<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 June 30, 2000
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 (I.R.S. Employer Identification No.)
of incorporation)
400 Inverness Drive South, Suite 400
Englewood, Colorado 80112
(303) 749-3000
(Address and telephone number of principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
(1) Yes X No
--------- ---------
(2) Yes X No
--------- ---------
On August 10, 2000, 29,585,641 shares of the registrant's
Common Stock were outstanding.
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<PAGE>
TABLE OF CONTENTS
Page No.
--------
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets--December 31, 1999 and June 30, 2000.......... 1
Consolidated Statements of Operations and Comprehensive Loss--Three
and Six months ended June 30, 1999 and 2000............................. 2
Consolidated Statement of Shareholders' Equity (Deficit)--Six months
ended June 30, 2000..................................................... 3
Consolidated Statements of Cash Flows--Six months ended June 30, 1999
and 2000................................................................ 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................................................ 17
Item 2. Changes in Securities and Use of Proceeds........................ 17
Item 3. Defaults Upon Senior Securities.................................. 17
Item 4. Submission of Matters to a Vote of Securities Holders............ 17
Item 5. Other Information................................................ 18
Item 6. Exhibits and Reports on Form 8-K
Exhibits...................................................... 18
Reports on Form 8-K........................................... 18
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 files 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
(in thousands)
<TABLE>
<CAPTION>
December 31, June 30,
1999 2000
------------ -----------
<S> <C> <C>
ASSETS (unaudited)
Current Assets:
Cash and cash equivalents $ 25,215 $ 111,679
Short-term investments 34,742 693
Restricted cash 20,800 20,232
Trade accounts receivable, net of allowance for doubtful accounts of
$2,512 and $2,132, respectively 39,922 35,642
Inventory 13,810 20,808
Prepaid expenses, deposits, leases receivable and other 9,070 16,850
--------- ---------
Total current assets 143,559 205,904
Property, network and equipment 77,455 103,170
Less accumulated depreciation (15,292) (27,874)
--------- ---------
Total property, network and equipment 62,163 75,296
Restricted cash 17,669 11,779
Goodwill, net of amortization of $8,528 and $8,876, respectively 56,037 36,529
Other intangible assets, net of amortization of $3,589 and
$4,379, respectively 10,967 11,546
Leases receivable, less current portion 6,150 9,090
Investments and other assets 812 3,211
--------- ---------
Total assets $ 297,357 $ 353,355
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Trade accounts payable $ 25,086 $ 22,974
Accrued compensation 10,423 22,936
Accrued interest 5,308 5,200
Other accrued liabilities 5,990 7,569
Deferred revenue and customer deposits 8,456 8,838
Current portion of long-term debt 1,788 6,761
Current portion of capital lease obligations 9,533 10,884
--------- ---------
Total current liabilities 66,584 85,162
Long-term debt, less discount and current portion 177,995 170,620
Long-term capital lease obligations, less current portion 16,158 16,550
--------- ---------
Total liabilities 260,737 272,332
--------- ---------
Commitments
Preferred stock, 1,000 shares authorized, none outstanding
at December 31, 1999; 175 outstanding at June 30, 2000 - 154,516
Shareholders' Equity (Deficit):
Common stock, no par value, 100,000 authorized, 28,642 and
29,414 shares issued and outstanding, respectively 196,937 200,010
Unexercised warrants and options 8,025 17,594
Treasury stock (919) (1,006)
Deferred compensation obligation 919 1,006
Accumulated other comprehensive income 573 692
Unearned compensation (250) (205)
Accumulated deficit (168,665) (291,584)
--------- ---------
Total shareholders' equity (deficit) 36,620 (73,493)
--------- ---------
Total liabilities and shareholders' equity (deficit) $ 297,357 $ 353,355
========= =========
</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
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
------------------------- -------------------------
1999 2000 1999 2000
-------- -------- -------- ----------
<S> <C> <C> <C> <C>
(unaudited)
Revenue $ 38,053 $ 53,264 $ 69,762 $ 106,111
Cost of sales excluding depreciation 28,439 50,222 53,739 96,105
Selling, general and administrative 22,685 37,001 41,466 71,782
Compensation related to restructuring - 12,617 - 15,643
Depreciation and amortization 4,108 8,402 6,970 16,126
Impairment of long-lived assets - 17,645 - 17,645
-------- -------- -------- ---------
Total operating expenses 55,232 125,887 102,175 217,301
Operating loss (17,179) (72,623) (32,413) (111,190)
Interest expense (6,149) (7,225) (12,086) (14,896)
Interest income 771 1,728 1,721 3,180
Other income (expense), net (403) (7) (311) (13)
-------- -------- -------- ---------
Net loss (22,960) (78,127) (43,089) (122,919)
Preferred dividends and accretion of discount - (3,241) - (3,241)
-------- -------- -------- ---------
Net loss available to common shareholders (22,960) (81,368) (43,089) (126,160)
Other comprehensive income, unrealized
holding gains (losses) on securities 11 (166) 22 119
-------- -------- -------- ---------
Comprehensive loss $(22,949) $(81,534) $(43,067) $(126,041)
======== ======== ======== =========
Net loss per share:
Net loss per share attributable to
common shareholders (basic and diluted) $ (1.61) $ (2.79) $ (3.06) $ (4.35)
======== ======== ======== =========
Weighted average number of shares
outstanding (basic and diluted) 14,253 29,172 14,099 28,981
======== ======== ======== =========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
2
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(in thousands)
<TABLE>
<CAPTION>
Unexercised Deferred
Common Common Warrants Treasury Compensation
Shares Stock and Options Stock Obligation
------ --------- ----------- -------- ------------
<S> <C> <C> <C> <C> <C>
(unaudited)
December 31, 1999 28,642 $196,937 $ 8,025 $ (919) $ 919
Common stock issued for:
401 (k) match 157 2,005 - - -
Business combinations 58 686 - - -
Exercise of stock options 151 226 - - -
Exercise of warrants 150 837 (663) - -
Stock compensation 264 2,569 - - -
Distribution of deferred stock (8) (116) - 173 (173)
Deferred stock compensation - - - (260) 260
Warrants issued in connection with
financing - - 10,232 - -
Preferred stock dividend and
accretion - (3,241) - - -
Other comprehensive income:
Unrealized gain on securities - - - - -
Other - 107 - - -
Net loss - - - - -
------ -------- ------- ------- ------
June 30, 2000 29,414 $200,010 $17,594 $(1,006) $1,006
====== ======== ======= ======= ======
Accumulated
Other
Comprehensive Unearned Accumulated
Income Compensation Deficit Total
December 31, 1999 $573 $(250) $(168,665) $ 36,620
Common stock issued for:
401 (k) match - - - 2,005
Business combinations - - - 686
Exercise of stock options - - - 226
Exercise of warrants - - - 174
Stock compensation - 45 - 2,614
Distribution of deferred stock - - - (116)
Deferred stock compensation - - - -
Warrants issued in connection with
financing - - - 10,232
Preferred stock dividend and
accretion - - - (3,241)
Other comprehensive income:
Unrealized gain on securities 119 - - 119
Other - - - 107
Net loss - - (122,919) (122,919)
---- ----- --------- --------
June 30, 2000 $692 $(205) $(291,584) $(73,493)
==== ===== ========= ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
3
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Six months ended
June 30, June 30,
1999 2000
-------- ---------
<S> <C> <C>
(unaudited)
Cash flows from operating activities:
Net Loss $(43,089) $(122,919)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 6,971 16,126
Impairment of long-lived assets - 17,645
Amortization of deferred financing costs and accretion of debt discount 843 1,494
Provision for uncollectible accounts 754 3,156
Stock compensation expense 974 2,614
401(k) contributions through the issuance of common stock 713 2,005
Loss on sale of investment 221 -
Other - 338
Change in working capital (net of acquisitions):
Trade accounts receivable (3,740) 269
Inventory (1,203) (7,425)
Prepaid expenses and other current assets (1,635) (6,452)
Revenue earned not billed - (2,121)
Trade accounts payable 3,397 (3,535)
Accrued compensation 242 12,513
Accrued interest 70 (108)
Other accrued liabilities (823) 1,704
Deferred revenue and customer deposits (816) 382
-------- ---------
Net cash used in operating activities (37,121) (84,314)
Cash flows from investing activities:
Additions of property, network and equipment (1,301) (15,054)
Acquisitions, net of cash acquired (2,052) -
Short-term investments (7,935) 34,692
Restricted cash 8,082 6,458
Leases receivable (3,070) (4,228)
Other assets 24 (1,321)
-------- ---------
Net cash (used in) provided by investing activities (6,252) 20,547
Cash flow from financing activities:
Proceeds from sale of preferred stock, net of related costs 19,206 161,507
Proceeds from new borrowings, net of financing costs 9,530 5,255
Payments on notes payable (2,243) (11,455)
Payments on capital leases (2,872) (5,459)
Proceeds from exercise of warrants and stock options 5,401 400
Other (4) (17)
-------- ---------
Net cash provided by financing activities 29,018 150,231
Net (decrease) increase in cash and cash equivalents (14,355) 86,464
Cash and cash equivalents at beginning of period 25,597 25,215
-------- ---------
Cash and cash equivalents at end of period $ 11,242 $111,679
======== =========
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 $ 10,519 $ 7,201
Acquisition of property, network and equipment in accounts payable
waiting to be financed 3,902 1,422
Cash paid for interest 11,172 13,510
</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.
We are a Broadband Internet and Web services provider with full service
network and systems integration capabilities for small and medium-sized
businesses with 25 to 500 employees. We provide turnkey communications,
networking, and Internet solutions such as the following:
. Web Services -- We help customers conceive, develop, implement, and
manage Web services to enable intranet, extranet, and e-commerce
applications.
. Broadband Internet Services -- We provide an integrated set of
Internet Protocol (IP) services such as dial-up and dedicated Internet
access, Frame Relay, Virtual Private Network (VPN) services, and
related server, firewall, and security offerings.
. Network Services -- We deliver traditional long-distance and data
networking services.
. System Integration -- We offer customers a market-leading portfolio of
data, video and voice network equipment, and installation,
integration, maintenance and support services.
Our ultimate success depends upon, among other factors, attracting and
retaining customers in our target markets, completing our product and service
portfolio with the addition of Web services, broadband and Internet services,
establishing alliances with best-of-breed providers, continuing to develop our
customer care and sales organizations, 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 growth and operations. As we continue to grow our business, we will
evaluate additional sources of financing to fund our development. We are
initiating steps to conserve capital and reduce costs to extend our available
cash resources. We estimate that our existing funds at June 30, 2000, 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 out 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 December 31, 1999 has been derived
from our audited financial statements. The consolidated balance sheet as of June
30, 2000, and the related consolidated statement of shareholders' equity
(deficit), statements of operations and comprehensive loss, and statements of
cash flows for the three and six months ended June 30, 1999 and 2000 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 1999 Form 10-K/A filed with the Securities
and Exchange Commission on April 24, 2000.
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. PREFERRED STOCK
In April 2000, we sold to an investment group led by Texas Pacific Group
(TPG), 175,000 shares of our 8% Series B convertible preferred stock, 700,000
warrants exercisable at $20 per share and 1.17 million warrants exercisable at
$25 per share for total consideration of $175 million. The investment was a
combination of $150 million from TPG and $25 million from affiliates of Sandler
Capital Management. The proceeds from the sale, net of related offering costs
were $161.5 million, of which, $10.2 million were allocated to the warrants
based on a value determined from a warrant valuation model. The preferred stock
is convertible into shares of our common stock at a conversion price of $13 per
share. If not converted, the preferred stock is mandatoraly redeemable in April
2010 at $175 million plus accrued dividends.
The $10 million senior secured credit facility with Goldman Sachs Credit
Partners L.P. was repaid in full with the proceeds from the sale of the Series B
preferred stock.
We have 1,000,000 shares of preferred stock authorized, none of which were
outstanding at December 31, 1999. 175,000 shares of Series B convertible
preferred stock were outstanding at June 30, 2000.
4. WORKING CAPITAL FACILITY
In April 2000, we entered into a three year $50 million Senior Secured
Revolving Line of Credit with Foothill Capital Corporation. Under the terms of
this $50 million credit facility, we may borrow up to 85% of eligible
receivables, as defined in the agreement, and the lessor of $12 million or 50%
of eligible inventory, as defined in the agreement. The facility renews
automatically for one year periods, unless terminated, and bears interest at 10%
per annum in addition to a monthly loan servicing fee of $7,500 and .25% on the
average daily unused portion of the facility. At June 30, 2000, there were no
borrowings under this facility.
5. IMPAIRMENT OF LONG-LIVED ASSETS
In compliance with our accounting policies, we periodically evaluate the
carrying amount of our long-lived assets. During the second quarter of 2000, in
connection with our change in business focus, we performed an evaluation
specifically related to goodwill, by revenue segment in each market, based on
the estimated future discounted cash flows generated by those assets. The amount
by which the carrying amount of goodwill exceeded the expected discounted cash
flow was charged to impairment of long-lived assets. Future cash flows were
estimated based on a combination of historical results and expected results from
our current business plan. This evaluation resulted in a charge to impairment in
long-lived assets of $17.6 million.
6. EXECUTIVE COMPENSATION
In connection with the hiring of our new president and chief executive
officer we were required to pay a signing bonus of $20 million, $10 million of
which was paid in April 2000 and fully earned as of June 30, 2000. The second
$10 million was paid in July 2000, of which $2 million had been earned as of
June 30, 2000. The remaining $8 million is subject to repayment if employment
is terminated before it is earned and is included in prepaid expenses at June
30, 2000. The amount subject to repayment will be reduced by $2 million each
quarter until fully earned at June 30, 2001.
6
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
7. NET LOSS PER SHARE
The net loss available to common shareholders and weighted average shares
outstanding consists of the following:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
--------- --------- --------- ----------
1999 2000 1999 2000
--------- --------- --------- ----------
<S> <C> <C> <C> <C>
(in thousands)
Net loss available to common shareholders $(22,960) $(81,368) $(43,089) $(126,160)
======== ======== ======== =========
Weighted average number of shares
outstanding (basic and diluted) 14,253 29,172 14,099 28,981
======== ======== ======== =========
</TABLE>
As of June 30, 1999 and 2000, a total of 9,777,115 and 13,116,478 options and
warrants were outstanding which were not considered in the above calculations as
their effect, if exercised, would have been anti-dilutive.
8. BUSINESS SEGMENTS
We classify our business into four fundamental areas: Web services,
broadband internet, network, and integration. 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 Six months ended
June 30, June 30,
1999 2000 1999 2000
-------- -------- -------- ---------
<S> <C> <C> <C> <C>
(in thousands)
Revenue:
Web Services $ 81 $ 1,469 $ 130 $ 3,558
Broadband Internet Services 69 921 89 1,483
Network Services 2,194 1,488 4,670 3,128
Systems Integration 35,709 49,386 64,873 97,942
-------- -------- -------- ---------
38,053 53,264 69,762 106,111
-------- -------- -------- ---------
Gross margin before depreciation:
Web Services (543) (88) (844) 120
Broadband Internet Services (74) (2,635) (152) (4,040)
Network Services 539 73 934 102
Systems Integration 9,692 5,692 16,085 13,824
-------- -------- -------- ---------
9,614 3,042 16,023 10,006
-------- -------- -------- ---------
Reconciliation to net loss:
Selling, general and administrative (22,685) (37,001) (41,466) (71,782)
Compensation related to restructuring - (12,617) - (15,643)
Depreciation and amortization (4,108) (8,402) (6,970) (16,126)
Impairment of long-lived assets - (17,645) (17,645)
-------- -------- -------- ---------
Operating loss (17,179) (72,623) (32,413) (111,190)
Interest expense (6,149) (7,225) (12,086) (14,896)
Interest income 771 1,728 1,721 3,180
Other income (expense) (403) (7) (311) (13)
-------- -------- -------- ---------
Net loss $(22,960) $(78,127) $(43,089) $(122,919)
======== ======== ======== =========
</TABLE>
Systems Integration revenue from a single customer represented 10.8% of total
revenue for the six months ended June 30, 2000.
7
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
9. SUBSEQUENT EVENTS
Subsequent to June 30, 2000 we completed the execution of a plan developed
by management, in conjunction with our business plan, to reduce the number of
our employees and to eliminate markets which did not appear to be strategic or
provide a sufficient and timely estimated return on investment. The result was a
reduction in headcount of approximately 250 including seven office closures
bringing our total markets to 29. We expect to recognize additional costs
between $2.0 million and $2.5 million associated with the headcount reductions
and office closures in the third quarter of 2000.
8
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read along with the consolidated
financial statements and the accompanying notes included elsewhere 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 Broadband Internet and Web services provider with full service
Network and Systems Integration capabilities for the small and medium sized
enterprise market, primarily businesses with 25 to 500 employees. We provide
turnkey communications, networking, and Internet solutions. Our four key product
and service portfolios are:
. Web Services -- We help customers conceive, develop, implement, and
manage Web services to enable intranet, extranet, and e-commerce
applications.
. Broadband Internet Services -- We provide an integrated set of
Internet Protocol (IP) services such as dial-up and dedicated Internet
access, Frame Relay, Virtual Private Network (VPN) services, and
related server, firewall, and security offerings.
. Network Services -- We deliver traditional long-distance and data
networking services.
. System Integration -- We offer customers a market-leading portfolio of
data, video and voice network equipment, and installation,
integration, maintenance and support services.
Our unique value proposition is our ability to combine all of these
components through a direct channel to the customer. We can offer each of these
services and products individually or in a bundled offering.
We were first capitalized in March 1996. Since that time, we have
successfully raised $513.6 million in capital, including $450,000 in initial
capitalization, $24 million in two private placements of common stock in 1996
and 1997, $160 million through the 1998 sale of our 13% Senior Notes and related
warrants, $20 million in a 1999 sale of our Series A convertible preferred
stock and warrants to affiliates of Sandler Capital Management and $134.1
million in our Initial Public Offering in July 1999. In addition, in April
2000, we raised $175 million through the sale of 175,000 shares of our Series B
convertible preferred stock and issuance of warrants to an investment group led
by Texas Pacific Group (TPG). We also have borrowing capacity under a $50
million Senior Secured Revolving Line of Credit Facility.
Since our inception, we have acquired 18 businesses which have accelerated
our market development. Primarily through these acquisitions, we now have a
nationwide footprint in 19 tier one markets and 10 tier two markets. We
currently offer systems integration in all of our markets and offer some
combination of Broadband Internet Services, Web Services or Network Services in
20 of our markets.
In conjunction with the investment made by TPG in April 2000 we have hired
a new president and chief executive officer as well as replacements for several
of our senior management positions and have elected several new members to our
board of directors. The senior management team has developed a bottoms-up,
productivity based business plan, placing a greater emphasis on higher margin
Broadband Internet and Web revenue. Our new strategy focuses the ongoing capital
investments on our core integrated broadband network and on the build out of our
Web and application hosting centers. In addition, we are developing critical
business alliances that will foster the rapid deployment and support of our new
business plan.
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 four segments: Web Services, Broadband
Internet Services, Network Services, and Systems Integration.
Revenue and cost of sales. The following chart outlines the components of
revenue and the related cost of sales excluding depreciation, by segment.
Revenue: Cost of Sales
Web Services (excluding depreciation):
. Web development . engineer and technician
. Web hosting direct compensation and
benefits
. hosting facilities and
support infrastructure
---------------------------------------------------------------------------
Broadband Internet Services
. Frame Relay (ATM and IP switching) . leased line facilities' costs
. Internet access . capacity charges imposed by
. virtual private network (VPN) Internet service Providers and
. digital subscriber line (DSL) other carriers
. remote LAN access (RLA) . collocation and entrance
facilities costs
---------------------------------------------------------------------------
Network Services
. long distance telephone service . costs of connecting customers
. local telephone service as an agent to long distance or local
. private line service networks
. capacity charges that long
distance and local carriers
impose on us to use their
equipment and networks or to
resell their services
---------------------------------------------------------------------------
Systems Integration
. network planning, design, . engineer and technician
maintenance, and monitoring direct compensation
. managed network services and benefits
. sale, installation, and financing . costs associated with all the
of data, voice, and video data and voice systems and
network systems services described in this
table
. cost of data, voice, and
video network systems
. costs of installation,
including technician
compensation and benefits
Selling, general, and administrative expenses have increased significantly
as we have recruited management and support personnel to support our growth.
. Selling expenses include salaries and commissions paid to our direct
sales force, marketing salaries and benefits, travel expenses, trade
show expenses, occupancy fees, consulting fees, and promotional costs.
Also included are the costs of soliciting potential customers such as
telemarketing, brochures, targeted advertising, and promotional
. 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
10
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Compensation related to restructuring represents costs incurred in
connection with changes in management, reductions in headcount and an office
closure resulting from our change in business focus.
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 long-term managed network service
contracts. Amortization expense includes the amortization of intangible assets
(over three to ten years), primarily goodwill (over ten years), that resulted
from business acquisitions.
Impairment of long-lived assets represents the write-down of goodwill
associated with revenue segments in some of our markets which are expected to
generate future cash flows below the carrying amount of the goodwill. During the
quarter ended June 30, 2000 we wrote off $17.6 million in goodwill largely due
to our change in business focus. Subsequent to the write-down we had $36.5
million of goodwill, net of amortization, on June 30, 2000. The write-down
represents the amount by which the carrying amount of the goodwill exceeded the
expected future discounted cash flow.
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 through
various capital leases and our credit facility.
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.
As a result, depreciation and amortization are not factors used by management in
evaluating the operating performance of our segments.
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 a percentage of revenue for the related segment.
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
--------------------------------------- ----------------------------------------
1999 2000 1999 2000
---------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
(dollars in thousands) (dollars in thousands)
Web Services $ 81 0% $ 1,469 3% $ 130 0% $ 3,558 3%
Broadband Internet Services 69 0 921 1 89 0 1,483 2
Network Services 2,194 6 1,488 3 4,670 7 3,128 3
Systems Integration 35,709 94 49,386 93 64,873 93 97,942 92
------- ----- -------- ----- -------- ----- -------- -----
38,053 100% 53,264 100 % 69,762 100% 106,111 100%
Web Services 624 770% 1,557 106 % 974 749% 3,438 97%
Broadband Internet Services 143 207 3,556 386 241 271 5,523 372
Network Services 1,655 75 1,415 95 3,736 80 3,026 97
Systems Integration 26,017 73 43,694 88 48,788 75 84,118 86
------- -------- -------- --------
28,439 50,222 53,739 96,105
Web Services (543) (670)% (88) (6)% (844) (649)% 120 3%
Broadband Internet Services (74) (107) (2,635) (286) (152) (171) (4,040) (272)
Network Services 539 25 73 5 934 20 102 3
Systems Integration 9,692 27 5,692 12 16,085 25 13,824 14
------- -------- -------- --------
$ 9,614 $ 3,042 $ 16,023 $ 10,006
======= ======== ======== ========
</TABLE>
12
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Results of Operations
Revenue increased $15.2 million (40%) and $36.3 million (52%) for the three
and six month periods ended June 30, 2000 compared to the same periods in 1999.
Revenue from our integration segment, which includes professional services,
maintenance, and sales of data and voice systems sales increased $13.7 million
and $33.1 million and represented 93% and 92% of total revenue for the 2000
periods. The majority of the increase in integration revenue came from sales of
data systems, which is largely attributable to the acquisition of three data
integration businesses in the second half of 1999. Also contributing to the
increase was a significant equipment sale that represented $11.5 million or
10.8% of total revenue for the six months ended June 30, 2000. Revenue from Web
Services and Broadband increased $2.2 million and $4.8 million for the three and
six month periods ended June 30, 2000, compared to the same periods in 1999. The
increase in Web Services and Broadband Internet is largely due to our emphasis
on growing these segments supported by our investments in network, personnel,
and training toward that goal. Increases in revenue were partially offset by
declines of $706,000 and $1.5 million in network revenue which is largely
attributable to competitive long-distance rate reductions.
Cost of sales excluding depreciation increased $21.8 million (77%) and
$42.4 million (79%) for the three and six month periods ended June 30, 2000
compared to the same periods in 1999. We have restated prior periods to reflect
a change in classification of unutilized integration service technician and Web
developer labor costs which had previously been classified in selling, general
and administrative expense. This reclassification resulted in a higher cost of
sales for all periods presented. Cost of sales also increased as a percentage of
revenue from 75% for the second quarter of 1999 to 94% for the second quarter of
2000 and from 77% for the first half of 1999 to 91% for the first half of 2000.
This increase in cost of sales as a percentage of revenue is due to a number of
factors as follows:
. a shift in revenue mix toward a higher percentage of revenue from data
systems which have a higher related direct cost;
. an increase in cost of sales for data systems as a percentage of
revenue from 83% to 90% for the second quarters of 1999 and 2000,
respectively;
. a higher percentage of unutilized labor costs for billable employees;
. an increase in recurring fixed infrastructure costs associated with
operating our Cisco based ATM/IP network, which does not yet have a
sufficient volume of customer traffic to cover these costs;
. approximately $3.3 million in non-recurring vendor and customer
related contract commitments and credits incurred during the second
quarter of 2000.
Selling, general, and administrative expenses increased $14.3 million (63%)
and $30.3 million (73%) for the three and six month periods ended June 30, 2000
compared to the same periods in 1999. The majority of the increase is
attributable to field expenses and is primarily a result of the three
acquisitions completed during the last six months of 1999, the development of
our Web Services group and other growth in selling, services, and order entry
personnel. Included in the increase in general and administrative expense was a
charge of approximately $2.0 million for the reserve of a doubtful receivable.
Compensation related to restructuring represents costs incurred in
connection with changes in management, reductions in headcount and an office
closure resulting from the change in business focus. The majority of the amount
recognized during the second quarter of 2000 represents the costs for a signing
bonus for our new chief executive officer of which $10 million had been paid as
of June 30, 2000 and $10 million was paid in July 2000. As of June 30, 2000, $12
million of the signing bonus had been expensed and an additional $2 million will
be recognized during each of the next four consecutive quarters through June 30,
2001 unless employment is terminated. The balance of the expense for the six
month period in 2000 represents severance related to changes in executive
management ($2 million), acquisition integration related compensation ($1
million) and other severance and payroll related costs related to headcount
reductions ($617,000). Some of the severance related amounts will be paid over
future periods in compliance with employment contracts.
13
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Depreciation and amortization expense increased $4.3 million (105%) and $9.2
million (131%) for the three and six month periods ended June 30, 2000 compared
to the same periods for 1999. The increase for the six month period is a result
of an increase of $58.4 million in property, network, and equipment from June
30, 1999 to June 30, 2000. However, the nominal change for the comparative
second quarter periods is due to the write-off of goodwill during the second
quarter of 2000 (see Impairment of long-lived assets below). The increase in
property, network, and equipment is largely due to:
. the development and deployment of 16 of our ATM/IP switching
platforms;
. continued development of our operational support systems; and
. the increase in assets under managed network services contracts.
Impairment of long-lived assets of $17.6 million represents the write-down
of long-lived assets, primarily goodwill, to fair value. Given recent changes in
business focus initiated by our executive management, we performed a review of
our expected future cash flow and other factors in each of our markets. As a
result, we determined that goodwill associated with some of our markets,
primarily those in which there is a higher percentage of data integration
business, was impaired.
Interest expense increased by approximately $1.1 million and $2.8 million
for the three and six months ended June 30, 2000 compared to the same periods in
1999. The increase is a result of increased indebtedness from June 30, 1999 to
June 30, 2000 of $12.6 million in network equipment financing under the Cisco
facility to fund our Cisco based ATM/IP network build-out and $7.8 million under
capital leases. Also, included in the 2000 expense are interest charges for the
$10 million Goldman Sachs Credit Partners L.P. senior secured credit facility,
which was repaid in April 2000.
Interest income increased approximately $1.0 million and $1.5 million for
the three and six months ended June 30, 2000 compared to the same periods in
1999. The increase is a result of earnings on the proceeds from the sale of our
Series B preferred stock in April 2000.
14
<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 borrowings 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>
Gross Net
Securities Sold Proceeds Proceeds
------------------------------------------------------------------------ ------------- --------------
<S> <C> <C>
(in thousands)
Initial sale of 3,750 shares of common stock
(April through October 1996) $ 450 $ 450
3,500 shares of common stock and 1,750 warrants
(December 1996 through February 1997) 7,000 6,296
3,410 shares of common stock and 1,705 warrants
(October through November 1997) 17,050 15,340
13% Senior Notes and 864 warrants (April 1998) 160,000 152,378
Sale of 800 shares of Series A Convertible Preferred Stock and
958 warrants (March 1999) 20,000 19,300
Initial Public Offering of 8,937 shares of common stock (July 1999) 134,051 122,281
Sale of 175 shares of Series B Convertible Preferred Stock and
1,867 warrants (April 2000) 175,000 161,507
------------- --------------
Total funds raised $ 513,551 $ 477,552
============= ==============
</TABLE>
Our principal uses of cash are to fund working capital requirements,
capital expenditures, operating losses, and interest expenses. We expect that
our expansion will require additional capital expenditures and direct operating
costs and expenses.
As of June 30, 2000, we had current assets of $205.9 million, including
cash and cash equivalents of $111.7 million, and restricted cash of $20.2
million, and working capital of $120.7 million. We also had $11.8 million in
non-current restricted cash. Approximately $20.2 million 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, the remaining
$11.8 million represents vendor collateral commitments. We invest excess funds
in short-term investments until these funds are needed for debt payments,
capital investments, acquisitions, and the operations of our business.
Cash Flows From Operating Activities. Operating activities used cash of
approximately $84.2 million during the six months ended June 30, 2000, compared
to $37.1 million for the six months ended June 30, 1999. Cash used in operating
activities in 2000 was primarily due to the net loss of $122.9 million, an
increase in inventory, prepaid expenses and other current assets and revenue
earned not billed of $16.0 million, and a decrease in accounts payable of $3.5
million. These uses of cash were partially offset by $43.4 million in non-cash
expenses including impairment of long-lived assets, depreciation and
amortization, provision for uncollectible accounts and stock compensation, and
an increase in accrued compensation and other liabilities of $14.2 million.
Cash used in operating activities as a percentage of revenue increased from 53%
for the first six months of 1999 to 79% for the first six months of 2000. The
increase as a percentage of revenue is directly related to the decline in our
operating results and as a result of one time charges associated with changes in
management and restructuring such as signing bonuses and severance and changes
in working capital.
Cash Flows From Investing Activities. Investing activities provided cash
of $20.5 million during the six months ended June 30, 2000 compared to cash used
of $6.3 million for the six months ended June 30, 1999. The cash provided from
investing activities was a result of $34.7 million in maturing short-term
investments and $6.5 provided from restricted cash partially offset by $15.1
million of cash used for capital expenditures and $5.5 million invested in
leases receivable and other assets.
15
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Cash Flows From Financing Activities. Financing activities provided cash
of approximately $150.2 for the six months ended June 30, 2000 and $29 million
for the same period in 1999. During the first half of 2000 we generated net
proceeds of $161.5 million from the sale of our Series B Convertible Preferred
Stock and $5.3 million in new borrowings from discounted long-term receivables,
partially offset by the repayment of $10.0 million under the Goldman Sachs
Credit Facility and $6.9 million in principal payments on other indebtedness.
In July, 1999, we entered into a six-year, $103.5 million credit facility
with Cisco Systems Capital Corporation. This credit facility provides 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 June 30, 2000. The warrant has an exercise price of $13.00 per share and is
exercisable for three years from the date of issuance. The facility is
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. As
of June 30, 2000, we had borrowed $12.6 million under this facility.
We have an agreement with an equipment financing company that was used to
finance our internal capital needs under which $4 million was outstanding on
June 30, 2000. We also have an $8 million inventory credit facility under which
$515,000 was outstanding as of June 30, 2000.
In April 2000, we entered into a $50 million Senior Secured Revolving Line
of Credit Facility. Under the terms of this $50 million credit facility, we may
borrow up to 85% of eligible receivables, as defined in the agreement, and the
lesser of $12 million or 50% of eligible inventory, as defined in the agreement.
As of June 30, 2000, no amounts had been borrowed under this facility.
In April 2000, we sold to an investment group led by Texas Pacific Group
(TPG), 175,000 shares of our 8% Series B convertible redeemable preferred stock,
700,000 warrants exercisable at $20 per share, and 1.17 million warrants
exercisable at $25 per share. The investment was a combination of $150 million
from TPG and $25 million from affiliates of Sandler Captial Management. The
preferred stock is convertible into shares of our common stock at a conversion
price of $13 per share. Unless converted, the preferred stock is mandatoraly
redeemable in 2010.
Future Capital Requirements. We have significant debt in relation to our
equity. At June 30, 2000, we had $204.8 million in debt and $73.5 million in
shareholders' deficit, which includes paid-in capital of $217.6 million. Our
business plan will continue to require a substantial amount of capital to fund
our growth and operations of our existing markets. Also, in connection with the
hiring of our new President and CEO, we were required to pay a $20.0 million
signing bonus, $10.0 million of which was paid in April 2000 and $10.0 million
of which was paid in July 2000. Our business plan includes the following:
. continuing to develop our customer care and sales organizations;
. continuing to develop our operational support system; and
. funding operating losses and debt service requirements.
We estimate that our existing funds at June 30, 2000, our available
borrowing under our current financing and leasing facilities and our $50 million
senior secured credit facility will be sufficient to meet our capital
requirements for the foreseeable future. We may require additional capital
sooner than anticipated if there are 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, 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 business, financial condition, results of operations and liquidity, and
on the price of our common stock.
16
<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>
Number of
Underwriters or Shares of
Date Class of Purchasers Common Stock Consideration Exemption Claimed
---- ------------------- ------------ ------------- -----------------
<S> <C> <C> <C> <C>
Apr 14, 2000 to Private Placement Warrant exercises 122,165 $ 92,675 Section 4(2)
June 22, 2000
Apr. 24, 2000 Seller in an acquisition 10,000 $100,000 Section 4(2)
May 15, 2000 Seller in an acquisition 17,782 $209,995 Section 4(2)
May 22, 2000 Seller in an acquisition 21,500 $253,902 Section 4(2)
May 26, 2000 Seller in an acquisition 17,771 $209,989 Section 4(2)
</TABLE>
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matter to a Vote of Security Holders
(a) Annual Meeting of the Shareholders held June 16, 2000
(b) Directors elected at the meeting: Jeffrey Shaw, Richard Boyce and
Michael Marocco
Directors continuing: Joseph Zell, Richard Tomlinson, Spencer
Browne and Clifford Rudolph
(c) Matters voted upon
<TABLE>
<CAPTION>
Votes In Favor
(includes Series B
preferred voting on an Votes
Resolution as converted basis) Against Abstentions Non-Votes
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Election of Mr. Shaw 34,376,591 163,368 - -
Election of Mr. Boyce 34,217,723 158,868 - -
Election of Mr. Marocco 34,376,591 204,868 - -
Appointment of
PricewaterhouseCoopers, LLP
as independent auditors 34,376,591 155,825 30,013 -
Approval of Employee Stock
Incentive Plan 21,042,760 952,906 96,102 12,556,860
</TABLE>
(d) None
17
<PAGE>
Part II (continued)
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1 Employment Agreement by and between Convergent
Communications, Inc. and David R. McNeill dated June 30,
2000
10.2 Employment Agreement by and between Convergent
Communications, Inc. and Michael G. Olson dated May 30, 2000
27 Financial Data Schedule
(b) Report filed on April 18, 2000 announcing the completion of the
$175 million sale of the Series B Preferred Stock Offering and the
completion of the $50 million Senior Secured Facility with
Foothill Capital Corporation
18
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report on Form 10-Q, for the quarter ended
June 30, 2000, to be signed on its behalf by the undersigned thereunto duly
authorized.
Convergent Communications, Inc.
Date: August 14, 2000
By: /S/ Joseph R. Zell
-------------------------------------------------
Joseph R. Zell
President and Chief Executive Officer
Date: August 14, 2000
By: /S/ Brian R. Ervine
-------------------------------------------------
Executive Vice President, Chief Financial Officer
and Treasurer
