<PAGE>
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
________________
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 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
of incorporation) Identification No.)
400 Inverness Drive South, Suite 400
Englewood, Colorado 80112
(303) 749-3000
(Address and telephone number of principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
(1) Yes X No ____
-----
(2) Yes X No ____
-----
On November 3, 2000, 29,706,378 shares of the registrant's Common Stock
were outstanding.
================================================================================
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets--December 31, 1999 and September 30, 2000.............................................. 1
Consolidated Statements of Operations and Comprehensive Loss--Three and Nine
months ended September 30, 1999 and 2000...................................................................... 2
Consolidated Statement of Shareholders' Equity (Deficit)--Nine months ended September 30, 2000..................... 3
Consolidated Statements of Cash Flows--Nine months ended September 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......................................................................................... 18
Item 2. Changes in Securities and Use of Proceeds................................................................. 18
Item 3. Defaults Upon Senior Securities........................................................................... 18
Item 4. Submission of Matters to a Vote of Securities Holders..................................................... 18
Item 5. Other Information......................................................................................... 19
Item 6. Exhibits and Reports on Form 8-K
Exhibits................................................................................................ 19
Reports on Form 8-K..................................................................................... 19
</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 reports filed 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, September 30,
1999 2000
------------ -------------
(unaudited)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 25,215 $ 71,964
Short-term investments 34,742 258
Restricted cash 20,800 20,514
Trade accounts receivable, net of allowance for doubtful accounts of
$2,512 and $3,560, respectively 39,922 38,794
Inventory 13,810 12,957
Prepaid expenses, deposits, leases receivable and other 9,070 15,965
---------- ----------
Total current assets 143,559 160,452
Property, network and equipment 77,455 107,655
Less accumulated depreciation (15,292) (34,721)
---------- ----------
Total property, network and equipment 62,163 72,934
Restricted cash 17,669 11,532
Goodwill, net of amortization of $8,528 and $10,013, respectively 56,037 35,481
Other intangible assets, net of amortization of $3,589 and
$5,013, respectively 10,967 11,327
Leases receivable, less current portion 6,150 12,355
Investments and other assets 812 1,192
---------- ----------
Total assets $ 297,357 $ 305,273
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Trade accounts payable $ 25,086 $ 21,353
Accrued compensation 10,423 9,451
Accrued interest 5,308 10,400
Other accrued liabilities 5,990 9,953
Deferred revenue and customer deposits 8,456 10,011
Current portion of long-term debt 1,788 9,524
Current portion of capital lease obligations 9,533 10,788
---------- ----------
Total current liabilities 66,584 81,480
Long-term debt, less discount and current portion 177,995 171,816
Long-term capital lease obligations, less current portion 16,158 13,937
---------- ----------
Total liabilities 260,737 267,233
---------- ----------
Commitments
Redeemable preferred stock, 1,000 shares authorized, none outstanding
at December 31, 1999; 175 outstanding at September 30, 2000 - 158,600
Shareholders' Equity (Deficit):
Common stock, no par value, 100,000 authorized, 28,642 and
29,636 shares issued and outstanding, respectively 196,937 197,327
Unexercised warrants and options 8,025 17,518
Treasury stock (919) (742)
Deferred compensation obligation 919 742
Accumulated other comprehensive income 573 240
Unearned compensation (250) (125)
Accumulated deficit (168,665) (335,520)
---------- ----------
Total shareholders' equity (deficit) 36,620 (120,560)
---------- ----------
Total liabilities and shareholders' equity (deficit) $ 297,357 $ 305,273
========== ==========
</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 Nine months ended
September 30, September 30,
------------------------- -------------------------
1999 2000 1999 2000
--------- -------- --------- ---------
(unaudited)
<S> <C> <C> <C> <C>
Revenue $ 42,422 $ 53,472 $112,183 $ 159,583
Cost of sales excluding depreciation 32,092 48,253 85,830 144,358
Selling, general and administrative 26,813 29,215 68,279 100,997
Restructuring charges - 6,051 - 21,695
Depreciation and amortization 4,872 8,722 11,842 24,847
Impairment of long-lived assets - 144 - 17,789
--------- -------- -------- ---------
Total operating expenses 63,777 92,385 165,951 309,686
--------- -------- -------- ---------
Operating loss (21,355) (38,913) (53,768) (150,103)
Interest expense (6,881) (7,122) (18,967) (22,019)
Interest income 1,776 1,898 3,497 5,079
Other income (expense), net 102 201 (209) 188
--------- -------- -------- ---------
Net loss (26,358) (43,936) (69,447) (166,855)
Preferred dividends and accretion of discount - (4,087) - (7,328)
--------- -------- -------- ---------
Net loss available to common shareholders (26,358) (48,023) (69,447) (174,183)
Other comprehensive income, unrealized
holding gains (losses) on securities 44 (452) 66 (333)
--------- -------- -------- ---------
Comprehensive loss $ (26,314) $(48,475) $(69,381) $(174,516)
========= ======== ======== =========
Net loss per share:
Net loss per share attributable to
common shareholders (basic and diluted) $ (1.06) $ (1.63) $ (3.92) $ (5.97)
========= ======== ======== =========
Weighted average number of shares
outstanding (basic and diluted) 24,776 29,529 17,697 29,165
========= ======== ======== =========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
2
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)
(in thousands)
<TABLE>
<CAPTION>
Accumulated
Unexercised Deferred Other
Common Common Warrants Treasury Compensation Comprehensive
Shares Stock and Options Stock Obligation Income
------- --------- ------------ -------- ------------ -------------
(unaudited)
<S> <C> <C> <C> <C> <C> <C>
December 31, 1999 28,642 $ 196,937 $ 8,025 $ (919) $ 919 $ 573
Common stock issued for:
401 (k) match 314 3,257 - - - -
Business combinations 83 742 - - - -
Exercise of stock options 203 326 - - - -
Exercise of warrants 150 837 (663) - - -
Stock compensation 256 2,579 (76) - - -
Distribution or cancellation of deferred stock (12) (136) - 437 (437) -
Deferred stock compensation - - - (260) 260 -
Warrants issued in connection with
financing - - 10,232 - - -
Preferred stock dividend and
accretion - (7,328) - - - -
Other comprehensive income:
Unrealized gain on securities - - - - - (333)
Other - 113 - - - -
Net loss - - - - - -
------- --------- ------------ -------- ------------ -------------
September 30, 2000 29,636 $ 197,327 $ 17,518 $ (742) $ 742 $ 240
======= ========= ============ ======== ============ =============
<CAPTION>
Unearned Accumulated
Compensation Deficit Total
------------ ----------- ----------
<S> <C> <C> <C>
December 31, 1999 $ (250) $ (168,665) $ 36,620
Common stock issued for:
401 (k) match - - 3,257
Business combinations - - 742
Exercise of stock options - - 326
Exercise of warrants - - 174
Stock compensation 125 - 2,628
Distribution or cancellation of deferred stock - - (136)
Deferred stock compensation - - -
Warrants issued in connection with
financing - - 10,232
Preferred stock dividend and
accretion - - (7,328)
Other comprehensive income:
Unrealized gain on securities - - (333)
Other - - 113
Net loss - (166,855) (166,855)
------------ ----------- ----------
September 30, 2000 $ (125) $ (335,520) $ (120,560)
============ =========== ==========
</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>
Nine months ended
September 30,
--------------------------
1999 2000
---------- -----------
(unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net Loss $ (69,447) $ (166,855)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 11,842 24,847
Impairment of long-lived assets - 17,789
Amortization of deferred financing costs and accretion of debt discount 1,409 2,137
Provision for uncollectible accounts 1,339 5,415
Stock compensation expense 1,421 2,628
401(k) contributions through the issuance of common stock 1,261 3,257
Sale of EMS equipment - 807
Loss on sale of investment 220 -
Other - 499
Change in working capital (net of acquisitions):
Trade accounts receivable (10,370) (1,181)
Inventory (2,543) 381
Prepaid expenses and other current assets (4,957) (7,249)
Leases receivable (3,195) (6,865)
Trade accounts payable (3,409) (4,893)
Accrued compensation 2,350 (972)
Accrued interest 5,323 5,092
Other accrued liabilities 1,214 4,076
Deferred revenue and customer deposits 754 1,555
---------- -----------
Net cash used in operating activities (66,788) (119,532)
Cash flows from investing activities:
Additions of property, network and equipment (11,837) (19,942)
Short-term investments (46,120) 34,151
Restricted cash 3,283 6,424
Other assets (220) (3,366)
Acquisitions, net of cash acquired (3,752) -
---------- -----------
Net cash (used in) provided by investing activities (58,646) 17,267
Cash flow from financing activities:
Proceeds from initial public offering, net of offering costs 122,410 -
Proceeds from sale of preferred stock, net of related costs 19,206 161,505
Proceeds from new borrowings, net of financing costs 13,000 9,104
Payments on notes payable (4,800) (12,960)
Payments on capital leases (5,408) (9,135)
Proceeds from exercise of warrants and stock options 13,051 500
Other (5) -
---------- -----------
Net cash provided by financing activities 157,454 149,014
---------- -----------
Net increase in cash and cash equivalents 32,020 46,749
Cash and cash equivalents at beginning of period 25,597 25,215
---------- -----------
Cash and cash equivalents at end of period $ 57,617 $ 71,964
========== ===========
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 $ 13,546 $ 12,787
Acquisition of property, network and equipment in accounts payable
waiting to be financed 9,118 1,016
Cash paid for interest 12,235 14,790
</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.
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 September 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 nine months ended September 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.
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 must be
redeemed 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.
5
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
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 September 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 nine months ended
September 30, 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 $17.8 million.
6. NET LOSS PER SHARE
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------------ ------------------------
1999 2000 1999 2000
--------- --------- --------- ----------
(in thousands)
<S> <C> <C> <C> <C>
Net loss available to common shareholders $ (26,358) $ (48,023) $ (69,447) $ (174,183)
========= ========= ========= ==========
Weighted average number of shares
outstanding (basic and diluted) 24,776 29,529 17,697 29,165
========= ========= ========= ==========
</TABLE>
The net loss available to common shareholders and weighted average shares
outstanding consists of the following:
As of September 30, 1999 and 2000, a total of 9,301,023 and 13,023,400 options
and warrants were outstanding which were not considered in the above
calculations as their effect, if exercised, would have been anti-dilutive.
6
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
7. BUSINESS SEGMENTS
We classify our business into four fundamental areas: Web Services,
Broadband Internet, Network, and Systems 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 Nine months ended
September 30, September 30,
------------------------ ------------------------
1999 2000 1999 2000
--------- --------- --------- ----------
(in thousands)
<S> <C> <C> <C> <C>
Revenue:
Web Services $ 896 $ 1,349 $ 1,027 $ 4,907
Broadband Internet Services 131 1,279 219 2,762
Network Services 1,621 1,476 6,291 4,604
Systems Integration 39,774 49,368 104,646 147,310
--------- --------- --------- ----------
42,422 53,472 112,183 159,583
--------- --------- --------- ----------
Gross margin before depreciation:
Web Services $ (200) $ (946) $ (1,044) $ (825)
Broadband Internet Services 156 (1,685) 4 (5,725)
Network Services (320) (375) 614 (273)
Systems Integration 10,694 8,225 26,779 22,048
--------- --------- --------- ----------
10,330 5,219 26,353 15,225
--------- --------- --------- ----------
Reconciliation to net loss:
Selling, general and administrative 26,813 29,215 $ 68,279 100,997
Restructuring charges - 6,051 - 21,695
Depreciation and amortization 4,872 8,722 11,842 24,847
Impairment of long-lived assets - 144 - 17,789
--------- --------- --------- ----------
Operating loss (21,355) (38,913) (53,768) (150,103)
Interest expense (6,881) (7,122) (18,967) (22,019)
Interest income 1,776 1,898 3,497 5,079
Other income (expense), net 102 201 (209) 188
--------- --------- --------- ----------
Net loss $ (26,358) $ (43,936) $ (69,447) $ (166,855)
========= ========= ========= ==========
</TABLE>
7
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
8. RESTRUCTURING
In August, 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 recognized additional costs of
approximately $4.1 million associated with the headcount reductions and office
closures during the third quarter of 2000. In addition, earlier in the year we
recognized severance related to changes in executive management and an
acquisition integration bonus totaling $3.0 million.
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 September 30, 2000. The
second $10 million was paid in July 2000, of which $4 million had been earned as
of September 30, 2000 and is included in restructuring charges. The remaining $6
million is subject to repayment if employment is terminated before it is earned
and is included in prepaid expenses at September 30, 2000. The amount subject to
repayment will be reduced by $2 million each quarter until fully earned at June
30, 2001.
9. RECENT ACCOUNTING PRONOUNCEMENTS
Staff Accounting Bulletin No. 101
In December 1999 the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements" ("SAB
101"). SAB 101 provides guidance in applying generally accepted accounting
principles to selected revenue recognition issues. We are currently evaluating
changes, if any, to our current revenue recognition policies that may result
from the application of this SAB. We will adopt this pronouncement in the fourth
quarter of 2000.
Emerging Issues Task Force No 00-10
Emerging Issues Task Force No. 00-10 "Accounting for Shipping and
Handling Fees and Costs" ("EITF 00-10") was issued in July, 2000. EITF 00-10
directs companies to classify shipping and handling fees billed to customers as
revenue versus as an offset to expense. We will adopt this pronouncement in the
fourth quarter of 2000. We do not anticipate any prior period reclassifications
as amounts billed to customers for shipping and handling have not been material.
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
businesses, 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 -- 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 -- We deliver traditional long-distance and data networking
services.
. 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 $160 million through
the 1998 sale of our 13% Senior Notes and related warrants, $134.1 million in
our Initial Public Offering in July 1999 and $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) in April 2000.
We also have borrowing capacity under a $50 million Senior Secured Revolving
Line of Credit facility.
We now have a nationwide footprint, primarily through acquisitions, 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 hired a
new president and chief executive officer as well as replacements for several of
our senior management positions and elected several new members to our board of
directors. The senior management team has developed a business plan placing a
greater emphasis on higher margin Broadband Internet and Web revenue. Our new
strategy focuses ongoing capital investments on our core integrated broadband
network and on the build out of our Web and application hosting centers. In
addition, we have and will continue to develop strategic business alliances that
will foster the rapid deployment and support of our business plan. Some of the
business alliances we have entered into to date are as follows:
. Exodus Communications - This alliance allows our customers to have
access to Class A and scalable Internet bandwidth capabilities
necessary to support our growing hosting and e-commerce services. This
also allows us to invest in and manage our client's Web servers located
in an Exodus Internet Data Center.
. Covad Communications - Through our alliance with Covad for Symmetrical
Digital Subscriber Line services we can provide our customers with low
cost, high speed access to our Cisco powered national switching
network, which further enhances our broadband offering.
. IBM - Our alliance with IBM allows us to offer our customers e-commerce
solutions through IBM's WebSphere product, thereby strengthening our
ability to provide full service communications solutions.
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,
Network, and Integration.
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>
Web Services
. Web development . engineer and technician direct compensation
and benefits
. Web hosting . hosting facilities and support infrastructure
----------------------------------------------------------------------------------------------------------
Broadband
. Frame Relay (ATM and IP switching) . leased line facilities' costs
. Internet access . capacity charges imposed by Internet service
providers and other carriers
. virtual private network (VPN) . collocation and entrance facilities costs
. digital subscriber line (DSL)
. remote LAN access (RLA)
----------------------------------------------------------------------------------------------------------
Network
. long distance telephone service . costs of connecting customers to long
. local telephone service as an agent distance or local networks
. private line service . capacity charges that long distance and local
carriers impose on us to use their equipment
and networks or to resell their services
----------------------------------------------------------------------------------------------------------
Integration
. network planning, design, maintenance, . engineer and technician direct compensation
and monitoring and benefits
. managed network services . costs associated with all the data and voice
. sale, installation, and leasing of data, systems and services described in this table
voice, and video network systems . cost of data, voice, and video network systems
. costs of installation, including technician
compensation and benefits
----------------------------------------------------------------------------------------------------------
</TABLE>
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 campaigns.
. 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)
Restructuring charges represent costs incurred in connection with
changes in management, reductions in headcount and office closures resulting
from our change in business focus.
Depreciation and amortization expense includes depreciation of
property, network, and equipment (between two and five years). 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
nine months ended September 30, 2000 we wrote off $17.7 million in goodwill and
$92,000 in property, plant and equipment, largely due to our change in business
focus. Subsequent to the write-down we had $35.5 million of goodwill, net of
amortization, on September 30, 2000. The write-down represents the amount by
which the carrying amount of the goodwill exceeded the expected future
discounted cash flows.
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 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 Nine months ended
September 30, September 30,
--------------------------------------- ----------------------------------------
1999 2000 1999 2000
----------------- ----------------- ----------------- ------------------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue:
Web Services $ 896 2 % $ 1,349 3 % $ 1,027 1 % $ 4,907 3 %
Broadband Internet Services 131 0 1,279 2 219 0 2,762 2
Network Services 1,621 4 1,476 3 6,291 6 4,604 3
Systems Integration 39,774 94 49,368 92 104,646 93 147,310 92
-------- ---- ------- ---- -------- ---- --------- ----
42,422 100 % 53,472 100 % 112,183 100 % 159,583 100 %
Cost of sales excluding depreciation:
Web Services 1,096 122 % 2,295 170 % 2,071 202 % 5,732 117 %
Broadband Internet Services (25) (19) 2,964 232 215 98 8,487 307
Network Services 1,941 120 1,851 125 5,677 90 4,877 106
Systems Integration 29,080 73 41,143 83 77,867 74 125,262 85
-------- ------- -------- ---------
32,092 48,253 85,830 144,358
Gross margin before depreciation:
Web Services (200) (22)% (946) (70)% (1,044) (102)% (825) (17)%
Broadband Internet Services 156 119 (1,685) (132) 4 2 (5,725) (207)
Network Services (320) (20) (375) (25) 614 10 (273) (6)
Systems Integration 10,694 27 8,225 17 26,779 26 22,048 15
-------- ------- -------- ---------
$ 10,330 $ 5,219 $ 26,353 $ 15,225
======== ======= ======== =========
</TABLE>
12
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Results of Operations
Revenue increased $11.1 million (26%) and $47.4 million (42%) for the
three and nine month periods ended September 30, 2000 compared to the same
periods in 1999.
Revenue from Web Services increased $453,000 (51%) and $3.9 million
(378%) for the three and nine month periods ended September 30, 2000,
compared to the same periods in 1999. The increase in Web Services for the
three month periods is primarily from Web hosting which increased $441,000
and primarily from Web development for the nine month period which
increased $3.1 million.
Revenue from Broadband increased $1.1 million (880%) and $2.5 million
(over 1000%) for the three and nine month periods ended September 30, 2000,
compared to the same periods in 1999. Frame Relay is the largest component
of the increases with $678,000 and $1.7 million increases for the three and
nine month periods. The balance of the increases is comprised of Internet
Access and Monitoring.
Network Services revenue declined for the three and nine month periods
ended September 30, 2000 compared to the same periods in 1999 by $145,000
and $1.7 million. The decreases are primarily in long distance revenue due
to declines in rates of 27% and 22% for the three and nine month periods,
which were offset in part by increases in minutes of 33% and 26% for the
same periods.
Revenue from our integration segment, which includes professional
services, maintenance, and sales of data and voice systems sales, increased
$9.6 million (24%) and $42.7 million (41%) and represented 92% of total
revenue for the three and nine month periods ended September 30, 2000. The
majority of the increase in integration came from sales of data systems,
which increased $12.4 million and $45.3 million, including conversions of
Managed Services contracts to system sales, for the three and nine month
periods ended September 30, 2000 compared to the same periods in 1999.
Sales of voice systems decreased by $5.7 million and $10.3 million for the
three and nine month periods. The increase in data systems sales is largely
attributable to the acquisition of three data integration businesses in the
second half of 1999 and significant sales to a single customer during 2000
which represented $14.1 million of data systems revenue, $2.6 million of
which was in the third quarter of 2000.
Cost of sales excluding depreciation increased $16.2 million (50%) and
$58.5 million (68%) for the three and nine month periods ended September 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 development 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 76% for the third quarter of 1999 to 90% for the
third quarter of 2000 and from 77% for the first nine months of 1999 to 90% for
the first nine months of 2000.
Web Services, Broadband and Network all have costs of sales in excess
of revenue for the three and nine month periods ended September 30, 2000
due to:
. Unutilized or non-billable labor costs associated with Web Services as
we continue to add personnel to the Web Services group to support
anticipated future increases in revenue;
. 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.
13
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Integration costs of sales as a percentage of revenue were 73% and 83%
for the third quarters of 1999 and 2000 and were 74% and 85% for the first
nine months of 1999 and 2000. The increase in costs as a percentage of
revenue is due to:
. 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 89% to 92% for the third quarters of 1999 and 2000;
. a greater amount of unutilized integration services labor costs during
2000 which has been addressed through the recent headcount reduction
efforts in August, 2000.
Selling, general, and administrative expenses ("SG&A") increased $2.4
million (9%) and $32.7 million (48%) for the three and nine month periods ended
September 30, 2000 compared to the same periods in 1999. However, SG&A decreased
as a percentage of revenue from 63% of revenue for the three months ended
September 30, 1999 to 55% for the three months ended September 30, 2000. We had
1,209 employees at September 30, 2000 compared to 1,380 at September 30, 1999,
however, the average headcount for the third quarter of 2000 was approximately
1,383 compared to an average headcount of 1,293 for the third quarter of 1999.
Also adding to the SG&A expenses during 2000 were increases in the following
expenses:
<TABLE>
<CAPTION>
Three months ended September 30, Nine months ended September 30,
--------------------------------- ---------------------------------
1999 2000 Increase 1999 2000 Increase
------ ------- -------- ------- ------- --------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Bad debt expense $ 706 $ 2,259 $ 1,553 $ 1,460 $ 5,415 $ 3,955
Consulting fees 520 1,401 881 1,141 2,984 1,843
Temporary labor costs 468 1,107 639 1,195 2,971 1,776
</TABLE>
The increase in bad debt was due to the clean up of uncollectible
accounts during 2000. We do not expect to sustain this level of write-offs going
forward. The increase in consulting fees is largely a result of consulting for
our business strategy development during 2000. The increase in temporary labor
was a result of the lack of enforcement of temporary labor control procedures.
This has been addressed through our efforts to tighten expense controls.
Restructuring charges represent 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 nine months ended September 30, 2000 represents the costs for a $20 million
signing bonus for our new chief executive officer, all of which had been paid as
of September 30, 2000. As of September 30, 2000, $14 million of the signing
bonus had been expensed and an additional $2 million will be recognized during
each of the next three consecutive quarters through June 30, 2001, unless
employment is terminated. The balance of the expense for the three month period
in 2000 represents other severance, payroll related costs and office closure
costs related to headcount reductions ($4.1 million). Some of the severance
related amounts will be paid over future periods in compliance with employment
contracts.
Depreciation and amortization expense increased $3.9 million (79%) and
$13.0 million (110%) for the three and nine month periods ended September 30,
2000 compared to the same periods for 1999. The increase is a result of an
increase of $44.0 million in property, network, and equipment from September 30,
1999 to September 30, 2000. 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.
14
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Impairment of long-lived assets of $17.8 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 was impaired.
Interest expense increased by approximately $241,000 and $3.1 million
for the three and nine months ended September 30, 2000 compared to the same
periods in 1999. The increase for the nine month period is a result of increased
indebtedness from September 30, 1999 to September 30, 2000 of $14.1 million in
network equipment financing under the Cisco Captial facility to fund our Cisco
based ATM/IP network build-out and $2.5 million under other capital leases and
also due to one-time charges associated with the repayment of the Goldman Sachs
Credit Partners facility in April 2000. The nominal increase for the third
quarter of 2000 compared to the third quarter of 1999 is due to greater interest
expense as a result of borrowing under the Cisco facility, partially offset by
lower interest as a result of the repayment of the Goldman Sachs facility in
April 1999.
Interest income increased approximately $122,000 and $1.5 million for
the three and nine months ended September 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.
15
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
Liquidity and Capital Resources
Our principal uses of cash are to fund working capital requirements,
capital expenditures, operating losses, and interest expenses. We expect that
our business plan will require additional capital expenditures and direct
operating costs and expenses.
As of September 30, 2000, we had cash, cash equivalents and restricted
cash of $104 million. Current assets as of September 30, 2000 were $160.5
million, including cash and cash equivalents of $72.0 million, and restricted
cash of $20.5 million, and working capital of $79.0 million. We also had $11.5
million in non-current restricted cash. Approximately $20.5 million of our
restricted cash, along with the interest we earn on this cash, will be used to
make the October 1, 2000 and April 2001 interest payments on our 13% Senior
Notes, the remaining $11.5 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 $119.5 million during the nine months ended September 30, 2000,
compared to $66.8 million for the nine months ended September 30, 1999. Cash
used in operating activities in 2000 was primarily due to the net loss of $166.9
million, an increase in accounts receivable, prepaid expenses, other current
assets and leases receivable of $15.3 million, and a decrease in accounts
payable and accrued compensation of $5.9 million. These uses of cash were
partially offset by $57.4 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 deferred revenue and
customer deposits and accrued interest and other liabilities of $10.7 million.
Cash used in operating activities as a percentage of revenue increased from 57%
for the first nine months of 1999 to 71% for the first nine months of 2000. The
increase as a percentage of revenue is directly related to one time charges
associated with changes in management and restructuring such as signing bonuses
and severance.
Cash Flows From Investing Activities. Investing activities provided
cash of $17.3 million during the nine months ended September 30, 2000 compared
to cash used of $58.6 million for the nine months ended September 30, 1999. The
cash provided from investing activities was a result of $34.1 million in
maturing short-term investments and $6.4 million provided from restricted cash
partially offset by $19.9 million of cash used for capital expenditures and $3.4
million invested in leases receivable and other assets.
Cash Flows From Financing Activities. Financing activities provided
cash of $149.0 million for the nine months ended September 30, 2000 and $157.5
million for the same period in 1999. During 2000 we generated net proceeds of
$161.5 million from the sale of our Series B Convertible Preferred Stock and
$9.1 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 $12.1 million in principal payments on other indebtedness.
In July, 1999, we entered into a credit facility with Cisco Systems
Capital Corporation. This credit facility provided the financing for the
purchase and installation of our Cisco Systems, Inc. multi-service data and
voice switching platform and for other Cisco equipment. Under the terms of this
agreement, Cisco Systems, Inc. also received a warrant to purchase 575,000
shares of our common stock, none of which had been exercised as of September 30,
2000. The warrant has an exercise price of $13.00 per share and is exercisable
for three years from the date of issuance. As of September 30, 2000, we had
borrowed $14.1 million and had received waivers for non-compliance with certain
financial conditions under this facility. We have amended this facility to limit
our borrowing to the amount currently outstanding as a result of our change in
strategy, in which we have entered into strategic alliances and scaled back our
deployment of our multi-service data and voice switching platforms and network
build-out. In doing so we have reduced our capital commitments and facility
commitment fees.
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 September 30, 2000, no amounts had been borrowed under this
facility.
16
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (continued)
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 must be redeemed
in 2010.
Future Capital Requirements. We have significant debt in relation to
our equity. At September 30, 2000, we had $206.1 million in debt and $120.6
million in shareholders' deficit, which includes paid-in capital of $214.8
million. Our business plan will continue to require a substantial amount of
capital to fund our growth and operations of our existing markets.
We estimate that we will require additional sources of capital, in
addition to our existing funds at September 30, 2000 of $104 million, our
available borrowing under our current financing and leasing facilities and our
$50 million senior secured credit facility, to meet our capital requirements and
sustain our operations to positive cash flow. We have initiated steps to
conserve capital and reduce costs to extend our available cash resources. As a
result of these efforts we have lowered our monthly recurring cash burn by more
than $4.0 million per month. We are currently assessing alternatives that will
accelerate EBITDA breakeven, further reduce cash consumption and increase
funding. The alternatives we are assessing include the potential disposition of
non-strategic assets and investments from strategic partners We cannot be
certain that we would be successful in any of these alternatives or 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 further 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 could have a material adverse effect on our business,
financial condition, results of operations and liquidity, and on the price of
our common stock.
17
<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>
August 4, 2000 Seller in an acquisition 15,000 $55,782 Section 4(2)
</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
10.1 Employment Agreement by and between Convergent
Communications, Inc. and Richard N. Gottbreht dated July 28,
2000
27 Financial Data Schedule
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 September 30, 2000, to be signed on its behalf by the undersigned
thereunto duly authorized.
Convergent Communications, Inc.
Date: November 13, 2000
By: /S/ Joseph R. Zell
---------------------------------------
Joseph R. Zell
President and Chief Executive Officer