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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 AUGUST 31, 1999.
[ ] 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 13, 1999, 7,776,500 shares of the issuer's common stock were
outstanding.
Transitional Small Business Disclosure Format (check one): Yes No X
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<PAGE>
MDI ENTERTAINMENT, INC. AND SUBSIDIARIES
FORM 10-QSB
FOR THE QUARTERLY PERIOD ENDED AUGUST 31, 1999
INDEX
-----
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.............................................................................1
Consolidated Balance Sheets as of August 31, 1999 (unaudited) and May 31, 1999........................1
Consolidated Statements of Operations for the three months ended
August 31, 1999 and 1998 (unaudited)..................................................................2
Consolidated Statement of Shareholders' Deficit for the three months ended
August 31, 1999 (unaudited)...........................................................................3
Consolidated Statements of Cash Flows for the three months ended
August 31, 1999 and 1998 (unaudited) .................................................................4
Notes to Unaudited Consolidated Financial Statements..................................................5
Item 2. Management's Discussion and Analysis.............................................................7
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.......................................................16
Item 6. Exhibits and Reports on Form 8-K................................................................17
Signatures...........................................................................................18
</TABLE>
<PAGE>
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MDI ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
August 31, May 31,
1999 1999
------------ -------------
(unaudited)
ASSETS
Cash and cash equivalents $ 984,321 $ 340,350
Accounts receivable 1,218,861 817,614
Inventory 72,890 57,596
Other current assets 161,279 58,253
----------- -----------
Total current assets 2,437,351 1,273,813
Property and equipment, net 154,308 106,022
Licensing costs, net 271,430 189,488
Other (Note 3) 102,295 260,039
----------- -----------
Total other assets 373,725 449,527
----------- -----------
Total assets $ 2,965,384 1,829,362
=========== ===========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Accounts payable $ 581,768 $ 364,909
Accrued liabilities 283,990 369,279
Current portion of long-term debt 373,962 365,911
Deferred revenue (Note 2) 134,211 268,405
Billings in excess of costs and estimated
earnings on uncompleted
contracts (Note 2) 1,444,356 1,695,886
Dividends payable 13,425 -
----------- -----------
Total current liabilities 2,831,712 3,064,390
Long-term debt, less current portion above 133,126 229,702
Minority interest 34,927 34,927
----------- -----------
Total liabilities 2,999,765 3,329,019
Contingencies (Note 6)
Common stock, $0.001 par value,
25,000,000 shares authorized,
7,776,500 issued and outstanding 7,777 7,777
Preferred stock-Series A, $0.001 par value,
5,000,000 shares authorized,
2,027 issued and outstanding 2 -
Additional paid-in capital 1,750,948 348,348
Accumulated deficit (1,793,108) (1,855,782)
----------- -----------
Total shareholders' deficit (34,381) (1,499,657)
----------- -----------
Total liabilities and
shareholders' deficit $ 2,965,384 $ 1,829,362
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
-1-
<PAGE>
MDI ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Three months ended
August 31,
1999 1998
------------- ------------
(unaudited) (unaudited)
Revenues $ 1,760,137 $ 2,102,324
Cost of revenue 1,159,587 1,096,139
--------- ---------
Gross profit 600,550 1,006,185
Selling, general and administrative expenses 516,351 546,794
--------- ---------
Operating profit 84,199 459,391
Interest expense (income), net 6,600 (6,366)
Other income, net -- (192)
Minority interest -- (243)
--------- ---------
Income before provision for income taxes 77,599 466,192
Provision for income taxes (Note 4) 1,500 1,019
--------- ---------
Net income $ 76,099 $ 465,173
=========== ===========
Basic earnings
per common share (Note 5) $ 0.01 $ 0.06
======== ========
Diluted earnings
per common share (Note 5) $ 0.01 $ 0.06
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
-2-
<PAGE>
<TABLE>
MDI Entertainment, Inc.
and Subsidiaries
Consolidated Statement of
Shareholders' Deficit
<CAPTION>
For the three months ended August 31, 1999
(unaudited)
-------------------------------------------------------------------------------------------------------
SHARES PAR VALUE $0.001
------------------------------- -------------------------
*
Preferred Preferred Additional
Stock ** Stock Common Paid in Accumulated
Series A Common Stock Series A Stock Capital Deficit Total
----------------- -------------- ----------- ------------ ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, May 31, 1999 -- 7,776,500 $ -- $ 7,777 $ 348,348 $ (1,855,782) $ (1,499,657)
Proceeds from sale of
Preferred stock Series A, net
of expenses of $347,400 2,027 -- 2 -- 1,402,600 -- 1,402,602
Net income -- -- -- -- -- 76,099 76,099
Stock dividend on
Preferred Stock -- -- -- -- -- (13,425) (13,425)
----- --------- - ----- --------- ------------ ------------
BALANCE, August 31, 1999 2,027 7,776,500 $ 2 $ 7,777 $1,750,948 $ (1,793,108) $ (34,381)
===== ========= = ===== ========= ============ ===========
</TABLE>
* 5,000,000 shares of preferred stock authorized
** 25,000,000 shares of common stock authorized
The accompanying notes are an integral part of these consolidated
financial statements.
-3-
<PAGE>
<TABLE>
MDI ENTERTAINMENT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<CAPTION>
Three months
ended
August 31,
1999 1998
----------- ------------
(unaudited) (unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 76,099 $ 465,173
Adjustments to reconcile net income to net
cash used for operating activities:
Minority interest -- (243)
Depreciation and amortization 67,201 49,111
Change in assets and liabilities:
Increase in accounts receivable (401,247) (290,577)
Increase in inventory (15,294) (32,044)
Increase in licensing costs (140,732) (3,050)
Increase in other assets (59,882) (130,344)
Increase in accounts payable 216,859 8,533
Decrease in accrued expenses (50,563) (51,009)
Decrease in taxes payable (34,726) --
Decrease in deferred revenue (134,194) (566,220)
Decrease in billings in excess of costs
and estimated earnings on uncompleted
contracts (251,530) --
----------- -----------
Net cash used for operating activities (728,009) (550,670)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (56,696) (1,500)
Costs associated with sale of preferred stock (232,798) --
----------- -----------
Net cash used for investing activities (289,494) (1,500)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of debt (88,526) (73,754)
Proceeds from sale of preferred stock 1,750,000 --
----------- -----------
Net cash provided by (used for) financing
activities 1,661,474 (73,754)
----------- -----------
NET INCREASE (DECREASE) IN CASH 643,971 (625,924)
CASH, beginning of the period 340,350 960,398
----------- -----------
CASH, end of the period $ 984,321 $ 334,474
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Interest $ 12,409 $ 3,264
Income taxes $ 36,376 $ 181
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
-4-
<PAGE>
MDI ENTERTAINMENT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS AS OF AUGUST 31, 1999
AND 1998
1. PRESENTATION OF UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS.
Information in the accompanying interim consolidated financial
statements and notes to the consolidated financial statements for the
three-month period ended August 31, 1999 and 1998 is unaudited. The accompanying
interim unaudited consolidated financial statements have been prepared by us in
accordance with generally accepted accounting principles and Regulation S-B.
Accordingly, they do not include all the information and footnotes required by
generally accepted accounting principles 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 August 31, 1999 are not
necessarily indicative of the results that may be expected for the year ending
May 31, 2000. The 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 May 31, 1999.
2. REVENUE AND COST RECOGNITION
Revenue is derived from various lottery game contracts (mainly with
states) between MDI and the lotteries. MDI has agreed to provide 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 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
contracts 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 August 31,
1999, 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.
-5-
<PAGE>
3. OTHER ASSETS
Other assets at May 31, 1999 primarily represented costs related to the
convertible preferred stock Series A offering. Approximately $114,600 were
netted against the gross proceeds of this offering which occurred during the
quarter ended August 31, 1999.
4. INCOME TAXES
We account 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 our
financial statements and its 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 August 31, 1999 and
May 31, 1999, we had a significant deferred tax asset, primarily as a result of
net operating loss carry-forwards. We have established a valuation allowance for
the full amount of this deferred tax asset, as of such dates.
We have a significant net operating loss carry-forward at August 31,
1999 and May 31, 1999. Due to such carry-forward, we reported minimum state tax
expense at August 31, 1999 and May 31, 1999, respectively.
5. EARNINGS PER SHARE
Basic earnings per common share are based on the average number of common
shares outstanding during the fiscal period. Diluted earnings per common share
include, in addition to the above, a dilutive effect of common share equivalents
during the fiscal period. Common share equivalents represent dilutive stock
options using the treasury method. We had 1,507,466 common share equivalents
during the three month period ended August 31, 1999. There were no common share
equivalents for this same period in fiscal 1998. The number of shares used in
the earnings per common share computations for the 1999 and 1998 periods were as
follows:
<TABLE>
<CAPTION>
Three Months Ended
August 31,
1999 1998
---- ----
<S> <C> <C>
Basic
Average common shares outstanding 7,776,500 7,776,500
Dilutive
Dilutive effect of options and
warrants 757,838 --
Dilutive effect of conversion of
Series A preferred stock 749,628 --
--------- ---------
Average dilutive common shares
outstanding 9,283,966 7,776,500
========= =========
</TABLE>
6. CONTINGENCIES
We are involved in various lawsuits incidental to our business. We
believe that these proceedings, in the aggregate, will not have a material
adverse effect on our operations or financial position.
-6-
<PAGE>
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 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.
-7-
<PAGE>
We derive over ninety-five percent (95%) of our revenues from lotteries
in two distinct ways. First, we will usually charge a lottery a license and
royalty fee to utilize a particular licensed property as a lottery game. License
fees are a fixed assessment while royalties are a percentage of the printing
cost of the tickets. Contracts for licensed properties typically include an
up-front license fee and a royalty based on the manufacturing cost of tickets.
Manufacturing costs of tickets usually range from $10.00 per thousand to $30.00
per thousand. Actual costs depend on the size of the ticket and the quantity
printed. Ticket quantities range from about one million to as many as 60 million
with an average quantity of about five million.
Our second source of lottery revenue is the sale of logo bearing
merchandise to the lottery as second-chance prizes. In merchandise-based lottery
games, between 5% to 10% of a lottery's prize fund is typically used for the
purchase of merchandise related to the property the lottery is utilizing.
Typically, we purchase merchandise from other licensees of the property and
resell the merchandise to the lottery at a price that is designed to include
overhead costs, profit, shipping and handling and any marketing support we
provide the lottery such as brochures, posters or other advertising assistance
for which there are no separate charges.
Our success is dependent on our ability to maintain and secure licensed
properties, 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 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.
-8-
<PAGE>
RECENT DEVELOPMENTS
Private Investment in MDI:
On August 4, 1999 we received gross proceeds of $1,750,000 from the
private sale of 2,027 shares of Series A Convertible Preferred Stock. This
preferred stock is convertible into 2,027,000 shares of common stock on an as
converted basis of common stock under specific conditions. See Item 2 "Changes
in Securities and Use of Proceeds" for details.
We are pleased by this investment in our company and the confidence it
reflects. These dollars are crucial to developing MDI's ongoing business plan,
which includes the acquisition of new licenses, expanding sales and marketing
staff and the development of our e-Commerce Lottery Prize Shop initiative. All
three of these elements are critical to our growth.
Scientific Games Strategic Alliance:
In September 1999, we announced a Strategic Alliance Agreement with
Scientific Games International, a wholly owned subsidiary of Scientific Games
Holding Corporation (NYSE:SG). We view this as a very positive development for
our future earnings potential. Scientific Games controls over 60% of the North
American instant ticket market and has contracts with 54 international lotteries
for a variety of products and services. As an integral part of the Agreement,
Scientific Games Sales and Marketing staff will market MDI's products to its
customers in exchange for a sliding scale commission based on gross sales
volume.
We believe that this relationship, which should begin generating revenue
by the third or fourth quarter of this fiscal year, will enhance our ability to
sell additional games both domestically and internationally.
In addition to the Strategic Alliance, Scientific Games, Inc. purchased
$750,000 of convertible debentures which can be converted to common stock at a
price of $2.00 per common share, as well as purchasing 333,000 shares of common
stock from MDI Management.
Finally, Scientific Games' Chairman, President and CEO, William Malloy,
has joined MDI Entertainment's Board of Directors.
Lottery Prize Shop:
In August 1999, the New Jersey Lottery introduced its second
Harley-Davidson game. This game called "Ticket to Ride" sells for $3.00 and has
a top cash prize of $30,000. The Lottery purchased approximately $650,000 worth
of Harley-Davidson motorcycles and merchandise from MDI. In addition, the game
introduced MDI's Lottery Prize Shop, which marks our initial e-Commerce efforts.
New Jersey Lottery "Ticket to Ride" players can use non-winning tickets
for discounts off the purchase of a variety of Harley-Davidson merchandise. Each
non-winning ticket functions as a $3.00 coupon and can be aggregated for
discounts of up to approximately 20% off the retail price. The players are able
to access this merchandise through a specially produced catalog that is
available at all New Jersey retail ticket locations, as well as a Web Site,
www.nj.lotteryprizeshop.com, which duplicates the catalog.
-9-
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED AUGUST 31
-----------------------------------------------
1999 % 1998 %
---- - ---- -
<S> <C> <C> <C> <C>
Total revenue $ 1,760,137 100.0% $ 2,102,324 100.0%
Cost of revenues 1,159,587 66% 1,096,139 52%
Gross profit 600,550 34% 1,006,185 48%
Selling, general and
Administrative expenses 516,351 29% 546,794 26%
Operating profit 84,199 5% 459,391 22%
Interest (income) expense, net 6,600 0% (6,366) 0%
Other income, net -- 0% (192) 0%
Minority interest -- 0% (243) 0%
Net income before income tax
expense 77,599 6% 466,192 22%
Income tax expense 1,500 0% 1,019 0%
Net income $ 76,099 6% $ 465,173 22%
</TABLE>
-10-
<PAGE>
THREE MONTHS ENDED AUGUST 31, 1999 COMPARED TO THREE MONTHS ENDED AUGUST
31, 1998
Results for the three months ended August 31, 1999 reflect revenues of
$1,760,100 as compared to $2,102,300 for the same period in 1998. This revenue
decrease of $342,200 reflects the revenue recognition fluctuations associated
with accounting for revenue as costs are incurred for each promotion. There were
less game drawings scheduled by the lotteries for the quarter ended August 31,
1999, which resulted in less costs incurred, which is the primary trigger point
for recognizing revenue. Also, the launch of our first Harley-Davidson
promotions in the three months ended August 31, 1998 and the tremendous response
the promotion received from the lottery industry resulted in significant revenue
recognized in that quarter. That response exceeded our anticipated revenue for
the first quarter of fiscal 1999 and has not been replicated this recent
quarter. Revenue during the three-month period ended August 31, 1999 was derived
primarily from sales based on three entertainment-based or brand name properties
including Harley-Davidson(R) (62% of revenue), Wheel of Fortune(R) (16% of
revenue) and Pepsi Cola(R) (12% of revenue).
Cost of revenue as a percentage of revenue increased to 66% from 52% for
the three months ended August 31, 1999, compared to the same period in 1998.
This increase in cost was primarily due to a retroactive change in licensing
fees for our Harley-Davidson(R) property. This change in fees was due to the
re-negotiation of our license and royalty fee with Harley-Davidson to enable us
to better position ourselves for a license renewal when the current license
expires at the end of Calendar Year 2000. Such fees increased by 150% for both
previously launched promotions and current games. As several promotions were
complete or almost complete, the change could not be spread over the future life
of these promotions. Also impacting our costs was the launch of the New Jersey
Harley-Davidson game which included, for the first time, the use of
Harley-Davidson motorcycles other than the Sportster 1200 Custom model. These
motorcycles cost more than twice as much as the Sportster 1200 Custom and
therefore reduced our normal profit margin.
Gross profit decreased in the three months ended August 31, 1999 to
$600,600 (34% of revenue) from $1,006,200 (48% of revenue) in the same period in
1998 primarily due to the retroactive change in licensing fees discussed above.
Had this retroactive expense of $126,000 not been incurred all during this
quarter the gross profit would have been $726,600 or 41% versus the 34%
reported.
Selling, general and administrative expenses were $516,400 (29% of revenue)
for the three months ended August 31, 1999 compared to $546,800 (26% of revenue)
for the same period in 1998. This decrease in expenses for the quarter was
primarily attributable to a reduction of $35,000 in legal and accounting fees as
compared to the same period ended August 31, 1998. In fiscal 1998 we spent
considerably more in professional fees to become an SEC reporting company.
Operating profit was $84,200 (5% of revenue) for the three months ended
August 31, 1999 compared to $459,400 (22% of revenue) for the same period in
1998. This was principally due to the factors described above.
Interest expense was $12,400 for the three months ended August 31, 1999
compared to $500 for the same period in 1998. This increase is attributable to
interest on the note for $600,000 executed in the fourth quarter of fiscal 1999
discussed in detail in "Liquidity and Capital Resources".
For the reasons set forth above, the Company had a profit of $77,600
before taxes for the three months ended August 31, 1999 as compared to a profit
of $466,200 for the same period in 1998.
-11-
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
As of August 31, 1999, we had cash and cash equivalents of $984,300
compared to $334,500 as of the same period in 1998. The increase was due
principally to the infusion of gross proceeds of $1,750,000, from the private
sale to an investor of 2,027 shares of Series A Convertible Preferred Stock. See
Item 2 "Changes in Securities and Use of Proceeds" for details.
As of August 31, 1999, we had a net working capital deficit of
$394,400. However, $1,578,600 of this deficit was "billings in excess of costs
and estimated earnings on uncompleted contracts" and "deferred revenue". Both
"billings in excess of costs and estimated earnings on uncompleted contracts"
and "deferred revenue" represent unrecognized revenue (i.e., revenue which we
have already been paid or billed for but which cannot be recognized until we
purchase the contracted merchandise before a game drawing occurs). Accordingly,
such liability will not adversely impact cash flow and, without such liability,
working capital would have been $1,184,200.
Our indebtedness as of August 31, 1999 was $507,100 primarily
represented by a note with a remaining balance of $414,100 bearing interest at
10.75% per annum and payable in monthly installments of $27,895 with the final
payment date of December 15, 2000. The note is secured by liens on substantially
all of our assets. This note resulted from the conversion of $600,000 of
accrued commissions due to a third party, which allows us to better manage our
cash flow requirements.
The cash requirements of funding our growth have historically exceeded
cash flow from operations. Accordingly, we have satisfied our capital needs
primarily through debt and equity financing, as well as cash flow from
operations. Therefore, to address our immediate needs, in addition to the equity
financing discussed above of $1,750,000, we raised $750,000 gross proceeds on
September 21, 1999 from the sale of a subordinated convertible debenture to
Scientific Games, Inc.
-12-
<PAGE>
The debenture bears interest at 7% per annum and is payable
semi-annually, on June 30 and December 31 of each year, until its maturity on
September 21, 2009. The debenture is convertible at the option of Scientific
Games for $2.00 per share of common stock, subject to adjustment under certain
circumstances, into an aggregate of 375,000 common stock shares and convertible
at our option at any time after the earlier of (a) September 21, 2001 or (b)
after the underlying common stock is registered pursuant to the Securities Act
of 1933 and the price of our common stock is at least $3.00 per share.
We do not have any specific capital commitments and do not currently
anticipate making any substantial expenditures other than in the normal course
of business. We have undertaken an aggressive program of acquiring new licenses,
some of which may require substantial up front payments. Several such licenses
have been obtained recently at a cost of approximately $126,000 and others are
in late stages of negotiations.
LICENSED PROPERTIES
In the past two years, we have entered into 18 separate contracts with
14 lotteries based on the Harley Davidson(R) property and such contracts
represent a combined total of over $7.2 million in revenue, of which
approximately $4.7 million was earned in fiscal 1999. A remaining $ 2.4 million
should be earned in fiscal 2000. Included is our first contract with a Canadian
lottery, the British Columbia Lottery Corporation. We secured the Harley
Davidson(R) license in December 1997 and will continue to aggressively market
the property to lotteries throughout the United States and Canada.
Our Wheel of Fortune(R) license expired in November 1998. However, this
license was extended to November 1999 at a cost of $10,000.
Our Star Trek(TM) property, which has been used or is scheduled to be
used by a total of ten lotteries, is beginning to decline in popularity. We do
not expect to renew this license, which expires in November 1999.
We have entered into a three-year licensing agreement with Universal
Spaceworks LLC for the property Heroes of Space(TM). Heroes of Space(TM) is a
group of 16 former astronauts aligned to call attention to the U.S. Space
program and their participation.
We have entered into a 30-month contract with MGM Consumer Products for
James Bond 007(TM), The Pink Panther(TM) and The Outer Limits(TM). These rights
are U.S. only.
-13-
<PAGE>
We have entered into a contract with Hillerich and Bradsby for the
property Louisville Slugger(R). These rights are for government operated
lotteries anywhere in the world. In May 1999, the Iowa lottery implemented a
Louisville Slugger(R) promotion.
We have entered into a three-year agreement with dick clark productions,
inc. for worldwide rights to American Bandstand(R).
We have entered into a three-year agreement with CBS Cable for U.S.
rights to cable networks TNN and CMT.
We have entered into a three-year agreement with King Features Syndicate
for the worldwide rights to Betty Boop(TM) and associated characters.
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 reelected. Accordingly, period to period comparisons may not be
indicative of future results.
YEAR 2000
We have commenced an assessment of the hardware, software and network
components of our information technology systems. To date, we have replaced all
of our 22 CPUs with those that, according to manufacturers' representations, are
Year 2000 compliant. We also purchased a new server less than a year ago which,
according to manufacturer's representations, is Year 2000 compliant. The
operating systems we use are Windows 95 and Microsoft Office 97, which are both
Year 2000 compliant according to manufacturers' representations. We have
upgraded our network as well.
New accounting and operational "SBT" software has been obtained which,
according to manufacturer's representations, is Year 2000 compliant. Peripheral
operational software, which was customized, is being reviewed for integration
with the "SBT" accounting and operational software. Due to our shift to licensed
promotions, it is anticipated that the customized software previously required
does not have to be completely rewritten. FoxPro which houses the additional
database required to operate the customized software is being upgraded to
Version 6.0 which, according to manufacturer's representations, is Year 2000
compliant. We have retained a Year 2000 compliance service provider (the
"Compliance Service Provider") to make the required changes and integrate this
software accordingly. Scheduling of this work has been undertaken by the
Compliance Service Provider, and is expected to be installed by October 1999 to
safeguard against delays in meeting financial reporting requirements.
-14-
<PAGE>
We utilize two third-party subcontractors. One is a fulfillment facility
and the other a data collection house. We have historically provided the
software needed to support these two functions. This software is also being
upgraded by the Compliance Service Provider to be Year 2000 compliant. Both
subcontractors have provided us with assurances that their hardware will also be
Year 2000 compliant.
The original budget for Year 2000 compliance work was $50,000. As of
August 31, 1999, we had incurred expenses of $48,500. We have revised this
budget to $65,000.
Our most substantial foreseeable risk in respect of the Year 2000 is
with third-party subcontractors and their own customized software which supports
them. To insure our ability to function in this period of uncertainty, we have
developed a contingency plan to permit fulfillment to be accomplished by
alternate procedures utilizing existing third-party subcontractors. Similar
contingency plans have been developed to manage inventory and data management
and accounting.
We believe we have taken appropriate steps to be Year 2000 compliant. We
have also prepared a contingency plan to handle as many risks as we can
reasonably address. However, we cannot assure you that problems will not be
encountered in connection with the date change from December 31, 1999 to January
1, 2000. We do not believe these problems will have a material adverse effect on
operations.
-15-
<PAGE>
PART II
OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
We received gross proceeds of $1,750,000 on August 4, 1999 from the
private sale to an investor of 2,027 shares of Series A Convertible Preferred
Stock (the "Preferred Stock"), representing approximately 20% of the outstanding
common stock of the Company on an as converted basis. The Preferred Stock has a
liquidation preference of $1,750,000, pays a dividend at the rate of 10% per
annum, payable in cash or common stock at the discretion of the Company, and is
convertible into an aggregate of 2,027,000 shares of the Company's common stock,
subject to adjustment under certain circumstances. As long as 2,027 shares of
the Preferred Stock remain outstanding, the holders of a majority of such shares
may elect a director of the Company. In addition, such holders are entitled to a
right of first refusal on new securities issued by the Company, subject to
certain exclusions. We may not create or increase the authorized number of
shares of any class or series of stock ranking prior to or on parity with the
Preferred Stock either as to dividends or liquidation without approval of a
majority of the holders of the Preferred Stock.
On September 21, 1999, we registered 2,027,000 of our common stock as
was required in connection with the Preferred Stock offering. As such the
Preferred Stock now pays a reduced dividend at the rate of 5% per annum. If not
previously converted by the investor, the Preferred Stock will automatically
convert into common stock in quarterly installments over a period of one year
following the effectiveness of the registration statement.
In connection with this placement, we paid Venture Partners Capital,
LLC, a registered broker-dealer a $140,000 cash fee and a seven-year warrant to
purchase 566,875 shares of common stock at $1.31 per share, which was the market
value of our stock when the warrants were granted.
Additionally, on September 21, 1999, we sold a subordinated convertible
debenture (the "Debenture") to Scientific Games, Inc. for $750,000 which bears
interest at 7% per annum and is payable semi-annually, on June 30 and December
31 of each year, until its maturity on September 21, 2009. The Debenture is
convertible at the option of Scientific Games for $ 2.00 per share, subject to
adjustment under certain circumstances, into an aggregate of 375,000 shares and
convertible at our option at any time after the earlier of (a) September 21,
2001 or (b) after the underlying common stock is registered pursuant to the
securities Act of 1933 and the price of our common stock is at least $3.00 per
share.
In connection with this placement, we paid Venture Partners Capital,
LLC, a registered broker-dealer a $62,000 cash fee and issued a seven-year
warrant to purchase 226,020 shares of common stock at $1.25 per share, which was
the market value of our stock when the warrants were granted.
-16-
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit 27 Financial Data Schedule
(b) Reports on Form 8-K
Filed on August 12, 1999 (Item 5: Other Events-
Sale of Series A Preferred Stock)
Filed on October 4, 1999 (Item 5: Other Events-
Strategic Alliance and Sale of Subordinated
Convertible Debenture)
-17-
<PAGE>
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 13, 1999
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
Chief Financial Officer, Secretary and Director
(Principal Financial and Accounting Officer)
-18-
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