<PAGE>
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
---------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 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)
<TABLE>
<CAPTION>
<S> <C>
Colorado 84-1337265
(State or other jurisdiction of incorporation) (I.R.S. Employer Identification No.)
</TABLE>
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 November 1, 1999, 27,965,250 shares of the registrant's Common
Stock were outstanding.
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<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page No.
--------
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
<S> <C>
Consolidated Balance Sheets--December 31, 1998 and September 30, 1999...................................... 1
Consolidated Statements of Operations and Comprehensive Loss--Three and Nine months ended
September 30, 1998 and 1999.............................................................................. 2
Consolidated Statement of Shareholders' Equity (Deficit)--Nine months ended September 30, 1999............. 3
Consolidated Statements of Cash Flows--Nine months ended September 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.................................................................... 22
Item 4. Submission of Matters to a Vote of Securities Holders.............................................. 22
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, September 30,
1998 1999
-------------- -------------
(unaudited)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents.................................................................... $ 25,597,461 $ 57,617,429
Short-term investments....................................................................... -- 46,186,003
Restricted cash.............................................................................. 20,800,000 20,800,000
Trade accounts receivable, net of allowance for doubtful accounts of
$1,908,811 and $979,655, respectively...................................................... 17,661,220 29,280,841
Inventory.................................................................................... 6,826,732 13,213,044
Prepaid expenses, deposits and other current assets.......................................... 2,134,210 6,931,692
-------------- -------------
Total current assets...................................................................... 73,019,623 174,029,009
Property, network and equipment................................................................ 28,139,460 63,656,018
Less accumulated depreciation................................................................ (4,882,832) (12,017,299)
-------------- -------------
Total property, network and equipment..................................................... 23,256,628 51,638,719
Restricted cash, non-current................................................................... 30,549,658 27,266,269
Goodwill, net of amortization of $2,967,283 and $6,929,136, respectively....................... 46,526,288 49,102,902
Other intangible assets, net of amortization of $1,470,363 and $3,004,333,
respectively.................................................................................. 10,281,016 11,467,934
Leases receivable, less current portion........................................................ 796,790 3,992,084
Investments and other assets................................................................... 1,225,626 711,088
-------------- -------------
Total assets.............................................................................. $ 185,655,629 $ 318,208,005
============== =============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Trade accounts payable....................................................................... $ 15,061,514 $ 23,492,681
Accrued compensation......................................................................... 4,583,140 7,294,671
Accrued interest............................................................................. 5,214,133 10,537,347
Other accrued liabilities.................................................................... 8,666,182 9,778,588
Deferred revenue and customer deposits....................................................... 5,211,748 6,586,585
Current portion of long-term debt............................................................ 603,919 1,714,707
Current portion of capital lease obligations................................................. 5,179,251 8,561,808
-------------- -------------
Total current liabilities................................................................. 44,519,887 67,966,387
Long term debt, less discount and current portion.............................................. 153,730,573 166,412,280
Long term capital lease obligations, less current portion...................................... 8,754,054 13,662,021
-------------- -------------
Total liabilities......................................................................... 207,004,514 248,040,688
Commitments
Shareholders' equity (deficit):
Common stock, no par value, 100 million shares authorized, 13,924,135
and 27,830,562 issued and outstanding, respectively........................................ 27,486,554 189,995,213
Warrants..................................................................................... 11,719,399 10,067,072
Treasury stock............................................................................... (501,674) (1,098,812)
Deferred compensation obligation............................................................. 501,674 1,098,812
Accumulated other comprehensive income....................................................... -- 66,124
Unearned compensation........................................................................ (150,150) (109,200)
Accumulated deficit.......................................................................... (60,404,688) (129,851,892)
-------------- -------------
Total shareholders' equity (deficit)...................................................... (21,348,885) 70,167,317
-------------- -------------
Total liabilities and shareholders' equity (deficit)...................................... $ 185,655,629 $ 318,208,005
============== =============
The accompanying notes are an integral part of these consolidated financial statements
</TABLE>
1
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------------------- -------------------------------
1998 1999 1998 1999
------------ ------------- ------------ -------------
(unaudited)
<S> <C> <C> <C> <C>
Data and voice service revenue.........................$ 10,724,742 $ 17,565,374 $ 14,954,360 $ 49,549,395
Data and voice product revenue......................... 11,591,660 24,856,140 21,866,745 62,634,023
------------ ------------- ------------ -------------
Total revenue........................................ 22,316,402 42,421,514 36,821,105 112,183,418
Cost of sales excluding depreciation................... 14,717,364 26,977,273 25,287,038 71,433,664
Selling, general and administrative.................... 15,506,655 31,927,075 29,279,065 82,675,523
Depreciation and amortization.......................... 2,646,215 4,871,757 4,599,367 11,842,179
------------ ------------- ------------ -------------
Total operating expenses............................. 32,870,234 63,776,105 59,165,470 165,951,366
Operating loss....................................... (10,553,832) (21,354,591) (22,344,365) (53,767,948)
Interest expense..................................... (5,868,531) (6,881,195) (11,751,121) (18,967,217)
Interest income...................................... 1,144,892 1,775,771 2,525,288 3,496,898
Other income (expense), net.......................... (78,009) 101,779 (64,669) (208,937)
------------ ------------- ------------ -------------
Net loss............................................... (15,355,480) (26,358,236) (31,634,867) (69,447,204)
Other comprehensive income, unrealized holding
gains on securities................................. 661,407 43,701 953,715 66,124
Comprehensive loss...................................$(14,694,073) $ (26,314,535) $ (30,681,152) $ (69,381,080)
============ ============= ============= =============
Net loss per share:
Net loss per share (basic and diluted)...............$ (1.11) $ (1.06) $ (2.31) $ (3.92)
Weighted average number of shares outstanding
(basic and diluted)................................. 13,869,405 24,775,455 13,667,608 17,696,792
============ ============ ============= =============
The accompanying notes are an integral part of these consolidated financial statements
</TABLE>
2
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)
(unaudited)
<TABLE>
<CAPTION>
Deferred
Common Common Treasury Compensation Unearned
Shares Stock Warrants Stock Obligation Compensation
------------- ------------- ------------ ------------ -------------- --------------
<S> <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)
Common stock issued for:
Initial public offering, net of
offering costs................... 8,936,710 122,409,649 -- -- -- --
401(k) match...................... 123,151 1,260,548 -- -- -- --
Business combinations............. 102,696 1,094,232 -- -- -- --
Exercise of stock options......... 53,326 231,000 -- -- -- --
Exercise of warrants.............. 1,937,070 16,931,279 (4,111,237) -- -- --
Preferred stock conversion......... 2,666,677 19,206,378 -- -- -- --
Compensation....................... 124,297 1,380,073 -- -- -- 40,950
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......................... -- -- 2,458,910 -- -- --
Other comprehensive income:
Unrealized gain on securities..... -- -- -- -- -- --
Net loss........................... -- -- -- -- -- --
------------ ------------- ------------ ------------ -------------- --------------
Balance, September 30, 1999........ 27,830,562 $ 189,995,213 $ 10,067,072 $ (1,098,812) $ 1,098,812 $ (109,200)
Accumulated
Other
Comprehensive Accumulated
Income Deficit Total
------------- ------------- ------------
Balance, December 31, 1998......... -- $ (60,404,688) (21,348,885)
Common stock issued for:
Initial public offering, net of
offering costs................... -- -- 122,409,649
401(k) match...................... -- -- 1,260,548
Business combinations............. -- -- 1,094,232
Exercise of stock options......... -- -- 231,000
Exercise of warrants.............. -- -- 12,820,042
Preferred stock conversion......... -- -- 19,206,378
Compensation....................... -- -- 1,371,023
Shares repurchased................. -- -- (4,500)
Distribution of deferred stock..... -- -- --
Deferred stock compensation........ -- -- --
Warrants issued in connection with
financing......................... -- -- 2,508,910
Other comprehensive income:
Unrealized gain on securities..... 66,124 -- 66,124
Net loss........................... -- (69,447,204) (69,447,204)
------------- ------------- ------------
Balance, September 30, 1999........ $ 66,124 $(129,851,892) $ 70,167,317
============= ============= ============
</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 Nine months ended
-------------------------------------------
September 30, September 30,
1998 1999
-------------------- -----------------
(unaudited)
<S> <C> <C>
Cash flows from operating activities
Net loss................................................................$ (31,634,867) $ (69,447,204)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization.......................................... 4,599,367 11,842,179
Amortization of deferred financing costs and accretion of debt discount 1,091,006 1,409,144
Provision for uncollectible accounts................................... 755,862 1,338,625
Stock compensation expense............................................. 620,178 1,421,023
401(k) contributions through the issuance of common stock.............. 297,079 1,260,548
Loss on sale of investment............................................. -- 220,500
Change in working capital (net of acquisitions):
Trade accounts receivable.............................................. (7,963,549) (10,369,765)
Inventory.............................................................. (3,468,655) (2,542,612)
Prepaid expenses and other current assets.............................. (1,106,065) (4,957,088)
Trade accounts payable................................................. 8,792,171 (3,409,271)
Accrued compensation................................................... 2,751,370 2,349,843
Accrued interest....................................................... 10,414,133 5,323,214
Other accrued liabilities.............................................. 1,042,958 1,213,998
Deferred revenue and customer deposits................................. 1,531,602 754,282
-------------------- -----------------
Net cash used in operating activities.................................... (12,277,410) (63,592,584)
Cash flows from investing activities
Additions of property, network and equipment............................ (9,113,322) (11,837,062)
Acquisitions, net of cash acquired...................................... (42,364,328) (3,752,039)
Short-term investments.................................................. (26,954,343) (46,119,879)
Restricted cash......................................................... (60,771,852) 3,283,389
Leases receivable....................................................... (52,367 ) (3,195,294)
Proceeds from sale of investment........................................ -- 154,500
Other assets............................................................ (189,825) (374,560)
-------------------- -----------------
Net cash used in investing activities.................................... (139,446,037) (61,840,945)
Cash flows from financing activities
Proceeds from initial public offering, net of offering costs............ -- 122,409,649
Proceeds from private placements, net of offering costs................. 152,922,348 19,206,378
Proceeds from new borrowings, net of financing costs.................... 109,206 12,999,572
Payments on notes payable............................................... (1,317,139) (4,800,387)
Payments on capital leases.............................................. (897,894) (5,408,257)
Proceeds from exercise of warrants and stock options.................... 125,100 13,051,042
Payments on notes payable............................................... 1,304,598 --
Repurchase of common shares............................................. -- (4,500)
-------------------- -----------------
Net cash provided by financing activities................................ 152,246,219 157,453,497
-------------------- -----------------
Net increase in cash and cash equivalents................................ 522,772 32,019,968
Cash and cash equivalents at beginning of period......................... 667,344 25,597,461
-------------------- -----------------
Cash and cash equivalents at end of period...............................$ 1,190,116 $ 57,617,429
==================== =================
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............................$ 4,059,330 $ 13,545,816
Acquisition of property, network and equipment in accounts payable
waiting to be financed................................................... -- 9,118,037
Cash paid for interest.................................................. 245,982 12,234,859
</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. As of
September 30, 1999 seven of these intregated switching platforms had been
installed. 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 September 30, 1999 and our
available borrowing and lease financing capacity 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 September 30, 1999, statement of
shareholders' equity (deficit) for the nine months ended September 30, 1999 and
the consolidated statements of operations and comprehensive loss, and cash flows
for the three and nine months ended September 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.
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.
5
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
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. In July 1999 $2.0 million of the notes payable was repaid and
the remaining balance was paid in November 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 20,000 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. CSI was a data network integration services provider
based in Dallas, Texas. The purchase price consisted of $1,125,000 in cash. Up
to an additional $225,000 in shares of our common stock may be issued if certain
financial conditions are met.
Network Technologies Group. In September 1999, we purchased the majority of
the assets and assumed certain liabilities of Network Technologies Group
("NTG"). NTG was a data network integration services provider based in Miami,
Florida. The purchase price consisted of $675,000 in cash and $475,000 in shares
of our common stock. Up to an additional $500,000 in shares of our common stock
may be issued if certain financial conditions are met.
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.
Allocation of consideration given during the nine months ended September 30,
1999 to the acquired assets is as follows:
<TABLE>
<CAPTION>
<S> <C>
Purchase price:
Cash paid................................................................................. $ 3,910,271
Notes payable issued to former owner...................................................... 4,490,000
Common stock issued to the former owners.................................................. 1,094,232
Total purchase price................................................................... $ 9,494,503
==============
Allocation of the purchase price to acquired assets and assumed liabilities:
Cash...................................................................................... $ 158,232
Accounts receivable....................................................................... 2,806,061
Inventory................................................................................. 3,687,128
Prepaid expenses, deposits and other current assets....................................... 126,924
Equipment................................................................................. 934,488
Goodwill.................................................................................. 6,808,871
Liabilities and debt assumed.............................................................. (5,027,201)
--------------
Amounts allocated...................................................................... $ 9,494,503
==============
</TABLE>
6
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. CREDIT FACILITIES:
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
are being 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, none of which had been exercised as of
September 30, 1999. We have obtained waivers for non-compliance with certain
financial covenants of this facility as of September 30, 1999. We have borrowed
the full amount available 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 agreement, Cisco Systems, Inc. also received a warrant to
purchase 575,000 shares of our common stock, none of which had been exercised as
of September 30, 1999. 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.
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 Capital 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 or September 30, 1999.
6. SHAREHOLDER'S EQUITY (DEFICIT):
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 $122.4 million, net of selling
shareholders ($10.8 million), underwriting discount ($10.1 million), and
offering expenses ($1.6 million).
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.
7
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7. 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 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 Nine Months Ended
September 30, September 30,
------------------------------------ ------------------------------------
1998 1999 1998 1999
--------------- --------------- --------------- ---------------
Revenue: (in thousands)
<S> <C> <C> <C> <C>
Data services................................... $ 924 $ 4,498 $ 2,354 $ 8,759
Voice services.................................. 9,155 11,990 11,204 37,941
Enterprise Network Services..................... 646 1,078 1,396 2,849
Data products................................... 5,899 10,797 15,750 27,365
Voice products.................................. 5,692 14,059 6,117 35,269
--------------- --------------- --------------- ---------------
Total revenue................................ 22,316 42,422 36,821 112,183
--------------- --------------- --------------- ---------------
Gross margin before depreciation:
Data services................................... 615 2,993 1,367 5,297
Voice services.................................. 4,087 5,686 4,777 17,505
Enterprise Network Services..................... 424 885 920 2,381
Data products................................... 804 1,135 2,647 3,560
Voice products.................................. 1,669 4,746 1,823 12,007
--------------- --------------- --------------- ---------------
Total gross margin before depreciation....... 7,599 15,445 11,534 40,750
--------------- --------------- --------------- ---------------
Reconciliation to net loss:
Selling, general and administrative............. (15,507) (31,927) (29,279) (82,676)
Depreciation and amortization................... (2,646) (4,872) (4,599) (11,842)
Operating loss.................................. (10,554) (21,355) (22,344) (53,768)
Interest expense................................ (5,868) (6,881) (11,751) (18,967)
Interest income................................. 1,145 1,776 2,525 3,497
Other income (expense), net..................... (78) 102 (65) (209)
--------------- --------------- --------------- ---------------
Net loss..................................... $ (15,355) $ (26,358) $ (31,635) $ (69,447)
=============== =============== =============== ===============
</TABLE>
8
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. NET LOSS PER SHARE:
The net loss available to common shareholders and weighted average shares
consists of the following:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------- ------------------------------
1998 1999 1998 1999
--------------- --------------- ------------- -------------
(in thousands)
<S> <C> <C> <C> <C>
Net loss..........................................$ (15,355) $ (26,358) $ (31,635) $ (69,447)
=============== =============== ============= =============
Weighted average common shares used for basic and
diluted earnings per share....................... 13,869 24,775 13,668 17,697
Warrants.......................................... -- -- -- --
Stock options..................................... -- -- -- --
--------------- --------------- ------------- -------------
Weighted average number of shares outstanding
(basic and diluted).............................. 13,869 24,775 13,668 17,697
=============== =============== ============= =============
</TABLE>
As of September 30, 1998 and 1999 a total of 8,017,532 and 9,301,023, options
and warrants were outstanding which were not considered in the above
calculations as their effect would have been anti-dilutive.
9. SUBSEQUENT EVENTS:
Entre Business Technology Group. In October 1999, we acquired Video
Enterprises Corporation, d/b/a Entre Business Technology Group ("EBTG"). EBTG
was a data network integration services provider based in Atlanta, Georgia. The
purchase price consisted of $2.0 in cash, $2.1 million in shares of our common
stock, and assumed debt of approximately $2.6 million, resulting in total
consideration of $6.7 million. An additional $700,000 in shares of our common
stock may be issued if certain financial conditions are met.
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 also offer 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
facilty 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 16 strategic acquisitions, through
which we have accelerated our growth into new markets and obtained employees who
are experienced in the products and services we offer. Acquiring business in new
markets that have been successful in either voice products and services or data
products and services has given us the opportunity to cross-market all of our
products and services, including Enterprise Network Services, to the existing
customers of the businesses we acquire.
We began offering Enterprise Network Services in December 1997 and have now
entered into long-term Enterprise Network Service contracts with 47 customers.
We expect these contracts will provide us with approximately $36.4 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.
10
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
Description of Financial Components
We classify our business into five segments: data services, voice services,
Enterprise Network Services, data products and voice products.
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>
<S> <C>
Revenue Cost of Sales (excluding depreciation)
------- --------------------------------------
Data Services
Professional Services
web design and hosting and network . engineer and technician compensation and
planning, design, maintenance, and benefits
monitoring
Network Services
frame relay (ATM and IP switching), . leased line costs of connecting a customer to a
Internet access and web hosting long distance or local network
. capacity charges that long distance and local
carriers, Internet providers and others impose to
use their equipment and network
---------------------------
</TABLE>
<TABLE>
<CAPTION>
<S> <C>
Voice Services
Professional Services
network planning, design, maintenance . engineer and technician compensation and
and monitoring benefits
Network Services
long distance service, local telephone . leased line facilities' costs of connecting a
service and public phone service customer to a long distance 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>
<CAPTION>
Enterprise Network Services
<S> <C>
Network Services
long-term contracts (typically three to five . all the costs associated with all the data and voice
years) under which we own, manage and products and services described in this table
are responsible for all or a portion of the
network inside our customers' premises
Leasing Services
long-term leases for sales of data and voice products . initial direct costs associated with providing lease
financing
---------------------------
</TABLE>
<TABLE>
<CAPTION>
<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>
<CAPTION>
<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. However, we expect these expenses to
continue 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 $49.1 million of goodwill, net of amortization, on
September 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.
12
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
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.
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 September 30, Nine Months Ended September 30,
---------------------------------- ---------------------------------------
1998 1999 1998 1999
-------------- --------------- ---------------- -----------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue:
Data services........................... $ 924 4% $ 4,498 11% $ 2,354 6% $ 8,759 8%
Voice services.......................... 9,155 41 11,990 28 11,204 30 37,941 34
Enterprise Network Services............. 646 3 1,078 3 1,396 4 2,849 3
Data products........................... 5,899 26 10,797 25 15,750 43 27,365 24
Voice products.......................... 5,692 26 14,059 33 6,117 17 35,269 31
Total revenue........................ $22,316 100% $42,422 100% $36,821 100% $112,183 100%
------- --- ------- --- ------- --- -------- ---
Cost of sales excluding depreciation:
Data services........................... $ 309 33% $ 1,505 33% $ 987 42% $ 3,462 40%
Voice services.......................... 5,068 55 6,304 52 6,427 57 20,437 54
Enterprise Network Services............. 222 34 193 18 476 34 468 16
Data products........................... 5,095 86 9,662 89 13,103 83 23,805 87
Voice products.......................... 4,023 71 9,313 66 4,294 70 23,262 66
Total cost of sales excluding
depreciation $14,717 66% $26,977 64% $25,287 69% $ 71,434 64%
------- ------- ------- --------
Gross margin before depreciation:
Data services........................... $ 615 67% $ 2,993 67% $ 1,367 58% $ 5,297 60%
Voice services.......................... 4,087 45 5,686 48 4,777 43 17,505 46
Enterprise Network Services............. 424 66 885 82 920 66 2,381 84
Data products........................... 804 14 1,135 11 2,647 17 3,560 13
Voice products.......................... 1,669 29 4,746 34 1,823 30 12,007 34
------- ------- ------- --------
Total gross margin before
depreciation........................ $ 7,599 34% $15,445 36% $11,534 31% $ 40,750 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 September 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
-------------------- ---------------------------------------------
3rd 4th 1st 2nd 3rd 4th
--------- --------- --------- ---------- ---------- ----------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Operating Statement Data:
Revenue................................... $ 3,144 $ 4,448 $ 6,523 $ 7,982 $ 22,316 $ 24,779
Cost of sales excluding depreciation...... 2,209 3,423 4,798 5,772 14,717 18,416
Selling, general and administrative....... 3,052 4,769 6,062 7,710 15,507 18,583
Depreciation and amortization............. 296 701 762 1,191 2,646 2,894
------- ------- ------- -------- -------- --------
Operating loss............................ (2,413) (4,445) (5,099) (6,691) (10,554) (15,114)
Net loss................................... $(2,817) $(4,166) $(5,111) $(11,169) $(15,355) $(18,941)
======= ======= ======= ======== ======== ========
EBITDA (1)................................. $(2,117) $(3,744) $(4,337) $ (5,500) $ (7,908) $(12,220)
======= ======= ======= ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
1999
----------------------------------
1st 2nd 3rd
--------- ---------- ----------
(in thousands)
<S> <C> <C> <C>
Operating Statement Data:
Revenue................................... $ 31,709 $ 38,053 $ 42,422
Cost of sales excluding depreciation...... 20,743 23,714 26,977
Selling, general and administrative....... 23,337 27,411 31,927
Depreciation and amortization............. 2,863 4,107 4,872
-------- -------- --------
Operating loss............................ (15,234) (17,179) (21,355)
Net loss................................... $(20,129) $(22,960) $(26,358)
======== ======== ========
EBITDA (1)................................. $(12,372) $(13,071) $(16,483)
======== ======== ========
</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 second and third
quarters of 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 seven
markets. The increases in amortization are due to the increase in goodwill and
other intangible assets resulting from the completion of 16 acquisitions through
September 30, 1999. We have also experienced increasing operating and net losses
every quarter. However, net loss has declined as a percentage of revenue from
90% for the third quarter of 1997 to 62% of revenue for the third quarter of
1999.
Results of Operations
Revenue for the third quarter of 1999 was $20.1 million greater than
revenue for the third quarter of 1998 and revenue for the nine months ended
September 30, 1999 was $75.4 million greater than revenue for the nine months
ended September 30, 1998. The increase in revenue was primarily due to the
addition of 24 new markets as result of an acquisition during the third quarter
of 1998 and an additional three new markets and the expansion of new and
existing markets through four acquisitions between September 30, 1998 to
September 30, 1999. The increase in revenue was also largely due to our growing
operations and sales staff having pursued the cross selling opportunities
presented in new markets. 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 eight at September 30, 1998 to 13 at
September 30, 1999. As a result of the Tie acquisition, and our continued
strategy to increase our service offerings, our overall revenue mix shifted from
14
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
approximately 41% in services for the nine months ended September 30, 1998, to
44% for the nine months ended September 30, 1999. A significant factor in our
strategy to increase services is through our Enterprise Network Services
offering. As of September 30, 1999 we had 47 customers, representing $36.4
million in revenue over the terms of their contracts compared to 16 customers
and $13.8 million in contract term revenue as of September 30, 1998.
Cost of sales excluding depreciation increased $12.2 million from the third
quarter of 1998 to the third quarter of 1999 and increased $46.1 million from
the nine months ended September 30, 1998 to the nine months ended September 30,
1999, while declining as a percentage of total revenue from 69% for the nine
months ended September 30, 1998 to 64% for the nine months and quarter ended
September 30, 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 third quarter of 1998 to 76%
for the third quarter of 1999 and from 80% for the first nine months of 1998 to
75% for the first nine 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
52% for the third quarter of 1998 to 46% for the third quarter of 1999 and 49%
for the first nine 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 our offering of professional services such as network and web,
design, maintenance and monitoring and Enterprise Network Services which have a
lower related cost.
Selling, general and administrative expenses increased $16.4 million from
the third quarter of 1998 to the third quarter of 1999 and increased $53.3
million from the nine months ended September 30, 1998 to the nine months ended
September 30, 1999. This increase in selling, general and administrative
expenses is largely due to continued growth of the support services organization
required to support expanding field operations, which accounted for
approximately $12.5 million or 39% of total selling, general and administrative
expenses for the three months ended September 30, 1999 and $34.2 million or 41%
of total selling, general and administrative expenses for the nine months ended
September 30, 1999. However, selling, general and administrative expenses
declined as a percentage of revenue from 80% for the first nine months of 1998
to 74% for the first nine months of 1999. We expect selling, general and
administrative expenses 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 addition and expansion of new and existing markets;
- the completion of four acquisitions;
- an increase from 777 employees at September 30, 1998 to 1,380 at
September 30, 1999.
Depreciation and amortization expense increased approximately $2.2 million
from the third quarter of 1998 to the third quarter of 1999 and increased $7.2
million from the first nine months of 1998 to the first nine months of 1999.
These increases are a direct result of increases of $42.2 million in property,
network and equipment. In addition, goodwill increased $10.7 million as a result
of the acquisitions completed between September 30, 1998 and September 30, 1999
and other intangible assets increased $3.2 million. As of September 30, 1999 we
had $49.1 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 addition and expansion of new and existing markets;
- the development and deployment of seven of our multi-functional,
integrated data and voice switching platforms;
- 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.
15
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
Interest expense increased by approximately $1.0 million from the third
quarter of 1998 to the third quarter of 1999 and increased $7.2 million from the
nine months ended September 30, 1998 to the nine months ended September 30,
1999. The increase for the nine month periods is primarily a result of a full
nine months of interest expense in 1999 compared to six 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, increased indebtedness under our equipment financing facilities
with Comdisco and Sun Financial Group, Inc. for property, network and equipment
purchased for our networks both inside and outside our customers' premises and
also as a result of indebtedness under the Goldman Sachs Credit Partners L.P.
senior secured credit facility.
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 Services and equipment purchased under our $103.5 million
equipment facility with Cisco Systems Capital Corporation.
Interest income decreased approximately $631,000 from the third quarter of
1998 to the third quarter of 1999 and increased $972,000 from the nine months
ended June 30, 1998 to the nine months ended September 30, 1999. The decline in
interest income for the third 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. The increases in interest income are due to earnings on the remaining
proceeds from the $160.0 million in principal amount of our 13% Senior Notes
issued in April 1998, proceeds from the sale of convertible preferred stock in
March 1999, the $10.0 million credit facility entered into in June 1999 and net
proceeds of approximately $122.4 million from the initial public offering in
July, 1999.
Other income (expense), net which consists of miscellaneous other non-
operating types of income and expenses, changed from net other expense of
approximately $78,000 for the third quarter of 1998 to net other income of
approximately $102,000 for the third quarter of 1999 and increased from net
other expense of approximately $65,000 for the nine months ended September 30,
1998 to net other expense of approximately $209,000 for the nine months ended
September 30, 1999. The increase in expense is primarily due to a loss
recognized on the termination of a stock purchase agreement and sale of an
investment.
16
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
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 proceeds equals the
gross proceeds of the offering less advisors' fees, underwriting discounts and
other expenses associated with the offering.
<TABLE>
<CAPTION>
Securities Sold Gross 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)................................................. 134,050,935 122,409,646
------------ ------------
Total funds raised.......................................................... $338,550,935 $316,079,560
============ ============
</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 27 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 September 30, 1999, we had current assets of $174.0 million,
including cash and cash equivalents of $57.6 million, short-term investments of
$46.1 million and restricted cash of $20.8 million, and working capital of
$106.1 million. In addition, we also had $27.3 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 $63.6 million during the nine months ended September 30, 1999 and
$12.3 million during the nine months ended 1998. The majority of this increase
was due to a net loss of $69.4 million and a combined increase in trade accounts
receivable, inventory and prepaid and other current assets of approximately
$17.9 million and a $3.4 million decrease in accounts payable, which were
partially offset by non-cash expenses including depreciation and amortization,
stock compensation and amortization of financing costs aggregating $17.4 million
and a net increase in current liabilities including accrued liabilities and
deferred revenue of $6.2 million. Cash used in operating activities for the
first nine months of 1998 was primarily due to our net loss of $31.6 million and
a combined increase in current assets including trade accounts receivable and
inventory of $12.5 million, partially offset by an increase in accrued interest
of $10.4 million, increases to current liabilities of $14.1 million and non-cash
expenses aggregating 7.4 million.
Cash Flows From Investing Activities: Investing activities used cash of
$61.8 million during the nine months ended September 30, 1999 and $139.4 million
during the nine months ended September 30, 1998. Cash used in investing
activities during the first nine months of 1999 primarily consisted of short-
term investments of $46.1 million, capital expenditures of $11.8 million,
business combinations of $3.8 million and investment in leases of $3.2 million.
These
17
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
investing outflows were partially offset by a change in restricted cash of $3.3
million. An additional $22.7 million of capital expenditures have been or are
waiting to be financed under our financing facilities. The large amount of cash
used in investing activities during the first nine months of 1998 was a result
of the investment of the proceeds from the $160.0 million Senior Notes, $27.0
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 September 30, 1999. In addition, $9.6 million was classified as
restricted cash as a result of the issuance of letters of credit, $9.1 million
was used for capital expenditures and approximately $42.4 million was used for
business combinations, primarily the acquisition of the majority of the assets
of Tie Communications, Inc.
Not reflected in investing activities is the acquisition of Entre Business
Technology Group (EBTG) in October 1999. EBTG was a provider of data network
integration services based in Atlanta, Georgia. The purchase price consisted of
$2.0 million in cash, $2.1 million in shares of our common stock and $2.6
million in assumed debt. Additional shares may be issued if certain financial
objectives are met.
Cash Flows From Financing Activities: Financing activities provided cash of
approximately $157.5 million during the first nine months of 1999 and
approximately $152.2 million during the first nine months of 1998. Cash provided
by financing activities during 1999 consisted of approximately $122.4 million in
net proceeds from our initial public offering, $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 $13.1 million in new
proceeds from the exercise of options and warrants, which was partially offset
by approximately $10.2 million in payments on long-term borrowings. Cash
provided by financing activities during the first nine months of 1998 consisted
of $152.9 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
September 30, 1999, $30.0 million was available to us under this facility of
which a total of approximately $14.8 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 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 are being
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. We have
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 agreement, Cisco Systems, Inc. also
18
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
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. As of September 30, 1999 nothing
had been borrowed under this facilty.
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 $122.4 million, net of selling shareholders
proceeds ($10.8 million), underwriting discount ($10.1 million), and offering
expenses ($1.6 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 $4.8 million was outstanding on September 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
September 30, 1999.
Future Capital Requirements. We have significant debt in relation to our
equity. At September 30, 1999, we had $190.4 million in debt and $70.2 million
in shareholders' equity, which includes paid-in capital of $200.1 million. 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:
- continued deployment of 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 September 30, 1999, our available
borrowing and lease financing 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.
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
19
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
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 modified. We have taken all steps that we believe are
necessary to ensure that our internal systems are year 2000 ready.
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 non-ready systems were
approximately $300,000. We have prepared contingency plans, including manual
order entry procedures and identification of potential software modifications,
in the event that there are any unforeseen problems. 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 have taken
all steps that we believe are necessary to ensure 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.
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.
20
<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 and Use of Proceeds
(c) Securities sold:
<TABLE>
<CAPTION>
Underwriters Number of Common Stock
or Class of Shares of Warrants/ Other Exemption
Date Purchasers Common Stock Options Securities Consideration Claimed
- ---- ---------- ------------ ------- ---------- ------------- -------
<S> <C> <C> <C> <C> <C> <C>
May 19, 1999 to Employee options 16,826 $ 102,000 Rule 701
September 30, 1999 exercised and Section
4(2)
June 26, 1999 to Warrants exercised 1,253,583 $ 7,598,206 Section 4(2)
September 30, 1999
July 19, 1999 Preferred share 2,666,677 $20,000,000 Section 4(2)
conversion originally paid for
preferred shares
September 23, 1999 Sellers in an 40,771 Substantially all Section 4(2)
acquisition of the assets of the
target company
</TABLE>
(d) Use of proceeds from initial public offering:
Pursuant to our initial public offering of our common stock we issued
8,936,729 shares, excluding 723,271 shares sold by selling shareholders, on July
19, 1999. The offering closed on July 23, 1999. The shares were registered with
the Securities and Exchange Commission pursuant to a Registration Statement on
Form S-1 (No. 333-78483) which was declared effective on July 19, 1999. The
public offering was underwritten by a syndicate of underwriters led by Goldman
Sachs & Co., J.P. Morgan & Co., Warburg Dillon Read LLC and William Blair &
Company. After deducting discounts and commisions of $10.1 million and expenses
of $1.6 million, we received net proceeds of $122.4 million.
Through September 30, 1999 the proceeds have been applied as follows:
<TABLE>
<S> <C>
Capital expenditures $10,536,148
Payments on long-term notes payable and capital leases 5,093,453
Cash consideration in business combinations 1,700,206
-----------
$17,329,807
===========
</TABLE>
The balance of the proceeds has been used for working capital purposes or
temporarily invested in short-term investments until used to meet anticipated
cash needs. The use of proceeds from the offering does not represent a material
change in the use of proceeds described in the Registration Statement. None of
the net proceeds of the offering were paid directly or indirectly to any of our
directors, officers or to persons owning 10 percent or more of any class of our
equity securities or of our affiliates.
21
<PAGE>
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K
August 18, 1999 - Resignation of Chief Financial Officer
22
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Convergent Communications, Inc.
Date: November 10, 1999
By: /s/ John R. Evans
----------------------------------------
John R. Evans
Chairman and Chief Executive Officer
Date: November 10, 1999
By: /s/ Keith V. Burge
----------------------------------------
Keith V. Burge
President and Chief Operating Officer
Date: November 10, 1999
By: /s/ Craig A. Dais
----------------------------------------
Craig A. Dais
Chief Accounting Officer
23
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C> <C> <C> <C>
<PERIOD-TYPE> YEAR 3-MOS 3-MOS 9-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1998 DEC-31-1999 DEC-31-1998 DEC-31-1999
<PERIOD-START> JAN-01-1998 JUL-01-1998 JUL-01-1999 JAN-01-1998 JAN-01-1999
<PERIOD-END> DEC-31-1998 SEP-30-1998 SEP-30-1999 SEP-30-1998 SEP-30-1999
<CASH> 25,597,461 0 57,617,429 0 0
<SECURITIES> 0 0 46,186,003 0 0
<RECEIVABLES> 19,570,031 0 30,260,496 0 0
<ALLOWANCES> (1,908,811) 0 (979,655) 0 0
<INVENTORY> 6,826,732 0 13,213,044 0 0
<CURRENT-ASSETS> 73,019,623 0 174,029,009 0 0
<PP&E> 28,139,460 0 63,656,018 0 0
<DEPRECIATION> (4,882,832) 0 (12,017,299) 0 0
<TOTAL-ASSETS> 185,655,629 0 318,208,005 0 0
<CURRENT-LIABILITIES> 44,519,887 0 67,966,387 0 0
<BONDS> 168,267,797 0 190,350,816 0 0
0 0 0 0 0
0 0 0 0 0
<COMMON> 27,486,554 0 189,995,213 0 0
<OTHER-SE> (48,835,439) 0 (119,827,896) 0 0
<TOTAL-LIABILITY-AND-EQUITY> 185,655,629 0 318,208,005 0 0
<SALES> 0 11,591,660 24,856,140 21,866,745 62,634,023
<TOTAL-REVENUES> 0 22,316,402 42,421,514 36,821,105 112,183,418
<CGS> 0 0 18,975,556 0 47,067,158
<TOTAL-COSTS> 0 14,717,364 26,977,273 25,287,038 71,433,664
<OTHER-EXPENSES> 0 18,152,870 36,798,832 33,878,432 94,517,702
<LOSS-PROVISION> 0 611,682 584,161 755,862 1,338,625
<INTEREST-EXPENSE> 0 5,868,531 6,881,195 11,751,121 18,967,217
<INCOME-PRETAX> 0 (15,355,480) (23,358,236) (31,634,867) (69,447,204)
<INCOME-TAX> 0 0 0 0 0
<INCOME-CONTINUING> 0 (15,355,480) (22,949,402) (31,634,867) (69,447,204)
<DISCONTINUED> 0 0 0 0 0
<EXTRAORDINARY> 0 0 0 0 0
<CHANGES> 0 0 0 0 0
<NET-INCOME> 0 (15,355,480) (22,949,402) (31,634,867) (69,447,204)
<EPS-BASIC> 0 (1.11) (1.06) (2.31) (3.92)
<EPS-DILUTED> 0 (1.11) (1.06) (2.31) (3.92)
</TABLE>
