U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 12 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002.
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____ TO ____.
------- -------
Commission file number 21143
CONVERGENCE COMMUNICATIONS, INC.
(Exact name of small business issuer as specified in its charter)
Nevada 87-0545056
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
102 West 500 South, Suite 320
Salt Lake City, Utah 84101
(Address of Principal Executive Offices) (Zip Code)
(801) 328-5618
(Issuer's telephone number)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes X No
---
As of April 30, 2001, 60,592,086 shares of registrant's Common Stock, par value
$.001 per share were outstanding.
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS REQUIRED BY FORM 10-Q
The accompanying unaudited consolidated financial statements of
Convergence Communications, Inc. have been prepared in accordance with
accounting principles generally accepted in the United States of America for
interim financial reporting and pursuant to the rules and regulations of the
Securities and Exchange Commission. They do not include all of the information
and footnotes required by accounting principles generally accepted for complete
financial statements. These financial statements should be read in conjunction
with Note 1 herein and the consolidated financial statements and notes thereto
included in our annual report on Form 10-K for the year ended December 31, 2001,
which are incorporated herein by reference. The accompanying financial
statements have not been examined by our independent accountants in accordance
with auditing standards generally accepted in the United States of America, but
in the opinion of management, all adjustments (consisting of normal recurring
entries) necessary for the fair presentation of our results of operations,
financial position and changes therein for the periods presented have been
included. The results of operations for the three months ended March 31, 2002
may not be indicative of the results that may be expected for the year ending
December 31, 2002.
[THIS SPACE INTENTIONALLY LEFT BLANK]
CONVERGENCE COMMUNICATIONS, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
MARCH 31, 2002 AND DECEMBER 31, 2001
- ------------------------------------------------------------------------------------------------------------------
March 31, December 31,
2002 2001
---------------- ----------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,610,854 $ 4,238,166
Accounts receivable - net 7,796,700 7,585,725
Inventory - net 41,437 41,111
Value added tax receivable 1,052,873 1,176,461
Prepaid expenses and other 2,897,369 1,861,570
---------------- ----------------
Total current assets 13,399,233 14,903,033
PROPERTY AND EQUIPMENT - net 53,846,305 54,939,546
INTANGIBLE ASSETS - net 27,679,995 28,700,844
OTHER ASSETS
Debt issue costs 1,616,856 1,737,733
Equipment lease receivables 1,675,113 1,508,586
Other 1,633,783 1,370,883
---------------- ----------------
Total other assets 4,925,752 4,617,202
---------------- ----------------
TOTAL ASSETS $ 99,851,285 $ 103,160,625
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable - current portion $ 13,524,072 $ 13,707,928
Current portion of long-term debt (payable to related party) 99,029 99,029
Accounts payable and accrued liabilities 22,294,797 19,172,978
---------------- ----------------
Total current liabilities 35,917,898 32,979,935
LONG-TERM LIABILITIES:
Notes payable - long-term portion 11,372,019 11,528,701
Long-term debt (payable to related parties) 8,288,118 8,288,118
Accrued restructuring costs 736,504 748,504
Accrued long-term interest 210,000 210,000
Other long-term liabilities 558,083 703,397
---------------- ----------------
Total long-term liabilities 21,164,724 21,478,720
MINORITY INTEREST IN SUBSIDIARIES - -
---------------- ----------------
Total liabilities 57,082,622 54,458,655
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock; $0.001 par value; 100,000,000 shares authorized:
60,019,618 and 60,061,284 shares outstanding in 2002 and 2001, respectively 60,592 60,634
Additional paid-in capital 184,136,754 184,136,712
Accumulated deficit (141,499,535) (135,074,437)
Accumulated other comprehensive loss 1,388,921 897,130
Treasury stock, 572,468 common shares in 2002 and 2001 at cost (1,318,069) (1,318,069)
---------------- ----------------
Total stockholders' equity 42,768,663 48,701,970
---------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 99,851,285 $ 103,160,625
================ ================
See notes to consolidated financial statements.
CONVERGENCE COMMUNICATIONS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND 2001
- -------------------------------------------------------------------------------------------------------------
Three Months Three Months
Ended Ended
March 31 March 31
2002 2001
----------------- ------------------
NET REVENUES FROM SERVICES $ 10,445,263 $ 10,509,328
----------------- ------------------
COSTS AND EXPENSES:
Variable cost of services 6,570,566 6,950,200
Salaries, wages and benefits 3,767,908 6,091,755
Selling, general and administrative 1,517,105 2,856,309
Depreciation and amortization 4,030,393 3,906,505
Stock option compensation expense - 32,703
----------------- ------------------
Total costs and expenses 15,885,972 19,837,472
----------------- ------------------
OPERATING LOSS (5,440,709) (9,328,144)
OTHER INCOME (EXPENSE):
Interest income 112,770 139,707
Interest expense (1,082,744) (1,231,403)
Other (96,332) 70,972
Net gain on foreign exchange 94,980 44,165
----------------- ------------------
Total other expense (971,326) (976,559)
----------------- ------------------
LOSS BEFORE INCOME TAXES AND MINORITY INTEREST (6,412,035) (10,304,703)
PROVISION FOR INCOME TAXES (13,063) (31,427)
----------------- ------------------
LOSS BEFORE MINORITY INTEREST (6,425,098) (10,336,130)
MINORITY INTEREST IN LOSS OF SUBSIDIARIES - 1,101,049
----------------- ------------------
NET LOSS $ (6,425,098) $ (9,235,081)
================= ==================
Net loss per basic and diluted common share $ (0.11) $ (0.34)
================= ==================
Weighted-average number of common shares:
Basic and diluted 60,046,932 27,069,000
================= ==================
See notes to consolidated financial statements.
CONVERGENCE COMMUNICATIONS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND YEAR ENDED DECEMBER 31, 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Preferred Stock
------------------------------------------------------------
Series "B" Series "C" Series "D"
----------------- -------------------- -------------------
Total Shares Amount Shares Amount Shares Amount
----------- -------- ------- ---------- -------- --------- --------
BALANCE, DECEMBER 31, 2000 58,589,045 - - 13,620,472 13,620 - -
Comprehensive income (loss):
Net loss for year ended
December 31, 2001 (55,598,897)
Other comprehensive income (loss)
consisting of foreign currency
translation adjustment 1,141,991
----------- -------- ------- --------- -------- --------- --------
Total comprehensive income (loss) (54,456,906) - - - - - -
Issuance of Series D shares 22,869,461 2,643,636 $ 2,644
Acquisition of treasury stock (1,318,069)
Issuance of warrants on debt 12,929
Stock-based compensation expense 54,505
Non-cash remeasurement of preferred
stock warrants -
Exercise of employee stock options 2,257
Exercise of warrants to preferred stock 64,243 3,973,758 3,974 2,450,523 2,450
Modification of common stock warrants -
Modification of common stock warrants -
Exercise of common stock warrants 7,457
Issuance of common stock for equipment 2,880,556
Conversion of Series C stock into
common stock - (17,594,230) (17,594)
Conversion of Series D stock into
common stock - (5,094,159) (5,094)
Conversion of promissory note to
common stock 1,818,082
Issuance of common stock 18,178,410
----------- -------- ------- --------- -------- --------- --------
BALANCE, DECEMBER 31, 2001 $ 48,701,970 - $ - - $ - - $ -
Comprehensive income (loss):
Net loss for the three months
ended March 31, 2002 (6,425,098)
Other comprehensive income (loss)
consisting of foreign currency
translation adjustment 491,791
----------- -------- ------- --------- -------- --------- --------
Total comprehensive income (loss) (5,933,307) - - - - - -
Retirement of shares in connection with
litigation settlement -
----------- -------- ------- --------- -------- --------- --------
BALANCE, MARCH 31, 2002 $ 42,768,663 - $ - - $ - - $ -
=========== ======== ======= ========= ======== ========= ========
See notes to consolidated financial statements.
(Continued On the Next Page)
CONVERGENCE COMMUNICATIONS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND YEAR ENDED DECEMBER 31, 2001
(Continued From the Previous Page)
- ------------------------------------------------------------------------------------------------------------------------------------
Accumulated
Common Stock Additional Other Treasury Stock
--------------------- Paid-in Accumulated Comprehensive ---------------------
Shares Amount Capital Deficit Income (Loss) Shares Amount
----------- ---------- ----------- ----------- ------------- ------- ------------
BALANCE, DECEMBER 31, 2000 11,921,094 11,921 127,897,441 (69,089,076) (244,861)
Comprehensive income (loss):
Net loss for year ended
December 31, 2001 (55,598,897)
Other comprehensive income (loss)
consisting of foreign currency
translation adjustment 1,141,991
----------- ---------- ----------- ----------- ----------- -------- -----------
Total comprehensive income (loss) - - - (55,598,897) 1,141,991
Issuance of Series D shares 22,866,817
Acquisition of treasury stock (572,468) 572,468 $ (1,318,069)
Issuance of warrants on debt 12,929
Stock-based compensation expense 54,505
Non-cash remeasurement of preferred
stock warrants 5,396,396 (5,396,396)
Exercise of employee stock options 103,177 103 2,154
Exercise of warrants to preferred stock 57,819
Modification of common stock warrants 626,346 (626,346)
Modification of common stock warrants 4,363,722 (4,363,722)
Exercise of common stock warrants 745,650 746 6,711
Issuance of common stock for equipment 1,646,032 1,646 2,878,910
Conversion of Series C stock into
common stock 17,594,230 17,594
Conversion of Series D stock into
common stock 5,094,159 5,094
Conversion of promissory note to
common stock 2,138,920 2,139 1,815,943
Issuance of common stock 21,390,490 21,391 18,157,019
----------- ---------- ----------- ----------- ----------- -------- -----------
BALANCE, DECEMBER 31, 2001 60,061,284 $ 60,634 $184,136,712 $(135,074,437) $ 897,130 572,468 $ (1,318,069)
Comprehensive income (loss):
Net loss for the three months
ended March 31, 2002 (6,425,098)
Other comprehensive income (loss)
consisting of foreign currency
translation adjustment 491,791
----------- ---------- ----------- ----------- ----------- -------- -----------
Total comprehensive income (loss) - - - (6,425,098) 491,791
Retirement of shares in connection with
litigation settlement (41,666) (42) 42
----------- ---------- ----------- ----------- ----------- -------- -----------
BALANCE, MARCH 31, 2002 60,019,618 $ 60,592 $184,136,754 $(141,499,535) $1,388,921 572,468 $ (1,318,069)
=========== ========== =========== =========== =========== ======== ===========
See notes to consolidated financial statements
CONVERGENCE COMMUNICATIONS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND 2001
- ------------------------------------------------------------------------------------------------------------
Three Months Three Months
Ended Ended
March 31 March 31
2002 2001
----------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (6,425,098) $ (9,235,081)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 4,030,393 3,906,505
Provision for bad debts 117,191 332,915
Minority interest in loss of subsidiaries - (1,101,049)
Stock-based compensation expense - 51,000
Amortization of discount on notes payable 13,210 211,900
Issuance of options on Alcatel debt - 6,625
Change in assets and liabilities:
Accounts receivable (328,166) (1,799,459)
Inventory (326) 20,888
Prepaid expenses and other (912,210) 978,491
Equipment lease receivables (166,527) (78,245)
Other assets (142,023) (69,630)
Accounts payable and accrued liabilities 3,506,411 2,715,625
Accrued restructuring costs (12,000) -
Other long-term liabilities (145,313) 410,886
----------------- ----------------
Net cash used in operating activities (464,458) (3,648,629)
----------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (1,902,383) (10,633,287)
----------------- ----------------
Net cash used in investing activities (1,902,383) (10,633,287)
----------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of Series "D" Preferred Stock - 22,937,349
Proceeds from related party borrowings - 4,230,000
Payments on related party borrowings (15,961) (3,000,000)
Payments on notes payable (287,787) (5,964,000)
----------------- ----------------
Net cash provided by (used in) financing activities (303,748) 18,203,349
----------------- ----------------
EFFECT OF EXCHANGE RATES ON CASH 43,277 (16,689)
----------------- ----------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (2,627,312) 3,904,744
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 4,238,166 4,193,170
----------------- ----------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,610,854 $ 8,097,914
================= ================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the quarter for interest $ 221,028 $ 507,910
================= ================
Cash paid during the quarter for income taxes (including prepaid) $ 18,027 $ 35,466
================= ================
See notes to consolidated financial statements.
CONVERGENCE COMMUNICATIONS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
(Unaudited)
1. Basis of Presentation
Convergence Communications, Inc. and subsidiaries (the "Company"), is a
Latin American facilities-based telecommunications company which owns and
operates IP-based, broadband metropolitan area networks. The Company offers a
menu of broadband connectivity, IP-telephony, high-speed Internet access,
web-site hosting, virtual private networks, e-commerce and pay television
services to businesses and consumers in Latin America, primarily in Mexico.
From its inception, the Company has focused on providing
telecommunications services using high-speed transmission networks within and
across national borders. The Company intends to capitalize on the rapidly
growing demand for telecommunications services in countries emerging from
developing and state-controlled economies and where there is growing
liberalization of regulations governing the provision of telecommunications
services.
The Company's consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and
satisfaction of liabilities in the normal course of business. The consolidated
financial statements do not include any adjustments relating to the
recoverability and classifications of recorded amounts of assets or the amounts
and classifications of liabilities that might be necessary should the Company be
unable to continue as a going concern. The Company's continuation as a going
concern depends upon its ability to generate sufficient cash flows to meet its
obligations on a timely basis and to obtain additional financing or refinancing
as may be required.
At March 31, 2002, the Company's current liabilities exceeded current
assets by $22.5 million. Since its inception, the Company has sustained net
losses and negative cash flow, due primarily to amortization of intangible
assets relating to acquisitions, interest expense on debt relating to
acquisitions, start-up costs, legal and professional expenses, and charges for
depreciation and other costs relating to acquisition and the development of its
business. The Company expects to continue to experience negative cash flow
through 2002, and may continue to do so thereafter while it develops and expands
its business, even if individual markets of the Company become profitable. As
described in more detail below, in April and May 2002, the Company received a
total of $4 million from a drawdown on a $4 million related party revolving
credit facility.
As of March 31, 2002, the Company continues to be out of compliance
with the operating covenants of the Alcatel equipment financing facility and had
not received a waiver of such noncompliance from the lender. As a result, the
company is unable to draw upon its facility until it meets those covenants, and
Alcatel has the right to accelerate the maturity of the outstanding debt. The
outstanding balance under the Alcatel facility of $7,591,555 has been classified
as a current liability in the accompanying consolidated balance sheets.
The Company intends to meet its operational and capital expenditure
requirements during 2002 from a combination of:
o Additional draw downs on the related party revolving credit facility
described in Note 7 below
o Extending or modifying repayment terms on seller notes
o Reductions in capital expenditures
o Control of operating expense growth
o The sale of its equity securities and of selected operations and
assets
2. Recently Adopted Accounting Standards
On January 1, 2002, the Company adopted Statement of Financial
Accounting Standard ("SFAS") No. 142, Goodwill and Other Intangible Assets. SFAS
No. 142 changes the accounting for goodwill and intangible assets with
indefinite lives from an amortization method to an impairment-only approach.
Upon adoption of SFAS No. 142, the Company is required to reassess the useful
lives of all acquired intangible assets and perform an impairment test on
goodwill. In the first quarter of 2002, the Company completed an assessment of
useful lives and concluded that no adjustments to the amortization periods of
intangible assets were necessary.
SFAS No. 142 provides for a six-month transitional period for the
Company to perform an initial assessment of whether there is an indication that
goodwill is impaired. The Company expects to complete that analysis by June 30,
2002, as required. SFAS No. 142 also requires goodwill to be tested for
impairment annually and if certain events occur.
The initial adoption of SFAS No. 142 had no impact on the Company's
financial statements for the three months ended March 31, 2002. The carrying
amount of goodwill for the three months ended March 31, 2002 was $10.1 million.
If SFAS No. 142 had been adopted at the beginning of the quarter ended March 31,
2001, the pro-forma net loss without goodwill amortization would have been $9
million.
The amortization expense on intangible assets, other than goodwill will
total approximately $1 million for each of the next five years. At March 31,
2002, the Company had the following intangible assets, other than goodwill and
related accumulated amortization recorded:
Subscriber Franchise License
Rights Rights Rights
--------------- ------------ -----------
Gross intangible $ 25,007,000 $ 2,300,000 $ 857,000
Accumulated amortization (10,296,000) (241,000) (75,000)
--------------- ------------ -----------
Net intangible $ 14,711,000 $ 2,059,000 $ 782,000
=============== ============ ===========
3. Principles of Consolidation
The consolidated financial statements include the accounts of
Convergence Communications, Inc., all wholly owned and controlled subsidiaries
including its 49% voting interest in International Van, S. A. de C.V.
("Intervan"). All significant intercompany accounts and transactions have been
eliminated in consolidation.
4. Net Loss per Common Share and Common Share Equivalent
Net loss per common share and common share equivalent amounts are
computed by both the basic method, which uses the weighted average number of
common shares and the common stock equivalents on a voting basis for the Series
B (which was converted to common stock in August 2000) and Series C and D
preferred stock outstanding (which was converted to common stock in September
2001), and the diluted method, which includes the dilutive common shares from
stock options and warrants, as calculated using the treasury stock method. At
March 31, 2002 and 2001, all outstanding options and warrants were anti-dilutive
due to the losses of the Company.
5. Use of Estimates in Preparing Financial Statements
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America 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.
6. Operating Segment Information
The Company makes key financial decisions based on certain operating
results of our subsidiaries and revenue types. The Company's operating segment
information is as follows for the three months ended March 31, 2002 and 2001:
Central
2002 Mexico Venezuela America Corporate Totals
- ---------------------- ------------- ------------- -------------- -------------- -------------
Revenue:
- - Data $ 4,677,064 $ - $ 2,302,784 $ - $ 6,979,848
- - CATV - - 208,965 - 208,965
- - Other 1,569,160 - 1,687,290 - 3,256,450
Operating loss (2,376,099) (458,823) (1,010,297) (1,595,490) (5,440,709)
Central
2001 Mexico Venezuela America Corporate Totals
- ---------------------- ------------- ------------- -------------- -------------- -------------
Revenue:
- - Data $ 3,513,812 $ 330,668 $ 1,115,862 $ - $ 4,960,342
- - CATV - - 1,836,354 - 1,836,354
- - Other 1,351,247 18,617 2,342,768 - 3,712,632
Operating loss (3,272,123) (1,022,827) (2,533,688) (2,499,506) (9,328,144)
7. Subsequent Events
April 2002 Revolving Credit Facility - In April 2002, the Company
entered into a series of agreements relating to a commitment by Internexus
S.C.A. to provide the Company's wholly owned subsidiary, Latin American
Broadband, Inc., with up to $4,000,000 under a revolving credit agreement.
Internexus S.C.A. is an affiliate and successor in interest to Norberto Priu,
one of the Company's principal shareholders. The Company received an advance of
$2,000,000 under the credit agreement at the closing and the other $2,000,000 in
May 2002. The amounts advanced under the agreement accrue interest at 25% per
annum and are collateralized by a pledge of the Company's common shares owned by
four of its largest shareholders. If the Company defaults on its obligations
under the Internexus credit agreement, and Internexus enforces its rights under
the stock pledges, Internexus would obtain control of a majority of the
outstanding voting shares of the Company and would have the ability, among other
things, to elect the board of directors and effect fundamental corporate
transactions.
The maturity date for the facility is the earliest to occur of (i) July
9, 2002, (ii) a change of control (iii) a liquidation, winding up or dissolution
or the sale of all or substantially all of the Company's assets, or (iv) the
issuance of equity securities to a third party. Additionally, at the maturity
date, the Company shall pay to the lender an amount equal to the greater of (A)
the amounts then outstanding hereunder, together with interest thereon, or (B)
an amount equal to two hundred percent (200%) of the committed amount under
certain circumstances, including if the amounts advanced under the facility are
repaid as a result of a change of control, liquidation event or equity invested
from a third party that occurs after September 30, 2002 for a transaction
entered into on or before July 9, 2002. The Company also engaged an investment
banker in May 2002 for the purpose of identifying strategic and/or funding
alternatives for the Company.
In connection with the execution of the April 2002 facility, the
Company entered into two additional transactions. The first transaction involved
the replacement of two notes totaling $7,000,000 previously delivered by one of
the Company's Venezuelan subsidiaries in favor of Telematica EDC, C.A. The
replacement note, which was delivered by the Company, is also in the principal
amount of $7,000,000, accrues interest at 3% per annum, and is due, along with
accrued interest, in a balloon payment on March 15, 2015.
The second transaction involved the execution of a settlement agreement
with the FondElec Group, Inc., an affiliate of one of the Company's shareholders
("FondElec Group"). In connection with the settlement, the Company (i) cancelled
a $2,750,000 promissory note payable to the Company by an affiliate of the
FondElec Group; (ii) wrote off $420,000 in related FondElec Group assets; and
(iii) was released of a $1,864,118 recorded obligation payable to the FondElec
Group. Additionally, the Company agreed to pay the FondElec Group $200,000 on
the 60th day following repayment in full of amounts due under the Internexus
revolving credit agreement and each party executed mutual releases for any and
all claims.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion and analysis relates to our financial
condition and results of operations for the three-month periods ended March 31,
2002 and 2001. This information should be read in conjunction with our
consolidated financial statements and the notes related thereto appearing
elsewhere in this report.
A. OVERVIEW
We provide high quality, low-cost integrated communications services
using our own metropolitan area networks and local networks of incumbent local
exchange providers. We operate primarily in recently deregulated and high-growth
markets, principally in Mexico and Central America. We offer customers
broadband, high-speed data connections, high-speed and dial-up Internet access,
voice and video services in a number of our markets using an IP-based technology
platform and networks that employ fiber-optic fixed wireless technologies and
hybrid fiber coaxial cable.
From our inception in 1995 until 1998, our main activities consisted of
acquiring licenses and authorizations in our various market countries, acquiring
building access rights, hiring management and other key personnel, developing
operating systems and activities directly associated with the acquisition and
deployment of our various networks. During fiscal 1998, we acquired the ability
to provide, or introduced, significant bundled telecommunications services in
our markets.
Since our inception, we have sustained significant net losses and
negative cash flow. We expect the losses and negative cash flow to continue
until we develop a customer base that will generate sufficient revenues to fund
our operating expenses. We also anticipate that the execution of our business
plan will result in a rapid expansion of our operations, which may place a
significant strain on our management, financial situation and other resources.
Our ability to manage the problems associated with our expansion will depend,
among other things, on our capability to monitor operations, control costs,
maintain effective quality control, secure necessary interconnect and regulatory
approvals, expand internal management, technical information and accounting
systems and attract, assimilate and retain qualified management and professional
personnel. Our inability or failure to effectively manage these issues could
result in significant subscriber turnover, stagnant or decreasing subscriber
growth, our inability to meet our contractual obligations for continued funding
under our various vendor financing relationships such as with Alcatel,
managerial inefficiencies, missed corporate opportunities and continuing or
increased losses.
The difficulties in managing these various business issues will be
compounded by a number of the unique attributes of our business operations and
our strategy for becoming a premier facilities-based telecommunications provider
in our various markets. For example, we use, as part of our operating network,
wireless technology. This technology has been used by other telecommunications
providers for a significant period of time, but our point-to-multipoint
technology has only been commercially used on a limited basis. We selected this
technology because we believe it complements the wireline technologies we
otherwise employ in our networks, but if that technology does not perform as
expected or provide the advantages that we expect, our business, financial
condition and the results of our operations may be materially and adversely
affected. Further, we employ an IP-based technology platform that uses packet
switching to transmit voice, video and data elements over the same network. We
believe that IP-based packet-switched networks have less overhead and greater
capacity than traditionally used technology platforms but, in the past, there
have been issues regarding the quality of service provided by those platforms.
We believe that the quality of services provided by other transport systems has
been incorporated into the newer generations of IP switches and bandwidth
managers, but if our technology platform does not perform as expected or provide
the advantages we expect, our business, financial condition and the results of
our operations could also be materially and adversely affected. Also, as part of
our operations in some of our markets, we rely on network capacity that we lease
from third parties, some of which may be our competitors in the market. Those
parties may not have the same incentive as other, non-competitive, network
owners to maintain those existing relationships with us on terms which promote
our competitive advantage.
B. MATERIAL CHANGES IN RESULTS OF OPERATIONS
Three months ended March 31, 2002 compared to the three months ended March 31,
2001:
Revenues. Our revenues for the three months ended March 31, 2002
totaled $10.4 million, or about the same compared with the same period in 2001.
The following table shows our revenues (in thousands) by region for the first
three months of 2002 and 2001:
TOTAL REVENUES
(in thousands) 2002 2001
---------- ----------
Mexico (Intervan) $ 6,246 $ 4,865
Central America 4,199 5,295
Venezuela - 349
---------- ----------
Consolidated total $ 10,445 $ 10,509
========== ==========
Our 2002 first quarter revenue compared to 2001 first quarter revenue
was impacted significantly by the reduction of $2.0 million in quarterly revenue
from the June 2001 sale of a portion of our El Salvadoran operations. The $2.0
million decrease was offset by significant growth of our operations in Mexico
(Intervan) and our remaining Central America operations. Intervan directly
contributed $1.4 million to offset the El Salvador revenue decrease, consisting
of an increase of $1.2 million in high-speed data revenue with the remainder
consisting of other revenue.
Variable Cost of Services. Variable cost of services consists primarily
of high-speed data bandwidth, telephony and cable programming charges. The cost
of these services totaled $6.6 million for the three months ended March 31,
2002, a decrease of $0.4 million over the same period in 2001. The June 2001
sale of our El Salvadoran operations contributed $0.8 million of this decrease.
This activity demonstrates the increase in our operational profitability as
revenues continue to increase at a higher rate than our variable cost of
services.
Salaries, Wages and Benefits. Our salaries, wages and benefits totaled
$3.8 million for the three months ended March 31, 2002, a decrease of $2.3
million over the same period in 2001. We maintained a total of 395 employees at
March 31, 2002, which compares with 795 employees at March 31, 2001. This
significant decrease in salaries, wages and benefits, along with employee
headcount, is primarily a result of the 255 employees we terminated in
connection with our business restructuring discussed below in Liquidity and
Capital Resources and the 123 employees associated with the El Salvador
operations sold in June 2001.
Selling, General and Administrative Expenses. We incurred SG&A expenses
of $1.5 million during the three months ended March 31, 2002, a decrease of $1.3
million compared to the same period in 2001. The decrease in SG&A expenses
reflects the impact of management's cost reduction program and business
restructuring.
Depreciation and Amortization. Our depreciation and amortization
expense totaled $4.0 million during the three months ended March 31, 2002 versus
$3.9 million during the same period in 2001. The minimal increase reflects the
sale of fixed assets in El Salvador and asset impairment reserves recorded on
Venezuela intangibles and fixed assets as of June 30, 2001.
Interest Income and Interest Expense. Our interest income decreased
$26,937 for a total of $112,770 during the three months ended March 31, 2002 due
to a lower average cash investment balance during the period. Interest expense
over the same period decreased $148,659 due primarily to lower average interest
rate recorded on our indebtedness during the three months ended March 31, 2002,
which was approximately 8%, compared to approximately 10.75% as of March 31,
2001.
Net Loss. We incurred a net loss attributable to common shareholders of
$6.4 million in the three months ended March 31, 2002, a decrease of $2.8
million compared to the same period in 2001. The principal reasons for the
decrease were:
o $2.3 million decrease in salary and benefits expense attributable
primarily to the employee headcount reduction.
o $1.3 million decrease in selling, general and administrative expense
due to cost reductions and restructuring charges.
o $0.4 million decrease in variable cost of services related to the El
Salvador operations sale and increase in operational profitability.
o The above decreases were offset by a $0.1 million increase in
depreciation and amortization and a $1.1 million increase relating to
the 2001 minority interest in loss of subsidiary generated from our
former interests in El Salvador, which were sold in June 2001.
Liquidity and Capital Resources
Since inception, we have funded our cash requirements at the parent
company level through debt and equity transactions. The proceeds from these
transactions were primarily used to fund our investments in, and acquisitions
of, start-up network operations, to provide working capital, and for general
corporate purposes, including the expenses we incurred in seeking and evaluating
new business opportunities. Our foreign subsidiary interests have been financed
by a combination of equity investments and shareholder loans.
We will continue to make significant capital expenditures in the next
several years in connection with building our networks, the further development
of our operations in Mexico and Central America, and new customer accounts (for
which we install our equipment on customer premises). We intend to meet our
capital requirements during 2002 from a combination of the following:
o Additional draw downs on the related party revolving credit facility
described in Note 7 above
o Extending or modifying repayment terms on seller notes
o Reductions in capital expenditures
o Control of operating expense growth
o The sale of its equity securities and of selected operations and
assets
We anticipate that we will require a minimum of $3.6 million during the
remainder of 2002 for capital expenditures related to the expansion of our
existing telecommunications business, and that we will require significant
amounts thereafter.
The telecommunications market dropped dramatically beginning in 2000,
which has significantly affected the market value of companies in that industry.
The values of telecommunications companies have also been adversely affected by
the credit experience of the established telecommunications vendors, which have
recently had increasing problems in collecting payments for their equipment. As
a result of these factors, investors and lenders are carefully evaluating
prospective investment opportunities in, and the investment values of,
telecommunications companies that are seeking investments. If we are unable to
obtain additional equity capital as a result of the factors noted above in this
paragraph, or otherwise, our ability to comply with the terms of the Alcatel
financing facility and make draw downs on the facility (and receive
reimbursement of certain amounts we have paid or will pay thereunder) also could
be adversely affected.
In connection with a restructuring plan to exit certain non-strategic
market regions and to streamline the Company's cost structure in both foreign
and corporate operations, the Company recorded a pre-tax charge of $21,869,264
for the year ended December 31, 2001, which included restructuring costs of
$5,810,583 and asset write-downs of $16,058,681.
For the year ended December 31, 2001, restructuring costs related to
involuntary employee separations of $3,660,653 for approximately 255 employees
and facility reduction costs of $2,149,930. The employee separation costs
impacted the Company's management employees in corporate operations and
Venezuela, and also impacted all geographic locations of the Company. As of
March 31, 2002, all of the 255 employee separations were completed.
The following table displays the status of the restructuring reserve at
March 31, 2002:
12-31-01 Cash Charges 3-31-02
Type of Cost Reserve Reserve
----------------------- ------------- ------------- -------------
Restructuring costs:
Employee separations $ 963,412 $ 232,462 $ 730,950
Facility reductions 1,828,941 665,055 1,163,886
------------- ------------- -------------
Total $ 2,792,353 $ 897,517 $ 1,894,836
============= ============= =============
During the three months ended March 31, 2002, our operating activities
used $0.5 million, compared with $3.6 million during the same period in 2001.
Our investing activities used $1.9 million in the three months ended March 31,
2002, compared with using $10.6 million during the same period in 2001.
Financing activities, principally the issuance of Series D Preferred Stock in
February 2001, provided $18.2 million in net cash flow during the three months
ended March 31, 2001.
As of March 31, 2002, we had current assets of $13.4 million, compared
to $14.9 million as of December 31, 2001, for a decrease of $1.5 million. The
decrease in current assets was primarily due to a $2.6 million decrease in cash
offset by a $1.0 increase in prepaid expenses and other current assets.
The cash flow generated by our foreign operations will not be
sufficient to cover our planned operational growth in the next fiscal year. Our
ability to execute our business plan will be dependent on our efforts to obtain
additional sources of funds to finance our business plan (see Item 5 below).
We have the ability to moderate our capital spending and losses by
varying the number and extent of our market build out activities and the
services we offer in our various markets. If we elect to slow the speed, or
narrow the focus, of our business plan, we will be able to reduce our capital
requirements and losses. The actual costs of building out and launching our
markets would depend on a number of factors, however, including our ability to
negotiate favorable prices for purchases of network equipment, the number of
customers and the services for which they subscribe, the nature and success of
the services that we may offer, regulatory changes and changes in technology. In
addition, actual costs and revenues could vary from the amounts we expect or
budget, possibly materially, and such variations are likely to affect how much
additional financing we will need for our operations. Accordingly, there can be
no assurance that our actual financial needs will not exceed the anticipated
amounts available to us, including from new, third parties, described above.
To the extent we acquire the amounts necessary to fund our business
plan through the issuance of equity securities, our shareholders may experience
dilution in the value per share of their equity securities. The acquisition of
funding through the issuance of debt could result in a substantial portion of
our cash flow from operations being dedicated to the payment of principal and
interest on that indebtedness, and could render us more vulnerable to
competitive pressures and economic downturns. Our subsidiaries or affiliates
could also obtain financing from third parties, but there can be no assurance
our subsidiaries or affiliates will be able to obtain the financing required to
make planned capital expenditures, provide working capital or meet other cash
needs on terms that are economically acceptable to us.
D. SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
Certain statements contained in "Management's Discussion and Analysis"
constitute forward-looking statements concerning our operations, economic
performance and financial condition. Because those statements involve risks and
uncertainties, actual results may differ materially from those expressed or
implied by those forward-looking statements.
In addition, any statements that express or involve discussions as to
expectations, beliefs, plans, objectives, assumptions or future events or
performance are not historical facts and may be forward-looking and,
accordingly, those statements involve estimates, assumptions and uncertainties
which could cause actual results to differ materially from those expressed in
the forward-looking statements. Accordingly, those types of statements are
qualified in their entirety by reference to, and are accompanied by, the factors
discussed throughout this report. Among the key factors that have a direct
bearing on our results of operations are the potential risk of delay in
implementing our business plan; the political, economic and legal aspects of the
markets in which we operate; competition; and our need for additional
substantial financing. We have no control over some of these factors.
The factors described in this report could cause our actual operating
results to differ materially from those expressed in any forward-looking
statements made by or on behalf of us. Persons reviewing this report, therefore,
should not place undue reliance on those forward-looking statements. Further, to
the extent this report contains forward-looking statements, they speak only as
of the date of this report, and we undertake no obligation to update any
forward-looking statement or statements to reflect the occurrence of
unanticipated events. New factors may emerge from time to time, and it is not
possible for management to predict all of such factors. Further, management
cannot assess the impact of each such factor on our business or the extent to
which any factor, or combination of factors, may cause actual results to differ
materially from those contained in any forward-looking statements.
E. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our operations are exposed to market risks principally from fluctuations in
foreign currency exchange rates. Our market risks arise from our operations, not
from any trading activities in derivatives. We seek to minimize these risks
through our regular operating and financing activities.
Exposure to Foreign Currency Exchange Rates. Our primary foreign currency
exchange risk relates to our operations in Latin America, where we conduct
business with more than one currency. We do not expect that the impact of
fluctuations in the foreign currency exchange rate on our foreign currency
denominated revenues and expenses to materially affect our results of operations
due primarily to the natural hedges, which are expected to exist within our
operations. Management continues to monitor foreign currency risk to determine
if any actions would be warranted to reduce such risk. Management considers its
operations in foreign subsidiaries and affiliates to be long-term in nature.
Accordingly, we do not hedge foreign currency exchange rate risk related to
translation risk.
Exposure to Interest Rates. All of our debt, with the exception of the Alcatel
debt is based on fixed interest rates. Our Alcatel debt requires quarterly
interest payments at LIBOR plus 4.5% with quarterly principal payments beginning
in September 2002 with the final payment maturing in January 2007.
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See the section entitled "Legal Proceedings" in our report on Form 10-K
for the year ended December 31, 2001.
ITEM 2. CHANGES IN SECURITIES
In October 2001, the Company was granted all of the Company's motions
and disposed of the last substantive issue in a case brought in federal court in
California in March 2000. The Company subsequently made a motion to recover its
costs and expenses in the matter, and, in February 2002, the parties negotiated
a settlement, which included the return of the common stock the Company issued
to the plaintiff in 1997 totaling 41,666 shares. These shares were subsequently
cancelled. See the section entitled "Legal Proceedings" in our report on Form
10-K for the year ended December 31, 2001 for a more detailed description of the
settlement.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
See the section entitled "Item 5 - Other Information" in our report on
Form 10-QSB for the quarter ended March 31, 2001 and the section entitled
"Management's Discussion and Analysis - Liquidity and Capital Resources" in our
report on Form 10-K for the year ended December 31, 2001.
ITEM 4. MATTERS SUBMITTED TO A VOTE OF THE COMPANY'S SHAREHOLDERS
None.
ITEM 5. OTHER INFORMATION
April 2002 Transactions. In April 2002, we entered into a series of
agreements relating to a commitment by Internexus S.C.A ("Internexus") to
provide our wholly owned subsidiary, Latin American Broadband, Inc., with up to
$4 million under a revolving credit agreement. Internexus is an affiliate of,
and successor to, in interest to Norberto Priu, one of our principal
shareholders. See "Our Principal Stockholders," below. We received an advance of
$2 million under the credit agreement at the closing and the other $2,000,000 in
May 2002. The amounts advanced under the agreement accrue interest at 25% per
annum and are collateralized by a pledge of our common shares owned by four of
our largest shareholders. If we default on our obligations under the Internexus
credit agreement, and Internexus enforces its rights under the stock pledges,
Internexus would obtain control of a majority of our outstanding voting power
and would have the ability, among other things, to elect our board of directors
and effect fundamental corporate transactions.
The maturity date for the facility is the earliest to occur of (i) July
9, 2002, (ii) a change of control (iii) a liquidation, winding up or dissolution
or the sale of all or substantially all of our assets, or (iv) the issuance of
equity securities to a third party. Additionally, at the maturity date, we
agreed to pay the lender an amount equal to the greater of (A) the amounts then
outstanding hereunder, together with interest thereon, or (B) an amount equal to
two hundred percent (200%) of the committed amount under certain circumstances,
including if the amounts advanced under the facility are repaid as a result of a
change of control, liquidation event or equity investment from a third party
that occurs after September 30, 2002 for a transaction entered into on or before
July 9, 2002. We also engaged an investment banker in May 2002 for the purpose
of identifying strategic and/or funding alternatives for us.
In connection with the execution of the April 2002 facility, we entered
into two additional transactions. The first transaction involved the replacement
of two notes totaling $7 million previously delivered by one of our Venezuelan
subsidiaries in favor of Telematica EDC, C.A. The replacement note, which was
delivered by our parent entity Convergence Communications, Inc., is also in the
principal amount of $7 million, accrues interest at 3% per annum, and is due,
along with accrued interest, in a balloon payment on March 15, 2015 (see
"Telematica Transactions" below).
The second transaction involved the execution of a settlement agreement
between us and the FondElec Group, Inc., an affiliate of one of our shareholders
("FondElec Group"), where each party dismissed its claims with prejudice against
the other party. In connection with the settlement, we (i) cancelled a
$2,750,000 promissory note payable to us by an affiliate of the FondElec Group;
(ii) wrote off 420,000 in related FondElec Group assets; and (iii) were released
of a $1,864,118 recorded obligation payable to the FondElec Group. Additionally,
we agreed to pay the FondElec Group $200,000 on the 60th day following repayment
in full of amounts due under the Internexus revolving credit agreement and each
party executed mutual releases for any and all claims. As a result of the above
settlement, we recorded a $1,505,882 arbitration settlement expense during the
year ended December 31, 2001.
ITEM 6. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
A. EXHIBITS.
None.
B. REPORTS ON FORM 8-K
None.
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 thereunto duly authorized.
CONVERGENCE COMMUNICATIONS, INC.
Date: May 15, 2001 BY /s/ GARY BARLOW
------------------------------------
Gary Barlow
Chief Accounting Officer