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Executives

Ann Parker – Director, Investor Relations

Scott C. Petersen – President and Chief Executive Officer

Gary H. Ritondaro – Senior Vice President and Chief Financial Officer

Analysts

James Boyle - C. L. King & Associates, Inc.

Ali Mogharabi - B. Riley & Co.

Marla Backer - Soleil-Research Associates

Arvind Bhatia - Sterne, Agee & Leach

Marshall Levine - Knott Partners L. P.

Lucas Binder - UBS

Josh Rosen – RLR Capital Partners

LodgeNet Interactive Corporation (OTC:LNET) Q1 2008 Earnings Call April 29, 2008 5:00 PM ET

Operator

At this time I would like to welcome everyone to the LodgeNet first quarter 2008 earnings conference call. (Operator Instructions) I would now like to turn the conference over to LodgeNet’s Director of Investor Relations, Ms. Ann Parker.

Ann Parker

I would like to thank all of you for taking the time today to listen to our first quarter 2008 conference call. You should have received copies of our earnings release. If not please call me at 605-988-1000. We will make sure you do get a copy.

Our speakers for today’s call will be Scott Petersen, President and CEO of LodgeNet, and Gary Ritondaro, our Senior Vice President and CFO. Scott and Gary will review our first quarter 2008 earnings and will then welcome your questions and your comments.

This call is being web cast live over the Internet through our company web site, www.lodgenet.com. We also have slides posted on our web site 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.

With that said, I will turn the call over to Mr. Scott Petersen.

Scott C. Petersen

I am pleased to report two things to you today. First that our first quarter results were in line with our internal expectations and put us on pace to achieve the full year guidance we issued in February. And second, that the strategic acquisitions that we made just one year ago, in 2007, of On Command and StayOnLine, and our aggressive integration and operational plans that we began extreme on last year are bearing fruit and our first quarter results are showing their positive impacts.

Total revenue was up 85% over last year, on a pro forma basis, which includes On Command and StayOnLine’s operating results for the first quarter 2007. Total revenue per room was up 2.2% this year, notwithstanding an approximate 3% reduction in hotel occupancy rates.

On a pro forma basis guest entertainment revenue, which includes all content purchased by guests such as movies, television on-demand programming and games, was level year-over-year on a per-occupied room basis. A solid result given the current economic environment.

In addition to the above, our revenue diversification efforts are also clearly bearing fruit. On a pro forma basis revenue from hotel services, which includes the fees hotels pay us for television programming and broadband Internet access services, was up 16.7% on a per-room basis.

And the revenue we generated from system sales, advertising, and other services was up 21.5% from last year on a per-room pro forma basis.

Operating costs, on a per-room basis, were also down 8% from pro forma first quarter 2007 levels and our first quarter results still do not incorporated the full level of operating synergies that will fall from the On Command acquisition. We expect additional synergies by the end of the second quarter, which should be an almost additional $4 million of annualized savings.

The capital costs of installing high-definition television systems came down substantially during the quarter, running at about 10% below the average investment levels we reported for 2007. And we expect to see continued improvement in this metric over the balance of this year and coming years.

We manage our capital investment plans from the lower side of our original annual guidance, having invested only about $17 million during the quarter, excluding the capital booked for installations in progress. We are managing our business, both operating costs and capital investment levels, as though we are on our adjusted free cash flow targets for the year.

Now, when reviewing our performance over the past year, we recognize that our strategic plan has transformed our business and has caused changes in many of our traditional business and financial metrics. Again we have taken special efforts to prepare a rather detailed analyses, primarily on a pro forma basis, which will hopefully help you better understand our financial performance.

And we have implemented a new reporting format which we believe gives greater clarity into the drivers of our expanded business and operations.

So at this time I am going to turn the call over to Gary Ritondaro, our Chief Financial Officer, to walk you through this information.

Gary H. Ritondaro

Before I review the slides I want to point out that the financials that are attached to the release are based on actual results for 2008 and actual LodgeNet stand-alone results for 2007. However, on the five-quarter summary that is also attached to the release, you will find a pro forma financial information for the first quarter of 2007, which includes room-based statistics, including revenue per room, a summary of operating results, and a reconciliation of adjusted operating cash flow. We believe that you will find this information very useful.

Now please turn to Slide 3. You can see by the graphical display the total revenue for the year was $139.8 million, an increase of 85% this quarter compared to our reported first quarter of 2007. We also see on the chart that our revenue increased on a pro forma basis 3% compared to the first quarter of 2007.

Slide 4 displays the composition of our revenue. Beginning in 2008 we will be reporting revenue by two primary classifications. The first is Guest Entertainment and Hotel Services and the second is System Sales, Advertising, and Other. This slide takes it one step further and separates Guest Entertainment and Hotel Services.

In 2007 Guest Entertainment, which includes on-demand entertainment such as movies, games, music, time-shifted television, and other interactive services, comprised 74% of total revenue. In the first quarter of 2008 that category accounted for 71% of total revenue.

We continue to diversity our revenue such that non-GAAP paid revenue comprised 29% of our revenue this quarter versus 26% a year ago.

Slide 5 provides the revenue per room in the format that we used in early March, which gives us better visibility or clarity to the source of our revenue. As on the previous slides, we are presenting first quarter 2008 actual compared to first quarter 2007 pro forma. Overall, total revenue per room increased 2.2% this quarter versus the pro forma results for the first quarter of 2007.

The approximately 3% reduction, or $0.57 in Guest Entertainment revenue per room was more than offset by an increase of 17%, or $0.76 per room, from TV programming and broadband recurring revenue, which is our hotel service sign-up products.

We also saw a 26.6%, or $0.34 per room, from System Sales, Advertising, and Other.

And finally, the 3.1% decrease in Guest Entertainment revenue was approximately the same as the decline in occupancies during the quarter. So Guest Entertainment revenue per occupied room was level, or flat, quarter-over-quarter.

On Slide 6, our gross margin from the first quarter was 45.%, down about 210% compared to the first quarter of 2007. Total gross margin was impacted by our revenue diversification initiative, which typically has lower margins but at the same time requires minimal capital investment by LodgeNet.

Total gross margin for Guest Entertainment was 59.6% compared to 60.6% on a pro forma basis.

Movie gross margin was impacted by the mix of [inaudible] mainly related to the Easter holiday, while other guest entertainment margins increased by 4.7%.

Margins for hotel services increased by 2.5% as we continue the conversion of a major customer to HD television programming. The non-HD programming is currently provided to this customer without charge but upon conversion to HD TV programming the customer is paying for the service.

Today we have about 25,000 out of 140,000 rooms converted and this conversion program will continue throughout the balance of the year and into 2009. One other point, the amount of decrease in gross margin for broadband might look dramatic but in fact, the dollars involved are relatively small.

Slide 7 provides information about the operational synergies that are being realized by our restructuring efforts. On a per room basis, our total operating costs, excluding integration expenses, decreased $0.47 per room per month compared to the free, stand alone company in the first quarter of 2007. This equates to $10.5 million of annualized operating cost savings.

Reducing the first quarter results to $5.35 per room per expenses that were incurred during the first quarter, that are non-recurring in nature, results in a normalized operating expense per room per month of $5.19. This compares to the $5.83 per room per month on a pro forma basis, a total reduction o $0.54 per room per month. And based on 1.9 million rooms, this translates into an annualized savings of $14.3 million, which should be largely implemented by the end of the second quarter.

Our adjusted operating cash flow was shown on Slide 8. We generated $34.6 million of adjusted operating cash flow during the quarter, up 52% compared to the first quarter of 2007. And compared to the pro forma for the first quarter of 2007, we had a 2% increase.

Slide 9 shows the comparison of LodgeNet for the first quarter compared to 2007 actual and 2007 pro forma. On a pro forma basis we reduced the loss by 37.5% from $11.2 million to $7 million. And on an adjusted net loss basis we have a $0.27 per share improvement.

Slide 10 presents our guidance for 2008, which is unchanged from the guidance that we issued in February, except for the per share information, which has changed somewhat due to the shares repurchased during the first quarter.

Slide 11. certainly since we’ve announced our preliminary first quarter results two weeks ago, many investors have asked how we can reach the mid-point of our 2008 adjusted operating cash flow guidance of $155 million when we generated $34.5 million of adjusted operating cash flow during the first quarter. The information on this slide provides the bridge between the first quarter results and our annual guidance.

Adjusting the first quarter results for seasonality we arrive at an annualized adjusted cash flow of $145.4 million. During the balance of the year we have a number of initiatives that we are very confident will bridge the gap and these were presented on this slide with a range of possibilities for each.

The initiatives are hospitality system sales, the deployment of more HD programming systems, healthcare system sales, and professional solution sales. And of course, also from additional operating synergies.

The sum of all these initiatives added to the annualized run rate of $145 million produces the $155 million of adjusted operating cash flow which is the mid-point of our annual 2008 guidance. We believe this analysis should provide comfort that our 2008 guidance is reasonably achievable, even in this challenging economic environment.

Adjusted operating cash flow analysis is presented on Slide 12. Again, this compares our first quarter actual results with the mid-point of our guidance. We’ve already covered how we expect to get to the $155 million of adjusted operating cash flow, so how do the other components stack up against guidance?

The first item that is worth noting is working capital. Working capital was use of cash during the quarter as we paid $5.2 million for retention and termination payments. Otherwise, the normal seasonality is reflected for this item.

The second item to mention is investment and corporate assets. The investment and corporate assets include $1.6 million for system components and another $1.9 million for installation work in progress, both of which will be used for future room deployments. Historically the first quarter has shown a large investment for this category compared to its total annual investment.

The other categories of capital investment are below the run rate of our annual guidance.

We are very focused as a management team on managing operational expenses and capital investments to deliver on our mid-point guidance of $30 million of adjusted free cash flow.

On Slide 13 it provides an analysis of our leverage ratio component. At the end of the quarter we had $630.1 million of outstanding debt and on a trailing 12-month basis had a $141.5 million of adjusted operating cash flow, which calculates to a leverage ratio of 4.4x, well below the covenant of 4.75x. On a net debt basis the leverage ratio would be 4.32x.

You will notice that the debt level was slightly higher at the end of the quarter than it was at the end of 2007. Given the issues that our lead banker had, we initiated a draw in mid-March against the revolver to test the availability of our line of credit. The funds were advanced without incident. At the end of the quarter we had $7 million of that draw outstanding, but all of that has been repaid during April.

Using the mid-point of 2008’s annual guidance, and assuming that we only repaid the required quarterly amount, total outstanding debt at the end of this year will be approximately $618 million and cash on hand will be approximately $36 million. That would equate to a leverage ratio of 3.99x at year end, or on a net debt basis a ratio of 3.76x against a 4.5x covenant.

This calculation fully reflects that we used $4.7 million of cash during the first quarter to repurchase 470,000 shares. And of course, we intend to pay down more of our outstanding debt during the year with cash on our balance sheet.

One other interesting data point, even with the retainment of the revolver we had, as of the close of business yesterday, $18.1 million of available cash.

With that I will turn the call back to Scott for additional comments.

Scott C. Petersen

I would like to take a few minutes and talk about our business strategy and the progress related to that strategy before going to your questions.

As is set forth on Slide 14, and as we stated in our March 31 press release, our fundamental financial goal for 2008 is to deliver on our adjusted free cash flow target of $25 million-$35 million, which creates approximately $1.11-$1.55 of adjusted free cash flow per share.

If you review the information in our 2008 proxy regarding management’s incentives and compensation plan for this year, you will see the watermark for potential goals is delivering $30 million of free cash flow in 2008. So I want you to know that management’s interest is completely in alignment with our shareholders in this respect.

Given the current economic environment we are and will continue to manage our business and moderate our operating costs and capital investment plans to strike a prudent balance between our numerous investment opportunities and our goal of delivering on our adjusted free cash flow target for 2008.

As we stated in the supplemental information document which we issued on March 10, a 1% reduction in movie revenue can generally be neutralized by a 2% reduction in our operating costs. And from a capital management perspective we have considerable flexibility in determining the timing and the amount of capital we invest in a given period, the first quarter being a good example of our ability to manage capital spending.

From a management perspective we are focusing on four elements. From maximizing the revenue and gross profit we generate per room, to realizing the operating synergies and [inaudible] on our recent acquisitions, to driving down the amount of capital we invest in each room, to managing our overall investment plans. Let’s take a few minutes just to look at each one of these elements.

First, we’re focused on delivering the maximum amount of revenue and gross profit that can be generated from our expanded business platform. In that regard we are enhancing the Guest Entertainment marketing on all of our platforms, as you can see on Slide 15. From implementing refreshed graphical user interfaces, to refining our pricing strategies per market segment, to optimizing the mix of content we offer our guests.

And the accelerating installation of our new interactive high definition television systems is also enhancing our revenues as we are realizing greater Guest Entertainment purchases on these systems as compared to our older.

Moreover, we are gaining new opportunities from some of the newest brands on the market, such as Starwood, aloft, and elements brands, as well as the traditional luxury brands such as The Four Seasons.

We are also focused on driving revenue and gross profit from our hotel services category, as is summarized on Slide 16, by providing TV programming to a larger percentage of interactive television rooms, which is more importantly related to our expanding HD TV service offering where we are achieving success rates in excess of 80%. And by converting hotels that were on the On Command free TV programming to a pay-for-service business model.

As Gary showed in his slides, the substantial increase in our TV programming revenue and gross profit this year over last evidences our progress on this focus. With only 58% of our total room base receiving these services today, we believe this represents a substantial business opportunity for us.

In addition, we are aggressively working to drive revenue and gross profit from hotel services based on the broadband Internet access business we acquired with the StayOnLine acquisition last year. While we have recently and successfully integrated this business into our overall organization and hotel offerings, so far the revenue and margin growth has lagged behind our internal expectations.

Now, this primarily resulted from a conscious decision we made about six months ago to increase the quality of the product, the strength of the technology, and enhancing our call center operations before aggressively going after the market. These efforts have now been substantially completed and we have created a more solid foundation to grow this business. We believe we are now in a position to accelerate the performance of this product line over the next several quarters.

For example, during this month alone, this month of April, we have received contracts that cover over 7,000 new rooms from such leading hotel companies as Marriott and Lowe’s hotels. Once again I would note that this is a service that is a must have for our hotel customers and that only 11% of our room base currently receives this service from us.

Our advertising business is now poised to move forward with more impactful results. We hired a new President at The Hotel Networks in February, we’re upgrading our ad sales organization, and we are beginning to gain traction from the market related to the interactive advertising opportunities available on our interactive television platform.

And lastly, our new Professional Solutions group is beginning to steer contracts with installation of high definition televisions, hotel wiring, and other technical solutions, as well as providing managed high-speed Internet connectivity services to conference facilities. But in only three months since we formed this group, we have entered into more than 40 contracts for these services, with such hotel groups as Hyatt, Hilton, Lowe’s, and Marriott.

Our Professional Solutions group delivered over $1.4 million of new revenue in the first quarter and we view this progress as being critically important as we seek to diversify our revenue and broaden our relationships with our client base and affirm our position in the market as the preferred and trusted partner to the industry.

Second, we are focused on realizing operating efficiencies throughout our business, primarily from our strategic acquisitions in 2007. As Gary presented, and as you can see in Slide 17, our operating costs on a per room basis were down 8% over 2007 first quarter pro forma levels, which equates over $10 million of annualized savings, and based on highly identified activities, we should be realizing an incremental $4 million of annualized operating savings by the end of the second quarter.

Third, we are focused on driving down the capital costs of installing our new high definition television platform. During the first quarter we made significant progress in this regard, reduced the cost of the new high definition room from the average of $460 per room in 2007 to $413 in the first quarter of this year.

And we expect further reductions in these investing expenses over the next several quarters and years as the cost of components continues to drop, our hotel customers pick up more of the cost of the high definition television programming equipment, and we implement more efficient designs.

In addition, over the course of the past year, we have been able to leverage the resources of our newly integrated organization to enhance and accelerate our new product development capabilities. As a result, we anticipate bringing a compelling new assortment of solutions to the market this year to meet our customers evolving and expanding needs.

These solutions include both forward-looking technology options, such as IP TV, and also cost-engineered solutions designed to address the needs of mid-scale properties in a most cost effective and profitable manner. We believe that this expanded product line will not only prove to be a financial benefit to our company, but will also help reinforce our position as the industry’s leader in providing media and connectivity solutions to our hotel customers.

And lastly, we are focused on managing our capital investment plan to strike a prudent balance between the amount we invest into our hotel business and the level of operating cash flows to deliver on our free cash targets for 2008.

During the quarter we invested only $17 million into our business, excluding the approximately $2 million of work in progress, and we expect that second quarter investment levels will be in the comparable range, which puts us on track, we believe, to deliver approximately $30 million of adjusted free cash flow for the year.

That target equates to about $2.50 per share of free cash flow on a pre-expansion basis and $1.30 per share on a post-expansion basis. And we believe that both metrics represent a very attractive free cash flow yield, given the current price of our stock.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from James Boyle - C. L King & Associates.

James Boyle - C. L. King & Associates, Inc.

Scott, is your full year guidance assuming no second half economic recovery or does it presume the recession lifts in Q3 or Q4?

Scott C. Petersen

I think it incorporates a very soft economy throughout the entire year.

James Boyle - C. L. King & Associates, Inc.

What was the average monthly room number of movie purchases in Q1 2008?

Scott C. Petersen

Jim, on Slide 5 it was $16.50 for the movies and a total of $17.83 for total of what we call guest entertainment purchases.

James Boyle - C. L. King & Associates, Inc.

I can see that but I’m assuming if your average movie is give-or-take about $12.00 that would imply about one point whatever purchases per month. I’m just trying to look at it through another metric so as to compare historically. Do you track it that way?

Scott C. Petersen

You mean the actual number of purchases per room?

James Boyle - C. L. King & Associates, Inc.

Correct.

Scott C. Petersen

That’s not a data point that we publish on a public basis. During this cash year there were really no changes in the general pricing structures that we have in the marketplace. In 2006 we had implemented an across the board, I believe it was the fourth quarter of 2006, and over the past 12 months we have basically been operating within the same framework we had before, which is a variable pricing structure.

The one footnote that I would make to that would be that on the LodgeNet platform we did institute and introduce an all day purchase option for mature audience content, which has the effect of making the number of actual buys, it’s not an apples-to-apples comparison, those purchase options could be anywhere from $25 to $30 to $35 per day. It depends on the system that it’s installed or the locations it’s installed at.

Taking that aside, overall the remainder of the pricing strategy has been relatively the same.

James Boyle - C. L. King & Associates, Inc.

I noted that people continue to ask whether your movie purchase rates are going down year-over-year due to technology and other options being available, and apparently since you’re raising your price, some of it is driven just by the pricing and therefore if you had that metric publicly disclosed it might allow us to get a feel for how much is driven by lower purchases driven by higher prices or not.

Scott C. Petersen

We are right on the elasticity curve so we’re always managing price to maximize the revenue we generate from the product line. So an all day purchase would certainly not be the equivalent of a one traditional Hollywood movie purchase, either.

So it does get a little confusing and complicated and I appreciate your point on that. Naturally, with the all day mature audience pricing strategy in the market on the LodgeNet platform now at the current time, of course the average sticker price is up period-over-period but it’s probably not as straight forward as we would all like to believe.

James Boyle - C. L. King & Associates, Inc.

There might be a way to make that equivalent, but let me move on. Typically do your business trends tend to get better before the recession finished off, or is it simultaneous, or does it lag, the economic recession end?

Scott C. Petersen

Every recession is a little different. The last dip was around 9/11 and it started to get soft pre the 9/11 events and then of course occupancies and the economy certainly had its troubles after that point. From what we’ve heard from the hotel industry so far is that the business traffic seems to continue to be relatively strong. Not a significant tail off there. If anything, they’ve been seeing some softness in more of the leisure market and being more price sensitive.

And of course, from our standpoint, generally that is the leader traveler. The marginal traveler has the lower propensity to buy our product than the more, I would call, the professional road warrior person. So I think it depends.

The counter balance to the economy from a business travelers prospective is if businesses are also starting to cut back on entertainment in the evenings and some of the things that take the business person out of the hotel room, therefore if the business person does spend more time in the hotel room, I think that is a counter-balancing opportunity for us.

There was an article in the Wall Street Journal yesterday that suggests that with air fares people will probably not be going as far this year as far as travel internationally or distances here in the U.S. and will take shorter trips, but nonetheless it seems to be still that the American way is to make sure you’re still taking that family vacation.

So there’s a lot of different things that can happen there. From our standpoint we are operating in a posture of taking a very cautious attitude about capital and about operating costs, just waiting to see where the industry is going and where the economy is going and try to be cautious in advance rather than reacting after the fact.

James Boyle - C. L. King & Associates, Inc.

You note in your press release that lodging and occupancy was off 3.2% in Q1. The FTR data for U.S. hotels was off 2.7% in the first quarter. What is different about your portfolio versus the overall USA that would suggest the slightly more weaker occupancy?

Scott C. Petersen

We are focused on specific segments within the industry so when it comes to the economy saga, which I understood was off significantly more. I’m not sure I would agree with that data point, Jim, as I’m looking at Gary. But the upper end of the market has, from the FTR data that we’ve seen, has actually been stronger. My understanding was that the general industry was off more than what we saw in our room base.

Operator

Your next question comes from Ali Mogharabi - B. Riley & Co.

Ali Mogharabi - B. Riley & Co.

Scott, on the advertising front, can you give us an idea about how well that’s progressing? And maybe you could mention some of the larger advertising people, if any, that you are currently working with.

Scott C. Petersen

The advertising primarily will mount under the umbrella of The Hotel Networks. It was a subsidiary we acquired with the On Command acquisition and took total ownership of that mid-to-last year.

We took the opportunity to do an actual search for a president of the organization. We wanted to have someone who was well-grounded in targeted advertising and well versed in the traditional advertising world, but also with the creativity to look at what we do from an interactive advertising standpoint, or could do from an interactive advertising standpoint, and be able to execute on expanded strategies.

Derrick White joined us in mid-February and he has been very busy on one hand getting the review of the current organization. We have actually upgraded our sales organization and bringing in very talented people that can perhaps be a little more aggressive on sales.

From the traditional standpoint of advertisement on the ad insertions we have available on the ten satellite-delivered channels we have, it’s anywhere from software companies like Microsoft, a lot of pharmaceutical companies, the automobile industry has been a provider in the past, the liquor industry, insurance, and financial services like GEICO, Bank of Scotland. So it’s a very interesting mix. Well over approaching triple digits as far as the various groups that have advertised on the system.

One of the key factors right now we’re focusing on is creating a differentiated offering from just the traditional ad insertions, that would be a cable channel, to provide some either cross opportunities or just brand new opportunities that would reside on our interactive television platform.

For example creating an ad-supported channel that the ads that do run coming off our interactive file server could then give the advertiser and the guest the opportunity to telescope into other information on the system. It’s short form full motion video contact or just other information or abilities to gain access to other consumer messages.

Derrick’s been with us a little over 60 days and we’ve plowed a lot of turf during this period of time and the more I see with him and the group he’s pulling together, I’m very hopeful for the future we’re going to start to see some impact from The Hotel Networks.

Ali Mogharabi - B. Riley & Co.

Just to follow up on that, maybe Gary, you can help me out on this. The mid-point on of guidance for Systems, Sales, and Advertising under revenues is I think around $62 million for the year. Can you give us an idea about basically what percentage of that may make up the advertising?

Gary H. Ritondaro

I will have to get that, Ali. I don’t really have the make up of that. Maybe Scott . . .

Scott C. Petersen

If the question is what is the total revenue we would expect from The Hotel Networks this year, or range there, that would be, last year they came in between $8 to $9 million and this year we would look for somewhere between $10 to $12 million.

The current economic environment, of course, is causing some questions on near-term successes but we are definitely going to get into double digits this year and hopefully move more toward that $12 million range.

Ali Mogharabi - B. Riley & Co.

Can you quickly give us an update about how the healthcare system services and technology offering is progressing?

Scott C. Petersen

We have roughly 21 facilities installed. Today we have five that are in progress for installation. The largest being [Bergens] and Women’s out of Boston, part of the Harvard network. That by itself is well over $1 million. And all five of those should be turning on now in the second quarter; maybe one falls into the third.

I think that the five together should generate more than $3 million of revenue for the company on a gross profit basis, so roughly about 35%-40%.

There was a very modest contribution in the first quarter from healthcare, given all the installations. The second quarter should have a nice bump.

I would also tell you we are seeing more and more activities as far as sales inquiries within healthcare. We are starting to get now some requests from proposals from groups or systems and in the past we were generally more single facilities. Although of the 20 we have today, mostly we were just asked on a facility-by-facility quote basis. We are starting to see now where groups are coming in that they have five facilities or ten facilities.

So the market is starting to move; they are starting to think about interactive television. Clearly one of the main drivers there is they are starting to move toward the digital televisions in the patient’s room, from the analog tubes. And as they are building that and making that investment, they are saying what else should they do now to capture the value that can be driven through that plasma set.

So, over time, we are learning as we are going, we are getting some nice traction this year, but I think, from my perspective, we certainly will continue to build nicely certainly over the balance of this year and I think next year will be better than this year.

Operator

Your next question comes from Marla Backer - Soleil.

Marla Backer - Soleil-Research Associates

Now that you’re moving forward very aggressively with the On Command integration, have you had any further conversations with content providers in terms of a) possibly lowering your overall cost of the content or, b) and probably more importantly, increasing the amount of content that you could provide on an on-demand basis?

Scott C. Petersen

First of all, since the close of the acquisition, which was about one year ago, we have had conversations, of course, with all of our major providers of content. Structurally, in the past the LodgeNet modus operandi was to do output arrangements with the major studios, guaranteeing placement and return for a sliding scale of royalties that we pay for that content.

On Command on the other hand, typically did purchase on a per title basis. Neither was right or wrong, it was just different approaches to the market. We have revisited all of those relationships at this point in time.

Overall the cost of content in the first quarter of this year was slightly lower than the cost of content in the first quarter of 2007. Not dramatically, but we are moving in the right direction.

I think, also, as we talk to our content providers it might not necessarily be in the form of changes in royalties, but them providing more marketing dollars to help us promote their products and increase sales, etc.

With the larger platform, also in the size of the file servers that we are deploying, that does give us the ability to present more content. In one hand is the long tail, every movie ever made, any time. I think that’s an interesting vision for the future. That’s probably not, because of licensing and windows that are part of the overall studio business arrangements today, that probably will take time to move in that direction.

But if that’s one of the questions that you may have, I think that is a definite possibility moving forward. I tell you, we probably made more progress though on the shorter form television content over the past 12 months, since the acquisition of On Command, having NBC universal content on the systems. And Fox will be providing more time-shifted television content.

And we certainly have had conversations with all the other broadcast networks, to create another outlet for them. And then from a guest standpoint, it’s for us to be more like the Tivo for the traveler where if they missed a show as they travel, they can catch them in their hotel room.

Marla Backer - Soleil-Research Associates

On the advertising initiative you talked a little bit about developing the interactive channels. And I know in the past you had talked about possibly being able to capture a web share on any television-linked commerce. Is that something that you’re still discussing with potential advertisers or is that something that’s on hold, given the economy?

Scott C. Petersen

I would say that would be a future. I think probably the current model would be more it’s a guaranteed placement, so if we’re inserting an ad or a sponsorship that the advertiser at this point in time will probably be focusing more on fixed compensation arrangements.

But in the future, as far as the abilities to identify guests, and for a T-commerce application or even just forwarding more information that the guest would request, that is definitely on our radar screen but it will take some time to develop.

Marla Backer - Soleil-Research Associates

When we talk about, or when we ask about, diversification efforts, of course the healthcare industry always comes to mind and the advertising initiative, but we haven’t really spent any time hearing or talking about the travel centers. Is that something that is still an active pursuit?

Scott C. Petersen

Well, we have 200 something locations installed, in that ballpark. The one firm that we had dealt with, we’ve installed the systems where they’re at today. Their expansion activities have been curtailed somewhat, I think, given probably the credit situations that happened the latter half of last year. So, we are up and operating in those facilities, we’re earning revenues from purchases of the entertainment content plus also service fees based on our maintaining those sites, but from a further expansion right now, it’s not really expanding at this point, but could well in the future.

Operator

Your next question comes from Arvin Bhatia - Sterne, Agee.

Arvind Bhatia - Sterne, Agee & Leach

I wonder if you can talk about trends that you’re seeing in April, especially given that you have somewhat easier compares to Easter last year. And then in general I think you talked about for the year you think the economy will remain soft. But in this quarter are you expecting, for example, movie purchase trends to be similar.

And my second question is in the third quarter you are going to fact the Olympics. What happens to your business, typically, around the Olympics? Does it go up because of traveling more? I’m just curious what happens during the Olympics to your business, in general?

Scott C. Petersen

It depends on how popular they are and how active the U.S. is in the events. So, if there is a lot of excitement with swimming or the track and field, there tends to be a negative for us as guests tune into what is happening, nightly updates. If it turns out to be that we’re not overly competitive then it’s less of an issue.

But as we planned the year we certainly thought about that and from an internal business plan perspective, incorporate that into our thinking.

That’s a good point and I’m glad you brought that up. As Gary mentioned in the first quarter with Easter holiday falling in March this year versus April, the mixed shift in March did tend to move away from [inaudible] content as compared to March last year, 2007.

But what we are seeing in April this year is a reversal where a person around Easter, more toward theatrical and away from mature. Now this year, on a relative basis we’re seeing that reversed. We were anticipating that and we are seeing that in the actual results that we’ve seen so far.

And I would say also that the On Command and the LodgeNet platforms are operating generally on comparable trends so going back to last year, there were some issues on the AccuNet platform. Actually in Q1 the revenue per room on the On Command platform was larger than the LodgeNet, which is the traditional relationship that we would expect given the type of hotels that we have our platform in from the On Command acquisition.

And I’ve lost your second question, I believe.

Arvind Bhatia - Sterne, Agee & Leach

I was just asking on the move side, movie purchases, what kind of trends? Are you modeling similar, like decline of 3% or so in the second quarter?

Scott C. Petersen

I think our mid-point guidance was assuming a 3% reduction in movie revenues as compared to a year ago. And I think given the current economic environment that’s an area we believe you all should continue to think about.

Arvind Bhatia - Sterne, Agee & Leach

And that’s despite the trend in April where, what you’re saying is [inaudible] in April.

Scott C. Petersen

Well, the Easter holiday is one-week to two-week, week before or after, so it’s a little really too early to talk about the whole second quarter. We’ve seen a reversal in the relationships between the theatrical and the mature audience in April so far because that would incorporate the entire Easter holiday last year.

But for May and June, we don’t have a forward view. Like hotels can look at bookings, etc; we are more contemporaneous as far as what we see and the reactions to the content.

At this point we would still rely on the general guidance of mid-point was down 3% this year over last.

Arvind Bhatia - Sterne, Agee & Leach

In rooms where you have broadband service available, are you able to track the movie purchases in those rooms and compare them to the ones that don’t have it? Again, trying to get an idea of the substitution effect that people worry about.

Scott C. Petersen

Of course, Arvind, I would say that almost every room that we serve, the 1.9 million, have some type of high-speed Internet access service, even though we might not be the provider of that. And we hope to change that over the years and we’re working on that. As far as from our perspective, the statistical evidence that would suggest, we don’t have the hard evidence one way or the other that that is impacting.

Clearly our programming strategy is keep our content the freshest, that you can’t get on the Internet from a theatrical standpoint. You know, provide for a mature audience content, a lot of travelers are business people and I think there’s a real hesitancy from their standpoint to access mature audience content with a corporate computer, given all the cookies and everything else that ends up on your machine from those types of activities.

So overall, we’re working to maximize the revenue we have, but we don’t know of any drastic situation when it comes to Internet access and the impact on movies.

Arvind Bhatia - Sterne, Agee & Leach

Like for people who track that you’re not seeing any major differential in those rooms?

Scott C. Petersen

No.

Arvind Bhatia - Sterne, Agee & Leach

And can you update us on the window you operate in, if you’re seeing any changes there? How many days it’s taking for movies to be available to you?

Scott C. Petersen

When we get the movies when they come out of the theater, many times they’re still in the theater window for some of the titles, but before they go to the Blockbusters for home video and then cable pay-for-view happens after that, no significant change in trends or situation today. And every title is released independently but generally we’re getting the titles, it can be anywhere from 45-70 days after they first are shown in the theater and then generally we have 45-70 days after that before they go to home video.

So if anything, over the years we’ve been moving up into the theatrical window and the home video has been moving with us. Our pitch to the studios is the sooner we can get the content the more afterglow from the marketing it happens for the theatrical release and the more revenue we can generate for them. And overall that’s been the direction. But no significant changes in that situation in certainly the last 90 days, or even last year, to be honest.

Arvind Bhatia - Sterne, Agee & Leach

Hilton. Any updates there?

Scott C. Petersen

We continue to do a lot of business with Hilton. We basically have reached economic terms and what the offer is, it’s with our friendly lawyers, on both sides, and it’s not soup yet from a lawyer’s standpoint, but it’s just matter of documentation. From offering from the marketplace the terms are out in front of a franchise base and so it’s really right now an administrative time to get it all wrapped up so we can actually close the business under the new terms.

Operator

Your next question comes from Marshall Levine - Knott Partners.

Marshall Levine - Knott Partners L. P.

I wanted to see if you could disaggregate for us the movie revenue between the consolidated company now versus old LodgeNet.

Scott C. Petersen

What do you mean by that, Marshall?

Marshall Levine - Knott Partners L. P.

For example, in Q2 2007 you disclosed it was $17.13 per room per month per movie revenue. And for the whole company it was $16.70, it was dragged down a little bit because of some On Command issues. Can you tell us how LodgeNet itself did without On Command this quarter?

Scott C. Petersen

From a movie standpoint, they operated within like .2 percentage points of each other, so they basically year-over-year moved almost in tandem. And I will also tell you as far as the new entertainment content, the time-shifted content, the other guest entertainment that we talked about, both had well over 11% increases on both platforms.

So the gap that we saw in the second quarter of last year, that gap has disappeared and the platforms are operating very comparable to each other.

Marshall Levine - Knott Partners L. P.

I’m sorry, to be clear, both sides of the company have increased, or decreased, by exactly the same amount, within a couple of percent?

Scott C. Petersen

Within a couple of percent.

Marshall Levine - Knott Partners L. P.

And then there is another metric that I think shines a bright spot on the company, which is the average price of a movie, which you’ve been disclosing. At the end of 2006 it was $12.00 for example. Last quarter you disclosed it was $13.00. How is it trending this quarter?

Scott C. Petersen

Well, as I said before, we’ve not done anything different, from a pricing strategy, certainly in the first quarter versus the fourth quarter of last year. From a variable which we price up certain titles based on their popularity and the newest titles, that has been basically the same structure over the past five quarters.

The only new thing that happened last year, which impacted and pushed the average ticket price, was introduction of the all day offerings in the fourth quarter on the LodgeNet platform. One purchase there raises the whole average ticket price.

And since our conference call in February, I think there’s a little bit of confusion around that. The average ticket price has been going up somewhat but it’s been based on the influence of that all day purchase versus generally instituting a price increase to the consumer for a single entertainment selection.

So I would say the price is quite similar. In Q1 the average ticket price, quite similar to what it was in Q4. Nothing really materially different there.

Marshall Levine - Knott Partners L. P.

Average ticket price is about the same and you’re saying that there may be a little bit more of a shift toward people paying for all day packages?

Scott C. Petersen

Not between the quarters. That was pretty comparable activity between those, also.

Operator

Your next question comes from Lucas Binder - UBS.

Lucas Binder – UBS

Can you tell us what was the digital number for the quarter, what number of rooms were digital?

Scott C. Petersen

It’s on our five-quarter summary. We had, at the end of the quarter, 110,000 rooms that were HD, out of our 1.9 million.

Lucas Binder – UBS

No, I’m asking for how many are digital rooms, have been converted to digital? You used to publish this number every quarter.

Scott C. Petersen

We would still be right around that 82% to 83%.

Lucas Binder – UBS

And just to check, the occupancy drop that you were talking about before, the 3.2%, that’s on a year-over-year basis, not a sequential basis, right?

Scott C. Petersen

It’s year-over-year, correct.

Lucas Binder – UBS

When you bought back about 470,000 shares, how do you think about additional buy-backs going forward? I mean, $10.00 a share I’m sure nobody’s really happy about but at the same time the stock is still lower than that and you have a real potential to take out a big chunk of the share base and help, at these prices I have got to think that that’s a good way to get your money.

Scott C. Petersen

I think, as we’ve talked about, there is a balance of all of the uses of our cash. As we said, we spent about $5 million, that leaves about $10 million in the basket. And we will look at the options of paying down debt, buying shares back. All of those options fit into our plans going forward and we will be opportunistic as we go forward.

Lucas Binder – UBS

When you think about competition, can you talk a little bit about are you seeing anybody new come into the space? What’s the scale of the nearest players? We’re still seeing churn as very low. It wasn’t as low as it was in the fourth quarter of 2007 but first quarter it was still .2% on a month-per-month. Can you talk a little about where are you loosing subs to, is it more of your own decision that rooms are coming off and are you seeing anything on the competitive front?

Scott C. Petersen

Well, the rooms that are coming off are generally the low, in fact the very low, properties that either their competitive situation changed over the last seven years since we did the contract, or even eight or nine years, it’s mostly the [inaudible] systems that would like to have a newer system and if they’re not willing to put up the capital for the systems sometimes they decided just to go to cable and get 80 channels of free TV for their guests.

We are 17 times bigger than our nearest competitor and that is [inaudible] a network based out of Las Vegas. They focus on the gaming markets only, have a very substantial presence in Las Vegas and Reno and Tahoe.

But from a competitor standpoint, we do serve, we just did the Venetian deal last year, we installed in two of the three towers now. That’s going very well. The Rio of the On Command platform, so it isn’t that we don’t in fact, that’s one area that we would like to get more aggressive in and plan to get more aggressive in over the next 12-24 months.

After that there are a couple of, I would call them smaller technology-based companies, that have a IP TV offering in the market. All of those together have 20,000 rooms installed. I would think that would probably be about accurate, or generous perhaps.

And we will be installing within the next four weeks an IP TV system in a property to test our technology and are fully intending to have that as an alternative to hotels that want that technology versus, the technologies we deal with traditionally use digital video broadcast algorithms.

So those are all the competitive landscapes. There’s always the cable company where hotels are not taking the TV programming from us, they’re taking it from their local cable company. We’re seeing a very interesting shift in competitive positioning where high definition programming is wanted, that we’re getting more than 80% penetration in those rooms. Because cable at this point in time does not have an effective way to deliver pro idiom and high def contents to the hotel industry.

So overall the market is very relatively quiet from our standpoint and we’re looking to cover all of our bases and segmentize our offerings more than we ever have in the past to provide cost effective and profitable systems for us, from the luxury market all the way down to the mid-market.

Lucas Binder – UBS

And just to check, when you talk about the cable systems, it’s purely on the free-to-guest, it’s not on the on-demand service?

Scott C. Petersen

It is purely on the free-to-guest side. It’s just getting 80 channels, or 70 channels, whatever it might be. And cable doesn’t want to get into a position where they have to put an expensive box in the hotel room. For any services it would be free to guest. The hotel does not want to pay that much for cable free TV services to guest. In fact, as they move more and more to the digital side, as far as delivery of even the basic programming, our competitive position increases there, too.

Operator

Your next question comes from Josh Rosen - RLR Capital.

Josh Rosen – RLR Capital Partners

On the capital investment plan, the run rate for the first of the year is about $34 million?

Scott C. Petersen

Yes. Mid-30s. That’s exactly right.

Josh Rosen – RLR Capital Partners

And that’s the capital plan managing and your run rate at the mid-point of your guidance, so even from mid-point of adjusted operating cash flow, the CapEx is trending lower than you expected, given what you’ve put in place, the capital cost savings.

Scott C. Petersen

I would say first quarter our results came in lower than our budget. And I’m assuming we’re going to continue with those types, so from a volume standpoint we cap volume as we beat our per unit capital per room, so to speak, that that creates more cash flow.

And we decided with the things we can do, one thing is make sure we’re being conservative in capital expenditures, as we watch and see how this recession plays out, so we can deliver on that free cash flow.

Josh Rosen – RLR Capital Partners

I assume that incremental $12 million, at least on a run rate basis, gives an incremental comfort in leverage ratios and was not included in the covenant analysis that is laid out.

Scott C. Petersen

That’s exactly right.

Operator

There are no further questions at this time.

Ann Parker – Director, Investor Relations

We would like to thank everyone for joining us today. Again, a reminder that replays of this call can be accessed over the next month via the Internet through our company web site, www.lodgenet.com. The slides used during this web cast will also be archived on our web site for your reference. If you have any difficult downloading those slides we would be happy to send them on request.

And thanks again everyone. Have a good day.

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Source: LodgeNet Interactive Corporation Q1 2008 Earnings Call Transcript
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