<PAGE> 1
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) December 9, 1999
----------------
PentaStar Communications, Inc.
----------------------------------------------------
(Exact Name of registrant as specified in its charter)
Delaware 0-27709 84-1502003
- ------------------------- ------------ -------------------
(State or other jurisdic- (Commission (IRS Employer
tion of incorporation) File Number) Identification No.)
1522 Blake Street, Denver, Colorado 80202
---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (303) 825-4400
----------------
None
--------------------------------------------------------------
(Former name or former address, if changed since last report.)
- --------------------------------------------------------------------------------
<PAGE> 2
ITEM 5. OTHER EVENTS
On August 16, 1999, PentaStar Communications, Inc. ("PentaStar") filed with
the Securities and Exchange Commission a registration statement on Form SB-2
under the Securities Act of 1933 with respect to its common stock. The
registration statement became effective on October 26, 1999 and PentaStar
successfully completed its initial public offering (the "Offering").
On August 13, 1999, PentaStar entered into acquisition agreements with the
shareholders of ICM Communications Integration, Inc. ("ICM") and DMA Ventures,
Inc., d/b/a/ Access Communications ("Access") (together, the "Acquired
Companies"), to acquire all of the shares of ICM and Access immediately prior to
the completion of the Offering. The registration statement and final prospectus
included in the registration statement contained interim financial statements of
ICM and Access as of June 30, 1999 and for the six months then ended.
Effective October 26, 1999, PentaStar completed the acquisitions of the
Acquired Companies and became the parent company of the Acquired Companies. As
a result, for periods beginning October 26, 1999, the financial statements of
both ICM and Access will be reported in the consolidated financial statements of
PentaStar. However, for the period from January 1, 1999 through October 25,
1999, the financial statements for ICM and Access will be reported separately,
rather than in the consolidated financial statements of PentaStar. This report
contains the financial statements of ICM and Access as of September 30, 1999 and
for the three and nine months then ended.
<PAGE> 3
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
ICM COMMUNICATIONS INTEGRATION, INC.
Balance Sheets............................................ 1
Statements of Operations.................................. 2
Statements of Operations.................................. 3
Statements of Cash Flows.................................. 4
Notes to Financial Statements............................. 5
Management's Discussion and Analysis of Financial
Condition and Results of Operations..................... 9
DMA VENTURES, INC., DBA ACCESS COMMUNICATIONS
Balance Sheets............................................ 12
Statements of Operations.................................. 13
Statements of Operations.................................. 14
Statements of Cash Flows.................................. 15
Notes to Financial Statements............................. 16
Management's Discussion and Analysis of Financial
Condition and Results of Operations..................... 22
</TABLE>
<PAGE> 4
ICM COMMUNICATIONS INTEGRATION, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1998 1999
------------ -------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 138 $ 180
Accounts receivable, net.................................. 1,229 1,435
Related party receivables................................. 27 --
Deferred income taxes..................................... 90 90
Prepaid expenses and other................................ 79 157
------ ------
Total current assets.............................. 1,563 1,862
Property and equipment, net................................ 178 153
Deferred income taxes....................................... 13 13
Other assets -- Related Party Note Receivable............... 281 553
------ ------
Total assets...................................... $2,035 $2,581
====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Line of credit............................................ $ 4 $ 136
Accounts payable and accrued expenses..................... 101 218
Compensation related accruals............................. 465 507
Income taxes payable...................................... 442 492
Deferred revenue.......................................... 159 288
Shareholder note payable.................................. 31 29
------ ------
Total current liabilities......................... 1,202 1,670
------ ------
Commitments and contingencies (Notes 2 and 6)
Shareholders' equity:
Common stock, no par value; 1,000,000 shares authorized;
520,000 shares issued and 514,000 shares outstanding... -- --
Retained earnings......................................... 833 911
------ ------
Total shareholders' equity........................ 833 911
------ ------
Total liabilities and shareholders' equity........ $2,035 $2,581
====== ======
</TABLE>
The accompanying notes to financial statements are an integral part of these
balance sheets.
1
<PAGE> 5
ICM COMMUNICATIONS INTEGRATION, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------
1998 1999
------- -------
(UNAUDITED)
<S> <C> <C>
Revenues:
Advanced communications services......................... $2,346 $2,520
Basic dial tone services................................. 336 489
------ ------
2,682 3,009
------ ------
Costs and Expenses:
Salaries and commissions................................. 1,915 2,117
Other general and administrative expenses................ 552 759
------ ------
2,467 2,876
------ ------
Income from operations........................... 215 133
------ ------
Other (Income) Expense:
Interest income.......................................... (4) (1)
Interest expense......................................... 1 6
------ ------
Other (income) expense........................... (3) 5
------ ------
Income Before Provision for Income Taxes................... 218 128
Provision for income taxes............................... 85 50
------ ------
Net Income................................................. $ 133 $ 78
====== ======
</TABLE>
The accompanying notes to financial statements are an integral part of these
statements.
2
<PAGE> 6
ICM COMMUNICATIONS INTEGRATION, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
------------------
1998 1999
------- -------
(UNAUDITED)
<S> <C> <C>
Revenues:
Advanced communications services......................... $ 708 $ 725
Basic dial tone services................................. 139 141
------ ------
847 866
------ ------
Costs and Expenses:
Salaries and commissions................................. 688 753
Other general and administrative expenses................ 193 321
------ ------
881 1,074
------ ------
Loss from operations.................... (34) (208)
------ ------
Other (Income) Expense:
Interest income.......................................... (1) --
Interest expense......................................... -- 2
------ ------
Other (income) expense........................... (1) 2
------ ------
Loss Before Benefit for Income Taxes....................... (33) (210)
Benefit for income taxes................................. (11) (83)
------ ------
Net Loss................................................... $ (22) $ (127)
====== ======
</TABLE>
The accompanying notes to financial statements are an integral part of these
statements.
3
<PAGE> 7
ICM COMMUNICATIONS INTEGRATION, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
1998 1999
------ ------
(UNAUDITED)
<S> <C> <C>
Cash Flows from Operating Activities:
Net income................................................ $ 133 $ 78
Adjustments to reconcile net income to net cash provided
by operating activities --
Provision for disputed items........................... 61 19
Depreciation........................................... 27 36
Changes in operating assets and liabilities --
Accounts receivable.................................. (269) (198)
Prepaid expenses and other........................... (69) (78)
Accounts payable and accrued expenses................ 36 159
Income taxes......................................... 19 50
Deferred revenue..................................... 186 129
----- -----
Net cash provided by operating activities......... 124 195
----- -----
Cash Flows from Investing Activities:
Purchase of property and equipment........................ (78) (11)
Advances to related parties............................... (127) (272)
----- -----
Net cash used in investing activities............. (205) (283)
----- -----
Cash Flows from Financing Activities:
Net change in line of credit.............................. -- 132
Treasury stock repurchase................................. -- (2)
Payments on capital lease obligations..................... (8) --
----- -----
Net cash provided by (used in) financing
activities...................................... (8) 130
----- -----
Net (Decrease) Increase in Cash and Cash Equivalents........ (89) 42
Cash and Cash Equivalents, beginning of period.............. 181 138
----- -----
Cash and Cash Equivalents, end of period.................... $ 92 $ 180
===== =====
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest.................................... $ 1 $ 6
===== =====
Cash paid for taxes....................................... $ 66 $ --
===== =====
Supplemental Schedule of Non Cash Investing and Financing
Activities:
Acquisition of treasury stock for note payable............ $ 38 $ --
===== =====
</TABLE>
The accompanying notes to financial statements are an integral part of these
statements.
4
<PAGE> 8
ICM COMMUNICATIONS INTEGRATION, INC.
NOTES TO FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
(UNAUDITED)
(1) BUSINESS AND ORGANIZATION
ICM Communications Integration, Inc., a Washington corporation (the
"Company"), was incorporated on January 3, 1995. On July 31, 1997, International
Communications Management, Inc. (the former parent of the Company) distributed
its shares in the Company to its shareholders.
Dependence Upon U S WEST
The Company acts as a sales agent for and generates substantially all of
its revenues from U S WEST Communications, Inc. ("U S WEST"), a regional Bell
operating company. The loss of the relationship with U S WEST or a material
diminishment in the volume of business with U S WEST would adversely affect the
Company. Management believes the Company could become a sales agent for another
provider with comparable terms if it were to lose its relationship with
U S WEST.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - Interim Financial Information
The financial statements as of and for the three and nine months ended
September 30, 1998 and 1999, are unaudited and prepared by the Company pursuant
to the interim reporting rules and regulations of the Securities and Exchange
Commission; however, they include all adjustments (consisting of normal
recurring adjustments) considered necessary by management for a fair
presentation of the financial position and results of operations for these
periods. The results of operations for interim periods are not necessarily
indicative of the results that may be expected for the entire year.
Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
Property and Equipment
Property and equipment is stated at cost and depreciated using the
straight-line method over the following estimated useful lives:
<TABLE>
<CAPTION>
ESTIMATED USEFUL
LIFE IN YEARS
----------------
<S> <C>
Computer and telephone equipment........................ 3-5
Office furniture and fixtures........................... 7
</TABLE>
Expenditures for repairs and maintenance are charged to expense when
incurred. Expenditures for major renewals and betterments, which extend the
useful lives of existing equipment, are capitalized and depreciated. Upon
retirement or disposition of property and equipment, the cost and related
accumulated depreciation are removed from the accounts and any resulting gain or
loss is recognized in the statement of operations.
Revenue Recognition
Revenue and the related commission expense are recognized in the month when
services are installed by U S WEST. Deferred revenue in the accompanying balance
sheets represents cash collected from U S WEST on uninstalled services.
5
<PAGE> 9
ICM COMMUNICATIONS INTEGRATION, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires the use of estimates and assumptions by
management in determining the reported amounts of assets and liabilities, the
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the period.
Actual results could differ from those estimates.
Fair Value of Financial Instruments
The Company's financial instruments consist of cash and cash equivalents,
investments, accounts receivable, accounts payable and borrowings. The carrying
value of these financial instruments on the accompanying balance sheets
approximates their fair value because of their short-term nature.
Concentration of Credit Risk
The Company's financial instruments exposed to concentrations of credit
risk consist primarily of cash and accounts receivable. The Company maintains
their cash in institutions which the Company considers of high credit quality.
The balances, at times, may exceed federally insured limits. Credit risk with
respect to accounts receivable is limited due to the credit worthiness of the
Company's primary customer, U S WEST. Management does not anticipate significant
credit losses from such financial instruments.
Asset Impairment
The Company reviews its long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Long-lived assets, which are held and used in operations would
be impaired if the undiscounted future cash flows related to the asset did not
exceed the net book value. If an asset is determined to be impaired, it is
written down to its fair value.
Advertising and Promotion
Advertising and promotional related expenses are charged to operations when
incurred or the first time the advertising occurs.
Income Taxes
Deferred tax assets and liabilities are provided for differences between
the financial statement and tax basis of assets and liabilities using current
enacted tax rates. The provision for income taxes includes the amount due for
the current period and the change in deferred taxes between periods.
Prior to July 31, 1997, the Company was included in the consolidated tax
return of International Communications Management, Inc. (the "Parent"). The
Company paid or received from the Parent, the incremental taxes resulting from
its inclusion in the consolidated tax return. The amounts reported in the
Company's financial statements approximates the amounts which would have been
reported had the Company been a stand-alone tax payor.
6
<PAGE> 10
ICM COMMUNICATIONS INTEGRATION, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133") which is as amended by SFAS
No. 137. The Company is required to adopt SFAS No. 133 in the year ended
December 31, 2001. SFAS No. 133 establishes methods of accounting for derivative
financial instruments and hedging activities related to those instruments as
well as other hedging activities. To date, the Company has not entered into any
derivative financial instruments or hedging activities. The Company has not
evaluated the impact of adopting SFAS No. 133.
(3) BORROWINGS
Line of Credit
In June 1997, the Company established a line of credit with SeaFirst Bank
("SeaFirst"), which permits the Company to borrow up to $50 at a rate equal to
the prime rate plus 3%. The line of credit expires on November 5, 1999. A
related party, who is a shareholder and director, guarantees borrowings under
the agreement. The line of credit was increased to $150 in April of 1999 and
three additional shareholders and directors became guarantors.
(4) RETIREMENT SAVING PLAN
The Company adopted an IRA plan in October 1997. Under the plan, qualified
employees may elect to defer up to $6 of their calendar year compensation. The
plan provides for contributions by the Company to match the first 3% of the
qualified compensation. The Company may match less than 3%, but not below 1%, in
no more than two out of the past five years. Alternatively, the Company may
contribute 2% of compensation to all eligible employees, whether or not they
participate in the plan.
(5) RELATED-PARTY TRANSACTIONS
Noncurrent Receivable
The Company has a note receivable from a related entity. The related entity
and the Company have some common shareholders. The receivable consists of cash
advances, commissions receivable from sales made on behalf of the related entity
and shared expenses. Management believes that the amount is fully collectible
and repayments will begin in the year 2000.
Amounts charged to the related entity for the shared expenses, commissions
earned from the sales made on behalf of the related entity and cash advances to
the related entity were as follows:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30,
--------------
1998 1999
------ ------
(UNAUDITED)
<S> <C> <C>
Commissions earned..................................... $20 $78
Salaries and bonuses................................... 31 68
Other expenses......................................... 34 30
Cash advances.......................................... 47 96
</TABLE>
Current Receivables
The Company had a note receivable from one of its shareholders. Interest
accrued at 12% per annum and the monthly principal and interest payments were
$1. The note was repaid in September 1999.
The Company had a $25 non-interest bearing receivable from a related entity
outstanding at December 31, 1998. The advance was repaid in July 1999.
7
<PAGE> 11
ICM COMMUNICATIONS INTEGRATION, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
Shareholder Notes Payable
In November 1998, the Company repurchased six shares of non-par stock
from a shareholder for $38. Consideration for the repurchase was a note payable
with monthly payments of $3, maturing in October of 1999. Interest accrues at a
rate of 6%.
Sublease Income
In October 1998, the Company sublet space to a related entity. The terms of
the sublease mirror the terms of the master lease. The related entity is
responsible for all lease payments and related property expenses.
Guarantees
In June 1997, a shareholder and director guaranteed the Company's line of
credit from SeaFirst Bank. Subsequent to December 31, 1998, the line of credit
was amended to include among other things, additional shareholders and directors
as guarantors.
(6) COMMITMENTS AND CONTINGENCIES
Litigation
The Company is involved in litigation which arose in the ordinary course of
business. It is the opinion of management and counsel that the outcome of such
litigation will not have a material effect on the financial statements of the
Company.
(7) SUBSEQUENT EVENT
On August 13, 1999, the shareholders of the Company entered into a
definitive agreement with PentaStar Communications, Inc. ("PentaStar"), pursuant
to which all outstanding shares of the Company's stock would be exchanged for
cash and shares of PentaStar common stock. The transaction was completed on
October 26, 1999 for approximately $1,923 in cash and 165,000 shares of
PentaStar common stock. The cash portion of the consideration is subject to
adjustment based upon certain closing balance sheet amounts. Additional shares
of PentaStar common stock may be issued to one of the shareholders based upon
the relative earnings performance of the Company to that of other acquired
companies.
8
<PAGE> 12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain matters discussed in this Report are "forward-looking statements,"
intended to qualify for the safe harbors from liability established by the
Private Securities Litigation Reform Act of 1995. These forward-looking
statements can generally be identified as such because the context of the
statement includes words such as "anticipates," "expects," "believes" and
"intends" or other similar words. Similarly, statements that describe the
Company's future plans, objectives or goals are also forward-looking statements.
Such forward-looking statements are subject to certain risks and uncertainties
that could cause actual results or outcomes to differ materially from those
currently anticipated. Factors that could affect actual results or outcomes are
described in detail in PentaStar's Registration Statement on Form SB-2 (No.
333-85281) under the heading "Risk Factors" and include:
o The Company's reliance on regional bell operating companies and other
service providers for communications services.
o The Company's ability to increase revenues from service providers other
than local access service providers.
Shareholders, potential investors and other readers are urged to consider
these factors in evaluating the forward-looking statements and are cautioned not
to place undue reliance on such forward-looking statements. The forward-looking
statements included herein are only made as of the date here of and PentaStar
undertakes no obligations to publicly update such forward-looking statements to
reflect subsequent events or circumstances.
GENERAL
The following discussion and analysis of financial condition and results of
operations of ICM Communications Integration, Inc. ("ICM" or the "Company"),
should be read in conjunction with the financial statements as of September 30,
1999 and for the nine months and three months ended September 30, 1999, which
provide additional information regarding financial condition and operating
results.
On August 13, 1999, the shareholders of the Company entered into an
acquisition agreement with PentaStar pursuant to which all outstanding shares of
the Company's stock would be exchanged for cash and shares of PentaStar common
stock.
The acquisition of ICM was structured to be completed and closed
immediately prior to PentaStar's Offering. The closing of the acquisition of ICM
was a condition imposed by the underwriters of the Offering to the closing of
the Offering. As a result of this structure, significant disclosures regarding
ICM's operations, financial statements, contracts and policies and procedures
were included in PentaStar's registration statement on Form SB-2 under the
Securities Act of 1933 filed with the Securities and Exchange Commission on
August 16, 1999. The registration statement became effective on October 26, 1999
and PentaStar successfully closed on the acquisition of ICM and completed the
Offering. Accordingly, from and after October 26, 1999, PentaStar is the parent
company of ICM and the financial statements of ICM will be reported in the
consolidated financial statements of PentaStar.
"Management's Discussion And Analysis of Financial Condition And Results Of
Operations" consists primarily of comparisons of the historical financial
statements. The information may not be reflective of the continuing results of
operations and financial condition of ICM as a wholly-owned subsidiary of
PentaStar, because of certain non-recurring expenses related to the acquisition
and the elimination of redundant costs.
RESULTS OF OPERATIONS
Nine-month period ended September 30, 1998 compared to the nine-month period
ended September 30, 1999
Revenues. Advanced communications services revenues increased $174,000, or
7.4%, from $2,346,000 for the period ended September 30, 1998 to $2,520,000 for
the period ended September 30, 1999. This increase was primarily attributable to
increased focus on selling advanced communications services, primarily for data.
Basic dial tone services revenues increased $153,000, or 45.5%, from $336,000
for the period ended September 30, 1998 to $489,000 for the period ended
September 30, 1999. This increase was primarily attributable to the creation of
a specific group dedicated to selling basic dial tone services.
Costs and expenses. Salaries and commissions increased $202,000, or 10.5%,
from $1,915,000 for the period ended September 30, 1998 to $2,117,000 for the
period ended September 30, 1999. This increase was primarily attributable to
increased staffing in sales, operations and accounting and additional
commissions due to increased revenues. Other general and administrative expenses
increased $207,000, or 37.5%, from $552,000 for the period ended September 30,
1998 to $759,000 for the period ended September 30, 1999. This increase was
primarily due to professional fees and other non-recurring costs associated with
the acquisition agreement and Offering with PentaStar together with increases in
general overhead expenses such as supplies and utilities and a minor increase in
rent.
9
<PAGE> 13
Income from operations. Income from operations decreased $82,000, or 38.1%,
from $215,000 for the period ended September 30, 1998 to $133,000 for the period
ended September 30, 1999. This decrease was primarily attributable to the
increases in costs and expenses discussed above. Income from operations
decreased from 8.0% of revenues for the period ended September 30, 1998 to 4.4%
of revenues for the period ended September 30, 1999 as a result of the above
discussed changes in revenues and costs and expenses.
Other (income) expense, net. Other (income) expense, net, decreased $8,000,
from income of $3,000 for the period ended September 30, 1998 to an expense of
$5,000 for the period ended September 30, 1999. Interest income, net of expense,
consists of interest on available cash balances less interest expense associated
with a line of credit.
Income taxes. Provision for income taxes decreased $35,000, or 41.2%, from
$85,000 for the period ended September 30, 1998 to $50,000 for the period ended
September 30, 1999. The effective tax rate was 39.0% in the 1998 period and
increased to 39.1% in the 1999 period.
Net income. For the reasons discussed above, net income decreased $55,000,
or 41.4%, from $133,000 for the period ended September 30, 1998 to $78,000 for
the period ended September 30, 1999.
Three month period ended September 30, 1998 compared to the three month period
ended September 30, 1999
Revenues. Advanced communications services revenues increased $17,000, or
2.4%, from $708,000 for the period ended September 30, 1998 to $725,000 for the
period ended September 30, 1999. This increase was primarily attributable to
increased focus on selling advanced communications services, primarily for data.
The increase was less than the percentage increase for the nine month period
because attention was diverted from the core operations of the Company as it
focused its attention on the acquisition agreement and Offering with PentaStar
during the third quarter. Basic dial tone services revenues remained relatively
constant for the period ended September 30, 1998 as compared to the period ended
September 30, 1999.
Costs and expenses. Salaries and commissions increased $65,000, or 9.4%,
from $688,000 for the period ended September 30, 1998 to $753,000 for the period
ended September 30, 1999. This increase was primarily attributable to increased
staffing in sales, operations and accounting along with additional employment
costs such as recruiting, benefits and taxes. These increases were primarily due
to the effects on the business as a result of the acquisition agreement and
Offering with PentaStar. Other general and administrative expenses increased
$128,000, or 66.3%, from $193,000 for the period ended September 30, 1998 to
$321,000 for the period ended September 30, 1999. This increase was primarily
due to professional fees and other non-recurring costs associated with the
acquisition agreement and Offering with PentaStar together with increases in
general overhead expenses such as supplies and utilities and a minor increase in
rent.
Loss from operations. Loss from operations increased $174,000 from a loss
of $34,000 for the period ended September 30, 1998 to a loss of $208,000 for the
period ended September 30, 1999. The increase was primarily attributable to the
increase in costs and expenses discussed above. Loss from operations increased
from 4.0% of revenues for the period ended September 30, 1998 to 24.0% of
revenues for the period ended September 30, 1999 as a result of the above
discussed changes in revenues and costs and expenses.
10
<PAGE> 14
Other (income) expense, net. Other (income) expense, net, decreased $3,000,
from income of $1,000 for the period ended September 30, 1998 to an expense of
$2,000 for the period ended September 30, 1999. Interest income, net of expense,
consists of interest on available cash balances less interest expense associated
with a line of credit.
Income taxes. A benefit for income taxes of $11,000 was recorded for the
period ended September 30, 1998 compared to a benefit for income taxes of
$83,000 for the period ended September 30, 1999. The effective tax rates for the
periods were 33.4% and 39.5%, respectively.
Net loss. For the reasons discussed above, net loss increased from a net
loss of $22,000 for the period ended September 30, 1998 to a net loss of
$127,000 for the period ended September 30, 1999.
Liquidity and Capital Resources
ICM's operations provided net cash of $195,000 for the first nine months of
1999, which is an increase over the $124,000 provided for the first nine months
of 1998 due to changes in the Company's working capital balances. ICM used net
cash in investing activities of $283,000 in the first nine months of 1999 to
purchase property, plant and equipment as well as to fund advances to related
parties of ICM. During the first nine months of 1998, ICM used net cash of
$205,000 to purchase property, plant and equipment as well as fund advances to
related parties of ICM. Cash of $130,000 was provided by financing activities
for the nine months ended September 30, 1999 by drawing on the line of credit.
ICM expects to be able to fund its cash needs such as working capital
through cash it generates from operations. It generally funds its purchases of
property, plant and equipment with internally generated cash or debt. ICM
maintains a $150,000 line of credit with a bank. At September 30, 1999, a
balance of $136,000 was outstanding under this line of credit. PentaStar has
repaid all interest bearing indebtedness and terminated the line of credit in
conjunction with the acquisition of ICM. The cash portion of the purchase price
otherwise payable to the shareholders of ICM at the closing was reduced by the
amount of interest bearing indebtedness repaid.
YEAR 2000 RISKS
Many software applications and computer hardware and related equipment and
systems that use embedded technology, such as microprocessors, rely on two
digits rather than four to represent years in performing computations and
decision-making functions. These programs, hardware items and systems may fail
beginning on January 1, 2000, or earlier, because they misinterpret "00" as the
year 1900 rather than 2000. These failures could have a material effect on the
Company because of the Company's direct dependence on the Company's own
software, equipment and systems and the indirect dependence on those of third
parties. The Company's year 2000 program has consisted of the following phases
and is 98% complete:
o identifying all items that may be affected by the year 2000;
o investigating those items for year 2000 compliance;
o assessing the potential impact of year 2000 non-compliance;
o identifying solutions for non-compliant items;
o repairing and replacing any non-compliant items;
o testing those repairs and replacements; and
o contingency planning.
Although the Company has followed the general steps outlined above, the
Company does not consider preparation and maintenance of formal inventories and
risk rankings, detailed test plans and documentation of results as being
necessary because of the small number of information technology systems used.
The Company has contacted their primary service provider, U S WEST, and
have obtained representations and assurances that their hardware, embedded
technology systems and software, which the Company uses or which may otherwise
impact the Company, has been or will be modified on a timely basis to be year
2000 compliant. The Company does not believe that any other third parties
utilized will have a significant impact on operations based upon year 2000
compliance issues.
All of the systems the Company currently uses include "off the shelf"
software which can easily be replaced. If the systems are not year 2000
compliant, the Company will replace these systems prior to December 31, 1999.
If the Company identifies significant risks related to year 2000 compliance
or if progress deviates from the anticipated program, the Company will develop
contingency plans as necessary.
The Company does not anticipate any material adverse effect to the business
from year 2000 failures, but can offer no guarantee that the Company will
achieve total compliance. Factors that give rise to this uncertainty include the
possible failure to identify all susceptible systems, non-compliance by third
parties whose systems and operations impact the Company and a possible loss of
technical resources to perform the work.
The Company's most likely worst-case year 2000 non-compliance scenarios
are:
o an interruption in the ability to collect amounts due from U S WEST and
other vendors;
o loss of sales due to customers focusing on year 2000 issues rather than
new communications services;
o loss of accurate accounting records;
o loss of phone service; and
o office equipment failures.
Depending on the length of any non-compliance or system failure, any of
these situations could have a material adverse impact on the Company's ability
to serve customers in a timely manner and result in lost business and revenues
or increased costs. This disclosure is subject to protection under the Year 2000
Information and Readiness Disclosure Act of 1998, Public Law 105-271, as a "Year
2000 Statement" and "Year 2000 Readiness Disclosure" as that Act defines those
terms.
11
<PAGE> 15
DMA VENTURES, INC.
dba ACCESS COMMUNICATIONS
BALANCE SHEETS
(In thousands, except share amounts)
<TABLE>
<CAPTION>
December 31, September 30,
1998 1999
------------ -------------
(unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 83 $ 2
Accounts receivable, net 179 273
Prepaid expenses and other 46 10
Deferred income taxes 149 165
Net current assets of discontinued operations 60 --
------ ------
Total current assets 517 450
PROPERTY AND EQUIPMENT, net 399 368
------ ------
Total assets $ 916 $ 818
====== ======
LIABILITIES AND SHAREHOLDER'S EQUITY
CURRENT LIABILITIES:
Related party borrowings, current maturities $ 5 $ 5
Current maturities of long-term borrowings 72 63
Current maturities of capital leases 63 42
Line of credit -- 37
Accounts payable 71 103
Accrued expenses 161 189
Income taxes payable 82 --
Deferred revenue 114 150
------ ------
Total current liabilities 568 589
------ ------
LONG-TERM BORROWINGS 185 136
CAPITAL LEASE OBLIGATIONS 18 9
COMMITMENTS AND CONTINGENCIES
SHAREHOLDER'S EQUITY:
Preferred stock, no par value; 10,000,000 shares authorized;
no shares issued and outstanding -- --
Common stock, no par value; 25,000,000 shares authorized;
10,000,000 shares issued and outstanding 1 114
Retained earnings (deficit) 144 (30)
------ ------
Total shareholder's equity 145 84
------ ------
Total liabilities and shareholder's equity $ 916 $ 818
====== ======
</TABLE>
The accompanying notes to financial statements
are an integral part of these balance sheets.
12
<PAGE> 16
DMA VENTURES, INC.
dba ACCESS COMMUNICATIONS
STATEMENTS OF OPERATIONS
(In thousands)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30,
---------------------
1998 1999
------- -------
(UNAUDITED)
<S> <C> <C>
REVENUES:
Advanced communications services $1,344 $1,245
Basic dial tone services 282 96
------ ------
1,626 1,341
------ ------
COSTS AND EXPENSES:
Salaries and commissions 995 1,056
Other general and administrative expenses 410 412
------ ------
1,405 1,468
------ ------
Income (loss) from operations 221 (127)
------ ------
OTHER (INCOME) EXPENSE:
Interest expense 44 23
Other (income) expense (17) 6
------ ------
Other (income) expense 27 29
------ ------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE PROVISION FOR INCOME TAXES 194 (156)
Provision (benefit) for income taxes 71 (58)
------ ------
NET INCOME (LOSS) FROM CONTINUING
OPERATIONS 123 (98)
LOSS FROM DISCONTINUED OPERATIONS
(less applicable income tax benefit of $174 and
$49, respectively) (303) (76)
------ ------
NET LOSS $ (180) $ (174)
====== ======
</TABLE>
The accompanying notes to financial statements
are an integral part of these statements.
13
<PAGE> 17
DMA VENTURES, INC.
dba ACCESS COMMUNICATIONS
STATEMENTS OF OPERATIONS
(In thousands)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
SEPTEMBER 30,
---------------------
1998 1999
------- -------
(UNAUDITED)
<S> <C> <C>
REVENUES:
Advanced communications services $ 661 $ 461
Basic dial tone services 56 27
------ ------
717 488
------ ------
COSTS AND EXPENSES:
Salaries and commissions 348 395
Other general and administrative expenses 98 132
------ ------
446 527
------ ------
Income (loss) from operations 271 (39)
------ ------
OTHER (INCOME) EXPENSE:
Interest expense 9 8
Other (income) expense (29) (3)
------ ------
Other (income) expense (20) 5
------ ------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE PROVISION FOR INCOME TAXES 291 (44)
Provision (benefit) for income taxes 105 (16)
------ ------
NET INCOME (LOSS) FROM CONTINUING
OPERATIONS 186 (28)
LOSS FROM DISCONTINUED OPERATIONS
(less applicable income tax benefit of $45) (78) --
------ ------
NET INCOME (LOSS) $ 108 $ (28)
====== ======
</TABLE>
The accompanying notes to financial statements
are an integral part of these statements.
14
<PAGE> 18
DMA VENTURES, INC.
dba ACCESS COMMUNICATIONS
STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30,
--------------------
1998 1999
------- ------
(UNAUDITED)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(180) $(174)
Adjustments to reconcile net loss to net cash
used in operating activities-
Depreciation 61 81
Deferred income tax benefit -- (16)
Changes in operating assets and liabilities-
Accounts receivable (57) (94)
Prepaid expenses (40) 36
Accounts payable 46 32
Accrued expenses (124) 28
Income tax payable (105) (82)
Deferred revenue 47 36
Discontinued operations (34) 60
----- -----
Net cash used in
operating activities (386) (93)
----- -----
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (7) (50)
----- -----
Net cash used in investing activities (7) (50)
----- -----
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in line of credit 300 37
Principal payments on related party borrowings (66) --
Principal payments on long-term borrowings (36) (58)
Payments on capital lease (63) (30)
Distributions to shareholder (66) --
Capital contribution -- 113
----- -----
Net cash provided by
financing activities 69 62
----- -----
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS (324) (81)
CASH AND CASH EQUIVALENTS, beginning of period 591 83
----- -----
CASH AND CASH EQUIVALENTS, end of period $ 267 $ 2
===== =====
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash paid for interest $ 44 $ 23
===== =====
Cash paid for taxes $ 12 $ 0
===== =====
</TABLE>
The accompanying notes to financial statements
are an integral part of these statements.
15
<PAGE> 19
DMA VENTURES, INC.
dba ACCESS COMMUNICATIONS
NOTES TO FINANCIAL STATEMENTS
(Dollar amounts in thousands)
(Unaudited)
(1) BUSINESS AND ORGANIZATION
DMA Ventures, Inc., dba Access Communications, a Colorado corporation (the
"Company") was incorporated on August 10, 1993 and acts as a sales agent for U S
WEST Communications, Inc. ("U S WEST"). In addition, the Company is a network
integrator, focused on converging technologies for voice, data and video
communication ("Hardware Business"). Subsequent to December 31, 1998, the
Company decided to discontinue the operations of the Hardware Business.
Fiscal Year
The Company's fiscal year ends on July 31. The accompanying financial statements
have been conformed to a December 31 year end in connection with the acquisition
of the Company by PentaStar Communications, Inc. ("PentaStar").
Dependence Upon U S WEST
The Company acts as a sales agent for and generates all of its continuing
revenues from U S WEST, a regional Bell operating company. The loss of the
relationship with U S WEST or a material diminishment in the volume of business
with U S WEST would adversely affect the Company. Management believes the
Company could become a sales agent for another provider with comparable terms if
it were to lose its relationship with U S WEST.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - Interim Financial Information
The financial statements as of and for the three and nine months ended September
30, 1998 and 1999 are unaudited and prepared by the Company pursuant to the
interim reporting rules and regulations of the Securities and Exchange
Commission; however, they include all adjustments (consisting of normal
recurring adjustments) considered necessary by management for a fair
presentation of the financial position and results of operations for these
periods. The results of operations for interim periods are not necessarily
indicative of the results that may be expected for the entire year.
Cash Equivalents
The Company considers all highly liquid investments purchased with an original
maturity of three months or less to be cash equivalents.
Property and Equipment
Property and equipment is stated at cost and depreciated using the straight-line
method over the estimated useful lives of the related assets. Leasehold
improvements are capitalized and amortized using the straight-line method over
the shorter of the useful lives or the remaining lease term. Estimated useful
lives are as follows:
<TABLE>
<CAPTION>
Estimated Useful
Life in Years
----------------
<S> <C>
Computer and telephone equipment 3-6
Office furniture and equipment 5-10
Leasehold improvements 3-10
Vehicles 5
</TABLE>
Expenditures for repairs and maintenance are charged to expense when incurred.
Expenditures for major renewals and betterments, which extend the useful lives
of existing equipment, are capitalized and depreciated. Upon retirement or
disposition of property and equipment, the cost and related accumulated
depreciation are removed from the accounts and any resulting gain or loss is
recognized in the statements of operations.
16
<PAGE> 20
DMA VENTURES, INC.
dba ACCESS COMMUNICATIONS
NOTES TO FINANCIAL STATEMENTS (Continued)
(Unaudited)
Revenue Recognition
Revenue and the related commission expense are recognized in the month when
services are installed by U S WEST. Deferred revenue in the accompanying balance
sheets represents cash collected from U S WEST on uninstalled services.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires the use of estimates and assumptions by
management in determining the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Fair Value of Financial Instruments
The Company's financial instruments consist of cash and cash equivalents,
accounts receivable, accounts payable and borrowings. The carrying value of
these financial instruments in the accompanying balance sheets approximates
their fair value because of their short-term nature.
Concentration of Credit Risk
The Company's financial instruments exposed to concentrations of credit risk
consist primarily of cash and accounts receivable. The Company maintains their
cash in institutions which the Company considers of high credit quality. The
balances, at times, may exceed federally insured limits. Credit risk with
respect to accounts receivable is limited due to the credit worthiness of the
Company's primary customer, U S WEST. Management does not anticipate significant
credit losses from such financial instruments.
Asset Impairment
The Company reviews its long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Long-lived assets which are held and used in operations would be
impaired if the undiscounted future cash flows related to the asset did not
exceed the net book value. If an asset is determined to be impaired, it is
written down to its fair value.
17
<PAGE> 21
DMA VENTURES, INC.
dba ACCESS COMMUNICATIONS
NOTES TO FINANCIAL STATEMENTS (Continued)
(Unaudited)
Advertising and Promotion
Advertising and promotional related expenses are charged to operations when
incurred or the first time the advertising appears.
Income Taxes
Deferred tax assets and liabilities are provided for differences between the
financial statement and tax basis of assets and liabilities using current
enacted tax rates. The provision for income taxes includes the amount due for
the current period and the change in deferred taxes between periods.
A valuation allowance is provided for a portion or all of the deferred tax asset
when it is more likely than not that the Company will not be able to realize the
benefits of the deferred tax assets in future years.
Stock-Based Compensation
The Company accounts for its stock-based employee compensation agreements using
the intrinsic value method under which no compensation is generally recognized
for options granted to employees with an exercise price equal to or greater than
the fair market of the underlying stock. Equity instruments granted to
non-employees are recorded at fair value on the date of grant.
Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133") which is as amended by SFAS
No. 137. The Company is required to adopt SFAS No. 133 in the year ended
December 31, 2001. SFAS No. 133 establishes methods of accounting for derivative
financial instruments and hedging activities related to those instruments as
well as other hedging activities. To date, the Company has not entered into any
derivative financial instruments or hedging activities. The Company has not
evaluated the impact of adopting SFAS No. 133.
(3) BORROWINGS
Line of Credit
The Company has a line of credit with Colorado Business Bank, N.A. which permits
the Company to borrow up to $350 at a rate equal to the prime rate plus 1%. The
line of credit is renewed on a yearly basis. Borrowings under the agreement are
collateralized by all accounts, inventory, equipment and general intangibles of
the Company, as well as shareholder owned marketable securities and the
shareholder's life insurance policy. The Company's borrowings are limited to 75%
of the total accounts receivable balance less than ninety days.
18
<PAGE> 22
DMA VENTURES, INC.
dba ACCESS COMMUNICATIONS
NOTES TO FINANCIAL STATEMENTS (Continued)
(Unaudited)
Notes Payable
At December 31, 1998 and September 30, 1999, notes payable consisted of the
following:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1998 1999
------------ -------------
<S> <C> <C>
Note payable to Colorado Business Bank, N.A., Denver, Colorado;
interest at 9.5% per annum; collateralized by all accounts, inventory,
equipment, general intangibles, and shareholder owned marketable
securities; cross collateralized with the line of credit; co-borrower
with the Company's shareholder and an officer; payable in monthly
installments of $6.3; due April 2002. $ 220 $ 174
Note payable to Lexus Financial Services Corporation; interest at
8.5% per annum; collateralized by a vehicle; payable in monthly
principal and interest installments of $.884; due April 2002. $ 31 $ 25
Note payable to Colorado Business Bank, N.A., Littleton, Colorado;
interest at 10.5% per annum; collateralized by a vehicle; payable in
monthly principal and interest installments of $.798; paid August 1999. 6 --
Note payable to shareholder; interest at the annual federal rate (5.1%
at December 31, 1998), unsecured 5 5
----- -----
262 204
Less: current maturities (77) (68)
----- -----
Long-term borrowings, net of current maturities $ 185 $ 136
===== =====
</TABLE>
Capital Leases
The Company leases certain office furniture and equipment under agreements which
are classified as capital leases.
19
<PAGE> 23
DMA VENTURES, INC.
dba ACCESS COMMUNICATIONS
NOTES TO FINANCIAL STATEMENTS (Continued)
(Unaudited)
(4) STOCK OPTION PLAN
In February 1998, the Company adopted a stock option plan which provides for the
granting of options to employees, directors and consultants. A maximum of
700,000 shares of common stock may be issued under the plan. The option price,
number of shares and grant date are determined at the discretion of the
Company's Board of Directors. The exercise price of the options granted have
been established at no less than the fair market value at the date of grant.
Options granted under the plan expire ten years after the grant date and vest
1/12th on the last day of each fiscal quarter.
(5) RETIREMENT SAVING PLAN
The Company maintains a qualified retirement savings plan under Section 401(k)
of the Internal Revenue Code. Under the plan, employees may elect to defer up to
15% of their compensation, subject to Internal Revenue Service limits. The plan
allows for discretionary contributions to be made by the Company. The plan is
administered by a third party.
(6) COMMITMENTS AND CONTINGENCIES
Guarantees
In December 1995, the Company, acting as a co-borrower with its shareholder and
an officer, obtained a loan from Key Bank ("Key Bank"). The funds were used to
purchase, among other items, real estate owned by the shareholder and officer.
The loan was secured by the real estate, through a Deed of Trust dated December
28, 1995. In May 1996, the U.S. Small Business Administration ("SBA") guaranteed
the Key Bank loan, which resulted in the Deed of Trust being transferred to the
SBA. In August of 1998, the Key Bank debt balance was paid in full, with
proceeds obtained by the shareholder and officer from the Colorado Business
Bank. The Company is a guarantor on the Colorado Business Bank note. The real
estate securing the note has been leased by the Company since April of 1996.
The Colorado Business Bank note bears interest at 9% and is due in monthly
principal and interest installments of $1. The note is secured by a first deed
of trust and an assignment of rents between the Company and its shareholder. At
September 30, 1999 the balance due on this note is approximately $120. The note
is due January, 2016.
Litigation
The Company is involved in litigation arising in the ordinary course of
business. It is the opinion of management that the outcome of such litigation
will not have a material effect on the financial statements of the Company.
20
<PAGE> 24
DMA VENTURES, INC.
dba ACCESS COMMUNICATIONS
NOTES TO FINANCIAL STATEMENTS (Continued)
(Unaudited)
(7) DISCONTINUED OPERATIONS
During February 1999, management approved a formal plan to dispose of the
Company's Hardware Business. Operations related to this business ceased on April
30, 1999, with the completion of all installations. The Company reduced its
labor force, eliminated all inventories, and wrote-down the value of the
property and equipment. As a result of this decision, the Company has reflected
the operations of the hardware business as discontinued operations in the
accompanying financial statements.
(8) SUBSEQUENT EVENTS
On August 13, 1999, the sole shareholder at the Company entered into a
definitive agreement with PentaStar Communications, Inc. ("PentaStar"), pursuant
to which all outstanding shares of the Company's stock would be exchanged for
cash and shares of PentaStar common stock. The transaction was completed on
October 26, 1999 for approximately $500 in cash and 205,000 shares of PentaStar
common stock. The cash portion of the consideration is subject to adjustment
based upon certain closing balance sheet amounts. Additional shares of PentaStar
common stock may be issued to the shareholder based upon the relative earnings
performance of the Company to that of other acquired companies.
21
<PAGE> 25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain matters discussed in this Report are "forward-looking statements,"
intended to qualify for the safe harbors from liability established by the
Private Securities Litigation Reform Act of 1995. These forward-looking
statements can generally be identified as such because the context of the
statement includes words such as "anticipates," "expects," "believes" and
"intends" or other similar words. Similarly, statements that describe the
Company's future plans, objectives or goals are also forward-looking statements.
Such forward-looking statements are subject to certain risks and uncertainties
that could cause actual results or outcomes to differ materially from those
currently anticipated. Factors that could affect actual results or outcomes are
described in detail in PentaStar's Registration Statement on Form SB-2 (No.
333-85281) under the heading "Risk Factors" and include:
o The Company's reliance on regional bell operating companies and other
service providers for communications services.
o The Company's ability to increase revenues from service providers other
than local access service providers.
Shareholders, potential investors and other readers are urged to consider
these factors in evaluating the forward-looking statements and are cautioned not
to place undue reliance on such forward-looking statements. The forward-looking
statements included herein are only made as of the date here of and PentaStar
undertakes no obligations to publicly update such forward-looking statements to
reflect subsequent events or circumstances.
GENERAL
The following discussion and analysis of financial condition and results of
operations of DMA Ventures, Inc., d/b/a Access Communications ("Access" or the
"Company"), should be read in conjunction with the financial statements as of
September 30, 1999 and for the nine months and three months ended September 30,
1999, which provide additional information regarding financial condition and
operating results.
On August 13, 1999, the shareholder of the Company entered into an
acquisition agreement with PentaStar, pursuant to which all outstanding shares
of the Company's stock would be exchanged for cash and shares of PentaStar
common stock.
The acquisition of Access was structured to be completed and closed
immediately prior to PentaStar's Offering. The closing of the acquisition of
Access was a condition imposed by the underwriters of the Offering to the
closing of the Offering. As a result of this structure, significant disclosures
regarding Access's operations, financial statements, contracts and policies and
procedures were included in PentaStar's registration statement on Form SB-2
under the Securities Act of 1933 filed with the Securities and Exchange
Commission on August 16, 1999. The registration statement became effective on
October 26, 1999 and PentaStar successfully closed on the acquisition of Access
and completed the Offering. Accordingly, from and after October 26, 1999,
PentaStar is the parent company of Access and the financial statements of Access
will be reported in the consolidated financial statements of PentaStar.
"Management's Discussion And Analysis of Financial Condition And Results Of
Operations" consists primarily of comparisons of the historical financial
statements. The information may not be considered reflective of the continuing
results of operations and financial condition of Access as a wholly-owned
subsidiary of PentaStar, because of certain non-recurring expenses related to
the acquisition and the elimination of redundant costs.
RESULTS OF OPERATIONS
Nine-month period ended September 30, 1998 compared to the nine-month period
ended September 30, 1999
Revenues. Advanced communications services revenues decreased $99,000, or
7.4%, from $1,344,000 for the period ended September 30, 1998 to $1,245,000 for
the period ended September 30, 1999. This decrease was primarily attributable to
attention diverted from the core operations of the Company as it focused its
attention on the acquisition agreement and Offering with PentaStar. Basic dial
tone services revenues decreased $186,000, or 66.0%, from $282,000 for the
period ended September 30, 1998 to $96,000 for the period ended September 30,
1999. This decline was primarily attributable to a decreased focus on basic
communications services and increased focus on advanced communications services,
primarily for data.
Costs and expenses. Salaries and commissions increased $61,000, or 6.1%,
from $995,000 for the period ended September 30, 1998 to $1,056,000 for the
period ended September 30, 1999. This increase was primarily attributable to
increased staffing in sales, operations and accounting along with additional
employment costs. These increases were primarily due to the effects on the
business as a result of the acquisition agreement and Offering with PentaStar.
Other general and administrative expenses remained relatively constant for the
period ended September 30, 1998 as compared to the period ended September 30,
1999.
22
<PAGE> 26
Income (loss) from operations. Loss from operations increased $348,000,
from income of $221,000 for the period ended September 30, 1998 to a loss of
$127,000 for the period ended September 30, 1999. This increase in loss from
operations is primarily attributable to the decrease in revenues from basic dial
tone services and the increases in costs and expenses discussed above. Income
(loss) from operations changed from 13.6% of revenues for the period ended
September 30, 1998 to (9.5%) of revenues for the period ended September 30, 1999
as a result of the above discussed changes in revenues and costs and expenses.
Other (income) expense, net. Other (income) expense, net, increased $2,000,
or 7.4%, from an expense of $27,000 for the period ended September 30, 1998 to
an expense of $29,000 for the period ended September 30, 1999. Other expenses in
these periods primarily reflect interest on a line of credit and long-term
borrowings.
Income taxes. Access provided an income tax benefit that increased
$129,000, from a provision of $71,000 for the period ended September 30, 1998 to
a benefit of $58,000 for the period ended September 30, 1999. The effective tax
rate increased from 36.6% to 37.2% between periods.
Loss from discontinued operations. Loss from discontinued operations
decreased $227,000, or 74.9%, from $303,000 for the period ended September 30,
1998 to $76,000 for the period ended September 30, 1999. The loss from
discontinued operations is net of income tax benefits of $174,000 for the period
ended September 30, 1998 and $49,000 for the period ended September 30, 1999.
The loss from discontinued operations relates to the disposition of Access'
hardware business in April 1999.
Net loss. For the reasons discussed above, net loss decreased
$6,000, or 3.3%, from a net loss of $180,000 for the period ended September 30,
1998 to a net loss of $174,000 for the period ended September 30, 1999.
Three month period ended September 30, 1998 compared to the three month
period ended September 30, 1999
Revenues. Advanced communications services revenues decreased $200,000, or
30.3%, from $661,000 for the period ended September 30, 1998 to $461,000 for the
period ended September 30, 1999. This decrease was primarily attributable to
attention diverted from the core operations of the Company as it focused its
attention on the formation of PentaStar, the development of PentaStar's business
plan, the acquisition agreement and Offering with PentaStar. Basic dial tone
services revenues decreased $29,000, or 51.8%, from $56,000 for the period ended
September 30, 1998 to $27,000 for the period ended September 30, 1999. This
decrease was primarily attributable to a decreased focus on basic communications
services and the same reasons as discussed for advanced communications services.
Costs and expenses. Salaries and commissions increased $47,000, or 13.5%,
from $348,000 for the period ended September 30, 1998 to $395,000 for the period
ended September 30, 1999. This increase was primarily attributable to increased
staffing in sales, operations and accounting along with additional employment
costs. These increases were incurred primarily due to the effects on the
business as a result of the acquisition agreement and Offering with PentaStar.
Other general and administrative expenses increased $34,000, or 34.7%, from
$98,000 for the period ended September 30, 1998 to $132,000 for the period ended
September 30, 1999. This was primarily due to professional fees and other
non-recurring costs associated with the acquisition agreement and Offering with
PentaStar.
23
<PAGE> 27
Income (loss) from operations. Loss from operations increased $310,000,
from income of $271,000 for the period ended September 30, 1998 to a loss of
$39,000 for the period ended September 30, 1999. The increase in loss from
operations is primarily attributable to the decrease in revenues and the
increase in costs and expenses discussed above. Income (loss) from operations
changed from 37.8% of revenues for the period ended September 30, 1998 to (8.0%)
of revenues for the period ended September 30, 1999 as a result of the above
discussed changes in revenues and costs and expenses.
Other (income) expense, net. Other (income) expense, net, increased
$25,000, from income of $20,000 for the period ended September 30, 1998 to an
expense of $5,000 for the period ended September 30, 1999. Other expenses
primarily reflect interest on a line of credit and long-term borrowings. Other
income primarily reflects non-recurring refunds not related to current period
operations.
Income taxes. Access provided an income tax benefit that increased
$121,000, from a provision of $105,000 for the period ended September 30, 1998
to a benefit of $16,000 for the period ended September 30, 1999. The effective
tax rates for the periods were 36.1% and 36.4%, respectively.
Loss from discontinued operations. A loss from discontinued operations of
$78,000 was recorded for the period ended September 30, 1998. The loss from
discontinued operations is net of an income tax benefit of $45. The loss from
discontinued operations relates to the disposition of Access' hardware business
in April 1999.
Net income (loss). For the reasons discussed above, net income (loss)
decreased from net income of $108,000 for the period ended September 30, 1998 to
a net loss of $28,000 for the period ended September 30, 1999.
Liquidity and Capital Resources
Access' operations used $93,000 of net cash for the first nine months of
1999, a decrease of $293,000 from $386,000 used in operations for the first nine
months of 1998. Access used net cash in investing activities of $50,000 in the
first nine months of 1999, all of which it spent on property, plant and
equipment compared to the $7,000 used to purchase property, plant and equipment
in the first nine months of 1998. In the first nine months of 1999, Access
generated net cash of $62,000 from its financing activities, which reflected net
proceeds from capital contributions and borrowings under its line of credit and
payments to fund capital lease obligations and long-term borrowings. During the
first nine months of 1998, Access generated net cash of $69,000 from its
financing activities by drawing on its line of credit to fund payments on
borrowings of a party related to Access and other long-term borrowings, capital
lease obligations, as well as to make distributions to its shareholder.
Access expects to be able to fund its cash needs such as working capital
through cash it generates from its operations. It generally funds its purchases
of property, plant and equipment with internally generated cash or debt. Access
maintains a $350,000 line of credit with a bank. At September 30, 1999, it had
$37,000 outstanding under this line of credit. PentaStar has repaid all interest
bearing indebtedness and terminated the line of credit in conjunction with the
acquisition of Access. The cash portion of the purchase price otherwise payable
to the shareholder of Access at the closing was reduced by the amount of
interest bearing indebtedness so repaid.
YEAR 2000 RISKS
Many software applications and computer hardware and related equipment and
systems that use embedded technology, such as microprocessors, rely on two
digits rather than four to represent years in performing computations and
decision-making functions. These programs, hardware items and systems may fail
beginning on January 1, 2000, or earlier, because they misinterpret "00" as the
year 1900 rather than 2000. These failures could have a material effect on the
Company because of the Company's direct dependence on the Company's own
software, equipment and systems and the indirect dependence on those of third
parties. The Company's year 2000 program has consisted of the following phases
and is 98% complete:
o identifying all items that may be affected by the year 2000;
o investigating those items for year 2000 compliance;
o assessing the potential impact of year 2000 non-compliance;
o identifying solutions for non-compliant items;
o repairing and replacing any non-compliant items;
o testing those repairs and replacements; and
o contingency planning.
Although the Company has followed the general steps outlined above, the
Company does not consider preparation and maintenance of formal inventories and
risk rankings, detailed test plans and documentation of results as being
necessary because of the small number of information technology systems used.
The Company has contacted their primary service provider, U S WEST, and
have obtained representations and assurances that their hardware, embedded
technology systems and software, which the Company uses or which may otherwise
impact the Company, has been or will be modified on a timely basis to be year
2000 compliant. The Company does not believe that any other third parties
utilized will have a significant impact on operations based upon year 2000
compliance issues.
All of the systems the Company currently uses include "off the shelf"
software which can easily be replaced. If the systems are not year 2000
compliant, the Company will replace these systems prior to December 31, 1999.
If the Company identifies significant risks related to year 2000 compliance
or if progress deviates from the anticipated program, the Company will develop
contingency plans as necessary.
The Company does not anticipate any material adverse effect to the business
from year 2000 failures, but can offer no guarantee that the Company will
achieve total compliance. Factors that give rise to this uncertainty include the
possible failure to identify all susceptible systems, non-compliance by third
parties whose systems and operations impact the Company and a possible loss of
technical resources to perform the work.
The Company's most likely worst-case year 2000 non-compliance scenarios
are:
o an interruption in the ability to collect amounts due from U S WEST and
other vendors;
o loss of sales due to customers focusing on year 2000 issues rather than
new communications services;
o loss of accurate accounting records;
o loss of phone service; and
o office equipment failures.
Depending on the length of any non-compliance or system failure, any of
these situations could have a material adverse impact on The Company's ability
to serve customers in a timely manner and result in lost business and revenues
or increased costs. This disclosure is subject to protection under the Year 2000
Information and Readiness Disclosure Act of 1998, Public Law 105-271, as a "Year
2000 Statement" and "Year 2000 Readiness Disclosure" as that Act defines those
terms.
24
<PAGE> 28
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
Date: December 9, 1999 PENTASTAR COMMUNICATIONS, INC.
By: /s/ David L. Dunham
----------------------------------
David L. Dunham
Chief Financial Officer
