** **

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

**(Mark One)**

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

 

**For the quarterly period endedSeptember 30, 2001**

 

**OR**

 

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

 

**For thetransition period from _____ to _____**

** **

**Commission File Number 0-22718**

 

**ZAMBA CORPORATION**

(Exact name of Registrant as specified in its charter)

 

| **Delaware**                                                          |   | **#41-1636021**                       |
|-----------------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of

incorporation or organization)       |   | (I.R.S. Employer

Identification No.) |
|                                                                  |   |                                  |
| **3033 Excelsior Boulevard, Suite 200, Minneapolis, Minnesota 55416** |
| (Address of principal executive offices, including zip  code)         |
|                                                                  |
| **(952) 832-9800**                                                    |
| (Registrant's telephone number, including area code)                  |

 

Indicate bycheck mark whether the Registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

YES         ý            NO          o

 

Indicate thenumber of shares outstanding of each of the issuer's classes of common stock,as of the latest practicable date.

 
| **Class**                     |   | **Outstanding at November 7, 2001** |
|-------------------------------|--------|-------------------------------------|
| Common Stock, $0.01 par value |   | 34,942,080                          |

 

 

ZAMBA CORPORATION

 

INDEX

 
|  
PART I - Financial  Information

 
 

Item 1.

Financial Statements (Unaudited)

 

 

 

Consolidated  Statements of Operations for the Three and Nine Months Ended September 30,  2001 and 2000

 

 

 

Consolidated Balance Sheets  as of September 30, 2001 and December 31, 2000

 

 

 

Consolidated Statements  of Cash Flows for the Nine Months Ended September 30, 2001 and 2000

 

 

 

Notes to Consolidated  Financial Statements

 

 

Item  2.

Management's  Discussion and Analysis of Financial Condition and Results of Operations

 

 

Item  3.

Quantitative  and Qualitative Disclosures About Market Risk

 

 

PART II -- Other  Information

 

 

Item 1.

Legal Proceedings

 

 

Item 2.

Changes in Securities

 

 

Item 3.

Defaults Upon  Senior Securities

 

 

Item  4.

Submission  of Matters to a Vote of Security Holders

 

 

Item 5.

Other Information

 

 

Item 6.

Exhibits and  Reports on Form 8-K

 

 

Signatures

 

 

 

**Part I.Financial Information**

** **

**Item1:  Financial Statements**

 

**ZAMBA CORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

** **

**(In thousands, except per share data)**

 

** **

** **

** For the three  months ended**

** **

** For the nine months  ended**

** **

** **

** **

**September 30,**

** **

**September 30,**

** **

** **

 

**2001**

** **

**2000**

 

**2001**

** **

**2000**

** **

**Net  revenues**

 

**$**

**7,669**

** **

**$**

**11,310**

** **

**$**

**27,499**

** **

**$**

**29,242**

** **

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Costs and  expenses:**

 

 

 

 

 

 

 

 

** **

**Project and personnel costs**

 

**4,345**

** **

**5,608**

** **

**16,176**

** **

**14,800**

** **

**Sales and marketing**

 

**1,321**

** **

**1,456**

** **

**4,533**

** **

**3,667**

** **

**General and administrative**

 

**2,896**

** **

**4,133**

** **

**11,799**

** **

**10,273**

** **

**Restructuring charges**

 

**-**

** **

**-**

** **

**2,188**

** **

**-**

** **

**Amortization of intangibles**

 

**31**

** **

**945**

** **

**106**

** **

**2,835**

** **

**Total costs and expenses**

 

**8,593**

** **

**12,142**

** **

**34,802**

** **

**31,575**

** **

 

 

 

 

 

 

 

 

 

 

**Loss from  operations**

 

**(924**

**) **

**(832**

**) **

**(7,303**

**)**

**(2,333**

**) **

 

 

 

 

 

 

 

 

 

 

**Other  income (expense):**

 

 

 

 

 

 

 

 

** **

**Interest  income**

 

**36**

** **

**46**

** **

**126**

** **

**177**

** **

**Interest  expense**

 

**(49**

**)**

**(16**

**) **

**(128**

**) **

**(55**

**) **

 

 

**(13**

**)**

**30**

** **

**(2**

**) **

**122**

** **

**Net loss**

 

**$**

**(937**

**)**

**$**

**(802**

**)**** **

**$**

**(7,305**

**)**** **

**$**

**(2,211**

**)**** **

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Net loss  per share - basic and diluted**

 

**$**

**(0.03**

**)**

**$**

**(0.03**

**)**** **

**$**

**(0.22**

**)**** **

**$**

**(0.07**

**)**** **

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Weighted  average shares outstanding - basic and diluted**

 

**34,727**

** **

**31,654**

** **

**33,100**

** **

**31,487**

** **

 

**The accompanying notes are an integral part of theconsolidated financial statements.**

 

 

**ZAMBACORPORATION**

**CONSOLIDATEDBALANCE SHEETS**

**(Unaudited)**

** **

**(In thousands, except per share data)**

 

 

 

**September 30,**

 

**December 31,**

 

**ASSETS**

 

**2001**

 

**2000**

 

**Current assets:**

 

 

 

 

** **

**Cash and cash equivalents**

 

**$**

**3,536**

** **

**$**

**4,843**

** **

**Accounts receivable, net**

 

**3,422**

** **

**5,858**

** **

**Unbilled receivables**

 

**134**

** **

**426**

** **

**Notes receivable, net**

 

**1,377**

** **

**1,979**

** **

**Notes receivable - related parties**

 

**314**

** **

**359**

** **

**Prepaid expenses and other current assets**

 

**809**

** **

**660**

** **

**Total current assets**

 

**9,592**

** **

**14,125**

** **

 

 

 

 

 

 

**Property and equipment, net**

 

**1,910**

** **

**1,650**

** **

**Restricted cash**

 

**471**

** **

**264**

** **

**Intangible assets, net**

 

**125**

** **

**231**

** **

**Other assets**

 

**305**

** **

**243**

** **

**Total assets**

 

**$**

**12,403**

** **

**$**

**16,513**

** **

 

** **

 

** **

**LIABILITIES AND STOCKHOLDERS' EQUITY**

 

 

 

 

 

**Liabilities:**

 

 

** **

 

** **

**Line of credit**

 

**$**

**2,800**

** **

**$**

**0**

** **

**Current installments of long-term debt**

 

**388**

** **

**607**

** **

**Accounts payable**

 

**852**

** **

**1,589**

** **

**Accrued expenses**

 

**3,472**

** **

**3,306**

** **

**Deferred revenue**

 

**453**

** **

**1,480**

** **

**Total current liabilities**

 

**7,965**

** **

**6,982**

** **

 

 

 

 

 

 

**Long-term debt, less current installments**

 

**267**

** **

**469**

** **

 

 

 

 

 

 

**Commitments**

 

 

** **

 

** **

**Total liabilities**

 

**8,232**

** **

**7,451**

** **

**Stockholders' equity:**

 

 

** **

 

** **

**Common stock, $0.01 par value, 120,000 shares  authorized, 34,857 and 32,164 shares issued and outstanding at  September 30, 2001 and December 31, 2000, respectively**

 

**349**

 

**322**

 

**Additional paid-in capital**

 

**84,263**

** **

**81,876**

** **

**Note receivable from director**

 

**(500**

**)**

**(500**

**)**

**Accumulated deficit**

 

**(79,941**

**)**

**(72,636**

**)**

**Total stockholders' equity**

 

**4,171**

** **

**9,062**

** **

 

 

 

 

 

 

**Total liabilities and stockholders' equity**

 

**$**

**12,403**

** **

**$**

**16,513**

** **

** **

**The accompanying notes are an integral part of theconsolidated financial statements.**

 

**ZAMBA CORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

** **

**(In thousands)**

 

**Nine Months Ended**

** **

 

 

**September 30,**

** **

 

 

**2001**

 

**2000**

 

**Cash flows from operating activities:**

 

 

** **

 

** **

**Net loss**

 

**$**

**(7,305**

**)**

**$**

**(2,211**

**)**

**Adjustments to reconcile net loss to net cash used  in operating activities:**

 

 

 

 

** **

**Depreciation and amortization**

 

**653**

** **

**3,696**

** **

**Provision for bad debts**

 

**691**

** **

**816**

** **

**Changes in operating assets and liabilities:**

 

 

** **

 

** **

**Accounts receivable**

 

**2,191**

** **

**(4,648**

**)**

**Unbilled receivables**

 

**292**

** **

**30**

** **

**Notes receivable**

 

**156**

** **

**-**

** **

**Prepaid expenses and other assets**

 

**(211**

**)**

**(725**

**)**

**Accounts payable**

 

**(737**

**)**

**601**

** **

**Accrued expenses**

 

**166**

** **

**(123**

**)**

**Deferred revenue**

 

**(1,027**

**)**

**534**

** **

**Net cash used in operating activities**

 

**(5,131**

**)**

**(2,030**

**)**

 

 

 

 

 

 

**Cash flows from investing activities:**

 

 

** **

 

** **

**Purchase of property and equipment**

 

**(670**

**)**

**(1,149**

**)**

**Restricted cash**

 

**(207**

**)**

**110**

** **

**Notes receivable - related parties**

 

**45**

** **

**(723**

**)**

**Net cash used in investing activities**

 

**(832**

**)**

**(1,762**

**)**

 

 

 

 

 

 

**Cash flows from financing activities:**

 

 

** **

 

** **

**Line of credit, net**

 

**2,800**

** **

**-**

** **

**Proceeds from sale of common stock**

 

**2,240**

** **

**-**

** **

**Proceeds from exercises of stock options**

 

**37**

** **

**909**

** **

**Payments of long-term debt**

 

**(421**

**)**

**(354**

**)**

**Net cash provided by financing activities**

 

**4,656**

** **

**555**

** **

 

 

 

 

 

 

**Net decrease in cash and cash equivalents**

 

**(1,307**

**)**

**(3,237**

**)**

**Cash and cash equivalents, beginning of period**

 

**4,843**

** **

**7,973**

** **

**Cash and cash equivalents, end of period**

 

**$**

**3,536**

** **

**$**

**4,736**

** **

 

 

 

 

 

 

**Supplemental  Schedule of Disclosures of Cash Flow Information:**

 

 

** **

 

** **

 

 

 

 

 

 

**Cash paid during the period for interest**

 

**$**

**110**

** **

**$**

**57**

** **

 

**The accompanying notes are an integral part of theconsolidated financial statements.**

 

ZAMBACORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 (Unaudited)

 

Note A.  Basis of Presentation:

 

The unaudited consolidated financial statements of ZAMBACorporation as of September 30, 2001, and for the three and nine month periodsended September 30, 2001 and 2000, reflect all adjustments (which include onlynormal recurring adjustments) necessary, in the opinion of management, tofairly state our financial position as of September 30, 2001, and our resultsof operations and cash flows for the reported periods.  The results of operations for any interimperiod are not necessarily indicative of the results to be expected for anyother interim period or for the full fiscal year.  The year-end balance sheet data was derived from auditedfinancial statements, but does not include all disclosures required bygenerally accepted accounting principles. Certain prior year amounts have been reclassified to conform with the2001 presentation.  These financialstatements should be read in conjunction with our audited consolidatedfinancial statements and related notes for the year ended December 31, 2000,which were included in our 2000 Annual Report on Form 10-K.

 

Note B. SelectedBalance Sheet Information:

 

**(in thousands)**

 

**September 30, 2001**

 

**December 31, 2000**

 

Accounts  receivable, net:

 

 

 

 

 

Accounts  receivable

 

$

3,664

 

$

6,287

 

Less allowance  for doubtful accounts

 

(242

)

(429

)

 

 

$

3,422

 

$

5,858

 

Notes  receivable, net:

 

 

 

 

 

Notes  receivable

 

$

1,823

 

$

1,979

 

Less allowance  for doubtful accounts

 

(446

)

-

 

 

 

$

1,377

 

$

1,979

 

Property and  equipment, net:

 

 

 

 

 

Computer  equipment

 

$

1,678

 

$

1,406

 

Furniture and  equipment

 

641

 

694

 

Leasehold  improvements

 

1,263

 

931

 

 

 

3,582

 

3,031

 

Less  accumulated depreciation and amortization

 

(1,672

)

(1,381

)

 

 

$

1,910

 

$

1,650

 

 

Accounts receivable represent amounts not yet paid by our clientsfor services rendered during the ordinary course of business.  We entered into interest-bearing promissorynotes with two of our customers who were unable to pay us the amounts due on atimely basis.  

 

On August 28, 2000 we entered into an interest-bearing promissorynote with Health Risk Management, Inc. (HRMI). The principal amount of the notewas $372,447, and it carried an interest rate of 12.0% per annum.  HRMI paid $250,049 in principal and interestthrough March 30, 2001, but ceased making payments following that date.  As of June 30, 2001, we reserved the$142,002 balance remaining on the promissory note because of our substantialdoubt about HRMI’s ability to continue operations and make payments. Thiscustomer subsequently filed for bankruptcy on August 2, 2001.

 

Between September 29, 2000and December 6, 2000, we entered into several interest-bearing promissory noteswith Lifescape, LLC (Lifescape).  Theprincipal amount of these notes totaled $1,681,381, and each note carried aninterest rate of 12.0% per annum. Lifescape did not make payments as scheduled in the notes.  During the first and second quarters of 2001we had several discussions with Lifescape and its affiliated companies,ValueOptions, Inc. (ValueOptions) and FHC Health Systems, Inc. (FHC), regardingpayment. As of June 30, 2001, based on negotiations we determined it wasappropriate to reserve for $300,000 of the amount due, because of our reducedexpectation of full payment. We continued to negotiate with Lifescape,ValueOptions and FHC during the third quarter and entered into a settlementagreement on October 1, 2001.  BeginningOctober 2001, ValueOptions and FHC have agreed to settle Lifescape’s obligationto us and to pay us $280,000 on the first day of each month for sixmonths.  We collected the first paymenton October 10, 2001, and the second payment on November 1, 2001.

 

Note C.  Net Loss Per Share:

 

We incurred net losses for the three and nine month periods endedSeptember 30, 2001 and 2000. The calculation of diluted net loss per commonshare does not include approximately 24,000 potential shares of common stockequivalents as their inclusion would be anti-dilutive.

 

Note D. Recent Accounting Standards:

 

In August 2001, theFinancial Accounting Standards Board (“FASB”) issued Statement No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS No.144), which addresses financial accounting and reporting for the impairment ordisposal of long-lived assets.  WhileSFAS No. 144 supersedes both SFAS No. 121, “Accounting for the Impairment ofLong-Lived Assets and for Long-Lived Assets to Be Disposed Of” and APB OpinionNo. 30, “Reporting the Results of Operations—Reporting the Effects of Disposalof a Segment of a Business, and Extraordinary, Unusual and InfrequentlyOccurring Events and Transactions” (APB No. 30), it retains the fundamentalprovisions of those Statements.  SFASNo. 144 becomes effective for fiscal years beginning after December 15,2001.  We are evaluating SFAS No. 144 todetermine the impact on our financial condition and results of operations, but do not expect that they will have amaterial effect on our financial statements.

 

In July 2001, the Financial Accounting Standards Board (FASB)issued Statement of Financial Accounting Standards (SFAS) No. 141, “BusinessCombinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets,” whichchange the accounting for business combinations and goodwill.  SFAS No. 141 requires that the purchasemethod of accounting be used for business combinations initiated after June 30,2001.  Use of the pooling-of-interestsmethod is prohibited.  SFAS No. 142changes the accounting for goodwill from an amortization method to animpairment-only approach.  Amortizationof goodwill, including goodwill recorded in past business combinations, willtherefore cease upon adoption of SFAS No. 142, which for us will be January 1,2002.  We are currently evaluating SFASNo. 141 and SFAS No. 142, but do not expect that they will have a materialeffect on our financial statements.  

The Financial AccountingStandards Board (FASB) issued Statement of Financial Accounting Standard (SFAS)No. 133, “Accounting for Derivative Instruments and Hedging Activities,” asamended by SFAS No. 138.  SFAS No. 133establishes accounting and reporting standards for derivative instruments andfor hedging activities.  SFAS No. 133requires companies to recognize all derivatives as either assets orliabilities, and measure those instruments at fair value. SFAS No. 133 iseffective beginning on January 1, 2001. We have implemented SFAS No. 133, asamended, in fiscal year 2001.  Theimplementation of SFAS No. 133 did not have an impact on our financialposition, results of operations or cash flows for the three or nine monthsended September 30, 2001.

 

Note E.  Restructuring Charges

 

Due to a decrease in demand forinformation technology consulting services, we undertook an initiative to focusour business and improve our operating performance by restructuring andstreamlining our operations during the second quarter of fiscal 2001.  This restructuring initiative included areduction in our workforce and the consolidation of certain unproductive orduplicative facilities.  In connectionwith our restructuring initiative,  weincurred a restructuring charge of $2.19 million in the second quarter offiscal 2001.  This charge was composedof $777,000 for severance payments, $123,000 for other employee-related costs,such as continued medical benefits, $1.173 million for facility closings andother leasehold termination costs, $87,000 arising out of a contract disputewith a vendor, and $28,000 of other related restructuring charges.  No non-cash write-offs were incurred inconnection with the restructuring charge.

 

In connection with the restructuring, we reduced our employeeheadcount by 89 employees, which represents approximately 28% of ourworkforce.  Of these 89 employees, 62employees (or approximately 70%) were billable consultants and 27 employees (orapproximately 30%) were non-billable staff. By the end of the third quarter of fiscal 2001, $72,000 in severancecosts and $8,000 in other employee-related costs remained, which are expectedto be paid during the fourth quarter of fiscal 2001.  The facilities charges were due to office closures in Pleasantonand Carlsbad, California, and St. Paul, Minnesota. By the end of the thirdquarter, $730,000 in facilities-related costs remained. We also wrote offapproximately $28,000 in fixtures and furniture.  No assets that were written off remained in use as of the end ofthe second quarter.

 

Restructuring activities through September 30, 2001, were asfollows:

 

**Restructuring Charge**

 

**Second Quarter 2001 Provision**

 

**Second Quarter 2001 Utilized**

 

**Third Quarter 2001 Utilized**

 

**Balance as of September 30, 2001**

 

Severance Payments to Employees

 

$

777,000 

 

$

430,000 

 

$

275,000 

 

$

72,000 

 

Other Employee Related Costs

 

$

123,000 

 

$

100,000 

 

$

15,000 

 

$

8,000 

 

Facility Closings

 

$

1,106,000 

 

$

248,000 

 

$

195,000 

 

$

663,000 

 

Leasehold Termination Costs

 

$

67,000 

 

$

-

 

$

-

 

$

67,000 

 

Other

 

$

115,000 

 

$

-

 

$

-

 

$

115,000 

 

Totals

 

$

2,188,000 

 

$

778,000 

 

$

485,000 

 

$

925,000 

 

 

Note F. Stockholders’ Equity and Warrants

 

On June 29, 2001, we sold 2,352,942 shares of our common stock atthe average closing bid price of our common stock on the Nasdaq Stock Marketfor the five trading days prior to the date of issuance, to Joseph B. Costello,our Vice Chairman, for $2.0 million.  Inconnection with this transaction, we also issued a warrant to Mr. Costello thatentitles him to purchase up to 1,176,471 shares of our common stock, at anexercise price of $1.0625 per share. The warrant exercise price represents 125% of the per share price of ourcommon stock on the date of issuance. The fair value of the warrant is $809,000, which is included as part ofadditional paid-in capital. The fair value of the warrant was calculated byutilizing the Black-Scholes option-pricing model and the following keyassumptions:

 

Assumptions:

 

 

 

 

 

 

 

Risk-free  interest rate

** **

4.69

%

Volatility

 

111

%

Expected life  (months)

 

48

 

 

On February 27, 2001, as amended on August 2, 2001, we establisheda secured revolving credit facility with Silicon Valley Bank that allows us toborrow up to a maximum of $5.0 million based on our eligible accountsreceivable.  The amended agreementrequires, among other things, that we comply with minimum tangible net worthand profitability covenants.  Inconnection with the establishment of the credit facility, we issued a warrantto purchase 35,000 shares at an exercise price of $2.80 per share to SiliconValley Bank.  The fair value of thewarrant issued upon establishment of the credit facility is $62,000.  The remaining fair value is being charged tointerest expense over the life of the credit facility.  As part of the amendment, we issued awarrant to Silicon Valley Bank to purchase an additional 35,000 shares ofcommon stock at an exercise price of $0.86 per share.  The exercise price for each warrant was established by averagingthe closing price of our common stock for the five trading days prior to thedate of issuance, and each warrant expires five years from the date ofissuance.  The fair value of the warrantissued upon the August 2001 amendment is $23,000.  The remaining fair value is being charged to interest expenseover the life of the credit facility. The aggregate fair value for the compensation cost for the warrantsgranted in connection with the February 27, 2001 establishment of the creditfacility and the August 2, 2001 amendment were calculated by using the fairvalue of the warrant on the date of grant, utilizing the Black-Scholesoption-pricing model and the following key assumptions:

 

Assumptions:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

February 27,  2001 warrant

 

 

** **

 

August 2, 2001 warrant

** **

 

** **

Risk-free  interest rate

 

4.80

%

 

Risk-free  interest rate

 

4.54

%

Volatility

 

83

%

 

Volatility

 

102

%

Expected life  (months)

 

48

 

 

Expected life  (months)

 

60

 

 

**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

**Overview**

 

ZAMBA Corporation provides customer relationship management (CRM)consulting and systems integration services for large corporations and otherorganizations.  CRM is a businessstrategy used by businesses and governmental organizations to help clientsbetter anticipate, understand and respond to the needs of their current andpotential customers through integrated, multi-channel solutions. CRM attemptsto increase their customers’ access to the enterprise through the use ofmultiple channels of communication, including the internet, call-based routing,and sales force automation, and to increase the enterprise’s knowledge of thepreferences and needs of its customers. Based on our CRM expertise and experience, we have created potentialsolutions addressing each aspect of CRM, including strategy, marketing andanalytics, commerce and content, contact center, mobile and wireless, sales,customer experience and support. We also own approximately 33% of the equity inNextNet Wireless, Inc., a private corporation engaged in the development ofwireless data products targeted at wireless digital subscriber lines. Our vicechairman, Joseph B. Costello, is also the chairman of NextNet Wireless, Inc.

 

We currently derive most of our revenues from systems integrationservices, including business case evaluation, system planning and design,software package implementation, custom software development, training,installation and change management.  Ourrevenues and earnings may fluctuate from quarter-to-quarter based on thenumber, size and scope of projects in which we are engaged, the contractualterms and degree of completion of such projects, any delays incurred inconnection with a project, the adequacy of provisions for losses, the accuracyof estimates of resources required to complete ongoing projects, and generaleconomic conditions and other factors. Consequently, the results of operationsdescribed in this report may not be indicative of results to be achieved infuture periods. In addition, revenues from a large client may constitute asignificant portion of our total revenues in any particular quarter.

 

**RestructuringCharges**

 

In connection with our initiative to focus our business andimprove our operating performance by restructuring and streamlining ouroperations, we recorded a restructuring charge of $2.19 million in the secondquarter of fiscal 2001, which represents approximately 8% of our revenue forthe nine months ended September 30, 2001. We conducted this restructuring dueto several factors, including (1) the impact of the slowing economy on ourbusiness, as evidenced by the 6% decrease in our revenue during the nine monthsended September 30, 2001, compared to the nine months ended September 30,2000,  (2) similar revenue decreasesexperienced by many other information technology consulting companies and (3)our expectation that our revenue during the remainder of the year would be lessthan the amount we had anticipated at the beginning of fiscal 2001. Because wehad increased our staffing and facilities during the last half of 2000 andfirst quarter of 2001 in anticipation of growth, our reduced expectationsrequired us to lower our ongoing costs, the largest of which are our payrolland facility expenses.

In order to reduce our payroll expenses, we reduced our headcountin the second quarter of fiscal 2001 by 89 employees, which representsapproximately 28% of our total workforce. Of these 89 employees, 62 employees (or approximately 70%) were billableconsultants and 27 employees (or approximately 30%) were non-billablestaff.Because most of the consultants who were laid off were not engaged onfull-time projects at the time of our workforce reduction, we do not believethat our ongoing operations will be significantly affected by this reduction.We paid $820,000 of the employee-related restructuring charge during the ninemonths ended September 30, 2001, and expect to pay $80,000 of theemployee-related restructuring charge during the fourth quarter of fiscal2001.  We expect the headcountreductions to result in a quarterly savings of approximately $2.0 million,which began in the third quarter of 2001.

 

The facilities portion of the restructuring charge includes newand additional lease termination costs and other expenses associated with ourdecision to consolidate our operations and close unproductive or duplicativeoffice locations in St. Paul, Minnesota, and Pleasanton and Carlsbad,California.  Of the approximately $1.2million in facilities-related restructuring charges, we paid $248,000 duringthe second quarter of fiscal 2001 and $195,000 during the third quarter offiscal 2001, and expect to pay the balance of approximately $730,000 betweenthe fourth quarter of fiscal 2001 and the third quarter of fiscal 2002.

 

Because our revenues were lower than anticipated in the secondquarter and the number of our consultants and size of our facilities wasdesigned to correlate with our expected revenues during the third quarter offiscal 2001, we do not expect our restructuring charges to have a materialadverse effect on our operations.  Infact, we anticipate that the restructuring charge will reduce our coststructure during the remainder of fiscal 2001 and into fiscal 2002.  We intend to continue our initiative toachieve more cost-efficient operations throughout the remainder of fiscal2001.  In addition, certain actions maynot be completed, or full savings realized, until sometime in fiscal 2002.  Although we do not expect to incur additionalrestructuring charges, our restructuring initiative, or a continued slowing ofthe demand for information technology consulting services, could cause us toincur additional restructuring expenses in amounts that have not yet beendetermined.  Although the amount andtiming of the cost savings that we expect to realize due to this restructuringis difficult to quantify, we currently anticipate that, in combination withother operational changes effectuated during the three months ended June 30,2001, we will realize cost savings of approximately $11.0 million during fiscal2002. Because we attempted to correlate the number of consultants andfacilities we retained with our expected revenues during the third quarter offiscal 2001, our workforce reductions in the second quarter of fiscal 2001should not significantly affect our operations, except that we expect therestructuring charge to reduce our cost structure during the remainder offiscal 2001 and into fiscal 2002.  Incombination with other operational changes effectuated during the secondquarter, the entire expected cost savings of $11.0 million should be realizedby the end of the second quarter of fiscal 2002.

 

**Resultsof Operations**

 

**Three months ended September 30, 2001,compared to the three months ended September 30, 2000**

** **

*Net Revenues*

Net revenues decreased 32% to $7.67 million in the third quarterof 2001 compared to $11.31 million in the third quarter of 2000.  The decrease was due principally to asignificant reduction in the demand for information technology consultingservices, due to a general slowdown in the economy.

 

*Project and Personnel Costs*

Project and personnel costs consist primarily of payroll andpayroll-related expenses for personnel dedicated to client assignments, and isdirectly associated with, and varies with, the level of client services beingdelivered.  These costs represent themost significant expense we incur in providing service.  Project costs were $4.35 million or 57% ofnet revenues in the third quarter of 2001 compared to $5.61 million or 50% ofnet revenues in the third quarter of 2000. The decrease in project costs between these periods was due primarily tothe decrease in the number of project personnel. Because our overall revenuedeclined, these costs represented an increased percentage of our overallrevenue in the third quarter of 2001. We anticipate project and personnel costs to decline on a dollar basisover the next two fiscal quarters, due to a decrease in the number of projectpersonnel.
**
*Sales and Marketing*

Sales and marketing costs consist primarily of salaries, employeebenefits and travel expenses of sales and marketing personnel, as well aspromotional costs.  Sales and marketingexpenses were $1.32 million or 17% of net revenues in the third quarter of2001, compared to $1.46 million or 13% of net revenues in the third quarter of2000.  The decrease in costs betweenthese periods was due to less commission expense, resulting from the decreasein revenue. The increase in percentage terms is due primarily to having lowerrevenue, but the same number of direct sales personnel between periods.  We anticipate the dollar amount of sales andmarketing expenses will remain relatively flat in the next two fiscal quarters.

 

*General and Administrative*

General and administrative costs consist primarily of expensesassociated with our management, information technology, training andrecruiting, occupancy costs, and finance and administrative groups.  General and administrative expenses were$2.90 million or 38% of net revenues in the third quarter of 2001, compared to$4.13 million or 37% of net revenues in the third quarter of 2000. The dollardecrease was primarily due to a decrease of $225,000 in salaries from reducedworkforce, a decrease of $340,000 in travel and entertainment expenses, and adecrease of $440,000 in bad debt expense, as we wrote off a large dot.comproject in the third quarter of fiscal 2000. We anticipate the dollar amount ofgeneral and administrative expenses will remain relatively flat in the next twofiscal quarters.

 

*Amortization of Intangibles*

Amortization of intangibles was $31,000 in the third quarter of2001 compared to $945,000 in the third quarter of 2000.  The amortization was mainly due to theacquisition of The QuickSilver Group, Inc. (“QuickSilver”) in September1998.  The QuickSilver acquisition wasaccounted for using the purchase method of accounting, and the purchase pricewas allocated to tangible and identifiable intangible assets.  The fair value of identifiable intangibleassets was $7.7 million and was allocated to the following categories: peopleand experiences, client references, client lists, and intellectual property anddelivery methodology.  These amounts arebeing amortized over economic useful lives ranging from two to four years.  Approximately 98% of the costs related tothe QuickSilver acquisition have been amortized as of September 30, 2001.

 

*Interest Income*

Interest income was $36,000 in the third quarter of 2001 comparedto $46,000 in the third quarter of 2000. The decrease is due to decreases in our cash and investment accounts,which were used in operating and investing activities, as well as thecontinuing decline in interest rates in 2001.

 

*Interest Expense*

Interest expense was $49,000 in the third quarter of 2001 comparedto $16,000 in the third quarter of 2000. The increase in interest charges is due to increased borrowings underour line of credit with Silicon Valley Bank, which we established in February2001.

 

*Income Taxes*

We have incurred net operating losses since inception.  Because we are uncertain as to whether wewill have taxable earnings in the future, we have not reflected any benefit ofsuch net operating loss carryforwards in the accompanying unauditedconsolidated financial statements.
**
*Net Loss*

Our net loss for the quarter ended September 30, 2001 was$937,000, or $0.03 per share, compared to a net loss for the quarter endedSeptember 30, 2000 of $802,000, or $0.03 per share.

 

**Nine months ended September 30, 2001,compared to the nine months ended September 30, 2000**

 

*Net Revenues*

Net revenues decreased 6% to $27.50 million in the nine monthsended September 30, 2001 compared to $29.24 million in the nine months endedSeptember 30, 2000. The decrease in revenues is primarily because demand forour services has significantly declined in the past two quarters, due to areduction in demand for information technology consulting services.  

 

*Project and Personnel Costs*

Project and personnel costs consist primarily of payroll and payroll-relatedexpenses for personnel dedicated to client assignments, and is directlyassociated with, and varies with, the level of client services beingdelivered.  These costs represent themost significant expense we incur in providing service.  Project costs were $16.18 million or 59% ofnet revenues in the nine months ended September 30, 2001, compared to $14.80million or 51% of net revenues in the nine months ended September 30,2000.  The increase in project costsbetween these periods was due primarily to the increase in the number ofproject personnel.  Project personnelincreased primarily as a result of an expected increase in the number and sizeof our engagements. The increase in these costs as a percentage of revenue isdue to a decline in our overall utilization. We anticipate project and personnel costs to decline on a dollar basisover the next two fiscal quarters, due to a decline in the number of projectpersonnel.

 

*Sales and Marketing*

Sales and marketing costs consist primarily of salaries, employeebenefits and travel expenses of sales and marketing personnel, as well aspromotional costs.  Sales and marketingexpenses were $4.53 million or 16% of net revenues in the nine months endedSeptember 30, 2001, compared to $3.67 million or 13% of net revenues in thenine months ended September 30, 2000. The increase in both dollar and percentage terms is due primarily to thehiring of additional sales and marketing personnel. We anticipate the dollar amountof sales and marketing expenses will remain relatively flat in the next twofiscal quarters.

 

*General and Administrative*

General and administrative costs consist primarily of expensesassociated with our management, information technology, training andrecruiting, occupancy costs, and finance and administrative groups.  General and administrative expenses were$11.80 million or 43% of net revenues in the nine months ended September 30,2001, compared to $10.27 million or 35% of net revenues in the nine monthsended September 30, 2000.  The dollarand percentage increases were due primarily to investments we made inattempting to grow the business, which resulted in an increase in payroll andbenefits expense of $900,000, an increase in occupancy costs related to asignificant expansion of our office space of $340,000, and an increase in ourfurniture and equipment leasing related to the expansion of our office space of$680,000, offset partially by reduced travel and entertainment expenses of$315,000. We anticipate the dollar amount of general and administrativeexpenses will remain relatively flat in the next two fiscal quarters.  

 

*Amortization of Intangibles*

Amortization of intangibles was $106,000 in the nine months endedSeptember 30, 2001 compared to $2.84 million in the nine months ended September30, 2000.  The amortization was mainlydue to the acquisition of The QuickSilver Group, Inc. (“QuickSilver”) inSeptember 1998, as described in the three-month period analysis above.

 

*Interest Income*

Interest income was $126,000 in the nine months ended September30, 2001 compared to $177,000 in the nine months ended September 30, 2000.  The decrease is due to decreases in our cashand investment accounts, which were used in operating and investing activities,as well as the continuing decline in interest rates in 2001.

*Interest Expense*

Interest expense was $128,000 in the nine months ended September30, 2001 compared to $55,000 in the nine months ended September 30, 2000. Theincrease in interest charges is due to increased borrowings under our line ofcredit with Silicon Valley Bank, which we established in February 2001.

 

*Income Taxes*

We have incurred net operating losses since inception.  Because we are uncertain as to whether wewill have taxable earnings in the future, we have not reflected any benefit ofsuch net operating loss carryforwards in the accompanying unauditedconsolidated financial statements.  

 

*Net Loss*

Our net loss for the nine months ended September 30, 2001 was$7.31 million, or $0.22 per share, compared to a net loss for the nine monthsended September 30, 2000 of $2.21 million, or $0.07 per share.

 

**Liquidity andCapital Resources**  

 

We invest primarily in instruments that are highly liquid,investment grade and have maturities of less than one year. At September 30, 2001,we had approximately $3.5 million in cash and cash equivalents, compared to$4.8 million at December 31, 2000.  

 

Cash used in operating activities was$5.1 million for the nine months ended September 30, 2001 and resultedprimarily from a loss before amortization, depreciation and other non-cashstock compensation charges of  $6.7million, which was offset by a decrease in accounts receivable of $2.2million.  Cash used in operatingactivities was $2.0 million for the nine months ended September 30, 2000, dueprimarily to income before amortization, depreciation and other non-cash stockcompensation charges of  $1.5 million,but was offset by an increase in accounts receivable of $4.6 million.

 

Cash used in investing activities was$832,000 for the nine months ended September 30, 2001, and resulted primarilyfrom the purchase of property and equipment of $670,000 and an increase inrestricted cash of $207,000.  Cash usedin investing activities was $1.8 million for the nine months ended September30, 2000 and resulted primarily from the purchase of property and equipment of$1.1 million and an increase in notes receivable to related parties of$723,000. 

 

Cash provided by financing activitieswas $4.7 million for the nine months ended September 30, 2001 and consistedprimarily of cash received from the line of credit of $2.8 million and cashreceived from the sale of common stock to Joseph B. Costello, a member of ourBoard of Directors, of $2.0 million. See Note F to our Notes to ConsolidatedFinancial Statements.  Cash provided byfinancing activities was $555,000 for the nine months ended September 30, 2000and consisted of cash received from the sale of common stock upon the exerciseof stock options of $909,000, which was offset partially by payments ofoutstanding debt of $354,000.  

On February 27, 2001, as amended onAugust 2, 2001, we established a secured revolving credit facility with SiliconValley Bank of up to a maximum of $5.0 million based on eligiblecollateral.  Borrowings under this line ofcredit bear interest at the bank’s prime rate plus 2.0%, and are payablemonthly.  The amended agreementrequires, among other things, that we comply with minimum tangible net worthand profitability covenants.  We were incompliance with the covenants as of September 30, 2001.  This facility is renewable annually. As ofSeptember 30, 2001, $2.8 million was outstanding under the line of credit.  

 

On June 29, 2001, we sold 2,352,942shares of our common stock at market value, to Joseph B. Costello, our ViceChairman, for $2.0 million.  Inconnection with this transaction, we also issued a warrant to Mr. Costello thatentitles him to purchase up to 1,176,471 shares of our common stock, at anexercise price of $1.0625 per share. The warrant exercise price represents 125% of the per share price of ourcommon stock on the date of issuance. The fair value of thewarrant is $809,000, which is included as part of additional paid-in capital.The fair value of the warrant was calculated by utilizing the Black-Scholesoption-pricing model.  See Note F to ourNotes to Consolidated Financial Statements. 

 

As of September 30, 2001, we had nosignificant capital spending or purchase commitments, except for a commitmentof approximately $325,000 relating to professional services software.  We had cash and cash equivalents totaling$3.5 million and working capital of $1.6 million.  We also have a secured revolving credit facility with Silicon ValleyBank that allows us to withdraw up to $5.0 million based on eligible accountsreceivable.  Under the secured revolvingcredit facility, we must be in compliance with certain tangible net worthcovenants. We believe that our existing cash and cash equivalents, togetherwith cash provided from operations and our secured revolving credit facility,should be sufficient to meet our working capital and capital expenditurerequirements through January 31, 2002. We also will continue to explorepossibilities for additional financing, which may include debt, equity, orother forms of financing.  We cannot becertain that additional financing will be available to us on favorable terms,if at all. If our financial performance causes us to violate the covenants inour secured revolving credit facility or adversely affects the amount of our eligibleaccounts receivable, and we are unable to obtain additional financing, we maynot be able to meet our cash requirements beyond January 31, 2002.

 

**Item 3.  Quantitative and Qualitative DisclosuresAbout Market Risk**  

 

We are exposed to market risk from changes in security prices andinterest rates. Market fluctuations could impact our results of operations andfinancial condition. We are exposed to certain market risks based on ouroutstanding debt obligations of $655,000 at September 30, 2001, as well as ourline of credit with Silicon Valley Bank, under which $2.8 million wasoutstanding at September 30, 2001. The interest rates charged on our long-termdebt obligations range from 6.0% to 10.5%, and these obligations mature monthlyand quarterly through December 2003.  Wedo not invest in any derivative financial instruments. Excess cash is investedin short-term low-risk vehicles, such as money market investments. Changes ininterest rates are not expected to have a material adverse effect on our business,financial condition or results of operations.  

 

On February 27, 2001, as amended on August 2, 2001, we establisheda secured revolving credit facility with Silicon Valley Bank. Borrowings underthis line of credit bear interest at the bank’s prime rate plus 2.0%. Theinterest is payable monthly.

 
****
**Cautionary Statement for Purposes of the‘Safe Harbor’ Provisions of the Private Securities Litigation Reform Act of1995**  

 

Certain statements in this Quarterly Report onForm 10-Q are "forward-looking statements" within the meaning of thePrivate Securities Litigation Reform Act of 1995. When used in this Quarterly Report on Form 10-Q, the words “may,”“should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,”“predicts,” “intends,” “potential” or “continue” and similar expressions aregenerally intended to identify forward-looking statements. Because theseforward-looking statements involve risks and uncertainties, actual resultscould differ materially from those expressed or implied by theseforward-looking statements. These statements are only predictions. Although webelieve that the expectations reflected in the forward-looking statements arereasonable, we cannot guarantee future results, levels of activity, performanceand/or achievements.  

 

Forward-looking statementsrepresent our expectations or beliefs concerning future events, includingstatements regarding our ability to reverse our recent revenue declines, ourability to realize the expected benefits from our recent restructuring initiative,the effect of the recent sale of the CRM products of a major CRM developer onour business, our ability to attract and retain customers, our ability toadjust the mix of our services to meet the needs of the market, our ability toadapt to rapidly changing technologies in the CRM industry, the ability of ourpartners to maintain competitive products, the impact of competition andpricing pressures from actual and potential competitors with greater financialresources, our ability to obtain large-scale consulting services agreements,the unpredictable client decision-making processes, changes in expectationsregarding the information technology consulting industry, our ability to hireand retain competent employees, our ability to make acquisitions underadvantageous terms and conditions, our success in integrating acquisitions intoour business and our culture and possible costs incurred related to theintegration, our ability to grow revenues from acquired companies, possiblechanges in collections of accounts receivable and notes receivable, our abilityto protect and reuse our intellectual property, our ability to continue to listour stock on the Nasdaq National Market, changes in general economic conditionsand interest rates, and other factors identified in our filings with theSecurities and Exchange Commission, including those identified in Exhibit 99 tothis Quarterly Report on Form 10-Q. We disclaim any intention or obligation toupdate or revise any forward-looking statements, whether as a result of newinformation, future events or otherwise. 

 

**PART II. OTHER INFORMATION**

** **

Item 1.    Legal Proceedings

                

We are subject to various legal proceedings and claims that arisein the ordinary course of business.  Wecurrently believe that resolving these matters will not have a material adverseeffect on our business, financial condition or results of operations.

                

Item 2.    Changes in Securities

                

                None.

                

Item 3.    Defaults UponSenior Securities

                

                None.

                

Item 4.    Submission ofMatters to a Vote of Security Holders

                

                None.

                

Item 5.    Other Information

                

                None.

                

Item 6.    Exhibits andReports on Form 8-K

                

(a)           Exhibits: (See attached exhibit index)

                

(b)           Reports on Form 8-K:

 

 

On July 2, 2001, we filed a report on Form8-K to report the purchase of 2,352,942 shares of common stock by Joseph B.Costello, our Vice Chairman. We also issued a warrant to Mr. Costello thatentitles him to purchase up to 1,176,471 shares of common stock at an exerciseprice of $1.0625 per share.

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned thereunto duly authorized.

 

 

ZAMBA  CORPORATION

 

 

 

 

By:

/s/ Douglas M.  HoldenDouglas M. Holden  President and Chief Executive Officer

 

 

 

 

By:

/s/ Michael H.  Carrel  Michael H. CarrelExecutive Vice President and  Chief Financial Officer  (Principal Financial and Accounting Officer)

 

 

 

 

Dated:

November 14,  2001

 

 

EXHIBITINDEX

 

 

**EXHIBIT NUMBER**

 

** **

**TITLE**

 

 

 

10.01

 

Settlement Agreement and Mutual Release between Lifescape,  LLC, ValueOptions, Inc., FHC Health Systems, Inc. and Zamba dated October 1,  2001

 

 

 

99

 

Cautionary Statement Regarding Forward-Looking  Statements

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