** **

**UNITED STATES**

**SECURITIES AND 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 thequarterly period ended September 30, 2001**

 

**Commission File Number 0-22334**

 

**LodgeNet Entertainment Corporation**

(Exactname of registrant as specified in its charter)

 

| **Delaware**                                                                       |   | **46-0371161**          |
|------------------------------------------------------------------------------------|--------|-------------------------|
| (State  or other jurisdiction of                                                   |   | (I.R.S.  Employer       |
| incorporation  or organization)                                                    |   | Identification  Number) |
|                                                                               |   |                    |
| **3900  West Innovation Street, Sioux Falls, South Dakota**                        |   | **57107**               |
| (Address  of Principal Executive Offices)                                          |   | (ZIP  code)             |
|                                                                               |   |                    |
| **(605)  988-1000**                                                                |
| (Registrant's  telephone number,including area code)                               |
|                                                                               |   |                    |
| (Former  name, former address and former fiscal year, if changed since last report |

 

                Indicate by check mark whetherthe Registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor 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.   Yesý   No  o

 

                At October 31, 2001, there were12,283,148 shares outstanding of the Registrant's common stock, $0.01 parvalue.

 

 

**LodgeNet Entertainment Corporation**

 

**Index**

 

**Part I.  Financial Information**

 
| Item 1 —                        | Financial Statements:                                                                                                      |
|--------------------------------------|----------------------------------------------------------------------------------------------------------------------------|
|                                 | Consolidated  Balance Sheets (Unaudited) as of September 30, 2001 and December 31, 2000                                    |
|                                 | Consolidated  Statements of Operations (Unaudited) for the Three Months and Nine Months  Ended September 30, 2001 and 2000 |
|                                 | Consolidated  Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30,  2001 and 2000                  |
|                                 | 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**                       |
|                                      |                                                                                                                            |  |

 

                

Asused herein (unless the context otherwise requires) "LodgeNet",  "the Company" and/or "theRegistrant" means LodgeNet Entertainment Corporation and itsmajority-owned subsidiaries.

 

**Part I— Financial Information**

 

**Item 1 — Financial Statements**

 

**LodgeNetEntertainment Corporation**

**ConsolidatedBalance Sheets (Unaudited)**

(Dollaramounts in thousands)

 
|                                                                                                                                                                  |   | **September  30,** |         | **December  31,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|--------------|-------------------|--------|
|                                                                                                                                                                  |   | **2001**           |         | **2000**          |   |
| **Assets**                                                                                                                                                            |   |               |         |              |   |
| Current assets:                                                                                                                                                       |   |               |         |              |   |
| Cash  and cash equivalents                                                                                                                                            |   | $                  | 13,550       |              | $      | 4,059 |   |
| Marketable  securities                                                                                                                                                |   | 3⁄4             |         | 1,398             |   |
| Accounts  receivable, net                                                                                                                                             |   | 31,447             |         | 26,553            |   |
| Prepaid  expenses and other                                                                                                                                           |   | 3,575              |         | 3,610             |   |
| Total current assets                                                                                                                                                  |   | 48,572             |         | 35,620            |   |
|                                                                                                                                                                  |   |               |         |              |   |
| Property  and equipment, net                                                                                                                                          |   | 239,874            |         | 224,927           |   |
| Investments  in and advances to unconsolidated affiliates                                                                                                             |   | 317                |         | 3,500             |   |
| Debt  issuance costs, net                                                                                                                                             |   | 9,853              |         | 7,121             |   |
| Other  assets, net                                                                                                                                                    |   | 10,443             |         | 10,437            |   |
|                                                                                                                                                                  |   | $                  | 309,059      |              | $      | 281,605 |   |
|                                                                                                                                                                  |   |               |         |              |   |
| **Liabilities  and Stockholders’ Deficit**                                                                                                                       |   |               |         |              |   |
| Current  liabilities:                                                                                                                                                 |   |               |         |              |   |
| Accounts  payable                                                                                                                                                     |   | $                  | 19,409       |              | $      | 12,671 |   |
| Current  maturities of long-term debt                                                                                                                                 |   | 8,109              |         | 21,563            |   |
| Accrued  expenses and other                                                                                                                                           |   | 14,834             |         | 11,988            |   |
| Deferred  revenue                                                                                                                                                     |   | 2,965              |         | 2,713             |   |
| Total  current liabilities                                                                                                                                            |   | 45,317             |         | 48,935            |   |
|                                                                                                                                                                  |   |               |         |              |   |
| Long-term  debt (Note 3)                                                                                                                                              |   | 317,912            |         | 269,096           |   |
| Derivative  instruments                                                                                                                                               |   | 6,662              |         | 3⁄4            |   |
| Total  liabilities                                                                                                                                                    |   | 369,891            |         | 318,031           |   |
|                                                                                                                                                                  |   |               |         |              |   |
| Stockholders’  deficit:                                                                                                                                          |   |               |         |              |   |
| Common  stock, $.01 par value, 50,000,000 shares authorized; 12,283,048 and  12,212,039 shares outstanding at September 30, 2001 and December 31, 2000,  respectively |   | 123                |    | 122               |   |
| Additional  paid-in capital                                                                                                                                           |   | 151,754            |         | 150,663           |   |
| Accumulated  deficit                                                                                                                                                  |   | (204,452           | )            | (185,981          | )      |
| Accumulated  other comprehensive loss                                                                                                                                 |   | (8,257             | )            | (1,230            | )      |
| Total  stockholders’ deficit                                                                                                                                     |   | (60,832            | )            | (36,426           | )      |
|                                                                                                                                                                  |   | $                  | 309,059      |              | $      | 281,605 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

**LodgeNet Entertainment Corporation**

**Consolidated Statements of Operations (Unaudited)**

(Dollaramounts, except per share amounts, in thousands)

** **
|                                  |   | **Three  Months Ended** |   | **Nine  Months Ended** |   |
|---------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                  |   | **September  30,**      |   | **September  30,**     |   |
|                                  |   | **2001**                |   | **2000**               |   | **2001** |   | **2000** |   |
| Revenues:                             |   |                    |   |                   |   |   |   |   |   |
| Guest Pay                             |   | $                       | 54,572 |                   | $      | 50,232 |   | $ | 155,676 |   | $ | 141,253 |   |
| Other                                 |   | 3,109                   |   | 2,662                  |   | 8,141 |   | 7,503 |   |
| Total revenues                        |   | 57,681                  |   | 52,894                 |   | 163,817 |   | 148,756 |   |
|                                  |   |                    |   |                   |   |   |   |   |   |
| Direct costs:                         |   |                    |   |                   |   |   |   |   |   |
| Guest Pay                             |   | 22,854                  |   | 20,509                 |   | 63,921 |   | 57,755 |   |
| Other                                 |   | 1,980                   |   | 925                    |   | 5,188 |   | 4,198 |   |
| Total direct costs                    |   | 24,834                  |   | 21,434                 |   | 69,109 |   | 61,953 |   |
|                                  |   |                    |   |                   |   |   |   |   |   |
| Gross profit                          |   | 32,847                  | `      | 31,460                 |   | 94,708 |   | 86,803 |   |
|                                  |   |                    |   |                   |   |   |   |   |   |
| Operating expenses:                   |   |                    |   |                   |   |   |   |   |   |
| Guest Pay operations                  |   | 7,183                   |   | 7,120                  |   | 21,647 |   | 20,923 |   |
| Selling, general and administrative   |   | 5,340                   |   | 5,020                  |   | 16,050 |   | 14,475 |   |
| Depreciation and amortization         |   | 16,295                  |   | 16,497                 |   | 49,168 |   | 49,038 |   |
| Total operating expenses              |   | 28,818                  |   | 28,637                 |   | 86,865 |   | 84,436 |   |
|                                  |   |                    |   |                   |   |   |   |   |   |
| Operating income                      |   | 4,029                   |   | 2,823                  |   | 7,843 |   | 2,367 |   |
|                                  |   |                    |   |                   |   |   |   |   |   |
| Investment losses                     |   | (790                    | )      | 3⁄4                 |   | (1,688 | ) | 3⁄4 |   |
| Interest expense                      |   | (7,728                  | )      | (6,990                 | )      | (22,089 | ) | (20,845 | ) |
| Other income (expense), net           |   | (68                     | )      | 92                     |   | (12 | ) | 359 |   |
|                                  |   |                    |   |                   |   |   |   |   |   |
| Loss before income taxes              |   | (4,557                  | )      | (4,075                 | )      | (15,946 | ) | (18,119 | ) |
| Provision for income taxes            |   | (114                    | )      | (69                    | )      | (434 | ) | (246 | ) |
|                                  |   |                    |   |                   |   |   |   |   |   |
| Loss before extraordinary item        |   | (4,671                  | )      | (4,144                 | )      | (16,380 | ) | (18,365 | ) |
| Extraordinary item,  net (Note 7)     |   | (2,091                  | )      | 3⁄4                 |   | (2,091 | ) | 3⁄4 |   |
|                                  |   |                    |   |                   |   |   |   |   |   |
| Net loss                              |   | $                       | (6,762 | )                      | $      | (4,144 | ) | $ | (18,471 | ) | $ | (18,365 | ) |
|                                  |   |                    |   |                   |   |   |   |   |   |   |   |   |   |
| Per common share (basic and diluted): |   |                    |   |                   |   |   |   |   |   |
| Loss before  extraordinary item       |   | $                       | (0.38  | )                      | $      | (0.34 | ) | $ | (1.34 | ) | $ | (1.51 | ) |
| Extraordinary item,  net              |   | (0.17                   | )      | 3⁄4                 |   | (0.17 | ) | 3⁄4 |   |
|                                  |   |                    |   |                   |   |   |   |   |   |
| Net loss                              |   | $                       | (0.55  | )                      | $      | (0.34 | ) | $ | (1.51 | ) | $ | (1.51 | ) |
| Weighted average  shares outstanding  |   | 12,265,897              |   | 12,191,981             |   | 12,236,310 |   | 12,135,067 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

**LodgeNet Entertainment Corporation**

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

(Dollaramounts in thousands)

 
|                                                                             |   | **Nine  Months Ended   September 30,** |       |
|----------------------------------------------------------------------------------|--------|----------------------------------------|------------|
|                                                                             |   | **2001**                               | ** ** | **2000** | ** ** |
| Operating activities:                                                            |   |                                   |       |   |   |
| Net loss                                                                         |   | $                                      | (18,471    | ) | $ | (18,365 | ) |
| Adjustments  to reconcile net loss to net cash provided by operating activities: |   |                                   |       |   |   |
|                                                                             |   |                                   |       |   |
| Depreciation and amortization                                                    |   | 49,168                                 |       | 49,038 |   |
| Investment losses                                                                |   | 1,688                                  |       | 3⁄4 |   |
| Non-cash portion of  extraordinary item                                          |   | 2,091                                  |       | 3⁄4 |   |
| Other, net                                                                       |   | 253                                    |       | 3⁄4 |   |
| Change in operating assets and liabilities:                                      |   |                                   |       |   |   |
| Accounts receivable, net                                                         |   | (4,983                                 | )          | 164 |   |
| Prepaid expenses and other                                                       |   | 34                                     |       | 109 |   |
| Accounts payable                                                                 |   | 6,349                                  |       | (973 | ) |
| Accrued expenses and other                                                       |   | 3,122                                  |       | 3,798 |   |
| Other                                                                            |   | (1,464                                 | )          | (130 | ) |
| Net cash provided by operating  activities                                       |   | 37,787                                 |       | 33,641 |   |
|                                                                             |   |                                   |       |   |   |
| Investing activities:                                                            |   |                                   |       |   |   |
| Property and equipment additions                                                 |   | (60,502                                | )          | (44,092 | ) |
| Proceeds from sale of investments                                                |   | 1,393                                  |       | 7,200 |   |
| Proceeds from affiliates, net                                                    |   | 1,498                                  |       | 1,270 |   |
| Net cash used for investing activities                                           |   | (57,611                                | )          | (35,622 | ) |
|                                                                             |   |                                   |       |   |   |
| Financing activities:                                                            |   |                                   |       |   |   |
| Proceeds from long-term debt                                                     |   | 150,000                                |       | 3⁄4 |   |
| Borrowings under prior revolving credit  facility                                |   | 27,000                                 |       | 11,000 |   |
| Repayments of prior revolving credit  facility                                   |   | (61,000                                | )          | (7,500 | ) |
| Repayment of long-term debt                                                      |   | (81,030                                | )          | (29 | ) |
| Payment on license rights liability                                              |   | 3⁄4                                 |       | (5,294 | ) |
| Repayment of capital lease obligations                                           |   | (373                                   | )          | (371 | ) |
| Debt issuance costs                                                              |   | (6,008                                 | )          | 3⁄4 |   |
| Exercise of stock options                                                        |   | 770                                    |       | 2,322 |   |
| Short-swing profits                                                              |   | 3⁄4                                 |       | 2,468 |   |
| Net cash provided by financing  activities                                       |   | 29,359                                 |       | 2,596 |   |
|                                                                             |   |                                   |       |   |   |
| Effect of exchange  rates on cash                                                |   | (44                                    | )          | (15 | ) |
| Increase in cash and cash equivalents                                            |   | 9,491                                  |       | 600 |   |
| Cash and cash equivalents at beginning  of period                                |   | 4,059                                  |       | 1,644 |   |
| Cash and cash equivalents at end of period                                       |   | $                                      | 13,550     |   | $ | 2,244 |   |
|                                                                             |   |                                   |       |   |   |
| Supplemental cash flow information:                                              |   |                                   |       |   |   |
| Cash paid for interest                                                           |   | $                                      | 20,651     |   | $ | 17,926 |   |
| Cash paid for taxes                                                              |   | $                                      | 891        |   | $ | 600 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

**LodgeNet Entertainment Corporation**

**Notes to Consolidated Financial Statements (Unaudited)**

 

Note1 — Basis of Presentation

 

Theaccompanying consolidated financial statements as of September 30, 2001, andfor the three and nine month periods ended September 30, 2001 and 2000, havebeen prepared by LodgeNet Entertainment Corporation (the "Company"),without audit, pursuant to the rules and regulations of the Securities andExchange Commission (the "Commission").  The information furnished in the accompanying consolidatedfinancial statements reflects all adjustments, consisting only of normalrecurring adjustments, which, in the opinion of management, are necessary for afair presentation of such financial statements.

 

Certaininformation and footnote disclosures, normally included in financial statementsprepared in accordance with generally accepted accounting principles, have beencondensed or omitted pursuant to the rules and regulations of the Commission.Although the Company believes that the disclosures are adequate to make theinformation presented herein not misleading, it is recommended that theseunaudited consolidated financial statements be read in conjunction with themore detailed information contained in the Company's Annual Report on Form 10-Kfor 2000, as filed with the Commission. The results of operations for the threeand nine month period ended September 30, 2001 are not necessarily indicativeof the results of operations for the full year.

 

Theconsolidated financial statements include the accounts of LodgeNetEntertainment Corporation and its majority-owned subsidiaries.  All significant intercompany accounts andtransactions have been eliminated in consolidation.

 

Note2 — Property and Equipment, Net

 

Propertyand equipment was comprised as follows at (in thousands):

 

|                                 |   | **September  30,** |    | **December  31,** |   |
|--------------------------------------|--------|--------------------|---------|-------------------|--------|
|                                 |   | **2001**           |    | **2000**          |   |
| Land, building and equipment         |   | $                  | 67,247  |              | $      | 62,432 |   |
| Free-to-guest equipment              |   | 23,979             |    | 20,175            |   |
| Guest Pay systems:                   |   |               |    |              |   |
| Installed                            |   | 389,881            |    | 349,313           |   |
| System components                    |   | 26,909             |    | 24,565            |   |
| Software costs                       |   | 14,322             |    | 12,816            |   |
| Total                                |   | 522,338            |    | 469,301           |   |
| Less - depreciation and amortization |   | (282,464           | )       | (244,374          | )      |
| Property and equipment, net          |   | $                  | 239,874 |              | $      | 224,927 |   |

 

Note3 — Long-term Debt and Credit Facilities

 

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

 

|                       |   | **September  30,** |    | **December  31,** |   |
|----------------------------|--------|--------------------|---------|-------------------|--------|
|                       |   | **2001**           |    | **2000**          |   |
| Bank  Credit Facility:     |   |               |    |              |   |
| Bank  term loan            |   | $                  | 150,000 |              | $      | 75,000 |   |
| Revolving  credit facility |   | 3⁄4             |    | 34,000            |   |
| 10.25%  senior notes       |   | 150,000            |    | 150,000           |   |
| 11.50%  senior notes       |   | 24,000             |    | 30,000            |   |
| Less  unamortized discount |   | (376               | )       | (523              | )      |
| Capital  leases            |   | 1,532              |    | 1,287             |   |
| Other                      |   | 865                |    | 895               |   |
|                       |   | 326,021            |    | 290,659           |   |
| Less  current maturities   |   | (8,109             | )       | (21,563           | )      |
|                       |   | $                  | 317,912 |              | $      | 269,096 |   |

 

*Bank Credit Facility*3⁄4 On August 29, 2001, the Company entered into a new $225 million bankcredit facility, comprised of a $150 million term loan and a $75 millionrevolving credit facility (which may be increased to $100 million,subject to certain limitations).  The$128.5 million outstanding under the Company’s prior credit facility was repaidwith the proceeds from the new term loan. Quarterly repayments on the term loan begin in December 2001.  The revolving credit facility matures inJune 2006.  Loans bear interest at theCompany’s option of (1) the bank’s base rate (as defined) plus a margin of from1.00% to 2.75%, depending on leverage as defined, or (2) adjusted LIBOR (asdefined) plus a margin of from 2.25% to 4.00%, depending on leverage asdefined.  The facility provides for the issuance of letters of credit up to $10million, subject to customary terms and conditions.  As of September 30, 2001, the Company had outstanding letters ofcredit totaling $2.0 million.

 

The facilityincludes terms and conditions which require the maintenance of certainfinancial ratios and place limitations on capital expenditures, additionalindebtedness, liens, investments, guarantees, asset sales and certain paymentsor distributions in respect of the common stock.  As of September 30, 2001, the Company was in compliance with allcovenants, terms and conditions of the bank credit facility.

 

*10.25%Senior Notes***—**In December 1996, the Company issued $150 million of unsecured 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 September 30, 2001, 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 theCompany, in whole or in part, on or after December 15, 2001, initially at105.125% of their principal amount (plus accrued and unpaid interest) decliningratably to 100% of their principal amount (plus accrued and unpaid interest) onor after December 15, 2003.

 

*11.50%Senior Notes***—**During 1995, the Company issued $30 million principal amount ofunsecured 11.50% senior notes (the “11.50% Notes”).  Mandatory annual principal payments of $6 million commence inJuly 2001 continuing through July 2005. Semi-annual interest payments are required.  The Company issued a total of 480,000 warrants to purchase commonstock of the Company in connection with the issuance of the 11.50% Notes andthe value of the warrants, $1.68 million, was recorded as additional paid-incapital and shown as a discount on the 11.50% Notes.  As part of the refinancing transaction in which the 10.25% Noteswere issued, the holders of the 11.50% Notes adopted the covenants and rankingof the 10.25% Notes.

 

Long-term debt has the followingscheduled principal maturities for the years ended December 31 (in thousands ofdollars): 2002 — $8,094; 2003 — $8,741; 2004 — $7,834; 2005 — $7,566; 2006 —$293,249.

 Note 4 3⁄4 Accountingfor Derivative Instruments and Hedging Activities

 

Effective January 1, 2001, the Companyadopted Statement of Financial Accounting Standard (“SFAS”) No. 133,“Accounting for Derivative Instruments and Hedging Activities”.  SFAS No. 133 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 transactions thatreceive hedge accounting.

 

At January 1, 2001, the Company hadinterest rate swap agreements on $100 million of long-term debt.  The swap agreements, which expire $50million in March 2003 and $50 million in December 2005, have been designatedas, and meet the criteria for cash flow hedges.  Initial adoption of SFAS No. 133 resulted in the recording of aliability for the fair value of the swap agreements of $1.3 million, with theoffset recorded in equity as a component of accumulated other comprehensiveloss.

 

Note 5 3⁄4Comprehensive Income (Loss)

 

Statement of Financial AccountingStandard No. 130, “Reporting Comprehensive Income,” provides standards forreporting and disclosure of comprehensive income and its components.  Comprehensive income reflects the changes inequity during a period from transactions and other events and circumstancesfrom non-owner sources.  For theCompany, comprehensive loss was as follows for the periods ended September 30(in thousands):

 
|                                                                                    |   | **Three  Months Ended** |   | **Nine  Months Ended** |   |
|-----------------------------------------------------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                                                                    |   | **September  30,**      |   | **September  30,**     |   |
|                                                                                    |   | **2001**                |   | **2000**               |   | **2001** |   | **2000** |   |
| Net loss                                                                                |   | $(6,762                 | )      | $(4,144                | )      | $(18,471 | ) | $(18,365 | ) |
| Foreign currency  translation adjustment                                                |   | (275                    | )      | (145                   | )      | (365 | ) | (425 | ) |
| Unrealized loss on marketable  securities                                               |   | 3⁄4                  |   | (4,648                 | )      | 3⁄4 |   | (21,368 | ) |
| Cumulative effect of adoption of SFAS  No. 133                                          |   | 3⁄4                  |   | 3⁄4                 |   | (1,287 | ) | 3⁄4 |   |
| Unrealized loss on derivative  instruments instrum instrument derivativediinsnstruments |   | (3,688                  | )      | 3⁄4                 |   | (5,375 | ) | 3⁄4 |   |
| Comprehensive loss                                                                      |   | $(10,725                | )      | $(8,937                | )      | $(25,498 | ) | $(40,158 | ) |

 

Note 6 3⁄4 Effect ofRecently Issued Accounting Standards

 

In July 2001, the Financial AccountingStandards Board issued SFAS No. 141, “Business Combinations” which eliminatesthe pooling-of-interests method of accounting for business combinations andmodifies the application of the purchase accounting method.  The elimination of the pooling-of-interestsmethod is effective for transactions initiated after June 30, 2001.  The remaining provisions in this statementwill be effective for transactions accounted for using the purchase method thatare completed after June 30, 2001.  Theadoption of this statement will not impact the Company’s consolidated financialstatements.

 

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 not determined the potentialimpact on its consolidated financial statements.

 

In June 2001, the Financial AccountingStandards Board issued SFAS No. 143, "Accounting for ObligationsAssociated with the Retirement of Long-Lived Assets". SFAS No. 143primarily establishes accounting standards for the recognition and measurementof an asset retirement obligation and its associated asset retirement costs.The provisions of SFAS No. 143 will be effective for fiscal years beginningafter June 15, 2002. Management is currently evaluating the impact thisstatement will have on the Company's consolidated financial statements.

 

In October 2001, the Financial AccountingStandards Board issued SFAS No. 144, "Accounting for the Impairment orDisposal of Long-Lived Assets". SFAS No. 144 supercedes SFAS 121,"Accounting for the Impairment of Long-Lived Assets and for Long-LivedAssets to Be Disposed Of". SFAS No. 144 primarily addresses significantissues relating to the implementation of SFAS No. 121 and develops a singleaccounting model for long-lived assets to be disposed of, whether previouslyheld and used or newly acquired. The provisions of SFAS No. 144 will beeffective for fiscal years beginning after December 15, 2001. Management iscurrently evaluating the impact this statement will have on the Company'sconsolidated financial statements.

 

Note 7 3⁄4Extraordinary Item

 

In August 2001, the Company retired its1999 bank credit facility.  As a resultof the early retirement, the Company wrote off related unamortized debtissuance costs of $2.1 million.

**Item 2—****Management'sDiscussion and Analysis****of Financial Condition and Results of Operations**

 

*Thefollowing discussion and analysis provides information concerning our resultsof operations and financial condition. This discussion should be read in conjunction with the accompanyingconsolidated financial statements and the notes thereto.*

 

***Special Note RegardingForward-Looking Statements****— Certain statements in this QuarterlyReport on Form 10-Q constitute forward-looking statements. 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. Suchforward-looking statements involve known and unknown risks, uncertainties andother factors, which may cause the Company’s actual performance or achievementsto be materially different from any future results, performance or achievementsexpressed or implied by such forward-looking statements.  In addition to the risks and uncertaintiesdiscussed in this Quarterly Report, such factors include, among others, thefollowing:  the impact of competitionand changes to the competitive environment for the Company’s products andservices, changes in technology, reliance on strategic partners, uncertainty oflitigation, changes in government regulation and other factors detailed,  from time to time, in the Company’s filingswith the Securities and Exchange Commission. These forward-looking statements speak only as of the date of thisQuarterly Report.  The Company expresslydisclaims any obligation or undertaking to release publicly any updates orrevisions to any forward-looking statements contained herein to reflect anychange in the Company’s expectations with regard thereto or any change inevents, conditions or circumstances on which any such statement is based.*

 

**Overview**

 

LodgeNet is an interactive services provider specializingin the delivery of interactive television and Internet access services to thelodging industry.  Utilizing broadbandtechnology, the Company provides services throughout the United States, Canadaand select international markets.  Theseservices include on-demand movies, music and music videos, Nintendo® video games, Internet-enhancedtelevision, high-speed Internet access, and other interactive televisionservices designed to serve the needs of the lodging industry and the travelingpublic.

 

*Guest PayInteractive Services.* Guest Payinteractive services are purchased by guests on a per-view, hourly, or dailybasis and include on–demand movies, music and music videos, network–basedNintendo video games, Internet enhanced television, and high-speed Internetaccess services.  Guest Pay packages mayalso include satellite-delivered basic and premium cable television programmingthat is paid for by the hotel and provided to guests at no charge, and otherinteractive services such as video review of room charges, video checkout,guest surveying, advertising and merchandising services.

 

The Company's Guest Pay interactive revenues depend on anumber of factors, including the number of rooms equipped with the Company'ssystems, hotel occupancy rates and guest demographics, and the popularity,pricing, and availability of programming. The primary direct costs of providing Guest Pay interactive services are(i) license fees paid to studios for non–exclusive distributionrights to recently–released major motion pictures, (ii) nominal one–timelicense fees paid for independent films, (iii) license fees for otherinteractive services, (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.

 

TheCompany installed its systems in the following number of rooms, net ofde-installations, during the three months and twelve months ended September 30,2001:

 

|                        |   | **Periods  Ended**      |   |
|-----------------------------|--------|-------------------------|--------|
|                        |   | **September  30, 2001** |   |
|                        |   | Three  Months           |   | Twelve  Months |   |
| Guest Pay interactive rooms |   | 25,146                  |   | 85,382 |   |
| Nintendo video game rooms   |   | 28,777                  |   | 89,871 |   |
| Internet services rooms     |   | 33,383                  |   | 94,945 |   |

 

The room installations for the twelvemonths ended September 30, 2001 represent increases of 12.0% for Guest Payinteractive rooms, 13.2% for Nintendo video game rooms, and 493% for Internetservices rooms over the number of installed rooms at September 30, 2000.  De-installation activity is generally lessthan 2% of the installed number of rooms.

 

TheCompany's base of installed rooms was comprised as follows at September 30:

 

|                             |   | **2001** |   | **2000** |   |
|----------------------------------|--------|----------|--------|----------|--------|
| Guest  Pay interactive rooms (1) |   | 794,359  |   | 708,977  |   |
| Nintendo  video game rooms       |   | 771,678  |   | 681,807  |   |
| Internet  services rooms         |   | 120,199  |   | 20,254   |   |
| Total  rooms served (2)          |   | 874,030  |   | 793,858  |   |

 

(1)– 100% of Guest Pay interactive rooms are served by the Company’s on-demandmovie system (as compared to a scheduled movie system that shows movies atpredetermined times).

 

(2)– Total rooms served represent rooms receiving one or more of the Company’sservices, including rooms served by international licensees.

 

*Free-to-Guestand Other Services.* In addition toGuest Pay interactive services, the Company provides satellite-delivered basicand premium cable television programming for which the hotel, rather than itsguests, pays the charges.  The hotelpays the Company a fixed monthly charge per room for each programming channelprovided. The Company obtains its free–to–guest programmingpursuant to multi–year agreements and pays a monthly fee per room, whichvaries depending on incentive programs in effect from time to time.

 

To meet the needs of its hotel customers related to theCompany’s service offerings, the Company provides a variety of other servicesto its hotel customers including the sale of system equipment and service partsand labor.  Results from these otherservices and free-to-guest services delivered to rooms not receiving Guest Payinteractive services are included in the “other” components of revenues anddirect costs in the statements of operations.

 

*InnMedia LLC.* During the fourth quarter of 2000, the Company entered into anarrangement with Hilton Hotels Corporation to form a new broadband, interactivemedia company, InnMedia LLC, to offer hotel guests new and innovativeinteractive television content such as high speed Internet access through the televisionas well as customized hotel and guest information.  Under this arrangement, InnMedia will supply Internet portal andinteractive television content to Hilton and other hotels using LodgeNet’sbroadband, interactive system.  InnMediawill report the operations of these activities, of which LodgeNet and Hiltonwill equally share, and will pay LodgeNet a fee for use of LodgeNet’ssystem.  The arrangement includes $5million financing commitments from both LodgeNet and Hilton to fund start-upand near-term operational costs.  TheCompany accounts for its investment in InnMedia using the equity method ofaccounting and has recorded equity losses of $1.5 million for the first ninemonths of 2001.

 

InnMedia began deliveryof content and services in the third quarter of 2001 under the arrangementdescribed above.  In connection withthese transactions, the Company charged InnMedia for system access fees of$332,000, connectivity costs of $531,000 and support and administrativeexpenses of $569,000.  As of September30, 2001, the Company had a receivable from InnMedia of $1.5 million and apayable to InnMedia of $720,000.

** **

**Discussion and Analysis of Results of Operations**

**Three Months Ended September 30, 2001 and 2000**

 

*Revenue Analysis*.  The Company's total revenue for the thirdquarter of 2001 increased 9.1%, or $4.8 million, in comparison to the thirdquarter of 2000.  The following tablesets forth the components of revenue (in thousands) for the quarter ending September30:

** **

|       |   | **2001**   |   | **2000**     |   |
|------------|--------|------------|--------|--------------|--------|
|       |   |       |   | **Percent**  |   |   |   | **Percent** |   |
|       |   |       |   | **of Total** |   |   |   | **of Total** |   |
| Revenue:   |   | **Amount** |   | **Revenue**  |   | **Amount** |   | **Revenue** |   |
| Guest  Pay |   | $          | 54,572 |         | 94.6   |   | $ | 50,232 |   | 95.0 |   |
| Other      |   | 3,109      |   | 5.4          |   | 2,662 |   | 5.0 |   |
|       |   | $          | 57,681 |         | 100.0  |   | $ | 52,894 |   | 100.0 |   |

 

GuestPay interactive revenue increased 8.6%, or $4.3 million, in the third quarterof 2001 in comparison to the same quarter of 2000. ** **Thisincrease was attributable to a 11.1% increase in the average number ofinstalled Guest Pay interactive rooms, offset by a 2.3% decrease in averagemonthly revenue per room.  The followingtable sets forth information in regard to average monthly revenue per Guest Payroom for the quarter ending September 30:

** **

|                               |   | **2001** |   | **2000** |   |
|------------------------------------|--------|----------|--------|----------|--------|
| Average  monthly revenue per room: |   |     |   |     |   |
| Movie  revenue                     |   | $        | 18.43  |     | $      | 19.03 |   |
| Other  interactive service revenue |   | 4.93     |   | 4.87     |   |
| Total  per Guest Pay room          |   | $        | 23.36  |     | $      | 23.90 |   |

 

Averagemovie revenue per room decreased 3.2% due to a 550 basis point decrease inoccupancy levels, partially offset by 3.1% increase in average movieprices.  Average other interactiveservice revenue per room increased 1.2% due to increased revenue from Internetaccess services and cable television programming services.

 

Revenue from other sources includes revenue fromfree-to-guest services provided to hotels not receiving Guest Pay services andsales of system equipment and service parts and labor. Other revenue increased$447,000 or 16.8% due to increased equipment sales to international licensees.

 

*Gross Profit.*  Gross profit totaled $32.8 million for thethird quarter ended September 30, 2001, an increase of 4.4% over the thirdquarter of 2000 on a 9.1% increase in revenue.

 

|                  |   | **2001** |   | **2000** |   |
|-----------------------|--------|----------|--------|----------|--------|
| Gross  profit:        |   |     |   |     |   |
| Guest  Pay            |   | $        | 31,718 |     | $      | 29,723 |   |
| Other                 |   | 1,129    |   | 1,737    |   |
|                  |   | $        | 32,847 |     | $      | 31,460 |   |
|                  |   |     |   |     |   |
| Gross  profit margin: |   |     |   |     |   |
| Guest  Pay            |   | 58.1     | %      | 59.2     | %      |
| Other                 |   | 36.3     | %      | 65.3     | %      |
| Composite             |   | 56.9     | %      | 59.5     | %      |

 

Grossprofit on Guest Pay interactive services increased 6.7%, or $2.0 million, on a8.6% increase in related revenue.  GuestPay direct costs (primarily studio license fees, video game license fees andthe commission retained by the hotel) generally tend to vary directly withrevenue.  The gross profit margindecreased from 59.2% to 58.1% primarily due to increased revenue fromfree-to-guest and Internet services which generally earn a lower profit marginin relation to movie revenue.

 

Grossprofit on other services decreased $608,000 or 35.0% in the third quarter of2001 from the prior year quarter and the gross profit margin decreased from65.3% to 36.3%.  These decreases weredue to increased equipment sales tointernational licensees which generally earn a lower profit margin.

 

TheCompany's overall gross profit margin decreased to 56.9% in the current quarterfrom 59.5% in the year earlier quarter due the decreases in gross margin fromGuest Pay interactive services as described above and the shift in sales fromthe more profitable Guest Pay interactive services to other revenue (95.0% inthe third quarter of 2000 to 94.6% in the third quarter of 2001).

 

*Operating Expenses.*  The following table sets forth informationin regard to the Company's operating expenses for the quarter ending September30 (dollar amounts in thousands):

 
|                                 |   | **2001**   |       | **2000**     |       |
|--------------------------------------|--------|------------|------------|--------------|------------|
|                                 |   |       |       | **Percent**  |       |   |   | **Percent** |   |
|                                 |   |       | ** ** | **of Total** | ** ** |   | ** ** | **of Total** |   |
|                                 |   | **Amount** | ** ** | **Revenues** | ** ** | **Amount** | ** ** | **Revenues** |   |
| Operating  expenses:                 |   |       |       |         |       |   |   |   |   |
| Guest  Pay operations                |   | $          | 7,183      |         | 12.4       |   | $ | 7,120 |   | 13.4 |   |
| Selling,  general and administrative |   | 5,340      |       | 9.3          |       | 5,020 |   | 9.5 |   |
| Depreciation  and amortization       |   | 16,295     |       | 28.3         |       | 16,497 |   | 31.2 |   |
| Total  operating expenses            |   | 28,818     |       | 50.0         |       | 28,637 |   | 54.1 |   |
|                                      |        |            |            |              |            |  |  |  |  |  |  |

 

Guest Pay operations expenses consist of costs directlyrelated to the operation of systems at hotel sites. The increase in Guest Payoperations expenses of $63,000 or 0.9% from the prior year quarter was due to a11.1% increase in average installed rooms offset by lower per room operatingcosts as a result of greater operating efficiencies.  Per average installed room, Guest Pay operations expenses were$3.08** **permonth in the third quarter of 2001 as compared to $3.39 per month in the thirdquarter of 2000.

 

Selling, general andadministrative expenses increased $320,000 or 6.4% in the third quarter of 2001compared to the year earlier quarter due to increased payroll related expenses.

 

Depreciation and amortization expenses decreased 1.2% to$16.3 million in the third quarter of 2001 from $16.5 million in the yearearlier quarter.  This decrease was dueto the continued increase in fully-depreciated assets remaining in service,offset by the increase in the number of installed Guest Pay interactive roomsin service since the prior year quarter. As a percentage of revenue, depreciation and amortization expensesdecreased to 28.3% in the current quarter from 31.2% in the third quarter of2000.

 

*Operating Income (Loss).*  Due to increased revenue from Guest Payinteractive services and decreased operating expenses as a percent of revenue,the Company generated operating income of $4.0 million in the third quarter of2001 compared to $2.8 million in the third quarter of 2000.

 

*Investment Losses*.  Global Interactive CommunicationsCorporation – Prior to the second quarter of 2001, the Company owned a minorityinterest in Global Interactive Communications Corporation (“GICC”) resultingfrom the merger transaction involving ResNet Communications LLC (formerly theCompany’s majority-owned subsidiary) in1998.  In the second quarter of 2001,the Company sold its equity interest in GICC and has no further financingobligation to GICC.  No losses wererecorded relating to this investment under the equity method of accounting inthe third quarter of 2001.

 

InnMedia LLC – As previously described,InnMedia was formed by LodgeNet and Hilton during the fourth quarter of2000.  The Company has a 50% equityinterest in InnMedia and recorded losses under the equity method of accountingfor an investment of $790,000 in the third quarter of 2001.

 

*Interest Expense.*  Interest expense increased $738,000 or10.6%, to $7.7 million during the third quarter of 2001 due to increases inlong-term debt to fund the Company's continuing expansion of its business.  Average principal amount of long-term debtoutstanding during the quarter ended September 30, 2001 was approximately $315million (at an average interest rate of approximately 9.8%) as compared to anaverage principal amount outstanding of approximately $282 million** **(atan average interest rate of approximately 9.9%) during the comparable period of2000.

 

*Extraordinary Item.*  The Company retired its February 1999 bankcredit facility during the third quarter of 2001 and recorded an extraordinarycharge of $2.1 million associated with the write off of unamortized debtissuance costs.

 

*Net Loss.*  For the reasons previously described, theCompany's net loss increased to $6.8 million in the third quarter of 2001 froma net loss of $4.1 million in the prior year quarter.

 

*EBITDA.*  EBITDA(defined by the Company as earnings before interest, income taxes,depreciation, amortization and other non-operating income or expenses)increased 5.2% to $20.3 million in the third quarter of 2001 as compared to$19.3 million in the prior year quarter. This increase is primarily due to a 11.1% increase in the average numberof installed rooms receiving Guest Pay interactive services, the relatedincrease in Guest Pay revenue and greater operating efficiencies as describedabove.  As a percentage of totalrevenue, EBITDA decreased to 35.2% in the current quarter compared to 36.5% inthe prior year quarter.

 

EBITDA is not intended to represent analternative to net income or cash flows from operating, financing or investingactivities (as determined in accordance with generally accepted accountingprinciples) as a measure of performance, and is not representative of fundsavailable for discretionary use due to the Company’s financing obligations.EBITDA, as defined by the Company, may not be calculated consistently amongother companies reporting similarly titled measures. EBITDA is included hereinbecause it is a widely accepted financial indicator used by certain investorsand financial analysts to assess and compare companies on the basis ofoperating performance. Management believes that EBITDA provides an importantadditional perspective on the Company's operating results and the Company'sability to service its long–term debt and to fund the Company'scontinuing growth.

** **

**Discussion and Analysis of Results of Operations**

**Nine Months Ended September 30, 2001 and 2000**

 

*Revenue Analysis*.  The Company's total revenue for the ninemonths ended September 30, 2001 increased 10.1%, or $15.1 million, incomparison to the nine months ended September 30, 2000.  The following table sets forth thecomponents of revenue (in thousands) for the nine months ending September 30:

** **

|       |   | **2001**   |       | **2000**     |       |
|------------|--------|------------|------------|--------------|------------|
|       |   |       |       | **Percent**  |       |   |   | **Percent** |   |
|       |   |       | ** ** | **of Total** | ** ** |   | ** ** | **of Total** | ** ** |
| Revenue:   |   | **Amount** | ** ** | **Revenue**  | ** ** | **Amount** | ** ** | **Revenue** | ** ** |
| Guest  Pay |   | $          | 155,676    |         | 95.0       |   | $ | 141,253 |   | 95.0 |   |
| Other      |   | 8,141      |       | 5.0          |       | 7,503 |   | 5.0 |   |
|       |   | $          | 163,817    |         | 100.0      |   | $ | 148,756 |   | 100.0 |   |

 

GuestPay interactive revenue increased 10.2%, or $14.4 million, in the first ninemonths of 2001 in comparison to the same period of 2000. ** **Thisincrease was attributable to a 10.1% increase in the average number ofinstalled Guest Pay interactive rooms. The following table sets forth information in regard to average monthlyrevenue per Guest Pay room for the nine months ending September 30:

** **

|                               |   | **2001** |   | **2000** |   |
|------------------------------------|--------|----------|--------|----------|--------|
| Average  monthly revenue per room: |   |     |   |     |   |
| Movie  revenue                     |   | $        | 18.34  |     | $      | 18.54 |   |
| Other  interactive service revenue |   | 4.59     |   | 4.36     |   |
| Total  per Guest Pay room          |   | $        | 22.93  |     | $      | 22.90 |   |

 

Averagemovie revenue per room decreased slightly due to lower occupancy levels in thefirst nine months of 2001 compared to 2000, partially offset by higher movieprices. Average other interactive service revenue per room increased 5.3% dueto increased revenue from Internet access services and cable televisionprogramming services.

 

Revenue from other sources includes revenue fromfree-to-guest services provided to hotels not receiving Guest Pay services andsales of system equipment and service parts and labor. Other revenue increased$638,000 or 8.5% due to increased equipment sales to international licensees.

 

*Gross Profit.*  Gross profit totaled $94.7 million for thenine months ended September 30, 2001, an increase of 9.1% over the first ninemonths of 2000 on a 10.1% increase in revenue.

 

|                  |   | **2001** |   | **2000** |   |
|-----------------------|--------|----------|--------|----------|--------|
| Gross  profit:        |   |     |   |     |   |
| Guest  Pay            |   | $        | 91,755 |     | $      | 83,498 |   |
| Other                 |   | 2,953    |   | 3,305    |   |
|                  |   | $        | 94,708 |     | $      | 86,803 |   |
|                  |   |     |   |     |   |
| Gross  profit margin: |   |     |   |     |   |
| Guest  Pay            |   | 58.9     | %      | 59.1     | %      |
| Other                 |   | 36.3     | %      | 44.0     | %      |
| Composite             |   | 57.8     | %      | 58.4     | %      |

 

Grossprofit on Guest Pay interactive services increased 9.9%, or $8.3 million, on an10.2% increase in related revenue. Guest Pay direct costs (primarily studio license fees, video gamelicense fees and the commission retained by the hotel) generally tend to varydirectly with revenue.  The gross profitmargin decrease from 59.1% to 58.9% was primarily due to increased revenue fromInternet services which generally earn a lower profit margin in relation tomovie revenue.

 

Grossprofit on other services decreased $352,000 or 10.7% in the first nine monthsof 2001 from the prior year first nine months and the gross profit margindecreased from 44.0% to 36.3%.  Thesedecreases were due to increased equipmentsales to international licensees which generally earn a lower profitmargin.

 

TheCompany's overall gross profit margin decreased to 57.8% in the first ninemonths of this year from 58.4% in the prior year first nine months due to thedecreases in gross margin from Guest Pay interactive services and other revenueas described above.

 

*Operating Expenses.*  The following table sets forth informationin regard to the Company's operating expenses for the period ending September30 (dollar amounts in thousands):

 
|                                 |   | **2001**   |       | **2000**     |       |
|--------------------------------------|--------|------------|------------|--------------|------------|
|                                 |   |       |       | **Percent**  |       |   |   | **Percent** |   |
|                                 |   |       | ** ** | **of Total** | ** ** |   | ** ** | **of Total** |   |
|                                 |   | **Amount** | ** ** | **Revenues** | ** ** | **Amount** | ** ** | **Revenues** |   |
| Operating  expenses:                 |   |       |       |         |       |   |   |   |   |
| Guest  Pay operations                |   | $          | 21,647     |         | 13.2       |   | $ | 20,923 |   | 14.1 |   |
| Selling,  general and administrative |   | 16,050     |       | 9.8          |       | 14,475 |   | 9.7 |   |
| Depreciation  and amortization       |   | 49,168     |       | 30.0         |       | 49,038 |   | 33.0 |   |
| Total  operating expenses            |   | $          | 86,865     |         | 53.0       |   | $ | 84,436 |   | 56.8 |   |

 

Guest Pay operations expenses consist of costs directlyrelated to the operation of systems at hotel sites. The increase in Guest Payoperations expenses of $724,000 or 3.5% from the prior year first nine monthswas due to a 10.1% increase in average installed rooms, partially offset bylower per room operating costs as a result of greater operating efficiencies.  Per average installed room, Guest Payoperations expenses were $3.19** **per month in the first nine months of2001 as compared to $3.39 per month in the same period of 2000.

 

Selling, general andadministrative expenses increased $1.6 million or 10.9% in the first ninemonths of 2001 compared to the year earlier period due to increased payrollrelated expenses and other professional fees. In addition, the Company incurred approximately $250,000 of one-timefees related to an employee benefit plan.

 

Depreciation and amortization expenses increased $130,000or 0.3% to $49.2 million in the first nine months of 2001 from $49.0 million inthe year earlier period.  This increasewas due to the increase in the number of installed Guest Pay interactive roomsin service since the prior year quarter, offset by the continued increase infully-depreciated assets remaining in service. As a percentage of revenue, depreciation and amortization expensesdecreased to 30.0% in the first nine months of 2001 from 33.0% in the year earlierperiod.

 

*Operating Income (Loss).*  Due to increased revenue from Guest Payinteractive services, increased gross profit margin and decreased operatingexpenses as a percent of revenue, the Company generated operating income of$7.8 million in the first nine months of 2001 compared to $2.4 million in thefirst nine months of 2000.

 

*Investment Losses*.  Global Interactive CommunicationsCorporation – Prior to the second quarter of 2001, the Company owned a minorityinterest in Global Interactive Communications Corporation (“GICC”) resultingfrom the merger transaction involving ResNet Communications LLC (formerly theCompany’s majority-owned subsidiary) in1998.  In the second quarter of 2001,the Company sold its equity interest in GICC and has no further financingobligation to GICC.  In the firstquarter of 2001, losses of $183,000 relating to this investment were recordedunder the equity method of accounting.

 

InnMedia LLC – As previously described,InnMedia was formed by LodgeNet and Hilton during the fourth quarter of2000.  The Company has a 50% equityinterest in InnMedia and recorded losses under the equity method of accountingfor an investment of $1.5 million in the first nine months of 2001.

 

*Interest Expense.*  Interest expense increased $1.2 million or6.0%, to $22.1 million in the first nine months of 2001 due to increases inlong-term debt to fund the Company's continuing expansion of its business.  Average principal amount of long-term debtoutstanding during the nine months ended September 30, 2001 was approximately$302 million (at an average interest rate of approximately 9.8%) as compared toan average principal amount outstanding of approximately $282 million** **(atan average interest rate of approximately 9.9%) during the comparable period of2000.

 

*Extraordinary Item. *The Companyretired its February 1999 bank credit facility during the third quarter of 2001and recorded an extraordinary charge of $2.1 million associated with the writeoff of unamortized debt issuance costs.

 

*Net Loss.* For the reasons previously described, theCompany's net loss increased to $18.5 million in the first nine months of 2001from a net loss of $18.4 million in the prior year quarter.

 

*EBITDA.*  EBITDA(defined by the Company as earnings before interest, income taxes,depreciation, amortization and other non-operating income or expenses)increased 10.9% to $57.0 million in the first nine months of 2001 as comparedto $51.4 million in the first nine months of 2000.  This increase is primarily due to a 10.1% increase in the averagenumber of installed rooms receiving Guest Pay interactive services, the relatedincrease in Guest Pay revenue and greater operating efficiencies as describedabove.  As a percentage of total revenue,EBITDA increased to 34.8% in the current period compared to 34.6% in the sameperiod of 2000.

 

EBITDAis not intended 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 becalculated consistently among other companies reporting similarly titledmeasures. EBITDA is included herein because it is a widely accepted financialindicator used by certain investors and financial analysts to assess andcompare companies on the basis of operating performance. Management believesthat EBITDA provides an important additional perspective on the Company'soperating 

resultsand the Company's ability to service its long–term debt and to fund theCompany's continuing growth.

 

**Recent Accounting Developments**

 

SeeNote 6 in the notes to consolidated financial statements.

 

**Seasonality**

 

TheCompany's quarterly operating results are subject to fluctuation depending uponhotel occupancy rates and other factors. Typically, occupancy rates are higher during the second and thirdcalendar quarters due to seasonal travel patterns.

 

**Liquidityand Capital Resources**

 

Historically, the growth of the Company’s business hasrequired substantial amounts of capital. The Company has incurred operating and net losses due in large part tothe depreciation, amortization and interest expenses related to the capitalrequired to expand its business. Historically, cash flow from operations has not been sufficient to fundthe cost of expanding the Company's business and to service existingindebtedness.  For 2000, capital expenditureswere $60.2 million and net cash provided by operating activities was $41.2million.  During the first nine monthsof 2001, capital expenditures were $60.5 million as compared to $44.1 millionin the first nine months of 2000, and net cash provided by operating activitieswas $37.8 million as compared to $33.6 million in the same period of 2000.

 

Depending on the rate of growth of its business and otherfactors, the Company expects to incur capital expenditures between $16 to $19million during the remaining three months of 2001 and $70 to $80 million in2002.  The Company’s cash requirementsfor 2002 are expected to include $8.1 million of payments for principalmaturities of long-term debt.  Inaddition, the Company has committed up to $5 million of financing to InnMediaLLC, of which $2.5 million had been funded as of September 30, 2001.  The Company has funded the remaining $2.5million during the fourth quarter of 2001.

 

The Company believes that its operating cash flows andborrowings available under its new $75 million revolving credit facility willbe sufficient to fund the Company’s future growth and financing obligations, ascontemplated under its current five-year business plan, depending on the rateof growth of its business and other factors. The Company may increase the revolving credit facility to $100 million,subject to certain conditions.

 

The foregoing statements regarding capital expendituresand cash requirements are forward-looking statements and there can be noassurance in this regard.  The actualamount and timing of the Company’s capital expenditures 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.

 

**September 11th Impact**

 

The tragic events of September 11thhad an adverse effect on the overall travel industry. Occupancy rates for thelodging industry following the attacks of September 11th were downsignificantly from the same period of 2000. While all hotel properties were affected by the attacks, occupancydeclines were most pronounced in the urban and airport type properties, asdefined by Smith Travel Services. Properties defined as highway and suburbanproperties were less impacted. The Company’s business is clearly linked to theeffects of changes in occupancy rates.

 

Geographically, the Company’s room baseis diversified with more than two-thirds of properties served being in highwayor suburban locations. In addition, less than 5% of the room base isconcentrated in the top ten urban areas of the United States. By serving a widevariety of geographically dispersed properties, the Company mitigates relianceon any one geographic sector.

 

Since the initial decline in occupancyrates during the two to three weeks following September 11th,occupancy rates have been improving but remain below the levels experienced inthe prior year. During the fourth quarter of 2001, occupancy rates areforecasted to continue improving but are expected to remain substantially belowthe levels of the fourth quarter of 2000.

 

 

To help mitigate the decline of occupancyon operating profit and EBITDA, the Company has taken steps to reduce operatingexpenses and capital spending.  TheCompany plans to reassess its operating and capital expenditure plansperiodically to respond to changes in the economic environment.

 

**Item 3 — Quantitative and Qualitative DisclosuresAbout Market Risk**

 

The Company is exposed to various market risks, includingpotential losses resulting from adverse changes in interest rates and foreigncurrency exchange rates. The Company does not enter into derivatives or otherfinancial instruments for trading or speculative purposes.

 

*Interest.* At September 30,2001, the Company had debt totaling $326 million.  The Company has interest rate swap arrangements covering debtwith a notional amount of $100 million to effectively change the underlyingdebt from a variable interest rate to a fixed interest rate for the term of theswap agreements.  After giving effect tothe interest rate swap arrangements the Company had fixed rate debt of $276million and variable rate debt of $50 million at September 30, 2001.  For fixed rate debt, interest rate changesaffect the fair market value but do not impact earnings or cash flows.  Conversely, for variable rate debt, interestrate changes generally do not affect the fair market value but do impact futureearnings and cash flows, assuming other factors are held constant. Assuming othervariables remain constant (such as debt levels), a one percentage pointincrease in interest rates would decrease the unrealized fair market value ofthe fixed rate debt by an estimated $24.5 million.  The impact on earnings and cash flow for the next year resultingfrom a one percentage point increase in interest rates would be approximately$500,000 assuming other variables remain constant.

 

*ForeignCurrency Transactions.*  A portion of the Company’s revenues arederived from the sale of Guest Pay services in Canada.  The results of operations and financialposition of the Company’s operations in Canada are measured in Canadian dollarsand translated into U.S. dollars.  Theeffects of foreign currency fluctuations in Canada are somewhat mitigated by thefact that expenses and liabilities are generally incurred in Canadian dollars.The reported income of the Company’s Canadian subsidiary will be higher orlower depending on a weakening or strengthening of the U.S. dollar against theCanadian dollar.  In addition, a portionof the Company’s assets are based in Canada and are translated into U.S.dollars at foreign currency exchange rates in effect as of the end of eachperiod.  Accordingly, the Company’sconsolidated assets will fluctuate depending on the weakening or strengtheningof the U.S. dollar against the Canadian dollar.  No significant foreign currency fluctuations occurred in thethird quarter of 2001 to materially impact consolidated results of operationsor financial condition.

 

 

**Part II — Other Information**

 

**Item 1 — Legal Proceedings**

 

TheCompany is subject to litigation arising in the ordinary course ofbusiness.  As of the date hereof, theCompany believes the resolution of such litigation will not have a materialadverse effect upon the Company's financial condition or results of operations.

 

**Item 2 — Changes in Securities and Use ofProceeds**

 

Notapplicable.

 

**Item 3 — Defaults Upon Senior Securities**

 

Notapplicable.

 

**Item 4  — Submissionof Matters to a Vote of Security Holders**

 

Therewere no matters submitted to a vote of security holders during the quarterended September 30, 2001.

 

# **Item 5 — Other Information**

 

Notapplicable.

 

**Item 6 — Exhibits and Reports on Form 8-K**

 

**a.     Exhibits:**

 

10.37  Amendment No. 1 to Restated Certificate ofIncorporation of LodgeNet Entertainment

Corporation.

 

10.38  Credit Agreement Dated as of August 29, 2001by and among LodgeNet Entertainment Corporation, Canadian Imperial Bank ofCommerce, Bear Stearns Corporate Lending, Inc., U. S. Bank NationalAssociation, Fleet National Bank and the Lenders Named Therein.

 

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

 

                The Company filed no Reports onForm 8-K during the quarter ended September 30, 2001.

 

**Signatures**

 

Pursuantto the requirements of the Securities and Exchange Act of 1934, the Registranthas duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized.

 
|                          |   |   |   |         |                               | **LodgeNet Entertainment Corporation**          |   |   |   |   |
|-------------------------------|--------|--------|--------|--------------|------------------------------------|-------------------------------------------------|--------|--------|--------|--------|
|                          |   |   |   | (Registrant) |                               |                                            |   |   |
|                          |   |   |   |         |                               |                                            |   |   |   |   |   |   |
| Date:  November 12, 2001 |   |   |   |         | **/ s /  Scott C.  Petersen** |                                            |   |   |   |
|                          |   |   |   |         | Scott C. Petersen                  |                                            |   |   |   |   |   |
|                          |   |   |   |         |                               | President and Chief  Executive Officer          |   |   |   |   |
|                          |   |   |   |         |                               | (Principal Executive  Officer)                  |   |   |   |   |
|                          |   |   |   |         |                               |                                            |   |   |   |   |   |   |
| Date:  November 12, 2001 |   |   |   |         | **/ s /  Gary H.  Ritondaro** |                                            |   |   |   |
|                          |   |   |   |         |                               | Gary H. Ritondaro                               |   |   |   |   |   |   |
|                          |   |   |   |         |                               | Senior Vice President,  Chief Financial Officer |   |   |   |   |
|                          |   |   |   |         |                               | (Principal Financial  Officer)                  |   |   |   |   |
|                               |        |        |        |              |                                    |                                                 |        |        |        |        |  |  |  |  |