SWDocID34
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________________ to________________________
Commission File Number: 0-24919
MDI ENTERTAINMENT, INC.
-----------------------
(Exact name of Registrant as specified in its Charter)
Delaware 73-1515699
---------- ----------
(State or other jurisdiction of (I.R.S Employer Identification No.)
incorporation or organization)
201 Ann Street
Hartford, Connecticut 06103
---------------------------
(Address of principal executive offices)
(860) 527-5359
--------------
(Registrant's telephone number)
(Former Name, Former Address and Former Fiscal Year,
if changed since last Report)
Check whether the registrant (1) has 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 __
As of November 19, 2002, 11,763,829 shares of the issuer's common stock were
outstanding.
Transitional Small Business Disclosure Format (check one): Yes __ No X_
1
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
FORM 10-QSB
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.....................................................................3
Condensed Consolidated Balance Sheets as of September 30, 2002 (unaudited)
and December 31, 2001.......................................................................3
Condensed Consolidated Statements of Operations for the nine months ended
September 30, 2002 and 2001 (unaudited).....................................................5
Condensed Consolidated Statements of Operations for the three months ended
September 30, 2002 and 2001 (unaudited).....................................................6
Condensed Consolidated Statement of Shareholders' Equity for the nine months
Ended September 30, 2002 (unaudited)........................................................7
Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 2002 and 2001 (unaudited).....................................................8
Notes to Unaudited Condensed Consolidated Financial Statements.............................10
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...14
Item 3. Controls and Procedures.................................................................25
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K........................................................26
Signatures......................................................................................27
Certifications..................................................................................28
Exhibit 99.1............................................................................Attachment
2
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
MDI Entertainment, Inc. and Subsidiary
Condensed Consolidated Balance Sheets
As of: As of:
September 30, December 31,
2002 2001
------------- ------------
ASSETS (unaudited)
CURRENT ASSETS:
Cash ........................................ $ 871,437 $ 251,578
Accounts receivable ......................... 1,696,031 2,709,543
Inventory ................................... 1,062,242 690,429
Deferred income taxes (Note 3) .............. 1,343,000 1,343,000
Other current assets ........................ 409,232 338,049
----------- -----------
Total current assets 5,381,942 5,332,599
----------- -----------
PROPERTY AND EQUIPMENT, AT COST:
Equipment ................................... 288,299 305,312
Furniture and fixtures ...................... 163,879 120,361
Leasehold improvements ...................... 8,751 8,751
----------- -----------
460,929 434,424
Less: Accumulated depreciation ............. (281,691) (271,408)
----------- -----------
Property and equipment, net ................. 179,238 163,016
----------- -----------
OTHER ASSETS:
Licensing costs, net ........................ 1,137,796 1,485,827
Deferred income taxes-long term (Note 3) .... 278,300 --
Other ....................................... 40,966 23,467
----------- -----------
Total other assets ..................... 1,457,062 1,509,294
----------- -----------
Total assets ........................... $ 7,018,242 $ 7,004,909
=========== ===========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
MDI Entertainment, Inc. and Subsidiary
Condensed Consolidated Balance Sheets (continued)
As of: As of:
September 30, December 31,
2002 2001
------------- ------------
LIABILITIES AND SHAREHOLDERS' EQUITY (unaudited)
CURRENT LIABILITIES:
Billings in excess of costs and estimated
earnings on uncompleted contracts (Note 2)... $ 2,411,485 $ 2,497,088
Note payable to officer ....................... -- 274,199
Accounts payable .............................. 369,653 1,112,880
Accrued expenses .............................. 994,017 734,302
----------- -----------
Total current liabilities ................ 3,775,155 4,618,469
----------- -----------
COMMITMENTS AND CONTINGENCIES (Notes 5 and 6)
SHAREHOLDERS' EQUITY:
Common stock .................................. 11,764 11,639
Additional paid-in capital .................... 5,603,941 5,609,657
Accumulated deficit ........................... (2,372,618) (3,234,856)
----------- -----------
Total shareholders' equity ................ 3,243,087 2,386,440
----------- -----------
Total liabilities and
shareholders' equity ................... $ 7,018,242 $ 7,004,909
=========== ===========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
MDI Entertainment, Inc. and Subsidiary
Condensed Consolidated Statements of Operations
Nine months ended
September 30,
2002 2001
------------ ------------
(unaudited) (unaudited)
REVENUE ............................................... $ 13,056,292 $ 10,687,122
COST OF REVENUES ...................................... 8,034,062 6,000,472
------------ ------------
Gross profit ...................................... 5,022,230 4,686,650
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES ............................................ 3,685,564 2,722,911
TERMINATED MERGER COSTS (Note 8) ...................... 391,083 --
TERMINATED TRANSACTION COSTS (Note 9) ................. 46,249 --
MERGER COSTS (Note 10) ................................ 150,015 --
COST OF UNSUCCESSFUL FUNDING (Note 7) ................. -- 188,742
------------ ------------
Operating profit ................................. 749,319 1,774,997
INTEREST EXPENSE, net ................................. 19,226 121,843
OTHER EXPENSE (INCOME) ................................ 99,855 (110,166)
GAIN ON SALE OF INVESTMENTS, NET ...................... -- (12,669)
------------ ------------
Income before (benefit) provision for income taxes 630,238 1,775,989
(BENEFIT) PROVISION FOR INCOME TAXES (Note 3)
(232,000) 46,824
------------ ------------
Net income ....................................... $ 862,238 $ 1,729,165
============ ============
Basic Earnings Per Common Share (Note 4) .............. $ 0.07 $ 0.16
============ ============
Diluted Earnings Per Common Share (Note 4) ............ $ 0.07 $ 0.14
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
MDI Entertainment, Inc. and Subsidiary
Condensed Consolidated Statements of Operations
Three months ended
September 30,
2002 2001
----------- ----------
(unaudited) (unaudited)
REVENUE ..................................... $4,894,021 $4,001,656
COST OF REVENUES ............................ 2,837,239 2,276,367
---------- ----------
Gross profit ............................ 2,056,782 1,725,289
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES .................................. 1,252,699 937,809
MERGER COSTS (Note 10) ...................... 150,015 --
COST OF UNSUCCESSFUL FUNDING (Note 7) ....... -- 99,109
---------- ----------
Operating profit ....................... 654,068 688,371
INTEREST EXPENSE, net ....................... 7,275 1,872
---------- ----------
Income before provision for income taxes 646,793 686,499
PROVISION FOR INCOME TAXES (Note 3) ......... 500,108 34,789
---------- ----------
Net income ............................. $ 146,685 $ 651,710
========== ==========
Basic Earnings Per Common Share (Note 4) .... $ 0.01 $ 0.06
========== ==========
Diluted Earnings Per Common Share (Note 4) .. $ 0.01 $ 0.05
========== ==========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
6
MDI Entertainment, Inc. and Subsidiary
Condensed Consolidated Statement of Changes in Shareholders' Equity
For the nine months ended September 30, 2002
(Unaudited)
--------------------------------------------
Shares Amount
------------ ------------
Common Stock, par value $.001 per share,
authorized 25,000,000 shares
Balance, December 31, 2001 ..................................... 11,638,925 $ 11,639
Stock options exercised ........................................ 124,904 125
------------ ------------
Balance, September 30, 2002 .................................... 11,763,829 11,764
------------ ------------
Additional Paid-in Capital:
Balance, December 31, 2001 ..................................... 5,609,657
Stock options exercised ........................................ 22,974
Compensation attributable to employee stock options ............ (28,690)
------------
Balance, September 30, 2002 .................................... 5,603,941
------------
Accumulated Deficit:
Balance, December 31, 2001 ..................................... (3,234,856)
Net income ..................................................... 862,238
------------
Balance, September 30, 2002 .................................... (2,372,618)
------------
Total Shareholders' Equity ............................................. $ 3,243,087
===========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
7
MDI Entertainment, Inc. and Subsidiary
Condensed Consolidated Statements of Cash Flows
Nine months ended
September 30,
2002 2001
----------- -----------
(unaudited) (unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ........................................................ $ 862,238 $ 1,729,165
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization ............................ 1,424,026 645,753
Gain on sale of investments, net ......................... -- (12,669)
Deferred income tax benefit (278,300) --
Change in assets and liabilities:
Decrease (increase) in accounts receivable ........ 1,013,512 (46,032)
Increase in inventory (371,813) (588,332)
Increase in licensing costs ....................... (1,030,646) (705,603)
Increase in other assets .......................... (71,183) (75,604)
Decrease in accounts payable ...................... (743,228) (467,637)
Increase in accrued expenses ...................... 213,651 196,069
Decrease in billings in excess of costs
and estimated earnings on uncompleted contracts (85,603) (378,228)
----------- -----------
Net cash provided by operating activities ................ 932,654 296,882
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment, net ............................ (61,570) (36,684)
Proceeds of sale of investments -- 192,669
----------- -----------
Net cash (used for) provided by investing activities ..... (61,570) 155,985
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of debt .................................................. (274,199) (652,691)
Proceeds from exercise of common stock options ..................... 22,974 6,600
----------- -----------
Net cash used for financing activities
(251,225) (646,091)
----------- -----------
NET INCREASE (DECREASE) IN CASH ........................................ 619,859 (193,224)
CASH, beginning of the period .......................................... 251,578 528,151
----------- -----------
CASH, end of the period ................................................ $ 871,437 $ 334,927
=========== ===========
8
MDI Entertainment, Inc. and Subsidiary
Condensed Consolidated Statements of Cash Flows (continued)
Nine months ended
September 30,
2002 2001
----------- -----------
(unaudited) (unaudited)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Interest ........................................................ $ 25,735 $ 57,708
Income taxes .................................................... $ 48,761 $ 2,588
Non-cash investing and financing activities:
Stock compensation .............................................. $ (28,690) $ --
Imputed interest on subordinated convertible debenture .......... $ -- $ 5,625
Conversion of subordinated debenture into common stock .......... $ -- $ 213,574
Common stock issued for services ................................ $ -- $ 269,025
The accompanying notes are an integral part of these condensed consolidated
financial statements.
9
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
Notes to Unaudited Condensed Consolidated Financial Statements as of September
30, 2002 and 2001
1. PRESENTATION OF UNAUDITED INTERIM CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
Information in the accompanying interim condensed consolidated financial
statements and notes to the condensed consolidated financial statements for the
nine-month periods ended September 30, 2002 and 2001 are unaudited. The
accompanying interim unaudited condensed consolidated financial statements have
been prepared by us in accordance with accounting principles generally accepted
in the United States and Regulation S-B. Accordingly, they do not include all
the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the nine-month period ended September 30, 2002 is not necessarily
indicative of the results that may be expected for the year ending December 31,
2002. The condensed consolidated financial statements should be read in
conjunction with the financial statements and notes thereto included in our
audited financial statements for the year ended December 31, 2001.
2. REVENUE AND COST RECOGNITION
Revenue is derived from various lottery game contracts (mainly with states)
between MDI and the lotteries. MDI provides second chance prize packages
consisting of grand prizes and various merchandise prizes. MDI also provides
marketing support related to each of the games and obtains the appropriate
licenses for the right to use these properties. Many of the lottery contracts
require the lotteries to pay MDI upon signing of the contract; therefore, MDI
defers this revenue and recognizes the revenue based on the percentage of
completion method.
Revenues from the lottery games are recognized on the percentage of
completion method, determined by the percentage of cost incurred to date to
estimated total costs on a specific contract basis. This method is utilized for
over 90% of MDI's revenue, as management considers cost incurred to be the best
available measure of progress on these contracts. Contract costs include all
direct costs. Merchandise prize costs are considered incurred when the prizes
are either shipped to the lottery game winner or, if a second chance lottery
drawing is committed to, when the merchandise prizes are in our fulfillment
facility. Should an event occur before these merchandise prizes are shipped to
the lottery winner that would damage or destroy these merchandise prizes, the
Company has both adequate insurance and the procurement sources to replace any
damaged or destroyed merchandise prizes. General and administrative costs are
charged to expense as incurred. Provisions for estimated losses on uncompleted
contracts are made in the period in which such losses are determined. As of
September 30, 2002, no losses were expected from existing contracts.
In addition, less than 10% of our revenue is recognized from charging a
license or royalty fee to the lottery for the use of one of the Company's
licensed properties (i.e., Harley-Davidson(R)) in connection with a lottery
scratch off ticket game, or for the services of a celebrity involved in the
occurrence of a lottery event or in the making of a lottery commercial. The
revenue is recognized on the completed contract method once contract obligations
are complete. In this respect, the results of revenue recognition are similar to
those under the percentage of completion method. Such obligations are usually of
very short duration (e.g., within a month).
The liability "billings in excess of costs and estimated earnings on
uncompleted contracts" represents billings in excess of revenues recognized.
Additionally, the Company has a receivable from its President and CEO of
approximately $44,000 related to personal expenses incurred during the year that
will be settled by year end 2002.
3. INCOME TAXES
Under accounting principles generally accepted in the United States, a
deferred tax asset is recognized when it is more likely than not that a portion
or all of a deferred tax asset will be realized. The Company has deferred tax
assets related to net operating losses that can be utilized to offset taxable
income in future years. In 2001, the Company determined that it was more likely
than not that a portion of its deferred tax assets would be utilized and,
accordingly, a $1.3 million deferred tax asset was recorded. During the quarter
ended March 31, 2002, the Company determined that it is more likely than not
that the remaining net operating loss would be utilized in future years and,
therefore, an additional deferred tax asset of $732,100 was recorded for the
period then ended.
10
For income tax purposes, the Company has a May 31 year end. In addition,
while the Company recognizes revenue on the percentage of completion method for
financial statement purposes, it recognizes revenue on a modified completed
contract basis for tax purposes. Upon the preparation of the tax return
extension for the tax year ended May 31, 2002 (which occurred during the quarter
and ended September 30, 2002), it was determined that book income exceeded
taxable income by approximately $627,000, mainly as a result of a number of
large contracts that were not complete for tax purposes as of that date. Based
on current information, management determined that a deferred tax liability of
$250,708 should be recorded to reflect this obligation. This liability has been
recorded as an additional reduction in the deferred tax asset since the
obligation will be offset by the Company's net operating loss carry-forward.
For the three and nine months ended September 30, 2002, the Company
recognized a tax provision (benefit) of $500,108 and ($232,000), respectively.
This was comprised of the following:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2002
------------------ ------------------
Recognition of deferred tax asset .............. $ -- $(732,108)
Deferred tax provision due to timing differences 250,708 250,708
Current tax provision .......................... 249,400 249,400
-------- ---------
Tax provision (benefit) ........................ $500,108 $(232,000)
======== =========
4. EARNINGS PER SHARE
Basic earnings per common share are based on the average number of common
shares outstanding during the fiscal period. Diluted earnings per common share
include, in addition to the above, the dilutive effect of common share
equivalents during the period. For the three and nine-month periods ended
September 30, 2002 and 2001, common share equivalents represented dilutive stock
options and warrants using the treasury method. The income available to common
shareholders and the number of shares used in the earnings per common share and
earnings per dilutive share computation for 2002 and 2001 was as follows:
NINE MONTHS ENDED
SEPTEMBER 30,
2002 2001
---- ----
Net income applicable to common shareholders $ 862,238 $ 1,729,165
=========== ===========
Basic:
Average number of common shares outstanding 11,747,514 11,070,096
Dilutive:
Dilutive effect of options and warrants ... 1,055,604 1,338,837
----------- -----------
Average dilutive common shares outstanding .. 12,803,118 12,408,933
=========== ===========
11
THREE MONTHS ENDED
SEPTEMBER 30,
2002 2001
---- ----
Net income applicable to common shareholders $ 146,685 $ 651,710
=========== ===========
Basic:
Average number of common shares outstanding 11,763,829 11,172,306
Dilutive:
Dilutive effect of options and warrants .... 1,055,604 1,338,837
----------- -----------
Average dilutive common shares outstanding . 12,819,433 12,511,143
=========== ===========
5. COMMITMENTS
The Company obtains licenses for both cultural and entertainment
properties, some of which have obligations continuing through the term of the
license. It also leases office equipment and office space under long-term
leases, which expire during the next one to four years. The following is a
schedule of both continuing non-cancelable obligations associated with our
licensing agreements, future minimum rental payments required under operating
leases and consulting agreements that have initial or remaining non-cancelable
lease terms in excess of one year as of September 30, 2002:
3 months ending December 31, 2002 ...................... $ 938,920
12 months ending December 31, 2003 ....................... 1,656,812
12 months ending December 31, 2004 ....................... 932,349
12 months ending December 31, 2005 ....................... 384,476
-----------
Total $ 3,912,557
===========
6. LITIGATION
On February 28, 2002, a class action suit on behalf of the Company's public
stockholders (the "Plaintiff") was filed in the Court of Chancery of the State
of Delaware against the Company, all of the members of the Company's Board of
Directors and Scientific Games Corporation ("Scientific Games"), to enjoin the
proposed business combination transaction pursuant to which Scientific Games
would acquire the outstanding shares of the Company's common stock which it does
not already own. In its complaint, the Plaintiff alleged that the consideration
offered to the Company's stockholders in the proposed acquisition was unfair and
inadequate because the Plaintiff believed that the intrinsic value of the
Company's common stock was materially in excess of the amount offered giving
consideration to the Company's growth and anticipated operating results, net
asset value, and future profitability. The Plaintiff requested the court to
preliminarily and permanently enjoin the Company from proceeding with,
consummating or closing the proposed transaction and in the event the proposed
transaction is consummated, to rescind it and award rescissory damages. In
addition, the Plaintiff requested that the court award to the Plaintiff
compensatory damages.
On May 6, 2002, a second complaint was filed in the same Court containing
nearly identical allegations. On May 6, 2002, lawyers for the plaintiffs
requested an order consolidating the two cases. On June 19, 2002, all of these
stockholder class action suits relating to the proposed transaction with
Scientific Games were dismissed without prejudice. (See Note 8 for further
discussion.)
12
7. COST OF UNSUCCESSFUL FUNDING
The Company recorded an expense of $188,742 for costs relating to the
placement and issuance of its Series C Preferred Stock to Oxford International,
Inc. These costs include legal, accounting and investment banking fees paid or
accrued during the nine-month period ended September 30, 2001.
8. TERMINATED MERGER WITH SCIENTIFIC GAMES CORPORATION
On February 22, 2002, MDI Entertainment, Inc. ("MDI") and Scientific Games
Corporation ("Scientific Games") entered into a Letter of Intent contemplating
the acquisition of MDI by Scientific Games at $2.10 per share, payable in
Scientific Games common stock. On May 8, 2002, MDI announced that Scientific
Games and the Company had mutually and amicably agreed to terminate their merger
negotiations in the wake of the competing offer the Company had received (see
ICP Proposal below). The announcement also indicated that Scientific Games and
the Company would continue their strategic alliance (See footnote 10 for
subsequent event).
The Company has incurred certain legal, accounting and investment banking
fees relating to this proposed merger. These costs totaled $0 and $391,083 for
both the three months and the nine months ended September 30, 2002.
9. ICP PROPOSAL
By letters dated April 17, 2002 and April 30, 2002, International Capital
Partners, LLC ("ICP") expressed an intention to acquire approximately 50% of the
outstanding shares of the Company which it did not already own for $3.30 per
share in cash. ICP owned 1,022,019 shares of the Company at such time.
On May 7, 2002, ICP filed an amendment to Schedule 13D with the Securities
and Exchange Commission expressing its intention to increase its holdings in the
Company by acquiring 50% of the outstanding shares of the Company it did not
currently own for $3.30 per share. According to the Schedule 13D filing, as
amended, the source of funds for such transaction were to be investment funds
under the direction and control of ICP. ICP indicated that it would consider
extending the Company a line of credit for working capital and add-on
acquisition purposes.
On June 27, 2002, ICP and MDI announced that they had mutually terminated
their discussions, in part because of the advice of the Company's Chief
Executive Officer and principal stockholder, Steven M. Saferin, that he would
not tender in the ICP proposal. The costs associated with this terminated
transaction amounted to $0 and $46,249 for both the three months and the nine
months ended September 30, 2002.
10. MERGER AGREEMENT WITH SCIENTIFIC GAMES
On November 19, 2002, the Company entered into an Agreement and Plan of
Merger (the "Merger Agreement"), dated as of November 19,2002, with Scientific
Games International, Inc., a wholly owned subsidiary of Scientific Games, which
sets forth the terms and conditions of the proposed acquisition of MDI by
Scientific Games. Pursuant to the Merger Agreement, a subsidiary of Scientific
Games will make a cash tender offer for all of the Company's outstanding shares
at a purchase price of $1.60 per share, net to the seller in cash, upon the
terms and subject to the conditions set forth in the Merger Agreement, including
the condition that 75% of MDI's outstanding shares (including the 708,833 shares
which are currently owned by Scientific Games and the 3,795,169 shares owned by
Steven M. Saferin, the Company's Chief Executive Officer and President) are
tendered in the offer. Mr. Saferin has agreed to sell his shares to Scientific
Games at a purchase price of $1.40 per share within five business days after the
close of the tender offer pursuant to a separate stock purchase agreement. In
addition, Mr. Saferin and Scientific Games have entered into a three-year
employment agreement which is effective upon the closing of the tender offer.
This transaction is expected to close by early next year. The Company has
incurred merger and transaction costs of approximately $150,000 for the three
and nine months ended September 30, 2002 related to this intended merger.
Additional costs will be incurred in the quarter ending December 31, 2002 to
finalize this transaction.
13
THIS QUARTERLY REPORT ON FORM 10-QSB CONTAINS FORWARD LOOKING STATEMENTS THAT
INVOLVE CERTAIN RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THE RESULTS DISCUSSED IN THE FORWARD LOOKING STATEMENTS.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
DESCRIPTION OF BUSINESS
The following discussion and analysis should be read in conjunction with
our Condensed Consolidated Financial Statements and the notes thereto appearing
elsewhere in this Form 10-QSB. All statements contained herein that are not
historical facts, including but not limited to, statements regarding our current
business strategy and our plans for future development and operations, are based
upon current expectations. These statements are forward-looking in nature and
involve a number of risks and uncertainties. Generally, the words "anticipates,"
"believes," "estimates," "expects" and similar expressions as they relate to us
and our management are intended to identify forward looking statements. Actual
results may differ materially. Among the factors that could cause actual results
to differ materially are those set forth in our Annual Report on Form 10-KSB
under the caption "Description of Business-Risk Factors." We wish to caution
readers not to place undue reliance on any such forward-looking statements,
which statements speak only as of the date made.
Our principal business has been the scratch ticket segment of the
government lottery industry. We are a leader in designing and marketing instant
scratch ticket games based on licensed brand names and entertainment properties
and our lottery promotions feature such properties licensed by us. Prizes
awarded in such promotions typically include a number of "second chance" prizes
related to the licensed property, including collectible logo bearing merchandise
such as T-shirts and caps, and other related merchandise such as posters, money
clips, telephones, playing cards, stadium blankets, carryall bags, jackets,
electronic games, video and music collections, watches, clocks, credit cards
with prepaid credit, trips and, in the case of Harley-Davidson(R),
Harley-Davidson 1200 Sportster motorcycles.
We developed our strategy of identifying such properties in early 1996.
Prior to that time, we had developed a series of promotions that utilized
popular videotapes, compact discs and audiocassettes as second chance lottery
prizes. Those promotions enabled us to develop an expertise in sourcing and
distributing products as second chance lottery prizes and to develop a
reputation with lottery personnel as a reliable organization attuned to the
special needs of lotteries and their players.
We derive approximately ninety-eight percent (98%) of our revenues from
lotteries in two distinct ways.
Our first source of lottery revenue is the sale of logo bearing merchandise
to the lottery as second-chance prizes. In merchandise-based lottery games,
between 5% to 10% of a lottery's prize fund is typically used for the purchase
of merchandise related to the property the lottery is utilizing. Typically, we
purchase merchandise from other licensees of the property and resell the
merchandise to the lottery at a price that is designed to include overhead
costs, profit, shipping and handling and any marketing support we provide the
lottery such as brochures, posters or other advertising assistance for which
there are no separate charges. Revenue from these merchandise based lottery
games generally represents over ninety percent (90%) of our revenue.
Secondly, we may charge a lottery a license or royalty fee to utilize a
particular licensed property for a lottery game. License fees may be fixed
assessments while royalties are a percentage of the printing cost of the tickets
or a percentage of the sales of the ticket. Contracts for licensed properties
typically include an up-front license fee or a royalty based on the price point
and quantity of tickets printed. Ticket quantities range from about one million
to as many as 60 million with an average quantity of about five million. Price
points range from $1.00 to $20.00 per ticket with most games sold at $2.00.
Revenue from these fee only games generally represents less than 10% of our
revenues.
Our success is dependent on our ability to maintain and secure licensed
properties, market these properties to lotteries and the performance of the
properties once they are introduced as lottery games to players. We believe that
revenues will fluctuate as individual license-based promotions commence or wind
down and terminate. In addition, our licenses (which are generally for 1.5 to 3
years) terminate at various times over the next several years. Moreover, the
useful life of a license is generally relatively short as the novelty of the
game or the popularity of the licensed material wanes over time. The timing of
agreements with the lotteries to run promotions, the acquisition of new licenses
and the commencement of new promotions is unpredictable. Accordingly,
period-to-period comparisons may not be indicative of future results.
14
We are in continuous negotiations to obtain additional licensed properties
and extend some existing licenses. We expect to reach several agreements over
the next six to 12 months; however we cannot assure you that such agreements
will actually be reached. Some of these agreements may require the expenditures
of significant up-front advances.
RECENT DEVELOPMENTS
MERGER AGREEMENT WITH SCIENTIFIC GAMES
On November 19, 2002, the Company entered into an Agreement and Plan of
Merger (the "Merger Agreement"), dated as of November 19,2002, with Scientific
Games International, Inc., a wholly owned subsidiary of Scientific Games, which
sets forth the terms and conditions of the proposed acquisition of us by
Scientific Games. Pursuant to the Merger Agreement, a subsidiary of Scientific
Games will make a cash tender offer for all of our outstanding shares at a
purchase price of $1.60 per share, net to the seller in cash, upon the terms and
subject to the conditions set forth in the Merger Agreement, including the
condition that 75% of MDI's outstanding shares (including the 708,833 shares
which are currently owned by Scientific Games and the 3,795,169 shares owned by
Steven M. Saferin, the Company's Chief Executive Officer and President) are
tendered in the offer. Mr. Saferin has agreed to sell his shares to Scientific
Games at a purchase price of $1.40 per share within five business days after the
closing of the tender offer pursuant to a separate stock purchase agreement. In
addition, Mr. Saferin and Scientific Games have entered into a three-year
employment agreement which is effective upon the closing of the tender offer.
This transaction is expected to close by early next year.
The merger and transaction costs incurred during the quarter ended
September 30, 2002, were approximately $150,000. Additional costs will be
incurred in the quarter ending December 31, 2002 to finalize this transaction.
GAME INTRODUCTIONS
During the quarter ended September 30, 2002, nine new MDI games were
introduced by lottery jurisdictions, bringing the total number of games that are
currently being offered in North America, Europe and Asia to 47 for the year.
The launches represented seven different MDI licensed lottery brands.
Milestones during the quarter included the following:
1. First MDI licensed game business in Ireland. At the peak of the worldwide
25th Anniversary observance of Elvis Presley's death, the An Post National
Lottery of Ireland launched a 2 Euro Elvis(R) lottery scratch game,
featuring five different images of The King of Rock and Roll.
2. First MDI licensed game business in Vermont. The Vermont Lottery became the
thirteenth U.S. lottery to launch an MDI-licensed instant game featuring
the likenesses, race cars and facsimile signatures of NASCAR(R) Winston Cup
Series drivers. The Vermont game highlights Dale Earnhardt, Jr., Bill
Elliott, Matt Kenseth and Mark Martin.
3. First 100th Anniversary Harley-Davidson(R) lottery scratch game. The
Illinois Lottery launched its second Harley-Davidson(R) instant scratch
game, getting an early start on the Centennial Anniversary of the famous
motorcycle brand that will be observed through Summer 2003. The Illinois
game is one of eight Harley-Davidson(R) lottery games currently on sale in
North America. At least 13 additional "Anniversary Edition" games are being
planned in the months ahead.
4. First 20th Anniversary Wheel of Fortune(R) licensed lottery game. Another
special anniversary game debut is credited to the Illinois Lottery, which
launched the latest Wheel of Fortune(R) licensed instant game in August.
Wheel of Fortune(R) is celebrating its 20th season in syndication.
5. First Betty Boop(TM) Bingo licensed lottery game. An adaptation of lottery
instant bingo, one of the most popular play styles of the last decade, the
branded Betty Boop(TM) Bingo made its first market appearance in September
at Connecticut Lottery retail locations.
6. First Lionel(R) licensed lottery game. In September 2002 the New Jersey
Lottery debuted the first lottery scratch game based on the nostalgic
Lionel(R) train. Lionel(R) Cash Express includes rail pass grand prizes,
model train sets and an assortment of other officially licensed Lionel(R)
merchandise as other prizes.
7. First Universal Studios Monsters(TM) licensed lottery game. Rich
illustrations and official movie logos of six classic Universal Studios(R)
movie monsters are highlighted in the Virginia Lottery's Monster Money game
that went on sale in September 2002.
15
NEW GAMES
In October, the New Jersey Lottery became the first lottery in North
America to launch a game tied to MDI's NBA license. The Company expects
additional NBA games to launch in the District of Columbia this month and
Wisconsin, Indiana and California in the first quarter of 2003.
NEW CUSTOMERS
During November, the Company will launch its first licensed game with the
Washington State Lottery when it introduces its $3 Harley-Davidson game. In
October, the Company executed a multi-year, multi-game contract with the
Minnesota State Lottery. Under the terms of the agreement, the Minnesota Lottery
has committed to MDI Licensed games with a total face value of $25,000,000 over
the two-year term of the agreement. This week, the Company has executed a
five-year agreement with the Florida Lottery. Under the terms of this agreement,
the Lottery will print MDI licensed games with a total face value of
$200,000,000 during the term of the agreement.
LICENSED PROPERTIES
MDI has reached agreement for the renewal of Roush Racing, Inc. for the
continued licensing of Roush's NASCAR(R) Winston Cup race drivers in the
upcoming 2003 racing season.
During the quarter ended September 30, 2002, MDI finalized and executed
contracts for new licensed properties, including X-Men 2, Daredevil, TV Guide
Crossword, Othello and The Honeymooners.
Through an agreement with 20th Century Fox, MDI will offer lotteries
licensed instant games tied to two major motion pictures that will premiere in
2003. Both Daredevil (February 2003) and X-Men 2 (May 2003) are based on classic
Marvel Comics superheroes. The Company earlier announced a similar agreement
with Universal Studios for the lottery rights to the motion picture, The Hulk,
which premieres in June 2003.
TV Guide Crossword provides the lottery industry with a famous trademark
brand for an already popular lottery scratch game category - crossword puzzle
games.
Othello(R) is the classic board game marketed by Mattel.
Like its previously announced license for I Love Lucy, MDI's agreement for
The Honeymooners enables lotteries to introduce Honeymooners scratch games
featuring the images of Jackie Gleason as Ralph Kramden, Art Carney as Ed
Norton, Audrey Meadows as Alice Kramden and Joyce Randolph as Trixie Norton in
some of the most famous scenes from the 1950s-era TV sitcom.
NEW BRANDS
We have reached agreements for several new brands which we expect to begin
marketing shortly. Among those are Corvette, Ford and Mercury and the Palms
Hotel and Casino. We continue to discuss additional opportunities with property
owners throughout North America and around the world.
INTERNET PLATFORMS
MDI continues to develop Internet applications for its licensed lottery
promotions, providing lottery customers with custom-designed Internet web sites
that enable consumers to enter second chance drawings over the Internet as an
alternative to sending entries through the mail. The web sites are marketed
under the trade names Lottery Bonus Zone(TM) and Second Chance Bonus Zone(TM).
During the quarter ended September 30, 2002, Lottery Bonus Zone(TM) web
sites were provided for second chance promotions related to the New Jersey
Lottery's Heroes Of Space(TM), TABASCO(R) Hot Cash(TM) and Lionel(R) Cash
Express games.
The Company also launched a Second Chance Bonus Zone(TM) web site during
the quarter in support of the Virginia Lottery's Universal Studios Monsters(TM)
Monster Money game.
16
NEW TECHNOLOGIES
MDI has reached an agreement in principle with Ingenio, the Montreal-based
subsidiary of the provincial lottery organization, Loto-Quebec, to develop
CD-Rom playable versions of instant lottery scratch games based on MDI's
licensed properties.
Targeted to the ever-expanding market of consumers with personal home
computers, Ingenio games integrate traditional instant scratch games with
personal computer game technology, adding drama, rich illustrations, detailed
animation, music and sound effects to the experience of playing a lottery
scratch ticket.
MDI believes that applying Ingenio's technology to MDI licensed lottery
games can expand the appeal of instant win lotteries to attractive new consumer
demographic segments.
EXPANSION INTO INTERNATIONAL MARKETS
We hired Ms. Evelyn Yenson as our Senior Vice President, International
Sales and Marketing, to focus on international development in September, 2001.
Ms. Yenson brings outstanding credentials to the position, having established
herself in the international lottery arena as the director of the Washington
State Lottery and as the first U.S. delegate to the World Lottery Association
Executive Committee. She later served as the corporate communications officer
for the instant ticket printing industry leader, Scientific Games. Through Ms.
Yenson's efforts and relationships, our products are now being actively marketed
on every continent where there are lottery jurisdictions. These efforts resulted
in our first time contracts in France and China, which launched our 2002 FIFA
World Cup Japan/Korea(TM) license game, discussed below. We have also retained
several consultants with off-shore lottery experience to assist in our marketing
efforts.
In late 2001, we established a valuable "calling card" in the International
lottery arena by acquiring the exclusive worldwide lottery licensing rights to
the 2002 FIFA World Cup Korea/Japan(TM) soccer finals. We are finding that, as
expected, owning rights to the 2002 FIFA World Cup Japan/Korea(TM) has given us
substantial access into some of the world's largest lottery organizations, and
has created prospects for business that go well beyond the 2002 FIFA World Cup
Japan/Korea(TM) event.
Reacting to the expressed interest of lotteries outside of North America,
we have also recently negotiated an expansion of our North American lottery
rights from domestic to worldwide for MGM's Pink Panther(TM). To the extent
practicable, we are seeking international rights for other existing properties,
as we also seek to identify viable consumer icons that have strong regional
appeal in foreign lottery markets.
For the first time, MDI will exhibit and be a sponsor of the World Lottery
Association conference which will be held later this month in Adelaide, South
Australia. To help bolster our presence at the conference, the Company has sold
to the South Australia Lottery our Hollywood Sign and Walk of Fame game which
will be on sale during the conference. This marks our second sale to the lottery
in Australia. Previously, the New South Wales Lottery ran our Elvis Presley
game.
17
NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2001
Nine months ended September 30,
---------------------------------------------------
2002 % 2001 %
---- - ---- -
(Unaudited) (Unaudited)
Revenue ................................................... $13,056,292 100.0% $ 10,687,122 100.0%
Cost of revenues .......................................... 8,034,062 61.5% 6,000,472 56.1%
---------------------------------------------------
Gross profit ........................................... 5,022,230 38.5% 4,686,650 43.9%
Selling, general and administrative expenses .............. 3,685,564 28.2% 2,722,911 25.5%
Terminated merger costs ................................... 391,083 3.0% -- -%
Terminated transaction costs .............................. 46,249 0.4% -- -%
Merger costs .............................................. 150,015 1.2% -- -%
Cost of unsuccessful funding .............................. -- -% 188,742 1.8%
---------------------------------------------------
Operating profit ....................................... 749,319 5.7% 1,774,997 16.6%
Interest expense .......................................... 25,735 0.2% 136,739 1.3%
Interest income ........................................... (6,509) (0.1%) (14,896) (0.1%)
Other expense (income) .................................... 99,855 0.8% (110,166) (1.0%)
Gain on sale of investments, net .......................... -- -% (12,669) (0.1%)
---------------------------------------------------
Income before (benefit) provision for income taxes ..... 630,238 4.8% 1,775,989 16.5%
(Benefit) provision for income taxes ...................... (232,000) (1.8%) 46,824 0.4%
---------------------------------------------------
Net income ............................................. $ 862,238 6.6% $ 1,729,165 16.1%
===================================================
REVENUE
Revenue sources are from both merchandise based lottery promotions and
promotions that generate license or royalty fees only. License or royalty fee
revenue represented 6% of our total revenue for the nine months ended September
30, 2002, whereas approximately 94% of our revenue for the nine months ended
September 30, 2002 was derived primarily from merchandise based promotions.
Prizes awarded in such promotions typically include a number of "second chance"
prizes related to the licensed property, such as collectible logo bearing
merchandise associated with the licensed property. These prizes are usually
awarded on predetermined dates, which allow us to purchase and inventory these
items in our outsourced fulfillment facility prior to these award-drawing dates.
However, procurement opportunities or contract terms may require all the
merchandise for a particular promotion to be procured prior to even the first
drawing.
Results for the nine months ended September 30, 2002, reflect a 22.2%
increase in revenue. Revenue for the nine months ended September 30, 2002 was
$13,056,300 compared to $10,687,100 for the nine months ended September 30,
2001. Overall revenue increased as a result of the increased game launches for
the nine months ended September 30, 2002 compared to the nine months ended
September 30, 2001. Harley-Davidson accounted for 35.4% of our revenue for the
nine months ended September 30, 2002. Elvis Presley(R) and NASCAR(R), accounted
for 27.4% and 9.8%, respectively, of our revenue for the nine months ended
September 30, 2002. The remaining 27.4% of our revenue for the nine months ended
September 30, 2002 was derived from 16 other licensed properties. We recently
entered into an agreement to extend our agreement with Harley Davidson(R) which
will allow us to provide Harley Davidson(R) lottery games to the industry
through the end of calendar year 2005. In addition, we entered into a new
agreement with Roush Racing, Inc. for the continued licensing of Roush's
NASCAR(R) Winston Cup race drivers in the upcoming 2003 racing season. Through
an agreement with 20th Century Fox, MDI will offer lotteries licensed instant
games tied to two major motion pictures that will premiere in 2003:Daredevil
(February 2003) and X-Men 2 (May 2003), which are both based on classic Marvel
Comics superheroes.
18
COST OF REVENUES
Cost of revenue, as a percentage of revenue, increased to 61.5% for the
nine months ended September 30, 2002 compared to 56.1%, for the nine months
ended September 30, 2001. This increase in the cost ratio reflects much higher
licensing and merchandising costs associated with the Elvis Presley(R) games
launched and running during the nine months ended September 30, 2002, which
represented 27.4% of our revenue. Elvis Presley(R) games, during the nine months
ended September 30, 2001, represented only 13.5% of our total revenue. Our cost
of sales includes merchandise from other licensees of the property, shipping and
handling and any marketing support we provide the lottery such as brochures,
posters or other advertising assistance. Costs also include trips associated
with our licensed properties. Additionally, another major cost is the
amortization of our licensing costs over the term of the various licenses.
GROSS PROFIT
The gross profit increased in the nine months ended September 30, 2002 to
$5,022,200 (38.5% of revenue) compared to $4,686,650 (43.9% of revenue) for the
nine months ended September 30, 2001. As mentioned above, this significant ratio
of Elvis Presley(R) games during this nine-month period made it difficult to
achieve our target gross profit of 40% for the nine months ended September 30,
2002. Without the Elvis Presley(R) games, our gross profit would have exceeded
40% for the nine months ended September 30, 2002.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general, and administrative expenses were $3,685,600 (28.2% of
revenue) for the nine months ended September 30, 2002 compared to $2,722,900
(25.5% of revenue) for the nine months ended September 30, 2001. Salaries and
employee benefits increased approximately $355,100 during the nine-month period
ending September 30, 2002 due to increased sales and marketing personnel for our
international sales effort and a new Vice President of Creative Development, who
was hired to support our lottery customers in innovative game promotion
concepts.
Marketing, promotional and related travel expenses increased by $212,500,
for a total of $681,300, for the nine months ended September 30, 2002. Expenses
in this area have increased significantly due to international marketing and
promotional costs which resulted in contracts in both France and China for our
2002 FIFA World Cup Korea/Japan(TM) licensed game. This license has generated
license or royalty fee revenue of approximately $148,000 for the nine months
ended September 30, 2002.
Costs related to both public reporting and investor relations increased to
$478,200 for the nine months ended September 30, 2002 compared to $390,600 for
the nine months ended September 30, 2001. This increase is due to a $110,000
increase in financial consulting expenses as compared to the nine month period
ended September 30, 2001. Part of this increase is a result of a credit recorded
during the nine-month period ended September 30, 2001 of $50,000 related to a
settlement of previously recorded consulting fees. Additionally, beginning in
2002, we have resolved to provide cash compensation to our outside directors for
their work as members of our Board. For the nine months ended September 30,
2002, this total compensation was $48,000. Operational expenses for our Fort
Worth, Texas office totaled approximately $51,000 in the nine months ended
September 30, 2002 compared to $0 for the nine months ended September 30, 2001.
TERMINATED MERGER AND TRANSACTION COSTS
We have incurred certain legal, accounting and investment banking fees
related to the previous proposed merger with Scientific Games. These costs
totaled $391,100 for the nine months ended September 30, 2002. Additionally, we
incurred $46,200 in the unsuccessful completion of a transaction with
International Capital Partners, LLC ("ICP") in its proposal to purchase a
majority of the outstanding common stock of our Company.
MERGER COSTS
In connection with the Merger Agreement with Scientific Games, we incurred
merger and transaction costs of approximately $150,000 for the three and nine
months ended September 30, 2002.
19
OPERATING PROFIT
The operating profit was $749,300 (5.7% of revenue) for the nine months
ended September 30, 2002 compared to an operating profit of $1,775,000 (16.6% of
revenue) for the nine months ended September 30, 2001. This decrease in
operating profitability is due to the factors described above, and particularly
the costs related to the proposed merger with Scientific Games, the unsuccessful
transaction with ICP and the ongoing merger discussions with a potential
acquirer. Without the costs related to these proposed transactions, there would
have been operating profit for the nine months ended September 30, 2002, of
$1,336,600 (10.2% of revenue).
INTEREST EXPENSE
Interest expense was $25,700 for the nine months ended September 30, 2002
compared to $136,700 for the nine months ended September 30, 2001. This
reduction in interest expense is related to the reduction of our short-term debt
from $274,200 at September 30, 2001 to $0 at September 30, 2002. In addition,
the results for the nine months ended September 30, 2001 reflected interest
expense related to a Subordinated Convertible Debenture which was converted to
equity prior to 2002.
OTHER EXPENSE
Other expense was $99,900 for the nine months ended September 30, 2002
compared to other income of $110,200 for the nine months ended September 30,
2001. This net expense of $99,900 is primarily due to the write-off of the total
$100,000 promissory note we received as settlement for the lawsuit with Oxford
International, Inc., settled on December 31, 2001. We were to receive $10,000 on
February 15, 2002. As of the date of this filing, we have not received payment
and the ultimate collection of this note is in doubt. We will evaluate the merit
of pursuing this matter further. The $110,200 in the comparable period ended
September 30, 2001 was attributable to the favorable exchange of stock for legal
services that was negotiated in the first quarter of 2001.
GAIN ON SALES OF SECURITIES
The $12,700 gain on securities for the nine months ended September 30, 2001
was attributable to the sale of shares of eLot stock held for investment.
NET INCOME
For the reasons set forth above, we had income before taxes of $630,200 for
the nine months ended September 30, 2002 compared to income before taxes of
$1,776,000 for the nine months ended September 30, 2001. Excluding expenses
incurred in connection with the potential merger and investment related
transactions, our net income before taxes for the nine months ending September
30, 2002 would have been $1,217,500 (9.3% of revenue).
Net income decreased to $862,200 for the nine months ended September 30,
2002 compared to $1,729,200 for the nine months ended September 30, 2001.
Contributing to the net income of $862,200 for the nine months ended September
30, 2002 was the decrease in the income tax benefit in the nine months ended
September 30, 2002, which is attributable to the reversal of approximately
$732,100 of a deferred tax asset valuation allowance that was recognized at
March 31, 2002. Under accounting principles generally accepted in the United
States, a valuation allowance is established when it is more likely than not
that a portion or all of a deferred tax asset will not be realized. Prior to
December 31, 2001, a valuation allowance was recorded for these deferred tax
assets. In 2001, we determined that, more likely than not, a portion of these
deferred tax assets would be utilized and, accordingly, $1.3 million of the
valuation allowance was reversed.
Reducing this tax benefit is the current tax provision for the nine months
ended September 30, 2002 of $249,400. Also, upon the preparation of the tax
return extension for the tax year ended May 31, 2002 (which occurred during the
quarter ended September 30, 2002), it was determined that book income exceeded
taxable income by approximately $627,000, mainly as a result of a number of
large contracts that were not complete for tax purposes as of that date. Based
on current information, management determined that a deferred tax liability of
approximately $250,700 should be recorded to reflect this obligation. This
liability has been recorded as an additional reduction in the deferred tax asset
since the obligation will be offset by the Company's net operating loss
carry-forward.
Basic earnings per share and fully diluted earnings per share were $.07 for
the nine months ended September 30, 2002 compared to basic earnings per share of
$.16 and fully diluted earnings per share of $.14 for the nine months ended
September 30, 2001.
20
THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2001
Three months ended September 30,
---------------------------------------------------
2002 % 2001 %
---- - ---- -
(Unaudited) (Unaudited)
Revenue .................................................... $ 4,894,021 100.0% $ 4,001,656 100.0%
Cost of revenues ........................................... 2,837,239 58.0% 2,276,367 56.9%
---------------------------------------------------
Gross profit ............................................ 2,056,782 42.0% 1,725,289 43.1%
Selling, general and administrative expenses ............... 1,252,699 25.6% 937,809 23.4%
Merger costs ............................................... 150,015 3.1% -- -%
Cost of unsuccessful funding ............................... -- -% 99,109 2.5%
---------------------------------------------------
Operating profit ........................................ 654,068 13.3% 688,371 17.2%
Interest expense ........................................... 8,752 0.2% 7,995 0.2%
Interest income ............................................ (1,477) -% (6,123) (0.2%)
---------------------------------------------------
Income before provision for income taxes ................ 646,793 13.1% 686,499 17.2%
Provision for income taxes ................................. 500,108 10.2% 34,789 0.9%
---------------------------------------------------
Net income .............................................. $ 146,685 2.9% $ 651,710 16.3%
===================================================
REVENUE
Revenue sources are from both merchandise based lottery promotions and
promotions that generate license or royalty fees only. License or royalty fee
revenue was minimal this quarter. Therefore, approximately 100% of our revenue
for the three months ended September 30, 2002 was derived primarily from
merchandise based promotions. Prizes awarded in such promotions typically
include a number of "second chance" prizes related to the licensed property,
such as collectible logo bearing merchandise associated with the licensed
property. These prizes are usually awarded on predetermined dates, which allow
us to purchase and inventory these items in our outsourced fulfillment facility
prior to these award-drawing dates. However, procurement opportunities or
contract terms may require all the merchandise for a particular promotion to be
procured prior to even the first drawing.
Results for the three months ended September 30, 2002 reflect a 22.3%
increase in revenue. Revenue for the three months ended September 30, 2002 was
$4,894,000 compared to $4,001,700 for the three months ended September 30, 2001.
Overall revenue increased as a result of the increased game launches for the
three months ended September 30, 2002 compared to the three months ended
September 30, 2001. Harley-Davidson(R) accounted for 41.1% of our revenue for
the three months ended September 30, 2002. Elvis Presley(R) and NASCAR accounted
for 20.8% and 7.7%, respectively, of our revenue, for the three months ended
September 30, 2002. The remaining 30.4% of the revenue was derived from 13 other
licenses for the three months ended September 30, 2002, compared to 20.8% for
the three months ended September 30, 2001. We recently entered into an agreement
to extend our agreement with Harley Davidson(R) which will allow us to provide
Harley Davidson(R) lottery games to the industry through the end of calendar
year 2005. In addition, we have entered into an agreement with Roush Racing,
Inc. for the continued licensing of Roush's NASCAR(R) Winston Cup race drivers
in the upcoming 2003 racing season. Through an agreement with 20th Century Fox,
MDI will offer lotteries licensed instant games tied to two major motion
pictures that will premiere in 2003: Daredevil (February 2003) and X-Men 2 (May
2003), which are both based on classic Marvel Comics superheroes.
21
COST OF REVENUES
Cost of revenues as a percentage of revenue increased slightly to 58.0% for
the three months ended September 30, 2002 compared to 56.9% for the three months
ended September 30, 2001. This increase in the cost ratio reflects higher
licensing and merchandising costs associated with the Elvis Presley(R) games
launched and running this quarter which represented 20.8% of our revenue,
compared to 10.8% of our revenue for the comparable period in 2001. Our cost of
sales includes merchandise from other licensees of the property, shipping and
handling and any marketing support we provide the lottery such as brochures,
posters or other advertising assistance. Costs also include trips associated
with our licenses properties. Additionally, another major cost is the
amortization of our licensing costs over the term of the various licenses.
GROSS PROFIT
The gross profit increased in the three months ended September 30, 2002 to
$2,056,800 (42.0% of revenue) compared to $1,725,300 (43.1% of revenue) for the
three months ended September 30, 2001. As mentioned above, the increased ratio
of Elvis Presley(R) games in the quarter lowered our gross profit percentage for
the quarter as compared to the same quarter last year. However, we now have
improved our gross profit percentage to above our target of 40%.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses were $1,252,700 (25.6% of
revenue) for the three months ended September 30, 2002 compared to $937,800
(23.4% of revenue) for the three months ended September 30, 2001. Salaries and
employee benefits increased approximately $100,900 this quarter due to increased
sales and marketing personnel for our international sales efforts and a new Vice
President of Creative Development who was hired to support our lottery customers
in innovative game promotion concepts.
Marketing, promotional and related travel expenses increased by $140,900
for a total of $291,800 for the three months ended September 30, 2002. More than
half of this increase was due to international marketing and promotions.
Lobbying expenses increased by $84,500 for a total of $135,600. Costs related to
both public reporting and investor relations decreased by approximately $23,000
for the three months ended September 30, 2002 compared to the three months ended
September 30, 2001.
MERGER COSTS
In connection with the Merger Agreement with Scientific Games, we incurred
merger and transaction costs of approximately $150,000 for the three months
ended September 30, 2002.
OPERATING PROFIT
The operating profit was $654,000 (13.4% of revenue) for the three months
ended September30, 2002 compared to an operating profit of $688,400 (17.2% of
revenue) for the three months ended September 30, 2001. The decrease in both
operating profit and its lower percentage of sales for the three months ended
September 30, 2002 is directly related to increased selling, general and
administrative expenses and on going merger costs discussed above.
NET INCOME
We had income before taxes of $646,800 for the three months ended September
30, 2002 compared to income before taxes of $686,500 for the three months ended
September 30, 2001. This decrease in income before taxes is due to the factors
described above, but particularly the costs related to the new merger
discussions. Excluding these costs, there would have been income before taxes of
$796,800 (16.3% of revenue) for the three months ended September 30, 2002. For
the three months ended September 30, 2002, we had income after taxes of
$146,000, compared to income after taxes of $651,700 for the three months ended
September 30, 2001.
The tax provision is made up of two components. The current tax provision
for the three months ended September 30, 2002 is $249,400. Additionally, upon
the preparation of the tax return extension for the tax year ended May 31, 2002
(which occurred during the quarter and ended September 30, 2002), it was
determined that book income exceeded taxable income by approximately $627,000,
mainly as a result of a number of large contracts that were not complete for tax
purposes as of that date. Based on current information, management determined
that a deferred tax liability of approximately $250,700 should be recorded to
reflect this obligation. This liability has been recorded as an additional
reduction in the deferred tax asset since the obligation will be offset by our
net operating loss carry-forward.
22
Earnings per share was $.01 per share on both a basic and fully diluted
basis for the three months ended September 30, 2002 compared to basic earnings
per share of $.06 and fully diluted earnings per share of $.05 for the three
months ended September 30, 2001.
LIQUIDITY AND CAPITAL RESERVES
As of September 30, 2002, we had cash of $871,437 compared to $251,600 as
of December 31, 2001. This significantly increased cash position was in part due
to the collection of receivables for games launched this quarter. Accounts
receivable decreased to $1,696,031 as of September 30, 2002 compared to
$2,709,500 as of December 31, 2001. On balance, it would appear we have less
liquid assets at September 31, 2002, however it should be noted we paid down the
remaining loan balance to our President and CEO of $110,000 and significantly
reduced our trade payables at September 30, 2002 to $369,700 from $1,112,900 at
December 31, 2001.
As of September 30, 2002, we had positive working capital of $1,606,700.
Included in current assets is $1,343,000 in deferred tax assets, a non-cash
asset. Also within current liabilities is $2,411,500 of "Billings in excess of
cost and estimated earnings on uncompleted contracts" representing unrecognized
revenue (i.e., amounts invoiced to, or received from our customers, but which
may not be recognized as revenue until we purchase the related contracted
merchandise). Accordingly, such liability will not adversely impact cash flow,
except to the extent that we need to purchase merchandise and incur subsequent
fulfillment costs relating to this revenue, which typically approximates 50% of
the related revenue. Without these two items, working capital would have been
$1,469,500.
We had no indebtedness as of September 30, 2002.
Our obligations and commitments to make future payments under licensing
agreements, lease and consulting agreements is summarized in the following
table:
Payments Due by Period
----------------------
CONTRACTUAL OBLIGATIONS Total 1-3 years 4-5 years
----------------------- ---------- ---------- ---------
License obligations ............... $2,962,502 $2,868,752 $93,750
Operating leases &
consulting agreements .......... 950,055 947,686 2,369
---------- ---------- ---------
Total contractual
obligations .................... $3,912,557 $3,816,438 $96,119
========== ========== =========
Notwithstanding those amounts presented in the above table, we do not have
any material capital commitments and do not currently anticipate making any
substantial expenditures other than in the normal course of business. We have
undertaken an aggressive program of acquiring new licenses, some of which may
require substantial up-front payments. Increasing competition of licenses,
including the relatively recent entrance to the field as a competitor by
Scientific Games and other lottery ticket printers, may adversely impact license
fees, which, in addition to the impact on liquidity, could also adversely impact
our operations.
As a result of our relatively low working capital position and inconsistent
cash flow, our President and Chief Executive Officer has, from time to time,
loaned money to us and personally guaranteed bonds to lotteries on our behalf.
Mr. Saferin is not obligated to extend such loans or make such guarantees and if
he does not do so in the future it could adversely affect us. In addition, we
currently have a $500,000 line of credit with a bank.
In light of the fact that our games represent a substantial amount of the
themed or branded type of lottery games offered in the United States, our
ability to expand revenue above that achieved in 2001 will depend on our ability
to expand internationally or develop new products. We cannot assure you that our
strategies to so expand or develop new products will be successful.
23
SEASONALITY AND REVENUE FLUCTUATIONS
Our business is not seasonal. However, our revenues are expected to
fluctuate as individual license-based promotions commence or wind down and
terminate. The useful life of a promotion is generally relatively short as the
novelty of the game or the popularity of the licensed material wanes over time.
In addition, our licenses (which are generally for 1.5 to 3 years) terminate at
various times over the next several years. The life span of a promotion, the
timing of agreements with the lotteries to run promotions, the acquisition of
new licenses and the commencement of new promotions are unpredictable. Also,
since most lotteries are government agencies with lottery executives appointed
by the state's governor or other high ranking official, opportunities or
projects in progress can be slowed after an election if the incumbent governor
is not re-elected. Accordingly, period-to-period comparisons may not be
indicative of future results.
24
ITEM 3. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures.
Our principal executive officer and principal financial officer, after
evaluating the effectiveness of our disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14(c) and 15d-14(c)) on November 19, 2002,
have concluded that, based on such evaluation, our disclosure controls and
procedures were adequate and effective to ensure that material information
relating to us was made known to them by others within MDI, particularly during
the period in which this Quarterly Report on Form 10-QSB was being prepared.
(b) Changes in Internal Controls.
There were no significant changes in our internal controls or in other
factors that could significantly affect these controls subsequent to the date of
their evaluation, nor were there any significant deficiencies or material
weaknesses in our internal controls. Accordingly, no corrective actions were
required or undertaken.
25
PART II
OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit 99.1 Certification pursuant to section 906 of the
Sarbanes-Oxley Act of 2002 (subsections (a)
and (b) of section 1350, chapter 63 of title
18, United States Code).
(b) Reports on Form 8-K Filed on July 16, 2002 (Item 5: Other Events -
Stockholder class action suit relating to the
proposed transaction with Scientific Games
Corporation had been dismissed - Date of Report
June 19, 2002).
Filed on August 16, 2002(Item 4: Changes to
Registrant's Certifying Accountants -
Determination to engage Scillia, Dowling &
Natarellli, LLC to serve as MDI's
independent accountants).
26
SIGNATURE PAGE
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Dated November 19, 2002
MDI ENTERTAINMENT, INC.
(Registrant)
By: /s/Steven M. Saferin
--------------------
Steven M. Saferin
President and Chief Executive Officer
and Director
(Principal Executive Officer)
By: /s/Kenneth M. Przysiecki
------------------------
Kenneth M. Przysiecki
Senior Vice President Accounting and
Administration, Secretary and Director
(Principal Financial and Accounting
Officer)
27
CERTIFICATION BY PRINCIPAL EXECUTIVE OFFICER
I, Steven M. Saferin, certify that:
1. I have reviewed this Quarterly Report on Form 10-QSB of MDI Entertainment,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 19, 2002 /s/ Steven M. Saferin
----------------------
Name: Steven M. Saferin
Title: President and Chief Executive Officer
28
CERTIFICATION BY PRINCIPAL FINANCIAL OFFICER
I, Kenneth M. Przysiecki, certify that:
1. I have reviewed this Quarterly Report on Form 10-QSB of MDI Entertainment,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 19, 2002 /s/ Kenneth M. Przysiecki
--------------------------
Name: Kenneth M. Przysiecki
Title: Senior Vice President, Accounting and
Administration and Corporate Secretary
29