##### Table of Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

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



For the quarterly period ended September 30, 2004



or



| ̈ | 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



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REWARDS NETWORK INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|DELAWARE                                                       |  | 84-6028875                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



Two North Riverside
Plaza, Suite 950, Chicago, Illinois 60606

(Address of principal executive offices) (Zip code)



312-521-6767

(Registrants telephone number, including area code)



N/A

(Former name, former address and
former fiscal year, if changed since last report)



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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 November 5, 2004, there were
24,778,069 shares of the registrants common stock, par value $.02 per share, outstanding.



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##### Table of Contents

INDEX



REWARDS NETWORK INC. AND
SUBSIDIARIES



|           |  |                                                                                                       |  |         
|---------- |  | ----------------------------------------------------------------------------------------------------- |  | --------
|           |  |                                                                                                       |  | PAGE NO.
|PART I.    |  | FINANCIAL INFORMATION                                                                                 |  |         
|           |  |                                                                                                      
|Item 1.    |  | Financial Statements:                                                                                 |  |         
|           |  |                                                                                                      
|           |  | Consolidated Balance SheetsSeptember 30, 2004 (unaudited) and December 31, 2003                      |  | 3       
|           |  |                                                                                                      
|           |  | Consolidated Statements of IncomeThree and nine months ended September 30, 2004 and 2003 (unaudited) |  | 4       
|           |  |                                                                                                      
|           |  | Consolidated Statements of Cash FlowsNine months ended September 30, 2004 and 2003 (unaudited)       |  | 5       
|           |  |                                                                                                      
|           |  | Notes to Unaudited Condensed Consolidated Financial Statements                                        |  | 6-11    
|           |  |                                                                                                      
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                 |  | 12-25   
|           |  |                                                                                                      
|Item 3.    |  | Quantitative and Qualitative Disclosure About Market Risk                                             |  | 25      
|           |  |                                                                                                      
|Item 4.    |  | Controls and Procedures                                                                               |  | 26      
|           |  |                                                                                                      
|PART II.   |  | OTHER INFORMATION                                                                                     |  |         
|           |  |                                                                                                      
|Item 1.    |  | Legal Proceedings                                                                                     |  | 26      
|           |  |                                                                                                      
|Item 6.    |  | Exhibits                                                                                              |  | 26-28   
|           | 
|SIGNATURES |  | 29                                                                                                   



2



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##### Table of Contents

REWARDS NETWORK INC. AND SUBSIDIARIES



PART I  FINANCIAL INFORMATION

Consolidated Balance Sheets

(in thousands, except per share data)



|                                                                                                                                                                         |  |                   |         |   |                   |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ----------------- | ------- | - | ----------------- | - | ------- | -
|                                                                                                                                                                         |  | September 30,2004 |         |   | December 31,2003* |  
|                                                                                                                                                                         |  | Unaudited         |         |   |                   |  
|Assets                                                                                                                                                                   |  |                   |         |   |                   |   |         |  
|Current assets:                                                                                                                                                          |  |                   |         |   |                   |   |         |  
|                                                                                                                                                                         |  |                  
|Cash and cash equivalents                                                                                                                                                |  | $                 | 2,075   |   |                   | $ | 9,709   |  
|Short-term available for sale securities                                                                                                                                 |  |                   | 2,268   |   |                   |   | 10,291  |  
|Accounts receivable, net of allowance for doubtful accounts of $2,534 and $2,502, respectively                                                                           |  |                   | 6,546   |   |                   |   | 6,268   |  
|Rights to Receive, net of allowance for doubtful accounts of $25,370 and $19,253, respectively                                                                           |  |                   | 142,529 |   |                   |   | 119,233 |  
|Deferred income taxes                                                                                                                                                    |  |                   | 8,235   |   |                   |   | 6,901   |  
|Prepaid expenses and other current assets                                                                                                                                |  |                   | 1,386   |   |                   |   | 3,764   |  
|                                                                                                                                                                         |  |                   |         |   |                   |   |         |  
|Total current assets                                                                                                                                                     |  |                   | 163,039 |   |                   |   | 156,166 |  
|                                                                                                                                                                         |  |                  
|Property and equipment, net of accumulated depreciation of $12,047 and $9,092, respectively                                                                              |  |                   | 10,265  |   |                   |   | 9,254   |  
|Other assets                                                                                                                                                             |  |                   | 1,617   |   |                   |   | 2,745   |  
|Long-term available for sale securities                                                                                                                                  |  |                   | 9,455   |   |                   |   | 8,395   |  
|Deferred income taxes                                                                                                                                                    |  |                   | 7       |   |                   |   | 894     |  
|Excess of cost over net assets acquired                                                                                                                                  |  |                   | 9,671   |   |                   |   | 9,671   |  
|                                                                                                                                                                         |  |                   |         |   |                   |   |         |  
|Total assets                                                                                                                                                             |  | $                 | 194,054 |   |                   | $ | 187,125 |  
|                                                                                                                                                                         |  |                   |         |   |                   |   |         |  
|Liabilities and Stockholders Equity                                                                                                                                     |  |                   |         |   |                   |   |         |  
|Current liabilities:                                                                                                                                                     |  |                   |         |   |                   |   |         |  
|                                                                                                                                                                         |  |                  
|Accounts payableRights to Receive                                                                                                                                       |  | $                 | 12,501  |   |                   | $ | 15,197  |  
|Accounts payabletrade                                                                                                                                                   |  |                   | 13,764  |   |                   |   | 16,458  |  
|Accrued compensation and other current liabilities                                                                                                                       |  |                   | 7,085   |   |                   |   | 7,547   |  
|Deferred membership fee income                                                                                                                                           |  |                   | 1,608   |   |                   |   | 2,101   |  
|                                                                                                                                                                         |  |                   |         |   |                   |   |         |  
|Total current liabilities                                                                                                                                                |  |                   | 34,958  |   |                   |   | 41,303  |  
|                                                                                                                                                                         |  |                  
|Convertible subordinated debentures                                                                                                                                      |  |                   | 70,000  |   |                   |   | 70,000  |  
|Deferred income taxes                                                                                                                                                    |  |                   | 1,756   |   |                   |   | 2,024   |  
|Other long-term liabilities                                                                                                                                              |  |                   | 6       |   |                   |   | 151     |  
|                                                                                                                                                                         |  |                   |         |   |                   |   |         |  
|Total liabilities                                                                                                                                                        |  |                   | 106,720 |   |                   |   | 113,478 |  
|                                                                                                                                                                         |  |                   |         |   |                   |   |         |  
|Stockholders equity:                                                                                                                                                    |  |                   |         |   |                   |   |         |  
|                                                                                                                                                                         |  |                  
|Common stock, par value $0.02 per share; authorized 70,000 shares; issued 25,083 and 24,473 shares, respectively; and outstanding 24,801 and
24,191 shares, respectively |  |                   | 502     |   |                   |   | 489     |  
|Additional paid-in capital                                                                                                                                               |  |                   | 57,099  |   |                   |   | 54,172  |  
|Cumulative other comprehensive income                                                                                                                                    |  |                   | 19      |   |                   |   | 11      |  
|Retained earnings                                                                                                                                                        |  |                   | 31,924  |   |                   |   | 21,185  |  
|Treasury stock, at cost (282 shares)                                                                                                                                     |  |                   | (2,210  | ) |                   |   | (2,210  | )
|                                                                                                                                                                         |  |                   |         |   |                   |   |         |  
|Total stockholders equity                                                                                                                                               |  |                   | 87,334  |   |                   |   | 73,647  |  
|                                                                                                                                                                         |  |                   |         |   |                   |   |         |  
|Total liabilities and stockholders equity                                                                                                                               |  | $                 | 194,054 |   |                   | $ | 187,125 |  
|                                                                                                                                                                         |  |                   |         |   |                   |   |         |  

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



See accompanying notes to unaudited condensed consolidated financial
statements.



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REWARDS NETWORK INC. AND SUBSIDIARIES



Consolidated Statements of Income

(Unaudited)

(in thousands, except earnings per share data)



|                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|--------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                            |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                                            |  | 2004                            |        |   | 2003                           |   |        | 2004 |  |   | 2003    |  
|Operating revenues:                                                         |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|                                                                            |  |                                 |        |  
|Sales                                                                       |  | $                               | 86,818 |   |                                | $ | 89,530 |      |  | $ | 266,047 |   |  | $ | 259,794 |  
|                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Cost of sales                                                               |  |                                 | 42,291 |   |                                |   | 42,844 |      |  |   | 128,254 |   |  |   | 125,140 |  
|Provision for losses                                                        |  |                                 | 6,788  |   |                                |   | 4,468  |      |  |   | 14,576  |   |  |   | 13,143  |  
|Member rewards and savings                                                  |  |                                 | 15,518 |   |                                |   | 18,463 |      |  |   | 50,596  |   |  |   | 53,304  |  
|                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total direct expenses                                                       |  |                                 | 64,597 |   |                                |   | 65,775 |      |  |   | 193,426 |   |  |   | 191,587 |  
|                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net revenue                                                                 |  |                                 | 22,221 |   |                                |   | 23,755 |      |  |   | 72,621  |   |  |   | 68,207  |  
|                                                                            |  |                                 |        |  
|Membership fees and other income                                            |  |                                 | 871    |   |                                |   | 1,121  |      |  |   | 2,743   |   |  |   | 3,676   |  
|                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total operating revenues                                                    |  |                                 | 23,092 |   |                                |   | 24,876 |      |  |   | 75,364  |   |  |   | 71,883  |  
|                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Operating expenses:                                                         |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Salaries and benefits                                                       |  |                                 | 3,347  |   |                                |   | 4,251  |      |  |   | 13,915  |   |  |   | 11,848  |  
|Sales commissions and expenses                                              |  |                                 | 5,011  |   |                                |   | 5,301  |      |  |   | 15,572  |   |  |   | 15,299  |  
|Member and merchant marketing                                               |  |                                 | 2,056  |   |                                |   | 1,729  |      |  |   | 6,720   |   |  |   | 5,364   |  
|Printing and postage                                                        |  |                                 | 1,160  |   |                                |   | 1,313  |      |  |   | 3,358   |   |  |   | 4,770   |  
|General and administrative                                                  |  |                                 | 5,880  |   |                                |   | 4,472  |      |  |   | 15,647  |   |  |   | 13,944  |  
|                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total operating expenses                                                    |  |                                 | 17,454 |   |                                |   | 17,066 |      |  |   | 55,212  |   |  |   | 51,225  |  
|                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Operating income                                                            |  |                                 | 5,638  |   |                                |   | 7,810  |      |  |   | 20,152  |   |  |   | 20,658  |  
|                                                                            |  |                                 |        |  
|Other income (expense):                                                     |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|                                                                            |  |                                 |        |  
|Interest and other income                                                   |  |                                 | 76     |   |                                |   | 49     |      |  |   | 305     |   |  |   | 130     |  
|Interest expense and financing costs                                        |  |                                 | (697   | ) |                                |   | (529   | )    |  |   | (2,408  | ) |  |   | (1,474  | )
|                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Income before income tax provision                                          |  |                                 | 5,017  |   |                                |   | 7,330  |      |  |   | 18,049  |   |  |   | 19,314  |  
|                                                                            |  |                                 |        |  
|Income tax provision                                                        |  |                                 | 2,028  |   |                                |   | 2,896  |      |  |   | 7,310   |   |  |   | 7,525   |  
|                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net income                                                                  |  | $                               | 2,989  |   |                                | $ | 4,434  |      |  | $ | 10,739  |   |  | $ | 11,789  |  
|                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Earnings per share of common stock:                                         |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Basic                                                                       |  | $                               | 0.12   |   |                                | $ | 0.19   |      |  | $ | 0.44    |   |  | $ | 0.53    |  
|                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Diluted                                                                     |  | $                               | 0.12   |   |                                | $ | 0.17   |      |  | $ | 0.42    |   |  | $ | 0.47    |  
|                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Weighted average number of common and common equivalent shares outstanding: |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|                                                                            |  |                                 |        |  
|Basic                                                                       |  |                                 | 24,752 |   |                                |   | 23,215 |      |  |   | 24,476  |   |  |   | 22,411  |  
|                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Diluted                                                                     |  |                                 | 25,566 |   |                                |   | 26,407 |      |  |   | 25,662  |   |  |   | 25,172  |  
|                                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  



See accompanying notes
to unaudited condensed consolidated financial statements.



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REWARDS NETWORK INC. AND SUBSIDIARIES



Consolidated Statements of Cash Flows

(Unaudited)

(in thousands)



|                                                                                            |  |                                |         |   |      |   |         |  
|------------------------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                                            |  | Nine months endedSeptember 30, |        
|                                                                                            |  | 2004                           |         |   | 2003 |  
|Cash flows from operating activities:                                                       |  |                                |         |   |      |   |         |  
|Net income                                                                                  |  | $                              | 10,739  |   |      | $ | 11,789  |  
|                                                                                            |  |                               
|Adjustments to reconcile net income to net cash (used in) provided by operating activities: |  |                                |         |   |      |   |         |  
|                                                                                            |  |                               
|Depreciation and amortization                                                               |  |                                | 3,009   |   |      |   | 2,904   |  
|Amortization of deferred financing cost                                                     |  |                                | 543     |   |      |   | 315     |  
|Deferred income taxes                                                                       |  |                                | (715    | ) |      |   | (1,950  | )
|Provision for losses on Rights to Receive                                                   |  |                                | 14,576  |   |      |   | 13,137  |  
|Impairment on investment                                                                    |  |                                | 500     |   |      |   |        |  
|                                                                                            |  |                               
|Changes in assets and liabilities:                                                          |  |                                |         |   |      |   |         |  
|Accounts receivable                                                                         |  |                                | (278    | ) |      |   | (430    | )
|Rights to Receive including accounts payableRights to Receive                              |  |                                | (40,568 | ) |      |   | (20,457 | )
|Prepaid expenses and other current assets                                                   |  |                                | 2,378   |   |      |   | (24     | )
|Other assets                                                                                |  |                                | (116    | ) |      |   | (527    | )
|Accounts payable                                                                            |  |                                | (2,694  | ) |      |   | 1,425   |  
|Accrued compensation and other current liabilities                                          |  |                                | (392    | ) |      |   | (118    | )
|Deferred membership fee income                                                              |  |                                | (493    | ) |      |   | (155    | )
|                                                                                            |  |                                |         |   |      |   |         |  
|Net cash (used in) provided by operating activities                                         |  |                                | (13,511 | ) |      |   | 5,909   |  
|                                                                                            |  |                                |         |   |      |   |         |  
|Cash flows from investing activities:                                                       |  |                                |         |   |      |   |         |  
|                                                                                            |  |                               
|Additions to property and equipment                                                         |  |                                | (3,964  | ) |      |   | (4,500  | )
|Decrease (increase) in short-term available for sale securities                             |  |                                | 8,023   |   |      |   | (2,047  | )
|(Increase) decrease in long-term available for sale securities                              |  |                                | (1,122  | ) |      |   | 41      |  
|                                                                                            |  |                                |         |   |      |   |         |  
|Net cash provided by (used in) investing activities                                         |  |                                | 2,937   |   |      |   | (6,506  | )
|                                                                                            |  |                                |         |   |      |   |         |  
|Cash flows from financing activities:                                                       |  |                                |         |   |      |   |         |  
|                                                                                            |  |                               
|Dividends paid                                                                              |  |                                |        |   |      |   | (15     | )
|Exercise of warrants and options for common stock                                           |  |                                | 2,940   |   |      |   | 5,054   |  
|                                                                                            |  |                                |         |   |      |   |         |  
|Net cash provided by financing activities                                                   |  |                                | 2,940   |   |      |   | 5,039   |  
|                                                                                            |  |                                |         |   |      |   |         |  
|Net (decrease) increase in cash                                                             |  |                                | (7,634  | ) |      |   | 4,442   |  
|                                                                                            |  |                               
|Cash and cash equivalents:                                                                  |  |                                |         |   |      |   |         |  
|Beginning of the period                                                                     |  |                                | 9,709   |   |      |   | 8,266   |  
|                                                                                            |  |                                |         |   |      |   |         |  
|End of the period                                                                           |  | $                              | 2,075   |   |      | $ | 12,708  |  
|                                                                                            |  |                                |         |   |      |   |         |  
|Supplemental disclosures of cash flow information:                                          |  |                                |         |   |      |   |         |  
|Cash paid during the period for:                                                            |  |                                |         |   |      |   |         |  
|Interest                                                                                    |  | $                              | 1,339   |   |      | $ | 1,110   |  
|                                                                                            |  |                                |         |   |      |   |         |  
|Income taxes                                                                                |  | $                              | 5,016   |   |      | $ | 8,051   |  
|                                                                                            |  |                                |         |   |      |   |         |  



See accompanying notes
to unaudited condensed consolidated financial statements.



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REWARDS NETWORK INC. AND SUBSIDIARIES



Unaudited Notes to Condensed Consolidated Financial Statements



(1) Basis of Presentation



These
unaudited condensed 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 September 30, 2004, consolidated results of operations for the three and nine months ended September 30, 2004 and 2003 and
the consolidated statements of cash flows for the nine-month periods ended September 30, 2004 and 2003 have been made. Operating results for the three and nine months ended September 30, 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 is 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 in order to fill empty tables and generate
incremental business. The Company attracts participating hotels by providing yield management tools in order 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 payment card they have registered with the Company. The Company partners with significant airlines and banks to obtain and service members.



Principles of consolidation: The Companys unaudited condensed
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) Available for sale securities



Investments and marketable securities, all classified as available-for-sale,
consisted of the following at September 30, 2004.



|                                               |  |                |       |                      |   |                       |  |             |    |  |   |      
|---------------------------------------------- |  | -------------- | ----- | -------------------- | - | --------------------- |  | ----------- | -- |  | - | -----
|                                               |  | AmortizedCost  |       | GrossUnrealizedGains |   | GrossUnrealizedLosses |  | MarketValue
|                                               |  | (in thousands)
|Short-term available for sale securities       |  |                |       |                      |   |                       |  |             |    |  |   |      
|U.S. government obligations                    |  | $              | 1,028 |                      | $ |                      |  | $           | 3  |  | $ | 1,025
|Municipalities                                 |  |                | 1,246 |                      |   |                      |  |             | 3  |  |   | 1,243
|                                               |  |                |       |                      |   |                       |  |             |    |  |   |      
|Total short-term available for sale securities |  | $              | 2,274 |                      | $ |                      |  | $           | 6  |  | $ | 2,268
|                                               |  |                |       |                      |   |                       |  |             |    |  |   |      
|Long-term available for sale securities        |  |                |       |                      |   |                       |  |             |    |  |   |      
|U.S. government obligations                    |  | $              | 5,751 |                      | $ |                      |  | $           | 31 |  | $ | 5,720
|Municipalities                                 |  |                | 3,418 |                      |   |                      |  |             | 14 |  |   | 3,404
|Other                                          |  |                | 331   |                      |   |                      |  |             |   |  |   | 331  
|                                               |  |                |       |                      |   |                       |  |             |    |  |   |      
|Total long-term available for sale securities  |  | $              | 9,500 |                      | $ |                      |  | $           | 45 |  | $ | 9,455
|                                               |  |                |       |                      |   |                       |  |             |    |  |   |      



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REWARDS NETWORK INC. AND SUBSIDIARIES



Unaudited Notes to Condensed Consolidated Financial
Statements(Continued)



(3) 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 in part of trusts established for the benefit of Samuel Zell, the Companys Chairman of the
Board of Directors, and members of his family. The lease initially provided for 10,000 square feet of office space at Two North Riverside Plaza, Chicago, Illinois and, effective July 1, 2004, the Company exercised its option to increase this space
to 14,324 square feet. The term of the lease is from September 1, 2003 through August 31, 2008.



On June 25, 2004, the Company entered into an office lease agreement with Equity Office Management, L.L.C., as indirect manager of San Felipe Plaza, Ltd.,
a limited partnership. Equity Office Management, L.L.C. is an affiliate of Equity Office Properties Trust. Samuel Zell is Chairman of the Board of Trustees of Equity Office Properties Trust. The lease provides for 827 square feet of office space at
5847 San Felipe, Suite 1675, Houston, Texas. The term of the lease is from July 1, 2004 through June 30, 2009.



The future minimum lease obligation for these two leases is as follows:



|                                   |  |                |      
|---------------------------------- |  | -------------- | -----
|Year ending December 31,           |  | (in thousands)
|2004 (remaining 3 months)          |  | $              | 72   
|2005                               |  |                | 291  
|2006                               |  |                | 298  
|2007                               |  |                | 305  
|Thereafter (through June 30, 2009) |  |                | 221  
|                                   |  |                |      
|Total minimum lease payments       |  | $              | 1,187
|                                   |  |                |      



Equity Group
Investments, L.L.C. (EGI), an affiliate of Samstock, L.L.C., the Companys largest stockholder, has provided investment and other financial advisory services to the Company. The Company paid $62,500 and $187,500, respectively, to
EGI for these services for each of the three and nine-month periods ended September 30, 2004 and 2003. Samuel Zell serves as Chairman of EGI. This arrangement was terminated as of September 30, 2004.



In March 2002, the Company and Responsys Inc. (Responsys) entered
into an agreement for Responsys to provide e-mail marketing services to the Company. The term of the agreement was from May 31, 2002 to May 31, 2004, and the total payments made were $386,544 for the two years. After May 31, 2004, the Company
has continued to employ Responsys on an as-needed basis. At the time the agreement was signed, George S. Wiedemann, the Companys President and Chief Executive Officer was the President, Chief Executive Officer, a director, and a
stockholder of Responsys. Subsequently, Mr. Wiedemann resigned as President, Chief Executive Officer and director of Responsys. The Company paid $77,584 and $215,593 respectively, to Responsys Inc. for the three and nine months ended September 30,
2004 compared to $40,044 and $108,398, respectively, for the three and nine months ended September 30, 2003.



(4) Litigation



On May 25, 2004, a complaint was filed in the Los Angeles County Superior Court against the Company and certain of its subsidiaries by Bistro Executive, Inc., Westward Beach Restaurant Holdings, LLC and MiniBar Lounge, all of which were
participants in the Companys Dining Credits Purchase Plan (the Plan), and their respective owners.



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REWARDS NETWORK INC. AND SUBSIDIARIES



Unaudited Notes to Condensed Consolidated Financial
Statements(Continued)



The complaint purports to be a class action brought by the named plaintiffs on behalf of a class
consisting of all restaurants located in California who participated in the Plan and all persons in California who provided personal guaranties of obligations under the Plan. The complaint claims that amounts paid by the Company under the Plan
constituted loans, and asserts claims for damages and equitable and injunctive relief for violations of California usury laws and the California Unfair Business Practices Act and declaratory relief. The complaint seeks, among other relief,
disgorgement of all purported interest and profits earned by the Company from the Plan in California, which plaintiffs allege to be a significant portion of an amount in excess of $300 million, and treble damages for all purported
interest paid within one year prior to the filing of the complaint.



On June 25, 2004, the action was removed to the United States District Court for the Central District of California. The Company believes that the complaint is without merit and intends to vigorously defend against
it. The ultimate cost to the Company from this action is not possible to predict and may not be determined for a number of years.



On October 1, 2004, a complaint was filed in the United States District Court for the Eastern District of Texas against Rewards Network Inc. by Source
Inc. The complaint claims that the Company is infringing four patents owned by Source Inc. The complaint seeks among other relief, treble damages due to willful infringement and equitable relief. The Company is investigating the claims asserted by
Source Inc. and believes that the complaint is without merit. The Company intends to vigorously defend against these claims. The ultimate cost to the Company from this action is not possible to predict and may not be determined for a number of
years.



(5) Earnings per Share



Basic earnings per share were computed by dividing net income available to
common stockholders by the weighted-average number of shares of the Companys common stock outstanding for each period presented. Diluted earnings per share were computed by dividing net income available to common stockholders by the
weighted-average number of shares of the Companys common stock and common stock equivalents outstanding for each period presented.



|                                                                                           |  |                                          |        |                   |   |         |  |         |        |  |   |        |  
|------------------------------------------------------------------------------------------ |  | ---------------------------------------- | ------ | ----------------- | - | ------- |  | ------- | ------ |  | - | ------ | -
|                                                                                           |  | Three months ended                       |        | Nine months ended |  
|                                                                                           |  | 9/30/04                                  |        | 9/30/03           |   | 9/30/04 |  | 9/30/03 |       
|                                                                                           |  | (in thousands, except per share amounts) |       
|Net income                                                                                 |  | $                                        | 2,989  |                   | $ | 4,434   |  | $       | 10,739 |  | $ | 11,789 |  
|Series A Preferred Stock dividends                                                         |  |                                          |       |                   |   |        |  |         |       |  |   | (15    | )
|                                                                                           |  |                                          |        |                   |   |         |  |         |        |  |   |        |  
|Net income available to common stockholders                                                |  | $                                        | 2,989  |                   | $ | 4,434   |  | $       | 10,739 |  | $ | 11,774 |  
|                                                                                           |  |                                          |        |                   |   |         |  |         |        |  |   |        |  
|Weighted average number of shares of common stock and common stock equivalents outstanding |  |                                          |        |                   |   |         |  |         |        |  |   |        |  
|Basic                                                                                      |  |                                          | 24,752 |                   |   | 23,215  |  |         | 24,476 |  |   | 22,411 |  
|Series A Preferred Stock                                                                   |  |                                          |       |                   |   |        |  |         |       |  |   | 130    |  
|Stock options                                                                              |  |                                          | 351    |                   |   | 1,612   |  |         | 607    |  |   | 1,203  |  
|Warrants                                                                                   |  |                                          | 463    |                   |   | 1,580   |  |         | 579    |  |   | 1,428  |  
|                                                                                           |  |                                          |        |                   |   |         |  |         |        |  |   |        |  
|Diluted                                                                                    |  |                                          | 25,566 |                   |   | 26,407  |  |         | 25,662 |  |   | 25,172 |  
|                                                                                           |  |                                          |        |                   |   |         |  |         |        |  |   |        |  
|Earnings per share:                                                                        |  |                                          |        |                   |   |         |  |         |        |  |   |        |  
|Basic                                                                                      |  | $                                        | 0.12   |                   | $ | 0.19    |  | $       | 0.44   |  | $ | 0.53   |  
|                                                                                           |  |                                          |        |                   |   |         |  |         |        |  |   |        |  
|Diluted                                                                                    |  | $                                        | 0.12   |                   | $ | 0.17    |  | $       | 0.42   |  | $ | 0.47   |  
|                                                                                           |  |                                          |        |                   |   |         |  |         |        |  |   |        |  



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Unaudited Notes to Condensed Consolidated Financial
Statements(Continued)



(6) Stock-based Compensation



In accordance with the Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards
No. 148, Accounting for Stock-Based CompensationTransition and Disclosure, the Company has elected to continue to comply with Accounting Principles Board Opinion No. 25 (APB 25) to account for stock options and,
accordingly, no compensation expense has been recognized in the Companys financial statements because the exercise price of employee stock options equals the fair market price of the underlying stock on the date of grant. Under Statement of
Financial Accounting Standards No. 123 (SFAS No. 123), compensation cost is measured at the grant date based on the estimated fair value of the award and is recognized as compensation expense over the vesting or service period. Had the
Company determined compensation expense based on the fair value at the grant date for its stock options under SFAS No. 123, the Companys net income would have been reduced to the pro forma amounts indicated below:



|                                                            |  |                                          |       |   |                   |   |        |          |  |   |          |   |  |   |        |  
|----------------------------------------------------------- |  | ---------------------------------------- | ----- | - | ----------------- | - | ------ | -------- |  | - | -------- | - |  | - | ------ | -
|                                                            |  | Three months ended                       |       |   | Nine months ended |  
|                                                            |  | 09/30/04                                 |       |   | 09/30/03          |   |        | 09/30/04 |  |   | 09/30/03 |  
|                                                            |  | (in thousands, except per share amounts) |      
|Net income                                                  |  |                                          |       |   |                   |   |        |          |  |   |          |   |  |   |        |  
|As reported                                                 |  | $                                        | 2,989 |   |                   | $ | 4,434  |          |  | $ | 10,739   |   |  | $ | 11,789 |  
|Employee stock option compensation expense, net of tax      |  |                                          | (747  | ) |                   |   | (1,218 | )        |  |   | (2,077   | ) |  |   | (3,109 | )
|                                                            |  |                                          |       |   |                   |   |        |          |  |   |          |   |  |   |        |  
|Pro forma                                                   |  | $                                        | 2,242 |   |                   | $ | 3,216  |          |  | $ | 8,662    |   |  | $ | 8,680  |  
|                                                            |  |                                          |       |   |                   |   |        |          |  |   |          |   |  |   |        |  
|Net income per common share (basic)                         |  |                                          |       |   |                   |   |        |          |  |   |          |   |  |   |        |  
|As reported                                                 |  | $                                        | 0.12  |   |                   | $ | 0.19   |          |  | $ | 0.44     |   |  | $ | 0.53   |  
|Employee stock option compensation expense, net of tax      |  |                                          | (0.03 | ) |                   |   | (0.05  | )        |  |   | (0.08    | ) |  |   | (0.14  | )
|                                                            |  |                                          |       |   |                   |   |        |          |  |   |          |   |  |   |        |  
|Pro forma                                                   |  | $                                        | 0.09  |   |                   | $ | 0.14   |          |  | $ | 0.36     |   |  | $ | 0.39   |  
|                                                            |  |                                          |       |   |                   |   |        |          |  |   |          |   |  |   |        |  
|Net income per common and common equivalent share (diluted) |  |                                          |       |   |                   |   |        |          |  |   |          |   |  |   |        |  
|As reported                                                 |  | $                                        | 0.12  |   |                   | $ | 0.17   |          |  | $ | 0.42     |   |  | $ | 0.47   |  
|Employee stock option compensation expense, net of tax      |  |                                          | (0.03 | ) |                   |   | (0.05  | )        |  |   | (0.08    | ) |  |   | (0.12  | )
|                                                            |  |                                          |       |   |                   |   |        |          |  |   |          |   |  |   |        |  
|Pro forma                                                   |  | $                                        | 0.09  |   |                   | $ | 0.12   |          |  | $ | 0.34     |   |  | $ | 0.35   |  
|                                                            |  |                                          |       |   |                   |   |        |          |  |   |          |   |  |   |        |  



The Company uses the
Black-Scholes valuation model for estimating the fair value of options granted. During the three months ended September 30, 2004 and 2003 there were no options granted by the Company. The following represents the estimated fair value of options
granted and the weighted-average assumptions used in calculating such estimate:



|                                                         |  |                   |      |   |          |   |      |  
|-------------------------------------------------------- |  | ----------------- | ---- | - | -------- | - | ---- | -
|                                                         |  | Nine months ended |     
|                                                         |  | 09/30/04          |      |   | 09/30/03 |  
|Weighted average estimated fair value per option granted |  | $                 | 6.10 |   |          | $ | 9.26 |  
|Stock volatility                                         |  |                   | 43.0 | % |          |   | 46.8 | %
|Risk-free interest rate                                  |  |                   | 4.3  | % |          |   | 3.2  | %
|Expected option life in years                            |  |                   | 10   |   |          |   | 10   |  
|Expected stock dividend yield                            |  |                   | 0    | % |          |   | 0    | %



Under the
Companys 2004 Long Term Incentive Plan, certain executives and other key employees were granted restricted stock unit awards for a total of 116,750 shares of the Companys common stock (Awards). The vesting of 106,750 of the
Awards is contingent upon the achievement of certain performance and service objectives. If the Company achieves a certain performance target in 2004, the Awards vest ratably over three years, subject to service objectives. If the performance
objective is not met at the end of 2004, the employee will



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REWARDS NETWORK INC. AND SUBSIDIARIES



Unaudited Notes to Condensed Consolidated Financial
Statements(Continued)



forfeit all rights with respect to the Award, and the Award will terminate in its entirety. As such, the Awards are variable until the performance objectives
have been achieved. The remaining 10,000 Awards vest ratably over three years, subject to service objectives, and are not contingent on the achievement of any performance targets.



Compensation cost of the Awards is calculated based upon the market value at the date of the grant and amortized over the
vesting period. Compensation cost for variable Awards is adjusted each reporting period for increases or decreases in the value of the shares until final measurement. Management has determined that the 2004 performance target will not be met and,
accordingly $445,100 of compensation cost accrued as of June 30, 2004 relating to the 106,750 of the Awards was reversed during the third quarter ended September 30, 2004. Compensation costs for the nine month period ended September 30, 2004 for the
remaining 10,000 Awards shares was $21,900.



(7) Recently Issued
Accounting Pronouncements



In December 2003, the FASB
issued revised Interpretation No. 46 (FIN 46R), Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (ARB 51), which addresses how a business enterprise should
evaluate whether it has a controlling interest in an entity through means other than voting rights and accordingly should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46 (FIN 46), which was issued in January
2003. Before concluding that it is appropriate to apply an ARB 51 voting interest consolidation model to an entity, an enterprise must first determine that the entity is not a variable interest entity. As of the effective date of FIN 46R, an
enterprise must evaluate its involvement with all entities or legal structures created before February 1, 2003 to determine whether consolidation requirements of FIN 46R apply to those entities. Application of FIN 46R is required in financial
statements of public entities that have interests in variable interest entities or potential variable interest entities commonly referred to as special-purpose entities for periods ending after December 15, 2003. Application by public entities for
all other types of entities is required in financial statements for periods ending after March 15, 2004. The Company has adopted both FIN 46 and FIN 46R, and their adoption had no impact on the Companys consolidated financial position, cash
flows or results of operations.



In May 2003, the FASB issued
Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (SFAS 150). SFAS 150 establishes standards for the classification and
measurement of certain financial instruments with characteristics of both liabilities and equity. SFAS 150 also includes required disclosures for financial instruments within its scope. For the Company, SFAS 150 was effective for instruments entered
into or modified after May 31, 2003 and otherwise will be effective as of January 1, 2004, except with respect to mandatorily redeemable financial instruments. For certain mandatorily redeemable financial instruments, SFAS 150 will be effective for
the Company on January 1, 2005. The effective date has been deferred indefinitely for certain other types of mandatorily redeemable financial instruments. The adoption of SFAS 150 did not have an impact on the Companys consolidated financial
position, cash flows or results of operations.



In March 2004,
the FASB issued a proposed statement, Share-Based Payment, that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or
(b) liabilities that are based on the fair value of the enterprises equity instruments or that may be settled by the issuance of such equity instruments. The proposed statement would eliminate the ability to account for share-based
compensation transactions using APB 25 and generally would require instead that such transactions be accounted for using a fair-value based method. The proposed statement is effective for awards granted, modified, or settled in interim and annual
period beginning after June 15, 2005 for public entities that used the fair-value based method of accounting under the original



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REWARDS NETWORK INC. AND SUBSIDIARIES



Unaudited Notes to Condensed Consolidated Financial
Statements(Continued)



provisions of SFAS No. 123 for recognition or pro forma disclosure purposes. The Company is currently evaluating the impact the proposed statement may have
on its consolidated financial position, cash flows or results of operations.



In April 2004, the Emerging Issues Task Force of the FASB issued Statement No. 03-06 Participating Securities and the Two-Class Method Under FASB Statement No. 128, Earnings Per Share (EITF
03-06). EITF 03-06 addresses a number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings
of the company when, and if, it declares dividends on its common stock. EITF 03-06 also provides further guidance in applying the two-class method of calculating earnings per share, clarifying what constitutes a participating security and how to
apply the two-class method of computing earnings per share once it is determined that a security is participating, including how to allocate undistributed earnings to such a security. EITF 03-06 is effective for fiscal periods beginning after March
31, 2004. The Company has adopted EITF 03-06, and its adoption did not have an impact on the Companys consolidated financial position, cash flows or results of operations.



In September 2004, the Emerging Issues Task Force of the FASB reached consensus on Issue No. 04-08, The Effect of
Contingently Convertible Debt on Diluted Earnings per Share (EITF 04-08). The guidance requires companies to include shares issuable under convertible debt in diluted earnings per share computations (if dilutive) regardless of
whether the market price trigger (or other contingent feature) has been met. EITF 04-08 is effective for reporting periods ending after December 15, 2004. The Company will adopt EITF 04-08 as of December 31, 2004. The Company has $70 million of
31/4% debentures that are convertible into approximately 3.9 million shares of common stock if certain
conditions are met. Applying the if-converted method, as required by EITF 04-08, net income for the diluted earnings per share calculation is adjusted for interest expense associated with the convertible debt instrument and diluted weighted average
shares outstanding are increased for shares issuable upon conversion. Prior periods diluted shares outstanding and diluted earnings per share amounts will be restated to present comparable information, effective with the Companys fourth
quarter of 2004. The estimated reduction in the Companys diluted earnings per share for the year ending December 31, 2004 is approximately $0.02 per share.



(8) Business and Credit Concentrations



As of September 30, 2004, the Company had contracts or relationships with nine major airlines that offer frequent flyer
miles as rewards. Also for the three and nine months ended September 30, 2004 and 2003, United Airlines and Upromise Inc. individually represented 10% or more of the Companys sales. The following table illustrates the Companys partner
sales concentration as a percentage of total sales



|                                             |  |                                 |   |  |                                |   |  |      |   |  |      |  
|-------------------------------------------- |  | ------------------------------- | - |  | ------------------------------ | - |  | ---- | - |  | ---- | -
|                                             |  | Three months endedSeptember 30, |   |  | Nine months endedSeptember 30, |  
|                                             |  | 2004                            |   |  | 2003                           |   |  | 2004 |   |  | 2003 |  
|Airlines                                     |  | 57                              | % |  | 58                             | % |  | 56   | % |  | 58   | %
|                                             |  |                                 |   | 
|Partners that represent 10% or more of sales |  | 35                              | % |  | 31                             | % |  | 34   | % |  | 33   | %



(9) Subsequent Event



On November 3, 2004, we entered into a $50 million
unsecured revolving credit facility with Bank of America, N.A. and LaSalle Bank, N.A. This facility expires on July 13, 2008.



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(dollar amounts in thousands except average transaction amounts and per share data)



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations



You should read the following discussion together with our 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 dependence on our relationships with airlines and other reward program partners for a significant number of our members, (ii) the concentration of a significant amount of our rewards currency in one industry
group, the airline industry, (iii) our inability to attract and retain merchants and members, (iv) our inability to maintain an appropriate balance between the number of members and the number of participating merchants in each market, (v) the
failure of our program offering members rewards for patronizing select hotels, (vi) the failure of our retail rewards program, (vii) the failure of our expansion into Canada, (viii) changes to card association rules and practices, (ix) our
dependence upon our relationships with transaction processors, presenters and aggregators, (x) network interruptions or processing errors, (xi) our susceptibility to a changing regulatory environment, (xii) increased operating costs due to
privacy concerns of our marketing partners, payment card processors, merchants and the public, (xiii) the failure of our security measures, (xiv) our susceptibility to restaurant credit risk, (xv) economic changes, (xvi) an adverse change in
our loss experience related to Rights to Receive, (xvii) adverse consequences of changes in our programs that affect the rate of rewards received by our members, (xviii) our inability to generate sufficient profit margin on expanded restaurant
products offerings, (xix) the loss of key personnel, (xx) adverse determination of lawsuits in which we are a defendant, (xxi) increasing competition, (xxii) our inability to obtain sufficient cash, (xxiii) our control by Samstock, L.L.C. and its
affiliates, (xxiv) the ability of our board of directors to issue shares of our preferred stock without stockholder approval, (xxv) possible future sales of restricted and other shares, (xxvi) the price of our common stock could be volatile, and
(xxvii) anti-takeover provisions that could delay or prevent a change in our control even if the change in control would be beneficial to our stockholders 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. See the cautionary statements included as Exhibit 99.1 to this quarterly report
on Form 10-Q 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



We market and administer loyalty rewards programs that bring our
participating merchants and members together. We do this by offering rewards in the form of savings and benefits to our members who patronize our participating merchants, principally restaurants and hotels. We attract 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 in order to fill empty tables and generate incremental business. We attract
participating hotels by providing yield management tools in order to fill empty hotel rooms and generate incremental business. We offer rewards in the form of cash, airline frequent flyer miles and other currencies to our members who patronize our
participating merchants and pay using a payment card they have registered with us. We partner with significant airlines and banks to obtain and service members.



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(dollar amounts in thousands except average transaction amounts and per
share data)(Continued)



Effective December 9, 2003, we changed our corporate name to Rewards Network Inc. from iDine Rewards
Network Inc. Shares of our common stock are traded on the American Stock Exchange under the symbol IRN.



Participating Merchants



Restaurants



As of September 30, 2004, we had approximately 10,611 participating restaurants in over 55 metropolitan markets in more than 40 states in the United
States and in Canada. We primarily offer two plans for our participating restaurantsthe Dining Credits Purchase Plan and the Revenue Management Plan.



Dining Credits Purchase Plan. Under this plan, we purchase food and beverage credits (Rights to Receive) from participating restaurants
typically for cash and at a discount from the retail price for which they sell the food and beverages. We then market to our members rewards in the form of savings or benefits for dining in our participating restaurants (in some cases, on certain
days of the week or times of day, set at the discretion of the restaurant). When a member dines at a restaurant that participates in the Dining Credits Purchase Plan, we are entitled to a percentage of the total transaction amount, and we generally
debit this amount from the participating restaurants bank account. We believe that the Dining Credits Purchase Plan is designed so that participating restaurants can make a wholesale profit in advance through the sale of food and beverage
credits that are utilized through subsequent dining transactions at the restaurants by our members.



If we do not purchase additional Rights to Receive from participating restaurants after the initial Rights to Receive are used and the participating
restaurants do not terminate their agreements with us, then in some cases they continue to be included on our website list of participating merchants, and in those cases our members continue to earn rewards and savings by dining in those
restaurants. In these cases, we receive a smaller percentage of the total transaction amount from the merchant in an arrangement similar to the Revenue Management Plan.



Revenue Management Plan. Under this plan, our members earn rewards by dining at participating restaurants (in most
cases, on certain days of the week or times of day, set at the discretion of the restaurant). Under the Revenue Management Plan, we receive a marketing fee from the merchant equal to a percentage of the total transaction amount from the merchant.
Although our revenue from these transactions is less than under the Dining Credits Purchase Plan, revenue management transactions do not require us to purchase any Rights to Receive from merchants. Our Revenue Management Plan is designed for
restaurants that choose to take advantage of only our marketing services.



Hotels



In the second quarter
of 2003, we launched a hotel revenue management product that initially focused principally on independent hotels, which typically do not have their own loyalty or rewards programs. In October 2003, we announced that we had entered into a
relationship with Travelweb LLC, a travel distribution company, to expand our hotel rewards program by including additional independent hotels as well as certain major U.S. hotel chains. Although our hotel rewards program remains in its early
stages, as of September 30, 2004, the number of participating hotels had grown to approximately 11,111. This number represents both hotels sourced through the Travelweb network as well as hotels under direct contract with us. Typically, our members
have access to reduced rates at participating hotels and also earn rewards by using the payment cards they register with us to pay for hotel stays after making reservations through our website or call center. Under our Revenue Management Plan for
hotels, we receive a marketing fee equal to a percentage of the hotel room rate. At September 30, 2004, participation in our hotel rewards program was available to approximately 70% of our members.



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REWARDS NETWORK INC. AND SUBSIDIARIES



(dollar amounts in thousands except average transaction amounts and per
share data)(Continued)



Members



As of September 30, 2004, we had approximately 3.7 million active member accounts (i.e., members with at least one
transaction with one of our participating merchants during the last 12 months). An active member account may consist of more than one payment card registered with us and may have more than one person associated with the account, although we consider
each member account to be held by one member. Our members come from a variety of sources and marketing efforts, including through direct solicitation or through our affiliations with major airlines, large banks, credit card issuers and
other affinity partners. In our affiliate programs, members may be solicited for enrollment or may be directly enrolled by our affiliate partner. We offer a choice of member programs. Membership in our programs that provide for cash rewards
generally requires an annual fee, and membership in our programs that provide rewards to members in other currencies, such as airline frequent flyer miles, does not require an annual fee. Our membership programs consist of the following:



Rewards Network No Fee Program. Our no-fee program offers
alternative currency rewards, predominantly airline frequent flyer miles on charges for food, beverages, tax and tip at participating restaurants and on charges for room rates at participating hotels. Members of this program are members of various
loyalty program providers.



Rewards Network Program.
This is a fee-based program that typically offers up to 20% cash savings on charges for food, beverage, tax and tip at participating restaurants and up to 15% cash savings on charges for room rates at participating hotels. Members typically pay an
upfront $49 annual fee. Alternatively, members may elect to earn their fee. In this case, we retain benefits and rewards until the member has reached the same $49 fee level, after which point the member receives a benefit and we (by not
providing a benefit until $49 of benefits has accumulated) have effectively received a fee.



Corporate Program.We offer this program as a travel and entertainment expense reduction program to large corporations. The corporate client enrolls some or all of its corporate payment cards in the Rewards
Network Program and we typically pay the rewards and savings directly to the corporate client. We typically earn an annual fee by retaining rewards or savings for each member account enrolled in the program.



Registered Card Platform



A critical part of the administration of our loyalty and rewards programs is
our registered card platform. Members in our programs have at least one major payment card registered with us. Members then present that registered payment card while transacting at a participating merchant. Based on our agreements with various
processors and presenters throughout the United States and Canada, we aggregate data for all the payment card transactions at our participating merchants. The transactions are then matched to a file containing our members registered card
information. The matched transactions are qualified via business rules as to whether they are eligible for a reward. Qualified transactions are then used to provide member savings, airline frequent flyer miles or other currency benefits, as well as
to invoice and collect from merchants, principally via an electronic debit to the merchants bank account.



Rewards



The vast majority of rewards are delivered to members in the form of a direct credit to their payment card account, a cash-denominated reward to a loyalty
or rewards program account, or a mileage credit to their frequent flyer account. Cash rewards typically represent up to 20% of the members total transaction amount with participating restaurants and typically up to 15% of the members
room rate with participating hotels. Loyalty partner program members may receive rewards either in cash or in alternative currencies such as airline frequent flyer miles, depending on the particular program. Members receiving airline frequent flyer
miles



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REWARDS NETWORK INC. AND SUBSIDIARIES



(dollar amounts in thousands except average transaction amounts and per
share data)(Continued)



generally earn up to ten miles for each dollar spent at participating restaurants and up to five miles for each room rate dollar spent at participating
hotels, provided that they make the hotel reservation through us. We communicate reward opportunities to our members via a variety of communication tools: email, our website, newsletters, directories, toll-free numbers, fax back services and
wireless devices such as personal digital assistants.



Canada



In June 2004, we launched our dining rewards
programs in Canada in the provinces of Ontario and British Columbia. As of September 30, 2004, we had approximately 56 participating restaurants in Canada.



CRITICAL ACCOUNTING POLICIES AND ESTIMATES



Our discussion and analysis of our financial condition and results of operations is based upon our unaudited 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 that we 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 provision for Rights to Receive losses, the valuation allowance,
if any, for net deferred tax assets, investments and intangible assets. We base our estimates on historical experience and on various other assumptions that 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. We believe the following critical
accounting policies affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements.



Allowance for Rights to Receive Losses



We provide allowances for Rights to Receive losses based on our estimate of losses that would result from the inability or unwillingness of
participating merchants to perform their obligations to us and enable us to recover outstanding Rights to Receive. If the financial condition of our merchant base were to deteriorate beyond our expectations, resulting in certain participating
merchants inability to provide food and beverage to our members thereby reducing the recoverability of Rights to Receive, additional allowances may be required.



We review our ability to realize Rights to Receive on a periodic basis and provide for anticipated losses on Rights to
Receive from restaurants that have ceased operations, restaurants that otherwise fail to pay us for unused Rights to Receive and restaurants whose Rights to Receive are not being utilized by our members. All other balances are segregated and
evaluated based on the size of balance and the number of months required to recover the Rights to Receive outstanding. Losses are reduced by recoveries of Rights to Receive previously provided for. Account balances are charged off against the
allowance after collection efforts have been exhausted.



Deferred Tax
Assets Valuation Allowance



We record a valuation
allowance to reduce our deferred tax assets when future realization is in question. 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.



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(dollar amounts in thousands except average transaction amounts and per
share data)(Continued)



Impairment Loss of Unamortized Goodwill



At least on an annual basis, we evaluate whether events and changes in circumstances warrant the recognition of an
impairment loss of unamortized 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 that the asset is expected to generate. 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 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 reassessed any intangible assets, including goodwill, recorded in connection with our
previous acquisitions. There were no impairment charges recorded as a result of our assessments. As of September 30, 2004, we had unamortized goodwill of $9,671.



Revenue Recognition



We recognize revenue when our members patronize our participating merchants and pay using a payment card they have registered with us. Revenue is
recognized only if the members transaction qualifies in accordance with the rules of the particular marketing 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 contract with the participating merchant.



Membership Fee and Other Income



Membership fee and other income consists principally of renewal fees paid by cash reward Rewards Network Program members and is recognized over the membership period, which is usually twelve months beginning in the
month the fee is received. Cardholder membership fees are cancelable and refunded to members, if requested, on a pro rata basis based on the remaining portion of the membership. Rewards and savings retained by us for earn your fee
members are amortized against member rewards and savings over the membership period.



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(dollar amounts in thousands except average transaction amounts and per
share data)(Continued)



(a) Results of operationsComparison of the quarters ended September 30, 2004 and 2003



The following table sets forth for the periods presented our sales,
components of our costs of sales and certain other information for each of our two revenue plans.



|                              |  |                             |         |   |                       |   |        |       |  |   |                           |   |  |                       |         |   |       |   |        |   |  |   |         |  
|----------------------------- |  | --------------------------- | ------- | - | --------------------- | - | ------ | ----- |  | - | ------------------------- | - |  | --------------------- | ------- | - | ----- | - | ------ | - |  | - | ------- | -
|                              |  | Quarter ended September 30, |        
|                              |  | 2004                        |         |   | 2003                  |  
|                              |  | DiningCreditsPurchasePlan   |         |   | RevenueManagementPlan |   |        | Total |  |   | DiningCreditsPurchasePlan |   |  | RevenueManagementPlan |         |   | Total |  
|Qualified transaction amounts |  | $                           | 107,258 |   |                       | $ | 28,599 |       |  | $ | 135,857                   |   |  | $                     | 106,498 |   |       | $ | 30,903 |   |  | $ | 137,401 |  
|                              |  |                             |         |   |                       |  
|Sales yield                   |  |                             | 74.6    | % |                       |   | 23.8   | %     |  |   | 63.9                      | % |  |                       | 76.3    | % |       |   | 26.8   | % |  |   | 65.2    | %
|                              |  |                             |         |   |                       |  
|Sales                         |  |                             | 80,000  |   |                       |   | 6,818  |       |  |   | 86,818                    |   |  |                       | 81,247  |   |       |   | 8,283  |   |  |   | 89,530  |  
|                              |  |                             |         |   |                       |  
|Cost of dining credits        |  |                             | 42,016  |   |                       |   |       |       |  |   | 42,016                    |   |  |                       | 42,512  |   |       |   |       |   |  |   | 42,512  |  
|Processing fee                |  |                             | 253     |   |                       |   | 22     |       |  |   | 275                       |   |  |                       | 301     |   |       |   | 31     |   |  |   | 332     |  
|                              |  |                             |         |   |                       |   |        |       |  |   |                           |   |  |                       |         |   |       |   |        |   |  |   |         |  
|Cost of sales                 |  | $                           | 42,269  |   |                       | $ | 22     |       |  | $ | 42,291                    |   |  | $                     | 42,813  |   |       | $ | 31     |   |  | $ | 42,844  |  
|                              |  |                             |         |   |                       |   |        |       |  |   |                           |   |  |                       |         |   |       |   |        |   |  |   |         |  
|Provision for losses          |  |                             | 6,788   |   |                       |   |       |       |  |   | 6,788                     |   |  |                       | 4,468   |   |       |   |       |   |  |   | 4,468   |  
|Member rewards and savings    |  |                             |         |   |                       |   |        |       |  |   | 15,518                    |   |  |                       |         |   |       |   |        |   |  |   | 18,463  |  
|                              |  |                             |         |   |                       |   |        |       |  |   |                           |   |  |                       |         |   |       |   |        |   |  |   |         |  
|Net revenue                   |  |                             |         |   |                       |   |        |       |  | $ | 22,221                    |   |  |                       |         |   |       |   |        |   |  | $ | 23,755  |  
|                              |  |                             |         |   |                       |   |        |       |  |   |                           |   |  |                       |         |   |       |   |        |   |  |   |         |  



As more fully
discussed below, net revenue for the third quarter of 2004 decreased primarily from a decrease in sales, due to a decline in the average transaction amount coupled with lower sales yield and an increase in the rate of provision for losses.



Qualified transaction amounts at our participating merchants
(which are transactions where our members are entitled to receive rewards or savings) declined 1.1% for the third quarter of 2004 as compared to the same period in 2003. While Dining Credit Purchase Plan qualified transactions increased 0.7% to
$107,258 during the third quarter of 2004 as compared with the third quarter of 2003, Revenue Management Plan qualified transaction amounts decreased 7.5% to $28,599 when compared with the same period in 2003. Qualified transaction amounts declined
in the third quarter of 2004 compared with the third quarter of 2003 because of a lower average transaction amount and the impact of the hurricanes that made landfall in the southeastern United States during August and September 2004, partially
offset by an increase in the number of transactions.



A
decrease in the average transaction amount to $48.12 for the third quarter of 2004 from $49.46 for the same period in 2003 was partially offset by the increase in number of transactions, which increased by 1.6% to approximately 2,824 during the
third quarter of 2004 as compared with 2,778 for the third quarter of 2003. Included in qualified transaction amounts were dining qualified transaction amounts, which decreased 3.0% to $132,731 for the third quarter of 2004 compared with $136,901
for the third quarter of 2003. The average dining transaction amount decreased 4.2% to $47.24 for the third quarter of 2004 compared with $49.31 for the third quarter of 2003. This was partially offset by an increase in hotel qualified transaction
amounts to $3,058 for the third quarter of 2004 compared with $500 for the third quarter of 2003. Although hotel qualified transaction amounts increased, the average hotel transaction amount also decreased to $244.41 for the third quarter of 2004
compared with $297.56 for the third quarter of 2003. We believe that the lower average dining transaction amount in the three months ended September 30, 2004 compared with the three months ended September 30, 2003 was due to a number of factors,
including the replacement of some merchants in our programs with merchants with lower menu prices, our expansion into secondary markets where the average transaction amount



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(dollar amounts in thousands except average transaction amounts and per
share data)(Continued)



tends to be lower and decreased sales in some large primary markets and increased weekday revenues where transaction amounts tend to be slightly lower. We
believe that the lower average hotel transaction amount in the third quarter of 2004 compared with the third quarter of 2003 was due to the availability in the 2004 quarter of over 10,000 additional hotels as compared with the 2003 quarter and
generally lower room rates at the hotels in this larger offering. The increase in the number of transactions was primarily the result of a 12.7% increase in the number of our active member accounts at September 30, 2004 as compared with September
30, 2003. Although the active member accounts increased by 12.7% at September 30, 2004 as compared with September 30, 2003, we did not experience a corresponding increase in the number of qualified transactions because we experienced an increased
rate of attrition in our restaurant merchants that resulted in a decline in the number of restaurant merchants in the third quarter of 2004 compared with the third quarter of 2003. An active member account is an account with at least one qualified
transaction with one of our participating merchants during the previous 12 months.



Sales yield, which represents sales as a percentage of qualified transaction amounts, decreased to 63.9% for the third quarter of 2004 compared with 65.2% for the third quarter of 2003. The decline in the sales yield
reflects the changing mix in business propositions marketed to our merchants. We continue to work to improve restaurant merchant products to meet the needs of new merchants and reduce attrition of existing merchants. Many of these products have more
favorable business propositions to our merchants and have resulted in lower sales yield from Dining Credit Purchase Plan and Revenue Management Plan qualified transaction amounts. Dining qualified transaction amounts included in the Revenue
Management Plan decreased $4,930 to $25,473 for the third quarter of 2004 compared with $30,403 for the same quarter in 2003 and hotel qualified transaction amounts included in the Revenue Management Plan increased $2,558 to $3,058 for the third
quarter of 2004 compared with $500 for the same quarter in 2003. Dining Revenue Management Plan qualified transactions typically have a higher sales yield than hotel qualified transactions and, therefore, the decrease in dining qualified transaction
amounts to 89.1% of total Revenue Management Plan qualified transaction amounts for the third quarter of 2004 compared with 98.4% of total Revenue Management Plan qualified transaction amounts for the third quarter of 2003 resulted in lower overall
yield from the Revenue Management Program Plan. We expect that all of our future product lines such as our retail rewards program will be of a Revenue Management nature, which results in a lower sales yield than Dining Credit Purchase Plan qualified
transactions.



Accordingly, we expect that in the future our
sales yield percentage will further decline as qualified transactions from our Revenue Management Plan represent a larger percentage of our total qualified transactions, as our hotel qualified transaction amounts increase, and to the extent we offer
our restaurant merchants more favorable economics to address the increased rate of attrition we have been experiencing and to attract new restaurant merchants. The extent to which we are successful in reducing restaurant merchant attrition and
attracting new restaurant merchants and the amount of increased sales that result from having more restaurant merchants will determine how much we are able to offset the impact of the lower sales yield.



Sales for the third quarter of 2004 decreased $2,712 or 3.0% when compared to
the same period in 2003, primarily as a result of the reduction in the average transaction amount and lower sales yield.



Cost of sales, which is composed of the cost of dining credits and related processing fees increased to 48.7% of sales during the third quarter of 2004
compared to 47.9% of sales for the same period in 2003. Contributing to the increase in the cost of sales percentage was the decrease in sales under our Revenue Management Plan to 7.9% of total sales for the third quarter of 2004 compared to 9.3% of
total sales for the same period in 2003. There is no cost of sales associated with sales under our Revenue Management Plan and, therefore, the relative decrease in these sales as a percentage of total sales results in a higher total cost of sales
percentage.



The provision for losses increased to 7.8% of
total sales and 8.5% of Dining Credits Purchase Plan sales for the third quarter of 2004 compared to 5.0% of sales and 5.5% of Dining Credits Purchase Plan sales for the same



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(dollar amounts in thousands except average transaction amounts and per
share data)(Continued)



period in 2003. We perform a quarterly analysis of the adequacy of our allowance for doubtful accounts on the balance sheet and, if necessary, adjust this
allowance. This analysis is based on a number of factors, including the aging of the Rights to Receive and the overall size of the portfolio.



Member rewards and savings decreased to 17.9% of sales for the third quarter of 2004 compared to 20.6% of sales for the same period in 2003. There are two
primary reasons for the decrease in the rate of rewards during the 2004 period. First, in some cases, as part of the changes in merchant deal economics, we have reduced member benefit levels. Secondly, we have continued the program of variable
benefits whereby some of our member rewards and savings are tied to their level of participation in our programs. The reduced rate of rewards paid to less engaged members has resulted in a lower overall effective rate of reward earned by our total
membership base.



Membership fees and other income decreased
$250 or 22.3% for the third quarter of 2004 compared with the same period in 2003. The decrease can be primarily attributed to the decline in membership fee income and reflects the continuing effects of a change in our marketing strategy. In the
fourth quarter of 1999, we reduced our marketing of the fee-based membership due to changes in the regulatory environment regarding direct marketing solicitations and we shifted our marketing strategy to focus mainly on marketing a no-fee dining
program to key affinity and loyalty partners where we could take advantage of the registered card platform and enroll large quantities of accounts at a reduced cost of acquisition and solicitation.



Salaries and benefits decreased $904 or 21.3% for the third quarter of 2004
compared with the same period in 2003 primarily due to the reversal of $1,751 of previously accrued management incentive compensation and restricted stock awards. Both of these incentive compensation programs were based on us achieving certain
financial performance targets which at the end of the second quarter of 2004 management believed would be achieved. However, management has now determined that these financial performances targets will not be met. Excluding the reversal of the
previously accrued incentive compensation, salaries and benefits increased $847 or 19.9% for the third quarter of 2004 compared with the same period in 2003 primarily as a result of a planned increase in the number of employees, annual merit
increases and higher employee benefit costs. The planned increase in the number of employees was principally in information technology, marketing, corporate development and customer services.



Sales commissions and expenses decreased $290 or 5.5% for the third quarter
of 2004 compared with the same period in 2003, and sales commissions and expenses amounted to 5.8% of sales for the third quarter of 2004 compared with 5.9% for the third quarter of 2003. The $290 decrease in sales commissions during the third
quarter of 2004 compared with the third quarter of 2003 reflects lower sales and the reversal of $125 of previously accrued salespersons incentive compensation which at the end of the second quarter of 2004 management believed would be
achieved. However, management has now determined that these financial performances targets will not be achieved. In January 2004, we changed our sales consultants compensation plan to increase the incentive for sales consultants to grow their
merchant portfolios. Sales consultants continue to earn a commission only when one of our members transacts at one of our participating merchants. We no longer anticipate that this new sales consultant compensation plan will result in decreased
sales commission rate in 2004. This change in outlook is because of the loss of some of our more experienced sales consultants and the replacement of such sales consultants with less experienced sales consultants who earn a fixed salary as part of
their compensation. We continue to include in sales commissions and expenses for the third quarter of 2004 and 2003 all costs associated with generating sales, including the cost of sales managers salaries, which in 2003 were included in
salaries and benefits.



Member and merchant marketing expenses
increased $327 or 18.9% for the third quarter of 2004 compared with the same period in 2003 primarily due to increases in the compensation we paid to loyalty program partners and bonus incentive rewards paid to our members.



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(dollar amounts in thousands except average transaction amounts and per
share data)(Continued)



Printing and postage expenses decreased $153 or 11.7% for the third quarter of 2004 compared with the
same period in 2003. This is primarily due to the marketing initiative we began in the second half of 2003, replacing national directories with a customized, pocket-sized, eight-panel directory of restaurant listings in a members frequent
dining areas (which we call Fold-N-Go statements) for segments of our membership base. These Fold-N-Go statements are less expensive to produce and distribute than the directories.



General and administrative expenses increased $1,408 or 31.5% for the third
quarter of 2004 compared with the same period in 2003. The increase is primarily the result of an impairment of $500 on an investment in a development stage entity, increases in professional fees primarily related to compliance with the
Sarbanes-Oxley Act and legal matters and rent and other office expenses related to our option to increase the space rented in the Chicago executive offices.



Interest expense and financing costs related to our securitization facility and convertible subordinated debentures increased $168 or 31.8% for the third
quarter of 2004 compared to the same period in 2003. The increase in our interest expense is a result of our having an additional $10,000 of debt outstanding in the third quarter of 2004 compared to the third quarter of 2003 and a fixed interest
rate on our convertible subordinated debentures that were outstanding in the third quarter of 2004 that is higher than the floating rate on the securitization facility under which we had outstanding debt in the third quarter of 2003.



Our effective tax rate for the third quarter of 2004 was 40.4% compared with
39.5% for the third quarter of 2003 due to the increase in the weighted average effective state tax rate resulting from a shift in the apportionment factors among the states in which we conduct business.



Net income decreased $1,445 or 32.6% for the third quarter of 2004 compared
with the same period in 2003. Diluted earnings per share decreased to $0.12 for the third quarter of 2004 compared to $0.17 for the third quarter of 2003, and there were 3.2% less diluted weighted average shares outstanding in the third quarter of
2004 than in the third quarter of 2003.



(b) Results of
operationsComparison of the nine months ended September 30, 2004 and 2003



The following table sets forth for the periods presented our sales, components of our costs of sales and certain other information for each of our two revenue plans.



|                              |  |                                 |         |   |                       |   |        |       |  |   |                           |   |  |                       |         |   |       |   |        |   |  |   |         |  
|----------------------------- |  | ------------------------------- | ------- | - | --------------------- | - | ------ | ----- |  | - | ------------------------- | - |  | --------------------- | ------- | - | ----- | - | ------ | - |  | - | ------- | -
|                              |  | Nine months ended September 30, |        
|                              |  | 2004                            |         |   | 2003                  |  
|                              |  | DiningCreditsPurchasePlan       |         |   | RevenueManagementPlan |   |        | Total |  |   | DiningCreditsPurchasePlan |   |  | RevenueManagementPlan |         |   | Total |  
|Qualified transaction amounts |  | $                               | 323,404 |   |                       | $ | 88,559 |       |  | $ | 411,963                   |   |  | $                     | 312,268 |   |       | $ | 77,611 |   |  | $ | 389,879 |  
|                              |  |                                 |         |   |                       |  
|Sales yield                   |  |                                 | 75.6    | % |                       |   | 24.4   | %     |  |   | 64.6                      | % |  |                       | 76.5    | % |       |   | 27.0   | % |  |   | 66.6    | %
|                              |  |                                 |         |   |                       |  
|Sales                         |  |                                 | 244,437 |   |                       |   | 21,610 |       |  |   | 266,047                   |   |  |                       | 238,856 |   |       |   | 20,938 |   |  |   | 259,794 |  
|                              |  |                                 |         |   |                       |  
|Cost of dining credits        |  |                                 | 127,330 |   |                       |   |       |       |  |   | 127,330                   |   |  |                       | 124,199 |   |       |   |       |   |  |   | 124,199 |  
|Processing fee                |  |                                 | 849     |   |                       |   | 75     |       |  |   | 924                       |   |  |                       | 865     |   |       |   | 76     |   |  |   | 941     |  
|                              |  |                                 |         |   |                       |   |        |       |  |   |                           |   |  |                       |         |   |       |   |        |   |  |   |         |  
|Cost of sales                 |  | $                               | 128,179 |   |                       | $ | 75     |       |  | $ | 128,254                   |   |  | $                     | 125,064 |   |       | $ | 76     |   |  | $ | 125,140 |  
|                              |  |                                 |         |   |                       |   |        |       |  |   |                           |   |  |                       |         |   |       |   |        |   |  |   |         |  
|Provision for losses          |  |                                 | 14,576  |   |                       |   |       |       |  |   | 14,576                    |   |  |                       | 13,143  |   |       |   |       |   |  |   | 13,143  |  
|                              |  |                                 |         |   |                       |  
|Member rewards and savings    |  |                                 |         |   |                       |   |        |       |  |   | 50,596                    |   |  |                       |         |   |       |   |        |   |  |   | 53,304  |  
|                              |  |                                 |         |   |                       |   |        |       |  |   |                           |   |  |                       |         |   |       |   |        |   |  |   |         |  
|Net revenue                   |  |                                 |         |   |                       |   |        |       |  | $ | 72,621                    |   |  |                       |         |   |       |   |        |   |  | $ | 68,207  |  
|                              |  |                                 |         |   |                       |   |        |       |  |   |                           |   |  |                       |         |   |       |   |        |   |  |   |         |  



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(dollar amounts in thousands except average transaction amounts and per
share data)(Continued)



As more fully discussed below, sales and net revenue for the nine months ended September 30, 2004
increased primarily from an increase in the number of active member accounts and qualified transactions and a reduction in the rate of rewards paid to our members, partially offset by a decrease in the average transaction amount and an increase in
the provision for losses.



Qualified transaction amounts at our
participating merchants (which are transactions where our members are entitled to receive rewards or savings) rose 5.7% for the nine months ended September 30, 2004 as compared to the same period in 2003. A decrease in the average transaction amount
to $48.89 for the nine months ended September 30, 2004 from $50.53 for the same period in 2003 was more than offset by the increase in number of transactions, which increased by 9.2% to approximately 8,426 during the nine months ended September 30,
2004 as compared with 7,716 for the nine months ended September 30, 2003. Included in qualified transaction amounts were dining qualified transaction amounts which increased to $404,630 for the nine months ended September 30, 2004 compared with
$389,303 for the nine months ended September 30, 2003. However, the average dining transaction amount decreased 4.5% to $48.22 for the nine months ended September 30, 2004 compared with $50.47 for the nine months ended September 30, 2003. Hotel
qualified transaction amounts increased to $7,003 for the nine months ended September 30, 2004 compared with $575 for the nine months ended September 30, 2003 and the average hotel transaction amount decreased to $251.20 for the nine months ended
September 30, 2004 compared with $292.57 for the nine months ended September 30, 2003. The increase in the number of transactions was primarily the result of a 12.7% increase in the number of our active member accounts at September 30, 2004 as
compared with September 30, 2003. An active member account is an account with at least one qualified transaction with one of our participating merchants during the previous 12 months. The lower average dining transaction amount in the nine months
ended September 30, 2004 compared to the nine months ended September 30, 2003 was due to a number of factors, including the replacement of some restaurant merchants in our programs with restaurant merchants with lower menu prices, our expansion into
secondary markets where the average transaction amount is lower, decreased sales in some large primary markets and increased weekday revenues where transaction amounts tend to be slightly lower. We believe that the lower average hotel transaction
amount in the nine months ended September 30, 2004 compared with the nine months ended September 30, 2003 was due to the availability in 2004 of over 10,000 additional hotels as compared with 2003 and generally lower room rates at the hotels in this
larger offering.



Sales yield, which represents sales as a
percentage of qualified transaction amounts, decreased to 64.6% for the nine months ended September 30, 2004 compared with 66.6% for the nine months ended September 30, 2003. The decline in the sales yield reflects the changing mix in business
propositions marketed to our merchants. We continue to work to improve restaurant merchant products to meet the needs of new merchants and reduce attrition of existing merchants. Many of these products have more favorable business propositions to
our merchants and have resulted in lower sales yield from Dining Credit Purchase Plan and Revenue Management Plan qualified transaction amounts. For the nine months ended September 30, 2004, Revenue Management Plan qualified transaction amounts
increased 14.1% to $88,559 when compared with the same period in 2003. Although dining qualified transaction amounts included in the total qualified transaction amount increased $15,326 to $404,631 for the nine months ended September 30, 2004
compared with $389,304 for the nine months ended September 30, 2003, the 2004 period amount represented 98.2% of total qualified transaction amount compared with 99.9% of total qualified transaction amount for the nine months ended September 30,
2003. Dining qualified transactions typically have a higher sales yield than hotel qualified transactions. Hotel qualified transaction amounts increased $6,428 to $7,003 for the nine months ended September 30, 2004 compared with $575 for the nine
months ended September 30, 2003. We expect that all of our future product lines such as our retail rewards program will be of a Revenue Management nature, which results in a lower sales yield than Dining Credit Purchase Plan qualified transactions.



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REWARDS NETWORK INC. AND SUBSIDIARIES



(dollar amounts in thousands except average transaction amounts and per
share data)(Continued)



We expect that in the future our sales yield percentage will further decline as qualified
transactions from our Revenue Management Plan represent a larger percentage of our total qualified transactions, as our hotel qualified transaction amounts increase, and to the extent we offer our restaurant merchants more favorable economics to
address the increased rate of attrition we have been experiencing and to attract new restaurant merchants. To the extent that we are successful in reducing restaurant merchant attrition and attracting new restaurant merchants, the increased sales
that result from having more restaurant merchants will offset the lower sales yield.



Sales for the nine months ended September 30, 2004 increased $6,253 or 2.4% when compared to the same period in 2003, primarily as a result of an increase in the number of active member accounts. We have increased the
number of active member accounts enrolled through our airline relationships. In the nine months ended September 30, 2004, we also had a 60.4% increase in active member accounts enrolled through other existing partner loyalty programs.



Cost of sales, which is composed of the cost of dining credits and related
processing fees, remained fairly stable at 48.2% of sales during the nine months ended September 30, 2004 and 2003. Sales under our Revenue Management Plan remained stable at 8.1% of total sales for the nine months ended September 30, 2004 and 2003.
There is no cost of sales associated with sales under our Revenue Management Plan and any change in these sales as a percentage of total sales would result in a change in the total cost of sales percentage.



The provision for losses increased to 5.5% of total sales and 6.0% of Dining
Credits Purchase Plan sales for the nine months ended September 30, 2004 compared to 5.1% of sales and 5.5% of Dining Credits Purchase Plan sales for the same period in 2003. This increase is primarily attributable to an adjustment to increase the
balance sheet allowance, an amount that is determined by an analysis based on a number of factors, including the aging of the Rights to Receive and the overall size of the portfolio.



Member rewards and savings decreased to 19.0% of sales for the nine months ended September 30, 2004 compared to 20.5% of
sales for the same period in 2003. There are two primary reasons for the decrease in the rate of rewards during the 2004 period. First, in some cases, as part of the changes in merchant business deal economics, we have reduced member benefit levels.
Secondly, we have commenced a program of variable benefits where some of our members rewards and savings are tied to their level of participation in our programs. The reduced rate of rewards paid to less engaged members has resulted in a lower
overall effective rate of reward earned by our total membership base.



Membership fees and other income decreased $933 or 25.4% for the nine months ended September 30, 2004 compared with the same period in 2003. The decrease can be mainly attributed to the decline in membership fee income and reflects the
continuing effects of a change in our marketing strategy. In the fourth quarter of 1999, we reduced our marketing of the fee-based membership due to changes in the regulatory environment regarding direct marketing solicitations and we shifted our
marketing strategy to focus mainly on marketing a no-fee dining program to key affinity and loyalty partners where we could take advantage of the registered card platform and enroll large quantities of accounts at a reduced cost of acquisition and
solicitation.



Salaries and benefits increased $2,067 or 17.4%
for the nine months ended September 30, 2004 compared with the same period in 2003 primarily due to a planned increase in the number of employees, annual merit increases and higher employee benefit costs. These increases were partially offset by a
$933 reduction in management incentive compensation for the nine months ended September 30, 2004 compared with the same period in 2003. The planned increase in the number of employees was principally in information technology, marketing, corporate
development and customer services. The reduced management incentive compensation expense is the result of the Company not achieving certain financial targets in 2004.



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REWARDS NETWORK INC. AND SUBSIDIARIES



(dollar amounts in thousands except average transaction amounts and per
share data)(Continued)



Sales commissions and expenses increased $273 or 1.8% for the nine months ended September 30, 2004
compared with the same period in 2003, and sales commissions and expenses amounted to 5.9% of sales for the nine months ended September 30, 2004 and 2003. Although our sales commission rate decreased during the nine months ended September 30, 2004
compared to the same period in 2003, this decrease was offset, in part, by increased expenses relating to a sales contest, sales person training, travel allowance and a national sales conference. In January 2004, we changed our sales
consultants compensation plan to increase the incentive for sales consultants to grow their merchant portfolios. Sales consultants continue to earn a commission only when one of our members transacts at one of our participating merchants. We
have included in sales commissions and expenses for the nine months ended September 30, 2004 and 2003 all costs associated with generating sales, including the cost of sales managers salaries, which in 2003 were included in salaries and
benefits.



Member and merchant marketing expenses increased
$1,356 or 25.3% for the nine months ended September 30, 2004 compared with the same period in 2003 primarily due to increases in the compensation we paid to loyalty program partners, in web and email promotion expenses and in bonus incentive
rewards paid to our members. In addition, during the first quarter of 2003 we terminated a media marketing purchase commitment with one of our partners. As a result, $448 of previously accrued compensation to this loyalty partner was eliminated.



Printing and postage expenses decreased $1,412 or 29.6% for
the nine months ended September 30, 2004 compared with the same period in 2003. This is primarily due to the marketing initiative we began in the second half of 2003, replacing national directories with a customized, pocket-sized, eight-panel
directory of restaurant listings in a members frequent dining areas (which we call Fold-N-Go statements) for segments of our membership base. These Fold-N-Go statements are less expensive to produce and distribute than the
directories.



General and administrative expenses increased
$1,703 or 12.2% for the nine months ended September 30, 2004 compared with the same period in 2003. However, during the nine months ended September 30, 2004, we had severance costs of $88 compared with $421 during the nine months ended September 30,
2003. Excluding the impact of severance expenses, general and administrative expenses increased $2,036 for the nine months ended September 30, 2004. The increase is primarily the result of an impairment on an investment in a development stage entity
and increases in professional fees primarily related to compliance with the Sarbanes-Oxley Act and legal matters, rent and other office expenses primarily related to the exercise of our option to increase the space rented for the Chicago executive
offices, programming and systems primarily related to the redesign of our websites and telephone expenses related to rate increases. These increases were partly offset by lower recruiting costs during the nine months ended September 30, 2004
compared with the same period in 2003.



Interest expense and
financing costs related to our securitization facility and convertible subordinated debentures increased $934 or 63.4% for the nine months ended September 30, 2004 compared to the same period in 2003. The increase in our interest expense is a result
of our having an additional $10,000 of debt outstanding in the nine months ended September 30, 2004 compared to the nine months ended September 30, 2003 and a fixed interest rate on our convertible subordinated debentures that were outstanding in
the nine months ended September 30, 2004 that is higher than the floating rate on the securitization facility under which we had outstanding debt in the nine months ended September 30, 2003. Additionally, we continued to amortize both the renewal
costs associated with the securitization and the issuance costs of the convertible subordinated debentures through May 2004. The costs relating to the securitization were fully amortized in May 2004.



Our effective tax rate for the nine months ended September 30, 2004 was 40.5%
compared with 39.0% for the nine months ended September 30, 2003 due to the increase in the weighted average effective state tax rate resulting from a shift in the apportionment factors among the states in which we conduct business.



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(dollar amounts in thousands except average transaction amounts and per
share data)(Continued)



Net income decreased $1,050 or 8.9% for the nine months ended September 30, 2004 compared with the
same period in 2003. There was a 1.9% increase in diluted weighted average shares outstanding in the nine months ended September 30, 2004 compared to the nine months ended September 30, 2003. The combination of the lower net income and the increase
in diluted weighted average shares resulted in a decline in diluted earnings per share to $0.42 for the nine months ended September 30, 2004 compared to $0.47 for the nine months ended September 30, 2003.



(b) Liquidity and Capital Resources



At September 30, 2004, our short-term investments, cash and cash equivalents
amounted to $4,343, and our long-term investments amounted to $9,455. Cash used in operating activities amounted to $13,511 in the nine months ended September 30, 2004 and was primarily due to the significant growth of our Rights to Receive
portfolio. During the nine months ended September 30, 2004, we purchased $25,992 in Rights to Receive.



Cash used in investing activities was $2,937 for the nine months ended September 30, 2004. During the nine months ended September 30, 2004, $6,901 of
investments were liquidated to fund operational activities and capital expenditures. Capital expenditures for the nine months ended September 30, 2004 were $3,964 and consisted primarily of website development for our products and software
development relating to our hotel and retail initiatives, our geographical expansion into Canada and the new sales compensation plan.



During the nine months ended September 30, 2004, our only source of financing cash flow was provided from the exercise of warrants and stock options.



On October 15, 2003, we completed a private placement of
$70,000 principal amount of our 31/4% 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 $67,500, and the issuance costs of $2,500 are being amortized over five years. A holder of the debentures may require us to repurchase for cash all or part of its debentures
on October 15, 2008, October 15, 2013 and October 15, 2018 or upon a change of our control at a price equal to 100% of the principal amount of the debentures, together with accrued and unpaid interest. We 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 our 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 our 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) we have 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) we make certain distributions to holders of our common stock or enter into specified corporate transactions.



On November 3, 2004, we entered into a $50 million unsecured revolving credit
facility with Bank of America, N.A. and LaSalle Bank, N.A. This facility expires on July 13, 2008.



Our working capital was $128,081 at September 30, 2004. As of the date of this quarterly report on Form 10-Q, we expect to continue to maintain a
positive working capital position. However, we cannot predict whether current trends and conditions will continue or what the effect on our business might be from events beyond our control, such as airline bankruptcies, consolidation or liquidation,
U.S. military actions, acts of terrorism or adverse litigation. We believe that investments available for sale at September 30, 2004, together with cash on hand, cash generated from operations and funds available under our new credit facility will
be sufficient to satisfy all of our funding requirements for at least the next 12 months.



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(dollar amounts in thousands except average transaction amounts and per
share data)(Continued)



(c) Business Expansion and Outlook



The following is a description of some of the initiatives that, as of the date of this quarterly report on Form 10-Q,
we are undertaking or we plan to undertake. There can be no assurance that any of the initiatives will be successful, and we undertake no obligation to, and expressly disclaim any such obligation to, update or revise any of the statements set forth
below.



In 2004, we have significantly increased the size of
the sales force and invested in their training. We have recently decided to maintain the sales force at the current level while we focus on improving the teams overall productivity. We believe that such productivity increases combined with new
products and services should result in an increase in the number of new participating restaurant merchants. Many of these restaurant merchants will be participants in the Dining Credits Purchase Plan and, therefore, we expect to use our capital to
fund this growth.



Marketing efforts in the hotel rewards
product offering will now be expanded to include approximately 600 Canadian hotels we added in October 2004. We also intend to invest in the growth of the dining product offerings in Canada that we commenced earlier this year. We anticipate that our
retail initiative will launch in December 2004 with an online mall of a group of national retailers. We expect that all of our future product lines such as retail will be of a Revenue Management nature.



The competitive environment in which we operate and an increase in the rate
of restaurant merchant attrition suggests that we will need to expand our array of product offerings to improve retention of existing restaurant merchants and attract new merchants to our program. The failure rate in the restaurant industry is quite
high. Although we experience merchant attrition due to the closing of restaurants, we also lose merchants as a result of their dissatisfaction with our programs impact on their business.



We have begun to create and deploy merchant marketing tools that are designed
to demonstrate the value of our product offerings in an effort to improve our rate of retention of restaurant merchants. Additionally, we have developed alternative marketing propositions that we believe will have broader applicability to both
independent and chain restaurant merchants and we intend to begin making these products available to our restaurant merchants in November 2004. We expect that this expanded array of product offerings will include products that result in more
favorable economics for participating restaurant merchants and, therefore, will continue to reduce our sales yield percentage.



Beginning in the second quarter of 2004, we started to implement changes to our member rewards and savings propositions. Currently, these changes consist
of reduced member benefit levels at certain merchants. Additional changes, expected to be effective during the second half of 2005, are designed to provide enhanced member benefits to some of our more active members relative to some of our less
active members and, correspondingly, reduced member benefits to some of our less active members. The tiered member benefit schedule that may result from our planned changes could continue to reduce the percentage of sales represented by member
rewards and savings.



Item 3. Quantitative and Qualitative Disclosures about Market Risk



Since December 31, 2003, there have been no changes with regard to market risk that would require further quantitative or qualitative disclosure. For our
quantitative and qualitative disclosures about market risk for the fiscal year ending December 31, 2003, refer to our annual report on Form 10-K, filed on March 12, 2004.



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REWARDS NETWORK INC. AND SUBSIDIARIES



(dollar amounts in thousands except average transaction amounts and per
share data)(Continued)



Item 4. Controls and Procedures



As of the end of the period covered by this report, our management, including our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and
procedures are effective in timely alerting them to material information required to be disclosed in our filings with the SEC. There has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act) that occurred during the period covered by this quarterly report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



PART IIOTHER INFORMATION



Item 1. Legal Proceedings



On
October 1, 2004, a complaint was filed in the United States District Court for the Eastern District of Texas against Rewards Network Inc. by Source Inc. The complaint claims that the Company is infringing four patents owned by Source Inc. The
complaint seeks among other relief, treble damages due to willful infringement and equitable relief. The Company is investigating the claims asserted by Source Inc. and believes that the complaint is without merit. The Company intends to vigorously
defend against these claims. The ultimate cost to the Company from this action is not possible to predict and may not be determined for a number of years.



Item 6. Exhibits



|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|3.1         |  | 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         |  | Form of Certificate of Designations, Preferences and Rights of Series A Preferred Stock of Transmedia Network Inc. is incorporated herein by reference to Exhibit 3.5 to Amendment No. 1 to
Transmedia Network Inc.s Registration Statement on Form S-2 (File No. 333-84947), filed on October 5, 1999.                                                                                                                                                             
|            | 
|4.2         |  | Form of Series A Preferred Stock certificate is incorporated herein by reference to Exhibit 4.1 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         |  | Form of Subscription Agreement between Transmedia Network Inc. and American Stock Transfer and Trust Company is incorporated herein by reference to Exhibit 4.2 to Amendment No. 1 to
Transmedia Network Inc.s Registration Statement on Form S-2 (File No. 333-84947), filed on October 5, 1999.                                                                                                                                                                   
|            | 
|4.4         |  | Investment Agreement, dated as of April 28, 2000, among Transmedia Network Inc., Gene M. Henderson, Herbert M. Gardner, James M. Callaghan, Gregory J. Robitaille, John A. Ward III,
George S. Wiedemann, Christine M. Donohoo, Frank F. Schmeyer, Elliot Merberg, Gerald Fleischman and Thomas J. Litle is incorporated herein by reference to Exhibit 4.7 to Transmedia Network Inc.s Annual Report on Form 10-K (File No. 001-13806),
filed on December 29, 2000.



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(dollar amounts in thousands except average transaction amounts and per
share data)(Continued)



|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                     
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                                                                                                                                                                                                                                         
|4.5         |  | Investment Agreement, dated as of April 28, 2000, among Transmedia Network Inc., Minotaur Partners II, L.P., ValueVision International Inc., Dominic Mangone and Raymond Bank is incorporated
herein by reference to Exhibit 4.5 to Transmedia Network Inc.s Annual Report on Form 10-K (File No. 001-13806), filed on December 29, 2000.                                                                                          
|            | 
|4.6         |  | First Amendment, dated February     , 2003, to that certain Investment Agreement, dated April 28, 2000, among iDine Rewards Network Inc., Minotaur Partners II, L.P.,
ValueVision International Inc., Dominic Mangone and Raymond Bank is incorporated herein by reference to Exhibit 4.8 to iDine Rewards Network Inc.s Annual Report on Form 10-K (File No. 001-13806), filed on March 31, 2003.                                 
|            | 
|4.7         |  | 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.                                                                                                                                              
|            | 
|4.8         |  | 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.                                             
|            | 
|4.9         |  | 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., 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.
|            | 
|4.10        |  | Form of Warrant to Purchase Shares of Common Stock is incorporated herein by reference to Exhibit 4.15 to Transmedia Network Inc.s Registration Statement on Form S-3 (File
No. 333-49366), filed on November 6, 2000.                                                                                                                                                                                                             
|            | 
|4.11        |  | Form of Warrant to Purchase Shares of Common Stock is incorporated herein by reference to Exhibit 4.17 to Transmedia Network Inc.s Registration Statement on Form S-3 (File
No. 333-49366), filed on November 6, 2000.                                                                                                                                                                                                             
|            | 
|4.12        |  | Form of Warrant to Purchase Shares of Common Stock is incorporated herein by reference to Exhibit 10.2 to Transmedia Network Inc.s Current Report on Form 8-K (File No. 001-13806), filed
on November 17, 1997.                                                                                                                                                                                                                    
|            | 
|4.13        |  | Indenture, dated as of October 15, 2003 and 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.                                                                                                               
|            | 
|4.14        |  | Registration Rights Agreement, dated October 8, 2003, between iDine Rewards Network Inc. and Credit Suisse First Boston LLC is incorporated herein by reference to Exhibit 4.18 to iDine
Rewards Network Inc.s Quarterly Report on Form 10-Q (File No. 001-13806), filed on November 14, 2003.                                                                                                                                     
|            | 
|10.1        |  | Lease by and between Equity Office Properties Management, as agent for Two North Riverside Plaza Joint Venture Limited Partnership, and iDine Rewards Network Inc., dated May 5, 2003 is
incorporated herein by reference to Exhibit 10.16 to iDine Rewards Network Inc.s Annual Report on Form 10-K/A (File No. 001-13806), filed on October 7, 2003.                                                                             
|            | 
|10.2        |  | Severance and Release Agreement, dated April 28, 2004, between Stephen E. Lerch and Rewards Network Inc. is incorporated herein by reference to Exhibit 10.1 to Reward Network Inc.s
Quarterly Report on Form 10-Q (File No. 001-13806), filed on May 10, 2004.                                                                                                                                                                    



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(dollar amounts in thousands except average transaction amounts and per
share data)(Continued)



|            |   |  |                                                                                                                                                                                                                                                                                                                                                             
|----------- | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |   |  | Description                                                                                                                                                                                                                                                                                                                                                 
|10.3        |   |  | Rewards Network Inc. 2004 Long-Term Incentive Plan is incorporated herein by reference to Exhibit 10.2 to Rewards Network Inc.s Quarterly Report on Form 10-Q (File No. 001-13806), filed
on August 5, 2004.                                                                                                                                               
|            |  
|10.4        |   |  | Amendment No. 1 to the Rewards Network Inc. 2004 Long-Term Incentive Plan is incorporated herein by reference to Exhibit 10.3 to Rewards Network Inc.s Quarterly Report on Form 10-Q
(File No. 001-13806), filed on August 5, 2004.                                                                                                                        
|            |  
|10.5        |   |  | Rewards Network Inc. 2004 Non-Employee Director Awards Program is incorporated herein by reference to Exhibit 10.4 to Rewards Network Inc.s Quarterly Report on Form 10-Q (File
No. 001-13806), filed on August 5, 2004.                                                                                                                                   
|            |  
|10.6        |   |  | Credit Agreement, dated as of November 3, 2004, by and among Rewards Network Inc., Bank of America, N.A., as Administrative Agent and Letter of Credit Issuer, and the other lenders party
thereto is incorporated herein by reference to Exhibit 10.1 to Rewards Network Inc.s Current Report on Form 8-K (File No. 001-13806), filed on November 4, 2004.
|            |  
|10.7        | * |  | Amendment Number One to the Rewards Network Inc. 2004 Non-Employee Director Awards Program                                                                                                                                                                                                                                                                  
|            |  
|10.8        | * |  | Lease by and between Equity Office Management, L.L.C., as indirect manager of San Felipe Plaza, Ltd.. and Rewards Network Inc., dated June 25, 2004                                                                                                                                                                                                         
|            |  
|31.1        | * |  | Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer                                                                                                                                                                                                                                                                                       
|            |  
|31.2        | * |  | Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer                                                                                                                                                                                                                                                                                       
|            |  
|32.1        | * |  | Section 1350 Certification of Chief Executive Officer                                                                                                                                                                                                                                                                                                       
|            |  
|32.2        | * |  | Section 1350 Certification of Chief Financial Officer                                                                                                                                                                                                                                                                                                       
|            |  
|99.1        | * |  | Cautionary Statements                                                                                                                                                                                                                                                                                                                                       

---

|* | Filed herewith
|- | --------------



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REWARDS NETWORK INC. AND SUBSIDIARIES



(dollar amounts in thousands except average transaction amounts and per
share data)(Continued)



SIGNATURES



Pursuant to the
requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



|                 |  |                                                                                                                                                               
|---------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|                 |  | REWARDS NETWORK INC.                                                                                                                                          
|                 | 
|November 8, 2004 |  | /s/    KENNETH R.
POSNER                                                                                                                                      
|                 |  | Kenneth R. Posner Senior Vice President, Finance and Administration, and Chief Financial Officer (Principal Financial Officer and on behalf of the registrant)



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REWARDS NETWORK INC. AND SUBSIDIARIES



EXHIBIT LIST



|            |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|3.1         |  | 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         |  | Form of Certificate of Designations, Preferences and Rights of Series A Preferred Stock of Transmedia Network Inc. is incorporated herein by reference to Exhibit 3.5 to Amendment No. 1 to
Transmedia Network Inc.s Registration Statement on Form S-2 (File No. 333-84947), filed on October 5, 1999.                                                                                                                                                             
|            | 
|4.2         |  | Form of Series A Preferred Stock certificate is incorporated herein by reference to Exhibit 4.1 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         |  | Form of Subscription Agreement between Transmedia Network Inc. and American Stock Transfer and Trust Company is incorporated herein by reference to Exhibit 4.2 to Amendment No. 1 to
Transmedia Network Inc.s Registration Statement on Form S-2 (File No. 333-84947), filed on October 5, 1999.                                                                                                                                                                   
|            | 
|4.4         |  | Investment Agreement, dated as of April 28, 2000, among Transmedia Network Inc., Gene M. Henderson, Herbert M. Gardner, James M. Callaghan, Gregory J. Robitaille, John A. Ward III,
George S. Wiedemann, Christine M. Donohoo, Frank F. Schmeyer, Elliot Merberg, Gerald Fleischman and Thomas J. Litle is incorporated herein by reference to Exhibit 4.7 to Transmedia Network Inc.s Annual Report on Form 10-K (File No. 001-13806),
filed on December 29, 2000.
|            | 
|4.5         |  | Investment Agreement, dated as of April 28, 2000, among Transmedia Network Inc., Minotaur Partners II, L.P., ValueVision International Inc., Dominic Mangone and Raymond Bank is incorporated
herein by reference to Exhibit 4.5 to Transmedia Network Inc.s Annual Report on Form 10-K (File No. 001-13806), filed on December 29, 2000.                                                                                                                           
|            | 
|4.6         |  | First Amendment, dated February     , 2003, to that certain Investment Agreement, dated April 28, 2000, among iDine Rewards Network Inc., Minotaur Partners II, L.P.,
ValueVision International Inc., Dominic Mangone and Raymond Bank is incorporated herein by reference to Exhibit 4.8 to iDine Rewards Network Inc.s Annual Report on Form 10-K (File No. 001-13806), filed on March 31, 2003.                                                                  
|            | 
|4.7         |  | 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.                                                                                                                                                                               
|            | 
|4.8         |  | 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.                                                                              
|            | 
|4.9         |  | 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., 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.                                 



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##### Table of Contents

|            |  |                                                                                                                                                                                                                                                                                                                                                             
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                                                                                                                                                                 
|4.10        |  | Form of Warrant to Purchase Shares of Common Stock is incorporated herein by reference to Exhibit 4.15 to Transmedia Network Inc.s Registration Statement on Form S-3 (File
No. 333-49366), filed on November 6, 2000.                                                                                                                                     
|            | 
|4.11        |  | Form of Warrant to Purchase Shares of Common Stock is incorporated herein by reference to Exhibit 4.17 to Transmedia Network Inc.s Registration Statement on Form S-3 (File
No. 333-49366), filed on November 6, 2000.                                                                                                                                     
|            | 
|4.12        |  | Form of Warrant to Purchase Shares of Common Stock is incorporated herein by reference to Exhibit 10.2 to Transmedia Network Inc.s Current Report on Form 8-K (File No. 001-13806), filed
on November 17, 1997.                                                                                                                                            
|            | 
|4.13        |  | Indenture, dated as of October 15, 2003 and 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.                                       
|            | 
|4.14        |  | Registration Rights Agreement, dated October 8, 2003, between iDine Rewards Network Inc. and Credit Suisse First Boston LLC is incorporated herein by reference to Exhibit 4.18 to iDine
Rewards Network Inc.s Quarterly Report on Form 10-Q (File No. 001-13806), filed on November 14, 2003.                                                             
|            | 
|10.1        |  | Lease by and between Equity Office Properties Management, as agent for Two North Riverside Plaza Joint Venture Limited Partnership, and iDine Rewards Network Inc., dated May 5, 2003 is
incorporated herein by reference to Exhibit 10.16 to iDine Rewards Network Inc.s Annual Report on Form 10-K/A (File No. 001-13806), filed on October 7, 2003.     
|            | 
|10.2        |  | Severance and Release Agreement, dated April 28, 2004, between Stephen E. Lerch and Rewards Network Inc. is incorporated herein by reference to Exhibit 10.1 to Reward Network Inc.s
Quarterly Report on Form 10-Q (File No. 001-13806), filed on May 10, 2004.                                                                                            
|            | 
|10.3        |  | Rewards Network Inc. 2004 Long-Term Incentive Plan is incorporated herein by reference to Exhibit 10.2 to Rewards Network Inc.s Quarterly Report on Form 10-Q (File No. 001-13806),
filed on August 5, 2004.                                                                                                                                               
|            | 
|10.4        |  | Amendment No. 1 to the Rewards Network Inc. 2004 Long-Term Incentive Plan is incorporated herein by reference to Exhibit 10.3 to Rewards Network Inc.s Quarterly Report on Form 10-Q
(File No. 001-13806), filed on August 5, 2004.                                                                                                                        
|            | 
|10.5        |  | Rewards Network Inc. 2004 Non-Employee Director Awards Program is incorporated herein by reference to Exhibit 10.4 to Rewards Network Inc.s Quarterly Report on Form 10-Q (File
No. 001-13806), filed on August 5, 2004.                                                                                                                                   
|            | 
|10.6        |  | Credit Agreement, dated as of November 3, 2004, by and among Rewards Network Inc., Bank of America, N.A., as Administrative Agent and Letter of Credit Issuer, and the other lenders party
thereto is incorporated herein by reference to Exhibit 10.1 to Rewards Network Inc.s Current Report on Form 8-K (File No. 001-13806), filed on November 4, 2004.
|            | 
|10.7*       |  | Amendment Number One to the Rewards Network Inc. 2004 Non-Employee Director Awards Program                                                                                                                                                                                                                                                                  
|            | 
|10.8*       |  | Lease by and between Equity Office Management, L.L.C., as indirect manager of San Felipe Plaza, Ltd. and Rewards Network Inc., dated June 25, 2004                                                                                                                                                                                                          
|            | 
|31.1*       |  | Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer                                                                                                                                                                                                                                                                                       
|            | 
|31.2*       |  | Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer                                                                                                                                                                                                                                                                                       
|            | 
|32.1*       |  | Section 1350 Certification of Chief Executive Officer                                                                                                                                                                                                                                                                                                       
|            | 
|32.2*       |  | Section 1350 Certification of Chief Financial Officer                                                                                                                                                                                                                                                                                                       
|            | 
|99.1*       |  | Cautionary Statements                                                                                                                                                                                                                                                                                                                                       

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|* | Filed herewith
|- | --------------