REWARDS NETWORK INC - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

x	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2004

¨	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.)

2 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)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). x Yes ¨ No

As of May 3, 2004, there were 24,468,916 shares of the registrant’s common stock, par value $.02 per share, outstanding.

I N D E X

REWARDS NETWORK INC. AND SUBSIDIARIES


		PAGE NO.
PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements:

	Consolidated Balance Sheets — March 31, 2004 (unaudited) and December 31, 2003	3

	Unaudited Consolidated Statements of Income — Three months ended March 31, 2004 and 2003	4

	Unaudited Consolidated Statements of Cash Flows — Three months ended March 31, 2004 and 2003	5

	Notes to Unaudited Consolidated Financial Statements	6-11

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12-23

Item 3.	Quantitative and Qualitative Disclosure About Market Risk	23

Item 4.	Controls and Procedures	23

PART II.	OTHER INFORMATION

Item 6.	Exhibits and Reports on Form 8-K	24-26

SIGNATURE		27

REWARDS NETWORK INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(in thousands, except per share data)


	March 31, 2004 (unaudited)			December31, 2003*
Assets
Current assets:
Cash and cash equivalents	$	15,666		$	9,709
Short-term investments		2,693			10,291
Accounts receivable, net of allowance for doubtful accounts of $2,450 and $2,502, respectively		6,030			6,268
Rights to Receive, net of allowance for doubtful merchant accounts of $20,260 and $19,253, respectively		120,129			119,233
Deferred income taxes		6,909			6,901
Prepaid expenses and other current assets		1,272			2,339

Total current assets		152,699			154,741
Property and equipment, net		9,064			9,254
Other assets		2,503			2,745
Investments		12,593			8,395
Deferred income taxes		886			894
Excess of cost over net assets acquired		9,671			9,671

Total assets	$	187,416		$	185,700

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable – Rights to Receive		13,629			15,197
Accounts payable – trade		16,064			16,458
Accrued compensation and other current liabilities		6,103			6,122
Deferred membership fee income		1,829			2,101

Total current liabilities		37,625			39,878
Convertible subordinated debentures		70,000			70,000
Deferred income taxes		2,024			2,024
Other long-term liabilities		119			151

Total liabilities		109,768			112,053

Stockholders’ equity :
Common stock, par value $0.02 per share; authorized 70,000 shares; issued 24,600 and 24,473 shares, respectively; and outstanding 24,318 and 24,191 shares, respectively		492			489
Additional paid-in capital		54,803			54,172
Cumulative other comprehensive income		41			11
Retained earnings		24,522			21,185
Treasury stock, at cost (282 shares)		(2,210	)		(2,210	)

Total stockholders’ equity		77,648			73,647

Total liabilities and stockholders’ equity	$	187,416		$	185,700

See accompanying notes to unaudited consolidated financial statements.

*	The balance sheet at December 31, 2003 is derived from the registrant’s audited consolidated financial statements.

REWARDS NETWORK INC. AND SUBSIDIARIES

Consolidated Statements of Income

(in thousands, except earnings per share)


	Three months ended March 31,
	2004			2003
	(unaudited)
Operating revenue:
Sales	$	88,649		$	82,595
Cost of sales		45,638			44,237
Member rewards and savings		17,917			16,867

Net revenue		25,094			21,491
Membership and renewal fee income		941			1,346
Other operating revenue		7			41

Total operating revenues		26,042			22,878

Operating expenses:
Salaries and benefits		5,660			3,823
Sales commissions and expenses		5,342			4,913
Member and merchant marketing		2,527			1,625
Printing and postage		1,149			1,777
General and administrative		4,962			4,871

Total operating expenses		19,640			17,009

Operating income		6,402			5,869
Other income (expense):
Interest and other income		139			33
Interest expense and financing cost		(932	)		(439	)

Income before income tax provision		5,609			5,463
Income tax provision		2,272			2,074

Net income	$	3,337		$	3,389

Net earnings per share of common stock:
Basic	$	0.14		$	0.16

Diluted	$	0.13		$	0.14

Weighted average number of common and common equivalent shares outstanding:
Basic		24,179			21,597

Diluted		25,859			23,884

See accompanying notes to unaudited consolidated financial statements.

REWARDS NETWORK INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(in thousands)


	Three months ended March 31,
	2004			2003
	(unaudited)
Cash flows from operating activities:
Net income	$	3,337		$	3,389
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		1,108			1,099
Amortization of deferred financing cost		254			63
Deferred income taxes		—			2,074
Provision for losses on Rights to Receive		3,243			4,215

Changes in assets and liabilities:
Accounts receivable		238			(1,001	)
Rights to Receive		(5,707	)		(4,166	)
Prepaid expenses and other current assets		1,067			(738	)
Other assets		(62	)		(12	)
Accounts payable		(394	)		1,053
Accrued compensation and other current liabilities		(19	)		(3,500	)
Deferred membership fee income		(272	)		(73	)

Net cash provided by operating activities		2,793			2,403

Cash flows from investing activities:
Additions to property and equipment		(900	)		(1,175	)
(Increase) decrease in short-term investments		7,598			(519	)
Decrease (increase) in investments		(4,168	)		140

Net cash provided by (used in) investing activities		2,530			(1,554	)

Cash flows from financing activities:
Dividends paid		—			(8	)
Conversion of warrants and options for common stock, net		634			1,259

Net cash provided by financing activities		634			1,251

Net increase in cash		5,957			2,100
Cash and cash equivalents:
Beginning of the period		9,709			8,266

End of the period	$	15,666		$	10,366

Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	109		$	317

Income taxes	$	587		$	1,001

See accompanying notes to unaudited consolidated financial statements.

REWARDS NETWORK INC. AND SUBSIDIARIES

Unaudited Notes to Consolidated Financial Statements

(1)

Basis of Presentation

These unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments that are of a normal recurring nature necessary to present fairly the consolidated financial position of Rewards Network Inc. and its subsidiaries (collectively, the “Company”) at March 31, 2004, consolidated results of operations for the three months ended March 31, 2004 and 2003 and the consolidated statements of cash flows for the three month periods ended March 31, 2004 and 2003 have been made. Operating results for the three months ended March 31, 2004 are not necessarily indicative of the results to be expected for the full year. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2003 filed with the Securities and Exchange Commission (“SEC”) on March 12, 2004. The consolidated balance sheet as of December 31, 2003 was derived from the Company’s audited consolidated financial statements.

Nature of operations: The Company markets and administers loyalty rewards programs that bring its participating merchants and members together. The Company does this by offering rewards in the form of savings and benefits to its members who patronize its participating merchants, principally restaurants and hotels. The Company attracts participating restaurants by purchasing credits for food and beverages in advance and by providing yield management tools such as variable promotions, dining incentives and off-peak pricing to fill empty tables and generate incremental business. The Company attracts participating hotels by providing yield management tools to fill empty hotel rooms and generate incremental business. The Company offers rewards in the form of cash, airline frequent flyer miles and other currencies to its members who patronize its participating merchants and pay using a credit card they have registered with the Company.

Principles of consolidation: The Company’s unaudited consolidated financial statements include the accounts of Rewards Network Inc. and its subsidiaries after the elimination of all material intercompany balances and transactions.

Reclassification: Certain prior period amounts have been reclassified to conform to the current period’s presentation.

(2)

Convertible Subordinated Debentures

On October 15, 2003, the Company completed a private placement of $70 million principal amount of its 3¼% Convertible Subordinated Debentures with a final maturity date of October 15, 2023. The debentures bear interest at 3.25% per annum, payable on April 15 and October 15 of each year, commencing on April 15, 2004. The net proceeds from the offering were $67.5 million, and the issuance costs of $2.5 million are being amortized over five years. Holders of the debentures may require the Company to repurchase for cash all or part of their

REWARDS NETWORK INC. AND SUBSIDIARIES

Unaudited Notes to Consolidated Financial Statements

debentures on October 15, 2008, October 15, 2013 and October 15, 2018 or upon a change of control at a price equal to 100% of the principal amount of the debentures, together with accrued and unpaid interest. The Company may redeem the debentures, in whole or in part, at any time after October 15, 2008 at a price equal to 100% of the principal amount of the debentures, together with accrued and unpaid interest. The debentures are convertible prior to the maturity date into shares of the Company’s common stock at an initial conversion price of $17.89 per share, subject to adjustment for certain events, upon the occurrence of any of the following: (i) the closing price of the Company’s common stock on the trading day prior to the conversion date was 110% or more of the conversion price of the debentures on such trading day; (ii) the Company has called the debentures for redemption; (iii) the average of the trading prices of the debentures for any five consecutive trading day period was less than the average conversion value for the debentures during that period, subject to certain limitations; or (iv) the Company makes certain distributions to holders of the Company’s common stock or enters into specified corporate transactions.

(3)

Securitization of Rights to Receive

The Company’s revolving securitization of the food and beverage credits that the Company purchases from participating restaurants for typically 50% of the retail price for which they sell the food and beverages (“Rights to Receive”) is privately placed through asset backed commercial paper conduits. Borrowing capacity under the facility is recalculated weekly based on a formula-driven advance rate applied to the then-current balance of Rights to Receive that is eligible to be securitized. The advance rate is determined based on recent sales trends and months on hand of Rights to Receive. Outstanding borrowings under the facility at March 31, 2004 were zero. Based on the level of eligible Rights to Receive at that date, the Company had $50 million available for borrowing.

Using part of the proceeds from the private placement described in Note 2, on October 15, 2003 the Company paid down the balance on its revolving securitization to zero and reduced the facility limit to $50 million. In connection therewith, a portion of the securitization renewal fees were expensed and the balance is being amortized over the remainder of the renewal term, which ends on May 13, 2004. As of the date of this quarterly report on Form 10-Q, the Company does not plan to renew the securitization, and the Company intends to seek an alternative line of credit financing vehicle to replace the securitization.

(4)

Certain Relationships and Related Party Transactions

On May 5, 2003, the Company entered into an office lease agreement with Equity Office Properties Management Corp., the agent for Two North Riverside Plaza Joint Venture Limited Partnership, a limited partnership comprised of trusts established for the benefit of the family of Samuel Zell, the Company’s Chairman of the Board of Directors. The lease provides for up to 14,324 square feet of office space at 2 North Riverside Plaza, Chicago, Illinois. Initially the Company will only require 10,000 square feet of office space, but the Company has options to increase this space over the term of the lease by increments of 1,000 square feet or more until the entire 14,324 square feet are occupied by the Company. The term of the lease is from

REWARDS NETWORK INC. AND SUBSIDIARIES

Unaudited Notes to Consolidated Financial Statements

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