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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-KSB
(MARK ONE)
/X/ ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001.
/ / TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934.
COMMISSION FILE NO. 0-24919
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MDI ENTERTAINMENT, INC.
(Name of small business issuer in its charter)
DELAWARE 73-1515699
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
MDI ENTERTAINMENT, INC.
201 ANN STREET
HARTFORD, CONNECTICUT 06103
(Address of principal executive offices) (Zip Code)
Issuer's telephone number (860) 527-5359
SECURITIES REGISTERED UNDER SECTION 12(B) OF THE EXCHANGE ACT:
Title of each Class Name of each exchange on which registered
SECURITIES REGISTERED UNDER SECTION 12(G) OF THE EXCHANGE ACT:
COMMON STOCK, PAR VALUE $.001 PER SHARE
(Title of Class)
------------------------------------
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days. Yes X
No _
Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this
Form 10-KSB or any amendment to this Form 10-KSB. / /
State issuer's revenues for its most recent fiscal year: $14,661,952
Aggregate market value of the voting and non-voting common equity stock held
by non-affiliates computed by reference to the price at which the common equity
was sold, or the average bid and asked price of such common equity, as of a
specified date within the past 60 days: $12,999,146 as of March 4, 2002.
Shares of common stock outstanding as of March 4, 2002: 11,751,452
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement relating to its Annual Meeting
of Stockholders to be held in June 2002 are incorporated into Part III of this
report by reference
Transitional Small Business Disclosure Format (check one): Yes _; No X
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10-KSB
TABLE OF CONTENTS
PART I
Item 1. Description of Business..................................... 2
- Recent Developments....................................... 3
- Industry Overview......................................... 6
- Lottery Promotions........................................ 7
- Licensed Based Games...................................... 7
- Contracts with Lotteries.................................. 8
- Government Regulation..................................... 13
- Competition............................................... 14
- Intellectual Property..................................... 14
- History and Organization.................................. 15
- Potential Expansion of Business........................... 15
- Employees................................................. 16
- Risk Factors.............................................. 16
Item 2. Description of Property..................................... 20
Item 3. Legal Proceedings........................................... 21
Item 4. Submission of Matters to a Vote of Security Holders......... 22
PART II
Item 5. Market for Common Equity and Related Stockholder Matters.... 23
Item 6. Management Discussion and Analysis or Plan of Operation..... 24
Item 7. Financial Statements........................................ 30
Item 8. Changes In and Disagreements with Accountants or Accounting
and Financial Disclosure.................................. 30
PART III
Item 9. Directors, Executive Officers, Promoters and Control
Persons; Compliance with Section 16(a) of the Exchange
Act....................................................... 31
Item 10. Executive Compensation...................................... 31
Item 11. Security Ownership of Certain Beneficial Owners and
Management................................................ 31
Item 12. Certain Relationships and Related Transactions.............. 31
Item 13. Exhibits and Reports on Form 8-K............................ 31
1
THIS ANNUAL REPORT ON FORM 10-KSB CONTAINS STATEMENTS WHICH CONSTITUTE
FORWARD-LOOKING STATEMENTS. THESE STATEMENTS APPEAR IN A NUMBER OF PLACES IN
THIS FORM 10-KSB AND INCLUDE STATEMENTS REGARDING THE INTENT, BELIEF OR CURRENT
EXPECTATIONS OF MDI ENTERTAINMENT, INC. (TOGETHER WITH ITS SUBSIDIARY, REFERRED
TO IN THIS REPORT AS "WE", "US" AND "OUR") WITH RESPECT TO (I) OUR FINANCING
PLANS, (II) TRENDS AFFECTING OUR FINANCIAL CONDITION OR RESULTS OF OPERATIONS,
(III) THE IMPACT OF COMPETITION, AND (IV) THE EXPANSION OF CERTAIN OPERATIONS.
INVESTORS ARE CAUTIONED THAT ANY SUCH FORWARD-LOOKING STATEMENTS ARE NOT
GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE RISKS AND UNCERTAINTIES, AND THAT
THE ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE IN THE FORWARD-LOOKING
STATEMENTS AS A RESULT OF VARIOUS FACTORS. THE INFORMATION CONTAINED IN THIS
FORM 10-KSB, INCLUDING, WITHOUT LIMITATION, THE INFORMATION UNDER "RISK
FACTORS," "MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS" AND
"DESCRIPTION OF BUSINESS," IDENTIFIES IMPORTANT FACTORS THAT COULD CAUSE OR
CONTRIBUTE TO SUCH DIFFERENCES. SEE "DESCRIPTION OF BUSINESS--RISK FACTORS--ALL
FORWARD LOOKING STATEMENTS SHOULD BE READ WITH CAUTION."
PART I
ITEM 1. DESCRIPTION OF BUSINESS
MDI Entertainment, Inc. specializes in creating, marketing and implementing
entertainment-based promotions to North American lotteries. Our principal
business has been the scratch ticket segment of the government lottery industry,
although we have run on-line entertainment-based promotions with lotto and daily
numbers type games featuring our licensed HARLEY-DAVIDSON-Registered Trademark-
logo. Our lottery promotions feature well-known brand names and entertainment
properties licensed to us and designed to attract new lottery players while
providing a new experience for existing lottery players. Our current promotions
feature a wide variety of such brand names and entertainment properties
including:
- Wheel of Fortune(R)
- Jeopardy!(TM)
- Harley-Davidson(R)
- Betty Boop(TM)
- Louisville Slugger(R)
- Country Music Television(R)/CMT(R)
- Heroes of Space(TM)
- The Pink Panther(TM)
- Dale Earnhardt, Jr.(R)
- Jeff Burton(R)
- Mark Martin(R)
- Bill Elliott(R)
- Matt Kenseth(R)
- Elliott Saddler(R)
- Ken Schrader(R)
- Let's Get Ready to Rumble(R)
- Sports Legends(R)
2
- Ray Charles(R)
- SPAM(R)
- CowParade(R)
- Hollywood Sign(TM) and Hollywood Walk of Fame(TM)
- Elvis Presley(R)
- Emmett Kelly, Jr.(R)
- Hollywood Squares(R)
- Tabasco(R)
- Miss Cleo(R)
- Magic 8 Ball(R)
- Universal Studios Monsters(TM)
- FIFA World Cup(R)
- I Love Lucy(R)
- Lionel Trains(TM)
The scratch tickets feature the licensed properties, usually displaying a
scene and/or logo from the entertainment-based and brand name properties. 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 HARLEY-DAVIDSON-Registered Trademark- T-shirts and caps, and other
related merchandise such as posters, money clips, telephones and, in the case of
HARLEY-DAVIDSON,-Registered Trademark- HARLEY-DAVIDSON Sportster motorcycles. We
currently derive most of our revenues from the sales of such merchandise to the
lotteries. Merchandise associated with the licensed properties accounted for 90%
of the revenues for the years ended December 31, 2001 and 2000.
We offer a full range of services, including ticket and point of sale
design, prize structure development, promotional event planning, market
research, fulfillment services, customer service support and second chance
drawing assistance.
RECENT DEVELOPMENTS
MERGER WITH SCIENTIFIC GAMES CORPORATION
On February 26, 2002 we announced that we had executed a Letter of Intent in
which Scientific Games Corporation will acquire all of the outstanding shares of
MDI (except for the 708,333 shares which are currently owned by Scientific
Games) by exchanging its shares for our shares at $2.10 per share. Steve
Saferin, our CEO, President and principal stockholder, will escrow approximately
$1.8 million worth of Scientific Games common stock subject to release upon the
achievement of certain EBITDA (earnings before interest, taxes, depreciation and
amortization) targets by the acquired business over four years. The closing of
the transaction is subject to certain conditions including the execution of
definitive agreements, the completion of due diligence and shareholder approval
by MDI shareholders.
Steven Saferin, our CEO and President, will continue as CEO and President of
MDI, which will become a wholly owned subsidiary of Scientific Games. MDI will
operate as an autonomous business unit and will continue to offer its products
and services to all lotteries.
Information about Scientific Games can be found in Scientific Games' annual,
quarterly and current reports, proxy statements and other filings made with the
Securities and Exchange Commission. These filings may be examined and copies may
be obtained at the SEC's Public Reference Room located at 450 Fifth Street,
N.W., Room 1024, Washington, D.C. 20549. You may obtain information on the
operation of the public reference room by calling the SEC at 1-800-SEC-0330. SEC
filings are also available to the public on the SEC's Internet site at
http://www.sec.gov. Additionally, Scientific Games' common stock is quoted on
the Nasdaq National Market under the symbol "SGMS," and its SEC filings can be
obtained at the following Nasdaq address: Nasdaq Operations, 745 K Street, N.W.,
Washington, D.C. 20006, through the Securities and Exchange Commission.
3
CLASS ACTION LAWSUIT BY SHAREHOLDERS
On February 28, 2002, a class action suit on behalf of our public
stockholders (the "Plaintiff") 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 Corporation, to enjoin the previously disclosed proposed
business combination transaction pursuant to which Scientific Games would
acquire the outstanding shares of our common stock which it does not already
own. In its complaint, the Plaintiff alleges that the consideration offered to
our stockholders in the proposed acquisition is unfair and inadequate because
the Plaintiff believes that the intrinsic value of our common stock is
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 alleges that the defendants have approved a proposal that
favors their own interests over those of our public stockholders. The Plaintiff
has 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 has requested that the court
award to the Plaintiff compensatory damages. We believe that the lawsuit lacks
merit and intend to contest it vigorously.
EXPANSION AND IMPROVEMENT OF PRODUCT LINE
We continue to hold our position as the premier supplier of sole source
licensed lottery products through an aggressive program of renewing rights for
our most popular properties and establishing additional licenses in order to
provide lotteries a sustained inventory of products. Also, MDI continues to look
for every opportunity to improve the nature and the terms of existing licensor
contracts, to make them more cost efficient for us and to give them added value
for lottery customers.
Lotteries in North America have long been frustrated in their individual
attempts to establish promotional relationships with major league sports teams
in the U.S., all of which have had prohibitions against such relationships. Just
as it has done internationally with the World Cup (see "EXPANSION INTO
INTERNATIONAL MARKETS" below), we have stirred new interest among domestic
lotteries with our recent agreement-in-principal, with the National Basketball
Association, marking the first time in lottery history that a professional
sports league has agreed to lend its icons and imagery to lottery tickets. We
are currently negotiating a formal contract.
Other recently acquired licenses that we believe offer excellent potential
for lottery applications include I Love Lucy(R), the most popular TV show of all
time, and Magic 8 Ball(R), the popular party accessory that connects with other
similarly popular lottery instant game themes.
We recently completed successful renewal negotiations with IMC Licensing for
the Louisville Slugger-TM- property, improving the marketability of the license
by giving MDI better rates for Louisville Slugger-branded merchandise as well as
providing us with the rights to source merchandise independently, of Hillerich &
Bradsby's existing suppliers.
4
Only one other significant license comes up for renewal in 2002, MDI's
contract with Columbia Tri-Star Productions for the lottery rights to the Wheel
of Fortune-TM- and Jeopardy-TM- TV game shows. We enjoy an excellent
relationship with this licensor and are currently in negotiations to renew both
properties.
Not only is MDI maintaining its inventory of licenses, we continue to look
for ways in which we can utilize our relationships with licensors to diversify
MDI's product offerings. Having successfully made strides toward that end in
2001 by developing a multi-state Powerball advertising campaign under license
with legendary entertainer Ray Charles, we are currently developing other
similar ad campaign concepts to market to the lottery industry.
Finally, we are seeking to develop other lottery promotional applications
for our licenses, to expand the scope of our offerings from being primarily
associated with instant scratch tickets to having applicability for both scratch
ticket promotions and promotions associated with terminal-generated lottery
products (i.e. lotto games, daily numbers games). An internal committee has been
assigned to work on this project.
EXPANSION OF SALES RESOURCES
MDI is positioning itself both to become a more valued supplier resource to
its existing customers in North America, and to become a viable vendor of
licensed lottery products in the international lottery arena.
We continue to make some progress toward our long-term goal of capturing ten
percent of the domestic output of instant lottery tickets through "multiple
game" contract arrangements with lottery organizations. Such multiple game
contracts are designed to create sustained customer relationships and enable our
sales and marketing representatives to focus more on building added value into
the contracted promotions. That, in turn, should increase the prospect for the
promotions to meet or exceed customer expectations and that should, in turn,
elevate the likelihood of repeat business. It should also facilitate positive
word of mouth to other customer prospects in the industry. In 2001, we added
Virginia to New Jersey and Wisconsin as a lottery who has entered into a
long-term multiple game contract.
MDI's experience is that among the most significant benefits of its licensed
games is the ability of the games to become springboards for positive
promotional public relations for the lotteries, filling a gap that most
lotteries have previously come to expect is a "necessary evil" of their
longevity--i.e., consumer, retailer and media apathy. We have created a staff
position dedicated to working with lottery customers to maximize the promotional
opportunities associated with the our games. On February 1, 2002, Illinois
Lottery veteran Jeffrey Schweig joined the MDI staff to, specialize in adding
promotional value to each game under contract. Mr. Schweig is considered the
pre-eminent industry authority in this area.
After a year in which MDI became the first lottery industry vendor to
successfully implement integrated Internet promotions tied to its products, we
continue to improve our Internet development resources. Our experience is that
providing lottery consumers the convenience of entering promotional drawings via
the Internet, as opposed to mailing in drawing entries, holds significant value
for a large segment of lottery consumers. Supplying these supplemental
promotional web sites to lotteries holds continued promise of expanded business
for MDI in two significant areas. First, having established the consumer
service, delivered by MDI's systems, the lotteries desire to sustain the service
over time, lest they be perceived as taking away consumer value. Secondly, more
lotteries are determined to develop comprehensive Internet marketing platforms
and data bases, and MDI has demonstrated that the Internet component of its
promotions provides significant consumer rationale to encourage consumers to
become registered users in a lottery's Internet marketing data base.
MDI continues to develop new and better communications tools with which to
arm its sales force. Work has been completed on the first generation of a
comprehensive DVD presentation of MDI's credentials and licensed lottery
promotion experience. The presentation, which includes video testimonials from
several of MDI's lottery customers, as well as a library of media clips, sales
statistics and other product information, will be utilized as part of MDI's
sales presentations to lotteries. MDI also expects the presentation to be in
demand at upcoming lottery industry trade conferences. The DVD has worldwide
utility as a sales tool, having been produced in multiple languages (English,
French, Spanish and German).
5
EXPANSION INTO INTERNATIONAL MARKETS
We hired Ms. Evelyn Yenson as our Sr. 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, MDI products are now being actively marketed on every continent
where there are lottery jurisdictions.
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 soccer finals. Currently, we are
aggressively marketing the World Cup to the 32 nations that will send teams into
the competition that runs May 31--June 30, 2002. We are finding that, as
expected, owning rights to the World Cup 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 event. Because of a variety of
factors the World Cup itself has not been as successful as had been expected.
These factors include the current shift to the Euro by many European countries,
lotteries ongoing relations with their respective national football teams, a
poor track record of previous football games and a reluctance to pay licensing
and royalty fees.
Reacting to the expressed interest of lotteries outside of North America,
MDI has also recently negotiated an expansion of its North American lottery
rights from domestic to worldwide for MGM's Pink Panther-TM-. To the extent
practical, MDI is seeking international rights for other existing properties, as
it also seeks to identify viable consumer icons that have strong regional appeal
in foreign lottery markets.
INDUSTRY OVERVIEW
State, local and foreign governmental authorities operate lotteries in over
155 jurisdictions. Governments use lotteries primarily as a means of generating
non-tax revenues. In the United States, lottery revenues frequently are
designated for particular purposes, such as education, economic development,
conservation, transportation and aid to the elderly. Many states have become
increasingly dependent on lotteries as a significant source of funding for these
purposes.
While the specific amounts vary substantially from state to state, according
to LaFleur's Lottery World 1999 Fast Facts (an industry report), approximately
52% of gross lottery revenues in the United States is returned to the public in
the form of prizes. Approximately 32% of such revenues is used to support
specific public programs or is contributed to the state's general fund.
Typically, 5% to 6% of such revenues is reserved for point-of-purchase
commissions for the retailer, and the remainder of such revenues is used to fund
lottery operations, including the cost of advertising.
Government lotteries can be categorized into two principal groups: on-line
games and "instant" or "scratch" ticket games. On-line varieties generally refer
to games such as lotto, sports pools, daily numbers and keno in which players
make their own selections. Instant ticket games consist of preprinted tickets in
which players scratch off a coating or pull off tabs to determine whether they
have purchased a winning ticket. Instant ticket games generally have several
tiers of cash prizes, ranging from $1.00 up to $1,000,000. Occasionally, instant
ticket games provide for second chance drawings that give scratch ticket
purchasers a "second chance" to win prizes on non-winning tickets. Second chance
drawing prizes range from cash prizes or spots as contestants on game shows to
various types of merchandise and trips.
We are a leader in designing and marketing instant scratch ticket games
based on licensed brand names (such as Harley-Davidson-Registered Trademark- or
Louisville Slugger-Registered Trademark-) and entertainment properties (such as
Elvis Presley-Registered Trademark- or Wheel of Fortune-Registered Trademark-).
We attempt to identify properties for licensing that have a large selection of
logo bearing products available that appeal to the 18 years of age and older
population, and our instant ticket promotions typically include logo bearing
merchandise related to such promotion
6
as prizes. In most of our lottery promotions, merchandise is awarded as first
prizes, such as Harley Davidson(R) motorcycles. In most of
our designed games, second chance prizes typically include logo bearing
merchandise such as posters, T-shirts, caps, jackets, watches, clocks, money
clips, telephones, playing cards, film cells, video and music collections,
stadium blankets, carryall bags, credit cards with prepaid credit, trips and
electronic games. We generate 90% of our revenues from the sale of such
merchandise to the government agency sponsoring the lottery.
Cooperative marketing partnerships are not new to the lottery industry.
Lotteries have been securing licensed brand names in exchange for advertising
for years in hopes of expanding the player base by attracting non-players who
have positive feelings about a particular brand. Licensing the rights for
trademarked entertainment material, however, is relatively new. For the most
part, the practice of purchasing the right to place a popular brand name on a
lottery ticket gained acceptance with the introduction and subsequent sales
success of the Monopoly-Registered Trademark- game in 1989. Since then, lottery
jurisdictions have secured a wide variety of brands and properties for licensed
lottery games. The rights to use or license a particular property can be secured
by a lottery directly from the entity that owns the property or from companies
like ours.
The popularity and success of lotteries has increased worldwide in recent
years, and the popularity of instant lotteries has increased at a rate that is
greater than that of lotteries generally. Lotteries typically introduce between
25 and 50 new instant games a year. Currently, lotteries operate in 39 states,
the District of Columbia and all provinces of Canada. In November 2000 the
voters of South Carolina approved the 40th U.S. lottery which began selling
tickets in January.
According to LaFleur's Lottery World 1999 Fast Facts and LaFleur's 1999
North American Gambling Abstract, instant ticket games now comprise
approximately 39% of total lottery sales. Factors contributing to the growth in
the popularity and success of such games include more sophisticated marketing
techniques, the introduction of new state instant ticket lotteries, lotteries
offering multiple games simultaneously, increased technological advances in the
distribution of instant tickets, lotteries offering a variety of instant ticket
price points (a $1.00 ticket, a $2.00 ticket, a $3.00 ticket, a $5.00 ticket, a
$10.00 ticket and even a $20.00 ticket, the first of which was the Connecticut
Lottery's use of our Times Square 2000(TM) licensed property, with related
increases in the top prizes and higher prize award pay-outs to lottery
consumers.)
LOTTERY PROMOTIONS
We believe that to achieve and sustain growth in the lottery business we
must offer promotions which will attract new or lapsed lottery players while
maintaining or increasing play by current lottery players. Our principal
strategy is to enhance the entertainment value and attractiveness of our
promotions by licensing well known brand names and entertainment properties and
designing games based on such properties. Such games are targeted to niche
markets (such as Pink Panther-TM- fans or Harley-Davidson-Registered Trademark-
motorcycle enthusiasts) to appeal to new or infrequent players while also
appealing to the core player base.
LICENSED-BASED GAMES
We have secured rights to, and targeted specific properties for, instant
lottery theme games and promotions that have broad appeal and significant brand
loyalty and that enable us to market collectible logo bearing merchandise tied
directly to the property or brand. The properties are specifically selected
because they possess a substantial following that can aid a lottery in
attracting new players, while at the same time providing a different experience
for many existing players. Currently, we have licensing agreements with 27
companies for 33 licenses. Licenses are generally held between two and three
years. We hold three licenses with three companies that each resulted in 10% or
more of revenues and an aggregate of 69% of revenues in the year ended December
31, 2001. Three licenses resulted in 10% or more of our revenues in the year
7
ended December 31, 2001. Three licenses resulted in 10% or more of our revenues
and an aggregate of 58% of total revenues in the year ended December 31, 2000.
Only one license contributed to 10% or more of the revenues and an aggregate of
58% of total revenues in both years. Please refer to Footnote 1 in the
accompanying financial statements. We continually seek to add to our licensed
properties and, to this end, have contacted, and continue to contact, potential
licensors.
We derive 90% of our revenues from the sale to the lotteries of logo bearing
merchandise (such as T-shirts, posters, hats, playing cards, telephones, film
cells, stadium blankets, carryall bags, money clips, jackets, electronic games,
watches, clocks, motorcycles and credit cards with prepaid credit) used as
second chance prizes. We typically order such merchandise directly from the
licensor or its authorized representatives at wholesale rates, thereby
generating additional income for the licensor either from direct sales or
royalty income. Typically, we rely on third parties for data entry and
verification of the names and addresses on winning tickets, and work with a
third party fulfillment house to deliver prizes to winning lottery players.
Inventory of prizes is typically held and shipped to prize winners by the
fulfillment house. See "Risk Factors-We may be unable to provide merchandise to
the lotteries when needed."
Our licensing agreements generally require us to pay the licensor a fixed
amount per million tickets printed or a fixed percentage (ranging from 20%--50%)
of the license and royalty fees we collect. One licensing agreement requires a
50/50 share of gross profit. The agreements generally require an initial payment
upon signing, which is usually credited against other payments that become due
during the term of the license. One agreement required us to issue common stock
and warrants to purchase common stock upon signing. While all the licensing
agreements grant us the right to market merchandise to the lotteries, certain
agreements require that a minimum amount of merchandise be purchased. The term
of the license agreements usually ranges between 2 to 3 years and they are
sometimes terminable upon the occurrence of certain events. The licenses are
typically exclusive for lottery scratch tickets, and such exclusivity is
generally for the United States and Canada. In some cases, the licenses also
include specific regions of the world for which such rights are appropriate. We
are attempting to acquire worldwide or certain international rights for specific
new licenses and are seeking to obtain worldwide or certain international rights
on some existing licenses.
We have also obtained patents on play styles or formats for instant games
based on existing games of chance or probability games. Such games include Jacks
Or Better-TM-, Hold'Em Poker-TM-, Black Jack, Roulette, Draw Poker, and Pick 2
Spin-TM-. See "Intellectual Property." Promotions associated with such games
generate revenues from licensing fees and royalties rather than from merchandise
sales. We do not currently derive significant revenues from such games.
CONTRACTS WITH LOTTERIES
Our contracts with the lotteries provide for services that are tailored to
the preferences of the lotteries and include ticket and point of sale design,
prize structure development, promotional event planning, market research,
customer service support, second chance drawing assistance and fulfillment
services. The lottery contracts generally provide us with two sources of revenue
which consist of (1) license and royalty fees for the use of the entertainment
properties and (2) mark-up on the sale and fulfillment of collectible and logo
bearing merchandise. See "Licensed-Based Games."
8
We have had contracts with over 90% of all North American lotteries, and
currently have over 50 promotions that are in progress or scheduled for
introduction during calendar 2002 with 32 lotteries. Those states, in which we
currently have or have previously had promotions, are as follows:
STATE LOTTERY PROMOTIONS
--------------------------------------------- ---------------------------------------------
Arizona Lottery Harley-Davidson
Star Trek
Atlantic Lottery Wheel of Fortune
British Columbia Lottery Harley-Davidson
Holiday Harley
Wheel of Fortune
Hollywood Stars
Elvis*
California Lottery Harley-Davidson
Elvis*
Colorado Lottery Star Trek
Wheel of Fortune
Jacks or Better
Times Square 2000
Harley Davidson*
Connecticut Lottery Harley-Davidson
Jacks or Better
The New Millionaires
Nifty Fifties
Star Trek
Ray Charles Powerball Campaign
Times Square 2000
Delaware Lottery Double Feature
NASCAR
Elvis*
Ray Charles Powerball Campaign
D.C. Lottery Ray Charles Powerball Campaign
Ray Charles Instant Game*
Florida Lottery Bonanza Bingo
Wheel of Fortune I
Wheel of Fortune II
Harley-Davidson I
Harley Davidson II*
Elvis*
France, La Francais Du Jeaux World Cup*
Georgia Lottery Money Movies & Music
Ray Charles Advertising Campaign I
Ray Charles Advertising Campaign II
Ray Charles III*
Ray Charles Instant Scratch Ticket
9
STATE LOTTERY PROMOTIONS
--------------------------------------------- ---------------------------------------------
Hoosier Lottery Bonanza Bingo
Indiana's Greatest Sports & Headlines
Harley-Davidson
Money Movies & Music
Star Trek
Wheel of Fortune
SPAM
NASCAR Drivers*
Elvis*
Idaho Lottery Movie Mania
Harley Davidson*
Illinois Lottery The New Millionaires
Harley Davidson I
Harley Davidson II*
Iowa Lottery Harley-Davidson
Jacks or Better
Louisville Slugger
Fast Car Cash*
Ray Charles Powerball Campaign
Kansas Lottery Star Trek
Wheel of Fortune
Harley Davidson
Harley Davidson II*
Ray Charles Powerball Campaign
Kentucky Lottery Harley Davidson
Elvis
NASCAR Drivers*
Betty Boop*
Ray Charles Powerball Campaign
Louisiana Lottery Harley-Davidson
Elvis*
Jacks or Better
Money Movies & Music
Ray Charles Powerball Campaign
Maine Lottery Harley-Davidson
NASCAR Drivers*
Maryland Lottery Harley-Davidson
The New Millionaires
Michigan Lottery Harley-Davidson
Harley Davidson II*
Minnesota Lottery Great Moments in Minnesota Sports
Jacks or Better
Double Feature
SPAM
Ray Charles Powerball Campaign
10
STATE LOTTERY PROMOTIONS
--------------------------------------------- ---------------------------------------------
Missouri Lottery Great Moments in Missouri Sports
Harley-Davidson
Money Movies & Music
Wheel of Fortune
NASCAR Drivers*
Elvis*
Montana Lottery Lottery's Magic Moments
Nebraska Lottery Wheel of Fortune
New Hampshire Lottery Harley-Davidson
Star Trek
Elvis*
Ray Charles Powerball Campaign
New Jersey Betty Boop
Double Feature
Harley-Davidson
Harley-Davidson Ticket to Ride
Jacks or Better
Jacks or Better II*
Jeopardy!
Louisville Slugger
Lucky Video
Star Trek
Twilight Zone
Wheel of Fortune
Elvis
SPAM
NASCAR Drivers*
Hollywood Squares*
CMT*
Ray Charles Instant Ticket*
Ray Charles Powerball Campaign
Hollywood Squares*
Heroes of Space*
Tabasco*
New Mexico Lottery Harley-Davidson I
Harley Davidson II*
Tabasco*
New South Wales Lottery Elvis*
New York Lottery The New Millionaires
Wheel of Fortune
Ohio Lottery Double Feature
Great Moments in Ohio Sports
Harley-Davidson I
Harley-Davidson II*
The New Millionaires
NASCAR Drivers*
11
STATE LOTTERY PROMOTIONS
--------------------------------------------- ---------------------------------------------
Ontario Lottery Wheel of Fortune
Oregon Lottery 1 for the Money, 2 for the Show
Star Trek
Twilight Zone
Wheel of Fortune
Harley-Davidson*
Ray Charles Powerball Campaign
Pennsylvania Lottery Grand Slam
Great Moments in Pennsylvania Sports
Harley Davidson I
Harley Davidson II
Harley-Davidson III*
Harley-Davidson Pick 3 promotion
Heavenly Fortunes Calendar
Million Dollar Wheel of Fortune
Elvis*
Wheel of Fortune II*
NASCAR Drivers
Betty Boop*
Money, Movies and Music
The New Millionaires
Rhode Island Lottery Harley-Davidson
SPAM
Betty Boop*
Wheel of Fortune*
Ray Charles Powerball Campaign
South Dakota Lottery Double Feature
Elvis*
Harley-Davidson
SPAM*
NASCAR Drivers*
Ray Charles Powerball Campaign
Texas Lottery Great Sports Headlines of Texas
Money Movies & Music
Harley-Davidson*
Vermont Lottery Money Movies & Music
Virginia Lottery Bonanza Bingo
Harley-Davidson
Jacks or Better
Money Movies & Music
Star Trek
Wheel of Fortune
Elvis*
NASCAR Drivers*
Washington Lottery Double Feature
Money Mania
Western Canada Lottery Harley-Davidson
West Virginia Lottery Elvis*
Ray Charles Powerball Campaign
12
STATE LOTTERY PROMOTIONS
--------------------------------------------- ---------------------------------------------
Wisconsin Lottery Betty Boop
Be My Boop
Bonanza Bingo
Harley-Davidson
Holiday Harley
Jacks or Better I
Jacks or Better II
Louisville Slugger
(NASCAR Drivers) Race for Cash
Pepsi and Cash
Ray Charles
Star Trek
TNN Outdoors
Twilight Zone
Wheel of Fortune
Tabasco*
CMT*
Ray Charles Powerball Campaign
* Promotions in Progress or Scheduled for Introduction.
We derived more than 10% of our revenue for the year ended December 31, 2001
from contracts with the following lotteries: California and New Jersey. For year
ended December 31, 2000, we had contracts representing more than 10% of our
revenue with the New Jersey and Wisconsin lotteries.
GOVERNMENT REGULATION
Lotteries are not permitted in the various states and jurisdictions of the
United States unless expressly authorized by legislation in the subject
jurisdiction. Currently, 39 states and the District of Columbia have enacted
legislation to allow for the operation of a lottery. The operation of the
lotteries in each of these jurisdictions is strictly regulated. The formal rules
and regulations governing lotteries vary from jurisdiction to jurisdiction but
typically authorize the lottery, create the governing authority administering
the lottery, dictate the prize structure, establish allocation of revenues,
determine the type of games permitted, detail appropriate marketing structures,
specify procedures for selecting vendors and define the qualifications of
lottery personnel.
To ensure the integrity of the lottery, state laws provide for extensive
background investigations of each of the lottery's vendors and their affiliates,
subcontractors, officers, directors, employees and principal stockholders. These
investigations generally require detailed disclosure on a continuous basis with
respect to the vendors, affiliates, subcontractors, officers, directors,
employees and principal stockholders and, in the event the lottery deems any of
such persons to be unsuitable, the lottery may require the termination of such
persons. The failure of any of the persons associated with us to obtain or
retain approval in any jurisdiction could have a material adverse effect on us.
Generally, regulatory authorities have broad discretion when granting such
approvals. Although we have never been disqualified from a lottery contract as a
result of a failure to obtain any such approvals, we cannot assure you that such
approvals will be obtained or retained in the future. We have retained
governmental affairs representatives in various jurisdictions of the United
States to monitor legislation, advise us on contract proposals, and assist with
other issues that may affect us. We believe we have complied with all applicable
state regulatory provisions relative to disclosure concerning our activities.
We have employed registered lobbyists and retained paid consultants in
certain states. Failure to comply with state regulatory provisions relating to
the activities of our advisors could adversely affect our ability to
successfully negotiate future lottery contracts.
13
The international jurisdictions in which we intend to market our products
have similar legislation and regulations governing lottery operations. In
addition, restrictions are often imposed on foreign corporations seeking to do
business in such jurisdictions. Failure to comply with these provisions could
result in contract cancellation or the institution of legal proceedings.
Laws and regulations of individual states and countries are subject to
change. We cannot assure you that any such change would not adversely affect us.
Our failure to comply with such laws and regulations could have an adverse
impact on our operations.
COMPETITION
We are aware of several other companies, which design and promote lottery
games based on licensed brands. Each is marketing to a particular niche. Telecom
Productions, Inc. licenses a variety of brand name board games, including
Monopoly(R), Trivial Pursuit(R) and Battleship(R). Promo-Travel represents a
cruise line, various casino-theme properties, such as "Caesar's Palace," table
games like "Let It Ride" and "Caribbean Stud" and the slot machine "Megabucks."
More recently, Promo-Travel has attempted to secure entertainment-based licenses
and has negotiated with several of the same license holders with whom we have
had discussions and entered into agreements. Promo Travel recently obtained the
lottery license for the comic strip character Blondie. Several other companies
have made one-shot or sporadic licensing efforts. One instant ticket printer,
Oberthur Gaming Technology, has acquired the licenses to Beetle Bailey(TM) and
Slingo(TM). New competitors have recently entered this market and some
that enter in the future may have considerably greater financial and other
resources, experience and customer recognition than we do and may compete with
us in both obtaining licenses to brand names or entertainment properties and
supplying lottery products to the lottery jurisdictions. In addition, new
competition in our market may require us to reduce our profit margins and spend
more on advertising and marketing to remain competitive.
In addition, to the best of our knowledge, no other company has ever
attempted to utilize substantial quantities of merchandise with a licensed
lottery game. We have positioned ourselves to utilize such merchandise prizes.
Between 1989 and 1996, the majority of our lottery business had been the
distribution of videos, compact discs and audiocassettes as second-chance
prizes. We distributed nearly five million such prizes and experienced little to
no competition in this area of the business. See "--Risk Factors--Intense
competition could reduce our market share."
INTELLECTUAL PROPERTY
In 1996, we created our Licensed and Patented Games division. To launch this
division, we purchased the assets of a games development company, Vegas Pull
Tabs, Inc. d/b/a GameMakers and Consultants, an unaffiliated third party. Those
assets consisted primarily of a U.S. patent for a series of instant games. Due
to this acquisition, we own patents for certain game formats or playstyles of
Jacks Or Better(TM), and Hold'Em Poker(TM), (based on pre-existing games of
chance) Black Jack, Roulette and Draw Poker (based on pre-existing probability
games). We currently derive less than one percent of our revenue from such
games.
In 1998, we developed an on-line lottery game with the trademarked name Pick
2 Spin(TM). We have the exclusive rights to the trademarked name and have filed
a patent application for certain game elements. The Pick 2 Spin(TM) is a
two-digit numbers game, which combines two random drawings with a wheel spin.
With top prize game odds of one in 10,000, the Pick 2 Spin(TM) features a top
prize of $20,000. We began marketing the game to North American lotteries in
January 1999 and do not currently derive any revenues from the game.
14
Bonus Games, a Tennessee partnership, is the owner of the trademarked name
Jacks Or Better(TM). We have the exclusive license to the trademark name as it
pertains to scratch-off instant lottery tickets sold to North American lotteries
pursuant to a three-year agreement with Bonus Games dated May 1, 2001.
HISTORY AND ORGANIZATION
We are a Delaware corporation originally incorporated on December 29, 1994
under the name Puff Process, Inc. Our name was changed to MDI
Entertainment, Inc. and a one share for one hundred reverse stock split was
effected in connection with the purchase, in August 1997, of both Media Drop-In
Productions Inc., a Delaware corporation ("MDIP"), and MDI-Missouri, Inc., a
Missouri corporation, in exchange for 4,800,000 shares of our common stock and
notes in the aggregate principal amount of $300,000. The acquisition was
effected through reverse mergers with two of our wholly-owned subsidiaries.
These transactions resulted in a change in control, with Steven Saferin holding
approximately 56% of the outstanding shares of our common stock. See "--Risk
Factors--Existing stockholders are able to exercise control over us." Pre-merger
holders of Puff Process, Inc. held approximately 32.1% of the outstanding shares
of common stock immediately after the merger.
MDIP was incorporated in Texas in 1986 and reincorporated in Delaware in
1989. MDI-Missouri was incorporated in Missouri in 1995 to operate our Missouri
lottery program. MDI-Missouri was collapsed into MDIP after the Missouri lottery
contract ended in 1999. MDI-Texas, LLC, a company of which MDIP owned 66.7%, was
formed in 1995 to operate our Texas lottery program. MDI-Texas was collapsed
into MDIP after the Texas lottery contract ended.
Steven M. Saferin, President, Chief Executive Officer and Director, founded
MDIP in 1986. Its initial mission was the production and sale of quality drop-in
or vignette programming (30-second programs produced in a donut format to allow
an advertiser to insert its commercial in the "hole" of the donut). MDIP
produced a series of vignettes, which it sold to Fortune 500 companies, other
nationally known companies and government agencies. In 1989, MDIP began the
development of its first video premium promotion.
MDIP began focusing on lottery promotions in 1987 when it marketed a drop-in
series titled "The New Millionaires" to state lotteries. In 1990, it created and
began marketing its Instant Entertainment Connection ("IEC") lottery promotion.
This promotion, tied to an instant or scratch ticket, allowed lotteries to offer
second-chance entertainment prizes, such as video tapes, compact discs and audio
cassettes, to players with non-cash winning tickets. To date, this promotion has
been utilized by 21 U.S. lotteries, with nearly 5 million prizes distributed to
lottery players in those states. We have begun marketing this promotion on a
limited basis internationally. In 1996, we changed our focus to concentrate on
lottery games designed around licensed brand names and entertainment properties,
leveraging off of the experience and reputation gained from the IEC promotions.
See"--Lottery Promotions."
POTENTIAL EXPANSION OF BUSINESS
We have begun to actively market our products with international lotteries.
Several of our current licenses permit us to market the property outside the
United States. In 2001, we hired Evelyn Yenson as Senior Vice President of
International Sales and Marketing to oversee that function. We have had
discussions with certain of our other license holders about acquiring
international rights on a country-by-country basis. We cannot assure you that
such rights will be obtained. We are seeking full
15
international rights, if appropriate, for all new properties and have acquired
such rights for Elvis Presley(R) and the Hollywood Sign(R) and Hollywood Walk of
Fame(R), Ray Charles(R), The Pink Panther(R) and World Cup 2002(R). We have
commenced a limited international marketing effort and expect to expand this
effort in the year ahead. We have signed our second non-North American license
with the French Lottery, La Francais du Jeaux. The French Lottery will introduce
our World Cup 2002 license. Although we will likely pursue additional
opportunities with respect to international lotteries; such pursuits depend upon
our evaluation of the costs of international fulfillment, including import and
export duties, foreign taxation issues, currency exchange issues and the costs
of marketing and developing our reputation in international lottery
jurisdictions.
We are also evaluating other non-licensing entertainment related
opportunities. Our contract arrangement with Mr. Ray Charles for advertising
campaigns is an example of this type of additional promotional offering.
We have invested significant resources in developing a catalog and
E-Commerce business strategy called "lotteryprizeshop.com" and the Lottery Bonus
Zone. This initiative permits lottery players of our licensed games to use
non-winning tickets for discounts off the purchase of branded merchandise. This
initiative can only be implemented with the approval of each lottery and we
expect to compensate the lottery for their approval. We are continuing to
examine other Internet lottery initiatives relating to our licensed properties.
EMPLOYEES
As of March 1, 2002, we had 22 full-time employees, approximately 11 of whom
were employed in the area of sales and marketing, three in operations and eight
in administration. Our employees are not represented by a union or governed by a
collective bargaining agreement. We have entered into employment agreements with
Steven M. Saferin and Kenneth M. Przysiecki. See "Executive
Compensation-Employment Agreements." We have also entered into a consulting
agreement with 1010 Productions, Inc., the president and sole shareholder of
which is Linda Kesterson Saferin, spouse of Steven M. Saferin, and former
employee, officer and director of MDIP. See "Certain Relationships and Related
Transactions."
RISK FACTORS
ALL FORWARD-LOOKING STATEMENTS SHOULD BE READ WITH CAUTION. Statements in
this Annual Report on Form 10-KSB under the captions "Description of Business,"
"Management's Discussion and Analysis or Plan of Operations," and elsewhere in
this Form 10-KSB, as well as statements made in press releases and oral
statements that may be made by us or by officers, directors or employees acting
on our behalf, that are not statements of historical fact, constitute
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements involve known and
unknown risks, uncertainties and other factors, including those described in
this Form 10-KSB under the caption "Risk Factors," that could cause our actual
results to be materially different from the historical results or from any
future results expressed or implied by such forward-looking statements. In
addition to statements which explicitly describe such risks and uncertainties,
readers are urged to consider statements labeled with the terms "believes,"
"belief," "expects," "plans," "anticipates," or "intends," to be uncertain and
forward-looking. All cautionary statements made in this Form 10-KSB should be
read as being applicable to all related forward-looking statements wherever they
appear. Investors should consider the following risk factors as well as the
risks described elsewhere in this Form 10-KSB.
WE HAVE SIGNED A LETTER OF INTENT TO MERGE. On February 26, 2002, we
executed a Letter of Intent for Scientific Games to acquire all of the
outstanding shares of MDI (except for the 708,333 shares which are currently
owned by Scientific Games) by exchanging its shares for MDI shares at $2.10 per
MDI share. The closing of the transaction is subject to certain conditions
including execution of
16
definitive agreements, the completion of due diligence and shareholder approval
by MDI shareholders and, accordingly, we can not assure you that the merger will
be consummated on the proposed terms, if at all. Steven Saferin, CEO and
President of MDI Entertainment will continue as CEO and President of MDI, which
will become a wholly owned subsidiary of Scientific Games. MDI is expected to
operate as an autonomous business unit and will continue to offer its products
and services to all lotteries. You should be cautioned that should the merger
take place on the proposed terms, the value of any shares of MDI is fixed at
$2.10 per share and subsequent to the merger former shareholders of MDI, except
for those who pursue any applicable appraisal rights, will be subject to the
risks involved in owning stock of Scientific Games.
WE HAVE HAD LOSSES. Although we had a profit of $3,320,900 for the year
ended December 31, 2001, we incurred a loss of $(4,047,100) for the year ended
December 31, 2000. We cannot assure you that we will operate profitably in the
near future or at all.
WE MAY CONTINUE TO NEED FINANCING OR ADDITIONAL EQUITY TO MEET OUR FUTURE
CAPITAL REQUIREMENTS. As of December 31, 2001, our current assets exceeded our
current liabilities (including "billings in excess of costs and estimated
earnings on uncompleted contracts" totaling $2,497,100) by $714,100. In
September 2000, we raised $520,000 in the form of two short- term loans
originally maturing on January 31, 2001 from our President and Chief Executive
Officer, and from an unaffiliated individual. The loan from the unaffiliated
individual of $260,000 was subsequently extended until May 15, 2001 and paid at
that time. The $260,000 loan from our President and Chief Executive Officer is
currently due and payable on demand.
As a result of our uneven cash flow and the up front costs of obtaining
licenses, our President and Chief Executive Office 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. Moreover, we
may require additional financing to meet our needs. We have not determined the
amount we may seek to raise or the form of this financing (i.e. debt or equity).
We cannot assure you that we will obtain additional financing for future
operations or capital needs on favorable terms if at all.
WE MAY BE UNABLE TO MAINTAIN OR RENEW ALL OUR CURRENT LICENSES. Our success
will be dependent upon maintaining our current licenses for the rights to use
names and well known logo bearing merchandise. The terms of the current licenses
are generally for 2 to 3 years, although they may be terminated sooner under
certain circumstances. We cannot assure you that the current licenses will be
renewed once they expire. In addition, increased competition for licenses may
cause the terms and costs of renewed licenses to be less favorable than they had
been historically.
WE MAY BE UNABLE TO PROVIDE MERCHANDISE TO THE LOTTERIES WHEN NEEDED. We
supply the lotteries with logo bearing merchandise related to our contracts with
them. We obtain approximately 95% of this merchandise from authorized
representatives of the licensor. We cannot assure you that the logo bearing
merchandise will be available from such authorized representatives when needed
by us to satisfy our obligations to the lotteries.
WE MAY BE UNABLE TO ACQUIRE NEW LICENSES. Our success is dependent on our
ability to obtain rights to use well-known entertainment and other similar
properties for use on lottery tickets and related merchandise. We cannot assure
you that we will continue to obtain such licenses on favorable terms or at all,
particularly in light of increased competition.
WE DEPEND ON CUSTOMER RELATIONSHIPS WITH NORTH AMERICAN LOTTERIES AND
INTERNATIONAL EXPANSION INVOLVES RISKS. Many of our licensing rights are
currently limited to United States or North American lotteries. There are
currently 40 United States lotteries and five additional Canadian lotteries. The
extremely limited potential customer base means that if any target lottery
refuses to purchase a particular promotion from us or if it only uses a
promotion once, there may be a significant negative impact on our revenue and
earnings. The four state lotteries that purchased promotions accounting for the
highest percentage of our revenues during the year ended December 31, 2001 were
New Jersey, California, Pennsylvania and Florida with 21%, 11%, 9% and 8%,
respectively. We cannot assure you
17
that these lotteries will maintain the same level of promotions or that other
lotteries will increase promotions beyond current levels, or enter into
contracts with us at all. In addition, in fiscal 2001 our current lottery
customers represented a substantial portion of all U.S. lotteries. Accordingly,
substantial expansion may be difficult unless we expand outside the U.S., or
develop additional products. Expansion outside the U.S. involves numerous
difficulties and risks, including differing cultural and regulatory issues,
foreign currency issues and political risk.
WE HAVE NO ON-GOING SOURCES OF REVENUE. Our revenues are derived on a
contract-by-contract basis from state lotteries. There are no regular on-going
sources of revenue at the present time and we must continually create and market
new promotions to our lottery customers. Lotteries frequently move start dates
for promotions thereby causing gaps in our cash flow. 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. We may depend on a
particular promotion in any given year, and a decrease in sales of the promotion
or the loss of the underlying license would seriously impact our revenues and
earnings.
WE MAY BE ADVERSELY AFFECTED BY GOVERNMENT REGULATION OF LOTTERIES AND
GAMBLING. 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 reelected. There is a growing concern in the United States about
the explosion of gaming. The creation of The National Gambling Impact Study
Commission and its released report, may negatively impact state lotteries and
other gaming activities and hence our business. We cannot assure you that there
will not be an adverse change in the lottery laws of any jurisdiction in which
we do business. In addition, we cannot predict the nature of the regulatory
process in any jurisdiction that may authorize the use of instant tickets in the
future. Any such regulatory process may be burdensome to us and our customers or
their key personnel and could include requirements that we would be unable to
satisfy. See "Government Regulation."
EXISTING STOCKHOLDERS ARE ABLE TO EXERCISE CONTROL OVER US. Our officers
and directors beneficially own approximately 47% of the outstanding common stock
and Steven M. Saferin owns approximately 34%. Our Certificate of Incorporation
does not provide for cumulative voting for the Board of Directors. As a result,
Steven M. Saferin and management have substantial influence over the election of
a majority of our directors and the outcome of issues submitted to a vote of our
stockholders. See "Security Ownership of Certain Beneficial Owners and
Management."
THE LOSS OF THE SERVICES OF STEVEN M. SAFERIN COULD HARM OUR BUSINESS. Our
success depends to a significant extent on the performance and continued service
of Steven M. Saferin, an officer and director. MDI has entered into an
employment agreement with Mr. Saferin which expires on August 8, 2002 or three
years from the date we first file a registration statement with the SEC
registering all of his shares, whichever is later. We do not carry key man
insurance. See "Executive Compensation--Employment Agreements."
INTENSE COMPETITION COULD REDUCE OUR MARKET SHARE. We have traditionally
acquired exclusive rights to license entertainment and other properties to the
U.S. lottery industry. We have faced only one situation in which there was
substantial competition in acquiring such rights and we were the successful
bidder for these rights. Having that competition has forced us to pay more than
usual for such rights and we are experiencing lower gross profit margins on this
property. However, there are several organizations that also design and promote
lottery games and promotions based on licensed brands. One of these companies is
pursuing the types of entertainment properties we have targeted. In addition, it
is possible that potential licensors may design their own lottery games and seek
to market them directly to the lotteries, thus bypassing us. Other potential
sources of competition are the printers of instant tickets who, to improve their
own competitive standing, might attempt to acquire licensing
18
rights for various properties to offer exclusively to their lottery customers
and enhance their competitive bidding for lottery printing contracts. Scientific
Games has indicated that it may compete directly with us if the contemplated
merger is not consummated. See "Competition."
WE DO NOT ANTICIPATE PAYING ANY DIVIDENDS. We have never paid any cash or
other dividends on our common stock. At present, we do not anticipate paying
dividends on our common stock in the foreseeable future and intend to devote any
earnings to the development of our business. Investors who anticipate the need
for immediate income from their investment should refrain from purchasing our
common stock.
WE INDEMNIFY OUR DIRECTORS AND OFFICERS AGAINST CERTAIN EXPENSES AND
LIABILITIES. So far as permitted by the Delaware General Corporation Law, our
Certificate of Incorporation and By-Laws provide that we will indemnify our
directors and officers against expenses and liabilities they incur to defend,
settle or satisfy any civil or criminal action brought against them on account
of their being or having been directors or officers, including the pending
litigation relating to the proposed merger, unless, in any such action, they are
adjudged to have acted with gross negligence or to have engaged in willful
misconduct. As a result of such provisions, stockholders may be unable to
recover damages against our directors and officers for actions taken by them
which constitute negligence or a violation of their fiduciary duties, which may
reduce the likelihood of stockholders instituting derivative litigation against
directors and officers and may discourage or deter stockholders from suing our
directors, officers, employees and agents for breaches of their duty of care,
even though such action, if successful, might otherwise benefit us and our
stockholders.
FUTURE SALES OF COMMON STOCK BY OUR EXISTING STOCKHOLDERS COULD ADVERSELY
AFFECT OUR STOCK PRICE. The market price of our common stock could decline as a
result of sales of a substantial number of shares of our common stock in the
market, or the perception that such sales could occur. Our stock has not been
particularly liquid since we were delisted from NASDAQ and as a result our stock
price has been more influenced by relatively small trade volumes. Such sales
also might make it more difficult for us to sell equity securities in the future
at a time and at a price that we deem appropriate. As of the date of this
Form 10-KSB, we had 11,751,452 outstanding shares of common stock. Of these
shares, 6,631,736 shares of common stock are freely tradeable, not including an
aggregate of 8,840,872 shares (including shares underlying certain options,
warrants and notes) which may be sold pursuant to an effective registration
statement.
In March 2001, Scientific Games converted its subordinated convertible
debenture into 375,000 shares of common stock at a conversion rate of $2.00 per
share.
On November 1, 2001, 444 shares of Series B Preferred Stock, held by
eLot, Inc. were converted into 444,444 shares of common stock. These shares will
become eligible for resale in the public market from time to time. Elot
currently holds a warrant to acquire 555,556 shares of our common stock at an
exercise price of $3.50 per share.
As of the date of this Form 10-KSB, options to purchase a total of 1,312,500
shares of our common stock are outstanding. Of such options, options to purchase
517,500 shares are currently exercisable. In addition, warrants to purchase a
total 2,408,656 shares of our common stock are outstanding and all of such
warrants are exercisable.
We have filed a registration statement covering an aggregate of 2,373,621
shares including shares of our common stock issued upon conversion of our
Series A Preferred Stock and subordinated convertible debenture and shares
issuable upon the exercise of certain warrants. All shares covered by that
registration statement are freely tradable. If a large number of such shares are
sold in the public market, the price of our common stock may fall.
19
On February 26, 2002, we executed a Letter of Intent for Scientific Games to
acquire all of the outstanding shares of MDI (except for the 708,333 shares
which are curently owned by Scientific Games) by exchanging its shares for MDI
shares at $2.10. We cannot predict what impact, if any, the proposed merger will
have on the price of our comon stock, except that you should be cautioned that,
should the merger take place on the terms proposed, the value of any shares of
MDI will be fixed at $2.10 per share.
THERE ARE CERTAIN ANTI-TAKEOVER EFFECTS ASSOCIATED WITH THE ISSUANCE OF
"BLANK CHECK" PREFERRED STOCK. Our Certificate of Incorporation authorizes our
Board of Directors to issue up to 5,000,000 shares of "blank check" preferred
stock, of which 2,027 shares has been designated Series A Preferred Stock. The
Series A Preferred stock has been fully converted. A second issuance of 444
shares have been designated as Series B Preferred, all of which has been
converted to common stock. The Board of Directors, without stockholder approval,
may fix all the rights of the preferred stock. The issuance of such stock could,
among other results, negatively affect the voting power of the holders of common
stock.
Under certain circumstances, the issuance of the preferred stock would make
it more difficult for a third party to gain control of us, discourage bids for
the common stock at a premium, or otherwise adversely affect the market price of
our common stock. Such provisions may discourage attempts to acquire us.
We have no arrangement, commitment or understanding with respect to the
issuance of our preferred stock. We cannot assure you, however, that we will
not, in the future, issue additional shares of preferred stock.
WE MAY BE SUBJECT TO CERTAIN RISKS BY DOING BUSINESS INTERNATIONALLY. As we
begin to market our properties to international lotteries and explore
international lottery opportunities, we may be subject to certain risks
associated with doing business over-seas, including the necessity of complying
with local laws and regulations and political, economic and other uncertainties.
In addition, because some of our existing and prospective customers deal
predominantly in non-U.S. currencies, we are exposed to exchange rate risks,
which may cause our financial results to suffer. The obligations of customers
with substantial revenues in non-U.S. currencies may be subject to unpredictable
and indeterminate increases in the event that those currencies lose value
against the U.S. dollar. As a result of the risks in currency exchange, some of
our revenues may decrease. Although we expect to invoice our sales of services
in U.S. dollars, our prospective customers may derive their revenues in
currencies other than U.S. dollars. These customers may also become subject to
exchange control restrictions limiting their ability to convert their revenue
currencies into U.S. dollars, in which case they may not be able to pay us in
U.S. dollars.
To date, our non-U.S. business is principally done with Canada. We have
experienced stable exchange rates with respect to Canadian currency during the
time we have had ongoing contracts. We currently have no hedging contracts or
other financial instruments outstanding which would mitigate the effect of a
currency translation loss. See risk factors "WE DEPEND ON CUSTOMER RELATIONSHIPS
WITH NORTH AMERICAN LOTTERIES AND INTERNATIONAL EXPANSION INVOLVES RISKS" for
additional discussion of risks associated with doing business internationally.
ITEM 2. DESCRIPTION OF PROPERTY.
We maintain our executive offices in approximately 5,179 square feet of
space in Hartford, Connecticut pursuant to a lease expiring on December 31,
2004. We are renting an additional 1,200 square feet of space in the same
building to conduct lottery drawings and for records storage. We do not have an
option to renew. Monthly lease payments are approximately $7,018 per month. We
also maintain executive offices in approximately 2,200 square feet in Fort Worth
Texas pursuant to a lease
20
expiring September 30, 2004. We do not have an option to renew. Monthly lease
payments are approximately $3,025 per month.
ITEM 3. LEGAL PROCEEDINGS.
THE LOTTERY CHANNEL, INC.
On November 7, 2000, we and our subsidiary, MDI Acquisition, Inc., were
notified that we had been named as defendents in a complaint filed by the
Lottery Channel, Inc. on November 2, 2000 in the Hamilton County, Common Pleas
Civil Division, Cincinnati, Ohio, arising from our decision to terminate our
merger agreement with Lottery Channel. Lottery Channel is seeking to recover
$1,763,343.29 in costs and expenses, damages in excess of $25,000, attorney's
fees and costs in in prosecuting the action, punitive damages and any other
relief to which it is entitled.
Steven M. Saferin, our President and Chief Executive Officer, had filed a
complaint, in his individual capacity, against Roger W. Ach, II, the President
and Chief Executive Officer of Lottery Channel, seeking $108,000 as payment for
a promissory note, due July 30, 2000. Also, on December 19, 2000, we filed a
complaint in the United States District Court for the Southern District of New
York against John Doe, seeking compensatory and punitive damages for defamation
occurring on Internet message boards.
On February 20, 2002 we entered into a Settlement Agreement and Release with
the Lottery Channel, Inc., which provided for a mutual release of all claims
arising out of this litigation. In addition, Steven Saferin dismissed his
lawsuit against Roger W. Ach, II.
OXFORD INTERNATIONAL, INC.
We entered into a Stock Purchase Agreement with Oxford International, Inc.
with an effective date of April 25, 2001. Pursuant to that Agreement, we issued
to Oxford 2,100 shares of Series C Preferred Stock (the "Series C Stock")
representing approximately 15.8% of our outstanding common stock on an as
converted basis. We anticipated receipt of $3,200,000 in cash from this
transaction.
Oxford failed to pay the consideration of $3,200,000 required by the
April 25, 2001 Stock Purchase Agreement, and because of this failure, we did not
release our stock to Oxford and did not consider the transaction consummated.
We entered into an agreement with Oxford with an effective date of July 9,
2001 whereunder we agreed to accept securities of two publicly traded companies
valued in excess of $3.2 million, by reference to the closing prices of such
securities, as of the date of its receipt of the securities in lieu of the cash
investment Oxford agreed to make under the April 25, 2001 Stock Purchase
Agreement. Among other things, Oxford agreed that it would not be entitled to
nominate one member to our Board of Directors; that it could not require
performance of any matters under the Stock Purchase Agreement and Certificate of
Designations up to the date of July 9, 2001 Agreement, including but not limited
to payments of dividends; and that the Certificate of Designations was null and
void.
Subsequent to the receipt of the securities of the two publicly traded
companies from Oxford, the issuers of those securities and the Federal Bureau of
Investigation made assertions about Oxford. The FBI notified us of its
investigations of Oxford, but did not make any assertions concerning us or any
of our officers or directors. Neither MDI nor its officers and directors are
under investigation by the FBI as part of their investigation of Oxford. We were
advised that, in the view of the issuers of the publicly traded securities and
the FBI, the securities we received from Oxford are or may be subject to a
dispute between the issuers and Oxford, which could impair the liquidity and
value of the securities. If
21
the liquidity and value of the securities were, in fact, impaired, then we
believe we may have been defrauded by Oxford.
By letter dated July 27, 2001, we notified Oxford that, pursuant to the
July 9, 2001 Agreement, we were exercising our right to exchange the publicly
traded securities we received from Oxford for all of our stock issued to Oxford.
Oxford did not honor our exchange right. On August 6, 2001, we filed a
Motion For Temporary Restraining Order and Preliminary Injunction and a Verified
Complaint in the United States District Court of the District of Maryland
against Oxford and Gregory C. Dutcher.
On December 31, 2001 we settled the lawsuit brought by us against Oxford.
and Gregory C. Dutcher concerning our financing transaction with Oxford. In the
settlement, we returned stock of DataMEG and McClendon Transportation to Oxford.
Oxford returned our MDI Series C Preferred Stock, which had been issued to them
in exchange for the DataMEG and McClendon securities. We also received a
non-interest bearing promissory note in the principal amount of $100,000,
$10,000 of which was due on February 15, 2002 and the balance of which is due on
the earlier of December 31, 2003 or from the sales proceeds of 1,000,000 shares
of DataMEG stock placed in escrow. The market value of the DataMeg shares at
March 13, 2002 was $75,000. As of the date of this 10-K filing we have not
received the $10,000, which was due on February 15, 2002. We are carrying the
note as an asset on our balance sheet at December 31, 2001.
CLASS ACTION LAWSUIT BY SHAREHOLDERS:
On February 28, 2002, a class action suit on behalf of our public
stockholders (the "Plaintiff") 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 Corporation, to enjoin the previously disclosed proposed
business combination transaction pursuant to which Scientific Games would
acquire the outstanding shares of our common stock which it does not already
own. In its complaint, the Plaintiff alleges that the consideration offered to
our stockholders in the proposed acquisition is unfair and inadequate because
the Plaintiff believes that the intrinsic value of our common stock is
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 alleges that independent valuatons performed by our board
of directors before they approved the proposed transacton valued us in excess of
the value of the proposed transaction. The Plaintiff further alleges that the
defendants have approved a proposal that favors their own interests over those
of our public stockholders. The Plaintiff has 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 has requested that the court award to the Plaintiff compensatory
damages. We believe that the lawsuit lacks merit and intend to contest it
vigorously.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of our security holders during the
fourth quarter of 2001.
22
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
PRICE RANGE OF COMMON STOCK
Our common stock commenced trading on the OTC Bulletin Board on August 8,
1997 under the symbol "MDIH" and commenced trading on the Nasdaq SmallCap Market
on July 18, 2000 under the symbol "LTRY." The following table sets forth, for
the fiscal periods indicated, the high and low bid prices of a share of common
stock as reported by the OTC Bulletin Board under the symbol MDIH for periods
prior to July 18, 2000 and under the symbol "LTRY" in the Nasdaq SmallCap Market
for periods subsequent to July 18, 2000. Such quotations reflect inter-dealer
prices, without retail mark-up, mark-down or commission and may not necessarily
represent actual transactions.
HIGH LOW
-------- --------
CALENDAR YEAR 2000
1st Quarter............................................... $14.875 $1.375
2nd Quarter............................................... $10.062 $3.813
3rd Quarter............................................... $ 6.750 $2.031
4th Quarter............................................... $ 3.688 $ .781
CALENDAR YEAR 2001
1st Quarter............................................... $ 2.44 $1.00
2nd Quarter............................................... $ 2.60 $1.65
3rd Quarter............................................... $ 1.87 $1.00
4th Quarter............................................... $ 1.70 $1.05
As of March 4, 2002, the high and low bid prices per share of common stock
as reported by the Over the Counter Bulletin Board under the symbol LTRY:OB were
$2.00 and $1.87, respectively and there were approximately 1,146 holders of
record of the common stock.
We have not paid dividends on the common stock since inception and do not
intend to pay any dividends to our stockholders in the foreseeable future. We
currently intend to retain earnings, if any, for the development of our
business. The declaration of dividends in the future will be at the election of
the Board of Directors and will depend upon our earnings, capital requirements,
financial position, general economic conditions, and other factors the Board of
Directors deems relevant.
SALE OF PREFERRED STOCK
On November 1, 2000, we entered into a Stock Exchange Agreement with
eLot, Inc. We issued 444 shares of Series B Preferred Stock and a three year
warrant to purchase 555,556 shares of common stock at an exercise price of $3.50
per share to eLot in exchange for 1,000,000 shares of eLot common stock. The
Series B Stock paid no dividends and was converted into 444,444 shares of our
common stock on November 1, 2001.
We have granted eLot certain registration rights with respect to the resale
of our common stock issued to eLot. Such rights include certain piggy-back and
S-3 registration rights, as well as eLot's right to demand one registration
commencing any time after closing, subject to certain limitations.
In connection with this placement, we paid Venture Partners Capital, LLC, a
registered broker-dealer and related party, a 2% cash fee.
We received gross proceeds of $1,750,000 on August 4, 1999 from the private
sale to an investor of 2,027 shares of Series A Preferred Stock representing
approximately 20% of our outstanding common
23
stock on an as converted basis. The Series A stock had a liquidation preference
of approximately $863 per share and paid a dividend at the rate of 5% per annum,
payable in cash or common stock at our option and was convertible into an
aggregate of 2,027,000 shares of common stock, subject to adjustment under
certain circumstances. As of the date of this Form 10-KSB, all of the Series A
stock has been converted into common stock and registered. The holders of the
common stock converted from Series A stock continue to be entitled to certain
rights of first refusal as to new securities issued by us, subject to certain
exclusions.
In connection with the placement, we paid Venture Partners Capital, LLC, a
registered broker-dealer, a $140,000 cash fee and issued a seven-year warrant to
purchase 566,875 shares of common stock at $1.31 per share.
ISSUANCE OF A SUBORDINATED CONVERTIBLE DEBENTURE
On September 21, 1999, we issued a subordinated convertible debenture to
Scientific Games for $750,000. The Debenture bore interest at 7% per annum and
is payable semi-annually, on June 30 and December 31 of each year, until its
maturity on September 21, 2009. The Debenture was convertible at the option of
Scientific Games at the rate of $2.00 per share of common stock, subject to
adjustment under certain circumstances, into an aggregate of 375,000 shares of
common stock and was convertible at our option at any time after the earlier of
(a) September 21, 2001 or (b) after the underlying common stock was registered
pursuant to the Securities Act of 1933, as amended, and the price of the
Company's common stock exceeded $3.00 per share. On March 14, 2001, the
Debenture was converted into 375,000 shares of common stock; however, as a
condition of the early conversion, we continued to make payments in lieu of
interest until September 21, 2001.
In addition, on September 21, 1999, Steven M. Saferin sold to Scientific
Games 333,333 shares of his common stock at a price of $1.50 per share. In
connection with this placement, we paid Venture Partners Capital, LLC, a
registered broker-dealer, a $62,000 cash fee and issued it a seven year warrant
to purchase 226,020 shares of common stock at $1.25 per share.
Accounting principles generally accepted in the United States require that
the interest rate on debt represent a fair market rate for "comparable" debt
instruments. We have determined that a fair market rate for this debt would
approximate 10% and, therefore, have discounted the carrying value of the
liability, with the offsetting credit reflected as additional paid-in capital.
This subordinated debenture was converted into 375,000 shares of common
stock on March 14, 2001.
WARRANTS
During the year ended December 31, 2001, we issued warrants to purchase
25,000 shares of common stock at an exercise price of $2.25 as part of a
remuneration package paid to an independent consultant. During the year ended
December 31, 2000, we issued warrants to purchase 555,556 shares of common stock
at an exercise price of $3.50 as part of our stock exchange agreement with
eLot, Inc. We also issued warrants to purchase 100,000 shares of common stock at
an exercise price of $4.56 in consideration for a licensing agreement and
910,205 warrants at exercise prices ranging from $.88 to $3.94 representing
prepaid financing costs on certain short-term borrowing arrangements during the
seven months ended December 31, 2000.
All of such warrants were outside of our 1998 Stock Options and Award Plan.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
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
24
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 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
logo bearing 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 over ninety-five percent (95%) of our revenues from lotteries in
two distinct ways. First, we will usually charge a lottery a license and royalty
fee to utilize a particular licensed property as a lottery game. License fees
are a fixed assessment while royalties are a percentage of the printing cost of
the tickets. Contracts for licensed properties typically include an up-front
license fee and a royalty based on the manufacturing cost of tickets.
Manufacturing costs of tickets usually range from $10.00 per thousand to $30.00
per thousand. Actual costs depend on the size of the ticket and the quantity
printed. Ticket quantities range from about one million to as many as
60 million with an average quantity of about five million.
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.
Our success is dependent on our ability to maintain and secure licensed
properties, sell 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 2 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 properties and expect
to reach several agreements over the next six to 12 months; however we cannot
assure you that such agreements will
25
actually be reached. Some of these agreements may require the expenditures of
significant up-front advances.
YEARS ENDED DECEMBER 31, 2001 AND 2000
-----------------------------------------------
2001 % 2000 %
----------- -------- ----------- --------
Revenue............................................. $14,661,952 100.0% $ 4,976,967 100.0%
Cost of revenues.................................... 8,516,354 58.1% 3,228,505 64.9%
----------- ------ ----------- ------
Gross profit...................................... 6,145,598 41.9% 1,748,462 35.1%
Selling, general and administrative expenses........ 3,925,326 26.8% 3,929,984 79.0%
Terminated merger expenses.......................... -- 0.0% 727,025 14.6%
Cost of unsuccessful funding........................ 182,296 1.2% -- 0.0%
----------- ------ ----------- ------
Operating profit (loss)........................... 2,037,976 13.9% (2,908,547) -58.4%
Interest expense.................................... 146,658 1.0% 167,802 3.4%
Interest (income)................................... (17,010) -0.1% (12,867) -0.3%
Other (income) expense.............................. (113,046) -0.8% 172,818 3.5%
(Gain)/loss-investment securities................... (12,669) -0.1% 807,401 16.2%
----------- ------ ----------- ------
Income (loss) before (benefit) provision for income
taxes............................................. 2,034,043 13.9% (4,043,701) -81.2%
(Benefit) provision for income taxes................ (1,286,838) -8.8% 3,429 0.1%
----------- ------ ----------- ------
Net income (loss)................................. $ 3,320,881 22.6% $(4,047,130) -81.3%
=========== ====== =========== ======
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Results for the year ended December 31, 2001 reflected a net income of
$3,320,900 compared to a net loss of $(4,047,100) for the comparable year ended
December 31, 2000. The increase in net income was attributable to three major
factors. The first is significantly improved revenue. The second is operational
cost improvements resulting in both an improved gross profit margin and lowered
selling, general and administrative expenses. Thirdly, the effect of reversing
$1.3 million of a $2 million valuation allowance established for deferred tax
assets. These three factors are discussed in further detail below.
Revenue during the year ended December 31, 2001 was $14,662,000 compared to
$4,977,000 for the year ended December 31, 2000. This is an 195% increase in
revenue.
Revenue for the year ended December 31, 2001 was derived primarily from
sales of three entertainment-based or branded name properties. Of the total
revenue of $14,662,000, approximately 36% represented Harley Davidson(R), 19%
represented Elvis Presley(R) and 13% represented NASCAR Drivers(R). The
remaining 32% of revenue were derived from 13 other entertainment-based or
branded name properties.
Cost of revenue as a percentage of revenue decreased from 64.9% for the year
ended December 31, 2000 to 58.1% for the year ended December 31, 2001. This
improvement enabled us to achieve our Gross Profit goal of 40% or greater.
As a result of this improved cost of revenue percentage, we achieved a gross
profit of 41.9% for the year ended December 31, 2001 compared to 35.1% for the
year ended December 31, 2000.
Selling, general and administrative expenses totaled $3,925,300 for the year
ended December 31, 2001 compared to $3,930,000 for the year ended December 31,
2000. This reduction in overall costs is especially significant due to the
increase in revenue of 195% over the same twelve-month period in 2000. Payroll
and employee related benefits increased approximately $300,000 compared to the
same period in 2000. This increase is attributable to the increased sales
staffing needed to develop our regional and global sales organization, which
contributed to our increased revenue in 2001 and our current backlog of
$14.5 million as of December 31, 2001.
26
Increases in payroll and employee related benefits costs were partially
offset by a nearly $200,000 reduction in nonrecurring lobbying expenses and
financial consulting fees related to the failed Lottery Channel merger.
Convention and advertising were also approximately $80,000 less than last year
again due to the failed merger, in our attempt last year to position ourselves
jointly to the lottery industry.
Cost of unsuccessful funding of $182,300 for the year ended December 31,
2001 includes legal, accounting and investment banking fees associated with the
unsuccessful placement of our Series C preferred Stock with Oxford which is
discussed in greater detail in Part I, Item 3 "Legal Proceedings."
Operating income was $2,038,000 (13.9% of revenue) for the year ended
December 31, 2001 compared to an operating loss of $(2,909,000)(58.4% of
revenue) for the year ended December 31, 2000. This improvement was principally
due to the factors described above.
Interest expense was $146,700 for the year ended December 31, 2001 compared
to $167,800 for the year ended December 31, 2000. This decrease in interest
expense is attributable to the reduction in the amount of principal outstanding
on loans during the year ended December 31, 2001, more fully discussed in
"Liquidity and Capital Resources".
There was $17,000 of interest income for the year ended December 31, 2001
compared to $12,900 for the year ended December 31, 2000. This increase is
related to the increase in our cash position as compared to last year.
Other income was $113,000 for the year ended December 31, 2001 compared to
other expense of $172,800 for the year ended December 31, 2000. The $113,000 of
income this year was primarily attributable to an exchange of stock for reduced
billings owed to our attorneys, which was settled during the first quarter of
2001. The $172,800 of other expense for the year ended December 31, 2000 was
primarily the cost of 100,000 penalty shares of common stock issued as a result
of not timely filing a registration statement covering restricted stock issued
in January 2000 in a stock for debt exchange to improve our cash flow. The cost
attributable to those shares was $115,600. These shares could not be registered
on a timely basis due to the ongoing merger negotiations with Lottery Channel.
The remainder of other expenses for the year ended December 31, 2000 was
primarily attributable to a $60,000 favorable settlement of a lawsuit we
instituted, which, after legal costs, resulted in an expense of $51,000.
The gain on investment securities for the year ended December 31, 2001 was
$12,700 compared to a loss on investment securities of $807,400 for the year
ended December 31, 2000. The gain of $12,700 this year was attributable to the
sale of eLot, Inc. stock held as an investment. The loss of $807,400 was due to
the write down of our investment in eLot, Inc. stock to market value at
December 31, 2000.
For the reasons set forth above, we had a net income before taxes of
$2,034,000 for the year ended December 31, 2001 compared to a loss before taxes
of $(4,043,700) for the year ended December 31, 2000.
Net income after taxes increased to $3,320,900 for the year ended
December 31, 2001 compared to a loss of $(4,047,100) for the year ended
December 31, 2000. The reduction in income taxes in the year ended December 31,
2001 is attributable to our reversal of approximately $1.3 million of a deferred
tax asset valuation allowance. 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. We
have deferred tax assets related to net operating losses that can be utilized to
offset taxable income in future years. As of December 31, 2000, a valuation
allowance was recorded for these deferred tax assets. In 2001, we determined
that it is more likely than not that a portion of these deferred tax assets will
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.
Earnings per share was $.30 and $.28 on a basic and fully diluted basis for
the year ended December 31, 2001, compared to an earnings per share loss of
($.47) and ($.47) on both a basic and fully diluted basis for the year ended
December 31, 2000.
However, our pro-forma fully-taxed (i.e. operating income less the statutory
tax rate) basic and fully diluted earnings per share was $.12 and $.11 for the
year ended December 31, 2001, compared to a pro-forma fully-taxed basic and
fully diluted loss per share of ($.47) and ($.47) for the year ended December
31, 2000.
27
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2001, we had cash and cash equivalents of $251,600
compared to $528,200 as of December 31, 2000. This lower cash position at
December 31, 2001 is primarily attributable to increases in inventory and
reductions in accounts payable at year-end. In addition, $80,000 was spent to
acquire licenses in the fourth quarter of 2001. Short-term debt was also paid
down from $955,000 at December 31, 2000 to $274,200 at December 31, 2001. Trade
receivables increased to $2,709,500 at December 31, 2001 from $1,140,900 at
December 31, 2000.
As of December 31, 2001 we had positive working capital of $714,100.
Included in current assets is $1,343,000 in deferred tax assets, a non-cash
asset. Also within current liabilities is $2,497,100 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 subsequent
cash flow, except to the extent that we need to purchase merchandise and incur
subsequent fulfillment costs relative to this revenue, which typically
approximates 50% of the related revenue. Without these two items working capital
would have been $619,700.
As part of our continuing effort to improve working capital in
January 2001, we negotiated a stock for fees exchange with two of our law firms
and our investment banking firm. The cash flow savings from this exchange
totaled $364,410.
Our indebtedness as of December 31, 2001 was $274,200, consisting primarily
of a promissory note payable to our President and Chief Executive Officer, in
the amount of $260,000. The remainder represents the final payment due under an
installment loan payable to our President and Chief Executive Officer. As stated
earlier, we repaid $460,000 of short-term loans to unrelated parties late in the
second quarter ended June 30, 2001.
The convertible subordinated debenture, with an outstanding balance of
$558,750 was converted into common stock on March 14, 2001. Under the terms of
the conversion we paid the interest payments which would have been due through
September 21, 2001.
As more fully disclosed under "Recent Developments" in April 2001, we
entered into an agreement to sell Series C Convertible Preferred Stock for
$3.2 million. The funds were never received and attempts were made to
restructure the financing transaction. We agreed to accept securities in lieu of
cash. Ultimately, we decided to exercise our right to exchange these securities
for our stock. Such exchange right was not honored and ultimately we settled the
matter by returning the securities previously accepted in lieu of cash and
receiving our previously issued Series C Convertible Preferred Stock and a
non-interest bearing promissory note in the amount of $100,000. See Part I, Item
3 "Legal Proceedings."
Our obligations and commitments to make future payments under contracts 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
----------------------- -------- --------- --------- --------
Long-term Debt.................................. $ 274,199 $ 274,199 $ -- $ --
Employment Contracts............................ 557,000 557,000 -- --
Operating Leases................................ 392,387 345,560 46,827
---------- ---------- ------ -----
Total Contractual Cash.......................... $1,223,586 $1,176,759 $46,827 $ --
========== ========== ====== =====
Included in the above amounts is $400,000 payable to our President and Chief
Executive Officer, Mr. Saferin, for current fiscal year 2002. This amount was
agreed to by the board as his new compensation until a new employment agreement
was completed subject to a new bonus compensation plan being established for
both him and other management personnel. However, a $50,000 bonus for Mr.
Saferin was approved by the board for 2001. The proposed merger with Scientific
Games contemplates that Mr. Saferin will enter into a new employment agreement
with the surviving entity.
Notwithstanding those amounts presented in the above table, we do not have
any material capital commitments and do not currently anticipate making any
substantial expenditure other than in the normal course of business except that
there will be a number of expenses, including legal fees and
28
investment banking fees associated with the proposed merger and related
litigation. We have undertaken an aggressive program of acquiring new licenses,
some of which may require substantial up front payments. Increasing competition
of licenses may adversely impact 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 do not
currently have, but are seeking to obtain, a working capital line from a bank to
draw on during anticipated cash flow valleys. We cannot assure you that we will
be able to obtain a credit line on favorable terms if at all.
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 will be successful.
CRITICAL ACCOUNTING POLICIES
We have identified the policies below as critical to our business operations
and understanding of our results of operations. The impact and any associated
risks related to these policies on our business operations is discussed
throughout "Management's Discussion and Analysis of Financial Condition and
Results of Operations", where such policies affect our reported and expected
financial results. For a detailed discussion on the application of these and
other accounting policies, see Note 1 in the Notes to the Consolidated Financial
Statements in Item 14 of this Annual Report on Form 10-KSB, beginning on page
63. Note that our preparation of this Annual Report on Form 10-KSB requires us
to make estimates and assumptions that affect the reported amount of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenue and expenses during
the reporting period. There can be no assurance that actual results will not
differ from those estimates.
- REVENUE RECOGNITION. Our revenue recognition policy is significant because
our revenue is a key component of our results of operations. We follow
very specific and detailed guidelines in measuring revenue; however,
certain judgements affect the application of our revenue policy. Revenue
results are difficult to predict, and any shortfall in revenue or delay in
recognizing revenue could cause our operating results to vary
significantly from quarter to quarter.
- INCOME TAXES. Our income tax policy records the estimated future tax
effects of temporary differences between the tax bases of assets and
liabilities reported in the accompanying consolidated balance sheets, as
well as operating loss carryforwards. We follow very specific and detailed
guidelines regarding the recoverability of any tax assets recorded on the
balance sheets and provide any necessary allowances as required.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statements of Financial Accounting Standards No.133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). This statement establishes
accounting and reporting standards for derivative instruments and for hedging
activities. In June 1999, the FASB issued SFAS No. 138 "Accounting for
Derivative Instruments and Hedging Activities--Deferral of Effective Date of
SFAS No. 133." This has resulted in the deferral of SFAS No. 133 to fiscal years
beginning after June 15, 2000. The adoption of SFAS No. 133, as amended by SFAS
No. 138, did not have an impact on our financial condition or results of
operations.
29
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No 101, "Revenue Recognition in Financial Statements"
("SAB No. 101"). SAB No. 101, among other things, provides guidance on revenue
recognition. We adopted SAB No. 101 on January 1, 2000. Adoption of SAB No. 101
did not have an effect on our operating results or financial position.
On June 30, 2001 the FASB finalized Statements of Financial Accounting
Standards No. 141 "Business Combinations" and No.142, "Goodwill and Other
Intangible Assets". Adoption of SFAS No. 142 is required beginning with the
first quarter of 2002. We have no planned or anticipated business acquisitions,
which would be affected by SFAS No. 141. Our intangible amortization policies
are consistent with SFAS No. 142. Therefore, the implementation of these two
standards is not expected to have a material impact on our financial condition
or results of operations.
In August 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment
or Disposal of Long-Lived Assets". SFAS No. 144 modifies the rules for
accounting for the impairment or disposal of long-lived assets. The new rules
become effective for fiscal years beginning after December 15, 2001 with earlier
application encouraged. The adoption of SFAS No. 144 is not anticipated to have
an effect on our operating results or financial position.
On December 19, 2001, the Securities and Exchange Commission (SEC) announced
that it had adopted amendments to its proxy statements and Form 10-K rules
concerning disclosure of outstanding options, warrants and rights granted by
public companies under their equity compensation plans. The new release,
entitled "Disclosure of Equity Compensation Plan Information" is effective for
Annual Reports on Form 10-K for fiscal years ending after March 15, 2002 and for
proxy and information statements for meetings of, or actions to be taken by,
stockholders on or after June 15, 2002.
ITEM 7. FINANCIAL STATEMENTS.
The Financial Statements and Notes thereto can be found beginning on page
F-1, "Index to Consolidated Financial Statements," following Part III of this
Annual Report on Form 10-KSB.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
30
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT.
The information set forth under the caption "Proposal 2" in the Registrant's
Proxy Statement to be furnished in connection with its Annual Meeting of
Stockholders to be held in June 2002 is hereby incorporated by reference."
ITEM 10. EXECUTIVE COMPENSATION.
The information set forth under the caption "Proposal 2" in the Registrant's
Proxy Statement to be furnished in connection with its Annual Meeting of
Stockholders to be held in June 2002 is hereby incorporated by reference."
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information set forth under the caption "Proposal 2" in the Registrant's
Proxy Statement to be furnished in connection with its Annual Meeting of
Stockholders to be held in June 2002 is hereby incorporated by reference."
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information set forth under the caption "Proposal 2" in the Registrant's
Proxy Statement to be furnished in connection with its Annual Meeting of
Stockholders to be held in June 2002 is hereby incorporated by reference."
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
EXHIBIT
NO. DESCRIPTION
--------------------- -----------
3.1 Certificate of Incorporation of MDI Entertainment, Inc.
(f/k/a Puff Process Inc.) dated December 29, 1994, as
amended.(2)
3.2 Certificate of Amendment to the Certificate of Incorporation
of MDI Entertainment, Inc. dated February 28, 1999.(3)
3.3 Amended and Restated By-Laws of MDI Entertainment, Inc.
dated April 27, 1999.(5)
3.4 Certificate of Designations, Preferences and Rights of
Series A Preferred Stock, dated August 4, 1999.(4)
3.5 Certificate of Designations, Preferences and Rights of
Series B Preferred Stock, dated November 1, 2000.(10)
4.1 Registration Rights Agreement dated August 8, 1997, between
MDI Entertainment Inc., Steven M. Saferin and Agostino T.
Galluzzo.(1)
4.2 1998 Stock Option and Award Plan, dated September 22,
1998.(1)
4.3 Registration Rights Agreement dated August 4, 1999 between
MDI Entertainment, Inc. and International Capital Partners,
LLC.(4)
4.4 Stock Purchase Agreement dated August 4, 1999 between MDI
Entertainment, Inc. and International Capital Partners,
LLC.(4)
31
EXHIBIT
NO. DESCRIPTION
--------------------- -----------
4.5 Convertible Subordinated Debenture Purchase Agreement dated
September 21, 1999 between MDI Entertainment, Inc. and
Scientific Games, Inc.(6)
4.6 Convertible Subordinated Debenture dated September 21, 1999
between MDI Entertainment, Inc. and Scientific
Games, Inc.(6)
4.7 Purchase Agreement dated September 21, 1999 between Steven
M. Saferin and Scientific Games, Inc.(6)
4.8 Stockholders' Agreement dated as of January 26, 2000 between
MDI Entertainment, Inc., MDI Acquisition, Inc. and certain
parties listed therein.(7)
4.9 Stockholders' Agreement dated January 26, 2000 between The
Lottery Channel, Inc. and certain parties listed therein.(7)
4.10 Letter Agreement dated January 26, 2000 between Steven M.
Saferin and MDI Entertainment, Inc.(7)
4.11 Letter Agreement dated January 26, 2000 between Roger W.
Ach, II and MDI Entertainment, Inc.(7)
4.12 Form of Warrant, dated September 8, 2000.(9)
4.13 Stock Exchange Agreement, dated November 1, 2000, between
MDI Entertainment, Inc. and eLot, Inc.(10)
4.14 Warrant, dated November 1, 2000, issued to eLot by MDI
Entertainment, Inc.(10)
4.15 eLot Registration Rights Agreement, dated November 1, 2000,
between MDI Entertainment, Inc. and eLot, Inc.(10)
4.16 MDI Registration Rights Agreement, dated November 1, 20000,
between MDI Entertainment, Inc. and eLot, Inc.(10)
4.17 Form of Warrant, dated December, 2000.(11)
4.18 Form of Warrant issued to certain lenders.(12)
4.19 Warrant, dated April 15, 2001, issued to Sam DePhillipo.(13)
10.1 Second Amended and Restated Employment Agreement dated
August 8, 1997, as amended, between Media Drop-In
Productions, Inc. and Steven M. Saferin.(1)
10.2 Employment Agreement dated April 30, 1996, as amended,
between Media Drop-In Productions, Inc., Kenneth Przysiecki
and Steven M. Saferin.(1)
10.3 First Amended and Restated Consulting Agreement dated
August 8, 1997, between Media Drop-In Productions, Inc. and
1010 Productions, Inc.(1)
10.4 Lease dated June 1992, as amended, between Ann Street
Limited Partnership by Tunxis Management Co., II, and Media
Drop-In Productions, Inc.(1)
10.5 Amended Lease Agreement between KWK IV, LLC. and Media
Drop-In Productions,Inc. dated March 25, 1999.(5)
10.6 Agreement and Plan of Reorganization dated August 8, 1997,
between MDI Entertainment, Inc., MDI-Connecticut, Inc.,
MDI-Missouri, Inc. (DE), Media Drop-In Productions, Inc.,
MDI-Missouri, Inc. (MO), Steven M. Saferin and Agostino T.
Galluzzo.(2)
10.7 Commission Agreement dated December 20, 1994, between Media
Drop-In Productions, Inc. and Stamford Media Group, LLC.(2)
32
EXHIBIT
NO. DESCRIPTION
--------------------- -----------
10.8 Letter of Intent dated July 31, 1998, between MDI
Entertainment, Inc., Fancaster, Inc. and Craig Krueger.(2)
10.9 Strategic Alliance Agreement, dated September 2, 1999
between MDI Entertainment, Inc. and Scientific
Games, Inc.(6)
10.10 Agreement and Plan of Merger dated as of January 26, 2000
between MDI Entertainment, Inc., MDI Acquisition, Inc. and
The Lottery Channel, Inc.(7)
10.11 Loan Agreement dated, September 8, 2000, between Robert R.
Sparacino, Steven M. Saferin, Media Drop-In
Productions, Inc. and MDI Entertainment, Inc.(9)
10.12 Form of Media Drop-In Productions, Inc. Security Agreement,
dated September 8, 2000.(9)
10.13 Form of MDI Entertainment, Inc. Guaranty, dated
September 8, 2000.(9)
10.14 Form of MDI Entertainment, Inc. Security Agreement, dated
September 8, 2000.(9)
10.15 Strategic Alliance Agreement, dated November 1, 2000,
between MDI Entertainment, Inc. and eLot, Inc.(10)
10.16 Form of Loan Agreement with certain lenders.(12)
10.17 Form of Media Drop-In Productions, Inc. Security Agreement
with certain lenders.(12)
10.18 Form of MDI Entertainment, Inc. Guaranty with certain
lenders.(12)
10.19 Form of MDI Entertainment, Inc. Security Agreement with
certain lenders.(12)
10.20 Letter of Intent contemplating the acquisition of MDI
Entertainment, Inc. by Scientific Games Corporation.(14)
21.1 Subsidiaries of MDI Entertainment, Inc.(8)
------------------------
(1) Incorporated by reference from the Company's Form 10-SB, filed
September 28, 1998.
(2) Incorporated by reference from the Company's Amendment No. 1 to the
Form 10-SB, filed February 1, 1999.
(3) Incorporated by reference from the Company's Form 10-QSB for the period
ended February 28, 1999 (filed April 14, 1999).
(4) Incorporated by reference from the Company's Form 8-K filed August 12, 1999.
(5) Incorporated by reference from the Company's Form 10-KSB filed August 27,
1999.
(6) Incorporated by reference from the Company's Form 8-K filed October 4, 1999.
(7) Incorporated by reference from the Company's Form 8-K filed February 7,
2000.
(8) Incorporated by reference from the Company's Form 10-KSB for the year ended
May 31, 2000 (filed September 12, 2000).
(9) Incorporated by reference from the Company's Form 8-K filed September 13,
2000.
(10)Incorporated by reference from the Company's Form 8-K filed November 9,
2000.
(11)Incorporated by reference from the Company's Form S-3/A, filed January 19,
2001.
(12)Incorporated by reference from the Company's Form 10-QSB for the period
ended November 30, 2000 (filed January 22, 2001).
(13)Substantially similar to Form or Warrant listed as Exhibit 4.12.
(14)Incorporated by reference from the Company's 8-K filed February 26, 2002.
33
(b) Reports on Form 8-K
Form 8-K filed on July 31, 2001 (Item 5: Other Events--MDI exercises its
option to exchange stock it received from Oxford International, Inc. for MDI
stock issued to Oxford; correction to previously reported date of securities
trade halt by NASDAQ.)
Form 8-K filed on August 8, 2001 (Item 5: Other Events--Officer Changes and
Filing of Temporary Restraining Order, Preliminary Injunction and Verified
Complaint against Oxford International, Inc. and Gregory C. Dutcher.)
Form 8-K filed on August 23, 2001 (Item 5: Other Events--MDI accepted to
trade on the Over The Counter bulletin Board.)
Form 8-K filed on February 26, 2002 (Item5: Other Events--Letter of Intent
for merger with Scientific Games Corporation.)
Form 8-K filed on March 4, 2002 (Item5: Other Events--Settlement of lawsuits
with Oxford International, Inc. and The Lottery Channel, Inc.)
Form 8-K filed on March 4, 2002 (Item5: Other Events- Class action lawsuit
filed by shareholders of MDI)
34
SIGNATURE PAGE
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
MDI ENTERTAINMENT, INC.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ STEVEN M. SAFERIN President, Chief Executive Officer and
------------------------------- Director (Principal Executive March 19, 2002
Steven M. Saferin Officer)
In accordance with the Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the registrant in the capacities and
on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ STEVEN M. SAFERIN President, Chief Executive Officer and
------------------------------- Director (Principal Executive March 19, 2002
Steven M. Saferin Officer)
Sr. Vice President Accounting and
/s/ KENNETH M. PRZYSIECKI Administration, Secretary and
------------------------------- Director (Principal Financial March 19, 2002
Kenneth M. Przysiecki Officer)
/s/ ROBERT J. WUSSLER
------------------------------- Director March 19, 2002
Robert J. Wussler
/s/ TODD P. LEAVITT
------------------------------- Director March 19, 2002
Todd P. Leavitt
/s/ S. DAVID FINEMAN
------------------------------- Director March 19, 2002
S. David Fineman
/s/ WILLIAM G. MALLOY
------------------------------- Director March 19, 2002
William G. Malloy
35
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Public Accountants.................... F-3
Consolidated Balance Sheets................................. F-4--F-5
Consolidated Statements of Operations....................... F-6
Consolidated Statements of Shareholders' Equity (Deficit)... F-7--F-8
Consolidated Statements of Cash Flows....................... F-9
Notes to Consolidated Financial Statements.................. F-10--F-28
F-1
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2001 AND 2000
TOGETHER WITH
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
F-2
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of MDI Entertainment, Inc.:
We have audited the accompanying consolidated balance sheets of MDI
Entertainment, Inc. and subsidiary as of December 31, 2001 and 2000, and the
related consolidated statements of operations, shareholders' equity (deficit)
and cash flows for the years then ended. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of MDI
Entertainment, Inc. and subsidiary as of December 31, 2001 and 2000, and the
results of their operations and their cash flows for the years then ended in
conformity with accounting principles generally accepted in the United States.
/s/ ARTHUR ANDERSEN, LLP
Hartford, Connecticut
February 8, 2002,
(except with respect to the matters discussed in Notes 8 and 14,
as to which the date is February 28, 2002)
F-3
ITEM 1. FINANCIAL STATEMENTS
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2001 AND 2000
DECEMBER 31,
-----------------------
2001 2000
---------- ----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 251,578 $ 528,151
Investment securities available-for-sale (Note 7)......... -- 180,000
Accounts receivable....................................... 2,709,543 1,140,919
Inventory................................................. 690,429 285,301
Deferred income taxes (Note 9)............................ 1,343,000 --
Other current assets...................................... 338,049 451,983
---------- ----------
Total current assets.................................... 5,332,599 2,586,354
---------- ----------
PROPERTY AND EQUIPMENT, AT COST:
Equipment................................................. 305,312 250,456
Furniture and fixtures.................................... 120,361 120,361
Leasehold improvements.................................... 8,751 --
---------- ----------
434,424 370,817
Less: Accumulated depreciation and amortization........... (271,408) (212,137)
Property and equipment, net............................... 163,016 158,680
---------- ----------
OTHER ASSETS:
Licensing costs, net (Note 2)............................. 1,485,827 1,397,680
Other (Note 1)............................................ 23,467 363,482
---------- ----------
Total other assets...................................... 1,509,294 1,761,162
---------- ----------
Total assets............................................ $7,004,909 $4,506,196
========== ==========
The accompanying notes are an integral
part of these consolidated financial statements.
F-4
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000
DECEMBER 31,
-----------------------
2001 2000
---------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Billings in excess of costs and estimated earnings on
uncompleted contracts (Note 1).......................... $2,497,088 $2,888,985
Current portion of long-term debt (Note 3)................ 274,199 955,006
Accounts payable.......................................... 1,112,880 1,378,444
Accrued expenses.......................................... 734,302 214,271
---------- ----------
Total current liabilities............................... 4,618,469 5,436,706
SUBORDINATED CONVERTIBLE DEBENTURE (Note 4)................. -- 553,125
---------- ----------
Total liabilities....................................... 4,618,469 5,989,831
---------- ----------
COMMITMENTS AND CONTINGENCIES (NOTES 8, 10 & 14)
SHAREHOLDERS' EQUITY (DEFICIT) (NOTES 5 & 6)
Common stock.............................................. 11,639 10,505
Convertible preferred stock-Series B...................... -- 1
Additional paid-in capital................................ 5,609,657 5,061,596
Accumulated deficit....................................... (3,234,856) (6,555,737)
---------- ----------
Total shareholders' equity (deficit)........................ 2,386,440 (1,483,635)
---------- ----------
Total liabilities and shareholders' equity (deficit)........ $7,004,909 $4,506,196
========== ==========
The accompanying notes are an integral
part of these consolidated financial statements.
F-5
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000
2001 2000
----------- -----------
REVENUE..................................................... $14,661,952 $ 4,976,967
COST OF REVENUES............................................ 8,516,354 3,228,505
----------- -----------
Gross profit.............................................. 6,145,598 1,748,462
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES................ 3,925,326 3,929,984
TERMINATED MERGER EXPENSES.................................. -- 727,025
COST OF UNSUCCESSFUL FUNDING................................ 182,296 --
----------- -----------
Operating profit (loss)................................... 2,037,976 (2,908,547)
INTEREST EXPENSE, net....................................... 129,648 154,935
OTHER (INCOME) EXPENSE...................................... (113,046) 172,818
(GAIN)/LOSS--INVESTMENT SECURITIES, net..................... (12,669) 807,401
----------- -----------
Income (loss) before (benefit) provision for income taxes... 2,034,043 (4,043,701)
(BENEFIT) PROVISION FOR INCOME TAXES (NOTE 9)............... (1,286,838) 3,429
----------- -----------
Net income (loss)......................................... $ 3,320,881 $(4,047,130)
=========== ===========
Basic Earnings (Loss) Per Common Share...................... $ .30 $ (.47)
=========== ===========
Diluted Earnings (Loss) Per Common Share.................... $ .28 $ (.47)
=========== ===========
The accompanying notes are an integral
part of these consolidated financial statements.
F-6
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
FOR THE YEAR ENDED DECEMBER 31, 2001
SHARES AMOUNT
---------- ----------
Preferred Stock, par value $.001 per share, authorized
5,000,000 shares:
Series B, liquidation amount $2,252.25 per share:
Balance, December 31, 2000.............................. 444 $ 1
Conversion into common stock............................ (444) (1)
---------- ----------
Balance, December 31, 2001.............................. -- $ --
========== ==========
Common Stock, par value $.001 per share, authorized
25,000,000 shares:
Balance, December 31, 2000.............................. 10,505,872 $ 10,505
Stock options exercised................................. 30,109 30
Issuance of common stock................................ 283,500 284
Conversion of Series B Preferred Stock.................. 444,444 445
Conversion of subordinated debenture.................... 375,000 375
---------- ----------
Balance, December 31, 2001.............................. 11,638,925 11,639
---------- ----------
Additional Paid-in Capital:
Balance, December 31, 2000.............................. 5,061,596
Stock options exercised................................. 6,570
Issuance of warrants.................................... 28,001
Issuance of common stock................................ 313,734
Compensation attributable to employee stock options..... (13,000)
Conversion of Series B Preferred Stock.................. (444)
Conversion of subordinated debenture.................... 213,200
----------
Balance, December 31, 2001.............................. 5,609,657
----------
Accumulated Deficit:
Balance, December 31, 2000.............................. (6,555,737)
Net income.............................................. 3,320,881
Balance, December 31, 2001.............................. (3,234,856)
----------
Total Shareholders' Equity, December 31, 2001............... $2,386,440
==========
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
FOR THE YEAR ENDED DECEMBER 31, 2000
SHARES AMOUNT
----------- -----------
Preferred Stock, par value $.001 per share, authorized
5,000,000 shares:
5% Series A, liquidation amount $863.34 per share
Balance, December 31, 1999.............................. 2027 $ 2
Converted to common..................................... (2027) (2)
----------- -----------
Balance, December 31, 2000.............................. -- --
=========== ===========
Series B, liquidation amount $2,252.25 per share
Balance, December 31, 1999.............................. 0 --
Issued.................................................. 444 1
----------- -----------
Balance, December 31, 2000.............................. 444 1
----------- -----------
Common Stock, par value $.001 per share, authorized
25,000,000 shares:
Balance, December 31, 1999.............................. 8,337,770 8,336
Stock options exercised................................. 442,128 443
Issuance of Common stock................................ 200,624 200
Conversion of series A convertible preferred stock to
common stock.......................................... 1,521,000 1,521
Preferred stock dividend paid in common stock........... 4,350 5
----------- -----------
Balance, December 31, 2000.............................. 10,505,872 $ 10,505
=========== ===========
Additional Paid-in capital:
Balance, December 31, 1999.............................. 2,042,016
Conversion of Series A convertible preferred............ (1,520)
Stock options exercised................................. 133,686
Issuance of common stock................................ 615,400
Issuance of Series B preferred stock.................... 569,653
Issuance of warrants.................................... 1,290,799
Beneficial conversion feature of Series B preferred
stock................................................. 430,346
Preferred stock dividend paid in common stock........... 26,397
Compensation attributable to employee stock options..... 20,944
Cost of issuing Series B preferred stock................ (70,673)
Other................................................... 4,548
-----------
Balance, December 31, 2000.............................. 5,061,596
-----------
Accumulated Deficit:
Balance, December 31, 1999.............................. (2,051,876)
Dividends on Series A preferred stock................... (26,385)
Beneficial conversion feature of Series B preferred
stock................................................. (430,346)
Net loss................................................ (4,047,130)
-----------
Balance, December 31, 2000.............................. (6,555,737)
-----------
Total Shareholders' Deficit................................. $(1,483,635)
===========
The accompanying notes are an integral part of these consolidated financial
statements.
F-8
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000
2001 2000
---------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)......................................... $3,320,881 $(4,047,130)
Adjustments to reconcile net income (loss) to net cash
provided by (used for) operating activities:
Depreciation and amortization......................... 1,019,364 305,818
Stock expense......................................... 31,730 196,897
(Gain) Loss on investments............................ (12,669) 807,401
Deferred income tax asset............................. (1,343,000) --
Change in assets and liabilities:
Increase in accounts receivable..................... (1,568,624) (775,914)
Increase in inventory............................... (405,128) (175,514)
Increase in licensing costs......................... (1,032,802) (288,120)
Decrease (increase) in other assets................. 126,961 (142,350)
Increase in accounts payable........................ 3,725 1,140,884
Increase in accrued expenses........................ 466,705 177,937
Increase in income taxes payable.................... 53,326 6,481
(Decrease) increase in billings in excess of costs
and estimated earnings on uncompleted contracts... (391,897) 1,707,044
---------- -----------
Net cash provided by (used for) operating
activities.......................................... 268,572 (1,086,566)
---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment........................ (63,607) (60,931)
Proceeds of sale of investments........................... 192,669 --
---------- -----------
Net cash provided by (used for) investing
activities.......................................... 129,062 (60,931)
---------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
(Repayment) borrowing of debt............................. (680,807) 48,968
Proceeds from short-term debt............................. -- 520,000
Costs of issuing Series B preferred stock................. -- (70,672)
Proceeds from exercise of common stock options............ 6,600 153,350
Other..................................................... -- 4,546
---------- -----------
Net cash (used for) provided by financing activities.... (674,207) 656,192
---------- -----------
NET DECREASE IN CASH (276,573) (491,305)
CASH, beginning of the year................................. 528,151 1,019,456
CASH, end of the year....................................... $ 251,578 $ 528,151
========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Interest.................................................. $ 111,738 $ 75,244
Income taxes.............................................. $ 2,836 $ 4,627
Non-cash investing and financing activities:
Series B preferred stock and warrants issued in
exchange for marketable securities (Note 8)............... $ -- $ 987,400
Common stock and warrants issued for license.............. $ -- $ 991,000
Preferred stock dividend paid in common stock............. $ -- $ 18,260
Imputed interest on subordinated convertible debenture.... $ 5,625 $ 22,500
Conversion of subordinated debenture into common stock.... $ 213,575 $ --
Common stock issued for services.......................... $ 269,288 $ --
Expenses related to warrants.............................. $ -- $ 32,750
The accompanying notes are an integral part of these consolidated financial
statements.
F-9
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
ORGANIZATION
MDI Entertainment, Inc. (the "Company") is a Delaware corporation
incorporated on
December 29, 1994 under the name Puff Process, Inc. In August 1997, the
Company purchased 100% of the shares of Media Drop-In Productions, Inc., a
Delaware corporation (Media Drop-In Productions, Inc. had a 66.7% owned
subsidiary, MDI-Texas, Inc.,) and MDI-Missouri, Inc., a Missouri corporation
(herein collectively referred to as "MDI"), in exchange for 4,800,000 shares of
the Company's common stock and notes payable to the shareholders of MDI for an
aggregate of $300,000. In connection with this acquisition, the name of the
Company was changed to MDI Entertainment, Inc. Both MDI-Texas, Inc. and
MDI-Missouri, Inc. ceased to operate as of May 31, 1999 as the state lottery
promotions these companies were established to operate were completed. Since the
Company had minimal assets, liabilities and no business activities prior to its
acquisition of MDI, this transaction was accounted for as a "reverse merger,"
with MDI as the successor corporation. Therefore, the accompanying consolidated
financial statements reflect the historical cost basis of MDI. All inter-
company transactions have been eliminated in the accompanying consolidated
financial statements.
MDI's principal activity has been the development and sale of entertainment
based promotions to North American lotteries. MDI is positioned to create a wide
variety of additional entertainment promotions. MDI has established itself as a
source for the creation, supply and administration of entertainment based
lottery promotions.
In 1996, MDI created its Licensed and Patented Games division ("LPG"). MDI
capitalized on current trends in the lottery industry to base some instant games
on pre-existing games of chance and well-known brands and logos. MDI has
acquired the rights to numerous well-known entertainment properties to license
as lottery theme games and promotions. Included among the properties already
licensed are "Star Trek," "Wheel of Fortune," "Jeopardy," "Pepsi," "Louisville
Slugger" and "Harley-Davidson."
INVENTORY
Inventory represent merchandise used in the Company's entertainment-based
promotions. The inventory is stated at the lower of cost or market using the
first-in, first-out method.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Expenditures for repairs and
maintenance are charged to expense as incurred. For assets sold or otherwise
disposed of, the cost and related accumulated depreciation are removed from the
accounts, and any resulting gain or loss is reflected in income for the period.
Depreciation is calculated on a straight-line basis over the estimated
useful life of the asset. Furniture and fixtures are depreciated over seven
years, office equipment is depreciated over five years and leasehold
improvements are depreciated over three years.
F-10
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2001 AND 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
LICENSING COSTS
The Company reviews its capitalized marketing costs quarterly to determine
if an impairment has occurred. The Company recognizes that impairment has
occurred when the license cost is no longer expected to be recovered in lottery
contracts. No impairment loss was recognized for the years ended December 31,
2001 and 2000.
OTHER ASSETS
Other assets as of December 31, 2000 were primarily comprised of prepaid
financing costs related to the subordinated convertible debenture, which were
being amortized over the term of the debentures. The debenture was converted
March 14, 2001 and all unamortized costs related to the debenture were charged
to additional paid-in capital.
REVENUE AND COST RECOGNITION
Revenue is derived from various lottery game contracts. The Company has
agreed to provide second chance prize packages consisting of grand prizes and
various merchandise prizes. The Company 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 the
Company upon signing of the contract; therefore, the Company defers this revenue
and recognizes the revenue based on the terms of the applicable game.
Revenues from the lottery game contracts that are greater than one year are
recognized on the percentage-of-completion method, determined by the percentage
of costs incurred to date to estimated total costs on a specific contract basis.
This method is utilized as management considers costs incurred to be the best
available measure of progress on these contracts. Contract costs include all
direct costs. 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 December 31, 2001, no
losses were expected from existing contracts.
The liability "billings in excess of costs and estimated earnings on
uncompleted contracts" represents billings in excess of revenues recognized.
F-11
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2001 AND 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
As of December 31, 2001, billings in excess of costs and estimated earnings on
uncompleted contracts was as follows:
BILLINGS IN EXCESS OF
BILLINGS REVENUE ESTIMATED EARNINGS ON
LOTTERY GAME TO DATE EARNED UNCOMPLETED CONTRACTS
------- ---------------------- ---------- ---------- -----------------------
Wisconsin Wheel of Fortune $ 510,000 $ 475,945 $ 34,055
Arizona Star Trek 130,250 103,038 27,212
Rhode Island Harley Davidson 144,160 108,702 35,458
New Jersey Harley Davidson 647,740 575,240 72,500
Wisconsin NASCAR Drivers 462,000 433,694 28,306
Wisconsin Ray Charles 513,800 491,602 22,198
Indiana SPAM 240,000 227,012 12,988
Wisconsin Louisville Slugger 126,000 107,593 18,407
Ohio Harley Davidson 470,975 426,704 44,271
Delaware NASCAR Drivers 111,000 48,852 62,148
New Jersey SPAM 583,000 556,644 26,356
South Dakota NASCAR Drivers 97,950 53,783 44,167
Oregon Harley Davidson 105,700 63,468 42,232
New Hampshire Elvis 265,000 213,106 51,894
New Jersey NASCAR Drivers 700,000 652,290 47,710
Indiana NASCAR Drivers 270,000 258,237 11,763
Maine NASCAR Drivers 162,000 154,020 7,980
New Jersey Hollywood Squares 700,000 337,934 362,066
Delaware Elvis 68,400 14,897 53,503
New Jersey CMT 700,000 73,525 626,475
California Elvis 882,000 222,533 659,467
Indiana Elvis 318,000 112,068 205,932
---------- ---------- ----------
$8,207,975 $5,710,887 $2,497,088
========== ========== ==========
Approximately 49% of revenue for the year ended December 31, 2001 was
derived from contracts with four state lotteries.
F-12
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2001 AND 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
As of December 31, 2000, billings in excess of costs and estimated earnings
on uncompleted contracts was as follows:
BILLINGS IN EXCESS OF
BILLINGS REVENUE ESTIMATED EARNINGS ON
LOTTERY GAME TO DATE EARNED UNCOMPLETED CONTRACTS
------- ---------------------- ---------- ---------- -----------------------
Wisconsin Wheel of Fortune $ 510,000 $ 469,208 $ 40,792
Arizona Star Trek 130,250 105,708 24,542
Rhode Island Harley Davidson 144,160 107,707 36,453
New Jersey Harley-Davidson 647,740 575,240 72,500
New Jersey Jeopardy! 518,700 484,548 34,152
New Jersey Louisville Slugger 518,580 447,569 71,011
Ohio Harley Davidson 392,500 366,382 26,118
Wisconsin NASCAR Drivers 462,000 350,191 111,809
Wisconsin Ray Charles 513,800 104,063 409,737
New Jersey Betty Boop 518,400 276,087 242,313
Atlantic Lottery Corp. Wheel of Fortune 140,000 58,070 81,930
New Jersey Elvis 702,000 -- 702,000
British Columbia Harley Davidson 117,000 95,398 21,602
Pennsylvania Betty Boop 116,495 -- 116,495
Kentucky Elvis 294,440 52,324 242,116
Indiana SPAM 240,000 -- 240,000
British Columbia Hollywood Walk of Fame 70,100 -- 70,100
Ontario Wheel of Fortune 345,315 -- 345,315
---------- ---------- ----------
Total $6,381,480 $3,492,495 $2,888,985
========== ========== ==========
Approximately 63% of revenue for the year ended December 31, 2000 was
derived from contracts with four state lotteries.
EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per common share are based on the average number of
common shares outstanding during the fiscal period. Diluted earnings (loss) per
common share include, in addition to the above, the dilutive effect of common
share equivalents. For the year ended December 31, 2001, options to purchase
150,000 shares of common stock, and warrants to purchase 808,761 shares of
common stock were excluded from the calculation of the diluted earnings (loss)
per share since their inclusion would be anti-dilutive. For the year ended
December 31, 2000, options to purchase 674,166 shares of common stock, preferred
stock convertible into 444,000 shares of common stock, subordinated debenture
convertible into 375,000 shares of common stock and warrants to purchase
2,383,656 shares of common stock were excluded from the calculation of the
diluted earnings (loss) per
F-13
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2001 AND 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
share since their inclusion would be anti-dilutive. The income (loss) available
to common shareholders and the number of shares used in the basic and diluted
earnings (loss) per common share computation for the years ended December 31,
2001 and 2000 was as follows:
YEARS ENDED
DECEMBER 31,
---------------------------
2001 2000
---------- --------------
Net income (loss)................................. $3,320,881 $ (4,047,130)
Preferred stock dividends......................... -- (26,402)
Beneficial conversion feature of Series B
Preferred Stock................................. -- (430,346)
---------- --------------
Net income (loss) applicable to common
shareholders.................................... $3,320,881 $ (4,503,878)
========== ==============
YEARS ENDED
DECEMBER 31,
---------------------------
2001 2000
---------- --------------
Basic:
Average number of common shares outstanding..... 11,186,428 9,570,516
Dilutive:
Dilutive effect of stock options, warrants and
convertible securities........................ 704,741 not applicable
---------- --------------
Average number of dilutive common shares
outstanding..................................... 11,891,169 9,570,516
========== ==============
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). This statement establishes
accounting and reporting standards for derivative instruments and for hedging
activities. In June 1999, the FASB issued SFAS No. 137 "Accounting for
Derivative Instruments and Hedging Activities--Deferral of Effective Date of
SFAS No. 137." Adoption of SFAS 133 was required beginning with the first
quarter of fiscal 2001. The adoption of SFAS No. 133, as amended by SFAS
No. 138, did not have an impact on the Company's financial position or results
of its operations.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements"
("SAB No. 101"). SAB No. 101, among other things, provides guidance on revenue
recognition. The Company adopted SAB NO. 101 on January 1, 2000. The cumulative
effect of applying SAB No. 101 did not have an effect on the Company's financial
position or results of operations.
On June 30, 2001 the FASB finalized Statements of Financial Accounting
Standards No. 141, "Business Combinations" and No. 142, "Goodwill and Other
Intangible Assets". Adoption of SFAS No. 142 is required beginning with the
F-14
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2001 AND 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
first quarter of 2002. The Company has no planned or anticipated business
acquisitions, which would be affected by SFAS No. 141. The Company's intangible
amortization policies are consistent with SFAS No. 142. Therefore, the
implementation of these two standards is not expected to have a material impact
on the Company's financial condition or results of operations.
In August 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment
or Disposal of Long-Lived Assets". SFAS No. 144 modifies the rules for
accounting for the impairment or disposal of long-lived assets. The new rules
become effective for fiscal years beginning after December 15, 2001 with earlier
application encouraged. The adoption of SFAS No. 144 is not anticipated to have
an effect on the Company's operating results or financial position.
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reported period. Actual results could differ
from those estimates.
INCOME TAXES
A valuation allowance is provided for the deferred tax assets if it is more
likely than not these items will expire before the Company is able to realize
their benefit, or that future deductibility is uncertain. Deferred tax assets
and liabilities are recognized for the expected future tax consequences of
events that have been realized in the financial statements or tax returns.
F-15
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2001 AND 2000
2. LICENSING COSTS
The Company capitalizes costs associated with obtaining the exclusive right
to use and to sublicense the use of licensed properties, as defined in license
agreements. These costs, which in most cases are advances against the future
license royalty payments, are applied to cost of revenues as the games are
launched. Approximately 68.0% of revenues for the year ended December 31, 2001
are derived from three licensed properties, which expire within six months to
four years.
As of December 31, 2001, the following costs have been capitalized:
King Features License....................................... $ 15,000
The Buffer License.......................................... 15,000
Country Music License....................................... 25,000
CowParade License........................................... 5,000
Dale Earnhardt, Inc. License................................ 30,000
Dale Earnhardt, Jr. License................................. 35,000
Elliott Racing License...................................... 15,150
Elvis Presley License....................................... 1,562,902
Emmett Kelly, Jr............................................ 2,500
Harley Davidson............................................. 100,000
Heroes of Space License..................................... 10,000
Hollywood Walk of Fame License.............................. 50,000
Hollywood Squares License................................... 50,000
Hormel License.............................................. 25,000
Hummer/Humvee License....................................... 10,000
James Bond 007 License...................................... 20,000
Louisville Slugger License.................................. 20,000
I Love Lucy License......................................... 70,000
Mattel License.............................................. 30,000
Outer Limits License........................................ 5,000
Pink Panther License........................................ 25,000
Rousch Racing License....................................... 67,893
Schrader Racing License..................................... 750
Tabasco License............................................. 50,000
TNN Trademark License....................................... 25,000
Universal Monsters License.................................. 50,000
World Cup License........................................... 167,750
----------
$2,481,945
==========
Less-accumulated amortization............................... $ (996,118)
----------
$1,485,827
==========
F-16
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2001 AND 2000
2. LICENSING COSTS (CONTINUED)
As of December 31, 2000, the following costs have been capitalized:
Louisville Slugger License.................................. $ 20,000
Harley Davidson............................................. 48,666
Heros of Space License...................................... 10,000
Hummer/Humvee License....................................... 10,000
Pink Panther License........................................ 5,000
Outer Limits License........................................ 5,000
Country Music License....................................... 25,000
TNN Trademark License....................................... 25,000
James Bond 007 License...................................... 20,000
Dale Earnhardt, Inc. License................................ 30,000
Dale Earnhardt, Jr. License................................. 32,500
World Cup License........................................... 60,250
Ray Charles Entertainment License........................... 30,400
King Features License....................................... 15,000
The Buffer License.......................................... 15,000
Hormel License.............................................. 52,500
Hollywood Walk of Fame License.............................. 25,000
Elliott Racing License...................................... 7,500
Rousch Racing License....................................... 45,393
CowParade License........................................... 5,000
Elvis Presley License....................................... 1,091,000
Emmett Kelly, Jr............................................ 2,500
----------
1,580,709
Less-accumulated amortization............................... (183,029)
----------
$1,397,680
==========
F-17
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2001 AND 2000
3. LONG-TERM DEBT AND NOTES PAYABLE
Long-term debt consists of the following:
DECEMBER 31 DECEMBER 31
2001 2000
----------- -----------
Promissory note payable bearing interest at a rate of 15%.
Interest payable monthly and principal due on May 15,
2001...................................................... $ -- $ 260,000
Promissory note payable bearing interest at a rate of 12%.
Interest Payable monthly and principal due on May 15,
2001...................................................... -- 50,000
Promissory note payable bearing interest at a rate of 12%.
Interest Payable monthly and principal due on May 15,
2001...................................................... -- 50,000
Promissory note payable bearing interest at a rate of 12%.
Interest Payable monthly and principal due on May 15,
2001...................................................... -- 50,000
Promissory note payable bearing interest at a rate of 12%.
Interest Payable monthly and principal due on May 15,
2001...................................................... -- 25,000
Promissory note payable bearing interest at a rate of 12%.
Interest Payable monthly and principal due on May 15,
2001...................................................... -- 25,000
Promissory note payable to President and Chief Executive
Officer bearing interest at a rate of 10%. Interest
payable monthly and principal due on demand............... 260,000 260,000
Promissory note payable to President and Chief Executive
Officer bearing interest at a rate of 8%; principal and
interest of $14,200 payable monthly through December 1,
2001 The Company is one month in arrears.................. 14,199 229,006
Promissory note payable bearing interest at 10%; principal
of $750 payable monthly through August 2001............... -- 6,000
--------- ---------
$ 274,199 $ 955,006
Less: current portion of long-term debt..................... (274,199) (955,006)
--------- ---------
$ -- $ --
========= =========
4. SUBORDINATED CONVERTIBLE DEBENTURE
On September 21, 1999, the Company issued a subordinated convertible
debenture (the "Debenture") to Scientific Games, Inc. for $750,000. The
subordinated convertible debenture was converted into 375,000 shares of common
stock on March 14, 2001. The Debenture bore interest at 7% per annum and was
payable semi-annually, on June 30 and December 31 of each year. The Company,
pursuant to its early conversion agreement with Scientific Games, Inc.,
continued to make interest payments on the converted obligation until
September 21, 2001.
Accounting principles generally accepted in the United States require that
the interest rate on debt represent a fair market rate for "comparable" debt
instruments. The Company has determined that a fair market rate for this debt
would be approximately 10% and therefore has discounted the carrying
F-18
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2001 AND 2000
4. SUBORDINATED CONVERTIBLE DEBENTURE (CONTINUED)
value of the liability, with the offsetting credit reflected as additional
paid-in capital. The carrying value of the Debenture as of December 31, 2000 was
as follows:
Face amount of subordinated convertible debenture........... $750,000
Less:
Imputed interest discount (difference between 10% fair
market rate and 7% stated rate)........................... (225,625)
--------
Discounted debenture value.................................. $524,375
Discount amortized through December 31, 2000................ 28,750
--------
Balance at December 31, 2000................................ $553,125
========
Each quarter, the imputed interest for that quarter was amortized with a
corresponding increase in the debenture until it was converted into common
stock.
5. STOCK OPTION AND AWARD PLAN AND WARRANTS
STOCK OPTION AND AWARD PLAN
On September 22, 1998, the Board of Directors approved the 1998 Stock Option
and Award Plan (the Plan) which provides for up to 800,000 incentive and
nonqualified common stock options. The plan was subsequently amended on June 8,
2001. An additional 800,000 options were added to the Plan on that date. Options
granted under the Plan to directors, selected employees, officers, agents,
consultants, and independent contractors of the Company are exercisable for a
period determined by the Company, but in no event longer than ten years from
date of grant, subject to certain conditions. As of December 31, 2001, 1,595,000
options available under the plan had been granted.
During the year ended December 31, 2001, the Company issued warrants to
purchase 25,000 shares of common stock at an exercise price of $2.25 for
consulting services.
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123").
The Company accounts for stock-based compensation for employees under Accounting
Principles Board Opinion No. 25 and related interpretations and includes only
disclosures required under SFAS No. 123. The Company has computed the pro forma
disclosures required under SFAS No. 123 for options granted as of December 31,
2001 and 2000 using the Black-Scholes option pricing model as prescribed by SFAS
F-19
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2001 AND 2000
5. STOCK OPTION AND AWARD PLAN AND WARRANTS (CONTINUED)
No. 123. For purposes of this calculation, the fair value of each option grant
is estimated on the grant date using the Black-Scholes option-pricing model with
the following assumptions:
YEARS ENDED
DECEMBER 31,
-------------------------
2001 2000
----------- -----------
Risk free interest rate..................................... 3.88%-4.53% 6.14%-6.47%
Expected dividend yield..................................... 0% 0%
Expected lives.............................................. 5-10 years 5-10 years
Expected volatility......................................... 257% 131%
Fair value.................................................. $ 1.32 $ 1.34
Had compensation cost for the Company's stock option plans been determined
consistent with SFAS No. 123, the Company's pro forma net income (loss) would
have been as follows:
YEAR ENDED
DECEMBER 31,
------------------------
2001 2000
---------- -----------
Net income (loss):
As reported....................................... $3,320,881 $(4,047,130)
Pro forma......................................... $3,095,491 $(4,079,278)
Basic earnings (loss) per common share
As reported....................................... $ .30 $ (.47)
Pro forma......................................... $ .28 $ (.48)
Diluted earnings (loss) per common share
As reported....................................... $ .28 $ (.47)
Pro forma......................................... $ .26 $ (.48)
The pro-forma information is not indicative of future years.
The following table summarizes both stock option activities under and
outside the Plan during the years ended December 31, 2001 and 2000:
2001 2000
----------------------------- -----------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
------ ---------------- ---------- ----------------
Outstanding, at beginning of year...... 674,166 $ .57 1,117,500 $.48
Granted.............................. 795,000 1.32 -- --
Exercised............................ (35,000) .33 (443,334) .36
---------- ----- ---------- ----
Outstanding, at end of year............ 1,434,166 1 .06 674,166 .57
========== ===== ========== ====
Options exercisable, at end of year.... 639,166 $ .74 349,584 $.48
========== ===== ========== ====
Weighted average fair value options
granted
during the year........................ $1,049,400 $1.32 -- $ --
========== ===== ========== ====
F-20
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2001 AND 2000
5. STOCK OPTION AND AWARD PLAN AND WARRANTS (CONTINUED)
As of December 31, 2001, options outstanding consisted of 489,166 shares at
an exercise price of $.33 per share, 795,000 shares at an exercise price of
$1.32 per share and 150,000 shares at an exercise price of $1.38 per share.
Total compensation (income) expense recorded in the accompanying
consolidated statements of operations associated with employee stock options was
$(13,000) and $20,944 for the years ended December 31, 2001 and 2000,
respectively.
WARRANTS
As of December 31, 2001, the Company has outstanding warrants to purchase
2,408,656 shares of common stock at exercise prices that range from $.88 per
share to $4.56 per share.
As of December 31, 2001, the Company has the following outstanding warrants:
YEAR EXPIRATION EXERCISE NUMBER OF
ISSUED DATE DESCRIPTION PRICE WARRANTS
--------------------- ---------- -------------------------------------------------------- -------- ---------
1999 2004 For investor relations services......................... $1.56 25,000
1999 2006 For placement costs of preferred stock.................. $1.31 350,000
1999 2006 For placement costs of preferred stock.................. $1.31 216,875
1999 2006 For placement costs of convertible subordinated
debenture............................................... $1.25 46,447
1999 2006 For placement costs of convertible subordinated
debenture............................................... $1.25 179,573
2000 2006 For financial consulting................................ $0.88 807,000
2000 2003 For license............................................. $4.56 100,000
2000 2005 For prepaid financing costs............................. $3.94 13,205
2000 2003 Stock exchange agreement with eLot, Inc................. $3.50 555,556
2000 2003 For prepaid financing costs............................. $1.75 40,000
2000 2005 For prepaid financing costs............................. $2.25 50,000
2001 2004 For consulting services................................. $2.25 25,000
---------
2,408,656
=========
6. CONVERTIBLE PREFERRED STOCK
SERIES A:
On August 4, 1999, the Company finalized a $1,750,000 private sale to an
investor of 2,027 shares of Series A Preferred Stock, representing approximately
20% of the outstanding common stock of the Company on an as converted basis. The
preferred stock has a liquidation preference of $1,750,000, pays a dividend of
10% per annum, payable in cash or common stock at the Company's option, and is
convertible into an aggregate of 2,027,000 shares of the Company's common stock,
subject to adjustment under certain circumstances. In September 1999, the
dividend rate was prospectively reduced to 5% per annum in connection with the
Company's filing of a registration statement with respect to the resale of the
common stock underlying the preferred stock. The holders of the preferred stock
were entitled to a right of first refusal on new securities issued by the
Company, subject to
F-21
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2001 AND 2000
6. CONVERTIBLE PREFERRED STOCK (CONTINUED)
certain exclusions. During fiscal year 2000, 1,015 shares of the preferred stock
were converted into 1,015,000 shares of common stock.
SERIES B:
The Company entered into a stock exchange agreement with eLot, Inc. ("eLot")
on November 1, 2000. The Company received 1,000,000 shares of eLot common stock
(see Note 7), valued at $987,400, in exchange for 444 shares of Series B
preferred stock and warrants to purchase 555,556 shares of MDI common stock. The
Series B preferred stock was converted into 444,444 shares of common stock on
November 1, 2001. The Series B preferred stock did not provide for dividends.
The warrants issued to eLot are exercisable at $3.50 per common share and expire
November 1, 2003. In connection with this transaction, the Company recorded a
charge to accumulated deficit and additional paid-in capital of $430,346, in
2000, representing the beneficial conversion feature of the Series B preferred
stock.
SERIES C:
On December 31, 2001, the Company settled the lawsuit brought against Oxford
International, Inc. ("Oxford") and Gregory C. Dutcher concerning the Company's
financing transaction with Oxford International, Inc. In the settlement, MDI
received shares of MDI stock held by Oxford which MDI had demanded in the
lawsuit; and gave up the shares of stock of DataMEG Corp. and McClendon
Transportation Group, Inc. that it had in its possession but which it sought to
return in the lawsuit. Due to the disputes regarding the financing transaction,
the MDI stock had not been treated as outstanding nor had the DataMEG or
McClendon stock been treated as assets of MDI. Accordingly, those portions of
the settlement will not affect MDI's accompanying consolidated financial
statements. MDI also received a non-interest bearing promissory note in the
principal amount of $100,000, $10,000 of which is due on February 15, 2002 and
the balance is due on the earlier of December 31, 2003 or from the sales
proceeds of 1,000,000 shares of DataMEG Corp. stock placed in escrow. If as of
December 31, 2003, sales of the stock have not been sufficient to pay the
balance of the $90,000, then MDI may request a sale of the remaining shares up
to the amount that will result in a sale paying off the remaining balance then
due under the promissory note at the time of the sale. The promissory note is
included in accounts receivable on the accompanying consolidated balance sheet.
7. AVAILABLE FOR SALE SECURITIES
All marketable securities are deemed by management to be available for sale
and are reported at fair value with net unrealized gains or losses reported
within shareholders' equity (deficit). Realized gains and losses are recorded
based on the specific identification method. There were no investments in
"available for sale" securities as of December 31, 2001. The Company had
recorded a charge to income of $807,400 in the year ended December 31, 2000
reflecting an other than temporary impairment in the
F-22
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2001 AND 2000
7. AVAILABLE FOR SALE SECURITIES (CONTINUED)
value of the securities. The carrying amount of the Company's investment as of
December 31, 2000 is shown in the table below:
DECEMBER 31, 2000
----------------------------------
OTHER THAN
TEMPORARY
DECLINE
COST IN VALUE FAIR VALUE
-------- ---------- ----------
U.S. corporate securities............................ $987,400 $(807,400) $180,000
8. SUBSEQUENT EVENTS
On February 20, 2002, the Company settled a lawsuit brought by Lottery
Channel and countersuit it brought arising from its termination of the merger
agreement with Lottery Channel. As part of the settlement agreement among
Lottery Channel and the Company's subsidiary MDI Acquisition Corp., all
litigation amongst the parties has been dismissed and the previously disclosed
lawsuit brought by Steven Saferin, the Company's President and Chief Executive
Officer, against Roger W. Ach, the President and Chief Executive Officer of
Lottery Channel, relating to Mr. Ach's non-payment to Mr. Saferin of $108,000
plus interest due under a promissory note, has also been dismissed.
On February 22, 2002, the Company and Scientific Games Corporation
("Scientific Games") entered into a Letter of Intent contemplating the
acquisition of the Company at $2.10 per share, payable in Scientific Games
common stock. Scientific Games will acquire all of the issued and outstanding
shares of capital stock of the Company by means of a tax-free merger (the
"Merger") in which a newly created subsidiary of Scientific Games will merge
into the Company and the Company will become a wholly-owned subsidiary of
Scientific Games. The Letter of Intent contemplates that Steve Saferin, the
Chief Executive Officer, President and principal stockholder of the Company,
will escrow a number of shares of Scientific Games common stock having an
aggregate value at the closing of $1,846,845, provided that such escrowed shares
shall be subject to release from escrow over a four-year period based on Mr.
Saferin's continued employment with the Company and the Company's achievement of
certain EBITDA targets pursuant to Mr. Saferin's new employment agreement.
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, to enjoin the 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 alleges that the consideration offered to the Company's stockholders
in the proposed acquisition is unfair and inadequate because the Plaintiff
believes that the intrinsic value of the Company's common stock is 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 has 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. The Company believes that the
lawsuit lacks merit and intends to contest it vigorously.
F-23
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2001 AND 2000
9. INCOME TAXES
The Components of the benefit (provision) for income taxes are:
2001 2000
---------- --------
Current income taxes
Federal................................................... $ (17,262) $ --
State..................................................... (38,900) (3,429)
---------- -------
Total................................................... (56,162) (3,429)
---------- -------
Deferred income taxes
Federal................................................... 1,343,000 --
State..................................................... -- --
---------- -------
Total................................................... 1,343,000 --
---------- -------
Total....................................................... $1,286,838 $(3,429)
========== =======
The provision for income taxes differs from the amount computed by applying
the statutory federal income tax rate to income before provision for income
taxes. The sources and tax effects of the differences are as follows:
2001 2000
----------- -----------
Income tax at the federal Statutory rate of 35%............ $ 711,915 $(1,415,295)
State income tax........................................... 38,900 3,429
Valuation allowance changes affecting the provision for
income taxes............................................. (2,037,653) 1,415,295
----------- -----------
Total.................................................. $(1,286,838) $ 3,429
=========== ===========
As of December 31, 2001 the Company has net operating loss carryforwards of
approximately $6.1 million which will expire between 2012 and 2021. The
following is a schedule of available net operating loss carryforwards and their
expiration dates:
May 31, 2012................................................ $ 598,360
May 31, 2013................................................ 2,246,099
May 31, 2020................................................ 2,103,770
May 31, 2021................................................ 1,230,817
----------
$6,179,046
==========
If there is a significant change in the ownership of the Company, loss
utilization may be limited under Section 382 of the Internal Revenue Code. If
such limitations are large enough, net-operating loss carryforwards may expire
before they may be utilized.
The Company has deferred tax assets related to net operating losses that can
be utilized to offset taxable income in future years. As of December 31, 2000, a
valuation allowance was recorded for the deferred tax assets. In 2001, the
Company determined that it is more likely than not that a portion of these
deferred tax assets will be utilized and accordingly, $1,343,000 of the
valuation allowance was
F-24
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2001 AND 2000
9. INCOME TAXES (CONTINUED)
reversed. This determination was based on the Company's profitability in 2001
and its expectations of continued profitability. The following table summarizes
the Company's deferred tax assets and liabilities and the related valuation
allowance:
2001 2000
---------- ----------
Gross Deferred Tax Asset Tax effect of net operating loss
carryforwards............................................. $2,075,100 $3,425,000
---------- ----------
Total................................................... 2,075,100 3,425,000
Valuation allowance......................................... (732,100) (3,425,000)
---------- ----------
Net deferred income tax asset............................... $1,343,000 $ --
========== ==========
10. COMMITMENTS
The Company leases office equipment, office space and vehicles under
long-term leases which expire during the next one to five years. Rent expense
totaled $125,000 and $96,600 for the years ended December 31, 2001 and 2000,
respectively. The following is a schedule of future minimum rental payments
required under operating leases that have initial or remaining non-cancelable
lease terms in excess of one year as of December 31, 2001:
2002........................................................ $120,638
2003........................................................ 118,933
2004........................................................ 105,989
2005........................................................ 46,827
--------
Total....................................................... $392,387
========
MDI has agreed to provide the following performance bonds to the following
lotteries:
California.................................................. $742,800
Wisconsin................................................... $400,000
The President and Chief Executive Officer of the Company has personally
guaranteed these performance bonds.
11. COMMISSION AGREEMENT
In December 1994, the Company entered into a commission agreement with a
media company to assist in the procurement of video and audio entertainment
media. The term of the agreement was from December 15, 1994 through
December 14, 1997. Commissions of 5.33% were required to be paid on monthly cash
receipts in excess of $337,500. If at the end of the term, the aggregate cash
collections were less than $27,300,000, then the media company could renew the
agreement for an additional year or periods of one year until the Company
reaches $27,300,000. There were no commissions paid in 2001 or 2000 under this
agreement.
The Company could have elected not to renew this agreement and would then be
required to deliver to the media group a promissory note in the amount of
$808,250, less previously paid
F-25
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2001 AND 2000
11. COMMISSION AGREEMENT (CONTINUED)
commissions, bearing interest at a rate of 3% above prime rate, payable over
24 months. The Company had renewed the agreement through December 14, 1998.
However, since the Company had significantly reduced the utilization of this
media company, they accrued the $786,287 minimum fee owed to them and charged it
to cost of revenues for the year ended May 31, 1998.
During 1999, the Company entered into a formal note agreement with the media
group to repay the remaining outstanding balance due to them in the amount of
$600,000. During 2000, the Company's President and Chief Executive Officer,
purchased the remaining balance of the note payable ($316,038) from the media
group. The new note bears interest at an 8% interest rate instead of 10.75% and
its maturity was extended to December 2001 from December 2000. The Company is
currently one month in arrears on this obligation (see Note 3).
12. RELATED PARTY TRANSACTIONS
For the years ended December 31, 2001 and 2000, the Company incurred
commission expense of $-0- and $-0- and wage expense of $373,515 and $339,025,
respectively, to the President of the Company, in accordance with his Employment
Agreement. The agreement contemplates a base salary of $300,000 with annual
increases of 5% or by an equation based on the consumer price index. In no event
shall the increase exceed 10% in any one year. In addition, the President
receives a commission equal to 2% of gross revenues of the Company (not to
exceed $335,000 over the term of the employment contract). The President waived
the right to approximately $293,239 and $57,534 of commissions in the years
ended December 31, 2001 and 2000, respectively. The contract began August 8,
1997 and terminates the later of August 7, 2002 or three years from the date the
Company files a registration statement with the Securities and Exchange
Commission registering his shares of common stock if such shares are traded on
NASDAQ.
The Company has retained 1010 Productions, Inc. (1010) to consult in the
areas of trade shows, software development, systems design, purchasing and
product fulfillment. The President and sole shareholder of 1010 is the wife of
the President of the Company. 1010 is paid $10,000 per month plus expenses and
is retained until December 31, 2003 pursuant to a consulting agreement.
A family member of the Company's President and Chief Executive Officer was
paid a total of $43,308 and $27,965 for the years ended December 31, 2001 and
2000, respectively, for consulting services.
In September 2001, the Company began leasing a house owned by its President
and Chief Executive Officer. The house is used by our out-of-state sales
personnel when visiting our Hartford headquarters. The two year lease provides
for a monthly rental of $2,500. Total rent paid under this agreement for 2001
amounted to $10,000.
In September 1999, the Company entered into a Strategic Alliance with
Scientific Games, Inc. ("SGI"). SGI will utilize its sales and marketing force
to market, license and sell the Company's products and deliverables to SGI's
customers. In payment of these services, SGI is to receive a commission based on
(1) gross revenues received from the sale of merchandise products by the Company
and (2) gross revenues received from license and royalty fees. As noted in the
footnote 8, on February 25, 2002, the Company signed a letter of intent to merge
with Scientific Games Corporation.
F-26
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2001 AND 2000
12. RELATED PARTY TRANSACTIONS (CONTINUED)
From October 14, 2000 to August 6, 2001, Jonathan D. Betts served as the
Company's Executive Vice President of Finance. Mr. Betts is a principal of
Venture Partners, Ltd., a firm, which has provided financial consulting services
to the Company.
During the year ended December 31, 2001, the Company paid Venture
Partners, Ltd. $31,551. During the same period in 2000 Venture Partners, Ltd.
was paid $210,000 and received warrants to purchase 807,000 shares of common
stock at an exercise price of $.88 per share.
13. EMPLOYEE BENEFIT PLAN
In fiscal 1996, the Company adopted a 401(k) savings plan, whereby
participants can elect to defer up to a specified minimum of their compensation
and the Company will match their contribution up to 3% of the employee's base
compensation. For the years ended December 31, 2001 and 2000, the Company
contributed $29,460 and $21,800 to the plan, respectively.
14. 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, 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 alleges that the consideration offered to the
Company's stockholders in the proposed acquisition is unfair and inadequate
because the Plaintiff believes that the intrinsic value of the Company's common
stock is 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 has 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 has requested that
the court award to the Plaintiff compensatory damages. The Company believes that
the lawsuit lacks merit and intends to contest it vigorously.
On February 20, 2002, the Company settled a lawsuit brought by The Lottery
Channel and countersuit it brought arising from its termination of the merger
agreement with Lottery Channel. As part of the settlement agreement among
Lottery Channel, the Company and the Company's subsidiary MDI Acquisition Corp.,
all litigation amongst the parties has been dismissed and the lawsuit brought by
Steven Saferin, the Company's President and Chief Executive Officer, against
Roger W. Ach, the President and Chief Executive Officer of Lottery Channel,
relating to Mr. Ach's non-payment to Mr. Saferin of $108,000 plus interest due
under a promissory note, has also been dismissed.
The Company settled the lawsuit brought against Oxford International, Inc.
("Oxford") and Gregory C. Dutcher concerning the Company's financing transaction
with Oxford International, Inc. In the settlement, the Company received shares
of the Company's stock held by Oxford which the Company had demanded in the
lawsuit; and gave up the shares of stock of DataMEG Corp. and McClendon
Transportation Group, Inc. that it had in its possession but which it sought to
return in the lawsuit. Due to the disputes regarding the financing transaction,
the Company's stock had not been treated as
F-27
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2001 AND 2000
14. LITIGATION (CONTINUED)
outstanding nor had the DataMEG or McClendon stock been treated as assets of
the Company. Accordingly, those portions of the settlement will not affect the
Company's accompanying consolidated financial statements. The Company also
received a non-interest bearing promissory note in the principal amount of
$100,000, $10,000 of which is due on February 15, 2002 and the balance is due on
the earlier of December 31, 2003 or from the sales proceeds of 1,000,000 shares
of DataMEG Corp. stock placed in escrow. The market value of the DataMeg shares
at March 13, 2002 was $75,000. If as of December 31, 2003, sales of the stock
have not been sufficient to pay the balance of the $90,000, then the Company may
request a sale of the remaining shares up to the amount that will result in a
sale paying off the remaining balance then due under the promissory note at the
time of the sale. The promissory note is included in accounts receivable on the
accompanying balance sheet for the year ended December 31, 2001. The initial
payment of $10,000 due on February 15, 2002 is currently past due.
F-28
EXHIBITS INDEX
EXHIBIT
NUMBER DESCRIPTION
--------------------- ------------------------------------------------------------
3.1 Certificate of Incorporation of MDI Entertainment, Inc.
(f/k/a Puff Process Inc.) dated December 29, 1994, as
amended.(2)
3.2 Certificate of Amendment to the Certificate of Incorporation
of MDI Entertainment, Inc. dated February 28, 1999.(3)
3.3 Amended and Restated By-Laws of MDI Entertainment, Inc.
dated April 27, 1999.(5)
3.4 Certificate of Designations, Preferences and Rights of
Series A Preferred Stock, dated August 4, 1999.(4)
3.4 Certificate of Designations, Preferences and Rights of
Series B Preferred Stock, dated November 1, 2000.(10)
4.1 Registration Rights Agreement dated August 8, 1997, between
MDI Entertainment Inc., Steven M. Saferin and Agostino T.
Galluzzo.(1)
4.2 1998 Stock Option and Award Plan, dated September 22,
1998.(1)
4.2 Registration Rights Agreement dated August 4, 1999 between
MDI Entertainment, Inc. and International Capital Partners,
LLC.(4)
4.4 Stock Purchase Agreement dated August 4, 1999 between MDI
Entertainment, Inc. and International Capital Partners,
LLC.(4)
4.5 Convertible Subordinated Debenture Purchase Agreement dated
September 21, 1999 between MDI Entertainment, Inc. and
Scientific Games, Inc.(6)
4.6 Convertible Subordinated Debenture dated September 21, 1999
between MDI Entertainment, Inc. and Scientific Games, Inc.
(6)
4.7 Purchase Agreement dated September 21, 1999 between Steven
M. Saferin and Scientific Games, Inc. (6)
4.8 Stockholders' Agreement dated as of January 26, 2000 between
MDI Entertainment, Inc., MDI Acquisition, Inc. and certain
parties listed therein. (7)
4.9 Stockholders' Agreement dated January 26, 2000 between The
Lottery Channel, Inc. and certain parties listed therein.
(7)
4.10 Letter Agreement dated January 26, 2000 between Steven M.
Saferin and MDI Entertainment, Inc. (7)
4.11 Letter Agreement dated January 26, 2000 between Roger W.
Ach, II and MDI Entertainment, Inc. (7)
4.12 Form of Warrant, dated September 8, 2000.(9)
4.13 Stock Exchange Agreement, dated November 1, 2000, between
MDI Entertainment, Inc. and eLot, Inc.(10)
4.14 Warrant, dated November 1, 2000, issued to eLot by MDI
Entertainment, Inc.(10)
4.15 eLot Registration Rights Agreement, dated November 1, 2000,
between MDI Entertainment, Inc. and eLot, Inc.(10)
4.16 MDI Registration Rights Agreement, dated November 1, 2000,
between MDI Entertainment, Inc. and eLot, Inc.(10)
4.17 Form of Warrant, dated December 2000.(11)
EXHIBIT
NUMBER DESCRIPTION
--------------------- ------------------------------------------------------------
4.18 Form of Warrant issued to certain lenders.(12)
4.19 Warrant, dated April 15, 2001, issued to Sam DePhillipo.(13)
10.1 Second Amended and Restated Employment Agreement dated
August 8, 1997, as amended, between Media Drop-In
Productions, Inc. and Steven M. Saferin.(1)
10.2 Employment Agreement dated April 30, 1996, as amended,
between Media Drop-In Productions, Inc., Kenneth Przysiecki
and Steven M. Saferin.(1)
10.3 First Amended and Restated Consulting Agreement dated August
8, 1997, between Media Drop-In Productions, Inc. and 1010
Productions, Inc.(1)
10.4 Lease dated June 1992, as amended, between Ann Street
Limited Partnership by Tunxis Management Co., II, and Media
Drop-In Productions, Inc.(1)
10.5 Amended Lease Agreement between KWK IV, LLC. and Media
Drop-In Productions, Inc. dated March 25, 1999.(5)
10.6 Agreement and Plan of Reorganization dated August 8, 1997,
between MDI Entertainment, Inc., MDI-Connecticut, Inc.,
MDI-Missouri, Inc. (DE), Media Drop-In Productions, Inc.
MDI-Missouri, Inc. (MO), Steven M. Saferin and Agostino T.
Galluzzo.(2)
10.7 Commission Agreement dated December 20, 1994, between Media
Drop-In Productions, Inc. and Stamford Media Group, LLC.(2)
10.8 Letter of Intent dated July 31, 1998, between MDI
Entertainment, Inc., Fancaster, Inc. and Craig Krueger.(2)
10.9 Strategic Alliance Agreement, dated September 2, 1999
between MDI Entertainment, Inc. and Scientific Games, Inc.
(6)
10.10 Agreement and Plan of Merger dated as of January 26, 2000
between MDI Entertainment, Inc., MDI Acquisition, Inc. and
The Lottery Channel, Inc.(7)
10.10 Loan Agreement dated, September 8, 2000, between Robert R.
Sparacino, Steven M. Saferin, Media Drop-In Productions,
Inc. and MDI Entertainment, Inc.(9)
10.12 Form of Media Drop-In Productions, Inc. Security Agreement,
dated September 8, 2000.(9)
10.13 Form of MDI Entertainment, Inc. Guaranty, dated September 8,
2000.(9)
10.14 Form of MDI Entertainment, Inc. Security Agreement, dated
September 8, 2000.(9)
10.15 Strategic Alliance Agreement, dated November 1, 2000,
between MDI Entertainment, Inc. and eLot, Inc.(10)
10.16 Form of Loan Agreement with certain lenders.(12)
10.17 Form of Media Drop-In Productions, Inc. Security Agreement
with certain lenders.(12)
10.18 Form of MDI Entertainment, Inc. Guaranty with certain
lenders (12)
10.19 Form of MDI Entertainment, Inc. Security Agreement with
certain lenders.(12)
10.20 Letter of Interest contemplating the acquisition of MDI
Entertainment, Inc. by Scientific Games Corporation (14)
21.1 Subsidiaries of MDI Entertainment, Inc.(8)
------------------------
(1) Incorporated by reference from the Company's Form 10-SB, filed
September 28, 1998.
(2) Incorporated by reference from the Company's Amendment No. 1 to the
Form 10-SB, filed February 1, 1999.
(3) Incorporated by reference from the Company's Form 10-QSB for the period
ended February 28, 1999 (filed April 14, 1999).
(4) Incorporated by reference from the Company's Form 8-K filed August 12, 1999.
(5) Incorporated by reference from the Company's Form 10-KSB filed August 27,
1999.
(6) Incorporated by reference from the Company's Form 8-K filed October 4, 1999.
(7) Incorporated by reference from the Company's Form 8-K filed February 7,
2000.
(8) Incorporated by reference from the Company's Form 10-KSB for the year ended
May 31, 2000 (filed September 12, 2000).
(9) Incorporated by reference from the Company's Form 8-K filed September 13,
2000.
(10)Incorporated by reference from the Company's Form 8-K filed November 9,
2000.
(11)Incorporated by reference from the Company's Form S-3/A, filed January 19,
2001.
(12)Incorporated by reference from the Company's Form 10-QSB for the period
ended November 30, 2000 (filed January 22, 2001).
(13)Substantially similar to Form of Warrant listed as exhibit 4.12
(14)Incorporated by reference from the Company's 8-K filed February 26, 2002.