<PAGE>
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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 March 31, 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 April 30 1999, 28,334,662 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
<S> <C>
Item 1. Financial Statements
Consolidated Balance Sheets--December 31, 1998 and March 31, 1999.... 1
Consolidated Statements of Operations and Comprehensive Loss--Three
months ended March 31, 1998 and 1999................................ 2
Consolidated Statement of Shareholders' Equity (Deficit)--Three
months ended March 31, 1999......................................... 3
Consolidated Statements of Cash Flows--Three months ended March 31,
1998 and 1999....................................................... 4
Notes to Consolidated Financial Statements........................... 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................... 9
PART II: OTHER INFORMATION
Item 1. Legal Proceedings............................................ 20
Item 2. Changes in Securities........................................ 20
Item 3. Defaults Upon Senior Securities.............................. 20
Item 4. Submission of Matters to a Vote of Securities Holders........ 20
Item 5. Other Information............................................ 20
Item 6. Exhibits and Reports on Form 8-K
Exhibits......................................................... 20
Reports on Form 8-K.............................................. 20
</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, March 31,
1998 1999
------------ ------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................ $ 25,597,461 $ 10,392,752
Short-term investments........................... -- 15,884,601
Restricted cash.................................. 20,800,000 20,800,000
Trade accounts receivable, net of allowance for
doubtful accounts of $1,908,811 and $2,932,559,
respectively.................................... 17,661,220 20,750,560
Inventory........................................ 6,826,732 9,026,881
Prepaid expenses, deposits and other current
assets.......................................... 2,134,210 2,995,457
------------ ------------
Total current assets........................... 73,019,623 79,850,251
Property, network and equipment.................... 28,139,460 31,882,773
Less accumulated depreciation.................... (4,882,832) (6,353,628)
------------ ------------
Total property, network and equipment.......... 23,256,628 25,529,145
Restricted cash, non-current....................... 30,549,658 32,024,750
Goodwill, net of amortization of $2,967,283 and
$4,174,400, respectively.......................... 46,526,288 49,035,071
Other intangible assets, net of amortization of
$1,470,363 and $1,880,211, respectively........... 10,281,016 10,365,858
Investments and other assets....................... 1,225,626 1,231,792
Leases receivable, less current portion............ 796,790 1,288,573
------------ ------------
Total assets................................... $185,655,629 $199,325,440
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Trade accounts payable........................... $ 15,061,514 $ 15,795,372
Accrued compensation............................. 4,583,140 6,564,699
Accrued interest................................. 5,214,133 10,414,133
Other accrued liabilities........................ 8,666,182 7,728,239
Deferred revenue and customer deposits........... 5,211,748 5,824,101
Current portion of long-term debt................ 603,919 5,358,614
Current portion of capital lease obligations..... 5,179,251 5,798,921
------------ ------------
Total current liabilities...................... 44,519,887 57,484,079
Long term debt, less discount and current portion.. 153,730,573 154,594,138
Long term capital lease obligations, less current
portion........................................... 8,754,054 9,185,791
------------ ------------
Total liabilities.............................. 207,004,514 221,264,008
Commitments
Convertible preferred stock........................ -- 19,300,000
Shareholders' equity (deficit):
Common stock, no par value, 100 million shares
authorized, 27,848,270 and 27,920,704 issued and
outstanding, respectively....................... 27,486,554 27,806,290
Warrants......................................... 11,719,399 12,171,879
Treasury stock................................... (501,674) (501,674)
Deferred compensation obligation................. 501,674 501,674
Accumulated other comprehensive income........... -- 11,700
Unearned compensation............................ (150,150) (136,500)
Accumulated deficit.............................. (60,404,688) (81,091,937)
------------ ------------
Total shareholders' equity (deficit)........... (21,348,885) (41,238,568)
------------ ------------
Total liabilities and shareholders' equity
(deficit)..................................... $185,655,629 $199,325,440
============ ============
</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
March 31,
-------------------------
1998 1999
----------- ------------
(unaudited)
<S> <C> <C>
Data and voice service revenue...................... $ 1,807,073 $ 15,310,576
Data and voice product revenue...................... 4,715,792 15,170,290
----------- ------------
Total revenue..................................... 6,522,865 30,480,866
Cost of sales excluding depreciation................ 4,798,024 20,073,569
Selling, general and administrative................. 6,061,845 23,337,581
Depreciation and amortization....................... 762,439 2,862,892
----------- ------------
Total operating expenses.......................... 11,622,308 46,274,042
Operating loss.................................... (5,099,443) (15,793,176)
Interest expense.................................. (52,568) (5,936,665)
Interest income................................... 31,478 950,646
Other income, net................................. 9,867 91,946
----------- ------------
Net loss............................................ (5,110,666) (20,687,249)
Other comprehensive income, Unrealized holding gains
on securities...................................... 57,690 11,700
----------- ------------
Comprehensive loss................................ $(5,052,976) $(20,675,549)
=========== ============
Net loss per share:
Net loss per share (basic and diluted)............ $ (0.19) $ (0.74)
=========== ============
Weighted average number of shares outstanding
(basic and diluted).............................. 26,958,467 27,885,235
=========== ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
2
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (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......... 27,848,270 $27,486,554 $11,719,399 $(501,674) $501,674 $(150,150) $ -- $(60,404,688)
Common stock
issued for:
401(k) match.... 42,434 169,736 -- -- -- -- -- --
Business
combinations.... 30,000 150,000 -- -- -- -- -- --
Compensation
expense.......... -- -- -- -- -- 13,650 -- --
Warrants issued
in connection
with financing... -- -- 452,480 -- -- -- -- --
Other
comprehensive
income:
Unrealized gain
on securities... -- -- -- -- -- -- 11,700 --
Net loss......... -- -- -- -- -- -- -- (20,687,249)
---------- ----------- ----------- --------- -------- --------- ------- ------------
Balance, March
31, 1999......... 27,920,704 $27,806,290 $12,171,879 $(501,674) $501,674 $(136,500) $11,700 (81,091,937)
========== =========== =========== ========= ======== ========= ======= ============
<CAPTION>
Total
-------------
<S> <C>
Balance, December
31, 1998......... $(21,348,885)
Common stock
issued for:
401(k) match.... 169,736
Business
combinations.... 150,000
Compensation
expense.......... 13,650
Warrants issued
in connection
with financing... 452,480
Other
comprehensive
income:
Unrealized gain
on securities... 11,700
Net loss......... (20,687,249)
-------------
Balance, March
31, 1999......... (41,238,568)
=============
</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 three months ended
-----------------------------
March 31, 1998 March 31, 1999
-------------- --------------
(unaudited)
<S> <C> <C>
Cash flows from operating activities
Net loss........................................ $(5,110,666) $(20,687,249)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization................... 762,439 2,862,892
Amortization of deferred financing costs and
accretion of debt discount..................... -- 400,927
Provision for uncollectible accounts............ -- 902,468
Stock compensation expense...................... 27,300 13,650
401(k) contributions through the issuance of
common stock................................... -- 169,736
Change in working capital (net of acquisitions):
Trade accounts receivable....................... (2,333,283) (2,275,973)
Inventory....................................... 21,106 439,135
Prepaid expenses and other current assets....... (299,099) (565,651)
Trade accounts payable.......................... 1,906,273 (421,975)
Accrued compensation............................ 799,600 1,630,229
Accrued interest................................ -- 5,200,000
Deferred revenue and customer deposits.......... 33,956 (205,321)
Other accrued liabilities....................... 1,752,207 (979,918)
----------- ------------
Net cash used in operating activities............ (2,440,167) (13,517,050)
Cash flows from investing activities
Additions of property and equipment............. (1,711,759) (1,074,597)
Acquisitions, net of cash acquired.............. (424,302) (1,500,000)
Short-term investments.......................... 4,926,509 (15,872,901)
Restricted cash................................. (3,482) (1,475,092)
Leases receivable............................... -- (700,262)
Other assets.................................... (217,245) (22,865)
----------- ------------
Net cash provided by (used in) investing
activities...................................... 2,569,721 (20,645,717)
Cash flows from financing activities
Proceeds from private placement, net of offering
costs.......................................... -- 19,300,000
Proceeds from new borrowings.................... -- 985,843
Payments on notes payable....................... (166,805) (29,743)
Payments on capital leases...................... (231,776) (1,298,042)
Proceeds from exercise of stock options......... 14,500 --
----------- ------------
Net cash provided by (used in) financing
activities...................................... (384,081) 18,958,058
----------- ------------
Net decrease in cash and cash equivalents........ (254,527) (15,204,709)
Cash and cash equivalents at beginning of
period.......................................... 667,344 25,597,461
----------- ------------
Cash and cash equivalents at end of period....... $ 412,817 $ 10,392,752
=========== ============
Supplemental disclosure of other cash and non-
cash investing and financing activities:
Acquisition of property and equipment through
the issuance of capital leases................. $ 537,500 $ 2,281,484
Cash paid for interest.......................... 97,958 335,738
</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 a next generation, converged 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. If we are
unsuccessful in obtaining financing, we would be compelled to alter our
business strategy or delay or abandon some of our future plans.
2. INTERIM FINANCIAL DATA:
The consolidated balance sheet as of March 31, 1999, statement of
shareholders' equity (deficit) for the three months ended March 31, 1999 and
the consolidated statements of operations and comprehensive loss, and cash
flows for the three months ended March 31, 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.
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
5
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
purchase price consisted of $1.5 million in cash, $4.5 million in notes
payable and 30,000 shares of our common stock (additional shares of our common
stock may be issued after certain financial adjustments are completed), which,
for purchase accounting purposes, were assigned a value of $5.00, and assumed
liabilities of $2.4 million resulting in total consideration of $8.7 million.
After March 31, 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 will be due upon the completion of a debt or equity
financing in excess of $25.0 million.
We accounted for this acquisition as a business combination using the
purchase method of accounting. In connection with the acquisition, 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 KCI from the effective date of the
acquisition.
The allocation of consideration given during the three months ended March
31, 1999 to the acquired assets is as follows:
<TABLE>
<S> <C>
Purchase price:
Cash paid................................................... $ 1,500,000
Notes payable issued to former owner........................ 4,490,000
Common stock issued to the former owners.................... 150,000
-----------
Total purchase price...................................... $ 6,140,000
===========
Allocation of the purchase price to acquired assets and
assumed liabilities:
Accounts receivable......................................... $ 1,715,835
Inventory................................................... 2,639,284
Prepaid expenses, deposits and other current assets......... 87,117
Equipment................................................... 391,129
Goodwill.................................................... 3,741,412
Liabilities and debt assumed................................ (2,434,777)
-----------
Amounts allocated......................................... $ 6,140,000
===========
</TABLE>
4. SERIES A PREFERRED STOCK:
In March 1999, we sold 800,000 shares of Series A Convertible Preferred
Stock and warrants to purchase 1,500,000 shares of our common stock to various
affiliates of the Sandler/21st Century Group for total consideration of $20.0
million. Each share of Series A Convertible Preferred Stock will automatically
convert into a minimum of 5 and maximum of 7.14 shares of common stock upon a
public offering that provides gross proceeds to us in excess of $50.0 million.
Each warrant entitles the holder to purchase one share of our common stock at
an exercise price of $7.50 per share for a period of five years. The number of
shares issuable upon the exercise of the warrants is subject to adjustment
based upon our initial public offering price, up to a maximum of 2,000,000
shares. If there is not a public offering providing gross proceeds to us in
excess of $50.0 million within five years of the sale of the Series A
Convertible Preferred Stock, the holders of the Series A Convertible Preferred
Stock have the option to require us to repurchase their shares plus accrued
interest. The proceeds from the sale, net of related offering costs were $19.3
million. One of our directors, Michael Marocco, is a principal of several of
the entities in the Sandler/21st Century Group. 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 March 31, 1999.
6
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. 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 March 31,
----------------------------------
1998 1999
----------- ------------
<S> <C> <C> <C> <C>
Revenue:
Data services............. $ 808,015 $ 2,118,940
Voice services............ 882,667 12,458,199
Enterprise Network
Services................. 116,391 733,437
Data products............. 4,462,299 7,161,752
Voice products............ 253,493 8,008,538
----------- ------------
Total revenue........... 6,522,865 30,480,866
----------- ------------
Gross margin before
depreciation:
Data services............. 446,732 987,008
Voice services............ 383,400 5,250,256
Enterprise Network
Services................. 61,374 591,455
Data products............. 740,389 794,861
Voice products............ 92,946 2,783,717
----------- ------------
Total gross margin
before depreciation.... 1,724,841 10,407,297
----------- ------------
Reconciliation to net loss:
Selling, general and
administrative........... (6,061,845) (23,337,581)
Depreciation and
amortization............. (762,439) (2,862,892)
----------- ------------
Operating loss............ (5,099,443) (15,793,176)
Interest expense.......... (52,568) (5,936,665)
Interest income........... 31,478 950,646
Other income, net......... 9,867 91,946
----------- ------------
Net loss................ $(5,110,666) $(20,687,249)
=========== ============
</TABLE>
6. NET LOSS PER SHARE:
The net loss available to common shareholders and weighted average shares
consists of the following:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-------------------------
1998 1999
----------- ------------
<S> <C> <C>
Net loss........................................ $(5,110,666) $(20,687,249)
=========== ============
Weighted average common shares used for basic
earnings per share............................. 26,958,467 27,885,235
Warrants........................................ -- --
Stock options................................... -- --
----------- ------------
Weighted average number of shares outstanding
(basic and diluted)............................ 26,958,467 27,885,235
=========== ============
Anti-dilutive weighted average options and
warrants not included.......................... 12,935,125 17,732,957
=========== ============
</TABLE>
7
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
7. SUBSEQUENT EVENTS:
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, 74,000 shares of our common stock, which
for purchase accounting purposes were assigned a value of $5.00 per share, and
assumed debt of approximately $525,000, resulting in total consideration of
$1.3 million. An additional 20,000 shares may be issued if certain financial
conditions are met.
In April 1999, we executed a memorandum of understanding with Cisco Systems,
Inc. for the purchase of approximately $103.5 million of Cisco equipment,
including Cisco's IP + ATM switches to be installed in our multi-service
switching platforms (which we call our ePOP).
In addition, in conjunction with our memorandum of understanding with Cisco
Systems, Inc., we executed a non-binding proposal letter with Cisco Systems
Capital Corporation for the financing of the Cisco equipment to be purchased
from Cisco Systems, Inc.
We are in the process of filing a registration statement with the Securities
and Exchange Commission in connection with a proposed initial public offering
of our common stock.
8
<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 $204.5 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 and $20.0
million in a 1999 sale of our convertible preferred stock and warrants to
affiliates of Sandler Capital/21st Century Group. As a result of that
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 the last three years, we completed 14 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 21 customers
with an aggregate of approximately 1,670 computers and telephones. We expect
these contracts will provide us with approximately $2.6 million in annual
contract revenue, and over their terms we expect they will produce total
revenue of approximately $15.4 million. 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.
9
<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>
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>
10
<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 $49.0 million of goodwill, net of
amortization, on March 31, 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 proposed
$103.5 million equipment facility with Cisco Systems Capital Corporation.
11
<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 March 31,
-----------------------
1998 1999
---------- -----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Revenue:
Data services........................................ $ 808 12% $ 2,119 7%
Voice services....................................... 883 14 12,458 41
Enterprise Network Services.......................... 116 2 733 2
Data products........................................ 4,462 68 7,162 24
Voice products....................................... 254 4 8,009 26
------ --- ------- ---
Total revenue...................................... $6,523 100% $30,481 100%
====== === ======= ===
Cost of sales excluding depreciation:
Data services........................................ $ 361 45% $ 1,132 54%
Voice services....................................... 499 57 7,208 58
Enterprise Network Services.......................... 55 48 142 19
Data products........................................ 3,722 84 6,367 89
Voice products....................................... 161 46 5,225 65
------ -------
Total cost of sales excluding depreciation......... $4,798 74% $20,074 66%
====== =======
Gross margin before depreciation:
Data services........................................ $ 447 55% $ 987 46%
Voice services....................................... 384 43 5,250 42
Enterprise Network Services.......................... 61 52 591 81
Data products........................................ 740 16 795 11
Voice products....................................... 93 54 2,784 35
------ -------
Total gross margin before depreciation............. $1,725 26% $10,407 34%
====== =======
</TABLE>
12
<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 March 31, 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
---------------------------------- ------------------------------------- --------
1st 2nd 3rd 4th 1st 2nd 3rd 4th 1st
------- ------- ------- ------- ------- -------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Operating Statement Data:
Revenue........................... $ 598 $ 2,020 $ 3,144 $ 4,448 $ 6,523 $ 7,982 $ 22,316 $ 24,779 $ 30,481
Cost of sales excluding depreciation.. 378 1,359 2,209 3,423 4,798 5,772 14,717 18,416 20,074
Selling, general and administrative.. 1,188 1,974 3,052 4,769 6,062 7,710 15,507 18,583 23,337
Depreciation and amortization..... 223 233 296 701 762 1,191 2,646 2,894 2,863
------- ------- ------- ------- ------- -------- -------- -------- --------
Operating loss.................... (1,191) (1,546) (2,413) (4,445) (5,099) (6,691) (10,554) (15,114) (15,793)
Net loss........................... $(1,086) $(1,586) $(2,817) $(4,166) $(5,111) $(11,169) $(15,355) $(18,941) $(20,687)
======= ======= ======= ======= ======= ======== ======== ======== ========
EBITDA (1)......................... $ (968) $(1,313) $(2,117) $(3,744) $(4,337) $ (5,500) $ (7,908) $(12,220) $(12,930)
======= ======= ======= ======= ======= ======== ======== ======== ========
</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 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 has
increased in each quarter through December 31, 1998. 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 13 acquisitions through March 31, 1999. We
have also experienced increasing operating and net losses every quarter.
However, net loss has declined as a percentage of revenue from 182% for the
first quarter of 1997 to 68% of revenue for the first quarter of 1999.
Three Months Ended March 31, 1998 Compared to Three Months Ended March 31,
1999
Revenue for the first quarter of 1999 was $24.0 million greater than revenue
for the first quarter of 1998. The increase in revenue was primarily due to
the addition of 27 new markets from 1998 to 1999. The increase in markets
resulted from acquisitions made between the end of the first quarter of 1998
and the first quarter of 1999. The increase in revenue was also due to
internal growth of our operations and sales staff. Our most significant
13
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
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 product revenue and voice services 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 March 31, 1998 to 12 at March 31, 1999. As a result of the Tie
acquisition, and our continued strategy to increase our service offerings, our
overall revenue mix shifted from approximately 28% in services for the first
three months of 1998, to 50% in services for the first three months of 1999.
Cost of sales excluding depreciation increased $15.3 million from the first
quarter of 1998 to the first quarter of 1999 and declined as a percentage of
total revenue from 74% for the first quarter of 1998 to 66% for the first
quarter of 1999. This decline as a percentage of total revenue is a reflection
of the decline in cost of product sales excluding depreciation, as a
percentage of product revenue, from 82% for the first quarter of 1998 to 76%
for the first quarter 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,
increased from 51% for the first quarter of 1998 to 55% for the first quarter
of 1999. The increase in cost of service sales excluding depreciation as a
percentage of service revenue was primarily due to an increase in voice
services, primarily long-distance services which have a higher related cost of
sales excluding depreciation.
Selling, general and administrative expenses increased $17.2 million from
the first quarter of 1998 to the first quarter of 1999, but decreased as a
percentage of revenue from 93% to 77%. 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 $17.2 million increase was primarily a result of:
. the expansion from eight to 35 markets;
. the completion of five acquisitions (four in the last nine months of
1998 and one in the first three months of 1999);
. an increase from 209 employees at March 31, 1998 to 1,080 at March 31,
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
$11.2 million or 48% of total selling, general and administrative
expenses for the three months ended March 31, 1999.
Depreciation and amortization expense increased approximately $2.1 million
from the first quarter of 1998 to the first quarter of 1999. This increase is
a direct result of increases of $23.7 million in property, network and
equipment. In addition, goodwill increased $44.5 million and other intangible
assets increased $1.7 million as a result of the five acquisitions completed
between March 31, 1998 and March 31, 1999. As of March 31, 1999 we had $49.0
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 converged data
and voice switching platform in three markets;
. 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.
14
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
Interest expense increased by approximately $5.9 million as a result of the
April 1998 issuance of $160.0 million in principal amount of our 13% Senior
Notes promissory notes and warrants to purchase 1,728,000 shares of common
stock. Approximately $400,000 of this increase relates to accretion of the
debt discount resulting from the value assigned to the warrants and
amortization of debt issuance costs, neither of which are cash expenses.
Interest expense also increased as a result of assumed indebtedness from
acquisitions, as well as 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 Services.
Interest income increased approximately $919,000 as a result of the
temporary investment of the remaining proceeds of the offering of the 13%
Senior Notes and proceeds from the sales of convertible preferred stock in
March 1999, prior to using the proceeds in our business.
Other income (net), which consists of miscellaneous other non-operating
types of expenses, increased by approximately $82,000.
Net loss increased approximately $15.6 million as a result of the factors
discussed above.
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 7,500,000 shares of common stock to
founders (April through October 1996)............. $ 450,000 $ 450,000
7,000,000 shares of common stock and 3,500,000 war-
rants (December 1996 through February 1997) 7,000,000 6,295,794
6,820,000 shares of common stock and 3,410,000
warrants (October through November 1997).......... 17,050,000 15,339,787
13% Senior Notes and 1,728,000 warrants (April
1998)............................................. 160,000,000 152,377,955
Sale of 800,000 shares of Series A Convertible
Preferred Stock and 1,500,000 warrants (March
1999)............................................. 20,000,000 19,300,000
------------ ------------
Total funds raised............................. $204,500,000 $193,763,536
============ ============
</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 36 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 larger proportion than operating expenses.
15
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
As of March 31, 1999, we had current assets of $79.9 million, including cash
and cash equivalents of $10.4 million, short-term investments of $15.9 million
and restricted cash of $20.8 million, and working capital of $22.4 million. In
addition, we also had $32.0 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 $13.5 million during the first quarter of 1999 and $2.4 million
during the first quarter of 1998. The majority of this increase was due to an
increase in net loss of $15.6 million and an increase in trade accounts
receivable of approximately $2.3 million, which were partially offset by an
increase in accrued interest expense of $5.2 million, depreciation and
amortization of $2.9 million, an increase of $1.6 million in accrued
compensation, non-cash expenses and other changes in working capital. Cash
used in operating activities for the first quarter of 1998 was primarily due
to our net loss of $5.1 million, partially offset by non-cash expenses such as
depreciation and amortization and changes in working capital.
Cash Flows From Investing Activities: Investing activities used cash of
$20.6 million during the first quarter of 1999 and provided cash of $2.6
million during the first quarter of 1998. Cash used in investing activities
during the first quarter of 1999 primarily consisted of short-term investments
and restricted cash of $17.3 million, business combinations of $1.5 million
and capital expenditures of $1.1 million. An additional $2.3 of capital
expenditures were financed under our financing facilities. Cash provided by
investing activities during the first quarter of 1998 consisted of $4.9
million resulting from maturing short-term investments, partially offset by
$1.7 million in capital expenditures and approximately $424,000 for business
combinations.
In April 1999, we completed the acquisition of BSSi Innovations, Inc.
(BSSi). BSSi was a provider of data network integration services based in
Chicago, Illinois. The purchase price consisted of $455,000 in cash, 74,000
shares of our common stock and assumed debt of approximately $525,000. An
additional 20,000 shares may be issued if certain financial conditions are
met.
Cash Flows From Financing Activities: Financing activities provided cash of
approximately $19.0 million during the first quarter of 1999 and used cash of
approximately $384,000 during the first quarter of 1998. Cash provided by
financing activities during 1999 consisted of approximately $19.3 million in
net proceeds from the sale of our convertible preferred stock and $1.0 million
in new borrowings, which was partially offset by approximately $1.3 million in
payments on long-term borrowings. Cash used in financing activities during the
first quarter of 1998 consisted of 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
March 31, 1999, $30.0 million was available to us under this facility. As of
March 31, 1999, a total of approximately $10.2 million had been utilized and
$19.8 million was available. 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
1,728,000 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, of which two have
been made as of 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.
16
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
In March 1999, we sold to affiliates of the Sandler/21st Century Group
800,000 shares of Series A Convertible Preferred Stock and warrants to
purchase 1,500,000 shares of our common stock, for total consideration of
$20.0 million. The proceeds from the sale, net of related offering costs, were
approximately $19.3 million.
In April 1999, we executed a non-binding proposal letter with Cisco Systems
Capital Corporation for a six-year $103.5 million credit facility. This credit
facility will provide the financing for the purchase and installation of our
Cisco Systems, Inc. powered multi-service data and voice switching platform
and for other Cisco System's equipment. Under the terms of this proposal,
Cisco Systems Capital would also receive a warrant to purchase 1,150,000
shares of our common stock. The warrant would have an exercise price of $10.00
per share and be exercisable for three years from the date of issuance. The
facility would 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.
We have an 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 March 31, 1999. We also have a $1.8
million agreement with GE Capital Fleet Services for financing purchases of
company vehicles, none of which was outstanding as of March 31, 1999.
Future Capital Requirements. We have significant debt in relation to our
equity. At March 31, 1999, we had $174.9 million in debt and $41.2 million in
shareholders' deficit, which includes paid-in capital of $40.0 million, but
excluded $19.3 million in convertible preferred stock classified outside of
shareholders' equity. 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 enterprise networks
of our Enterprise Network Services customers (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 are
currently in the process of filing a registration statement with the
Securities and Exchange Commission for a proposed initial public offering of
our common stock.
We estimate that our existing funds, the proceeds from our proposed initial
public offering, our available borrowing and lease financing capacity and the
proceeds from the exercise of our warrants expiring in July 1999 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.
17
<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 our two most recent acquisitions (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
18
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--(Continued)
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 vice 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.
19
<PAGE>
Part II
Item 1. Legal Proceedings
The Company is involved in legal proceedings from time to time, none of
which management believes, if decided adversely to the Company, would have a
material adverse effect on the business, financial condition or results of
operations of the Company.
Item 2. Changes in Securities
<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>
Feb. 12, 1999 Sellers in an 30,000 Substantially Section 4(2)
acquisition all
of the assets
of the target
company
Mar. 17, 1999 and Accredited 1,500,000 800,000 shares $20,000,000 Section 4(2)
Mar. 31, 1999 investors and of Class A
one investor Convertible
who retained Preferred
Company Stock
director
Michael
Marocco
as Investor
Representative
Mar. 21, 1999 Credit 400,000 Extension of Section 4(2)
facility $20.0 million
provider of credit
</TABLE>
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
Articles of Incorporation
+3.3 Articles of Amendment to the Amended and Restated Articles of
Incorporation of Convergent Communications, Inc.
++3.4 Articles of Amendment to the Amended and Restated Articles of
Incorporation of Convergent Communications, Inc.
10 Material Contracts
+10.23 Securities Purchase Agreement dated March 17, 1999 between Convergent
Communications, Inc. and the Initial Purchaser
27 Financial Data Schedule
(b) Reports on Form 8-K
None
+ Previously filed and incorporated by reference to the exhibit of the same
number in the Form 10-K (SEC File 333-53953)
++ Previously filed and incorporated by reference to the exhibit of the same
number in the Form S-1 filed on the date hereof.
20
<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: May 14, 1999 /s/ John R. Evans
By: _________________________________
John R. Evans
Chairman and Chief Executive
Officer
Date: May 14, 1999 /s/ Keith V. Burge
By: _________________________________
Keith V. Burge
President and Chief Operating
Officer
Date: May 14, 1999 /s/ John J. Phibbs
By: _________________________________
John J. Phibbs Jr.
Chief Financial Officer and
Treasurer
21
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<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1998 DEC-31-1999
<PERIOD-START> JAN-01-1998 JAN-01-1998 JAN-01-1999
<PERIOD-END> DEC-31-1998 MAR-31-1998 MAR-31-1999
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0 0 19,300,000
0 0 0
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<CGS> 0 3,882,456 11,591,712
<TOTAL-COSTS> 0 4,798,024 20,073,569
<OTHER-EXPENSES> 0 6,824,284 26,200,473
<LOSS-PROVISION> 0 0 902,468
<INTEREST-EXPENSE> 0 52,568 5,936,665
<INCOME-PRETAX> 0 (5,110,666) (20,687,249)
<INCOME-TAX> 0 0 0
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