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Executives

Scott Petersen - Chairman and Chief Executive Officer

Gary Ritondaro - Senior Vice President and Chief Financial Officer

Ann Parker - Director of Investor Relations

Analysts

Alex Lieblong - Key Colony

Michael Demaray - Elevated Capital

Greg Blaszczynski - Gulf Stream Asset Management

Varkki Chacko - Credit Capital

Pallo Blum-Tucker - Aladdin Capital

Chris Tejawalt - Babson Capital

LodgeNet Interactive Corporation (OTC:LNET) Q1 2009 Earnings Call April 22, 2009 5:00 PM ET

Operator

Good day ladies and gentlemen and welcome to the LodgeNet Interactive Q1 2009 earnings call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions).

I would now like to introduce your host for today's conference Ms. Ann Parker Director of Investor Relations. Ma'am you may begin.

Ann Parker

Thank you operator. Good day everyone. I'd like to thank all of you for taking the time today to listen to our first quarter 2009 conference call. You should have received copies of our earnings release. If not please call me Ann Parker at 605-988-1000. We'll make sure you do get a copy.

Our speakers for today's call will be Scott Petersen Chairman and CEO of LodgeNet and Gary Ritondaro our Senior Vice President and CFO. Scott and Gary will review our first quarter 2009 earnings and will then welcome your questions and your comments.

This call is being webcast live over the Internet through our company website www.lodgenet.com. We also have slides posted on our website which correspond with today's comments and they can be found under the Investor section.

Before we get started I'd like to remind you that some topics to be discussed today that do not relate to historical performance may include or constitute forward-looking statements within the meaning of the Federal Securities laws and are subject to risks uncertainties and other factors that could cause actual results performance or achievements of the company to be materially different from those expressed or implied by such forward-looking statements. Certain of the risk factors which could affect the company are set forth in the company's 10-K and other filings.

With that said I'll now turn the call over to Mr. Scott Petersen.

Scott Petersen

Thank you Ann and good afternoon everyone. I'm very pleased to share our first quarter results with you today and I believe they reflect an outstanding job by the entire LodgeNet team.

Our decision last year to move early and decisively to right size our operations for the deteriorating economic conditions continue to produce impressive results during the first quarter. That plan involved proactively reducing operating costs and capital investment levels while continuing to focus on the expansion of our strategic growth initiatives. As a result during the quarter we generated a significant expansion in our free cash flow and a major reduction in our debt levels.

If you take a look at slide 2 that we posted on our website you'll see some of the highlights. We right-sized our operations by cutting expenditures; you'll note that operating expenditures were down over 30% from one year ago and actually 11.5% versus the fourth quarter of just last year.

Our capital investment levels were down over 70% versus a year ago and about a half of what they were in the last quarter. In addition, we continue to focus on our long-term strategic growth initiatives which are producing results. The revenue from these initiatives was up 27% this quarter versus a year ago and gross profit was up over 90% versus a year ago as we continue to improve the profitability from these initiatives.

I think it's very interesting to note that our new strategic initiatives buffered almost half of the revenue decline from guest entertainment. As a result, we're driving free cash flow. Cash from operations was up over 75% versus one year ago and free cash flow was up over $17 million this year versus a negative $1 million in the first quarter of 2008.

Given the results of our proactive management plan, we're able to dramatically decrease our debt levels during the quarter. We dropped long-term debt by $40 million in the first quarter alone by allocating somewhere right around 80% of our cash from operations to pay down debt and also the results of our very successful debt purchase or debt investment program under which we purchased over $31 million of face value at around 30% discount to face.

So at this point, I'm going to turn the call over to Gary Ritondaro, our CFO, to give you some more details and thoughts about the quarter. Gary?

Gary Ritondaro

Thank you, Scott, and I am starting now on slide number 3. You can see what our total revenue has done for the quarter versus the first quarter of 2009. We experienced a decrease in revenue of about 8.4%. As you can see most of that decrease obviously came from our guest entertainment down about 23%.

As Scott mentioned we've seen our growth initiatives producing very nice improvements in revenue with direct hotel services up about 12% and our other revenues, which are chiefly healthcare and professional solutions up nicely at 67%. So overall, our revenues from strategic growth initiatives generated about $52 million worth of revenue, and as Scott mentioned offset about 50% of the revenue decline that we saw from guest entertainment.

If you go on to slide number 4, you'll see more of the breakdown of that. Certainly this is on a revenue-per-room basis, and it shows very similar to the numbers that we saw on the previous slide; again guest entertainment down about 23% period-over-period. Certainly the occupancy rates are a major factor of why guest entertainment revenue is down. We saw occupancy rates decrease about 12% period-over-period, and then the balance of the decline in guest entertainment is coming from few purchases by those guests that are actually in those rooms.

As an aside, April seems to have firmed up somewhat over the Q1 levels with both occupancy levels stabilizing and consumer purchases coming off low points of that first quarter.

We'll talk about it later, but our second quarter guidance for guest entertainment revenue is based on a down 15% to a down 20% so you can see that we are forecasting some improvement versus what we saw in the first quarter.

Moving on to hotel services, we continue to roll out our HD television programming and we convert other properties to HD as well which had a nice increase of almost 12%. Our system sales increased 75%, and this is due mainly to a completion of a contract to upgrade technology for four HD channels for a major program provider. For those that are technical, we're converting from an MPEG-2 receiver to an MPEG-4 receiver and this added about $5 million of revenue period-over-period.

Within the other section, healthcare had a nice increase of over 200% at an increased revenue of $1.6 million, as we installed six new systems during the first quarter of this year versus only one system installed during the first quarter of 2008.

Of course, the flip side of revenue is how much are we making on the gross margin side, and I think when you look at slide number 5, you'll see that every one of our business lines from guest entertainment, hotel services, system sales, and all of other all had improved margins even in a downturn economy. We continue to generate higher margins at our guest entertainment. This is generally due to the fact that we are paying lower commissions in this area.

Hotel services is compromised of our broadband service revenue and TV programming. Margins improved here to 11%. We have expanded our margins for broadband Internet services and that's certainly being driven by the cost reductions that we've been doing within our broadband business, primarily due to the outsourcing of what we refer to as Tier One calls to a St. Louis-based company. Then, of course, the TV programming is going up nicely. It's being driven by our conversion to HD television from analogue.

Within system sales and related services margins here are almost 29%. Again expanding margins are from broadband systems sales, and they're offset somewhat by the lower margin of that HD channel conversion. Again, we had nice revenue, but at a slightly lower margin.

On slide number 6, you'll see the impact that Scott mentioned here on the reduction of our operating expenses both on a period-over-period as well as sequentially. This combines both our system operations and SG&A.

For Q1, you'll see the $20.8 million of total operating expenses, and that is 32% reduction over Q1 of 2008 and slightly ahead of the guidance that we gave to you back in February. Several factors certainly are contributing to this nice reduction. That's the completion of the integration processes that we've been doing with the acquisition of On Command. We've been improving our operational efficiencies, which are mainly associated with back office operations and of course with our field service organization.

From an early recognition of the fact that we were seeing an impact on our business from lower occupancy rates, we implemented several cost control measures some of these going back into the fourth quarter of last year and the first quarter of this year, plus we continue to watch our general expense controls.

Some examples of this, as we've mentioned in previous calls, we have a freeze on all salaries and wages for '09. We eliminated our 401(k) match. We eliminated the 2009 bonus program and during the month of March, we had an unpaid time-off program that all of the employees participated in.

On slide number 7, you'll see the adjusted operating cash flow and certainly this is a result of margins that we talked about and the reduction in the operating expense. We have an 8.5% higher than what we saw sequentially from Q4 of last year, and again the stability is coming from the increase in revenue from our strategic initiatives that we discussed on previous slides about a third of it being offset at the guest entertainment. And then, of course, the reduction in operating expenses which offsets another two-thirds of that such that we are showing a very stable adjusted operating cash flow from Q1 of '08 to Q1 of '09.

On slide number 8, you'll notice that we are reporting net income of $6 million versus the loss of $13 million last year. After adjusting for unusual items as well as items that we don't expect to reoccur in future periods, you'll see that we have a break-even for '09 versus a $7.1 million loss in the last year. Again, pretty significant change in net income even with the kind of economy that we're working with.

I won't go each one of those items that are listed there, but you can see many of the Q1 '08 were associated with taking restructuring charges and then Q1 of '09, of course, we had the $9.3 million gain on the consolidation of the acquired debt that we did during the quarter.

On slide number 9, you'll notice that we used $5 million of our cash for capital investments. That was pretty much what we expressed to you that we would be doing for this quarter, down significantly 72% versus what we did in Q1 of '08.

We installed 5,400 new rooms. The average investment per room did go up this quarter. It was expected as we have fewer rooms that we allocate our fixed overhead costs. However, I'd tell you that equipment and the actual installation costs continue to be lower than they were in the first quarter of '08. So, the issue here is the number of rooms we're installing not really the base costs of doing the installation.

Also we converted almost 2,600 rooms from basically the analogue systems to our HD systems. A 100% of those were HD systems and again here the average did go up as well to about $357 for the same reasons that we've just talked about. We are seeing the hotels continue to contribute towards our capital investment in each one of these rooms and if you look to slide number 10, you'll see graphically what's happening there.

Since the acquisition of On Command two years ago, we've transformed more of the system investment to hotel properties and this is primarily the cost of the TV programming reception equipment. On a trailing 12-month basis, hotels are now contributing at about 27% of the capital versus about 7% back in April of 2007. Again from our perspective that's a very positive result.

Slide number 11, we talked about the increase in free cash flow and as you can see from the chart we improved free cash flow by $18.2 million quarter-over-quarter. As we talked about with the adjusted operating cash flow, it's being driven by increased revenue and cash flow from the strategic initiatives, reduction of our operating expenses, improvement in working capital and a reduction in our capital investment.

The detail of how we invested then our $5.3 million is showing on slide number 12. Again we're starting with a very stable adjusted operating cash flow period-over-period, and you'll notice that in every case we're using less cash for each one of the categories than we did in the first quarter of 2008. The pre-investment cash flow increased 26% to $22.5 million or the equivalent of a $1 per share for the quarter. After capital investments for corporate assets, minor extensions and major renewals, which totaled about $2.8 million compared to $13 million last year, we had $19.6 million of pre-expansion cash flow versus that $4.9 last year.

We invested $2.5 million for new rooms versus $5.9 million last year and overall then our pre-cash flow after all capital investments was $17.2 million versus that negative $1 million last year, and if you look at that on a per share basis that's $0.76 for the quarter. Annualizing that, that's over $3 of cash flow per year on an annualized basis.

Slide number 13 talks about our covenant analysis. You'll see here that consolidated debt is just shy of $550 million. We have bank-adjusted operating cash flow of $135.8 million, and you'll notice that there is a difference between the reported adjusted operating cash flow and the bank-adjusted operating cash flow and that's due to severance payments that we've deducted from the reported, but under the bank agreement we have to count that as a negative adjustment to our adjusted operating cash flow. That's why there's a difference. However, you'll notice that our consolidated debt ratio is 4.04 versus the covenant of 4.25. Again a very nice improvement versus what we had in Q4 of '08, which is that 4.30.

So with those comments I'll turn the call back over to Scott.

Scott Petersen

Thank you, Gary. Before going to your questions, I would also like to make a few additional comments and some guidance. As I said at the beginning of the call, I believe the first quarter results reflect an outstanding job is being done by the entire LodgeNet team. We moved early and decisively. We've made very meaningful cuts to our costs and our capital, which are sustainable, and will improve our operating results for the foreseeable future. We did this while maintaining good relations with our customers and our employees, and we believe these efforts place us in a great position as the economic environment stabilizes and eventually begins to rebound.

So on slide 14, you'll find our principal goals and strategies for 2009. As we said, we are proactively and conservatively managing the company to meet compliance with our covenants, but with strategies that drive long-term shareholder value.

That right-sizing to the economic environment means we're tightly managing our operating expenses, and I would say this effort has been enhanced by the synergies that we are harvesting from the two major acquisitions we did in 2007 and that's allowing us to continue to operate very effectively, but at a much significantly lower cost basis.

Then, of course, we're targeting the reduced allocation of capital to our highest return opportunities, and we're continuing also then to focus on driving the strategic and diversified revenue, which is not directly related to our guest entertainment purchase or hotel occupancy rates.

As was mentioned before we generate over $50 million or 40% of our revenue from these non-guest entertainment sources, a level that's 27% higher. At the same time, we're expanding the margin on those strategic revenue streams as Gary said, and this enhanced profitability is happening as the initiatives are gaining scale, and we hone our business models in those new areas.

So from my perspective, I believe the strategy is working. I believe it's sustainable, and I believe it should continue to bear fruit as the economy moves forward.

On slide 15, I think shows the great progress. You take the strategy and the great progress we're making in de-leveraging our company despite this challenging economic environment. Since we generally completed the On Command integration one year ago, we have reduced our consolidated debt by over $80 million. From a leverage perspective that equates about six-tenths of a turn on leverage in just 12 months.

So I think it's a remarkable progress we're making here. Then that also puts in a situation where right now we're less than another six-tenths turn away from reaching the 3.5 times leverage level, which is the lowest leverage ratio required under existing credit facility and that doesn't go into effect for another 18 months. There's a gradual step-down through this time. So we believe we've established an operating formula that will keep us in compliance during this de-leveraging phase of our company.

So given that's still challenging to give a full guidance, I know a lot of companies have elected not to. First of all, we want to give you a view into the building blocks that will frame our performance over the next couple of quarters and then give you some specific guidance for what we see for the second quarter.

So on slide 16, it's just once again reflecting the methodical progress we've made in reducing our operating expenses over the past year. We are on track to continue to operate at the $21 to $23 million level per quarter, which we believe is sustainable in the current environments.

Of course, the note there is this is a cost structure that reflect 34% less than what existed immediately after the On Command-LodgeNet merger. So that acquisition was clearly paying dividends for us especially in this down environment.

If you go to slide 17, the data reflects the similar methodical progress we've been making in reducing the amount of our cash flow we're allocating to our capital investment programs. We've always said over the years that we have the ability to vary the level of capital investment dependent upon circumstances, and I think this graph clearly shows that ability and our willingness to make those changes.

So if you look at Q2 and Q3 of this year we are indicating that we will continue to invest in that $5 to $7 million range per quarter with about 80% of the investment going to revenue-producing hotel installations and this level also is sustainable until circumstances warrant a change.

I think I also must note that all of our major customers have basically accepted this new program and what we're trying to accomplish and now we're in the habit of working with them on their specific priorities.

If I take you to slide 18 that also show the progress we're making in selling more services and systems to our hotels and our healthcare customers. In addition to capturing significant operating synergies, this strategy was one of the principal reasons we purchased On Command and StayOnline in early 2007, and I believe it's fair to say that has been gaining momentum since. The first quarter's results were very strong and we expect this strategy to continue to produce increased revenue and gross profit during 2009 as we sell more TV programming and Internet services along with selling them more systems and solutions to our hotels and our hospitals.

Before we go into specific guidance, slide 19 just reflects our capital allocation plan for 2009 and I'd like to take a few moments to review that again with you. On the left hand side of slide 19, you'll see last year's cash from operations and how we used that cash. We generated roughly about $100 million from our operations and invested roughly about 70% of that into our investment programs and around 30% to pay down debt.

On the right hand side philosophically and what the first quarter clearly showed is we modified our allocations where we are actually looking to generate you know roughly a comparable amount of cash from operations this calendar year, but then allocate 70% to 80% of that cash to pay down debt in order to maintain compliance with our leverage covenants, and then the balance 20% to 30% we'll invest in our business.

So if you take all of this information and apply it to the second quarter of 2009, here's what we see at this time. On slide 20, you'll find our revenue through adjusted operating cash flow guidance. It's in the same form we gave our first quarter guidance, and hopefully the structure gives you a little bit more logic and you can see how it comes together.

First of all from a revenue standpoint, we're expecting guest entertainment to be off 15% to 20% from the second quarter of 2008. Gary mentioned that clearly this is better than our first quarter results, but it is consistent with what we've seen so far in April.

I would also note the second quarter last year ended on a very soft note as the $4 gas prices significantly impacted family travel and their buying patterns as the summer season kicked off last year. So we believe we are looking for less of a decline this second quarter than we saw in both the first quarter of this year and the fourth quarter of last. Of course, the continued growth from our strategic initiatives as we talked about on slide 18 and then the reduced operating cost structures that we showed on slide 16.

So this should produce anticipated revenue in the range of $126 to $131 million and adjusted operating cash flow from slightly better to last year's second quarter to about $4 million less and that is the range that we believe we'll be producing.

Then if you take that information on slide 21, you'll see how we see our cash flow and debt leverage guidance coming down for the second quarter. Cash from operations we believe will be in that $21 to $22 million range, we will be using about $13 million of that cash to settle some of the debt that we purchased during the very last couple weeks of March, and then we expect we'll also wrap up our debt purchase program under which we can utilize up to $25 million of cash for the repurchase of our debt.

We're just shy of $2 million that we can utilize under that program. So we should end with debt in the $543 to $540 million range and with our adjusted operating cash flow guidance that should put us in at a leverage ratio that's well within our 4.25 times covenant for the quarter.

So that's how we see the second quarter. I guess just very briefly with that same approach to our business as we think about the third quarter and the third quarter tends to be the strongest quarter of the entire year that we believe we'll be generating sufficient cash flow again to take our consolidated debt levels down to the $520 to $525 million range and once again keeping us in compliance with our bank agreements.

So with that operator would you like to explain the procedure for asking questions?

Question-and-Answer Session

Operator

(Operator instructions). Our first question comes from Alex Lieblong of Key Colony.

Alex Lieblong - Key Colony

In your covenants, should I think in my mind figure in your cash balances or not? Is your covenant that you subtract your cash balances or is it --?

Gary Ritondaro

Alex, no it's based on a gross debt, but what we want to show there is if we needed to we would have additional cash to pay down debt further. So that's why we're showing the net debt but the covenant is actually calculated on a gross debt.

Operator

Our next question comes from Michael Demaray of Elevated Capital.

Michael Demaray - Elevated Capital

I want to ask you about the system sales line. Obviously there's a portion of that that's kind of a one-time revenue component and then there's going to be a recurring component. What percent of those would you say are one-time versus recurring? And then also what does the pipeline for that business look like?

Scott Petersen

I guess you should think about what the system sales line as we've broken that out. Most if not all of that represents the one-time sale of the equipment. Now once we've installed the broadband system then there's a reoccurring revenue stream that then is shown going forward under the hotel services, the reoccurring piece of it and the same thing with television programming. We sell the satellite reception equipment. That shows up under system sales or related as revenue when it's sold and then the ongoing programming revenues also show up then on the next line up on our hotel services.

So from a purely technical matter everything on that line item is one-time. However, I think you have to think of it as our business is an ongoing business that we have relationships with 10,000 hotels. They have needs for these types of equipment. And so that can be a little bit more bumpy as far as results than the reoccurring revenue piece from the hotel services because that is contracted on a reoccurring basis monthly for typically three, five, seven years, it depends on what the system is.

Like in the other healthcare line item, the lead time from the time we get a healthcare contract to the time of installation a lot of times is easily three to nine months and sometimes can be 12 months based on the needs of the hospital to do certain enhancements to their internal television system, etc. Lot of times we actually then contract and do the work for during that period of time. So within healthcare we have quite a long visibility from the time we get the contract to the time we recognize the revenue.

In the broadband space, it's a faster cycle. Hotels when they're buying the systems like to see something done within 60 to 90 days. So our sales efforts do convert to revenue much quicker there. Same thing would be on the upgrades from the analogue to the high-def digital television. When the properties buy HD sets and they want the systems installed that also can be a 60- to 120-day installation cycle.

So for second quarter and third quarter what we've shown there further back in kind of the guidance section is where we see that some of it is one-time expenditures, but we're comfortable with the levels there that we're showing.

Michael Demaray - Elevated Capital

Then you mentioned healthcare, are the healthcare system sales booked then under the other category or are they under the system sales and related services?

Scott Petersen

They are under the other. So on slide 4, you'll see other, in parentheses, healthcare and THN. THN is The Hotel Networks; it's our subsidiary, that's focused on generating advertising-based revenues from our hotel. So healthcare is below the hospitality line, but then we wrap it up in entire total kind revenue per room just to give a combined metric for investors.

Michael Demaray - Elevated Capital

One other question, I did want to ask about Hotel Networks. Obviously it's a bad ad environment and I know you guys are kind of ramping the business up and you've hired new personnel. Can you give us any color on what's going on there?

Scott Petersen

Certainly. It's probably an understatement that the ad market is under some clouds these days. I would tell you though that even though revenues were off on the traditional ad insertion side of the business, that's where we're inserting 30-second, 60-second ads in to 10 cable channels. We also have a new initiative with the Hotel Networks that is downloading kind of sponsored content to our file servers on premise. This will be interactive television systems and then are creating new ad opportunities or sponsorship opportunities. That was up nicely over the first quarter of last year as we're taking that across. Now we're probably offering that type of advertising opportunities in over a million of our 1.9 million rooms.

So that did actually buffer some of the softness on the traditional side. And then I would tell you if I have to take that down to the adjusted operating cash flow line they've been doing a great job on kind of matching overheads with revenues, and the adjusted operating cash flow or EBITDA so to speak coming out of that subsidiary was basically flat year-over-year. So I think despite a very tough environment, the bottom line results were very good and didn't distract from our EBITDA during this last quarter.

Operator

Our next question comes from Greg Blaszczynski of Gulf Stream Asset Management.

Greg Blaszczynski - Gulf Stream Asset Management

Just a quick question on your debt purchase program, you did that under the investment basket, correct?

Gary Ritondaro

That is correct.

Greg Blaszczynski - Gulf Stream Asset Management

Is there any room left under that basket?

Gary Ritondaro

There is about $2 million left of room in that basket and that basket does not change through the life of the facility.

Operator

Our next question comes from Varkki Chacko of Credit Capital.

Varkki Chacko - Credit Capital

Just a question on slide 10. I noticed that the hotels are contributing a larger percentage of the capital from what 7% or so to up to 25%. What is the quid pro quo there? Why are they doing that and what does that mean in terms of I guess your PP&E and other aspects of maintaining that equipment?

Scott Petersen

Historically I would say that the break on that prior to the On Command acquisition, we as an industry were a lot of times providing all of the equipment. So it was not only the interactive television equipment in the system, but we would also provide the television reception equipment. So we have a long-term deal with DirecTV.

We would put in the DirecTV head-in and that would be part of the overall business deal. We would charge a rental fee for that equipment for the seven-year life of the contract, but generally that would be at a lower interest rate so to speak than the returns that we are generating from our traditional model on the direct share on the interactive television part of the system.

Especially now as the industry has been moving then toward high-definition systems the capital costs of a high-def reception equipment is much more expensive because it's early stage technology than the tried and trued analogue equipment from a couple years ago. So as the hotels are starting to adopt this and I think also given that On Command and LodgeNet did come together, it's been well accepted that it's a fair business transaction for the hotels to actually purchase that themselves.

We also have lease programs financing programs for hotels if they would not rather turn that into a financed purchase or an operating lease, but it takes it off of our balance sheet and takes it out of our capital equipment the need for the capital. Then, of course, from our perspective right now the cost of capital that a third-party leasing company can provide is probably less expensive than where we would want the return to be for our shareholders.

So the quid pro quo there is that by them purchasing the equipment they're in a situation where they should be having a lower cost over the entire term of that specific capital and we're finding very good acceptance. All of the major hotel brands, which don't actually buy the equipment from us they just generally negotiate general terms for their franchisees they then spend their money, they all have agreed that that's a fair approach to it and that's well under way.

So that has been one of the major reasons that the capital sharing arrangement, because when you think about that whole capital, we're still concerning that both the interactive TV and then the free TV reception equipment is part of the entire installation. So that's one of the major reasons we've been moving up.

Then also there is cards that go in the sets that historically the companies would have provided without compensation. Now as the hotels are moving toward HD panels, they are buying those cards from us that make those sets compatible with our systems, and that's also providing a considerable amount of revenue and kind of a capital subsidy so to speak to the overall systems. So that's kind of generally what's happening and where you see that is I don't necessarily know that you can see the trend line continuing up on this. In fact I wouldn't expect the line to keep going up to the pace that it has been, but we certainly don't see it retreating either.

Varkki Chacko - Credit Capital

Does that in any way increase the risk of migration away from you if indeed they control the capital equipment?

Scott Petersen

I would say very modestly if at all. We basically do provide it. It's the total package; it's a single-source purchase. Our service organization takes care of and services both types of equipment. The program arrangement with DirecTV comes through us. So on one hand if everything is always fully financed by us you can say that's probably an easier buy from a hotel standpoint, but we don't believe that this is much of a distraction if at all.

Varkki Chacko - Credit Capital

And going back to slide 4, where we saw the guest entertainment per room drop from $17.83 to $13.73 that is based on per occupied room is that right?

Gary Ritondaro

This is based on total guest entertainment rooms. It's not based on a per occupied room.

Varkki Chacko - Credit Capital

You make a point that the balance of the decrease part of that occupancy was down 12.2, but the balance of the decrease was from the cautious consumer. Are you seeing any migration due to kind of technological advances people bringing in movies on their laptops or things like that? Is that part of the competitive environment and how do you kind of deal with that?

Scott Petersen

Well there's no doubt on a longer-term trend. There is the ability to access entertainment content via DVD players, laptops, et cetera. So I would say we do plan for a secular decline cycle, but a very gradual effect from our own kind of statistical analysis. It's not very easy to detect. Then, of course, then this economic cycle came along and provides quite a cyclical down draft. So it's clearly our view and if you've gone back the last couple of years, it might have been fading at a 2% per year type range. That's with level kind of occupancies.

This, of course, is a big down-draft on the number of people traveling and then it's also I think that consumers have just been holding very tightly to their purse strings as they are traveling being more cautious. Now as Gary said in April, we've occupancies in hotels as more people are traveling. We have seen actually a pretty nice rebound from the first quarter areas because our guidance now is between 15% and 20%. And right now April's kind of midrange there.

We watch the consumer sentiment and the consumer confidence tracking and there have been some positive or at least less severe declines in those. And I think one of the other significant factors that will come to our benefit over the next 6 to 12 months are hotels now are starting to discount rate quite a bit.

So from personal experience as you travel a lot of times you're seeing that the room is 20% to 30% less costly than it was a year ago and from our past experience it has been that once the rate of the room drops, I think the consumer have a feeling they might have more disposable income to spend on property and we're one of the services that they may well purchase.

So especially as I think we come to the summer months that could be a nice upper side. I'm not going to call it an upside opportunity, but I think an upper opportunity for us.

Varkki Chacko - Credit Capital

That's very helpful. Are you seeing growth of just Internet access, while there's a decrease of kind of accessing the movies? Is that one way to grow this?

Scott Petersen

We have about 227,000 rooms that we provide high-speed Internet access services to our hotels. The reality is all 1.9 million of our interactive television rooms do have some sort of high-speed access wireless or wired capabilities since that is one of the most demanded services from the traveling businessperson. From a competitive standpoint, the internal networks within hotels generally have not been engineered and then equipped with wireless systems that could deliver actually to multiple people, a decent streaming video experience.

And if anything hotels are purchasing from us what's called bandwidth management tools where they have a certain -- they're buying the high-speed pipe that comes to the hotel and they don't want one or two guests hogging all the bandwidth from streaming video content into the internal networks. So these bandwidth management tools then kind of put a cap on how much bandwidth each guest can access, and that cap that makes then the video side much less, sometimes it's almost unusable or at the very least it's not as good of an experience as watching on a big-screen TV.

So if anything we're certainly aware of the new wireless technologies and other Internet-based video. That at this point in time really is not a major player within the hotel space, and we believe we're just providing a better guest experience. The flat panels are coming and that does provide a better experience from the guest's standpoint.

Varkki Chacko - Credit Capital

One last question, on slide 19 right at the bottom it says '08 adjusted cash flow operations of $100 million, expect comparable level of '09 of $100 million. But a little later when you look at the AOCF that's running closer to 140, I guess 135 or so. What's the difference between the 100 and the 135?

Scott Petersen

The difference there is interest. So if you take the adjusted operating cash flow that's pre-interest and then pre-working capital. So then the cash from operations would be the GAAP-defined term.

Operator

Our next question comes from Pallo Blum-Tucker of Aladdin Capital.

Pallo Blum-Tucker - Aladdin Capital

Hey guys. I just wanted to confirm that it looks like the basket has pretty much been used up, $2 million less. It's below debt buybacks. I just want to confirm your statement that you are going to maintain compliance throughout 2009. You're saying that without any ideas of replenishing that basket for amendments.

Scott Petersen

That's correct. Based on the approximately $2 million we have left that is the only, as we're thinking about that and making that statement, pure operating cash flow and managing our capital investment program. That's what our assumption is to make the statement that we believe we will be maintaining compliance through 2009.

Pallo Blum-Tucker - Aladdin Capital

And on slide 21, the investment settlement numbers of $13 million? I just wondered if you could run me through exactly what happened there.

Gary Ritondaro

Well we acquired some of the debt late in the month of March and its just normal settlement terms that we don't actually pay for that until April. So that's why we're showing that the cash is going out the door during the second quarter for those purchases that we made the last week of March.

Pallo Blum-Tucker - Aladdin Capital

So the Q1 debt number includes you guys buying that debt in Q1, where's the cash showing up?

Gary Ritondaro

Well again the cash will come out in the second quarter. So what we've done is acquired face value of debt. When we do the consolidation of course that gets eliminated in consolidation, so the debt level is lower. But it does show up then on the balance sheet as a payable.

Pallo Blum-Tucker - Aladdin Capital

Last thing, the City Center deal? And I'm not a game analyst, so forgive ignorance on this. Were you guys involved in? Are you in some of those rooms and if so, are you worried about this could potentially affect in future?

Scott Petersen

Fortunately, well we have been competing for that. In Las Vegas, we have around 25,000 rooms most notably the Las Vegas Sands properties, the Venetian and the Harrah's organization. But in Las Vegas, the local cable company has a subsidiary. It's part of the Cox hospitality division. From what I understand that probably would be their project. I don't think the final decision has been made on that specifically. We have been competing but that doesn't really impact our forward view and it certainly is not a take-away from our current business.

Operator

(Operator Instructions). Our next question comes from [Chris Tejawalt] of Babson Capital.

Chris Tejawalt - Babson Capital

Most of my questions have been answered, but I just want to clarify something that was mentioned on the fourth quarter call with regard to the debt buyback as well as obviously it's a larger issue now. But you said that it wasn't retired and it remained outstanding last time, but I noticed that just from an accounting perspective, just taking a gain on the extinguishment of it you're essentially not paying interest on it and it has lost its earning rights. Am I right in that assumption?

Gary Ritondaro

We do continue to pay interest because it still is outstanding debt and the accounting treatment is such that the difference between the face value and what we paid for it at a discount becomes that gain. So you recognize the gain when you do that transaction. The alternative would be to spread that gain over the remaining life of the debt. But the accounting that Pricewaterhouse has steered us towards is to take the gain at one time.

So the debt remains outstanding. We eliminate it in consolidation when we pay the quarterly principle amount. We get some of that quarterly principal back and when we pay the interest we get some of the interest back.

Chris Tejawalt - Babson Capital

So for compliance purposes it's just assigned to the whole term so it's not being included in the calculations?

Gary Ritondaro

If you look at the credit agreement it talks about the fact that the calculation is done based on GAAP and because you do the consolidation and eliminate it in GAAP that's why it affects the numbers that we're showing.

Operator

(Operator Instructions). We have a follow-up from Varkki Chacko of Credit Capital.

Varkki Chacko - Credit Capital

Just on the debt question, after the basket is used up and there's still kind of free cash flow being generated, how do you plan to use that?

Gary Ritondaro

Well again we will use that free cash flow then to pay down the debt at par. Then it does in fact get retired at par versus us being able to acquire the debt at a discount.

Varkki Chacko - Credit Capital

Okay. And that is the expected use of the free cash flow you said?

Gary Ritondaro

Yes, and again that goes back to the slides that we showed. We're about 70 to 80% of our free cash flow will be used to retire debt. Again that was slide number 19.

Operator

You have another question. Alex Lieblong of Key Colony, your line is open.

Alex Lieblong - Key Colony

At 3.5 multiple, as you keep going through the new hoops so to speak, do your rates drop and is it correspondingly?

Gary Ritondaro

There is a rate drop once we get below 3.75.

Alex Lieblong - Key Colony

Then again, is it 3.50 or does it just bottom out at the 3.75?

Gary Ritondaro

Let me make sure I got your question right here, Alex. The leverage covenant continues to drop until we get to 3.50. And then it levels off from the balance up until April of 2014. So there's no further step down after we get to 3.5, which occurs in September of '09.

Alex Lieblong - Key Colony

Okay, now that would mean the interest rate drop. You get a little drop at 3.75 is that right?

Gary Ritondaro

I'll have to look but I think it's at 3.50. Once we get to 3.50 it drops to 175 versus right now we're at LIBOR plus 200.

Operator

I'm not showing any further questions at this time.

Ann Parker

All right. Thank you, operator. Well we understand that some of our participants may have experienced some technical difficulties with the call, perhaps more of our web participants.

For those of you who would like to hear a complete replay of the call that will be available starting at 8:00 this evening Central Time or perhaps that's Eastern Time. Anyway it'll be available this evening and run through May 6th and the number for that will be 888-266-2081 with an access code of 1353082. We are notifying our e-mail contacts as well with that information. Again the dial-in is 888-266-2081 with an access code of 1353082, and if you didn't catch that you can certainly call me Ann Parker, 605-988-1382. We will give you the replay information as well.

We'd like to thank everyone for joining us today. Again as a reminder, the replay of this call, as I said, is going to be available through May 6. You can log into our company website if you'd like to look at the slides, once again www.lodgenet.com. The slides used during this webcast will be archived for your reference indefinitely. If you have difficulty downloading those slides we would be happy to send them on request.

Thanks again everyone and have a good day.

Operator

Ladies and gentlemen thank you for your participation in today's conference. This concludes the program. You may all disconnect. Everyone have a great day.

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