**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

| **ý   Quarterly Report Pursuant to Section 13 or 15(d) of the Securities  Exchange Act of 1934** |
|------------------------------------------------------------------------------------------------------------|

 

**For the quarterly period ended March31, 2002**

 

**CommissionFile Number 0-22334**

 

**LodgeNetEntertainment Corporation**

(Exact name ofregistrant as specified in its charter)

 

| **Delaware**                                                                                          |   | **46-0371161**                           |
|-------------------------------------------------------------------------------------------------------|--------|------------------------------------------|
| (State or other  jurisdiction of incorporation or organization)                                       |   | (I.R.S. Employer  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 checkmark whether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes  ý No  o.

 

At May 1, 2002,there were 12,389,054 shares outstanding of the Registrant’s common stock,$0.01 par value.

 

*Thisreport contains a total of 20 pages*

 

 

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**LodgeNetEntertainment Corporation**

 

**Index**

 
| **Part I.  Financial Information**                                                                    |
|------------------------------------------------------------------------------------------------------------|
|                                                                                                       |
| Item 1 — Financial Statements:                                                                        |
|                                                                                                       | Consolidated Balance  Sheets (Unaudited) as of March 31, 2002 and December 31, 2001 |
|                                                                                                       | Consolidated  Statements of Operations (Unaudited) for the Three Months Months Ended March  31, 2002 and 2001 |
|                                                                                                       | Consolidated  Statements of Cash Flows (Unaudited) for the Three Months Ended March 31,  2002 and 2001 |
|                                                                                                       | Notes  to Consolidated Financial Statements (Unaudited) |
| Item  2 — Management’s Discussion and Analysis of Financial Condition and Results  of Operations |
| Item  3 — Quantitative and Qualitative Disclosures About Market Risk                                  |
|                                                                                                       |   |   |
| **Part II.  Other Information**                                                                       |
|                                                                                                       |   |   |
| Item  1 — Legal Proceedings                                                                           |
| Item  2 — Changes in Securities and Use of Proceeds                                                   |
| Item 3 — Defaults  Upon Senior Securities                                                             |
| Item  4 — Submission of Matters to a Vote of Security Holders                                         |
| Item  5 — Other Information                                                                           |
| Item 6 —  Exhibits and Reports on Form 8-K                                                            |
|                                                                                                       |
| **Signatures**                                                                                             |
|                                                                                                            |  |  |  |

 

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As used herein(unless the context otherwise requires) “LodgeNet”,  “the Company” and/or “the Registrant” means LodgeNetEntertainment Corporation and its majority-owned subsidiaries.

 

2

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**Part I — Financial Information**

 

**Item 1 — Financial Statements**

 

**LodgeNetEntertainment Corporation**

**Consolidated Balance Sheets(Unaudited)**

(Dollar amounts in thousands)

 
|                                                                                                                                                              |   | **March 31,  2002** |    | **December  31,  2001** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|---------|-------------------------|--------|
| Assets                                                                                                                                                            |   |                |    |                    |   |
| Current assets:                                                                                                                                                   |   |                |    |                    |   |
| Cash and cash  equivalents                                                                                                                                        |   | $                   | 1,059   |                    | $      | 1,528 |   |
| Accounts  receivable, net                                                                                                                                         |   | 31,742              |    | 26,677                  |   |
| Prepaid expenses  and other                                                                                                                                       |   | 3,111               |    | 2,864                   |   |
| Total current assets                                                                                                                                              |   | 35,912              |    | 31,069                  |   |
|                                                                                                                                                              |   |                |    |                    |   |
| Property and  equipment, net                                                                                                                                      |   | 241,893             |    | 240,274                 |   |
| Investments in  and advances to unconsolidated affiliates                                                                                                         |   | 3⁄4              |    | 484                     |   |
| Debt issuance  costs, net                                                                                                                                         |   | 8,664               |    | 9,176                   |   |
| Other assets,  net                                                                                                                                                |   | 9,884               |    | 10,482                  |   |
|                                                                                                                                                              |   | $                   | 296,353 |                    | $      | 291,485 |   |
|                                                                                                                                                              |   |                |    |                    |   |
| Liabilities and Stockholders’ Equity (Deficit)                                                                                                               |   |                |    |                    |   |
| Current  liabilities:                                                                                                                                             |   |                |    |                    |   |
| Accounts payable                                                                                                                                                  |   | $                   | 15,954  |                    | $      | 14,502 |   |
| Current  maturities of long-term debt                                                                                                                             |   | 8,958               |    | 8,168                   |   |
| Accrued expenses  and other                                                                                                                                       |   | 13,748              |    | 10,251                  |   |
| Deferred revenue                                                                                                                                                  |   | 3,140               |    | 3,100                   |   |
| Total current  liabilities                                                                                                                                        |   | 41,800              |    | 36,021                  |   |
|                                                                                                                                                              |   |                |    |                    |   |
| Long-term debt                                                                                                                                                    |   | 322,899             |    | 317,663                 |   |
| Derivative  instruments                                                                                                                                           |   | 4,139               |    | 5,369                   |   |
| Total  liabilities                                                                                                                                                |   | 368,838             |    | 359,053                 |   |
|                                                                                                                                                              |   |                |    |                    |   |
| Stockholders’  equity (deficit):                                                                                                                             |   |                |    |                    |   |
| Common stock,  $.01 par value, 50,000,000 shares authorized;  12,344,934 and 12,284,998 shares outstanding at March 31, 2002  and December 31, 2001, respectively |   | 123                 |    | 123                     |   |
| Additional  paid-in capital                                                                                                                                       |   | 152,528             |    | 151,990                 |   |
| Accumulated  deficit                                                                                                                                              |   | (219,054            | )       | (212,389                | )      |
| Accumulated  other comprehensive loss                                                                                                                             |   | (6,082              | )       | (7,292                  | )      |
| Total  stockholders’ equity (deficit)                                                                                                                        |   | (72,485             | )       | (67,568                 | )      |
|                                                                                                                                                              |   | $                   | 296,353 |                    | $      | 291,485 |   |

 

The accompanying notes are an integral part of these consolidated financialstatements.

 

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**LodgeNetEntertainment Corporation**

**Consolidated Statements of Operations(Unaudited)**

(Dollar amounts,except per share amounts, in thousands)

 
|                                  |   | **Three  Months Ended  March 31,** |   |
|---------------------------------------|--------|------------------------------------|--------|
|                                  |   | **2002**                           |   | **2001** |   |
| Revenues:                             |   |                               |   |   |   |
| Guest Pay                             |   | $                                  | 52,637 |   | $ | 48,781 |   |
| Other                                 |   | 2,372                              |   | 2,257 |   |
| Total revenues                        |   | 55,009                             |   | 51,038 |   |
|                                  |   |                               |   |   |   |
| Direct costs:                         |   |                               |   |   |   |
| Guest Pay                             |   | 21,361                             |   | 19,649 |   |
| Other                                 |   | 1,281                              |   | 1,374 |   |
| Total direct costs                    |   | 22,642                             |   | 21,023 |   |
|                                  |   |                               |   |   |   |
| Gross profit                          |   | 32,367                             |   | 30,015 |   |
|                                  |   |                               |   |   |   |
| Operating expenses:                   |   |                               |   |   |   |
| Guest Pay operations                  |   | 6,993                              |   | 7,344 |   |
| Selling, general and administrative   |   | 5,760                              |   | 5,294 |   |
| Depreciation and amortization         |   | 18,393                             |   | 16,501 |   |
| Total operating expenses              |   | 31,146                             |   | 29,139 |   |
|                                  |   |                               |   |   |   |
| Operating income                      |   | 1,221                              |   | 876 |   |
|                                  |   |                               |   |   |   |
| Investment gains (losses)             |   | 280                                |   | (480 | ) |
| Interest expense                      |   | (8,126                             | )      | (7,131 | ) |
| Other income, net                     |   | 84                                 |   | 66 |   |
|                                  |   |                               |   |   |   |
| Loss before income taxes              |   | (6,541                             | )      | (6,669 | ) |
| Provision for income taxes            |   | (124                               | )      | (113 | ) |
| Net loss                              |   | $                                  | (6,665 | ) | $ | (6,782 | ) |
|                                  |   |                               |   |   |   |
| Per common share (basic and diluted): |   |                               |   |   |   |
| Net loss                              |   | $                                  | (0.54  | ) | $ | (0.56 | ) |
| Weighted average shares outstanding   |   | 12,300,969                         |   | 12,212,210 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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**LodgeNet Entertainment Corporation**

**Consolidated Statements of Cash Flows(Unaudited)**

(Dollar amounts inthousands)

 
|                                                                             |   | **Three  Months Ended  March 31,** |   |
|----------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                             |   | **2002**                           |   | **2001** |   |
| Operating activities:                                                            |   |                               |   |   |   |
| Net loss                                                                         |   | $                                  | (6,665 | ) | $ | (6,782 | ) |
| Adjustments to reconcile net loss to net cash provided by operating  activities: |   |                               |   |   |   |
| Depreciation and amortization                                                    |   | 18,393                             |   | 16,501 |   |
| Investment (gains) losses                                                        |   | (280                               | )      | 480 |   |
| Change in operating assets and liabilities:                                      |   |                               |   |   |   |
| Accounts receivable, net                                                         |   | (5,069                             | )      | (1,805 | ) |
| Prepaid expenses and other                                                       |   | (237                               | )      | (404 | ) |
| Accounts payable                                                                 |   | 1,455                              |   | 2,789 |   |
| Accrued expenses and other                                                       |   | 3,538                              |   | 2,743 |   |
| Other                                                                            |   | 84                                 |   | (176 | ) |
| Net cash provided by operating activities                                        |   | 11,219                             |   | 13,346 |   |
|                                                                             |   |                               |   |   |   |
| Investing activities:                                                            |   |                               |   |   |   |
| Property and equipment additions                                                 |   | (18,817                            | )      | (17,863 | ) |
| Proceeds from sale of investments                                                |   | 3⁄4                             |   | 888 |   |
| Proceeds from affiliates, net                                                    |   | 763                                |   | 267 |   |
| Net cash used for investing activities                                           |   | (18,054                            | )      | (16,708 | ) |
|                                                                             |   |                               |   |   |   |
| Financing activities:                                                            |   |                               |   |   |   |
| Borrowings under revolving credit facility                                       |   | 7,000                              |   | 6,000 |   |
| Repayments of revolving credit facility                                          |   | (550                               | )      | 3⁄4 |   |
| Repayment of long-term debt                                                      |   | (385                               | )      | (10 | ) |
| Repayment of capital lease obligations                                           |   | (122                               | )      | (113 | ) |
| Exercise of stock options                                                        |   | 423                                |   | 4 |   |
| Net cash provided by financing activities                                        |   | 6,366                              |   | 5,881 |   |
|                                                                             |   |                               |   |   |   |
| Effect of exchange rates on cash                                                 |   | 3⁄4                             |   | (37 | ) |
| Increase (decrease) in cash and cash equivalents                                 |   | (469                               | )      | 2,482 |   |
| Cash and cash equivalents at beginning of period                                 |   | 1,528                              |   | 4,059 |   |
| Cash and cash equivalents at end of period                                       |   | $                                  | 1,059  |   | $ | 6,541 |   |
|                                                                             |   |                               |   |   |   |
| Supplemental cash flow information:                                              |   |                               |   |   |   |
| Cash paid for interest                                                           |   | $                                  | 4,793  |   | $ | 5,010 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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**LodgeNetEntertainment Corporation**

**Notes to Consolidated FinancialStatements (Unaudited)**

 

Note 1 — Basis ofPresentation

 

The accompanyingconsolidated financial statements as of March 31, 2002, and for the three monthperiods ended March 31, 2002 and 2001, have been prepared by LodgeNetEntertainment Corporation (the “Company”), without audit, pursuant to the rulesand regulations of the Securities and Exchange Commission (the “Commission”).  The information furnished in theaccompanying consolidated financial statements reflects all adjustments,consisting only of normal recurring adjustments, which, in the opinion ofmanagement, are necessary for a fair presentation of such financial statements.

 

Certain information andfootnote disclosures, normally included in financial statements prepared inaccordance with generally accepted accounting principles, have been condensedor omitted pursuant to the rules and regulations of the Commission. Although theCompany believes that the disclosures are adequate to make the informationpresented herein not misleading, it is recommended that these unauditedconsolidated financial statements be read in conjunction with the more detailedinformation contained in the Company’s Annual Report on Form 10-K for 2001, asfiled with the Commission. The results of operations for the three month periodended March 31, 2002 are not necessarily indicative of the results ofoperations for the full year due to seasonality inherent within the business.

 

The consolidatedfinancial statements include the accounts of LodgeNet Entertainment Corporationand its majority-owned subsidiaries. All significant intercompany accounts and transactions have beeneliminated in consolidation.

 

Note 2 — Property andEquipment, Net

 

Property and equipmentwas comprised as follows at (in thousands):

 
|                                 |   | **March 31,  2002** |    | **December  31,  2001** |   |
|--------------------------------------|--------|---------------------|---------|-------------------------|--------|
| Land, building and equipment         |   | $                   | 69,076  |                    | $      | 68,007 |   |
| Free-to-guest equipment              |   | 24,466              |    | 24,798                  |   |
| Guest Pay systems:                   |   |                |    |                    |   |
| Installed                            |   | 413,380             |    | 399,520                 |   |
| System components                    |   | 28,588              |    | 27,548                  |   |
| Software costs                       |   | 15,300              |    | 14,793                  |   |
| Total                                |   | 550,810             |    | 534,666                 |   |
| Less - depreciation and amortization |   | (308,917            | )       | (294,392                | )      |
| Property and equipment, net          |   | $                   | 241,893 |                    | $      | 240,274 |   |

 

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Note 3 — Long-term Debtand Credit Facilities

 

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

 
|                       |   | **March 31,  2002** |    | **December  31,  2001** |   |
|----------------------------|--------|---------------------|---------|-------------------------|--------|
| Bank Credit Facility:      |   |                |    |                    |   |
| Bank term loan             |   | $                   | 149,250 |                    | $      | 149,625 |   |
| Revolving credit facility  |   | 6,450               |    | 3⁄4                  |   |
| 10.25% senior  notes       |   | 150,000             |    | 150,000                 |   |
| 11.50% senior  notes       |   | 24,000              |    | 24,000                  |   |
| Less unamortized  discount |   | (290                | )       | (333                    | )      |
| Capital leases             |   | 1,615               |    | 1,697                   |   |
| Other                      |   | 832                 |    | 842                     |   |
|                       |   | 331,857             |    | 325,831                 |   |
| Less current  maturities   |   | (8,958              | )       | (8,168                  | )      |
|                       |   | $                   | 322,899 |                    | $      | 317,663 |   |

 

*Bank Credit Facility*3⁄4 On August 29, 2001, the Companyentered into a $225 million bank credit facility, comprised of a $150 millionterm loan and a $75 million revolving credit facility which may be increased to $100 million,subject to certain limitations.  The$128.5 million outstanding ($67.5 million of term loan and $61 million ofrevolving credit facility) under the Company’s prior credit facility was repaidwith the proceeds from the term loan. The term loan matures in June 2006 and quarterly repayments began inDecember 2001.  The term loan bearsinterest at the Company’s option of (1) the bank’s base rate plus a margin of2.75% or (2) LIBOR plus a margin of 4.00%. The term loan interest rate as of March 31, 2002 was 5.91%.  The revolving credit facility matures inJune 2006 and loans bear interest at the Company’s option of (1) the bank’sbase rate plus a margin of from 1.00% to 1.75%, or (2) LIBOR plus a margin offrom 2.25% to 3.00%.  The weightedaverage interest rate for the revolving credit facility as of March 31, 2002was 5.38%.  Loans under the creditfacility are secured by a first priority security interest in all of theCompany’s assets.

 

The facility provides for the issuance of lettersof credit up to $10 million, subject to customary terms and conditions.  As of March 31, 2002, the Company hadoutstanding letters of credit totaling $2.0 million.

 

The facility includes terms and conditions whichrequire compliance with material adverse effect covenants as well as themaintenance of certain financial ratios and place limitations on capitalexpenditures, additional indebtedness, liens, investments, guarantees, assetsales and certain payments or distributions in respect of the commonstock.  As of March 31, 2002, theCompany was in compliance with all covenants, terms and conditions of the bankcredit facility.

 

*10.25% Senior Notes***—**In December 1996, the Company issued $150 million ofunsecured 10.25% senior notes (the “10.25% Notes”), due December 15, 2006.  The 10.25% Notes are unsecured, rank *pari passu*in right of payment with future unsubordinated unsecured indebtedness and ranksenior in right of payment to all subordinated indebtedness of theCompany.  The 10.25% Notes requiresemi-annual interest payments and contain certain restrictive covenants.  As of March 31, 2002, the Company was incompliance with all covenants, terms, and conditions of the 10.25% Notes.

 

The 10.25% Notes are redeemable at the option of the Company, in wholeor in part, on or after December 15, 2001, initially at 105.125% of theirprincipal amount (plus accrued and unpaid interest) declining ratably to 100%of their principal amount (plus accrued and unpaid interest) on or afterDecember 15, 2003.

 

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*11.50% SeniorNotes***—**During 1995, the Company issued$30 million principal amount of unsecured 11.50% senior notes (the “11.50%Notes”).  Mandatory annual principalpayments of $6 million commenced in July 2001 continuing through July2005.  Semi-annual interest payments arerequired.  The Company issued a total of480,000 warrants to purchase common stock of the Company in connection with theissuance of the 11.50% Notes and the value of the warrants, $1.68 million, wasrecorded as additional paid-in capital and shown as a discount on the 11.50%Notes.  As part of the refinancingtransaction in which the 10.25% Notes were issued, the holders of the 11.50% Notesadopted the covenants and ranking of the 10.25% Notes.  As of March 31, 2002, the Company was incompliance with all covenants, terms and conditions of the 11.50% Notes.

 

Long-term debt has the following scheduled principal maturities for theyears ended March 31 (in thousands of dollars): 2002 — $8,958; 2003 — $8,011;2004 — $7,880; 2005 — $7,222; 2006 — $299,786

 

The Company does not utilize special purposeentities or off-balance sheet financial arrangements.

 

Note 4 3⁄4Accounting for Derivative Instruments and Hedging Activities

 

Statement of Financial Accounting Standard No. 133, “Accounting forDerivative Instruments and Hedging Activities”, establishes accounting andreporting standards requiring that every derivative instrument (includingcertain derivative instruments embedded in other contracts) be recorded in thebalance sheet as either an asset or liability measured at its fair value.  The statement requires that changes in thederivative’s fair value be recognized currently in earnings unless specifichedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative’s gains andlosses to offset related results on the hedged item and requires that a companymust formally document, designate and assess the effectiveness of transactionsthat receive hedge accounting.

 

In March 2002, the Company entered into a $50 million interest rateswap agreement, which expires in March 2006. In addition, the Company had existing interest rate swap agreements on$100 million of long-term debt, which expire $50 million in March 2003 and $50million in December 2005.  The swapagreements, have been designated as, and meet the criteria for, cash flowhedges.

 

Note 5 3⁄4 Comprehensive Income (Loss)

 

Statement of Financial Accounting Standard No. 130, “ReportingComprehensive Income,” provides standards for reporting and disclosure ofcomprehensive income and its components. Comprehensive income reflects the changes in equity during a period fromtransactions and other events and circumstances from non-owner sources.  For the Company, comprehensive loss was asfollows for the periods ended March 31 (in thousands):

 
|                                             |   | **Three  Months Ended  March 31,** |   |
|--------------------------------------------------|--------|------------------------------------|--------|
|                                             |   | **2002**                           |   | **2001** |   |
| Net loss                                         |   | $                                  | (6,665 | ) | $ | (6,782 | ) |
| Foreign currency translation adjustment          |   | (20                                | )      | (582 | ) |
| Unrealized loss on marketable securities         |   | 3⁄4                             |   | (330 | ) |
| Cumulative effect of adoption of SFAS No. 133    |   | 3⁄4                             |   | (1,287 | ) |
| Unrealized gain (loss) on derivative instruments |   | 1,230                              |   | (2,341 | ) |
| Comprehensive loss                               |   | $                                  | (5,455 | ) | $ | (11,322 | ) |

 

Note 6 3⁄4 Effect of Recently Issued AccountingStandards

 

*Effectof Recently Issued Accounting Standards* —  In July 2001, the Financial AccountingStandards Board issued SFAS No. 142, “Goodwill and Other Intangible Assets”which eliminates the current requirement to amortize goodwill andindefinite-lived intangible assets, addresses the amortization of intangibleassets with a defined life and addresses the impairment testing and recognitionfor goodwill and intangible assets.  Theprovisions in this statement are effective January 1, 2002.  The Company has determined the adoption ofthis statement will not

 

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impact its consolidated financial statements.

 

In June 2001, the Financial Accounting Standards Board issued SFAS No.143, “Accounting for Obligations Associated with the Retirement of Long-LivedAssets”. SFAS No. 143 primarily establishes accounting standards for therecognition and measurement of an asset retirement obligation and itsassociated asset retirement costs. The provisions of SFAS No. 143 will be effectivefor fiscal years beginning after June 15, 2002.  The Company has determined the adoption of this statement willnot significantly impact its consolidated financial statements.

 

In October 2001, the Financial Accounting Standards Board issued SFAS No.144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. SFAS No.144 supercedes SFAS 121, “Accounting for the Impairment of Long-Lived Assetsand for Long-Lived Assets to Be Disposed Of”. SFAS No. 144 primarily addressessignificant issues relating to the implementation of SFAS No. 121 and developsa single accounting model for long-lived assets to be disposed of, whetherpreviously held and used or newly acquired. The provisions of SFAS No. 144 willbe effective for fiscal years beginning after December 15, 2001.  The Company has determined the adoption ofthis statement will not significantly impact its consolidated financialstatements.

 

Note 7 3⁄4 Subsequent Event

 

On April 12, 2002, the Company terminated the Distribution and CarriageAgreement, dated October 9, 2000, and Services Agreement, dated October 9,2000, with InnMedia LLC, a joint venture of which the Company owns 47.5% of theequity interest.  The terminationsfollowed the institution of legal proceedings by InnMedia against the Company,as described in Part II — Legal Proceedings. The agreements were terminated due to, among other things, InnMedia’seffective repudiation of the agreements and InnMedia’s failure to perform.  The Company reserved $900,000 foruncollectable receivables, recorded additional expenses of $345,000 againstoperating results, and recorded an equity loss for its remaining investmentbalance of $167,000 in the first quarter of 2002.  As of March 31, 2002, the Company had a receivable balance fromInnMedia of approximately $2.7 million and a payable to InnMedia ofapproximately $1.2 million.

 

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**Item2 —****Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

 

*The following discussion andanalysis provides information concerning our results of operations andfinancial condition.  This discussionshould be read in conjunction with the accompanying consolidated financialstatements and the notes thereto.*

 

***Special Note Regarding Forward-Looking Statements***

 

*Certainstatements in this Quarterly Report on Form 10-Q constitute “forward-lookingstatements”.  When used in thisQuarterly Report, the words “expects,” “anticipates,” “estimates,” “believes,”“no assurance” and similar expressions, and statements which are made in thefuture tense, are intended to identify such forward-looking statements.  Such forward-looking statements involveknown and unknown risks, uncertainties and other factors, which may cause theCompany’s actual results, performance or achievements to be materiallydifferent from any future results, performance or achievements expressed orimplied by such forward-looking statements. Such factors include, among others, the following: the impact ofcompetition and changes to the competitive environment for the Company’sproducts and services, changes in technology, reliance on strategic partners,uncertainty of litigation, changes in government regulation and other factorsdetailed, from time to time, in the Company’s filings with the Securities andExchange Commission.  Theseforward-looking statements speak only as of the date of this QuarterlyReport.  The Company expressly disclaimsany obligation or undertaking to release publicly any updates or revisions toany forward-looking statements contained herein to reflect any change in theCompany’s expectations with regard thereto or any change in events, conditionsor circumstances on which any such statement is based.*

 

**Overview**

 

LodgeNet, a leadingprovider of broadband services to the hospitality industry, specializes in thedelivery of interactive television and Internet access services to the lodgingindustry throughout the United States, Canada and select international markets.As of March 31, 2002, the Company provided interactive and television servicesto approximately 5,500 hotel properties, more properties than any otherbroadband service provider in the world. The Company’s services include on-demand movies, music and music videos,Nintendo® video games, Internet-enhanced television, high-speed Internetaccess, and other interactive services designed to serve the needs of thelodging industry and the traveling public. The Company has installed itsinteractive television system in more than 828,000 rooms, which host more than260 million guests on an annual basis.

 

*Guest Pay Interactive Services.* Guest Payinteractive services are purchased by hotel guests on a per-view, hourly, ordaily basis and include on-demand movies, music and music videos, network-basedvideo games, Internet-enabled television, and high-speed Internet accessservices. Guest Pay packages may also include video review of room charges,video checkout, guest surveying, and merchandising services that are paid forby the hotel and provided to guests at no charge.

 

TheCompany’s Guest Pay interactive revenues depend on a number of factors,including the number of rooms equipped with the Company’s systems, hoteloccupancy rates and guest demographics, and the popularity, pricing, andavailability of programming.  Theprimary direct costs of providing Guest Pay interactive services are(i) license fees paid to studios for non-exclusive distribution rights torecently-released major motion pictures; (ii) nominal one-time licensefees paid for independent films; (iii) license fees for other interactiveservices; (iv) Internet connectivity costs; and (v) the commissionretained by the hotel.  Guest Payoperating expenses include costs of system maintenance and support, programmingdelivery and distribution, data retrieval, insurance, and personal propertytaxes.

 

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The room installations for the twelve months endedMarch 31, 2002 represent an increase of 11.3% for Guest Pay interactive roomsas compared to March 31, 2001. Additionally, digital services rooms increased 774.7% over the number ofinstalled rooms at March 31, 2001. De-installation activity is generally less than 2% of the installednumber of rooms.

 

The Company’s baseof installed rooms was comprised as follows at March 31:

 
|                            |   | **2002** |   | **2001** |   |
|---------------------------------|--------|----------|--------|----------|--------|
|                            |   |     |   |     |   |
| Guest Pay interactive rooms (1) |   | 828,650  |   | 744,587  |   |
| Digital services rooms (2)      |   | 143,177  |   | 16,368   |   |
| Total rooms served (3)          |   | 908,487  |   | 832,899  |   |

 

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(1) – 100% of Guest Payinteractive rooms are served by the Company’s on-demand movie system (ascompared to basic cable and free-to-guest systems that show movies atpredetermined times and rooms served by international licensees).

 

(2) – Digital servicesrooms are equipped with the Company’s newinteractive digital systems that store content such as on-demand movies andmusic on file servers and are updated and delivered via satellite to theCompany’s system within the hotel. Digital rooms are included with the total Guest Pay interactive roomsand represent 17.3% of the Guest Pay interactive rooms served.

 

(3) – Total rooms servedrepresent rooms receiving one or more of the Company’s services, includingrooms served by international licensees.

 

*Free-to-Guestand Other Services.* In addition to Guest Pay interactive services, theCompany provides satellite-delivered basic and premium cable televisionprogramming for which the hotel, rather than its guests, pays the charges.  The hotel pays the Company a fixed monthlycharge per room for each programming channel provided. The Company obtains itsfree - to - guest programming pursuant to multi - year agreements and pays amonthly fee per room, which varies depending on incentive programs in effectfrom time to time.

 

To meet the needs of its hotel customers related to the Company’sservice offerings, the Company provides a variety of other services to itshotel customers, including the sale of system equipment and service parts andlabor.  Results from these other servicesand free-to-guest services delivered to rooms not receiving Guest Payinteractive services are included in the “other” components of revenues anddirect costs related to such revenues are included in the statements ofoperations.

 

11

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*InnMediaLLC.*  During the fourth quarter of 2000, theCompany entered into an arrangement with Hilton Hotels Corporation to form anew broadband, interactive media company, InnMedia LLC.    Under the agreements entered into betweenthe Company and InnMedia, InnMedia would supply Internet portal and certaininteractive television content to LodgeNet for distribution to subscribinghotels using LodgeNet’s broadband, interactive system for which it is requiredto pay LodgeNet a fee for the use of LodgeNet’s system.  The arrangement included a $5 million equityfunding commitment from LodgeNet and a $5 million equity funding commitmentfrom Hilton to fund start-up and near-term operational costs.  These funding commitments have beensatisfied.  The Company has a 47.5% equityinterest in InnMedia and accounts for its investment using the equity method ofaccounting.  For the three months endedMarch 31, 2002, the Company recorded equity losses of $167,000, the balance ofthe Company’s investment in InnMedia.

 

On April 12, 2002, the Company terminated its Distribution and CarriageAgreement, dated October 9, 2000, and its Services Agreement date October 9,2000 with InnMedia.  The terminationsfollowed the institution of legal proceedings by InnMedia against the Company,as described in Part II – Legal Proceedings. The agreements were terminated due to, among other things, InnMedia’srepudiation of the agreements and InnMedia’s failure to perform.  As a result of the dispute with InnMedia,the Company has continued to incur the costs associated with the provision ofInnMedia’s programming, but has not recognized corresponding revenues.  As a result, the Company reserved $900,000for uncollectable receivables, recorded additional expenses of $345,000 againstoperating results, and recorded an equity loss for its remaining investmentbalance of $167,000 in the first quarter of 2002.  As of March 31, 2002, the Company had a receivable balance fromInnMedia of approximately $2.7 million and a payable to InnMedia ofapproximately $1.2 million.

 

Due to the dispute with InnMedia, Hilton may assert it has a right toterminate its agreements based on the Company's alleged breach of the InnMediaagreements.  While the Company believessuch an action is not authorized under the agreement with Hilton, if Hiltonwere to assert such a claim, it might nevertheless jeopardize the currentinstalled base of approximately 21,000 Hilton owned hotel rooms.  Furthermore, if Hilton attempts to terminateits agreement, Hilton managed and franchised hotels may each assert that theircontracts are also terminable based on the alleged breach of the InnMediaagreements, which could jeopardize approximately an additional 22,000 Hiltonfranchised and 7,000 Hilton managed rooms. These Hilton owned, managed and franchisedhotel rooms represent less than 6% of the Company's room base as of March 31,2002.  In addition, the Companyestimates that over the next four years, there are approximately 160,000 roomsowned, managed and franchised by Hilton that could be available for serviceunder the agreement with Hilton.  Adispute with Hilton could also impact the ability to secure these rooms forservice, could have a material adverse effect on our current and futurecustomer base and result in a reduction of revenues.

 

In addition, the Company currently serves approximately 90,000 roomswith interactive content and Internet access that has been sourced fromInnMedia.  At this time, the Company isnot certain if and how it will secure replacement content.  Any interruption in the distribution of thiscontent could affect the Company's relationships with these properties andcould have a material adverse effect on the current and future customer baseand could result in a reduction in revenues.

 

**Critical Accounting Policies**

 

*Propertyand Equipment***—**Propertyand equipment is stated at cost, net of accumulated depreciation andamortization.  Installed Guest Pay andfree-to-guest systems consist of equipment and related costs of installation,including certain payroll costs. Maintenance costs, which do not significantly extend the useful lives ofthe respective assets, and repairs are charged to operations as incurred.  Depreciation of Guest Pay and free-to-guestsystems begins when such systems are installed and activated.  Depreciation of other equipment begins whensuch equipment is placed in service. The Company attributes no salvage value toequipment. Depreciation and amortization is computed using the straight-linemethod over the following useful lives, not to exceed the life of a contract:

 
|                |   | **Years** |   |
|---------------------|--------|-----------|--------|
| Buildings           |   | 30        |   |
| Guest Pay  systems: |   |      |   |
| System  components  |   | 5 - 7     |   |
| In-room  equipment  |   | 2 - 5     |   |
| Other equipment     |   | 3 - 10    |   |

 

*SoftwareDevelopment***—**TheCompany has capitalized certain costs of developing software for its Guest Paysystems in accordance with AICPA Statement of Position 98-1, “Accounting forthe Costs of Computer Software Developed or Obtained for Internal Use”.  Capitalized costs are reported at the lowerof unamortized cost or net realizable value, and are amortized over thesystem’s estimated useful life, not to exceed five years.  During the first quarter of 2002, Guest Paysystem development costs capitalized was $507,000 and amortization of such costwas $410,000.  The Company charged$258,000 to operations for the three months ended March 31, 2002 related toresearch and development activities.

 

*RevenueRecognition***—**InDecember 1999, the SEC staff released Staff Accounting Bulletin No. 101,“Revenue

 

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Recognition in Financial Statements” (“SAB 101”).  SAB 101 provides interpretive guidance onthe recognition, presentation and disclosures of revenue in the financialstatements effective for all transactions beginning January 1, 2000.  Adoption of SAB 101 did not impact theCompany’s revenue recognition policies.

 

Revenue from the sale of interactive television services is recognizedin the period the services are provided. Revenue from the sale of system equipment and service parts and labor isrecognized when the equipment is delivered or the service has beenprovided.  Deferred revenue consists ofadvance billings for certain interactive television services that arerecognized in the periods that services are provided.

 

**Discussionand Analysis of Results of Operations**

**Three Months Ended March 31, 2002 and2001**

 

*Revenue Analysis*.  TheCompany’s total revenue for the first quarter of 2002 increased 7.8%, or $4.0million, in comparison to the first quarter of 2001.  The following table sets forth the components of revenue (inthousands) for the quarter ending March 31:

 
|      |   | **2002**   |   | **2001**                       |   |
|-----------|--------|------------|--------|--------------------------------|--------|
|      |   | **Amount** |   | **Percent  of Total  Revenue** |   | **Amount** |   | **Percent  of Total  Revenue** |   |
| Revenue:  |   |       |   |                           |   |   |   |   |   |   |   |
| Guest Pay |   | $          | 52,637 |                           | 95.7   |   | $ | 48,781 |   | 95.6 |   |
| Other     |   | 2,372      |   | 4.3                            |   | 2,257 |   | 4.4 |   |
|      |   | $          | 55,009 |                           | 100.0  |   | $ | 51,038 |   | 100.0 |   |

 

Guest Pay interactiverevenue increased 7.9% or $3.9 million, in the first quarter of 2002 incomparison to the same quarter of 2001. ** **Thisincrease was attributable to a 11.9% increase in the average number of installedGuest Pay interactive rooms, offset by a 3.6% decrease in average monthlyrevenue per room.  The following tablesets forth information in regard to average monthly revenue per Guest Pay roomfor the quarter ending March 31:

 
|                               |   | **2002** |   | **2001** |   |
|------------------------------------|--------|----------|--------|----------|--------|
| Average monthly revenue per room:  |   |     |   |     |   |
| Movie revenue                      |   | $        | 17.04  |     | $      | 18.03 |   |
| Other interactive service  revenue |   | 4.41     |   | 4.21     |   |
| Total per Guest Pay room           |   | $        | 21.45  |     | $      | 22.24 |   |

 

Average movie revenue perroom decreased 5.5% due to a 300 basis point decrease in occupancy levels,partially offset by a 4.8% increase to other Guest Pay interactive services,driven by expanding revenue from digital music and music videos, cabletelevision programming services and other interactive TV services.

 

Revenue from other sources includes revenue from free-to-guest servicesprovided to hotels not receiving Guest Pay services and sales of systemequipment and service parts and labor. Other revenue increased $115,000 or 5.1%due to increased equipment sales to international licensees.

 

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*Gross Profit.*  Gross profittotaled $32.4 million for the first quarter ended March 31, 2002, an increaseof 7.8% over the first quarter of 2001.

 
|                 |   | **2002** |   | **2001** |   |
|----------------------|--------|----------|--------|----------|--------|
| Gross profit:        |   |     |   |     |   |
| Guest Pay            |   | $        | 31,276 |     | $      | 29,132 |   |
| Other                |   | 1,091    |   | 883      |   |
|                 |   | $        | 32,367 |     | $      | 30,015 |   |
|                 |   |     |   |     |   |
| Gross profit margin: |   |     |   |     |   |
| Guest Pay            |   | 59.4     | %      | 59.7     | %      |
| Other                |   | 46.0     | %      | 39.1     | %      |
| Composite            |   | 58.8     | %      | 58.8     | %      |

 

Gross profit on Guest Payinteractive services increased 7.4%, or $2.1 million, on a 7.9% increase inrelated revenue.  Guest Pay direct costs(primarily studio license fees, license fees for other interactive services,Internet connectivity fees, and the commission retained by the hotel) are primarilybased on related revenue, and such costs generally vary directly withrevenue.  As a percentage of revenue,the decrease to gross profit margin from 59.7% to 59.4% was primarily due tothe shift from sales of higher margin Guest Pay interactive services to lowermargin free-to-guest and Internet services.

 

Gross profit on otherservices increased $208,000 or 23.6% in the first quarter of 2002 from theprior year quarter and the gross profit margin increased from 39.1% to46.0%.  These increases were due to lower costs related to cable programming services,which resulted from favorable pricing and incentive arrangements.

 

As a percentage ofrevenue, the Company’s overall gross profit margin of 58.8% was equal to prioryear quarter. The nominal decreases in gross margin from Guest Pay interactiveservices were offset by increases in other gross margin as described above.

 

*Operating Expenses.*  The followingtable sets forth information in regard to the Company’s operating expenses forthe quarter ending March 31 (dollar amounts in thousands):

 
|                                 |   | **2002**   |   | **2001**                        |   |
|--------------------------------------|--------|------------|--------|---------------------------------|--------|
|                                 |   | **Amount** |   | **Percent  of Total  Revenues** |   | **Amount** |   | **Percent  of Total  Revenues** |   |
| Operating expenses:                  |   |       |   |                            |   |   |   |   |   |
| Guest Pay operations                 |   | $          | 6,993  |                            | 12.7   |   | $ | 7,344 |   | 14.4 |   |
| Selling, general and  administrative |   | 5,760      |   | 10.5                            |   | 5,294 |   | 10.4 |   |
| Depreciation and amortization        |   | 18,393     |   | 33.4                            |   | 16,501 |   | 32.3 |   |
| Total operating expenses             |   | $          | 31,146 |                            | 56.6   |   | $ | 29,139 |   | 57.1 |   |

 

Guest Pay operations expenses consist of costs directly related to theoperation of systems at hotel sites. The decrease in Guest Pay operationsexpenses of $351,000 or 4.8% from the prior year quarter was due primarily toimproved cost controls and greater operating efficiencies.  Per average installed room, Guest Payoperations expenses were $2.85****per month in the first quarter of 2002 ascompared to $3.35 per month in the first quarter of 2001.

 

Selling, general and administrative expensesincreased $466,000 or 8.8% in the first quarter of 2002 compared to the yearearlier quarter primarily due to the $900,000 increase in bad debt reserverelated to InnMedia offset by cost containments in outside professional feesand compensation related expenses.

 

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Depreciationand amortization expenses increased 11.5% to $18.4 million in the first quarterof 2002 from $16.5 million in the year earlier quarter.  This increase was due to the 11.9% increasein the average number of rooms in operation. Additionally, the associated software costs and other capitalized costsincluding service vans, equipment, and computers that are related to theincreased number of rooms in service since the prior year.  As a percentage of revenue, depreciation andamortization expenses increased to 33.4% in the current quarter from 32.3% inthe first quarter of 2001.

 

*Operating Income.*  As a resultof increased revenue from Guest Pay interactive services and decreasedoperating expenses as a percent of revenue, the Company generated operatingincome of $1.2 million in the first quarter of 2002 compared to $876,000 in thefirst quarter of 2001.

 

*InvestmentGains (Losses)*.  Prior to the second quarter of 2001, theCompany owned a minority interest in Global Interactive CommunicationsCorporation (“GICC”) resulting from the merger transaction involving ResNetCommunications LLC (formerly the Company’s majority-owned subsidiary) in 1998. In the second quarter of 2001, the Company transferred its equityinterest in GICC back to GICC and has no further financing obligation toGICC.  As of December 31, 2001,the Company had an investment balance in GICC of $316,000.  Duringthe first quarter of 2002, the Company received $763,000 from GICC andrecognized an investment gain of $447,000. The Company recorded an equity loss for its remaining investment balancein InnMedia LLC of $167,000 in the first quarter of 2002.

 

*Interest Expense.*  Interestexpense increased $995,000 or 14.0%, to $8.1 million during the first quarterof 2002 due to increases in long-term debt to fund the Company’s continuingexpansion of its digital platform.  Averageprincipal amount of long-term debt outstanding during the quarter ended March31, 2002 was approximately $328 million (at an average interest rate ofapproximately 9.9%) as compared to an average principal amount outstanding ofapproximately $292 million****(at an average interest rate ofapproximately 9.8%) during the comparable period of 2001.

 

*Net Loss.*  For thereasons previously described, the Company’s net loss decreased to $6.7 millionin the first quarter of 2002 from a net loss of $6.8 million in the prior yearquarter.

 

*EBITDA.*  EBITDA (defined by the Company as earnings beforeinterest, income taxes, depreciation, amortization and other non-operatingincome or expenses) increased 12.9% to $19.6 million in the first quarter of2002 as compared to $17.4 million in the prior year quarter.  This increase is primarily due to an 11.9%increase in the average number of installed rooms receiving Guest Payinteractive services, the related increase in Guest Pay revenue driven by thedigital platform, and greater operating efficiencies as described above.  As a percentage of total revenue, EBITDAincreased to 35.7% in the current quarter compared to 34.0% in the prior yearquarter.

 

EBITDA is notintended to represent an alternative to net income or cash flows fromoperating, financing or investing activities (as determined in accordance withgenerally accepted accounting principles) as a measure of performance, and isnot representative of funds available for discretionary use due to theCompany’s financing obligations. EBITDA, as defined by the Company, may not be calculated consistentlyamong other companies reporting similarly titled measures. EBITDA is includedherein because it is a widely accepted financial indicator used by certaininvestors and financial analysts to assess and compare companies on the basisof operating performance.  Managementbelieves that EBITDA provides an important additional perspective on theCompany’s operating results and the Company’s ability to service its long-termdebt and to fund the Company’s continuing growth.

 

 

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**Recent Accounting Developments**

 

See Note 6 in the notesto consolidated financial statements.

 

**Seasonality**

 

The Company’squarterly operating results are subject to fluctuation depending upon hoteloccupancy rates and other factors. Typically, occupancy rates are higher during the second and thirdcalendar quarters due to seasonal travel patterns.

 

**Liquidity and Capital Resources**

 

Historically, the growth of the Company’s business has requiredsubstantial amounts of capital.  TheCompany has incurred operating and net losses due in large part to thedepreciation, amortization and interest expenses related to the capital requiredto expand its business.  Historically,cash flow from operations has not been sufficient to fund the cost of expandingthe Company’s business and to service existing indebtedness.  For 2001, net cash flow from operations wassufficient enough to cover all debt service as well as capital expendituresclassified as renewal, general corporate, maintenance capital and a portion ofgrowth capital. The funding of the remaining portion of growth capitalexpenditures was provided by the Company’s bank facility. For 2001, capitalexpenditures were $78.4 million and net cash provided by operating activitieswas $46.5 million.  During the firstquarter of 2002, capital expenditures were $18.8 million as compared to $17.9million in the first quarter of 2001. Net cash provided by operating activities was $11.2 million as comparedto $13.3 million in the same period of 2001.

 

Depending on the rate of growth of its business and other factors, theCompany expects to incur capital expenditures of $73 to $75 million in 2002 ascontemplated under its 2002 business plan. The Company’s cash requirements for 2002 include $7.6 million ofpayments for principal maturities of long-term debt.  The Company was in compliance with all covenants related to itsbank debt and its Senior notes as of March 31, 2002.

 

The Companybelieves that its operating cash flows and borrowings available under therevolving credit facility will be sufficient to fund the Company’s futuregrowth, financing obligations, and its negative working capital, ascontemplated under its 2002 business plan. However, if operating cash flows are significantly below the amountanticipated in its current business plan, the Company would cover the shortfall through any combination of additional borrowings available under itscurrent revolving credit facility and a reduction in capital spending.  The Company also believes that it willcontinue to be in compliance with the covenants contained within the bankfacility and the Senior notes.

 

The foregoing statements regarding capital expenditures and cash requirementsare forward-looking statements and there can be no assurance in thisregard.  The actual amount and timing ofthe Company’s capital expenditures and liquidity needs will vary (and suchvariations could be material) depending upon the number of new contracts forservices entered into by the Company, the cost of installations and otherfactors.

 

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*Obligations and Commitments.*

 
|                          |   |      |    | **Payments due by period** |   |
|-------------------------------|--------|-----------|---------|----------------------------|--------|
|                          |   | **Total** |    | **Less than  1 year**      |   | **1**–**3  years** |   | **4**–**5  years** |   | **Over  5 years** |   |
| Contractual obligations:      |   |      |    |                       |   |   |   |   |   |   |   |
| Long-term debt(s)             |   | $         | 330,242 |                       | $      | 8,332 |   | $ | 15,000 |   | $ | 306,910 |   | 3⁄4 |   |
| Capital lease obligations     |   | 1,615     |    | 626                        |   | 891 |   | 98 |   | 3⁄4 |   |
| Operating leases              |   | 959       |    | 428                        |   | 402 |   | 129 |   | 3⁄4 |   |
| Total contractual obligations |   | $         | 332,816 |                       | $      | 9,386 |   | $ | 16,293 |   | $ | 307,137 |   | 3⁄4 |   |

 
|                          |   |      |   | **Amount of commitment expiration per  period** |   |
|-------------------------------|--------|-----------|--------|-------------------------------------------------|--------|
|                          |   | **Total** |   | **Less than  1 year**                           |   | **1**–**3  years** |   | **4**–**5  years** |   | **Over   5 years** |   |
| Other commercial commitments: |   |      |   |                                            |   |   |   |   |   |   |   |
| Standby letters of credit     |   | $         | 2,000  |                                            | $      | 2,000 |   | 3⁄4 |   | 3⁄4 |   | 3⁄4 |   |
|                               |        |           |        |                                                 |        |  |  |  |  |  |  |  |  |

 

**September 11th Impact**

 

The tragic events of September 11th and the general economicclimate continue to have an adverse effect on the overall travel industry.Occupancy rates from the properties served by the Company were 300 basis pointsbelow the same period last year. While all hotel properties remain affected,occupancy declines remain more pronounced in the urban and airport typeproperties, as defined by Smith Travel Research.  Properties defined as highway and suburban properties were lessimpacted. While the average occupancy rate for the Company’s served hotels istypically higher than the average of the entire lodging industry, the Company’sbusiness is clearly linked to the continued effects of changes in occupancy levels.

 

Geographically, the Company’s room base is diversified with more thantwo-thirds of properties served being in highway or suburban locations. Inaddition, less than 5% of the room base is concentrated in the top ten urbanareas of the United States. By serving a wide variety of geographicallydispersed properties, the Company mitigates reliance on any one geographicsector.

 

Since the initial decline, occupancy rates have been improving butremain below the levels experienced in the prior year. During the secondquarter of 2002, occupancy rates are forecasted to continue improving but areexpected to remain below the levels of the second quarter of 2001.

 

To help mitigate the affect of occupancy levels on operating profit andEBITDA, the Company continues to firmly control operating expenses and capitalspending.  The Company plans to reassessits operating and capital expenditure plans periodically to respond to changesin the economic environment.

 

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**Item 3 — Quantitative and Qualitative Disclosures AboutMarket Risk**

 

The Company is exposed to various market risks, including potentiallosses resulting from adverse changes in interest rates and foreign currencyexchange rates. The Company does not enter into derivatives or other financialinstruments for trading or speculative purposes.

 

*Interest.* At March 31, 2002, the Company had debttotaling $332 million.  The Company hasinterest rate swap arrangements covering debt with a notional amount of $150 millionto effectively change the underlying debt from a variable interest rate to afixed interest rate for the term of the swap agreements.  After giving effect to the interest rateswap arrangements the Company had fixed rate debt of $283 million and variablerate debt of $49 million at March 31, 2002. For fixed rate debt, interest rate changes affect the fair market valuebut do not impact earnings or cash flows. Conversely, for variable rate debt, interest rate changes generally donot affect the fair market value but do impact future earnings and cash flows,assuming other factors are held constant. Assuming other variables remainconstant (such as debt levels), a one percentage point increase in interestrates would decrease the unrealized fair market value of the fixed rate debt byan estimated $25.4 million.  The impacton earnings and cash flow for the next year resulting from a one percentagepoint increase in interest rates would be approximately $493,000 assuming othervariables remain constant.

 

*ForeignCurrency Transactions.*  A portionof the Company’s revenues are derived from the sale of Guest Pay services inCanada.  The results of operations andfinancial position of the Company’s operations in Canada are measured inCanadian dollars and translated into U.S. dollars.  The effects of foreign currency fluctuations in Canada aresomewhat mitigated by the fact that expenses and liabilities are generallyincurred in Canadian dollars. The reported income of the Company’s Canadiansubsidiary will be higher or lower depending on a weakening or strengthening ofthe U.S. dollar against the Canadian dollar. In addition, a portion of the Company’s assets are based in Canada andare translated into U.S. dollars at foreign currency exchange rates in effectas of the end of each period. Accordingly, the Company’s consolidated assets will fluctuate dependingon the weakening or strengthening of the U.S. dollar against the Canadiandollar.  No significant foreign currencyfluctuations occurred in the first quarter of 2002 to materially impactconsolidated results of operations or financial condition.

 

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**PartII — Other Information**

 

**Item 1 — Legal Proceedings**

 

On April 11, 2002, InnMedia LLC, a joint venture of which the Companyowns 47.5% of the equity interest, filed a complaint in the Superior Court ofthe State of California, County of Los Angeles alleging that the Companybreached the Distribution and Carriage Agreement and Services Agreement betweenthe Company and InnMedia.  The complaintfurther alleged that the Company breached the implied covenant of good faithand fair dealing between the parties; that the Company improperly retainedmonies owed to InnMedia; that the Company committed fraud in connection withthe Distribution and Carriage Agreement and the Services Agreement between theCompany and InnMedia; that the Company unjustly enriched itself at InnMedia’sexpense; that the Company breached its fiduciary duty to InnMedia; and that theCompany violated California's business and professions code.  The complaint alleges damages in excess of$425 million.

 

On April 12, 2002, the Company terminated the Distribution and CarriageAgreement and the Services Agreement, based on InnMedia’s effective repudiationof the agreements and InnMedia’s failure to perform.  The Company intends to vigorously defend itself and to availitself of all legal and equitable remedies and counterclaims available to it.  The Company may incur significant legalcosts in defending itself and in pursuing its own remedies andcounterclaims.  As of the date of thefiling of this Report on Form 10-Q, the Company had not filed an answer to thecomplaint or any counterclaims.

 

As of the date of the filing of this Report on Form 10-Q, the Companycontinues to provide distribution of InnMedia’s content and certain services toInnMedia on an interim basis and is exploring settlement discussions.   Nevertheless, no assurance can be giventhat the litigation will be settled, or will be settled in a timely manner.

 

**Item2 — Changes in Securities and Use of Proceeds**

 

Not applicable.

 

**Item3 — Defaults Upon Senior Securities**

 

Not applicable.

 

**Item4  — Submission of Matters to a Vote ofSecurity Holders**

 

There were no matters submitted to a vote of securityholders during the quarter ended March 31, 2002.

 

**Item5 — Other Information**

 

Not applicable.

 

**Item6 — Exhibits and Reports on Form 8-K**

 

**a.****              ****Exhibits:**

 

None

**b. Reports on Form 8-K:**

 

The Company filed no Reports on Form 8-K during thequarter ended March 31, 2002.

 

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**LodgeNet Entertainment Corporation**

 

**Signatures**

 

 

Pursuant to the requirements of the Securities andExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                      |   | **LodgeNet  Entertainment Corporation**        |   |
|---------------------------|--------|------------------------------------------------|--------|
|                      |   | (Registrant)                                   |   |
|                      |   |                                           |
|                      |   |                                           |
| Date:  May  13, 2002 |   | **/ s  /  Scott C. Petersen**             |   |
|                      |   | Scott C. Petersen                              |
|                      |   | President and Chief Executive Officer          |
|                      |   | (Principal Executive Officer)                  |
|                      |   |                                           |
|                      |   |                                           |
| Date:  May  13, 2002 |   | **/ s  /  Gary H. Ritondaro**             |   |
|                      |   | Gary H. Ritondaro                              |
|                      |   | Senior Vice President, Chief Financial Officer |
|                      |   | (Principal Financial & Accounting Officer) |

 

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