##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-Q
 
 (Mark One)
 þ
    
    Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
 For the quarterly period ended September 30, 2007
 or
 o
    
    Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the transition period from            to
 Commission File Number 1-13806
 
 REWARDS NETWORK INC.
 (Exact name of registrant as specified in its charter)
 
 DELAWARE
    
    84-6028875(State or other jurisdiction of 
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)Two North Riverside Plaza, Suite 950, Chicago, Illinois 60606
(Address of principal executive offices) (Zip code)
 312-521-6767
(Registrants telephone number, including area code)
 N/A
(Former name, former address and former fiscal year, if changed since last report)
 
 þ o
  o þ o
 o þ




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##### 



INDEX
 REWARDS NETWORK INC. AND SUBSIDIARIES
 Page No.PART I. FINANCIAL INFORMATIONItem 1.
    
    Financial Statements:Condensed Consolidated Balance SheetsSeptember 30, 2007 (unaudited)
and December 31, 2006
    
    
    3Condensed Consolidated Statements of OperationsThree and nine months ended
September 30, 2007 and 2006 (unaudited)
    
    
    4Condensed Consolidated Statements of Cash FlowsNine months ended
September 30, 2007 and 2006 (unaudited)
    
    
    5Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    6-11Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    12-26Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    27Item 4.
    
    Controls and Procedures
    
    
    27PART II. OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    28Item 1A.
    
    Risk Factors
    
    
    28Item 5.
    
    Other Information
    
    
    28Item 6.
    
    Exhibits
    
    
    29SIGNATURES
    
    
    30Exhibit 10.1Exhibit 10.2Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
   2




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REWARDS NETWORK INC. AND SUBSIDIARIES
 
 PART IFINANCIAL INFORMATION
 
 Item 1  Financial Statements
 
 Condensed Consolidated Balance Sheets
 (in thousands, except per share data)
 September 30,
    
    
    December 31,2007
    
    
    2006(Unaudited)AssetsCurrent assets:Cash and cash equivalents
    
    $
    14,602
    
    
    $
    52,496Short-term available for sale securities
    
    
    30,865
    
    
    
    32,500Accounts receivable, net of allowance for doubtful
accounts of $2,706 and $2,078, respectively
    
    
    11,395
    
    
    
    6,793Dining credits, net of allowance for doubtful accounts of
$20,726 and $12,210, respectively
    
    
    91,692
    
    
    
    76,366Deferred income taxes
    
    
    10,809
    
    
    
    10,409Prepaid expenses
    
    
    2,310
    
    
    
    2,449Income taxes receivable
    
    
    2,798
    
    
    
    1,433Total current assets
    
    
    164,471
    
    
    
    182,446Property and equipment, net of accumulated depreciation and
amortization of $23,072 and $20,380, respectively
    
    
    11,139
    
    
    
    8,712Other assets
    
    
    292
    
    
    
    1,124Goodwill
    
    
    8,117
    
    
    
    8,117Deferred income taxes
    
    
    1,324
    
    
    
    6,180Total assets
    
    $
    185,343
    
    
    $
    206,579Liabilities and Stockholders EquityCurrent liabilities:Accounts payabledining credits
    
    $
    7,433
    
    
    $
    6,801Accounts payablemember benefits
    
    
    7,498
    
    
    
    5,766Accounts payabletrade
    
    
    1,758
    
    
    
    1,953Accrued compensation
    
    
    1,659
    
    
    
    3,599Other current liabilities
    
    
    3,728
    
    
    
    3,738Deferred membership fee income
    
    
    779
    
    
    
    982Litigation and related accruals, current
    
    
    12,168
    
    
    
    13,650Total current liabilities
    
    
    35,023
    
    
    
    36,489Convertible subordinated debentures
    
    
    55,000
    
    
    
    70,000Litigation and related accruals, net of current portion
    
    
    4,085
    
    
    
    15,000Other long-term liabilities
    
    
    
    
    
    
    353Total liabilities
    
    
    94,108
    
    
    
    121,842Stockholders equity:Common stock, par value $0.02 per share; authorized
70,000 shares; issued 27,127 and 26,875 shares,
respectively; and outstanding 26,847 and 26,593 shares,
respectively
    
    
    543
    
    
    
    538Additional paid-in capital
    
    
    66,438
    
    
    
    66,138Accumulated other comprehensive income:Foreign currency translation, net of income taxes
    
    
    286
    
    
    
    391Retained earnings
    
    
    26,163
    
    
    
    19,880Treasury stock, at cost (280 and 282 shares, respectively)
    
    
    (2,195
    )
    
    
    (2,210
    )Total stockholders equity
    
    
    91,235
    
    
    
    84,737Total liabilities and stockholders equity
    
    $
    185,343
    
    
    $
    206,579
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REWARDS NETWORK INC. AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Operations
(in thousands, except per share data)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006(Unaudited)
    
    
    (Unaudited)Operating revenues:Sales
    
    $
    57,180
    
    
    $
    60,389
    
    
    $
    166,918
    
    
    $
    194,347Cost of sales
    
    
    28,652
    
    
    
    30,802
    
    
    
    83,439
    
    
    
    100,488Provision for losses
    
    
    3,171
    
    
    
    1,682
    
    
    
    8,020
    
    
    
    2,379Member benefits
    
    
    8,724
    
    
    
    8,812
    
    
    
    27,889
    
    
    
    27,211Total direct expenses
    
    
    40,547
    
    
    
    41,296
    
    
    
    119,348
    
    
    
    130,078Net revenue
    
    
    16,633
    
    
    
    19,093
    
    
    
    47,570
    
    
    
    64,269Membership fees and other income
    
    
    409
    
    
    
    504
    
    
    
    1,328
    
    
    
    1,624Total operating revenues
    
    
    17,042
    
    
    
    19,597
    
    
    
    48,898
    
    
    
    65,893Operating expenses:Salaries and benefits
    
    
    5,063
    
    
    
    5,626
    
    
    
    15,339
    
    
    
    17,535Sales commissions and expenses
    
    
    5,072
    
    
    
    4,452
    
    
    
    15,541
    
    
    
    13,838Professional fees
    
    
    369
    
    
    
    828
    
    
    
    1,717
    
    
    
    2,227Member and merchant marketing
    
    
    1,752
    
    
    
    1,429
    
    
    
    5,425
    
    
    
    3,800General and administrative
    
    
    4,054
    
    
    
    4,881
    
    
    
    13,464
    
    
    
    14,837Litigation and related expenses
    
    
    
    
    
    
    3,210
    
    
    
    (11,631
    )
    
    
    6,935Total operating expenses
    
    
    16,310
    
    
    
    20,426
    
    
    
    39,855
    
    
    
    59,172Operating income (loss)
    
    
    732
    
    
    
    (829
    )
    
    
    9,043
    
    
    
    6,721Other income (expense):Interest and other income
    
    
    636
    
    
    
    771
    
    
    
    2,134
    
    
    
    1,924Interest expense and financing costs
    
    
    (783
    )
    
    
    (715
    )
    
    
    (2,376
    )
    
    
    (2,170
    )Gain on extinguishment of convertible subordinate debentures
    
    
    739
    
    
    
    
    
    
    
    739
    
    
    
    Income (loss) before income tax provision (benefit)
    
    
    1,324
    
    
    
    (773
    )
    
    
    9,540
    
    
    
    6,475Income tax provision (benefit)
    
    
    179
    
    
    
    (365
    )
    
    
    3,257
    
    
    
    2,463Net income (loss)
    
    $
    1,145
    
    
    $
    (408
    )
    
    $
    6,283
    
    
    $
    4,012Earnings (loss) per share of common stock:Basic
    
    $
    0.04
    
    
    $
    (0.02
    )
    
    $
    0.23
    
    
    $
    0.15Diluted
    
    $
    0.04
    
    
    $
    (0.02
    )
    
    $
    0.23
    
    
    $
    0.15Weighted average number of common and common equivalent shares
outstanding:Basic
    
    
    27,038
    
    
    
    26,725
    
    
    
    26,969
    
    
    
    26,663Diluted
    
    
    27,120
    
    
    
    26,725
    
    
    
    27,098
    
    
    
    26,884
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REWARDS NETWORK INC. AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Cash Flows
(in thousands)
 Nine Months EndedSeptember 30,(Unaudited)2007
    
    
    2006Cash flows from operating activities:Net income
    
    $
    6,283
    
    
    $
    4,012Adjustments to reconcile net income to net cash (used in) provided by
operating activities:Depreciation and amortization
    
    
    3,445
    
    
    
    3,177Loss on disposal of fixed assets
    
    
    68
    
    
    
    Amortization of deferred financing costs
    
    
    401
    
    
    
    481Provision for losses
    
    
    8,020
    
    
    
    2,379Stock-based compensation
    
    
    710
    
    
    
    2,369Deferred income taxes
    
    
    4,455
    
    
    
    649Gain on extinguishment of convertible subordinate debentures
    
    
    (739
    )
    
    
    Changes in assets and liabilities:Accounts receivable
    
    
    (5,289
    )
    
    
    541Dining credits including accounts payabledining credits
    
    
    (21,701
    )
    
    
    38,930Prepaid expenses
    
    
    5
    
    
    
    (766
    )Income taxes receivable
    
    
    (1,366
    )
    
    
    233Other assets
    
    
    463
    
    
    
    (441
    )Accounts payablemember benefits
    
    
    1,716
    
    
    
    2,197Accounts payabletrade
    
    
    (687
    )
    
    
    (1,349
    )Accrued compensation
    
    
    (1,946
    )
    
    
    1,855Other liabilities
    
    
    (539
    )
    
    
    1,023Deferred membership fee income
    
    
    (203
    )
    
    
    (226
    )Litigation and related accruals
    
    
    (12,397
    )
    
    
    Net cash (used in) provided by operating activities
    
    
    (19,301
    )
    
    
    55,064Cash flows from investing activities:Purchases of available for sale securities
    
    
    (1,125
    )
    
    
    (35,000
    )Sales of available for sale securities
    
    
    2,760
    
    
    
    15,000Additions to property and equipment
    
    
    (5,930
    )
    
    
    (3,311
    )Net cash used in investing activities
    
    
    (4,295
    )
    
    
    (23,311
    )Cash flows from financing activities:Tax benefit from the exercise of stock options
    
    
    27
    
    
    
    250Proceeds from the exercise of stock options
    
    
    249
    
    
    
    851Purchase of convertible subordinate debentures
    
    
    (14,150
    )
    
    
    Net cash (used in) provided by financing activities
    
    
    (13,874
    )
    
    
    1,101Effect of exchange rate on cash
    
    
    (424
    )
    
    
    121Net (decrease) increase in cash
    
    
    (37,894
    )
    
    
    32,975Cash and cash equivalents:Beginning of the period
    
    
    52,496
    
    
    
    31,585End of the period
    
    $
    14,602
    
    
    $
    64,560Supplemental disclosures of cash flow information:Cash paid during the period for:Interest
    
    $
    1,138
    
    
    $
    1,138Income taxes
    
    $
    140
    
    
    $
    2,839
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REWARDS NETWORK INC. AND SUBSIDIARIES
 
 Notes to Unaudited Condensed Consolidated Financial Statements
(amounts in thousands, except per share data)
 Note 1  Basis of Presentation
  Nature of operations:
     6




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Note 2  Certain Relationships and Related Party Transactions (square footage not in thousands)
    Remaining quarter of 2007
    
    $
    136Year ended December 31, 2008
    
    
    547Year ended December 31, 2009
    
    
    555Year ended December 31, 2010
    
    
    569Year ended December 31, 2011
    
    
    361Total minimum lease payments
    
    $
    2,168
 Previous related party agreements
    7




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Terminated agreements
  Note 3  Litigation
       8




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Balance at
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance atOriginal
    
    
    Amounts
    
    
    
    
    
    
    December 31,
    
    
    Amounts
    
    
    
    
    
    
    
    
    
    
    Interest
    
    
    September 30,Charge
    
    
    Paid
    
    
    Reclassifications
    
    
    2006
    
    
    Paid
    
    
    Adjustments
    
    
    Reclassifications
    
    
    Expense
    
    
    2007California Class
Action Suit:Expense for Class
    
    $
    16,740
    
    
    $
    
    
    
    $
    
    
    
    $
    16,740
    
    
    $
    
    
    
    $
    (11,133
    )
    
    $
    
    
    
    $
    139
    
    
    $
    5,746Related litigation
expenses
    
    
    21,481
    
    
    
    (9,771
    )
    
    
    
    
    
    
    11,710
    
    
    
    (656
    )
    
    
    (683
    )
    
    
    
    
    
    
    136
    
    
    
    10,507Dining credits
reserve
    
    
    550
    
    
    
    
    
    
    
    (550
    )
    
    
    
    
    
    
    
    
    
    
    210
    
    
    
    (210
    )
    
    
    
    
    
    
    Total
California
litigation
    
    
    38,771
    
    
    
    (9,771
    )
    
    
    (550
    )
    
    
    28,450
    
    
    
    (656
    )
    
    
    (11,606
    )
    
    
    (210
    )
    
    
    275
    
    
    
    16,253Source Inc.
litigation:Settlement
    
    
    1,000
    
    
    
    (800
    )
    
    
    
    
    
    
    200
    
    
    
    (175
    )
    
    
    (25
    )
    
    
    
    
    
    
    
    
    
    
    Associated legal
costs
    
    
    740
    
    
    
    (740
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total Source
Inc. litigation
    
    
    1,740
    
    
    
    (1,540
    )
    
    
    
    
    
    
    200
    
    
    
    (175
    )
    
    
    (25
    )
    
    
    
    
    
    
    
    
    
    
    Total
litigation and
related
expenses
    
    $
    40,511
    
    
    $
    (11,311
    )
    
    $
    (550
    )
    
    $
    28,650
    
    
    $
    (831
    )
    
    
    (11,631
    )
    
    $
    (210
    )
    
    $
    275
    
    
    $
    16,253
 Note 4 -Earnings (Loss) per Share
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Net income (loss)
    
    $
    1,145
    
    
    $
    (408
    )
    
    $
    6,283
    
    
    $
    4,012Weighted average number of shares of common stock and
common stock equivalents outstandingBasic
    
    
    27,038
    
    
    
    26,725
    
    
    
    26,969
    
    
    
    26,663Stock options and restricted stock
    
    
    82
    
    
    
    
    
    
    
    129
    
    
    
    221Diluted
    
    
    27,120
    
    
    
    26,725
    
    
    
    27,098
    
    
    
    26,884Earnings (loss) per shareBasic
    
    $
    0.04
    
    
    $
    (0.02
    )
    
    $
    0.23
    
    
    $
    0.15Diluted
    
    $
    0.04
    
    
    $
    (0.02
    )
    
    $
    0.23
    
    
    $
    0.15
  9




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Note 5  Business and Credit Concentrations
  Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Airlines
    
    
    57
    %
    
    
    60
    %
    
    
    58
    %
    
    
    58
    %All partners that each represent 10% or more of sales
    
    
    42
    %
    
    
    52
    %
    
    
    42
    %
    
    
    49
    %
 Note 6  Minimum Partner and Vendor Obligations
  Note 7  Available for Sale Securities
  Note 8  Comprehensive Income (Loss)
  Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Net income (loss)
    
    $
    1,145
    
    
    $
    (408
    )
    
    $
    6,283
    
    
    $
    4,012Other comprehensive (loss) income:Translation adjustment
    
    
    (48
    )
    
    
    (7
    )
    
    
    (105
    )
    
    
    151Total comprehensive income (loss)
    
    $
    1,097
    
    
    $
    (415
    )
    
    $
    6,178
    
    
    $
    4,163
 Note 9  Recently Accepted Accounting Pronouncements
     10




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(amounts in thousands, except per share data)
 You should read the following discussion together with our unaudited condensed consolidated
financial statements and notes to those financial statements, which are included in this report.
This report contains forward-looking statements made pursuant to the safe harbor provisions of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. The words anticipates, intends, expects, could, should, plans,
believes, estimates or words or phrases of similar import generally identify forward-looking
statements. You are cautioned that forward-looking statements are subject to risks, trends and
uncertainties that could cause actual results, performance or achievements to differ materially
from those expressed in any forward-looking statements. Important factors that could cause our
actual results, performance or achievements to be materially different from any future results,
performance or achievements expressed or implied by those statements include, but are not limited
to, the following: (i) our inability to attract and retain merchants, (ii) our inability to
maintain a fully-staffed sales force, (iii) our dependence on our relationships with airlines and
other reward program partners for a significant number of members, (iv) the concentration of a
significant amount of our rewards currency in one industry group, the airline industry, (v) our
inability to attract and retain active members, (vi) our inability to maintain an appropriate
balance between the number of members and the number of participating merchants in each market,
(vii) our dependence upon our relationships with payment card issuers, transaction processors,
presenters and aggregators, (viii) our susceptibility to restaurant credit risk and the risk that
our allowance for losses related to restaurant credit risk in connection with dining credits and
RCR Loan notes may prove inadequate, (ix) our minimum purchase obligations and performance
requirements, (x) changes to payment card association rules and practices, (xi) network
interruptions, processing interruptions or processing errors, (xii) our susceptibility to a
changing regulatory environment, (xiii) increased operating costs or loss of members due to privacy
concerns of our program partners, payment card processors and the public, (xiv) the failure of our
security measures, (xv) economic changes, (xvi) the loss of key personnel, (xvii) the filing of
class action lawsuits in other states that are similar to the class action lawsuit in California
that we settled, (xviii) increasing competition, (xix) a shift in our product mix toward Marketing
Services Program that may cause revenues to decline, (xx) our inability to obtain sufficient cash
for our operations or to fund the repurchase of debentures in October 2008, if necessary, and (xxi)
the failure of our RCR Loan product to be successful. We undertake no obligation to, and expressly
disclaim any such obligation to, update or revise any forward-looking statements to reflect changed
assumptions, the occurrence of anticipated or unanticipated events or changes to future results
over time or otherwise, except as required by law. See the risk factors included as Part II, Item
1A Risk Factors in this Quarterly Report on Form 10-Q and our Quarterly Reports on Form 10-Q for
the periods ended June 30, 2007 and March 31, 2007 and Part I, Item 1A Risk Factors in our Annual
Report on Form 10-K for the year ended December 31, 2006 for a more detailed discussion of the
foregoing and other factors that could cause actual results to differ materially from those
included in the forward-looking statements and that, among others, should be considered in
evaluating our outlook.
 OVERVIEW
     12




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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
 Our discussion and analysis of the financial condition and results of operations are based
upon our condensed consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On
an on-going basis, we evaluate our estimates, including those related to the allowance for dining
credits losses, the valuation allowance, if any, for net deferred tax assets, investments and
intangible assets. Our estimates are based on historical experience and on various other
assumptions we believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities that are not readily
apparent from other sources. Actual results may differ from these estimates under different
assumptions or conditions. The following critical accounting policies affect our more significant
judgments and estimates used in the preparation of our consolidated financial statements.
 Allowance for Losses
 We provide allowances for dining credits losses based on our estimate of losses that would
result from the inability of participating merchants to remain in business or our merchants
unwillingness to honor their obligations relating to dining credits. If the financial condition of
our merchant base were to deteriorate beyond our expectations, resulting in participating
merchants inability to provide food, beverage, goods and services to members thereby reducing the
redemption of dining credits, or if merchants are unwilling or otherwise unable to honor their
obligations relating to dining credits in greater numbers than we expect, additional allowances may
be required.
 We review our ability to redeem dining credits on a regular basis and provide for anticipated
losses on dining credits. The dining credits portfolio is aged based on sales for the preceding
quarter and the allowance is determined primarily by applying estimated loss percentages to the
aged portfolio. Allowances are also provided for specifically identified accounts and for dining
credits balances that are large or slow moving. Losses are reduced by recoveries of dining
credits previously written off. Account balances are charged off against the allowance once we
conclude that a merchant is unwilling or unable to honor their obligation relating to dining
credits. After the write-off of the account, we continue to pursue recovery efforts. In the beginning of 2007, we implemented a new write-off policy that requires longer periods
of time to determine if an account should be written off. As a result of this new policy, there
was a slower write off of assets in the gross dining credits asset and an increase in the allowance
for doubtful accounts. The new policy requires an account to be written off only after collection
efforts have been exhausted. There was no change, however, in the reserve methodology.
  14




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##### Table of Contents



We also provide an allowance for our RCR Loan product using a specific reserve method based on
the merchants payment history and previous experience with the merchant, if applicable. We
purchase RCR Loan notes from WebBank after WebBank originates and funds the RCR Loan. If an RCR
Loan merchant fails, we may not realize any value for the RCR Loan note that we purchased. Even if
an RCR Loan merchant stays in business, it may fail to repay the note that we purchased and we may
incur costs to collect on the note and may not recover amounts sufficient to compensate us for
damages that we suffer. Although RCR Loans are originated and funded by WebBank based on its due
diligence standards and the notes are secured by a lien on the merchants assets, we cannot assure
you that these measures will be adequate to ensure that we will realize the full value of every
note that we purchase.
 Deferred Tax Assets Valuation Allowance
 We record a valuation allowance to reduce our deferred tax assets when it is not likely to be
recognized due to cumulative losses and the uncertainty as to future recoverability. We consider
future taxable income and available tax planning strategies in assessing the need for the valuation
allowance. In the event we determine that we would not be able to realize all or part of our net
deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to
income in the period in which such determination is made.
 Impairment Loss on Goodwill
 On at least an annual basis, we evaluate whether events and changes in circumstances warrant
the recognition of an impairment loss on goodwill. The conditions that would trigger an impairment
assessment of unamortized goodwill include a significant, sustained negative trend in our operating
results or cash flows, a decrease in demand for our programs, a change in the competitive
environment and other industry and economic factors. Recoverability of an asset is measured by
comparison of its carrying amount to the expected future cash flows. Any impairment to be
recognized is measured by the amount by which the carrying amount of the asset exceeds its fair
market value. Significant management judgment is required in the forecasting of future operating
results that are used in the preparation of projected cash flows, and, if different conditions
prevail or judgments are made, a material write-down of goodwill could occur.
 We comply with Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and
Other Intangible Assets, the current standard for periodic assessment of the carrying value of
intangible assets, including goodwill. We assess the impact of SFAS No. 142 using a two-step
approach to assess goodwill based on applicable reporting units and any intangible assets,
including goodwill, recorded in connection with our previous acquisitions.
 Revenue Recognition
 We recognize revenue from the Marketing Credits Program and Marketing Services Program when
members patronize participating merchants and pay using a payment card they have registered with
us. Revenue is recognized only if the members transaction qualifies for a benefit in accordance
with the rules of the members particular program. The amount of revenue recognized is that portion
of the members total transaction amount that we are entitled to receive in cash, in accordance
with the terms of our agreement with the participating merchant. For example, if a members total
qualified transaction amount is $100 at a participating merchant, as evidenced by the full amount
of the payment card transaction, and our contract provides for us to receive 80%, the amount of
revenue we recognize is $80, representing what we actually realize in cash. Similarly, under the
typical Marketing Services Program contract, we recognize revenue only to the extent that we are
contractually entitled to receive cash for a portion of the members total qualified transaction
amount. The same $100 transaction referred to above at a Marketing Services Program merchant may
yield $17 in revenue to be recognized. Under the RCR Loan product, we recognize interest income
over the life of the loan.
 Legal Contingencies
 We review the status of significant legal matters and assess our potential financial exposure
with respect to such legal matters on at least a quarterly basis. If the potential loss from any
claim or legal proceeding is considered probable and the amount can be reasonably estimated, we
accrue a liability for the estimated loss. Significant judgment is required in both the
determination of probability and the determination as to whether an exposure is reasonably
estimable. Because of uncertainties related to these matters, accruals are based only on the best
information available at the time. As additional information becomes available, we reassess the
potential liability related to pending claims and legal proceedings and may
revise our estimates. Such revisions in the estimates of the potential liabilities could have
a material impact on our results of operations and financial position.
  15




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RESULTS OF OPERATIONS  COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
  Percentage of Salesfor the Three Months EndedSeptember 30,2007
    
    
    2006Sales
    
    
    100.0
    
    
    
    100.0Cost of sales
    
    
    50.1
    
    
    
    51.0Provision for losses
    
    
    5.6
    
    
    
    2.8Member benefits
    
    
    15.3
    
    
    
    14.6Net revenue
    
    
    29.1
    
    
    
    31.6Membership fees and other income
    
    
    0.7
    
    
    
    0.8Total operating revenue
    
    
    29.8
    
    
    
    32.4Salaries and benefits
    
    
    8.9
    
    
    
    9.3Sales commission and expenses
    
    
    8.9
    
    
    
    7.4Professional fees
    
    
    0.6
    
    
    
    1.4Member and merchant marketing expenses
    
    
    3.1
    
    
    
    2.4General and administrative expenses
    
    
    7.1
    
    
    
    8.1Litigation and related expenses
    
    
    0.0
    
    
    
    5.3Total operating expenses
    
    
    28.5
    
    
    
    33.9Operating income (loss)
    
    
    1.3
    
    
    
    (1.4
    )Other income, net
    
    
    1.0
    
    
    
    0.1Income (loss) before income tax provision (benefit)
    
    
    2.3
    
    
    
    (1.3
    )Income tax provision (benefit)
    
    
    0.3
    
    
    
    (0.6
    )Net income (loss)
    
    
    2.0
    
    
    
    (0.7
    )
  16




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Operating Revenues
  For the Three Months Ended September 30,2007
    
    
    2006Marketing
    
    
    Marketing
    
    
    
    
    
    
    Marketing
    
    
    MarketingCredits
    
    
    Services
    
    
    
    
    
    
    Credits
    
    
    ServicesProgram
    
    
    Program
    
    
    Total
    
    
    Program
    
    
    Program
    
    
    TotalMerchant count as of
September 30, 2007 and 2006,
respectively
    
    
    6,188
    
    
    
    3,045
    
    
    
    9,233
    
    
    
    6,285
    
    
    
    2,341
    
    
    
    8,626Number of qualified
transactions
    
    
    1,440
    
    
    
    727
    
    
    
    2,167
    
    
    
    1,659
    
    
    
    697
    
    
    
    2,356Average transaction amount
    
    $
    47.07
    
    
    $
    47.25
    
    
    $
    47.13
    
    
    $
    47.08
    
    
    $
    47.90
    
    
    $
    47.32Qualified transaction amount
    
    $
    67,786
    
    
    $
    34,349
    
    
    $
    102,135
    
    
    $
    78,105
    
    
    $
    33,384
    
    
    $
    111,489Sales yield
    
    
    75.6
    %
    
    
    17.2
    %
    
    
    56.0
    %
    
    
    70.1
    %
    
    
    16.9
    %
    
    
    54.2
    %Sales
    
    $
    51,267
    
    
    $
    5,913
    
    
    $
    57,180
    
    
    $
    54,733
    
    
    $
    5,656
    
    
    $
    60,389Cost of dining credits
    
    $
    28,349
    
    
    $
    
    
    
    $
    28,349
    
    
    $
    30,347
    
    
    $
    
    
    
    $
    30,347Processing fee
    
    
    190
    
    
    
    113
    
    
    
    303
    
    
    
    319
    
    
    
    136
    
    
    
    455Total cost of sales
    
    $
    28,539
    
    
    $
    113
    
    
    $
    28,652
    
    
    $
    30,666
    
    
    $
    136
    
    
    $
    30,802Provision for losses
    
    $
    3,171
    
    
    $
    
    
    
    $
    3,171
    
    
    $
    1,682
    
    
    $
    
    
    
    $
    1,682Member benefits
    
    $
    4,483
    
    
    $
    2,333
    
    
    $
    6,816
    
    
    $
    4,759
    
    
    $
    1,913
    
    
    $
    6,672Bonus rewards
    
    
    320
    
    
    
    170
    
    
    
    490
    
    
    
    585
    
    
    
    250
    
    
    
    835Partner Commissions
    
    
    788
    
    
    
    630
    
    
    
    1,418
    
    
    
    937
    
    
    
    368
    
    
    
    1,305Total member benefits
    
    $
    5,591
    
    
    $
    3,133
    
    
    $
    8,724
    
    
    $
    6,281
    
    
    $
    2,531
    
    
    $
    8,812Net revenue
    
    $
    13,966
    
    
    $
    2,667
    
    
    $
    16,633
    
    
    $
    16,104
    
    
    $
    2,989
    
    
    $
    19,093
     17




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18




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Operating Expenses
       Other Income and Expense
   19




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Income tax provision
  Net Income
    20




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RESULTS OF OPERATIONS  COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
  Percentage of Salesfor the Nine Months EndedSeptember 30,2007
    
    
    2006Sales
    
    
    100.0
    
    
    
    100.0Cost of sales
    
    
    50.0
    
    
    
    51.7Provision for losses
    
    
    4.8
    
    
    
    1.2Member benefits
    
    
    16.7
    
    
    
    14.0Net revenue
    
    
    28.5
    
    
    
    33.1Membership fees and other income
    
    
    0.8
    
    
    
    0.9Total operating revenue
    
    
    29.3
    
    
    
    33.9Salaries and benefits
    
    
    9.2
    
    
    
    9.0Sales commission and expenses
    
    
    9.3
    
    
    
    7.1Professional fees
    
    
    1.0
    
    
    
    1.2Member and merchant marketing expenses
    
    
    3.3
    
    
    
    2.0General and administrative expenses
    
    
    8.1
    
    
    
    7.6Litigation and related expenses
    
    
    (7.0
    )
    
    
    3.6Total operating expenses
    
    
    23.9
    
    
    
    30.5Operating income
    
    
    5.4
    
    
    
    3.5Other income (expense), net
    
    
    0.3
    
    
    
    (0.1
    )Income before income tax provision
    
    
    5.7
    
    
    
    3.3Income tax provision
    
    
    2.0
    
    
    
    1.3Net income
    
    
    3.8
    
    
    
    2.1
  21




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Operating Revenues
  
 For the Nine Months Ended September 30,2007
    
    
    2006Marketing
    
    
    Marketing
    
    
    
    
    
    
    Marketing
    
    
    MarketingCredits
    
    
    Services
    
    
    
    
    
    
    Credits
    
    
    ServicesProgram
    
    
    Program
    
    
    Total
    
    
    Program
    
    
    Program
    
    
    TotalMerchant count
    
    
    6,188
    
    
    
    3,045
    
    
    
    9,233
    
    
    
    6,285
    
    
    
    2,341
    
    
    
    8,626Number of qualified
transactions
    
    
    4,271
    
    
    
    2,151
    
    
    
    6,422
    
    
    
    5,376
    
    
    
    1,991
    
    
    
    7,367Average transaction amount
    
    $
    47.49
    
    
    $
    48.28
    
    
    $
    47.75
    
    
    $
    47.59
    
    
    $
    48.48
    
    
    $
    47.83Qualified transaction
amount
    
    $
    202,833
    
    
    $
    103,842
    
    
    $
    306,675
    
    
    $
    255,828
    
    
    $
    96,527
    
    
    $
    352,355Sales yield
    
    
    73.5
    %
    
    
    17.3
    %
    
    
    54.4
    %
    
    
    69.7
    %
    
    
    16.6
    %
    
    
    55.2
    %Sales
    
    $
    148,981
    
    
    $
    17,937
    
    
    $
    166,918
    
    
    $
    178,298
    
    
    $
    16,049
    
    
    $
    194,347Cost of dining credits
    
    $
    82,615
    
    
    
    
    
    
    $
    82,615
    
    
    
    99,301
    
    
    
    
    
    
    
    99,301Processing fee
    
    
    551
    
    
    
    273
    
    
    
    824
    
    
    
    862
    
    
    
    325
    
    
    
    1,187Total cost of sales
    
    $
    83,166
    
    
    $
    273
    
    
    $
    83,439
    
    
    $
    100,163
    
    
    $
    325
    
    
    $
    100,488Provision for dining
credits losses
    
    $
    8,020
    
    
    
    
    
    
    $
    8,020
    
    
    
    2,379
    
    
    
    
    
    
    
    2,379Member benefits
    
    $
    14,085
    
    
    $
    6,974
    
    
    $
    21,059
    
    
    $
    15,424
    
    
    $
    5,448
    
    
    $
    20,872Bonus rewards
    
    
    1,867
    
    
    
    962
    
    
    
    2,829
    
    
    
    1,805
    
    
    
    682
    
    
    
    2,487Partner Commissions
    
    
    2,586
    
    
    
    1,415
    
    
    
    4,001
    
    
    
    2,875
    
    
    
    977
    
    
    
    3,852Total member
benefits
    
    $
    18,538
    
    
    $
    9,351
    
    
    $
    27,889
    
    
    $
    20,104
    
    
    $
    7,107
    
    
    $
    27,211Net revenue
    
    $
    39,257
    
    
    $
    8,313
    
    
    $
    47,570
    
    
    $
    55,652
    
    
    $
    8,617
    
    
    $
    64,269
       22




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Operating Expenses
       23




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##### Table of Contents



Other Income and Expense
  Income tax provision
  Net income
   LIQUIDITY AND CAPITAL RESOURCES
 General
      24




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##### Table of Contents



Convertible Subordinated Debentures
   Contractual Obligations and Commitments
  Payments Due by PeriodFourth QuarterContractual Obligations and Commitments
    
    Total
    
    
    of 2007
    
    
    2008
    
    
    2009 and afterConvertible subordinated debentures (including net interest)
    
    $
    57,870
    
    
    $
    981
    
    
    $
    56,889
    
    
    $
    Vendor contracts
    
    
    13,059
    
    
    
    4,739
    
    
    
    8,320California class action litigation settlement and related expenses
    
    
    16,656
    
    
    
    8,954
    
    
    
    3,601
    
    
    
    4,101Operating leases
    
    
    5,664
    
    
    
    418
    
    
    
    1,624
    
    
    
    3,622Total
    
    $
    93,249
    
    
    $
    15,092
    
    
    $
    70,434
    
    
    $
    7,723
  25




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##### Table of Contents



Revolving Credit Facility
    Dining Credits
  Off Balance Sheet Arrangements
  Litigation
  RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
    26




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##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures about Market Risk
  
 Item 4. Controls and Procedures
 Evaluation of Disclosure Controls and Procedures.
 Changes in Internal Control over Financial Reporting.
  27




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##### Table of Contents



PART IIOTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 1A. Risk Factors
  
 Item 5. Other Information
       28




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##### Table of Contents



Item 6. Exhibits
 Exhibit No.
    
    Description3.1
    
    Restated Certificate of Incorporation of Rewards Network Inc. is
incorporated herein by reference to Exhibit 4.1 to Rewards Network
Inc.s Registration Statement on Form S-3 (File No. 333-111390),
filed on December 19, 2003.3.2
    
    By-Laws of Rewards Network Inc., as amended, are incorporated herein
by reference to Exhibit 3.2 to Rewards Network Inc.s Annual Report
on Form 10-K (File No. 001-13806), filed on March 12, 2004.4.1
    
    Letter Agreement, dated as of June 12, 2002, between iDine Rewards
Network Inc. and Samstock, L.L.C. is incorporated herein by
reference to Exhibit 4.11 to Amendment No. 1 to iDine Rewards
Network Inc.s Annual Report on Form 10-K (File No. 001-13806),
filed on October 7, 2003.4.2
    
    Second Amended and Restated Investment Agreement, dated as of June
30, 1999, among Transmedia Network Inc., Samstock, L.L.C.,
EGI-Transmedia Investors, L.L.C. and Robert M. Steiner, as trustee,
is incorporated herein by reference to Exhibit 4.3 to Amendment No.
1 to Transmedia Network Inc.s Registration Statement on Form S-2
(File No. 333-84947), filed on October 5, 1999.4.3
    
    Amendment, dated February 5, 2003, to the Second Amended and
Restated Investment Agreement, dated as of June 30, 1999, among
iDine Rewards Network Inc., Samstock, L.L.C., and the former members
and distributees of EGI-Transmedia Investors, L.L.C., is
incorporated herein by reference to Exhibit 4.13 to Amendment No. 1
to iDine Rewards Network Inc.s Annual Report on Form 10-K (File No.
001-13806), filed on October 7, 2003.4.4
    
    Indenture, dated as of October 15, 2003, as amended and restated as
of February 4, 2004, between Rewards Network Inc. and LaSalle Bank
National Association is incorporated herein by reference to Exhibit
4.15 to Rewards Network Inc.s Annual Report on Form 10-K (File No.
001-13806), filed on March 12, 2004.4.5
    
    Registration Rights Agreement, dated October 8, 2003, between iDine
Rewards Network Inc. and Credit Suisse First Boston LLC is
incorporated herein by reference to Exhibit 4.18 to iDine Rewards
Network Inc.s Quarterly Report on Form 10-Q (File No. 001-13806),
filed on November 14, 2003.10.1*
    
    Letter Agreement, dated as of November 7, 2007, between Rewards
Network Inc. and Christopher J. Locke10.2*
    
    Loan and Security Agreement, dated as of November 6, 2007, between
Rewards Network Inc. and each of its domestic subsidiaries signatory
thereto and RBS Business Capital31.1*
    
    Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer31.2*
    
    Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer32.1*
    
    Section 1350 Certification of Chief Executive Officer32.2*
    
    Section 1350 Certification of Chief Financial Officer
 
 *
    
    Filed herewith  29




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##### Table of Contents



SIGNATURES
  REWARDS NETWORK INC.November 8, 2007
    
    /s/ Christopher J. Locke

Christopher J. Locke 
Senior Vice President
and Chief Financial Officer
(Principal Financial Officer and on behalf of the registrant)
  30




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##### Table of Contents



Exhibit Index
 Exhibit No.
    
    Description3.1
    
    Restated Certificate of Incorporation of Rewards Network Inc. is
incorporated herein by reference to Exhibit 4.1 to Rewards Network
Inc.s Registration Statement on Form S-3 (File No. 333-111390),
filed on December 19, 2003.3.2
    
    By-Laws of Rewards Network Inc., as amended, are incorporated herein
by reference to Exhibit 3.2 to Rewards Network Inc.s Annual Report
on Form 10-K (File No. 001-13806), filed on March 12, 2004.4.1
    
    Letter Agreement, dated as of June 12, 2002, between iDine Rewards
Network Inc. and Samstock, L.L.C. is incorporated herein by
reference to Exhibit 4.11 to Amendment No. 1 to iDine Rewards
Network Inc.s Annual Report on Form 10-K (File No. 001-13806),
filed on October 7, 2003.4.2
    
    Second Amended and Restated Investment Agreement, dated as of June
30, 1999, among Transmedia Network Inc., Samstock, L.L.C.,
EGI-Transmedia Investors, L.L.C. and Robert M. Steiner, as trustee,
is incorporated herein by reference to Exhibit 4.3 to Amendment No.
1 to Transmedia Network Inc.s Registration Statement on Form S-2
(File No. 333-84947), filed on October 5, 1999.4.3
    
    Amendment, dated February 5, 2003, to the Second Amended and
Restated Investment Agreement, dated as of June 30, 1999, among
iDine Rewards Network Inc., Samstock, L.L.C., and the former members
and distributees of EGI-Transmedia Investors, L.L.C., is
incorporated herein by reference to Exhibit 4.13 to Amendment No. 1
to iDine Rewards Network Inc.s Annual Report on Form 10-K (File No.
001-13806), filed on October 7, 2003.4.4
    
    Indenture, dated as of October 15, 2003, as amended and restated as
of February 4, 2004, between Rewards Network Inc. and LaSalle Bank
National Association is incorporated herein by reference to Exhibit
4.15 to Rewards Network Inc.s Annual Report on Form 10-K (File No.
001-13806), filed on March 12, 2004.4.5
    
    Registration Rights Agreement, dated October 8, 2003, between iDine
Rewards Network Inc. and Credit Suisse First Boston LLC is
incorporated herein by reference to Exhibit 4.18 to iDine Rewards
Network Inc.s Quarterly Report on Form 10-Q (File No. 001-13806),
filed on November 14, 2003.10.1*
    
    Letter Agreement, dated as of November 7, 2007, between Rewards
Network Inc. and Christopher J. Locke10.2*
    
    Loan and Security Agreement, dated as of November 6, 2007, between
Rewards Network Inc. and each of its domestic subsidiaries signatory
thereto and RBS Business Capital31.1*
    
    Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer31.2*
    
    Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer32.1*
    
    Section 1350 Certification of Chief Executive Officer32.2*
    
    Section 1350 Certification of Chief Financial Officer
 
 *
    
    Filed herewith  31