SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001.
[ ] 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 October 31, 2001, 11,172,306 shares of the issuer's common stock were
outstanding.
Transitional Small Business Disclosure Format (check one): Yes No X
--- -
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
FORM 10-QSB
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
INDEX
PART I. FINANCIAL INFORMATION
Item 1.Financial Statements................................ .............................................................1
Condensed Consolidated Balance Sheets as of September 30, 2001 (unaudited) and
December 31, 2000.......................................................................................................1
Condensed Consolidated Statements of Operations (unaudited) for the nine months ended
September 30, 2001 and 2000.............................................................................................3
Condensed Consolidated Statements of Operations (unaudited) for the three months ended
September 30, 2001 and 2000.............................................................................................4
Condensed Consolidated Statement of Changes in Shareholders' Equity (unaudited)
for the nine months ended September 30, 2001............................................................................5
Condensed Consolidated Statements of Cash Flows (unaudited)
for the nine months ended September 30, 2001 and 2000...................................................................6
Notes to Unaudited Condensed Consolidated Financial Statements...........................................................7
Item 2. Management's Discussion and Analysis............................................................................12
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...............................................................................................22
Item 2. Change in Securities and Use of Proceeds........................................................................23
Item 6. Exhibits and Reports on Form 8-K................................................................................24
Signatures...........................................................................................................25
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
2001 2000
---------------- -----------------
ASSETS (unaudited)
CURRENT ASSETS:
Cash and cash equivalents $334,927 $528,151
Investment securities
available-for-sale - 180,000
Accounts receivable 1,186,951 1,140,919
Inventory 873,633 285,301
Other current assets 509,314 451,983
---------------- -----------------
Total current assets 2,904,825 2,586,354
----------------- -----------------
PROPERTY AND EQUIPMENT, at cost:
Equipment 287,140 250,456
Furniture and fixtures 120,361 120,361
----------------- -----------------
407,501 370,817
Less: Accumulated depreciation (254,182) (212,137)
----------------- -----------------
Property and Equipment, net 153,319 158,680
----------------- -----------------
OTHER ASSETS:
Licensing costs, net 1,515,013 1,397,680
Other (Note 3) 54,767 363,482
------------------- --------------------
Total other assets 1,569,780 1,761,162
------------------- --------------------
Total assets $4,627,924 $4,506,196
=================== ====================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
1
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
September 30, December 31,
2001 2000
-------------------- ---------------------
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) (unaudited)
CURRENT LIABILITIES:
Billings in excess of costs and estimated earnings
on uncompleted contracts (Note 2) $2,510,757 $2,888,985
Current portion of long term debt 302,315 955,006
Accounts payable 641,519 1,378,444
Accrued expenses 356,233 204,400
Income taxes payable (Note 5) 54,107 9,871
------------------ ------------------
Total current liabilities 3,864,931 5,436,706
SUBORDINATED CONVERTIBLE DEBENTURE (Note 4) - 553,125
------------------ ------------------
Total liabilities 3,864,931 5,989,831
------------------ ------------------
SHAREHOLDERS' EQUITY (DEFICIT) (Notes 4 and 6):
Common stock 11,172 10,505
Convertible preferred stock-Series B 1 1
Convertible preferred stock-Series C (Note 10) - -
Additional paid-in capital 5,578,392 5,061,596
Accumulated deficit (4,826,572) (6,555,737)
------------------ ------------------
Total shareholders' equity (deficit) 762,993 (1,483,635)
------------------ ------------------
Total liabilities and
shareholders' equity (deficit) $4,627,924 $4,506,196
================== ==================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
2
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Nine months ended
September 30,
2001 2000
----------------- ------------------
(unaudited) (unaudited)
REVENUE $ 10,687,122 $4,267,456
COST OF REVENUES 6,000,472 2,823,568
----------------- ------------------
Gross profit 4,686,650 1,443,888
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES 2,722,911 2,631,468
TERMINATED MERGER EXPENSES (NOTE 8) - 727,025
COST OF UNSUCCESSFUL FUNDING (NOTE 7) 188,742 -
----------------- ------------------
Operating profit (loss) 1,774,997 (1,914,605)
INTEREST EXPENSE, net 121,843 73,224
OTHER (INCOME) EXPENSE (110,166) 57,218
GAIN ON SALE-INVESTMENT SECURITIES. net (12,669) -
----------------- ------------------
Income (loss) before provision for income taxes 1,775,989 (2,045,047)
PROVISION FOR INCOME TAXES (NOTE 5) 46,824 3,429
----------------- ------------------
Net income (loss) $ 1,729,165 $(2,048,476)
================= ==================
Basic Earnings (Loss) Per Common Share (Note 6 ) $.16 $(.22)
=================== ==================
Diluted Earnings (Loss) Per Common Share (Note 6 ) $.14 $(.22)
=================== ==================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
3
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three months ended
September 30,
2001 2000
------------------- ------------------
(unaudited) (unaudited)
REVENUE $ 4,001,656 $1,536,592
COST OF REVENUES 2,276,367 958,205
------------------- ------------------
Gross profit 1,725,289 578,387
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES 937,809 786,932
COST OF UNSUCCESSFUL FUNDING (NOTE 7) 99,109 -
------------------- ------------------
Operating profit (loss) 688,371 (208,545)
INTEREST EXPENSE, net 1,872 31,725
------------------- ------------------
Income (loss) before provision for income taxes 686,499 (240,270)
PROVISION FOR INCOME TAXES (Note 5) 34,789 1,100
------------------- ------------------
Net income (loss) $ 651,710 $(241,370)
=================== ==================
Basic Earnings (Loss) Per Common Share (Note 6 ) $.06 $(.02)
=================== ==================
Diluted Earnings (Loss) Per Common Share (Note 6 ) $.05 $(.02)
=================== ==================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
4
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the nine months ended September 30, 2001
(Unaudited)
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
and September 30, 2001 444 $ 1
============== ===============
Common Stock, par value $.001 per share,
authorized 25,000,000 shares
Balance, December 31, 2000 10,505,872 10,505
Stock options exercised 28,934 29
Issuance of common stock 262,500 263
Conversion of subordinated debenture 375,000 375
--------------- ---------------
Balance, September 30, 2001 11,172,306 11,172
=============== ---------------
Additional Paid-in Capital:
Balance, December 31, 2000 5,061,596
Stock options exercised 6,571
Issuance of warrants 28,001
Issuance of common stock 269,025
Conversion of subordinated debenture 213,199
---------------
Balance, September 30, 2001 5,578,392
---------------
Accumulated Deficit:
Balance, December 31, 2000 (6,555,737)
Net income 1,729,165
----------------
Balance, September 30, 2001 (4,826,572)
----------------
Total Shareholders' Equity, September 30, 2001 $ 762,993
=================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
5
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended
September 30,
2001 2000
---------------- ----------------
(unaudited) (unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $1,729,165 $(2,048,478)
Adjustments to reconcile net income (loss) to net
cash provided by (used for) operating activities:
Depreciation and amortization 645,753 220,200
Stock based compensation - 46,707
Gain on sale of investments, net (12,669) -
Change in assets and liabilities:
Increase in accounts receivable (46,032) (83,750)
Increase in inventory (588,332) (29,845)
Increase in licensing costs (705,603) (267,870)
(Increase) decrease in other assets (75,604) 4,405
(Decrease) increase in accounts payable (467,637) 706,825
Increase in accrued expenses 151,833 55,782
Increase in income taxes payable 44,236 6,481
(Decrease) increase in billings in excess of costs
and estimated earnings on uncompleted contracts (378,228) 430,430
---------------- ----------------
Net cash provided by (used for) operating activities 296,882 (959,113)
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (36,684) (26,432)
Proceeds of sale of investments 192,669 -
---------------- ----------------
Net cash provided by (used for) investing activities 155,985 (26,432)
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of debt (652,691) (164,401)
Proceeds from short-term debt - 520,000
Proceeds from exercise of common stock options 6,600 153,350
Other - 4,546
---------------- ----------------
Net cash (used for) provided by financing activities (646,091) 513,495
---------------- ----------------
NET DECREASE IN CASH (193,224) (472,050)
CASH, beginning of the period 528,151 1,019,456
---------------- ----------------
CASH, end of the period $ 334,927 $ 547,406
================ ================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Interest $ 57,708 $ 65,277
Income taxes $ 2,588 $ 4,627
Non-cash investing and financing activities:
Common stock and warrants issued for license $ - $ 500,000
Preferred stock dividend paid in common stock $ - $ 18,260
Imputed interest on subordinated convertible debenture $ 5,625 $ 16,875
Conversion of subordinated debenture into common stock $ 213,574 $ -
Common stock issued for services $ 269,288 $ -
Expenses related to warrants $ - $ 32,750
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
6
MDI ENTERTAINMENT, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR NINE MONTHS
ENDED SEPTEMBER 30, 2001.
1. PRESENTATION OF UNAUDITED INTERIM CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS.
Information in the accompanying interim condensed consolidated
financial statements and notes to the financial statements of MDI Entertainment,
Inc. and subsidiary (MDI or the Company) for the nine-month periods ended
September 30, 2001 and 2000 is unaudited. The accompanying interim unaudited
consolidated financial statements have been prepared by us in accordance with
accounting principles generally accepted in the United States and Regulation
S-B. Accordingly, they do not include all the information and footnotes required
by accounting principles generally accepted in the United States for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the nine-month period ended September 30,
2001 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2001. The consolidated financial statements should be
read in conjunction with the financial statements and notes thereto included in
the audited financial statements of the Company as and for the seven months
ended December 31, 2000.
2. REVENUE AND COST RECOGNITION
Revenue is derived from various lottery game contracts (mainly with
states) between the Company and the lotteries. 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 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 game contracts that are greater than one year
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. Contracts' 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 September 30,
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.
3. OTHER ASSETS
Other assets at September 30, 2001 consisted primarily of prepaid
financing costs and security deposits. Other assets at December 31, 2000 also
included deferred financing costs related to the subordinated convertible
debenture, described in Note 4. These costs were charged to paid in capital when
the debenture was converted into common stock on March 14, 2001.
7
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 debenture
was converted into common stock on March 14, 2001, as discussed below. The
Debenture bore interest at 7% per annum and was 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 the
Company's 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 holder of the subordinated convertible debenture
exercised its conversion privilege and was issued 375,000 shares of common
stock. The carrying amount of the debenture was $558,750 and the Company's
common stock was trading for $1.75 on the date of conversion. The Company
recorded the transaction utilizing the book value method and accordingly,
recognized no gain or loss from the conversion.
5. INCOME TAXES
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109 (SFAS No. 109), "Accounting for Income
Taxes", which requires that a deferred tax liability or asset be recognized for
the estimated future tax effects attributable to temporary differences between
the Company's financial statements and tax return. SFAS No. 109 provides for
recognition of deferred tax assets for all future deductible temporary
differences that, more likely than not, will provide a future benefit. As of
September 30, 2001 and December 31, 2000, the Company had a significant deferred
tax asset, primarily as a result of net operating loss carry-forwards. A
valuation allowance has been established for the full amount of this deferred
tax asset. The primary difference between the Company's effective tax rate and
the statutory tax rate is the utilization of the net operating loss
carryforwards and the related reversal of the valuation allowance.
6. EARNINGS PER SHARE
Basic and diluted earnings (loss) per common share are based on the
average number of common shares outstanding during the period. The Company has
excluded 2,142,000 shares, representing the total of its Series C Preferred
Stock on an as converted basis and origination fees paid in common stock, from
its weighted average common stock outstanding, as of September 30, 2001. See
"Note 10: Stock Purchase Agreement-Oxford International, Inc."
Diluted earnings per common share include, in addition to the above,
the dilutive effect of common share equivalents during the period. For the three
and nine months ended September 30, 2001, common share equivalents represented
convertible preferred stock (convertible into 444,444 shares of common stock),
dilutive stock options (convertible into 404,309 net shares of common stock) and
warrants (convertible into 490,084 net shares of common stock) using the
treasury method. For the three and nine months ended September 30, 2000, a
subordinated debenture convertible into 375,000 shares of common stock, warrants
to purchase 831,100 shares of common stock and options to purchase 974,166
shares of common stock were excluded from the calculation of the diluted
earnings per share since their inclusion would be anti-dilutive.
The net income (loss) available to common shareholders and the number
of shares used in the earnings (loss) per common share and earnings (loss) per
dilutive share computation for 2001 and 2000 were as follows:
8
Nine Months Ended
September 30,
--------------------------------
2001 2000
Net income (loss) ........................ $ 1,729,165 $(2,048,476)
Preferred stock dividends ................ - (26,402)
----------- -----------
Net income (loss) applicable
to common shareholders ................. $ 1,729,165 $(2,074,878)
=========== ===========
Nine Months Ended
September 30,
---------------------------------
2001 2000
Basic:
Average number of common
shares outstanding ..................... 11,070,096 9,272,718
=========
Dilutive effect of options,
warrants and
convertible securities ................. 1,338,837
----------
Average dilutive common
shares outstanding ..................... 12,408,933
==========
Three Months Ended
September 30,
----------------------------------
2001 2000
Net income (loss) $651,710 $(241,370)
Preferred stock dividends - (4,617)
--------- ---------
Net income (loss) applicable
to common shareholders $651,710 $(245,987)
========= =========
Three Months Ended
September 30,
---------------------------------
2001 2000
Basic:
Average number of common
shares outstanding 11,172,306 9,873,960
=========
Dilutive effect of options,
warrants and
convertible securities 1,338,837
----------
Average dilutive common
shares outstanding 12,511,143
==========
9
7. COST OF UNSUCCESSFUL FUNDING
During the nine months ended September 30, 2001 the Company recorded an
expense of $188,742 for costs relating to the placement and issuance of its
Series C Preferred Stock to Oxford International, Inc. Theses costs include
legal, accounting, and investment banking fees paid. (See Note 10 "Stock
Purchase Agreement-Oxford International, Inc.")
8. TERMINATED MERGER EXPENSES
The Company entered into an Agreement and Plan of Merger with The
Lottery Channel, Inc. (Lottery Channel) and the Company's wholly-owned
subsidiary (established to facilitate the merger), MDI Acquisition, Inc.(MDI
Acquisition), dated as of January 26, 2000. The obligations of MDI Acquisition,
Lottery Channel and the Company to effect the merger were subject to the
fulfillment of a number of conditions including, among others, the consummation
of certain contemplated investments and receipt of third party consents. Certain
of such conditions were not met and on August 25, 2000, the Company sent a
notice of termination to The Lottery Channel, Inc. terminating the Agreement and
Plan of Merger. In accordance with accounting principles generally accepted in
the United States, $727,025 of costs related to the proposed merger were written
off, as reflected in the accompanying financial statements. Subsequently, by
letter dated August 28, 2000, Lottery Channel responded by purporting to
terminate the merger agreement due to MDI's breach. The letter claimed that the
Company was responsible for all cost and expenses incurred in connection with
the transaction. The Company disputes this assertion.
On November 7, 2000, the Company and its subsidiary, MDI Acquisition,
Inc., were notified that they had been named as defendants in a complaint filed
by Lottery Channel. on November 2, 2000 in the Hamilton County, Common Pleas
Civil Division, Cincinnati, Ohio, arising from a decision to terminate its
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. The Company believes that the lawsuit is without merit
and will vigorously defend its position, as well as assert a varity of
counterclaims against Lottery Channel, including a demand that Lottery Channel
pay certain expenses under the termination provisions of the merger agreement.
The lawsuit alleges that MDI (i) breached the merger agreement by failing to
fulfil certain conditions necessary to obligate us to close the merger and by
entering into an agreement with a competitor of Lottery Channel and (ii)
breached its fiduciary duty to Lottery Channel by entering into an agreement
with a competitor of Lottery Channel. The two conditions specifically cited in
the complaint are the requirement of a $10 million investment by the National
Broadcasting Company ("NBC"), the partial owner and strategic partner of Lottery
Channel, and the raising of an additional $5 million in equity as part of a
private placement. It is the Company's position that the condition for NBC to
invest $10 million, as well as to amend its stock purchase agreement with
Lottery Channel, were conditions that Lottery Channel was obligated to, but did
not fulfill. The condition that $5 million in additional equity be raised was
not satisfied by Lottery Channel for a variety of reasons, including the
legislative environment relating to activities in Congress with respect to the
Internet sale of lottery tickets and because of the change in financial markets
relating to Internet companies. There can be no assurance as to the outcome of
this litigation. Steven M. Saferin, the Company's President and Chief Executive
Officer, has filed a complaint, in his individual capacity, against Roger W. Ach
II, the President and Chief Executive Officer of Lottery Channel, seeking
$108,000 plus interest as payment for a promissory note, due July 30, 2000. The
Company has withdrawn its complaint in the United States District Court for the
Southern District of New York against John Doe. The complaint, which was
originally filed on December 19, 2000, had sought compensatory and punitive
damages for defamation occuring on Internet message boards.
9. RECENT ACCOUNTING PRONOUNCEMENTS
On June 30, 2001 the Financial Accounting Standards Board (FASB)
finalized Statements of Financial Accounting Standards No. 141, "Business
Combinations" and No. 142, "Goodwill and Other Intangible Assets". Adoption of
FASB 142 is required beginning with the first quarter of 2002. The Company has
no planned or anticipated business combinations, which would be affected by FASB
141. The Company's intangible amortization policies are consistent with FASB
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.
10
10. STOCK PURCHASE AGREEMENT - OXFORD INTERNATIONAL, INC.
The Company entered into a Stock Purchase Agreement with Oxford
International, Inc. ("Oxford") with an effective date of April 25, 2001.
Pursuant to that Agreement, the Company issued to Oxford 2,100 shares of Series
C Preferred Stock (the "Series C Stock") representing approximately 15.8% of the
outstanding common stock of MDI on an as converted basis. The Company
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, the
Company did not release its stock to Oxford and did not consider the transaction
consummated.
The Company entered into an "Agreement" with Oxford with an effective
date of July 9, 2001, whereunder the Company 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 the Company's Board of
Directors; that it could not require performance of any matters under the Stock
Purchase Agreement and Certificates of Designation 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 (FBI) made assertions about Oxford. The FBI notified the Company
of its investigations of Oxford, but did not make any assertions concerning the
Company or any of its officers or directors. Neither the Company nor its
officers and directors are under any investigation by the FBI as part of their
investigation of Oxford.
The Company was advised that, in the view of the issuers of the
publicly traded securities and the FBI, the securities it 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 the Company believes it may have
been defrauded by Oxford.
By letter dated July 27, 2001, the Company notified Oxford that,
pursuant to the July 9th Agreement, it was exercising its right to exchange the
publicly traded securities it received from Oxford for all of the Company's
stock issued to Oxford.
Oxford has refused to honor the Company's exchange right. On August 6,
2001, the Company 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.
Therefore, the Company has excluded 2,142,000 shares, representing the
total of its Series C Preferred Stock on an as converted basis and origination
fees paid in common stock, from its total common stock outstanding, as of
September 30, 2001. See "Part II Item 1: Legal Proceedings."
Upon the filing of the Company's Form 8-K on July 16, 2001 reporting
these issues, NASDAQ halted trading in the Company's securities. On such date,
the Company also received a letter from NASDAQ asking it to respond to various
questions, which the Company responded to by the July 20, 2001 deadline.
Representatives of the Company met with NASDAQ both on July 30 and August 7,
2001 to discuss the contents of that submission and other issues concerning the
Company's financing transaction with Oxford.
The Company agreed with NASDAQ that, since the Company exercised its
right of exchange under the Agreement dated July 9, 2001, it no longer met the
net tangible asset maintenance requirements for continued listing on the NASDAQ
SmallCap Market. The Company has applied for, and its securities have been
accepted for, trading on the Over-The-Counter Bulletin Board under the trading
symbol, "LTRY:OB".
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, trips and, in the case of Harley-Davidson(R), Harley-Davidson 1200
Sportster and Heritage Softtail Classic 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 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
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 quantity range from about one
million to as many as 60 million with an average quantity of about five million.
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 2.5 to 4
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, including those from professional sports leagues, and to 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.
13
RECENT DEVELOPMENTS
STOCK PURCHASE AGREEMENT WITH 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, ithe 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 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 9th 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 has refused to 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.
We have therefore excluded 2,142,000 shares, representing the total of
our Series C Preferred Stock on an as converted basis and origination fees paid
in common stock, from our total common stock outstanding, as of September 30,
2001. See "Part II, Item 1: Legal Proceedings."
Upon the filing of our Form 8-K on July 16, 2001 reporting the issues,
NASDAQ halted trading in our securities. On such date, we also received a letter
from NASDAQ asking us to respond to various questions, which we responded to by
the July 20, 2001 deadline. Our representatives met with NASDAQ both on July 30
and August 7, 2001 to discuss the contents of that submission and other issues
concerning our financing transaction with Oxford.
We agreed with NASDAQ that, since we exercised our right of exchange
under an Agreement with Oxford dated July 9, 2001, we no longer met the net
tangible asset maintenance requirement for continued listing on NASDAQ SmallCap
Market. Therefore, we moved the trading of our securities to the
Over-The-Counter Bulletin Board effective August 22, 2001. If in the future, we
meet the criteria for listing on NASDAQ, we may elect to reapply for such
listing.
14
SALES AND MARKETING
The third quarter, which ended on September 30, 2001, represents the
third consecutive profitable quarter for the Company. This quarter, we again
reached record revenue and earnings. There are a variety of factors responsible
for these results. They include the expansion of our sales and marketing staff
to more aggressively pursue our business plan and the fact that our licensed
games are being embraced by more and more lotteries in North America.
We have also entered into two groundbreaking agreements, the first of
which is with the Multi-State Lottery Association ("MUSL"), "), the consortium
of 22 Lotteries that run Powerball, which will allow its members to use a
generic advertising campaign starring the American musical icon Ray Charles, who
is under exclusive license to MDI for lottery games, advertising and promotions.
These spots should begin airing sometime in the fourth quarter of fiscal year
2001 and represent the first time that 16 different lottery jurisdictions have
adopted the same creative advertising. The largest cooperative MUSL program
before ours consisted only of seven states. We anticipate two or three
additional states will join the promotion before the end of this year. We are
very excited about the potential that this agreement has for the Company and we
are working on similar projects elsewhere.
We also have signed a contract with the Virginia Lottery, which
affords both the lottery and MDI maximum flexibility. The contract calls for the
lottery to print scratch tickets with a total minimum face value of $25 million
over the 31-month term of the contract. The Lottery may select from any of our
properties, which are currently or may be licensed by us in the future. The
games can be set at any price point or quantity, as long as the $ 25 million
amount is met during the term of the agreement. Our gross revenue under the
contract is expected to range between 8% and 10% of the lottery's prize fund,
depending on which properties are selected. This guarantees us a certain level
of revenue and gives the lottery the flexibility to pick and choose from any of
our games.
We have recently executed a Master License Agreement with the
Federation Internationale de Football Association for exclusive lottery
licensing rights for The World Cup 2002 Japan/Korea. The agreement allows us to
market the World Cup property anywhere in the world, with the exception of the
host countries of Korea and Japan. This is a property that we have vigorously
pursued for nearly two years. Our strategy to expand internationally has been
somewhat dependent on a premier property with interest throughout the world and
the World Cup, which is the largest sporting event in the world, is such a
property. Management is optimistic and believes that the World Cup will help the
company establish relationships with numerous lotteries through Europe, Latin
America, Asia and Africa.
We have also reached an agreement in principle with the National
Basketball Association ("NBA"). This marks the first time that a professional
sports league in the United States has embraced the lottery-licensing concept.
We expect to finalize this agreement during the fourth quarter of 2001. However,
we cannot provide assurance that a license agreement will be approved and
executed by the NBA. Nevertheless, with permission from the NBA, we have already
begun marketing NBA lottery games to our lottery customers, subject to our
execution of an agreement with the NBA.
During the third quarter ended September 30, 2001, we created the new
position of Senior Vice President for International Sales and Marketing, and
retained Evelyn P. Yenson, the former Executive Director of the Washington State
Lottery and Senior Director of Corporate Communications for Scientific Games
International, to serve in that position. Ms. Yenson also served one term as
President of the North American Association of State and Provincial Lotteries
and was the first United States' delegate of the World Lottery Association
Executive Committee.
15
OPERATIONAL RESULTS
The quarter ended September 30, 2001 continues the trend of profitable
operations started in the first two quarters of fiscal year 2001. As we
indicated after the termination of our merger with The Lottery Channel in August
2000, and through the ensuing months, our focus has been on developing our core
business. The results of this third profitable quarter reflect that focus. Our
revenue of over $4.0 million is a new record for any single quarter.
Our revenue for the three months ended June 30, 2001 is more than twice
our revenue for the three-month period ended September 30, 2000, and we have
earned $.06 per common share as opposed to a loss of $(.02) per share for the
same period in 2000. We believe our core business is strong. Our contract
backlog continues to be strong and our games continue to perform well in the
marketplace. We believe the acceptance of licensed games by lotteries in North
America has never been higher. It is our aim to continue to focus on the core
business as we strive to increase shareholder value, build a more successful
company and strengthen our position as the leader in our licensed lottery game
market.
INTERNET PLATFORMS
Our initiative to provide customers with Internet components related
to our licensed games continues to add value to our lottery customers. By the
end of December 2001, we expect to have launched ten web sites tied to our state
lottery promotions. The MDI model enables a lottery consumer to register
non-winning tickets for second chance merchandise drawings on the Internet,
instead of going to the expense of physically mailing the tickets to the
lottery, thus providing a tangible convenience and a real cost savings for
lottery consumers.
LICENSES AND CONTRACTS
In addition to the Multi-State Lottery Association promotion there were
43 other MDI-licensed lottery promotions underway in North America and Australia
at the end of the quarter ended September 30, 2001. During this quarter there
were eight games launched, which we anticipate will generate revenues in excess
of $3.3 million over the next year and a half. These new games join another 35
games on sale prior to the beginning of the quarter. With the MUSL promotions
and at least 4 other MDI licensed promotions already launched or scheduled to
launch prior to the end of the fiscal year, 2001 will mark the first time that
lotteries have launched more than 50 of our proprietary games and/or promotions
in a single fiscal year.
During the quarter ended September 30, 2001, we had active licensed
games on sale in 20 of the 39 government lottery jurisdictions in the United
States, three of the five provincial lotteries in Canada, and in Australia.
In addition to our Multi-State Lottery Association promotion, the
following licensed games launched during the quarter ended September 30, 2001:
Total Anticipated
State Game Contract Revenues
--------------------------------------------------------------------------------
Delaware Elvis $ 93,000
Florida Elvis 750,000
Illinois Harley-Davidson 1,039,200
Kansas Harley-Davidson 115,000
New Jersey NASCAR Drivers 700,000
New Jersey Jacks or Better 500,000
Pennsylvania Wheel of Fortune 182,400
West Virginia Elvis 310,000
--------------
Total $ 3,689,600
==============
16
Nine months ended
September 30
-----------------------------------------------------------
2001 % 2000 %
---- - ---- -
Revenue $ 10,687,122 100.0% $4,267,456 100.0%
Cost of revenues 6,000,472 56.1% 2,823,568 66.2%
-----------------------------------------------------------
Gross profit 4,686,650 43.9% 1,443,888 33.8%
Selling, general and administrative expenses 2,722,911 25.5% 2,631,468 61.7%
Terminated merger expenses - 0.0% 727,025 17.0%
Cost of unsuccessful funding 188,742 1.8% - 0.0%
-----------------------------------------------------------
Operating profit (loss) 1,774,997 16.6% (1,914,605) -44.9%
Interest expense 136,739 1.3% 83,341 2.0%
Interest income (14,896) -0.1% (10,117) -0.2%
Other (income) expense (110,166) -1.0% 57,218 1.3%
Gain on sale-investment securities, net (12,669) -0.1% - 0.0%
-----------------------------------------------------------
Income (loss) before provision for income taxes 1,775,989 16.5% (2,045,047) -48.0%
Provision for income taxes 46,824 0.4% 3,429 0.1%
-----------------------------------------------------------
Net income (loss) $ 1,729,165 16.1% $ (2,048,476) -48.1%
===========================================================
NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 2000
Results for the first three-quarters of 2001 reflect a 150% increase in
revenue compared to the same nine month period of the fiscal year ended December
31, 20000. Our Harley-Davidson(R) license "leads the pack" of launching
increased revenue and profitability. Revenue for the nine months ended September
30, 2001 was $10,687,100 compared to $4,267,500 for the nine months ended
September 30, 2000. Harley-Davidson(R), which launched in 9 states during the
nine-month period ended September 30, 2001, accounted for 45% of our revenue for
such period. This was followed by Elvis(R) (13.5% of revenue), NASCAR(R) Drivers
(12.9% of revenue), SPAM(R) (6.7% of revenue), and Wheel of Fortune(R) (6.2% of
revenue) properties. The remaining 15.7% of revenue was from 10 other licensed
properties. Revenue for the nine months ended September 30, 2001 were
concentrated in five states with New Jersey, California, Pennsylvania, Florida
and Illinois accounting for over 57% of revenue recognized during the nine
months ended September 30, 2001. Our regional sales approach has enabled us to
continue to penetrate new markets. For the nine-month period ended September 30,
2001 16.8% of revenues came from sales to new customers, including the state
lotteries of Illinois, Michigan, New Mexico, West Virginia and Delaware.
17
Cost of revenue as a percentage of revenue decreased to 56.1% from
66.2% for the nine months ended September 30, 2001 compared to the nine months
ended September 30, 2000. This decrease in the cost ratio reflects our ability
to achieve a higher gross profit due to product mix and creative game design.
The gross profit increased in the nine months ended September 30, 2001
to $4,686,700 (43.9% of revenue) compared to $1,443,900 (33.8 % of revenue) for
the nine months ended September 30, 2000. This represents a gross profit
percentage increase of 29.9% over the nine months ended September 30, 2000.
Selling, general and administrative expenses were $2,722,900 (25.5% of
revenue) for the nine months ended September 30, 2001 compared to $2,631,500 for
the nine months ended September 30, 2000. Salaries and employee benefits
increased approximately $216,000 during the first nine months of 2001 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 has
helped to maintain our sales backlog of $13.4 million as of September 30, 2001.
Notwithstanding this increase in salaries and employee benefits the total of the
other selling, general and administrative expenses is actually lower for the
nine months ended September 30, 2001 compared to the nine months ended September
30, 2000. This was possible even though revenue increased by 150% for the nine
months ended September 30, 2001 compared to the nine months ended September 30,
2000.
Costs of unsuccessful funding of $188,700 for the nine months ended
September 30, 2001 includes legal, accounting and investment banking fees
associated with the unsuccessful placement of our Series C Preferred Stock with
Oxford International, Inc. which is discussed in greater detail in "Part II,
Item 1 Legal Proceedings."
Terminated merger expenses for the nine months ended September 30, 2000
of $727,000 relate to our unsuccessful merger with The Lottery Channel, Inc.
Operating income was $1,775,000 (16.6% of revenue) for the nine months
ended September 30, 2001 compared to an operating loss of $(1,914,600) (44.9% of
revenue) for the nine months ended September 30, 2000. This substantial positive
net increase of $3,689,600 is due to the factors described above.
Interest expense was $136,700 for the nine months ended September 30,
2001 compared to $83,300 for the nine months ended September 30, 2000. This
increase in interest expense is attributable to both interest and amortization
of warrant costs associated with $720,000 of additional short-term debt
outstanding during most of the nine months ended September 30, 2001. All but
$260,000 of this debt was paid off during the second quarter ended June 30,
2001. We anticipate repaying the remaining $260,000, which is owed to our
President and Chief Executive Officer, sometime in the first quarter of 2002.
Other income was $110,200 for the nine months ended September 30, 2001
compared to a $57,200 expense for the nine months ended September 30, 2000. The
$110,200 income for the nine months ended September 30, 2001 was attributable to
forgiveness of debt owed to our attorneys and settled during the first quarter
of 2001. The $57,200 expense for the nine months ended September 30, 2000
represented legal fees in excess of an inventory loss judgement favorable to us.
The gain on sale of securities of $12,700 for the nine months ended
September 30, 2001 was attributable to the sale of eLot stock held for
investment.
For the reasons set forth above, we had income before taxes of
$1,776,000 for the nine months ended September 30, 2001 compared to a loss
before taxes of $(2,045,000) for the nine months ended September 30, 2000.
The foregoing resulted in a $.16 basic earnings per share and a $.14
diluted earnings per share on net income for the nine months ended September 30,
2001. Loss per share on a basic and diluted basis was $(.22) for the nine months
ended September 30, 2000.
18
Three months ended
September 30,
-------------------------------------------------------------
2001 % 2000 %
---- - ---- -
Revenue $ 4,001,656 100.0% $1,536,592 100.0%
Cost of revenues 2,276,367 56.9% 958,205 62.4%
-------------------------------------------------------------
Gross profit 1,725,289 43.1% 578,387 37.6%
Selling, general and administrative expenses 937,809 23.4% 786,932 51.2%
Cost of unsuccessful funding 99,109 2.5% - 0.0%
-------------------------------------------------------------
Operating profit (loss) 688,371 17.2% (208,545) -13.6%
Interest expense 7,995 0.2% 32,853 2.1%
Interest income (6,123) -0.2% (1,128) -0.1%
-------------------------------------------------------------
Income (loss) before provision for income taxes 686,499 17.2% (240,270) -15.6%
Provision for income taxes 34,789 0.9% 1,100 0.1%
-------------------------------------------------------------
Net income (loss) $ 651,710 16.3% $ (241,370) -15.7%
=============================================================
THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 2000.
Results for the third quarter of 2001 reflect a 160% increase in
revenue as our Harley-Davidson(R) license "leads the pack" of launching
increased revenue and profitability into this year. Revenue for the three months
ended September 30, 2001 was $4,001,700 compared to $1,536,600 for the three
months ended September 30, 2000. Harley-Davidson(R), which launched in Illinois
and Kansas in the third quarter of 2001, accounted for 49.9% of our revenue.
NASCAR(R) Drivers and Elvis accounted for 21.4% and 10.8% of the three-month
period's revenues, respectively. The remaining 17.9% represented revenue from 10
other licensed properties. Sales for the three months ended September 30, 2001
were concentrated in five states with Illinois, New Jersey, Pennsylvania,
California and Florida accounting for over 68% of revenue recognized during the
three months ended September 30, 2001. Our regional sales approach has enabled
us to continue to penetrate new markets. 26.9% of revenues for the three-month
period ended September 30, 2001 came from sales to new customers, including the
state lotteries of Illinois, Michigan, New Mexico, West Virginia and Delaware.
19
Cost of revenues as a percentage of revenue decreased to 56.9% from
62.4% for the three months ended September 30, 2001 compared to the three months
ended September 30, 2000. This decrease in the cost ratio reflects our ability
to achieve a higher gross profit due to product mix and creative game design.
Gross profit increased in the three months ended September 30, 2001 to
$1,725,300 (43.1% of revenue) compared to $578,400 (37.6% of revenue) for the
three months ended September 30, 2000. This result represents a gross profit
percentage increase of 14.6% over the three months ended September 30, 2000.
Selling, general and administrative expenses were $937,800 (23.4% of
revenue) for the three months ended September 30, 2001 compared to $786,900
(51.2% of revenue) for the three months ended September 30, 2000. The largest
single component increasing within selling, general and administrative expenses
was salaries and employee benefits, which increased approximately $85,000 for
the three months ended September 30, 2001. This increase is attributable to
increased sales staffing to develop our regional sales organization, which has
helped to maintain our sales backlog of $13.4 million as of September 30, 2001.
Accounting and legal expenses increased $25,400 over the same period in 2000 as
a result of our efforts to remain on NASDAQ. There were additional costs
associated with our Fort Worth, Texas office, which was opened in October 2001,
of $11,600.
Costs of unsuccessful funding of $99,100 for the three months ended
September 30, 2001 includes legal, accounting and investment banking fees
associated with the unsuccessful placement of our Series C Preferred Stock with
Oxford International, Inc. which is discussed in greater detail in "Part II,
Item 1 Legal Proceedings."
Operating income was $688,400 (17.2% of revenue) for the three months
ended September 30, 2001 compared to an operating loss of $(208,500) (13.6% of
revenue) for the three months ended September 30, 2000. This substantial
positive net increase of $896,900 is due to the factors described above.
Interest expense was $8,000 for the three months ended September 30,
2001 compared to $32,900 for the three months ended September 30, 2000. This
reduction in interest expense is attributable to the retirement of short-tem
debt in the second quarter of 2001 and the conversion of our convertible
subordinated debenture, which occurred in the first quarter of 2001.
Interest income was $6,100 for the three months ended September 30,
2001 compared to $1,100 for the three months ended September 30, 2000. This
additional interest income is attributable to our improved cash position for the
three months ended September 30, 2001.
For the reasons set forth above, we had income before taxes of $686,500
for the three months ended September 30, 2001 compared to a loss before taxes of
$(240,300) for the three months ended September 30, 2000.
The foregoing resulted in a $.06 basic and a $.05 diluted earnings per
share on net income for the three months ended September 30, 2001. For the three
months ended September 30, 2000 we had a basic and diluted loss per share of
$(.02).
20
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2001, we had cash and cash equivalents of $334,900
compared to $528,200 as of December 31, 2000. This decreased cash position is
attributable to increases in inventory, acquisition of new licenses, the
reduction of accounts payable and repayment of short-term debt occurring during
the nine months ended September 30, 2001.
As of September 30, 2001, we had a net working capital deficit of
$960,100. However, within current liabilities is $2,510,800 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 such liability, working capital
would have been $295,300.
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
$269,025.
Our indebtedness as of September 30, 2001 was $302,315, consisting of
an installment note, with a remaining balance of $42,315, and a short-term note
of $260,000 both 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 determined to exercise our right to exchange these securities for
our stock. See "Part II, Item 1: Legal Proceedings"
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. We have undertaken an aggressive program of acquiring new licenses,
some of which may require substantial up front payments.
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 2.5 to 4 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.
21
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
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 International, Inc.
and its principal, Gregory C. Dutcher.
We asked the court to enter an Order and Decree to the effect that
Oxford and Mr. Dutcher (and their officers, agents, servants, employees,
attorneys and any persons in active concert or participation with them) shall
not transfer, alienate, sell, gift, pledge without giving notice of our right to
exchange, hypothecate, give, grant an option as to, or otherwise dispose in any
way any of our shares of stock that we transferred to Oxford. In addition, we
requested the court to set a date for a Preliminary Injunction maintaining such
an Order and Decree, or alternatively, entering a mandatory injunction causing
the parties to exchange our stock for the securities we received from Oxford.
The court held a telephone conference on August 6, 2001. During the
telephone conference, according to the order, Mr. Dutcher stated that he had no
intention of transferring of our stock within the next 20 days. At 4:00 p.m. on
August 6, 2001, the court ordered, among other things, that Oxford and Mr.
Dutcher, and their officers, agents, servants, employees, attorneys, and any
person in active concert or participation with them, shall not transfer or
otherwise dispose in any way of any shares of our stock that were transferred to
Oxford by us. The Temporary Restraining Order issued by the court was to expire
at 5 p.m. on August 16, 2001, unless within such time the order was extended for
good cause, or unless Oxford and Mr. Dutcher consent to an extension.
Subsequently, by agreement of the parties, the material terms of the August 6,
2001 Temporary Restraining Order were extended to September 7, 2001, with the
parties to confer with the Judge during the week of September 4, 2001, to
schedule a Preliminary Injunction hearing. Oxford and Mr. Dutcher, their
officers, agents, servants employees, attorneys, and any person in active
concert or participation with them, still cannot transfer or otherwise dispose
of our stock during that time period. Copies of the Temporary Restraining Orders
have been forwarded to Prudential Securities Inc. During discovery in litigation
we issued a subpoena to Prudential. In response to that subpoena, on October 24,
2001,we were provided with a copy of the Series C preferred stock certificate by
Prudential, which stock was the subject of the Court's order to prevent transfer
or disposal, indicating that this stock certificate remains in Prudential's
physical possession and has not been transferred or disposed of as directed by
the Court's Order.
Subsequent to filing the Complaint, we filed an Amended Complaint. In
our Verified Amended Complaint, we alleged claims of federal and state
securities fraud and common law fraud, claims of misrepresentation and breach of
contract, and other claims. We asked for remedies including specific performance
that Oxford and Mr. Dutcher transfer our stock to us, rescission, monetary
damages and injunctive relief, as referenced above.
22
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
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, 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 its 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 our 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.
The Series C Preferred Stock originally had a liquidation preference of
$1,523.81 per share, paid a cumulative preferred dividend at the rate of 8% per
annum, payable in cash or common stock at our discretion, and was convertible
into an aggregate of 2,100,000 shares of common stock, subject to adjustment
only for events such as stock splits, stock dividends and similar events, and
was not adjustable or resettable based on the market price of the common stock.
If not previously converted by Oxford, five hundred twenty five (525) shares of
the Series C Preferred Stock would have been automatically converted into common
stock no later than 120 days from the issue date, and after a registration
statement covering the full amount of the shares of common stock underlying the
Series C Preferred Stock had been filed by us with the Securities and Exchange
Commission, and an aggregate of five hundred twenty five (525) shares of Series
C Preferred Stock would have been automatically converted into common stock
every ninety (90) days thereafter. We were not permitted to create or increase
the authorized number of shares of any class or series of stock ranking prior to
or on parity with the Series C Preferred Stock either as to dividends or
liquidation without approval of the holders of at least a majority of the then
outstanding shares of Series C Preferred Stock.
Oxford had the option of nominating one member of our Board of
Directors reasonably acceptable to us so long as the sum of (i) the aggregate
number of shares of common stock issuable upon conversion of the Series C
Preferred Stock and (ii) aggregate number of shares of common stock owned by
Oxford and its subsidiaries was equal to or greater than 2,100,000 and Oxford
and its subsidiaries beneficially owned greater than ten percent (10%) of the
number of shares of our common stock outstanding.
In connection with the transaction, we issued an aggregate of 42,000
shares of common stock as an origination fee. We also contemplated paying
Venture Partners Capital, LLC, a registered broker-dealer with whom our former
Executive Vice President of Finance is affiliated, a $256,000 cash fee. Such fee
was not paid due to the circumstances surrounding the transaction. We also
therefore excluded 2,142,000 shares, representing the total of our Series C
Preferred Stock on an as converted basis and origination fees paid in common
stock, from our total common stock outstanding, as of September 30, 2001. See
"Item 1. Legal Proceedings."
23
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit 10.1 Agreement, dated July 9, 2001, between
MDI Entertainment, Inc and Oxford
International, Inc.
(Incorporated by reference to Form
8-K filed July 16, 2001).
(b) Reports on Form 8-K
Filed on July 16, 2001 (Item 5: Other
Events- Amendment of Financing Agreement
regarding Oxford International,Inc.).
Filed on July 24, 2001 (Item 5: Other
Events-NASDAQ halts trading of MDI
Entertainment,Inc. securities -Press release
dated July 19, 2001).
Filed on July 31, 2001 (Item 5: Other Evets-
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).
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).
Filed on August 23, 2001 (Item 5: Other
Events-MDI accepted to trade on the
Over-The-Counter Bulletin Board.).
24
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: October 31, 2001
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
Vice President of Accounting and Administration, Secretary and Director
(Principal Financial Officer)
25
EXHIBIT INDEX
--------------------------------------------------------------------------------
No. Description
10.1 Agreement, dated July 9, 2001,
between MDI Entertainment, Inc and
Oxford International, Inc.
(Incorporated by reference to Form
8-K filed July 16, 2001).