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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-K

(MARK ONE)

|x |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ------------------------------------------------------------------------------------



FOR THE FISCAL YEAR ENDED: DECEMBER 31, 2004



OR



| ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ----------------------------------------------------------------------------------------



FOR THE TRANSITION PERIOD FROM
 TO



COMMISSION FILE NUMBER 000-28009



RAINMAKER SYSTEMS, INC.

(Exact name of registrant as specified in its charter)



|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|DELAWARE                                                       |  | 33-0442860                             
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification Number)
|                                                               | 
|1800 GREEN HILLS ROAD SCOTTS VALLEY, CALIFORNIA                |  | 95066                                  
|(address of principal executive offices)                       |  | (zip code)                             



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



SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None



SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

Common Stock, $0.001 par value (Title
of Class)



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.    Yes  x    No ̈



Indicate by check mark if
disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part
III of this Form 10-K or any amendment to this Form 10-K.  x



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



The aggregate market value of Common Stock held by non-affiliates of the
registrant as of June 30, 2004, based upon the closing sales price reported by the Nasdaq SmallCap Market on that date was $59.8 million. The aggregate market value of Common Stock held by non-affiliates of the registrant on February 28, 2005, was
$22.9 million, based upon the last sales price reported for such date on the Nasdaq SmallCap Market. For purposes of this disclosure, shares of Common Stock held by persons who hold more than 5% of the outstanding shares of Common Stock and shares
held by officers and directors of the registrant have been excluded in that such persons may be deemed to be affiliates. This determination is not necessarily conclusive.



At February 28, 2005, registrant had 47,745,898 shares of Common Stock outstanding.



DOCUMENTS INCORPORATED BY REFERENCE



Portions of the Proxy Statement to be filed by Registrant with the Securities
and Exchange Commission within 120 days of Registrants fiscal year ended December 31, 2004 are incorporated by reference in Part III of this Form 10-K.

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS



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



Among the
important factors which could cause actual results to differ materially from those in the forward-looking statements are general market conditions, unfavorable economic conditions, our ability to execute our business strategy, our ability to
integrate acquisitions (including our recent acquisition of Sunset Direct) and expand our call center without disruption to our business, 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.



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RAINMAKER SYSTEMS, INC.



Table of
Contents



|          |  |                                                                                       |  |     
|--------- |  | ------------------------------------------------------------------------------------- |  | ----
|          |  |                                                                                       |  | Page
|PART I.   |  |                                                                                       |  |     
|Item 1.   |  | Business                                                                              |  | 4   
|Item 2.   |  | Properties                                                                            |  | 10  
|Item 3.   |  | Legal Proceedings                                                                     |  | 10  
|Item 4.   |  | Submission of Matters to a Vote of Security Holders                                   |  | 10  
|          |  |                                                                                      
|PART II.  |  |                                                                                       |  |     
|Item 5.   |  | Market for the Registrants Common Equity and Related Stockholder Matters             |  | 11  
|Item 6.   |  | Selected Financial Data                                                               |  | 12  
|Item 7.   |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 13  
|Item 7A.  |  | Qualitative and Quantitative Disclosures About Market Risk                            |  | 33  
|Item 8.   |  | Consolidated Financial Statements and Supplementary Data                              |  | 34  
|Item 9.   |  | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure  |  | 57  
|Item 9A.  |  | Controls and Procedures                                                               |  | 57  
|Item 9B.  |  | Other Information                                                                     |  | 57  
|          |  |                                                                                      
|PART III. |  |                                                                                       |  |     
|Item 10.  |  | Directors and Executive Officers of the Registrant                                    |  | 58  
|Item 11.  |  | Executive Compensation                                                                |  | 58  
|Item 12.  |  | Security Ownership of Certain Beneficial Owners and Management                        |  | 58  
|Item 13.  |  | Certain Relationships and Related Transactions                                        |  | 58  
|Item 14.  |  | Principal Accountants Fees and Services                                               |  | 58  
|          |  |                                                                                      
|PART IV.  |  |                                                                                       |  |     
|Item 15.  |  | Exhibits, Financial Statement Schedules, and Reports on Form 8-K                      |  | 59  
|          |  |                                                                                      
|          |  | Signatures                                                                            |  | 66  



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PART I



ITEM 1.    BUSINESS



Introduction



Rainmaker Systems, Inc. and its
subsidiaries (Rainmaker, we, our, us) was founded in 1991 and is a leading 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 and order management, which represents almost 100% of our net revenue. Additional services include customer database enhancement and CRM
technology integration. These services are available individually or as an integrated solution.



On February 8, 2005, Rainmaker acquired all of the issued and outstanding voting securities of Quarter End, Inc. by means of a merger of Quarter End, Inc.
and a wholly owned subsidiary of Rainmaker, with Quarter End, Inc. continuing as the surviving corporation. Quarter End, Inc. conducted business under the name Sunset Direct and changed its name to Sunset Direct, Inc. (Sunset Direct) in
connection with the transaction. Founded in 1992, Sunset Direct is an outsourcing company that helps primarily high-tech companies to improve their business-to-business selling process. Sunset Direct provides strategic lead generation services and
applications that include: outsourced call center services, on-site training workshops, database and list management services and Web-based lead generation campaigns. Sunset Direct has approximately 160 employees with headquarters in Austin, Texas.



The following business discussion does not include the
operations of Sunset Direct.



Industry Background



Businesses have recognized the value of improving their customer
relationships to increase revenue and customer loyalty. For technology companies, this revenue and loyalty is often the result of customers purchasing support contracts and maintenance agreements.



As technology companies evaluate the resources needed to deploy sales and
marketing programs for support contracts and maintenance agreements, they may find a significant commitment is required for building the needed systems infrastructure and expertise. They must also balance the level of internal resources devoted to
building customer relationships with the level of resources committed to other corporate priorities, such as acquiring new customers and developing new products.



We believe that companies faced with this type of resource dilemma may find it advantageous to focus on their core strengths
and to outsource their non-core functions to others with expertise in those specific areas. Outsourcing has moved from traditional functions such as manufacturing and facilities management to critical areas such as customer service. According to a
Gartner forecast from July 2004, combined software and hardware support services in North America will grow from $59.8 billion in 2004 to $68.4 billion in 2008.



The Rainmaker Solution



We specialize in business-to-business sales, marketing, and ecommerce services on an outsourced basis for technology companies. In addition, our services
include customer database hosting and enhancement, technology integration with client systems, and order management, including invoicing and collecting payment from our clients customers. Our services are designed to generate increased revenue
from the sale of service contracts to our technology clients customers. While increased revenue is the primary benefit of our services, an important side benefit is an enhanced relationship with the customers we contact on behalf of our
clients. By selecting Rainmaker to focus on this aspect of their business, clients are able to focus their attention on other business priorities.



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We identify and profile our clients customers in order to maximize selling opportunities through
all stages of the service contract life cycle. From the point of purchase, until a product is replaced or retired, there are a variety of opportunities to generate services revenue, including the following:



|                              |  |                                                                  
|----------------------------- |  | -----------------------------------------------------------------
|Stage of Lifecycle            |  | Services Revenue Opportunity                                     
|Post-Purchase Attach          |  | Sell extended warranties and uplift services to recent buyers    
|Warranty Conversion           |  | Sell annual service contracts to customers coming off warranty   
|Contract Renewal              |  | Renew expiring service contracts                                 
|Contract Reactivation         |  | Sell annual service contracts to customers with expired contracts
|Time and Materials Conversion |  | Sell annual service contracts to Time and Material customers     



Our services
incorporate the following distinguishing characteristics:



| |  |  | Combination of Technology, Process and People.    We offer our clients comprehensive services that combine technology infrastructure with established
processes and staff to establish frequent personalized contact with our clients customer bases. We act as a transparent extension of our clients sales and marketing organization by designing targeted direct marketing programs using
coordinated Web, email, direct mail, fax and telephone campaigns. Our processes are designed to successfully market support contracts throughout all points of the service contract life cycle.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Database Expertise.    We use our specialized database expertise to combine our clients disparate databases into an integrated view of their support
contract customers. Once this view is developed, we analyze the characteristics of the clients customer base and identify the best approach to segmenting and stratifying the database for effective marketing programs. We host the clients
customer data and continue to enhance it with information we uncover through profiling and regular contact. This enhanced information increases our ability to refine the targeting of our sales and marketing services. We can also provide this
enhanced data back to our clients so they can benefit from richer customer profiles.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Expertise in Technology Markets.    Our understanding of technology customer buying behavior and industry-specific marketing strategies is built upon
years of experience and millions of customer contacts. This focus benefits our hardware and software clients through reduced program implementation times and the sharing of best practices from our collective experience.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Pay-for-Performance Contracts.    We provide our services primarily under pay-for-performance arrangements in which our revenue is based on a contractual
percentage of the selling price of the products and services we sell to our clients customers. Clients can also purchase complementary services, such as additional database management and supplementary marketing programs, on a fee basis. We
believe that this business model aligns our activities with the goals of our clients. Under our pay-for-performance model, our programs are designed to develop stronger relationships with our clients customers, which lead to a better
understanding of the needs of our clients customers and increase our ability to maximize revenue per customer.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Our Clients



Our clients consist of hardware and software companies with significant customer bases and products that benefit from focused sales and marketing programs
for support contracts or maintenance agreements. We generate a significant portion of our net revenues from sales to the customers of a limited number of clients. In 2004 and 2003, sales to customers of Dell Products, L.P. (Dell), Hewlett-Packard
Company (HP), Nortel Networks, Inc. (Nortel) and Sybase, Inc. (Sybase) each accounted for more than 10% of our net revenues. On a combined basis, sales to customers of these clients accounted for 96% and 99% of our net revenues in 2004 and 2003,
respectively. The largest individual client accounted for 47% and 34% of our net revenues in 2004 and 2003, respectively.



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Services



Our primary service offering for sales and marketing of time-based contracts is Contracts Renewals Plus ® (CRP), a modular solution that allows clients to select the services they need, from
the most complex, fully outsourced solution to the simplest marketing or telesales project. Our services combine a technology infrastructure, established processes, and trained, customer-oriented personnel to deliver a comprehensive solution that is
designed to cost-effectively generate increased revenue from our clients customer bases. Our services extend beyond contract sales and renewals to include contract reactivations, conversion of free warranties into paid services, service
upgrades, add-on license sales, and new license sales. Our primary services are designed to effectively profile a clients customer base and then market and sell service and support contracts. We believe that the more information we obtain
concerning a clients customer, the more likely we will be able to market and sell services that meet the needs of the clients customer. We implement these services using a variety of proprietary systems and communication channels,
including web site and email interaction, fax, personal assistance and direct mail. We believe that our services foster deeper, richer customer relationships that strengthen customer loyalty to our clients. During 2004, 2003 and 2002, Contract
Renewals Plus generated 98%, 97% and 96% of our net revenue, respectively.



Within CRP, we generate additional sales and cultivate closer customer relationships through innovative sales and marketing programs that include:



| |  |  | Web Site and Email Interaction:    Our client-branded web sites and email interaction allow our clients customers to obtain key information and
purchase online. We develop, host and operate a web site that reflects the look and feel of our clients corporate branding. Email campaigns include links to personalized web pages, and alert our clients customers of product enhancements,
special promotions or upcoming renewal dates. When they visit the web site, customers can view a secure, personalized listing of the warranties and service contracts associated with the products they have purchased from our client. The website gives
the customer the ability to view the service offerings available from our client, generate a quote and place an order for new or extended services.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Fax and Direct Mail Marketing:    In addition to web and email, we use compelling marketing programs, including traditional mail and fax campaigns. These
campaigns alert our clients customers to service, special promotions and renewal opportunities and direct them to contact our telesales team or to visit our client-branded web site.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Personal Assistance and Telesales:    We are experts at creating sophisticated inbound and outbound calling programs. We also provide sales assistance to
our clients customers who email, call or fax in response to marketing campaigns. Our client teams are trained to answer questions, provide detailed product information, pursue up-sell and cross-sell opportunities and close orders.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The Rainmaker Strategy



Our objective is to strengthen our position in providing outsourced sales
and marketing services to technology companies. The following are the key elements of our strategy:



| |  |  | Sign New Clients.    We continue to emphasize our high technology industry focus while seeking to expand the scope of this expertise. We believe that our
expertise in providing services to the customer base of our existing clients enhances our ability to help new clients use our services to gain competitive advantages. Our focus enables us to employ industry experts, pursue targeted sales and
marketing campaigns, develop effective marketing and customer retention programs and capitalize on referrals from existing clients.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Further Penetrate Our Existing Client Base.    We use our experience to increase the level of services provided to existing clients, many of whom
currently use our services supporting selected product or customer segments.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Improve Productivity.    We continue to identify areas in which to streamline our processes and improve our marketing approach for each clients
specific customer base characteristics and to deploy technology in order to increase the productivity of our staff and to deliver more efficiently our services.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Sales and Marketing



We market our services to hardware, software and other technology companies through a direct sales force. We have a well-defined target customer and use
direct marketing, public relations, and trade association programs to communicate our service offerings. Our direct sales professionals typically have significant enterprise-level technology sales experience. We employ sales professionals who are
responsible for developing new clients as well as new opportunities with existing clients. We support the sales process with cross-functional representation from support groups including operations, finance, order management and technology. We also
support this effort with product management professionals responsible for continued development and enhancement of our service offerings.



Services and Technology Development



We use a combination of business processes and technical systems to support our marketing and sales services. We collect customer input and conduct
regular internal reviews to identify areas for improvement of our existing processes and systems as well as opportunities for development of new service offerings. We believe we follow best industry practices for developing the design, coding,
production, documentation and testing of our processes and systems. Our technical systems are based on a combination of commercially available hardware and software as well as custom software developed internally. Our policy is to select
market-leading commercial products and to leverage open-systems development environments for our internal development efforts. We believe this policy provides a stable technical foundation for the development and operation of our technical systems.
We focus our proprietary technical development efforts on business functions that are unique to the process of marketing and selling service contracts. These business functions include: the loading, repair and analysis of customer data, direct
marketing and telesales activities such as customer interaction tracking, pricing configuration and tracking, e-commerce tools, rapid deployment of client branded service, contract websites, and billing and reporting systems that expedite invoicing
and collections as well as the transfer of data and reports to our clients.



Employees



As of December 31, 2004, we
employed 138 people. Our 81 sales and marketing personnel are responsible for promoting and selling our clients products, building relationships with our clients customers and for promoting our services to new and existing clients. This
includes 75 personnel consisting of direct marketing and professional telesales who are responsible for delivering the Companys end user customer communication programs and driving service contract sales. We also employed 23 technology
personnel who develop and maintain the computer, Internet, web and telecommunications infrastructure that provides the foundation for our service offerings. Our remaining 34 employees were in general administration and finance.



Our total headcount increased to 298 employees with the acquisition of Sunset
Direct. At the date of acquisition, Sunset Direct employed 160 people of which 141 are in sales and marketing, 10 are technology personnel and 9 are in general administration and finance.



None of our employees are represented by a labor union or are subject to a collective bargaining agreement, nor have we
experienced any work stoppage. We consider our relationships with our employees to be good.



Competition



The market
for solutions and services to generate revenue from clients customers and build relationships with those customers is intensely competitive and subject to rapid change. In addition to the competitors listed



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below, we face competition from internal departments of current and potential clients. Our competitors have a variety of strategic business and pricing
models.



The main competitors of our services are companies
that offer solutions that are specifically designed to sell service contracts. We are aware of two companies of this type; ServiceSource and Encover. ServiceSource offers a telesales-based service without the web site and other technology components
that Rainmaker offers. Encovers offering is similar to Rainmakers. Both ServiceSource and Encover are private and based in the San Francisco Bay Area.



To supplement its internal efforts, a prospect company will often use point solution providers to deliver the technology or
outsourcing needed to handle a specific touchpoint (or single action) of the business process. These services can include outbound call centers or web site development agencies. Because these point solution providers often have limited
specialization in the process of managing service contracts, their specialization tends to be the specific point activity. Point solution competitors include: companies that may tailor or integrate existing systems and processes; companies that
provide various components of hosted ecommerce services; and companies that provide any variety of outsourced customer interaction services.



There are also regional companies that offer services similar to ours, particularly for teleservices and technology integration. A few of the larger
companies that offer potentially competitive outsource services include: Convergys Corporation, Digital Impact, Digital River, Inc., Harte-Hanks, Inc., Sitel Corporation, Sykes Enterprises, Inc., and West Corporation. In addition, many large ERP
software developers, including Oracle Corporation, Salesforce.com, Inc. and Siebel Systems, Inc., and their consulting partners have developed sales and marketing solutions that may compete with our offerings.



The principal competitive factors affecting our market include the return on
investment from the implementation of our service and the breadth, performance, scalability and reliability of the service once implemented. Although we believe that our pay-for-performance model, ease of integration and comprehensive service
offering currently competes favorably with respect to these factors, our market is relatively new and evolving rapidly.



Intellectual Property and Proprietary Rights



We protect our intellectual property through a combination of service mark, trade name and copyright protection, trade secret protection and
confidentiality agreements with our employees and independent contractors, and have procedures to control access to and distribution of our technology, documentation and other proprietary information and the proprietary information of our clients.
Effective trade name, trademark, service mark, copyright and trade secret protection may not be available in every country in which our services and products are made available on-line. The steps we take to protect our proprietary rights may not be
adequate and third parties may infringe or misappropriate our copyrights, trade names, trademarks, service marks and similar proprietary rights. In addition, other parties may assert claims of infringement of intellectual property or other
proprietary rights against us. The legal status of many aspects of intellectual property on the Internet is currently uncertain. 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) 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.



Government Regulation



We are subject, both directly and indirectly, to various laws and governmental regulations relating to our business. In
addition, laws with respect to online commerce may cover issues such as pricing, distribution,



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characteristics and quality of products and services. Laws affecting the Internet may also cover content, copyrights, libel, and personal privacy. Any new
legislation or regulation or the application of existing laws and regulations to the Internet could have a material adverse effect on our business.



Although our online transmissions currently originate in California, the governments of other states or foreign countries might attempt to regulate our
transmissions or levy sales or other taxes relating to our activities. As our services are available over the Internet virtually anywhere in the world, multiple jurisdictions may claim that we are required to qualify to do business as a foreign
corporation in each of those jurisdictions. Our failure to qualify as a foreign corporation in a jurisdiction where we are required to do so could subject us to taxes and penalties for the failure to qualify. It is possible that state and foreign
governments might also attempt to regulate our transmissions of content on our Web site or prosecute us for violations of their laws. We cannot assure you that state or foreign governments will not charge us with violations of local laws or that we
might not unintentionally violate these laws in the future.



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 clients customers or to collect and use such information.



Our business is also subject to regulation in connection with our direct marketing activities. 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 have a material adverse effect on our business. There can be no assurance that
additional federal or state legislation, 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.



Financial Information About Geographic Areas



Rainmaker and Sunset Direct primarily operate in one geographical segment,
North America. Substantially all of our sales are made to our clients customers in the United States of America. See Segment Reporting in Note 1 to our Financial Statements.



Available Information



Our web site is http://www.rmkr.com. We make available, free of charge, on or through our website, our annual,
quarterly and current reports, and any amendments to those reports, as soon as reasonably practicable after electronically filing such reports with the Securities and Exchange Commission. Information contained on our website is not part of this
report.



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ITEM 2.    PROPERTIES



Facilities



Our headquarters is located in one
building in Scotts Valley, California. We occupy approximately 23,400 square feet of floor space covered by a lease that expires in September 2005.



On February 8, 2005, we acquired Sunset Direct which occupies approximately 46,400 square feet in one building in Austin, Texas covered by a lease that
expires in June 2009 and 7,400 square feet in one building in Wallace, Idaho covered by a month-to-month lease.



We believe these facilities are adequate for our current needs.



ITEM 3.    LEGAL PROCEEDINGS



We currently are not a party to any material legal proceedings and are not aware of any pending or threatened litigation that would have a material adverse effect on us or our business.



ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



Not applicable.



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PART II



|ITEM 5. |  | MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
|------- |  | -------------------------------------------------------------------------



Our common stock is traded on the Nasdaq SmallCap Market under the symbol RMKR. The following table lists the high and low
closing prices for Rainmakers common stock as reported on Nasdaq for each full quarterly period within the two most recent fiscal years.



|     |  |    |      |    |   |      |  |    |      |  |   |     
|---- |  | -- | ---- | -- | - | ---- |  | -- | ---- |  | - | ----
|     |  | Q1 |      | Q2 |   | Q3   |  | Q4
|2004 |  |    |      |    |   |      |  |    |      |  |   |     
|High |  | $  | 3.13 |    | $ | 3.50 |  | $  | 2.10 |  | $ | 1.70
|Low  |  | $  | 1.30 |    | $ | 1.80 |  | $  | 1.09 |  | $ | 0.91
|2003 |  |    |      |    |   |      |  |    |      |  |   |     
|High |  | $  | 1.10 |    | $ | 0.84 |  | $  | 1.43 |  | $ | 1.48
|Low  |  | $  | 0.58 |    | $ | 0.48 |  | $  | 0.69 |  | $ | 1.11



As of February 28,
2005, we had approximately 190 common stockholders of record. On February 28, 2005, the last reported sale price of our common stock on the Nasdaq SmallCap Market was $0.69 per share.



Dividend Policy



We have never declared or paid any cash dividends on our common stock. We currently expect to retain future earnings, if any, for use in the operation and
expansion of our business and do not anticipate paying any cash dividends in the foreseeable future.



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ITEM 6.     SELECTED FINANCIAL DATA



The following selected financial data should be read together with our financial statements and Managements Discussion and Analysis of Financial Condition and Results of Operations included elsewhere
in this annual report. The statement of operations data for the years ended December 31, 2004, 2003, and 2002 and the balance sheet data at December 31, 2004 and 2003 are derived from our audited financial statements that are included elsewhere in
this annual report. The statement of operations data for the years ended December 31, 2001 and 2000 and the balance sheet data as of December 31, 2002, 2001, and 2000 are derived from our audited financial statements not included herein. Revenue
presentation and certain prior year amounts have been reclassified to conform to the 2004 presentation. Historical results of operations are not necessarily indicative of future results.



|                                                                   |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |         |   |  |   |         |  
|------------------------------------------------------------------ |  | ------------------------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | - |  | ---- | ------- | - |  | - | ------- | -
|                                                                   |  | Years ended December 31,              |       
|                                                                   |  | 2004                                  |        |   | 2003 |   |        | 2002 |  |   | 2001   |   |  | 2000 |        
|                                                                   |  | (in thousands, except per share data) |       
|Statement of Operations Data:                                      |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |         |   |  |   |         |  
|Net revenue                                                        |  | $                                     | 15,323 |   |      | $ | 13,689 |      |  | $ | 11,157 |   |  | $    | 13,435  |   |  | $ | 17,657  |  
|Operating expenses:                                                |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |         |   |  |   |         |  
|Costs of services                                                  |  |                                       | 8,632  |   |      |   | 5,697  |      |  |   | 4,686  |   |  |      | 10,269  |   |  |   | 16,024  |  
|Sales and marketing                                                |  |                                       | 1,770  |   |      |   | 1,788  |      |  |   | 1,253  |   |  |      | 2,808   |   |  |   | 6,917   |  
|Technology                                                         |  |                                       | 1,331  |   |      |   | 1,731  |      |  |   | 1,656  |   |  |      | 714     |   |  |   | 4,443   |  
|General and administrative                                         |  |                                       | 6,838  |   |      |   | 6,056  |      |  |   | 5,743  |   |  |      | 8,585   |   |  |   | 9,112   |  
|Depreciation and amortization                                      |  |                                       | 1,740  |   |      |   | 1,497  |      |  |   | 1,906  |   |  |      | 3,409   |   |  |   | 2,448   |  
|(Recoveries of) restructuring and other related charges            |  |                                       |       |   |      |   | (23    | )    |  |   | (240   | ) |  |      | 2,389   |   |  |   | 675     |  
|                                                                   |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |         |   |  |   |         |  
|Total operating expenses                                           |  |                                       | 20,311 |   |      |   | 16,746 |      |  |   | 15,004 |   |  |      | 28,174  |   |  |   | 39,619  |  
|                                                                   |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |         |   |  |   |         |  
|Operating loss                                                     |  |                                       | (4,988 | ) |      |   | (3,057 | )    |  |   | (3,847 | ) |  |      | (14,739 | ) |  |   | (21,962 | )
|Interest and other income (expense), net                           |  |                                       | 50     |   |      |   | (25    | )    |  |   | (31    | ) |  |      | 388     |   |  |   | 1,756   |  
|Gain from sale of catalog/distributor                              |  |                                       |       |   |      |   |       |      |  |   |       |   |  |      |        |   |  |   | 50      |  
|                                                                   |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |         |   |  |   |         |  
|Loss before income taxes                                           |  |                                       | (4,938 | ) |      |   | (3,082 | )    |  |   | (3,878 | ) |  |      | (14,351 | ) |  |   | (20,156 | )
|Income tax benefit                                                 |  |                                       |       |   |      |   | (23    | )    |  |   | (373   | ) |  |      |        |   |  |   |        |  
|                                                                   |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |         |   |  |   |         |  
|Net loss                                                           |  |                                       | (4,938 | ) |      |   | (3,059 | )    |  |   | (3,505 | ) |  |      | (14,351 | ) |  |   | (20,156 | )
|                                                                   |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |         |   |  |   |         |  
|Basic and diluted net loss per share                               |  | $                                     | (0.11  | ) |      | $ | (0.08  | )    |  | $ | (0.09  | ) |  | $    | (0.38   | ) |  | $ | (0.52   | )
|                                                                   |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |         |   |  |   |         |  
|Shares used to compute basic and diluted net loss per share        |  |                                       | 43,573 |   |      |   | 38,957 |      |  |   | 38,684 |   |  |      | 38,010  |   |  |   | 38,798  |  
|                                                                   |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |         |   |  |   |         |  
|                                                                   | 
|                                                                   |  | As of December 31,                    |       
|                                                                   |  | 2004                                  |        |   | 2003 |   |        | 2002 |  |   | 2001   |   |  | 2000 |        
|                                                                   |  | (in thousands)                        |       
|Balance Sheet Data:                                                |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |         |   |  |   |         |  
|Cash, cash equivalents and short-term investments                  |  | $                                     | 10,104 |   |      | $ | 4,854  |      |  | $ | 8,128  |   |  | $    | 8,606   |   |  | $ | 22,879  |  
|Working capital                                                    |  |                                       | 2,372  |   |      |   | 970    |      |  |   | 3,273  |   |  |      | 5,599   |   |  |   | 17,546  |  
|Total assets                                                       |  |                                       | 22,362 |   |      |   | 15,817 |      |  |   | 18,681 |   |  |      | 19,910  |   |  |   | 42,222  |  
|Long-term debt and capital lease obligations, less current portion |  |                                       | 42     |   |      |   | 31     |      |  |   | 96     |   |  |      | 674     |   |  |   | 1,041   |  
|                                                                   |  |                                       |        |   |     
|Total stockholders equity                                         |  |                                       | 5,576  |   |      |   | 3,847  |      |  |   | 6,803  |   |  |      | 10,284  |   |  |   | 25,283  |  



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|ITEM 7. |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- |  | -------------------------------------------------------------------------------------



This report contains forward-looking statements within the meaning of Section 72A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. Actual events and/or future results of operations may differ materially from those contemplated by such forward-looking statements, as a result of the factors described here, and in the documents
incorporated herein by reference, including,, those factors described under Factors That May Affect Future Results and Market Price of Stock.



Overview



We are a leading provider of outsource sales and marketing programs for service contracts for technology companies, which represents almost 100% of our
revenues. Our cost-effective programs generate service revenue and promote customer retention for our clients. Core services include professional telesales, direct marketing, hosted ecommerce and order management, including invoicing and collecting
from our clients customers. Additional services include customer database hosting and enhancement, technology integration with client systems. Our services to technology clients are designed to increase the revenue from their support contracts
and to enhance their customer relationships. These services are available individually or, more typically, as an integrated solution.



Our business primarily consists of marketing and selling our clients products and services to their business customers. We provide our
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. 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.



The majority of our revenues are derived
from marketing and selling our clients service contracts. Because of this, our quarterly and annual revenues may fluctuate based on the total service contracts available for renewal or conversion in that period. As a result of this as well as
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.



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Critical Accounting Policies/Estimates



Our significant accounting polices are described in Note 1 of Notes to Financial Statements. The significant accounting
policies that we believe are critical, either because they relate to financial statement line items that are key indicators of our financial performance (e.g., revenue) and/or because their application requires significant management judgment, are
described in the following paragraphs.



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.



Use of Estimates



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:



| |  |  | revenue recognition;
| | - |  | --------------------



| |  |  | the allowance for doubtful accounts; and
| | - |  | ----------------------------------------



| |  |  | impairment of long-lived assets.
| | - |  | --------------------------------



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.



Revenue Recognition and Financial Statement Presentations



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 year 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 years ended December 31, 2003 and 2002 are as follows (in thousands):



|                                                               |  |                          |         |   |      |   |         |  
|-------------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------- | -
|                                                               |  | Years ended December 31, |        
|                                                               |  | 2003                     |         |   | 2002 |  
|Net revenue, as previously reported                            |  | $                        | 41,258  |   |      | $ | 39,312  |  
|Impact of reclassification to reflect net revenue presentation |  |                          | (27,569 | ) |      |   | (28,155 | )
|                                                               |  |                          |         |   |      |   |         |  
|Net revenue, as reclassified                                   |  | $                        | 13,689  |   |      | $ | 11,157  |  
|                                                               |  |                          |         |   |      |   |         |  



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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.



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.



In the fourth quarter of 2004, we also 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 change in presentation has been made for all financial periods presented
herein.



Allowance for Doubtful Accounts



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 December 31, 2004 and 2003 was $208,000 and
$207,000, respectively.



Impairment of Long-lived Assets



We review all of our long-lived assets, consisting
principally of fixed assets, for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include, but are not limited to,
significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for our overall business, significant negative industry or economic trends, a
significant decline in our stock price for a sustained period, and a significant change in our market capitalization relative to our net book value. An asset or a group of assets is determined to be impaired if the estimated future undiscounted net
cash flows attributable to the asset or group of assets are less than their carrying value. If impairment exists, it is measured as the difference between the carrying value of the asset or group of assets and their estimated fair values. Fair
values are determined using third party valuations, discounted cash flow analyses or other generally accepted methods. Estimating future cash flows attributable to a particular asset or group of assets is difficult, and requires the use of
significant judgment.



Significant Concentrations



We generated a significant portion of our net revenues from the marketing
and selling of products and services for a limited number of clients. In 2004, 2003 and 2002, sales to customers of Dell, HP, Nortel and Sybase each accounted for more than 10% of our net revenues. In 2004, 2003, and 2002, sales to customers of the
previously mentioned clients collectively accounted for 96%, 99%, and 93%, respectively, of net revenues and the largest individual client accounted for 47%, 34%, and 30% of our net revenues in 2004, 2003, and 2002,



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respectively. With the acquisition of Sunset Direct, we expect the percentage of net revenue generated from our largest customers to decrease from over 96%
to approximately 60% in 2005.



We have outsource services
agreements with 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 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.



Financial
Statement Categories



Net revenue consists
primarily of fees earned by us on the on the sales of our clients hardware and software support and service contracts, licenses and license upgrades to our clients customer base. Most of our revenue is based on a pay for
performance model in which we generate revenue only when we complete the sale of our clients products and services. All revenue reported in this Form 10-K 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.



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 are relatively fixed. 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 and software licenses.



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



Related Party Transactions



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 14.5% and 17.9% per annum and expire at various dates
through October 2006. As of December 31, 2004, property and



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equipment included amounts held under these capital leases of approximately $252,000 and related accumulated depreciation of approximately $57,500. Principal
and interest owed to Dell amounted to approximately $148,000 at December 31, 2004. The capital lease obligations are collateralized by the related leased property and equipment.



During the six-month period ending June 30, 2002, we purchased inventories and service agreements from a client who had a
board member that also sits on our board of directors. Total purchases from such client during the six months ended June 30, 2002, the period during which it was a related party, amounted to $1.1 million. During the same six-month period, we
received marketing development fund reimbursements of $32,000 from that client. As of June 28, 2002, this board member was no longer on the board of our client.



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



Results of Operations



The following table
presents, for the periods given, selected financial data as a percentage of our net revenue.



|                                                      |  |                          |   |  |       |   |  |       |  
|----------------------------------------------------- |  | ------------------------ | - |  | ----- | - |  | ----- | -
|                                                      |  | Years ended December 31, |  
|                                                      |  | 2004                     |   |  | 2003  |   |  | 2002  |  
|Net revenue                                           |  | 100.0                    | % |  | 100.0 | % |  | 100.0 | %
|                                                      |  |                          |  
|Operating expenses:                                   |  |                          |   |  |       |   |  |       |  
|Costs of services                                     |  | 56.3                     | % |  | 41.6  | % |  | 42.0  | %
|Sales and marketing                                   |  | 11.6                     | % |  | 13.1  | % |  | 11.2  | %
|Technology                                            |  | 8.7                      | % |  | 12.6  | % |  | 14.8  | %
|General and administrative                            |  | 44.6                     | % |  | 44.2  | % |  | 51.5  | %
|Depreciation and amortization                         |  | 11.4                     | % |  | 10.9  | % |  | 17.1  | %
|Recoveries of restructuring and other related charges |  | 0.0                      | % |  | -0.2  | % |  | -2.2  | %
|                                                      |  |                          |   |  |       |   |  |       |  
|Total operating expenses                              |  | 132.6                    | % |  | 122.3 | % |  | 134.5 | %
|                                                      |  |                          |   |  |       |   |  |       |  
|Operating loss                                        |  | -32.6                    | % |  | -22.3 | % |  | -34.5 | %
|                                                      |  |                          |  
|Interest and other income (expense), net              |  | 0.3                      | % |  | -0.2  | % |  | -0.3  | %
|                                                      |  |                          |   |  |       |   |  |       |  
|Loss before income taxes                              |  | -32.2                    | % |  | -22.5 | % |  | -34.8 | %
|Income tax benefit                                    |  | 0.0                      | % |  | 0.2   | % |  | 3.3   | %
|                                                      |  |                          |   |  |       |   |  |       |  
|Net loss                                              |  | -32.2                    | % |  | -22.3 | % |  | -31.4 | %
|                                                      |  |                          |   |  |       |   |  |       |  



Comparison of Years Ended
December 31, 2004 and 2003



Net
Revenue.    Net revenue from services increased 11.9% to $15.3 million in 2004 from $13.7 million in 2003. The increase was primarily due to expansion of business with one existing client and, to a small degree, revenue from
new clients, offset by a decline in business with two existing clients. One clients business with us increased to 47.1% of our net revenue in 2004 from 27.2% of net revenue in 2003.



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



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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 51.6% to $8.6 million in 2004 from $5.7 million in 2003. Costs of services also increased as a percentage of revenue from 41.6% in 2003 to 56.3% in 2004. The increase in absolute dollars and as a percentage of net revenue was
primarily due to increases for direct marketing costs of $1.4 million, salaries and benefit expenses of $911,000 as we increased our direct sales and marketing personnel by 60.0% from 47 employees at December 31, 2003 to 75 employees at December 31,
2004, and $272,000 for temporary service personnel. 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. 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 remained relatively constant at $1.8 million in 2004 and 2003.



Technology Expenses.    Technology expenses decreased 23.1% to $1.3 million in 2004 from $1.7
million in 2003. This decrease was primarily attributable to $332,000 of personnel costs allocated to other departments in 2004 as compared to 2003 and lower consulting expenses of $118,000 offset by an increase of $111,000 in salary and benefit
expenses, as we increased our technology personnel from 16 employees at December 31,2003 to 23 employees at December 31, 2004. The higher allocation to other departments was due to increased headcount in those departments. We expect technology
expenses to continue to fluctuate in absolute dollars, and as a percentage of revenue, as we continue to balance investment in technology with ongoing efforts to scale our cost structure.



General and Administrative Expenses.    General and administrative expenses increased 12.9% to
$6.8 million in 2004 as compared to $6.1 million in 2003. During the fourth quarter of 2004 the company terminated discussions to acquire a privately held company. The Company incurred approximately $675,000 in professional fees related to this
activity that were expensed on termination. Consulting and interim staffing costs and travel costs increased by $382,000 and $78,000 in 2004, respectively, but these increases were offset by decreases in payroll and benefit expenses and corporate
insurance expense of $339,000 and $164,000 respectively. We expect general and administrative expenses to increase in 2005 as we incur additional costs related to further investments in our business and as we continue to implement the requirements
of the Sarbanes-Oxley Act.



Depreciation and Amortization
Expenses.    Depreciation and amortization expense increased 16.2% to $1.7 million from $1.5 million in 2003. The increase of $243,000 in 2004 is primarily the result of higher net book values of depreciable assets, primarily
related to capitalized internal software development projects, as compared to 2003.



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



|                 |  |                         |     |   |                     |   |     |       |  |   |     |   |  |        |  
|---------------- |  | ----------------------- | --- | - | ------------------- | - | --- | ----- |  | - | --- | - |  | ------ | -
|                 |  | Years EndedDecember 31, |     |   | Increase/(Decrease) |  
|                 |  | 2004                    |     |   | 2003                |   |     | $ Amt |  |   | %   |  
|Interest income  |  | $                       | 87  |   |                     | $ | 56  |       |  | $ | 31  |   |  | 55.4   | %
|Interest expense |  |                         | (30 | ) |                     |   | (89 | )     |  |   | (59 | ) |  | 66.3   | %
|Other            |  |                         | (7  | ) |                     |   | 8   |       |  |   | 15  |   |  | n/a    |  
|                 |  |                         |     |   |                     |   |     |       |  |   |     |   |  |        |  
|                 |  | $                       | 50  |   |                     | $ | (25 | )     |  | $ | 75  |   |  | -300.0 | %
|                 |  |                         |     |   |                     |   |     |       |  |   |     |   |  |        |  



The increase in
interest income is attributable to higher average cash balances invested in interest bearing instruments in 2004 as compared to 2003. The decrease in interest expense is the result of lower average obligations under capital leases and other
financing arrangements in 2004 as compared to 2003.



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Comparison of Years Ended December 31, 2003 and 2002



Net Revenue.    Net revenue from services
increased 22.7% to $13.7 million in 2003 from $11.2 million in 2002. The increase was primarily due to expansion of business with certain existing clients, offset by declines in business with other existing clients as well as a decline attributable
to the discontinuation of a contract in 2003 for a client for whom we provided services in 2002. Net revenue from the discontinued client represented $16,000 in 2003 while the same client accounted for $617,000 in 2002.



Costs of services.    Costs of services increased
21.6% to $5.7 million in 2003 from $4.6 million in 2002. Costs of services decreased marginally as a percentage of revenues to 41.6 % in 2003 as compared to 42.0% in 2002. The increase in absolute dollars was primarily due to increases in salaries
and benefit expenses of $443,000 as we increased our direct sales and marketing personnel by 17.5% from 40 employees at December 31, 2002 to 47 employees at December 31, 2003, direct marketing costs of $311,000 and $81,000 for temporary service
personnel. The increase in sales personnel related to the increase in sales volume to support new customers added in 2003.



Sales and Marketing Expenses.    Sales and marketing expenses increased 42.7% to $1.8 million in 2003 from $1.3 million in
2002. The increase was primarily due to increases of $461,000 in salaries and benefit expenses and $51,000 in travel expenses.



Technology Expenses.    Technology expenses remained relatively constant at $1.7 million in 2003 and 2002. The $75,000 increase
in spending between 2003 and 2002 was the result of slightly higher salaries and benefits.



General and Administrative Expenses.    General and administrative expenses increased 5.5% to $6.1 million in 2003 as compared to $5.7 million in 2002. Professional services expenses and
interim staffing costs were higher in 2003 by $224,000 and $333,000 respectively. These expenses were partially offset by lower telephone expense of $114,000 and lower facilities expense of $88,000.



Depreciation and Amortization
Expenses.    Depreciation and amortization expense decreased 21.5% to $1.5 million in 2003 from $1.9 million in 2002. The reduction of $409,000 in 2003 is primarily the result of lower net book values of depreciable assets as
compared to 2002.



Restructuring and Other Related
Charges.    Recoveries of restructuring and related charges declined by $217,000 in 2003 as compared to the benefit realized in 2002. The charge for restructuring and other related expenses was originally recorded in the
fourth quarter of 2001 in the amount of $2.4 million. During 2002, the Company was able to negotiate more favorable terms under a lease arrangement to vacate unused facilities and, as a result, was able to recover a total of $263,000 of the original
charge including $240,000 in 2002. The amount recovered in 2003 in the amount of $23,000 was primarily due to a reduction in the cost of leased facilities.



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The following table summarizes the activity related to the restructuring liability during 2001, 2002 and
2003, respectively (in thousands):



|                                         |  |                   |      |   |                                         |   |       |                            |  |   |                       |   |  |                                             |     |   |  |   |        |  
|---------------------------------------- |  | ----------------- | ---- | - | --------------------------------------- | - | ----- | -------------------------- |  | - | --------------------- | - |  | ------------------------------------------- | --- | - |  | - | ------ | -
|                                         |  | EmployeeSeverance |      |   | LeaseCancellationand FacilityExit Costs |   |       | Write-OffofAbandonedAssets |  |   | LegalandOtherExpenses |   |  | AccruedRestructuringCosts andRelatedCharges |    
|2001:                                    |  |                   |      |   |                                         |   |       |                            |  |   |                       |   |  |                                             |     |   |  |   |        |  
|Reserve established                      |  | $                 | 158  |   |                                         | $ | 1,035 |                            |  | $ | 1,115                 |   |  | $                                           | 81  |   |  | $ | 2,389  |  
|Utilization of reservenon-cash          |  |                   |     |   |                                         |   |      |                            |  |   | (1,115                | ) |  |                                             |    |   |  |   | (1,115 | )
|Utilization of reservecash payments     |  |                   | (132 | ) |                                         |   | (158  | )                          |  |   |                       |   |  |                                             | (63 | ) |  |   | (353   | )
|                                         |  |                   |      |   |                                         |   |       |                            |  |   |                       |   |  |                                             |     |   |  |   |        |  
|Balance at December 31, 2001             |  |                   | 26   |   |                                         |   | 877   |                            |  |   |                      |   |  |                                             | 18  |   |  |   | 921    |  
|                                         |  |                   |      |   |                                        
|2002:                                    |  |                   |      |   |                                         |   |       |                            |  |   |                       |   |  |                                             |     |   |  |   |        |  
|Utilization of reservecash payments     |  |                   | (1   | ) |                                         |   | (383  | )                          |  |   |                      |   |  |                                             | (74 | ) |  |   | (458   | )
|Adjustment to reserve                    |  |                   | 6    |   |                                         |   | (66   | )                          |  |   |                       |   |  |                                             | 60  |   |  |   |       |  
|Recovery of excess restructuring reserve |  |                   | (31  | ) |                                         |   | (205  | )                          |  |   |                      |   |  |                                             | (4  | ) |  |   | (240   | )
|                                         |  |                   |      |   |                                         |   |       |                            |  |   |                       |   |  |                                             |     |   |  |   |        |  
|Balance at December 31, 2002             |  | $                 |     |   |                                         | $ | 223   |                            |  |   |                       |   |  | $                                           |    |   |  | $ | 223    |  
|                                         |  |                   |      |   |                                         |   |       |                            |  |   |                       |   |  |                                             |     |   |  |   |        |  
|                                         |  |                   |      |   |                                        
|2003:                                    |  |                   |      |   |                                         |   |       |                            |  |   |                       |   |  |                                             |     |   |  |   |        |  
|Utilization of reservecash payments     |  |                   |      |   |                                         |   | (171  | )                          |  |   |                      |   |  |                                             |     |   |  |   | (171   | )
|Adjustment to reserve                    |  |                   |      |   |                                         |   | (29   | )                          |  |   |                       |   |  |                                             |     |   |  |   | (29    | )
|Recovery of excess restructuring reserve |  |                   |      |   |                                         |   | (23   | )                          |  |   |                      |   |  |                                             |     |   |  |   | (23    | )
|                                         |  |                   |      |   |                                         |   |       |                            |  |   |                       |   |  |                                             |     |   |  |   |        |  
|Balance at December 31, 2002             |  | $                 |     |   |                                         | $ |      |                            |  |   |                       |   |  | $                                           |    |   |  | $ |       |  
|                                         |  |                   |      |   |                                         |   |       |                            |  |   |                       |   |  |                                             |     |   |  |   |        |  



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



|                 |  |                        |     |   |                     |   |      |       |  |   |     |   |  |       |  
|---------------- |  | ---------------------- | --- | - | ------------------- | - | ---- | ----- |  | - | --- | - |  | ----- | -
|                 |  | Year EndedDecember 31, |     |   | Increase/(Decrease) |  
|                 |  | 2003                   |     |   | 2002                |   |      | $ Amt |  |   | %   |  
|Interest income  |  | $                      | 56  |   |                     | $ | 122  |       |  | $ | (66 | ) |  | -54.1 | %
|Interest expense |  |                        | (89 | ) |                     |   | (103 | )     |  |   | (14 | ) |  | 13.6  | %
|Other            |  |                        | 8   |   |                     |   | (50  | )     |  |   | (58 | ) |  | n/a   |  
|                 |  |                        |     |   |                     |   |      |       |  |   |     |   |  |       |  
|                 |  | $                      | (25 | ) |                     | $ | (31  | )     |  | $ | 6   |   |  | -19.4 | %
|                 |  |                        |     |   |                     |   |      |       |  |   |     |   |  |       |  



The decrease in
interest income is attributable to reduced investments in interest bearing instruments and lower interest rates throughout 2003. The decrease in interest expense is the result of lower obligations under capital leases as we paid in full certain of
our lease obligations, and this was partially offset by interest payments on capital and lease and other financing agreements that we entered into in the year ended December 31, 2003.



Income Tax Benefit.    We recorded an income tax benefit of $23,000 in 2003 as compared to a
benefit of $373,000 in 2002. In March 2002, the Internal Revenue Service issued the Job Creation and Worker Assistance Act of 2002, which extended the regular and alternative minimum tax net operating loss carryback period from two years to five
years.



Liquidity and Sources of Capital



To date, we have funded operations from operating cash flows and net cash
proceeds from the sale of common stock.



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On February 20, 2004, we completed a private placement of common stock and common stock purchase warrants
with certain private investment funds. The Company sold an aggregate of approximately 4.67 million shares of common stock at $1.50 per share with net proceeds to the Company of approximately $6.3 million. The investors also received warrants to
purchase an aggregate of approximately 933,340 shares of Rainmakers common stock at an exercise price of $1.875 per share. In connection with the private placement, our investment banker in the transaction also received a warrant to purchase
37,333 shares of our common stock at an exercise price of $1.875 per share. The financing was completed under the provisions of Regulation D of the Securities and Exchange Commission. The net proceeds from the offering have been and will continue to
be used for working capital, capital expenditures, and general corporate purposes to support business expansion including new client acquisition, capital expenditures, development of new services and continuing investment in our proprietary
technology platform. In addition, we may use a portion of the net proceeds to expand into international markets, or to acquire complementary products, technologies or businesses.



Cash and cash equivalents were $10.1 million at December 31, 2004 as compared to $4.9 million at December 31, 2003. Working
capital was $2.4 million and $1.1 million at December 31, 2004 and 2003, respectively. The increase in cash and working capital was primarily the result of the proceeds from the private placement noted above as well as a $6.1 million increase in
accounts payable.



Operating activities during 2004 provided
cash of $208,000, as compared to cash used in operating activities of $823,000 in 2003, and cash provided by operating activities of $421,000 in 2002. Cash provided by operating activities during 2004 was primarily the result of an increase of $6.1
million in accounts payable and non cash depreciation and amortization charges of $1.7 million, which was mostly offset by our net loss of $4.9 million, an increase in accounts receivable of $2.1 million and a decrease in other accrued liabilities
of $1.2 million.



Accounts receivable increased at December 31,
2004 as compared to December 31, 2003 as a result of higher fourth quarter sales in 2004 as compared to 2003, particularly from sales relating to our largest client, while the days sales outstanding (based on gross billing, which are amounts
invoiced to customers) remained constant at 30 days at December 31, 2004 and 2003. 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 were 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. Other accrued liabilities decreased in 2004 primarily due to a decrease of $1.2 million in misdirected payments received from our clients customers for
product sales made by our clients. At December 31, 2004, all misdirected payments received by us had been remitted to our clients.



Cash used in investing activities was $744,000, $928,000 and $651,000 in 2004, 2003 and 2002, respectively. The decrease in cash used in investing
activities was due to increased capital expenditures in 2004 offset by a reduction in restricted cash. During 2004, we invested $1.8 million in capital additions as compared to $800,000 in 2003. This increase of $1.0 million year-over-year was
primarily to improve the capacity of our systems and software to support expansion of client business. We anticipate making additional investments of $3.6 million in capital equipment during 2005.



On February 8, 2005, Rainmaker acquired all of the issued and outstanding
voting securities of Quarter End, Inc. by means of a merger of Quarter End, Inc. and a wholly owned subsidiary of Rainmaker, with Quarter End, Inc. continuing as the surviving corporation. Quarter End, Inc. conducted business under the name Sunset
Direct and changed its name to Sunset Direct, Inc. (Sunset Direct) in connection with the transaction. Under the terms of the merger agreement, the Company paid approximately $3.5 million in cash, primarily to retire debt, and issued
3,320,400 shares of common stock in exchange for the outstanding capital stock of Sunset Direct.



Concurrent with the closing of the merger transaction, the Company entered into a Business Loan Agreement and Commercial Security Agreement with Bridge
Bank, N.A., and obtained a $3.0 million term loan



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(the Term Loan) that was fully utilized to retire Sunset Direct debt. The Term Loan is to be repaid over 36 months and bears interest at a
variable rate of prime plus 1.00% per annum, initially set at 6.25% per annum. 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.



In April 2004, the Company obtained a $3 million secured revolving line of credit that includes a $1 million Letter of Credit facility (the
Revolving Credit Facility) from Bridge Bank. In connection with the execution of the Term Loan, the maximum amount available under the Revolving Credit Facility was decreased to $2 million. As of March 7, 2005, the Company had incurred
no indebtedness to Bridge Bank 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 was $5.8 million in 2004
as compared to cash used in financing activities of $562,000 and $834,000 in 2003 and 2002, respectively. Cash provided by financing activities was primarily the result of the net proceeds of $6.3 million received from the private placement of our
common stock and net proceeds of $362,000 received from the exercise of employee stock options and our employee stock purchase plan offset by $873,000 used to repay capital lease and other financing arrangements. Repayments of capital lease and
other financing arrangements in 2003 and 2002 amounted to $1.5 million and $903,000, respectively. Proceeds from the issuance of common stock to employees resulting from stock option exercises and purchases under the employee stock purchase plan
were $103,000 and $72,000 in 2003 and 2002, respectively.



Our
principal source of liquidity as of December 31, 2004 consisted of $10.1 million of cash and cash equivalents and our $3.0 million Revolving Credit Facility (decreased to $2.0 million on February 8, 2005 in connection with the execution of the Term
Loan). 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, if we do not achieve our plans we may need to raise additional cash to fund operations.



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



Off-Balance Sheet Arrangements



Leases



As of December 31, 2004, our off-balance sheet arrangements include operating leases for our facility and certain property
and equipment that expire at various dates through 2007. These arrangements allow us to obtain the use of the equipment and facilities without purchasing them. If we were to acquire these assets, we would be required to obtain financing and record a
liability related to the financing of these assets. Leasing these assets under operating leases allows us to use these assets for our business while minimizing the obligations and up front cash flow related to purchasing the assets. During 2004, we
recorded rent expense related to these leases of $311,000. Rent expense in 2005 will increase as a result of the acquisition of Sunset Direct.



Guarantees



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



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on behalf of our clients and expire in November 2005 and September 2006, respectively. The letters of credit are issued under the Letter of Credit facility
with Bridge Bank N.A. At December 31, 2004, no amounts have been drawn against the Letters of Credit.



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 been obligated to make any payments for these obligations, and no liabilities have been recorded for these obligations on our balance sheets as of December 31, 2004.



Contractual Obligations



Capital Leases



We lease certain property under capital leases that expire at various dates through 2006. The effective annual interest rates on our capital lease
obligations range from 14.5% to 17.9%, with an average of 15.5%. As of December 31, 2004 and 2003, property and equipment included amounts held under capital leases of approximately $1.5 million and $2.1 million and related accumulated depreciation
of approximately $1.3 million and $2.0 million respectively. The capital lease obligations are collateralized by the related leased property and equipment.



Financing Obligations



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 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 December 31, 2004, our liability related to the Financing Agreement was $355,000, all of which will be paid in 2005.



Future payments under our contracts and obligations at December 31, 2004 are as follows:



|               |  |                |     |                      |   |                 |  |       |     |  |   |    
|-------------- |  | -------------- | --- | -------------------- | - | --------------- |  | ----- | --- |  | - | ---
|               |  | CapitalLeases  |     | FinancingObligations |   | OperatingLeases |  | Total
|               |  | (in thousands)
|2005           |  |                | 138 |                      |   | 363             |  |       | 230 |  |   | 731
|2006           |  |                | 44  |                      |   |                |  |       | 39  |  |   | 83 
|2007           |  |                |    |                      |   |                |  |       | 17  |  |   | 17 
|Thereafter     |  |                |    |                      |   |                |  |       |    |  |   |   
|               |  |                |     |                      |   |                 |  |       |     |  |   |    
|Total payments |  | $              | 182 |                      | $ | 363             |  | $     | 286 |  | $ | 831
|               |  |                |     |                      |   |                 |  |       |     |  |   |    



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



On February 8, 2005, we acquired Sunset Direct, which occupies approximately 46,400 square feet in one building in Austin,
Texas and 7,400 square feet in one building in Wallace, Idaho. The rental commitment for the lease in Austin is approximately $500,000 per year and the lease expires in June 2009 and the facility in Wallace is a month-to-month lease.



Potential Impact of Inflation



To date, inflation has not had a material impact on our business.



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Recent Accounting Pronouncements



In December 2003, the FASB issued FIN 46R, Consolidation of Variable Interest Entities, a revision to FIN 46,
which was issued in January 2003. Under FIN 46R, a variable interest entity must be consolidated by a company if that company is subject to a majority of the entitys expected losses or entitled to receive a majority of the entitys
expected residual returns or both. FIN 46R requires disclosures about variable interest entities that a company is not required to consolidate, but in which it has a significant variable interest. The consolidation requirements apply to existing
entities in the first reporting period that ends after March 15, 2004. The adoption of FIN 46 did not have a material impact on our results of consolidated operations or financial position.



In December 2003, the Staff of the SEC issued SAB 104, Revenue Recognition,
which supersedes SAB 101, Revenue Recognition in Financial Statements. SAB 104s primary purpose is to rescind the accounting guidance contained in the SAB 101 related to multiple-element revenue arrangements that was superseded as a result of
the issuance of EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. Additionally, SAB 104 rescinds the SECs related Revenue Recognition in Financial Statements Frequently Asked Questions and Answers issued with SAB 101
that had been codified in SEC Topic 13, Revenue Recognition. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104, which was
effective upon issuance.



In December 2004, the Financial
Accounting Standards Board (FASB) issued FASB Staff Position No. FAS 109-1 (FAS 109-1), Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production
Activities Provided by the American Jobs Creation Act of 2004 (AJCA). The AJCA introduces a special 9% tax deduction on qualified production activities. FAS 109-1 clarifies that this tax deduction should be accounted for as a
special tax deduction in accordance with Statement 109. Pursuant to the AJCA, the Company will not be able to claim this tax benefit until the first quarter of fiscal 2006. We do not expect the adoption of these new tax provisions to have a material
impact on our consolidated results of operations, financial position or cash flows.



In March 2004, the FASB issued EITF Issue No. 03-1 (EITF 03-1), The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments which provided new guidance for
assessing impairment losses on investments. Additionally, EITF 03-1 includes new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB delayed the accounting provisions of EITF 03-1; however
the disclosure requirements remain effective for annual periods ending after June 15, 2004. The adoption of the disclosure requirements of EITF 03-1 did not have, and we do not expect the implementation of EITF 03-1 to have, a material impact on our
consolidated financial position, results of operations or cash flows. We will evaluate the impact of EITF 03-1 once final guidance is issued.



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. SFAS No. 123R is effective for the beginning of the first interim or annual reporting period after June 15, 2005 (the quarter ended September 30, 2005 for the Company) and 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).



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In December 2004, the FASB issued Statement of Financial Accounting Standards (SFAS) 153,
Exchanges of Nonmonetary Assets (SFAS 153). SFAS 153 amends the guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions to eliminate certain exceptions to the principle that exchanges of
nonmonetary assets be measured based on the fair value of the assets exchanged. SFAS 153 eliminates the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets
that do not have commercial substance. This statement is effective for nonmonetary asset exchanges in fiscal years beginning after June 15, 2005. The adoption of SFAS 153 is not expected to have an impact on our consolidated results of operations,
financial position or cash flows.



Factors That May Affect Future Results
and Market Price of Stock



We have incurred recent
losses and may incur losses in the future.



We
incurred an operating loss of $5.0 million and net loss of $4.9 million for 2004, an operating loss of and net loss of $3.1 million for 2003, and an operating loss of $3.8 million and a net loss of $3.5 million for 2002. 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 expect that our current cash and cash equivalent balances will be adequate to meet our working capital and capital expenditure needs for at least
twelve months. After that, we may need to raise additional funds, and 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 revenue from sales to
customers of a limited number of clients. In 2004, 2003 and 2002, sales to customers of Dell, HP, Nortel and Sybase each accounted for more than 10% of our net revenues. For 2004, 2003, and 2002, sales to customers of the previously mentioned
clients collectively accounted for 96%, 99%, and 93%, respectively, of net revenues. No individual client accounted for more than 47%, 34%, and 30% of our net revenues in 2004, 2003, and 2002, respectively.



We expect that a small number of clients will continue to account for a
significant portion of our net revenue for the foreseeable future. The loss of any of our principal clients could cause a significant decrease in our net 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



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products and services fail to appeal to its customers for reasons beyond our control, such as preference for a competing product or service, our revenue from
the sale of the clients products and services may decline.



We are exposed to general economic conditions.



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



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



We are spending 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. In addition, the evaluation and attestation processes required by Section 404 are new and
neither companies nor auditing firms have significant experience in testing or complying with these requirements. Accordingly, we may encounter problems or delays in completing the review and evaluation, the implementation of improvements and the
receipt of a positive attestation by our independent auditors. 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 growth of the market for outsourced sales and marketing solutions;
| | - |  | ----------------------------------------------------------------------



| |  |  | the demand for and acceptance of our services;
| | - |  | ----------------------------------------------



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| |  |  | the demand for our clients products and services;
| | - |  | --------------------------------------------------



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



| |  |  | our ability to expand relationships with existing clients;
| | - |  | ----------------------------------------------------------



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



| |  |  | the success of our direct sales force;
| | - |  | --------------------------------------



| |  |  | our ability to retain existing clients; and
| | - |  | -------------------------------------------



| |  |  | our ability to integrate acquisitions (including our recent acquisition of Sunset Direct).
| | - |  | ------------------------------------------------------------------------------------------



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 since revenues are not earned until we sell our clients services to customers. 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.



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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.



Our success depends on our ability to successfully manage growth.



Any future growth will place additional demands on our managerial, administrative, operational and financial resources. We
will need to 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. Future business combinations by us, such as the acquisition of Sunset Direct, 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:



| |  |  | difficulties in the assimilation of operations, personnel, technologies, products and the information systems of the combined companies;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | diversion of managements attention from other business concerns;
| | - |  | -----------------------------------------------------------------



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



| |  |  | potential loss of key employees of acquired organizations.
| | - |  | ----------------------------------------------------------



We cannot be certain that we would be able to successfully integrate any businesses, products, technologies or personnel that might be acquired in the
future, and our failure to do so could limit our future growth. Although we do not currently have any agreement with respect to any additional 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.



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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.



Damage to our facilities may disrupt our operations.



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 minimize 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) in the United States and



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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 13.1% of our outstanding shares (based on the number of shares outstanding as of February 28, 2005). As a result, any significant combination of those stockholders, acting together,
will have the ability to control all matters requiring stockholder approval, including the election of all directors, and any merger, consolidation or sale of all or substantially all of our assets. Accordingly, such concentration of ownership may
have the effect of delaying, deferring or preventing a change in control of Rainmaker, which, in turn, could depress the market price of our common stock.



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



The provisions of
Delaware law and of our certificate of incorporation and bylaws could make it difficult for a third party to acquire us, even though an acquisition might be beneficial to our stockholders. Our certificate of incorporation provides our board of
directors the authority, without stockholder action, to issue up to 20,000,000 shares of preferred stock in one or more series. Our board determines when we will issue preferred stock, and the rights, preferences and privileges of any preferred
stock. In addition, our bylaws establish an advance notice



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procedure for stockholder proposals and for nominating candidates for election as directors. Delaware corporate law also contains provisions that can affect
the ability to take over a company.



Our stock price may
be volatile resulting in potential litigation.



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



| |  |  | quarter to quarter variations in results of operations;
| | - |  | -------------------------------------------------------



| |  |  | loss of a major client;
| | - |  | -----------------------



| |  |  | announcements of technological innovations by us or our competitors;
| | - |  | --------------------------------------------------------------------



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



| |  |  | new products or services offered by us or our competitors;
| | - |  | ----------------------------------------------------------



| |  |  | changes in market valuations of similar companies;
| | - |  | --------------------------------------------------



| |  |  | announcements of strategic relationships or acquisitions by us or our competitors;
| | - |  | ----------------------------------------------------------------------------------



| |  |  | other events or factors that may be beyond our control; or
| | - |  | ----------------------------------------------------------



| |  |  | if we raise additional cash, this would likely be highly dilutive to investors and our stock price may decline.
| | - |  | ---------------------------------------------------------------------------------------------------------------



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



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insurers. Since 1999, the premiums we have paid for this insurance have increased substantially. One consequence of the current economic downturn 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, including our company and certain of our current and former officers and
directors. 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 the Company 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, 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 February 28,
2005, we had outstanding 47,745,898 shares of common stock. As of February 28, 2005, there were an aggregate of 6,436,475 shares of common stock issuable



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upon exercise of outstanding stock options and warrants, including 5,465,802 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 security holders 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 8,546,020 shares and 2,380,588 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 agreements or understanding 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, on a commercially reasonable efforts basis, 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.



ITEM 7A.    QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK



Our exposure to market risk for changes in interest rates relates primarily to the increase or decrease in the amount of interest income we can earn on
our investment portfolio. We currently do not and do not plan to use derivative financial instruments in our investment portfolio. We plan to ensure the safety and preservation of our invested principal funds by limiting default risk, market risk
and investment risk. We mitigate default risk by investing in low-risk securities. To minimize our risks, we maintain our portfolio of cash equivalents and short-term investments in a variety of short-term and liquid securities including money
market funds, commercial paper, U.S. government and agency securities and municipal bonds. In general, money market funds are not subject to market risk because the interest paid on such funds fluctuates with the prevailing interest rate. As of
December 31, 2004, 100% of our portfolio was invested in instruments that mature in less than 90 days. See Note 3 of Notes to Consolidated Financial Statements.



Due to the short duration and conservative nature of our investment portfolio at December 31, 2004, we do not believe we have a material exposure to
interest rate risk.



At December 31, 2004, the interest rates
on all of our outstanding capital leases and debt are fixed and therefore not subject to interest rate fluctuations. See Note 6 of Notes to Consolidated Financial Statements.



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ITEM 8.    CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



Index to Financial Statements and Schedules



|                                                                                                      |  |     
|----------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                      |  | Page
|Consolidated Financial Statements:                                                                    |  |     
|Report of Independent Registered Public Accounting Firm  BDO Seidman, LLP                            |  | 35  
|Report of Independent Registered Public Accounting Firm  Ernst & Young LLP                           |  | 36  
|                                                                                                      | 
|Consolidated Financial Statements:                                                                    |  |     
|Consolidated Balance Sheets as of December 31, 2004 and 2003                                          |  | 37  
|Consolidated Statements of Operations for the years ended December 31, 2004, 2003, and 2002           |  | 38  
|Consolidated Statements of Stockholders Equity for the years ended December 31, 2004, 2003, and 2002 |  | 39  
|Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003, and 2002           |  | 40  
|Notes to Consolidated Financial Statements                                                            |  | 41  
|                                                                                                      | 
|Consolidated Financial Statement Schedule:                                                            |  |     
|Report of Independent Registered Public Accounting Firm  BDO Seidman, LLP                            |  | 64  
|Schedule II  Valuation and Qualifying Accounts                                                       |  | 65  



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



We have audited the accompanying consolidated balance sheet of Rainmaker Systems, Inc. as of December 31, 2004 and the related consolidated statements of operations, stockholders equity, and cash flows for the
year then ended. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.



We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of
internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Companys internal control over
financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.



In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the
financial position of Rainmaker Systems, Inc. at December 31, 2004, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.



/s/    BDO
SEIDMAN, LLP



San Francisco,
California

February 1, 2005



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



The Board of Directors and Stockholders

Rainmaker Systems, Inc.



We
have audited the accompanying consolidated balance sheet of Rainmaker Systems, Inc. as of December 31, 2003 and the related statements of operations, stockholders equity, and cash flows for each of the two years in the period ended December
31, 2003. Our audits also included the financial statement schedule listed in the Index at Item 15(a) for the two years in period ended December 31, 2003. These financial statements and schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.



We conducted our audits in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis
for our opinion.



In our opinion, the financial statements
referred to above present fairly, in all material respects, the consolidated financial position of Rainmaker Systems, Inc. at December 31, 2003, and the consolidated results of its operations and its cash flows for each of the two years in the
period ended December 31, 2003, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information stated therein.



/s/    ERNST & YOUNG LLP



San Jose, California

January 26, 2004



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RAINMAKER SYSTEMS, INC.



CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)



|                                                                                                                                                |  |              |         |   |      |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------- | - | ---- | - | ------- | -
|                                                                                                                                                |  | December 31, |        
|                                                                                                                                                |  | 2004         |         |   | 2003 |  
|ASSETS                                                                                                                                          |  |              |         |   |      |   |         |  
|Current assets:                                                                                                                                 |  |              |         |   |      |   |         |  
|Cash and cash equivalents                                                                                                                       |  | $            | 10,104  |   |      | $ | 4,854   |  
|Restricted cash                                                                                                                                 |  |              |        |   |      |   | 1,096   |  
|Accounts receivable, less allowance for doubtful accounts of $208 and $207 at December 31, 2004 and 2003, respectively                          |  |              | 7,895   |   |      |   | 5,952   |  
|Prepaid expenses and other current assets                                                                                                       |  |              | 1,117   |   |      |   | 1,007   |  
|                                                                                                                                                |  |              |         |   |      |   |         |  
|Total current assets                                                                                                                            |  |              | 19,116  |   |      |   | 12,909  |  
|Property and equipment, net                                                                                                                     |  |              | 3,160   |   |      |   | 2,808   |  
|Other noncurrent assets                                                                                                                         |  |              | 86      |   |      |   | 100     |  
|                                                                                                                                                |  |              |         |   |      |   |         |  
|Total assets                                                                                                                                    |  | $            | 22,362  |   |      | $ | 15,817  |  
|                                                                                                                                                |  |              |         |   |      |   |         |  
|                                                                                                                                                |  |             
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                            |  |              |         |   |      |   |         |  
|Current liabilities:                                                                                                                            |  |              |         |   |      |   |         |  
|Accounts payable                                                                                                                                |  | $            | 15,130  |   |      | $ | 9,055   |  
|Accrued compensation and benefits                                                                                                               |  |              | 390     |   |      |   | 369     |  
|Other accrued liabilities                                                                                                                       |  |              | 747     |   |      |   | 1,931   |  
|Obligations under financing arrangements                                                                                                        |  |              | 355     |   |      |   | 504     |  
|Current portion of capital lease obligations                                                                                                    |  |              | 122     |   |      |   | 80      |  
|                                                                                                                                                |  |              |         |   |      |   |         |  
|Total current liabilities                                                                                                                       |  |              | 16,744  |   |      |   | 11,939  |  
|Capital lease obligations, less current portion                                                                                                 |  |              | 42      |   |      |   | 31      |  
|                                                                                                                                                |  |             
|Commitments and Contingencies (Notes 4, 5 and 9)                                                                                                |  |              |         |   |      |   |         |  
|                                                                                                                                                |  |             
|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, 44,419,791 and 39,168,429 outstanding at December 31, 2004 and 2003,
respectively |  |              | 44      |   |      |   | 39      |  
|Additional paid-in capital                                                                                                                      |  |              | 63,509  |   |      |   | 56,847  |  
|Accumulated deficit                                                                                                                             |  |              | (57,977 | ) |      |   | (53,039 | )
|                                                                                                                                                |  |              |         |   |      |   |         |  
|Total stockholders equity                                                                                                                      |  |              | 5,576   |   |      |   | 3,847   |  
|                                                                                                                                                |  |              |         |   |      |   |         |  
|Total liabilities and stockholders equity                                                                                                      |  | $            | 22,362  |   |      | $ | 15,817  |  
|                                                                                                                                                |  |              |         |   |      |   |         |  



See accompanying
notes.



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RAINMAKER SYSTEMS, INC.



CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)



|                                                            |  |                          |        |   |      |   |        |      |  |   |        |  
|----------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                            |  | Years ended December 31, |       
|                                                            |  | 2004                     |        |   | 2003 |   |        | 2002 | 
|Net revenue                                                 |  | $                        | 15,323 |   |      | $ | 13,689 |      |  | $ | 11,157 |  
|                                                            |  |                          |       
|Operating expenses:                                         |  |                          |        |   |      |   |        |      |  |   |        |  
|Costs of services                                           |  |                          | 8,632  |   |      |   | 5,697  |      |  |   | 4,686  |  
|Sales and marketing                                         |  |                          | 1,770  |   |      |   | 1,788  |      |  |   | 1,253  |  
|Technology                                                  |  |                          | 1,331  |   |      |   | 1,731  |      |  |   | 1,656  |  
|General and administrative                                  |  |                          | 6,838  |   |      |   | 6,056  |      |  |   | 5,743  |  
|Depreciation and amortization                               |  |                          | 1,740  |   |      |   | 1,497  |      |  |   | 1,906  |  
|Recoveries of restructuring and other related charges       |  |                          |       |   |      |   | (23    | )    |  |   | (240   | )
|                                                            |  |                          |        |   |      |   |        |      |  |   |        |  
|Total operating expenses                                    |  |                          | 20,311 |   |      |   | 16,746 |      |  |   | 15,004 |  
|                                                            |  |                          |        |   |      |   |        |      |  |   |        |  
|Operating loss                                              |  |                          | (4,988 | ) |      |   | (3,057 | )    |  |   | (3,847 | )
|Interest and other income (expense), net                    |  |                          | 50     |   |      |   | (25    | )    |  |   | (31    | )
|                                                            |  |                          |        |   |      |   |        |      |  |   |        |  
|Loss before income taxes                                    |  |                          | (4,938 | ) |      |   | (3,082 | )    |  |   | (3,878 | )
|Income tax benefit                                          |  |                          |       |   |      |   | (23    | )    |  |   | (373   | )
|                                                            |  |                          |        |   |      |   |        |      |  |   |        |  
|Net loss                                                    |  | $                        | (4,938 | ) |      | $ | (3,059 | )    |  | $ | (3,505 | )
|                                                            |  |                          |        |   |      |   |        |      |  |   |        |  
|Basic and diluted net loss per share                        |  | $                        | (0.11  | ) |      | $ | (0.08  | )    |  | $ | (0.09  | )
|                                                            |  |                          |        |   |      |   |        |      |  |   |        |  
|Shares used to compute basic and diluted net loss per share |  |                          | 43,573 |   |      |   | 38,957 |      |  |   | 38,684 |  
|                                                            |  |                          |        |   |      |   |        |      |  |   |        |  





See accompanying notes.



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RAINMAKER SYSTEMS, INC.



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

(In thousands, except share data)



|                                                            |  |              |   |                          |        |    |                                            |   |        |                    |  |   |       |   |  |   |         |   |  |   |        |  
|----------------------------------------------------------- |  | ------------ | - | ------------------------ | ------ | -- | ------------------------------------------ | - | ------ | ------------------ |  | - | ----- | - |  | - | ------- | - |  | - | ------ | -
|                                                            |  | Common Stock |   | AdditionalPaid-inCapital |        |    | AccumulatedOtherComprehensiveIncome (Loss) |   |        | AccumulatedDeficit |  |   | Total |  
|                                                            |  | Shares       |   |                          | Amount |    |                                            |   |       
|Balance at December 31, 2001                                |  | 38,417,625   |   |                          | $      | 38 |                                            | $ | 56,676 |                    |  | $ | 45    |   |  | $ | (46,475 | ) |  | $ | 10,284 |  
|Exercise of employee stock options                          |  | 340,981      |   |                          |        |   |                                            |   | 57     |                    |  |   |      |   |  |   |        |   |  |   | 57     |  
|Issuance of common stock under employee stock purchase plan |  | 74,786       |   |                          |        |   |                                            |   | 15     |                    |  |   |      |   |  |   |        |   |  |   | 15     |  
|Repurchase of common stock for retirement                   |  | (1,924       | ) |                          |        |   |                                            |   | (3     | )                  |  |   |      |   |  |   |        |   |  |   | (3     | )
|Components of comprehensive loss:                           |  |              |   |                          |        |    |                                            |   |        |                    |  |   |       |   |  |   |         |   |  |   |        |  
|Net loss                                                    |  |             |   |                          |        |   |                                            |   |       |                    |  |   |      |   |  |   | (3,505  | ) |  |   | (3,505 | )
|Unrealized loss on investments                              |  |             |   |                          |        |   |                                            |   |       |                    |  |   | (45   | ) |  |   |        |   |  |   | (45    | )
|                                                            |  |              |   |                          |        |    |                                            |   |        |                    |  |   |       |   |  |   |         |   |  |   |        |  
|Total comprehensive loss                                    |  |             |   |                          |        |   |                                            |   |       |                    |  |   | (45   | ) |  |   | (3,505  | ) |  |   | (3,550 | )
|                                                            |  |              |   |                          |        |    |                                            |   |        |                    |  |   |       |   |  |   |         |   |  |   |        |  
|Balance at December 31, 2002                                |  | 38,831,468   |   |                          |        | 38 |                                            |   | 56,745 |                    |  |   |      |   |  |   | (49,980 | ) |  |   | 6,803  |  
|Exercise of employee stock options                          |  | 248,992      |   |                          |        | 1  |                                            |   | 78     |                    |  |   |      |   |  |   |        |   |  |   | 79     |  
|Issuance of common stock under employee stock purchase plan |  | 87,969       |   |                          |        |   |                                            |   | 24     |                    |  |   |      |   |  |   |        |   |  |   | 24     |  
|Net loss                                                    |  |             |   |                          |        |   |                                            |   |       |                    |  |   |      |   |  |   | (3,059  | ) |  |   | (3,059 | )
|                                                            |  |              |   |                          |        |    |                                            |   |        |                    |  |   |       |   |  |   |         |   |  |   |        |  
|Balance at December 31, 2003                                |  | 39,168,429   |   |                          |        | 39 |                                            |   | 56,847 |                    |  |   |      |   |  |   | (53,039 | ) |  |   | 3,847  |  
|Exercise of employee stock options                          |  | 507,478      |   |                          |        |   |                                            |   | 283    |                    |  |   |      |   |  |   |        |   |  |   | 283    |  
|Issuance of common stock under employee stock purchase plan |  | 72,494       |   |                          |        |   |                                            |   | 79     |                    |  |   |      |   |  |   |        |   |  |   | 79     |  
|Issuance of common stock for executive bonuses              |  | 4,690        |   |                          |        |   |                                            |   | 8      |                    |  |   |      |   |  |   |        |   |  |   | 8      |  
|Issuance of common stock in private placement               |  | 4,666,700    |   |                          |        | 5  |                                            |   | 6,292  |                    |  |   |      |   |  |   |        |   |  |   | 6,297  |  
|Net loss                                                    |  |             |   |                          |        |   |                                            |   |       |                    |  |   |      |   |  |   | (4,938  | ) |  |   | (4,938 | )
|                                                            |  |              |   |                          |        |    |                                            |   |        |                    |  |   |       |   |  |   |         |   |  |   |        |  
|Balance at December 31, 2004                                |  | 44,419,791   |   |                          | $      | 44 |                                            | $ | 63,509 |                    |  | $ |      |   |  | $ | (57,977 | ) |  | $ | 5,576  |  
|                                                            |  |              |   |                          |        |    |                                            |   |        |                    |  |   |       |   |  |   |         |   |  |   |        |  







See accompanying notes.



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RAINMAKER SYSTEMS, INC.



CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



|                                                                                         |  |                          |        |   |      |   |        |      |  |   |        |  
|---------------------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                         |  | Years Ended December 31, |       
|                                                                                         |  | 2004                     |        |   | 2003 |   |        | 2002 | 
|Operating activities:                                                                    |  |                          |        |   |      |   |        |      |  |   |        |  
|Net loss                                                                                 |  | $                        | (4,938 | ) |      | $ | (3,059 | )    |  | $ | (3,505 | )
|Adjustment to reconcile net loss to net cash provided by (used in) operating activities: |  |                          |        |   |      |   |        |      |  |   |        |  
|Depreciation and amortization of property and equipment                                  |  |                          | 1,740  |   |      |   | 1,497  |      |  |   | 1,906  |  
|Recoveries of restructuring and other related charges                                    |  |                          |       |   |      |   | (23    | )    |  |   | (240   | )
|Provision for allowances for doubtful accounts                                           |  |                          | 186    |   |      |   | 13     |      |  |   | 149    |  
|Loss on disposal of fixed assets                                                         |  |                          |       |   |      |   | 43     |      |  |   | 50     |  
|Changes in operating assets and liabilities:                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Accounts receivable                                                                      |  |                          | (2,129 | ) |      |   | (316   | )    |  |   | (973   | )
|Income taxes receivable                                                                  |  |                          |       |   |      |   | 211    |      |  |   | (211   | )
|Prepaid expenses and other assets                                                        |  |                          | 429    |   |      |   | 32     |      |  |   | 1,015  |  
|Accounts payable                                                                         |  |                          | 6,075  |   |      |   | 1,541  |      |  |   | 3,817  |  
|Accounts payable to related party                                                        |  |                          |       |   |      |   |       |      |  |   | (861   | )
|Accrued compensation and benefits                                                        |  |                          | 29     |   |      |   | (512   | )    |  |   | 123    |  
|Accrued restructuring and related charges                                                |  |                          |        |   |      |   | (200   | )    |  |   | (458   | )
|Other accrued liabilities                                                                |  |                          | (1,184 | ) |      |   | (50    | )    |  |   | (391   | )
|                                                                                         |  |                          |        |   |      |   |        |      |  |   |        |  
|Net cash provided by (used in) operating activities                                      |  |                          | 208    |   |      |   | (823   | )    |  |   | 421    |  
|                                                                                         |  |                          |        |   |      |   |        |      |  |   |        |  
|Investing activities:                                                                    |  |                          |        |   |      |   |        |      |  |   |        |  
|Purchases of property and equipment                                                      |  |                          | (1,840 | ) |      |   | (803   | )    |  |   | (195   | )
|Restricted cash, net                                                                     |  |                          | 1,096  |   |      |   | (135   | )    |  |   |       |  
|Sale of long-term investments                                                            |  |                          |       |   |      |   | 10     |      |  |   | 130    |  
|                                                                                         |  |                          |        |   |      |   |        |      |  |   |        |  
|Net cash used in investing activities                                                    |  |                          | (744   | ) |      |   | (928   | )    |  |   | (65    | )
|                                                                                         |  |                          |        |   |      |   |        |      |  |   |        |  
|Financing activities:                                                                    |  |                          |        |   |      |   |        |      |  |   |        |  
|Repurchase of common stock                                                               |  |                          |       |   |      |   |       |      |  |   | (3     | )
|Proceeds from issuance of common stock from option exercises                             |  |                          | 283    |   |      |   | 78     |      |  |   | 57     |  
|Proceeds from issuance of common stock from ESPP                                         |  |                          | 79     |   |      |   | 25     |      |  |   | 15     |  
|Proceeds from issuance of common stock and warrants from private placement               |  |                          | 6,297  |   |      |   |       |      |  |   |       |  
|Proceeds under financing arrangements                                                    |  |                          |        |   |      |   | 821    |      |  |   |       |  
|Repayment of financing arrangements                                                      |  |                          | (674   | ) |      |   |       |      |  |   | (766   | )
|Repayment of capital lease/debt obligations                                              |  |                          | (199   | ) |      |   | (1,486 | )    |  |   | (137   | )
|                                                                                         |  |                          |        |   |      |   |        |      |  |   |        |  
|Net cash provided by (used in) financing activities                                      |  |                          | 5,786  |   |      |   | (562   | )    |  |   | (834   | )
|                                                                                         |  |                          |        |   |      |   |        |      |  |   |        |  
|Net increase (decrease) in cash and cash equivalents                                     |  |                          | 5,250  |   |      |   | (2,313 | )    |  |   | (478   | )
|                                                                                         |  |                          |        |   |      |   |        |      |  |   |        |  
|Cash and cash equivalents at beginning of period                                         |  |                          | 4,854  |   |      |   | 7,167  |      |  |   | 7,645  |  
|                                                                                         |  |                          |        |   |      |   |        |      |  |   |        |  
|Cash and cash equivalents at end of period                                               |  | $                        | 10,104 |   |      | $ | 4,854  |      |  | $ | 7,167  |  
|                                                                                         |  |                          |        |   |      |   |        |      |  |   |        |  
|Supplement disclosures of cash flow information:                                         |  |                          |        |   |      |   |        |      |  |   |        |  
|Cash paid for interest                                                                   |  | $                        | 30     |   |      | $ | 89     |      |  | $ | 92     |  
|                                                                                         |  |                          |        |   |      |   |        |      |  |   |        |  
|Supplemental non-cash investing and financing activities:                                |  |                          |        |   |      |   |        |      |  |   |        |  
|Acquisition of assets under capital lease                                                |  | $                        | 252    |   |      | $ |       |      |  | $ | 223    |  
|                                                                                         |  |                          |        |   |      |   |        |      |  |   |        |  
|Purchase of prepaid maintenance contracts under capital lease                            |  |                          |        |   |      | $ | 172    |      |  | $ | 120    |  
|                                                                                         |  |                          |        |   |      |   |        |      |  |   |        |  
|Insurance premiums financed                                                              |  | $                        | 525    |   |      | $ | 605    |      |  | $ | 822    |  
|                                                                                         |  |                          |        |   |      |   |        |      |  |   |        |  
|Issuance of common stock for executive bonus accrual                                     |  | $                        | 8      |   |      | $ |       |      |  | $ |       |  
|                                                                                         |  |                          |        |   |      |   |        |      |  |   |        |  



See accompanying
notes.



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##### Table of Contents

RAINMAKER SYSTEMS, INC.



NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS



1.  Summary of
Significant Accounting Policies



Business



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 and hosted e-commerce. Additional services include customer database
hosting and enhancement, technology integration with client systems and order management, including invoicing and collecting from our clients customers. These services are available individually or as an integrated solution.



Principles of Consolidation



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



Basis of Presentation



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 year 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 years ended December 31, 2003 and 2002 are as follows (in thousands):



|                                                               |  |                          |         |   |      |   |         |  
|-------------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------- | -
|                                                               |  | Years ended December 31, |        
|                                                               |  | 2003                     |         |   | 2002 |  
|Net revenue, as previously reported                            |  | $                        | 41,258  |   |      | $ | 39,312  |  
|Impact of reclassification to reflect net revenue presentation |  |                          | (27,569 | ) |      |   | (28,155 | )
|                                                               |  |                          |         |   |      |   |         |  
|Net revenue, as reclassified                                   |  | $                        | 13,689  |   |      | $ | 11,157  |  
|                                                               |  |                          |         |   |      |   |         |  



Certain other prior
year amounts in 2003 and 2002 have been reclassified to conform to 2004 presentation. Such reclassifications had no effect on previously report results of operations, total assets or accumulated deficit.



Use of Estimates



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



41



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##### Table of Contents

RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Cash and Cash Equivalents



We consider all highly liquid investments purchased with an original maturity of three months or less to be cash
equivalents. Cash equivalents generally consist of money market funds and certificates of deposit. The fair market value of cash equivalents represents the quoted market prices at the balance sheet dates and approximates their carrying value.



The following is a summary of our cash and cash equivalents at
December 31, 2004 and 2003, respectively (in thousands):



|                                |  |              |        |      |   |      
|------------------------------- |  | ------------ | ------ | ---- | - | -----
|                                |  | December 31,
|                                |  | 2004         |        | 2003
|Cash and cash equivalents:      |  |              |        |      |   |      
|Cash                            |  | $            | 1,253  |      | $ | 1,371
|Certificates of deposit         |  |              | 102    |      |   | 1,096
|Money market funds              |  |              | 8,749  |      |   | 2,387
|                                |  |              |        |      |   |      
|Total cash and cash equivalents |  | $            | 10,104 |      | $ | 4,854
|                                |  |              |        |      |   |      



Allowance for Doubtful Accounts



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 December 31, 2004 and 2003, our allowance for potentially uncollectible accounts was $208,000 and $207,000, respectively.



Property and Equipment



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 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.



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate
that the carrying value may not be recoverable. An asset or group of assets is determined to be impaired if the estimated future undiscounted cash flows attributable to the asset or group of assets are less than their carrying value. If impairment
exists, it is measured as the difference between the carrying value of the asset or group of assets and their estimated fair values. Fair value is determined by third party valuations, discounted cash flow analyses, or other generally accepted
methods.



Revenue Recognition and Presentation



We recognize revenue from the sale of service contracts and maintenance
renewals under the provisions of Staff Accounting Bulleting (SAB) 104 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



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
are relatively fixed. Bonuses and sales commissions will typically change in proportion to revenue or profitability.



Advertising



We expense advertising costs as incurred. These costs were not material and are included in sales and marketing expense.



Income Taxes



We account for income taxes using the liability method in accordance with Financial Accounting Standards Board Statement No.
109, Accounting for Income Taxes (SFAS 109). SFAS 109 requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements, but
have not been reflected in our taxable income. A valuation allowance is established to reduce deferred tax assets to their estimated realizable value. Therefore, we provide a valuation allowance to the extent that we do not believe it is more
probable than not that we will generate sufficient taxable income in



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



future periods to realize the benefit of our deferred tax assets. At December 31, 2004 and 2003, we had deferred tax assets of $18.1 and $16.2 million,
respectively, that are subject to a 100% valuation allowance and therefore are not recorded on our balance sheet as an asset.



Stock-Based Compensation



As of December 31, 2004, we had three stock-based compensation plans, the 2003 Stock Incentive Plan, the 1999 Stock Incentive Plan, and the 1999 Employee
Stock Purchase Plan, which are more fully described in Note 8. 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. See the following Recently Issued Accounting Standards for discussion on changes to expense recognition beginning in the third quarter of 2005.



Pro forma information regarding net income (loss) and earnings (loss) per share is required by SFAS No. 148 and SFAS No. 123 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, 1999 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):



|                                                                                       |  |                          |        |   |      |   |        |      |  |   |        |  
|-------------------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                       |  | Years Ended December 31, |       
|                                                                                       |  | 2004                     |        |   | 2003 |   |        | 2002 | 
|Net loss as reported                                                                   |  | $                        | (4,938 | ) |      | $ | (3,059 | )    |  | $ | (3,505 | )
|Total stock-based employee compensation expense determined under the fair value method |  |                          | (948   | ) |      |   | (470   | )    |  |   | (696   | )
|                                                                                       |  |                          |        |   |      |   |        |      |  |   |        |  
|Pro forma net loss                                                                     |  | $                        | (5,886 | ) |      | $ | (3,529 | )    |  | $ | (4,201 | )
|                                                                                       |  |                          |        |   |      |   |        |      |  |   |        |  
|Basic and diluted net loss per share as reported                                       |  | $                        | (0.11  | ) |      | $ | (0.08  | )    |  | $ | (0.09  | )
|                                                                                       |  |                          |        |   |      |   |        |      |  |   |        |  
|Basic and diluted net loss per share pro forma                                         |  | $                        | (0.14  | ) |      | $ | (0.09  | )    |  | $ | (0.11  | )
|                                                                                       |  |                          |        |   |      |   |        |      |  |   |        |  



For pro forma
purposes, the estimated fair value of our stock-based grants is amortized using the graded method over the options vesting period for stock options granted under the 2003 and 1999 Stock Incentive Plans and the purchase period for stock
purchases under the 1999 Employee Stock Purchase Plan. See Note 8 for assumptions used in estimating the fair value of our stock-based grants.



Concentrations of Credit Risk and Credit Evaluations



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



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



We place our cash and cash equivalents in a variety of financial institutions and limit the amount of
credit exposure through diversification and by investing the funds in money market accounts and certificates of deposit.



We sell our clients products and services primarily to business end users and, in most transactions, assume full credit risk on the sale. Credit is
extended based on an evaluation of the financial condition of our clients customer, and collateral is generally not required. Credit losses have traditionally been immaterial, and such losses have been within managements expectations.



We enter into contracts with our clients to market and sell
our clients products and services. As a result, we primarily earn revenue from sales to the clients customer, not the client itself. We generated a significant portion of our net revenues from the marketing and selling of products and
services for a small number of clients. In 2004, sales to customers of four individual clients accounted for 47%, 24%, 13% and 13%. In 2003, sales to customers of four individual clients accounted for 34%, 27%, 22% and 17% of our net revenues. In
2002, sales to customers of four individual clients accounted for 30%, 29%, 22 and 11% of our net revenues.



No individual clients customer accounted for 10% or more of our revenues in any period presented.



We have outsourced services agreements with our clients that expire at
various dates ranging 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. Any loss of a single significant client may have a material adverse effect on the Companys consolidated financial position, cash flows and results of operations.



Fair Value of Financial Instruments



The amounts reported as cash and cash equivalents, accounts receivable,
accounts payable and accrued liabilities approximate fair value due to their short-term maturities. The fair value for our investments in marketable equity securities is estimated based on quoted market prices. The carrying value of those
securities, as of each period presented, approximates their fair value.



The fair value of short-term and long-term capital lease and debt obligations is estimated based on current interest rates available to us for debt instruments with similar terms, degrees of risk and remaining maturities. The carrying
values of these obligations, as of each period presented, approximate their respective fair values.



Segment Reporting



We operate in one market segment, the sale and marketing of technology companies products and services to their customers. We primarily operate in one geographical segment, North America. Substantially all of our sales are made to our
clients customers in the United States.



Recently Issued Accounting
Standards



In December 2003, the Financial Accounting
Standards Board (FASB) issued FIN 46R, Consolidation of Variable Interest Entities, a revision to FIN 46, which was issued in January 2003. Under FIN 46R, a variable interest entity must be consolidated by a company if that
company is subject to a majority of the entitys expected losses or entitled to receive a majority of the entitys expected residual returns or both. FIN 46R requires disclosures about variable interest entities that a company is not
required to consolidate, but in which it has a significant variable interest. The consolidation requirements apply to existing entities in the first reporting period that ends after March 15, 2004. The adoption of FIN 46 did not have a material
impact on our consolidated results of operations or financial position.



45



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



In December 2003, the Staff of the Securities and Exchange Commission ( SEC) issued SAB
104, Revenue Recognition, which supersedes SAB 101, Revenue Recognition in Financial Statements. SAB 104s primary purpose is to rescind the accounting guidance contained in the SAB 101 related to multiple-element revenue arrangements that was
superseded as a result of the issuance of EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables (EITF 00-21). Additionally, SAB 104 rescinds the SECs related Revenue Recognition in Financial Statements
Frequently Asked Questions and Answers issued with SAB 101 that had been codified in SEC Topic 13, Revenue Recognition. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101
remain largely unchanged by the issuance of SAB 104, which was effective upon issuance.



In December 2004, the FASB issued FASB Staff Position No. FAS 109-1 (FAS 109-1), Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified
Production Activities Provided by the American Jobs Creation Act (AJCA) of 2004. The AJCA introduces a special 9% tax deduction on qualified production activities. FAS 109-1 clarifies that this tax deduction should be accounted for
as a special tax deduction in accordance with Statement 109. Pursuant to the AJCA, the Company will not be able to claim this tax benefit until the first quarter of fiscal 2006. We do not expect the adoption of these new tax provisions to have a
material impact on our consolidated results of operations, financial position or cash flows.



In March 2004, the FASB issued EITF Issue No. 03-1 (EITF 03-1), The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments which provided new guidance for
assessing impairment losses on investments. Additionally, EITF 03-1 includes new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB delayed the accounting provisions of EITF 03-1; however
the disclosure requirements remain effective for annual periods ending after June 15, 2004. The adoption of the disclosure requirements of EITF 03-1 did not have, and we do not expect the implementation of EITF 03-1 to have, a material impact on our
consolidated financial position, results of operations or cash flows. We will evaluate the impact of EITF 03-1 once final guidance is issued.



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. SFAS No. 123R is effective for the beginning of the first interim or annual reporting period after June 15, 2005 (the quarter ended September 30, 2005 for the Company) and applies to all outstanding and unvested
share-based payment awards at a companys adoption date. We are currently assessing the impact of this statement on our consolidated financial statements. 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).



In December 2004, the FASB issued SFAS 153, Exchanges of
Nonmonetary Assets (SFAS 153). SFAS 153 amends the guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions to eliminate certain exceptions to the principle that exchanges of nonmonetary assets be
measured based on the fair value of the assets exchanged. SFAS 153 eliminates the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have
commercial



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



substance. This statement is effective for nonmonetary asset exchanges in fiscal years beginning after June 15, 2005. The adoption of SFAS 153 is not
expected to have an impact on our consolidated results of operations or financial position or cash flows.



2.  Net Loss Per Share



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



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



|                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|---------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                             |  | Years Ended December 31, |       
|                                                                             |  | 2004                     |        |   | 2003 |   |        | 2002 | 
|Net loss                                                                     |  | $                        | (4,938 | ) |      | $ | (3,059 | )    |  | $ | (3,505 | )
|                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Basic and diluted:                                                           |  |                          |        |   |      |   |        |      |  |   |        |  
|Weighted-average common shares of common stock outstanding                   |  |                          | 43,573 |   |      |   | 38,957 |      |  |   | 38,685 |  
|Less: weighted-average shares subject to repurchase                          |  |                          |       |   |      |   |       |      |  |   | (1     | )
|                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Weighted-average shares used to compute basic and diluted net loss per share |  |                          | 43,573 |   |      |   | 38,957 |      |  |   | 38,684 |  
|                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Basic and diluted net loss per share                                         |  | $                        | (0.11  | ) |      | $ | (0.08  | )    |  | $ | (0.09  | )
|                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  



The Company has
excluded all outstanding warrants, stock options, and shares subject to repurchase by the Company from the calculation of basic and diluted net loss per share because these securities are antidilutive for all periods presented. Options and warrants
to purchase 6,460,415, 4,350,253 and 4,390,400 shares of common stock have been excluded for the years ended December 31, 2004, 2003 and 2002.



3.  Balance Sheet Components (in thousands)



|                                                |  |              |         |   |      |   |         |  
|----------------------------------------------- |  | ------------ | ------- | - | ---- | - | ------- | -
|                                                |  | December 31, |        
|                                                |  | 2004         |         |   | 2003 |  
|Prepaid expenses and other current assets:      |  |              |         |   |      |   |         |  
|Prepaid insurance                               |  | $            | 549     |   |      | $ | 582     |  
|Prepaid support and maintenance contracts       |  |              | 91      |   |      |   | 167     |  
|Other prepaid expenses and other current assets |  |              | 477     |   |      |   | 258     |  
|                                                |  |              |         |   |      |   |         |  
|                                                |  | $            | 1,117   |   |      | $ | 1,007   |  
|                                                |  |              |         |   |      |   |         |  
|Property and equipment:                         |  |              |         |   |      |   |         |  
|Computer equipment                              |  | $            | 5,228   |   |      | $ | 4,920   |  
|Capitalized software and development            |  |              | 8,661   |   |      |   | 6,926   |  
|Furniture and fixtures                          |  |              | 947     |   |      |   | 917     |  
|Leasehold improvements                          |  |              | 336     |   |      |   | 321     |  
|                                                |  |              |         |   |      |   |         |  
|                                                |  |              | 15,172  |   |      |   | 13,084  |  
|Accumulated depreciation and amortization       |  |              | (12,012 | ) |      |   | (10,276 | )
|                                                |  |              |         |   |      |   |         |  
|Property and equipment, net                     |  | $            | 3,160   |   |      | $ | 2,808   |  
|                                                |  |              |         |   |      |   |         |  



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



4.  Capital Leases, Line of Credit, Financing Obligations and Guarantees



Capital Leases



We lease certain property under capital leases that expire at various dates through 2006. The effective annual interest
rates on our capital lease obligations range from 14.5% to 17.9%, with an average of 15.5%. As of December 31, 2004 and 2003, property and equipment included amounts held under capital leases of approximately $1.5 million and $2.1 million and
related accumulated depreciation of approximately $1.3 million and $2.0 million respectively. The capital lease obligations are collateralized by the related leased property and equipment.



During 2004 we entered in four capital leases for various computer hardware
and software. During 2003, we entered into one capital lease for software subscription. These leases have terms ranging from 12 to 36 months. Future minimum payments under these leases are $138,000 in 2005 and $44,000 in 2006.



Future minimum lease payments due under our capital leases are as follows (in
thousands):



|                                        |  |               |      |  
|--------------------------------------- |  | ------------- | ---- | -
|                                        |  | CapitalLeases |     
|2005                                    |  | $             | 138  |  
|2006                                    |  |               | 44   |  
|                                        |  |               |      |  
|Total minimum payments                  |  |               | 182  |  
|Less interest portion                   |  |               | (18  | )
|                                        |  |               |      |  
|Present value of minimum lease payments |  |               | 164  |  
|Less current portion                    |  |               | (122 | )
|                                        |  |               |      |  
|Long-term portion                       |  | $             | 42   |  
|                                        |  |               |      |  



Line of Credit and Letters of
Credit



In April 2004, the Company entered into a
Business Loan Agreement and a Commercial Security Agreement (the Facilities) with Bridge Bank N.A. (the Lender). The Facilities, which mature in May 2005, provide borrowing availability up to a maximum of $3.0 million through
a secured revolving line of credit that includes a $1.0 million Letter of Credit facility. The Facilities are subject to certain financial covenants, which include maintaining a working capital ratio and tangible net worth and bear interest at the
Prime Rate published in the Wall Street Journal but not less than 4.0%. These agreements are subject to borrowing base calculations and other limitations and authorize the Lender to perfect a security interest in substantially all of the
Companys assets including intellectual property. The Facilities contain 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 Facilities also provide 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 Facilities. As of this date, the Company has incurred no indebtedness to the Lender, however, two letters of credit in the amounts of $250,000
and $500,000, respectively, are outstanding under the Facilities as noted below. (See also Note 11).



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



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



on behalf of our clients and expire in November 2005 and September 2006, respectively. The letters of credit were issued under the Facilities with Bridge
Bank N.A. described above. At December 31, 2004, no amounts have been drawn against the letters of credit.



Financing Obligations



In November 2003, we entered into a Commercial Insurance Premium Finance and Security Agreement (2004 Financing Agreement) to finance certain of our liability insurance premiums in the amount of $605,000. At December 31, 2004,
our liability related to the Financing Agreement was fully paid.



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
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 December 31, 2004, our liability related to the Financing Agreement was
$355,000, all of which will be paid in 2005. (See Note 11)



Guarantees



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 been obligated to make any payments for these obligations, and no liabilities have been recorded for these obligations on our balance sheets as of
December 31, 2004.



5.  Commitments



We lease our facility and certain property and equipment under operating
leases that expire at various dates through 2007. The operating lease for our corporate facility expires in September 2005. Future minimum lease payments under non-cancelable operating lease agreements are as follows (in thousands):



|                       |  |                 |    
|---------------------- |  | --------------- | ---
|                       |  | OperatingLeases
|2005                   |  | $               | 230
|2006                   |  |                 | 39 
|2007                   |  |                 | 17 
|                       |  |                 |    
|Total minimum payments |  | $               | 286
|                       |  |                 |    



Rent expense under
operating lease agreements during the years ended December 31, 2004, 2003, and 2002 was $311,000, $434,000, and $502,000, respectively.



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##### Table of Contents

RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



6.  Income Taxes



The federal and state income tax benefit for the years ended December 31, 2004, 2003, and 2002 consists of the following (in
thousands):



|         |  |              |   |      |   |     |      |  |   |      |  
|-------- |  | ------------ | - | ---- | - | --- | ---- |  | - | ---- | -
|         |  | December 31, |  
|         |  | 2004         |   | 2003 |   |     | 2002 | 
|Current: |  |              |   |      |   |     |      |  |   |      |  
|Federal  |  | $            |  |      | $ | (24 | )    |  | $ | (373 | )
|State    |  |              |  |      |   | 1   |      |  |   |     |  
|         |  |              |   |      |   |     |      |  |   |      |  
|         |  |              |  |      |   | (23 | )    |  |   | (373 | )
|Deferred |  |              |   |      |   |     |      |  |   |      |  
|Federal  |  |              |  |      |   |    |      |  |   |     |  
|State    |  |              |  |      |   |    |      |  |   |     |  
|         |  |              |   |      |   |     |      |  |   |      |  
|         |  |              |  |      |   |    |      |  |   |     |  
|         |  |              |   |      |   |     |      |  |   |      |  
|         |  | $            |  |      | $ | (23 | )    |  | $ | (373 | )
|         |  |              |   |      |   |     |      |  |   |      |  



In March 2002, the
Internal Revenue Service issued the Job Creation and Worker Assistance Act of 2002 which extended the regular and alternative minimum tax net operating loss carryback period from two years to five years for losses arising in 2001 or 2002 tax years.
As a result of this new law, we recorded an income tax benefit of $373,000 during the year ended December 31, 2002, attributable to the recovery of income taxes paid in prior periods.



A reconciliation of taxes computed at the statutory federal income tax rate to income tax benefit follows (in thousands):



|                                                        |  |              |        |   |      |   |        |      |  |   |        |  
|------------------------------------------------------- |  | ------------ | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                        |  | December 31, |       
|                                                        |  | 2004         |        |   | 2003 |   |        | 2002 | 
|Tax benefit computed at federal statutory rate          |  | $            | (1,679 | ) |      | $ | (1,048 | )    |  | $ | (1,319 | )
|Loss for which no tax benefit is currently recognizable |  |              | 1,660  |   |      |   | 1,017  |      |  |   | 937    |  
|Other                                                   |  |              | 19     |   |      |   | 8      |      |  |   | 9      |  
|                                                        |  |              |        |   |      |   |        |      |  |   |        |  
|Total tax provision (benefit)                           |  | $            |       |   |      | $ | (23    | )    |  | $ | (373   | )
|                                                        |  |              |        |   |      |   |        |      |  |   |        |  



Deferred income taxes
reflect the net tax effects of temporary differences between the value of assets and liabilities used for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets as of December 31,
2004 and 2003 are as follows (in thousands):



|                                 |  |                          |         |   |      |   |         |  
|-------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------- | -
|                                 |  | Years Ended December 31, |        
|                                 |  | 2004                     |         |   | 2003 |  
|Deferred Tax Assets:             |  |                          |         |   |      |   |         |  
|Net operating loss carryforwards |  | $                        | 18,522  |   |      | $ | 16,156  |  
|Accrued reserves and other       |  |                          | 295     |   |      |   | 261     |  
|                                 |  |                          |         |   |      |   |         |  
|Total Deferred Tax Assets        |  |                          | 18,817  |   |      |   | 16,417  |  
|Valuation allowance              |  |                          | (18,248 | ) |      |   | (16,228 | )
|                                 |  |                          |         |   |      |   |         |  
|Net Deferred Tax Assets          |  |                          | 569     |   |      |   | 189     |  
|Tax over book depreciation       |  |                          | (569    | ) |      |   | (189    | )
|                                 |  |                          |         |   |      |   |         |  
|Net Deferred Tax Assets          |  | $                        |        |   |      | $ |        |  
|                                 |  |                          |         |   |      |   |         |  



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Realization of deferred tax assets is dependent upon future taxable earnings, the timing and
amount of which are uncertain. Accordingly, a full valuation allowance is provided because management cannot determine that it is more likely than not that the deferred tax asset will be realized. The valuation allowance for deferred tax assets
increased approximately $2.0 million, $277,000, and $2.1 million during the years ended December 31, 2004, 2003 and 2002, respectively.



As of December 31, 2004, we had net operating loss carryforwards for federal and state tax purposes of $49 million and $32 million respectively. The
federal and state net operating loss carryforwards will expire at various dates beginning in 2005 through 2024, if not utilized.



Utilization of our net operating loss carryforwards may be subject to a substantial annual limitation due to the ownership change limitations provided by
the Internal Revenue Code of 1986, as amended, and similar state provisions. The annual limitation may result in the expiration of net operating loss carryforwards before utilization.



7.  Stockholders Equity



Preferred Stock



We have 20,000,000 shares of preferred stock authorized The board of directors has the authority to issue the preferred stock and to fix or alter the
rights, privileges, preferences and restrictions related to the preferred stock, and the number of shares constituting any such series or designation. No shares of preferred stock were outstanding at December 31, 2004 and 2003.



Common Stock Warrants



In February 2004, we completed a private placement of common stock and
common stock purchase warrants with certain institutional investors that resulted in net proceeds to the company of approximately $6.3 million. The Company sold an aggregate of approximately 4.67 million shares of common stock at $1.50 per share.
The investors also received warrants to purchase an aggregate of 933,340 shares of our common stock at an exercise price of $1.875 per share. In connection with the private placement, our investment banker also received a warrant to purchase 37,333
shares of our common stock at an exercise price of $1.875 per share. The common stock and shares of common stock underlying the warrants issued in the private placement were subsequently registered on a commercially best efforts basis in March 2004.
The warrants expire in February 2009 and the Company has reserved 970,673 shares of common stock for the exercise of the warrants. At December 31, 2004, the warrants were still outstanding.



Stock Repurchases



During the year ended December 31, 2002, we repurchased and retired 1,924
shares of our common stock for total consideration of $3,000. At December 31, 2004, there were no shares of common stock subject to repurchase outstanding.



Stock Option Plans



In 2003, the board of directors adopted and the shareholders approved the 2003 Stock Incentive Plan (the 2003 Plan). The 2003 Plan provides
for the issuance of incentive stock options or nonqualified stock options to employees, consultants and non-employee members of the board of directors, and issuance of shares of common stock for purchase or as a bonus for services rendered. Options
granted under the 2003 Plan are priced at not less than 100% of the fair value of the common stock on the date of grant and have a maximum term of ten years



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



from the date of grant. In the case of incentive stock options granted to employees who own 10% or more of our outstanding common stock, the exercise price
may not be less than 110% of the fair value of the common stock on the date of grant and such options will have a maximum term of five years from the date of grant. Options granted to employees and consultants become exercisable and vest in one or
more installments over varying periods ranging up to five years as specified by the board of directors. Unexercised options expire upon, or within, six months of termination of employment, depending on the circumstances surrounding termination.



The 2003 Plan provides for a fixed issuance amount to
non-employee members of the board of directors at prices not less than 100% of the fair value of the common stock on the date of grant and a maximum term of ten years from the date of grant. Generally, options granted to non-employee members of the
board of directors are immediately exercisable and vest in two or more installments over periods ranging from twelve to twenty-four months from the date of grant. Unvested options expire twelve months from the date termination of service as a
non-employee member of the board of directors.



The number of
shares authorized for grant under the 2003 Plan automatically increases annually on the first trading date of January by an amount equal to the lesser of 4% of our outstanding common stock at December 31 or 3,000,000 shares.



In 1999, the board of directors adopted and the shareholders approved the
1999 Stock Incentive Plan (the 1999 Plan). The 1999 Plan provides for the issuance of incentive stock options or nonqualified stock options to employees, consultants and non-employee members of the board of directors, and issuance of
shares of common stock for purchase or as a bonus for services rendered. Options granted under the 1999 Plan are priced at not less than 100% of the fair value of the common stock on the date of grant and have a maximum term of ten years from the
date of grant. In the case of incentive stock options granted to employees who own 10% or more of our outstanding common stock, the exercise price may not be less than 110% of the fair value of the common stock on the date of grant and such options
will have a maximum term of five years from the date of grant. Options granted to employees and consultants become exercisable and vest in one or more installments over varying periods ranging up to five years as specified by the board of directors.
Unexercised options expire upon, or within, six months of termination of employment, depending on the circumstances surrounding termination.



The 1999 Plan provides for a fixed issuance amount to non-employee members of the board of directors at prices not less than 100% of the fair value of the
common stock on the date of grant and a maximum term of ten years from the date of grant. Generally, options granted to non-employee members of the board of directors are immediately exercisable and vest in two or more installments over periods
ranging from twelve to twenty-four months from the date of grant. Unvested options expire twelve months from the date termination of service as a non-employee member of the board of directors. No additional shares will be granted under the 1999
Plan.



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



A summary of activity under our Stock Incentive Plans is as follows:



|                             |  |                     |   |  |                 |   |  |                              |     
|---------------------------- |  | ------------------- | - |  | --------------- | - |  | ---------------------------- | ----
|                             |  | Options Outstanding
|                             |  | Availablefor Grant  |   |  | Number ofShares |   |  | WeightedAverageExercisePrice
|Balance at December 31, 2001 |  | 4,348,433           |   |  | 4,330,706       |   |  | $                            | 2.29
|Authorized                   |  | 1,536,703           |   |  |                |   |  | $                            |    
|Granted                      |  | (4,239,990          | ) |  | 4,239,990       |   |  | $                            | 0.30
|Exercised                    |  |                    |   |  | (340,981        | ) |  | $                            | 0.17
|Canceled                     |  | 3,839,315           |   |  | (3,839,315      | ) |  | $                            | 2.32
|Repurchases                  |  | 2,211               |   |  |                |   |  |                              |     
|                             |  |                     |   |  |                 |   |  |                              |     
|Balance at December 31, 2002 |  | 5,486,672           |   |  | 4,390,400       |   |  | $                            | 0.51
|Authorized                   |  | 1,553,259           |   |  |                |   |  | $                            |    
|Granted                      |  | (720,200            | ) |  | 720,200         |   |  | $                            | 0.93
|Exercised                    |  |                    |   |  | (248,992        | ) |  | $                            | 0.31
|Canceled                     |  | 511,355             |   |  | (511,355        | ) |  | $                            | 1.12
|                             |  |                     |   |  |                 |   |  |                              |     
|Balance at December 31, 2003 |  | 6,831,086           |   |  | 4,350,253       |   |  | $                            | 0.52
|Authorized                   |  | 1,566,742           |   |  |                |   |  | $                            |    
|Granted                      |  | (2,127,100          | ) |  | 2,127,100       |   |  | $                            | 1.88
|Exercised                    |  |                    |   |  | (507,478        | ) |  | $                            | 0.56
|Canceled                     |  | 480,133             |   |  | (480,133        | ) |  | $                            | 1.55
|                             |  |                     |   |  |                 |   |  |                              |     
|Balance at December 31, 2004 |  | 6,750,861           |   |  | 5,489,742       |   |  | $                            | 0.95
|                             |  |                     |   |  |                 |   |  |                              |     



The following table
summarizes information about stock options outstanding as of December 31, 2004:



|                         |  |                     |  |                                          |  |                              |       |                 |           |                              |   |      
|------------------------ |  | ------------------- |  | ---------------------------------------- |  | ---------------------------- | ----- | --------------- | --------- | ---------------------------- | - | -----
|                         |  | Outstanding Options |  | Options Exercisable                     
|Range of Exercise Prices |  | Number ofShares     |  | WeightedAverageContractualLife (InYears) |  | WeightedAverageExercisePrice |       | Number ofShares |           | WeightedAverageExercisePrice
|$0.06 - $0.22            |  | 15,841              |  | 7.49                                     |  | $                            | 0.22  |                 | 8,436     |                              | $ | 0.21 
|$0.23                    |  | 1,776,340           |  | 6.35                                     |  | $                            | 0.23  |                 | 1,665,548 |                              | $ | 0.23 
|$0.27 - $0.49            |  | 935,908             |  | 5.88                                     |  | $                            | 0.31  |                 | 747,872   |                              | $ | 0.31 
|$0.50 - $1.59            |  | 969,435             |  | 8.52                                     |  | $                            | 1.02  |                 | 381,470   |                              | $ | 0.85 
|$1.60 - $2.03            |  | 758,983             |  | 9.18                                     |  | $                            | 1.67  |                 | 100,209   |                              | $ | 1.72 
|$2.04 - $5.00            |  | 1,032,666           |  | 9.30                                     |  | $                            | 2.21  |                 | 76,166    |                              | $ | 2.76 
|$5.01 - $16.63           |  | 569                 |  | 4.97                                     |  | $                            | 12.55 |                 | 569       |                              | $ | 12.55
|                         |  |                     |  |                                          |  |                              |       |                 |           |                              |   |      
|$0.06 - $16.63           |  | 5,489,742           |  | 7.60                                     |  | $                            | 0.95  |                 | 2,980,270 |                              | $ | 0.45 
|                         |  |                     |  |                                          |  |                              |       |                 |           |                              |   |      



Employee Stock Purchase Plan



In 1999, our board of directors adopted and our
shareholders approved the 1999 Employee Stock Purchase Plan (the Purchase Plan). The Purchase Plan is available for all full-time employees possessing less than 5% of combined voting power on all outstanding classes of stock. The
Purchase Plan provides for the issuance of common stock at a purchase price of 85% of the fair value of the common stock at the beginning or end of the offering period, whichever is lower. Purchase of shares is made through employee payroll
deductions and may



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



not exceed 15% of an employees total compensation. Unless terminated earlier at the discretion of our board of directors, the Purchase Plan terminates
on the earlier of the last business day in October 2009, the date on which all shares available for issuance have been sold or the date on which all purchase rights are exercised in connection with a change in control. The number of shares available
for future issuance under the Purchase Plan automatically increases annually on the first trading day of January by an amount equal to the lesser of 1% of our outstanding common stock at the end of the calendar year, or 400,000 shares. As of
December 31, 2004, a total of 575,797 shares had been issued under the Purchase Plan and 1,980,588 shares were available for future issuance.



FAS 123 Assumptions and Fair Values



The Company has elected to follow APB Opinion No. 25 and related interpretations in accounting for its employee stock options because, as discussed below,
the alternative fair value accounting provided for under FAS 123 requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB Opinion No. 25, when the exercise price of the Companys
employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. The fair value of options granted in 2004, 2003 and 2002 reported in Note 1 was estimated at the date of grant.



The option valuation models used to estimate the fair value of
options under FAS 123 were developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions,
including the expected life of the option. Because the Companys employee stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the
fair value estimate, in managements opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. Pro forma information regarding net loss is required by FAS 123, which
requires that the information be determined as if the Company has accounted for its employee stock-based awards under the fair value method of FAS 123. The fair value of the options granted in all periods were estimated using the Black-Scholes
method assuming no expected dividends, with the following weighted average assumptions:



The weighted-average fair value of stock options granted in the years ended December 31, 2004, 2003, and 2002 was $1.74, $0.87, and $0.28 per share, respectively. No option shares were granted during the years ended
December 31, 2004 or 2003 with an exercise price below the deemed fair value of our common stock on the date of grant. The weighted-average fair value of the option element of the employee stock purchase plan stock granted in the years ended
December 31, 2004, 2003, and 2002 was $0.99, $0.26, and $0.16 per share, respectively.



8.  Related Party Transactions



During 2004, we purchased certain of our computer equipment and software, from our largest client, through arrangements accounted for as capital leases. The leases bear interest at rates ranging between 14.5% and 17.9% per annum and expire
at various dates through October 2006. As of December 31, 2004, property and equipment included amounts held under these capital leases of approximately $252,000 and related accumulated depreciation of approximately $57,500. Principal and interest
owed to this client amounted to approximately $148,000 at December 31, 2004. The capital lease obligations are collateralized by the related leased property and equipment.



During the six-month period ending June 30, 2002, we purchased inventories and service agreements from a client who had a
board member that also sits on our board of directors. Total purchases from such client during the six months ended June 30, 2002, the period during which it was a related party, amounted to $1.1 million. During the same six-month period, we
received marketing development fund reimbursements of $32,000 from that client. As of June 28, 2002, this board member was no longer on the board of our client.



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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



9.  Employee Benefit Plan



We have a defined contribution benefit plan established under the provisions of Section 401(k) of the Internal Revenue Code. All employees may elect to
contribute up to 20% of their compensation to the plan through salary deferrals. We match 25% of the first 6% of the employees compensation contributed to the plan. Participants contributions are fully vested at all times. Our
contributions vest incrementally over a four-year period. During the years ended December 31, 2004, 2003, and 2002, we expensed $64,000, $48,000, and $41,000, respectively, relating to our contributions under the plan.



10.  Interest and Other Income (Expense), Net



The components of interest and other (expense) income, net are as follows
(in thousands):



|                 |  |                          |     |   |      |   |     |      |  |   |      |  
|---------------- |  | ------------------------ | --- | - | ---- | - | --- | ---- |  | - | ---- | -
|                 |  | Years Ended December 31, |    
|                 |  | 2004                     |     |   | 2003 |   |     | 2002 | 
|Interest income  |  | $                        | 87  |   |      | $ | 56  |      |  | $ | 122  |  
|Interest expense |  |                          | (30 | ) |      |   | (89 | )    |  |   | (103 | )
|Other            |  |                          | (7  | ) |      |   | 8   |      |  |   | (50  | )
|                 |  |                          |     |   |      |   |     |      |  |   |      |  
|                 |  | $                        | 50  |   |      | $ | (25 | )    |  | $ | (31  | )
|                 |  |                          |     |   |      |   |     |      |  |   |      |  



11.  Subsequent Events
(Unaudited)



Acquisition



On February 8, 2005, Rainmaker acquired all of the issued and outstanding
voting securities of Quarter End, Inc. by means of a merger of Quarter End, Inc. and a wholly owned subsidiary of Rainmaker, with Quarter End, Inc. continuing as the surviving corporation. Quarter End, Inc. conducted business under the name Sunset
Direct and changed its name to Sunset Direct, Inc. (Sunset Direct) in connection with the transaction. Under the terms of the Merger Agreement, the Company paid approximately $3.5 million in cash, primarily to retire debt, and issued
3,320,400 shares of common stock in exchange for the outstanding capital stock of Sunset Direct.



The Company has agreed to file a registration statement with the Securities and Exchange Commission on a commercially reasonable efforts basis 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.



Financing Agreement



Concurrent with the closing of the merger transaction, the Company entered into a Business Loan Agreement and Commercial Security Agreement with Bridge
Bank, N.A., and obtained a $3.0 million term loan (the Term Loan) that was fully utilized to retire Sunset Direct debt. The Term Loan is to be repaid over 36



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##### Table of Contents

RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



months and bears interest at a variable rate of prime plus 1.00% per annum, initially set at 6.25% per annum. 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.



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.



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 Bridge Bank. 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 February 8, 2005, the Company has incurred no indebtedness to Bridge Bank 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.



13.  Unaudited Quarterly Financial Data



|                                     |  |                                       |       |   |         |   |       |              |  |   |             |   |  |   |        |     
|------------------------------------ |  | ------------------------------------- | ----- | - | ------- | - | ----- | ------------ |  | - | ----------- | - |  | - | ------ | ----
|                                     |  | Three Months Ended                    |      
|                                     |  | March 31                              |       |   | June 30 |   |       | September 30 |  |   | December 31 |  
|                                     |  | (in thousands, except per share data) |      
|2004:                                |  |                                       |       |   |         |   |       |              |  |   |             |   |  |   |        |     
|Net revenue (a)                      |  | $                                     | 3,784 |   |         | $ | 3,634 |              |  | $ | 3,711       |   |  | $ | 4,194  |     
|Operating loss                       |  |                                       | (450  | ) |         |   | (832  | )            |  |   | (1,082      | ) |  |   | (2,624 | )(b)
|Net loss                             |  |                                       | (440  | ) |         |   | (818  | )            |  |   | (1,073      | ) |  |   | (2,606 | )(b)
|Basic and diluted net loss per share |  |                                       | (0.01 | ) |         |   | (0.02 | )            |  |   | (0.02       | ) |  |   | (0.06  | )   
|                                     |  |                                       |       |  
|2003:                                |  |                                       |       |   |         |   |       |              |  |   |             |   |  |   |        |     
|Net revenue (a)                      |  | $                                     | 3,278 |   |         | $ | 3,159 |              |  | $ | 3,753       |   |  | $ | 3,499  |     
|Operating loss                       |  |                                       | (807  | ) |         |   | (897  | )            |  |   | (691        | ) |  |   | (662   | )   
|Net loss                             |  |                                       | (802  | ) |         |   | (906  | )            |  |   | (693        | ) |  |   | (658   | )   
|Basic and diluted net loss per share |  |                                       | (0.02 | ) |         |   | (0.02 | )            |  |   | (0.02       | ) |  |   | (0.02  | )   

---

|(a) |  |  Quarterly amounts have been reclassified to conform to current year presentation which reflects net revenue presentation in conformity with EITF 99-19 (See Note 1)
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(b) |  | During the fourth quarter of 2004, the Company terminated discussions to acquire a privately held company. The Company incurred approximately $675,000 in professional
fees related to this activity that were expensed on termination, which represents the primary reason for the noted increase in operating and net loss during the fourth quarter of 2004.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE



None.



ITEM 9A.    CONTROLS AND PROCEDURES



Evaluation of Disclosure Controls and Procedures



As of December 31, 2004, our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), have conducted an evaluation of the effectiveness of our disclosure controls and procedures
pursuant to Rule 13a-15(b) of the Exchange Act. Based on that evaluation, the CEO and CFO concluded that our disclosure controls and procedures are effective in ensuring that all material information required to be filed in this annual report has
been made known to them in a timely manner.



Changes in Internal Control
Over Financial Reporting



There has been no change in our
internal control over financial reporting during the fourth quarter of 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



ITEM 9B. OTHER INFORMATION



None.



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##### Table of Contents

PART III



Certain information
required by Part III is omitted from this Report because the Registrant will file a definitive Proxy Statement pursuant to Regulation 14A (the Proxy Statement) not later than 120 days after the end of the fiscal year covered by this
Report, and certain information included therein is incorporated herein by reference.



ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT



The information concerning our officers required by this Item is incorporated by reference to our Proxy Statement under the heading Executive Officers. The information concerning our directors required by
this Item is incorporated by reference to our Proxy Statement under the heading Election of Directors. Information concerning compliance by our officers, directors and 10% stockholders with Section 16(a) of the Securities Exchange Act of
1934 is incorporated by reference to the information contained in our Proxy Statement under the heading Section 16(a) Beneficial Ownership Reporting Compliance. Information regarding the identification of the audit committee and the
presence of an audit committee financial expert required by this Item is incorporated by reference to our Proxy Statement under the heading Audit Committee.



The Companys directors, officers and employees are required to comply with the Companys Code of Business Conduct
and Ethics. The purpose of the Companys Code of Business Conduct and Ethics is to deter wrongdoing and to promote, among other things, honest and ethical conduct and to ensure to the greatest possible extent that the Companys business is
conducted in a consistently legal and ethical manner. The Code of Business Conduct and Ethics is intended to cover the requirement of a Code of Ethics for senior financial officers as provided by the SECs rules with respect to Section 406 of
the Sarbanes-Oxley Act. Employees may submit concerns or complaints regarding ethical issues on a confidential basis by means of a telephone call to an assigned voicemail box or via email. The audit committee investigates all such concerns and
complaints.



The Companys Code of Business Conduct and
Ethics is posted on the Companys website, at http://www.rmkr.com. The Company will also disclose any amendment to, or waiver from, a provision of the Code of Business Conduct and Ethics that applies to a director or officer in
accordance with applicable NASDAQ and SEC requirements.



ITEM 11. EXECUTIVE COMPENSATION



The information required by this Item is incorporated by reference to our Proxy Statement under the heading Executive Compensation and Other Information.



ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT



The information required by this Item is incorporated by reference to our Proxy Statement under the heading Ownership of Securities.



ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS



The information required by this Item is incorporated by reference to our Proxy Statement under the heading Employment Contracts, Termination of Employment and Change in Control Arrangements.



ITEM 14. PRINCIPAL ACCOUNTANTS FEES AND SERVICES



The information required by this Item is incorporated by reference to our Proxy Statement under the heading Principal Accountants Fees and Services.



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##### Table of Contents

PART IV



ITEM 15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS OF FORM 8-K



The following documents are filed as part of this report:



(a)  1.  Financial Statements



See Item 8 for a list of financial statements filed herein.



(a)  2.  Financial Statement Schedules



See Item 8 for a list of financial statement schedules filed. All other schedules have been omitted because they are not applicable or the required
information is shown elsewhere in the Financial Statements or notes thereto.



(a)  3.  Exhibit Index:



The following Exhibits are incorporated herein by reference or are filed with this report as indicated below.



|     |       |  |                                                                                                                                                                                                                                                                        
|---- | ----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1  | (1)   |  | Certificate of Incorporation of Rainmaker Systems, Inc. filed with the Delaware Secretary of State on October 29,
1999.                                                                                                                                                
|     |      
|3.2  | (1)   |  | Bylaws of Rainmaker Systems, Inc.                                                                                                                                                                                                                                      
|     |      
|4.1  | (1)   |  | Specimen certificate representing shares of common stock of Rainmaker Systems, Inc.                                                                                                                                                                                    
|     |      
|4.2  | (1)   |  | Registration Rights Agreement dated March 8, 1994 between UniDirect Corporation and Silicon Valley Bank.                                                                                                                                                               
|     |      
|4.3  | (1)   |  | Registration Rights Agreement dated February 12, 1999 among Rainmaker Systems, Inc., ABS Capital Partners III, L.P., H & Q Rainmaker
Investors, L.P., Hambrecht & Quist California, Hambrecht & Quist Employee Venture Fund, L.P. II and The Santa Cruz Operation, Inc.
|     |      
|4.4  | (20)  |  | Purchase Agreement dated as of February 19, 2004, by and among Rainmaker Systems, Inc. and the purchasers set forth on the signature pages
thereto.                                                                                                                    
|     |      
|4.5  | (21)  |  | Stock Purchase Agreement dated as of June 10, 2004, by and among ABS Capital Partners III, L.P., Tarentella, Inc., Rainmaker Systems, Inc.,
and the purchasers identified on the schedule thereto.                                                                     
|     |      
|4.6  | (22)  |  | Registration Rights Agreement dated as of June 10, 2004, by and among ABS Capital Partners III, L.P., Tarentella, Inc., Rainmaker Systems,
Inc., the purchasers identified on the schedule thereto and SDS Capital Group SPC, Ltd.                                     
|     |      
|10.1 | (1)   |  | Form of Indemnification Agreement.                                                                                                                                                                                                                                     
|     |      
|10.2 | (1)   |  | 1999 Stock Incentive Plan.                                                                                                                                                                                                                                             
|     |      
|10.3 | (1)   |  | 1999 Stock Purchase Plan.                                                                                                                                                                                                                                              
|     |      
|10.4 | (1.1) |  | Net Lease Agreement dated July 29, 1996 between UniDirect Corporation and Borland International, Inc., together with amendments dated
February 27, 1997, April 14, 1998 and November 15, 1998.                                                                         
|     |      
|10.5 | (1.2) |  | Net Lease Agreement dated November 5, 1998 between UniDirect Corporation and Inprise Corporation.                                                                                                                                                                      
|     |      
|10.6 | (1.3) |  | Master Lease Agreement dated May 5, 1999 between Rainmaker Systems, Inc. and Celtic Leasing Corp.                                                                                                                                                                      
|     |      
|10.7 | (1.4) |  | Loan and Security Agreement dated October 28, 1997 between UniDirect Corporation and MetLife Capital Corporation, together with related
agreements dated May 5, 1999.                                                                                                  



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|      |       |  |                                                                                                                                                                                                                                                                                         
|----- | ----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.8  | (2)   |  | Form of Notice of Grant of Stock Option                                                                                                                                                                                                                                                 
|      |      
|10.9  | (3)   |  | Form of Stock Option Agreement                                                                                                                                                                                                                                                          
|      |      
|10.10 | (5)   |  | +Internet Applications Division (IAD) Reseller Agreement dated March 22, 1999 between Sybase, Inc. and Rainmaker Systems,
Inc.                                                                                                                                                          
|      |      
|10.11 | (1.5) |  | +Outsource Services Agreement dated March 26, 1999 between Rainmaker Systems, Inc. and Novell, Inc., together with amendment dated
September 8, 1999.                                                                                                                                   
|      |      
|10.12 | (6)   |  | +Amendment No. 2, dated March 1, 2001 to Outsource Services Agreement dated March 26, 1999 between Rainmaker Systems, Inc. and Novell,
Inc., together with amendments dated September 8, 1999                                                                                           
|      |      
|10.13 | (7)   |  | +Amendment No. 1, dated February 5, 2001, to Internet Applications Division (IAD) Reseller Agreement dated March 22, 1999 between Sybase,
Inc. and Rainmaker Systems, Inc.                                                                                                              
|      |      
|10.14 | (8)   |  | +Non Technical Services Agreement, dated April 6, 2001 between Rainmaker Systems, Inc. and International Business Machines
Corporation                                                                                                                                                  
|      |      
|10.15 | (9)   |  | +Master Agreement, dated May 4, 2001, between Rainmaker Systems, Inc. and Caldera International, Inc.                                                                                                                                                                                   
|      |      
|10.16 | (10)  |  | +Non Technical Services Agreement, dated July 10, 2001 between Rainmaker Systems, Inc. and Nortel Networks, Inc.                                                                                                                                                                        
|      |      
|10.17 | (4)   |  | Option Exchange Offer, dated November 30, 2001                                                                                                                                                                                                                                          
|      |      
|10.18 | (11)  |  | +Employment Agreement with Michael Silton, dated January 1, 2001                                                                                                                                                                                                                        
|      |      
|10.19 | (11)  |  | +Employment Agreement with Martin D. Hernandez, dated January 1, 2001                                                                                                                                                                                                                   
|      |      
|10.20 | (12)  |  | +Master Services Agreement dated December 19, 2001 between Rainmaker Systems, Inc. and Dell Products L.P.                                                                                                                                                                               
|      |      
|10.21 | (32)  |  | +Services Sales Outsourcing Partner Agreement dated September 25, 2000, between Rainmaker Systems, Inc. and Hewlett-Packard
Company.                                                                                                                                                    
|      |      
|10.22 | (13)  |  | +Services Sales Outsourcing Partner Agreement, Amendment No. 1 dated January 2, 2001, between Rainmaker Systems, Inc. and Hewlett-Packard
Company.                                                                                                                                      
|      |      
|10.23 | (13)  |  | +Schedule 4, Operational Plan/Business Rules Document to Service Sales Outsourcing Partner Agreement dated September 25, 2000, between
Rainmaker Systems, Inc. and Hewlett-Packard Company.                                                                                             
|      |      
|10.24 | (13)  |  | +Services Sales Outsourcing Partner Agreement dated August 1, 2002, between Rainmaker Systems, Inc. and Hewlett-Packard
Company.                                                                                                                                                        
|      |      
|10.25 | (13)  |  | +Business Rules Approval dated September 5, 2002, between Rainmaker Systems, Inc. and Hewlett-Packard Company (amend/adds to Exhibit
10.23).                                                                                                                                            
|      |      
|10.26 | (13)  |  | +Amendment to Internet Applications Division (IAD) Reseller Agreement and Outsourcing Addendum dated June 12, 2002, between Rainmaker
Systems, Inc. and Sybase, Inc.                                                                                                                    
|      |      
|10.27 | (13)  |  | +Amendment to Outsourced Services Agreement dated August 15, 2002, between Rainmaker Systems, Inc. and Nortel Networks,
Inc.                                                                                                                                                            
|      |      
|10.28 | (14)  |  | Form of Ethics Policy for financial executives.                                                                                                                                                                                                                                         
|      |      
|10.29 | (15)  |  | Amendment to Statement of Work dated January 16, 2003, between Rainmaker Systems, Inc. and Dell Products, L.P (amends/adds to the Master
Services Agreement dated December 19, 2001, filed as Exhibit 10.20 to the Report on Form 10-Q filed by Rainmaker Systems, Inc. on May 3, 2002).
|      |      
|10.30 | (15)  |  | Schedule A Statement of Work dated January 16, 2003, between Rainmaker Systems, Inc. and Dell Products, L.P (amends/adds to the Master
Services Agreement dated December 19, 2001, filed as Exhibit 10.20 to the Report on Form 10-Q filed by Rainmaker Systems, Inc. on May 3, 2002).  



60



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|      |      |  |                                                                                                                                                                                                                                                                                                                                                                                         
|----- | ---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.31 | (15) |  | Business Rules Approval dated February 6, 2003, between Rainmaker Systems, Inc. and Hewlett-Packard Company (amends/adds to Schedule 4,
Operational Plan/Business Rules Document to Service Sales Outsourcing Partner Agreement dated September 25, 2000, filed as Exhibit 10.23 to the Report on Form 10-Q filed by Rainmaker Systems, Inc. on November 14, 2002).                     
|      |     
|10.32 | (16) |  | Statement of Work for IBM ServicePac Sales Under IBM Non-Technical Service Agreement #4901AD0002 between International Business Machines
and Rainmaker Systems, Inc. dated June 16, 2003 (amends/adds to the IBM Non-Technical Service Agreement #4901AD0002 dated April 6, 2001 filed as Exhibit 10.27 to the Report on Form 10-Q filed by Rainmaker Systems, Inc. on August 10,
2001).
|      |     
|10.33 | (17) |  | 2003 Stock Incentive Plan.                                                                                                                                                                                                                                                                                                                                                              
|      |     
|10.34 | (18) |  | Addendum to Schedule A to Statement of Work dated August 27, 2003, between Rainmaker Systems, Inc. and Dell Products, L.P. (amends/adds to
the Master Services Agreement dated December 19, 2001, filed as Exhibit 10.20 to the Report on Form 10-Q filed by Rainmaker Systems, Inc. on May 3, 2002).                                                                                   
|      |     
|10.35 | (18) |  | Schedule B to Statement of Work dated August 27, 2003, between Rainmaker Systems, Inc. and Dell Products, L.P. (amends/adds to the Master
Services Agreement dated December 19, 2001, filed as Exhibit 10.20 to the Report on Form 10-Q filed by Rainmaker Systems, Inc. on May 3, 2002).                                                                                               
|      |     
|10.36 | (23) |  | +Master Services Agreement and accompanying Statement of Work dated April 22, 2004 between Rainmaker Service Sales, Inc. and Sony
Electronics Inc.                                                                                                                                                                                                                                      
|      |     
|10.37 | (24) |  | Agreement and Plan of Merger, dated as of February 8, 2005, by and among RAINMAKER SYSTEMS, INC., CW ACQUISITION, INC., QUARTER END, INC.,
the individuals listed on Exhibit A thereto and Jeffrey T. McElroy.                                                                                                                                                                          
|      |     
|10.38 | (25) |  | Business Loan Agreement and Commercial Security Agreement, entered into February 8, 2005 and dated as of February 2, 2005 between RAINMAKER
SYSTEMS, INC. and BRIDGE BANK, N.A.                                                                                                                                                                                                         
|      |     
|10.39 | (26) |  | Amendment of Employment Agreement between Rainmaker Systems, Inc. and Michael Silton dated February 24, 2005.                                                                                                                                                                                                                                                                           
|      |     
|10.40 | (27) |  | Amendment of Employment Agreement between Rainmaker Systems, Inc. and Martin Hernandez dated February 24, 2005.                                                                                                                                                                                                                                                                         
|      |     
|10.41 | (28) |  | Employment Agreement between Rainmaker Systems, Inc. and Steve Valenzuela dated February 24, 2005                                                                                                                                                                                                                                                                                       
|      |     
|14    | (19) |  | Code of Business Conduct and Ethics                                                                                                                                                                                                                                                                                                                                                     
|      |     
|21.1  |      |  | List of Subsidiaries                                                                                                                                                                                                                                                                                                                                                                    
|      |     
|23.1  |      |  | Consent of BDO Seidman, LLP, Independent Registered Public Accounting Firm                                                                                                                                                                                                                                                                                                              
|      |     
|23.2  |      |  | Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm.                                                                                                                                                                                                                                                                                                            
|      |     
|23.3  | (1)  |  | Consent of legal counsel or company                                                                                                                                                                                                                                                                                                                                                     
|      |     
|31.1  |      |  | Certification of Chief Executive Officer Pursuant to Exchange Act Rules 13a-14 and 15d-14                                                                                                                                                                                                                                                                                               
|      |     
|31.2  |      |  | Certification of Chief Financial Officer Pursuant to Exchange Act Rules 13a-14 and 15d-14                                                                                                                                                                                                                                                                                               
|      |     
|32.1  |      |  | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002                                                                                                                                                                                                                                       
|      |     
|32.2  |      |  | Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002                                                                                                                                                                                                                                       

---

|(1) |  | Incorporated by reference to the similarly numbered exhibit to the Registration Statement on Form S-1 filed by Rainmaker (Reg. No. 333-86445).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------

|(1.1) |  | Incorporated by reference to exhibit 10.7 to the Registration Statement on Form S-1 filed by Rainmaker (Reg. No. 33-86445).
|----- |  | ---------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

|(1.2) |  | Incorporated by reference to exhibit 10.8 to the Registration Statement on Form S-1 filed by Rainmaker (Reg. No. 33-86445).
|----- |  | ---------------------------------------------------------------------------------------------------------------------------

|(1.3) |  | Incorporated by reference to exhibit 10.13 to the Registration Statement on Form S-1 filed by Rainmaker (Reg. No. 33-86445).
|----- |  | ----------------------------------------------------------------------------------------------------------------------------

|(1.4) |  | Incorporated by reference to exhibit 10.14 to the Registration Statement on Form S-1 filed by Rainmaker (Reg. No. 33-86445).
|----- |  | ----------------------------------------------------------------------------------------------------------------------------

|(1.5) |  | Incorporated by reference to exhibit 10.22 to the Registration Statement on Form S-1 filed by Rainmaker (Reg. No. 33-86445).
|----- |  | ----------------------------------------------------------------------------------------------------------------------------

|(2) |  | Incorporated by reference to exhibit number 99.2 to the Registration Statement on Form S-8 filed by Rainmaker (Reg. No. 333-91095).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------

|(3) |  | Incorporated by reference to exhibit number 99.3 to the Registration Statement on Form S-8 filed by Rainmaker (Reg. No. 333-91095).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------

|(4) |  | Incorporated by reference to exhibit (a)(1) to the Tender Offer Statement on Form SC TO-I filed by Rainmaker (Reg. No 005-58179).
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------

|(5) |  | Incorporated by reference to exhibit 10.20 to the Report on Form 10-Q filed by Rainmaker on May 15, 2000.
|--- |  | ---------------------------------------------------------------------------------------------------------

|(6) |  | Incorporated by reference to exhibit 10.25 to the Report on Form 10-Q filed by Rainmaker on May 2, 2001.
|--- |  | --------------------------------------------------------------------------------------------------------

|(7) |  | Incorporated by reference to exhibit 10.26 to the Report on Form 10-Q filed by Rainmaker on May 2, 2001.
|--- |  | --------------------------------------------------------------------------------------------------------

|(8) |  | Incorporated by reference to exhibit 10.27 to the Report on Form 10-Q filed by Rainmaker on August 10, 2001.
|--- |  | ------------------------------------------------------------------------------------------------------------

|(9) |  | Incorporated by reference to exhibit 10.28 to the Report on Form 10-Q filed by Rainmaker on August 10, 2001.
|--- |  | ------------------------------------------------------------------------------------------------------------

|(10) |  | Incorporated by reference to exhibit 10.29 to the Report on Form 10-Q filed by Rainmaker on October 19, 2001.
|---- |  | -------------------------------------------------------------------------------------------------------------

|(11) |  | Incorporated by reference to the similarly numbered exhibit to the Report on Form 10-K filed by Rainmaker on March 29, 2002.
|---- |  | ----------------------------------------------------------------------------------------------------------------------------

|(12) |  | Incorporated by reference to the similarly numbered exhibit to the Report on Form 10-Q filed by Rainmaker on May 3, 2002.
|---- |  | -------------------------------------------------------------------------------------------------------------------------

|(13) |  | Incorporated by reference to the similarly numbered exhibit to the Report on Form 10-Q filed by Rainmaker on November 14, 2002.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------

|(14) |  | Incorporated by reference to the similarly numbered exhibit to the Report on Form 10-K Filed by Rainmaker on March 28, 2003.
|---- |  | ----------------------------------------------------------------------------------------------------------------------------



62



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##### Table of Contents

|(15) |  | Incorporated by reference to the similarly numbered exhibit to the Report on Form 10-Q Filed by Rainmaker on May 15, 2003.
|---- |  | --------------------------------------------------------------------------------------------------------------------------

|(16) |  | Incorporated by reference to the similarly numbered exhibit to the Report on Form 10-Q Filed by Rainmaker on August 14, 2003.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------

|(17) |  | Incorporated by reference to Exhibit 99.1 to the Registration Statement on Form S-8 filed by Rainmaker on July 23, 2003 (Reg. No. 333-107285).
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------

|(18) |  | Incorporated by reference to the similarly numbered exhibit to the Report on Form 10-Q Filed by Rainmaker on November 14, 2003.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------

|(19) |  | Incorporated by reference to the similarly numbered exhibit to the Report on Form 10-K Filed by Rainmaker on March 18, 2004.
|---- |  | ----------------------------------------------------------------------------------------------------------------------------

|(20) |  | Incorporated by reference to the similarly numbered exhibit to the Registration Statement on Form S-3 filed by Rainmaker on March 22, 2004.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------

|(21) |  | Incorporated by reference to Exhibit 99.2 to the Current Report on Form 8-K Filed by Rainmaker on June 18, 2005
|---- |  | ---------------------------------------------------------------------------------------------------------------

|(22) |  | Incorporated by reference to Exhibit 99.3 to the Current Report on Form 8-K Filed by Rainmaker on June 18, 2005
|---- |  | ---------------------------------------------------------------------------------------------------------------

|(23) |  | Incorporated by reference to the similarly numbered exhibit to the Report on Form 10-Q Filed by Rainmaker on August 16, 2004
|---- |  | ----------------------------------------------------------------------------------------------------------------------------

|(24) |  | Incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K Filed by Rainmaker on February 11, 2005
|---- |  | -------------------------------------------------------------------------------------------------------------------

|(25) |  | Incorporated by reference to Exhibit 10.2 to the Current Report on Form 8-K Filed by Rainmaker on February 11, 2005
|---- |  | -------------------------------------------------------------------------------------------------------------------

|(26) |  | Incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K Filed by Rainmaker on February 25, 2005
|---- |  | -------------------------------------------------------------------------------------------------------------------

|(27) |  | Incorporated by reference to Exhibit 10.2 to the Current Report on Form 8-K Filed by Rainmaker on February 25, 2005
|---- |  | -------------------------------------------------------------------------------------------------------------------

|(28) |  | Incorporated by reference to Exhibit 10.3 to the Current Report on Form 8-K Filed by Rainmaker on February 25, 2005
|---- |  | -------------------------------------------------------------------------------------------------------------------

|+ |  | Confidential treatment has previously been granted by the Commission for certain portions of the referenced exhibit.
|- |  | --------------------------------------------------------------------------------------------------------------------



63



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Report of Independent Registered Public Accounting Firm



Board of Directors and Stockholders

Rainmaker Systems, Inc.

Scotts Valley, California



The audit referred to in our report dated February 1, 2005 relating to the
consolidated financial statements of Rainmaker Systems, Inc., which is contained in Item 8 of this Form 10-K included the audit of the financial statement schedule listed in the accompanying index for the year ended December 31, 2004. This financial
statement schedule is the responsibility of the Companys management. Our responsibility is to express an opinion on this financial statement schedule based upon our audit.



In our opinion such financial statement schedule presents fairly, in all material respects, the information set forth
therein for the year ended December 31, 2004.



|                       
|-----------------------
|/s/    BDO SEIDMAN, LLP



San
Francisco, California

February 1, 2005



64



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##### Table of Contents

SCHEDULE II



VALUATION AND
QUALIFYING ACCOUNTS

YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002



|                                 |  |                            |     |                                      |   |              |  |   |                      |   |  |   |    
|-------------------------------- |  | -------------------------- | --- | ------------------------------------ | - | ------------ |  | - | -------------------- | - |  | - | ---
|Description                      |  | Balance atBeginningof Year |     | AdditionsCharged toCosts andExpenses |   | Deductions * |  |   | Balanceat Endof Year
|                                 |  | (in thousands)            
|Allowance for doubtful accounts: |  |                            |     |                                      |   |              |  |   |                      |   |  |   |    
|Year ended December 31, 2004     |  | $                          | 207 |                                      | $ | 186          |  | $ | (185                 | ) |  | $ | 208
|Year ended December 31, 2003     |  | $                          | 342 |                                      | $ | 13           |  | $ | (148                 | ) |  | $ | 207
|Year ended December 31, 2002     |  | $                          | 410 |                                      | $ | 149          |  | $ | (217                 | ) |  | $ | 342

---

|* |  | Uncollectible accounts written off, net of recoveries.
|- |  | ------------------------------------------------------



65



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##### Table of Contents

SIGNATURES



Pursuant to the
requirements of Section 13 or 15(d) of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Scotts Valley, State of California, on the 18th
day of March 2005.



RAINMAKER SYSTEMS, INC.By:

/s/    MICHAEL SILTONMichael Silton, Chief Executive Officer




Pursuant to
the requirements of the Securities Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated:



|                                                |  |                                                                      |  |               
|----------------------------------------------- |  | -------------------------------------------------------------------- |  | --------------
|Signature                                       |  | Title                                                                |  | Date          
|                                                |  |                                                                     
|/s/    MICHAEL SILTONMichael Silton             |  | Director, and Chief Executive Officer (Principal Executive Officer)  |  | March 18, 2005
|                                                |  |                                                                     
|/s/    STEVE
VALENZUELASteve
Valenzuela         |  | Chief Financial Officer (Principal Financial and Accounting Officer) |  | March 18, 2005
|                                                |  |                                                                     
|/s/    ALOK MOHANAlok Mohan                     |  | Chairman of the Board                                                |  | March 18, 2005
|                                                |  |                                                                     
|/s/    ROBERT LEFFRobert Leff                   |  | Director                                                             |  | March 18, 2005
|                                                |  |                                                                     
|/s/    MITCHELL LEVYMitchell Levy               |  | Director                                                             |  | March 18, 2005
|                                                |  |                                                                     
|/s/    BRADFORD
PEPPARDBradford
Peppard         |  | Director                                                             |  | March 18, 2005
|                                                |  |                                                                     
|/s/    GEORGE A. DE
URIOSTEGeorge A. de
Urioste |  | Director                                                             |  | March 18, 2005



66