† competition from providers of similar services and from alternative sources;

† changes in demand for our products and services, programming costs, availability, timeliness, and quality;

† technological developments by competitors;

† developmental costs, difficulties, and delays;

† relationships with clients and property owners;

† the availability of capital to finance growth;

† the impact of government regulations;

† potential effects of litigation;

† risks of expansion into new markets;

† risks related to the security of our data systems; and

† other factors detailed, from time to time, in our filings with the SEC.

With respect to any proposed or completed acquisition, we are subject to risks that integration costs will exceed expectations, that synergies we anticipate will not be realized, or will take longer than anticipated to realize, that our management and management systems will encounter difficulties in dealing with a bigger, more diversified enterprise, and that the financial results we expect from the acquisition will not be realized.
LodgeNet is a leading provider of media and connectivity services designed to meet the unique needs of hospitality, healthcare and other visitor and guest-based businesses. LodgeNet serves more than 1.9 million hotel rooms representing 9,300 hotel properties worldwide in addition to healthcare facilities throughout the United States. LodgeNet's services include on demand movies, games, television programming, music and information, along with subscription sports programming and high-speed Internet access. LodgeNet Entertainment Corporation owns and operates businesses under the industry leading brands: LodgeNet, LodgeNetRX, On Command, StayOnline, Spectradyne, and The Hotel Networks.
During the third quarter, we made significant progress in the integration of On Command and StayOnline into our business and organization. The combination of the three companies provides an enhanced level of scale, resources, competencies, and operating efficiencies that will enable us to remain the leader in developing new and innovative interactive solutions for our customers. With these acquisitions, we believe we have created a more strategic platform from which we will be able to drive cash flow growth from our core operations and diversify revenue growth from a broad array of new and innovative solutions. The StayOnline acquisition greatly enhances our solutions and capabilities in the area of Internet based technology and On Command expands our customer base into which we can sell these enhanced solutions.

The acquisitions of On Command and StayOnline continue to impact our financial results. During the third quarter, total revenue increased $66.1 million, of which $63.1 million was attributable to On Command and StayOnline. Guest Pay revenue, including high-speed Internet access (HSIA) service revenues increased $57.5 million to $131.4 million or 77.9%. On a per-room basis, monthly Guest Pay revenue was $23.70 compared to $24.55 for the third quarter of 2006. The decline was driven by the addition of the On Command room base, which generates lower revenue per room for both movie revenue and basic cable programming. Other revenue increased $8.6 million to $11.2 million during the third quarter of 2007 versus $2.6 million in the third quarter of 2006. The increase is attributed to our diversification initiatives and includes higher HSIA equipment sales, higher Healthcare related revenue, revenue from the sale interactive television system equipment to hotels and travel centers, revenues from the sale of guest connectivity centers, revenues from the sale and installation of DirecTV satellite systems and the addition of advertising revenue. The advertising revenue was generated primarily by The Hotel Networks, a subsidiary acquired as part of the On Command acquisition.
For the third quarter of 2007, total operating costs and expenses increased $75.9 million, primarily due to the acquisition of On Command. Our Guest Pay direct costs increased to $68.2 million as compared to $34.7 million for the third quarter of 2006. Guest Pay operations expenses increased to $15.4 million in the third quarter of 2007 as compared to $8.9 million in the third quarter of 2006. SG&A expenses were $16.1 million in the third quarter of 2007, compared to $7.1 in the prior year quarter. The integration of our On Command and StayOnline acquisitions accounted for $6.3 million of the increase. SG&A as a percentage of revenue was 11.3% in the current quarter compared to 9.2% in the third quarter of 2006. Depreciation and amortization expenses increased to $34.1 million in the current year quarter versus $16.1 million in the third quarter of 2006. The increase was attributable to our acquired companies, which included $15.5 million of depreciation related to acquired fixed assets and $3.1 million related to the amortization of acquired intangibles.
Guest Pay Interactive Services. Our primary source of revenue is providing in-room, interactive television services to the lodging industry, for which the hotel guest pays on a per-view, hourly or daily basis. Our products include on-demand movies, network-based video games, music and music videos, high-speed Internet access and service fees and television on-demand programming. Our total guest generated revenue depends on a number of factors, including:
• The number of rooms on our network. We can increase revenue over time by increasing the number of rooms served by our interactive systems. With the acquisition of On Command, we have expanded our room base to over 1.9 million rooms. Our ability to continue expanding our room base is dependent on a number of factors, including the attractiveness of our technology, service and support to hotels currently operating without an interactive television system and newly constructed hotel properties.

• The variety of services offered at the hotel. Rooms equipped with our digital system generate higher revenue than rooms equipped with our tape-based system primarily because they offer a greater variety of services and content choices. We plan to continue to grow the revenue we generate per average room by the installation of our digital system in all newly contracted rooms and by converting selected tape-based rooms to our digital system in exchange for long-term contract extensions.

• The popularity, timeliness and amount of content offered at the hotel. Our revenues vary to a certain degree with the number, timeliness and popularity of movie content available for viewing. Historically, a decrease in the availability of popular movie content has adversely impacted revenue. Although not completely within our control, we seek to program and promote the most popular available movie content and other content to maximize revenue and gross profit.

• The price of the service purchased by the hotel guest. Generally, we control the prices charged for our products and services and manage pricing in an effort to maximize revenue and overall gross profit. We establish pricing based on such things as the demographics of the property served, the popularity of the content and overall economic conditions. Our technology enables us to measure popularity of our content and make decisions to best position such content and optimize revenue from such content.

• The occupancy rate at the property. Our revenue also varies depending on hotel occupancy rates, which are subject to a number of factors, including seasonality, general economic conditions and world events, such as terrorist threats or public health issues. Occupancy rates are typically higher during the second and third quarters due to seasonal travel patterns. We target higher occupancy properties in diverse demographic and geographic locations in an effort to mitigate occupancy-related risks.

The primary direct costs of providing Guest Pay interactive services are:
† license fees paid to major motion picture studios, which are based on a percent of guest-generated revenue, for non-exclusive distribution rights of recently released major motion pictures;

† commissions paid to our hotel customers, which are also based on a percent of guest-generated revenue;

† fixed monthly programming charges paid primarily to DIRECTV for satellite-delivered basic and premium television programming;

† HSIA customer support costs;

† Internet connectivity costs;

† license fees, which are based on a percent of guest-generated revenue, for television on demand, music, music video, video games and sports programming; and

† one-time license fees paid for independent films, most of which are non-rated and intended for mature audiences.

Other Products and Services. Our revenue from other services continued to expand and was $11.2 million in the third quarter of 2007, an increase of $8.6 million compared to the prior year quarter. The increase in revenue is attributed to HSIA equipment sales, interactive system sales and advertising revenue. Components of our other revenue sources are as follows:
High Speed Internet Access System Sales, Service and Support. We generate revenue through the sale and installation of high-speed Internet access equipment. In addition, we provide ongoing maintenance, service and call center support services to hotel properties that have been installed by us and also to hotel properties that have been installed by other providers. In some cases, we provide the hotel property with the portal to access the Internet. We receive monthly service fees from such hotel properties for our maintenance services and Internet access. In the third quarter of 2007, we generated $6.1 million of HSIA related revenue compared to $1.1 million in 2006. As a result of the acquisitions of StayOnline and On Command, we increased our HSIA room base from approximately 37,000 rooms in the third quarter of last year to approximately 216,000 rooms as of September 30, 2007. We expect that the expertise acquired from StayOnline, together with access to our significantly larger room base, will result in significant growth in our HSIA business in 2008. Healthcare System Sales and Support. We provide our interactive television infrastructure and content to the healthcare industry. We generate revenue from the sale and installation of system equipment and long-term agreements with the healthcare facility to provide software maintenance, programming and system maintenance. In the third quarter of 2007, we continued to focus on developing our healthcare business and had 25 facilities under contract as of September 30, 2007. Revenue comes from the initial sale of system hardware, software licensing, and implementation services, and we additionally earn recurring revenues, under long-term contracts, by providing entertainment content, software maintenance and technical field service. We had 19 interactive systems installed as of September 30, 2007. For the remainder of 2007, we have four healthcare facilities under installation.
System Sales and Support to Travel Centers. We also market and sell our interactive systems to IdleAire Technologies Corp. We generate revenue from three sources: 1) the sale of the interactive system, which includes equipment and a non-exclusive, non-transferable right to use the initial software package,
2) extended service and maintenance agreements, which include future software upgrades as they become available, and 3) entertainment programming. Other. Revenue generated from other sources includes the following:
† revenue generated from the sale of our interactive television systems to hotels, along with recurring support for interactive content, software maintenance and technical field service for a fixed fee;

† revenue from the sale of miscellaneous system equipment such as television remotes and service parts and labor;

† revenue from the sale of equipment to our international licensees;

† revenue from the installation of master antenna wiring and related infrastructure;

† revenue from the sale of guest connectivity centers;

† revenue from the sale and installation of DirecTV satellite systems; and

† revenue generated from delivery of satellite basic and premium television programming for which the hotel pays us a fixed monthly charge per room.

Key Metrics:
Special Note Regarding the Use of Non-GAAP Financial Information To supplement our consolidated financial statements presented in accordance with accounting principles generally accepted in the United States ("GAAP"), we use net free cash flow, a non-GAAP measure that is derived from results based on GAAP. The presentation of this additional information is not meant to be considered superior to, in isolation of, or as a substitute for, results prepared in accordance with GAAP.
We define net free cash flow, a non-GAAP measure, as cash provided by operating activities less cash used for certain investing activities and excluding consideration paid for acquisitions. Net free cash flow is a key liquidity measure but should not be construed as an alternative to cash flows from operating activities or as a measure of our profitability or performance. We provide information about net free cash flow because we believe it is a useful way for us, and our investors, to measure our ability to satisfy cash needs, including interest payments on our debt, taxes and capital expenditures. GAAP requires us to provide information about cash flow generated from operations. However, GAAP cash flow from operations is reduced by the amount of interest and tax payments and also takes into account changes in net current liabilities (e.g., changes in working capital) that do not impact net income. Because changes in working capital can reverse in subsequent periods, and because we want to provide information about cash available to satisfy interest and income tax expense (by showing our cash flows before deducting interest and income tax expense), we are also presenting net free cash flow information. Our definition of net free cash flow does not take into account our working capital requirements, debt service requirements or other commitments. Accordingly, net free cash flow is not necessarily indicative of amounts of cash that may be available to us for discretionary purposes. Our method of computing net free cash flow may not be comparable to other similarly titled measures of other companies.
Rooms Served
One of the metrics we monitor is the growth, net of de-installations, of our interactive television network. Over the last five years, de-installation activity averaged approximately 3% of our total installed room base. As lower revenue tape-based systems come up for contract renewal the overall economics may not support upgrading the site to our digital system. In these situations, many properties decide to switch to their local cable provider or we may elect to remove a certain number of these sites from our interactive room base. We expect this trend to continue as we focus on the quality of rooms installed and upgraded with greater returns when investing our capital dollars. We installed our systems in the following number of net new rooms and had the following total rooms installed as of September 30:

                                                                             September 30,
                                                                       2007                 2006
Total rooms served (1)                                               1,954,116            1,051,046
Total Guest Pay interactive rooms (2)                                1,852,124            1,003,602
Total HSIA rooms (3)                                                   215,581               36,665
Net new Guest Pay interactive rooms for the three months
ended (4)                                                                7,673               (3,011 )
Net new Guest Pay interactive rooms for the nine months
ended (4)                                                               21,632                1,673

(1) Total rooms served include guest pay interactive rooms, rooms served by international licensees, properties receiving only basic and premium television services and properties receiving only HSIA services. The increase from 2006 is due to the addition of the On Command room base of approximately 830,000 rooms.

(2) Guest Pay interactive rooms are equipped with our interactive television systems.

(3) Represents rooms receiving high-speed Internet service included in total rooms served.

(4) Amounts shown are net of de-installations during the period. The gross number of new rooms installed was 17,790 and 18,295 for the three months ended September 30, 2007 and 2006, respectively, and 56,077 and 48,164 for the nine months ended September 30, 2007 and 2006, respectively.

                  LodgeNet Entertainment Corporation   Form 10-Q


Digital Room Growth
We continue to expand our digital base as we install our digital system in all
newly contracted rooms as well as converting select tape-based served rooms to
the digital system in exchange for long-term contract extensions. Rooms equipped
with our digital system typically generate higher revenue since the range of
services is greater than rooms equipped with our tape-based systems. We expect
to have approximately 80% of our room base installed with a digital system by
the end of 2007.

                                                                               September 30,
                                                                          2007                2006
Net new digital rooms for the three months ended                           31,743             24,240
Net new digital rooms for the nine months ended                            91,995             81,708
Net new HDTV rooms for the three months ended (1)                          12,552              5,351
Net new HDTV rooms for the nine months ended (1)                           31,858             11,325
Total HDTV rooms installed (2)                                             63,502             13,880
Total digital rooms installed                                           1,443,303            710,793
Digital rooms as a percent of total Guest Pay interactive rooms              77.9 %             70.8 %

(1) HDTV rooms are equipped with high-definition capabilities and are included in total digital rooms.

(2) HDTV rooms are included in the total digital rooms installed.

Capital Investment Per Room
The average investment per-room associated with a digital installation can
fluctuate due to engineering efforts, component costs, product segmentation,
cost of assembly and installation, average property size, certain fixed costs,
hotel capital contributions and the expanding number of high-definition
installations, which have a higher cost per room. The following table sets forth
our average installation and conversion investment cost per room during the
periods ended:

                                                Three Months Ended                                       Years Ended
                                       September 30,         September 30,         December 31,         December 31,         December 31,
                                           2007                  2006                  2006                 2005                 2004
Average cost per room - new
installation                            $      399            $       356           $      354           $      340           $      364
Average cost per room -
conversion                              $      310            $       235           $      252           $      262           $      284

The increase in the average cost per new and converted rooms from 2006 to 2007 is primarily driven by the change in average room size of the property and the increase in high definition installations, which have a higher cost per room. The incremental cost for a high-definition installation ranges from approximately $50 to $100 per room depending upon the average room size, the mix of high-definition services and the amount of hotel capital contributions.

                  LodgeNet Entertainment Corporation   Form 10-Q


Revenue Per Room
Guest Pay revenue can fluctuate based on several factors including the
popularity of movie content, mix of movies purchased and the availability of
alternative programming. The following table sets forth the components of our
Guest Pay revenue per room for the three and nine months ended September 30:

                                          Three Months Ended          Nine Months Ended
                                             September 30,              September 30,
                                           2007          2006          2007         2006
    Average monthly revenue per room:
    Movie revenue                       $    17.43      $ 18.56     $    17.00     $ 17.56
    Other interactive service revenue         6.27         5.99           5.96        5.80

    Total per Guest Pay room            $    23.70      $ 24.55     $    22.96     $ 23.36

Certain contracts within our acquired customer base included discounts for satellite-delivered television programming which negatively impacted other interactive service revenue. These discounts will be eliminated as the sites are upgraded with high-definition television capabilities. Direct Costs
Guest Pay direct costs (exclusive of operating expenses and depreciation and amortization discussed separately below) for interactive services include movie license fees, license fees for other interactive services, the commission retained by the hotel, and programming and other related costs. The following table sets forth our Guest Pay direct expenses per room and as a percent of revenue during the three and nine months ended September 30:

                                                    Three Months Ended                  Nine Months Ended
                                                       September 30,                      September 30,
                                                   2007             2006              2007             2006
Guest Pay direct costs per room                 $  12.31          $ 11.55          $  11.66          $ 10.67
Guest Pay direct costs as a percent of
total revenue                                       51.9 %           47.0 %            50.1 %           45.7 %

Guest Pay direct costs increased to 51.9% in the third quarter of 2007 from 47.0% in the third quarter of 2006. The increase was primarily due to higher programming costs related to our acquired businesses. Operating Expenses
We continue to monitor and manage the operating expenses per room in order to increase the level of cash flow our business generates. Guest Pay operations expenses consist of costs directly related to the operation and maintenance of systems at hotel sites. Selling, general and administrative expense ("SG&A") primarily includes administrative payroll costs, stock based compensation, engineering development costs and legal, professional and compliance costs. The On Command and StayOnline acquisitions accounted for a $6.3 million increase in SG&A expenses. We also incurred approximately $2.5 million of expenses related to the integration of the two acquisitions. Net Income (Loss)
We focus on improving profitability by increasing room and revenue growth coupled with managing direct costs, overhead expenses, installation costs resulting in decreases in depreciation and amortization expenses, and interest costs. As a result of our acquisitions and the refinancing activities, the results for the nine months ended September 30, 2007, included a $22.2 million loss on early retirement of debt, $31.4 million related to the depreciation of acquired fixed assets, $5.0 million of restructuring expense and $5.8 million of amortization of intangible assets associated with our acquisitions. As a result of our acquisitions and the refinancing activities, the third quarter 2007 results included $15.5 million related to the depreciation of acquired fixed assets, $2.3 million of restructuring expense and $3.1 million of amortization of intangible assets associated with our acquisitions. These results are not indicative of our ability to generate net income in the future. The following table sets forth our net income (loss) for the three and nine months ended September 30 (in thousands of dollars):

Three Months Ended Nine Months Ended September 30, September 30, 2007 2006 2007 2006 Net income (loss) $ (11,411 ) $ 2,184 $ (45,470 ) $ 1,963

Free Cash Flow
One of our goals is to generate net free cash flow. In addition to increasing . . .