SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

ZAMBA CORPORATION

(Exact name of Registrant as specified in its charter)

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of May 9,August 8, 2003.

ZAMBA CORPORATION

INDEX

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Part I. Financial Information

Item 1:  Financial Statements

ZAMBA CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share data)

The accompanying notes are an integral part of the consolidated financial statements.

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ZAMBA CORPORATION

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands, except per share data)

The accompanying notes are an integral part of the consolidated financial statements.

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ZAMBA CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

4

ZAMBA CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

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ZAMBA CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note A.  Basis of Presentation:

The unaudited consolidated financial statements of ZAMBAZamba Corporation as of March 31,June 30, 2003, and for the three and six month periods ended March 31,June 30, 2003 and 2002, reflect all adjustments (which include only normal recurring adjustments, except as disclosed in the footnotes) necessary, in the opinion of management, to fairly state our financial position as of March 31,June 30, 2003, and our results of operations and cash flows for the reported periods.  The results of operations for any interim period are not necessarily indicative of the results to be expected for any other interim period or for the full fiscal year.  The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.  Certain prior year amounts have been reclassified to conform with the 2003 presentation.  These financial statements should be read in conjunction with our audited consolidated financial statements and related notes for the year ended December 31, 2002, which were included in our 2002 Annual Report on Form 10-K.

Note B.  Liquidity:

AsWe had working capital of March 31,$87,000 as of June 30, 2003, we had aan improvement from the negative working capital of $709,000 and a stockholder’sas of March 31, 2003. We had stockholders’ equity of $516,000 as of June 30, 2003, an improvement from the stockholders’ deficit of $266,000.$266,000 as of March 31, 2003.  To partially fund our operations during the first and second quarters of 2003, we receivedutilized $1.5 million as a resultreceived from the sales of investing activity between January 1, 2003 and March 31, 2003 by selling someshares of the NextNet Wireless, Inc. Series A Preferred Stock we own.  Transactions between January 1, 2003Stock.  These funds were received in transactions with Entrx Corporation (“Entrx”) and March 31, 2003 were as follows:

two private investors.  We received $750,000 in the first quarter of 2003 as part of a loan agreement we entered into with Entrx Corporation (“Entrx”).  Thisduring the fourth quarter of 2002.  The amounts received under the loan were originally classified as a note payable, which then was converted into 415,340 shares of our NextNet Series A Preferred Stock on March 31, 2003.2003 at a price of $4.23 per share.  See Note JK for additional discussion.

discussion of this transaction.  We also received $750,000 in the first quarter of 2003 when we soldfrom two private investors in exchange for an aggregate of 177,306 shares of NextNet Series A Preferred Stock to two private investors.  These investors received 177,306 shares of our NextNet Series A Preferred Stock at an averagea price of $4.23 per share.  See note H for additional discussion.discussion of this transaction.

Cash used in operating activities was $2.08 million for the six months ended June 30, 2003 and resulted primarily from an increase of $1.13 million in accounts receivable and a decrease of $1.18 million in accrued expenses.  The increase in accounts receivable resulted mainly due to the timing of billings and collections during the quarter.  A higher than typical proportion of billing occurred in the last half of the second quarter compared with the first half of the second quarter, which resulted in collections of those invoices after the end of the second quarter.  The decrease in accrued expenses resulted mainly from payments related to office and furniture lease termination settlement agreements negotiated over the past year.  The remaining payments related to these settlements total $273,000, and will be paid through October 2003.

We partly fund our operations through our Accounts Receivable Purchase Agreement with Silicon Valley Bank.  Although there are no financial covenants in theThis agreement with Silicon Valley Bank, it may still declare us to be in default in certain circumstances.  This facilitywas renewed on July 29, 2003 and expires on July 29, 2003.2004. However, both parties have the right to terminate this Agreement at any time.  See Note G for additional discussion.

Our ability to continue as a going concern depends upon our ability to sustain profitability, continue to sustain profitability, access our borrowing facility with our bank, and obtain any additional funding that may be needed.

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Note C. Selected Balance Sheet Information:

Note D.  Net Income (Loss) Per Share:

Basic income (loss) per share is computed based on the weighted average number of common shares outstanding.  Diluted income (loss) per share is computed based on the weighted average number of common shares outstanding adjusted by the number of additional shares that would have been outstanding had the potentially dilutive common shares been issued.  Potentially dilutive shares of common stock include stock options.  A total of 702,0001.3 million and 0 additional shares were included in the diluted income (loss) per share calculation at March 31,June 30, 2003 and 2002, respectively. The calculation of weighted average diluted shares outstanding excludes options for approximately 2.3 million common shares at June 30, 2003, as the exercise price of those options was greater than the average market price, resulting in an anti-dilutive effect on diluted earnings per share.

Note E.  Recent Accounting Standards:

In June 2002,May 2003, the Financial Accounting Standards Board (FASB) issued SFASStatement of Financial Accounting Standards No. 146150, “Accounting for Costs AssociatedCertain Financial Instruments with Exit or Disposal Activities.Characteristics of both Liabilities and Equity.”  SFAS No. 146 supersedes EITF No. 94-3.  The principal difference between SFAS No. 146150 establishes standards for issuer classification and EITF No. 94-3 relates to when an entity can recognize a liability related to exit or disposal activities.  SFAS No. 146 requires a liability be recognized for a cost associatedmeasurement of certain financial instruments with an exit or disposal activity whencharacteristics of both liabilities and equity.  Instruments that fall within the liability is incurred.  EITF No. 94-3 allowed a liability related to an exit or disposal activity, to be recognized at the date an entity commits to an exit plan.  The provisionsscope of SFAS No. 146 became150 must be classified as a liability.  SFAS No. 150 is effective on January 1,for financial instruments entered into or modified after May 31, 2003.  Accordingly, we will apply this standardFor financial instruments issued prior to any exit or disposal activities initiated after January 1, 2003.  We incurred no exit or disposal activities after JanuaryJune 1, 2003, soSFAS No. 150 is effective in the adoptionthird quarter of 2003.  Adoption of SFAS No. 146 had no effect150 is not expected to have an impact on our financial position, or results of operations.operations or cash flows.

In January 2003, the FASB issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (“SFAS 148”).  SFAS 148 amends FASB Statement of Financial Accounting Standards No. 123,  “Accounting for Stock-Based Compensation”  (“SFAS 123”) to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements of the method of accounting for stock-based employee compensation and the effect of the method used on reported results.  SFAS 148 is effective for fiscal years beginning after December 15, 2002 and was adopted by ZAMBAZamba for all periods presented herein.  ZAMBAZamba did not change to the fair value based method of accounting for stock-based employee compensation; therefore, adoption of SFAS 148 will only impact disclosures, not the financial results, of ZAMBA.Zamba.

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Note F.   Restructuring and Unusual Charges:

We incurred restructuring and unusual charges in 2002 that significantly reduced our ongoing cost structure.  In the first quarter of 2002, we incurred unusual charges of $1.69 million for facility and employment matters.  Included in this amount was a $1.34 million charge related to closing our Campbell, California, and Colorado Springs, Colorado facilities.  These transactions have resulted in annual cost savings of $1.0 million.  In addition, a $350,000 charge was taken for severance pay relating to reduced headcount, including the separation of three vice presidents, in the first quarter of 2002.  These headcount reductions have resulted in annual savings of $3.5 million.

In the second quarter of 2002, we incurred unusual charges of $1.64 million for facility and non-cash compensation matters. Included in this amount was a $1.19 million charge for facility closings and lease termination costs.  The facility charges included $190,000 for closing the Boston, Massachusetts, facility, $290,000 for reducing the amount of space leased in Minneapolis, Minnesota, and $713,000 for increasing the accrual for our St. Paul, Minnesota and Campbell, California facilities to amounts consistent with buy-out offers made by our landlords.  These charges have resulted in additional annual savings of $1.2 million.  We also incurred a $443,000 non-cash compensation charge arising out of the exercise by Paul Edelhertz, a member of our board of directors, of his right to assign to us an aggregate of 250,000 shares of our common stock in exchange for our cancellation of a promissory note issued to us by Mr. Edelhertz bearing a principal balance of $500,000 and accrued interest through the date of cancellation of $43,250.  This transaction relatesrelated to an agreement dated December 26, 2000, as amended on August 2, 2001.

A summary of restructuring and unusual charge activity through March 31,June 30, 2003 is as follows:

Note G.   Line of Credit:

On July 29, 2002, we entered into an Accounts Receivable Purchase Agreement with Silicon Valley Bank to replace a prior revolving credit facility we had established with Silicon Valley Bank.  This agreement entitles us to borrow up to a maximum of $2.0 million based on 80% of eligible receivables, and is secured by virtually all of our assets.  Borrowings under this agreement bear interest at a monthly rate of 1% of the 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 each receivable purchased by Silicon Valley Bank during that reconciliation period.  Although there are no financial covenants inThe Accounts Receivable Purchase Agreement was renewed on July 29, 2003 and expires on July 29, 2004.  However, both parties have the new agreement with Silicon Valley Bank, they may still declare default in certain circumstances, including our default underright to terminate this Agreement at any leases or contracts.time.  If Silicon Valley

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Bank decides not to purchase receivables from us, our ability to fund our operations could be materially harmed.

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This facility expires on July 29, 2003.  The amount outstanding under this agreement was $340,000$875,000 at March 31,June 30, 2003.

The Accounts Receivable Purchase Agreement replaced a secured revolving credit facility that we established with Silicon Valley Bank on February 27, 2001, and amended on August 2, 2001 and December 31, 2001. The secured revolving credit facility entitled us to borrow up to a maximum of $5.0 million based on eligible collateral.  Borrowings under this line of credit bore interest at the bank’s prime rate plus 2.0%, and were payable monthly.  The amended agreement required, among other things, that we comply with minimum tangible net worth and profitability covenants. This facility was to expire on December 31, 2002, but was replaced by the Accounts Receivable Purchase Agreement.  Amounts outstanding under the revolving credit facility were converted to amounts outstanding under the Accounts Receivable Purchase Agreement.

Note H.   Sales of Investments:

In the first quarter of 2003, we entered into transactions with private investors in which we sold portions of our equity holdings in NextNet Wireless, Inc.  Our chairman, Joseph B. Costello, is also the chairman of NextNet. Another of our directors, Dixon Doll, is also a director and a shareholder of NextNet.  Additionally, another director of Zamba, Sven Wehrwein, has been a consultant for NextNet.  There have been no other relationships or business transactions between the two companies since January 1, 2000.during this reporting period.

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

On February 17, 2003, we sold 177,306 shares of NextNet Series A Preferred Stock to two private investors for $750,000.  We recorded a deferred gain on sale of investment in the first quarter of 2003 when we received the cash from these transactions. A gain on sale of investment will bewas recorded when the shares are transferred to the private investors, which will occur in the second quarter of 2003.2003, when the share transfer was completed.  In connection with these sales, we issued a warrant to purchase up to 125,000 additional shares of NextNet Series A Preferred Stock to an investor affiliated with a prior purchaser of NextNet shares to purchase 125,000 additional sharesshares.  This warrant bears an exercise price of NextNet Series A Preferred Stock owned by us at $6.00 per share and may be exercised any time prior to the close of business on May 17,December 31, 2004.

We transferred 413,712415,340 shares of our NextNet Wireless stockSeries A Preferred Stock to Entrx Corporation on March 31, 2003, pursuant to a loan agreement we entered into with Entrx on November 5, 2002.  See Note JK for more information regarding our transaction with Entrx.

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

As of March 31,June 30, 2003, we owned approximately 700,000 shares of NextNet Series A Preferred Stock, or approximately 6% of the outstanding equity in NextNet.  Of our remaining shares, we have issued three warrants to two private investors to purchase up to 148,337 additional shares of our NextNet Series A Preferred Stock from us at a price of $6.00 per share.  A warrant to purchase up to 125,000 shares expires on May 17,December 31, 2004, and two warrants to purchase 23,337shares expiresa total of 23,337 shares expire on December 31, 2005.

Note I. Income Taxes:

We have not recorded any current or deferred income tax provision for any of the periods presented since we have a net operating loss carryforward.  Because of the uncertainty about whether we will have taxable earnings in the future, we have not reflected any benefit of such net operating loss carryforwards in the accompanying consolidated financial statements.  At June 30, 2003, we had approximately $84 million of net operating loss carryforwards remaining, which begin to expire starting in 2005.  The use of these carryforwards in any one year may be limited under Internal Revenue Code Section 302 due to significant ownership changes.

Note J. Legal MattersMatters:

We are subject to various legal proceedings and claims that arise in the ordinary course of business.

On August 5, 2002, our former president and CEO, Doug Holden, notified us that he believed we breached his severance agreement with us following the separation of his employment.  Mr. Holden requested continued payroll and benefits and continued vesting of stock options for six months from June 27, 2002, the date of his separation.  Mr. Holden’s annualized salary at the time of his separation was $240,000. Therefore, the value of Mr. Holden’s claims is approximately $120,000, plus the value of his benefits and continued vesting of

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his options.  We believe that we have valid defenses to Mr. Holden’s claims and/or that Mr. Holden is not entitled to the items he is requesting.  The timing and ultimate resolution of Mr. Holden’s claims are uncertain at this time.

We are also subject to other various legal proceedings and claimsbusiness that we do not believe are material either separately or in the aggregate.

On June 6, 2003, we reached an agreement with Doug Holden, our former president and CEO, related to a claim for severance he threatened to bring against us following the separation of his employment.  Under the agreement, we will pay Mr. Holden a total of $50,000 in five monthly installments, ending in October 2003.

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Note J.K.  Loan Agreement with Entrx CorporationCorporation:

On November 5, 2002, we entered into a loan agreement with Entrx Corporation, under which Entrx agreed to lend us up to $2.5 million in three separate advances.  We received the first advance of $1 million on November 4, 2002.  On February 19, 2003, this loan agreement was amended.  In connection with the amendment, we received the second advance of $750,000 but waived the third advance.  Entrx also waived its rights to convert all outstanding advances into shares of our common stock, and terminated an option under the original loan agreement to purchase additional shares of our NextNet.  Entrx also agreed to waive interest charges accruing after December 2002.

Entrx elected to convertWe received $1.75 million under the loan.  On March 31, 2003, principal amount of the loanand accrued interest was converted into 413,712415,340 shares of NextNet Wireless Series A Preferred Stock we own on March 31, 2003.Stock. The conversion price was $4.23 per share, which was the per share price (on a common share equivalent basis, without giving effect to differences in rights or to anti-dilution provisions or any other purchase price adjustments set forth in the NextNet loan agreement) that NextNet agreed to receive for a sale of other preferred stock.  If NextNet sells additional preferred stock in an amount that is at least one million dollars ($1,000,000.00) before June 30, 2003, at a price lower than $4.23 per share (on a common share equivalent basis, without giving effect to differences in rights or to anti-dilution provisions or any other purchase price adjustments set forth inUpon conversion, our repayment obligations under the NextNet loan agreement), we are required to issue additional shares to Entrx to give it the benefit of such lower per share price.were extinguished.

Note K.L.  Major CustomersCustomers:

A portion of our revenues have been derived from significant customers for the three monthsand six month periods ended March 31,June 30, 2003 and 2002 as follows:

Note L.M.  Stockholders’ EquityEquity:

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

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No compensation cost has been recognized for stock options granted to employees or directors under our 1989 Stock Option Plan, 1993 Equity Incentive Plan, 1993 Directors Option Plan, 1997 Stock Option Plan, 1998 Non-Officers Plan, 1999 Non-Officers Plan, 2000 Non-Officers Plan, or 2000 Non-Qualified Plan (collectively referred to as the “Plans”).  Had compensation cost for the Plans been determined based on the fair value of options at the grant date for awards in the three monthsand six month periods ended March 31,June 30, 2003 and 2002, our net income (loss) and net income (loss) per share would have decreasedchanged to the pro forma amounts indicated below:

(In thousands, except per share amounts)