<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT OF
1934
FOR THE TRANSITION PERIOD FROM TO
----- -----
Commission file number 0-27709
PENTASTAR COMMUNICATIONS, INC.
(Exact name of small business issuer as specified in its charter)
DELAWARE 84-1502003
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
1660 WYNKOOP STREET, SUITE 1010, DENVER, COLORADO 80202
(Address of principal executive offices)
(303) 825-4400
(Issuer's telephone number)
NONE
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court. Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS
As of November 8, 2000, the number of shares outstanding of the issuer's common
stock, par value $.0001 per share, was 5,502,244.
================================================================================
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
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TABLE OF CONTENTS
<TABLE>
PART I
<S> <C> <C>
Item 1. Financial Statements................................................. F-1
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................ 2
PART II
Item 2. Changes in Securities................................................ 7
Item 6. Exhibits and Reports on Form 8-K..................................... 8
</TABLE>
1
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PART I
ITEM 1. FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
<TABLE>
PENTASTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
<S> <C>
Consolidated Balance Sheets as of September 30, 2000 and
December 31, 1999.............................................................. F-2
Consolidated Statements of Operations for the Nine Months Ended
September 30, 2000 and for the Period from Inception (March 15, 1999)
through September 30, 1999..................................................... F-3
Consolidated Statements of Operations for the Three Months Ended
September 30, 2000 and 1999.................................................... F-4
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2000 and for the Period from Inception (March 15, 1999)
through September 30, 1999..................................................... F-5
Notes to Consolidated Financial Statements.......................................... F-6
</TABLE>
F-1
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PENTASTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 2000 AND DECEMBER 31, 1999
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
ASSETS 2000 1999
------------- -----------
(UNAUDITED) (AUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents ................................ $ 604 $ 8,137
Accounts receivable, net ................................. 4,189 1,092
Inventory ................................................ 200 --
Prepaid commissions expense .............................. 908 45
Prepaid expenses and other ............................... 637 158
Amounts due from related parties ......................... 136 --
Related party note receivable ............................ -- 601
---------- ----------
Total current assets ............................. 6,674 10,033
Property and equipment, net ................................ 2,715 555
Deferred income taxes ...................................... 979 323
Related party note receivable .............................. 528 --
Prepaid commissions expense, net of current portion ........ 1,078 --
Other assets ............................................... 73 45
Goodwill, net .............................................. 22,534 4,459
---------- ----------
Total assets ..................................... $ 34,581 $ 15,415
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable ......................................... $ 1,045 $ 170
Other accrued liabilities ................................ 1,103 65
Related party acquisition payables ....................... 72 326
Accrued compensation ..................................... 1,140 541
Deferred revenue ......................................... 1,742 393
Current portion of capital lease obligations ............. 44 --
Current portion of long-term debt ........................ 892 --
Deferred income taxes .................................... 301 97
---------- ----------
Total current liabilities ........................ 6,339 1,592
Capital lease obligations, net of current portion ........ 156 --
Long-term debt, net of current portion ................... 3,496 --
Other long-term liabilities .............................. 58 --
---------- ----------
Total liabilities ................................ 10,049 1,592
---------- ----------
Commitments and contingencies
Shareholders' equity:
Series A preferred stock, $1,000 stated value; 1,000,000
shares authorized; 86 shares issued and outstanding.... 89 86
Common stock, $.0001 par value; 20,000,000 shares
authorized; shares issued and outstanding -
5,450,310 as of September 30, 2000 and 4,797,842
as of December 31, 1999 ............................... 1 1
Additional paid-in capital ............................... 27,300 14,169
Retained deficit ......................................... (2,858) (433)
---------- ----------
Total shareholders' equity ....................... 24,532 13,823
---------- ----------
Total liabilities and shareholders' equity ....... $ 34,581 $ 15,415
========== ==========
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
F-2
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PENTASTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000
AND FOR THE PERIOD FROM INCEPTION (MARCH 15, 1999)
THROUGH SEPTEMBER 30, 1999
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
2000 1999
------------ -----------
<S> <C> <C>
Revenue:
Advanced communications services ............... $ 11,624 $ --
Basic dial tone services ....................... 5,979 --
Product sales and other ........................ 1,342 --
------------ -----------
18,945 --
------------ -----------
Costs and expenses:
Salaries and commissions ....................... 15,812 --
Cost of product sales .......................... 516 --
Other general and administrative expenses ...... 4,634 7
Depreciation and amortization .................. 1,351 --
------------ -----------
22,313 7
------------ -----------
Loss from operations ................... (3,368) (7)
------------ -----------
Other (income) expense:
Interest income ................................ (181) --
Interest expense and other ..................... 285 1
------------ -----------
Other (income) expense, net ............ 104 1
------------ -----------
Loss before benefit for income taxes ............. (3,472) (8)
Benefit for income taxes ......................... 1,050 --
------------ -----------
Net loss ......................................... $ (2,422) $ (8)
============ ===========
Preferred dividends .............................. (3) --
------------ -----------
Net loss - common shareholders ................... $ (2,425) $ (8)
============ ===========
Basic and diluted net loss per common share....... $ (.48) $ --
Weighted-average common shares outstanding ....... 5,001,095 3,129,997
============ ===========
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
F-3
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PENTASTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
2000 1999
----------- -----------
<S> <C> <C>
Revenue:
Advanced communications services .......... $ 4,472 $ --
Basic dial tone services .................. 2,022 --
Product sales and other ................... 461 --
----------- -----------
6,955 --
----------- -----------
Costs and expenses:
Salaries and commissions .................. 6,043 --
Cost of product sales ..................... 246 --
Other general and administrative expenses.. 1,788 5
Depreciation and amortization ............. 511 --
----------- -----------
8,588 5
----------- -----------
Loss from operations .............. (1,633) (5)
----------- -----------
Other (income) expense:
Interest income ........................... (6) --
Interest expense and other ................ 123 1
----------- -----------
Other (income) expense, net ....... 117 1
----------- -----------
Loss before benefit for income taxes ........ (1,750) (6)
Benefit for income taxes .................... 547 --
----------- -----------
Net loss .................................... $ (1,203) $ (6)
=========== ===========
Preferred dividends ......................... (1) --
----------- -----------
Net loss - common shareholders .............. $ (1,204) $ (6)
=========== ===========
Basic and diluted net loss per common share.. $ (.23) $ --
Weighted-average common shares outstanding .. 5,303,350 3,129,997
=========== ===========
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
F-4
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PENTASTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000
AND FOR THE PERIOD FROM INCEPTION (MARCH 15, 1999)
THROUGH SEPTEMBER 30, 1999
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
2000 1999
------- -------
Cash flows from operating activities:
<S> <C> <C>
Net loss ........................................... $ (2,422) $ (8)
Adjustments to reconcile net loss to net cash
used in operating activities--
Depreciation and amortization ................... 1,351 --
Deferred income tax benefit ..................... (1,050) --
Changes in operating assets and liabilities--
Accounts receivable, net ...................... 1,448 --
Inventory ..................................... (24) --
Prepaid expenses and other .................... (311) (98)
Accounts payable and accrued liabilities ...... (1,616) 26
Deferred revenue .............................. 925 --
------- -------
Net cash used in operating activities ...... (1,699) (80)
------- -------
Cash flows from investing activities:
Purchase of property and equipment ................. (445) --
Amounts advanced against contingent purchase
consideration ...................................... (500) --
Related party acquisition payables ................. (254) --
Acquisitions, net of cash acquired ................. (5,074) --
Purchase price adjustment .......................... 439 --
Payment of assumed acquisition debt ................ (1,057) --
Other .............................................. (32) --
------- -------
Net cash used in investing activities ...... (6,923) --
------- -------
Cash flows from financing activities:
Payments on capital lease obligations .............. (56) --
Payments on long-term debt ......................... (146) --
Payments on short-term acquisition debt obligation.. (1,734) --
Payment of financing costs ......................... (83) --
Issuance of common stock for cash, net of offering
costs .............................................. 3,108 --
Proceeds from related party debt ................... -- 86
------- -------
Net cash provided by financing activities .. 1,089 86
------- -------
Net (decrease) increase in cash and cash equivalents.. (7,533) 6
Cash and cash equivalents, beginning of period ....... 8,137 --
------- -------
Cash and cash equivalents, end of period ............. $ 604 $ 6
======= =======
Noncash investing and financing activities:
Purchase of property and equipment pursuant to
capital lease ...................................... $ 110 $ --
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
F-5
<PAGE> 8
PENTASTAR COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
1. BUSINESS AND ORGANIZATION
PentaStar Communications, Inc., a Delaware corporation ("PentaStar" or the
"Company"), was founded on March 15, 1999, to become a multi-regional company
that designs, sells and facilitates the installation and usage of communications
services for small and medium-size business customers. On October 26, 1999
PentaStar, through its wholly-owned subsidiaries, acquired the outstanding
capital stock and other equity interests of DMA Ventures, Inc., dba Access
Communications ("Access") and ICM Communications Integration, Inc. ("ICM") and
completed an initial public offering of its common stock (the "Offering").
Upon closing of the acquisitions of Access, ICM and the Offering, PentaStar
commenced its business operations as a sales agent for communications services
including local access, long distance, wireless and internet services for voice
and data communications. PentaStar designs, procures and facilitates the
installation and use of communications services to best meet its customers'
specific needs. In the first nine months of fiscal 2000 the Company acquired
seven communications services agents to expand its operations (see Note 5).
On September 1, 2000, PentaStar closed a private placement of 156,313
shares of its common stock, resulting in proceeds of $3,108, net of cash
offering costs of $192.
The financial statements as of September 30, 2000 and for the nine months
ended September 30, 2000, the period from inception (March 15, 1999) through
September 30, 1999 and the three months ended September 30, 2000 and 1999, are
unaudited and prepared by the Company pursuant to the interim reporting rules
and regulations of the Securities and Exchange Commission; however, the
financial statements 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 the periods presented. The
results of operations for interim periods are not necessarily indicative of the
results that may be expected for the entire year.
2. NEW ACCOUNTING STANDARDS
In December 1999, the staff of the Securities and Exchange Commission
released Staff Accounting Bulletin ("SAB") No. 101 "Revenue Recognition in
Financial Statements". SAB No. 101 provides interpretive guidance on the
recognition, presentation and disclosure of revenue in financial statements. The
Company's accounting policies are consistent with the guidance provided in SAB
No. 101 and its implementation in the fourth quarter of fiscal 2000 is not
expected to have a significant effect on the previously reported results of
operations or financial position of the Company.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities". The Company is
required to adopt SFAS No. 133 no later than the first fiscal quarter of 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 determined the
impact of adopting SFAS No. 133.
3. INVENTORIES
Inventories consist of finished goods and refurbished and used equipment
held for resale in the ordinary course of business. Inventories are carried at
the lower of cost or market. Cost is determined on a FIFO (first-in, first-out)
basis.
4. EARNINGS PER SHARE
The Company applies Statement of Financial Accounting Standards ("SFAS")
No. 128, "Earnings Per Share". SFAS No. 128 provides for the calculation of
"Basic" and "Diluted" earnings or net income per share. Basic net income per
share includes no dilution and is computed by dividing earnings available to
common shareholders by the weighted average number of common shares outstanding
for the period. Diluted net income per share reflects the potential dilution of
stock options and warrants using the treasury
F-6
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stock method. Outstanding options and warrants exercisable into 113,750 shares
of common stock have been excluded from the calculation of diluted loss per
share as they are antidilutive.
5. BUSINESS COMBINATIONS
In the first quarter of fiscal 2000, PentaStar completed the acquisitions
of four communications services agents. Following is a summary of the
acquisitions.
PentaStar, through a wholly-owned subsidiary, acquired the assets of
USTeleCenters, Inc. and Vermont Network Services Corporation (collectively
referred to as "UST"). UST, founded in 1986 and headquartered in Boston,
Massachusetts, is a full-service communications agent focusing on small business
customers located throughout Verizon Communications (f/k/a Bell Atlantic) 13
state Northeast and Mid-Atlantic region. UST has agency agreements with service
providers including Verizon Communications, Bell South, Southwestern Bell and
Sprint. The purchase consideration consisted of $277 in cash including
acquisition costs, the issuance of 5,980 shares of the Company's common stock
with a fair market value of $100 and the assumption of liabilities.
PentaStar, through a wholly-owned subsidiary, acquired the assets of NCI
Communications, Inc. ("NCI"). NCI is primarily a long distance communications
services agent located in Seattle, Washington. NCI has agency agreements with
Qwest, AT&T and GST Telecom. NCI was owned by certain of the previous
shareholders of ICM, who, upon the Company's acquisition of ICM, became
shareholders of the Company. The purchase consideration consisted of $18 in cash
including acquisition costs and the cancellation of a $601 note receivable from
NCI to PentaStar.
PentaStar acquired ParTel, Inc. ("ParTel") by merger. ParTel, founded in
1982, is a full-service communications agent based in Phoenix, Arizona primarily
servicing customers in the Phoenix and Tucson metropolitan markets. ParTel is an
agent of Qwest (f/k/a US WEST) and sells primarily high-end, data-oriented
services. The initial purchase consideration consisted of $606 in cash including
acquisition costs and the issuance of 30,310 shares of the Company's common
stock with a fair market value of $539. In addition, the agreement provides for
additional consideration in the form of cash and the Company's common stock if
certain operating performance criteria are met by ParTel for the year ending
December 31, 2000.
PentaStar, through a wholly-owned subsidiary, acquired Resource
Communications, Inc. ("Resource") by merger. Resource, based in Dublin,
California, is a full-service communications agent, which furnishes
communication solutions to customers in Northern California. Resource is one of
the largest Cable & Wireless long distance master agents and a significant
Pacific Bell authorized sales representative. The initial purchase consideration
consisted of $1,037 of cash including acquisition costs and the issuance of
81,250 shares of the Company's common stock. Of the 81,250 of issued shares,
50,000 shares with a fair market value of $919 were placed in an indemnification
escrow until March 31, 2001. The remaining 31,250 shares were placed in escrow
until March 15, 2001 to be released upon Resource attaining certain performance
criteria for the year ending December 31, 2000. As a result, the fair market
value of the 31,250 shares has not been reflected in the initial purchase
consideration. When and if the performance criteria is met, the additional
consideration will be treated as goodwill and recorded on the balance sheet. In
addition, the agreement provides for additional consideration in the form of
cash and the Company's common stock if certain operating performance criteria
are met by Resource for the period from January 1, 2000 to June 30, 2001.
In the second quarter of fiscal 2000, PentaStar completed the acquisitions
of two communications services agents. Following is a summary of the
acquisitions.
PentaStar, through a wholly-owned subsidiary, acquired the assets of VSI
Network Solutions, Inc. dba Eastern Telecom ("ETI"). ETI, founded in 1992, is a
full-service communications agent based in Warwick, Rhode Island, primarily
servicing customers in Boston, New York, Albany, Providence and Warwick. ETI is
an authorized agent for Verizon Communications and Bell South. The initial
purchase consideration consisted of $2,009 of cash including acquisition costs,
the issuance of 57,122 shares of the Company's common stock with a fair market
value of $961, the assumption of $758 in debt and the assumption of operating
liabilities. The assumed debt was paid at closing. The 57,122 shares of common
stock were placed in an indemnification escrow until November 18, 2001. In
addition, the agreement provides for additional consideration in the form of
cash and the Company's common stock if certain combined operating performance
criteria of ETI and UST are met by ETI for the year ending December 31, 2000.
PentaStar, through a wholly-owned subsidiary, acquired the assets of the
Network Services Agency Division of Telecomm Industries Corp. ("TCMM"). TCMM's
Network Services Agency Division is Ameritech's largest distributor of voice and
data services. TCMM is also an authorized distributor for BellSouth. The initial
purchase consideration consisted of $1,362 of cash including
F-7
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acquisition costs, the issuance of 278,949 shares of the Company's common stock
with a fair market value of $6,494 and the assumption of certain debt and
operating liabilities of TCMM. The assumed debt included $1,260 of short-term
obligations which were paid at closing. The remaining assumed debt is secured by
approximately $6,500 of future commissions due to PentaStar from existing
Ameritech contracts, which should be realized over the next several years. In
addition to the initial purchase consideration, the agreement provides for
additional consideration in the form of cash and the Company's common stock if
certain operating performance criteria are met by TCMM for the period from April
1, 2000 through March 31, 2001. The total purchase consideration, including
cash, stock and the short-term debt obligation paid at closing, cannot exceed
$18,000. The earn-out will be recorded as additional purchase consideration when
and if realized by TCMM. The 278,949 shares of PentaStar common stock were
placed in a general indemnification escrow until the date at which the earn-out
amount is determined.
In the third quarter of fiscal 2000, PentaStar completed the acquisition of
one communications services agent. Following is a summary of the acquisition.
PentaStar acquired the Circuits Business of NetLink, Inc. ("NetLink") by
merger. NetLink, located in St. Louis, Missouri, is a full-service
communications agent for Southwestern Bell and primarily sells high-end data
services. NetLink is also an Ameritech distributor of voice and data services in
Southern Illinois. The initial purchase consideration consisted of $204 in cash
including acquisition costs, the issuance of 42,544 shares of the Company's
common stock with a fair market value of $1,010, the assumption of $299 in debt
and the assumption of operating liabilities. The assumed debt was paid at
closing. In addition, the agreement provides for additional consideration in the
form of cash and the Company's common stock if certain operating performance
criteria are met by NetLink for the period from August 1, 2000 through July 31,
2001.
The acquisitions discussed above were recorded using the purchase method of
accounting under which the purchase consideration was allocated to the
identifiable assets and liabilities of the acquired companies and the excess of
the purchase consideration over the fair value of the net assets acquired was
recorded as goodwill. The allocation of the purchase consideration was as
follows:
<TABLE>
Purchase Consideration:
<S> <C>
Cash ........................ $ 4,669
PentaStar common stock ...... 10,023
Acquisition costs ........... 844
-------
$15,536
=======
</TABLE>
Of the total purchase consideration of $15,536, $2,282 was allocated to
property and equipment, ($2,751) to net working capital, $1,039 to noncurrent
assets, ($4,220) to noncurrent liabilities and $19,186 to goodwill. The
financial statements reflect a preliminary allocation of the purchase price, to
be finalized upon evaluation of the fair market values of certain assets and
liabilities acquired. Goodwill will be amortized over a twenty year period.
The following unaudited pro forma condensed consolidated financial
information presents the consolidated results of operations of the Company for
the nine months ended September 30, 2000 as if the acquisitions discussed above
occurred at January 1, 2000. The unaudited pro forma financial data does not
purport to represent what PentaStar's combined results of operations would
actually have been if such transactions in fact had occurred on January 1, 2000
and are not necessarily representative of PentaStar's combined results of
operations for any future period. Since the acquisitions discussed above were
not under common control or management, historical combined results may not be
comparable to, or indicative of, future performance.
<TABLE>
<S> <C>
Revenue .................................. $ 22,879
Net loss ................................. (2,464)
Net loss per share - basic and diluted.... $ (.45)
</TABLE>
In the second quarter of fiscal 2000, the Company collected cash of $271
for receivables of ICM which were outstanding as of the date of PentaStar's
acquisition of ICM. This amount was not allocated to receivables in the original
purchase price allocation and as a result, a reduction to goodwill has been
recorded in the second quarter of fiscal 2000 to reflect the purchase price
adjustment. In the third quarter of fiscal 2000, the Company revalued certain
liabilities acquired and allocated in original purchase price allocations. The
revaluation resulted in a $168 reduction to goodwill in the third quarter of
fiscal 2000 to reflect the purchase price adjustment.
In addition to the above acquisition terms, certain shareholders of the
acquired companies have entered into escrow and contingent stock agreements with
PentaStar upon closing of the acquisitions. These agreements adjust the final
consideration paid to those shareholders in return for their interest in their
acquired companies. Under these agreements, shares of PentaStar common stock
were placed into escrow. Based upon the earnings performance of an acquired
company relative to that of all other acquired companies for the 12-month period
prior to the earlier of a sale of substantially all of the assets or stock of
PentaStar or five years, the shareholder
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associated with that company will receive back from escrow all, some or none of
the shares placed in escrow. In addition, based again upon the relative earnings
performance of the acquired company, that shareholder may receive additional
shares of common stock from PentaStar. The agreements are designed, however, so
that there will be no net change to the total number of shares of PentaStar
common stock outstanding after the combined adjustments are made for all of the
acquired companies.
In connection with the acquisition of ParTel, the Company advanced $500 to
Par.com, Inc. ("Par.com"). Par.com is a corporation controlled by the former
shareholders of ParTel. The promissory note bears interest at the prime rate
plus 1%. The principal and accrued interest is due on December 31, 2001, unless
the Company becomes obligated to make payment under the earn-out provisions of
the ParTel acquisition agreement, at which time the required obligation would be
applied to payment on the promissory note. The promissory note is secured by a
security and pledge agreement whereby the assets of Par.com and the Company's
common stock issued in the acquisition are collateral to secure payment under
the promissory note. Certain former shareholders of ParTel have also personally
guaranteed payment.
6. CREDIT FACILITY
On July 18, 2000 PentaStar entered into a Credit and Security Agreement
(the "Agreement") with Wells Fargo Bank West, National Association ("Wells
Fargo"). Terms of the Agreement provide for maximum borrowings of $10 million
limited to 75% of eligible accounts receivable, as defined. The Agreement is
secured by accounts receivable and by substantially all of the remaining assets
of PentaStar. Interest is payable monthly at the prime rate or, if elected by
PentaStar, the LIBOR rate plus 2.50%. As of September 30, 2000, there were no
outstanding borrowings.
7. SUBSEQUENT EVENTS
In the fourth quarter of fiscal 2000, PentaStar, through a wholly-owned
subsidiary, acquired Vision Communications Group, Inc. ("Vision") by merger.
Vision, based in Montclair, New Jersey, is a communications services agent
selling primarily data-oriented local and long distance services in the
Mid-Atlantic market. Vision is an authorized agent for Verizon Communications.
Under the terms of the merger agreement, the consideration for the transaction
consisted of approximately $167 of cash and the issuance of 51,934 shares of the
Company's common stock with a fair market value of approximately $1,200. Of the
51,934 of issued shares, 38,950 were placed in escrow and will be released upon
Vision attaining certain performance criteria for the period from July 1, 2000
through June 30, 2001. In addition, there are potential earnout payments to
Vision based upon certain operating performance criteria during the period from
July 1, 2000 through June 30, 2001.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain matters discussed in this Quarterly Report on Form 10-QSB are
"forward-looking statements," intended to qualify for the safe harbor 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,"
"estimates," "plans," "believes" and "intends" or other similar words.
Similarly, statements that describe our future plans, objectives or goals are
also forward-looking statements. All 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 Item 1 of our Annual
Report on Form 10-KSB for the period from inception (March 15, 1999) through
December 31, 1999 and our Registration Statement on Form SB-2 (Registration No.
333-85281) under the heading "Risk Factors" and include:
o Our lack of combined operating history and our untested business
model.
o Our success in carrying out our acquisition strategy.
o Our reliance on regional bell operating companies and other service
providers for communications services.
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o Our 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 hereof and we undertake
no obligation to publicly update such forward-looking statements to reflect
subsequent events or circumstances.
INTRODUCTION
The following discussion and analysis of financial condition and results of
operations should be read in conjunction with the consolidated financial
statements and related notes as of September 30, 2000 and for the nine months
ended September 30, 2000, the period from inception (March 15, 1999) through
September 30, 1999 and the three months ended September 30, 2000 and 1999.
We were incorporated on March 15, 1999 under Delaware law. For the period
from inception (March 15, 1999) through September 30, 1999 we had not conducted
any operations, and all activity in the period related to organizing PentaStar,
developing our business plan, management and corporate structure, pursuing
acquisitions of communications services agents and activities in connection with
our initial public offering. Accordingly, the following discussions regarding
results of operations and cash flows are for the periods ended September 30,
2000 and do not include a comparison to a prior year period.
OVERVIEW
Through the acquisitions of existing communications services agents in
major metropolitan areas, we have become a leading communications services agent
for communications services including local access, long distance, wireless and
Internet services for voice and data communications. We design, procure and
facilitate the installation and use of communications services to best meet our
customers' needs. We currently act as a sales agent for Verizon Communications
(f/k/a Bell Atlantic), Qwest (f/k/a US WEST Communications), Ameritech, Cable &
Wireless, Pacific Bell, BellSouth, Southwestern Bell, Sprint, Epoch Internet and
other communications services providers. We plan to continue to acquire other
communications services agents and to enter into agency agreements with other
communications services providers.
Substantially all of our revenues are generated from the commissions we
receive from selling communications services as agents for communications
service providers. We are paid a commission by each service provider. Currently
we primarily sell advanced communications services and basic dial tone services
for the local access market to facilitate data, voice and video communications.
We expect that, over time, the percentage of advanced communications services
revenues will increase as a percentage of revenues because of increased demand
for, and availability of, these services. Basic dial tone services in general
are telephone connections, voice messaging and call management services.
Advanced communications services are all other voice and data communications
services, including:
o data transmission oriented services;
o dedicated high-capacity transmission services;
o high speed real time communications access, including digital
subscriber line (DSL);
o packet-based transmission for wide area networks, including frame
relay service; and
o an advanced digital network for data, video, voice and Internet
traffic, including integrated services digital network (ISDN).
In addition to acting as a sales agent for local access, long distance,
wireless and Internet, we also offer, to a limited extent, products such as
telephone equipment and the related hardware installation.
Salaries and commissions expenses consist principally of salary and
incentive compensation that our operating companies pay
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<PAGE> 13
their sales and marketing, operations and engineering support and administrative
staff.
Cost of product sales consists of the cost of the product sold and any
subcontract labor incurred in installing the equipment.
Other general and administrative expenses include communications expenses,
office rent and utilities, travel and marketing for the operating companies.
These expenses also include the operations and staffing related to our corporate
office.
We experience some seasonal variations in our businesses. Orders for
communications services tend to slow in the last quarter of the calendar year
due to customers' budgetary constraints. Generally, orders increase in the first
quarter of the following year. Because of the time lag between order and
installation, revenues in the first four months of each calendar year are
typically below the average of revenues for the remaining portion of the year.
Recent Acquisitions.
In the first nine months of fiscal 2000, we completed the acquisitions of
seven communications services agents. Following is a summary of our acquisition
activity.
PentaStar, through a wholly-owned subsidiary, acquired the assets of
USTeleCenters, Inc. and Vermont Network Services Corporation (collectively
referred to as UST). UST, founded in 1986 and headquartered in Boston,
Massachusetts, is a full-service communications agent focusing on small business
customers located throughout Verizon Communications (f/k/a Bell Atlantic) 13
state Northeast and Mid-Atlantic region. UST has agency agreements with service
providers including Verizon Communications, Bell South, Southwestern Bell and
Sprint. The purchase consideration consisted of $277 in cash including
acquisition costs, the issuance of 5,980 shares of the Company's common stock
with a fair market value of $100 and the assumption of liabilities.
PentaStar, through a wholly-owned subsidiary, acquired the assets of NCI
Communications, Inc. NCI is primarily a long distance communications services
agent located in Seattle, Washington. NCI has agency agreements with Qwest, AT&T
and GST Telecom. NCI was owned by certain of the previous shareholders of ICM,
who, upon the Company's acquisition of ICM, became shareholders of the Company.
The purchase consideration consisted of $18 in cash including acquisition costs
and the cancellation of a $601 note receivable from NCI to PentaStar.
PentaStar acquired ParTel, Inc. by merger. ParTel, founded in 1982, is a
full-service communications agent based in Phoenix, Arizona primarily servicing
customers in the Phoenix and Tucson metropolitan markets. ParTel is an agent of
Qwest (f/k/a U S WEST) and sells primarily high-end, data-oriented services. The
initial purchase consideration consisted of $606 in cash including acquisition
costs and the issuance of 30,310 shares of the Company's common stock with a
fair market value of $539. In addition, the agreement provides for additional
consideration in the form of cash and the Company's common stock if certain
operating performance criteria are met by ParTel for the year ending December
31, 2000.
PentaStar, through a wholly-owned subsidiary, acquired Resource
Communications, Inc. by merger. Resource, based in Dublin, California, is a
full-service communications agent, which furnishes communication solutions to
customers in Northern California. Resource is one of the largest Cable &
Wireless long distance master agents and a significant Pacific Bell authorized
sales representative. The initial purchase consideration consisted of $1,037 of
cash including acquisition costs and the issuance of 81,250 shares of the
Company's common stock. Of the 81,250 of issued shares, 50,000 shares with a
fair market value of $919 were placed in an indemnification escrow until March
31, 2001. The remaining 31,250 shares were placed in escrow until March 15, 2001
to be released upon Resource attaining certain performance criteria for the year
ending December 31, 2000. In addition, the agreement provides for additional
consideration in the form of cash and the Company's common stock if certain
operating performance criteria are met by Resource for the period from January
1, 2000 to June 30, 2001.
PentaStar, through a wholly-owned subsidiary, acquired the assets of VSI
Network Solutions, Inc. dba Eastern Telecom (ETI). ETI, founded in 1992, is a
full-service communications agent based in Warwick, Rhode Island, primarily
servicing customers in Boston, New York, Albany, Providence and Warwick. ETI is
an authorized agent for Verizon Communications and Bell South. The initial
purchase consideration consisted of $2,009 of cash including acquisition costs,
the issuance of 57,122 shares of the Company's common stock with a fair market
value of $961, the assumption of $758 in debt and the assumption of operating
liabilities. The assumed debt was paid at closing. The 57,122 shares of common
stock were placed in an indemnification escrow until November 18, 2001. In
addition, the agreement provides for additional consideration in the form of
cash and the Company's common stock if certain combined operating performance
criteria of ETI and UST are met by ETI for the year ending December 31, 2000.
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<PAGE> 14
PentaStar, through a wholly-owned subsidiary, acquired the assets of the
Network Services Agency Division of Telecomm Industries Corp. (TCMM). TCMM's
Network Services Agency Division is Ameritech's largest distributor of voice and
data services. TCMM is also an authorized distributor for BellSouth. The initial
purchase consideration consisted of $1,362 of cash including acquisition costs,
the issuance of 278,949 shares of the Company's common stock with a fair market
value of $6,494 and the assumption of certain debt and operating liabilities of
TCMM. The assumed debt included $1,260 of short-term obligations which were paid
at closing. The remaining assumed debt is secured by approximately $6,500 of
future commissions due to PentaStar from existing Ameritech contracts, which
should be realized over the next several years. In addition to the initial
purchase consideration, the agreement provides for additional consideration in
the form of cash and the Company's common stock if certain operating performance
criteria are met by TCMM for the period from April 1, 2000 through March 31,
2001. The total purchase consideration, including cash, stock and the short-term
debt obligation paid at closing, cannot exceed $18,000. The earn-out will be
recorded as additional purchase consideration when and if realized by TCMM. The
278,949 shares of PentaStar common stock were placed in a general
indemnification escrow until the date at which the earn-out amount is
determined.
PentaStar acquired the Circuits Business of NetLink, Inc. by merger.
NetLink, located in St. Louis, Missouri, is a full-service communications agent
for Southwestern Bell and primarily sells high-end data services. NetLink is
also an Ameritech distributor of voice and data services in Southern Illinois.
The initial purchase consideration consisted of $204 in cash including
acquisition costs, the issuance of 42,544 shares of the Company's common stock
with a fair market value of $1,010, the assumption of $299 in debt and the
assumption of operating liabilities. The assumed debt was paid at closing. In
addition, the agreement provides for additional consideration in the form of
cash and the Company's common stock if certain operating performance criteria
are met by NetLink for the period from August 1, 2000 through July 31, 2001.
In the fourth quarter of fiscal 2000, PentaStar, through a wholly-owned
subsidiary, acquired Vision Communications Group, Inc. by merger. Vision, based
in Montclair, New Jersey, is a communications services agent selling primarily
data-oriented local and long distance services in the Mid-Atlantic market.
Vision is an authorized agent for Verizon Communications. Under the terms of the
merger agreement, the consideration for the transaction consisted of
approximately $167 of cash and the issuance of 51,934 shares of the Company's
common stock with a fair market value of approximately $1,200. Of the 51,934 of
issued shares, 38,950 were placed in escrow and will be released upon Vision
attaining certain performance criteria for the period from July 1, 2000 through
June 30, 2001. In addition, there are potential earnout payments to Vision based
upon certain operating performance criteria during the period from July 1, 2000
through June 30, 2001.
Private Placement Of Common Stock.
On September 1, 2000, we closed a private placement of 156,313 shares of
our common stock, resulting in proceeds of $3,108, net of cash offering costs of
$192. The shares of common stock are restricted and were sold to three selected
institutional investors and a private investor. The investors participating in
the private placement may demand registration of the securities in a written
request after December 30, 2000. Thereafter, we have sixty days to file a
registration statement with the Securities and Exchange Commission and use our
best efforts to cause the registration statement to become effective. The
investors have two "demand" registration rights and also have "piggyback"
registration rights on other registration statements we file.
RESULTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000
Revenues. Revenues consist principally of commissions from sales of
communications services as an agent for communications services providers. We
recorded revenue of $11,624 resulting from sales of advanced communications
services, $5,979 from sales of basic dial tone services and $1,342 from product
sales and other. The acquisition of UST provided us with a telemarketing sales
division. The telemarketing group focuses on high volume, lower revenue
services, which contributes to the significant amount of basic dial tone
services revenues recorded in the nine months ended September 30, 2000. During
the three months ended September 30, 2000, Verizon Communications experienced a
work stoppage due to the expiration of collective bargaining agreements with
unions representing approximately 85,000 employees in the former Bell Atlantic
region. As a result of the work stoppage, the installation by Verizon of
services sold by our Verizon agents was curtailed and thus had a negative impact
on our revenue recognized during the three months ended September 30, 2000. The
work stoppage has since been settled and normal service installations have
resumed.
Costs and expenses. Costs and expenses consist principally of salaries and
commissions, general and administrative expenses and
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<PAGE> 15
depreciation and amortization. Salaries and commissions expense of $15,812
consists principally of costs of operations, sales, management and
administrative personnel at the operating companies. Cost of product sales of
$516 consists of the cost of the equipment and subcontract labor attributable to
the product sales. Other general and administrative expenses of $4,634 consists
principally of the overhead expenses of the operating companies such as rent,
telephone and supplies and the expenses applicable to our corporate office such
as personnel costs, travel, insurance and professional fees. Depreciation and
amortization expense of $1,351 consists of depreciation expense on the property
and equipment and the amortization of goodwill associated with the acquisitions
of the operating companies in fiscal 1999 and in the first nine months of fiscal
2000.
Loss from operations. A loss from operations of $3,368 was recognized for
the nine months ended September 30, 2000. This loss from operations was
negatively impacted by the Verizon Communications work stoppage discussed above.
Other (income) expense, net. Other expense, net, of $104 consists of $285
of interest expense and other offset by $181 of interest income earned on our
invested cash. Interest expense, is primarily attributable to the debt assumed
in the acquisition of TCMM and interest incurred due to outstanding borrowings
on our credit facility. Interest expense also includes interest expense on
capital lease obligations assumed in the acquisition of UST.
Income taxes. A benefit of $1,050 was recorded for the period representing
an effective tax rate of 30.2%. The difference between the federal statutory
rate of 34% and the effective rate is due to state income taxes offset by
nondeductible goodwill amortization.
Net loss. A net loss of $2,422 was recognized for the nine months ended
September 30, 2000. This net loss was negatively impacted by the Verizon
Communications work stoppage discussed above.
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000
Revenues. We recorded revenue of $4,472 resulting from sales of advanced
communications services, $2,022 from sales of basic dial tone services and $461
from product sales and other. The acquisition of UST provided us with a
telemarketing sales division. The telemarketing group focuses on high volume,
lower revenue services, which contributes to the significant amount of basic
dial tone services revenues recorded in the three months ended September 30,
2000. During the three months ended September 30, 2000, Verizon Communications
experienced a work stoppage due to the expiration of collective bargaining
agreements with unions representing approximately 85,000 employees in the former
Bell Atlantic region. As a result of the work stoppage, the installation by
Verizon of services sold by our Verizon agents was curtailed and thus had a
negative impact on our revenue recognized during the three months ended
September 30, 2000. The work stoppage has since been settled and normal service
installations have resumed.
Costs and expenses. Salaries and commissions expense of $6,043 consists
principally of costs of operations, sales, management and administrative
personnel at the operating companies. Cost of product sales of $246 consists of
the cost of the equipment and subcontract labor attributable to the product
sales. Other general and administrative expenses of $1,788 consists principally
of the overhead expenses of the operating companies such as rent, telephone and
supplies and the expenses applicable to our corporate office such as personnel
costs, travel, insurance and professional fees. Depreciation and amortization
expense of $511 consists of depreciation expense on the property and equipment
and the amortization of goodwill associated with the acquisitions of the
operating companies in fiscal 1999 and in the first nine months of fiscal 2000.
Loss from operations. A loss from operations of $1,633 was recognized for
the three months ended September 30, 2000. This loss from operations was
negatively impacted by the Verizon Communications work stoppage discussed above.
Other (income) expense, net. Other expense, net, of $117 consists primarily
of $123 of interest expense and other. Interest expense, is primarily
attributable to the debt assumed in the acquisition of TCMM and interest
incurred due to outstanding borrowings on our credit facility. Interest expense
also includes interest expense on capital lease obligations assumed in the
acquisition of UST.
Income taxes. A benefit of $547 was recorded for the period representing an
effective tax rate of 31.3%. The difference between the federal statutory rate
of 34% and the effective rate is due to state income taxes offset by
nondeductible goodwill amortization.
Net loss. A net loss of $1,203 was recognized for the three months ended
September 30, 2000. This net loss was negatively impacted by the Verizon
Communications work stoppage discussed above.
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<PAGE> 16
LIQUIDITY AND CAPITAL RESOURCES
Our operations used net cash of $1,699 for the nine months ended September
30, 2000, which was primarily attributable to the net loss recognized during the
period offset by the collection of accounts receivable and the payment of
accounts payable and accrued liabilities. The acquisition of UST included the
assumption of approximately $2,441 in current liabilities. This use of cash
primarily represents the payment of these assumed liabilities.
We used cash of $6,923 in investing activities for the nine months ended
September 30, 2000 primarily as a result of our acquisition activity, the
issuance of a promissory note and the purchase of property and equipment. We
used cash of $5,074 to fund the cash consideration used in our acquisitions in
the first nine months of fiscal 2000, net of cash acquired. In connection with
the acquisition of ParTel, we issued a promissory note in the amount of $500 to
a corporation controlled by the former shareholders of ParTel. The principal and
accrued interest is due no later than December 31, 2001. In connection with the
acquisitions of ETI and NetLink we assumed $1,057 of debt which was immediately
paid at the closing of the acquisitions. Property and equipment of $445 was
purchased for the nine months ended September 30, 2000.
Our financing activities for the nine months ended September 30, 2000
provided cash of $1,089 which was primarily the $3,108 of net proceeds from the
private placement of common stock, offset by the payments on the debt assumed in
the TCMM acquisition.
We intend to fund future acquisitions through remaining proceeds of the
private placement of common stock completed in the third quarter of fiscal 2000,
the issuance of common stock, internally generated cash flow and future
borrowings.
On July 18, 2000 we entered into a credit and security agreement with Wells
Fargo Bank West, National Association. Terms of the agreement provide for
maximum borrowings of $10 million limited to 75% of eligible accounts
receivable, as defined. The agreement is secured by accounts receivable and by
substantially all of the remaining assets of PentaStar. Interest is payable
monthly at the prime rate or, if elected by PentaStar, the LIBOR rate plus
2.50%. As of September 30, 2000, there were no outstanding borrowings.
We believe that the net proceeds from the private placement of common stock
closed in the third quarter of fiscal 2000, cash flow from operations, and
current and future debt financing will be sufficient to satisfy our anticipated
cash requirements for the next twelve months. We will likely require additional
equity or debt financing beyond that period, and possibly sooner, dependent upon
the scope of our acquisition activity.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the staff of the Securities and Exchange Commission
released Staff Accounting Bulletin ("SAB") No. 101 "Revenue Recognition in
Financial Statements". SAB No. 101 provides interpretive guidance on the
recognition, presentation and disclosure of revenue in financial statements.
PentaStar's accounting policies are consistent with the guidance provided in SAB
No. 101 and its implementation in the fourth quarter of fiscal 2000 is not
expected to have a significant effect on the previously reported results of
operations or financial position of PentaStar.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities". PentaStar is
required to adopt SFAS No. 133 no later than the first fiscal quarter of 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, PentaStar has not entered into any derivative
financial instruments or hedging activities. PentaStar has not determined the
impact of adopting SFAS No. 133.
PART II
ITEM 2. CHANGES IN SECURITIES
(c.) Effective during the period from July 1, 2000 through September 30,
2000, PentaStar sold unregistered securities as follows:
o On September 1, 2000, PentaStar issued 156,313 shares of common
stock to three selected institutional investors and a private
investor for $3,300,000 in cash.
o On September 29, 2000, PentaStar issued 42,544 shares of common
stock to the shareholders of NetLink, Inc. as partial consideration
for the acquisition of NetLink, Inc. by merger.
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<PAGE> 17
The sales and issuance of securities in the transactions described in the above
paragraphs were deemed to be exempt from registration under the Securities Act
by virtue of Rule 506. The entities and persons to whom the shares were issued
are accredited investors with the exception of one NetLink shareholder who
PentaStar believes, either alone or with his purchaser representative, has such
knowledge and experience in financial and business matters as to be capable of
evaluating the merits and risks of the investment in PentaStar common stock.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) The following exhibits are attached.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<S> <C>
2.14 Agreement and Plan of Merger among PentaStar Communications,
Inc., NetLink, Inc. and the Shareholders Of NetLink, Inc. dated
September 29, 2000
4.4 PentaStar Communications, Inc. Common Stock Purchase Agreement
dated September 1, 2000
27.1 Financial Data Schedule
</TABLE>
----------
(b) The issuer filed the following reports on Form 8-K during the period
from July 1, 2000 through September 30, 2000:
o Current Report on Form 8-K dated July 18, 2000
o Current Report on Form 8-K dated July 19, 2000
o Current Report on Form 8-K dated July 19, 2000 as amended by Amendment
No. 1 on Form 8-K/A filed on August 11, 2000
o Current Report on Form 8-K dated September 1, 2000
o Current Report on Form 8-K dated September 29, 2000
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized on November 14, 2000.
PENTASTAR COMMUNICATIONS, INC.
By: /s/ DAVID L. DUNHAM
---------------------------------------
David L. Dunham Chief Financial Officer
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<PAGE> 18
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<S> <C>
2.14 Agreement and Plan of Merger among PentaStar Communications,
Inc., NetLink, Inc. and the Shareholders Of NetLink, Inc. dated
September 29, 2000
4.4 PentaStar Communications, Inc. Common Stock Purchase Agreement
dated September 1, 2000
27.1 Financial Data Schedule
</TABLE>
