RAINMAKER SYSTEMS INC - 10-Q Quarterly Report

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.

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 April 29, 2005, the registrant had 47,764,132 shares of Common Stock outstanding.

Rainmaker Systems, Inc. is a provider of outsource sales and marketing programs. Our cost-effective programs generate service revenue and promote customer retention for our clients. Core services include professional telesales, direct marketing, hosted e-commerce, strategic lead generation services and applications that include outsourced call center services, lead/campaign management, training workshops, database and list management services, and web-based lead management campaigns.

The accompanying condensed consolidated financial statements include the accounts of Rainmaker Systems, Inc. and its wholly-owned subsidiaries (“Rainmaker”, “we”, “our” or “the Company”). All intercompany balances and transactions have been eliminated in consolidation. The condensed consolidated financial statements 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.

These interim financial statements reflect Rainmaker’s purchase of Quarter End, Inc. (“Quarter End”) and include Quarter End’s financial results from the date of acquisition, February 8, 2005, through March 31, 2005. Quarter End conducted business under the name Sunset Direct and changed its name to Sunset Direct, Inc. (“Sunset Direct”) in connection with the transaction. Accordingly, herein after in this Form 10-Q, Quarter End is referred to as Sunset Direct. See Note 3 below for the terms of the transaction.

The results of our operations for the quarter ended March 31, 2005 are not necessarily indicative of results to be expected for the year ending December 31, 2005, or any other period. These condensed consolidated 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, 2004.

Certain amounts reported in the accompanying financial statements for 2004 have been reclassified to conform to the 2005 presentation. Such reclassifications had no effect on previously reported results of operations, total assets or accumulated deficit.

The preparation of financial statements in conformity with generally accepted accounting practices 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 the assessment of the recoverability and measuring impairment of fixed assets, intangible assets and goodwill, allocation of purchase price in business combinations, revenue recognition and presentation policies, and the valuation of accounts receivable.

We maintain an allowance for potentially uncollectible accounts receivable based on our assessment of collectibility. We assess collectibility based on a number of factors, including past history, the number of days an amount is past due (based on invoice due date), credit ratings of our client’s customers, current events and circumstances regarding the business of our client’s customers and other factors that we believe are relevant. Charges for uncollectible accounts are included as a component of costs of services in our statement of operations. At March 31, 2005 and December 31, 2004, our allowance for potentially uncollectible accounts was $538,000 and $208,000, respectively.

Property and equipment are stated at cost. Depreciation of property and equipment is recorded using the straight-line method over the assets’ estimated useful lives. Computer equipment and capitalized software are depreciated over two years and furniture and fixtures are depreciated over five years. Amortization of leasehold improvements is recorded using the straight-line method over the shorter of the lease term or the estimated useful lives of the assets. Amortization of fixed assets under capital leases is included in depreciation expense.

Costs of internal use software are accounted for in accordance with Statement of Position 98-1 (“SOP 98-1”), “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use” and Emerging Issue Task Force Issue No. 00-02 (“EITF 00-02”), “Accounting for Website Development Costs.” SOP 98-1 and EITF 00-02 require that we expense computer software and website development costs as they are incurred during the preliminary project stage. Once the capitalization criteria of SOP 98-1 and EITF 00-02 have been met, external direct costs of materials and services consumed in developing or obtaining internal-use software, including website development, and the payroll and payroll-related costs for employees who are directly associated with and who devote time to the internal use computer software, are capitalized. Capitalized costs are amortized using the straight-line method over the shorter of the term of the related client agreement, if such development relates to a specific outsource client, or the software’s estimated useful life, ranging from two to five years. Capitalized internal use software and website development costs are included in property and equipment in the accompanying balance sheets.

Goodwill represents the excess of the acquisition purchase price over the estimated fair value of net tangible and intangible assets acquired. Goodwill and intangible assets acquired in a business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values, and are reviewed for impairment in accordance with Financial Accounting Standards Board (FASB) Statement No. 144, Accounting for Impairment or Disposal of Long-Lived Assets.

In accordance with Statement No. 144, long-lived assets, such as property, equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposed group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet.

Goodwill is tested at least annually for impairment, and more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. This determination is made at the reporting unit level and consists of two steps. First, the Company determines the fair value of a reporting unit and compares it to its carrying amount. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with FASB Statement No. 141, Business Combinations. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill.

During the fourth quarter of fiscal 2004, we reevaluated our application of Emerging Issues Task Force No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent” (EITF 99-19), to the presentation of our revenues generated from the sale of our client’s products and services. Based on our evaluation, we have changed the manner in which we report revenues earned from certain client contracts in the Statement of Operations to the “Net” basis. Prior to the fourth quarter of 2004, we reported such revenues on a “Gross” basis. In order to provide consistency in all periods presented, revenues and costs of revenues for all prior periods have been reclassified to conform to the current period presentation. Such reclassifications had no effect on previously reported results of

operations, total assets or accumulated deficit. The effect of such reclassification on the Company’s net revenue for the quarter ended March 31, 2004 is as follows (in thousands):

Substantially all of our revenues are generated from the sale of service contracts and maintenance renewals, and performance of lead generation services. We recognize revenue from the sale of our client’s service contracts and maintenance renewals under the provisions of Staff Accounting Bulletin (“SAB”) 104 “Revenue Recognition” and on the “net basis” in accordance with EITF Issue No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent”. 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. Revenue from services we perform is recognized as the services are accepted. Revenue from fee-based activities is recognized once these services have been delivered. We generally do not enter into multiple-element revenue arrangements with our clients.

Our revenue recognition policy involves significant judgments and estimates about 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 revenue recognition until such time as collection becomes reasonably assured, which is generally upon receipt of cash payment.

Costs of services consist of costs associated with promoting and selling our clients’ products and services including compensation costs of sales personnel, sales commissions and bonuses, costs of designing, producing and delivering marketing services, and salaries and other personnel expenses related to fee-based activities. Costs of services also include the cost of inbound and outbound shipping, net of amounts recovered from our client’s customers. Most of the costs are personnel related and may fluctuate in absolute dollars based on our client mix. Bonuses and sales commissions will typically change in proportion to revenue or profitability.

In the fourth quarter of 2004, we reclassified our direct costs associated with promoting and selling our clients’ products and services from Sales and Marketing expense to Costs of Services. Sales and Marketing expenses now primarily represent our corporate sales and marketing efforts to secure new clients. This reclassification has been made for all financial periods presented herein.

We expense advertising costs as incurred. These costs were not material and are included in Sales and Marketing expense.

As of March 31, 2005, we had two active stock-based compensation plans, the 2003 Stock Incentive Plan and the 1999 Employee Stock Purchase Plan, which are more fully described in Note 7 to the financial statements included in our Annual Report on Form 10-K/A for the year ended December 31, 2004. We account for our stock-based awards to employees in accordance with the intrinsic value method and 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 and related interpretations in accounting for its stock-based awards to employees. Under APB No. 25, the Company 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.

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 single option method over the options’ vesting period for stock options granted under the 2003 Stock Incentive Plan and the purchase period for stock purchases under the 1999 Employee Stock Purchase Plan.

Our financial instruments that expose us to concentrations of credit risk consist primarily of cash and cash equivalents and trade accounts receivable.

In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment.” SFAS No. 123R revises SFAS No. 123, “Accounting for Stock-Based Compensation” and generally requires the cost associated with employee services received in exchange for an award of equity instruments be measured based on the grant-date fair value of the award and recognized in the financial statements over the period during which employees are required to provide services in exchange for the award. SFAS No. 123R also provides guidance on how to determine the grant-date fair value for awards of equity instruments as well as alternative methods of adopting its requirements. In April 2005, the Securities and Exchange Commission announced a new rule allowing companies to implement Statement No. 123R at the beginning of their next fiscal year, instead of the next reporting period, that begins after June 15, 2005, or Dec. 15, 2005 for small business issuers. We do not need to comply with Statement No. 123R until the interim financial statements for the first quarter of 2006 are filed with the Securities and Exchange Commission. Statement No. 123R applies to all outstanding and unvested share-based payment awards at a company’s adoption date. We expect that the adoption of this standard will increase our net loss and loss per share, however it will have no impact on cash flow.

Although we have not yet determined whether the adoption of SFAS 123R will result in amounts that are similar to the current pro forma disclosures under SFAS 123, we are evaluating the requirements under SFAS 123R including the valuation methods and support for the assumptions that underlie the valuation of the awards and the transition methods (modified prospective transition method or the modified retrospective transition method).

On February 8, 2005, we acquired all of the issued and outstanding voting securities of Sunset Direct by means of a merger of Sunset Direct and a wholly owned subsidiary of Rainmaker, with Sunset Direct continuing as the surviving corporation. The results of Sunset Direct’s operations have been included in the condensed consolidated financial statements since that date. Sunset Direct is an outsource provider of lead generation services primarily to high-tech companies. As a result of the acquisition, we expect that Sunset Direct will be accretive to our financial results and provide certain other benefits including cross-selling, client diversification, expanded service offering and a larger, more cost-effective talent pool. Pursuant to our Agreement and Plan of Merger (the “Merger Agreement”) with Sunset Direct, we paid approximately $3.5 million in cash that was used to retire approximately $3.3 million of debt and certain liabilities retained by Sunset Direct, issued 3,320,400 shares of common stock in exchange for the outstanding capital stock of Sunset Direct, and incurred approximately $745,000 of acquisition related costs. The estimated value of the 3,320,400 shares of Rainmaker common stock was $2.2 million computed at a per share price of $0.664, the average closing price for the period from February 8, 2005 through February 14, 2005.

Our acquisition of Sunset Direct has been accounted for as a business combination. Assets acquired and liabilities assumed were recorded at their estimated fair values as of February 8, 2005. The total purchase price was $6.4 million as follows:

Using the purchase method of accounting, the total purchase price was allocated to Sunset Direct’s net tangible and identifiable intangible assets based on their estimated fair values as of February 8, 2005. The excess of the purchase price over the net tangible and identifiable intangible assets was recorded as goodwill. Based upon a valuation by management, the total purchase price was allocated as follows:

Goodwill represents the excess of the purchase price over the fair value of tangible and identifiable intangible assets acquired. Goodwill amounts are not amortized, but rather are tested for impairment at the reporting unit level at least annually. In the event that we determine that the value of goodwill has become impaired, we will incur an accounting charge for the amount of impairment during the fiscal quarter in which such determination is made.

Identifiable intangible assets acquired consist of developed technology, customer relationships, trade names, and a proprietary database. The estimated fair value of identifiable intangible assets was determined by management. Amortization of the intangible assets is calculated using an accelerated method for customer relationships that is based on the estimated future cash flows of the relationships, and the straight-line method for the proprietary database and developed technology. The weighted-average useful life of amortizable intangible assets acquired is approximately five years. The “Sunset Direct” trade name is expected to be used indefinitely and is not being amortized, but will be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the trade name may not be recoverable.

The Company has agreed to file a registration statement with the Securities and Exchange Commission with respect to the shares that have been issued to Sunset Direct’s shareholders. After the registration statement becomes effective, approximately 330,378 of such shares will be available for public sale, with an additional 1,359,951 of such shares available for sale six months from closing, 399,986 of such shares available for sale nine months from closing and 399,985 of such shares available for sale twelve months from closing. Approximately 830,100 shares of common stock consideration have been placed in escrow and will not be released until twelve months after closing, subject to potential post-closing adjustments.

The following unaudited pro forma information presents a summary of the results of operations of the Company assuming the acquisition of Sunset Direct occurred on January 1, 2004 and assumes the amortization of intangible assets and recording additional interest expense. In August 2004, Sunset Direct acquired certain assets and assumed certain liabilities of a private Texas lead generation company. The following unaudited financial information of Sunset Direct also gives effect to such acquisition as if it occurred on January 1, 2004. (in thousands, except per share amounts):

Basic net loss per common share is computed using the weighted-average number of shares of common stock outstanding during the year. Diluted net loss 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.

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 7,080,687 and 5,157,146 shares of common stock were outstanding at March 31, 2005 and 2004, respectively, and were not included in the diluted net loss per share computation, as the effect of including such options and warrants would be anti-dilutive because of the net loss recorded in each period.



						Estimated Useful life
Intangible assets:
Customer relationships	$	1,600		$	—	5 years
Proprietary database		1,100			—	5 years
Trade name		1,100			—	Indefinite
Developed technology		500			—	4 years

		4,300			—
Accumulated amortization		(162	)		—

	$	4,138		$	—

At March 31, 2005, the unamortized balance of purchased intangible assets that will be amortized to future cost of operations was approximately $3.0 million, of which $684,000 is expected to be amortized in the remainder of 2005 and $801,000, $675,000, $550,000, $309,000 and $19,000 is expected to be amortized in 2006, 2007, 2008, 2009 and 2010, respectively.

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, and strategic lead generation services and applications that include outsourced call center services, lead/campaign management, training workshops, database and list management services, and web-based lead management campaigns.

Our services are provided through a number of operating subsidiaries in various locations throughout the United States. However, the nature of services, the nature of the processes involved in providing those services, the types of clients, and the expected long-term operating income from these subsidiaries are similar.

We primarily operate in one geographical segment, North America. Substantially all of our net revenues are derived from customers in the United States.

We lease certain property under capital leases that expire at various dates through 2007. The effective annual interest rates on our capital lease obligations range from 2.4% to 17.9%, with an average of 11.8%. The capital lease obligations are collateralized by the related leased property and equipment.

In November 2004, we entered into a Commercial Insurance Premium Finance and Security Agreement (“2005 Financing Agreement”) to finance certain of our liability insurance premiums in the amount of $525,000. Amounts owed under the 2005 Financing Agreement bear interest at an annual rate of 4.99% and principal and interest are payable in monthly installments of approximately $40,300, through September 2005. At March 31, 2005, our liability related to the 2005 Financing Agreement was $198,000, all of which will be paid in 2005. In addition, Sunset Direct financed certain liability insurance premiums in the amount of $69,000. At March 31, 2005, our liability related to this financing agreement was $30,000, all of which will be paid in 2005.

In April 2004, the Company entered into a Business Loan Agreement and a Commercial Security Agreement (the “Revolving Credit Facility”) with Bridge Bank N.A. (the “Lender”). The Revolving Credit Facility, which matures in May 2005, provides borrowing availability up to a maximum of $2.0 million through a secured revolving line of credit that includes a $1.0 million letter of credit facility. The Revolving Credit Facility is subject to certain financial covenants, which include maintaining a working capital ratio and tangible net worth and bears interest at the Prime Rate published in the Wall Street Journal but not less than 4.0%. Borrowings and letter of credit issuances are subject to borrowing base calculations and other limitations. The Revolving Credit Facility is secured by substantially all of the Company’s assets including intellectual property. The Revolving Credit Facility contains customary covenants that will, subject to limited exceptions, limit the Company’s ability to, among other things, (i) create liens; (ii) make capital expenditures; (iii) pay cash dividends; and (iv) merge or consolidate with another company. The Revolving Credit Facility also provides for customary events of default, including nonpayment, breach of covenants, payment defaults of other indebtedness, and certain events of bankruptcy, insolvency and reorganization that may result in acceleration of outstanding amounts under the Revolving Credit Facility. As of March 31, 2005, no amounts were drawn on the Company’s line of credit with the Lender.

In 2004, the Company issued Irrevocable Standby Letters of Credit to two of its clients. The letters of credit were issued in the amounts of $250,000 and $500,000 as guarantees for service contracts sold by the Company on behalf of our clients and expire in November 2005 and September 2006, respectively. The letters of credit were issued under the Revolving Credit Facility described above. At March 31, 2005, no amounts have been drawn against the letters of credit.

In February 2005, concurrent with the closing of the merger transaction described in Note 3, the Company entered into a Business Loan Agreement and Commercial Security Agreement with the Lender pursuant to which the Company obtained a $3.0 million term loan (the “Term Loan”) that was utilized to fund a portion of the cash purchase price of Sunset Direct. The Term Loan is to be repaid over 36 months and bears interest at a variable rate of prime plus 1.00% per annum, 6.25% per annum at March 31, 2005. The Term Loan is secured by substantially all of the Company’s consolidated assets including intellectual property. The Company must comply with certain financial covenants, including maintaining a minimum quick ratio and maintaining unrestricted cash of $3.0 million with the Lender. As of March 31, 2005, the Company was in compliance with such covenants.

The Term Loan contains customary covenants that will, subject to limited exceptions, limit the Company’s ability to, among other things, (i) create liens; (ii) make capital expenditures; (iii) pay cash dividends; and (iv) merge or consolidate with another company. The Term Loan also provides for customary events of default, including nonpayment, breach of covenants, payment defaults of other indebtedness, and certain events of bankruptcy, insolvency and reorganization that may result in acceleration of outstanding amounts under the Term Loan. As of March 31, 2005, the Company had $2,917,000 outstanding on the Term Loan.

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 March 31, 2005 or December 31, 2004.

Restricted cash is comprised of cash receipts inadvertently remitted to the Company for goods and services sold by our clients. At the time of cash receipt, the Company records a liability for the amount of cash received and subsequently remits the amounts to its clients. At March 31, 2005, the Company designated that all cash receipts inadvertently remitted to the Company be classified in the balance sheet as restricted cash.

As of March 31, 2005, our off-balance sheet arrangements include operating leases for our facilities and certain property and equipment that expire at various dates through 2009, including an additional facility operating lease commitment assumed in connection with the Company’s acquisition of Sunset Direct in February 2005. 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 up front cash flow related to purchasing the assets. During the quarters ended March 31, 2005 and 2004, we recorded rent expense related to these leases of $223,000 and $80,000, respectively.

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

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 integrate acquisitions (including our recent acquisition of Sunset Direct) and expand our call center without disruption to our business, 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.

We are a leading provider of outsource sales and marketing programs. Our cost-effective services are designed to increase our client’s revenue from service and product revenue and to enhance their customer relationships. Our core capabilities were expanded with the recent acquisition of Sunset Direct and include professional telesales, direct marketing, hosted ecommerce and strategic lead generation. Our service programs are designed to meet the strategic goals of our clients and typically include a combination of service offerings such as outsourced call center services, lead/campaign management, training workshops, customer database and list management, web-based lead management campaigns and order management, including invoicing and collecting from our client’s customers.

Our business primarily consists of marketing and selling our clients’ products and services to their business customers. We provide our telesales services primarily under pay-for-performance arrangements in which our revenue is based on our ability to sell our clients’ products and services to their customers. Lead generation projects typically are sold at a fixed rate, with marketing and other services being billed on a time-and-materials basis. 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. Our clients can also purchase complementary services, such as additional database management and supplementary marketing programs, on a fee basis.

New clients may require us to make significant up-front investments, including hiring additional staff and creating the necessary infrastructure to deliver our services. These costs are typically incurred some time before significant revenue is generated. We may charge for certain 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.

To date, the majority of our revenues have been derived from marketing and selling our client’s service contracts. Because of this, our quarterly and annual revenues are subject to fluctuation based on the total service contracts available for renewal or conversion in that period. As a result of this as well as general conditions in the United States,

our net revenue has declined in the past and may do so again. 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 expanded service contracts on their existing technology.

Our quarterly and annual 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.”

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, asset impairments, restructuring charges, income taxes and 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 March 31, 2005 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, 2004, except for the newly applicable accounting policies and estimates relating to our acquisition of Sunset Direct in February 2005, including those relating to the allocation of purchase price and the evaluation of goodwill and intangible assets for impairment.

The preparation of the financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires us to establish accounting policies that contain estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. On an on-going basis, we evaluate our estimates, including those related to bad debts, investments, commissions and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. These policies that contain estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes include:

We have other equally important accounting policies and practices; however, once adopted, these other policies either generally do not require us to make significant estimates or assumptions or otherwise only require

implementation of the adopted policy, not a judgment as to the application of policy itself. Despite our intention to establish accurate estimates and assumptions, actual results could differ from those estimates under different assumptions or conditions.

We maintain allowances for doubtful accounts for 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. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. The allowance for doubtful accounts at March 31, 2005 and December 31, 2004 was $538,000 and $208,000, respectively.

Costs of internal use software are accounted for in accordance with Statement of Position 98-1 (“SOP 98-1”), “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” and Emerging Issue Task Force Issue No. 00-02 (“EITF 00-02”), “Accounting for Website Development Costs.” SOP 98-1 and EITF 00-02 require that we expense computer software and website development costs as they are incurred during the preliminary project stage. Once the capitalization criteria of SOP 98-1 and EITF 00-02 have been met, external direct costs of materials and services consumed in developing or obtaining internal-use software, including website development, and the payroll and payroll-related costs for employees who are directly associated with and who devote time to the internal use computer software, are capitalized. Capitalized costs are amortized using the straight-line method over the shorter of the term of related client agreement, if such development relates to a specific outsource client, or the software’s estimated useful life, ranging from two to five years. Capitalized internal use software and website development costs are included in property and equipment in the accompanying balance sheets.

Goodwill represents the excess of the acquisition purchase price over the estimated fair value of net tangible and intangible assets acquired. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values, and are reviewed for impairment in accordance with Financial Accounting Standards Board (FASB) Statement No. 144, Accounting for Impairment or Disposal of Long-Lived Assets.

a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with FASB Statement No. 141, Business Combinations. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill.

Substantially all of our revenues are generated from the sale of service contracts and maintenance renewals, and performance of lead generation services. The Company recognizes revenue from the sale of service contracts and maintenance renewals under the provisions of Staff Accounting Bulletin (“SAB”) 104 “Revenue Recognition” and on the “net basis” in accordance with EITF Issue No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent”. 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. Revenue from services we perform is recognized as the services are accepted. Revenue from fee-based activities is recognized once these services have been delivered.

We expense advertising costs as incurred. These costs were not material and are included in Sales and Marketing expense.

We generated 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 ended March 31, 2005, sales to customers of Dell Inc., (“Dell”) and Hewlett-Packard Company (“HP”) each accounted for more than 10% of our net revenues. For the quarter ended March 31, 2004, sales to customers of Dell, HP, Nortel, and Sybase each accounted for more than 10% of our net revenues. For the quarter ended March 31, 2005, sales to customers of Dell and HP collectively accounted for 57% of net revenues. For the quarter ended March 31, 2004, sales to customers of Dell and HP collectively accounted for 68% of net revenues and sales to customers of Dell, HP, Nortel, and Sybase collectively accounted for 96% of net revenues. No individual client’s customer accounted for 10% or more of our net revenues in any period presented.

We have outsource services agreements with certain of our clients that expire at various dates ranging from July 2005 through April 2007. Many of our client agreements contain automatic renewal clauses. These clients may, however, terminate their contracts for cause 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. The termination or non-renewal of outsource agreements with any one of our significant clients could have a material adverse effect on our financial position, results of operations and cash flows. We do not expect to renew our contract with Nortel, which expires in July 2005.

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

Net revenue consists primarily of fees earned by us on the sales of our clients’ hardware and software support and service contracts, licenses and license upgrades to our clients’ customer base, and strategic lead generation services and applications that include outsourced call center services, lead/campaign management, training workshops, database and list management services, and web-based lead management campaigns. To date, the majority of our revenues are based on a “pay for performance” model in which we generate revenue only when we complete the sale of our clients’ products and services. Revenues from the sale of our clients’ products and services have been reported on a net basis equal to the net amount we earn in a transaction, in accordance with the guidance provided for in EITF 99-19. All other revenues are reported under the provisions of Staff Accounting Bulletin (“SAB”) 104.

Costs of services consists of costs associated with promoting and selling our clients’ products and services including compensation costs of sales personnel, sales commissions and bonuses, costs of designing, producing and delivering marketing services, credit card fees, bad debts, and salaries and other personnel expenses related to fee-based activities. Costs of services also include the cost of inbound and outbound shipping, net of amounts recovered from our client’s customers. Most of the costs are personnel related and may fluctuate in absolute dollars based on our client mix. Bonuses and sales commissions will typically change in proportion to net revenue or profitability.

Sales and marketing expenses include costs associated with client acquisition. Included in these costs are client integration costs, compensation costs of marketing and sales personnel, sales commissions, bonuses, and marketing and promotional expenses.

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. This financial statement category excludes 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, software licenses, and intangible assets.

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.

During 2004, we purchased certain of our computer equipment and software from Dell, our largest client, through arrangements accounted for as capital leases. The leases bear interest at rates ranging between 4.9% and 17.9% per annum and expire at various dates through February 2007. As of March 31, 2005, property and equipment included amounts held under these capital leases of approximately $276,000 and related accumulated depreciation of approximately $95,000. Principal and interest owed to Dell amounted to approximately $127,000 at March 31, 2005. The capital lease obligations are collateralized by the related leased property and equipment.

During 2003, we purchased certain of our computer equipment from HP, one of our significant clients, through an arrangement accounted for as capital lease. The lease bears interest at 2.4% per annum and expires in June 2006. As of March 31, 2005, property and equipment included amounts held under this capital lease of approximately $122,000 and related accumulated depreciation of approximately $33,000. Principal and interest owed to HP amounted to approximately $127,000 at March 31, 2005. This capital lease obligation is collateralized by the related leased property and equipment.

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, 2004.

Net Revenue. Net revenue increased 70% to $6.4 million for the quarter ended March 31, 2005 from $3.8 million for the comparable period in 2004. The increase in revenue was primarily the result of $1.8 million of revenues contributed by Sunset Direct, which we acquired in February 2005, in addition to continued revenue growth with certain clients, partially offset by a decline in business with two existing clients.

Our quarterly and annual 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 and are affected by changes in our clients’ service program offerings, including service contract fees, and by general economic conditions in the United States. In the current economic environment, we have limited visibility over anticipated revenue trends in future periods. Our liquidity, including our ability to comply with loan agreement covenants, may be adversely affected if we were to lose a significant client.

Costs of services. Costs of services increased 158% to $3.9 million for the quarter ended March 31, 2005 from $1.5 million for the quarter ended March 31, 2004. Costs of services also increased as a percentage of revenue from 39.8% in the quarter ended March 31, 2004 to 60.6% for the quarter ended March 31, 2005. The increase in absolute dollars and as a percentage of net revenue was primarily due to increased direct sales and marketing personnel in the quarter ended March 31, 2005 as compared to the quarter ended March 31, 2004. The increase in sales personnel was directly related to the increase in sales volume for our largest client and to support new clients added in 2004. In addition, costs of services increased in absolute dollars due to our acquisition of Sunset Direct. Costs of services in absolute dollars and as a percentage of revenue are expected to continue to fluctuate based on our client mix.

Sales and Marketing Expenses. Sales and marketing expenses increased 109% to $744,000 for the quarter ended March 31, 2005 from $356,000 for the quarter ended March 31, 2004. This increase was primarily attributable to the addition of sales and marketing personnel through our acquisition of Sunset Direct, increased marketing program expenses directly related to our largest client, and the accrual of $139,000 in severance costs related to employees terminated in the quarter ended March 31, 2005.

Technology Expenses. Technology expenses increased 47% to $901,000 for the quarter ended March 31, 2005 from $612,000 for the quarter ended March 31, 2004. This increase was primarily attributable to additional headcount in the quarter ended March 31, 2005 as compared to the quarter ended March 31, 2004, an increase in consulting fees, as well as the addition of technology personnel through our acquisition of Sunset Direct.

General and Administrative Expenses. General and administrative expenses increased 90% to $2.6 million for the quarter ended March 31, 2005, as compared to $1.4 million for the comparable period of 2004. This increase was primarily attributable to severance costs of $493,000 related to employee terminations in the quarter ended March 31, 2005, an increase in professional and consulting fees, as well as the addition of Sunset Direct administrative personnel.

Depreciation and Amortization Expenses. Depreciation and amortization expenses increased 104% to $778,000 for the quarter ended March 31, 2005, from $382,000 for the comparable period in 2004. The increase is due to $162,000 of amortization expense associated with intangibles acquired in connection with our acquisition of Sunset Direct, and the result of higher net book values of depreciable assets, primarily related to capitalized internal software development projects, as compared to 2004.

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 is attributable to increased investments in interest bearing instruments. The increase in interest expense is the result of increased borrowings during the period, primarily the $3.0 million Term Loan obtained in February 2005 in connection with the acquisition of Sunset Direct, in addition to interest on obligations of Sunset Direct under capital leases.

To date, we have funded operations from operating cash flows and net cash proceeds from the sale of common stock. In February 2005, we obtained a $3 million term loan to assist in financing the cash purchase price portion of our acquisition of Sunset Direct.

Cash and cash equivalents were $9.0 million at March 31, 2005 as compared to $10.1 million at December 31, 2004. We had negative working capital of $3.7 million at March 31, 2005 as compared to working capital of $2.4 million at December 31, 2004. The decrease in cash and working capital was primarily a result of cash used in our acquisition of Sunset Direct, accrued liabilities and transaction costs associated with the acquisition, an increase in our accounts payable balance, and an increase in accrued compensation related to severance payments.

Operating activities for the quarter ended March 31, 2005 provided cash of $1.9 million as compared to cash provided by operating activities of $962,000 in the comparable quarter in 2004. Cash provided by operating activities during the quarter ended March 31, 2005 was primarily the result of an increase of $2.2 million in accounts payable and non cash depreciation and amortization charges of $778,000, an increase in other accrued compensation and benefits and other accrued liabilities of $1.0 million and $914,000, respectively, which was partially offset by our net loss of $2.5 million, and an increase in accounts receivable of $602,000.

Accounts receivable increased to $9.6 million at March 31, 2005 as compared to $7.9 million at December 31, 2004. The increase is primarily attributable to higher sales in the quarter ended March 31, 2005 as compared to the quarter ended December 31, 2004, particularly from sales relating to our largest client. In addition, accounts receivable increased through our acquisition of Sunset Direct. The increase in accounts payable was primarily due to the timing of payments to our largest client for service and maintenance contracts we sold on their behalf. The timing of payments to this client was changed from our standard 30-day terms to a staggered payment schedule. Sales for the first month of a quarter are now required to be paid in the third month of that current quarter and sales for the second and third month of that quarter are remitted in the first month of the following quarter. Accrued compensation and benefits increased in the quarter ended March 31, 2005 as compared to December 31, 2004 as a result of the accrual of severance costs related to employees terminated in March 2005 and accrued compensation costs associated with Sunset Direct. Other accrued liabilities increased in the quarter ended March 31, 2005 primarily due to the accrual of costs related to the acquisition of Sunset Direct.

Cash used in investing activities was $5.7 million for the quarter ended March 31, 2005 as compared to cash provided by investing activities of $210,000 for the quarter ended March 31, 2004. The increase in cash used in investing activities in the quarter ended March 31, 2005 was due to increased capital expenditures, an increase in restricted cash, and our investment in Sunset Direct. During the quarter ended March 31, 2005, we invested $786,000 in capital additions as compared to $323,000 in the comparable quarter of 2004. This increase of $463,000 was primarily to improve the capacity of our systems and software to support expansion of client business. We anticipate making additional investments of $2.8 million in capital equipment during the remainder of 2005.

On February 8, 2005, we acquired all of the issued and outstanding voting securities of Sunset Direct. Pursuant to the Agreement and Plan of Merger (the “Merger Agreement”) with Sunset Direct, we paid approximately $3.5 million in cash that was used to retire approximately $3.3 million of debt and certain liabilities retained by Sunset Direct, issued 3,320,400 shares of common stock in exchange for the outstanding capital stock of Sunset Direct, and incurred approximately $745,000 of acquisition related costs. The estimated value of the 3,320,400 shares of Rainmaker common stock was $2.2 million computed at a per share price of $0.664, the average closing price for the period from February 8, 2005 through February 14, 2005.

Concurrent with the closing of the merger transaction with Sunset Direct, we entered into a Business Loan Agreement and Commercial Security Agreement with Bridge Bank, N.A. (the “Lender”), and obtained a $3.0 million term loan (the “Term Loan”) that that was utilized to fund a portion of the cash purchase price of Sunset Direct. The Term Loan is to be repaid over 36 months and bears interest at a variable rate of prime plus 1.00% per annum, 6.25% per annum at March 31, 2005. The Term Loan is secured by substantially all of the Company’s and Sunset Direct’s assets, including intellectual property. The Company must comply with certain financial covenants, including maintaining a minimum quick ratio and maintaining unrestricted cash of $3.0 million with Bridge Bank. As of March 31, 2005, we were in compliance with such covenants.

In April 2004, the Company obtained a $3.0 million secured revolving line of credit that includes a $1.0 million Letter of Credit facility (the “Revolving Credit Facility”) from the Lender. In connection with the execution of the Term Loan, the maximum amount available under the Revolving Credit Facility was decreased to $2.0 million. As of March 31, 2005, the Company had incurred no indebtedness to the Lender under the Revolving Credit Facility, however two letters of credit in the amounts of $250,000 and $500,000, respectively, are outstanding under the Revolving Credit Facility (see “Guarantees” below).

Cash provided by financing activities of $2.7 million in the quarter ended March 31, 2005 was primarily a result of our Term Loan proceeds of $3.0 million, partially offset by repayment of capital lease and other financing arrangements, whereas cash provided by financing activities of $6.3 million in the quarter ended March 31, 2004 was primarily the result of the net proceeds of $6.4 million received from the private placement of our common stock and net proceeds of $133,000 received from the exercise of employee stock options and our employee stock purchase plan, partially offset by repayment of capital lease and other financing arrangements.

Our principal source of liquidity as of March 31, 2005 consisted of $9.0 million of cash and cash equivalents and our $2.0 million Revolving Credit Facility. In connection with a financial covenant related to our Term Loan, we

are required to maintain unrestricted cash deposits of $3.0 million with the Lender, which is included in the $9.0 million of cash and cash equivalents. We anticipate that our existing capital resources, cash flow expected to be generated from future operations, including the newly acquired Sunset Direct operations, and availability of external equity and debt financing sources 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. However, we may not be able to obtain equity or debt financing on terms acceptable to the Company. If we are unable to obtain the required equity or debt financing, it may impact our ability to execute our operating plan, which could seriously harm our business, operating results and financial condition.

We expect we will require additional funding through a combination of long-term secured and unsecured indebtedness and the issuance of additional equity securities by us to meet our long-term liquidity requirements for the funding of operations, material non-recurring capital expenditures and potential acquisitions.

As of March 31, 2005, our off-balance sheet arrangements include operating leases for our facilities and certain property and equipment that expire at various dates through 2009. 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 March 31, 2005 and March 31, 2004, we recorded rent expense related to these leases of $223,000 and $80,000, respectively.

In 2004, the Company issued Irrevocable Standby Letters of Credit to two of its clients. The letters of credit were issued in the amounts of $250,000 and $500,000 as guarantees for service contracts sold by the Company on behalf of our clients and expire in November 2005 and September 2006, respectively. The letters of credit are issued under the Revolving Credit Facility. At March 31, 2005, no amounts have been drawn against the letters of credit.

In February 2005, concurrent with the closing of the acquisition of Sunset Direct, the Company entered into a Business Loan Agreement and Commercial Security Agreement with the Lender (the “Term Loan”). The Term Loan is to be repaid over 36 months and bears interest at a variable rate of prime plus 1.00% per annum, 6.25% per annum at March 31, 2005. As of March 31, 2005, the Company had $2,917,000 outstanding on the Term Loan.

Future payments under our contracts and obligations at March 31, 2005 are as follows:

Included in future minimum operating lease payments in 2005 is our obligation relating to our facilities. The operating lease for our corporate facility expires in September 2005. The operating lease for our Austin facility expires in June 2009.

We incurred a net loss of $2.5 million for the quarter ended March 31, 2005 and and a net loss of $4.9 million for the year ended December 31, 2004. We may incur losses in the future, depending on the timing of signing of new clients, costs to initiate service for 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.

We may need to raise additional capital which might not be available or which, if available, could be on terms adverse to our common stockholders.

We anticipate that our existing capital resources, cash flow expected to be generated from future operations, including the newly acquired Sunset Direct operations, and availability of external equity and debt financing sources will enable us to maintain our current level of operations, our planned operations and planned capital expenditures for at least the next twelve months. We cannot be certain that we will be able to obtain additional financing on favorable terms, if at all. We may also require additional capital for the acquisition of businesses, products and technologies that are complementary to ours. Further, if we issue equity securities to raise capital, the ownership percentage of our stockholders would be reduced, and the new equity securities may have rights, preferences or privileges senior to those existing holders of our common stock. If we cannot raise needed funds on acceptable terms, we may not be able to take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, which could seriously harm our business, operating results and financial condition.

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 net revenues from the marketing and selling of products and services for a limited number of clients. For the quarter ended March 31, 2005, sales to customers of Dell and HP each accounted for more than 10% of our net revenues. For the quarter ended March 31, 2004, sales to customers of Dell, HP, Nortel, and Sybase each accounted for more than 10% of our net revenues. For the quarter ended March 31, 2005, sales to customers of Dell and HP collectively accounted for 57% of net revenues. For the quarter ended March 31, 2004, sales to customers of Dell and HP collectively accounted for 68% of net revenues and sales to customers of Dell, HP, Nortel, and Sybase collectively accounted for 96% of net revenues. We do not expect to renew our contract with Nortel, which expires in July 2005.

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. Any loss of a single significant client may have a material adverse effect on our financial position, cash flows and results of operations.

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 increased costs and risks associated with complying with increasing and new regulations of corporate governance and disclosure standards.

In March 2005, the Securities and Exchange Commission postponed, for one year, the compliance date for reporting on internal control by non-accelerated filers. Despite this postponement, we expect to continue to spend an increased amount of management time and internal and external resources to comply with changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq Stock Market rules. In particular, Section 404 of the Sarbanes-Oxley Act of 2002 requires management’s annual review and evaluation of our internal control systems and attestations of the effectiveness of these systems by our independent auditors. We are currently documenting and testing our internal control systems and procedures and considering improvements that may be necessary in order for us to comply with the requirements of Section 404 by the end of 2006. This process has required us to hire outside advisory services and has resulted in additional accounting and legal expenses. While we believe that we currently have adequate internal controls over financial reporting, in the event that our chief executive officer, chief financial officer or independent auditors determine that our controls over financial reporting are not effective as defined under Section 404, investor perceptions of our company may be adversely affected and could cause a decline in the market price of our stock.

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:

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 nine 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 chief executive officer, and Steve Valenzuela, our chief financial officer could seriously harm our business. We have obtained a life insurance policy in the amount of $6.3 million on Michael Silton.

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 system integrators, ecommerce solutions providers, and other outsource providers of different components of customer interaction management. We also face competition from internal marketing departments of current and potential clients. Additionally, we may face competition from outsource providers with substantial offshore facilities which may enable them to compete aggressively with similar service offerings at a substantially lower price. 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 demand for outsourced sales and marketing services is highly uncertain.

Demand and acceptance of our sales and marketing services is dependent upon companies’ willingness 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.

Any future growth will place additional demands on our managerial, administrative, operational and financial resources. We will need to improve our operational, financial and managerial controls and information systems and procedures and will need 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 may include 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. In addition, we may be exposed to political risks associated with operating in foreign markets. 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.

Any business combinations in which we participate 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 business combination prospects that would complement our existing business or enhance our technological capabilities, such as our recent acquisition of Sunset Direct. Future business combinations 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 expenses related to goodwill and other intangible assets, any of which could cause our financial performance to suffer. Furthermore, business combinations entail numerous risks and uncertainties, including:

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 business combinations, we may enter into business combinations with complementary businesses, products or technologies in the future. However, we may not be able to locate suitable business combination 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 clients or our clients’ customers.

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.

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 any of our facilities would not disable these operations.

In February 2005, we acquired Sunset Direct that has its primary facility located in Austin, Texas. We believe our combined operational facilities would help to minimize but not eliminate disruptions to the operations of the Company in the event of a business interruption in any one of our facilities on a short-term basis. In the event of the loss of a facility in either Scotts Valley or Austin, our business would be impacted until such time as we were able to transfer operations to the sister facility. While we maintain insurance coverage for business interruptions, such coverage does not extend to losses caused by earthquake and such coverage may not be sufficient to cover all possible losses.

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), CONTRACT RENEWALS PLUS, and EDUCATION SALES PLUS services marks in the United States and certain foreign countries, and have received registrations for the RAINMAKER SYSTEMS service mark in the United States, Canada, Australia, the European Community, Switzerland, Norway and New Zealand, the RAINMAKER (and Design) mark in the United States and the European Community, the CONTRACTS RENEWALS PLUS mark in the United States and Switzerland, and the EDUCATION SALES PLUS mark in the United States and Switzerland.

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 our clients’ 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 email 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, executive officers and entities affiliated with them together beneficially control approximately 16.2% of our outstanding shares (based on the number of shares outstanding as of April 29, 2005). As a result, any significant combination of those stockholders, acting together, may have the ability to disproportionately influence 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. 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.

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:

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.

Recently enacted and proposed changes in securities laws and regulations are likely to increase our costs.

The Sarbanes-Oxley Act of 2002 that became law in July 2002 has required us to make changes in some of our corporate governance and securities disclosure or compliance practices. That Act also requires the SEC to promulgate new rules on a variety of subjects, in addition to rule proposals already made, and Nasdaq has also issued revisions to its requirements for companies that are Nasdaq-listed. These developments have increased our legal and accounting compliance costs and will likely continue to do so in the future. These developments have also made it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage in the future. These developments could make it more difficult for us to attract and retain qualified members of our board of directors, or qualified executive officers. We are presently evaluating and monitoring regulatory developments and cannot estimate the timing or magnitude of additional costs we may incur as a result.

We may have difficulty obtaining director and officer liability insurance in acceptable amounts for acceptable rates.

Like most other public companies, we carry insurance protecting our officers and directors and us against claims relating to the conduct of our business. This insurance covers, among other things, the costs incurred by companies and their management to defend against and resolve claims relating to management conduct and results of operations, such as securities class action claims. These claims typically are extremely expensive to defend against and resolve. Hence, as is customary, we purchase and maintain insurance to cover some of these costs. We pay significant premiums to acquire and maintain this insurance, which is provided by third-party insurers. Since 1999, the premiums we have paid for this insurance have increased substantially. One consequence of the current economic climate and decline in stock prices has been a substantial general increase in the number of securities class actions and similar claims brought against public corporations and their management. Many, if not all, of these actions and claims are, and will likely continue to be, at least partially insured by third-party insurers. Consequently, insurers providing director and officer liability insurance have in recent periods sharply increased the premiums they charge for this insurance, raised retentions (that is, the amount of liability that a company is required to itself pay to defend and resolve a claim before any applicable insurance is provided), and limited the amount of insurance they will provide. Moreover, insurers typically provide only one-year policies. We renewed our director and officer insurance in the fourth quarter of 2004 for a one year term. In the fourth quarter of 2005, we will be required to do the same. Particularly in the current economic environment, we cannot assure that we will be able to obtain sufficient director and officer liability insurance coverage at acceptable rates and with acceptable deductibles and other limitations. Failure to obtain such insurance could materially harm our financial condition in the event that we are required to defend against and resolve any future securities class actions or other claims made against us or our management. Further, the inability to obtain such insurance in adequate amounts may impair our future ability to retain and recruit qualified officers and directors.

Our business may be subject to additional obligations to collect and remit sales tax and, any successful action by state authorities to collect additional sales tax could adversely harm our business.

We file sales tax returns in certain states within the United States as required by law and certain client contracts for a portion of the outsourced sales and marketing services that we provide. We do not collect sales or other similar taxes in other states and many of the states do not apply sales or similar taxes to the vast majority of the services that we provide. However, one or more states could seek to impose additional sales or use tax collection and record-keeping obligations on us. Any successful action by state authorities to compel us to collect and remit sales tax, either retroactively or prospectively or both, could adversely affect our results of operations and business.

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

Our common stock 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, or 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 and cure 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.

As we reported on our Current Report on Form 8-K filed on March 11, 2005, we received a deficiency notice from Nasdaq on March 9, 2005, indicating that our stock failed to close above $1.00 for 30 consecutive trading days, making us subject to delisting from Nasdaq for this deficiency at the conclusion of a 180-day grace period which expires on September 6, 2005, unless we are able to cure such deficiency before such time or are then eligible for an additional 180-day grace period under Nasdaq’s marketplace rules.

Shares eligible for sale in the future could negatively affect our stock price.

The market price of our common stock could decline as a result of sales of a large number of shares of our common stock or the perception that these sales could occur. This might also make it more difficult for us to raise funds through the issuance of securities. As of April 29, 2005, we had 47,764,132 outstanding shares of common stock. As of April 29, 2005, there were an aggregate of 8,287,899 shares of common stock issuable upon exercise of outstanding stock options and warrants, including 7,317,226 shares issuable upon exercise of options outstanding under our option plan and 970,673 shares of common stock issuable upon exercise of the outstanding warrants issued to the selling securityholders in our private placement transaction completed on February 20, 2004. Under our existing stock option plan and employee stock purchase plan, we may issue up to an additional 6,676,233 shares and 2,334,864 shares of our common stock, respectively, subject to the terms and conditions of such plans. We may issue and/or register additional shares, options, or warrants in the future in connection with acquisitions, compensation or otherwise. We have not entered into any definitive agreements regarding any future acquisitions and cannot ensure that we will be able to identify or complete any acquisition in the future.

In connection with the acquisition of Sunset Direct on February 8, 2005, the Company has agreed to file a registration statement with the Securities and Exchange Commission with respect to the shares that were issued to Sunset Direct’s shareholders pursuant to the merger transaction by which we acquired Sunset Direct. After the registration statement becomes effective, approximately 330,378 of such shares will be available for public sale, with an additional 1,359,951 of such shares available for sale six months from closing, 399,986 of such shares available for sale nine months from closing and 399,985 of such shares available for sale twelve months from closing. Approximately 830,100 shares of common stock consideration have been placed in escrow and will not be released until twelve months after closing, subject to potential post-closing adjustments.

We are exposed to changes in interest rates on our variable rate borrowings. Interest rates on our capital lease obligations are fixed, but rates on borrowings under our Term Loan are variable. In February 2005, the Company entered into a Business Loan Agreement and Commercial Security Agreement pursuant to which the Company obtained a $3.0 million Term Loan that is to be repaid over 36 months and bears interest at a variable rate of prime plus 1.00% per annum, 6.25% per annum at March 31, 2005. Based on our projected cash needs for the foreseeable future, we do not expect that our exposure to changes in interest rates for these borrowings will have a material impact on our interest expense.

Rainmaker’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness Rainmaker’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that Rainmaker’s disclosure controls and procedures as of the end of the period covered by this report have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by Rainmaker in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

No change in Rainmaker’s internal control over financial reporting occurred during Rainmaker’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, Rainmaker’s internal control over financial reporting.

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.


		Page
PART I.	FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements (Unaudited):	3
	Condensed Consolidated Balance Sheets –March 31, 2005 and December 31, 2004	3
	Condensed Consolidated Statements of Operations – Quarters Ended March 31, 2005 and 2004	4
	Condensed Consolidated Statements of Cash Flows – Quarters Ended March 31, 2005 and 2004	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3.	Qualitative and Quantitative Disclosures About Market Risk	31
Item 4.	Controls and Procedures	31

PART II.	OTHER INFORMATION
Item 6.	Exhibits	32

	Signatures	33


	March 31, 2005			December 31, 2004
	(Unaudited)
ASSETS

Current assets:
Cash and cash equivalents	$	9,002		$	10,104
Restricted cash		700			—
Accounts receivable, less allowance for doubtful accounts of $538 and $208 at March 31, 2005 and December 31, 2004, respectively		9,645			7,895
Prepaid expenses and other current assets		1,190			1,117

Total current assets		20,537			19,116
Property and equipment, net		3,587			3,160
Other noncurrent assets		147			86
Intangible assets, net		4,138			—
Goodwill		3,058			—

Total assets	$	31,467		$	22,362

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	17,895		$	15,130
Accrued compensation and benefits		2,128			390
Other accrued liabilities		1,757			747
Deferred revenue		1,014			—
Obligations under financing arrangements		228			355
Current portion of capital lease obligations		184			122
Current portion of note payable		1,000			—

Total current liabilities		24,206			16,744

Capital lease obligations, less current portion		61			42
Note payable, less current portion		1,917			—

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, 47,764,132 and 44,419,791 outstanding at March 31, 2005 and December 31, 2004, respectively		47			44
Additional paid-in capital		65,719			63,509
Accumulated deficit		(60,483	)		(57,977	)

Total stockholders’ equity		5,283			5,576

Total liabilities and stockholders’ equity	$	31,467		$	22,362


	Quarter Ended March 31,
	2005			2004
Net revenue	$	6,420		$	3,784

Operating expenses:
Costs of services		3,892			1,508
Sales and marketing		744			356
Technology		901			612
General and administrative		2,608			1,376
Depreciation and amortization		778			382

Total operating expenses		8,923			4,234

Operating loss		(2,503	)		(450	)

Interest and other (expense) income, net		(3	)		10

Net loss	$	(2,506	)	$	(440	)

Basic and diluted net loss per share	$	(0.05	)	$	(0.01	)

Weighted average common shares outstanding - basic and diluted		46,347			41,417


	Quarter Ended March 31,
	2005			2004
Operating activities:
Net loss	$	(2,506	)	$	(440	)
Adjustment to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization of property and equipment		616			382
Amortization of intangible assets		162			—
Provision (credit) for allowances for doubtful accounts		330			(28	)
Loss on disposal of property and equipment		26			—
Changes in operating assets and liabilities, net of assets acquired and liabilities assumed:
Accounts receivable		(602	)		(909	)
Prepaid expenses and other assets		24			(54	)
Accounts payable		2,169			1,108
Accrued compensation and benefits		1,000			75
Other accrued liabilities		914			828
Deferred revenue		(246	)		—

Net cash provided by operating activities		1,887			962

Investing activities:
Purchases of property and equipment		(786	)		(323	)
Restricted cash		(700	)		533
Acquisition of business, net of cash acquired		(4,221	)		—

Net cash (used in) provided by investing activities		(5,707	)		210

Financing activities:
Proceeds from issuance of common stock from option exercises		8			133
Proceeds from issuance of common stock and warrants from private placement		—			6,351
Proceeds from note payable		3,000			—
Principal payments on note payable		(83	)		—
Principal payments on financing arrangements		(127	)		(150	)
Principal payments on capital lease obligations		(80	)		(41	)

Net cash provided by financing activities		2,718			6,293

Net (decrease) increase in cash and cash equivalents		(1,102	)		7,465

Cash and cash equivalents at beginning of period		10,104			4,854

Cash and cash equivalents at end of period	$	9,002		$	12,319

Supplemental disclosure of cash paid during the period:
Interest	$	20		$	7


Net revenue, as previously reported	$	10,814

Impact of reclassification to reflect net revenue presentation		(7,030	)

Net revenue, as reclassified	$	3,784

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	Quarter Ended March 31,
	2005			2004
Net loss as reported	$	(2,506	)	$	(440	)
Total stock-based employee compensation expense determined under the fair value method		(231	)		(118	)

Pro forma net loss	$	(2,737	)	$	(558	)

Basic and diluted net loss per share as reported	$	(0.05	)	$	(0.01	)

Basic and diluted net loss per share pro forma	$	(0.06	)	$	(0.01	)


	(in thousands)
Issuance of 3,320,400 shares of Rainmaker Common Stock	$	2,205
Cash payment for acquisition of Sunset Direct		3,476
Acquisition related transaction costs		745

Total purchase price	$	6,426


	(in thousands)
Tangible assets acquired	$	1,866
Identifiable intangible assets		4,300
Goodwill		3,058
Net liabilities assumed		(2,798	)

Total purchase price allocation	$	6,426


	Three Months Ended
	March 31, 2005			March 31, 2004
Revenues	$	7,411		$	6,803

Net loss	$	(2,800	)	$	(666	)

Pro forma net loss per share — basic and diluted:	$	(0.06	)	$	(0.01	)

Pro forma weighted average shares outstanding – basic and diluted:		47,749			44,737


	March 31, 2005			December 31, 2004
Prepaid expenses and other current assets:
Prepaid insurance	$	380		$	549
Prepaid support and maintenance contracts		146			91
Other prepaid expenses and other current assets		664			477

	$	1,190		$	1,117

Property and equipment:
Computer equipment	$	5,642		$	5,228
Capitalized software and development		9,187			8,661
Furniture and fixtures		1,083			947
Leasehold improvements		347			336

		16,259			15,172
Accumulated depreciation and amortization		(12,672	)		(12,012	)

	$	3,587		$	3,160


	Quarter Ended March 31,						Increase/(Decrease)
	2005			2004			$ Amt			%
Interest income	$	32		$	17		$	15		88.2	%
Interest expense		(35	)		(7	)		28		(400.0	)%

	$	(3	)	$	10		$	(13	)	(130.0	)%


(In thousands)	Capital Leases			Financing Obligations			Term Loan		Operating Leases		Total
Remainder of 2005	$	167		$	231		$	750	$	551	$	1,699
2006		89			—			1,000		571		1,660
2007		4			—			1,000		539		1,543
2008		—			—			167		545		712
2009		—			—			—		278		278

Total minimum payments		260			231			2,917		2,484		5,892
Less amount representing interest		(15	)		(3	)		—		—		(18	)

Net amount of payments	$	245		$	228		$	2,917	$	2,484	$	5,874


31.1		Certification of Chief Executive Officer, pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, filed under Exhibit 31 of Item 601 of Regulation S-K.

31.2		Certification of Chief Financial Officer, pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, filed under Exhibit 31 of Item 601 of Regulation S-K.

32.1		Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, furnished under Exhibit 32 of Item 601 of Regulation S-K.

32.2		Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, furnished under Exhibit 32 of Item 601 of Regulation S-K.


		RAINMAKER SYSTEMS, INC.

Dated: May 13, 2005		/s/ MICHAEL SILTON
		Michael Silton
		Chief Executive Officer
		(Principal Executive Officer)

		/s/ STEVE VALENZUELA
		Steve Valenzuela
		Secretary and Chief Financial Officer
		(Chief Accounting Officer)