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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q þ
    
    Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the quarterly period ended March 31, 2005 or o
    
    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 Entertainment Corporation 
  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 
     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 þ No o. Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Act). Yes þNo o. At May 2, 2005, there were 17,946,123 shares outstanding of the Registrants common stock,
$0.01 par value.




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LodgeNet Entertainment Corporation and Subsidiary Index  
 PageNo.Part I. Financial InformationItem 1  Financial Statements:Consolidated Balance Sheets (Unaudited) as of March 31, 2005 and December 31, 2004
    
    
    3Consolidated Statements of Operations (Unaudited) for
the Three Months Ended March 31, 2005 and 2004
    
    
    4Consolidated Statements of Cash Flows (Unaudited) for
the Three Months Ended March 31, 2005 and 2004
    
    
    5Notes to Consolidated Financial Statements (Unaudited)
    
    
    6Item 2  Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    12Item 3  Quantitative and Qualitative Disclosures About Market Risk
    
    
    24Item 4  Controls and Procedures
    
    
    25Part II. Other InformationItem 1  Legal Proceedings
    
    
    26Item 2  Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    26Item 3  Defaults Upon Senior Securities
    
    
    26Item 4  Submission of Matters to a Vote of Security Holders
    
    
    26Item 5  Other Information
    
    
    26Item 6  Exhibits
    
    
    26Signatures
    
    
    27Rule 13a-14(a)/15(d)-14(a) Certification of CFORule 13a-14(a)/15(d)-14(a) Certification of CEOSection 1350 Certifications
   
    LodgeNet, the LodgeNet logo, SigNETure TV, SigNETure PC, Hotel SportsNET, and
TechConnection are service marks or registered trademarks of LodgeNet Entertainment Corporation;
all other trademarks or service marks used herein are the property of their respective owners.  March 31, 2005
    
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Part I  Financial Information 
 Item 1  Financial Statements 
 LodgeNet Entertainment Corporation and Subsidiary
Consolidated Balance Sheets (Unaudited)
(Dollar amounts in thousands, except share data) March 31, 2005
    
    
    December 31, 2004AssetsCurrent assets:Cash and cash equivalents
    
    $
    32,881
    
    
    $
    24,995Accounts receivable, net
    
    
    29,433
    
    
    
    28,031Prepaid expenses and other
    
    
    1,909
    
    
    
    1,959Total current assets
    
    
    64,223
    
    
    
    54,985Property and equipment, net
    
    
    208,453
    
    
    
    212,659Debt issuance costs, net
    
    
    8,915
    
    
    
    9,330Intangible assets, net
    
    
    3,973
    
    
    
    4,628Other assets
    
    
    1,317
    
    
    
    1,434Total assets
    
    $
    286,881
    
    
    $
    283,036Liabilities and Stockholders DeficiencyCurrent liabilities:Accounts payable
    
    $
    17,037
    
    
    $
    16,807Current maturities of long-term debt
    
    
    2,835
    
    
    
    2,543Accrued expenses
    
    
    17,343
    
    
    
    12,738Deferred revenue
    
    
    4,604
    
    
    
    4,364Total current liabilities
    
    
    41,819
    
    
    
    36,452Long-term debt
    
    
    309,887
    
    
    
    309,748Other long-term liability
    
    
    3,154
    
    
    
    3,154Derivative instruments
    
    
    4,475
    
    
    
    5,800Total liabilities
    
    
    359,335
    
    
    
    355,154Commitments and contingenciesStockholders deficiency:Preferred stock, $.01 par value, 5,000,000 shares authorized;
no shares issued or outstandingCommon stock, $.01 par value, 50,000,000 shares authorized;
17,829,186 and 17,625,364 shares outstanding at March 31,
2005 and December 31, 2004, respectively
    
    
    178
    
    
    
    176Additional paid-in capital
    
    
    229,093
    
    
    
    226,986Accumulated deficit
    
    
    (300,952
    )
    
    
    (297,348
    )Accumulated other comprehensive loss
    
    
    (773
    )
    
    
    (1,932
    )Total stockholders deficiency
    
    
    (72,454
    )
    
    
    (72,118
    )Total liabilities and stockholders deficiency
    
    $
    286,881
    
    
    $
    283,036
 The accompanying notes are an integral part of these consolidated financial statements.  March 31, 2005
    
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##### Table of Contents



LodgeNet Entertainment Corporation and Subsidiary
Consolidated Statements of Operations (Unaudited)
(Dollar amounts in thousands, except share data) Three Months Ended March 31,2005
    
    
    2004Revenues:Guest Pay
    
    $
    64,152
    
    
    $
    62,323Other
    
    
    1,837
    
    
    
    1,508Total revenues
    
    
    65,989
    
    
    
    63,831Costs and Expenses:Direct costs
(exclusive of operating expenses and
depreciationand amortization shown separately below):Guest Pay
    
    
    28,344
    
    
    
    27,507Other
    
    
    916
    
    
    
    742Operating expenses:Guest Pay operations
    
    
    8,622
    
    
    
    8,138Selling, general and administrative
    
    
    6,072
    
    
    
    5,705Depreciation and amortization
    
    
    17,992
    
    
    
    19,668Total costs and operating expenses
    
    
    61,946
    
    
    
    61,760Income from operations
    
    
    4,043
    
    
    
    2,071Other Income and Expenses:Interest expense
    
    
    (7,454
    )
    
    
    (8,223
    )Other (expense) income
    
    
    (75
    )
    
    
    53Loss before income taxes
    
    
    (3,486
    )
    
    
    (6,099
    )Provision for income taxes
    
    
    (118
    )
    
    
    (117
    )Net loss
    
    $
    (3,604
    )
    
    $
    (6,216
    )Net loss per common share (basic and diluted)
    
    $
    (0.20
    )
    
    $
    (0.48
    )Weighted average shares outstanding (basic and diluted)
    
    
    17,679,872
    
    
    
    12,979,981
 The accompanying notes are an integral part of these consolidated financial statements.  March 31, 2005
    
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LodgeNet Entertainment Corporation and Subsidiary
Consolidated Statements of Cash Flows (Unaudited)
(Dollar amounts in thousands) Three Months Ended March 31,2005
    
    
    2004Operating activities:Net loss
    
    $
    (3,604
    )
    
    $
    (6,216
    )Adjustments to reconcile net loss to net cash provided
by operating activities:Depreciation and amortization
    
    
    17,992
    
    
    
    19,668Non-cash stock compensation
    
    
    57
    
    
    
    Change in operating assets and liabilities:Accounts receivable
    
    
    (1,417
    )
    
    
    (474
    )Prepaid expenses and other
    
    
    54
    
    
    
    (707
    )Accounts payable
    
    
    235
    
    
    
    2,304Accrued expenses and deferred revenue
    
    
    4,784
    
    
    
    3,605Other
    
    
    112
    
    
    
    100Net cash provided by operating activities
    
    
    18,213
    
    
    
    18,280Investing activities:Property and equipment additions
    
    
    (12,553
    )
    
    
    (13,201
    )Note receivable repayments
    
    
    
    
    
    
    567Net cash used for investing activities
    
    
    (12,553
    )
    
    
    (12,634
    )Financing activities:Repayment of long-term debt
    
    
    (375
    )
    
    
    (375
    )Proceeds from equipment financing
    
    
    1,022
    
    
    
    Payment of capital lease obligations
    
    
    (291
    )
    
    
    (279
    )Borrowings under revolving credit facility
    
    
    
    
    
    
    4,000Repayments of revolving credit facility
    
    
    
    
    
    
    (11,000
    )Debt issuance costs
    
    
    
    
    
    
    (367
    )Proceeds from sale of interest rate swap
    
    
    
    
    
    
    3,052Exercise of stock options
    
    
    1,870
    
    
    
    2,515Net cash provided by (used for) financing activities
    
    
    2,226
    
    
    
    (2,454
    )Effect of exchange rates on cash
    
    
    
    
    
    
    7Increase in cash and cash equivalents
    
    
    7,886
    
    
    
    3,199Cash and cash equivalents at beginning of period
    
    
    24,995
    
    
    
    2,772Cash and cash equivalents at end of period
    
    $
    32,881
    
    
    $
    5,971
 The accompanying notes are an integral part of these consolidated financial statements.  March 31, 2005
    
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LodgeNet Entertainment Corporation and Subsidiary
Notes to Consolidated Financial Statements (Unaudited) Note 1  Basis of Presentation The accompanying consolidated financial statements as of March 31, 2005 and for the three month
periods ended March 31, 2005 and 2004, 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 that the
disclosures are adequate to make the information presented herein not misleading, it is recommended
that these unaudited consolidated financial statements be read in conjunction with the more
detailed information contained in our Annual Report on Form 10-K for 2004, as filed with the
Commission. The results of operations for the three-month periods ended March 31, 2005 and 2004
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 Entertainment Corporation
and its wholly-owned subsidiary. All significant inter-company accounts and transactions have been
eliminated in consolidation. We manage our operations as one reportable segment. Note 2  Share-Based Compensation We measure compensation costs associated with our stock option plans using the intrinsic value
method. Accordingly, compensation costs for stock options are measured as the excess, if any, of
the quoted market price of our stock at the date of grant over the amount an employee must pay to
acquire the stock. Had compensation costs been determined based on the fair value methodology at
the date of grant for awards, net loss and loss per share would have changed to the pro forma
amounts as follows for the periods ended March 31 (in thousands of dollars, except per share
amounts): Three Months EndedMarch 31,2005
    
    
    2004Net loss, as reported
    
    $
    (3,604
    )
    
    $
    (6,216
    )Add: stock based employee compensation expense
determined under fair value method, net of related
tax effects
    
    
    (716
    )
    
    
    (976
    )Less: stock based employee compensation expense
included in reported net loss, net of related
tax effects
    
    
    57
    
    
    
    57Net loss, pro forma
    
    $
    (4,263
    )
    
    $
    (7,135
    )Loss per share (basic and diluted)As reported
    
    $
    (0.20
    )
    
    $
    (0.48
    )Pro forma
    
    
    (0.24
    )
    
    
    (0.55
    )
 In January 2005 and 2004, we awarded 21,500 and 22,500 shares, respectively, of restricted stock to
executive officers pursuant to our 2003 Stock Option and Incentive Plan. The shares vest over four
years from the date of grant with 50% vested at the end of year three and 50% at the end of year four. The fair value of
the restricted shares  March 31, 2005
    
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on the date of grant is amortized ratably over the vesting period. As result
of these transactions, we recorded compensation expense of $57,000 and $30,000, respectively,
during the quarters ended March 31, 2005 and 2004. Note 3  Property and Equipment, Net Property and equipment was comprised as follows (in thousands of dollars): March 31,
    
    
    December 31,2005
    
    
    2004Land, building and equipment
    
    $
    81,195
    
    
    $
    80,956Free-to-guest equipment
    
    
    33,351
    
    
    
    32,753Guest Pay systems:Installed system costs
    
    
    441,501
    
    
    
    450,495Customer acquisition costs
    
    
    51,853
    
    
    
    50,869System components
    
    
    24,367
    
    
    
    25,466Software costs
    
    
    20,689
    
    
    
    20,393Total
    
    
    652,956
    
    
    
    660,932Less  depreciation and amortization
    
    
    (444,503
    )
    
    
    (448,273
    )Property and equipment, net
    
    $
    208,453
    
    
    $
    212,659
 The decrease in Guest Pay installed system costs was due to the retirement of fully depreciated
assets, approximately $18.8 million, offset by approximately $9.7 million of asset additions. Note 4  Intangible Assets We have intangible assets consisting of certain acquired technology, patents, trademarks and
licensee fees. We account for these assets in accordance with SFAS No. 142, Goodwill and Other
Intangible Assets. The intangible assets have been deemed to have definite useful lives and are
amortized over their current estimated useful lives ranging from three to five years. We have the following intangible assets (in thousands of dollars): March 31, 2005
    
    
    December 31, 2004Carrying
    
    
    Accumulated
    
    
    Carrying
    
    
    AccumulatedAmount
    
    
    Amortization
    
    
    Amount
    
    
    AmortizationAssets subject to
amortization:Acquired technology
    
    $
    14,291
    
    
    $
    13,127
    
    
    $
    14,291
    
    
    $
    12,786Acquired intangibles
    
    
    5,774
    
    
    
    3,080
    
    
    
    5,774
    
    
    
    2,791Other
    
    
    512
    
    
    
    397
    
    
    
    512
    
    
    
    372$
    20,577
    
    
    $
    16,604
    
    
    $
    20,577
    
    
    $
    15,949
 We recorded amortization expense of $655,000 and $916,000, respectively, for the three months
ended March 31, 2005 and 2004. We estimate amortization expense for the nine months remaining in
2005 and the years ending December 31, as follows: 2005  $1,950,000; 2006  $1,313,000; 2007 
$710,000. Actual amounts may change from such estimated amounts due to additional intangible asset
acquisitions, potential impairment, accelerated amortization, or other events. Note 5  Loss Per Share Computation We follow SFAS No. 128, Earnings Per Share (EPS), which requires the computation and disclosure
of two EPS amounts, basic and diluted. Basic EPS is computed based only on the weighted average
number of common shares actually outstanding during the period. Diluted EPS is computed based on
the weighted average number of common shares outstanding plus all potentially dilutive common
shares outstanding during the period. Potential common shares that have an anti-dilutive effect
are excluded from diluted earnings per share.  March 31, 2005
    
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The loss per common share for the three months ended March 31, 2005 and 2004 is based on 17,679,872
and 12,979,981 weighted average shares outstanding during the respective periods. The increase in
shares outstanding resulted primarily from our equity offering in July of 2004. Potential dilutive
common shares were not included in the computation of diluted earnings per share because their
inclusion would be anti-dilutive. As of March 31, 2005 and 2004, the number of potential dilutive
common shares was approximately 4,540,000 and 4,570,000, respectively. Such potential dilutive
common shares consist of stock options, restricted stock and warrants. Note 6  Accrued Expenses Accrued expenses were comprised as follows (in thousands of dollars): March 31,
    
    
    December 31,2005
    
    
    2004Accrued taxes
    
    $
    3,518
    
    
    $
    3,413Accrued compensation
    
    
    4,126
    
    
    
    4,869Accrued interest
    
    
    5,851
    
    
    
    970Other
    
    
    3,848
    
    
    
    3,486$
    17,343
    
    
    $
    12,738
 The increase in accrued expenses is primarily due to the timing of interest payments on the 9.50%
senior notes. The payments occur semi-annually in June and December. Note 7  Long-term Debt and Credit Facilities Long-term debt was comprised as follows (in thousands of dollars): March 31,
    
    
    December 31,2005
    
    
    2004Bank Credit Facility:Bank term loan
    
    $
    109,750
    
    
    $
    110,125Revolving credit facility
    
    
    3⁄4
    
    
    
    3⁄49.50% senior notes
    
    
    200,000
    
    
    
    200,000Capital leases
    
    
    2,972
    
    
    
    2,166312,722
    
    
    
    312,291Less current maturities
    
    
    (2,835
    )
    
    
    (2,543
    )$
    309,887
    
    
    $
    309,748
 Bank Credit Facility3⁄4 In August 2001, we entered into a $225.0 million bank Credit Facility,
comprised of a $150.0 million term loan and a $75.0 million revolving credit facility that may be
increased to $100.0 million, subject to certain limitations. The term loan matures in August 2008
and quarterly repayments began in December 2001. The term loan bears interest at our option of (1)
the banks base rate plus a margin of 1.50% or (2) LIBOR plus a margin originally established at
4.00%. In January 2004, LodgeNet and the holders of the term loan amended the LIBOR pricing to be
LIBOR plus a margin of 3.50%. In April 2004, LodgeNet and the holders of the term loan executed
another amendment to establish the LIBOR pricing at LIBOR plus a margin of 2.75%. The term loan
interest rate as of March 31, 2005 was 5.84% based on LIBOR pricing. The revolving credit facility
matures in August 2007 and loans bear interest at our option of (1) the banks base rate plus a
margin of 1.00% to
1.75%, or (2) LIBOR plus a margin of 2.25% to 3.25%. As of March 31, 2005, there were no amounts
outstanding under the revolving credit facility. Loans under the Credit Facility are
collateralized by a first priority interest in all of our assets. As of March 31, 2005, we had
$68.0 million of borrowing available under the revolver portion of the bank Credit Facility.  March 31, 2005
    
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The facility provides for the issuance of letters of credit up to $10.0 million, subject to
customary terms and conditions. As of March 31, 2005, we had outstanding letters of credit
totaling $2.5 million. The facility includes terms and conditions which require compliance with a material adverse effect
covenant as well as the maintenance of certain financial ratios and place limitations on capital
expenditures, additional indebtedness, liens, investments, guarantees, asset sales and certain
payments or distributions in respect of the common stock. As of March 31, 2005, we were in
compliance with all covenants, terms and conditions of the bank Credit Facility. Our consolidated
leverage ratio was 3.47 compared to the maximum allowable of 4.25, the consolidated senior secured
leverage ratio was 1.25 compared to the maximum allowable of 2.25 and the consolidated interest
coverage ratio was 2.83 compared to the minimum allowable of 2.50. 9.50% Senior Notes3⁄4 In June 2003, we issued $200.0 million of unsecured 9.50% Senior
Subordinated Notes (the 9.50% Notes), due June 15, 2013. The 9.50% Notes are unsecured, are
subordinated in right of payment to all existing and future senior debt of LodgeNet and rank pari
passuin right of payment with any future senior subordinated indebtedness of LodgeNet. The 9.50%
Notes require semi-annual interest payments and contain covenants which restrict our ability to
incur additional indebtedness, create liens, pay dividends or make certain distributions with
respect to our common stock, redeem capital stock, issue or sell stock of subsidiaries in certain
circumstances, effect certain business combinations and effect certain transactions with affiliates
or stockholders. As of March 31, 2005, we were in compliance with all covenants, terms, and
conditions of the 9.50% Notes. The 9.50% Notes are redeemable at our option, in whole or in part, on or after June 15, 2008,
initially at 104.75% of their principal amount (plus accrued and unpaid interest), declining
ratably to 100% of their principal amount (plus accrued and unpaid interest) on or after June 15,
2011. At any time prior to June 15, 2006, we may redeem up to 35% of the aggregate principal
amount at 109.50% of the principal amount (plus accrued and unpaid interest) with the cash proceeds
of certain equity offerings. Capital Leases As of March 31, 2005, we have total capital lease obligations of $2,972,000.
Equipment acquired under capital lease arrangements during the three months ended March 31, 2005
totaled $1,099,000 and $657,000 during the year ended December 31, 2004. Long-term debt has the following scheduled annual maturities for the twelve months ended March 31
(in thousands of dollars): 2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    ThereafterLong-term debt
    
    $
    1,500
    
    
    $
    1,500
    
    
    $
    1,500
    
    
    $
    105,250
    
    
    $
    
    
    
    $
    200,000Capital leases
    
    
    1,496
    
    
    
    1,072
    
    
    
    584
    
    
    
    86
    
    
    
    
    
    
    
    2,996
    
    
    
    2,572
    
    
    
    2,084
    
    
    
    105,336
    
    
    
    
    
    
    
    200,000Less amount
representing
interest on
capital leases
    
    
    (161
    )
    
    
    (78
    )
    
    
    (25
    )
    
    
    (2
    )
    
    
    
    
    
    
    $
    2,835
    
    
    $
    2,494
    
    
    $
    2,059
    
    
    $
    105,334
    
    
    $
    
    
    
    $
    200,000
 We do not utilize special purpose entities or off-balance sheet financial arrangements.  March 31, 2005
    
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Note 8 3⁄4 Comprehensive Loss Statement of Financial Accounting Standard No. 130, Reporting Comprehensive Income, provides
standards for reporting and disclosure of comprehensive loss and its components. Comprehensive
loss reflects the changes in equity during a period from transactions and other events and
circumstances. Comprehensive loss was as follows for the periods ended March 31 (in thousands of
dollars): Three Months EndedMarch 31,2005
    
    
    2004Net loss
    
    $
    (3,604
    )
    
    $
    (6,216
    )Foreign currency translation adjustment
    
    
    (95
    )
    
    
    (103
    )Unrealized gain on derivative
instruments
    
    
    1,254
    
    
    
    175Comprehensive loss
    
    $
    (2,445
    )
    
    $
    (6,144
    )
 Components of accumulated other comprehensive loss as shown on our consolidated balance sheets were
as follows (in thousands of dollars): March 31,
    
    
    December 31,2005
    
    
    2004Unrealized loss on derivative instruments
    
    $
    (2,158
    )
    
    $
    (3,412
    )Foreign currency translation adjustment
    
    
    1,385
    
    
    
    1,480Accumulated other comprehensive loss
    
    $
    (773
    )
    
    $
    (1,932
    )
 Note 9  Warrants In 1995, we issued 480,000 warrants to purchase common stock in connection with the issuance of our
11.50% Senior Notes which was repaid in July of 2004. Each warrant entitles the holder to purchase
one share of common stock at an exercise price of $7.00 per share. The warrants include demand
registration rights and anti-dilution provisions and expire on July 15, 2005. In January 2004, a
holder of the 11.50% Notes, exercised 240,000 warrants. On March 3, 2005, a holder of the 11.50%
Notes, exercised 80,000 warrants. As of March 31, 2005, 160,000 warrants remain outstanding. Note 10 3⁄4 Effect of Recently Issued Accounting Standards In December 2004, the Financial Accounting Standards Board issued SFAS 123R, Share Based Payment.
SFAS 123R requires that the compensation cost relating to share-based payment transactions be
recognized in financial statements. That cost will be measured based on the fair value of the
equity or liability instruments issued. Public entities will be required to apply Statement 123R to
annual reporting periods that begin after June 15, 2005. We are currently evaluating this
statement and believe the adoption, effective January 1, 2006, will have an impact on our
consolidated financial statements. Based on our current Black-Scholes option valuation
assumptions, we estimate the annual expense to be $3.0 to $4.0 million. Components of this
estimate may change due to the variability of certain assumptions such as expected life and
volatility under either of the allowable Black-Scholes or Binomial pricing model. In March 2005, the FASB issued FASB Interpretation No. 47, Accounting for Conditional Asset
Retirement Obligations  An Interpretation of FASB Statement No. 143. FIN 47 concludes that an
entity is required to recognize a liability for the fair value of a conditional asset retirement
obligation when incurred if the liabilitys fair value can be reasonably estimated. FIN 47 must be
applied for periods ending after December 15, 2005. We are currently evaluating the impact of FIN
47 and believe the adoption, effective December 31, 2005, will not have an impact on our
consolidated financial statements.  March 31, 2005
    
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Note 11 3⁄4 Other Related Party Transactions As of December 31, 2004, we had an outstanding promissory note in the amount of $39,000 due from a
former officer. As of March 31, 2005, the note was paid in full.  March 31, 2005
    
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##### Table of Contents



Item 2  Managements Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis provides information concerning our results of operations and
financial condition. This discussion should be read in conjunction with the accompanying
consolidated financial statements and the notes thereto. Special Note Regarding Forward-Looking Statements Certain statements in this Quarterly Report on Form 10-Q constitute forward-looking statements.
When used in this Quarterly Report, the words expects, intends, anticipates, estimates,
believes,, goal, no assurance and similar expressions and statements which are made in the future
tense, are intended to identify such forward-looking statements. Such forward-looking statements
within the meaning of the Securities Act of 1933, as amended, and the Securities Exchange Act of
1934, as amended, are subject to risks, uncertainties, and other factors that could cause our
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, such factors include, among
others, the following: the effects of economic conditions, including in particular the economic
condition of the lodging industry, including the effects of
international crises, acts of terrorism and public health issues,
competition, demand for our products and services, programming
availability, timeliness and quality, technological
developments by competitors, developmental costs, difficulties and delays, relationships with clients and property
owners, the availability of capital to finance growth, the impact of
government regulations, government regulations, potential effects of
litigation, risks of expansion into new markets, 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 Quarterly 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 our expectations with regard thereto or any change in
events, conditions or circumstances on which any such statement is based. Executive Overview We are one of the worlds largest providers of interactive television and broadband solutions to
hotels, including resorts and casino hotels, throughout the United States and Canada, as well as
select international markets. It is estimated that, currently, more than 275 million guests each
year have access to our interactive television services, which are designed to make their stay more
enjoyable, productive and convenient, and to allow our hotel customers to provide greater guest
services and promote hotel brand loyalty. As of March 31, 2005, we provided television services to
approximately 6,000 hotel properties serving over one million rooms. During the first quarter, we continued to deliver on our strategic goal of growing our core
business while simultaneously generating net free cash flow, which we define as having cash
provided by operating activities exceeding cash used for investing. We increased our Guest Pay
room base during the quarter by more than 11,200 net new rooms and our digital room base by 32,000
rooms. Our digital system is now installed in 55% of our Guest Pay room base. We installed 18,300
gross new digital rooms during the quarter, or 7.5% more digital rooms this quarter as compared to
the first quarter last year. Total capital invested in gross new digital rooms was $6.4 million,
or 6% lower than during the firs quarter of 2004. We continued to manage and monitor capital
expenditures per new or converted room. New digital room installation costs decreased 8.1% during
the quarter to $351 per room compared to $382 per room during the first quarter of 2004, while the
cost of converting an analog room to our digital platform decreased 14.8% to $260 per room. The
reduction of the capital cost per room is a result of technological improvements, engineering
development and product segmentation. For the quarter, we generated the same level of net free cash flow as compared to the first quarter
of last year, despite a disappointing 2.5% reduction in average per room revenue and the higher
installation activities discussed above. Our balance sheet continues to improve. Cash increased $7.9 million to $32.9 million from December
31, 2004. A contributing factor to our improved balance sheet includes an increase in positive net
free cash flow. Cash
provided by operating activities exceeded cash used for investing by $5.7 million for the three
months ended March 31, 2005.  March 31, 2005
    
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Additionally, we continue to explore revenue growth opportunities with new content and products
such as SportsNet (our new PPV sports service) and more current television-on-demand programming.
We also have efforts underway which are focused on enhancing our marketing directly to the guests.
These efforts are facilitated by the capabilities of our recently released LodgeNet Media
Management System (LMMS) that can change pricing, selections and promotions based on time-of-day or
day-of-week, among other marketing to the guest efforts. Guest Pay Interactive Services.Our primary source of revenue is providing in-room, interactive
television services to the lodging industry, for which the hotel guest pays on a per-view, hourly
or daily basis. Our services include on-demand movies, network-based video games, music and music
videos, Internet on television (which does not require a laptop), and television on-demand
programming. Our total guest generated revenue depends on a number of factors, including:  
    The number of rooms equipped with our system.We can increase
revenue over time by increasing the number of rooms served by our
interactive systems. Our ability to expand our room base is
dependent on a number of factors, including the attractiveness of
our technology, service and support to hotels currently operating
without an interactive television system, newly constructed hotel
properties and hotels with expiring contracts currently served by
our competitors.  
    The variety of services offered at the hotel.Rooms equipped with
our digital system generate higher revenue than rooms equipped
with our tape-based system primarily because they offer a greater
variety of services and content choices. We plan to continue to
grow the revenue we generate per average room by the installation
of our digital system in all newly contracted rooms and by
converting selected tape-based rooms to our digital system in
exchange for long-term contract extensions.  
    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 content available for viewing.
Historically, a decrease in the availability of popular content
has from time-to-time adversely impacted revenue. Although not
completely within our control, we seek to program and promote the
most popular available content and other content to maximize
revenue and profit.  
    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 overall profit. We
establish pricing based on such things as the demographics of the
property served, the popularity of the content and general
economic conditions. Our technology enables us to measure
popularity of the content offered through our systems and make
decisions to best position such content and optimize revenue from
such content.  
    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 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 primary direct costs of providing Guest Pay interactive services are:  4
    license fees paid to major motion picture studios, which are based on a percent of
guest-generated revenue, for non-exclusive distribution rights of recently released major
motion pictures; 4
    commissions paid to our hotel customers, which are also based on a percent of
guest-generated revenue;
 4
    fixed monthly programming charges paid primarily to DIRECTV for satellite-delivered
basic and premium television programming;
 4
    internet connectivity costs;
 4
    license fees, which are based on a percent of guest-generated revenue, for television on
demand, music, music video and video games; and
 4
    one-time license fees paid for independent films, most of which are non-rated and
intended for mature audiences.
  March 31, 2005
    
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Other Services.In addition to the sales of equipment to our international markets, we continue to
promote the sale and installation of high-speed Internet equipment coupled with maintenance and
customer support services. While this is a highly competitive area, we believe we have important
advantages as a result of our existing hotel customer relationships, our nationwide field service
network, and our 24-hour call center which provides service 7 days a week. We are also offering our interactive television systems to the healthcare industry. In this
industry segment, we intend to sell our interactive systems through a sales and marketing
relationship with McKesson Corporations; through an arrangement with an independent television
equipment distributor or directly to individual healthcare facilities and earn recurring revenues
from providing service and maintenance activities. In addition, we generate revenue from the sale of content and services directly to our hotel
customers, which are generally provided free to hotel guests. Included in these services is
satellite-delivered basic and premium television programming for which the hotel pays us a fixed
monthly charge per room. We compete with local cable television operators by tailoring different
programming packages to provide specific channels desired by the hotel subscriber, which typically
reduces the overall cost to the hotel for the services provided. Key Metrics: Rooms Served One of the metrics we monitor is the growth, net of de-installations, of our Guest Pay interactive
room base. De-installation activity has not had a material effect on our growth, historically
averaging approximately 2% of total installed rooms per year. We expect de-installations to be
approximately 3.5% of our total installed rooms base for 2005 as a result of the decision by a Red
Roof Inn to transition to a competitor over the next 18  24 months. We installed our systems in
the following number of net new rooms and had the following total rooms installed as of March 31: March 31,2005
    
    
    2004New Guest Pay interactive rooms (1)
    
    
    11,226
    
    
    
    9,617Total Guest Pay interactive rooms (2)
    
    
    986,024
    
    
    
    934,260Total rooms served (3)
    
    
    1,043,278
    
    
    
    1,001,876
  (1)
    Amounts shown are net of de-installations.(2)
    Guest Pay interactive rooms are equipped with our interactive television system, which
includes both digital and tape-based systems(3)
    Total rooms served include guest pay interactive rooms, rooms served by international
licensees, and properties receiving only basic and premium television services. Digital Room Growth We continue to expand our digital base as we install our digital system in all newly contracted
rooms as well as converting select tape-based served rooms to the digital system in exchange for
contract extensions. Rooms equipped with our digital system typically generate higher revenue
since the range of services is greater than rooms equipped with our tape-based systems. Our goal
is to have approximately 75% of our room base installed with a digital system by the end of 2006.  March 31, 2005
    
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March 31,2005
    
    
    2004Digital room installations
    
    
    31,988
    
    
    
    29,989Total Digital rooms installed
    
    
    540,967
    
    
    
    415,415Digital rooms as a percent of total Guest Pay
interactive rooms
    
    
    55
    %
    
    
    45
    %
 Cost of Installation The average per-room cost associated with a digital installation has continued to decline due to
our ongoing reengineering, which simplifies the system while adding enhancements, lower component
costs, product segmentation, and reduced cost of assembly and installation. The following table
sets forth our average installation and conversion cost per room during the periods ended: Three Months Ended
    
    
    Years EndedMarch 31,
    
    
    March 31,
    
    
    December 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2004
    
    
    2003
    
    
    2002Average cost per room 
new installation
    
    $
    351
    
    
    $
    382
    
    
    $
    364
    
    
    $
    405
    
    
    $
    438Average cost per room 
Conversion
    
    $
    260
    
    
    $
    305
    
    
    $
    284
    
    
    $
    337
    
    
    $
    358
 The cost of installation can fluctuate from quarter to quarter due to the mix of services
installed, property sizes, product segmentation, and certain fixed costs. Operating Expense Per Room We plan to continue to manage operating expenses per room in order to increase the level of cash
flow our business generates, over time. Guest Pay operations expenses consist of costs directly
related to the operation and maintenance of systems at hotel sites. Selling, general and
administrative expense primarily includes administrative payroll costs, facilities costs,
engineering development costs and legal, professional and compliance costs. The following table
sets forth our operating expenses, SG&A and depreciation and amortization per room and as a percent
of revenue during the three months ended March 31: 2005
    
    
    2004Guest Pay operating expenses
    
    $
    2.94
    
    
    $
    2.93SG&A expense
    
    
    2.07
    
    
    
    2.05Depreciation and amortization (D&A)
    
    
    6.13
    
    
    
    7.07$
    11.14
    
    
    $
    12.05Guest Pay operations as a percent of total revenue
    
    
    13.1
    %
    
    
    12.7
    %SG&A as a percent of total revenue
    
    
    9.2
    %
    
    
    8.9
    %D&A as a percent of total revenue
    
    
    27.3
    %
    
    
    30.8
    %
  March 31, 2005
    
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Cash Flow One of our goals is to generate net free cash flow, which we define as having cash provided by
operating activities exceeding cash used for investing. We generally seek to generate net free
cash flow to reduce our historical reliance on external financing to grow our business. In
addition to increasing revenue and controlling expenses, we can manage our cash flow by varying the
number of rooms we install with the digital system in any given period. The level of net free cash flow generation is set forth in the following table (in thousands of
dollars): March 31,2005
    
    
    2004Cash provided by operating activities
    
    $
    18,213
    
    
    $
    18,280Cash used for investing activities
    
    
    (12,553
    )
    
    
    (12,634
    )Difference
    
    $
    5,660
    
    
    $
    5,646
 Liquidity and Capital Resources Historically, we have required substantial amounts of capital to fund operations, expand our
business and service existing indebtedness. For the quarter, cash provided by operating activities
was $18.2 million while cash used for investing activities, including growth-related capital
investments, was $12.5 million, resulting in a net change of $5.7 million. During the fourth
quarter of 2004, cash provided by operating activities was $6.9 million while cash used for
investing activities, including growth-related capital investments, was $13.7 million, resulting in
a net change of $6.8 million. Cash on the balance sheet as of March 31, 2005 was $32.9 million
versus $25.0 million as of December 31, 2004. The improvement was primarily driven by the increase
in operating cash during the first quarter of 2005 versus the fourth quarter of 2004. Depending on the rate of growth in our business and other factors, we expect to incur capital
expenditures of $55.0 to $57.0 million in 2005. Based on expected capital expenditures, we
estimate we will install between 42,000 and 45,000 net new rooms and convert between 48,000 and
52,000 existing rooms from tape-based to digital systems in exchange for long-term contract
extensions in 2005. Our principal sources of liquidity are our cash on hand, operating cash flow and the revolving loan
portion of our Credit Facility, which matures in 2007. We believe that our cash on hand and
operating cash flow will be sufficient for the foreseeable future to fund our future growth and
financing obligations. If this proves not to be the case, we have borrowing capacity under the
Credit Facility to fund any shortfall. As of March 31, 2005, working capital was $22.4 million,
compared to $18.5 million at December 31, 2004. In order to continue to operate and expand our business, we must remain in compliance with
covenants imposed by our Credit Facility and Senior Notes. As of March 31, 2005, we were in
compliance with all covenants, terms and conditions related to our Credit Facility and Senior
Notes. We are not aware of any events that qualify under the material adverse effect clause of the
Credit Facility. The total amount of long-term debt outstanding, including that portion of debt
classified as current, as of March 31, 2005 was $312.7 million versus $312.3 million as of December
31, 2004.  March 31, 2005
    
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Our leverage and interest coverage ratios were as follows for the periods ended March 31: 2005
    
    
    2004Actual consolidated total leverage ratio (1) (4)
    
    
    3.47
    
    
    
    4.20Maximum per covenant
    
    
    4.25
    
    
    
    4.75Actual senior secured leverage ratio (2) (4)
    
    
    1.25
    
    
    
    1.73Maximum per covenant
    
    
    2.25
    
    
    
    2.50Actual consolidated interest coverage ratio (3) (4)
    
    
    2.83
    
    
    
    2.51Minimum per covenant
    
    
    2.50
    
    
    
    2.25
  (1)
    Our maximum consolidated leverage ratio is a function of total indebtedness divided by
operating income exclusive of depreciation and amortization and other miscellaneous
non-recurring items as defined by the covenant.  (2)
    Our maximum senior secured leverage ratio is a function of total indebtedness less total
unsecured indebtedness, divided by operating income exclusive of depreciation and amortization
and other miscellaneous non-recurring items as defined by the covenant.  (3)
    Our minimum consolidated interest coverage ratio is a function of operating income exclusive
of depreciation and amortization and other miscellaneous non-recurring items divided by
interest expense as defined by the covenant.  (4)
    Maximum consolidated total leverage ratio, maximum senior secured leverage ratio, and minimum
consolidated interest coverage ratios are not based on generally accepted accounting
principles and are not presented as alternative measures of operating performance or
liquidity. They are presented here to demonstrate compliance with the covenants in our Credit
Facility, as noncompliance with such covenants could have a material adverse effect on us. We do not utilize special purpose entities or off balance sheet financial arrangements. Certain of our future debt covenant ratios will change as follows: Q4 2005
    
    
    Q1 2006
    
    
    Q4 2006Maximum consolidated total leverage ratio
    
    
    4.00
    
    
    
    3.75
    
    
    
    3.50Maximum senior secured leverage ratio
    
    
    2.25
    
    
    
    2.25
    
    
    
    2.25Minimum consolidated interest coverage ratio
    
    
    2.50
    
    
    
    2.75
    
    
    
    2.75
 In January 2004, we amended the existing LIBOR margin under our existing Credit Facility to be
LIBOR plus a margin of 3.50%. In April 2004, we amended our existing Credit Facility again to
establish, for term loans that
are LIBOR based loans, the LIBOR pricing at LIBOR plus an applicable LIBOR margin of 2.75% and, as
long as our senior secured debt ratings are not less than BB- from Standard and Poors and Ba3 from
Moodys, the applicable LIBOR margin is 2.50%. As of March 31, 2005, our senior secured debt
rating from Standard and Poors was B+ and our rating from Moodys was upgraded to Ba3. As a
result of refinancing our 10.25% notes in July 2004, we  March 31, 2005
    
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extended the maturity dates of the term
loan and the revolver loan under our Credit Facility, without the payment of any additional costs,
expenses or fees, from June 2006 to August 2008 and August 2007, respectively. In June 2003, we issued $200 million, principal amount of unsecured 9.50% Senior Subordinated Notes
(the 9.50% Notes), due June 15, 2013. The proceeds of the 9.50% Notes, which were issued at par,
after underwriter fees and offering expenses, were approximately $192.5 million. Approximately
$154.8 million of such proceeds were used to redeem the outstanding principal amount of the 10.25%
Senior Notes, pay accrued interest, pay call premiums, and pay related fees. Approximately $35
million of the proceeds were used to reduce outstanding amounts under our Credit Facility. The
remaining proceeds of approximately $2.7 million were for use in funding general corporate
purposes. The 9.50% Notes are unsecured, are subordinated in right of payment to all of our existing and
future senior debt and rank pari passuin right of payment with any future senior subordinated
indebtedness. The 9.50% Notes require semi-annual interest payments and contain covenants which
restrict our ability to incur additional indebtedness, create liens, pay dividends or make certain
distributions in respect to our common stock, redeem capital stock, issue or sell stock of
subsidiaries in certain circumstances, effect certain business combinations and effect certain
transactions with affiliates or stockholders. As of March 31, 2005, we were in compliance with all
covenants, terms, and conditions of the 9.50% Notes. The 9.50% Notes are redeemable at our option, in whole or in part, on or after June 15, 2008,
initially at 104.75% of their principal amount (plus accrued and unpaid interest) declining ratably
to 100% of their principal amount (plus accrued and unpaid interest) on or after June 15, 2011. At
any time prior to June 15, 2006, we may redeem up to 35% of the aggregate principal amount at
109.50% of the principal amount (plus accrued and unpaid interest) with the cash proceeds of
certain equity offerings. We do not utilize special purpose entities or off-balance sheet financial arrangements. Our weighted average interest rate on long-term debt outstanding during the first quarter of 2005
was approximately 9.6% as compared to approximately 9.0% during the comparable period of 2004. In the event of significant international crises, adverse economic conditions, acts of terrorism,
public health issues, or catastrophic events, we believe that the general economy and the lodging
industry could be negatively affected. If such a crisis is protracted or the effects on the
lodging industry are severe, the effect on our financial performance could result in us being in
violation of one or more of our bank or note covenants. This could require us to renegotiate our
covenants, significantly reduce our growth plans and/or curtail expenditures for operating
expenses. While we believe we could renegotiate our covenants, there is no assurance that this
could be accomplished, nor can we determine at this time the financial cost of such a renegotiation
or that refinancing, if required, would be available on terms favorable to us. The foregoing statements regarding capital expenditures and cash requirements are forward-looking
statements and there can be no assurance actual results will not vary from expected results. Our
actual cash flow and cash requirements will vary, and such variations could be material, depending
upon the number of new contracts for services entered into by us, the cost of installations, demand
for our services, competitive factors, hotel occupancy rates, general economic factors and other
factors including, without limitation, those set forth above under the Special Note Regarding
Forward-Looking Statements and elsewhere herein.  March 31, 2005
    
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Obligations and Commitments as of March 31, 2005 (dollar amounts in thousands): Payments due by periodLess than
    
    
    2  3
    
    
    4  5
    
    
    OverTotal
    
    
    1 year
    
    
    years
    
    
    years
    
    
    5 yearsContractual obligations:Long-term debt(s)
    
    $
    312,722
    
    
    $
    2,835
    
    
    $
    4,553
    
    
    $
    105,334
    
    
    $
    200,000Interest on fixed rate debt
    
    
    161,500
    
    
    
    19,000
    
    
    
    38,000
    
    
    
    38,000
    
    
    
    66,500Other long-term obligationsOther long-term liability (1)
    
    
    5,000
    
    
    
    1,250
    
    
    
    3,750
    
    
    
    
    
    
    
    Operating lease payments
    
    
    1,842
    
    
    
    593
    
    
    
    883
    
    
    
    366
    
    
    
    Purchase obligations
    
    
    3,215
    
    
    
    3,215
    
    
    
    
    
    
    
    
    
    
    
    Total contractual obligations
    
    $
    484,279
    
    
    $
    26,893
    
    
    $
    47,186
    
    
    $
    143,700
    
    
    $
    266,500
 Amount of commitment expiration per periodLess than
    
    
    2  3
    
    
    4  5
    
    
    OverTotal
    
    
    1 year
    
    
    years
    
    
    years
    
    
    5 yearsOther commercial commitments:Standby letters of credit
    
    $
    2,522
    
    
    $
    2,522
    
    
    $
    3⁄4
    
    
    $
    3⁄4
    
    
    $
    3⁄4
  (1)
    Other long-term liability represents the undiscounted payments to Hilton Hotels Corporation
for the acquired rights to provide Internet on television access and television on-demand
programming services to participating hotels and the right to independently pursue and further
develop interactive television content. Seasonality Our quarterly operating results are subject to fluctuation depending upon hotel occupancy rates and
other factors. 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 in those quarters. However, quarterly revenue can be affected by the availability of
popular content during those quarters and by commercial televised events such as the Olympics,
among other things. We have no control over when new content is released, how popular it will be
or the popularity of other televised events. Dependence on Performance of Lodging Industry Our results are closely connected to the performance of the lodging industry, where occupancy rates
may fluctuate resulting from various factors. Reduction in hotel occupancy resulting from
business, economic, or other events, such as significant international crises, acts of terrorism,
war or public health issues, could adversely impact our business, financial condition and results
of operations. The overall travel industry can be, and has been in the past, adversely affected by
weaker general economic climates, geopolitical instability and concerns about public health. Any future terrorist attack or credible threat of an attack is also likely to adversely affect the
travel industry, including lodging occupancy rates. For example, lodging occupancy rates fell
significantly after the events of September 11, 2001. Any reduction in occupancy rates,
particularly if extended over a long period of time, will reduce our revenue opportunities, which
would have an adverse impact on our financial condition and results of operations. To help mitigate the impact of reductions in industry occupancy rates on our financial condition
and results of operations, we continue to control expenses and capital spending. We plan to
reassess our operating and capital expenditure plans periodically to respond to changes in the
economic environment. Additionally, our room base is geographically diversified, with more than
two-thirds of properties served being in highway or suburban locations. Our room base concentration
is less than 5% in any of the top ten urban areas of the United States. By serving a wide variety
of geographically dispersed properties, we mitigate reliance on any one geographic sector.  March 31, 2005
    
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Discussion and Analysis of Results of Operations
Three Months Ended March 31, 2005 and 2004 Revenue Analysis. Total revenue for the first quarter of 2005 increased 3.4%, or $2.2 million, in
comparison to the first quarter of 2004. The following table sets forth the components of revenue
(in thousands of dollars) for the quarter ended March 31: 2005
    
    
    2004Percent
    
    
    
    
    
    
    Percentof Total
    
    
    
    
    
    
    of TotalRevenues:
    
    Amount
    
    
    Revenues
    
    
    Amount
    
    
    RevenuesGuest Pay
    
    $
    64,152
    
    
    
    97.2
    
    
    $
    62,323
    
    
    
    97.6Other
    
    
    1,837
    
    
    
    2.8
    
    
    
    1,508
    
    
    
    2.4$
    65,989
    
    
    
    100.0
    
    
    $
    63,831
    
    
    
    100.0
 Revenue from Guest Pay interactive services increased $1.8 million, or 2.9% on a 5.5% increase in
average number of rooms in operation, offset by a 2.5% decrease in revenue per room. Guest Pay
revenue per room decreased to $21.86 per month in the first quarter of 2005 from $22.41 per month
in the first quarter of 2004. The following table sets forth information with respect to revenue
per Guest Pay room for the quarter ended March 31: 2005
    
    
    2004Average monthly revenue per room:Movie revenue
    
    $
    16.42
    
    
    $
    17.04Other interactive service revenue
    
    
    5.44
    
    
    
    5.37Total per Guest Pay room
    
    $
    21.86
    
    
    $
    22.41
 Movie revenue per room decreased 3.6% to $16.42 this quarter as compared to $17.04 in the year
earlier quarter. Purchases of Hollywood content were higher this year as compared to last year;
however purchases of independent films, most of which are unrated and intended for mature
audiences, were lower on a per room basis. Movie revenue during the first quarter this year was
also lower on a relative basis due to the fact that the Easter holiday occurred in the first
quarter this year as compared to April of last year. The Easter holiday generally changes the mix
of family and business travel, which can impact the level of products purchased. Revenue per room
from other interactive services increased 1.3%, from $5.37 per month in the first quarter of 2004
compared to $5.44 in the current year quarter. The increase was primarily due to price changes
associated with basic cable services and increased revenue from the high-speed Internet access
systems, which was offset in part by our TV Internet initiative. Under this program, we proactively
reduced the average number of TV Internet rooms by 42,000 this quarter as compared to last quarter. Other revenue includes revenue from free-to-guest services provided to hotels not receiving Guest
Pay services, sales of system equipment and service parts and labor, and other revenue. Other
revenue increased $329,000, or 21.8%, in comparison to 2004. The increase is a result of reseller
commissions received for programming services and sales of high-speed Internet equipment offset by
a decrease in free-to guest only revenue.  March 31, 2005
    
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Direct Costs (exclusive of operating expenses and depreciation and
amortization discussed separately below).
Guest Pay direct costs for interactive services, which generally fluctuate
directly with revenue, include movie license fees, license fees for other
interactive services, and the commission retained by the hotel increased 3.0%,
or $837,000 on a 2.9% increase in related revenue. Guest Pay direct costs that
are fixed include Internet connectivity fees and one-time programming license
fees, which are independent of changes to revenue or occupancy. Direct costs
for other services increased $174,000, or 23.5%, in the first quarter of 2005
from the prior year quarter on a 21.8% or $329,000 increase in related revenue. As a percentage of revenue, overall direct costs remained flat at 44.3% for the
first quarter of 2005 as compared to the same period last year. In addition to
the information provided above, the following table sets forth the primary
change drivers of direct costs for the quarters ended March 31: 2005
    
    
    2004
    
    
    ChangeDirect costs as a percent of revenue
(exclusive of operating expenses and depreciation
and amortization discussed separately below):
    
    
    44.3
    %
    
    
    44.3
    %
    
    
    0.0
    %Change drivers:TV Internet costs
    
    
    
    
    
    
    
    
    
    
    -0.6Hotel commissions
    
    
    
    
    
    
    
    
    
    
    0.1Programming costs
    
    
    
    
    
    
    
    
    
    
    0.50.0
    %
  March 31, 2005
    
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Operating Expenses.The following table sets forth information in regard to operating expenses for
the quarter ended March 31 (in thousands of dollars): 2005
    
    
    2004Percent
    
    
    
    
    
    
    Percentof Total
    
    
    
    
    
    
    of TotalAmount
    
    
    Revenues
    
    
    Amount
    
    
    RevenuesOperating expenses:Guest Pay operations
    
    $
    8,622
    
    
    
    13.1
    
    
    $
    8,138
    
    
    
    12.7Selling, general and administrative
    
    
    6,072
    
    
    
    9.2
    
    
    
    5,705
    
    
    
    8.9Depreciation and amortization
    
    
    17,992
    
    
    
    27.3
    
    
    
    19,668
    
    
    
    30.8Total operating expenses
    
    $
    32,686
    
    
    
    49.6
    
    
    $
    33,511
    
    
    
    52.4
 Guest Pay operations expenses consist of costs directly related to the operation and maintenance of
systems at hotel sites. Guest Pay operations expenses increased by $484,000, or 5.9%, in 2005 from
the prior year quarter. The increase was primarily due to the 5.5% increase in the average number
of rooms served and other increased costs of labor, property tax, and fuel. As a percentage of
revenue, Guest Pay operations expenses increased to 13.1% in the first quarter of 2005 as compared
to 12.7% in the first quarter of 2004. Per average installed room, Guest Pay operations expense
was $2.94 per month in the first quarter of 2005 as compared to $2.93 per month in the prior year
quarter. Selling, general and administrative expenses were $6.1 million, an increase of $367,000 compared to
$5.7 million in the first quarter of 2004. The increase was driven by payroll and compensation
related expenses, professional fees and other compliance costs. As a percentage of revenue, SG&A
increased to 9.2% in the current quarter compared to 8.9% for the first quarter of 2004. Per
average Guest Pay room, SG&A expenses increased to $2.07 in the first quarter of 2005 from $2.05 in
the prior year quarter. Depreciation and amortization expenses decreased to $18.0 million in the current year quarter
versus $19.7 million in the first quarter of 2004. The decrease was primarily due to reductions in
Guest Pay system depreciation of $1.1 million from higher-cost assets becoming fully depreciated
and a technology asset becoming fully amortized at the end of 2004. Additionally, the cost basis of
the new assets being deployed is significantly less. As a percentage of revenue, depreciation and
amortization expense decreased to 27.3% in the first quarter of 2005 versus 30.8% in the first
quarter of 2004. Operating Income.As a result of the factors described above, we generated operating income of
$4.0 million in the first quarter of 2005 compared to $2.1 million in the first quarter of 2004. Interest Expense.Interest expense decreased $769,000, or 9.4%, to $7.5 million during the first
quarter of 2005. Average debt during the first quarter of 2005 was $312.3 million versus $367.3
million, a decrease of $55.0 million as compared to the first quarter of 2004. The decrease in
debt was due to the July 2004 payoff of the 11.50% Senior Notes and the repayment on the Credit
Facility term loan from our equity offering proceeds. The average interest rate was 9.6% for the
first quarter of 2005 as compared 9.0% in the prior year quarter due to increased interest rates on
our term loan. Other (Expense) Income.In the first quarter of 2005, we recorded a $210,000 provision for state
use tax. The provision was offset by interest income of $135,000. In the first quarter of 2004,
we recorded $53,000 of interest income. Taxes.For the first quarter of 2005, we incurred state franchise taxes of $118,000 versus
$117,000 during the first quarter of 2004. Net Loss.For the reasons previously described, net loss decreased to $3.6 million in the first
quarter of 2005 from a net loss of $6.2 million in the prior year quarter.  March 31, 2005
    
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Critical Accounting Policies Managements discussion and analysis of financial condition and results of operations are based
upon our financial statements, which have been prepared in conformity with accounting principles
generally accepted in the United States of America. Our primary cost drivers are predetermined
rates, such as hotel commissions, license fees paid for major motion pictures and other content, or
one-time fixed fees for independent films. However, the preparation of financial statements
requires us to make estimates and assumptions that affect the reported amounts of assets and
liabilities and the reported amounts of revenues and expenses during the reporting period. We base
our estimates on historical experience and on various other assumptions that we believe to be
reasonable based upon the available information. The following critical policies relate to the
more significant judgments and estimates used in the preparation of the financial statements: Revenue recognition.We recognize revenue from the sale of interactive television services in the
period the related services are sold to the hotel or guest and collection is reasonably assured.
Persuasive evidence of an arrangement exists through our long-term contract with each hotel. No
future performance obligations exist on a service that has been provided. The prices related to
our products or services are fixed or determinable prior to delivery of the products or services.
Revenue from the sale of system equipment and service parts and labor is recognized when the
equipment is delivered or the service has been provided. We also have advance billings from one
month to three months for certain free-to-guest programming services where the revenue is deferred
and recognized in the periods that services are provided. We provide high-speed Internet access through the sale and installation of
equipment to subscribing hotels. Revenue from the sale and installation of
this equipment is recognized when the equipment is installed or the service has
been provided. Equipment prices are fixed and determinable prior to delivery.
We receive monthly service fees from such hotels for technical maintenance and
call center support services following the initial installation. Under the
service arrangement, the monthly service revenue is recognized ratably over the
term of the maintenance contract. We also provide our interactive television infrastructure and content to the
healthcare industry. Under a relationship with a healthcare services provider,
we sell our interactive system and provide recurring support for interactive
content, software maintenance and technical field service for a fixed fee.
Revenue from the sale and installation of our interactive system is recognized
when the equipment is installed or the service has been provided. The
interactive system prices are fixed and determinable prior to delivery. Under
the support arrangement, the fixed fee is deferred and recognized ratably over
the term of the related contract. Allowance for doubtful accounts.We determine the estimate of the allowance for doubtful accounts
considering several factors, including: (1) historical experience, (2) aging of the accounts
receivable, and (3) contract terms between the hotel and us. In accordance with our hotel
contracts, monies collected by the hotel for interactive television services are held in trust on
our behalf. Collectibility is reasonably assured as supported by our credit check process and
nominal write-off history. If the financial condition of a hotel chain or group of hotels were to
deteriorate and reduce the ability to remit our monies, we may be required to increase our
allowance by recording additional bad debt expense. Allowance for excess or obsolete system components.We regularly evaluate component levels to
ascertain build requirements based on our backlog and service requirements based on our current
installed base. When a certain system component becomes obsolete due to technological changes and
it is determined that the component cannot be utilized within our current installed base, we record
a provision for excess and obsolete component inventory based on estimated forecasts of product
demand and service requirements. We make every effort to ensure the accuracy of our forecasts of
service requirements and future production; however any significant unanticipated changes in demand
or technological advances could have an impact on the value of system components and reported
operating results. Property and equipment.Our property and equipment is stated at cost, net of accumulated
depreciation and amortization. Installed Guest Pay and free-to-guest systems consist of equipment
and related costs of installation, including certain payroll costs, sales commissions and customer
acquisition costs. Maintenance costs, which do not significantly extend the useful lives of the
respective assets, and repair costs are charged to Guest Pay
operations as incurred. We begin depreciating Guest Pay and free-to-guest systems when such
systems are installed and activated.  March 31, 2005
    
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Depreciation of other equipment begins when such equipment is
placed in service. We attribute no salvage value to equipment, and depreciation and amortization
are computed using the straight-line method over the following useful lives: YearsBuildings
    
    
    30Guest Pay systems:Installed system costs
    
    
    2  7Customer acquisition costs
    
    
    5  7System components
    
    
    5  7Software costs
    
    
    3  5Other equipment
    
    
    3  10
 Allowance for system removal.We de-install properties through the course of normal operations due
to a number of factors, including: poor revenue performance, hotel bankruptcy or collection issues,
hotel closings, and change in service provider. We regularly evaluate our backlog of properties
scheduled for de-installation and record a provision for estimated system removal costs. The costs
incurred as a result of de-installation include the labor to de-install the system as well as
unamortized installation costs. Historically, de-installation activity has averaged approximately
2% of our installed room base. Recent Accounting Developments In December 2004, the Financial Accounting Standards Board issued SFAS 123R, Share Based Payment.
SFAS 123R requires that the compensation cost relating to share-based payment transactions be
recognized in financial statements. That cost will be measured based on the fair value of the
equity or liability instruments issued. Public entities will be required to apply Statement 123R to
annual reporting periods that begin after June 15, 2005. We are currently evaluating this
statement and believe the adoption, effective January 1, 2006, will have an impact on our
consolidated financial statements. Based on our current Black-Scholes option valuation
assumptions, we estimate the annual expense to be $3.0 to $4.0 million. Components of this
estimate may change due to the variability of certain assumptions such as expected life and
volatility under either of the allowable Black-Scholes or Binomial pricing model. In March 2005, the FASB issued FASB Interpretation No. 47, Accounting for Conditional Asset
Retirement Obligations  An Interpretation of FASB Statement No. 143. FIN 47 concludes that an
entity is required to recognize a liability for the fair value of a conditional asset retirement
obligation when incurred if the liabilitys fair value can be reasonably estimated. FIN 47 must be
applied for periods ending after December 15, 2005. We are currently evaluating the impact of FIN
47 and believe the adoption, effective December 31, 2005, will not have an impact on our
consolidated financial statements. 
 Item 3  Quantitative and Qualitative Disclosures About Market Risk We are exposed to various market risks, including potential losses resulting from adverse changes
in interest rates and foreign currency exchange rates. We do not enter into derivatives or other
financial instruments for trading or speculative purposes. Interest.At March 31, 2005, we had debt totaling $312.7 million. We have interest rate swap
arrangements covering debt with a notional amount of $100.0 million to effectively change the
underlying debt from a variable interest rate to a fixed interest rate for the term of the swap
agreements. After giving effect to the interest rate swap arrangements, we had fixed rate debt of
$302.9 million and variable rate debt of $9.8 million at March 31, 2005. For fixed rate debt,
interest rate changes affect the fair market value but do not impact earnings or cash flows.
Conversely, for variable rate debt, interest rate changes generally do not affect the fair market
value but do impact future earnings and cash flows, assuming other factors are held constant.
Assuming other variables remain
constant (such as debt levels), a one percentage point increase in interest rates would decrease
the unrealized fair market value of the fixed rate debt by an estimated $29.4 million. The impact
on earnings and cash flow from a one percentage point increase in interest rates would be
approximately negative $98,000 on an annualized basis assuming other variables remain constant.  March 31, 2005
    
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Foreign Currency Transactions.A portion of our revenues is derived from the sale of Guest Pay
services in Canada. The results of operations and financial position of our operations in Canada
are measured in Canadian dollars and translated into U.S. dollars. The effects of foreign currency
fluctuations in Canada are somewhat mitigated by the fact that expenses and liabilities are
generally incurred in Canadian dollars. The reported income of our Canadian subsidiary will be
higher or lower depending on a weakening or strengthening of the U.S. dollar against the Canadian
dollar. In addition, portions of our assets are based in Canada and are translated into U.S.
dollars at foreign currency exchange rates in effect as of the end of each period. Accordingly,
our consolidated assets will fluctuate depending on the weakening or strengthening of the U.S.
dollar against the Canadian dollar. No significant foreign currency fluctuations occurred in the
first three months of 2005 to materially impact consolidated results of operations or financial
condition. 
 Item 4  Controls and Procedures Evaluation of Disclosure Controls and Procedures.Based on their evaluation as of the end of the
period covered by this Quarterly Report on Form 10-Q, the Chief Executive Officer and Chief
Financial Officer have concluded that the disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) are effective to ensure that
information required to be disclosed by us in reports that we file or submit under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods
specified in Securities and Exchange Commission rules and forms. Additionally, our disclosure
controls and procedures were also effective in ensuring that information required to be disclosed
in our Exchange Act reports is accumulated and communicated to our management, including our Chief
Executive Officer and Chief Financial Officer to allow timely decisions regarding required
disclosures. Changes in Internal Control over Financial Reporting.There was no change in our internal control
over financial reporting that occurred during the first quarter of 2005 that has materially
affected, or is reasonably likely to materially affect, our internal control over financial
reporting.  March 31, 2005
    
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Part II  Other Information 
 Item 1  Legal Proceedings We are subject to litigation arising in the ordinary course of business. As of the date hereof, we
believe the resolution of such litigation will not have a material adverse effect upon our
financial condition or results of operations. In connection with our effort to support the development of technology, which could utilize our
interactive system, we advanced $1.0 million to Gamet Technology, Inc. pursuant to a written
promissory note during the first quarter of 2003. The Gamet note was personally guaranteed by
Steve and Margaret Urie, the principal owners of Gamet, and was collateralized by the unconditional
assignment of rights to receive quarterly deferred payments due to the principal owner in
connection with the sale of a prior business. The Gamet note was due and payable on April 18,
2003. On July 2, 2003, we filed a lawsuit in U.S. District Court, Southern Division, in South
Dakota, against Gamet and against the Uries, demanding payment of the Note. On August 12, 2003,
the defendants submitted an answer denying liability on the Gamet note. Gamet also asserted
counterclaims against us alleging our failure to procure private financing for PointOne
Technologies, L.L.C., a joint venture between us and Gamet, caused Gamet to suffer damages in an
undetermined amount. On December 29, 2003, the Uries and various companies owned or controlled by
the Uries, including Gamet, filed for Chapter 11 reorganization in the U.S. Bankruptcy Court of the
District of Nevada. It is expected that the various bankruptcy cases will be consolidated for
court management and trustee administration purposes into one case. As a result of the bankruptcy
filings, our claims against the Uries and Gamet are stayed. In late January 2005 we became aware
that the purchaser of the prior business owned by the Uries had ceased making deferred payments,
claiming a right of set-off against the Uries. We have challenged this action as a violation of
the automatic stay in the bankruptcy case and have also challenged the alleged set-off rights.
However, based on this information, we believe the probability of collection on the note has been
significantly reduced and, accordingly, in the fourth quarter of 2004 we fully reserved for the
$1.0 million promissory note. No new information has been noted during the first quarter of 2005. 
 Item 2  Unregistered Sales of Equity Securities and Use of Proceeds Not applicable. 
 Item 3  Defaults Upon Senior Securities Not applicable. 
 Item 4  Submission of Matters to a Vote of Security Holders Not applicable. 
 Item 5  Other Information Not applicable. 
 Item 6  Exhibits 31.1
    
    Rule 13a-14(a)/15(d)-14(a) Certification of Chief Financial Officer31.2
    
    Rule 13a-14(a)/15(d)-14(a) Certification of Chief Executive Officer32
    
    Section 1350 Certifications
  March 31, 2005
    
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LodgeNet Entertainment Corporation and Subsidiary 
 Signatures Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. LodgeNet Entertainment Corporation(Registrant)Date:  May 9, 2005
    /s/  Scott C. PetersenScott C. PetersenPresident, Chief Executive Officer and
Chairman of the Board of Directors
(Principal Executive Officer)Date:  May 9, 2005
    /s/  Gary H. RitondaroGary H. RitondaroSenior Vice President, Chief Financial Officer
(Principal Financial & Accounting Officer)  March 31, 2005
    
    Page 27