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UNITED STATES

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, 2005



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 No.)
|                                                               | 
|900 EAST HAMILTON AVE CAMPBELL, CALIFORNIA                     |  | 95008                               
|(Address of principal executive offices)                       |  | (Zip Code)                          



Registrants
telephone number, including area code: (408) 626-3800



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 if the Registrant is a
well-known seasoned issuer as defined in Rule 405 of the Securities Act.    Yes ̈No  x



Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes ̈No  x



Note  Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from
their obligations under those Sections.



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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of
accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):



|                         |  |                    |  |                         
|------------------------ |  | ------------------ |  | ------------------------
|Large accelerated filer ̈ |  | Accelerated filer ̈ |  | Non-accelerated filer  x



Indicate by check mark
whether the Registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act) Yes ̈No  x



The aggregate market value of Common Stock held by non-affiliates of the registrant as of June 30, 2005, based upon the closing sales price reported by the Nasdaq Capital Market on that date was $22 million. 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 24, 2006, registrant had 13,322,380 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, 2005 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 Risk Factors, 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 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 1A. |  | Risk Factors                                                                          |  | 10
|          |  | Item 1B. |  | Unresolved Staff Comments                                                             |  | 19
|          |  | Item 2.  |  | Properties                                                                            |  | 19
|          |  | Item 3.  |  | Legal Proceedings                                                                     |  | 19
|          |  | Item 4.  |  | Submission of Matters to a Vote of Security Holders                                   |  | 19
|          |  |         
|PART II.  |  |          |  |                                                                                      
|          |  | Item 5.  |  | Market for the Registrants Common Equity and Related Stockholder Matters             |  | 20
|          |  | Item 6.  |  | Selected Financial Data                                                               |  | 21
|          |  | Item 7.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 22
|          |  | Item 7A. |  | Qualitative and Quantitative Disclosures About Market Risk                            |  | 35
|          |  | Item 8.  |  | Consolidated Financial Statements and Supplementary Data                              |  | 37
|          |  | Item 9.  |  | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure  |  | 67
|          |  | Item 9A. |  | Controls and Procedures                                                               |  | 67
|          |  | Item 9B. |  | Other Information                                                                     |  | 67
|          |  |          | 
|PART III. |  |          |  |                                                                                       |  |   
|          |  | Item 10. |  | Directors and Executive Officers of the Registrant                                    |  | 68
|          |  | Item 11. |  | Executive Compensation                                                                |  | 68
|          |  | Item 12. |  | Security Ownership of Certain Beneficial Owners and Management                        |  | 68
|          |  | Item 13. |  | Certain Relationships and Related Transactions                                        |  | 68
|          |  | Item 14. |  | Principal Accountants Fees and Services                                               |  | 68
|          |  |          | 
|PART IV.  |  |          |  |                                                                                       |  |   
|          |  | Item 15. |  | Exhibits, Financial Statement Schedules, and Reports on Form 8-K                      |  | 69
|          |  |          | 
|          |  |          |  | Signatures                                                                            |  | 77



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PART I



|ITEM 1. | BUSINESS
|------- | --------



Introduction



Rainmaker
is a leading provider of business-to-business sales and marketing services, leveraging integrated telesales, marketing, web technologies, and data analytics to achieve higher revenue for clients. Our core activities include lead qualification and
nurturing management, lead generation for product sales, subscription and service contract sales, and contract renewals and warranty extension sales. Our services are available individually or as an integrated solution.



In 2005, we completed two acquisitions that enabled us to broaden our product
and service offering, enhance our technology platform, expand our customer base, lower our cost structure, and gain significant cross-selling and up-selling opportunities. By year-end 2005, we were able to fully integrate the two acquired businesses
into our existing operations. In February 2005, we acquired a lead generation business headquartered in Austin, Texas, and in July 2005, we acquired the assets of a company that further improved the technology platform associated with our lead
generation business.



We were founded in 1991 and are
headquartered in California with our major operations center in Texas.



Industry Background



With companies continuing
to realize the benefits of outsourcing functions that are not core competencies, there has been significant growth in business process outsourcing (BPO). Business process outsourcing involves contracting with an external organization to take primary
responsibility for providing a business process or function.



Companies initially used outsourcing primarily to achieve cost savings in transaction-intensive, back office business processes and in areas such as manufacturing and facilities management. Today, outsourcing adoption is also driven by
opportunities for companies to improve a wide range of business processes, to improve customer service, and to generate revenues more efficiently.



As companies evaluate the resources needed to deploy sales and marketing programs, such as those that we offer, and to increase revenue and the sale of
support contracts and maintenance agreements, they discover that a significant commitment is required to build the needed systems infrastructure and expertise. Given the required resource and cost commitment, companies must carefully balance the
appropriate internal resources to devote to building customer relationships with the resources they can commit to other corporate priorities, such as developing new products. Many companies conclude decisively that contracting for outsourced sales
and marketing services provides them with a range of benefits, including compelling ROIs and the ability to achieve higher revenue growth rates more efficiently.



Rainmaker Services



We focus on providing services to our clients that enable them to grow their revenues more efficiently for their products and services. With the expertise
of our people, the efficiency of our processes, and our proprietary technology, we offer individual and integrated services that increase our clients revenue potential.



Our core activities are data development and analytics, lead generation, lead management and nurturing, installed base
sales, and subscription and service contract sales. In addition to helping to generate increased revenue for our clients, we also enable our clients to deepen the relationship they have with the customers we contact on behalf of our clients. By
selecting Rainmaker to assist them with improving the efficiency of their sales and marketing activities, clients can focus their attention on other business priorities.



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Below we provide a detailed description of the services that we offer for installed base sales,
subscription and service sales, lead generation services, and data development and analytics.



Installed Base Sales and Subscription/ Service Sales.    We identify and profile our clients customers in order to maximize selling opportunities through all stages of the
customer life cycle. From the point of purchase, until a product is replaced or retired, there are a variety of opportunities to generate add on products as well as services revenue, including the following:



|                              |  |                                                                                                                             
|----------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------
|Stage of Lifecycle            |  | Add On Product and Services Revenue Opportunity                                                                             
|                              | 
|Post-Purchase Attach          |  | Sell additional products and services, extend warranties, and uplift services to higher levels of coverage for 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                                                                



Contract Renewals Plus®



Contract Renewals Plus® (CRP) is our enterprise-class solution for organizations that require an end-to-end
solution for increasing warranty, service and subscription renewal sales. Contract Renewals Plus enables our clients to maximize service revenue, increase renewal rates on service and subscription contracts, sell more upgrades and add-in licenses,
and enhance customer relationships. The solution leverages each of our core services, ranging from data enhancement services to direct marketing and e-commerce.



CRP is 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 installed base customers. 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 installed base and then market and sell relevant products and service 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 multiple medium communication channels, including direct mail, e-mail, web and e-commerce technology, online marketing, and
one-to-one personal assistance. We believe that our services foster deeper, richer customer relationships that strengthen customer loyalty to our clients. During 2005, 2004 and 2003, Contract Renewals Plus generated 59%, 98% and 97% of our net
revenue, respectively. The 2005 percentage reflects the addition of lead generation revenue into our product mix which were added during the year.



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 services or add-on products associated with the initial products they have purchased from our client. The website
gives the customer the ability to view the service or product offerings that are available, generate a quote and place an order.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Direct mail marketing:    In addition to web and email, we use compelling multi-touch direct marketing programs. These campaigns alert our clients
customers to services and products, special promotions and renewal opportunities which 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.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Strategic Lead Generation and
Management.We provide comprehensive strategic lead generation and management services that include planning, executing and generating actionable leads for sales and service organizations. By wrapping services and
applications around the process of generating actionable leads, we empower customers to have complete control and visibility over their lead activities, including campaign ROI and automated process for nurturing leads in their sales funnel.



Unlike other providers, our lead generation and management
activities center around our industry-leading database of executive decision makers. This database, Prospect Intelligence, not only contains accurate contact information, but also includes organizational profiles, evaluation history and purchasing
plans. The result is exemplary leads with a wealth of information that sales and partner organizations can leverage and use to immediately begin the sales process.



Data Development and Analytics.At the launch of a client engagement, we are able to profile, cleanse,
supplement, and append data, as required, to ensure program success. We have created an industry-leading database development solution that are deployed for traditional systems and the Web, plus proprietary modeling tools that turn data into
actionable strategies for sales and direct marketing activities. Additionally, we also provide resources for cleansing, supplementing and appending data, to build a foundation for achieving higher results from these campaigns.



Rainmakers proprietary Prospect Intelligence Database provides access to executive level technology
and business decision makers. Our database contains over 2 million key titles with contact details, organizational profiles, and purchasing plans in all of the major market segments. We leverage this database for the sales and marketing
campaigns that we offer.



Our Clients



Our clients consist of large enterprises in a range of industries, including
technology, telecommunications, and financial services. Our clients typically have large customer bases and products and services that require complex selling processes to generate sales, thereby enabling them to benefit from our focused sales and
marketing programs to drive more revenue. On a combined basis, sales to our top two customers accounted for 47% of our net revenues in 2005. We believe that there are significant opportunities for cross-selling and up-selling our services within our
existing customer base.



Future Growth Strategy



Our objective is to continue to grow our revenue and capabilities by
providing industry leading outsourced sales and marketing programs to our clients.



| |  |  | Sign new clients.    We continue to emphasize our industry leading sales and marketing solutions with top tier clients 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.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Further penetrate our existing client base.    We continually seek to increase the level of services provided to our existing clients, many of whom
currently use our services supporting selected product or customer segments. We also plan to continue to cross-sell our lead-generation services to our clients using our service sales programs and to cross-sell our service sales programs to our lead
generation clients. We also believe there are opportunities to expand our services with our existing customers.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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. In 2005, we relocated our major operations to Austin, Texas where we have been able to
take advantage of a skilled labor force and a lower-cost environment.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Technology.    We plan to continue to develop and refine our technology to allow us to seamlessly integrate with our clients to provide a complete
closed-loop solution for tracking and nurturing leads from our systems to our clients CRM systems, and also allow us to exchange service contract renewal information with our clients. We believe these technology solutions provide a high barrier to
entry for other competitors and make it difficult for our clients to switch to competitors.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Future strategic initiatives.    From time to time, the Company may be presented with opportunities to pursue strategic initiatives, such as the
acquisition of Sunset Direct in 2005. The Company believes that acquisitions could help to supplement organic growth and will potentially pursue transactions if they meet rigorous financial and operational criteria and provide the Company with clear
strategic and financial benefits.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Sales and Marketing



We market our services through a direct sales force that
we have increased from four sales representatives at the beginning of 2005 to ten sales representatives as of December 31, 2005. 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 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 provide data enhancement services that ensure that our clients sales and marketing campaigns are accurately reaching the right targets through the right channels, with the necessary
reporting and modeling capabilities to ensure ongoing success. 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.



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Acquisition of Sunset Direct



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 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. We have now fully integrated our operations with those of
Sunset Direct, including relocating most of our operations to Sunset Directs facility in Austin, Texas.



Employees



As of
December 31, 2005, we employed 336 people. Our 259 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 240 personnel consisting of direct marketing and professional telesales individuals who are responsible for delivering the Companys end user customer communication programs and driving lead generation and
service contract sales. We also employed 29 technology personnel who develop and maintain the computer, Internet, web and telecommunications infrastructure that provides the foundation for our service offerings. Our remaining 48 employees were in
general administration and finance. We also use temporary personnel from time to time, and they are not included in our headcount.



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 lead generation services 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 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 and provide lead
generation services. We are aware of two companies that provide service contract sales: 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. There are many lead generation competitors, the largest of which are Harte-Hanks, a public company, and
Sutherland, a large private company. We also compete with many other private companies that provide lead generation services.



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 outsourced services
include: Convergys Corporation, Digital Impact, Digital River, Inc., Harte-Hanks, Inc., Sitel Corporation, Sykes



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Enterprises, Inc., and West Corporation. In addition, many large ERP software developers, including Oracle Corporation, Salesforce.com, Inc., 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, 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 and Texas, 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.



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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 Consolidated Financial Statements.



Other Information



Our principal office is 900 East Hamilton Ave., Suite 400, Campbell, CA 95008 and our phone number is 408.626.3800. 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 SEC. Information contained on our website is not part of this Form 10-K.



|ITEM 1A. | RISK FACTORS
|-------- | ------------



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



We incurred a net loss of $5.0 million for the year ended December 31, 2005, a net loss of $4.9 million for the year
ended December 31, 2004, and a net loss of $3.1 million for the year ended December 31, 2003. Our accumulated losses through December 31, 2005 were $63.0 million. We may incur losses in the future, depending on the timing of signing
of new clients, costs to initiate service for new clients, impact of new and existing clients, our decisions to further invest in our technology or infrastructure, and our ability to continue to increase our operating efficiencies.



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



We anticipate that our existing capital resources and cash flow expected to be generated from future operations, along with the $5.4 million, net of estimated issuance costs, from our February 7, 2006 private
placement of our common stock 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. 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.



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 2005, two customers accounted for more than 10% of our revenue and collectively represented 47% of



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our net revenue with the largest representing 36% of our net revenue. In 2004 and 2003, four customers accounted for more than 10% of our net revenues. In
2004 and 2003, combined sales to these customers accounted for 96%, and 99%, respectively, of net revenue and the largest individual client accounted for 47% and 34% of our net revenue in 2004 and 2003, respectively.



We expect that a small number of clients will continue to account for a
significant portion of our revenue for the foreseeable future. The loss of any of our principal clients could cause a significant decrease in our revenue. In addition, our software and technology clients operate in industries that experience
consolidation from time to time, which could reduce the number of our existing and potential clients. Any loss of a single significant client may have a material adverse effect on our financial position, cash flows and results of operations. We are
currently providing services to Sybase on a month to month basis as our contract with Sybase expired on December 31, 2005.



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



Our business primarily consists of marketing and selling our clients
products and services to their customers. In addition, most of our revenue is based on a pay for performance model in which our revenues are based on the amount of our clients products and services that we sell. Accordingly, if a
particular clients products and services fail to appeal to its customers for reasons beyond our control, such as preference for a competing product or service, our revenue from the sale of the clients products and services may decline.
In addition, revenue from our lead generation product offering is predominately based on fixed-fee retainer contracts. Our customers are under no obligation to renew their engagements with us when their contracts come up for renewal from time to
time.



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



In March 2005, the SEC postponed, for one year, the compliance date for reporting on internal control by non-accelerated filers. Despite this
postponement, we expect to continue to spend an increased amount of management time and internal and external resources to comply with changing laws, regulations and standards relating to corporate governance and public disclosure, including the
Sarbanes-Oxley Act of 2002, new SEC regulations and NASDAQ Stock Market rules. In particular, Section 404 of the Sarbanes-Oxley Act of 2002 requires managements annual review and evaluation of our internal control systems and attestations
of the effectiveness of these systems by our independent auditors. We are currently documenting and testing our internal control systems and procedures and considering improvements that may be necessary in order for us to comply with the
requirements of Section 404 by the end of 2007. This process has required us to hire outside advisory services and has resulted in additional accounting and legal expenses. While we believe that we currently have adequate internal controls over
financial reporting, in the event that our chief executive officer, chief financial officer or independent auditors determine that our controls over financial reporting are not effective as defined under Section 404, investor perceptions of our
company may be adversely affected and could cause a decline in the market price of our stock.



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



Terrorist acts or acts of war may 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.



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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;
| | - |  | ----------------------------------------------



| |  |  | 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 (including the assets acquired from Launch Project);
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------



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



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



| |  |  | our ability to integrate acquisitions.
| | - |  | --------------------------------------



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



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



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



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



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



Competition in CRM services is intense,
and we expect such competition to increase in the future. Our competitors include system integrators, ecommerce solutions providers, and other outsource providers of



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different components of customer interaction management. We also face competition from internal marketing departments of current and potential clients.
Additionally, we may face competition from outsource providers with substantial offshore facilities which may enable them to compete aggressively with similar service offerings at a substantially lower price. Many of our existing or potential
competitors have greater name recognition, longer operating histories, and significantly greater financial, technical and marketing resources, which could further impact our ability to address competitive pressures. Should competitive factors
require us to increase spending for, and investment in, client acquisition and retention or for the development of new services, our expenses could increase disproportionately to our revenues. Competitive pressures may also necessitate price
reductions and other actions that would likely affect our business adversely. Additionally, there can be no assurances that we will have the resources to maintain a higher level of spending to address changes in the competitive landscape. Failure to
maintain or to produce revenue proportionate to any increase in expenses would have a negative impact on our financial results.



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



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



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 (which may include asset
acquisitions) that would complement our existing business or enhance our technological capabilities, such as our acquisition of Sunset Direct and our acquisition of assets from Launch Project. Future business combinations by us could result in
potentially dilutive issuances of equity securities, large and immediate write-offs, the incurrence of debt and contingent liabilities or amortization expenses related to goodwill and other intangible assets, any of which could cause our financial
performance to suffer. Furthermore, business combinations entail numerous risks and uncertainties, including:



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



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



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



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



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



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



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



We make investments in technology and capitalize these costs and begin depreciating once the technology is deployed. If the technology is not
deployable we would incur a charge for technology assets under development.



We make technology and system improvements and capitalize those costs until the technology is deployed, at which time we begin to depreciate the asset over the expected useful life of the asset. As of
December 31, 2005 we have $2.9 million in development that we have capitalized on our balance sheet and have not deployed. In the event that we do not deploy these assets, we would incur a charge to our income statement in the quarter that
determination was made.



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 disable 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 help to minimize but not eliminate disruptions to the operations of the Company in the event of a business interruption in any one of our facilities
on a short-term basis. In the event of the loss of a facility in either Campbell 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.



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



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



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



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



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



The Federal Trade Commissions (FTCs) telemarketing sales rules prohibit misrepresentations of the
cost, terms, restrictions, performance or duration of products or services offered by telephone solicitation and specifically addresses other perceived telemarketing abuses in the offering of prizes. Additionally, the FTCs rules limit the
hours during which telemarketers may call consumers. The Federal Telephone Consumer Protection Act of 1991 contains other restrictions on facsimile transmissions and on telemarketers, including a prohibition on the use of automated telephone dialing
equipment to call certain telephone numbers. A number of states also regulate telemarketing and some states have enacted restrictions similar to these federal laws. In addition, a number of states regulate email and facsimile transmissions. The
failure to comply with applicable statutes and regulations could result in penalties. There can be no assurance that additional federal or state legislation, or changes in regulatory implementation, or judicial interpretation of existing or future
laws would not limit our activities in the future or significantly increase the cost of regulatory compliance.



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



Our directors, executive officers and entities affiliated with them together beneficially control approximately 16% of our outstanding shares (based on the number of shares outstanding as of February 24, 2006).
As a result, any significant combination of those stockholders, acting together, may have the ability to disproportionately influence all matters requiring stockholder approval, including the election of all directors, and any merger, consolidation
or sale of all or substantially all of our assets. Accordingly, such concentration of ownership may have the effect of delaying, deferring or preventing a change in control of Rainmaker, which, in turn, could depress the market price of our common
stock.



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



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



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.



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



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



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



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



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



Our common stock is currently listed on the NASDAQ Capital Market. NASDAQ has requirements that a company must meet in order to remain listed on the
NASDAQ Capital 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 Capital 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 Capital Market, our stock would become harder to buy and sell. Consequently, if we were removed from the NASDAQ Capital 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 previously reported on Form 8-K, on March 9, 2005, the Company received a notice from NASDAQ that the bid price of the Companys common
stock had closed below the minimum $1.00 per share requirement for 30 consecutive business days. The notice further provided that in accordance with Marketplace Rule 4310(c)(8)(D), the Company would be provided 180 calendar days, or until
September 6, 2005, to regain



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compliance. The notice also stated that if the Company could not demonstrate compliance with the minimum bid price requirement by September 6, 2005, but
met all of the other NASDAQ Capital Market initial listing criteria as set forth in Marketplace Rule 4310(c) on such date, then the Company would be granted an additional 180 calendar days, or until March 6, 2006, to regain compliance with the
minimum bid price requirement.



As we also previously reported
on Form 8-K, on September 7, 2005, NASDAQ notified the Company that as of September 6, 2005 the Company had met all initial inclusion criteria for the NASDAQ Capital Market set forth in Marketplace Rule 4310(c) except for the bid price.
Therefore, in accordance with Marketplace Rule 4310(c)(8)(D), NASDAQ provided the Company with an additional 180 calendar days, or until March 6, 2006, to regain compliance with the minimum bid price requirement.



In order to increase our closing bid price to meet NASDAQs $1.00
minimum requirement, on December 15, 2005 the Companys stockholders approved, and the Companys Board of Directors effected, a one-for-five reverse split of the outstanding shares of our common stock. Trading in our Common Stock on a
post-split basis began on the NASDAQ Capital Market at the open of business on December 16, 2005.



On January 3, 2006, NASDAQ Capital Market notified the Company that it had regained compliance with the $1.00 minimum bid price requirement as a
result of the stock trading for ten consecutive days above $1.00.



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 24, 2006, we had 13,322,380 outstanding shares of common stock. This amount includes shares issued under the Securities
Purchase Agreements on February 7, 2006, as described below. As of February 24, 2006, there were an aggregate of 2,994,377 shares of common stock issuable upon exercise of outstanding stock options and warrants, including 1,799,177 shares
issuable upon exercise of options outstanding under our option plan and 1,195,200 shares of common stock issuable upon exercise of the outstanding warrants issued to the selling stockholders in our private placement transactions completed on
February 7, 2006, June 15, 2005 and February 20, 2004. Under our existing stock option plan and employee stock purchase plan, we may issue up to an additional 728,416 shares and 455,779 shares of our common stock, respectively,
subject to the terms and conditions of such plans. We may issue and/or register additional shares, options, or warrants in the future in connection with acquisitions, compensation or otherwise. We have not entered into any definitive agreements
regarding any future acquisitions and cannot ensure that we will be able to identify or complete any acquisition in the future.



On February 7, 2006, the Company entered into two Securities Purchase Agreements with certain new and existing investors. Pursuant to the Securities
Purchase Agreements, the Company issued a total of 2,000,000 shares of the Companys common stock at a price of $3.00 per share for gross proceeds of $6.0 million and issued warrants to the investors to purchase an additional 799,999 shares of
common stock of the Company at an exercise price of $4.28 per share. The securities issued pursuant to the Securities Purchase Agreements were not registered under the Securities Act of 1933, as amended (the Securities Act), or the
securities laws of certain states, in reliance on the exemptions provided by Section 4(2) of the Securities Act and Regulation D promulgated there under and in reliance on similar exemptions under applicable state laws. Under the Securities
Purchase Agreements, the Company also granted certain registration rights to each of the investors pursuant to which the Company expects to file a registration statement on Form S-3 by April 7, 2006, with respect to the common stock issued
under the Securities Purchase Agreements and the common stock issuable upon conversion of the related warrants.



In connection with the asset purchase with Launch Project LLC, we filed a registration statement with the SEC with respect to the shares that were issued
to Launch Projects members that was declared effective August 12, 2005. Pursuant to that registration statement, approximately 70,000 of such shares are available for



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public sale, with an additional 35,000 of such shares available for sale April 1, 2006 and the final 35,000 of such shares available for sale
July 1, 2006. In addition 28,000 shares of common stock consideration have been placed in escrow to secure certain indemnity obligations and will not be released until July 1, 2006 subject to potential post closing adjustments.



As of February 24, 2006, all 664,080 shares of common stock issued in
connection with the Sunset Direct acquisition have been released and are available for public sale.



|ITEM 1B. | UNRESOLVED STAFF COMMENTS
|-------- | -------------------------



None.



|ITEM 2. | PROPERTIES
|------- | ----------



Facilities



Our
headquarters is located in one building in Campbell, California. We occupy approximately 16,600 square feet of floor space covered by a lease that expires in 2008.



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
|------- | ---------------------------------------------------



On December 15, 2005, the Company held a Special Meeting of Stockholders. At the meeting, the Stockholders authorized the Companys Board of
Directors to amend the Companys Certificate of Incorporation to effect a reverse split of the outstanding shares of the Companys common stock by a ratio of between one-for-three to one-for-ten, inclusive, without further approval or
authorization of the Companys stockholders (with 47,623,555 shares voting for, 1,732,940 against, and 64,449 abstaining). The Board of Directors elected to effect the reverse split in the ratio of one-for-five effective as of 5:00 p.m. Eastern
Time on December 15, 2005.



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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 Capital 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, adjusted to reflect the one-for-five reverse split of the Companys outstanding common stock effected
on December 15, 2005.



|     |  |    |       |    |   |       |  |    |       |  |   |     
|---- |  | -- | ----- | -- | - | ----- |  | -- | ----- |  | - | ----
|     |  | Q1 |       | Q2 |   | Q3    |  | Q4
|2005 |  |    |       |    |   |       |  |    |       |  |   |     
|High |  | $  | 6.35  |    | $ | 3.00  |  | $  | 3.55  |  | $ | 3.10
|Low  |  | $  | 2.40  |    | $ | 1.95  |  | $  | 2.60  |  | $ | 2.20
|2004 |  |    |       |    |   |       |  |    |       |  |   |     
|High |  | $  | 15.65 |    | $ | 17.50 |  | $  | 10.50 |  | $ | 8.50
|Low  |  | $  | 6.50  |    | $ | 9.00  |  | $  | 5.45  |  | $ | 4.55



As of
February 24, 2006, we had approximately 228 common stockholders of record. On February 24, 2006, the last reported sale price of our common stock on the Nasdaq Capital Market was $3.60 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.



20



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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, 2005, 2004, and 2003 and the balance sheet data at December 31, 2005 and 2004
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, 2002 and 2001 and the balance sheet data as of December 31, 2003, 2002,
and 2001 are derived from our audited financial statements not included herein. Certain prior year amounts have been reclassified to conform to the 2005 presentation. Historical results of operations are not necessarily indicative of future results.



|                                                               |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|-------------------------------------------------------------- |  | ------------------------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | - |  | ---- | ------ | - |  | - | ------- | -
|                                                               |  | Years ended December 31,              |       
|                                                               |  | 2005                                  |        |   | 2004 |   |        | 2003 |  |   | 2002   |   |  | 2001 |       
|                                                               |  | (in thousands, except per share data) |       
|Statement of Operations Data:                                  |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Net revenue                                                    |  | $                                     | 32,114 |   |      | $ | 15,323 |      |  | $ | 13,689 |   |  | $    | 11,157 |   |  | $ | 13,435  |  
|Operating expenses:                                            |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Costs of services                                              |  |                                       | 18,716 |   |      |   | 7,709  |      |  |   | 5,052  |   |  |      | 4,177  |   |  |   | 7,817   |  
|Sales and marketing                                            |  |                                       | 2,838  |   |      |   | 1,651  |      |  |   | 1,671  |   |  |      | 718    |   |  |   | 1,424   |  
|Technology                                                     |  |                                       | 4,248  |   |      |   | 2,826  |      |  |   | 2,920  |   |  |      | 2,586  |   |  |   | 5,152   |  
|General and administrative                                     |  |                                       | 8,134  |   |      |   | 6,385  |      |  |   | 5,629  |   |  |      | 5,857  |   |  |   | 7,983   |  
|Depreciation and amortization                                  |  |                                       | 3,114  |   |      |   | 1,740  |      |  |   | 1,497  |   |  |      | 1,906  |   |  |   | 3,409   |  
|(Recoveries of) restructuring and other related charges        |  |                                       |       |   |      |   |       |      |  |   | (23    | ) |  |      | (240   | ) |  |   | 2,389   |  
|                                                               |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Total operating expenses                                       |  |                                       | 37,050 |   |      |   | 20,311 |      |  |   | 16,746 |   |  |      | 15,004 |   |  |   | 28,174  |  
|                                                               |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Operating loss                                                 |  |                                       | (4,936 | ) |      |   | (4,988 | )    |  |   | (3,057 | ) |  |      | (3,847 | ) |  |   | (14,739 | )
|Interest and other income (expense), net                       |  |                                       | (68    | ) |      |   | 50     |      |  |   | (25    | ) |  |      | (31    | ) |  |   | 388     |  
|                                                               |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Loss before income taxes                                       |  |                                       | (5,004 | ) |      |   | (4,938 | )    |  |   | (3,082 | ) |  |      | (3,878 | ) |  |   | (14,351 | )
|Income tax benefit                                             |  |                                       |       |   |      |   |       |      |  |   | (23    | ) |  |      | (373   | ) |  |   |        |  
|                                                               |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Net loss                                                       |  |                                       | (5,004 | ) |      |   | (4,938 | )    |  |   | (3,059 | ) |  |      | (3,505 | ) |  |   | (14,351 | )
|                                                               |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Basic and diluted net loss per share (1)                       |  | $                                     | (0.48  | ) |      | $ | (0.57  | )    |  | $ | (0.39  | ) |  | $    | (0.45  | ) |  | $ | (1.89   | )
|                                                               |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  
|Shares used to compute basic and diluted net loss per share(1) |  |                                       | 10,464 |   |      |   | 8,715  |      |  |   | 7,791  |   |  |      | 7,737  |   |  |   | 7,602   |  
|                                                               |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |         |  



|(1) |  | - Adjusted to reflect the one-for-five reverse split of the Companys outstanding common stock effected on December 15, 2005.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------



|                                                                   |  |                    |        |   |      |   |        |  |      |        |      |   |        |  |   |       
|------------------------------------------------------------------ |  | ------------------ | ------ | - | ---- | - | ------ |  | ---- | ------ | ---- | - | ------ |  | - | ------
|                                                                   |  | As of December 31,
|                                                                   |  | 2005               |        |   | 2004 |   | 2003   |  | 2002 |        | 2001
|                                                                   |  | (in thousands)    
|Balance Sheet Data:                                                |  |                    |        |   |      |   |        |  |      |        |      |   |        |  |   |       
|Cash, cash equivalents and short-term investments                  |  | $                  | 9,746  |   |      | $ | 10,104 |  | $    | 4,854  |      | $ | 8,128  |  | $ | 8,606 
|Working capital                                                    |  |                    | (3,764 | ) |      |   | 2,372  |  |      | 970    |      |   | 3,273  |  |   | 5,599 
|Total assets                                                       |  |                    | 34,158 |   |      |   | 22,362 |  |      | 15,817 |      |   | 18,681 |  |   | 19,910
|Long-term debt and capital lease obligations, less current portion |  |                    | 1,917  |   |      |   | 42     |  |      | 31     |      |   | 96     |  |   | 674   
|Total stockholders equity                                         |  |                    | 6,119  |   |      |   | 5,576  |  |      | 3,847  |      |   | 6,803  |  |   | 10,284



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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 Risk Factors



Overview



We are a leading provider of business-to-business sales and marketing services, leveraging integrated telesales, marketing, web technologies, and data
analytics to achieve higher revenue for clients. Our core activities include lead qualification and nurturing management, lead generation for product sales, subscription and service contract sales, and contract renewals and warranty extension sales.
Our services are available individually or as an integrated solution.



Our two primary product offerings of service contract sales and lead generation share the same business strategy for our clients of marketing and selling their products and services to their business customers. We provide our service
contract telesales offerings primarily under pay-for-performance arrangements in which our revenue is based on our ability to sell our clients products and services to their customers. Lead generation projects typically are sold at a fixed
rate, with marketing and other services being billed on a time-and-materials basis. Accordingly, if a particular clients products and services fail to appeal to its customers for reasons beyond our control, such as preference for a competing
product or service, our revenue from the sale of the clients products and services may decline. Our clients can also purchase complementary services, such as additional database management and supplementary marketing programs, on a fee basis.



New clients may require us to make 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.



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, including but not limited to the continued demand for outsourced services, market conditions in the industries in which we operate and our ability to execute our business strategy . 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 Risk Factors.



Critical Accounting Policies/Estimates



Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts in our consolidated financial
statements. We evaluate our estimates on an on-going basis, including those related to our revenues, asset impairments, restructuring charges, income taxes and commitments and contingencies. We base our estimates on historical experience and on
various other



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assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of
assets and liabilities. Although actual results have historically been reasonably consistent with managements expectations, the actual results may differ from these estimates or our estimates may be affected by different assumptions or
conditions.



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



Management believes there have been no
significant changes during the year ended December 31, 2005 to the items that we disclosed as our critical accounting policies and estimates in Managements Discussion and Analysis of Financial Condition and Results of Operations in our
Annual Report on Form 10-K/A for the fiscal year ended December 31, 2004, except for the newly applicable accounting policies and estimates relating to our acquisition of Sunset Direct in February 2005 and our asset purchase with Launch
Project, LLC, including those relating to the allocation of purchase price and the evaluation of goodwill and intangible assets for impairment.



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
revenue recognition and presentation policies, valuation of accounts receivable, and the assessment of recoverability and measuring impairment of goodwill, intangible assets and fixed assets. 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;
| | - |  | ------------------------------------



| |  |  | impairment of long-lived assets, including goodwill, intangible assets and property and equipment;
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | allocation of purchase price in business combinations; and
| | - |  | ----------------------------------------------------------



| |  |  | fair value estimates for the expense of employee stock options.
| | - |  | ---------------------------------------------------------------



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



Substantially all of our revenues are generated from the sale of service contracts and maintenance renewals, and performance of lead generation services. We recognize revenue from the sale of our clients service
contracts and maintenance renewals under the provisions of Staff Accounting Bulletin (SAB) 104 Revenue Recognition and on the net basis in accordance with EITF Issue No. 99-19, Reporting
Revenue Gross as a Principal versus Net as an Agent. Revenue from the sale of service contracts and maintenance renewals is recognized when a purchase order from the clients customer is received; the service contract or maintenance
agreement is delivered; the fee is fixed or determinable; the collection of the receivable is reasonably assured;



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and no significant post-delivery obligations remain unfulfilled. Revenue from lead generation services we perform is recognized as the services are accepted
and is generally earned ratably over the service contract period. Some of our lead generation service revenue is earned when we achieve certain attainment levels and is recognized upon customer acceptance of the service. Revenue from service
sales activities is recognized once these services have been delivered. Revenue from product sales is recognized at the time of shipment of the product directly to the clients customer and has been historically an insignificant percentage of
our net revenue. We generally do not enter into multiple-element revenue arrangements with our clients or customers.



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 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. At December 31, 2005 and December 31, 2004, our allowance for potentially uncollectible accounts was $422,000 and $208,000, 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 to five 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, the payroll and payroll-related costs for employees who are directly associated with and who
devote time to the internal use computer software and associated interest costs, 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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During late 2004 and throughout 2005, we have been developing a replacement for our existing system to
identify potential service sales opportunities, track the sales contacts and process the sale of the service contracts. As of December 31, 2005, we had invested $2.9 million in the new order entry system including $100,000 in capitalized
interest costs. We currently expect to deploy and begin depreciating the new order entry system in the second quarter of 2006.



Goodwill and Other Intangible Assets



Goodwill represents the excess of the acquisition purchase price over the estimated fair value of net tangible and intangible assets acquired. Goodwill
and intangible assets acquired in a business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually. Intangible assets with estimable useful lives are amortized over their
respective estimated useful lives to their estimated residual values, and are reviewed for impairment in accordance with Financial Accounting Standards Board (FASB) Statement No. 144, Accounting for Impairment or Disposal of Long-Lived
Assets.We will perform the impairment test for the goodwill generated by the Sunset Direct acquisition in the first quarter of 2006. To date, no circumstances or indicators have arisen to indicate that the carrying value has been impaired.



Impairment of Long-Lived Assets



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



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



Significant Concentrations



We have generated a significant portion of our revenue from sales to
customers of a limited number of clients. In 2005, two customers accounted for more than 10% of our net revenue and collectively represented 47% of our net revenue with the largest representing 36% of our net revenue. In 2004 and 2003, four
customers accounted for more than 10% of our net revenues. In 2004 and 2003, combined sales to these customers accounted for 96%, and 99%, respectively, of net revenue and the largest individual client accounted for 47% and 34% of our net revenue in
2004 and 2003, respectively.



We have outsource services
agreements with our clients that expire at various dates ranging from March 2006 (which is being renewed on a month to month basis) through April 2009. Many of our client agreements contain automatic renewal clauses. These clients may, however,
terminate their contracts for cause in accordance



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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 are currently providing services to Sybase on a month to month basis
as our contract with Sybase expired on December 31, 2005.



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



Financial Statement Categories



Net revenue consists of fees earned by us on the
sales of our clients hardware and software support and service contracts, licenses and license upgrades to our clients customer base, as well as fixed fees for lead generation services. Revenue from our sales of service contracts are
mainly based on a pay for performance model in which we generate revenue only when we complete the sale of our clients products and services, and revenue from the sale of our lead generation and related services are mainly based on
fixed price contracts. 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 allocated facility and telephone usage for our telesales representatives as well as other direct costs associated with the delivery of our services. 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, and intangible assets.



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



Related Party Transactions



During 2004, we
purchased certain of our computer equipment and software from our two largest clients, through arrangements accounted for as capital leases. The leases have imputed interest at rates ranging between 14.5% and 17.9% per annum and expire at
various dates through October 2006. As of December 31, 2005,



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property and equipment included amounts held under these capital leases of approximately $398,000 and related accumulated depreciation of approximately
$249,000. Principal owed to these clients amounted to approximately $99,000 at December 31, 2005. The capital lease obligations are collateralized by the related leased property and equipment.



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, |  
|                                                      |  | 2005                     |   |  | 2004  |   |  | 2003  |  
|Net revenue                                           |  | 100.0                    | % |  | 100.0 | % |  | 100.0 | %
|Operating expenses:                                   |  |                          |   |  |       |   |  |       |  
|Costs of services                                     |  | 58.3                     | % |  | 50.3  | % |  | 36.9  | %
|Sales and marketing                                   |  | 8.9                      | % |  | 10.8  | % |  | 12.2  | %
|Technology                                            |  | 13.2                     | % |  | 18.4  | % |  | 21.3  | %
|General and administrative                            |  | 25.3                     | % |  | 41.7  | % |  | 41.1  | %
|Depreciation and amortization                         |  | 9.7                      | % |  | 11.4  | % |  | 11.0  | %
|Recoveries of restructuring and other related charges |  | 0.0                      | % |  | 0.0   | % |  | -0.2  | %
|                                                      |  |                          |   |  |       |   |  |       |  
|Total operating expenses                              |  | 115.4                    | % |  | 132.6 | % |  | 122.3 | %
|                                                      |  |                          |   |  |       |   |  |       |  
|Operating loss                                        |  | -15.4                    | % |  | -32.6 | % |  | -22.3 | %
|Interest and other income (expense), net              |  | -0.2                     | % |  | 0.4   | % |  | -0.2  | %
|                                                      |  |                          |   |  |       |   |  |       |  
|Loss before income taxes                              |  | -15.6                    | % |  | -32.2 | % |  | -22.5 | %
|Income tax benefit                                    |  | 0.0                      | % |  | 0.0   | % |  | 0.2   | %
|                                                      |  |                          |   |  |       |   |  |       |  
|Net loss                                              |  | -15.6                    | % |  | -32.2 | % |  | -22.3 | %
|                                                      |  |                          |   |  |       |   |  |       |  



Comparison of Years Ended
December 31, 2005 and 2004



Net
Revenue.    Net revenue from services increased 109.6% to $32.1 million in 2005 from $15.3 million in 2004. The increase in net revenue is primarily the result of $13.1 million of lead generation revenues contributed by
Sunset Direct, which we acquired in February 2005. In addition, net revenues from our service contracts product line increased $3.7 million, or 24%, from $15.3 million in 2004 to $19.0 million in 2005.



Our quarterly and annual operating results have fluctuated in the past and
are likely to do so in the future. In particular, our revenues are not predictable with any significant degree of certainty and are affected by changes in our clients service program offerings, including service contract fees, and by general
economic conditions in the United States. In the current economic environment, we have limited visibility over anticipated revenue trends in future periods. Our future net revenue may be adversely affected if we were to lose a significant client.



Costs of services.    Costs of
services increased 142.8% to $18.7 million in 2005 from $7.7 million in 2004. Costs of services also increased as a percentage of revenue from 50.3% in 2004 to 58.3% in 2005. The percentage increase in cost of services in relation to revenue is
attributable to duplicate costs that were incurred when we moved a significant part of our operations from California to our location in Austin, Texas. The increase in absolute dollars was due to an overall increase of approximately 141 people in
direct sales and marketing personnel as a result of our acquisition of Sunset Direct as well as the aforementioned duplication of costs during the move.



Sales and Marketing Expenses.    Sales and marketing expenses increased 71.9% to $2.8 million in 2005 from $1.7 million in
2004. This was primarily attributable to the addition of 9 sales and marketing personnel



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through our acquisition of Sunset Direct and the increase of 6 salespeople focused on adding new clients to our business and $139,000 in severance costs
related to employees terminated in 2005.



Technology
Expenses.    Technology expenses increased 50.3% to $4.2 million in 2005 from $2.8 million in 2004. This increase was primarily attributable to the addition of approximately 9 technology personnel and operations through our
acquisition of Sunset Direct. In addition, we incurred higher consulting and support fees in connection with the on-going upgrade of our IT infrastructure.



General and Administrative Expenses.    General and administrative expenses increased 27.4% to $8.1 million in 2005 as compared
to $6.4 million in 2004. The increase is primarily due to the addition of approximately 12 Sunset Direct administrative personnel, the rent expense of $372,000 associated with the Sunset Direct facility in Austin, Texas and severance costs of
$788,000 related to employee terminations in 2005. During 2005, we moved a significant part of our operations from California to our location in Austin, Texas. During this transition we incurred some duplicate staffing costs as well as other costs
associated with the hiring of employees.



Depreciation and
Amortization Expenses.    Depreciation and amortization expense increased 79% to $3.1 million from $1.7 million in 2004. The increase is due to $845,000 of amortization expense associated with intangibles acquired in
connection with our acquisition of Sunset Direct, and the result of higher net book values of depreciable assets, primarily related to capitalized internal software development projects, as compared to 2004.



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



|                 |  |                         |      |   |                     |   |     |       |  |   |      |   |  |      |   
|---------------- |  | ----------------------- | ---- | - | ------------------- | - | --- | ----- |  | - | ---- | - |  | ---- | --
|                 |  | Years EndedDecember 31, |      |   | Increase/(Decrease) |  
|                 |  | 2005                    |      |   | 2004                |   |     | $ Amt |  |   | %    |  
|Interest income  |  | $                       | 113  |   |                     | $ | 87  |       |  | $ | 26   |   |  | 29   | % 
|Interest expense |  |                         | (177 | ) |                     |   | (30 | )     |  |   | 147  |   |  | (490 | %)
|Other            |  |                         | (4   | ) |                     |   | (7  | )     |  |   | (3   | ) |  | 42   | % 
|                 |  |                         |      |   |                     |   |     |       |  |   |      |   |  |      |   
|                 |  | $                       | (68  | ) |                     | $ | 50  |       |  | $ | (118 | ) |  | (236 | %)
|                 |  |                         |      |   |                     |   |     |       |  |   |      |   |  |      |   



The increase in
interest income is attributable to an increase in interest rates on investments in interest bearing instruments. The increase in interest expense is the result of increased borrowings during the period, primarily the $3.0 million Term Loan obtained
in February 2005 in connection with the acquisition of Sunset Direct, interest on the $1.5 million June 2005 Term Loan to fund the purchase and implementation of our new client management system, in addition to interest on obligations of Sunset
Direct under capital leases.



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 existing clients 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 future periods. Our liquidity future net revenue may be adversely affected if we were to lose a significant client.



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Costs of services.    Costs of services increased 52.6% to $7.7 million in
2004 from $5.1 million in 2003. Costs of services also increased as a percentage of revenue from 36.9% in 2003 to 50.3% 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.



Sales and Marketing Expenses.    Sales and marketing expenses remained relatively constant at
$1.7 million in 2004 and 2003.



Technology
Expenses.    Technology expenses decreased 3.2% to $2.8 million in 2004 from $2.9 million in 2003. This decrease was primarily attributable to lower consulting expenses of $118,000.



General and Administrative Expenses.    General
and administrative expenses increased 13.4% to $6.4 million in 2004 as compared to $5.6 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.



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.



Liquidity and Sources
of Capital



To date, we have funded operations from net
cash proceeds from the sale of common stock and the incurrence of debt. On February 7, 2006, we raised $5.4 million, net of estimated issuance costs, from a private placement of our common stock. In December 2005, our lender increased our line
of credit facility from $2 million to $4 million. In June 2005, we raised $2.6 million, net of issuance costs, from a private placement of our common stock. In June 2005, we also obtained a $1.5 million term loan that is being utilized to fund the
purchase and implementation of our new client management system. In February 2005, we obtained a $3 million term loan to retire certain indebtedness and certain other liabilities of Sunset Direct in connection with our acquisition of Sunset Direct.
In February 2004, we raised $6.3 million, net of issuance costs, from a private placement of our common stock.



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Cash and cash equivalents were $9.7 million at December 31, 2005 as compared to $10.1 million at
December 31, 2004. We had negative working capital of $3.8 million at December 31, 2005 as compared to working capital of $2.4 million at December 31, 2004. As a result of the net $5.4 million raised in a private placement of our
common stock in February 2006, the negative working capital at December 31, 2005 has been fully funded. The decrease in cash and working capital was primarily a result of the net loss for the year, cash used in our acquisition of Sunset Direct,
transaction costs associated with the acquisition and purchases of property and equipment. These uses of cash were partially offset by an increase in our accounts payable balance due to increased service sales, an increase in accrued compensation,
increased liabilities of Sunset Direct, increased sales tax payables due to a higher volume of gross billings, and an increase in liabilities related to cash received for non-service payments inadvertently paid to the Company by its customers
instead of paid directly to the Companys clients. Our cash balances may fluctuate throughout each quarter due to our terms for payment to our clients for the service contracts that we sell.



Operating activities during 2005 used cash of $112,000 as compared to cash
provided by operating activities of $208,000 in 2004, and cash used in operating activities of $823,000 in 2003. Cash used by operating activities during 2005 was primarily the result of our net loss of $5.0 million, an increase in our accounts
receivable of $1.2 million, partially offset by $3.2 million in non-cash depreciation and amortization, an increase of $2.0 million in accounts payable, and an increase in other accrued liabilities of $934,000.



Accounts receivable increased at December 31, 2005 as compared to
December 31, 2004 as a result of higher fourth quarter sales in 2005 as compared to 2004, particularly from sales relating to our largest client, while the days sales outstanding (DSO), improved to 28 days at December 31, 2005 from 30 days
at December 31, 2004. Our accounting treatment for net revenue (see Net Revenue under Financial Statement Categories) requires that we report revenue net of the obligation to our clients for our cost of the service sales
contracts we sell on their behalf. Since we record the gross billing to the end customer of our clients in our accounts receivable, we calculate DSO based on our ability to collect those gross billings from the end customers. The increase in
accounts payable was primarily due to the timing of payments to our clients for service and maintenance contracts we sold on their behalf. The increase in accrued compensation and benefits in 2005 as compared to 2004 is due to the accrual of wages
for Sunset Direct employees at December 31, 2005. The increase in other accrued liabilities is attributable to increased liabilities of Sunset Direct, increased sales tax payables due to a higher volume of gross billings, and an increase in
liabilities related to cash received for non-service payments inadvertently paid to the Company by its customers instead of paid directly to the Companys clients. At the time of cash receipt the Company records a current liability for the
amount of non-service payments received.



Cash used in
investing activities was $8.3 million, $744,000 and $928,000 in 2005, 2004 and 2003, respectively. The increase in cash used in investing activities was primarily due to our investment in Sunset Direct and our purchase of certain assets of Launch
Project, an increase in restricted cash, as well as an increase in capital expenditures. In the year ended December 31, 2005, we invested $3.2 million in capital additions as compared to $1.8 million in the comparable period of 2004. This
increased investment was primarily to improve the capacity of our systems and software to support expansion of client business. Restricted cash as of December 31, 2005 increased by $586,000 during the year ended December 31, 2005, as
compared to an decrease of $1.1 million in the comparable period in 2004.



Cash provided by financing activities was $8.1 million in 2005 as compared to cash provided by financing activities of $5.8 million in 2004 and cash used in financing activities of $562,000 in 2003. Cash provided by
financing activities in 2005 was primarily a result of our Term Loan and June Term Loan proceeds aggregating $4.5 million, $2.0 million drawn down from our Revolving Credit Facility, and net proceeds of $2.6 million from our private placement of
common stock in June 2005, partially offset by repayments totaling $1.7 million for installments related to notes payable, capital leases and other financing arrangements. Repayments of capital lease and other financing arrangements in 2004 and 2003
amounted to $873,000 and $1.5 million, respectively. Proceeds from the issuance of common stock to employees resulting from stock option exercises and purchases under the employee stock purchase plan were $360,000, $362,000 and $103,000 in 2005,
2004, and 2003, respectively.



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Our principal source of liquidity as of December 31, 2005 consisted of $9.7 million of cash and cash
equivalents and $1.0 million remaining on our Revolving Credit Facility. In connection with a financial covenant related to our Term Loan and the June 2005 Term Loan, we are required to maintain unrestricted cash deposits of $3.0 million with our
lender Bridge Bank, N.A., which is included in the $9.7 million of cash and cash equivalents. We anticipate that our existing capital resources and cash flow expected to be generated from future operations, along with the $5.4 million, net of
estimated issuance costs, from our February 7, 2006 private placement of our common stock 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.



In December 2005, our Business Loan Agreement and a
Commercial Security Agreement with Bridge Bank, N.A. (the Revolving Credit Facility) was increased to $4.0 million from the then existing $2.0 million. In addition, the maturity date was extended to December 2006 from May 2006. We had
originally entered into this Revolving Credit Facility with our lender in April 2004. A component of the Revolving Credit Facility is a $1.0 million Letter of Credit facility. The Revolving Credit Facility is subject to certain financial covenants,
which include maintaining a minimum working capital ratio and tangible net worth and bears interest at the Prime Rate published in the Wall Street Journal but not less than 4.0% per annum. Borrowings and letter of credit issuances are subject
to borrowing base calculations and other limitations. The Revolving Credit Facility is secured by substantially all of our assets including intellectual property. For the year ended December 31, 2005, the Companys capital expenditures were in
excess of the limit specified in the loan agreement. The loan agreement restricted our capital expenditures to $3 million whereas our actual expenditures amounted to $3.2 million. We obtained a waiver of this covenant breach from our lender. As of
December 31, 2005, we had borrowed $2.0 million from the lender, which was repaid in full in January 2006. Interest on the Revolving Line of Credit is a variable rate of prime per annum (7.25% at December 31, 2005). In addition, three
letters of credit in the aggregate face amount of $925,000 were outstanding under the Revolving Credit Facility as of December 31, 2005 (as described below).



In July 2005, we issued an Irrevocable Standby Letter of Credit in the amount of $100,000 to our landlord for a security
deposit for our new corporate headquarters located in Campbell, California. In 2004, we issued Irrevocable Standby Letters of Credit to two of our clients. The letters of credit were issued in the amounts of $325,000 and $500,000 as guarantees for
service contracts sold by us on behalf of our clients and both expire in September 2006. The letters of credit were issued under the Revolving Credit Facility described above. As of December 31, 2005, no amounts have been drawn against the
letters of credit.



On July 1, 2005, Rainmaker and Sunset
Direct entered into, and simultaneously closed, an Asset Purchase Agreement (the Purchase Agreement) with Launch Project, LLC, the members of Launch Project, LLC, and Chad Nuss, as representative of the members. Pursuant to the Purchase
Agreement, Sunset Direct acquired certain of the assets of Launch Project, LLC including certain software and intellectual property. Under the terms of the Purchase Agreement, Sunset Direct paid $40,000 in cash, which was paid upon satisfaction of a
condition subsequent to the closing, Rainmaker issued 140,000 shares of common stock in exchange for the assets and incurred approximately $82,000 of purchase related costs. The estimated value of the 140,000 shares of Rainmaker common stock was
$385,000 computed at a per share price of $2.75, the average closing price for the period from June 30, 2005 through July 7, 2005.



On June 15, 2005, we entered into a Purchase Agreement with certain investors. Pursuant to the Purchase Agreement, we agreed to issue 1,340,444
shares of our common stock for gross proceeds of approximately $2.7 million to a group of investors that included members of our management and our board of directors. Estimated stock offering costs of $100,000 have been reflected as a reduction of
gross proceeds received. The sale to investors who were not members of management or the board of directors consisted of 1,280,000 shares of our common stock at a price of $2.00 per share, for gross proceeds of $2,560,000, and the sale to investors
who were members of management or the board of directors consisted of 60,444 shares of our common stock at the market price of $2.25 per share, for gross proceeds of $136,000. In addition, we issued warrants to the investors to purchase a total of
201,066 shares of our common stock at an exercise price of $2.40 per share.



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In June 2005, we entered into a Business Loan Agreement with Bridge Bank, N.A., pursuant to which we
obtained a $1.5 million term loan (the June 2005 Term Loan) that is being utilized to fund the purchase and implementation of our new client management system. The June 2005 Term Loan is to be repaid in 36 monthly installments of $42,000
plus interest at a variable rate of prime plus 1.00% per annum (8.25% per annum at December 31, 2005).



On February 8, 2005, we acquired all of the issued and outstanding voting securities of Sunset Direct. Pursuant to the Agreement and Plan of Merger
with Sunset Direct, we paid approximately $3.5 million in cash that was used to retire approximately $3.3 million of debt and certain liabilities retained by Sunset Direct, issued 664,080 shares of common stock in exchange for the outstanding
capital stock of Sunset Direct, and incurred approximately $910,000 of acquisition related costs. The estimated value of the 664,080 shares of Rainmaker common stock was $2.2 million computed at a per share price of $3.32, the average closing price
for the period from February 8, 2005 through February 14, 2005.



Concurrent with the closing of the merger transaction with Sunset Direct in February 2005, we 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 that was utilized to retire certain indebtedness and certain other liabilities of Sunset Direct. The Term Loan is to be repaid in 36 monthly installments of $83,000 plus interest at a variable rate
of prime plus 1.00% per annum (8.25% per annum at December 31, 2005).



The Term Loan, June 2005 Term Loan and Revolving Credit Facility are secured by substantially all of our consolidated assets, including intellectual property. We must comply with certain financial covenants, including
maintaining a minimum quick ratio and maintaining unrestricted cash of $3.0 million with the Lender. The Term Loan, the June 2005 Term Loan and the Revolving Credit Facility contain customary covenants that will, subject to limited exceptions, limit
our 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, June 2005 Term Loan and the Revolving Credit
Facility 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 Term Loan, the June 2005 Term Loan and Revolving Credit Facility. For the year ended December 31, 2005, the Companys capital expenditures were in excess of the limit specified in the loan agreement. The loan agreement
restricted our capital expenditures to $3 million whereas our actual expenditures were $3.2 million. We obtained a waiver of this covenant breach from our lender. As of December 31, 2005, we had $2.2 million and $1.2 million outstanding on the
Term Loan and June 2005 Term Loan, respectively, and $2.0 million outstanding on the Revolving Credit Facility which was repaid in January 2006.



Off-Balance Sheet Arrangements



Leases



As of December 31, 2005, our off-balance sheet arrangements include operating leases for our facilities and certain property and equipment that
expire at various dates through 2009, including an additional facility operating lease commitment assumed in connection with the Companys acquisition of Sunset Direct in February 2005 and the lease for the Companys corporate headquarters
in Campbell, California (as described below). 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. Rent expense under
operating lease agreements during the years ended December 31, 2005, 2004, and 2003 was $771,000, $311,000, and $434,000, respectively.



On August 4, 2005, the Company executed an operating lease to occupy approximately 16,600 square feet in an existing facility in Campbell,
California. The office space serves as the Companys corporate headquarters.



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The lease term began on November 1, 2005 and will end on October 31, 2008. The Company has an option to extend the lease term for an additional
three years. The base rent for the new corporate headquarters during the initial lease term will escalate from approximately $270,000 for the initial year, to approximately $290,000 for the final year. In addition, the Company must pay its
proportionate share of operating costs and taxes. In connection with the execution of the lease, the Company has issued a Letter of Credit to the Landlord in the amount of $100,000 as a security deposit.



In August 2005, we renewed our operating lease for 46,300 square feet of
office space for our facility in Austin, Texas. The facility serves as an operations center for our lead generation services as well as a major part of our service sales operations. The renewed term will expire in July 2009. The base rent for the
Austin facility will escalate from approximately $325,000 for the initial year, to approximately $383,000 for the final year. In addition, the Company must pay its proportionate share of operating costs and taxes. In both the California and the
Texas facilities, we pay rent and maintenance on some of the common areas in each of our leased facilities.



Guarantees



In July 2005, we issued an Irrevocable Standby Letter of Credit in the amount of $100,000 to our landlord for a security deposit for our new corporate
headquarters located in Campbell, California. In 2004, we issued Irrevocable Standby Letters of Credit to two of our clients. The letters of credit were issued in the amounts of $325,000 and $500,000 as guarantees for service contracts sold by us on
behalf of our clients and both expire in September 2006. The letters of credit were issued under the Revolving Credit Facility described above. As of December 31, 2005, 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 had to make any payments for these obligations, and no liabilities have been recorded for these obligations on our balance sheets as of December 31, 2005 and 2004.



Contractual Obligations



Capital Leases



We lease certain property under capital leases that expire at various dates through 2006. The effective annual imputed interest rates on our capital lease
obligations range from 2.4% to 17.0%, with a weighted average of 12.0%. 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 2005 Financing Agreement bore interest at an annual rate of 4.99% and principal and interest were payable in monthly installments of approximately $40,300, through
September 2005. At December 31, 2005, our liability related to the 2005 Financing Agreement was fully paid.



In November 2005, we entered into a Commercial Insurance Premium Finance and Security Agreement (2006 Financing Agreement) to finance certain
of our liability insurance premiums in the amount of $334,000. Amounts owed under the 2006 Financing Agreement bear interest at an annual rate of 6.0% and principal and



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interest are payable in monthly installments of approximately $33,000, through September 2006. At December 31, 2005, our liability related to the 2006
Financing Agreement was $301,000.



Term Loans



In June 2005, the Company entered into a Business Loan
Agreement with Bridge Bank, N.A. (the Lender), pursuant to which the Company obtained a $1.5 million term loan (the  June 2005 Term Loan) that is being utilized to fund the implementation of the Companys new client
management system. The June 2005 Term Loan is to be repaid in 36 monthly installments of $42,000 plus interest at a variable rate of prime plus 1.00% per annum (8.25% per annum at December 31, 2005). As of December 31, 2005, the
Company had $1.2 million outstanding on the June 2005 Term Loan.



In February 2005, concurrent with the closing of the acquisition of Sunset Direct, the Company entered into a Business Loan Agreement and Commercial Security Agreement with the Lender (the Term Loan). The Term Loan is to be
repaid in 36 monthly installments of $83,000 plus interest at a variable rate of prime plus 1.00% per annum (8.25% per annum at December 31, 2005). As of December 31, 2005, the Company had $2.2 million outstanding on the Term Loan.



Revolving Credit Facility



In April 2004, we entered into a Business Loan Agreement and a Commercial
Security Agreement (the Revolving Credit Facility) with the Lender. The Revolving Credit Facility originally matured in May 2005, and provided 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. In December 2005, the total available under the Revolving Credit Facility was increased to $4.0 million and the maturity was extended to December 2006. As of December 31, 2005, we
had borrowed $2.0 million from the Lender, which was repaid in full in January 2006. As of February 3, 2006, we had not incurred additional borrowings under the Term Loans or the Revolving Credit Facility.



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



|                                  |  |               |     |   |                         |   |                    |  |              |       |                        |   |                 |  |       |       |  |   |       |  |   |       |  
|--------------------------------- |  | ------------- | --- | - | ----------------------- | - | ------------------ |  | ------------ | ----- | ---------------------- | - | --------------- |  | ----- | ----- |  | - | ----- |  | - | ----- | -
|(In thousands)                    |  | CapitalLeases |     |   | FinancingObligation (1) |   | CreditFacility (1) |  | TermLoan (1) |       | June 2005 TermLoan (1) |   | OperatingLeases |  | Total |      
|2006                              |  | $             | 106 |   |                         | $ | 301                |  | $            | 2,000 |                        | $ | 1,000           |  | $     | 500   |  | $ | 634   |  | $ | 4,541 |  
|2007                              |  |               |    |   |                         |   |                   |  |              |      |                        |   | 1,000           |  |       | 500   |  |   | 645   |  |   | 2,145 |  
|2008                              |  |               |    |   |                         |   |                   |  |              |      |                        |   | 167             |  |       | 250   |  |   | 612   |  |   | 1,029 |  
|2009                              |  |               |    |   |                         |   |                   |  |              |      |                        |   |                |  |       |      |  |   | 197   |  |   | 197   |  
|                                  |  |               |     |   |                         |   |                    |  |              |       |                        |   |                 |  |       |       |  |   |       |  |   |       |  
|Total minimum payments            |  |               | 106 |   |                         |   | 301                |  |              | 2,000 |                        |   | 2,167           |  |       | 1,250 |  |   | 2,088 |  |   | 7,912 |  
|Less amount representing interest |  |               | (7  | ) |                         |   |                   |  |              |      |                        |   |                |  |       |      |  |   |      |  |   | (7    | )
|                                  |  |               |     |   |                         |   |                    |  |              |       |                        |   |                 |  |       |       |  |   |       |  |   |       |  
|Net amount of payments            |  | $             | 99  |   |                         | $ | 301                |  | $            | 2,000 |                        | $ | 2,167           |  | $     | 1,250 |  | $ | 2,088 |  | $ | 7,905 |  
|                                  |  |               |     |   |                         |   |                    |  |              |       |                        |   |                 |  |       |       |  |   |       |  |   |       |  

---

|(1) |  |  Excludes interest payments.
|--- |  | -----------------------------



Included in future minimum operating lease payments is our obligation relating to our facilities, including the lease for the Companys corporate
headquarters in Campbell, California. The operating lease for our Austin facility expires in June 2009.



Potential Impact of Inflation



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



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Recently Issued Accounting Standards



In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment. SFAS No. 123R revises SFAS
No. 123, Accounting for Stock-Based Compensation and generally requires the cost associated with employee services received in exchange for an award of equity instruments be measured based on the grant-date fair value of the award
and recognized in the financial statements over the period during which employees are required to provide services in exchange for the award. SFAS No. 123R also provides guidance on how to determine the grant-date fair value for awards of
equity instruments as well as alternative methods of adopting its requirements. In April 2005, the Securities and Exchange Commission announced a new rule allowing companies to implement Statement No. 123R at the beginning of their next fiscal
year, instead of the next reporting period, that begins after June 15, 2005, or December 15, 2005 for small business issuers. In accordance with that rule, we will comply with Statement No. 123R beginning with the interim financial
statements for the first quarter of 2006, filed with the Securities and Exchange Commission. Statement No. 123R applies to all outstanding and unvested share-based payment awards at a companys adoption date. We 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). 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. We estimate that the 2006 compensation expense related to stock options will be between $60,000 and
$200,000.



On December 13, 2005, our Board of Directors
approved the accelerated vesting of unvested and out-of-the-money stock options with exercise prices equal to or greater than $2.25 per share that were previously awarded to the Companys employees, officers and its directors
under the Companys stock option plan. As a result, these fully vested options will not have to be expensed in future periods which was the primary purpose for this action.



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.



|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, 2005, 100% of our portfolio was invested in instruments that mature in less than 90 days. See Note 1 of Notes to Consolidated Financial Statements.



Due to the short duration and conservative nature of our investment portfolio at December 31, 2005, we do not believe
we have a material exposure to interest rate risk.



Our
earnings are affected by changes in short-term interest rates as a result of our two Term Loans and our Revolving Credit Facility, which bear interest at variable rates based on the prime lending rate (7.25% at



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December 31, 2005). Maturity dates on these loans range from December 2006 to May 2008. At December 31, 2005, we had $5.4 million of debt
outstanding under these loans. Based on the funding dates for these loans and payments made during 2005, we estimate that a 1% increase in interest rates would result in $33,000 in additional interest expense for the year ended December 31,
2005. Due to the our debt level at December 31, 2005, anticipated cash flows from operations, and the various financial alternatives available to management, should there be an adverse change in interest rates, we do not believe that we have
significant exposure to market risks associated with changing interest rates as of December 31, 2005. We do not use derivative financial instruments in our operations.



At December 31, 2005, the interest rates on all of our outstanding capital leases are fixed and therefore not subject
to interest rate fluctuations. Our interest rates on our debt are at a variable rate of prime plus 1.00% per annum. See Note 4 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                            |  | 38  
|Report of Independent Registered Public Accounting Firm  Ernst & Young LLP                           |  | 39  
|                                                                                                      | 
|Consolidated Financial Statements:                                                                    |  |     
|Consolidated Balance Sheets as of December 31, 2005 and 2004                                          |  | 40  
|Consolidated Statements of Operations for the years ended December 31, 2005, 2004, and 2003           |  | 41  
|Consolidated Statements of Stockholders Equity for the years ended December 31, 2005, 2004, and 2003 |  | 42  
|Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004, and 2003           |  | 43  
|Notes to Consolidated Financial Statements                                                            |  | 44  
|                                                                                                      | 
|Consolidated Financial Statement Schedule:                                                            |  |     
|Report of Independent Registered Public Accounting Firm  BDO Seidman, LLP                            |  | 75  
|Schedule II  Valuation and Qualifying Accounts                                                       |  | 76  



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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 sheets of Rainmaker Systems, Inc. as of December 31, 2005 and
2004 and the related consolidated statements of operations, stockholders equity, and cash flows for the years then ended. These consolidated 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 audits.



We conducted our audits 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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included 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 audits provide 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, 2005 and 2004, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.



/s/    BDO SEIDMAN, LLP



San Francisco, California

February 3, 2006



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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 statements of operations, stockholders equity, and cash flows of Rainmaker Systems,
Inc for the year ended December 31, 2003. Our audit also included the financial statement schedule listed in the Index at Item 15(a) for the year 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 audit.



We conducted our audit 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 audit provides a reasonable basis
for our opinion.



In our opinion, the financial statements
referred to above present fairly, in all material respects, the consolidated results of Rainmaker Systems, Inc.s operations and its cash flows for the year 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, |        
|                                                                                                                                               |  | 2005         |         |   | 2004 |  
|ASSETS                                                                                                                                         |  |              |         |   |      |   |         |  
|Current assets:                                                                                                                                |  |              |         |   |      |   |         |  
|Cash and cash equivalents                                                                                                                      |  | $            | 9,746   |   |      | $ | 10,104  |  
|Restricted cash                                                                                                                                |  |              | 586     |   |      |   |        |  
|Accounts receivable, less allowance for doubtful accounts of $422 and $208 at December 31, 2005 and 2004, respectively                         |  |              | 10,374  |   |      |   | 7,895   |  
|Prepaid expenses and other current assets                                                                                                      |  |              | 1,212   |   |      |   | 1,117   |  
|                                                                                                                                               |  |              |         |   |      |   |         |  
|Total current assets                                                                                                                           |  |              | 21,918  |   |      |   | 19,116  |  
|Property and equipment, net                                                                                                                    |  |              | 4,410   |   |      |   | 3,160   |  
|Intangible assets, net                                                                                                                         |  |              | 3,652   |   |      |   |        |  
|Goodwill                                                                                                                                       |  |              | 3,921   |   |      |   |        |  
|Other noncurrent assets                                                                                                                        |  |              | 257     |   |      |   | 86      |  
|                                                                                                                                               |  |              |         |   |      |   |         |  
|Total assets                                                                                                                                   |  | $            | 34,158  |   |      | $ | 22,362  |  
|                                                                                                                                               |  |              |         |   |      |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                           |  |              |         |   |      |   |         |  
|Current liabilities:                                                                                                                           |  |              |         |   |      |   |         |  
|Accounts payable                                                                                                                               |  | $            | 17,741  |   |      | $ | 15,130  |  
|Accrued compensation and benefits                                                                                                              |  |              | 1,427   |   |      |   | 390     |  
|Other accrued liabilities                                                                                                                      |  |              | 1,732   |   |      |   | 747     |  
|Deferred revenue                                                                                                                               |  |              | 882     |   |      |   |        |  
|Obligations under financing arrangements                                                                                                       |  |              | 301     |   |      |   | 355     |  
|Current portion of capital lease obligations                                                                                                   |  |              | 99      |   |      |   | 122     |  
|Current portion of notes payable                                                                                                               |  |              | 3,500   |   |      |   |        |  
|                                                                                                                                               |  |              |         |   |      |   |         |  
|Total current liabilities                                                                                                                      |  |              | 25,682  |   |      |   | 16,744  |  
|Deferred tax liability                                                                                                                         |  |              | 440     |   |      |   |        |  
|Capital lease obligations, less current portion                                                                                                |  |              |        |   |      |   | 42      |  
|Notes payable, less current portion                                                                                                            |  |              | 1,917   |   |      |   |        |  
|                                                                                                                                               |  |             
|Commitments and Contingencies (Notes 4, 5, 6, 9 and 10)                                                                                        |  |              |         |   |      |   |         |  
|                                                                                                                                               |  |             
|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, 11,306,937 and 8,883,959 outstanding at December 31, 2005 and 2004,
respectively |  |              | 11      |   |      |   | 9       |  
|Additional paid-in capital                                                                                                                     |  |              | 69,089  |   |      |   | 63,544  |  
|Accumulated deficit                                                                                                                            |  |              | (62,981 | ) |      |   | (57,977 | )
|                                                                                                                                               |  |              |         |   |      |   |         |  
|Total stockholders equity                                                                                                                     |  |              | 6,119   |   |      |   | 5,576   |  
|                                                                                                                                               |  |              |         |   |      |   |         |  
|Total liabilities and stockholders equity                                                                                                     |  | $            | 34,158  |   |      | $ | 22,362  |  
|                                                                                                                                               |  |              |         |   |      |   |         |  



See accompanying
notes.



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RAINMAKER SYSTEMS, INC.



CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)



|                                                            |  |                          |        |   |      |   |        |      |  |   |        |  
|----------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                            |  | Years ended December 31, |       
|                                                            |  | 2005                     |        |   | 2004 |   |        | 2003 | 
|Net revenue                                                 |  | $                        | 32,114 |   |      | $ | 15,323 |      |  | $ | 13,689 |  
|                                                            |  |                          |       
|Operating expenses:                                         |  |                          |        |   |      |   |        |      |  |   |        |  
|Costs of services                                           |  |                          | 18,716 |   |      |   | 7,709  |      |  |   | 5,052  |  
|Sales and marketing                                         |  |                          | 2,838  |   |      |   | 1,651  |      |  |   | 1,671  |  
|Technology                                                  |  |                          | 4,248  |   |      |   | 2,826  |      |  |   | 2,920  |  
|General and administrative                                  |  |                          | 8,134  |   |      |   | 6,385  |      |  |   | 5,629  |  
|Depreciation and amortization                               |  |                          | 3,114  |   |      |   | 1,740  |      |  |   | 1,497  |  
|Recoveries of restructuring and other related charges       |  |                          |       |   |      |   |       |      |  |   | (23    | )
|                                                            |  |                          |        |   |      |   |        |      |  |   |        |  
|Total operating expenses                                    |  |                          | 37,050 |   |      |   | 20,311 |      |  |   | 16,746 |  
|                                                            |  |                          |        |   |      |   |        |      |  |   |        |  
|Operating loss                                              |  |                          | (4,936 | ) |      |   | (4,988 | )    |  |   | (3,057 | )
|Interest and other (expense) income, net                    |  |                          | (68    | ) |      |   | 50     |      |  |   | (25    | )
|                                                            |  |                          |        |   |      |   |        |      |  |   |        |  
|Loss before income taxes                                    |  |                          | (5,004 | ) |      |   | (4,938 | )    |  |   | (3,082 | )
|Income tax benefit                                          |  |                          |       |   |      |   |       |      |  |   | (23    | )
|                                                            |  |                          |        |   |      |   |        |      |  |   |        |  
|Net loss                                                    |  | $                        | (5,004 | ) |      | $ | (4,938 | )    |  | $ | (3,059 | )
|                                                            |  |                          |        |   |      |   |        |      |  |   |        |  
|Basic and diluted net loss per share                        |  | $                        | (0.48  | ) |      | $ | (0.57  | )    |  | $ | (0.39  | )
|                                                            |  |                          |        |   |      |   |        |      |  |   |        |  
|Shares used to compute basic and diluted net loss per share |  |                          | 10,464 |   |      |   | 8,715  |      |  |   | 7,791  |  
|                                                            |  |                          |        |   |      |   |        |      |  |   |        |  



See accompanying
notes.



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RAINMAKER SYSTEMS, INC.



CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

(In thousands, except share data)



|                                                            |  |              |  |                          |    |                    |   |        |       |   |         |   |  |   |        |  
|----------------------------------------------------------- |  | ------------ |  | ------------------------ | -- | ------------------ | - | ------ | ----- | - | ------- | - |  | - | ------ | -
|                                                            |  | Common Stock |  | AdditionalPaid-inCapital |    | AccumulatedDeficit |   |        | Total |  
|                                                            |  | Shares       |  | Amount                   |    |                    |  
|Balance at December 31, 2002                                |  | 7,766,294    |  | $                        | 8  |                    | $ | 56,775 |       | $ | (49,980 | ) |  | $ | 6,803  |  
|Exercise of employee stock options                          |  | 49,798       |  |                          |   |                    |   | 79     |       |   |        |   |  |   | 79     |  
|Issuance of common stock under employee stock purchase plan |  | 17,594       |  |                          |   |                    |   | 24     |       |   |        |   |  |   | 24     |  
|Net loss                                                    |  |             |  |                          |   |                    |   |       |       |   | (3,059  | ) |  |   | (3,059 | )
|                                                            |  |              |  |                          |    |                    |   |        |       |   |         |   |  |   |        |  
|Balance at December 31, 2003                                |  | 7,833,686    |  |                          | 8  |                    |   | 56,878 |       |   | (53,039 | ) |  |   | 3,847  |  
|Exercise of employee stock options                          |  | 101,496      |  |                          |   |                    |   | 283    |       |   |        |   |  |   | 283    |  
|Issuance of common stock under employee stock purchase plan |  | 14,499       |  |                          |   |                    |   | 79     |       |   |        |   |  |   | 79     |  
|Issuance of common stock for executive bonuses              |  | 938          |  |                          |   |                    |   | 8      |       |   |        |   |  |   | 8      |  
|Issuance of common stock in private placement               |  | 933,340      |  |                          | 1  |                    |   | 6,296  |       |   |        |   |  |   | 6,297  |  
|Net loss                                                    |  |             |  |                          |   |                    |   |       |       |   | (4,938  | ) |  |   | (4,938 | )
|                                                            |  |              |  |                          |    |                    |   |        |       |   |         |   |  |   |        |  
|Balance at December 31, 2004                                |  | 8,883,959    |  |                          | 9  |                    |   | 63,544 |       |   | (57,977 | ) |  |   | 5,576  |  
|Exercise of employee stock options                          |  | 258,116      |  |                          |   |                    |   | 314    |       |   |        |   |  |   | 314    |  
|Issuance of common stock under employee stock purchase plan |  | 20,338       |  |                          |   |                    |   | 46     |       |   |        |   |  |   | 46     |  
|Issuance of common stock in private placement               |  | 1,340,444    |  |                          | 1  |                    |   | 2,596  |       |   |        |   |  |   | 2,597  |  
|Issuance of common stock for Sunset acquisition             |  | 664,080      |  |                          | 1  |                    |   | 2,204  |       |   |        |   |  |   | 2,205  |  
|Issuance of common stock for Launch Project assets          |  | 140,000      |  |                          |   |                    |   | 385    |       |   |        |   |  |   | 385    |  
|Net loss                                                    |  |             |  |                          |   |                    |   |       |       |   | (5,004  | ) |  |   | (5,004 | )
|                                                            |  |              |  |                          |    |                    |   |        |       |   |         |   |  |   |        |  
|Balance at December 31, 2005                                |  | 11,306,937   |  | $                        | 11 |                    | $ | 69,089 |       | $ | (62,981 | ) |  | $ | 6,119  |  
|                                                            |  |              |  |                          |    |                    |   |        |       |   |         |   |  |   |        |  



See accompanying
notes.



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RAINMAKER SYSTEMS, INC.



CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



|                                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|-------------------------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                             |  | Years Ended December 31, |       
|                                                                                             |  | 2005                     |        |   | 2004 |   |        | 2003 | 
|Operating activities:                                                                        |  |                          |        |   |      |   |        |      |  |   |        |  
|Net loss                                                                                     |  | $                        | (5,004 | ) |      | $ | (4,938 | )    |  | $ | (3,059 | )
|Adjustment to reconcile net loss to net cash (used in) provided by operating activities:     |  |                          |        |   |      |   |        |      |  |   |        |  
|Depreciation and amortization of property and equipment                                      |  |                          | 2,216  |   |      |   | 1,740  |      |  |   | 1,497  |  
|Amortization of intangible assets                                                            |  |                          | 898    |   |      |   |       |      |  |   |       |  
|Recoveries of restructuring and other related charges                                        |  |                          |       |   |      |   |       |      |  |   | (23    | )
|Provision for allowances for doubtful accounts                                               |  |                          | 321    |   |      |   | 186    |      |  |   | 13     |  
|Loss on disposal of fixed assets                                                             |  |                          | 62     |   |      |   |       |      |  |   | 43     |  
|Changes in operating assets and liabilities, net of assets acquired and liabilities assumed: |  |                          |        |   |      |   |        |      |  |   |        |  
|Accounts receivable                                                                          |  |                          | (1,322 | ) |      |   | (2,129 | )    |  |   | (316   | )
|Income taxes receivable                                                                      |  |                          |       |   |      |   |       |      |  |   | 211    |  
|Prepaid expenses and other assets                                                            |  |                          | (153   | ) |      |   | 429    |      |  |   | 32     |  
|Accounts payable                                                                             |  |                          | 2,015  |   |      |   | 6,075  |      |  |   | 1,541  |  
|Accrued compensation and benefits                                                            |  |                          | 299    |   |      |   | 29     |      |  |   | (512   | )
|Accrued restructuring and related charges                                                    |  |                          |       |   |      |   |       |      |  |   | (200   | )
|Other accrued liabilities                                                                    |  |                          | 934    |   |      |   | (1,184 | )    |  |   | (50    | )
|Deferred revenue                                                                             |  |                          | (378   | ) |      |   |       |      |  |   |       |  
|                                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Net cash (used in) provided by operating activities                                          |  |                          | (112   | ) |      |   | 208    |      |  |   | (823   | )
|                                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Investing activities:                                                                        |  |                          |        |   |      |   |        |      |  |   |        |  
|Purchases of property and equipment                                                          |  |                          | (3,245 | ) |      |   | (1,840 | )    |  |   | (803   | )
|Restricted cash, net                                                                         |  |                          | (586   | ) |      |   | 1,096  |      |  |   | (135   | )
|Acquisition of businesses, net of cash acquired                                              |  |                          | (4,509 | ) |      |   |       |      |  |   |       |  
|Sale of long-term investments                                                                |  |                          |       |   |      |   |       |      |  |   | 10     |  
|                                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Net cash used in investing activities                                                        |  |                          | (8,340 | ) |      |   | (744   | )    |  |   | (928   | )
|                                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Financing activities:                                                                        |  |                          |        |   |      |   |        |      |  |   |        |  
|Proceeds from issuance of common stock from option exercises                                 |  |                          | 314    |   |      |   | 283    |      |  |   | 78     |  
|Proceeds from issuance of common stock from ESPP                                             |  |                          | 46     |   |      |   | 79     |      |  |   | 25     |  
|Proceeds from issuance of common stock and warrants from private placement                   |  |                          | 2,597  |   |      |   | 6,297  |      |  |   |       |  
|Proceeds from notes payable                                                                  |  |                          | 6,500  |   |      |   |       |      |  |   |       |  
|Proceeds under financing arrangements                                                        |  |                          | 334    |   |      |   |       |      |  |   | 821    |  
|Repayment of notes payable                                                                   |  |                          | (1,083 | ) |      |   |       |      |  |   |       |  
|Repayment of financing arrangements                                                          |  |                          | (388   | ) |      |   | (674   | )    |  |   |       |  
|Repayment of capital lease/debt obligations                                                  |  |                          | (226   | ) |      |   | (199   | )    |  |   | (1,486 | )
|                                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Net cash provided by (used in) financing activities                                          |  |                          | 8,094  |   |      |   | 5,786  |      |  |   | (562   | )
|                                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Net (decrease) increase in cash and cash equivalents                                         |  |                          | (358   | ) |      |   | 5,250  |      |  |   | (2,313 | )
|                                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Cash and cash equivalents at beginning of year                                               |  |                          | 10,104 |   |      |   | 4,854  |      |  |   | 7,167  |  
|                                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Cash and cash equivalents at end of year                                                     |  | $                        | 9,746  |   |      | $ | 10,104 |      |  | $ | 4,854  |  
|                                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Supplement disclosures of cash flow information:                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Cash paid for interest                                                                       |  | $                        | 148    |   |      | $ | 30     |      |  | $ | 89     |  
|                                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Supplemental non-cash investing and financing activities:                                    |  |                          |        |   |      |   |        |      |  |   |        |  
|Acquisition of assets under capital lease                                                    |  | $                        |       |   |      | $ | 252    |      |  | $ |       |  
|                                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Purchase of prepaid maintenance contracts under capital lease                                |  | $                        |       |   |      | $ |       |      |  | $ | 172    |  
|                                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Insurance premiums financed                                                                  |  | $                        | 334    |   |      | $ | 525    |      |  | $ | 605    |  
|                                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Issuance of common stock for executive bonus accrual                                         |  | $                        |       |   |      | $ | 8      |      |  | $ |       |  
|                                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Common stock issued in acquisitions                                                          |  | $                        | 2,590  |   |      | $ |       |      |  | $ |       |  
|                                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  



See accompanying
notes.



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



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 inter-company balances and transactions have been eliminated in consolidation.



Basis of Presentation



Reclassifications



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



Reverse Stock Split



On December 15, 2005, the Company held a Special Meeting of Stockholders. At the meeting, the Stockholders approved the amendment the Companys
Certificate of Incorporation to effect a reverse split of the outstanding shares of the Companys common stock by a ratio of between one-for-three to one-for-ten, inclusive, without further approval or authorization of the Companys
stockholders. On December 15, 2005, the Companys Board of Directors authorized an amendment of the Companys Certificate of Incorporation to effect a one-for-five reverse split of the outstanding shares of the Companys Common
Stock, which decreased the Companys total number of outstanding shares from approximately 56.5 million to approximately 11.3 million, subject to adjustment for fractional shares. Stockholders equity has been restated to give
retroactive recognition to the reverse stock split for all periods presented by combining the par value previously attributable to the common stock and then reclassifying the excess common stock par value resulting from the reverse split to
additional paid-in capital. In addition, all references in the financial statements and notes to numbers of shares and per share amounts have been restated to reflect the reclassification and the reverse stock split.



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 include particularly
significant estimates are revenue recognition and



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



presentation policies, valuation of accounts receivable, and the assessment of recoverability and measuring impairment of goodwill, intangible assets and
fixed assets.



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, 2005 and 2004, respectively (in thousands):



|                                |  |              |       |      |   |       
|------------------------------- |  | ------------ | ----- | ---- | - | ------
|                                |  | December 31,
|                                |  | 2005         |       | 2004
|Cash and cash equivalents:      |  |              |       |      |   |       
|Cash                            |  | $            | 5,549 |      | $ | 1,253 
|Certificates of deposit         |  |              | 200   |      |   | 102   
|Money market funds              |  |              | 3,997 |      |   | 8,749 
|                                |  |              |       |      |   |       
|Total cash and cash equivalents |  | $            | 9,746 |      | $ | 10,104
|                                |  |              |       |      |   |       



Included in cash and
cash equivalents is $3 million of unrestricted cash which must be maintained on deposit with a lending institution as required under the loan agreement with the lender. (Note 4)



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. At December 31, 2005 and 2004, our allowance for potentially uncollectible accounts was $422,000 and $208,000, 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 to five 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



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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, the payroll and payroll-related costs for employees who are directly associated with and who devote time to the internal use computer software and
associated interest costs are capitalized. Capitalized costs are amortized using the straight-line method over the shorter of the term of related client agreement, if such development relates to a specific outsource client, or the softwares
estimated useful life, ranging from two to five years. Capitalized internal use software and website development costs are included in property and equipment in the accompanying balance sheets.



Goodwill and Other Intangible Assets



Goodwill represents the excess of the acquisition purchase price over the
estimated fair value of net tangible and intangible assets acquired. Goodwill and intangible assets acquired in a business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least
annually. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values, and are reviewed for impairment in accordance with Financial Accounting Standards Board (FASB)
Statement No. 144, Accounting for Impairment or Disposal of Long-Lived Assets. We will perform the impairment test for the goodwill generated by the Sunset Direct acquisition in the first quarter of 2006. To date, no circumstances or
indicators have arisen to indicate that the carrying value has been impaired.



Impairment of Long-Lived Assets



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



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



Revenue Recognition and Presentation



Substantially all of our revenues are generated from the sale of service contracts and maintenance renewals, and performance of lead generation services. We recognize revenue from the sale of our clients service contracts



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



and maintenance renewals under the provisions of Staff Accounting Bulletin (SAB) 104 Revenue Recognition and on the net
basis in accordance with EITF Issue No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent. Revenue from the sale of service contracts and maintenance renewals is recognized when a purchase order from
the clients customer is received; the service contract or maintenance agreement is delivered; the fee is fixed or determinable; the collection of the receivable is reasonably assured; and no significant post-delivery obligations remain
unfulfilled. Revenue from lead generation services we perform is recognized as the services are accepted and is generally earned ratably over the service contract period. Some of our lead generation service revenue is earned when we achieve certain
attainment levels and is recognized upon customer acceptance of the service. Revenue from service sales activities is recognized once these services have been delivered. Revenue from product sales is recognized at the time of shipment of the
product directly to the clients customer and has been historically an insignificant percentage of our net revenue. We generally do not enter into multiple-element revenue arrangements with our clients or customers.



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 allocated facility and telephone usage for our telesales representatives as well as other direct costs associated with the delivery of
our services. 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 future periods to realize the benefit of our deferred tax assets. At December 31, 2005 and 2004, we had gross deferred tax assets of $20.6 and $18.8 million. In
2005 and 2004, the deferred tax asset was subject to a 100% valuation allowance and therefore is not recorded on our balance sheet as an asset.



Stock-Based Compensation



As of December 31, 2005, 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



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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 first quarter of 2006.



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, |       
|                                                                                       |  | 2005                     |        |   | 2004 |   |        | 2003 | 
|Net loss as reported                                                                   |  | $                        | (5,004 | ) |      | $ | (4,938 | )    |  | $ | (3,059 | )
|Total stock-based employee compensation expense determined under the fair value method |  |                          | (4,124 | ) |      |   | (948   | )    |  |   | (470   | )
|                                                                                       |  |                          |        |   |      |   |        |      |  |   |        |  
|Pro forma net loss                                                                     |  | $                        | (9,128 | ) |      | $ | (5,886 | )    |  | $ | (3,529 | )
|                                                                                       |  |                          |        |   |      |   |        |      |  |   |        |  
|Basic and diluted net loss per share as reported                                       |  | $                        | (0.48  | ) |      | $ | (0.57  | )    |  | $ | (0.39  | )
|                                                                                       |  |                          |        |   |      |   |        |      |  |   |        |  
|Basic and diluted net loss per share pro forma                                         |  | $                        | (0.87  | ) |      | $ | (0.68  | )    |  | $ | (0.45  | )
|                                                                                       |  |                          |        |   |      |   |        |      |  |   |        |  



For pro forma
purposes, the estimated fair value of our stock-based grants is amortized using the single option method over the options vesting period for stock options granted under the 2003 Stock Incentive Plan and the purchase period for stock purchases
under the 1999 Employee Stock Purchase Plan. See Note 8 for assumptions used in estimating the fair value of our stock-based grants. The 2005 pro forma comp expense includes $2.0 million for the acceleration of options that was authorized in
December 2005. The acceleration was done to avoid future compensation expense that would have been required under the implementation of SFAS 123R. (Recently Issued Accounting Standards).



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.



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 which are insured by the FDIC.



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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 have generated a significant
portion of our net revenue from sales to customers of a limited number of clients. In 2005, two customers accounted for more than 10% of our revenue and collectively represented 47% of our net revenue with the largest representing 36% of our net
revenue. In 2004 and 2003, four customers accounted for more than 10% of our net revenues. In 2004 and 2003, combined sales to these customers accounted for 96%, and 99%, respectively, of net revenue and the largest individual client accounted for
47% and 34% of our net revenue in 2004 and 2003, respectively.



No individual clients end-user 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. We are currently providing services to Sybase on a month to month basis as our
contract with Sybase expired on December 31, 2005.



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 report segment results in accordance with SFAS No. 131, Segment Reporting (SFAS 131). Under SFAS 131, reportable
segments represent an aggregation of operating segments that meet certain criteria for aggregation specified in SFAS 131.



Our two primary business units, service sales and lead generation, have been aggregated into one reportable segment. The aggregation of operating segments
is based on management by the chief operating decision-maker for the segment as well as similarities of products, production processes, and economic characteristics. 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.



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Nasdaq Listing



On January 3, 2006, NASDAQ Capital Market notified the Company that it regained compliance with the $1.00 minimum bid
price requirement as a result of the stock trading for ten consecutive days above $1.00.



Recently Issued Accounting Standards



In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment. SFAS No. 123R revises SFAS No. 123, Accounting for Stock-Based Compensation and generally requires the cost
associated with employee services received in exchange for an award of equity instruments be measured based on the grant-date fair value of the award and recognized in the financial statements over the period during which employees are required to
provide services in exchange for the award. SFAS No. 123R also provides guidance on how to determine the grant-date fair value for awards of equity instruments as well as alternative methods of adopting its requirements. In April 2005, the
Securities and Exchange Commission announced a new rule allowing companies to implement Statement No. 123R at the beginning of their next fiscal year, instead of the next reporting period, that begins after June 15, 2005, or Dec. 15, 2005
for small business issuers. In accordance with that rule, we will comply with SFAS No. 123R beginning with the interim financial statements for the first quarter of 2006. SFAS. No. 123R applies to all outstanding and unvested share-based
payment awards at a companys adoption date. 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). 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. We estimate that the 2006
compensation expense related to stock options will be between $60,000 and $200,000.



On December 13, 2005, our Board of Directors approved the accelerated vesting of unvested and out-of-the-money stock options with exercise prices equal to or greater than $2.25 per share that
were previously awarded to the Companys employees, officers and its directors under the Companys stock option plan. As a result, these fully vested options will not have to be expensed in future periods. A total of 1,126,439 shares were
fully vested under this action resulting in $2.0 million of pro forma 2005 expense. Although we have not yet determined precisely what the adoption of SFAS 123R will result in future compensation expense, we expect it will be less than 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). See Note 8.



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.



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



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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, |       
|                                                                             |  | 2005                     |        |   | 2004 |   |        | 2003 | 
|Net loss                                                                     |  | $                        | (5,004 | ) |      | $ | (4,938 | )    |  | $ | (3,059 | )
|                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Basic and diluted:                                                           |  |                          |        |   |      |   |        |      |  |   |        |  
|Weighted-average common shares of common stock outstanding                   |  |                          | 10,464 |   |      |   | 8,715  |      |  |   | 7,791  |  
|Less: weighted-average shares subject to repurchase                          |  |                          |       |   |      |   |       |      |  |   |       |  
|                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Weighted-average shares used to compute basic and diluted net loss per share |  |                          | 10,464 |   |      |   | 8,715  |      |  |   | 7,791  |  
|                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  
|Basic and diluted net loss per share                                         |  | $                        | (0.48  | ) |      | $ | (0.57  | )    |  | $ | (0.39  | )
|                                                                             |  |                          |        |   |      |   |        |      |  |   |        |  



The Company has
excluded all outstanding warrants and stock options 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 2,226,472, 1,292,083, and 870,051
shares of common stock have been excluded for the years ended December 31, 2005, 2004 and 2003, respectively.



On December 15, 2005, we effected a 1-for-5 reverse stock split. All per share and share amounts have been restated to reflect the reverse stock
split. Basic and diluted loss per common share are calculated by dividing net loss by the weighted average number of common shares outstanding during the period.



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



3. Balance Sheet Components (in thousands)



|                                                 |  |                      |  |              |         |   |      |   |         |  
|------------------------------------------------ |  | -------------------- |  | ------------ | ------- | - | ---- | - | ------- | -
|                                                 |  |                      |  | December 31, |        
|                                                 |  |                      |  | 2005         |         |   | 2004 |  
|Prepaid expenses and other current assets:       |  |                      |  |              |         |   |      |   |         |  
|Prepaid insurance                                |  |                      |  | $            | 428     |   |      | $ | 549     |  
|Prepaid support and maintenance contracts        |  |                      |  |              | 114     |   |      |   | 91      |  
|Other prepaid expenses and other current assets  |  |                      |  |              | 670     |   |      |   | 477     |  
|                                                 |  |                      |  |              |         |   |      |   |         |  
|                                                 |  |                      |  | $            | 1,212   |   |      | $ | 1,117   |  
|                                                 |  |                      |  |              |         |   |      |   |         |  
|Property and equipment:                          |  |                      |  |              |         |   |      |   |         |  
|                                                 |  | Estimated UsefulLife |  |              |         |   |      |  
|Computer equipment                               |  | 3 years              |  | $            | 5,934   |   |      | $ | 4,156   |  
|Capitalized software and development             |  | 2-5 years            |  |              | 8,830   |   |      |   | 8,661   |  
|Furniture and fixtures                           |  | 5 years              |  |              | 511     |   |      |   | 947     |  
|Leasehold improvements                           |  | Lease term           |  |              | 103     |   |      |   | 336     |  
|                                                 |  |                      |  |              |         |   |      |   |         |  
|                                                 |  |                      |  |              | 15,378  |   |      |   | 14,100  |  
|Accumulated depreciation and amortization        |  |                      |  |              | (13,851 | ) |      |   | (12,012 | )
|Construction in process (1)                      |  |                      |  |              | 2,883   |   |      |   | 1,072   |  
|                                                 |  |                      |  |              |         |   |      |   |         |  
|Property and equipment, net                      |  |                      |  | $            | 4,410   |   |      | $ | 3,160   |  
|                                                 |  |                      |  |              |         |   |      |   |         |  
|Intangibles and indefinite life intangibles:     |  |                      |  |              |         |   |      |   |         |  
|Developed technology                             |  | 3-5 years            |  | $            | 680     |   |      | $ |        |  
|Customer relations                               |  | 2-5 years            |  |              | 1,670   |   |      |   |        |  
|Database                                         |  | 5 years              |  |              | 1,100   |   |      |   |        |  
|Trade name                                       |  | Indefinite           |  |              | 1,100   |   |      |   |        |  
|Goodwill                                         |  | Indefinite           |  |              | 3,921   |   |      |   |        |  
|                                                 |  |                      |  |              |         |   |      |   |         |  
|                                                 |  |                      |  |              | 8,471   |   |      |   |        |  
|Accumulated amortization                         |  |                      |  |              | (898    | ) |      |   |        |  
|                                                 |  |                      |  |              |         |   |      |   |         |  
|Intangibles and indefinite life intangibles, net |  |                      |  | $            | 7,573   |   |      | $ |        |  
|                                                 |  |                      |  |              |         |   |      |   |         |  

---

|(1) |  | During late 2004 and throughout 2005, we have been developing a replacement for our existing system to identify potential service sales opportunities, track the sales contacts and
process the sale of the service contracts. As of December 31, 2005, we had invested $2.9 million in the new order entry system including $100,000 in capitalized interest costs. We expect to deploy and begin depreciating the new order entry
system in the second quarter of 2006 and estimate that costs to complete this project will be between $300,000 and $600,000.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



At December 31, 2005, the unamortized balance of purchased intangible assets that will be amortized to future cost of operations was approximately
$2.4 million, of which $801,000, $675,000, $550,000, $309,000 and $19,000 is expected to be amortized in 2006, 2007, 2008, 2009 and 2010, respectively.



The value of our intangibles is based on allocations of the purchase price of assets included in our acquisitions (Note 5). For developed technology,
the allocation was based on the estimated cost to reproduce the technology as well as market comparisons for similar purchases. For customer relations, we estimated the cash flows associated with the excess earnings the contacts would generate
and allocated the present value of those earnings to the asset. For the database and trade name, we estimated the relief from royalties that we would have



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



had to otherwise pay to use these assets and allocated the present value of those payments to the assets. In all cases we used a discount rate between
24% and 25%. We expect to use the Sunset Direct trade name for the foreseeable future.



Restricted Cash



Restricted cash are
amounts related to cash received for non-service payments inadvertently paid to the Company by its customers instead of paid directly to the Companys clients. At the time of cash receipt the Company records a liability for the amount of
non-service payments received.



4. Capital Leases, Financing
Agreements, Financing Obligations, and Guarantees



Capital Leases



We lease certain property under capital leases that
expire at various dates through 2006. The imputed effective annual interest rates on our capital lease obligations range from 2.4% to 17.0%, with a weighted average of 12.0%. As of December 31, 2005 and 2004, property and equipment included
amounts held under capital leases of approximately $398,000 and $1.5 million and related accumulated depreciation of approximately $249,000 and $1.3 million, respectively. The capital lease obligations are collateralized by the related leased
property and equipment.



During 2005 we did not enter into new
capital leases. During 2004 we entered in four capital leases for various computer hardware and software. During 2003, we entered into one capital lease for a software subscription. These leases have terms ranging from 24 to 36 months. Future
minimum payments under these leases in 2006 are $106,000, of which $7,000 represents the interest portion.



Financing Agreements



In February 2005, concurrent with the closing of the Sunset Direct merger transaction described in Note 5, we entered into a Business Loan Agreement and Commercial Security Agreement with Bridge Bank, N.A. (the Lender) pursuant
to which we obtained a $3.0 million term loan (the Term Loan) that was utilized retire certain indebtedness and certain other liabilities of Sunset Direct. The Term Loan is to be repaid in 36 monthly installments of $83,000 plus interest
at a variable rate of prime plus 1.00% per annum (8.25% per annum at December 31, 2005).



In June 2005, we entered into a Business Loan Agreement with the Lender pursuant to which we obtained a $1.5 million term loan (the  June 2005 Term
Loan) that will be utilized to fund the purchase and implementation of our new client management system. The June 2005 Term Loan is to be repaid in 36 monthly installments of $42,000 plus interest at a variable rate of prime plus
1.00% per annum (8.25% per annum at December 31, 2005). As of December 31, 2005, we had $2.2 million and $1.2 million outstanding on the Term Loan and June 2005 Term Loan, respectively, of which $1.5 million, $1.5 million, and
$417,000 are payable in 2006, 2007, and 2008, respectively.



In
December 2005, our Business Loan Agreement and a Commercial Security Agreement (the Revolving Credit Facility) was increased to $4.0 million from the then existing $2.0 million. In addition, the maturity date was extended to December
2006 from May 2006. We had originally entered into this Revolving Credit Facility with our lender in April 2004. A component of the Revolving Credit Facility is a $1.0 million Letter of Credit facility. The Revolving Credit Facility is subject to
certain financial covenants, which include maintaining a minimum working capital ratio and tangible net worth and bears interest at the Prime Rate published in the Wall



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Street Journal but not less than 4.0%. Borrowings and letter of credit issuances are subject to borrowing base calculations and other limitations. The Term
Loan, June 2005 Term Loan and the Revolving Credit Facility are secured by substantially all of our consolidated assets, including intellectual property. We must comply with certain financial covenants, including maintaining a minimum quick ratio
and maintaining unrestricted cash of $3.0 million with the Lender. The Term Loan, June 2005 Term Loan and the Revolving Credit Facility also 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 Revolving Credit Facility also provides for customary events of default,
including nonpayment, breach of covenants, payment defaults of other indebtedness, and certain events of bankruptcy, insolvency and reorganization that may result in acceleration of outstanding amounts under the Term Loan, June 2005 Term Loan and
Revolving Credit Facility. For the year ended December 31, 2005, the Companys capital expenditures were in excess of the limit specified in the loan agreement. The loan agreement restricted our capital expenditures to $3 million whereas our
actual expenditures amounted to $3.2 million. We obtained a waiver of this covenant breach from our lender. As of December 31, 2005, we had borrowed $2.0 million under the Revolving Credit Facility, which was repaid in January 2006. Interest on
the Revolving Line of Credit is a variable rate of prime per annum (7.25% at December 31, 2005). In addition, three letters of credit in the aggregate face amount of $925,000 were outstanding under the Revolving Credit Facility (as
described below).



In July 2005, we issued an Irrevocable
Standby Letter of Credit in the amount of $100,000 to our landlord for a security deposit for our new corporate headquarters located in Campbell, California. In 2004, we issued Irrevocable Standby Letters of Credit to two of our clients. The letters
of credit were issued in the amounts of $325,000 and $500,000 as guarantees for service contracts sold by us on behalf of our clients and both expire in September 2006. The letters of credit were issued under the Revolving Credit Facility described
above. As of December 31, 2005, no amounts have been drawn against the letters of credit.



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, 2005, our liability related to the Financing Agreement
was fully paid.



In November 2005, we entered into a Commercial
Insurance Premium Finance and Security Agreement (2006 Financing Agreement) to finance certain of our liability insurance premiums in the amount of $334,000. Amounts owed under the Financing Agreement bear interest at an annual rate of
6.0% and principal and interest are payable in monthly installments of approximately $33,000, through September 2006. At December 31, 2005, our liability related to the Financing Agreement was $301,000.



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



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



make any payments for these obligations, and no liabilities have been recorded for these obligations on our balance sheets as of December 31, 2005 and
2004.



Restricted Cash



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



5.  Acquisitions



Launch Project Asset Purchase



On
July 1, 2005, Rainmaker and Sunset Direct entered into, and simultaneously closed, an Asset Purchase Agreement (the Purchase Agreement) with Launch Project, LLC, the members of Launch Project, LLC, and Chad Nuss, as representative
of the members (Launch Project). Pursuant to the Purchase Agreement, Sunset Direct acquired certain of the assets of Launch Project including certain software and intellectual property. Under the terms of the Purchase Agreement, Sunset
Direct paid $40,000 in cash and Rainmaker issued 140,000 shares of common stock in exchange for the assets and incurred approximately $82,000 of purchase related costs. The estimated value of the 140,000 shares of Rainmaker common stock was $385,000
computed at a per share price of $2.75, the average closing price for the period from June 30, 2005 through July 7, 2005.



Assets acquired from Launch Project were recorded at their estimated fair values as of July 1, 2005. The total purchase price was $507,000 as
follows:



|                                                     |  |                |    
|---------------------------------------------------- |  | -------------- | ---
|                                                     |  | (in thousands)
|Issuance of 140,000 shares of Rainmaker Common Stock |  | $              | 385
|Cash payment for acquisition of Launch Project       |  |                | 40 
|Acquisition related transaction costs                |  |                | 82 
|                                                     |  |                |    
|Total purchase price                                 |  | $              | 507
|                                                     |  |                |    



Using the purchase
method of accounting, the total purchase price was allocated to Launch Projects net tangible and identifiable intangible assets based on their estimated fair values as of July 1, 2005. The excess of the purchase price over the net
tangible and identifiable intangible assets was recorded as goodwill. Based upon a valuation by management, the total purchase price was allocated as follows:



|                                                |  |                |    
|----------------------------------------------- |  | -------------- | ---
|                                                |  | (in thousands)
|Developed technology and customer relationships |  | $              | 249
|Goodwill                                        |  |                | 258
|                                                |  |                |    
|Total purchase price allocation                 |  | $              | 507
|                                                |  |                |    



In connection with the
asset purchase with Launch Project LLC, we filed a registration statement with the SEC with respect to the shares that were issued to Launch Projects members that was declared effective August 12, 2005. Pursuant to that registration
statement, approximately 70,000 of such shares are available for public sale, with an additional 35,000 of such shares available for sale April 1, 2006 and the final 35,000 of such shares available for sale July 1, 2006. In addition 28,000
shares of common stock consideration have been placed



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



in escrow to secure certain customary indemnity obligations and will not be released until July 1, 2006 subject to potential post closing adjustments.



Sunset Direct



On February 8, 2005, we acquired all of the issued and outstanding
voting securities of Sunset Direct by means of a merger of Sunset Direct and a wholly owned subsidiary of Rainmaker, with Sunset Direct continuing as the surviving corporation. The results of Sunset Directs operations have been included in the
consolidated financial statements since that date. Sunset Direct is an outsource provider of lead generation services primarily to high-tech companies. As a result of the acquisition, Sunset Direct has been accretive to our financial results and has
provided certain other benefits including cross-selling, client diversification, expanded service offering and a larger, more cost-effective talent pool. Pursuant to our Agreement and Plan of Merger (the Merger Agreement) with Sunset
Direct, we paid approximately $3.5 million in cash that was used to retire approximately $3.3 million of debt and certain liabilities retained by Sunset Direct, issued 664,080 shares of common stock in exchange for the outstanding capital stock of
Sunset Direct, and incurred approximately $910,000 of acquisition related costs. The estimated value of the 664,080 shares of Rainmaker common stock was $2.2 million computed at a per share price of $3.32, the average closing price for the period
from February 8, 2005 through February 14, 2005.



Our
acquisition of Sunset Direct has been accounted for as a business combination. Assets acquired and liabilities assumed were recorded at their estimated fair values as of February 8, 2005. The total purchase price was $6.6 million as follows:



|                                                     |  |                |      
|---------------------------------------------------- |  | -------------- | -----
|                                                     |  | (in thousands)
|Issuance of 664,080 shares of Rainmaker Common Stock |  | $              | 2,205
|Cash payment for acquisition of Sunset Direct        |  |                | 3,476
|Acquisition related transaction costs                |  |                | 910  
|                                                     |  |                |      
|Total purchase price                                 |  | $              | 6,591
|                                                     |  |                |      



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



|                                |  |                |        |  
|------------------------------- |  | -------------- | ------ | -
|                                |  | (in thousands) |       
|Tangible assets acquired        |  | $              | 1,866  |  
|Identifiable intangible assets  |  |                | 4,300  |  
|Goodwill                        |  |                | 3,663  |  
|Net liabilities assumed         |  |                | (3,238 | )
|                                |  |                |        |  
|Total purchase price allocation |  | $              | 6,591  |  
|                                |  |                |        |  



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



Identifiable intangible assets acquired consist of developed technology, customer relationships, trade names, and a
proprietary database. The estimated fair value of identifiable intangible assets was determined by



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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



On June 30, 2005, the Company filed a registration
statement with the Securities and Exchange Commission with respect to the shares were issued to Sunset Directs shareholders that was declared effective July 19, 2005. Pursuant to that registration statement all shares are available for
public sale.



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



|                                                                  |  |                         |        |   |             |   |        |  
|----------------------------------------------------------------- |  | ----------------------- | ------ | - | ----------- | - | ------ | -
|                                                                  |  | Year Ended December 31, |       
|                                                                  |  | 2005                    |        |   | 2004        |  
|                                                                  |  | (Unaudited)             |        |   | (Unaudited) |  
|Revenues                                                          |  | $                       | 33,105 |   |             | $ | 26,937 |  
|                                                                  |  |                         |        |   |             |   |        |  
|Net loss                                                          |  | $                       | (5,298 | ) |             | $ | (6,382 | )
|                                                                  |  |                         |        |   |             |   |        |  
|Pro forma net loss per share- basic and diluted:                  |  | $                       | (0.50  | ) |             | $ | (0.68  | )
|                                                                  |  |                         |        |   |             |   |        |  
|Pro forma weighted average shares outstanding -basic and diluted: |  |                         | 10,534 |   |             |   | 9,379  |  
|                                                                  |  |                         |        |   |             |   |        |  



6.  Commitments



On August 4, 2005, the Company executed an operating
lease to occupy approximately 16,600 square feet in an existing facility in Campbell, California. The office space serves as the Companys corporate headquarters. The lease term began on November 1, 2005 and will end on October 31,
2008. The Company has an option to extend the lease term for an additional three years. The base rent for the new corporate headquarters during the initial lease term will escalate from approximately $270,000 for the initial year, to approximately
$280,000 for the final year. In addition, the Company must pay its proportionate share of operating costs and taxes. In connection with the execution of the lease, the Company has issued a Letter of Credit to the Landlord in the amount of $100,000
as a security deposit.



As of December 31, 2005, our
off-balance sheet arrangements include operating leases for our facilities and certain property and equipment that expire at various dates through 2009, including an additional facility operating lease commitment assumed in connection with the
Companys acquisition of Sunset Direct in February 2005 and the recently executed lease for the Companys new corporate headquarters in Campbell, California discussed above. 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 upfront cash flow related to purchasing the assets.



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



All leases require the Company to pay a portion of the common area maintenance, utilities and insurance costs on the leased property. Future minimum payments
under our operating leases at December 31, 2005 are as follows:



|                       |  |                 |      
|---------------------- |  | --------------- | -----
|                       |  | OperatingLeases
|2006                   |  | $               | 634  
|2007                   |  |                 | 645  
|2008                   |  |                 | 612  
|2009                   |  |                 | 197  
|                       |  |                 |      
|Total minimum payments |  | $               | 2,088
|                       |  |                 |      



Rent expense under
operating lease agreements during the years ended December 31, 2005, 2004, and 2003 was $771,000, $311,000, and $434,000, respectively.



7.  Income Taxes



The federal and state income tax benefit for the years ended December 31, 2005, 2004, and 2003 consists of the following (in thousands):



|         |  |              |   |      |   |      |  |   |     |  
|-------- |  | ------------ | - | ---- | - | ---- |  | - | --- | -
|         |  | December 31, |  
|         |  | 2005         |   | 2004 |   | 2003 | 
|Current: |  |              |   |      |   |      |  |   |     |  
|Federal  |  | $            |  |      | $ |     |  | $ | (24 | )
|State    |  |              |  |      |   |     |  |   | 1   |  
|         |  |              |   |      |   |      |  |   |     |  
|         |  |              |  |      |   |     |  |   | (23 | )
|Deferred |  |              |   |      |   |      |  |   |     |  
|Federal  |  |              |  |      |   |     |  |   |    |  
|State    |  |              |  |      |   |     |  |   |    |  
|         |  |              |   |      |   |      |  |   |     |  
|         |  |              |  |      |   |     |  |   |    |  
|         |  |              |   |      |   |      |  |   |     |  
|         |  | $            |  |      | $ |     |  | $ | (23 | )
|         |  |              |   |      |   |      |  |   |     |  



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



|                                                        |  |              |        |   |      |   |        |      |  |   |        |  
|------------------------------------------------------- |  | ------------ | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                        |  | December 31, |       
|                                                        |  | 2005         |        |   | 2004 |   |        | 2003 | 
|Tax benefit computed at federal statutory rate          |  | $            | (1,701 | ) |      | $ | (1,679 | )    |  | $ | (1,048 | )
|Loss for which no tax benefit is currently recognizable |  |              | 1,685  |   |      |   | 1,660  |      |  |   | 1,017  |  
|Other                                                   |  |              | 16     |   |      |   | 19     |      |  |   | 8      |  
|                                                        |  |              |        |   |      |   |        |      |  |   |        |  
|Total tax provision (benefit)                           |  | $            |       |   |      | $ |       |      |  | $ | (23    | )
|                                                        |  |              |        |   |      |   |        |      |  |   |        |  



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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, 2005 and 2004 are as follows (in thousands):



|                                 |  |                          |         |   |      |   |         |  
|-------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------- | -
|                                 |  | Years Ended December 31, |        
|                                 |  | 2005                     |         |   | 2004 |  
|Deferred Tax Assets:             |  |                          |         |   |      |   |         |  
|Net operating loss carryforwards |  | $                        | 19,693  |   |      | $ | 18,522  |  
|Depreciation and amortization    |  |                          | 16      |   |      |   |        |  
|Accrued reserves and other       |  |                          | 792     |   |      |   | 295     |  
|                                 |  |                          |         |   |      |   |         |  
|Total Deferred Tax Assets        |  |                          | 20,501  |   |      |   | 18,817  |  
|Valuation allowance              |  |                          | (19,565 | ) |      |   | (18,248 | )
|                                 |  |                          |         |   |      |   |         |  
|Net Deferred Tax Assets          |  |                          | 936     |   |      |   | 569     |  
|Depreciation and amortization    |  |                          |        |   |      |   | (569    | )
|Acquired Intangibles             |  |                          | (1,376  | ) |      |   |        |  
|                                 |  |                          |         |   |      |   |         |  
|Net Deferred Tax Liability       |  | $                        | 440     |   |      | $ |        |  
|                                 |  |                          |         |   |      |   |         |  



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 $1.3 million and $2.0 million during the years ended December 31, 2005 and 2004, respectively. Included in the December 31, 2005 valuation
allowance is approximately $490,000 related to stock options, which will be credited to stockholders equity when realized for tax purposes.



As of December 31, 2005, we had net operating loss carryforwards for federal and state tax purposes of $52 million and $34 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.



8. 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, 2005 and 2004.



Common Stock and Warrants



On July 1, 2005, Rainmaker and Sunset Direct entered into, and
simultaneously closed, an Asset Purchase Agreement (the Purchase Agreement) with Launch Project, LLC, the members of Launch Project, LLC, and Chad Nuss, as representative of the members. Pursuant to the Purchase Agreement, Sunset Direct
acquired



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



certain of the assets of Launch Project, LLC including certain software and intellectual property. Under the terms of the Purchase Agreement, Sunset Direct
paid $40,000 in cash, which was paid upon satisfaction of a condition subsequent to the closing, and Rainmaker issued 140,000 shares of common stock in exchange for the assets and incurred approximately $82,000 of purchase related costs. Also, the
members entered into certain non-compete agreements and two members accepted employment positions with Sunset Direct or Rainmaker.



On June 15, 2005, we entered into a Purchase Agreement with certain investors. Pursuant to the Purchase Agreement, we agreed to issue 1,340,444
shares of our common stock for gross proceeds of approximately $2.7 million to a group of investors that included members of our management and our board of directors. The sale to investors who were not members of management or the board of
directors consisted of 1,280,000 shares of our common stock at a price of $2.00 per share, for gross proceeds of $2,560,000, and the sale to investors who were members of management or the board of directors consisted of 60,444 shares of our common
stock at the market price of $2.25 per share, for gross proceeds of $136,000. In addition, we issued warrants to the investors to purchase a total of 201,066 shares of our common stock at an exercise price of $2.40 per share. Estimated stock
offering costs of $99,000 have been reflected as a reduction of the gross proceeds received



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 933,000 shares of common stock at $7.50 per share. The investors also received warrants to purchase an aggregate of 186,668 shares of our common stock at an exercise price of $9.375 per share. In
connection with the private placement, our investment banker also received a warrant to purchase 7,466 shares of our common stock at an exercise price of $9.375 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 194,134 shares of common stock for the exercise of the warrants. At
December 31, 2005, the warrants were still outstanding.



For each of the aforementioned private placements of common stock, we are required by the terms of the respective Purchase Agreements to register the shares with the Securities Exchange Commission and maintain the effectiveness of the
registration for periods of up to 2 years. In the event that we do not meet these obligations, we are potentially liable to the investors to pay penalties that range between 15% and 36% of the gross proceeds of the transaction. To date we have met
these obligations and no penalties have been incurred.



Stock Repurchases



At December 31, 2005, 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 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



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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.



On December 29, 2005, we awarded the four non-employee members of our board of directors options to purchase an aggregate of 117,500 shares of the
Companys common stock at a price of $2.56 per share. These options were fully vested as of December 29, 2005. In connection with the granting of these options, the directors waived their respective rights to receive their automatic
option grants for 2006 that would otherwise be issuable to the non-employee directors following the 2006 annual meeting of stockholders. In addition, the Companys board of directors awarded the Companys Chief Executive Officer,
Michael Silton 100,000 fully vested options to purchase shares of the Companys common stock at $2.56 per share. The Companys stock closed trading at $2.56 per share on December 29, 2005 which is the price that was used for the
option awards. The Company has chosen to award these fully vested option grants at this time in order to avoid recognition of future compensation expense that will be required with the adoption of FASB Statement of Financial Accounting Standards
No. 123R Share-Based Payment (SFAS 123R). Previously, the Company accounted for employee and director stock options using the intrinsic value method prescribed in Accounting Principles Board Opinion (APB) No. 25,
Accounting for Stock Issued to Employees, in which no compensation expense was recognized when the stock option price was equal to the market price of the underlying stock on the date of grant. However, SFAS 123R is effective for the
Company beginning in the first quarter of fiscal year 2006, and will require that compensation



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



expense associated with stock options be recognized in the consolidated statement of operations, rather than as a pro forma footnote disclosure in the
Companys consolidated financial statements.



On
December 13, 2005, our Board of Directors approved the accelerated vesting of unvested and out-of-the-money stock options with exercise prices equal to or greater than $2.25 per share that were previously awarded to the
Companys employees, officers and its directors under the Companys stock option plan. The prior days closing stock price for the Companys common stock was $2.20 per share. Options to purchase 1,126,439 shares of the
Companys common stock became exercisable immediately, representing approximately 98% of the Companys outstanding unvested options. The other terms of the accelerated options remain unchanged. The weighted average exercise price of the
options subject to the acceleration was $3.50 and the exercise price of the options subject to the acceleration range from $2.30-$20.30 per share.



The primary purpose of the acceleration is to enable the Company to avoid recognizing compensation expense associated with these options in future periods
in its consolidated statements of operations, upon adoption of FASB Statement of Financial Accounting Standards No. 123R Share-Based Payment (SFAS 123R). Previously, the Company accounted for employee stock options using
the intrinsic value method prescribed in Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, in which no compensation expense was recognized when the stock option price was equal to the market
price of the underlying stock on the date of grant. However, SFAS 123R is effective for the Company beginning in the first quarter of fiscal year 2006, and will require that compensation expense associated with stock options be recognized in the
consolidated statement of operations, rather than as a footnote disclosure in the Companys consolidated financial statements. The estimated pre-tax charge to be avoided amounts to approximately $3.2 million over the course of the original
remaining vesting periods, which on average was approximately 3.27 years from the effective date of acceleration. The acceleration of the vesting of these options did not result in a charge to earnings based on existing generally accepted accounting
principles since the exercise price of these options was equal to or greater than the $2.25 market price of the Companys common stock on the date of acceleration. The Company will report all of the compensation expense related to the affected
options for pro forma disclosure purposes only in its fourth quarter 2005 consolidated financial statements. The Company also believes that the underwater options were no longer achieving their original objective of incentive compensation and
employee retention.



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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, 2002 |  | 1,097,334           |   |  | 878,080         |   |  | $                            | 2.55
|Authorized                   |  | 310,652             |   |  |                |   |  | $                            |    
|Granted                      |  | (144,040            | ) |  | 144,040         |   |  | $                            | 4.65
|Exercised                    |  |                    |   |  | (49,798         | ) |  | $                            | 1.55
|Canceled                     |  | 102,271             |   |  | (102,271        | ) |  | $                            | 5.60
|                             |  |                     |   |  |                 |   |  |                              |     
|Balance at December 31, 2003 |  | 1,366,217           |   |  | 870,051         |   |  | $                            | 2.60
|Authorized                   |  | 313,348             |   |  |                |   |  | $                            |    
|Granted                      |  | (425,420            | ) |  | 425,420         |   |  | $                            | 9.40
|Exercised                    |  |                    |   |  | (101,496        | ) |  | $                            | 2.80
|Canceled                     |  | 96,027              |   |  | (96,027         | ) |  | $                            | 7.75
|                             |  |                     |   |  |                 |   |  |                              |     
|Balance at December 31, 2004 |  | 1,350,172           |   |  | 1,097,948       |   |  | $                            | 4.75
|Authorized                   |  | 355,359             |   |  |                |   |  | $                            |    
|Granted                      |  | (1,386,900          | ) |  | 1,386,900       |   |  | $                            | 2.60
|Exercised                    |  |                    |   |  | (258,116        | ) |  | $                            | 1.22
|Canceled                     |  | 393,998             |   |  | (395,321        | ) |  | $                            | 5.10
|                             |  |                     |   |  |                 |   |  |                              |     
|Balance at December 31, 2005 |  | 712,629             |   |  | 1,831,131       |   |  | $                            | 3.56
|                             |  |                     |   |  |                 |   |  |                              |     



The following table
summarizes information about stock options outstanding as of December 31, 2005:



|                         |  |                     |  |                                          |  |                              |       |                 |           |                              |   |      
|------------------------ |  | ------------------- |  | ---------------------------------------- |  | ---------------------------- | ----- | --------------- | --------- | ---------------------------- | - | -----
|                         |  | Outstanding Options |  | Options Exercisable                     
|Range of Exercise Prices |  | Number ofShares     |  | WeightedAverageContractualLife (InYears) |  | WeightedAverageExercisePrice |       | Number ofShares |           | WeightedAverageExercisePrice
|$  1.10 - $  1.35        |  | 140,781             |  | 4.59                                     |  | $                            | 1.15  |                 | 139,204   |                              | $ | 1.15 
|$  1.36 - $  2.29        |  | 141,320             |  | 5.10                                     |  | $                            | 1.61  |                 | 123,293   |                              | $ | 1.55 
|$  2.30 - $  2.55        |  | 622,800             |  | 9.59                                     |  | $                            | 2.51  |                 | 622,800   |                              | $ | 2.51 
|$  2.56 - $  2.80        |  | 448,070             |  | 9.59                                     |  | $                            | 2.60  |                 | 448,070   |                              | $ | 2.60 
|$  2.81 - $  3.90        |  | 140,423             |  | 9.36                                     |  | $                            | 3.00  |                 | 140,423   |                              | $ | 3.00 
|$  3.91 - $  7.70        |  | 76,733              |  | 7.56                                     |  | $                            | 5.75  |                 | 76,733    |                              | $ | 5.75 
|$  7.71 - $13.28         |  | 252,924             |  | 8.26                                     |  | $                            | 9.48  |                 | 253,064   |                              | $ | 9.48 
|$13.29 - $20.32          |  | 8,080               |  | 7.42                                     |  | $                            | 16.42 |                 | 8,080     |                              | $ | 16.42
|                         |  |                     |  |                                          |  |                              |       |                 |           |                              |   |      
|$  1.10 - $20.32         |  | 1,831,131           |  | 8.56                                     |  | $                            | 3.56  |                 | 1,811,666 |                              | $ | 3.57 
|                         |  |                     |  |                                          |  |                              |       |                 |           |                              |   |      



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



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offering period, whichever is lower. Purchase of shares is made through employee payroll deductions and may 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, 2005, a total of 135,498 shares had been issued under the Purchase Plan and 455,779 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 2005, 2004 and 2003 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:



|                        |  |         |   |  |               |   |  |      |   |  |      |   |  |      |   |  |      |  
|----------------------- |  | ------- | - |  | ------------- | - |  | ---- | - |  | ---- | - |  | ---- | - |  | ---- | -
|                        |  | Options |   |  | Purchase Plan |  
|                        |  | 2005    |   |  | 2004          |   |  | 2003 |   |  | 2005 |   |  | 2004 |   |  | 2003 |  
|Expected life in years  |  | 4.09    |   |  | 4             |   |  | 4    |   |  | 0.72 |   |  | 0.5  |   |  | 1.12 |  
|Volatility              |  | 1.09    |   |  | 1.75          |   |  | 1.89 |   |  | 0.94 |   |  | 0.91 |   |  | 1.19 |  
|Risk-free interest rate |  | 4.1     | % |  | 3.1           | % |  | 2.5  | % |  | 3.3  | % |  | 1.6  | % |  | 1.3  | %



The weighted-average
fair value of stock options granted in the years ended December 31, 2005, 2004, and 2003 was $1.96, $8.72, and $4.37 per share, respectively. No option shares were granted during the years ended December 31, 2005 or 2004 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, 2005, 2004, and 2003 was $1.18
$4.61, and $2.66 per share, respectively.



9. 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 have imputed interest at rates ranging between 14.5% and 17.9% per annum and expire at various dates through October
2006. As of December 31, 2005, property and equipment included amounts held under these capital leases of approximately $398,000 and related accumulated depreciation of approximately $249,000. Principal and interest owed to this client amounted
to



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



approximately $106,000 at December 31, 2005. The capital lease obligations are collateralized by the related leased property and equipment.



10. 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, 2005, 2004, and 2003, we expensed $57,000, $64,000, and $48,000,
respectively, relating to our contributions under the plan.



11. Interest and Other Income (Expense), Net



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



|                 |  |                          |      |   |      |   |     |      |  |   |     |  
|---------------- |  | ------------------------ | ---- | - | ---- | - | --- | ---- |  | - | --- | -
|                 |  | Years Ended December 31, |     
|                 |  | 2005                     |      |   | 2004 |   |     | 2003 | 
|Interest income  |  | $                        | 113  |   |      | $ | 87  |      |  | $ | 56  |  
|Interest expense |  |                          | (177 | ) |      |   | (30 | )    |  |   | (89 | )
|Other            |  |                          | 4    |   |      |   | (7  | )    |  |   | 8   |  
|                 |  |                          |      |   |      |   |     |      |  |   |     |  
|                 |  | $                        | (68  | ) |      | $ | 50  |      |  | $ | (25 | )
|                 |  |                          |      |   |      |   |     |      |  |   |     |  



12. Unaudited Quarterly
Financial Data



|                                     |  |                                       |        |   |         |   |        |              |  |   |             |   |  |   |        |     
|------------------------------------ |  | ------------------------------------- | ------ | - | ------- | - | ------ | ------------ |  | - | ----------- | - |  | - | ------ | ----
|                                     |  | Three Months Ended                    |       
|                                     |  | March 31                              |        |   | June 30 |   |        | September 30 |  |   | December 31 |  
|                                     |  | (in thousands, except per share data) |       
|2005:                                |  |                                       |        |   |         |   |        |              |  |   |             |   |  |   |        |     
|Net revenue                          |  | $                                     | 6,420  |   |         | $ | 8,037  |              |  | $ | 8,594       |   |  | $ | 9,063  |     
|Operating loss                       |  |                                       | (2,503 | ) |         |   | (1,404 | )            |  |   | (656        | ) |  |   | (373   | )(b)
|Net loss                             |  |                                       | (2,506 | ) |         |   | (1,474 | )            |  |   | (716        | ) |  |   | (308   | )(b)
|Basic and diluted net loss per share |  |                                       | (0.26  | ) |         |   | (0.14  | )            |  |   | (0.06       | ) |  |   | (0.03  | )   
|                                     |  |                                       |        |  
|2004:                                |  |                                       |        |   |         |   |        |              |  |   |             |   |  |   |        |     
|Net revenue                          |  | $                                     | 3,784  |   |         | $ | 3,634  |              |  | $ | 3,711       |   |  | $ | 4,194  |     
|Operating loss                       |  |                                       | (450   | ) |         |   | (832   | )            |  |   | (1,082      | ) |  |   | (2,624 | )(a)
|Net loss                             |  |                                       | (440   | ) |         |   | (818   | )            |  |   | (1,073      | ) |  |   | (2,606 | )(a)
|Basic and diluted net loss per share |  |                                       | (0.06  | ) |         |   | (0.10  | )            |  |   | (0.12       | ) |  |   | (0.29  | )   

---

|(a) |  | 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.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(b) |  | During the fourth quarter of 2005, the Company recorded $100,000 in capitalized interest costs relating to internally developed software costs.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------



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RAINMAKER SYSTEMS, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



13. Subsequent Events (unaudited)



Private Placement



On February 7, 2006, the Company entered into two Securities Purchase Agreements with certain new and existing investors. Pursuant to the Securities
Purchase Agreements, the Company issued a total of 2,000,000 shares of the Companys common stock at a price of $3.00 per share for gross proceeds of $6.0 million and issued warrants to the investors to purchase an additional 799,999 shares of
common stock of the Company at an exercise price of $4.28 per share. The warrants have a 5-year term and will be exercisable beginning August 7, 2006. Net proceeds from the issuance are expected to be approximately $5.4 million after payment of
fees and costs. The securities issued pursuant to the Securities Purchase Agreements were not registered under the Securities Act of 1933, as amended (the Securities Act), or the securities laws of certain states, in reliance on the
exemptions provided by Section 4(2) of the Securities Act and Regulation D promulgated thereunder and in reliance on similar exemptions under applicable state laws. Under the Securities Purchase Agreements, the Company also granted certain
registration rights to each of the investors pursuant to which the Company expects to file a registration statement on Form S-3 by April 7, 2006, with respect to the common stock issued under the Securities Purchase Agreements and the common
stock issuable upon conversion of the related warrants.



Amended Service
Agreement



On March 7, 2006, we executed an amendment
to the Master Services Agreement with Dell Products L.P. The amendment, among other things, extends the term of the agreement for three years to 2009. After the initial three year term, the agreement automatically renews for additional one year
terms unless either party gives prior notice that it does not wish to renew.



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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, 2005, 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 2005 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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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 AND RELATED STOCKHOLDER MATTERS
|-------- | ----------------------------------------------------------------------------------------------



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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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.                                                                                                                                                                                                                                      
|         | 
|3.3(37)  |  | Certificate of Amendment of Certificate of Incorporation of Rainmaker Systems, Inc., dated December 15, 2005                                                                                                                                                           
|         | 
|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.                                     
|         | 
|4.7(29)  |  | Form of Stock Purchase Agreement dated as of June 15, 2005, by and among Rainmaker Systems, Inc., and the purchasers identified on the
signature page thereto.                                                                                                         
|         | 
|4.8(30)  |  | Form of Registration Rights Agreement dated as of June 15, 2005, by and among Rainmaker Systems, Inc. and the purchasers identified on the
signature page thereto.                                                                                                     
|         | 
|4.9(38)  |  | Securities Purchase Agreement dated February 7, 2006, by and among the Company and the investors party thereto.                                                                                                                                                        
|         | 
|4.91(39) |  | Securities Purchase Agreement dated February 7, 2006, by and among the Company and the investors party thereto.                                                                                                                                                        



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|           |      |  |                                                                                                                                                                                               
|---------- | ---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|           |     
|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.                         
|           |     
|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.                                                              



70



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|          |  |                                                                                                                                                                                                                                                                                                                                                                                         
|--------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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).                                                                                                  
|          | 
|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                                                                                                                                                                                                                                                                                       



71



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|          |  |                                                                                                                                                                                                                                           
|--------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.42(31) |  | Asset Purchase Agreement, dated as of July 1, 2005, by and among Rainmaker Systems, Inc., Sunset Direct, Inc., Launch Project LLC, The
Members Identified on the signature page thereto, and Chad Nuss, as Representative.                
|          | 
|10.43(32) |  | Business Loan Agreement, entered into and dated as of June 14, 2005 between RAINMAKER SYSTEMS, INC. and BRIDGE BANK,
N.A.                                                                                                                 
|          | 
|10.44(33) |  | Business Loan Agreement (Asset Based) and Change in Terms Agreement, entered into and dated as of June 14, 2005 between RAINMAKER SYSTEMS,
INC. and BRIDGE BANK, N.A.                                                                     
|          | 
|10.45(34) |  | Fifth Amendment to Lease entered into June 1, 2005 between HUB PROPERTIES TRUST and SUNSET DIRECT, INC.                                                                                                                                   
|          | 
|10.46(35) |  | Guaranty entered into June 1, 2005 between HUB PROPERTIES TRUST and RAINMAKER SYSTEMS, INC.                                                                                                                                               
|          | 
|10.47(36) |  | Lease Agreement, dated as of July 19, 2005, by and between Rainmaker Systems, Inc., and OTR, an Ohio general partnership, as Nominee of The
State Teachers Retirement Board of Ohio, a statutory organization created by the laws of Ohio.
|          | 
|10.48(40) |  | Business Loan Agreement (Asset Based) and Change in Terms Agreement, each dated as of December 16, 2005 between RAINMAKER SYSTEMS,
INC. and BRIDGE BANK, N.A.                                                                             
|          | 
|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).
|----- |  | ---------------------------------------------------------------------------------------------------------------------------



|(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).
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

|(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.
|---- |  | ----------------------------------------------------------------------------------------------------------------------------



|(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, 2004
|---- |  | ---------------------------------------------------------------------------------------------------------------

|(22) |  | Incorporated by reference to Exhibit 99.3 to the Current Report on Form 8-K Filed by Rainmaker on June 18, 2004
|---- |  | ---------------------------------------------------------------------------------------------------------------

|(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
|---- |  | -------------------------------------------------------------------------------------------------------------------

|(29) |  | Incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K Filed by Rainmaker on June 16, 2005
|---- |  | ---------------------------------------------------------------------------------------------------------------



73



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|(30) |  | Incorporated by reference to Exhibit 10.2 to the Current Report on Form 8-K Filed by Rainmaker on June 16, 2005
|---- |  | ---------------------------------------------------------------------------------------------------------------

|(31) |  | Incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K Filed by Rainmaker on July 5, 2005
|---- |  | --------------------------------------------------------------------------------------------------------------

|(32) |  | Incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K Filed by Rainmaker on July 14, 2005
|---- |  | ---------------------------------------------------------------------------------------------------------------

|(33) |  | Incorporated by reference to Exhibit 10.2 to the Current Report on Form 8-K Filed by Rainmaker on July 14, 2005
|---- |  | ---------------------------------------------------------------------------------------------------------------

|(34) |  | Incorporated by reference to Exhibit 10.3 to the Current Report on Form 8-K Filed by Rainmaker on July 14, 2005
|---- |  | ---------------------------------------------------------------------------------------------------------------

|(35) |  | Incorporated by reference to Exhibit 10.4 to the Current Report on Form 8-K Filed by Rainmaker on July 14, 2005
|---- |  | ---------------------------------------------------------------------------------------------------------------

|(36) |  | Incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K Filed by Rainmaker on August 5, 2005
|---- |  | ----------------------------------------------------------------------------------------------------------------

|(37) |  | Incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K Filed by Rainmaker on December 21, 2005
|---- |  | ------------------------------------------------------------------------------------------------------------------

|(38) |  | Incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K Filed by Rainmaker on February 10, 2006
|---- |  | -------------------------------------------------------------------------------------------------------------------

|(39) |  | Incorporated by reference to Exhibit 10.2 to the Current Report on Form 8-K Filed by Rainmaker on February 10, 2006
|---- |  | -------------------------------------------------------------------------------------------------------------------

|(40) |  | Incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K Filed by Rainmaker on December 29, 2005
|---- |  | -------------------------------------------------------------------------------------------------------------------

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



74



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##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



Board of Directors and Stockholders

Rainmaker Systems, Inc.

Campbell, California



The audits referred to in our report dated February 3, 2006 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 as of and for the years ended
December 31, 2005 and 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 audits.



In our opinion such financial statement schedule presents fairly, in all
material respects, the information set forth therein as of and for the years ended December 31, 2005 and 2004.



/s/    BDO SEIDMAN, LLP



San Francisco, California

February 3, 2006



75



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##### Table of Contents

SCHEDULE II



VALUATION AND
QUALIFYING ACCOUNTS

YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003



|                                 |  |                            |     |                                      |   |              |  |   |                      |   |  |   |    
|-------------------------------- |  | -------------------------- | --- | ------------------------------------ | - | ------------ |  | - | -------------------- | - |  | - | ---
|Description                      |  | Balance atBeginningof Year |     | AdditionsCharged toCosts andExpenses |   | Deductions * |  |   | Balanceat Endof Year
|                                 |  | (in thousands)            
|Allowance for doubtful accounts: |  |                            |     |                                      |   |              |  |   |                      |   |  |   |    
|Year ended December 31, 2005     |  | $                          | 208 |                                      | $ | 321          |  | $ | (107                 | ) |  | $ | 422
|Year ended December 31, 2004     |  | $                          | 207 |                                      | $ | 186          |  | $ | (185                 | ) |  | $ | 208
|Year ended December 31, 2003     |  | $                          | 342 |                                      | $ | 13           |  | $ | (148                 | ) |  | $ | 207

---

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



76



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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 Campbell, State of California, on the 10th
day of March 2006.



RAINMAKER SYSTEMS, INC.By:

/s/    MICHAEL SILTONMichael Silton, Chief Executive OfficerBy:

/s/    STEVE
VALENZUELASteve Valenzuela, Chief Financial OfficerBy:

/s/    ALOK MOHANAlok Mohan, Chairman of the BoardBy:

/s/    ROBERT LEFFRobert Leff, DirectorBy:

/s/    MITCHELL LEVYMitchell Levy, DirectorBy:

/s/    BRADFORD
PEPPARDBradford Peppard, Director




77