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Executives

Ann Parker - Director of Investor Relations

Scott Petersen - Chairman and Chief Executive Officer

Gary Ritondaro - Senior Vice President and Chief Financial Officer

Analysts

Jim Boyle – Gilfred Securities

Frank McEverly – Craig Hallum

Michael Demaray - Elevated Capital

LodgeNet Interactive Corporation (OTC:LNET) Q4 2009 Earnings Call Transcript February 18, 2010 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the LodgeNet fourth quarter 2009 earnings call. (Operator Instructions)

Now it’s my pleasure to introduce your host, Ann Parker, Director of Investor Relations with LodgeNet.

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 fourth quarter 2009 conference call. You should have received copies of our earnings release. If not, please call me 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

Good afternoon, everyone, and thank you, Ann.

I’d guess I’d summarize the 2009 financial highlights in a very short phrase and that is greater profitability and free cash flow. First we delivered what I believe are very remarkable improvements to our bottom line performance during the year. Operating income was posted at $22 million positive versus a loss of about $5 million in the prior year.

Regarding our net loss, we reduced that to $13 million this year as compared to a $48 million level just one year ago. Then we drove free cash flow. It was up 155% to $65 million. Free cash flow per share on an outstanding share basis just around $2.90 up per share and on a fully converted basis right over $1.72. Then a yield perspective either 55% free cash flow or 50% free cash flow yield depends on how you calculate to look at that.

In addition, we reduced our long-term debt by 20%. We dropped our ratio by 50 basis points during the year. It now stands at 3.68 times on a net basis and that is already below our first quarter covenant requirement.

Economic recovery, we are reworking our business model, changes to that, which are reflected in 15% to 20% lower investment active room that we’re reporting today. We completed the integration through the year, which lowered our operating cost by 20% during 2009. I’d like to spend some more time on this on the call today after Gary’s comments, but we’re seeing some very interesting performance from our high definition systems. They’re performing well and projecting a recovery that is somewhere on the horizon. I certainly believe we have significant upside both from a revenue standpoint and a cash flow perspective as the recovery becomes to materialize to a greater extent.

So with that, I’m going to turn the call over to Gary for some more color on the quarter in the year. Gary?

Gary Ritondaro

Thank you, Scott, and thank you again for joining us this afternoon.

On slide number 3, you’ll see that there’s efforts that we are undergoing about the decrease that we had in entertainment revenue for the year. For the year, revenue from our diversification efforts was up almost $190 million. Overall revenue was down about 9.3 year-over-year. Entertainment was down 18.9% for the year, offset somewhat by nice increases in the hotel services and in other.

If you turn to slide number 4, you'll see again on the pie chart where we graphically show the progress we’ve made with our diversification effort. We are growing our topline revenue from $280 million in 2006 to $485 million in 2009 through a combination of organic growth and the acquisitions that we completed in 2007.

While I’ve said that our business has grown nicely, the important point is that we are becoming a more revenue diversed company. In 2006, 80% of our revenue came from guest entertainment versus 61% in 2009, which means we become less reliant on occupancy rates and guest purchases.

If you turn to slide number five, you’ll see our revenue on a full year basis. Results produced by hotel services, system sales, and related services and advertising and health care offset about 35% of the decline from guest entertainment.

Guest entertainment was down as you can see on the chart by 17.6% and the rate of decline has moderated throughout the year as each quarter of 2009 showed an improvement in the rate of decline compared to the same quarter in 2008.

On the next slide, it presents the same data points for the quarter.

Slide number six, you can see again that guest entertainment was down for the quarter by 8.3%. This is the result impacted by lower occupancy rates. Our consumer buying pattern and softness in business travel.

The decrease in occupancy rates period over period accounted for about 45% of the decline of 8.3%. On a positive note, revenue from those installed with HD interactive system showed a 5% increase in guest entertainment revenue period over period.

The growth in revenue from hotel services and system sales and related services slowed somewhat during the quarter as many hotel properties have reduced capital investment in light of their lower occupancy rates.

On slide number seven, you’ll see our gross. A decrease in gross margin for the year was in line with our expectations and as a function of changes in our revenue composition of our businesses, which is also moving us away from a capital intensive business. The gross margin for guest entertainment declined 110 basis points, due to the mix of products sold during the year compared to 2008. This reflects the occupancy rates during the week, which is an indicator of lighter business travel during the year. This was offset somewhat by lower hotel commissions.

All of our growth initiatives generated higher margins in 2009 than they did in 2008. This is the combination of improving buying, cost controls, and efficiency improvements.

On slide number eight, our operating expenses certainly proved solid expense controls and improvements of operation is that we are completing the integration of the acquisitions. We reduced operating expenses during the year by almost 21%.

Reduction in operating expenses of $23 million of that 66% of the decline in gross profit for 2009.

This is certainly a great result and it compliment to our entire staff for achieving these results.

On slide number nine, you see adjusted operating cash flow. This slide shows both the full year on the left and the quarter on the right. Both periods did show a decline in adjusted operating cash flow due to lower revenue in gross profit offset in part by the reduction of operating expenses we’ve already talked about.

For the quarter, the change is also due to an adjustment made in the fourth quarter of 2008 of $1.5 million, eliminated the bonus reserve which accrued during the first three quarters of 2008. Excluding this benefit from the fourth quarter of 2008, reduction of operating cash flow would have been 8% period over period.

On slide number ten, our operating income, as the slide indicates, we’ve had a five fold improvement in operating income period over period.

Including the items already discussed for changes in adjusted operating cash flow, there are two other important improvements to note on this slide. We had a reduction of depreciation in amortization of almost $24 million and the impairment charge we reported in 2008 of $11 million.

A reduction in depreciation is due to over assets becoming full depreciated and lower capital spending.

We expect that depreciation and amortization would decrease another $15 to $18 million in 2010 compared to 2009.

Slide number eleven is our next watch slide. Again, you can see a significant improvement of 79% in the amount of net loss we recorded in 2009 compared to 2008. Change of operating profit carry over into improvements in net loss. In addition, we had a reduction in interest expense of $4.5 million. As you know, we’ve been paying down our debt by almost $120 million period over period and a gain on the purchase of our debt in early 2009 of a steep discount to its face value of $9 million.

On a fully diluted share basis, we had a loss of $0.59 compared to a loss of $2.16 last year. We further expect a reduction of our interest expense in 2010 of somewhere between $5 to $6 million as we continue to pay down our debt.

Slide number 12 shows our capital investment for the year. We invest 67% less capital into our business as compared to 2008. Thirdly, we installed fewer rooms, but we also are enjoying the benefit of lower capital per room as we achieve greater efficiencies, lower costs of components, and hotels contributing more of the capital to install the guest systems. Certainly we showed a lower cost capital use for (?) as well.

All of this combines to increase our free cash flow for the year. As Scott mentioned, we increased cash flow by 155% despite a difficult economy. This was achieved by operating expense reductions, by lower interest expense, capital investment reductions, and strong management and work in capital.

For the quarter, we generated 19% more cash flow for this very same reason. This is higher than what we guided due to two factors. We received a pre-payment of $2 million late in the quarter from a THN customer for advertising. Revenue associated with the pre-payment will be recognized as we provide the service and this has been factored into our guidance.

We also made a concerted effort to collect our accounts receivable. We improved our DSOs from 32 days at the end of 2008 compared to 26 days at the end of 2009, thereby generating more cash flow.

On slide number 15, you see the detail of our cash flow. As we generated more cash and how we invested our capital, we generated $86 million of pre-investment cash flow during the year. $3.84 for common share or $2.29 per share on an ads converted basis.

After investing $15.5 million in pre-expansion capital, we have generated $70.6 million of cash and in turn used $5.8 million to grow the room base predominantly with the installation of HD systems. The result is free cash flow of $64.8 million, that 155% increase we mentioned, and $25.4 million generated in 2008. This translates into $2.89 per common share or $1.72 per share on a fully converted basis.

On slide 15, you’ll see the fact that we have continued to reduce our leverage. For the quarter, we have reported leverage ratio of 3.8 two times compared to four times as a covenant. At the end of 2008, we have reduced our leverage ratio by about half a turn. On a net debt basis, our leverage is at 3.68 times, already below the covenant level required at the end of the first quarter.

During the year, we lowered our consolidated debt by about $119 million. $53 million of that reduction came from the proceeds of the preferred stock offerings. $39 million from our free cash flow and $26 million from the purchase of our debt at deep discounts to the fact value.

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 provide a few comments on our outlook.

If you look at slide 16, it kind of gives you an overview. First of all, I want to make sure that you know we remain focused on free cash flow and debt reduction. I think 2009 showcased our abilities to do that in a very tough environment and I have a couple slides coming that will highlight that ability.

As we think about 2010, we’ll continue to manage the business within our leverage covenants. As Gary mentioned, we dropped our ratio by about 50 basis points last year.

Growth opportunities with our free cash flow performance, we have excellent investment opportunities in our markets structured with the high definition systems that we’re rolling out, but we are very mindful of our investors’ desire for free cash flow and that factor does play a very important part in our overall stock valuation.

We’ll maintain our current conservative operating plan pending the economic rebound. Near term revenue outlook is being impacted by tight hotel budgets, as Gary mentioned. We saw that in the fourth quarter. That is lowering our diversification goal of selling more systems and services for our hotel customers, but over time we certainly believe that will return. Of course, also recovering guest revenues has been dampened by cutbacks in business travel.

Lastly, I’d like to highlight some very positive developments that are seeing within our platform and the results we’re generating there. I believe that our HD platform should provide a very solid earnings growth engine as the economy recovers.

So if you move to slide 17, this is one of my favorite slides. It certainly highlights our ability to drive free cash flow even during this very tough economic environment. Right now free cash flow yield is running about 30% or 50%, depending on how you calculate it. If we increase from $25 to $65 million in one year, I think was a great accomplishment for the company and you can see on the bottom of that slide, we’re also telling the market that we plan to manage our free cash flow during 2010 in this $60 to $65 million dollar range.

If you go to slide 18, I’ve got to tell you that’s another one of my favorite slides. It shows the great progress that we’ve made for the past couple of years. Long term debt levels during 2009 and we reduced that by 20%. On the bottom of the slide, you can see also our viewpoint that as the year 2010 ends, we should be approaching the $400 million dollar level at the end of this year.

On slide 19, progress we’re making in lowering our investment per our interactive room. As you can see in the graphs, for new high definition rooms, our investment level was down about 15% over 2008. We can also see for the 2010 viewpoint, we’re looking for incremental 20 to 30% reductions coming during this next year. Right side is the data points for our HD conversion rooms, rooms that we already serve with the on-demand system and new contract to extend the agreements. Our investment levels during 2008 were about 25% lower than what we experienced during 2008. You can also see for the 2010 timeframe, we’re looking for incremental reductions in the 20 to almost 40% range that’s on the horizon.

Now if the gains in the reductions here are coming from two areas. One is technology advances and also changes to our business model. Technology advances, I would say we’re riding the cost curve as the equipment used is becoming more cost effective. A couple of years ago, it was clearly early stage. Digital equipment today, we’re seeing nice benefits of reducing cost as volumes increase from the manufacturers and we’re benefiting from lower costs.

Then also, one of the benefits of (?) acquisition, which gave us such a large market share within the hotel space, we’re seeing and expecting our incremental reductions in our investment costs that are reflected in the graphs, factors of televisions are embedding our technology into their sets which eliminates then our requirement to install terminal within the guest room.

So all of those are moving along nicely and then the other factor is also we’ve been establishing new business models with our major customers. This has been a process over the last year, two years, and the basic outline is we’re strengthening with our major customers, the hotels, the properties themselves, are buying the equipment necessary to bring down the high definition television programming, the free programming, and of course if they buy the right TVs from leading companies such as LGs, LG and Phillips, where communications and technology is built in the set that also provides new opportunities for hotels basically to also have the ability of our market position.

Slide 20, highlighting some of the revenue performance we’re seeing within our high definition system, I’m using the fourth quarter as an example. Our HD rooms generated 50% more revenue than our average room. Approximately 40% come from entertainment purchases. With the high definition picture quality, we’ve given the better guest experiences, buying more content as a result. Then you also see there’s a 65% more revenue coming from hotels from the hotel services category and that really is where we’re selling larger packages of TV programming that incorporate high definition channels to hotels and also larger percentage of hotels are buying the HD TV packages from us.

In Q4, highlights that are average revenue for HD room was up 5% versus 1% a year ago. Guest entertainment was up 8%, very nice improvement there. Up 5% compares to our average room that was down about 3.5%.

So capital investment trends seen and are experiencing and forecasting along with these factors, I believe HD represents a very solid investment opportunity for our company. For example, if you take the mid point for the new capital investments that we’re looking at for 2010 and beyond, you’re expecting to generate cash flow from these systems that would be sufficient to return our capital investment back to us within 18 to 24 months. So it does represent a very solid investment for our organization.

I think the other important fact to point out is you can see at the bottom the HD systems are only about 13% of our rooms today. So these economics will spread across our total room base over the next several years as the economy recovers in hotels upgrading to the flat panel high definition televisions.

On slide 21, here’s an analysis we put in the market in November. It demonstrates the revenue and cash flow leverage that we have in our business as occupancies increase and consumer confidence of buying patterns return to more normal levels. With this, we’re now predicting, not the timing nor the expense of the recovery, but only the impacts of the return and the way to read this information is you’ll see the middle of the slide. Revenue rebounds only halfway to the levels that we had in 2008, revenue would be up $37 million and adjusted operating cash flow would be up about $22 million. Of course, that’s very meaningful compared to the current $123-$124 million we’re at today.

On the far right hand side, you’ll see a full recovery that revenues would be up $74 million and the (?) would be up incremental $44 from where we’re at today, which would put us at approaching the $170 million level.

Lastly, slide 22 and 23 are guidance for the first quarter. A little more color here than what was in the press release. Once again, I would say I believe this is conservative guidance. It’s based on the two drivers guest and entertainment still being down this quarter versus one year ago in the 5 to 10% range and also reflects the high capital budgets for hotel versus one year ago and you can see the data point there that we’re estimating that system sales will be down about $5 to $7 million versus what we had in the first quarter of last year where hotels were still spending money before their budgets kind of collapsed, from that perspective. Of course, we will be maintaining our low operating cost structure that we have today pending the return of the economy and certainly during this first quarter.

Then on slide 23, it gets to the free cash flow side. You’ll see that we’re looking for free cash flow in the $18 and $19 million dollar range and using that cash to pay down debt to keep compliance with our credit facility and we’re fully expecting that to be the case.

So with that, operator, I would ask you to explain the procedure for asking questions.

Question-and-Answer Session

Operator

(Operator instructions). Our first question comes from Jim Boyle – Gilfred Securities

Jim Boyle – Gilfred Securities

If revenue keeps plunging in 2010, how much operating leverage do you have left to either react with or to dial back?

Scott Petersen

Well, Jim, we did a lot of reductions last year. Now fortunately most of that came from the integration of on-demand into the overall organization.

I would say we have additional opportunities in an operating level. We’re certainly not fat by any means today, but if that is what the calling of the cards that we’re dealt with, we would have some incremental opportunities there. We planned our year, from a budgetary standpoint, we were planning for period over period reductions in guest entertainment during the first half of the year. Then looking for modest increase for next.

So that was part of our thinking as we planned our budgets and operations this year, but that does provide…we would have some dry powder here, not to the extent that we had of course last year, but that would be one school we still would have in our arsenal.

Jim Boyle – Gilfred Securities

Given what you just said, does that better second half, lesser first half, with economic trend recovery?

Scott Petersen

The industry is expecting relatively flat occupancies this year. There’s still somewhat negative leader points coming out during the earlier part of the year and looking for 2011, so I think as the year ends, I think we have a consistent view with the overall hotel industry. That should have bottomed and should be moving back upwards, not dramatically, but at least moving in that direction.

From a hotel standpoint, there’s occupancies, but they’re trying to drive occupancy with reductions in their run rates and I do believe we are not the direct beneficiary, but certainly a beneficiary of those reductions in hotel room rates. So the hotel guests, you’re seeing lower price for the room, I do believe like in the high definition systems that could easily be one of the buy products is guest…discretionary spend on the property and we would be one of the areas that they could spend that money.

Jim Boyle – Gilfred Securities

So lodging…higher occupancy, but if you had a somewhat softer or lower…so that they would have more discretionary dollars, they could spend with you, which of the two do you watch the most?

Scott Petersen

Well less people are traveling, so you can’t sell a movie in an empty room. So occupancy is by far, you know, it’s probably the key driver there. The rate is kind of marginal and so I think occupancy would be the primary driver there from a standpoint of driving guest entertainment revenues.

Jim Boyle – Gilfred Securities

NexFlicks and Red Box, their DVD window, caused any shifts in your earlier window with Warners or any of the other studios?

Scott Petersen

No, the relationships are the basic structure. If anything, over the last several years, we’ve seen us moving into the theatrical window more. So any kind of movement where the studios want to release the DVD sooner, generally pushes our opportunity closer to the initial theatrical release and one of the data point is to generally on a first-time movie, we generate well over 70-80% of the revenue on that given title within the first couple months that have it. So I think that’s the key factor there. So no changes I would say in the relationship we have at this time with our windows.

Jim Boyle – Gilfred Securities

Avatar?

Scott Petersen

We’re scheduled right now for April. Oh, you moved it to May. Sorry, so it’s on the horizon, not too far off.

Operator

Next from Frank McEverly – Craig Hallum

Frank McEverly – Craig Hallum

Does your guidance assume for free cash flow additional collections in the accounts receivables?

Gary Ritondaro

We certainly want to maintain the same kind of levels that we achieved for Q4, so managing work in capital in total is certainly something that we’re looking at very, very closely from month-to-month and quite frankly week-to-week. So that is a focus. Continuing to reduce receivables and manage work in capital, keeping inventory at low levels, etc.

Frank McEverly – Craig Hallum

In terms of the buy rates, Q1 typically has perhaps seasonally the highest buy rate. Have you seen buy rates increase?

Gary Ritondaro

Our buy rates reflects our current experience from January and what we’ve been seeing now through February, the big snow storms of the east coast for the last four weeks has not necessarily been our friend. So far this quarter is reflected in our guidance. Seasonality, fourth quarter is the lowest, starts to build in first. So we certainly would expect a sequentially higher revenue from the first versus the fourth.

Frank McEverly – Craig Hallum

I think you mentioned the EBITDA was positive or had improved for all of the growth initiatives?

Gary Ritondaro

I was talking about gross profit, but it’s also true on the adjusted operating cash flow side as well.

Frank McEverly – Craig Hallum

Continue going forward?

Gary Ritondaro

We certainly would expect operating cash flow to grow with those businesses. We are seeing improvement on the THM, the advertising side, both on interactive and the super block channels, the ten channels that we have. Health care has been doing nicely. We had five installations in the fourth quarter.

Operator

Next question from Michael Demaray - Elevated Capital

Michael Demaray - Elevated Capital

On slide 14, it appears maintenance CapEx was $15 and $16 million. Do you think that’s going to be maintenance CapEx going forward?

Scott Petersen

We said that we were going to maintain the same level of capital generally that we’ve been experiencing over the last few quarters. Until we see improvements in the economy, we’re certainly in the near term I would expect it to be in that range.

Michael Demaray - Elevated Capital

How often do you guys change over the equipment in each room?

Scott Petersen

I think there’s different components, but generally the systems are installed for a seven-year contract. We depreciate that investment over the seven years with no residual value. The upgrades, there are certain components that can be reused for the next cycle and that’s one of the reasons that the renewal capital is lower than a new room, because we are in fact reusing many of those same components. Definitely longer than the seven-year contract.

Operator

Your next question comes from Jim Boyle – Gilfred Securities

Jim Boyle – Gilfred Securities

Has LodgeNet ever sold a geographic or non-strategic cluster of properties to another media company such as the local cable company and would you do so for the right price?

Scott Petersen

Everything is for sale that might characterize me as inappropriately, Jim, but the short answer is no we have not in the past. Generally you’re dealing with management and ownership groups that like to deal from single source providers. Customers buying from us because they generally are like….Minneapolis and Denver or upper Midwest and they would be somewhat counter to their, you know, single source provider to sell off a geographic area and basically how the market operates. At the right price, Jim, we value something we could entertain. There could be a couple local media companies that might make sense for, from that perspective, but we have not approached that on a focus basis at this point.

We have not been approached by an organization that had that kind of a cluster mentality, which can exist in the world of media, but if approached, we would certainly consider and look for the best interest of the shareholders and our customers.

Jim Boyle – Gilfred Securities

Number two in the lodging private cable business in your industry sub-sector, how big are they now? You used to have a number two that was give or take a 120,000 rooms. Has anyone started getting bigger on you?

Scott Petersen

That would still be the size of number two. That would be cost due to services focused on Las Vegas or local MSL. That subsidiary is purchased Vegas Cable Systems. So they are a company, you know, they’re really looking to leverage their plant within the Vegas market and then of course they have Sun Atlantic City, but most presence in Vegas, but the only movement I believe I’ve seen over the last several years is where we actually took the Venetian from Cox. That was a couple years ago and there’s been no attrition from our side to Cox within those markets.

Operator

Your next question comes from Frank McEverly – Craig Hallum

Frank McEverly – Craig Hallum

I noticed that the number of guest entertainment rooms was down about 4.6% year-over-year in Q4. Can you talk about what’s causing that?

Scott Petersen

Should expect kind of a similar relationship this year, but the backup that is the rooms that are leaving, the vast majority are over $10 of movie revenue proven per month. So it is the smaller, less prime rooms and I think the general fact on there is two to three years ago, the business model, they would have believed we would have been at their hotel sometime in the not too far off future to upgrade them to the next generation platform space also on renewed contract extensions.

From our standpoint, we’re focusing on quality, our best customers, and so on the lower revenue side of our existing customer base, that’s where we’re seeing the attrition. I think this year probably we’re continuing somewhere in that level, but as the capital costs keep coming down, we can also make some pretty interesting opportunities available to them to perhaps purchase or co-invest in (?) to provide the basic TV services to them at the capital cost of the equipment necessary to bring them HD direct TV also continues to decrease. So that’s what’s going on there. I think this year, probably continue somewhere in that range. I would hope, I believe we’ll flatten that curve as we move into 2010.

Frank McEverly – Craig Hallum

HD up 5% year-over-year?

Gary Ritondaro

Profitability would also be increasing that same kind of rate. The margins are dependent upon how well a hotel is generating revenue in terms of what we paid on that commission. We’re definitely seeing the same level or slightly higher level of margins on those HD properties.

Frank McEverly – Craig Hallum

Final question on the average price per movie. I think last quarter you talked about it being roughly 3% up year-over-year. What do you see the average pricing going in 2010 versus 2009?

Scott Petersen

Pretty level. We’re checking some bungling strategies that perhaps packages…higher ticket price, but fundamentally it’s pretty level from here on out.

Operator

I’m showing no further questions in the queue.

Ann Parker

All right. Thanks, everyone, for joining us today. A reminder that replays of this call can be accessed over the next month via the Internet through our company website www.lodgenet.com. The slides used during this webcast will also be archived on our website for your reference under the Investors’ section.

If you have any difficulty downloading those slides, we would be happy to send them on request.

Thanks again and have a good day.

Operator

Ladies and gentlemen, this does conclude your conference. You may now disconnect and have a great day.

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Source: LodgeNet Interactive Corporation Q4 2009 Earnings Call Transcript
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