SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________________ to________________________
Commission File Number: 0-24919
MDI ENTERTAINMENT, INC.
-----------------------
(Exact name of Registrant as specified in its Charter)
Delaware 73-1515699
---------- ----------
(State or other jurisdiction of (I.R.S Employer Identification No.)
incorporation or organization)
201 Ann Street
Hartford, Connecticut 06103
---------------------------
(Address of principal executive offices)
(860) 527-5359
--------------
(Registrant's telephone number)
(Former Name, Former Address and Former Fiscal Year,
if changed since last Report)
Check whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes X No __
As of May 15, 2001, 11,763,829 shares of the issuer's common stock were
outstanding.
Transitional Small Business Disclosure Format (check one): Yes __ No X
1
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
FORM 10-QSB
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002
INDEX
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Page
Item 1. Financial Statements....................................................................................... 3
Condensed Consolidated Balance Sheets as of March 31, 2002 (unaudited) and
December 31, 2001............................................................................................3
Condensed Consolidated Statements of Operations for the three months ended
March 31, 2002 and 2001 (unaudited)..........................................................................5
Condensed Consolidated Statement of Shareholders' Equity for the three months ended
March 31, 2002 (unaudited)...................................................................................6
Condensed Consolidated Statements of Cash Flows for the three months ended
March 31, 2002 and 2001 (unaudited)..........................................................................7
Notes to Unaudited Condensed Consolidated Financial Statements.................................................9
Item 2. Management's Discussion and Analysis..................................................................12
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..........................................................................................20
Item 6. Exhibits and Reports on Form 8-K...........................................................................22
Signatures.........................................................................................................23
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2002 2001
-------------------- -----------------------
ASSETS (unaudited)
CURRENT ASSETS:
Cash and cash equivalents $1,130,850 $251,578
Accounts receivable 2,274,184 2,709,543
Inventory 635,057 690,429
Deferred income taxes (Note 3) 1,343,000 1,343,000
Other current assets 304,245 338,049
-------------------- -----------------------
Total current assets 5,687,336 5,332,599
PROPERTY AND EQUIPMENT, AT COST:
Equipment 271,889 305,312
Furniture and fixtures 120,361 120,361
Leasehold improvements 8,751
-
-------------------- -----------------------
392,250 434,424
Less: Accumulated depreciation (241,334) (271,408)
-------------------- -----------------------
Property and equipment, net 150,916 163,016
-------------------- -----------------------
OTHER ASSETS:
Licensing costs, net 1,370,237 1,485,827
Deferred income taxes-long term (Note 3) 732,108 -
Other 22,566 23,467
-------------------- -----------------------
Total other assets 2,124,911 1,509,294
-------------------- -----------------------
Total assets $7,963,163 $7,004,909
==================== =======================
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
March 31, December 31,
2002 2001
-------------------- -----------------------
LIABILITIES AND SHAREHOLDERS' EQUITY (unaudited)
CURRENT LIABILITIES:
Billings in excess of costs and estimated earnings
on uncompleted contracts (Note 2) $2,779,409 $2,497,088
Current portion of long term debt 260,000 274,199
Accounts payable 1,353,869 1,112,880
Accrued expenses 783,978 734,302
-------------------- -----------------------
Total current liabilities 5,177,256 4,618,469
-------------------- -----------------------
Total liabilities 5,177,256 4,618,469
-------------------- -----------------------
COMMITMENTS AND CONTINGENCIES (Notes 5,6 & 7)
SHAREHOLDERS' EQUITY
Common stock 11,764 11,639
Additional paid-in capital 5,650,441 5,609,657
Accumulated deficit (2,876,298) (3,234,856)
-------------------- -----------------------
Total shareholders' equity 2,785,907 2,386,440
-------------------- -----------------------
Total liabilities and
shareholders' equity $7,963,163 $7,004,909
==================== =======================
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three months ended
March 31,
2002 2001
------------------- -------------------
(unaudited) (unaudited)
REVENUE $ 3,519,356 $3,121,999
COST OF REVENUES 2,269,615 1,719,883
------------------- -------------------
Gross profit 1,249,741 1,402,116
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES 1,210,201 873,544
TERMINATED MERGER COSTS (Note 7) 306,455 -
------------------- -------------------
Operating (loss) profit 528,572
(266,915)
INTEREST EXPENSE, net 6,780 77,761
OTHER EXPENSE (INCOME) 99,855 (110,166)
GAIN ON SALE OF INVESTMENTS, NET - (24,307)
------------------- -------------------
(Loss) Income before provision for income taxes 585,284
(373,550)
(BENEFIT) PROVISION FOR INCOME TAXES (Note 3) (732,108) 8,000
------------------- -------------------
Net income $ 358,558 $ 577,284
=================== ===================
Basic Earnings Per Common Share (Note 4) $0.03 $0.05
=================== ===================
Diluted Earnings Per Common Share (Note 4) $0.03 $0.05
=================== ===================
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the three months ended March 31, 2002
(Unaudited)
Shares Amount
Common Stock, par value $.001 per share,
authorized 25,000,000 shares
Balance, December 31, 2001 11,638,925 $ 11,639
Stock options exercised 124,904 125
------------ -------------
Balance, March 31, 2002 11,763,829 11,764
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Additional Paid-in capital:
Balance, December 31, 2001 5,609,657
Stock options exercised 22,974
Compensation attributable to employee stock options 17,810
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Balance, March 31, 2002 5,650,441
-------------
Accumulated Deficit:
Balance, December 31, 2001 (3,234,856)
Net income 358,558
-----------
Balance, March 31, 2002 (2,876,298)
------------
Total Shareholders' Equity $2,785,907
============
The accompanying notes are an integral part of these condensed consolidated financial statements.
6
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months ended
March 31,
2002 2001
------------------ -----------------
(unaudited) (unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 358,558 $ 577,284
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 432,457 134,672
Compensation expense 17,810 -
Gain on sale of investments, net - (24,307)
Deferred income tax benefit (732,108) -
Change in assets and liabilities:
Decrease (increase) in accounts receivable 435,359 (1,174,491)
Decrease in inventory 55,372 50,827
Increase in licensing costs (301,757) (138,900)
Decrease in other assets 34,705 67,317
Increase (decrease) in accounts payable 240,989 (55,910)
Increase in accrued expenses 49,767 514,448
(Decrease) increase in income taxes payable (91) 7,675
Increase in billings in excess of costs
and estimated earnings on uncompleted contracts 282,321 213,428
------------------ -------------------
Net cash provided by operating activities 873,382 172,043
------------------ -------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment, net (3,010) (1,033)
Proceeds of sale of investments - 59,155
------------------ -------------------
Net cash (used for) provided by investing activities (3,010) 58,122
------------------ -------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of debt (14,199) (15,016)
Proceeds from exercise of common stock options 23,099 6,600
------------------ -------------------
Net cash provided by (used for) financing activities 8,900 (8,416)
------------------ -------------------
NET INCREASE IN CASH 879,272 221,749
CASH, beginning of the period 251,578 528,151
------------------ -------------------
CASH, end of the period $ 1,130,850 $ 749,900
================== ===================
7
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Three months ended
March 31,
2002 2001
------------------ -------------------
(unaudited) (unaudited)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Interest $ 15,967 $ 49,362
Income taxes $ - $ 325
Non-cash investing and financing activities:
Stock compensation $ 17,810 $ -
Imputed interest on subordinated convertible debenture $ - $ 5,625
Conversion of subordinated debenture into common stock $ - $ 558,750
Common stock issued for services $ - $ 269,288
The accompanying notes are an integral part of these condensed consolidated financial statements.
8
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 2002 AND 2001
1. PRESENTATION OF UNAUDITED INTERIM CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
Information in the accompanying interim condensed consolidated
financial statements and notes to the condensed consolidated financial
statements for the three-month periods ended March 31, 2002 and 2001 are
unaudited. The accompanying interim unaudited condensed consolidated financial
statements have been prepared by us in accordance with accounting principles
generally accepted in the United States and Regulation S-B. Accordingly, they do
not include all the information and footnotes required by accounting principles
generally accepted in the United States for complete financial statements. In
the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three-month period ended March 31, 2002 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2002. The condensed consolidated financial statements should be
read in conjunction with the financial statements and notes thereto included in
our audited financial statements for the year ended December 31, 2001.
2. REVENUE AND COST RECOGNITION
Revenue is derived from various lottery game contracts (mainly with
states) between MDI and the lotteries. MDI provides second chance prize packages
consisting of grand prizes and various merchandise prizes. MDI also provides
marketing support related to each of the games and obtains the appropriate
licenses for the right to use these properties. Many of the lottery contracts
require the lotteries to pay MDI upon signing of the contract; therefore, MDI
defers this revenue and recognizes the revenue based on the terms of the
applicable game.
Revenues from the lottery games are recognized on the percentage of
completion method, determined by the percentage of cost incurred to date to
estimated total costs on a specific contract basis. This method is utilized, as
management considers cost 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 March 31, 2002, 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.
9
3. INCOME TAXES
In the quarter ended March 31, 2002 the Company reversed approximately
$732,100 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. 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 these
deferred tax assets. In 2001, the Company determined that it was more likely
than not that a portion of these deferred tax assets would be utilized and
accordingly, $1.3 million of the valuation allowance was reversed. During the
quarter ended March 31, 2002 the Company determined that it is more likely than
not that the remaining $732,100 will be utilized in future years, and the
remaining valuation allowance was reversed.
4. EARNINGS PER SHARE
Basic earnings per common share are based on the average number of
common shares outstanding during the fiscal year. Diluted earnings per common
share include, in addition to the above, the dilutive effect of common share
equivalents during the year. For the three months ended March 31, 2002 and 2001,
common share equivalents represented dilutive stock options and warrants using
the treasury method. The income available to common shareholders and the number
of shares used in the earnings per common share and earnings per dilutive share
computation for 2002 and 2001 was as follows:
THREE MONTHS ENDED
MARCH 31,
2002 2001
---- ----
Net income applicable to common shareholders $ 358,558 $ 577,284
=========== ===========
Basic:
Average number of common shares outstanding 11,713,968 10,797,539
Dilutive:
Dilutive effect of options, warrants and convertible securities 1,494,172 1,796,733
----------- -----------
Average dilutive common shares outstanding 13,208,140 12,594,272
=========== ===========
10
5. COMMITMENTS
The Company obtains licenses for both cultural and entertainment
properties, some of which have obligations continuing through the term of the
license. It also leases office equipment, office space and vehicles under
long-term leases, which expire during the next one to five years. The following
is a schedule of both continuing non-cancelable obligations associated with our
licensing agreements and future minimum rental payments required under operating
leases that have initial or remaining non-cancelable lease terms in excess of
one year as of March 31, 2002:
2002 ......................... $1,145,622
2003 ......................... 860,794
2004 ......................... 526,823
2005 ......................... 396,827
-----------
Total..........................$2,930,066
===========
6. LITIGATION
On February 28, 2002, a class action suit on behalf of the Company's
public stockholders (the "Plaintiff") was filed in the Court of Chancery of the
State of Delaware against the Company, all of the members of the Company's Board
of directors and Scientific Games Corporation ("Scientific Games"), to enjoin
the proposed business combination transaction pursuant to which Scientific Games
would acquire the outstanding shares of the Company's common stock which it does
not already own. In its complaint, the Plaintiff 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.
On May 6, 2002, a second complaint was filed in the same Court
containing nearly identical allegations. On May 6, 2002, lawyers for the
plantiffs requested an order consolidating the two cases. While we believe that
the lawsuits lack merit and intend to contest them vigorously, we believe that
the termination of our merger negotiatons with Scientific Games has mooted the
complaints.
7. SUBSEQUENT EVENTS
TERMINATED MERGER WITH SCIENTIFIC GAMES CORPORATION
On February 22, 2002, MDI Entertainment, Inc. ("MDI") and Scientific
Games Corporation ("Scientific Games") entered into a Letter of Intent
contemplating the acquisition of MDI at $2.10 per share, payable in Scientific
Games common stock. On May 8, 2002 MDI announced that Scientific Games and the
Company had mutually and amicably agreed to terminate their merger negotiations
in the wake of the competing offer the Company had received (see ICP proposal
below). The announcement also indicated that Scientific Games and the Company
would continue their strategic alliance.
The Company had incurred certain legal, accounting and investment
banking fees relating to this terminated merger. These costs totaled $306,500 as
of March 31, 2002. Additional terminated merger expenses that have been incurred
after the three months ended March 31, 2002 are approximately $100,000.
ICP PROPOSAL
By letters dated April 17, 2002 and April 30, 2002 International
Capital Partners, LLC ("ICP") expressed an intention to acquire approximately
50% of the outstanding shares of the Company which it does not already own for
$3.30 per share in cash. ICP currently owns 1,022,019 shares of the Company.
On May 7, 2002, ICP filed a Form 13D with the Securities and Exchange
Commission expressing its intention to increase its holdings in the Company by
acquiring 50% of the outstanding shares of the Company it does not currently own
for $3.30 per share. According to the Form 13D filing, the source of funds for
such transaction would be investment funds under the direction and control of
ICP. ICP has indicated that it would consider extending the Company a line of
credit for working capital and add-on acquisition purposes.
11
THIS QUARTERLY REPORT ON FORM 10-QSB CONTAINS FORWARD LOOKING STATEMENTS THAT
INVOLVE CERTAIN RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THE RESULTS DISCUSSED IN THE FORWARD LOOKING STATEMENTS.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
DESCRIPTION OF BUSINESS
The following discussion and analysis should be read in conjunction
with our Condensed Consolidated Financial Statements and the notes thereto
appearing elsewhere in this Form 10-QSB. All statements contained herein that
are not historical facts, including but not limited to, statements regarding our
current business strategy and our plans for future development and operations,
are based upon current expectations. These statements are forward-looking in
nature and involve a number of risks and uncertainties. Generally, the words
"anticipates," "believes," "estimates," "expects" and similar expressions as
they relate to us and our management are intended to identify forward looking
statements. Actual results may differ materially. Among the factors that could
cause actual results to differ materially are those set forth in our Annual
Report on Form 10-KSB under the caption "Description of Business-Risk Factors."
We wish to caution readers not to place undue reliance on any such
forward-looking statements, which statements speak only as of the date made.
Our principal business has been the scratch ticket segment of the
government lottery industry. We are a leader in designing and marketing instant
scratch ticket games based on licensed brand names and entertainment properties
and our lottery promotions feature such properties licensed by us. Prizes
awarded in such promotions typically include a number of "second chance" prizes
related to the licensed property, including collectible logo bearing merchandise
such as 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 approximately ninety percent (90%) of our revenues from
lotteries in two distinct ways. First, we may charge a lottery a license and
royalty fee to utilize a particular licensed property as a lottery game. License
fees may be fixed assessments while royalties are a percentage of the printing
cost of the tickets or a percentage of sales of the ticket. Contracts for
licensed properties typically include an up-front license fee and a royalty
based on the price point and quantity of tickets printed. Ticket quantities
range from about one million to as many as 60 million with an average quantity
of about five million. Price points range from $1.00 to $20.00 with most games
sold at $2.00.
12
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, market these properties to lotteries and the performance of the
properties once they are introduced as lottery games to players. We believe that
revenues will fluctuate as individual license-based promotions commence or wind
down and terminate. In addition, our licenses (which are generally for 1.5 to 3
years) terminate at various times over the next several years. Moreover, the
useful life of a license is generally relatively short as the novelty of the
game or the popularity of the licensed material wanes over time. The timing of
agreements with the lotteries to run promotions, the acquisition of new licenses
and the commencement of new promotions is unpredictable. Accordingly, period to
period comparisons may not be indicative of future results.
We are in continuous negotiations to obtain additional licensed
properties and extend some existing licenses. We expect to reach several
agreements over the next six to 12 months; however we cannot assure you that
such agreements will actually be reached. Some of these agreements may require
the expenditures of significant up-front advances.
RECENT DEVELOPMENTS
MERGER WITH SCIENTIFIC GAMES CORPORATION
On February 26, 2002, we announced that we had executed a Letter of
Intent in which Scientific Games Corporation ("Scientific Games") would acquire
all of our outstanding shares of common stock (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. Steven M. Saferin, our CEO, President and principal
stockholder, would escrow approximately $1.8 million worth of Scientific Games
common stock subject to release upon the achievement of certain financial
targets by the acquired business over four years.
On May 8, 2002, we announced that Scientific Games and the Company had
mutually and amicably agreed with Scientific Games to terminate our merger
negotiations in the wake of the competing offer the Company had received (see
ICP proposal below). The announcement also indicated that Scientific Games and
the Company would continue their strategic alliance.
ICP PROPOSAL
By letters dated April 17, 2002 and April 30, 2002, International
Capital Partners, LLC ("ICP") expressed an intention to acquire approximately
50% of our outstanding common stock of the Company which it does not already own
for $3.30 per share in cash. ICP currently owns 1,022,019 of our shares..
On May 7, 2002 ICP filed a Form 13D with the Securities and Exchange
Commission expressing its intention to increase its holdings in the Company by
acquiring 50% of our outstanding shares it does not currently own. According to
the Form 13D filing the source of funds for such transaction would be investment
funds under the direction and control of ICP.
ICP has indicated that it would consider extending us a line of credit
for working capital and add-on acquisition purposes.
13
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, to enjoin the 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.
On May 6, 2002, a second complaint was filed in the same Court
containing nearly identical allegations. On May 6, 2002, lawyers for the
plantiffs requested an order consolidating the two cases. While we believe that
the lawsuits lack merit and intend to contest them vigorously, we believe that
the termination of our merger negotiatons with Scientific Games (see above) has
mooted the complaints.
GAME INTRODUCTIONS:
Our licensed properties are being accepted by lotteries at
unprecedented levels. As of the date of this 10-QSB, 83 lottery promotions
involving nineteen different properties are either currently on sale or are
planned for introduction in this fiscal year as follows:
Harley-Davidson(R): 26 lotteries
Elvis Presley(R): 16 lotteries
NASCAR(R) Drivers: 8 lotteries
Betty Boop(TM): 6 lotteries
OTHER BRANDS: 27 lotteries
Limited time marketing opportunities have driven interest in two
properties: Harley-Davidson(R), which begins a year-long celebration of its
100th corporate anniversary in Summer 2002, and Elvis Presley(R), which is
observing the 25th anniversary of his death in 2002.
In the U.S., contracts have been executed or are planned for execution
in 2002 for MDI lottery games in six of the seven lotteries that had not
introduced our licensed games previously: D.C., Idaho, Massachusetts, Texas,
Vermont and Washington. We expect that by year's end, only one U.S. lottery, the
recently launched South Carolina Lottery, will not have been a customer of our
games.
Our acquisition of the FIFA/WORLD CUP 2002 lottery license has enabled
us to expand our international business into two continents: Europe (France,
Ireland) and Asia (China).
14
INTERNET PLATFORMS:
In late 2001 we entered into a contract with Digiknow, LLC, a
Cleveland-based web development company with offices in Dallas, for the purpose
of continuing our Internet-based second chance promotion web sites, offered to
lotteries as a value-added service tied to our licensed game promotions.
Digiknow's services replace the services that were previously provided to us by
eLottery.
Our Internet-based service is currently being provided to the lotteries
in New Jersey and Virginia. The Idaho Lottery is also currently offering a
similar service in association with our licensed games, through the lottery's
pre-existing relationship with eLottery/IMARCS Group.
During the current quarter ended March 31, 2002, we received
notification from the U.S. Patent Office that our applications for registration
of our Internet service trade names, Lottery Bonus Zone(TM) and Second Chance
Bonus Zone(TM) have been accepted.
LICENSED PROPERTIES:
During the quarter ended March 31, 2002 we have executed contracts for
new licensed properties, including I Love Lucy(R) and the National Basketball
Association/NBA(R).
I Love Lucy(R) endures as one of the entertainment industry's most
powerful consumer icons, more than 50 years after the TV show made its debut. In
its May 3, 2002 issue, TV Guide ranks I Love Lucy(R) as the second most popular
TV series of all time. The license includes the use of the widely recognizable
show logo, as well as various images of Lucy, Ricky, Ethel and Fred in many of
their most entertaining moments from the show. Additionally, the license
provides us access to a wide variety of officially licensed I Love Lucy(R)
merchandise.
The NBA(R) license represents a significant milestone in domestic
lottery marketing. The NBA is the first professional sports league to authorize
its imagery to be associated with government lottery tickets. Our license
provides lotteries with opportunities to use a variety of league and team
imagery and official NBA(R) merchandise.
As of the date of this 10-QSB, seven of our licensed properties are
expected to generate their first lottery contracts in 2002: Heroes of Space(TM)
(currently on sale in New Jersey), I Love Lucy(R), Lionel(R), NBA(R), Pink
Panther(TM), Universal Studios Monsters(TM) and World Cup(R).
EXPANSION INTO INTERNATIONAL MARKETS
Late last year we hired Ms. Evelyn Yenson as our Senior Vice President,
International Sales and Marketing, to focus on international development. Ms.
Yenson brings outstanding credentials to the position, having established
herself in the international lottery arena as the director of the Washington
State Lottery and as the first U.S. delegate to the World Lottery Association
Executive Committee. She later served as the corporate communications officer
for the instant ticket printing industry leader, Scientific Games. Through Ms.
Yenson's efforts and relationships, our products are now being actively marketed
on every continent where there are lottery jurisdictions. These efforts resulted
in first time contracts in France and China, which are both doing our World
Cup(R) license game, discussed below. We have also retained several consultants
with off-shore lottery experience to assist in our marketing efforts.
In late 2001, we established a valuable "calling card" in the
International lottery arena by acquiring the exclusive worldwide lottery
licensing rights to the 2002 FIFA/World Cup Korea/Japan soccer finals. We are
finding that, as expected, owning rights to the World Cup(R) has given us
substantial access into some of the world's largest lottery organizations, and
has created prospects for business that go well beyond the World Cup(R) event.
Because of a variety of factors, the World Cup(R) 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, we have also recently negotiated an expansion of our North American
lottery rights from domestic to worldwide for MGM's Pink Panther(TM). To the
extent practical, we are seeking international rights for other existing
properties, as we also seek to identify viable consumer icons that have strong
regional appeal in foreign lottery markets.
15
Three months ended March 31, 2002 and March 31, 2001
----------------------------------------------------------------
2002 % 2001 %
---- - ---- -
Total revenue $ 3,519,356 100.0% $3,121,999 100.0%
Cost of revenues 2,269,615 64.5% 1,719,883 55.1%
----------------------------------------------------------------
Gross profit 1,249,741 35.5% 1,402,116 44.9%
Selling, general and administrative expenses 1,210,201 34.4% 873,544 28.0%
Terminated merger costs 306,455 8.7% - 0.0%
----------------------------------------------------------------
Operating (loss) profit (266,915) -7.6% 528,572 16.9%
Interest expense 9,141 0.3% 80,215 2.6%
Interest income (2,361) -0.1% (2,454) -0.1%
Other expense (income) 99,855 2.8% (110,166) -3.5%
Gain on sale of investments, net - 0.0% (24,307) -0.8%
----------------------------------------------------------------
(Loss) Income before provision for income taxes (373,550) -10.6% 585,284 18.7%
(Benefit) provision for income taxes (732,108) -20.8% 8,000 0.2%
----------------------------------------------------------------
Net income $ 358,558 10.2% $ 577,284 18.5%
================================================================
THREE MONTHS ENDED MARCH 31, 2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001
Results for the first quarter ended March 31, 2002 reflect a 12.7%
increase in revenue. Revenue for the three months ended March 31, 2002 was
$3,519,400 compared to $3,122,000 for the three months ended March 31, 2001.
Overall revenue increased as a result of the increased game launches for the
three months ended March 31, 2002 compared to the three months ended March 31,
2001. Elvis Presley(R), which is currently on sale with ten lotteries, accounted
for 43.7% of our revenue for the quarter ended March 31, 2002. Harley
Davidson(R) and CMT(R) accounted for 14% and 11.5% of our revenue for the
quarter ended March 31, 2002. The remaining 30.8% of revenue for the quarter
ended March 31, 2002 was derived from 11 other licensed properties.
Cost of revenue as a percentage of revenue increased to 64.5% from
55.1% for the three months ended March 31, 2002 compared to the three months
ended March 31, 2001. This increase in the cost ratio reflects much higher
licensing and merchandising costs associated with the Elvis Presley(R) games
launched and running this quarter which represented 43.7% of our revenue.
16
The gross profit decreased in the three months ended March 31, 2002 to
1,249,700 (35.5% of revenue) compared to $1,402,100 (44.9% of revenue) for the
three months ended March 31, 2001. As mentioned above, this significant ratio of
Elvis Presley(R) games all in the quarter made it difficult to achieve our
target gross profit of 40%. Without the Elvis Presley(R) games our gross profit
would have been approximately 40%. Based on the game mix we expect to exceed our
targeted 40% next quarter.
Selling, general and administrative expenses were $1,210,201 (34.4% of
revenue) for the three months ended March 31, 2002 compared to $873,500 (28.0%
of revenue) for the three months ended March 31, 2001. Salaries and employee
benefits increased approximately $109,000 this quarter due to increased sales
and marketing personnel for our international sales efforts and a new Vice
President of Creative Development who was hired to support our lottery customers
in innovative game promotion concepts. Marketing, promotional and related travel
expenses increased by $45,300 for a total of $174,300 for the three months ended
March 31, 2002. Nearly one half of this increase was due to international
marketing and promotions which resulted in contracts in both France and China,
international lotteries that we have never penetrated before. They are both
doing our World Cup(R) licensed game.
Costs related to both public reporting and investor relations increased
significantly to $248,900 for the three months ended March 31, 2002 from
$116,400 for the three months ended March 31, 2001. This increase is due to an
$86,000 change in financial consulting expenses between quarters due to a
$50,000 negotiated settlement in reduced fees with our investment banking firm
that resulted in a credit balance for financial consulting of ($48,000) for the
three months ended March 31, 2001 compared to fees of $38,000 for the three
months ended March 31, 2002. This negotiated settlement in 2001 also included an
exchange of stock for fees. Operational expenses for our Fort Worth, Texas
office totaled approximately $18,000 in the three months ended March 31, 2002
which did not exist in the same quarter in 2001.
The Company also had certain legal, accounting and investment banking
fees relating to the terminated merger with Scientific Games. These
non-recurring costs totaled $306,500 as of March 31, 2002. Additional terminated
merger expenses that have been incurred after the three months ended March 31,
2002 are approximately $100,000.
The operating loss was ($266,900) (7.6% of revenue) for the three
months ended March 31, 2002 compared to an operating profit of $528,600 (16.9%
of revenue) for the three months ended March 31, 2001. This decrease in
operating profitability is due to the factors described above but particularly
the costs related to the terminated merger. Without these merger costs there
would have been an operation profit for the quarter ended March 31, 2002 of
$39,500 (1.1% of revenue).
Interest expense was $9,100 for the three months ended March 31, 2002
compared to $80,200 for the three months ended March 31, 2001. This reduction in
interest expense is related to the reduction of short term debt from $940,000 at
March 31, 2001 to $260,000 at March 31, 2002. Interest on our Subordinated
Convertible Debenture also existed during the three months ended March 31, 2001.
Other expense was $99,800 for the three months ended March 31, 2002
compared to other income of $110,200 for the three months ended March 31, 2001.
This net expense of $99,800 is primarily the write off of the total $100,000
promissory note we received as settlement for the lawsuit with Oxford
International, Inc. settled on December 31, 2001. We were to receive $10,000 on
February 15, 2002. As of this filing we have not received payment and the
ultimate collection of this note is in doubt. We will evaluate the merits of
pursuing this matter further. The $110,200 in the comparative period ended March
31, 2001 was attributable to the favorable exchange of stock for legal services
that was negotiated during the first quarter of 2001.
The $24,300 gain on securities for the three months ended March 31,
2001 was attributable to the sale of 193,000 shares of eLot stock held for
investment.
17
For the reasons set forth above, we had a loss before taxes of $373,600
for the three months ended March 31, 2002 compared to income before taxes of
$585,300 for the three months ended March 31, 2001.
Net income decreased to $358,600 for the quarter ended March 31, 2002
compared to $577,300 for the quarter ended March 31, 2001. The increase in the
income tax benefit in the quarter ended March 31, 2002 is attributable to the
reversal of approximately $732,100 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 would be utilized and
accordingly, $1.3 million of the valuation allowance was reversed. This
determination was based on our profitability in 2001 and our expectation of
continued profitability. We have determined that profitability will continue
well into 2002 after reporting $3.5 million of revenue in the first quarter and
by a backlog of $10.4 million that continues strong with additional significant
interest by lotteries in our licensed properties. For these reasons we
determined that this remaining $732,100 of deferred tax asset valuation should
also be reversed as its utilization is more likely than not.
Earnings per share was $.03 on both a basic and fully diluted basis for
the quarter ended March 31, 2002, compared to an earnings per share of $.05 on
both a basic and fully diluted basis for the quarter ended March 31, 2001.
Our pro-forma fully-taxed (i.e., operating income less the statutory
tax rate) basic and fully diluted loss per share was ($.03) for the quarter
ended March 31, 2002, compared to a pro-forma fully-taxed basic and fully
diluted earnings per share of $.04 and $.03 for the quarter ended March 31,
2001.
LIQUIDITY AND CAPITAL RESERVES
As of March 31, 2002, we had cash and cash equivalents of $1,130,900
compared to $251,600 as of December 31, 2001. This significantly increased cash
position was in part due to the collection of receivables for games launched
this quarter. Accounts receivable decreased to $2,274,200 as of March 31, 2002
compared to $2,709,600 as of March 31, 2001 reflecting the additional
collections in the current quarter ended March 31, 2002 contributing to our
improved cash position.
As of March 31, 2002, we had positive working capital of $510,100.
Included in current assets is $1,343,000 in deferred tax assets, a non-cash
asset. Also within current liabilities is $2,779,400 of "Billings in excess of
cost and estimated earnings on uncompleted contracts" representing unrecognized
revenue (i.e., amounts invoiced to, or received from our customers, but which
may not be recognized as revenue until we purchase the related contracted
merchandise). Accordingly, such liability will not adversely impact cash flow,
except to the extent that we need to purchase merchandise and incur subsequent
fulfillment costs relative to this revenue, which typically approximates 50% of
the related revenue. Without these two items, working capital would have been
$556,800.
Our indebtedness as of March 31, 2002 was $260,000, consisting of an
installment note payable to our President and Chief Executive Officer.
18
Our obligations and commitments to make future payments under license
contracts consulting agreements, debt and lease agreements is summarized in the
following table:
Payments Due by Period
----------------------
After 5
Contractual Obligations Total 1-3 years 4-5 years years
----------------------- -------- --------- --------- ------
License Obligations $2,543,581 $2,193,581 $350,000 $ -
Long-term debt 260,000 260,000 - -
Operating leases &
consulting agreements 755,485 708,658 46,827 -
------- ------- --------- -------
Total contractual cash $3,559,066 $3,162,239 $396,827 $ -
========== ========== ======== =======
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 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 currently have a bank commitment for a $750,000 line of credit,
$250,000 of this line is specifically for Letters of Credit to be utilized in
the place of performance bonds for lotteries that occasionally require them. The
disaster of September 11, 2001 and the Enron collapse have contributed to an
extremely tight (if existent) performance bond market. It is expected to close
by the end of May, 2002. Further, if this line does not close we cannot assure
you that we will be able to secure an alternative financing 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.
SEASONALITY AND REVENUE FLUCTUATIONS
Our business is not seasonal. However, our revenues are expected to
fluctuate as individual license-based promotions commence or wind down and
terminate. The useful life of a promotion is generally relatively short as the
novelty of the game or the popularity of the licensed material wanes over time.
In addition, our licenses (which are generally for 1.5 to 3 years) terminate at
various times over the next several years. The life span of a promotion, the
timing of agreements with the lotteries to run promotions, the acquisition of
new licenses and the commencement of new promotions are unpredictable. Also,
since most lotteries are government agencies with lottery executives appointed
by the state's governor or other high ranking official, opportunities or
projects in progress can be slowed after an election if the incumbent governor
is not re-elected. Accordingly, period-to-period comparisons may not be
indicative of future results.
19
PART II
OTHER INFORMATION
ITEM 1. 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 defendants 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 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 The 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. ("Oxford") 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, DataMEG and McClendon Transportation, 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 the
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 any of our officers or 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 the liquidity and value of the securities were, in
fact, impaired, then we believe Oxford may have defrauded us.
20
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 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.
As of this filing we have not received payment and the ultimate
collection of this note is in doubt. We will evaluate the merits of pursuing
this matter further.
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 the 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.
On May 6, 2002, a second complaint was filed in the same Court
containing nearly identical allegations. On May 6, 2002, lawyers for the
plantiffs requested an order consolidating the two cases. While we believe that
the lawsuits lack merit and intend to contest them vigorously, we believe that
the termination of our merger negotiatons with Scientific Games has mooted the
complaints.
21
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit 10.1 Letter of Intent between Scientific Games
Corporation and MDI Entertainment, Inc.
dated February 25, 2002 (Incorporated by
reference to Form 8-K filed
February 26, 2002).
(b) Reports on Form 8-K Filed on February 26, 2002 (Item 5: Other
Events - Letter of Intent contemplating the
acquisition of MDI Entertainment, Inc. by
Scientific Games Corporation).
Filed on March 4, 2002 (Item 5: Other Events
- Class action lawsuit filed on behalf of
MDI Entertainment, Inc.'s public
shareholders).
Filed on March 4, 2002 (Item 5: Other Events
- Settlement of Oxford lawsuit).
Filed on May 9, 2002 (Item 5: Other Events -
Mutually and amicably terminated merger
negotiations between MDI Entertainment and
Scientific Games Corporation - Press release
dated May 8, 2002).
22
SIGNATURE PAGE
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Dated May 20, 2002
MDI ENTERTAINMENT, INC.
(Registrant)
By: /s/Steven M. Saferin
--------------------
Steven M. Saferin
President and Chief Executive Officer
and Director
(Principal Executive Officer)
By: /s/Kenneth M. Przysiecki
------------------------
Kenneth M. Przysiecki
Senior Vice President Accounting and
Administration, Secretary and Director
(Principal Financial and Accounting
Officer)
23