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Executives

Ann Parker – Director, IR

Scott Petersen – President & CEO

Gary Ritondaro – Sr. VP & CFO

Analysts

Ali Mogharabi – B. Riley & Company

Lucas Binder – UBS

Marshall Levine – Knott Partners

Ben Vadinsky – Bear, Stearns

Jeff Bronchick – RCB Investment Management

LodgeNet Interactive Corp. (OTC:LNET) Q4 2007 Earnings Call February 20, 2008 5:00 PM ET

Operator

Good afternoon. At this time I would like to welcome everyone to the fourth quarter 2007 earnings conference call. (Operator Instructions) At this time I would like to turn the conference over to our host, Ms. Ann Parker, Director of Investor Relations for LodgeNet Interactive Corporation.

Ann Parker

Good day everyone. I’d like to thank all of you for taking the time today to listen to our fourth quarter 2007 conference call. You should have received copies of our earnings release. If not please call at 605-988-1000. We’ll make sure you do get a copy. Our speakers for today’s call will be Scott Petersen, President and CEO of LodgeNet Interactive Corporation and Gary Ritondaro our Senior Vice President and CFO. Scott and Gary will review our fourth quarter 2007 earnings and will then welcome your questions and your comments.

This call is being webcast live over the internet through out company website at 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 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. And now I will turn the call over to Mr. Scott Petersen.

Scott Petersen

Thank you Ann and good afternoon everyone. 2007 was a transformational year for LodgeNet. During the year we transformed from a company that traditionally had focused on movies and entertainment to an organization that is now the largest provider of interactive media and connectivity solutions for the hospitality and healthcare industries. In making this transformation we expanded the scope of our operations and also broadened our suite of services and solutions that connect and form and entertainment, guests and patients.

This transformation was so core to our future direction that we also decided to update our corporate name from LodgeNet Entertainment to LodgeNet Interactive to firmly signal our transformation beyond just entertainment. That transformation was accelerated with the acquisition of three companies; On Command, our biggest competitor in the hospitality space, StayOnLine, the leading provider of broadband internet connectivity solutions to hotels and The Hotel Networks, an advertising media services company targeted in the hospitality market.

We now have a business that generates substantial revenue from selling more services to our existing customers and more revenue that is not reliant upon guest entertainment purchases. We have greatly increased the revenue we generate from the sale of services to hotels, like broadband internet connectivity and the high definition television channels and we’ve established a revenue or an avenue to generate new revenue from third party consumer marketing companies seeking a place for advertising messages in front of our audience.

And you’ll see from the review of our annual and quarterly guest pay data that these new revenue streams largely offset the softness we experienced during the second half of 2007 related to movie revenues, a softness we believe that was largely correlated to the external economic environment and a reduction in consumer competence levels. We believe this counterbalance further confirms our focus on driving revenue diversification and that is a sound strategy. This transformation made 2007 a very busy and productive year. Revenue increased 68%, adjusted operating cash flow increased 39%, total hospitality room served is now approaching 2 million rooms, our diversification in this initiative generated meaningful revenues, about $40 million or about 8% of our revenue for the year. And we view this as a good start down our new strategic path.

And the integration of On Command and StayOnLine, the integration of those organizations is now complete in about half the time we originally estimating and at the $15 million of operating synergies we are promising. In reviewing our performance over the past year we continue to recognize that our transformation has also caused changes to many of our traditional business and financial metrics and because this can be hard to interpret on the face of our financial statements, we’ve once again taken special efforts to prepare rather detailed analysis which will hopefully help you better understand our financial performance. Which by the way was within our guidance for the year. So I’m going to turn the call over to Gary Ritondaro our CFO to walk you through some of this information.

Gary Ritondaro

Thank you Scott and good afternoon again everyone. I’d like to begin with slide number three and you can see by the graphical display, the total revenue for the year was $485.6 million, an increase of 68% year over year. This revenue attainment was about in the middle of our guidance for revenues. The next slide, number four, provides further detail. Revenue from guest pay services was $446 million, an increase of 61% due mainly to the additional guest pay rooms added with the On Command acquisition. The sales of movies continues to be a major source of revenue as we generated $327 million of movie revenue and over $200 million of gross profit from that revenue. Our other revenue increased more than two and a half fold to $39.4 million. This increase is being generated from our revenue diversification initiative including broadband equipment sales, advertising, healthcare and video on demand system sales to hotels.

Slide number five provides information on guest pay revenue on a per room basis. Revenue per room during the year was impacted by several factors. The first is the blending of the result of the LodgeNet and the On Command room basis where the On Command base generated lower movie revenue than LodgeNet base in the second and third quarter but rebounded in the fourth quarter. And because the On Command base generates lower other guest pay revenue based on a major hotel agreement where basic cable was provided without charge.

You will see when we get to the revenue per room that we are seeing improvement in both of these areas. Second we experienced slower movie sales in the third and fourth quarter which were down 6.1% and 4.8% over the prior year. Evidence suggests that the significant decrease in consumer confidence during the last half of 2007 hurt movie sales. We saw similar weakness in January but February has rebounded nicely to compare to last year’s levels. However we must remember that the Easter holiday will impact March results this year compared to March of last year. In 2007 Easter was in April. We certainly are closely monitoring and implementing detailed marketing programs to counter these recent trends of lower movie sales.

Fourth we are seeing significant increases in revenue from non-movie services such as basic cable programming and broadband service fees. And fifth, an increasingly positive influence of our HD TV systems on movie buys. As we have experienced in the past the development of a new operating system, in this case [HD] systems improved revenue in the range of 30% to 40%. On a per room basis total guest pay revenue was $22.59 for the year versus $23.02 last year, a decrease of 1.9% and revenue per room for movies was $16.62 in 2007 compared to $17.27 last year. Revenue from other guest pay services increased 3.8% to almost $6.00 per room versus $5.75 last year.

In the middle portion of slide five shows how the LodgeNet base performed for the year and you can see that revenue per room increased by 2.1% on the strength of a 15% increase in other interactive services offsetting the 2.2% decline in movies. The lower section of this slide depicts the results from the On Command base down in total 1.9%. We are seeing a strong increase in other interactive revenue which is coming from the increase of revenue from cable programming.

Slide number six displays the same level of detail but in this case for the fourth quarter. Combined guest pay revenue per room was $21.61 a reduction of 1.7% versus the fourth quarter of 2006. The changes that we have made to pricing, menu improvements and programming selections moderated the decline in movie revenue. This quarter, movies’ revenue was down 4.8% versus 6.1% during the third quarter of this year. For the quarter you will notice that the LodgeNet base and the On Command base were flat period over period. The decline in movie revenue was offset by the increases in other interactive services. For the On Command base we are seeing the improvement in basic cable fees as I’ve already mentioned. And you will also notice that the movie revenue per room for the On Command rooms actually exceeded the movie revenue from the LodgeNet base.

Slide number seven provides and analysis of change in margin. As in percent of revenue direct costs for 2007 were 52.1% compared to 45.8% last year. The increase of 630 basis points is coming from two main sources. The first is the direct costs associated with the sale of broadband equipment and for our broadband call center. These costs increased 310 basis points but generated about a 12% margin. During the fourth quarter we have fully integrated our broadband operation which will improve the cost structure of this business and given the increasing [SIC] scale we expect higher margins in 2008.

The second area impacting direct costs is the lower margin of cable programming within the On Command base. The decreased margin relative to our historical levels to revenue is due to the contractual arrangement with a major On Command customer. As of the end of the year 25,000 rooms of the 130,000 rooms we serve were operating HD cable programming at which time they started paying for basic cable. We expect to upgrade another 50,000 to 75,000 rooms this year which will substantially help our margins. I mentioned on slide six that we were seeing the improvement in revenue as a result of these conversions.

It is also important to note on this slide that the major costs associated with movie revenue, that is royalties and hotel commissions, in total, are down slightly this year over last. And during the year, and especially during the fourth quarter, we made significant progress in combining the operations of LodgeNet, On Command and StayOnLine. I’m pleased to report that the integration efforts related to our acquisitions are substantially completed. We are now beginning to realize substantial synergy especially from the On Command acquisition as you will see by the per room metrics for guest pay operations and SG&A.

Slide number eight has the detail for our operating expenses. Guest pay operations expense for 2007 was $54.1 million but this includes integration expense of $1.6 million. Excluding these expenses guest pay operations expense was $52.5 million versus $35.2 million last year. The increase was due to the additional expenses for guest pay operations of On Command but remember we added revenue and rooms to our base as well. Using these metrics of expense per room the results are quite impressive. Expense per room in 2007 after removing the integration expense, was $2.61 versus $2.92 per room last year, a reduction of almost 11%. The results for SG&A expenses are very similar. The reported SG&A for 2007 was $55.9 million which includes integration expense of $4 million. SG&A exclusive of these integration expenses was $51.9 million compared to $29 million last year. Again the reason for the increase is associated with the acquisition of On Command. As a percent of revenue SG&A increased from 10.1% of revenue to 10.7%. On a per room basis however SG&A was $2.54 versus $2.41 in 2006.

Slide number nine graphically shows the progression made to realize the synergies associated with the acquisition of On Command. We have taken our per room costs of operating expenses from $5.40 per room on a pro forma basis in 2006 to a run rate of $4.74 per room by the fourth quarter of 2007. Given the number of rooms we had in the base immediately after the acquisition we calculate that approximately $15 million of synergies on an annualized basis will be realized through our restructuring and integration efforts.

Slide number 10 shows the trends for adjusted operating cash flow. For the year we generated $130.7 million of adjusted operating cash flow exclusive of restructuring and integration expenses and the amortization of acquired intangibles. This compares to $94.1 million last year or an increase of 39%. The adjusted operating cash flow of $131 million is in the upper middle of our 2007 guidance.

Slide number 11 shows our reported net loss versus the adjusted net loss. The analysis begins with the reported net loss of $65.2 million and adds back the expenses for restructuring and integration, the amortization of acquired intangibles and the loss on the retirement of debt. Again it is important to note that we have quickened the pace of the integration incurring a higher expense for restructuring in 2007 than earlier expected. Back in April of 2007 we said the integration of On Command would take 18 to 24 months. In fact we have completed substantially all of the integration efforts this year. On a reported basis we had a slightly higher net loss than indicated by our guidance but this is due to an extra $3.5 million of restructuring expense taken in the fourth quarter. This was recorded due to the acceleration of closing of the warehouse and manufacturing site in Denver in December. We would have been within guidance without this extra charge. On an adjusted net loss basis, we were within guidance, $17.7 million loss versus guidance of a loss of between $20 million and $17 million.

Moving to the free cash flow analysis on slide number 12, on the cash flow statement you will see that we had $58.9 million of cash from operations. Removing all of the one-time items such as cash used for restructuring and integration, the refinancing of the debt and non-recurring changes to working capital, you will see that we generated $97 million of cash from operations.

On slide 13 you will see how we utilized that cash. We invested a total of $78.5 million in hotel systems and other corporate assets resulting in an adjusted net free cash flow of $18.6 million. This falls within our guidance of $18 million to $21 million. The investment to install a new room in 2007 was $399.00. This increased as we installed significantly more rooms with an HD system than we did in 2006. In turn the investment required to install an HD site is expected to come down through out engineering efforts and general cost decreases in components. Conversely we have seen an increase in revenue per room from sites installed with HD because of the increase in revenue and therefore cash flow, we are getting the same level of return on our investment as we have earned from the digital system.

And with that I’ll now turn the call back to Scott for additional comments.

Scott Petersen

Thank you Gary. I’d like to take a few minutes and talk about our business strategy and financial guidance for 2008 before going to your questions.

As you can see on slide 14, in 2008 we are looking to build upon the multi dimensional that we began constructing in 2007. To put it in terms of how we speak about our strategy within our company we are seeking to expand our networks, our video networks, our broadband network and our advertising network to deliver an increasing diversified array of revenue and expand array of solutions we provide our customers; from technology bases systems to technical and project management services to marketing based services.

We believe our strategy is resonating with our major customers. For example at Marriott, whose our largest customer, we are moving forward on a variety of strategic fronts including the implementation of our HD TV systems to fully support their full service, high definition television brand standard. In addition, the Marriott organization is our largest broadband internet customer. We serve over 400 of their hotels having more than 70,000 total rooms. This past year we installed our broadband services in several of their major properties including the New York Marriott East Side, The Renaissance Time’s Square and JW Marriott, San Francisco. We are also selected to install and service a broadband solution in a block of Marriott-managed select service properties and we have already sold the system in over 75 locations under that agreement.

At Starwood we’re working closely with them on implementing marketing programs that utilize the power of our interactive television platform to enhance their guest marketing which makes us a more important and strategic partner to them. The [Seanet] Sheridan is one example that has received quite a bit of press recently. You might have seen in the New York Times yesterday that we are working with Sheridan to manage their exclusive advance screening of Show Time’s awarding winning series, The Tudors. That project is enabled by leveraging our centrally managed satellite distribution network and our locally installed interactive television system and you should expect to see more promotions using this flexible technology platform in the coming months.

At Hyatt the current focus is on installing a high definition television and media connectivity solutions in all of their Hyatt Place locations. They are utilizing our new professional solutions group to project manage the installation of the new flat panel televisions and connectivity centers in many of their locations, and even run special weekend packages that highlight our Sports Net service focusing on the Sunday NFL ticket.

And at Hilton, the program for 2008 has been generally determined and is in the process of being memorialized. We will be supporting the expansion of their technology room project through our professional solutions group under which participating properties will purchase specially configured high definition systems from us. And we’ve also established the offering terms for franchisees desiring to move to HD TV under which the properties will purchase the high definition [inaudible] equipment from us and we will upgrade our VOD systems to the new high def technology in return for an extension of our service contract.

In addition to the traction we’re experiencing with our major hotel partners, I’m also pleased with the progress we’re making with regard to our advertising media business. On slide 15 you’ll note that yesterday that Derek White has joined us as the President of the Hotel Networks, our wholly owned subsidiary that we acquired in the On Command transaction which is focused on creating and driving advertising based revenues. Derek has a 25 year track record in building high performance teams and businesses and joins us from Alloy, one of the country’s largest providers of targeted media and marketing services.

Today The Hotel Networks delivers targeted advertising on 10 popular satellite delivered channels such as CNBC, Fox News and The Weather Channel and to more than 350,000 of our hotel rooms. That content reaches more than 7 million Neilson metered consumers each month. Last year The Hotel Networks generated about $9 million of revenue or about $2.00 of gross revenue per room per month. In addition to the satellite platform we see additional advertising base revenue opportunities from further developing server based channels which we have operating in about 400,000 of our rooms today and by developing other interactive and location based applications that can be delivered by our interactive television platform.

With Derek on board, next steps include driving current revenue opportunities, by expanding the reach of our advertising networks and by maximizing the revenue potential of that base. In addition Derek will be working to develop the next generation strategy with an eye towards substantially increasing the business prospects of this business unit.

On slide 16 you’ll see the summary of our financial guidance for 2008. The principal elements of our financial strategy center on driving revenue by about 18%, increasing our adjusted operating cash flow by approximately 20% and managing our capital investments to put us in the position of generating between $25 million and $35 million of adjusted free cash flow for the year. On slide 17 we present a bridge analysis setting out how we plan to accomplish our forecasted revenue growth for 2008. About $53 million to $55 million of that increase will come from having the On Command room base in our business for the full 12 months this year versus only nine months during 2007. You also see an incremental $37 million to $45 million coming from our strategic growth initiatives by selling more to our existing customers, with a primary focus on internet, high definition television and project management services and by further developing our advertising media and healthcare businesses.

Now the big unknown for the year is what impact the general economic environment will have on our business from potential decreases in occupancy rates and any dampening on guest entertainment purchases. For guidance purposes we estimate this could involve up to a $5 million reduction in the revenue we generate from movies. The lower end of our guidance accommodates about a 5% decrease in per room movie revenue while the upper end approximates about a 1$ reduction. January’s results for movies were similar to the fourth quarter as Gary mentioned and as Gary also mentioned, February has shown revenue levels similar to about one year ago. And to maximize movie revenues our strategy has been and will continue to be focused on maximizing our opportunities. Last fall we implemented an extensive program to enhance the movie performance on both the On Command and the LodgeNet platforms and this includes optimizing programming and pricing and guest interfaces and promotions as well as the technical performance in the field.

As Gary indicated the [move] to revenues to revenues on the On Command platform rebounded in the fourth quarter to be higher than the LodgeNet platform and that result is continuing in January and February so we do not anticipate that drag in performance in 2008 that we saw during the second and third quarters of last year. On slide 18 we’ve also included a bridge analysis for our forecast for adjusted operating cash flow. We anticipate growing operating cash flow from $130 million in 2007 to between $150 million to $160 million this year. About $12 million to $13 million of that increase will come from having On Command for the full year and an incremental $5 million to $7 million should come from our growth initiatives. As Gary mentioned we anticipate the margin on our new initiatives will be relatively modest in 2008 given their early stage developments but the margin should expand in 2009 as we gain scale with these new businesses. In addition the synergies from On Command acquisition should be in the $13 million to $15 million range given the great progress we made in the fourth quarter; however as a counter point to these synergies, we will have somewhat higher operating costs based on normal inflationary increases for wages and other operating costs. And of course the headwinds we experienced because of the general economic environment may trim EBITDA by approximately $3 million for the year.

And lastly on slide 19 we present analysis for our adjusted free cash flow guidance. As I said before we are focusing on generating between $25 million and $35 million of adjusted free cash flow and $50 million to $60 million of pre expansion cash flow for the year. Both ranges exclude the cash outflows we anticipate for integration and restructuring charges for 2008 which will complete the assimilation of all of our 2007 acquisitions. Within this guidance we anticipate selling approximately 60,000 new interactive television rooms and upgrading about 100,000 existing rooms to our digital or high definition platforms during the year. And overall we anticipate limiting our investment activities to approximately $78 million to $83 million of capital during the year.

Now the pre expansion cash flow of about $2.22 to $2.65 per share represents the level of cash flow net of system upgrades and corporate capital investments which our existing 1.9 million of hotel rooms should generate this year. Given our current stock price our pre expansion cash flow multiple is less than 7x our 2008 guidance. And of course given the 30% plus returns we’re generating on newly installed rooms, we are planning to invest $27 million to $29 million of capital into new rooms which will leave us with a very solid $1.10 to $1.50 of net adjusted free cash flow per share for 2008.

Now while this guidance may be more conservative than what we had discussed earlier, the fundamentals are directionally very consistent but they also reflect the current economic environment. And I do want to [inaudible] that we are realizing the substantial operating synergies from the On Command acquisition and we have four solid growth initiatives underway that leverage our enhanced strategic position and do not require substantial capital investment on our part. And as a result we see significant increases in revenues and free cash flow continuing into 2009 and beyond.

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

Question-and-Answer Session

Operator

Your first question comes from the line of Ali Mogharabi – B. Riley & Company

Ali Mogharabi – B. Riley & Company

Gary I think you mentioned regarding your HD rooms, how many HD are actually upgraded in Q4, I missed that? That were upgraded, the cable programmer will actually pay?

Gary Ritondaro

Those are HD free to guest rooms for the Marriott brand and as I mentioned we have about 25,000 rooms have been converted out of the 130, we have another 25 to 35,000 waiting to be installed and basically the rest are out in contract waiting for the contracts to come back. We plan to install about 50 to 75,000 rooms this year which would bring our total of the 130 up to about 100,000 rooms.

Ali Mogharabi – B. Riley & Company

Okay, and can you give, and again I may have missed it, can you give me more detail on what the $6.1 million restructuring represents? And also how much more restructuring going forward?

Gary Ritondaro

Well we certainly, again there’s two issues with restructuring that I would mention. The first one is the accounting records where we’re booking the accrual which is what we’re talking about mainly in the $11 million that we booked throughout the year of 2007. And then of course we will continue to pay out some of the benefits in 2008.

Ali Mogharabi – B. Riley & Company

Okay and you guys are providing details so I’m going ask some detail questions here. Do you guys have an idea how much it costs now to install an HD room?

Scott Petersen

Well it’s highly dependent upon the size of the property, so in the fourth quarter we had the average size of property skewed toward the small end which have the impact of driving the average install cost. On a kind of a normalized room basis, through the third quarter the year to date information I had was ranging around the, between $400 and $425 per room and I would suggest that that is probably a more realistic going forward level. Engineering is very close to having a second generation kind of engineering platform ready for release. We expect that to come online somewhere in the second quarter which will have the impact of reducing, especially on the smaller size properties, could easily take $30 to $40 per room even off the small properties and would have benefits all the way across. So there is just as well you know five years ago when we first came out with out digital VOD systems with the storage, the average cost to install a room back then was $450 which we took down to $350 over a five year period of time. Somewhat to the fourth quarter I don’t believe represents a good run rate, that was a, the balance and the blend of properties in Q1 and our visibility in Q2 would be more normal that you’re going to see some nice reductions on that going forward.

Ali Mogharabi – B. Riley & Company

Alright and then last question, Hilton. I see that you guys continue to work with them, just wondering has the contract been renewed and will it be renewed?

Scott Peterson

Well basically we entered into kind of an automatic renewal with Hilton last fall which is what we’re under, operating under today. The basic terms and conditions of, for the offer for high definition to their franchise base and for working with them on some of their strategic projects, in my comments when I said is being memorialized that means its being reduced to writing as part of the agreement. So there will be a formal legal document that will be signed sometime I would guess within the next 30 to 60 days. But from a day to day perspective we moving forward, we’re installing properties, each one under a seven year contract. So the relationship there is good. We’re, the master agreements basically in the hotel industry sent very few of the major brands actually own properties. It’s really determining pricing at a programs that will offer their franchisees. So overall a lot of activity happening on the Hilton side. We look forward to working with them for many years to come.

Ali Mogharabi – B. Riley & Company

Thanks.

Operator

Your next question comes from Lucas Binder – UBS

Lucas Binder – UBS

I have a bunch of questions as well. I guess for starters it looks like churn, as I calculate it, was almost zero here Gary? You know like 0.04% per month implying you lost all of like 2,000 hotel rooms this quarter, is that about right?

Gary Ritondaro

That’s about right Lucas.

Lucas Binder – UBS

Okay and is that something that we should see continue going forward? I mean you usually lose like 10 to 12,000 but 2,000 is almost nothing.

Gary Ritondaro

I think in our budget I would tell you that we’re still looking from being again conservative, probably around that 2% for the whole year of ’08 but you are correct, we were seeing less churn. Some of the churn we are seeing is really for properties that are not meeting our minimum revenue guidelines so therefore we don’t want to install our capital in those types of properties. So it’s more us deciding not to renew than it is necessarily the customer.

Lucas Binder – UBS

And would you say that that is also indicative of the lack of competition you’re seeing in the market given that you bought On Command?

Scott Petersen

Well Lucas, I don’t necessarily know that that’s, most of the churn, I mean we had the Red Roof account between On Command and LodgeNet that did a kind of a roundabout out of our base in the On Command base, most of the other churn that we experienced over the last several years has been smaller properties that generally were lower revenue properties that were just deciding to go to basic cable from the local cable company. Interesting enough, since the acquisition consummated in April, all types of churn have actually, of course the On Command churn is gone now, but even the kind of swap outs to the local cable company has dropped dramatically so, you know hopefully our goal here is to keep, and if we’re not willing to invest capital into their properties because the revenue they generate or the economic returns are not adequate for us, we’re not afraid to walk away from units just to maintain units, but if its good business our goal is to provide great service, good products, the best high definition platform that hotels can actually get so we’re hoping to earn the business, not just keep it because there aren’t any other choices.

Lucas Binder - UBS

Okay, what – maybe I missed it in the press release, but what percentage of your total rooms are digital?

Gary Ritondaro

Right now we have 79% of our total rooms are installed with a digital, which would also include HD digital.

Lucas Binder - UBS

Alright of course, okay. Within your interest expense guidance of $42 million, what’s the rate that you’re assuming?

Gary Ritondaro

Around 7 1/4.

Lucas Binder - UBS

And is there any assumption of some debt reduction throughout the year then?

Gary Ritondaro

That would certainly be in our plans to use some of the cash that we generate to pay back debt, yes.

Lucas Binder - UBS

Okay and then just the last two questions real quick, on corporate capital and other as far as CapEx is concerned $21 to $22 million, is this a number that we should expect to stay relatively stable going forward beyond 2008 or is there other, what’s going into this number I guess?

Gary Ritondaro

I think that’s, that $18 million to $20 million would be a good range because again we’re including in that number minor extensions so that would be a valid look.

Lucas Binder - UBS

Okay and then on the upgrades to digital, I know the question keeps on coming on what does an HD room cost. Have you done a digital room going to HD at this point? And what is that cost because every single time at least as I understand it, the HD rooms that you’ve done have either been new to digital and HD or analog upgrade to digital and HD. So you’ve taken a digital room and put to HD and how much of that cost is incremental?

Scott Petersen

If one peels out the free to guest capital so that the capital cost of bringing the equipment to bring that high def HBO, ESPN etc. and you just look at the HD VOD system which is directionally with the major customers that’s what we’re moving in the direction saying we’re willing to sell, we think we have the lowest price in equipment for the basic cable to be purchased and they have the hotels basically lease that from third parties or pay cash. So fundamentals of VOD side, and of course once again its size dependent but on average that is at the present time somewhere in the $250 to $300 range. And we see that would be drifting south with some of the engineering savings we see coming on board in the second quarter and then that would be kind of an ongoing cost reductions based on technology in the future.

Lucas Binder – UBS

Okay, thank you very much.

Operator

Your next question comes from Marshall Levine – Knott Partners

Marshall Levine – Knott Partners

Just a couple of questions. Hopefully it will show a bright point here. Can you talk about the average price of a movie now over the past year? I know it has been about $12 for LodgeNet as a stand alone in 2006 up quite a bit from $11.50 or something the year before.

Scott Petersen

Marshall we continue of course to do price elasticity testing on a constant basis looking to try to figure where the maximum point is from a pricing perspective. With the On Command acquisition of course we had the ability to expand our laboratory if you want to think about it that way, so the bottom line is the average movie price level has moved up again last year quite nicely. Some of it has to do with; we also have been on the mature audience content. There are bundled packages all day kind of packages that do drive the average ticket price overall. But fundamentally I would tell you also we’ve finished some price testing in the fourth quarter and we are working to be more targeted by brand or by market segment on the pricing and we did implement some basic dollar type price increases in the upper, the luxury brands in the upper, upper brands where we found that to be less price sensitive than the mid market and so as we’re thinking about our marketing activities going forward, is to be more targeted and more focused in more sophisticated in how we do push price within the very segments in the industry. And I think we’ve seen the data would suggest that the dollar increase in certain brands is producing high returns on that incremental pricing.

Marshall Levine – Knott Partners

That’s exactly why so many people are interested in your company; the pricing power that you’ve got. But not to nit pick here, but can you be a little bit more specific than that in terms of the increase of the price per average movie?

Scott Petersen

I know we’re over $12 on an average ticket price at this point in time.

Gary Ritondaro

We’re somewhere north of $12.50.

Marshall Levine – Knott Partners

North of $12.50 now for the year or for Q4?

Gary Ritondaro

No that was for the year. Q4 was approaching $13.00.

Marshall Levine – Knott Partners

That’s fantastic. Only $13.00 for Q4?

Gary Ritondaro

Yes.

Marshall Levine – Knott Partners

Okay, that’s fantastic. Listen, it’s a tough environment for everyone, just hang in there.

Scott Petersen

Thank you and I will tell you from a, the pricing power to the consumer side is one of course, if you overprice we actually don’t, they can always watch free TV so that’s an area that we’re, but we are doing some very interesting marketing I think here that will hopefully just keep pushing overall revenues on movies.

Marshall Levine – Knott Partners

Great, thank you.

Operator

Your next questions comes from Ben Vadinsky – Bear, Stearns

Ben Vadinsky – Bear, Stearns

Integration expense for 2008, do you have an estimate for that yet?

Gary Ritondaro

We’re looking for restructuring somewhere around the $2.4 million most of which will be in Q1.

Ben Vadinsky – Bear, Stearns

Is that a restructuring or an integration?

Gary Ritondaro

That’s restructuring. Integration would be in that $0.75 million to $1 million. We’re not going to see too much more integration expense.

Ben Vadinsky – Bear, Stearns

Okay and then options expense for ’08?

Gary Ritondaro

Option expense share based comp is somewhere around $2 million, $2.2 million in that range.

Ben Vadinsky – Bear, Stearns

And then if you were to actually turn a profit what would the fully diluted share count be?

Gary Ritondaro

That I don’t have in my mind. I think we’ve got about 24.4 million shares, so it’s got to be close to that number.

Ben Vadinsky – Bear, Stearns

Just a conceptual question here, in terms of the, you’ve historically given us a pre expansion and post expansion cash flow number, and if you were to think about the Hilton contract or the Hilton deal that you’ve just signed, it would seem that the only way you’re able to sign that is by actually investing in upgrading that system. So I’m wondering if you could help us think about whether or not the pre expansion cash flow is actually a material number.

Scott Petersen

Well conceptually the pre expansion is after our investments into our existing hotel base and taking them to the next generation platform so it would be, I think it’s a valid, I think that is intellectually a valid data point because the Hilton base that we already have today, the concept is, that’s what’ll be left after we’ve invested back into taking certain of the properties up to the new high definition platforms. Now every property that we serve, Hilton, Marriott, Hyatt, is subject to generally it’s about a seven year contract. And they stage out quite ratably, from now, in fact on the Hilton agreement, just a few of the properties start to come up for natural renewal at the end of this year and then a couple of years out, its probably more heavy. But that’s where we have the abilities to manage the capital investment looking this year, thinking of investing somewhere about $30 million to $32 million back into our existing customers, be it the Hilton, Marriott, Hyatt and taking them generally at this point in time from a tape base to a high def or a digital to a high def system. So I think the pre expansion, that does accommodate the whole concept of reinvesting back into your existing customers, taking them to the next platform.

Ben Vadinsky – Bear, Stearns

Right but if you did not invest in the Hilton rooms, what do you think would have happened? Meaning if you did not make the commitment to invest in their HD network, do you think that they would have gone to a cable-based system? Do you think that they would have figured out a system in house?

Scott Petersen

System in house, no. Nobody has the scale more, that’s far beyond anybody’s capabilities even of larger organization like a Hilton or a Marriott, whatever. I think ultimately we have to assume that they would have opportunities with just basic cable that they take it from their local cable company. But I would tell you as we are looking at these, our new transactions, our new business terms; we are attempting to share more of the capital between ourselves and our hotel customers. Especially in the area of the free to guest that I mentioned a little bit earlier prior question. Now historically the analog, direct TV equipment was not, the cost of that I guess I should say was quite modest versus the capital costs of the new high definition basic cable equipment. And it’s definitely our strategy and so far we’ve seen very good acceptance of the concept from our major customers of saying, we understand that we need, our properties need to take the responsibility to purchase that type of equipment which overall then drives down our capital costs and we think enhances our economic model.

Ben Vadinsky – Bear, Stearns

Okay and if we were to look at slide six or five, and there’s the line, the other interactive services for On Command which you’ve historically attributed to free to guest and the fact that there’s so many Marriott rooms that don’t pay for free to guest, would it be fair to say that the only remaining gap is that 662 to 525, the legacy LodgeNet room is generating 662 and On Command is generating 525, so when the Marriott rooms convert, you’ll have that gap closed?

Scott Petersen

That would represent the vast majority of that gap. From the LodgeNet base this year the significant increase is because we’ve been installing broadband internet services into our video base which has driven a nice increase in revenue. Now the On Command also did have some broadband that came online also so that was part of the, partially in there but I think it’s probably fair to say the vast majority of that gap today would be the lack of charging for the free to guest service in the major account. So you should see that increase and kind of merge over the next couple of years.

Ben Vadinsky – Bear, Stearns

And then the last question for me, you highlighted with your Marriott relationship that you now have broadband internet access in more than 400 properties. This to me sounds a little bit different than what you’ve historically pitched as the StayOnLine idea which is you provide more of a maintenance service than you do the actual broadband access, can you talk about that a little bit about?

Scott Petersen

In the concept it’s the exactly the same. Basically the properties on the Marriott base are purchasing the internet access equipment from us. They are either providing the high speed line or we’re reselling the high speed line, but most of the case it’s an independent expense at the property level. So the ongoing revenues there, there’s the upfront where we’re selling the equipment so as we’ve installed the 75 properties in the select service market over the past six months, they have been writing us checks for the purchase of equipment. And kind of going back to the margin point that Gary made earlier, that tends to be about a 10% to 12% gross profit margin on the sale of the equipment. Then we get an ongoing per monthly fee for the help desk service and then also being available for technical services and that would be on a time and materials basis. So there is no change in business model. I would not want to suggest from that language that now we are providing the, it’s our capital that’s going into the properties for broadband but technically they are looking to us as the service provider for both them and their guests.

Ben Vadinsky – Bear, Stearns

Okay and then just as a quick follow-up, what’s the total room count now that has an internet maintenance contract?

Scott Petersen

We’re right at about, just shy of 220,000 rooms.

Ben Vadinsky – Bear, Stearns

And what’s the target for a full year?

Scott Petersen

We would like to see some, an increase of somewhere between 60,000 and 80,000 rooms for the year.

Ben Vadinsky – Bear, Stearns

Great, that’s it for me, thanks.

Operator

Your next question comes from Jeff Bronchick – RCB Investment Management

Jeff Bronchick – RCB Investment Management

See if I can sum up here, so Hilton arrangement you expect to formally sign in [inaudible] it will as you go through the franchises over the next few years, you’re saying that there’s still these seven yearish deals and you’re saying that the return on invested capital even with the increased HD upgrades that people like Hilton and others are assisting and in sharing to get it installed that your return on invested capital is still 30% plus. Is that a summation of what you’ve said today?

Scott Petersen

Yes.

Jeff Bronchick – RCB Investment Management

Okay, the second thing is I’m just a little confused on slides 11 and 12. What exactly are, for example on slide 11 for 2007 you show 5.6 of integration expense and 11.2 of restructuring expense for 16.8 for ’07 and then on the next place the cash flow you’re saying that that, out of that number, 11.2 is actual a cash number?

Gary Ritondaro

That’s correct Jeff.

Jeff Bronchick – RCB Investment Management

And what does that comparison look like for ’08?

Gary Ritondaro

In ’08, again in the first quarter, we will be paying out the rest of the redundancy payments so there is another roughly $4.5 million to $5 million worth of cash that will be spent on restructuring. I mentioned on an earlier question where there’s about $750,000 to $1 million worth or integration and generally integration is all cash.

Jeff Bronchick – RCB Investment Management

So roughly $5 million of cash integration and restructuring cash out the door in ’08 and about $3.5 million of actually GAAP expense in ’08?

Gary Ritondaro

That’s correct.

Jeff Bronchick – RCB Investment Management

Is there any reason, this integration, is there any inherent reason why On Command margins should not be equivalent to the LodgeNet margins and at what time [inaudible].

Scott Petersen

And you’re speaking margins?

Jeff Bronchick – RCB Investment Management

Yes, margins.

Scott Petersen

Okay so from the standpoint of the gross profits line, from a movie perspective now, we share the same movie contracts so there’s no difference at this point in time, Direct TV is the one, is the provider for our basic cable. We have direct relationships with all the studios so there is no difference between the margins on entertainment revenues because we’re consolidated the contracts. The margin when it comes to the, we have the major customer that we’re working through on evolving from basically free basic cable to a pay model. That is the one element there that accounts for a reduction in margin at this point in time. And in fact on the slide that looked at the analysis of our margin, slide seven, that 260 basis points really that’s the entire foundation for that. It’s the one account that is getting cable without charge today and as that goes to a full paid model, that 260 will disappear.

Jeff Bronchick – RCB Investment Management

What time period is that do you think?

Scott Petersen

Within the general concept is, by the end of next year, the end of 2009, the brand standard is that all properties have to have high definition television installed and once it’s installed the basic cable, then they start paying. So technically the end of next year would be the time frame. That doesn’t mean all of the franchisees will necessarily make the targets. It’s still, they have to spend quite a bit of capital to buy the televisions, buy the equipment, etc. So but vast majority should be wrapped up by the end of next year.

Jeff Bronchick – RCB Investment Management

So excluding any material new winds on a room basis or material losses on a room basis, your reported inter cash flow statement CapEx should stay at $80 million, decrease or [inaudible] on just one your current book of business.

Scott Petersen

On a current book of business, within that $80 million does have just shy of $30 million allocated to new rooms right? So on slide 19, to install roughly 60,000 to 70,000 new rooms into our system that $80 million for next year has roughly $27 million to $29 million of capital allocated toward that activity. So if we just stayed with our current book of business we’re investing something like $50 million into ongoing operations and then maintaining, upgrading rooms and corporate capital. So and I would think, and to be honest, I think that that’s if you want to think of it at that level, or if you want to think of the $80 million level, I think for the next several years that’s a number that one should think about, it probably goes, it could be $5 million on either side, something like that. Depends on rates of growth of new properties, but I think that’s kind of a sustainable number for the next couple of years.

Jeff Bronchick – RCB Investment Management

And just lastly, maybe just big picture, technology change in general, what you’re seeing from clients, what’s the competitive product? What are the cable companies doing, the new AT&T Verizon offerings, how you hear a variety of different things in the market. But what is, is there a legitimate competitive on an ITB platform in today’s market?

Scott Petersen

Well there’s a technology offering that uses IT technology to transport video signal and that’s what the Telco’s like the ATTs of the world are doing because they don’t have the pipe, the broadband pipe like the cable operators have. Within the hotel industry we have relationships with all the major vendors, the LGs, the Philips, the Panasonics, the Sharps, they are all certifying to our system because we represent the industry to a great extent. Now I would tell you IT transport, there are certain properties in certain, when it comes to the CIOs or the CTOs of some of the major brands, they’re saying, geez what about having an IP transport offering, is that possible? And we are actually, we’re near testing of our IP platform and by the end of the year our goal is to have something that is a releasable product to the market. But given the pricing of the IP based platforms and the relative and actually the relative cost that a hotel would have to undertake to install a major IP backbone in their properties, we don’t expect much volume of business from IP TV for the next several years. But as an industry leader, we also want, we are technology agnostic and there’s going to be a lot of chatter about IP TV and somehow that that is a, it’s certainly a different technology. I don’t believe it’s a better technology for the hotel industry today but we certainly fully intend to be able to support that in the future because it’s just another application of a system integration from our perspective.

Jeff Bronchick – RCB Investment Management

And is the cost from conversion, from what you have now to IP TV, if I’m starting a hotel from scratch, what would you offer me?

Scott Petersen

Well if you were a hotel and you put in a big, some big gigabyte IP network in your property that has huge capacity, we would be in the position by the end of this year to be the, to attach to that big network that the hotel installed, to deliver video to the room using IP technology versus using the digital video broadcast standards that we utilize, well as cable industry does today. But most of the systems that are floating around out there today from some small technology companies, actually are hybrid systems that primarily use the technologies that we primarily use but there interactive menus are not using IP formats so its, there’s a lot more smoke around this than substance I think from that perspective. But we are actively involved in technology groups in the industry. From our perspective if the hotel wants to use an IP based technology within the next 12 months, we will be in a position to do that at the cost points that that new technology will require.

Jeff Bronchick – RCB Investment Management

Great, thank you very much.

Operator

At this time we have reached our allotted time for Q&A. I would like to turn the conference back over to our host.

Ann Parker

Thanks again everyone for joining us today. I’d like to remind you 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. And if you have any difficulty downloading those slides, we would be happy to send them on request. Thanks again for joining us and have a great day.

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Source: LodgeNet Interactive Corp., Q4 2007 Earnings Call Transcript
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