**SECURITIES AND EXCHANGE COMMISSION**

**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 ended September  30, 2003** |
|                                                   |   |                                                                                                                                                                                     |
| **OR**                                                 |
|                                                   |   |                                                                                                                                                                                     |
| **o**                                                  |   | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                            |
|                                                   |   |                                                                                                                                                                                     |
|                                                   |   | **For the transition period from                to            ** |

 

**CommissionFile Number 0-22718**

 

**ZAMBACORPORATION**

(Exact name of Registrant as specified in itscharter)

 

| **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, includingarea code)

 

Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

YES                          ý                                                            NO                              o

 

Indicate by check mark whether the Registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).

YES                          o                                                            NO                              ý

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.

 
| **Class**                     |   | **Outstanding at  November 7, 2003** |
|-------------------------------|--------|--------------------------------------|
| Common Stock, $0.01 par value |   | 38,883,817                           |

 

 

----

 

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, 2003 and 2002 |
|                                |   |
|                                | Consolidated Balance Sheets as of  September 30, 2003 and December 31, 2002 |
|                                |   |
|                                | Consolidated Statements of Cash Flows for  the  Nine Months Ended September 30, 2003 and 2002 |
|                                |   |
|                                | 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 |
|                                |   |
| Item 4.                             | Disclosure Controls and Procedures |
|                                |   |
| PART II – Other Information    |
|                                |
| Item 1.                             | Legal Proceedings |
|                                |   |
| Item  2.                            | Changes  in Securities and Use of Proceeds |
|                                |   |
| 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                          |

 

2

----

 

**Part I.Financial Information**

 

**Item 1: Financial Statements**

 

**ZAMBACORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 

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

 
|                                               |   | **Three months ended  September 30,** |       | **Nine months ended  September 30,** |       |
|----------------------------------------------------|--------|---------------------------------------|------------|--------------------------------------|------------|
|                                               |   | **2003**                              |       | **2002**                             |       | **2003** |   | **2002** |   |
| **Revenues:**                                      |   |                                  |       |                                 |       |   |   |   |   |
| **Professional services**                          |   | **$**                                 | **2,479**  | ** **                           | **$**      | **2,449** | ** ** | **$** | **7,591** | ** ** | **$** | **7,679** | ** ** |
| **Reimbursable expenses**                          |   | **241**                               | ** ** | **168**                              | ** ** | **759** | ** ** | **686** | ** ** |
| **Total revenues**                                 |   | **2,720**                             | ** ** | **2,617**                            | ** ** | **8,350** | ** ** | **8,365** | ** ** |
|                                               |   |                                  |       |                                 |       |   |   |   |   |
| **Costs and expenses:**                            |   |                                  |       |                                 |       |   |   |   |   |
| **Project and personnel costs**                    |   | **1,526**                             | ** ** | **1,859**                            | ** ** | **4,482** | ** ** | **7,776** | ** ** |
| **Reimbursable expenses**                          |   | **241**                               | ** ** | **168**                              | ** ** | **759** | ** ** | **686** | ** ** |
| **Sales and marketing**                            |   | **304**                               | ** ** | **246**                              | ** ** | **829** | ** ** | **1,582** | ** ** |
| **General and administrative**                     |   | **839**                               | ** ** | **1,599**                            | ** ** | **2,384** | ** ** | **6,175** | ** ** |
| **Restructuring and unusual charges**              |   | **—**                            | ** ** | **—**                           | ** ** | **—** | ** ** | **3,321** | ** ** |
| **Total costs and expenses**                       |   | **2,910**                             | ** ** | **3,872**                            | ** ** | **8,454** | ** ** | **19,540** | ** ** |
|                                               |   |                                  |       |                                 |       |   |   |   |   |
| **Loss from operations**                           |   | **(190**                              | **)**      | **(1,255**                           | **)**      | **(104** | **)** | **(11,175** | **)** |
|                                               |   |                                  |       |                                 |       |   |   |   |   |
| **Other income (expense):**                        |   |                                  |       |                                 |       |   |   |   |   |
| **Gain on sale of NextNet shares**                 |   | **—**                            | ** ** | **310**                              | ** ** | **2,603** | ** ** | **2,965** | ** ** |
| **Interest income**                                |   | **—**                            | ** ** | **1**                                | ** ** | **—** | ** ** | **12** | ** ** |
| **Interest expense**                               |   | **(47**                               | **)**      | **(94**                              | **)**      | **(94** | **)** | **(219** | **)** |
| **Other income (expense), net**                    |   | **(47**                               | **)**      | **217**                              | ** ** | **2,509** | ** ** | **2,758** | ** ** |
|                                               |   |                                  |       |                                 |       |   |   |   |   |
| **Income (loss) before extraordinary item**        |   | **(237**                              | **)**      | **(1,038**                           | **)**      | **2,405** | ** ** | **(8,417** | **)** |
|                                               |   |                                  |       |                                 |       |   |   |   |   |
| **Extraordinary gain from extinguishment of debt** |   | **—**                            | ** ** | **—**                           | ** ** | **198** | ** ** | **—** | ** ** |
|                                               |   |                                  |       |                                 |       |   |   |   |   |
| **Net income (loss)**                              |   | **$**                                 | **(237**   | **)**                                | **$**      | **(1,038** | **)** | **$** | **2,603** | ** ** | **$** | **(8,417** | **)** |
|                                               |   |                                  |       |                                 |       |   |   |   |   |
| **Basic net income (loss) per share:**             |   |                                  |       |                                 |       |   |   |   |   |
| **Income (loss) before extraordinary item**        |   | **$**                                 | **(0.01**  | **)**                                | **$**      | **(0.03** | **)** | **$** | **0.07** | ** ** | **$** | **(0.22** | **)** |
| **Extraordinary gain from extinguishment of debt** |   | **—**                            | ** ** | **—**                           | ** ** | **—** | ** ** | **—** | ** ** |
| **Basic net income (loss) per share:**             |   | **$**                                 | **(0.01**  | **)**                                | **$**      | **(0.03** | **)** | **$** | **0.07** | ** ** | **$** | **(0.22** | **)** |
|                                               |   |                                  |       |                                 |       |   |   |   |   |
| **Diluted net income (loss) per share:**           |   |                                  |       |                                 |       |   |   |   |   |
| **Income (loss) before extraordinary item**        |   | **$**                                 | **(0.01**  | **)**                                | **$**      | **(0.03** | **)** | **$** | **0.07** | ** ** | **$** | **(0.22** | **)** |
| **Extraordinary gain from extinguishment of debt** |   | **—**                            | ** ** | **—**                           | ** ** | **—** | ** ** | **—** | ** ** |
| **Diluted net income (loss) per share**            |   | **$**                                 | **(0.01**  | **)**                                | **$**      | **(0.03** | **)** | **$** | **0.07** | ** ** | **$** | **(0.22** | **)** |
|                                               |   |                                  |       |                                 |       |   |   |   |   |
| **Weighted average shares outstanding:**           |   |                                  |       |                                 |       |   |   |   |   |
| **Basic**                                          |   | **38,865**                            | ** ** | **38,762**                           | ** ** | **38,840** | ** ** | **38,281** | ** ** |
| **Diluted**                                        |   | **38,865**                            | ** ** | **38,762**                           | ** ** | **40,973** | ** ** | **38,281** | ** ** |

 

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

 

3

----

 

**ZAMBA CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 

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

 
|                                                                                                                                                                      |   | **September 30,  2003** |       | **December 31,  2002** |       |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|------------------------|------------|
| **ASSETS**                                                                                                                                                                |   |                    |       |                   |       |
| **Current assets:**                                                                                                                                                       |   |                    |       |                   |       |
| **Cash and cash equivalents**                                                                                                                                             |   | **$**                   | **473**    | ** **             | **$**      | **549** | ** ** |
| **Accounts receivable, net**                                                                                                                                              |   | **1,839**               | ** ** | **662**                | ** ** |
| **Unbilled receivables**                                                                                                                                                  |   | **247**                 | ** ** | **470**                | ** ** |
| **Prepaid expenses and other current assets**                                                                                                                             |   | **117**                 | ** ** | **507**                | ** ** |
| **Total current assets**                                                                                                                                                  |   | **2,676**               | ** ** | **2,188**              | ** ** |
|                                                                                                                                                                      |   |                    |       |                   |       |
| **Property and equipment, net**                                                                                                                                           |   | **390**                 | ** ** | **531**                | ** ** |
| **Other assets**                                                                                                                                                          |   | **55**                  | ** ** | **102**                | ** ** |
| **Total assets**                                                                                                                                                          |   | **$**                   | **3,121**  | ** **             | **$**      | **2,821** | ** ** |
|                                                                                                                                                                      |   |                    |       |                   |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY (DEFICIT)**                                                                                                                  |   |                    |       |                   |       |
| **Liabilities:**                                                                                                                                                          |   |                    |       |                   |       |
| **Line of credit**                                                                                                                                                        |   | **$**                   | **1,301**  | ** **             | **$**      | **298** | ** ** |
| **Short-term loan**                                                                                                                                                       |   | **—**              | ** ** | **1,000**              | ** ** |
| **Current installments of long-term debt**                                                                                                                                |   | **—**              | ** ** | **266**                | ** ** |
| **Accounts payable**                                                                                                                                                      |   | **158**                 | ** ** | **584**                | ** ** |
| **Accrued expenses**                                                                                                                                                      |   | **1,106**               | ** ** | **2,593**              | ** ** |
| **Deferred revenue**                                                                                                                                                      |   | **185**                 | ** ** | **57**                 | ** ** |
| **Deferred gain on sale of NextNet shares**                                                                                                                               |   | **—**              | ** ** | **25**                 | ** ** |
| **Total current liabilities**                                                                                                                                             |   | **2,750**               | ** ** | **4,823**              | ** ** |
|                                                                                                                                                                      |   |                    |       |                   |       |
| **Long-term debt, less current installments**                                                                                                                             |   | **—**              | ** ** | **164**                | ** ** |
| **Other long-term liabilities**                                                                                                                                           |   | **81**                  | ** ** | **164**                | ** ** |
| **Commitments and contingencies**                                                                                                                                         |   |                    |       |                   |       |
| **Total liabilities**                                                                                                                                                     |   | **2,831**               | ** ** | **5,151**              | ** ** |
| **Stockholders’ equity (deficit):**                                                                                                                                  |   |                    |       |                   |       |
| **Common stock, $0.01 par value, 120,000 shares authorized,  38,884 and 38,823 shares issued and outstanding at September 30, 2003 and  December 31, 2002, respectively** |   | **389**                 | ** ** | **388**                | ** ** |
| **Additional paid-in capital**                                                                                                                                            |   | **86,077**              | ** ** | **86,060**             | ** ** |
| **Accumulated deficit**                                                                                                                                                   |   | **(86,176**             | **)**      | **(88,778**            | **)**      |
| **Total stockholders’ equity (deficit)**                                                                                                                             |   | **290**                 | ** ** | **(2,330**             | **)**      |
|                                                                                                                                                                      |   |                    |       |                   |       |
| **Total liabilities and stockholders’ equity (deficit)**                                                                                                             |   | **$**                   | **3,121**  | ** **             | **$**      | **2,821** | ** ** |

 

**The accompanying notes are anintegral part of the consolidated financial statements.**

 

4

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**ZAMBA CORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
|                                                                                      |   | **Nine months ended  September 30,** |       |
|-------------------------------------------------------------------------------------------|--------|--------------------------------------|------------|
| **(In thousands)**                                                                        |   | **2003**                             |       | **2002** |   |
|                                                                                      |   |                                 |       |   |   |
| **Cash flows from operating activities:**                                                 |   |                                 |       |   |   |
| **Net income (loss)**                                                                     |   | **$**                                | **2,603**  | ** ** | **$** | **(8,417** | **)** |
| **Adjustments to reconcile net income (loss) to net cash used  in operating activities:** |   |                                 |       |   |   |
| **Depreciation and amortization**                                                         |   | **233**                              | ** ** | **347** | ** ** |
| **Non-cash compensation - forgiveness of director loan**                                  |   | **—**                           | ** ** | **443** | ** ** |
| **Provision for bad debts**                                                               |   | **—**                           | ** ** | **20** | ** ** |
| **Gain on disposal of fixed assets**                                                      |   | **(7**                               | **)**      | **(2** | **)** |
| **Gain on sale of NextNet shares**                                                        |   | **(2,603**                           | **)**      | **(2,965** | **)** |
| **Extraordinary gain on extinguishment of debt**                                          |   | **(198**                             | **)**      | **—** | ** ** |
| **Changes in operating assets and liabilities:**                                          |   |                                 |       |   |   |
| **Accounts receivable**                                                                   |   | **(1,177**                           | **)**      | **(113** | **)** |
| **Unbilled receivables**                                                                  |   | **223**                              | ** ** | **479** | ** ** |
| **Notes receivable**                                                                      |   | **—**                           | ** ** | **535** | ** ** |
| **Prepaid expenses and other assets**                                                     |   | **402**                              | ** ** | **426** | ** ** |
| **Accounts payable**                                                                      |   | **(426**                             | **)**      | **(355** | **)** |
| **Accrued expenses and other long-term liabilities**                                      |   | **(1,552**                           | **)**      | **1,592** | ** ** |
| **Deferred revenue**                                                                      |   | **128**                              | ** ** | **114** | ** ** |
| **Net cash used in operating activities**                                                 |   | **(2,374**                           | **)**      | **(7,896** | **)** |
|                                                                                      |   |                                 |       |   |   |
| **Cash flows from investing activities:**                                                 |   |                                 |       |   |   |
| **Purchase of property and equipment**                                                    |   | **(53**                              | **)**      | **(49** | **)** |
| **Proceeds from sale of NextNet shares**                                                  |   | **750**                              | ** ** | **5,045** | ** ** |
| **Proceeds from sale of equipment**                                                       |   | **9**                                | ** ** | **4** | ** ** |
| **Restricted cash**                                                                       |   | **—**                           | ** ** | **471** | ** ** |
| **Notes receivable - related parties**                                                    |   | **—**                           | ** ** | **310** | ** ** |
| **Net cash provided by investing activities**                                             |   | **706**                              | ** ** | **5,781** | ** ** |
|                                                                                      |   |                                 |       |   |   |
| **Cash flows from financing activities:**                                                 |   |                                 |       |   |   |
| **Line of credit, net**                                                                   |   | **1,003**                            | ** ** | **(463** | **)** |
| **Proceeds from short-term loan**                                                         |   | **750**                              | ** ** | **—** | ** ** |
| **Proceeds from sale of common stock**                                                    |   | **4**                                | ** ** | **1,712** | ** ** |
| **Proceeds from exercises of stock options**                                              |   | **8**                                | ** ** | **13** | ** ** |
| **Payments of long-term debt**                                                            |   | **(173**                             | **)**      | **(147** | **)** |
| **Net cash provided by financing activities**                                             |   | **1,592**                            | ** ** | **1,115** | ** ** |
|                                                                                      |   |                                 |       |   |   |
| **Net decrease in cash and cash equivalents**                                             |   | **(76**                              | **)**      | **(1,000** | **)** |
| **Cash and cash equivalents, beginning of period**                                        |   | **549**                              | ** ** | **1,326** | ** ** |
| **Cash and cash equivalents, end of period**                                              |   | **$**                                | **473**    | ** ** | **$** | **326** | ** ** |
|                                                                                      |   |                                 |       |   |   |
| **Supplemental Schedule for Disclosures of Cash Flow  Information:**                      |   |                                 |       |   |   |
|                                                                                      |   |                                 |       |   |   |
| **Cash paid during the period for interest**                                              |   | **$**                                | **78**     | ** ** | **$** | **161** | ** ** |
|                                                                                      |   |                                 |       |   |   |
| **Non-cash investing and financing activity:**                                            |   |                                 |       |   |   |
|                                                                                      |   |                                 |       |   |   |
| **Conversion of note payable into sale of NextNet shares**                                |   | **$**                                | **1,750**  | ** ** | **$** | **—** | ** ** |
| **Conversion of long-term debt into sale of NextNet shares**                              |   | **$**                                | **71**     | ** ** | **$** | **—** | ** ** |

 

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

 

5

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ZAMBA CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Note A.  Basis of Presentation:

 

Theunaudited consolidated financial statements of Zamba Corporation as ofSeptember 30, 2003, and for the three and nine month periods ended September30, 2003 and 2002, reflect all adjustments (which include only normal recurringadjustments, except as disclosed in the footnotes) necessary, in the opinion ofmanagement, to fairly state our financial position as of September 30, 2003,and our results of 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 byaccounting principles generally accepted in the United States of America.  Certain prior year amounts have beenreclassified to conform with the 2003 presentation.  These financial statements should be read in conjunction with ouraudited consolidated financial statements and related notes for the year endedDecember 31, 2002, which were included in our 2002 Annual Report on Form 10-K.

 

Note B.  Liquidity:

 

We had a working capital deficit of $74,000 and stockholders’ equity of$290,000 as of September 30, 2003.  Topartially fund our operations during the nine months ended September 30, 2003,we utilized $1.5 million of proceeds received from the sales of shares of NextNetWireless, Inc. Series A Preferred Stock to Entrx Corporation (“Entrx”) and twoprivate investors during the first quarter. We received $750,000 as part of a loan agreement we entered into withEntrx during the fourth quarter of 2002. The amounts received under the loan were originally classified as a notepayable, which then was satisfiedby the transfer to Entrx of 415,340 shares of our NextNet Series A PreferredStock on March 31, 2003 at a price of $4.23 per share.  See Note K for additional discussion of thistransaction.  We also received $750,000from two private investors in exchange for an aggregate of 177,306 shares ofNextNet Series A Preferred Stock at a price of $4.23 per share.  Between September 30 and November 7, 2003,we received an additional $40,000 from two private investors from sales ofapproximately 27,000 shares of NextNet Series A Preferred Stock.  See Note H for additional discussionof these transactions.

 

We also partly fund our operations throughour Accounts Receivable Purchase Agreement with Silicon Valley Bank. This agreement renewed on July 29, 2003 and expires on July 29,2004.  However, both parties have theright to terminate this Agreement at any time. A total of $1,301,000 wasoutstanding as of September 30, 2003.  See Note G for additionaldiscussion.

 

Cash used in operating activities was $2.37 million for the nine monthsended September 30, 2003 and resulted primarily from an increase of $1.18million in accounts receivable and a decrease of $1.55 million in accruedexpenses.  Accounts receivable increasedmainly because collections from two of our significant customers during thethird quarter were slower than our historical average.  Accrued expenses decreased mainly because wecontinued to make payments under office and furniture lease terminationsettlement agreements negotiated since January 1, 2002.  The final such settlement payment of $15,000was paid in October 2003.

 

Our ability to continue as a going concerndepends upon our ability to regain and sustain profitability, continue toaccess our borrowing facility with our bank, and obtain any additional fundingthat may be needed.

 

6

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Note C. Selected BalanceSheet Information:

 
| **(in  thousands)**                             |   | **September 30, 2003** |   | **December 31, 2002** |   |
|-------------------------------------------------|--------|------------------------|--------|-----------------------|--------|
|                                            |   |                   |   |                  |   |
| Accounts  receivable, net:                      |   |                   |   |                  |   |
| Accounts  receivable                            |   | $                      | 1,983  |                  | $      | 806 |   |
| Less  allowance for doubtful accounts           |   | (144                   | )      | (144                  | )      |
| Totals                                          |   | $                      | 1,839  |                  | $      | 662 |   |
|                                            |   |                   |   |                  |   |
| Property  and equipment, net:                   |   |                   |   |                  |   |
| Computer  equipment                             |   | $                      | 828    |                  | $      | 802 |   |
| Furniture  and equipment                        |   | 293                    |   | 286                   |   |
| Leasehold  improvements                         |   | 60                     |   | 60                    |   |
| Totals                                          |   | 1,181                  |   | 1,148                 |   |
| Less  accumulated depreciation and amortization |   | (791                   | )      | (617                  | )      |
| Totals                                          |   | $                      | 390    |                  | $      | 531 |   |

 

Note D.  Net Income (Loss) Per Share:

 

Basic income(loss) per share is computed based on the weighted average number of commonshares outstanding.  Diluted income(loss) per share is computed based on the weighted average number of common shares outstanding adjusted bythe number of additional shares that would have been outstanding had thepotentially dilutive common shares been issued.  Potentially dilutive shares of common stock include options andwarrants to purchase our common stock at prices at or below the average marketprice for our common stock as of the last date of the time period beingmeasured.  A total of 2.1 million and noadditional shares were included in the diluted income (loss) per sharecalculation at September 30, 2003 and 2002, respectively. The calculation of weightedaverage diluted shares outstanding excludes options and warrants forapproximately 3.7 million common shares at September 30, 2003 that wereanti-dilutive, as the exercise prices of those options and warrants weregreater than the average market price.

 

Note E.  Recent Accounting Standards:

 

In May 2003, theFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity.”  SFAS No. 150 establishes standards for issuer classification andmeasurement of certain financial instruments with characteristics of bothliabilities and equity.  Instrumentsthat fall within the scope of SFAS No. 150 must be classified as liabilities.  SFAS No. 150 is effective for financialinstruments entered into or modified after May 31, 2003.  For financial instruments issued prior toJune 1, 2003, SFAS No. 150 was effective in the third quarter of 2003.  Adoption of SFAS No. 150 did not have animpact on our financial position, results of operations or cash flows in thethird quarter of 2003.

 

In January 2003, the FASBissued Statement of Financial Accounting Standards No. 148, “Accounting forStock-Based Compensation - Transition and Disclosure” (“SFAS 148”).  SFAS 148 amends FASB Statement of FinancialAccounting Standards No. 123, “Accounting for Stock-Based Compensation”  (“SFAS 123”) to provide alternative methods of transition for avoluntary change to the fair value based method of accounting for stock-basedemployee compensation.  In addition,SFAS 148 amends the disclosure requirements of SFAS 123 to require prominentdisclosures in both annual and interim financial statements of the method ofaccounting for stock-based employee compensation and the effect of the methodused on reported results.  SFAS 148 iseffective for fiscal years beginning after December 15, 2002 and was adopted byZamba for all periods presented herein. The adoption of SFAS 148 did not have an effect on our financialposition, results of operations or cash flows.

 

7

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In November 2002, theEmerging Issues Task Force (“EITF”) issued a final consensus on Issue 00-21:“Accounting for Revenue Arrangements with Multiple Deliverables.” In May 2003,the EITF issued additional interpretive guidance regarding the application ofIssue 00-21. Issue 00-21 provides guidance on how and when to recognizerevenues on arrangements requiring delivery of more than one product orservice. Issue 00-21 is effective prospectively for arrangements entered intoin fiscal periods beginning after June 15, 2003. Companies may also elect toapply the provisions of Issue 00-21 to existing arrangements and record theincome statement impact as the cumulative effect of a change in accountingprinciple.  The adoption of Issue 00-21is not expected to have an effect on our financial position, results ofoperations or cash flows.

 

NoteF.  Restructuring and Unusual Charges:

 

We incurred restructuring and unusual charges in 2002 that significantlyreduced our ongoing cost structure.  Inthe first quarter of 2002, we incurred unusual charges of $1.69 million forfacility and employment matters. Included in this amount was a$1.34 million charge related to closing our Campbell, California, and ColoradoSprings, Colorado facilities.  Thesetransactions have resulted in annual cost savings of $1.0 million.  In addition, a $350,000 charge was taken forseverance pay relating to reduced headcount, including the separation of threevice presidents, in the first quarter of 2002. These headcount reductions have resulted in annual savings of $3.5million.

 

In the second quarter of 2002, we incurred unusual charges of $1.64million for facility and non-cash compensation matters. Included in this amountwas a $1.19 million charge for facility closings and lease terminationcosts.  The facility charges included$190,000 for closing our Boston, Massachusetts, facility, $290,000 for reducingthe amount of space leased in Minneapolis, Minnesota, and $713,000 forincreasing the accrual for our St. Paul, Minnesota and Campbell, Californiafacilities to amounts consistent with buy-out offers made by ourlandlords.  These charges have resultedin annual savings of $1.2 million.  Wealso incurred a $443,000 non-cash compensation charge arising out of theexercise by Paul Edelhertz, a member of our board of directors, of his right toassign to us an aggregate of 250,000 shares of our common stock in exchange forour cancellation of a promissory note issued to us by Mr. Edelhertz bearing aprincipal balance of $500,000 and accrued interest through the date ofcancellation of $43,250.  Thistransaction related to an agreement dated December 26, 2000, as amended onAugust 2, 2001.

 

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A summary ofrestructuring and unusual charge activity through September 30, 2003 is asfollows:

 
|                                                                 |   | **Facility Closings  and Lease  Termination Costs** |    | **Severance and  Other Employee  Related Costs** |   | **Other** |   | **Total**  |    |
|----------------------------------------------------------------------|--------|-----------------------------------------------------|---------|--------------------------------------------------|--------|-----------|--------|------------|---------|
|                                                                 |   |                                                |    |                                             |   |      |   |       |    |
| Fourth  Quarter 2000 Provision                                       |   | $                                                   | 240,000 |                                             | $      | 307,000   |   | $          | 206,000 |   | $ | 753,000 |   |
| 2000  Utilized                                                       |   | —                                              |    | (137,000                                         | )      | (206,000  | )      | (343,000   | )       |
| Balance  as of December 31, 2000                                     |   | 240,000                                             |    | 170,000                                          |   | —    |   | 410,000    |    |
| Second  Quarter 2001 Provision                                       |   | 1,173,000                                           |    | 900,000                                          |   | 115,000   |   | 2,188,000  |    |
| Additional  facility related accruals in the fourth quarter of 2001  |   | 175,000                                             |    | —                                           |   | —    |   | 175,000    |    |
| 2001  Utilized                                                       |   | (786,000                                            | )       | (1,070,000                                       | )      | (115,000  | )      | (1,971,000 | )       |
| Balance  as of December 31, 2001                                     |   | 802,000                                             |    | —                                           |   | —    |   | 802,000    |    |
| First  Quarter 2002 Provision                                        |   | 1,335,000                                           |    | 350,000                                          |   | —    |   | 1,685,000  |    |
| Second  Quarter 2002 Provision                                       |   | 1,193,000                                           |    | —                                           |   | 443,000   |   | 1,636,000  |    |
| Additional  severance related accruals in the second quarter of 2002 |   | —                                              |    | 100,000                                          |   | —    |   | 100,000    |    |
| 2002  Utilized                                                       |   | (1,804,000                                          | )       | (315,000                                         | )      | (443,000  | )      | (2,562,000 | )       |
| Balance  as of December 31, 2002                                     |   | 1,526,000                                           |    | 135,000                                          |   | —    |   | 1,661,000  |    |
| First  Quarter 2003 Utilized                                         |   | (582,000                                            | )       | —                                           |   | —    |   | (582,000   | )       |
| Second  Quarter 2003 Utilized                                        |   | (452,000                                            | )       | (105,000                                         | )      | —    |   | (557,000   | )       |
| Third  Quarter 2003 Utilized                                         |   | (286,000                                            | )       | (30,000                                          | )      |      |   | (316,000   | )       |
| Balance  as of September 30, 2003                                    |   | $                                                   | 206,000 |                                             | $      | —    |   | $          | —  |   | $ | 206,000 |   |

 

NoteG.  Accounts Receivable PurchaseAgreement:

 

On July 29, 2002, weentered into an Accounts Receivable Purchase Agreement with Silicon Valley Bankto replace a prior revolving credit facility we had established with SiliconValley Bank.  This agreement entitles usto borrow up to a maximum of $2.0 million based on 80% of eligible receivables,and is secured by virtually all of our assets. Borrowings under this agreement bear interest at a monthly rate of 1% ofthe average daily balance outstanding during the period.  Additionally, on each reconciliation date,we pay an administrative fee equal to 0.25% of the face amount of eachreceivable purchased by Silicon Valley Bank during that reconciliationperiod.  The Accounts ReceivablePurchase Agreement renewed on July 29, 2003 and expires on July 29, 2004.  However, both parties have the right toterminate this Agreement at any time. If Silicon Valley Bank decides not to purchase receivables from us, ourability to fund our operations could be materially harmed.  The amount outstanding under this AccountsReceivable Purchase Agreement was $1,301,000 at September 30, 2003.

 

NoteH.  Sales of Investments:

 

In the first quarterof 2003, we entered into transactions with private investors in which we soldportions of our equity holdings in NextNet Wireless, Inc.  Several members of our board and managementteam are also involved in a variety of capacities at NextNet.  Our chairman, Joseph B. Costello, is alsothe chairman of NextNet. Another of our directors, Dixon Doll, is also adirector and a shareholder of NextNet. Additionally, another director of Zamba, Sven Wehrwein, has providedconsulting services to NextNet, and Michael Carrel, our CFO, is currentlyproviding consulting services to NextNet. There have been no other relationships or business transactions betweenthe two companies during this reporting period.

 

On January 27, 2003, we entered into an agreement to pay a third party$165,000 and transfer 16,667 shares of NextNet Series A Preferred Stock to thethird party’s family trust in exchange for cancellation of a debt obligationunder which we owed approximately $434,000 in principal and accrued interest.  As a result, we recorded an extraordinarygain on debt extinguishment of approximately $198,000 and a gain on sale ofNextNet shares of $71,000 in the first quarter of 2003.

 

On February 17, 2003, we sold 177,306 shares of NextNet Series APreferred Stock to two private investors for $750,000.  We recorded a deferred gain on sale ofinvestment in the first quarter of 2003 when we

 

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received the cash from thesetransactions. A gain on sale of investment was recorded in the second quarterof 2003, when the share transfer was completed.  In connection with these sales, we issued a warrant to purchaseup to 125,000 additional shares of NextNet Series A Preferred Stock to an investoraffiliated with a prior purchaser of NextNet shares.  This warrant bears an exercise price of $6.00 per share and maybe exercised any time prior to the close of business on December 31, 2004.

 

We transferred 415,340 shares of our NextNet Series A PreferredStock to Entrx Corporation on March 31, 2003, pursuant to a loan agreement weentered into with Entrx on November 5, 2002. See Note K for more information regarding our transaction with Entrx.

 

Between September 30 and November 7, 2003, we received an additional$40,000 from two private investors from sales of approximately 27,000 shares ofNextNet Series A Preferred Stock.

 

All NextNet shares that we sell are subject to the right of firstrefusal on the parts of NextNet and the holders of the Series B Preferred Stockof NextNet.

 

We currently own approximately 673,000 shares of NextNet Series APreferred Stock, or approximately 4.5% of the outstanding equity ofNextNet.  Of our remaining shares, wehave issued three warrants to two private investors to purchase up to 148,337additional shares of our NextNet Series A Preferred Stock from us at a price of$6.00 per share.  A warrant to purchaseup to 125,000 shares expires on December 31, 2004, and two warrants to purchasea total of 23,337 shares expire on December 31, 2005.  The two warrants that expire on December 31, 2005, were issued inconnection with each private investors’ commitment to purchase, at our requestat any time through December 31, 2003, NextNet shares from us at a purchaseprice of $1.47 per share that results in the first investor purchasing up to anaggregate of $500,000 worth of NextNet shares and the second investorpurchasing up to an aggregate of $200,000 worth of NextNet shares.

 

Note I. Income Taxes:

 

We have notrecorded any current or deferred income tax provision for any of the periodspresented since we have a net operating loss carryforward.  Because of the uncertainty about whether wewill have taxable earnings in the future, we have not reflected any benefit ofsuch net operating loss carryforwards in the accompanying consolidatedfinancial statements.  At September 30,2003, we had approximately $84 million of net operating loss carryforwardsremaining, which begin to expire in 2005. The use of these carryforwards in any one year may be limited underInternal Revenue Code Section 302 due to significant ownership changes.

 

Note J. Legal Matters:

 

We aresubject to various legal proceedings and claims that arise in the ordinarycourse of business that we do not believe are material either separately or inthe aggregate.

 

Note K. Loan Agreementwith Entrx Corporation:

 

On November 5, 2002, we entered into a loan agreement with EntrxCorporation, under which Entrx agreed to lend us up to $2.5 million in threeseparate advances.  We received thefirst advance of $1 million on November 4, 2002.  On February 19, 2003, this loan agreement wasamended.  In connection with theamendment, we received the second advance of $750,000, but waived our right toreceive the third advance.  Entrx alsowaived its rights to convert all outstanding advances into shares of our commonstock, and terminated an option under the original loan agreement to purchaseadditional shares of NextNet Series A Preferred Stock we own.  Entrx also agreed to waive interest chargesaccruing after December 2002.

 

OnMarch 31, 2003, all principal and accrued interest totaling $1.76 million was,pursuant to the loan agreement, converted into 415,340 shares of NextNetWireless Series A Preferred Stock. The conversion price was $4.23 per share,which was the per share price (on a common share equivalent basis,without giving effect to differences in rights or to anti-dilution provisionsor any other purchase price

 

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adjustments set forth in theNextNet loan agreement) that NextNet agreed to receive for a sale of otherpreferred stock.

 

NoteL. Major Customers:

 

A portion of our revenues have been derived from significant customersfor the three and nine month periods ended September 30, 2003 and 2002 as follows:

 
|        |   | **Three Months  Ended September 30,** |   | **Nine Months  Ended September 30,** |   |
|-------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|        |   | **2003**                              |   | **2002**                             |   | **2003** |   | **2002** |   |
| Customer  1 |   | 41                                    | %      | 0                                    | %      | 21 | % | 0 | % |
| Customer  2 |   | 17                                    | %      | 21                                   | %      | 19 | % | 8 | % |
| Customer  3 |   | 14                                    | %      | 15                                   | %      | 11 | % | 14 | % |
| Customer  4 |   | 7                                     | %      | 6                                    | %      | 7 | % | 11 | % |
| Customer  5 |   | 5                                     | %      | 3                                    | %      | 11 | % | 6 | % |
| Customer  6 |   | 3                                     | %      | 21                                   | %      | 8 | % | 19 | % |

 

Note M.  Stockholders’ Equity:

 

We have chosen to account for stock-based compensation using theintrinsic value method prescribed in Accounting Principles Board Opinion No.25, “Accounting for Stock Issued to Employees,” and related interpretations(APB No. 25).  We account forstock-based compensation to non-employees using the fair value methodprescribed by Statements of Financial Accounting Standards (SFAS) No. 123.  Accordingly, compensation costs for stockoptions granted to employees are measured as the excess, if any, of the valueof our stock at the date of the grant over the amount an employee must pay toacquire the stock.  Compensation costfor stock options granted to non-employees is measured as the fair value of theoption at the date of grant.  Suchcompensation costs, if any, are amortized on a straight-line basis over theunderlying option vesting terms.

 

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No compensation cost hasbeen recognized for stock options granted to employees or directors under our1989 Stock Option Plan, 1993 Equity Incentive Plan, 1993 Directors Option Plan,1997 Stock Option Plan, 1998 Non-Officers Plan, 1999 Non-Officers Plan, 2000Non-Officers Plan, or 2000 Non-Qualified Plan (collectively referred to as the“Plans”).  Had compensation cost for thePlans been determined based on the fair value of options at the grant date forawards in the three and nine month periods ended September 30, 2003 and 2002,our net income (loss) and net income (loss) per share would have changed to thepro forma amounts indicated below:

 

(Inthousands, except per share amounts)

 
|                                                                                                                                         |   | **Three Months  Ended September 30,** |   | **Nine Months  Ended September 30,** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                                                                                                                                         |   | **2003**                              |   | **2002**                             |   | **2003** |   | **2002** |   |
| Net  income (loss), as reported                                                                                                              |   | $                                     | (237   | )                                    | $      | (1,038 | ) | $ | 2,603 |   | $ | (8,417 | ) |
|                                                                                                                                         |   |                                  |   |                                 |   |   |   |   |   |
| Deduct  total stock based employee compensation expense determined under fair value  based method for all awards, net of related tax effects |   | (71                                   | )      | (1,900                               | )      | (805 | ) | (5,700 | ) |
|                                                                                                                                         |   |                                  |   |                                 |   |   |   |   |   |
| Pro  forma net income (loss)                                                                                                                 |   | $                                     | (308   | )                                    | $      | (2,938 | ) | $ | 1,798 |   | $ | (14,117 | ) |
|                                                                                                                                         |   |                                  |   |                                 |   |   |   |   |   |
| Earnings  per share:                                                                                                                         |   |                                  |   |                                 |   |   |   |   |   |
| Basic  - as reported                                                                                                                         |   | $                                     | (0.01  | )                                    | $      | (0.03 | ) | $ | 0.07 |   | $ | (0.22 | ) |
| Basic  - pro forma                                                                                                                           |   | $                                     | (0.01  | )                                    | $      | (0.08 | ) | $ | 0.05 |   | $ | (0.37 | ) |
|                                                                                                                                         |   |                                  |   |                                 |   |   |   |   |   |
| Diluted  - as reported                                                                                                                       |   | $                                     | (0.01  | )                                    | $      | (0.03 | ) | $ | 0.06 |   | $ | (0.22 | ) |
| Diluted  - pro forma                                                                                                                         |   | $                                     | (0.01  | )                                    | $      | (0.08 | ) | $ | 0.04 |   | $ | (0.37 | ) |

 

Inthe second quarter of 2003, we conducted an option exchange program under whichall of our directors, officers and employees could return their existing stockoptions to us in exchange for replacement options to be granted at least sixmonths and one day after the conclusion of the exchange program.  The number of replacement options to bereceived by any individual in exchange for that person’s existing optionsvaries, depending on the exercise prices of the options returned by thatperson.  Options to purchaseapproximately 3.9 million shares of common stock were cancelled under theoption exchange program.  We expect toissue options to purchase approximately 1.3 million shares of our stock underour option plans in exchange for the cancelled options.

 

**Item2.  Management’s Discussion****andAnalysis of Financial Condition and Results of Operations**

 

**Overview**

 

ZambaCorporation is a customer care services company.  We help our clients be more successful inacquiring, servicing, and retaining their customers.  Having served over300 clients, Zamba is focused exclusively on customer-centric services byleveraging best practices and best-in-class technologies to enable insightful,consistent interactions across all customer touch points.  We provide strategy and business processconsulting, as well as customization and systems integration for softwareapplications, which we call “packages,” that our clients purchase from thirdparties.  Based on our expertise and experience, we have created a framework ofinterdependent processes and technologies to help our clients, includingstrategy, analytics and marketing, contact center, content and commerce, fieldsales, field service, and enterprise integration.

 

Our revenues and earnings historically have fluctuated fromquarter-to-quarter based on the number, size, and scope of projects in which weare engaged, the contractual terms and degree of completion of such projects,any delays incurred in connection with a project, the adequacy of provisionsfor losses, the accuracy of estimates of resources required to complete ongoingprojects, general economic conditions, and other factors.  Consequently, the results of operationsdescribed in this report may not be indicative of results to be achieved in

 

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future periods.  In addition, revenues from a large clientmay constitute a significant portion of our total revenues in any particularquarter.

 

**Results of Operations**

 

**Three months endedSeptember 30, 2003, compared to the three months ended September 30, 2002**

 

*Net Revenues*

Revenues increased approximately 4% to $2.72 millionin the third quarter of 2003 compared to $2.62 million in the third quarter of2002.  Revenues before reimbursementsincreased approximately 1% to $2.48 million in the third quarter of 2003compared to $2.45 million in the third quarter of 2002.  The increase was due primarily to anincrease in our overall utilization in the third quarter of 2003 as compared tothe third quarter of 2002.  Our revenuewas stronger in the beginning of the third quarter than it was at the end ofthe quarter, and we do not yet foresee an upturn in our revenues in the fourthquarter of 2003.

 

*Project andPersonnel Costs*

Project and personnel costs consist primarily ofpayroll and payroll-related expenses for personnel dedicated to clientassignments.  These costs represent themost significant expense we incur in providing client service.  Project costs were $1.53 million orapproximately 56% of net revenues in the third quarter of 2003 compared to$1.86 million or approximately 71% of net revenues in the third quarter of 2002.  The decrease in project costs in dollar andpercentage of revenue terms between these periods was due primarily to thedecrease in our headcount.

 

*ReimbursableExpenses*

Reimbursable expenses consist of out-of-pocket expenses incurred whileproviding services that are reimbursed by our clients.  Pursuant to Financial Accounting StandardsBoard Staff Announcement (Topic No. D-103), reimbursable expenses are separateline items in both revenue and cost of revenue.

 

*Sales and MarketingCosts*

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 $304,000 or approximately 11% of net revenues in the thirdquarter of 2003, compared to $246,000 or approximately 9% of net revenues inthe third quarter of 2002.  The increasebetween these periods was due to a higher commission rate paid on revenuesearned from a new customer.

 

*General andAdministrative Costs*

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$839,000 or approximately 31% of net revenues in the third quarter of 2003,compared to $1.60 million or approximately 61% of net revenues in the thirdquarter of 2002.  A key factor in thedecrease in general and administrative costs was cost savings in office andequipment lease expenses.

 

*Interest Expense*

Interest expense was $47,000 in the third quarter of 2003 compared to$94,000 in the third quarter of 2002. The decrease was due to the absence in the third quarter of 2003 ofcharges incurred during the third quarter of 2002 for amortizing the commitmentfee for our former credit facility with Silicon Valley Bank and the warrants topurchase our common stock that were issued in connection with the establishmentand amendment of the credit facility, and the payoff of a majority of ourlong-term debt in the first quarter of 2003.

 

*Income Taxes*

Because we are uncertain as to whether we will have taxable earnings inthe future, we have not reflected any benefit of additional net operating losscarryforwards in the accompanying unaudited consolidated financial statements.  The use of these carryforwards in any oneyear may be limited under Internal Revenue Code Section 302 due to significantownership changes.

 

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*Net Income (Loss)*

Our net loss for the quarter ended September 30, 2003 was ($237,000),or ($0.01) per share, compared to a net loss for the quarter ended September30, 2002 of ($1.04) million, or ($0.03) per share.  Our net loss from operations, which does not include the gain onsale of NextNet shares, interest income and interest expense, was ($190,000)for the quarter ended September 30, 2003, compared to a net loss fromoperations of ($1.26) million for the quarter ended September 30, 2002.

 

**Nine months endedSeptember 30, 2003, compared to the nine months ended September 30, 2002**

 

*Net Revenues*

Revenues decreased less than 1% to $8.35 million forthe nine months ended September 30, 2003 compared to $8.37 million for the ninemonths ended September 30, 2002. Revenues before reimbursements decreased approximately 1% to $7.59million for the nine months ended September 30, 2003 compared to $7.68 millionfor the nine months ended September 30, 2002.

 

*Project andPersonnel Costs*

Project and personnel costs consist primarily ofpayroll and payroll-related expenses for personnel dedicated to clientassignments.  These costs represent themost significant expense we incur in providing client service.  Project costs were $4.48 million orapproximately 54% of net revenues for the nine months ended September 30, 2003compared to $7.78 million or approximately 93% of net revenues for the ninemonths ended September 30, 2002.  Thedecrease in project costs in dollar and percentage of revenue terms betweenthese periods was due primarily to the decrease in our headcount.

 

*Reimbursable Expenses*

Reimbursable expenses consist of out-of-pocket expenses incurred whileproviding services that are reimbursed by our clients.  Pursuant to Financial Accounting StandardsBoard Staff Announcement (Topic No. D-103), reimbursable expenses are separate lineitems in both revenue and cost of revenue.

 

*Sales and MarketingCosts*

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 $829,000 or approximately 10% of net revenues for the nine monthsended September 30, 2003, compared to $1.58 million or approximately 19% of netrevenues for the nine months ended September 30, 2002.  The decrease between these periods was primarilydue to a reduction in the average number of sales and marketing personnel.

 

*General andAdministrative Costs*

General and administrative costs consist primarily of expensesassociated with our management, information technology, training and recruiting,occupancy costs, and finance and administrative groups.  General and administrative expenses were$2.38 million or approximately 29% of net revenues for the nine months endedSeptember 30, 2003, compared to $6.18 million or approximately 74% of net revenuesfor the nine months ended September 30, 2002. Key factors in the decrease in general and administrative costs werecost savings in office and equipment lease expenses, a reduction in payrollexpenses, a gain (offset against costs) due to termination of a lease foroffice furniture and settlement of related litigation, and an $85,000 reductionin expense from the release of an accrual related to a settlement on aseverance agreement with our former CEO.

 

*Interest Expense*

Interest expense was $94,000 for the nine months ended September 30,2003 compared to $219,000 for the nine months ended September 30, 2002.  The decrease was due to the absence in thethird quarter of 2003 of charges incurred during the third quarter of 2002 foramortizing the commitment fee for our former credit facility with SiliconValley Bank and the warrants to purchase our common stock that were issued inconnection with the establishment and amendment of the credit facility, and thepayoff of a majority of our long-term debt in the first quarter of 2003.

 

*Gain on Sale ofNextNet Shares*

Gain on sale of NextNet shares was $2.60 million for the nine monthsended September 30, 2003 compared to $2.97 million for the nine months endedSeptember 30, 2002. This represents a gain on sales of a

 

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portionof our shares of NextNet Series A Preferred Stock, as described in Note H ofour Notes to Consolidated Financial Statements.

 

*Extraordinary Gainon Extinguishment of Debt*

Extraordinary gain on extinguishment of debt was $198,000 for the ninemonths ended September 30, 2003 compared to $0 for the nine months endedSeptember 30, 2002.  This represents again from an agreement to pay off our long-term debt owed to a third party inthe first quarter of 2003.

 

*Income Taxes*

Because we have net operating loss carryforwards that we may utilizeagainst taxes due on our earnings, we have not recognized a tax expense on ournet income for the nine month period ended September 30, 2003.  Because we are uncertain as to whether wewill have taxable earnings in the future, we have not reflected any benefit ofadditional net operating loss carryforwards in the accompanying unauditedconsolidated financial statements.  Theuse of these carryforwards in any one year may be limited under InternalRevenue Code Section 302 due to significant ownership changes.

 

*Net Income (Loss)*

Our net income for the nine months ended September 30, 2003 was $2.60million, or $0.07 per share, compared to a net loss for the nine months endedSeptember 30, 2002 of ($8.42) million, or ($0.22) per share.  Our net loss from operations for the ninemonths ended September 30, 2003 was ($104,000), compared to a net loss fromoperations for the nine months ended September 30, 2002 of ($11.18) million.

 

**Critical AccountingPolicies**

 

We have identified thepolicies below as critical to our business operations and the understanding ofour results of operations.  The impactand any associated risks to these policies on our business, financial conditionand results of operations is discussed throughout Management’s Discussion andAnalysis of Financial Condition and Results of Operations where these policiesaffect our reported financial results. Our preparation of this Form 10-Q requires us to make estimates andassumptions that affect the reported amount of assets and liabilities,disclosure of contingent assets and liabilities as of the date of our financialstatements, and the reported amounts of revenue and expenses during thereporting period.  There can be noassurance that actual results will not differ from those estimates.

 

Our critical accounting policies are asfollows:

•                  Revenue Recognition;

•                  Allowance for Doubtful Accounts; and

•                  Investment in NextNet Wireless, Inc.

 

For a detailed discussion ofthe application of these and other accounting policies, see Note 1 of the notesto the consolidated financial statements in our 2002 Annual Report on Form10-K.

 

***Liquidity andCapital Resources***

 

At September 30, 2003, wehad approximately $473,000 in cash and cash equivalents, compared to $549,000at December 31, 2002. As of September 30, 2003, we had no significant capitalspending or purchase commitments.  We had a working capital deficit of $74,000as of September 30, 2003. We had stockholders’ equity of $290,000 as ofSeptember 30, 2003.

 

Cash used in operatingactivities was $2.37 million for the nine months ended September 30, 2003 andresulted primarily from an increase of $1.18 million in accounts receivable anda decrease of $1.55 million in accrued expenses.  Accounts receivable increased mainly because collections from twoof our significant customers during the third quarter were slower than ourhistorical average.  Accrued expensesdecreased mainly because we continued to pay off office and furniture leasetermination settlement agreements negotiated over the past year.  The remaining settlement payment of $15,000was paid in October 2003.  For the ninemonths ended September 30, 2002, cash used in operating activities was $7.90million, which resulted primarily from a loss

 

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before depreciation and amortization of $8.07 millionand a gain on sale of NextNet shares of $2.97 million, which was partially offset by an increase of $1.59 millionin accrued expenses and a decrease of $535,000 in notes receivable.

 

Cash provided frominvesting activities was $706,000 for the nine months ended September 30, 2003,and resulted primarily from proceeds of $750,000 from the sale of a portion ofour NextNet shares to two private investors. For the nine months ended September 30, 2002, cash provided frominvesting activities was $5.78 million, which resulted primarily from proceedsfrom the sale of a portion of our NextNet shares.

 

Cash provided byfinancing activities was $1.59 million for the nine months ended September 30,2003 and consisted primarily of $750,000 in cash received under a loan fromEntrx Corporation and an increase of $1.00 million in borrowings under ouraccounts receivable purchase agreement with Silicon Valley Bank.  For the nine months ended September 30,2002, cash provided by financing activities was $1.12 million, which consistedprimarily of cash received from the sale of $1.71 million of common stock,partially offset by a decrease of $463,000 in borrowings under our line ofcredit.

 

Futurepayments due under debt and lease obligations as of September 30, 2003, are asfollows (in thousands):

 
| **Year  Ending  December 31,** |   | **Accounts  Receivable  Purchase  Agreement** |   | **Non  Cancelable  Operating  Leases** |   | **Accrued  Lease  Settlements** |   | **Total** |   |
|--------------------------------|--------|-----------------------------------------------|--------|----------------------------------------|--------|---------------------------------|--------|-----------|--------|
| 2003                           |   | $                                             | 1,301  |                                   | $      | 157                             |   | $         | 15     |   | $ | 1,473 |   |
| 2004                           |   | —                                        |   | 572                                    |   | —                          |   | 572       |   |
| 2005                           |   | —                                        |   | 404                                    |   | —                          |   | 404       |   |
| 2006                           |   | —                                        |   | 15                                     |   | —                          |   | 15        |   |
| 2007                           |   | —                                        |   | 4                                      |   | —                          |   | 4         |   |
| Total                          |   | $                                             | 1,301  |                                   | $      | 1,152                           |   | $         | 15     |   | $ | 2,468 |   |

 

On July 29, 2002, weentered into an Accounts Receivable Purchase Agreement with Silicon Valley Bankto replace our prior bank line of credit. This agreement entitles us to borrowup to a maximum of $2.0 million based on 80% of eligible receivables, and issecured by virtually all of our assets. Borrowings under this agreement bear interest at a monthly rate of 1% ofthe average daily balance outstanding during the period.  Additionally, on each reconciliation date,we pay an administrative fee equal to 0.25% of the face amount of eachreceivable purchased by Silicon Valley Bank during that reconciliationperiod.  This agreement renewed on July29, 2003 and expires on July 29, 2004. However, both parties have the right to terminate this Agreement at anytime.  The amount outstanding under thisagreement was $1,301,000 at September 30, 2003.

 

We believe that our existing cash and cash equivalents, together withcash provided from operations, our borrowings from the Accounts ReceivablePurchase Agreement with Silicon Valley Bank, $40,000 from sales ofapproximately 27,000 shares of NextNet Series A Preferred Stock betweenSeptember 30 and November 7, 2003, and commitments from two private investorsthrough December 31, 2003, to pay $700,000 for our remaining NextNet shares, ifnecessary, should be sufficient to meet our working capital and capitalexpenditure requirements through at least December 31, 2003.  Beyond that date, our ability to continue asa going concern depends on our ability to achieve and sustain profitability andgenerate positive cash flow from operations, continue to access borrowing withour bank, and obtain additional funding, if necessary.

 

We will continue to explore possibilities for additional financing,which may include debt, equity, or other strategic alternatives that may beavailable to us, including a potential sale of all or a portion of our stock,assets, or remaining investment in NextNet. We cannot be certain that additional financing will be available to uson favorable terms, if at all. If our financial performance adversely affectsour ability to obtain funds secured by our accounts receivable, and we areunable to obtain additional financing, we may not be able to meet our cashrequirements beyond December 31, 2003.

 

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

 

We are not currentlyexposed to market risk from changes in security prices and interest rates. 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 ourbusiness, financial condition or results of operations.

 

**Item 4.  Disclosure Controls and Procedures**

 

Our principal executive officer and principalfinancial officer have evaluated the effectiveness of the design and operationof our disclosure controls and procedures as of the end of the period coveredby this report (the “Evaluation Date”). Based on such evaluation, such officershave concluded that, as of the Evaluation Date, our disclosure controls andprocedures were effective to ensure that information required to be disclosedin the reports we file and submit under the Securities Exchange Act of 1934, asamended, is recorded, processed, summarized and reported within the timeperiods specified in the Securities and Exchange Commission’s rules and forms.

 

There has been no change in our internalcontrol over financial reporting during the period covered by this report thathas materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

**Cautionary Statementfor Purposes of the ‘Safe Harbor’ Provisions of the Private Securities LitigationReform Act of 1995**

 

Certain statements in this Quarterly Reporton Form 10-Q are “forward-looking statements” within the meaning of the PrivateSecurities Litigation Reform Act of 1995. When usedin this Quarterly Report on Form 10-Q, the words “may,” “should,” “expects,”“plans,” “anticipates,” “believes,” “estimates,” “predicts,” “intends,”“potential” or “continue” and similar expressions are generally intended toidentify forward-looking statements. Because these forward-looking statementsinvolve risks and uncertainties, actual results could differ materially fromthose expressed or implied by these forward-looking statements. Thesestatements are only predictions. Although we believe that the expectationsreflected in the forward-looking statements are reasonable, we cannot guaranteefuture results, levels of activity, performance and/or achievements.

 

Forward-looking statements represent our expectations or beliefsconcerning future events, including statements regarding the growth rate of the marketplace forcustomer-centric solutions, our ability to maintain skills in providingcustomer-centric solutions, changing client preferences for customer-centricsolutions, the ability of our partners to maintain competitive products, theimpact of competition and pricing pressures from actual and potentialcompetitors with greater financial resources, the impact of competition andpricing pressures from actual and potential competitors who have lower-costoperations, such as offshore consulting firms based in India and othercountries in Asia and Europe, our ability to obtain large-scale consultingservices agreements, possibly lengthy client decision-making processes, ourability to fund operations, our ability to hire and retain competent employees,possible delays in collections of accounts receivable, changes in generaleconomic conditions and interest rates, changes in information technologyspending within companies, changes in the global geopolitical situation, salesof our NextNet shares, and other factors identified in ourfilings with the Securities and Exchange Commission, including those identifiedin Exhibit 99.01 to this Quarterly Report on Form 10-Q. We disclaim anyintention or obligation to update or revise any forward-looking statements,whether as a result of new information, future events or otherwise.

 

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**PART II. OTHER INFORMATION**

 

Item 1.             Legal Proceedings

 

We are subjectto various legal proceedings and claims that arise in the ordinary course ofbusiness, which we do not believe are material either separately or in theaggregate.

 

Item 2.             Changes in Securities and Use of Proceeds

 

None.

 

Item 3.             Defaults Upon Senior Securities

 

None.

 

Item 4.             Submission of Matters to a Vote of SecurityHolders

 

None.

 

Item 5.             Other Information

 

None.

 

Item 6.             Exhibits and Reports on Form 8-K

 

(a)                                  Exhibits:(See attached exhibit index)

 

(b)                                 Reportson Form 8-K:

 

On November 6,2003, we filed a report on Form 8-K, which contained a copy of our press releaseannouncing our financial results for the three and nine month periods endedSeptember 30, 2003.

 

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SIGNATURES

 

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

 

 
|   | ZAMBA CORPORATION        |
|--------|--------------------------|
|   |                     |   |
|   | By:                      | /s/ Norm Smith |   |
|   |                     | Norman D. Smith |
|   |                     | President and Chief Executive Officer |
|   |                     |   |
|   | By:                      | /s/ Michael H. Carrel |   |
|   |                     | Michael H. Carrel |
|   |                     | Executive Vice President and Chief Financial Officer |
|   |                     | (Principal Financial and Accounting Officer) |
|   |                     |   |
|   | Dated: November 12, 2003 |

 

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EXHIBIT INDEX

 
| **EXHIBIT NUMBER** |   | **TITLE**                                                                                                                |
|--------------------|--------|--------------------------------------------------------------------------------------------------------------------------|
| 31.1               |   | Rule  13a-14(a) Certification by Norman D. Smith, President and Chief Executive  Officer                                 |
|               |   |                                                                                                                     |
| 31.2               |   | Rule  13a-14(a) Certification by Michael H. Carrel, Executive Vice President and  Chief Financial Officer                |
|               |   |                                                                                                                     |
| 32.1               |   | Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
|               |   |                                                                                                                     |
| 32.2               |   | Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
|               |   |                                                                                                                     |
| 99.01              |   | Cautionary  Statement Regarding Forward-Looking Statements                                                               |

 

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