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Executives

Ann Parker - Director, Investor Relations

Phillip Spencer - Interim President & Chief Executive Officer

Frank Elsenbast - Senior Vice President and Chief Financial Officer

Analysts

Michael Kupinski – Noble Financial

David Rogers - Apollo Management

Peter Reed - Mast Capital Management

James Dawson - Bank of America

LodgeNet Interactive Corp. (OTC:LNET) Q2 2012 Earnings Call June 19, 2012 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to LodgeNet Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, this conference call may be recorded.

I would now like to turn the conference over to Ms. Ann Parker, Director of Investor Relations of LodgeNet Interactive. 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 second quarter 2012 conference call. You should have received copies of our earnings release. If not, please call me at 605-988-1000, and we'll make sure you do get a copy.

Our speakers for today's call will be Phillip Spencer, Interim CEO of LodgeNet Interactive Corporation, and Frank Elsenbast, our Senior Vice President and CFO. Phil and Frank will review our second quarter 2012 earnings, and we'll 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 Investors section.

Before we get started, I would 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 Phillip Spencer.

Phillip Spencer

Thank you, Ann. Thanks, everyone for joining the call today. I would just also like to take a quick minute. I want to thank our hotel and management companies that have joined the call today.

My actual first day with LodgeNet within Chicago, meeting with the Hyatt, and then couple of weeks later I was in Baltimore, high-tech, and I had the opportunity to meet senior executives from Marriot, IHG, Hilton, Loews, Starwood, all the major brands, but I just wanted to hook out and know to know that our number one priority is going to be serving your hotels and making sure your guests are happy, so I appreciate you guys jumping on the call.

The first slide. Just let me give you a quick kind of background on myself. I spent the last 20 years in my career working in private equity backed cable, telecom and technology companies. Most recently I served as President and CEO of Windjammer. Windjammer owned 143 cable companies across the United States, and ironically we actually competed with LodgeNet in most of these markets.

However, most of my work has been around building customer-centric organizations, addressing top line revenue growth issues and reversing customer churn. Clearly, those are three areas we need to work on here at LodgeNet.

What have I been doing for the last 45 days? Next slide. I have been working in the LodgeNet offices for the 45 days, conducting financial and operational reviews. I have also spent a lot of time talking to customers, employees, reviewing the organizational structuring, analyzing financials and most of my time has been really focused around here, why are we losing these rooms and why has guest entertainment revenue declined. Those have been the areas that I have spent the vast majority of my time over the last few weeks.

At this time, I am turning the call over to Frank, so he can step you through the financial results and then afterwards we are going to share our plan going forward. How we discuss these issues.

Frank Elsenbast

All right. Thanks, Phil. Our financial results for the second quarter did not meet our expectations. Room loss and challenging sales results in our Guest Entertainment business resulted in a 13% decline in revenue and AOCF for the quarter of $19.2 million.

The company did continue to make progress in certain strategic areas with over 15,000 high-def rooms added during the quarter, our mobile app room base expanded to over 600,000 rooms and app functionality increased with the introduction of Interactive Program Guide, and we continue to have a strong focus on controlling our cost structure with another quarter of year-on-year expense reductions.

Going forward, the company's primary objective is to address two issues that have the most immediate impact on our financial results. Reducing our room churn and improving the performance of our Guest Entertainment business.

I'll now walk through the financial results for the quarter and address the slides that we (Inaudible) this afternoon.

Starting on slide number five and six, we will look at our total revenue and revenue per room performance. In the second quarter, revenue was $92.8 million, a 13% decline versus prior year and below our expectations for the quarter. The decline in total revenue was driven primarily by 12% reduction in our room base versus last year and 1.5% decline in hospitality revenue per room.

In the second quarter, hospitality revenue per room was $20.79, a decline of 1.4% versus prior year with guest entertainment down 13.8% versus last year largely offset by 13.5% growth delivered by diversification initiatives. This is a fifth consecutive quarter of double-digit revenue per room growth for our diversification revenues.

The guest entertainment revenue per room decline of 13.8% was disappointing. We are looking at all aspects of this business. We believe that this is rate of decline can be reduced with the right adjustments to our pricing and promotion along with certain adjustments to our system configuration, which will de-clutter our menu system and speed up navigation. Phil will provide more color on this later on the call.

Our other businesses continue to perform well. Hotel Services increased its revenue per room by 7% driven by higher TV programming sales. System Sales and Related were up 45% over last year due to significant upgraded activities as hotels are accelerating their upgrade process on their TV programming services.

Advertising revenue per room declined as planned due to the transition to our expanded ad insertion network.

On slide number seven, we have outlined the revenue per room performance for high definition rooms versus our analog base. These rooms continue to perform very well with over 60% higher revenue per room.

The rollout of high definition rooms continues to be a strategic focus for the company, and when we upgrade a property to HD, several positive things happen. The guest experience is improved by providing the HD programming that our hotel guests are accustomed to at home, movie revenue increases which drives improved economics for LodgeNet as well as the hotel, we extend the contract with that hotel for another five to seven years and we get our Envision platform installed which is the foundation for providing incremental services to the hotel through our Envision apps.

Slide number eight lays out the quarterly activity for the rollout of our high definition platform. For the quarter, we added over 15,000 HD rooms. This was a significant increase versus last year and we are seeing a higher sustained demand for HD upgrades over the last three quarters.

The installations this quarter bring our HD room base total to 340,000 rooms, or 24% of our total guest entertainment room base. We are encouraged by the growth and demand and believe it will continue to grow as we address some of our major customers upgrade plans.

Gross margins by product line are detailed on next slide number nine. In the second quarter, our gross margin was 40.6%. The majority of the change in our margin was driven by changes in revenue mix during the quarter as our guest entertainment mix declined to 46% of total revenue versus 53% last year.

The significant increase in our advertising margin was also driven by change in revenue mix. As we are transitioning to our expanded Ad Insertion business, advertising revenue this year will be largely comprised of server-based advertising and carriage revenue. These businesses have a very modest cost structures and should operate at these higher gross margins for the balance of the year.

Healthcare operated at 39.5% margins for the quarter. The decline versus last year was due to one large installation this quarter, which included lower margin revenue related to the purchase and installation of TVs. We expect our Healthcare business to return to their historical averages in the second half of the year.

On slide number 10, is a summary of our operating expenses for the quarter. We continue to aggressively manage our cost structure. The 8% reduction this quarter was a result of reductions in our fixed overhead costs and lower expenses directly related to the operations of our room base.

For the balance of the year, the company will continue to focus on identifying operating efficiencies in order to reduce our cost structure while providing a high level of service to our hotel customers. Adjusted operating cash flow for the quarter was $19.2 million. The decline versus last year was largely due to the issues impacting our room base and guest entertainment that were discussed earlier.

Net income available to common shareholders was a loss of $103 million for the quarter and includes an estimated $94 million one-time non-cash charge related to the impairment of certain goodwill and purchase intangibles. Excluding the charge, net income available to common shareholders would have been a loss of $9.1 million versus the loss of $4.4 million, last year. We continue to evaluate the exact impairment charge with our auditors and we'll have this finalized by the time we filed our 10-Q in August.

Let me comment briefly on the nature of the impairment issue. This charge is related to the goodwill and intangible assets that were created in 2007 at the time of the On Command and StayOnline acquisitions. These assets represent the excess of our original purchase price over the identifiable assets from our acquisitions.

The recent declines in guest entertainment revenue, our room base and the market capitalization trigger an assessment to test the recoverability of the goodwill balances on an interim basis to determine if the fair value of these assets were below the carrying value. The preliminary evaluation indicates an impairment of $94 million of the goodwill and purchase intangibles is required. We are working through our final calculations as well as the review process being conducted by our external auditors, PWC. And just to be clear, this non-cash item is the only amount that remains under review. All of our ongoing operating results included in the financials are final.

Free cash flow for the second quarter is detailed on slide number 13. The company continues to generate significant cash flow that supports our capital investment programs as we upgrade our room base to HD, as well as continuing to pay down debt. In the second quarter, we generated nearly $18 million in free cash flow. This performance was positively impacted by favorable working capital changes in addition to a decline in interest payments versus last year. The company funded the installation of over 15,000 high-def rooms which are strategically important as we rollout the Envision platform and continue our revenue diversification efforts.

On slide number 14, we have laid out the specifics on our debt reduction and covenant compliance. The company paid down $19 million in debt during the second quarter and now has net debt of $321.5 million, a reduction of $75 million over the past two years. Our net leverage ratio was 3.68, well below our current leverage covenant of 4.0.

I will conclude with a comment on our guidance. As we stated in the press release, we are rescinding the guidance that was provided on the first quarter call. With Phil still completing his assessment of the company and the recent volatility in our business, we have decided to rescind our guidance for the balance of 2012.

Phil will provide some directional guidance on our churn rates and revenue churns in the next section. I would say that we expect to remain covenant-compliant through a combination of improved churn performance, revenue enhancement measures and continued focus on controlling our cost.

With that I will turn the call back to Phil.

Phillip Spencer

Thanks, Frank. We're on slide number 15. LodgeNet is a very interesting company, has a tough competitive advantages. We serve 1.5 million hotel rooms across North America. We have a footprint that offers tremendous operating scale and we have a nationwide field service organization with 300 field service reps around the country and we have a tremendous network of customers.

LodgeNet has a log issue in innovation. I mean, we on the VOD side, mobile Envision, IPTV, we also have a several growth opportunities with our HD rollout, our healthcare, our advertising business and we have outstanding relationships with all the brands that our competitors essentially do not have.

Now, clearly, the company has some current challenges that need to be address immediately. And, so my priorities going forward, they're pretty simple. The first one is how do we stop the rooms and second how do we stabilize the guest entertainment rep.

Let me take a look at both of that. First, I will walk through my segment and then we will look at the actions that we are going to take to resolve the issue. LodgeNet lost 200,000 rooms last year and 60,000 rooms so far this year. As I stated earlier, our room base is our greatest asset, so if I look at the assessment, what happened?

Number one, we have increased competition from cable. In fact, the vast majority of our rooms are lost to cable. I know that first hand, because again I come from that industry. We have a long contract in install process. It just takes too long from the time we sell a hotel to the time that they actually get installed. Our pricing and packaging is too complex, and frankly we're just not selling our competitive advantages, so what are we going to do about it?

First of all, everything single disconnect flows through me. If the hotel wants to disconnect, I get a copy of the disconnect letter, so I can find out what happened, what went wrong and who is responsible.

Number two, we are implementing one call resolution. The hotel should not have to call us three or four times for the same issue. We will work on resolving issue on the first call. Significantly shorter install cycle, where too many touch point that makes the process slow in [vertical]. We are looking at simplifying our contract and shorten the install windows. We have proactive consistent proactive customer average. We need to get in front of our customers before they have an issue and before they call us.

We're going to improve our field service organization, same thing. When a customer on a field service representative goes to a hotel, we should fix that issue the first time. We are going to strengthen our product offering and we already started looking at our product offering.

Improving our overall value proposition. We don't always leverage our competitive advantages to differentiate ourselves from the competitor. I mean, we are the only company that have national coverage, one billing source, consistent channel lineup, field service reps across the country in Mexico and Canada, as well as VOD offering that we did 60 days after the theater. Our competitor simply do not have the advantages (Inaudible).

Our second issue, stabilizing guest entertainment revenue. My assessment in this area is focused on three areas. One, technology change. Look, we got to realize that people are using iPad, VOD at home, mobile devices and that's going to impact our business.

Two, our industry does not embrace the HD penetration unless we need to look at that, and then our inconsistent menu change when you got to make that menu simple, so the hotel guest can go in order movie and should not be complicated. Nonetheless, we do have our Guest Entertainment business and certain competitive advantages until we can take advantage of that, so anyway what are we going to do to stabilize the Guest Entertainment business?

We have to exploit our content window. As I mentioned earlier, we maintain advantage window of content which gives us access to the best movies 60 days after they lead the theater and 90 days before they are available to stream online. Our studio partner value the incremental revenue that we generate during the window and most of their movies received on our platform. It's the huge advantage that we're trying to exploit more aggressively (Inaudible) require guest interface.

We made a lot of changes to our menu over the last two years. These changes have made our systems too cluttered in my view and in some cases difficult to use. We will return to a simplified menu that provides that crisp presentation of the entertainment option available to hotel guest. In fact, every time I go to hotel, the first thing I do is turn on the television and to make sure that the LodgeNet system is simple. The next thing we are going to do is enhance our pricing and promotion.

Our interactive TV systems have the ability to deliver real time compelling promotion. We will use these two to increase the buy. And then finally, we realize that we need to standardize our middleware and address [the] we have some older systems out there.

On slide 18, we got some more additional priorities. We are going to continue to rollout our HD Envision system, we're going to monetize our mobile application. We are going to watch our expanded advertising initiative, work to extend our master agreements with hotels, and I think we can really replace some of the revenue that we lost in other areas in our healthcare business. All of these initiatives support long-term growth of the company.

Next slide 19. Our operating goals. What is our outlook for the balance of the year and going into 2013. First (Inaudible). My main focus is how do we stop the room churn and how do we stabilize guest entertainment revenue. These are two long-term trends that are not going to swing positive quickly. I absolutely believe we can correct trends over the next four quarters.

As far as room churn, I believe we will start to see a moderation in the room lost trend in Q4 this year and continued improvement in the first half of next year. Remember there's a delay of about 60 to 90 days, so if a customer calls and disconnects today, typically they are saying disconnect to service in November, so there's a lag. Our goal is to have our room base decline reduced to less than 2% to 3% on the second half of next year.

Our guest entertainment revenue per revenue has been down double-digit through last two quarters, but this business confronting some ongoing secular pressure. Our goal is to reduce that rate of decline into first half of 2013, and return the business to revenue per room trend 5% or less in the second half of next year. By then, our other initiatives would start to ramp up to replace that revenue.

Finally, slide 20, a summary. Addressing our two short-term issues of room churn and decline in guest entertainment revenue will help stabilize the company financially and allow us to continue development of several long-term opportunities that will further diversify our revenue, strengthen our relationship with our hotel partners and generate significant cash flow.

I am looking forward to work with our customers, our employees and our stakeholders. At this time, I would like to turn over the call to the operator to open for calls.

Question-and-Answer Session

Operator

(Operator Instructions). We do have a question from Michael Kupinski from Noble Financial.

Michael Kupinski – Noble Financial

Noble Financial. Just a couple of quick questions here. Number one, I was wondering if you can add a little color on your initiatives particularly on the ad insertion initiative. What level of advertising you might be able to gain from that? If you have any thoughts on whatever metrics you would like to used to see what type of benchmarks that we might envision let's say over the coming six months, maybe a year or maybe even three years?

Phillip Spencer

Hi. This is Phil. I'll let Frank jump in if he wants to. Again, I came from the cable industry and we often use ad insertion to supplement our income. We have a group of folks that work on private network initiatives in terms of. Frank, you know the numbers?

Frank Elsenbast

Yes. So, Mike, separately, metrics as we look at the opportunity within the Ad Insertion business, but we are planning to launch next year is an expanded footprint. We used to have a business, a much smaller business called The Hotel Networks that was in 300,000 rooms around the country and we are transitioning to a larger network that would be a 500,000-room base that would give us the scale to attract national media buys would be converting the platform through standard definition to high definition platform.

In the past, we only had one level of insertion, so it was always a national feed on the advertisements that we sold. The new platform will allow great segmentation. We will be able to go down to the specific hotel level. By DMA, we'll off course have great coverage in the 25 DMAs, so we think that there is a great opportunity to expand the network. Also have more networks.

We used to have up to 10 networks in our advertising business and that should expand to well over 20, so we are very excited about the opportunity. We continue to develop the software, we are working with the hardware providers and our various other partners towards launching this early in 2013.

Michael Kupinski – Noble Financial

Do you have any set parameters in terms of expectations maybe on a per room basis or however you want to look at it? What you might be able to achieve in the full year 2013 or maybe newer lookout to 2014 or 2015?

Frank Elsenbast

Mike, I think as we get closer to the launch of this network, we will be providing a lot more guidance on what the size and profitability of this business could be. Right now, we are still rolling out the platform. There are still some things that are being negotiated, and so I think some of that is still DVD, but we certainly we want to provide more clarity as we get closer to launch.

Michael Kupinski – Noble Financial

And if you can just add a little bit more color on the type of competition that you are seeing particularly from the cable operators? I assume that is mostly on price, but I was just wondering if there are other dynamics that the cable operators are offering that maybe, whether it be feature sets or, where they are winning the business. What are you losing to?

Phillip Spencer

Actually it's fewer features left obviously, but actually can't do VOD, they can't do mobile, they can't do Envision, so it's basically free to get HD, and our primary issues around capital, obviously the cable company has the infrastructure already in the ground. They have head in, they have the plan, so in hotel switch they are typically able to offer a lower free-to-guest rate and more importantly they don't require any capital up front.

In our case, obviously, when they do the upgrade we require capital, so from a pricing standpoint. It's primarily price, so the cable guy is able to win strictly on pricing, and that goes back to what we were saying earlier about taking advantage of our superior service the fact that we can serve hotels all over the countries, so here most of the hotels are clearly owned by management companies, so do you really want to have a different local cable providers and the new 10, 20 different builds with different channel items, but basically it's price. That's where you get the price.

Michael Kupinski – Noble Financial

With all these initiatives that you have, both on the revenue side and it sounds like on the cost side as well. I was wondering if you just kind of give us the framework of what you would believe to be sustainable margins I guess looking out the next three years once you hopefully kind of rounded out all the initiatives you have currently in place and finally got onto a point where the business kind of stabilizes. Where do you think sustainable margins might be in the business?

Frank Elsenbast

Well, I think that our margins have come down a little bit recently with the decline in the Guest Entertainment business. And in the short-term if you think about showing up our free-to-guest business that is a lower margin business, but then all of the other initiatives that we are growing including the advertising platform, the Envision applications that we are selling to the hotels, the potential to monetize the mobile app, all of those advertising is very high margin business for us and also the applications that we would be selling to the hotels, that is on software-as-a-service, so once we roll that out to an acceptable footprint size then that becomes incrementally high margin as well.

So, I think , what you might see? There is a little bit of a dip here in the short-term, and if we build these other businesses, I think they will come back at equal or greater margins than the Guest Entertainment business that it is replacing.

Michael Kupinski – Noble Financial

Okay. That's all I had. Thank you.

Frank Elsenbast

Okay. Thanks, Mike.

Operator

(Operator Instructions). Your next question comes from (Inaudible).

Unidentified Analyst

Hi. Just a couple of quick questions for you. How exactly would you go about monetizing your app?

Frank Elsenbast

Right now, the apps is available in 600,000 rooms. It is provided free to the hotels and to the guests that say in their rooms. There are few different ways that we can monetize that application. Certain hotels, they wanted to customize with additional information added about their hotel, so there's ways that we can take the functionality and customize an app for our hotel.

Another very interesting opportunity is from the major brands Marriots and Hilton, who have seen the app and like the functionality and would like to embed certain parts of that technology into their mobile app. Specifically, things like the remote control for the TV, the ability to check out of the hotel using the mobile app, those are pieces of technology that we own, that we have developed and hotels have a very difficult time replicating that.

It's much easier for them to just license our technology and whatever the rate per room per month is that we would agree to, so that's a great way for us to support the hotels and also monetize the mobile app which we developed and launched at the end of January. Now in 600,000 rooms, it's gotten very good reviews, but as re-audits had to had very little monetization, we mainly wanted to get an interesting product out there that was received by the both, the hotel and the hotel guests.

Unidentified Analyst

How many downloads have you have?

Phillip Spencer

We will probably be putting disclosure on that. We have not disclosed that, but it's been coming up and down but I think we will probably be giving more usage information in the future and that is something that as it's rolled out and we are adjusting some of the things we do with the mobile app and kind of want to fine-tune it before we put out usage metrics on them, but those will be coming.

Unidentified Analyst

Okay. And, when would you expect? I mean are you in the process of monetizing it? Is something that is going to occur a year from now? Three months from now? What's sort of your expectation of that?

Frank Elsenbast

No. I would expect us to monetize it in the near future. These are the conversations that we've already had with some of the brands around what pieces of the technology they would like to license and lots of hotels have requested various customization, so I think we are working through that. Our focus initially at least is to get a widely distributed well accepted app out there. I think we've checked that box and we are moving on to figure out how to monetize it?

Unidentified Analyst

Then in terms of room churn. Obviously, you are taking some aggressive initiatives to stop that. Have you seen the impact of that yet, or is it too early to tell?

Frank Elsenbast

Yes. We've seen the impact, whereas actually again when a customer sends the cancelation letter, that cancellation letter comes directly to me, so clearly we don't take that lies that we get on the phone, see what's going on, what happened and we've actually failed. Some of the hotels are using that method.

Gathering all of that information, then we want to implement those across the company, so we are not obviously saving them on a one-off basis, but actually have implemented a companywide policy that prevents churns. I have got a list of probably five to eight key reasons why rooms churn and so we are going to fix those five to eight things starting obviously with the first one and then working our working way down, so yes we've seen some positive results, but clearly taking out some of the one-off to a companywide policy. That take a little bit of time.

Unidentified Analyst

Sure. Then it looks like you generated some decent cash flow in the quarter. Is that something that you think is sustainable or is this just and you paid down debt which was nice, but is that something you think is sustainable over the next few quarters?

Frank Elsenbast

Well, we didn't provide cash flow guidance for the rest of the year, so I am kind of limited on what I can tell you about what is sustainable. I mean, certainly, if you look at the cash flow statement, you will see we did generate favorability from our payables and that is something that we had done, and over time we have had those increasing or decreasing depending on the current situation that we're in and this quarter it was a favorable for us, so of course you can continue to do that quarter-on-quarter.

Unidentified Analyst

Okay. Thank you, and continued success with the turnaround.

Frank Elsenbast

Thank you.

Operator

Thank you. Our next question comes from David Rogers from Apollo Management.

David Rogers - Apollo Management

Hi, guys. Thanks for taking the call. I was just hoping you could provide some color on the slate of movies available on the second quarter of 2012 versus 2011, and whether they provided a little bit of tailwind for performance.

Frank Elsenbast

Well, in the second quarter, we didn't specifically comment on that but I would say that it was a net kind of neutral. The top-10 movies. We tend to see a swing in the top movies that we get for the quarter. Do we have a blockbuster? If we have a blockbuster or two that can swing the results a little for the quarter, and when you look at this quarter versus prior quarter, the top-10 movies were down about 15% in total revenue this year to last year.

When our top movie was Safe House and Sherlock Holmes, we do anticipate better performance from our theatrical movies as we get into choose three was primarily Hunger Games being the lead, new movie that was got out there, so this quarter I would say didn't really improve or impact our results.

David Rogers - Apollo Management

Right. Could you provide any color on the delay in getting the Hunger Games to your systems. I had thought that that would be a movie that would be available in the second quarter and maybe help some of your results.

Frank Elsenbast

In general, on average we get the movie 60 days after those theatrical premier and we work with our studio partners on all of those release and there are some situations where we will get a blockbuster a little earlier. In the non-film situation, we did it little bit later, so really depends on studio-by-studio and certainly we are in conversations with all of them.

As Phil said, the studios do value, the incremental revenues that they earn and they also really value the amount of impressions that they get on our systems in front of a affluent demographic, so we are very pleased with the relationships that we have the studios. We would love to see every movie coming our way earlier and that's what we're working towards.

David Rogers - Apollo Management

Okay. Thanks for taking the question. Best of luck, guys.

Frank Elsenbast

Thanks.

Operator

Thank you. Our next question comes from Peter Reed from Mast Capital Management.

Peter Reed - Mast Capital Management

Hi, Phil. Hi, Frank.

Frank Elsenbast

Hi, Peter.

Peter Reed - Mast Capital Management

First question is for Frank. If we compare this quarter, which appears to have surprised you the way that AOCF numbered turned in. What would you say surprised you most about it, because it seems like your guest entertainment room count loss was sort of in line with what your expectations would have been coming into the quarter, so was it the guest entertainment revenue per room? Did that decline more than you had anticipated or were you expecting to take more cost out or something else that in short was the source of the negative surprise?

Frank Elsenbast

No. You've hit the nail on the head. It was the guest entertainment revenue program.

Peter Reed - Mast Capital Management

Okay. And if I recall correctly on the last call, you had had some sense that if the second quarter may be helped by the Hollywood slate as compared to the first quarter and that seems like that didn't come through. Is that a timing thing, or is that movies that you thought would have generated a certain amount of revenue generated less.

Frank Elsenbast

Yes. I guess that's an interesting question. It wasn't a benefit for us in the second quarter, but it also wasn't a negative impact for us as there was in the first quarter, so I do think it was a little bit of an improvement versus the first quarter, but it turned from negative to neutral.

Peter Reed - Mast Capital Management

You were expecting it to do more than that? Is that fair?

Frank Elsenbast

Well, we were expecting that improve from negative.

Peter Reed - Mast Capital Management

Got it. Okay. And I know you are not giving guidance, but your capital spending trend line as a result of your new initiatives you've spent in or around $10 million of capital spending through last three quarters. Do you expect that? Is that a good run rate going forward or directionally? Do you expect it to change much at all?

Frank Elsenbast

That depends on the demand that we have coming in the door for upgrades on high-def and the business results of course, so we will manage the business to upgrade as rooms as we can while also remaining compliance with our debt agreements. And so if that means we have to spread out more and more updates, we will do that, but to the extent we can, we will keep upgrading at a rapid rate.

Peter Reed - Mast Capital Management

How far out can you see as far as scheduled and installs? It sounds like one of the initiatives that might result in you having less visibility if you are connecting people faster after signing them, but as you look forward now, do you have a slate of rooms to be installed August through September, or how does that actually work?

Frank Elsenbast

Great. So we are building a backlog now. I mean, we used to be handling orders as they were coming in. As demand has increased, we have built the backlog, so we already have the third quarter largely scheduled and I would say we are starting to determine can we add additional upgrades to the third quarter, but this is probably the longest backlog we've had over the last couple of years.

Peter Reed - Mast Capital Management

Sorry. I guess I lied. That wasn't the last question. With that already scheduled is, sort of 15,000-ish rooms per quarter, is that a comfortable pace for you? Do you need to add personnel or contractors to be able to go faster than that?

Frank Elsenbast

For 15,000 rooms per quarter is a very manageable number for us. The installations, high definition on the VOD side are done by contractors, so for us it is very easy to ramp from there. We had extra contractors that we can go to and we could easily double that rate within the quarter, but 15,000 per quarter is a very manageable rate for us to do and manage internally and contract with third parties to get them installed.

Peter Reed - Mast Capital Management

Great. Thank you.

Operator

Thank you. And our next question comes from James Dawson, Bank of America.

James Dawson - Bank of America

Hi. Thanks for taking my question. I was just hoping if you could summarize, again, the top five reasons for the churn. You said you had those and you are going to be addressing them. I was wondering if maybe you could just repeat to us on a phone what those kind of top reasons for the churn the guest entertainment rooms was?

Frank Elsenbast

Sure. I don't have any specific order, but the fact that I found, one is we are slow to get back the customer, so we call and in some case when I talk the hotels, they call us two to three, four times and we have again, so basic customer, so that obviously is key. I think it makes it vulnerable. It makes the customer vulnerable. They haven't talked to us and the competitor comes knocking on the door, and in some cases we haven't talked to them literally in years that are one of the main reason I think is customer follow-up.

Another big one for me is installed timeframe, so if a customer says I want to buy your service, I'm switching in a lot of cases. It takes us three to six months before we can actually go out and install that customer. All kinds of things slow the process. I firmly believe, our contract process fiercely broken.

Again, I have competed with lost and other business, we literally walk into a hotel with a four, five-page contract based on the bottom of it, we saw the other half and we're often running. We have a difficult prospects that a whole lot of hands touch, and frankly if the sales person can't necessarily just hand the contract across the table signed and be done. There's a lot of other things unfortunately that we have in our process of that bought down the process.

Another piece is price. The cable company can offer a cheaper free-to-guest price to the hotel, and then the last piece is capital, so what happens is customer calls us, wants the upgrade. We say here is the price. I need a check for $10,000 or whatever it is to do the install or to buy the equipment. Cable providers simply say sign here, here's my per room rate. No capital required, so obviously those are the top kind of five off the top of my head.

James Dawson - Bank of America

Okay. Thanks. When you say capital required, I mean do you think more like the installation equipment, because they still would have to buy the TV, right?

Phillip Spencer

It's the TV. It's more equipment that we put in the hotel when we racked one basin of the hotel to deliver these, so obviously on the cable side, their headwind is built, their plants built, so that investment is already made, so they don't necessarily have to do a lot of work inside the hotel.

James Dawson - Bank of America

Yes. Okay, and then can you just breakdown the debt level for us? You the consolidated balance sheet, but what's the outstanding under the revolver at the end of the quarter and what is it today?

Frank Elsenbast

Yes. The debt at the end of the quarter on the Term B loan we had $328 million outstanding and we had $7 million of cash on the balance sheet. We had a few leases that also rolled up into consolidated debt, so the net debt was $321.5 million and at the end of the quarter the revolver was undrawn, and I think today the revolver has $10 million drawn on it.

James Dawson - Bank of America

Great. And then you said you are comfortable with your compliance with the bank covenants. Are you in any discussions with the banks, or anything?

Frank Elsenbast

Yes. We are always in conversations with our financial advisors, and with our major accounts on the Term B loan, so that is something we are managing every day.

James Dawson - Bank of America

Okay. Thank you.

Operator

(Operator Instructions).

Ann Parker

It sounds like that might be it for questions, so we're just going to go ahead and thank everyone again for joining us today.

A reminder that replay of this call can be accessed over the next month via the internet through our company website. I'll get that to you again www.lodgenet.com. The slide featuring this webcast will also be archived on our website for your reference under the Investors section, and if you find any difficulty downloading those slides, I would be happy to send them on request. Thanks again, everyone and have a good day.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes our program. You may all disconnect and have a wonderful day.

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