RAINMAKER SYSTEMS INC - 10-Q Quarterly Report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2002

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 000-28009

RAINMAKER SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

Delaware		33-0442860
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

1800 Green Hills Road

Scotts Valley, California 95066

(address of principal executive offices) (zip code)

Registrant’s telephone number, including area code: (831) 430-3800

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.

(1) Yes x No ¨

(2) Yes x No ¨

As of October 31, 2002, there were 38,764,783 shares of the registrant’s Common Stock outstanding.

RAINMAKER SYSTEMS, INC.

FORM 10-Q

AS OF AND FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002

TABLE OF CONTENTS

		Page

PART I.	FINANCIAL INFORMATION

Item 1.	Interim Financial Statements:

	Balance Sheets–September 30, 2002 and December 31, 2001	3

	Statements of Operations–Three and Nine Months Ended September 30, 2002 and 2001	4

	Statements of Cash Flows–Nine Months Ended September 30, 2002 and 2001	5

	Notes to Interim Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11

Item 3.	Qualitative and Quantitative Disclosures About Market Risk	25

Item 4.	Controls and Procedures	25

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	26

Item 2.	Changes in Securities and Use of Proceeds	26

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

	Signatures	27

	Certifications	28

PART I.—FINANCIAL INFORMATION

ITEM 1. INTERIM FINANCIAL STATEMENTS

RAINMAKER SYSTEMS, INC.

BALANCE SHEETS

(In thousands, except share data)

	September 30, 2002			December 31, 2001 *
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	8,167		$	8,606
Accounts receivable, less allowance for doubtful
accounts of $342 in 2002 and $410 in 2001		5,508			4,778
Prepaid expenses and other current assets		818			1,167

Total current assets		14,493			14,551
Property and equipment, net		3,774			5,075
Other noncurrent assets		72			284

Total assets	$	18,339		$	19,910


LIABILITIES AND EQUITY
Current liabilities:
Accounts payable	$	8,304		$	4,855
Payable to related parties		—			861
Accrued compensation and benefits		585			758
Accrued restructuring and related charges		332			552
Other accrued liabilities		1,174			1,213
Current portion of capital lease obligations		641			713

Total current liabilities		11,036			8,952
Capital lease obligations, less current portion		100			305
Accrued restructuring and other related charges, less current portion		152			369

Stockholders’ equity:
Preferred stock, $0.001 par value; 20,000,000 shares authorized, none issued and outstanding		—			—
Common stock, $0.001 par value; 80,000,000 shares authorized, 38,678,169 and 38,417,625 outstanding at Sept. 30, 2002 and Dec. 31, 2001, respectively		38			38
Additional paid-in capital		56,705			56,676
Accumulated other comprehensive income/(loss)		(3	)		45
Accumulated deficit		(49,689	)		(46,475	)

Total stockholders’ equity		7,051			10,284

Total liabilities and stockholders’ equity	$	18,339		$	19,910

Derived from the Company’s audited financial statements for the year ended December 31, 2001.

The accompanying notes are an integral part of these financial statements.

RAINMAKER SYSTEMS, INC.

STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2002			2001			2002			2001
CRM services revenue	$	10,626		$	9,836		$	28,835		$	32,814
Cost of CRM services revenue		7,606			6,615			20,777			22,586

CRM services gross profit		3,020			3,221			8,058			10,228
Selling, general and administrative expenses		3,676			5,702			11,487			20,972
Recoveries of restructuring and other related charges		(35	)		—			(35	)		—

Operating loss		(621	)		(2,481	)		(3,394	)		(10,744	)
Interest income, net		11			58			34			363

Loss before income taxes		(610	)		(2,423	)		(3,360	)		(10,381	)
Income Tax benefit		—			—			(146	)		—

Net loss	$	(610	)	$	(2,423	)	$	(3,214	)	$	(10,381	)

Basic and diluted net loss per share	$	(0.02	)	$	(0.06	)	$	(0.08	)	$	(0.27	)

Weighted average common shares
outstanding—basic and diluted		38,678			37,956			38,647			37,958

The accompanying notes are an integral part of these financial statements.

RAINMAKER SYSTEMS, INC.

STATEMENTS OF CASH FLOW

(In thousands)

(Unaudited)

	Nine Months Ended September 30,
	2002			2001
Operating activities:
Net loss	$	(3,214	)	$	(10,381	)
Adjustment to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization of property and equipment		1,509			2,237
Amortization of deferred stock compensation		—			231
Provision (credit) for sales returns and allowances		(68	)		(15	)
Recoveries of restructuring and other related charges		(35	)		—
Changes in operating assets and liabilities:
Accounts receivable		(662	)		3,377
Inventories		(19	)		372
Income taxes receivable		(146	)		2
Prepaid expenses and other assets		670			523
Other receivables		(4	)		507
Accounts payable		3,449			(4,007	)
Accounts payable to related party		(861	)		(373	)
Accrued compensation and benefits		(173	)		(1,585	)
Accrued restructuring and related charges		(402	)		—
Other accrued liabilities		(39	)		(1,291	)

Net cash provided by (used in) operating activities		5			(10,403	)

Investing activities:
Purchases of property and equipment		(33	)		(754	)
Sale of long-term investments		130			—

Net cash provided by (used in) investing activities		97			(754	)

Financing activities:
Proceeds from issuance of common stock from option exercises		26			84
Proceeds from issuance of common stock from ESPP		6			50
Repurchase of common stock		(3	)		(1,194	)
Repayment of capital lease obligations		(570	)		(989	)

Net cash used in financing activities		(541	)		(2,049	)

Net decrease in cash and cash equivalents		(439	)		(13,206	)
Cash and cash equivalents at beginning of period		8,606			22,879

Cash and cash equivalents at end of period	$	8,167		$	9,673

Supplement disclosure of cash paid during the period:
Interest	$	66		$	131

Income taxes, net of refunds	$	—		$	—

Supplemental non-cash investing and financing activities:
Acquisition of assets under capital lease	$	167		$	—

Purchase of prepaid maintenance contracts under lease	$	126		$	—

The accompanying notes are an integral part of these financial statements.

RAINMAKER SYSTEMS, INC.

NOTES TO INTERIM FINANCIAL STATEMENTS

— UNAUDITED —

NOTE 1: BASIS OF PRESENTATION

The accompanying financial statements of Rainmaker Systems, Inc. (“Rainmaker”) have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The interim financial statements are unaudited but reflect all normal recurring adjustments which are, in the opinion of management, necessary for the fair presentation of the results of these periods. The results of operations for the three and nine months ended September 30, 2002 are not necessarily indicative of results to be expected for the year ending December 31, 2002, or any other period. These financial statements should be read in conjunction with Rainmaker’s financial statements and notes thereto included in Rainmaker’s Annual Report on Form 10-K for the year ended December 31, 2001 and our Forms 10-Q for the quarters ended March 31, 2002 and June 30, 2002.

The preparation of financial statements in conformity with generally accepted accounting practices requires management to make estimates and assumptions that affect the amounts reported in the unaudited financial statements and accompanying notes. Actual results could differ from those estimates.

Recently Issued Accounting Standards

In November 2001, the Financial Accounting Standards Board (“FASB”) issued a Staff Announcement (the “Announcement”), Topic D-103, which concluded that the reimbursement of “out-of-pocket” expenses should be classified as revenue in the statement of operations. This Announcement should be applied in financial reporting periods beginning after December 15, 2001. Upon application of this Announcement, comparative financial statements for prior periods should be reclassified to comply with the guidance in this Announcement. Rainmaker previously recorded reimbursement of “out-of-pocket” expenses in cost of services. Effective January 1, 2002, Rainmaker adopted the Announcement. The adoption of the Announcement had no significant impact on our results of operation and on our comparative financial statements for prior periods.

In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”). SFAS 146 nullifies Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)” (“EITF 94-3”). The principle difference between SFAS 146 and EITF 94-3 relates to its requirement for recognition of a liability for a cost associated with an exit or disposal activity. This statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost as defined in EITF 94-3 was recognized at the date of an entity’s commitment to an exit plan. This statement also establishes that fair value is the objective for initial measurement of the liability. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. We do not expect adoption of SFAS 146 will have a material impact on our financial statements.

NOTE 2: REVENUE RECOGNITION AND PRESENTATION

Revenue from the sale of service contracts and maintenance renewals is recognized when a purchase order from the end user customer is received; the service contract or maintenance agreement is delivered; the fee is fixed or determinable; the collection of the receivable is reasonably assured; and no significant post-delivery obligations remain. Revenue from product sales is recognized at the time of shipment of the product directly to the customer. Revenue from services we perform is recognized as the services are delivered. Fee based pricing revenue is recognized once these services have been delivered. Substantially all of our sales transactions are reported under the “gross” method, which is based on the total purchase price billed by us to customers for our clients’ products and services. We also sell products and services on behalf of our clients whereby we record revenue net, equal to the amount earned in the transaction.

In December 1999, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 101 “Revenue Recognition” (“SAB 101”), which provides guidance on the recognition, presentation and disclosure of revenue in financial statements filed with the SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosures related to revenue recognition policies. The adoption of SAB 101 did not have a material impact on our revenue or results of operations.

Concurrent with the adoption of SAB 101, Rainmaker also adopted the Financial Accounting Standards Board’s Emerging Issues Task Force Issue No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent” (“EITF 99-19”). EITF 99-19 interprets SAB 101 and addresses when a company should report revenue as the gross amount billed to a customer versus the net amount earned by the company in the transaction. Specific “indicators” should be used by companies to determine if it is more appropriate to record revenues on a “gross” versus a “net” basis. These “indicators” include, but are not limited to, (1) whether the vendor is the primary obligor in the transaction, (2) whether the vendor assumes general inventory risk, and (3) whether the vendor has latitude for setting the pricing for the goods or services it sells to its customers. Absence of these indicators might indicate that revenue should be recorded on a “net” basis. If our revenues were recorded on a net basis, they would essentially equal our currently reported gross profit. A substantial amount of our sales transactions are reported under the “gross” method based on amounts billed to our customers, as we take title and assume risk of loss for products/service contracts sold and assume the full credit risk and establish pricing for the products and services we sell. However, we also sell products and services on behalf of customers of our clients whereby, based on the evaluation of the same indicators, we record revenue equal to the net amount earned in the transaction. Our current revenue reporting practices are consistent with the revenue reporting criteria established in EITF 99-19. The adoption of EITF 99-19 did not have a material impact on our reported revenues.

NOTE 3: NET LOSS PER SHARE

Basic net loss per share has been computed using the weighted-average number of shares of common stock outstanding during the year, less shares subject to repurchase. Diluted net loss per share also gives effect, as applicable, to the potential dilutive effect of outstanding stock options, using the if converted method, as of the beginning of the period presented or the original date of issuance, if later. Rainmaker has excluded all outstanding options and shares subject to repurchase from the calculation of diluted net loss per share because all such securities are anti-dilutive. Options to purchase 4,350,391 and 4,349,419 shares of common stock were outstanding at September 30, 2002 and December 31, 2001, respectively. At September 30, 2002 and December 31, 2001, there were 461 and 4,708, respectively, of common shares subject to repurchase.

NOTE 4: COMPREHENSIVE LOSS

The primary difference between net loss and comprehensive loss for Rainmaker arises from unrealized gains/(losses) on investments classified as available-for-sale. For the three months and nine months ended September 30, 2002, the net change in unrealized holding loss on investments was approximately $4,000 and $48,000, respectively. Comprehensive loss for Rainmaker for the three and nine months ended September 30, 2002 was $614,000 and $3.3 million, respectively.

NOTE 5: ACCRUED RESTRUCTURING AND OTHER RELATED CHARGES

During the fourth quarter of 2001, we recorded restructuring and other related charges of $2.4 million or $0.06 per share in connection with a restructuring program approved by the Board of Directors during the quarter. This resulted in a reduction of 39 positions at all levels throughout Rainmaker, for which the total annual salary at the date of termination was approximately $2.6 million. All affected employees were informed of the reduction and their severance amounts prior to December 31, 2001. The charges consisted of cash severance payments to be made to severed employees, lease payments related to property abandoned as a result of our facilities consolidation, write-offs of excess equipment and leasehold improvements that were abandoned and whose estimated fair market value was zero, and discontinued use of internally developed and licensed software.

During the three months ended June 30, 2002, we made an adjustment to the provision for higher than anticipated legal and severance costs, and lower than anticipated facility exit costs. There was no incremental effect to the provision as a result of this adjustment.

As of September 30, 2002, all severance and legal costs related to the restructuring had been paid and there were no remaining obligations for severance or legal costs related to the restructuring. Accordingly, in the three months ended September 30, 2002, we recorded a benefit of $35,000 to reverse the remaining accrued restructuring liability related to severance and legal costs. This amount was reported as “Recoveries of restructuring and other related charges” and is included in operating expenses in our statement of operations.

The following table lists the activity related to restructuring accruals (short and long-term) by quarter for the nine months ended September 30, 2002 (in thousands):

	Employee Severance			Lease Cancellation and Facility Exit Costs			Legal and Other Expenses			Subtotal			Less Current Portion			Accrued Restructuring Costs Less Current Portion
Balance at December 31, 2001	$	26		$	877		$	18		$	921		$	552		$	369
Less cash payments		(1	)		(144	)		(18	)		(163	)		(73	)		(90	)

Balance at March 31, 2002		25			733			—			758			479			279
Adjustment to reserve		6			(66	)		60			—			—			—
Less cash payments		—			(100	)		(56	)		(156	)		(65	)		(91	)

Balance at June 30, 2002		31			567			4			602			414			188
Adjustment to reserve		(31	)		—			(4	)		(35	)		(35	)		—
Less cash payments		—			(83	)		—			(83	)		(47	)		(36	)

Balance at September 30, 2002	$	—		$	484		$	—		$	484		$	332		$	152

NOTE 6: STOCK OPTION EXCHANGE PROGRAM

On November 30, 2001, we announced a voluntary stock option exchange program for our employees. Under the program, Rainmaker employees were given the opportunity, if they chose, to cancel outstanding stock options previously granted to them in exchange for an equal number of replacement options to be granted at a future date at least six months and one day from the cancellation date, which was January 24, 2002. Rainmaker employees were required to remain employed with Rainmaker at the date of the replacement grant in order to receive replacement options. Non-employee members of our Board of Directors were not eligible to participate in this program. Under the exchange program, options for approximately 2.5 million shares of our common stock were tendered and cancelled.

On July 25, 2002, pursuant to the voluntary employee stock option exchange program, each participating employee received, for each option included in the exchange, a one-for-one replacement option. Under the exchange program, Rainmaker issued approximately 2.4 million shares of replacement options. The exercise price of each replacement option was $0.23, equal to the closing selling price per share of our common stock on the trading day immediately before day of grant, which was the highest of (i) the closing selling price per share of our common stock on the trading day immediately before day of grant, (ii) the average of the high and low per share sales price on day of grant and (iii) the closing selling price per share on day of grant, as quoted on Nasdaq or on the OTC Bulletin Board. The replacement options have terms and conditions that are substantially the same as those of the canceled options. The exchange program did not result in any compensation charges.

NOTE 7: SEGMENT REPORTING

Rainmaker operates in one market segment, the sale of software and other technology companies’ support contracts and software subscriptions to their installed base of customers. Rainmaker primarily operates in one

geographical segment, North America. Substantially all of Rainmaker’s sales are made to customers in the United States.

NOTE 8: INCOME TAX BENEFIT

In March 2002, the Internal Revenue Service issued the Job Creation and Worker Assistance Act of 2002 which extended the regular and alternative minimum tax net operating loss carryback period from two years to five years for losses arising in 2001 or 2002 tax years. As a result of this new law, Rainmaker recorded an income tax benefit of $146,000 during the three months ended March 31, 2002, attributable to the recovery of income taxes paid in prior periods.

NOTE 9: RELATED PARTY TRANSACTIONS

In prior years and during the three and six months ended June 30, 2002, Rainmaker purchased inventories and service agreements from a customer who had a board member who also sits on Rainmaker’s Board of Directors. As of June 28, 2002, this board member was no longer on the board of Rainmaker’s customer, and accordingly, Rainmaker’s outstanding payables to that customer as of September 30, 2002 have been included in our balance sheet as a component of accounts payable. Total purchases from such customer during the six months ended June 30, 2002, the period during which it was a related party, amounted to $1.1 million. During the same six-month period, Rainmaker received marketing development fund reimbursements of $32,000 from that customer.

In February of 2002, Rainmaker entered into an agreement with a member of its Board of Directors to procure consulting services. The agreement had a two-month term commencing February 2002, with minimum cash compensation to the board member of $53,000, based upon specific deliverables during the term. As of September 30, 2002, the Company had recorded and paid all $53,000 of consulting fees related to this agreement and the consulting agreement has expired pursuant to its terms.

NOTE 10: COMMITMENTS AND CONTINGENCIES

Rainmaker leases office space and property and equipment under operating and capital leases that expire at various dates through 2006. Future minimum lease payments under non-cancelable operating and capital lease arrangements at September 30, 2002 are as follows:

	Capital Leases		Operating Leases		Total
	(in thousands)
2002	$	298	$	178	$	476
2003		425		620		1,045
2004		45		391		436
2005		12		46		58
2006		—		5		5

Total minimum lease payments	$	780	$	1,240	$	2,020

During the quarter ended September 30, 2002, we entered into four separate capital leases for various software, equipment and maintenance services. The leases, of which two have subjective acceleration clauses, have terms ranging from 12 to 36 months. Future minimum payments under these leases are $87,000 in the remainder of 2002, $80,000 in 2003, $32,000 in 2004 and $12,000 in 2005.

In June 2002 and September 2002, we entered into two separate letters of credit in the original amounts of $89,000 and $124,000, respectively, to secure two of the capital leases. These letters of credit will decline over time, in accordance with the remaining balance payable under the financing which they secure. As of September 30, 2002, these letters of credit have current values of $89,000 and $124,000, respectively. On October 1, 2002, the current value of the June 2002 letter of credit was reduced from $89,000 to $67,000.

In December 2001, we obtained a standby letter of credit in the original amount of $552,000 to secure financing for our Directors & Officers insurance premiums, which will be paid prior to the end of the 2002 fiscal year. This letter of credit declines over time, in accordance with the remaining balance payable under the financing which it secures. As of September 30, 2002, this letter of credit had a current value of $123,000. On October 17, 2002, the current value of this letter of credit was reduced to $61,000.

We do not have commercial commitments under lines of credit, guarantees, standby repurchase obligations or other such arrangements.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Form 10-Q contains forward-looking statements in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may”, “will”, “should”, “expects”, “plans”, “anticipates”, “believes”, “estimates”, “predicts”, “potential” or “continue” or the negative of such terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, including the risks outlined under “Factors That May Affect Future Results and Market Price of Stock”, that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activities, performance or achievements expressed or implied by such forward-looking statements.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of such statements.

Overview

Rainmaker Systems, Inc. (“Rainmaker”) is a leading outsource provider of sales and marketing programs. Rainmaker’s cost-effective programs generate service revenue and promote customer retention for its clients. Core services include professional telesales, direct marketing, and hosted e-commerce. Additional services include customer database enhancement, CRM technology integration, and order management. These services are available individually or as an integrated solution. By integrating technology, processes and people, Rainmaker provides a transparent customer relationship infrastructure for its clients.

We incurred operating losses and net losses for the three and nine months ended September 30, 2002 and for the fiscal years ended 2001, 2000, and 1999. During 1999 and 2000, we incurred increasing operating and net losses as we increased our operating expenses to build our services business. New clients require significant up-front investments including the costs to hire additional staff and create the necessary infrastructure to deliver our services. These costs are typically incurred some time before significant revenue is generated. In late 2000, we repackaged our service offering to include fee-based pricing. Revenue is recognized once these services have been delivered. We now charge for many of these costs; however, these costs could have an adverse effect on our future financial condition and operating results, depending on market acceptance of new service combinations and pricing options.

Our quarterly operating results may continue to fluctuate in the future based on a number of factors, many of which are beyond our control. We believe that period-to-period comparisons of operating results should not be relied upon as predictive of future performance. Our operating results are expected to vary significantly from quarter to quarter and are difficult to predict. Our historical revenue has tended to fluctuate based on seasonal buying patterns in the computer industry. Our prospects must be considered in light of the risks, expenses and difficulties encountered by high-technology companies, particularly given that we operate in new and rapidly evolving markets, and face an uncertain economic environment. We may not be successful in addressing such risks and difficulties. In the second quarter of 2000, we began a review of our existing client base, as well as our client targeting process and methodology. As a result, in the last half of 2000 and during 2001, we discontinued reselling certain client products and services, which resulted in a lower base of revenues. See “Factors That May Affect Future Results and Market Price of Stock.”

Critical Accounting Policies and Estimates

Accounting policies, methods and estimates are an integral part of the financial statements prepared by management and are based upon management’s current judgments. Those judgments are normally based on knowledge and experience with regard to past and current events and assumptions about future events. Certain accounting policies, methods and estimates are particularly sensitive because of their significance to the financial statements and because of the possibility that future events affecting them may differ markedly from management’s current judgments. Actual results may differ from these estimates under different assumptions or conditions. While there are a number of accounting policies, methods and estimates affecting our financial statements, areas that are

particularly significant include revenue recognition policies, valuation of accounts receivable, the assessment of recoverability and measuring impairment of fixed assets, and recognition of restructuring reserves.

Revenue Recognition and Classification

Our CRM services revenue consists of sales of our clients’ software subscriptions, support and service contracts, licenses and license upgrades to our clients’ installed customer base. A substantial portion of our sales transactions are reported under the “gross” method, which is based on the total purchase price billed by us to customers for our clients’ products and services. We also sell products and services on behalf of our clients whereby we record revenue equal to the net amount earned in the transaction. Revenue from the sale of service contracts and maintenance renewals is recognized when a purchase order from the end user is received; the service contract or maintenance agreement is delivered; the fee is fixed or determinable; the collection of the receivable is reasonably assured; and no significant post-delivery obligations remain. Revenue from product sales is recognized at the time of shipment of the product directly to the customer. Revenue from services we perform is recognized as the services are delivered. Revenue from sales of new clients’ products and services typically increases over several quarters before reaching a more moderate level of growth. However, revenue growth can be affected by many factors including customer contract renewal history, customer product satisfaction and competitive pricing.

Concurrent with the adoption of SAB 101, Rainmaker also adopted the Financial Accounting Standards Board’s Emerging Issues Task Force Issue No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent” (“EITF 99-19”). EITF 99-19 interprets SAB 101 and addresses when a company should report revenue as the gross amount billed to a customer versus the net amount earned by the company in the transaction. Specific “indicators” should be used by companies to determine if it is more appropriate for them to record revenues on a “gross” versus a “net” basis. These “indicators” include, but are not limited to, 1) whether the vendor is the primary obligor in the transaction, 2) whether the vendor assumes general inventory risk, and 3) whether the vendor has latitude for setting the pricing for the goods or services it sells to its customers. Absence of these indicators might indicate that revenue should be recorded on a “net” basis. If our revenues were recorded on a net basis, they would essentially equal our currently reported gross profit. A substantial amount of our sales transactions are reported under the “gross” method based on amounts billed to our customers, as we take title and assume risk of loss for products/service contracts sold and assume the full credit risk and establish pricing for the products and services we sell. However, we also sell products and services on behalf of customers of our clients whereby, based on the evaluation of the same indicators, we record revenue net equal to the amount earned in the transaction. Our current revenue reporting practices are consistent with the revenue reporting criteria established in EITF 99-19. The adoption of EITF 99-19 did not have a material impact on our reported revenues.

Our business primarily consists of marketing and selling our clients’ products and services to their existing customers. In addition, most of our revenue is based on a “pay for performance” model in which our revenue is generated by the amount of our clients’ products and services that we sell. Accordingly, if a particular client’s products and services fail to appeal to its customers for reasons beyond our control, such as preference for a competing product or service, our revenue from the sale of client’s products and services may decline.

We have generated a significant portion of our revenue from the marketing and selling of products and services from a limited number of clients. For the three and nine months ended September 30, 2002, sales to customers of HP, Nortel Networks, Inc., and Sybase, Inc. (“Sybase”) each individually accounted for 10% or more of our CRM services revenue. For the three months ended September 30, 2001, sales to customers of Sybase, HP, Santa Cruz Operation (“SCO”) and IBM each individually accounted for 10% or more of our CRM services revenue. For the nine months ended September 30, 2001, sales to customers of Sybase, HP, SCO, and Novell, Inc. each individually accounted for approximately 10% or more of our CRM services revenue. We expect that a small number of clients will continue to account for a significant portion of our revenue for the foreseeable future. The loss of any of our principal clients could cause a significant decrease in our revenue. In addition, our software and technology clients operate in industries that are consolidating, which may reduce the number of our existing and potential clients.

We focus our resources on service offerings and client relationships with which we can maintain profitable business relationships. In the past, this focus has resulted in the discontinuation of relationships with certain clients and a lower base of revenues. There is a possibility that more client relationships may be discontinued which could cause a decrease to our revenue in future periods.

Until recently, and as a result of unfavorable economic conditions in the United States, our revenue declined, and may once again decline. If the economic conditions in the United States continue to worsen or if a wider or global economic slowdown occurs, we may experience a material adverse impact on our business, operating results, and financial condition. During these unfavorable economic periods, it may be more difficult to sign new clients or expand relationships with existing clients.

Allowance for Doubtful Accounts

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments of amounts due to us. The allowance is comprised of specifically identified customer account balances for which collection is currently deemed doubtful. In addition to specifically identified accounts, estimates of amounts that may not be collectible are made based on actual historical bad debt write off experience of those accounts whose collection is not yet deemed doubtful but which may become doubtful in the future if the financial condition of our customers were to deteriorate.

Impairment of Long-lived Assets

We review all of our long-lived assets, including fixed assets, for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include, but are not limited to, significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for our overall business, significant negative industry or economic trends, a significant decline in our stock price for a sustained period, and our market capitalization relative to net book value. An asset or a group of assets is determined to be impaired if the estimated future undiscounted net cash flows attributable to the asset or group of assets are less than their carrying value. If impairment exists, it is measured by the amount of which the fair value of the assets, estimated by Rainmaker using estimated future discounted cash flows, appraisals, or other methods, is less than the asset or group of assets’ carrying value. The identification of long-lived asset impairment and the amount of impairment charges, if any, recorded in any one period, are subject to the aforementioned events and management estimates and therefore, could change in the future requiring additional charges to our operating results. We have no amounts of goodwill or intangible assets recorded on our financial statements.

Restructuring and Other Related Charges

During the fourth quarter of fiscal 2001, we restructured the company under a plan approved by the Board of Directors, by reducing our headcount and consolidating our facilities utilization. As a result of these actions, we recorded restructuring and other related charges consisting of cash severance payments to be made to severed employees, lease payments related to property abandoned as a result of our facilities consolidation, write-offs of excess equipment and leasehold improvements that were abandoned and whose estimated fair market value was zero, and discontinued use of internally developed software. Each reporting period we will review these estimates based on the status of execution of our restructuring plan and, to the extent that these assumptions change due to changes in market conditions and our business, the ultimate restructuring expenses could vary by material amounts. As of September 30, 2002, all severance and legal costs related to the restructuring had been paid and there were no remaining obligations for severance or legal costs related to the restructuring. Accordingly, in the three months ended September 30, 2002, we recorded a benefit of $35,000 to reverse the remaining accrued restructuring liability related to severance and legal costs. This amount was reported as “Recovery of restructuring and other related charges” and is included in operating expenses in our statement of operations.

Other Financial Statement Categories

Cost of revenue includes payments for our clients’ products and services based on the specific pricing terms of each contract and costs associated with fee-based revenues. Costs associated with fee-based revenues consist primarily of salaries and other personnel-related expenses. Some client relationships may be structured such that the costs of these products and services can be higher during the start up phase of our relationship with a client until higher purchase discounts are achieved from increased sales volume. In these relationships, once we integrate a client’s customer database and begin to meet targeted sales volumes, our gross margins from that client can improve. Cost of revenue also consists of the cost of products and service arrangements sold to customers, the cost of inbound and outbound shipping, net of amounts recovered from customers, and the costs of designing, producing and delivering services.

Selling, general and administrative expenses primarily include costs associated with the marketing and selling of our clients’ products and services, including client integration costs, salaries of marketing and sales personnel, technology systems and communications costs, product and service development, and administrative overhead.

Interest income, net, reflects income received on cash and cash equivalents and interest expense on leases to secure equipment and software.

Related Party Transactions

In prior years and during the three and six months ended June 30, 2002, Rainmaker purchased inventories and service agreements from a customer who had a board member who also sits on Rainmaker’s Board of Directors. As of June 28, 2002, this board member was no longer on the board of Rainmaker’s customer, and accordingly Rainmaker’s outstanding payables to that customer as of September 30, 2002 have been included in our balance sheets as a component of accounts payable. Total purchases from such customer during the six months ended June 30, 2002, the period during which it was a related party, amounted to $1.1 million. Also during that period, Rainmaker received marketing development fund reimbursements of $32,000 from that customer.

In February of 2002, Rainmaker entered into an agreement with a member of its Board of Directors to procure consulting services. The agreement had a two-month term commencing February 2002, with a minimum cash compensation to the board member of $53,000, based upon specific deliverables during the term. As of September 30, 2002, the Company had recorded and paid all $53,000 of consulting fees related to this agreement and the agreement had expired pursuant to its terms.

Results of Operations

The following table sets forth for the periods given, selected financial data as a percentage of our revenue. The table and discussion below should be read in connection with the financial statements and the notes thereto, which appear elsewhere in this report as well as with Rainmaker’s financial statements and notes thereto included in Rainmaker’s Annual Report on Form 10-K for the year ended December 31, 2001 and our Forms 10-Q for the quarters ended March 31, 2002 and June 30, 2002.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2002		2001		2002		2001
CRM services revenue	100.0	%	100.0	%	100.0	%	100.0	%
Cost of CRM services revenue	71.6	%	67.3	%	72.1	%	68.8	%

CRM services gross profit	28.4	%	32.7	%	27.9	%	31.2	%
Selling, general and administrative expenses	34.6	%	58.0	%	39.8	%	63.9	%
Recoveries of restructuring and other related charges	-0.3	%	0.0	%	-0.1	%	0.0	%

Operating loss	-5.9	%	-25.3	%	-11.8	%	-32.7	%
Interest income, net	0.1	%	0.6	%	0.1	%	1.1	%

Loss before income taxes	-5.8	%	-24.7	%	-11.7	%	-31.6	%
Income tax benefit	0.0	%	0.0	%	-0.6	%	0.0	%

Net loss	-5.8	%	-24.7	%	-11.1	%	-31.6	%

Comparison of Three Months Ended September 30, 2002 and 2001

CRM Services Revenue. Revenue from CRM services increased 8.0% to $10.6 million for the three months ended September 30, 2002 from $9.8 million for the comparable period of 2001. This increase is primarily due to an increase in revenues from new clients and increased volume with certain existing clients, which more than offset the decrease in revenues from terminated clients for whom we discontinued marketing and selling their products and services in 2001. In late 2000 and during 2001, we decided to focus our resources on clients with whom we could maintain profitable business relationships. As a result, we discontinued relationships with various clients that represented no revenue for the three months ended September 30, 2002, but from which we generated $3.2 million of revenue in the comparable period in 2001. This was offset in part by the addition of a new client in July 2001 who represented $3.3 million of revenue during the three months ended September 30, 2002, as compared to $156,000 of revenue during the same period in 2001. In addition, increased volumes for an existing client resulted in an increase in revenues of $1.9 million from the three months ended September 30, 2001 to the three months ended September 30, 2002. Our quarterly operating results have fluctuated in the past and are likely to do so in the future. In particular, our revenues are not predictable with any significant degree of certainty. In the current economic environment, we have very limited visibility over revenue trends in future periods.

CRM Services Gross Profit. Gross profit from CRM services decreased 6.2% to $3.0 million for the three months ended September 30, 2002, from $3.2 million for the comparable period in 2001. Gross margin from CRM services decreased to 28.4% in the most recent period compared to 32.7% during the comparable period of the prior year. The decrease in gross margin is due primarily to a change in both client mix and product and services mix. For the three months ended September 30, 2001, 13.0% of total revenues were generated through sales of upgrades, new licenses and education, compared with 2.3% in the same period in fiscal 2002. In prior years, these non-core contract revenues did generate higher gross margins, but proved less profitable to deliver because we could not leverage our core business processes or systems. We expect our gross margins to continue to vary based on the mix of clients and the services provided.

Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased 35.5% to $3.7 million for the three months ended September 30, 2002 from $5.7 million for the comparable period of 2001. The percentage and absolute dollar decrease was primarily attributable to a reduction in personnel (a decrease of 43 headcount from September 30, 2001 to September 30, 2002) and an associated reduction of $1.1 million in personnel-related expenses, reductions of $292,000 in depreciation and $331,000 in rent expenses associated with our restructuring in fiscal 2001, and a reduction of $513,000 in consulting, legal and outside services expenses as part of ongoing efforts to reduce operating expenses. As a percentage of total revenue, selling, general and administrative expenses decreased to 34.6% for the most recent period from 58.0% in the comparable period of the prior year. The decrease in selling, general and administrative expenses as a percentage of total revenue is primarily due to management’s ongoing efforts to control and reduce operating expenses, and to leverage our cost structure. Operating

expenses in absolute dollars and as a percentage of revenue will continue to fluctuate based on our revenue base and management of operating expenses.

Recoveries of Restructuring and Other Related Charges. During the fourth quarter of 2001, we recorded restructuring and other related charges of $2.4 million, or $0.06 per share, in connection with a restructuring program approved by the Board of Directors during the quarter. This resulted in a reduction of 39 positions at all levels throughout Rainmaker, for which the total annual salary at the date of termination was approximately $2.6 million. All affected employees were informed of the reduction and their severance amounts prior to December 31, 2001. The charges consisted of cash severance payments to be made to severed employees, lease payments related to property abandoned as a result of our facilities consolidation, write-offs of excess equipment and leasehold improvements that were abandoned and whose estimated fair market value was zero, and discontinued use of internally developed and licensed software.

The following table lists the activity related to restructuring accruals (short and long-term) for the three and nine months ended September 30, 2002 (in thousands):

	Employee Severance			Lease Cancellation and Facility Exit Costs			Legal and Other Expenses			Subtotal			Less Current Portion			Accrued Restructuring Costs Less Current Portion
Balance at December 31, 2001	$	26		$	877		$	18		$	921		$	552		$	369
Less cash payments		(1	)		(144	)		(18	)		(163	)		(73	)		(90	)

Balance at March 31, 2002		25			733			—			758			479			279
Adjustment to reserve		6			(66	)		60			—			—			—
Less cash payments		—			(100	)		(56	)		(156	)		(65	)		(91	)

Balance at June 30, 2002		31			567			4			602			414			188
Adjustment to reserve		(31	)		—			(4	)		(35	)		(35	)		—
Less cash payments		—			(83	)		—			(83	)		(47	)		(36	)

Balance at September 30, 2002	$	—		$	484		$	—		$	484		$	332		$	152

Interest Income, Net. We recorded $31,000 of interest income and $20,000 of interest expense, or net interest income of $11,000 for the three months ended September 30, 2002. This compares to $94,000 of interest income and $36,000 of interest expense, or net interest income of $58,000 in the comparable period of 2001. The net decrease was primarily attributable to lower invested cash balances and lower interest rates.

Comparison of Nine Months Ended September 30, 2002 and 2001

CRM Services Revenue. Revenue from CRM services decreased 12.1% to $28.8 million for the nine months ended September 30, 2002, from $32.8 million for the comparable period of 2001. This decrease is primarily due to a decline in business attributable to clients for whom we discontinued marketing and selling their products and services in

2001. In late 2000 and during 2001, we decided to focus our resources on clients with whom we could maintain profitable business relationships. As a result, we discontinued relationships with various clients that represented no revenue for the nine months ended September 30, 2002, but from which we generated $12.9 million for the comparable period in 2001. This was partially offset by the addition of a new client in July 2001 who represented $9.5 million of revenue during the nine months ended September 30, 2002. Our quarterly operating results have fluctuated in the past and are likely to do so in the future. In particular, our revenues are not predictable with any significant degree of certainty. In the current economic environment, we have very limited visibility over revenue trends in future periods.

CRM Services Gross Profit. Gross profit from CRM services decreased 21.2% to $8.1 million for the nine months ended September 30, 2002, from $10.2 million for the comparable period in 2001. Gross margin from CRM services decreased to 27.9% in the most recent period compared to 31.2% during the comparable period of the prior year. The decrease in gross margin is due primarily to a change in the mix of services provided for our clients. For the nine months ended September 30, 2001, 26.7% of total revenues were generated through sales of upgrades, new licenses and education, compared with 4.9% in the same period in fiscal 2002. In prior years, these non-core contract revenues did generate higher gross margins, but proved less profitable to deliver because we could not leverage our core business processes or systems. We expect our gross margins to continue to vary based on the mix of clients and services provided.

Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased 45.2% to $11.5 million for the nine months ended September 30, 2002, from $21.0 million for the comparable period of 2001. The percentage and absolute dollar decrease was primarily attributable to a reduction in personnel (a decrease of 43 headcount from September 30, 2001 to September 30, 2002) and an associated reduction of $5.8 million in personnel-related expenses, reductions of $723,000 in depreciation and $759,000 in rent expenses associated with our restructuring in fiscal 2001, and a reduction of $2.5 million in consulting, legal and outside services expenses as part of ongoing efforts to reduce operating expenses. As a percentage of total revenue, selling, general and administrative expenses decreased to 39.8% for the most recent period from 63.9% in the comparable period of the prior year. The decrease in selling, general and administrative expenses as a percentage of total revenue is primarily due to management’s ongoing efforts to control and reduce operating expenses, and to leverage our cost structure. Operating expenses in absolute dollars and as a percentage of revenue will continue to fluctuate based on our revenue base and management of operating expenses.

As of September 30, 2002, all severance and legal costs related to the restructuring had been paid and there were no remaining obligations for severance or legal costs related to the restructuring. Accordingly, in the nine months ended September 30, 2002, we recorded a benefit of $35,000 to reverse the remaining accrued restructuring liability related to severance and legal costs. This amount was reported as “Recoveries of restructuring and other related charges” and is included in operating expenses in our statement of operations.

Interest Income, Net. We recorded $100,000 of interest income and $66,000 of interest expense, or net interest income of $34,000 for the nine months ended September 30, 2002. This compares to $494,000 of interest income and $131,000 of interest expense, or net interest income of $363,000 in the comparable period of 2001. The net decrease was primarily attributable to lower invested cash balances and lower interest rates.

Income Tax Benefit. In March 2002, the Internal Revenue Service issued the Job Creation and Worker Assistance Act of 2002 which extended the regular and alternative minimum tax net operating loss carryback period from two years to five years for losses arising in 2001 or 2002 tax years. As a result of this new law, Rainmaker recorded an income tax benefit of $146,000 during the nine months ended September 30, 2002, attributable to the recovery of

income taxes paid in prior periods. During the nine months ended September 30, 2001, no income tax benefit was recorded.

Liquidity and Sources of Capital

Historically, we have funded operations from operating cash flows and net cash proceeds from private placements of preferred stock and, in November 1999, the initial public offering of our common stock. Cash and cash equivalents were $8.2 million at September 30, 2002. Working capital at September 30, 2002 was $3.5 million. Receivables increased to $5.5 million at September 30, 2002 from $4.8 million at December 31, 2001, primarily as a result of increased sales. Our continued focus on collections resulted in a decrease in our receivables days sales outstanding to 44 days at September 30, 2002 from 49 days at December 31, 2001.

Cash provided by operating activities during the nine months ended September 30, 2002 was $5,000. The most significant sources of cash were related to an increase in accounts payable of $3.4 million, offset by a decrease in accounts payable to related party of $861,00, and a decrease in prepaid and other current assets of $670,000. These were offset by our net loss before non-cash expenses, including depreciation, of $1.8 million and an increase in accounts receivable of $662,000. Cash used in operating activities was $10.4 million for the nine months ended September 30, 2001, primarily related to net losses, net of non-cash expenses including depreciation, and decreases in accrued liabilities and accounts payable, offset by a decrease in accounts receivable.

Cash provided by investing activities during the nine months ended September 30, 2002 was $97,000, compared to cash used of $754,000 for the comparable period of the prior year. For the nine months ended September 30, 2002, cash provided by investing activities was due primarily to the sale of a long-term investment of $130,000, offset by purchase of equipment of $33,000. In the comparable nine-month period of 2001, cash used by investing activities was related to the purchase of fixed assets.

Cash used in financing activities during the nine months ended September 30, 2002 was $541,000, compared to $2.0 million for the comparable period of the prior year. In the first nine months of 2002, we repaid $570,000 of capital lease obligations, offset by $29,000 of net proceeds from the issuance of common stock from stock option exercises and from ESPP. During the comparable period in 2001, we repaid $989,000 of capital lease obligations and purchased $1.2 million of treasury stock, offset by $134,000 of proceeds received from the issuance of common stock from stock option exercises and from ESPP.

	Capital Leases		Operating Leases		Total
	(in thousands)
2002	$	298	$	178	$	476
2003		425		620		1,045
2004		45		391		436
2005		12		46		58
2006		—		5		5

Total minimum lease payments	$	780	$	1,240	$	2,020

accordance with the remaining balance payable under the financing which they secure. As of September 30, 2002, these letters of credit have current values of $89,000 and $124,000, respectively. On October 1, 2002, the current value of the June 2002 letter of credit was reduced from $89,000 to $67,000.

We do not have commercial commitments under lines of credit, guarantees, standby repurchase obligations or other such arrangements.

Our principal source of liquidity as of September 30, 2002 consisted of $8.2 million of cash and cash equivalents. We anticipate that our existing capital resources and the cash flow expected to be generated from future operations will enable us to maintain our current level of operations, our planned operations and our planned capital expenditures for at least the next twelve months.

Stock Option Exchange Program. On November 30, 2001, we announced a voluntary stock option exchange program for our employees. Under the program, Rainmaker employees were given the opportunity, if they chose, to cancel outstanding stock options previously granted to them in exchange for an equal number of replacement options to be granted at a future date at least six months and one day from the cancellation date, which was January 24, 2002. Rainmaker employees were required to remain employed with Rainmaker at the date of the replacement grant in order to receive replacement options. Non-employee members of our Board of Directors were not eligible to participate in this program. Under the exchange program, options for approximately 2.5 million shares of our common stock were tendered and cancelled.

On July 25, 2002, each participating employee received, for each option included in the exchange, a one-for-one replacement option. Under the exchange program, Rainmaker issued approximately 2.4 million shares of replacement options. The exercise price of each replacement option was $0.23, equal to the closing selling price per share of our common stock on the trading day immediately before day of grant, which was the highest of (i) the closing selling price per share of our common stock on the trading day immediately before day of grant, (ii) the average of the high and low per share sales price on day of grant and (iii) the closing selling price per share on the day of grant, as quoted on Nasdaq or on the OTC Bulletin Board. The replacement options have terms and conditions that are substantially the same as those of the canceled options. The exchange program did not result in any compensation charges.

Factors That May Affect Future Results and Market Price of Stock

We have incurred recent losses and expect to incur losses in the future.

We incurred operating and net losses of $0.6 million for the three months ended September 30, 2002, and operating and net losses of $3.4 million and $3.2 million, respectively for the nine months ended September 30, 2002. We incurred an operating loss of $14.7 million and net loss of $14.4 million for fiscal year 2001. We may incur losses in the future, depending in part on the timing of signing of new clients, impact of new and existing clients and our ability to continue to increase our operating efficiencies.

Because we depend on a small number of clients for a significant portion of our revenue, the loss of a single client could result in a substantial decrease in our revenue.

We have generated a significant portion of our revenue from the marketing and selling of products and services from a limited number of clients. For the three and nine months ended September 30, 2002, sales to customers of HP, Nortel Networks, Inc., and Sybase, Inc. (“Sybase”) each individually accounted for 10% or more of our CRM services revenue. For the three months ended September 30, 2001, sales to customers of Sybase, HP, Santa Cruz Operation (“SCO’) and IBM each individually accounted for 10% or more of our CRM services revenue. For the nine months ended September 30, 2001, sales to customers of Sybase, HP, SCO and Novell, Inc. each individually accounted for approximately 10% or more of our CRM services revenue. We expect that a small number of clients will continue to account for a significant portion of our revenue for the foreseeable future. The loss of any of our principal clients could cause a significant decrease in our revenue. In addition, our software and technology clients operate in industries that are consolidating, which may reduce the number of our existing and potential clients.

In late 2000, we decided to focus our resources on clients with which we can maintain a profitable business relationship. This resulted in discontinuation of relationships with certain clients and a lower base of revenues. There is a possibility that more client relationships may discontinue which could cause a decrease to our revenue in future periods.

Our revenue will decline if demand for our clients’ products and services decreases.

Our business primarily consists of marketing and selling our clients’ products and services to their existing customers. In addition, most of our revenue is based on a “pay for performance” model in which our compensation is based on the amount of our clients’ products and services that we sell. Accordingly, if a particular client’s products and services fail to appeal to its customers for reasons beyond our control, such as preference for a competing product or service, our revenue from the sale of the client’s products and services may decline.

We are exposed to general economic conditions.

As a result of recent unfavorable economic conditions in the United States, our revenue has declined, and may continue to do so. If the economic conditions in the United States worsen or if a wider or global economic slowdown occurs, we may experience a material adverse impact on our business, operating results, and financial condition. During these unfavorable economic periods, it may be more difficult to sign new clients or expand relationships with existing clients.

Our quarterly operating results may fluctuate, and if we do not meet market expectations, our stock price could decline.

We believe that quarter-to-quarter comparisons of our operating results are not a good indication of future performance. Although our operating results have generally improved from quarter to quarter, our future operating results may not follow past trends in every quarter, even if they continue to improve overall. In any future quarter, our operating results may be below the expectation of public market analysts and investors.

Factors which may cause our future operating results to be below expectations include:

•

the growth of the market for outsourced CRM solutions;

•

the demand for and acceptance of our services;

•

the demand for our clients’ products and services;

•

the length of the sales and integration cycle for our new clients;

•

our ability to develop and implement additional services, products and technologies; and

•

the success of our direct sales force.

The length and unpredictability of the sales and integration cycles for our full solution service offering could cause delays in our revenue growth.

Selection of our services often entails an extended decision-making process on the part of prospective clients. We often must provide a significant level of education regarding the use and benefit of our services, which may delay the evaluation and acceptance process. The selling cycle can extend to approximately six to twelve months or longer between initial client contact and signing of a contract for our services. Additionally, once our services are selected, the integration of our services often can be a lengthy process which further impacts the timing of revenue. Because we are unable to control many of the factors that will influence our clients’ buying decisions or the integration of our services, the length and unpredictability of the sales and integration cycles make it difficult for us to forecast the growth and timing of our revenue.

If we are unable to attract and retain highly qualified management, sales and technical personnel, the quality of our services may decline, and our ability to execute our growth strategies may be harmed.

Our success depends to a significant extent upon the contributions of our executive officers and key sales and technical personnel and our ability to attract and retain highly qualified sales, technical and managerial personnel. Competition for personnel is intense as these personnel are limited in supply. We have at times experienced difficulty in recruiting qualified personnel, and there can be no assurance that we will not experience difficulties in the future. Any difficulties could limit our future growth. The loss of certain key personnel, particularly Michael Silton, our chairman, president and chief executive officer, and Martin Hernandez, our chief operating officer and acting chief financial officer, could seriously harm our business. We have obtained life insurance policies in the amount of $6.3 million on Michael Silton and $3.0 million on Martin Hernandez.

We have strong competitors and may not be able to compete effectively against them.

Competition in CRM services is intense, and we expect such competition to increase in the future. Our competitors include comprehensive system integrators, e-commerce solutions providers, and other outsource providers of different components of customer interaction management. We also face competition from internal marketing and sales departments of current and potential clients. Many of our existing or potential competitors have greater name recognition, longer operating histories, and significantly greater financial, technical and marketing resources, which could further impact our ability to address competitive pressures. Should competitive factors require us to increase spending for, and investment in, client acquisition and retention or for the development of new services, our expenses could increase disproportionately to our revenues. Competitive pressures may also necessitate price reductions and other actions that would likely affect our business adversely. Additionally, there can be no assurances that we will have the resources to maintain a higher level of spending to address changes in the competitive landscape. Failure to maintain or to produce revenue proportionate to any increase in expenses would have a negative impact on our financial results.

The growth in demand for outsourced sales and marketing services is highly uncertain.

Demand and acceptance of our sales and marketing services is dependent upon companies being willing to outsource these processes. It is possible that these outsourced solutions may never achieve broad market acceptance. If the market for our services does not grow or grows more slowly than we currently anticipate, our business, financial condition and operating results may be materially adversely affected.

Our success depends on our ability to successfully manage growth.

Any future growth will place additional demands on our managerial, administrative, operational and financial resources. We will need to continue to improve our operational, financial and managerial controls and information

systems and procedures and will need to continue to train and manage our overall work force. If we are unable to manage additional growth effectively, our business will be harmed.

Our business strategy may ultimately include expansion into foreign markets, which would require increased expenditures, and if our international operations are not successfully implemented, they may not result in increased revenue or growth of our business.

Our long-term growth strategy includes expansion into international markets. As a result, we may need to establish international operations, hire additional personnel and establish relationships with additional clients and customers in those markets. This expansion may require significant financial resources and management attention and could have a negative effect on our earnings. We cannot assure you that we will be successful in creating international demand for our CRM services or that we will be able to effectively sell our clients’ products and services in international markets.

The development of international operations may also involve the following risks:

•

the appeal of our marketing programs, including the use of e-mail and direct marketing techniques, to international customers;

•

the increased cost associated with designing and operating Web sites in foreign languages;

•

differing technology standards and internet regulations in other countries that may affect access to and operation of our Web sites; and

•

difficulties in collecting international accounts receivable for the products and services that we sell.

We cannot assure you that these factors will not have an adverse effect on future international sales and earnings.

Any acquisitions we may make could result in dilution, unfavorable accounting charges and difficulties in successfully managing our business.

As part of our business strategy, we review from time to time acquisition prospects that would complement our existing business or enhance our technological capabilities. Future acquisitions by us could result in potentially dilutive issuances of equity securities, large and immediate write-offs, the incurrence of debt and contingent liabilities or amortization expense related to definite-lived intangible assets, any of which could cause our financial performance to suffer. Furthermore, acquisitions entail numerous risks and uncertainties, including:

•

difficulties in the assimilation of operations, personnel, technologies, products and the information systems of the acquired companies;

•

diversion of management’s attention from other business concerns;

•

risks of entering geographic and business markets in which we have no or limited prior experience; and

•

potential loss of key employees of acquired organizations.

We cannot be certain that we would be able to successfully integrate any businesses, products, technologies or personnel that might be acquired in the future, and our failure to do so could limit our future growth. Although we do not currently have any agreement with respect to any material acquisitions, we may make acquisitions of complementary businesses, products or technologies in the future. However, we may not be able to locate suitable acquisition opportunities.

We rely heavily on our communications infrastructure, and the failure to invest in or the loss of these systems could disrupt the operation and growth of our business and result in the loss of customers or clients.

Our success is dependent in large part on our continued investment in sophisticated computer, Internet and telecommunications systems. We have invested significantly in technology and anticipate that it will be necessary to continue to do so in the future to remain competitive. These technologies are evolving rapidly and are characterized by short product life cycles, which require us to anticipate technological developments. We may be unsuccessful in anticipating, managing, adopting and integrating technological changes on a timely basis, or we may not have the capital resources available to invest in new technologies. Temporary or permanent loss of these systems could limit our ability to conduct our business and result in lost revenue.

If we are unable to safeguard our networks and clients’ data, our clients may not use our services and our business may be harmed.

Our networks may be vulnerable to unauthorized access, computer hacking, computer viruses and other security problems. A user who circumvents security measures could misappropriate proprietary information or cause interruptions or malfunctions in our operations. We may be required to expend significant resources to protect against the threat of security breaches or to alleviate problems caused by any breaches. Although we intend to continue to implement industry-standard security measures, these measures may be inadequate.

Damage to our single facility may disable our operations.

Our operations are housed in a single facility in Scotts Valley, California. We have taken precautions to protect ourselves from events that could interrupt our services, such as off-site storage of computer backup data and a backup power source, but there can be no assurance that an earthquake, fire, flood or other disaster affecting our facility would not disable these operations. Any significant damage to this facility from an earthquake or other disaster could prevent us from operating our business.

If we fail to adequately protect our intellectual property or face a claim of intellectual property infringement by a third party, we may lose our intellectual property rights and be liable for significant damages.

We cannot guarantee that the steps we have taken to protect our proprietary rights will be adequate to deter misappropriation of our intellectual property. In addition, we may not be able to detect unauthorized use of our intellectual property and take appropriate steps to enforce our rights. If third parties infringe or misappropriate our trade secrets, copyrights, trademarks, service marks, trade names or other proprietary information, our business could be seriously harmed. In addition, although we believe that our proprietary rights do not infringe the intellectual property rights of others, other parties may assert infringement claims against us that we violated their intellectual property rights. These claims, even if not true, could result in significant legal and other costs and may be a distraction to management. In addition, protection of intellectual property in many foreign countries is weaker and less reliable than in the United States, so if our business expands into foreign countries, risks associated with protecting our intellectual property will increase. We have applied to register the RAINMAKER SYSTEMS, RAINMAKER (and Design), EDUCATION SALES PLUS and CONTRACT RENEWALS PLUS service marks in the United States and certain foreign countries, and have received registrations for the RAINMAKER SYSTEMS service mark in the United States, Australia, the European Community, Switzerland, Norway and New Zealand, the CONTRACTS RENEWALS PLUS mark in the United States and Switzerland, and the EDUCATION SALES PLUS mark in the United States and Norway.

Increased government regulation of the Internet could decrease the demand for our services and increase our cost of doing business.

The increasing popularity and use of the Internet and online services may lead to the adoption of new laws and regulations in the U.S. or elsewhere covering issues such as online privacy, copyright and trademark, sales taxes and fair business practices or which require qualification to do business as a foreign corporation in certain jurisdictions. Increased government regulation, or the application of existing laws to online activities, could inhibit Internet growth. A number of government authorities are increasingly focusing on online privacy issues and the use of personal information. Our business could be adversely affected if new regulations regarding the use of personal information are introduced or if government authorities choose to investigate our privacy practices. In addition, the European Union has adopted directives addressing data privacy that may limit the collection and use of some information regarding Internet users. Such directives may limit our ability to target customers or collect and use information. A decline in the growth of the Internet could decrease demand for our services and increase our cost of doing business and otherwise harm our business.

We are subject to government regulation of direct marketing, which could restrict the operation and growth of our business.

The Federal Trade Commission’s (“FTC’s”) telemarketing sales rules prohibit misrepresentations of the cost, terms, restrictions, performance or duration of products or services offered by telephone solicitation and specifically addresses other perceived telemarketing abuses in the offering of prizes. Additionally, the FTC’s rules limit the hours

during which telemarketers may call consumers. The Federal Telephone Consumer Protection Act of 1991 contains other restrictions on facsimile transmissions and on telemarketers, including a prohibition on the use of automated telephone dialing equipment to call certain telephone numbers. A number of states also regulate telemarketing and some states have enacted restrictions similar to these federal laws. In addition, a number of states regulate e-mail and facsimile transmissions. The failure to comply with applicable statutes and regulations could result in penalties. There can be no assurance that additional federal or state legislation, or changes in regulatory implementation, or judicial interpretation of existing or future laws would not limit our activities in the future or significantly increase the cost of regulatory compliance.

Our directors and their affiliates own a large percentage of our stock and can significantly influence all matters requiring stockholder approval.

Our directors and entities affiliated with them together control a large percentage of our outstanding shares. As a result, any significant combination of those stockholders, acting together, could have the ability to control all matters requiring stockholder approval, including the election of all directors, and any merger, consolidation or sale of all or substantially all of our assets. Accordingly, such concentration of ownership may have the effect of delaying, deferring or preventing a change in control of Rainmaker, which, in turn, could depress the market price of our common stock.

Our charter documents and Delaware law contain anti-takeover provisions that could deter takeover attempts, even if a transaction would be beneficial to our stockholders.

The provisions of Delaware law and of our certificate of incorporation and bylaws could make it difficult for a third party to acquire us, even though an acquisition might be beneficial to our stockholders. Our certificate of incorporation provides our board of directors the authority, without stockholder action, to issue up to 20,000,000 shares of preferred stock in one or more series. Our board determines when we will issue preferred stock, and the rights, preferences and privileges of any preferred stock. Our certificate of incorporation presently provides for a classified board, with each board member serving a staggered three-year term. In addition, our bylaws establish an advance notice procedure for stockholder proposals and for nominating candidates for election as directors. Delaware corporate law also contains provisions that can affect the ability to take over a company.

Our stock price may be volatile which could result in potential litigation.

If our stock price is volatile, we could face securities class action litigation. In the past, following periods of volatility in the market price of their stock, many companies have been the subjects of securities class action litigation. If we were sued in a securities class action, it could result in substantial costs and a diversion of management’s attention and resources and could cause our stock price to fall. The trading price of our common stock could fluctuate widely due to:

•

quarter to quarter variations in results of operations;

•

loss of a major client;

•

announcements of technological innovations by us or our competitors;

•

changes in, or our failure to meet, the expectations of securities analysts;

•

new products or services offered by us or our competitors;

•

changes in market valuations of similar companies;

•

announcements of strategic relationships or acquisitions by us or our competitors; or

•

other events or factors that may be beyond our control.

In addition, the securities markets in general have experienced extreme price and trading volume volatility in the past. The trading prices of securities of many business process outsourcing companies have fluctuated broadly, often for reasons unrelated to the operating performance of the specific companies. These general market and industry factors may adversely affect the trading price of our common stock, regardless of our actual operating performance.

If we fail to meet Nasdaq SmallCap Market listing requirements, our common stock will be delisted.

Our common stock was previously listed on the Nasdaq National Market and, effective as of May 30, 2002, is currently listed on the Nasdaq SmallCap Market. Nasdaq has requirements that a company must meet in order to remain listed on the Nasdaq SmallCap Market. If we continue to experience losses from our operations, are unable to

raise additional funds or our stock price does not meet minimum standards, we may not be able to maintain the standards for continued listing on the Nasdaq SmallCap Market, which include, among other things, that our stock maintain a minimum closing bid price of at least $1.00 per share (subject to applicable grace periods). If as a result of the application of such listing requirements our common stock is delisted from the Nasdaq SmallCap Market, our stock would become harder to buy and sell. Consequently, if we were removed from the Nasdaq SmallCap Market, the ability or willingness of broker-dealers to sell or make a market in our common stock might decline. As a result, the ability to resell shares of our common stock could be adversely affected.

ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

No material changes have occurred from our report on Form 10-K for the year ended December 31, 2001.

ITEM 4. CONTROLS AND PROCEDURES

Based on their review, as of a date within 90 days of the filing of this Form 10-Q, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934) are effective. There have been no significant changes in internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Rainmaker has a documented formal ethics policy to which all of its financial executives agree to adhere and advocate in governing his/her professional and ethical conduct.

PART II.—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

Rainmaker completed the initial public offering of 5,750,000 shares of its common stock, including 750,000 shares subject to an over allotment option, pursuant to a registration statement on Form S-1 (Commission File No. 333-86445) declared effective on November 16, 1999. The joint book-running managing underwriters of the public offering were Donaldson, Lufkin & Jenrette and Thomas Weisel Partners LLC.

The shares were sold at a price per share of $8.00. The aggregate offering price of the shares offered by Rainmaker was $46,000,000, less underwriting discounts and commissions of $3,220,000 and expenses of approximately $2,207,000. Approximately $26.4 million of the proceeds have been used for operating activities through September 30, 2002 and approximately $8.3 million of the proceeds have been used for capital expenditures. The balance of such proceeds is to be used for general corporate purposes to support business expansion including new client acquisition, capital expenditures, development of new services and possible expansion into international markets. In addition, we may use a portion of the net proceeds to acquire complementary products, technologies or businesses; however, we currently have no commitments or agreements and are not involved in any negotiations to do so. None of Rainmaker’s net proceeds of the offering were paid directly or indirectly to any director, officer or their associates, persons owning 10% or more of any class of equity securities of Rainmaker or an affiliate of Rainmaker.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)		Exhibits

		The following exhibits are filed with this report as indicated below:

10.21		Services Sales Outsourcing Partner Agreement dated September 25, 2000, between Rainmaker Systems, Inc. and Hewlett-Packard Company. *

10.22		Service Sales Outsourcing Partner Agreement, Amendment No. 1 dated January 2, 2001, between Rainmaker Systems, Inc. and Hewlett-Packard Company.*

10.23		Schedule 4, Operational Plan/Business Rules Document to Service Sales Outsourcing Partner Agreement dated September 25, 2000, between Rainmaker Systems, Inc. and Hewlett-Packard Company.*

10.24		Services Sales Outsourcing Partner Agreement dated August 1, 2002, between Rainmaker Systems, Inc. and Hewlett-Packard Company. *

10.25		Business Rules Approval dated September 5, 2002, between Rainmaker Systems, Inc. and Hewlett-Packard Company (amend/adds to Exhibit 10.23).*

10.26		Amendment to Internet Applications Division (IAD) Reseller Agreement and Outsourcing Addendum dated June 12, 2002, between Rainmaker Systems, Inc. and Sybase, Inc.*

10.27		Amendment to Outsourced Services Agreement dated August 15, 2002, between Rainmaker Systems, Inc. and Nortel Networks, Inc. *

Confidential treatment has been requested by Rainmaker for certain portions of the referenced exhibit pursuant to Rule 24b-2.

(b)

Reports on Form 8-K

On August 15, 2002, we filed a current report on Form 8-K to report under Item 7 and Item 9 the filing of certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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.

Dated: November 13, 2002

RAINMAKER SYSTEMS, INC.

/s/ MICHAEL SILTON

Michael Silton

Chairman of the Board, President and

Chief Executive Officer

(Principal Executive Officer)

/s/ MARTIN HERNANDEZ

Martin Hernandez

Secretary, Chief Operating Officer and Chief Financial

Officer

(Chief Accounting Officer)

CERTIFICATIONS

I, Michael Silton, certify that:

I have reviewed this quarterly report on Form 10-Q of Rainmaker Systems, Inc. (“Rainmaker”);

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

Rainmaker’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for Rainmaker and we have;

designed such controls and procedures to ensure that material information relating to Rainmaker, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

evaluated the effectiveness of Rainmaker’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

Rainmaker’s other certifying officers and I have disclosed, based on our most recent evaluation, to Rainmaker’s auditors and the audit committee of Rainmaker’s board of directors (or persons performing the equivalent function):

All significant deficiencies in the design or operation of internal controls which could adversely affect Rainmaker’s ability to record, process, summarize and report financial data and have identified for Rainmaker’s auditors any material weaknesses in internal controls, and

Any fraud, whether or not material, that involves management or other employees who have a significant role in Rainmaker’s internal controls; and

Rainmaker’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: November 13, 2002

/s/ MICHAEL SILTON

Michael Silton

Chief Executive Officer

(Principal Executive Officer)

I, Martin Hernandez, certify that:

I have reviewed this quarterly report on Form 10-Q of Rainmaker Systems, Inc. (“Rainmaker”);

evaluated the effectiveness of Rainmaker’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

Any fraud, whether or not material, that involves management or other employees who have a significant role in Rainmaker’s internal controls; and

Date: November 13, 2002

/s/ MARTIN HERNANDEZ

Martin Hernandez

Chief Financial Officer

(Chief Accounting Officer)

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