BERLINER COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. History and Description of Business
Berliner Communications, Inc. (“Berliner”, “we”, “us” and “our”) was originally incorporated in Delaware in 1987 as Adina, Inc. (“Adina”). Adina’s corporate existence was permitted to lapse in February of 1996 and was subsequently reinstated as eVentures Group, Inc., (“eVentures”) in August of 1999. In December of 2000, eVentures changed its name to Novo Networks, Inc. (“Novo”) and on September 16, 2005, Novo changed its name to Berliner Communications, Inc.
On February 18, 2005, Novo entered into an asset purchase agreement with the former Berliner Communications, Inc. (“Old Berliner”) and BCI Communications, Inc. (“BCI”), a Delaware corporation and our wholly-owned subsidiary, whereby BCI acquired (the “Acquisition”) the operations and substantially all of the assets (the “Berliner Assets”) and liabilities of Old Berliner.
Founded in 1995, Old Berliner originally provided wireless carriers with comprehensive real estate site acquisition and zoning services. Over the course of the following 10 years, the service offerings were expanded to include radio frequency and network design and engineering, infrastructure equipment construction and installation, radio transmission base station modification and project management services. With the consummation of the Acquisition, BCI carries on the historical operations of Old Berliner. Unless otherwise specified or otherwise clear from the context, each reference to we, us, or BCI in this Quarterly Report will be deemed to be a reference to both us and the historical operations and activities of Old Berliner prior to February 18, 2005.
2. Basis of Presentation
Since the Acquisition was settled through the issuance of a controlling interest in Novo’s Common Stock, Old Berliner is deemed to be the acquirer for accounting purposes and adopted the accounting year end of June 30. Furthermore, since Novo was deemed to be a shell company prior to the Acquisition, purchase accounting was not applied. Therefore, the transaction was accounted for as a reverse acquisition and recapitalization of Old Berliner.
The accompanying consolidated financial statements as of December 31, 2005, and for the three and six months ended December 31, 2005, and 2004, respectively, have been prepared by us, without audit, pursuant to the interim financial statements rules and regulations of the United States Securities and Exchange Commission (“SEC”). The consolidated Statement of Operations for the three and six months ended December 31, 2004 are that of Old Berliner. In our opinion, the accompanying consolidated financial statements include all adjustments necessary to present fairly the results of our operations and cash flows at the dates and for the periods indicated. The results of operations for the interim periods are not necessarily indicative of the results for the full fiscal year. The accompanying consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2005, and the historical consolidated financial statements of Old Berliner included in our Form 8-K/A, which was filed on May 9, 2005.
3. Accounting Policies
Use of Estimates.The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Some of the more significant estimates being made include the allowance for doubtful accounts and percentage of completion of construction projects. Actual results could differ from those estimates.
Revenue Recognition .Revenue from radio frequency and network design and engineering, infrastructure equipment construction and installation, radio transmission base station modifications and project management services are recognized as work is performed. Revenue from real estate acquisition and zoning services is recognized upon the identification of an acceptable site and when the lease is signed between the landlord and customer. Revenue associated with multiple element contracts is allocated based on the relative fair value of the services included in the contract. Revenue from infrastructure equipment construction and installation contracts, which are generally
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completed within 90 days, is recorded under the percentage-of-completion method based on the percentage that total direct costs incurred to date bear to estimated total costs at completion. Losses on infrastructure equipment construction and installation contracts are recognized when such losses become known.
Risks and Uncertainties.Financial instruments that potentially subject us to concentrations of credit risk consist primarily of accounts receivable. We routinely assess the financial strength of our customers and do not require collateral or other security to support customer receivables. Credit losses are provided for in our consolidated financial statements in the form of an allowance for doubtful accounts. Our allowance for doubtful accounts is based upon the expected collectibility of all our accounts receivable. We determine our allowance by considering a number of factors, including the length of time it is past due, our previous loss history and the customer’s current ability to pay its obligation. Accounts receivable are written off when they become uncollectible and payments subsequently received on such receivables are credited to the allowance for doubtful accounts.
Income (Loss) Per Share. We calculate earnings (loss) per share in accordance with SFAS No. 128,Earnings Per Share(“EPS”). SFAS No. 128 requires dual presentation of basic EPS and diluted EPS on the face of the income statement for all entities with complex capital structures. Basic EPS is computed as net income (loss) divided by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock options, warrants and convertible debentures.
Earnings per share in the accompanying Statement of Operations is computed based upon recapitalization accounting. Therefore, the weighted number of common shares utilized in the earnings per share computation for the three and six months ended December 31, 2005, and 2004, was 17,034,857, 67,414, 10,185,125 and 67,414respectively, and takes into account the deemed preferred stock dividends and reverse stock split referred in Note 8 below.
Stock-based Compensation.We have a stock option plan, which is described more fully in Note 9. In December of 2004, the FASB issued SFAS No. 123 (revised 2004),Share-Based Payment,which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on the fair values (i.e., pro forma disclosure is no longer an alternative to financial statement recognition). SFAS 123(R) is effective for public companies, which are small business issuers, at the beginning of the first interim or annual period beginning after December 15, 2005. This required us to adopt SFAS No.123(R) effective January 1, 2006. We, in fact, adopted SFAS No. 123(R) early, in the first quarter of fiscal 2006, which ended on September 30, 2005. We have elected to adopt FAS 123(R) using a modified prospective application, whereby the provisions of the statement will apply going forward only from the date of adoption to new (issued subsequent to September 30, 2005) stock option awards, and for the portion of any previously issued and outstanding stock option awards for which the requisite service is rendered after the date of adoption (all of our previously issued options had fully vested prior to July 1, 2005). In addition, compensation expense must be recognized for any awards modified, repurchased, or cancelled after the date of adoption. Under the modified prospective application, no restatement of previously issued results is required. We use the Black-Scholes option-pricing model to measure fair value. This is the same method we used in prior years for disclosure purposes. The adoption of SFAS No. 123(R) did not have a significant impact on our overall results of operations or financial position.
4. Accounts Receivable
Accounts receivable at December 31, 2005, and June 30, 2005, consist of the following:
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| | | December 31, | | | June 30, | |
| | | 2005 | | | 2005 | |
| | | (Unaudited) | | | | | |
| Accounts receivable | | $ | 8,943,699 | | | $ | 4,209,743 | |
| Unbilled receivables | | | 1,262,849 | | | | 1,143,140 | |
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| | | | 10,206,548 | | | | 5,352,883 | |
| Allowance for doubtful accounts | | | (135,821 | ) | | | (91,572 | ) |
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| Total | | $ | 10,070,727 | | | $ | 5,261,311 | |
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Unbilled receivables principally represent the value of services rendered to customers not billed as of the balance sheet date. Unbilled receivables are generally billed within three months subsequent to the provision of the services.
For the three months ended December 31, 2005, we derived 86% of our total revenues from our five largest customers. Of those customers, all of them individually represented greater than 5% of net revenues, and four of them represented greater than 10% of net revenues for the period. In the three months ended December 31, 2005, the five customers represented approximately 25%, 20%, 16%, 15% and 9%, respectively.
For the six months ended December 31, 2005, we derived 79% of our total revenues from our five largest customers. Of those customers, all of them individually represented greater than 5% of net revenues, and four of them represented greater than 10% of net revenues for the period. In the six months ended December 31, 2005, the five customers represented approximately 23%, 19%, 18%, 14% and 5%, respectively.
5. Inventories
Inventories, which consist mainly of raw materials, are stated at the lower of cost or market value. Cost is determined using average cost method.
6. Accrued Liabilities
Accrued liabilities at December 31, 2005, and June 30, 2005, consist of the following:
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| | | December 31, | | | June 30, | |
| | | 2005 | | | 2005 | |
| | | (Unaudited) | | | | | |
| Employee compensation | | $ | 191,290 | | | $ | 192,702 | |
| Construction costs | | | 4,097,611 | | | | 1,937,786 | |
| Other | | | 193,691 | | | | 155,401 | |
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| | | $ | 4,482,592 | | | $ | 2,285,889 | |
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7. Revolving Credit Facility
In March of 2005, BCI renewed its revolving credit facility with Presidential Corporation of Delaware Valley (“Presidential”), which provides for borrowings up to $1,250,000. The credit facility is available for working capital, capital expenditures and general corporate purposes. The credit facility interest rate is prime plus two percent (2%) (as of December 31, 2005, the prime rate was 7.25%.)
The credit facility is secured by all of the BCI assets and a guaranty from us as collateral for the repayment of any borrowings under the credit facility and the balance outstanding at December 31, 2005, was approximately $533,800. The revolving credit facility is for periods of eight months with automatic renewals if notice not to renew is not given by either party sixty (60) days before the end of any period.
8. Recapitalization of Berliner Communications
In connection with the Acquisition, we entered into a voting agreement (the “Voting Agreement”), with Old Berliner, as a holder of a majority of our common stock and as the sole holder of our newly issued Series E Preferred Stockholders of all of our Series D Preferred Stock and more than two-thirds of the holders of our Series B Preferred Stock. The Voting Agreement provided for, among other things, the approval of certain amendments to our Certificate of Incorporation and the Certificates of Designation for the Series B Preferred Stock and the Series D Preferred Stock. Accordingly, the amendments to our Certificate of Incorporation and the Certificates of Designation were filed with the Delaware Secretary of State on September 16, 2005, to effect the recapitalization as follows:
| | § | | To increase the aggregate number of shares that we will have the authority to issue from 225,000,000 to 6,600,000,000 shares, of which 6,000,000,000 shares will be shares of Common Stock, and 600,000,000 shares will be shares of Preferred Stock; |
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| | § | | To change our name from Novo Networks, Inc. to Berliner Communications, Inc.; |
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| | § | | To amend the Certificate of Designation, Preferences and Rights of Series B Convertible Preferred Stock to reduce the conversion price of the Series B Convertible Preferred Stock to $0.014018, and thereby increase the number of shares of Common Stock issuable upon conversion of such |
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| | | | shares of the Series B Convertible Preferred Stock to 321,015,546 (in the quarter ended September 30, 2005, we recorded a deemed dividend of approximately $6.4 million due to the reduction in the conversion price that appears on the accompanying Consolidated Statement of Operations in computing the net loss allocable to common shareholders); |
| | § | | To amend the Certificate of Designation, Preferences and Rights of Series D Convertible Preferred Stock to reduce the conversion price of the Series D Convertible Preferred Stock to $0.014018, and thereby increase the number of shares of Common Stock issuable upon conversion of such shares of the Series D Convertible Preferred Stock to 675,773,394 (in the quarter ended September 30, 2005, we recorded a deemed dividend of approximately $13.5 million due to the reduction in the conversion price that appears on the accompanying Consolidated Statement of Operations in computing the net loss allocable to common shareholders); |
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| | § | | To provide that, upon the filing of the Certificate of Amendment, all shares of the Series B Convertible Preferred Stock, Series D Convertible Preferred Stock, and Series E Convertible Preferred Stock will be automatically converted into Common Stock; |
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| | § | | To effect a 1:300 reverse stock split, such that the outstanding shares of Common Stock and Convertible Preferred Stock will be reclassified and one new share of Common Stock will be issued for every 300 shares of existing Common Stock (which has been retroactively reflected in the accompanying Balance Sheet); and |
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| | § | | To amend the Certificate of Incorporation, such that, after giving effect to the reverse stock split, the aggregate number of shares that we will have the authority to issue is 22,000,000 shares, of which 20,000,000 shares will be shares of Common Stock, and 2,000,000 shares will be shares of Preferred Stock. |
The deemed dividend on the Series B and D Convertible Preferred Stock was recorded as the excess of the fair value of the consideration transferred to the preferred holders as of the date of the Voting Agreement over the carrying value of the preferred stock on our balance sheet prior to the conversion. This amount is deemed to represent a return to the preferred holders and therefore, is treated in a manner similar to dividends paid to holders of preferred stock in the calculation of earnings per share.
9. Stock Compensation
In July 1999, Novo adopted a stock option and incentive plan, which Berliner adopted in its acquisition of Novo, and amended (the “Plan”). Pursuant to the Plan, our officers, employees and non-employee directors are eligible to receive awards of incentives and non-qualified stock options, performance awards, unrestricted awards, and restricted stock awards. Under the Plan, we are authorized to issued stock options or awards equal to 15% of the fully diluted outstanding common shares. The compensation committee of our board of directors is responsible for determining the type of award, when and to whom awards are granted, the number of shares and terms of the awards and the exercise price. The options are exercisable for a period not to exceed ten years from the date of the grant, unless otherwise approved by the committee. Vesting periods range from immediate to four years.
On December 21, 2005 the compensation committee of our board of directors approved a compensation program, for fiscal 2006, that includes granting 402,500 of options to qualifying employees. Stock based compensation expense of approximately $10,200 was recorded during the three months ended December 31, 2005. The fair value of each stock option grant is estimated on the grant date using the Black-Scholes option-pricing model with the following assumptions: dividend yield of 0%; expected volatility of 29% derived from peer company implied estimated volatility; expected term of four years based on our best estimate since we do not have any historical data; and risk-free interest rate of 4.43% based on the yield at the time of grant of a U.S. Treasury security with an equivalent remaining term.
10. Related Party Transactions
We contract with RBI Real Estate, LLC (“RBI”) for the lease of certain vehicles used in our operations. This contract resulted in payment to RBI in an amount equal to $32,000 and $23,800 during the three months ended December 31, 2005, and 2004, respectively, and $48,000 and$49,600 during the months ended December 31, 2005, and 2004, respectively. RBI is owned by a current and a former senior executive officer.
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11. Legal Proceedings
We and our subsidiaries are involved in legal proceedings from time to time, none of which we believe, if decided adversely to us or our subsidiaries, would have a material adverse effect on our business, financial condition or results of operations.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Statement for the Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995
Certain information included in this Quarterly Report on Form 10-Q and in other reports, SEC filings, statements and presentations is forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995, including, but not limited to, statements concerning our anticipated operating results, financial resources, growth and expansion and the ability to obtain new contracts. Such forward-looking information involves important risks and uncertainties that could significantly affect actual results and cause them to differ materially from expectations expressed herein and in other reports, SEC filings, statements and presentations. Therefore, this Quarterly Report should only be read in context described under “Forward-Looking Statements and Risk Factors” below.
Forward-Looking Statements
“Forward-looking” statements appear throughout this Quarterly Report. We have based these forward-looking statements on our current expectations and projections about future events. The important factors listed in Part II, Item 1A of this Quarterly Report and in our Annual Report on Form 10-K for our fiscal year ended June 30, 2005 (the “Annual Report”) under the heading entitled “Risk Factors,” as well as all other cautionary language in this Quarterly Report, provide examples of risks, uncertainties and events that may cause actual results to differ materially from the expectations described in these “forward-looking” statements. It is important to note that the occurrence of the events described in these considerations and elsewhere in this Quarterly Report and our Annual Report could have an adverse effect on the business, results of operations or financial condition of the entity affected.
Forward-looking statements in this Quarterly Report include, without limitation, the following:
Statements concerning our financial condition and strategic direction:
| | § | | our financial condition and strategic direction; |
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| | § | | our future capital requirements and our ability to satisfy our capital needs; |
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| | § | | the potential generation of future revenues; |
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| | § | | BCI’s ability to adequately staff its service offerings; |
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| | § | | opportunities for BCI from new and emerging wireless technologies; |
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| | § | | our discussions with Presidential, or some other lender, to obtain additional financing; |
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| | § | | our growth strategy for BCI; |
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| | § | | trends in the wireless telecommunications industry; |
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| | § | | key drivers of change in BCI’s business; |
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| | § | | BCI’s position in the wireless telecommunications industry; |
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| | § | | BCI’s competitive position; and |
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| | § | | other statements that contain words like “believe,” “anticipate,” “expect” and similar expressions are also used to identify forward-looking statements. |
It is important to note that all of our forward-looking statements are subject to a number of risks, assumptions and uncertainties, such as (and in no particular order):
| | § | | risks associated with competition in the wireless telecommunications sector we entered with the acquisition of the Berliner Assets; |
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| | § | | BCI’s function as an early stage company; |
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| | § | | risk that we may not be able to obtain additional financing from Presidential or any other lender; |
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| | § | | risks associated with Old Berliner’s history of losses; |
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| | § | | risks related to a concentration in revenues from a small number of customers; |
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| | § | | risks that BCI will not be able to take advantage of new and emerging wireless technologies; and |
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| | § | | risks that BCI will be unable to adequately staff its service offerings. |
This list is only an example of the risks that may affect the forward-looking statements. If any of these risks or uncertainties materialize (or if they fail to materialize), or if the underlying assumptions are incorrect, then actual results may differ materially from those projected in the forward-looking statements.
Additional factors that could cause actual results to differ materially from those reflected in the forward-looking statements include, without limitation, those discussed elsewhere in this Quarterly Report. It is important not to place undue reliance on these forward-looking statements, which reflect our analysis, judgment, belief or expectation only as of the date of this report. We undertake no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date of this Quarterly Report, respectively.
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Summary of Operating Results
Since we were a shell company prior to the Acquisition, purchase accounting has not been applied and the transaction is being accounted for as a recapitalization of Berliner Communications.
The table below summarizes our operating results.
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| | | Three months ended | | | Six months ended | |
| | | December 31, | | | December 31, | |
| | | 2005 | | | 2004 | | | 2005 | | | 2004 | |
| | | (Unaudited) | | | (Unaudited) | | | (Unaudited) | | | (Unaudited) | |
| Revenues | | $ | 11,107,423 | | | $ | 3,952,132 | | | $ | 19,764,788 | | | $ | 7,790,333 | |
| Costs of revenues | | | 8,588,115 | | | | 2,441,247 | | | | 14,805,665 | | | | 4,678,200 | |
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| Gross margin | | | 2,519,308 | | | | 1,510,885 | | | | 4,959,123 | | | | 3,112,133 | |
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| Selling, general and administrative expenses | | | 2,241,441 | | | | 1,750,601 | | | | 4,285,188 | | | | 3,274,067 | |
| Depreciation and amortization | | | 62,909 | | | | 79,381 | | | | 124,045 | | | | 162,102 | |
| (Gain) loss on sale of fixed assets | | | (509 | ) | | | 721 | | | | (759 | ) | | | 4,273 | |
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| Income (loss) from operations | | | 215,467 | | | | (319,818 | ) | | | 550,649 | | | | (328,309 | ) |
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| Other (income) expense | | | | | | | | | | | | | | | | |
| Interest expense | | | 17,292 | | | | 14,689 | | | | 26,863 | | | | 27,700 | |
| Interest income | | | (3,342 | ) | | | (543 | ) | | | (6,188 | ) | | | (1,089 | ) |
| Gain on sale of equity investment, net of losses | | | (163,742 | ) | | | — | | | | (97,995 | ) | | | — | |
| Other | | | (85,399 | ) | | | — | | | | (84,999 | ) | | | — | |
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| Income (loss) before income taxes | | | 450,658 | | | | (333,964 | ) | | | 712,968 | | | | (354,920 | ) |
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| Income tax expense (recovery) | | | 2,250 | | | | (12,900 | ) | | | 3,050 | | | | (3,900 | ) |
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| Net income (loss) | | $ | 448,408 | | | $ | (321,064 | ) | | $ | 709,918 | | | $ | (351,020 | ) |
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| Deemed Series B and D preferred dividends | | | — | | | | — | | | | 19,935,779 | | | | — | |
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| Net income (loss) allocable to common shareholders | | $ | 448,408 | | | $ | (321,064 | ) | | $ | (19,225,861 | ) | | $ | (351,020 | ) |
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| Net income (loss) per share — basic and diluted | | $ | 0.03 | | | $ | (4.76 | ) | | $ | (1.89 | ) | | $ | (5.21 | ) |
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| Weighted average number of shares outstanding — basic and diluted | | | 17,034,857 | | | | 67,414 | | | | 10,185,125 | | | | 67,414 | |
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Three months ended December 31, 2005, Compared to Three months ended December 31, 2004
Since the Acquisition is being accounted for as a recapitalization of Old Berliner, the following discussion is based upon the operations of us for the three months ended December 31, 2005, as compared to the historical operations for Old Berliner for the three months ended December 31, 2004. Accordingly, no distinction is made between us, Berliner Communications and BCI for the purposes of following period to period comparison.
Revenues. We had revenues of $11.1 million for the three months ended December 31, 2005, versus $4.0 million for the three months ended December 31, 2004. Revenues from infrastructure equipment construction and installation contracts accounted for approximately 73% and 60% in the three months ended December 31, 2005, and 2004, respectively. Revenue from real estate site acquisition and zoning services accounted for approximately 4% and 13% in both of the three months ended December 31, 2005, and 2004, respectively. Revenues from radio
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frequency engineering and network services accounted for approximately 18% and 21% in the three months ended December 31, 2005, and 2004, respectively. The increase in revenues in the three months ended December 31, 2005, versus the three months ended December 31, 2004, is due to increased spending from our customers in infrastructure and equipment construction including modifications to existing installations in order to improve their networks in preparation for future offerings of video and music offset by reduced spending in real estate acquisition and zoning services. We recognize revenues from infrastructure and equipment construction and installation contracts on the percentage of completion method of accounting and real estate site acquisition and zoning services upon the identification of an acceptable site and when the lease is signed between the landlord and the customer.
Cost of Revenues. Our cost of revenues was $8.6 million for the three months ended December 31, 2005, versus $2.4 million for the three months ended December 31, 2004.
Gross Margin.Our gross margin for the three months ended December 31, 2005, was $2.5 million as compared to $1.5 million or for the three months ended December 31, 2004. The decrease in gross margin as a percentage of revenues of approximately 16% can be attributed to the shift in the type of revenues generated in the three months ended December 31, 2005, as compared to the three months ended December 31, 2004. Historically, we have had higher margins on our real estate acquisition and zoning services than on infrastructure and equipment construction and installation contracts. In addition, we performed more modification contracts, which do not generate as high of gross margins as new construction contracts.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased approximately 28% during three months ended December 31, 2005, to $2.2 million from $1.8 million in the three months ended December 31, 2004. The increase in selling, general and administrative expenses resulted primarily from the additional costs associated with being a public company as well as increased staffing and related costs to support the 280% increase in revenues.
Selling, general and administrative expenses for the three months ended December 31, 2005, consisted primarily of approximately (i) $1.3 million of salaries and benefits, (ii) $93,400 of legal and professional fees, (iii) $182,500 of business insurance, (iv) $156,800 of office rents, (v) $136,500 of travel and entertainment, (vi) $134,900 of office expenses including telephone and utilities and (vii) $215,300 of other general operating expenses. Selling, general and administrative expenses for the three months ended December 31, 2004, consisted primarily of approximately (i) $944,400 million of salaries and benefits, (ii) $56,800 of legal and professional fees, (iii) $236,300 of business insurance, (iv) $135,500 of office rents, (v) $58,500 of travel and entertainment, (vi) $91,100 of office expenses including telephone and utilities and (vii) $ 137,600 of other general operating expenses. We anticipate that selling, general and administrative expenses will remain constant during our third quarter of fiscal 2006.
Depreciation and Amortization. Depreciation recorded on fixed assets during the three months ended December 31, 2005, totaled approximately $62,900 as compared to approximately $79,400 for three months ended December 31, 2004. The decrease in depreciation is due to certain assets being fully depreciated.
Loss in Equity Investments. Loss in equity investments results from our minority ownership interest in gelato manufacturing, retailing and catering business operated under the brand name “Paciugo.” Paciugo is accounted for under the equity method of accounting. Under the equity method, our proportionate share of each subsidiary’s operating loss is included in equity in loss of investments. The values of our outstanding equity interests, other than Paciugo, had been reduced to zero either by recording our proportionate share of prior period losses incurred by each subsidiary to the cost of that interest or from impairment losses. We sold our interest in Paciugo on December 31, 2005 and recorded a gain of $200,000.
Other Income. Other income during the three months ended December 31, 2005, includes a recovery of approximately $88,000 of legal fees previously expensed, which had been paid on behalf of a third party.
Income Taxes.At June 30, 2005, we have net operating loss carryforwards for federal and state income tax purposes of approximately $3.0 million expiring in 2025, which may be applied against future taxable income. As a result of the Acquisition, net operating loss carryforwards of Old Berliner in the amount of approximately $3.4 million were lost and net operating loss carryforwards of Novo of approximately $800,000 were retained, resulting in a reduction in the valuation allowance of approximately $2.6 million.
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Six months ended December 31, 2005, Compared to Six months ended December 31, 2004
Since the Acquisition is being accounted for as a recapitalization of Old Berliner, the following discussion is based upon the operations of us for the six months ended December 31, 2005, as compared to the historical operations for Old Berliner for the six months ended December 31, 2004. Accordingly, no distinction is made between us, Berliner Communications and BCI for the purposes of following period- to- period comparison.
Revenues. We had revenues of $19.8 million for the six months ended December 31, 2005, versus $7.8 million for the six months ended December 31, 2004. Revenues from infrastructure equipment construction and installation contracts accounted for approximately 77% and 63% in the six months ended December 31, 2005, and 2004, respectively. Revenue from real estate site acquisition and zoning services accounted for approximately 6% and 19% in both of the six months ended December 31, 2005, and 2004, respectively. Revenues from radio frequency engineering and network services accounted for approximately 17% and 9% in the six months ended December 31, 2005, and 2004, respectively. The increase in revenues in the six months ended December 31, 2005, versus the six months ended December 31, 2004, is due to increased spending from our customers in infrastructure and equipment construction including modifications to existing installations in order to improve their networks in preparation for future offerings of video and music offset by reduced spending in real estate acquisition and zoning services. We recognize revenues from infrastructure and equipment construction and installation contracts on the percentage of completion method of accounting and real estate site acquisition and zoning services upon the identification of an acceptable site and when the lease is signed between the landlord and the customer.
Cost of Revenues. Our cost of revenues was $14.8 million for the six months ended December 31, 2005, versus $4.7 million for the six months ended December 31, 2004.
Gross Margin.Our gross margin for the six months ended December 31, 2005, was $5.0 million as compared to $3.1 million or for the six months ended December 31, 2004. The decrease in gross margin as a percentage of revenues of approximately 15% can be attributed to the shift in the type of revenues generated in the six months ended December 31, 2005, as compared to the six months ended December 31, 2004. Historically, we have had higher margins on our real estate acquisition and zoning services than on infrastructure and equipment construction and installation contracts. In addition, we performed more modification contracts, which do not generate as high of gross margins as new construction contracts.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased approximately 31% during the six months ended December 31, 2005, to $4.3 million from $3.3 million in the six months ended December 31, 2004. The increase in selling, general and administrative expenses resulted primarily from the additional costs associated with being a public company as well as increased staffing and related costs to support the 253% increase in revenues in the comparable periods.
Selling, general and administrative expenses for the six months ended December 31, 2005, consisted primarily of approximately (i) $2.6 million of salaries and benefits, (ii) $184,200 of legal and professional fees, (iii) $361,100 of business insurance, (iv) $293,600 of office rents, (v) $225,000 of travel and entertainment, (vi) $266,400 of office expenses including telephone and utilities and (vii) $368,800 of other general operating expenses. Selling, general and administrative expenses for the six months ended December 31, 2004, consisted primarily of approximately (i) $1.8 million of salaries and benefits, (ii) $73,000 of legal and professional fees, (iii) $353,000 of business insurance, (iv) $266,500 of office rents, (v) $116,800 of travel and entertainment, (vi) $181,700 of office expenses including telephone and utilities and (vii) $372,100 of other general operating expenses. We anticipate that selling, general and administrative expenses will remain constant during our third quarter of fiscal 2006.
Depreciation and Amortization. Depreciation recorded on fixed assets during the six months ended December 31, 2005, totaled approximately $124,000, as compared to approximately $162,100 for six months ended December 31, 2004. The decrease in depreciation is due to certain assets being fully depreciated.
Loss in Equity Investments. Loss in equity investments results from our minority ownership interest in Paciugo that is accounted for under the equity method of accounting. Under the equity method, our proportionate share of each subsidiary’s operating loss is included in equity in loss of investments. The values of our outstanding equity interests, other than Paciugo, had been reduced to zero either by recording our proportionate share of prior period losses incurred by each subsidiary to the cost of that interest or from impairment losses. We sold our interest in Paciugo on December 30, 2005 and recorded a gain of $200,000.
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Other Income. Other income during the six months ended December 31, 2005, includes a recovery of approximately $88,000 of legal fees previously expensed, which had been paid on behalf of a third party.
Income Taxes.At June 30, 2005, we have net operating loss carryforwards for federal and state income tax purposes of approximately $3.0 million expiring in 2025, which may be applied against future taxable income. As a result of the Acquisition, net operating loss carryforwards of Old Berliner in the amount of approximately $3.4 million were lost and net operating loss carryforwards of Novo of approximately $800,000 were retained, resulting in a reduction in the valuation allowance of approximately $2.6 million.
Liquidity and Capital Resources
At December 31, 2005, we had consolidated current assets of approximately $11.5 million, including, without limitation, cash and cash equivalents of approximately $667,300 and net working capital of approximately $2.0 million. Historically, we funded our operations primarily through the proceeds of private placements of our common and preferred stock and borrowings under loan and capital lease agreements. We do not currently believe that private placements of common and preferred stock will be available in the near term. Principal uses of cash during the three months ended December 31, 2005, have been to fund (i) working capital requirements; (ii) capital expenditures; and (iii) reductions in debt.
On March 17, 2005, we concluded negotiations with Presidential Corporation of Delaware Valley (“Presidential”) regarding the establishment of a credit facility for BCI. A total of $1,250,000 in financing is available under the agreement with Presidential and approximately $533,800 was outstanding as of December 31, 2005. Presidential has a security interest on all of the BCI assets and a guaranty from us as collateral for the repayment of any borrowings under the credit facility. As of February 10, 2005, we had outstanding borrowings against the agreement with Presidential of approximately $180,300.
Our ability to satisfy our current obligations is dependent upon our cash on hand, borrowings under our credit facility with Presidential and the operations of BCI. Our current obligations consist of capital expenditures and funding working capital. In the event we do not generate positive cash flow in the near term, or if we incur unanticipated expenses for operations and are unable to acquire additional capital or financing, we will likely have to reassess our strategic direction, make significant changes to our business operations and substantially reduce our expenses until such time we achieve positive cash flow.
As of December 31, 2005, our backlog was approximately $9.4 million and we currently anticipate completing those backlog orders by June 30, 2006.
BCI’s failure to generate revenues sufficient to fund its continuing operations, as well as to fund our operations, would jeopardize our ability to continue as a going concern. Due to these factors, we intend to seek additional financing within the next twelve months, from Presidential or another lender.
The net cash provided (used in) by operating, investing and financing activities for the six months ended December 31, 2005, and 2004, respectively, is summarized below:
Cash provided by operating activities in the six months ended December 31, 2005, and 2004 totaled approximately $285,900 and $71,200, respectively. During six months ended December 31, 2005, cash flow provided by operating activities primarily resulted from operating income, net of non-cash charges, of approximately $789,600, an increase in accounts receivable of approximately $4.9 million due to increased revenue during the six months ended December 31, 2005, an decrease in prepaid and other assets of approximately $267,100 due to amortization of our business insurance, an increase in accounts payable of approximately $1.8 million and an increase in accrued liabilities of approximately $2.2 million mainly contributable to subcontracts costs associated with our increased revenues. In the six months ended December 31, 2004, cash flow used by operating activities primarily resulted from operating income, net of non-cash charges, of approximately $139,000, a decrease in accounts receivable of approximately $78,700, an increase in prepaid expenses and other assets of approximately $104,200 and an increase in accrued liabilities of approximately $189,900.
Investing activities provided and used approximately $59,400 and $82,000 in the six months ended December 31, 2005, and 2004, respectively. The primary net cash used in investing activities was due to the purchase of fixed assets.
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Financing activities used approximately $80,500 and provided approximately $253,400 in the six months ended December 31, 2005, and 2004, respectively. During the six months ended December 31, 2005, financing activities provided was additional borrowings against the Presidential credit facility net of payments of approximately $40,000 and reductions of other debt obligations net of borrowings of approximately $102,600. During the six months ended December 31, 2004, the primary net cash provided by financing activities was net borrowings from Presidential of approximately $233,900.
We believe our existing cash, cash equivalents and line of credit will be sufficient to meet our cash requirements in the near term. However, we intend to seek additional funding within the next twelve months. Our future capital requirements will depend on many factors, including our rate of revenue growth, the timing and extent of capital expenditures to support our contracts and expansion of sales and marketing. We cannot assure you that additional equity or debt financing will be available on acceptable terms, or at all. Our sources of liquidity beyond twelve months, in management’s opinion, will be our then current cash balances, funds from operations, if any, and our current credit facility and any additional equity or credit facilities we can arrange. We have no other agreements or arrangements with third parties to provide us with sources of liquidity and capital resources beyond twelve months.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to the impact of interest rate and other risks. We have investments in money market funds of approximately $350,000 at December 31, 2005. Due to the short-term nature of our investments, we believe that the effects of changes in interest rates are limited and would not materially affect profitability.
Item 4. Controls and Procedures
We carried out an evaluation, under the supervision and with the participation of our Principal Executive Officer and Principal Financial and Accounting Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15 of the Securities Exchange Act of 1934 as well as those of BCI. Based upon that evaluation, the Principal Executive Officer and the Principal Financial and Accounting Officer concluded that our disclosure controls and procedures are effective, as of the end of the period covered by this report, in timely alerting them to material information relating to us (including our consolidated subsidiaries) required to be included in this Quarterly Report. There have been no significant changes in our internal controls over financial reporting or in other factors, which could significantly affect such internal controls, subsequent to the date that we carried out our evaluation.
PART II: OTHER INFORMATION
Item 1. Legal Proceedings
We and our subsidiaries are involved in legal proceedings from time to time, none of which we believe, if decided adversely to us or our subsidiaries, would have a material adverse effect on our business, financial condition or results of operations.
Item 1A. Risk Factors
We, in essence, are an early stage company. Therefore, in light of its anticipated significance, our business prospects are difficult to evaluate.
Old Berliner commenced operations in 1995. Although it has remained in continuous operation since that time, it continues to function, in essence, as an early stage company. As a result, Old Berliner historically struggled with, and we expect to continue to struggle with, capital constraints, limited market presence, inadequate processes and systems, limited customer and supplier relationships, intense demands on management resources and limited insight into industry trends and conditions that may exist or emerge, among other things. Further, as an early stage company, it is impossible to accurately determine whether BCI’s business model is viable over the long term.
To progress beyond an early stage company, we will need to do the following:
| | § | | adapt successfully execute an evolving and unpredictable business model; |
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| | § | | attract necessary working capital; |
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| | § | | establish, train and manage a larger and more productive workforce; |
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| | § | | develop meaningful customer and vendor relationships; |
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| | § | | provide services that consistently meet customer demands in a rapidly evolving industry; |
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| | § | | implement and improve operational, financial and management systems and processes; |
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| | § | | respond effectively to competitive developments; and |
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| | § | | otherwise manage and adapt to changing operations. |
As a result, our prospects, must be considered in light of the many risks, expenses, delays and difficulties encountered by companies in their early stages of development. It is important to note that the growth we seek is extremely rare.
We may need additional financing, almost immediately, to grow our business.
Although the Acquisition resulted in gaining our access to certain additional sources of funds, it may not be enough for us to pursue our business strategy on a long-term basis. We may elect to seek additional working capital. To the extent we are unable to increase our working capital assets, our growth, and potentially our viability, could be jeopardized.
Old Berliner has a history of losses and we anticipate that our combined operations will generate losses in the short term.
With the exception of a one-time gain on the extinguishment of debt, Old Berliner has incurred net losses for the years ended December 31, 2002, 2003, and 2004. Old Berliner incurred a net loss in 2002 in the amount of $5.1 million. Old Berliner did have net income of $5.4 million for the year ended December 31, 2003, but it resulted from a gain on the extinguishment of a debt of $7.2 million. For the year ended December 31, 2004, Old Berliner incurred a loss of $836,800 and we incurred a net loss of $1.2 million for the six months ended June 30, 2005. When combined with our operations, we could experience even greater losses. Among other things, our status as a public company will increase significantly the operating costs to be borne by us. We anticipate that our combined businesses will generate operating losses until we are successful in generating significant additional revenues to support our level of operating expenses. We cannot assure you that we will ever achieve or sustain profitability or that our operating losses will not increase, perhaps materially, in the future.
Since the percentage of our revenues derived from construction-related activities continues to increase, our gross margins may suffer.
Old Berliner has historically earned lower relative gross margins on engineering and construction-related activities. It typically performs its own network design-related, site acquisition-related services and hires subcontractors to perform engineering and construction services under its direct management. Subcontracted work generally carries lower profit margins than self- performed work. Our construction-related services have proportionally increased over the past several quarters. If the proportion of construction-related services we deliver continues to increase, then our gross margins and net income may suffer.
We generate a substantial portion of our revenues from a limited number of customers, and if our relationships with such customers were harmed, our business would suffer.
For the three months ended December 31, 2005, and 2004, we derived 86% and 87%, respectively, of our total revenues from our five largest customers. For the six months ended December 31, 2005, and 2004, we derived 79% and 82%, respectively, of our total revenues from our five largest customers. For the years ended December 31, 2004, and 2003, Old Berliner derived 87% and 83%, respectively, of its total revenues from its six and four largest customers, respectively. We believe that a limited number of clients will continue to be the source of a substantial portion of our revenues for the foreseeable future. Key factors in maintaining our relationships with such customers include, for example, our performance on individual contracts and the strength of our professional reputation. To the extent that our performance does not meet client expectations, or our reputation or relationships with one or more key customers are impaired, our revenues and operating results could be materially harmed.
If we experience delays and or defaults in customer payments, we could be unable to cover all expenditures.
Because of the nature of our contracts, at times we commit resources to projects prior to receiving payments from our customer in amounts insufficient to cover expenditures on client projects as they are incurred. Delays in
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customer payments may require us to make a working capital investment. If a customer defaults in making its payments on a project in which we have devoted significant resources, it could have a material negative effect on our results of operations.
Many of our customers face difficulties in obtaining financing to fund the expansion of their wireless networks, which may reduce demand for our services.
Due to the general downturn in the financial markets since 2000, and specifically within the telecommunications sector, many of our customers or potential customers have had and may continue to have trouble obtaining financing to fund the expansion or improvement of their wireless networks. Some customers have also found it difficult to predict demand for their products and services. Most vulnerable are customers that are new licensees and wireless service providers who have limited sources of funds from operations or have business plans that are dependent on funding from the capital markets. In addition, many of our customers have slowed or postponed deployment of new networks and development of new products, which reduces the demand for its services.
If we are unable to collect receivables from our smaller customers, our operating results may be materially harmed.
We frequently perform services for smaller or development-stage customers that carry a higher degree of financial risk for us. Our customers have been and may continue to be impacted by the tightening of available credit and the general economic slowdown. As a result of such conditions, our customers may be unable to pay, or may delay payment, for services performed by us. If we are not able to collect amounts owed to us by our customers, we may be required to write off significant accounts receivable and recognize bad debt expense. Our operating results may be materially harmed if we are not able to collect amounts due from our customers.
New technologies may reduce the demand for our services.
The technology relating to the wireless industry changes rapidly. If technologies develop that compete with current technologies, but do not require the services we provide, our revenues could decrease and we could cease to be commercially viable.
Further delays in the adoption and deployment of next generation wireless networks could negatively affect the demand for our services and our ability to grow our revenues.
Wireless service providers may continue to delay their development of next generation technology if, among other things, they expect slow growth in the adoption of such technology, reduced profitability due to price competition for subscribers or regulatory delays. For example, even though wireless service providers have made substantial investments worldwide in acquiring 3G licenses, many providers have delayed deployment of 3G networks. Since we expect that a substantial portion of our growth will be derived from our services related to new technologies, further delays in the adoption and deployment of these technologies, such as 3G, would negatively affect the demand for its services and our ability to grow our revenues.
We bear the risk of cost overruns in some of our contracts.
We conduct our business under various types of contractual arrangements. In terms of dollar-value, a majority of our contracts are guaranteed maximum or lump sum contracts, where it bears a significant portion of the risk for cost overruns. Under such contracts, prices are established, in part, on cost and scheduling estimates, which are based on a number of assumptions, including, without limitation, assumptions about future economic conditions, prices and availability of labor, equipment and materials, and other exigencies. If those estimates prove inaccurate, or circumstances change, cost overruns may occur, and we could experience reduced profits or, in some cases, a loss for that project.
If we guarantee the timely completion or performance standard of a project, we could incur significant, additional costs.
In some instances and in many of our fixed-price contracts, we guarantee a customer that we will complete a project by a scheduled date. The contract sometimes provides that the project, when completed, will also achieve certain performance standards. If we subsequently fail to complete the project as scheduled, or if the project falls short of guaranteed performance standards, we may be held responsible for cost impacts to the client resulting from any delay or the costs to cause the project to achieve such performance standards. In some cases, where we fail to meet those performance standards, we may also be subject to agreed-upon liquidated damages. To the extent that these events
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occur, the total costs of the project would exceed its original estimates and we could experience reduced profits or, in some cases, a loss for that project.
The nature of our engineering and construction business exposes us to potential liability claims and contract disputes that may negatively affect our results of operations.
We engage in engineering and construction activities for wireless networks where design, construction or systems failures can result in substantial injury or damage to third parties. Any liability in excess of insurance limits at locations engineered or constructed by us could result in significant liability claims against us, which claims may negatively affect our results of operations, perhaps materially. In addition, if there is a customer dispute regarding our performance of project services, the customer may decide to delay or withhold payment to us. If we were ultimately unable to collect on these payments, our results of operations would be negatively impacted, perhaps materially.
We maintain a workforce based upon current and anticipated workloads. If we do not receive future contract awards or if these awards are delayed, significant costs may result.
Our estimates of future performance depend on, among other matters, whether and when we will receive certain new contract awards. While our estimates are based upon our good faith judgment, they can be unreliable and may frequently change based on newly available information. In the case of our larger projects where timing is often uncertain, it is particularly difficult to project whether and when we will receive a contract award. The uncertainty of contract award timing can present difficulties in matching our workforce size with our contract needs. If an expected contract award is delayed or not received, we could incur costs resulting from reductions in staff or redundancy of facilities that would have the effect of negatively impacting our operating performance.
We may not be able to hire or retain sufficient number of qualified engineers and other employees to meet our contractual obligations or maintain the quality of our services.
As a service business, our ultimate success depends significantly on our ability to attract, train and retain engineering, system deployment, managerial, marketing and sales personnel who have excellent technical and intrapersonal skills. Competition for employees with the required range of skills fluctuates, depending on customer needs, and can be intense, particularly for radio frequency engineers. At times, we have had difficulty recruiting and retaining qualified technical personnel to properly and quickly staff large customer projects. In addition to recruitment difficulties, we must fully and properly train our employees according to our customers’ technology requirements and deploy and fully integrate each employee into our customers’ projects. Increased competition in the wireless industry is increasing the level of specific technical experience and training required to fulfill customer-staffing requirements. This process is costly and resource constraints may impede our ability to quickly and effectively train and deploy all of the personnel required to staff a large project.
Intense competition in the engineering and construction industry could reduce our market share.
We serve markets that are highly competitive and in which a large number of multinational companies compete. In particular, the engineering and construction markets are highly competitive and require substantial resources and capital investment in equipment, technology and skilled personnel. Competition also places downward pressure on our contract prices and profit margins. Intense competition is expected to continue in these markets. If we are unable to meet these competitive challenges, we could lose market share to our competitors and experience an overall reduction in our operating performance.
Past and future environmental, safety and health regulations could impose on us significant additional costs that negatively affect our operations.
Our operations are subject to numerous environmental laws and health and safety regulations. Our projects can involve the handling of hazardous and other highly regulated materials, which, if improperly handled or disposed of, could subject us to civil and criminal liabilities. It is impossible to reliably predict the full nature and effect of judicial, legislative or regulatory developments relating to health and safety regulations and environmental protection regulations applicable to our future operations.
We are vulnerable to the cyclical nature of the market we serve.
The demand for our services and products is dependent upon the existence of projects with engineering, procurement, construction and management needs. The telecommunications market, where we principally compete,
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is particularly cyclical in nature. Such industries have historically been and will continue to be vulnerable to general downturns and are cyclical in nature. As a result, Old Berliner’s past results have varied considerably and our performance may continue to be volatile, depending upon the demand for future projects in the industry.
We may experience significant fluctuations in our quarterly results as a result of uncertainties relating to our ability to generate additional revenues, manage expenditures and other factors, certain of which are outside of our control.
The quarterly and annual operating results of Old Berliner have varied considerably in the past, and our operating results are likely to do so as well, due to a number of factors, including, without limitation, those listed in this section. Many of these factors are outside our control and include, without limitation, the following:
| | § | | financing provided to potential customers; |
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| | § | | the commencement, progress, completion or termination of contracts during any particular quarter; |
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| | § | | the availability of equipment to deploy new technologies, such a 3G and broadband; |
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| | § | | the growth rate of wireless subscribers, which has a direct impact on the rate at which new cell sites are developed and built; and |
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| | § | | telecommunications market conditions and economic generally. |
Due to these factors, our results for a particular quarter, and therefore, our combined results for that same period, may not meet the expectations of investors, which could cause the price of our common stock to decline significantly.
Because Old Berliner experienced, and we expect to continue to experience, long sales cycles, we expect to incur significant costs to generate new business and our customer base may not experience growth commensurate with such costs.
Historically, purchases of Old Berliner’s services by customers often entailed a lengthy decision-making process for the customer. Selecting wireless network deployment services involves substantial costs and has strategic implications. Senior management of the customer is often involved in this process, given the importance of the decision, as well as the risks faced by the customer if the services do not meet the customer’s particular needs. We may expend substantial funds and effort to negotiate agreements for these services, but may ultimately be unable to consummate agreements for services and expand its customer base. As a result of lengthy sales cycles, we expect to continue to incur relatively high costs to generate new business.
Item 2. Unregistered Sale of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
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Item 6. Exhibits
| | 10.16 | | Employment Agreement between Berliner Communications, Inc. and Richard B. Berliner, dated January 6, 2006. |
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| | 10.17 | | Employment Agreement between Berliner Communications, Inc. and Patrick G. Mackey, dated January 6, 2006. |
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| | 31.1 | | Certification of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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| | 31.2 | | Certification of the Principal Financial and Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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| | 32.1 | | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, Berliner Communications, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
BERLINER COMMUNICATIONS, INC.
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| Date: February 14, 2006 | | By: | | /s/ Richard B. Berliner | | |
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| | | Richard B. Berliner
Chief Executive Officer
(Principal Executive Officer) | | |
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| Date: February 14, 2006 | | By: | | /s/ Patrick G. Mackey | | |
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| | | | | | | |
| | | Patrick G. Mackey
Senior Vice President
(Principal Financial and Accounting Officer) | | |
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