**SECURITIESAND 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 June 30, 2002**

** **

**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**

(Exactname of Registrant as specified in its charter)

 

| **Delaware**                     |   | **#41-1636021**      |
|----------------------------------|--------|----------------------|
| (State  or other jurisdiction of |   | (I.R.S.  Employer    |
| incorporation  or organization)  |   | Identification  No.) |
|                             |   |                 |

### **3033Excelsior Boulevard, Suite 200, Minneapolis, Minnesota 55416**

(Addressof principal executive offices, including zip code)

 

**(952) 832-9800**

(Registrant’stelephone number, including area code)

 

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

YES            ý                         NO          o

 

Indicate the number of shares outstanding ofeach of the issuer’s classes of common stock, as of the latest practicabledate.

 

|                           |   | **Outstanding at**  |
|--------------------------------|--------|---------------------|
| **Class**                      |   | **August 14, 2002** |
| Common  Stock, $0.01 par value |   | 38,761,729          |

 

 

 

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ZAMBA CORPORATION

 

INDEX

 

PART I — FinancialInformation

 
| Item 1.                          | Financial Statements  (Unaudited)                                     |                                               |   |
|----------------------------------|-----------------------------------------------------------------------|----------------------------------------------------|--------|
|                             |                                                                  |                                               |   |
|                             |                                                                  | Consolidated  Statements of Operations for the     |   |
|                             |                                                                  | Three and Six Months  Ended June 30, 2002 and 2001 |   |
|                             |                                                                  |                                               |   |
|                             |                                                                  | Consolidated Balance Sheets  as of                 |   |
|                             |                                                                  | June 30, 2002 and December  31, 2001               |   |
|                             |                                                                  |                                               |   |
|                             |                                                                  | Consolidated  Statements of Cash Flows for the     |   |
|                             |                                                                  | Six Months Ended  June 30, 2002 and 2001           |   |
|                             |                                                                  |                                               |   |
|                             |                                                                  | 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                       |                                                                  |
|                                  |                                                                       |                                                    |        |  |

 

 

2

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**Part I. Financial Information**

**Item1:Financial Statements**

** **

**ZAMBA CORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
|                                                                                    |   | **For the  three months ended**           |   | **For the  sixmonths ended** |   |
|-----------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|------------------------------|--------|
|                                                                                    |   | **June 30,**                              |   | **June 30,**                 |   |
|                                                                                    |   | **2002**                                  |   | **2001**                     |   | **2002** |   | **2001** |   |
|                                                                                    |   | **(In thousands, except per share data)** |   |
| Revenues:                                                                               |   |                                      |   |                         |   |   |   |   |   |
| Professional services                                                                   |   | $                                         | 2,230  |                         | $      | 8,020 |   | $ | 5,230 |   | $ | 19,830 |   |
| Reimbursable expenses                                                                   |   | 283                                       |   | 1,140                        |   | 518 |   | 2,542 |   |
| Total revenue                                                                           |   | $                                         | 2,513  |                         | $      | 9,160 |   | $ | 5,748 |   | $ | 22,372 |   |
|                                                                                    |   |                                      |   |                         |   |   |   |   |   |
| Costs and expenses:                                                                     |   |                                      |   |                         |   |   |   |   |   |
| Project and personnel costs                                                             |   | 2,596                                     |   | 5,688                        |   | 5,917 |   | 11,768 |   |
| Reimbursable expenses                                                                   |   | 283                                       |   | 1,140                        |   | 518 |   | 2,542 |   |
| Sales and marketing                                                                     |   | 478                                       |   | 1,292                        |   | 1,336 |   | 3,185 |   |
| General and administrative                                                              |   | 2,161                                     |   | 4,043                        |   | 4,576 |   | 8,900 |   |
| Restructuring and unusual charges                                                       |   | 1,636                                     |   | 2,188                        |   | 3,321 |   | 2,188 |   |
| Amortization of intangibles                                                             |   | —                                    |   | 76                           |   | — |   | 168 |   |
| Total costs and expenses                                                                |   | 7,154                                     |   | 14,427                       |   | 15,668 |   | 28,751 |   |
|                                                                                    |   |                                      |   |                         |   |   |   |   |   |
| Loss from operations                                                                    |   | (4,641                                    | )      | (5,267                       | )      | (9,920 | ) | (6,379 | ) |
|                                                                                    |   |                                      |   |                         |   |   |   |   |   |
| Other income (expense):                                                                 |   |                                      |   |                         |   |   |   |   |   |
| Gain on sale of NextNet shares                                                          |   | 2,655                                     |   | —                       |   | 2,655 |   | — |   |
| Interest income                                                                         |   | 3                                         |   | 36                           |   | 11 |   | 90 |   |
| Interest expense                                                                        |   | (59                                       | )      | (55                          | )      | (124 | ) | (79 | ) |
| Other income (expense), net                                                             |   | 2,599                                     |   | (19                          | )      | 2,542 |   | 11 |   |
|                                                                                    |   |                                      |   |                         |   |   |   |   |   |
| Net loss                                                                                |   | ($2,042                                   | )      | ($5,286                      | )      | ($7,378 | ) | ($6,368 | ) |
|                                                                                    |   |                                      |   |                         |   |   |   |   |   |
| Net loss per share — basic and diluted                                             |   | ($0.05                                    | )      | ($0.16                       | )      | ($0.19 | ) | ($0.20 | ) |
|                                                                                    |   |                                      |   |                         |   |   |   |   |   |
| Weighted average shares outstanding — basic and diluted                            |   | 38,938                                    |   | 32,340                       |   | 37,998 |   | 32,258 |   |
|                                                                                    |   |                                      |   |                         |   |   |   |   |   |
| The  accompanying notes are an integral part of the consolidated financial  statements. |

 

3

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**ZAMBACORPORATION**

**CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 

 
|                                                                                                                                                             |   | **June 30,**                              |   | **December  31,** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|-------------------|--------|
|                                                                                                                                                             |   | **2002**                                  |   | **2001**          |   |
|                                                                                                                                                             |   | **(In thousands, except per share data)** |   |
| **ASSETS**                                                                                                                                                       |
| Current assets:                                                                                                                                                  |   |                                      |   |              |   |
| Cash and cash equivalents                                                                                                                                        |   | $                                         | 356    |              | $      | 1,326 |   |
| Accounts receivable, net                                                                                                                                         |   | 1,392                                     |   | 1,556             |   |
| Unbilled receivables                                                                                                                                             |   | 356                                       |   | 608               |   |
| Notes receivable                                                                                                                                                 |   | —                                    |   | 560               |   |
| Notes receivable — related parties                                                                                                                          |   | 90                                        |   | 310               |   |
| Prepaid expenses and other current assets                                                                                                                        |   | 716                                       |   | 737               |   |
| Total current assets                                                                                                                                             |   | 2,910                                     |   | 5,097             |   |
| Property and equipment, net                                                                                                                                      |   | 941                                       |   | 1,799             |   |
| Restricted cash                                                                                                                                                  |   | 105                                       |   | 471               |   |
| Other assets                                                                                                                                                     |   | 215                                       |   | 301               |   |
| Total assets                                                                                                                                                     |   | $                                         | 4,171  |              | $      | 7,668 |   |
|                                                                                                                                                             |   |                                      |   |              |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                    |
| Liabilities:                                                                                                                                                     |   |                                      |   |              |   |
| Line of credit                                                                                                                                                   |   | $                                         | 695    |              | $      | 1,100 |   |
| Current installments of long-term debt                                                                                                                           |   | 155                                       |   | 392               |   |
| Advance from director                                                                                                                                            |   | 450                                       |   | —            |   |
| Accounts payable                                                                                                                                                 |   | 1,116                                     |   | 1,059             |   |
| Accrued expenses                                                                                                                                                 |   | 3,889                                     |   | 2,490             |   |
| Deferred revenue                                                                                                                                                 |   | 97                                        |   | 101               |   |
| Deferred gain on sale of investment                                                                                                                              |   | 310                                       |   | —            |   |
| Total current liabilities                                                                                                                                        |   | 6,712                                     |   | 5,142             |   |
| Long-term debt, less current installments                                                                                                                        |   | 292                                       |   | 194               |   |
| Other long-term liabilities                                                                                                                                      |   | 272                                       |   | 244               |   |
| Commitments and contingencies                                                                                                                                    |   |                                      |   |              |   |
| Total liabilities                                                                                                                                                |   | 7,276                                     |   | 5,580             |   |
| Stockholders’ equity (deficit):                                                                                                                             |   |                                      |   |              |   |
| Common stock, $0.01 par value, 120,000 shares authorized, 38,762 and  35,007 shares issued and outstanding at June 30, 2002 and December 31, 2001,  respectively |   | 388                                       |   | 350               |   |
| Additional paid-in capital                                                                                                                                       |   | 86,050                                    |   | 84,403            |   |
| Note receivable from director                                                                                                                                    |   | —                                    |   | (500              | )      |
| Accumulated deficit                                                                                                                                              |   | (89,543                                   | )      | (82,165           | )      |
| Total stockholders’ equity (deficit)                                                                                                                        |   | (3,105                                    | )      | 2,088             |   |
|                                                                                                                                                             |   |                                      |   |              |   |
| Total liabilities and stockholders’ equity                                                                                                                  |   | $                                         | 4,171  |              | $      | 7,668 |   |
|                                                                                                                                                             |   |                                      |   |              |   |
| The  accompanying notes are an integral part of the consolidated financial  statements.                                                                          |

 

4

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**ZAMBACORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
|                                                                                    |   | **Six Months  Ended June 30,** |   |
|-----------------------------------------------------------------------------------------|--------|--------------------------------|--------|
|                                                                                    |   | **2002**                       |   | **2001** |   |
|                                                                                    |   | **(In thousands)**             |   |
| Cash flows from operating activities:                                                   |   |                           |   |   |   |
| Net loss                                                                                |   | $                              | (7,378 | ) | $ | (6,368 | ) |
| Adjustments to reconcile net loss to net cash used in operating  activities:            |   |                           |   |   |   |
| Depreciation and amortization                                                           |   | 257                            |   | 420 |   |
| Non-cash compensation — forgiveness of director loan                               |   | 443                            |   | — |   |
| Provision for bad debts                                                                 |   | 20                             |   | 641 |   |
| Gain on sale of NextNet shares                                                          |   | (2,655                         | )      | — |   |
| Changes in operating assets and liabilities:                                            |   |                           |   |   |   |
| Accounts receivable                                                                     |   | 169                            |   | 2,596 |   |
| Unbilled receivables                                                                    |   | 252                            |   | (57 | ) |
| Notes receivable                                                                        |   | 535                            |   | 156 |   |
| Prepaid expenses and other assets                                                       |   | 107                            |   | (232 | ) |
| Accounts payable                                                                        |   | 57                             |   | (645 | ) |
| Accrued expenses and other long-term liabilities                                        |   | 2,095                          |   | 912 |   |
| Deferred revenue                                                                        |   | (4                             | )      | (555 | ) |
| Net cash used in operating activities                                                   |   | (6,102                         | )      | (3,132 | ) |
|                                                                                    |   |                           |   |   |   |
| Cash flows from investing activities:                                                   |   |                           |   |   |   |
| Purchase of property and equipment                                                      |   | (49                            | )      | (534 | ) |
| Proceeds from sale of NextNet shares                                                    |   | 2,965                          |   | — |   |
| Proceeds from sale of equipment                                                         |   | 1                              |   | — |   |
| Restricted cash                                                                         |   | 366                            |   | (207 | ) |
| Notes receivable — related parties                                                 |   | 220                            |   | 21 |   |
| Net cash provided by (used in) investing activities                                     |   | 3,503                          |   | (720 | ) |
|                                                                                    |   |                           |   |   |   |
| Cash flows from financing activities:                                                   |   |                           |   |   |   |
| Line of credit, net                                                                     |   | (405                           | )      | 2,000 |   |
| Advance from director                                                                   |   | 450                            |   | — |   |
| Proceeds from sale of common stock                                                      |   | 1,710                          |   | 2,211 |   |
| Proceeds from exercises of stock options                                                |   | 13                             |   | 23 |   |
| Payments of long-term debt                                                              |   | (139                           | )      | (300 | ) |
| Net cash provided by financing activities                                               |   | 1,629                          |   | 3,934 |   |
|                                                                                    |   |                           |   |   |   |
| Net increase (decrease) in cash and cash equivalents                                    |   | (970                           | )      | 82 |   |
| Cash and cash equivalents, beginning of period                                          |   | 1,326                          |   | 4,843 |   |
| Cash and cash equivalents, end of period                                                |   | $                              | 356    |   | $ | 4,925 |   |
|                                                                                    |   |                           |   |   |   |
| Supplemental Schedule for Disclosures of Cash Flow Information:                         |   |                           |   |   |   |
|                                                                                    |   |                           |   |   |   |
| Cash paid during the period for interest                                                |   | $                              | 124    |   | $ | 64 |   |
|                                                                                    |   |                           |   |   |   |
| The  accompanying notes are an integral part of the consolidated financial  statements. |

 

 

5

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ZAMBA CORPORATION

NOTESTO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

NoteA.  Basis of Presentation:

 

The unauditedconsolidated financial statements of ZAMBA Corporation as of June 30, 2002, andfor the three and six month periods ended June 30, 2002 and 2001, reflect alladjustments (which include only normal recurring adjustments) necessary, in theopinion of management, to fairly state our financial position as of June 30,2002, and our results of operations and cash flows for the reportedperiods.  The results of operations forany interim period are not necessarily indicative of the results to be expectedfor any other interim period or for the full fiscal year.  The year-end balance sheet data was derivedfrom audited financial statements, but does not include all disclosuresrequired by generally accepted accounting principles.  Certain prior year amounts have been reclassified to conform withthe 2002 presentation.  These financialstatements should be read in conjunction with our audited consolidatedfinancial statements and related notes for the year ended December 31, 2001,which were included in our 2001 Annual Report on Form 10-K.

 

Note B. Liquidity

 

Weincurred significant losses and negative cash flows from operations during thethree and six months ended June 30, 2002, and continued to incur operatinglosses in the first month of the third quarter of fiscal 2002.  To fund our operations, we raisedapproximately $5.97 million in financing between January 1, 2002 and July 31,2002. This amount includes approximately $4.29 million in exchange forselling some of our NextNet Wireless, Inc. (“NextNet”) stock, and an additional$1.68 million in exchange for our own common stock.  Transactions in the second quarter were as follows:

 

Between April 1, 2002 andJune 30, 2002, we entered into stock purchase agreements to sell 481,664 sharesof our Series A Preferred Stock in NextNet to eleven accredited investors,including three investment funds managed by one of our directors, Dixon Doll,in private transactions for an aggregate consideration of approximately$2,290,000.  We received $1,480,000 ofthe proceeds in April, $500,000 in May and $310,000 in June.  See Note H for additional discussion.

 

In April, we also enteredinto stock purchase agreements to sell 133,332 shares of our Series A PreferredStock in NextNet to two accredited investors in private transactions for anaggregate consideration of approximately $800,000.  Pursuant to these agreements, we expect to receive $400,000 inAugust 2002 and $400,000 in September 2002. See Note H for additional discussion.

 

In June 2002, we receivedan advance in the amount of $450,000 from Joseph B. Costello, our chairman. InJuly 2002, we received an additional $850,000 in advances from Mr. Costello. OnAugust 6, 2002, these advances were converted to shares of Zamba’s NextNetStock.** **See Notes H and I for additional discussion.

 

Wepartly fund our operations through our banking relationship with Silicon ValleyBank.  Prior to July 29, 2002, wemaintained a line of credit with Silicon Valley Bank. As of June 30, 2002, wewere not in compliance with covenants regarding profitability and tangible networth for our line of credit.  On July 29,2002, we entered into an Accounts Receivable Purchase Agreement with SiliconValley Bank to replace the line of credit. There are no financial covenants inthe new agreement with Silicon Valley Bank. See Note G for additional discussion.

 

6

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Ourability to continue as a going concern depends upon our ability to continue toaccess our borrowing facility with our bank, obtain additional funding, andachieve and sustain profitability. Additionally, if we receive an adverse judgment in any of the mattersdescribed in Note J, particularly with regard to our offices in Campbell, California,and St. Paul, Minnesota, our financial position could be materially adverselyaffected and we may not be able to continue as a going concern.  The accompanying financial statements havebeen prepared on a going concern basis, which assumes continuity of operationsand realization of assets and liabilities in the ordinary course ofbusiness.  These financial statements donot include any adjustments that might result if we were forced to discontinueour operations.

 

Note C. Selected BalanceSheet Information:

 

|                                           |   | **June 30,  2002**  |   | **December  31, 2001** |   |
|------------------------------------------------|--------|---------------------|--------|------------------------|--------|
|                                           |   | **(in  thousands)** |   |
| Accounts receivable, net:                      |   |                |   |                   |   |
| Accounts receivable                            |   | $                   | 1,532  |                   | $      | 1,739 |   |
| Less allowance for doubtful accounts           |   | (140                | )      | (183                   | )      |
|                                           |   | $                   | 1,392  |                   | $      | 1,556 |   |
| Property and equipment, net:                   |   |                |   |                   |   |
| Computer equipment                             |   | $                   | 1,668  |                   | $      | 1,695 |   |
| Furniture and equipment                        |   | 508                 |   | 614                    |   |
| Leasehold improvements                         |   | 410                 |   | 1,189                  |   |
|                                           |   | 2,586               |   | 3,498                  |   |
| Less accumulated depreciation and amortization |   | (1,645              | )      | (1,699                 | )      |
|                                           |   | $                   | 941    |                   | $      | 1,799 |   |

 

Note D.  Net Loss Per Share:

 

We incurred net losses forthe three and six-month periods ended June 30, 2002 and 2001. The calculationof diluted net loss per common share does not include approximately 0 and288,000 potential shares of common stock equivalents as of June 30, 2002 and2001, respectively, as their inclusion would be anti-dilutive.

 

**               **Note E.  RecentAccounting Standards:

 

                InJune 2002, the FASB issued Statement No. 146 (“FAS 146”), *Accounting for Costs Associated with Exit or DisposalActivities*, which addresses financial accounting and reporting forcosts associated with exit or disposal activities.  Under FAS 146, such costs will be recognized when the liabilityis incurred, rather than at the date of commitment to an exit plan.  FAS 146 is effective for exit or disposalactivities that are initiated after December 31, 2002, with early applicationpermitted.

 

In November 2001, theFinancial Accounting Standards Board (“FASB”) issued a Staff Announcement,entitled Topic No. D-103, regarding the income statement classification ofreimbursements received for “out-of-pocket” expenses incurred. This StaffAnnouncement requires that out-of-pocket expenses incurred and the relatedreimbursements for these expenses be reflected in the income statement on agross basis as both revenue and expense. Previously, we had classified these out-of-pocket expense reimbursementsas a reduction of project and personnel costs. This Staff Announcement is effective for financial reporting periodsbeginning after December 15, 2001, and accordingly, we implemented this StaffAnnouncement on January 1, 2002.  Wehave adjusted revenue for all periods reported to include out-of-pocket expensereimbursements.  This change inclassification had no effect on current or previously reported net loss or lossper share.

 

In August 2001, FASB issuedStatement of Financial Accounting Standards No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), which addressesfinancial accounting and reporting for the impairment or disposal of long-livedassets.  While SFAS No. 144 supersedesboth SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and forLong-Lived Assets to Be Disposed Of,” and APB Opinion No. 30, “Reporting theResults of Operations—Reporting the Effects of Disposal of a Segment of a

 

7

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Business, and Extraordinary, Unusual and InfrequentlyOccurring Events and Transactions”, it retains the fundamental provisions ofthose Statements.  SFAS No. 144 iseffective for fiscal years beginning after December 15, 2001, and accordingly,we implemented it on January 1, 2002. The implementation of SFAS No. 144 did not have an impact on ourfinancial position, results of operations or cash flows for the three or sixmonths ended June 30, 2002.

 

In July 2001, FASB issuedSFAS No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and OtherIntangible Assets,” which change the accounting for business combinations andgoodwill.  SFAS No. 141 requires thatthe purchase method of accounting be used for business combinations initiatedafter June 30, 2001.  Use of thepooling-of-interests method is prohibited. SFAS No. 142 changes the accounting for goodwill from an amortizationmethod to an impairment-only approach. Amortization of goodwill, including goodwill recorded in past businesscombinations, would have therefore ceased upon adoption of SFAS No. 142, whichfor us was January 1, 2002.  Theimplementation of SFAS No. 141 and SFAS No. 142 did not have an impact on ourfinancial position, results of operations or cash flows for the three or sixmonths ended June 30, 2002, as we had no goodwill remaining to be amortizedfrom past business combinations.

 

Note F.   Restructuring and Unusual Charges:

 

In the second quarter of2002, we incurred unusual charges of $1.64 million for facility and non-cashcompensation matters. Included in this amount was a $1.19 million charge forfacility closings and leasehold termination costs.  The facility charges included $190,000 for closing the Boston,Massachusetts, facility, $290,000 for reducing the amount of space leased inMinneapolis, Minnesota, and $713,000 for increasing the accrual for our St.Paul, Minnesota and Campbell, California facilities to amounts consistent withbuy-out offers made by our landlords. These charges will result in an annual savings of $1.8 million.  We also incurred a $443,000 non-cashcompensation charge arising out of the exercise by Paul Edelhertz, a member ofour board of directors, of his right to assign to us an aggregate of 250,000 sharesof our common stock in exchange for our cancellation of a promissory note owedby Mr. Edelhertz to us bearing a principal balance of $500,000 and accruedinterest through the date of cancellation of $43,250.  This transaction relates to an agreement dated December 26, 2000,as amended on August 2, 2001.

 

In the first quarter of2002, we incurred unusual charges of $1.69 million for facility and employmentmatters. Included in this amount was a  $1.34 million charge related to subleasingour Campbell, California, facility and terminating the lease for our ColoradoSprings, Colorado facility. Subsequently, the sublease in Campbell was cancelled, and as notedabove, we increased the reserve to reflect the buyout offer from ourlandlord.  These transactions willresult in an annual cost savings of $1.0 million.  In addition, a $350,000 charge was taken for severance payrelating to reduced headcount, including the separation of three vicepresidents, in the first quarter of 2002. Our headcount decreased in the first quarter of 2002 by 32 employees, or19% of our total workforce, through layoffs or voluntary attrition. Of thesereductions, 24 employees (or approximately 75%) were billable consultants and 8employees (or approximately 25%) were non-billable staff.  Because most of the consultants whoseparated from employment were not engaged on full-time projects at the time ofour workforce reduction, our ongoing operations were not materially adverselyaffected by this reduction. However, the reductions in our billable staff mayprevent us from obtaining future revenues from those positions, if revenueopportunities are available, unless we are able to hire replacement personnelin time to staff the potential future revenue opportunities.  Weexpect the headcount reductions to result in an annual savings of $3.5 million.We have paid $860,000 of these unusual charges as of June 30, 2002, and expectto pay  $330,000 in the third quarter of2002, $250,000 in the fourth quarter of 2002, and $250,000 in the first quarterof 2003.

 

                Weundertook a restructuring action in the second quarter of 2001, when werecorded a restructuring charge of $2.19 million.  We made other headcount reductions in the third and fourthquarters of 2001, and took further cost-reduction measures in the first andsecond quarters of 2002, as described above.

 

                Ourrestructuring charge in the second quarter of 2001 was composed of $777,000 forseverance payments, $123,000 for other employee-related costs (includingcontinued medical benefits for the terminated employees), $1.173 million forfacility closings and other leasehold termination costs, $87,000 to resolve acontract dispute with a vendor, and $28,000 of other related restructuringcharges.  No non-cash write-offs wereincurred in connection with the restructuring charge.

 

                Thefacilities portion of the restructuring charge in the second quarter of 2001includes new and additional lease termination costs and other expensesassociated with our decisions to consolidate our operations and closeunproductive or duplicative office locations in St. Paul, Minnesota, andPleasanton and Carlsbad, California.  Ofthe approximately $1.2 million in facilities-related restructuring chargesincurred in the second quarter of 2001, we paid $947,000 through June 30, 2002,and expect to pay the balance of approximately $226,000 in the third and fourthquarters of fiscal 2002.

 

                Asummary of restructuring and unusual charge activity through June 30, 2002 isas follows:

 
|                            |   | **Facility  Closings  and Leasehold Termination Costs** |      | **Severance  and  Other Employee Related Costs** |   | **Other** |   | **Total**  |    |
|---------------------------------|--------|---------------------------------------------------------|-----------|--------------------------------------------------|--------|-----------|--------|------------|---------|
|                            |   |                                                    |      |                                             |   |      |   |       |    |   |   |   |   |
| Second Quarter 2001 Provision   |   | $                                                       | 1,173,000 |                                             | $      | 900,000   |   | $          | 115,000 |   | $ | 2,188,000 |   |
| 2001 Utilized                   |   | (546,000                                                | )         | (900,000                                         | )      | (115,000  | )      | (1,561,000 | )       |
| Balance as of December 31, 2001 |   | 627,000                                                 |      | —                                           |   | —    |   | 627,000    |    |
| First Quarter 2002 Provision    |   | 1,345,000                                               |      | 350,000                                          |   | —    |   | 1,695,000  |    |
| Second Quarter 2002 Provision   |   | 1,193,000                                               |      | —                                           |   | 443,000   |   | 1,636,000  |    |
| YTD 2002 Utilized               |   | (1,102,000                                              | )         | (263,000                                         | )      | (443,000  | )      | (1,808,000 | )       |
| Balance as of June 30, 2002     |   | $                                                       | 2,063,000 |                                             | $      | 87,000    |   | $          | —  |   | $ | 2,150,000 |   |

 

                Wealso have accruals related to facilities and employees in addition to the abovebalances at June 30, 2002.  Additionalfacility related accruals total $196,000 at June 30, 2002, and additionalemployee severance related accruals total $100,000 at June 30, 2002.

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Note G.   Line of Credit:

 

                On July 29, 2002, we enteredinto an Accounts Receivable Purchase Agreement with Silicon Valley Bank toreplace a prior revolving credit facility we had established with SiliconValley Bank.. This agreement entitles us to borrow up to a maximum of $2.0million based on eligible receivables, and is secured by virtually all of ourassets.  Borrowings under this agreementbear interest at a monthly rate of 1% of the average daily balance outstandingduring the period.  Additionally, oneach reconciliation date, we pay an administrative fee equal to 0.25% of the faceamount of each receivable purchased by Silicon Valley Bank during thatreconciliation period.  This facilityrequires no financial covenants and expires on July 29, 2003.

 

                The Accounts Receivable PurchaseAgreement replaces a secured revolving credit facility that we established withSilicon Valley Bank on February 27, 2001, and amended on August 2, 2001 andDecember 31, 2001. The secured revolving credit facility entitled us to borrowup to a maximum of $5.0 million based on eligible collateral.  Borrowings under this line of credit boreinterest at the bank’s prime rate plus 2.0%, and were payable monthly.  The amended agreement required, among otherthings, that we comply with minimum tangible net worth and profitabilitycovenants.  We were not in compliancewith these covenants as of June 30, 2002. As of June 30, 2002, a total of $695,000 was outstanding under the lineof credit, which was the maximum eligible amount available to us under thecredit facility as of that date.  Thisfacility was to expire on December 31, 2002, but was replaced by the AccountsReceivable Purchase Agreement.  Amountsoutstanding under the revolving credit facility were converted to beingoutstanding under the Accounts Receivable Purchase Agreement.  We had previously received a $2 millioncommitment from our Chairman, Joe Costello, in support of our former line ofcredit.  Because of the expiration ofthe line of credit, and because Mr. Costello has provided us an amount inexcess of $2 million, Mr. Costello’s obligations under this commitment are nolonger in effect.

 

Note H.   Sales of Investments:

 

                Inthe second quarter of 2002, we entered into several transactions with privateinvestors in which we sold portions of our equity holdings in NextNet Wireless,Inc. (“NextNet”). NextNet is a private corporation that developsnon-line-of-sight broadband wireless access platforms that providetelecommunications carriers with solutions for rapid deployment of high-speed,two-way voice and data services over the “last mile” of the communicationsnetwork.  Our chairman, Joseph B.Costello, is also the chairman of NextNet. Another of our directors, DixonDoll, is also a director and a shareholder of NextNet.  There are no other relationships or businesstransactions between the two companies since at least January 1, 2000. 

 

                Wesold a portion of our shares of Series A Preferred Stock in NextNet for $3.00per share, and a portion of our shares of Series A Preferred Stock in NextNetfor $6.00 per share.  We determined thesales price for our NextNet shares from various sources, including: a)discussions with potential investors, wireless telecommunications industryexperts, investment bankers, and venture capitalists, b) looking at a proposedsale of NextNet stock with similar rights as ours that NextNet itself hadconsidered immediately prior to our first sale to an outside investor, c)analyzing and comparing publicly held securities in related industries, d)considering our immediate cash needs, and e) the stage of development thatNextNet was at as a company, at the time of the transactions. Another majorfactor in establishing the sales price was our determination of what anarms-length purchaser would pay for our shares.  We had approached potential buyers of our NextNet shares sinceJune 2001, but we were unable to find any interest, for many reasons includingthe facts that NextNet had not yet obtained any significant orders andinvestors were not interested in the telecommunications sector in general.  On April 8, 2002, NextNet announced itsfirst significant client, MVS Comunicaciones, the largest holder of fixedwireless spectrum in Mexico.  Based onthis announcement, some potential buyers became more interested in purchasingNextNet stock from us.

 

Based on our analysis, wedetermined that we would offer our NextNet shares at $6.00 per share.  However, as we discussed in our AnnualReport on Form 10-K, which we filed on April 1, 2002, we had only enough cashto meet our financial requirements through April 30, 2002.  We therefore had an immediate desire toobtain approximately $600,000 by mid-to-late April for payroll and otherimmediate cash needs.  The largerpotential investors included Imagine Capital Partners, The Rahn Group, BlakeCapital and Wyncrest Capital, which eventually participated in both the firstand second series of transactions. This group told us that they would not paymore than $3.00 per share if we wanted to raise money in such a short timeframe.  Other than several smallerparticipants in our first round, none of the other potential purchasers we hadcontacted indicated any interest in buying any of our NextNet shares at anyprice.  Therefore, for our initialseries of sales of NextNet stock, we agreed to sell 200,000 shares at $3.00 pershare.  Because Mr. Costello’sagreements to buy some of our NextNet shares, which were signed in February andMarch 2002, before any third party was willing to buy any of our NextNet stock,at any price, called for his shares to be valued at the per share priceestablished upon our sale of any shares of our NextNet stock to any thirdparty, the shares he purchased were then also valued at $3.00 per share.  In the next two series of investments, wewere able to offer more desirable and flexible payment terms, and therefore, wewere able to sell 281,664 shares at $6.00 per share from late April to earlyJune.  

 

The first series oftransactions occurred between April 10 and April 16, 2002, when we entered intostock purchase agreements with six private investors, in which the investorspurchased an aggregate of 200,000 shares of our Series A Preferred Stock inNextNet.  The investors paid us anaggregate amount of $600,000 for the shares, which were sold at a per shareprice of $3.00.  As a result of thisfirst series of transactions, the NextNet shares that we had agreed to sell toour chairman, Joseph B. Costello, pursuant to two stock purchase agreements,one dated February 26, 2002, and amended on March 25, 2002, and the seconddated March 25, 2002, were valued at $3.00 per share. As of March 31, 2002, Mr.Costello had paid us $700,000 pursuant to these two purchase agreements, whichmeans that as a result of the $3.00 per share valuation, Mr. Costello received233,333 of our NextNet shares.  We haveaccounted for Mr. Costello’s shares as being purchased at $3.00 per share.  In connection with a Registration Statementon Form S-3 that we filed on August 27, 2001, as amended on May 10, 2002, wereceived a comment letter from the SEC. In connection with this comment letter, our accounting for these sharesmay change, which could cause us to increase the gain we booked for sellingthese shares.  This gain would be offsetby a compensation charge equal to the amount of the increase. Therefore, thepotential alternative accounting treatment would not change the net proceeds wereceived from the transaction and we would recognize the same quarterly netloss under either accounting treatment.

 

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The second series oftransactions occurred between April 10 and April 30, 2002. During this secondseries, we entered into stock purchase agreements with seven private investors,in which we sold an aggregate of 229,997 shares of our Series A Preferred Stockin NextNet for an aggregate consideration of $1,380,000.  Of this amount, $880,000 was received inApril and $500,000 was received in May. All of the shares were sold at a per share price of $6.00.

 

The third series oftransactions occurred between May 29, 2002 and June 13, 2002. During this thirdseries, we entered into stock purchase agreements with two private investorsand three private investment funds managed by Dr. Doll, a director of ourcompany, in which we sold an aggregate of 51,667 shares of our Series APreferred Stock in NextNet for an aggregate consideration of $310,000.  Of this consideration, the entities managedby Dr. Doll purchased an aggregate of 25,000 of our NextNet shares for anaggregate consideration of $150,000.  Wereceived the cash for these shares in June. All of the shares were sold at a per share price of $6.00.

 

All of the NextNet sharesthat we sell, including those sold to Mr. Costello, are subject to the right offirst refusal on the parts of NextNet and the holders of the Series B PreferredStock of NextNet.

 

During the second quarter of2002, as a result of the first two series of NextNet stock sales, including thesales to Mr. Costello arising out of his payments in February and March, wereported a gain on sale of investment of $2,655,000, net of commissions of$25,000 to Ralph Muse, a former CEO of NextNet.  As of June 30, 2002, the third series of transactions, includingthe sales to entities managed by Dr. Doll, were recorded as a deferred gain onsale of investment, because the shares had not yet been transferred.  As of June 30, 2002, our remaining ownershipis 1,685,003 shares of Series A Preferred Stock in NextNet, or approximately27% of the equity in NextNet.

 

In connection with thesecond series of sales of NextNet shares in April 2002, we entered into stockpurchase agreements with two private investors, pursuant to which we agreed tosell an aggregate of 133,332 shares of our Series A Preferred Stock in NextNetfor an aggregate consideration of $800,000. Of this amount, $400,000 is to be received in August 2002 and $400,000is to be received in September 2002. The price for these shares is also $6.00 per share.  We will record a deferred gain on sale ofinvestment when we receive the cash from these transactions, and a gain on saleof investment will be recorded when the shares are transferred to the privateinvestors. However, we have not received the August 2002 payments, which weredue on August 1, so we intend to commence legal action to recover the amountsdue, as well as our costs and any other damages we may incur because of thefailures of the two investors to pay us on time.

 

In addition to the abovetransactions, in order to make payroll and other critical vendor payments,Joseph B. Costello, our chairman, advanced $450,000 to us in June 2002, and$850,000 in July 2002.  In considerationof these advances, our Board of Directors has agreed to transfer a total of216,668 of our shares of NextNet Series A Preferred Stock valued at $6.00 pershare. Mr. Costello may also receive more of our NextNet shares if, at any timeprior to December 31, 2002, the Company sells additional NextNet shares for anaggregate purchase price equal to or in excess of One Hundred Thousand Dollars($100,000) at a per share purchase price that is less than $6.00 per share.  In such event, we will provide Mr. Costellowith an amount of additional NextNet shares that causes the per share purchaseprice paid by Mr. Costello to be equivalent to the lower per share price of thesubsequent sale.

 

 

 

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Note I. Advance fromDirector:

 

                We received a $450,000 advance from Joseph Costello,our chairman, in June 2002.  We incurredno interest expense in connection with this advance during the secondquarter.  This advance was converted toNextNet Wireless shares on August 6, 2002. See Note H for additional discussion.

 

Note J. LegalMatters

 

                We are subject to various legalproceedings and claims that arise in the ordinary course of business.  The following is a summary of our currentlegal proceedings.

 

On January 24, 2002, ArmyCorps Operating Associates (“Army Corps”) filed a complaint in Minnesotadistrict court in Ramsey County against us and ZCA Corporation (f/k/a Camworks,Inc.), which is our wholly-owned subsidiary, alleging that we had failed to payrent for the month of January 2002 for a facility leased by ZCA in St. Paul,Minnesota.  The amount sought by ArmyCorps is approximately $35,000.  Thefacility had been leased by Camworks, Inc., from October 1997 through December1999, at which time ZCA acquired Camworks. Following the acquisition, the lease remained in the name of Camworksand was not assigned to us.  Monthlyrent for this facility is approximately $35,000, and has not been paid sinceDecember 2001.  Army Corps has notifiedus that it intends to amend its claim to seek rent for the months since January2002 and claim that the entire lease has been breached and seek to acceleratepayment of rent for the balance of the lease, which is approximately$1,700,000.  Because the lease is in thename of ZCA as successor-in-interest to Camworks and not in our name, ourposition is that we should not be held liable for the breach of the lease.  However, we cannot be sure that a courtwould not allow the plaintiff to pierce the corporate veil of ZCA and find usprimarily liable on the lease.  Thematter is scheduled to go to trial in mid-November 2002.  If we are unable to resolve this matter, andif we are unsuccessful in litigation, our financial position could bematerially harmed.

 

On July 17, 2002, WTA CampbellTechnology Park LLC (“WTA”) filed a complaint against us in the Superior Courtof California, County of Santa Clara, alleging that we had failed to maintainand restore the security deposit for our facility in Campbell, California.  WTA is seeking at least $163,638.97, pluslegal fees and interest, as part of its action.  Monthly rent for this facility is approximately $65,000, and thelease expires in June 2007.  WTA had drawnupon our security deposit to pay for rent that was past due for the facility.  Subsequently, rent for the month of August2002 has not been paid.  Therefore, WTAcould amend its claim to include the amount of the security deposit that itdraws upon for rent for the month of August 2002.  WTA may also claim that the entire lease has been breached andseek to accelerate payment of rent for the balance of the lease, which isapproximately $5,300,000.  Our answer toWTA's complaint is due within 30 days of the date of the complaint, and a pre-trialconference is scheduled for November 19, 2002. If we are unable to resolve this matter, and if we are unsuccessful inlitigation, our financial position could be materially harmed.

 

On May 20, 2002, a furniturelessor notified us by letter that it was declaring three furniture leases in default.  Subsequent to our receipt of this letter,this lessor collected on the approximately $263,000 letter of credit that wassecurity for these leases, which carry an aggregate monthly rent ofapproximately $22,000.  The amountreceived by this lessor exceeds by approximately $200,000 the amount of rentthat was unpaid as of June 30, 2002. This lessor has subsequently requested that we pay it approximately$331,000 and return the equipment. Although we believe this lessor has not yet engaged counsel, we have noassurance that this lessor will not file a lawsuit to recover the amounts thatit believes it is due under the leases. If we are unable to resolve this matter, and if we are unsuccessful inlitigation, our financial position could be materially harmed.

 

On July 22, 2002, anattorney for a second furniture lessor sent us a letter notifying us that itintended to declare that we had defaulted in payment of five leases for officefurniture and requested payment of approximately $215,000 in settlement of itsclaim.  We are in discussions with thislessor's attorney in an attempt to reach a mutually satisfactory settlement,but we cannot guarantee that this matter will not proceed to litigation or thatwe will be able to resolve this matter in a manner that will not materiallyaffect our financial position.

 

On August 5, 2002, ourformer president and CEO, Doug Holden, notified us by email that he believes wehave breached our severance agreement with him following the separation of hisemployment.  Mr. Holden has requestedcontinued payroll and benefits and continued vesting of stock options for sixmonths from June 27, 2002, the date of his separation.  The value of Mr. Holden's claims isapproximately $150,000.  We believe thatwe have valid defenses to Mr. Holden's claims. The timing and ultimate resolution of Mr. Holden's claims are uncertainat this time.

 

We have not receivedapproximately $400,000 from two private investors that was due on August 1,2002, in exchange for a total of 66,666 shares of NextNet Wireless, Inc. SeriesA Preferred Stock. We intend to commence legal action to recover the amountsdue, as well as our costs and any other damages we may incur because of thefailures of the two investors to pay on time.

 

We are attempting to resolvethese matters, but we cannot be certain that we will be able to successfullyresolve these matters on favorable terms, and we cannot be certain that we willbe successful in litigation.  If we areunable to resolve these matters, and if we lose the litigation for thesematters, our financial position could be materially harmed and we could becomeunable to pay our other creditors.  Wehave an aggregate total of $2.1 million accrued as of June 30, 2002, related tothe disputes above, based on various settlement offers we have received.  We cannot provide any assurance that we willbe able to settle these matters, if at all, for such amount.  We are also subject to other various legalproceedings and claims that we do not believe are material either separately orin the aggregate.

 

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

 

**Overview**

 

ZAMBA Corporation providescustomer relationship management (“CRM”) consulting and systems integrationservices for large corporations and other organizations.  CRM is a business strategy used bybusinesses and governmental organizations to help clients better anticipate,understand and respond to the needs of their current and potential customersthrough integrated, multi-channel solutions. CRM attempts to increase theircustomers’ access to the enterprise through the use of multiple channels ofcommunication, including the 

 

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internet, call-based routing, and sales forceautomation, with the goal being to increase the enterprise’s knowledge of thepreferences and needs of its customers. Based on our CRM expertise and experience, we have created solutionsthat we believe address each aspect of CRM, including strategy, marketing andanalytics, content and commerce, contact center, field sales, field service andenterprise integration.  We also ownstock in NextNet Wireless, Inc. (“NextNet”), a private corporation thatdevelops non-line-of-sight broadband wireless access platforms that providetelecommunications carriers with solutions for rapid deployment of high-speed,two-way voice and data services over the “last mile” of the communicationsnetwork.  Our chairman, Joseph B.Costello, is also the chairman of NextNet. Another one of our directors, DixonDoll, is also a director and a shareholder of NextNet.  See Note H to our Notes to ConsolidatedFinancial Statements for additional discussion regarding our sales of a certainportion of our NextNet investment.

 

We currently derive mostof our client revenues from systems integration services, including businesscase evaluation, system planning and design, software package implementation,custom software development, training, installation and change management.  Our revenues and earnings may fluctuate 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, and general economic conditions and other factors. Consequently, theresults of operations described in this report may not be indicative of resultsto be achieved in future periods. In addition, revenues from a large client mayconstitute a significant portion of our total revenues in any particularquarter.

 

**Strategic Alliance With HCL Technologies**

 

On February 22, 2002, we entered into a Strategic Alliance Agreementwith HCL Technologies America, Inc. (“HCL America”) and HCL TechnologiesLimited, India (“HCL”), in which we will work with HCL and HCL America tojointly pursue, facilitate, manage and maintain business opportunities withAmdocs and Blue Cross Blue Shield for the provision of CRM services through theuse of the services offered by, and the particular experience and expertise of,ZAMBA, HCL America and HCL.

 

Under the agreement, the costs of certain employees of Zamba and HCL,as well as related expenses, are assigned to this alliance.  The funding ratio for obligations related tothis alliance is 55% for HCL America and 45% Zamba for the first 18 months, and50% each after 18 months.  Revenuerecognized by Zamba depends on whether or not the contract is in Zamba’s name.If the contract is in HCL America’s name, as we expect most will be, revenuewill be earned by Zamba first, based on hourly rates worked for each Zambaresource.  Then any remaining profits onthe contract are split using the same ratio as describe above.  If the contract is in Zamba’s name, the fullcontract will be recognized as revenue as earned, and an amount for cost ofsales would be recorded for hourly rates of HCL employees working on thecontract, as well as for the remaining profits allocated to HCL.

 

Here is an example of howa contract under the strategic alliance will be accounted for.  For this example, we will assume thefollowing

 

•      thecontract revenue is $200,000;

•      thecontract is directly with HCL;

•      all revenueis received in one month;

•      thecontract is in the first 18 months of the alliance;

•      Zambaresources work 400 hours on the contract;

 

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•      HCLresources do not work on the contract; and

•      HCL Indiaresources work 640 hours.

 

                HCLwill subcontract the contract to Zamba, and Zamba will, in consultation withHCL, determine the hours to be worked by Zamba, HCL, and HCL Indiaresources.  Zamba would retain $78 foreach hour worked by its resources. Because Zamba’s resources in this example work 400 hours, Zamba wouldretain $31,200 for services performed by its resources.  Then, Zamba would pay $50 to HCL for eachhour worked by HCL resources, and $25 to HCL India for each hour worked by HCLIndia resources.  In this example, HCLdoes not provide any resources, and HCL India provides resources who work 640hours, which means that Zamba would pay $0 to HCL and $16,000 to HCL India forthe hours worked by its resources.

 

                Aftersubtracting the fees for hourly resources from the contract value, the balanceis $152,800.  Zamba would then receive aproject management fee equal to 44.125% of the balance, which in this examplewould be $67,423.  After Zamba’s projectmanagement fee is accounted for, the remaining $85,377 will be paid toHCL.  The total revenue for Zamba inthis example would be $98,623 ($31,200 from hours worked on the project, plus$67,423 in project management fees).

 

Our revenue related tothe alliance with HCL was $230,000 for the three months ended June 30,2002.  We received approximately$346,000 from HCL in connection with this alliance during the second quarter asreimbursement for the costs we have incurred on behalf of the alliance.  Of this amount, we are obligated to repay toHCL approximately $135,000 as of June 30, 2002.  This amount will be paid to HCL as a holdback from the projectmanagement fees we are to receive from future client services performed underthe alliance.  If the alliance does notgenerate enough client service revenues to allow us to earn sufficient projectmanagement fees to repay this obligation, we will not have to pay anyshortfall.  Our $135,000 repaymentobligation is recorded in the accrued liabilities section on our balance sheet

** **

**Results ofOperations**

 

**Three months ended June 30, 2002, compared to the threemonths ended June 30, 2001**

 

*Net Revenues*

Revenues decreasedapproximately 73% to $2.51 million in the second quarter of 2002 compared to$9.16 million in the second quarter of 2001. Revenues before reimbursements decreasedapproximately 72% to $2.23 million in the second quarter of 2002 compared to$8.02 million in the second quarter of 2001. The decrease was due principally to the continued significant reductionin the demand for information technology consulting services, associated with ageneral slowdown in the economy. With this economic slowdown, many companieshave either delayed decisions on information technology consulting projects, orcancelled the projects altogether, resulting in an industry-wide decrease inservices revenue.  In conjunction withthe decrease in our revenues, our billable headcount decreased to 70 as of June30, 2002, compared to 162 as of June 30, 2001. We are also experiencing strongpricing pressures, which is impacting our revenue.  

 

*Project and Personnel Costs*

Project andpersonnel costs consist primarily of payroll and payroll-related expenses forpersonnel dedicated to client assignments. These costs represent the most significant expense we incur in providingclient service.  Project costs were$2.60 million or 103% of net revenues in the second quarter of 2002 compared to$5.69 million or 38% of net revenues in the second quarter of 2001.  The decrease in project costs in dollarterms between these 

 

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periods was due primarilyto the decrease in our headcount from 162 billable consultants as of June 30,2002, to 70 billable consultants as of June 30, 2002. However, these costsrepresented an increased percentage of our overall revenue in the secondquarter of 2002, because our revenue decreased at a greater rate than wereduced project and personnel costs. Additionally, we are experiencing strong pricing pressures, which is notonly impacting our revenue as described above, but our gross margins as well.

 

*Reimbursable Expenses*

*               *Reimbursable expenses consist of out-of-pocket expenses incurred whileproviding services that are reimbursed by our clients. Pursuant to FinancialAccounting Standards Board Staff Announcement (Topic No. D-103), which waseffective for reporting periods beginning after December 15, 2001, reimbursableexpenses are separate line items in both revenue and cost of revenue. Prior toimplementation of this Announcement, we had accounted for reimbursable expensesby offsetting the amounts we were paid against project and personnelcosts.  Reimbursable expenses decreased75% to $283,000 in the second quarter of 2002 compared to $1.14 million in thesecond quarter of 2001. The decrease is due to the overall decline in revenueand services performed during the same time period.

 

*Sales and Marketing*

Sales and marketing costsconsist primarily of salaries, employee benefits and travel expenses of salesand marketing personnel, as well as promotional costs.  Sales and marketing expenses were $478,000or 19% of net revenues in the second quarter of 2002, compared to $1.29 millionor 14% of net revenues in the second quarter of 2001.  The decrease in dollar terms between these periods was due to areduction in the number of sales and marketing personnel, as well as lowercommission expenses resulting from the decrease in revenue. The increase inpercentage terms is due primarily to sales salaries being an increasingpercentage of revenue as a result of our revenue being lower than anticipatedin the second quarter of 2002.

 

*General and Administrative*

General and administrativecosts consist primarily of expenses associated with our management, informationtechnology, training and recruiting, occupancy costs, and finance and administrativegroups.  General and administrativeexpenses were $2.16 million or 86% of net revenues in the second quarter of2002, compared to $4.04 million or 44% of net revenues in the second quarter of2001. The overall decrease in costs was primarily due to cost savings of$700,000 in salaries, $550,000 in bad debt expense, $90,000 in travel andentertainment expenses, and $190,000 in telephone and network connectionexpenses.  The increase in percentageterms is due primarily to our costs for occupancy, information technology andsalaries not decreasing at the same rate as our revenue. We anticipate thedollar amount of general and administrative expenses will decrease over thenext two fiscal quarters.

 

*Restructuringand Unusual**Charges*

In the second quarter of2002, we incurred unusual charges of $1.64 million for facility and non-cashcompensation matters. Included in this amount was a $1.19 million charge forfacility closings and leasehold termination costs.  The facility charges included $190,000 for closing the Boston,Massachusetts facility, $290,000 for reducing the amount of space leased in theMinneapolis, Minnesota by approximately 60%, and $713,000 for increasing theaccrual for our St. Paul, Minnesota and Campbell, California facilities to amountsconsistent with buy-out offers made by our landlords.  These transactions will result in an annual savings of$800,000.  We also incurred a $443,000non-cash compensation charge arising out of the exercise by Paul Edelhertz, amember of our board of directors, of his right to assign to us an aggregate of250,000 shares of our

 

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common stock in exchange for our cancellationof a promissory note owed by Mr. Edelhertz to us bearing a principal balance of$500,000 and accrued interest through the date of cancellation of $43,250. Thistransaction relates to an agreement dated December 26, 2000, as amended onAugust 2, 2001.

* *

We undertook a restructuringaction in the second quarter of 2001, when we recorded a restructuring chargeof $2.19 million.  We made otherheadcount reductions in the third and fourth quarters of 2001, and took furthercost-reduction measures in the first and second quarters of 2002.  As a result of all of these actions, we havereduced our fixed quarterly expenses by more than $8.8 million, which is anapproximate annual savings of $35 million.

 

Our restructuring charge inthe second quarter of 2001 was composedof $777,000 for severance payments, $123,000 for other employee-related costs(including continued medical benefits for the terminated employees), $1.173million for facility closings and other leasehold termination costs, $87,000 toresolve a contract dispute with a vendor, and $28,000 of other relatedrestructuring charges.  No non-cashwrite-offs were incurred in connection with the restructuring charge.

 

We conducted thisrestructuring for reasons including the following: (1) the impact of theslowing economy on our business, and similar revenue decreases experienced bymany other information technology consulting companies, and (2) our expectationthat our revenue during the remainder of 2001 would be less than the amount wehad anticipated at the beginning of 2001. Because we had increased both ourstaffing and facilities during the last half of 2000 and first quarter of 2001in anticipation of growth, our reduced expectations required us to lower ourongoing costs, the largest of which were our payroll and facilityexpenses.  Even with theserestructurings, payroll and facility expenses remain our largest ongoingexpenses.

 

In order to reduce ourpayroll expenses, we reduced our headcount in the second quarter of fiscal 2001by 89 employees, which represented approximately 28% of our totalworkforce.  Of these 89 employees, 62employees (or approximately 70%) were billable consultants and 27 employees (orapproximately 30%) were non-billable staff.  Because most of the consultants who were laid off were not engaged onfull-time projects at the time of our workforce reduction, our ongoingoperations were not materially adversely affected by this reduction. We paidout all $900,000 of the employee-related restructuring charge during the yearended December 31, 2001.

 

The facilities portion ofthe restructuring charge in the second quarter of 2001 includes new andadditional lease termination costs and other expenses associated with ourdecisions 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 incurred in the secondquarter of 2001, we paid $947,000 through June 30, 2002, and expect to pay thebalance of approximately $226,000 in the third and fourth quarters of fiscal2002.

 

The restructuring charge wehave incurred reduced our cost structure for the second half of fiscal 2001 andinto fiscal 2002.  We intend to continueour initiative to achieve more cost-efficient operations throughout fiscal2002.  In addition, certain actionsrelated to facilities may not be completed, or full savings realized, untilsometime in fiscal 2002. A continued slowing of the demand for informationtechnology consulting services could cause us to incur additional restructuringexpenses in amounts that have not yet been determined.  Although the amount and timing of the costsavings that we expect to realize due to this restructuring is difficult toquantify, we currently anticipate that, in combination with other operational changeseffectuated during the second quarter of 2001, we 

 

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will realize cost savings of approximately$11.0 million during fiscal 2002, which is part of the $35 million annual costsavings as described in the first paragraph of this section. Because weattempted to correlate the number of consultants and facilities we retainedwith our expected revenues during the remainder of fiscal 2001, our workforcereductions in the second quarter of fiscal 2001 did not significantly affectour operations, except that we expect the restructuring charge to reduce ourcost structure into fiscal 2002.

 

A summary of restructuring and unusual chargeactivities through June 30, 2002, were as follows:

 
|                            |   | **Facility  Closings** |      | **Severance  and**  |   |      |   |       |    |
|---------------------------------|--------|------------------------|-----------|---------------------|--------|-----------|--------|------------|---------|
|                            |   | **and  Leasehold**     |      | **Other  Employee** |   |      |   |       |    |
|                            |   | **Termination  Costs** |      | **Related  Costs**  |   | **Other** |   | **Total**  |    |
|                            |   |                   |      |                |   |      |   |       |    |
| Second Quarter 2001 Provision   |   | $                      | 1,173,000 |                | $      | 900,000   |   | $          | 115,000 |   | $ | 2,188,000 |   |
| 2001Utilized                    |   | (546,000               | )         | (900,000            | )      | (115,000  | )      | (1,561,000 | )       |
| Balance as of December 31, 2001 |   | 627,000                |      | —              |   | —    |   | 627,000    |    |
| First Quarter 2002 Provision    |   | 1,345,000              |      | 350,000             |   | —    |   | 1,695,000  |    |
| Second Quarter 2002 Provision   |   | 1,193,000              |      | —              |   | 443,000   |   | 1,636,000  |    |
| YTD 2002 Utilized               |   | (1,102,000             | )         | (263,000            | )      | (443,000  | )      | (1,808,000 | )       |
| Balance as of June 30, 2002     |   | $                      | 2,063,000 |                | $      | 87,000    |   | $          | —  |   | $ | 2,150,000 |   |

 

Wealso have accruals related to facilities and employees in addition to the abovebalances at June 30, 2002.  Additionalfacility related accruals total $196,000 at June 30, 2002, and additionalemployee severance related accruals total $100,000 at June 30, 2002.

 

*Amortization of Intangibles*

Amortization of intangibleswas $0 in the second quarter of 2002 compared to $76,000 in the second quarterof 2001.  The amortization in 2001 wasmainly due to tangible and identifiable intangible assets incurred from theacquisition of The QuickSilver Group, Inc. (“QuickSilver”) in September 1998.  All tangible and identifiable intangibleassets from the acquisition were completely amortized as of December 31, 2001.

 

*Interest Income*

Interest income was $3,000in the second quarter of 2002 compared to $36,000 in the second quarter of2001.  The decrease is due to decreasesin our cash and investment accounts, which were used in operating and investingactivities.

 

*Interest Expense*

Interest expense was $59,000in the second quarter of 2002 compared to $55,000 in the second quarter of2001.  The increase in interest chargesis due to increased borrowings under our line of credit with Silicon ValleyBank, as well as amortization of our issuance costs related to the creditfacility, which we established in February 2001.

 

*Gain on Sale of Investment*

                Gain on sale of investment was$2.66 million in the second quarter of 2002 compared to $0 in the secondquarter of 2001. This represents a gain from our sales of a total of 714,997shares of our Series A Preferred Stock in NextNet for an aggregateconsideration of $2,655,000, net of commissions of $25,000 to Ralph Muse, aformer CEO of NextNet, as described in Note H of our Notes to ConsolidatedFinancial Statements.

 

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*Income Taxes*

We have incurred netoperating losses since inception. Because we are uncertain as to whether we will have taxable earnings inthe future, we have not reflected any benefit of such net operating losscarryforwards in the accompanying unaudited consolidated financial statements.

 

*Net Loss*

Our net loss for the quarterended June 30, 2002 was $2.04 million, or $0.05 per share, compared to a netloss for the quarter ended June 30, 2001 of $5.29 million, or $0.16 pershare.  Our net loss from operations forthe quarter ended June 30, 2002 was $4.64 million, or $0.12 per share, comparedto a net loss from operations for the quarter ended June 30, 2001 of $5.27million, or $0.16 per share.

 

**Six months ended June 30, 2002, compared to the six monthsended June 30, 2001**

 

*Net Revenues*

Revenues decreasedapproximately 74% to $5.75 million in the six months ended June 30, 2002compared to $22.37 million in the six months ended June 30, 2001. Revenuesbefore reimbursements decreased approximately 74% to $5.23 million in the sixmonths ended June 30, 2002 compared to $19.83 million in the six months endedJune 30, of 2001.  The decrease was dueprincipally to the continued significant reduction in the demand forinformation technology consulting services, due to a general slowdown in theeconomy. With the economic slowdown, many companies have either delayeddecisions on information technology consulting projects, or cancelled theprojects altogether, resulting in an industry-wide decrease in servicesrevenue. We are also experiencing strong pricing pressures, which is impactingour revenue. 

 

*Project and Personnel Costs*

Project andpersonnel costs consist primarily of payroll and payroll-related expenses forpersonnel dedicated to client assignments. These costs represent the most significant expense we incur in providingservice.  Project costs were $ 5.92million or 103% of net revenues in the six months ended June 30, 2002 comparedto $11.77 million or 53% of net revenues in the six months ended June 30,2001.  The decrease in project costs indollar terms between these periods was due primarily to the decrease in our headcountfrom 162 billable consultants as of June 30, 2001, to 70 billable consultantsas of June 30, 2002. However, these costs represented an increased percentageof our overall revenue in the six months ended June 30, 2002, because ourrevenue decreased at a greater rate than we reduced project and personnelcosts.  Additionally, we areexperiencing strong pricing pressures, which is not only impacting our revenueas described above, but our gross margins.

 

*Reimbursable Expenses*

*               *Reimbursable expenses consist of out-of-pocket expenses incurred whileproviding services that are reimbursed by our clients. Pursuant to FinancialAccounting Standards Board Staff Announcement (Topic No. D-103), which waseffective for reporting periods beginning after December 15, 2001, reimbursableexpenses are separate line items in both revenue and cost of revenue. Prior toimplementation of this Announcement, we had accounted for reimbursable expensesby offsetting the amounts we were paid against project and personnel costs.  Reimbursable expenses decreased 80% to$518,000 in the six months ended June 30, 2002 compared to $2.54 million in thesix months ended June 30, 2001. The decrease is due to the overall decline inrevenue and services performed during the same time period.

 

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*Sales and Marketing*

Sales and marketing costsconsist primarily of salaries, employee benefits and travel expenses of salesand marketing personnel, as well as promotional costs.  Sales and marketing expenses were $1.34million or 23% of net revenues in the six months ended June 30, 2002, comparedto $3.19 million or 14% of net revenues in the six months ended June 30,2001.  The decrease in dollar termsbetween these periods was due to a reduction in the number of sales andmarketing personnel, as well as lower commission expenses resulting from thedecrease in revenue. The increase in percentage terms is due primarily to salessalaries being an increasing percentage of revenue as a result of our revenuebeing lower than anticipated in the six months ended June 30, 2002.

 

*General and Administrative*

General and administrativecosts consist primarily of expenses associated with our management, informationtechnology, training and recruiting, occupancy costs, and finance andadministrative groups.  General andadministrative expenses were $4.58 million or 80% of net revenues in the sixmonths ended June 30, 2002, compared to $8.90 million or 40% of net revenues inthe six months ended June 30, 2001. The dollar decrease was primarily due toimplementing cost savings measures resulting in a decrease of $1.70 million insalaries, a decrease of $620,000 in bad debt expense, a decrease of $500,000 inrecruiting fees, a decrease of $300,000 in travel and entertainment expenses,and a decrease of $370,000 in telephone and network connection expenses. Theincrease in percentage terms is due primarily to our costs for occupancy,information technology and salaries not decreasing at the same rate as ourrevenue.  We anticipate the dollaramount of general and administrative expenses will decrease over the next twofiscal quarters.

 

*Restructuring and Unusual Charges*

Restructuringand unusual charges were $3.32 million in the six months ended June 30, 2002compared to $2.19 million in the six months ended June 30, 2001.  Included in the current yearamount was a $2.53 million charge for facility closings, subleasing, andleasehold termination costs, as well as $350,000 in severance pay related to headcount reductions, includingthree vice presidents, in the first quarter of 2002.  The facility charges included $276,000 forclosing the Colorado Springs, Colorado and Boston, Massachusetts facilities,$290,000 for reducing the amount of space leased in the Minneapolis, Minnesotafacility by approximately 60%, and $1.96 million for increasing the accrual forour St. Paul, Minnesota and Campbell, California facilities to amountsconsistent with buy-out offers made by our landlords.  We also incurred a $443,000 non-cash compensation charge arisingout of the exercise by Paul Edelhertz, a member of our board of directors, ofhis right to assign to us an aggregate of 250,000 shares of our common stock inexchange for our cancellation of a promissory note owed by Mr. Edelhertz to us bearinga principal balance of $500,000 and accrued interest through the date ofcancellation of $43,250.  Thistransaction relates to an agreement dated December 26, 2000, as amended onAugust 2, 2001.  Also, as discussed inmore detail in the analysis of the three months ended June 30, 2002 compared tothe three months ended June 30, 2001, we undertook a restructuring action inthe second quarter of 2001, when we recorded a restructuring charge of $2.19million.

 

*Amortization of Intangibles and Non-cash Compensation*

Amortization of intangibleswas $0 in the six months ended June 30, 2002 compared to $168,000 in the sixmonths ended June 30, 2001.  Theamortization in 2001 was mainly due to tangible and identifiable intangible assetsincurred from the acquisition of The QuickSilver Group, Inc. (“QuickSilver”) inSeptember 1998.  All tangible andidentifiable intangible assets from the acquisition were completely amortizedas of December 31, 2001.

 

18

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*Interest Income*

Interest income was $11,000in the six months ended June 30, 2002 compared to $90,000 in the six monthsended June 30, 2001.  The decrease isdue to decreases in our cash and investment accounts, which were used in operatingand investing activities.

 

*Interest Expense*

Interest expense was$124,000 in the six months ended June 30, 2002 compared to $79,000 in the sixmonths ended June 30, 2001. The increase in interest charges is due toincreased borrowings under our line of credit with Silicon Valley Bank, as wellas amortization of our issuance costs related to the credit facility, which weestablished in February 2001.

 

*Gain on Sale of Investment*

                Gain on sale of investment was$2.66 million in the six months ended June 30, 2002 compared to $0 in the sixmonths ended June 30, 2001. This represents a gain from our sales of a total of714,997 shares of our Series A Preferred Stock in NextNet for an aggregateconsideration of $2,655,000, net of commissions of $25,000 to Ralph Muse, aformer CEO of NextNet, as described in Note H of our Notes to ConsolidatedFinancial Statements.

 

*Income Taxes*

We have incurred netoperating losses since inception. Because we are uncertain as to whether we will have taxable earnings inthe future, we have not reflected any benefit of such net operating losscarryforwards in the accompanying unaudited consolidated financial statements.

 

*Net Loss*

As a result of the above,our net loss for the six months ended June 30, 2002 was $7.38 million, or $0.19per share, compared to a net loss for the six months ended June 30, 2001 of$6.37 million, or $0.20 per share.  Ournet loss from operations for the six months ended June 30, 2002 was $9.92million, or $0.26 per share, compared to a net loss from operations for the sixmonths ended June 30, 2001 of $6.38 million, or $0.20 per share.

 

**Critical Accounting Policies**

 

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, financialconditions and results of operations is discussed throughout Management’sDiscussion and Analysis of Financial Condition and Results of Operations wherethese policies affect our reported and expected financial results.  Our preparation of this Form 10-Q requiresus to make estimates and assumptions that affect the reported amount of assetsand liabilities, disclosure of contingent assets and liabilities as of the dateof our financial statements, and the reported amounts of revenue and expensesduring the reporting period.  There canbe no assurance that actual results will not differ from those estimates.

 

Ourcritical accounting policies are as follows:

•      Revenue Recognition;

•      Allowance for DoubtfulAccounts; and

•      Investmentin 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 2001 Annual Report on Form10-K.

* *

 

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***Liquidity and Capital Resources***

 

At June 30, 2002, we hadapproximately $356,000 in cash and cash equivalents, compared to $1.33 millionat December 31, 2001. As of June 30, 2002, we had no significant capitalspending or purchase commitments, except for a $500,000 purchase order forsoftware licenses and training. We have not formally completed the purchaseagreement for this, and do not intend to complete this purchase.  As of June 30, 2002, we had working capitalof a negative $3.8 million.

 

Cash used in operatingactivities was $6.10 million for the six months ended June 30, 2002 andresulted primarily from a loss before depreciation and amortization and gain onsale of investment in NextNet of  $9.33 million,which was offset by an increase in accrued expenses of $2.10 million and adecrease in notes receivable of $535,000. Cash used in operating activities was $3.13 million for the six monthsended June 30, 2001, due primarily to a loss before depreciation andamortization of  $5.95 million, offsetby a decrease in accounts receivable of $2.60 million and an increase inaccrued liabilities of $0.91 million.

 

Cash provided frominvesting activities was $3.50 million for the six months ended June 30, 2002,and resulted primarily from proceeds of $2.97 million from the sale of aportion of our NextNet shares.  Cashused in investing activities was $720,000 for the six months ended June 30,2001 and resulted primarily from the purchase of property and equipment.

 

Cash provided byfinancing activities was $1.63 million for the six months ended June 30, 2002and consisted primarily of cash received from sale of our common stock, and anadvance from director in the amount of $450,000, offset by a decrease of$405,000 in borrowings under our line of credit.  Cash provided by financing activities was $3.93 million for thesix months ended June 30, 2001 and consisted primarily of cash received fromthe sale of common stock of $2.21 million and proceeds from the line of creditof $2.00 million.

 

Future payments due underdebt and lease obligations are as follows (in thousands):

 
|             |   |          |   |        |   | **Non**        |   |      |   |
|------------------|--------|---------------|--------|-------------|--------|----------------|--------|-----------|--------|
|             |   |          |   |        |   | **Cancelable** |   |      |   |
| **Year Ending**  |   | **Bank Line** |   | **Notes**   |   | **Operating**  |   |      |   |
| **December 31,** |   | **Of Credit** |   | **Payable** |   | **Leases**     |   | **Total** |   |
| 2002             |   | $             | 695    |        | $      | 155            |   | $         | 1,546  |   | $ | 2,396 |   |
| 2003             |   | —        |   | 292         |   | 2,731          |   | 3,023     |   |
| 2004             |   | —        |   | —      |   | 2,249          |   | 2,249     |   |
| 2005             |   | —        |   | —      |   | 1,951          |   | 1,951     |   |
| 2006             |   | —        |   | —      |   | 1,119          |   | 1,119     |   |
| Later            |   | —        |   | —      |   | 528            |   | 528       |   |
| Total            |   | $             | 695    |        | $      | 447            |   | $         | 10,124 |   | $ | 11,266 |   |

 

                On July 29, 2002, we enteredinto an Accounts Receivable Purchase Agreement with Silicon Valley Bank toreplace the agreement described above. This agreement entitles us to borrow upto a maximum of $2.0 million based on eligible receivables, and is secured byvirtually all of our assets.  Borrowingsunder this agreement bear interest at a monthly rate of 1% of the average dailybalance outstanding during the period. Additionally, on each reconciliation date, we pay an administrative feeequal to 0.25% of the face amount of each receivable purchased 

 

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by Silicon ValleyBank during that reconciliation period. This facility expires on July 29, 2003. Our defaults under leases for furniture and facilities in Campbell,California and St. Paul, Minnesota, as set forth more fully in Note J, are eachtechnically an "Event of default" under the Accounts ReceivablePurchase Agreement. Upon default, Silicon Valley Bank may elect from remediesincluding declaring all amounts paid to us under the agreement due and payablein full, or ceasing to buy receivables from us. Silicon Valley Bank has notelected to enforce this provision. If Silicon Valley Bank does enforce thisprovision, or otherwise does not purchase receivables from us, our ability tofund our operations could be materially harmed. The Accounts ReceivablePurchase Agreement replaces a secured revolving credit facility that weestablished with Silicon Valley Bank on February 27, 2001, and amended onAugust 2, 2001 and December 31, 2001. The secured revolving credit facilityentitled us to borrow up to a maximum of $5.0 million based on eligiblecollateral.  Borrowings under this lineof credit bore interest at the bank’s prime rate plus 2.0%, and were payable monthly.  The amended agreement required, among otherthings, that we comply with minimum tangible net worth and profitabilitycovenants.  We were not in compliancewith these covenants as of June 30, 2002. As of June 30, 2002, a total of $695,000 was outstanding under the lineof credit, which was the maximum eligible amount available to us under thecredit facility as of that date.  Thisfacility was to expire on December 31, 2002, but was replaced by the AccountsReceivable Purchase Agreement.  Amountsoutstanding under the revolving credit facility were converted to beingoutstanding under the Accounts Receivable Purchase Agreement.

 

In the second quarter of2002, we entered into stock purchase agreements to sell certain of our Series APreferred Stock in NextNet Wireless, Inc. (“NextNet”) to various parties. Thetotal proceeds received were $1,480,000 in April, $500,000 in May and $310,000in June.  We also expect to receive anadditional $400,000 in August and $400,000 in September from these sales.  See Note H to our Notes to Consolidated FinancialStatements for additional discussion regarding our sales of NextNet stock.

 

We believe that our existingcash and cash equivalents, together with cash provided from operations, ourborrowings from the Accounts Receivable Purchase Agreement with Silicon ValleyBank, additional advances in July in the amount of $850,000 from Joe Costello,our chairman, and the receipt of $800,000 in August and September from twoprivate investors for a portion of our NextNet investment, should be sufficientto meet our working capital and capital expenditure requirements through atleast October 10, 2002. However, if we do not receive the $800,000 payment, anddo not receive any additional funding, we will not have enough capital to meetour spending requirements beyond September 10, 2002.  In the event that we do not have enough cash at that time, ourfinancial position could be materially harmed and we could become unable to payour creditors.

 

We will continue to explorepossibilities for additional financing, which may include debt, equity, orother forms of financing transactions, and other strategic alternatives thatmay be available to us, including a potential sale of all or a portion of ourstock, assets, or investments.  Wecannot be certain that additional financing will be available to us onfavorable terms, if at all. If our financial performance adversely affects ourability to obtain funds through our accounts receivable, and we are unable toobtain additional financing, we may not be able to meet our cash requirementsbeyond September 10, 2002.  Additionally, if we receive an adversejudgment in any of the matters described in the discussion of “LegalProceedings” set forth in Part II of this Quarterly Report on Form 10-Q,particularly with regard to offices in Campbell, California, and St. Paul,Minnesota, our financial position could be materially adversely affected and wemay not be able to continue as a going concern.  Our ability to continue as a going concern depends upon ourability to continue to access our Accounts Receivable Purchase Agreement withSilicon Valley Bank, obtain additional funding, and achieve sustainedprofitability.  The accompanyingfinancial statements have been prepared on a going concern basis, which assumescontinuity of operations and realization of assets and liabilities in theordinary course of business.  Thesefinancial statements do not include any adjustments that might result if wewere forced to discontinue our operations.

 

**Item 3. Quantitative and Qualitative Disclosures About Market Risk**

 

We are exposed to marketrisk from changes in security prices and interest rates. Market fluctuationscould impact our results of operations and financial condition. We are exposedto certain market risks based on our outstanding debt obligations of $447,000at June 30, 2002, as well as our Accounts Receivable Purchase

 

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Agreement with Silicon ValleyBank, under which$695,000 was outstanding at June 30, 2002. The interest rates charged on ourlong-term debt obligations range from 7.0% to 10.0%, and these obligationsmature quarterly through December 2003. 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 interest is payablemonthly. We do not invest in any derivative financial instruments. Excess cashis invested in short-term low-risk vehicles, such as money market investments.Changes in interest rates are not expected to have a material adverse effect onour business, financial condition or results of operations

 

**Cautionary Statement for Purposes of the ‘Safe Harbor’Provisions of the Private Securities Litigation Reform Act of 1995**

 

Certainstatements in this Quarterly Report on Form 10-Q are “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995. When used in this Quarterly Report on Form 10-Q, thewords “may,” “should,” “expects,” “plans,” “anticipates,” “believes,”“estimates,” “predicts,” “intends,” “potential” or “continue” and similarexpressions are generally intended to identify forward-looking statements.Because these forward-looking statements involve risks and uncertainties,actual results could 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 restructuring initiatives,the effect of the recent sale of the CRM products of a major CRM developer onour business, our ability to derive profitable business from our alliance withHCL, our ability to attract and retain customers, our ability to adjust the mixof our services to meet the needs of the market, our ability to adapt torapidly changing technologies in the CRM industry, the ability of our partnersto maintain competitive products, the impact of competition and pricingpressures from actual and potential competitors with greater financialresources, our ability to obtain large-scale consulting services agreements,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 ability to grow revenues from acquiredcompanies, possible changes in collections of accounts receivable and notesreceivable, our ability to protect and reuse our intellectual property, changesin general economic conditions and interest rates, and other factors identifiedin our filings with the Securities and Exchange Commission, including thoseidentified in Exhibit 99.01 to this Quarterly Report on Form 10-Q. We disclaimany intention 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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**PARTII.  OTHER INFORMATION**

 

Item 1.  Legal Proceedings

 

We are subject to variouslegal proceedings and claims that arise in the ordinary course ofbusiness.  The following is a summary ofour current legal proceedings.

 

On January 24, 2002, ArmyCorps Operating Associates (“Army Corps”) filed a complaint in Minnesotadistrict court in Ramsey County against us and ZCA Corporation (f/k/a Camworks,Inc.), which is our wholly-owned subsidiary, alleging that we had failed to payrent for the month of January 2002 for a facility leased by ZCA in St. Paul,Minnesota.  The amount sought by ArmyCorps is approximately $35,000.  Thefacility had been leased by Camworks, Inc., from October 1997 through December1999, at which time ZCA acquired Camworks. Following the acquisition, the lease remained in the name of Camworksand was not assigned to us.  Monthlyrent for this facility is approximately $35,000, and has not been paid sinceDecember 2001. Army Corps has notified us that it intends to amend its claim toseek rent for the months since January 2002 and claim that the entire lease hasbeen breached and seek to accelerate payment of rent for the balance of thelease, which is approximately $1,700,000. Because the lease is in the name of ZCA as successor-in-interest toCamworks and not in our name, our position is that we should not be held liablefor the breach of the lease.  However,we cannot be sure that a court would not allow the plaintiff to pierce thecorporate veil of ZCA and find us primarily liable on the lease.  The matter is scheduled to go to trial inmid-November 2002.  If we are unable toresolve this matter, and if we are unsuccessful in litigation, our financialposition could be materially harmed.

 

On July 17, 2002, WTACampbell Technology Park LLC (“WTA”) filed a complaint against us in theSuperior Court of California, County of Santa Clara, alleging that we hadfailed to maintain and restore the security deposit for our facility inCampbell, California.  WTA is seeking atleast $163,638.97, plus legal fees and interest, as part of its action.  Monthly rent for this facility isapproximately $65,000, and the lease expires in June 2007.  WTA had drawn upon our security deposit topay for rent that was past due for the facility.  Subsequently, rent for the month of August 2002 has not beenpaid.  Therefore, WTA could amend its claimto include the amount of the security deposit that it draws upon for rent forthe month of August 2002.  WTA may alsoclaim that the entire lease has been breached and seek to accelerate payment ofrent for the balance of the lease, which is approximately $5,300,000.  Our answer to WTA’s complaint is due within30 days of the date of the complaint, and a pre-trial conference is scheduledfor November 19, 2002.  If we are unableto resolve this matter, and if we are unsuccessful in litigation, our financialposition could be materially harmed.

 

On May 20, 2002, afurniture lessor notified us by letter that it was declaring three furnitureleases in default.  Subsequent to ourreceipt of this letter, this lessor collected on the approximately $263,000 letterof credit that was security for these leases, which carry an aggregate monthlyrent of approximately $22,000.  Theamount received by this lessor exceeds by approximately $200,000 the amount ofrent that was unpaid as of June 30, 2002. This lessor has subsequentlyrequested that we pay it approximately $331,000 and return the equipment.  Although we believe this lessor has not yetengaged counsel, we have no assurance that this lessor will not file a lawsuitto recover the amounts that it believes it is due under the leases.  If we are unable to resolve this matter, andif we are unsuccessful in litigation, our financial position could bematerially harmed.

 

On July 22, 2002, anattorney for a second furniture lessor sent us a letter notifying us that itintended to declare that we had defaulted in payment of five leases for officefurniture and requested payment of approximately $215,000 in settlement of itsclaim.  We are in discussions with thislessor's attorney in an attempt to reach a mutually satisfactory settlement,but we cannot 

 

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guarantee that thismatter will not proceed to litigation or that we will be able to resolve thismatter in a manner that will not materially affect our financial position.

 

On August 5, 2002, ourformer president and CEO, Doug Holden, notified us by email that he believes wehave breached our severance agreement with him following the separation of hisemployment.  Mr. Holden has requested continued payroll and benefits andcontinued vesting of stock options for six months from June 27, 2002, the dateof his separation.  The value of Mr.Holden’s claims is approximately $150,000. We believe that we have valid defenses to Mr. Holden’s claims.  The timing and ultimate resolution of Mr.Holden’s claims are uncertain at this time.

 

We have not received approximately $400,000 from twoprivate investors that was due on August 1, 2002, in exchange for a total of66,666 shares of NextNet Wireless, Inc. Series A Preferred Stock. We intend tocommence legal action to recover the amounts due, as well as our costs and anyother damages we may incur because of the failures of the two investors to payon time.

We are attempting to resolve these matters, but wecannot be certain that we will be able to successfully resolve these matters onfavorable terms, and we cannot be certain that we will be successful inlitigation.  If we are unable to resolvethese matters, and if we lose the litigation for these matters, our financialposition could be materially harmed and we could become unable to pay our othercreditors.  We are also subject to othervarious legal proceedings and claims that we do not believe are material eitherseparately or in the aggregate.

 

Item 2.  Changes in Securities

 

                None.

 

Item 3.  Defaults Upon Senior Securities

 

                None.

 

Item 4.  Submission of Matters to a Vote of SecurityHolders

 

                Zamba held its Annual Meeting on June 4, 2002. Twoproposals were presented at the Annual Meeting for voting by the stockholders:(i) the election of directors; and (ii) the approval of two amendments to our1993 Equity Incentive Plan. The stockholders approved both proposals.

 

                Eachperson nominated for director was elected. For Joseph B. Costello, a total of 33,952,797 votes were cast in favorof his election, and 1,164,147 votes were withheld.  For Dixon R. Doll, 33,777,803 votes were cast in favor of hiselection, and 1,339,141 votes were withheld. For Paul D. Edelhertz, 33,737,098 votes were cast in favor of hiselection, and 1,379,846 votes were withheld. For Douglas M. Holden, 33,923,535 votes were cast in favor of hiselection, and 1,193,409 votes were withheld. For John Olsen, 33,789,824 votes were cast in favor of his election, and1,327,120 votes were withheld. For Subrahmanyan Raman, 33,966,430 votes werecast in favor of his election, and 1,150,514 votes were withheld. For Sven A.Wehrwein, 33,968,164 votes were cast in favor of his election, and 1,148,780votes were withheld.

 

                Atotal of 13,817,171 votes were cast in favor of the proposal to approve twoamendments to our 1993 Equity Incentive Plan, 2,240,747 votes were castagainst, 70,761 votes were abstentions, and there were 18,988,265 brokernon-votes.

 

Item 5.  Other Information

 

                None.

 

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Item 6.  Exhibits and Reports on Form 8-K

 

(a)           Exhibits: (See attached exhibitindex)

 

(b)                           Reportson Form 8-K:

 

OnJuly 1, 2002, we filed a report on Form 8-K to report the following:

 

OnJune 28, 2002, we issued a press release announcing that our common stock hadbeen delisted from the Nasdaq National Market and will instead be traded on theOver The Counter Bulletin Board, under the symbol “ZMBA.”

 

OnJuly 2, 2002, we filed a report on Form 8-K to report the following:

 

OnJuly 1, 2002, we issued a press release announcing that we had appointed NormSmith as our new president and chief executive officer, replacing Doug Holden,who resigned. As discussed in the press release, Mr. Smith is also replacingMr. Holden on our Board of Directors. Additionally, Paul Edelhertz, a Director of our Company, has exercisedhis option pursuant to the Settlement and Release Agreement dated August 2,2001, between Mr. Edelhertz and Zamba, filed on August 9, 2001, with ourQuarterly Report on Form 10-Q for the quarter ended June 30, 2001, to assign250,000 shares of our common stock to us in exchange for our cancellation ofhis promissory note dated December 26, 2000, under which he was indebted to usin the amount of $500,000 plus interest.

 

On August 8, 2002, we fileda report on Form 8-K to report the following:

 

OnAugust 6, 2002, we entered into two Stock Purchase Agreements with JoeCostello, the Chairman of our Board of Directors, in which we agreed to sell toMr. Costello a portion of our holdings of Series A Preferred Stock in NextNetWireless, Inc. (“NextNet”) at a purchase price of $6.00 per share.  Pursuant to the first agreement, we sold Mr.Costello a total of 58,334 shares of our NextNet stock for an aggregatepurchase price of $350,004, and pursuant to the second agreement, we sold Mr.Costello a total of 158,334 shares of our NextNet stock for an aggregatepurchase price of $950,004.  Pursuant tothese agreements, Mr. Costello will also receive more of our NextNet shares if,at any time prior to December 31, 2002, we sell additional NextNet shares foran aggregate purchase price equal to or in excess of One Hundred ThousandDollars ($100,000) at a per share purchase price that is less than $6.00 pershare.  In such event, we will provideMr. Costello with an amount of additional NextNet shares that causes the pershare purchase price paid by Mr. Costello to be equivalent to the lower pershare price of the subsequent sale. Both agreements are subject to rights of first refusal on the part ofNextNet and the holders of NextNet Series B Preferred Stock.  These transactions with Mr. Costello wereapproved by a majority of the independent members of our Board of Directors.  

 

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SIGNATURES

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned 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:  August 14, 2002 |

 

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EXHIBIT INDEX

 
| **EXHIBIT NUMBER** |   | **TITLE**                                                                                                                                                                                                                                                                                                     |
|--------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.01               |   | Rights Agreement dated September 12, 1994 between Racotek, Inc. n/k/a  Zamba Corporation and Norwest Bank Minnesota, N.A. n/k/a Wells Fargo Bank  Minnesota, N.A., as Rights Agent, which includes as exhibits thereto the form  of rights certificate and the summary of rights to purchase preferred shares |
|               |   |                                                                                                                                                                                                                                                                                                          |
| 4.02               |   | Amendment No. 1 to Rights Agreement dated January 29, 2002 by and  among Zamba Corporation and Wells Fargo Bank Minnesota, N.A. f/k/a Norwest  Bank Minnesota, N.A., as Rights Agent                                                                                                                          |
|               |   |                                                                                                                                                                                                                                                                                                          |
| 10.01              |   | Lease Termination Agreement between EOP-New England Executive Park,  L.L.C. and Zamba Corporation, dated May 31, 2002                                                                                                                                                                                         |
|               |   |                                                                                                                                                                                                                                                                                                          |
| 10.02              |   | Stock Purchase Agreement between Robert S. Colman Trust and Zamba  Corporation, dated May 29, 2002                                                                                                                                                                                                            |
|               |   |                                                                                                                                                                                                                                                                                                          |
| 10.03              |   | Stock Purchase Agreement between Doll Technology Investment Fund and  Zamba Corporation, dated June 7, 2002                                                                                                                                                                                                   |
|               |   |                                                                                                                                                                                                                                                                                                          |
| 10.04              |   | Stock Purchase Agreement between Doll Technology Affiliates Fund and  Zamba Corporation, dated June 7, 2002                                                                                                                                                                                                   |
|               |   |                                                                                                                                                                                                                                                                                                          |
| 10.05              |   | Stock Purchase Agreement between Doll Technology Side Fund L.P. and  Zamba Corporation, dated June 7, 2002                                                                                                                                                                                                    |
|               |   |                                                                                                                                                                                                                                                                                                          |
| 10.06              |   | Stock Purchase Agreement between Thomas Magne and Zamba Corporation,  dated June 13, 2002                                                                                                                                                                                                                     |
|               |   |                                                                                                                                                                                                                                                                                                          |
| 10.07              |   | Zamba Corporation Second Amendment To Lease Agreement between  Acky-Calhoun, LLC and Zamba Corporation, dated July 11, 2002                                                                                                                                                                                   |
|               |   |                                                                                                                                                                                                                                                                                                          |
| 10.08              |   | Accounts Receivable Purchase Agreement between Silicon Valley Bank and  Zamba Corporation, dated July 29, 2002                                                                                                                                                                                                |
|               |   |                                                                                                                                                                                                                                                                                                          |
| 99.01              |   | Cautionary Statement Regarding Forward-Looking Statements                                                                                                                                                                                                                                                     |
|               |   |                                                                                                                                                                                                                                                                                                          |
| 99.02              |   | Certification of Chief Executive Officer and Chief Financial Officer  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                               |

 

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** Management contract orcompensation plan

 

 

 

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