Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2004

OR

FOR THE TRANSITION PERIOD FROM              TO             

COMMISSION FILE NUMBER 000-28009

RAINMAKER SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

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  ¨

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

As of October 29, 2004, the registrant had 44,374,039 shares of Common Stock outstanding.

Table of Contents

RAINMAKER SYSTEMS, INC.

FORM 10-Q

AS OF AND FOR THE QUARTER ENDED SEPTEMBER 30, 2004

TABLE OF CONTENTS

2

Table of Contents

PART I. - FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

RAINMAKER SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands except share and per share data)

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

3

Table of Contents

RAINMAKER SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

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

4

Table of Contents

RAINMAKER SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

(in thousands)

(Unaudited)

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

5

Table of Contents

RAINMAKER SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

— UNAUDITED —

1. BASIS OF PRESENTATION

The accompanying financial statements of Rainmaker Systems, Inc. (“Rainmaker,” “we,” “our,” “us”) 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 that are, in the opinion of management, necessary for the fair presentation of the results of these periods. The results of operations for the quarter and nine months ended September 30, 2004 are not necessarily indicative of results to be expected for the year ending December 31, 2004, 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/A for the year ended December 31, 2003.

Certain prior year amounts in 2003 have been reclassified to conform to the 2004 presentation. Such reclassifications had no effect on previously reported results of operations, total assets or accumulated deficit.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenue and expenses during the reporting period. Our estimates are based on historical experience, input from sources outside the company, and other relevant facts and circumstances. Actual results could differ from those estimates. Areas that are particularly significant include revenue recognition and presentation policies, valuation of accounts receivable, and the assessment of the recoverability and measuring impairment of long-lived assets.

Revenue Recognition and Presentation

Revenue from the sale of service contracts and maintenance renewals is recognized when a purchase order from our client’s 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 unfulfilled. Revenue from product sales is recognized at the time of shipment of the product directly to the client’s customer, if all other revenue recognition criteria have been met. Revenue from services we perform is recognized as the services are accepted, if all other revenue recognition criteria has been met. Revenue from fee-based activities is recognized once these services have been delivered, if all other revenue recognition criteria has been met. A substantial amount of our sales transactions are reported based on the gross amount we bill to our clients’ customers for products and services, since we take title to and assume risk of loss for products and service contracts sold, we can sell the products or service contracts at prices we determine, and we assume the full credit risk for the products and service contracts. However, we also sell products and services on behalf of our clients whereby, based on the evaluation of the specific facts and circumstances, we record revenue equal to the net amount we earn in the transaction.

We follow Staff Accounting Bulletin No. 101 “Revenue Recognition” (“SAB 101” and “SAB 104”). We also follow 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 addresses when a company should report revenue as the gross amount billed 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 at the gross amount versus the net amount. 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, 3) whether the vendor has latitude for setting the pricing for the goods or services it sells to its customers, and 4) whether the vendor bears the credit risk in the transaction. The absence of these indicators might indicate that revenue should be recorded at the net amount earned in the transaction. We believe our current revenue reporting practices are consistent with the revenue reporting criteria established in EITF 99-19.

6

Table of Contents

A significant amount of the Company’s sales transactions are reported based upon the gross amounts Rainmaker bills its customers for client services and products; however, the Company also sells products and services on behalf of its clients whereby it records revenue equal to the net amount that it earns in the transaction. The Company believes that gross billings, a measurement of the total volume of amounts billed by the Company to its customers for its clients’ products and services; provides a meaningful indication of the volume of Rainmaker’s business activity. The following table reconciles our net services revenue in accordance with accounting principles generally accepted in the United States (U.S. GAAP) and our gross billings for the quarters and nine months ended September 30, 2004 and 2003 (in thousands):

Effective in fiscal year 2003, the Company established an allowance for sales returns. The amount provided in the allowance is an estimate based in part on recent historical experience. As of September 30, 2004 and December 31, 2003, the balance of the allowance for sales returns was $213,000 and $59,000, respectively.

Cost of Revenue

Cost of revenue consists of the cost of products and service arrangements sold to our client’s customers, costs of designing, producing and delivering marketing services, and salaries and other personnel expenses related to fee-based activities. Cost of revenue also includes the cost of inbound and outbound shipping, net of amounts recovered from our client’s customers.

Advertising

We expense the production costs of advertising as incurred, except for direct response advertising, which we capitalize. Direct response advertising consists primarily of the costs to produce emails, faxes and mailings. The capitalized production costs are amortized over the three-month period following the commencement of the advertising campaign.

Stock-Based Compensation

As of September 30, 2004, we had two active stock-based compensation plans, the 2003 Stock Incentive Plan, described below, and the 1999 Employee Stock Purchase Plan, which is more fully described in Note 8 “Stockholders’ Equity” to the financial statements included in our Annual Report on Form 10-K/A for the year ended December 31, 2003. We account for our stock-based awards to employees using the intrinsic value method and we disclose the pro forma effect on operations of using the fair value method of valuing these awards. The fair value of these awards is calculated using the Black-Scholes option pricing model, which requires that we estimate the volatility of our stock, an appropriate risk-free interest rate, and our dividend yield. The calculation of fair value is highly sensitive to the expected life of the stock-based award and the volatility of our stock, both of which we estimate based primarily on historical experience.

As permitted under FASB Statement No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), the Company has elected to continue to follow APB No. 25 “Accounting for Stock Issued to Employees”, and related interpretations in accounting for its stock-based awards to employees. Under APB No. 25, the Company uses the intrinsic value method and generally recognizes no compensation expense with respect to such awards.

Pro forma information regarding net income (loss) and earnings (loss) per share is required by SFAS No. 148 and has been determined as if the Company had accounted for awards to employees under the fair value method of SFAS No. 123. The fair value of stock options under the Company’s 2003 Stock Incentive Plan and stock purchase rights under the Company’s 1999 Employee Stock Purchase Plan was estimated as of the grant date using the Black-Scholes option pricing model.

7

Table of Contents

Had we recognized compensation expense for the grant date fair value of stock-based awards granted to employees and non-employee members of our Board of Directors in accordance with SFAS 123, our net loss and net loss per share would have increased to the pro forma amounts below (in thousands, except per share data):

For pro forma purposes, the estimated fair value of our stock-based grants is amortized using the graded method over the options’ vesting period for stock options granted under the 2003 and 1999 Stock Incentive Plans and the purchase period for stock purchases under the employee stock purchase plan.

The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that do not have specific vesting schedules and are ordinarily transferable. The Black-Scholes model requires the input of highly subjective assumptions, including the expected stock price volatility and estimated time to exercise, which can significantly impact the fair value on the grant date. As a result, the pro forma disclosures are not necessarily indicative of pro forma effects on reported financial results for future years.

Recently Issued Accounting Standards

In January 2003, the FASB issued FIN 46 – “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities (VIEs) to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new VIEs created or acquired after January 31, 2003. For VIEs created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. However, in October 2003, the FASB deferred the effective date of FIN 46 to the end of the first interim or annual period ending after March 15, 2004. We do not conduct business or have not entered into transactions with parties having characteristics of VIE’s, the adoption of FIN 46 did not have a material impact on our results of operations or financial position.

3. NET LOSS PER SHARE

Basic earnings per common share is computed using the weighted-average number of shares of common stock outstanding during the year, less shares subject to repurchase. Diluted earnings per common share also gives effect, as applicable, to the potential dilutive effect of outstanding stock options, using the treasury stock method, and convertible securities, using the if converted method, as of the beginning of the period presented or the original issuance date, if later.

8

Table of Contents

The following table presents the calculation of basic and diluted net loss per common share (in thousands, except per share data):

Options and warrants to purchase 6,359,568 shares and options to purchase 4,410,369 shares of common stock were outstanding at September 30, 2004 and 2003, respectively, and were not included in the diluted net loss per share computation, as the effect of including such options and warrants would be antidilutive because of the net loss recorded in each period. At September 30, 2004 and 2003, respectively, there were no common shares subject to repurchase.

4. STOCKHOLDERS’ EQUITY

On February 20, 2004, the Company completed an offering of its common stock and warrants to a group of private investment funds. The offering resulted in net proceeds to the Company of $6.3 million after selling expenses. The Company issued 4,666,700 common shares and warrants for the purchase of 970,673 shares of common stock. The shares reserved for issuance upon exercise of the warrants are not included for the purpose of computing the weighted average common shares outstanding used in the net loss per share calculation.

5. BALANCE SHEET COMPONENTS (in thousands)

Cash and cash equivalents and Designated cash to be remitted to others for non-service payments

Prior to July 1, 2004, the Company’s cash and cash equivalents included amounts related to cash received for non-service payments inadvertently paid to the Company by its customers instead of paid directly to the Company’s clients. At the time of cash receipt the Company records a liability for the amount of non-service payments received. While cash received from non-service payments is not restricted, as of July 1, 2004, the Company designated that all cash received for non-service payments will be classified in the balance sheet as designated cash to be remitted to others for non-service payments. As a result, at July 1, 2004, cash and cash equivalents was reduced by $775,000 when un-remitted cash received for non-service payments was classified as designated cash to be remitted to others for non-service payments. At September 30, 2004, designated cash to be remitted to others for non-service payments was $1,555,000. Designated cash to be remitted to others for non-service payments increased significantly during the third quarter as a result of a change in the Company’s banking services. The Company has implemented procedures to quickly identify and remit these payments and it does not expect the un-remitted balances to be significant in future periods.

9

Table of Contents

6. SEGMENT REPORTING

We operate in one market segment, the marketing and sale of companies’ products and services to their customers, primarily for hardware and software manufacturers and communications equipment manufacturers. We primarily operate in one geographical segment, North America. Substantially all of our sales are made to our clients’ customers in the United States.

7. 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, we recorded an income tax benefit of $23,000 during the three months ended March 31, 2003, attributable to previously unrecognized prior year research and development credits released as a result of this new law.

8. CAPITAL LEASE AND FINANCING OBLIGATIONS, GUARANTEES, AND RESTRICTED CASH

Capital Leases

During September 2004, we entered into a capital lease in connection with the acquisition of computing and network storage equipment in the amount of $20,000 with an effective interest rate of 17.0%. The lease is for a period of 24 months and payments are made monthly.

During September 2004, we entered into a capital lease in connection with the acquisition of computing and network storage equipment in the amount of $14,000 with an effective interest rate of 17.0%. The lease is for a period of 24 months and payments are made monthly.

During July 2004, we entered into a capital lease in connection with the acquisition of computing and network storage equipment in the amount of $27,000 with an effective interest rate of 17.9%. The lease is for a period of 12 months and payments are made monthly.

During May 2004, we entered into a capital lease in connection with the acquisition of computing and network storage equipment in the amount of $190,000 with an effective interest rate of 14.5%. The lease is for a period of 24 months and payments are made monthly.

Financing Obligations

In November 2003, we entered into a Commercial Insurance Premium Finance and Security Agreement (“2004 Financing Agreement”) to finance certain of our liability insurance premiums in the amount of $605,000. Amounts owed under the 2004 Financing Agreement bear interest at an annual rate of 3.25% and principal and interest are payable in monthly installments of $51,000, through October 2004. At September 30, 2004, our liability related to the 2004 Financing Agreement was $102,000, all of which will be paid in 2004.

10

Table of Contents

On April 30, 2004, the Company and Bridge Bank N.A. (the “Lender”) executed a Business Loan Agreement and a Commercial Security Agreement in connection with a $3 million secured revolving line of credit that includes a $1 million Letter of Credit facility. These agreements authorize the Lender to perfect a security interest in substantially all of the Company’s assets including intellectual property. As of this date, the Company has incurred no indebtedness to the Lender.

Guarantees

In December 2003, we entered into a standby letter of credit in the original amount of $563,000 as security for our liability under the Commercial Insurance Premium Finance and Security Agreement (“2004 Financing Agreement”). The letter of credit decreases over time in accordance with the remaining balance payable under the 2004 Financing Agreement. At September 30, 2004, the letter of credit had a current value of $256,000.

From time to time, we enter into certain types of contracts that contingently require us to indemnify parties against third party claims. These obligations primarily relate to certain agreements with our officers, directors and employees, under which we may be required to indemnify such persons for liabilities arising out of their employment relationship. The terms of such obligations vary. Generally, a maximum obligation is not explicitly stated. Because the obligated amounts of these types of agreements often are not explicitly stated, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, we have not had to make any payments for these obligations, and no liabilities have been recorded for these obligations on our balance sheets as of September 30, 2004 or December 31, 2003.

Restricted Cash

Restricted cash includes the pledge of a Certificate of Deposit (“CD”) as security for the establishment of standby letters of credit required for the benefit of the lender and lessor in certain financing and or lease arrangements discussed above. As of September 30, 2004 and December 31, 2003, we had pledged CD’s in the amount of $256,000 and $1.1 million, respectively, to secure financing and lease obligations. The requirement to secure obligations generally declines in proportion to the outstanding balance of the underlying financing arrangement.

9. COMMITMENTS

As of September 30, 2004, we have operating leases related to our facility and certain property and equipment that expire at various times through 2007. These arrangements allow us to obtain the use of the equipment and facilities without purchasing them. If we were to acquire these assets, we would be required to obtain financing and record a liability related to the financing of these assets. Leasing these assets under operating leases allows us to use these assets for our business while minimizing the obligations and cash flow related to purchasing the assets. During the quarters ended September 30, 2004 and 2003, we recorded rent expense related to these leases of $75,000 and $122,000, respectively. During the nine months ended September 30, 2004 and 2003, we recorded rent expense related to these leases of $230,000 and $363,000 respectively.

10. SUBSEQUENT EVENTS

During the third quarter, the Company was engaged in discussions to acquire a private company until October 31, 2004, at which time the discussions were terminated. As a result of this activity, the Company incurred approximately $375,000 in professional fees through September 30, 2004. These amounts are included in other non-current assets and in accrued liabilities on the Company’s consolidated condensed consolidated balance sheet at September 30, 2004. From October 1, 2004 through October 31, 2004, the Company estimates that it incurred additional professional fees of approximately $300,000 associated with this acquisition activity. This amount together with the amounts incurred through September 30, 2004 aggregating approximately $675,000 will be recorded as expense during the quarter ended December 31, 2004.

11

Table of Contents

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.

Among the important factors which could cause actual results to differ materially from those in the forward-looking statements are general market conditions, unfavorable economic conditions, our ability to execute our business strategy, the effectiveness of our sales team and approach, our ability to target, analyze and forecast the revenue to be derived from a client and the costs associated with providing services to that client, the date during the course of a calendar year that a new client is acquired, the length of the integration cycle for new clients and the timing of revenues and costs associated therewith, our client concentration given that the Company is currently dependent on a few large client relationships, potential competition in the marketplace, the ability to retain and attract employees, market acceptance of our service programs and pricing options, our ability to maintain our existing technology platform and to deploy new technology, our ability to sign new clients and control expenses, the possibility of the discontinuation of some client relationships, the financial condition of our clients’ business and other factors detailed in the Company’s filings with the Securities and Exchange Commission.

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. We assume no obligation to update such forward-looking statements publicly for any reason even if new information becomes available in the future.

Overview

We are a leading outsource provider of sales and marketing programs for service contracts. Our cost-effective programs generate service revenue and promote customer retention for our clients. Core services include professional telesales, direct marketing, and hosted ecommerce. Additional services include customer database enhancement, CRM technology integration, and order management. These services are available individually or as an integrated solution.

As a result of the focus on our core service contracts business and restructuring activities during the past several years, we have been able to increase our gross profit at a greater rate than the increase in underlying operating expenses. During the nine months ended September 30, 2004, our total gross profit increased by 9.5% as compared to the comparable period in 2003. At the same time, our operating expenses in total grew by only 7.4%.

Our business primarily consists of marketing and selling our clients’ products and services to their customers. In addition, most of our revenue is derived from a “pay for performance” model in which our revenue 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.

The majority of our revenues are derived from marketing and selling our client service contracts. Because of this, our quarterly revenues may fluctuate based on the total service contracts available for renewal or conversion in that period. As a result of this as well as the unfavorable economic conditions in the United States, our net revenue has, and may continue to, decline. 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 unfavorable economic periods, it may be more difficult to sign new clients or expand relationships with existing clients. In addition, during unfavorable economic periods, spending on existing and new technology may decrease, resulting in downgrades of service contracts or fewer new service contracts, which may have a material adverse impact on our business. This impact may be offset as technology companies may compensate for decreased spending on new technology and technology upgrades with more robust service contracts on their existing technology.

12

Table of Contents

Terrorist acts or acts of war (wherever located around the world) may cause damage or disruption to our facilities, employees, clients or clients’ customers. The potential for future terrorist attacks, the national and international response to terrorist attacks or perceived threats to national security, and other acts of war or hostility have created many uncertainties that could adversely affect our business or results of operations in ways that cannot presently be predicted.

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 of our clients and their customers. Our prospects must be considered in light of the risks, expenses and difficulties encountered by 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. See “Factors That May Affect Future Results and Market Price of Stock.”

Critical Accounting Policies/Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts in our consolidated financial statements. We evaluate our estimates on an on-going basis, including those related to our revenues, allowance for doubtful accounts, asset impairments, income taxes, commitments and contingencies. 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. Although actual results have historically been reasonably consistent with management’s expectations, the actual results may differ from these estimates or our estimates may be affected by different assumptions or conditions.

Management has discussed the development of our critical accounting policies with the audit committee of the board of directors and they have reviewed the disclosures of such policies and management’s estimates in this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Management believes there have been no significant changes during the quarter ended September 30, 2004 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2003.

Revenue Recognition and Presentation

Revenue from the sale of service contracts and maintenance renewals is recognized when a purchase order from the client’s 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 unfulfilled. Revenue from product sales is recognized at the time of shipment of the product directly to the client’s customer, if all other revenue recognition criteria have been met. Revenue from services we perform is recognized as the services are accepted, if all other revenue recognition criteria has been met. Revenue from fee-based activities, such as customized integration and development, is recognized once these services have been delivered if all other revenue recognition criteria have been met. A significant amount of our sales transactions are reported based on the gross amount we bill to our clients’ customers for products and services, since we take title and assume risk of loss for products and service contracts sold, we can sell the products or service contracts at prices we determine, and we assume the full credit risk for the products and service contracts. However, we also sell products and services on behalf of our clients whereby, based on the evaluation of the specific facts and circumstances, we record revenue equal to the net amount that we earn in the transaction. The difference between our gross billings, a measurement of the total volume of products and services billed by us to our clients’ customers, and our net revenue earned was $11.8 million and $32.2 million in the quarter and nine months ended September 30, 2004, respectively. For the quarter and nine months ended September 30, 2003, the difference between our gross billings and our net revenue earned was $5.8 million and 15.5 million, respectively. The following table reconciles our net services revenue in accordance with accounting principles generally accepted in the United States (U.S. GAAP) and our gross billings for the quarters and nine months ended September 3, 2004 and 2003 (in thousands):

13

Table of Contents

The aspects of our revenue recognition policy that involve significant judgments and estimates include the following:

Gross versus Net Presentation - We evaluate each arrangement with our clients to determine whether we should report revenue as the gross amount billed to our client’s customer versus the net amount earned in the transaction. In determining whether to report revenue at the gross amount or net amount, we evaluate the existence of specific indicators as provided in the Financial Accounting Standards Board’s Emerging Issues Task Force Issue No. 99-19, “Reporting Revenue Gross as a Principle versus Net as an Agent” (“EITF No. 99-19”). The primary indicators include, but are not limited to, 1) whether the Company is the primary obligor in the transaction, 2) whether the Company assumes general inventory risk, 3) whether the Company has latitude for setting the pricing for the goods or services it sells to its customers, and 4) whether the vendor bears credit risk in the transaction. The evaluation of the indicators involves significant management judgment. To the extent that facts or circumstances change, our conclusion as to whether to report revenue at the gross amount or net amount may change, which could have a significant impact on our reported net revenues, although it would not impact our gross billings, net income (loss), financial position or cash flows.

Collectibility - We assess the probability of collection based on a number of factors, including past transaction history and/or the creditworthiness of our clients’ customers, which is based on current published credit ratings, current events and circumstances regarding the business of our client’s customer and other factors that we believe are relevant. If we determine that collection is not reasonably assured, we defer recognition until such time as collection becomes reasonably assured, which is generally upon receipt of cash payment.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenue and expenses during the reporting period. Our estimates are based on historical experience, input from sources outside the company, and other relevant facts and circumstances. Actual results could differ from those estimates. Areas that are particularly significant include revenue recognition and presentation policies, valuation of accounts receivable, and the assessment of the recoverability and measuring impairment of long-lived assets.

Allowance for Doubtful Accounts

We maintain allowances for doubtful accounts based upon estimated losses resulting from the inability of our clients’ customers to make required payments of amounts due to us. The allowance is comprised of specifically identified account balances for which collection is currently deemed doubtful. In addition to specifically identified accounts, estimates of amounts that may not be collectible from those accounts whose collection is not yet deemed doubtful but which may become doubtful in the future are made based on historical bad debt write-off experience. The allowance for doubtful accounts at September 30, 2004 and December 31, 2003 was $124,000 and $207,000, respectively.

Allowance for Sales Returns.

We evaluate quarterly the adequacy of the allowance for sales returns based upon historical experience. This reserve is reflected as part of other accrued liabilities in our consolidated balance sheets. The allowance for sales returns at September 30, 2004 and December 31, 2003 was $213,000 and $59,000, respectively.

14

Table of Contents

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 a significant change in our market capitalization relative to our 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 as the difference between the carrying value of the asset or group of assets and their estimated fair values. Fair values are determined using third party valuations, discounted cash flow analyses or other generally accepted methods. Estimating future cash flows attributable to a particular asset or group of assets is difficult, and requires the use of significant judgment.

Concentrations

We generate a significant portion of our net revenues from the marketing and selling of products and services for a limited number of clients. For the quarter and nine months ended September 30, 2004, sales to customers of Dell Products, L.P. (“Dell”), Hewlett-Packard Company (“HP”), Nortel Networks, Inc. (“Nortel”) and Sybase, Inc. (“Sybase”), each accounted for more than 10% of our net revenues. For the quarter and nine months ended September 30, 2003, sales to customers of HP, Nortel and Sybase each accounted for more than 10% of our net revenues. For the quarters ended September 30, 2004 and 2003, customers of the previously mentioned clients collectively accounted for 99% and 90%, respectively, of net revenues and for the nine months ended September 30, 2004 and 2003, sales to the customers of the previously mentioned clients collectively accounted for 99% and 91%, respectively, of our net revenues. In the quarters ended September 30, 2004 and 2003, no individual client’s customers accounted for more than 37% and 45%, respectively, of net revenues.

As a percentage of gross billings, Dell, HP and Nortel, each accounted for more than 10% of our gross billings in the quarter ended September 30, 2004. As a percentage of gross billings, Dell, HP, Nortel and Sybase each accounted for more than 10% of our gross billings in the quarter ended September 30, 2003. For the quarter ended September 30, 2004 and 2003, sales to customers of the previously mentioned clients collectively accounted for 92%, and 99%, respectively, of gross billings, and for the nine months ended September 30, 2004 and 2003, sales to customers of the previously mentioned clients collectively accounted for 91% and 99% respectively, of gross billings. In the quarters ended September 30, 2004 and 2003, no individual client’s customers accounted for more than 60% and 40% of our gross billings, respectively. Gross billings represent the amount we invoice to our clients’ customers and we believe it provides a meaningful indication of the volume of our business. See the reconciliation of net services revenue to gross billings under the captions “Comparison of Quarters Ended September 30, 2004 and 2003”.

We have outsource services agreements with our clients that expire at various dates ranging from March 2005 to April 2007. Many of our client agreements contain automatic renewal clauses. These clients may, however, terminate their contracts in accordance with the provisions of each contract. In most cases, a client must provide us with advance written notice of its intention to terminate.

We expect that a small number of clients will continue to account for a significant portion of our net revenue and gross billings. In addition, our technology clients operate in industries that are experiencing consolidation, which may reduce the number of our existing and potential clients.

15

Table of Contents

Financial Statement Categories

Net services revenue consists of sales of our clients’ hardware and software support and service contracts, licenses and license upgrades to our clients’ customer base. Most of our revenue is based on a “pay for performance” model in which we generate revenue only when we complete the sale of our clients’ products and services. A significant amount of our sales transactions are reported based on the gross amount we bill to our clients’ customers for products and services, since we take title and assume risk of loss for products and services we sell, we can sell the products or service contracts at prices we determine, and we assume the full credit risk for the products and service contracts. However, we also sell products and services on behalf of our clients whereby, based on the evaluation of the specific facts and circumstances, we record revenue equal to the net amount we earn in the transaction.

Cost of services revenue includes payments for our clients’ products and services that we sell, 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 may be higher during the start up phase of our relationship 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 may improve. Cost of revenue also consists of the cost of inbound and outbound shipping, net of amounts recovered from our clients’ customers, as well as the costs of designing, producing and delivering marketing services.

Sales and marketing expenses include costs associated with the marketing and selling of our services and costs associated with promoting and selling our clients’ products and services. Included in these costs are client integration costs, compensation costs of marketing and sales personnel, sales commissions, bonuses, marketing and promotional expenses and costs related to product and service development. Also included are unreimbursed client-related marketing expenses. Most of the costs are personnel related. Staffing levels, bonuses and sales commissions will typically change in proportion to revenue.

Technology expenses include costs associated with systems and telecommunications, including compensation and related costs for technology personnel, consultants, purchases of non-capitalizable software and hardware, and support and maintenance costs related to our systems. A significant proportion of our technology resources are capitalized as part of the internally developed software and expansion of our core technology platform. In addition, a portion of our IT-related overhead costs are allocated to other functional departments on the basis of headcount. This financial statement category excludes all depreciation on systems hardware and software.

General and administrative expenses include costs associated with the administration of our business and consist primarily of compensation and related costs for administrative personnel, insurance, and legal and other professional fees. Most of these costs relate to personnel, insurance and facilities and are relatively fixed.

Depreciation and amortization expenses consist of depreciation and amortization of property, equipment and software licenses.

Interest and other income (expense), net, reflects income received on cash and cash equivalents, interest expense on leases to secure equipment, software and other financing agreements, and other income and expense.

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 our financial statements and notes thereto included in our Annual Report on Form 10-K/A for the year ended December 31, 2003.

16

Table of Contents

Comparison of Quarters Ended September 30, 2004 and 2003

Net Services Revenue. Net services revenue decreased to $10.8 million for the quarter ended September 30, 2004 from $11.0 million for the comparable period in 2003. The decrease in net revenue was primarily the result of a decline in business with clients for which we account for revenue on the gross basis.

A significant amount of our net services revenue is reported based on the gross amounts we bill to our clients’ customers for their products and services. We also sell products and services on behalf of our clients whereby we record revenue equal to the net amount that we earn in the transaction. Pursuant to guidance in EITF No. 99-19, we also disclose gross billings in our financial statements, a measurement of the total volume of products and services billed by us to our clients’ customers for their products and services. We believe that gross billings, a non-GAAP financial measure, provides a meaningful indication of the volume of our business activity. Gross billings increased 34.9% to $22.7 million for the quarter ended September 30, 2004, from $16.8 million for the comparable period of 2003. The increase is primarily due to increased volume arising from expansions of certain client engagements into new product and market segments. The following table reconciles our net services revenue in accordance with accounting principles generally accepted in the United States (U.S. GAAP) and our gross billings for the quarters ended September 30, 2004 and 2003 (in thousands):

Gross Profit. Gross profit remained unchanged at $3.7 million for the quarter ended September 30, 2004 as compared to the same period in 2003. Gross margin increased to 34.1% for the quarter ended September 30, 2004, compared to 33.7% during the comparable period of the prior year. The increase in gross margin was primarily due to a change in the mix of existing clients and the increased proportion of net services revenues being reported as the amount we earn in the transaction as compared to that being reported based on the amount we bill to our clients’ customers. In addition, gross margin increased as a result of the mix of our clients’ products and services that we sell. We expect our gross margins to continue to vary based on the mix of clients and the services provided.

17

Table of Contents

Sales and Marketing Expenses. Sales and marketing expenses increased 28% to $2.55 million for the quarter ended September 30, 2004 from $1.99 million for the comparable period of 2003. This increase is due, in part, to an increase in telesales payroll costs to support higher transaction volumes and to support new clients in the current quarter. Telesales staffing as of September 30, 2004 increased to 60 total headcount from 46 as of September 30, 2003. We also increased our marketing expenditures on behalf of certain clients in connection with newly expanded product and market segments and incurred an increase in costs driven by an increase in the volume of credit card transactions.

Technology Expenses. Technology expenses decreased 42% to $274,000 for the quarter ended September 30, 2004 from $473,000 for the comparable period of 2003. The majority of the decline in expenses recognized in the current year period was due to an increase in capitalized costs related to internal development incurred to create client-specific website, e-commerce or other facilities in support of business expansion and for development of our core technology platform. Capitalized internal payroll costs for internally developed software for the quarters ended September 30, 2004 and 2003 were $290,000 and $61,000, respectively. These internally developed assets are capitalized, placed in service upon completion, and amortized generally over the shorter of the useful life of the asset or the term of the specific client agreement.

General and Administrative Expenses. General and administrative expenses declined 3% to $1.51 million for the quarter ended September 30, 2004, as compared to $1.56 million for the comparable period of 2003. The decrease is primarily due to reduced staffing costs of $48,000 because of a reduction in headcount, and a decline in liability insurance costs by $36,000, partially offset by higher sales taxes, which increased by $14,000 as compared to the same quarter in the prior year.

Depreciation and Amortization Expenses. Depreciation and amortization expenses increased 25% to $452,000 for the quarter ended September 30, 2004, from $363,000 for the comparable period in 2003. The increase is primarily the result of higher amortization expense on internally developed software asset balances in 2004 as compared to 2003.

Interest and Other (Expense) Income, Net. The components of interest and other (expense) income, net are as follows (dollars in thousands):

The increase in interest income was attributable to higher invested balances offset slightly by lower interest rates. The decrease in interest expense was the result of lower average capital lease and financing obligation balances outstanding for the quarter ended September 30, 2004, as compared to the comparable period in 2003.

Comparison of Nine months Ended September 30, 2004 and 2003

Net Services Revenue. Net services revenue increased 4% to $32.3 million for the nine months ended September 30, 2004, from $31.0 million in comparable period in 2003. The growth in net revenue is attributable to the expansion of service offerings to existing clients.

A substantial amount of our net services revenue is reported based on the gross amounts we bill to our clients’ customers for their products and services. We also sell products and services on behalf of our clients whereby we record revenue equal to the net amount that we earn in the transaction. Pursuant to EITF No. 99-19, we also disclose gross billings in our financial statements, a measurement of the total volume of products and services billed by us to our clients’ customers for their products and services. We believe that gross billings, a non-GAAP financial measure, provides a meaningful indication of the volume of our business activity. Gross billings increased 39% to $64.5 million for the nine months ended September 30, 2004, from $46.5 million for the comparable period of 2003. The increase is primarily due to expansions into new product and service areas for existing clients. The following table reconciles our net services revenue and our gross billings for the nine months ended September 30, 2004 and 2003 (in thousands):

18

Table of Contents

Gross Profit. Gross profit increased 10% to $11.0 million for the nine months ended September 30, 2004, from $10.0 million for the comparable period in 2003. Gross margin increased to 34.1% for the nine months ended September 30, 2004, compared to 32.4% during the comparable period of the prior year. The increase in gross margin was due primarily to a change in the mix of existing clients and the increased proportion of net services revenues being reported at the amount we earn in the transaction as compared the being reported based on the amount we bill to our clients’ customers. We expect our gross margins to continue to vary based on the mix of clients and the services provided.

Sales and Marketing Expenses. Sales and marketing expenses increased 28% to $6.8 million for the nine months ended September 30, 2004, from $5.3 million for the comparable period of 2003. This increase is primarily due to an increase in compensation and benefits costs, which increased $404,000 for the nine months ended September 30, 2004 as compared to the comparable period in 2003 as a result of an increase in headcount. The average sales and marketing headcount increased from 49 in the nine months ended September 30, 2003 to 60 in the nine months ended September 30, 2004. An increase in client marketing and selling activities associated with expansions of services to existing clients resulted in increased direct marketing expenses of $528,000 and an increase in the costs associated with higher order processing costs due to increased transaction volume in the amount of $214,000 for the nine months ended September 30, 2004 as compared to the comparable period in 2003. Temporary staffing costs increased by $180,000 for the nine months ended September 30, 2004 as compared to the comparable period in 2003. Allocations of certain administrative and facilities costs also increased by $157,000 from $1,004,000 in the nine months ended September 30, 2003 to $1,161,000 in the nine months ended September 30, 2004, primarily as a result of the growth in sales and marketing headcount.

Technology Expenses. Technology expenses decreased 40% to $0.81 million for the nine months ended September 30, 2004, from $1.37 million for the comparable period of 2003. The decrease is primarily attributable to a change in the allocation of the Company’s core applications development resources. Due to significant client expansion activities during the nine months ended September 30, 2004, the level of investment in internally developed software increased to $734,000 from $230,000 during the comparable period in 2003. These internally developed assets are capitalized, placed in service upon completion, and amortized generally over the shorter of the useful life of the asset or the term of the specific client agreement.

General and Administrative Expenses. General and administrative expenses decreased 3% to $4.47 million for the nine months ended September 30, 2004, as compared to $4.62 million for the comparable period of 2003. Decreased staffing costs of $189,000 and insurance premiums of $134,000 were partially offset by increased professional services fees of $110,000 during the nine months ending September 30, 2004 as compared to the comparable period in 2003.

Depreciation and Amortization Expenses. Depreciation and amortization expenses increased 12% to $1.26 million for the nine months ended September 30, 2004, from $1.13 million for the comparable period in 2003. The increase is primarily the result of higher amortization expense related to internally developed software.

19

Table of Contents

Interest and Other (Expense) Income, Net. The components of interest and other (expense) income, net are as follows (dollars in thousands):

The decrease in interest expense was the result of lower average capital lease and financing obligation balances outstanding for the nine months ended September 30, 2004, as compared to the comparable period in 2003.

Liquidity and Sources of Capital

Cash and cash equivalents, excluding amounts related to designated cash to be remitted to others, increased to $11.9 million at September 30, 2004 as compared to $4.9 million at December 31, 2003, primarily as a result of proceeds from the sale of our common stock and warrants in a private placement completed in February 2004. Working capital was $4.8 million and $1.0 million at September 30, 2004 and December 31, 2003, respectively. Net accounts receivable increased $1.9 million or 32% from December 31, 2003 to September 30, 2004, primarily as a result of increased revenue during the period. Our days sales outstanding, on a net services revenue basis, were 64 days at September 30, 2004, as compared to 51 days at December 31, 2003. A significant amount of our net services revenue is reported based on the gross amounts we bill to our clients’ customers. We also sell products and services on behalf of our clients whereby we record revenue equal to the net amount that we earn in the transaction. Pursuant to Emerging Issues Task Force Consensus No. 99-19, we disclose gross billings in our financial statements, a measurement of the total volume of products and services billed by us to our clients’ customers. We believe that gross billings, a non-GAAP financial measure, provides a meaningful indication of the volume of our business activity. Our accounts receivable balance is predominantly comprised of the amounts we bill to our clients’ customers, regardless of whether we record revenue equal to the gross amount we bill to our clients’ customer or the amount that we earn in the transaction. As a result, we also disclose our days sales outstanding on a gross billings basis. On a gross billings basis, our days sales outstanding were 30 days at September 30, 2004, as compared to 30 days at December 31, 2003. The following table reconciles net services revenue to gross billings and net services revenue days sales outstanding to days sales outstanding on a gross billings basis for the quarter September 30, 2004 and 2003, respectively (dollars in thousands):

20

Table of Contents

Prior to July 1, 2004, the Company’s cash and cash equivalents included amounts related to cash received for non-service payments inadvertently paid to the Company by its customers instead of paid directly to the Company’s clients. As of July 1, 2004, the Company designated that all cash received for non-service payments will be classified in the balance sheet as designated cash to be remitted to others for non-service payments. As a result, at July 1, 2004, cash and cash equivalents was reduced by $775,000 when un-remitted cash received for non-service payments was classified as designated cash to be remitted to others for non-service payments. See Note 5 in the Condensed Consolidated Financial Statements.

Cash provided by operating activities during the nine months ended September 30, 2004 was $2.5 million as compared to cash used in operating activities of $371,000 during the nine months ended September 30, 2003. Cash provided by operating activities of $2.5 million during the nine months ended September 30, 2004 was primarily the result of an increase in accounts payable of $5.2 million offset by increased accounts receivable of $1.8 million and our net loss, adjusted for non cash items of $1.3 million.

Cash used in investing activities during the nine months ended September 30, 2004 was $574,000 compared to cash used in investing activities of $229,000 during the nine months ended September 30, 2003. For the nine months ended September 30, 2004, cash used in investing activities was the result of an increase in purchases of property and equipment of $1.4 million offset by a reduction in restricted cash of $840,000.

Cash provided by financing activities during the nine months ended September 30, 2004 was $5.8 million as compared to cash used in financing activities of $1.3 million during the same nine months of 2003. For the nine months ended September 30, 2004, cash provided by financing activities of $5.8 million was primarily the result of the sale of common stock in a private placement completed in February. Cash used in financing activities of $1.3 million during the nine months ended September 30, 2003 was primarily the result of repayments of debt obligations.

Our principal source of liquidity as of September 30, 2004 consisted of $11.9 million of cash and cash equivalents. We anticipate that our existing capital resources and 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.

On April 30, 2004, the Company and Bridge Bank N.A. (the “Lender”) executed a Business Loan Agreement and a Commercial Security Agreement in connection with a $3 million secured revolving line of credit that includes a $1 million Letter of Credit facility. The Lender has perfected a security interest in substantially all of the Company’s assets including intellectual property. As of this date, the Company has incurred no indebtedness to the Lender.

21

Table of Contents

Off-Balance Sheet Arrangements

Operating Leases

As of September 30, 2004, we have operating leases of our facility and certain property and equipment that expire at various times through 2007. These arrangements allow us to obtain the use of the equipment and facilities without purchasing them. If we were to acquire these assets, we would be required to obtain financing and record a liability related to the financing of these assets. Leasing these assets under operating leases allows us to use these assets for our business while minimizing the obligations and cash flow related to purchasing the assets. During the quarter and nine months ended September 30, 2004, we recorded rent expense related to these leases of $75,000 and $230,000, respectively.

Guarantees

In December 2003, we entered into a standby letter of credit in the original amount of $563,000 as security for our liability under the 2004 Financing Agreement. The standby letter of credit declines over time in accordance with the balance payable under the 2004 Financing Agreement. At September 30, 2004, the amount of the standby letter of credit is $256,000 and is fully secured by the pledge of a certificate of deposit.

From time to time, we enter into certain types of contracts that contingently require us to indemnify parties against third party claims. These obligations primarily relate to certain agreements with our officers, directors and employees, under which we may be required to indemnify such persons for liabilities arising out of their employment relationship. The terms of such obligations vary. Generally, a maximum obligation is not explicitly stated. Because the obligated amounts of these types of agreements often are not explicitly stated, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, we have not had to make any payments for these obligations, and no liabilities have been recorded for these obligations on our balance sheets as of September 30, 2004 or December 31, 2003.

Contractual Obligations

During May 2004, we entered into a capital lease facility in connection with the acquisition of computing and network storage equipment. As of September 30, 2004, we have acquired such equipment under the lease facility in the amount of $252,000 with an effective interest rate of 8.6%. The leases range from 12 to 24 months and payments are made monthly. Future minimum lease payments in the remainder of 2004 are $43,000 and for 2005 are $138,000 and for 2006 are $43,000.

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 have incurred operating losses and net losses since fiscal 1999, and most recently we recorded an operating loss of $2.4 million and net loss of $2.3 million for the nine months ended September 30, 2004 and an operating loss and net loss of $3.1 million for the year ended December 31, 2003, respectively. We may incur losses in the future, depending on the timing of signing of new clients, impact of new and existing clients, our decisions to further invest in our technology or infrastructure, 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 generate a significant portion of our net revenues from the marketing and selling of products and services for a limited number of clients. For the quarter and nine months ended September 30, 2004, sales to customers of Dell Products, L.P. (“Dell”), Hewlett-Packard Company (“HP”), Nortel Networks, Inc. (“Nortel”) and Sybase, Inc. (“Sybase”), each accounted for more than 10% of our net revenues. For the quarter and nine months ended September 30, 2003, sales to customers of HP, Nortel and Sybase each accounted for more than 10% of our net revenues. For the quarters ended September 30, 2004 and 2003, customers of the previously mentioned clients collectively accounted for 99% and 90%, respectively, of net revenues and for the nine months ended September 30, 2004 and 2003, sales to

22

Table of Contents

the customers of the previously mentioned clients collectively accounted for 99% and 91%, respectively, of our net revenues. In the quarters ended September 30, 2004 and 2003, no individual client’s customers accounted for more than 37% and 45%, respectively, of net revenues.

As a percentage of gross billings, Dell, HP and Nortel, each accounted for more than 10% of our gross billings in the quarter ended September 30, 2004. As a percentage of gross billings, Dell, HP, Nortel and Sybase each accounted for more than 10% of our gross billings in the quarter ended September 30, 2003. For the quarter ended September 30, 2004 and 2003, sales to customers of the previously mentioned clients collectively accounted for 92%, and 99%, respectively, of gross billings, and for the nine months ended September 30, 2004 and 2003, sales to customers of the previously mentioned clients collectively accounted for 91% and 99% respectively, of gross billings. In the quarters ended September 30, 2004 and 2003, no individual client’s customers accounted for more than 60% and 40% of our gross billings, respectively. Gross billings represent the amount we invoice to our clients’ customers and we believe it provides a meaningful indication of the volume of our business. See the reconciliation of net services revenue to gross billings under the captions “Comparison of Quarters Ended September 30, 2004 and 2003”.

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 experience consolidation from time to time, which could reduce the number of our existing and potential clients.

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 customers. In addition, most of our revenue is based on a “pay for performance” model in which our revenues are 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.

In part, as a result of recent unfavorable economic conditions in the United States, our revenue has declined and may continue to do so in the future. 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 has been, and may continue to be more difficult to sign new clients or expand relationships with existing clients.

Terrorist acts and acts of war may harm our business and revenue, costs and expenses, and financial position.

Terrorist acts or acts of war my cause damage to our employees, facilities, clients, our clients’ customers, and vendors, which could significantly impact our revenues, costs and expenses and financial position. The potential for future terrorist attacks, the national and international responses to terrorist attacks or perceived threats to national security, and other acts of war or hostility have created many economic and political uncertainties that could adversely affect our business and results of operations in ways that cannot be presently predicted. We are predominantly uninsured for losses and interruptions caused by terrorist acts and acts of war.

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 until recently, 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: