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 JUNE 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 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 August 14, 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 JUNE 30, 2002
INDEX
-----
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements....................................................................3
Condensed Consolidated Balance Sheets as of June 30, 2002 (unaudited) and
December 31, 2001..........................................................................3
Condensed Consolidated Statements of Operations for the six months ended
June 30, 2002 and 2001 (unaudited).........................................................5
Condensed Consolidated Statements of Operations for the three months
ended June 30, 2002 and 2001 (unaudited)...................................................6
Condensed Consolidated Statement of Shareholders' Equity for the six months
ended June 30, 2002 (unaudited)............................................................7
Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 2002 and 2001 (unaudited)...................................................8
Notes to Unaudited Condensed Consolidated Financial Statements............................10
Item 2. Management's Discussion and Analysis...................................................14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings......................................................................27
Item 6. Exhibits and Reports on Form 8-K.......................................................28
Signatures.....................................................................................29
Exhibit 99.1...........................................................................Attachment
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2002 2001
-------------------- -----------------------
ASSETS (unaudited)
CURRENT ASSETS:
Cash $ 854,921 $ 251,578
Accounts receivable 2,608,133 2,709,543
Inventory 757,414 690,429
Deferred income taxes (Note 3) 1,343,000 1,343,000
Other current assets 459,032 338,049
-------------------- -----------------------
Total current assets
6,022,500 5,332,599
---------- ----------
PROPERTY AND EQUIPMENT, AT COST:
Equipment 289,484 305,312
Furniture and fixtures 169,967 120,361
Leasehold improvements - 8,751
-------------------- -----------------------
459,451 434,424
Less: Accumulated depreciation (256,738) (271,408)
-------------------- -----------------------
Property and equipment, net 202,713 163,016
-------------------- -----------------------
OTHER ASSETS:
Licensing costs, net 1,313,066 1,485,827
Deferred income taxes-long term (Note 3) 732,108 -
Other 40,967 23,467
-------------------- -----------------------
Total other assets 2,086,141 1,509,294
-------------------- -----------------------
Total assets $ 8,311,354 $ 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)
June 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) $3,111,483 $2,497,088
Note payable to officer 110,000 274,199
Accounts payable 1,432,229 1,112,880
Accrued expenses 514,740 734,302
-------------------- -----------------------
Total current liabilities 5,168,452 4,618,469
-------------------- -----------------------
COMMITMENTS AND CONTINGENCIES (NOTES 5 AND 6)
SHAREHOLDERS' EQUITY:
Common stock 11,764 11,639
Additional paid-in capital 5,650,441 5,609,657
Accumulated deficit (2,519,303) (3,234,856)
-------------------- -----------------------
Total shareholders' equity 3,142,902 2,386,440
-------------------- -----------------------
Total liabilities and
shareholders' equity $8,311,354 $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
Six months ended
June 30,
2002 2001
------------------- -------------------
(unaudited) (unaudited)
REVENUE $ 8,162,272 $6,685,465
COST OF REVENUES 5,196,825 3,724,105
------------------- -------------------
Gross profit 2,965,447 2,961,360
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES 2,432,864 1,785,101
TERMINATED MERGER COSTS (Note 8) 391,083 -
TERMINATED TRANSACTION COSTS (Note 8) 46,249 -
COST OF UNSUCCESSFUL FUNDING (Note 7) - 89,633
------------------- -------------------
Operating profit 95,251 1,086,626
INTEREST EXPENSE, net 11,951 119,972
OTHER EXPENSE (INCOME) 99,855 (110,166)
GAIN ON SALE OF INVESTMENTS, NET - (12,669)
------------------- -------------------
(Loss) income before (benefit) provision for income taxes (16,555) 1,089,489
(BENEFIT) PROVISION FOR INCOME TAXES (Note 3) (732,108) 12,035
------------------- -------------------
Net income $ 715,553 $ 1,077,454
=================== ===================
Basic Earnings Per Common Share (Note 4) $0.06 $0.10
=================== ===================
Diluted Earnings Per Common Share (Note 4) $0.05 $0.09
=================== ===================
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
June 30,
2002 2001
------------------ -------------------
(unaudited) (unaudited)
REVENUE $ 4,642,916 $3,563,467
COST OF REVENUES 2,927,210 2,004,222
------------------ -------------------
Gross profit 1,715,706 1,559,245
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES 1,222,663 911,557
TERMINATED MERGER COSTS (Note 8) 84,628 -
TERMINATED TRANSACTION COSTS (Note 8) 46,249 -
COST OF UNSUCCESSFUL FUNDING (Note 7) - 89,633
------------------ -------------------
Operating profit 362,166 558,055
INTEREST EXPENSE, net 5,170 42,212
OTHER EXPENSE (INCOME) - -
LOSS ON SALE OF INVESTMENTS, NET - 11,637
------------------ ------------------
Income before provision for income taxes 356,996 504,206
PROVISION FOR INCOME TAXES (Note 3) - 4,035
------------------ -------------------
Net income $ 356,996 $ 500,171
================== ===================
Basic Earnings Per Common Share (Note 4) $0.03 $0.04
================== ===================
Diluted Earnings Per Common Share (Note 4) $0.03 $0.04
=================== ===================
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 six months ended June 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, June 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 17,810
---------
Balance, June 30, 2002 5,650,441
----------
Accumulated Deficit:
Balance, December 31, 2001 (3,234,856)
Net income 715,553
----------
Balance, June 30, 2002 (2,519,303)
----------
Total Shareholders' Equity $3,142,902
==========
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
Six months ended
June 30,
2002 2001
------------------ -------------------
(unaudited) (unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 715,553 $ 1,077,454
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 926,302 416,368
Compensation expense 17,810 -
Gain on sale of investments, net - (12,669)
Deferred income tax benefit (732,108) -
Change in assets and liabilities:
Decrease (increase) in accounts receivable 101,410 (1,620,162)
Increase in inventory (66,985) (424,667)
Increase in licensing costs (733,147) (563,484)
Increase in other assets (138,483) (13,916)
Increase (decrease) in accounts payable 319,346 (21,286)
(Decrease) increase in accrued expenses (219,782) 693,329
Increase in income taxes payable 232 11,236
Increase in billings in excess of costs
and estimated earnings on uncompleted contracts 614,395 576,903
------------------ -------------------
Net cash provided by operating activities 804,543 119,106
------------------ -------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment, net (60,092) (10,654)
Proceeds of sale of investments - 192,669
------------------ -------------------
Net cash (used for) provided by investing activities (60,092) 182,015
------------------ -------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of debt (164,199) (477,266)
Proceeds from exercise of common stock options 23,099 6,600
------------------ -------------------
Net cash (used for) financing activities (141,100) (470,666)
------------------ -------------------
NET INCREASE (DECREASE) IN CASH 603,343 (169,545)
CASH, beginning of the period 251,578 528,151
------------------ -------------------
CASH, end of the period $ 854,921 $ 358,606
================== ===================
8
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Six months ended
June 30,
2002 2001
------------------ -------------------
(unaudited) (unaudited)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Interest $16,986 $ 56,213
Income taxes $ - $ 799
Non-cash investing and financing activities:
Stock compensation $17,810 $ -
Imputed interest on subordinated convertible debenture $ - $ 5,625
Conversion of subordinated debenture into common stock $ - $ 418,410
Common stock issued for services $ - $ 269,025
Expenses related to warrants $ - $ 1
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 JUNE 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 six-month periods ended June 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 six-month periods ended June 30, 2002 are 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
approximately 91% 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 June 30, 2002, no losses were expected from existing
contracts.
An additional approximate 7% 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.
10
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 recognized. During the
quarter ended March 31, 2002, the Company determined that it is more likely than
not that an additional $732,100 will be utilized in future years, and,
therefore, the remaining deferred tax asset was recognized.
4. EARNINGS PER SHARE
Basic earnings per common share are based on the average number of
common shares outstanding during the fiscal year. Diluted earnings per common
share include, in addition to the above, the dilutive effect of common share
equivalents during the year. For the three and six months ended June 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:
SIX MONTHS ENDED
JUNE 30,
----------
2002 2001
---- ----
Net income applicable to common shareholders $ 715,553 $1,077,454
=========== ==========
Basic:
Average number of common shares outstanding 11,739,175 11,018,145
Dilutive:
Dilutive effect of options, warrants and convertible securities 1,309,747 1,610,131
----------- -----------
Average dilutive common shares outstanding 13,048,922 12,628,276
========== ==========
THREE MONTHS ENDED
JUNE 30,
----------
2002 2001
---- ----
Net income applicable to common shareholders $ 356,996 $ 500,171
============ ==========
Basic:
Average number of common shares outstanding 11,763,829 11,172,306
Dilutive:
Dilutive effect of options, warrants and convertible securities 1,309,747 1,610,131
----------- -----------
Average dilutive common shares outstanding 13,073,576 12,782,437
========== ==========
11
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, office space and vehicles under
long-term leases, which expire during the next one to five years. The following
is a schedule of both continuing non-cancelable obligations associated with our
licensing agreements and future minimum rental payments required under operating
leases that have initial or remaining non-cancelable lease terms in excess of
one year as of June 30, 2002:
2002 ....................... $ 629,000
2003 ....................... 1,255,600
2004 ....................... 782,700
2005 ....................... 402,700
-----------
Total...................... $3,070,000
===========
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 has 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.)
7. COST OF UNSUCCESSFUL FUNDING
The Company recorded an expense of $89,633 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 six-month period ended June 30, 2001.
12
8. SUBSEQUENT EVENTS
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 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.
The Company had incurred certain legal, accounting and investment
banking fees relating to this terminated merger. These costs totaled $391,100 as
of June 30, 2002.
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 $46,200 at June 30, 2002.
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
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, film cells, 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. First, 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 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 represent
approximately 7% of our revenues.
14
Our second 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 represents approximately 91% 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.
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
PROPOSED MERGER WITH SCIENTIFIC GAMES CORPORATION
On February 26, 2002, we announced that we had executed a Letter of
Intent with Scientific Games Corporation ("Scientific Games") pursuant to which
Scientific Games would acquire all of our outstanding shares of common stock
(except for the 708,333 shares which were owned by Scientific Games) by
exchanging its shares for our shares at $2.10 per share. Pursuant to the Letter
of Intent, Steven M. Saferin, our CEO, President and principal stockholder,
would escrow approximately $1.8 million worth of Scientific Games common stock
subject to release upon the achievement of certain financial targets by the
acquired business over four years.
On May 8, 2002, we announced that the Company had mutually and amicably
agreed with Scientific Games to terminate our 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.
CLASS ACTION LAWSUIT BY SHAREHOLDERS
On February 28, 2002, a class action suit on behalf of our public
stockholders was filed in the Court of Chancery of the State of Delaware against
us, all of the members of our Board of Directors and Scientific Games, to enjoin
the proposed business combination transaction pursuant to which Scientific Games
would acquire the outstanding shares of our common stock which it did not
already own. In its complaint, the plaintiff alleged that the consideration
offered to our stockholders in the proposed acquisition was unfair and
inadequate because the plaintiff believed that the intrinsic value of our common
stock was materially in excess of the amount offered giving consideration to our
growth and anticipated operating results, net asset value, and future
profitability. The plaintiff further alleged that the defendants had approved a
proposal that favors their own interests over those of our public stockholders.
The plaintiff requested the Court to preliminarily and permanently enjoin us
from proceeding with, consummating or closing the proposed transaction and in
the event the proposed transaction was consummated, to rescind it and award
rescissory damages. In addition, the plaintiff requested that the court award to
the plaintiff compensatory damages.
15
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. We believed that the
lawsuits lacked merit and intended to contest them vigorously, however, the
termination of our merger agreement with Scientific Games mooted the complaints.
On June 19, 2002, all of these stockholder class action suits relating
to the proposed transaction with Scientific Games were dismissed without
prejudice in light of the termination of the negotiations with Scientific Games.
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 our outstanding common stock, exclusive of the shares which it currently
did not own, for $3.30 per share in cash. ICP owned 1,022,019 of our shares 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 our outstanding shares, exclusive of
the shares it already owned. 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 us 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 his shares to ICP.
GAME INTRODUCTIONS
During the quarter ended June 30, 2002, a total of 19 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 39. The
launches included eight Harley-Davidson(R) games, three Elvis Presley(R) games,
three games featuring NASCAR(R) Winston Cup drivers, and five other games
representing four other MDI licensed lottery brands.
Milestones during the quarter included the following:
1. FIRST MDI LICENSED GAME BUSINESS IN EUROPE AND ASIA. We achieved
our goal of expanding our market internationally using its lottery
license for the 2002 FIFA World Cup Korea/Japan(TM). Both the
China Sports Lottery and the French National Lottery licensed the
2002 FIFA World Cup Korea/Japan(TM) for lottery games in their
countries.
2. FIRST MDI LICENSED LOTTERY GAME IN TEXAS. The Texas Lottery
launched its Harley-Davidson(R) instant scratch game, breaking
existing sales records for the popular licensed brand.
16
3. FIRST PINK PANTHER(TM) LICENSED LOTTERY GAME. The Pennsylvania
Lottery became the first to introduce a lottery instant scratch
game featuring the name and images of the classic Pink Panther(TM)
animated character.
4. FIRST HEROES OF SPACE(TM) LICENSED LOTTERY GAME. The New Jersey
Lottery provided players with second chance opportunities to win
official NASA merchandise and grand prizes related to astronauts
and space travel in the first instant scratch game that serves as
a tribute to the astronauts involved in the U.S. space program.
5. FIRST MDI LICENSED LOTTERY GAME IN IDAHO. The power of the
Harley-Davidson(R) brand also went to work in Idaho, where the
Idaho Lottery offered its players the opportunity to win Harley(R)
motorcycles and merchandise in addition to cash in an instant
scratch game.
MDI's most popular property in terms of number of games, not
necessarily recognized revenue, during the quarter was Elvis Presley(R) with 11
lotteries offering Elvis(R) scratch games featuring vacation trips to Graceland
and licensed Elvis merchandise prizes. Nine Harley-Davidson(R) games were on
sale during the quarter. Eleven other MDI properties represented the other 19
games currently on sale.
The appeal of Harley-Davidson(R) games continues to surpass that of any
of our other licensed properties, with five of the nine games representing
lotteries' second edition of Harley games. At least 11 more lotteries plan to
introduce new Harley games during the manufacturer's 100th anniversary year,
which began in July 2002.
LICENSED PROPERTIES
Our most significant milestone during the quarter ended June 30, 2002
was the successful completion of negotiations with Sony Consumer Products for
the renewal of MDI's lottery license for the popular Wheel of Fortune(R) and
Jeopardy!(R) television shows. The shows continue their phenomenal success as
the #1 and #2 syndicated programs, with special 20th anniversary seasons ahead
for both Wheel of Fortune(R) (2002/03) and Jeopardy!(R) (2003/04). Renewed
through December 31, 2005, the new contracts represent the longest term in MDI's
licensing experience, maximizing the opportunity for customers to include Wheel
and Jeopardy! games in their planning.
We also successfully negotiated renewal of our contract with MGM
Consumer Products for the classic Pink Panther(TM) animated character, extending
territorial rights for the brand to the worldwide lottery market.
MDI continually evaluates new licensing opportunities in an effort to
offer lotteries worldwide with a broad selection of brands. During the quarter
ended June 30, 2002, we finalized and executed contracts for new licensed
properties, including I Love Lucy(R), the National Basketball Association/NBA,
Popeye(TM) and The Hulk(TM).
I Love Lucy(R) endures as a powerful consumer icon, more than 50 years
after the TV show made its debut. In its May 3, 2002 issue, TV Guide ranked I
Love Lucy(R) as the second most popular TV series of all time. The license
includes the use of the widely recognizable show logo, as well as various images
of Lucy, Ricky, Ethel and Fred in many of their most entertaining moments from
the show. Additionally, the license provides us access to a wide variety of
officially licensed I Love Lucy(R) merchandise.
The NBA(R) license represents a significant milestone in domestic
lottery marketing. The NBA is the first professional sports league to authorize
its imagery to be associated with government lottery tickets. MDI's license
provides lotteries with opportunities to use a variety of league and team
imagery and official NBA(R) merchandise.
17
Introduced in the 1920s, Popeye the Sailor Man(TM) is an
internationally known cartoon character. Licensed from King Features Syndicate,
Popeye's consumer awareness and appeal are higher than any other similar
character being marketed to lotteries, according to Q Score data from the
research firm Marketing Evaluations, Inc.
MDI acquired lottery rights for The Hulk(TM) from Universal Studios at
a time when classic comic book superhero characters are making a significant
contribution to consumer entertainment value in major motion pictures like
Spider-Man(TM) and Men In Black(TM). Our license will enable lotteries to
introduce games and promotions featuring exclusive logo and character images
tied to Universal's major motion picture, The Hulk(TM), in the summer of 2003.
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 June 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) and TABASCO(R) Hot Cash(TM) games. The first
Second Chance Bonus Zone(TM) web site was introduced during the quarter, in
support of the Virginia Lottery's Fast Cash (NASCAR(R) drivers) game.
Web sites are currently being developed for upcoming lottery promotions
related to Harley-Davidson(R), Lionel(R), Universal Studios Monsters(TM) and the
NBA.
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
Late last year we hired Ms. Evelyn Yenson as our Senior Vice President,
International Sales and Marketing, to focus on international development. 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 are both doing our 2002
FIFA World Cup Korea/Japan(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
Korea/Japan(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 World Cup(R) 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.
18
SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001
Six months ended June 30, 2002 and June 30, 2001
----------------------------------------------------------------
2002 % 2001 %
---- - ---- -
Total revenue $ 8,162,272 100.0% $6,685,465 100.0%
Cost of revenues 5,196,825 63.7% 3,724,105 55.7%
----------------------------------------------------------------
Gross profit 2,965,447 36.3% 2,961,360 44.3%
Selling, general and administrative expenses 2,432,864 29.8% 1,785,101 26.7%
Terminated merger costs 391,083 4.7% - -%
Terminated transaction costs 46,249 0.6% - -%
Cost of unsuccessful funding - -% 89,633 1.3%
----------------------------------------------------------------
Operating profit 95,251 1.2% 1,086,626 16.3%
Interest expense 16,983 0.2% 128,745 1.9%
Interest income (5,032) -0.1% (8,773) -0.1%
Other expense (income) 99,855 1.3% (110,166) -1.6%
Gain on sale of investments, net - -% (12,669) -0.2%
----------------------------------------------------------------
(Loss) income before (benefit) provision for income taxes (16,555) -0.2% 1,089,489 16.3%
(Benefit) provision for income taxes (732,108) -9.0% 12,035 0.2%
----------------------------------------------------------------
Net income $ 715,553 8.8% $1,077,454 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 represents 9% of our total revenue. Approximately 91% of our revenue for
the six months ended June 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.
19
Results for the six months ended June 30, 2002, reflect a 22.1%
increase in revenue. Revenue for the six months ended June 30, 2002 was
$8,162,300 compared to $6,685,500 for the six months ended June 30, 2001.
Overall revenue increased as a result of the increased game launches for the six
months ended June 30, 2002, compared to the six months ended June 30, 2001.
Harley-Davidson(R) took the lead away from Elvis with 32.1% of our revenue for
the six months ended June 30, 2002. Elvis Presley(R), however, is not far behind
with revenue representing 31.4% of our revenue for the six months ended June 30,
2002. NASCAR(R) continued strong in third place, representing 11.1% of our
revenue. The remaining 25.4% of our revenue for the six months ended June 30,
2002 was derived from 14 other licensed properties. During the quarter ended
June 30, 2002, we executed contracts for new licensed properties including I
Love Lucy(R), the National Basketball Association/NBA, Popeye(TM) and The
Hulk(TM). The appeal of Harley-Davidson(R) games continues to surpass that of
any other licensed property, with five of the nine games representing lotteries'
second edition of Harley games. At least 11 more lotteries plan to introduce new
Harley games during the manufacturer's 100th anniversary year, which begins in
July 2002.
COST OF REVENUE
Cost of revenue, as a percentage of revenue, increased to 63.7% from
55.7% for the six months ended June 30, 2002, compared to the six months ended
June 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 six-months ended June 30, 2002, which represented 31.4% of
our revenue. Elvis Presley(R) games, during the six months ended June 30, 2001,
represented only 15.3% 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 six months ended June 30, 2002, to
$2,965,400 (36.3% of revenue) compared to $2,961,400 (44.3% of revenue) for the
six months ended June 30, 2001. As mentioned above, this significant ratio of
Elvis Presley(R) games during this six-month period made it difficult to achieve
our target gross profit of 40%. Without the Elvis Presley(R) games, our gross
profit would have been approximately 40%.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general, and administrative expenses were $2,432,900 (29.8% of
revenue), for the six months ended June 30, 2002, compared to $1,785,100 (26.7%
of revenue) for the six months ended June 30, 2001. Salaries and employee
benefits increased approximately $254,200 during the six-month period ending
June 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
$143,900, for a total of $571,600 for the six-months ended June 30, 2002. Of
this total increase, approximately $100,000 represents 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 $138,000 for the six
months ended June 30, 2002.
20
Costs related to both public reporting and investor relations increased
significantly to $422,300 for the six months ended June 30, 2002 from $249,200
for the six months ended June 30, 2001. This increase is due to a $115,000
change in financial consulting expenses between the comparable six month period
ended June 30, 2001. Part of this increase is a result of a credit recorded
during the six-month period ended June 30, 2002, of $50,000 related to a
settlement of previously recorded consulting fees. Additionally, beginning in
2002, we have resolved to compensate outside directors for their work as members
of our Board. For the six months ended June 30, 2002, this total compensation
was $32,000. Operational expenses for our Fort Worth, Texas office totaled
approximately $34,700 in the six-months ended June 30, 2002, which did not exist
in the same quarter in 2001.
We have incurred certain legal, accounting and investment banking fees
related to the terminated merger with Scientific Games. These costs totaled
$391,100 for the six months ended June 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.
OPERATING PROFIT
The operating profit was $95,300 (1.2% of revenue) for the six months
ended June 30, 2002, compared to an operating profit of $1,086,600 (16.3% of
revenue) for the six months ended June 30, 2001. This decrease in operating
profitability is due to the factors described above, but particularly the costs
related to the terminated merger with Scientific Games and the unsuccessful
transaction with ICP. Without these two unsuccessful transactions, there would
have been operating profit for the six months ended June 30, 2002, of $495,200
(6.1% of revenue).
INTEREST EXPENSE
Interest expense was $17,000 for the six months ended June 30, 2002,
compared to $128,700 for the six months ended June 30, 2001. This reduction in
interest expense is related to the reduction of our short-term debt from
$477,700 at June 30, 2001, to $110,000 at June 30, 2002. In addition, the
results for the six months ended June 30, 2001, reflected interest expense
related to a Subordinated Convertible Debenture which was converted to equity
prior to 2002.
OTHER EXPENSE
Other expense was $99,800 for the six months ended June 30, 2002,
compared to other income of $110,200 for the six months ended June 30, 2001.
This net expense of $99,800 is primarily 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 comparble period ended June
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 six months ended June 30, 2001,
was attributable to the sale of shares of eLot stock held for investment.
NET INCOME
For the reasons set forth above, we have a loss before tax benefit of
$16,600 for the six months ended June 30, 2002, compared to income before taxes
of $1,089,500 for the six months ended June 30, 2001. Had we not incurred
expenses for the equity transactions that did not close with Scientific Games
Corp. and ICP, our net income before taxes for the six months ending 2002 would
have been $420,800 (6.4% of revenue).
21
Net income decreased to $715,600 for the six months ended June 30,
2002, compared to $1,077,500 for the six months ended June 30, 2001.
Contributing to the net income of $715,600 for the six months ended June 30,
2002 was the increase in the income tax benefit in the six months ended June 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. This determination was based on our profitability in 2001 and our
expectation of continued profitability. We have determined that profitability
will continue well into 2002 after reporting $3.5 million of revenue in the
first quarter followed by $4.6 million of revenue in the quarter ended June 30,
2002, and without the costs related to the terminated Scientific Games and ICP
transactions.
Basic earnings per share was $.06 and fully diluted earnings per share
was $.05 for the six months ended June 30, 2002, compared to basic earnings per
share of $.10 and fully diluted earnings per share of $.09 for the six months
ended June 30, 2001.
22
THREE MONTHS ENDED JUNE 30, 2002 COMPARED TO THREE MONTHS ENDED JUNE 30, 2001
Three months ended June 30, 2002 and June 30, 2001
----------------------------------------------------------------
2002 % 2001 %
---- - ---- -
(Unaudited) (Unaudited)
Total revenue $ 4,642,916 100.0% $3,563,467 100.0%
Cost of revenues 2,,927,210 63.0% 2,004,222 56.2%
----------------------------------------------------------------
Gross profit 1,715,706 37.0% 1,559,245 43.8%
Selling, general and administrative expenses 1,222,663 26.3% 911,557 25.6%
Terminated merger costs 84,628 1.9% - -%
Terminated transaction costs 46,249 1.0% - -%
Cost of unsuccessful funding - -% 89,633 2.5%
----------------------------------------------------------------
Operating profit 362,166 7.8% 558,055 15.7%
Interest expense 7,842 0.2% 48,531 1.5%
Interest income (2,672) -0.1% (6,319) -0.2%
Loss on sale of investment securities, net - -% 11,637 0.3%
----------------------------------------------------------------
Income before provision for income taxes 356,996 7.7% 504,206 14.1%
Provision for income taxes - -% 4,035 0.1%
----------------------------------------------------------------
Net income $ 356,996 7.7% $ 500,171 14.0%
================================================================
REVENUE
Revenue sources are from both merchandise based lottery promotions and
promotions that generate license or royalty fees only. License or royalty fee
revenue represents 7% of our total revenue. Approximately 93% of our revenue for
the three months ended June 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.
23
Results for the quarter ended June 30, 2002 reflect a 30.3% increase in
revenue. Revenue for the three months ended June 30, 2002 was $4,642,900
compared to $3,563,500 for the three months ended June 30, 2001. Overall revenue
increased as a result of the increased game launches for the three months ended
June 30, 2002 compared to the three months ended June 30, 2001. Harley-Davidson
took the lead away from Elvis Presley(R), which it held the two previous
quarters by representing 45.7% of the revenue for the three months ended June
30, 2002, Elvis Presley(R) dropped to second with revenue of 22%, followed by
NASCAR with 13.1% of our revenue for the three months ended June 30, 2002. The
remaining 19.2% of the revenue for the three months ended June 30, 2002 was
derived from 11 other licenses. During the quarter ended June 30, 2002, we
finalized and executed contracts for new licensed properties including I Love
Lucy(R), the National Basketball Association/NBA, Popeye(TM) and The Hulk(TM).
The appeal of Harley-Davidson(R) games continues to surpass that of any other
licensed property, with five of the nine games representing lotteries' second
edition of Harley games. At least 11 more lotteries plan to introduce Harley
games during the manufacturer's 100th anniversary year, which began in July
2002.
COST OF REVENUE
Cost of revenues as a percentage of revenue increased to 63.0% from
56.2% for the three months ended June 30, 2002 compared to the three months
ended June 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 this quarter which represented 22% of our revenue, compared
to 14.3% 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 June 30, 2002 to
$1,715,700 (37.0% of revenue) compared to $1,559,200 (43.8% of revenue) for the
three months ended June 30, 2001. As mentioned above, this significant ratio of
Elvis Presley(R) games in the quarter made it difficult to achieve our target
gross profit of 40%. Without the Elvis Presley(R) games our gross profit would
have been approximately 40.2%.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses were $1,222,700 (26.3% of
revenue) for the three months ended June 30, 2002 compared to $911,600 (25.6% of
revenue) for the three months ended June 30, 2001. Salaries and employee
benefits increased approximately $87,600 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 $86,300 for a total of $333,000 for the three months ended
June 30, 2002. Nearly all of this increase was due to international marketing
and promotions, which resulted in contracts in both France and China,
international lotteries that we have never penetrated before. They both launched
our 2002 FIFA World Cup Korea/Japan(TM) licensed game. The 2002 FIFA World Cup
Korea/Japan(TM) license or royalty fee revenue was approximately $50,000 for the
three months ended June 30, 2002.
Costs related to both public reporting and investor relations increased
to $155,300 for the three months ended June 30, 2002 from $114,500 for the three
months ended June 30, 2001. Most of this increase is related to paying our
outside directors compensation for sitting on the board. This compensation
totals $16,000 per quarter.
24
We incurred certain legal, accounting and investment banking fees
relating to the terminated merger with Scientific Games. Terminated merger and
transaction expenses incurred in the three months ended June 30, 2002 are
$131,000. 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 outstandig common stock of our Company.
OPERATING PROFIT
The operating profit was $362,200 (7.7% of revenue) for the three
months ended June 30, 2002 compared to an operating profit of $558,100 (15.7% of
revenue) for the three months ended June 30, 2001.
INTEREST EXPENSE
Interest expense was $7,800 for the three months ended June 30, 2002
compared to $48,500 for the three months ended June 30, 2001. This reduction in
interest expense is related to the reduction of our short term debt from
$477,700 at June 30, 2001 to $110,000 at June 30, 2002. In addition, the results
for the three months ended June 30, 2001 reflect interest expense related to a
Subordinated Convertible Debenture which was converted to equity prior to 2002.
LOSS ON SALES OF SECURITIES
The $11,600 loss on securities for the three months ended June 30, 2001
was attributable to the sale of eLot stock held for investment.
NET INCOME
For the reasons set forth above, we had a income before taxes of
$357,000 for the three months ended June 30, 2002 compared to income before
taxes of $504,200 for the three months ended June 30, 2001. This decrease in
income before taxes is due to the factors described above, but particularly the
costs related to the two terminated transactions. Without these costs there
would have been an income before taxes for the three months ended June 30, 2002
of $487,900 (10.5% of revenue). For the six months ended June 30, 2002, we had a
loss before taxes of $16,600, therefore, no taxes are required to be calculated
for the three months ended June 30, 2002.
Earnings per share was $.03 per share on both a basic and fully diluted
basis for the quarter ended June 30, 2002, compared to an earnings per share of
$.04 on both a basic and fully diluted basis for the quarter ended June 30,
2001.
LIQUIDITY AND CAPITAL RESERVES
As of June 30, 2002, we had cash and cash equivalents of $854,900
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 slightly to $2,608,100 as of June 30,
2002 compared to $2,709,500 as of December 31, 2001 reflecting the additional
collections in the current quarter ended June 30, 2002 contributing to our
improved cash position.
As of June 30, 2002, we had positive working capital of $854,000.
Included in current assets is $1,343,000 in deferred tax assets, a non-cash
asset. Also within current liabilities is $3,111,500 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
$1,066,800.
25
Our indebtedness as of June 30, 2002 was $110,000, consisting of a note
payable to our President and Chief Executive Officer.
Our obligations and commitments to make future payments under license
contracts consulting agreements, debt and lease agreements is summarized in the
following table:
PAYMENTS DUE BY PERIOD
----------------------
After 5
CONTRACTUAL OBLIGATIONS TOTAL 1-3 YEARS 4-5 YEARS YEARS
- ----------------------- ---------- ---------- --------- ---------
License obligations $2,722,500 $2,372,500 $350,000 $ -
Note payable to officer 110,000 110,000 - -
Operating leases &
consulting agreements 635,400 582,700 52,700 -
---------- ---------- ---------- ---------
Total contractual
obligations $3,467,900 $3,065,200 $402,700 $ -
========== ========== ========== =========
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, will also adversely impact
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.
Also, we currently have a $750,000 line of credit with a bank, of which $250,000
of this line is specifically for Letters of Credit to be utilized in the place
of performance bonds for lotteries that occasionally require them. We had not
drawn on the line as of June 30, 2002 or as of August 15, 2002. The disaster of
September 11, 2001 and the Enron collapse have contributed to an extremely tight
(if existent) performance bond market.
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.
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.
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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
CLASS ACTION LAWSUIT BY SHAREHOLDERS
On February 28, 2002, a class action suit on behalf of our public
stockholders was filed in the Court of Chancery of the State of Delaware against
us, all of the members of our Board of Directors and Scientific Games , to
enjoin the proposed business combination transaction pursuant to which
Scientific Games would acquire the outstanding shares of our common stock which
it did not already own. In its complaint, the plaintiff alleged that the
consideration offered to our stockholders in the proposed acquisition was unfair
and inadequate because the plaintiff believed that the intrinsic value of our
common stock was materially in excess of the amount offered giving consideration
to our growth and anticipated operating results, net asset value, and future
profitability. The plaintiff further alleged that the defendants had approved a
proposal that favors their own interests over those of our public stockholders.
The plaintiff requested the Court to preliminarily and permanently enjoin us
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 in light of the
termination of the negotiations with Scientific Games.
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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 May 9, 2002 (Item 5: Other Events -
Mutually and amicably terminated merger
negotiations between MDI Entertainment and
Scientific Games Corporation - Press release
dated May 8, 2002).
Filed on June 5, 2002, as amended on June
24, 2002 (Item 4: Changes to Registrant's
Certifying Accountants - Determination to
dismiss Arthur Andersen LLP as MDI's
independent auditors).
Filed on June 28, 2002 (Item 5: Other Events
- Announcement that MDI and ICP had mutually
agreed to terminate discussions relating to
ICP's proposal to acquire a majority
interest in MDI - Press Release dated June
27, 2002).
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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 August 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)
29