Hi Rob,
DCI Telecommunications, Inc.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Overview
--------
The following discussion and analysis provides information that
management believes is relevant to an assessment and understanding of DCI
Telecommunications, Inc. and its subsidiaries (collectively, the
Company), consolidated results of operations and financial condition for
the nine months ended December 31, 1998. The discussion should be read in
conjunction with the Company's consolidated financial statements and
accompanying notes.
The Company, since its recent acquisitions, operates predominantly in the
telecommunications industry providing a broad range of communication
service. The Company's services include long distance, prepaid phone
cards, motion picture distribution, a travel agency, as well as real-time
fax over the Internet. Through continued investments and fiscal 1998
business acquisitions, the Company has expanded its business into rapidly
developing markets.
Recent Acquisitions and Dispositions
------------------------------------
In the quarter ended June 30, 1997, the Company acquired CardCall
International and CyberFax. CardCall International, through its
subsidiaries CardCall UK and CardCaller Canada, sold prepaid phone cards.
In the third quarter of fiscal 1998, the Company sold its phone card
distribution contract in the U.K. for $9,000,000. Due to a non-compete
clause in the sale agreement, CardCall UK discontinued its operations
after the sale. During fiscal 1998 the Company also discontinued
operations of Privilege Enterprises Limited and its Alpha Products
division due to a lack of profitability.
On March 31, 1998 the Company and DataWave Systems, Inc. formed a new
company, PhoneLine CardCall International ("PhoneLine") for the
marketing, sale and service of prepaid long distance phone cards in
Canada. The accompanying financial statements include the results of
PhoneLine for the nine months ending December 31, 1998. This new company
joins together two of the larger prepaid phone card distributors in
Canada, and the Company is expecting economies of scale by facility and
staff reductions, as well as better long distance rates with carriers.
DCI owns 60% and DataWave 40% of PhoneLine.
During the quarter ended June 30, 1998 the Company acquired Edge
Communications, Inc. This acquisition gave the Company a meaningful
entrance into the U.S. prepaid phone card market. Edge had sales of
$8,780,000 for the twelve months ended March 31, 1998 and has been
sustaining rapid growth in the last several months. Edge was accounted
for as a pooling of interests.
12--------------------------------------------------------------------------------Liquidity and Capital Resources
-------------------------------
At December 31, 1998 the Company had unrestricted cash of $2,112,629 and
$42,000 of marketable securities. During the quarter ended June 30, 1998,
the Company sold SmarTalk stock realizing net proceeds of $8,125,000. The
Company repaid its loans of $4,939,000 which it had borrowed against its
position in SmarTalk stock.
Also, on June 9, 1998 the former shareholders of Muller Media exercised
their put options to receive $2,000,000 in cash, and the Company
repurchased 800,000 shares of its common stock. The Company received
$1,170,000 of Muller Media's cash with the acquisition.
Other sources of cash during the first nine months included $2,750,000
from the sale of preferred stock, and $691,000 from the exercise of stock
options.
Year 2000 Issues
----------------
The Year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. In other
words, date-sensitive software may recognize a date using "00" as the
year 1900 rather than the Year 2000. This could result in system failures
or miscalculations causing disruptions of operations, including, among
others, a temporary inability to process transactions, send invoices or
engage in similar normal business activities.
Company's State of Readiness
One of the Company's critical internal areas is its information
technology systems, including general ledger, accounts receivable,
payable, inventory and related packages for DCI and each of its
subsidiaries. In this regard, the parent company has installed new
software that is Year 2000 compliant and plans to install the same
systems in each of its subsidiaries prior to September 30, 1999.
All of the Company owned switches, used to direct and monitor long
distance telephone traffic, are currently Year 2000 compliant according
to the manufacturer. Other less critical internal systems such as
telephone and voice mail systems are in the process of being evaluated.
The Company also has relationships with outside third parties that could
impact its business. The most important are the carriers that process and
monitor the Company's long distance and prepaid card phone calls. All the
carriers expect to be Year 2000 compliant and are in various stages of
readiness. The Company's travel business is partially dependent on an
outside reservation system representing many airlines. This system
expects to be compliant by the end of 1998, and accepting year 2000
bookings by January 4, 1999.
13--------------------------------------------------------------------------------Costs
The Company is addressing Year 2000 issues in house and at the present
time the only other costs involve the purchase of financial software
packages. Total costs are estimated at $110,000. Costs incurred to date
are approximately $23,000.
Risks
The Company believes that its most reasonable likely worst case Year 2000
scenario would be if any of its third party long distance telephone
carriers were unable to properly monitor or admit authorized personal
identification numbered prepaid phone card calls through their systems.
The time frame for the carrier to fix the problem, or the ability of the
Company to recall prepaid phone cards and switch to another carrier with
competitive rates, could cause a material business interruption.
The risks associated with the failure of the Company's financial
software, or third party payroll preparation and stock transfer system,
are considered less severe in that the Company believes switching to
other vendors or using other methods would be relatively easy.
The risk of failure of the third party airline reservation system is that
the Company would have to secure its travel arrangements by methods that
would be more cumbersome and time consuming than the current automated
system.
Contingency Plan
The Company is still evaluating whether it will develop a contingency
plan for any of the risks noted above. A decision is expected by June 30,
1999.
Consolidated Results of Operations
----------------------------------
Nine Months Ended
December 31,
1998 1997
---- ----
Net Sales $28,106,330 $ 8,020,695
---------
Net sales increased $20,085,635 in the 1998 nine months compared to the
comparable 1997 period. Edge sales of prepaid phone cards increased
$15,801,511 due to rapid growth and new contracts. Muller Media, which
was acquired as of June 9, 1998, accounted for approximately $2,295,000
of the increase. The prepaid phone card sales of PhoneLine in 1998
exceeded CardCaller Canada 1997 sales by $1,270,000. Travel Source sales
were up $137,000 in 1998, and European sales were up $534,000.
14--------------------------------------------------------------------------------1998 1997
---- ----
Cost of Sales $25,160,848 $6,967,821
-------------
Cost of sales in 1998 exceeded 1997 by approximately $18,193,000. Edge
cost of sales associated with higher sales noted above resulted in
$14,776,000 of the increase. Costs associated with the recently acquired
Muller Media accounted for $1,608,000 of the increase. PhoneLine 1998
costs exceeded CardCaller Canada by $1,049,000. Cost of sales for
European operations were up $469,000 on increased sales. Travel Source
costs increased $100,000 on increased sales.
1998 1997
-------- --------
Selling, General & Administration Expense $2,009,008 $846,252
-----------------------------------------
Selling, general and administrative increased $1,163,000 over the 1997
period. CyberFax costs increased $75,000 principally due to higher
research and development costs as its product got closer to market.
Expenses of the newly acquired Muller contributed $182,000 to the
increase. Increased operations in Europe added $135,000 to the increase.
SG&A expenses of PhoneLine, a much larger operation than CardCaller
Canada in 1997, accounted for $406,000 increased costs. In addition,
CardCaller Canada was only owned for seven months of the 1997 period.
SG&A expenses of Edge increased $283,000 due to large growth.
1998 1997
---- ----
Salaries and Compensation $1,879,811 $ 755,924
-------------------------
Salaries increased $1,123,887 over 1997 levels. Salaries at the corporate
level increase $257,000 due to wage increases and additional personnel
added due to growth. The acquisition of Muller accounts for $373,000 of
the increase. Salaries in Europe have increased $185,000 as operations
have now increased. Salaries at Edge have increased $162,000 principally
due to expanded operations. PhoneLine nine month salaries were $90,000
higher than CardCallers 1997 seven months.
1998 1997
---- ----
Amortization and Depreciation $422,160 $56,168
-----------------------------
The $56,168 in 1997 represents depreciation expense for continuing
operations. Included in 1998 is depreciation of $206,910, amortization of
Travel Source goodwill of $3,750, Muller goodwill of $24,000, CyberFax
goodwill of $37,500 and CardCaller Canada goodwill of $150,000.
15--------------------------------------------------------------------------------1998 1997
---- ----
Professional and Consulting Fees $761,218 $346,866
--------------------------------
Professional fees increased $414,000 over the 1997 period. Professional
fees at corporate were $278,000 higher than 1997 charges principally due
to outside legal charges as the Company expands and additional accounting
charges for restatements. Edge professional fees also rose $83,000 due to
its dramatic growth. Legal and accounting fees of the newly acquired
Muller and increased CyberFax fees principally account for the remaining
difference.
1998 1997
---- ----
Interest Expense ($83,162) ($43,413)
Interest Income $136,269 $ 4,276
--------------- -------- -------
Net Interest $53,107 ($39,137)
Interest expense increased in 1998 principally due to corporate short
term borrowing earlier in the year.
The $132,000 increase in interest income is a result of $38,000 earned by
DCI on short term investments plus $97,000 of interest earned on short-
term investments of the newly acquired Muller Media.
1998 1997
---- ----
Discontinued operations - Computer Board -- ($559,840)
----------------------- - Prepaid Phone
Card - UK -- ($647,948)
- Gain on Phone
Card Contract -- $3,078,421
The computer board loss in 1997 reflects the discontinuance of the Alpha
Products division at September 30, 1997. Included in the loss was the
write-off of unamortized customer base totaling $493,000. The prepaid
phone card discontinued loss was due to a non-compete clause in the 1997
distribution contract sale to Smartalk for $9,000,000, which necessitated
the shut-down of the UK operations.
1998 1997
---- ----
Preferred Dividends $902,851 $369,376
-------------------
Preferred dividends increased $533,475 in 1998. The increase is related
to the presumed incremental yield the investor may derive from the
discounted conversion rate of preferred stock issued by the Company
during the year.
16--------------------------------------------------------------------------------
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