Rainmaker Systems 10Q 2006 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

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

FOR THE QUARTERLY PERIOD ENDED: September 30, 2006

COMMISSION FILE NUMBER 000-28009

RAINMAKER SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

Delaware

33-0442860

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification Number)

900 East Hamilton Ave.

Campbell, California 95008

(address of principal executive offices) (zip code)

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

(1) Yes x No ¨

(2) Yes x No ¨

Indicate by check mark whether the registrant is 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.


Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x

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

As of October 27, 2006, the registrant had 14,619,000 shares of Common Stock outstanding.

RAINMAKER SYSTEMS, INC.

FORM 10-Q

AS OF SEPTEMBER 30, 2006

TABLE OF CONTENTS


		Page
PART I.	FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements (Unaudited):	3
	Condensed Consolidated Balance Sheets at September 30, 2006 and December 31, 2005	3
	Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2006 and 2005	4
	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2006 and 2005	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Qualitative and Quantitative Disclosures About Market Risk	29
Item 4.	Controls and Procedures	29

PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	29
Item 1A.	Risk Factors	30
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	37
Item 3.	Default Upon Senior Securities	37
Item 4.	Submission of Matters to a Vote of Security Holders	37
Item 5.	Other Information	38
Item 6.	Exhibits	38

	Signatures	39

PART I. - FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

RAINMAKER SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)


	September 30, 2006			December 31, 2005
ASSETS
Current assets:
Cash and cash equivalents	$	18,979		$	9,746
Restricted cash		467			586
Accounts receivable, less allowance for doubtful accounts of $323 and $422 at September 30, 2006 and December 31, 2005, respectively		11,147			10,374
Prepaid expenses and other current assets		886			1,212

Total current assets		31,479			21,918
Property and equipment, net		4,155			4,410
Intangible assets, net		6,171			3,652
Goodwill		7,018			3,921
Other noncurrent assets		264			257

Total assets	$	49,087		$	34,158

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	19,090		$	17,741
Accrued compensation and benefits		1,699			1,427
Other accrued liabilities		2,422			1,732
Deferred revenue		3,304			882
Obligations under financing arrangements		—			301
Current portion of capital lease obligations		4			99
Current portion of notes payable		1,500			3,500

Total current liabilities		28,019			25,682
Deferred tax liability		16			440
Notes payable, less current portion		792			1,917

Stockholders’ equity:
Preferred stock, $0.001 par value; 5,000,000 shares authorized, none issued and outstanding		—			—
Common stock, $0.001 par value; 50,000,000 shares authorized, 14,617,873 and 11,306,937 outstanding at September 30, 2006 and December 31, 2005, respectively		15			11
Additional paid-in capital		80,766			69,089
Accumulated deficit		(60,521	)		(62,981	)

Total stockholders’ equity		20,260			6,119

Total liabilities and stockholders’ equity	$	49,087		$	34,158

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

RAINMAKER SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)


	Three Months Ended September 30,					Nine Months Ended September 30,
	2006		2005			2006		2005
Net revenue	$	12,219	$	8,594		$	34,556	$	23,051
Operating expenses:
Costs of services		6,231		4,925			17,315		13,856
Sales and marketing		1,034		741			2,658		1,955
Technology		1,487		1,035			4,116		3,044
General and administrative		1,745		1,699			5,594		6,272
Depreciation and amortization		797		850			2,283		2,485

Total operating expenses		11,294		9,250			31,966		27,612

Operating income (loss)		925		(656	)		2,590		(4,561	)
Interest and other (expense) income, net		56		(60	)		54		(133	)

Income (loss) before income taxes	$	981	$	(716	)	$	2,644	$	(4,694	)
Provision for income taxes		112		—			184		—

Net income (loss)	$	869	$	(716	)	$	2,460	$	(4,694	)

Basic income (loss) per share	$	0.06	$	(0.06	)	$	0.19	$	(0.46	)

Diluted income (loss) per share	$	0.06	$	(0.06	)	$	0.18	$	(0.46	)

Weighted average common shares
Basic		13,921		11,278			13,049		10,135

Diluted		14,959		11,278			13,851		10,135

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

RAINMAKER SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)


	Nine Months Ended September 30,
	2006			2005
Operating activities:
Net income (loss)	$	2,460		$	(4,694	)
Adjustment to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization of property and equipment		1,382			1,832
Amortization of intangible assets		901			653
Stock-based compensation expense		52			—
Provision for allowances for doubtful accounts		217			259
Loss on disposal of fixed assets		10			62
Changes in operating assets and liabilities, net of assets acquired and liabilities assumed:
Accounts receivable		(734	)		(1,898	)
Prepaid expenses and other assets		375			91
Accounts payable		1,349			1,486
Accrued compensation and benefits		272			371
Other accrued liabilities		696			1,908
Deferred revenue		82			675

Net cash provided by operating activities		7,062			745

Investing activities:
Purchases of property and equipment		(1,073	)		(2,778	)
Restricted cash, net		119			(602	)
Acquisition of businesses, net of cash acquired		354			(4,508	)

Net cash used in investing activities		(600	)		(7,888	)

Financing activities:
Proceeds from issuance of common stock from option exercises		768			315
Proceeds from issuance of common stock from ESPP		23			22
Proceeds from issuance of common stock upon exercise of warrants		189			—
Net proceeds from issuance of common stock and warrants from private placement		5,312			2,596
Proceeds from notes payable		—			4,500
Principal payment of notes payable		(3,125	)		(708	)
Principal payment of financing arrangements		(301	)		(355	)
Principal payment of capital lease obligations		(95	)		(192	)

Net cash provided by financing activities		2,771			6,178

Net increase (decrease) in cash and cash equivalents		9,233			(965	)

Cash and cash equivalents at beginning of period		9,746			10,104

Cash and cash equivalents at end of period	$	18,979		$	9,139

Supplement disclosures of cash flow information:
Cash paid for income taxes	$	60		$	—

Cash paid for interest	$	203		$	143

Issuance of common stock in Business Acquisitions		913			518

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

RAINMAKER SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

— UNAUDITED —

1. BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements include the accounts of Rainmaker Systems, Inc. and its wholly-owned subsidiaries (“Rainmaker”, “we”, “our” or “the Company”). All intercompany balances and transactions have been eliminated in consolidation. The condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The interim financial statements are unaudited but reflect all normal recurring adjustments, which are, in the opinion of management, necessary for the fair presentation of the results of these periods.

The results of our operations for the three and nine months ended September 30, 2006 are not necessarily indicative of results to be expected for the year ending December 31, 2006, or any other period. These condensed consolidated financial statements should be read in conjunction with Rainmaker’s financial statements and notes thereto included in Rainmaker’s Annual Report on Form 10-K for the year ended December 31, 2005. Balance sheet information as of December 31, 2005 has been derived from the audited financial statements for the year then ended.

Certain amounts reported in the accompanying financial statements for 2005 have been reclassified to conform to the 2006 presentation. Such reclassifications had no effect on previously reported results of operations, total assets or accumulated deficit.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business

Rainmaker Systems, Inc. is a leading provider of business-to-business sales and marketing services. Through the use of proprietary technologies and enhanced data analytics, our solutions leverage integrated multi-channel communications to accelerate the sales process and achieve higher revenue for our clients. Our core services include complete lead qualification and management, new product sales, webcast event management, online sales of training classes, channel enablement, subscription renewals, and service contract sales.

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.

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 presentation policies, valuation of accounts receivable, allocation of purchase price in business combinations and assessing the recoverability and measuring any 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.

Allowance for Doubtful Accounts

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers and 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 September 30, 2006 and December 31, 2005, our allowance for potentially uncollectible accounts was $323,000 and $422,000, 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.

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 acquired in a business combination is 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. During the quarter end ending March 31, 2006, we performed the annual impairment test for the goodwill and indefinite lived intangible generated by the Sunset Direct acquisition in the first quarter of 2005 (see Note 4). The results of that test indicated that the fair value of the Sunset Direct goodwill and the indefinite lived intangible is greater than the carrying value, and accordingly, no impairment charge was recorded.

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, performance of lead generation services and subscriptions to deliver webcast event management and online sales of training classes. We recognize revenue from the sale of our client’s service contracts and maintenance renewals under the provisions of Staff Accounting Bulletin (“SAB”) 104 “Revenue Recognition” and on the “net basis” in accordance with EITF Issue No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent”. Revenue from the sale of service contracts and maintenance renewals is recognized when a purchase order from the client’s customer is received; the service contract or maintenance agreement is delivered; the fee is fixed or determinable; the collection of the receivable is reasonably assured; and no significant post-delivery obligations remain unfulfilled. Revenue from 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. Revenue from our internet subscriptions for webcast event management and online sales of training classes are recognized ratably over the life of each subscription. 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 September 30, 2006, we had gross deferred tax assets of approximately $18 million. Our deferred tax asset is subject to a 100% valuation allowance and therefore is not recorded on our balance sheet as an asset.

Stock-Based Compensation

The Company adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of the Company’s fiscal year 2006. The Company’s Consolidated Financial Statements as of and for the three and nine months ended September 30, 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, the Company’s Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R).

SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s Consolidated Statement of Operations. Prior to the adoption of SFAS 123(R), the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under Statement of Financial Accounting Standards No. 123,Accounting for Stock-Based Compensation (SFAS 123). Under the intrinsic value method, no stock-based compensation expense had been recognized in the Company’s Consolidated Statements of Operations, other than option grants to employees and directors below the fair market value of the underlying stock at the date of grant. See Note 7 for further discussion of the adoption of this standard and its effects on the financial statements presented herein.

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.

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. During the three and nine months ended September 30, 2006, two customers accounted for more than 10% of our revenue and collectively represented 51% and 49% of our net revenue for the three and nine months ended September 30, 2006, respectively. Our largest client represented 41% and 39% of our net revenue for the respective three and nine month periods. In the three and nine month periods ended September 30, 2005, these same two customers each accounted for more than 10% of our revenue and collectively represented 45% and 48% of our net revenue, 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 November 2009. Many of our client agreements contain automatic renewal clauses. These clients may, however, terminate their contracts for

cause in accordance with the provisions of each contract. In most cases, a client must provide us with advance written notice of its intention to terminate. Any loss of a single significant client may have a material adverse effect on the Company’s consolidated financial position, cash flows and results of operations.

Fair Value of Financial Instruments

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

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

Segment Reporting

We 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 customers in the United States.

Recently Issued Accounting Standards

In June 2006, the Financial Accounting Standards Board (FASB) issued Financial Interpretation 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with Financial Accounting Statement No. 109, “Accounting for Income Taxes.” The interpretation is effective for fiscal years beginning after December 15, 2006. We do not expect FIN 48 to have a material impact on our financial statements.

3. Net Income (Loss) Per Share

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

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


	Three Months Ended September 30,						Nine Months Ended September 30,
	2006			2005			2006			2005
Net income(loss)	$	869		$	(716	)	$	2,460		$	(4,694	)
Weighted-average common shares of common stock outstanding – basic		13,921			11,278			13,049			10,135
Plus: Outstanding dilutive options and warrants outstanding		2,202			—			2,178			—
Less: weighted-average shares subject to repurchase		(1,164	)		—			(1,376	)		—

Weighted-average shares used to compute diluted net loss per share		14,959			11,278			13,851			10,135

Basic net income (loss) per share	$	0.06		$	(0.06	)	$	0.19		$	(0.46	)

Diluted net income (loss) per share	$	0.06		$	(0.06	)	$	0.18		$	(0.46	)

The Company has excluded all outstanding warrants and stock options to purchase 1,693,578 shares of common stock from the calculation of diluted net loss per share for the three and nine month period ended September 30, 2005, because these securities are antidilutive.

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.

4. Acquisition of Assets and Business’

ViewCentral

On September 15, 2006, we closed an Asset Purchase Agreement with ViewCentral, Inc., a California corporation (“ViewCentral”), and Dan Tompkins as representative of certain shareholders of ViewCentral. The results of View Central’s operations have been included in the consolidated financial statements since that date. ViewCentral is a provider of enterprise training and marketing program management solutions, and is expected to enhance the Company’s revenue delivery platform with modules for marketing and training event management. Under the terms of the Purchase Agreement, Rainmaker issued 754,968 shares of common stock representing approximately 5.5% of Rainmaker’s 13,845,000 common shares outstanding as of August 31, 2006 and assumed certain liabilities of ViewCentral under its customer contracts, purchase orders and office lease in exchange for substantially all of ViewCentral’s assets. In connection with the acquisition, ViewCentral’s employees became employees of Rainmaker. In connection with their employment, Rainmaker awarded a total of 28,976 shares of restricted stock in the company that will be earned by each employee over one or two years of continued employment. See Note 7 for further discussion of the restricted stock awarded to the former VieweCentral employees. The estimated value of the 754,968 shares issued was $4.4 million computed at a share price of $5.88 which is the average closing price between September 15 and September 21, 2006.

Our acquisition of View Central has been accounted for as a business combination. Assets acquired and deferred revenue assumed from ViewCentral were recorded at their estimated fair values as of September 15, 2006. The total purchase price was $4.6 million as follows:


	(in thousands)
Issuance of 754,968 shares of Rainmaker Common Stock	$	4,439
Acquisition related transaction costs		210

Total purchase price	$	4,649

Using the purchase method of accounting, the total purchase price was allocated to ViewCentral’s net tangible and identifiable intangible assets based on their estimated fair values. The excess of the purchase price over the net tangible and identifiable intangible assets was recorded as goodwill, which will be amortized over 15 years for tax purposes. Using the estimated future discounted cash flows from the assets acquired, management performed a valuation and the total purchase price was allocated as follows:


	(in thousands)
Cash	$	634
Identified tangible assets		366
Developed technology		920
Customer relationships		2,190
Goodwill		2,879
Deferred revenue assumed(a)		(2,340	)

Total purchase price allocation	$	4,649

(a) In accordance with EITF 01-03, Accounting in a Business Combination of Deferred Revenue of an Acquiree, we have reduced the carrying value of the deferred revenue by 11.4%, which represents our best estimate of the reduction from carrying to fair value for the legal performance obligation assumed from View Central.

Amortization of the intangible assets is calculated using an accelerated method for customer relationships that is based on the estimated future cash flows for the relationship, and the straight-line method for the developed technology. The estimated useful life of the amortizable intangible assets acquired is five years for customer relationships and three years for the developed technology. For developed technology and customer relations, we estimated the cash flows associated with the excess earnings the technology and contacts would generate and allocated the present value of those earnings to the asset. We used a discount rate of 16%.

Rainmaker has agreed to use commercially reasonable efforts to file a registration statement with the Securities and Exchange Commission by November 14, 2006 for the shares issued in conjunction with the ViewCentral acquisition. Such shares are initially subject to a contractual prohibition of sale that will be removed as follows: 50% of such shares will be available for public sale commencing 181 days after the closing of September 15, 2006 and the remaining 50% of such shares will be available for public sale commencing 366 days from the closing. In addition, approximately 20% of the shares of the common stock consideration have been placed in escrow to secure certain indemnity obligations under the Purchase Agreement and will not be released until twelve months after the closing, subject to adjustment.

Business Telemetry Acquisition

On May 16, 2006, we announced that we had entered into and closed an Asset Purchase Agreement (the “Purchase Agreement”) with Business Telemetry, Inc. (d/b/a Metrics Corporation), a California corporation (“Metrics”), and Kenneth S. Forbes, III, as representative of the shareholders of Metrics. Pursuant to the Purchase Agreement, Rainmaker acquired certain of the assets of Metrics, including certain software and related intellectual property. Under the terms of the Purchase Agreement, Rainmaker issued 158,480 shares of common stock in exchange for the assets and incurred approximately $70,000 of acquisition related costs. Also, the shareholders of Metrics entered into non-compete agreements with Rainmaker and accepted employment positions with Rainmaker. The estimated value of the 158,480 shares of Rainmaker common stock was $898,000 computed at a per share price of $5.67, the average closing price for the period from May 12, 2006 through May 18, 2006.

Our acquisition of Metrics has been accounted for as a business combination. Assets acquired from Metrics were recorded at their estimated fair values as of May 12, 2006. The total purchase price was $968,000 as follows:


	(in thousands)
Issuance of 158,480 shares of Rainmaker Common Stock	$	898
Acquisition related transaction costs		70

Total purchase price	$	968

Using the purchase method of accounting, the total purchase price was allocated to Metric’s net tangible and identifiable intangible assets based on their estimated fair values. The excess of the purchase price over the net tangible and identifiable intangible assets was recorded as goodwill, which will be amortized over 15 years for tax purposes. Using the estimated future discounted cash flows from the assets acquired, management performed a valuation and the total purchase price was allocated as follows:


	(in thousands)
Developed technology and customer relationships	$	310
Goodwill		658

Total purchase price allocation	$	968

Amortization of the intangible assets is calculated using an accelerated method for customer relationships that is based on the estimated future cash flows for the relationship, and the straight-line method for the developed technology. The weighted-average useful life of the amortizable intangible assets acquired is approximately three years. For developed technology and customer relations, we estimated the cash flows associated with the excess earnings the technology and contacts would generate and allocated the present value of those earnings to the asset. We used a discount rate of 22%.

Rainmaker filed a registration statement with the Securities and Exchange Commission on June 23, 2006 that became effective July 28, 2006 with respect to the shares that were issued to Metrics. Such shares are initially subject to a contractual prohibition of sale that will be removed as follows: 39,620 of such shares became available for public sale commencing 91 days after the closing; an additional 39,620 of such shares will be available for public sale commencing 181 days from the closing; an additional 39,620 of such shares will be available for public sale commencing 281 days from the closing; and the remaining 39,620 of such shares will be available for public sale commencing 366 days from the closing. In addition, 31,696 shares of the common stock consideration have been placed in escrow to secure certain indemnity obligations under the Purchase Agreement and will not be released until twelve months after the closing, subject to adjustment.

Unaudited pro forma information presenting a summary of the results of operations of the Company assuming the acquisition of Metrics occurred at the beginning of each respective period has not been presented since the effect of the Metrics acquisition on the results of operations was deemed insignificant.

Sunset Direct Acquisition

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 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.

During the nine months ended September 30, 2006, the Company determined that due to certain marketing and branding initiatives, the “Sunset Direct” trade name was now estimated to have a 10 year life as opposed to an indefinite life as originally determined at the acquisition date. In accordance with SFAS 142 (Goodwill and Other Intangible Assets), a valuation to test for impairment was performed. No impairment was noted and the Sunset Direct trade name is being amortized over 10 years using an accelerated amortization method. During the three and nine months ended September 30, 2006, we recorded $54,000 and $107,000 in amortization related to the trade name, respectively.

On June 30, 2005, the Company filed a registration statement with the Securities and Exchange Commission with respect to the shares that 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 purchase of assets from ViewCentral and the acquisition of Sunset Direct occurred at the beginning of the three and nine month periods ended September 30, 2005 and 2006 and assumes the amortization of intangible assets, the effect to compensation expense for the restricted stock awards, the reduction of revenue to the estimated fair value of the legal performance obligation in accordance with the guidance of EITF 01-03, the addition of interest expense related to the Sunset Direct acquisition and the tax effect of the aforementioned adjustments (in thousands, except per share amounts):


	Three Months Ended September 30,					Nine Months Ended September 30,
	(Unaudited)
	2006		2005			2006		2005
Revenues	$	13,136	$	9,420		$	37,822	$	26,434
Net income (loss)	$	218	$	(1,262	)	$	1,918	$	(6,917	)
Pro forma – basic net income (loss) per share:	$	0.01	$	(0.10	)	$	0.14	$	(0.63	)
Pro forma – diluted net income (loss) per share:	$	0.01		N/A		$	0.13		N/A
Pro forma weighted average shares outstanding – basic:		14,676		12,033			13,804		11,032
Pro forma weighted average shares outstanding - diluted:		15,744		12,033			14,636		11,032

5. Property and Equipment


		September 30, 2006			December 31, 2005
Property and equipment:
	Estimated Useful Life
Computer equipment	3 years	$	6,448		$	5,934
Capitalized software and development (1)	2-5 years		12,114			8,830
Furniture and fixtures	5 years		320			511
Leasehold improvements	Lease term		172			103

			19,054			15,378
Accumulated depreciation and amortization			(14,899	)		(13,851	)
Construction in process (1)			—			2,883

Property and equipment, net		$	4,155		$	4,410

(1)

During late 2004 and throughout 2005, we developed a replacement for our existing system to identify potential service sales opportunities, track the sales contacts and process the sale of the service contracts. During the nine months ended September 30, 2006 we deployed and began depreciating the new order entry system. In total, we have invested $3.2 million in the new order entry system including $163,000 in capitalized interest costs. We placed this asset in service in March 2006 and are depreciating this asset on a straight line basis over an estimated life of 5 years.

6. Intangible Assets


		September 30, 2006			December 31, 2005
Intangible Assets:
	Estimated Useful Life
Developed technology	3-5 years	$	1,880		$	680
Customer relations	2-5 years		3,890			1,670
Database	5 years		1,100			1,100
Trade name	10 years (a)		1,100			1,100

			7,970			4,550
Accumulated amortization			(1,799	)		(898	)

Intangible assets, net		$	6,171		$	3,652

(a)	During the nine months ended September 30, 2006, the Company determined that due to certain marketing and branding initiatives, the “Sunset Direct” trade name was now estimated to have a 10 year life as opposed to an indefinite life as originally determined at the acquisition date.

The following is the current future amortization amounts that are scheduled for the remainder of 2006 and the future annual periods. The customer relations and trade name intangible assets are amortized on an accelerated method using sum of the year’s digits amortization. All other intangible assets are amortized on a straight-line basis. Future amortization is subject to continued estimates of the useful lives which are reviewed for impairment in accordance with Financial Accounting Standards Board (FASB) Statement No. 144,Accounting for Impairment or Disposal of Long-Lived Assets.


	Period Amortization
Remainder of 2006	$	573
Fiscal: 2007		2,065
2008		1,727
2009		1,115
2010		359
2011		151
Thereafter		181

Total future amortization	$	6,171

7. Stockholders’ Equity

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 were exercisable beginning August 7, 2006. Net proceeds from the issuance were $5.3 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 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 filed a registration statement on Form S-3 that became effective on March 21, 2006, with respect to the common stock issued under the Securities Purchase Agreements and the common stock issuable upon conversion of the related warrants.

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 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 600,000 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.

Stock-based compensation expense

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004),Share-Based Payment, (SFAS 123(R)) which establishes standards for the accounting of transactions in which an entity exchanges its equity instruments for goods or services, primarily focusing on accounting for transactions where an entity obtains employee services in share-based payment transactions. SFAS No. 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments, including stock options, based on the grant-date fair value of the award and to recognize it as compensation expense over the period the employee is required to provide service in exchange for the award, usually the vesting period. SFAS 123(R) supersedes the Company’s previous accounting under Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees (APB 25) for periods beginning in fiscal 2006. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (SAB 107) relating to SFAS 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS 123(R).

Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Stock-based compensation expense recognized in the Company’s Consolidated Statement of Operations for the three and nine months ended September 30, 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested as of December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 and compensation expense for the share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). As stock-based compensation expense recognized in the Consolidated Statement of Operations for the three and nine months ended September 30, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We included estimated forfeiture rates of 9.59% for option awards and 6.12% for restricted stock awards for the three and nine months ended September 30, 2006. As a result of the acceleration of vesting of 1,126,439 “out-of-the-money” options in December 2005, which was done in order to avoid compensation expense under the provisions of SFAS 123(R),there were a small number of unvested options remaining that were held by directors, officers and long term employees. The remaining options had relatively short vesting periods remaining with strike prices below the current market price for the stock. Therefore we expected all options to be exercised. We have applied the forfeiture estimates to option and restricted stock compensation awards issued in 2006. In the Company’s pro forma information required under SFAS 123 for the periods prior to fiscal 2006, the Company accounted for forfeitures as they occurred.

SFAS 123(R) requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options to be classified as financing cash flows. Due to the Company’s historical losses and significant NOLs, we did not record such tax benefits during the three and nine months ended September 30, 2006. Prior to the adoption of Statement SFAS 123(R) those benefits would have been reported as operating cash flows had the Company received any tax benefits related to stock option exercises.

The fair value of stock-based awards to employees is calculated using the Black-Scholes option pricing model, even though this model was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which differ significantly from the Company’s stock options. The Black-Scholes model also requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. The risk-free rate is based on the U.S Treasury rates in effect during the corresponding period of grant. The expected volatility is based on the historical volatility of our stock price. These factors could change in the future, which would affect the stock-based compensation expense in future periods.

During the three months ended September 30, 2006, the company issued a total of 28,976 shares of restricted stock awards to the employees who were hired by the company in conjunction with the ViewCentral acquisition. These awards are authorized by the 2003 Plan and therefore reduce the number of grants available under that plan. The restricted shares were valued at the market close price for Rainmaker’s stock on the date of the award. The restricted shares vest over one or two year terms according to each individual employees’ agreement with the company. Accordingly, we will record compensation expense for the full value less forfeiture of these restricted shares over the respective vesting periods. Until each restricted stock award becomes vested, it will not be considered part of the total shares outstanding for our common stock.

Valuation and Expense Information under SFAS 123(R)

The weighted-average fair value of stock-based compensation to employees is based on the single option valuation approach. Estimated forfeiture rates are applied separately to option and restricted stock awards and it is assumed no dividends will be declared. The estimated fair value of stock-based compensation awards to employees is amortized using the straight-line method over the vesting period of the options. We calculate the estimated compensation expense separately for Employee Stock Options (“Options”) and Employee Stock Purchase Plan (“Purchase Plan”).

We expense stock-based compensation to the same operating expense categories that the respective award grantee’s salary expense is reported. The table below reflects stock based compensation expense under SFAS 123(R) for the Options and Purchase Plan for the three and nine months ended September 30, 2006 as follows (in thousands):


	Three Months Ended Sept. 30, 2006						Nine Months Ended Sept. 30, 2006
	Options & Restricted Stock		Purchase Plan		Total		Options & Restricted Stock		Purchase Plan		Total
Stock based compensation expense included :
Cost of services	$	3	$	—	$	3	$	5	$	2	$	7
Sales and marketing		11		—		11		19		—		19
Technology		2		—		2		4		1		5
General and administrative		5		—		5		18		3		21

	$	21	$	—	$	21	$	46	$	6	$	52

At September 30, 2006, approximately $30,000 of stock-based compensation related to unvested awards had not been amortized and will be expensed during the remainder of fiscal 2006 and $407,000 of stock based compensation relating to unvested awards will be expensed in future periods through 2010.

The table below reflects net income and basic and diluted net income per share for the three and nine months ended September 30, 2006 compared with the pro forma information for the three and nine months ended September 30, 2005 as follows (in thousands except per-share amounts):


	Actual Results under SFAS 123R for the Three Months Ended Sept. 30, 2006			Pro Forma Results under SFAS 123R for the Three Months Ended Sept. 30, 2005			Actual Results under SFAS 123R for the Nine Months Ended Sept. 30, 2006			Pro Forma Results under SFAS 123R for the Nine Months Ended Sept. 30, 2005
Net loss as reported for the comparative period⁽¹⁾		N/A		$	(716	)		N/A		$	(4,694	)
Stock-based employee compensation expense⁽²⁾		(21	)		(252	)		(52	)		(734	)

Net income (loss) including effect of stock based compensation⁽³⁾	$	869		$	(968	)	$	2,460		$	(5,428	)

Basic and diluted loss reported for the comparative period⁽³⁾		N/A		$	(0.06	)		N/A		$	(0.46	)

Basic net income (loss) including effect of stock based compensation⁽³⁾	$	0.06		$	(0.09	)	$	0.19		$	(0.54	)

Diluted net income (loss) including effect of stock based compensation⁽³⁾	$	0.06		$	(0.09	)	$	0.18		$	(0.54	)

⁽¹⁾	Net loss and net loss per share prior to fiscal 2006 did not include stock-based compensation expense for employee stock options under SFAS 123 because the Company did not adopt the recognition provisions of SFAS 123.

⁽²⁾	Stock-based compensation expense prior to fiscal 2006 is calculated based on the pro forma application of SFAS 123.

⁽³⁾	Net income and net income per share prior to fiscal 2006 represents pro forma information based on SFAS 123.

No options were issued during the three months ended September 30, 2006. During the three months ended September 30, 2005, the fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model

based on an estimated life of 4 years, a volatility range between 1.4 and 1.8, risk free interest rate between 3.1% and 4% and no dividend assumption.

Expected life is estimated using the simplified method under Staff Accounting Bulletin 107, which takes into account vesting and contractual term. Expected stock price volatility is based on the historical volatility from traded shares of our stock over the expected term. The risk-free interest rate is based on the rate of a zero-coupon U.S. Treasury instrument with a remaining term approximately equal to the expected term. We do not expect to pay dividends in the near term and therefore do not incorporate the dividend yield as part of our assumptions.

A summary of activity under our Stock Incentive Plans for the nine months ended September 30, 2006 is as follows:


	Options Outstanding
	Available for Grant		Number of Shares		Weighted Average Exercise Price
Balance at December 31, 2005	712,629		1,831,411		$	4.75
Authorized	452,277		—		$	—
Granted	(114,476	)	114,476		$	4.57
Restricted Stock Awards	—		(28,976	)	$	5.96
Exercised	—		(308,349	)	$	2.46
Canceled	113,040		(113,040	)	$	8.45

Balance at September 30, 2006	1,163,470		1,495,522		$	3.41

The following table summarizes information about stock options outstanding as of September 30, 2006:


	Outstanding Options			Options Exercisable
Range of Exercise Prices	Number of Shares	Weighted Average Contractual Life (In Years)	Weighted Average Exercise Price	Number of Shares	Weighted Average Exercise Price
$1.10 -$1.35	134,859	4.04	$1.14	134,854	$1.14
$1.36 - $2.29	99,656	4.69	$2.06	95,418	$2.06
$2.30 - $2.55	401,853	8.56	$2.51	401,848	$2.51
$2.56 - $2.80	421,490	8.48	$2.62	421,490	$2.63
$2.81 - $3.90	120,400	8.44	$3.09	120,399	$3.09
$3.91 - $7.70	128,390	7.28	$5.63	42,888	$5.63
$7.71 - $13.28	180,794	6.75	$10.23	180,793	$10.23
$13.29 - $20.32	8,080	6.08	$17.17	8,080	$17.17

$1.10 - $20.32	1,495,522	7.47	$3.41	1,405,770	$4.00

Employee Stock Purchase Plan

In 1999, our board of directors adopted and our shareholders approved the 1999 Employee Stock Purchase Plan (the “Purchase Plan”) and further amended the Purchase Plan on December 15, 2005 with regard to the discount price. 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 95% of the fair value of the common stock at the purchase date. 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 80,000 shares. Prior to the amendment on December 15, 2005, the Purchase Plan provided for the issuance of common stock at a

purchase price of 85% of the fair value of the common stock at the beginning or end of the offering period, whichever was lower. As of September 30, 2006, a total of 145,892 shares had been issued under the Purchase Plan and 525,385 shares were available for future issuance.

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

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Form 10-Q contains forward-looking statements in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may”, “will”, “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of such terms or other comparable terminology. These statements are only predictions and involve known and unknown risks, uncertainties and other factors, including the risks outlined under “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 integrate acquisitions and expand our call center without disruption to our business, our ability to execute our business strategy, the effectiveness of our sales team and approach, our ability to target, analyze and forecast the revenue to be derived from a client and the costs associated with providing services to that client, the date during the course of a calendar year that a new client is acquired, the length of the integration cycle for new clients and the timing of revenues and costs associated therewith, our client concentration given that the Company is currently dependent on a few large client relationships, potential competition in the marketplace, the ability to retain and attract employees, market acceptance of our service programs and pricing options, our ability to maintain our existing technology platform and to deploy new technology, our ability to sign new clients and control expenses, the possibility of the discontinuation of some client relationships, the financial condition of our clients’ business, our ability to raise additional equity or debt financing and other factors detailed in Part II Item 1A – “Risk Factors” of this Form 10-Q.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of such statements. We assume no obligation to update such forward-looking statements publicly for any reason even if new information becomes available in the future.

Overview

We 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, subscription and service contract sales webcast event management and online sales of training classes. 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

To date, the majority of our revenues have been derived from marketing and selling our client’s service contracts and lead generation activities. Because of this, our quarterly and annual revenues are subject to fluctuation based on the total service contracts available for renewal or conversion in that period. As a result of this as well as general economic conditions in the United States, our net revenue has fluctuated in the past and may do so again. If the economic conditions in the United States worsen or if a wider or global economic slowdown occurs, we may experience a material adverse impact on our business, operating results, and financial condition. During unfavorable economic periods, it may be more difficult to sign

new clients or expand relationships with existing clients. In addition, during unfavorable economic periods, spending on existing and new technology may decrease, resulting in downgrades of service contracts or fewer new service contracts, which may have a material adverse impact on our business. This impact may be offset as technology companies may compensate for decreased spending on new technology and technology upgrades with expanded service contracts on their existing technology.

Our quarterly and annual operating results may continue to fluctuate in the future based on a number of factors, many of which are beyond our control. We believe that period-to-period comparisons of operating results should not be relied upon as predictive of future performance. Our operating results are expected to vary significantly from quarter to quarter and are difficult to predict. Our historical revenue has tended to fluctuate based on seasonal buying patterns of our clients and their customers. Our prospects must be considered in light of the risks, expenses and difficulties encountered by technology companies, particularly given that we operate in new and rapidly evolving markets, and face an uncertain economic environment. We may not be successful in addressing such risks and difficulties. See Part II Item 1A – “Risk Factors” of this Form 10-Q.

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 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.

On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004),Share-Based Payment, (SFAS 123(R)) which, among other things, requires us to amortize as expense the estimated intrinsic value of our employee share-based compensation. As disclosed in Note 6 in the Condensed Consolidated Financial Statements in Part I Item 1 of this Form 10-Q, we incurred $21,000 and $52,000 of share-based compensation during the three and nine months ended September 30, 2006, respectively.

Other than the adoption of SFAS 123 (R), management believes there have been no significant changes during the three months ended September 30, 2006 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 for the fiscal year ended December 31, 2005.

Related Party Transactions

We have made purchases of computer equipment and services from several vendors including Dell, our largest client. During the three and nine months ended September 30, 2006, we purchased equipment from Dell totaling $112,000 and $308,000, respectively.

During 2004, we purchased certain of our computer equipment and software from Dell through arrangements accounted for as capital leases. The single remaining lease bears interest at 4.9% per annum and expires in February 2007.

As of September 30, 2006, property and equipment included amounts held under capital leases with Dell of approximately $24,000 and related accumulated depreciation of approximately $18,000. Principal and interest owed to Dell amounted to approximately $4,000 at September 30, 2006. These capital lease obligations are collateralized by the related

leased property and equipment. Additionally, we are leasing computers from HP, another significant client, on a month to month basis. These capital lease obligations are collateralized by the related leased property and equipment.

Results of Operations

The following table sets forth for the periods given selected financial data as a percentage of our revenue. The table and discussion below should be read in connection with the financial statements and the notes thereto which appear elsewhere in this report as well as with our financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2005.


	Three Months Ended September 30,				Nine Months Ended September 30,
	2006		2005		2006		2005
Net revenue	100.0	%	100.0	%	100.0	%	100.0	%
Operating expenses:
Costs of services	51.0	%	57.3	%	50.1	%	60.1	%
Sales and marketing	8.5	%	8.6	%	7.7	%	8.5	%
Technology	12.2	%	12.0	%	11.9	%	13.2	%
General and administrative	14.3	%	19.7	%	16.2	%	27.2	%
Depreciation and amortization	6.5	%	9.8	%	6.6	%	10.8	%

Total operating expenses	92.4	%	107.6	%	92.5	%	119.8	%

Operating income (loss)	7.6	%	(7.6	)%	7.5	%	(19.8	)%
Interest and other (expense) income, net	0.5	%	(0.6	)%	0.2	%	(0.6	)%
Provision for income taxes	0.9	%	0.0	%	0.5	%	0.0	%

Net income (loss)	7.1	%	(8.3	)%	7.1	%	(20.4	)%

Comparison of three months ended September 30, 2006 and 2005

Net Revenue. Net revenue increased 42% to $12.2 million for the three months ended September 30, 2006 from $8.6 million for the comparable period in 2005. The $3.6 million overall increase in revenue is attributable to $2.6 million growth of revenues contributed by our services sales activities and a $771,000 increase in reported revenue from lead generation activities. In addition, we recognized revenue of $182,000 from ViewCentral which was acquired on September 15, 2006. The revenue growth from service sales activities is mainly within our existing client base as we were able expand our presence with our clients as well as execute on our sales and marketing strategies. The increase in revenue from our lead generation activities is the result of expansion within our existing customer base and the addition of new customers.

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

Costs of services. Costs of services increased 27% to $6.2 million for the three months ended September 30, 2006 from $4.9 million for the three months ended September 30, 2005. Costs of services decreased as a percentage of revenue from 57.3% in the three months ended September 30, 2005 to 50.0% for the three months ended September 30, 2006. The total increase of $1.3 million between the comparative three month periods was due to higher salary and commission costs as well as periodic temporary staffing increases in relation to our increased revenue levels. Additionally, with our lead generation service offering, we are offering expanded marketing services to our clients and thus incurring additional costs of services. Our reduction of cost of services as a percentage of revenue reflects our improved gross margin partly due to our transition to our Austin, Texas call center in early 2005, which was completed by June 30, 2005. The Austin operation provides us with a lower cost environment where, over the past year, we have been able to improve productivity per sales rep. Costs of services in absolute dollars and as a percentage of revenue have both fixed and variable components. These costs are expected to continue to fluctuate based on our client mix and our revenue levels.

Sales and Marketing Expenses. Sales and marketing expenses increased 40% to $1.0 million for the three months ended September 30, 2006 from $741,000 for the three months ended September 30, 2005. Over the past year we have added additional sales professionals who are dedicated to growing our business. Our sales staff has been successful in creating new sales opportunities and therefore we have incurred additional commission expense in relation to increased revenue levels. Additionally, we incurred additional costs as we expand our corporate marketing including the further development of our web site.

Technology Expenses. Technology expenses increased 44% to $1.5 million for the three months ended September 30, 2006 from $1.0 million for the three months ended September 30, 2005. The increase is primarily attributable to the capitalization of internal development costs for our new order entry system during the comparable period ended September 30, 2005. The order entry system was deployed during the first quarter of 2006. During the three months ended September 30, 2006, we incurred additional employment costs due to increased headcount. The increased technology expense level also reflects additional hosting and support costs related to our new order entry system of approximately $100,000 per quarter.

General and Administrative Expenses. General and administrative expenses increased $46,000 to $1.7 million between the two comparative three month periods ended September 30. The three months ended September 30, 2005 included consulting and temporary personnel costs related to transitioning certain accounting functions to our Austin, Texas office. The elimination of these costs and the lower cost environment in Austin reduced the cost of our overall financial operations. These cost reductions were offset during the three months ended September 30, 2006 by higher professional fees as we incurred one time additional costs related to our audit and tax services.

Depreciation and Amortization Expenses. Depreciation and amortization expenses decreased 6% to $797,000 for the three months ended September 30, 2006, from $850,000 for the comparable period in 2005. The overall decrease in depreciation and amortization expense is primarily the result of assets becoming fully depreciated over the past year. These include our legacy order entry system and the leasehold improvements on our former headquarters in Scotts Valley. Additionally, several of the intangible assets that are related to our various acquisitions are being amortized on an accelerated basis. As a result, the amortization of these assets is approximately $24,000 less each quarter.

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


	Quarter Ended September 30,						Increase (Decrease)
	2006			2005			$ Amt			%
Interest income	$	122		$	29		$	93		320.6	%
Interest expense		(56	)		(90	)		(34	)	37.7	%
Other		(10	)		1			(11	)	111.0	%

	$	56		$	(60	)	$	117		195.0	%

The increase in interest income is attributable to an increase in cash available to invest as we generate cash from operations as well as the proceeds of our private equity placement that raised $5.3 million, net of expenses, that was completed on February 7, 2006. As explained further in “Liquidity and Sources of Capital”, our cash balances will fluctuate throughout each quarter due to our terms for payment to our clients for the service contracts that we sell.

Over the past year our borrowings have included the $3.0 million Term Loan obtained in February 2005 in connection with the acquisition of Sunset Direct and the $1.5 million June 2005 Term Loan to fund the purchase and implementation of our new client management system. These loans have been reduced by contractual principal reductions scheduled over three years from the date of inception of each loan. The decrease in interest expense is due to the reduction in principal outstanding.

During the 2006 comparative period, we recorded a loss on the disposition of assets which was reflected as other expense.

Comparison of nine months ended September 30, 2006 and 2005

Net Revenue. Net revenue increased 50% to $34.6 million for the nine months ended September 30, 2006 from $23.1 million for the comparable period in 2005. The $11.5 million overall increase in revenue is attributable to $7.1 million

growth of revenues contributed by our services sales activities, a $4.2 million increase in reported revenue from lead generation activities and $0.2 million in revenue from our ViewCentral acquisition that was completed on September 15, 2006. The revenue growth from service sales activities is mainly within our existing client base as we were able expand our presence with our clients as well as execute on our sales and marketing strategies. The increase in revenue from our lead generation activities is the result of expansion within our existing customer and the addition of new customers.

Costs of services. Costs of services increased 25% to $17.3 million for the nine months ended September 30, 2006 from $13.9 million for the nine months ended September 30, 2005. Costs of services decreased as a percentage of revenue from 60.1% in the nine months ended September 30, 2005 to 50.1% for the nine months ended September 30, 2006. In the year between the comparative periods, we have increased overall staff of out bound telesales professionals to support our higher revenue levels. The nine month period ended September 30, 2005 does not include the cost of services of our lead generation services for the period from January 1, 2005 until we completed the acquisition of Sunset Direct on February 8, 2005 and therefore the 2006 period included almost 6 weeks in additional comparative costs. Our reduction of cost of services as a percentage of revenue reflects our improved gross margin. In June 2005, we completed the transition to our Austin, Texas facility. The Austin call center provides us with a lower cost environment where, over the past year, we have been able to improve productivity per sales rep. Costs of services in absolute dollars and as a percentage of revenue have both fixed and variable components. These costs are expected to continue to fluctuate based on our client mix and our revenue levels.

Sales and Marketing Expenses. Sales and marketing expenses increased 36% to $2.7 million for the nine months ended September 30, 2006 from $2.0 million for the nine months ended September 30, 2005. Over the past year we have added additional sales professionals who are dedicated to growing our business. Our sales staff has been successful in creating new sales opportunities and therefore we have incurred additional commission expense.

Technology Expenses. Technology expenses increased 35% to $4.1 million for the nine months ended September 30, 2006 from $3.0 million for the nine months ended September 30, 2005. The increase in technology expense is primarily due to the capitalization of internal software development costs that occurred in the nine months ended September 30, 2005, while similar cost were only capitalized in the first quarter of 2006. Also, we incurred $61,000 of severance costs during the quarter ended June 30, 2006 and have increased our technology staff over the nine months ended September 30, 2006 as well as added consultants as we continue to develop our service delivery systems.

General and Administrative Expenses. General and administrative expenses decreased 11% to $5.6 million for the nine months ended September 30, 2006, as compared to $6.3 million for the comparable period in 2005. The nine month period ended September 30, 2005 included $493,000 of severance costs that were not incurred in the nine months ended September 30, 2006. Over the past year, we have realized certain cost savings through the elimination of administrative redundancies.

Depreciation and Amortization Expenses. Depreciation and amortization expenses decreased 8% to $2.3 million for the nine months ended September 30, 2006, from $2.5 million for the comparable period in 2005. The overall decrease in depreciation and amortization expense is the result of assets becoming fully depreciated over the past year. These include our legacy order entry system and the leasehold improvements on our former headquarters in Scotts Valley. In March of 2006, we placed in service our new order entry system and began depreciation of this $3.2 million asset over its estimated useful life of five years on a straight line basis.

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


	Nine Months Ended Sept. 30,						Increase (Decrease)
	2006			2005			$ Amt			%
Interest income	$	198		$	93		$	105		112.9	%
Interest expense		(134	)		(191	)		(57	)	(29.8	)%
Other		(10	)		(35	)		(25	)	(71.4	)%

	$	54		$	(133	)	$	187		140.6	%

The increase in interest income is attributable to an increase in cash available to invest as we generate cash from operations as well as the proceeds of our private equity placement that raised $5.3 million, net of expenses, that was completed on February 7, 2006. As explained further in “Liquidity and Sources of Capital” our cash balances will fluctuate throughout each quarter due to our terms for payment to our clients for the service contracts that we sell.

The decrease in interest expense is the result of the capitalization of interest cost. During the development of our client management system and while we capitalize internal costs, we are required to capitalize interest on the costs of assets under development. Accordingly, $63,000 in interest costs were capitalized to our client management system during the quarter ended March 31, 2006. Over the past year our borrowings have included the $3.0 million Term Loan obtained in February 2005 in connection with the acquisition of Sunset Direct and the $1.5 million June 2005 Term Loan to fund the purchase and implementation of our new client management system. Excluding the reduction of interest expense for capitalized costs, our interest cost is higher because the term loans were outstanding the entire nine month period ended September 30, 2006 as compared to the nine month period ended September 30, 2005, during which the Term Loan and June 2005 Term Loan were funded in March 2005 and June 2005, respectively.

During the both comparative periods, we recorded losses on the disposition of assets which were reflected as other expense.

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. During the nine months ended September 30, 2006, we achieved GAAP profitability and generated cash from operations in the amount of $7.1 million. On February 7, 2006, we raised $5.3 million, net of 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 was 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.

Cash and cash equivalents were $19.0 million at September 30, 2006 as compared to $9.7 million at December 31, 2005. We had negative working capital of $3.8 million at December 31, 2005. As a result of the net $5.3 million raised in a private placement of our common stock in February 2006 and positive operating results, the negative working capital at December 31, 2005 has been fully funded and we now have positive working capital of $3.5 million at September 30, 2006. Our cash balances fluctuate throughout each quarter due to our terms for payment to our clients for the service contracts that we sell.

Operating activities for the nine months ended September 30, 2006 provided cash of $7.1 million as compared to cash provided by operating activities of $745,000 in the comparable period in 2005. Cash provided by operating activities during the nine months ended September 30, 2006 is primarily the result of net income totaling $2.4 million and non-cash expenditures of depreciation and amortization of property and intangibles, stock-based compensation and the provision for allowance for doubtful accounts that totaled $2.6 million. Together, net income and non-cash expenditures contributed $5.0 million to cash from operating activities.

During the nine months ended September 30, 2006, we achieved profitability and generated cash from operations in the amount of $7.1 million. While we have not been profitable in the past, our ability to generate a profit in the nine months ended September 30, 2006 was the result of investments in technology, sales and marketing and personnel that in turn resulted in the successful execution of our business strategy. While we are hopeful that we can continue to be profitable and generate cash from operations in the future, there can be no assurances that we will continue to do so. We expect to continue to invest in technology and marketing strategies as well as additional acquisitions of businesses. Accordingly, in order to fully execute these long-term business strategies, we may continue to raise cash proceeds from the sale of stock and the incurrence of debt.

Accounts receivable increased at September 30, 2006 as compared to December 31, 2005 as a result of higher sales in the third quarter of 2006 as compared to the fourth quarter of 2005. We have consistently experienced higher net revenues during the three and nine month periods ended September 30, 2006 as compared to the prior periods in 2005, and therefore, our account receivable balances have been higher. Our days sales outstanding (DSO), improved to 24 days at September 30, 2006 from 28 days at December 31, 2005. Our accounting treatment for net revenue (see “Revenue Recognition and Presentation” under Note 2 to the Condensed Consolidated Financial Statements) 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 receivable reported for the nine months ended September 30, 2005 reflects the increase in receivables from our Sunset Direct subsidiary which was acquired on February 8, 2005.

Accounts payable is comprised mostly of amounts due to our clients for service and maintenance contracts we sold on their behalf. Accounts payable increased in relation to increased sales of service contracts. Our accounts payable has increased at a faster rate than the increase in accounts receivable because we have been able to improve our collection efforts as well as receive credit card payment for a higher percentage of our net revenues. Our payments to our clients for the service contracts we have sold are made monthly upon the completion of an activity reconciliation with each client. The increase in accrued compensation and benefits at September 30, 2006 as compared to December 31, 2005 is due to higher accruals for commissions and bonuses as result of higher sales volumes and positive operating results. Deferred revenue increased as a result of the increase in our lead generation service offerings which are invoiced and often paid in advance of the work to be performed. The increase in other accrued liabilities is attributable, in part, to increased sales tax liability due to increased sales volumes and current tax liability for income and franchise tax.

Cash used in investing activities was $0.6 million and $7.9 million for the nine months ended September 30, 2006 and 2005, respectively. The decrease in cash used in investing activities was primarily due to our investment in Sunset Direct that totaled $4.4 million and was reported in the comparative period last year. In March 2006, we completed the development of our new order entry system. That development was ongoing throughout the prior period ended September 30, 2005 and therefore the investment in property and equipment was higher in the 2005 period as compared to the nine months ended September 30, 2006. Restricted cash represents the reserve for the refund due 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. The decrease in restricted cash represents the reduction of our balance of refunds due to customers. During the nine months ended September 30, 2006, we completed two business acquisitions. While both acquisitions were predominately effected by Rainmaker issuing its common stock, in the Metrics transaction, we incurred $70,000 of acquisition costs, and with the ViewCentral transaction, we received cash of $424,000 net of acquisition costs.

Cash provided by financing activities was $2.8 million for the nine months ended September 30, 2006 as compared to cash provided by financing activities of $6.2 million for the comparative period in 2005. Cash provided by financing activities in 2006 was primarily a result of net proceeds totaling $5.3 million from our placement of private equity which was completed on February 7, 2006. This amount was offset by principal payments totaling $3.5 million on our line of credit, term loans and other financing obligations. Also during the 2006 period, we received $980,000 from the exercise of stock options, warrants and employee stock purchase plans. Cash provided by financing activities in the 2005 comparative period was primarily the result of term loan proceeds of $4.5 million and net proceeds totaling $2.6 million from a private placement of equity completed in June 2005. These amounts were partially offset by the repayment of capital lease and other financing arrangements.

Our principal source of liquidity as of September 30, 2006 consisted of $19.0 million of cash and cash equivalents and $3.0 million remaining on our Revolving Credit Facility. In connection with a financial covenant related to our term loans, we are required to maintain unrestricted cash deposits of $2.5 million with our lender Bridge Bank, N.A., which is included in the $15.0 million of cash and cash equivalents. We anticipate that our existing capital resources and cash flow expected to be generated from future operations will enable us to maintain our current level of operations, our planned operations and our planned capital expenditures for at least the next twelve months.

On July 6, 2006, we executed a further amendment to our secured revolving line of credit (the “Revolving Credit Facility”) with our lender, Bridge Bank. The amendment extends the maturity date of the Revolving Credit Facility from December 10, 2006 to October 10, 2007. The amount of credit available to the company remains at $4,000,000 with a $1,000,000 subfacility for standby letters of credit, and the interest rate for any advances under the Revolving Credit Facility remains at the prime lending rate, currently at 8.25%. As of September 30, 2006, the company had no borrowings under the Revolving Credit Facility and had two undrawn letters of credit outstanding under the Revolving Credit Facility and together combine for a face amount of $425,000. We had originally entered into this Revolving Credit Facility with our lender in April 2004.

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 an Irrevocable Standby Letter of Credit to one of our clients. The letter of credit was issued in the amount of $325,000 as a guarantee for service contracts sold by us on behalf of our client and will expire in September 2007. The letters of credit were issued under

the Revolving Credit Facility described above. As of September 30, 2006, no amounts have been drawn against the letters of credit.

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 per annum (8.25% per annum at September 30, 2006). The interest rate on the June 2005 Term Loan was reduced from prime plus 1% to prime by the amendment that we executed with our lender on July 6, 2006.

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 per annum (8.25% per annum at September 30, 2006). The interest rate on the Term Loan was reduced from prime plus 1% to prime by the amendment that we executed with our lender on July 6, 2006.

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 maintenance of unrestricted cash of $2.5 million with Bridge Bank, reducing from time to time to the outstanding amount of Rainmaker’s Term Loan and June 2005 Term Loan referenced above rounded upwards to the nearest $250,000 increment. Prior to the July 6, 2006 amendment, we were required to maintain minimum unrestricted cash of $3.0 million. Beginning July 1, 2006, we are now also required to maintain a specified minimum net income and minimum debt service coverage ratio. 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. At September 30, 2006, we were in compliance with all loan covenants and had $1.4 million and $875,000 outstanding on the Term Loan and June 2005 Term Loan, respectively, and no amount outstanding on the Revolving Credit Facility.

Off-Balance Sheet Arrangements

Leases

As of September 30, 2006, 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.

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 $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. On March 27, 2006, Sunset Direct entered into an amendment with its landlord in Austin, Texas. The Amendment, among other things, expands Sunset Direct’s premises by an additional 7,623 rentable square feet effective as of March 31, 2006. As a result, the annual base rent in Austin, Texas will be on average an additional $61,000 per year

through the remainder of the lease term ending in July 2009. 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

From time to time, we enter into certain types of contracts that contingently require us to indemnify parties against third party claims. These obligations primarily relate to certain agreements with our officers, directors and employees, under which we may be required to indemnify such persons for liabilities arising out of their employment relationship. The terms of such obligations vary. Generally, a maximum obligation is not explicitly stated. Because the obligated amounts of these types of agreements often are not explicitly stated, the overall maximum amount of the obligations cannot be reasonably estimated. Historically, we have not had to make any payments for these obligations, and no liabilities have been recorded for these obligations on our balance sheets as of September 30, 2006 and December 31, 2005.

Contractual Obligations

Capital Leases

We lease certain property under capital leases that expire at various dates through 2006. The effective annual imputed interest rate on our single remaining capital lease obligation is 4.9%. The capital lease obligation is collateralized by the related leased property and equipment.

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 per annum (8.25% per annum at September 30, 2006). As of September 30, 2006, the Company had $875,000 outstanding on the June 2005 Term Loan. The interest rate on the June 2005 Term Loan was reduced from prime plus 1% to prime by the amendment that we executed with our lender on July 6, 2006.

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 per annum (8.25% per annum at September 30, 2006). As of September 30, 2006, the Company had $1.4 million outstanding on the Term Loan. The interest rate on the Term Loan was reduced from prime plus 1% to prime by the amendment that we executed with our lender on July 6, 2006.

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. In July 2006, the maturity date of the Revolving Credit Facility was further extended to October 2007. As of September 30, 2006, we had no amounts outstanding under the Revolving Credit Facility.

Future payments under our contracts and obligations at September 30, 2006 are as follows:


(In thousands)	Capital Leases		Term Loan (1)		June 2005 Term Loan (1)		Operating Leases		Total
2006	$	4	$	250	$	125	$	173	$	552
2007		—		1,000		500		705		2,205
2008		—		167		250		675		1,092
2009		—						229		229

Total minimum payments		4		1,417		875		1,955		4,078

(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 July 2009.

ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to changes in interest rates on our variable rate borrowings. Interest rates on our capital lease and financing obligations are fixed, but rates on borrowings under our Term Loan, June 2005 Term Loan and Revolving Credit Facility are variable. In February 2005, the Company entered into a Business Loan Agreement and Commercial Security Agreement pursuant to which the Company obtained a $3.0 million Term Loan that is to be repaid in 36 monthly installments of $83,000 plus interest at a variable rate of prime per annum (8.25% per annum at September 30, 2006). As of September 30, 2006, the Company had $1.4 million outstanding on the Term Loan. In June 2005, the Company entered into a Business Loan Agreement pursuant to which the Company obtained a $1.5 million term loan (the “June 2005 Term Loan”). The June 2005 Term Loan is to be repaid in 36 monthly installments of $42,000 plus interest at a variable rate of prime per annum (8.25% per annum at September 30, 2006). As of September 30, 2006, the Company had $875,000 outstanding on the June 2005 Term Loan.

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 (the prime rate was 8.25% at September 30, 2006). Maturity dates on these loans range from October 2007 to May 2008. At December 31, 2005, we had $3.0 million of debt outstanding under these loans. Based on the funding dates for these loans and payments already made during 2006, we estimate that a 1% increase in interest rates would result in $30,000 in additional interest expense for the year ended December 31, 2006. Due to our debt level at September 30, 2006, 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 September 30, 2006. We do not use derivative financial instruments in our operations.

ITEM 4. CONTROLS AND PROCEDURES

(a)	Disclosure Controls and Procedures

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

(b)	Change in Internal Control over Financial Reporting

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

PART II. – OTHER INFORMATION

ITEM 1. LEGAL PPOCEEDINGS

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 1A. RISK FACTORS

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

Although we reported net income for the three and nine month period ended September 30, 2006, 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 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.

No individual client’s end-user customer accounted for 10% or more of our revenues in any period presented.

We expect that a small number of clients will continue to account for a significant portion of our revenue for the foreseeable future. The loss of any of our principal clients could cause a significant decrease in our revenue. In addition, our software and technology clients operate in industries that experience consolidation from time to time, which could reduce the number of our existing and potential clients. Any loss of a single significant client may have a material adverse effect on our financial position, cash flows and results of operations. Our contracts generally allow our clients to cancel the agreement with 90 to 180 days notice.

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, a significant percentage 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.

Failure by us to achieve and maintain effective internal control over financial reporting in accordance with the rules of the SEC could harm our business and operating results and/or result in a loss of investor confidence in our financial reports, which could in turn have a material adverse effect on our business and stock price.

Under current rules of the SEC, we will be required to document and test our internal control over financial reporting so that our management can certify as to the effectiveness of our internal control over financial reporting and our independent

registered public accounting firm can render an opinion on management’s assessment. We are in the process of documenting our internal controls systems to allow management to evaluate and report on, and our independent auditors to audit, our internal controls over financial reporting. Once the documentation is complete, we will be performing the system and process evaluation and testing (and any necessary remediation) required to comply with the management certification and auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002. Based on current SEC rules, we will be required to comply with the management report on internal controls over financial reporting as of December 31, 2007. Since our market capitalization, excluding the holdings of officers, directors and other affiliates, was below $75 million on June 30, 2006, we will be required under currently proposed rules to be compliant with the auditor attestation provisions of Section 404 of the Sarbanes Oxley Act of 2002 by December 31, 2008. However, if our market capitalization, as defined, increases to above $75 million on June 30, 2007, we will be required to be compliant with the auditor attestation provisions of Section 404 of the Sarbanes Oxley Act of 2002 by December 31, 2007. We cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or the impact of the same on our operations. Furthermore, upon completion of this process, we may identify control deficiencies of varying degrees of severity under applicable SEC and Public Company Accounting Oversight Board rules and regulations that remain unremediated. We are required to report, among other things, control deficiencies that constitute a “material weakness” or changes in internal controls that, or that are reasonably likely to, materially affect internal controls over financial reporting. A “material weakness” is a significant deficiency or combination of significant deficiencies that results in more than a remote likelihood that a material misstatement of the annual or interim consolidated financial statements will not be prevented or detected. If we fail to implement the requirements of Section 404 in a timely manner, we might be subject to sanctions or investigation by regulatory authorities such as the SEC. In addition, failure to comply with Section 404 or the report by us of a material weakness may cause investors to lose confidence in our consolidated financial statements, and our stock price may be adversely affected as a result. If we fail to remedy any material weakness, our consolidated financial statements may be inaccurate, we may face restricted access to the capital markets and our stock price may be adversely affected.

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.

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

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

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

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the growth of the market for outsourced sales and marketing solutions;

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the demand for and acceptance of our services;

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the demand for our clients’ products and services;

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

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our ability to expand relationships with existing clients;

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

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our ability to execute on pay for performance contract arrangements;

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the success of our direct sales force;

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our ability to retain existing clients; and

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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 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, Metrics Corp and ViewCentral. 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:

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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;

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

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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. Such assets are subject to reviews for impairment in the event they are not fully utilized.

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. During the nine months ended September 30, 2006, we deployed our new order entry system for use on one of our clients. We have invested $3.2 million in this system and expect to use it as our order entry platform for all of our service sales clients. If unforeseen events or circumstances prohibit us from using this system with all clients, we may be forced to impair some or all of this asset.

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.

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

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

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

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

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

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

Our directors, executive officers and their affiliates own a significant 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 9.3% of our outstanding shares (based on the number of shares outstanding as of September 30, 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 5,000,000 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:

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quarter to quarter variations in results of operations;

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loss of a major client;

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announcements of technological innovations by us or our competitors;

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

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new products or services offered by us or our competitors;

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changes in market valuations of similar companies;

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

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other events or factors that may be beyond our control; or

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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.

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 recent 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 have recently renewed our director and officer insurance for a one-year term beginning November 2006.

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 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.

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 October 27, 2006, we had 14,619,000 outstanding shares of common stock. This amount includes shares issued under the Asset Purchase Agreements we entered into on September 15, 2006 and May 12, 2006, as described below. As of September 30, 2006, there were an aggregate of 2,611,973 shares of common stock issuable upon exercise of outstanding stock options and warrants, including 1,495,522 issuable upon exercise of options outstanding under our option plan and 1,116,451 shares of common stock issuable upon exercise of the outstanding warrants issued to the investors 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 1,163,470 shares and 445,554 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 September 15, 2006, we closed an Asset Purchase Agreement with ViewCentral, Inc., a California corporation (“ViewCentral”), and Dan Tompkins as representative of the shareholders of ViewCentral. Under the terms of the Purchase Agreement, we issued 754,968 shares of common stock representing approximately 5.5% of Rainmaker’s 13,845,000 common shares outstanding as of August 31, 2006 and assumed certain liabilities of ViewCentral under its customer contracts, purchase orders and office lease in exchange for substantially all of ViewCentral’s assets. Such shares are initially subject to a contractual prohibition of sale that will be removed as follows: 50% of such shares will be available for public sale commencing 181 days after the closing and the remaining 50% of such shares will be available for public sale commencing 366 days from the closing. In addition, approximately 20% of the shares of the common stock consideration will be placed in escrow to secure certain indemnity obligations under the Purchase Agreement and will not be released until twelve months after the closing, subject to adjustment.

On May 16, 2006, we announced that we had entered into and closed an Asset Purchase Agreement with Business Telemetry, Inc. (d/b/a Metrics Corporation), a California corporation (“Metrics”), and Kenneth S. Forbes, III, as representative of the shareholders of Metrics. We issued 158,480 shares of common stock in exchange for certain assets of Metrics. Such shares are initially subject to a contractual prohibition of sale that will be removed as follows: 39,620 of such

shares became available for public sale commencing 91 days after the closing; an additional 39,620 of such shares will be available for public sale commencing 181 days from the closing; an additional 39,620 of such shares will be available for public sale commencing 281 days from the closing; and the remaining 39,620 of such shares will be available for public sale commencing 366 days from the closing. In addition, 31,696 shares of the common stock consideration have been placed in escrow to secure certain indemnity obligations under the Purchase Agreement and will not be released until twelve months after the closing, subject to adjustment.

The securities issued pursuant to each of the aforementioned Asset 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 Metrics Asset Purchase Agreement, the Company granted certain registration rights to each of the Metrics shareholders pursuant to which the Company filed a registration statement on Form S-3 that became effective on July 28, 2006, with respect to the common stock issued under the Asset Purchase Agreement for Metrics. Under the ViewCentral Asset Purchase Agreement, Rainmaker has agreed to use commercially reasonable efforts to file a registration statement with the Securities and Exchange Commission by November 14, 2006 for the shares issued in conjunction with the purchase of the ViewCentral assets.

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 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 filed a registration statement on Form S-3 that became effective on March 21, 2006, with respect to the common stock issued under the Securities Purchase Agreements and the common stock issuable upon conversion of the related warrants.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

On September 15, 2006, the Company entered into an Asset Purchase Agreements with ViewCentral, Inc., a California corporation (“ViewCentral”), and Dan Tompkins, as representative of the shareholders of ViewCentral. We issued 754,968 shares of common stock and other consideration in exchange for certain assets of ViewCentral. The securities issued pursuant to the Asset Purchase Agreement 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 Asset Purchase Agreement, the Company also granted certain registration rights to each of the shareholders of ViewCentral pursuant to which the Company has agreed to use commercially reasonable efforts to file a registration statement on Form S-3 by November 14, 2006, with respect to the common stock issued under the Asset Purchase Agreement.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

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

None

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS

(a)

Exhibits

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


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

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

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

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

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


				RAINMAKER SYSTEMS, INC.

Dated: November 13, 2006				/s/ MICHAEL SILTON
				Michael Silton
				Chief Executive Officer
				(Principal Executive Officer)

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

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Rainmaker Systems (VCTL) Inactive 10-Q2006 Q3 Quarterly report

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