Company Quick10K Filing
Quick10K
Convergeone Holdings
10-Q 2018-09-30 Quarter: 2018-09-30
10-Q 2018-06-30 Quarter: 2018-06-30
10-Q 2018-03-31 Quarter: 2018-03-31
10-K 2017-12-31 Annual: 2017-12-31
10-Q 2017-09-30 Quarter: 2017-09-30
10-Q 2017-06-30 Quarter: 2017-06-30
10-Q 2017-03-31 Quarter: 2017-03-31
8-K 2019-01-04 Enter Agreement, Leave Agreement, Exhibits
8-K 2019-01-04 M&A, Shareholder Rights, Control, Officers, Amend Bylaw, Other Events, Exhibits
8-K 2018-12-07 Other Events, Exhibits
8-K 2018-11-06 Enter Agreement, Exhibits
8-K 2018-10-30 Earnings, Exhibits
8-K 2018-08-09 Earnings, Exhibits
8-K 2018-06-19 Exhibits
8-K 2018-05-22 Other Events
8-K 2018-05-08 Officers
8-K 2018-04-25 Sale of Shares, Exhibits
8-K 2018-04-10 Enter Agreement, Leave Agreement, Off-BS Arrangement, Exhibits
8-K 2018-03-22 Exhibits
8-K 2018-03-20 Earnings, Exhibits
8-K 2018-02-22 Enter Agreement, M&A, Earnings, Sale of Shares, Shareholder Rights, Accountant, Control, Officers, Amend Bylaw, Shell Status, Other Events, Exhibits
8-K 2018-02-15 Other Events, Exhibits
8-K 2018-02-02 Exhibits
8-K 2018-02-01 Regulation FD, Exhibits
8-K 2018-01-29 Other Events, Exhibits
PSA Public Storage 38,900
AFG American Financial Group 9,140
FIZZ National Beverage 2,570
ARCO Arcos Dorados Holdings 1,390
RCM R1 RCM 1,310
ICLK Iclick Interactive Asia Group 232
JP Jupai Holdings 125
MYO Myomo 21
UBI Universal Biosensors 0
JRSS JRSIS Health Care 0
CVON 2018-09-30
Part I. - Financial Information
Item 1. - Financial Statements
Item 2. - Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. - Quantitative and Qualitative Disclosures About Market Risk
Item 4. - Controls and Procedures
Part II. - Other Information
Item 1. - Legal Proceedings
Item 1A. - Risk Factors
Item 2. - Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. - Defaults Upon Senior Securities
Item 4. - Mine Safety Disclosures
Item 5. - Other Information
Item 6. - Exhibits
EX-31.1 d632094dex311.htm
EX-31.2 d632094dex312.htm
EX-32.1 d632094dex321.htm
EX-32.2 d632094dex322.htm

Convergeone Holdings Earnings 2018-09-30

CVON 10Q Quarterly Report

Balance SheetIncome StatementCash Flow

10-Q 1 d632094d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended: September 30, 2018

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 001-38053

 

 

ConvergeOne Holdings, Inc.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Delaware   81-4619427

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

3344 Highway 149, Eagan, MN 55121

(Address of principal executive offices) (Zip Code)

(888) 321-6227

(Registrant’s telephone number, including area code)

Forum Merger Corporation, c/o Forum Investors I, LLC, 135 East 57th Street, 8th Floor, New York, NY 10022

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer      Smaller reporting company  
     Emerging growth company  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

Shares of the registrant’s common stock, $0.0001 par value, outstanding at October 29, 2018: 76,398,309 shares.

 

 

 


Table of Contents

CONVERGEONE HOLDINGS, INC. AND ITS SUBSIDIARIES

INDEX

 

PART I. – FINANCIAL INFORMATION

     3  

Item 1. – Financial Statements

     3  

Item 2. – Management’s Discussion and Analysis of Financial Condition and Results of Operations

     36  

Item 3. – Quantitative and Qualitative Disclosures About Market Risk

     55  

Item 4. – Controls and Procedures

     55  

PART II. – OTHER INFORMATION

     56  

Item 1. – Legal Proceedings

     56  

Item 1A. – Risk Factors

     56  

Item 2. – Unregistered Sales of Equity Securities and Use of Proceeds

     72  

Item 3. – Defaults Upon Senior Securities

     72  

Item 4. – Mine Safety Disclosures

     72  

Item 5. – Other Information

     72  

Item 6. – Exhibits

     73  

SIGNATURES

     74  

 

2


Table of Contents

PART I. – FINANCIAL INFORMATION

Item 1. – Financial Statements

CONVERGEONE HOLDINGS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

     As of
September 30,
2018
    As of
December 31,
2017
 
     (unaudited)        
Assets     

Current Assets

    

Cash

   $ 11,228     $ 13,475  

Trade accounts receivable, less allowances

     390,114       289,236  

Inventories

     34,719       14,717  

Prepaid expenses and other current assets

     15,326       9,294  

Deferred customer support contract costs

     41,534       35,151  

Income tax receivable

     23,595       10,576  
  

 

 

   

 

 

 

Total current assets

     516,516       372,449  
  

 

 

   

 

 

 

Other Assets

    

Goodwill

     342,758       331,456  

Finite-life intangibles, net

     163,951       173,642  

Property and equipment, net

     36,304       36,659  

Deferred customer support contract costs and other, noncurrent

     6,787       3,915  

Non-current income tax receivable

     580       2,620  
  

 

 

   

 

 

 

Total other assets

     550,380       548,292  
  

 

 

   

 

 

 

Total assets

   $ 1,066,896     $ 920,741  
  

 

 

   

 

 

 
Liabilities and Stockholders’ Equity (Deficit)     

Current Liabilities

    

Current maturities of long-term debt

   $ 6,700     $ 5,652  

Accounts payable

     215,544       157,778  

Customer deposits

     21,631       22,498  

Accrued compensation

     38,210       34,522  

Accrued other

     34,174       27,362  

Earnout consideration payable

     99,000       —    

Deferred revenue

     87,569       68,127  
  

 

 

   

 

 

 

Total current liabilities

     502,828       315,939  
  

 

 

   

 

 

 

Long-Term Liabilities

    

Long-term debt, net of debt issuance costs and current maturities

     701,815       566,424  

Deferred income taxes

     3,792       18,056  

Long-term income tax payable

     —         1,563  

Deferred revenue and other long-term liabilities

     15,126       13,118  
  

 

 

   

 

 

 

Total long-term liabilities

     720,733       599,161  
  

 

 

   

 

 

 

Commitments and Contingencies

    

Stockholders’ Equity (Deficit)

    

Preferred stock, $0.0001 par value; 10,000,000 shares authorized; no shares issued and outstanding

     —         —    

Common stock, $0.0001 par value; 1,000,000,000 shares authorized; 76,398,309 shares issued and 75,331,363 outstanding as of September 30, 2018; 39,860,610 shares issued and outstanding as of December 31, 2017*

     8       4  

Class B convertible common stock, $0.0001 par value; 16,000,000 nonvoting shares authorized; 6,585,546 nonvoting shares issued and outstanding as of December 31, 2017*

     —         1  

Subscription receivable from related party

     —         (1,805

Additional paid-in capital

     78,864       13,464  

Treasury stock, 1,066,946 shares held as of September 30, 2018

     (10,044     —    

Accumulated deficit

     (225,493     (6,023
  

 

 

   

 

 

 

Total stockholders’ equity (deficit)

     (156,665     5,641  
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity (deficit)

   $ 1,066,896     $ 920,741  
  

 

 

   

 

 

 

 

*

Retroactively restated for the effect of the reverse recapitalization

See accompanying notes to condensed consolidated financial statements.

 

3


Table of Contents

CONVERGEONE HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

 

     Three months ended
September 30,
    Nine months ended
September 30,
 
     2018     2017     2018     2017  

Revenue

        

Technology offerings

   $ 193,507     $ 121,033     $ 532,123     $ 315,201  

Services

     211,247       124,379       569,983       304,499  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     404,754       245,412       1,102,106       619,700  
  

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenue

        

Technology offerings

     144,250       95,444       402,385       245,732  

Services

     142,157       79,045       378,661       191,965  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue

     286,407       174,489       781,046       437,697  
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

        

Technology offerings

     49,257       25,589       129,738       69,469  

Services

     69,090       45,334       191,322       112,534  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total gross profit

     118,347       70,923       321,060       182,003  
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

        

Sales and marketing

     57,172       35,657       156,297       93,904  

General and administrative

     25,108       15,385       79,992       36,989  

Transaction costs

     4,116       3,920       16,167       5,955  

Depreciation and amortization

     12,064       9,127       35,421       23,112  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     98,460       64,089       287,877       159,960  
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     19,887       6,834       33,183       22,043  
  

 

 

   

 

 

   

 

 

   

 

 

 

Other (income) expense

        

Interest income

     (53     (44     (118     (51

Interest expense

     12,362       9,772       50,097       41,553  

Preliminary bargain purchase gain

     (1,212     —         (12,185     —    

Other expense, net

     (168     44       (142     49  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense, net

     10,929       9,772       37,652       41,551  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     8,958       (2,938     (4,469     (19,508

Income tax benefit

     (5,540     (4,241     (20,312     (6,323
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

     14,498       1,303       15,843       (13,185
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnout consideration

     (63,041     —         (187,047     —    
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) available to common shareholders

   $ (48,543   $ 1,303     $ (171,204   $ (13,185
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per common share:

        

Basic and diluted

   $ (0.64   $ 0.03     $ (2.53   $ (0.33
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average number of shares outstanding:

        

Basic and diluted

     75,507,802       39,860,619       67,538,373       39,867,488  
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash dividends declared per common share

   $ 0.02     $ —       $ 0.04     $ —    
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

4


Table of Contents

CONVERGEONE HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

(in thousands, except share data)

(Unaudited)

 

    Preferred
Stock
    Common Stock     Class B
Common Stock
    Subscription    

Additional

Paid-In

    Treasury     Accumulated        
    Shares     Amount     Shares     Amount     Shares     Amount     Receivable     Capital     Stock     Deficit     Total  

Balance at December 31, 2017, as previously reported

    —       $  —         89,766,294     $ 9       14,830,683     $ 1     $ (1,805   $ 13,459     $ —       $ (6,023)     $ 5,641  

Retroactive conversion of shares

    —         —         (49,905,684     (5     (8,245,137     —         —         5       —         —         —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2017, before effect of reverse recapitalization (Note 2)

    —         —         39,860,610       4       6,585,546       1       (1,805     13,464       —         (6,023     5,641  

Effect of reverse recapitalization

    —         —         31,339,391       3       (6,585,546     (1     —         (18,306     —         (48,266     (66,570

Repayment of stock subscription
receivable

    —         —         —         —         —         —         1,805       —         —         —         1,805  

Stock-based compensation
expense

    —         —         —         —         —         —         —         5,322       —         —         5,322  

Earnout consideration

    —         —         5,162,500       1       —         —         —         90,255       —         (187,047     (96,791

Payment of taxes for employee stock awards

    —         —         (21,485     —         —         —         —         (194     —         —         (194

Repurchase of warrants

    —         —         —         —         —         —         —         (9,098     —         —         (9,098

Share repurchase

    —         —         —         —         —         —         —         —         (10,044     —         (10,044

Employee stock purchase plan

    —         —         57,293       —         —         —         —         476       —         —         476  

Dividends paid

    —         —         —         —         —         —         —         (3,055     —         —         (3,055

Net income

    —         —         —         —         —         —         —         —         —         15,843       15,843  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2018

    —       $ —         76,398,309     $ 8     $ —       $  —       $ —       $ 78,864     $ (10,044   $ (225,493   $ (156,665
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

5


Table of Contents

CONVERGEONE HOLDINGS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

     Nine months ended
September 30,
 
     2018     2017  

Cash Flows from Operating Activities

    

Net income (loss)

   $ 15,843     $ (13,185

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

    

Preliminary bargain purchase gain

     (12,185     —    

Depreciation of property and equipment in operating expenses

     8,004       5,221  

Depreciation of property and equipment in cost of revenue

     4,183       1,112  

Amortization of finite-life intangibles

     27,417       17,891  

Change in fair value of acquisition-related contingent consideration

     (956     —    

Deferred income taxes

     (10,180     (3,991

Amortization of debt issuance costs

     1,213       2,205  

Loss on extinguishment of debt

     14,732       13,638  

Stock-based compensation expense

     7,530       521  

Other

     (145     49  

Changes in assets and liabilities, net of business acquisitions

    

Trade accounts receivable

     (29,083     (5,684

Inventories

     (13,738     4,475  

Prepaid expenses, deferred customer support contract costs and other

     3,877       8,739  

Income tax receivable

     (10,961     2  

Accounts payable and accrued expenses

     25,859       (22,028

Customer deposits

     (1,222     (2,522

Income tax payable

     (1,562     (6,618

Deferred revenue and other long-term liabilities

     (11,421     (6,479
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     17,205       (6,654
  

 

 

   

 

 

 

Cash Flows from Investing Activities

    

Purchases of property and equipment

     (10,635     (7,251

Acquisition of business, net of cash acquired

     (42,965     (97,543
  

 

 

   

 

 

 

Net cash used in investing activities

     (53,600     (104,794
  

 

 

   

 

 

 

Cash Flows from Financing Activities

    

Proceeds from revolving credit agreement

     184,000       84,000  

Repayment of revolving credit agreement

     (154,000     (58,000

Proceeds from term notes, less discount

     670,000       510,138  

Payment on long-term debt

     (564,000     (415,213

Payment of deferred financing costs

     (9,806     (6,513

Payment of extinguishment charges

     (5,684     (3,353

Dividends paid

     (3,055     —    

Repurchase of common stock

     (10,044     (385

Proceeds from issuance of common stock

     476       —    

Proceeds from subscription receivable

     1,805       —    

Proceeds from Forum cash

     147,335       —    

Payment of reverse recapitalization costs

     (30,934     —    

Payment to former C1 Securityholders

     (182,847     —    

Repurchase of warrants

     (9,098     —    

Deferred offering costs

     —         (1,175
  

 

 

   

 

 

 

Net cash provided by financing activities

     34,148       109,499  
  

 

 

   

 

 

 

Net decrease in cash

     (2,247     (1,949

Cash-beginning of the period

     13,475       9,632  
  

 

 

   

 

 

 

Cash-end of the period

   $ 11,228     $ 7,683  
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information

    

Interest paid

   $ 35,745     $ 27,712  

Income taxes paid

     140       4,272  

Supplemental disclosures of noncash investing and financing activities

    

Settlement of Earnout consideration payable

   $ 58,886     $ —    

Earnout consideration payable

     128,161       —    

Deferred offering costs in accounts payable and accrued expenses

     —         1,219  

Liabilities assumed from Forum

     317       —    

Property and equipment purchases financed with accounts payable

     542       163  

Contingent condsideration for business acquisition

     —         4,000  

See accompanying notes to condensed consolidated financial statements.

 

6


Table of Contents

1. Nature of Business and Summary of Significant Accounting Policies

Organization

ConvergeOne Holdings, Inc. and its subsidiaries (collectively, “ConvergeOne”, or the “Company”) is a leading IT services provider of collaboration and technology solutions for large and medium enterprises. The Company serves clients through its comprehensive engagement model which includes the full lifecycle of services from consultation through implementation, optimization, and ongoing support services. The Company provides innovative and sophisticated services, including professional and managed, cloud and maintenance services, and complex multi-vendor technology offerings to its clients. The Company’s core technology markets are (1) collaboration and (2) enterprise networking, data center, cloud, and security.

On November 30, 2017, C1 Investment Corp. (“C1”) and Clearlake Capital Management III, L.P. (“Clearlake” or “Seller Representative”) signed an Agreement and Plan of Merger (“Merger Agreement”) with Forum Merger Corporation (“Forum”), whereby the parties agreed a subsidiary of Forum and C1 shall consummate a merger, pursuant to which the subsidiary shall be merged with and into C1, following which the separate corporate existence of the subsidiary shall cease and C1 shall continue as the surviving corporation (the “Business Combination” or “Merger”). All outstanding C1 stock options and all outstanding shares of C1’s Class A common and Class B common stock held by C1 option holders and C1 stockholders (collectively, the “C1 Securities” and “C1 Securityholders”, respectively) were to be canceled and exchanged for a combination of cash and new shares of common stock as computed in accordance with the Merger Agreement.

On February 22, 2018, the transactions contemplated by the Merger (“Transactions”) were consummated and the name of the surviving corporation was changed to ConvergeOne Holdings, Inc. See Note 2—Business Combination/Merger for further discussion.

References to “the Company,” “we,” “us,” “our,” and similar words refer to ConvergeOne Holdings, Inc. and all of the consolidated subsidiaries, unless specifically noted otherwise.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The condensed consolidated balance sheet as of December 31, 2017 included herein was derived from the C1 audited financial statements as of that date, but does not include all disclosures including notes required by U.S. GAAP. Operating results for the three and nine months ended September 30, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018 or any other period. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company’s Registration Statement on Form S-1/A filed on April 24, 2018. There have been no changes to the Company’s significant accounting policies described in the consolidated financial statements for the year ended December 31, 2017 that have had a material impact on the condensed consolidated financial statements and related notes for the three and nine months ended September 30, 2018. Accounting policies that are new as a result of the Merger have been included below.

The Business Combination was accounted for as a reverse recapitalization in accordance with U.S. GAAP. Under this method of accounting, Forum was treated as the “acquired” company for financial reporting purposes. This determination was primarily based on C1 shareholders having a majority of the voting power of the combined company, C1 comprising the ongoing operations of the combined entity, C1 comprising a majority of the governing body of the combined company, and C1’s senior management comprising the senior management of the combined company. Accordingly, for accounting purposes, the Business Combination was treated as the equivalent of C1 issuing stock for the net assets of Forum, accompanied by a recapitalization (referred to as “the Merger”). The net assets of Forum were stated at historical cost, with no goodwill or other intangible assets recorded. Operations prior to the Merger are those of C1.

 

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Earnout Consideration

As discussed in Note 2—Business Combination/Merger, upon the completion of the Merger, the C1 Securityholders received a combination of cash and shares of ConvergeOne common stock in exchange for all of their C1 Securities. Subject to terms and conditions set forth in the Merger Agreement, the former C1 Securityholders have the contingent right to receive additional consideration for their former C1 Securities, in the form of cash and shares of ConvergeOne common stock (the “Earnout Consideration”, as defined in the Merger Agreement), based on specified Earnout Targets for 2018, 2019 and 2020 (“Earnout Years”) that may be accelerated. As of September 30, 2018, all three Earnout Targets have been achieved. See Note 2 for the details of the Earnout Consideration.

The Earnout Consideration is contingent on the Company meeting the pre-established Earnings Targets and thus is recorded, if and when earned or probable to be earned. The portion of the Earnout Consideration pertaining to the former C1 option holders, who are current employees of the Company, is accounted for as compensation when the Earnings Targets have been met. The Earnout Consideration pertaining to the former C1 shareholders is accounted for as an equity transaction when the Earnings Targets have been met. All the Earnings Targets have been met as of September 30, 2018.

Common Stock Purchase Warrants

The Company accounts for the issuance of common stock purchase warrants based on the terms of the contract and whether there are any requirements for the Company to net cash settle the contract under any terms or conditions. Warrants for the purchase of 8.9 million shares of common stock were issued by Forum as part of the units sold in its initial public offering (“IPO”) in April 2017 (the “Warrants”). Each unit (a “Unit”), was comprised of one share of Class A common stock, a warrant to purchase one half of one share of Class A common stock and a right to receive one-tenth of a share of Class A common stock upon the consummation of a business combination by Forum. See Notes 2 and 7—Business Combination/Merger and Stockholders’ Equity (Deficit). None of the terms of the Warrants have been modified as a result of the Merger.

The Warrants are freestanding financial instruments that are legally detachable from the shares that were issued at the same time. Most of the Warrants are redeemable at the Company’s option in certain conditions. The Warrants require settlement to be in physical shares of common stock only. The terms of all of the outstanding Warrant contracts expressly state there are no requirements for the Company to net cash settle the Warrants under any circumstances. The Company has accounted for the Warrants as equity instruments.

The Nasdaq has delisted the Company’s warrants from The Nasdaq Capital Market, effective on July 30, 2018, following a determination by Nasdaq that the Company’s warrants no longer qualified for listing. See Note 7 —Stockholders’ Equity (Deficit).

Unit Purchase Option

Subsequent to the Merger, the Company has a unit purchase option (“UPO”) outstanding that was issued to Earlybird Capital LLC (“EBC”) and its designees in connection with Forum’s IPO. The UPO is accounted for as an equity instrument. The underwriters had performed all of their services in April 2017 and the fair value measurement was a one-time, nonrecurring measurement that is not subject to re-measurement over the life of the UPO (see Notes 2 and 7).

Net Income (Loss) Per Share

Prior to the Merger on February 22, 2018, net income (loss) per share was computed using the two-class method. The change in the Company’s capital structure as a result of the Merger and reverse capitalization during 2018 has eliminated the need for a two-class method earnings per share calculation.

The historical number of outstanding shares of C1 common stock have been adjusted to retroactively reflect the effect of the Merger and the historical net income (loss) per share has been adjusted to give effect to this retroactive adjustment (see Note 2—Business Combination/Merger and Note 8—Net Income (Loss) per Share).

Post-Merger, basic net income (loss) per share is computed by dividing net income (loss) available to common shareholders, which is computed by subtracting the Earnout Consideration from net income, by the weighted-average number of shares of common stock outstanding during the period, as adjusted for the Sponsor Earnout Shares that are not participating securities until vested, and the effect of shares that were contingently issuable for which the contingency has been resolved, whether or not those shares have been issued. The contingently issuable shares of common stock pertain to those shares to be issued when the Company meets the Earnings Targets established as part of the Merger Agreement as described in Note 2—Business Combination/Merger.

 

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Diluted net income (loss) per share is computed by dividing net income (loss) available to common shareholders, which is computed by subtracting the Earnout Consideration from net income, by the weighted-average number of shares of common stock outstanding during the period, as adjusted for the Sponsor Earnout Shares that are not participating securities until vested, the effect of shares that were contingently issuable for which the contingency has been resolved, whether or not those shares have been issued yet, and any dilutive equity instruments (warrants and options) that are “in-the-money”. The effect of the contingently issuable shares and dilutive equity instruments are included for the shorter of the date the underlying contracts were in existence to the end of the reporting period or the entire reporting period. However, diluted net loss per share excludes all dilutive potential shares if their effect is anti-dilutive.

Emerging Growth Company Status

The Company is an “emerging growth company,” as defined in Section 2(a) of the Securities Act of 1933, as amended, (the “Securities Act”), as modified by the Jumpstart Our Business Startups Act of 2012, (the “JOBS Act”). Section 102(b)(1) of the JOBS Act exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies (that is, those that have not had a Securities Act registration statement declared effective or do not have a class of securities registered under the Securities Exchange Act of 1934, as amended) are required to comply with the new or revised financial accounting standards. The JOBS Act provides that a company can elect to opt out of the extended transition period and comply with the requirements that apply to non-emerging growth companies but any such election to opt out is irrevocable. The Company has elected not to opt out of such extended transition period which means that when a standard is issued or revised and it has different application dates for public or private companies, the Company, as an emerging growth company, can adopt the new or revised standard at the time private companies adopt the new or revised standard.

Since revenues exceeded $1 billion for the nine months ended September 30, 2018, the Company will cease to be an “emerging growth company” on December 31, 2018.

Recently Adopted Accounting Pronouncements

On January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) 2017-09, Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting, which clarifies that modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the changes in terms or conditions. The amendments in this standard should be applied prospectively to an award modified on or after the adoption date. The adoption of ASU 2017-09 did not have any impact on the consolidated financial statements.

Recently Issued Accounting Pronouncements Not Yet Adopted

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which outlines a single, comprehensive model for accounting for revenue from contracts with customers. The model requires an entity to recognize revenue when or as a customer obtains control of promised goods or services at an amount to which the entity expects to be entitled for the transfer of promised goods or services to customers. The new standard will replace most existing revenue recognition guidance in U.S. GAAP. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which defers the effective date of ASU 2014-09 by one year, making it effective for public entities for annual reporting periods beginning after December 15, 2017, and for nonpublic entities for annual periods beginning after December 15, 2018. Early adoption is permitted. The Company will cease to be an “emerging growth company” on December 31, 2018 and accordingly, the Company will be required to apply the new standard in its annual report as of December 31, 2018.

The standard allows either a “full retrospective adoption” in which the standard is applied to all of the periods presented or a “modified retrospective adoption” with the cumulative effect recognized in retained earnings as of the date of adoption. The Company will adopt the new standard using the modified retrospective method.

The Company continues to refine its processes, system changes and internal controls necessary to support the requirements of the new standard. The Company does not expect that the new standard will have a material impact on the recognition of revenue except for the presentation of revenue and cost of revenue related to certain third-party maintenance contracts. The exact impact of the new standard will be dependent on facts and circumstances at adoption and could vary from quarter to quarter.

 

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In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which changes the accounting for leases in order to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The guidance in this ASU supersedes the leasing guidance in Topic 840, Leases. Under the new guidance, lessees are required to recognize lease assets and lease liabilities on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The standard has an effective date for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years, with early adoption permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company does not currently intend to early adopt the new leasing guidance. The Company will cease to be an “emerging growth company” on December 31, 2018 and accordingly, the new standard will be effective for the Company for the year ending December 31, 2019. The Company is evaluating the effect of the leases standard ASUs. The evaluation includes selecting a transition method for these ASUs and determining the effect that the updated standards will have on the historical and future consolidated financial statements.

The FASB has issued the following additional ASUs to amend the guidance in ASU 2016-02, all of which have effective dates concurrent with the effective date of ASU 2016-02:

 

  (1)

In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, Leases, which provides additional guidance around narrow areas of the new leases standard. These areas included, but are not limited to, the rate implicit in the lease, impairment of the net investment in the lease, and lessee reassessment of lease classification.

 

  (2)

In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842), Targeted Improvements, which includes amendments to respond to implementation challenges and provide another option for transition. The transition option allows presentation of comparative period financial statements in the year of adoption of the new leases standard.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Receipts and Cash Payments, to address diversity in practice regarding the presentation of eight specific cash flow situations. These situations include, but are not limited to, debt prepayment and debt extinguishment costs and contingent consideration payments made after a business combination. The standard has an effective date for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the impact that the standard will have on the consolidated financial statements.

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, to clarify the definition of a business and add guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The standard has an effective date for annual periods beginning after December 15, 2018, and interim periods within those annual periods, with early adoption permitted. The Company is currently evaluating the impact that the standard will have on the consolidated financial statements.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Changes to the Disclosure Requirements for Fair Value Measurement, to amend the disclosure requirements related to fair value measurements. These amendments include, but are not limited to, additional disclosures related to the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. The standard has an effective date for annual periods beginning after December 15, 2019, and interim periods within those annual periods, with early adoption permitted. The Company is currently evaluating the impact that the standard will have on the consolidated financial statements.

Reclassifications

Certain reclassifications have been made to prior periods in the Consolidated Statements of Operations for presentation purposes. The reclassification had no effect on total operating expenses, net income (loss), or accumulated deficit.

 

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2. Business Combination/Merger

On February 22, 2018, C1 consummated its business combination/merger with Forum pursuant to the terms of the Merger Agreement. The following Transactions occurred shortly before the Merger:

 

   

Holders of 16,940,909 shares of Forum common stock sold in its IPO in April 2017 exercised their rights to redeem those shares for cash at a price of $10.15 per share, for an aggregate of approximately $172 million (the “Redemption”). The per share conversion price of approximately $10.15 for holders of public shares electing Redemption was paid out of Forum’s trust account.

 

   

Subscription agreements entered into in connection with the Merger Agreement resulted in the issuance of 16,459,375 shares of common stock to private investors for an aggregate cash purchase price of $131,675,000 (the “PIPE Investment”). An additional subscription agreement had been entered into with one of the private investors for 1,500,000 shares for $12,000,000 (the “Deferred PIPE”) for which payment was due upon the Company’s completion of an effective registration statement that registered all of the shares issued in the PIPE for resale. See below for discussion of issuance of the Deferred PIPE common shares for the Deferred PIPE and the corresponding additional payments to C1 Securityholders.

The following Transactions occurred simultaneously with the Merger which took place on February 22, 2018 (the “Closing”):

 

   

The remaining 309,091 Forum shares that were subject to Redemption, but not redeemed, and the 1,725,000 shares pertaining to the 17,250,000 Public Rights outstanding that had been issued as part of the Units sold in the IPO, were converted to ConvergeOne common shares on a one-for-one-basis. The 8,625,000 Public Warrants issued as part of the Units in the IPO continue in existence post-Merger and represent the right to purchase shares of ConvergeOne common stock (see Note 7—Stockholders’ Equity (Deficit)).

 

   

All outstanding C1 Securities, which included 89,766,294 shares of Class A common stock, 14,830,683 shares of Class B common stock and 1,527,597 outstanding stock options, were immediately vested, canceled, and exchanged for a combination of new shares of ConvergeOne common stock and cash. The C1 Securities aggregated to 106,124,574 and were exchanged for 47,124,494 common shares of ConvergeOne (the “Merger Exchange Ratio”) and cash consideration (see below). Approximately 10,000 of the new shares were immediately forfeited by the C1 Securityholders for the payment of income taxes.

 

   

The C1 Securityholders are entitled to additional consideration in a combination of cash and shares of ConvergeOne common stock (collectively, “Earnout Consideration”), if the Earnout Targets, as defined in the Merger Agreement, are met. As of March 31, 2018, the Earnout Targets for 2018 and 2019 have been achieved. See Earnout Consideration Payments discussion below.

 

   

All of the remaining funds in Forum’s trust account, after taking into account the Redemption, Forum’s operating cash account, and the $131.7 million in proceeds from the PIPE Investment, all of which aggregated to approximately $135.3 million of cash, remained in escrow immediately prior to the Closing, which, together with approximately $35.3 million of cash of C1, was used to pay the cash component of the consideration of approximately $170.6 million paid to C1 Securityholders in connection with the Closing.

 

   

Forum’s primary underwriter, EBC and its designees, collectively owned 172,500 shares of Forum common stock and a UPO to purchase up to a total of 1,125,000 Units exercisable at $10.00 per Unit. These    outstanding shares were converted to ConvergeOne common stock on a one-for-one basis upon the Closing of the Merger. The UPO continues to exist post-Merger with the same terms and the underlying shares that would be issued upon exercise of the UPO and associated warrants pertain to ConvergeOne common stock (see Note 7).

 

   

The Forum founders (“the Sponsor”) had previously entered into a Sponsor Earnout Letter and Amendment to Escrow Agreement, which among other things, resulted in immediate forfeiture of 1,078,125 shares of Class F common stock and subjected 2,156,250 of their remaining Class F common shares to future forfeiture (“Sponsor Earnout Shares”) if the C1 Securityholder Earnout Targets are not met (see Note 7). The remaining 1,078,125 shares of Class F common stock, combined with the 622,500 shares of Class A common stock purchased by the Forum founders during the IPO (that were not subject to Redemption), along with the immediate conversion of the Sponsor’s Private Rights from the IPO to 62,250 common shares, resulted in a total of 3,919,125 common shares held by the Sponsor upon completion of the Merger transactions. All of the Sponsor’s shares were converted to ConvergeOne shares on a one-for-one basis. The 311,250 Private Warrants issued to the Sponsor as part of the Units it purchased in the IPO continue in existence post-Merger and represent the right to purchase shares of ConvergeOne common stock (see Note 7).

 

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Immediately after giving effect to the Transactions described above (including the redemptions, forfeiture of some of the Forum common stock immediately prior to the Closing, the issuance of 47.1 million shares to the C1 Securityholders for the stock component of their consideration, and the issuance of 16.5 million shares of common stock to the PIPE investors), there were approximately 69.7 million shares of ConvergeOne common stock issued and outstanding, warrants to purchase approximately 8.9 million shares of common stock of ConvergeOne issued and outstanding, and a unit purchase option outstanding for the purchase of 1,125,000 Units of ConvergeOne common stock (that would result in the issuance of 1,237,500 total shares of ConvergeOne common stock, including the corresponding Rights, plus a warrant for the purchase of 562,500 additional shares of common stock at $11.50 per share) (see Note 7).

 

   

The registration rights agreement was amended (see Note 7).

 

   

Transaction expenses, net of tax, of $30,934,000 have been recorded as a cost of equity for the legal acquirer’s transaction costs, PIPE related costs, and our costs related to effectuating the reverse recapitalization which is an equity transaction.

 

   

Upon the Closing, the Rights and Units ceased trading, and ConvergeOne’s common stock and warrants began trading on The Nasdaq Stock Market (“Nasdaq”) under the symbols “CVON” and “CVONW,” respectively. Additionally, the C1 Class A common stock and Class B common stock ceased to exist.

 

   

As of the Closing, entities affiliated with Clearlake beneficially owned approximately 54.7% of ConvergeOne’s outstanding shares of common stock and the former Forum securityholders collectively beneficially owned approximately 8.8% of ConvergeOne’s outstanding shares. As a result, ConvergeOne is a “controlled company” within the meaning of the Nasdaq listing rules.

On April 25, 2018, the Company received a Notice of Effectiveness for the Registration Statement it filed to register all the shares issued in the PIPE for resale. Upon completion of an effective registration statement, the private investor immediately paid $12,000,000 to the Company for the Deferred PIPE and 1,500,000 shares of the Company’s common stock were issued. On April 26, 2018, the Company distributed the $12,000,000 of proceeds to the former C1 Securityholders as additional consideration according to the terms of the Merger Agreement.

The following is a summary of the reverse recapitalization, as recorded in the condensed consolidated statement of stockholders’ equity (deficit) (in thousands):

 

     Cash      Noncash      Total  

Proceeds from Forum cash, including proceeds from PIPE

   $ 147,335      $ —        $ 147,335  

Payments made to C1 Security holders in exchange for all of their C1 Securities

     (182,654      —          (182,654

Reverse recapitalization expenses, net of tax

     (28,204      (2,730      (30,934

Assumption of Forum liabilities

            (317      (317
  

 

 

    

 

 

    

 

 

 
   $ (63,523    $ (3,047    $ (66,570
  

 

 

    

 

 

    

 

 

 

C1 provided cash towards the payment to the C1 Securityholders

   $ 35,240      $ —        $ 35,240  

Earnout Consideration Payments

Subject to terms and conditions set forth in the Merger Agreement, the former C1 Securityholders have the contingent right to receive the Earnout Consideration (as defined in the Merger Agreement), based on specific Earnout Target measurements for 2018, 2019 and 2020 (“Earnout Targets”). The key terms pertaining to the Earnout Consideration are as follows:

 

  (1)

The amounts that can be earned for each Earnout Target consist of $33 million of cash (“Earnout Cash Payment”) and 3,300,000 ConvergeOne common shares, less Sponsor Earnout Shares of 718,750 that vest each time an Earnout Target is met (see Note 7) which results in 2,581,250 common shares for each Earnout Target measurement met (“Earnout Stock Payment”), collectively a “Regular Earnout Payment”.

 

  (2)

“Measurement Dates” are the last calendar day of each fiscal quarter beginning with the first fiscal quarter ending after the Closing of the Merger. The “Earnout Period” is the period from the Closing of the Merger to December 31, 2020.

 

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(3)

The Earnout Targets to be met, which are calculated using a trailing twelve months methodology, are as follows:

 

  a.

Earnout EBITDA (as defined in, and calculated in accordance with, the Merger Agreement and measured at any applicable Measurement Date occurring within calendar year 2018) exceeds $144,000,000 (the “2018 Target”);

 

  b.

Earnout EBITDA (as defined in, and calculated in accordance with, the Merger Agreement and measured at any applicable Measurement Date occurring within calendar year 2019) exceeds $155,000,000 (the “2019 Target”); or

 

  c.

Earnout EBITDA (as defined in, and calculated in accordance with, the Merger Agreement and measured at any applicable Measurement Date occurring within calendar year 2020) exceeds $165,000,000 (the “2020 Target”).

See discussion below on the 2019 and 2020 Earnout Targets being accelerated under certain circumstances (that is, measured during earlier periods than the years ending December 31, 2019 and 2020).

 

(4)

In the event that at the time payment of an Earnout Cash Payment is due, such Earnout Cash Payment is an amount that would exceed either (i) the amount of cash available to the Company that is permitted to be distributed and paid without breaching the terms of any agreement related to indebtedness (“Permitted Agreement Payment Amount”) or (ii) the amount that could be paid without exceeding a permitted leverage measurement as set forth in the Merger Agreement (“Permitted Leverage Payment Amount”), the “Permitted Cash Payment” would be the lesser of the two amounts.

Clearlake has the right to direct the Company to do either of the following with regard to the corresponding shortfall between the Permitted Cash Payment Amount and the Earnout Cash Payment that has been earned (“Permitted Cash Payment Shortfall” or “Cash Shortfall”): (i) pay the Cash Shortfall through the issuance of additional shares of common stock with an equivalent value equal to the Cash Shortfall, valued based on a twenty day trading period as defined in the Merger Agreement (“Earnout Cash Payment Shortfall Parent Shares” or “Shortfall Shares”) or (ii) provide notice to the Company that it elects to defer payment of the Cash Shortfall until the following Measurement Date. Clearlake shall have the option on each succeeding Measurement Date until the end of the Earnout Period to elect to be paid the applicable Shortfall Shares in full satisfaction of the Cash Shortfall or continue to defer payment. At the end of the Earnout Period, in the event that the Company has not paid a Cash Shortfall to the former C1 Securityholders, such Cash Shortfall shall automatically be converted into a right for the former C1 Securityholders to receive Shortfall Shares.

 

(5)

In the event that the Earnout EBITDA (as measured using the methodology set forth in the Merger Agreement) on any Measurement Date occurring within

 

  i.

The 2018 calendar year is in excess of the Earnout Target for a subsequent Earnout Year, then the Earnout Target for such subsequent Earnout Year shall also be deemed to have been achieved for such subsequent Earnout Year and the payment of the Regular Earnout Payment for such subsequent Earnout Year shall be accelerated and paid at the same time that the Regular Earnout Payment for the 2018 calendar year is paid or

 

  ii.

The 2019 calendar year is in excess of the 2020 Earnout Target, then the 2020 Earnout Target for the 2020 calendar year shall also be deemed to have been achieved for the 2020 calendar year and the payment of the Regular Earnout Payment for the 2020 calendar year shall be accelerated and paid at the same time that the Regular Earnout Payment for the 2019 calendar year is paid, provided that

 

  iii.

The accelerated Regular Earnout Payments (“Accelerated Earnout Payment”) shall be subject to the determination of the maximum amount of Permitted Cash Payment as described above.

 

(6)

In the event that the applicable Earnout Target is not met for any Earnout Year, the former C1 Securityholders shall not be entitled to receive the Regular Earnout Payment for such Earnout Year; however, the C1 Securityholders will be entitled to receive a Catchup Earnout Payment (as defined in the Merger Agreement) and/or an Accelerated Earnout Payment (as defined in the Merger Agreement) upon satisfaction of certain terms and conditions. In the event that during the Earnout Period there is a Change of Control (as defined in the Merger Agreement), then any Regular Earnout Payments that have not previously been paid (whether or not previously earned) to the C1 Securityholders shall be deemed earned and due to the C1 Securityholders upon such Change of Control.

 

(7)

The holders of C1 stock options that were accelerated as part of the Merger transactions are entitled to their respective pro rata share of the Earnout Consideration if they are an employee, director, or consultant to the Company at the time such installment is paid or issued.

 

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Each Earnout Payment otherwise payable to the former C1 Securityholders, under any circumstances, will be reduced by the amount of the Sponsor Earnout Shares that become vested in connection with an Earnout Payment by directly reducing each Earnout Stock Payment by the amount of the Sponsor Earnout Shares that have become vested.

The allocation of total merger consideration as between the cash consideration and common stock payable to the former C1 Securityholders shall be adjusted, by decreasing the cash consideration and correspondingly increasing the portion of total merger consideration paid in common stock, if and to the extent necessary to ensure that the former C1 Securityholders receive sufficient common stock such that, when aggregated with common stock previously paid as total merger consideration to the former C1 Securityholders, the amount of common stock is not less than the minimum amount of common stock necessary to satisfy the requirements for qualification as a reorganization under Section 368(a)(1)(A) of the Internal Revenue Code.

Earnout Consideration Measurement as of September 30, 2018

The thresholds for the Earnings Targets for 2018 and 2019 were met as of March 31, 2018, the first Measurement Date. Management believes the Company’s calculations of Earnout EBITDA, made in accordance with the terms of the Merger Agreement, indicate that the threshold for the Earnings Target for 2020 has been met as of September 30, 2018. Although a final determination will not be made until a formal review and approval process has been completed with the parties to the Merger Agreement, for accounting purposes it is considered probable that the calculations will be approved and the 2020 Earnings Target construed to be officially met. Accordingly, based on the terms of the Merger Agreement, in connection with meeting all three of the Earnings Targets, the former C1 Securityholders were entitled to receive an aggregate of $99 million in cash and 7,743,750 newly issued shares of common stock, after deducting 2,156,250 Sponsor Earnout Shares which vested and immediately became participating securities. The Company recorded the estimated value of the Earnout consideration for the Earnings Targets for 2018 and 2019 as of March 31, 2018 and for the Earnings Target for 2020 as of September 30, 2018.

The aggregate net Earnout Stock Payments for the 2018 and 2019 Earnouts of 5,162,500 shares were issued on May 22, 2018. Approximately 21,000 of the new shares were immediately forfeited by the C1 Securityholders for the payment of income taxes. It is expected that the aggregate Stock Earnout Payments for the 2020 Earnout of 2,581,250 shares would be issued shortly after the approval process under the Merger Agreement is completed.

As noted above, payment of the Earnout Cash Payments are subject to limitations and restrictions on cash distribution, as described in the Merger Agreement and set forth in the Company’s debt facilities. In the event of a Cash Shortfall, Clearlake would need to determine whether the Company would pay the Cash Shortfall through the issuance of additional shares of common stock with an equivalent value or defer a decision on the Cash Shortfall until the next quarterly Measurement Date. As of the March 31, 2018 and June 30, 2018 Measurement Dates, there was a Cash Shortfall for the 2018 and 2019 Earnout Cash Payment, and Clearlake elected to defer a decision on the Cash Shortfall until the next quarterly Measurement Date. Management believes that as of the September 30, 2018 Measurement Date, that there may be a Cash Shortfall for the entire $99 million Earnout Cash Payment. The liability for the Earnout Cash Payments of $99,000,000 is recorded on the condensed consolidated balance sheet, and as of September 30, 2018 represents approximately 10.6 million of equivalent common shares, based on the measurement terms in the Merger Agreement.

The fair value of the Earnout Stock Payments that were made and to be made to the former C1 Securityholders and the fair value of the Sponsor Earnout Shares that vested or to be vested, aggregated to $90,255,000, which has been recorded as an equity transaction during the nine months ended September 30, 2018.

A portion of the total Earnout Consideration is payable to the former C1 option holders, who must continue to be employed by the Company as of the payment date in order to receive their pro rata share of the Earnout Consideration. Management has recorded compensation expense related to the pro rata portion of the Earnout Stock Payments that were issued in May and the pro rata portion of the Earnout Cash Payments that has been accrued but not yet paid and is expected to be given to the former C1 option holders at a future date. The compensation was measured using the provisions set forth in the Merger Agreement which aggregated to approximately $681,000 and $2,208,000 during the three and nine months ended September 30, 2018, respectively.

 

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The total Earnout Consideration that was recognized during the three and nine months ended September 30, 2018 was $63,723,000 and $189,255,000, respectively, which includes compensation expense for the former C1 option holders. The net amount of $63,041,000 and $187,047,000 has been treated as a reduction to net income (loss) available to common shareholders for earnings per share purposes for the three and nine months ended September 30, 2018, respectively. See Note 8.

The shares issued in connection with the Earnout provisions represented contingently issuable shares as of the date they were construed to be officially met, which for the 2018 & 2019 Earnouts is March 31, 2018 and for the 2020 Earnout is September 30, 2018. For earnings per share purposes, contingently issuable shares are included in weighted average shares outstanding when it appears that there are no further contingences to be resolved. These shares have been factored into the earnings per share calculations for the three and nine months ended September 30, 2018 as contingently issuable shares as of March 31, 2018 for the 2018 & 2019 Earnouts and as of September 30, 2018 for the 2020 Earnout.

3. Business Acquisitions

Acquisitions were accounted for as business combinations and the assets acquired and liabilities assumed were recognized based on the estimated fair values at the acquisition date as determined by the Company’s management, using information currently available and current assumptions as to projections of future events and operating performance, and consideration of market conditions.

2018 Acquisitions

Advantel Networks

On September 28, 2018, the Company, through its subsidiary ConvergeOne, Inc., acquired Advantel, Inc. (“Advantel”) for cash consideration of $16,736,000. The Company incurred transaction costs of $535,000 related to the acquisition and included the amount in transaction costs on the condensed consolidated statements of operations.

The purchase price has been preliminarily allocated to the assets acquired and liabilities assumed based on fair values as of the acquisition date. Based on the preliminary fair value measurement of the assets acquired and liabilities assumed, the Company paid a premium over the fair value of the net tangible and identified intangible assets acquired, resulting in preliminary goodwill of approximately $11,561,000. The premium paid is attributed to Advantel’s presence in the business communications industry and its growth potential.

The acquisition fair value measurement is preliminary and subject to completion of the valuation of Advantel and further management reviews and assessments of the preliminary fair value of the assets acquired and liabilities assumed. The adjustments arising from the completion of the outstanding matters may materially affect the preliminary purchase accounting. The purchase price allocation will be finalized as soon as practicable within the measurement period, but not later than one year following the acquisition date.

No revenue or net income for Advantel is included in the accompanying condensed consolidated statement of operations for the nine months ended September 30, 2018.

As a result of the acquisition, a portion of the consideration, $1,260,000, was placed in an escrow account. The total escrow is included in cash consideration paid in the table below. The funds in the escrow account are to secure the sellers’ and the Company’s indemnification obligations in the purchase agreement and for any post-closing purchase price adjustments. The funds held in escrow after settlement of indemnification claims of the buyer will be paid to the sellers at a future date.

Arrow Systems Integration, Inc.

On March 1, 2018, the Company, through its subsidiary ConvergeOne, Inc., acquired Arrow Systems Integration, Inc. (“ASI”) for cash consideration of $28,376,000. During the nine months ended September 30, 2018, the Company incurred transaction costs of $487,000 related to the acquisition and included the amount in transaction costs on the condensed consolidated statements of operations.

 

 

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The purchase price has been preliminarily allocated to the assets acquired and liabilities assumed based on fair values as of the acquisition date. The fair value of the net assets acquired was approximately $40,561,000. The excess of the aggregate fair value of the net assets acquired of $12,185,000 has been accounted for as a gain on bargain purchase in accordance with Accounting Standards Codification (“ASC”) 805 and included in preliminary bargain purchase gain on the consolidated statement of operations for the nine months ended September 30, 2018. The bargain purchase gain is due to the seller divesting a non-core asset from its overall business. The Company acquired a significant income tax benefit pertaining to a goodwill write-off.

The acquisition fair value measurement is preliminary and subject to completion of the valuation of ASI and further management reviews and assessments of the preliminary fair value of the assets acquired and liabilities assumed. The adjustments arising from the completion of the outstanding matters may materially affect the preliminary purchase accounting. The purchase price allocation will be finalized as soon as practicable within the measurement period, but not later than one year following the acquisition date.

Adjustments to preliminary amounts made during the three and nine months ended September 30, 2018, which were the result of information that existed as of the acquisition date, were recognized prospectively. The adjustments during the three months ended September 30, 2018 resulted in increased preliminary bargain purchase gain by approximately $1,212,000 as a result of an increase in assets acquired of $917,000 and a decrease in liabilities assumed of $725,000 offset by a decreased in deferred income tax asset of $430,000. The adjustments during the nine months ended September 30, 2018 resulted in a decrease to preliminary bargain purchase gain by approximately $3,873,000 as a result of an increase in liabilities assumed of $9,237,000 offset by a an increase in assets acquired of $917,000, an increase in deferred income tax asset of $2,181,000 and decrease in purchase price of $2,266,000.

Since the acquisition date of March 1, 2018, $148,042,000 of revenue and $18,670,000 of net income (inclusive of preliminary acquisition gain) are included in the accompanying condensed consolidated statement of operations for the nine months ended September 30, 2018.

The fair value of accounts receivable was adjusted for approximately $3,048,000 for amounts not expected to be collected.

The following table summarizes the preliminary fair value of the assets acquired and liabilities assumed (in thousands) for acquisitions completed in the nine months ended September 30, 2018:

 

     ASI      Advantel      Total  

Assets Acquired:

        

Cash

   $ 716      $ 621      $ 1,337  

Trade accounts receivable

     64,426        7,369        71,795  

Inventories

     2,635        3,629        6,264  

Prepaid expenses and other current assets

     1,752        153        1,905  

Deferred customer support contract costs

     13,653        76        13,729  

Goodwill

     —          11,561        11,561  

Customer relationships

     10,217        5,500        15,717  

Trademarks

     —          300        300  

Property and equipment

     337        298        635  

Other non current assets

     —          3,563        3,563  

Deferred income taxes

     7,352        —          7,352  
  

 

 

    

 

 

    

 

 

 

Total assets acquired

     101,088        33,070        134,158  
  

 

 

    

 

 

    

 

 

 

Liabilities Assumed:

        

Accounts payable and accrued expenses

     (33,390      (9,689      (43,079

Deferred income taxes

     —          (911      (911

Deferred revenue and long-term liabilities

     (27,137      (5,734      (32,871
  

 

 

    

 

 

    

 

 

 

Total liabilities assumed

     (60,527      (16,334      (76,861
  

 

 

    

 

 

    

 

 

 

Net assets acquired as at September 30, 2018

   $ 40,561      $ 16,736      $ 57,297  
  

 

 

    

 

 

    

 

 

 

 

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Unaudited Pro-Forma Information

Following are the supplemental consolidated results of the Company on an unaudited pro forma basis, as if the acquisition of Advantel and ASI had been consummated on January 1, 2017. The pro forma results presented below show the impact of acquisition-related costs as well as the increase in interest expense related to acquisition-related debt (in thousands).

 

     Three Months Ended
September 30,
     Nine months ended
September 30,
 
(in thousands, except per share data)    2018      2017      2018      2017  

Revenue

   $  417,663      $  326,662      $  1,172,421      $  864,070  

Net income (loss)

     13,632        1,106        10,739        (15,343

Net income (loss) per share - basic and diluted

     0.18        0.03        0.16        (0.38

These pro forma results were based on estimates and assumptions, which the Company believes are reasonable. Pro forma net income (loss) does not take into effect the impact of the earnout consideration for net income (loss) per share calculations. The weighted-average shares outstanding used to calculate pro forma net income (loss) per share were retroactively adjusted to reflect the Merger Exchange Ratio as described in Notes 2 and 7. These pro forma results are not the results that would have been realized had the Company been a combined company during the periods presented and are not necessarily indicative of consolidated results of operations in future periods.

2017 Acquisition

Annese & Associates, Inc.

On July 14, 2017, the Company, through its subsidiary ConvergeOne, acquired Annese & Associates, Inc. (“Annese”) for cash consideration of $24,483,000 plus additional consideration of up to $4,000,000, contingent upon the achievement of certain gross profit targets for the twelve months ending June 30, 2018.

The Company estimated the fair value of the contingent consideration to be approximately $956,000 at December 31, 2017, based upon current assumptions as to projections of future events and operating performance, and consideration of market conditions. As of September 30, 2018, no additional contingent consideration is expected to be paid and the reduction in the fair value of the contingent consideration for the nine months ended September 30, 2018 is included in the condensed consolidated statement of operations.

4. Trade Accounts Receivable

The following is a roll forward of our allowance for doubtful accounts (in thousands):

 

     September 30,      December 31,  
     2018      2017  

Balance at beginning of period

   $  1,480      $  1,024  

Amounts expensed (recovered)

     (2      1,006  

Deductions(1)

     (34      (550
  

 

 

    

 

 

 

Balance at end of period

   $ 1,444      $ 1,480  
  

 

 

    

 

 

 

 

(1)

Deductions include actual accounts written off, net of recoveries.

 

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5. Goodwill and Finite-Life Intangible Assets

Goodwill

The changes in the carrying amount of goodwill are as follows (in thousands):

 

Balance as of December 31, 2017

   $  331,456  

Acquisitions

     11,561  

Measurement period adjustments

     (2,616

Other

     2,357  
  

 

 

 

Balance as of September 30, 2018

   $ 342,758  
  

 

 

 

During the nine months ended September 30, 2018, goodwill increased $11,561,000 for the acquisition of Advantel in 2018, decreased by $2,616,000 related primarily to adjustments to the fair value of intangible assets acquired in 2017 and increased by $2,357,000 associated with an adjustment of deferred income taxes.

Finite-life Intangibles

In connection with business acquisitions the Company acquired certain customer relationships, trademarks, noncompetition agreements, and internally developed software. The Company’s management determined, based upon information available at the time of acquisition and on certain assumptions as to future operations and market considerations, the values of the finite-life intangibles as follows: trademarks, using the relief from royalty method; and customer relationships, noncompetition agreements and internally developed software using, in part, a discounted cash flow method. The amortization periods were estimated by management, considering both the economic and legal lives, as well as the expected period of benefit.

Finite-life intangible assets consist of the following (in thousands):

 

     September 30,      December 31,  
     2018      2017  

Customer relationships

   $ 226,293      $  208,451  

Trademarks

     38,659        38,546  

Noncompetition agreements

     6,012        6,241  

Internally developed software

     541        541  
  

 

 

    

 

 

 
     271,505        253,779  

Less accumulated amortization

     (107,554      (80,137
  

 

 

    

 

 

 

Finite-life intangibles, net

   $ 163,951      $ 173,642  
  

 

 

    

 

 

 

During the three months ended September 30, 2018 and 2017, aggregate amortization expense was $9,318,000 and $6,711,000, respectively. During the nine months ended September 30, 2018 and 2017, aggregate amortization expense was $27,417,000 and $17,891,000, respectively. Based on the recorded intangible assets at September 30, 2018, estimated amortization expense is expected to be as follows (in thousands):

 

Years Ending December 31,

      

Remainder of 2018

   $ 9,707  

2019

     38,122  

2020

     34,774  

2021

     31,584  

2022

     27,190  

2023 and thereafter

     22,574  
  

 

 

 

Total

   $
163,951
 
  

 

 

 

 

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6. Debt

Long-term debt consists of the following (in thousands):

 

     September 30,      December 31,  
     2018      2017  

Revolving line-of-credit

   $ 50,000      $ 20,000  

Term loan facility

     668,325        562,325  
  

 

 

    

 

 

 

Total long-term debt

     718,325        582,325  

Less unamortized original issue discount

     (3,440      (5,623

Less unamortized deferred financing costs

     (6,370      (4,626
  

 

 

    

 

 

 

Total long-term debt, net of debt issuance costs

     708,515        572,076  

Less current maturities

     (6,700      (5,652
  

 

 

    

 

 

 

Long-term debt, net

   $ 701,815      $ 566,424  
  

 

 

    

 

 

 

April 2018 Credit Facilities

Senior Secured Term Loan

On April 10, 2018, certain of ConvergeOne Holdings, Inc.’s subsidiaries, C1 Intermediate Corp. and C1 Holdings Corp. (f/k/a ConvergeOne Holdings Corp.) entered into a Term Loan Agreement with Credit Suisse AG, Cayman Islands Branch as the administrative agent and collateral agent (the “Term Loan Agreement”). The Term Loan Agreement provides for senior secured term loans in the aggregate principal amount of $670,000,000 (the “Term Loans”). A portion of the proceeds of the Term Loans was used to repay the existing credit facilities including the outstanding indebtedness under the Revolver Agreement of $90,000,000 and to pay debt issuance costs. The remaining proceeds will be used for working capital needs and general corporate purposes. The Company incurred financing transaction costs of approximately $5,931,000 and an original issue discount of $3,700,000 related to the Term Loan Agreement which will be amortized over the life of the credit agreement.

The principal installments in the amount of $1,675,000 are due on the last business day of each quarter commencing September 30, 2018, with the remaining outstanding principal amount to be paid on its maturity date of April 10, 2025.

The Term Loan Agreement contains a number of significant restrictive covenants. Such restrictive covenants, among other things, restrict, subject to certain exceptions, our and our restricted subsidiaries’ ability to incur additional indebtedness and make guarantees; create liens on assets; pay dividends and distributions or repurchase their capital stock; make investments, loans and advances, including acquisitions; engage in mergers, consolidations, dissolutions or similar transactions; sell or otherwise dispose of assets, including sale and leaseback transactions; engage in certain transactions with affiliates; enter into certain restrictive agreements; make changes in the nature of their business, fiscal year and organizational documents; make prepayments or amend the terms of certain junior debt; and enter into certain hedging arrangements.

The Term Loan Agreement also contains certain customary representations and warranties, affirmative covenants and events of default, including the occurrence of a Change of Control, as defined in the Term Loan Agreement. If an event of default occurs, the lenders under the Term Loan Agreement will be entitled to take various actions, including the acceleration of amounts due under the Term Loan Agreement and actions permitted to be taken by a secured creditor.

The Term Loan Agreement requires us to prepay outstanding Term Loans, subject to certain exceptions, in amounts equal to the following: commencing with the year ending December 31, 2018, 50% of “excess cash flow” (which percentage steps down to 25% and 0% when we obtain certain consolidated total net leverage ratios), provided that any mandatory “excess cash flow” prepayment shall be at least $10 million; 100% of the net cash proceeds of all non-ordinary course asset sales or other dispositions of property (which percentage steps down to 50% when we obtain a certain consolidated total net leverage ratio); and 100% of the net cash proceeds of any incurrence of debt, other than debt permitted to be incurred or issued under the Term Loan Agreement.

We are permitted to voluntarily repay outstanding Term Loans at any time without premium or penalty unless such payment is made prior to October 10, 2018 in connection with a repricing transaction as described in the Term Loan Agreement, in which case we are required to pay a premium of 1% on the Term Loans so prepaid.

The Term Loans bear interest at 2.75% above the alternate base rate or 3.75% above the Eurodollar rate, as described in the Term Loan Agreement. Interest on the Eurodollar rate Term Loans is payable on the last day of the Interest Period, as defined in the Term Loan Agreement, and interest on alternate base rate Term Loans is payable on the last day of each quarter. Borrowings under the Term Loans had an interest rate of 5.99% at September 30, 2018.

 

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June 2017 Credit Facilities

Senior Secured Term Loan

On June 20, 2017, ConvergeOne Holdings Corp. (“Holdings”) and the Company’s subsidiary, and direct corporate parent of Holdings, C1 Intermediate Corp. (“Intermediate”) entered into a Term Loan Agreement (the “2017 Term Loan Agreement”) with JPMorgan Chase Bank, N.A. as the administrative agent and collateral agent. The 2017 Term Loan Agreement provides for senior secured term loans in the aggregate principal amount of $430,000,000 (the “Term Loans”). A portion of the proceeds of the Term Loans were used to repay the existing credit facilities and to pay debt issuance costs. The remaining proceeds were used for working capital needs and general corporate purposes.

Principal installments in the amount of $1,413,000 were due on the last business day of each quarter, commencing September 30, 2017, with the remaining outstanding principal amount to be paid on its maturity date of June 20, 2024.

The Company was permitted to repay outstanding Term Loans at any time without premium or penalty, unless such payment is made prior to June 20, 2018 in connection with a repricing transaction as described in the 2017 Term Loan Agreement, in which case the Company is required to pay a premium of 1% of the Term Loans so prepaid.

The Term Loans bore interest at 3.75% above the alternate base rate or 4.75% above the Eurodollar rate as described in the agreement. Interest on the Eurodollar rate Term Loans was payable on the last day of the Interest Period, as defined in the Term Loan Agreement, and interest on alternate base rate Term Loans was payable on the last day of each quarter.

The Company incurred financing transaction costs of approximately $4,778,000 and an original issue discount of $4,300,000 related to the Term Loan Agreement which the Company amortized over the term of the credit agreement.

In July 2017, Holdings borrowed an additional $75,000,000 of term loans under an incremental amendment to the Term Loan Agreement, which loans are part of the same class of, and on the same terms as, the initial Term Loans. Proceeds from the incremental amendment were used for the acquisitions of Annese and SPS Holdco, LLC (“SPS”).

In October 2017, Holdings borrowed an additional $60,000,000 of term loans under an incremental amendment to the Term Loan Agreement, which loans are part of the same class of, and on the same terms as, the initial Term Loans. Proceeds from the incremental amendment were used to acquire AOS, Inc. (“AOS”).

The Company incurred financing transaction costs of approximately $2,208,000 and an original issue discount of $713,000 related to the incremental term loan joinder agreements. The Company expensed $1,793,000 of direct issuance costs incurred within interest expense on the consolidated statement of operations and amortized $1,128,000 over the remaining term of the credit agreement.

On April 10, 2018, concurrent with entering into the Term Loan Agreement, the Company terminated the 2017 Term Loan Agreement. The Company accounted for this termination as debt extinguishment and in accordance with the applicable accounting guidance for debt modification and extinguishments, and for interest costs accounting, the Company expensed $5,684,000 in extinguishment costs incurred including a 1% pre-payment penalty, the remaining unamortized deferred financing costs of $4,588,000, the remaining unamortized original issue discount of $4,443,000 and $17,000 of prepaid administrative fees relating to the 2017 Credit Facilities. The Company reported theses expenses within interest expense on the condensed consolidated statement of operations for the nine months ended September 30, 2018.

Senior Secured Revolving Loan Facility

On June 20, 2017, Holdings and Intermediate entered into a Revolving Loan Credit Agreement (the “Revolver Agreement”) with Wells Fargo Commercial Distribution Finance, LLC (“Wells Fargo”) as the administrative agent and collateral agent and as Floorplan Funding Agent. The Revolver Agreement provides a senior secured revolving loan facility of $150,000,000 aggregate principal amount of revolving loans and amends and restates the existing floorplan agreement with Wells Fargo in order to extend credit in the form of a floorplan subfacility. The Revolver Agreement matures on June 20, 2022.

 

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The obligations under the Revolver Agreement are unconditionally and irrevocably guaranteed by Intermediate and certain restricted subsidiaries of Holdings. The obligations under the Revolver Agreement are secured by a first priority lien on the receivable accounts, inventory, and deposit and securities accounts, and a second priority lien on substantially all of the other assets of Holdings and each guarantor. The aggregate principal amount of the revolving loans and floorplan advances is limited to a Borrowing Base as defined by the Revolver Agreement, reduced by outstanding letters of credit. Mandatory prepayments are required in the event that the sum of the outstanding principal amount of the revolving loans, letter of credit and floorplan advances exceeds the less of (i) the aggregate revolving commitments of $150,000,000 or (ii) the Borrowing Base, in an amount equal to the excess.

On February 13, 2018, the Company amended the Revolver Agreement to increase the aggregate revolving commitments from $150,000,000 to $200,000,000 and incurred financing transaction costs of $175,000 which the Company will amortize over the remaining term of the agreement.

The Revolver Agreement contains a number of covenants including, among other things, requirements to maintain certain financial ratios and restrictions on dividends. If the Revolving Exposure, as described in the Revolver Agreement, exceeds the lesser of the revolving loan commitments or the borrowing base, the Revolver Agreement requires the Company to prepay outstanding Revolving Loans in an aggregate amount equal to such excess. The Company is permitted to repay outstanding Revolving Loans at any time without premium or penalty.

Borrowings under the Revolver Agreement bear interest at rates ranging from 0.25% to 0.75% above the alternate base rate or from 1.25% to 1.75% above the Eurodollar rate as described in the Revolver Agreement, in each case based on availability under the Revolver Agreement as of such interest payment date. A commitment fee equal to 0.250% or 0.375% per annum (based on availability under the Revolver Agreement) times the average daily unused amount of the available revolving commitments is payable on the last day of each quarter.

On April 10, 2018, Intermediate, C1 Holdings Corp., certain of our subsidiaries and Wells Fargo entered into a Third Amendment to Revolving Loan Credit Agreement and revised certain definitions and restrictive covenants in such agreement to be consistent with the terms of the new Term Loan Agreement described above.

At September 30, 2018, the Borrowing Base was $200,000,000. There were no letters of credit outstanding, the outstanding balance on the revolver was $50,000,000 and the outstanding floorplan balance was $71,780,000; therefore, the maximum borrowing available was $78,220,000 at September 30, 2018.

Floor Planning Facilities

On June 20, 2017, concurrent with entering into the Revolver Agreement, the Company amended and restated its existing floor planning facilities with Wells Fargo to extend credit in the form of floorplan advances up to an aggregate principal amount of $150,000,000. If advances under the agreement are not paid within 60 days or by the end of the free flooring period (which ranges from 45-90 days), the floorplan advance automatically converts to a revolving loan subject to terms under the Revolver Agreement.

Concurrent with the amendment to the Revolver Agreement on February 13, 2018, the aggregate principal amount of floor plan advances credit limit increased from $150,000,000 to $200,000,000.

The outstanding balance of floorplan advances at September 30, 2018 was $71,780,000 and is included in accounts payable on the condensed consolidated balance sheet.

Debt Issuance Costs

The Company amortizes original issue discount and deferred financing costs (debt issuance cost) using the effective interest method over the life of the related instrument, and such amortization is included in interest expense in the consolidated statements of operations.

 

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Debt issuance costs are as follows (in thousands):

 

     Revolving
Line of Credit
     Term Loan      Total  

Balance as of December 31, 2017

   $ 829      $ 9,420      $ 10,249  

Additions

     175        9,631        9,806  

Extinguishment

     —          (9,032      (9,032

Amortization

     (166      (1,047      (1,213
  

 

 

    

 

 

    

 

 

 

Balance as of September 30, 2018

   $ 838      $ 8,972      $ 9,810  
  

 

 

    

 

 

    

 

 

 

Long-term Debt Maturities

The approximate future principal payments on long-term debt are as follows (in thousands):

 

Years Ending December 31,

   Debt  

Remainder of 2018

   $ 1,675  

2019

     6,700  

2020

     6,700  

2021

     6,700  

2022

     6,700  

2023 and thereafter

     639,850  
  

 

 

 

Total

     668,325  

Revolving line-of-credit

     50,000  

Less unamortized debt issuance costs

     (9,810
  

 

 

 

Total debt

   $  708,515  
  

 

 

 

7. Stockholders’ Equity (Deficit)

Prior to the Merger

C1

Prior to the Merger, C1 had two classes of common stock authorized, Class A and Class B which had differing rights. Class B common shares were subject to vesting.

As part of the Merger transactions, all of the outstanding shares of C1 Class A and Class B common stock were exchanged for new shares of ConvergeOne common stock using a Merger Exchange Ratio that was the same for both classes of common stock (see Note 2—Business Combination/Merger).

At December 31, 2017, there were 89,766,294 and 14,830,683 shares of Class A and Class B common shares, respectively, issued and outstanding. In the Company’s consolidated statement of stockholders’ equity (deficit), these amounts have been retroactively adjusted to 39,860,610 and 6,585,546, respectively, to reflect the Merger Exchange Ratio. All outstanding C1 Securities, including the C1 stock options, were immediately vested, canceled, and exchanged for a combination of new shares of ConvergeOne common stock and cash. The C1 Securities aggregated to 106,124,574 and were exchanged for 47,124,494 common shares of ConvergeOne and cash consideration of approximately $170,600,000. Approximately 10,000 of the newly issued shares were immediately forfeited by C1 Securityholders for the payment of income taxes.

Both classes of C1 common stock ceased to exist upon completion of the Merger.

Forum

Prior to the Merger, Forum had two classes of common stock authorized, Class A and Class F which had differing rights. As discussed below and in Note 2, all of the outstanding shares of Class A and Class F common stock remaining (after various Merger related transactions were consummated) were converted into shares of ConvergeOne common stock.

Both classes of Forum common stock ceased to exist upon completion of the Merger.

 

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Preferred Stock

The Company is authorized to issue 10,000,000 shares of preferred stock, $0.0001 par value per share. The Company’s board of directors may, without further action by the stockholders, fix the rights, preferences, privileges and restrictions of up to an aggregate of 10,000,000 shares of preferred stock in one or more series and authorize their issuance. These rights, preferences and privileges could include dividend rights, conversion rights, voting rights, terms of redemption, liquidation preferences, sinking fund terms and the number of shares constituting any series or the designation of such series, any or all of which may be greater than the rights of our common stock. The issuance of preferred stock could adversely affect the voting power of holders of common stock and the likelihood that such holders will receive dividend payments and payments upon liquidation. In addition, the issuance of preferred stock could have the effect of delaying, deterring or preventing a change of control or other corporate action. No shares of preferred stock are currently outstanding, and we have no present plan to issue any shares of preferred stock.

Common Stock

The Company is authorized to issue 1,000,000,000 shares of common stock, $0.0001 par value per share.

Voting Power

Except as otherwise required by law or as otherwise provided in any certificate of designation for any series of preferred stock, the holders of common stock possess all voting power for the election of the Company’s directors and all other matters requiring stockholder action. Holders of common stock are entitled to one vote per share on matters to be voted on by stockholders.

Dividends

Holders of common stock are entitled to receive such dividends, if any, as may be declared from time to time by the Company’s board of directors in its discretion out of funds legally available therefore. In no event will any stock dividends or stock splits or combinations of stock be declared or made on common stock unless the shares of common stock at the time outstanding are treated equally and identically.

The Company paid a regular quarterly cash dividend of $0.02 per share during each of the second and third quarters of 2018. Dividends paid in the three and nine months ended September 30, 2018 were approximately $1,528,000 and $3,055,000, respectively. The Company had an accumulated deficit at the time of declaration and, as a result, the dividends were recorded as a reduction to paid-in-capital.

Liquidation, Dissolution and Winding Up

In the event of the Company’s voluntary or involuntary liquidation, dissolution, distribution of assets or winding-up, the holders of the common stock will be entitled to receive an equal amount per share of all of the Company’s assets of whatever kind available for distribution to stockholders, after the rights of the holders of the preferred stock have been satisfied.

Preemptive or Other Rights

There are no sinking fund provisions applicable to the common stock.

Sponsor Earnout Shares

Prior to the Merger

On December 28, 2016, Forum issued an aggregate of 3,593,750 of its Class F Common Stock to its Founders for an aggregate purchase price of $25,000 (the “Founders Shares”). On April 6, 2017, Forum effectuated a 1.2-for-1 stock dividend of its Class F Common Stock resulting in an aggregate of 4,312,500 Founders Shares outstanding. The Founders Shares automatically converted into shares of common stock upon the consummation of the Merger.

 

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Simultaneously with the Forum IPO, the Sponsor purchased an aggregate of 555,000 Units in a private placement (the “Placement Units”) at a price of $10.00 per unit (or an aggregate purchase price of $5,550,000). In addition, on April 18, 2017, Forum consummated the sale of an additional 67,500 Placement Units at a price of $10.00 per unit, which were purchased by the Sponsor, generating gross proceeds of $675,000. Each Placement Unit consisted of one Placement Share, one Placement Right and one-half of one Placement Warrant (“Private Warrant”). The proceeds from the Placement Units were added to the proceeds from the Forum IPO held in the trust account of Forum.

The Placement Units were identical to the Units sold in the Forum IPO except that the Placement Warrants (i) are not redeemable by Forum and (ii) may be exercised for cash or on a cashless basis, so long as they are held by the initial purchaser or any of its permitted transferees.

Just prior to the Merger, the Founders owned 4,312,500 shares of Class F common stock, 622,500 shares of Class A common stock, Rights to 62,250 additional shares of Class A common stock, and warrants for the purchase of 311,250 shares of Class A common stock at $11.50 per share.

Merger

As part of the Merger Agreement, the Sponsor entered into a letter agreement on November 30, 2017 (the “Sponsor Earnout Letter”), with Forum, C1, and other parties whereby the Sponsor agreed that effective upon the Closing, with respect to the Founder Shares owned by the Sponsor, the Sponsor would (a) forfeit 1,078,125 of the Founder Shares and (b) subject 2,156,250 of the Founder Shares (the “Sponsor Earnout Shares”) to potential forfeiture in the event that the Earnout Payments are not achieved by Company Securityholders (see Note 2). Subject to certain limited exceptions, the Sponsor Earnout Shares will be subject to lock-up from the Closing until 180 days thereafter; provided that if the volume-weighted average price of Forum Common Shares for 15 trading days is at least $12.50 per share, then 25% of the Sponsor Earnout Shares will be released from escrow immediately (but still subject to the vesting requirements under the Sponsor Earnout Letter).

The Sponsor Earnout Shares will either (1) be forfeited if the C1 Earnings Targets are not met or (2) vest if the C1 Earnings Targets are met. The Earnout Targets are described in detail in Note 2. One-third of the Sponsor Earnout Shares, 718,750 shares, will become vested for each of the three Earnout Targets. The Sponsor Earnout Shares will convert to participating shares when vesting occurs. If the Earnings Targets are not met, the corresponding Sponsor Earnout Shares will be forfeited by the Sponsor.

All of the Sponsor’s shares, including the 62,250 shares issued as part of the Rights, were converted into shares of ConvergeOne common shares on a one-for-one basis. The 311,250 Private Warrants issued to the Sponsor as part of the Units it purchased in the IPO continue in existence post-Merger and represent the right to purchase shares of ConvergeOne common stock under the same terms and conditions as originally issued.

Post-Merger

Upon completion of the Merger, the Sponsor distributed 3,919,125 shares of ConvergeOne common stock to its members, including the 2,156,250 Sponsor Earnout Shares which are treated as issued and outstanding. The Sponsor Earnout Shares are not considered participating for dividend purposes and net income per share calculations until released from forfeiture restrictions upon achievement of the Earnout Targets (“vested”). As discussed in Note 2, all three Earnings Targets were met as of September 30, 2018 and thus 2,156,250 Sponsor Earnout Shares are vested and treated as participating shares and are included in weighted-average shares outstanding for net income per share computations. Additionally, the Sponsor distributed to its members Private Warrants for the purchase of 311,250 shares of ConvergeOne common stock at $11.50 per share.

Warrants to Purchase Common Stock

Warrants for the purchase of 8.9 million shares of common stock were issued by Forum as part of the units sold in its IPO in April 2017. Each unit was comprised of one share of Class A common stock, a warrant to purchase one half of one share of Class A common stock and a right to receive one-tenth of a share of Class A common stock upon the consummation of a business combination by Forum. Upon completion of the Merger, these warrants pertain to the purchase of ConvergeOne common stock and the terms and conditions remain the same.

On February 26, 2018, the Company initiated a Public Offer to Purchase for cash up to 8,936,250 warrants at a price of $0.95 per Warrant, net to the seller without interest and subject to certain conditions, until March 23, 2018 (the “Tender Offer”). The Company increased the offer price to $1.20 per Warrant and extended the Tender Offer period to April 20, 2018.

 

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The Tender Offer expired at 5:00 P.M., New York City time, on April 20, 2018, and a total of 7,581,439 warrants were validly tendered and not withdrawn pursuant to the Tender Offer as of such date. In accordance with the terms of the Tender Offer, the Company purchased all 7,581,439 validly tendered and not withdrawn warrants at a price of $1.20 per warrant for an aggregate purchase price of approximately $9,098,000, which was paid on April 23, 2018.

At September 30, 2018, there were a total of 1,354,810 warrants outstanding consisting of 1,091,060 Public Warrants originally sold as part of Units in the Forum IPO and 263,750 Placement Warrants.

The Company received a letter, dated June 19, 2018, from the Listing Qualifications Department of The Nasdaq Stock Market LLC (“Nasdaq”) indicating that Nasdaq intends to suspend and then delist the Company’s warrants (NASDAQ: CVONW) from The Nasdaq Capital Market at the opening of business on June 28, 2018 for the failure to meet the requisite number of warrant holders requirement.

The Nasdaq has delisted the Company’s warrants (NASDAQ: CVONW) from The Nasdaq Capital Market, effective at the opening of the trading session on July 30, 2018 following a determination by Nasdaq that the Company’s warrants no longer qualified for listing pursuant to Listing Rule IM-5101-2.

Warrant Terms

Each whole warrant entitles the registered holder to purchase one share of common stock at a price of $11.50 per share, subject to adjustment as discussed below, at any time commencing on April 12, 2018. Pursuant to the warrant agreement, a warrantholder may exercise such warrants only for a whole number of shares of common stock. This means that only a whole warrant may be exercised at any given time by a warrantholder. No warrants will be exercisable for cash unless there is an effective and current registration statement covering the shares of common stock issuable upon exercise of the warrants and a current prospectus relating to such shares of common stock. Notwithstanding the foregoing, if a registration statement covering the shares of common stock issuable upon exercise of the Public Warrants is not effective within 90 days following the consummation of the Business Combination, warrant holders may, until such time as there is an effective registration statement and during any period when the Company shall have failed to maintain an effective registration statement, exercise warrants on a cashless basis pursuant to the exemption provided by Section 3(a)(9) of the Securities Act, provided that such exemption is available. If that exemption, or another exemption, is not available, holders will not be able to exercise their warrants on a cashless basis. In such event, each holder would pay the exercise price by surrendering the warrants for that number of shares of common stock equal to the quotient obtained by dividing (x) the product of the number of shares of common stock underlying warrants, multiplied by the difference between the exercise price of the warrants and the “fair market value” (defined below) by (y) the fair market value. The “fair market value” for this purpose will mean the average reported last sale price of the shares of common stock for the 5 trading days ending on the trading day prior to the date of exercise. The warrants will expire on February 22, 2023, the fifth anniversary of the completion of the Business Combination, at 5:00 p.m., New York City time, or earlier upon redemption or liquidation.

The warrants were originally issued in registered form under a warrant agreement between Continental, as warrant agent, and Forum. The warrant agreement provides that the terms of the warrants may be amended without the consent of any holder to cure any ambiguity or correct any defective provision, but requires the approval, by written consent or vote, of the holders of at least 50% of the then outstanding warrants in order to make any change that adversely affects the interests of the registered holders.

The exercise price and number of shares of common stock issuable on exercise of the warrants may be adjusted in certain circumstances including in the event of a stock dividend, extraordinary dividend or our recapitalization, reorganization, merger or consolidation. However, the warrants will not be adjusted for issuances of shares of common stock at a price below their respective exercise prices.

The warrants may be exercised upon surrender of the warrant certificate on or prior to the expiration date at the offices of the warrant agent, with the exercise form on the reverse side of the warrant certificate completed and executed as indicated, accompanied by full payment of the exercise price, by certified or official bank check payable to us, for the number of warrants being exercised. The warrant holders do not have the rights or privileges of holders of shares of common stock and any voting rights until they exercise their warrants and receive shares of common stock. After the issuance of shares of common stock upon exercise of the warrants, each holder will be entitled to one vote for each share held of record on all matters to be voted on by stockholders.

Under the terms of the warrant agreement, the Company agreed to use its best efforts to have declared effective a prospectus relating to the shares of common stock issuable upon exercise of the warrants and keep such prospectus current until the expiration of the warrants. However, the Company cannot assure that it will be able to do so and, if it does not maintain a current prospectus relating to the shares of common stock issuable upon exercise of the warrants, holders will be unable to exercise their warrants for cash and the Company will not be required to net cash settle or cash settle the warrant exercise.

 

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Warrant holders may elect to be subject to a restriction on the exercise of their warrants such that an electing warrant holder would not be able to exercise their warrants to the extent that, after giving effect to such exercise, such holder would beneficially own in excess of 9.8% of the shares of common stock outstanding.

No fractional shares will be issued upon exercise of the warrants. If, by reason of any adjustment made pursuant to the warrant agreement, upon exercise of the warrants, a holder would be entitled to receive a fractional interest in a share, the Company will, upon exercise, round up to the nearest whole number the number of shares of common stock to be issued to the warrant holder.

The Company’s Redemption Right

The Company may call the Public Warrants for redemption, in whole and not in part, at a price of $0.01 per warrant:

 

   

At any time during the exercise period,

 

   

Upon not less than 30 days’ prior written notice of redemption to each Public Warrant holder,

 

   

If, and only if, the reported last sale price of the shares of common stock equals or exceeds $18.00 per share (as adjusted for stock splits, stock dividends, reorganizations and recapitalizations), for any 20 trading days within a 30 trading day period ending on the third business day prior to the notice of redemption to Public Warrant holders; and

 

   

If, and only if, there is a current registration statement in effect with respect to the shares of common stock underlying the Public Warrants.

The right to exercise will be forfeited unless the Public Warrants are exercised prior to the date specified in the notice of redemption. On and after the redemption date, a record holder of a Public Warrant will have no further rights except to receive the redemption price for such holder’s Public Warrant upon surrender of such Public Warrant.

The redemption criteria for the Public Warrants have been established at a price which is intended to provide warrant holders a reasonable premium to the initial exercise price and provide a sufficient differential between the then-prevailing share price and the warrant exercise price so that if the share price declines as a result of a redemption call, the redemption will not cause the share price to drop below the exercise price of the Warrants.

If the Public Warrants are called for redemption as described above, the Company will have the option to require all holders that wish to exercise warrants to do so on a “cashless basis.” In such event, each holder would pay the exercise price by surrendering the warrants for that number of shares of common stock equal to the quotient obtained by dividing (x) the product of the number of shares of common stock underlying the warrants, multiplied by the difference between the exercise price of the warrants and the “fair market value” (defined below) by (y) the fair market value. The “fair market value” shall mean the average reported last sale price of the shares of common stock for the 5 trading days ending on the third trading day prior to the date on which the notice of redemption is sent to the holders of Public Warrants.

Unit Purchase Option

As part of its IPO, in April 2017 Forum sold to its primary underwriter, EBC, and its designees, for $100, a UPO to purchase up to a total of 1,125,000 Units exercisable at $10.00 per Unit. The option represents the right to purchase up to 1,237,500 shares of common stock (which includes 112,500 shares which will be issued for the Rights included in the Units) and warrants to purchase 562,500 shares of common stock at $11.50 per share for an aggregate maximum amount of $6,468,750. Forum accounted for the UPO, inclusive of the receipt of $100 cash payment, as an expense of its IPO resulting in a charge directly to stockholders’ equity.

Upon completion of the Merger, the UPO pertains to the purchase of ConvergeOne common stock and the terms and conditions remain the same.

The UPO may be exercised for cash or on a cashless basis, at the holder’s option, at any time during the period commencing April 6, 2018 (the first anniversary of the effective date of the registration statement filed in connection with the Forum IPO) and will terminate on April 6, 2022 (the fifth anniversary of the effective date of the registration statement filed in connection with the Forum IPO).

 

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The UPO grants to holders demand and “piggy back” registration rights for periods of five and seven years, respectively, from April 6, 2017 (the effective date of the registration statement filed in connection with the Forum IPO) with respect to the registration under the Securities Act of the securities directly and indirectly issuable upon exercise of the UPO. EBC and/or its designees may only make a demand registration (i) on one occasion and (ii) during the five year period beginning on April 6, 2017, the effective date of the registration statement filed with the SEC for the Forum IPO. The Company will bear all fees and expenses attendant to registering the securities, other than underwriting commissions, which will be paid for by the holders themselves.

The exercise price and number of Units issuable upon exercise of the UPO may be adjusted in certain circumstances including in the event of a stock dividend, or recapitalization, reorganization, merger or consolidation. However, the UPO will not be adjusted for issuances of common stock at a price below the Company’s exercise price. The Company has no obligation to net cash settle the exercise of the UPO or the Rights or warrants underlying the UPO. The holder of the UPO will not be entitled to exercise the UPO or the Rights or warrants underlying the UPO unless a registration statement covering the securities underlying the UPO is effective or an exemption from registration is available. If the holder is unable to exercise the UPO or underlying Rights or warrants, the UPO, Rights or warrants, as applicable, will expire worthless.

The underwriters had performed all of their services in April 2017 and thus the fair value measurement of the UPO at the date of issuance by Forum was a one-time, nonrecurring measurement that is not subject to re-measurement over the life of the UPO.

Registration Rights

In April 2017, the Sponsor entered into a registration rights agreement with Forum pursuant to which the Sponsor was granted certain rights relating to the registration of shares of common stock and warrants held by it and its transferees. In February 2018, upon the Closing of the Merger, the Company, certain C1 Securityholders, including the Company’s executive officers and Clearlake, and the Sponsor entered into an amended and restated registration rights agreement, pursuant to which such parties hold registration rights with respect to shares of common stock issued as merger consideration under the Merger Agreement, including any Earnout Stock Payments, as well as shares of common stock held by the Sponsor and its transferees, or issuable upon the exercise of warrants by the Sponsor (collectively, the “Registration Rights”). Stockholders holding a majority-in-interest of such registrable securities are entitled to make a written demand for registration under the Securities Act of all or part of their registrable securities. Subject to certain exceptions, such stockholders also have certain “piggy-back” registration rights with respect to registration statements filed by the Company, as well additional rights to provide for registration of registrable securities on Form S-3 and any similar short-form registration statement that may be available at such time. The Company will bear the expenses incurred in connection with the filing of any such registration statements described above.

The Registration Rights do not meet the definition of a registration payment arrangement as there are no terms that require the Company to transfer consideration to the various securityholders if a registration statement is not declared effective or effectiveness is not maintained.

Common Stock Repurchase Program

On August 22, 2018, the Company’s Board of Directors approved a common stock repurchase program whereby the Company is authorized to purchase up to a maximum of $25 million of its common stock, subject to compliance with applicable law and the limitations in the Company’s credit facilities on stock repurchases.

The authorization allows repurchases from time to time in the open market or in privately negotiated transactions. The amount and timing of repurchases made under the repurchase program will depend on a variety of factors, including available liquidity, cash flow and market conditions. Shares can be purchased through the repurchase program through August 2020, unless extended or shortened by the Company’s Board of Directors. The program does not obligate the Company to acquire any particular amount of common stock and the program may be modified or suspended at any time at the Company’s discretion. The repurchases would be funded from available working capital and are subject to compliance with the terms and limitations of the Company’s credit facilities.

Pursuant to its common stock repurchase program, during the three and nine months ended September 30, 2018, the Company repurchased in the open market 1,066,946 shares of its common stock at a total cost of approximately $10,044,000 (an average price of $9.41 per share). As of September 30, 2018, the maximum dollar value of shares that may be purchased under the Repurchase Program is approximately $14,956,000. All shares delivered from these repurchases have been placed into treasury stock.

 

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8. Stock-based Compensation

2014 Equity Incentive Plan

Prior to the Merger, C1 issued equity awards for compensation purposes to employees, directors and consultants under the Company’s 2014 Equity Incentive Plan, which provided for the issuance of incentive stock options, nonqualified stock options, stock appreciation rights, restricted shares, and other awards. Stock-based compensation expense was computed based on the grant date fair values of those awards and periodic re-measurement to current fair value was done each reporting period for one non-employee stock award. The fair value of the stock awards was amortized as compensation expense over the corresponding vesting periods until the awards were fully vested.

All outstanding stock awards were accelerated and vested in full just prior to the Closing of the Merger, which resulted in a modification to the vesting terms of the Company’s stock awards. A portion of the modified stock awards were subject to re-measurement to current fair value, as a direct result of the modification, which resulted in an incremental $583,000 of fair value to be recorded as stock-based compensation expense over the life of the awards. All of the Company’s stock awards were immediately fully vested, canceled and exchanged for cash and shares of common stock upon completion of the Merger. As a result, the full amount of previously unrecognized stock-based compensation expense of $4,842,000, including the incremental $583,000, was recognized in full during the nine months ended September 30, 2018.

No further awards will be made pursuant to the 2014 Equity Incentive Plan.

2018 Equity Incentive Plan

The 2018 Equity Incentive Plan (the “Equity Incentive Plan”) was approved by the Company’s board of directors and stockholders in February 2018, and became effective upon the Closing of the Merger. The Equity Incentive Plan provides for the grant of incentive stock options, or ISOs, nonstatutory stock options, or NSOs, stock appreciation rights, restricted stock awards, restricted stock unit awards, performance-based stock awards, and other forms of equity compensation, or collectively, stock awards, all of which may be granted to the Company’s employees, including officers, non-employee directors and consultants. Additionally, the Equity Incentive Plan provides for the grant of performance cash awards. ISOs may be granted only to employees. All other awards may be granted to employees, including officers, and to non-employee directors and consultants.

The Company granted 5,039,000 options during the three and nine months ended September 30, 2018 with an average exercise price of $11.49 per share.

2018 Employee Stock Purchase Plan

The 2018 Employee Stock Purchase Plan (the “ESPP”) was approved by the Company’s board of directors and stockholders in February 2018, and became effective upon the Closing of the Merger. The ESPP provides a means by which the Company’s employees may be given an opportunity to purchase shares of the Company’s common stock. The rights to purchase common stock granted under the ESPP are intended to qualify as options issued under an “employee stock purchase plan” as that term is defined in Section 423(b) of the Code.

The Board initially authorized an Offering beginning on May 1, 2018 and ending on June 30, 2018 (the “Initial Offering”). Following the end of the Initial Offering, a new Offering (“Subsequent Offering”) will automatically begin on the day that immediately follows the conclusion of the preceding Offering. Each Subsequent Offering will be approximately six months long, and will consist of one Purchase Period ending on June 30 and December 31 each year. The Board may change the terms and dates of Subsequent Offerings and Purchase Periods pursuant to the terms of the Purchase Plan.

The Initial Offering consisted of one Purchase Period, ending on June 30, 2018. The Initial Offering resulted in 57,293 shares being issued in July, 2018.

Options

The Company’s option awards under the 2018 Equity Incentive Plan vest and become exercisable over a five-year period; 20% vest on the first annual anniversary of issuance and the balance vest ratably monthly over the remaining four-year period, subject to the optionholders continuous service as of each such vesting date.

 

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Equity awards were valued at their estimated fair value at the time of issuance and are being amortized as compensation expense on a straight-line basis over the period in which they are earned by the individuals. The grant-date fair value of our option grants was calculated using the Black-Scholes option-pricing model with the following weighted-average assumptions:

 

     2018 Equity
Incentive Plan
   2014 Equity
Incentive Plan

Expected life (in years) (1)

   6.32 - 8.16    8.8

Expected volatility (2)

   31.24% - 31.98%    42.80%

Dividend yield (3)

   0.87%    0.00%

Risk-free interest rate (4)

   2.80% - 2.84%    2.10%

 

(1)

The simplified method was used for awards with an exercise price equal to the market value on the measurement date; since, historical exercise data is not available to provide a reasonable basis to estimate future exercise patterns.

(2)

The expected stock price volatility is based on the average of the historical volatility over the expected term of public companies in similar industries.

(3)

We used annualized dividend of $0.08/share based on paid quarterly dividends of $0.02/share to calculate dividend yield.

(4)

The risk-free interest rate is based on U.S. Treasury yields in effect at the time of grant over the expected term of the option.

A summary of the stock option activity for the 2014 Equity Incentive Plan is presented below:

 

     2014 Equity Incentive Plan  
     Total Outstanding options  
            Weighted-average      Aggregate
Intrinsic Value
 
     Number of options      Exercise price      Grant-Date
Fair value
     Remaining
Contract Term
 

Balance, December 31, 2017

     1,528,000      $  0.96      $  0.54        7.6      $  7,319,000  

Exercised

     1,528,000        0.96        0.54        7.6        7,319,000  
  

 

 

             

Balance post Merger, February 21, 2018

     —                
  

 

 

             

A summary of the stock option activity for the 2018 Equity Incentive Plan is presented below:

 

     2018 Employee Stock Purchase Plan  
     Total Outstanding options  
            Weighted-average      Aggregate
Intrinsic Value (1)
 
     Number of options      Exercise price      Grant-Date
Fair value
     Remaining
Contract Term
 

Balance, February 21, 2018

     —        $ —        $ —          —        $ —    

Granted or issued

     5,039,000        11.49        2.73        9.87        180,000  
  

 

 

             

Balance, September 30, 2018

     5,039,000      $  11.49      $  2.73        9.87      $  180,000  
  

 

 

             

 

(1)

Aggregate intrinsic value represents the difference between the estimated fair value of the underlying common stock and the exercise price of outstanding, in-the-money options at the date of measurement.

 

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Expense

Stock-based compensation expense recognized for all equity awards for the three and nine months ended September 30 is as follows (in thousands):

 

     Three Months Ended      Nine months ended  
     September 30,      September 30,  
(In Thousands)    2018      2017      2018      2017  

Stock Options- 2014 Equity Incentive Plan

   $ —        $  191      $  4,842      $ 521  

Stock Options- 2018 Equity Incentive Plan

     381        —          381        —    

Employee Stock Purchase Plan

     37        —          99        —    

Earnout Consideration

     681        —          2,208        —    
  

 

 

    

 

 

    

 

 

    

 

 

 
   $  1,099      $ 191      $  7,530      $ 521  
  

 

 

    

 

 

    

 

 

    

 

 

 

Reported as:

           

Cost of revenue

   $ 18      $ —        $ 18      $  —    

Sales and marketing

     526        —          1,953        —    

General and administrative

     555        191        5,559        521  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,099      $ 191      $ 7,530      $ 521  
  

 

 

    

 

 

    

 

 

    

 

 

 

Income tax benefit for share-based compensation

   $ 269      $ 8      $ 858      $ 19  
  

 

 

    

 

 

    

 

 

    

 

 

 

Approximately $918,000 of the $2,208,000 of deemed compensation expense from the earnout for the nine months ended September 30, 2018 is recorded in the condensed consolidated statement of stockholders’ equity (deficit) and the remainder is recorded in the earnout consideration payable on the condensed consolidated balance sheet.

9. Net Income (Loss) per Share

Prior to the Merger

Prior to the Merger, C1 had two classes of common stock, Class A and Class B. The Company applied the two-class method of computing net income (loss) per share in which net income (loss) is allocated to the two classes of common stock in the same fashion as dividends are distributed. The holders of the Class A common stock were entitled to receive dividends in preference to the holders of the Class B common stock. After the payment of the Class A preferential dividends, the holders of the Class A and Class B common stock were entitled to share equally, on a per share basis, in all dividends declared by the Board of Directors. As a result of a cash dividend paid in October 2016, the holders of the Class A common stock were no longer entitled to receive any preferential dividends or preferential amounts in the event of any liquidation, dissolution, winding up or change of control transaction. Shares of Class B common stock were considered participating securities subsequent to the dividend payment in October 2016 for computation of net income (loss) per share. However, Class B common stockholders did not participate in a net loss.

In the Company’s consolidated statement of operations for the three and nine months ended September 30, 2017, the Class B common stockholders did not participate in the net loss. There were no Class A dilutive securities for the three and nine months ended September 30, 2017. As a result, diluted net loss per common share is the same as basic net loss per common share for the three and nine months ended September 30, 2017.

For the three and nine months ended September 30, 2017, the Company has retroactively adjusted the weighted-average number of shares of common stock outstanding to reflect the Merger Exchange Ratio as described in Notes 2 and 7.

There were no Class A dilutive securities for the period from January 1, 2018 to the Merger date.

Post-Merger

Basic net income (loss) per share is computed by dividing net income (loss) available to common shareholders, which is computed by subtracting the Earnout Consideration from net income, by the weighted-average number of shares of common stock outstanding during the period, as adjusted for the Sponsor Earnout Shares that are not participating securities until vested, and the effect of shares that were contingently issuable for which the contingency has been resolved, whether or not those shares have been issued. The contingently issuable shares of common stock pertain to those shares to be issued and vested when the Company meets the Earnings Targets established as part of the Merger Agreement as described in Note 2—Business Combination/Merger.

Diluted net income (loss) per share is computed by dividing net income (loss) available to common shareholders, which is computed by subtracting the Earnout Consideration from net income, by the weighted-average number of shares of common stock outstanding during the period, as adjusted for the Sponsor Earnout Shares that are not participating securities until vested, the effect of shares that were contingently issuable for which the contingency has been resolved, whether or not those shares have been issued yet,

 

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and any dilutive equity instruments (warrants and options) that are “in-the-money”. The effect of the contingently issuable shares and dilutive equity instruments are included for the shorter of the date the underlying contracts were in existence to the end of the reporting period or the entire reporting period. However, diluted net loss per share excludes all dilutive potential shares if their effect is anti-dilutive.

For the three months and nine ended September 30, 2018, the Company adjusted the weighted-average number of C1 Class A common shares outstanding from January 1, 2018 to the Merger date of February 22, 2018, to retroactively adjust those share amounts to reflect the Merger Exchange Ratio as described in Notes 2 and 7.

As of September 30, 2018, there were equivalent shares of common that were evaluated for purposes of including in weighted-average shares outstanding:

 

     Three months
ended
     Nine months
ended
 

New shares related to Earnout Stock Payments

     2,581,250        7,743,750  

Vesting of Sponsor Earnout Shares

     718,750        2,156,250  

Equivalent shares of common stock pertaining to Earnout Cash Payments

     10,622,318        10,622,318  
  

 

 

    

 

 

 
     13,922,318        20,522,318  
  

 

 

    

 

 

 

The actual amount of common share equivalents that were excluded from the calculation of diluted net loss per share for the three and nine months ended September 30, 2018, as their effect was anti-dilutive:

 

     Three months
ended
     Nine months
ended
 

All of above from date of Merger through end of period

     13,922,318        16,613,305  

Less effect of period which is included in WAS basic

     (35,870      (4,460,440
  

 

 

    

 

 

 
     13,886,448        12,152,865  
  

 

 

    

 

 

 

Additionally, all of the Company’s outstanding options and warrants to purchase common stock and the UPO were excluded from the computation of weighted-average shares outstanding for dilutive purposes during the three and nine months ended September 30, 2018, due to the instruments having exercise prices in excess of the market value of the Company’s common stock. These instruments could result in dilution in future periods.

 

   

There were 5,039,000 options outstanding with an average exercise price of $11.49 per share at September 30, 2018.

 

   

There were warrants outstanding for the purchase of 1,354,810 shares of common stock at $11.50 per share at September 30, 2018.

 

   

The UPO that is outstanding at September 30, 2018 represents the right to purchase 1,125,000 Units at $10.00 per share, which would result in the issuance of 1,237,500 shares of common stock and warrants for the purchase of 562,500 shares of common stock at $11.50 per share.

 

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The following is a summary of the information used to compute basic and diluted net loss per common share (in thousands, except per share amounts):

 

     Three months ended      Nine months ended  
     September 30,      September 30,  
     2018      2017      2018      2017  

Numerator:

           

Net income (loss)

   $ 14,498      $ 1,303      $ 15,843      $ (13,185

Earnout consideration

     (63,041      —          (187,047      —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Net loss available to common shareholders

   $ (48,543    $ 1,303      $ (171,204    $ (13,185
  

 

 

    

 

 

    

 

 

    

 

 

 

Denominator:

           

Weighted-average shares outstanding during the
period - basic and diluted (1)

     75,507,802        39,860,619        67,538,373        39,867,488  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net loss per common share:

           

Basic and diluted (1)

   $ (0.64    $ 0.03      $ (2.53    $ (0.33
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)

Share amounts were retroactively adjusted for the reverse recapitalization (see Note 2)

10. Fair Value Measurements

For certain of the Company’s financial instruments, including cash, trade accounts receivable, accounts payable, and accrued expenses, the carrying value approximates fair value due to the short-term maturities of these instruments.

The fair value of the Company’s long-term debt as of September 30, 2018 and December 31, 2017 approximates the carrying value of $718,325,000 and $582,325,000, respectively. The Company uses significant other unobservable inputs to estimate fair value (Level 3 of the fair value hierarchy) of long-term debt based on the present value of future cash flows, interest rates, maturities and collateral requirements available for companies with similar credit ratings.

For certain of the Company’s nonfinancial assets, including goodwill, intangible assets and property and equipment, the Company may be required to assess the fair values of these assets, on a recurring or nonrecurring basis, and record an impairment if the carrying value exceeds the fair value. In determining the fair value of these assets, the Company may use a combination of valuation methods, which include Level 3 inputs. For the periods presented, there were no impairment charges. See Notes 1—Nature of Business and Summary of Significant Accounting Policies and 5—Goodwill and Finite-Life Intangible Assets for additional information regarding the Company’s determination of fair value regarding goodwill and indefinite-lived intangible assets.

In conjunction with the acquisitions of ASI and Advantel discussed in Note 3—Business Acquisitions, the Company used a combination of valuation methods which include Level 3 inputs in determining the fair values of the assets and liabilities acquired as well as the fair value of the consideration transferred.

11. Major Vendors and Economic Dependence

The Company has numerous technology partners whose communication products are purchased and resold. Although the Company purchases from a diverse vendor base, products manufactured by two of our vendors, Avaya Inc. (“Avaya”) and Cisco Systems, Inc. (“Cisco”), represented the majority of the Company’s technology offerings revenue.

Avaya-related revenue represented 25% and 16% for the three months ended September 30, 2018 and 2017; and, 22% and 20% for the nine months ended September 30, 2018 and 2017, respectively. Cisco-related revenue represented 44% and 43% for the three months ended September 30, 2018 and 2017; and, 39% and 37% for the nine months ended September 30, 2018 and 2017, respectively.

The Company has one distributor that supplies a significant portion of its Avaya communication products.

At September 30, 2018 and December 31, 2017, the Company owed $25,799,000 and $28,146,000, respectively, to this distributor.

12. Operating Leases

The Company leases office and warehouse space and vehicles under operating lease agreements that expire on various dates through 2026.

 

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Approximate future minimum annual rental commitments under these operating leases as of September 30, 2018 are as follows (in thousands):

 

Years Ending December 31,

   Amount  

Remainder of 2018

   $ 2,532  

2019

     7,950  

2020

     6,455  

2021

     5,411  

2022

     4,801  

2023 and thereafter

     13,998  
  

 

 

 

Total

   $  41,147  
  

 

 

 

Rent expense was $2,886,000 and $8,286,000 for the three and nine months ended September 30, 2018 and $1,255,000 and $3,417,000 for the three and nine months ended September 30, 2017, respectively.

13. Employee Benefit Plans

The Company sponsors defined contribution plans for substantially all employees. Annual Company contributions under the plans are discretionary. Company contribution expense during the three and nine months ended September 30, 2018 was $1,187,000 and $4,216,000, respectively. Company contribution expense during the three and nine months ended September 30, 2017 was $861,000 and $2,811,000, respectively.

14. Income Taxes

On December 22, 2017, H.R. 1, originally known as the Tax Cuts and Jobs Act was signed into law making significant changes to the Internal Revenue Code. Changes include, but are not limited to, a permanent reduction of the U.S. corporate income tax rate from 35% to 21% effective January 1, 2018.

Various factors can create volatility in the Company’s quarterly tax provision and quarterly effective income tax rate (after discrete items). Certain factors include permanent tax items, discrete items recognized in the period, as well as the actual amount of income or loss before income taxes.

The Company’s estimated annual effective tax rate (excluding discrete items) for the nine months ended September 30, 2018 and 2017 is 106.5% and 31.5%, respectively. The Company’s annual effective tax rate differs from the federal statutory rate due to state taxes and non-deductible permanent items. The increase in the annual effective tax rate from the prior year is primarily driven by two components. One is that the Company experienced significant or unusual discrete benefit items that primarily included a bargain purchase gain not recognized for tax purposes and excess tax benefits associated with stock-based compensation expense. The bargain purchase gain and the related tax impact are considered unusual items and not included when determining ordinary income from operations or the estimated annual effective tax rate. This component, coupled with the impact of significant non-deductible permanent tax items when there is low pre-tax ordinary book income from operations, are having the greatest impacts on the increase in the estimated annual effective tax rate. These increases are slightly offset by the decrease in the U.S. corporate income tax rate on income or loss before taxes.

The Company’s effective income tax rate (after discrete items and including the bargain purchase gain) for the nine months ended September 30, 2018 and 2017 is 454.5% and 32.4%, respectively. The increase in the effective income tax rate from the prior period is driven by a combination of two factors. One factor is that the Company experienced significant or unusual discrete benefit items related to the bargain purchase gain and stock-based compensation expense. The Company’s estimated annual effective tax rate, as noted above, applied to year-to-date ordinary loss before income taxes (and before the bargain purchase gain) is greater than 100% and, when coupled with the impact of the excess tax benefits associated with stock-based compensation, result in significant or unusual discrete benefit items of $14.1 million in the current period. The other factor is that the significant non-deductible permanent tax items have a greater impact to the increase in the effective income tax rate when combined with low year-to-date pre-tax book loss.

Certain of the Company’s historical net operating losses are subject to Internal Revenue Code Section 382 limitations which have been considered in determining the amount of available net operating loss carryforwards. The Company has federal net operating loss carryforwards of $4.3 million that begin to expire in 2031 if not utilized. The Company also has $21.7 million of various state net operating loss carryforwards that begin to expire in 2020 if not utilized.

 

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Uncertain Tax Positions

The Company recognizes the tax effects of an uncertain tax position only if it is more likely than not to be sustained based solely upon its technical merits at the reporting date. Interest and penalties associated with unrecognized tax benefits are recorded within income tax expense. The unrecognized tax benefit is the difference between the tax benefit recognized and the tax benefit claimed on the Company’s income tax return. The Company has reviewed its prior year returns and believes that all material tax positions in the current and prior years have been analyzed and properly accounted for and that the risk that additional material uncertain tax positions have not been identified is remote.

During the nine months ended September 30, 2018, the previously recorded uncertain tax position was settled with the IRS unfavorably and reclassified to current income taxes. There was no overall impact to the effective tax rate as all liabilities were previously recorded.

The Company’s federal income tax returns remain open to examination for 2014 through 2017 and certain of the Company’s state income tax returns remain open to examination for 2013 through 2017.

15. Segment Reporting

Management has concluded that our chief operating decision maker (CODM) consists of both our chief executive officer and chief financial officer. The Company’s CODMs collectively review the entire organization’s consolidated results as a whole on a monthly basis to evaluate performance and make resource allocation decisions. Management views the Company’s operations and manages its business as one operating segment.

Geographic Areas

Sales to customers outside of the United States are not material for any of the periods presented. Additionally, the Company does not have long-lived assets outside of the United States.

Revenue by Technology Market

The following table presents total technology offerings revenue and services revenue by technology market, based on the Company’s internal classification of revenue (in thousands):

 

     Three Months Ended      Nine months ended  
     September 30,      September 30,  
     2018      2017      2018      2017  

Technology Offerings

           

Collaboration

   $ 86,402      $ 63,047      $ 242,421      $ 159,246  

Enterprise Networking, Data Center, Cloud and Security

     107,105        57,986        289,702        155,955  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $  193,507      $  121,033      $ 532,123      $  315,201  
  

 

 

    

 

 

    

 

 

    

 

 

 

Services

           

Collaboration

   $ 178,235      $ 104,164      $ 480,810      $ 250,779  

Enterprise Networking, Data Center, Cloud and Security

     33,012        20,215        89,173        53,720  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 211,247      $ 124,379      $ 569,983      $ 304,499  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

           

Collaboration

   $ 264,637      $ 167,211      $ 723,231      $ 410,025  

Enterprise Networking, Data Center, Cloud and Security

     140,117        78,201        378,875        209,675  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 404,754      $ 245,412      $  1,102,106      $ 619,700  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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16. Related-Party Transactions

In June 2014, the Company entered into a Management and Monitoring Services Agreement with Clearlake, pursuant to which Clearlake provided the Company advisory services and received fees and reimbursements of related out-of-pocket expenses. For the three and nine months ended September 30, 2018, the expense under the agreement was nil and $221,000 respectively. For the three and nine months ended September 30, 2017, the expense under the agreement was $375,000 and $1,125,000, respectively, which $375,000 was included in accrued expenses at September 30, 2017. In connection with the Merger, this agreement was terminated.

On August 17, 2017, the Company granted 530,772 options to purchase the Company’s Class B Common Stock to a newly appointed board member. On September 25, 2017, the board member early exercised the options for a total exercise price of $1,805,000 with payment in the form of a Recourse Promissory Note. The note bore interest at 2.6% and was paid in full upon the Closing of the Merger.

 

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Item 2. – Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to our management. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “goal,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “project,” “predict,” “potential” and similar expressions intended to identify forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance, time frames or achievements to be materially different from any future results, performance, time frames or achievements expressed or implied by the forward-looking statements. We discuss many of these risks, uncertainties and other factors in this Quarterly Report on Form 10-Q in greater detail under the heading “Risk Factors.” Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this filing. You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect. We hereby qualify our forward-looking statements by these cautionary statements. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

The following discussion and analysis provides information management believes to be relevant in understanding the financial condition and results of operations of ConvergeOne Holdings, Inc. and its subsidiaries (“ConvergeOne,” the “Company,” “we,” “us,” or “our”). The discussion should be read in conjunction with both our condensed consolidated financial statements and related notes included in Part I, Item 1 - “Financial Statements,” and Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Registration Statement on Form S-1/A filed on April 24, 2018.

Prior to February 22, 2018, we were known as Forum Merger Corporation. On February 22, 2018, we completed the Business Combination, with C1 Investment Corp., a private company. For accounting purposes, Forum Merger Corporation was deemed to be the acquired entity in the Merger.

Overview

We are a leading IT services provider of collaboration and technology solutions for large and medium enterprises. We serve clients through our comprehensive engagement model which includes the full lifecycle of services from consultation and design through implementation, optimization, and ongoing support. Our deep technical expertise enables us to deliver complex, multi-vendor solutions across a number of delivery models, including on-premise and in private, hybrid, C1 Cloud, and public cloud environments. We served over 7,200 clients in 2017, which includes clients served by companies we acquired in 2017. From 2015 to 2017, we served 57% of the Fortune 100, 43% of the Fortune 500, and 36% of the Fortune 1000, which includes clients served in the same period by companies we acquired in 2017 and 2015.

Our technical expertise and client-centric culture have led to long-standing and expanding client relationships. With approximately 1,700 highly skilled engineers and consulting professionals and approximately 360 sales professionals, we are able to deliver customized services and technology offerings to address the specific needs of our clients. Additionally, among our top 100 clients based on 2017 revenue, we have an average tenure of more than nine years. We generated 93% of our total revenue in 2017 from clients we served in a prior year, excluding the impact of our 2017 acquisitions.

We design thousands of solutions each year across our core technology markets: (i) collaboration and (ii) enterprise networking, data center, cloud, and security. Collaboration is primarily comprised of software-centric unified communications technology, which enables communication anywhere on any device, and our customer engagement applications which deliver a personalized and omni-channel experience for our clients’ end customers. Our other core technology markets, enterprise networking, data center, cloud, and security, focus on the critical software and hardware IT infrastructure to enable our clients to securely process and store the applications and information they need to conduct their business. Our solutions are a combination of our professional services and technology offerings and are complemented by our industry-leading managed, cloud, and maintenance services.

For the nine months ended September 30, 2018 and 2017, 52% and 49% of our total revenue, respectively, was derived from professional and managed, cloud, and maintenance services and 48% and 51% was derived from technology offerings. For the nine months ended September 30, 2018 and 2017, 66% of our total revenue was derived from our services and technology offerings in the collaboration market. The remaining 34% of our total revenue was derived from our enterprise networking, data center, cloud, and security services and technology offerings. In 2018, we acquired Arrow Systems Integration, Inc. (“ASI”) and Advantel, Inc. (“Advantel”), and in 2017, we acquired Annese & Associates, Inc. (“Annese ”), SPS Holdco, LLC (“SPS ”), Rockefeller Group Technology Solutions, Inc. (“RGTS ”) and AOS, Inc. (“AOS ”), which significantly affect comparability of our 2018 and 2017 results of operations and metrics. Please see the section below titled “ Recent Acquisitions ” for further information regarding these acquisitions.

 

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Services

During the nine months ended September 30, 2018 and 2017, 32% and 35% of our services revenue, respectively, came from professional services and 68% and 65%, respectively, was derived from managed, cloud, and maintenance services. For the nine months ended September 30, 2018 and 2017, services in the collaboration market comprised 84% and 82%, respectively, of our services revenue.

Technology Offerings

For the nine months ended September 30, 2018 and 2017, 46% and 51% of our technology offerings revenue, respectively, was generated by technology offerings in the collaboration market.

Our Corporate History

Since our founding in 1993, our client-centric culture has defined how we operate. We have worked, since the beginning, to deliver innovative multi-vendor services and solutions to solve our clients’ IT challenges and to help them grow. Our business model has driven our internal organic growth while at the same time allowing us to add capabilities and vendor relationships through both internal investments and acquisitions.

See further discussion in our Registration Statement on Form S-1/A filed on April 24, 2018.

Recent Acquisitions

In September 2018, we acquired Advantel for cash consideration of $16.7 million. The acquisition increases our multivendor collaboration technologies, support and services business and expands our geographic presence in the California market.

In March 2018, we acquired ASI for cash consideration of $28.4 million. The acquisition increases our collaboration business.

In December 2017, we acquired AOS for cash consideration of $65.2 million. The acquisition increases our presence in the Midwest and broadens our portfolio of collaboration services and solutions capabilities.

In September 2017, we acquired RGTS for cash consideration of $20.9 million. The acquisition increases our presence in the New York City market and brings additional capabilities in collaboration and cloud.

In August 2017, we acquired SPS for cash consideration of $51.1 million. The acquisition brought additional solutions and services capabilities in collaboration and video.

In July 2017, we acquired Annese for cash consideration of $24.5 million. The Annese acquisition brought additional solutions and service capabilities in enterprise networking, security, collaboration, and cloud, backed by four decades of experience and expertise.

Factors Affecting our Operating Performance

We believe the following trends and factors may have an impact on our operating performance:

Evolution of cloud-based collaboration solutions. Within the broader unified communications and customer engagement market, cloud and hosted solutions are expected to grow faster than on-premise solutions as organizations increasingly look for scalable, agile, and mobile-enabled solutions while simultaneously seeking to reduce capital costs. As a result, enterprises are shifting from on-premise, hardware infrastructure to software-centric hosted and cloud solutions. Given our ability to deliver collaboration and other technology offerings over private, hybrid, C1 Cloud, and public cloud environments, we believe we are well positioned to benefit from these trends and expect these trends to drive growth in our managed, cloud, and maintenance services business, which typically have multi-year contractual terms and high renewal rates. We calculate renewal rate as the annual contract value (“ACV ”) of contracts renewed as a percentage of the total ACV up for renewal in an applicable period. This can result in a renewal rate greater than 100% in the event that a contract renews at a higher value than the expiring contract value. Additionally, we exclude customer bankruptcies, site closures, short-term contracts and other adjustments in the calculation of the renewal rate.

 

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Growing complexity of technology solutions and expansion of our services business mix. Due to increased technology and vendor complexity, we are seeing an increased demand for multi-vendor IT solutions. As a result, enterprises are increasingly seeking the assistance of IT service providers who have the expertise to consult, design, integrate, and manage their technology solutions and platforms. Given our technical expertise, leading managed, cloud, and maintenance services, and customized services approach, we expect that our services offerings will comprise a higher percentage of our revenue in the future, which would have a favorable impact on our gross margins.

Our ability to increase penetration of our existing, long-standing clients. Our future growth will depend in part on our ability to expand sales of our services and solutions to our existing clients. For 2017, 93% of our total revenue was derived from clients we served in a prior year, excluding the impact of our 2017 acquisitions. We believe we are well positioned to identify new opportunities to expand or sell new services and solutions to our existing clients. For 2017, 66.3% of our total revenue came from collaboration solutions, and we believe there are additional opportunities to sell our other technology offerings, including enterprise networking, data center, cloud, and security into our existing client base. In addition, we believe there is opportunity to further penetrate our existing client base with our managed, cloud, and maintenance services.

Customer adoption of our expanding technology offerings and services. We plan to continue to invest in the development of our innovative and client-centric services and solutions. As technology becomes increasingly complex and clients look to reduce their capital cost, we believe our clients will transition from maintenance to managed services, and ultimately to cloud services. Most recently, we added advanced monitoring capabilities for our managed services platform, developed our own cloud hosted capabilities, and, through acquisitions, significantly bolstered our security technical expertise, offering end-to-end network and data security services and solutions to our clients. We believe that customer adoption of our cloud and security technology offerings and managed and hosted services can drive growth in our business over time.

Continue to maintain relationships with key technology partners. Through our leading professional services capabilities, we design thousands of solutions a year for our clients across our core technology markets: (i) collaboration and (ii) enterprise networking, data center, cloud, and security. We are vendor agnostic, as we enjoy strong relationships with more than 300 leading and next-generation technology partners. In order to retain access to the best-of-breed solutions and offer the latest technology solutions, we need to continue to maintain our relationships with existing key technology partners and develop new relationships.

Impact of Avaya Restructuring. Avaya, which was one of our largest vendors as a percentage of our technology offerings revenue in 2018 and 2017, filed for reorganization under Chapter 11 in January 2017, filed its preliminary plan of reorganization in April 2017, and had its Chapter 11 plan of reorganization approved by the Bankruptcy Court in November 2017. As a result of Avaya’s restructuring, new or existing clients have, in some cases, elected to delay purchasing decisions with respect to Avaya technology offerings or have chosen to replace existing Avaya technology offerings with the technology offerings of other vendors. Delays in customer purchasing decisions, or an election by our clients to purchase alternative technology offerings from us or from other providers, has resulted in decreased technology offerings revenue in 2017, and could result in lower revenues and gross profits or margins or otherwise have an adverse effect on our business in the future. Management continues to evaluate the impact that Avaya’s reorganization has had on our results of operations and financial condition.

Components of Results of Operations

There are a number of factors that impact the revenue and margin profile of the services and technology offerings we provide, including, but not limited to, solution and technology complexity, technical expertise requiring the combination of products and types of services provided, as well as other elements that may be specific to a particular client solution.

Revenue

Our revenue consists of the sale of our technology offerings and services. We separately present technology offerings and services revenue, along with the associated cost of revenue, in our consolidated statements of operations.

Technology Offerings Revenue

Technology offerings revenue includes revenue from the sale of hardware and software products and is generally recognized on a gross basis with the selling price to the client recorded as revenue because we act as the primary obligor under these contracts. Revenue is generally recognized when the title and risk of loss are passed to the customer, there is persuasive evidence of an arrangement for sale, the sales price is fixed and determinable, and collectability is reasonably assured. Hardware and software items can be delivered to our clients in a variety of ways including shipping from our facilities, via drop-shipment by the vendor or distributor, or via electronic delivery for software licenses.

 

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Services Revenue

Services revenue includes:

Revenue for Professional Services. Revenue for professional services is generally recognized when professional services are performed and all obligations have been substantially met. The majority of professional services revenue is fixed price.

Revenue for Managed, Cloud, and Maintenance Services. Revenue for managed and cloud services is generally recognized on a straight-line basis over the contractual term of the arrangements, which is consistent with the timing of services rendered. Revenue from the sale of third-party retail maintenance contracts is recognized net of the related cost of revenue. In third-party retail maintenance contracts, all services are provided by third-party providers and, as a result, we are acting as an agent and not considered the primary obligor. As we are under no obligation to perform additional services, revenue is recognized at the time of sale. Revenue from the sale of third-party wholesale maintenance contracts is recognized on a gross basis at the time of sale with the selling price to the client recorded as revenue and the acquisition cost recorded as cost of revenue. Based upon the evaluation of indicators for gross and net reporting, we have concluded that we are acting as a principal in these contracts.

Cost of Revenue, Gross Profit, and Gross Margin

Technology Offerings Gross Profit

Technology offerings gross profit is equal to technology offerings revenue less the acquisition cost of the product, recorded as cost of revenue, net of technology partners and distributor rebates. Technology offerings gross profit is impacted by the complexity of hardware and software sold in our solutions, as well as the mix of product type with generally higher gross profits coming from the sale of collaboration products.

Services Gross Profit

Services gross profit is equal to services revenue less cost of revenue associated with services.

Professional Services Gross Profit. Cost of revenue associated with professional services includes the compensation, benefits, and other costs associated with our delivery and project management engineering team, as well as costs charged by third-party contractors. Costs associated with our delivery and project management engineering team are generally recognized as incurred. Costs charged by third-party contractors are initially deferred as prepaid expense and generally recorded as cost of revenue when the professional service project is complete or when contractual milestones have been achieved. As a result, our services gross profit may fluctuate from period to period.

Managed, Cloud, and Maintenance Services Gross Profit. Compensation, benefits, and other costs associated with our managed and in-house maintenance services engineering team, costs charged by subcontractors, and costs of running our three Network Operations Centers, or NOCs, are recorded as cost of revenue as incurred. These costs include depreciation of certain equipment and software utilized in our NOCs in support of our managed, cloud, and maintenance services contracts. We incur external costs associated with professional and managed services, primarily related to purchasing maintenance support contracts with third-party manufacturers and software licenses, which are generally prepaid. These costs, associated with maintenance contracts where we have an obligation to perform services, are incurred specifically to assist us in rendering services to our customers and are recorded as deferred customer support contract costs at the time the costs are incurred. The costs are amortized to expense as a cost of revenue—services on a straight-line basis over the period during which we fulfill our performance obligation. Third-party wholesale maintenance services cost of revenue is the acquisition cost from technology partners. In addition, our managed, cloud, and maintenance services gross profit is impacted by the mix of wholesale versus retail third-party maintenance revenue and the average contractual length of the third-party maintenance agreements.

Services gross profit is generally impacted by our ability to negotiate longer term managed and cloud contracts with our clients, maintaining a high contract renewal rate, effectively managing our service level agreements, or SLAs, resolving a large percentage of the incidents in-house, increasing utilization rates of our NOC engineers, and timing of revenue recognition. Our services gross profit is also impacted by our ability to deliver on fixed-price professional services engagements within scope, and our ability to keep our delivery engineers utilized.

Gross margin measures our gross profit as a percentage of revenue. Gross margin is generally impacted by changes in the mix of product type sold as well as the mix of services versus technology offerings revenue, with generally higher gross margins coming from the sale of collaboration products and services revenue.

 

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Operating Expenses

Our operating expenses include sales and marketing expenses, general and administrative expenses, transaction costs, and depreciation and amortization.

Sales and Marketing Expense. Sales and marketing expense is comprised of compensation, commission expense, variable incentive pay, and benefits related to our sales personnel, along with travel expenses, other employee related costs including stock-based compensation, and expenses related to marketing programs and events. Commission expenses are largely driven by gross margin performance and are generally paid to the sales personnel when the solutions revenue has been collected from the client.

General and Administrative Expense. General and administrative expense is comprised of compensation and benefits of administrative personnel, including variable incentive pay and stock-based compensation, and other administrative costs such as facilities expenses, professional fees, and travel expenses.

Transaction Costs. We present transaction costs as a separate line item within operating expenses based on it being a material cost that varies period to period. Transaction costs include acquisition-related expenses, including integration costs, employee retention bonuses, severance charges, advisory and due diligence fees, and transaction-related legal and accounting due diligence costs.

Depreciation and Amortization Expense. Depreciation expense relates to our fixed assets except for assets used in cost of revenue. Amortization expense relates to intangible assets we acquired in our business acquisitions.

Other (Income) Expense, Net

Other (income) expense, net includes the preliminary bargain purchase gain related to the acquisition of ASI. It also includes interest expense associated with our outstanding debt and costs associated with the refinancing of our debt. We also may seek to finance strategic acquisitions in the future with the proceeds from additional debt incurrences, which may have an impact on our interest expense.

Income Tax Expense (Benefit)

We are subject to U.S. federal income taxes, state income taxes net of federal income tax effect, and nondeductible expenses. Our effective tax rate will vary depending on permanent nondeductible expenses and other factors.

 

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Results of Operations

The following tables set forth our consolidated financial data in dollar amounts and as a percentage of total revenue.

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2018     2017     2018     2017  
     (in thousands)  

Revenue

        

Technology offerings

   $ 193,507     $ 121,033     $ 532,123     $ 315,201  

Services

     211,247       124,379       569,983       304,499  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     404,754       245,412       1,102,106       619,700  
  

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenue

        

Technology offerings

     144,250       95,444       402,385       245,732  

Services

     142,157       79,045       378,661       191,965  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue

     286,407       174,489       781,046       437,697  
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

        

Technology offerings

     49,257       25,589       129,738       69,469  

Services

     69,090       45,334       191,322       112,534  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total gross profit

     118,347       70,923       321,060       182,003  
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

        

Sales and marketing

     57,172       35,657       156,297       93,904  

General and administrative

     25,108       15,385       79,992       36,989  

Transaction costs

     4,116       3,920       16,167       5,955  

Depreciation and amortization

     12,064       9,127       35,421       23,112  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     98,460       64,089       287,877       159,960  
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     19,887       6,834       33,183       22,043  
  

 

 

   

 

 

   

 

 

   

 

 

 

Other (income) expense

        

Interest income

     (53     (44     (118     (51

Interest expense

     12,362       9,772       50,097       41,553  

Preliminary bargain purchase gain

     (1,212     —         (12,185     —    

Other expense, net

     (168     44       (142     49  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense, net

     10,929       9,772       37,652       41,551  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     8,958       (2,938     (4,469     (19,508

Income tax benefit

     (5,540     (4,241     (20,312     (6,323
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

     14,498       1,303       15,843       (13,185
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnout consideration

     (63,041     —         (187,047     —    
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss to common shareholders

   $ (48,543   $ 1,303     $ (171,204   $ (13,185
  

 

 

   

 

 

   

 

 

   

 

 

 
     Three Months Ended September 30,     Nine Months Ended September 30,  
     2018     2017     2018     2017  
     (as a percentage of total revenue)  

Revenue

        

Technology offerings

     47.8     49.3     48.3     50.9

Services

     52.2     50.7     51.7     49.1

Total revenue

        

Gross margin

        

Technology offerings

     25.5     21.1     24.4     22.0

Services

     32.7     36.4     33.6     37.0

Total gross margin

     29.2     28.9     29.1     29.4

 

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Three Months Ended September 30, 2018 Compared to the Three Months Ended September 30, 2017

Revenue

 

     Three Months Ended September 30,     Change  
     2018     2017     Amount      %  
     (in thousands)               

Technology offerings

   $ 193,507     $ 121,033     $ 72,474        59.9

Services

     211,247       124,379       86,868        69.8
  

 

 

   

 

 

   

 

 

    

Total revenue

   $ 404,754     $ 245,412     $ 159,342        64.9
  

 

 

   

 

 

   

 

 

    

Technology offerings as a percentage of total revenue

     47.8     49.3     

Services revenue as a percentage of total revenue

     52.2     50.7     

The revenue increase in the third quarter of 2018 over the same period in 2017 was driven by the $86.9 million growth in our services and by a $72.5 million growth in technology offerings.

The technology offerings revenue increase is primarily attributable to recent acquisitions with revenue from the Annese, RGTS, AOS & ASI acquisitions of $84.3 million in the third quarter of 2018.

The services revenue growth was primarily driven by acquisitions and revenue growth for managed, cloud, and maintenance services due to new contracts. Services revenue from the Annese, RGTS, AOS and ASI acquisitions accounted for $72.8 million in the third quarter of 2018.

Revenue by Core Technology Market

 

     Three Months Ended September 30,      Change  
     2018      2017      Amount      %  
     (in thousands)                

Collaboration revenue:

           

Technology offerings

   $ 86,402      $ 63,047      $ 23,355        37.0

Services

     178,235        104,164        74,071        71.1
  

 

 

    

 

 

    

 

 

    

Total collaboration revenue

   $ 264,637      $ 167,211      $ 97,426        58.3
  

 

 

    

 

 

    

 

 

    

Enterprise networking, data center, cloud, and security revenue

           

Technology offerings

   $ 107,105      $ 57,986      $ 49,119        84.7

Services

     33,012        20,215        12,797        63.3
  

 

 

    

 

 

    

 

 

    

Total enterprise networking, data center, cloud, and security revenue

   $ 140,117      $ 78,201      $ 61,916        79.2
  

 

 

    

 

 

    

 

 

    

Total revenue

   $ 404,754      $ 245,412      $ 159,342        64.9
  

 

 

    

 

 

    

 

 

    

Collaboration

The increase in collaboration revenue of $97.4 million is primarily related to revenue increases from the SPS, ASI and RGTS acquisitions.

Enterprise, Networking, Data Center, Cloud, and Security

Enterprise, networking, data center, cloud, and security revenue increased $61.9 million, or 79%, to $140.1 million for the third quarter of 2018 from $78.2 million for the third quarter of 2017. The increase is primarily related to revenues from the Annese and AOS acquisitions.

 

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Cost of Revenue, Gross Profit, and Gross Margin

 

     Three Months Ended September 30,     Change  
     2018     2017     Amount      %  
     (in thousands)               

Cost of revenue

         

Technology offerings

   $ 144,250     $ 95,444     $ 48,806        51.1

Services

     142,157       79,045       63,112        79.8
  

 

 

   

 

 

   

 

 

    

Total cost of revenue

   $ 286,407     $ 174,489     $ 111,918        64.1
  

 

 

   

 

 

   

 

 

    

Gross profit

         

Technology offerings

   $ 49,257     $ 25,589     $ 23,668        92.5

Services

     69,090       45,334       23,756        52.4
  

 

 

   

 

 

   

 

 

    

Total gross profit

   $ 118,347     $ 70,923     $ 47,424        66.9
  

 

 

   

 

 

   

 

 

    

Gross Margin

         

Technology offerings

     25.5     21.1     

Services

     32.7     36.4     

Total gross margin

     29.2     28.9     

The increase in total gross profit is primarily attributed to the acquisitions made in 2017 and 2018.

Technology offerings gross margins as a percentage of revenue increased primarily due to adoption of margin approval thresholds at our recently acquired companies.

Services gross margin decreased primarily due to impact of recent acquisitions which typically had lower gross margins as a percent of revenues.

Operating Expenses

 

     Three Months Ended September 30,      Change  
     2018      2017      Amount      %  
     (in thousands)                

Sales and marketing

   $ 57,172      $ 35,657      $ 21,515        60.3

General and administrative

     25,108        15,385        9,723        63.2

Transaction costs

     4,116        3,920        196        5.0

Depreciation and amortization

     12,064        9,127        2,937        32.2
  

 

 

    

 

 

    

 

 

    
   $ 98,460      $ 64,089      $ 34,371        53.6
  

 

 

    

 

 

    

 

 

    

Sales and Marketing Expense

The increase in sales and marketing expense was primarily driven by $15.3 million of additional expenses for operations of businesses acquired in the third and fourth quarters of 2017 and first quarter of 2018 and by increased commissions and bonuses of $5.2 million and increased salaries and benefits of $1.5 million offset by a $0.5 million decrease in office expenses, professional fees and other expenses.

General and Administrative Expense

The increase was primarily driven by $9.2 million of additional expenses for operations of businesses acquired in the third and fourth quarters of 2017 and first quarter of 2018, $1.6 million increase in bonus and commissions offset by a decrease of $0.9 million in salaries and benefits and a decrease of $0.2 million in other expenses.

Depreciation and Amortization

The increase in depreciation and amortization was primarily due to additional property and equipment and finite-lived intangibles acquired from recent acquisitions.

 

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Other Expense, Net

 

     Three Months Ended September 30,      Change  
     2018      2017      Amount      %  
     (in thousands)                

Other expense, net

   $ 10,929      $ 9,772      $ 1,157        11.8

The increase in other expense, net of $1.2 million was primarily the result of higher interest expense of $2.6 million associated with increased debt balances as a result of borrowings used to pay for our recent acquisitions offset by an increase in the preliminary bargain purchase gain by $1.2 million related to ASI.

Nine months ended September 30, 2018 Compared to the Nine months ended September 30, 2017

Revenue

 

     Nine Months Ended September 30,     Change  
     2018     2017     Amount      %  
     (in thousands)               

Technology offerings

   $ 532,123     $ 315,201     $ 216,922        68.8

Services

     569,983       304,499       265,484        87.2
  

 

 

   

 

 

   

 

 

    

Total revenue

   $ 1,102,106     $ 619,700     $ 482,406        77.8
  

 

 

   

 

 

   

 

 

    

Technology offerings as a percentage of total revenue

     48.3     50.9     

Services revenue as a percentage of total revenue

     51.7     49.1     

Total revenue increased $482.4 million, or 77.8%, to $1,102.1 million in the first nine months of 2018 from $619.7 million in the first nine months of 2017. The revenue increase was driven by the $265.4 million growth in our services and by a $216.9 million growth in technology offerings.

The technology offerings revenue increase was primarily driven by acquisition activity from the Annese, RGTS, AOS & ASI acquisitions which accounted for $207.9 million of the increase in the first nine months of 2018.

The services revenue growth was primarily driven by acquisitions and revenue growth for managed, cloud, and maintenance services due to new contracts. Services revenue from the Annese, RGTS, AOS and ASI acquisitions accounted for $172.9 million in the first nine months of 2018.

Revenue by Core Technology Market

 

     Nine Months Ended September 30,      Change  
     2018      2017      Amount      %  
     (in thousands)                

Collaboration revenue:

           

Technology offerings

   $ 242,421      $ 159,246      $ 83,175        52.2

Services

     480,810        250,779        230,031        91.7
  

 

 

    

 

 

    

 

 

    

Total collaboration revenue

   $ 723,231      $ 410,025      $ 313,206        76.4
  

 

 

    

 

 

    

 

 

    

Enterprise networking, data center, cloud, and security revenue

           

Technology offerings

   $ 289,702      $ 155,955      $ 133,747        85.8

Services

     89,173        53,720        35,453        66.0
  

 

 

    

 

 

    

 

 

    

Total enterprise networking, data center, cloud, and security revenue

   $ 378,875      $ 209,675      $ 169,200        80.7
  

 

 

    

 

 

    

 

 

    

Total revenue

   $ 1,102,106      $ 619,700      $ 482,406        77.8
  

 

 

    

 

 

    

 

 

    

Collaboration

The increase in collaboration services revenue of $230.0 million is primarily related to services revenue increases from the SPS, ASI and RGTS acquisitions. The increase in collaboration technology revenue of $83.2 million was primarily related to the SPS, ASI and RGTS acquisitions.

 

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Enterprise, Networking, Data Center, Cloud, and Security

Enterprise, networking, data center, cloud, and security revenue increased $169.2 million, or 80.7%, to $378.9 million for the first nine months of 2018 from $209.7 million for the first nine months of 2017. The increase is primarily related to revenues from the Annese and AOS acquisitions.

Cost of Revenue, Gross Profit, and Gross Margin

 

     Nine Months Ended September 30,     Change  
     2018     2017     Amount      %  
     (in thousands)               

Cost of revenue

         

Technology offerings

   $ 402,385     $ 245,732     $ 156,653        63.7

Services

     378,661       191,965       186,696        97.3
  

 

 

   

 

 

   

 

 

    

Total cost of revenue

   $ 781,046     $ 437,697     $ 343,349        78.4
  

 

 

   

 

 

   

 

 

    

Gross profit

         

Technology offerings

   $ 129,738     $ 69,469     $ 60,269        86.8

Services

     191,322       112,534       78,788        70.0
  

 

 

   

 

 

   

 

 

    

Total gross profit

   $ 321,060     $ 182,003     $ 139,057        76.4
  

 

 

   

 

 

   

 

 

    

Gross Margin

         

Technology offerings

     24.4     22.0     

Services

     33.6     37.0     

Total gross margin

     29.1     29.4     

The increase in total gross profit is primarily attributed to the acquisitions made in the third and fourth quarters of 2017 and first quarter of 2018.

Technology offerings gross margins as a percent of revenue increased slightly driven by adoption of margin approval thresholds at our recently acquired businesses.

Services gross margin decreased primarily due to the impact of recent acquisitions which historically had lower gross margins.

Operating Expenses

 

     Nine Months Ended September 30,      Change  
     2018      2017      Amount      %  
     (in thousands)                

Sales and marketing

   $ 156,297      $ 93,904      $ 62,393        66.4

General and administrative

     79,992        36,989        43,003        116.3

Transaction costs

     16,167        5,955        10,212        171.5

Depreciation and amortization

     35,421        23,112        12,309        53.3
  

 

 

    

 

 

    

 

 

    
   $ 287,877      $ 159,960      $ 127,917        80.0
  

 

 

    

 

 

    

 

 

    

Sales and Marketing Expense

The increase in sales and marketing expense was primarily driven by $39.6 million of additional expenses for operations of the businesses acquired in the third and fourth quarters of 2017 and first quarter of 2018 and by increased salaries and benefits of $13.3 million, increased commissions and bonuses of $6.4 million, increase in meetings and travel of $2.2 million, $0.5 million lower marketing development funds received, and an increase in marketing expense and other of $0.4 million.

General and Administrative Expense

The increase in general and administrative expense was primarily driven by $31.6 million of additional expenses for operations businesses acquired in the third and fourth quarters of 2017 and first quarter of 2018 and $8.3 million increase in salaries and benefits, increased commissions and bonuses of $1.7 million, increased professional fees of $1.1 million and $0.3 million of office expenses and other.

 

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Transaction Costs

The increase in transaction costs was due to $2.9 million of additional transaction-related professional fees and expenses, including legal, accounting, tax, and advisory fees, $5.1 million of additional acquisition-related integration costs and $2.2 million of additional severance charges and employee retention bonuses.

Depreciation and Amortization

The increase in depreciation and amortization expense was primarily due to an increase in amortization due to recent acquisitions and purchases of property and equipment.

Other Expense, Net

 

     Nine Months Ended September 30,      Change  
     2018      2017      Amount      %  
     (in thousands)                

Other expense, net

   $ 37,652      $ 41,551      $ (3,899      -9.4

The net change in other expense was primarily the result of a preliminary bargain purchase gain of $12.2 million related to the ASI acquisition offset by higher interest expense associated with the losses on extinguishment of debt that occurred in the second quarter of 2018 over the second quarter of 2017 and increased debt balances as a result of additional borrowings used to partially pay for our recent acquisitions and closing of the merger.

Income Tax Benefit

 

     Nine Months Ended September 30,      Change  
     2018      2017      Amount      %  
     (in thousands)                

Income tax benefit

   $ (20,312    $ (6,323    $ (13,989      221.2

Our estimated annual effective tax rate (excluding discrete items) for the nine months ended September 30, 2018 and 2017 is 106.5% and 31.5%, respectively. The increase in the annual effective tax rate from the prior year is primarily driven by the impact of non-deductible permanent tax items offset by the decrease in the U.S. corporate income tax rate on income or loss before taxes.    

Our effective income tax rate (after discrete items and including the bargain purchase gain) for the nine months ended September 30, 2018 and 2017 is 454.5% and 32.4%, respectively. The increase in the effective income tax rate from the prior period is driven by a combination of two factors. One factor is that we experienced significant or unusual discrete benefit items of $14.1 million in the current period and when combined with a net loss before income taxes, it causes the effective income tax rate to increase. These discrete items primarily include a bargain purchase gain that is not recognized for tax purposes and excess tax benefits associated with stock-based compensation payments. The other factor is that the impact of the significant non-deductible permanent tax items result in a greater incremental increase to the effective income tax rate when combined with low year-to-date net loss before taxes.

 

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Key Business Metrics - Non-GAAP Financial Measures

Our management regularly monitors certain financial measures to track the progress of our business against internal goals and targets. We believe that the most important of these measures include Adjusted Revenue, Gross Margin, Adjusted EBITDA, Adjusted Net Income, and Services Revenue as a Percentage of Total Revenue.

 

     Three Months     Nine Months Ended  
     September 30,     September 30,  
     2018     2017     2018     2017  
     (in thousands)  

Total Revenue

   $ 404,754     $ 245,412     $ 1,102,106     $ 619,700  

Adjusted Revenue

     405,395       249,583       1,108,411       623,914  

Services mix:

        

Professional services revenue as a percentage of total revenue

     17     18     17     17

Managed, cloud, and maintenance services revenue as a percentage of total revenue

     35       33       35       32  
  

 

 

   

 

 

   

 

 

   

 

 

 

Services revenue as a percentage of total revenue

     52     51     52     49
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross Margin

     29     29     29     29

Net income (loss)

   $ 14,498     $ 1,303     $ 15,843     $ (13,185

Adjusted Net Income

     27,930       11,366       61,753       17,485  

Adjusted EBITDA

     41,831       23,670       103,416       58,058  

Adjusted Revenue

Adjusted Revenue is a non-GAAP financial measure. We believe that Adjusted Revenue provides supplemental information with respect to our revenue activity associated with our ongoing operations. We define Adjusted Revenue as total revenue adjusted to exclude non-cash acquisition accounting adjustments to revenue as a result of our acquisitions.

Adjusted EBITDA

Adjusted EBITDA is a non-GAAP financial measure. We believe Adjusted EBITDA provides helpful information with respect to our operating performance as viewed by management, including a view of our business that is not dependent on (i) the impact of its capitalization structure and (ii) items that are not part of our day-to-day operations. Management uses Adjusted EBITDA (1) to compare our operating performance on a consistent basis, (2) to calculate incentive compensation for our employees, (3) for planning purposes including the preparation of our internal annual operating budget, (4) to evaluate the performance and effectiveness of our operational strategies, and (5) to assess compliance with various metrics associated with the agreements governing our indebtedness. Accordingly, we believe that Adjusted EBITDA provides useful information to investors and others in understanding and evaluating our operating performance in the same manner as management.

We define Adjusted EBITDA as net income (loss) plus (a) total depreciation and amortization, (b) interest expense and other, net, and (c) income tax expense, as further adjusted to eliminate non-cash stock-based compensation expense, acquisition accounting adjustments, transaction costs, and other one-time nonrecurring costs. We do not believe these adjustments are indicative of our ongoing performance.

Services Revenue as a Percentage of Total Revenue

Our professional services involve the consultation, design, integration and implementation, application development, and program management of customized solutions for core technology markets. We view professional services as a percentage of revenue as a key measure in the successful execution of our operating strategies of leading client engagements with professional services and the profitability of our business.

We provide comprehensive managed, cloud, and maintenance services to our clients across our core technology markets. Given these services typically have multi-year contractual terms, with high renewal rates, we view managed, cloud, and maintenance services as a percentage of revenue as a key measure of our revenue visibility and profitability of our business.

Adjusted Net Income

Adjusted Net Income is a non-GAAP financial measure which management uses in our evaluation of past performance, trends, and prospects for the future. Management uses Adjusted Net Income (1) to compare our operating performance on a consistent basis, (2) for planning purposes, including the preparation of our internal annual operating budget, and (3) to evaluate the performance and effectiveness of our operational strategies. Accordingly, we believe that Adjusted Net Income provides useful information to investors and others in understanding and evaluating our operating performance in the same manner as management. We believe that Adjusted Net Income is utilized by investors and other interested parties as a measure of our comparative operating performance period-over-period that considers the impact of certain items that do not directly correlate to our ongoing operating performance and that vary significantly from period to period, such as the interest expense associated with our outstanding debt, as well as the impact of depreciation on our fixed assets and income taxes. We define Adjusted Net Income as net income (loss) adjusted to exclude (a)

 

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amortization of acquisition-related intangible assets, (b) amortization of debt issuance costs, (c) non-cash stock-based compensation expense, (d) costs related to debt refinancing, (e) acquisition accounting adjustments, (f) transaction costs, (g) other costs, and (h) the income tax impact associated with the foregoing items. We do not believe these adjustments are indicative of our ongoing performance.

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2018      2017      2018      2017  
     (in thousands)  

Other Financial Data:

           

Adjusted Revenue (1)

   $ 405,395      $ 249,583      $ 1,108,411      $ 623,914  

Adjusted EBITDA (2)

   $ 41,831      $ 23,670      $ 103,416      $ 58,058  

Adjusted Net Income (3)

   $ 27,930      $ 11,366      $ 61,753      $ 17,485  

 

(1)

The reconciliation of revenue, the most directly comparable financial measure calculated and presented in accordance with GAAP, to Adjusted Revenue for each of the periods presented is as follows. See “Use of Non-GAAP Financial Measures” below for additional information.

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2018      2017      2018      2017  
     (in thousands)  

Revenue

   $ 404,754      $ 245,412      $ 1,102,106      $ 619,700  

Acquisition accounting adjustments

     641        4,171        6,305        4,214  
  

 

 

    

 

 

    

 

 

    

 

 

 

Adjusted Revenue

   $ 405,395      $ 249,583      $ 1,108,411      $ 623,914  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(2)

The reconciliation of net income (loss), the most directly comparable financial measure calculated and presented in accordance with GAAP, to Adjusted EBITDA for each of the periods presented is as follows. See “Use of Non-GAAP Financial Measures” below for additional information.

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2018      2017      2018      2017  
     (in thousands)  

Net income (loss)

   $ 14,498      $ 1,303      $ 15,843      $ (13,185

Depreciation and amortization (a)

     13,455        9,549        39,604        24,224  

Preliminary bargain purchase gain

     (1,212      —          (12,185      —    

Other expense, net

     12,141        9,772        49,837        41,551  

Income tax (benefit) expense

     (5,540      (4,241      (20,312      (6,323
  

 

 

    

 

 

    

 

 

    

 

 

 

EBITDA

     33,342        16,383        72,787        46,267  

Stock-based compensation expense

     1,099        191        7,530        521  

Acquisition accounting adjustments (b)

     3,208        2,651        6,472        2,654  

Transaction costs (c)

     4,116        3,920        16,167        5,955  

Other costs (d)

     66        525        460        2,661  
  

 

 

    

 

 

    

 

 

    

 

 

 

Adjusted EBITDA

   $ 41,831      $ 23,670      $ 103,416      $ 58,058  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

a)

Depreciation and amortization equals the sum of (1) depreciation and amortization included in total operating expenses and (2) depreciation and amortization included in total cost of revenue within our consolidated financial statements.

b)

Acquisition accounting adjustments include charges associated with non-cash acquisition accounting fair value adjustments to deferred revenue and deferred customer support costs.

c)

Transaction costs of (1) $4.1 million for the three months ended September 30, 2018 include $1.3 million related to transaction-related professional fees, including legal, accounting, tax, and advisory fees, $2.5 million of acquisition-related integration costs, and acquisition-related expenses of $0.3 million related to severance charges and employee retention bonuses, and (2) $3.9 million for the three months ended September 30, 2017 include acquisition-related expenses of $2.3 million related to transaction-related professional fees and expenses, $1.5 million of acquisition-related integration costs and acquisition-related expenses of $0.1 million related to severance charges and employee retention bonuses. Transaction costs of (3) $16.2 million for the nine months ended September 30, 2018 include $6.2 million related to transaction-related professional fees, including legal, accounting, tax, and advisory fees, $7.6 million of acquisition-related integration costs, and acquisition-related expenses of $2.4 million related to severance charges and employee retention bonuses, and (4) $6.0 million for the nine months ended September 30, 2017 include acquisition related expenses of $3.4 million related to transaction-related professional fees and expenses, $2.4 million of acquisition-related integration costs and acquisition-related expenses of $0.2 million related to severance charges and employee retention bonuses.

 

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d)

Other costs of (1) $0.1 million for the three months ended September 30, 2018 represent severance and related legal expenses, and (2) $0.5 million for the three months ended September 30, 2017 include expenses of $0.3 million related to severance and related legal expenses and $0.2 million related to payments to Clearlake for advisory and consulting services pursuant to its management and monitoring services agreement. Other costs of (3) $0.5 million for the nine months ended September 30, 2018 include expenses of $0.1 million related to severance and related legal expenses and $0.4 million related to payments to Clearlake for advisory and consulting services pursuant to its management and monitoring services agreement which was terminated in connection with the Business Combination and one-time recruiting expenses, and (4) $2.7 million for the nine months ended September 30, 2017 include expenses of $1.6 million related to severance and related legal expenses and $1.1 million related to payments to Clearlake for advisory and consulting services pursuant to its management and monitoring services agreement.

 

(3)

The reconciliation of net income (loss), the most directly comparable financial measure calculated and presented in accordance with GAAP, to Adjusted Net Income for each of the periods presented is as follows. See “—Use of Non-GAAP Financial Measures” below for additional information.

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2018      2017      2018      2017  
     (in thousands)  

Net income (loss)

   $ 14,498      $ 1,303      $ 15,843      $ (13,185

Amortization of intangible assets

     9,318        6,711        27,417        17,891  

Amortization of debt issuance costs

     414        450        1,213        2,205  

Preliminary bargain purchase gain

     (1,212      —          (12,185      —    

Stock-based compensation expense

     1,099        191        7,530        521  

Costs related to debt financing (a)

     —          999        14,732        15,193  

Acquisition accounting adjustments (b)

     3,208        2,651        6,472        2,654  

Transaction costs (c)

     4,116        3,920        16,167        5,955  

Other costs (d)

     66        525        460        2,661  

Income tax impact of adjustments (e)

     (3,577      (5,384      (15,896      (16,410
  

 

 

    

 

 

    

 

 

    

 

 

 

Adjusted net income

   $ 27,930      $ 11,366      $ 61,753      $ 17,485  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

a)

Costs related to debt refinancing in the three months ended September 30, 2017 of $1.0 million consists of financing transaction costs. Costs related to debt refinancing in the nine months ended September 30, 2018 of $14.7 million consists of $5.7 million in extinguishment costs incurred including a 1% pre-payment penalty and $9.0 million write-off of unamortized debt financing transaction costs. Costs related to debt refinancing in the nine months ended September 30, 2017 of $15.2 million consists of $3.4 million in extinguishment costs incurred including a 1% pre-payment penalty, $1.6 financing transaction costs and $10.2 million write-off of unamortized debt financing transaction costs.

b)

Acquisition accounting adjustments include charges associated with non-cash acquisition accounting fair value adjustments to deferred revenue and deferred customer support costs.

c)

Transaction costs of (1) $4.1 million for the three months ended September 30, 2018 include $1.3 million related to transaction-related professional fees, including legal, accounting, tax, and advisory fees, $2.5 million of acquisition-related integration costs, and acquisition-related expenses of $0.3 million related to severance charges and employee retention bonuses, and (2) $3.9 million for the three months ended September 30, 2017 include acquisition-related expenses of $2.3 million related to transaction-related professional fees and expenses, $1.5 million of acquisition-related integration costs and acquisition-related expenses of $0.1 million related to severance charges and employee retention bonuses. Transaction costs of (3) $16.2 million for the nine months ended September 30, 2018 include $6.2 million related to transaction-related professional fees, including legal, accounting, tax, and advisory fees, $7.6 million of acquisition-related integration costs, and acquisition-related expenses of $2.4 million related to severance charges and employee retention bonuses, and (4) $6.0 million for the nine months ended September 30, 2017 include acquisition related expenses of $3.4 million related to transaction-related professional fees and expenses, $2.4 million of acquisition-related integration costs and acquisition-related expenses of $0.2 million related to severance charges and employee retention bonuses.

d)

Other costs of (1) $0.1 million for the three months ended September 30, 2018 represent severance and related legal expenses, and (2) $0.5 million for the three months ended September 30, 2017 include expenses of $0.3 million related to severance and related legal expenses and $0.2 million related to payments to Clearlake for advisory and consulting services pursuant to its management and monitoring services agreement. Other costs of (3) $0.5 million for the nine months ended September 30, 2018 include expenses of $0.1 million related to severance and related legal expenses and $0.4 million related to payments to Clearlake for advisory and consulting services pursuant to its management and monitoring services agreement which was terminated in connection with the Business Combination and one-time recruiting expenses, and (4) $2.7 million for the nine months ended September 30, 2017 include expenses of $1.6 million related to severance and related legal expenses and $1.1 million related to payments to Clearlake for advisory and consulting services pursuant to its management and monitoring services agreement.

e)

Income tax impact of adjustments includes an estimated tax impact of the adjustments to net income (loss) at our average statutory tax rate of 26.0% and 40.0% for the three and nine months ended September 30, 2018 and 2017, respectively, except for the impact of tax-deductible goodwill and intangible assets resulting from certain historical acquisitions.

 

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Use of Non-GAAP Financial Measures

Adjusted Revenue, Adjusted EBITDA, and Adjusted Net Income should be considered in addition to, not as a substitute for, or superior to, financial measures calculated in accordance with GAAP. They are not measurements of our financial performance under GAAP and should not be considered as alternatives to revenue or net income (loss), as applicable, or any other performance measures derived in accordance with GAAP and may not be comparable to other similarly titled measures of other businesses. Adjusted Revenue, Adjusted EBITDA, and Adjusted Net Income have limitations as analytical tools and you should not consider them in isolation or as a substitute for analysis of our operating results as reported under GAAP. Some of these limitations include:

 

   

non-cash compensation is and will remain a key element of our overall long-term incentive compensation package, although we exclude it as an expense when evaluating its ongoing operating performance for a particular period;

 

   

Adjusted EBITDA and Adjusted Net Income do not reflect the impact of certain cash charges resulting from matters we consider not to be indicative of ongoing operations; and

 

   

other companies in our industry may calculate Adjusted Revenue, Adjusted EBITDA, and Adjusted Net Income, differently than we do, limiting their usefulness as comparative measures.

We compensate for these limitations to Adjusted Revenue, Adjusted EBITDA, and Adjusted Net Income by relying primarily on GAAP results and using Adjusted Revenue, Adjusted EBITDA, and Adjusted Net Income only for supplemental purposes. Adjusted EBITDA and Adjusted Net Income include adjustments for items that may occur in future periods. However, we believe these adjustments are appropriate because the amounts recognized can vary significantly from period to period, do not directly relate to the ongoing operations of our business, and complicate comparisons of internal operating results and operating results of other peer companies over time. For example, it is useful to exclude non-cash, stock-based compensation expenses because the amount of such expenses in any specific period may not directly correlate to the underlying performance of our business operations and these expenses can vary significantly across periods due to timing of new stock-based awards. We also exclude certain discrete, unusual, one-time, or non-cash costs, including transaction costs, and the income tax impact of adjustments in order to facilitate a more useful period over- period comparison of its financial performance. Each of the normal recurring adjustments and other adjustments described in this paragraph help management with a measure of our operating performance over time by removing items that are not related to day-to-day operations or are non-cash expenses.

Liquidity and Capital Resources

As of September 30, 2018, we had $11.2 million of cash. We believe our cash, cash flows from operations and availability of borrowings will be sufficient to support our planned operations for at least the next 12 months. We finance our operations and capital expenditures through a combination of internally generated cash from operations and from borrowings under our revolver. Our long-term needs primarily include meeting debt service requirements, working capital requirements, and capital expenditures. We may also pursue strategic acquisition opportunities that may impact our future cash requirements. There are a number of factors that may negatively impact our available sources of funds in the future including the ability to generate cash from operations and borrow on our debt facilities. The amount of cash generated from operations is dependent upon factors such as the successful execution of our business strategies and general economic conditions. The amount of cash available for borrowings under our various debt facilities is dependent on our ability to maintain sufficient collateral and general financial conditions in the marketplace.

We may opportunistically raise debt capital, subject to market and other conditions, to refinance our existing capital structure at a lower cost of capital. Additionally, as part of our growth strategies, we may also raise debt capital for strategic alternatives and general corporate purposes. If additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results, and financial condition may be adversely affected.

Merger and Earnout Consideration

The following cash transactions resulted from the consummation of the business combination/merger with Forum which took place on February 22, 2018 (the “Closing”):

 

   

All of the remaining funds in Forum’s trust account, after taking into account the Redemption, Forum’s operating cash account, and the $131.7 million in proceeds from the PIPE Investment, all of which aggregated to approximately $135.3 million of cash, remained in escrow immediately prior to the Closing, which, together with approximately $35.3 million of cash of C1, was used to pay the cash component of the consideration of approximately $170.6 million paid to C1 Securityholders in connection with the Closing.

 

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All outstanding C1 Securities were immediately vested, canceled, and exchanged for a combination of new shares of ConvergeOne common stock and cash of $170,654,000.

 

   

An additional subscription agreement had been entered into with one of the private investors for 1,500,000 shares for $12,000,000 (the “Deferred PIPE”) for which payment was made to the Company on April 26, 2018. The Company distributed the $12,000,000 of proceeds to the former C1 Securityholders as additional consideration on April 26, 2018.

 

   

Proceeds of $1,805,000 for the repayment of related party stock subscription receivable were received.

 

   

Transaction expenses, net of tax of $30,934,000 were incurred including the legal acquirer’s transaction costs, PIPE Investment related costs, and our costs related to effectuating the reverse recapitalization.

The C1 Securityholders are entitled to additional consideration in a combination of cash and shares of ConvergeOne common stock (collectively, “Earnout Consideration”), if the Earnout Target measurements for 2018, 2019 and 2020 (“Earnout Targets”), as defined in the Merger Agreement, are met.

 

  (1)

The amounts that can be earned for each Earnout Target consist of $33 million of cash (“Earnout Cash Payment”) and 3,300,000 ConvergeOne common shares, less Sponsor Earnout Shares of 718,750 that vest each time an Earnout Target is met which results in 2,581,250 common shares for each Earnout Target measurement met (“Earnout Stock Payment”), collectively a “Regular Earnout Payment”.

 

  (2)

In the event that at the time payment of an Earnout Cash Payment is due, such Earnout Cash Payment is an amount that would exceed either (i) the amount of cash available to the Company that is permitted to be distributed and paid without breaching the terms of any agreement related to indebtedness (“Permitted Agreement Payment Amount”) or (ii) the amount that could be paid without exceeding a permitted leverage measurement as set forth in the Merger Agreement (“Permitted Leverage Payment Amount”), the “Permitted Cash Payment” would be the lesser of the two amounts.

Clearlake will have the right to direct the Company to do either of the following with regard to the corresponding shortfall between the Permitted Cash Payment Amount and the Earnout Cash Payment that has been earned (“Permitted Cash Payment Shortfall” or “Cash Shortfall”): (i) pay the Cash Shortfall through the issuance of additional shares of common stock with an equivalent value equal to the Cash Shortfall, valued based on a twenty day trading period as defined in the Merger Agreement (“Earnout Cash Payment Shortfall Parent Shares” or “Shortfall Shares”) or (ii) provide notice to the Company that it elects to defer payment of the Cash Shortfall until the following Measurement Date. Clearlake shall have the option on each succeeding Measurement Date until the end of the Earnout Period to elect to be paid the applicable Shortfall Shares in full satisfaction of the Cash Shortfall or continue to defer payment. At the end of the Earnout Period, in the event that the Company has not paid a Cash Shortfall to the former C1 Securityholders, such Cash Shortfall shall automatically be converted into a right for the former C1 Securityholders to receive Shortfall Shares.

 

  i.

Earnout Cash Payments may be accelerated in the event that the Earnout Targets occurring within an Earnout Year are in excess of the Earnout Target for a subsequent Earnout Year. Payment of the Regular Earnout Payment for such subsequent Earnout Year shall be accelerated and paid at the same time that the Regular Earnout Payment is paid.

 

  ii.

The accelerated Regular Earnout Payments (“Accelerated Earnout Payment”) shall be subject to the determination of the maximum amount of Permitted Cash Payment as described above.

All three Earnout Target measurements are construed to have been met as of September 30, 2018. See Financial Statement Note 2—Business Combination/Merger for further discussion of Earnout Consideration and the Measurement Date results.

Indebtedness

In June 2017, we entered into a $430 million term loan agreement with a maturity date in June 2024. In July 2017, we borrowed an additional $75 million as an incremental term loan to partially fund our acquisitions, which also matured in June 2024. In October 2017, we borrowed an additional $60 million as an incremental term loan, which also matured in June 2024. In addition, in June 2017, we entered into a revolving loan agreement that provides a loan facility of $150 million and amended and restated the existing floorplan arrangement to extend credit in the form of floorplan advances, up to $150 million.

 

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In February 2018, the revolver agreement was amended to increase the revolving loan facility amount to $200 million. The revolver agreement matures in June 2022.

On April 10, 2018, we paid off the existing term loan agreement in its entirety and entered into a new financing arrangement. We entered into a $670 million term loan agreement with a maturity date in April 2025. A portion of the proceeds of the term loan was used to repay the existing credit facilities including the outstanding indebtedness under the Revolver Agreement of $90 million and to pay debt issuance and debt extinguishment costs. The remaining proceeds will be used for working capital needs and general corporate purposes.

The principal installments in the amount of $1,675,000 are due on the last business day of each quarter commencing September 30, 2018, with the remaining outstanding principal amount to be paid on its maturity date of April 10, 2025.

The outstanding borrowing on the revolver as of September 30, 2018 was $50 million which was used for the acquisition of Advantel and normal working capital purposes.

Stock Repurchase program

Our Board of Directors approved a common stock repurchase program in August 2018 whereby we can purchase up to a maximum of $25 million of our common stock, subject to compliance with applicable law and the limitations in the credit facilities on stock repurchases.

The authorization allows repurchases from time to time in the open market or in privately negotiated transactions. The amount and timing of repurchases made under the repurchase program will depend on a variety of factors, including available liquidity, cash flow and market conditions. Shares can be purchased through the repurchase program through August 2020, unless extended or shortened by our Board of Directors. The program does not obligate us to acquire any particular amount of common stock and the program may be modified or suspended at any time. The repurchases would be funded from available working capital and are subject to compliance with the terms and limitations of the credit facilities.

Pursuant to our common stock repurchase program, during the three and nine months ended September 30, 2018, we repurchased in the open market 1,066,946 shares of our common stock at a total cost of approximately $10,044,000 (an average price of $9.41 per share). As of September 30, 2018, the maximum dollar value of shares that may be purchased under the Repurchase Program is approximately $14,956,000. All shares delivered from these repurchases have been placed into treasury stock.

Liquidity

We generally fund our short- and long-term liquidity needs through a combination of cash on hand, cash flows generated from operations, and available borrowings under our revolving credit facility. Our management regularly monitors certain liquidity measures to monitor performance. We believe that the most important of those measures include net debt and available liquidity.

 

     September 30,      December 31,  
     2018      2017  
     (in thousands)  

Net debt

   $ 707,097      $ 568,850  

Available liquidity

     89,448        91,153  

 

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Net Debt

We define net debt as total debt less cash. The following table presents our calculation of net debt as of the dates indicated:

 

     September 30,      December 31,  
     2018      2017  
     (in thousands)  

Long-term debt, net of debt issuance costs and current maturities

   $ 701,815      $ 566,424  

Plus unamortized debt issuance costs

     9,810        10,249  

Plus current maturities of long-term debt

     6,700        5,652  
  

 

 

    

 

 

 

Total debt

     718,325        582,325  

Less cash

     11,228        13,475  
  

 

 

    

 

 

 

Net debt

   $ 707,097      $ 568,850  
  

 

 

    

 

 

 

Available Liquidity

We calculate our available liquidity as the sum of cash from our consolidated balance sheet plus the amount available and unutilized on our revolving credit facilities.

The following table presents our calculation of available liquidity as of the dates indicated:

 

     September 30,      December 31,  
     2018      2017  
     (in thousands)  

Cash

   $ 11,228      $ 13,475  

Unutilized revolver

     78,220        77,678  
  

 

 

    

 

 

 

Available liquidity

   $ 89,448      $ 91,153  
  

 

 

    

 

 

 

Cash Flows

The following table shows our cash flows for the nine months ended September 30, 2018 and 2017:

 

     Nine Months Ended September 30,  
     2018      2017  
     (in thousands)  

Operating activities

   $ 17,205      $ (6,654

Investing activities

     (53,600      (104,794

Financing activities

     34,148        109,499  

Operating Activities

Net cash provided by (used in) operating activities consists of net income (loss) adjusted for noncash items, such as: preliminary bargain purchase gain, depreciation and amortization of property and equipment and intangible assets, deferred income taxes, stock-based compensation, amortization of debt issuance costs, losses on extinguishments of debt, and for changes in net working capital assets and liabilities. Generally, the most significant factor relates to nondeductible book amortization expense associated with intangible assets. The timing between the conversion of our receivables into cash from our customers and disbursements to our vendors is the primary driver of changes in our working capital.

Net cash provided by operating activities for the first nine months of 2018 was $17.2 million. This was primarily attributable to net income before preliminary bargain purchase gain, depreciation and amortization, loss on extinguishment of debt and other of $55.4 million offset by working capital component changes that aggregate to a net $38.2 million provision of cash for operating activities. The most significant working capital component changes relate to: (1) a $29.0 million increase in accounts receivable primarily due to increased revenues, (2) a $13.7 million increase in inventory due to timing of purchases and additional inventory from acquisitions, (3) a $11.0 million increase in income tax receivable and (4) a $11.4 million decrease in deferred revenue offset by a $25.9 million decrease in accounts payable and accrued expenses due to a decrease in the days outstanding as well as changes in the timing of payments.

 

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Net cash used in operating activities for the nine months ended September 30, 2017 was $6.7 million. This was primarily attributable to net income (loss) before depreciation and amortization of $11.0 million partially offset by several working capital component changes that aggregate to a net $30.1 million use of cash for operating activities. The most significant working capital component changes relate to: (1) a $22.0 million decrease in accounts payable and accrued expenses due to a decrease in the days outstanding as well as changes in the timing of purchases and (2) a $5.7 million decrease in accounts receivable due to a cyclical decrease in sales revenue.

Investing Activities

Net cash used in investing activities for the first nine months of 2018 was $53.6 million, primarily due to business acquisitions net of cash acquired of $27.7 million for ASI and $16.1 million for Advantel plus $10.6 million of capital expenditures.

Net cash used in investing activities for the first nine months of 2017 was $104.8 million, primarily due to business acquisitions of Annese, SPS and RGTS.

Financing Activities

Net cash provided by financing activities for the first nine months of 2018 was $34.1 million and was primarily related to net additional borrowings on term debt including the revolving credit agreements of $136.0 million, plus proceeds from Forum cash accounts of $147.3 million offset by payment of debt extinguishment costs and debt issuance costs of $15.5 million, payment to former C1 securityholders of $182.8 million, payment of reverse recapitalization costs of $30.9 million, the repurchase of common stock of $10.0 million and warrants of $9.1 million, and $3.1 million payment of dividends.

Net cash provided by financing activities for the nine months ended September 30, 2017 was $109.5 million and was primarily related to proceeds, net of discount, from the refinancing of term loans of $510.1 million offset by the repayment of the existing first and second lien term loans of $415.2 million. $26.0 million was also provided by proceeds from the revolving credit agreements, which was partially offset by a $3.4 million payment of extinguishment charges for repayment of the existing loans, a $6.5 million payment of deferred financing costs for the new term loan, a $1.2 million payment of deferred offering costs, and $0.4 million for repurchase of C1’s common stock.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet transactions or interests.

Seasonality

Our results are affected by the budget cycles of our client base which generally result in stronger sales in the second half of the year. We believe this variability is largely due to our clients’ and technology partners’ fiscal year ends, as well as budgetary and spending patterns of our clients. As a result of our historically higher portion of sales in the second half of each year, our cost of revenue and commission expense increase during such periods relative to any increase in revenue. The increased cost of revenue and commission expense, and other impacts of seasonality, may affect profitability in a given quarter.

Critical Accounting Policies and Estimates

There were no changes to critical accounting policies and estimates from those disclosed in Critical Accounting Policies and Estimates within Convergeone’s Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Registration Statement on Form S-1/A filed on April 24, 2018.

Emerging Growth Company Status

We are an “emerging growth company,” as defined in Section 2(a) of the Securities Act of 1933, as amended, (the “Securities Act”), as modified by the Jumpstart Our Business Startups Act of 2012, (the “JOBS Act”). Section 102(b)(1) of the JOBS Act exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies (that is, those that have not had a Securities Act registration statement declared effective or do not have a class of securities registered under the Exchange Act) are required to comply with the new or revised financial accounting standards. The JOBS Act provides that a company can elect to opt out of the extended transition period and comply with the requirements that apply to non-emerging growth companies but any such election to opt out is irrevocable. We have elected not to opt out of such extended transition period which means that when a standard is issued or revised and it has different application dates for public or private companies, we, as an emerging growth company, can adopt the new or revised standard at the time private companies adopt the new or revised standard. This may make comparison of our consolidated financial statements with another public company which is neither an emerging growth company nor an emerging growth company which has opted out of using the extended transition period difficult or impossible because of the potential differences in accounting standards used.

We will cease to be an “emerging growth company” on December 31, 2018.

 

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Recent Accounting Pronouncements

See Note 1 to our Condensed Consolidated Financial Statements for a discussion of recent accounting pronouncements.

Item 3. – Quantitative and Qualitative Disclosures About Market Risk

Interest rate risk

Interest rates are highly sensitive to many factors, including U.S. fiscal and monetary policies and domestic and international economic and political considerations, as well as other factors beyond our control. Interest rate risk is the exposure to loss resulting from changes in the level of interest rates and the spread between different interest rates. We are exposed to market risk from changes in interest rates on debt, which bears interest at variable rates. Our debt has floating interest rates. We are exposed to changes in the level of interest rates and to changes in the relationship or spread between interest rates for our floating rate debt. Our floating rate debt requires payments based on variable interest rates such as the federal funds rate, prime rate, eurocurrency rate, and LIBOR. Therefore, increases in interest rates may reduce our net income or increase our net loss by increasing the cost of debt. As of September 30, 2018, we had $707.1 million of total debt subject to variable interest rates. Based on the amount outstanding as of September 30, 2018, if the interest rate on our borrowings were to increase or decrease by 100 basis points over a twelve month period, our annual interest cost on borrowings subject to variable interest rates would increase or decrease by $7.1 million.

Item 4. – Controls and Procedures

On February 22, 2018, C1 Investment Corp., or C1, and a subsidiary of Forum Merger Corporation, or Forum, consummated a merger, following which the separate corporate existence of the subsidiary ceased and C1 continued as the surviving corporation (the “Merger”). Upon the closing of the Merger on February 22, 2018, the sole business conducted by us is the business conducted by C1. Also, as a result of the Merger, the internal control over financial reporting utilized by C1 prior to the Merger became the internal control over financial reporting of the Company.

Management’s Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of September 30, 2018. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2018, our disclosure controls and procedures were effective in providing reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, reported and accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the quarter ended September 30, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on Effectiveness of Controls and Procedures

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs.

 

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PART II. – OTHER INFORMATION

Item 1. – Legal Proceedings

From time to time we may be involved in litigation relating to claims arising out of our operations in the normal course of business. We are not currently a party to any legal proceedings that we believe would have a material adverse effect on our financial position, results of operations, or cash flows and are not aware of any material legal proceedings contemplated by governmental authorities.

Item 1A. – Risk Factors

Investing in our securities involves a high degree of risk. You should consider carefully the risks and uncertainties described below before deciding whether to purchase any of our securities. If any of these risks actually occur, it could harm our business, financial condition, results of operations and cash flows and our prospects. In that event, the price of our securities could decline and you could lose part or all of your investment.

Risks Related to Our Business and Industry

Our results of operations and ability to grow could be negatively affected if we cannot adapt and expand our technology offerings and services in response to ongoing market changes.

The collaboration and technology solutions business and markets are characterized by rapid technological change, evolving industry standards, changing client preferences, and new product and service introductions. Our success depends on our ability to continue to develop and implement technology offerings and services that anticipate or timely respond to rapid and continuing changes in technology and industry developments and offerings by new technology providers to serve the evolving needs of our clients. Examples of areas of significant change in the industry include cloud, software-defined infrastructure, virtualization, security, mobility, data analytics, and Internet of Things, or IoT, the continued shift from maintenance to managed services and ultimately to cloud-based services, as-a-service solutions, security, and information technology automation. In addition, enterprises are continuing to shift from on-premise, hardware infrastructure to software-centric hosted solutions. Technological developments such as these may materially affect the cost and use of technology and services by our clients and could affect the nature of how our revenue is generated. These technologies, and others that may emerge, could reduce and, over time, replace some of our current business. In addition, clients may delay spending under existing contracts and engagements and may delay entering into new contracts while they evaluate new technologies. If we do not sufficiently invest in new technology, industry developments, and our personnel, or evolve and expand our business at sufficient speed and scale, or if we do not make the right strategic investments to respond to these developments and successfully drive innovation, our technology offerings and services, our results of operations, and our ability to develop and maintain a competitive advantage and to continue to grow could be negatively affected.

In addition, if we are unable to keep up with changes in technology and new hardware, software, and services offerings, for example, by providing the appropriate training to our account managers, sales technology specialists, engineers, and consultants to enable them to effectively sell and deliver such new offerings to clients, our business, results of operations, or financial condition could be adversely affected.

Our business depends on our technology partner relationships and the availability of their products.

We have relationships with over 100 technology partners, including Avaya, Cisco, Dell, IBM, Interactive Intelligence, and Microsoft. Our business depends on the sale and installation of a variety of hardware and software that we purchase for resale from technology partners, which include original equipment manufacturers, or OEMs, software publishers, and wholesale distributors. We are authorized by our technology partners to sell all or some of their technology offerings via direct marketing activities. Our authorization with each technology partner is subject to specific terms and conditions regarding but not limited to, sales channel restrictions, product return privileges, price protection policies, purchase discounts, and technology partner programs and funding, including purchase rebates, sales volume rebates, purchasing incentives, and cooperative advertising reimbursements. However, we do not have long-term contracts with many of our technology partners and many of these arrangements are terminable upon notice by either party. Material changes to the agreements with our technology partners, including changes to purchase discounts and rebate programs, or our failure to timely react to such changes, could have an adverse effect on our business, results of operations, or financial condition.

 

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The priorities and objectives of our partners may differ from ours. As most of our relationships are non-exclusive, our partners are not prohibited from competing with us or forming closer or preferred arrangements with our competitors. From time to time, technology partners may terminate or limit our right to sell some or all of their technology offerings or change the terms and conditions or reduce or discontinue the incentives that they offer us. For example, there is no assurance that, as our technology partners continue to sell directly to customers and through resellers, they will not limit or curtail the availability of their products to solutions providers like us. Any such termination or limitation or the implementation of such changes could have a negative impact on our business, results of operations, or financial condition.

In addition, our success is dependent on our ability to develop relationships with and sell hardware, software, and services from new emerging vendors, including vendors that we have not historically represented in the marketplace. To the extent that a vendor’s offering that is highly in demand is not available to us to provide in one or more client channels, and there is not a competitive offering from another vendor that we are authorized to sell in such client channels, or we are unable to develop relationships with new technology providers or companies that we have not historically represented, our business, results of operations, or financial condition could be adversely impacted.

In addition, the termination of key technology partner relationships as a result of the sale, spin-off, combination, bankruptcy, or other similar circumstances of any of our technology partners and/or certain of their business units, including any such sale to or combination with a vendor with whom we do not currently have a commercial relationship or whose products we do not sell, could have an adverse impact on our business, results of operations, or financial condition.

We rely on a small number of key vendors for a significant portion of our technology offerings revenue.

Although we purchase from a diverse vendor base, in 2017, products manufactured by Avaya and Cisco represented 21% and 39%, respectively, of our technology offerings revenue. The loss of, or change in business relationship with, either of these or any other key technology partners, the diminished availability or quality of their products, or backlogs for their products leading to manufacturer allocation, could reduce the supply and increase the cost of products we sell and negatively impact our competitive position. In addition, we rely on one distributor that supplies a significant portion of our Avaya products and the termination of this distributor relationship could negatively impact our business.

Avaya, which was our largest vendor as a percentage of our technology offerings revenue in 2015 and 2016, filed for reorganization under Chapter 11 in January 2017, filed its preliminary plan of reorganization in April 2017 and had its Chapter 11 plan of reorganization approved by the Bankruptcy Court in November 2017. As a result of Avaya’s restructuring, new or existing clients may elect to delay purchasing decisions with respect to Avaya technology offerings or may choose to replace existing Avaya technology offerings with the technology offerings of other vendors. Although we have partner relationships with a diverse vendor base, new or existing clients may elect to purchase such alternative technology offerings from a provider other than us or such alternative technology offerings may have lower margins. Delays in customer purchasing decisions, or an election by our clients to purchase alternative technology offerings from us or from other providers, could result in lower revenues and gross profits or margins or otherwise have an adverse effect on our business, although we cannot estimate the impact at this time.

If we are unable to expand or renew sales to existing clients, or attract new clients, our growth could be slower than we expect and our business may be harmed.

Our future growth depends upon expanding sales and renewals of our technology offerings and services with existing clients. Our clients may not purchase our technology offerings and services, or our clients may reduce their purchasing volumes, if we do not demonstrate the value proposition for their investment, and we may not be able to replace existing clients with new clients. In addition, our clients may not renew their contracts with us on the same terms, or at all, because of dissatisfaction with our service. If our clients do not renew their contracts, our revenue may grow more slowly than expected, may not grow at all, or may decline. Additionally, increasing incremental sales to our current client base may require increasingly sophisticated and costly sales efforts that are targeted at senior management. We plan to continue expanding our sales efforts but we may be unable to hire qualified sales personnel, may be unable to successfully train those sales personnel that we are able to hire, and sales personnel may not become fully productive on the timelines that we have projected, or at all. Additionally, although we dedicate significant resources to sales and marketing programs, these sales and marketing programs may not have the desired effect and may not expand sales. We cannot assure you that our efforts will increase sales to existing clients or additional revenue. If our efforts to upsell to our clients are not successful, our future growth may be limited.

Our ability to achieve significant growth in revenue in the future will also depend upon our ability to attract new clients. This may be particularly challenging where an organization has already invested substantial personnel and financial resources to integrate competing technology offerings and services into its business, as such organization may be reluctant or unwilling to invest in new technology offerings and services. If we fail to attract new clients and maintain and expand those client relationships, our revenue may grow more slowly than expected and our business may be harmed.

 

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Demand for our technology offerings and services could be adversely affected by volatile, negative, or uncertain economic conditions and the effects of these conditions on our clients’ businesses.

Our revenue and profitability depend on the demand for our technology offerings and services, which could be negatively affected by numerous factors, many of which are beyond our control. Volatile, negative, or uncertain economic conditions affect our clients’ businesses and the markets we serve. Such economic conditions in our markets have undermined, and could in the future undermine, business confidence in our markets and cause our clients to reduce or defer their spending on new technology offerings and services, or may result in clients reducing, delaying or eliminating spending under existing contracts with us, which would negatively affect our business. Growth in the markets we serve could be at a slow rate, or could stagnate or contract, in each case for an extended period of time. Ongoing economic volatility and uncertainty and changing demand patterns affect our business in a number of other ways, including making it more difficult to accurately forecast client demand and effectively build our revenue and resource plans.

Economic volatility and uncertainty is particularly challenging because it may take some time for the effects and changes in demand patterns resulting from these and other factors to manifest themselves in our business and results of operations. Changing demand patterns from economic volatility and uncertainty could have a significant negative impact on our business, results of operations, or financial condition.

Substantial competition could reduce our market share and significantly harm our financial performance.

Our current competition includes:

 

 

in-house IT departments;

 

 

global service providers and integrators;

 

 

local and regional providers;

 

 

resellers; and

 

 

equipment manufacturers.

We expect the competitive landscape in which we compete to continue to change as new technologies are developed. While innovation can help our business as it creates new offerings for us to sell and provide complementary services, it can also disrupt our business model and create new and stronger competitors. For instance, while cloud-based solutions present an opportunity for us, cloud-based solutions and technologies that deliver technology solutions as a service could increase the amount of sales directly to clients rather than through solutions providers like us, or could reduce the amount of hardware we sell, leading to a reduction in our technology offerings revenue and/or profitability. In addition, some of our hardware and software technology partners sell, and could intensify their efforts to sell, their products directly to our clients. Moreover, traditional OEMs have increased their services capabilities through mergers and acquisitions with service providers, which could potentially increase competition in the market to provide comprehensive technology solutions to clients. If any of these trends becomes more prevalent, it could adversely affect our business, results of operations, or financial condition.

We focus on offering a high level of service to gain new clients and retain existing clients. To the extent we face increased competition to gain and retain clients, we may be required to reduce prices, increase advertising expenditures, or take other actions that could adversely affect our business, results of operations, or financial condition. Additionally, some of our competitors may reduce their prices in an attempt to stimulate sales, which may require us to reduce prices. This would require us to sell a greater number of products and services to achieve the same level of revenue and gross profit. If such a reduction in prices occurs and we are unable to attract new clients and sell increased quantities of products and services, our sales growth and profitability could be adversely affected.

Our future results will depend on our ability to continue to focus our resources and manage costs effectively.

We are continually implementing productivity measures and focusing on measures intended to further improve cost efficiency. We may be unable to realize all expected cost savings in connection with these efforts within the expected time frame, or at all, and we may incur additional and/or unexpected costs to realize them. Further, we may not be able to sustain any achieved savings in the future. Future results will depend on the success of these efforts.

If we are unable to control costs, we may incur losses, which could decrease our operating margins and significantly reduce or eliminate our profits. Our future profitability will depend on our ability to manage costs or increase productivity. An inability to effectively manage costs could adversely impact our business, results of operations, or financial condition.

 

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Our profitability could suffer if we are not able to manage large and complex projects and complete fixed-price, fixed-timeframe contracts on budget and on time.

Our profitability and operating results are dependent on the scale of our projects and the prices we are able to charge for our technology offerings and services. We perform a significant portion of our work through fixed-price contracts, in which we assume full control of the project team and manage all facets of execution. As a significant portion of our projects are on a fixed-price model, we may be unable to accurately estimate the appropriate project price and successfully manage such projects. Although we use specified technical processes and our past experience to reduce the risks associated with estimating, planning, and performing fixed-price and fixed-timeframe projects, we face the risk of cost overruns, completion delays, and wage inflation in connection with these projects. If we fail to accurately estimate the resources or time required for a project or future rates of wage inflation, or if we fail to perform contractual obligations within the contractual timeframe, our profitability could suffer.

The challenges of managing larger and more complex projects include:

 

 

maintaining high-quality control and process execution standards;

 

 

maintaining planned resource utilization rates on a consistent basis;

 

 

maintaining productivity levels and implementing necessary process improvements;

 

 

controlling project costs;

 

 

maintaining close client contact and high levels of client satisfaction;

 

 

recruiting and retaining sufficient numbers of skilled IT professionals; and

 

 

maintaining effective client relationships.

In addition, large and complex projects may involve multiple engagements or stages, and there is a risk that a client may choose not to retain us for additional stages or may cancel or delay additional planned engagements. Such cancellations or delays may make it difficult to plan our project resource requirements, and may result in lower profitability levels than we anticipated upon commencing engagements.

Our investments in new services and technologies may not be successful.

We continue to invest in new services and technologies, including cloud, software-defined infrastructure, virtualization, security, mobility, data analytics, and IoT. The complexity of these solutions, our learning curve in developing and supporting them, and significant competition in the markets for these solutions could make it difficult for us to market and implement these solutions successfully. Additionally, there is a risk that our clients may not adopt these solutions widely, which would prevent us from realizing expected returns on these investments. Even if these solutions are successful in the market, they still rely on third-party hardware and software and our ability to meet stringent service levels. If we are unable to deploy these solutions successfully or profitably, it could adversely impact our business, results of operations, or financial condition.

If we lose any of our key personnel, or are unable to attract and retain the talent required for our business, our business could be disrupted and our financial performance could suffer.

Our success is heavily dependent upon our ability to attract, develop, engage, and retain key personnel to manage and grow our business, including our key executive, management, sales, services, and technical personnel.

Our future success will depend to a significant extent on the efforts of our executive officers: John A. McKenna, Jr., our President, Chief Executive Officer and Chairman of the Board; John F. Lyons, our President, Field Organization; Paul K. Maier, our President, Services Organization; and Jeffrey E. Nachbor, our Chief Financial Officer, as well as the continued service and support of other key employees. Our future success also will depend on our ability to attract and retain highly skilled technology specialists, engineers, and consultants, for whom the market is extremely competitive. All of our officers and key employees are at-will employees, meaning that they can terminate their employment with us at any time. Further, we do not maintain “key man” life insurance policies for any of our officers or key employees.

Our inability to attract, develop, and retain key personnel could have an adverse effect on our relationships with our technology partners and clients and adversely affect our ability to expand our offerings of technology offerings and services. Moreover, our inability to train our sales, services, and technical personnel effectively to meet the rapidly changing technology needs of our clients could cause a decrease in the overall quality and efficiency of such personnel. Such consequences could adversely affect our business, results of operations, or financial condition.

 

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Our ability to attract and retain business and personnel may depend on our reputation in the marketplace.

We believe our brand name and our reputation in the marketplace are important corporate assets that help distinguish our technology offerings and services from those of competitors and also contribute to our ability to recruit and retain talented personnel, in particular our engineers and consulting professionals. However, our corporate reputation is potentially susceptible to material damage by events such as disputes with clients, cybersecurity breaches, service outages, internal control deficiencies, delivery failures, or compliance violations. Similarly, our reputation could be damaged by actions or statements of current or former clients, directors, employees, competitors, vendors, partners, our joint ventures or joint venture partners, adversaries in legal proceedings, legislators, or government regulators, as well as members of the investment community or the media. There is a risk that negative information about us, even if based on rumor or misunderstanding, could adversely affect our business. Damage to our reputation could be difficult, expensive and time-consuming to repair, could make potential or existing clients reluctant to select us for new engagements, resulting in a loss of business, and could adversely affect our recruitment and retention efforts. Damage to our reputation could also reduce the value and effectiveness of our brand name and could reduce investor confidence in us, adversely affecting our share price.

We have experienced rapid internal growth as well as growth through acquisitions in recent periods. If we fail to manage our growth effectively, or our business does not grow as expected, our operating results may suffer.

Our headcount and operations have grown substantially. We had approximately 2,185 employees as of December 31, 2017, as compared with approximately 1,349 employees as of December 31, 2015. This growth has placed, and will continue to place, a significant strain on our operational, financial, and management infrastructure. We anticipate further increases in headcount will be required to support increases in our technology offerings and continued expansion. To manage this growth effectively, we must continue to improve our operational, financial, and management systems and controls by, among other things:

 

 

effectively attracting, training, and integrating a large number of new employees, particularly technical personnel and members of our management and sales teams;

 

 

further improving our key business systems, processes, and information technology infrastructure to support our business needs;

 

 

enhancing our information and communication systems to ensure that our employees are well-coordinated and can effectively communicate with each other and our clients; and

 

 

improving our internal control over financial reporting and disclosure controls and procedures to ensure timely and accurate reporting of our operational and financial results.

If we fail to manage our expansion or implement our new systems, or if we fail to implement improvements or maintain effective internal controls and procedures, our costs and expenses may increase more than expected and we may not expand our client base, increase renewal rates, enhance our existing applications, develop new applications, satisfy our clients, respond to competitive pressures, or otherwise execute our business plan. If we are unable to manage our growth, our operating results likely will be harmed.

Future acquisitions could disrupt our business and may divert management’s attention, and if unsuccessful, harm our business.

We may choose to expand by making additional acquisitions that could be material to our business. We have in the past made several acquisitions of complementary businesses, including ASI and Advantel in 2018, RGTS, SPS, Annese and AOS in 2017. In 2015, we acquired SIGMAnet, MSN Communications, and Sunturn. Acquisitions involve many risks, including the following:

 

 

an acquisition may negatively affect our results of operations and financial condition because it may require us to incur charges or assume substantial debt or other liabilities, may cause adverse tax consequences or unfavorable accounting treatment, may expose us to claims and disputes by third parties, including intellectual property claims and disputes, or may not generate sufficient financial return to offset additional costs and expenses related to the acquisition;

 

 

we may encounter difficulties or unforeseen expenditures in integrating the business, technologies, products, personnel, or operations of any company that we acquire, particularly if key personnel of the acquired company decide not to work for us;

 

 

an acquisition may disrupt our ongoing business, divert resources, increase our expenses, or distract our management;

 

 

an acquisition may result in a delay or reduction of client purchases for both us and the company we acquired due to client uncertainty about continuity and effectiveness of service from either company;

 

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we may encounter difficulties in, or may be unable to, successfully sell any acquired technology offerings or services;

 

 

an acquisition may involve the entry into geographic or business markets in which we have little or no prior experience or where competitors have stronger market positions;

 

 

the challenges inherent in effectively managing an increased number of employees in diverse locations;

 

 

the potential strain on our financial and managerial controls and reporting systems and procedures;

 

 

the potential known and unknown liabilities associated with an acquired company;

 

 

our use of cash to pay for acquisitions would limit other potential uses for our cash;

 

 

if we incur additional debt to fund such acquisitions, such debt may subject us to additional material restrictions on our ability to conduct our business as well as additional financial maintenance covenants;

 

 

the risk of impairment charges related to potential write-downs of acquired assets or goodwill in future acquisitions;

 

 

to the extent that we issue a significant amount of equity or equity-linked securities in connection with future acquisitions, existing stockholders may be diluted and earnings per share may decrease; and

 

 

managing the varying intellectual property protection strategies and other activities of an acquired company.

We may not succeed in addressing these or other risks or any other problems encountered in connection with the integration of any acquired business. The inability to integrate successfully the business, technologies, products, personnel, or operations of any acquired business, or any significant delay in achieving integration, could harm our business, results of operations, or financial condition.

We may not be able to recognize revenue in the period in which our services are performed, which may cause our margins to fluctuate.

Our services are performed under both time-and-material and fixed-price contract arrangements. All revenue is recognized pursuant to applicable accounting standards. We recognize revenue from professional services, which includes the design, configuration, installation, and integration of business communication and data systems, as the services are performed and all obligations have been substantially met. Our failure to meet all the obligations, or otherwise meet a client’s expectations, may result in our having to record the cost related to the performance of services in the period that services were rendered, but delay the timing of revenue recognition to a future period in which all obligations have been met.

We may experience quarterly fluctuations in our operating results due to a number of factors, which makes our future results difficult to predict and could cause our operating results to fall below expectations.

Our quarterly operating results have fluctuated in the past and we expect them to fluctuate in the future due to a variety of factors, many of which are outside of our control. As a result, our past results may not be indicative of our future performance, and comparing our operating results on a period-to-period basis may not be meaningful. In addition to the other risks described herein, factors that may affect our quarterly operating results include:

 

 

changes in spending on collaboration and technology offerings and services by our current or prospective clients;

 

 

pricing our technology offerings and services effectively so that we are able to attract and retain clients without compromising our operating results;

 

 

attracting new clients and increasing our existing clients’ use of our technology offerings and services;

 

 

the mix between wholesale and retail maintenance new contracts and renewals;

 

 

client renewal rates and the amounts for which agreements are renewed;

 

 

seasonality and its effect on client demand;

 

 

awareness of our brand;

 

 

changes in the competitive dynamics of our market, including consolidation among competitors or clients and the introduction of new technologies and technology enhancements;

 

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changes to the commission plans, quotas, and other compensation-related metrics for our sales representatives;

 

 

the amount and timing of payment for operating expenses, particularly sales and marketing expense;

 

 

our ability to manage our existing business and future growth, domestically and internationally;

 

 

unforeseen costs and expenses related to the expansion of our business, operations, and infrastructure, including disruptions in our hosting network infrastructure and privacy and data security; and

 

 

general economic and political conditions in our domestic and international markets.

We may not be able to accurately forecast the amount and mix of future technology offerings and services, size or duration of contracts, revenue, and expenses and, as a result, our operating results may fall below our estimates.

We could be held liable for damages or our reputation could suffer from security breaches or disclosure of confidential information or personal data.

We are dependent on IT networks and systems to process, transmit, and securely store electronic information and to communicate among our locations and with our clients. Through our cloud technology offerings, we process, transmit, and store electronic information of our clients. Security breaches of this infrastructure could lead to shutdowns or disruptions of our systems and potential loss or unauthorized disclosure of confidential information or data, including personal data. In addition, many of our engagements involve projects that are critical to the operations of our clients’ businesses. The theft and/or unauthorized use or publication of our, or our clients’, confidential information or other proprietary business information as a result of such an incident could adversely affect our competitive position and reduce marketplace acceptance of our services. Any failure in the networks or computer systems used by us or our clients could result in a claim for substantial damages against us and significant reputational harm, regardless of our responsibility for the failure.

In addition, we often have access to or are required to manage, utilize, collect, and store sensitive or confidential client or employee data, including personal data. As a result, we are subject to numerous U.S. and non-U.S. laws and regulations designed to protect this information, such as the European Union Directive on Data Protection and various U.S. federal and state laws governing the protection of personal data. If any person, including any of our employees, negligently disregards or intentionally breaches controls or procedures with which we are responsible for complying with respect to such data, or otherwise mismanages or misappropriates that data, or if unauthorized access to or disclosure of data in our possession or control occurs, we could be subject to liability and penalties in connection with any violation of applicable privacy laws and/or criminal prosecution, as well as significant liability to our clients or our clients’ customers for breaching contractual confidentiality and security provisions or privacy laws. These risks will increase as we continue to grow our cloud-based offerings and services and store and process increasingly large amounts of our clients’ confidential information and data and host or manage parts of our clients’ businesses, especially in industries involving particularly sensitive data such as the financial services industry and the healthcare industry. The loss or unauthorized disclosure of sensitive or confidential client or employee data, including personal data, whether through breach of computer systems, systems failure, employee negligence, fraud or misappropriation, or otherwise, could damage our reputation and cause us to lose clients. Similarly, unauthorized access to or through our information systems and networks or those we develop or manage for our clients, whether by our employees or third parties, could result in negative publicity, legal liability, and damage to our reputation, which could in turn harm our business, results of operations, or financial condition.

If we cause disruptions in our clients’ businesses or provide inadequate service, our clients may have claims for substantial damages against us, which could cause us to lose clients, have a negative effect on our corporate reputation, and adversely affect our results of operations.

If we make errors in the course of delivering services to our clients or fail to consistently meet our service level obligations or other service requirements of our clients, these errors or failures could disrupt our client’s business, which could result in a reduction in our revenue or a claim for substantial damages against us. In addition, a failure or inability by us to meet a contractual requirement could subject us to penalties, cause us to lose clients or damage our brand or corporate reputation, and limit our ability to attract new business.

The services we provide are often critical to our clients’ businesses. Certain of our client contracts require us to comply with security obligations including maintaining network security and backup data, ensuring our network is virus-free, maintaining business continuity planning procedures, and verifying the integrity of employees that work with our clients by conducting background checks. Any failure in a client’s system, failure of our data center, cloud or other offerings, or breach of security relating to the services we provide to the client could damage our reputation or result in a claim for substantial damages against us. Any significant failure of our equipment or systems, or any major disruption to basic infrastructure in the locations in which we operate, such as power and telecommunications, could impede our ability to provide services to our clients, have a negative impact on our reputation, cause us to lose clients, and adversely affect our results of operations.

 

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Under our client contracts, our liability for breach of our obligations is in some cases limited pursuant to the terms of the contract. Such limitations may be unenforceable or otherwise may not protect us from liability for damages. In addition, certain liabilities, such as claims of third parties for which we may be required to indemnify our clients, are generally not limited under our contracts. The successful assertion of one or more large claims against us in amounts greater than those covered by our current insurance policies could harm our business, results of operations, or financial condition. Even if such assertions against us are unsuccessful, we may incur reputational harm and substantial legal fees.

The length and unpredictability of the sales cycle for our technology offerings and services could delay new sales and cause our revenue and cash flows for any given quarter to fail to meet our projections or market expectations.

The sales cycle between our initial contact with a potential client and the signing of a contract to provide technology offerings and services varies. As a result of the variability and length of the sales cycle, we have a limited ability to forecast the timing of sales. A delay in or failure to complete transactions could harm our business and financial results, and could cause our financial results to vary significantly from quarter to quarter. Our sales cycle varies widely, reflecting differences in our potential clients’ decision-making processes, procurement requirements, and budget cycles, and is subject to significant risks over which we have little or no control, including:

 

 

our clients’ budgetary constraints and priorities;

 

 

the timing of our clients’ budget cycles; and

 

 

the length and timing of clients’ approval processes.

Reliance on shipments at the end of the quarter could cause our revenue for the applicable period to fall below expected levels. Our profitability depends, in part, on the volume of technology offerings and services sold, and we may be unable to achieve increases in our profit margins in the future.

As a result of client purchasing patterns and the efforts of our client engagement team to meet or exceed their performance objectives, we have historically generated a substantial portion of revenue during the last few weeks of each quarter. If expected revenue at the end of any quarter is delayed for any reason, including the failure of anticipated purchase orders to materialize, our inability to ship and demonstrate clients’ receipt of products prior to quarter-end to fulfill purchase orders received near the end of the quarter, our failure to manage inventory to meet demand, our inability to release new products on schedule, or any failure of our systems related to order review and processing, our revenue for that quarter could fall below our expectations, which could adversely impact our business, results of operations, or financial condition.

Seasonality may cause fluctuations in our revenue and profitability.

We believe there are significant seasonal factors that cause us to record higher revenue in some quarters compared to others. We believe this variability is largely due to our clients’ and technology partners’ fiscal year ends, as well as budgetary and spending patterns of our clients. For example, we have historically generated a higher portion of our sales in the second half of each year, at which point our cost of revenue and commission expense increases relative to any increase in revenue. The increased cost of revenue and commission expense, and other impacts of seasonality, may affect profitability in a given quarter. Our growth rate may have made seasonal fluctuations more difficult to detect. If our growth rate slows over time, seasonal or cyclical variations in our operations may become more pronounced, and our business, results of operations, or financial position may be adversely affected.

Our work with government clients exposes us to additional risks inherent in the government contracting environment.

We provide IT services to various government agencies, including federal, state, and local government entities. For 2016 and 2017, approximately 7% and 10%, respectively, of our total revenue was derived from sales to federal, state, and local governments. While our sales to public sector clients are diversified across various agencies and departments, changes in law, regulation, or the political climate, or an across-the-board change in government spending policies, including budget cuts at the federal level, could result in our public sector clients reducing their purchases and terminating their service contracts, which could adversely impact our business, results of operations, or financial condition.

Furthermore, we derive a substantial portion of our government contracts revenue from contracts awarded through competitive procurement processes, which can impose substantial costs upon us to prepare for and participate in competitions. Moreover, there is no assurance that our proposal will be selected for any future opportunity and even where we are awarded a contract, the award may be subject to protest by competitors, which may require the contracting agency or department to suspend our performance pending the outcome of the protest.

 

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In addition, government contracts often contain additional audit rights, termination for convenience provisions, compliance, and disclosure obligations, and are subject to heightened reputational and contractual risks compared to contracts with commercial clients, including the risk of False Claims Act prosecutions and/or suspensions or debarment proceedings. The additional obligations and risks could affect not only our business with the particular government entities involved, but also our business with other entities of the same or other governmental bodies or with certain commercial clients, and could adversely impact our business, results of operations, or financial condition.

Our technology offerings and services could infringe upon the intellectual property rights of others or we might lose our ability to utilize the intellectual property of others.

We cannot be sure that our brand, technology offerings, and services, including, for example, the software solutions of others that we offer to our clients, do not infringe on the intellectual property rights of third parties, and these third parties could claim that we or our clients are infringing upon their intellectual property rights. These claims could harm our reputation, cause us to incur substantial costs or prevent us from offering some services or solutions in the future, or require us to rebrand. Any related proceedings could require us to expend significant resources over an extended period of time. In most of our contracts, we agree to indemnify our clients for expenses and liabilities resulting from claimed infringements of the intellectual property rights of third parties. In some instances, the amount of these indemnities could be greater than the revenue we receive from the client. Any claims or litigation in this area, regardless of merit, could be time-consuming and costly, damage our reputation, and/or require us to incur additional costs to obtain the right to continue to offer a service or solution to our clients. If we cannot secure this right at all or on reasonable terms, or, alternatively, substitute a non-infringing technology, our business, results of operations, or financial condition could be harmed. Similarly, if we are unsuccessful in defending a trademark claim, we could be forced to re-brand, which could harm our business, results of operations, or financial condition. Additionally, in recent years, individuals and firms have purchased intellectual property assets where their sole or primary purpose is to assert claims of infringement against technology providers and clients that use such technology. Any such action naming us or our clients could be costly to defend or lead to an expensive settlement or judgment against us. Moreover, such an action could result in an injunction being ordered against our client or our own services or operations, causing further damages.

If we are unable to protect our intellectual property rights from unauthorized use or infringement by third parties, our business could be adversely affected.

Our success depends, in part, upon our ability to protect our proprietary methodologies and other intellectual property. Existing laws offer only limited protection of our intellectual property rights, and the protection in some countries in which we operate or may operate in the future may be very limited. We rely upon a combination of confidentiality policies, nondisclosure and other contractual arrangements, and trade secret, copyright, and trademark laws to protect our intellectual property rights. These laws are subject to change at any time and could further limit our ability to protect our intellectual property. There is uncertainty concerning the scope of available intellectual property protection for software and business methods, which are fields in which we rely on intellectual property laws to protect our rights. The validity and enforceability of any intellectual property right we obtain may be challenged by others and, to the extent we have enforceable intellectual property rights, those intellectual property rights may not prevent competitors from reverse engineering our proprietary information or independently developing technology offerings and services similar to or duplicative of ours. Further, the steps we take in this regard might not be adequate to prevent or deter infringement or other misappropriation of our intellectual property by competitors, former employees or other third parties, and we might not be able to detect unauthorized use of, or take appropriate and timely steps to enforce, our intellectual property rights. Enforcing our rights might also require considerable time, money, and oversight, and we may not be successful in enforcing our rights.

If we are unable to collect our receivables from, or bill our unbilled services to, our clients, our business, results of operations, or financial condition could be adversely affected.

Our business depends on our ability to successfully obtain payment from our clients of the amounts they owe us for technology offerings sold or services performed. We typically evaluate the financial condition of our clients and usually bill and collect on relatively short cycles. We maintain allowances against receivables and unbilled services. Actual losses on client balances could differ from those that we currently anticipate and, as a result, we might need to adjust our allowances. There is no guarantee that we will accurately assess the creditworthiness of our clients. Macroeconomic conditions could also result in financial difficulties for our clients, including limited access to the credit markets, insolvency, or bankruptcy, and, as a result, could cause clients to delay payments to us, request modifications to their payment arrangements that could increase our receivables balance, or default on their payment obligations to us. Timely collection of client balances also depends on our ability to complete our contractual commitments and bill and collect our contracted revenue. If we are unable to meet our contractual requirements, we might experience delays in collection of and/or be unable to collect our client balances, and if this occurs, our business, results of operations, or financial condition could be adversely affected. In addition, if we experience an increase in the time to bill and collect for our services, our cash flows could be adversely affected.

 

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Increased costs of labor and employee health and welfare benefits may adversely impact our results of operations.

Given our large number of employees, labor-related costs represent a significant portion of our expenses. Salaries, wages, benefits, commissions, and other labor compensation costs excluding bonus and payroll tax for our full-time employees amounted to $133 million in 2017, which represented approximately 62% of our selling, general and administrative expenses and approximately 10% of our cost of revenue. An increase in labor costs, for example, as a result of increased competition for skilled labor, or employee benefit costs, such as health care costs or otherwise, could adversely impact our business, results of operations, or financial condition.

We rely on third-party companies to perform certain of our obligations to clients, which could impact our business if not performed.

We deliver and manage mission-critical software, systems and network solutions for our clients. We also offer certain services, such as implementation, installation, and deployment services, to our clients through various third-party providers who are engaged to perform these services on our behalf. We are also required, as a component of some of our contracts with our OEM partners, to utilize their engineers as part of our solutions. In addition, we support approximately 150 multinational clients through our Aura and Unified Comms alliances, offering access to more than 50 IT service providers in approximately 60 countries and enabling us to offer our managed services internationally. If we or our third-party services providers, including our alliance service providers, fail to provide high-quality services to our clients, or if such services result in a disruption of our clients’ businesses, we could be subject to legal claims, proceedings, and liability.

The interruption of the flow of products from suppliers could disrupt our supply chain.

A significant portion of the products we sell are manufactured or purchased by our technology partners outside of the United States, primarily in Asia. Political, social, or economic instability in Asia, or in other regions in which our technology partners purchase or manufacture the products we sell, could cause disruptions in trade, including exports to the United States. Other events that could also cause disruptions to our supply chain include:

 

 

the imposition of additional trade law provisions or regulations or changes to existing trade laws provisions or regulations;

 

 

the imposition of additional duties, tariffs, and other charges on imports and exports;

 

 

foreign currency fluctuations;

 

 

natural disasters or other adverse occurrences at, or affecting, any of our suppliers’ facilities;

 

 

restrictions on the transfer of funds;

 

 

the financial instability or bankruptcy of manufacturers; and

 

 

significant labor disputes, such as strikes.

We cannot predict whether the countries in which the products we sell are purchased or manufactured, or may be purchased or manufactured in the future, will be subject to new or additional trade restrictions or sanctions imposed by the U.S. or foreign governments, including the likelihood, type or effect of any such restrictions. Trade restrictions, including new or increased tariffs or quotas, embargoes, sanctions, safeguards, and customs restrictions against the products we sell, as well as foreign labor strikes and work stoppages or boycotts, could increase the cost or reduce the supply of product available to us and adversely affect our business, results of operations, or financial condition. In addition, our exports are subject to regulations and noncompliance with these requirements could have a negative effect on our business, results of operations, or financial condition.

Our global operations are subject to complex risks, some of which might be beyond our control.

Our clients have operations across South America, Europe, Australia, and Asia. Although international revenue currently represents a small portion of our business, our revenue from clients outside of the United States may expand in the future as we expand our international presence. As a result, we may be subject to risks inherently associated with international operations, including risks associated with foreign currency exchange rate fluctuations, difficulties in enforcing intellectual property and/or

 

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contractual rights, the burdens of complying with a wide variety of foreign laws and regulations, potentially adverse tax consequences, tariffs, quotas, and other barriers, potential difficulties in collecting accounts receivable, international hostilities, terrorism, and natural disasters. Expansion of international operations also increases the likelihood of potential or actual violations of domestic and international anticorruption laws, such as the Foreign Corrupt Practices Act, or of U.S. and international export control and sanctions regulations. We may also face difficulties integrating any new facilities in different countries into our existing operations, as well as integrating employees that we hire in different countries into our existing corporate culture. If we are unable to manage the risks of our global operations, our business, results of operations, or financial condition could be adversely affected.

Changes in accounting rules could adversely affect our future financial results.

We prepare our financial statements in conformity with generally accepted accounting principles, or U.S. GAAP. These accounting principles are subject to interpretation by the Financial Accounting Standards Board, the SEC, the American Institute of Certified Public Accountants, and various other bodies formed to interpret and create appropriate accounting policies. Technology offerings and services, and the manner in which they are bundled, are technologically complex and the characterization of these technology offerings and services requires judgment to apply revenue recognition policies. Any mischaracterization of these technology offerings and services could result in misapplication of revenue recognition policies. Future periodic assessments required by current or new accounting standards, including through the implementation of ASU 2014-09 as described in the notes to our condensed consolidated financial statements found elsewhere in this report, may result in non-cash changes and/or changes in presentation or disclosure. In addition, any change in accounting standards may influence our clients’ decision to purchase from us or to finance transactions with us, which could adversely impact our business, results of operations, or financial condition.

Risks Related to Our Indebtedness

We face risks related to our substantial indebtedness.

As of September 30, 2018, we had total outstanding debt of $718 million. Our substantial leverage could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk associated with our variable rate debt, and prevent us from meeting our obligations under our credit facilities. Substantially all of our assets are secured by our credit facilities. Our substantial indebtedness could have important consequences to us, including:

 

 

making it more difficult for us to satisfy our obligations with respect to our debt, and any failure to comply with the obligations under our debt instruments, including restrictive covenants, could result in an event of default under the agreements governing our indebtedness, increasing our vulnerability to general economic and industry conditions;

 

 

reducing the benefits we expect to receive from our recent and any future acquisition transactions;

 

 

requiring a substantial portion of our cash flow from operations to be dedicated to the payment of principal and interest on our debt, thereby reducing our ability to use our cash flow to fund our operations, capital expenditures, selling and marketing efforts, product development, future business opportunities, and other purposes;

 

 

exposing us to the risk of increased interest rates as substantially all of our borrowings are at variable rates;

 

 

restricting us from making strategic acquisitions and from pursuing certain business opportunities;

 

 

limiting our ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements, acquisitions, and general corporate or other purposes; and

 

 

limiting our flexibility and ability to plan for, or adjust to, changing market conditions and placing us at a competitive disadvantage compared to our competitors who may be less highly leveraged.

The occurrence of any one of these events could have an adverse effect on our business, results of operations, financial condition, and ability to satisfy our obligations under our indebtedness.

Despite our high indebtedness level, we and our subsidiaries may still be able to incur significant additional amounts of debt, which could further exacerbate the risks associated with our substantial indebtedness.

We and our subsidiaries may be able to incur substantial additional indebtedness in the future. Although the agreements governing our indebtedness contain restrictions on the incurrence of additional indebtedness, these restrictions are subject to a number of significant qualifications and exceptions and, under certain circumstances, the amount of indebtedness that could be incurred in compliance with these restrictions could be substantial.

 

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Our debt agreements impose significant operating and financial restrictions on us and our subsidiaries that may prevent us from pursuing certain business opportunities and restrict our ability to operate our business.

The credit agreements governing our credit facilities contain covenants that restrict us and our subsidiaries’ ability to take various actions, such as:

 

 

incur additional indebtedness and make guarantees;

 

 

create liens on assets;

 

 

engage in mergers or consolidations;

 

 

sell assets, including sale and leaseback transactions;

 

 

make fundamental changes;

 

 

pay dividends and distributions or repurchase our capital stock;

 

 

make investments, loans and advances, including acquisitions;

 

 

engage in certain transactions with affiliates;

 

 

make changes in the nature of our business and organizational documents; and

 

 

make prepayments of junior debt.

The restrictions in the credit agreements governing our credit facilities also limit our ability to plan for or react to market conditions, meet capital needs, or otherwise restrict our activities or business plans and adversely affect our ability to finance our operations, enter into acquisitions or to engage in other business activities that could be in our interest.

To service our indebtedness and other cash needs, we require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control.

Our ability to satisfy our debt obligations and to fund any planned capital expenditures, dividends, and other cash needs will depend in part upon the future financial and operating performance of our subsidiaries and upon our ability to renew or refinance borrowings. We cannot assure you that our business will generate cash flow from operations, or that we will be able to draw under our revolving credit facilities or otherwise, in an amount sufficient to fund our liquidity needs, including the payment of principal and interest on our indebtedness. Prevailing economic conditions and financial, business, competitive, legislative, regulatory, and other factors, many of which are beyond our control, will affect our ability to make these payments.

If we are unable to make payments, refinance our debt or obtain new financing under these circumstances, we may consider other options, including:

 

 

sales of assets;

 

 

sales of equity;

 

 

reduction or delay of capital expenditures, strategic acquisitions, investments, and alliances; or

 

 

negotiations with our lenders to restructure the applicable debt.

These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. Our ability to restructure or refinance our debt will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. In addition, the terms of the credit agreements governing the credit facilities may restrict us from adopting some of these alternatives. In the absence of sufficient cash flow from operating results and other resources, we could face substantial liquidity problems and could be required to dispose of material assets or operations to meet our debt service and other obligations. We may not be able to consummate those dispositions for fair market value, or at all. Furthermore, any proceeds that we could realize from any such dispositions may not be adequate to meet our debt service obligations then due. Our inability to generate sufficient cash flow to satisfy our debt obligations, or to refinance our indebtedness on commercially reasonable terms or at all, could adversely impact our business, results of operation, and financial condition.

 

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Any decline in the ratings of our corporate credit could adversely affect our ability to access capital.

Any decline in the ratings of our corporate credit or any indications from the rating agencies that their ratings on our corporate credit are under surveillance or review with possible negative implications could adversely impact our ability to access capital.

We are subject to fluctuations in interest rates.

Borrowings under our credit facilities are subject to variable rates of interest and expose us to interest rate risk. For example, assuming the revolving portion of our credit facilities is fully drawn along with the outstanding term loan balance as of September 30, 2018, on a pro forma basis, each 0.5% change in assumed blended interest rates would result in an approximately $4.3 million change in annual interest expense on indebtedness. At present, we do not have any existing interest rate swap agreements, which involve the exchange of floating for fixed rate interest payments to reduce interest rate volatility. However, we may decide to enter into such swaps in the future. If we do, we may not maintain interest rate swaps with respect to all of our variable rate indebtedness and any swaps we enter into may not fully mitigate our interest rate risk, may prove disadvantageous, or may create additional risks.

Our only significant asset is ownership of our subsidiaries and such ownership may not be sufficient to pay dividends or make distributions or loans to enable us to pay any dividends on our Common Stock.

We have no direct operations and no significant assets other than the ownership of our subsidiaries. We will depend on our subsidiaries for distributions, loans and other payments to generate the funds necessary to meet our financial obligations, including our expenses as a publicly traded company, and to pay any dividends with respect to our common stock. In addition, there are legal and contractual restrictions in agreements governing current and future indebtedness of our subsidiaries, as well as the financial condition and operating requirements of our subsidiaries. The earnings from, or other available assets of, our subsidiaries, may not be sufficient to pay dividends or make distributions or loans to enable us to pay any dividends on our common stock or satisfy our other financial obligations.

If securities or industry analysts do not publish or cease publishing research or reports about us, our business, or our market, or if they change their recommendations regarding our securities adversely, the price and trading volume of our securities could decline.

The trading market for our securities will be influenced by the research and reports that industry or securities analysts may publish about us, our business, our market, or our competitors. Securities and industry analysts do not currently, and may never, publish research on us. If no securities or industry analysts commence coverage of us, our stock price and trading volume would likely be negatively impacted. If any of the analysts who may cover us change their recommendation regarding our stock adversely, or provide more favorable relative recommendations about our competitors, the price of our securities would likely decline. If any analyst who may cover us were to cease coverage of us or fail to regularly publish reports on it, we could lose visibility in the financial markets, which could cause our stock price or trading volume to decline.

Exercise of warrants for common stock would increase the number of shares eligible for future resale in the public market and result in dilution to our stockholders.

As of September 30, 2018, we had warrants to purchase 1,354,810 shares of common stock outstanding. Each whole warrant is exercisable to purchase one share of common stock at $11.50 per share. To the extent such warrants