<PAGE>
As filed with the Securities and Exchange Commission on November 20, 2000
Registration Number 333-46840
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------
AMENDMENT NO. 1 TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
-----------
CONVERGENT NETWORKS, INC.
(Exact name of registrant as specified in its charter)
-----------
<TABLE>
<S> <C> <C>
Delaware 3576 04-3420240
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification Number)
</TABLE>
-----------
900 Chelmsford Street
Lowell, Massachusetts 01851
(978) 323-3300
(Address, including ZIP code, and telephone number, including area code, of
Registrant's Principal Executive Offices)
-----------
John C. Thibault
President and Chief Executive Officer
900 Chelmsford Street
Lowell, Massachusetts 01851
(978) 323-3300
(Name, Address, including ZIP code, and telephone number, including area code,
of Agent for Service)
-----------
Copies to:
<TABLE>
<S> <C>
John A. Burgess, Esq. Jocelyn M. Arel, Esq.
Richard G. Costello, Esq. Testa, Hurwitz & Thibeault, LLP
Hale and Dorr LLP 125 High Street
60 State Street Boston, Massachusetts 02110
Boston, Massachusetts 02109 Telephone: (617) 248-7000
Telephone: (617) 526-6000 Telecopy: (617) 248-7100
Telecopy: (617) 526-5000
</TABLE>
-----------
Approximate date of commencement of proposed sale to the public: As soon as
practicable after the Registration Statement becomes effective.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act,
check the following box. [_]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [_]
-----------
CALCULATION OF REGISTRATION FEE
<TABLE>
------------------------------------------------------------------------------
------------------------------------------------------------------------------
<CAPTION>
Proposed Proposed
Maximum Maximum
Title of each Class of Amount Offering Aggregate Amount of
Securities to be to be Price Offering Registration
Registered Registered(1) Per Share Price Fee(2)
------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, par value
$0.00001 per share...... 5,750,000 shares $17.00 $97,750,000 $25,806
------------------------------------------------------------------------------
------------------------------------------------------------------------------
</TABLE>
(1) Includes 750,000 shares which the underwriters have the option to purchase
to cover over-allotments, if any. See "Underwriting."
(2) Pursuant to Rule 457(o) under the Securities Act of 1933, as amended,
$26,400 was paid in connection with the initial filing of the Registration
Statement on September 28, 2000.
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Securities and Exchange Commission, acting
pursuant to said Section 8(a), may determine.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus is not complete and may be changed. We may +
+not sell these securities until the registration statement filed with the +
+Securities and Exchange Commission is effective. This prospectus is not an +
+offer to sell these securities and it is not soliciting an offer to buy these +
+securities in any state where the offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED NOVEMBER 20, 2000
5,000,000 Shares
Common Stock
---------
Prior to this offering, there has been no public market for our common stock.
The initial public offering price of our common stock is expected to be between
$15.00 and $17.00 per share. We have applied to list our common stock on The
Nasdaq Stock Market's National Market under the symbol "CVNI".
The underwriters have an option to purchase a maximum of 750,000 additional
shares to cover over-allotments of shares.
Investing in our common stock involves risks. See "Risk Factors" on page 5.
<TABLE>
<CAPTION>
Underwriting Proceeds
Discounts to
Price to and Convergent
Public Commissions Networks
-------- ------------ ----------
<S> <C> <C> <C>
Per Share.................................. $ $ $
Total...................................... $ $ $
</TABLE>
Delivery of the shares of common stock will be made on or about , 2000.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.
Credit Suisse First Boston
J.P. Morgan & Co.
U.S. Bancorp Piper Jaffray
The date of this prospectus is , 2000.
<PAGE>
------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary.................. 1
Risk Factors........................ 5
Special Note Regarding Forward-
Looking Statements................. 16
Use of Proceeds..................... 17
Dividend Policy..................... 17
Capitalization...................... 18
Dilution............................ 19
Selected Consolidated Financial
Data............................... 20
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 22
Business............................ 29
Management.......................... 40
</TABLE>
<TABLE>
<CAPTION>
Page
----
<S> <C>
Related Party Transactions.......... 53
Principal Stockholders.............. 56
Description of Capital Stock........ 58
Shares Eligible for
Future Sale........................ 60
U.S. Federal Tax Consequences to
Non-United States Holders.......... 62
Underwriting........................ 66
Notice to Canadian Residents........ 69
Legal Matters....................... 70
Experts............................. 70
Where You Can Find More
Information........................ 70
Index to Consolidated Financial
Statements......................... F-1
</TABLE>
------------
You should rely only on the information contained in this document or to
which we have referred you. We have not authorized anyone to provide you with
information that is different. This document may only be used where it is legal
to sell these securities. The information in this document may only be accurate
on the date of this document.
Dealer Prospectus Delivery Obligation
Until , 2000 (25 days after the commencement of this offering), all
dealers that effect transactions in these securities, whether or not
participating in this offering, may be required to deliver a prospectus. This
is in addition to the dealer's obligation to deliver a prospectus when acting
as an underwriter and with respect to unsold allotments or subscriptions.
<PAGE>
PROSPECTUS SUMMARY
You should read this prospectus summary together with the more detailed
information contained in this prospectus, including the risk factors and
financial statements and the notes to the financial statements.
Convergent Networks, Inc.
We design, develop and market a new generation of switching equipment and
software that enable communications service providers to rapidly deliver voice
and data services over high-speed, or broadband, networks. Our target customers
include both new and established communications service providers, including
local exchange carriers, long distance carriers, operators of foreign telephone
networks and Internet service providers.
We believe that two dramatic developments in the telecommunications
industry--increased competition resulting from governmental deregulation and
the growth of Internet use--are revolutionizing the public telephone network
worldwide. Today's circuit-switched public telephone network is inadequate for
the efficient transport of both voice traffic and the increasing volume of data
traffic resulting from these developments. In response, communications service
providers are transitioning their delivery of voice and data services from the
circuit-switched telephone network to new packet-based networks. Packet-based
networks divide voice and data traffic into small transmission units called
packets, which results in more efficient transmission and greater utilization
of network capacity than circuit-based networks, which tie up the circuit for
the duration of the call or transmission. Because packet-based networks offer
enhanced performance, we believe that they will ultimately replace the public
telephone network to evolve into what is commonly referred to as the "new
public network."
Our products have been designed to meet the needs of the new public network.
In addition to providing the reliability, voice service quality and scalability
of today's public telephone network, our products offer improved economics and
efficiencies for service providers that deliver both voice and data traffic to
end users. Our products also enable service providers to rapidly deliver new
revenue-generating communications services and features demanded by consumer
and business users. Our Cohesion product family includes the:
. ICS2000 broadband switch, which enables voice traffic to be transported
over packet-based networks;
. ICServiceWorks voice switching software, commonly referred to as a
softswitch, which manages the switching of voice calls between networks
and the provisioning of related services and features; and
. ICView network management system.
Our products currently support asynchronous transfer mode, or ATM, a packet-
based transport protocol widely used by many service providers for the delivery
of voice, data and video over mediums including fiber-optic cable, copper
telephone lines and wireless transmission. We intend to deliver products in the
future that will support Internet Protocol, or IP, which is the alternative
packet-based transport protocol.
As of September 30, 2000, we had recognized revenues from BT, Global NAPs
and Missouri Telecom. In addition, we have shipped products under signed
purchase orders to several additional companies, subject to acceptance testing.
We sell our products primarily through a direct sales force, which we intend to
complement in the future with distribution relationships with leading
technology partners.
1
<PAGE>
Our objective is to become a leading supplier of switching products that
enable communications service providers to rapidly deliver voice and data
services over packet-based networks. We intend to achieve this objective by:
. leveraging our solutions-oriented approach;
. broadening our customer base through expanded product offerings;
. increasing our global sales and marketing capabilities;
. delivering superior customer service and support; and
. pursuing strategic alliances and acquisitions.
We were incorporated in May 1998. We have a limited operating history and we
have not reported an operating profit for any period since our incorporation.
We expect to continue to incur net losses for the foreseeable future. As of
September 30, 2000, we had an accumulated deficit of $80.2 million. Through
September 30, 2000, we have recognized revenues from three customers. While we
have shipped products to other service providers, these companies may choose to
return the products rather than pay for them if our products fail acceptance
testing. Sales to Global NAPs, an affiliate of which owns approximately 1% of
our capital stock, accounted for 73% of our revenues for the nine months ended
September 30, 2000. We expect that, for the foreseeable future, substantially
all of our revenues will depend on sales of our products to a small number of
customers, so the loss of any one customer could harm our business.
Our principal executive offices are located at 900 Chelmsford Street,
Lowell, Massachusetts, 01851, and our telephone number is (978) 323-3300. Our
website address is www.convergentnet.com. Information contained in our website
is not incorporated by reference into this prospectus, and you should not
consider information contained in our website as part of this prospectus.
2
<PAGE>
The Offering
<TABLE>
<S> <C>
Common stock offered........................... 5,000,000 shares
Common stock to be outstanding after this
offering...................................... 60,447,072 shares
Use of proceeds................................ For general corporate purposes
Proposed Nasdaq National Market symbol......... CVNI
</TABLE>
The number of shares to be outstanding after this offering is based on
shares outstanding as of September 30, 2000 and excludes:
. 4,154,723 shares of common stock issuable upon exercise of options
outstanding as of September 30, 2000 at a weighted average exercise
price of $5.38 per share;
. 240,000 shares of common stock issuable upon exercise of warrants
outstanding as of September 30, 2000 at a weighted average exercise
price of $14.54 per share;
. 10,000,000 shares of common stock available for issuance under our 2000
stock incentive plan; and
. 5,000,000 shares of common stock available for issuance under our 2000
employee stock purchase plan.
Unless indicated otherwise, all information in this prospectus assumes:
. the conversion of all shares of convertible preferred stock into an
aggregate of 28,757,452 shares of common stock upon the completion of
this offering;
. the effectiveness of our amended and restated certificate of
incorporation; and
. that the underwriters do not exercise their over-allotment option.
Convergent Networks, the Convergent Networks logo, Cohesion, ICS,
ICServiceWorks, ICSG, ICSX, ICView and The Voice of Broadband Networking are
our trademarks. All other trade names referred to in this prospectus are the
property of their respective owners.
3
<PAGE>
Summary Consolidated Financial Data
(in thousands, except per share data)
<TABLE>
<CAPTION>
Period from
Inception Nine Months Ended
(May 6, 1998) to Year Ended September 30,
December 31, December 31, ------------------
1998 1999 1999 2000
---------------- ------------ -------- --------
(unaudited)
<S> <C> <C> <C> <C>
Consolidated Statement of
Operations Data:
Revenues..................... $ -- $ -- $ -- $ 6,759
Cost of revenues............. -- -- -- 5,042
------- -------- -------- --------
Gross profit............... -- -- -- 1,717
Operating expenses:
Research and development... 2,182 13,067 7,646 9,293
Selling and marketing...... 163 3,523 1,871 5,076
General and
administrative............ 283 1,273 698 2,652
Stock-based compensation... -- 3,546 134 8,080
Amortization of intangible
assets.................... -- -- -- 6,554
Acquired in-process
research and development.. -- -- -- 23,000
------- -------- -------- --------
Total operating
expenses................ 2,628 21,409 10,349 54,655
------- -------- -------- --------
Loss from operations......... (2,628) (21,409) (10,349) (52,938)
Net loss..................... (2,528) (21,272) (10,261) (51,631)
Net loss attributable to
common stockholders......... (2,783) (22,339) (10,872) (55,047)
Net loss per share:
Basic and diluted.......... $ (4.87) $ (7.47) $ (4.22) $ (10.61)
Shares used in computing net
loss per share:
Basic and diluted.......... 572 2,991 2,577 5,188
</TABLE>
<TABLE>
<CAPTION>
September 30, 2000
-----------------------
Pro Forma
Actual As Adjusted
----------- -----------
(unaudited) (unaudited)
<S> <C> <C>
Consolidated Balance Sheet Data:
Cash, cash equivalents and marketable securities...... $87,384 $160,284
Working capital....................................... 77,591 150,491
Total assets.......................................... 214,197 287,097
Notes payable and capital lease obligations, net of
current portion...................................... 705 705
Redeemable convertible preferred stock................ 133,368 --
Total stockholders' equity (deficit).................. 62,402 268,670
</TABLE>
The pro forma as adjusted balance sheet data give effect to the conversion
into common stock of all outstanding convertible preferred stock upon the
closing of this offering and our receipt of the net proceeds from the sale of
the 5,000,000 shares of common stock offered by us at the assumed initial
public offering price of $16.00 per share, after deducting estimated
underwriting discounts and commissions and estimated offering expenses.
4
<PAGE>
RISK FACTORS
Investing in our common stock involves a high degree of risk. You should
consider carefully the following risk factors and all other information
contained in this prospectus before purchasing our common stock.
Risks Related to Our Financial Results
We have a limited operating history and have operated as a consolidated company
for a short period of time, which will make it difficult for you to predict our
future operating results.
We have a limited operating history and have operated as a consolidated
company for a short period of time. We were incorporated in May 1998. We only
began to recognize revenues during the second quarter of fiscal 2000. We
acquired TCS in July 2000. Due to our limited operating history, it is
difficult to predict our future operating results. You should consider our
business and prospects in light of the risks and difficulties typically
encountered by companies like us in their early stages of development,
particularly those that are in the process of consolidating different lines of
business and that are in rapidly evolving and intensely competitive markets.
We have incurred significant losses and negative cash flows since our inception
and we expect to continue to incur significant losses and negative cash flows
for the foreseeable future, and we may never achieve profitability.
We have incurred significant losses and negative cash flow for our entire
history, and we expect to continue to incur significant losses and negative
cash flow for the foreseeable future. As of September 30, 2000, we had an
accumulated deficit of $80.2 million. We have incurred and will continue to
incur significant expenses for research and development, sales and marketing,
customer support and general and administrative expenses as we expand our
business. We will need to generate significantly higher revenues to achieve
profitability, and we may never be able to achieve or sustain profitability.
Our revenues and operating results are likely to fluctuate significantly and as
a result our stock price could significantly decline.
Our quarterly revenues and operating results are likely to fluctuate
significantly in the future due to a variety of factors, many of which are
beyond our control. If our quarterly or annual operating results do not meet
the expectations of investors or securities analysts, our common stock price
could significantly decline. Some of the factors that could affect our
quarterly or annual revenues and operating results include:
. the timing and size of sales of our products;
. the speed with which our customers deploy our products in their
networks;
. variations in the capital spending budgets of communications service
providers;
. the ability of service providers to fund network equipment purchases;
. announcements, new product introductions and reductions in the prices of
products offered by our competitors;
. our ability to develop, manufacture, introduce, ship and support our
current product lines as well as new products and product enhancements;
and
. our ability to obtain sufficient supplies of sole or limited source
components for our products.
In addition, based on the experience of other communications equipment
providers, we believe we may recognize a substantial portion of our revenues in
a given quarter from sales booked and shipped in the last weeks of that
quarter. As a result, any delay in fulfillment of a customer order is likely to
result in a delay in shipment and recognition of revenues beyond the end of a
given quarter, which would have a significant impact on our operating results
for that quarter.
5
<PAGE>
We plan to increase significantly our operating expenses to fund greater
levels of research and development, expand our sales and marketing operations,
broaden our customer support capabilities and develop new distribution
channels. We also plan to expand our general and administrative functions to
address the increased reporting and other administrative demands related to
being a publicly traded company and the increasing size of our business. Our
operating expenses are largely based on anticipated revenue trends, and a high
percentage of our expenses are and will continue to be fixed in the short term.
As a result, a delay in generating or recognizing revenues could cause
significant variations in our operating results from quarter to quarter and
could result in substantial operating losses.
We expect to rely on sales of our Cohesion family of products for our future
revenues, and if these products fail to achieve market acceptance we may never
achieve profitability.
Our future growth depends upon market acceptance of our Cohesion family of
products. We expect to derive nearly all of our revenues for the foreseeable
future from sales of our ICS2000 switch, ICService Works software and ICView
Network Management System. If we are unable to sell sufficient quantities of
our products at acceptable prices, we may not achieve or maintain
profitability.
We may need additional capital to fund our existing and future operations. If
we are unable to obtain additional capital, we may be required to reduce the
scope of our planned product development and sales and marketing efforts, which
would harm our business.
The development and marketing of new products and the expansion of our
direct sales operation and associated support personnel is expected to require
a significant commitment of resources. We may incur significant operating
losses or expend significant amounts of capital if:
. the market for our products develops more slowly than anticipated;
. we fail to establish market share or generate revenues;
. our capital expenditure forecasts change or prove inaccurate; or
. we need to respond to unforeseen challenges or take advantage of
unanticipated opportunities.
As a result, we may need to raise substantial additional capital. To the
extent that we raise additional capital through the sale of equity or
convertible debt securities, the issuance of those securities could result in
dilution to our existing shareholders. If additional funds are raised through
the issuance of debt securities, the terms of the debt could impose additional
restrictions on our operations. Additional capital, if required, may not be
available on acceptable terms, or at all. If we are unable to obtain additional
capital, we may be required to reduce the scope of our planned product
development and sales and marketing efforts, which would harm our business.
Risks Related to Our Customers
If our customers are unable to raise sufficient capital to finance the
development of new networks, our business would be harmed.
We focus our sales and marketing efforts on next-generation communications
service providers. Many of these companies were recently formed, and few have
achieved profitability to date. As a result, some of these companies may not
have sufficient capital to finance the necessary infrastructure to build a
packet-based network. To date, we have not offered to finance customer
purchases of our products. To the extent that our competitors offer vendor
financing, we may not be able to successfully compete in selling our products
to next-generation service providers. If our customers are unable to raise
necessary capital, demand for our products from these companies would be
reduced, and our business and operating results would suffer.
6
<PAGE>
We will not be successful if we do not expand our customer base beyond our
initial few customers.
Our future success will depend on our ability to attract additional
customers beyond our current limited number. To date, we have recognized
revenues from three customers and have shipped products under purchase orders
to several additional service providers for acceptance testing. We expect that
in the foreseeable future, substantially all of our revenues will depend on
sales of our products to a limited number of customers. Many of the
communications service providers to which we have shipped products are
currently using our products in laboratory testing and internal trials.
Communications service providers still in the test and trial process may not
deploy our products in their commercial networks on a timely basis, or at all.
The loss of one or more of our current customers, a reduction in sales to them,
cancellation of or delays in orders placed by our customers or the failure to
sell our products to additional service providers would significantly reduce
our revenues. None of our contracts require customers to make minimum purchase
commitments. Sales to Global NAPs, an affiliate of which owns approximately 1%
of our capital stock, accounted for approximately 73% of our revenues for the
nine months ended September 30, 2000. Sales to BT accounted for approximately
22% of our revenues for the nine months ended September 30, 2000.
The long and variable sales and deployment cycles for our products may cause
our revenues and operating results to vary significantly.
Our products have lengthy sales cycles and we may incur substantial sales
and marketing expenses and expend significant management effort without making
a sale. A company's decision to purchase our products often involves a
significant commitment of its resources and a lengthy product evaluation and
qualification process. Some potential customers may require an extended
technical pre-qualification process, which may cause the initial sales cycle to
be over a year. Even after making the decision to purchase our products, our
customers often have a lengthy deployment process. Timing of deployment can
vary widely and depends on:
. the size of the network deployment;
. the complexity of our customers' network environments;
. our customers' in-house skill sets;
. the hardware and software configuration and customization necessary to
deploy our products; and
. our customers' ability to finance their purchases of our products.
As a result, it is difficult for us to predict the quarter in which our
customers may purchase or deploy our products and our revenues and operating
results may vary significantly from quarter to quarter.
If our products fail to interoperate with our customers' networks, demand for
our products will be reduced and substantial product returns could occur, which
could harm our business and our reputation.
Our customers generally require that our products be designed to
interoperate with their existing networks, each of which may have different
specifications and use multiple standards. Our customers' networks may contain
multiple generations of products from different vendors that have been added
over time as their networks have grown and evolved. Our products must
interoperate with these products as well as with future products in order to
meet our customers' requirements. In some cases, we may be required to modify
our product designs to achieve a sale, which may result in a longer sales
cycle, increased research and development expense, and reduced operating
margins. If our products do not interoperate with existing equipment in our
customers' networks, installations could be delayed, orders for our products
could be canceled or our products could be returned. This could harm our
business, reputation and operating results.
If we fail to develop and sell new products that meet the evolving needs of our
customers, or if our new products or enhancements fail to achieve market
acceptance, our business and operating results would be harmed.
Our success depends on our ability to anticipate our customers' evolving
needs and to develop and market products that address those needs. We are
currently in the process of developing enhancements to our products,
7
<PAGE>
including the transport of voice traffic over digital subscriber lines and
Internet Protocol-based networks, to meet the growing demands of communications
service providers. The timely development of these new or enhanced products is
a complex and uncertain process. We may experience design, manufacturing,
marketing and other difficulties that could delay or prevent our development,
introduction or marketing of these and other new products and enhancements. We
may not have sufficient resources to anticipate successfully and accurately
technological and market trends, or to manage successfully long development
cycles. We may also be required to collaborate with third parties, or to
license or purchase third-party software or hardware, to develop our products,
and may not be able to do so on a timely and cost-effective basis, if at all.
If we are not able to develop new products or enhancements to existing products
on a timely and cost-effective basis, or if our new products or enhancements
fail to achieve market acceptance, our ability to continue to sell our products
and grow our business would be harmed.
If we fail to capitalize on opportunities to win contracts from our target
customers, we may not be able to sell products to those customers for an
extended period of time.
We believe that communications service providers deploy and upgrade their
networks infrequently and in large increments. As a result, if we fail to win a
purchase contract from a target customer, we may not have an opportunity to
sell products to that service provider for an extended period of time. In
addition, if we fail to win contracts from target customers that are at an
early stage in their network design cycle, we may never be able to sell
products to these service providers because they may prefer to continue
purchasing products from the first vendor selected at the design stage. Because
we rely on a limited number of customers for our sales, our failure to
capitalize on opportunities to win contracts with these service providers would
harm our business and operating results.
Consolidation among communications services providers may cause a reexamination
of strategic and purchasing decisions by our current and potential customers,
which could harm our business.
Consolidation among communications service providers may cause delays in the
purchase of our products and cause a reexamination of strategic and purchasing
decisions by our current and potential customers. In addition, we may lose
valuable relationships with key personnel of a customer of ours due to budget
cuts, layoffs or other disruptions following, or during, a consolidation.
Risks Related to Our Industry
Intense competition and consolidation in the markets in which we compete could
prevent us from increasing or sustaining our revenues and prevent us from
achieving or sustaining profitability.
The market for voice switching equipment and software is highly competitive.
We compete directly with numerous companies, including Cisco Systems, Lucent
Technologies, Nortel Networks and Sonus Networks. In the future, we expect that
additional companies will enter the market with competitive solutions. Many of
our current and potential competitors have longer operating histories, larger
customer bases, significantly greater selling and marketing, technical,
financial and customer support resources and broader product offerings than we
do. As a result, these competitors may be able to devote greater resources to
the development, promotion, sale and support of their products. In addition,
these companies may adopt aggressive pricing policies and leverage their
customer bases and broader product offerings to gain market share. We believe
that competitive pressures are likely to result in price reductions and reduced
margins, which would harm our operating results. Our competitors may foresee
market and technological developments earlier or more accurately than we do and
could develop new technologies that compete with our products or even render
our products obsolete.
The markets in which we compete are characterized by increasing
consolidation. We cannot predict how industry consolidation will affect our
competitors, and we may not be able to compete successfully in an
8
<PAGE>
increasingly consolidated industry. Our competitors that have large market
capitalizations or significant cash reserves are better positioned than we are
to acquire other companies, thereby obtaining new technologies or products that
may displace our product lines. Any of these acquisitions could give our
competitors a strategic advantage that would harm our business.
If usage of packet-based networks does not continue to grow as expected or the
migration of communications services to packet-based networks is not widely
accepted, our business could be harmed.
Packet-based technology may not be widely accepted as the core technology
for the new public network. If the use of packet-based technology does not grow
significantly, or the migration to, and the market acceptance of, packet-based
technology as the core technology for the new public network does not occur, or
occurs more slowly than expected, we may not be able to sell our products in
significant volumes. Many factors beyond our control may limit the increased
use of packet-based networks or delay the migration of communications services
to packet-based networks, including:
. inadequate demand for broadband voice and data services from business
and consumer users;
. the development of legislation and regulations related to the new public
network;
. installation, space and power constraints at communications service
providers' central offices; and
. evolving industry standards for voice switching and other technologies.
If we fail to respond to technological changes or to evolving industry
standards, our products could fail to achieve market acceptance.
The market for our products for the new public network is characterized by
rapid technological change and, in the future, will likely require frequent new
product introductions and enhancements. We may be unable to respond quickly or
effectively to these developments. Currently, our products support asynchronous
transfer mode technology. We intend to support Internet Protocol technology in
future versions of our existing products. The introduction of new products by
competitors, the market acceptance of products based on new or alternative
technologies or the emergence of new industry standards, particularly with
respect to networking technologies such as asynchronous transfer mode or
Internet Protocol, could render our existing or future products obsolete. If
industry standards adopted in the future are different from those that we have
chosen to support, market acceptance of our products may be significantly
reduced or delayed.
Communications service providers are subject to governmental regulation, and
changes in current or future laws or regulations that negatively impact
communications service providers could harm our business.
The jurisdiction of the Federal Communications Commission, or FCC, extends
to the entire communications industry, including communications service
providers. Future FCC regulations affecting the Internet, communications
service providers or their service offerings may harm our business. For
example, FCC regulatory policies that affect the availability of data and
Internet services may impede communications service providers' penetration into
some markets or affect the prices that they are able to charge. In addition,
domestic and international regulatory bodies, such as the Federal Trade
Commission and the European Commission, are beginning to adopt standards and
regulations for the Internet. These domestic and foreign standards and
regulations address various aspects of Internet use, including issues regarding
invasion of privacy, the security of data transmitted over the Internet and
taxation of e-commerce. Resulting standards and regulations could adversely
affect the development of e-commerce and other uses of the Internet. To the
extent communications service providers are adversely affected by laws or
regulations regarding their business, products or service offerings, this could
harm our business.
9
<PAGE>
Risks Associated With Our Products
We depend on ACT Manufacturing and other contract manufacturers to manufacture
our products and are vulnerable to disruptions in the manufacture and delivery
of our products.
We rely on ACT Manufacturing and other contract manufacturers to manufacture
our products according to our specifications and to fill orders on a timely
basis. We do not have internal manufacturing capabilities. ACT provides
comprehensive manufacturing services, including assembly of our products and
procurement of materials. Other contract manufacturers, including Celestica,
Sanmina and SMTC, manufacture sub-assemblies and other components of our
products. With the exception of ACT, we do not have contracts with our contract
manufacturers. Our reliance on ACT and our other contract manufacturers
involves a number of risks, including the absence of adequate capacity, the
unavailability of, or interruptions in access to, process technologies and
reduced control over component availability, delivery schedules, manufacturing
yields and costs. Each of our contract manufacturers also builds products for
other companies and may not always have sufficient quantities of inventory
available to fill our orders, or may not allocate its internal resources to
fill these orders on a timely basis. If ACT is unable or unwilling to continue
manufacturing our products in required volumes and at high quality levels, we
will have to identify, qualify and select an acceptable alternative
manufacturer. The process of qualifying a new contract manufacturer and
commencing commercial-scale production is expensive and time consuming, and
could result in a significant interruption in the supply of our products. In
addition, it is possible that an alternative manufacturer may not be available
to us when needed or be able to satisfy our production requirements at
acceptable prices and quality. If a change in contract manufacturers results in
delays of our fulfillment of customer orders or if ACT or any other contract
manufacturer fails to make timely delivery of products or key sub-assemblies or
components, we may lose revenues and suffer damage to our customer
relationships.
If we fail to accurately predict our component or manufacturing requirements,
we could incur additional costs or experience manufacturing delays.
We currently provide forecasts of our demand to ACT and our sub-assembly and
component suppliers months prior to scheduled delivery of products to our
customers. Lead times for the materials and components that we order vary
significantly and depend on numerous factors, including the specific supplier,
contract terms and demand for a component at a given time. If we overestimate
our component requirements, ACT may purchase excess inventory on our behalf.
For those parts that are unique to our products, we could be required to pay
for these excess parts and recognize related inventory write-down costs. If we
underestimate our requirements, ACT may have an inadequate inventory, which
could interrupt the assembly of our products and result in delays in shipments
and revenues, or could cause us to purchase materials and components from third
parties at higher costs.
We depend on sole source and limited source suppliers for some of our key
components, and if we are unable to obtain these components on a timely basis,
we will not be able to deliver our products to our customers.
We currently purchase several key components of our products from single or
limited sources, including semiconductors from Lattice Semiconductor, Lucent,
Mitel, PMC-Sierra and Texas Instruments. We purchase these components on a
purchase order basis. In the past, there have been shortages of individual
components from time to time. For example, we have experienced shortages in
flash memory chips, which required us to hold excess inventory of these
components to avoid disruption to our manufacturing process. Shortages of flash
memory chips and other components are likely to occur in the future. To the
extent shortages occur in the future, we may again be required to hold extra
inventory or our ability to manufacture our products could be disrupted. We
currently do not have guaranteed supply contracts with our component suppliers
and they are not required to supply us with products for any specified periods,
in any specified quantities or at any set price, except as may be specified in
a particular purchase order. In addition, any of our sole-source suppliers
could be acquired by, or enter into exclusive arrangements with, our
competitors or stop selling their products or components to us at commercially
reasonable prices, or at all. In the event of a disruption or delay in supply,
10
<PAGE>
we may not be able to develop an alternate source in a timely manner or at
favorable prices, or at all. A failure to find acceptable alternative sources
could require us to redesign our products to use a substitute component, which
would require us to incur significant expense and may result in substantial
delay in our ability to deliver products to our customers.
Because our products are complex, they may have errors or defects that we find
only after initial deployment, which could harm our business and our
reputation.
Our products are complex and are designed to be deployed in large,
sophisticated communications networks. Because of the nature of our products,
they can only be fully tested when deployed in large networks with high volumes
of traffic. In addition, our customers may use our products in conjunction with
products from other vendors. As a result, if problems occur, it may be
difficult to identify the source of these problems. We have from time to time
experienced software and hardware defects with products shipped to our
customers that were not detected by our internal quality assurance procedures.
We have fixed these defects by providing software fixes and replacing faulty
hardware components. However, in the future we may not be able to correct every
defect as required by our customers, or at all. Any defects or errors in our
products discovered in the future, or failures of our customers' networks,
whether caused by our products or another vendor's products, could result in:
. loss of, or delay in, revenues and loss of market share;
. loss of customers;
. negative publicity regarding us and our products;
. increased service and warranty costs; and
. costly and time-consuming legal actions by our customers.
Claims based on errors in our products or in performing product-related
services could result in costly litigation against us.
Because our products are designed to provide critical communications
services, we may be subject to significant liability claims under contracts
with our customers. Our insurance may not, or may not be sufficient to, cover
us against these liabilities or may not continue to be available to us.
Liability claims could also require us to spend significant time and money in
litigation. As a result, any of these claims, whether or not successful, could
seriously damage our reputation and harm our business and operating results.
Risks Associated With Other Aspects of Our Business
If we fail to manage the growth of our operations, our operating results may be
harmed and our future growth will be limited.
We have rapidly and significantly expanded our operations. From September
30, 1999 to September 30, 2000, we increased the number of our employees from
73 to 241. Our rapid growth has placed, and our anticipated growth will
continue to place, a significant strain on our management systems and
resources. Our ability to successfully develop and market our products and to
implement our business plan in a rapidly evolving market requires effective
planning and management processes. We expect that we will need to continue to
upgrade and improve our financial, managerial and manufacturing controls and
reporting systems, and will need to continue to expand, train and manage our
work force. If we fail to implement adequate control systems in an efficient
and timely manner, our costs may be increased and our growth could be impaired.
In addition, we are still in the process of integrating managerial and other
personnel. In particular, John C. Thibault, our Chairman, President and Chief
Executive Officer, joined our company in February 2000. Our Chief Financial
Officer, Pamela F. Lenehan, joined our company in March 2000. Brian R.
Fitzgerald, our Vice President of Worldwide Sales, joined our company in May
2000. Our Vice President of Worldwide Customer Support, Ronald J. Rando, joined
us in August 2000.
11
<PAGE>
If we fail to manage the risks associated with our acquisition of TCS, our
business, financial condition or operating results could be harmed.
In July 2000, we acquired TCS. We are still in the process of integrating
the technologies and products we acquired from TCS with our other products. If
this integration process takes longer than expected to complete or is not
completed, our business, financial condition or operating results could be
harmed.
If we make any acquisitions or strategic investments in the future, our
business could be disrupted and our financial condition or operating results
could be harmed.
Although we have no current agreement or negotiations underway with respect
to any acquisitions or strategic investments, one aspect of our business
strategy is to pursue acquisitions and investments in other businesses,
products or technologies in the future. Any future acquisition or strategic
investments may entail risks that could harm our business, financial condition
or operating results, including:
. substantial dilution of our current stockholders' ownership;
. assumption of debt;
. incurrence of significant amortization expenses related to goodwill and
other intangible assets; and
. incurrence of significant immediate write-offs in the form of in-process
research and development expense.
Our executive officers and key personnel are critical to our business and the
loss of their services could disrupt our operations and our customer
relationships.
Our success depends to a significant degree upon the continued contributions
of the principal members of our management, many of whom would be difficult to
replace. In particular, we rely on the services of each of John C. Thibault,
our Chairman, President and Chief Executive Officer, Pamela F. Lenehan, our
Vice President and Chief Financial Officer, Bing Yang, our Senior Vice
President and Chief Technology Officer, Sally J. Bament, our Vice President,
Marketing, and Brian R. Fitzgerald, our Vice President, Worldwide Sales. The
loss of the services of Mr. Thibault, Ms. Lenehan, Mr. Yang, Ms. Bament or Mr.
Fitzgerald or any other key personnel, particularly senior management, sales
personnel and engineers, could harm our operations and our customer
relationships.
If we are unable to retain and hire the qualified personnel we require, our
future growth may be limited.
Competition for highly skilled engineering, sales, marketing and support
personnel is particularly intense in the New England area and in the
communications equipment industry. Our failure to attract, assimilate or retain
qualified personnel to fulfill our current or future needs could impair our
growth. The support of our products requires highly trained customer support
and professional services personnel. Once we hire them, they typically require
extensive training. If we are unable to hire, train and retain our research and
development, customer support and professional services personnel, we may not
be able to continue our product development efforts or increase sales of our
products.
If we cannot obtain necessary third-party technology, our product development
efforts may be hampered.
We have incorporated third-party licensed technology into our current
products, and expect to continue to do so in the future to develop new products
and product enhancements. However, third-party licenses may not be available or
continue to be available to us on commercially reasonable terms. For example,
we license
12
<PAGE>
Signaling System 7 technology, which is an important part of our ICS2000
switch, from Ulticom under an agreement which Ulticom may terminate on July 23,
2002. If Ulticom terminates this license, or if we are unable to maintain or
renew other third-party licenses of technology required in our products, our
business and our operating results may be harmed. In addition, if we are unable
to obtain new third-party licenses to develop new products and product
enhancements, we could be required to obtain substitute technology of lower
quality or at greater cost, which could delay or prevent us from making these
products or enhancements, any of which could seriously harm our business.
Our business could be harmed if we are unable to protect our intellectual
property.
We rely on a combination of patent, copyright, trademark and trade secret
laws and restrictions on disclosure to protect our intellectual property
rights. To date, we have one issued patent and two patent applications pending
in the United States. Additionally, we have several related non-U.S. patent
applications pending, relating to the design and operation of our products. Our
pending patent applications may not result in the issuance of any patents. If
any patent is issued, it may be invalidated or circumvented or may otherwise
fail to provide us with any meaningful protection. We do not conduct
comprehensive patent searches to determine whether the technology used in our
products infringes any patents held by third parties.
We have applied for federal trademark registration of Cohesion, Convergent
Networks, ICS, ICServiceWorks, ICSG, ICSX, ICView and The Voice of Broadband
Networking. We also claim common law protections for other marks we use in our
business. We have received a notice from another company with a similar name
demanding that we change our name. We may not be able to continue using our
name and our trademark applications may not be granted.
If we were to discover that any of our products violated the intellectual
property rights of a third party, we might be unable to redesign our product to
avoid violating those rights, and we might be unable to obtain a license on
commercially reasonable terms to use the third-party intellectual property. In
addition, we might be prevented from continuing to sell that product, which
could cause us to lose sales.
Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy or otherwise obtain and use our products or technology.
Monitoring unauthorized use of our products is difficult and we cannot be sure
that the steps we have taken will prevent unauthorized use of our technology,
particularly in foreign countries where the laws may not protect our
proprietary rights as fully as in the United States. If competitors are able to
use our technology, our ability to compete effectively would be harmed.
If we become subject to intellectual property rights litigation, we could incur
significant costs and we may be forced to stop selling our products.
We may become involved in litigation as a result of allegations by third
parties that we infringe their intellectual property rights. If a third party
asserted that our products infringed upon their proprietary rights, we would be
forced to defend ourselves and possibly our customers or contract manufacturers
against the alleged infringement. These claims and any resulting lawsuit, if
successful, could subject us to significant liability for damages and could
result in the invalidation of our proprietary rights. Any potential
intellectual property litigation also could force us to do one or more of the
following:
. stop selling or using our products that use the challenged intellectual
property;
. obtain from the owner of the infringed intellectual property a license
to sell or use the relevant technology, which license might not be
available on reasonable terms, or at all; or
. attempt to redesign those products that use any allegedly infringing
technology, which might not be successful.
Any lawsuits regarding intellectual property rights, regardless of their
ultimate outcome, would be time consuming and expensive to resolve and would
divert our management's time and attention.
13
<PAGE>
We face risks associated with our international expansion that could harm our
financial condition and operating results.
The market for our products is global and we expect to market, sell and
service our products in the United States and internationally. We intend to
expand our international operations and enter new international markets. This
expansion will require management attention and financial resources to develop
direct and indirect international sales and support channels.
We have limited experience in marketing and distributing our products
internationally. In addition, our international operations may be subject to
risks including:
. certification requirements and differing regulatory and industry
standards;
. difficulties and costs of staffing and managing foreign operations;
. reduced protection for intellectual property rights;
. fluctuations in currency exchange rates; and
. import or export licensing requirements.
Additional Risks that May Affect Our Stock Price
Our stock price may be volatile and you may not be able to resell our shares at
or above the price you paid, or at all.
There has previously not been a public market for our common stock. We
cannot predict the extent to which investor interest in our stock will lead to
the development of a trading market or how liquid that market might become. The
initial public offering price for the shares will be determined by negotiations
between us and the representatives of the underwriters and may not be
indicative of prices that will prevail in the trading market. The trading price
of our common stock could be subject to wide fluctuations in response to
factors such as:
. actual or anticipated variations in quarterly operating results;
. failure to meet analysts' predictions and projections;
. changes in market valuations of communications service providers and
communications equipment companies;
. new products or services offered by us or our competitors; and
. our sales of common stock or other securities in the future.
In addition, stock markets in general, and The Nasdaq Stock Market's
National Market and technology companies in particular, have experienced
extreme price and volume fluctuations that have often been unrelated or
disproportionate to the operating performance of the companies. These broad
market and industry factors may harm the market price of our common stock,
regardless of our actual operating performance.
In addition, in the past, following periods of volatility in the overall
market and the market price of a company's securities, securities class action
litigation has often been instituted against that company. This type of
litigation, if instituted against us, could result in substantial costs and a
diversion of our management's attention and resources, which would harm our
business, financial condition and operating results.
Future sales by existing stockholders and option holders could depress the
market price of our common stock.
Once a trading market develops for our common stock, many of our
stockholders and option holders will have an opportunity to sell their common
stock for the first time. Sales of a substantial number of shares of
14
<PAGE>
common stock in the public market after this offering, or the threat that
substantial sales might occur, could cause the market price of our common stock
to decrease. Based on shares outstanding as of September 30, 2000, upon
completion of this offering, we will have approximately 60,447,072 shares of
outstanding common stock. Other than the shares of common stock sold in this
offering, 10,750 shares will immediately be eligible for sale in the public
market. Substantially all of our stockholders will be subject to agreements
with the underwriters or us that restrict their ability to transfer their stock
for 180 days from the date of this prospectus, subject to a number of
exceptions. For a detailed description of these exceptions, please see
"Underwriting." If the conditions specified in the lock-up agreements are met,
an additional 7,789,238 shares will be eligible for sale in the public market
before the expiration of these agreements. After these agreements expire, an
additional 24,778,354 shares will be eligible for immediate sale in the public
market, and the remaining 22,868,730 shares will be eligible thereafter for
sale in the public market subject to certain contractual vesting schedules and
restrictions under rules of the Securities and Exchange Commission. Credit
Suisse First Boston Corporation may, in its sole discretion without notice,
release shares subject to lock-up agreements, although it has no current
intention to do so. For a description of the shares eligible for future sale,
please see "Shares Eligible for Future Sale."
Our management may use the proceeds of this offering in ways that may not
increase our profitability or our market value.
Our management will have considerable discretion in how we use the net
proceeds from this offering, and you will not have the opportunity, as part of
your investment decision, to assess whether the proceeds are being used
appropriately. The net proceeds may be used for corporate purposes that do not
increase our profitability or our market value. Pending application of the
proceeds, they may be placed in investments that do not produce income or that
lose value.
After this offering, our management and directors will exercise significant
control over our company, and this could limit your ability to influence the
outcome of important company decisions, including potential changes of control.
We expect that, after this offering, our executive officers and directors,
including their affiliated entities, will, in the aggregate, beneficially own
approximately 35.8% of our outstanding common stock, after giving effect to the
conversion of all of our outstanding preferred stock. These stockholders, if
acting together, would be able to influence all matters requiring approval by
our stockholders, including the election of directors and the approval of
mergers or other business combination transactions, which may have the effect
of delaying, deferring or preventing a change in control of our company or of
discouraging a potential acquirer from attempting to obtain control of us,
which could harm the market price of our common stock.
Our charter documents and Delaware law may have anti-takeover effects that
could prevent a change of control that might otherwise be beneficial to our
stockholders.
Provisions of our amended and restated certificate of incorporation, amended
and restated by-laws and Delaware law may deter an unsolicited offer to
purchase our company. For example, our board of directors will be divided into
three classes, only one of which will be elected at each annual meeting. These
factors could make it more difficult for a third party to acquire us, even if
doing so might allow our stockholders to recognize a significant premium on
their common stock.
You will incur immediate dilution because the initial public offering price of
a share of our common stock will exceed its tangible book value.
The initial public offering price of our common stock will be substantially
higher than the tangible book value per share of the outstanding common stock
immediately after the completion of this offering. Based upon an assumed
initial offering price of $16.00, if you purchase common stock in this
offering, you will incur immediate dilution of approximately $13.39 in the book
value per share of the common stock from the price you pay.
15
<PAGE>
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements. In some cases, you can
identify forward-looking statements by terminology--for example, the words may,
will, should, expect, plan, anticipate, believe, estimate, predicts, potential
or continue, the negative of these terms, or other comparable terminology.
These statements are only predictions. Actual events or results may differ
materially. In evaluating these statements, you should specifically consider
various factors, including the risks outlined in the risk factors section.
These factors may cause our actual results to differ materially from any
forward-looking statement. Although we believe that the expectations reflected
in the forward-looking statements are reasonable, we cannot guarantee future
results, levels of activity, performance or achievements. Moreover, neither we
nor any other person assumes responsibility for the accuracy and completeness
of the forward-looking statements. We are under no duty to update any of the
forward-looking statements after the date of this prospectus to conform these
statements to actual results or to changes in our expectations.
16
<PAGE>
USE OF PROCEEDS
We will receive net proceeds of approximately $72.9 million from the sale of
5,000,000 shares in this offering at an assumed initial public offering price
of $16.00 per share and after deducting estimated underwriting discounts and
commissions and estimated offering expenses. If the underwriters exercise their
over-allotment option in full, our net proceeds will be approximately $84.1
million.
The principal purposes of this offering are to obtain additional capital, to
create a public market for our common stock and to facilitate our future access
to public equity markets. We have not allocated the net proceeds of this
offering for specific uses. We expect to use the proceeds for general corporate
purposes, including working capital. We may also use a portion of the net
proceeds for acquisitions of businesses, products and technologies that
complement our business. We have no present plans, commitments or current
negotiations with respect to any acquisitions.
Pending our use of the net proceeds from this offering, we intend to invest
the proceeds in interest-bearing, investment-grade securities.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our capital stock. We
presently intend to retain future earnings, if any, to finance the expansion of
our business and do not expect to pay any cash dividends in the foreseeable
future. Payment of future cash dividends, if any, will be at the discretion of
our board of directors after taking into account various factors, including our
financial condition, operating results, current and anticipated cash needs and
plans for expansion.
17
<PAGE>
CAPITALIZATION
The following table sets forth our capitalization as of September 30, 2000:
. on an actual basis; and
. on a pro forma as adjusted basis to give effect to the conversion into
common stock of all outstanding convertible preferred stock upon the
closing of this offering and to reflect our receipt of the estimated net
proceeds from our sale of 5,000,000 shares of common stock in this
offering, at an assumed initial public offering price of $16.00 per
share, after deducting the estimated underwriting discounts and
commissions and estimated offering expenses.
<TABLE>
<CAPTION>
September 30, 2000
---------------------
Pro Forma
Actual As Adjusted
-------- -----------
(in thousands,
except share data)
(unaudited)
<S> <C> <C> <C>
Cash and cash equivalents............................ $ 87,384 $160,284
======== ========
Notes payable and capital lease obligations, net of
current portion..................................... $ 705 $ 705
-------- --------
Redeemable convertible preferred stock, $0.01 par
value; 22,600,000 shares authorized, 21,781,452
issued and outstanding actual; no shares authorized,
issued or outstanding, pro forma as adjusted........ 133,368 --
-------- --------
Stockholders' equity (deficit):
Preferred Stock, $0.01 par value; 10,000,000 shares
authorized, no shares issued or outstanding....... -- --
Common Stock, $0.00001 par value; 400,000,000
shares authorized, 29,646,970 shares issued
actual; 400,000,000 shares authorized, 63,404,422
shares issued pro forma as adjusted............... -- 1
Additional paid-in capital......................... 172,457 378,724
Treasury stock, at cost: 2,957,350 shares.......... (176) (176)
Accumulated deficit................................ (80,238) (80,238)
Deferred compensation.............................. (23,559) (23,559)
Stock subscriptions receivable..................... (6,082) (6,082)
-------- --------
Total stockholders' equity (deficit)............. (62,402) 268,670
-------- --------
Total capitalization........................... $196,475 $269,375
======== ========
</TABLE>
The data in the table above excludes:
. 4,154,723 shares of common stock issuable upon exercise of options
outstanding as of September 30, 2000 at a weighted average exercise
price of $5.38 per share;
. 240,000 shares of common stock issuable upon exercise of warrants
outstanding as of September 30, 2000 at a weighted average exercise
price of $14.54 per share;
. 10,000,000 shares of common stock available for issuance under our 2000
stock incentive plan; and
. 5,000,000 shares of common stock available for issuance under our 2000
employee stock purchase plan.
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<PAGE>
DILUTION
If you invest in our common stock, your ownership interest will be diluted
by the difference between the public offering price per share of our common
stock and the pro forma as adjusted net tangible book value per share of
common stock upon the completion of this offering.
Our pro forma net tangible book value at September 30, 2000 was
approximately $84.9 million, or $1.53 per share of common stock. Pro forma net
tangible book value per share represents the amount of our total tangible
assets less total liabilities, divided by the pro forma number of shares of
common stock outstanding at September 30, 2000 and assumes the conversion of
our currently outstanding shares of preferred stock into common stock upon the
closing of this offering. Dilution in pro forma net tangible book value per
share represents the difference between the amount per share paid by investors
in this offering and the pro forma net tangible book value per share of our
common stock immediately after the completion of this offering. After giving
effect to the sale of 5,000,000 shares of our common stock in this offering at
an assumed initial public offering price of $16.00 per share and after
deducting the estimated underwriting discounts and commissions and estimated
offering expenses, our pro forma net tangible book value at September 30, 2000
would have been approximately $157.8 million, or approximately $2.61 per share
of common stock. This represents an immediate increase in net tangible book
value of $1.08 per share to our existing stockholders and an immediate
dilution in net tangible book value of $13.39 per share to new investors, or
approximately 83.7% of the assumed initial public offering price of $16.00 per
share. The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share............... $16.00
Pro forma net tangible book value per share at September 30,
2000....................................................... $1.53
Increase per share attributable to this offering............ 1.08
-----
Pro forma net tangible book value per share after this
offering..................................................... 2.61
------
Dilution per share to new investors........................... $13.39
======
</TABLE>
The following table shows, on a pro forma basis at September 30, 2000,
after giving effect to the conversion of all outstanding shares of preferred
stock into common stock upon the closing of this offering, the total number of
shares of common stock purchased from us, the total consideration paid to us
and the average price per share paid to us by existing stockholders and by new
investors before deducting the estimated underwriting discounts and
commissions and estimated offering expenses, at an assumed initial public
offering price of $16.00 per share:
<TABLE>
<CAPTION>
Shares Issued Total Consideration
--------------------- ----------------------- Average Price
Numbers Percentage Amount Percentage Per Share
---------- ---------- ------------ ---------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders... 55,447,072 91.7% $275,989,138 77.5% $ 4.98
New investors........... 5,000,000 8.3 80,000,000 22.5 16.00
---------- ----- ------------ -----
Total................. 60,447,072 100.0% $355,989,138 100.0%
========== ===== ============ =====
</TABLE>
The foregoing discussions and tables exclude:
. 4,154,723 shares of common stock issuable upon exercise of options
outstanding as of September 30, 2000 at a weighted average exercise
price of $5.38 per share;
. 240,000 shares of common stock issuable upon exercise of warrants
outstanding as of September 30, 2000 at a weighted average exercise
price of $14.54 per share;
. 10,000,000 shares of common stock available for issuance under our 2000
stock incentive plan; and
. 5,000,000 shares of common stock available for issuance under our 2000
employee stock purchase plan.
To the extent outstanding options and warrants are exercised, there will be
further dilution to new investors.
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<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
This information should be read in conjunction with the financial statements
and related notes included elsewhere in this prospectus and "Management's
Discussion and Analysis of Financial Condition and Results of Operations." The
table below sets forth our selected financial data. The consolidated financial
data as of December 31, 1999 and for the period from May 6, 1998, date of
inception, through December 31, 1998 and the year ended December 31, 1999 are
derived from our audited consolidated financial statements included elsewhere
in this prospectus. The consolidated financial data as of and for the nine
months ended September 30, 2000 and for the nine months ended September 30,
1999 are derived from our unaudited consolidated financial statements included
elsewhere in this prospectus. We believe that the unaudited consolidated
financial statements include all adjustments, consisting only of normal
recurring adjustments, necessary for the fair presentation of our financial
condition and our operating results for such periods and as of such dates.
Operating results for the nine months ended September 30, 2000 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2000 or for any future period.
<TABLE>
<CAPTION>
Period from Nine Months Ended
Inception Year Ended September 30,
(May 6, 1998) to December 31, ------------------
December 31, 1998 1999 1999 2000
----------------- ------------ -------- --------
(unaudited)
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Consolidated Statement of
Operations Data:
Revenues.................... $ -- $ -- $ -- $ 6,759
Cost of revenues (/1/)...... -- -- -- 5,042
------- -------- -------- --------
Gross profit.............. -- -- -- 1,717
Operating expenses:
Research and development
(/1/).................... 2,182 13,067 7,646 9,293
Selling and marketing
(/1/).................... 163 3,523 1,871 5,076
General and administrative
(/1/).................... 283 1,273 698 2,652
Stock-based compensation.. -- 3,546 134 8,080
Amortization of intangible
assets................... -- -- -- 6,554
Acquired in-process
research and
development.............. -- -- -- 23,000
------- -------- -------- --------
Total operating
expenses............... 2,628 21,409 10,349 54,655
------- -------- -------- --------
Loss from operations........ (2,628) (21,409) (10,349) (52,938)
Interest income (expense),
net........................ 100 137 88 1,307
------- -------- -------- --------
Net loss.................... (2,528) (21,272) (10,261) (51,631)
Accretion of dividends and
issuance costs on
redeemable convertible
preferred stock............ (255) (1,067) (611) (3,416)
------- -------- -------- --------
Net loss attributable to
common stockholders........ $(2,783) $(22,339) $(10,872) $(55,047)
======= ======== ======== ========
Net loss per share:
Basic and diluted......... $ (4.87) $ (7.47) $ (4.22) $ (10.61)
Shares used in computing net
loss per share:
Basic and diluted......... 572 2,991 2,577 5,188
(1)
Excludes non-cash, stock-
based compensation as
follows:
Cost of revenues.......... $ -- $ -- $ -- $ 253
Research and development.. -- 1,714 -- 829
Selling and marketing..... -- 276 -- 3,309
General and
administrative........... -- 1,556 134 3,689
------- -------- -------- --------
$ -- $ 3,546 $ 134 $ 8,080
======= ======== ======== ========
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
December 31,
----------------- September 30,
1998 1999 2000
------- -------- -------------
(unaudited)
(in thousands)
<S> <C> <C> <C>
Consolidated Balance Sheet Data:
Cash, cash equivalents and marketable
securities.................................. $ 4,746 $ 21,508 $ 87,384
Working capital.............................. 4,006 16,509 77,591
Total assets................................. 5,085 24,370 214,197
Notes payable and capital lease obligations,
net of current portion...................... -- 943 705
Redeemable convertible preferred stock....... 7,131 40,891 133,368
Total stockholders' equity (deficit)......... (2,787) (22,789) 62,402
</TABLE>
21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with our
financial statements and the related notes included elsewhere in this
prospectus.
Overview
We design, develop and market a new generation of switching equipment and
software that enable communications service providers to rapidly deliver voice
and data services over broadband networks. From our inception on May 6, 1998
through early 2000, our operations consisted primarily of start-up activities,
including raising capital, recruiting personnel, conducting research and
development, establishing the market for our initial products and purchasing
operating assets. In addition, we developed our final product assembly and
testing capabilities, arranged manufacturing with third parties and began
development of our sales, marketing, customer service and administrative
organizations. We first began recognizing revenues from sales of our products
during the second quarter of 2000. We sell our products through our direct
sales force to service providers in North America and Europe. In the future, we
anticipate expanding our sales through domestic and international distribution
partners and resellers.
Three customers have accounted for all our revenues to date, and we expect
that customer concentration will continue in the future. Global NAPs, an
affiliate of which owns approximately 1% of our capital stock, accounted for
73% of our revenues for the nine months ended September 30, 2000, and BT
accounted for 22% of our revenues.
On July 31, 2000, we completed our acquisition of Hemisphere Investments and
its wholly owned subsidiaries, including Technology Control Services,
collectively TCS. TCS developed and sold custom softswitch and service creation
software products and, through its service division, provided network-based
service applications such as unified messaging and calling card services. We
issued an aggregate of 10,106,845 shares of our common stock in consideration
for all of the outstanding capital stock of TCS, reserved an aggregate of
1,229,436 shares of our common stock in connection with our assumption of
outstanding options to purchase capital stock of TCS and assumed $5.5 million
of TCS debt, which we repaid immediately upon closing the transaction. However,
1,516,025 of the shares of common stock issued to stockholders of TCS are
currently held in escrow to secure indemnification obligations of TCS and some
of its stockholders. We have accounted for the acquisition as a purchase.
Accordingly, the operating results of TCS are included in our financial results
from the date of the acquisition. Management was primarily responsible for
estimating the fair value of the assets and liabilities acquired and performed
due diligence in our determination. We made estimates and assumptions that
affect the reported amounts of assets, liabilities and expenses resulting from
the acquisition. Actual results could differ from those amounts. We recorded a
$23.0 million charge for in-process research and development in the third
quarter of 2000. Goodwill and other intangibles as of the date of acquisition
were $117.4 million, which will be amortized on a straight-line basis over
three years.
We have refocused the efforts of TCS to provide standard software products,
which will be part of our ICServiceWorks product, and we have decided to
dispose of the service division and related assets. For the years ended
December 31, 1997, 1998 and 1999 and the six months ended June 30, 2000, the
service division accounted for approximately $12.5 million or 81%, $5.7 million
or 93%, $3.3 million or 47% and $2.2 million or 37%, respectively of TCS
revenues. For the years ended December 31, 1997, 1998 and 1999 and the six
months ended June 30, 2000, the service division incurred operating losses of
approximately $7.6 million, $5.0 million, $315,000 and $111,000, respectively.
We have accounted for the disposition of the service division and related
assets as assets held for sale in accordance with EITF Issue No. 87-11 and
accordingly, the service division's results of operations from the date of
acquisition to the date of disposition will be excluded from our consolidated
results of operations. Revenues and operating losses excluded from our
consolidated results of operations from the date of acquisition to September
30, 2000 were approximately $425,000 and $25,000, respectively. As a result, we
expect that the TCS operations will generate revenues significantly lower than
those generated by TCS in prior periods.
22
<PAGE>
Revenues. We recognize revenues from product sales upon product shipment,
provided that there are no uncertainties regarding acceptance, there is
persuasive evidence of an arrangement, the sales price is fixed or determinable
and collection of the related accounts receivable is probable. If there are
uncertainties regarding customer acceptance, revenues are deferred until the
uncertainties are resolved. We evaluate the creditworthiness of each customer
and revenues are not recognized unless the collection of the related accounts
receivable is probable. Our products incorporate software that is more than
incidental to the related hardware and, accordingly, we recognize revenues in
accordance with Statement of Position 97-2, Software Revenue Recognition and
Statement of Position 98-9, Modification of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions. Revenues from installation
and training services are recognized as the services are provided. Revenues
from support and maintenance contracts are recognized ratably over the terms of
the contracts. Amounts collected prior to satisfying the above revenue
recognition criteria are reflected as deferred revenue. In certain limited
arrangements with customers of TCS that require significant customization or
modification of the software, revenues are recognized in conformity with SOP
81-1, Accounting for Performance of Construction-Type and Certain Production-
Type Contracts, using the completed contract method.
Cost of Revenues. Cost of revenues consists of payments to our contract
manufacturers, costs associated with in-house systems integration and testing,
customer service and estimated warranty costs. Additionally, material, labor
and overhead related to arrangements, with certain TCS customers, that require
significant customization or modification to software products are included in
cost of revenues.
Research and Development. Research and development expenses consist
primarily of salaries and related personnel and recruiting costs, and prototype
costs related to the design, development, testing and enhancement of our
products. We continue to build our research and development infrastructure to
develop enhancements to our broadband voice products, as well as to anticipate
our customers' evolving needs and develop products that address those needs. We
expense research and development costs as they are incurred. Some aspects of
our research and development efforts require material short-term expenditures,
which can cause significant quarterly fluctuations in our research and
development expenses. We believe that research and development is critical in
achieving current and strategic product objectives. We expect that our research
and development expenses will significantly increase in absolute dollars in the
future as we continue to enhance our existing products and develop new
products.
Selling and Marketing. Selling and marketing expenses consist primarily of
salaries and related expenses for personnel engaged in sales and marketing, and
promotional and other marketing expenses. We expect that selling and marketing
expenses will increase substantially in absolute dollars in the future as we
increase our direct sales efforts by expanding our domestic and international
sales offices, hiring additional marketing personnel and initiating additional
marketing programs.
General and Administrative. General and administrative expenses consist
primarily of salaries and related expenses for executive, finance, legal,
information systems and human resources personnel, professional fees and other
general corporate expenses. We expect that general and administrative expenses
will increase in absolute dollars as we add personnel and incur additional
costs related to the growth of our business and our operations as a public
company.
Stock-based Compensation. We recorded deferred compensation of approximately
$2.3 million for 1999 and $27.3 million for the nine months ended September 30,
2000. These amounts represent the aggregate difference between the exercise or
purchase price of stock options granted or stock sold to our employees and the
deemed fair value of our stock at the time of grant or sale. We are amortizing
these amounts over the vesting period of the options and stock awards, which
are generally four to five years. In addition, in the third quarter of 2000 we
issued warrants with an aggregate value of $1.9 million to three companies in
exchange for evaluating and testing our products and technical assistance that
we believe is critical in expanding the sale of our products. We recorded total
stock-based compensation expense of $3.5 million for 1999, of which $1.8
million related to amortization of deferred compensation, and $8.1 million for
the nine months ended September 30, 2000, of which $6.2 million relates to
deferred compensation expense. We also expect to record
23
<PAGE>
compensation expense relating to stock options and stock awards of
approximately $3.1 million in the fourth quarter of 2000, $8.6 million in 2001,
$5.0 million in 2002, $2.7 million in 2003, $1.0 million in 2004 and $100,000
in 2005. It is possible that the amount of our total deferred compensation, and
therefore the amount of expense we incur each year, may increase as a result of
factors such as the grant of additional options and stock awards with an
exercise or purchase price, as applicable, below the deemed fair market value
of our common stock. In addition, on December 17, 1999, we issued shares of
Series C convertible preferred stock to an affiliate of Global NAPs in
consideration for research and development and other services, including
technical assistance and testing facilities through December 31, 1999, provide
to us by Global NAPs. The related stock-based compensation charge of $1.7
million was recorded in December 1999.
Amortization of Intangible Assets. We recorded a $6.6 million expense
related to the amortization of intangible assets for the nine months ended
September 30, 2000. This was a result of the recording of $117.4 million of
goodwill and other intangible assets in conjunction with the acquisition of
TCS. We are amortizing the goodwill and intangibles over a three-year period.
Consequently, for the next eleven quarters, we expect amortization expense to
be approximately $9.8 million per quarter.
Acquired In-Process Research and Development. In connection with the
acquisition of TCS, we allocated $23.0 million of the purchase price to in-
process research and development projects. These allocations represented the
estimated fair value based on risk-adjusted cash flows related to the
incomplete research and development projects. At the date of acquisition, the
development of these projects had not yet reached technological feasibility and
the research and development in progress had no alternative future uses.
Accordingly, these costs were expensed in the third quarter of 2000. We do not
expect any future charges for in-process research and development related to
the TCS acquisition.
Historically, we have incurred significant losses. As of September 30, 2000,
we had an accumulated deficit of $80.2 million. We expect to incur substantial
losses for the foreseeable future. We plan to increase significantly our
operating expenses. As a result, we will need to generate significant revenues
to achieve and maintain profitability. We may never achieve profitability.
Results of Operations
Nine months ended September 30, 2000 and September 30, 1999
Revenues. Revenues were $6.8 million for the nine months ended September 30,
2000. We first began recognizing revenues from shipment of our products during
the second quarter of 2000. Global NAPs, an affiliate of which owns
approximately 1% of our capital stock, accounted for 73% of our revenues for
the nine months ended September 30, 2000, and BT accounted for 22% of our
revenues for this period. We had no revenues in the nine months ended September
30, 1999.
Cost of Revenues. Cost of revenues for the nine months ended September 30,
2000 was $5.0 million. In connection with the TCS acquisition, we recorded the
unbilled costs and fees on contracts in process on the date of acquisition at
estimated fair market value. As a result, the gross margin was minimal on
revenues of approximately $1.5 million from BT. There was no cost of revenues
in the nine months ended September 30, 1999.
Research and Development. Research and development expenses increased $1.7
million to $9.3 million for the nine months ended September 30, 2000 from $7.6
million for the nine months ended September 30, 1999. The increase primarily
reflected higher salaries and related benefits for new personnel, including
additional personnel resulting from the TCS acquisition. Personnel related
costs increased $3.1 million and prototype spending decreased $2.0 million. Our
research and development personnel are working on enhancements to our current
broadband infrastructure products, our softswitch and related applications
software.
Selling and Marketing. Selling and marketing expenses increased $3.2 million
to $5.1 million for the nine months ended September 30, 2000 from $1.9 million
for the nine months ended September 30, 1999. The
increase was due to costs associated with the establishment of a sales and
marketing group, increased
24
<PAGE>
advertising, marketing and other costs associated with sales and support
activities, as well as additional personnel resulting from the TCS acquisition.
Personnel costs increased $2.3 million and advertising, marketing and other
costs associated with sales and support activities increased $545,000.
General and Administrative. General and administrative expenses increased
$2.0 million to $2.7 million for the nine months ended September 30, 2000 from
$698,000 for the nine months ended September 30, 1999. The increase was due
primarily to an increase in salaries and related benefits due to the hiring of
additional personnel, including additional personnel resulting from the TCS
acquisition, as well as increases in the occupancy allocation and depreciation
expense. Personnel related costs increased $911,000, the occupancy allocation
increased $270,000 and depreciation expense accounted for $245,000 of the
remaining increase.
Stock-based Compensation. Stock-based compensation expense increased $8.0
million to $8.1 million for the nine months ended September 30, 2000 from
$134,000 for the nine months ended September 30, 1999.
Interest Income (Expense), Net. Interest income consists of interest earned
on our cash balances and marketable securities. Interest expense consists of
interest incurred on our equipment line of credit. Interest income, net of
interest expense increased $1.2 million to $1.3 million for the nine months
ended September 30, 2000 from $88,000 for the nine months ended September 30,
1999. The increase was primarily attributable to higher invested cash balances
from the proceeds of private financings and interest on promissory notes to
executive officers, partially offset by an increase of interest expense from
incurred borrowings.
Year ended December 31, 1999 and Period from May 6, 1998 (Inception) to
December 31, 1998
Revenues. We recognized no revenues in either period.
Research and Development. Research and development expenses increased $10.9
million to $13.1 million for 1999 from $2.2 million for the period from
inception to December 31, 1998. The increase reflected increased salaries and
related benefits due to the hiring of additional personnel and increased
prototype and laboratory expenses. Prototype spending increased $5.2 million
and personnel related costs increased $3.1 million. During these periods, our
focus was on development of our initial product, the ICS2000 switch, which was
released in the quarter ended June 30, 2000.
Selling and Marketing. Selling and marketing expenses increased $3.3 million
to $3.5 million for 1999 from $163,000 for the period from inception to
December 31, 1998. The increase was due to costs associated with the
establishment of a sales and marketing group, and increased advertising,
marketing and other costs associated with sales and support activities.
Personnel costs related to the establishment of the sales and marketing group
increased $1.7 million. Advertising, marketing and other costs associated with
sales and support activities increased $1.1 million.
General and Administrative. General and administrative expenses increased
$1.0 million to $1.3 million for 1999 from $283,000 for the period from
inception to December 31, 1998. The increase was due primarily to salaries and
related benefits related to the hiring of additional general and administrative
personnel, as well as increased professional fees. Personnel related costs
increased $621,000. Professional service costs such as legal and accounting
fees increased $115,000.
Stock-based Compensation. We recorded stock-based compensation expense of
$3.5 million for 1999, including $1.7 million related to the issuance of
264,853 shares of Series C convertible preferred stock to an affiliate of
Global NAPs in exchange for services performed by Global NAPs. There was no
stock-based compensation expense recorded in the period from inception to
December 31, 1998.
Interest Income (Expense), Net. Interest income, net of interest expense
increased $37,000 to $137,000 for 1999 from $100,000 for the period from
inception to December 31, 1998. The increase was primarily attributable to
higher invested cash balances from the proceeds of private financings,
partially offset by an increase of interest expense from incurred borrowings.
25
<PAGE>
Liquidity and Capital Resources
Since inception, we have financed our operations primarily through private
sales of convertible preferred stock. As of September 30, 2000, cash and cash
equivalents were $87.4 million.
For the nine months ended September 30, 2000, we used $19.4 million of cash
for operations, primarily due to our net loss of $51.6 million, which includes
non-cash charges of $23.0 million for in-process technology, $8.2 million for
depreciation and amortization of intangibles, and $8.1 million for stock-based
compensation. Cash used for operations for the nine months ended September 30,
2000 was impacted by an increase in inventory of $4.5 million and net payment
of accounts payable of $2.8 million. The increase in inventory resulted
primarily from the manufacture and shipment of evaluation units to potential
customers. The net payment of accounts payable occurred primarily as a result
of the TCS acquisition whereby overdue accounts payable assumed as part of the
acquisition were paid subsequent to the closing of the acquisition. For 1999,
we used $13.2 million of cash for operations due to our net loss of $21.3
million, which was partially offset by a $3.5 million stock-based compensation
charge as well as a $2.4 million increase in accrued expenses and a $1.4
million increase in accounts payable. We used $1.7 million of cash for
operations for the period from inception to December 31, 1998 due primarily to
the net loss of $2.5 million, partially offset by an increase in accounts
payable and accrued expenses.
For the nine months ended September 30, 2000, our investing activities
included the purchase of $3.1 million of property and equipment. For 1999, our
investing activities included the purchase of $2.3 million of property and
equipment. For the period from inception to December 31, 1998, our investing
activities included the purchase of $416,000 of property and equipment.
Cash provided by financing activities for the nine months ended September
30, 2000 was $88.5 million, primarily due to the receipt in the first quarter
of 2000 of a $15.0 million stock subscription receivable from the Series C
financing, as well as $78.7 million in proceeds from the Series D financing
which closed in September 2000. Issuance costs related to the Series D
financing of $4.7 million were paid subsequent to September 30, 2000. In
conjunction with the acquisition of TCS, we paid off $5.4 million of assumed
debt at the closing of the transaction. Cash provided by financing activities
for 1999 was $32.9 million, primarily from the private sales of convertible
preferred stock. Cash provided by financing activities for the period from
inception to December 31, 1998 was $6.9 million, primarily from the private
sales of convertible preferred stock.
We previously had a $1.5 million bank equipment line of credit. On November
30, 1999, this line of credit converted into a 36-month term loan, which we are
repaying at a rate of $123,000 each fiscal quarter through the fourth quarter
of 2002. The loan is secured by substantially all of our assets, and bears
interest at the bank's prime rate plus 0.75%. We are required to comply with
financial and restrictive covenants set forth in the loan, and as of September
30, 2000, we were in compliance with these covenants. As part of the TCS
acquisition, we assumed $656,000 of capital leases with an average rate of
11.9%, which are being repaid over a period of 22 months.
As of December 31, 1999, we were obligated to pay lease payments of $9.6
million over the lease periods of our operating leases, with $1.1 million due
in 2000.
We expect our cash requirements will increase significantly in 2001, as we
continue to hire employees for our research and development efforts, expand our
sales, support, marketing and product development organizations, and grow our
administrative support activities. Personnel costs have been and are expected
to continue to be our single largest expense item. We have also expanded our
leased facilities by moving our Florida-based employees to a larger facility,
establishing an engineering group in the Chicago area and opening sales offices
in the United States and United Kingdom. As our business grows we anticipate
significant cash requirements for working capital and capital expenditures. The
amount and timing of cash requirements will depend on market acceptance of our
products and the resources we devote to researching and developing, marketing,
selling and supporting our products. We believe that our current cash and cash
equivalents on hand
26
<PAGE>
should be sufficient to fund our operations for at least the next 12 months.
However, any material acquisition of complementary businesses, products or
technologies or any joint ventures could require us to obtain additional equity
or debt financing. Thereafter, if current sources are not sufficient to meet
our needs, we may seek additional equity or debt financing. Additional
financing may not be available on acceptable terms, if at all. If we raise
additional funds through the issuance of equity securities, the percentage
ownership of our stockholders would be reduced. If we are unable to raise
sufficient funds on acceptable terms we may not succeed in executing our
strategy and achieving our business objectives. In particular, we could be
forced to reduce personnel and limit our product development, sales and
marketing activities, forego attractive business opportunities, and be unable
to respond to competitive pressures.
Acquired In-Process Research and Development
During the third quarter of 2000, we recorded a $23.0 million charge related
to in-process research and development resulting from the TCS acquisition. This
charge represented the estimated fair value based on risk-adjusted cash flows
related to the incomplete research and development projects. At the date of
acquisition, the development of these projects had not yet reached
technological feasibility, and the research and development in progress had no
alternative future uses. Accordingly, these costs were expensed as of the
acquisition date.
At the acquisition date, TCS was conducting design, development, engineering
and testing activities associated with the completion of several next-
generation technologies for its LiteSwitch platform designed to address
emerging market demands for the voice/data networking market. Projects included
the development of a media gateway controller, call control technology, Class
4/5 switch compatibility, Internet dial offload technology and Signaling System
7 signaling gateway.
At the acquisition date, the technologies under development were
approximately 75% complete based on engineering man-month data and
technological progress. TCS had spent approximately $7.5 million on the in-
process projects, and expected to spend approximately $2.5 million to complete
all phases of the research and development.
In making the purchase price allocation, management considered present value
calculations of income, an analysis of project accomplishments and remaining
outstanding items, and an assessment of overall contributions, as well as
project risks. The value assigned to purchased in-process research and
development was determined by estimating the costs to develop the acquired
research and development into commercially viable products, estimating the
resulting net cash flows from the projects, and discounting the net cash flows
to their present value. The revenue projections used to value the in-process
research and development were based on estimates of relevant market sizes and
growth factors, expected trends in technology, and the nature and expected
timing of new product introductions by us and our competitors. The resulting
net cash flows from such projects are based on management's estimates of cost
of sales, operating expenses and income taxes from such projects.
The rates utilized to discount the net cash flows to their present value
were based on estimated cost of capital calculations. Due to the nature of the
forecast and the risks associated with the research and development projects, a
discount rate of 25% was used for the in-process research and development. The
discount rate utilized was higher than our weighted average cost of capital due
to the inherent uncertainties surrounding the successful development of the
purchased in-process research and development, the useful life of the
technology, the profitability levels of the technology, and the uncertainty of
technological advances that are unknown at this time.
If these projects are not successfully developed, the sales and
profitability of the combined company may be adversely affected in future
periods. Additionally, the value of other acquired intangible assets may become
impaired.
27
<PAGE>
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board, or the FASB, issued
Statement of Financial Accounting Standards, or SFAS, No. 133, Accounting for
Derivative Instruments and Hedging Activities. This statement established
accounting and reporting standards for derivative instruments and hedging
activities. SFAS 133, as amended by SFAS 137, will be effective for our
financial reporting beginning in the first quarter of 2001. SFAS 133 will
require that we recognize all derivatives as either assets or liabilities in
the balance sheet and measure those instruments at fair value. The accounting
for gains and losses from changes in the fair value of a particular derivative
will depend on the intended use of that derivative. We believe the adoption of
this statement will not have a significant impact on our financial position,
operating results or cash flows.
In December 1999, the SEC issued Staff Accounting Bulletin No. 101, Revenue
Recognition. This bulletin summarizes some views of the staff on applying
accounting principles generally accepted in the United States to revenue
recognition in financial statements. We believe that our current revenue
recognition policy complies with the SEC guidelines.
In March 2000, the FASB issued Interpretation No. 44, Accounting for Certain
Transactions Involving Stock Compensation--an Interpretation of APB Opinion No.
25. The interpretation clarifies the application of APB Opinion No. 25 to
accounting for stock issued to employees. The interpretation is effective July
1, 2000, but covers events occurring during the period between December 15,
1998 and the effective date.
Quantitative and Qualitative Disclosures About Market Interest Rate Sensitivity
The primary objective of our investment activities is to preserve principal
while at the same time maximizing the income we receive from our investments
without significantly increasing risk. Some of the securities that we may
invest in may be subject to market risk. This means that a change in prevailing
interest rates may cause the principal amount of the investment to fluctuate.
For example, if we hold a security that was issued with a fixed interest rate
at the then-prevailing rate and the prevailing interest rate later rises, the
principal amount of our investment will probably decline. To minimize this risk
in the future, we intend to maintain our portfolio of cash equivalents and
short-term investments in a variety of securities, including commercial paper,
money market funds, and government and investment grade non-government debt
securities. In general, money market funds are not subject to market risk
because the interest paid on these funds fluctuates with the prevailing
interest rate. As of September 30, 2000, all of our cash and cash equivalents
were in a cash reserves money market fund or in an operating checking fund.
28
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BUSINESS
Overview
We design, develop and market a new generation of switching equipment and
software that enable voice and data services to be delivered over broadband
networks. Our Cohesion product family offers communications service providers
an integrated voice infrastructure solution, which consists of the ICS2000
switch, the ICServiceWorks software and the ICView network management system.
Compared with traditional alternatives, our products significantly reduce the
cost to build and operate a network that is capable of providing both voice and
high-speed data services. Our products are also compatible with existing
circuit-based networks. We believe that our products enable the creation and
delivery of both traditional and advanced end-user services to generate
incremental revenues and attract and retain end users.
Industry Background
The public telephone network has been heavily regulated for most of its
century-old existence. As a result, the public telephone network's underlying
circuit-switched technology has evolved slowly and, until recently, service
providers have experienced little market pressure to deploy innovative services
and applications for their customers. We believe that two dramatic developments
in the telecommunications industry--governmental deregulation and the growth of
Internet use--are now revolutionizing the public telephone network worldwide.
Market deregulation has increased competition among service providers
Deregulation of the telecommunications industry worldwide has accelerated
dramatically in the last decade. In the United States, the Telecommunications
Act of 1996 removed traditional barriers that once restricted service providers
to a specific geography or service offering. This legislation has enabled
thousands of new service providers to enter the telephony services market.
Intense competition between existing and emerging service providers has driven
down prices for basic telephone service, and eroded profit margins for service
providers. In response, service providers are seeking next-generation products
and solutions to decrease network infrastructure and operating costs, and to
increase revenues by selling innovative new service offerings. Internationally,
similar deregulation forces have led to new entrants and increased demand for
next-generation solutions.
Internet usage is increasing data traffic on unoptimized and overburdened
circuit networks
The Internet has become a critical communications medium for many businesses
and consumers, leading to dramatic growth in data traffic. The Internet, email,
electronic commerce, telecommuting and online entertainment have all driven
this increase in data traffic. New applications, such as the delivery of audio
and video over the Internet, will continue to drive this data growth in the
future.
Today, a significant portion of this data traffic is carried over the
traditional circuit-switched public telephone network. However, the circuit-
switched public network was originally built to support voice services and is
very inefficient for carrying data traffic, particularly in high volumes.
Circuit-based networks use a dedicated circuit or path to transmit voice or
data traffic. This approach is inefficient because the circuit uses network
capacity during the entire call, even when there is nothing to be transmitted,
such as during pauses in a conversation. The inefficiency is even greater when
transmitting data traffic, which is characterized by bursts of traffic,
followed by long periods of inactivity. These bursts of data traffic can at
times exceed the capacity of the transmitting circuit, resulting in slow
transfer rates or dropped connections. As a result, service providers have
begun to rapidly deploy new packet-based networks capable of supporting high-
speed data services.
There are significant benefits in combining voice and data traffic into a
single packet-based network
Because voice traffic is currently carried over traditional circuit-switched
networks, and data traffic carried over packet-based networks, service
providers face the expense and complexity of building and maintaining separate
voice and data networks. Service providers can eliminate duplicate equipment
costs and reduce network operating costs associated with managing two separate
networks by converging voice and data traffic on a packet-based network.
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A packet-based network aggregates voice and data from multiple sources and
transports it over shared network connections. Information is broken down into
packets which are channeled through the network and reassembled at their
destination. The aggregation of packets from multiple sources enables service
providers to
better utilize network capacity, further reducing equipment, network and
operating costs.
Data traffic volume on communications networks now exceeds that of voice
traffic. Nonetheless, the majority of service provider revenues still are
generated from voice services delivered on circuit-switched networks.
Consequently, service providers are seeking to protect their profits derived
from voice services, particularly custom calling features such as caller ID and
call forwarding, while transitioning to packet-based networks that can handle
voice and data traffic efficiently. These requirements have driven the
emergence of the new public network--a network based on packet technology
capable of delivering integrated voice and high-speed data services to end
users, with improved efficiencies and economics as well as performance
advantages compared to the traditional circuit-switched telephone network.
Converging voice services with data over a packet-based network also creates
opportunities for service providers to provide new, high-margin service
offerings such as unified messaging.
Requirements for Voice Infrastructure Products for the New Public Network
We believe that packet-based networks will become the new public network,
delivering both voice and high-speed data communications and services to
consumers and businesses. The new public network must match the reliability,
voice service quality and scalability of today's public telephone network,
while offering improved economics for service providers to more efficiently
deliver large amounts of voice and data traffic. The network must also enable
service providers to increase revenues and profits by rapidly delivering new
and innovative communications services and features to meet changing end-user
demands. To meet these requirements, new products must be able to offer the
following benefits:
Reliable and High Quality Voice Services. Today's public voice network has
set high user expectations for reliability and voice service quality. The new
packet-based networks must provide the same service quality and reliability
provided to users by traditional circuit-based networks.
Compatibility and Interoperability. Due to their substantial investment in
circuit-switched networks, traditional service providers are continuing to use
their existing networks as they migrate over time to new packet-based networks.
Next-generation service providers are building new networks based on packet
technology that must interoperate with the existing networks of traditional
service providers. As a result, new network equipment and software must support
a full range of voice and data networking standards and interfaces to
interoperate with software and equipment from multiple vendors. Networking
standards include Signaling System 7, or SS7, a set of call control standards
and protocols used by service providers to enable integration with the global
public network for basic and advanced voice service delivery, as well as data
networking standards, such as asynchronous transfer mode, or ATM, and Internet
Protocol, or IP, voice coding standards and common optical network interfaces.
Low Cost. Packet-based networks must deliver a compelling economic advantage
over circuit-based networks in equipment and facilities costs to encourage
service providers to invest in the new public network.
Scalable, High-Capacity and High-Speed. The new public network must be
capable of efficiently and effectively delivering voice and high-speed data
services to meet consumer demand for Internet access, the delivery of audio and
video over the Internet, video conferencing, online entertainment and other new
bandwidth-intensive services. The infrastructure solutions for the new public
network must also scale to accommodate thousands of users making simultaneous
connections while delivering the reliability and quality of traditional
circuit-based networks.
Open Service Creation Architecture, Rapid Service Delivery. As competition
increases, service providers must differentiate themselves by offering their
customers not only traditional voice services but also enhanced, value-added
services. An open architecture will allow service providers and third-party
software companies to write applications, enabling the rapid creation and
delivery of both traditional voice services as well as new value-added services
and applications.
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Network-Based, Service-Enabling Applications. Service providers generate
revenues by delivering communications services and features ranging from
traditional call waiting and call forwarding to advanced applications such as
unified messaging. Because price competition has driven down revenues generated
by providing basic call services, service providers are seeking to increase
revenues by delivering full-featured and competitive service offerings to their
customers. The ability to quickly deploy new service applications is
particularly important for emerging carriers that generally do not have the
time or resources necessary to develop service applications in-house.
Meanwhile, incumbent carriers will require traditional service applications to
be readily available to ensure the seamless migration of their existing voice
services to packet-based networks.
Convergent Networks' Solution
We design, develop and market a new generation of switching equipment and
software that enable communications service providers to deliver voice and data
services over broadband networks.
Our Cohesion product family consists of the following:
. ICS2000 Broadband Switch
. ICServiceWorks comprised of:
. ICSX Softswitch
. ICSG Signaling Gateway
. ICServiceWorks Application Modules
. ICView Network Management System
[A graphic depiction of the ICView Management System appears here. A large
rectangle labelled ICServiceWorks Service Creation Softswitch occupies the top
half of the graphic.
A cluster of three clouds appears to the right of the rectangle labelled
ICS2000 Broadband Switch. The clouds are individually labelled Packet, Internet
and Public Telephone Network, and are each connected by a solid line to the
rectangle labelled ICS2000 Broadband Switch. The six smaller rectangles are
arranged in two rows with four rectangles over two rectangles. The four top
rectangles, from left to right, read as follows: ICService Works Class 5
Module; ICService Works Calling Card Module; ICService Works Unified Messaging
Module; and ICService Works Future Application Module. These four rectangles
are connected by dotted lines to another small rectangle labelled ICSX
Softswitch located in the bottom center of the larger rectangle. The ICSX
Softswitch rectangle is connected by a dotted line to another small rectangle
labelled ICSG Signaling Gateway.
A solid line extends downward from the ICSX Softswitch rectangle, crossing
over the boundary of the large rectangle, and connects to a rectangle labelled
ICS2000 Broadband Switch. This rectangle has four solid lines extending left to
four small rectangles stacked vertically. The top rectangle is labelled Modem
and is connected to the ICS2000 Broadband Switch by a line labelled ISDN PRI.
The second rectangle is labelled Traditional Circuit Switch and is connected to
the ICS2000 Broadband Switch by a line labelled Inter Machine Trunk, or IMT.
The third rectangle is labelled Integrated Access Device and is connected to
the ICS2000 Broadband Switch by a line labelled ATM or xDSL. The bottom
rectangle is labelled Private Branch Exchange and is connected to the ICS2000
Broadband Switch by a line labelled ISDN PRI.]
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Our products can be offered together as an integrated solution or
individually as elements of a multi-vendor solution. Our Cohesion family of
products is designed to offer the following key advantages:
Reliability and Voice Service Quality. Our products are designed for the
stringent reliability and performance standards required by incumbent local
exchange carriers, long distance carriers and competitive local exchange
carriers. The ICS2000 is designed to support the same high level of voice
quality over packet-based networks as is provided by today's circuit-based
networks. The specific reliability capabilities include:
. hardware designed and certified for Network Equipment Building
Standards, or NEBS, Level 3 compliance;
. full equipment redundancy, including hot standby for the common
equipment and redundancy for network interfaces;
. non-disruptive software upgrades, which allow software upgrades to be
made while the switch is in use;
. sophisticated network management and web-based configuration
capabilities; and
. a complete set of serviceability features and remote diagnostics
designed to ease maintenance.
Interoperability with Existing Infrastructure. Our products are designed to
interface with existing circuit switches, supporting the switching of calls
between broadband packet-based and traditional circuit-based networks. This
allows service providers to migrate to the new public network while preserving
their investment in traditional circuit-based networks. Our products are also
designed to be fully compatible with all major voice and data networking
standards and interfaces, including Signaling System 7 signaling protocol,
asynchronous transfer mode data networking standards, voice coding standards
and all widely deployed, high-speed interfaces.
High Port Density and Efficient Space Usage. The cost-effectiveness of our
broadband switching solution is realized through the lower central office space
costs, lower power and cooling requirements, and reduced capital equipment
investment required to deploy our solution as opposed to traditional circuit-
based networks. Our ICS2000 broadband switch has been designed to handle high
voice port density, particularly when compared to legacy circuit switches. The
ICS2000 can switch up to 36,000 voice ports and three ICS2000's stacked in a
standard telecommunications bay can switch up to 108,000 voice ports in a 24 x
24 inch footprint. This represents a fraction of the space needed for
traditional circuit switches, allowing service providers to deploy our
equipment in central office locations where space is limited and where
traditional circuit switches may not be an option due to their expansive space
requirements.
Broadband Performance and Scalability. By leveraging a high-capacity packet
switch architecture and call control software, the ICS2000 delivers high-
performance switching of calls over broadband packet-based networks. Together,
the ICS2000 and the ICSG signaling gateway can process up to 500,000 voice
calls in one hour. To meet a service provider's expanding network demands, the
solution can be scaled by aggregating up to 20 ICS2000s and connecting them to
an asynchronous transfer mode core switch. The resulting virtual switch can
support in excess of 300,000 voice ports and can process up to ten million
voice calls in one hour. Additionally, a single redundant ICSG signaling
gateway can support up to 20 geographically distributed ICS2000 switches,
minimizing the need for multiple and costly Signaling System 7 signaling links
for each switch.
Open Architecture, Flexible Call Control and Service Creation. The
ICServiceWorks software is designed to provide call control, Signaling System 7
signaling and an open service creation environment allowing third parties to
create network-based service applications. Today, ICServiceWorks works with
some switching products offered by Cisco and Lucent for service applications
such as calling card services. Because ICServiceWorks will control and manage
calls and services for the ICS2000 by using the industry standard
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Media Gateway Control Protocol, or MGCP, future releases will be compatible
with other vendors' switching equipment using this industry standard.
Additionally, ICServiceWorks will include an application programming interface,
allowing third parties to create new service applications, including end-user
subscription services for businesses and consumers, as well as future advanced
voice applications.
Network-Based Service Applications. Our ICServiceWorks solution includes
service-enabling applications such as prepaid and postpaid calling card
services and unified messaging. Unified messaging provides capabilities for
voicemail, interactive voice response, follow-me/find-me, voice recognition and
text-to-speech. Our service-enabling applications allow our customers to
differentiate their service offerings and generate increased revenues.
Convergent Networks' Strategy
Our objective is to become a leading supplier of switching products that
enable communications service providers to rapidly deliver voice and data
services over packet-based networks. Our strategy to achieve this objective
includes the following key elements:
Leverage Our Solutions-Oriented Approach
We intend to aggressively expand the market we serve by providing an
integrated and open solution, which includes switching products, software that
manages call switching and enables new services and applications, and network-
based service applications. We believe that our solution will enable our
customers to rapidly deploy next-generation networks and offer revenue-
generating services. By providing an integrated product line, we are offering
service providers a single vendor solution to their network requirements. In
addition, we are developing our softswitch with an industry-standard interface,
which will allow it to be used on other vendors' hardware. We intend to make
available an application programming interface to encourage third-party
development of new, network-based service applications. This strategy will
allow service providers with existing circuit-switched equipment to migrate to
next-generation networks, as well as enabling next-generation service providers
to build new networks.
Increase Our Customer Base Though Expanded Product Offerings
We intend to continue to expand our product offerings to provide value-added
network solutions to current and potential customers. Our Internet offload
product routes modem calls from Internet users off of the circuit-switched
network to packet-based networks, which saves expensive and overloaded circuit-
based network and equipment resources. Our broadband network access product
will enable service providers to deliver high-speed Internet access coupled
with voice services over digital subscriber line or asynchronous transfer mode
networks to small business and residential users. Our broadband trunking
solution will allow service providers to expand and compete in the long
distance market by switching voice and data traffic between local access
networks over next-generation asynchronous transfer mode and Internet Protocol
core backbone networks.
Increase Our Global Sales and Marketing Capabilities
We are rapidly expanding our sales, sales engineering and marketing
personnel to increase our worldwide presence. We have recently opened regional
sales offices and hired additional sales personnel in the United States to
increase our direct sales force capabilities. We expect to continue to hire
additional sales personnel and open new sales offices in the United States. Our
recent acquisition of TCS has provided us with a sales office in the United
Kingdom. We expect to increase our international presence by opening additional
offices in Europe and Asia, and we plan to augment our direct sales force
through international distribution partners. We also plan to expand our
marketing efforts to build market awareness and acceptance of our company and
our products, as well as to generate qualified customer leads.
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Deliver Superior Customer Service and Support
Because our products are a critical element of our customers' networks, we
will continue to seek to increase customer satisfaction and strengthen customer
loyalty through our quality service offerings. We believe that delivering
superior customer service and support is essential to winning and retaining
business. We offer comprehensive customer service and support, including
consulting, training, software upgrades, and 24 by 7 on-line and telephone
support. We intend to continue improving our customer support services and
devoting significant resources to our customers to help them fully utilize the
benefits of our products.
Pursue Strategic Alliances and Acquisitions
We intend to expand our product offerings by aggressively pursuing strategic
alliances with leading communications infrastructure providers that have
complementary technology and products. These may include vendors of access
equipment and customer premise equipment, as well as application development
companies. Our intention is to provide greater value to our customers by
providing solutions to their network issues and, if necessary, we will partner
with other companies to provide the best result for our customers. We also
intend to establish sales and distribution relationships with third parties
that will resell, integrate or support our products. We will continue to
participate in industry standards-making forums to ensure the long-term
interoperability of our products with evolving industry standards. We also
intend to selectively pursue acquisitions of companies or technologies that
complement our product family and our business.
Products
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[A graphic depiction of Convergent Networks' Cohesion Product Family in the
New Public Network appears here. In the center is a cloud labelled Packet
Backbone. This cloud appears in front of a larger oval cloud. Below the Packet
Backbone cloud appears an item labelled ICView. Appearing in clockwise order
around the center cloud are depictions of the ICS2000, ICServiceWorks ICSG,
ICServiceWorks ICSX, ICServiceWorks Applications Server and ICS2000,
representing the family of Convergent Networks' Cohesion products. Each of these
items is connected by a solid line to the center cloud.
In the upper right corner of the graphic is a small cloud labelled Public
Telephone Network which is connected to the ICS2000. To the right of the Public
Telephone Network cloud is a telephone and a workstation. In the lower right
corner of the graphic is a small oval labelled ATM which is connected by a solid
line to the ICS2000. Within that oval is a telephone, a workstation and modem
representing peripheral equipment using ATM interfaces.
In the upper left corner of the graphic appears a cloud within an oval
labelled Internet Service Provider which is also connected by a solid line to
the ICS2000. In the lower left corner of the graphic, is an oval which is also
connected by a solid line to the ICS2000. Within that oval is a telephone, a
workstation and a modem, representing peripheral equipment using xDSL
interfaces.
Above the depiction labelled ICServiceWorks ICSG, connected by a solid line,
is an oval cloud labelled SS7.]
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ICS2000 Broadband Switch
The ICS2000 broadband switch is designed to enable voice traffic to be
transported over broadband packet-based networks. Today, the ICS2000 supports
both circuit-based and asynchronous transfer mode packet-based interfaces, and
is designed to support Internet Protocol packet-based interfaces, which will be
available in a future release. The ICS2000 consists of a single chassis,
designed specifically for service providers' central offices, with 20 slots and
a 10 Gigabit packet switch architecture, which is configured as two 5 Gigabit
redundant switches. The switch architecture provides dedicated bandwidth to
each slot. Two of the slots are dedicated to the redundant switching
architecture and control processor, while the remaining 18 slots are available
for DS3, OC-3 or OC-12 interfaces, as well as new feature modules. The new
feature modules which will be supported will provide additional value-added
functions, including high-density asynchronous transfer mode user switching,
echo cancellation conforming to the latest G.168 standard, G.711 and G.726
voice compression and full tone generation and detection capabilities. The
ICS2000 can be initially deployed with only two slots occupied and capacity and
features can be added by inserting additional cards into the open slots,
providing a flexible solution for next-generation network developers. A single
ICS2000 can switch up to 36,000 voice ports and three ICS2000s stacked in a
telecommunications bay can switch up to 108,000 voice ports in a 24 x 24 inch
footprint. Up to 20 geographically distributed ICS2000s can also be linked
together to provide a scalable solution for service providers managing heavy
network demands.
The ICS2000 is designed to provide network-level reliability and has
received full Network Equipment Building Standards Level 3 certification. The
ICS2000 also supports optional full redundancy, including hot standby for the
common equipment, redundancy for the network interfaces and new feature
modules. All optical interfaces support Automatic Protection Switching for
increased resiliency, and the system is designed to support non-disruptive
upgrades to the software.
In the current version of the ICS2000, voice calls are controlled and
managed using software technology that resides in the ICS2000 and the ICSG.
With the addition of the industry-standard Media Gateway Control Protocol, or
MGCP, protocol, future releases of the ICS2000 will be controlled by the
ICServiceWorks MGCP-based ICSX softswitch, as well as any MGCP-compliant
softswitch offered by other vendors.
ICServiceWorks Service Creation Softswitch
ICServiceWorks is a software product that controls and manages voice calls
in packet-based networks. Today, the ICServiceWorks ICSG Signaling System 7
signaling software works in conjunction with the ICS2000's call control
functionality to provide a cost-effective Signaling System 7 signaling solution
to interconnect the traditional public telephone network with a network of
ICS2000 switches, allowing service providers to preserve their existing
infrastructure investment and offer a range of traditional network services,
such as 800 number lookup and local number portability, in a packet-based voice
network. With the addition of industry-standard MGCP protocol, future releases
of ICServiceWorks will control and manage calls for the ICS2000, and will allow
network-based service applications, such as traditional custom calling features
as well as enhanced applications, including unified messaging and calling card
services, to be supported in an ICS2000 network. Additionally, future releases
of ICServiceWorks will include an application programming interface that will
enable the rapid delivery of additional advanced services by next-generation
service providers.
Today, the ICServiceWorks ICSX softswitch is compatible with some switching
products offered by Cisco and Lucent for service applications such as calling
card services. With the introduction of MGCP, future releases will also be
compatible with other vendors' switching equipment using this industry
standard.
ICView Network Management System
ICView is a suite of management tools for element management, billing and
subscriber management. ICView provides a Java-based network manager with
service provisioning capabilities that can be accessed anywhere in the network
via a web browser. ICView allows network managers to monitor and control their
deployed ICS2000s and can remotely manage fault, configuration, asset,
performance and security functions. ICView presents
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information critical to business and operational decisions by collecting and
analyzing alarms and statistics on circuit-based and packet-based networks, and
by processing call traffic for both real-time and historical reporting. It also
simplifies configuration by providing automated tools to help network managers
make changes and backups from a central location. The system also interfaces
with service providers' billing systems.
Customers
Our target customers include both new and established communications service
providers, including local exchange carriers, long distance carriers, operators
of foreign telephone networks and Internet service providers. As of September
30, 2000, we had recognized revenues from the following customers:
. BT
. Global NAPs
. Missouri Telecom
For the nine months ended September 30, 2000, Global NAPs, an affiliate of
which owns approximately 1% of our capital stock, accounted for approximately
73% of our revenues and BT accounted for approximately 22% of our revenues.
In addition, we shipped products under signed purchase orders to several
additional companies, including Broadwing and Focal Communications, subject to
acceptance testing.
Sales and Marketing
We sell and market our products through a direct sales force made up of
sales professionals with experience in selling network equipment to
communications service providers. In addition, we intend to establish a
strategic distribution relationship with a global technology partner to provide
sales and support of our products and services outside of the United States, in
order to better serve customers in specific geographic regions.
We maintain 13 sales offices; 12 in the United States and one in the United
Kingdom. Our direct sales account managers are responsible for a market on
primarily a geographic basis and work as a team with a dedicated system
engineer. Our system engineers consult with and assist our customers in
deploying our products and identifying features required for specific
applications. We believe that through this direct interaction we can more fully
understand the business models and product requirements of our customers.
We have a number of marketing programs to drive demand for our products in
broadband packet-based network applications. These programs include
comprehensive sales tools, pricing strategies, sales training, competitive
information, product collateral, application notes, customer deployment
information and customer support programs. We work actively with major industry
publications and industry analysts to help educate service providers on the
benefits of broadband packet-based network technology. In addition, we
participate in and monitor the activities of industry consortiums and standards
organizations, including the Internet Engineering Task Force, the International
Telecommunications Union, the ATM Forum, the DSL Forum, the International
Softswitch Consortium and the Optical Domain Service Interconnect.
Customer Service and Support
We are committed to delivering the products and resources that will
contribute to the growth and success of our customers' businesses. We offer
customer support and professional services delivered by a team of support
experts. We have established a technical assistance center at our worldwide
headquarters in Lowell, Massachusetts, which supports our customers 24 hours a
day, seven days a week. We believe that our customer service and support
offerings help ensure a customer's success with our products. As of September
30, 2000,
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we employed 31 people in our customer service and support organization. To
complement our internal customer service organization, we plan to enter into a
global service and support arrangement for our products with one or more
independent service providers.
Our customers can purchase contractual support and services to gain access
to software and hardware services, training services and installation services.
Software and hardware service contracts provide extended coverage beyond the
end of the standard warranty periods, customer access to new releases of
previously licensed software features, and alternatives regarding advanced
replacement or return to factory for hardware repair. Training services offer
training for installation, operations and maintenance personnel.
Research and Development
Our future success depends on our ability to increase the performance of our
products, to develop and introduce new products and product enhancements and to
effectively respond to our customers' changing needs. Our research and
development team is primarily responsible for, and is currently working on,
meeting these objectives. We have made, and will continue to make, a
substantial investment in research and development. Research and development
expenses were $13.1 million for 1999 and $9.3 million for the nine months ended
September 30, 2000. To meet customer demand for products that support a full
range of voice and data networking standards and interfaces, we intend to
develop our ICS2000 switch to support the delivery of voice traffic over
networks based on Internet Protocol and other protocols used in countries
outside of the United States. We are also developing features for our
ICServiceWorks product to enable our customers to offer new value-added voice
services. We conduct our research and development at facilities in Lowell,
Massachusetts and Sunrise, Florida.
Manufacturing
We maintain only limited in-house manufacturing capability for final system
integration and testing of our products. Our internal manufacturing expertise
is focused on product design for testability, design for manufacturability and
the transfer of products from development to manufacturing.
We have established a contract manufacturing relationship with ACT
Manufacturing. Using a contract manufacturer allows us to reduce our capital
expenditures, achieve purchasing economies of scale and reduce inventory
warehousing. Under our manufacturing services agreement with ACT, ACT
manufactures our ICS2000 broadband switch and provides related services to us.
This agreement is for an initial one-year term and automatically renews at the
end of the term for additional one-year terms. At any time after the initial
term, either party can terminate the agreement on 180 days' prior notice. Other
manufacturers, including Celestica, Sanmina and SMTC, manufacture sub-
assemblies and other components of our products on a purchase order basis. If
ACT or any other contract manufacturer fails to make timely delivery of
products or key sub-assemblies or components, our ability to make timely
product deliveries may be disrupted.
We currently purchase several key components of our products from single or
limited sources, including semiconductors from Lattice Semiconductor, Lucent,
Mitel, PMC-Sierra and Texas Instruments. We purchase these components on a
purchase order basis. In the past, there have been shortages of individual
components from time to time. For example, we have experienced shortages in
flash memory chips, which required us to hold excess inventory of these
components to avoid disruption to our manufacturing process. Shortages of flash
memory chips and other components are likely to occur in the future. To the
extent shortages occur in the future, we may again be required to hold excess
inventory or our ability to manufacture our products could be disrupted.
Competition
The market for voice switching equipment and software for the new public
network is intensely competitive, subject to rapid technological changes and
significantly affected by new product introductions and other market
activities. We encounter strong competition from large suppliers, such as
Cisco, Lucent and
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Nortel, who offer a broad range of products across multiple service areas, are
substantially larger than we are and have significantly greater financial,
sales, marketing, distribution, technical, manufacturing and other resources.
This makes them better positioned to acquire other companies, thereby obtaining
new technologies or products that may displace our product lines. We also
compete with Sonus Networks in the next-generation voice switching market, and
several other companies in the same market. We also compete with single product
companies which offer or will offer solutions that compete with one of our
product areas. In the future, we expect that additional companies will enter
the market with competitive solutions.
Our products compete with traditional circuit-switch network products sold
by established manufacturers, including Lucent and Nortel. We believe that our
products compete with circuit-switch products based on the following principal
factors:
. higher voice port density, which reduces floor space requirements for
equipment;
. ability to more rapidly develop network-based services and features
using our products;
. the lower cost of the initial investment required to install our
products and lower cost of operating our products; and
. interoperability with both traditional circuit-switch networks and
packet-based networks.
Our products also compete with Cisco and other providers of packet-based
network equipment. We believe that our products compete with Cisco and other
packet-based network equipment providers on the following factors:
. performance, reliability and quality of our products;
. scalability to support additional simultaneous voice calls;
. support of multiple voice and data networking standards and interfaces;
and
. support of communications services-enabling applications.
Nonetheless, our products may not compete effectively with the current or
future products of our competitors. In addition, we believe that a knowledge of
the network infrastructure requirements applicable to communications service
providers, experience in working with service providers to develop new services
for their customers, and an ability to provide vendor-sponsored financing are
important competitive factors in our market. While we believe that we have
significant knowledge of infrastructure requirements and experience relating to
developing new services, we do not currently have the ability to provide
vendor-sponsored financing. This may influence the purchasing decisions of
prospective customers, who may decide to purchase products from our competitors
that offer vendor financing.
Intellectual Property
Our success and ability to compete are dependent on our ability to develop
and maintain the proprietary aspects of our technology. We rely on a
combination of trademark, copyright and trade secret laws, employee and third-
party nondisclosure agreements and licensing arrangements to protect our
intellectual property. These legal protections afford only limited protection
for our technology. We cannot assure you that others will not develop
technologies that are similar or superior to our technology. We have applied
for federal trademark registration of Cohesion, Convergent Networks, ICS,
ICServiceWorks, ICSG, ICSX, ICView and The Voice of Broadband Networking. We
also claim common law protections for other marks we use in our business. We
have received a notice from another company with a similar name demanding that
we change our name. We may not be able to continue using our name and our
trademark applications may not be granted.
To date, we have one issued patent and two patent applications pending in
the United States. Additionally, we have several related non-U.S. patent
applications pending, relating to the design and operation of our products. Our
pending patent applications may not result in the issuance of any patents. If
any patent is issued, it may be invalidated or circumvented or may otherwise
fail to provide us with any meaningful protection. We
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do not conduct comprehensive patent searches to determine whether the
technology used in our products infringes any patents held by third parties. If
we were to discover that any of our products violated the intellectual property
rights of a third party, we might be unable to redesign our product to avoid
violating their rights, and we might be unable to obtain a license on
commercially reasonable terms to use the third-party intellectual property. In
addition, we might be prevented from continuing to sell that product, which
could cause us to lose sales.
We have incorporated third-party licensed technology into our current
products. From time to time, we may be required to license additional
technology from third parties to develop new products or product enhancements.
Third-party licenses may not be available or continue to be available to us on
commercially reasonable terms. For example, we license Signaling System 7
technology, which is an important part of our ICS2000 switch, from Ulticom
under an agreement which Ulticom may terminate on July 23, 2002. If Ulticom
terminates this license, or if we are unable to maintain or renew other third-
party licenses of technology required in our products, our business and our
operating results may be harmed. In addition, if we are unable to obtain any
new third-party licenses to develop new products and product enhancements, we
could be required to obtain substitute technology of lower quality or
performance standards or at greater cost, which could delay or prevent us from
making these products or enhancements.
Employees
As of September 30, 2000, we had a total of 241 employees. Of the total, 115
were in research and development, 45 in sales and marketing, 31 in customer
support and professional services, 20 in manufacturing and 30 in finance and
administration. None of our employees is subject to a collective bargaining
agreement and we believe that our relations with our employees are good.
Facilities
We are headquartered in Lowell, Massachusetts where we lease approximately
72,000 square feet under a lease which expires in August 2006. We also lease
approximately 24,090 square feet in Sunrise, Florida under a sublease which
expires in January 2004. We also lease approximately 9,680 square feet in Fort
Lauderdale, Florida under a lease which expires in July 2003. We intend to
sublease to a third party the Fort Lauderdale premises as soon as we locate a
subtenant. We believe our current facilities will be adequate to meet our near-
term space requirements.
Legal Proceedings
On May 27, 1999, MCIWorldcom filed a lawsuit in the Circuit Court of the
17th Judicial Circuit in the State of Florida alleging breach of contract and
unjust enrichment by Technology Control Services and breach of guaranty by its
parent company Hemisphere Investments. On July 31, 2000, we acquired Hemisphere
and its wholly owned subsidiaries, including Technology Control Services,
collectively TCS. MCI alleges that TCS breached two contracts and was unjustly
enriched by failing to pay for telecommunications services allegedly rendered
by MCI in connection with TCS' discontinued business of the resale of voice
traffic. MCI is seeking up to $3,227,487 in damages, as well as costs and
attorneys' fees. We intend to defend ourselves vigorously against MCI's claim.
TCS has also filed counter-claims against MCI for breach of contract and
intentional interference with business relationships for an unspecified sum.
However, there can be no assurance that we will be successful in the defense of
this litigation. We may consider settlement due to the costs and uncertainties
associated with litigation in general, and the diversion of the time and
attention of some members of our management. In connection with our acquisition
of TCS, fifteen percent of the shares of our common stock issued to
stockholders of TCS have been held in escrow to secure specified
indemnification obligations of TCS and its stockholders, including any damages
we might incur as a result of the MCI litigation.
From time to time, we may be involved in litigation relating to claims
arising out of our operations in the normal course of business.
39
<PAGE>
MANAGEMENT
Executive Officers, Directors and Key Employees
Our executive officers, directors and key employees and their respective
ages and positions as of September 30, 2000, are as follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
John C. Thibault................ 46 Chairman of the Board, President and Chief
Executive Officer and Director
Bing Yang....................... 38 Senior Vice President and Chief Technology
Officer and Director
Pamela F. Lenehan............... 48 Vice President and Chief Financial Officer
Sally J. Bament................. 38 Vice President, Marketing
Brian R. Fitzgerald............. 40 Vice President, Worldwide Sales
Kenneth MacLure................. 42 Vice President, Operations
Ronald J. Rando................. 56 Vice President, Worldwide Customer Support
Todd A. Dagres (1)(2)........... 40 Director
David E. Schantz (2)............ 34 Director
William E. Foster (1)(2)........ 56 Director
</TABLE>
---------------------
(1) Member of the compensation committee.
(2) Member of the audit committee.
John C. Thibault has served as our President and Chief Executive Officer,
Chairman of the Board of Directors and a Director since February 2000. Mr.
Thibault served as Senior Vice President for the Applications Technology Group
of Cisco Systems, a provider of networking solutions, delivering customer
contact software solutions for enterprise and service provider environments
from June 1999 to December 1999. Before joining Cisco, Mr. Thibault was
President and Chief Executive Officer of GeoTel Communications, a provider of
software solutions for distributed voice call centers for enterprise and
service provider customers, from December 1993 to June 1999 when GeoTel was
acquired by Cisco Systems. Before founding GeoTel Communications, Mr. Thibault
served as President and Chief Executive Officer of Coral Network, which
designed, developed and marketed a backbone router for enterprise network
applications, from 1991 to 1993. He was Senior Vice President and General
Manager of the Codex division of Motorola, a provider of integrated
communications solutions and embedded electronic solutions, from 1988 to 1991.
Mr. Thibault was at Wang Laboratories, a global network and desktop integrating
and services company, from 1975 to 1988.
Bing Yang co-founded Convergent Networks in May 1998 after serving more than
14 years in the data communication and telecommunications industries. Most
recently, Mr. Yang served as Vice President of Engineering and Technology at
XCOM Technology, a New England-based communications service provider, from
January 1998 to May 1998, where he developed the company's Internet Signaling
System 7 gateway product. He founded Cadia Networks, a manufacturer of
asynchronous transfer mode access equipment, which was later acquired by FORE
Systems, a manufacturer of asynchronous transfer mode access and switching
equipment, where he managed system development for the company's multi-service
asynchronous transfer mode access solution from March 1996 to January 1998. Mr.
Yang worked from 1994 to March 1996 at Cascade Communications, a manufacturer
of carrier frame relay and asynchronous transfer mode switching equipment,
where he was responsible for asynchronous transfer mode switch development, and
at Cabletron Systems, a manufacturer of data networking products and services,
from March 1991 to April 1994, where he managed an application-specific
integrated circuit design team for next-generation hub development.
Pamela F. Lenehan has served as our Vice President and Chief Financial
Officer since March 2000. Prior to joining Convergent Networks, Ms. Lenehan
served as Senior Vice President, Corporate Development and Treasurer for Oak
Industries, a manufacturer of highly engineered communications components, from
February 1995 until Oak Industries' acquisition by Corning, a manufacturer of
fiber optic cable and components, in January 2000. Previously, Ms. Lenehan was
at Credit Suisse First Boston from June 1981 to December 1994,
40
<PAGE>
most recently as Managing Director, Investment Banking, where she handled
equity and debt financings and mergers and acquisitions for technology
companies. Before joining Credit Suisse First Boston, Ms. Lenehan served as a
lending officer at the Chase Manhattan Bank from 1974 to 1981.
Sally J. Bament has served as our Vice President, Marketing since February
1999. From June 1994 to February 1999, Ms. Bament was at Bay Networks, now
Nortel Networks, a provider of telephone, data and wireless wireline solutions
for the Internet, most recently as Vice President of Product Management, where
she was responsible for establishing strategic direction and executing short-
and long-term product plans for the company's routing products divisions. From
June 1991 to June 1994, she was Director of Marketing at Coral Network, which
was later acquired by Synoptics, a manufacturer of enterprise local area
network equipment. Ms. Bament spent four years from September 1987 to June 1991
with Motorola, with senior product management and marketing responsibilities
for the company's asynchronous transfer mode and frame relay products. She was
with British Petroleum from 1983 to 1987, in both London and New York, where
she worked as a software engineer in data networking.
Brian R. Fitzgerald has served as our Vice President, Worldwide Sales since
May 2000. From March 1997 to May 2000 he was at Lucent Technologies, a provider
of communications systems, products, technologies and support, most recently as
Senior Director of Global Accounts, with responsibility for sales and systems
engineering teams for enterprise internetworking systems. Prior to that, he was
Senior Director of Original Equipment Manufacturers Sales for Agile Networks, a
division of Lucent, where he managed the worldwide original equipment
manufacturers sales organization. Mr. Fitzgerald also held several senior-level
sales positions with Racal Data Group, a manufacturer of telecommunications
equipment, from March 1990 to March 1997, including Vice President of Original
Equipment Manufacturers Sales. From 1982 to February 1990, he held various
sales positions with Digital Communications Associates, a manufacturer of data
communications equipment, Exxon Office Systems, a manufacturer of word
processing office equipment, and Procter & Gamble, a provider of consumer
products and services.
Kenneth MacLure has served as our Vice President, Operations since September
1998. Prior to that, from November 1997 to August 1998, Mr. MacLure was
Director of Manufacturing at Aptis Communications, a manufacturer of an access
switch designed for network service providers, which was acquired by Nortel
Networks. From 1994 to October 1997, he was Director of Operations Technology
at Cascade Communications. From 1991 to 1994, Mr. MacLure was Manager of
Operations at Supernetics, a startup manufacturer of integrated services
digital network products. Prior to that, Mr. MacLure spent 13 years at Motorola
in various engineering positions for wide area network, local area network and
wireless technologies.
Ronald J. Rando has served as our Vice President, Worldwide Customer Support
since August 2000. From December 1998 to August 2000, Mr. Rando was Vice
President Global Service and Support at Cabletron Systems. From December 1996
to December 1998, Mr. Rando was Vice President, Customer Services of the
Computer Systems Division of NEC, a provider of information and communications
systems and equipment. From 1994 to December 1996 and from 1974 to 1984, Mr.
Rando held various management positions at Digital Equipment Corporation, a
supplier of high performance web-based computing solutions, most recently Vice
President, Americas' Customer Service and Support, Personal Computer Business
Unit.
Todd A. Dagres has served on our board of directors since May 1998. Mr.
Dagres is a General Partner of Battery Ventures, a venture capital firm, which
he joined in August 1995. From 1994 to August 1995, he worked at Montgomery
Securities, where he was a Principal and Senior Technology Analyst focusing on
the networking industry. Prior to Montgomery, he was a Senior Technology
Analyst and Vice President of a division of Smith Barney. Mr. Dagres also held
positions as Vice President of Communications Research at The Yankee Group, a
provider of industry analysis and research, and Business Development Manager
for Networking at Digital Equipment Corporation. Mr. Dagres serves on the
boards of directors of Akamai Technologies, Edgix, Equipe Communications, Focal
Communications, Inventa, Predictive Networks and RiverDelta Networks.
41
<PAGE>
David E. Schantz has served on our board of directors since May 1998. Mr.
Schantz is a General Partner of Matrix Partners, a venture capital firm, which
he joined in January 1998. From June 1996 to January 1998, he was Director of
Product Management and Marketing and was a member of the founding team at Cadia
Networks, which was acquired by FORE Systems. Prior to that, Mr. Schantz served
as Product Line Manager of the Service Provider Products Division at Bay
Networks, now Nortel Networks, from 1993 to June 1996. He was a member of the
Technical Staff and a Product Manager in the Data Communications Business Unit
at AT&T Bell Laboratories, a systems and technology research and development
company, which is now Lucent, from 1988 to 1993. Mr. Schantz serves on the
boards of directors of Airvana, Appian Communications, Cereva Networks,
Crossbeam Systems, Sandburst and Silverback Technologies.
William E. Foster has served on our board of directors since August 2000.
Mr. Foster has over 17 years of experience in the computer and
telecommunications industries. Mr. Foster co-founded Stratus Computer, a
designer of fault-tolerant computer systems for online transaction processing
and communications controls, and served as Chief Executive Officer from 1980 to
May 1997 and as Chairman from 1980 to October 1998 when Stratus Computer was
acquired by Ascend Communications, a manufacturer of telecommunications
equipment, which was subsequently acquired by Lucent. Prior to that time, Mr.
Foster spent 14 years in the computer industry at Data General as Vice
President of Software, and at Hewlett-Packard, where he held several management
and technical positions. Mr. Foster is currently a private investor and serves
on the board of directors of Natural MicroSystems.
Executive Officers
Each officer serves at the discretion of our board of directors and holds
office until his successor is elected and qualified or until his earlier
resignation or removal. There are no family relationships among any of our
directors or executive officers.
Election of Directors
Following this offering, the board of directors will be divided into three
classes, with members of each class serving for a staggered three-year term.
Messrs. Schantz and Thibault will serve in the class whose term expires in
2001, Messrs. Foster and Yang will serve in the class whose term expires in
2002, and Mr. Dagres will serve in the class whose term expires in 2003. At
each annual meeting of stockholders, a class of directors will be elected for a
three-year term to succeed the directors of the same class whose terms are then
expiring.
Compensation of Directors
We reimburse directors for reasonable out-of-pocket expenses incurred in
attending meetings of the board of directors. On August 28, 2000, we granted an
option to purchase 200,000 shares of common stock at an exercise price of
$10.00 per share to Mr. Foster. Twenty-five percent of the shares subject to
the option vest on August 28, 2001, and the remaining shares vest evenly over
the next 12 quarters.
Board Committees
The board of directors has established a compensation committee and an audit
committee. The compensation committee, which consists of Messrs. Dagres and
Foster, reviews executive salaries, administers bonuses, incentive compensation
and stock plans, and approves the salaries and other benefits of our executive
officers. In addition, the compensation committee consults with our management
regarding our benefit plans and compensation policies and practices.
The audit committee, which consists of Messrs. Dagres, Foster and Schantz,
reviews the professional services provided by our independent accountants, the
independence of our accountants, our annual financial statements and our system
of internal accounting controls. The audit committee also reviews other matters
with respect to our accounting, auditing and financial reporting practices and
procedures as it may find appropriate or may be brought to its attention.
42
<PAGE>
Compensation Committee Interlocks and Insider Participation
Messrs. Dagres and Foster are the members of our compensation committee.
Neither Mr. Dagres nor Mr. Foster is an executive officer of Convergent
Networks, nor has either received any compensation from us within the last two
years other than in his capacity as a director. Mr. Thibault served on the
compensation committee from February 2000 until September 2000. From January
1999 through April 1999, Mr. Yang served on the compensation committee. Messrs.
Thibault and Yang did not participate in deliberations regarding their own
compensation. No interlocking relationship exists between any member of our
board of directors or our compensation committee and any member of the board of
directors or compensation committee of any other company, and no such
interlocking relationships have existed in the past.
Executive Compensation
The following table sets forth the total compensation paid or accrued for
the fiscal year ended December 31, 1999 for Messrs. Karl May, our former
President and Chief Executive Officer, Bing Yang, Hwang-Ruey Wang, Sally J.
Bament and Kenneth MacLure, who were the only executive officers whose salary
and bonus for the fiscal year were in excess of $100,000. We refer to all of
these officers collectively as our "named executive officers."
Summary Compensation Table
<TABLE>
<CAPTION>
Long-Term
Annual Compensation Compensation
------------------------------ ---------------------
Restricted Securities
Name and Principal Other Annual Stock Underlying
Position Salary Bonus Compensation Awards Options
------------------ -------- ----- ------------ ---------- ----------
<S> <C> <C> <C> <C> <C>
Bing Yang................. $141,019 -- -- --(2) --
President, Executive Vice
President and Chief
Technical Officer(1)
Hwang-Ruey Wang........... 158,467(3) -- -- --(2) --
Vice President,
Engineering
Sally J. Bament........... 134,344 -- -- --(4) --
Vice President, Marketing
Kenneth MacLure........... 102,060 -- -- --(5) 20,000
Vice President,
Operations
Karl May.................. 105,942 -- $121,875(7) --(8) --
Former Chief Executive
Officer and President(6)
</TABLE>
---------------------
(1) Mr. Yang served as our President from January 1, 1999 to March 22, 1999 and
from November 5, 1999 through January 31, 2000. Mr. Yang served as our
Executive Vice President and Chief Technical Officer from April 10, 1999
through April 13, 2000, and since that time has been our Senior Vice
President and Chief Technical Officer.
(2) The officer held 1,397,000 shares of restricted stock at December 31, 1999
worth an aggregate of $22,352,000 based on an assumed initial public
offering price of $16.00 per share. A total of 2,540,000 shares of
restricted stock were originally granted to the officer, of which 508,000
shares vested on July 14, 1998 and 127,000 shares vest at the end of each
three-month period thereafter. For details relating to changes to the
vesting schedule in the event of an acquisition of our company, see
"Related Party Transactions." We do not intend to pay dividends on these
shares.
(3) Includes payments in the amount of $18,038 related to relocation expenses
reported as income to Mr. Wang.
(4) Ms. Bament held 640,000 shares of restricted stock at December 31, 1999
worth an aggregate of $10,240,000 based on an assumed initial public
offering price of $16.00 per share. A total of 640,000 shares of restricted
stock were originally granted to Ms. Bament, of which 128,000 shares vested
on February 17, 2000 and 32,000 shares vest at the end of each three-month
period thereafter. For details relating to changes to the vesting schedule
upon our change of control, see "--Agreements with Executive Officers." We
do not intend to pay dividends on these shares.
43
<PAGE>
(5) Mr. MacLure held 120,800 shares of restricted stock at December 31, 1999
worth an aggregate of $1,932,800 based on an assumed initial public
offering price of $16.00 per share. Mr. MacLure was originally granted a
total of 126,000 shares of restricted stock, of which 25,200 shares vested
on October 5, 1999 and 6,300 shares vest at the end of each three-month
period thereafter. Mr. MacLure was granted an additional 20,000 shares of
restricted stock, of which 4,000 shares vested on June 29, 2000 and 1,000
shares vest on a quarterly basis thereafter. For details relating to
changes to the vesting schedules upon our change of control, see "--
Agreements with Executive Officers." We do not intend to pay dividends on
these shares.
(6) Mr. May was appointed our President and Chief Executive Officer on March
22, 1999 and ceased to be our Chief Executive Officer and President as of
November 5, 1999.
(7) Consists of $100,000, which represents the difference between the fair
market value, as determined by us, of the 100,000 shares of Series A
convertible preferred stock that Mr. May purchased from us in March 1999
and the price paid for these shares, and a severance payment of $21,875 in
connection with the termination of Mr. May's employment with us.
(8) Upon termination of Mr. May's employment, we repurchased 2,032,000 shares
of common stock at a purchase price of $0.05 per share, the original
purchase price per share paid by Mr. May.
Option Grants in Last Fiscal Year
The following table provides information concerning grants of options to
purchase shares of our common stock made during the fiscal year ended December
31, 1999 to each of the named executive officers. These options vest over a
five-year period as to 20% of the total number of shares on the first
anniversary of the date of grant and as to 5% of the total number of shares
every three months thereafter. The exercise price per share of each option was
equal to the fair market value of the common stock on the date of grant, as
determined by our board of directors.
The potential realizable values are calculated based on the assumption that
the price of our common stock will appreciate from an assumed initial public
offering price of $16.00 at the compounded annual rate shown from the date of
grant until the end of the option term. These values do not take into account
amounts required to be paid as income taxes under the Internal Revenue Code and
any applicable state laws or option provisions providing for termination of an
option following termination of employment. These amounts are calculated based
on the requirements promulgated by the Securities and Exchange Commission and
do not reflect our estimate of future price growth of shares of our common
stock.
<TABLE>
<CAPTION>
Individual Grants
--------------------------------------------
Potential Realizable
Number of % of Total Value at Assumed
Securities Options Exercise Annual Rates of Stock
Underlying Granted to or Base Price Appreciation
Options Employees in Price Expiration for Option Term
Name Granted Fiscal Year Per Share Date 5% 10%
---- ---------- ------------ --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Bing Yang............... -- -- -- -- -- --
Hwang-Ruey Wang......... -- -- -- -- -- --
Sally J. Bament......... -- -- -- -- -- --
Kenneth MacLure......... 20,000 0.6% $0.25 6/29/09 $516,246 $824,998
Karl May................ -- -- -- -- -- --
</TABLE>
44
<PAGE>
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option
Values
The following table sets forth information regarding the exercise of options
to purchase common stock by our named executive officers during fiscal 1999 and
the number and value of unexercised stock options held as of December 31, 1999
by each of these executive officers. The values set forth below have been
calculated based on an assumed initial public offering price of $16.00 per
share, less the applicable per share exercise price, multiplied by the number
of shares issued or issuable upon exercise of the option. During fiscal 1999,
no stock appreciation rights were granted or outstanding.
<TABLE>
<CAPTION>
Number of Securities
Underlying Unexercised Value of Unexercised In-
Options at Fiscal Year- the-Money Options at
Securities End Fiscal Year-End
Acquired Value ------------------------- -------------------------
on Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
----------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Bing Yang............... -- -- -- -- -- --
Hwang-Ruey Wang......... -- -- -- -- -- --
Sally J. Bament......... -- -- -- -- -- --
Kenneth MacLure......... 20,000(1) $315,000 -- -- -- --
Karl May................ -- -- -- -- -- --
</TABLE>
---------------------
(1) As of December 31, 1999, the shares remained subject to repurchase.
Employee Benefit Plans
2000 Stock Incentive Plan
Our 2000 stock incentive plan was adopted by our board of directors in
September 2000, subject to stockholder approval. The 2000 stock incentive plan
authorizes the issuance of up to a total of 10,000,000 shares of common stock
to eligible employees, plus an annual increase of shares beginning in 2001 and
ending in 2010 equal to the lesser of:
.15,000,000 shares;
.4% of the outstanding shares of our common stock on the date of the
increase; or
.an amount determined by the board.
As of September 30, 2000, there were no outstanding options to purchase
shares of common stock under this plan.
The 2000 stock incentive plan provides for the grant of incentive stock
options intended to qualify under Section 422 of the Internal Revenue Code,
nonstatutory stock options, restricted stock awards and other stock-based
awards. Our employees, officers, directors, consultants and advisors and those
of our subsidiaries are eligible to receive awards under the 2000 stock
incentive plan. Under present law, however, incentive stock options may be
granted only to employees. Under the 2000 stock incentive plan, no participant
may receive an award for more than 1,000,000 shares, subject to adjustment in
the event of stock splits and other similar events, in any calendar year.
Optionees may pay the exercise price of their options by cash, check or
delivery of shares of our common stock owned by the optionee for at least six
months prior to their delivery, valued at their fair market value as determined
by our board of directors. Our board of directors, in its discretion, may
permit payment of the option exercise price by delivery of an irrevocable
undertaking by a creditworthy broker, delivery by the optionee of a copy of
irrevocable instructions to a creditworthy broker, delivery of a promissory
note of the option holder, payment of other lawful consideration, or any
combination of the permitted forms of payment.
Our board of directors administers the 2000 stock incentive plan. Our board
of directors has the authority to adopt, amend and repeal the administrative
rules, guidelines and practices relating to the 2000 stock incentive plan and
to interpret its provisions. Our board may delegate authority under the 2000
stock incentive
45
<PAGE>
plan to one or more of its committees and, subject to various limitations, to
one or more of our executive officers. Our board of directors has authorized
the compensation committee to administer the 2000 stock incentive plan,
including the granting of options to our executive officers. Subject to any
applicable limitations contained in the 2000 stock incentive plan, our board of
directors, our compensation committee or any other committee or executive
officer to whom our board of directors delegates authority, as the case may be,
selects the recipients of awards and determines:
. the number of shares of common stock covered by options and the dates
upon which the options become exercisable;
. the duration of options;
. the exercise price of options; and
. the number of shares of common stock subject to any restricted stock or
other stock-based awards and the terms and conditions of the awards,
including the conditions for repurchase, issue price and repurchase
price.
Our board of directors may at any time provide for the acceleration of the
vesting of any options, the removal of restrictions on any restricted stock
awards and the acceleration of the vesting of or the removal of restrictions on
any other stock-based awards, as the case may be.
For purposes of the 2000 stock incentive plan, a reorganization event means
a merger, consolidation or share exchange transaction, and a change in control
event means:
. the acquisition of 50% or more of either:
. the outstanding shares of our common stock; or
. the voting power of our outstanding securities entitled to vote in
the election of our directors;
. the consummation of a merger, consolidation, reorganization,
recapitalization or share exchange, unless specified conditions are
satisfied; or
. the sale of all our assets, unless specified conditions are satisfied.
In the event of a reorganization event that is not also a change in control
event, our board of directors shall provide that all outstanding options under
this plan be assumed or substituted for by the acquiror. If the acquiror does
not agree to this assumption or substitution, then all outstanding options will
become exercisable in full.
In the event of a reorganization event that is also a change in control
event, options shall accelerate in an amount equal to not more than 30% of the
number of shares originally subject to option, with the remaining unvested
shares to vest in accordance with the original vesting schedule. If the
acquiror does not agree to assume or substitute for all unexercised options,
all unexercised options will become exercisable in full.
In the event of a change in control event that is not also a reorganization
event, options shall accelerate in an amount equal to not more than 30% of the
number of shares originally subject to option, with the remaining unvested
shares to vest in accordance with the original vesting schedule.
In the event of a reorganization event that is not a change in control
event, our rights under outstanding restricted stock awards shall inure to the
benefit of our successor. In the event of a change in control event, the
vesting schedule of all outstanding restricted stock awards shall be
accelerated so that an amount equal to no more than 30% of the number of shares
originally subject to restriction shall immediately become free from
conditions, with the remaining unvested shares to become free from conditions
in accordance with the original vesting schedule.
The board of directors may amend, suspend or terminate the 2000 stock
incentive plan or any portion thereof at any time, except that, no award
granted after an amendment to the 2000 stock incentive plan and
46
<PAGE>
designated as subject to Section 162(m) of the Internal Revenue Code by our
board of directors shall become exercisable, realizable or vested, to the
extent an amendment was required to grant an award, unless and until an
amendment is approved by our stockholders.
2000 Employee Stock Purchase Plan
Our 2000 employee stock purchase plan was adopted by our board of directors
in September 2000, subject to stockholder approval. The 2000 employee stock
purchase plan authorizes the issuance to participating employees of up to a
total of 5,000,000 shares of common stock.
All of our employees, whose customary employment is more than 20 hours per
week, including our directors who are employees, and all employees of any
participating subsidiaries, are eligible to participate in the 2000 employee
stock purchase plan. Employees who would immediately after the grant own five
percent or more of the total combined voting power or value of our stock or any
subsidiary are not eligible to participate. As of September 30, 2000,
approximately 238 of our employees were eligible to participate in the 2000
employee stock purchase plan.
On the first day of a designated payroll deduction period, the offering
period, we will grant to each eligible employee who has elected to participate
in the 2000 employee stock purchase plan an option to purchase shares of common
stock as follows: the employee may authorize up to 10% of his or her base pay
to be deducted by us from his or her base pay during the offering period. On
the last day of the offering period, the employee is deemed to have exercised
the option, at the option exercise price, to the extent of accumulated payroll
deductions. Under the terms of the 2000 employee stock purchase plan, the
option price is an amount equal to 85% of the average market price per share of
the common stock on either the first day or the last day of the offering
period, whichever is lower. In no event may an employee purchase in any one
offering period a number of shares which exceeds the number of shares
determined by dividing the product of the number of full months in the offering
period and $2,083 by the closing market price of a share of common stock on the
commencement date of the offering period or another lower number as may be
determined by the board prior to the commencement date of the offering period.
Under current federal tax law, an employee may not purchase more than $25,000
of stock per year, based on the fair market value of the stock at the start of
the purchase period, under a tax-advantaged employee stock purchase plan. The
compensation committee may, in its discretion, choose an offering period of six
months or less for each offering and may choose a different offering period for
each offering.
An employee who is not a participant on the last day of the offering period
is not entitled to exercise any option, and the employee's accumulated payroll
deductions will be refunded. However, upon termination of employment because of
death, the employee's beneficiary has rights to elect to exercise the option to
purchase the shares that the accumulated payroll deductions in the
participant's account would purchase at the date of death.
Because participation in the 2000 employee stock purchase plan is voluntary,
currently we cannot determine the number of shares of common stock to be
purchased by any particular current executive officer, by all current executive
officers as a group or by non-executive employees as a group.
1998 Stock Option Plan
Our 1998 stock option plan was adopted by our board of directors in November
1998 and approved by our stockholders in November 1999. The aggregate number of
shares of our common stock that may be issued under the plan is 16,195,000
shares, subject to adjustment in the event of any stock split and other similar
events, less that number of shares issued under our 1998 restricted stock
purchase plan. As of September 30, 2000, options to purchase an aggregate of
3,046,345 shares of common stock were outstanding under this plan. We are no
longer granting options under this plan.
The 1998 stock option plan provides for the grant of options intended to
qualify as incentive stock options under Section 422 of the Internal Revenue
Code, and nonstatutory stock options. We may grant incentive stock
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options only to our employees including those of our subsidiaries and
nonstatutory stock options to our officers, directors, employees, consultants
and advisors including those of our subsidiaries. No nonstatutory stock options
may be granted at less than 50% of the fair market value of the common stock on
the date of grant.
The board of directors has designated the compensation committee to
administer this plan. Decisions of the compensation committee as to all
questions of interpretation and application of this plan are final, binding and
conclusive. Subject to any applicable limitations contained in this plan, the
compensation committee:
. has the authority to adopt, amend and rescind these rules and
regulations as it deems advisable in the administration of the plan;
. may correct any defect or supply any omission or reconcile any
inconsistency in the plan or in any option agreement granted thereunder;
. determines the eligibility for and selects the recipients of option
grants; and
. determines the terms and conditions of each option, including the number
of shares subject to each option and the grant date.
In general, options granted under our 1998 stock option plan expire ten
years after the original grant date. Options granted from November 1998 to May
2000 generally vest over a five-year period at the rate of 20% of the total
number of shares on the first anniversary of the grant date and 5% of the total
number of shares every three months thereafter. Options granted since May 16,
2000 generally vest over a four-year period at the rate of 25% of the total
number of shares on the first anniversary of the grant date and 6.25% of the
total number of shares every three months thereafter. In addition, the vesting
schedule contained in some option agreements is tied to our achievement of
specified performance goals during the applicable fiscal year.
Notwithstanding the foregoing, options granted prior to May 15, 2000 are
immediately exercisable by the holder thereof upon his execution of a stock
repurchase agreement approved by the compensation committee that provides for
the lapse of our right to repurchase the shares of restricted stock purchased
by these option holders at the same rate that the option would have vested.
These shares of restricted stock are held in escrow by us under the terms of
individual escrow agreements and are released from escrow in accordance with
the applicable vesting schedule.
Upon a change of control, unexercisable but outstanding options to purchase
shares of our common stock will become vested and immediately exercisable as to
an additional number of shares of common stock equal to 30% of the total number
of shares underlying options. Alternatively, upon a change in control, any
purchaser of our assets or stock may in its discretion deliver to the holders
of outstanding options the same kind of consideration that is delivered to our
stockholders in connection with the transaction equal to the value of the
shares of stock the option holder would have received had the option been
exercised prior to the transaction, less the option exercise price, or the
equivalent in cash. Upon receipt of the consideration by the option holder, his
option will immediately terminate. Notwithstanding the foregoing, our board of
directors may in its discretion accelerate the vesting of unexercisable options
at any time, including upon a change of control.
1998 Restricted Stock Purchase Plan
Our 1998 restricted stock purchase plan was adopted by our board of
directors and approved by our stockholders in August 1998. As of September 30,
2000, the aggregate number of shares of our common stock that may be issued
under the plan is 16,195,000 shares, subject to adjustment in the event of any
stock split and other similar events, less that number of shares issued or
reserved for issuance under our 1998 stock option plan. We are no longer
issuing shares of common stock under this plan.
The 1998 restricted stock purchase plan provides for the grant of rights to
purchase shares of our common stock, or share purchase rights, to our
directors, officers, consultants and other key personnel. The board of
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directors has designated the compensation committee to administer this plan.
Subject to any applicable limitations contained in this plan, the compensation
committee:
. has the authority to adopt, amend and rescind these rules and
regulations as it deems advisable in the administration of the plan;
. may correct any defect or supply any omission or reconcile any
inconsistency in the plan or in any offer made thereunder;
. determines the eligibility for and selects the recipients of share
purchase rights; and
. determines the terms and conditions of each offer, including the number
of shares covered by the offer, the purchase price per share and any
related repurchase and escrow rights.
Restricted stock granted under the 1998 restricted stock purchase plan
generally vests over a five-year period at the rate of 20% of the total number
of shares on the first anniversary of the grant date and 5% of the total number
of shares every three months thereafter. Any shares that are not vested remain
subject to repurchase by us at the original purchase price paid by the
participant. Certificates representing unvested shares are held in escrow until
we exercise our repurchase right or our repurchase right lapses with respect to
these unvested shares. Subject to our repurchase rights, restricted stock
issued under this plan may not be sold or transferred.
Upon a change of control, an additional number of shares equal to 30% of the
total number of shares originally issued to a participant shall immediately
vest and no longer be subject to our repurchase right. Notwithstanding the
foregoing, our board of directors may in its discretion specifically provide a
different vesting schedule for restricted stock issued under this plan or
accelerate the vesting thereof.
TCS Third Amended and Restated 1996 Employee Stock Option Incentive Plan
In connection with our merger with TCS in July 2000, we assumed the
obligations of TCS under its third amended and restated 1996 employee stock
option incentive plan. As of September 30, 2000, options to purchase an
aggregate of 1,108,378 shares of common stock were outstanding under this plan.
We are no longer granting options under this plan.
The plan provides for the grant of incentive stock options intended to
qualify under Section 422 of the Internal Revenue Code to employees of ours or
any of our subsidiaries, and nonstatutory stock options to employees, officers,
directors or persons or service companies that provide services to us or any of
our subsidiaries.
The compensation committee of our board of directors administers this plan
and has sole discretion to determine the terms and provisions of all options
granted thereunder. However, all options outstanding under the plan were
granted by the board of directors of Hemisphere Investments prior to our
assumption of the plan.
Stock options granted under this plan have terms not in excess of ten years
and vest at the rate specified in each option agreement, which generally
specify vesting ratably over four years. No participant in the plan may receive
incentive stock options vesting in a calendar year having a fair market value
at the time of grant having a value in excess of $100,000.
401(k) Plan
In August 1998, we adopted an employee savings and retirement plan,
qualified under Section 401(a) of the Internal Revenue Code, covering all of
our employees. Under the 401(k) plan, employees may elect to reduce their
current compensation by up to the statutorily prescribed annual limit and have
the amount of the reduction contributed to the 401(k) plan. We may make
matching or additional contributions to the 401(k) plan in amounts to be
determined annually by our board of directors. We have made no contributions to
the 401(k) plan to date.
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Agreements with Executive Officers
In September 2000, we entered into an employment agreement with John C.
Thibault which provides for his employment as our President and Chief Executive
Officer from September 1, 2000 until March 31, 2002. Under the terms of this
agreement, Mr. Thibault receives a base salary of $200,000 per year, which will
increase to $250,000 on January 1, 2001.
Mr. Thibault's employment agreement also provides for a payment of $275,000
payable within 90 days of the consummation of this offering and a payment of
$275,000 on April 1, 2001 in the event our board of directors determines that
we have met specified financial targets for fiscal year 2000. Mr. Thibault is
also eligible to receive a payment of up to $300,000 in the event we meet
financial targets for fiscal 2001 as determined by our board of directors. If
we terminate Mr. Thibault's employment without cause, he will be entitled to
the balance of his salary through March 31, 2002.
In connection with his employment with us, Mr. Thibault purchased an
aggregate of 3,482,000 shares of restricted stock on February 15, 2000, for
which he paid $3,482,000 in the form of three recourse promissory notes. Mr.
Thibault's employment agreement provides us with the right to repurchase his
unvested restricted stock at the original purchase price paid by Mr. Thibault,
or $1.00 per share, subject to the vesting described below. Mr. Thibault's
restricted stock vests as to 100,000 shares on February 15, 2000, as to 180,125
shares for each full three-month period beginning March 15, 2000 through March
15, 2002 during which he is employed by us and for an additional 1,441,000
shares on March 31, 2002, provided he is employed by us at that time. Upon
consummation of this offering, Mr. Thibault's restricted stock will immediately
vest as to 250,000 shares, provided he is employed by us at that time. Mr.
Thibault's restricted stock will vest as to an additional 250,000 shares on
January 31, 2005, or on April 1, 2001 if we meet specified sales and revenue
targets for fiscal year 2000 as determined by our board of directors, provided
Mr. Thibault is employed by us through December 31, 2000. If we terminate Mr.
Thibault's employment with or without cause on or before September 1, 2001, 50%
of his unvested restricted stock will immediately vest. Mr. Thibault's stock
will vest in full in the event of a change in control or sale of our company or
if we terminate his employment with or without cause after September 1, 2001.
Additionally, Mr. Thibault's employment agreement limits his ability to
transfer this restricted stock, except to members of his family or to a trust
for their benefit.
The promissory notes issued by Mr. Thibault to purchase the 3,482,000 shares
of restricted stock are unsecured and bear interest at a rate of 6.8% per year,
and are payable as to $250,000 of the principal amount upon the closing of this
offering and as to $3,232,000 of the principal amount and all accrued interest
upon the earlier of March 31, 2002 or termination of Mr. Thibault's employment.
As of September 30, 2000, the aggregate amount of principal and interest
outstanding under these notes was $3,629,988. Mr. Thibault's employment
agreement provides that if he continues his employment with us through
September 1, 2001 and we have completed an initial public offering prior to
January 1, 2002, $745,000 of the principal amount under the notes will be
forgiven. If Mr. Thibault continues his employment with us through January 1,
2002 an additional $745,000 of the principal amount under the notes will be
forgiven. If Mr. Thibault continues his employment with us through March 31,
2002, an additional $1,492,000 of the principal amount will be forgiven. All
principal under Mr. Thibault's notes will be forgiven upon our change of
control.
In March 2000, we entered into an employment letter agreement with Pamela F.
Lenehan which provides for her employment as Vice President and Chief Financial
Officer. Under the terms of this agreement, Ms. Lenehan receives a base salary
of $155,000 per year. Under the terms of an employment termination agreement
with us, if we terminate Ms. Lenehan's employment without cause, she will be
entitled to receive a severance payment of $100,000 payable in lump sum within
30 days of termination.
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In connection with her employment with us, Ms. Lenehan purchased an
aggregate of 450,000 shares of restricted stock on March 31, 2000 under the
1998 restricted stock purchase plan, for which she paid $900,000, $100,000 in
cash and $800,000 in the form of a recourse promissory note. We have the right
to repurchase the restricted stock at the original purchase price paid by Ms.
Lenehan, or $2.00 per share, until the shares vest. Of the 450,000 shares sold
to Ms. Lenehan, 25,000 shares will vest upon the consummation of this offering.
Another 25,000 shares will vest on March 31, 2005, or on April 1, 2001 if our
board of directors determines we have met specified sales and revenue targets
for fiscal 2000, provided Ms. Lenehan is employed with us at that time. The
remaining 400,000 shares will vest as to 100,000 shares on March 31, 2001 and
25,000 shares will vest at the end of each full three-month period thereafter
during which Ms. Lenehan is employed by us so as to be fully vested on March
31, 2004. Upon a change of control of our company, 135,000 shares of Ms.
Lenehan's then unvested shares will vest, and, if, in connection with our
change of control, her employment is terminated, she is required to relocate or
the resulting company fails to offer her a position with compensation and
responsibilities comparable to her employment with us, all of Ms. Lenehan's
shares will vest.
The promissory note in the principal amount of $800,000 issued by Ms.
Lenehan to purchase the 400,000 shares of our common stock is unsecured and
bears interest at a rate of 6.8% per year, and is payable upon the earlier of
March 31, 2004 or the termination of Ms. Lenehan's employment. As of September
30, 2000, the aggregate amount of principal and interest outstanding under this
note was $827,200.
On July 13, 2000, we granted Ms. Lenehan an option to purchase 100,000
shares of our common stock at an exercise price of $5.00 per share. These
options vest and become exercisable as to 25,000 shares on July 13, 2001 and as
to 6,250 additional shares each three-month period thereafter. Upon our change
of control, 30,000 of Ms. Lenehan's then unvested shares will vest, and, if in
connection with our change of control, her employment is terminated, she is
required to relocate, or the resulting company fails to offer her a position
with compensation and responsibilities comparable to her employment with us,
all of Ms. Lenehan's shares will vest.
In May 2000, we entered into an employment letter agreement with Brian
Fitzgerald which provides for his employment as our Vice President, Worldwide
Sales. Under the terms of this agreement, Mr. Fitzgerald receives a base salary
of $150,000 per year, and is eligible to receive a cash bonus of up to $150,000
upon meeting sales and revenue goals. Mr. Fitzgerald has also received an
option to purchase up to 25,000 shares of our common stock, which will vest on
May 15, 2004 or on April 1, 2001 if our board of directors determines we have
met specified sales and revenue targets for fiscal 2000, provided Mr.
Fitzgerald is employed with us at that time. Mr. Fitzgerald has also received
an option to purchase up to 25,000 shares of our common stock, which will vest
on May 15, 2004 or on April 1, 2002 depending on whether we meet financial
targets for fiscal 2001, which are to be determined by our board of directors,
and provided he is employed by us at that time. If we terminate Mr.
Fitzgerald's employment without cause, he is entitled to a severance payment of
$120,000 and continuation of medical benefits payable by us over a period of
six months from the date of his termination.
In connection with his employment with us, Mr. Fitzgerald purchased 600,000
shares of restricted stock on May 15, 2000 under the 1998 restricted stock
purchase plan, for which he paid $1,800,000 in the form of a recourse
promissory note. We have the right to repurchase the restricted stock at the
original purchase price paid by Mr. Fitzgerald, or $3.00 per share, until the
shares vest. Of the 600,000 shares, 150,000 shares will vest on May 15, 2001
and 37,500 will vest at the end of each full three-month period thereafter
during which Mr. Fitzgerald is employed by us so as to be fully vested by May
15, 2004. Upon a change of control of our company, 30% of Mr. Fitzgerald's then
unvested shares will become vested. If, in connection with our change in
control, his employment with us is terminated, he is required to relocate or
the resulting company fails to offer him a position with comparable
compensation and responsibilities to his employment with us, an additional 50%
of Mr. Fitzgerald's then unvested shares will vest.
The promissory note issued by Mr. Fitzgerald to purchase the 600,000 shares
of restricted stock is unsecured and bears interest at a rate of 6.8% per year,
and is payable upon the earlier of May 15, 2004 or
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termination of Mr. Fitzgerald's employment with us. As of September 30, 2000,
the aggregate amount of principal and interest outstanding under this note was
$1,845,418.
In August 2000, we entered into an employment letter agreement with Ron
Rando which provides for his employment as our Vice President, Worldwide
Customer Support. Under the terms of this agreement, Mr. Rando receives a base
salary of $160,000 per year. Mr. Rando received an option to purchase up to
400,000 shares of our common stock, which will vest as to 100,000 shares on
August 23, 2001 and as to an additional 25,000 shares each full three-month
period thereafter during which Mr. Rando is employed with us. Mr. Rando also
received an option to purchase up to 15,000 shares of our common stock, which
will become exercisable on August 23, 2004, or on April 1, 2000 if our board of
directors determines we have met specified sales and revenue targets for fiscal
2000 and Mr. Rando is employed with us through April 1, 2000. Mr. Rando also
received an option to purchase up to 25,000 shares of our common stock, which
will vest on August 23, 2004 or on April 1, 2002 depending on whether we meet
financial targets for fiscal 2001, which are to be determined by our board of
directors, and provided he is employed by us at that time. Upon a change of
control of our company, 30% of Mr. Rando's then unvested shares will become
vested. If, in connection with our change of control, his employment with us is
terminated, he is required to relocate or the resulting company fails to offer
him a position with comparable compensation or responsibilities, an additional
50% of Mr. Rando's then unvested shares will vest. If we terminate Mr. Rando's
employment without cause, he is entitled to a severance payment of $80,000 and
continuation of medical benefits payable by us over a period of six months from
the date of his termination.
On September 21, 1998, Kenneth MacLure entered into an agreement to purchase
126,000 shares of restricted stock for a total purchase price of $630. These
shares vested as to 20% of the original number of shares on October 5, 1999,
and vest as to 5% of the original number of shares for each full three-month
period thereafter during which he is employed by or consulting with us so as to
be fully vested on October 5, 2003. On August 4, 1999, Mr. MacLure purchased
20,000 shares of restricted stock through the early exercise of an option
granted to him under the 1998 stock option plan for a total purchase price of
$5,000. These shares vested as to 20% of the original number of shares on June
29, 2000, and vest as to 5% of the original number of shares thereafter on a
quarterly basis so as to be fully vested on June 29, 2004. Mr. MacLure's stock
will vest as to an additional 37,800 shares in the event of a change of control
of our company.
On October 2, 2000, we granted Mr. MacLure an option to purchase 100,000
shares of our common stock at an exercise price of $13.20 per share. These
options were vested as to 25,000 of the shares on October 2, 2000 and will vest
as to 6,250 additional shares each three-month period thereafter. Upon our
change of control, 30% of Mr. MacLure's then unvested shares will become
vested. If, in connection with our change of control, his employment with us is
terminated, he is required to relocate or the resulting company fails to offer
him a position with comparable compensation or responsibilities, an additional
50% of Mr. MacLure's then unvested shares will vest.
On March 11, 1999, Sally J. Bament entered into an agreement to purchase
640,000 shares of restricted stock for a total purchase price of $32,000. The
restricted stock held by Ms. Bament vested as to 20% of the original number of
shares on February 17, 2000, and vests as to 5% of the original number of
shares for each full three-month period thereafter during which she is employed
by or consulting with us so as to be fully vested on February 17, 2004. Ms.
Bament's stock will vest as to an additional 192,000 shares in the event of a
change of control of our company.
On October 2, 2000, we granted Ms. Bament an option to purchase 100,000
shares of our common stock at an exercise price of $13.20 per share. These
options were vested as to 25,000 of the shares on October 2, 2000 and will vest
as to 6,250 additional shares each three-month period thereafter. Upon our
change of control, 30% of Ms. Bament's then unvested shares will become vested.
If, in connection with our change of control, her employment with us is
terminated, she is required to relocate or the resulting company fails to offer
her a position with comparable compensation or responsibilities, an additional
50% of Ms. Bament's then unvested shares will vest.
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RELATED PARTY TRANSACTIONS
Preferred Stock Issuances
Series A Preferred Stock. In July 1998 and March 1999, we issued an
aggregate of 6,976,000 shares of Series A convertible preferred stock at a
price of $1.00 per share, for an aggregate offering price of $6,976,000. In
this private placement, we sold 2,625,000 shares to Battery Ventures IV, L.P.
and Battery Investment Partners IV, LLC, or the Battery entities, which
beneficially own more than five percent of our outstanding common stock and
have a representative on our board, 2,625,000 shares to Matrix Partners, L.P.
and Matrix V Entrepreneurs Fund, L.P., or the Matrix entities, which
beneficially own more than five percent of our outstanding common stock and
have a representative on our board, 1,250,000 shares to North Bridge Venture
Partners II, L.P which beneficially owns more than five percent of our
outstanding common stock, 100,000 shares to Bing Yang, a director and our
Senior Vice President and Chief Technology Officer, and 100,000 shares to
Hwang-Ruey Wang, our Vice President, Engineering.
Series B Preferred Stock. In July 1999, we issued an aggregate of 4,133,892
shares of Series B convertible preferred stock at a price of $2.39 per share,
for an aggregate offering price of $9,880,002. In this private placement, we
sold 1,574,477 shares to the Battery entities, 1,574,477 shares to the Matrix
entities, 749,791 shares to North Bridge Venture Partners II, L.P., 59,833
shares to Mr. Yang and 59,833 shares to Mr. Wang.
Series C Preferred Stock. In December 1999 and March 2000, we issued an
aggregate of 5,602,782 shares of Series C convertible preferred stock at a
purchase price of $6.47 per share, for an aggregate offering price of
$36,250,000. In this private placement, we sold 298,065 shares to the Battery
entities, 298,065 shares to the Matrix entities, 141,938 shares to North Bridge
Venture Partners II, L.P., 3,091,189 shares to VantagePoint Communications
Partners, L.P., VantagePoint Venture Partners III (Q), L.P. and VantagePoint
Venture Partner III, L.P., or the VantagePoint entities, which beneficially own
more than five percent of our outstanding common stock, 19,976 shares to Mr.
Yang and 38,640 shares to Pamela F. Lenehan, our Vice President and Chief
Financial Officer.
Series D Preferred Stock. In September 2000, we issued an aggregate of
4,803,925 shares of Series D convertible preferred stock at a price of $16.35
per share, for an aggregate offering price of $78,544,173. In this private
placement, we sold 183,486 shares to the VantagePoint entities, 122,324 shares
to the Battery entities, 122,324 shares to the Matrix entities, 122,324 shares
to North Bridge Venture Partners II, L.P., 61,162 shares to William E. Foster,
a director, 6,116 shares to Christian S. Zousas, John Thibault's brother-in-
law, 10,000 shares to Despena Zousas, Mr. Thibault's mother-in-law, 9,174
shares to Ms. Linda Thoa Phan, Mr. Yang's wife, 10,000 shares to Mr. Lemmao
Wang, Mr. Wang's brother, and 12,232 shares to Dr. Lawrence F. Geuss, Jr., Ms.
Lenehan's husband.
Common Stock Purchases by Executive Officers and Key Employees
On May 15, 1998, each of Bing Yang and Hwang-Ruey Wang purchased 2,540,000
shares of common stock for a purchase price of $150 each. On July 14, 1998, we
entered into stock restriction agreements with each of Mr. Yang and Mr. Wang
providing us with the right to repurchase unvested shares of restricted stock
at a per share price of $.005 if Mr. Yang's or Mr. Wang's employment with us
terminates prior to July 14, 2002. The restricted stock held by each of Mr.
Yang and Mr. Wang vests as to 20% of the original number of shares on July 14,
1998, and 5% of the original number of shares for each full three-month period
thereafter during which Mr. Yang or Mr. Wang, as applicable, is employed by us
so as to be fully vested on July 14, 2002. In January 1999, both of these stock
restriction agreements were amended to provide that an additional number of
shares equal to 30% of the total shares originally issued to them will vest
upon the acquisition of our business by merger, sale of our assets or
otherwise, with the remaining unvested shares to vest at a quarterly rate of 5%
of the restricted stock that was originally issued. Upon an acquisition, 100%
of the restricted stock originally issued to Mr. Wang and Mr. Yang will vest,
unless the acquiring corporation agrees that the original vesting schedule
shall continue in effect and that all unvested shares shall become vested if
Mr. Wang's or Mr. Yang's
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employment with the acquiring corporation is terminated without cause or if Mr.
Wang or Mr. Yang terminates his employment with the acquiring corporation for
good reason, in either case, within 12 months after the acquisition.
Investor Rights Agreement
We have entered into an amended and restated investor rights agreement with
some of our executive officers and stockholders, including the Battery
entities, the Matrix entities, North Bridge Venture Partners II, L.P., the
VantagePoint entities, William Foster, John Thibault, Bing Yang, Hwang-Ruey
Wang and Pamela F. Lenehan. The holders of at least 35% of the shares of common
stock issued upon conversion of our preferred stock can request that we
register all or a portion of their shares under the Securities Act. Those
stockholders must also request registration of enough shares so that the
offering would have an anticipated aggregate offering price of $5.0 million. We
are only required to effect up to two of these demand registrations.
Beginning 180 days after the closing of this offering, if we propose to
register shares of common stock under the Securities Act, the parties to the
investor rights agreement will have the right to receive notice of the proposed
registration and to include their shares in the registration statement.
At any time we become eligible to file a registration statement on Form S-3
under the Securities Act, upon the request of the holders of shares of common
stock issued upon conversion of our preferred stock, we must effect a
registration statement on Form S-3. However, the registration must have a
minimum anticipated aggregate offering price of $1.0 million.
These registration rights are subject to conditions and limitations,
including, in the case of an underwritten public offering, the right of the
managing underwriter to limit the number of shares of common stock to be
included in the registration. We are generally required to bear all the
expenses of registrations under the investor rights agreement, except
underwriting discounts and commissions. The investor rights agreement also
contains our commitment to indemnify the holders of registration rights for
specified losses they incur in connection with registrations under the
agreement. These registration rights terminate ten years after the closing of
this offering and do not apply to any shares that are sold under Rule 144 under
the Securities Act. All holders of registration rights have agreed not to
exercise their registration rights until 180 days following the date of this
prospectus without the consent of Credit Suisse First Boston Corporation.
Other Material Transactions
For the nine months ended September 30, 2000, Global NAPs accounted for
approximately 73% of our revenues. On December 17, 1999, BABP, L.L.C., an
affiliate of Global NAPs, purchased 155,147 shares of our Series C convertible
preferred stock, at a price of $6.47 per share, for aggregate consideration of
$1,003,801. In addition, we issued 264,853 shares of Series C convertible
preferred stock to BABP in consideration for research and development and other
related services performed for us by Global NAPs.
On September 22, 2000, we sold 183,486 shares of Series D convertible
preferred stock to BABP at a price of $16.35 per share, for aggregate
consideration of $2,999,996.
Under an agreement dated December 17, 1999 by and among us, Global NAPs and
BABP, BABP granted an irrevocable proxy to our President to vote all shares of
our capital stock held by BABP in favor of any stockholder action in which the
holders of a majority of our capital stock have voted either to:
. sell all of their shares of our capital stock;
. enter into a transaction to merge with another entity; or
. enter into a transaction to sell all or substantially all of our assets.
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On August 4, 2000, we issued a warrant to purchase 100,000 shares of our
common stock at $12.00 per share to Focal Communications. On August 30, 2000,
we entered into a master purchase and license agreement with Focal. Todd
Dagres, one of our directors, is also a director of Focal.
Agreements with Executive Officers
We have entered into agreements with some of our executive officers relating
to employment compensation. See "Management -- Agreements with Executive
Officers."
All future transactions, including loans between us and our officers,
directors, principal stockholders and their affiliates will be approved by a
majority of the board of directors, including a majority of the independent and
disinterested directors on the board of directors, and will be on terms no less
favorable to us than could be obtained from unaffiliated third parties.
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PRINCIPAL STOCKHOLDERS
The following table sets forth information regarding beneficial ownership of
our common stock as of September 30, 2000 and as adjusted to reflect the sale
of our common stock offered in this prospectus by:
. each person we know to own beneficially more than 5% of our common stock;
. each of our directors and named executive officers; and
. all directors and executive officers as a group.
The number of shares of common stock deemed outstanding prior to this
offering includes 55,447,072 shares of common stock outstanding as of September
30, 2000, assuming conversion of all outstanding shares of convertible
preferred stock into common stock. The number of shares of common stock deemed
outstanding after this offering includes the 5,000,000 shares that are being
offered for sale by us in this offering.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission, and includes voting and investment power
with respect to shares. Unless otherwise indicated below, each person named in
the table has sole voting and investment power, or shares such power with his
or her spouse, with respect to all shares of capital stock listed as owned by
such person. Shares issuable upon exercise of options that are currently
outstanding or will become exercisable within 60 days of September 30, 2000 are
considered outstanding for the purposes of computing the percentage ownership
of the person holding such option but are not considered outstanding for
purposes of computing the percentage ownership of any other person. The number
of shares of restricted stock set forth below with respect to a particular
stockholder is included in the calculation of the number of shares beneficially
owned by that stockholder.
Unless otherwise indicated below, the address of each stockholder listed is
c/o Convergent Networks, Inc., 900 Chelmsford Road, Lowell, Massachusetts
01851, and related entities share the same address.
<TABLE>
<CAPTION>
Percentage of
Shares Outstanding
------------------
Name and Address of Number of Shares Number of Shares Before After
Beneficial Owner Beneficially Owned Subject to Repurchase Offering Offering
------------------- ------------------ --------------------- --------- --------
<S> <C> <C> <C> <C>
Battery Ventures IV,
L.P. (1).............. 7,244,866 -- 13.1% 12.0%
20 William Street
Wellesley, MA 02481
Matrix Partners V, L.P.
(2)................... 7,244,866 -- 13.1 12.0
Bay Colony Corporate
Center
1000 Winter Street,
Suite 4500
Waltham, MA 02451
North Bridge Venture
Partners II, L.P.
(3)................... 3,514,053 -- 6.3 5.8
950 Winter Street,
Suite 4600
Waltham, MA 02451
VantagePoint Venture
Partners III (Q), L.P.
(4)................... 3,274,676 -- 5.9 5.4
1001 Bayhill Drive,
Suite 100
San Bruno, CA 94066
John C. Thibault (5)... 3,482,000 2,841,625 6.3 5.8
Bing Yang (6).......... 2,819,809 1,016,000 5.1 4.7
Hwang-Ruey Wang........ 2,799,833 1,016,000 5.0 4.6
Sally J. Bament (7).... 640,000 448,000 1.2 1.2
Kenneth MacLure........ 146,000 96,900 * *
Karl May............... 708,000 -- 1.3 1.2
Todd Dagres (8)........ 7,244,866 -- 13.1 12.0
c/o Battery Ventures
IV, L.P.
20 William Street
Wellesley, MA 02481
David Schantz (9)...... 7,244,866 -- 13.1 12.0
c/o Matrix Partners
Bay Colony Corporate
Center
1000 Winter Street,
Suite 4500
Waltham, MA 02451
William E. Foster...... 61,162 -- * *
All executive officers
and directors as a
group (10 persons).... 21,638,703 5,452,525 39.0 35.8
</TABLE>
56
<PAGE>
---------------------
* Less than 1%
(1) Also includes 108,673 shares held by Battery Investment Partners IV, LLC.
(2) Also includes 199,486 shares held by Matrix V Entrepreneurs Fund, L.P.
(3) Edward T. Anderson, Richard A. D'Amore, William J. Geary and Jeffrey P.
McCarthy have shared voting and dispositive power over the shares held by
North Bridge Venture Partners II, L.P. Messrs. Anderson, D'Amore, Geary and
McCarthy each disclaim beneficial ownership of the shares held by North
Bridge Venture Partners II, L.P., except to the extent of their respective
pecuniary interests as managing partners of North Bridge Venture Partners
II, L.P.
(4) Also includes 1,091,604 shares held by VantagePoint Communications
Partners, L.P. and 240,206 shares held by VantagePoint Venture Partners
III, L.P. James Marver and Alan Salzman are the managing members of
VantagePoint Venture Associates III, L.L.C. and VantagePoint Communications
Associates, L.L.C., the general partners of VantagePoint Venture Partners
III (Q), L.P. and VantagePoint Venture Partners III, L.P., and VantagePoint
Communications Partners, L.P., respectively. Each of Messrs. Marver and
Salzman have sole voting and dispositive power over the shares held by each
of the VantagePoint entities. Messrs. Marver and Salzman each disclaim
beneficial ownership of the shares held by the VantagePoint entities,
except to the extent of their respective pecuniary interest as managing
members of VantagePoint Venture Associates III, L.L.C. and VantagePoint
Communications Associates, L.L.C.
(5) Includes 25,000 shares held by Susan C. Thibault, 25,000 shares held by
Cynthia B. Thibault and 50,000 shares held by Elaine Zouzas. Mr. Thibault
disclaims beneficial ownership of the shares held by Susan C. Thibault,
Cynthia B. Thibault and Elaine Zouzas.
(6) Includes 200,000 shares held by the Nikki Mei-Hui Yang Trust, 200,000
shares held by the Caroline Yang Trust and 200,000 shares held by the Troy
Yang Trust. Mr. Yang disclaims beneficial ownership of the shares held by
these trusts.
(7) Includes 20,000 shares held by The Bament Children's 1999 Irrevocable
Trust. Ms. Bament disclaims beneficial ownership of the shares held by this
trust.
(8) Also includes 108,673 shares held by Battery Investment Partners IV, LLC.
Battery Ventures IV, L.P. is the managing member of Battery Investment
Partners IV, LLC. Todd A. Dagres, one of our directors, has sole voting and
dispositive power over the shares held by each of the Battery entities. Mr.
Dagres disclaims beneficial ownership of the shares held by the Battery
entities, except to the extent of his pecuniary interest as a managing
member of Battery Investment Partners IV, LLC.
(9) Also includes 199,486 shares held by Matrix V Entrepreneurs Fund, L.P.
David Schantz is a managing member of Matrix V Management Co., L.L.C., the
general partner of Matrix Partners V, L.P. and Matrix V Entrepreneurs Fund,
L.P. Mr. Schantz has sole voting and dispositive power over the shares held
by both Matrix entities. Mr. Schantz disclaims beneficial ownership of the
shares held by both Matrix entities, except to the extent of his pecuniary
interest as a managing member of Matrix V Management Co., L.L.C.
57
<PAGE>
DESCRIPTION OF CAPITAL STOCK
Effective upon the closing of this offering and the filing of our amended
and restated certificate of incorporation, our authorized capital stock will
consist of 400,000,000 shares of common stock, $0.00001 par value per share,
and 10,000,000 shares of preferred stock, $0.01 par value per share.
The following summary description of our capital stock, as of the closing of
this offering, may not contain all the information that is important to you.
You should also refer to the provisions of applicable law and to our amended
and restated certificate of incorporation and amended and restated by-laws
filed as exhibits to the registration statement of which this prospectus is a
part.
Common Stock
As of September 30, 2000, there were 55,447,072 shares of common stock
outstanding and held of record by 275 stockholders, after giving effect to the
conversion of all outstanding shares of convertible preferred stock upon the
closing of this offering. Based upon the number of shares outstanding as of
September 30, 2000 and giving effect to the issuance of the shares of common
stock offered by us in this offering, there will be 60,447,072 shares of common
stock outstanding upon the closing of this offering. In addition, as of
September 30, 2000, there were outstanding stock options for the purchase of a
total of 4,154,723 shares of common stock.
Holders of our common stock are entitled to one vote per share for each
share held of record on all matters submitted to a vote of stockholders and do
not have cumulative voting rights. Our directors are elected by a plurality of
the votes of the shares present in person or by proxy at the meeting. The
holders of common stock are entitled to receive ratably lawful dividends as may
be declared by our board of directors. However, these dividends are subject to
preferences that may be applicable to the holders of any outstanding shares of
preferred stock. In the event of our liquidation, dissolution or winding up of
our affairs, whether voluntarily or involuntarily, the holders of common stock
will be entitled to receive pro rata all of our remaining assets available for
distribution to our stockholders. Any pro rata distribution would be subject to
the rights of the holders of any outstanding shares of preferred stock. The
common stock has no preemptive, redemption, conversion or subscription rights.
All outstanding shares of common stock are fully paid and nonassessable. The
shares of common stock to be issued by us in this offering will be fully paid
and nonassessable. The rights, powers, preferences and privileges of holders of
common stock are subject to, and may be adversely affected by, the rights of
the holders of shares of any series of preferred stock that we may designate
and issue in the future. Upon the closing of this offering, there will be no
shares of preferred stock outstanding.
Preferred Stock
Our board of directors will be authorized, subject to any limitations
prescribed by Delaware law, without further stockholder approval, to issue from
time to time up to an aggregate of 10,000,000 shares of preferred stock, in one
or more series. Each share of preferred stock would be entitled to no more than
one vote per share. Our board of directors is also authorized, subject to the
limitations prescribed by Delaware law, to establish the number of shares to be
included in each series and to fix the voting powers, preferences,
qualifications and special or relative rights or privileges of each series. Our
board of directors is authorized to issue preferred stock with conversion and
other rights and preferences that could adversely affect the voting power or
other rights of the holders of common stock.
We have no current plans to issue any preferred stock. However, the issuance
of preferred stock or of rights to purchase preferred stock could have the
effect of making it more difficult for a third party to acquire, or of
discouraging a third party from attempting to acquire, a majority of the shares
of our outstanding common stock.
58
<PAGE>
Warrants
As of September 30, 2000, there were warrants outstanding for purchase of
up to 240,000 shares of our common stock at exercise prices of ranging from
$12.00 per share to $16.35 per share. The warrants terminate on the earlier of
two years from the date of issuance or our acquisition by another company.
Registration Rights
Pursuant to a first amended and restated investor rights agreement dated
September 22, 2000 among us and some of our stockholders, these stockholders
have participation registration rights with respect to the registration of
37,719,452 shares of our common stock, and demand registration rights with
respect to 28,757,452 of those shares. See "Related Party Transactions" for a
description of the rights and obligations under this agreement. In addition,
the former stockholders of TCS, who collectively hold 10,106,845 shares of our
common stock, have the right to participate in any future registrations of
securities by us. All holders of registration rights have agreed not to
exercise their registration rights until 180 days following the date of this
prospectus without the consent of Credit Suisse First Boston Corporation.
Section 203 of the Delaware General Corporation Law
Our certificate of incorporation contains a provision expressly electing
not to be governed by Section 203 of the Delaware General Corporation Law. In
general, Section 203 restricts some business combinations involving interested
stockholders, defined as any person or entity that is the beneficial owner of
at least 15% of a corporation's voting stock or is an affiliate or associate
of the corporation or the owner of 15% or more of the outstanding voting stock
of the corporation at any time in the past three years, or their affiliates.
Because of this election, Section 203 will not apply to us.
Limitation of Liability and Indemnification
Our certificate of incorporation provides that none of our directors shall
be personally liable to us or to our stockholders for monetary damages for
breach of fiduciary duty as a director, except to the extent that the
elimination or limitation of this liability is not permitted by Delaware
General Corporation Law as it exists or may later be amended.
Our certificate of incorporation further provides for the indemnification
of our directors and officers to the fullest extent permitted by Section 145
of the Delaware General Corporation Law, including circumstances in which
indemnification is otherwise discretionary.
Transfer Agent and Registrar
The transfer agent and registrar for our common stock is American Stock
Transfer and Trust Company.
59
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Effect of Sales of Shares
Prior to this offering, no public market existed for our common stock, and
we can make no prediction as to the effect, if any, that sales of shares of our
common stock or the availability of shares of our common stock for sale will
have on the market price of the common stock prevailing from time to time.
Nevertheless, sales of substantial amounts of our common stock in the public
market, or the perception that sales occur, could cause the market price of our
common stock to decrease and could impair our future ability to raise capital
through an offering of our equity securities.
Sale of Restricted Shares
Upon completion of this offering, based upon the number of shares
outstanding as of September 30, 2000, we will have an aggregate of 60,447,072
shares of common stock outstanding, assuming no exercise of the underwriters'
over-allotment option and no exercise of outstanding options. Of these
outstanding shares, the 5,000,000 shares sold in this offering will be freely
tradable without restriction or further registration under the Securities Act,
except that any shares purchased by our "affiliates," as that term is defined
in Rule 144 under the Securities Act, generally only may be sold in compliance
with the limitations of Rule 144 described below. The remaining 55,447,072
shares of common stock that will be outstanding after this offering will be
"restricted securities" as that term is defined under Rule 144. Restricted
securities may be sold in the public market only if they qualify for an
exemption from registration under Rule 144, including Rule 144(k), or Rule 701
under the Securities Act. Of these restricted securities, 54,328,175 shares are
also subject to the lock-up agreements described in "Underwriting."
Rule 144. In general, under Rule 144, commencing 90 days after the date of
this prospectus, a person who has beneficially owned shares of our common stock
for at least one year is entitled to sell within any three-month period a
number of shares that does not exceed the greater of:
. 1% of the number of shares our common stock then outstanding, which is
expected to be approximately 604,471 shares upon completion of this
offering; or
. the average weekly trading volume of our common stock on The Nasdaq
Stock Market's National Market during the four calendar weeks preceding
the filing of a notice on Form 144 with respect to a sale, subject to
the restrictions specified in Rule 144.
Sales under Rule 144 are also subject to manner of sale provisions and
notice requirements and to the availability of current public information about
us.
Rule 144(k). Under Rule 144(k), a person who is not one of our affiliates at
any time during the three months preceding a sale and who has beneficially
owned the shares proposed to be sold for at least two years is entitled to sell
their shares under Rule 144(k) without complying with the manner of sale,
public information, volume limitation or notice provisions of Rule 144. As a
result, unless otherwise restricted, Rule 144(k) shares may be sold immediately
upon completion of this offering.
Lock-up Agreements. A total of 54,328,175 shares of our common stock are
subject to the lock-up agreements described in "Underwriting" which provide
that stockholders will not offer, sell or otherwise dispose of any shares owned
by them for a period of 180 days after the date of this prospectus. However, if
a fiscal quarter has ended at least 45 days after the date of this prospectus,
and the last recorded sale price of our common stock on The Nasdaq Stock
Market's National Market is at least twice the initial public offering price
60
<PAGE>
per share for 20 of the 30 trading days ending on the last trading day
preceding the 90th day after the date of this prospectus, then holders of
shares that are subject to the lock-up agreements may offer, sell or otherwise
dispose of 25% of those shares on one of the following dates:
. the 91st day after the date of this prospectus if we publicly release
our financial results for the above-mentioned fiscal quarter prior to
the 88th day after the date of this prospectus; or
. the second trading day following the public release of our financial
results for the above-mentioned fiscal quarter if such release occurs on
or after the 88th day after the date of this prospectus.
Eligibility of Restricted Shares for Sale in the Public Market Under Rules 144
and 701
(Listed by date upon which shares first become saleable)
<TABLE>
<CAPTION>
Number of
Date Shares
---- ----------
<S> <C>
Immediately upon completion of this offering........................ 10,750
91st day after the date of this prospectus or the second trading day
following the public release of our quarterly financial results, as
applicable(1)...................................................... 7,789,238
181 days after the date of this prospectus (expiration of lock-up).. 24,778,354
Thereafter (subject to contractual vesting schedules and volume
limitations under Rule 144)........................................ 22,868,730
</TABLE>
---------------------
(1) The number of shares listed may be offered, sold or traded provided that
the last recorded sale price per share for 20 of the 30 trading days ending
on the applicable date is at least twice the initial public offering price
per share.
However, Credit Suisse First Boston Corporation, may in its sole discretion
without notice, release shares subject to lock-up agreements, although it has
no current intention to do so.
Options
Rule 701 provides that the shares of common stock acquired upon the exercise
of options outstanding as of September 30, 2000 or under other rights granted
under our stock plans may be resold, to the extent not subject to the lock-up
agreements, by persons, other than affiliates, beginning 90 days after the date
of this prospectus, subject only to the manner of sale provisions of Rule 144,
and by affiliates under Rule 144, without compliance with its one-year minimum
holding period, subject to limitations. As of September 30, 2000, options to
purchase a total of 4,154,723 shares of common stock were outstanding, 673,025
of which are exercisable. Of the total shares issuable upon the exercise of
these options, 4,027,330 shares are subject to the lock-up agreements described
in "Underwriting."
We intend to file one or more registration statements on Form S-8 under the
Securities Act following the offering to register up to 23,691,723 shares of
common stock which have been issued or are issuable under our stock option and
stock purchase plans. These registration statements are expected to become
effective upon filing. Shares covered by these registration statements will
thereupon be eligible for sale in the public markets, subject to the lock-up
agreements, to the extent applicable, and to Rule 144 limitations applicable to
affiliates.
Registration Rights
Following this offering, under specified circumstances and subject to
specified conditions, holders of our common stock will have the right to
require us to register their shares of common stock under the Securities Act
and to participate in any future registrations of securities by us. All holders
of registration rights have agreed not to exercise their registration rights
until 180 days following the date of this prospectus without the consent of
Credit Suisse First Boston Corporation. See "Related Party Transactions" and
"Description of Capital Stock."
61
<PAGE>
UNITED STATES FEDERAL TAX CONSEQUENCES
TO NON-UNITED STATES HOLDERS
The following is a general discussion of the material U.S. federal income
and estate tax consequences of the ownership and disposition of our common
stock by a non-U.S. holder. As used in this discussion, the term non-U.S.
holder means a beneficial owner of our common stock that is not, for U.S.
federal income tax purposes:
. an individual who is a citizen or resident of the United States;
. a corporation, an entity taxable as a corporation, or a partnership
created or organized in or under the laws of the United States or of any
political subdivision of the United States, other than a partnership
treated as foreign under U.S. Treasury regulations;
. an estate whose income is includible in gross income for U.S. federal
income tax purposes regardless of its source; or
. a trust, in general, if a U.S. court is able to exercise primary
supervision over the administration of the trust and one or more U.S.
persons have authority to control all substantial decisions of the
trust.
An individual may be treated as a resident of the United States in any
calendar year for U.S. federal income tax purposes, instead of a nonresident,
by, among other ways, being present in the United States on at least 31 days in
that calendar year and for an aggregate of at least 183 days during a three-
year period ending on December 31 of the current calendar year. For purposes of
this calculation, you would count all of the days present in the current year,
one-third of the days present in the immediately preceding year and one-sixth
of the days present in the second preceding year. Residents are taxed for U.S.
federal income purposes as if they were U.S. citizens.
This discussion does not consider:
. U.S. state and local or non-U.S. tax consequences;
. specific facts and circumstances that may be relevant to a particular
non-U.S. holder's tax position, including, if the non-U.S. holder is a
partnership or trust that the U.S. tax consequences of holding and
disposing of our common stock may be affected by certain determinations
made at the partner or beneficiary level;
. the tax consequences for the stockholders, partners or beneficiaries of
a non-U.S. holder;
. special tax rules that may apply to particular non-U.S. holders, such as
financial institutions, insurance companies, tax-exempt organizations,
U.S. expatriates, broker-dealers, and traders in securities; or
. special tax rules that may apply to a non-U.S. holder that holds our
common stock as part of a straddle, hedge, conversion transaction,
synthetic security or other integrated investment.
The following discussion is based on provisions of the U.S. Internal Revenue
Code of 1986, as amended, applicable U.S. Treasury regulations and
administrative and judicial interpretations, all as in effect on the date of
this prospectus, and all of which are subject to change, retroactively or
prospectively. The following summary assumes that a non-U.S. holder holds our
common stock as a capital asset for U.S. federal tax purposes. EACH NON-U.S.
HOLDER SHOULD CONSULT A TAX ADVISOR REGARDING THE U.S. FEDERAL, STATE, LOCAL
AND NON-U.S. INCOME, ESTATE, GIFT AND OTHER TAX CONSEQUENCES OF ACQUIRING,
HOLDING AND DISPOSING OF SHARES OF OUR COMMON STOCK.
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<PAGE>
Dividends
We do not anticipate paying cash dividends on our common stock in the
foreseeable future. In the event, however, that we pay dividends on our common
stock, we will have to withhold a U.S. federal withholding tax at a rate of
30%, or a lower rate under an applicable income tax treaty, from the gross
amount of the dividends paid to a non-U.S. holder. Non-U.S. holders should
consult their tax advisors regarding their entitlement to benefits under a
relevant income tax treaty.
Dividends that are effectively connected with a non-U.S. holder's conduct of
a trade or business in the United States and, in the event that an income tax
treaty applies, are also attributable to a permanent establishment maintained
by the non-U.S. holder in the United States, are taxed on a net income basis at
the regular graduated rates and in the manner applicable to U.S. persons. In
that case, we will not have to withhold U.S. federal withholding tax if the
non-U.S. holder complies with applicable certification and disclosure
requirements. In addition, a branch profits tax may be imposed at a 30% rate,
or a lower rate under an applicable income tax treaty, on dividends received by
a foreign corporation that are effectively connected with such foreign
corporation's conduct of a trade or business in the United States.
Dividends paid prior to 2001 to an address in a foreign country are
presumed, absent actual knowledge to the contrary, to be paid to a resident of
such country for purposes of the withholding discussed above and for purposes
of determining the applicability of an income tax treaty rate. For dividends
paid after 2000, a non-U.S. holder who claims the benefit of an applicable
income tax treaty rate generally will be required to satisfy applicable
certification and other requirements. However,
. in the case of common stock held by a foreign partnership, the
certification requirement will generally be applied to the partners of
the partnership and the partnership will be required to provide certain
information;
. in the case of common stock held by a foreign trust, the certification
requirement will generally be applied to the trust or the beneficial
owners of the trust depending on whether the trust is a foreign complex
trust, foreign simple trust, or foreign grantor trust as defined in the
U.S. Treasury regulations; and
. look-through rules will apply for tiered partnerships, foreign simple
trusts and foreign grantor trusts.
A non-U.S. holder which is a foreign partnership or a foreign trust is urged
to consult its own tax advisor regarding its status under these U.S. Treasury
regulations and the certification requirements applicable to it.
A non-U.S. holder that is eligible for a reduced rate of U.S. federal
withholding tax under an income tax treaty may obtain a refund or credit of any
excess amounts withheld by filing an appropriate claim for a refund with the
U.S. Internal Revenue Service.
Gain on Disposition of Common Stock
A non-U.S. holder generally will not be taxed on gain recognized on a
disposition of our common stock unless:
. the gain is effectively connected with the non-U.S. holder's conduct of
a trade or business in the United States and, in the event that an
income tax treaty applies, is also attributable to a permanent
establishment maintained by the non-U.S. holder in the United States; in
these cases, the gain will be taxed on a net income basis at the regular
graduated rates and in the manner applicable to U.S. persons, unless an
applicable treaty provides otherwise, and, if the non-U.S. holder is a
foreign corporation, the branch profits tax described above may also
apply;
. the non-U.S. holder is an individual who holds our common stock as a
capital asset, is present in the United States for more than 182 days in
the taxable year of the disposition and meets other requirements; or
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<PAGE>
. we are or have been a U.S. real property holding corporation for U.S.
federal income tax purposes at any time during the shorter of the five-
year period ending on the date of disposition or the period that the
non-U.S. holder held our common stock.
Generally, a corporation is a U.S. real property holding corporation if the
fair market value of its U.S. real property interests equals or exceeds 50% of
the sum of the fair market value of its worldwide real property interests plus
its other assets used or held for use in a trade or business. The tax relating
to stock in a U.S. real property holding corporation generally will not apply
to a non-U.S. holder whose holdings, direct and indirect, at all times during
the applicable period, constituted 5% or less of our common stock, provided
that our common stock was regularly traded on an established securities market.
We believe that we are not currently, and we do not anticipate becoming in the
future, a U.S. real property holding corporation.
Federal Estate Tax
Common stock owned or treated as owned by an individual who is a non-U.S.
holder at the time of death will be included in the individual's gross estate
for U.S. federal estate tax purposes, unless an applicable estate tax or other
treaty provides otherwise and, therefore, will be subject to U.S. federal
estate tax.
Information Reporting and Backup Withholding Tax
We must report annually to the U.S. Internal Revenue Service and to each
non-U.S. holder the amount of dividends paid to that holder and the tax
withheld from those dividends. Copies of the information returns reporting
those dividends and withholding may also be made available to the tax
authorities in the country in which the non-U.S. holder is a resident under the
provisions of an applicable income tax treaty or agreement.
Under some circumstances, U.S. Treasury regulations require additional
information reporting and backup withholding at a rate of 31% on some payments
on our common stock. Under currently applicable law, non-U.S. holders generally
will be exempt from these additional information reporting requirements and
from backup withholding on dividends paid prior to 2001 if we either were
required to withhold a U.S. federal withholding tax from those dividends or we
paid those dividends to an address outside the United States. After 2000,
however, the gross amount of dividends paid to a non-U.S. holder that fails to
certify its non-U.S. holder status in accordance with applicable U.S. Treasury
regulations generally will be reduced by backup withholding at a rate of 31%.
The payment of the proceeds from the disposition of our common stock by a
non-U.S. holder to or through the U.S. office of a broker generally will be
reported to the U.S. Internal Revenue Service and reduced by backup withholding
at a rate of 31% unless the non-U.S. holder either certifies its status as a
non-U.S. holder under penalties of perjury or otherwise establishes an
exemption and the broker has no actual knowledge to the contrary. The payment
of the proceeds from the disposition of our common stock by a non-U.S. holder
to or through a non-U.S. office of a non-U.S. broker will not be reduced by
backup withholding or reported to the U.S. Internal Revenue Service unless the
non-U.S. broker is a U.S. related person. In general, the payment of the
proceeds from the disposition of our common stock by or through a non-U.S.
office of a broker that is a U.S. person or a U.S. related person will be
reported to the U.S. Internal Revenue Service and, after 2000, may in limited
circumstances be reduced by backup withholding at a rate of 31%, unless the
broker receives a statement from the non-U.S. holder, signed under penalties of
perjury, certifying its non-U.S. status or the broker has documentary evidence
in its files that the holder is a non-U.S. holder and the broker has no actual
knowledge to the contrary. For this purpose, a U.S. related person is
generally:
. a controlled foreign corporation for U.S. federal income tax purposes;
. a foreign person 50% or more of whose gross income from all sources for
the three-year period ending with the close of its taxable year
preceding the payment, or for such part of the period that the broker
has been in existence, is derived from activities that are effectively
connected with the conduct of a U.S. trade or business; or
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<PAGE>
. effective after 2000, a foreign partnership if, at any time during the
taxable year, at least 50% of the capital or profits interest in the
partnership is owned by U.S. persons or the partnership is engaged in a
U.S. trade or business.
Non-U.S. holders should consult their own tax advisors regarding the
application of the information reporting and backup withholding rules to them,
including changes to these rules that will become effective after 2000.
Any amounts withheld under the backup withholding rules from a payment to a
non-U.S. holder will be refunded, or credited against the holder's U.S. federal
income tax liability, if any, provided that the required information or
appropriate claim for refund is furnished to the U.S. Internal Revenue Service.
65
<PAGE>
UNDERWRITING
Under the terms and subject to the conditions contained in an underwriting
agreement dated , 2000, we have agreed to sell to the underwriters named
below, for whom Credit Suisse First Boston Corporation, J.P. Morgan Securities
Inc. and U.S. Bancorp Piper Jaffray Inc. are acting as representatives, the
following respective numbers of shares of common stock:
<TABLE>
<CAPTION>
Number
Underwriter of Shares
----------- ---------
<S> <C>
Credit Suisse First Boston Corporation............................
J.P. Morgan Securities Inc........................................
U.S. Bancorp Piper Jaffray Inc....................................
---------
Total........................................................... 5,000,000
=========
</TABLE>
The underwriting agreement provides that the underwriters are obligated to
purchase all the shares of common stock in the offering if any are purchased,
other than those shares covered by the over-allotment option described below.
The underwriting agreement also provides that if an underwriter defaults the
purchase commitments of non-defaulting underwriters may be increased or the
offering may be terminated.
We have granted to the underwriters a 30-day option to purchase on a pro
rata basis up to 750,000 additional shares from us at the initial public
offering price less the underwriting discounts and commissions. The option may
be exercised only to cover any over-allotments of common stock.
The underwriters propose to offer the shares of common stock initially at
the public offering price on the cover page of this prospectus and to selling
group members at that price less a selling concession of $ per share. The
underwriters and selling group members may allow a discount of $ per share
on sales to other broker/dealers. After the initial public offering, the public
offering price and concession and discount to broker/dealers may be changed by
the representatives.
The following table summarizes the compensation and estimated expenses we
will pay:
<TABLE>
<CAPTION>
Per Share Total
----------------------------- -----------------------------
Without With Without With
Over-allotment Over-allotment Over-allotment Over-allotment
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Underwriting Discounts
and
Commissions paid by
us..................... $ $ $ $
Expenses payable by us.. $ $ $ $
</TABLE>
The representatives have informed us that the underwriters do not expect
discretionary sales to exceed 5% of the shares of common stock being offered.
We have agreed that we will not offer, sell, contract to sell, pledge or
otherwise dispose of, directly or indirectly, or file with the Securities and
Exchange Commission a registration statement under the Securities Act of 1933
relating to, any shares of our common stock or securities convertible into or
exchangeable or exercisable for any shares of our common stock, or publicly
disclose the intention to make any such offer, sale, pledge, disposition or
filing, without the prior written consent of Credit Suisse First Boston
Corporation for a period of 180 days after the date of this prospectus, subject
to exceptions set forth in the underwriting agreement.
66
<PAGE>
Our officers, directors and substantially all of our stockholders and option
holders have agreed that they will not offer, sell, contract to sell, pledge or
otherwise dispose of, directly or indirectly, any shares of our common stock or
securities convertible into or exchangeable or exercisable for any shares of
our common stock, enter into a transaction that would have the same effect, or
enter into any swap, hedge or other arrangement that transfers, in whole or in
part, any of the economic consequences of ownership of our common stock,
whether any of these transactions are to be settled by delivery of our common
stock or other securities, in cash or otherwise, or publicly disclose the
intention to make any offer, sale, pledge or disposition, or to enter into any
of these types of transactions, swaps, hedges or other arrangements, without,
in each case, the prior written consent of Credit Suisse First Boston
Corporation for a period of 180 days after the date of this prospectus. If the
reported last sale price of our common stock on The Nasdaq Stock Market's
National Market is at least twice the offering price per share for 20 of the 30
trading days ending on the last trading day preceding the 90th day after the
date of this prospectus, then 25% of the shares of our common stock owned by
the officers, directors and stockholders described above and subject to the
180-day restriction described above, or 13,842,780 shares, will be released
from these restrictions. The release of these shares will occur on one of the
following dates:
. if we publicly release our financial results for the above-mentioned
fiscal quarter prior to the 88 days after the date of this prospectus,
it will occur on the 91st day after the date of this prospectus; or
. if such release occurs on or after the 88th day after the date of this
prospectus, it will occur on the second trading day following the public
release of our financial results for the above-mentioned fiscal quarter.
The underwriters have reserved for sale, at the initial public offering
price, up to % of the shares of common stock offered pursuant to this
prospectus for employees, directors and other persons associated with us who
have expressed an interest in purchasing common stock in the offering. The
number of shares available for sale to the general public in the offering will
be reduced to the extent these persons purchase the reserved shares. Any
reserved shares not so purchased will be offered by the underwriters to the
general public on the same terms as the other shares.
We have agreed to indemnify the underwriters against liabilities under the
Securities Act, or contribute to payments that the underwriters may be required
to make in that respect.
We have applied to list the shares of common stock on The Nasdaq Stock
Market's National Market under the symbol "CVNI".
In connection with its services as placement agent for the Series D
convertible preferred stock financing, Credit Suisse First Boston Corporation
received a placement agent fee of approximately $4.4 million. In addition,
affiliates of Credit Suisse First Boston Corporation beneficially own an
aggregate of 179,370 shares of our Series D convertible preferred stock. These
shares will automatically convert into 179,370 shares of common stock upon the
closing of this offering.
Before this offering, there has been no public market for our common stock.
The initial public offering price will be determined by negotiation between the
representatives and us. The principal factors to be considered in determining
the public offering price include:
. the information in this prospectus or available to the underwriters;
. the history and the prospects for the industry in which we will
complete;
. the ability of our management;
. the prospects for our future earnings;
. the present state of our developments and our current financial
condition;
67
<PAGE>
. the general condition of the securities markets at the time of this
offering; and
. the recent market prices of, and the demand for, publicly traded common
stock of generally comparable companies.
We cannot be sure that the initial offering price will correspond to the
price at which the common stock will trade in the public market following this
offering or that an active trading market for the common stock will develop and
continue after this offering.
In connection with this offering, the underwriters may engage in stabilizing
transactions, over-allotment transactions, syndicate covering transactions and
penalty bids in accordance with Regulation M under the Securities Exchange Act
of 1934.
. Stabilizing transactions permit bids to purchase the underlying security
so long as the stabilizing bids do not exceed a specified maximum.
. Over-allotment involves sales by the underwriters of shares in excess of
the number of shares the underwriters are obligated to purchase, which
creates a syndicate short position. The short position may be either a
covered short position or a naked short position. In a covered short
position, the number of shares over-allotted by the underwriters is not
greater than the number of shares that they may purchase in the over-
allotment option. In a naked short position, the number of shares
involved is greater than the number of shares in the over-allotment
option. The underwriters may close out any short position by either
exercising their over-allotment option or purchasing shares in the open
market.
. Syndicate covering transactions involve purchases of the common stock in
the open market after the distribution has been completed in order to
cover syndicate short positions. In determining the source of shares to
close out the short position, the underwriters will consider, among
other things, the price of shares available for purchase in the open
market as compared to the price at which they may purchase shares
through the over-allotment option. If the underwriters sell more shares
than could be covered by the over-allotment option -- a naked short
position -- the position can only be closed out by buying shares in the
open market. A naked short position is more likely to be created if the
underwriters are concerned that there could be downward pressure on the
price of the shares in the open market after pricing that could
adversely affect investors who purchase in the offering.
. Penalty bids permit the representatives to reclaim a selling concession
from a syndicate member when the common stock originally sold by the
syndicate member is purchased in a stabilizing or syndicate covering
transaction to cover syndicate short positions.
These stabilizing transactions, syndicate covering transactions and penalty
bids may have the effect of raising or maintaining the market price of the
common stock or preventing or retarding a decline in the market price of the
common stock. As a result, the price of the common stock may be higher than the
price that might otherwise exist in the open market. These transactions may be
effected on The Nasdaq Stock Market's National Market or otherwise and, if
commenced, may be discontinued at any time.
A prospectus in electronic format may be made available on the web sites
maintained by one or more of the underwriters participating in this offering.
The representatives may agree to allocate a number of shares to underwriters
for sale to their online brokerage account holders. Internet distributions will
be allocated by the underwriters that will make internet distributions on the
same basis as other allocations. Credit Suisse First Boston Corporation may
effect an online distribution through its affiliate, DLJdirect, Inc., an online
broker/dealer, as a selling group member.
68
<PAGE>
NOTICE TO CANADIAN RESIDENTS
Resale Restrictions
The distribution of the common stock in Canada is being made only on a
private placement basis exempt from the requirement that we prepare and file a
prospectus with the securities regulatory authorities in each province where
trades of common stock are made. Any resale of the common stock in Canada must
be made under applicable securities laws which will vary depending on the
relevant jurisdiction, and which may require resales to be made under available
statutory exemptions or under a discretionary exemption granted by the
applicable Canadian securities regulatory authority. Purchasers are advised to
seek legal advice prior to any resale of the common stock.
Representations of Purchasers
By purchasing common stock in Canada and accepting a purchase confirmation,
a purchaser is representing to us and the dealer from whom the purchase
confirmation is received that:
. the purchaser is entitled under applicable provincial securities laws to
purchase the common stock without the benefit of a prospectus qualified
under those securities laws,
. where required by law, the purchaser is purchasing as principal and not
as agent, and
. the purchaser has reviewed the text above under Resale Restrictions.
Rights of Action (Ontario Purchasers)
The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
Ontario securities law. As a result, Ontario purchasers must rely on other
remedies that may be available, including common law rights of action for
damages or rescission of rights of action under the civil liability provisions
of the U.S. federal securities laws.
Enforcement of Legal Rights
All of the issuer's directors and officers as well as the experts named
herein may be located outside of Canada and, as a result, it may not be
possible for Canadian purchasers to effect service of process within Canada
upon the issuer or such persons. All or a substantial portion of the assets of
the issuer and such persons may be located outside of Canada and, as a result,
it may not be possible to satisfy a judgment against the issuer or such persons
in Canada or to enforce a judgment obtained in Canadian courts against such
issuer or persons outside of Canada.
Notice to British Columbia Residents
A purchaser of common stock to whom the Securities Act (British Columbia)
applies is advised that such purchaser is required to file with the British
Columbia Securities Commission a report within ten days of the sale of any
common stock acquired by the purchaser pursuant to this offering. The report
must be in the form attached to British Columbia Securities Commission Blanket
Order BOR #95/17, a copy of which may be obtained from us. Only one report must
be filed for common stock acquired on the same date and under the same
prospectus exemption.
Taxation and Eligibility for Investment
Canadian purchasers of common stock should consult their own legal and tax
advisors with respect to the tax consequences of an investment in the common
stock in their particular circumstances and about the eligibility of the common
stock for investment by the purchaser under relevant Canadian legislation.
69
<PAGE>
LEGAL MATTERS
The validity of the common stock offered hereby will be passed upon for us
by Hale and Dorr LLP, Boston, Massachusetts. H&D Investments 2000, a fund
affiliated with Hale and Dorr LLP, owns 6,116 shares of our Series D
convertible preferred stock. Legal matters for the underwriters will be passed
upon by Testa, Hurwitz & Thibeault, LLP, Boston, Massachusetts.
EXPERTS
The audited consolidated financial statements as of December 31, 1998 and
1999 and for the period from inception, May 6, 1998, to December 31, 1998 and
the year ended December 31, 1999, included in this prospectus and elsewhere in
the registration statement have been audited by Arthur Andersen LLP,
independent public accountants, as indicated in their report dated January 13,
2000 with respect thereto, and are included herein in reliance upon the
authority of said firm as experts in giving said report.
The consolidated financial statements of Hemisphere Investments, Inc. at
December 31, 1998 and 1999 and for each of the three years in the period ended
December 31, 1999, appearing in this prospectus and registration statement have
been audited by Ernst & Young LLP, independent auditors, as set forth in their
report thereon appearing elsewhere herein, and are included in reliance upon
such report given on the authority of such firm as experts in accounting and
auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1, including the exhibits and schedules to the registration
statement, under the Securities Act with respect to the shares to be sold in
this offering. This prospectus does not contain all the information set forth
in the registration statement. For further information with respect to us and
the shares to be sold in this offering, reference is made to the registration
statement. Statements contained in this prospectus as to the contents of any
contract, agreement or other document referred to, are not necessarily
complete, and in each instance reference is made to the copy of each contract,
agreement or other document filed as an exhibit to the registration statement.
You may read and copy all or any portion of the registration statement or
any reports, statements or other information we file at the Commission's public
reference room at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549 and at the regional offices of the Commission located at
Seven World Trade Center, 13th Floor, New York, New York 10048 and 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661. You can request copies of
these documents upon payment of a duplicating fee, by writing to the
Commission. Please call the Commission at 1-800-SEC-0330 for further
information on the operation of the public reference rooms. Our Commission
filings, including the registration statement, will also be available to you on
the Commission's Internet site (http://www.sec.gov).
70
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Convergent Networks, Inc. and Subsidiaries:
Report of Independent Public Accountants................................ F-2
Consolidated Balance Sheets as of December 31, 1998 and 1999, September
30, 2000 (Unaudited)................................................... F-3
Consolidated Statements of Operations for the Period from Inception (May
6, 1998) to December 31, 1998, for the Year Ended December 31, 1999 and
for the Nine Months Ended September 30, 1999 and 2000 (Unaudited)...... F-4
Consolidated Statements of Redeemable Convertible Preferred Stock and
Stockholders' Equity (Deficit) for the Period from Inception (May 6,
1998) to December 31, 1998, for the Year Ended December 31, 1999, for
the Nine Months Ended September 30, 2000 (Unaudited)................... F-5
Consolidated Statements of Cash Flows for the Period from Inception (May
6, 1998) to December 31, 1998, for the Year Ended December 31, 1999 and
for the Nine Months Ended September 30, 1999 and 2000 (Unaudited)...... F-6
Notes to Consolidated Financial Statements.............................. F-7
Hemisphere Investments, Inc. and Subsidiaries:
Report of Independent Auditors.......................................... F-26
Consolidated Balance Sheets as of December 31, 1998 and 1999 and June
30, 2000 (unaudited) .................................................. F-27
Consolidated Statements of Operations for the years ended December 31,
1997, 1998 and 1999 and for the six months ended June 30, 1999 and 2000
(unaudited)............................................................ F-28
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1997, 1998 and 1999 and for the six months ended June 30,
2000 (unaudited) ...................................................... F-29
Consolidated Statements of Cash Flows for the years ended December 31,
1997, 1998 and 1999 and for the six months ended June 30, 1999 and 2000
(unaudited) ........................................................... F-31
Notes to Consolidated Financial Statements.............................. F-32
Convergent Networks, Inc. and Subsidiaries Unaudited Pro Forma Financial
Data:
Introduction to Unaudited Pro Forma Financial Data...................... F-48
Unaudited Pro Forma Condensed Consolidated Statement of Operations for
the Year Ended December 31, 1999 and for the Nine Months Ended
September 30, 2000 .................................................... F-49
Notes to Unaudited Pro Forma Financial Data............................. F-51
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors of
Convergent Networks, Inc.:
We have audited the accompanying consolidated balance sheets of Convergent
Networks, Inc. (a Delaware Corporation) and subsidiaries as of December 31,
1998 and 1999 and the related consolidated statements of operations, redeemable
convertible preferred stock and stockholders' equity (deficit), and cash flows
for the period from inception (May 6, 1998) to December 31, 1998 and the year
ended December 31, 1999. These financial statements are the responsibility of
Convergent Networks, Inc.'s management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Convergent Networks, Inc.
and subsidiaries as of December 31, 1998 and 1999 and the results of their
operations and their cash flows for the period from inception (May 6, 1998) to
December 31, 1998 and the year ended December 31, 1999 in conformity with
accounting principles generally accepted in the United States.
Boston, Massachusetts Arthur Andersen LLP
January 13, 2000
F-2
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
------------------------- September 30,
1998 1999 2000
----------- ------------ -------------
(Unaudited)
<S> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents........... $ 4,746,450 $ 21,507,673 $ 87,384,130
Restricted investments.............. -- 150,000 150,000
Accounts receivable................. -- -- 447,640
Inventory........................... -- -- 4,534,731
Unbilled costs and fees............. -- -- 1,393,266
Assets held for sale................ -- -- 675,509
Prepaid expenses and other current
assets............................. 1,000 176,282 728,399
----------- ------------ ------------
Total current assets.............. 4,747,450 21,833,955 95,313,675
Property and equipment, net........... 337,824 2,036,330 7,124,534
----------- ------------ ------------
Restricted investments................ -- 500,000 500,000
----------- ------------ ------------
Other assets.......................... -- -- 432,356
Goodwill and other intangible assets,
net of accumulated amortization of
$6,554,639........................... -- -- 110,826,844
----------- ------------ ------------
$ 5,085,274 $ 24,370,285 $214,197,409
=========== ============ ============
Liabilities, Redeemable Convertible
Preferred Stock and Stockholders'
Equity (Deficit)
Current liabilities:
Notes payable....................... $ -- $ 564,409 $ 994,416
Accounts payable.................... 155,540 1,526,729 4,466,666
Accrued expenses.................... 585,878 2,982,033 10,067,605
Deferred rent....................... -- 192,213 476,962
Deferred revenue.................... -- 59,789 1,716,828
----------- ------------ ------------
Total current liabilities......... 741,418 5,325,173 17,722,477
----------- ------------ ------------
Notes payable, net of current
portion.............................. -- 943,285 705,059
----------- ------------ ------------
Commitments and contingencies (Note 4)
Redeemable convertible preferred
stock, $0.01 par value:
Authorized--22,600,000 shares
Issued and outstanding--6,876,000,
16,938,887 and 21,781,452 shares as
of December 31, 1998 and 1999 and
September 30, 2000, respectively
(redemption value of
$138,093,415)...................... 7,130,729 55,891,126 133,368,192
Preferred stock subscriptions
receivable........................ -- (15,000,000) --
----------- ------------ ------------
7,130,729 40,891,126 133,368,192
----------- ------------ ------------
Stockholders' equity (deficit):
Common stock, $0.00001 par value--
Authorized--400,000,000 shares
Issued--8,458,000, 14,426,000 and
29,646,970 shares as of December
31, 1998 and 1999 and September
30, 2000, respectively............ 84 144 296
Additional paid-in capital.......... 17,106 3,068,588 172,457,067
Treasury stock--159,000, 2,791,000
and 2,957,350 shares at cost as of
December 31, 1998 and 1999 and
September 30, 2000, respectively... (795) (132,395) (176,467)
Accumulated deficit................. (2,803,268) (25,191,230) (80,238,404)
Deferred compensation............... -- (512,531) (23,558,811)
Common stock subscriptions
receivable......................... -- (21,875) (6,082,000)
----------- ------------ ------------
Total stockholders' equity
(deficit)........................ (2,786,873) (22,789,299) 62,401,681
----------- ------------ ------------
$ 5,085,274 $ 24,370,285 $214,197,409
=========== ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Period from
Inception
(May 6, Nine Months Ended
1998) to Year Ended September 30,
December 31, December 31, --------------------------
1998 1999 1999 2000
------------ ------------ ------------ ------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Related-party revenues.. $ -- $ -- $ -- $ 4,957,413
Third-party revenues.... -- -- -- 1,801,817
----------- ------------ ------------ ------------
Total revenues...... -- -- -- 6,759,230
Cost of revenues(1)..... -- -- -- 5,041,676
----------- ------------ ------------ ------------
Gross profit........ -- -- -- 1,717,554
----------- ------------ ------------ ------------
Operating expenses:
Research and
development(1)....... 2,181,884 13,067,158 7,646,074 9,292,823
Selling and
marketing(1)......... 163,121 3,522,903 1,870,986 5,075,750
General and
administrative(1).... 283,024 1,273,363 697,596 2,652,057
Stock-based
compensation......... -- 3,545,710 134,400 8,079,670
Amortization of
intangible assets.... -- -- -- 6,554,639
Acquired in-process
research and
development.......... -- -- -- 23,000,000
----------- ------------ ------------ ------------
Total operating
expenses........... 2,628,029 21,409,134 10,349,056 54,654,939
----------- ------------ ------------ ------------
Loss from
operations......... (2,628,029) (21,409,134) (10,349,056) (52,937,385)
Interest income......... 99,576 204,551 128,397 1,497,525
Interest expense........ -- (67,139) (40,469) (190,913)
----------- ------------ ------------ ------------
Net loss............ (2,528,453) (21,271,722) (10,261,128) (51,630,773)
Accretion of dividends
and issuance costs on
preferred stock........ (254,729) (1,066,817) (611,256) (3,416,401)
----------- ------------ ------------ ------------
Net loss
attributable to
common
stockholders....... $(2,783,182) $(22,338,539) $(10,872,384) $(55,047,174)
=========== ============ ============ ============
Basic and diluted net
loss per common share.. $ (4.87) $ (7.47) $ (4.22) $ (10.61)
=========== ============ ============ ============
Weighted average common
shares outstanding:
Basic and diluted..... 571,500 2,991,313 2,577,411 5,188,235
=========== ============ ============ ============
(1) Excludes non-cash,
stock-based
compensation as
follows:
Cost of revenues...... $ -- $ -- $ -- $ 253,048
Research and
development.......... -- 1,713,599 -- 828,880
Selling and
marketing............ -- 276,242 -- 3,309,029
General and
administrative....... -- 1,555,869 134,400 3,688,713
----------- ------------ ------------ ------------
$ -- $ 3,545,710 $ 134,400 $ 8,079,670
=========== ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS EQUITY (DEFICIT)
For the Period from Inception (May 6, 1998) to December 31, 1998 the Year
Ended December 31, 1999 and for the Nine Months Ended September 30, 2000
(unaudited)
<TABLE>
<CAPTION>
Stockholders' Equity (Deficit)
--------------------------------------------------------------------------------
Redeemable Convertible
Preferred Stock Common Stock Treasury Stock
----------------------- ------------------- -------------------
Carrying $0.00001 Additional
Amount, Par Paid-in Accumulated Deferred
Shares Net Shares Value Capital Shares Cost Deficit Compensation
---------- ------------ ---------- -------- ------------ --------- --------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Inception (May 6,
1998)............ -- $ -- -- $-- $ -- -- $ -- $ -- $ --
Sale of common
stock........... -- -- 8,458,000 84 17,106 -- -- -- --
Sale of Series A
redeemable
convertible
preferred stock,
net of issuance
costs of
$20,086......... 6,876,000 6,876,000 -- -- -- -- -- (20,086) --
Repurchase of
common stock.... -- -- -- -- -- 159,000 (795) -- --
Accretion of
dividends on
redeemable
convertible
preferred
stock........... -- 254,729 -- -- -- -- -- (254,729) --
Net loss........ -- -- -- -- -- -- -- (2,528,453) --
---------- ------------ ---------- ---- ------------ --------- --------- ------------ ------------
Balance, December
31, 1998......... 6,876,000 7,130,729 8,458,000 84 17,106 159,000 (795) (2,803,268) --
Sale of common
stock........... -- -- 3,530,000 36 344,164 -- -- -- --
Exercise of
common stock
options......... -- -- 2,438,000 24 362,676 -- -- -- --
Sale of Series A
redeemable
convertible
preferred
stock........... 100,000 100,000 -- -- -- -- -- -- --
Sale of Series B
redeemable
convertible
preferred stock,
net of issuance
costs of
$9,423.......... 4,133,892 9,879,998 -- -- -- -- -- (9,423) --
Sale of Series C
redeemable
convertible
preferred stock,
net of issuance
costs of
$40,000......... 5,564,142 20,999,983 -- -- -- -- -- (40,000) --
Issuance of
Series C
redeemable
convertible
preferred stock
in exchange for
services
received........ 264,853 1,713,599 -- -- -- -- -- -- --
Collection of
stock
subscriptions
receivable...... -- -- -- -- -- -- -- -- --
Deferred
compensation
related to stock
options and
capital stock... -- -- -- -- 2,344,642 -- -- -- (2,344,642)
Amortization of
deferred
compensation.... -- -- -- -- -- -- -- -- 1,832,111
Repurchase of
common stock.... -- -- -- -- -- 2,632,000 (131,600) -- --
Accretion of
dividends on
redeemable
convertible
preferred
stock........... -- 1,066,817 -- -- -- -- -- (1,066,817) --
Net loss........ -- -- -- -- -- -- -- (21,271,722) --
---------- ------------ ---------- ---- ------------ --------- --------- ------------ ------------
Balance, December
31, 1999......... 16,938,887 40,891,126 14,426,000 144 3,068,588 2,791,000 (132,395) (25,191,230) (512,531)
Sale of common
stock
(unaudited)..... -- -- 4,549,500 46 6,181,954 -- -- -- --
Exercise of
common stock
options
(unaudited)..... -- -- 564,625 5 592,431 -- -- -- --
Sale of Series C
redeemable
convertible
preferred stock
(unaudited)..... 38,640 250,000 -- -- -- -- -- -- --
Sale of Series D
redeemable
convertible
preferred stock;
net of issuance
costs of
$4,734,035
(unaudited)..... 4,803,925 73,810,665 -- -- -- -- -- -- --
Collection of
stock
subscriptions
receivable
(unaudited)..... -- 15,000,000 -- -- -- -- -- -- --
Deferred
compensation
related to stock
options and
capital stock
(unaudited)..... -- -- -- -- 27,318,468 -- -- -- (27,318,468)
Amortization of
deferred
compensation
(unaudited)..... -- -- -- -- -- -- -- -- 8,079,670
Repurchase of
common stock
(unaudited)..... -- -- -- -- -- 166,350 (44,072) -- --
Common stock
issued and stock
options assumed
in connection
with the TCS
acquisition
(Note 9(a))
(unaudited)..... -- -- 10,106,845 101 135,295,626 -- -- -- (3,807,482)
Accretion of
dividends and
issuance costs
on redeemable
convertible
preferred stock
(unaudited)..... -- 3,416,401 -- -- -- -- -- (3,416,401) --
Net loss
(unaudited)..... -- -- -- -- -- -- -- (51,630,773) --
---------- ------------ ---------- ---- ------------ --------- --------- ------------ ------------
Balance,
September 30,
2000
(unaudited)...... 21,781,452 $133,368,192 29,646,970 $296 $172,457,067 2,957,350 $(176,467) $(80,238,404) $(23,558,811)
========== ============ ========== ==== ============ ========= ========= ============ ============
<CAPTION>
Stock Total
Subscrip- Stockholders'
tions Equity
Receivable (Deficit)
------------ --------------
<S> <C> <C>
Inception (May 6,
1998)............ $ -- $ --
Sale of common
stock........... -- 17,190
Sale of Series A
redeemable
convertible
preferred stock,
net of issuance
costs of
$20,086......... -- (20,086)
Repurchase of
common stock.... -- (795)
Accretion of
dividends on
redeemable
convertible
preferred
stock........... -- (254,729)
Net loss........ -- (2,528,453)
------------ --------------
Balance, December
31, 1998......... -- (2,786,873)
Sale of common
stock........... (45,000) 299,200
Exercise of
common stock
options......... -- 362,700
Sale of Series A
redeemable
convertible
preferred
stock........... -- --
Sale of Series B
redeemable
convertible
preferred stock,
net of issuance
costs of
$9,423.......... -- (9,423)
Sale of Series C
redeemable
convertible
preferred stock,
net of issuance
costs of
$40,000......... -- (40,000)
Issuance of
Series C
redeemable
convertible
preferred stock
in exchange for
services
received........ -- --
Collection of
stock
subscriptions
receivable...... 23,125 23,125
Deferred
compensation
related to stock
options and
capital stock... -- --
Amortization of
deferred
compensation.... -- 1,832,111
Repurchase of
common stock.... -- (131,600)
Accretion of
dividends on
redeemable
convertible
preferred
stock........... -- (1,066,817)
Net loss........ -- (21,271,722)
------------ --------------
Balance, December
31, 1999......... (21,875) . (22,789,299)
Sale of common
stock
(unaudited)..... (6,082,000) 100,000
Exercise of
common stock
options
(unaudited)..... -- 592,436
Sale of Series C
redeemable
convertible
preferred stock
(unaudited)..... -- --
Sale of Series D
redeemable
convertible
preferred stock;
net of issuance
costs of
$4,734,035
(unaudited)..... -- --
Collection of
stock
subscriptions
receivable
(unaudited)..... 21,875 21,875
Deferred
compensation
related to stock
options and
capital stock
(unaudited)..... -- --
Amortization of
deferred
compensation
(unaudited)..... -- 8,079,670
Repurchase of
common stock
(unaudited)..... -- (44,072)
Common stock
issued and stock
options assumed
in connection
with the TCS
acquisition
(Note 9(a))
(unaudited)..... -- 131,488,245
Accretion of
dividends and
issuance costs
on redeemable
convertible
preferred stock
(unaudited)..... -- (3,416,401)
Net loss
(unaudited)..... -- (51,630,773)
------------ --------------
Balance,
September 30,
2000
(unaudited)...... $(6,082,000) $ 62,401,681
============ ==============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Period from
Inception Nine Months Ended
(May 6, 1998) to Year Ended September 30,
December 31, December 31, --------------------------
1998 1999 1999 2000
---------------- ------------ ------------ ------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Cash flows from
operating activities:
Net loss............... $(2,528,453) $(21,271,722) $(10,261,128) $(51,630,773)
Adjustments to
reconcile net loss to
net cash used in
operating
activities--
Depreciation and
amortization....... 78,336 698,154 411,208 8,195,299
Acquired in-process
research and
development........ -- -- -- 23,000,000
Stock-based
compensation....... -- 3,545,710 134,400 8,079,670
Changes in assets
and liabilities,
net of
acquisition--
Accounts
receivable....... -- -- -- 220,612
Inventory......... -- -- -- (4,472,731)
Prepaid expenses
and other current
assets........... (1,000) (175,282) (19,022) (74,838)
Unbilled costs and
fees............. -- (28,825)
Assets held for
sale............. -- -- -- 86,169
Other assets...... -- -- -- (341,213)
Accounts payable.. 155,540 1,371,189 1,060,808 (2,755,559)
Accrued expenses.. 585,878 2,396,155 1,196,070 (483,348)
Deferred rent..... -- 192,213 -- 278,796
Deferred revenue.. -- 59,789 59,790 557,039
----------- ------------ ------------ ------------
Net cash used in
operating
activities..... (1,709,699) (13,183,794) (7,417,874) (19,369,702)
----------- ------------ ------------ ------------
Cash flows from
investing activities:
Purchase of property
and equipment........ (416,160) (2,296,660) (1,471,124) (3,063,896)
Cash paid for TCS, net
of cash acquired..... -- -- -- (219,467)
Increase in restricted
investments.......... -- (650,000) (650,000) --
----------- ------------ ------------ ------------
Net cash used in
investing
activities..... (416,160) (2,946,660) (2,121,124) (3,283,363)
----------- ------------ ------------ ------------
Cash flows from
financing activities:
Proceeds from sale of
redeemable
convertible preferred
stock, net of
issuance costs....... 6,855,914 30,930,558 9,945,574 78,692,933
Proceeds from sale of
common stock and
exercise of common
stock options........ 17,190 661,900 249,300 692,436
Proceeds from the
collection of
subscriptions
receivable........... -- 23,125 -- 15,021,875
Purchase of treasury
stock................ (795) (131,600) (30,000) (44,072)
Borrowings on notes
payable.............. -- 1,472,665 848,125 --
Payments on notes
payable.............. -- (64,971) -- (5,833,650)
----------- ------------ ------------ ------------
Net cash
provided by
financing
activities..... 6,872,309 32,891,677 11,012,999 88,529,522
----------- ------------ ------------ ------------
Net increase in cash and
cash equivalents....... 4,746,450 16,761,223 1,474,001 65,876,457
Cash and cash
equivalents, beginning
of period.............. -- 4,746,450 4,746,450 21,507,673
----------- ------------ ------------ ------------
Cash and cash
equivalents, end of
period................. $ 4,746,450 $ 21,507,673 $ 6,220,451 $ 87,384,130
=========== ============ ============ ============
Supplemental disclosure
of noncash investing
and financing
activities:
Equipment acquired
with note payable.... $ -- $ 100,000 $ -- $ --
=========== ============ ============ ============
Common stock issued
for subscriptions
receivables.......... $ -- $ 45,000 $ -- $ 6,082,000
=========== ============ ============ ============
Accretion of dividends
and issuance costs on
redeemable
convertible preferred
stock................ $ 254,729 $ 1,066,817 $ 611,256 $ 3,416,401
=========== ============ ============ ============
Series C preferred
stock issued for
subscriptions
receivable........... $ -- $ 15,000,000 $ -- $ --
=========== ============ ============ ============
Supplemental disclosure
of cash flow
information:
Cash paid during the
period for interest.. $ -- $ 67,139 $ 39,062 $ 95,972
=========== ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(including data applicable to unaudited periods)
(1) Operations and Significant Accounting Policies
Convergent Networks, Inc. (the Company) was incorporated as a Delaware
corporation on May 6, 1998. The Company designs, develops and markets a new
generation of switching equipment and software that enable communications
service providers to rapidly deliver voice and data services over broadband
networks.
The Company incurred net losses of approximately $2.5 million, $21.3 million
and $51.6 million for the period from inception (May 6, 1998) to December 31,
1998, for the year ended December 31, 1999 and the nine months ended September
30, 2000, respectively. At September 30 2000, the Company has an accumulated
deficit of approximately $80.2 million. During the nine months ended September
30, 2000 the Company commenced commercial shipment of its products and emerged
from the development stage. Although no longer in the development stage, the
Company continues to be subject to the risks and challenges similar to other
companies in a similar stage of development. These risks include, but are not
limited to, dependence on key individuals, dependence on contract manufacturers
and key suppliers of integral components, successful development and marketing
of products, the ability of next-generation service providers to raise
sufficient capital to purchase the Company's products, the ability to obtain
adequate financing to support growth, technological change and competition from
substitute products and larger companies with greater financial, technical,
management and marketing resources.
The accompanying consolidated financial statements reflect the application
of certain significant accounting policies as described in this note and
elsewhere in these notes to consolidated financial statements.
(a) Principles of Consolidation
The accompanying consolidated financial statements reflect the operations
and include the accounts of the Company and its wholly owned subsidiaries. All
significant intercompany transactions and balances have been eliminated in
consolidation.
(b) Unaudited Interim Financial Information
The financial statements as of September 30, 2000, and for the nine months
ended September 30, 1999 and 2000 are unaudited but include all adjustments,
consisting of only normal recurring adjustments, that in the opinion of
management are necessary for a fair presentation of the Company's financial
position, operating results, and cash flows for such periods. Operating results
for the nine months ended September 30, 2000 are not necessarily indicative of
results to be expected for the full fiscal year of 2000 or any future period.
The information disclosed in the notes to consolidated financial statements for
these periods is unaudited.
(c) Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
(d) Revenue Recognition
The Company recognizes revenue from product sales upon product shipment
provided that there are no uncertainties regarding acceptance, there is
persuasive evidence of an arrangement, the sales price is fixed or
F-7
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(including data applicable to unaudited periods)
determinable and collection of the related accounts receivable is probable. If
there are uncertainties regarding customer acceptance, revenue is deferred
until the uncertainties are resolved. The Company evaluates the
creditworthiness of each customer and revenue is not recognized unless the
collection of the related accounts receivable is probable. The Company's
products incorporate software that is more than incidental to the related
hardware and, accordingly, the Company recognizes revenue in accordance with
Statement of Position (SOP) 97-2, Software Revenue Recognition. For
arrangements that include the delivery of multiple elements, revenue is
allocated to the various elements based on vendor specific objective evidence
of fair value (VSOE). The Company establishes VSOE based on either the price
charged for the element when sold separately or for elements not yet sold
separately, the price established by management with the relevant authority to
do so. In accordance with SOP 98-9, Modification of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions, the Company uses the
residual method when fair value does not exist for one of the delivered
elements in the arrangements. Under the residual method, the fair value of the
undelivered element is deferred and recognized when delivered. Revenue from
installation and training services is recognized as the services are provided.
Revenue from support and maintenance contracts is recognized ratably over the
terms of the contracts. Amounts collected prior to satisfying the above
revenue recognition criteria are reflected as deferred revenue.
In certain limited arrangements with TCS' customers that require
significant customization or modification of the software, revenue is
recognized in conformity with SOP 81-1, Accounting for Performance of
Construction-Type and Certain Production-Type Contracts, using the completed
contract method. Provisions for anticipated losses on contracts are made in
the period in which they first become determinable. Unbilled costs and fees on
contracts represent the excess of costs incurred to date on contracts over
billings to date on those contracts. Billings made on contracts are recorded
as a reduction of the related unbilled costs and fees on contracts.
Warranty costs are estimated and recorded by the Company at the time of
product revenue recognition.
(e) Single Source Suppliers and Contract Manufacturers
Several key components of the Company's products are currently available
from single or limited sources. If the Company is unable to obtain sufficient
quantities of these components, it would be unable to manufacture and ship its
products on a timely basis. This could result in lost or delayed revenues,
damage to the Company's reputation and increased manufacturing costs.
The Company currently subcontracts the manufacturing and assembly of its
products and procurement of materials to independent manufacturers. The
Company does not have internal manufacturing capabilities. The Company's
reliance on contract manufacturers exposes it to a number of risks, including
reduced control over manufacturing capacity and component availability,
product completion and delivery times, product quality, manufacturing costs
and inadequate or excess inventory levels which could lead to product shortage
or charges for excess or obsolete inventory.
(f) Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity of 90 days or less to be cash equivalents. The Company
accounts for its cash equivalents and short-term investments in accordance
with Statement of Financial Accounting Standards (SFAS) No. 115, Accounting
for Certain Investments in Debt and Equity Securities. All cash equivalents
are classified as held-to-maturity and are recorded at their amortized cost,
which approximates market.
F-8
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(including data applicable to unaudited periods)
(g) Inventory
Inventory is stated at the lower of cost (first-in, first-out) or market and
consists of the following at September 30, 2000 (unaudited):
<TABLE>
<S> <C>
Raw materials................................................... $ 45,400
Work-in-progress................................................ 1,131,836
Finished goods.................................................. 3,357,495
----------
$4,534,731
==========
</TABLE>
(h) Property and Equipment
Property and equipment consists of the following:
<TABLE>
<CAPTION>
December 31,
-------------------- September 30,
1998 1999 2000
-------- ---------- -------------
(unaudited)
<S> <C> <C> <C>
Asset
Computer and office equipment.......... $144,920 $ 897,837 $ 2,056,727
Furniture and fixtures................. 101,315 262,184 455,464
Technology licenses.................... 136,319 195,053 195,053
Engineering equipment.................. 33,606 1,457,746 6,834,442
-------- ---------- -----------
Cost................................. 416,160 2,812,820 9,541,686
Accumulated depreciation and
amortization.......................... (78,336) (776,490) (2,417,152)
-------- ---------- -----------
Property and equipment, net.......... $337,824 $2,036,330 $ 7,124,534
======== ========== ===========
</TABLE>
(i) Depreciation and Amortization
The Company provides for depreciation and amortization by charges to
operations on a straight-line basis in amounts estimated to allocate the cost
of the assets over their estimated useful lives, as follows:
<TABLE>
<CAPTION>
Estimated
Asset Classification Useful Life
-------------------- -----------
<S> <C>
Computer and office equipment.................................. 2 years
Furniture and fixtures......................................... 3 years
Technology licenses............................................ 2 years
Engineering equipment.......................................... 2 years
</TABLE>
F-9
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(including data applicable to unaudited periods)
(j) Accrued Expenses
Accrued expenses consisted of the following:
<TABLE>
<CAPTION>
December 31,
------------------- September 30,
1998 1999 2000
-------- ---------- -------------
(unaudited)
<S> <C> <C> <C>
Accrued accounts payable................. $446,807 $1,410,708 $ 578,366
Accrued issuance costs related to pre-
ferred stock............................ -- -- 4,632,268
Accrued payroll and related expenses..... 78,034 883,985 1,745,448
Accrued professional fees................ 44,130 280,953 333,212
Customer deposits........................ -- -- 256,933
Other.................................... 16,907 406,387 2,521,378
-------- ---------- -----------
$585,878 $2,982,033 $10,067,605
======== ========== ===========
</TABLE>
(k) Software Development Costs
The Company accounts for its software development costs in accordance with
SFAS No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased
or Otherwise Marketed. Accordingly, the costs for the development of new
software and substantial enhancements to existing software are expensed as
incurred until technological feasibility has been established, at which time
any additional costs are capitalized. The Company believes technological
feasibility has been established at the time at which a working model of the
software has been completed. Because the Company believes its current process
for developing software is essentially completed concurrently with the
establishment of technological feasibility, no costs have been capitalized to
date.
(l) Concentration of Credit Risk and Significant Customers
Financial instruments that potentially expose the Company to concentrations
of credit risk consist mainly of cash and cash equivalents and accounts
receivable. The Company maintains its cash and cash equivalents principally in
domestic financial institutions of high credit standing. At December 31, 1998
and 1999 the Company did not have any accounts receivable. At September 30,
2000, the Company had one customer that accounted for 93% of accounts
receivable. During the period from inception (May 6, 1998) to December 31, 1998
and for the year ended December 31, 1999 the Company had no revenues. For the
nine months ended September 30, 2000, the Company had one customer that
accounted for 73% of revenues and an affiliate of that customer owns
approximately 1% of the Company's capital stock and one customer that accounted
for 22% of revenues.
(m) Fair Value of Financial Instruments
The Company's financial instruments consist mainly of cash and cash
equivalents, subscriptions receivable, accounts payable and a term loan. The
carrying amounts of these instruments approximate their fair value.
(n) Comprehensive Income (Loss)
The Company has adopted SFAS No. 130, Reporting Comprehensive Income. SFAS
No. 130 requires disclosure of all components of comprehensive income (loss),
on an annual and interim basis. Comprehensive income (loss) is defined as the
change in equity of a business enterprise during a period from transactions and
other events and circumstances from nonowner sources. Comprehensive net loss is
the same as the reported net loss for all periods presented.
F-10
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(including data applicable to unaudited periods)
(o) Net Loss Per Share
Basic and diluted net loss per share are presented in conformity with SFAS
No. 128, Earnings Per Share, for all periods presented. In accordance with SFAS
No. 128, basic and diluted net loss per share have been computed by dividing
the net loss attributable to common stockholders by the weighted-average number
of shares of common stock outstanding during the period, less shares subject to
repurchase. Basic and diluted net loss per share are the same because all
outstanding common stock options have been excluded as they are antidilutive
since the Company has incurred net losses for all periods presented. Options
and warrants to purchase a total of 1,003,200 and 4,399,723 common shares have
been excluded from the computations of diluted weighted average shares
outstanding for the year ended December 31, 1999, and for the nine months ended
September 30, 2000, respectively. As of December 31, 1999 and September 30,
2000, 6,131,200 and 8,752,350 shares were subject to repurchase by the Company
and were excluded from the computation of weighted-average shares outstanding.
Shares of common stock issuable upon the conversion of outstanding shares of
redeemable convertible preferred stock have also been excluded for all periods
presented.
In accordance with Securities and Exchange Commission (SEC) Staff Accounting
Bulletin (SAB) No. 98, Earnings Per Share in a Public Offering, the Company has
determined that it has not had any issuances or grants for nominal
consideration.
(p) Segment and Geographic Information
SFAS No. 131, Disclosures About Segments of an Enterprise and Related
Information established standards for reporting information about operating
segments in annual financial statements and requires companies to report
selected segment information in interim financial reports to stockholders. To
date the Company has viewed its operations and manages its business as one
segment. The Company had no revenues from customers outside of the United
States for the period from inception (May 6, 1998) to December 31, 1998 and for
the year ended December 31, 1999. The Company had revenues of approximately
$1.5 million from one customer in the United Kingdom for the nine months ended
September 30, 2000.
(q) Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
establishes methods of accounting for derivative financial instruments and
hedging activities related to those instruments as well as other hedging
activities. The Company will be required to adopt SFAS No. 133 for its year
ending December 31, 2001. However, because the Company currently does not
utilize derivative financial instruments, the Company does not believe the
impact of SFAS No. 133 will be material to its financial position, results of
operations, or cash flows.
In December 1999, the SEC released SAB No. 101, Revenue Recognition in
Financial Statements. This bulletin summarizes some views of the staff on
applying accounting principles generally accepted in the United States to
revenue recognition in financial statements. The Company believes that its
current revenue recognition policy complies with SAB No. 101.
In March 2000, the FASB issued Interpretation No. 44, Accounting for Certain
Transactions Involving Stock Compensation--an Interpretation of APB Opinion No.
25. This interpretation clarifies the application of APB Opinion No. 25 in
certain situations, as defined. The interpretation is effective July 1, 2000,
but covers certain events occurring during the period after December 15, 1998
but before the effective date.
F-11
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(including data applicable to unaudited periods)
(2) Income Taxes
The Company accounts for federal and state income taxes in accordance with
SFAS No. 109, Accounting for Income Taxes. Under the liability method specified
by SFAS No. 109, deferred tax assets and liabilities are determined based on
the differences between the financial statement and tax bases of assets and
liabilities, using currently enacted tax rates.
No provision for federal or state income taxes has been recorded, as the
Company has incurred net operating losses for all periods presented.
As of December 31, 1999, the Company had federal and state net operating
loss carryforwards and research and development credits available of
approximately $20,800,000 and $88,000, respectively, to offset future taxable
income, if any. These carryforwards expire through 2019 and are subject to
review and possible adjustment by the Internal Revenue Service.
The U.S. Internal Revenue Code of 1986, as amended (the Code), contains
provisions that may limit the U.S. net operating loss and tax credit
carryforwards available to be used in any given year upon the occurrence of
certain events, including significant changes in the ownership interests, as
defined.
The components of the Company's net deferred tax assets are approximately as
follows:
<TABLE>
<CAPTION>
December 31,
-----------------------
1998 1999
---------- -----------
<S> <C> <C>
Net operating loss carryforwards.................... $1,010,000 $ 8,362,000
Tax credit carryforwards............................ -- 88,000
Other temporary differences......................... (27,000) 488,000
---------- -----------
983,000 8,938,000
Valuation allowance................................. (983,000) (8,938,000)
---------- -----------
$ -- $ --
========== ===========
</TABLE>
The Company has recorded a 100% valuation allowance against its gross
deferred tax assets at December 31, 1998 and 1999 because the future
realizability of such assets is uncertain. The tax benefit at the federal
statutory rate of 34% related to net operating losses has been offset by this
100% valuation allowance.
(3) Notes Payable
(a) Equipment Line of Credit
During 1998, the Company entered into a $1,500,000 equipment line of credit
with a bank. All outstanding borrowings bear interest at the prime rate (8.50%
at December 31, 1999) plus 0.75% and are collateralized by substantially all
assets of the Company. In addition, the Company is required to comply with
certain financial and restrictive covenants regarding minimum levels of
tangible net worth. As of December 31, 1999 and September 30, 2000, the Company
was in compliance with all such covenants.
All equipment advances outstanding as of December 31, 1999 had been
converted into a term loan payable in 36 consecutive equal monthly principal
installments of $41,012. As of December 31, 1999, the Company has included
approximately $492,000 in current liabilities and approximately $943,000 in
long-term liabilities.
F-12
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(including data applicable to unaudited periods)
(b) Notes Payable
In October 1999, the Company purchased $100,000 of equipment from a vendor
in exchange for a $100,000 note payable. The note bears interest at a rate of
10% per annum, payable monthly. Final payment of the note was made in March
2000. As of December 31, 1999, the balance on this note was $72,265 and is
included in current liabilities.
(4) Commitments and Contingencies
(a) Operating Leases
The Company conducts its operations in leased facilities and is obligated
to pay monthly rent through August 2006. Rental expense charged to operations
in 1998, 1999 and for the nine months ended September 30, 1999 and 2000 was
approximately $89,000, $519,000, $245,000 and $971,000, respectively.
Additionally, the Company maintains letters of credit totaling $650,000 as a
condition of its facility leases. The letters of credit have been fully
collateralized by certificates of deposit maintained at the bank that issued
the letters of credit. The certificates of deposit have been classified as
restricted investments in the accompanying consolidated balance sheet.
Future minimum rental payments under the lease as of December 31, 1999 are
approximately as follows:
<TABLE>
<CAPTION>
Year Amount
---- ----------
<S> <C>
2000............................................................ $1,107,000
2001............................................................ 1,332,000
2002............................................................ 1,404,000
2003............................................................ 1,477,000
2004............................................................ 1,549,000
Thereafter...................................................... 2,736,000
----------
Total......................................................... $9,605,000
==========
</TABLE>
(b) Trade Name Infringement Claim
The Company received a letter from the counsel of Convergent Communications
on January 6, 2000 alleging that the Company's use of the name Convergent
Networks and the convergentnet.com domain name is an infringement of
Convergent Communications trademarks. The Company believes an adverse outcome
of this matter would not have a material impact on its financial condition or
results of operations.
(c) Litigation (unaudited)
On May 27, 1999, MCIWorldcom filed a lawsuit in the Circuit Court of the
17th Judicial Circuit in the State of Florida alleging breach of contract and
unjust enrichment by Technology Control Services and breach of guaranty by its
parent company Hemisphere Investments. MCI alleges that TCS breached two
contracts and was unjustly enriched by failing to pay for telecommunications
services allegedly rendered by MCI in connection with TCS' discontinued
business of the resale of voice traffic. MCI is seeking up to $3,227,487 in
damages, as well as costs and attorneys' fees. The Company intends to defend
itself vigorously against MCI's claim. TCS has also filed counter-claims
against MCI for breach of contract and intentional interference with business
relationships for an unspecified sum. However, there can be no assurance that
the Company will be successful in the defense of this litigation. The Company
may consider settlement due to the costs and
F-13
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(including data applicable to unaudited periods)
uncertainties associated with litigation in general, and the diversion of the
time and attention of some members of its management. In connection with the
acquisition of TCS, 1,516,025 shares of common stock issued to stockholders of
TCS have been held in escrow to secure specified indemnification obligations of
TCS and its stockholders, including any damages the Company might incur as a
result of the MCI litigation.
(5) Redeemable Convertible Preferred Stock
At September 30, 2000, the Company had 22,600,000 authorized shares of
redeemable convertible preferred stock of which 7,000,000, 4,200,000, 6,500,000
and 4,900,000 shares have been designated as Series A, Series B, Series C and
Series D redeemable convertible preferred stock, respectively.
During 1998, the Company sold 6,876,000 shares of Series A redeemable
convertible preferred stock (Series A Preferred Stock) at $1.00 per share,
resulting in net proceeds to the Company of approximately $6,856,000. In 1999,
the Company sold an additional 100,000 shares of Series A Preferred Stock for
net proceeds of $100,000.
During 1999, the Company sold 4,133,892 shares of Series B redeemable
convertible preferred stock (Series B Preferred Stock) at $2.39 per share
resulting in net proceeds to the Company of approximately $9,871,000.
In December 1999, the Company sold 5,564,142 shares of Series C redeemable
convertible preferred stock (Series C Preferred Stock) at $6.47 per share,
resulting in net cash proceeds to the Company of approximately $20,960,000 and
a note receivable of $15,000,000 which was paid in January 2000. In addition,
on December 17, 1999, the Company issued 264,853 shares of Series C Preferred
Stock to an affiliate of a customer in consideration for research and
development and other related services, including technical assistance and
testing facilities through December 31, 1999, provided to the Company by that
customer. These shares were fully vested upon issuance. Accordingly, the
Company has charged the fair value of these shares, approximately $1,714,000,
to its consolidated statement of operations for the year ended December 31,
1999. Also on December 17, 1999, the affiliate purchased 155,147 shares of
Series C Preferred Stock for consideration of $1,003,801. In March 2000, the
Company sold an additional 38,640 shares of Series C Preferred Stock at $6.47
per share for net proceeds of $250,000.
In September 2000, the Company sold 4,803,925 shares of Series D redeemable
convertible preferred stock at $16.35 per share for net proceeds of
approximately $73.8 million.
F-14
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(including data applicable to unaudited periods)
Redeemable convertible preferred stock outstanding consists of the
following:
<TABLE>
<CAPTION>
December 31, September
---------------------- 30,
1998 1999 2000
---------- ----------- ------------
(unaudited)
<S> <C> <C> <C>
Series A, $0.01 par value--7,000,000
shares authorized, 6,876,000,
6,976,000 and 6,976,000 shares issued
and outstanding at December 31, 1998
and 1999 and September 30, 2000 (at
redemption value)..................... $7,130,729 $ 7,786,048 $ 8,203,462
Series B, $0.01 par value--4,200,000
shares authorized, none, 4,133,892 and
4,133,892 shares issued and
outstanding at December 31, 1998 and
1999 and September 30, 2000 (at
redemption value)..................... -- 10,275,778 10,866,954
Series C, $0.01 par value--6,500,000
shares authorized, none, 5,828,995 and
5,867,635 shares issued and
outstanding at December 31, 1998 and
1999 and September 30, 2000 (at
redemption value)..................... -- 37,829,300 40,344,300
Series D, $0.01 par value--4,900,000
shares authorized, none, none and
4,803,925 shares issued and
outstanding at December 31, 1998 and
1999 and September 30, 2000
(redemption value of $78,678,699)..... -- -- 73,953,476
---------- ----------- ------------
$7,130,729 $55,891,126 $133,368,192
========== =========== ============
</TABLE>
The rights, preferences and privileges of the Series A, Series B, Series C
and Series D Preferred Stock are listed below.
Dividends
The Company shall not declare or pay any dividends on shares of common stock
unless the holders of the Series A, Series B, Series C and Series D Preferred
Stock then outstanding receive an amount equal to the dividends declared or
paid on common stock.
Voting Rights
The Series A, Series B, Series C and Series D Preferred Stockholders are
entitled to vote on all matters with the common stockholders as if they were
one class of stock. The Series A, Series B, Series C and Series D Preferred
Stockholders are entitled to the number of votes equal to the number of shares
of common stock into which each share of the Series A, Series B, Series C and
Series D Preferred Stock is then convertible.
Liquidation
In the event of any voluntary or involuntary liquidation, dissolution or
winding-up of the corporation, as defined, the holders of the Series A, Series
B, Series C and Series D Preferred Stock then outstanding will be entitled to
be paid an amount equal to $1.00, $2.39, $6.47 and $16.35 per share,
respectively, plus any dividends declared but unpaid on such shares prior to
any payment to common stockholders. Amounts remaining after the preference
payment to the Series A, Series B, Series C and Series D Preferred
Stockholders, if any, will be shared on a proportional basis among all
stockholders, including the Series A, Series B, Series C and Series D Preferred
Stockholders, whose portion will be determined based on the number of shares of
F-15
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(including data applicable to unaudited periods)
common stock into which the Series A, Series B, Series C and Series D Preferred
Stock is convertible, provided however, that if on an as converted basis, the
holders of Series C Preferred Stock would receive more than $12.94 per share as
their participation amount, then such holders would not be entitled to receive
their liquidation amount.
Conversion
Each share of Series A Preferred Stock is convertible at the option of the
holder, at any time, into two shares of common stock, adjusted for certain
dilutive events, as defined. Each share of Series B, Series C and Series D
Preferred Stock is convertible at the option of the holder, at any time, into
one share of common stock, adjusted for certain antidilutive events, as
defined. In addition, all shares of Series A, Series B, Series C and Series D
Preferred Stock shall be automatically converted into shares of common stock
upon the closing of an underwritten public offering in which the per share
price to the public is not less than $20.44 and the aggregate net proceeds are
not less than $50 million.
Redemption Rights
The Company will be required to redeem, subject to certain conditions, on
July 1, 2004, July 1, 2005 and July 1, 2006 (each a Mandatory Redemption Date)
the percentage of Series A, Series B, Series C and Series D Preferred Stock, as
listed in the following table, at a price equal to $1.00, $2.39, $6.47 and
$16.35 per share, respectively, plus an amount equal to 8% per annum from the
original issue date to the mandatory redemption date per share. In addition,
the Company is accreting the difference between the carrying amount and the
redemption value of the Series D Preferred Stock over the redemption period.
<TABLE>
<CAPTION>
Mandatory Redemption
Date Portion of Shares of Preferred Stock to be Redeemed
-------------------- ---------------------------------------------------
<S> <C>
July 1, 2004............ 33 1/3%
July 1, 2005............ 50%
July 1, 2006............ All shares then held
</TABLE>
(6) Stockholders' Equity
(a) Common Stock
The Company has authorized 400,000,000 shares of common stock at September
30, 2000.
(b) Stock Split
On June 29, 1999, the Company's Board of Directors approved a two-for-one
stock split of the Company's outstanding $0.00001 par value common stock, to be
effected in the form of a stock dividend payable on July 1, 1999 to
stockholders of record at the close of business on June 30, 1999. All share and
per share amounts for all periods presented have been retroactively adjusted to
reflect the two-for-one stock split.
(c) Reserved Shares
The Company has reserved the following number of shares of common stock for
the conversion of preferred stock:
<TABLE>
<S> <C>
Series A Preferred Stock........................................ 14,000,000
Series B Preferred Stock........................................ 4,200,000
Series C Preferred Stock........................................ 6,500,000
Series D Preferred Stock........................................ 4,900,000
----------
29,600,000
==========
</TABLE>
F-16
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(including data applicable to unaudited periods)
(d) Founders Shares
In 1998, the Company sold 2,540,000 shares of restricted common stock to its
senior vice president and 2,540,000 shares to another founding employee at
$0.00001 per share, which represented the fair value of the common stock. The
Company entered into stock repurchase agreements with its senior vice president
and the founding employee that provide for the immediate vesting to each
founder of 508,000 of these shares. In the event that the senior vice
president's or other founding employee's employment is terminated, the Company
has the right to repurchase, at $0.00001 per share through October 14, 2002,
the total number of shares that have not vested. The repurchase right on the
4,064,000 shares will lapse at the rate of 127,000 shares for each founder per
quarter beginning on October 14, 1998. As of September 30, 2000, 2,032,000 of
these shares were subject to repurchase.
(7) Equity Incentive Plans
In July 1998, the Company's Board of Directors approved the 1998 Restricted
Stock Purchase Plan (the 1998 Stock Plan), which provides for the sale of
common stock to directors, officers, consultants and other key personnel.
Additionally, in July 1998, the Company's Board of Directors approved the 1998
Stock Option Plan, which provides for the granting of incentive stock options
(ISOs) and nonqualified stock options to employees, officers, directors,
advisors and consultants of the Company. The Company reserved an aggregate of
16,195,000 shares of common stock pursuant to these plans.
On September 22, 2000, the Board of Directors resolved that no additional
shares of common stock will be issued under the 1998 Restricted Stock Purchase
Plan and that no additional options to purchase common stock will be granted
under the 1998 Stock Option Plan.
(a) Restricted Common Stock
Under the 1998 Stock Plan, the Board of Directors could authorize the sale
of common stock to key employees, directors and consultants of the Company. The
purchase price was determined by the Board of Directors. In addition, for each
grant, the Board of Directors determined the terms under which the Company may
repurchase such shares.
During 1998 and 1999, the Company sold a total of 6,908,000 shares of
restricted common stock to various employees under the 1998 Stock Plan. The
6,908,000 shares were sold at prices ranging from $0.005--$0.50 per share. All
of these shares are subject to repurchase restrictions, which generally expire
over four to five years, except that upon a change of control, as defined,
approximately 30% of the original shares purchased are subject to acceleration
provisions. During 1998 and 1999, the Company repurchased 159,000 and 2,032,000
shares, respectively under the 1998 stock plan as a result of employee
terminations.
During 1999, the Company issued 180,000 shares of restricted common stock
under the 1998 Restricted Stock Purchase Plan to two employees in exchange for
recourse promissory notes in the amount of $45,000. As of December 31, 1999 and
September 30, 2000, the balance on these notes totaled $21,875 and $0,
respectively and is included in the accompanying consolidated financial
statements as stock subscriptions receivable.
During the nine months ended September 30, 2000, the Company sold a total of
4,549,500 shares of restricted common stock to various employees at prices
ranging from $1.00--$3.00 per share. The Company received $100,000 in cash and
recourse promissory notes in the amount of $6,082,000 in consideration for
these shares. The promissory notes bear interest at a rate of 6.8% per year.
The promissory notes are due on the earlier of four years from the date of
employment or termination of employment, except with respect to
F-17
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(including data applicable to unaudited periods)
$3,482,000 of the promissory notes. (See Note 7(f)). The repurchase
restrictions related to 1,050,000 shares generally expire over four years,
except that upon a change of control, as defined, approximately 30% of the
original shares purchased are subject to acceleration provisions. See Note 7(f)
for repurchase restrictions on 3,482,000 shares. The Company also repurchased
112,500 shares under the 1998 Stock Plan as a result of employee terminations.
As of September 30, 2000, 6,720,350 of the shares issued under the 1998
Stock Plan were subject to repurchase by the Company at the original purchase
price.
(b) 1998 Stock Option Plan
Under the 1998 Stock Option Plan, the Board of Directors could grant ISO's
and nonqualified stock options to officers, employees, directors, consultants
and advisors of the Company. ISO's could be granted only to employees who did
not own stock representing more than 10% of the voting power or more than 10%
of the value of all classes of stock of the Company, unless the purchase price
was at least 110% of its fair value at the time the option was granted and the
option was not exercisable more than five years from the grant date.
Nonqualified stock options could be granted to officers, employees, consultants
and advisors of the Company. The Board determined the option price for
nonqualified stock options. All stock options issued under the 1998 Stock
Option Plan expire 10 years from the date of grant.
(c) 2000 Stock Incentive Plan
In September 2000, the Company's Board of Directors adopted the 2000 Stock
Incentive Plan (the 2000 Plan), subject to stockholder approval. The 2000 Plan
authorizes the issuance of up to 10,000,000 shares of common stock plus an
annual increase of shares beginning in 2001 equal to the lesser of:
. 15,000,000 shares;
. 4% of the outstanding shares of the Company's common stock on the date
of the increase; or
. an amount determined by the Board of Directors.
The 2000 Plan provides for the grant of ISO's, nonstatutory stock options,
restricted stock awards and other stock-based awards. Incentive stock options
may be granted under the 2000 Plan only to employees. Under the 2000 Plan, no
participant may receive an award for more than 1,000,000 shares, subject to
adjustment in the event of stock splits and other similar events, in any
calendar year.
The 2000 Plan is administered by the Board of Directors. The Board of
Directors approves the individuals to whom options will be granted and
determines the option exercise price and other terms of each award, subject to
the provisions of the 2000 Plan.
As of September 30, 2000, the Company had 10,000,000 shares available for
future grant under the 2000 Plan.
F-18
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(including data applicable to unaudited periods)
Stock option activity is summarized as follows:
<TABLE>
<CAPTION>
Weighted
Average
Exercise
Price
Number of Price per per
Shares Share Share
---------- ------------ --------
<S> <C> <C> <C>
Outstanding, May 6, 1998................. -- $ -- $ --
Granted................................ 160,000 0.05 0.05
---------- ------------ -----
Outstanding, December 31, 1998........... 160,000 0.05 0.05
Granted................................ 3,353,200 0.05--1.00 0.24
Exercised.............................. (2,438,000) 0.05--0.50 0.15
Canceled............................... (72,000) 0.05--0.50 0.19
---------- ------------ -----
Outstanding, December 31, 1999........... 1,003,200 0.05--1.00 0.42
Granted................................ 2,779,345 1.00--13.20 6.80
Stock options assumed in connection
with TCS acquisition.................. 1,229,436 0.73--4.59 3.92
Exercised.............................. (564,625) 0.05--4.59 2.40
Canceled............................... (292,633) 0.05--8.00 3.01
---------- ------------ -----
Outstanding, September 30, 2000.......... 4,154,723 $0.05--13.20 $5.38
========== ============ =====
Exercisable, September 30, 2000........ 673,025 $0.05--13.20 $2.80
========== ============ =====
Exercisable, December 31, 1999......... 985,200 $ 0.42 $0.42
========== ============ =====
Exercisable, December 31, 1998......... 160,000 $ 0.05 $0.05
========== ============ =====
</TABLE>
Options granted under the 1998 Stock Option Plan generally vest over four to
five years, except that upon a change of control, as defined, approximately 30%
of the original stock options granted are subject to acceleration provisions.
Certain option grants are fully vested but shares of common stock issued
pursuant to such option exercises are subject to repurchase restrictions which
generally expire over four to five years, except that upon a change of control,
as defined, approximately 30% of the original shares purchased are subject to
acceleration provisions. During 1999, the Company repurchased 600,000 shares
issued under the 1998 Stock Option Plan for $30,000. As of September 30, 2000,
1,497,760 shares are subject to repurchase by the Company.
The range of exercise prices for options outstanding and options exercisable
at September 30, 2000 are as follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exerciseable
---------------------------- ----------------------------------------------
Range of Weighted Average
Exercise Options Remaining Weighted Average Options Weighted Average
Prices Outstanding Contractual Life Exercise Price Exerciseable Exercise Price
-------- ----------- ---------------- ---------------- ------------ ----------------
<S> <C> <C> <C> <C> <C>
$0.05-$0.25 232,680 8.81 $ 0.21 76,430 $0.13
$0.50-$3.00 700,760 8.30 0.92 228,660 0.70
$4.00-$10.00 3,144,783 9.55 6.55 367,935 4.58
$12.00-$13.20 76,500 9.94 13.19 -- --
------------- --------- -------
$0.05-$13.20 4,154,723 9.31 5.37 673,025 2.76
============= ========= =======
</TABLE>
SFAS No. 123, Accounting for Stock-Based Compensation, which requires the
measurement of the fair value of stock options or warrants to be included in
the statement of operations or disclosed in the notes to the financial
statements. The Company has determined that it will account for stock-based
compensation for
F-19
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(including data applicable to unaudited periods)
employees under Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees, and elect the disclosure-only alternative under SFAS
No. 123. Options granted have been valued for disclosure purposes using the
Black-Scholes option pricing model prescribed by SFAS No. 123. The weighted
average assumptions used are as follows:
<TABLE>
<CAPTION>
Nine Months Ended
December 31, September 30,
-------------------- -------------------
1998 1999 1999 2000
--------- --------- -------- ---------
(unaudited)
<S> <C> <C> <C> <C>
Risk-free interest rate........... 4.65-4.78% 4.80-6.38% 4.8-6.12% 6.05-6.79%
Expected dividend yield........... 0.00% 0.00% 0.00% 85%
Expected lives.................... 7 years 7 years 7 years 7 years
Expected volatility............... 0.00% 0.00% 0.00% 0.00%
</TABLE>
The effects of applying SFAS No. 123 would have been as follows:
<TABLE>
<CAPTION>
Nine Months Ended
December 31, September 30,
------------------------- --------------------------
1998 1999 1999 2000
----------- ------------ ------------ ------------
(unaudited)
<S> <C> <C> <C> <C>
Net loss attributable to
common stockholders--
As reported........... $(2,783,182) $(22,338,539) $(10,872,384) $(55,047,174)
Pro forma............. (2,803,235) (22,504,711) (10,963,807) (57,489,346)
Basic and diluted net
loss per share--
As reported........... (4.87) (7.47) (4.22) (10.61)
Pro forma............. (4.91) (7.52) (4.25) (11.08)
</TABLE>
The weighted average fair value of options granted during the period ended
December 31, 1998, the year ended December 31, 1999 and the nine months ended
September 30, 2000 under the 1998 Stock Option Plan is $0.03, $0.27 and $4.98
per share, respectively. As of December 31, 1998 and 1999 and for the nine
months ended September 30, 2000, the weighted average remaining contractual
life of outstanding options under the 1998 Stock Option Plan is 9.9 years, 9.6
years and 9.3 years, respectively.
The Black-Scholes option pricing model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are
fully transferable. In addition, option pricing models require the input of
highly subjective assumptions, including expected stock price volatility.
Because the Company's stock options have characteristics significantly
different from those of traded options and because changes in the subjective
input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its stock options.
(d) Stock-based Compensation
In connection with certain stock option grants and stock sales during the
year ended December 31, 1999 and the nine months ended September 30, 2000, the
Company recorded deferred compensation in the accompanying statements of
stockholders' equity (deficit) of $2,344,642 and $27,318,468, respectively. The
deferred compensation represents the aggregate difference between the deemed
fair value of the Company's stock and the exercise price of stock options
granted or the selling price of stock sold, as applicable. The deferred
compensation will be recognized as an expense over the vesting period of the
underlying common stock and stock options using the accelerated method
prescribed under FASB Interpretation No. 28, Accounting
F-20
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(including data applicable to unaudited periods)
for Stock Appreciation Rights and Other Variable Stock Option or Award Plans--
An Interpretation of APB Opinion Nos. 15 and 25.
The Company accelerated the vesting on two stock awards during the year
ended December 31, 1999 and recorded stock-based compensation expense of
approximately $1,639,740 as of the new measurement date, which occurred as a
result of the modification of the original stock award. During 1999, the
Company also recorded stock-based compensation expense of $100,000 in
connection with the sale of 100,000 shares of Series A Preferred Stock, which
represents the aggregate difference between the purchase price and the fair
market value of the preferred stock.
The Company recorded total stock-based compensation expense related to these
stock option grants and stock sales of $1,832,111 and $6,172,124 in the year
ended December 31, 1999 and the nine months ended September 30, 2000,
respectively. The Company expects to record the following stock-based
compensation expense related to the above stock option grants and stock sales
during the period from October 1, 2000 to December 31, 2000 and during the
years ending December 31:
<TABLE>
<S> <C>
2000........................................................... $ 3,079,599
2001........................................................... 8,647,722
2002........................................................... 4,880,655
2003........................................................... 2,684,301
2004........................................................... 936,721
2005........................................................... 65,737
-----------
$20,294,735
===========
</TABLE>
(e) 2000 Employee Stock Purchase Plan
In September 2000, the Company's Board of Directors adopted the 2000
Employee Stock Purchase Plan (the Stock Purchase Plan), subject to stockholder
approval. The Stock Purchase Plan authorizes the issuance of up to a total of
5,000,000 shares of the Company's common stock.
Under the terms of the Stock Purchase Plan, all employees, whose customary
employment is more than 20 hours per week, including directors who are
employees, and all employees of any participating subsidiaries, are eligible to
participate in the Stock Purchase Plan. Employees whom immediately after the
grant, own five percent or more of the total combined voting power or value of
all classes of stock of the Company or any subsidiary are not eligible to
participate in the Stock Purchase Plan.
The right to purchase common stock under the Stock Purchase Plan is made
available through a series of offerings. On the first day of an offering
period, the Company will grant to each eligible employee who has elected to
participate in the Stock Purchase Plan an option to purchase shares of common
stock. The employee may authorize between 1% and 10% of his or her base pay to
be deducted from his or her base pay during the offering period. On the last
day of the offering period, the employee will be deemed to have exercised the
option, at the option exercise price, to the extent of accumulated payroll
deductions. Under the terms of the Stock Purchase Plan, the option price is an
amount equal to 85% of the average market price per share of the common stock
on either the first day or last day of the offering period, whichever is lower.
The Stock Purchase Plan is administered by the compensation committee of the
Board of Directors. The compensation committee may, in its discretion, choose
an offering period of six months or less for each offering and may choose a
different offering period for each offering.
F-21
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(including data applicable to unaudited periods)
(f) Other employee arrangements
(1) Employee Benefit Plan
In August 1998, the Company adopted a 401(k) retirement plan (the 401(k)
Plan) for eligible employees, as defined. Each participant may elect to
contribute up to 12% of his or her compensation for the plan year, subject to
certain IRS limitations. At this time, the Company has decided not to make any
discretionary contributions to the 401(k) Plan during all periods presented.
(2) Employment Agreements
In September 2000, the Company entered into an employment agreement with its
Chief Executive Officer (CEO). The agreement provides for bonus and salary as
follows: base annual salary of $200,000, which will increase to $250,000 on
January 1, 2001; cash bonus of $275,000 upon consummation of an initial public
offering prior to January 1, 2002; and a cash bonus of up to $275,000 and
$300,000, if certain financial targets are met for fiscal years 2000 and 2001,
respectively.
In connection with the CEO's employment, the CEO purchased 3,482,000 shares
of restricted common stock, subject to vesting terms, as defined below. The
Company received recourse promissory notes in the amount of $3,482,000 in
consideration for these shares. The promissory notes bear interest at a rate of
6.8% per year and are payable as to $250,000 of the principal on the closing of
an initial public offering and as to $3,232,000 of the principal amount and all
accrued interest upon the earlier of March 31, 2002 or the termination of the
CEO's employment. The employment agreement provides that if the Company
completes an initial public offering prior to January 1, 2002 and the CEO
continues employment with the Company the principal on the promissory notes
will be forgiven as follows: $745,000 on September 1, 2001, $745,000 on January
1, 2002 and $1,492,000 on March 31, 2002. All principal on the promissory notes
will be forgiven upon a change of control, as defined.
The restricted stock vests as to 100,000 shares on February 15, 2000, as to
180,125 shares for each full three-month period beginning March 15, 2000
through March 15, 2002 during which the CEO is employed by the Company and for
an additional 1,441,000 shares on March 31, 2002, provided he is employed by
the Company at that time. Upon the completion of an initial public offering
before January 1, 2002, the restricted stock will immediately vest as to
250,000 shares, provided that the CEO is employed by the Company at that time
and the Company will record stock-based compensation expense of approximately
$465,000. The restricted stock will vest as to an additional 250,000 shares on
January 31, 2005, or on April 1, 2001 if the Company meets specified financial
targets for fiscal year 2000 as determined by the board of directors, provided
that the CEO is employed by us through December 31, 2000. If this occurs the
Company will record stock-based compensation expense of approximately $465,000.
If the Company terminates his employment with or without cause on or before
September 1, 2001, 50% of his unvested restricted stock will immediately vest.
The restricted stock will vest in full in the event of a change in control or
sale of the Company or if the Company terminates his employment with or without
cause after September 1, 2001.
Certain other officers of the Company have purchased restricted stock
subject to repurchase agreements or have been granted options to purchase
common stock, which provide for accelerated vesting upon the completion of an
initial public offering or the achievement of certain operating results for the
year ended December 31, 2000. If the Company completes its proposed initial
public offering, 25,000 shares of restricted common stock will vest immediately
and the Company will record stock-based compensation expense of approximately
$64,000. If the Company achieves certain operating results for the year ended
December 31,
F-22
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(including data applicable to unaudited periods)
2000, 25,000 shares of restricted common stock and options to purchase 200,000
shares of common stock will immediately vest and the Company will record stock-
based compensation expense of approximately $922,000.
(8) Warrants (unaudited)
On August 4, 2000 the Company issued a warrant to purchase 100,000 shares of
common stock at $12.00 per share to a potential customer. The warrant was fully
vested and exercisable on the date of issue and the warrant will expire on the
earlier of two years or the acquisition of the Company. On August 4, 2000, the
Company shipped an evaluation unit to the potential customer, which allocated
lab space, engineering resources and test equipment to support the
certification of the product. On August 30, 2000, the Company entered into a
master purchase and license agreement with the potential customer, pursuant to
which, the potential customer has the ability but not the obligation to
purchase equipment from the Company.
On August 11, 2000, the Company shipped an evaluation unit to the potential
customer; this unit was subsequently returned to the Company. On September 15,
2000 the Company entered into a master purchase agreement with the potential
customer, pursuant to which, the potential customer has the ability but not the
obligation to purchase equipment from the Company. On September 18, 2000, the
Company issued a warrant to purchase 50,000 shares of common stock at $16.35
per share to a potential customer. The warrant was fully vested and exercisable
on the date of issuance and will expire on the earlier of two years or the
acquisition of the Company. On September 22, 2000, the Company received a
purchase order for one unit to replace the evaluation unit that had been
returned. The potential customer has made no future commitments and will also
be testing several other competitive products. The evaluation may not be
completed this year.
On September 22, 2000, the Company issued a warrant to purchase 90,000
shares of common stock at $16.35 per share to a potential customer. The warrant
was fully vested and exercisable on the date of issuance and will expire on the
earlier of two years or the acquisition of the Company. The potential customer
has not signed a purchase agreement and has not committed to test an evaluation
unit.
The warrants were valued using the Black-Scholes option pricing model using
the following assumptions: 100% volatility, 5.5% risk-free interest rate, 0.0%
dividend yield and a 2 year expected life. The value of the warrants,
approximately $1,908,000, was recorded as stock-based compensation during the
third quarter of 2000.
(9) TCS Acquisition (unaudited)
On July 31, 2000, the Company acquired Hemisphere Investments, Inc. and its
wholly owned subsidiaries including, Technology Control Services, Inc.
(collectively, TCS) for an aggregate of 10,106,845 shares of common stock in
consideration for all the outstanding capital stock of TCS, and reserved an
aggregate of 1,229,436 shares of the Company's common stock in connection with
the assumption of outstanding options to purchase capital stock of TCS and
assumed approximately $5.5 million of TCS debt, which was repaid upon closing
the transaction. 1,516,025 shares of common stock issued to stockholders of TCS
are currently held in escrow to secure certain indemnification obligations of
TCS and certain of its stockholders. The acquisition was accounted for using
the purchase method of accounting in accordance with APB No. 16, Business
Combinations. Accordingly, the operating results of TCS have been included in
the Company's financial results from the date of the acquisition. The
allocation of the purchase price to the assets acquired and liabilities assumed
was based on the estimated fair value of the assets and liabilities of TCS. The
purchase price allocation is subject to refinement until all pertinent
information regarding the acquisition is obtained. The 1,516,025 shares held in
escrow have been reflected as outstanding in the September 30, 2000
consolidated balance sheet and have been included in the purchase price
allocation in accordance with the provisions of SFAS No. 38 "Accounting for
Preacquisition Contingencies of Purchased Enterprises." The value assigned to
each element of the purchase price is as follows:
F-23
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(including data applicable to unaudited periods)
<TABLE>
<S> <C>
Common stock.................... $121,282,000
Vested stock options............ 6,748,000
Unvested stock options.......... 3,450,000
Acquisition costs............... 354,000
------------
$131,834,000
============
</TABLE>
The Company has accounted for the assumption of TCS stock options in
accordance with FIN 44. The fair value of the vested stock options has been
included in the purchase price and the difference between the intrinsic value
and the fair value of the unvested stock options is included in the purchase
price. In addition, the Company has recorded approximately $3,807,000 in
deferred compensation related to the intrinsic value of unvested stock options
assumed in the transaction, which will be recorded as stock-based compensation
expense over the remaining vesting period of approximately three years.
The Company has allocated the following amounts to intangible assets:
<TABLE>
<CAPTION>
Identifiable Amortization
Intangible Assets Period Amount
----------------- ------------ ------------
<S> <C> <C>
Assembled workforce 3 years $ 900,000
Developed technology 3 years $ 4,200,000
Goodwill 3 years $112,281,000
</TABLE>
The Company believes the amortization periods represent the estimated useful
lives of the intangible assets and will evaluate the realizability of such
assets using the undiscounted cash flow method as prescribed by SFAS No. 121 at
each reporting period. Approximately $23 million of the purchase price was
recorded as acquired in process research and development in the third quarter
of fiscal 2000.
TCS developed and sold custom softswitch and service creation software
products and, through its service division, provided network-based service
applications such as unified messaging and calling card services. The Company
has refocused the efforts of TCS to provide standard software products, which
will be part of the ICServiceWorks product, and the Company has decided to
dispose of the service division and related assets. The Company has accounted
for the proposed disposition of the service division and related assets as
assets held for sale pursuant to EITF Issue No. 87-11 "Allocation of Purchase
Price To Assets To Be Sold" and accordingly, the service division's results of
operations from the date of acquisition to the date of disposition will be
excluded from the Company's consolidated results of operations. The Company
expects to dispose of the service division and related assets by March 31,
2001. The service division's net assets have been recorded at their estimated
net realizable value in the September 30, 2000 consolidated balance sheet. The
service division's revenues and operating losses have been excluded from the
Company's consolidated results of operations from the date of acquisition to
September 30, 2000 and were approximately $425,000 and $25,000, respectively.
In accordance with EITF 87-11, any difference between the estimated net
realizable value of the service division's net assets and the actual net
proceeds received upon disposition will be recorded as an adjustment to
goodwill. As a result, the Company expects that the acquired TCS operations
will generate revenues significantly lower than those generated by TCS in prior
periods and has excluded service division revenue and operating losses of
approximately $3.3 million and $315,000, respectively and revenue and operating
losses of $2.8 million and $215,000, respectively from the following pro forma
resulting operations for the year ended December 31, 1999 and the nine months
ended September 30, 2000, respectively.
F-24
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(including data applicable to unaudited periods)
The unaudited pro forma combined results of operations are as follows:
<TABLE>
<CAPTION>
Nine Months
Year Ended Ended
December 31, September
1999 30, 2000
------------ ------------
<S> <C> <C>
Revenues..................................... $ 3,764,665 $ 10,528,328
============ ============
Loss from continuing operations attributable
to common stockholders...................... $(71,617,248) $(61,556,325)
============ ============
Basic and diluted net loss per share......... $ (5.47) $ (4.02)
============ ============
</TABLE>
F-25
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders
of Hemisphere Investments, Inc.
We have audited the accompanying consolidated balance sheets of Hemisphere
Investments, Inc. and subsidiaries (the "Company") as of December 31, 1998 and
1999, and the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the three years in the period ended December
31, 1999. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Hemisphere Investments, Inc. and subsidiaries at December 31, 1998 and 1999,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 1999 in conformity with
accounting principles generally accepted in the United States.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in
Note 2 to the financial statements, the Company's recurring operating losses
and working capital deficiencies raise substantial doubt about its ability to
continue as a going concern. Management's plans in regard to these matters,
which include raising additional capital, are also described in Note 2. The
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the
amounts and classification of liabilities that might result from the outcome of
this uncertainty.
Ernst & Young LLP
Atlanta, Georgia
July 7, 2000
F-26
<PAGE>
HEMISPHERE INVESTMENTS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, June 30,
---------------------- -----------
1998 1999 2000
---------- ---------- -----------
(Unaudited)
<S> <C> <C> <C>
Assets:
Current assets:
Cash and cash equivalents................ $3,944,916 $1,064,252 $ 1,611,858
Trade accounts receivable, net of
allowance for doubtful accounts of
$42,780, $23,919 and $78,185 at December
31, 1998 and 1999 and June 30, 2000
(unaudited), respectively............... 541,561 877,861 1,396,859
Loan origination fees.................... 1,898,250 -- --
Uninstalled equipment.................... 370,446 460,126 2,255,950
Balance receivable on sale of
discontinued operation.................. -- 273,107 273,107
Prepaid expenses and other current
assets.................................. 206,129 468,680 332,954
---------- ---------- -----------
Total current assets...................... 6,961,302 3,144,026 5,870,728
Property and equipment:
Computer and telephone equipment......... 9,210,370 11,743,198 13,842,478
Furniture and equipment.................. 334,095 382,573 388,179
Leasehold improvements................... 557,002 583,902 590,252
---------- ---------- -----------
10,101,467 12,709,673 14,820,909
Accumulated depreciation................. (3,431,469) (6,358,602) (8,097,736)
---------- ---------- -----------
6,669,998 6,351,071 6,723,173
Development costs, net of accumulated
amortization of $32,709 at December 31,
1999 and $98,335 at June 30, 2000
(unaudited) .............................. -- 359,791 294,165
Other assets............................... 169,047 99,472 31,340
----------- ---------- -----------
Total assets............................... $13,800,347 $9,954,360 $12,919,406
=========== ========== ===========
Liabilities and stockholders' equity
(deficit)
Current liabilities:
Accounts payable.......................... $ 1,824,976 $3,184,118 $ 4,908,938
Deferred revenue.......................... -- 2,698,574 3,568,995
Accrued expenses.......................... 886,167 2,123,205 2,320,684
Accrued future operating losses on
discontinued operations.................. 4,600,000 -- --
Current installments of long-term debt.... 2,007,552 3,773,205 4,029,029
Current installments of obligations to
related parties.......................... 5,000,000 -- 3,500,000
Current installments of obligations under
capital leases........................... 260,076 399,032 543,853
----------- ---------- -----------
Total current liabilities.................. 14,578,771 12,178,134 18,871,499
Long-term debt, excluding current portion.. 3,875,057 59,862 59,862
Obligations to related parties............. -- 5,000,000 --
Obligations under capital leases, excluding
current portion........................... 216,842 320,113 153,467
----------- ---------- -----------
Total liabilities.......................... 18,670,670 17,558,109 19,084,828
Commitments and contingencies
Stockholders' equity (deficit):
Preferred stock $.001 par value;
25,000,000 shares authorized;
5,856,488 shares issued and
outstanding at December 31, 1999 and
June 30, 2000 (unaudited); $1.14 per
share liquidation preference.......... -- 5,856 5,856
Common stock $.001 par value;
60,000,000 shares authorized;
30,317,203, 31,337,321 and 36,186,230
issued and outstanding at December 31,
1998 and 1999, and June 30, 2000
(unaudited), respectively............. 30,317 31,337 36,186
Additional paid in capital............. 50,475,188 57,317,356 64,051,779
Deferred compensation.................. -- -- (1,375,000)
Accumulated other comprehensive loss... (83,015) (66,385) (76,546)
Accumulated deficit.................... (55,105,697) (64,891,913) (68,807,697)
----------- ----------- -----------
(4,683,207) (7,603,749) (6,165,422)
Treasury stock, 70,000 shares at cost.. (187,116) -- --
----------- ----------- -----------
Total stockholders' equity (deficit).... (4,870,323) (7,603,749) (6,165,422)
----------- ---------- -----------
Total liabilities and stockholders'
equity (deficit)....................... $13,800,347 $9,954,360 $12,919,406
=========== ========== ===========
</TABLE>
See accompanying notes.
F-27
<PAGE>
HEMISPHERE INVESTMENTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Six months ended June
Years ended December 31, 30,
-------------------------------------- ------------------------
1997 1998 1999 1999 2000
<S> <C> <C> <C> <C> <C>
----------- ------------ ----------- ----------- -----------
<CAPTION>
(Unaudited)
<S> <C> <C> <C> <C> <C>
Service revenues....... $12,474,261 $ 5,652,991 $ 3,344,909 $ 1,160,761 $ 2,169,388
Sales of products...... 2,929,673 440,173 3,764,665 1,912,077 3,705,845
----------- ------------ ----------- ----------- -----------
Net sales.............. 15,403,934 6,093,164 7,109,574 3,072,838 5,875,233
Cost of services....... 12,633,349 5,583,966 987,970 388,855 449,149
Product costs.......... 1,109,468 210,582 2,990,597 1,506,330 604,564
----------- ------------ ----------- ----------- -----------
Gross profit........... 1,661,117 298,616 3,131,007 1,177,653 4,821,520
General and
administrative........ 6,783,741 8,603,072 1,340,325 709,912 1,202,593
Research and
development........... -- 2,867,691 6,678,306 3,942,197 3,953,171
Selling and marketing.. 358,405 253,590 133,560 71,063 1,702,182
Depreciation and
amortization.......... 1,088,532 1,572,036 2,964,755 1,790,235 1,365,704
----------- ------------ ----------- ----------- -----------
Operating loss......... (6,569,561) (12,997,773) (7,985,939) (5,335,754) (3,402,130)
Other income (expense):
Gain on settlement of
litigation........... -- -- 2,775,259 2,775,259 --
Interest income....... 107,346 254,107 105,089 45,568 16,720
Interest expense...... (327,200) (566,560) (3,029,895) (1,504,452) (530,374)
----------- ------------ ----------- ----------- -----------
Loss from continuing
operations before net
loss from discontinued
operations............ (6,789,415) (13,310,226) (8,135,486) (4,019,379) (3,915,784)
Net loss from
discontinued
operations............ -- (5,537,233) -- -- --
Loss on disposal of
discontinued
operations............ -- (20,172,686) (1,650,730) (1,650,730) --
----------- ------------ ----------- ----------- -----------
Net loss............... $(6,789,415) $(39,020,145) $(9,786,216) $(5,670,109) $(3,915,784)
=========== ============ =========== =========== ===========
</TABLE>
See accompanying notes.
F-28
<PAGE>
HEMISPHERE INVESTMENTS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Accumulated
Preferred Stock Common Stock Additional Other Treasury Stock
---------------- --------------------- Paid-in Deferred Comprehensive -------------------
Shares Par Value Shares Par Value Capital Compensation Income (loss) Shares Value
------ --------- ---------- --------- ---------- ------------ ------------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1997.. -- $ -- 18,066,850 $18,066 $8,589,284 $ -- $23,709 (705,000) $(499,295)
Net loss...... -- -- -- -- -- -- -- -- --
Foreign
currency
translation
adjustment... -- -- -- -- -- -- (75,541) -- --
Total
comprehensive
loss.........
Conversion of
note payable
to
stockholder
to common
stock........ -- -- 1,250,000 1,250 1,998,750 -- -- -- --
Sale of common
stock........ -- -- 4,701,090 4,701 14,718,643 -- -- -- --
Common stock
issued for
services..... -- -- 2,461 3 8,859 -- -- -- --
Noncash
compensation
expense ..... -- -- -- -- 200,750 -- -- -- --
Common stock
repurchase
and
retirement... -- -- (705,000) (705) -- -- -- 705,000 499,295
Exercise of
stock
options...... -- -- 421,560 422 3,794 -- -- -- --
Exercise of
warrants..... -- -- 100,000 100 15,900 -- -- -- --
------ ------ ---------- ------- ---------- ------ ------- -------- ---------
Balance at
December 31,
1997........... -- -- 23,836,961 23,837 25,535,980 -- (51,832) -- --
Net loss...... -- -- -- -- -- -- -- -- --
Foreign
currency
translation
adjustment... -- -- -- -- -- -- (31,183) -- --
Total
comprehensive
loss.........
Issuance of
common stock
in connection
with
acquisition.. -- -- 2,334,688 2,335 8,402,540 -- -- -- --
Sale of common
stock........ -- -- 3,988,888 3,989 14,356,008 -- -- -- --
Warrants
issued in
connection
with debt.... -- -- -- -- 2,020,000 -- -- -- --
Noncash
compensation
expense...... -- -- -- -- 135,750 -- -- -- --
Common stock
repurchase... -- -- -- -- -- -- -- (70,000) (187,116)
Exercise of
stock
options...... -- -- 156,666 156 24,910 -- -- -- --
------ ------ ---------- ------- ---------- ------ ------- -------- ---------
Balance at December 31, 1998.. -- -- 30,317,203 30,317 50,475,188 -- (83,015) (70,000) (187,116)
<CAPTION>
Total
Accumulated Stockholders'
Deficit Equity
------------ -------------
<S> <C> <C>
Balance at January 1, 1997.. $(8,797,547) $ (665,783)
Net loss...... (6,789,415) (6,789,415)
Foreign
currency
translation
adjustment... -- (75,541)
-------------
Total
comprehensive
loss......... (6,864,956)
Conversion of
note payable
to
stockholder
to common
stock........ -- 2,000,000
Sale of common
stock........ -- 14,723,344
Common stock
issued for
services..... -- 8,862
Noncash
compensation
expense ..... -- 200,750
Common stock
repurchase
and
retirement... (498,590) --
Exercise of
stock
options...... -- 4,216
Exercise of
warrants..... -- 16,000
------------ -------------
Balance at
December 31,
1997........... (16,085,552) 9,422,433
Net loss...... (39,020,145) (39,020,145)
Foreign
currency
translation
adjustment... -- (31,183)
-------------
Total
comprehensive
loss......... (39,051,328)
Issuance of
common stock
in connection
with
acquisition.. -- 8,404,875
Sale of common
stock........ -- 14,359,997
Warrants
issued in
connection
with debt.... -- 2,020,000
Noncash
compensation
expense...... -- 135,750
Common stock
repurchase... -- (187,116)
Exercise of
stock
options...... -- 25,066
------------ -------------
Balance at December 31, 1998.. (55,105,697) (4,870,323)
</TABLE>
F-29
<PAGE>
HEMISPHERE INVESTMENTS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY--(Continued)
<TABLE>
<CAPTION>
Accumulated
Preferred Stock Common Stock Additional Other Treasury Stock
------------------- --------------------- Paid-in Deferred Comprehensive -------------- Accumulated
Shares Par Value Shares Par Value Capital Compensation Income (loss) Shares Value Deficit
--------- --------- ---------- --------- ------------ ------------ ------------- ------ ------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net loss........ -- -- -- -- -- -- -- -- -- (9,786,216)
Foreign currency
translation
adjustment..... -- -- -- -- -- -- 16,630 -- -- --
Total
comprehensive
loss...........
Conversion of
note payable to
preferred
stock.......... 1,470,523 1,470 -- -- 1,674,926 -- -- -- -- --
Sale of Series A
preferred
stock.......... 4,385,965 4,386 -- -- 4,922,046 -- -- -- -- --
Sale of common
stock.......... -- -- 39,474 40 44,960 -- -- -- -- --
Treasury stock
retirement..... -- -- (70,000) (70) (187,046) -- -- 70,000 187,116 --
Noncash
compensation
expense........ -- -- -- -- 370,126 -- -- -- -- --
Additional
common stock
issued to
shareholder.... -- -- 833,333 833 (833) -- -- -- -- --
Exercise of
stock options.. -- -- 217,311 217 17,989 -- -- -- -- --
--------- ------- ---------- ------- ------------ ------------ --------- ------ ------- ------------
Balance at
December 31,
1999........... 5,856,488 5,856 31,337,321 31,337 57,317,356 -- (66,385) -- -- (64,891,913)
Net loss
(unaudited).... -- -- -- -- -- -- -- -- -- (3,915,784)
Foreign currency
translation
adjustment
(unaudited).... -- -- -- -- -- -- (10,161) -- -- --
Total
comprehensive
loss
(unaudited)....
Conversion of
note payable to
Common stock... -- -- 4,385,965 4,386 4,995,614 -- -- -- -- --
Deferred stock
compensation
(unaudited).... -- -- -- -- 1,375,000 (1,375,000) -- -- -- --
Noncash
compensation
expense
(unaudited).... -- -- -- -- 110,000 -- -- -- -- --
Exercise of
warrants
(unaudited).... -- -- 250,000 250 249,750 -- -- -- -- --
Exercise of
stock options
(unaudited).... -- -- 212,944 213 4,059 -- -- -- -- --
--------- ------- ---------- ------- ------------ ------------ --------- ------ ------- ------------
Balance at June
30, 2000
(unaudited).... 5,856,488 $ 5,856 36,186,230 $36,186 $ 64,051,779 $ (1,375,000) $ (76,546) -- $ -- $(68,807,697)
========= ======= ========== ======= ============ ============ ========= ====== ======= ============
<CAPTION>
Total
Stockholders'
Equity
--------------
<S> <C>
Net loss........ (9,786,216)
Foreign currency
translation
adjustment..... 16,630
--------------
Total
comprehensive
loss........... (9,769,586)
Conversion of
note payable to
preferred
stock.......... 1,676,396
Sale of Series A
preferred
stock.......... 4,926,432
Sale of common
stock.......... 45,000
Treasury stock
retirement..... --
Noncash
compensation
expense........ 370,126
Additional
common stock
issued to
shareholder.... --
Exercise of
stock options.. 18,206
--------------
Balance at
December 31,
1999........... (7,603,749)
Net loss
(unaudited).... (3,915,784)
Foreign currency
translation
adjustment
(unaudited).... (10,161)
--------------
Total
comprehensive
loss
(unaudited).... (3,825,945)
Conversion of
note payable to
Common stock... 5,000,000
Deferred stock
compensation
(unaudited).... --
Noncash
compensation
expense
(unaudited).... 110,000
Exercise of
warrants
(unaudited).... 250,000
Exercise of
stock options
(unaudited).... 4,272
--------------
Balance at June
30, 2000
(unaudited).... $ (6,165,422)
==============
</TABLE>
See accompanying notes
F-30
<PAGE>
HEMISPHERE INVESTMENTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended December 31, Six months ended June 30,
-------------------------------------- --------------------------
1997 1998 1999 1999 2000
----------- ------------ ----------- ------------ ------------
Cash flows from operating
activities
<S> <C> <C> <C> <C> <C>
Net loss................. $(6,789,415) $(39,020,145) $(9,786,216) $ (5,670,109) $ (3,915,784)
Adjustments to reconcile
net loss to net cash
used in continuing
operating activities:
Depreciation and
amortization.......... 1,088,532 1,572,036 3,155,755 1,790,235 1,804,760
Non-cash compensation
expense............... 200,750 135,750 370,126 310,277 110,000
Amortization of loan
origination cost...... -- 121,750 1,898,250 1,015,458 --
Loss (gain) on disposal
of property and
equipment............. 104,914 (16,571) 846,869 846,869 --
Loss from discontinued
operations -- 5,537,233 -- -- --
Loss on disposal of
discontinued
operation............. -- 20,172,686 1,650,730 1,650,730 --
Changes in assets and
liabilities:
Trade accounts
receivable.......... (1,174,116) 1,688,467 (336,300) 22,777 (518,998)
Uninstalled
equipment........... -- (370,446) (89,680) (119,617) (1,795,824)
Balance receivable on
sale of discontinued
operation........... -- -- (273,107) (273,107) --
Prepaid expenses and
other current
assets.............. (103,012) 128,265 (262,551) (1,305,407) 135,726
Other assets......... (22,597) (23,577) 69,575 (31,778) 68,132
Accounts payable..... 1,548,676 (993,525) 1,359,142 1,395,078 1,724,820
Deferred revenue..... -- -- 2,698,574 75,000 870,421
Accrued expenses..... 520,833 (1,107,585) 1,269,996 22,814 197,479
Accrued future
operating losses on
discontinued
operations.......... -- -- (4,600,000) (1,650,730) --
----------- ------------ ----------- ------------ ------------
Net cash used in
operating activities.... (4,625,435) (12,175,662) (2,028,837) (1,921,510) (1,319,268)
Cash flows from investing
activities
Acquisition, net of cash
acquired................ -- (139,966) -- -- --
Proceeds from sale of
equipment............... 22,834 66,454 -- -- --
Purchase of property and
equipment............... (2,906,071) (3,371,630) (3,149,899) (709,878) (2,111,236)
Deferred development
costs................... -- -- (359,791) -- --
----------- ------------ ----------- ------------ ------------
Net cash used in
investing activities of
continuing operations... (2,883,237) (3,445,142) (3,509,690) (709,878) (2,111,236)
Cash flows from financing
activities
Proceeds from issuance of
preferred stock......... -- -- 4,926,432 -- --
Proceeds from issuance of
common stock............ 14,723,344 14,359,997 45,000 -- --
Proceeds from stock
option exercise......... 4,216 25,066 18,206 12,800 4,272
Proceeds from exercise of
warrants................ 16,000 -- -- -- 250,000
Proceeds from long-term
debt.................... -- -- 1,639,765 1,639,765 500,000
Proceeds from borrowings
from related parties.... -- 5,000,000 -- -- 3,500,000
Purchase of treasury
stock................... -- (187,116) -- -- --
Repayment of borrowings.. (1,020,554) (2,860,060) (2,371,655) (2,125,797) (266,001)
----------- ------------ ----------- ------------ ------------
Net cash provided by
(used in) financing
activities of continuing
operations.............. 13,723,006 16,337,887 4,257,748 (473,232) 3,988,271
Effect of exchange rate
fluctuation on cash..... (75,541) (33,756) 50,845 34,870 (10,161)
Net cash used by
discontinued
operations.............. -- (4,033,998) (1,650,730) (675,493) --
----------- ------------ ----------- ------------ ------------
Net increase (decrease)
in cash and cash
equivalents............. 6,138,793 (3,350,671) (2,880,664) (3,745,243) 547,606
Cash and cash equivalents
at beginning of period.. 1,156,794 7,295,587 3,944,916 3,944,916 1,064,252
----------- ------------ ----------- ------------ ------------
Cash and cash equivalents
at end of period........ $ 7,295,587 $ 3,944,916 $ 1,064,252 $ 199,673 $ 1,611,858
=========== ============ =========== ============ ============
</TABLE>
See accompanying notes.
F-31
<PAGE>
HEMISPHERE INVESTMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information subsequent to December 31, 1999 and pertaining to June 30, 2000
and
for the six months ended June 30, 1999 and 2000 is unaudited)
1. Organization and Nature of Business
Description of Business
Hemisphere Investments, Inc. (the "Company") was formed in 1994 to develop
telecommunications software applications to enhance functionality related to
programmable switching technology. Software applications focus on enhanced
telecommunications capabilities in the convergence of voice and data
communications.
The Company has historically derived its primary sources of revenue from
facilities-based resellers of long distance services. The Company charges
switching fees or transaction fees for each minute of traffic that its
facilities process. In 1999, the Company began releasing its software
applications into the marketplace. In 1999 and going forward, the majority of
the Company's revenue will be derived from software sales.
2. Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries Interglobe Telecommunications
(International), Plc., Interglobe Telecommunications (International), Inc. (see
note 3), Technology Control Systems, Inc., Technology Control Services, Inc.,
Technology Control Services (UK), Ltd., European International Teleconsultants,
Ltd., Technology Control Services (Hong Kong), Limited and Nicom, Inc. All
significant intercompany transactions and accounts have been eliminated in
consolidation.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates and such differences may be
material to the financial statements.
The estimated fair value of financial instruments has been determined by the
Company using available market information and appropriate valuation
methodologies. However, considerable judgment is required in interpreting data
to develop the estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of the amounts that the Company could
realize in a current market exchange. The fair value estimates presented in the
balance sheets herein are based on pertinent information available to
management as of the respective balance sheet dates. Although management is not
aware of any factors that would significantly affect the estimated fair value
amounts, such amounts have not been comprehensively revalued for purposes of
these financial statements since that date and current estimates of fair value
may differ significantly from the amounts presented herein.
Interim Financial Information (Unaudited)
The accompanying financial statements at June 30, 2000 and for the six
months ended June 30, 1999 and 2000 are unaudited but include all adjustments
(consisting of normal recurring accruals), which, in the opinion of management,
are necessary for a fair statement of the financial position and the operating
results and cash flows for the interim date and periods presented. Results for
the interim period ended June 30, 2000 are not necessarily indicative of
results for the entire year or future periods.
F-32
<PAGE>
HEMISPHERE INVESTMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information subsequent to December 31, 1999 and pertaining to June 30, 2000
and
for the six months ended June 30, 1999 and 2000 is unaudited)
2. Summary of Significant Accounting Policies (continued)
Revenue Recognition
The Company designs and manufactures an advanced softswitch platform that
provides both call control and an open service creation environment that
enables the rapid deliver of carrier-class services and enhanced applications
like unified messaging and pre-paid calling card services.
Revenue for customer contracts that include multiple elements, such as
software license, implementation and consulting services, maintenance and
customer training, are allocated to the various elements based on vendor
specific objective evidence of fair value (VSOE). The Company establishes VSOE
based on the price charged for the element when sold separately.
Revenue from sales of software products which do not require significant
modification or customization is recognized when persuasive evidence of an
arrangement exists, delivery has occurred, the fee is fixed or determinable
and collectibility is probable in accordance with Statement of Position 97-2,
Software Revenue Recognition, as amended. Revenue from implementation
services, including installation, on-site testing, validation and training is
recognized as the services are provided.
Where customers require significant customization of the software products,
the license and service fees are recognized as long-term contracts in
conformity with Accounting Research Bulletin No. 45, Long Term Construction
Type Contracts and Statement Position 81-1, Accounting for Performance of
Construction-Type and Certain Production-Type Contracts. Revenue is recognized
based upon the completed contract method. Provisions for anticipated losses on
contracts are made in the period in which they first become determinable.
Equipment purchased of contracts are recorded as uninstalled equipment until
such time as the revenue recognition criteria have been met.
Service bureau revenue is recognized at the time of customer usage based
upon minutes of traffic processed at contractual fees.
Revenue related to ongoing support services including both product and
service bureau revenue following the completion of the initial service or
product launch of the software is recognized as the work is performed. Revenue
from maintenance service is recognized ratably over the term of the
maintenance or service contract. Deferred revenue represents revenue from
customers in advance of the revenue being earned.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original
maturities of three months or less when purchased to be cash equivalents.
Loan Origination Fees
The Company capitalized costs to obtain a Facility Agreement. These amounts
were amortized over the life of the loan. See Note 3 for further information.
Uninstalled Equipment
Uninstalled equipment consists of equipment received for future
installation. This equipment is stated at cost.
F-33
<PAGE>
HEMISPHERE INVESTMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information subsequent to December 31, 1999 and pertaining to June 30, 2000
and
for the six months ended June 30, 1999 and 2000 is unaudited)
2. Summary of Significant Accounting Policies (continued)
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization is
provided for financial reporting purposes using the straight line method over
the following estimated useful lives:
<TABLE>
<S> <C>
Computer and telephone equipment 2-7 years
Furniture and equipment 5 years
Leasehold improvements Term of lease
</TABLE>
Repairs and maintenance are expensed as incurred. Replacements and
betterments are capitalized. Amortization of assets recorded under capital
leases is included with depreciation and amortization expense. Property and
equipment are periodically reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount may not be recoverable.
Total depreciation expense for 1997, 1998 and 1999 was $1,089,000, $1,572,000
and $3,123,000, respectively. Total depreciation expense for the six months
ended June 30, 1999 and 2000 was $1,790,000 and $1,739,000, respectively.
Effective January 1, 1999, the Company prospectively revised the estimated
useful lives of computer and telephone equipment from seven to three years. The
decision to change the estimated service period for these assets was to conform
to industry standards and more accurately reflect the useful period of these
assets. This change in accounting estimate resulted in a $397,000 and $794,000
increase in depreciation expense for the six months ended and the year ended
December 31, 1999, respectively.
Impairment of Long-Lived Assets
The Company evaluates impairment of long-lived assets pursuant to Statement
of Financial Accounting Standard No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, which requires
impairment losses to be recorded on long-lived assets used in operations when
events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. Management periodically evaluates property and
equipment for impairment whenever events or changes in circumstances indicate
the assets may be impaired.
This evaluation consists of comparing estimated future cash flows
(undiscounted and without interest charges) over the remaining life of the
asset to its carrying value. When such evaluation results in a deficiency, the
asset is written down to its estimated fair value.
Research and Development Costs
The Company accounts for its software development costs in accordance with
Statement of Financial Accounting Standard No. 86, Accounting for the Costs of
Computer Software to Be Sold, Leased or Otherwise Marketed. Accordingly, the
costs for the development of new software that is included in the hardware
products and substantial enhancements to such existing software are expensed as
incurred until technological feasibility has been established, at which time
any additional costs are capitalized. Capitalized costs are amortized over the
greater of the amount computed using (a) the ratio that current gross revenues
for a product bear to the total of current anticipated future gross revenues
for that product or (b) the straight-line method over the estimated economic
life of the related product (currently not to exceed three years). During 1999,
the Company capitalized approximately $393,000. Amortization expense was
approximately $33,000 for the year ended December 31, 1999 and $66,000 for the
six months ended June 30, 2000.
F-34
<PAGE>
HEMISPHERE INVESTMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information subsequent to December 31, 1999 and pertaining to June 30, 2000
and
for the six months ended June 30, 1999 and 2000 is unaudited)
2. Summary of Significant Accounting Policies (continued)
The Company determines technological feasibility has been established at the
time at which a working model of the software has been completed. Research and
development expenses consist primarily of salaries, benefits, equipment and
allocable overhead for software engineers, pre-production quality assurance
personnel, program managers and technical writers.
In July 1999, pursuant to an agreement with its largest customer, the
Company received a $2,500,000 non-refundable license fee for the purchase and
installation of certain test beds required for continued custom software
development. The agreement provided for payment within 45 days of receipt of
invoice and requires the Company to maintain the test bed such that it is
capable of testing the current release of the Company's unified messaging
application. The Company recognized revenues of $294,000 for the year ended
December 31, 1999 and $294,000 for the six months ended June 30, 2000. The
agreement will terminate in October of 2003.
Advertising Costs
Advertising costs are expensed in the period incurred. Total advertising
expenses were approximately $152,000, $150,000 and $6,000,for the years ended
December 31, 1997, 1998 and 1999, respectively. Total advertising expenses were
$2,000 and $73,000 for the six months ended June 30, 1999 and 2000,
respectively.
Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Such amounts are
measured using enacted tax rates and laws that are expected to be in effect
when the differences reverse.
Statements of Cash Flows
In April and May 1999, the Company received proceeds from loans amounting in
total to approximately $1,650,000. In July 1999, the notes together with
accrued interest were converted to 1,470,523 shares of Series A Preferred
Stock.
In June 2000, obligations to related parties of $5,000,000 were converted to
4,385,965 shares of common stock.
The Company has entered into capital lease agreements aggregating
approximately $568,000 and $101,000 for the years ended December 31, 1999 and
1998, respectively. These non-cash transactions are excluded from the
statements of cash flows; however, depreciation expense from the assets
recorded under such capital leases is included in the statements of cash flows.
Interest paid for the years ended December 31, 1997, 1998 and 1999 was
approximately $349,000, $248,000 and $1,054,000, respectively. Interest paid
for the six months ended June 30, 1999 and 2000 was approximately $235,000 and
$249,000, respectively.
Foreign Currency Translation
The Company's United Kingdom subsidiaries consider the British pound to be
their functional currency. The Company considers its functional currency to be
the U.S. dollar. The foreign subsidiary's assets and liabilities are translated
at year-end rates of exchange and revenues and expenses are translated at the
average rates of exchange during the year.
F-35
<PAGE>
HEMISPHERE INVESTMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information subsequent to December 31, 1999 and pertaining to June 30, 2000
and
for the six months ended June 30, 1999 and 2000 is unaudited)
2. Summary of Significant Accounting Policies (continued)
Gains and losses resulting from currency translation are accumulated as a
separate component of stockholders' equity. Gains and losses resulting from
foreign currency transactions are included in the results of operations.
Accounting for Employee Stock Options
In October 1995, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation ("Statement 123"). Under Statement 123, the Company may continue
following existing accounting rules or adopt a new fair value method of valuing
stock-based awards.
The Company elected to continue following the existing accounting rules
under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued
to Employees ("APB 25"), and related interpretations in accounting for its
employee stock options. The pro forma effect on the accompanying consolidated
statements of operations of adopting Statement 123 is presented in Note 7.
Concentrations of Credit Risk
The Company received approximately 83%, 68% and 66% of its revenue from its
two largest customers for the years ended December 31, 1997, 1998 and 1999,
respectively.
Reclassifications
Certain items in the prior year consolidated financial statements have been
reclassified to conform to the current presentation.
Liquidity
Since its existence, the Company has been developing its core technology,
which has resulted in working capital deficiencies and recurring losses through
December 1999. The activities engaged in by the Company involve a high degree
of risk and uncertainty. Successful implementation of the Company's strategy
will depend upon many factors including among others, the need for additional
financing, the dependence on technology, acceptance and pricing of the
Company's services, the ability to meet Federal Communication Commission's
requirements and the competitive environment in the Company's marketplace. The
Company's ability to develop these operations may be impacted by uncertainties
related to technological change and obsolescence, product development,
competition and government regulations. As a result of the aforementioned
factors and the related uncertainties, there can be no assurance of the
Company's future success.
The Company must raise additional funds during the next 12 months to
maintain its operations and meet its debt service obligations. Capital
requirements including costs of development and start-up activities for the
Company will be significant.
While the Company believes that sufficient capital will be raised so that
the Company can maintain its operations and meet its debt service obligations,
there can be no assurances that such funds will be secured or have favorable
terms. Depending on their extent and timing, these factors, individual or in
the aggregate, could have a material adverse effect on the Company's financial
condition.
F-36
<PAGE>
HEMISPHERE INVESTMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information subsequent to December 31, 1999 and pertaining to June 30, 2000
and
for the six months ended June 30, 1999 and 2000 is unaudited)
2. Summary of Significant Accounting Policies (continued)
As a result of the aforementioned factors and the related uncertainties,
there is substantial doubt about the Company's ability to continue as a going
concern. The financial statements do not include any adjustments relating to
the recoverability and classification of asset carrying amounts or the amount
and classification of liabilities that might result from the outcome of this
uncertainty.
3. Investment in Interglobe Telecommunications (International). Plc.
On March 31, 1998, the Company acquired all of the outstanding capital stock
of Interglobe Telecommunications (International), Plc. ("Interglobe"), a
London, England based telecommunications company principally engaged in
providing long distance services from the sale of prepaid and post paid calling
cards.
The acquisition was accounted for under the purchase method of accounting.
The purchase price of Interglobe was approximately $18,471,000 consisting
primarily of $8,090,000 in seller notes payable, liabilities in excess of
assets acquired of $1,714,000, acquisition costs of $262,000, and 2,334,688
shares of the Company's common stock. The shares were valued at approximately
$8,405,000 based on the board of directors' estimate of the fair value of the
stock in the absence of a trading market for the stock.
As a result of Interglobe's deteriorating operating results, the Company
formalized its plan to discontinue the business on January 8, 1999. Interglobe
has been accounted for as a discontinued operation and, accordingly, the
results of its operations have been excluded from continuing operations in the
consolidated statements of operations for 1998 and 1999.
The Company recorded an estimated loss on disposal of $20,172,686 in 1998
associated with the divestiture of Interglobe. The loss was based upon expected
operating losses of $4,600,000 to be incurred during the phase-out period and
upon management's estimate of net realizable value based on contract
negotiations. The Company completed the sale in February 2000 and will receive
approximately $273,000 in proceeds from the ultimate sale of Interglobe. Based
upon the actual results of operations and proceeds upon disposal, the estimated
loss on disposal was increased by $1,650,730 and is reflected in the 1999
statement of operations.
Operating results of Interglobe for the years ended December 31, 1998 and
1999 were:
<TABLE>
<CAPTION>
1998 1999
----------- -----------
<S> <C> <C>
Revenues......................................... $ 8,850,919 $ 8,834,371
Cost of services................................. 5,311,753 4,955,755
Loss from operations............................. (5,536,280) (5,693,333)
Net loss......................................... (5,537,233) (5,695,728)
</TABLE>
The net assets and liabilities of the discontinued operations consist of the
following at December 31, 1998 and 1999:
<TABLE>
<CAPTION>
1998 1999
---------- ----------
<S> <C> <C>
Cash................................................ $1,049,132 $ 325,406
Accounts receivable................................. 2,748,777 1,200,826
Inventories......................................... 113,924 113,924
Other current assets................................ 185,853 157,870
---------- ----------
Total current assets................................ 4,097,686 1,798,026
Property and equipment.............................. 1,401,404 1,363,483
---------- ----------
Total assets........................................ $5,499,090 $3,161,509
========== ==========
Accounts payable.................................... $5,887,393 $4,376,751
Other current liabilities........................... 1,369,956 2,304,350
Long-term debt...................................... 288,488 --
---------- ----------
Total liabilities................................... $7,545,837 $6,681,101
========== ==========
Net liabilities..................................... $2,046,747 $3,519,592
========== ==========
</TABLE>
F-37
<PAGE>
HEMISPHERE INVESTMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information subsequent to December 31, 1999 and pertaining to June 30, 2000
and
for the six months ended June 30, 1999 and 2000 is unaudited)
4. Long-Term Debt
Long-term debt consists of the following:
<TABLE>
<CAPTION>
December 31, June 30,
--------------------- -----------
1998 1999 2000
---------- ---------- -----------
(Unaudited)
<S> <C> <C> <C>
Notes payable on March 31, 2000 with interest
at 8% per annum with quarterly interest
payments.................................... $3,815,195 $3,773,205 $3,529,029
Notes payable upon demand by holder after
September 30, 1998. Interest accrues at
5.25% per annum with quarterly interest
payments.................................... 2,007,552 -- --
Convertible note payable upon demand by
holder. Interest accrues at 10% per annum
with interest due upon maturity............. -- -- 500,000
Financing received for research and
development payable May 1, 2003 unless
certain financial criteria are met by the
Company. Interest accrues at prime plus 1%
(9.5% at December 31, 1999) per annum with
semi-annual interest payments............... 59,862 59,862 59,862
---------- ---------- ----------
Total........................................ 5,882,609 3,833,067 4,088,891
Less current portion......................... 2,007,552 3,773,205 4,029,029
---------- ---------- ----------
$3,875,057 $ 59,862 $ 59,862
========== ========== ==========
</TABLE>
In connection with the purchase of Interglobe, the Company held notes
payable in the amount of $3,773,205 payable to the sellers of Interglobe ("Note
Holders"). The notes accrued interest of 8% per annum with quarterly interest
payments and were payable on March 31, 2000. An event of default due to non-
payment occurred on March 31, 2000 in respect of the notes between the Company
and the Note Holders. Pursuant to an extension agreement dated May 25, 2000,
the Note Holders agreed to forbear the event of default subject to a payment
plan and the issuance of warrants to purchase up to 99,600 shares of common
stock at the exercise price of $.01 per share. Additional loan origination
costs were recorded relating to the fair value of the warrants issued using a
Black-Scholes option pricing model with the following assumptions: a risk-free
interest rate of 6.57%; no anticipated dividends; a 0.5 volatility factor; a
fair market value of $1.00 and an expected life of 5 years. The payment plan
calls for periodic payments by the Company through September 30, 2000 and
restricts the Company from borrowing additional funds without the Note Holders'
consent.
5. Obligations to Related Parties
On December 9, 1998, the Company executed a Facility Agreement with Nomura
International Plc., Ramot AG, and another shareholder for $5 million. The term
of the facility was for one year with a 12% per annum rate of interest.
Interest payments were due on December 9, 1999. Additionally, the lenders were
granted warrants to purchase an aggregate of 2,000,000 shares of Common Stock
at an exercise price of $.001 per share. Such warrants were immediately
exercisable with an expiration date five years from the date of execution of
the agreement.
The warrants were granted at less than the fair market value of the stock as
determined by the Company. As a result, the Company recorded approximately $2.0
million of loan origination fees associated with the warrants in 1998 which
were amortized over the life of the loan. The fair value of the warrants were
estimated on the date of grant using a Black-Scholes option pricing model with
the following assumptions: a risk-free interest rate of 5.55%; no anticipated
dividends; a 0.5 volatility factor; a fair market value of $1.02 and an
F-38
<PAGE>
HEMISPHERE INVESTMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information subsequent to December 31, 1999 and pertaining to June 30, 2000
and
for the six months ended June 30, 1999 and 2000 is unaudited)
5. Obligations to Related Parties (Continued)
expected life of 5 years. Under the terms of the Facility Agreement,
substantially all of the assets and stock of the Company have been used to
secure the debt. On January 13, 2000, the Company issued convertible promissory
notes to other investors (collectively, the "Holders") for a total principal
amount of $5,000,000 and used the principal received to repay the existing
bridge loan facility. Interest on the promissory notes accrued at the rate of
12% per annum and the loan is payable on January 13, 2001. As additional
consideration, the Company issued the Holders warrants to purchase up to
250,000 shares of Common Stock at an exercise price of $1.00. The Holders have
the right to convert all outstanding principal debt to common stock of the
Company upon the occurrence of certain events at a purchase price per share
determined in accordance with such agreement. In accordance with the terms of
the promissory notes, the Holders elected to convert the $5 million principal
amount into common stock of the Company during June 2000 using a conversion
price equal to the price per share paid in the last equity financing being
$1.14. Upon such conversion, one of the Holders provided a loan to the Company
of an additional $2.5 million. Principal and interest on the $2.5 million loan
is not convertible. Interest accrued at the rate of 12% per annum.
From April 27, 2000, to May 28, 2000, the Company entered into convertible
promissory notes with Portil AG and another shareholder for $1 million. The
notes were payable upon 30 days written notice and accrued interest at the rate
of 10% per annum. The notes were convertible at the election of the Lender. The
Lenders have elected to convert their Notes into shares of the Company's common
stock using a conversion price equal to the price per share paid in the last
equity financing being $1.14.
6. Income Taxes
The Company's deferred income tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
December 31
--------------------------
1998 1999
------------ ------------
<S> <C> <C>
Deferred income tax liabilities:
Depreciation.................................. $ 263,629 $ 179,155
Deferred income tax assets:
Accrued bonus................................. -- 115,790
Deferred revenue.............................. -- 808,511
Research & development credit................. -- 318,056
Net operating loss carryforwards.............. 10,162,245 13,682,504
Other......................................... 634,526 394,526
------------ ------------
Total deferred income tax assets............... 10,796,771 15,319,387
Valuation allowance for deferred income tax
assets........................................ (10,533,142) (15,140,232)
------------ ------------
Net deferred income tax assets................. 263,629 179,155
------------ ------------
Net deferred income taxes...................... $ -- $ --
============ ============
</TABLE>
At December 31, 1999, the Company has U.S. and U.K. net operating loss
carryforwards for federal income tax purposes of approximately $32,495,000 and
$5,531,000, respectively, which are available to offset future federal taxable
income, if any, through 2018.
F-39
<PAGE>
HEMISPHERE INVESTMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information subsequent to December 31, 1999 and pertaining to June 30, 2000
and
for the six months ended June 30, 1999 and 2000 is unaudited)
6. Income Taxes (Continued)
The actual income tax expense attributable to earnings from continuing
operations differed from the amounts computed by applying the statutory federal
income tax rate of 34% to pretax earnings from continuing operations as a
result of the following:
<TABLE>
<CAPTION>
December 31
------------------------
1998 1999
----------- -----------
<S> <C> <C>
Federal income taxes at statutory rate............. $(4,525,477) $(2,766,065)
State tax, net of federal benefit.................. (399,307) (244,065)
Change in valuation allowance...................... 4,868,220 3,132,643
Research and development costs..................... -- (318,056)
Other.............................................. 56,564 195,543
----------- -----------
$ -- $ --
=========== ===========
</TABLE>
7. Stockholders' Equity
Preferred Stock Issuances
On July 7, 1999, the Company issued 4,385,965 shares of Series A Preferred
Stock for an aggregate amount of approximately $4,926,000, net of expenses of
$74,000. In conjunction with this transaction, debt of $1,676,396 including
accrued interest was converted into 1,470,523 shares of Series A Preferred
Stock.
Holders of shares of Series A Preferred Stock are entitled to the following:
(1) In the event of any liquidation, dissolution or winding up of the
corporation, receive, prior and in preference to any distribution of any of the
assets of the Corporation to the holders of Common Stock, an amount equal to
$1.14 for each outstanding share of preferred stock; (2) The merger,
consolidation or acquisition of the Corporation with or into another
corporation, which results in the exchange of outstanding shares for securities
or other consideration issued or paid shall be deemed to be a liquidation,
dissolution or winding up of the Corporation. The amount deemed distributed to
the holders of preferred stock shall be the cash or the value of the property,
rights and/or securities distributed to such holders by the acquiring party;
(3) Each preferred share shall be convertible, at the option of the holder, at
any time after the date of issuance of such share into such number of fully
paid and non-assessable shares of Common Stock as is determined by dividing (a)
the Original Series A Issue Price by (b) the conversion price, as defined,
applicable to such share, in effect on the date that the certificate is
surrendered for conversion; (4) There is automatic conversion into Common Stock
upon the earlier to occur of (a) the Corporation's sale of its common stock in
a firm commitment underwritten public offering in which the Corporation is to
receive aggregate cash proceeds in excess of $25 million and the public
offering price of which is not less than $5.50 per share or (b) the date
specified by written consent or agreement of the holders of a majority of the
then outstanding preferred stock; (5) The preferred stockholder shall have the
right to one vote for each share of Common Stock into which such Series A
preferred stock could then be converted, with powers equal to the voting rights
and powers of the holders of the Common Stock.
At December 31, 1999, warrants to purchase 75,000 shares of Series A
Preferred Stock were issued at an exercise price of $1.43 per share. The
warrants expire three years from the date of issuance.
Common Stock Issuances
During March through August 1998, the Company issued an aggregate of
3,988,888 shares of common stock at $3.60 per share. The proceeds to the
Company were $14,359,997. On August 21, 1999, the Company issued a further
833,333 shares of common stock in connection with this offering as a result of
certain financial and performance targets not being met.
F-40
<PAGE>
HEMISPHERE INVESTMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information subsequent to December 31, 1999 and pertaining to June 30, 2000
and
for the six months ended June 30, 1999 and 2000 is unaudited)
7. Stockholders' Equity (Continued)
Stock Option Plan
In October 1996, the Company adopted the 1996 Employee Stock Option
Incentive Plan ("the Plan"), which provides for the granting to directors,
officers, key employees and consultants up to 6,270,007 and 6,645,007 shares of
common stock at December 31, 1999 and June 30, 2000 (unaudited), respectively.
Options for 5,637,667 and 6,012,667 shares at December 31, 1999 and June 30,
2000 (unaudited), respectively are governed by the Hemisphere Investments plan
under which grants of options may be incentive stock options and will be at
such exercise prices, in such amounts, and upon such terms and conditions, as
determined by the stock option committee under the Plan (such committee is
comprised of several members of the board of directors). In October 1996, the
Company's directors set aside 1,969,623 shares for issuance under
the Plan. On April 20, 1998, the Company's Board of Directors increased the
number of options available under the Hemisphere Investments plan from
1,969,623 options to 3,343,198 options. On October 5, 1998, the Company's Board
of Directors increased the number of options available under the Hemisphere
Investments' plan from 3,343,198 options to 3,565,420 options. On September 16,
1999, the number of options available under the Hemisphere Investments' plan
was increased from 3,565,420 to 5,637,667. On June 12, 2000, the
number of options available under the Hemisphere Investments' plan was
increased from 5,637,667 to 6,012,667. Each of the foregoing increases to the
Plan were subsequently approved and ratified by a majority of the shareholders.
However, with respect to incentive stock options, the option exercise price may
not be less than 100 percent of the market value at the time of grant (110
percent if the incentive stock option is granted to a 10 percent or more
stockholder) and the term of any option may not exceed ten years.
The remaining 632,340 options are governed by the McCarthy plan under which
the grants of options will be at such exercise prices, in such amounts, and
upon such terms and conditions, as determined by the Stock Option committee
under the McCarthy Plan (such committee is comprised of those Directors of the
Board who represent McCarthy Corporation's interest in the Company). All
options available under the McCarthy Plan had been issued to members of the
stock option committee at a stock option exercise price of $0.01.
The following table summarizes all option activity:
<TABLE>
<CAPTION>
Options Weighted-
Available Average
for Future Number of Exercise
Grant Shares Price
---------- --------- ---------
<S> <C> <C> <C>
Balance as of December 31, 1996............ 804,623 1,797,340 $0.11
Granted................................... (684,000) 684,000 2.45
Exercised................................. -- (421,560) 0.04
Canceled/forfeited........................ 10,000 (10,000) 0.16
---------- ---------
Balance as of December 31, 1997............ 130,623 2,049,780 0.91
Additional shares reserved................ 1,595,797 -- --
Granted................................... (1,151,750) 1,151,750 3.20
Exercised................................. -- (156,667) 0.16
Canceled/forfeited........................ 417,833 (417,833) 1.91
---------- ---------
Balance as of December 31, 1998............ 992,503 2,627,030 1.79
Additional shares reserved................ 2,072,247 -- --
Granted................................... (3,210,500) 3,210,500 0.97
Exercised................................. -- (219,182) 0.08
Canceled/forfeited........................ 700,068 (700,068) 0.98
---------- ---------
Balance as of December 31, 1999............ 554,318 4,918,280 0.79
Additional shares reserved (unaudited).... 375,000 -- --
Granted (unaudited)....................... (1,085,500) 1,085,500 0.75
Exercised (unaudited)..................... -- (212,944) 0.02
Canceled/forfeited (unaudited)............ 163,338 (163,338) 1.00
---------- --------- -----
Balance as of June 30, 2000 (unaudited).... 7,156 5,627,498 $0.81
========== =========
</TABLE>
F-41
<PAGE>
HEMISPHERE INVESTMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information subsequent to December 31, 1999 and pertaining to June 30, 2000
and
for the six months ended June 30, 1999 and 2000 is unaudited)
7. Stockholders' Equity (Continued)
Stock Option Plan (Continued)
The following table summarizes information about stock options outstanding
at December 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------- -----------------------
Number Weighted Number
Outstanding Weighted Average Exercisable Weighted
Range of at Average Remaining at Average
Exercise December Exercise Contractual December Exercise
Price 31, 1999 Price Life (Years) 31, 1999 Price
-------- ----------- -------- ----------- ----------- --------
<S> <C> <C> <C> <C> <C>
$0.01 310,780 $0.01 7.63 210,780 $0.01
0.16 910,000 0.16 6.88 910,000 0.16
1.00 3,697,500 1.00 9.45 389,000 1.00
--------- ---------
4,918,280 1,509,780
========= =========
</TABLE>
Compensation expense has been recognized for stock options granted at less
than market value in the amount of $1,485,000 and $59,850 for the six months
ended June 30, 2000 and 1999, respectively and $119,699, $135,750 and $200,750
for the years ended December 31, 1999, 1998 and 1997, respectively.
On February 9, 1999, the board of directors of Hemisphere Investments
resolved that all options granted under the 1996 Employee Stock Option Plan
with an exercise price greater than $1.00 per share would be repriced at $1.00
per share, the fair market value determined by the Company's Board in absence
of a public market, effective immediately. The repricing of the options
qualified the awards as variable under FASB Interpretation Number 44,
Accounting for Certain Transactions Involving Stock Compensation--an
interpretation of APB Opinion No. 25 ("FIN 44").
In addition, certain options were repriced below market and compensation
expense of $137,200 was recognized during 1999.
Pro forma information regarding net income is required by Statement 123,
which also requires that the information be determined as if the Company has
accounted for its employee stock options granted subsequent to December 31,
1994 under the fair value method of that Statement. The fair value for these
options was estimated using the "minimum value" method which may be used by
nonpublic companies to value an award.
The "minimum value" of each option grant is estimated on the date of grant
as the excess of the fair value of the stock at the date of grant over the
present value of the exercise price using the following weighted-average
assumptions for grants in 1997, 1998 and 1999: a weighted average risk-free
interest rate of 5.98%, 5.47% and 5.71%; no anticipated dividends; no
volatility; and a weighted average expected life of the options of three years.
Had compensation cost for the Company's stock option plan been determined
based on the fair value at the grant dates for awards under those plans
consistent with the method prescribed by Statement 123, the Company's net loss
would have been changed to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1997 1998 1999
----------- ------------ -----------
<S> <C> <C> <C>
Net Loss
As Reported........................ $(6,789,415) $(39,020,145) $(9,786,216)
Pro Forma.......................... (6,775,897) (39,161,837) (9,841,777)
</TABLE>
F-42
<PAGE>
HEMISPHERE INVESTMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information subsequent to December 31, 1999 and pertaining to June 30, 2000
and
for the six months ended June 30, 1999 and 2000 is unaudited)
8. Reservations of Common Stock
A summary of the Company's shares of common stock reserved for future
issuance at December 31, 1999 is as follows:
<TABLE>
<S> <C>
Warrants........................................................ 2,000,000
Employee Options................................................ 5,472,598
Conversion of preferred stock................................... 5,856,488
----------
13,329,086
==========
</TABLE>
9. Gain on Settlement of Litigation
Pursuant to a settlement agreement in April 1999 and in consideration for a
full release from future claims or liability, the Company recovered damages in
the amount of approximately $2.8 million, net of expenses of $1.2 million, for
unauthorized use of the Company's intellectual property.
10. Commitments and Contingencies
Leases
The Company leases its office space and certain equipment under terms of
non-cancelable operating leases. The Company also leases equipment under
various capital leases. The leases generally require that the Company pay
certain maintenance, insurance and other operating expenses. Rent expense under
operating leases was approximately $475,000, $689,000 and $551,000 for the
years ended December 31, 1997, 1998 and 1999, respectively. Rent expense under
operating leases was approximately $256,000 and $216,000 for the six months
ended June 30, 1999 and 2000, respectively.
At December 31, 1999, future minimum lease payments under capital leases and
non-cancelable operating leases with initial or remaining lease terms in excess
of one year are as follows:
<TABLE>
<CAPTION>
Capital Operating
Leases Leases
-------- ---------
<S> <C> <C>
2000.................................................. $458,336 $242,178
2001.................................................. 308,308 207,808
2002.................................................. 33,250 207,604
2003.................................................. -- 125,314
-------- --------
Total minimum lease payments.......................... 799,894 $782,904
========
Less amounts representing interest at rates ranging
from 10% to 13%...................................... 80,749
--------
Present value of net minimum capital lease payments... 719,145
Less current installments of obligations under capital
leases............................................... 399,032
--------
Obligations under capital leases, excluding current
installments......................................... $320,113
========
</TABLE>
F-43
<PAGE>
HEMISPHERE INVESTMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information subsequent to December 31, 1999 and pertaining to June 30, 2000
and
for the six months ended June 30, 1999 and 2000 is unaudited)
10. Commitments and Contingencies
Leases (continued)
Property and equipment at year end include the following amounts for
capitalized leases:
<TABLE>
<CAPTION>
1998 1999
---------- ----------
<S> <C> <C>
Computer and telephone equipment................... $1,281,218 $1,475,734
Less accumulated depreciation...................... (794,070) (777,997)
---------- ----------
$ 487,148 $ 697,737
========== ==========
</TABLE>
Amortization of these assets is included in depreciation expense.
Legal Proceedings
In May 1999, MCI WorldCom filed a lawsuit against Hemisphere Investments,
Inc. and its subsidiary claiming breach of contract in the sum of $1.5 million.
In a subsequent amendment response to an interrogatory, additional invoices
were added increasing the balance to approximately $3.2 million. The Company
has filed an answer denying liability and instituted a counter-claim against
MCI WorldCom for an unspecified sum. At present both parties are in the process
of discovery. The Company has provided for any anticipated losses.
The Company is involved in other claims and legal actions which arose in the
ordinary course of business. In the option of management and outside legal
counsel the ultimate disposition of these matters will not have a material
adverse effect on the Company's consolidated financial position or results of
operations.
Employment Agreements
During 1999, the Company entered into employee agreements with the Company's
chief executive officer, president and chief financial officer. The Company
also has employee agreements with certain other senior management of the
Company. The amount of minimum commitment on the employment agreements is
approximately $1,086,660 through September 31, 2001. Each of the agreements
provides for certain benefits upon change of control or termination without
cause.
11. Impact of Recently Issued Accounting Pronouncements
In June 1998, the FASB issued Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities ("Statement 133"), which establishes
accounting and reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts, and for hedging
activities. In June 1999, Statement 133 was amended by Statement No. 137,
Accounting for Derivative Instruments and Hedging Activities--Deferral of the
Effective Date of Statement 133 ("Statement 137"). As a result of this
amendment, Statement 133 is effective for all fiscal quarters of all fiscal
years beginning after June 15, 2000. In accordance with Statement 133, an
entity is required to recognize all derivatives as either assets or liabilities
in the statement of financial position and measure those instruments at fair
value. Statement 133 requires that changes in the derivative's fair value be
recognized currently in earnings unless specific hedge accounting criteria are
met. Special accounting for qualifying hedges allows a derivative's gains and
losses to offset related results on the hedged item in the income statement and
requires that a company formally document, designate and assess the
effectiveness of transactions that receive hedge accounting. The Company does
not expect the adoption of this statement to have a material effect on its
consolidated financial position or results of operations.
F-44
<PAGE>
HEMISPHERE INVESTMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information subsequent to December 31, 1999 and pertaining to June 30, 2000
and
for the six months ended June 30, 1999 and 2000 is unaudited)
11. Impact of Recently Issued Accounting Pronouncements (Continued)
On December 3, 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"). SAB 101 summarizes certain areas of
the Staff's views in applying generally accepted accounting principles to
revenue recognition in financial statements. The Company believes that its
current revenue recognition policies comply with SAB 101.
12. Industry and Geographic Segment Information
Industry Segment Disclosures
The Company operates in two business segments: services and products. The
Company's service division sells enhanced services on a per minute basis using
TCS-owned and managed platforms. The primary services offered by this division
are calling card and unified messaging services. The Company's product division
sells software products to telecommunications providers. These products
generally require an extensive amount of customization to interface with the
customer's existing network and billing infrastructure.
The accounting policies of the reportable segments are the same as those
described in the summary of significant accounting policies. There is no
intercompany profit or loss on transactions between the reportable segments.
<TABLE>
<CAPTION>
Six months ended June
Years ended December 31, 30,
-------------------------------------- ------------------------
1997 1998 1999 1999 2000
----------- ------------ ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Net Sales
Services............... $12,474,261 $ 5,652,991 $ 3,344,909 $ 1,160,761 $ 2,169,388
Products............... 2,929,673 440,173 3,764,665 1,912,077 3,705,845
----------- ------------ ----------- ----------- -----------
$15,403,934 $ 6,093,164 $ 7,109,574 $ 3,072,838 $ 5,875,233
=========== ============ =========== =========== ===========
Operating income (loss):
Services............... $(7,566,698) $ (5,040,626) $ (315,383) $ (485,253) $ (111,492)
Products............... 997,137 (7,957,147) (7,670,556) (4,850,501) (3,290,638)
----------- ------------ ----------- ----------- -----------
Total operating loss.... (6,569,561) (12,997,773) (7,985,939) (5,335,754) (3,402,130)
Gain on settlement of
litigation............. -- -- 2,775,259 2,775,259 --
Interest income......... 107,346 254,107 105,089 45,568 16,720
Interest expense........ (327,200) (566,560) (3,029,895) (1,504,452) (530,374)
----------- ------------ ----------- ----------- -----------
Loss from continuing
operations............. $(6,789,415) $(13,310,226) $(8,135,486) $(4,019,379) $(3,915,784)
=========== ============ =========== =========== ===========
</TABLE>
F-45
<PAGE>
HEMISPHERE INVESTMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information subsequent to December 31, 1999 and pertaining to June 30, 2000
and
for the six months ended June 30, 1999 and 2000 is unaudited)
<TABLE>
<CAPTION>
Six months ended June
Years ended December 31, 30,
------------------------------------ -----------------------
1997 1998 1999 1999 2000
----------- ------------ ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Depreciation
and amortization expense:
Services.................. $ 241,608 $ 563,532 $ 939,326 $ 765,133 $ 446,900
Products.................. 725,516 824,518 2,016,798 910,287 1,268,045
Corporate................. 121,408 183,986 199,631 114,815 89,815
----------- ------------ ----------- ----------- -----------
Total depreciation and
amortization expense...... $ 1,088,532 $ 1,572,036 $ 3,155,755 $ 1,790,235 $ 1,804,760
=========== ============ =========== =========== ===========
Capital expenditures:
Services.................. $ 1,042,341 $ 1,970,585 $ 524,655 $ 524,655 $ --
Products.................. 1,648,129 966,946 2,600,963 175,260 2,060,302
Corporate................. 215,601 434,299 24,281 9,963 50,934
----------- ------------ ----------- ----------- -----------
Total capital
expenditures.............. $ 2,906,071 $ 3,371,830 $ 3,149,899 $ 709,878 $ 2,111,236
=========== ============ =========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
December 31,
---------------------- June 30,
1998 1999 2000
----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Identifiable assets:
Services................... $ 3,179,186 $2,910,750 $ 2,615,508
Products................... 3,604,296 4,499,281 7,479,702
Corporate.................. 7,016,865 2,544,329 2,824,196
----------- ---------- -----------
Total identifiable assets... $13,800,347 $9,954,360 $12,919,406
=========== ========== ===========
</TABLE>
Geographic Segment Disclosures
The Company's geographic segments include United States and Europe. The
Company has no material amounts of sales or transfers between its United States
and European territories and no significant United States export sales.
The following presents net sales and long-lived assets by geographical
territory:
<TABLE>
<CAPTION>
Six months ended June
Years ended December 31, 30,
--------------------------------- ---------------------
1997 1998 1999 1999 2000
----------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Net Sales
United States......... $14,870,223 $5,516,401 $5,074,734 $2,335,677 $5,113,538
Europe................ 533,711 576,763 2,034,840 737,161 761,695
----------- ---------- ---------- ---------- ----------
$15,403,934 $6,093,164 $7,109,574 $3,072,838 $5,875,233
=========== ========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
December 31,
--------------------- June 30,
1998 1999 2000
---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Long-lived Assets:
United States.............. $5,555,556 $5,577,793 $6,043,737
Europe..................... 1,114,442 773,278 679,436
---------- ---------- ----------
$6,669,998 $6,351,071 $6,723,173
========== ========== ==========
</TABLE>
F-46
<PAGE>
HEMISPHERE INVESTMENTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Information subsequent to December 31, 1999 and pertaining to June 30, 2000
and
for the six months ended June 30, 1999 and 2000 is unaudited)
13. Subsequent Events -- Unaudited
Merger with Convergent Networks
On July 7, 2000, Convergent Networks, Inc. ("Convergent") entered into a
Purchase and Sale Agreement with the Company to acquire all of the outstanding
shares of Hemisphere Investments, Inc. On July 31, 2000 the transaction closed
and, the Company's stockholders received an aggregate of 10,106,845 Convergent
shares based on the fully diluted shares outstanding at closing.
F-47
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL DATA
The unaudited pro forma condensed consolidated financial data of Convergent
Networks, Inc and subsidiaries (the Company) were prepared to illustrate the
estimated effects of the Company's acquisition of Hemisphere Investments, Inc.
and its wholly owned subsidiaries, including Technology Control Services, Inc.
(collectively TCS). The unaudited consolidated pro forma statements of
operations for the year ended December 31, 1999 and for the nine months ended
September 30, 2000 give effect to the acquisition as if it had occurred on
January 1, 1999.
The unaudited pro forma consolidated financial data have been prepared using
the purchase method of accounting for the acquisition whereby the total cost of
the acquisition is allocated to the tangible and intangible assets acquired and
liabilities assumed based upon their respective fair values at the effective
date of the acquisition. Such allocation has been made based upon currently
available information and management's estimates. Final allocations will be
determined upon completion of the analysis of the assets acquired and
liabilities assumed and accordingly, the amounts presented herein are subject
to change.
The following unaudited pro forma condensed consolidated financial
statements are based on the audited consolidated financial statements of the
Company and TCS for the year ended December 31, 1999 and the unaudited
consolidated financial statements of the Company for the nine months September
30, 2000 and TCS for the seven months ended July 31, 2000. The unaudited
financial statements reflect all adjustments, consisting of normal recurring
adjustments, which in the opinion of management are necessary for a
presentation of results for the respective periods in accordance with the basis
of presentation described in Note 1 of the notes to the Company's consolidated
financial statements and similar statements found in TCS's financial
statements.
The unaudited pro forma condensed consolidated financial statements of
operations do not purport to represent what the results of operations of the
Company would actually have been if the acquisition had occurred on January 1,
1999 or to project the results of operations of the Company for any future date
or period. TCS developed and sold custom softswitch and service creation
software products and, through its service division, provided network-based
service applications such as unified messaging and calling card services. The
Company has refocused the efforts of TCS to provide standard software products,
which will be part of the ICServiceWorks product, and the Company has decided
to dispose of the service division and related assets. For the years ended
December 31, 1997, 1998 and 1999 and the six months ended June 30, 2000, the
service division accounted for approximately $12.5 million or 81%, $5.7 million
or 93%, $3.3 million or 47% and $2.2 million or 37%, respectively of TCS
revenues. For the years ended December 31, 1997, 1998 and 1999 and the six
months ended June 30, 2000 the service division incurred operating losses of
approximately $7.6 million, $5.0 million, $315,000 and $111,000, respectively.
The Company has accounted for the proposed disposition of the service division
and related assets as assets held for sale pursuant to EITF Issue No. 87-11
"Allocation of Purchase Price To Assets To Be Sold" and accordingly, the
service division's results of operations from the date of acquisition to the
date of disposition will be excluded from the Company's consolidated results of
operations. The Company expects to sell the service division and related assets
by March 31, 2001. The service division's net assets have been recorded at
their estimated net realizable value in the September 30, 2000 consolidated
balance sheet. The service division's revenues and operating losses have been
excluded from the Company's consolidated results of operations from the date of
acquisition to September 30, 2000 and were approximately $425,000 and $25,000,
respectively. In accordance with EITF 87-11, any difference between the
estimated net realizable value of the service division's net assets and the
actual net proceeds received upon disposition will be recorded as an adjustment
to goodwill. As a result, the Company expects that TCS operations will generate
revenues significantly lower than those generated by TCS in prior periods. The
unaudited pro forma condensed consolidated statements of operations set forth
below should be read in conjunction with the respective consolidated financial
statements and notes thereto of the Company and the respective consolidated
financial statements and notes thereto of TCS included elsewhere in this
prospectus and "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
F-48
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the Year ended December 31, 1999
<TABLE>
<CAPTION>
Historical
--------------------------
Convergent Hemisphere
Networks, Investments, Pro Forma
Inc. Inc. Adjustments Pro Forma
------------ ------------ ------------- ------------
<S> <C> <C> <C> <C>
Revenues................ $ -- $ 7,109,574 $ (3,344,909)(d) $ 3,764,665
Cost of revenues........ -- 3,978,567 (987,970)(d) 2,990,597
------------ ----------- ------------- ------------
Gross profit........ -- 3,131,007 (2,356,939) 774,068
------------ ----------- ------------- ------------
Operating expenses:
Research and
development.......... 13,067,158 7,738,082 (909,759)(d) 19,895,481
Selling and
marketing............ 3,522,903 1,644,145 (481,439)(d) 4,685,609
General and
administrative....... 1,273,363 1,734,719 (1,281,125)(d) 1,726,957
Stock-based
compensation......... 3,545,710 -- 2,331,606 (c) 5,877,316
Amortization of
intangible assets.... -- -- 39,127,000 (b) 39,127,000
------------ ----------- ------------- ------------
Total operating
expenses........... 21,409,134 11,116,946 38,786,283 71,312,363
------------ ----------- ------------- ------------
Loss from operations.. (21,409,134) (7,985,939) (41,143,222) (70,538,295)
Gain on settlement of
litigation........... -- 2,775,259 -- 2,775,259
Interest income
(expense), net....... 137,412 (2,924,806) -- (2,787,394)
------------ ----------- ------------- ------------
Loss from continuing
operations......... (21,271,722) (8,135,486) (41,143,222) (70,550,430)
Accretion of dividends
on preferred stock..... (1,066,817) -- -- (1,066,817)
------------ ----------- ------------- ------------
Loss from continuing
operations
attributable to
common
stockholders....... $(22,338,539) $(8,135,486) $(41,143,222) $(71,617,249)
============ =========== ============= ============
Basic and diluted loss
from continuing
operations per common
share.................. $ (7.47) $ (5.47)
============ ============
Weighted average common
shares outstanding:
Basic and diluted..... 2,991,313 10,106,845 (e) 13,098,158
============ ============= ============
</TABLE>
The accompanying notes are an integral part of these unaudited pro forma
condensed consolidated financial statements.
F-49
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the Nine Months ended September 30, 2000
<TABLE>
<CAPTION>
Historical
----------------------------------------
Convergent Hemisphere
Networks, Investments, Pro Forma
Inc. Inc. Adjustments Pro Forma
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues................ $ 6,759,230 $ 6,186,350 $ (2,417,252)(d) $ 10,528,328
Cost of revenues........ 5,041,676 1,161,401 (529,660)(d) 5,673,417
------------ ----------- ------------ ------------
Gross profit........ 1,717,554 5,024,949 (1,887,592) 4,854,911
------------ ----------- ------------ ------------
Operating expenses:
Research and
development.......... 9,292,823 5,460,780 (363,906)(d) 14,389,697
Selling and
marketing............ 5,075,750 2,518,230 (502,066)(d) 7,091,914
General and
administrative....... 2,652,057 2,543,826 (1,231,551)(d) 3,964,332
Stock-based
compensation......... 8,079,670 -- 794,866 (c) 8,874,536
Amortization of
intangible assets.... 6,554,639 -- 22,790,611 (b) 29,345,250
Acquired in-process
research and
development.......... 23,000,000 -- (23,000,000)(a) --
------------ ----------- ------------ ------------
Total operating
expenses........... 54,654,939 10,522,836 (1,512,046) 63,665,729
------------ ----------- ------------ ------------
Loss from operations.. (52,937,385) (5,497,887) (375,546) (58,810,818)
Interest income
(expense), net....... 1,306,612 (635,718) -- 670,894
------------ ----------- ------------ ------------
Loss from continuing
operations......... (51,630,773) (6,133,605) (375,546) (58,139,924)
Accretion of dividends
on preferred stock..... 3,416,401 -- -- 3,416,401
------------ ----------- ------------ ------------
Loss from continuing
operations
attributable to
common
stockholders....... $(55,047,174) $(6,133,605) $ (375,546) $(61,556,325)
============ =========== ============ ============
Basic and diluted loss
from continuing
operations per common
share.................. $ (10.61) $ (4.02)
============ ============
Weighted average common
shares outstanding:
Basic and diluted..... 5,188,235 10,106,845 (e) 15,295,080
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these unaudited pro forma
condensed consolidated financial statements.
F-50
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
On July 31, 2000, the Company acquired Hemisphere Investments, Inc. and its
wholly owned subsidiaries, including Technology Control Services, Inc.
(collectively, TCS) for an aggregate of 10,106,845 shares of common stock in
consideration for all the outstanding capital stock of TCS, and reserved an
aggregate of 1,229,436 shares of the Company's common stock in connection with
the assumption of outstanding options to purchase capital stock of TCS and
assumed approximately $5.5 million of TCS debt, which was repaid upon closing
the transaction. 1,516,025 shares of common stock issued to stockholders of TCS
are currently held in escrow to secure certain indemnification obligations of
TCS and certain of its stockholders. The acquisition was accounted for using
the purchase method of accounting in accordance with APB No. 16, Business
Combinations. Accordingly, the operating results of TCS have been included in
the Company's financial results from the date of the acquisition. The
allocation of the purchase price to the assets acquired and liabilities assumed
was based on the estimated fair value of the assets and liabilities of TCS.
Approximately $23 million of the purchase price was recorded as acquired in
process research and development in the third quarter of fiscal 2000. This
charge has been excluded from the unaudited pro forma condensed consolidated
statements of operations due to its nonrecurring nature. Goodwill and other
intangible assets of approximately $117.4 million will be amortized on a
straight-line basis over three years. The purchase price allocation and the
following pro forma condensed consolidated financial statements are based upon
a preliminary valuation and may change upon final determination of the fair
value of assets and liabilities acquired. Accordingly, the amounts presented
herein are subject to change.
The 1,516,025 shares held in escrow have been reflected as outstanding in
the September 30, 2000 consolidated balance sheet and have been included in the
purchase price allocation in accordance with the provisions of SFAS No. 38
"Accounting for Preacquisition Contingencies of Purchased Enterprises." The
value assigned to each element of the purchase price is as follows:
<TABLE>
<S> <C>
Common stock.................... $121,282,000
Vested stock options............ 6,748,000
Unvested stock options.......... 3,450,000
Acquisition costs............... 354,000
------------
$131,834,000
============
</TABLE>
The Company has accounted for the assumption of TCS stock options in
accordance with FIN 44. The fair value of the vested stock options has been
included in the purchase price and the difference between the intrinsic value
and the fair value of the unvested stock options is included in the purchase
price. In addition, the Company has recorded approximately $3,807,000 in
deferred compensation related to the intrinsic value of unvested stock options
assumed in the transaction, which will be recorded as stock-based compensation
expense over the remaining vesting period of approximately three years.
The Company has allocated the following amounts to identifiable intangible
assets:
<TABLE>
<CAPTION>
Identifiable Amortization
Intangible Assets Period Amount
----------------- ------------ ------------
<S> <C> <C>
Assembled workforce 3 years $ 900,000
Developed technology 3 years $ 4,200,000
Goodwill 3 years $112,281,000
</TABLE>
The Company believes the amortization periods represent the estimated useful
lives of the intangible assets and will evaluate the realizability of such
assets using the undiscounted cash flow method as prescribed by SFAS No. 121 at
each reporting period.
F-51
<PAGE>
The Company recorded a $23.0 million charge related to in-process research
and development resulting from the TCS acquisition. This charge represented the
estimated fair value based on risk-adjusted cash flows related to the
incomplete research and development projects. At the date of acquisition, the
development of these projects had not yet reached technological feasibility,
and the research and development in progress had no alternative future uses.
Accordingly, these costs were expensed as of the acquisition date.
At the acquisition date, TCS was conducting design, development, engineering
and testing activities associated with the completion of several next-
generation technologies for its LiteSwitch platform designed to address
emerging market demands for the voice/data networking market. Projects included
the development of a media gateway controller, call control technology, Class
4/5 switch compatibility, Internet dial offload technology and Signaling System
7 signaling gateway.
At the acquisition date, the technologies under development were
approximately 75% complete based on engineering man-month data and
technological progress. TCS had spent approximately $7.5 million on the in-
process projects, and expected to spend approximately $2.5 million to complete
all phases of the research and development.
In making the purchase price allocation, management considered present value
calculations of income, an analysis of project accomplishments and remaining
outstanding items, and an assessment of overall contributions, as well as
project risks. The value assigned to purchased in-process research and
development was determined by estimating the costs to develop the acquired
research and development into commercially viable products, estimating the
resulting net cash flows from the projects, and discounting the net cash flows
to their present value. The revenue projections used to value the in-process
research and development were based on estimates of relevant market sizes and
growth factors, expected trends in technology, and the nature and expected
timing of new product introductions by us and our competitors. The resulting
net cash flows from such projects are based on management's estimates of cost
of sales, operating expenses and income taxes from such projects.
The rates utilized to discount the net cash flows to their present value
were based on estimated cost of capital calculations. Due to the nature of the
forecast and the risks associated with the research and development projects, a
discount rate of 25% was used for the in-process research and development. The
discount rate utilized was higher than our weighted average cost of capital due
to the inherent uncertainties surrounding the successful development of the
purchased in-process research and development, the useful life of the
technology, the profitability levels of the technology, and the uncertainty of
technological advances that are unknown at this time.
If these projects are not successfully developed, the sales and
profitability of the combined company may be adversely affected in future
periods. Additionally, the value of other acquired intangible assets may become
impaired.
F-52
<PAGE>
CONVERGENT NETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The following adjustments have been reflected in the unaudited pro forma
consolidated statements of operations:
(a) The pro forma adjustment to acquired in-process research and
development excludes the charge from the results of operations due to its
non-recurring nature.
(b) The pro forma adjustment to amortization of intangible assets
adjusts the amortization expense to reflect the acquisition of TCS as if it
occurred on January 1, 1999 and the amortization of intangible assets began
as of that date.
(c) The pro forma adjustment to stock-based compensation adjusts the
stock-based compensation expense to reflect compensation expense related to
the amortization of deferred compensation associated with unvested common
stock options assumed in the acquisition. The deferred compensation is
being amortized over the remaining vesting period of approximately three
years.
(d) The pro forma adjustment to revenues, cost of revenues and operating
expenses eliminates the results of operations of the service bureau to
reflect the Company's proposed disposition of the service bureau and
related assets.
(e) The pro forma adjustment to weighted average shares outstanding
adjusts the weighted average shares outstanding to reflect the shares
issued by the Company as if they were issued on January 1, 1999.
F-53
<PAGE>
[Convergent Networks logo]
<PAGE>
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution.
Estimated expenses (other than underwriting discounts and commissions)
payable in connection with the sale of our common stock offered hereby are as
follows:
<TABLE>
<S> <C>
SEC registration fees.......................................... $ 25,806
NASD filing fees............................................... 10,275
Nasdaq National Market listing fee............................. 95,000
Blue Sky fees and expenses..................................... 15,000
Transfer Agent and Registrar fees.............................. 3,500
Accounting fees and expenses................................... 650,000
Legal fees and expenses........................................ 400,000
Printing and mailing expenses.................................. 125,000
Miscellaneous.................................................. 175,419
----------
Total........................................................ $1,500,000
==========
</TABLE>
We will bear all expenses shown above.
Item 14. Indemnification of Directors and Officers.
Article EIGHTH of our amended and restated certificate of incorporation
provides that we will indemnify our directors and officers (a) against all
expenses (including attorneys' fees), judgments, fines and amounts paid in
settlement incurred in connection with any litigation or other legal proceeding
(other than an action by or in the right of us) brought against him by virtue
of his position as our director or officer if he acted in good faith and in a
manner he reasonably believed to be in, or not opposed to, our best interests,
and, with respect to any criminal action or proceeding, had no reasonable cause
to believe his conduct was unlawful and (b) against all expenses (including
attorneys' fees) and amounts paid in settlement incurred in connection with any
action by or in the right of us brought against him by virtue of his position
as our director or officer if he acted in good faith and in a manner he
reasonably believed to be in, or not opposed to, our best interests, except
that no indemnification shall be made with respect to any matter as to which
such person will have been adjudged to be liable to us, unless a court
determines that, despite such adjudication but in view of all of the
circumstances, he is entitled to indemnification of such expenses.
Notwithstanding the foregoing, to the extent that a director or officer has
been successful, on the merits or otherwise, including, without limitation, the
dismissal of an action without prejudice, we are required to indemnify him
against all expenses (including attorneys' fees) incurred in connection
therewith. Expenses shall be advanced to the director or officer at his
request, provided that he undertakes to repay the amount advanced if it is
ultimately determined that he is not entitled to indemnification for such
expenses.
Indemnification is required to be made unless we determine that the
applicable standard of conduct required for indemnification has not been met.
If we determine that the director or officer did not meet the applicable
standard of conduct required for indemnification, or if we fail to make an
indemnification payment within 60 days after such payment is claimed by such
person, such person is permitted to petition the court to make an independent
determination as to whether such person is entitled to indemnification.
As a condition precedent to the right of indemnification, the director or
officer must give us notice of the action for which indemnity is sought and we
have the right to participate in such action or assume the defense thereof.
II-1
<PAGE>
Article EIGHTH of our amended and restated certificate of incorporation
further provides that the indemnification provided therein is not exclusive and
that if the Delaware General Corporation Law is amended to expand the
indemnification permitted to directors or officers, we must indemnify those
persons to the fullest extent permitted by such laws as so amended.
Article EIGHTH of the our amended and restated certificate of incorporation
provides that none of our directors will be personally liable for any monetary
damages for any breach of fiduciary duty as a director, except to the extent
that the Delaware General Corporation Law prohibits the elimination or
limitation of liability of directors for breach of fiduciary duty. We intend to
obtain a policy of directors and officers insurance that provides insurance
against certain expenses and liabilities which may be incurred by directors and
officers.
Under Section of the underwriting agreement, the underwriters are
obligated, under certain circumstances, to indemnify our directors and officers
against certain liabilities, including liabilities under the Securities Act.
Reference is made to the form of underwriting agreement filed as Exhibit 1.1
hereto.
Item 15. Recent Sales of Unregistered Securities.
Since our incorporation, we have issued the following securities that were
not registered under the Securities Act:
(a) Issuance of Capital Stock and Warrants
1. On July 14, 1998, the Registrant issued and sold an aggregate of
5,080,000 shares of its common stock to accredited investors for an aggregate
purchase price of approximately $300.
2. Between July 14, 1998 and March 31, 1998, the Registrant issued and sold
an aggregate of 6,976,000 shares of its Series A convertible preferred stock to
accredited investors for an aggregate purchase price of approximately
$6,976,000.
3. Since August 12, 1998, the Registrant issued and sold pursuant to stock
restriction agreements under the 1998 Restricted Stock Purchase Plan, as
amended, 6,950,500 shares of its common stock to 29 employees for an aggregate
purchase price of $726,530. In addition, under the same stock plan, the
Registrant issued 4,482,000 shares to three employees for aggregate
consideration of $6,082,000 in the form of promissory notes, 25,000 shares to a
consultant for a purchase price of $125 on August 14, 1998, and 17,500 shares
to a consultant in exchange for services with a value of $220,000.
4. On July 1, 1999, the Registrant issued and sold an aggregate of 4,133,892
shares of its Series B convertible preferred stock to accredited investors for
an aggregate purchase price of $9,879,998.
5. Between December 17, 1999 and March 31, 2000, the Registrant issued and
sold an aggregate of 5,602,782 shares of its Series C convertible preferred
stock to accredited investors for an aggregate purchase price of $36,249,984.
In December 1999, 264,853 shares were issued to a consultant in exchange for
services with a value of $1,714,599.
6. On July 31, 2000, in connection with the Registrant's acquisition of
Hemisphere Investments, Inc., the Registrant issued an aggregate of 10,106,845
shares of common stock to 96 former shareholders of Hemisphere Investments,
Inc. and to an investment bank to satisfy the obligations of Hemisphere
Investments, Inc. to the bank.
These shares were issued pursuant to Regulation D and Regulation S as
promulgated under the Securities Act of 1933, as amended. With respect to the
shares that were issued in accordance with Rule 506 of Regulation D, (i) there
were no more than, or the Registrant reasonably believed that there were no
more than,
II-2
<PAGE>
35 non-accredited purchasers in the offering, (ii) each purchaser who was not
an accredited investor either alone or with his purchaser representative had
such knowledge and experience in financial and business matters that he was
capable of evaluating the merits and risks of the prospective investment, or
the Registrant reasonably believed immediately prior to making any sale that
such purchaser came within this description, (iii) the Registrant furnished the
information specified in Rule 502 of Regulation D to all purchasers who were
not accredited investors, (iv) neither the Registrant nor any person acting on
its behalf offered or sold securities in the offering by any form of general
solicitation or general advertising, and (v) the Registrant exercised
reasonable care to assure that the purchasers of the securities in the offering
were not underwriters within the meaning of Section 2(11) of the Securities
Act.
With respect to the shares that were issued in accordance with Regulation S,
(i) the offer and sale of the shares were made in offshore transactions, (ii)
no directed selling efforts were made in the United States by the Registrant, a
distributor, any of their respective affiliates, or any person acting on behalf
of the foregoing, (iii) appropriate offering restrictions were implemented, and
(iv) offers or sales of the shares (a) were not made to a U.S. person or for
the account or benefit of a U.S. person and (b) were made pursuant to the
conditions specified in Rule 903 of Regulation S.
7. On August 4, 2000, the Registrant issued a warrant for the purchase of up
to 100,000 shares of common stock at an exercise price of $12.00 per share,
terminating on the earlier of August 4, 2002 or our acquisition by another
company.
8. On September 19, 2000, the Registrant issued a warrant for the purchase
of up to 50,000 shares of common stock at an exercise price of $16.35 per
share, terminating on the earlier of September 19, 2002 or our acquisition by
another company.
9. On September 22, 2000, the Registrant issued a warrant for the purchase
of up to 90,000 shares of common stock at an exercise price of $16.35 per
share, terminating on the earlier of September 22, 2002 or our acquisition by
another company.
10. On September 22, 2000, the Registrant issued and sold an aggregate of
4,803,925 shares of its Series D convertible preferred stock to accredited
investors for an aggregate price of $78,544,174.
(b) Grants and Exercises of Stock Options.
1. On July 31, 2000, the Registrant reserved an aggregate of 1,229,436
shares of common stock in connection with the assumption of outstanding options
to purchase capital stock issued to employees, directors and consultants of
Hemisphere Investments, Inc. The as converted exercise prices range from $.05
to $4.59 per share.
2. From inception through September 30, 2000, the Registrant granted under
the 1998 Stock Option Plan options to purchase 6,292,545 shares of common stock
at exercise prices ranging from $.05 to $13.20 per share to employees,
consultants and directors.
3. From inception through September 30, 2000, the Registrant issued and sold
an aggregate of 3,002,625 shares of its common stock pursuant to the exercise
of stock options to employees, consultants and directors for aggregate
consideration of $989,736.
No underwriters were involved in the foregoing sales of securities. Such
sales were made in reliance upon an exemption from the registration provisions
of the Securities Act set forth in Section 4(2) thereof relative to sales by an
issuer not involving any public offering or the rules and regulations
thereunder, or, in the case of options to purchase our common stock, Rule 701
under the Securities Act. All of the foregoing securities are deemed restricted
securities for purposes of the Securities Act.
II-3
<PAGE>
Item 16. Exhibits and Financial Statements Schedules.
(a) Exhibits:
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<C> <S>
1.1** Form of Underwriting Agreement
2.1* Agreement and Plan of Merger dated July 6, 2000 by and among
Convergent Networks, Inc., Hemisphere Acquisition Corporation and
Hemisphere Investments, Inc. and certain shareholders of
Hemisphere Investments, Inc.
3.1* Restated Certificate of Incorporation
3.2* Amended and Restated Certificate of Incorporation, to become
effective upon completion of this offering
3.3* By-laws
Amended and Restated By-Laws, to become effective upon completion
3.4* of this offering
4.1** Specimen certificate for shares of common stock
5.1** Opinion of Hale and Dorr LLP
10.1* 1998 Stock Option Plan, as amended
10.2* 1998 Restricted Stock Purchase Plan, as amended
10.3* Hemisphere Investments, Inc. Third Amended and Restated 1996
Employee Stock Option Incentive Plan
10.4* 2000 Stock Incentive Plan
10.5* 2000 Employee Stock Purchase Plan
10.6* Form of First Amended and Restated Investor Rights Agreement dated
September 22, 2000 by and among Convergent Networks, Inc. and the
individuals and entities listed on Attachment A and Attachment B
thereto
10.7* Lease between Cross Point Limited Partnership and Convergent
Networks, Inc. dated August 1999.
10.8* Sublease Agreement dated as of September 1, 2000 between Nortel
Networks (CALA) Inc. and Convergent Networks, Inc.
10.9* Employment Agreement dated September 26, 2000 between Convergent
Networks, Inc. and John C. Thibault
10.10*+ Purchase and License Agreement dated May 1, 2000 between Global
NAPs, Inc. and Convergent Networks, Inc.
10.11+ Manufacturing Services Agreement between ACT Manufacturing, Inc.
and Convergent Networks, Inc. dated as of September 20, 2000.
10.12 Repurchase Agreement dated March 11, 1999 by and between
Convergent Networks, Inc. and Sally J. Bament.
10.13 Repurchase Agreement dated September 21, 1998 by and between
Convergent Networks, Inc. and Kenneth MacLure.
10.14 Repurchase Agreement dated August 4, 1999 between Convergent
Networks, Inc. and Kenneth MacLure.
10.15 Stock Restriction Agreement dated July 14, 1998 between Tiger
Networks Corporation and Bing Yang, as amended by Amendment to
Stock Restriction Agreement dated January 20, 1999 between
Convergent Networks, Inc. and Bing Yang.
10.16 Stock Restriction Agreement dated July 14, 1998 between Tiger
Networks Corporation and Hwang-Ruey Wang, as amended by Amendment
to Stock Restriction Agreement dated January 20, 1999 between
Convergent Networks, Inc. and Hwang-Ruey Wang.
10.17 Joint Venture Agreement dated December 16, 1999 by and between
Global NAPs, Inc., B.A.B.P. LLC and Convergent Networks, Inc.
10.18+ OEM License Agreement dated July 23, 1999 by and between Ulticom,
Inc. and Convergent Networks, Inc.
21* Subsidiaries
23.1 Consent of Arthur Andersen LLP
23.2 Consent of Ernst & Young LLP
23.3** Consent of Hale and Dorr LLP (included in Exhibit 5.1)
Power of Attorney (included in the signature pages to this
24.1* registration statement)
27.1 Financial Data Schedule
</TABLE>
---------------------
*Previously filed.
**To be filed by amendment.
+ We have sought confidential treatment from the Securities and Exchange
Commission for selected portions of this exhibit. The omitted portions will
be separately filed with the Securities and Exchange Commission.
II-4
<PAGE>
Item 17. Undertakings.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
registrant pursuant to the provisions described in Item 14 above, or otherwise,
the registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Securities Act and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
The undersigned registrant hereby undertakes:
(1) To provide to the underwriters at the closing specified in the
underwriting agreement, certificates in such denominations and registered
in such names as required by the underwriters to permit prompt delivery to
each purchaser.
(2) For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form
of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(3) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant has duly caused this Amendment No. 1 to this registration statement
to be signed on its behalf by the undersigned, thereunto duly authorized, in
Lowell, Massachusetts on November 20, 2000.
Convergent Networks, Inc.
/s/ John C. Thibault
By: _________________________________
John C. Thibault
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Amendment No. 1 to this registration statement has been signed by the following
persons in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ John C. Thibault Chairman, President, Chief November 20, 2000
______________________________________ Executive Officer and
John C. Thibault Director (Principal
Executive Officer)
/s/ Pamela F. Lenehan Vice President and Chief November 20, 2000
______________________________________ Financial Officer
Pamela F. Lenehan (Principal Financial and
Accounting Officer)
* Senior Vice President, Chief November 20, 2000
______________________________________ Technology Officer and
Bing Yang Director
* Director November 20, 2000
______________________________________
Todd A. Dagres
* Director November 20, 2000
______________________________________
David E. Schantz
* Director November 20, 2000
______________________________________
William E. Foster
/s/ John C. Thibault
*By: _________________________________
John C. Thibault
As Attorney-In-Fact
</TABLE>
II-6
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<C> <S>
1.1** Form of Underwriting Agreement
2.1* Agreement and Plan of Merger dated July 6, 2000 by and among
Convergent Networks, Inc. and Hemisphere Investments, Inc. and
certain shareholders of Hemisphere Investments, Inc.
3.1* Restated Certificate of Incorporation
3.2* Amended and Restated Certificate of Incorporation, to become
effective upon completion of this offering
3.3* By-laws
Amended and Restated By-Laws, to become effective upon completion
3.4* of this offering
4.1** Specimen certificate for shares of common stock
5.1** Opinion of Hale and Dorr LLP
10.1* 1998 Stock Option Plan, as amended
10.2* 1998 Restricted Stock Purchase Plan, as amended
10.3* Hemisphere Investments, Inc. Third Amended and Restated 1996
Employee Stock Option Incentive Plan
10.4* 2000 Stock Incentive Plan
10.5* 2000 Employee Stock Purchase Plan
10.6* Form of First Amended and Restated Investor Rights Agreement dated
September 22, 2000 by and among Convergent Networks, Inc. and the
individuals and entities listed on Attachment A and Attachment B
thereto
10.7* Lease between Cross Point Limited Partnership and Convergent
Networks, Inc. dated August 1999.
10.8* Sublease Agreement dated as of September 1, 2000 between Nortel
Networks (CALA) Inc. and Convergent Networks, Inc.
10.9* Employment Agreement dated September 26, 2000 between Convergent
Networks, Inc. and John C. Thibault
10.10*+ Purchase and License Agreement dated May 1, 2000 between Global
NAPs, Inc. and Convergent Networks, Inc.
10.11+ Manufacturing Services Agreement between ACT Manufacturing, Inc.
and Convergent Networks, Inc. dated as of September 20, 2000.
10.12 Repurchase Agreement dated March 11, 1999 by and between
Convergent Networks, Inc. and Sally J. Bament.
10.13 Repurchase Agreement dated September 21, 1998 by and between
Convergent Networks, Inc. and Kenneth MacLure.
10.14 Repurchase Agreement dated August 4, 1999 between Convergent
Networks, Inc. and Kenneth MacLure.
10.15 Stock Restriction Agreement dated July 14, 1998 between Tiger
Networks Corporation and Bing Yang, as amended by Amendment to
Stock Restriction Agreement dated January 20, 1999 between
Convergent Networks, Inc. and Bing Yang.
10.16 Stock Restriction Agreement dated July 14, 1998 between Tiger
Networks Corporation and Hwang-Ruey Wang, as amended by Amendment
to Stock Restriction Agreement dated January 20, 1999 between
Convergent Networks, Inc. and Hwang-Ruey Wang.
10.17 Joint Venture Agreement dated December 16, 1999 by and between
Global NAPs, Inc., B.A.B.P. LLC and Convergent Networks, Inc.
10.18+ OEM License Agreement dated July 23, 1999 by and between Ulticom,
Inc. and Convergent Networks, Inc.
21* Subsidiaries
23.1 Consent of Arthur Andersen LLP
23.2 Consent of Ernst & Young LLP
23.3** Consent of Hale and Dorr LLP (included in Exhibit 5.1)
Power of Attorney (included in the signature pages to this
24.1* registration statement)
27.1 Financial Data Schedule
</TABLE>
---------------------
*Previously filed.
**To be filed by amendment.
+ We have sought confidential treatment from the Securities and Exchange
Commission for selected portions of this exhibit. The omitted portions will
be separately filed with the Securities and Exchange Commission.
