<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 JUNE 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)
<PAGE> 2
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 August 8, 2000, the number of shares outstanding of the issuer's common
stock, par value $.0001 per share, was 5,251,453.
--------------------------------------------------------------------------------
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
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TABLE OF CONTENTS
<TABLE>
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PART I
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............................................... 6
Item 4. Submission of Matters to a Vote of Security Holders................. 7
Item 6. Exhibits and Reports on Form 8-K ................................... 7
</TABLE>
1
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PART I
ITEM 1. FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
PENTASTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets as of June 30, 2000 and
December 31, 1999........................................................ F-2
Consolidated Statements of Operations for the Six Months Ended
June 30, 2000 and for the Period from Inception (March 15, 1999)
through June 30, 1999.................................................... F-3
Consolidated Statements of Operations for the Three Months Ended
June 30, 2000 and 1999................................................... F-4
Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2000 and for the Period from Inception (March 15, 1999)
through June 30, 1999.................................................... F-5
Notes to Consolidated Financial Statements ................................. F-6
F-1
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PENTASTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2000 AND DECEMBER 31, 1999
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
ASSETS 2000 1999
------------ ------------
(UNAUDITED) (AUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents ......................................... $ 2,003 $ 8,137
Accounts receivable, net .......................................... 3,942 1,092
Inventory ......................................................... 168 --
Prepaid commissions expense ....................................... 755 45
Prepaid expenses and other ........................................ 459 158
Related party note receivable ..................................... -- 601
------------ ------------
Total current assets ...................................... 7,327 10,033
Property and equipment, net ......................................... 2,685 555
Deferred income taxes ............................................... 431 323
Related party note receivable ....................................... 515 --
Prepaid commissions expense, net of current portion ................. 1,151 --
Other assets ........................................................ 125 45
Goodwill, net ....................................................... 21,630 4,459
------------ ------------
Total assets .............................................. $ 33,864 $ 15,415
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable .................................................. $ 1,492 $ 170
Other accrued liabilities ......................................... 1,000 65
Related party acquisition payables ................................ 1,136 326
Accrued compensation .............................................. 1,429 541
Deferred revenue .................................................. 1,037 393
Current portion of capital leases ................................. 23 --
Current portion of long-term debt ................................. 777 --
Short-term acquisition debt obligation ............................ 1,260 --
Deferred income taxes ............................................. 301 97
------------ ------------
Total current liabilities ................................. 8,455 1,592
Long-term portion of capital leases ............................... 165 --
Long-term debt, net of current portion ............................ 3,627 --
------------ ------------
Total liabilities ......................................... 12,247 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 ............ 88 86
Common stock, $.0001 par value; 20,000,000 shares
authorized; shares issued and outstanding - 5,251,453 as of
June 30, 2000 and 4,797,842 as of December 31, 1999 ............ 1 1
Additional paid-in capital ........................................ 23,182 14,169
Retained deficit .................................................. (1,654) (433)
------------ ------------
Total shareholders' equity ................................ 21,617 13,823
------------ ------------
Total liabilities and shareholders' equity ................ $ 33,864 $ 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 SIX MONTHS ENDED JUNE 30, 2000
AND FOR THE PERIOD FROM INCEPTION (MARCH 15, 1999)
THROUGH JUNE 30, 1999
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
2000 1999
----------- -----------
<S> <C> <C>
Revenue:
Advanced communications services ............... $ 7,152 $ --
Basic dial tone services ....................... 3,957 --
Product sales and other ........................ 881 --
----------- -----------
11,990 --
----------- -----------
Costs and expenses:
Salaries and commissions ....................... 9,769 --
Cost of product sales .......................... 270 --
Other general and administrative expenses ...... 2,846 2
Depreciation and amortization .................. 840 --
----------- -----------
13,725 2
----------- -----------
Loss from operations ................... (1,735) (2)
----------- -----------
Other (income) expense:
Interest income ................................ (175) --
Interest expense and other ..................... 162 --
----------- -----------
Other (income) expense, net ............ (13) --
----------- -----------
Loss before benefit for income taxes ............. (1,722) (2)
Benefit for income taxes ......................... 503 --
----------- -----------
Net loss ......................................... $ (1,219) $ (2)
=========== ===========
Preferred dividends .............................. (2) --
----------- -----------
Net loss - common shareholders ................... $ (1,221) $ (2)
=========== ===========
Basic and diluted net loss per common share ...... $ (0.24) $ --
Weighted-average common shares outstanding ....... 5,029,005 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 JUNE 30, 2000 AND 1999
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
2000 1999
----------- -----------
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Revenue:
Advanced communications services ............. $ 4,734 $ --
Basic dial tone services ..................... 2,242 --
Product sales and other ...................... 574 --
----------- -----------
7,550 --
----------- -----------
Costs and expenses:
Salaries and commissions ..................... 5,894 --
Cost of product sales ........................ 139 --
Other general and administrative expenses .... 1,869 2
Depreciation and amortization ................ 545 --
----------- -----------
8,447 2
----------- -----------
Loss from operations ................. (897) (2)
----------- -----------
Other (income) expense:
Interest income .............................. (72) --
Interest expense and other ................... 157 --
----------- -----------
Other (income) expense, net .......... 85 --
----------- -----------
Loss before benefit for income taxes ........... (982) (2)
Benefit for income taxes ....................... 264 --
----------- -----------
Net loss ....................................... $ (718) $ (2)
=========== ===========
Preferred dividends ............................ (1) --
----------- -----------
Net loss - common shareholders ................. $ (719) $ (2)
=========== ===========
Basic and diluted net loss per common share .... $ (0.14) $ --
Weighted-average common shares outstanding ..... 5,251,453 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 SIX MONTHS ENDED JUNE 30, 2000
AND FOR THE PERIOD FROM INCEPTION (MARCH 15, 1999)
THROUGH JUNE 30, 1999
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
2000 1999
-------- ------
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Cash flows from operating activities:
Net loss ........................................................ $ (1,219) $ (2)
Adjustments to reconcile net loss to net cash
used in operating activities--
Depreciation and amortization ................................ 840 --
Deferred income tax benefit .................................. (503) --
Changes in operating assets and liabilities--
Accounts receivable, net ................................... 1,458 --
Inventory .................................................. 9 --
Prepaid expenses and other ................................. (39) (25)
Accounts payable and accrued liabilities ................... (901) --
Deferred revenue ........................................... 220 --
-------- ------
Net cash used in operating activities ................... (135) (27)
-------- ------
Cash flows from investing activities:
Purchase of property and equipment .............................. (327) --
Amounts advanced against contingent purchase consideration ...... (500) --
Related party acquisition payables .............................. 810 --
Acquisitions, net of cash acquired .............................. (4,870) --
Purchase price adjustment ....................................... 271 --
Payment of assumed acquisition debt ............................. (758) --
Other ........................................................... 19 --
-------- ------
Net cash used in investing activities ................... (5,355) --
-------- ------
Cash flows from financing activities:
Payments on capital lease obligations ........................... (41) --
Payments on long-term debt ...................................... (129) --
Payments on short-term acquisition debt obligation .............. (474) --
Proceeds from related party debt ................................ -- 27
Shareholders' contributions ..................................... -- 1
-------- ------
Net cash provided by (used in) financing activities ..... (644) 28
-------- ------
Net increase (decrease) in cash and cash equivalents .............. (6,134) 1
Cash and cash equivalents, beginning of period .................... 8,137 --
-------- ------
Cash and cash equivalents, end of period .......................... $ 2,003 $ 1
======== ======
Noncash investing and financing activities:
Purchase of property and equipment pursuant to capital lease..... $ 25 $ --
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
F-5
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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 and second quarters of fiscal 2000 the Company
acquired four and two communications services agents, respectively to expand its
operations (see Note 5).
The financial statements as of June 30, 2000 and for the six months ended
June 30, 2000, the period from inception (March 15, 1999) through June 30, 1999
and the three months ended June 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 period. 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.
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 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 acquisition of
four communications services agents. Following is a summary of the acquisitions.
F-6
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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 Bell Atlantic's 13 state Northeast and Mid-Atlantic
region. UST has agency agreements with service providers including Bell
Atlantic, 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 U S WEST (now Qwest) and sells primarily high-end, data-oriented
products. 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 acquisition 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 Bell Atlantic 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 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. $1,065 of the cash consideration was paid to the former TCMM shareholders
subsequent to June 30, 2000 and is shown as a related party acquisition payable
on the June 30, 2000 balance sheet. The shares of common stock were issued
subsequent to June 30, 2000. The assumed debt included $1,260 of short-term
obligations which were repaid subsequent to June 30, 2000. 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
F-7
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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.
The acquisitions discussed above were recorded using the purchase method of
accounting by 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>
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Purchase Consideration:
Cash...................... $ 4,571
PentaStar common stock.... 9,013
Acquisition costs......... 738
--------
$ 14,322
========
</TABLE>
Of the total purchase consideration of $14,322, $2,236 was allocated to
property and equipment, ($2,856) to net working capital, $1,039 to noncurrent
assets, ($3,921) to noncurrent liabilities and $17,824 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 six months ended June 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>
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Revenue....................................................................... $ 15,293
Net income (loss) from continuing operations.................................. (1,334)
Net income (loss) from continuing operations per share - basic and diluted.... $ (0.25)
</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 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 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. SUBSEQUENT EVENTS
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. Advances under the Agreement may be used for short-term working
capital needs and future acquisitions. There are no compensating balance
requirements and the Agreement requires compliance with financial loan covenants
related to debt levels compared to annualized cash flows from operations. The
Agreement terminates and is payable in full on July 31, 2001. Interest is
payable monthly at the prime rate or, if elected by the Company, the LIBOR rate
plus 2.50%. A commitment fee in the amount of .25% is payable quarterly in
arrears based on the average daily unused portion of the total commitment.
F-8
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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 the Company's 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 the
Company's Annual Report on Form 10-KSB for the period from inception (March 15,
1999) through December 31, 1999 and the Company's Registration Statement on Form
SB-2 (Registration No. 333-85281) under the heading "Risk Factors" and include:
o The Company's lack of combined operating history and its untested
business model.
o The Company's success in carrying out its acquisition strategy.
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 hereof and the Company
undertakes no obligations to publicly update such forward-looking statements to
reflect subsequent events or circumstances.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
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 June 30, 2000 and for the six months ended
June 30, 2000, the period from inception (March 15, 1999) through June 30, 1999
and the three months ended June 30, 2000 and 1999.
We were incorporated on March 15, 1999 under Delaware law. For the period
from inception (March 15, 1999) through June 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 June 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 Bell Atlantic, US WEST
Communications (now Qwest), Ameritech, Cable & Wireless, Pacific Bell,
BellSouth, Southwestern Bell, Sprint, Qwest, 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:
2
<PAGE> 13
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 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 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 six months of fiscal 2000, we completed the acquisition of six
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 Bell Atlantic's 13 state Northeast and Mid-Atlantic
region. UST has agency agreements with service providers including Bell
Atlantic, 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 U S WEST (now Qwest) and sells primarily high-end, data-oriented
products. 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
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<PAGE> 14
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 Bell Atlantic 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 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. $1,065 of the cash consideration was paid to the former TCMM shareholders
subsequent to June 30, 2000 and is shown as a related party acquisition payable
on the June 30, 2000 balance sheet. The shares of common stock were issued
subsequent to June 30, 2000. The assumed debt included $1,260 of short-term
obligations which were repaid subsequent to June 30, 2000. 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.
RESULTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2000
Revenues. Revenues consist principally of commissions from sales of
communications services as an agent for communications services providers. We
recorded revenue of $7,152 resulting from sales of advanced communications
services, $3,957 from sales of basic dial tone services and $881 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 six months ended June 30, 2000.
Costs and expenses. Salaries and commissions expense of $9,769 consists
principally of costs of operations, sales, management and administrative
personnel at the operating companies. Cost of product sales of $270 consists of
the cost of the equipment and subcontract labor attributable to the product
sales. Other general and administrative expenses of $2,846 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 $840 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 six months of fiscal 2000.
Loss from operations. A loss from operations of $1,735 was recognized for
the six months ended June 30, 2000.
Other (income) expense, net. Other income, net, of $13 consists of $175 of
interest income earned on our invested cash offset by the interest expense,
which is primarily attributable to the debt assumed in the acquisition of TCMM.
Interest expense also includes interest expense on capital lease obligations
assumed in the acquisition of UST.
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<PAGE> 15
Income taxes. A benefit of $503 was recorded for the period representing an
effective tax rate of 29.2%. 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 $1,219 was recognized for the six months ended June
30, 2000.
FOR THE THREE MONTHS ENDED JUNE 30, 2000
Revenues. Revenues consist principally of commissions from sales of
communications services as an agent for communications services providers. We
recorded revenue of $4,734 resulting from sales of advanced communications
services, $2,242 from sales of basic dial tone services and $574 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 June 30, 2000.
Costs and expenses. Salaries and commissions expense of $5,894 consists
principally of costs of operations, sales, management and administrative
personnel at the operating companies. Cost of product sales of $139 consists of
the cost of the equipment and subcontract labor attributable to the product
sales. Other general and administrative expenses of $1,869 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 $545 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 six months of fiscal 2000.
Loss from operations. A loss from operations of $897 was recognized for the
three months ended June 30, 2000.
Other (income) expense, net. Other expense, net, of $85 consists of $157 of
interest expense offset by $72 of interest income earned on our invested cash.
Interest expense is primarily attributable to the debt assumed in the
acquisition of TCMM and also includes interest expense on capital lease
obligations assumed in the acquisition of UST.
Income taxes. A benefit of $264 was recorded for the period representing an
effective tax rate of 26.9%. 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 $718 was recognized for the three months ended June
30, 2000.
LIQUIDITY AND CAPITAL RESOURCES
Our operations used net cash of $135 for the six months ended June 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 $5,355 in investing activities for the six months ended June
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
$4,870 to fund the cash consideration used in our acquisitions in the first six
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
acquisition of ETI we assumed $758 of debt which was immediately paid at the
closing of the acquisition. Property and equipment of $327 was purchased for the
six months ended June 30, 2000.
Our financing activities for the six months ended June 30, 2000 used cash of
$644, which consisted primarily of payments on the debt assumed in the TCMM
acquisition.
We intend to fund future acquisitions through the remaining proceeds of our
initial public offering, the issuance of common stock, internally generated cash
flow and future borrowings.
On July 18, 2000 we 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. Advances under the Agreement may be used for short-term working
capital needs and future acquisitions. There are no
5
<PAGE> 16
compensating balance requirements and the Agreement requires compliance with
financial loan covenants related to debt levels compared to annualized cash
flows from operations. The Agreement terminates and is payable in full on July
31, 2001. Interest is payable monthly at the prime rate or, if elected by the
Company, the LIBOR rate plus 2.50%. A commitment fee in the amount of .25% is
payable quarterly in arrears based on the average daily unused portion of the
total commitment.
We believe that the net proceeds from the initial public offering, 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. 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.
PART II
ITEM 2. CHANGES IN SECURITIES
(c.) Effective during the period from April 1, 2000 through June 30, 2000,
PentaStar sold unregistered securities as follows:
o On May 18, 2000, PentaStar issued 57,122 shares of common stock to the
shareholder of VSI Network Solutions, Inc. dba Eastern Telecom as
partial consideration for the acquisition of the assets of VSI Network
Solutions, Inc. dba Eastern Telecom.
o On July 19, 2000, PentaStar issued 278,949 shares of common stock to
Telecomm Industries Corp. as partial consideration for the acquisition
of the assets of the Network Services Agency Division of Telecomm
Industries Corp.
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 to whom the shares were
issued are accredited investors.
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<PAGE> 17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 31, 2000, PentaStar held its Annual Meeting of Shareholders. At such
meeting, PentaStar's shareholders (i) elected Messrs. Carleton A. Brown and
Reynaldo U. Ortiz as directors to the Board of Directors to serve for a term
until the 2003 annual meeting. (The terms of Messrs. Robert S. Lazzeri, Richard
M. Tyler and Craig J. Zoellner as directors, continued after the meeting); (ii)
approved an amendment to the PentaStar Communications, Inc. Stock Option Plan to
increase the number of shares under the plan by 500,000 shares. The number of
votes cast in matters is set forth below:
<TABLE>
<CAPTION>
VOTES VOTES AGAINST
FOR OR WITHHELD ABSTENTIONS NON-VOTES
---------- ------------- ----------- ---------
<S> <C> <C> <C> <C>
Election of Directors:
Carleton A. Brown 4,198,307 -- -- --
Reynaldo U. Ortiz 4,198,307 -- -- --
</TABLE>
<TABLE>
<CAPTION>
VOTES VOTES AGAINST
FOR OR WITHHELD ABSTENTIONS NON-VOTES
---------- ------------- ----------- ---------
<S> <C> <C> <C> <C>
Amendment to PentaStar Stock
Option Plan 3,072,698 218,973 7,000 --
</TABLE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) The following exhibits are attached or incorporated by reference to the
documents indicated which have previously been filed with the Securities and
Exchange Commission.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<S> <C>
2.11 Letter Agreement dated May 17, 2000 among PentaStar
Communications, Inc., OC Mergerco 4, Inc., VSI Network
Solutions, Inc. and the Shareholder of VSI Network
Solutions, Inc.
2.12(2) Purchase Agreement among PentaStar Communications, Inc.,
PentaStar Corporation and Telecomm Industries Corp. as of
April 15, 2000
2.13(2) Letter Agreement among PentaStar Communications, Inc.,
PentaStar Corporation and Telecomm Industries Corp. as of
April 15, 2000
</TABLE>
7
<PAGE> 18
<TABLE>
<S> <C>
10.16 Credit and Security Agreement by and among PentaStar
Communications, Inc., PentaStar Acquisition Corp. I,
PentaStar Acquisition Corp. II, PentaStar Acquisition Corp.
III, PentaStar Acquisition Corp. IV, PentaStar Acquisition
Corp. VI, PentaStar Internet, Inc., PentaStar Holding
Corporation, PentaStar Telemarketing, Inc. and PentaStar
Corporation as borrowers and Wells Fargo Bank West, N.A.
dated as of July 10, 2000.
10.17(1) Authorized Distributor Agreement Between Ameritech and
Telecomm Industries Corp.
27.1 Financial Data Schedule
</TABLE>
----------
(1) Filed herewith. The Company has applied for confidential treatment for
portions of this Exhibit.
(2) Incorporated by reference from the Company's Current Report on Form 8-K
dated July 19 2000.
(b) The issuer filed the following reports on Form 8-K during the period
from January 1, 2000 through June 30, 2000:
o Current Report on Form 8-K dated February 18, 2000
o Current Report on Form 8-K dated February 18, 2000 as amended by
Amendment No. 1 on Form 8-K/A filed on May 5, 2000
o Current Report on Form 8-K dated February 23, 2000
o Current Report on Form 8-K dated March 17, 2000
o Current Report on Form 8-K dated March 31, 2000
o Current Report on Form 8-K dated March 31, 2000
o Current Report on Form 8-K dated April 24, 2000
o Current Report on Form 8-K dated May 18, 2000
o Current Report on Form 8-K dated May 18, 2000
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<PAGE> 19
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 August 14, 2000.
PENTASTAR COMMUNICATIONS, INC.
By: /s/ DAVID L. DUNHAM
----------------------------
David L. Dunham
Chief Financial Officer
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<PAGE> 20
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<S> <C>
2.11 Letter Agreement dated May 17, 2000 among PentaStar
Communications, Inc., OC Mergerco 4, Inc., VSI Network
Solutions, Inc. and the Shareholder of VSI Network Solutions,
Inc.
2.12(2) Purchase Agreement among PentaStar Communications, Inc.,
PentaStar Corporation and Telecomm Industries Corp. as of
April 15, 2000
2.13(2) Letter Agreement among PentaStar Communications, Inc.,
PentaStar Corporation and Telecomm Industries Corp. as of
April 15, 2000
10.16 Credit and Security Agreement by and among PentaStar
Communications, Inc., PentaStar Acquisition Corp. I,
PentaStar Acquisition Corp. II, PentaStar Acquisition Corp.
III, PentaStar Acquisition Corp. IV, PentaStar Acquisition
Corp. VI, PentaStar Internet, Inc., PentaStar Holding
Corporation, PentaStar Telemarketing, Inc. and PentaStar
Corporation as borrowers and Wells Fargo Bank West, N.A.
dated as of July 10, 2000.
10.17(1) Authorized Distributor Agreement Between Ameritech and
Telecomm Industries Corp.
27.1 Financial Data Schedule
</TABLE>
----------
(1) Filed herewith. The Company has applied for confidential treatment for
portions of this Exhibit.
(2) Incorporated by reference from the Company's Current Report on Form 8-K
dated July 19 2000.
10
