Prepared by R.R. Donnelley Financial -- From 10-Q

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

	March 31, 2002			December 31, 2001(1)
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	8,112		$	8,606
Accounts receivable, less allowance for doubtful accounts of $277 in 2002 and $410 in 2001		4,012			4,778
Prepaid expenses and other current assets		1,113			1,167

Total current assets		13,237			14,551
Property and equipment, net		4,512			5,075
Other noncurrent assets		177			284

Total assets	$	17,926		$	19,910


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	5,112		$	4,855
Payable to a related party		391			861
Accrued compensation and benefits		576			758
Accrued restructuring and other related charges		479			552
Other accrued liabilities		1,335			1,213
Current portion of capital lease obligations		645			713

Total current liabilities		8,538			8,952
Capital lease obligations, less current portion		174			305
Accrued restructuring and other related charges, less current portion		279			369

Stockholders’ equity:
Common stock, $0.001 par value:
Authorized shares: 80,000,000;
Issued and outstanding shares: 38,644,225 at March 31, 2002 and 38,417,625 at December 31, 2001		38			38
Additional paid-in capital		56,702			56,676
Accumulated other comprehensive income		25			45
Accumulated deficit		(47,830	)		(46,475	)

Total stockholders’ equity		8,935			10,284

Total liabilities and stockholders’ equity	$	17,926		$	19,910

	Three months ended March 31,
	2002			2001
	(unaudited)
CRM services revenue	$	8,485		$	12,224
Cost of CRM services revenue		6,080			8,803

CRM services gross profit		2,405			3,421
Selling, general and administrative expenses		3,918			8,307

Operating loss		(1,513	)		(4,886	)
Interest income, net		12			210

Loss before income taxes		(1,501	)		(4,676	)
Income tax benefit		(146	)		—

Net loss	$	(1,355	)	$	(4,676	)

Basic and diluted net loss per common share	$	(0.04	)	$	(0.12	)

Number of shares used in basic and diluted per share computations		38,600			38,057

	Three months ended March 31,
	2002			2001
	(unaudited)
Operating activities:
Net loss	$	(1,355	)	$	(4,676	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		590			754
Amortization of deferred stock compensation		—			97
Reduction in allowance for doubtful accounts		(133	)		(55	)
Changes in operating assets and liabilities:
Accounts receivable		898			1,312
Inventories		—			157
Income taxes receivable		(146	)		—
Prepaid expenses and other assets		208			(199	)
Other receivables		—			308
Accounts payable		259			(1,689	)
Payable to a related party		(470	)		(464	)
Accrued compensation and benefits		(182	)		(590	)
Accrued restructuring and other related charges		(163	)		—
Other accrued liabilities		122			(692	)

Net cash used in operating activities		(372	)		(5,737	)


Investing activities:
Purchases of property and equipment		(27	)		(492	)
Sale of marketable securities		78			—

Net cash provided by (used in) investing activities		51			(492	)


Financing activities:
Proceeds from issuance of common stock from option exercises		26			21
Repurchase of common stock		—			(1,184	)
Repayment of capital lease obligations		(199	)		(395	)

Net cash used in financing activities		(173	)		(1,558	)

Net decrease in cash and cash equivalents		(494	)		(7,787	)
Cash and cash equivalents at beginning of period		8,606			22,879

Cash and cash equivalents at end of period	$	8,112		$	15,092


Supplemental disclosure of cash paid during the period:
Interest paid	$	26		$	53

Income taxes paid, net of refunds	$	3		$	—

The accompanying financial statements of Rainmaker Systems, Inc. (“Rainmaker”) 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. 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 adjustments (consisting of normal recurring items) which are necessary for their fair presentation, in the opinion of management. The results of operations for the interim period ended March 31, 2002 are not necessarily indicative of results to be expected for the year ending December 31, 2002. These financial statements should be read in conjunction with Rainmaker’s financial statements and notes thereto included in Rainmaker’s Annual Report on Form 10-K for the year ended December 31, 2001.

Revenue from the sale of service contracts and maintenance renewals is recognized when a purchase order from the end user 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. Revenue from product sales is recognized at the time of shipment of the product directly to the customer. Revenue from services we perform is recognized as the services are delivered. Fee based pricing revenue is recognized once these services have been delivered. Substantially all of our sales transactions are reported under the “gross” method, which is based on the total purchase price billed by us to customers for our clients’ products and services. We also sell products and services on behalf of our clients whereby we record revenue net, equal to the amount earned in the transaction.

In December 1999, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 101 “Revenue Recognition” (“SAB 101”), which provides guidance on the recognition, presentation and disclosure of revenue in financial statements filed with the SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosures related to revenue recognition policies. The adoption of SAB 101 did not have a material impact on our revenue or results of operations.

Concurrent with the adoption of SAB 101, Rainmaker also adopted the Financial Accounting Standards Board’s Emerging Issues Task Force Issue No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent” (“EITF 99-19”). EITF 99-19 interprets SAB 101 and addresses when a company should report revenue as the gross amount billed to a customer versus the net amount earned by the company in the transaction. Specific “indicators” should be used by companies to determine if it is more appropriate for them to record revenues on a “gross” versus a “net” basis. These “indicators” include, but are not limited to, 1) whether the vendor is the primary obligor in the transaction, 2) whether the vendor assumes general inventory risk, and 3) whether the vendor has latitude for setting the pricing for the goods or services it sells to its customers. Absence of these indicators might indicate that revenue should be recorded on a “net” basis. Substantially all of our sales transactions are reported under the “gross” method based on amounts billed to our customers as we take title and assume risk of loss for products sold and assume the full credit risk and establish pricing for the products and services we sell. However, we also sell products and services on behalf of customers of our clients whereby, based on the evaluation of the same indicators, we record revenue net equal to the amount earned in the transaction. Our current revenue

Basic net loss per share has been computed using the weighted-average number of shares of common stock outstanding during the year, less shares subject to repurchase. Diluted net loss per share also gives effect, as applicable, to the potential dilutive effect of outstanding stock options, using the if converted method, as of the beginning of the period presented or the original date of issuance, if later. Rainmaker has excluded all outstanding options and shares subject to repurchase from the calculation of diluted net loss per share because all such securities are anti-dilutive.

Comprehensive income (loss) for Rainmaker consists of net income (loss) plus the effect of unrealized holding gains or losses on investments classified as available-for-sale. For the three months ended March 31, 2002, the net change for unrealized holding loss on investments was approximately $20,000. Comprehensive loss for Rainmaker for the three months ended March 31, 2002 was $1.4 million.

During the fourth quarter of 2001, we recorded restructuring and other related charges of $2.4 million or $0.06 per share in connection with a restructuring program approved by the Board of Directors during the quarter. This resulted in a reduction of 39 positions at all levels throughout Rainmaker whose total annual salary at the date of termination was approximately $2.6 million. All affected employees were informed of the reduction and their severance amounts prior to December 31, 2001. The charges consisted of cash severance payments to be made to severed employees, lease payments related to property abandoned as a result of our facilities consolidation, write-offs of excess equipment and leasehold improvements that were abandoned and whose estimated fair market value was zero, and discontinued use of internally developed and licensed software.

	Employee Severance			Lease Cancellation and Facility Exit Costs			Legal and Other Expenses			Subtotal			Less Current Portion			Accrued Restructuring Costs Less Current Portion
Balance at December 31, 2001	$	26,000		$	877,000		$	18,000		$	921,000		$	552,000		$	369,000
Less Cash Payments		(1,000	)		(144,000	)		(18,000	)		(163,000	)		(73,000	)		(90,000	)

Balance at March 31, 2002	$	25,000		$	733,000		$	0		$	758,000		$	479,000		$	279,000

On November 30, 2001, we announced a voluntary stock option exchange program for our employees. Under the program, Rainmaker employees were given the opportunity, if they chose, to cancel outstanding stock options previously granted to them in exchange for an equal number of replacement options to be granted at a future date at least six months and a day from the cancellation date, which was January 24, 2002. The expected new grant date will be on or after July 25, 2002. Under the exchange program, options for approximately 2.5 million shares of our common stock were tendered and cancelled. Each participating employee will receive, for each option included in the exchange, a one-for-one replacement option, subject to adjustments for any stock splits. The exercise price of each replacement option will be equal to the highest of (i) the closing selling price per share of our common stock on the trading day immediately before day of grant, (ii) the average of the high and low per share sales price on day of grant or (iii) the closing selling price per share on day of grant, as quoted on Nasdaq or on the OTC Bulletin Board. The replacement options will have terms and conditions that are substantially the same as those of the canceled options. Rainmaker employees must remain employed with Rainmaker at date of grant to receive replacement options. The exchange program is not expected to result in any additional compensation charges or variable plan accounting. Non-employee members of our Board of Directors were not eligible to participate in this program.

Rainmaker operates in one market segment, the sale of installed base marketing and sales services to software and other technology companies, for their support contracts and software subscriptions. Rainmaker primarily operates in one geographical segment, North America. Substantially all of Rainmaker’s sales are made to customers in the United States.

During March 2002, the Internal Revenue Service issued the Job Creation and Worker Assistance Act of 2002 which extended the regular and alternative minimum tax net operating loss carryback period from two years to five years for losses arising in 2001 or 2002 tax years. As a result of this new law, Rainmaker recorded a $146,000 income tax benefit during the three months ended March 31, 2002 that is attributed to income taxes recoverable from prior periods.

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

Rainmaker Systems, Inc. (“Rainmaker”) is a leading outsource provider of sales and marketing programs. Rainmaker’s cost-effective programs generate service revenue and promote customer retention for its clients. Core services include professional telesales, direct marketing, and hosted e-commerce. Additional services include customer database enhancement, CRM technology integration, and order management. These services are available individually or as an integrated solution. By integrating technology, processes and people, Rainmaker provides a transparent customer relationship infrastructure for its clients.

We incurred operating losses and net losses for the three months ended March 31, 2002 and for the fiscal years ended 2001, 2000, and 1999. During 1999 and 2000, we incurred increasing operating and net losses as we increased our operating expenses to build our services business. New clients require significant up-front investments including the costs to hire additional staff and create the necessary infrastructure to deliver our services. These costs are typically incurred some time before significant revenue is generated. In late 2000, we repackaged our service offering to include fee-based pricing. Revenue is recognized once these services have been delivered. We now charge for many of these costs; however, these costs could have an adverse effect on our future financial condition and operating results, depending on market acceptance of new service combinations and pricing options.

Our quarterly 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 or impossible to predict. Our historical revenue has tended to fluctuate based on seasonal buying patterns in the computer industry. Our prospects must be considered in light of the risks, expenses and difficulties encountered by high-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. In the second quarter of 2000, we began a review of our existing client base, as well as our client targeting process and methodology. As a result, in the last half of 2000 and during 2001, we have discontinued services to certain clients that have resulted in a lower base of revenues. See “Factors That May Affect Future Results and Market Price of Stock.”

Accounting policies, methods and estimates are an integral part of the financial statements prepared by management and are based upon management’s current judgments. Those judgments are normally based on knowledge and experience with regard to past and current events and assumptions about future events. Certain accounting policies, methods and estimates are particularly sensitive because of their significance to the financial statements and because of the possibility that future events affecting them may differ markedly from management’s current judgments. Actual results may differ from these estimates under different assumptions or conditions. While there are a number of accounting policies, methods and estimates affecting our financial statements, areas that are particularly significant include revenue recognition policies, valuation of accounts receivable, the assessment of recoverability and measuring impairment of fixed assets, and recognition of restructuring reserves.

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments of amounts due to us. The allowance is comprised of specifically identified customer account balances for which collection is currently deemed doubtful. In addition to specifically identified accounts, estimates of amounts that may not be collectible are made based on actual historical bad debt write off experience of those accounts whose collection is not yet deemed doubtful but which may become doubtful in the future if the financial condition of our customers were to deteriorate.

We review all of our long-lived assets including fixed assets, for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include, but are not limited to, significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for our overall business, significant negative industry or economic trends, a significant decline in our stock price for a sustained period, and our market capitalization relative to net book value. An asset or a group of assets is determined to be impaired if the estimated future undiscounted net cash flows attributable to the asset or group of assets are less than their carrying value. If impairment exists, it is measured by the amount of which the fair value of the assets, estimated by Rainmaker using estimated future discounted cash flows, appraisals, or other methods, is less than the asset or group of assets’ carrying value. The identification of long-lived asset impairment and the amount of impairment charges, if any, recorded in any one period, are subject to the aforementioned events and management estimates and therefore, could change in the future requiring additional charges to our operating results.

During the fourth quarter of fiscal 2001, we restructured the company under a plan approved by the Board of Directors, by reducing our headcount and consolidating our facilities utilization. As a result of these actions, we recorded restructuring and other related charges consisting of cash severance payments to be made to severed employees, lease payments related to property abandoned as a result of our facilities consolidation, write-offs of excess equipment and leasehold improvements that were abandoned and whose estimated fair market value was zero, and discontinued use of internally developed software. Each reporting period we will review these estimates based on the status of execution of our restructuring plan and, to the extent that these assumptions change due to changes in market conditions and our business, the ultimate restructuring expenses could vary by material amounts.

to customers for our clients’ products and services. We also sell products and services on behalf of our clients whereby we record revenue net, equal to the amount earned in the transaction. Revenue from the sale of service contracts and maintenance renewals is recognized when a purchase order from the end user 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. Revenue from product sales is recognized at the time of shipment of the product directly to the customer. Revenue from services we perform is recognized as the services are delivered. Revenue from sales of new clients’ products and services typically increases over several quarters before reaching a more moderate level of growth. However, revenue growth can be affected by many factors including customer contract renewal history, customer product satisfaction and competitive pricing.

Concurrent with the adoption of SAB 101, Rainmaker also adopted the Financial Accounting Standards Board’s Emerging Issues Task Force Issue No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent” (“EITF 99-19”). EITF 99-19 interprets SAB 101 and addresses when a company should report revenue as the gross amount billed to a customer versus the net amount earned by the company in the transaction. Specific “indicators” should be used by companies to determine if it is more appropriate for them to record revenues on a “gross” versus a “net” basis. These “indicators” include, but are not limited to, 1) whether the vendor is the primary obligor in the transaction, 2) whether the vendor assumes general inventory risk, and 3) whether the vendor has latitude for setting the pricing for the goods or services it sells to its customers. Absence of these indicators might indicate that revenue should be recorded on a “net” basis. Substantially all of our sales transactions are reported under the “gross” method based on amounts billed to our customers as we take title and assume risk of loss for products sold and assume the full credit risk and establish pricing for the products and services we sell. However, we also sell products and services on behalf of customers of our clients whereby, based on the evaluation of the same indicators, we record revenue net equal to the amount earned in the transaction. Our current revenue reporting practices are consistent with the revenue reporting criteria established in EITF 99-19. The adoption of EITF 99-19 did not have a material impact on our reported revenues.

Our business primarily consists of marketing and selling our clients’ products and services to their existing customers. In addition, most of our revenue is based on a “pay for performance” model in which our compensation is based on the amount of our clients’ products and services that we sell. Accordingly, if a particular client’s products and services fail to appeal to its customers for reasons beyond our control, such as preference for a competing product or service, our revenue from the sale of client’s products and services may decline.

We have generated a significant portion of our revenue from the marketing and selling of products and services from a limited number of clients. For the three months ended March 31, 2002, sales to customers of Nortel Networks, Inc., Hewlett-Packard (“HP”), Sybase, Inc. (“Sybase”), and Caldera International, Inc., each individually accounted for 10% or more of our CRM services revenue. For the three months ended March 31, 2001, sales to customers of Sybase, Parametric Technology Corporation, The Santa Cruz Operation, Inc., HP, PumaTech, Inc., and Novell, Inc. each individually accounted for 10% or more of our CRM services revenue. 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 are consolidating, which may reduce the number of our existing and potential clients.

We focus our resources on service offerings and client relationships with which we can maintain profitable business relationships. In the past, this focus has resulted in the discontinuation of relationships with certain clients and a lower base of revenues. There is a possibility that more client relationships may be discontinued which could cause a decrease to our revenue in future periods.

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

Cost of revenue includes payments for our clients’ products and services based on the specific pricing terms of each contract and costs associated with fee-based revenues. Costs associated with fee-based revenues consist primarily of salaries and other personnel-related expenses. Some client relationships may be structured such that the costs of these products and services can be higher during the start up phase of our relationship with a client until higher purchase discounts are achieved from increased sales volume. In these relationships, once we integrate a client’s customer database and begin to meet targeted sales volumes, our gross margins from that client can improve. Cost of revenue also consists of the cost of products and service arrangements sold to customers, the cost of inbound and outbound shipping, net of amounts recovered from customers and the costs of designing, producing and delivering services.

Rainmaker purchased inventories and service agreements from a customer who has a board member that also sits on Rainmaker’s Board of Directors. Total purchases amounted to $649,000 during the first three months ended March 31, 2002. At March 31, 2002, Rainmaker owed that customer $391,000 for such purchases. Also during this period, Rainmaker received marketing development fund reimbursements of $17,000 from that customer. Amounts totaling $26,000 were receivable from that customer at March 31, 2002.

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 Rainmaker’s financial statements and notes thereto included in Rainmaker’s Annual Report on Form 10-K for the year ended December 31, 2001.

	Three Months Ended
	March 31, 2002		March 31, 2001
CRM services revenue	100.0	%	100.0	%
Cost of CRM services revenue	71.7		72.0

CRM services gross profit	28.3		28.0
Selling, general and administrative expenses	46.2		68.0

Operating loss	(17.9	)	(40.0	)
Interest income, net	0.1		1.7

Loss before income taxes	(17.8	)	(38.3	)
Income tax benefit	(1.7	)	—

Net loss	(16.1	)%	(38.3	)%

CRM Services Revenue. Revenue from CRM services decreased 30.6% to $8.5 million for the three months ended March 31, 2002 from $12.2 million for the comparable period of 2001. This decrease is primarily due to a decline in business attributable to clients with whom we discontinued marketing and selling their products and services in 2001. In late 2000 and during 2001, we decided to focus our resources on clients with whom we could maintain profitable business relationships. As a result, we discontinued relationships with various clients that represented no revenue for the three months ended March 31, 2002, but which we generated $5.1 million for the comparable period in 2001. This was offset by the addition of a new client in July 2001 who represented $2.7 million of revenue during the three months ended March 31, 2002. Our quarterly 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. In the current economic environment, we have very limited visibility over revenue trends in future periods.

CRM Services Gross Profit. Gross profit from CRM services decreased 29.7% to $2.4 million for the three months ended March 31, 2002, from $3.4 million for the comparable period in 2001. Gross margin from CRM services increased to 28.3% in the most recent period compared to 28.0% during the comparable period of the prior year. The increase in gross margin is due primarily to an increased focus on our higher margin core Contract Renewals Plus services and a change in the mix of existing clients, resulting from our decision in late 2000 and 2001 to focus on clients with whom we can maintain profitable business relationships. We expect our gross margins to continue to vary based on the mix of clients and the services provided.

Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased 52.5% to $3.9 million for the three months ended March 31, 2002 from $8.3 million for the comparable period of 2001. The percentage and absolute dollar decrease was primarily attributable to a reduction in personnel (a decrease of 100 average headcount at March 31, 2002 compared to March 31, 2001), and an increased effort to manage and reduce operating expenses. As a percentage of total revenue, these expenses decreased to 46.2% for the most recent period from 68.0% in the comparable period of the prior year. The decrease in selling, general and administrative expenses as a percentage of total revenue is primarily due to management’s efforts to control and reduce operating expenses for the three months ended March 31, 2002, compared to the comparable period of the prior year. Operating expenses as a percentage of revenue will continue to fluctuate based on our revenue base and management of operating expenses. Although we anticipate that the recent restructuring of our operations will reduce our sales and marketing expenses for the near-term, these expenses may fluctuate over the longer term.

Interest Income and Expense. We recorded $38,000 of interest income and $26,000 of interest expense or net interest income of $12,000 for the three months ended March 31, 2002. This compares to $263,000 of interest income and $53,000 of interest expense or net interest income of $210,000 in the comparable period of 2001. The net decrease was primarily attributable to lower invested cash balances and lower interest rates.

Income Tax Benefit. During March 2002, the Internal Revenue Service issued the Job Creation and Worker Assistance Act of 2002 which extended the regular and alternative minimum tax net operating loss carryback period from two years to five years for losses arising in 2001 or 2002 tax years. As a result of this new law, Rainmaker recorded a $146,000 income tax benefit during the three months ended March 31, 2002 that is attributed to income taxes recoverable from prior periods. During the three months ended March 31, 2001, no income tax benefit was recorded.

Cash used in operating activities during the three months ended March 31, 2002 was $372,000 compared to $5.7 million for the comparable period of the prior year. The change of $5.4 million was due primarily to a lower net loss for the three months ended March 31, 2002 and changes in our balance sheet accounts. During the first quarter of 2002, net loss improved to $1.4 million from $4.7 million for the comparable period in 2001. Accounts payable and other accrued liabilities increased by a total of $381,000 compared to a decrease of $2.3 million in the comparable period of last year.

Cash provided by investing activities during the first quarter of 2002 was $51,000 compared to cash used of $492,000 for the comparable period of the prior year. In the first quarter of 2002, cash provided by investing activities was due primarily to a sale of a long-term investment of $78,000 offset by purchase of equipment of $27,000. In the first quarter of 2001, cash used by investing activities was due to the purchase of fixed assets.

Cash used in financing activities during the three months ended March 31, 2002 was $173,000 compared to $1.6 million for the comparable period of the prior year. In the first quarter of 2002, we repaid $199,000 of capital lease obligations offset by $26,000 of proceeds from the issuance of common stock from stock option exercises. In the first quarter of 2001, we repurchased and retired $1.2 million of common stock and repaid $395,000 of capital lease obligations. This was offset partially by $21,000 of proceeds received from the issuance of common stock from stock option exercises.

Our principal source of liquidity as of March 31, 2002 consisted of $8.1 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.

We incurred an operating loss of $1.5 million and net loss of $1.4 million for the first quarter of 2002, and an operating loss of $4.9 million and net loss of $4.7 million for 2001. We may incur losses in the future, depending on the timing of signing of new clients, impact of new and existing clients and our ability to continue to increase our operating efficiencies.

In late 2000, we decided to focus our resources on clients with which we can maintain a profitable business relationship. This resulted in discontinuation of relationships with certain clients and a lower base of revenues. There is a possibility that more client relationships may discontinue which could cause a decrease to our revenue in future periods.

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

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

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 six to nine 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.

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 chairman, president and chief executive officer, and Martin Hernandez, our chief operating officer and acting chief financial officer could seriously harm our business. We have obtained life insurance policies in the amount of $6.3 million on Michael Silton and $3.0 million on Martin Hernandez.

Competition in CRM services is intense, and we expect such competition to increase in the future. Our competitors include comprehensive system integrators, e-commerce 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. 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

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

Any future growth will place additional demands on our managerial, administrative, operational and financial resources. We will need to continue to improve our operational, financial and managerial controls and information systems and procedures and will need to continue to train and manage our overall work force. If we are unable to manage additional growth effectively, our business will be harmed.

Our long-term growth strategy includes 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. 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.

As part of our business strategy, we review from time to time acquisition prospects that would complement our existing business or enhance our technological capabilities. Future acquisitions 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 expense related to other intangible assets, any of which could cause our financial performance to suffer. Furthermore, acquisitions entail numerous risks and uncertainties, including:

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

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.

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.

Our operations are housed in a single facility in Scotts Valley, California. 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 our facility would not disable these operations. Any significant damage to this facility from an earthquake or other disaster could prevent us from operating our business.

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

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 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.

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 e-mail and facsimile transmissions. The failure to comply with applicable statutes and regulations could result in penalties. There can be no assurance that additional federal or state legislation, or changes in regulatory implementation, or judicial interpretation of existing or future laws would not limit our activities in the future or significantly increase the cost of regulatory compliance.

Our directors and entities affiliated with them together control approximately 48% of our outstanding shares (based on the number of shares outstanding as of February 28, 2002). As a result, any significant combination of those stockholders, acting together, will have the ability to control all matters requiring stockholder approval, including the election of all directors, and any merger, consolidation or sale of all or substantially all of our assets. Accordingly, such concentration of ownership may have the effect of delaying, deferring or preventing a change in control of Rainmaker, which, in turn, could depress the market price of our common stock.

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

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

In addition, the securities markets in general have experienced extreme price and trading volume volatility in the past. The trading prices of securities of many business process outsourcing companies have fluctuated broadly, often for reasons unrelated to the operating performance of the specific companies. These general market and industry factors may adversely affect the trading price of our common stock, regardless of our actual operating performance.

Our common stock is currently listed on the Nasdaq National Market. Nasdaq has requirements that a company must meet in order to remain listed on the Nasdaq National Market. If we continue to experience losses from our operations, 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 National Market, which include, among other things that our stock maintain a minimum closing bid price of at least $1.00 per share and we maintain either stockholders’ equity of at least $10 million or net tangible assets of at least $4 million. Commencing November 1, 2002, we will be required to comply with the $10 million stockholders’ equity requirement. Rainmaker received a deficiency notice from Nasdaq on February 14, 2002, advising us that our common stock had traded below the minimum bid price requirement for 30 consecutive business days and that we have 90 calendar days from such date (or until May 15, 2002) to regain compliance with the minimum bid price requirement. Compliance with such requirement is regained if the minimum bid price of Rainmaker’s common stock closes at or above $1.00 for 10 consecutive business days during such 90-day period.

The Securities & Exchange Commission recently approved a new Nasdaq program that modifies the minimum bid price grace period for the Nasdaq SmallCap Market. This program allows companies currently listed on the Nasdaq National Market, who are out of compliance with the minimum bid price requirement, to, upon acceptance by Nasdaq, have the opportunity to extend the 90-day grace period during which they may regain compliance with the minimum bid price requirement by transferring to the Nasdaq SmallCap Market. Rainmaker may elect to transfer from the Nasdaq National Market to the Nasdaq SmallCap Market in order to take advantage of this extended grace period, subject to acceptance by Nasdaq. Should Rainmaker transfer to the Nasdaq SmallCap Market to take advantage of this extended grace period, Rainmaker may be eligible under certain circumstances to transfer back to the Nasdaq National Market at a later date.

Our exposure to market risk for changes in interest rates relates primarily to the increase or decrease in the amount of interest income we can earn on our investment portfolio. We currently do not and do not plan to use derivative financial instruments in our investment portfolio. We plan to ensure the safety and preservation of our invested principal funds by limiting default risk, market risk and investment risk. We mitigate default risk by investing in low-risk securities. To minimize our risks, we maintain our portfolio of cash equivalents and short-term investments in a variety of short-term and liquid securities including money market funds, commercial paper, U.S. government and agency securities and municipal bonds. In general, money market funds are not subject to market risk because the interest paid on such funds fluctuates with the prevailing interest rate. As of March 31, 2002, 100% of our portfolio was invested in instruments that mature in less than 90 days.

Rainmaker completed the initial public offering of 5,750,000 shares of its common stock, including 750,000 shares subject to an over allotment option, pursuant to a registration statement on Form S-1 (Commission File No. 333-86445) declared effective on November 16, 1999. The joint book-running managing underwriters of the public offering were Donaldson, Lufkin & Jenrette and Thomas Weisel Partners LLC.

The shares were sold at a price per share of $8.00. The aggregate offering price of the shares offered by Rainmaker was $46,000,000, less underwriting discounts and commissions of $3,220,000 and expenses of approximately $2,207,000. Approximately $26.8 million of the proceeds have been used for operating activities through March 31, 2002 and approximately $8.2 million of the proceeds have been used for capital expenditures. The balance of such proceeds is to be used for general corporate purposes to support business expansion including new client acquisition, capital expenditures, development of new services and possible expansion into international markets. In addition, we may use a portion of the net proceeds to acquire complementary products, technologies or businesses; however, we currently have no commitments or agreements and are not involved in any negotiations to do so. None of Rainmaker’s net proceeds of the offering were paid directly or indirectly to any director, officer or their associates, persons owning 10% or more of any class of equity securities of Rainmaker or an affiliate of Rainmaker.

Delaware		33-0442860
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

		Page
PART I.	FINANCIAL INFORMATION
Item 1.	Interim Financial Statements:
	Balance Sheets	3
	Statements of Operations	4
	Statements of Cash Flows	5
	Notes to Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	9
Item 3.	Qualitative and Quantitative Disclosures About Market Risk	21

PART II.	OTHER INFORMATION
Item 1.	Legal proceedings	22
Item 2.	Changes in securities and use of proceeds	22
Item 6.	Exhibits and reports on Form 8-K	22
	Signatures	23

	Capital Leases		Operating Leases		Total
2002	$	562	$	452	$	1,015
2003		306		629		935
2004		12		385		397
2005		—		39		39

Total minimum lease payments	$	880	$	1,506	$	2,386

	Maturing in three months or less			Estimated Fair Value
(in thousands)
Fixed rate securities	$	2,030		$	2,030
Weighted average interest rate		1.68	%

	RAINMAKER SYSTEMS, INC.

Dated: May 3, 2002	By:	/s/ MICHAEL SILTON
		Michael Silton Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer)


	By:	/s/ MARTIN HERNANDEZ
		Martin Hernandez Secretary, Chief Operating Officer and acting Chief Financial Officer (Chief Accounting Officer)


10.20		+Master Services Agreement dated December 19, 2001 between Rainmaker Systems, Inc. and Dell Products L.P.