| REWARDS NETWORK INC Item 1A Risk Factors 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 statements in this Annual Report on Form 10-K include, but are not limited to, the risk factors set forth below |
| If the events discussed in these risk factors occur, our business, financial condition, results of operations or cash flows could be adversely affected in a material way and the market value of our common stock could decline |
| A significant number of our active member accounts are obtained from our relationships with airlines and other program partners |
| We depend on our relationships with airline and other program partners for a significant number of members and a significant portion of our revenue |
| We are particularly dependent on our relationships with airline partners |
| For the year ended December 31, 2005, approximately 57prca of our sales were derived from members enrolled in our programs through airline frequent flyer programs |
| As of December 31, 2005, we had contracts or relationships with nine major airlines and approximately 2dtta0 million of our approximately 3dtta4 million active member accounts were enrolled through airline frequent flyer programs |
| In addition, member accounts enrolled through three of our program partners jointly accounted for approximately 54prca of our active member accounts and approximately 46prca of our sales for the year ended December 31, 2005 |
| (“United Airlines”) and Delta Air Lines, Inc |
| (“Delta Airlines”) programs separately accounted for approximately 19prca, 16prca and 11prca, respectively, of our sales for the year ended December 31, 2005 |
| If our contracts or relationships with airline and other program partners terminate, we will likely lose those member accounts that are enrolled in our programs through these program partners |
| We cannot assure you that any of our contracts with our program partners will be renewed or, if renewed, will be renewed on terms as favorable to us as the current terms |
| Moreover, we cannot assure you that relationships with our program partners with which we do not have contracts will continue or will continue on terms as favorable to us as the current terms |
| If our program partner contracts are terminated, are not renewed or are renewed on less favorable terms, for example if our program partner raises the price for us to purchase benefits currency, or if our program partner relationships are terminated or altered in ways unfavorable to us, the number of members in our programs could significantly decline |
| In addition, some of our relationships with loyalty program partners depend upon the use of bank affinity payment cards that are associated with our loyalty program partners |
| If the relationship between a loyalty program partner and its payment card issuer terminates, we may lose access to the member accounts enrolled through that payment card program |
| We have relationships with various organizations for the marketing, support and endorsement of our services and products |
| For example, we rely on our agreements with banks, payment card issuers, corporations, airline frequent flyer programs, member savings and loyalty programs and other entities across the country to market our services to their existing and future customers |
| However, we need to expand these relationships and 8 ______________________________________________________________________ enter into new relationships |
| The development and management of these relationships (including keeping our web site content attractive) is a long and difficult process, requiring experienced sales and marketing personnel and may not be successful |
| A significant amount of our benefits currency is concentrated in one industry group |
| A significant portion of the benefits currency we provide members consists of airline miles |
| Although airline miles are currently considered to be an attractive benefits currency, there is no assurance that airline miles benefits will continue to be viewed favorably by consumers and members |
| The terms of frequent flyer programs are subject to change at the discretion of the airlines, and changes to these programs may make frequent flyer miles a less attractive benefits currency |
| For example, if the airlines increase the number of miles required to earn travel rewards, reduce the number of seats available for reward travel or otherwise limit the availability of redemption options, the attractiveness of airline miles will diminish and may result in reduced membership in our programs and in reduced usage of our programs |
| Furthermore, a sustained economic downturn in the airline industry could have an adverse effect on the financial condition of our business because there is no assurance that we can convert members who choose frequent flyer miles over our other benefits currencies to other forms of benefits currencies should the airlines no longer be able to participate |
| Following September 11, 2001, the airline industry suffered a significant decline in passenger traffic and profitability, including several airlines with which we have program relationships, and events in the future may again cause a decline in passenger traffic and profitability |
| Although Delta Airlines and Northwest Airlines have continued to honor their outstanding frequent flyer miles after filing for bankruptcy protection, there is no assurance that they or any other airline will continue to offer frequent flyer programs or to sell frequent flyer miles to third parties such as us |
| The continued impact of the economic downturn of the airline industry on our airline partners may result in the diminished attractiveness of airline miles as a currency that we offer to members and, thus, reduce the usage of our programs |
| We have minimum program partner purchase obligations and other performance requirements |
| We have agreements with various program partners that obligate us, among other things, to purchase a minimum amount of benefits currency in a given period |
| If member activity is not sufficient to fulfill our minimum currency purchase obligation with a program partner, we will be required to purchase additional currency from that program partner that we may not be able to utilize, or we may be required to make a payment to the program partner |
| We have agreements with various program partners that include minimum levels of marketing activity |
| Minimum marketing requirements may obligate us to incur marketing expenses that we otherwise would not incur |
| If we do not meet minimum benefits currency purchase obligations and other performance requirements in the normal course of our business, we will incur expenses that we otherwise would not incur |
| We depend on our ability to attract and retain restaurants |
| Our business requires significant marketing and sales efforts to restaurants |
| Partially due to the high rate of restaurant failures, we are always at risk for decreases in the number of participating restaurants |
| Because of this, we constantly need to recruit new restaurants to participate in our programs |
| Moreover, we need to continually demonstrate to our participating and prospective restaurants the value of our programs in order to retain them in our programs |
| Achieving these goals requires us to improve our product offerings to existing and potential restaurants and to improve the effectiveness of our sales force |
| We have invested in the training of our sales force in an effort to increase its effectiveness |
| If the sales approach that is the subject of this training prove ineffective, or if our sales force does not effectively adopt this sales approach, we may not experience an increase in sales effectiveness |
| In 2004 and early 2005, we changed the pricing structure of our product offerings, which resulted in a decline in deal profitability |
| We are now working on improving the profitability of restaurant deals, and if 9 ______________________________________________________________________ restaurants do not accept our new pricing for our products, we may not attract new participating restaurants or retain existing participating restaurants |
| We are also implementing more conservative dining credits purchasing policies in an attempt to decrease the time it takes for members to use the dining credits we purchase from restaurants |
| In addition, we augmented our due diligence process and began developing and implementing new credit evaluation tools in an effort to better assess the financial risk of proposed deals and the credit profile of our restaurants |
| We cannot assure you that these initiatives will be successful in reducing the financial risk profile of our restaurants and these initiatives may make it more difficult for us to attract new participating merchants or retain existing participating restaurants |
| An absence of desirable merchants could cause members to either become less engaged or cancel their memberships with us or cause affiliates and loyalty program partners to choose not to participate in our programs |
| This would reduce our revenues and profitability and harm our ability to attract new members and participating merchants |
| We depend on our ability to attract and retain active members |
| We must increase the frequency with which members patronize participating merchants |
| Any number of factors could affect the frequency with which members participate in our programs or whether consumers enroll in any of our programs at all |
| These factors include (1) consumer tastes and preferences, (2) the frequency with which consumers dine out, (3) the number of desirable merchants participating, (4) general economic conditions, and (5) the availability of alternative discount programs in the local regions where consumers live and work |
| Any significant decline in usage or increase in membership cancellations, without a corresponding increase in new member enrollments, could make our programs less desirable to participating or prospective restaurants, would adversely affect our revenue and could have a material adverse effect on our business, financial condition and results of operations |
| Any decline in member usage of dining credits would cause a decline in revenue and a higher cost of our dining credits inventory |
| During an initial annual membership term or a renewal term, members who pay a fee may cancel their memberships in the program, generally for a pro rata refund of the membership fees for that period |
| Accordingly, our profitability depends, in part, on recurring and sustained fee membership renewals |
| Changes in our programs that affect the rate of rewards received by members could have adverse consequences |
| We have implemented a tiered member benefit program with substantially all of our loyalty partner programs that is designed to align member benefits with member activity |
| If members react to these changes by reducing the frequency of transactions with our participating merchants, our sales could decrease and members could use our dining credits more slowly |
| In addition, the rate of our new member activation could suffer if potential members perceive our tiered benefit program as offering fewer benefits |
| We must maintain an appropriate balance between the number of members and the number of participating restaurants in each market |
| A critical success factor for our business is our ability to maintain an appropriate balance of members to participating restaurants within each geographic market we serve |
| If we have too many members and too few participating restaurants, our member base may become dissatisfied and/or participating restaurants may experience a higher volume of business from members than anticipated |
| This could result in low program usage, high membership cancellations and participating restaurant attrition |
| Alternatively, if too many restaurants participate in our programs with too few members, dining credits usage will be reduced, resulting in reduced revenue |
| Managing this balance may be difficult where a particular loyalty partner program has a concentration of members in a single geographic market |
| We cannot assure you that we will be able to manage this balance effectively in each of our markets |
| 10 ______________________________________________________________________ We are subject to changes to payment card association rules and practices |
| Our business model depends on our ability to obtain information with respect to payment card transactions made by members at our participating restaurants |
| Current VISA and MasterCard rules and practices permit the aggregation of data for payment card transactions at our participating restaurants and the comparison of this data with a file containing members’ registered card information |
| However, there is no assurance that payment card association rules and practices will not change and limit our ability to obtain this information |
| We depend upon our relationships with payment card issuers, transaction processors, presenters and aggregators |
| Payment card transaction processing is an integral part of our business, and our relationships with payment card issuers, payment card processors, transaction presenters and aggregators of payment card transactions are very important |
| We obtained transaction data for approximately 22prca of our sales for the year ended December 31, 2005, through our relationship with First Data Merchant Services Corporation |
| On September 19, 2005, we entered into an agreement with American Express Travel Related Services Company, Inc |
| (“American Express”) to obtain American Express card transaction data directly from American Express |
| We obtain transaction data for approximately 15prca of our sales from American Express |
| We currently have contracts with a significant number of other processors, presenters and aggregators of payment card transactions |
| If these relationships terminate and we are unable to find suitable replacements, our ability to receive and process restaurants transactions could be impaired, which would adversely affect our ability to pay member benefits and recognize revenues |
| Network interruptions, processing interruptions or processing errors could occur |
| We depend on the functionality of transaction processing networks |
| Network interruptions and processing errors may result from various causes, including disruptions to telecommunications services or the electricity supply |
| Such disruptions may be caused by human error |
| There is also the potential threat of telecommunications and electrical disruptions caused by natural disasters, acts of terrorism or the malicious acts of computer criminals, who may attempt to compromise specific systems or generally propagate malicious software, such as viruses and worms |
| Any extensive or long-term disruptions affecting transaction processors could cause us to incur substantial additional expense |
| We are susceptible to a changing regulatory environment |
| We are subject to a number of current and pending federal and state laws and regulations governing privacy and the use and storage of financial data and personally identifiable information |
| Changes to existing laws and regulations or the promulgation of new laws and regulations could increase our operating costs, change our competitive environment or otherwise adversely affect us |
| Privacy concerns of our program partners, payment card processors and the public may result in increased operating costs |
| Privacy concerns make it more difficult for us to obtain and retain program partners |
| Our program partners may be subject to public pressure not to divulge information regarding their members to us |
| Our program partners may also adopt more stringent policies regarding the use and disclosure of financial data than their existing policies and practices |
| Our operating costs will increase if we are required to implement new systems and processes to comply with changes to our program partners’ privacy policies and practices or to address privacy concerns of our payment card processors and the public |
| Our security measures may not be successful |
| We have developed and implemented a number of measures in an effort to keep our member and participating merchant data secure |
| We continually work on enhancing and improving our security measures |
| 11 ______________________________________________________________________ These measures may be expensive and involve hiring additional personnel or suppliers and consultants |
| The complete or partial failure of our security measures could result in damage to our reputation, the loss of members and participating merchants, incurring costs related to notification requirements and the filing of claims and lawsuits against us |
| We typically purchase dining credits from restaurants that participate in our Marketing Credits Program |
| These dining credits are used by members when they patronize participating restaurants |
| However, members may not be able to use any or all of the amount of the outstanding dining credits that we have purchased from that restaurant due to restaurant failure or other breach by the restaurant of our agreement with the restaurant |
| Although we perform due diligence on certain transactions and we generally secure dining credits by obtaining personal guarantees from restaurant owners and security interests in available assets, we cannot assure you that these measures will be adequate to enforce our agreement with the restaurant |
| Economic changes could hurt our business |
| The success of our business depends on members’ use at participating merchants of payment cards registered with us |
| If the national or local economy slows in the regions in which we do business, members may perceive that they have less disposable income to permit them to dine out |
| Any decline in program usage would hurt our business |
| In addition, a sustained economic downturn could cause participating restaurants to go out of business or cause members to dine out less frequently |
| It is likely that, if the number of restaurants entering bankruptcy rises, the amount of dining credits that members are unable to use would also rise |
| Alternatively, if the economy is robust and consumers have more disposable income to spend, merchants may be less inclined to participate in our programs |
| Any decline in the quality, attractiveness or number of participating merchants could hurt our business |
| Our allowance for doubtful dining credits accounts is an estimate and may prove inadequate to absorb actual losses |
| We maintain an allowance for doubtful dining credits accounts |
| We perform a quarterly analysis of the adequacy of our balance sheet allowance and, if necessary, adjust this allowance |
| This analysis is based on a number of factors, including the specific identification of at-risk dining credits, the aging of the dining credits and the overall size of the portfolio |
| The amount of our allowance, however, is an estimate, and we cannot assure you that our actual dining credits losses will not be materially greater than our allowance for doubtful dining credits accounts |
| We could lose key personnel |
| Our success depends, in part, on the skills, experience, efforts and policies of key personnel, including our President and Chief Executive Officer |
| We cannot assure you that we will continue to retain such personnel |
| We are a defendant in lawsuits that, if adversely determined, could result in significant monetary damages and expenses to us and/or restrictions on how we conduct our business |
| Our annual reports on Form 10-K and our quarterly reports on Form 10-Q describe matters in which we are a defendant |
| In addition, from time to time, we become involved in various litigation matters that arise in the ordinary course of business |
| These matters could result in significant monetary damages and expenses to us and/or restrictions on how we conduct our business |
| 12 ______________________________________________________________________ We face significant competition |
| We compete for both members and participating merchants, and we experience competition with respect to different aspects of our business |
| Some of our competitors provide loyalty programs, and others provide merchant financing |
| Although we believe that none of our competitors provides the suite of services that we offer and that none of our competitors operates in all of the markets in which we operate, new competitors could enter our business |
| Our competitors include major payment card companies that offer discount and rewards programs using a registered card platform, various loyalty program providers and companies that offer marketing services and marketing programs to merchants |
| There are numerous small companies that offer services that may compete with the services currently offered or to be offered in the future by us |
| We also compete with various finance companies to address the liquidity needs of restaurants |
| Certain of our competitors or potential competitors have substantially greater financial resources and expend considerably larger sums than we do for new product development and marketing |
| Further, we must compete with many larger and better-established companies for the hiring and retention of qualified sales and marketing personnel |
| If we are unable to obtain sufficient cash, our business, financial condition and results of operations may be adversely affected |
| Our business is cash intensive |
| We typically purchase dining credits from participating restaurants in exchange for cash |
| As of December 31, 2005, our cash and cash equivalents and short-term investments were dlra31dtta6 million, we have dlra25 million of borrowing availability under our revolving credit facility, subject to compliance with conditions in the credit facility agreement that we may not be in compliance with at the time of borrowing, and we had dlra121dtta0 million of dining credits, net of our allowance for doubtful dining credits accounts |
| We cannot assure you that we will be able to raise cash in the future on acceptable terms or at all |
| If we raise funds through the sale of equity or convertible debt securities, the value of our outstanding stock likely will be reduced |
| The expansion of our program into Canada may not be successful |
| The expansion of our program into Canada has required and will require us to make investments of management time and infrastructure, as well as funds |
| Prior to our expansion into Canada, we had no direct experience in markets outside the United States |
| We cannot assure you that we will be successful in having our program accepted by Canadian restaurants and members |
| There are Canadian laws and regulations that differ materially from the laws and regulations of the United States and, as a result, we are subject to restrictions on the conduct of our business in Canada that we are not subject to in the United States |
| Conducting business in Canada requires us to enter into new relationships with Canadian payment card processors, whose guidelines may now or in the future place restrictions on the manner in which we conduct business in Canada |
| We face competitors in Canada who have already established a network of merchants and a base of Canadian members |
| We cannot assure you that our expansion into Canada will be successful |
| We are controlled by Samstock, LLC and its affiliates |
| As of March 1, 2006, our largest stockholder, Samstock, LLC and its affiliates, beneficially owned in aggregate 6cmam589cmam026 shares of our common stock, representing approximately 25prca (based on 26cmam463cmam564 shares of common stock outstanding at March 1, 2006) of our outstanding common stock (assuming the exercise of all exercisable stock options and warrants and issuance of all vested stock awards) |
| Of this amount, 6cmam056cmam446 shares were owned by Samstock and its affiliates and 532cmam580 shares were held by others but were subject to voting and disposition restrictions in favor of Samstock |
| As a result of their ownership, Samstock and its affiliates may be able to substantially influence the outcome of all matters submitted to a vote of our stockholders, including the 13 ______________________________________________________________________ election of directors |
| Samstock is ultimately owned by certain trusts and the trustee of these trusts is Chai Trust Company, LLC The current chairman of our board of directors, Donald J Liebentritt, is the president of Chai Trust Company, LLC Our board of directors may issue our authorized preferred stock without stockholder approval |
| Our certificate of incorporation authorizes the issuance of up to 10cmam000cmam000 shares of preferred stock with rights and preferences that may be determined from time to time by our board of directors |
| Accordingly, our board of directors may, without stockholder approval, issue one or more series of preferred stock with rights which could adversely affect the voting power or other rights of the holders of outstanding shares of preferred stock or common stock |
| Although we do not have any current plans to issue any series or shares of preferred stock, we may do so in the future |
| The future sales of restricted and other shares may cause dilution to each stockholder’s percentage ownership interest and could cause our stock price to decline |
| Sales of a substantial amount of stock in the public market (such as the shares previously registered by us), or the perception that these sales may occur, could result in lower market prices of our common stock |
| This could also impair our ability to raise additional capital through the sale of other securities |
| As of March 1, 2006, 26cmam463cmam564 shares of our common stock were outstanding |
| In addition, as of March 1, 2006, 1cmam124cmam250 shares of our common stock were issuable upon exercise of outstanding employee and director stock options; 228cmam410 shares of our common stock were issuable upon the exercise of outstanding director stock awards; 480cmam580 shares of our common stock were issuable upon the exercise of employee stock awards and an additional 514cmam660 shares of our common stock were available under our incentive stock option plans for future grant |
| The issuance and sale of a significant number of shares of our common stock upon the exercise of stock options and warrants, or the sale of a substantial number of shares of our common stock pursuant to Rule 144 or otherwise, could result in a dilution to each stockholder’s percentage ownership and could adversely affect the market prices of our securities |
| The price of our common stock could be volatile |
| The market prices of our securities have been volatile and could continue to be subject to significant fluctuations in response to the factors set forth above and other factors, many of which are beyond our control |
| Such fluctuations, as well as economic conditions generally, may adversely affect the market price of our securities |
| In addition, the stock market in recent years has experienced extreme price and trading volume fluctuations that often have been unrelated or disproportionate to the operating performance of individual companies |
| These fluctuations may adversely affect the price of our securities regardless of operating performance |
| Delaware corporate law, our certificate of incorporation and our by-laws contain anti-takeover provisions that could delay or prevent a change of control even if the change of control would be beneficial to our stockholders |
| Delaware law, our certificate of incorporation and our by-laws contain anti-takeover provisions that could delay or prevent a change of control of the Company, even if a change of control would be beneficial to our stockholders |
| These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock |
| These provisions: • authorize the issuance of preferred stock that can be created and issued by our board of directors without prior stockholder approval to increase the number of outstanding shares and deter or prevent a takeover attempt; • prohibit common stockholder action by written consent, thereby requiring all common stockholder actions to be taken at a meeting of our common stockholders; 14 ______________________________________________________________________ • prohibit cumulative voting in the election of directors, which would otherwise enable less than a majority of stockholders to elect director candidates; • limit the ability of stockholders to call special meetings of stockholders; and • establish advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings |
| In addition, Section 203 of the Delaware General Corporation Law, our certificate of incorporation and the terms of our 2004 Long-Term Incentive Plan may discourage, delay or prevent a change of control of our company |
| Specifically, Section 203 and our certificate of incorporation prohibit us from engaging in any business combination with an interested stockholder unless specific conditions are met |
| Also, our 2004 Long-Term Incentive Plan includes provisions that allow us to grant options, stock appreciation rights and other stock-based awards that will become vested immediately upon a change of control of the Company |