##### 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 June 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
(State or other jurisdiction of 
incorporation or organization)
    
    84-6028875
(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June 30, 2007 (unaudited) and December 31, 2006
    
    
    3Condensed Consolidated Statements of OperationsThree and six months ended June 30, 2007 and 2006 (unaudited)
    
    
    4Condensed Consolidated Statements of Cash FlowsSix months ended June 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
    
    
    26Item 4.
    
    Controls and Procedures
    
    
    26PART II.
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    27Item 1A.
    
    Risk Factors
    
    
    27Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    27-29Item 6.
    
    Exhibits
    
    
    29SIGNATURES
    
    
    30Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
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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)
 June 30,
    
    
    December 31,2007
    
    
    2006(Unaudited)AssetsCurrent assets:Cash and cash equivalents
    
    $
    31,717
    
    
    $
    52,496Short-term available for sale securities
    
    
    32,975
    
    
    
    32,500Accounts receivable, net of allowance for doubtful
accounts of $2,027 and $2,078, respectively
    
    
    9,211
    
    
    
    6,793Dining credits, net of allowance for doubtful
accounts of $17,739 and $12,210, respectively
    
    
    87,171
    
    
    
    76,366Deferred income taxes
    
    
    8,825
    
    
    
    10,409Prepaid expenses
    
    
    2,057
    
    
    
    2,449Income taxes receivable
    
    
    2,641
    
    
    
    1,433Total current assets
    
    
    174,597
    
    
    
    182,446Property and equipment, net of accumulated depreciation and
amortization of $22,703 and $20,380, respectively
    
    
    10,659
    
    
    
    8,712Other assets
    
    
    540
    
    
    
    1,124Goodwill
    
    
    8,117
    
    
    
    8,117Deferred income taxes
    
    
    3,604
    
    
    
    6,180Total assets
    
    $
    197,517
    
    
    $
    206,579Liabilities and Stockholders EquityCurrent liabilities:Accounts payabledining credits
    
    $
    7,292
    
    
    $
    6,801Accounts payablemember benefits
    
    
    6,643
    
    
    
    5,766Accounts payabletrade
    
    
    2,031
    
    
    
    1,953Accrued compensation
    
    
    1,210
    
    
    
    3,599Other current liabilities
    
    
    3,190
    
    
    
    3,738Deferred membership fee income
    
    
    848
    
    
    
    982Litigation and related accruals, current
    
    
    9,034
    
    
    
    13,650Total current liabilities
    
    
    30,248
    
    
    
    36,489Convertible subordinated debentures
    
    
    70,000
    
    
    
    70,000Litigation and related accruals, net of current portion
    
    
    7,391
    
    
    
    15,000Other long-term liabilities
    
    
    44
    
    
    
    353Total liabilities
    
    
    107,683
    
    
    
    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 26,845 and 26,593
shares,
respectively
    
    
    543
    
    
    
    538Additional paid-in capital
    
    
    66,149
    
    
    
    66,138Accumulated other comprehensive income:Foreign currency translation, net of income taxes
    
    
    334
    
    
    
    391Retained earnings
    
    
    25,018
    
    
    
    19,880Treasury stock, at cost (282 shares)
    
    
    (2,210
    )
    
    
    (2,210
    )Total stockholders equity
    
    
    89,834
    
    
    
    84,737Total liabilities and stockholders equity
    
    $
    197,517
    
    
    $
    206,579
   3




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REWARDS NETWORK INC. AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Operations
(in thousands, except per share data)
 Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Operating revenues:Sales
    
    $
    56,822
    
    
    $
    66,356
    
    
    $
    109,738
    
    
    $
    133,958Cost of sales
    
    
    28,351
    
    
    
    34,400
    
    
    
    54,787
    
    
    
    69,686Provision for losses
    
    
    2,574
    
    
    
    250
    
    
    
    4,849
    
    
    
    697Member benefits
    
    
    9,717
    
    
    
    9,311
    
    
    
    19,165
    
    
    
    18,399Total direct expenses
    
    
    40,642
    
    
    
    43,961
    
    
    
    78,801
    
    
    
    88,782Net revenue
    
    
    16,180
    
    
    
    22,395
    
    
    
    30,937
    
    
    
    45,176Membership fees and other income
    
    
    445
    
    
    
    545
    
    
    
    919
    
    
    
    1,120Total operating revenues
    
    
    16,625
    
    
    
    22,940
    
    
    
    31,856
    
    
    
    46,296Operating expenses:Salaries and benefits
    
    
    4,788
    
    
    
    6,048
    
    
    
    10,276
    
    
    
    11,909Sales commissions and expenses
    
    
    5,308
    
    
    
    4,438
    
    
    
    10,469
    
    
    
    9,386Professional fees
    
    
    478
    
    
    
    544
    
    
    
    1,348
    
    
    
    1,399Member and merchant marketing
    
    
    2,086
    
    
    
    1,054
    
    
    
    3,673
    
    
    
    2,371General and administrative
    
    
    4,593
    
    
    
    5,350
    
    
    
    9,410
    
    
    
    9,956Litigation and related expenses
    
    
    (11,631
    )
    
    
    1,100
    
    
    
    (11,631
    )
    
    
    3,725Total operating expenses
    
    
    5,622
    
    
    
    18,534
    
    
    
    23,545
    
    
    
    38,746Operating income
    
    
    11,003
    
    
    
    4,406
    
    
    
    8,311
    
    
    
    7,550Other income (expense):Interest and other income
    
    
    662
    
    
    
    696
    
    
    
    1,498
    
    
    
    1,154Interest expense and financing costs
    
    
    (710
    )
    
    
    (721
    )
    
    
    (1,593
    )
    
    
    (1,456
    )Income before income tax provision
    
    
    10,955
    
    
    
    4,381
    
    
    
    8,216
    
    
    
    7,248Income tax provision
    
    
    3,828
    
    
    
    1,778
    
    
    
    3,078
    
    
    
    2,828Net income
    
    $
    7,127
    
    
    $
    2,603
    
    
    $
    5,138
    
    
    $
    4,420Net income available for common stockholders
    
    $
    7,579
    
    
    $
    2,603
    
    
    $
    5,138
    
    
    $
    4,420Earnings per share of common stock:Basic
    
    $
    0.26
    
    
    $
    0.10
    
    
    $
    0.19
    
    
    $
    0.17Diluted
    
    $
    0.24
    
    
    $
    0.10
    
    
    $
    0.19
    
    
    $
    0.16Weighted average number of common and common
equivalent shares outstanding:Basic
    
    
    27,018
    
    
    
    26,672
    
    
    
    26,934
    
    
    
    26,632Diluted
    
    
    30,992
    
    
    
    26,958
    
    
    
    27,064
    
    
    
    26,879
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REWARDS NETWORK INC. AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Cash Flows
(in thousands)
 Six Months EndedJune 30,(Unaudited)2007
    
    
    2006Cash flows from operating activities:Net income
    
    $
    5,138
    
    
    $
    4,420Adjustments to reconcile net income to net cash (used in) provided by
operating activities:Depreciation and amortization
    
    
    2,328
    
    
    
    2,121Amortization of deferred financing costs
    
    
    278
    
    
    
    341Provision for losses
    
    
    4,849
    
    
    
    697Stock-based compensation
    
    
    364
    
    
    
    1,301Deferred income taxes
    
    
    4,159
    
    
    
    1,175Changes in assets and liabilities:Accounts receivable
    
    
    (2,692
    )
    
    
    1,345Dining credits including accounts payabledining credits
    
    
    (14,748
    )
    
    
    32,526Prepaid expenses
    
    
    364
    
    
    
    (187
    )Income taxes receivable
    
    
    (1,208
    )
    
    
    2,438Other assets
    
    
    330
    
    
    
    (26
    )Accounts payablemember benefits
    
    
    877
    
    
    
    725Accounts payabletrade
    
    
    (410
    )
    
    
    237Accrued compensation
    
    
    (2,391
    )
    
    
    1,108Other liabilities
    
    
    (985
    )
    
    
    1,159Deferred membership fee income
    
    
    (134
    )
    
    
    (155
    )Litigation and related accruals
    
    
    (12,224
    )
    
    
    Net cash (used in) provided by operating activities
    
    
    (16,105
    )
    
    
    49,225Cash flows from investing activities:Purchases of available for sale securities
    
    
    (1,125
    )
    
    
    (35,000
    )Sales of available for sale securities
    
    
    650
    
    
    
    Additions to property and equipment
    
    
    (4,258
    )
    
    
    (1,745
    )Net cash used in investing activities
    
    
    (4,733
    )
    
    
    (36,745
    )Cash flows from financing activities:Tax benefit from the exercise of stock options
    
    
    27
    
    
    
    253Proceeds from the exercise of stock options
    
    
    249
    
    
    
    772Net cash provided by financing activities
    
    
    276
    
    
    
    1,025Effect of exchange rate on cash
    
    
    (217
    )
    
    
    112Net (decrease) increase in cash
    
    
    (20,779
    )
    
    
    13,617Cash and cash equivalents:Beginning of the period
    
    
    52,496
    
    
    
    31,585End of the period
    
    $
    31,717
    
    
    $
    45,202Supplemental disclosures of cash flow information:Cash paid during the period for:Interest
    
    $
    1,138
    
    
    $
    1,138Income taxes
    
    $
    100
    
    
    $
    470
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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 two quarters of 2007
    
    $
    271Year ended December 31, 2008
    
    
    547Year ended December 31, 2009
    
    
    554Thereafter
    
    
    930Total minimum lease payments
    
    $
    2,302
 Previous related party agreements
   Terminated agreements
   7




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Note 3  Litigation
        8




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Original
    
    
    Amounts
    
    
    
    
    
    
    Balance at
    
    
    Amounts
    
    
    
    
    
    
    
    
    
    
    Interest
    
    
    Balance atCharge
    
    
    Paid
    
    
    Reclassifications
    
    
    December 31, 2006
    
    
    Paid
    
    
    Adjustments
    
    
    Reclassifications
    
    
    Expense
    
    
    June 30, 2007California
Class Action Suit:Expense for Class
    
    $
    16,740
    
    
    $
    
    
    
    $
    
    
    
    $
    16,740
    
    
    $
    
    
    
    $
    (11,133
    )
    
    $
    
    
    
    $
    93
    
    
    $
    5,700Related litigation
expenses
    
    
    21,481
    
    
    
    (9,771
    )
    
    
    
    
    
    
    11,710
    
    
    
    (392
    )
    
    
    (683
    )
    
    
    
    
    
    
    90
    
    
    
    10,725Dining credits
reserve
    
    
    550
    
    
    
    
    
    
    
    (550
    )
    
    
    
    
    
    
    
    
    
    
    210
    
    
    
    (210
    )
    
    
    
    
    
    
    Total
California
litigation
    
    
    38,771
    
    
    
    (9,771
    )
    
    
    (550
    )
    
    
    28,450
    
    
    
    (392
    )
    
    
    (11,606
    )
    
    
    (210
    )
    
    
    183
    
    
    
    16,425Source 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
    
    
    $
    (567
    )
    
    
    (11,631
    )
    
    $
    (210
    )
    
    $
    183
    
    
    $
    16,425


Note 4 Earnings per Share
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Net income
    
    $
    7,127
    
    
    $
    2,603
    
    
    $
    5,138
    
    
    $
    4,420Convertible debentures, net of tax
    
    
    452
    
    
    
    
    
    
    
    
    
    
    
    Net income available for common stockholders
    
    $
    7,579
    
    
    $
    2,603
    
    
    $
    5,138
    
    
    $
    4,420Weighted average number of shares of common stock and
common stock equivalents outstandingBasic
    
    
    27,018
    
    
    
    26,672
    
    
    
    26,934
    
    
    
    26,632Stock options and restricted stock
    
    
    61
    
    
    
    286
    
    
    
    130
    
    
    
    247Convertible debentures
    
    
    3,913
    
    
    
    
    
    
    
    
    
    
    
    Diluted
    
    
    30,992
    
    
    
    26,958
    
    
    
    27,064
    
    
    
    26,879Earnings per shareBasic
    
    $
    0.26
    
    
    $
    0.10
    
    
    $
    0.19
    
    
    $
    0.17Diluted
    
    $
    0.24
    
    
    $
    0.10
    
    
    $
    0.19
    
    
    $
    0.16
  9




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Note 5  Business and Credit Concentrations
  Three Months Ended June 30,
    
    
    Six Months Ended June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Airlines
    
    
    57.2
    %
    
    
    57.6
    %
    
    
    58.3
    %
    
    
    57.6
    %All partners that each represent 10% or more of sales
    
    
    41.0
    %
    
    
    47.9
    %
    
    
    41.1
    %
    
    
    47.4
    %
 Note 6  Minimum Partner and Vendor Obligations
  Note 7  Available for Sale Securities
  Note 8  Comprehensive Income
  Three Months Ended June 30,
    
    
    Six Months Ended June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Net income
    
    $
    7,127
    
    
    $
    2,603
    
    
    $
    5,138
    
    
    $
    4,420Other comprehensive (loss) income:Translation adjustment
    
    
    (54
    )
    
    
    156
    
    
    
    (57
    )
    
    
    158Total comprehensive income
    
    $
    7,073
    
    
    $
    2,759
    
    
    $
    5,081
    
    
    $
    4,578
 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 termination
of the settlement of a class action lawsuit, (xviii) the filing of class action lawsuits in other
states, (xix) increasing competition, (xx) a shift in our product mix toward Marketing Services
Program that may cause revenues to decline, (xxi) our inability
to obtain sufficient cash for our operations or to
fund the repurchase of debentures in October 2008, if necessary, and (xxii)
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 the Quarterly Report on
Form 10-Q for the period ended 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
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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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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 restaurant fails, we may not realize any value for the RCR Loan note that we purchased. Even
if an RCR Loan restaurant 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 restaurant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 upon receipt of payment from our merchants.
 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 JUNE 30, 2007 AND 2006
  Percentage of Salesfor the Three Months EndedJune 30,2007
    
    
    2006Sales
    
    
    100.0
    
    
    
    100.0Cost of sales
    
    
    49.9
    
    
    
    51.8Provision for losses
    
    
    4.5
    
    
    
    0.4Member benefits
    
    
    17.1
    
    
    
    14.0Net revenue
    
    
    28.5
    
    
    
    33.7Membership fees and other income
    
    
    0.8
    
    
    
    0.8Total operating revenue
    
    
    29.3
    
    
    
    34.6Salaries and benefits
    
    
    8.4
    
    
    
    9.1Sales commission and expenses
    
    
    9.3
    
    
    
    6.7Professional fees
    
    
    0.8
    
    
    
    0.8Member and merchant marketing expenses
    
    
    3.7
    
    
    
    1.6General and administrative expenses
    
    
    8.1
    
    
    
    8.1Litigation and related expenses
    
    
    (20.5
    )
    
    
    1.7Total operating expenses
    
    
    9.9
    
    
    
    27.9Operating income
    
    
    19.4
    
    
    
    6.6Other expense, net
    
    
    0.1
    
    
    
    0.0Income before income tax provision
    
    
    19.3
    
    
    
    6.6Income tax provision
    
    
    6.7
    
    
    
    2.7Net income
    
    
    12.5
    
    
    
    3.9
  16




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##### Table of Contents



Operating Revenues
  For the Three Months Ended June 30,2007
    
    
    2006Marketing
    
    
    Marketing
    
    
    
    
    
    
    Marketing
    
    
    MarketingCredits
    
    
    Services
    
    
    
    
    
    
    Credits
    
    
    ServicesProgram
    
    
    Program
    
    
    Total
    
    
    Program
    
    
    Program
    
    
    TotalMerchant count as of June
30, 2007 and 2006, respectively
    
    
    5,928
    
    
    
    2,745
    
    
    
    8,673
    
    
    
    6,834
    
    
    
    2,307
    
    
    
    9,141Number of qualified transactions
    
    
    1,430
    
    
    
    740
    
    
    
    2,170
    
    
    
    1,817
    
    
    
    658
    
    
    
    2,475Average transaction amount
    
    $
    48.16
    
    
    $
    48.84
    
    
    $
    48.39
    
    
    $
    48.10
    
    
    $
    49.58
    
    
    $
    48.50Qualified transaction amount
    
    $
    68,872
    
    
    $
    36,138
    
    
    $
    105,010
    
    
    $
    87,406
    
    
    $
    32,624
    
    
    $
    120,030Sales yield
    
    
    73.4
    %
    
    
    17.3
    %
    
    
    54.1
    %
    
    
    69.8
    %
    
    
    16.4
    %
    
    
    55.3
    %Sales
    
    $
    50,580
    
    
    $
    6,242
    
    
    $
    56,822
    
    
    $
    61,002
    
    
    $
    5,354
    
    
    $
    66,356Cost of dining credits
    
    $
    28,077
    
    
    
    
    
    
    $
    28,077
    
    
    $
    34,025
    
    
    
    
    
    
    $
    34,025Processing fee
    
    
    193
    
    
    
    81
    
    
    
    274
    
    
    
    338
    
    
    
    37
    
    
    
    375Total cost of sales
    
    $
    28,270
    
    
    $
    81
    
    
    $
    28,351
    
    
    $
    34,363
    
    
    $
    37
    
    
    $
    34,400Provision for losses
    
    $
    2,574
    
    
    
    
    
    
    $
    2,574
    
    
    $
    250
    
    
    
    
    
    
    $
    250Member benefits
    
    
    4,995
    
    
    
    2,368
    
    
    
    7,363
    
    
    
    5,353
    
    
    
    1,803
    
    
    
    7,156Bonus rewards
    
    
    633
    
    
    
    332
    
    
    
    965
    
    
    
    632
    
    
    
    234
    
    
    
    866Partner Commissions
    
    
    961
    
    
    
    428
    
    
    
    1,389
    
    
    
    974
    
    
    
    315
    
    
    
    1,289Total member
benefits
    
    
    6,589
    
    
    
    3,128
    
    
    
    9,717
    
    
    
    6,959
    
    
    
    2,352
    
    
    
    9,311Net revenue
    
    $
    13,147
    
    
    $
    3,033
    
    
    $
    16,180
    
    
    $
    19,430
    
    
    $
    2,965
    
    
    $
    22,395
     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 SIX MONTHS ENDED JUNE 30, 2007 AND 2006
  Percentage of Salesfor the Six Months EndedJune 30,2007
    
    
    2006Sales
    
    
    100.0
    
    
    
    100.0Cost of sales
    
    
    49.9
    
    
    
    52.0Provision for losses
    
    
    4.4
    
    
    
    0.5Member benefits
    
    
    17.5
    
    
    
    13.7Net revenue
    
    
    28.2
    
    
    
    33.7Membership fees and other income
    
    
    0.8
    
    
    
    0.8Total operating revenue
    
    
    29.0
    
    
    
    34.6Salaries and benefits
    
    
    9.4
    
    
    
    8.9Sales commission and expenses
    
    
    9.5
    
    
    
    7.0Professional fees
    
    
    1.2
    
    
    
    1.0Member and merchant marketing expenses
    
    
    3.4
    
    
    
    1.8General and administrative expenses
    
    
    8.6
    
    
    
    7.4Litigation and related expenses
    
    
    (10.6
    )
    
    
    2.8Total operating expenses
    
    
    21.5
    
    
    
    28.9Operating income
    
    
    7.6
    
    
    
    5.6Other expense, net
    
    
    0.1
    
    
    
    0.2Income before income tax provision
    
    
    7.5
    
    
    
    5.4Income tax provision
    
    
    2.8
    
    
    
    2.1Net income
    
    
    4.7
    
    
    
    3.3
  21




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##### Table of Contents



Operating Revenues
  For the Six Months Ended June 30,2007
    
    
    2006Marketing
    
    
    Marketing
    
    
    
    
    
    
    Marketing
    
    
    MarketingCredits
    
    
    Services
    
    
    
    
    
    
    Credits
    
    
    ServicesProgram
    
    
    Program
    
    
    Total
    
    
    Program
    
    
    Program
    
    
    TotalMerchant count
    
    
    5,928
    
    
    
    2,745
    
    
    
    8,673
    
    
    
    6,834
    
    
    
    2,307
    
    
    
    9,141Number of qualified transactions
    
    
    2,831
    
    
    
    1,424
    
    
    
    4,255
    
    
    
    3,717
    
    
    
    1,294
    
    
    
    5,011Average transaction amount
    
    $
    47.70
    
    
    $
    48.80
    
    
    $
    48.07
    
    
    $
    47.81
    
    
    $
    48.80
    
    
    $
    48.06Qualified transaction amount
    
    $
    135,047
    
    
    $
    69,493
    
    
    $
    204,540
    
    
    $
    177,705
    
    
    $
    63,143
    
    
    $
    240,848Sales yield
    
    
    72.4
    %
    
    
    17.3
    %
    
    
    53.7
    %
    
    
    69.5
    %
    
    
    16.5
    %
    
    
    55.6
    %Sales
    
    $
    97,714
    
    
    $
    12,024
    
    
    $
    109,738
    
    
    $
    123,565
    
    
    $
    10,393
    
    
    $
    133,958Cost of dining credits
    
    $
    54,266
    
    
    
    
    
    
    $
    54,266
    
    
    $
    68,989
    
    
    
    
    
    
    $
    68,989Processing fee
    
    
    361
    
    
    
    160
    
    
    
    521
    
    
    
    574
    
    
    
    123
    
    
    
    697Total cost of sales
    
    $
    54,627
    
    
    $
    160
    
    
    $
    54,787
    
    
    $
    69,563
    
    
    $
    123
    
    
    $
    69,686Provision for dining
credits losses
    
    $
    4,849
    
    
    
    
    
    
    $
    4,849
    
    
    $
    697
    
    
    
    
    
    
    $
    697Member benefits
    
    
    9,602
    
    
    
    4,641
    
    
    
    14,243
    
    
    
    10,668
    
    
    
    3,533
    
    
    
    14,201Bonus rewards
    
    
    1,547
    
    
    
    792
    
    
    
    2,339
    
    
    
    1,218
    
    
    
    433
    
    
    
    1,651Partner Commissions
    
    
    1,798
    
    
    
    785
    
    
    
    2,583
    
    
    
    1,938
    
    
    
    609
    
    
    
    2,547Total member
benefits
    
    
    12,947
    
    
    
    6,218
    
    
    
    19,165
    
    
    
    13,824
    
    
    
    4,575
    
    
    
    18,399Net revenue
    
    $
    25,291
    
    
    $
    5,646
    
    
    $
    30,937
    
    
    $
    39,481
    
    
    $
    5,695
    
    
    $
    45,176
      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 PeriodRemaining 2Contractual Obligations and Commitments
    
    Total
    
    
    Quarters of 2007
    
    
    2008
    
    
    2009 and afterConvertible subordinated debentures (including interest)
    
    $
    73,413
    
    
    $
    1,138
    
    
    $
    72,275
    
    
    $
    Vendor contracts
    
    
    15,743
    
    
    
    7,473
    
    
    
    8,270
    
    
    
    California class action litigation settlement and related expenses
    
    
    16,920
    
    
    
    9,218
    
    
    
    3,601
    
    
    
    4,101Operating leases
    
    
    6,084
    
    
    
    838
    
    
    
    1,624
    
    
    
    3,622Total
    
    $
    112,160
    
    
    $
    18,667
    
    
    $
    85,770
    
    
    $
    7,723
 Revolving Credit Facility
  Dining Credits
   25




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##### Table of Contents



Off Balance Sheet Arrangements
  Litigation
  RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
   
 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.
  26




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##### Table of Contents



PART IIOTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 1A. Risk Factors
 We may not have cash available or be able to raise sufficient cash to repurchase our 3.25%
Convertible Subordinated Debentures in October 2008, if necessary.
  
 Item 4. Submission of Matters to a Vote of Security Holders
       Donald J. Liebentritt
 For
    
    
    21,343Withheld/Against
    
    
    1,092Exceptions/Abstain
    
    
    Total shares voted
    
    
    22,435Broker no vote
    
    
    4,384Total shares eligible to vote
    
    
    26,819
 Adam M. Aron
 For
    
    
    21,340Withheld/Against
    
    
    1,095Exceptions/Abstain
    
    
    Total shares voted
    
    
    22,435Broker no vote
    
    
    4,384Total shares eligible to vote
    
    
    26,819
 Ronald L. Blake
 For
    
    
    21,335Withheld/Against
    
    
    1,100Exceptions/Abstain
    
    
    Total shares voted
    
    
    22,435Broker no vote
    
    
    4,384Total shares eligible to vote
    
    
    26,819
  27




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##### Table of Contents



Karen Bremer
 For
    
    
    21,344Withheld/Against
    
    
    1,091Exceptions/Abstain
    
    
    Total shares voted
    
    
    22,435Broker no vote
    
    
    4,384Total shares eligible to vote
    
    
    26,819
 Peter C.B. Bynoe
 For
    
    
    21,340Withheld/Against
    
    
    1,095Exceptions/Abstain
    
    
    Total shares voted
    
    
    22,435Broker no vote
    
    
    4,384Total shares eligible to vote
    
    
    26,819
 Raymond A. Gross
 For
    
    
    20,813Withheld/Against
    
    
    1,622Exceptions/Abstain
    
    
    Total shares voted
    
    
    22,435Broker no vote
    
    
    4,384Total shares eligible to vote
    
    
    26,819
 F. Philip Handy
 For
    
    
    21,276Withheld/Against
    
    
    1,159Exceptions/Abstain
    
    
    Total shares voted
    
    
    22,435Broker no vote
    
    
    4,384Total shares eligible to vote
    
    
    26,819
 Nils E. Larsen
 For
    
    
    21,338Withheld/Against
    
    
    1,097Exceptions/Abstain
    
    
    Total shares voted
    
    
    22,435Broker no vote
    
    
    4,384Total shares eligible to vote
    
    
    26,819
 Harold I. Shain
 For
    
    
    21,301Withheld/Against
    
    
    1,134Exceptions/Abstain
    
    
    Total shares voted
    
    
    22,435Broker no vote
    
    
    4,384Total shares eligible to vote
    
    
    26,819
 John A. Ward, III
 For
    
    
    19,049Withheld/Against
    
    
    3,386Exceptions/Abstain
    
    
    Total shares voted
    
    
    22,435Broker no vote
    
    
    4,384Total shares eligible to vote
    
    
    26,819
  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, 2003.31.1*
    
    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.August 8, 2007
    /s/    Christopher J. LockeChristopher J. LockeSenior 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, 2003.31.1*
    
    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