Table of Contents

  **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, 2006******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****LodgeNetEntertainment Corporation**(Exact name of registrant as specified in its charter)   **Delaware** **46-0371161**   (State or other jurisdiction of (I.R.S. Employerincorporation 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 reportIndicate by check mark whether the Registrant (1) has filed all reports required to be filedby Section 13 or 15(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 beensubject to such filing requirements for the past 90 days. Yes þ No o.Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer ora non-accelerated filer (as defined in Exchange Act Rule 12b-2).     Large accelerated filer o Accelerated filer þ Non-accelerated filer oIndicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yeso No þAt May 4, 2006, there were 18,358,093 shares outstanding of the Registrant’s common stock, $0.01par value.  
 

 
 LodgeNet Entertainment Corporation Form 10-Q**LodgeNet Entertainment Corporation and Subsidiary****Index**       Page   No. **Part I. Financial Information**         Item 1 — Financial Statements:    Consolidated Balance Sheets (Unaudited) as of March 31, 2006 and December 31, 2005   3 Consolidated Statements of Operations (Unaudited) for the Three Months Ended March 31, 2006 and 2005   4 Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended March 31, 2006 and 2005   5 Notes to Consolidated Financial Statements (Unaudited)  6 Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations  15 Item 3 — Quantitative and Qualitative Disclosures About Market Risk  33 Item 4 — Controls and Procedures   33      **Part II. Other Information**         Item 1 — Legal Proceedings  34 Item 1A — Risk Factors  34 Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds   34 Item 3 — Defaults Upon Senior Securities  34 Item 4 — Submission of Matters to a Vote of Security Holders  34 Item 5 — Other Information  34 Item 6 — Exhibits   34      **Signatures**  35  Rule 13a-14(a)/15(d)-14(a) Certification of CFO Rule 13a-14(a)/15(d)-14(a) Certification of CEO Section 1350 Certifications As used herein (unless the context otherwise requires) “LodgeNet” and/or the “Registrant,” as wellas the terms “we,” “us” and “our” refer to LodgeNet Entertainment Corporation and its consolidatedsubsidiary.“LodgeNet ”, the LodgeNet logo, “SigNETure TV”, “SigNETure PC”, “SigNETure HDTV, and “HotelSportsNET” are service marks or registered trademarks of LodgeNet Entertainment Corporation; allother trademarks or service marks used herein are the property of their respective owners.March 31, 2006
Page 2

Table of Contents
 LodgeNet Entertainment Corporation Form 10-Q**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,  December 31,   2006  2005 Assets        Current assets:        Cash and cash equivalents $19,599  $20,742 Accounts receivable, net  31,663   29,617 Prepaid expenses and other  2,458   2,629        Total current assets  53,720   52,988          Property and equipment, net  196,446   199,882 Debt issuance costs, net  6,916   7,423 Intangible assets, net  1,573   2,007 Other assets  2,671   772        Total assets $261,326  $263,072                 Liabilities and Stockholders’ Deficiency        Current liabilities:        Accounts payable $19,203  $16,036 Current maturities of long-term debt  2,645   2,749 Accrued expenses  17,867   15,322 Deferred revenue  6,535   5,143        Total current liabilities  46,250   39,250          Long-term debt  278,755   289,251 Other long-term liabilities  4,189   2,541 Derivative instruments  2,036   2,263        Total liabilities  331,230   333,305                 Commitments and contingencies                 Stockholders’ 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;18,286,143 and 18,165,643 shares outstanding at March 31,2006 and December 31, 2005, respectively  183   182 Additional paid-in capital  233,140   232,327 Accumulated deficit  (304,961)  (304,307)Accumulated other comprehensive income  1,734   1,565        Total stockholders’ deficiency  (69,904)  (70,233)       Total liabilities and stockholders’ deficiency $261,326  $263,072        The accompanying notes are an integral part of these consolidated financial statements.March 31, 2006
Page 3

Table of Contents
 LodgeNet Entertainment Corporation Form 10-Q**LodgeNet Entertainment Corporation and Subsidiary****Consolidated Statements of Operations (Unaudited)**(Dollar amounts in thousands, except share data)           Three Months Ended March 31,   2006  2005 Revenues:        Guest Pay $68,208  $64,152 Other  1,985   1,837        Total revenues  70,193   65,989                 Costs and Expenses:        Direct costs (exclusive of operating expenses anddepreciation and amortization shown separatelybelow) :        Guest Pay  30,686   28,344 Other  909   916 Operating expenses:        Guest Pay operations  8,786   8,622 Selling, general and administrative  6,892   6,072 Depreciation and amortization  16,915   17,992        Total costs and operating expenses  64,188   61,946                 Income from operations  6,005   4,043          Other Income and Expenses:        Interest expense  (6,533)  (7,454)Write-off of debt issuance costs  (129)  — Other income (expense)  126   (75)                Loss before income taxes  (531)  (3,486)Provision for income taxes  (123)  (118)                Net loss $(654) $(3,604)                Net loss per common share (basic and diluted) $(0.04) $(0.20)                Weighted average shares outstanding (basic and diluted)  18,125,623   17,679,872        The accompanying notes are an integral part of these consolidated financial statements.March 31, 2006
Page 4

Table of Contents
 LodgeNet Entertainment Corporation Form 10-Q**LodgeNet Entertainment Corporation and Subsidiary****Consolidated Statements of Cash Flows (Unaudited)**(Dollar amounts in thousands)           Three Months Ended March 31,   2006  2005 Operating activities:        Net loss $(654) $(3,604)Adjustments to reconcile net loss to net cash providedby operating activities:        Depreciation and amortization  16,915   17,992 Write-off of debt issuance costs  129   — Share-based compensation  669   57 Change in operating assets and liabilities:        Accounts receivable  (2,041)  (1,417)Prepaid expenses and other  141   54 Accounts payable  3,164   235 Accrued expenses and deferred revenue  3,612   4,784 Other  31   112        Net cash provided by operating activities  21,966   18,213                 Investing activities:        Property and equipment additions  (12,518)  (12,553)       Net cash used for investing activities  (12,518)  (12,553)                Financing activities:        Repayment of long-term debt  (10,375)  (375)Proceeds from lease transaction  —   1,022 Payment of capital lease obligations  (354)  (291)Exercise of stock options  145   1,870        Net cash (used for) provided by financing activities  (10,584)  2,226                 Effect of exchange rates on cash  (7)  —        Increase (decrease) in cash and cash equivalents  (1,143)  7,886 Cash and cash equivalents at beginning of period  20,742   24,995                 Cash and cash equivalents at end of period $19,599  $32,881        The accompanying notes are an integral part of these consolidated financial statements.March 31, 2006
Page 5

Table of Contents
 LodgeNet Entertainment Corporation Form 10-Q**LodgeNet Entertainment Corporation and Subsidiary****Notes to Consolidated Financial Statements (Unaudited)**Note 1 — Basis of PresentationThe accompanying consolidated financial statements as of March 31, 2006, and for the three monthperiods ended March 31, 2006 and 2005, have been prepared by us, without audit, pursuant to therules and regulations of the Securities and Exchange Commission (the “Commission”). Theinformation furnished in the accompanying consolidated financial statements reflects alladjustments, consisting of normal recurring adjustments, which, in our opinion, are necessary for afair statement of such financial statements.Certain information and footnote disclosures, normally included in annual financial statementsprepared in accordance with generally accepted accounting principles, have been condensed oromitted pursuant to the rules and regulations of the Commission. Although we believe that thedisclosures are adequate to make the information presented herein not misleading, it is recommendedthat these unaudited consolidated financial statements be read in conjunction with the moredetailed information contained in our Annual Report on Form 10-K for 2005, as filed with theCommission. The results of operations for the three-month periods ended March 31, 2006 and 2005are not necessarily indicative of the results of operations for the full year due to inherentseasonality within the business, among other factors.The consolidated financial statements include the accounts of LodgeNet Entertainment Corporationand its wholly-owned subsidiary. All significant inter-company accounts and transactions have beeneliminated in consolidation. We manage our operations as one reportable segment.Note 2 — Share-Based CompensationThe LodgeNet Entertainment Corporation 2003 Stock Option and Incentive Plan (the “2003 Plan”)provides for the award of incentive stock options, non-qualified stock options, restricted stock(non-vested shares), stock appreciation rights and phantom stock units. The stockholders approvedand adopted this plan at the 2003 Annual Meeting. As of March 31, 2006 there were 900,000 sharesauthorized under this plan and 157,378 shares available for grant. The Board of Directors hasrecommended an amendment to the 2003 Plan that would allow for an additional 600,000 shares to beauthorized. This amendment is scheduled for shareholder consideration and vote at our AnnualMeeting, to be held in May 2006. If approved, the total authorized shares under the 2003 Planwould be 1,500,000. The amendment also does the following: 1) prohibits the re-pricing of optionswithout shareholder approval, except in the case of adjustments required by stock splits,recapitalization, plans of exchange and similar transactions, 2) limits the number of options andthe value of restricted stock (non-vested shares) granted to any single participant in any fiscalyear, and 3) allows the Administrator the appropriate discretion in determining the form and levelof awards to non-employee directors. In addition to the stock option and non-vested share awardscurrently outstanding under the 2003 Plan, we have stock options outstanding under previouslyapproved plans, which are inactive.Certain officers, directors and key employees have been awarded non-vested shares (restrictedstock) and options to purchase common stock of LodgeNet under the 2003 Plan and other prior plans.Stock options issued under the plans have an exercise price equal to the fair market value, asdefined by the terms of the plan, on the date of grant. The options become exercisable inaccordance with vesting schedules determined by the Compensation Committee of the Board ofDirectors, and expire ten years after the date of grant. Restrictions applicable to non-vestedshares (restricted stock) lapse based either on performance or service standards as determined bythe Compensation Committee of the Board of Directors. We currently do not have a stock repurchaseprogram, which would allow us to issue awards from treasury shares, therefore stock optionexercises and non-vested share awards are new issues of common stock.Prior to January 1, 2006, we accounted for our stock option and incentive plans under therecognition and measurement provisions of APB Opinion No. 25, *Accounting for Stock Issued toEmployees*, and relatedInterpretations, as permitted by FASB Statement No. 123, *Accounting for Stock-Based Compensation*.Accordingly,March 31, 2006
Page 6

Table of Contents
 LodgeNet Entertainment Corporation Form 10-Qcompensation costs for stock options were measured as the excess, if any, of thequoted market price of our stock at the date of grant over the amount an employee must pay toacquire the stock. Effective January 1, 2006, we adopted FASB Statement No. 123(R), *Share-BasedPayment*, which requires the measurement and recognition of compensation expense for all stock-basedawards based on estimated fair values. In March 2005, the SEC issued Staff Accounting Bulletin No.107 (“SAB 107”) providing supplemental implementation guidance for Statement 123(R). We haveapplied the provisions of SAB 107 in our adoption of Statement 123(R). We adopted Statement 123(R)using the modified prospective transition method. In accordance with that method, the consolidatedfinancial statements for prior periods have not been restated to reflect, and do not include, theimpact of Statement 123(R). Share-based compensation expense recognized in 2006 under Statement123(R) includes: (a) compensation cost for all share-based payments granted prior to, but not yetvested as of January 1, 2006 and (b) compensation cost for all share-based payments grantedsubsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with theprovisions of Statement 123(R).As a result of adopting Statement 123(R), we recognized compensation expense related to stockoptions of $493,000 for the quarter ended March 31, 2006. Additionally, compensation expenserelated to non-vested shares (restricted stock) in the amount of $176,000 was recognized during theperiod, for a total share-based compensation expense of $669,000 in the first quarter of 2006. Asa result of the adoption, included within the reported net loss of $(654,000) was an additionalexpense of $612,000 or $(0.04) per share in the first quarter of 2006 versus an expense of $57,000in the first quarter of 2005. For the quarter ended March 31,2006, we did not issue stock options to employees. We may issue stockoptions only to non-employee directors for the balance of 2006.Cash received from stock option exercises for the quarters ended March 31, 2006 and 2005 was$145,000 and $1,870,000, respectively. Statement 123(R) requires that the cash retained as aresult of the tax deductibility of employee share-based awards be presented as a component of cashflows from financing activities in the consolidated statement of cash flows. Due to our netoperating loss position, we did not recognize a tax benefit from options exercised under theshare-based payment arrangements. As a result of adopting Statement 123(R), our cash flow fromoperating activities for the quarter ended March 31, 2006 included non-cash compensation expenserelated to stock options of $493,000 and non-cash compensation expense in the amount of $176,000related to non-vested shares (restricted stock).*Pro Forma Information under Statement 123*The following table illustrates the effect on net income and earnings per share if we had appliedthe fair value recognition provisions of Statement 123 to options granted under our stock optionplan for the three months ended March 31, 2005. For purposes of this pro forma disclosure, thevalue of the options was estimated using the Black-Scholes-Merton option-pricing formula at date ofgrant and amortized to expense over the options’ vesting periods (dollars amounts in thousands,except per share data).       March 31,   2005 Net loss, as reported $(3,604)Add: stock based employee compensation expense included inreported net loss  57 Less: stock based employee compensation expense determined underfair value method, net of related tax effects  (768)    Net loss, pro forma $(4,315)         Loss per share (basic and diluted)    As reported $(0.20)Pro forma  (0.24)March 31, 2006
Page 7

Table of Contents
 LodgeNet Entertainment Corporation Form 10-Q*Stock Option Valuation and Expense Information under Statement 123(R)*We did not grant stock options during the quarter ended March 31, 2006. Had options been granted,the applicable valuation methodology would be the Black-Scholes-Merton option-pricing model, whichis an acceptable model to estimate the fair value of stock options in accordance with Statement123(R). The Black-Scholes-Merton model requires the use of exercise behavior data and the use of anumber of assumptions including volatility of the stock price, the weighted average risk-freeinterest rate, and the weighted average expected life of the options. We do not pay dividendstherefore the dividend rate variable in the Black-Scholes-Merton model is zero.The risk-free interest rate assumption is based upon observed interest rates on zero coupon U.S.Treasury bonds whose maturity period is appropriate for the term of our stock options and iscalculated by using the average monthly yield for the twelve months preceding the grant date.The volatility assumption is calculated as the annualized standard deviation of the naturallogarithms of relative stock prices over the option’s expected term and is based on monthlyhistorical stock prices through the month preceding the grant date.The expected life of stock options granted to employees represents the weighted average of theresult of the “simplified” method applied to “plain vanilla” options granted during the period, asprovided within Staff Accounting Bulletin No. 107 (“SAB 107”). The expected life of stock optionsgranted to non-employee directors represents the weighted average period that those options areexpected to remain outstanding and is based on analysis of historical behavior of non-employeedirector option holders. There were no options granted during the quarter ended March 31, 2006.Prior to the adoption of Statement 123(R), we used five years as the expected term for the purposesof pro forma information under Statement 123, as disclosed in our Notes to Consolidated FinancialStatements for the related periods.Share-based compensation expense recognized in our results for the quarter ended March 31, 2006 isbased on awards ultimately expected to vest and has been reduced for estimated forfeitures.Statement 123(R) requires forfeitures to be estimated at the time of grant and revised insubsequent periods if actual forfeitures differ from those estimates. Our forfeiture rates wereestimated based on our historical experience. Prior to adoption of Statement 123(R), we accountedfor forfeitures as they occurred for the purposes of our pro forma information under Statement 123,as disclosed in the Notes to Consolidated Financial Statements for the related periods.The weighted average fair value of options granted and the assumptions used in theBlack-Scholes-Merton model during the quarters ended March 31 are set forth in the table below.There were no options granted during the quarter ended March 31, 2006. If options had been grantedduring the quarter, the assumptions used would have approximated these values.           March 31, 2006 March 31, 2005Weighted average fair value of options granted  n/a  $9.02 Dividend yield  0.0%  0.0%Weighted average risk-free interest  4.4%  3.4%Weighted average expected volatility  53.4%  55.8%Weightedaverage expected life — employee 6.25 years 5.0 yearsWeightedaverage expected life — non-employee director 8.47 years 5.0 yearsMarch 31, 2006
Page 8

Table of Contents
 LodgeNet Entertainment Corporation Form 10-QThe following is a summary of the stock option activity for the quarter ended March 31, 2006:                   Three Months Ended         March 31, 2006  Weighted          Weighted  Average          Average  Remaining  Aggregate       Exercise  Term  Intrinsic   Options  Price  in Years  Value Outstanding, beginning of period  2,492,075  $16.33         Granted  —   —         Exercised  (14,300)  10.09         Forfeited/canceled  (27,200)  22.71                         Outstanding, end of period  2,450,575  $16.30   5.4  $3,077,335                                  Outstanding, net of expectedforfeiture  2,446,237  $16.31   5.6  $3,059,346                                  Options exercisable, end of period  2,349,200  $16.50   5.3  $2,659,394                 The aggregate intrinsic value in the table above represents the difference between the closingstock price on March 31, 2006 and the exercise price, multiplied by the number of in-the-moneyoptions that would have been received by the option holders had all option holders exercised theiroptions on March 31, 2006. The total intrinsic value of options exercised during the quarter wasapproximately $79,000.As of March 31, 2006, unrecognized share-based compensation related to unvested options wasapproximately $441,000, net of estimated forfeitures. These costs are to be recognized over aweighted average period of 13 months. Outstanding options to purchase shares expire in 2006 though2015. 26,450 share options with a weighted average exercise price of $23.06 expired in the firstquarter of 2006.*Non-Vested Shares (Restricted Stock)*In January 2006, 2005 and 2004, we awarded 21,500, 21,500 and 22,500 shares of time-basedrestricted stock (non-vested shares), respectively, to certain officers pursuant to our 2003 StockOption and Incentive Plan. The shares vest over four years from the date of grant with 50% vestedat the end of year three and 50% at the end of year four. The fair value of the non-vested sharesis equal to the fair market value, as defined by the terms of the 2003 Plan, on the date of grantand is amortized ratably over the vesting period. We recorded $79,000 and $57,000 as compensationexpense related to time-based restricted stock during the quarters ended March 31, 2006 and 2005,respectively. Also in January 2006, we awarded 84,700 shares of performance-based restricted stock(non-vested shares) to certain officers that vest according to the terms of our Restricted StockAgreement for Performance-Based Vesting. The fair value of the Performance-Based restricted stockis currently being amortized ratably over the period that the performance metric is being measured.We currently expect to achieve these performance goals. If such goals are not met, nocompensation cost is ultimately recognized and any amount of previously recognized compensationcost will be reversed. We recorded $97,000 as compensation expense related to performance-basedrestricted stock during the quarter ended March 31, 2006.March 31, 2006
Page 9

Table of Contents
 LodgeNet Entertainment Corporation Form 10-QA summary of the status of non-vested shares and changes as of March 31, 2006 is set forth below:                       Three Months Ended       March 31, 2006   Time Based  Performance Based       Weighted      Weighted   Non-  Average  Non-  Average   vested  Grant-date  vested  Grant-date   Shares  Fair Value  Shares  Fair Value Non-vested sharesoutstanding,beginning of period  44,000  $18.01   —  $— Granted  21,500   13.76   84,700   13.71 Vested  —   —   —   — Forfeited/canceled  —   —   —   —                Non-vested sharesoutstanding, end ofperiod  65,500  $16.61   84,700  $13.71                As of March 31, 2006, unrecognized stock based compensation related to non-vested time basedvesting shares and performance based vesting shares was approximately $657,000 and $1,064,000,respectively. These costs are to be recognized over a weighted average period of 33 months. Nonon-vested shares vested during the quarter ended March 31, 2006.Note 3 — Property and Equipment, NetProperty and equipment was comprised as follows (in thousands of dollars):           March 31,  December 31,   2006  2005 Land, building and equipment $83,705  $83,267 Free-to-guest equipment  34,192   33,989 Guest Pay systems:        Installed system costs  451,575   450,754 Customer acquisition costs  52,795   52,264 System components  25,446   25,336 Software costs  22,219   21,889        Total  669,932   667,499 Less — depreciation and amortization  (473,486)  (467,617)       Property and equipment, net $196,446  $199,882        Note 4 — Intangible AssetsWe have intangible assets consisting of certain acquired technology, patents, trademarks andlicensee fees. We account for these assets on an ongoing basis in accordance with SFAS No. 142,“Goodwill and Other Intangible Assets”. The intangible assets have been deemed to have definiteuseful lives based on several factors including our anticipation of technological changesassociated with increasing accessibility to the Internet by the traveler, the economic viability ofcharging a hotel guest to access the Internet through the television, and a finite market potentialfor the products acquired. Intangible assets are amortized over their current estimated usefullives ranging from three to five years.March 31, 2006
Page 10

Table of Contents
 LodgeNet Entertainment Corporation Form 10-QWe have the following intangible assets (in thousands of dollars):                   March 31, 2006  December 31, 2005   Carrying  Accumulated  Carrying  Accumulated   Amount  Amortization  Amount  Amortization Assets subject toamortization:                Acquired technology $10,280  $10,280  $14,291  $14,150 Acquired intangibles  5,774   4,234   5,774   3,945 Other  454   421   497   460                $16,508  $14,935  $20,562  $18,555              In thefirst quarter of 2006, we retired an asset no longer in service andreduced the carrying amount and related accumulated amortization of$4.0 million. We recorded amortization expense of $435,000 and $655,000, respectively, for the three months endedMarch 31, 2006 and 2005. We estimate amortization expense for the nine months remaining in 2006 tobe $878,000 and for the full year ending December 31, 2007 — $695,000. Actual amounts may changefrom such estimated amounts due to additional intangible asset acquisitions, potential impairment,accelerated amortization, or other events.Note 5 — Earnings Per Share ComputationWe follow SFAS No. 128, “Earnings Per Share” (EPS), which requires the computation and disclosureof two EPS amounts, basic and diluted. Basic EPS is computed based only on the weighted averagenumber of common shares actually outstanding during the period. Diluted EPS is computed based onthe weighted average number of common shares outstanding plus all potentially dilutive commonshares outstanding during the period. Potential common shares that have an anti-dilutive effectare excluded from diluted earnings per share.The loss per common share for the three months ended March 31, 2006 and 2005 is based on 18,125,623and 17,679,872 weighted average shares outstanding during the respective periods. Potentialdilutive common shares were not included in the computation of diluted earnings per share becausetheir inclusion would be anti-dilutive. As of March 31, 2006 and 2005, the number of potentialdilutive common shares was approximately 4,360,000 and 4,540,000, respectively. Such potentialdilutive common shares consist of stock options, restricted stock and warrants.Note 6 — Accrued ExpensesAccrued expenses were comprised as follows (in thousands of dollars):           March 31, 2006  December 31, 2005 Accrued taxes $3,845  $3,679 Accrued compensation  3,501   5,803 Accrued interest  5,963   1,100 Other  4,558   4,740           $17,867  $15,322        March 31, 2006
Page 11

Table of Contents
 LodgeNet Entertainment Corporation Form 10-QNote 7 — Long-term Debt and Credit FacilitiesLong-term debt was comprised as follows (in thousands of dollars):           March 31,  December 31,   2006  2005 Bank Credit Facility:        Bank term loan $79,250  $89,625 Revolving credit facility  3⁄4   3⁄4 9.50% senior notes  200,000   200,000 Capital leases  2,150   2,375           281,400   292,000 Less current maturities  (2,645)  (2,749)         $278,755  $289,251        *Bank Credit Facility*3⁄4 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 beincreased to $100.0 million, subject to certain limitations. The term loan matures in August 2008and quarterly repayments of $375,000 began in December 2001. The term loan bears interest at ouroption of (1) the bank’s base rate plus a margin of 1.50% or (2) LIBOR plus a margin originallyestablished at 4.00%. In January 2004, LodgeNet and the holders of the term loan amended the LIBORpricing to be LIBOR plus a margin of 3.50%. In April 2004, LodgeNet and the holders of the termloan executed another amendment to establish the LIBOR pricing at LIBOR plus a margin of 2.75%. InJuly 2005, LodgeNet and the holders of the term loan again executed an amendment to establish theLIBOR pricing at LIBOR plus a margin of 2.25%. The term loan interest rate as of March 31, 2006was 7.08% based on LIBOR pricing. The revolving credit facility matures in August 2007 and loansbear interest at our option of (1) the bank’s base rate plus a margin of 1.00% to 2.00%, or (2)LIBOR plus a margin of 2.25% to 3.25%. As of March 31, 2006, there were no amounts outstandingunder the revolving credit facility. Loans under the Credit Facility are collateralized by a firstpriority interest in all of our assets. As of March 31, 2006, we had $69.0 million of borrowingavailable under the revolver portion of the bank Credit Facility.The facility provides for the issuance of letters of credit up to $10.0 million, subject tocustomary terms and conditions. As of March 31, 2006, we had outstanding letters of credittotaling $2.0 million.The facility includes terms and conditions which require compliance with a material adverse effectcovenant as well as the maintenance of certain financial ratios and places limitations on capitalexpenditures, additional indebtedness, liens, investments, guarantees, asset sales and certainpayments or distributions in respect of the common stock. Our consolidated total leverage ratiowas 2.99 compared to the maximum allowable of 3.75, the consolidated senior secured leverage ratiowas 0.87 compared to the maximum allowable of 2.25 and the consolidated interest coverage ratio was3.38 compared to the minimum allowable of 2.75. As of March 31, 2006, we were in compliance withthe financial covenants of the bank Credit Facility.*9.50% Senior Notes*3⁄4 In September 2003, we issued $200.0 million of unsecured 9.50% SeniorSubordinated Notes (the “9.50% Notes”), due September 15, 2013. The 9.50% Notes are unsecured, aresubordinated in right of payment to all existing and future senior debt of LodgeNet and rank *paripassu*in 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 toincur additional indebtedness, create liens, pay dividends or make certain distributions withrespect to our common stock, redeem capital stock, issue or sell stock of subsidiaries in certaincircumstances, effect certain business combinations and effect certain transactions with affiliatesor stockholders. As of March 31, 2006, we were in compliance with the financial covenants of the9.50% 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), decliningratably 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 unpaidinterest) with the cash proceeds of certain equity offerings.March 31, 2006
Page 12

Table of Contents
 LodgeNet Entertainment Corporation Form 10-Q*Capital Leases*— As of March 31, 2006, we have total capital lease obligations of $2,331,000.Equipment acquired under capital lease arrangements during the three months ended March 31, 2006totaled $128,000.Long-term debt has the following scheduled maturities for the nine months remaining in 2006 and thefull years ending December 31, 2007 and after (in thousands of dollars):                           2006  2007  2008  2009  2010  Thereafter Long-term debt $1,125  $1,500  $76,625  $—  $—  $200,000 Capital leases  1,009   871   335   107   9   —                       2,134   2,371   76,960   107   9   200,000                          Less amountrepresentinginterest on capitalleases  (93)  (61)  (21)  (5)  (1)  —                      $2,041  $2,310  $76,939  $102  $8  $200,000                    During the first quarter of 2006, we prepaid $10.0 million on our term loan and wrote-off $129,000of related debt issuance costs.We do not utilize special purpose entities or off-balance sheet financial arrangements.Note 8 3⁄4 Comprehensive Income (Loss)Statement of Financial Accounting Standard No. 130, “Reporting Comprehensive Income,” providesstandards for reporting and disclosure of comprehensive income (loss) and its components.Comprehensive income (loss) reflects the changes in equity during a period from transactions andother events and circumstances. Comprehensive income (loss) was as follows for the periods endedMarch 31 (in thousands of dollars):           Three Months Ended   March 31,   2006  2005 Net income (loss) $(654) $(3,604)Foreign currency translation adjustment  13   (95)Unrealized gain on derivative instruments  156   1,254        Comprehensive income (loss) $(485) $(2,445)       Components of accumulated other comprehensive income (loss) as shown on our consolidated balancesheets were as follows (in thousands of dollars):           March 31,  December 31,   2006  2005 Unrealized loss on derivative instruments $—  $(156)Foreign currency translation adjustment  1,734   1,721        Accumulated other comprehensive income (loss) $1,734  $1,565        Note 9 3⁄4 Statements of Cash FlowsCash equivalents are comprised of demand deposits and temporary investments in highly liquidsecurities having original maturities of 90 days or less at the date of purchase. Cash paid forinterest was $1,670,000 and $2,573,000, respectively, for the three months ended March 31, 2006 and2005. Cash paid for taxes, primarily state franchise tax,was $92,000 and $134,000 for the three months ended March 31, 2006 and 2005, respectively.March 31, 2006
Page 13

Table of Contents
 LodgeNet Entertainment Corporation Form 10-QNote 10 3⁄4 Effect of Recently Issued Accounting StandardsIn May 2005, the FASB issued FASB Statement No. 154, “Accounting Changes and Error Corrections”.This new standard replaces APB Opinion No. 20, “Accounting Changes”, and FASB Statement No. 3,“Reporting Accounting Changes in Interim Financial Statements.” Among other changes, Statement 154requires that a voluntary change in accounting principle be applied retrospectively with all priorperiod financial statements presented on the new accounting principle, unless it is impracticableto do so. The new standard is effective for accounting changes and correction of errors made infiscal years beginning after December 15, 2005. The adoption of FASB No. 154 did not have animpact on our consolidated financial position or results of operations.In September 2005, the American Institute of Certified Public Accountants (AICPA) has issuedStatement of Position (SOP) 05-1, “Accounting by Insurance Enterprises for Deferred AcquisitionCosts in Connection with Modifications or Exchanges of Insurance Contracts”. This SOP providesguidance on accounting by insurance enterprises for deferred acquisition costs on internalreplacements of insurance and investment contracts other than those specifically described in FASBStatement No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-DurationContracts and for Realized Gains and Losses from the Sale of Investments”. The provisions in SOP05-1 are effective for internal replacements occurring in fiscal years beginning after December 15,2006. The SOP is applicable to us as it relates to the accounting treatment of long-term contractsand customer acquisition costs. We believe the adoption of SOP 05-01 will not have a materialimpact on our consolidated financial position or results of operations.In November 2005, the FASB issued FASB Staff Position (FSP) FIN 45-3, “Application of FASBInterpretation No. 45 to Minimum Revenue Guarantees Granted to a Business or Its Owners.” This FSPamends the guidance in FASB Interpretation (FIN) No. 45, “Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”. The FASBconcludes in this FSP that a guarantor should apply the recognition, measurement, and disclosureprovisions of FIN 45 to a guarantee granted to a business or its owners that the revenue of thebusiness (or a specific portion of the business) for a specified period of time will be at least aspecified minimum amount. For new minimum revenue guarantees issued or modified on or afterJanuary 1, 2006, we will record the fair value of guarantees in our consolidated financialstatements. The adoption of this FSP did not have a material impact on our consolidated financialposition or results of operations.Note 11 — Insurance Proceeds from the Impact of Hurricane KatrinaOn August 29, 2005, Hurricane Katrina swept through the Gulf of Mexico region, causing severedamage to properties located in Louisiana, Alabama, Mississippi, and Florida. LodgeNet sustainedsignificant property damage to its systems installed at the hotels located within those states.The initial damage estimate included 121 hotels or approximately 21,000 rooms served by theLodgeNet interactive systems. In December 2005, we received insurance proceeds associated with theHurricane Katrina recovery of $788,000 offset by a $280,000 charge for equipment impairment during2005. As of March 31, 2006, approximately 5,800 rooms remain out of service and no amounts wererecognized for future recoveries. In April 2006, we received $200,000 from our insurance carrierrelated to business interruption indemnification.March 31, 2006
Page 14

Table of Contents
 LodgeNet Entertainment Corporation Form 10-Q**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 andfinancial condition. This discussion should be read in conjunction with the accompanyingconsolidated 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,” “no assurance” and similar expressions and statements which are made in the futuretense, 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 of1934, as amended, are subject to risks, uncertainties, and other factors that could cause ouractual results, performance or achievements to be materially different from any future results,performance or achievements expressed or implied by such forward-looking statements. In additionto the risks and uncertainties discussed elsewhere in this Report, such factors include, amongothers, the following: the effects of economic conditions, including in particular the economiccondition of the lodging industry, competition, demand for our products and services, programmingavailability and quality, technological developments, developmental difficulties and delays,relationships with clients and property owners, the availability of capital to finance growth, theimpact of government regulations, international crises, acts of terrorism, public health issues,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 speakonly as of the date of this Quarterly Report. We expressly disclaim any obligation or undertakingto release publicly any updates or revisions to any forward-looking statements contained herein toreflect any change our expectations with regard thereto or any change in events, conditions orcircumstances on which any such statement is based.***Executive Overview**We are one of the world’s largest providers of interactive television and broadband solutions tohotels throughout the United States and Canada, as well as select international markets. It isestimated that, currently, more than 300 million domestic and international travelers have accessto our interactive television network annually, which is designed to make their hotel stay moreenjoyable, productive and convenient, and to allow our hotel customers to provide greater guestservices and promote hotel brand loyalty. As of March 31, 2006, we provided interactive and basiccable television services to approximately 6,100 hotel properties serving over one million rooms.In addition, LodgeNet began delivery of on-demand patient education, information and entertainmentto healthcare facilities in the United States.In the first quarter of 2006, we continued to execute on our strategic plan focused on growth,profitability and the generation of net free cash flow, which we define as cash provided byoperating activities less cash used for investing activities, including growth-related capital. Weincreased our digital room base during the quarter by more than 29,000 net digital rooms. As ofMarch 31, 2006, more than 65% of our Guest Pay interactive room base, or 658,000 rooms, wereequipped with a digital system. In addition, we continued to move toward our profitability goal.Our operating income was up 48.5% to $6.0 million in the first quarter of 2006, while our net lossdecreased from $3.6 million in the first quarter of 2005 to $654,000 in the current year quarter.Cash from operations increased 20.6% to $22.0 million in the first quarter of 2006. Afterdeducting all capital investment activities of $12.5 million, we generated $9.5 million of net freecash flow during first quarter of 2006. This represents a $3.8 million, or 66.7%, improvement overthe prior year quarter.During first quarter of 2006, total revenue increased 6.4%, or $4.2 million as compared to thefirst quarter of 2005. The growth was driven in part by our expanding digital room base, and inpart by a 4.2% increase in per-room movie revenue. The increase in movie revenue was notattributable to any specific genre or major title in our window. On a per room basis, monthlyGuest Pay revenue increased 3.7% to $22.66 in the first quarter of 2006 as compared to$21.86 for the first quarter of 2005. Revenue per room from other interactive services also grewdriven in part by price increases associated with basic cable services and increased revenue fromour TV on-demand and music products, offset in part by our TV Internet profitability enhancementinitiative that removed this service from poorlyMarch 31, 2006
Page 15

Table of Contents
 LodgeNet Entertainment Corporation Form 10-Qperforming rooms. For the first quarter of 2006,we estimate that the TV Internet initiative decreased revenue by approximately $306,000, or about$0.10 per room, while lowering direct operating costs by approximately $384,000 as compared to thefirst quarter of 2005.During the quarter, our Guest Pay direct costs varied directly with our revenue growth andincreased to $10.20 per room as compared to $9.66 per room for the first quarter of 2005. Theincrease was primarily a result of our “pay for performance” commission structure whereby anincrease in revenue per room may result in a higher commission paid to the hotel. Our Guest Payoperations expenses were $2.92 per average Guest Pay room versus $2.94 in the first quarter of 2005driven by the economy of scale from our expanded room base. Our selling, general, andadministrative expenses increased to 9.8% of revenue for the first quarter of 2006 compared to 9.2%for the prior year quarter. Per average Guest Pay room, SG&A expenses increased to $2.29 per monthin the first quarter of 2006 from $2.07 per month in the prior year quarter. The increase wasprimarily due to the expensing of share-based compensation required under Financial AccountingStandard 123(R) and professional fees. Share-based compensation expenses were $669,000 for thefirst quarter of 2006, compared to $57,000 in the same period of last year. Our depreciation andamortization decreased 6.0%, or $1.1 million, primarily driven by higher-cost assets being fullydepreciated while the cost basis of more recently deployed Guest Pay systems are lower. We expectthis trend to level off during 2006 as most of our older systems become fully depreciated. Peraverage Guest Pay room, depreciation and amortization expenses decreased to $5.62 in the firstquarter of 2006 compared to $6.13 in the prior year quarter.We continue to de-leverage our balance sheet with the reduction of our investment of equipment intohotels through market and product segmentations and engineering development, reduction of interestcosts by prepaying on our long-term debt, and prudent management of working capital. Cash at March31, 2006 was $19.6 million compared to $20.7 million at December 31, 2005. The reduction in cashwas due to the $10.0 million prepayment on our term loan offset by cash generated from operations.We continue to promote our industry-leading SigNETure HDTVSM solution that enables us todeliver high-definition guest room entertainment content to the hotels we serve that are equippedto receive and display HDTV. We have programming agreements with DIRECTV, ESPN, Lion’s Gate, andParamount to provide high-definition television content. Additionally, our SigNETureHDTVSM solution coupled with our LodgeNet Media Management System (LMMS) helped ussecure two key contracts during 2005 with Starwood Hotels & Resorts Worldwide, Inc., and TheRitz-Carlton Hotel Company, L.L.C., a wholly-owned subsidiary of Marriott International, Inc.We continue to explore revenue growth opportunities within our core lodging business. Theseinclude, but are not limited to, new content and products such as Hotel SportsNETSM (ourdaily subscription of sports programming), which recently added NHL Center Ice to its programmingline up. Other Hotel SportsNETSM programming includes NBA LEAGUE PASS, NFL SUNDAYTICKET and ESPN’s GamePlan and Full Court packages. In addition, we continue to focus on marketingdirectly to the hotel guest through the capabilities of LMMS. LMMS allows us to refreshinteractive menus, promote different products and different titles to different demographics andchange pricing of our products, selection and promotions based on time-of-day or day-of week, amongother marketing efforts to the guest.We plan to expand our advertising initiative by developing linear and on-demand advertising andpromotional messages. We are able to selectively place these messages at properties and to recordthe number of views and the viewing time per view using LMMS. This business model has thepotential of generating revenue from the advertiser in contrast to the hotel or the guest. Webelieve the additional capital investment required for this initiative will be minimal.Our Healthcare initiative continues to expand with three new hospitals going “live” during thefirst quarter of 2006. As of March 31, 2006, our interactive system is installed at five healthcaresites. In addition, we have four contracted healthcare sites that are in process or pendinginstallation. We offer our interactive television system and content aspart of McKesson’s Horizon PatientVisionTM system and sell our interactive systems toMcKesson Corporation for resale to their customers, and also contract directly with healthcarefacilities sold by LodgeNet or through MDM Commercial, a licensed sales agent. Revenue comes fromthe initial sale of system hardware, software licensing, and implementation services, and weadditionally earn recurring revenues, under long-term contracts, by providing entertainmentcontent, software maintenance and technical field service.March 31, 2006
Page 16

Table of Contents
 LodgeNet Entertainment Corporation Form 10-QAs we move through 2006, we will continue to execute on our strategic plan and maximize on theflexible technology aspects of our platform which has allowed us to diversify our customer base,tap new revenue opportunities with additional content offerings and enter vertical markets such ashealthcare and travel centers with business models that require little or no incremental capitalinvestment on our part. We are committed to prudently leveraging our technology, content expertiseand nationwide service presence to expand our overall customer base, and we remain focused ondriving growth, improving profitability and increasing cash flow.*Guest Pay Interactive Services.*Our primary source of revenue is providing in-room, interactivetelevision services to the lodging industry, for which the hotel guest pays on a per-view, hourlyor daily basis. Our services include on-demand movies, network-based video games, music and musicvideos, Internet on television (which does not require a laptop), and television on-demandprogramming.Our total guest generated revenue depends on a number of factors, including:**•** *The number of rooms on our network.*We can increase revenue overtime by increasing the number of rooms served by our interactivesystems. Our ability to expand our room base is dependent on anumber of factors, including the attractiveness of our technology,service and support to hotels currently operating without aninteractive television system, newly constructed hotel properties,and hotels with expiring contracts currently served by ourcompetitors.**•** *The variety of services offered at the hotel.*Rooms equipped withour digital system generate higher revenue than rooms equippedwith our tape-based system primarily because they offer a greatervariety of services and content choices. We plan to continue togrow the revenue we generate per average room by the installationof our digital system in all newly contracted rooms and byconverting selected tape-based rooms to our digital system inexchange for long-term contract extensions.**•** *The popularity, timeliness and amount of content offered at thehotel.*Our revenues vary to a certain degree with the number,timeliness and popularity of movie content available for viewing.Historically, a decrease in the availability of popular moviecontent has adversely impacted revenue. Although not completelywithin our control, we seek to program and promote the mostpopular available movie content and other content to maximizerevenue and gross profit.**•** *The price of the service purchased by the hotel guest.*Generally,we control the prices charged for our products and services andmanage pricing in an effort to maximize revenue and overall grossprofit. We establish pricing based on such things as thedemographics of the property served, the popularity of the contentand overall economic conditions. Our technology enables us tomeasure popularity of our content and make decisions to bestposition such content and optimize revenue from such content.**•** *The occupancy rate at the property.*Our revenue also variesdepending on hotel occupancy rates, which are subject to a numberof factors, including seasonality, general economic conditions andworld events, such as terrorist threats or public health issues.Occupancy rates are typically higher during the second and thirdquarters due to seasonal travel patterns. We target higheroccupancy properties in diverse demographic and geographiclocations in an effort to mitigate occupancy-related risks.The primary direct costs of providing Guest Pay interactive services are: **Ø** license fees paid to major motion picture studios, which are based on a percent ofguest-generated revenue, for non-exclusive distribution rights of recently released majormotion pictures;  **Ø** commissions paid to our hotel customers, which are also based on a percent ofguest-generated revenue;  **Ø** fixed monthly programming charges paid primarily to DIRECTV for satellite-deliveredbasic and premium television programming;  **Ø** internet connectivity costs;March 31, 2006
Page 17

Table of Contents
 LodgeNet Entertainment Corporation Form 10-Q **Ø** license fees, which are based on a percent of guest-generated revenue, for television ondemand, music, music video, video games and sports programming; and  **Ø** one-time license fees paid for independent films, most of which are non-rated andintended for mature audiences.*Other Services.*In addition to the sales of equipment to our international markets, we continuedto promote the sale and installation of high-speed Internet equipment coupled with maintenance andcustomer support services. While this is a highly competitive area, we believe we have importantadvantages as a result of our existing hotel customer relationships, our nationwide field servicenetwork, and our 24-hour call center which provides service seven days a week**.**We also 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 issatellite-delivered basic and premium television programming for which the hotel pays us a fixedmonthly charge per room. We compete with local cable television operators by tailoring differentprogramming packages to provide specific channels desired by the hotel subscriber, which typicallyreduces 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 interactive televisionnetwork. De-installation activity has not had a material effect on our growth, averaging between2% to 3% of total installed rooms per year over the last five years. During the three-month periodindicated, we installed our systems in the following number of net new rooms and had the followingtotal rooms installed as of March 31:           March 31,  2006 2005Total rooms served (3) (4)  1,057,953   1,043,278 Total Guest Pay interactive rooms (2) (4)  1,006,513   986,024 New Guest Pay interactive rooms (1)  4,584   11,226  (1) Amounts shown are net of de-installations during the period. The gross numbers of new roomsinstalled were 12,625 in the first quarter of 2006 and 18,509 in the first quarter of 2005. (2) Guest Pay interactive rooms are equipped with our interactive television system, whichincludes high-definition (HD), digital and tape-based systems. (3) Total rooms served include guest pay interactive rooms, rooms served by internationallicensees, and properties receiving only basic and premium television services. (4) As a result of Hurricane Katrina, room count as of March 31, 2006 was reduced by 5,842 rooms.March 31, 2006
Page 18

Table of Contents
 LodgeNet Entertainment Corporation Form 10-Q*Digital Room Growth*We continue to expand our digital base as we install our digital system in all newly contractedrooms as well as converting select tape-based served rooms to the digital system in exchange forlong-term contract extensions. Rooms equipped with our digital system typically generate higherrevenue 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 endof 2006.           March 31,  2006 2005Digital room installations for the three months ended  29,091   31,988 Total Digital rooms installed (1)  658,176   540,967 Digital rooms as a percent of total Guest Payinteractive rooms  65%  55% (1) Total digital room count as of March 31, 2006, was reduced by 2,387 rooms due to the impactof Hurricane Katrina. Total room count was reduced by an additional 3,455 tape-based roomsdue to the impact of Hurricane Katrina.*CapitalInvestment Per Room*Theaverage investment per-room associated with a digital installationhas continued to decline over the past several years due toour ongoing engineering efforts, while adding enhancements, lower component costs, productsegmentation, and reduced cost of assembly and installation. The following table sets forth ouraverage installation and conversion investment cost per room during the periods ended:           Three Months Ended  March 31, March 31,  2006 2005Averageinvestment per room — new installation $348  $351 Averageinvestment per room — conversion $262  $260 The cost of installation can fluctuate from quarter to quarter due to the mix of servicesinstalled, average property size, and certain fixed costs.*Direct Costs*Guest Pay direct costs (exclusive of operating expenses and depreciation and amortization discussedseparately below) for interactive services include movie license fees, license fees for otherinteractive services, the commission retained by the hotel, programming and other related costs.The following table sets forth our Guest Pay direct expenses per room and as a percent of revenueduring the three months ended March 31:           2006 2005Guest Pay direct costs per room $10.20   $9.66 Guest Pay direct costs as a percent of total revenue  45.0%  44.2%March 31, 2006
Page 19

Table of Contents
 LodgeNet Entertainment Corporation Form 10-QGuest Pay direct costs increased to 45.0% in the first quarter of 2006 from 44.2% in the firstquarter of 2005 driven by higher hotel commissions resulting from our “pay for performance”commission structure whereby an increase in revenue per room may result in a higher commission paidto the hotel.*Operating Expense Per Room*We plan to continue to monitor and manage the operating expenses per room in order to increase thelevel of cash flow our business generates. Guest Pay operations expenses consist of costs directlyrelated to the operation and maintenance of systems at hotel sites. Selling, general andadministrative expense (SG&A) primarily includes administrative payroll costs, engineeringdevelopment costs and legal, professional and compliance costs. The following table sets forth ouroperating expenses per room and SG&A as a percent of revenue during the three months ended March31:           2006  2005 Guest Pay operating expenses $2.92  $2.94 SG&A expense  2.29   2.07 Depreciation and amortization (D&A)  5.62   6.13          $10.83  $11.14                 Guest Pay operations as a percent of total revenue  12.5%  13.1%SG&A as a percent of total revenue  9.8%  9.2%D&A as a percent of total revenue  24.1%  27.3%For thefirst quarter of 2006, share-based compensation expense included inSG&A was $669,000 or $0.22 per average Guest Pay room or 1.0% ofrevenue, as compared to $57,000 or $0.02 per average Guest Pay roomor 0.1% of revenue for the first quarter of 2005.*Net Income/(Loss)*We focused on reducing our net loss by improving room and revenue growth coupled with reducingdirect costs, overhead expenses, installation costs, depreciation and amortization expenses, andinterest costs. The following table sets forth our net loss for the three months ended March 31(in thousands of dollars):           2006 2005Net loss $(654) $(3,604)*Free Cash Flow*One of our goals is to generate net free cash flow, which we define as cash provided by operatingactivities less cash used for investing activities, including growth-related capital. We generallyseek to generate net free cash flow to reduce our historical reliance on external financing to growour business. In addition to increasing revenue and controlling expenses, we can manage ouractions related to this goal by reducing the per-room installation cost of a digital room and byvarying the number of rooms we install with the digital system in any given period. Over the pasttwelve months we have generated $16.6 million of net free cash flow while having simultaneouslyinstalled more than 122,000 digital rooms. Since existing operations more than fully funded ourgrowth capital needs during the quarter,we strengthened our balance sheet by reducing long-term debt to $281.4 million.March 31, 2006
Page 20

Table of Contents
 LodgeNet Entertainment Corporation Form 10-QOur progress toward the goal of continuing to generate increased levels of net free cash flow isset forth in the following table (in thousands of dollars):           Three Months Ended   March 31,   2006  2005 Cash provided by operating activities $21,966  $18,213 Cash used for investing activities  (12,518)  (12,553)       Difference $9,448  $5,660                 Expansion capital investment $3,900  $6,407 *New Revenue Sources*In 2005, we began offering our interactive television systems into the healthcare industry througha sales and marketing relationship with McKesson Corporation. In this market, we sold ourinteractive system and license our software to McKesson or individual healthcare facilities, andearn recurring revenues from the provision of hardware and software service and maintenanceactivities, and the sale of entertainment content. In addition to McKesson, we have entered intoan agreement with MDM Commercial, a leading distributor of audio-visual equipment and systems tothe healthcare industry. The agreement designates MDM Commercial as a sales representative for ourHorizon PatientVisionTM healthcare solution.In addition, we continued investigating other adjacent markets into which we can sell ourinteractive television system. We recently signed an agreement with IdleAire Technologies for thesale and installation of our digital system into travel centers and terminals. IdleAire isplanning to install its patented Advanced Truckstop Electrification (ATE) systems in approximately210 travel centers and terminal locations, having more than 13,000 total spaces, over the nextfifteen months. IdleAire will be purchasing our interactive television platform, licensing oursoftware, and contracting with us for a variety of entertainment and service options as part of itsoverall service offering.Another adjacent market where we have opportunities to generate new revenue growth is the timesharemarket. We estimate that the timeshare market has approximately 158,000 units in the UnitedStates, most of which do not have interactive television services. In these markets, we intend tosell our system and license our software, and earn recurring revenue from the provision of hardwareand software maintenance and sale of entertainment content.March 31, 2006
Page 21

Table of Contents
 LodgeNet Entertainment Corporation Form 10-Q**Liquidity and Capital Resources**Historically, we have required substantial amounts of capital to fund operations, expand ourbusiness and service existing indebtedness. Since 2003, we have transitioned to a net free cashflow position. We define net free cash flow as cash provided by operating activities less cashused for investing activities, including growth-related capital. For the first quarter of 2006,cash provided by operating activities was $22.0 million while cash used for investing activities,including growth-related capital investments, was $12.5 million, resulting in a net difference of$9.5 million. During the first quarter of 2005, cash provided by operating activities was $18.2million while cash used for investing activities, including growth-related capital investments, was$12.5 million, resulting in a net change of $5.7 million. Cash as of March 31, 2006 was $19.6million versus $20.7 million as of December 31, 2005.Our principal sources of liquidity are our cash on hand, operating cash flow and the revolverportion of our Credit Facility, which matures in 2007. Over the past twelve months we havegenerated $16.6 million of net free cash flow while having simultaneously installed more than122,000 digital rooms. Since existing operations more than fully funded our growth capital needsduring the quarter, we strengthened our balance sheet by reducing long-term debt by $10.0 million.We believe that our cash on hand, operating cash flow and borrowing available under the CreditFacility will be sufficient for the foreseeable future to fund our future growth and financingobligations. As of March 31, 2006, working capital was $7.5 million, compared to $13.7 million atDecember 31, 2005. The decrease was primarily caused by the $10.0 million prepayment on our termloan.In order to continue to operate and expand our business, we must remain in compliance withcovenants imposed by our Credit Facility and Senior Notes. As of March 31, 2006, we were incompliance with all covenants, terms and conditions related to our Credit Facility and SeniorNotes. We are not aware of any events that qualify under the material adverse effect clause of theCredit Facility. The total amount of long-term debt outstanding, including that portion of debtclassified as current, as of March 31, 2006 was $281.4 million versus $292.0 million as of December31, 2005.Our leverage and interest coverage ratios were as follows for the periods ended March 31:           2006 2005Actual consolidated total leverage ratio (1) (4)  2.99   3.47 Maximum per covenant  3.75   4.25          Actual senior secured leverage ratio (2) (4)  0.87   1.25 Maximum per covenant  2.25   2.25          Actual consolidated interest coverage ratio (3) (4)  3.38   2.83 Minimum per covenant  2.75   2.50  (1) Our maximum consolidated leverage ratio is a function of total indebtedness divided byoperating income exclusive of depreciation and amortization and other miscellaneousnon-recurring items as defined by the covenant. (2) Our maximum consolidated senior secured leverage ratio is a function of total indebtednessless total unsecured indebtedness, divided by operating income exclusive of depreciation andamortization and other miscellaneous non-recurring items as defined by the covenant. (3) Our minimum consolidated interest coverage ratio is a function of operating income exclusiveof depreciation and amortization and other miscellaneous non-recurring items divided byinterest expense as defined by the covenant.March 31, 2006
Page 22

Table of Contents
 LodgeNet Entertainment Corporation Form 10-Q (4) Maximum consolidated total leverage ratio, maximum consolidated senior secured leverageratio, and minimum consolidated interest coverage ratios are not based on generally acceptedaccounting principles and are not presented as alternative measures of operating performanceor liquidity. They are presented here to demonstrate compliance with the covenants in ourCredit Facility, as noncompliance with such covenants could have a material adverse effect onus.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 2006 Maximum consolidated total leverage ratio  3.50      Maximum senior secured leverage ratio  2.25      Minimum consolidated interest coverage ratio  2.75 In January 2004, LodgeNet and the holders of the term loan amended the LIBOR pricing to be LIBORplus a margin of 3.50%. In April 2004, LodgeNet and the holders of the term loan executed anotheramendment to establish the LIBOR pricing at LIBOR plus a margin of 2.75%. In July 2005, LodgeNetand the holders of the term loan again executed an amendment to establish the LIBOR pricing atLIBOR plus a margin of 2.25%. The term loan interest rate as of March 31, 2006 was 7.08% based onLIBOR pricing. The revolving credit facility matures in August 2007 and loans bear interest at ouroption of (1) the bank’s base rate plus a margin of 1.00% to 2.00%, or (2) LIBOR plus a margin of2.25% to 3.25%. As of March 31, 2006, our senior secured debt rating from Standard and Poor’s wasB+ and our rating from Moody’s was B1. The maturity dates of the term loan and the revolver loanunder our Credit Facility are August 2008 and August 2007, respectively.In June 2003, we issued $200.0 million, principal amount of unsecured 9.50% Senior SubordinatedNotes (the “9.50% Notes”), due June 15, 2013. The proceeds of the 9.50% Notes, which were issuedat 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 amountof the 10.25% Senior Notes, pay accrued interest, pay call premiums, and pay related fees.Approximately $35.0 million of the proceeds were used to reduce outstanding amounts under ourCredit Facility. The remaining proceeds of approximately $2.7 million were for use in fundinggeneral corporate purposes.The 9.50% Notes are unsecured, are subordinated in right of payment to all of our existing andfuture senior debt and rank *pari passu*in right of payment with any future senior subordinatedindebtedness. The 9.50% Notes require semi-annual interest payments and contain covenants whichrestrict our ability to incur additional indebtedness, create liens, pay dividends or make certaindistributions in respect to our common stock, redeem capital stock, issue or sell stock ofsubsidiaries in certain circumstances, effect certain business combinations and effect certaintransactions with affiliates or stockholders. As of March 31, 2006, we were in compliance with allcovenants, 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 ratablyto 100% of their principal amount (plus accrued and unpaid interest) on or after June 15, 2011. Atany time prior to June 15, 2006, we may redeem up to 35% of the aggregate principal amount at109.50% of the principal amount (plus accrued and unpaid interest) with the cash proceeds ofcertain equity offerings.March 31, 2006
Page 23

Table of Contents
 LodgeNet Entertainment Corporation Form 10-QObligations and Commitments as of March 31, 2006 (dollar amounts in thousands):                          Payments due by period       Less than  2 – 3  4 – 5  Over   Total  1 year  years  years  5 years Contractual obligations:                    Long-term debt(s) $281,400  $2,645  $78,685  $70  $200,000 Interest on fixed rate debt  142,500   19,000   38,000   38,000   47,500 Interest on bank term loan (1)  13,480   5,461   8,019   —   —                      Other long-term obligations                    Acquired intangible asset (2)  3,750   1,250   2,500   —   — Operating lease payments  1,680   580   835   265   — Purchase obligations  5,356   5,356   —   —   — Nintendo minimum royalty (3)  30,100   4,200   8,400   8,400   9,100 Programming related minimumroyalty and commissions (4)  10,570   2,490   4,549   3,531   —                 Total contractual obligations $488,836  $40,982  $140,988  $50,266  $256,600                                          Amount of commitment expiration per period      Less than 2 – 3 4 – 5 Over  Total 1 year years years 5 yearsOther commercial commitments:                    Standby letters of credit $1,969  $1,969  $3⁄4  $3⁄4  $3⁄4                  (1) Interest payments are estimates based on current LIBOR and scheduled amortization. (2) In July 2002, we acquired from Hilton Hotels Corporation the right to provide Internet ontelevision access and television on-demand programming services to participating hotels andthe right to independently pursue and further develop interactive television contentthroughout our entire room base. (3) Nintendo video games pursuant to a non-exclusive license agreement with Nintendo, whichexpires in May 2013. Under the terms of the agreement, we pay a monthly royalty equal to apercent of revenue generated from the sale of Nintendo video game services, subject to amonthly minimum. (4) In connection with our programming related agreements, we may guarantee minimum royalties forspecific periods or by individual programming content.**Seasonality**Our quarterly operating results are subject to fluctuation depending upon hotel occupancy rates andother factors. Our hotel customers typically experience higher occupancy rates during the secondand third quarters due to seasonal travel patterns and, accordingly, we historically have higherrevenue in those quarters. However, quarterly revenue can be affected by the availability ofpopular content during those quarters. We have no control over when new content is released or howpopular it will be.March 31, 2006
Page 24

Table of Contents
 LodgeNet Entertainment Corporation Form 10-Q**Discussion and Analysis of Results of Operations**