<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number 000-30897
CONVERGENT GROUP CORPORATION
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 84-1264004
------------------------------- -------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
6399 South Fiddler's Green Circle, Suite 600, Greenwood Village, CO 80111
-------------------------------------------------------------------------
(Address of principal executive offices)
(Zip Code)
(303) 741-8400
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such report(s), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
As of October 24, 2000, there were 43,414,293 shares outstanding of the
registrant's Common Stock, $.001 par value per share.
<PAGE> 2
CONVERGENT GROUP CORPORATION
INDEX
<TABLE>
<CAPTION>
Page No.
<S> <C> <C>
PART I--FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements ................................................... 3
Condensed Consolidated Balance Sheets at December 31, 1999 and
September 30, 2000 ..................................................................... 3
Condensed Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 1999 and September 30, 2000 .................. 4
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1999 and September 30, 2000 ............................ 5
Notes to Condensed Consolidated Financial Statements ................................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ................................................ 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk .......................... 18
PART II--OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds ........................................... 19
Item 4. Submission of Matters to a Vote of Security Holders ................................. 20
Item 6. Exhibits and Reports on Forms 8-K ................................................... 20
EXHIBITS
27. Financial Data Schedule (for SEC information only)
</TABLE>
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<PAGE> 3
PART I
ITEM 1. FINANCIAL STATEMENTS.
CONVERGENT GROUP CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
ASSETS DECEMBER 31, SEPTEMBER 30,
1999 2000
------------ -------------
CURRENT ASSETS (unaudited)
<S> <C> <C>
Cash and cash equivalents $ 1,596 $ 15,149
Accounts receivable (net of allowance for doubtful
accounts of $43 and $19, respectively) 9,181 8,259
Unbilled revenues 6,351 17,365
Deferred tax asset 3,400 2,627
Prepaid expenses and other 995 2,866
--------- ---------
Total current assets 21,523 46,266
PROPERTY AND EQUIPMENT, AT COST (net of
accumulated depreciation and amortization of
$4,963 and $6,344, respectively) 3,102 5,022
LOAN RECEIVABLE FROM RELATED PARTY 2,046 2,135
OTHER ASSETS 36 1,623
--------- ---------
Total assets $ 26,707 $ 55,046
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable $ 2,346 $ 4,497
Note payable 40 --
Deferred revenue 2,182 3,687
Accrued liability for anticipated contract costs 1,949 3,299
Accrued compensation and related expense 2,128 3,832
Accrued project related costs 5,619 4,090
Other accrued expenses 1,327 1,156
--------- ---------
Total current liabilities 15,591 20,561
NON-CURRENT LIABILITIES:
Accrued liability for anticipated contract costs 171 547
Accrued compensation and related expenses 227 227
Long-term loan (net of deferred acquisition costs) 21,753 6,403
--------- ---------
Total non-current liabilities 22,151 7,177
--------- ---------
Total liabilities 37,742 27,738
COMMITMENTS -- --
STOCKHOLDERS' EQUITY (DEFICIT):
Series A convertible preferred stock ($.001 par value; 75,000,000 shares
authorized; 41,978,689 and -0- shares issued and outstanding) 42 --
Common Stock ($0.001 par value; 125,000,000 shares authorized;
13,749,322 and 43,414,293 shares issued and outstanding) 14 43
Additional paid-in capital 62,666 110,531
Deferred compensation (9,037) (10,328)
Accumulated deficit (65,030) (73,240)
Accumulated other comprehensive income 310 302
--------- ---------
Total stockholders' equity (deficit) (11,035) 27,308
--------- ---------
Total liabilities and stockholders' equity (deficit) $ 26,707 $ 55,046
========= =========
</TABLE>
See accompanying notes.
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<PAGE> 4
CONVERGENT GROUP CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------ ------------------------------
1999 2000 1999 2000
------------ ------------ ------------ ------------
REVENUE: (unaudited) (unaudited)
<S> <C> <C> <C> <C>
Integration, consulting and other services $ 10,724 $ 14,793 $ 30,373 $ 42,501
Subcontractor and other revenue 6,925 5,702 18,387 18,601
------------ ------------ ------------ ------------
Total revenues 17,649 20,495 48,760 61,102
COST OF REVENUES:
Cost of integration, consulting and other services 5,600 9,823 16,618 23,363
(exclusive of $245 and $245 in 1999 and $25 and
$45 in 2000 reported as employee stock
compensation expense)
Cost of subcontractor and other revenue 5,731 4,229 14,795 14,405
------------ ------------ ------------ ------------
Total cost of revenue 11,331 14,052 31,413 37,768
Gross profit 6,318 6,443 17,347 23,334
EXPENSES:
Selling, general and administrative expenses 4,056 8,759 11,760 24,469
(exclusive of $10,882 and $10,882 in 1999
and $1,082 and $1,981 in 2000 reported as
employee stock compensation expense)
Recapitalization costs 7,098 -- 7,098 --
Consulting agreement termination costs 3,920 -- 3,920 --
Management agreement financing fee -- 3,038 -- 3,038
Employee stock compensation expense 11,127 1,107 11,127 2,026
------------ ------------ ------------ ------------
26,201 12,904 33,905 29,533
Operating loss (19,883) (6,461) (16,558) (6,199)
OTHER INCOME (EXPENSE):
Interest income 57 115 90 215
Interest expense (288) (325) (316) (1,350)
------------ ------------ ------------ ------------
Total other income (expense) (231) (210) (226) (1,135)
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES (20,114) (6,671) (16,784) (7,334)
INCOME TAX BENEFIT (EXPENSE) 928 (25) 1,186 (877)
------------ ------------ ------------ ------------
NET INCOME (LOSS) (19,186) (6,696) (15,598) (8,211)
PREFERRED STOCK ADJUSTMENTS (210) -- 12,432 --
------------ ------------ ------------ ------------
NET INCOME (LOSS) AVAILABLE TO
COMMON STOCKHOLDERS $ (19,396) $ (6,696) $ (3,166) $ (8,211)
============ ============ ============ ============
Net Loss Per Common Share
(Basic and Diluted) $ (1.39) $ (0.20) $ (0.22) $ (0.40)
============ ============ ============ ============
Weighted Average Share
Outstanding (Basic and Diluted) 13,962,234 33,308,659 14,558,394 20,510,721
============ ============ ============ ============
</TABLE>
See accompanying notes.
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<PAGE> 5
CONVERGENT GROUP CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------
1999 2000
-------- --------
<S> <C> <C>
OPERATING ACTIVITIES (unaudited)
Net loss $(15,598) $ (8,211)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 1,031 1,381
Deferred income taxes (1,277) 773
Stock and options issued as compensation 11,127 2,026
Changes in operating assets and liabilities:
Receivables and unbilled revenues (8,666) (10,092)
Prepaid expenses and other assets (624) (1,835)
Accounts payable and accrued expenses 6,635 2,155
Accrual for anticipated contract costs (538) 1,726
Unearned revenue and customer deposits (2,378) 1,505
-------- --------
NET CASH USED IN OPERATING ACTIVITIES (10,288) (10,572)
INVESTING ACTIVITIES
Purchase of property and equipment (1,201) (3,301)
-------- --------
NET CASH USED IN INVESTING ACTIVITIES (1,201) (3,301)
-------- --------
FINANCING ACTIVITIES
Issuance of Common Stock -- 12,676
Exercise of stock options 108 148
Issuance of convertible preferred stock, net of issuance costs of $687 44,859 --
Purchase of Common Stock (1,430) --
Purchase of redeemable stock and Class A Common Stock (44,264) --
Note receivable from a shareholder (2,016) (89)
Borrowing line of credit 1,000 --
Pay down line of credit (1,000) --
Borrowings on revolving credit loan agreements 24,000 1,000
Payments on revolving credit loan agreements (2,000) (16,390)
Proceeds from initial public offering, net of issuance costs of $4,911 -- 30,089
Deferred loan acquisition costs (270) --
Repayment of note payable (500) --
Distribution to common stockholders (7,341) --
-------- --------
NET CASH PROVIDED BY FINANCING ACTIVITIES 11,146 27,434
-------- --------
Effect of exchange rate variances on cash and cash equivalents 5 (8)
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (338) 13,553
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,958 1,596
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,620 $ 15,149
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 310 $ 1,299
======== ========
Noncash activities:
Issuance of note payable in exchange for stock repurchase $ 40 $ --
======== ========
</TABLE>
See accompanying notes.
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<PAGE> 6
CONVERGENT GROUP CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE A. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Convergent Group Corporation and Subsidiaries (collectively, the "Company") have
been prepared in accordance with generally accepted accounting principals
("GAAP") and with the instructions to Form 10-Q. In the opinion of management,
they contain all normal recurring accruals and adjustments, which are necessary
to present fairly the consolidated financial position of Convergent Group at
September 30, 2000, the consolidated results of operations for the three and
nine months ended September 30, 1999 and 2000, and the consolidated cash flows
for the nine months ended September 30, 1999 and September 30, 2000. The results
for interim periods are not necessarily indicative of results which may be
expected for any other interim period or for the full year. These statements
should be read in conjunction with the consolidated financial statements and
notes thereof included in our Registration Statement on Form S-1 (SEC File No.
333-30586) relating to our initial public offering of Common Stock.
NOTE B. BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
all subsidiaries. All significant intercompany accounts and transactions have
been eliminated.
NOTE C. INCOME TAXES
We provided for income tax expense in accordance with Statement of Financial
Accounting Standards No. 109 (SFAS 109), Accounting for Income Taxes. Under SFAS
109, the liability method is used in accounting for income taxes. Under this
method, deferred tax assets and liabilities are determined based on the
differences between financial reporting and tax basis of assets and liabilities
and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse.
NOTE D. COMPREHENSIVE INCOME
We adopted Statement of Financial Accounting Standards No. 130 (SFAS 130),
Reporting Comprehensive Income. SFAS 130 establishes standards for reporting and
display of comprehensive income and its components. Comprehensive income has no
impact on our net income, balance sheet or stockholders' equity (deficit). The
components of comprehensive income are as follows:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
1999 2000 1999 2000
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net loss $(19,186) $ (6,696) $(15,598) $ (8,211)
Foreign currency translation adjustments -- (21) 5 (8)
-------- -------- -------- --------
Comprehensive income (loss) $(19,186) $ (6,717) $(15,593) $ (8,219)
======== ======== ======== ========
</TABLE>
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<PAGE> 7
CONVERGENT GROUP CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE E. RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements,"which provides
guidance on the measurement and timing of revenue recognition in financial
statements.
In March 2000, the Financial Accounting Standards Board, issued FASB
Intrepretations No. 44, Accounting for Certain Transactions Involving
Compensation (FIN No. 44). FIN No. 44 generally provides for prospective
application for grants or modifications to existing stock option or awards after
June 30, 2000. However for certain transactions the guidance is effective after
December 15, 1998 and January 12, 2000.
The adoption of these recent accounting pronouncements did not have a material
effect on our financial position or results of operations.
NOTE F. EARNINGS PER SHARE
We compute earnings per share in accordance with SFAS No. 128, Earnings per
Share (SFAS 128). The following table sets forth the computation of earnings per
share:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
1999 2000 1999 2000
----------- ----------- ----------- ------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Numerator:
Net loss $ (19,396) $ (6,696) $ (3,166) $ (8,211)
=========== =========== =========== ============
Denominator:
Weighted average shares basic
and diluted 13,962,234 33,308,659 14,558,394 20,510,721
=========== =========== =========== ============
Basic and diluted loss
Per common shares $ (1.39) $ (0.20) $ (0.22) $ (0.40)
=========== =========== =========== ============
</TABLE>
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<PAGE> 8
CONVERGENT GROUP CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE G. STOCKHOLDERS' EQUITY
On August 13, 1999, we affected a Common Stock split on a 7.8 for one basis. On
July 24, 2000, we affected a reverse split of our Common Stock on a one for two
basis. All share amounts have been restated to retroactively reflect the stock
splits.
On August 4, 2000, we consummated our initial public offering, issuing 5,000,000
shares of Common Stock at a price of $7.00 per share. Upon completion of our
initial public offering, 42,487,701 outstanding shares of Series A Convertible
Preferred Stock were converted to 21,243,850 shares of our Common Stock.
On June 15, 2000, Cinergy Communications, Inc., a wholly owned subsidiary of
Cinergy Corp., one of our principal utility customers, purchased in a private
placement 1,237,000 shares of our Common Stock for $10,000,000. Concurrent with
the closing of our initial public offering, Cinergy Communications, Inc. in a
private placement purchased an additional 929,279 shares of our Common Stock for
$2,131,162. The purchase price for the additional shares purchased concurrently
with the closing of our initial public offering was determined based on a
formula so that the average purchase price for all shares purchased by Cinergy
Communications, Inc. was equal to 80% of the initial public offering price in
accordance with the stock purchase agreement, as amended. We recorded an
approximate $2.2 million discount on the sale of Common Stock which will be
amortized as a reduction of revenues over the life of a related services
contract with Cinergy Corp. $550,000 was amortized as a reduction of revenue for
the quarter ended September 30, 2000.
NOTE H. SUBSEQUENT EVENTS
On October 13, 2000 we executed a definitive merger agreement with Schlumberger
Technology Corporation ("STC"), Convergent Holding Corporation ("Parent"), a
wholly owned subsidiary of STC, and Convergent Acquisition Sub, Inc.
("Purchaser"), a wholly owned subsidiary of Parent, in which Parent will acquire
an approximate 72% majority interest in us for cash consideration of $8.00 per
share. The transaction is structured as a tender offer by Purchaser for all of
our outstanding Common Stock followed by the merger of Purchaser with and into
us, which will result in us becoming a wholly owned subsidiary of Parent. Our
executive management and an affiliate of our largest client, Cinergy Corp., will
retain a minority interest of approximately 28% in Parent. The consummation of
the tender offer is subject to a number of standard conditions including receipt
of any necessary government approvals.
-8-
<PAGE> 9
ITEM 2.
CONVERGENT GROUP CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANICAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
We provide consulting, software engineering, systems integration, and
project management services that enable our utility and local government clients
to implement Internet-based eBusiness solutions. We combine the use of existing
and emerging digital technologies with our business expertise in the utility and
local government sectors to deliver solutions that address our clients'
mission-critical business objectives. These eBusiness transformation solutions
help our clients integrate data from various isolated sources to create a
single, Web-based point of entry through which internal decision-makers,
business partners, suppliers, customers and constituents can access business
information on a real-time basis. Our solutions help our clients increase
revenues, reduce costs, improve customer services, ensure service reliability,
improve resource management and exploit their information assets.
We derive the majority of our revenue from our professional services,
which include consulting and software integration. Our consulting services
consist of evaluating existing information systems, recommending solutions and
components including hardware and software to transition to real-time
information digital environments, analyzing the cost and benefit of the
transition, developing the strategies to implement digital environments and
training personnel to transition the change. Integration services consist of
developing specific software code or employing our previously developed code,
which is our intellectual property, to integrate new software into new or
existing systems. These professional services are included in integration,
consulting and other services revenue.
Subcontractor and other revenue include data conversion services and
computer hardware and software revenue, each of which can be a portion of the
solution we provide to our clients. Data conversion has historically been
performed principally through a single subcontractor whom we manage as part of
delivering our solutions to our clients. We have recently begun using several
other subcontractors for new client engagements. We act as a value added
reseller for some computer hardware and software manufacturers.
We expect revenue from data conversion services to decline in future
years as a percent of our overall revenues. We expect that we will derive an
increasing percentage of our revenues from consulting and integration services
in future periods. We provide most of our hardware and software procurement
during the earlier stages of a client engagement, and once we have completed
these services for a client, the client's further requirements for these
services are substantially lower. Thus, when existing clients retain us for
subsequent projects, it will increasingly be to provide consulting and
integration software and eBusiness services.
-9-
<PAGE> 10
ITEM 2.
CONVERGENT GROUP CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANICAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
GENERAL (CONTINUED)
Our most significant operating expenses for integration, consulting and
other services consist of project personnel costs, including compensation,
benefits and project-related travel expenses. We expect to continue to increase
the number of professional staff during 2000 and significantly in future years
to support our expected revenue growth in this area. As a result of this growth,
we expect our direct cost of integration, consulting and other services revenue
to increase significantly. In addition, we expect the personnel cost of each
professional staff member to increase as the solutions we deliver become more
complex and we require our staff members to obtain additional training. Members
of our professional staff are highly trained and we expect that salary and
benefit costs will increase as we strive to maintain our competitive position.
Although these direct costs are expected to increase, we expect our gross profit
margins on our integration, consulting and other services revenue to increase
due to improved delivery efficiencies achieved through the use of our internally
developed software solutions and our Rapid Performance Modeling methodology.
Rapid Performance Modeling is the methodology we employ to speed the delivery of
integration software solutions to our clients and to reduce our professional
service costs. At the outset of each engagement, we identify the components used
in previously developed software that can be used to satisfy our new client's
requirements. We deliver the core code of these previously developed software
components to our client, customize the code to meet the client's solution
requirements and eliminate the professional labor cost associated with
redeveloping the core software code.
Expenses related to subcontractor and other revenue include software,
hardware and subcontractor costs. We expect costs of software and hardware to
decrease as a percentage of total revenue as a result of an increased percentage
of total revenue being derived from integration and consulting services. Data
conversion services are labor intensive and generate low gross profit margins.
We plan to improve our profit margins on these services by better managing our
subcontractors and by engaging additional subcontractors. Data migration
services, which will be included in integration consulting and other services
revenues, are less labor intensive than data conversion services but require a
higher degree of technical skill. As a result of our personnel growth and
accompanying enhanced internal capabilities, we believe that we can realize
higher profit margins on data migration services than on data conversion
services by performing these services internally.
Selling, general and administrative expenses are expected to increase
through the remainder of 2000 due to the addition of sales and marketing
personnel in the United States, United Kingdom and Australia. Selling expenses
are also expected to increase due to our efforts to develop brand name
recognition through the aggressive marketing of our Digital Utility and
Government Gateway solutions. In addition, administrative costs are expected to
increase as a percentage of revenue as we hire additional administrative support
personnel.
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<PAGE> 11
ITEM 2.
CONVERGENT GROUP CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANICAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
GENERAL (CONTINUED)
We plan to continue to expand our operations by hiring additional
professional staff members and other employees, and adding new systems and other
infrastructure. The resulting increase in operating expenses would harm our
operating results if our revenues do not increase to support such expenses.
Based on all of the foregoing, we believe that our quarterly revenue and
operating results are likely to vary significantly in the future and that
period-to-period comparisons of our operating results are not necessarily
meaningful and should not be relied on as indications of future performance.
FORWARD-LOOKING STATEMENTS
The information in this discussion contains forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements are based on our current expectations and are
subject to a number of risks, uncertainties and assumptions. Any statements
contained herein that are not statements of historical fact may be deemed to be
forward-looking statements. For example, words such as "may," "will," "should,"
"estimates," "predicts," "strategy," "believes," "anticipates," "plans,"
"intends," and similar expressions are intended to identify forward-looking
statements. Our actual results and the timing of certain events may differ
significantly from those discussed in the forward-looking statements. Among the
important factors that could cause actual results to differ significantly from
those expressed or implied by such forward-looking statements are our dependence
on a limited number of significant clients and the loss of any major client or
the loss or reduction in scope of any significant project; unexpected project
delays, project cancellations or the failure to obtain new projects; increased
costs from any associated employee underutilization; the failure to maintain
costs under our fixed-price contracts at or below the estimated levels; our
reliance on a single subcontractor for our data conversion services and the
failure of that subcontractor to perform services on a timely basis; the failure
of our eBusiness transformation products and services to be accepted in the
marketplace; the intense competition in our industry; technological change;
damage to our reputation which could result from unexpected network
interruptions, undetected errors or defects in our services, breaches of our
network security or computer viruses or government audits; the risk that our
utility and government clients will postpone or cancel projects if there is an
economic downturn or if they are unable to comply with their regulatory
requirements; demand for our services could decrease if the rate of deregulation
in the utility industry slows; the imposition of new burdensome government
regulations and legal uncertainties regarding the Internet which could increase
our costs or limit our operations; the risk that our intellectual property and
proprietary rights may not be fully protected; our inability to negotiate
contracts which permit us to reuse our software codes and methodologies; the
risk that we fail to manage and maintain our growth, including our international
growth; our need to successfully develop awareness of our brand names; the risk
that we may be subject to employment-related claims relating to the hiring of
new employees; the potential need for additional financing; as well as the other
risk factors affecting the Company detailed from time to time in the documents
filed by the Company with the Securities and Exchange Commission, including but
not limited to those discussed under the caption "Risk Factors" in the Company's
registration statement on Form S-1 (file no. 333-30586) declared effective by
the SEC on July 31 , 2000.
-11-
<PAGE> 12
ITEM 2.
CONVERGENT GROUP CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANICAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS
REVENUES. For the first nine months of 2000, revenues increased 25.2%
to $61.1 million, as compared to $48.8 million for the same period last year.
This increase was primarily due to an increase in integration, consulting and
other service revenues of $12.1 million, or 39.8%, from $30.4 million for the
nine months ended September 30, 1999 to $42.5 million for the nine months ended
September 30, 2000, as a result of the increase in the number and scope of our
engagements. Revenue from subcontractor and other revenue increased by $0.2
million, or 1.1%, from $18.4 million for the nine months ended September 30,
1999 to $18.6 million for the nine months ended September 30, 2000. The increase
in subcontractor and other revenue was primarily due to an approximate $4.8
million increase in software sales and a decrease in conversion and
subcontractor revenue of approximately $4.4 million.
For the third quarter of 2000, revenues increased 16.5% to $20.5
million, as compared to $17.6 million for the same period last year. Revenue
from integration, consulting and other services increased 38.3% from $10.7
million for the three months ended September 30, 1999 to $14.8 million for the
three months ended September 30, 2000. The increase in revenue from integration,
consulting, and other services was due to an increase in the number and scope of
consulting engagements. Revenue from integration, consulting and other services
for the three months ended September 30, 2000 was reduced by approximately $0.6
million for amortization of a discount on Cinergy Communications, Inc's purchase
of our common stock at 80% of our initial public offering price in accordance
with a stock purchase agreement. In connection with the purchase of our common
stock by Cinergy Communications, Inc., Cinergy Corp. entered into a new service
contract with us under which we will provide professional services to Cinergy
Corp. over the next two years. The total scope of the work under the new
contract is currently estimated at $40.0 million. For accounting purposes the
total discount allocated to the sale of shares to Cinergy Communications, Inc.
of approximately $2.2 million will be amortized as a reduction of revenue over
the life of the service contract because the discount received by Cinergy
Communication, Inc. was viewed as an incentive for Cinergy Corp. to enter into
the service contract. Revenue from subcontractor and other revenue decreased
17.4% from $6.9 million for the three months ended September 30, 1999 to $5.7
million for the three months ended September 30, 2000. Revenue from conversion
decreased by approximately $3.1 million from $4.6 million for the three months
ended September 30, 1999 to approximately $1.5 million for the three months
ended September 30, 2000 due to the timing of conversion work, offset by an
increase in software revenue of approximately $3.0 million from $0.2 million for
the three months ended September 30, 1999 to $3.2 million for the three months
ended September 30, 2000 due to the addition of new client engagements during
the current period.
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<PAGE> 13
ITEM 2.
CONVERGENT GROUP CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANICAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS (CONTINUED)
GROSS PROFIT. Gross profit for the third quarter was $6.4 million
compared to $6.3 million reported in the third quarter last year. Gross profit
margin for the third quarter decreased from 35.8% for the three months ended
September 30, 1999 to 31.2% for the three months ended September 30, 2000. This
decrease in gross profit margin for the three months ended September 30, 2000 is
primarily due to an increase in our estimated costs to complete two professional
services agreements. Excluding the effect of the this increase in costs to
complete the two engagements and $25 thousand of employee stock compensation
expense, gross profit and gross margin for the three months ended September 30,
2000 would have been $8.1 million and 39.5%. Gross profit for the first nine
months of 2000 rose to $23.3 million, an increase of 34.7% over the $17.3
million reported for the first nine months of last year. Gross profit margin for
the first nine months of 2000 increased from 35.5% for the nine months ended
September 30, 1999 to 38.1% for the nine months ended September 30, 2000.
Excluding the adjustments to our costs to complete as discussed above and $45
thousand of employee stock compensation, gross profit and gross profit margin
for the nine months ended September 30, 2000 would have been $25.0 million and
40.9%
Gross profit from integration, consulting, and other services decreased
by $0.1 million from $5.1 million for the three months ended September 30, 1999
to $5.0 million for the three months ended September 30, 2000, and increased for
the nine months ended September 30, 2000 by $5.3 million to $19.1 million from
$13.8 million for the nine months ended September 30, 1999. Gross profit margin
from integration, consulting, and other services for the third quarter decreased
from 47.7% for the three months ended September 30, 1999 to 33.8% for the three
months ended September 30, 2000. Gross profit margin from integration,
consulting, and other services decreased from 45.4% for the nine months ended
September 30, 1999 to 44.9% for the nine months ended September 30, 2000. These
decreases in gross profit margin were primarily due to $0.6 million of
amortization for common stock issued at a discount that we recorded as a
reduction to revenue in the third quarter of 2000 and an increase in our
estimated costs to complete two professional service agreements.
Gross profit from subcontractor and other revenue increased from $1.2
million for the three months ended September 30, 1999 to $1.5 million for the
three months ended September 30, 2000. Gross profit from subcontractor and other
revenue increased from $3.6 million for the nine months ended September 30, 1999
to $4.2 million for the nine months ended September 30, 2000. Gross profit
margin from subcontractor and other revenue increased from 17.4% for the three
months ended September 30, 1999 to 26.3% for the three months ended September
30, 2000. Gross profit margin from subcontractor and other revenue increased
from 19.6% for the nine months ended September 30, 1999 to 22.6% for the nine
months ended September 30, 2000. These increases in gross profit margin result
primarily from a shift in revenue from conversion revenue, on which we realize a
lower gross profit margin, to software revenue, on which we realize a higher
gross profit margin.
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<PAGE> 14
ITEM 2.
CONVERGENT GROUP CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANICAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS (CONTINUED)
OPERATING EXPENSES. For the three and nine months ended September 30,
2000 (excluding $1.1 million and $2.0 million of employee stock compensation
expense and $3.0 million in management agreement expenses paid in the third
quarter to InSight Capital Partners in connection with our initial public
offering) our operating expenses were $8.8 million and $24.5 million,
respectively, compared to $4.0 million and $11.8 million for the three and nine
months ended September 30, 1999 (excluding $11.1 million for stock compensation
expense, $7.1 million of recapitalization costs, and $3.9 million to terminate a
consulting agreement for both the three and nine months ended September 30,
1999.) These increases in operating expenses between periods reflect an increase
in our selling, general, and administrative personnel headcount, primarily in
the area of sales and marketing and resource management. The increase in
resource management personnel is a result of our need to continually recruit
professional and technical personnel due to our increasing customer base and
scope of projects. In addition, this increase was caused by the expansion of our
service offerings into other markets, primarily attributable to the U.S, as well
as the addition of sales and marketing personnel in London, England, and
Brisbane, Australia.
NET INTEREST INCOME (EXPENSE). Net interest income (expense) for the
three and nine months ended September 30, 1999 was ($231) thousand and ($226)
thousand compared to net interest expense of ($210) thousand and ($1.1) million
for the three and nine months ended September 30, 2000. This decrease in
interest expense for the third quarter of 2000 compared to the third quarter of
1999 resulted from our increase in interest income from temporary cash
investments as a result of higher cash balances, primarily due to cash obtained
from our initial public offering in the third quarter of 2000. The increase in
interest expense for the first nine months of 2000 compared to the first nine
months of 1999 was due to our interest payable on the $24.0 million borrowed
under our revolving credit loan facility during the August 1999
recapitalization. We repaid $16.4 million of the revolving credit loan facility
in August of 2000 with part of the proceeds from our initial public offering
completed in August 2000.
INCOME (LOSS) BEFORE TAXES. Our income (loss) before provision
(benefit) for income taxes decreased from ($20.1) million and ($16.8) million
for the three and nine months ended September 30, 1999 to ($6.7) million and
($7.3) million for the three and nine months ended September 30, 2000. This
decrease is primarily due to having completed our 1999 recapitalization, whereby
we paid a consulting agreement fee of $3.9 million, and incurred
recapitalization costs and stock compensation costs of $7.1 million and $11.1
million, respectively. During the three and nine months ended September 30,
2000, we incurred expenses of $3.0 million resulting from a management agreement
entered into during our 1999 recapitalization with InSight Capital Partners
which became payable at the time we completed our initial public offering,
employee stock compensation expense of $1.1 million and $2.0 million,
respectively, and interest expense of $0.3 million and $1.4 million,
respectively, primarily due to borrowings on our revolving credit loan facility
prior to completing our initial public offering.
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<PAGE> 15
ITEM 2.
CONVERGENT GROUP CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANICAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS (CONTINUED)
INCOME TAX BENEFIT (PROVISION). The income tax benefit for the three
months ended September 30, 1999 was $928 thousand compared to an income tax
provision of ($25) thousand for the three months ended September 30, 2000. For
the nine months ended September 30, 1999, income tax benefit was $1.2 million
compared to an income tax provision of ($877) thousand for the nine months ended
September 30, 2000. Income tax benefit was recorded to the extent we expected to
realize a tax benefit from the use of our net operating losses in future
periods. We believe that, based upon our history of operations, recording a tax
benefit for more than the amount we expect to realize in our next fiscal year
would be inappropriate. Based upon our expectations for the remaining portion of
this fiscal year and our fiscal year 2001 and limitations placed on the use of
our net operating losses by the Internal Revenue Code and Regulations, we have
reduced our deferred tax asset to reflect the asset we believe will be allowable
under these limitations to offset income taxes for the current and our next
fiscal year.
NET INCOME (LOSS). As a result of the foregoing factors, we incurred a
net loss of $(19.2) million and $(15.6) million for the three and nine months
ended September 30, 1999 as compared to a net loss of ($6.7) million and ($8.2)
million for the three and nine months ended September 30, 2000.
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<PAGE> 16
ITEM 2.
CONVERGENT GROUP CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANICAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities for the nine months ended
September 30, 2000 remained relatively consistent at $10.6 million compared to
$10.3 million for the nine months ended September 30, 1999. Although relatively
consistent in total, cash used in operating activities for the nine months ended
September 30, 2000 resulted primarily from decreases in our net loss to $(8.2)
million compared to $(15.6) million for the nine months ended September 30,
1999, and decreases in our non-cash stock compensation expense from $11.1
million for the nine months ended September 30, 1999 to $2.0 million for the
nine months ended September 30, 2000. Net cash used in operating activities also
increased as a result of increases in receivables and unbilled revenue of $10.1
million in the current nine month period, compared to $8.7 million in the prior
nine month period, resulting from increases in our current client base, as well
as revenue growth from existing clients.
Accounts receivable from our system integration clients, primarily
large stable utilities and government enterprises, represent nominal credit
risk, as a result we realized no bad debt expense on any system integration or
consulting engagement during the periods ended September 30, 2000 and 1999.
Net cash used in investing activities increased from $1.2 million for
the nine months ended September 30, 1999 to $3.3 million for the nine months
ended September 30, 2000. Capital expenditures during 2000 were used primarily
to purchase new personal computer hardware and software as a result of the
increase in our headcount. We expect these increases to continue as we continue
to hire additional technical personnel to fulfill our contract commitments.
Net cash provided by financing activities increased from $11.1 million
for the nine months ended September 30, 1999 to $27.4 million for the nine
months ended September 30, 2000. Cash provided by financing activities for the
nine months ended September 30, 2000 resulted primarily from the issuance of
Common Stock in our initial public offering and the private placement with
Cinergy Corp. On August 4, 2000, we consummated our initial public offering,
issuing 5,000,000 shares of Common Stock at a price of $7.00 per share. Net
proceeds of the initial public offering, which exclude underwriting discounts,
commissions, and other related expenses incurred in connection with the initial
public offering were $30.1 million. In addition, pursuant to a stock purchase
agreement, Cinergy Communications, Inc. purchased 929,279 shares of our Common
Stock for $2,131,162 concurrently with the closing of our initial public
offering and Cinergy Communication, Inc. acquired 1,237,000 shares of common
stock for $10.0 million in a private placement in June 2000. Cash provided by
financing activities was partially offset by repayments on our revolving line of
credit of $16.4 million. During the nine months ended September 30, 1999, cash
provided by financing activities was primarily due to our recapitalization
during which we issued convertible preferred stock for $44.9 million, net of
issuance costs of $0.7 million, and repurchased our outstanding Series A and
Series B Preferred and Class A Common Stock for $44.3 million. In connection
with our August 1999 recapitalization, we entered into a Revolving Credit Loan
Agreement with Fleet Bank, which provides a line of credit of up to $25 million.
We borrowed $24 million under the Agreement during 1999 to partially fund the
purchase of our previously outstanding Series A and Series B Preferred Stock and
Class A Common Stock, we loaned $2.0 million to our Chief Executive Officer and
distributed $7.3 million to shareholders. In addition, we borrowed and repaid an
additional $1.0 million during the nine months ended September 30, 2000 for
temporary working capital.
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<PAGE> 17
ITEM 2.
CONVERGENT GROUP CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANICAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Our Revolving Credit Loan Agreement with Fleet Bank includes covenants
relating to the maintenance of specific financial ratios, including minimum
interest coverage, debt service, current assets ratios and limitations on
additional debt. At September 30, 2000, we were in violation of certain
covenants for which we have obtained waivers.
Cash and cash equivalents increased from $4.6 million for the nine
months ended September 30, 1999 to $15.1 million for the nine months ended
September 30, 2000.
We believe that cash provided from operations, borrowings available
under our revolving credit loan facility or a new credit facility and the net
proceeds of our initial public offering will be sufficient to meet working
capital and capital expenditure requirements for at least the next twelve
months. Thereafter, we may need to raise additional funds through public or
private financing, or make other arrangements to fund our operations and
potential acquisitions, if any. We cannot assure you that any financing or other
arrangements will be available in amounts or on terms acceptable to us or at
all, and any financing or other arrangements could place operating or other
restrictions on us. Our inability to raise capital when needed could seriously
harm the growth of our business and results of operations. If additional funds
are raised through the issuance of equity securities, the percentage ownership
of our stockholders would be reduced. Furthermore, these equity securities could
have rights, preferences or privileges senior to those of our Common Stock.
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<PAGE> 18
ITEM 3.
CONVERGENT GROUP CORPORATION AND SUBSIDIARIES
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We currently provide services to clients located in North America, and
to a lesser extent, Europe, South America and the Asia-Pacific region. As a
result, our financial results could be affected by factors such as changes in
foreign currency exchange rates or weak economic conditions in foreign markets.
As all of our contracts with clients currently provide that payments to us be
made in U.S. dollars, a strengthening of the dollar could make our services less
competitive in foreign markets. We do not expect any material adverse effect on
our consolidated financial position, results of operations or cash flows due to
movements in any specific foreign currency. We currently do not use financial
instruments to hedge foreign denominated operating expenses, but we intend to
assess the need to utilize financial instruments to hedge currency exposures on
an ongoing basis. We do not enter into derivative or other financial instruments
for trading or speculative purposes. Our interest income is sensitive to changes
in the general level of U.S. interest rates, particularly since our investments
are in short-term instruments. Due to the short-term nature of our investments,
we believe that there is no material risk exposure. Our revolving credit
facility, which constitutes long-term debt, bears interest at variable rates
based on LIBOR or the prime rate. As a result, interest rate changes generally
do not affect the fair market value of our variable rate debt, but do impact
future earnings and cash flows, assuming other factors are held constant.
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<PAGE> 19
CONVERGENT GROUP CORPORATION AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS.
Use of proceeds
Pursuant to a Form S-1 Registration Statement (SEC File No. 333-30586) declared
effective by the SEC on July 31, 2000, the Company on August 4, 2000 completed
the sale of 5,000,000 shares of its common stock in connection with an initial
public offering at a price of $7 per share. The managing underwriters in the
offering were FleetBoston Robertson Stephens Inc., Donaldson, Lufkin & Jenrette
Securities Corporation and WitSoundview Corporation.
The following table details the underwriting discounts, commissions and
estimated expenses incurred by us in connection with the completion of our
initial public offering.
<TABLE>
<CAPTION>
(in thousands)
--------------
<S> <C>
Gross proceeds $ 35,000
Underwriting discounts and commissions 2,450
Expenses:
Nasdaq Listing Fee 102
Blue Sky Fees 463
SEC Filing Fees 40
NASD Fee 16
Transfer Agent Fees 3
Accounting Fees 136
Legal Fees 1,183
Printing Fees 440
Miscellaneous 78
--------
Total underwriting discounts, commissions and estimated expenses (4,911)
--------
Net proceeds $ 30,089
========
</TABLE>
None of such expenses involved direct or indirect payments to our directors or
officers or their associates, our 10% stockholders or our affiliates.
Since the effective date of the Registration Statement through October 24, 2000,
we have used the net proceeds of the offering plus the net proceeds of $2.1
million of a concurrent private placement as follows:
o Approximately $16.4 million to pay indebtedness under a
revolving credit facility plus accrued interest;
o $3.0 million in payment of fees owed to InSight Capital
Partners, which with affiliated entities owns approximately
18.3% of our outstanding common stock; and
o $2.0 million for general operating purposes.
We maintain the balance of net proceeds in an interest bearing account.
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<PAGE> 20
CONVERGENT GROUP CORPORATION AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS. (CONTINUED)
Use of proceeds
These uses of proceeds do not represent a material change from the anticipated
uses described in our Prospectus for our initial public offering.
Except for the payment to InSight, none of the proceeds from our initial public
offering were used to make direct or indirect payments to our directors or
officers or their associates, our 10% stockholders or our affiliates.
Changes in Securities
Concurrent with the closing of our initial public offering, we sold an
additional 929,279 shares of Common Stock to Cinergy Communications, Inc. in a
private placement for $2.1 million. The purchase price of the additional shares
sold to Cinergy Communications, Inc. was in an amount such that the purchase
price per share of all the shares sold to Cinergy Communications, Inc. would be
at a price equal to 80% of the IPO price per share. Concurrently with the
closing of the IPO, our Series A Convertible Preferred Stock automatically
converted into 21,243,850 shares of Common Stock.
During the quarter ended September 30, 2000 and prior to the closing of the
Company's initial public offering on August 4, 2000, the Company granted options
to purchase 1,200,211 shares of its Common Stock to employees, officers and
directors of the Company with an exercise price of $5.95 to $7.00. These options
were granted pursuant to the Company's 1999 Stock Option Plan. During the
quarter ended September 30, 2000 and prior to the closing of the Company's
initial public offering on August 4, 2000, the Company issued 9,160 shares of
its Common Stock upon the exercise of options at an exercise price of $0.09,
resulting in a total purchase price of $825.
The issuance of options and the sale of the Common Stock upon exercise of
employee stock options was deemed to be exempt from registration under the
Securities Act of 1933 in reliance upon Section 4(2) of the Securities Act of
1933 ("the Act") or Rule 701 promulgated under Section 3 (b) of the Act. The
issuance of Common Stock upon automatic conversion of our previously outstanding
Series A Preferred stock upon consummation of the IPO was exempt from
registration under the Act by virtue of Section 3 (a)(9) of the Act. The
issuances of Common Stock to Cinergy Communications, Inc. was exempt from
registration under the Act in reliance upon Section 4(2) or Regulation D
promulgated thereunder.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
ITEM 5. OTHER INFORMATION
On October 13, 2000 we executed a definitive merger agreement with Schlumberger
Technology Corporation (STC), Convergent Holding Corporation ("Parent") a wholly
owned subsidiary of STC, and Convergent Acquisition Sub, Inc. ("Purchaser"), a
wholly owned subsidiary of Parent, in which Parent will acquire an approximate
72% majority interest in us for cash consideration of $8.00 per share. The
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<PAGE> 21
transaction is structured as a tender offer by Purchaser for all of our
outstanding Common Stock followed by the merger of Purchaser with and into us,
which will result in us becoming a wholly owned subsidiary of Parent. Our
executive management and an affiliate of our largest client, Cinergy Corp., will
retain a minority interest of approximately 28% in Parent. The consummation of
the tender offer is subject to a number of standard conditions including receipt
of any necessary government approvals.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a. Exhibits
27. Financial Data Schedule
b. Reports on Form 8-K
None.
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<PAGE> 22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
CONVERGENT GROUP CORPORATION
(Registrant)
Dated: November 14, 2000 By: /s/ Bryan R. Mileger
------------------------------------------
Bryan R. Mileger, Chief Financial Officer
(Principal Financial Officer and Principal
Accounting Officer)
<PAGE> 23
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit Number Description
-------------- -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
