<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
----------------
FORM 10-Q/A
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 333-53953
CONVERGENT COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Colorado 84-1337265
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation)
400 Inverness Drive South, Suite 400
Englewood, Colorado 80112
(303) 749-3000
(Address and telephone number of principal executive offices)
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.
(1) Yes X No
(2) Yes X No
On August 5, 1999, 27,681,241 shares of the registrant's Common Stock were
outstanding
(reflects the one-for-two reverse stock split on July 20, 1999).
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<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page No.
---------
PART I: FINANCIAL INFORMATION
<S> <C>
Item 1. Financial Statements
Consolidated Balance Sheets--December 31, 1998 and June 30,
1999......................................................... 1
Consolidated Statements of Operations and Comprehensive
Loss--Three and Six months ended June 30, 1998 and 1999.... 2
Consolidated Statement of Shareholders' Deficit--Six months
ended June 30, 1999......................................... 3
Consolidated Statements of Cash Flows--Six months ended June 30,
1998 and 1999............................................... 4
Notes to Consolidated Financial Statements................... 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 10
PART II: OTHER INFORMATION
Item 1. Legal Proceedings............................................ 21
Item 2. Changes in Securities........................................ 21
Item 3. Defaults Upon Senior Securities.............................. 21
Item 4. Submission of Matters to a Vote of Securities Holders........ 21
Item 5. Other Information............................................ 22
Item 6. Exhibits and Reports on Form 8-K
Exhibits..................................................... 22
Reports on Form 8-K.......................................... 22
</TABLE>
When used in this Report, the words "intend," "expects," "plans,"
"estimates," "anticipates," "projects," "believes," and similar expressions
are intended to identify forward-looking statements. Specifically, statements
included in this Report that are not historical facts, including statements
about our beliefs and expectations about our business and our industry are
forward-looking statements. These statements are subject to risks and
uncertainties that could cause actual results or outcomes to differ
materially. These risks and uncertainties include, but are not limited to, the
degree to which we are leveraged and the restrictions imposed on us under our
existing debt instruments that may adversely affect our ability to finance our
future operations, to compete effectively against better capitalized
competitors, to withstand downturns in our business or the economy generally
and other factors discussed in our filings with the Securities and Exchange
Commission. Forward-looking statements included in this Report speak only as
of the date of this report and we will not revise or update these statements
to reflect events or circumstances after the date of this report or to reflect
the occurrence of unanticipated events.
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, June 30,
1998 1999
------------ ------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................ $ 25,597,461 $ 11,242,052
Short-term investments........................... -- 7,957,400
Restricted cash.................................. 20,800,000 20,800,000
Trade accounts receivable, net of allowance for
doubtful accounts of $1,908,811 and $1,581,197,
respectively 17,661,220 22,796,717
Inventory........................................ 6,826,732 11,337,352
Prepaid expenses, deposits and other current
assets.......................................... 2,134,210 4,722,549
------------ ------------
Total current assets........................... 73,019,623 78,856,070
Property, network and equipment.................... 28,139,460 44,784,898
Less accumulated depreciation.................... (4,882,832) (8,906,829)
------------ ------------
Total property, network and equipment.......... 23,256,628 35,878,069
Restricted cash, non-current....................... 30,549,658 22,467,381
Goodwill, net of amortization of $2,967,283 and
$5,530,474, respectively.......................... 46,526,288 50,100,536
Other intangible assets, net of amortization of
$1,470,363 and $2,336,189, respectively 10,281,016 10,537,971
Leases receivable, less current portion............ 796,790 3,034,890
Investments and other assets....................... 1,225,626 646,792
------------ ------------
Total assets................................... $185,655,629 $201,521,709
============ ============
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Trade accounts payable........................... $ 15,061,514 $ 24,466,860
Accrued compensation............................. 4,583,140 5,184,433
Accrued interest................................. 5,214,133 5,284,578
Other accrued liabilities........................ 8,666,182 7,940,721
Deferred revenue and customer deposits........... 5,211,748 5,252,206
Liability related to business combination........ -- 1,350,000
Current portion of long-term debt................ 603,919 4,107,090
Current portion of capital lease obligations..... 5,179,251 7,790,672
------------ ------------
Total current liabilities...................... 44,519,887 61,376,560
Long term debt, less discount and current portion.. 153,730,573 165,409,037
Long term capital lease obligations, less current
portion........................................... 8,754,054 11,790,481
------------ ------------
Total liabilities.............................. 207,004,514 238,576,078
Commitments
Convertible preferred stock........................ -- 19,206,378
Shareholders' deficit:
Common stock, no par value, 100 million shares
authorized, 13,924,135 and 14,838,347 issued and
outstanding, respectively 27,486,554 36,438,015
Warrants......................................... 11,719,399 10,895,321
Treasury stock................................... (501,674) (1,098,812)
Deferred compensation obligation................. 501,674 1,098,812
Accumulated other comprehensive income........... -- 22,423
Unearned compensation............................ (150,150) (122,850)
Accumulated deficit.............................. (60,404,688) (103,493,656)
------------ ------------
Total shareholders' deficit.................... (21,348,885) (56,260,747)
------------ ------------
Total liabilities and shareholders' deficit.... $185,655,629 $201,521,709
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
1
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
<TABLE>
<CAPTION>
Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
1998 1999 1998 1999
------------ ------------- ------------ ------------
(unaudited)
<S> <C> <C> <C> <C>
Data and voice service
revenue................ $ 2,422,546 $ 16,673,445 $ 4,229,619 $ 31,984,021
Data and voice product
revenue................ 5,559,292 21,379,903 10,275,084 37,777,883
------------ ------------ ------------ ------------
Total revenue......... 7,981,838 38,053,348 14,504,703 69,761,904
Cost of sales excluding
depreciation........... 5,771,651 23,713,539 10,569,675 44,456,392
Selling, general and
administrative......... 7,710,565 27,410,867 13,772,410 50,748,448
Depreciation and
amortization........... 1,190,712 4,107,529 1,953,151 6,970,421
------------ ------------ ------------ ------------
Total operating
expenses............. 14,672,928 55,231,935 26,295,236 102,175,261
Operating loss........ (6,691,090) (17,178,587) (11,790,533) (32,413,357)
Interest expense...... (5,830,022) (6,149,357) (5,882,591) (12,086,022)
Interest income....... 1,348,919 770,480 1,380,397 1,721,126
Other income
(expense), net....... 3,473 (402,661) 13,340 (310,715)
------------ ------------ ------------ ------------
Net loss................ (11,168,720) (22,960,125) (16,279,387) (43,088,968)
Other comprehensive
income, unrealized
holding gains on
securities........... 234,618 10,723 292,308 22,423
------------ ------------ ------------ ------------
Comprehensive loss.... $(10,934,102) $(22,949,402) $(15,987,079) $(43,066,545)
------------ ------------ ------------ ------------
Net loss per share:
Net loss per share
(basic and diluted).. $ (0.82) $ (1.61) $ (1.20) $ (3.06)
------------ ------------ ------------ ------------
Weighted average
number of shares
outstanding(basic and
diluted)............. 13,660,317 14,253,268 13,565,687 14,098,801
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
2
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' DEFICIT
(unaudited)
<TABLE>
<CAPTION>
Accumulated
Deferred Other
Common Common Treasury Compensation Unearned Comprehensive Accumulated
Shares Stock Warrants Stock Obligation Compensation Income Deficit
---------- ----------- ----------- ----------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December
31, 1998......... 13,924,135 $27,486,554 $11,719,399 $ (501,674) $ 501,674 $(150,150) $ -- $ (60,404,688)
Common stock
issued for:
401(k) match.... 75,503 712,596 -- -- -- -- -- --
Business
combinations.... 61,925 619,250 -- -- -- -- -- --
Exercise of
stock options... 36,500 179,000 -- -- -- -- -- --
Exercise of
warrants........ 683,487 6,498,395 (1,276,558) -- -- -- -- --
Compensation
expense.......... 94,297 946,720 -- -- -- 27,300 -- --
Shares
repurchased...... (37,500) (4,500) -- -- -- -- -- --
Distribution of
deferred stock... -- -- -- 52,199 (52,199) -- -- --
Deferred stock
compensation..... -- -- -- (649,337) 649,337 -- -- --
Warrants issued
in connection
with financing... -- -- 452,480 -- -- -- -- --
Other
comprehensive
income:
Unrealized gain
on securities... -- -- -- -- -- -- 22,423 --
Net loss......... -- -- -- -- -- -- -- (43,088,968)
---------- ----------- ----------- ----------- ---------- --------- ------- -------------
Balance, June 30,
1999............. 14,838,347 $36,438,015 $10,895,321 $(1,098,812) $1,098,812 $(122,850) $22,423 $(103,493,656)
========== =========== =========== =========== ========== ========= ======= =============
<CAPTION>
Total
-------------
<S> <C>
Balance, December
31, 1998......... $(21,348,885)
Common stock
issued for:
401(k) match.... 712,596
Business
combinations.... 619,250
Exercise of
stock options... 179,000
Exercise of
warrants........ 5,221,837
Compensation
expense.......... 974,020
Shares
repurchased...... (4,500)
Distribution of
deferred stock... --
Deferred stock
compensation..... --
Warrants issued
in connection
with financing... 452,480
Other
comprehensive
income:
Unrealized gain
on securities... 22,423
Net loss......... (43,088,968)
-------------
Balance, June 30,
1999............. $(56,260,747)
=============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
3
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the six months ended
----------------------------
June 30, 1998 June 30, 1999
------------- -------------
(unaudited)
<S> <C> <C>
Cash flows from operating activities
Net loss......................................... $ (16,279,387) $(43,088,968)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization................... 1,953,151 6,970,421
Amortization of deferred financing costs and
accretion of debt discount..................... 191,804 843,459
Provision for uncollectible accounts............ 144,180 754,464
Stock compensation expense...................... 576,528 974,020
401(k) contributions through the issuance of
common stock................................... 297,079 712,596
Loss on sale of investment...................... -- 220,500
Change in working capital (net of acquisitions):
Trade accounts receivable....................... (3,197,592) (3,740,375)
Inventory....................................... (547,597) (1,203,027)
Prepaid expenses and other current assets....... (1,471,531) (1,634,802)
Trade accounts payable.......................... 2,353,884 3,397,280
Accrued compensation............................ 536,941 242,059
Accrued interest................................ 5,200,000 70,445
Other accrued liabilities....................... 1,406,099 (822,576)
Deferred revenue and customer deposits.......... -- (816,102)
------------- ------------
Net cash used in operating activities............. (8,836,441) (37,120,606)
Cash flows from investing activities
Additions of property, network and equipment..... (5,645,999) (1,300,914)
Acquisitions, net of cash acquired............... (1,608,743) (2,051,833)
Short-term investments........................... (73,746,649) (7,934,977)
Restricted cash.................................. (59,478,484) 8,082,277
Leases receivable................................ -- (3,070,067)
Proceeds from sale of investment................. -- 154,500
Other assets..................................... (179,819) (131,303)
------------- ------------
Net cash used in investing activities............. (140,659,694) (6,252,317)
Cash flows from financing activities
Proceeds from private placements, net of offering
costs........................................... 154,153,217 19,206,378
Proceeds from new borrowings, net of financing
costs........................................... 120,738 9,529,990
Payments on notes payable........................ (704,868) (2,243,541)
Payments on capital leases....................... (559,882) (2,871,650)
Proceeds from exercise of warrants and stock
options......................................... 123,100 5,400,837
Repurchase of common shares...................... -- (4,500)
------------- ------------
Net cash provided by financing activities......... 153,132,305 29,017,514
------------- ------------
Net increase (decrease) in cash and cash
equivalents...................................... 3,636,170 (14,355,409)
Cash and cash equivalents at beginning of period.. 667,344 25,597,461)
------------- ------------
Cash and cash equivalents at end of period........ $ 4,303,514 $ 11,242,052
============= ============
Supplemental disclosure of other cash and non-cash
investing and financing activities
Acquisition of property, network and equipment
through the issuance of capital leases and other
financing facilities............................ $ 3,372,326 $ 10,518,704
Acquisition of property, network and equipment in
accounts payable waiting to be financed......... -- 3,901,556
Cash paid for interest............................ 490,787 11,172,108
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
4
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BASIS OF PRESENTATION:
References in these footnotes to "Convergent Communications," "us," "we,"
"our" refer to Convergent Communications, Inc. and its subsidiaries.
Convergent Communications is a single-source provider of data and voice
communications systems, services and solutions to small and medium sized
businesses. We design, build, install, manage and monitor data and voice
networks inside enterprises and provide external network services such as data
transport, long distance, local service and Internet access. We offer these
products and services on a stand-alone basis or as part of a bundled offering
that can include owning an enterprise's internal data and voice networks. We
are also installing an integrated data and voice switching platform in each of
the markets in which we operate to efficiently handle our customers' traffic.
We provide the following products and services:
. Data Services
. Voice Services
. Enterprise Network Services
. Data Products
. Voice Products
Our ultimate success depends upon, among other factors, establishing our
nationwide network, funding the development of our enterprise networks,
continuing to develop our customer care and sales organizations, integrating
acquired businesses, attracting and retaining customers, continuing to develop
and integrate our operational support system and other back office systems,
responding to competitive developments, continuing to attract, retain and
motivate qualified personnel, and continuing to upgrade our technologies and
commercialize our services incorporating these technologies. There is no
assurance that we will be successful in addressing these matters and our
failure to do so could have a material adverse effect on our business
prospects, operating results and financial condition.
Our business plan will continue to require a substantial amount of capital
to fund our expansion of our existing and acquired markets. As we continue to
expand our business, we will seek additional sources of financing to fund our
development. We estimate that our existing funds at June 30, 1999, the
proceeds from our July initial public offering, our available borrowing and
lease financing capacity and the proceeds from the exercise of warrants in
July will be sufficient to meet our capital requirements for the foreseeable
future. We could, however, require additional capital sooner due to material
shortfalls in our operating and financial performance or if we are more
aggressive in our expansion than currently contemplated. We cannot be certain
that we would be successful in raising sufficient debt or equity capital to
fund our operations on a timely basis or on acceptable terms. If needed
financing were not available on acceptable terms, we could be compelled to
alter our business strategy, or delay or abandon some of our future plans or
expenditures or fail to make interest payments on our debt. Any of these
events would have a material adverse effect on our financial condition,
results of operations and liquidity.
2. INTERIM FINANCIAL DATA:
The consolidated balance sheet as of June 30, 1999, statement of
shareholders' deficit for the six months ended June 30, 1999 and the
consolidated statements of operations and comprehensive loss, and cash flows
for the three and six months ended June 30, 1998 and 1999 have been prepared
by us without audit. In our opinion, all adjustments, consisting of only
normal recurring adjustments, necessary to present fairly the consolidated
financial position, results of operations and cash flows have been made. The
results of operations for these interim periods are not necessarily indicative
of the results for the full year.
5
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The accompanying financial statements should be read with our consolidated
financial statements included in our 1998 Form 10-K filed with the Securities
and Exchange Commission on March 16, 1999.
Certain prior period amounts have been reclassified to conform to the
current period's presentation.
3. ACQUISITIONS:
Kansas Communications, Inc. In February 1999, we acquired the assets and
assumed certain liabilities of Kansas Communications, Inc. ("KCI"). KCI was a
telecommunications equipment provider and integrator. The purchase price
consisted of $1.5 million in cash, $4.5 million in notes payable and 24,925
shares of our common stock, which, for purchase accounting purposes, were
assigned a value of $10.00, and assumed liabilities of $2.4 million resulting
in total consideration of $8.7 million. In April 1999, $1.5 million of the
notes payable were paid with the proceeds from the sale of our Series A
Convertible Preferred Stock. An additional $2.0 million was paid subsequent to
June 30, 1999.
BSSi Innovations, Inc. In April 1999, we acquired BSSi Innovations, Inc.
("BSSi"). BSSi was a data network integration services provider based in
Chicago, Illinois. The purchase price consisted of $455,000 in cash, 37,000
shares of our common stock, which for purchase accounting purposes were
assigned a value of $10.00 per share, and assumed debt of approximately
$525,000, resulting in total consideration of $1.4 million. An additional
10,000 shares may be issued if certain financial conditions are met.
Choice Solutions, Inc. In June 1999 we entered into an agreement to purchase
the majority of the assets and assume certain liabilities of Choice Solutions,
Inc. ("CSI"). In addition, in June, we entered into a Management Agreement
with CSI which gives us effective control of the operations of CSI. Our
financial statements include the accounts and results of operations from the
effective date of the management agreement. Subsequent to June 30, 1999 we
completed the acquisition of the majority of the assets and certain
liabilities of CSI. CSI was a data network integration services provider based
in Dallas, Texas. The purchase price consisted of $1,125,000 in cash and
15,000 shares of our common stock valued at $225,000, resulting in total
consideration of $1,350,000. Additional shares of our common stock may be
issued if certain financial results are attained. As of June 30, 1999 we had
recorded a liability for the acquisition of $1,350,000.
We accounted for each of these acquisitions as a business combination using
the purchase method of accounting. In connection with the acquisitions, the
excess of consideration given over the fair market value of the net assets
acquired is being amortized on a straight line basis over the estimated life
of the intangible asset acquired which is ten years. The accompanying
financial statements include the accounts of the acquired companies from the
effective dates of the acquisitions.
6
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The allocation of consideration given during the six months ended June 30,
1999 to the acquired assets is as follows:
<TABLE>
<S> <C>
Purchase price:
Cash paid................................................... $ 2,056,535
Notes payable issued to former owner........................ 4,490,000
Liability related to a business combination................. 1,350,000
Common stock issued to the former owners.................... 619,250
-----------
Total purchase price...................................... $ 8,515,785
===========
Allocation of the purchase price to acquired assets and
assumed liabilities:
Cash........................................................ $ 4,702
Accounts receivable......................................... 2,332,929
Inventory................................................... 3,307,593
Prepaid expenses, deposits and other current assets......... 121,570
Equipment................................................... 805,964
Goodwill.................................................... 5,954,096
Liabilities and debt assumed................................ (4,011,069)
-----------
Amounts allocated......................................... $ 8,515,785
===========
</TABLE>
4. CREDIT FACILITY:
In June 1999, we entered into a $10.0 million senior secured credit facility
with Goldman Sachs Credit Partners L.P. The proceeds of this facility will be
used for working capital and other general corporate purposes. Interest
accrues at the greater of 13.0% or LIBOR plus 6.0% with interest payments due
monthly. The principal amount outstanding along with any accrued interest is
due in June, 2002. We cannot re-borrow amounts repaid under this facility. In
connection with this facility, we also issued to Goldman Sachs Credit Partners
L.P. a warrant to acquire 375,000 shares of common stock at an exercise price
of $15.00 per share. As of June 30, 1999 we had borrowed the full amount
available under this facility.
5. SERIES A PREFERRED STOCK:
In March 1999, we sold 800,000 shares of Series A Convertible Preferred
Stock and warrants to purchase 958,333 shares of our common stock to various
affiliates of the Sandler/21st Century Group for total consideration of $20.0
million. The Series A Convertible Preferred Stock automatically converted into
2,666,677 shares of common stock upon the completion of our initial public
offering which closed on July 23, 1999. The proceeds from the sale, net of
related offering costs were $19.2 million. One of our directors, Michael
Marocco, is a principal of several of the entities in Sandler Capital. Mr.
Roland Casati, another director, also purchased shares of Series A Convertible
Preferred Stock.
We have 1,000,000 shares of preferred stock authorized none of which were
outstanding as of December 31, 1998 and 800,000 of which were outstanding as
of June 30, 1999.
6. BUSINESS SEGMENTS:
We classify our business into five fundamental areas: data services, voice
services, Enterprise Network Services, data products and voice products.
Senior management evaluates and makes operating decisions about each of these
operating segments based on a number of factors. We do not account for assets
by business segment
7
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
and, therefore, depreciation and amortization are not factors used in
evaluating operating performance. Two of the more significant factors used in
evaluating our operating performance are: revenue and gross margin before
depreciation as presented below:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- ------------------
1998 1999 1998 1999
--------- --------- -------- --------
(in thousands)
<S> <C> <C> <C> <C>
Revenue:
Data services...................... $ 622 $ 2,142 $ 1,430 $ 4,261
Voice services..................... 1,167 13,493 2,050 25,951
Enterprise Network Services........ 634 1,038 750 1,772
Data products...................... 5,388 9,155 9,850 16,568
Voice products..................... 171 12,225 425 21,210
--------- --------- -------- --------
Total revenue.................... 7,982 38,053 14,505 69,762
--------- --------- -------- --------
Gross margin before depreciation:
Data services...................... 306 1,317 753 2,304
Voice services..................... 307 6,569 691 11,819
Enterprise Network Services........ 435 905 496 1,496
Data products...................... 1,101 1,566 1,841 2,425
Voice products..................... 61 3,983 154 7,261
--------- --------- -------- --------
Total gross margin before
depreciation.................... 2,210 14,340 3,935 25,305
--------- --------- -------- --------
Reconciliation to net loss:
Selling, general and
administrative.................... (7,711) (27,410) (13,772) (50,748)
Depreciation and amortization...... (1,190) (4,108) (1,953) (6,970)
Operating loss..................... (6,691) (17,178) (11,790) (32,413)
Interest expense................... (5,830) (6,149) (5,882) (12,086)
Interest income.................... 1,349 770 1,380 1,721
Other income, net.................. 3 (403) 13 (311)
--------- --------- -------- --------
Net loss......................... $ (11,169) $ (22,960) $(16,279) $(43,089)
========= ========= ======== ========
</TABLE>
7. NET LOSS PER SHARE:
The net loss available to common shareholders and weighted average shares
consists of the following:
<TABLE>
<CAPTION>
Three Months Six Months Ended
Ended June 30, June 30,
------------------ ------------------
1998 1999 1998 1999
-------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C>
Net loss.............................. $(11,169) $(22,960) $(16,279) $(43,089)
======== ======== ======== ========
Weighted average common shares used
for basic and diluted earnings per
share................................ 13,660 14,253 13,365 14,099
Warrants.............................. -- -- -- --
Stock options......................... -- -- -- --
-------- -------- -------- --------
Weighted average number of shares
outstanding (basic and diluted)...... 13,660 14,253 13,365 14,099
======== ======== ======== ========
</TABLE>
As of June 30, 1998 and 1999 a total of 7,794,282 and 9,777,115, options and
warrants were outstanding which were not considered in the above calculations
as their effect would have been anti-dilutive.
8
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8. SUBSEQUENT EVENTS:
On July 20, 1999, we completed a one-for-two reverse split of our common
stock. The accompanying consolidated financial statements and related
disclosures have been restated for all periods presented to reflect the
reverse stock split.
In July 1999, we entered into a six-year $103.5 million credit facility with
Cisco Systems Capital Corporation. This credit facility will provide the
financing for the purchase and installation of our Cisco Systems, Inc. multi-
service data and voice switching platform and for other Cisco equipment. Under
the terms of this agreement, Cisco Systems, Inc. also received a warrant to
purchase 575,000 shares of our common stock. The warrant has an exercise price
of $15.00 per share and is exercisable for three years from the date of
issuance. The facility will be available in three tranches over a three year
period with quarterly payments due over three years beginning one year from
the availability of each tranche.
In July 1999, we completed an initial public offering of our common stock in
which 9,660,000 shares, including 723,271 shares sold by selling shareholders,
were sold at an offering price of $15.00 per share. We received proceeds from
the offering of approximately $122.7 million, net of selling shareholders
($10.8 million), underwriting discount ($10.1 million), and offering expenses
($1.2 million).
9. LEASE ACCOUNTING:
In November 1999 we concluded that we should have accounted for certain data
and voice product leasing transactions provided to our customers through our
leasing subsidiary, Convergent Capital Corporation, as sales type lease
transactions in accordance with Statements of Financial Accounting Standards
No.'s 13 and 94. The effect of this adjustment was to increase revenue by $1.4
million, increase cost of sales, excluding depreciation by $1.1 million and
reduce net loss by approximately $368,000 for the three months ended June 30,
1999 and increase revenue by $2.7 million, increase cost of sales, excluding
depreciation by approximately $1.7 million and reduce net loss by
approximately $1.0 million for the six months ended June 30, 1999, as
presented below:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, 1999 June 30, 1999
------------------------- -------------------------
As Previously As Previously
Stated As Restated Stated As Restated
------------- ----------- ------------- -----------
(in thousands)
<S> <C> <C> <C> <C>
Revenue................... $ 36,624 $ 38,053 $ 67,105 $ 69,762
Cost of sales, excluding
depreciation............. 22,652 23,714 42,726 44,456
Net loss.................. (23,328) (22,960) (44,015) (43,089)
EBITDA.................... (13,439) (13,071) (26,369) (25,443)
Net loss per share........ (1.64) (1.61) (3.12) (3.06)
</TABLE>
9
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated
Financial Statements and the accompanying footnotes included in this Form 10-
Q. This discussion includes forward-looking statements and is based on current
expectations which involve risks and uncertainties. Because of the uncertainty
of many factors, what actually occurs in the future may be very different from
what we project in our forward-looking statements.
Overview
We are a rapidly growing national provider of single-source data and voice
communications systems, services and solutions primarily to businesses with 25
to 500 employees. Inside our customers' premises we own communications
networks and provide professional services, such as the design, installation,
management and monitoring of those networks to our customers. Outside our
customer' premises, we provide a full range of data and voice transport
services. By operating networks, both inside and outside our customers'
premises, and by offering a broad range of data and voice products and
services, we enable small and medium sized businesses to use state-of-the-art
communications solutions, including data and voice networks based on Internet
Protocol, electronic commerce, the Internet and sophisticated communications
systems. We offer each of our products and services on a stand-alone basis and
are now offering a bundled communications solution, which we call Enterprise
Network Services, in which we design, install, own, manage and monitor the
data and voice networks inside our customers' premises and provide
communications services outside our customers' premises.
We were first capitalized on March 1, 1996. Since that time, we have
successfully raised $338.6 million in capital, including $450,000 in founder's
capital, $24.0 million in two private placements of common stock in 1996 and
1997 (including an additional $450,000 from the founders), $160.0 million
through the 1998 sale of our 13% Senior Notes and related warrants, $20.0
million in a 1999 sale of our convertible preferred stock and warrants to
affiliates of Sandler Capital and $134.1 million in our July 1999 initial
public offering of common stock. As a result of the investment in our
preferred stock, we also have increased the borrowing capacity under our
existing Comdisco equipment lease facility by $20.0 million to a total of
$30.0 million. In addition, in June 1999, we entered into a $10.0 million
senior secured credit facility with Goldman Sachs Credit Partners L.P. and in
July we entered into a six year $103.5 million equipment financing facility
with Cisco Systems Capital Corporation.
In the last three years, we completed 15 strategic acquisitions, the most
significant of which was the 1998 acquisition of substantially all of the
assets of Tie Communications, Inc. at a cost of approximately $51.4 million.
With the acquisition of these assets, we accelerated our growth by adding 24
new markets and 452 employees with experience in voice products and services.
This acquisition also gave us the opportunity to cross-market our data
products and services, including Enterprise Network Services, to the
approximately 77,000 customers that purchased products or services from Tie in
the past.
We began offering Enterprise Network Services in December 1997 and have now
entered into long-term Enterprise Network Service contracts with 23 customers.
We expect these contracts will provide us with approximately $16.2 million in
total revenue over their terms. Although these contracts may be canceled by
the customer, exposing us to risks related to remarketing, cancellation
requires payment of a fee designed to reimburse us for all or substantially
all of our costs incurred in entering into the contract.
Description of Financial Components
We classify our business into five segments: data services, voice services,
Enterprise Network Services, data products and voice products.
10
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
Revenue and cost of sales. The following chart outlines the components of
revenue and the related cost of sales excluding depreciation, by segment.
<TABLE>
<CAPTION>
Revenue Cost of Sales (excluding depreciation)
-------------------------------- -------------------------------------------
<S> <C>
Data Services
Professional Services
web design and hosting and . engineer and technician compensation and
network planning, design, benefits
maintenance, and monitoring
Network Services
frame relay (ATM and IP . leased line costs of connecting a
switching), Internet access and customer to a long distance or local
web hosting network
. capacity charges that long distance and
local carriers, Internet providers and
others impose to use their equipment and
network
</TABLE>
----------------
<TABLE>
<S> <C>
Voice Services
Professional Services
network planning, design, . engineer and technician compensation and
maintenance and monitoring benefits
Network Services
long distance service, local . leased line facilities' costs of
telephone service and public connecting a customer to a long distance
phone service or local network
. capacity charges that long distance and
local carriers, Internet service
providers and others impose to use their
equipment and network
</TABLE>
----------------
<TABLE>
<S> <C>
Enterprise Network Services
long-term contracts (typically . all the costs associated with all the
three to five years) under which data and voice products and services
we own, manage and are responsible described in this table
for all or a portion of the
network inside our customers'
premises
</TABLE>
----------------
<TABLE>
<S> <C>
Data Products
sale and installation of network . cost of data network equipment
equipment
. costs of installation, including
technician
compensation and benefits.
</TABLE>
----------------
<TABLE>
<S> <C>
Voice Products
sale and installation of network . cost of voice network equipment
equipment
. costs of installation, including
technician
compensation and benefits.
</TABLE>
11
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
Selling, general and administrative expenses have increased significantly
and will continue to increase as we recruit additional management and support
personnel necessary for continued growth. The Tie acquisition contributed
substantially to this increase. However, we expect these expenses to decline
as a percentage of our revenue as we expand our customer base and begin
selling additional products and services in each of our markets.
. Sales and marketing expenses include commissions paid in connection with
our sales programs, marketing salaries and benefits, travel expenses,
trade show expenses, consulting fees and promotional costs. Also
included are the costs of soliciting potential customers such as
telemarketing, brochures, targeted advertising and promotional
campaigns. We expect these expenses to increase as we add additional
sales and marketing personnel and further implement our business plan.
. General and administrative expenses primarily consist of salaries and
related expenses of management and support services personnel, occupancy
fees, professional fees and general corporate and administrative
expenses. We also include costs associated with the development, support
and expected enhancements of our operational support software platform,
to the extent these costs are not capitalized.
Depreciation and amortization expense includes depreciation of property,
network and equipment (over two to five years), including our assets located
inside our customers' premises provided under Enterprise Network Services
contracts. Amortization expense includes the amortization of intangible assets
(over three to ten years), primarily goodwill (over ten years), that result
from business acquisitions. We had $50.1 million of goodwill, net of
amortization, on June 30, 1999. Depreciation and amortization will increase as
we install additional ePOP switching platforms and expand our Enterprise
Network Services business and as a result of increased amortization of
intangibles expected to result from future acquisitions.
Interest expense includes interest expense on our short-term and long-term
debt, including capital leases. The majority of the interest expense is
related to our 13% Senior Notes which mature in 2008. Interest expense will
increase as we continue to finance a significant portion of our capital
expenditures, including our purchase of Cisco Systems Inc.'s multi-service,
data and voice switches and additional Cisco equipment under the
$103.5 million equipment facility with Cisco Systems Capital Corporation and
as a result of the Goldman Sachs Credit Facility.
Results of Operations
Management evaluates and makes operating decisions about each of our
operating segments based on a number of factors. Two of the more significant
factors we use in evaluating operating performance are: revenue and gross
margin before depreciation. We do not account for assets by business segment
and, therefore, depreciation and amortization are not factors used by
management in evaluating operating performance.
12
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
The percentages shown in the following table with respect to revenue
represent revenue for each business segment as a percentage of total revenue.
Percentages with respect to cost of sales excluding depreciation and gross
margin before depreciation are of the revenue for the related segment.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended June
June 30, 30,
----------------------- ------------------------
1998 1999 1998 1999
---------- ----------- ----------- -----------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue:
Data services............. $ 622 8% $ 2,142 6% $ 1,430 10% $ 4,261 6%
Voice services............ 1,167 15 13,493 35 2,050 14 25,951 37
Enterprise Network
Services................. 634 8 1,038 3 750 5 1,772 3
Data products............. 5,388 67 9,155 24 9,850 68 16,568 24
Voice products............ 171 2 12,225 32 425 3 21,210 30
------ --- ------- --- ------- --- ------- ---
Total revenue........... $7,982 100% $38,053 100% $14,505 100% $69,762 100%
====== === ======= === ======= === ======= ===
Cost of sales excluding
depreciation:
Data services............. $ 317 51% $ 825 39% $ 678 47% $ 1,957 46%
Voice services............ 859 74 6,924 51 1,358 66 14,132 54
Enterprise Network
Services................. 199 31 133 13 254 34 276 16
Data products............. 4,287 80 7,589 83 8,009 81 14,143 85
Voice products............ 110 64 8,242 67 271 64 13,949 66
------ --- ------- --- ------- --- ------- ---
Total cost of sales
excluding
depreciation........... $5,772 72% $23,713 62% $10,570 73% $44,457 64%
====== === ======= === ======= === ======= ===
Gross margin before
depreciation:
Data services............. $ 306 49% $ 1,317 61% $ 753 53% $ 2,304 54%
Voice services............ 307 26 6,569 49 691 34 11,819 46
Enterprise Network
Services................. 435 69 905 87 496 66 1,496 84
Data products............. 1,101 20 1,566 17 1,841 19 2,425 15
Voice products............ 61 36 3,983 33 154 36 7,261 34
------ --- ------- --- ------- --- ------- ---
Total gross margin
before depreciation.... $2,210 28% $14,340 38% $ 3,935 27% $25,305 36%
====== === ======= === ======= === ======= ===
</TABLE>
13
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
Summary Quarterly Financial Data
The table below presents unaudited quarterly statement of operations data
for each of the nine quarters through June 30, 1999. This information has been
derived from unaudited financial statements that have been prepared on the
same basis as the audited financial statements contained in our 1998 Form 10-K
and, in our opinion, includes all adjustments, consisting only of normal
recurring adjustments, that we consider necessary for a fair presentation of
the information. The operating results for any quarter are not necessarily
indicative of results for any future periods.
<TABLE>
<CAPTION>
1997 1998 1999
------------------------- ------------------------------------- ------------------
2nd 3rd 4th 1st 2nd 3rd 4th 1st 2nd
------- ------- ------- ------- -------- -------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Operating Statement Data:
Revenue.......................... $ 2,020 $ 3,144 $ 4,448 $ 6,523 $ 7,982 $ 22,316 $ 24,779 $ 31,709 $ 38,053
Cost of sales excluding depreciation.. 1,359 2,209 3,423 4,798 5,772 14,717 18,416 20,743 23,714
Selling, general and administrative.. 1,974 3,052 4,769 6,062 7,710 15,507 18,583 23,337 27,411
Depreciation and amortization.... 233 296 701 762 1,191 2,646 2,894 2,863 4,107
------- ------- ------- ------- -------- -------- -------- -------- --------
Operating loss................... (1,546) (2,413) (4,445) (5,099) (6,691) (10,554) (15,114) (15,234) (17,179)
Net loss.......................... $(1,586) $(2,817) $(4,166) $(5,111) $(11,169) $(15,355) $(18,941) $(20,129) $(22,960)
======= ======= ======= ======= ======== ======== ======== ======== ========
EBITDA (1)........................ $(1,313) $(2,117) $(3,744) $(4,337) $ (5,500) $ (7,908) $(12,220) $(12,372) $(13,071)
======= ======= ======= ======= ======== ======== ======== ======== ========
</TABLE>
- --------
(1) EBITDA consists of earnings before interest (net), income taxes,
depreciation and amortization and other income (expense). EBITDA is a
measure commonly used to analyze companies on the basis of operating
performance. It is not a measure of financial performance under GAAP and
should not be considered as an alternative to net income (loss) as a
measure of performance or as an alternative to cash flow as a measure of
liquidity. Our measure of EBITDA may not be comparable to similarly titled
measures used by other companies.
We have generated greater revenue in each successive quarter since our
inception, reflecting increases in the number of customers, mainly due to
acquisitions, and in sales to existing customers. Cost of sales excluding
depreciation has increased in every quarter, reflecting product and service
costs directly associated with the increases in revenue. Our selling, general
and administrative expenses have increased in every quarter and reflect sales
and marketing costs such as sales commissions, and the development and growth
of regional and corporate support staff. Depreciation and amortization
increased in each quarter through December 31, 1998 and again in the quarter
ended June 30, 1999. The increases in depreciation are due to the purchase of
property, network and equipment both inside and outside our customers'
premises associated with our expansion from one to 35 markets since inception,
and due to the deployment of our multi-service data and voice switching
platform in three markets. The increases in amortization are due to the
increase in goodwill and other intangible assets resulting from the completion
of 15 acquisitions through June 30, 1999. We have also experienced increasing
operating and net losses every quarter. However, net loss has declined as a
percentage of revenue from 79% for the second quarter of 1997 to 60% of
revenue for the second quarter of 1999.
Results of Operations
Revenue for the second quarter of 1999 was $30.1 million greater than
revenue for the second quarter of 1998 and revenue for the six months ended
June 30, 1999 was $55.3 million greater than revenue for the six months ended
June 30, 1998. The increase in revenue was primarily due to the addition of 27
new markets through acquisitions between June 30, 1998 to June 30, 1999. The
increase in revenue was also due to internal growth of our operations and
sales staff. Our most significant acquisition was the acquisition of the
assets of Tie Communications, which occurred in the third quarter of 1998. The
Tie acquisition contributed to the sizable increase in voice services revenue
and voice product revenue. The increase in data products was primarily a
result of the development and growth of existing markets and a result of the
expansion of data services markets from
14
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
eight at June 30, 1998 to 13 at June 30, 1999. As a result of the Tie
acquisition, and our continued strategy to increase our service offerings, our
overall revenue mix shifted from approximately 29% in services for the six
months ended June 30, 1998, to 46% for the six months ended June 30, 1999 and
44% in services for the second quarter of 1999. A significant factor in our
strategy to increase services is through our Enterprise Network Services
offering. As of June 30, 1999 we had 23 customers, representing $16.2 million
in revenue over the terms of their contracts compared to 13 customers and
$11.9 million in contract term revenue as of June 30, 1998.
Cost of sales excluding depreciation increased $17.9 million from the second
quarter of 1998 to the second quarter of 1999 and increased $33.9 million from
the six months ended June 30, 1998 to the six months ended June 30, 1999,
while declining as a percentage of total revenue from 73% for the six months
ended June 30, 1998 to 64% for the six months ended June 30, 1999 and to 62%
for the second quarter of 1999. This decline as a percentage of total revenue
is a reflection of the decline in cost of sales excluding depreciation for
both products and services. Cost of product sales excluding depreciation
declined as a percentage of product revenue, from 79% for the second quarter
of 1998 to 74% for the second quarter of 1999 and from 80% for the first six
months of 1998 to 74% for the first six months of 1999. This decrease as a
percentage of product revenue is due to an increase in sales of voice products
which have a lower related cost of sales excluding depreciation than data
products. Cost of service sales excluding depreciation as a percentage of
service revenue, decreased from 57% for the second quarter of 1998 to 47% for
the second quarter of 1999 and from 54% for the first six months of 1998 to
51% for the first six months of 1999. The decrease in cost of service sales
excluding depreciation as a percentage of service revenue was primarily due to
an increase in in our offering of professional services such as network and
web, design, maintenance and monitoring which have a lower related cost.
Selling, general and administrative expenses increased $19.7 million from
the second quarter of 1998 to the second quarter of 1999 and increased $37.0
million from the six months ended June 30, 1998 to the six months ended June
30, 1999. However, selling, general and administrative expenses declined as a
percentage of revenue from 95% for the first six months of 1998 to 73% for the
first six months of 1999 and further declined to 72% of revenue for the second
quarter of 1999. We expect selling, general and administrative expenses to
continue to decrease as a percentage of revenue as we expand our customer base
and begin selling additional products and services in each of our markets.
The increases in selling, general and administrative described above were
primarily a result of:
. the expansion from eight to 35 markets;
. the completion of three acquisitions;
. an increase from 274 employees at June 30, 1998 to 1,206 at June 30,
1999 (452 of which were hired as a result of the Tie acquisition); and
. continued growth of the support services organization required to
support expanding field operations, which accounted for approximately
$12.5 million or 46% of total selling, general and administrative
expenses for the three months ended June 30, 1999 and $23.7 million or
47% of total selling, general and administrative expenses for the six
months ended June, 1999.
Depreciation and amortization expense increased approximately $2.9 million
from the second quarter of 1998 to the second quarter of 1999 and increased
$5.0 million from the first six months of 1998 to the first six months of
1999. These increases are a direct result of increases of $30.1 million in
property, network and equipment. In addition, goodwill increased $45.4 million
as a result of the acquisitions completed between June 30, 1998 and June 30,
1999 and other intangible assets increased $3.2 million. As of June 30, 1999
we had
15
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
$50.1 million in goodwill, net of amortization, which is being amortized over
ten years. The increase in property, network and equipment is largely due to:
. the expansion from eight to 35 markets;
. the development and deployment of our multi-functional, integrated data
and voice switching platform
. continued development of our operational support system;
. the increase in assets managed under Enterprise Network Services
contracts; and
. office equipment and furniture related to the growth of our support
services organization.
Interest expense increased by approximately $320,000 from the second quarter
of 1998 to the second quarter of 1999 and increased $6.2 million from the six
months ended June 30, 1998 to the six months ended June 30, 1999. The large
increase for the six month periods is primarily a result of a full six months
of interest expense in 1999 compared to three months of interest in 1998 on
$160.0 million in principal amount of our 13% Senior Notes issued in April
1998. The increase is also a result of assumed indebtedness from acquisitions
and increased indebtedness under our equipment financing facilities with
Comdisco and Sun Financial Group, Inc. due to property, network and equipment
purchased for our networks both inside and outside our customers' premises.
Interest expense will increase as we continue to finance a significant
portion of our capital expenditures, including equipment purchased for
installation at our customers' offices in connection with the provision of
Enterprise Network Service, equipment purchased under our $103.5 million
equipment facility with Cisco Systems Capital Corporation and as a result of
$10.0 million in increased indebtedness as a result of the Goldman Sachs
Credit Partners L.P. senior secured credit facility.
Interest income decreased approximately $578,000 from the second quarter of
1998 to the second quarter of 1999 and increased $341,000 from the six months
ended June 30, 1998 to the six months ended June 30, 1999. The decline in
interest income for the second quarter comparison is a result of the decline
in cash, cash equivalents, short-term investments and restricted cash due to
our continued use of the proceeds from the offering of the 13% Senior Notes
for working capital requirements, capital expenditures, acquisitions and debt
payments. However the increase from the first six months of 1998 to the first
six months of 1999 is due to a full six months interest earned in 1999 on the
remaining proceeds from the $160.0 million in principal amount of our 13%
Senior Notes issued in April 1998 and interest earned on the proceeds from the
sale of convertible preferred stock in March 1999 compared to three months of
interest earned in 1998.
Interest income will increase in the third quarter of 1999 due to the
temporary investment of the proceeds from our Initial Public Offering in July
1999, prior to their use in our business.
Other income (expense), net which consists of miscellaneous other non-
operating types of income and expenses, decreased from net other income of
approximately $3,000 for the second quarter of 1998 to net other expense of
approximately $403,000 for the second quarter of 1999 and decreased from net
other income of approximately $13,000 for the six months ended June 30, 1998
to net other expense of approximately $311,000 for the six months ended June
30, 1999. This change is primarily due to a loss recognized on the termination
of a stock purchase agreement and sale of an investment.
Liquidity and Capital Resources
Since inception, in addition to borrowing under our credit facilities we
have funded our net losses and capital expenditures through financing
activities as outlined in the following table. In the table below, net
16
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
proceeds equals the gross proceeds of the offering less advisors' fees,
underwriting discounts and other expenses associated with the offering.
<TABLE>
<CAPTION>
Gross
Securities Sold Proceeds Net Proceeds
- --------------- ------------ ------------
<S> <C> <C>
Initial sale of 3,750,000 shares of common stock to
founders (April through October 1996).............. $ 450,000 $ 450,000
3,500,000 shares of common stock and 1,750,000
warrants (December 1996 through February 1997) 7,000,000 6,295,794
3,410,000 shares of common stock and 1,705,000
warrants (October through November 1997)........... 17,050,000 15,339,787
13% Senior Notes and 864,000 warrants (April 1998).. 160,000,000 152,377,955
Sale of 800,000 shares of Series A Convertible
Preferred Stock and 958,333 warrants (March 1999).. 20,000,000 19,206,378
Initial Public Offering of 8,936,729 shares of
common stock, net of selling shareholders shares
(July 1999)........................................ 134,050,935 122,737,700
------------ ------------
Total funds raised.............................. $338,550,935 $316,407,614
============ ============
</TABLE>
Our principal uses of cash are to fund working capital requirements, capital
expenditures, business acquisitions and operating losses. We expect that our
expansion will require additional capital expenditures and direct operating
costs and expenses. As a result, we expect to incur net losses for at least
the next 30 months. However, if our customer base grows and we are successful
in offering all of our data services and products, we believe revenue will
increase in a larger proportion to operating expenses.
As of June 30, 1999, we had current assets of $78.9 million, including cash
and cash equivalents of $11.2 million, short-term investments of $8.0 million
and restricted cash of $20.8 million, and working capital of $17.5 million. In
addition, we also had $22.5 million in non-current restricted cash. The
majority of our restricted cash, along with the interest we earn on this cash,
will be used to make the interest payments through April 2001 on our 13%
Senior Notes. We invest excess funds in short-term investments until these
funds are needed for capital investments, acquisitions and operations of the
business.
Cash Flows From Operating Activities: Operating activities used cash of
approximately $37.1 million during the six months ended June 30, 1999 and $8.8
million during the six months ended 1998. The majority of this increase was
due to a net loss of $43.1 million and a combined increase in trade accounts
receivable, inventory and prepaid and other current assets of approximately
$6.6 million, which were partially offset by non-cash expenses including
depreciation and amortization, stock compensation and amortization of
financing costs aggregating $10.5 million and a net increase in current
liabilities including trade accounts payable, accrued liabilities and deferred
revenue of $2.1 million. Cash used in operating activities for the first six
months of 1998 was primarily due to our net loss of $16.3 million and a
combined increase in current assets including trade accounts receivable and
inventory of $5.2 million, partially offset by an increase in accrued interest
of $5.2 million, increases to current liabilities of $4.3 million and non-cash
expenses aggregating 3.2 million.
Cash Flows From Investing Activities: Investing activities used cash of $6.3
million during the six months ended June 30, 1999 and $140.7 million during
the six months ended June 30, 1998. Cash used in investing activities during
the first six months of 1999 primarily consisted of short-term investments of
$8.0 million, business combinations of $2.0 million, investment in leases of
$3.1 million and capital expenditures of $1.3 million. These investing
outflows were partially offset by $8.1 million provided from maturities in
restricted cash which were used to make interest payments. An additional $10.5
million of capital expenditures were financed under our financing facilities.
The large amount of cash used in investing activities during the first
17
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
six months of 1998 was a result of the investment of the proceeds from the
$160.0 million Senior Notes, $73.7 million of which was invested in short-term
investments, pending their use in our business and $56.8 million was invested
and is classified as restricted cash pending its use for interest payments on
the Senior Notes, two of which had been made as of June 30, 1999. In addition,
$2.7 million was classified as restricted cash as a result of the issuance of
letters of credit, $5.6 million was used for capital expenditures and
approximately $1.6 million was used for business combinations.
Not reflected in investing activities is the acquisition of Choice
Solutions, Inc. (CSI) in July 1999. CSI was a provider of data network
integration services based in Dallas, Texas. The purchase price consisted of
$1.1 million in cash and 15,000 shares of our common stock. Additional shares
may be issued if certain financial objectives are met.
Cash Flows From Financing Activities: Financing activities provided cash of
approximately $29.0 million during the first six months of 1999 and
approximately $153.1 million during the first six months of 1998. Cash
provided by financing activities during 1999 consisted of approximately $19.2
million in net proceeds from the sale of our convertible preferred stock, $9.5
million in net proceeds from borrowing under the senior secured credit
facility and $5.4 million in new proceeds from the exercise of options and
warrants, which was partially offset by approximately $5.1 million in payments
on long-term borrowings. Cash provided by financing activities during the
first six months of 1998 consisted of $154.2 million in net proceeds from the
sale of the $160.0 million Senior Notes, net of $1.3 million in payments on
long-term notes payable and capital leases.
In November 1997, we entered into an agreement with Comdisco, Inc. through
which we can receive up to $50.0 million of equipment lease financing. At June
30, 1999, $30.0 million was available to us under this facility of which a
total of approximately $14.6 million had been utilized. This facility will
expire on June 30, 2000. The remaining $20.0 million will become available
upon the satisfaction of additional conditions.
On April 2, 1998, we completed the offering of our 13% Senior Notes, in the
aggregate principal amount of $160.0 million and warrants to purchase 864,000
shares of common stock. At the closing, we deposited $56.8 million of the
proceeds from that offering in a collateral account. The amount in the
collateral account along with the interest earned will be sufficient to pay
the first six interest payments on the 13% Senior Notes, the second of which
was made on April 1, 1999. We received approximately $95.6 million after
deducting offering costs of approximately $7.6 million and funding the
collateral account. The 13% Senior Notes contain certain covenants that
restrict our ability to incur additional debt and make certain payments,
including dividends.
In March 1999, we sold to affiliates of the Sandler Capital 800,000 shares
of Series A Convertible Preferred Stock and warrants to purchase 958,333
shares of our common stock, for total consideration of $20.0 million. The
warrants have an exercise price of $15.00 per share and are exercisable for
five years. The proceeds from the sale, net of related offering costs, were
approximately $19.2 million.
In June 1999,we entered into a $10.0 million senior secured credit facility
with Goldman Sachs Credit Partners L.P. The proceeds of this facility will be
used for working capital and other general corporate purposes. We cannot re-
borrow amounts repaid under this facility. In connection with this facility,
we also issued to Goldman Sachs Credit Partners L.P. a warrant to acquire
375,000 shares of common stock at an exercise price of $15.00 per share. As of
June 30, 1999 we had borrowed the full amount under this facility.
In July 1999, we entered into a six-year $103.5 million credit facility with
Cisco Systems Capital Corporation. This credit facility will provide the
financing for the purchase and installation of our Cisco Systems, Inc. multi-
service data and voice switching platform and for other Cisco equipment. Under
the terms of this
18
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
agreement, Cisco Systems, Inc. also received a warrant to purchase 575,000
shares of our common stock. The
warrant has an exercise price of $15.00 per share and is exercisable for three
years from the date of issuance. The facility will be available in three
tranches over a three year period with quarterly payments due over the three
years beginning one year from the availability of each tranche.
In July 1999 we completed an initial public offering of our common stock in
which 9,660,000 shares, including 723,271 shares sold by selling shareholders,
were sold at an offering price of $15.00 per share. We received proceeds from
the offering of approximately $122.7 million, net of selling shareholders
proceeds ($10.8 million), underwriting discount ($10.1 million), and offering
expenses ($1.2 million).
In addition, we have a financing agreement with Sun Financial Group, Inc. a
subsidiary of GATX Capital Corporation, that was used to finance our internal
capital needs under which $5.0 million was outstanding on June 30, 1999. We
also have an agreement with GE Capital Fleet Services for financing purchases
of company vehicles, $1.2 million was outstanding under this facility as of
June 30, 1999.
Future Capital Requirements. We have significant debt in relation to our
equity. At June 30, 1999, we had $189.1 million in debt and $56.3 million in
shareholders' deficit, which includes paid-in capital of $47.3 million, but
excluded $19.2 million in convertible preferred stock classified outside of
shareholders' equity. Upon the completion of our Initial Public Offering in
July 1999, we received an additional $122.7 million of paid-in-capital from
the sale of common shares, net of underwriter's discount and other costs, and
$19.2 million in convertible preferred stock was converted to common stock.
Our business plan will continue to require a substantial amount of capital to
fund our expansion of existing and acquired markets. Our business plan
includes the following:
. deploying our multi-functional converged data and voice switching
platform in all of our markets and leasing of our IP/ATM network
connecting our switches;
. funding the purchase, installation and ownership of our Enterprise
Network Services customers networks (which includes providing our
customers with all necessary hardware, software, transmission facilities
and management maintenance and monitoring);
. continuing to develop customer care and sales organizations;
. continuing to develop our operational support system; and
. funding operating losses and debt service requirements.
In addition, we will continue to evaluate acquisitions and investments.
Completing additional acquisitions and investments could require us to spend a
portion of our cash, and compel us to raise additional capital sooner.
We estimate that our existing funds at June 30, 1999, the proceeds from our
July initial public offering, our available borrowing and lease financing
capacity and the proceeds from the exercise of warrants in July will be
sufficient to meet our capital requirements for the foreseeable future. We
could, however, require additional capital sooner due to material shortfalls
in our operating and financial performance or if we are more aggressive in our
expansion than currently contemplated. We cannot be certain that we would be
successful in raising sufficient debt or equity capital to fund our operations
on a timely basis or on acceptable terms. If needed financing were not
available on acceptable terms, we could be compelled to alter our business
strategy, or delay or abandon some of our future plans or expenditures or fail
to make interest payments on our debt. Any of these events would have a
material adverse effect on our financial condition, results of operations and
liquidity.
19
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
Impact of the Year 2000 Issue
The year 2000 issue generally describes the various problems that may result
from the improper processing of dates and date-sensitive calculations by
computers and other equipment as a result of computer hardware and
software using two digits to identify the year in a date. Those computers and
software will need to be upgraded or replaced to accept four digit dates to
distinguish dates in the 21st century from dates in the 20th century. The
problem could result in system failures or miscalculations and cause
disruptions in operations including, among other things, the inability to
process transactions, send invoices, provide data and voice communications
services or engage in similar normal business activities.
State of Readiness. We have created a task force (consisting of
representatives from our information technology, product management, sales and
marketing, finance and legal departments) that evaluates our internal and
external systems as they relate to year 2000 issues. We have reviewed our
critical internal systems, including our systems for customer billing,
customer service and financial reporting. We have obtained year 2000 readiness
certifications from most manufacturers and suppliers of our internal systems.
Any internal systems which were identified as having a potential problem have
already been replaced or are in the process of being replaced or modified.
Except for portions of two systems relating to order entry procedures which we
acquired in two of the acquisitions we made in the last year (Tie and KCI), we
believe that our internal systems are year 2000 ready. We are in the process
of upgrading the two systems based upon the manufacturer's recommendation,
which should be completed by the third quarter of 1999.
We continue to assess internal non-information technology systems and
external systems, including systems used by manufacturers and suppliers of
computer equipment, software programs, telephone systems, data systems,
systems comprising our enterprise networks and equipment used to provide
services to our customers.
To date, we have not identified any year 2000 issues with third-parties
which could have a material adverse effect on our business. We may identify a
significant internal or external year 2000 issue in the future which, if not
remediated in a timely manner, could have a material adverse effect on our
business, financial condition and results of operations.
Costs. We have not incurred any significant costs in identifying year 2000
issues other than the opportunity cost of the time spent by our personnel. We
do not anticipate any significant further costs in identifying year 2000
issues. Programming costs associated with conforming the two non-ready systems
are estimated to be approximately $500,000. We have prepared contingency
plans, including manual order entry procedures and identification of potential
software modifications, in the event that there are delays in moving the
information from the non-ready systems to our year 2000 systems. Costs
associated with our contingency plans could include the hiring of additional
personnel to process orders and implement software modifications. The exact
amount of the costs associated with our contingency plans cannot be determined
at this time as a result of not knowing the number of additional personnel
that may need to be hired.
Risks of Year 2000 Issues. Based on our assessments to date, we believe that
we will not experience any material disruption in internal systems or
information processing as a result of year 2000 issues. However, almost all of
our systems and products relating to our internal and external systems and
products are manufactured or supplied by third parties which are outside of
our control. Although we have taken steps that we believe should have
identiied potential year 2000 issues, if some or all of our internal or
external systems and products fail, or if any critical systems are overlooked
or are not year 2000 ready in a timely manner, there could be a material
adverse effect on our business, financial condition or results of operations.
In addition, if a critical provider of services, such as those providers
supplying electricity, water or other services, or a vendor or manufacturer
supplying products sold to our customers, experiences difficulties resulting
in disruption of services to us or the
sale of malfunctioning products to our customers, there could be a material
adverse effect on our business.
20
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
Potential risks include
. the disruption of utility services resulting in a closure of the
affected facility for the duration of the disruption;
. the disruption of data or voice services we provide to our customers;
. the inability to process customer billing accurately or in a timely
manner;
. the inability to provide accurate financial reporting to management,
auditors, investors and others;
. litigation costs associated with potential suits from customers and
investors; and
. delays in implementing other projects as a result of work by internal
personnel on year 2000 issues.
21
<PAGE>
Part II
Item 1. Legal Proceedings
We are involved in legal proceedings from time to time, none of which we
believe, if decided adversely to us, would have a material adverse effect on
our business, financial condition or results of operations.
Item 2. Changes in Securities
<TABLE>
<CAPTION>
Number of
Underwriters or Shares of Common Stock Other Exemption
Date Class of Purchasers Common Stock Warrants/Options Securities Consideration Claimed
- ----------------- -------------------------- ------------ ---------------- ---------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C>
April 19, 1999 Sellers in an acquisition 37,000 Substantially all Section 4(2)
of the assets of the
target company
April 19, 1999 to Employee options exercised 16,500 $85,000 Rule 701
May 18, 1999
April 23, 1999 to Warrants exercised 683,487 $5,221,837 Section 4(2)
June 25, 1999
May 26, 1999 Sellers in an acquisition 9,925 Substantially all Section 4(2)
of the assets of the
target company
June 3, 1999 Credit facility provider 375,000 $10.0 million credit Section 4(2)
facility
</TABLE>
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
(a) May 28, 1999 Annual Meeting of the Shareholders.
(b) Directors elected at the meeting: Spencer I. Browne (Class III) and
Richard Tomlinson Ph.D. (Class III).
Directors continuing: John R. Evans (Class I), Keith V. Burge (Class
I), Philip G. Allen (Class II), Roland Casati (Class II) and Michael J.
Marocco (Class II)
(c) Matters voted upon at the Annual Meeting of the Shareholders.
<TABLE>
<CAPTION>
Votes Cast
--------------------------
For Against Abstain
---------- ------- -------
<S> <C> <C> <C>
1 Election of Class III Directors.
Richard Tomlinson Ph.D. ......................... 15,731,572 65,000 208,333
Spencer I. Browne................................ 15,731,572 65,000 208,333
2 Ratify Appointment of PricewaterhouseCoopers, LLP 15,741,572 65,000 198,333
as auditors.......................................
3 Approve Second Amendment to the 1998 Stock Option 15,431,794 222,500 350,611
Plan increasing the number of shares reserved for
issuance upon exercise of options granted under
the plan..........................................
4Approve 1999 Employee Stock Option Plan............. 15,418,072 288,500 298,333
5Approve 1999 Director Stock Option Plan............. 15,350,794 330,778 323,333
6 Approve Reverse Split Amendments to the Articles 15,457,627 262,278 285,000
of Incorporation granting the Directors the
authority to file an amendment to our Articles of
Incorporation combining any number of shares of
our common stock between 1.1 and 2.0 into one
share of common stock.............................
</TABLE>
22
<PAGE>
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
<TABLE>
<C> <S>
3.1+ Articles of Amendment to the Amended and Restated Articles of
Incorporation of Convergent Communications, Inc.
3.2++ Third Articles of Amendment to Amended and Restated Articles of
Incorporation of Convergent Communications, Inc.
4+ Warrant Agreement, dated as of June 3, 1999
10.1+ Second Amendment to Employment Agreement by and between Convergent
Communications, Inc. and Philip G. Allen, dated April 8, 1999
10.2+ Second Amendment to Employment Agreement by and between Convergent
Communications, Inc. and Martin E. Freidel, dated April 8, 1999
10.3+ Second Amendment to Employment Agreement by and between Convergent
Communications, Inc. and Evans, dated April 8, 1999
10.4+ Third Amendment to Employment Agreement by and between Convergent
Communications, Inc. and John J. Phibbs, dated April 8, 1999
10.5+ Second Amendment to Employment Agreement by and between Convergent
Communications, Inc. and Keith V. Burge, dated April 8, 1999
10.6++ Credit and Guaranty Agreement among Convergent Communications,
Inc., Convergent Communications Services, Inc., Convergent Capital
Corporation, various lenders, and Goldman Sachs Credit Partners
L.P., dated as of June 3, 1999
10.7++ Pledge and Security Agreement among Convergent Communications,
Inc., Convergent Communications Services, Inc., Cponvergent Capital
Corporation and Goldman Sachs Credit Partners L.P., dated as of
June 3, 1999
10.8++++ Purchase and License Agreement by and Between Cisco Systems, Inc.
and Convergent Communications Services, Inc. dated July 16, 1999
10.9++++ Credit Agreement dated as of July 16, 1999 between Convergent
Communications Services, Inc. and Cisco Systems Capital Corporation
10.10++++ Guaranty dated as of July 16, 1999 by Convergent Communications,
Inc. in favor of Cisco Systems Capital Corporation Amendment No. 1
to Guaranty dated as of July 19, 1999 by Convergent Communications,
Inc. in favor of Cisco Systems Capital Corporation
27 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
None
- --------
+ Previously filed and incorporated by reference to the Registration
Statement on Form S-1 (Reg. No. 333-78483) filed on May 14, 1999
++ Previously filed and incorporated by reference to Amendment No. 1 to
Registration Statement on Form S-1 (Reg. No. 333-78483) filed on June 28,
1999
++ Previously filed and incorporated by reference to Amendment No. 2 to
Registration Statement on Form S-1 (Reg. No. 333-78483) filed on July 15,
1999
+++Previously+filed and incorporated by reference to Amendment No. 4 to
Registration Statement on Form S-1 (Reg. No. 333-78483) filed on July 19,
1999
23
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C> <C> <C> <C>
<PERIOD-TYPE> YEAR 3-MOS 3-MOS 6-MOS 6-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1998 DEC-31-1999 DEC-31-1998 DEC-31-1999
<PERIOD-START> JAN-01-1998 APR-01-1998 APR-01-1999 JAN-01-1998 JAN-01-1999
<PERIOD-END> DEC-31-1998 JUN-30-1998 JUN-30-1999 JUN-30-1998 JUN-30-1999
<CASH> 25,597,461 0 11,242,052 0 0
<SECURITIES> 0 0 7,957,400 0 0
<RECEIVABLES> 19,570,031 0 24,377,914 0 0
<ALLOWANCES> (1,908,811) 0 (1,581,197) 0 0
<INVENTORY> 6,826,732 0 11,337,352 0 0
<CURRENT-ASSETS> 73,019,623 0 78,856,070 0 0
<PP&E> 28,139,460 0 44,784,898 0 0
<DEPRECIATION> (4,882,832) 0 (8,906,829) 0 0
<TOTAL-ASSETS> 185,655,529 0 201,521,709 0 0
<CURRENT-LIABILITIES> 44,519,887 0 61,376,560 0 0
<BONDS> 168,267,797 0 189,097,280 0 0
0 0 19,206,378 0 0
0 0 0 0 0
<COMMON> 27,486,554 0 36,438,015 0 0
<OTHER-SE> (48,835,439) 0 (92,698,762) 0 0
<TOTAL-LIABILITY-AND-EQUITY> 185,655,529 0 201,521,709 0 0
<SALES> 0 5,559,292 21,379,903 10,275,084 37,777,883
<TOTAL-REVENUES> 0 7,981,838 38,053,348 14,504,703 69,761,904
<CGS> 0 4,396,718 15,830,606 8,279,174 28,091,602
<TOTAL-COSTS> 0 4,798,024 23,713,539 10,569,675 44,456,392
<OTHER-EXPENSES> 0 8,901,277 31,518,396 15,569,675 44,456,392
<LOSS-PROVISION> 0 144,180 (148,004) 144,180 754,464
<INTEREST-EXPENSE> 0 5,830,022 6,149,357 5,882,591 12,086,022
<INCOME-PRETAX> 0 (11,168,720) (23,327,991) (16,279,387) (43,088,968)
<INCOME-TAX> 0 0 0 0 0
<INCOME-CONTINUING> 0 (11,168,720) (22,949,402) (16,279,387) (43,088,968)
<DISCONTINUED> 0 0 0 0 0
<EXTRAORDINARY> 0 0 0 0 0
<CHANGES> 0 0 0 0 0
<NET-INCOME> 0 (11,168,720) (22,949,402) (16,279,387) (43,088,968)
<EPS-BASIC> 0 (0.82) (1.61) (1.20) (3.06)
<EPS-DILUTED> 0 0.82 (1.61) (1.20) (3.06)
</TABLE>
