<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 March 31, 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 of (I.R.S. Employer Identification No.)
incorporation)
400 Inverness Drive South, Suite 400
Englewood, Colorado 80112
(303) 749-3000
(Address and telephone number of principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
(1) Yes X No
--- ---
(2) Yes X No
--- ---
On May 10, 2000, 29,151,536 shares of the registrant's Common Stock were
outstanding
<PAGE>
TABLE OF CONTENTS
Page
No.
----
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets--December 31, 1999 and March 31, 2000.......... 1
Consolidated Statements of Operations and Comprehensive Loss--
Three months ended March 31, 1999 and 2000............................... 2
Consolidated Statement of Shareholders' Equity (Deficit)--
Three months ended March 31, 2000........................................ 3
Consolidated Statements of Cash Flows--Three months ended
March 31, 1999 and 2000.................................................. 4
Notes to Consolidated Financial Statements................................. 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...................................... 8
PART II: OTHER INFORMATION
Item 1. Legal Proceedings.................................................. 16
Item 2. Changes in Securities and Use of Proceeds.......................... 16
Item 3. Defaults Upon Senior Securities.................................... 16
Item 4. Submission of Matters to a Vote of Securities Holders.............. 16
Item 5. Other Information.................................................. 16
Item 6. Exhibits and Reports on Form 8-K
Exhibits....................................................... 16
Reports on Form 8-K............................................ 16
When used in this Report, the words "intend," "expects," "plans," "estimates,"
"anticipates," "projects," "believes," and similar expressions are intended to
identify forward-looking statements. Specifically, statements included in this
Report that are not historical facts, including statements about our beliefs and
expectations about our business and our industry are forward-looking statements.
These statements are subject to risks and uncertainties that could cause actual
results or outcomes to differ materially. These risks and uncertainties include,
but are not limited to, the degree to which we are leveraged and the
restrictions imposed on us under our existing debt instruments that may
adversely affect our ability to finance our future operations, to compete
effectively against better capitalized competitors, to withstand downturns in
our business or the economy generally and other factors discussed in our filings
with the Securities and Exchange Commission. Forward--looking statements
included in this Report speak only as of the date of this report and we will not
revise or update these statements to reflect events or circumstances after the
date of this report or to reflect the occurrence of unanticipated events.
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
December 31, March 31,
1999 2000
-------- --------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 25,215 $ 13,896
Short-term investments 34,742 1,208
Restricted cash 20,800 20,800
Trade accounts receivable, net of allowance for doubtful accounts of
$2,512 and $1,559, respectively 37,778 38,277
Inventory 13,810 17,698
Prepaid expenses, deposits, leases receivable and other 9,070 10,049
-------- --------
Total current assets 141,415 101,928
Property, network and equipment 77,455 86,286
Less accumulated depreciation (15,292) (21,024)
-------- --------
Total property, network and equipment 62,163 65,262
Restricted cash 17,669 19,818
Goodwill, net of amortization of $8,528 and $10,129, respectively 56,037 54,520
Other intangible assets, net of amortization of $3,589 and
$3,791, respectively 10,967 10,909
Leases receivable, less current portion 6,150 8,481
Investments and other assets 812 532
-------- --------
Total assets $295,213 $261,450
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Trade accounts payable $ 25,086 $ 21,416
Accrued compensation 10,423 12,315
Accrued interest 5,308 10,508
Other accrued liabilities 5,990 8,538
Deferred revenue and customer deposits 6,312 6,278
Current portion of long-term debt 1,788 13,993
Current portion of capital lease obligations 9,533 9,047
-------- --------
Total current liabilities 64,440 82,095
Long-term debt, less discount and current portion 177,995 169,231
Long-term capital lease obligations, less current portion 16,158 15,400
-------- --------
Total liabilities 258,593 266,726
-------- --------
Commitments
Shareholders' equity (deficit):
Preferred stock, 1 million shares authorized, none issued - -
Common stock, no par value, 100 million shares authorized, 28,642
and 28,930 shares issued and outstanding, respectively 196,937 199,533
Additional paid-in-capital 8,025 8,017
Treasury stock (919) (746)
Deferred compensation obligation 919 746
Accumulated other comprehensive income 573 859
Unearned compensation (250) (228)
Accumulated deficit (168,665) (213,457)
-------- --------
Total shareholders' equity (deficit) 36,620 (5,276)
-------- --------
Total liabilities and shareholders' equity (deficit) $295,213 $261,450
======== ========
</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
March 31,
------------------------------
1999 2000
-------- --------
<S> <C> <C>
Revenue $ 31,709 $ 52,847
Cost of sales excluding depreciation 20,743 37,513
Selling, general and administrative 23,338 41,150
Depreciation and amortization 2,863 7,723
Non-recurring compensation expense - 5,027
-------- --------
Total operating expenses 46,944 91,413
Operating loss (15,235) (38,566)
Interest expense (5,937) (7,672)
Interest income 951 1,453
Other income (expense), net 92 (7)
-------- --------
Net loss (20,129) (44,792)
Other comprehensive income, unrealized holding gains on securities 12 286
-------- --------
Comprehensive loss $(20,117) $(44,506)
======== ========
Net loss per share:
Net loss per share (basic and diluted) $ (0.72) $ (1.56)
Weighted average number of shares outstanding (basic and diluted) 27,885 28,789
</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
Additional Deferred Other
Common Common Paid-in Treasury Compensation Comprehensive
Shares Stock Capital Stock Obligation Income
------ --------- --------- ------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1999 28,642 $ 196,937 $ 8,025 $ (919) $ 919 $ 573
Common stock issued for:
401 (k) match 59 932 - - - -
Exercise of stock options 78 40 - - - -
Exercise of warrants 28 90 (8) - - -
Stock Compensation 130 1,505 - - - -
Distribution of deferred stock (7) (78) - 173 (173) -
Other comprehensive income:
Unrealized gain on securities - - - - - 286
Other - 107 - - - -
Net loss - - - - - -
------ --------- --------- ------- ------------ -------------
Balance, March 31, 2000 28,930 $ 199,533 $ 8,017 $ (746) $ 746 $ 859
====== ========= ========= ======= ============ =============
Unearned Accumulated
Compensation Deficit Total
------------ ------------ ---------
<S> <C> <C> <C>
Balance, December 31, 1999 $ (250) $ (168,665) $ 36,620
Common stock issued for:
401 (k) match - - 932
Exercise of stock options - - 40
Exercise of warrants - - 82
Stock Compensation 22 - 1,527
Distribution of deferred stock - - (78)
Other comprehensive income:
Unrealized gain on securities - - 286
Other - - 107
Net loss - (44,792) (44,792)
------------ ------------ ---------
Balance, March 31, 2000 $ (228) $ (213,457) $ (5,276)
============ ============ =========
</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>
Three months ended
March 31, March 31,
1999 2000
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net Loss $ (20,129) $ (44,792)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 2,863 7,723
Amortization of deferred financing costs and accretion of debt discount 401 570
Provision for uncollectible accounts 902 2,074
Stock compensation expense 14 1,527
401(k) contributions through the issuance of common stock 170 932
Other - 378
Change in working capital (net of acquisition):
Trade accounts receivable (2,276) (3,429)
Inventory 439 (3,888)
Prepaid expenses and other current assets (566) 484
Trade accounts payable (422) (5,082)
Accrued compensation 1,630 1,892
Accrued interest 5,200 5,545
Other accrued liabilities (980) 2,673
Deferred revenue and customer deposits (205) (33)
--------- ---------
Net cash used in operating activities (12,959) (33,426)
Cash Flows from investing activities:
Additions of property, network and equipment (1,075) (6,538)
Acquisitions, net of cash acquired (1,500) -
Short-term investments (15,873) 34,343
Restricted cash (1,475) (2,149)
Leases receivable (1,259) (2,938)
Other assets (23) (588)
--------- ---------
Net cash (used in) provided by investing activities (21,205) 22,130
Cash flow from financing activities:
Proceeds from private placement, net of offering costs 19,300 -
Proceeds from new borrowings, net of financing costs 986 3,663
Payments on notes payable (30) (725)
Payments on capital leases (1,298) (3,065)
Proceeds from exercise of warrants and stock options - 122
Repurchase of common shares - (18)
--------- ---------
Net cash provided by (used in) financing activities 18,958 (23)
Net decrease in cash and cash equivalents (15,206) (11,319)
Cash and cash equivalents at beginning of period 25,597 25,215
--------- ---------
Cash and cash equivalents at end of period $ 10,391 $ 13,896
========= =========
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 $ 2,281 $ 1,768
Acquisition of property, network and equipment in accounts payable
waiting to be financed - 1,411
Cash paid for interest 336 1,557
</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 an Integrated Communications Provider (ICP) that is focused on the
small and medium enterprise market, primarily businesses with 25 to 500
employees. As an ICP, we provide turnkey communications, networking and Internet
solutions such as the following:
. eBusiness Solutions - We help customers conceive, develop, implement and
manage Web services to enable intranet, extranet, and e-commerce
applications; additionally, we provide Web hosting and hosting
applications.
. IP/Broadband Services - We provide an integrated set of Internet Protocol
(IP) services such as dial-up and dedicated Internet access, Virtual
Private Network (VPN) services, and related server, firewall and security
offerings.
. Network Service - We deliver traditional long distance and local voice
and data networking services, including dedicated and Wide Area Networks
(WAN).
. System Integration - We offer customers a market-leading portfolio of
data, video and voice network equipment, installation, integration and
support.
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 eBusiness solutions, broadband and Internet
services and network services, completing the build out of our Cisco based
ATM/IP network, 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 market expansion. As we continue to expand our business, we will
seek additional sources of financing to fund our development. We estimate that
our existing funds at March 31, 2000, the additional funds raised through the
sale of our Series B Preferred Stock in April (see Note 5) and our available
borrowing and lease financing capacity will be sufficient to meet our capital
requirements for the foreseeable future. We could, however, require additional
capital sooner due to material shortfalls in our operating and financial
performance or if we are more aggressive in our expansion than currently
contemplated. We cannot be certain that we would be successful in raising
sufficient debt or equity capital to fund our operations on a timely basis or on
acceptable terms. If needed financing were not available on acceptable terms, we
could be compelled to alter our business strategy, or delay or abandon some of
our future plans or expenditures or fail to make interest payments on our debt.
Any of these events would have a material adverse effect on our financial
condition, results of operations and liquidity.
2. INTERIM FINANCIAL DATA
The consolidated balance sheet as of March 31, 2000, and the related
consolidated statement of shareholders' equity (deficit), statements of
operations and comprehensive loss, and statements of cash flows for the three
months ended March 31, 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.
5
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Certain prior period amounts have been reclassified to conform to the
current period's presentation.
3. BUSINESS SEGMENTS
We classify our business into four fundamental areas: eBusiness, broadband,
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
March 31,
------------------------------
1999 2000
------------ -----------
<S> <C> <C>
(in thousands)
Revenue:
eBusiness $ 49 $ 2,082
Broadband 20 253
Network 2,477 1,640
Integration 29,163 48,872
------------ -----------
Total Revenue 31,709 52,847
------------ -----------
Gross margin before depreciation:
eBusiness 49 751
Broadband (77) (1,110)
Network 394 (576)
Integration 10,600 16,269
------------ -----------
Total gross margin before depreciation 10,966 15,334
------------ -----------
Reconciliation to net loss:
Selling, general and administrative (23,338) (43,150)
Depreciation and amortization (2,863) (7,723)
Non-recurring compensation expense - (3,027)
------------ -----------
Operating loss (15,235) (38,566)
Interest expense (5,937) (7,672)
Interest income 951 1,453
Other income (expense) 92 (7)
------------ -----------
Net loss $ (20,129) $ (44,792)
============ ===========
</TABLE>
6
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. NET LOSS PER SHARE
The net loss available to common shareholders and weighted average shares
consists of the following:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------------
1999 2000
----------- ----------
<S> <C> <C>
(in thousands)
Net Loss $ 20,129 $ 44,792
=========== ==========
Weighted average number of shares outstanding (basic and diluted) 27,885 28,789
=========== ==========
</TABLE>
As of March 31, 1999 and 2000, a total of 9,786,769 and 10,168,851, options and
warrants were outstanding which were not considered in the above calculations as
their effect, if exercised, would have been anti-dilutive.
5. SUBSEQUENT EVENTS
In April 2000, we entered into a three year $50.0 million Senior Secured
Revolving Line of Credit with Foothill Capital Corporation. Under the terms of
this $50.0 million credit facility we are able to borrow up to 85% of eligible
receivables, as defined in the agreement, and the lessor of $12.0 million or 50%
of eligible inventory, as defined in the agreement. The facility will
automatically renew for one year periods, unless earlier terminated, and carries
an interest rate of 1.0% above the Wells Fargo Bank, N.A. base rate.
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 Capital Management. 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.
In conjunction with the sale of our Series B preferred stock, the $10.0
million senior secured credit facility with Goldman Sachs Credit Partners L.P.
has been repaid in full.
We have 1,000,000 shares of preferred stock authorized, none of which were
outstanding as of December 31, 1999 or March 31, 2000.
7
<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 later 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, IP-centric, Integrated Communications Provider (ICP)
that is focused on the small and medium sized enterprise market, primarily
businesses with 25 to 500 employees. An ICP is a company that can provide
turnkey communications, networking and Internet solutions. To accomplish this,
the company is developing and integrating four key product and service
portfolios:
. eBusiness Solutions - We help customers conceive, develop, implement and
manage Web services to enable intranet, extranet, and e-commerce
applications; additionally, we provide Web hosting and hosting
applications.
. IP/Broadband Services - We provide an integrated set of IP services such
as dial-up and dedicated Internet access, Virtual Private Network (VPN)
services, and related server, firewall and security offerings.
. Network Service - We deliver a complete set of traditional long distance
and local voice and data networking services, including dedicated and
Wide Area Networks (WAN).
. System Integration - We offer customers a market-leading portfolio of
data, video, and voice network equipment, installation, integration and
support.
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 $338.6 million in capital, including $450,000 in founders'
capital, $24.0 million in two private placements of common stock in 1996 and
1997, $160.0 million through the 1998 sale of our 13% Senior Notes and related
warrants, $20.0 million in a 1999 sale of our convertible preferred stock and
warrants to affiliates of Sandler Capital Management and $134.1 million in our
Initial Public Offering in July 1999. In addition, in April 2000, we raised
$175.0 million through the sale of 175,000 shares of our Series B Preferred
Stock and issuance of warrants to an investment group led by Texas Pacific
Group. We also have borrowing capacity under our existing Comdisco equipment
lease facility of $30.0 million. In April 2000, we entered into a $50.0 million
Senior Secured Revolving Line of Credit Facility with Foothill Capital
Corporation.
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 35 tier 1, tier 2 and tier 3 markets. We now have voice
and data customer bases with the appropriate sales and service personnel in 17
of these markets of which 7 of these markets we have a full suite of ICP
products and services, including network and Internet services, Web site
development and e-commerce support. The remaining markets have voice oriented
customer bases and resources. We have and are continuing to build underlying
network, Internet and Web hosting platforms to enable us to offer facilities
based web applications including hosting and security services. To support this
strategy we are building a network based on Cisco-ATM/IP switches, 16 of which
have been deployed and an additional 8 which are planned for this year.
8
<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: eBusiness, 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):
e Business
<S> <C>
. Web development and hosting . engineer and technician direct compensation and benefits
. Web applications
. eBusiness development
Broadband
. frame relay (ATM and IP switching) . leased line facilities' costs
. Internet access . capacity charges imposed by Internet service providers
. virtual private network (VPN) and other carrier
. digital subscriber line (DSL)
Network
. long distance telephone service . costs of connecting customers to long distance or local
. local telephone service networks
. private line service . capacity charges that long distance and local carriers
impose on us to use their equipment and networks
Integration
. network planning, design, maintenance and monitoring . engineer and technician direct compensation and benefits
. long-term contracts (typically three to five years) . costs associated with all the data and
under which we own, manage and are responsible for all voice systems and services described in this table
or a portion of the network inside our customers' premises
. sale and installation of data, voice and video . cost of data, voice and video network system systems
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.
. Sales and marketing expenses include commissions paid in connection with
our sales programs, 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.
9
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - (Continued)
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. We had $54.5 million of goodwill, net of
amortization, on March 31, 2000.
Interest expense includes interest expense on our short-term and long-term
debt, including capital leases. The majority of the interest expense is related
to our 13% Senior Notes which mature in 2008. Interest expense will increase as
we continue to finance a significant portion of our capital expenditures,
including our purchase of Cisco Systems Inc.'s multi-service, data and voice
ATM/IP switches and additional Cisco Systems, Inc. equipment under our $103.5
million equipment facility with Cisco Systems Capital Corporation.
10
<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
March 31,
--------------------------------------------
1999 2000
------------------- ------------------
<S> <C> <C> <C> <C>
(dollars in thousands)
Revenue:
eBusiness $ 49 -% $ 2,082 4%
Broadband 20 - 253 -
Network 2,477 8 1,640 3
Integration 29,163 92 48,872 93
---------- ------ --------- -----
Total revenue 31,709 100% 52,847 100%
Cost of sales excluding depreciation:
eBusiness - -% 1,330 64%
Broadband 98 490 1,363 539
Network 2,082 84 2,216 135
Integration 18,563 64 32,604 67
---------- ------ --------- -----
Total cost of sales excluding depreciation 20,743 37,513
Gross margin before depreciation:
eBusiness 49 100% 751 36%
Broadband (77) (385) (1,110) (439)
Network 394 16 (576) (35)
Integration 10,600 36 16,269 33
---------- ------ --------- -----
Total gross margin before depreciation $ 10,966 $ 15,334
---------- ---------
</TABLE>
11
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - (Continued)
Results of Operations
Revenue for the first quarter of 2000 was $21.1 million greater than revenue
for the first quarter of 1999. More than 90% of the increase in revenue came
from our integration segment which increased $19.7 million and includes
professional services, maintenance and systems sales. The majority of this
increase is in sales of data systems, which increased $16.7 million, and is
largely attributable to the acquisition of five data integration businesses
during the last 12 months. As a result, revenue from sales of data systems
increased as a percentage of revenue from 23% for the first quarter of 1999 to
46% for the first quarter of 2000. The balance of the change in revenue comes
from a $2.0 million increase in eBusiness, a $233,000 increase in broadband and
a decline of approximately $837,000 in network. The decline in network revenue
is largely attributable to three competitive long-distance rate reductions
during the last 12 months.
Cost of sales excluding depreciation increased $16.8 million from the first
quarter of 1999 to the first quarter of 2000. Cost of sales also increased as a
percentage of revenue from 65% for the first quarter of 1999 to 71% for the
first quarter of 2000. This increase in cost of sales as a percentage of revenue
is directly related to the revenue shift toward data systems, which have a
higher related direct cost. However, we believe that the addition of these data
capabilities will result in higher-margin eBusiness and IP/Broadband
opportunities. Also contributing to the higher percentage of cost of sales are
the 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.
Selling, general and administrative expenses increased $19.8 million from
the first quarter of 1999 to the first quarter of 2000. The majority of the
increase is attributable to field expenses and is primarily a result of the five
acquisitions completed during the last 12 months, the development of our
eBusiness group and other growth in selling, services and order entry personnel
to support our expanding field operations. Continued growth of the support
services organization also contributed, to a lessor degree, to the increase in
general and administrative expenses, but increased less than the percentage
increase in revenue. Included in the increase in general and administrative
expense was a charge of approximately $2.0 million for the reserve of a doubtful
receivable.
Non-recurring compensation expense which was approximately $3.0 million for
the three months ended March 31, 2000 included approximately $2.0 million
related to severance as a result of changes in executive management and an
additional $1.0 million in compensation related to acquisition integration.
Depreciation and amortization expense increased approximately $4.9 million
from the first quarter of 1999 to the first quarter of 2000. This increase is a
direct result of increases of $54.4 million in property, network and equipment.
In addition, goodwill increased $11.4 million as a result of the five
acquisitions completed between March 31, 1999 and March 31, 2000. As of March
31, 2000 we had $54.5 million in goodwill, net of amortization, which is being
amortized over ten years. The increase in property, network and equipment is
largely due to:
. the addition and expansion of new and existing markets;
. the development and deployment of 16 of our ATM/IP switching platforms;
. continued development of our operational support systems; and
. the increase in assets under managed network services contracts.
Interest expense increased by approximately $1.7 million from the first
quarter of 1999 to the first quarter of 2000. The increase is a result of
increased indebtedness under our equipment financing facilities with Comdisco
and GATX Capital Corporation, Inc. for property, network and equipment,
borrowing under the Cisco facility to fund our Cisco based ATM/IP network build-
out, and also as a result of indebtedness under the $10.0 million Goldman Sachs
Credit Partners L.P. senior secured credit facility which was repaid in April
2000.
Interest income increased approximately $502,000 from the first quarter of
1999 to the first quarter of 2000. The increase is a result of the maturity of
our remaining investments during the quarter ended March 31, 2000.
12
<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
- ------------------------------------------------------------------------ ------------- --------------
(in thousands)
<S> <C> <C>
Initial sale of 3,750 shares of common stock to founders
(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
------------- --------------
Total funds raised $ 338,551 $ 316,045
============= ==============
</TABLE>
Our principal uses of cash are to fund working capital requirements, capital
expenditures, business acquisitions, operating losses and interest expenses. We
expect that our expansion will require additional capital expenditures and
direct operating costs and expenses.
As of March 31, 1999, prior to the $175 million sale of our Series B
Preferred Stock in April 2000, we had current assets of $101.9 million,
including cash, cash equivalents of $13.9 million and restricted cash of $20.8
million, and working capital of $19.8 million. We also had $19.8 million in non-
current restricted cash. The majority of our restricted cash, along with the
interest we earn on this cash, will be used to make the interest payments
through April 2001 on our 13% Senior Notes. We invest excess funds in short-term
investments until these funds are needed for debt payments, capital investments,
acquisitions and the operations of our business.
13
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - (Continued)
Cash Flows From Operating Activities. Operating activities used cash of
approximately $33.4 million during the quarter ended March 31, 2000 compared to
$13.0 million for the quarter ended March 31, 1999. Cash used in operating
activities in 2000 was primarily due to the net loss of $44.8 million, an
increase in trade accounts receivable and inventory of $7.3 million and a
decrease in accounts payable of $5.1 million. These uses of cash were partially
offset by $13.2 million in non-cash expenses such as depreciation and
amortization, provision for uncollectible accounts and stock compensation and an
increase in accrued expenses of $10.1 million. Cash used in operating activities
as a percentage of revenue increased from 41% for the first quarter of 1999 to
63% for the first quarter of 2000. The primary reason for this increase is due
to our vendor credit lines not increasing adequately to support the significant
increase in our purchasing activity which resulted in a net decrease or, cash
used, of $5.1 million in accounts payable. The strengthening of our liquidity
position, as a result of the proceeds from the sales of our preferred stock and
borrowing under the $50.0 million credit facility ( see "Cash Flow From
Financing Activities" and "Future Capital Requirements" below), should allow us
to negotiate better credit terms with our vendors.
Cash Flows From Investing Activities. Investing activities provided cash of
$22.1 million during the first quarter of 2000 compared to cash used of $21.2
million for the first quarter of 1999. The cash provided from investing
activities was a result of $34.3 million in maturing short-term investments
during the first quarter of 2000. Cash provided was partially offset by $11.5
million of cash used for capital expenditures ($6.5 million), cash invested in
leases receivable of ($2.9 million) and restricted cash ($2.1 million).
Cash Flows From Financing Activities. Financing activities used cash of
approximately $23,000 for the first quarter of 2000 and provided cash of $19.0
million during the first quarter of 1999. During the first quarter of 2000,
there was $3.7 million provided from new borrowing which was offset by $3.7
million in debt and capital lease payments.
In June 1999, we entered into a $10.0 million senior secured credit facility
with Goldman Sachs Credit Partners L.P. The proceeds of this facility were being
used for working capital and other general corporate purposes. Interest accrued
at the greater of 13.0% or LIBOR plus 6.0% with interest payments due monthly.
In connection with this facility, we also issued to Goldman Sachs Credit
Partners L.P. a warrant to acquire 375,000 shares of common stock at an exercise
price of $15.00 per share, none of which had been exercised as of March 31,
2000. This facility was repaid in full in April 2000 with a portion of the
proceeds from the sale of our Series B preferred stock, discussed below.
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 March 31,
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 March 31, 2000,
we had borrowed $9.8 million under this facility.
We have an agreement with GATX Capital Corporation, that was used to finance
our internal capital needs under which $4.1 million was outstanding on March 31,
2000.
In April 2000, we entered into a $50.0 million Senior Secured Revolving Line
of Credit Facility with Foothill Capital Corporation. Under the terms of this
$50.0 million credit facility we are able to borrow up to 85% of eligible
receivables, as defined in the agreement, and the lessor of $12.0 million or 50%
of eligible inventory, as defined in the agreement.
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
14
<PAGE>
CONVERGENT COMMUNICATIONS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - (Continued)
exercisable at $25 per share. The investment was a combination of $150 million
from TPG and $25 million from affiliates of Sandler Capital Management. The
preferred stock is convertible into shares of our common stock at a conversion
price of $13 per share.
Future Capital Requirements. We have significant debt in relation to our
equity. At March 31, 2000, we had $207.7 million in debt and $5.3 million in
shareholders' deficit, which includes paid-in capital of $207.6 million. Our
business plan will continue to require a substantial amount of capital to fund
our expansion of existing markets and acquisitions. Also, in connection with the
hiring of our new President and CEO, we are required to pay a $20.0 million
signing bonus, $10.0 million of which was paid in cash in April 2000, the
remaining amount will be paid, in cash or shares of our common stock, at his
option, on or before December 31, 2000. Our business plan includes the
following:
. deploying our Cisco based IP/ATM network connecting our switches;
. funding the purchase, installation and ownership of managed networks
(which includes providing these customers with all necessary hardware,
software, transmission facilities and management, maintenance and
monitoring services);
. continuing to develop our customer care and sales organizations;
. continuing to develop our operational support system;
. funding operating losses and debt service requirements; and
. evaluating acquisitions and investments.
We estimate that our existing funds at March 31, 2000, our available
borrowing under our financing and leasing facilities currently in place and
additional funds from the sale of our Series B Preferred Stock and the $50.0
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.
15
<PAGE>
Part II
Item 1. Legal Proceedings
We are involved in legal proceedings from time to time, none of which we
believe, if decided adversely to us, would have a material adverse effect on our
business, financial condition or results of operations.
Item 2. Changes in Securities and Use of Proceeds
(c) Securities sold:
<TABLE>
<CAPTION>
Underwriters Number of
or Class of Shares of Exemption
Date Purchasers Common Stock Consideration Claimed
- ------------------ ------------------ ------------- ---------------- --------------
<S> <C> <C> <C> <C>
Jan. 4, 2000 to Private Placement 27,733 $ 81,590 Section 4(2)
Mar. 28, 2000 Warrant exercises
Jan. 5, 2000 to Employee option 60,205 $126,206 Section 4(2)
Jan. 24, 2000 exercises
Jan. 12, 2000 Seller in an 1,000 $ 11,813 Section 4(2)
acquisition
</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
27 Financial Data Schedule
(b) None
16
<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 March
31, 2000, to be signed on its behalf by the undersigned thereunto duly
authorized.
Convergent Communications, Inc.
Date: May 15, 2000
By: /s/ JOSEPH R. ZELL
-------------------------------------
Joseph R. Zell
President and Chief Executive Officer
Date: May 15, 2000
By: /s/ Brian R. Ervine
-------------------------------------
Brian R. Ervine
Executive Vice President, Chief Financial
Officer and Treasurer
17
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> YEAR 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1999 DEC-31-2000
<PERIOD-START> JAN-01-1999 JAN-01-1999 JAN-01-2000
<PERIOD-END> DEC-31-1999 MAR-31-1999 MAR-31-2000
<CASH> 25,215 0 13,896
<SECURITIES> 34,742 0 1,208
<RECEIVABLES> 40,290 0 39,836
<ALLOWANCES> (2,512) 0 (2,933)
<INVENTORY> 13,810 0 17,698
<CURRENT-ASSETS> 141,415 0 101,928
<PP&E> 77,455 0 86,286
<DEPRECIATION> (15,292) 0 (21,024)
<TOTAL-ASSETS> 295,213 0 261,450
<CURRENT-LIABILITIES> 64,440 0 82,095
<BONDS> 205,474 0 207,671
0 0 0
0 0 0
<COMMON> 196,937 0 199,533
<OTHER-SE> (160,317) 0 (204,809)
<TOTAL-LIABILITY-AND-EQUITY> 295,213 0 261,450
<SALES> 0 16,398 34,214
<TOTAL-REVENUES> 0 31,709 52,847
<CGS> 0 12,261 27,493
<TOTAL-COSTS> 0 20,743 37,513
<OTHER-EXPENSES> 0 31,519 53,900
<LOSS-PROVISION> 0 (148) 2,074
<INTEREST-EXPENSE> 0 6,149 7,672
<INCOME-PRETAX> 0 (20,129) (44,792)
<INCOME-TAX> 0 0 0
<INCOME-CONTINUING> 0 (20,129) (44,792)
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 0 (20,129) (44,792)
<EPS-BASIC> 0 (0.72) (1.56)
<EPS-DILUTED> 0 (0.72) (1.56)
</TABLE>
