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SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-QSB
  þ
    
    Quarterly Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
 For the quarterly period ended September 30, 2006
 OR
 o
    
    Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
 Commission file number: 0-9463
 MDI, INC.
  DELAWARE
    
    75-2626358(State or other jurisdiction
    
    (I.R.S. EmployerOf incorporation or organization)
    
    IdentificationNo.)9725 DATAPOINT DRIVE, SUITE 200SAN ANTONIO, TEXAS
    
    78229(Address of principal executive offices)
    
    (Zip Code)
 (210) 582-2664
 o þ
 o þ




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##### 



MDI, INC.
FORM 10-QSB
TABLE OF CONTENTS
 PART I. FINANCIAL INFORMATIONItem 1. Financial Statements.Consolidated Balance Sheets as of September 30, 2006 and December 31, 2005Consolidated Statement of Operation For the Three Month Periods Ended September 30, 2006 and 2005Consolidated Statement of Operation For the Nine Month Periods Ended September 30, 2006 and 2005Consolidated Statement of Cash Flows For the Three Month Periods Ended September 30, 2006 and 2005Consolidated Statement of Cash Flows For the Nine Month Periods Ended September 30, 2006 and 2005Notes to Financial StatementsItem 2. Managements Discussion and Analysis and Results of Operation.Item 3. Controls and Procedures.PART II. OTHER INFORMATIONItem 1. Legal Proceedings.Item 6. Exhibits and Reports on Form 8-KSIGNATURESCertification of CEO Pursuant to Rule 13a-14(a)Certification of CFO Pursuant to Rule 13a-14(a)Certifications of CEO and CFO Pursuant to Section 1350
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PART I  FINANCIAL INFORMATION
 
 ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
 MDI, INC. and SUBSIDIARIES
 
 CONSOLIDATED BALANCE SHEETS
 (in thousands, except share and per share data)
(Unaudited)
 September 30,
    
    
    December 31,2006
    
    
    2005ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    722
    
    
    $
    2,140Trade accounts receivable, net
    
    
    1,569
    
    
    
    1,012Inventories
    
    
    979
    
    
    
    1,008Prepaid expenses and other current assets
    
    
    226
    
    
    
    191Total current assets
    
    
    3,496
    
    
    
    5,251Property and Equipment, net
    
    
    378
    
    
    
    661Other Assets:Goodwill
    
    
    4,612
    
    
    
    2,792Other intangible assets, net
    
    
    30
    
    
    
    35Other assets
    
    
    350
    
    
    
    520Total assets
    
    $
    8,866
    
    
    $
    9,259LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Trade accounts payable
    
    $
    961
    
    
    $
    876Accrued expenses
    
    
    387
    
    
    
    256Deferred legal settlement
    
    
    388
    
    
    
    388Accrued compensation
    
    
    304
    
    
    
    401Other current liabilities
    
    
    89
    
    
    
    70Deferred revenue
    
    
    236
    
    
    
    236Total current liabilities
    
    
    2,364
    
    
    
    2,227Long-Term Liabilities
    
    
    
    
    
    
    Commitments and Contingencies
    
    
    
    
    
    
    Stockholders Equity:Preferred stock, $5 par value, issuable in
series; 2,000,000 shares authorized; Series A,
LIBOR + 2% cumulative convertible; 195,351
shares authorized, issued and outstanding
    
    
    977
    
    
    
    977Common stock, $.01 par value; 100,000,000 shares
authorized; 26,108,460 and 21,174,137 shares
issued at September 30, 2006 and December 31,
2005, respectively (includes 3,488,350 shares
held in treasury)
    
    
    260
    
    
    
    212Additional paid-in-capital
    
    
    171,425
    
    
    
    166,926Accumulated deficit
    
    
    (127,459
    )
    
    
    (122,382
    )Treasury stock, at cost 3,488,350 common shares
at September 30, 2006 and December 31, 2005)
    
    
    (38,701
    )
    
    
    (38,701
    )Total stockholders equity
    
    
    6,502
    
    
    
    7,032Total liabilities and stockholders equity
    
    $
    8,866
    
    
    $
    9,259
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MDI, INC. and SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 (in thousands, except share and per share data)
(Unaudited)
 Three months ended September 30,2006
    
    
    2005Net sales
    
    $
    1,933
    
    
    $
    2,346Cost of sales (exclusive of depreciation shown separately below)
    
    
    932
    
    
    
    1,267Gross profit
    
    
    1,001
    
    
    
    1,079Other operating costs:Selling, general and administrative
    
    
    2,444
    
    
    
    2,450Non cash stock compensation
    
    
    187
    
    
    
    Depreciation and amortization
    
    
    118
    
    
    
    1982,749
    
    
    
    2,648Operating loss
    
    
    (1,748
    )
    
    
    (1,569
    )Other income (expense):Interest income
    
    
    10
    
    
    
    Other, net
    
    
    1
    
    
    
    11
    
    
    
    Loss from continuing operations
    
    
    (1,737
    )
    
    
    (1,569
    )Income (loss) from discontinued operations
    
    
    
    
    
    
    (11
    )Net loss
    
    
    (1,737
    )
    
    
    (1,580
    )Dividend requirements on preferred stock
    
    
    (8
    )
    
    
    (8
    )Net loss allocable to common stockholders
    
    $
    (1,745
    )
    
    $
    (1,588
    )Basic and diluted earnings (loss) per share from:Continuing operations
    
    $
    (0.08
    )
    
    $
    (0.10
    )Discontinued operations
    
    
    0.00
    
    
    
    0.00Basic and diluted loss per share
    
    $
    (0.08
    )
    
    $
    (0.10
    )Number of common shares used in computations
    
    
    22,620,110
    
    
    
    16,456,439
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MDI, INC. and SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 (in thousands, except share and per share data)
(Unaudited)
 Nine months ended September 30,2006
    
    
    2005Net sales
    
    $
    6,846
    
    
    $
    6,048Cost of sales (exclusive of depreciation shown separately below)
    
    
    3,348
    
    
    
    3,181Gross profit
    
    
    3,498
    
    
    
    2,867Other operating costs:Selling, general and administrative
    
    
    7,667
    
    
    
    7,480Non cash stock compensation
    
    
    534
    
    
    
    Depreciation and amortization
    
    
    359
    
    
    
    5928,560
    
    
    
    (8,072
    )Operating loss
    
    
    (5,062
    )
    
    
    (5,205
    )Other income (expense):Interest income
    
    
    20
    
    
    
    3Loss form disposal of fixed assets
    
    
    
    
    
    
    (2
    )Other, net
    
    
    2
    
    
    
    62822
    
    
    
    629Loss from continuing operations
    
    
    (5,040
    )
    
    
    (4,576
    )Income (loss) from discontinued operations
    
    
    (12
    )
    
    
    (48
    )Net loss
    
    
    (5,052
    )
    
    
    (4,624
    )Dividend requirements on preferred stock
    
    
    (25
    )
    
    
    (25
    )Net loss allocable to common stockholders
    
    $
    (5,077
    )
    
    $
    (4,649
    )Basic and diluted earnings (loss) per share from:Continuing operations
    
    $
    (0.24
    )
    
    $
    (0.30
    )Discontinued operations
    
    
    0.00
    
    
    
    (0.00
    )Basic and diluted loss per share
    
    $
    (0.24
    )
    
    $
    (0.30
    )Number of common shares used in computations
    
    
    21,036,224
    
    
    
    15,255,766
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MDI, INC. and SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (in thousands)
 Three months ended September 30,2006
    
    
    2005Operating Activities:Net loss
    
    $
    (1,737
    )
    
    $
    (1,580
    )Adjustments to reconcile net loss to net cash used in operating
activities:Non cash stock compensation
    
    
    187
    
    
    
    Loss on disposal of fixed assets
    
    
    
    
    
    
    Depreciation and amortization
    
    
    118
    
    
    
    198Provision for losses on accounts receivable
    
    
    5
    
    
    
    44Changes in operating assets and liabilities, net of dispositions:Trade accounts receivable
    
    
    349
    
    
    
    (91
    )Inventories
    
    
    99
    
    
    
    262Prepaid and other current assets
    
    
    193
    
    
    
    36Trade accounts payable
    
    
    (76
    )
    
    
    47Accrued and other current liabilities
    
    
    (117
    )
    
    
    (187
    )Net cash used in operating activities
    
    
    (979
    )
    
    
    (1,271
    )Investing Activities:Purchases of property and equipment
    
    
    (7
    )
    
    
    (4
    )Net cash provided by (used in) investing activities
    
    
    (7
    )
    
    
    (4
    )Financing Activities:Purchase of treasury stock
    
    
    
    
    
    
    Issuance of common stock
    
    
    
    
    
    
    3,744Payment of preferred stock dividends
    
    
    
    
    
    
    (8
    )Net cash provided by (used in) financing activities
    
    
    
    
    
    
    3,736Net increase (decrease) in cash and cash equivalents
    
    
    (986
    )
    
    
    2,461Cash and cash equivalents, beginning of period
    
    $
    1,708
    
    
    $
    607Cash and cash equivalents, end of period
    
    $
    722
    
    
    $
    3,068Supplemental cash flow information:Cash paid during the year for:Interest
    
    $
    
    
    
    $
    Income taxes
    
    $
    
    
    
    $
    Non-cash investing and financing activitiesGoodwill acquisition from purchase of
Advanced Security Link
with common stock
    
    $
    
    
    
    $
    
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MDI, INC. and SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (in thousands)
 Nine months ended September 30,2006
    
    
    2005Operating Activities:Net loss
    
    $
    (5,052
    )
    
    $
    (4,624
    )Adjustments to reconcile net loss to net cash used in operating activities:Non cash stock compensation
    
    
    534
    
    
    
    Loss on disposal of fixed assets
    
    
    
    
    
    
    2Depreciation and amortization
    
    
    359
    
    
    
    592Provision for losses on accounts receivable
    
    
    16
    
    
    
    (14
    )Changes in operating assets and liabilities, net of dispositions:Trade accounts receivable
    
    
    327
    
    
    
    1,400Inventories
    
    
    29
    
    
    
    (158
    )Prepaid and other current assets
    
    
    135
    
    
    
    (46
    )Trade accounts payable
    
    
    85
    
    
    
    (63
    )Accrued and other current liabilities
    
    
    44
    
    
    
    (978
    )Net cash used in operating activities
    
    
    (3,523
    )
    
    
    (3,889
    )Investing Activities:Purchases of property and equipment
    
    
    (71
    )
    
    
    (130
    )Net cash used in investing activities
    
    
    (71
    )
    
    
    (130
    )Financing Activities:Purchase of treasury stock
    
    
    
    
    
    
    Issuance of common stock
    
    
    2,193
    
    
    
    3,774Payment of preferred stock dividends
    
    
    (17
    )
    
    
    (25
    )Net cash provided by financing activities
    
    
    2,176
    
    
    
    3,719Net decrease in cash and cash equivalents
    
    
    (1,418
    )
    
    
    (300
    )Cash and cash equivalents, beginning of period
    
    $
    2,140
    
    
    $
    3,368Cash and cash equivalents, end of period
    
    $
    722
    
    
    $
    3,068Supplemental cash flow information:Interest
    
    $
    
    
    
    $
    Income taxes
    
    $
    
    
    
    $
    Non-cash investing and financing activitiesGoodwill acquisition from purchase of Advanced Security Link
with common stock
    
    $
    1,820
    
    
    $
    
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 Business Description
  Basis of Presentation
  Use of Estimates
  Stock-Based Compensation
    8




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Three months endedSeptember 30, 2005Net loss from continuing operations
allocable to common stockholders:As reported
    
    $
    (1,588
    )Deduct: Total stock-based compensation under fair value
based method for all awards
    
    
    (902
    )Pro forma
    
    $
    (2,490
    )Basic and diluted loss per share from continuing
operationsAs reported
    
    $
    (0.10
    )Pro forma
    
    $
    (0.15
    )
 Nine months endedSeptember 30, 2005Net loss from continuing operations
allocable to common stockholders:As reported
    
    $
    (4,649
    )Deduct: Total stock-based compensation under fair value
based method for all awards
    
    
    (1,282
    )Pro forma
    
    $
    (5,931
    )Basic and diluted loss per share from continuing
operationsAs reported
    
    $
    (0.30
    )Pro forma
    
    $
    (0.39
    )
 Earnings (Loss) Per Share
   
 ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 Forward Looking Statements
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Risks Associated With Our Common Equity
  Overview
            Our Growth Strategy
   10




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Cash Requirements
   Leased Facilities
  Employee Costs
   Financial Condition, Liquidity and Capital Resources
    11




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Results of Operations
  Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005
 PercentagePercentage of Net Sales
    
    Increase (Decrease)In Dollar ValueThree Months ended September 30,
    
    Between Periods2006
    
    2005
    
    2006 vs. 2005Net Sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    -17.6
    %Cost of sales
    
    
    48.2
    %
    
    
    54.0
    %
    
    
    -26.4
    %Gross profit
    
    
    51.8
    %
    
    
    46.0
    %
    
    
    -7.2
    %Operating expenses:Selling, general and administrative
    
    
    126.4
    %
    
    
    104.4
    %
    
    
    -0.2
    %Non cash stock compensation
    
    
    9.7
    %
    
    
    0.0
    %
    
    
    100.0
    %Depreciation and amortization
    
    
    6.1
    %
    
    
    8.4
    %
    
    
    -40.4
    %Operating loss
    
    
    -90.4
    %
    
    
    -66.9
    %
    
    
    -11.4
    %Other income (expense)
    
    
    0.6
    %
    
    
    0.0
    %
    
    
    100.0
    %Loss before taxes and discontinued operations
    
    
    -89.9
    %
    
    
    -66.9
    %
    
    
    -10.7
    %Loss from continuing operations
    
    
    -89.9
    %
    
    
    -66.9
    %
    
    
    -10.7
    %Loss from discontinued operations
    
    
    0.0
    %
    
    
    -0.5
    %
    
    
    100.0
    %Net loss
    
    
    -89.9
    %
    
    
    -67.3
    %
    
    
    -9.9
    %Net loss allocable to common stockholders
    
    
    -90.3
    %
    
    
    -67.7
    %
    
    
    -9.9
    %
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Nine Months Ended September 30, 2006 Compared to Nine Months Ended September 30, 2005
 PercentageIncrease (Decrease)Percentage of Net Sales
    
    In Dollar ValueNine Months ended September 30,
    
    Between Periods2006
    
    2005
    
    2006 vs. 2005Net Sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    14.0
    %Cost of sales
    
    
    48.9
    %
    
    
    52.6
    %
    
    
    5.2
    %Gross profit
    
    
    51.1
    %
    
    
    47.4
    %
    
    
    22.0
    %Operating expenses:Selling, general and administrative
    
    
    112.0
    %
    
    
    123.7
    %
    
    
    2.5
    %Non cash stock compensation
    
    
    7.8
    %
    
    
    0.0
    %
    
    
    100.0
    %Depreciation and amortization
    
    
    5.2
    %
    
    
    9.8
    %
    
    
    -39.4
    %Operating loss
    
    
    -73.9
    %
    
    
    -86.1
    %
    
    
    -2.7
    %Other income (expense)
    
    
    0.3
    %
    
    
    10.4
    %
    
    
    96.5
    %Loss before taxes and discontinued operations
    
    
    -73.6
    %
    
    
    -75.7
    %
    
    
    -10.1
    %Loss from continuing operations
    
    
    -73.6
    %
    
    
    -75.7
    %
    
    
    -10.1
    %Loss from discontinued operations
    
    
    -0.2
    %
    
    
    -0.8
    %
    
    
    75.0
    %Net loss
    
    
    -73.8
    %
    
    
    -76.5
    %
    
    
    -9.3
    %Net loss allocable to common stockholders
    
    
    -74.2
    %
    
    
    -76.9
    %
    
    
    -9.2
    %
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ITEM 3. CONTROLS AND PROCEDURES
 Evaluation of Disclosure Controls and Procedures
  Changes in Internal Controls
  
 PART II  OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
  
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
 Exhibits
 1.
    
    31.1 Certification of CEO Pursuant to Rule 13a-14(a)2.
    
    31.2 Certification of CFO Pursuant to Rule 13a-14(a)3.
    
    32.1 Joint Certification of CEO and CFO Pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code.
 Reports on Form 8-K
  1.
    
    On August 23, 2006, in accordance with the provisions of the Companys Bylaws, the Board of
Directors (the Board) of MDI, Inc. (the Company) appointed Robert E. McCann III to serve
as a member of the Board, effective immediately. After the appointment of Mr. McCann to the
Board, the Board consisted of six (6) members.2.
    
    On June 30, 2006 the Company filed a Form 8-K stating that on June 27, 2006, the Nasdaq Stock
Market (Nasdaq) notified us that for 30 consecutive trading days the bid price for our
common stock had closed below the $1.00 per share minimum required for continued inclusion
under NASDAQ Marketplace Rule 4310(c)(4).
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SIGNATURES
  MDI, INC.Dated: November 9, 2006
    By:
    /s/ James A. KitchensJames A. KitchensVice President and Chief Financial Officer 15