk

37

Item 4 — Controls and Procedures

38

 

 

Part II. Other Information

 

 

Item 1 — Legal Proceedings

39

Item 1A — Risk Factors

39

Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds

39

Item 3 — Defaults Upon Senior Securities

39

Item 4 — Mine Safety Disclosures

39

Item 5 — Other Information

39

Item 6 — Exhibits

40

 

 

Signatures

41

 


As used herein (unless the context otherwise requires) “LodgeNet” and/or the “Registrant,” as well as the terms “we,” “us” and “our,” refer to LodgeNet Interactive Corporation (f/k/a LodgeNet Entertainment Corporation) and its consolidated subsidiaries.

 

“LodgeNet,” “On Command,” “The Hotel Networks,” “Envision,” “eCompendium,” “eConcierge” and the LodgeNet logo are trademarks or registered trademarks of LodgeNet Interactive Corporation.  All rights reserved.  iPad is a trademark of Apple, Inc.  All other trademarks or service marks used herein are the property of their respective owners.

 

Page 2



Table of Contents

 

Part I — Financial Information

 

Item 1 — Financial Statements

 

LodgeNet Interactive Corporation and Subsidiaries

Consolidated Balance Sheets

(Dollar amounts in thousands, except share data)

 

 

 

(Unaudited)

 

 

(Audited)

 

 

 

March 31,

 

 

December 31,

 

 

 

2012

 

 

2011

 

Assets

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

Cash

 

  $

9,473

 

 

 $

14,019

 

Accounts receivable, net

 

43,587

 

 

53,963

 

Other current assets

 

10,307

 

 

11,021

 

Total current assets

 

63,367

 

 

79,003

 

 

 

 

 

 

 

 

Property and equipment, net

 

118,242

 

 

119,164

 

Debt issuance costs, net

 

3,732

 

 

4,373

 

Intangible assets, net

 

89,882

 

 

91,642

 

Goodwill

 

100,081

 

 

100,081

 

Other assets

 

13,111

 

 

14,409

 

Total assets

 

 $

388,415

 

 

 $

408,672

 

 

 

 

 

 

 

 

Liabilities and Stockholders’ Deficiency

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Accounts payable

 

 $

48,697

 

 

 $

48,255

 

Current maturities of long-term debt

 

11,701

 

 

10,395

 

Accrued expenses

 

17,967

 

 

18,813

 

Deferred revenue

 

19,404

 

 

19,949

 

Total current liabilities

 

97,769

 

 

97,412

 

 

 

 

 

 

 

 

Long-term debt

 

335,583

 

 

352,905

 

Other long-term liabilities

 

8,814

 

 

9,296

 

Total liabilities

 

442,166

 

 

459,613

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ deficiency:

 

 

 

 

 

 

Preferred stock, $.01 par value, 5,000,000 shares authorized;

 

 

 

 

 

 

Series B cumulative perpetual convertible, 10%, 57,500 issued; 57,266 outstanding at March 31, 2012 and December 31, 2011, respectively (liquidation preference of $1,000 per share; $57,266,000 total at March 31, 2012 and December 31, 2011, respectively)

 

1

 

 

1

 

Common stock, $.01 par value, 50,000,000 shares authorized;
25,347,609 and 25,272,734 shares outstanding at March 31, 2012 and December 31, 2011, respectively

 

253

 

 

253

 

Additional paid-in capital

 

383,706

 

 

384,843

 

Accumulated deficit

 

(440,624

)

 

(438,527

)

Accumulated other comprehensive income

 

2,913

 

 

2,489

 

Total stockholders’ deficiency

 

(53,751

)

 

(50,941

)

Total liabilities and stockholders’ deficiency

 

 $

388,415

 

 

 $

408,672

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 3



Table of Contents

 

LodgeNet Interactive Corporation and Subsidiaries

Consolidated Statements of Operations (Unaudited)

(Dollar amounts in thousands, except share data)

 

 

 

Three Months Ended
March 31,

 

 

2012

 

 

2011

 

Revenues:

 

 

 

 

 

 

Hospitality and Advertising Services

 

 $

91,794

 

 

 $

105,835

 

Healthcare

 

2,901

 

 

1,894

 

Total revenues

 

94,695

 

 

107,729

 

 

 

 

 

 

 

 

Direct costs and operating expenses:

 

 

 

 

 

 

Direct costs (exclusive of operating expenses and depreciation and amortization shown separately below):

 

 

 

 

 

 

Hospitality and Advertising Services

 

54,745

 

 

59,361

 

Healthcare

 

1,848

 

 

922

 

Operating expenses:

 

 

 

 

 

 

System operations

 

8,935

 

 

10,069

 

Selling, general and administrative

 

9,187

 

 

9,689

 

Depreciation and amortization

 

15,219

 

 

19,641

 

Restructuring charge

 

632

 

 

1,160

 

Other operating income

 

(49

)

 

(14

)

Total direct costs and operating expenses

 

90,517

 

 

100,828

 

 

 

 

 

 

 

 

Income from operations

 

4,178

 

 

6,901

 

 

 

 

 

 

 

 

Other income and (expenses):

 

 

 

 

 

 

Interest expense

 

(5,965

)

 

(7,671

)

Loss on early retirement of debt

 

(156

)

 

(158

)

Other income

 

17

 

 

317

 

 

 

 

 

 

 

 

Loss before income taxes

 

(1,926

)

 

(611

)

Provision for income taxes

 

(171

)

 

(297

)

 

 

 

 

 

 

 

Net loss

 

(2,097

)

 

(908

)

Preferred stock dividends

 

(1,432

)

 

(1,438

)

 

 

 

 

 

 

 

Net loss attributable to common stockholders

 

 $

(3,529

)

 

 $

(2,346

)

 

 

 

 

 

 

 

Net loss per common share (basic and diluted)

 

 $

(0.14

)

 

 $

(0.09

)

 

 

 

 

 

 

 

Weighted average shares outstanding (basic and diluted)

 

25,165,165

 

 

25,037,122

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 4



Table of Contents

 

LodgeNet Interactive Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income (Unaudited)

(Dollar amounts in thousands)

 

 

 

Three Months Ended
March 31,

 

 

2012

 

 

2011

 

Net loss

 

 $

(2,097

)

 

 $

(908

)

Currency translation adjustment:

 

 

 

 

 

 

Unrealized net change during period

 

424

 

 

454

 

Cash flow hedging:

 

 

 

 

 

 

Net gain on interest rate swaps

 

-

 

 

(89

)

Reclassification of net realized loss on interest rate swaps

 

-

 

 

4,003

 

Amortization of unrealized loss on interest rate swaps

 

-

 

 

448

 

Total cash flow hedging

 

-

 

 

4,362

 

Other comprehensive income

 

424

 

 

4,816

 

Comprehensive (loss) income

 

 $

(1,673

)

 

 $

3,908

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 5



Table of Contents

 

LodgeNet Interactive Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

(Dollar amounts in thousands)

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

 

2011

 

Operating activities:

 

 

 

 

 

 

Net loss

 

 $

(2,097

)

 

 $

(908

)

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

 

Depreciation and amortization

 

15,219

 

 

19,641

 

Gain on derivative instruments

 

-

 

 

(745

)

Loss on early retirement of debt

 

156

 

 

158

 

Share-based compensation and restricted stock

 

286

 

 

414

 

Other, net

 

136

 

 

122

 

Change in operating assets and liabilities:

 

 

 

 

 

 

Accounts receivable, net

 

10,526

 

 

(2,667

)

Other current assets

 

339

 

 

459

 

Accounts payable

 

382

 

 

4,709

 

Accrued expenses and deferred revenue

 

(1,765

)

 

(2,127

)

Other

 

(405

)

 

178

 

Net cash provided by operating activities

 

22,777

 

 

19,234

 

 

 

 

 

 

 

 

Investing activities:

 

 

 

 

 

 

Property and equipment additions

 

(9,150

)

 

(4,645

)

Net cash used for investing activities

 

(9,150

)

 

(4,645

)

 

 

 

 

 

 

 

Financing activities:

 

 

 

 

 

 

Repayment of long-term debt

 

(17,500

)

 

(3,025

)

Payment of capital lease obligations

 

(164

)

 

(214

)

Borrowings on revolving credit facility

 

10,000

 

 

25,000

 

Repayments of revolving credit facility

 

(10,000

)

 

(25,000

)

Debt issuance costs

 

-

 

 

(2,410

)

Proceeds from investment in long-term debt

 

1,022

 

 

177

 

Payment of dividends to preferred shareholders

 

(1,432

)

 

(1,438

)

Exercise of stock options

 

10

 

 

5

 

Net cash used for financing activities

 

(18,064

)

 

(6,905

)

 

 

 

 

 

 

 

Effect of exchange rates on cash

 

(109

)

 

9

 

(Decrease) increase in cash

 

(4,546

)

 

7,693

 

Cash at beginning of period

 

14,019

 

 

8,381

 

 

 

 

 

 

 

 

Cash at end of period

 

 $

9,473

 

 

 $

16,074

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

Page 6



Table of Contents

 

LodgeNet Interactive Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

 

Note 1 — Basis of Presentation

 

The accompanying consolidated financial statements as of March 31, 2012, and for the three month periods ended March 31, 2012 and 2011, have been prepared by us, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “Commission”).  The information furnished in the accompanying consolidated financial statements reflects all adjustments, consisting of normal recurring adjustments, which, in our opinion, are necessary for a fair statement of such financial statements.

 

Certain information and footnote disclosures, normally included in annual financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to the rules and regulations of the Commission.  Although we believe the disclosures are adequate to make the information presented herein not misleading, it is recommended these unaudited consolidated financial statements be read in conjunction with the more detailed information contained in our Annual Report on Form 10-K for 2011, as filed with the Commission.  The results of operations for the three month periods ended March 31, 2012 and 2011 are not necessarily indicative of the results of operations for the full year due to inherent seasonality within the business, among other factors.

 

The consolidated financial statements include the accounts of LodgeNet Interactive Corporation and its subsidiaries.  All significant inter-company accounts and transactions have been eliminated in consolidation.

 

Note 2 — Property and Equipment, Net

 

Property and equipment was comprised as follows (dollar amounts in thousands):

 

 

 

March 31,

 

 

December 31,

 

 

 

2012

 

 

2011

 

Land, building and equipment

 

 $

114,412

 

 

 $

114,407

 

Hotel systems

 

601,141

 

 

610,807

 

Total

 

715,553

 

 

725,214

 

Less - depreciation and amortization

 

(597,311

)

 

(606,050

)

Property and equipment, net

 

 $

118,242

 

 

 $

119,164

 

 

Note 3 — Goodwill and Other Intangible Assets

 

Goodwill represents the excess of cost over the fair value of net assets acquired.  In 2007, we recorded goodwill in connection with the acquisitions of StayOnline, On Command and The Hotel Networks.  The product lines of both StayOnline and On Command shared the same operating and economic characteristics as our pre-acquisition product lines, and were integrated into the Hospitality operating segment.

 

Effective January 1, 2012, we adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2011-08, “Testing Goodwill for Impairment,” which is now codified under FASB Accounting Standards Codification (“ASC”) Topic 350, “Intangibles – Goodwill and Other.”  This ASU allows an entity to first assess qualitative factors to evaluate if the existence of events or circumstances leads to a determination it is necessary to perform the current two-step test.  After assessing the totality of events or circumstances, if it is determined it is more likely than not the fair value of a reporting unit is less than its carrying amount, then the two-step impairment test must be performed for that reporting unit or units.  An entity has the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to the two-step impairment test, and then resume performing the qualitative assessment in any subsequent period.

 

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Table of Contents

 

Per FASB ASC Topic 350, our goodwill is not amortized; rather, it is tested for impairment annually or if there is a triggering event which indicates the carrying value may not be recoverable.  The goodwill impairment test is a two step test; the first step compares a reporting unit’s fair value to its carrying amount.  If the carrying amount is positive and does not exceed the reporting unit’s fair value, no impairment loss exists.  If the carrying amount exceeds the reporting unit’s fair value, the second step (Step 2) is to be performed.  Reporting units with zero or negative carrying amounts are required to perform Step 2 of the goodwill impairment test if it is more likely than not goodwill impairment exists.  In considering whether it is more likely than not that an impairment loss exists, we evaluate qualitative factors, including the same factors presented in existing guidance which would trigger an interim impairment test of goodwill.  Factors include a significant deterioration in market conditions, unanticipated competition, loss of key personnel or an anticipated sale of a reporting unit.  If an entity determines it is more likely than not that impairment exists, Step 2 of the impairment test must be performed for that reporting unit or units.  Step 2 involves allocating the fair value of the reporting unit to each asset and liability, with the excess being implied goodwill.  An impairment loss results if the amount of recorded goodwill exceeds the implied goodwill.

 

We perform our annual goodwill impairment test for each reporting unit during the fourth quarter.  During the first quarter of 2012, we did not encounter events or circumstances which could trigger an impairment of our goodwill or intangible assets, and the adoption of the additional provisions of FASB ASC Topic 350, as noted above, has not had an impact on our consolidated financial position, results of operations or cash flows.  The determination of fair value requires us to make significant estimates and assumptions.  These estimates may differ from actual results due to inherent uncertainty, such as deterioration in market conditions, prohibiting expected revenue recovery levels.  Our revenue is closely linked to the performance of products and services sold to business and leisure travelers.  A significant slow-down in economic activities impacting the travel and lodging industry, consumer conservatism and other market dynamics, including hotel room loss, a decline in Guest Entertainment revenue, new technologies and increased competition, could adversely impact our business, financial conditions, results of operations and cash flows.  Certain costs within the reporting units are fixed in nature; therefore, changes in revenue which exceed or fall below the fixed cost threshold would have an effect on cash flow and recoverability of goodwill.  Consequently, our goodwill may be impaired if the market conditions deteriorate, revenues and profits decline in a persistent fashion or the capital market erodes.

 

The carrying amount of goodwill by reportable segment was as follows (dollar amounts in thousands):

 

 

 

 

 

Advertising

 

 

 

 

 

 

Hospitality

 

Services

 

 

Total

 

Balance as of December 31, 2011

 

 

 

 

 

 

 

 

Goodwill

 

 $

92,614

 

 $

18,679

 

 

 $

111,293

 

Accumulated impairment losses

 

-

 

(11,212

)

 

(11,212

)

 

 

92,614

 

7,467

 

 

100,081

 

Activity during the period

 

-

 

-

 

 

-

 

 

 

 

 

 

 

 

 

 

Balance as of March 31, 2012

 

 

 

 

 

 

 

 

Goodwill

 

92,614

 

18,679

 

 

111,293

 

Accumulated impairment losses

 

-

 

(11,212

)

 

(11,212

)

 

 

 $

92,614

 

 $

7,467

 

 

 $

100,081

 

 

We have intangible assets consisting of certain acquired technology, patents, trademarks, hotel contracts, customer relationships, studio agreements and licensee fees.  These intangible assets have been deemed to have finite useful lives and are amortized over their current estimated useful lives, ranging from 2 to 20 years.  We review the intangible assets for impairment when triggering events occur or a change in circumstances, such as a significant deterioration in market conditions, warrant modifications to the carrying amount of the assets.

 

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Table of Contents

 

We had the following intangible assets (dollar amounts in thousands):

 

 

 

March 31, 2012

 

 

December 31, 2011

 

 

 

Carrying

 

Accumulated

 

 

Carrying

 

Accumulated

 

 

 

Amount

 

Amortization

 

 

Amount

 

Amortization

 

Assets subject to amortization:

 

 

 

 

 

 

 

 

 

 

Acquired contracts and relationships

 

 $

120,315

 

 $

(31,804

)

 

 $

120,315

 

 $

(30,237

)

Other acquired intangibles

 

13,987

 

(13,362

)

 

13,988

 

(13,273

)

Tradenames

 

3,162

 

(2,603

)

 

3,145

 

(2,508

)

Acquired patents

 

5,228

 

(5,041

)

 

5,216

 

(5,004

)

 

 

 $

142,692

 

 $

(52,810

)

 

 $

142,664

 

 $

(51,022

)

 

We recorded amortization expense of $1.8 million and $2.0 million, respectively, for the three months ended March 31, 2012 and 2011.  We estimate total amortization expense for the nine months remaining in 2012 and the years ending December 31 as follows (dollar amounts in millions): 2012 - $5.0; 2013 - $6.6; 2014 - $6.4; 2015 - $6.3; 2016 - $6.2 and 2017 - $5.9.  Actual amounts may change from such estimated amounts due to additional intangible asset acquisitions, potential impairment, accelerated amortization or other events.

 

Note 4 — Earnings Per Share Computation

 

We follow FASB ASC Topic 260, “Earnings Per Share,” which requires the computation and disclosure of two earnings per share (“EPS”) amounts, basic and diluted.  Basic EPS is computed based on the weighted average number of common shares actually outstanding during the period.  Diluted EPS is computed based on the weighted average number of common shares outstanding plus all potentially dilutive common shares outstanding during the period.  Potential common shares which have an anti-dilutive effect are excluded from diluted earnings per share.  The provisions of FASB ASC Topic 260 also provide that unvested share-based payment awards which contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method.  We determined our outstanding shares of non-vested restricted stock are participating securities.

 

Page 9



Table of Contents

 

The following table reflects the calculation of weighted average basic and fully diluted shares for the periods ended March 31.  Dollar amounts are in thousands, except share data:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2012

 

 

2011

 

Basic EPS:

 

 

 

 

 

 

Net income (loss)

 

 $

(2,097

)

 

 $

(908

)

Preferred stock dividends

 

(1,432

)

 

(1,438

)

 

 

 $

(3,529

)

 

 $

(2,346

)

Income (loss) allocated to participating securities (1)

 

-

 

 

-

 

Net income (loss) available to common stockholders

 

 $

(3,529

)

 

 $

(2,346

)

 

 

 

 

 

 

 

Weighted average shares outstanding for basic earnings per common share

 

25,165,165

 

 

25,037,122

 

Basic earnings per share

 

 $

(0.14

)

 

 $

(0.09

)

 

 

 

 

 

 

 

Diluted EPS:

 

 

 

 

 

 

Net income (loss)

 

 $

(2,097

)

 

 $

(908

)

Preferred stock dividends

 

(1,432

)

 

(1,438

)

 

 

 $

(3,529

)

 

 $

(2,346

)

Income (loss) allocated to participating securities (1)

 

-

 

 

-

 

Net income (loss) available to common stockholders

 

 $

(3,529

)

 

 $

(2,346

)

 

 

 

 

 

 

 

Weighted average shares outstanding for basic earnings per common share

 

25,165,165

 

 

25,037,122

 

Dilutive effect of potential shares (2)

 

N/A       

 

 

N/A       

 

Weighted average shares outstanding for diluted earnings per common share

 

25,165,165

 

 

25,037,122

 

Diluted earnings per share

 

 $

(0.14

)

 

 $

(0.09

)

 

 

 

 

 

 

 

Participating securities (1)

 

173,625

 

 

111,375

 

 

 

 

 

 

 

 

Potential dilutive common shares (2)

 

17,226,187

 

 

17,251,792

 

 

(1)

 

For the three months ended March 31, 2012 and 2011, participating securities, which do not participate in losses, were not included in the calculations of earnings per share, as we were in a loss position and their inclusion would have been anti-dilutive.

(2)

 

For the three months ended March 31, 2012 and 2011, potential dilutive common shares, which include stock options, unvested restricted stock, warrants and the conversion of preferred stock, were not included in the computation of diluted earnings per share, as we were in a loss position and their inclusion would have been anti-dilutive.

 

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Note 5 — Accrued Expenses

 

Accrued expenses were comprised as follows (dollar amounts in thousands):

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

Property, sales and other taxes

 

 $

5,242

 

 $

5,369

 

Compensation

 

4,263

 

5,275

 

Interest

 

733

 

778

 

Programming related

 

1,183

 

958

 

Restructuring and reorganization

 

288

 

80

 

Preferred stock dividends

 

1,432

 

1,432

 

Purchase commitments

 

2,243

 

2,786

 

Other

 

2,583

 

2,135

 

 

 

 $

17,967

 

 $

18,813

 

 

Note 6 — Long-term Debt and Credit Facilities

 

Long-term debt was comprised as follows (dollar amounts in thousands):

 

 

 

March 31,

 

 

December 31,

 

 

 

2012

 

 

2011

 

Bank Credit Facility:

 

 

 

 

 

 

Term loan

 

 $

346,122

 

 

 $

362,601

 

Revolving loan commitment

 

-

 

 

-

 

Capital leases

 

1,162

 

 

699

 

 

 

347,284

 

 

363,300

 

Less current maturities

 

(11,701

)

 

(10,395

)

 

 

 $

335,583

 

 

 $

352,905

 

 

Bank Credit Facility ¾  In April 2007, we entered into a $675.0 million bank Credit Facility, comprised of a $625.0 million term loan, which matures in April 2014, and a $50.0 million revolving loan commitment, which matures in April 2013.  The term loan originally required quarterly repayments of $1,562,500, which began September 30, 2007.  The term loan originally bore interest at our option of (1) the bank’s base rate plus a margin of 1.0% or (2) LIBOR plus a margin of 2.0%.  The term loan is collateralized by substantially all of the assets of the Company.

 

Effective March 22, 2011, we entered into a First Amendment (the “Amendment”) to the bank Credit Facility.  The Amendment modified certain terms of the Credit Facility, including an increase in the permitted consolidated leverage ratio, the creation of a specific preferred stock dividend payment basket and the potential to extend the term beyond its current expiration in April 2014.  The restricted payment basket within the Amendment allows for dividend payments not to exceed $5,750,000 per year.  In 2011, the Company incurred $2.7 million of debt issuance costs related to certain fees and expenses in connection with this Amendment.

 

Under the Amendment, the $50.0 million revolving loan commitment was reduced to $25.0 million.  The Amendment also requires us to make quarterly term loan repayments of $2.5 million, which began June 30, 2011, through December 31, 2012, and $3.75 million beginning March 31, 2013 through December 31, 2013.  The amended term loan and revolving loan commitment bear interest at our option of (1) the bank’s base rate plus a margin of 4.0% or (2) LIBOR plus a margin of 5.0%.  In addition, a LIBOR floor of 1.5% was established under the Amendment.

 

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The Amendment includes terms and conditions which require compliance with leverage and interest coverage covenants.  As of March 31, 2012, our consolidated leverage ratio was 3.67 compared to the maximum allowable ratio of 4.00 and our consolidated interest coverage ratio was 2.68 compared to the minimum allowable ratio of 2.25.  Per the Amendment, the maximum allowable consolidated leverage ratio will remain at 4.00 until September 30, 2012, when it will change to 3.75 for the quarters ending December 31, 2012 through June 30, 2013.  It will then drop to 3.50 for the quarter ending September 30, 2013 until maturity.  The minimum allowable consolidated interest coverage ratio will continue to be 2.25 until maturity.

 

The Credit Facility also requires we notify the agent upon the occurrence of a “Material Adverse Effect” prior to any draw on the Company’s revolving loan commitment, as such terms are defined and used within our bank Credit Facility.  However, under the Credit Facility, the provision of such a notice is not an event of default, but if such an event occurred, it could restrict the Company’s ability to obtain additional financing under the revolving loan commitment.  The original Credit Facility also stipulated we enter into hedge agreements to provide at least 50% of the outstanding term loan into a fixed interest rate for a period not less than two years.  Our fixed rate swap agreements expired in June 2011 (see Note 13).  The Amendment did not require us to enter into any hedge agreements.  The term loan interest rate as of March 31, 2012 was 6.5%.  The weighted average interest rate for the quarter ended March 31, 2012 was 6.6%.  As of March 31, 2012, we were in compliance with all financial covenants required by our bank Credit Facility.

 

Our ability to remain in compliance with those covenants will depend on our ability to generate sufficient Consolidated EBITDA (a term defined in the Amendment) and to manage our capital investment and debt levels.  We continue taking actions within our control to manage our debt level and remain in compliance with our debt covenants.  The actions within our control include our management of capital investment, working capital and operating costs and exploring other alternative financing.  Our ability to continue to comply with our current covenants is subject to the general economic climate and business conditions beyond our control.  The uncertainties impacting travel and lodging, in addition to the constraints in the credit markets, consumer conservatism and other market dynamics, including technological changes, may continue to negatively impact our planned results and required covenants.  If we are not able to remain in compliance with our current debt covenants and our lenders will not amend or waive covenants with which we are not in compliance, the debt would be due, we would not be able to satisfy our financial obligations and we would need to seek alternative financing.  If we were not able to secure alternative financing, this would have a substantial adverse impact on the Company and our ability to continue our operations.

 

During the first quarter of 2012, we made a prepayment of $15.0 million on the term loan, along with the required payment of $2.5 million.  We expensed $0.2 million of debt issuance costs related to the prepayment.

 

In the first quarter of 2011, we made our required quarterly payment of $1.0 million, prepaid $2.0 million on the term loan and expensed $0.2 million of debt issuance costs related to the prepayment and the Amendment described above.

 

The Credit Facility originally provided for the issuance of letters of credit up to $15.0 million, subject to customary terms and conditions.  Under the terms of the Amendment, this amount was reduced to $7.5 million.  As of March 31, 2012, we had outstanding letters of credit totaling $350,000, which reduce amounts available under the revolving loan commitment.  During the first quarter of 2012, we borrowed $10.0 million under the revolving loan commitment and repaid the entire amount during the quarter.

 

Capital Leases As of March 31, 2012, we had total capital lease obligations of $1.2 million.  We acquired approximately $0.6 million of equipment under capital lease arrangements during the three months ended March 31, 2012.  Our capital lease obligations consist primarily of vehicles used in our field service operations.

 

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As of March 31, 2012, long-term debt had the following scheduled maturities for the nine months remaining in 2012 and the full years ending December 31, 2013 and after (dollar amounts in thousands):

 

 

 

2012

 

2013

 

2014

 

2015

 

2016

 

Long-term debt

 

 $

7,500

 

 $

15,000

 

 $

323,622

 

 $

-

 

 $

-

 

Capital leases

 

420

 

295

 

250

 

213

 

37

 

 

 

7,920

 

15,295

 

323,872

 

213

 

37

 

Less amount representing interest on capital leases

 

(24)

 

(16)

 

(9)

 

(3)

 

(1)

 

 

 

 $

7,896

 

 $

15,279

 

 $

323,863

 

 $

210

 

 $

36

 

 

We do not utilize special purpose entities or off-balance sheet financial arrangements.

 

Note 7 ¾  Comprehensive Income

 

FASB ASC Topic 220, “Comprehensive Income,” provides standards for reporting and disclosure of comprehensive income and its components.  Comprehensive (loss) income reflects the changes in equity during a period from transactions related to foreign currency translation adjustments for the periods ended March 31, 2012 and 2011, and our interest rate swap arrangements for the period ended March 31, 2011.  Effective January 1, 2012, we adopted FASB ASU No. 2011-05, “Presentation of Comprehensive Income,” which is now codified under FASB ASC Topic 220.  This guidance gives entities two options for presenting the total of comprehensive income, the components of net income and the components of other comprehensive income.  We elected to present two separate, but consecutive statements, presenting: each component of and a total of net income; each component of and a total of other comprehensive income; and a total of comprehensive income.  Effective January 1, 2012, we also adopted FASB ASU No. 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05,” which is now codified under FASB ASC Topic 220.  This ASU deferred certain aspects of FASB ASU No. 2011-05 while the FASB redeliberates the requirement to measure and present reclassification adjustments from accumulated other comprehensive income to net income by income statement line item in net income and also in other comprehensive income.

 

Accumulated other comprehensive income, as shown on our Consolidated Balance Sheets, consisted of foreign currency translation adjustments as of March 31, 2012 and December 31, 2011.

 

Note 8 ¾ Statements of Cash Flows

 

Cash is comprised of demand deposits.  Cash paid for interest was $6.0 million and $8.0 million, respectively, for the three months ended March 31, 2012 and 2011.  Cash paid for taxes was $57,000 and $93,000 for the three months ended March 31, 2012 and 2011, respectively.

 

Note 9 — Share-Based Compensation

 

We account for our stock option and incentive plans under the recognition and measurement provisions of FASB ASC Topic 718, “Compensation — Stock Compensation,” which require the measurement and recognition of compensation expense for all stock-based awards based on estimated fair values, net of estimated forfeitures.  Share-based compensation expense recognized in the three months ended March 31, 2012 and 2011 includes compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of this Topic.

 

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The following amounts were recognized in our Consolidated Statements of Operations for share-based compensation plans for the periods ended March 31 (dollar amounts in thousands):

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2012

 

2011

 

Compensation cost:

 

 

 

 

 

Stock options

 

 $

194

 

 $

314

 

Restricted stock

 

92

 

100

 

Total share-based compensation expense

 

 $

286

 

 $

414

 

 

For the three months ended March 31, 2012 and 2011, cash received from stock option exercises was $10,000 and $5,000, respectively.  Due to our net operating loss tax position, we did not recognize a tax benefit from options exercised under the share-based payment arrangements.  The amounts presented in the table above are included as non-cash compensation in our cash flow from operating activities.

 

Stock Options

 

For the three months ended March 31, 2012, we did not grant any stock options to non-employee directors of the Company; however, we did grant 217,500 stock options to certain officers and employees.  The valuation methodology used to determine the fair value of the options issued during the quarter was the Black-Scholes-Merton option-pricing model.  The Black-Scholes-Merton model requires the use of exercise behavior data and the use of a number of assumptions, including volatility of the stock price, the weighted average risk-free interest rate and the weighted average expected life of the options.  We do not pay dividends on our common stock; therefore, the dividend rate variable in the Black-Scholes-Merton model is zero.

 

Restricted Stock

 

For the three months ended March 31, 2012, we did not award any shares of time-based or performance-based restricted stock to our non-employee directors; however, we did award 60,000 shares of time-based restricted stock to certain officers pursuant to our 2003 Stock Option Incentive Plan.  The shares will vest over four years from the date of grant, with 50% vested at the end of year three and 50% vested at the end of year four.  The fair value of the restricted stock is equal to the fair market value, as defined by the terms of the 2003 Plan, on the date of grant and is amortized ratably over the vesting period.  In the first quarter of 2012, we did not issue any performance-based restricted stock to our officers.

 

Note 10 — Restructuring

 

In 2012, we implemented a reorganization initiative to gain operating efficiencies by reducing the number of service operation locations.  This initiative included a reduction in workforce and vacating leased warehouse/office facilities.  As a result of this action, we incurred $0.6 million of costs during the three months ended March 31, 2012, related to our Hospitality and Advertising Services businesses.  As a result of the 2011 initiative to gain operating efficiencies by reorganizing departments and reducing layers of management, we incurred $1.2 million of costs during the three months ended March 31, 2011.  All such costs are included in operating expenses on the Consolidated Statements of Operations. 

 

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Liabilities associated with our restructuring activities to date, along with charges to expense and cash payments, were as follows (dollar amounts in thousands):

 

 

 

Severance and
other benefit
related costs

 

Cost of closing
redundant
acquired
facilities

 

Total

 

December 31, 2011 balance

 

 $

40

 

 $

40

 

 $

80

 

Charges to expense

 

547

 

85

 

632

 

Cash payments

 

(388)

 

(36)

 

(424)

 

March 31, 2012 balance

 

 $

199

 

 $

89

 

 $

288

 

 

Note 11 — Fair Value Measurements

 

We follow the fair value measurement and disclosure provisions of FASB ASC Topic 820, “Fair Value Measurements and Disclosures,” relating to financial and nonfinancial assets and liabilities.  The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability.  FASB ASC Topic 820 includes a fair value hierarchy, which is intended to increase consistency and comparability in fair value measurements and related disclosures.  The fair value hierarchy is based on inputs to valuation techniques, which are used to measure fair value and which are either observable or unobservable.  Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources, while unobservable inputs reflect a reporting entity’s pricing based upon their own market assumptions.  The fair value hierarchy consists of the following three levels:

 

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.

Level 3: Unobservable inputs that are not corroborated by market data.

 

Effective January 1, 2012, we adopted FASB ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs,” which is now codified under FASB ASC Topic 820.  This new guidance provides common requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. generally accepted accounting principles (“GAAP”) and International Financial Reporting Standards (“IFRSs”).  Certain fair value measurement principles were clarified or amended in this ASU, such as the application of the highest and best use and valuation premise concepts.  New and revised disclosure requirements include: quantitative information about significant unobservable inputs used for all Level 3 fair value measurements and a description of the valuation processes in place, as well as a qualitative discussion about the sensitivity of recurring Level 3 fair value measurements; public companies will need to disclose any transfers between Level 1 and Level 2 fair value measurements on a gross basis, including the reason(s) for those transfers; a requirement regarding disclosure on the highest and best use of a nonfinancial asset; and a requirement that all fair value measurements be categorized in the fair value hierarchy with disclosure of that categorization.

 

Financial Assets and Financial Liabilities ¾  The estimated carrying and fair values of our financial instruments in the financial statements were as follows (dollar amounts in thousands):

 

 

 

March 31, 2012

 

December 31, 2011

 

 

 

Carrying

 

Fair

 

Carrying

 

Fair

 

 

 

Amount

 

Value

 

Amount

 

Value

 

Long-term debt

 

 $

347,284

 

 $

333,439

 

 $

363,300

 

 $

319,788

 

 

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The fair value of our long-term debt is classified as Level 2 and is estimated based on current interest rates for similar debt of the same remaining maturities and quoted market prices, except for capital leases, which are reported at carrying value.  For our capital leases, the carrying value approximates the fair value.  The fair value of our long-term debt is strictly hypothetical and not indicative of what we are required to pay under the terms of our debt instruments.

 

Nonfinancial Assets and Nonfinancial Liabilities ¾  Certain assets and liabilities measured at fair value on a non-recurring basis could include nonfinancial assets and nonfinancial liabilities measured at fair value in the goodwill impairment tests and intangible assets and other nonfinancial long-lived assets measured at fair value for impairment assessment.  There was no triggering event which warranted an evaluation of impairment; therefore, there were no nonfinancial assets or liabilities measured at fair value on a non-recurring basis during the three months ended March 31, 2012.

 

Note 12 — Segment Information

 

We operate in three reportable segments, Hospitality, Advertising Services and Healthcare.  We organize and manage our segments based upon the products and services delivered and the nature of our customer base receiving those products and services.  The Hospitality business distributes entertainment, media and connectivity services to the hospitality industry.  Our Advertising Services business generates revenue from the sale of advertising-based media services within our hospitality customer base, utilizing the same server-based technology or by satellite transmission.  Our Healthcare business generates revenue from the sale of interactive system hardware, software licenses, installation services and related programming and support agreements to the healthcare market.

 

Our Hospitality and Advertising Services businesses provide a variety of interactive and media network services to hotels and/or the respective hotels’ guests.  The products can include interactive video-on-demand programming, music, games, cable television programming, Internet services or advertising services, and have an analogous consumer base.  All products and services are delivered through a proprietary system platform utilizing satellite delivery technology, and are geared towards the hotels and their guests.

 

The accounting policies of the segments are the same as those described in the summary of significant accounting policies, except certain expenses are not allocated to the segments.  These unallocated expenses are corporate overhead, depreciation and amortization expenses, restructuring charges, other operating income (expense), interest expense, loss on the early retirement of debt, other income (expense) and income tax expense.  We evaluate segment performance based upon operating profit and loss before the aforementioned expenses.

 

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Table of Contents

 

Financial information related to our reportable segments for the three months ended March 31 was as follows (dollar amounts in thousands):

 

 

 

 

Three Months Ended

 

 

 

 

March 31,

 

 

 

 

2012

 

 

 

2011

 

Total revenues:

 

 

 

 

 

 

 

 

Hospitality

 

 

$

90,507

 

 

 

$

103,301

 

Advertising Services

 

 

1,287

 

 

 

2,534

 

Healthcare

 

 

2,901

 

 

 

1,894

 

Total

 

 

$

94,695

 

 

 

$

107,729

 

 

 

 

 

 

 

 

 

 

Operating profit:

 

 

 

 

 

 

 

 

Hospitality

 

 

$

23,452

 

 

 

$

31,484

 

Advertising Services

 

 

342

 

 

 

540

 

Healthcare

 

 

103

 

 

 

443

 

Operating profit

 

 

23,897

 

 

 

32,467

 

 

 

 

 

 

 

 

 

 

Corporate

 

 

(3,917

)

 

 

(4,779

)

Depreciation and amortization

 

 

(15,219

)

 

 

(19,641

)

Restructuring charge

 

 

(632

)

 

 

(1,160

)

Other operating income

 

 

49

 

 

 

14

 

Interest expense

 

 

(5,965

)

 

 

(7,671

)

Loss on early retirement of debt

 

 

(156

)

 

 

(158

)

Other income

 

 

17

 

 

 

317

 

Loss before income taxes

 

 

$

(1,926

)

 

 

$

(611

)

 

Note 13 — Derivative Information

 

We follow the provisions of FASB ASC Topic 815, “Derivatives and Hedging Activities,” which establish accounting and disclosure standards regarding a company’s derivative instruments and hedging activities.

 

We were required by our original Credit Facility to convert 50% of the outstanding term loan into a fixed interest rate for a period not less than two years.  Our objective of entering into hedge transactions (or interest rate swaps) using derivative financial instruments was to reduce the variability of cash flows associated with variable-rate loans and comply with the terms of our Credit Facility.  As changes in interest rates impact future interest payments, the hedges provided an offset to the rate changes.  The swap agreements expired in June 2011.  The Amendment to our Credit Facility did not require us to enter into any hedge agreements.

 

In April 2007, we entered into interest rate swap agreements with notional values of $312.5 million, at a fixed rate of 5.09%, and $125.0 million, at a fixed rate of 4.97%, both of which expired in June 2011.  These swap arrangements effectively changed the underlying debt from a variable interest rate to a fixed interest rate for the term of the swap agreements.  All of the swap agreements were issued by Credit Suisse International.  The swap agreements were designated as, and met the criteria for, cash flow hedges and were not considered speculative in nature.

 

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Table of Contents

 

With our amended Credit Facility, our interest rate swaps ceased to be effective and hedge accounting was discontinued effective March 22, 2011 and going forward, primarily related to the LIBOR floor of 1.5% as established under the Amendment.  As a result, our deferred losses of $4,928,000 recorded in other comprehensive income were frozen and were amortized into earnings over the original remaining term of the hedged transaction.  All subsequent changes in the fair value of the swaps were recorded directly to interest expense.  For the three months ended March 31, 2011, we recorded a loss of $448,000 related to nine days of amortization of our deferred losses and a gain of $1,193,000 related to the change in fair value of the interest rate swaps.  The net amount of $745,000 is a non-cash gain and did not impact the amount of cash interest paid during the quarter.

 

A summary of the effect of cash flow hedges on our financial statements for the three months ended March 31, 2011 was as follows (dollar amounts in thousands):

 

 

 

Effective Portion

 

 

 

 

 

 

 

Income Statement

 

 

 

 

 

 

 

 

 

Location of

 

 

 

 

 

 

 

 

 

Amount of

 

Swap Interest

 

Swap Interest

 

 

 

 

 

 

 

Gain (Loss)

 

Reclassified From

 

Reclassified From

 

 

 

 

 

 

 

Recognized

 

Accumulated

 

Accumulated

 

Ineffective Portion

 

 

 

in Other

 

Other

 

Other

 

Income

 

 

 

Type of Cash

 

Comprehensive

 

Comprehensive

 

Comprehensive

 

Statement

 

Amount

 

Flow Hedge

 

Income

 

Income

 

Income

 

Location

 

Recognized

 

Three Months Ended March 31, 2011:

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

 $

(89)  

 

Interest expense

 

  $

4,672  

 

Interest expense

 

 $

(745)  

 

 

Note 14 ¾ Perpetual Preferred Stock Dividend

 

Subject to the declaration of dividends by our Board of Directors, cumulative dividends on the preferred stock will be paid at a rate of 10% per annum of the $1,000 liquidation preference per share, starting from the date of original issue, June 29, 2009.  Dividends accumulate quarterly in arrears on each January 15, April 15, July 15 and October 15, beginning on October 15, 2009.  Dividend payments not to exceed $5,750,000 in any fiscal year are allowable under the restricted payment basket as defined within the Amendment to our Credit Facility.

 

Dividends were declared on the preferred stock by our Board of Directors.  We had $1.4 million of unpaid dividends as of March 31, 2012.  The dividends were recorded as a reduction to additional paid-in capital, due to our accumulated deficit balance.  These dividends were paid on April 16, 2012.

 

Note 15 ¾ Legal Proceedings

 

We are subject to litigation arising in the ordinary course of business.  We believe the resolution of such litigation will not have a material adverse effect upon our financial condition, results of operations or cash flows.

 

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On July 11, 2008, Linksmart Wireless Technology, LLC, a California limited liability company based in Pasadena, California, filed several actions for patent infringement in the U.S. District Court in Marshall, Texas.  The suits allege the Company and numerous other defendants infringe a patent issued on August 17, 2004 entitled “User Specific Automatic Data Redirection System.”  All pending cases have been consolidated.  The complaint does not specify an amount in controversy.  The Company believes it does not infringe the patent in question, has filed responsive pleadings and is vigorously defending the action.  The case was stayed in October 2010, pending a re-examination of the patent by the U.S. Patent and Trademark Office (the “PTO”).  In January 2012, the PTO issued a notice it intended to re-issue the patent with certain claims canceled, other claims confirmed and other claims modified.  In February 2012, the Court removed the stay, but in light of the substantial changes to the patent, cleared the docket by denying all outstanding motions without prejudice.  On April 5, 2012, the Texas action was dismissed, and a similar action was filed in the Central District of California.  The parties are in the process of examining the case in light of the significant revisions to the patent.  The Company believes the changes to the scope of the patent may reduce or eliminate liability for past infringement, and the patent as amended remains subject to further review by the PTO and by the Court.  As a result of these events, the case remains at a very preliminary stage, and the Company believes any possible loss would be immaterial to our consolidated financial position, results of operations or cash flows.

 

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Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion should be read in conjunction with our Consolidated Financial Statements, including the notes thereto, appearing elsewhere herein.

 

Special Note Regarding Forward-Looking Statements

 

Certain statements in this report or documents incorporated herein by reference constitute “forward-looking statements.”  When used in this report, the words “intends,” “expects,” “anticipates,” “estimates,” “believes,” “goal,” “no assurance” and similar expressions, and statements which are made in the future tense or refer to future events or developments, are intended to identify such forward-looking statements.  Such forward-looking statements are subject to risks, uncertainties and other factors which could cause the actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.  In addition to the risks and uncertainties discussed elsewhere in this Report and in Item 1A of our most recent Annual Report on Form 10-K for the year ended December 31, 2011 and filed on March 15, 2012, in any prospectus supplement or any report or document incorporated herein by reference, such factors include, among others, the following:

 

             the effects of general economic and financial conditions;

             the economic condition of the hospitality industry, which can be particularly affected by general economic and financial conditions, as well as by factors such as high gas prices, levels of unemployment, consumer confidence, acts or threats of terrorism and public health issues;

             decreases in hotel occupancy, whether related to economic conditions or other causes;

             competition from providers of similar services and from alternative sources;

             changes in demand for our products and services;

             programming costs, availability, timeliness and quality;

             technological developments by competitors;

             developmental costs, difficulties and delays;

             relationships with clients and property owners;

             the impact of covenants contained in our credit agreement, compliance with which could adversely affect capital available to finance growth, and the violation of which would constitute an event of default;

             changes to government laws and regulations and industry compliance standards;

             potential effects of litigation;

             risks of expansion into new markets and territories;

             risks related to the security of our data systems; and

             other factors detailed, from time to time, in our filings with the Securities and Exchange Commission.

 

These forward-looking statements speak only as of the date of this report.  We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

 

Executive Overview

 

We are the largest provider of interactive media and connectivity services to the hospitality industry in the United States, Canada and Mexico.  Our primary offerings include guest-paid entertainment, such as on-demand movies, advertising services and hotel-paid services, including cable television programming, Internet access services and interactive applications through our Envision and Mobile platforms.  As of March 31, 2012, we provided interactive media and connectivity services to approximately 1.6 million hotel rooms in North America and in select international markets, primarily through local or regional licensees.  In addition, we also have a growing presence in the healthcare market, where we sell and maintain interactive television systems which provide on-demand patient education, information and entertainment to healthcare facilities throughout the United States.  As of March 31, 2012, our systems were installed in 72 healthcare facilities, representing approximately 16,700 beds.

 

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The Company experienced a 12.1% decrease in total revenue for the first quarter of 2012, to $94.7 million, a decrease of $13.0 million compared to the first quarter of 2011.  The decrease was primarily due to an 11.9% decline in the number of Guest Entertainment rooms served and also by a 1.5% decline in Hospitality and Advertising Services revenue per room.  Guest Entertainment revenue per room decreased 11.3% period over period, while revenue generated from non-Guest Entertainment services increased 10.8%.  Revenue generated from non-Guest Entertainment services comprised 51.4% of total revenue for the quarter.

 

Guest Entertainment revenue decreased $12.8 million or 21.8%.  The decrease in Guest Entertainment revenue resulted primarily from an 11.9% reduction in the average number of Guest Entertainment rooms served period over period and an 11.3% decline in Guest Entertainment revenue per room, which was primarily caused by a decline in revenue from Hollywood and non-theatrical movies.  The majority of room reductions were attributable to hotel customers who did not switch to a different interactive television provider, but chose to limit their media offering to only free television content.  The decline in revenue per room was due to several factors, including the top box office movies experiencing less popularity than the prior year, certain merchandising and promotional pricing initiatives which, in some cases, had a negative impact on revenue and reduced purchase frequency of mature content.  We are engaged in a comprehensive review of the issues impacting Guest Entertainment revenues.  This review includes all operating parameters impacting current performance, including recent marketing and pricing changes, modifications to the user interface and changes to content offerings, as well as general environmental factors.

 

Hotel Services revenue was $32.1 million in the current quarter, a decline of 7.6% versus the prior year period, primarily due to a 9.4% decline in the number of rooms receiving cable television programming services.  On a per-room basis, Hotel Services revenue increased 5.1% quarter over quarter, driven primarily by an increase in the number of rooms receiving high definition (“HD”) cable television programming service and the expiration of contracts with unfavorable terms.  System Sales and Related Services revenue per room improved 45.4%, related to professional services work, television programming system sales and service-related revenue and programming fees.  Our advertising services subsidiary generated revenue of $1.3 million, a decrease of 49.2% compared to the first quarter of 2011.  This decline was expected, due to the previously announced transition of our current analog Superblock platform to an expanded HD advertising platform, targeted to begin operation in early 2013.  Our Healthcare subsidiary generated $2.9 million of revenue during the first quarter of 2012, an increase of $1.0 million or 53.2%, driven by increased system installation revenue and a 31.5% increase in the number of beds receiving our recurring services.

 

Our total direct costs decreased $3.7 million or 6.1% period over period, to $56.6 million in the first quarter of 2012 as compared to $60.3 million in the first quarter of 2011.  The decrease in total direct costs was primarily due to lower sales volume in Guest Entertainment and Hotel Services, resulting in lower royalties, hotel commissions and programming fees.  Advertising Services direct costs were lower due to the transition to our new advertising platform.  Gross margins decreased to 40.2% for the first quarter of 2012, compared to 44.0% for the prior year period.

 

System operations expenses and selling, general and administrative (“SG&A”) expenses decreased $1.7 million or 8.3% quarter over quarter, to $18.1 million in the first quarter of 2012 compared to $19.8 million in the prior year quarter.  Factors driving the improvement period over period include reduced system repair costs, content distribution costs, professional services and facilities expenses and our first quarter expense reduction initiatives, which included the reduction of personnel and other payroll-related expenses with a first quarter benefit of $1.5 million.  These changes will result in modest expense reductions going forward.  Depreciation and amortization expenses decreased 22.5%, to $15.2 million in the first quarter of 2012 versus $19.6 million in the first quarter of 2011.  The improvement was due to assets becoming fully depreciated, lower cost systems being installed and the reduction in capital investment levels over the past three years.  As a result of the factors noted above, operating income was $4.2 million in the first quarter of 2012 compared to $6.9 million in the prior year quarter.

 

We generated $22.8 million of cash from operating activities, an 18.4% increase as compared to $19.2 million in the first quarter of 2011.  Cash used for capital investments was $9.2 million in the first quarter of 2012.  In March 2012, we made the required quarterly payment of $2.5 million on our term loan and prepaid $15.0 million.

 

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We continued to make progress on our strategic initiatives, such as Envision, and diversifying our business during the first quarter of 2012.  Hotel adoption of Envision, our cloud-connected interactive television system, continues to grow, which is driving the conversion of the room base to our higher revenue, HD platform and creating new subscription-based revenues.  As of March 31, 2012, our Envision platform was installed in over 43,000 rooms, with over 71,000 total rooms under contract.  Our LodgeNet Mobile App was launched during the quarter, expanding our relationship with the traveler beyond the guest room television.  The App is available in over 570,000 rooms as of March 31, 2012.  During the quarter, we upgraded or installed nearly 17,000 rooms with HD interactive systems.  These additional rooms brought us to over 326,000 HD rooms installed at the end of the first quarter, representing 22.5% of our Guest Entertainment room base.  Our HD platform continues to generate over 60% more revenue per room versus our analog base. In addition, the average cost to install a HD room has declined 24.7% quarter over quarter, to $140 per room, due to lower component and labor costs.

 

Hospitality and Advertising Services Businesses

 

Our Hospitality and Advertising Services businesses include television content sold to hotels and/or the respective hotels’ guests.  The products can include interactive video-on-demand (VOD), cable television programming, Internet services or advertising services, and have an analogous consumer base.  All products and services are delivered through a proprietary system platform having related satellite communication technology, and are geared towards the hotels and their guests.

 

Guest Entertainment (includes purchases for on-demand movies, network-based video games, music and music videos and television on-demand programming).  One of our main sources of revenue, generating 48.6% of total revenue for the quarter ended March 31, 2012, is providing in-room, interactive guest entertainment, for which the hotel guest pays on a per-view, hourly or daily basis.

 

Our total guest-generated revenue depends on a number of factors, including:

 

·      The number of rooms on our network.  Our ability to maintain our room base is dependent on a number of factors, including the number of newly constructed hotel properties or properties serviced by a competitor, and the attractiveness of our technology, service and support to hotels currently serviced by us.

·      The occupancy rate at the property.  Our revenue also varies depending on hotel occupancy rates, which are subject to a number of factors, including seasonality, general economic conditions and world events, such as terrorist threats or public health issues.  Occupancy rates for the properties we serve are typically higher during the second and third quarters due to seasonal travel patterns.  We target higher occupancy properties in diverse demographic and geographic locations in an effort to mitigate occupancy-related risks.

·      The buy rate of hotel guests.  This is impacted by a number of issues, some of which are not under our control.  Specific issues impacting buy rate include:

·      The number of rooms equipped with our interactive high-definition television (“iHDTV”) systems.  We typically earn higher revenue from a property when we convert it to our iHDTV platform.  Our ability to expand our iHDTV room base is dependent on a number of factors, including availability of capital resources from the hotels and us to invest in HD televisions and equipment.  We are focused on accelerating the installation of our iHDTV systems as hotels increase their purchase of HD televisions.

·      The popularity, timeliness and amount of content offered at the hotel.  Our revenues vary, to a certain degree, with the number, timeliness and popularity of movie content available for viewing, and whether the content is presented in digital or analog format.  Historically, a decrease in the availability of popular movie content has adversely impacted revenue, and the availability of high definition content has increased revenue.  Although not completely within our control, we seek to program and promote the most popular available movie content and other content to maximize our revenue and profitability.

 

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·      The price of the service purchased by the hotel guest.  Generally, we control the prices charged for our products and services, and manage pricing in an effort to maximize revenue and overall profitability.  We establish pricing based on such things as the demographics of the property served, the popularity of the content and overall general economic conditions.  Our technology enables us to measure the popularity of our content and make decisions to best position such content and optimize revenue from such content.

·      The effectiveness of our promotional and marketing campaigns.  We believe we can promote increased browsing activity through: tiered pricing; an improved user interface and navigational experiences for hotel guests; and enhanced merchandising and marketing of the latest content in our exclusive hotel window.  By increasing browsing activity, attracting new buyers and lifting buy rates, we believe we can improve theatrical movie revenue per room.  Certain merchandising and promotional pricing programs may, in some cases, have a negative impact on revenue before they are modified or suspended.

·      The availability of alternative programming and portable devices.  We compete directly for customers with a variety of other content providers delivering content across different portable devices.  Competing content providers include cable and satellite television companies; Internet streaming services, including Netflix, Hulu and Amazon; and Internet websites which provide access to free adult content, including streaming video.  These sources of alternative content can be delivered across a variety of portable viewing devices, such as laptop computers, smart phones and iPads®.

·      Consumer sentiment.  The willingness of guests to purchase our entertainment services is also impacted by the general economic environment and its impact on consumer sentiment.  Historically, such impacts were not generally material to our revenue results; however, since the last half of 2008, economic conditions have had a significant, negative impact on our revenue levels.

 

The primary direct costs of providing Guest Entertainment are:

 

·      license fees paid to major motion picture studios, which are variable and based on a percent of guest-generated revenue, for non-exclusive distribution rights of recently released major motion pictures;

·      commissions paid to our hotel customers, which are also variable and based on a percent of guest-generated revenue;

·      license fees, which are based on a percent of guest-generated revenue, for television on-demand, music, music videos, video games and sports programming; and

·      fixed monthly Internet connectivity costs.

 

Hotel Services (includes revenue from hotels for services such as television channels and recurring Internet service and support to the hotels).  Another major source of our revenue is providing cable television programming, hotel services applications on our Envision and Mobile platforms and Internet access services to the lodging industry, for which the hotel pays a fixed monthly fee.

 

·      Cable Television Programming.  We offer a wide variety of satellite-delivered cable television programming paid for by the hotel and provided to guests at no charge.  The cable television programming is delivered via satellite, pursuant to an agreement with DIRECTV®, and is distributed over the internal hotel network.  It typically includes premium channels such as HBO and Showtime, which broadcast major motion pictures and specialty programming, as well as non-premium channels, such as CNN and ESPN.  With the launch of the high-definition configuration of our interactive television system, we also began offering high-definition cable television programming to the extent available from broadcast sources and DIRECTV.

 

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·      Mobile Applications.  In 2011, we developed the software and technology to deliver the LodgeNet Mobile App, which brings together guest entertainment, hotel services and local area guide information.  We launched the LodgeNet Mobile App in January 2012 and, as of March 31, 2012, it is available in over 570,000 rooms.  The app provides travelers with in-room television control and on-demand content discovery capabilities, along with hotel and local area information and services.  For hotels, the app can be utilized to provide guests with customized brand and property information services.  We expect to drive new revenues from hotels as they subscribe for enhanced mobile services, such as making it possible for a guest to check out of their room or order room service by the pool on their mobile device.  The new app will also create a one-to-one marketing relationship with the consumer, where we can drive incremental revenues from advertising, promotional campaigns or from transactional revenue, such as ticket purchases or restaurant reservations.

·      Envision.  The Envision platform is our next generation, cloud-connected interactive television platform.  This is considered our standard platform and, as of March 31, 2012, we had 113 systems installed and providing services to over 43,000 rooms, and had over 71,000 rooms under contract.  Envision supports extensive branding, as well as a variety of interactive applications designed to assist hoteliers to increase on-premise revenues and save operating costs.  In addition, Envision enhances the guest experience by allowing expanded purchase options, to enable purchases of certain services through the interactive television system using personal credit cards or their hotel folio.  The Envision system also features traveler-centric guest applications, including real time flight data, local information and ecommerce opportunities, such as purchasing tickets for local area attractions and events, reserving tee times and making restaurant reservations.  Envision’s subscription apps and transactional-based revenues represent an ongoing revenue growth opportunity for the Company as we continue to expand our Envision room base and introduce additional apps.

·      Internet Service and Support.  We also design, install and operate wired and wireless Internet systems at hotel properties.  These systems control access to the Internet, provide bandwidth management tools and allow hotels to charge guests or provide the access as a guest amenity.  Post-installation, we generate recurring revenue through the ongoing maintenance, service and call center support services to hotel properties installed by us and also to hotel properties installed by other providers, or through a revenue-share model in which hotel guests pay for Internet and we pay a commission to our hotel customers.  While this is a highly competitive area, we believe we have important advantages as a result of our proactive monitoring interface with hotel systems to improve up time, existing hotel customer relationships and our nationwide field service network.

 

System Sales and Related Services.  We also generate revenue from other products and services within the hotel and lodging industry, including sales of interactive television and Internet access systems, HD programming reception equipment, Internet conference services and professional services, such as network design, project management and installation services.

 

Advertising Services.  We deliver advertising-supported media into select hotel segments, from which we earn revenue from the sale of traditional television advertising, place-based digital advertising and promotional marketing solutions.  The demographic and professional profile of the traveler within our room base tends to have characteristics we believe are attractive to consumer marketing organizations.  By approaching guests with relevant messaging when they are in the comfort of a hotel room, free of distractions, advertisers have a prime opportunity to capture the attention of and connect with these desired consumers.  In addition to market demands, our revenue is also dependent on rooms available to promote customer products and services.  As of March 31, 2012, we provided advertising and media services to approximately 1.1 million hotel rooms.  As our hotel customers upgrade to high-definition signals, we believe our existing analog system will be less attractive both to hoteliers and to advertisers.  During 2012, it is our intention to transition our 300,000 room Superblock platform to an expanded high definition platform with over 20 channels, capable of inserting targeted advertising into an existing nationwide direct-broadcast satellite signal.  This transition, which will involve a substantial capital investment, will enable us to deliver our advertising content in a more cost-effective manner across a much larger segment of our existing room base.  As an initial step of this transition, we discontinued certain services provided through the Superblock platform.  Our new high definition platform, targeted to begin operations in early 2013, will have the scale to attract national advertisers and will also have the ability to target specific designated market areas and zip codes.  Longer term, we believe our new advertising platform will have the potential to significantly enhance our ability to monetize the advertising value of our extensive room base and valuable guest demographic.

 

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Key Metrics:

 

Rooms Served

 

One of the metrics we monitor within our Hospitality and Advertising Services businesses is the number of rooms we serve with our various services.  As of March 31, we had the following number of rooms installed with the designated service:

 

 

 

March 31,

 

 

 

2012

 

2011

 

Total rooms served (1)

 

1,587,229 

 

1,797,336 

 

Total Guest Entertainment rooms (2)

 

1,447,034 

 

1,649,296 

 

Total iHDTV rooms (3)

 

326,145 

 

273,309 

 

Percent of Total Guest Entertainment rooms

 

22.5% 

 

16.6% 

 

Total Envision rooms (4)

 

43,681 

 

1,099 

 

Percent of Total Guest Entertainment rooms

 

3.0% 

 

0.1% 

 

Total Mobile rooms (5)

 

572,322 

 

 

Percent of Total Guest Entertainment rooms

 

39.6% 

 

 

Total Cable Television Programming (FTG) rooms (6)

 

918,574 

 

1,013,551 

 

Percent of Total Guest Entertainment rooms

 

63.5% 

 

61.5% 

 

 

(1)

 

Total rooms served include rooms receiving one or more of our services, including rooms served by international licensees.

(2)

 

Guest Entertainment rooms, of which 92.1% were digital as of March 31, 2012, receive one or more Guest Entertainment services, such as movies, video games, music or other interactive and advertising services.

(3)

 

iHDTV rooms are equipped with high-definition capabilities.

(4)

 

Guest Entertainment rooms installed with our Envision interactive platform.

(5)

 

Guest Entertainment rooms compatible with the LodgeNet Mobile App.

(6)

 

Cable television programming (FTG) rooms receive basic or premium cable television programming.

 

High Definition Room Growth

 

We also track the penetration of our interactive, high-definition television (“iHDTV”) system, since rooms equipped with iHDTV services typically generate higher revenue from Guest Entertainment and Hotel Services than rooms equipped with our analog systems.  iHDTV room growth occurs as we install our iHDTV system in newly contracted rooms or convert certain existing rooms to the iHDTV system in exchange for contract extensions.  The installation of an iHDTV system typically requires a capital investment by both the Company and the hotel operator.  During the past three years, iHDTV growth has been constrained by reduced hotel capital spending on HD televisions, given the negative impact of the economy on the hospitality industry.  We are prepared to increase capital investment levels and work jointly with our best hotel customers to continue the rollout of high-definition systems within the operating and capital plans of the hotels and the Company.  We installed our iHDTV systems in the following number of net new rooms as of March 31:

 

 

 

March 31,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Net new iHDTV rooms for the three months ended

 

16,906 

 

2,859 

 

 

iHDTV rooms, including new installations and major upgrades, are equipped with high-definition capabilities.

 

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Capital Investment Cost Per Installed Room

 

The average investment cost per room associated with an installation can fluctuate due to engineering efforts, component costs, product segmentation, cost of assembly and installation, average number of rooms for properties installed, certain fixed costs and hotel capital contributions.  The following table sets forth our average installation cost per room during the periods ended:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Average cost per installed iHDTV room

 

  $

140  

 

  $

186  

 

 

The decrease in the average cost per iHDTV room from 2011 to 2012 was primarily driven by lower component, installation and other related costs.

 

Average Revenue Per Room

 

We monitor the average revenue we generate per Hospitality and Advertising Services room. Guest Entertainment revenue can fluctuate based on several factors, including occupancy, consumer sentiment, mix of travelers, the availability of high definition and alternative programming, the popularity of movie content, the mix of services purchased and the overall economic environment. Hotel Services revenue can fluctuate based on the percentage of our hotels purchasing cable television programming services from us, the type of services provided at each site, as well as the number of hotels purchasing Internet service and support from us. System Sales and Related Services revenue can fluctuate based on the number of system and equipment sales, including Internet systems sales. Advertising Services revenue can fluctuate based on the demand for advertising and the performance of products and services sold to business and leisure travelers, as well as the number of rooms available to promote within. The following table sets forth the components of our Hospitality and Advertising Services revenue per room for the three months ended March 31:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2012

 

2011

 

Average monthly revenue per room:

 

 

 

 

 

Hospitality and Advertising Services

 

 

 

 

 

Guest Entertainment

 

    $

10.46 

 

    $

11.79 

 

Non-Guest Entertainment

 

 

 

 

 

Hotel Services

 

7.28 

 

6.93 

 

System Sales and Related Services

 

2.82 

 

1.94 

 

Advertising Services

 

0.29 

 

0.51 

 

 

 

10.39 

 

9.38 

 

Total Hospitality and Advertising Services revenue per room

 

    $

20.85 

 

    $

21.17 

 

 

Our diversified revenue initiatives, including Hotel Services, Systems Sales and Related Services and Advertising Services, increased to $10.39 per room for the current quarter, a 10.8% increase from the prior year quarter.  Quarter over quarter, Guest Entertainment revenue per room decreased 11.3% to $10.46.  Total Non-Guest Entertainment revenue, including Healthcare, comprised 51.4% of total revenue during the first quarter of 2012.

 

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Average Direct Costs Per Room

 

Guest Entertainment direct costs vary based on content license fees, the mix of Guest Entertainment products purchased and the commission earned by the hotel.  Hotel Services direct costs include the cost of cable television programming and the cost of Internet support services.  The cost of System Sales and Related Services primarily includes the cost of the systems and equipment sold to hotels.  Advertising Services direct costs include the cost of developing and distributing programming.  The overall direct cost margin primarily varies based on the composition of revenue.  The following table sets forth our Hospitality and Advertising Services direct costs per room for the three months ended March 31:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2012

 

2011

 

Average monthly direct costs per room:

 

 

 

 

 

Hospitality and Advertising Services

 

 

 

 

 

Guest Entertainment

 

 $

4.15

 

 $

4.59

 

Hotel Services

 

6.16

 

5.76

 

System Sales and Related Services

 

2.07

 

1.26

 

Advertising Services

 

0.06

 

0.26

 

Total Hospitality and Advertising Services direct costs per room

 

 $

12.44

 

 $

11.87

 

 

Healthcare Business

 

The healthcare market in the United States consists of over 940,000 hospital beds across approximately 5,800 facilities.  We believe most hospitals currently do not have any form of interactive television services.  The primary reasons hospitals purchase interactive television systems are to increase patient satisfaction, to improve clinical outcomes and to increase operational efficiencies.  Our Healthcare revenue is generated through a variety of services and solutions provided to care facilities, including:

 

·

revenue generated from the sale of the interactive system hardware, software licenses and installation services;

·

revenue from the sale and installation of satellite television equipment and related programming;

·

revenue from recurring support agreements for interactive content, software maintenance and technical field service support, including service agreements covering cable plant, satellite television equipment and interactive systems; and

·

revenue generated from cable plant design, modification and installation, as well as television installation services.

 

As of March 31, these services and solutions were installed as follows:

 

 

 

March 31,

 

 

 

2012

 

2011

 

Systems installed

 

72

 

58

 

Beds served

 

16,741

 

12,659

 

 

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General Operations

 

Total Operating Expenses

 

System operations expenses consist of costs directly related to the operation and maintenance of systems at hotel sites.  Selling, general and administrative expenses (“SG&A”) primarily include payroll costs, share-based compensation, engineering development costs and legal, marketing, professional and compliance costs.  The following table sets forth the components of our operating expenses per room for the three months ended March 31:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2012

 

2011

 

Systems operations expenses

 

 $

2.03

 

 $

2.01

 

SG&A expenses

 

2.09

 

1.94

 

Depreciation and amortization (D&A)

 

3.46

 

3.93

 

Restructuring charge

 

0.14

 

0.24

 

Other operating income, net

 

(0.01)

 

-  

 

 

 

 $

7.71

 

 $

8.12

 

 

 

 

 

 

 

Systems operations as a percent of total revenue

 

9.4%

 

9.3%

 

SG&A as a percent of total revenue

 

9.7%

 

9.0%

 

D&A as a percent of total revenue

 

16.1%

 

18.2%

 

Total operating expenses as a percent of total revenue

 

35.8%

 

37.6%

 

 

Special Note Regarding the Use of Non-GAAP Financial Information

 

To supplement our consolidated financial statements presented in accordance with accounting principles generally accepted in the United States (“GAAP”), we use free cash flow, a non-GAAP measure derived from results based on GAAP.  The presentation of this additional information is not meant to be considered superior to, in isolation of or as a substitute for results prepared in accordance with GAAP.

 

We define free cash flow, a non-GAAP measure, as cash provided by operating activities less cash used for certain investing activities.  Free cash flow is a key liquidity measure, but should not be construed as an alternative to cash flows from operating activities or as a measure of our profitability or performance.  We provide information about free cash flow because we believe it is a useful way for us, and our investors, to measure our ability to satisfy cash needs, including interest payments on our debt, taxes and capital expenditures.  GAAP requires us to provide information about cash flow generated from operations.  Our definition of free cash flow does not take into account our debt service requirements or other commitments.  Accordingly, free cash flow is not necessarily indicative of amounts of cash which may be available to us for discretionary purposes.  Our method of computing free cash flow may not be comparable to other similarly titled measures of other companies.

 

Free Cash Flow

 

We manage our free cash flow by seeking to maximize the amount of cash we generate from our operations and managing the level of our investment activity.  In addition, we can manage capital expenditures by varying the number of rooms we install in any given period.

 

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Levels of free cash flow are set forth in the following table (dollar amounts in thousands):

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2012

 

2011

 

Cash provided by operating activities

 

 $

22,777

 

 $

19,234

 

Property and equipment additions

 

(9,150)

 

(4,645)

 

 

 

 $

13,627

 

 $

14,589

 

 

Liquidity and Capital Resources

 

During the first three months of 2012, cash provided by operating activities was $22.8 million, and we used $9.2 million of the cash we generated for property and equipment additions.  During the same period, we prepaid $15.0 million against our Credit Facility, in addition to the required payment of $2.5 million.  We also used $1.4 million for preferred stock dividends.  During the first three months of 2011, cash provided by operating activities was $19.2 million, and we used cash for property and equipment additions of $4.6 million.  During the same period, we prepaid $2.0 million against our Credit Facility, in addition to the required payment of $1.0 million.  We also used $1.4 million for the preferred stock dividend payments.  Cash as of March 31, 2012 was $9.5 million versus $14.0 million as of December 31, 2011.

 

Our principal sources of liquidity are our cash from operations, our cash on hand and the $25.0 million revolving loan commitment, which matures in April 2013.  We have significant outstanding indebtedness and financial commitments.  As of March 31, 2012, our debt totaled $347.3 million.  The majority of our debt matures in the next two years, including $346.1 million outstanding under the bank Credit Facility, which matures on April 4, 2014.  We estimate, but can provide no assurance, that cash flows from operations, combined with existing cash balances, available borrowings under the bank Credit Facility, including any extensions or replacements thereof, and, subject to market conditions and regulatory requirements, potential availability under our shelf registration will be sufficient to fund our cash requirements for scheduled interest and debt payments on our outstanding indebtedness, planned capital expenditures and projected working capital needs over the next twelve months.  Please refer to “Part I. Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 for further details regarding risks relating to our sufficiency of cash flows, indebtedness and covenants.  As of March 31, 2012, working capital was negative $34.4 million, compared to negative $18.4 million at December 31, 2011.

 

The collectability of our receivables is reasonably assured, as supported by our broad customer base.  Our interactive hotel base is well diversified in terms of location, demographics and customer contracts.  We provide our services to various hotel chains, ownership groups and management companies.  In accordance with our hotel contracts, monies collected by the hotel for interactive television services are held in trust on our behalf, thereby limiting our risk from hotel bankruptcies.

 

In April 2007, we entered into a $675.0 million bank Credit Facility, comprised of a $625.0 million term loan, which matures in April 2014, and a $50.0 million revolving loan commitment, which matures in April 2013.  The term loan originally bore interest at our option of (1) the bank’s base rate plus a margin of 1.0% or (2) LIBOR plus a margin of 2.0%.  The term loan is collateralized by substantially all of the assets of the Company.

 

Effective March 22, 2011, we entered into a First Amendment (the “Amendment”) to the bank Credit Facility.  The Amendment modified certain terms of the Credit Facility, including an increase in the permitted consolidated leverage ratio, the creation of a specific preferred stock dividend payment basket and the potential to extend the term beyond its current expiration in April 2014.  The restricted payment basket within the Amendment allows for dividend payments not to exceed $5,750,000 per year.  The Amendment also reduced the commitments under the revolving loan commitment, increased the interest rate and required quarterly repayment amount and adjusted other covenants.  In 2011, the Company incurred $2.7 million of debt issuance costs related to certain fees and expenses in connection with this Amendment.

 

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Under the Amendment, the $50.0 million revolving loan commitment was reduced to $25.0 million.  The Amendment also requires us to make quarterly term loan repayments of $2.5 million, which began June 30, 2011, through December 31, 2012, and $3.75 million beginning March 31, 2013 through December 31, 2013.  The amended term loan and revolving loan commitment bear interest at our option of (1) the bank’s base rate plus a margin of 4.0% or (2) LIBOR plus a margin of 5.0%.  In addition, a LIBOR floor of 1.5% was established under the Amendment.  The Amendment includes terms and conditions which require compliance with leverage and interest coverage covenants.

 

Our leverage and interest coverage ratios were as follows for the periods ended March 31:

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Actual consolidated leverage ratio (1) (3)

 

3.67

 

3.46

 

Maximum per covenant

 

4.00

 

4.00

 

 

 

 

 

 

 

Actual consolidated interest coverage ratio (2) (3)

 

2.68

 

2.76

 

Minimum per covenant

 

2.25

 

2.25

 

 

(1)

 

Our maximum consolidated leverage ratio is the total amount of all indebtedness of the Company, determined on a consolidated basis in accordance with GAAP, divided by operating income exclusive of depreciation and amortization and adjusted (plus or minus) for certain other miscellaneous cash items, non-cash items and non-recurring items, as defined by the terms of the bank Credit Facility and the Amendment.

(2)

 

Our minimum consolidated interest coverage ratio is a function of operating income exclusive of depreciation and amortization and adjusted (plus or minus) for certain other miscellaneous cash items, non-cash items and non-recurring items divided by interest expense and preferred dividends, as defined by the terms of the bank Credit Facility and the Amendment.

(3)

 

Maximum consolidated leverage ratio and minimum consolidated interest coverage ratios are defined terms of the bank Credit Facility and the Amendment, and are presented here to demonstrate compliance with the covenants in the Amendment, as noncompliance with such covenants could have a material adverse effect on us.

 

Our debt covenant ratios will change in future periods as follows:

 

 

 

 

 

Q3 2013

 

 

 

Q4 2012

 

to maturity

 

Maximum consolidated leverage ratio

 

3.75

 

3.50

 

 

 

 

 

 

 

Minimum consolidated interest coverage ratio

 

2.25

 

2.25

 

 

We do not utilize special purpose entities or off-balance sheet financial arrangements.

 

In order to continue operating efficiently and expand our business, we must remain in compliance with covenants outlined in the Amendment.  Our ability to remain in compliance with those covenants will depend on our ability to generate sufficient Consolidated EBITDA (a term defined in the Amendment) and to manage our capital investment and debt levels.  We continue taking actions within our control to manage our debt level and remain in compliance with our debt covenants.  The actions within our control include our management of capital investment, working capital and operating costs and exploring other options, which may include alternative financing, raising additional capital, wage reductions, reduced service hours or other reductions to the workforce.  If we are not able to remain in compliance with our current debt covenants and our lenders will not amend or waive covenants with which we are not in compliance, the debt would be due, we would not be able to satisfy our financial obligations and we would need to seek alternative financing.  If we were not able to secure alternative financing, this would have a substantial adverse impact on the Company and our ability to continue our operations.

 

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As of March 31, 2012, our consolidated leverage ratio was 3.67 compared to the maximum allowable ratio of 4.00.  Our ability to continue to comply with our current covenants is subject to the general economic climate and business conditions beyond our control.  Additionally, our ability to comply with these covenants depends on achieving our planned operating results and making further debt reductions, as necessary.  Although there are signs of stabilization in certain sectors of the economy, the uncertainties impacting travel and lodging, in addition to the constraints in the credit markets, consumer conservatism and other market dynamics, including continued hotel room loss and decline in Guest Entertainment revenue per room, may continue to negatively impact our planned results and required covenants.  Our significant level of debt and interest payment obligations may impair our financial condition, limit our ability to compete, expose us to interest rate risk to the extent of our variable rate debt and prevent us from meeting our financial obligations.  The covenants under our Credit Facility may also restrict our ability to finance future operations or capital needs or to engage in other business activities.  If we are not able to remain in compliance with our current debt covenants, it will likely have a significant, unfavorable impact on our business and financial condition.

 

The Credit Facility also requires we notify the agent upon the occurrence of a “Material Adverse Effect” prior to any draw on the Company’s revolving loan commitment, as such terms are defined and used within our bank Credit Facility.  However, under the Credit Facility, the provision of such a notice is not an event of default, but if such an event occurred, it could restrict the Company’s ability to obtain additional financing under the revolving loan commitment.  As of March 31, 2012, we are not aware of any events which would qualify under the Material Adverse Effect clause of the Credit Facility.  The total amount of long-term debt outstanding, including the current portion, as of March 31, 2012 was $347.3 million versus $363.3 million as of December 31, 2011.

 

The Credit Facility originally provided for the issuance of letters of credit up to $15.0 million, subject to customary terms and conditions.  Under the terms of the Amendment, this amount was reduced to $7.5 million.  As of March 31, 2012, we had outstanding letters of credit totaling $350,000.

 

As noted above, our Term B Credit Facility matures in April 2014 and the $25.0 million revolving credit facility matures in April 2013.  We intend to refinance our indebtedness prior to maturity in order for us to maintain sufficient funds for our operations.  Our ability to successfully refinance this debt will be impacted by a number of factors, including:

 

·                  our current financial performance, including revenue, AOCF, cash flow and consolidated leverage ratio;

·                  the outlook for the Company, including the rate of HD rollout, Hospitality revenue per room, the success of the Envision and Mobile platforms, the growth of our Advertising and Healthcare businesses and the overall financial forecast which results from these and other business initiatives; and

·                  the current state of the debt markets, which can be impacted by any range of economic or geopolitical issues impacting the global debt markets.

 

We cannot assure we will be able to refinance our existing Credit Facility or financing options available to us, if any, will be on acceptable terms.  If we are not able to refinance or secure alternative financing and our lenders will not amend the terms of our current debt, we would not be able to satisfy our financial obligations and would have significant financial constraints.  This would have a substantial adverse impact on the Company and our ability to continue our operations.

 

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Obligations and commitments as of March 31, 2012 were as follows (dollar amounts in thousands):

 

 

 

 

 

Payments due by period

 

 

 

 

 

Less than

 

2 – 3

 

4 – 5

 

Over

 

 

 

Total

 

1 year

 

years

 

years

 

5 years

 

Contractual obligations:

 

 

 

 

 

 

 

 

 

 

 

Long-term debt(s)

 

  $

347,284 

 

  $

11,701 

 

  $

335,385 

 

  $

198 

 

  $

 

Interest on long-term debt (1)

 

47,394 

 

24,007 

 

23,385 

 

 

 

Operating lease payments

 

2,290 

 

1,025 

 

947 

 

318 

 

 

Purchase obligations (2)

 

11,984 

 

8,933 

 

2,618 

 

413 

 

20 

 

Minimum royalties (3)

 

459 

 

459 

 

 

 

 

Total contractual obligations

 

  $

409,411 

 

  $

46,125 

 

  $

362,335 

 

  $

931 

 

  $

20 

 

 

 

 

 

 

Amount of commitment expiration per period

 

 

 

 

 

Less than

 

2 – 3

 

4 – 5

 

Over

 

 

 

Total

 

1 year

 

years

 

years

 

5 years

 

Other commercial commitments:

 

 

 

 

 

 

 

 

 

 

 

Standby letters of credit

 

  $

350

 

  $

350

 

  $

-

 

  $

-

 

  $

-

 

 

(1)

 

Interest payments are estimates based on current LIBOR and scheduled debt amortization.

(2)

 

Consists of open purchase orders and commitments.

(3)

 

In connection with our programming-related agreements, we may guarantee minimum royalties for specific periods or by individual programming content.

 

Seasonality

 

Our quarterly operating results are subject to fluctuation, depending upon hotel occupancy rates and other factors, including travel patterns and the economy.  Our hotel customers typically experience higher occupancy rates during the second and third quarters, due to seasonal travel patterns and, accordingly, we historically have higher revenue and cash flow in those quarters.  However, quarterly revenue can be affected by the availability of popular content during those quarters and by consumer purchasing behavior.  We have no control over when new content is released or how popular it will be, or the effect of economic conditions on consumer behavior.

 

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Discussion and Analysis of Results of Operations

Three Months Ended March 31, 2012 and 2011

 

Revenue Analysis.  Total revenue for the first quarter of 2012 was $94.7 million, a decrease of $13.0 million or 12.1%, compared to the first quarter of 2011.  The decrease in revenue was from Guest Entertainment, Hotel Services and Advertising Services revenues, partially offset by increases in revenue from System Sales and Related Services and Healthcare.  The following table sets forth the components of our revenue (dollar amounts in thousands) for the quarter ended March 31:

 

 

 

2012

 

2011

 

 

 

 

 

Percent

 

 

 

Percent

 

 

 

 

 

of Total

 

 

 

of Total

 

 

 

Amount

 

Revenues

 

Amount

 

Revenues

 

Revenues:

 

 

 

 

 

 

 

 

 

Hospitality and Advertising Services

 

 

 

 

 

 

 

 

 

Guest Entertainment

 

  $

46,069 

 

48.6% 

 

  $

58,922 

 

54.6% 

 

Hotel Services

 

32,052 

 

33.8% 

 

34,679 

 

32.2% 

 

System Sales and Related Services

 

12,386 

 

13.1% 

 

9,700 

 

9.0% 

 

Advertising Services

 

1,287 

 

1.4% 

 

2,534 

 

2.4% 

 

Total Hospitality and Advertising Services

 

91,794 

 

96.9% 

 

105,835 

 

98.2% 

 

Healthcare

 

2,901 

 

3.1% 

 

1,894 

 

1.8% 

 

 

 

  $

94,695 

 

100.0% 

 

  $

107,729 

 

100.0% 

 

 

Hospitality and Advertising Services revenue, which includes Guest Entertainment, Hotel Services, System Sales and Related Services and Advertising Services, decreased $14.0 million or 13.3%, to $91.8 million in the first quarter of 2012 compared to $105.8 million in the first quarter of 2011. Average monthly Hospitality and Advertising Services revenue per room was $20.85 in the first quarter of 2012, a decrease of 1.5% as compared to $21.17 in the prior year quarter. The following table sets forth information with respect to Hospitality and Advertising Services revenue per room for the quarter ended March 31:

 

 

 

2012

 

2011

 

Average monthly revenue per room:

 

 

 

 

 

Hospitality and Advertising Services

 

 

 

 

 

Guest Entertainment

 

  $

10.46 

 

  $

11.79 

 

Hotel Services

 

7.28 

 

6.93 

 

System Sales and Related Services

 

2.82 

 

1.94 

 

Advertising Services

 

0.29 

 

0.51 

 

Total Hospitality and Advertising Services revenue per room

 

  $

20.85 

 

  $

21.17 

 

 

Guest Entertainment revenue, which includes on-demand entertainment such as movies, television on-demand, music and games, decreased $12.8 million or 21.8%, to $46.1 million in the first quarter of 2012 as compared to $58.9 million in the prior year quarter. The decrease in revenue resulted primarily from an 11.9% reduction in the average number of Guest Entertainment rooms served and an 11.3% decline in Guest Entertainment revenue per room, which primarily resulted from a decline in revenue from Hollywood and non-theatrical movies, music, video games and television Internet access.  The majority of room reductions were attributable to hotel customers who did not switch to a different interactive television provider, but chose to limit their media offering to only free television content.  As a result, monthly Guest Entertainment revenue for the first quarter of 2012 declined to $10.46 compared to $11.79 for the first quarter of 2011.  On a per-room basis, average monthly movie revenue per room was $9.87 for the first quarter of 2012, an 11.3% reduction as compared to $11.13 per room in the prior year quarter.  Non-movie Guest Entertainment revenue per room decreased 10.6% to $0.59 in the first quarter of 2012, related to decreases in music and video game revenue.

 

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Hotel Services revenue, which includes recurring revenue from hotels for cable television programming and Internet service and support, was $32.1 million in the first quarter of 2012 versus $34.7 million in the first quarter of 2011.  On a per-room basis, monthly Hotel Services revenue for the first quarter of 2012 increased 5.1%, to $7.28 compared to $6.93 for the first quarter of 2011.  Monthly cable television programming revenue per room increased 5.4%, to $6.67 for the first quarter of 2012 as compared to $6.33 for the first quarter of 2011.  This increase was the result of an increase in the number of rooms receiving HD service and the expiration of contracts with unfavorable terms.  Recurring Internet revenue per room decreased slightly, to $0.58 in the current quarter compared to $0.60 in the prior year quarter.

 

System Sales and Related Services revenue includes the sale of cable television programming equipment, Internet equipment, HDTV installations and other services to hotels.  For the first quarter of 2012, revenue increased $2.7 million or 27.7%, to $12.4 million as compared to $9.7 million for the first quarter of 2011.  The increase was the result of professional services work, television programming system sales and service-related revenue and programming fees.

 

Advertising Services revenue consists of revenue generated by our advertising services subsidiary.  For the first quarter of 2012, revenue decreased $1.2 million or 49.2%, to $1.3 million as compared to $2.5 million in the prior year period.  This decrease was primarily the result of the transition of our analog system to a high-definition platform.

 

Healthcare revenue includes the sale of interactive systems and services to healthcare facilities.  Healthcare revenue increased $1.0 million or 53.2%, to $2.9 million in the first quarter of 2012 as compared to $1.9 million for the first quarter of 2011, driven by higher revenue and more systems sales and installations in the current quarter, as well as an increase in the number of beds receiving our recurring services.  During the current quarter, we installed 810 beds and four facilities compared to 435 beds and two facilities during the prior year period.

 

Direct Costs (exclusive of operating expenses and depreciation and amortization discussed separately below). Total direct costs decreased $3.7 million or 6.1%, to $56.6 million in the first quarter of 2012 as compared to $60.3 million in the first quarter of 2011.  Total direct costs were 59.8% of revenue for the first quarter of 2012 as compared to 56.0% in the first quarter of 2011.  Direct costs related to the Hospitality and Advertising Services businesses, which include Guest Entertainment, Hotel Services, System Sales and Related Services and Advertising Services, were $54.7 million for the first quarter of 2012 compared to $59.4 million for the prior year quarter.  Lower sales volume in Guest Entertainment and Hotel Services resulted in lower royalties, hotel commission and programming fees.  Advertising Services direct costs were also lower, due to the transition of our advertising platform.

 

Operating Expenses.  The following table sets forth information in regard to operating expenses for the quarter ended March 31 (dollar amounts in thousands):

 

 

 

2012

 

2011

 

 

 

 

 

Percent

 

 

 

Percent

 

 

 

 

 

of Total

 

 

 

of Total

 

 

 

Amount

 

Revenues

 

Amount

 

Revenues

 

Operating expenses:

 

 

 

 

 

 

 

 

 

System operations

 

  $

8,935 

 

9.4% 

 

  $

10,069 

 

9.3% 

 

Selling, general and administrative

 

9,187 

 

9.7% 

 

9,689 

 

9.0% 

 

Depreciation and amortization

 

15,219 

 

16.1% 

 

19,641 

 

18.2% 

 

Restructuring charge

 

632