SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

Commission file number: 0-9463

MDI, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:

(210) 582-2664

Securities registered pursuant to Section 12(b) of the Act:

NONE

Securities registered pursuant to Section 12(g) of the Act:

COMMON STOCK, $.01 PAR VALUE

      Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in a definitive proxy to be filed or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     o

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).     Yes o          No þ

      The aggregate market value of the voting stock held by non-affiliates of the registrant, as of June 30, 2004 was $22,681,751. As of that date 14,633,388 shares of the Registrant’s Common Stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

      The information required by Part III of this Form (Items 10, 11, 12, 13 and 14) is incorporated by reference from the registrant’s Proxy Statement to be filed on or before April 29, 2005.

MDI, INC.

Form 10-K

TABLE OF CONTENTS

Forward Looking Statements

      Certain statements contained or incorporated in this annual report on Form 10-K, which are not statements of historical fact, constitute “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”). Forward looking statements are made in good faith by MDI, Inc. (the “Company” or “MDI”) pursuant to the “safe harbor” provisions of the Reform Act. These statements may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements to differ materially from any future results, performance or achievements, whether expressed or implied. These risks, uncertainties and factors include the timely development and acceptance of new products and services, the impact of competitive pricing, fluctuations in operating results, the ability to introduce new products and services, technological changes, reliance on intellectual property and other risks. The objectives set forth in this Form 10-K are subject to change due to global market and economic conditions beyond the control of the Company.

PART I

General

      Since 1979, MDI has remained an established leader in the integrated access control and physical security products business. As a manufacturer of high-grade access control solutions for both the enterprise and small to mid-sized markets, the Company has held notable competitive positions in the government and commercial integrated systems space for over two decades; successfully assisting end users in protecting their people, facilities and assets. The Company promotes their solutions via global dealer channels and maintains an impressive portfolio of dedicated partners with a strong end-user referral base. The MDI product family has protected thousands of customers around the world, including many of the world’s most security-minded government agencies including the Department of Homeland Security, major financial institutions, healthcare organizations, manufacturing companies, energy and power providers, gaming and entertainment establishments, educational institutions and Fortune ranked corporations.

      The Company was reincorporated in Delaware in 1995 as Ultrak, Inc. On December 20, 2002, following stockholder approval, the Company sold its closed-circuit television (“CCTV”) business to Honeywell International, Inc. (“Honeywell”) and changed its name to American Building Control, Inc. in connection with the Honeywell Asset Sale. Additional information regarding the Honeywell Asset Sale is set forth at the end of this Item 1 under the heading “Honeywell Asset Sale”.

      On July 1, 2004, the Company sold its SecurityandMore and Industrial Vision Source distribution businesses to Mace Security International, Inc. (“Mace”). Additional information regarding the Mace Asset Sale is set forth at the end of this Item 1 under the heading “Mace Asset Sale”. On September 22, 2004, the Company filed a Certificate of Ownership and Merger with the Secretary of State of Delaware pursuant to Section 253 of the Delaware General Corporation Law whereby ABC Merger Corp., a wholly-owned subsidiary of the Company, was merged with and into the Company. As part of the merger, the registrant changed its name to MDI, Inc. effective as of the close of business on September 24, 2004. In accordance with the Certificate, the By-Laws of the Company were amended to reflect the change in the Company’s name. The Company’s trading symbol with the NASDAQ National Market (“NASDAQ”) was changed from ABCX to MDII effective Monday, September 27, 2004, the effective date of the Company’s name change with NASDAQ.

      The Company maintains an internet website at www.mdisecure.com. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to those reports, are available free of charge on our website, under the heading Investors (see Investor Info & SEC Filings), immediately after they are filed with, or furnished to, the Securities and Exchange Commission (SEC).

      The certifications of our Chief Executive Officer and Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 about the disclosure contained in this Annual Report on Form 10-K, are included as Exhibits 31.1 and 31.2 to this Annual Report and are available free of charge on our website under the heading Investors (see Investor Info & SEC Filings).

NASDAQ listing

      On November 11, 2004, the Company received a NASDAQ Stock Market letter notifying the Company that for the last 30 consecutive business days, the Company’s common stock bid price had closed under the minimum $1.00 per share requirement for continued inclusion. The letter provides the Company 180 calendar days, or until May 10, 2005, to regain compliance. Compliance is regained by the Company maintaining a common stock closing bid price of $1.00 or more for a minimum of ten consecutive business days. If the deficiency is not cured within 180 calendar days, NASDAQ could begin delisting proceedings. Those proceedings could lead to the Common Stock no longer trading on the NASDAQ National Market. After the Company’s common stock shares have traded above $1.00 per share for those ten days, NASDAQ will notify the Company that it has regained compliance. Delisting from NASDAQ could result in a reduction in the

liquidity of any investment in the Common Stock and have an adverse effect on its trading price. Delisting could also reduce the ability of holders of the Common Stock to purchase or sell shares as quickly and inexpensively as they have done historically. A press release and Form 8-K SEC filing were issued detailing the NASDAQ notification event. At March 18, 2005, the Company remained in non-compliance of the minimum share price rule. Should the Company’s bid price deficiency still exist on May 10, 2005, the Company will request an extension from NASDAQ for additional time to cure the deficiency.

Businesses

      During 2004, the Company completed consolidation efforts and non-core divestitures. With the sale of its SecurityandMore and Industrial Vision Source divisions to MACE during 2004, MDI is able to more effectively concentrate on its core business of integrating access control, alarm management and video security management into one centralized control platform that is able to deliver enterprise wide command of the entire physical security infrastructure.

      MDI’s central station software development product line, ABM Data Systems, continues to provide alarm management software to outsourced central station monitoring companies that oversee and dispatch assistance to residential and business alarms as well as the in-house security monitoring and management capabilities usually found in large geographically dispersed environments such as universities, municipalities, manufacturers and global enterprises

      The Company’s Mobile Video Products (“MVP”) product line promotes and markets state of the art video recording devices and cameras to operators of public transit vehicles, school system transportation fleets and various mobile law enforcement organizations. MVP products empower these entities to protect their passengers, deter violent behavior, avoid frivolous lawsuits and capture direct acts of vandalism to property.

Markets and Strategy

      World events and continued regulatory changes have brought continually renewed attention to many sectors within the security industry. Governments, commercial organization and individuals are now focusing much more on their security arrangements in a proactive, rather than reactive manner and the market has grown accordingly. The trend towards seamless integration of physical security systems (access, alarm and video) continues to grow. The ability to scale systems to need and manage them in the most cost effective and efficient manner is becoming more important for security operators and managers.

      The trend to integrate security and IT systems (convergence) has added complexity to design and installation. The impact of ⁹/11 has created special growth opportunities in many diverse areas requiring varying levels of security support. High tech systems coupled with solid technical support and integrated systems are at the forefront of market demand. These areas, from basic needs to advanced security systems, are where MDI excels.

      In the short term, MDI is well positioned to capitalize on the security integration market as their SAFEnet® enterprise and middle market integrated access control products offer what the Company considers the only “true” integration capabilities in the industry (vs. simple interfacing). In the long term, calculated investments in research and development will position MDI to expand on these integration capabilities, beyond point security, into an open platform that effectively integrates business applications with enterprise security products and other critical data sources to provide a centralized enterprise risk management system.

Products and Services

      The Company’s primary lines of business include proprietary software, hardware and its continued support of legacy systems using its SAFEnet® brand of integrated access control software for the enterprise coupled with a scaled-down version for small to mid-sized organizations. The Company’s products are sold to integrators and value added resellers for implementation into end-user environments. The ABM Data Systems and MVP sales models promote their products directly to the consumer.

      The Company has continued to refine its solution-based recurring service revenue model, and recognizes that service revenues will play an increasingly important role in the future. Implementation of this model means delivering additional value-added fee for service components that include field engineering (to assist integrators), certification training levels and tiered customer support packages. New software maintenance contracts should bring an additional revenue stream to the company while allowing for smoother product upgrades and migrations.

      MDI’s branded line of Intelligent Door Control (IDC) hardware is arguably the most robust and technically advanced solution in the industry. The true power of this “door based” hardware line is in its ability to maintain itself as a disparate access control data center for extended periods of time without connection to the server. While competing products hold a single week’s worth of access data, the IDC line is able to efficiently hold 52 weeks of data.

Product Design and Development

      During its re-organization phase, MDI refined and restructured its engineering team, naming a new Vice President of Engineering and relocating its development team from Rancho Cucamonga, CA to Ontario, CA. The new engineering team is responsible for product engineering, product development and quality assurance. The members are seasoned industry veterans with many years of experience in the design and development of software solutions and security products for both government and commercial focused organizations. During the fiscal years ended December 31, 2004, 2003, and 2002, the Company expensed approximately $2.0 million, $1.3 million and $1.6 million, respectively, on engineering and software development costs.

Supplier Relationships

      The Company believes that its supplier relationships are good and stable. Dell, Inc. and a single contract manufacturer are the largest vendors for access control equipment. Sudden loss of either vendor could result in material short-term supply problems. The Company continuously evaluates potential vendors to bridge any supply chain disruptions that may occur in its business operations.

Competition

      Substantial competition exists in all of MDI’s markets. Significant competitive factors include company brand, quality, product performance, customer service, price and ease of integration. MDI’s major competitors in the Integrated Access Control space for both the enterprise and middle markets continue to be Lenel Systems International, Inc., Software House (a division of Tyco), General Electric Security, Northern Computers (a subsidiary of Honeywell), DSX and NexWatch.

      Mass consolidation in the industry has positioned MDI as one of the last truly independent access control manufacturers in the industry. Certain current and potential competitors have substantially greater resources than MDI. In order to compete successfully, the company must continue to invest in engineering, marketing and customer support. There is no assurance that these competitors will or will not develop products that offer superior price or performance features.

Employees

      As of December 31, 2004, the Company had approximately 70 full-time employees, compared with 150 full-time employees worldwide as of December 31, 2003. Approximately 37 of the Company’s former employees joined Mace in July 2004 as a result of the Mace Asset Sale. Another 8 of the Company’s former employees were severed as part of a management buyout of its Swiss Operations in November 2004. Other personnel reductions during 2004 can be attributed to the consolidation of facilities into the Company’s new San Antonio headquarters, involuntary workforce reductions and attrition.

      The Company’s future success will depend in large part on its ability to attract and retain highly skilled technical, managerial, financial and sales personnel. None of the Company’s employees are represented by a

union or covered by a collective bargaining agreement. The Company has not experienced a work stoppage or strike. Relations with the Company’s employees are considered good.

Mace Asset Sale

      On July 1, 2004, The Company sold the consumer/do-it-yourself business (“SecurityandMore”) and the industrial vision business (Industrial Vision Source, or “IVS”), collectively the Company’s former “DSG” segment, to Mace Security International, Inc. The total consideration paid was cash in the amount of $5.6 million paid upon closing. The Company realized a $1.3 million gain from the sale in 2004.

MDI Switzerland Management Buyout

      In November 2004, the Company sold 100% of it’s Swiss business, MDI Monitor Dynamics Intl. S.A., to the local management team for a nominal amount. The Company realized a loss from the sale transaction of $133 thousand in 2004. The Company realized a gain from foreign currency translation of $124 thousand related to the Swiss business in 2004.

Honeywell Asset Sale

      The CCTV Business sold by the Company in the Honeywell Asset Sale consisted of assets in the United States, Germany, Italy, Poland, South Africa, Australia, Singapore and the United Kingdom. The sale price of $36 million included a $2.2 million holdback for anticipated royalties due to a license agreement that Honeywell required the Company to enter into (see Note 2: Discontinued Operations) as well as a $5.4 million purchase price hold back. The latter was subject to change in the net value of CCTV assets between March 31, 2002 and December 20, 2002 as well as general representations and warranties made by the Company to Honeywell. The $5.4 million purchase price holdback was to be paid to the Company, with accrued interest, over three installments every six months after the close of the sale.

      In April 2003, Honeywell disputed the change in net asset value and, after failing to resolve the differences by August 2003, Honeywell and the Company entered into arbitration. In December 2003, the final resolution rendered by the arbitrator increased the purchase price by approximately $888 thousand. Honeywell made payments for the increase of the purchase price, the first two of the three holdback installments and the accrued interest in December 2003. The increase to the purchase price is included as a component of discontinued operations in 2003. The final $1.8 million payment was received in June 2004.

      During 2004 the Company vacated it’s former headquarters facility in Lewisville, Texas and consolidated operations previously maintained in Austin, Texas, Rancho Cucamonga, California and Fairfax, Virginia into it’s new headquarters facility in San Antonio, Texas. The headquarters facility consists of approximately 33,000 square feet of office and warehouse space.

      The Company also maintains a 6,000 square foot office facility in Ontario, California. The California facility is dedicated to the Company’s 12 person development engineering staff.

      MDI is subject to various legal proceedings and claims, that arise in the ordinary course of business.

      A French court awarded the Company and its French subsidiary a 2.5 million Euro (approximately $3.0 million) judgment against a French company, Aasset Security, for unfair trade practices. Of this 2.5 million Euro, the court ordered Aasset Security to begin to pay 1 million Euro in monthly installments of 75,000 Euro. As of December 31, 2004, Aasset Security had paid the Company 307,000 Euros. As of March 25, 2005, Aasset Security has paid a total of 682,000 Euros. Pursuant to the terms of a 2001 agreement with French legal counsel, the case has been handled on a partial contingency basis. The contingency fee to be paid to outside counsel may be between 35% to 40% of the payments received, depending upon the timing of the receipts. It is the position of the Company that no fees will be paid under the contingency fee arrangement

until there is a final, non-appealable award in favor of the Company and its French subsidiary. Aasset Security filed several appeals against the initial decision of the trial court, the latest one of which was heard by a French court in February 2005. The decision from this court is expected sometime in late April 2005. The Company will continue to pursue the collection of the balance of the 1 million Euros owed, though the timing of collection and Aasset Security’s ability to pay are not certain. Due to the degree of uncertainty of collection, no amounts have been included as income, and no legal expenses have been included in the 2004 financial statements. All cash receipts have been included in the Company’s cash balance, and a corresponding liability has been recorded as Deferred Legal Settlement in the financial statements pending legal resolution.

      Management believes that there are no other existing legal matters that will have a material adverse effect on the Company’s financial condition or results of operations.

      NONE

PART II

      The Company’s Common Stock, $0.01 par value, has been listed on the NASDAQ under the symbol “MDII” since September 27, 2004.

      The Company’s Common Stock previously traded under the symbol “ABCX” from December 20, 2002 through September 24, 2004, and prior to December 20, 2002 traded under the symbol “ULTK” since its original listing on NASDAQ on January 18, 1994.

      The following table sets forth the high and low closing prices of the Company’s Common Stock (“Common Stock”) for each quarter during the years ended December 31, 2004 and 2003:

      As of March 25, 2005, there were approximately 1,200 holders of record of the Common Stock.

      The Company has not declared or paid any cash dividends on the Common Stock since inception. The declaration of any future cash dividends on the Common Stock will depend upon the earnings, capital requirements and financial position of the Company, general economic conditions and other pertinent factors.

      Dividends in the amount of $33,698 were paid during 2004 to Victoria & Eagle Strategic Fund (“VESF”), the sole holder of the Company’s Series A preferred stock. Prior to 2004, dividends in the amount of $117,210 were paid annually since the issuance of the Company’s Series A preferred stock. In December 2003, the Company reached an agreement (the “Standstill Agreement”) with VESF, not to redeem the preferred shares for a period of 18 months and lowered the dividend to 200 basis points over one-year LIBOR during the effective period of the standstill agreement.

      The following selected consolidated financial data for the five fiscal years ended December 31, 2004, have been derived from the Company’s audited consolidated financial statements. The operations effected by the Mace Asset Sale, Switzerland management buyout and the Honeywell Asset Sale are presented as discontinued operations. This data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operation” and the consolidated financial statements and related notes set forth in Item 8 of this Form 10-K.

Overview

      The consolidated financial statements include the Company’s accounts and its consolidated subsidiaries. The Company is organized into a single selling segment, which are supported by administrative functions such as accounting, human resources, legal and computer support services (the “Corporate Staff”). All significant inter-company balances and transactions among subsidiaries and divisions have been eliminated in consolidation.

      Product sales are recorded when goods are shipped to the customer. Most sales made to domestic customers are on net 30-day terms after a credit review is performed to establish creditworthiness and to determine an appropriate credit limit. International sales are made under varying terms depending upon the creditworthiness of the customer and include the use of letters of credit, payment in advance of shipment and open trade terms. Revenue is deferred when collection is determined not to be probable.

      Cost of sales for most of the Company’s products includes the cost of the product shipped plus customs duty and other costs associated with delivery from foreign contract manufacturers or from domestic suppliers.

      Operating expenses include selling, general and administrative expenses, as well as depreciation. Selling, general and administrative costs include salaries, commissions and related benefits, telephone, advertising, printing, product literature, sales promotion, legal, audit and other professional fees, supplies, engineering and travel.

Application of Critical Accounting Policies and Estimates

      Management’s discussion and analysis of the Company’s financial condition and results of operations are based upon the consolidated financial statements, which have been prepared in accordance with accounting principles generally acceptable in the United States of America. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Because of the use of estimates in the preparation of financial statements, actual results could differ from those estimates.

      The following critical accounting policies are affected by significant judgments and estimates used in the preparation of the Company’s consolidated financial statements:

      The Company’s inventories are comprised principally of goods held for resale, which are valued at the lower of cost (first in-first out) or market. Inventories are written down to their estimated net realizable value for obsolescence, returned inventory deemed not economical to repair or discontinued product lines. This

estimate is based upon historical results, current inventories on hand, market conditions and current and expected sales trends. If market conditions become less favorable than those expected by management, then additional inventory write-downs may be required.

      The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make payments. To estimate this allowance, the Company analyzes the composition of its accounts receivable, historical bad debts, customer concentrations, customer creditworthiness and current economic trends. If the financial condition of the Company’s customers were to deteriorate and result in an impairment of their ability to make payments, additional allowances may be required.

      The Company maintains warranty reserves for estimated warranty costs when revenue is recognized. The costs of warranty obligations are estimated based on warranty policy or applicable contractual warranty, historical experience of known product failure rates and use of materials and service delivery charges incurred in correcting product failures.

      Goodwill is tested for impairment annually or at other times if events have occurred or circumstances exist that indicate the carrying value of goodwill may no longer be recoverable. The impairment test for goodwill involves a two-step process: step one consists of a comparison of the fair value of a reporting unit with its carrying amount, including the goodwill allocated to each reporting unit. If the carrying amount exceeds the fair value, step two requires the comparison of the implied fair value of the reporting unit goodwill with the carrying amount of the reporting unit goodwill. Any excess of the carrying value of the reporting unit goodwill over the implied fair value of the reporting unit goodwill will be recorded as an impairment loss. Fair value of the business units is determined using the income approach. Under the income approach, value is dependent on the present value of future cash flows and discount rates. The determination of fair value involves estimates of future sales growth, product costs, selling and administrative costs and costs of capital.

      Whenever certain events or changes in circumstances indicate that the carrying value of long-lived assets may not be recoverable, an evaluation is performed. Such events or circumstances include, but are not limited to, a prolonged industry downturn, a significant decline in the Company’s market value or significant reductions in projected future cash flows. In assessing the recoverability of long-lived assets, the carrying value is compared to the undiscounted future cash flows the assets are expected to generate. If the total of the undiscounted future cash flows is less than the carrying amount of the assets, then the net book values of such assets are written down based on the excess of the carrying amount over the fair value of the assets. Fair value is generally determined by calculating the discounted future cash flows, which includes estimating long-term forecasts of the amounts and timing of overall market growth, utilization of assets, discount rate and terminal growth rates. Differences between the Company’s estimates and actual results would change the calculation of discounting future cash flows, which could require an impairment charge.

      Deferred tax assets are regularly assessed for their likelihood and the amounts believed to be realizable. A valuation allowance is provided against deferred tax assets not expected to be realized. Projected future taxable income estimates are incorporated in the considerations. Significant management judgment is required in projecting future taxable income to support the realization of net deferred tax assets and any required valuation allowance. Due to uncertainties related to the Company’s ability to generate taxable income and utilize the net deferred tax asset, a valuation allowance has been recorded against the net deferred tax asset

balance. If the Company generates taxable income in future periods, the valuation allowance would be reduced, resulting in a tax benefit in the financial statements.

      The estimated fair value of financial instruments has been determined using available market information and appropriate methodologies. However, considerable judgment is required in interpreting market data to develop estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company would realize in a current market sale.

      The fair value of cash, cash equivalents, accounts receivable and accounts payable approximate their fair value based on the short maturities of these instruments.

      Prior year balances have been reclassified to conform with current year presentation due to divestitures that have been reclassified as Discontinued Operations.

Results of Operations

      The Company’s financial statements have been restated to report the Company’s CCTV, SecurityandMore, IVS and Swiss businesses as discontinued operations (see note 2 to the Company’s Consolidated Financial Statements for additional detail).

      The following table contains information regarding the percentage of net sales for the years ended December 31, 2004, 2003, and 2002 and the percentage changes in these income and expense items from year to year:

      For the year ended December 31, 2004, net sales were $14.2 million, a decrease of $2.0 million or 12% from 2003.

      The MDI business had a decrease of $0.9 million in sales, attributed to delayed product releases during the year to allow additional time for field testing of new technologies.

      Royalty revenues from the MVP business were $0.5 million less in 2004. Additionally, mobile video products sales decreased by $0.3 million in 2004. The decline in royalty payments resulted primarily from reduced sales of products using our patent rights by licensees during 2004. MVP’s sales reduction was due to reduced sales opportunities available in the Division’s market.

      Gross profit decreased $0.2 million during 2004 due to the lower sales volume, but gross profit increased to 44.2% versus 40.1% in 2003. The improvement was due to a favorable move to integrated systems sales which include higher margin software and services.

      Selling, general and administrative expenses (“SG&A”) were $13.9 million of 2004, a decrease of $0.6 million (4%) over the same period in 2003. The decrease was primarily related to consolidation and restructuring of the Company during 2004. During the second quarter of 2004, the Company closed the MDI mixed-use facility in Rancho Cucamonga, California and the MDI engineering group moved to smaller office space in Ontario, California. During the third quarter of 2004 the Company closed its headquarters facility in Lewisville, Texas and relocated to a office and warehouse facility in San Antonio, Texas. The Company has also consolidated its ABM Data Systems business and its Fairfax, VA operations into the San Antonio facility.

      During 2004, the Company recorded $948 thousand for severance, $220 thousand in relocation related expenses and $75 thousand for lease settlement costs related to the consolidation efforts.

      There were no goodwill impairment charges in 2004, compared with $650 thousand in 2003 related to the central station alarm management unit.

      Depreciation and amortization expenses were $1.0 million in 2004, a decrease of $0.8 million from 2003. The decrease was primarily due to less building depreciation and the write-off of the SAP software cost upon conversion to a new system in the fourth quarter of 2003.

      Other expenses in 2004 were $0.1 million, compared with other expenses $0.1 million in 2003.

      Discontinued operations had a loss of $0.4 million in 2004, primarily due to losses from the Switzerland entity and continued cost of liquidating foreign entities. Discontinued operations had a loss of $0.8 million in 2003, due to a $1.1 million goodwill impairment of the Switzerland business offset by $0.3 million of income generated from the divested DSG segment.

      The gain on disposal of discontinued operations in 2004 was $1.2 million, which resulted from a net gain from the Mace Asset Sale of $1.4 million and a $0.2 million loss from the Switzerland management buyout and other related disposals.

      For the year ended December 31, 2003, net sales were $16.2 million, a decrease of $3.3 million or 17% from 2002.

      MDI products had a $2.2 million decrease in sales in 2003 compared to 2002. The decrease primarily resulted from lower sales of video products as part of access control projects. Though the Company retained the video part of the access control business after the Honeywell Asset Sale, Honeywell has increasingly supplied video components directly to the integrators who purchase access control products from the Company.

      Revenues from the Company’s central station alarm management products were $0.4 million less year on year, a decrease of 32% for that unit.

      MVP^tm royalty and product sales also experienced a sales decrease of $1.1 million (46%) due to product transition, as the public transit business shifts toward digital solutions.

      Gross profit margin improved to 40.1% in 2003, versus 31.4% in 2002. The improvement was due to more a favorable product mix towards integrated systems, as well as increased high-margin royalty revenues.

      Selling, general and administrative expenses were $14.5 million in 2003, compared to $15.6 million in 2002, a decrease of $1.1 million, or 7%, over 2002. The decrease was primarily due to less employee separation and severance expenses for former executives compared to 2002.

      Goodwill and asset impairment charges were $0.7 million in 2003, compared to $3.3 million in 2002. The 2003 charges included goodwill impairments related to the central station alarm management unit. The 2002 charges included a $2.7 million write-down of the Company’s SAP enterprise software system and a $0.6 million impairment of goodwill related to the central station alarm management unit.

      Depreciation and amortization expenses were $1.8 million in 2003, a decrease of $0.1 million from 2002. The decrease was due to a smaller asset base, particularly in the SAP software cost.

      Other expense in 2003 was $0.1 million, compared with $2.2 million in 2002. The 2002 expense included $2.8 million in interest expense. The Company paid off its bank debts at the end of 2002 with proceeds from the Honeywell Asset Sale.

      Discontinued operations had a loss of $0.8 million in 2003, reflecting the increase of the purchase price and the costs of the dissolution process of international entities, the business content of which, with the exception of Switzerland, was sold to Honeywell in the Honeywell Asset Sale. The loss was compared to a $12.4 million loss in 2002, as the discontinued operations have tapered off in 2003. The 2002 discontinued operations loss was due to professional fees on the Honeywell Asset Sale of $2.7 million, $2.2 million in realized accumulated currency losses, other expenses of $1.6 million caused by the transaction, $0.3 million in operating losses and a $5.6 million net loss from the asset sale.

Financial condition, liquidity and capital resources

      At the end of 2004, the Company had $3.4 million in cash and cash equivalents, down from $6.3 million in at the end of 2003. The decrease was mainly due to the settlement of accrued liabilities as well as the on-going operating losses.

      Cash provided by investing activities was $6.6 million in 2004. The cash was primarily generated by the Mace Asset Sale and the sale of marketable securities.

      For 2005, the Company’s primary source of liquidity will be its cash and cash equivalents. Although cash requirements will fluctuate depending on the timing and extent of many factors, the Company believes that it should have enough liquidity to satisfy its liquidity requirements for at least the next 12 months. The Company also plans to continue consolidation and the rationalization of operating expenses in conjunction with operational and financial performance.

Contractual obligations and commitments

      The following table summarizes the Company’s contractual obligations and commitments with definitive payment terms that will require cash outlays in the future. These amounts are as of December 31, 2004 in thousands;

      The Company’s significant operating leases include facilities and office equipment. Monthly payments for the Company’s two facilities total approximately $42 thousand.

Factors Affecting the Company’s Future Results or the Price of the Company’s Stock.

      Set forth below and elsewhere in this report and other documents the Company files with the SEC, are risks and uncertainties that could cause the Company’s results to differ materially from the results contemplated by the forward-looking statements contained in this report and other public statements that the Company makes.

      The Company has suffered losses in each of the last five years. The Company has consolidated and reduced expenses during 2004 to reflect the smaller size of the Company following the Mace and Honeywell Asset sales. The Company continues to have significant fixed costs that are required to support the installed customer base and maintain a public company status. Should the Company not achieve revenue growth, the Company may incur significant operating expenses to further reduce the size of the infrastructure and can give no assurance that it will achieve profitability or be capable of sustaining profitable operations.

      The Company does not have a line of credit or other loan facility in place, and the Company’s working capital consists of cash reserves. The Company is investigating raising capital to continue to implement the Company’s business plan and to grow the business. The Company can not assure that it will be able to raise additional capital.

      The Company may not keep pace with technological advances or the Company may pursue technologies that do not become commercially accepted and, in either case, customers may not buy the Company’s products and the Company’s revenues may decline.

      The demand for the Company’s products can change quickly and in ways the Company may not anticipate because the Company’s industry is generally characterized by:

      The loss of the services of any key personnel or the Company’s inability to hire new personnel with the requisite management, sales, engineering, and/or financial skills could restrict the Company’s ability to develop new products, enhance existing products in a timely manner, sell products to its customers or effectively manage the Company’s operations.

      On November 11, 2004, the Company received a NASDAQ Stock Market letter notifying the Company that for the last 30 consecutive business days, the Company’s common stock bid price had closed under the minimum $1.00 per share requirement for continued inclusion. The letter provides the Company 180 calendar days, or until May 10, 2005, to regain compliance. Compliance is regained by the Company maintaining a common stock closing bid price of $1.00 or more for a minimum of ten consecutive business days. If the deficiency is not cured within 180 calendar days, NASDAQ could begin delisting proceedings. Those proceedings could lead to the Common Stock no longer trading on the NASDAQ National Market. After the

Company’s common stock shares have traded above $1.00 per share for those ten days, NASDAQ will notify the Company that it has regained compliance. Delisting from NASDAQ could result in a reduction in the liquidity of any investment in the Common Stock and have an adverse effect on its trading price. Delisting could also reduce the ability of holders of the Common Stock to purchase or sell shares as quickly and inexpensively as they have done historically. A press release and Form 8-K SEC filing were issued detailing the NASDAQ notification event. At March 18, 2005, the Company remained in non-compliance of the minimum share price rule.

      Some of the Company’s products might require a higher level of investment in engineering and distribution. If revenues generated from these products become a greater percentage of the Company’s total revenues and if the expenses associated with these products on a percentage of revenues basis do not decrease, then the Company’s operating margins will be reduced.

      The Company has sometimes received notices from others claiming that the Company infringes their patent and intellectual property rights, and the Company has been involved in litigation on patent and intellectual property rights (see Note 9 of the Notes to Consolidated Financial Statements). Companies are more frequently seeking patent protection because of developments in the law that may extend the ability to obtain such patents. As a result, the Company expects to receive more patent infringement claims. Responding to any infringement claim, regardless of its validity, could:

      The Company is exposed to minimal market risk issues. Exposure to these risks is managed through regular operating and financing activities.

Foreign Exchange

      Changes in the foreign currency rates are not expected to have a material adverse effect on the Company’s future consolidated financial position or results of operations. With the divestiture of the Company’s business in Switzerland in November 2004, the Company no longer maintains any active foreign-based operations.

Interest Rates

      The Company had no debt as of December 31, 2004.

      An interest rate swap agreement with Bank One remained in effect through February 15, 2004. The Company paid $52,000 on February 17, 2004 for the final settlement of the interest rate swap contract. The final settlement was fully accrued for at December 31, 2003.

Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders

MDI, Inc.

      We have audited the accompanying consolidated balance sheets of MDI, Inc. (formerly American Building Control, Inc.) and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

      We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of MDI, Inc. and subsidiaries as of December 31, 2004 and 2003, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America.

Dallas, Texas

March 18, 2005

MDI, INC. AND SUBSIDIARIES

(Formerly American Building Control, Inc.)

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these consolidated financial statements.

MDI, INC. AND SUBSIDIARIES

(Formerly American Building Control, Inc.)

CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these consolidated financial statements.

MDI, INC. AND SUBSIDIARIES

(Formerly American Building Control, Inc.)

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

The accompanying notes are an integral part of these consolidated financial statement.

MDI, INC. AND SUBSIDIARIES

(Formerly American Building Control, Inc.)

CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these consolidated financial statements.

MDI, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

      The consolidated financial statements include the accounts of MDI, Inc. (formerly known as American Building Control, Inc.), a Delaware corporation, and its wholly-owned subsidiaries. These companies are collectively referred to as the “Company”. All significant inter-company balances and transactions have been eliminated in consolidation.

      On December 20, 2002, the Company sold its CCTV Business to Honeywell for $36 million, subject to post-closing adjustments plus the transfer of certain liabilities. On July 1, 2004, the Company sold its consumer/retail (SecurityandMore) and Industrial Vision Source (IVS) businesses to Mace Security International, Inc. for $5.6 million. On November 17, 2004, the Company sold its Swiss Business to the local management team for a nominal amount in order to mitigate future operating losses. The financial statements for all periods present the divested businesses as discontinued operations.

      Prior to the divestiture to Mace Security, the Company had two operating segments: the Professional Security Group (“PSG”), whose primary focus is access control and alarm management products, and the Diversified Sales Group (“DSG”), which markets products to the consumer/do-it-yourself business as well as its industrial video businesses. A third segment, Corporate, provides human resources, legal, financial, information technologies, accounting and reporting functions for the entire business.

      Following the Honeywell Asset Sale in December of 2002, and subsequent DSG segment divesture to MACE Security in July of 2004, the Company, which consolidated operations into a new headquarters facility in San Antonio, Texas, is focused on designing, marketing, selling and servicing security products for use in industrial, governmental and other surveillance markets worldwide. The Company has a facility dedicated to development engineering activities in Ontario, CA.

      In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, the Company’s management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities on the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates.

      The fair value of cash, cash equivalents, accounts receivable and accounts payable approximate their fair value based on the short maturities of these instruments.

      The Company considers all highly-liquid investments with original maturities of three months or less to be cash equivalents. At December 31, 2004 the Company had no cash balances in foreign bank accounts as compared with a balance of $0.2 million at December 31, 2003.

MDI, Inc. and Subsidiaries

Notes to Consolidated Financial Statements — (Continued)

      The Company estimates the collectibility of its trade accounts receivable. In order to assess the collectibility of these receivables, the Company monitors the current creditworthiness of each customer and analyzes the balances aged beyond the customer’s credit terms. These evaluations may indicate a situation in which a certain customer cannot meet its financial obligations due to deterioration of its financial viability, credit ratings or bankruptcy. The allowance requirements are based on current facts and are reevaluated and adjusted as additional information is received. Trade accounts receivable are reserved when it is probable that the balance will not be collected.

      Inventories are comprised primarily of finished goods stated at the lower of cost (first-in, first out) or market through the use of an inventory valuation allowance. In order to assess the ultimate realization of inventories, the Company is required to make judgments as to future demand requirements compared to current or committed inventory levels. Allowance requirements generally increase as the projected demand requirement decreases due to market conditions, technological and product life cycle changes.

      The table below shows the roll forward of inventory provisions for the years ended December 31, 2004, 2003 and 2002 (in thousands):

      Property and equipment, when acquired, are recorded at cost and depreciated using the straight-line method over estimated useful lives or, in the case of leasehold improvements, over the term of the lease, if shorter.

      The Company capitalizes software development costs. These represent the costs incurred from the time technological feasibility is established until the software is ready for use in the Company’s products. Engineering and development costs related to software development are expensed as incurred. The capitalized costs relate to software that will become an integral part of the Company’s revenue producing products and are amortized over an estimated useful life of three to five years in relation to the expected revenues of each product. Software development costs are regularly reviewed for impairment, and a loss is recognized when the net realizable value falls below the unamortized cost. Engineering and development expenses were $2.0 million, $1.3 million and $1.6 million for the years ended December 31, 2004, 2003, and 2002, respectively.

      The Company capitalizes external direct costs of materials and services, internal payroll and related payroll costs and other qualifying costs incurred with developing or obtaining internal software. These costs are amortized over three to eight years.

MDI, Inc. and Subsidiaries

Notes to Consolidated Financial Statements — (Continued)

      Assets that are held and used are analyzed for impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. Impairment is recognized when the estimated undiscounted cash flow generated by those assets is less than the carrying amounts of such assets. The amount of impairment is the excess of the carrying amount over the fair value of such assets. Assets held for sale are carried at the lower of carrying amount or fair value less selling costs.

      The Company accounts for its goodwill and intangible assets using SFAS No. 142, Goodwill and Intangible Assets. In performing its impairment analysis, the Company completes a two step process to determine the amount of any impairment as of December 31^st of each year. The first step involves comparison of the fair value of the reporting unit to its carrying value to determine if an impairment may exist. The second step involves comparison of the fair value of the goodwill to the carrying value of the goodwill. Any excess of the carrying value over the fair value is recorded as an impairment charge. In calculating an impairment charge, the fair value of a reporting unit is estimated using discounted cash flow methodology.

      The Company utilizes the asset and liability approach for financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed for differences between the financial statement basis and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future. These amounts are based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Deferred tax assets are recognized when it becomes more likely than not that the asset will be realized. A valuation allowance is provided for net assets not expected to be realized.

      Revenue for product sales and services is recognized when a firm sales agreement is in place, the price is fixed and determinable, delivery has occurred or services have been rendered and collectibility is probable. Revenues from royalties are recognized as earned, based upon the shipment of products covered by license agreements, and collectibility is probable. Revenue from the sale of contract software maintenance service is recognized over the one-year term of the agreement.

      Reserves are provided for estimated warranty costs when revenue is recognized. The costs of warranty obligations are estimated based on warranty policy or applicable contractual warranty, historical experience of known product failure rates and use of materials and service delivery charges incurred in correcting product failures. Specific warranty accruals may be made if unforeseen technical problems arise. If actual experience, relative to these factors, adversely differs from these estimates, additional warranty expense may be required.

MDI, Inc. and Subsidiaries

Notes to Consolidated Financial Statements — (Continued)

      The table below shows the roll forward of warranty expense for the years ended December 31, 2004, 2003 and 2002 (in thousands):

      Comprehensive income (loss) presented in the statement of stockholders’ equity consists of net income (loss), foreign currency translation adjustments and unrealized gains and losses on investments held for sale.

      The Company recognizes advertising expenses as incurred. The Company’s advertising expense was $50 thousand, $96 thousand and $33 thousand for 2004, 2003 and 2002 respectively.

      The Company computes basic income (loss) per share based on the weighted average number of shares of Common Stock outstanding. Diluted income (loss) per share includes the number of additional shares of Common Stock that would have been outstanding if the potential dilutive effect of the conversion of stock options, convertible preferred stock and the exercise of outstanding warrants had been included. For the years ended December 31, 2004, 2003 and 2002, respectively, all stock options, preferred shares or warrants were excluded from the computation of diluted loss per share because the effect would have been anti-dilutive.

      At December 31, 2003, all of the Company’s investments were designated as held for sale. Securities available for sale are reported at fair value, with unrealized gains and losses, net of tax, excluded from earnings and reported as a separate component of stockholders’ equity. Realized gains and losses on securities available for sale are reported as income in the period of sale. Marketable securities at December 31, 2003 had a balance of $1.5 million and consisted of callable government securities from the Federal Home Loan Bank (“FHLB”), the Federal National Mortgage Association (“FNMA”) and the Federal Home Loan Mortgage Corporation (“FRMC”).

      During the year ended December 31, 2004, all remaining securities were either called or sold. The Company did not own any marketable securities at December 31, 2004.

      The Company accounts for stock-based compensation to employees using the intrinsic value method. Compensation costs for stock options is measured as the excess, if any, of the quoted market price of the Company’s Common Stock at the date of grant over the amount an employee must pay to acquire the stock. The Company has adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation and its amendment SFAS No. 148, Accounting for Stock Based Compensation — Transition and Disclosure.

      Option exercise prices generally are equal to the market price at the date of grant. Shares under grant generally become exercisable in three equal annual installments beginning one year after the date of grant and

MDI, Inc. and Subsidiaries

Notes to Consolidated Financial Statements — (Continued)

expire after ten years. The Honeywell Asset Sale triggered the change of control provisions in the Company’s stock option plans that provided for the immediate vesting of all outstanding stock options.

      No compensation cost is reflected in operations when options granted under the Company’s option plans have an exercise price equal to the quoted market price of the Company’s common stock on the date of grant. The following table illustrates the effect on operations and per share data as if the Company had applied the fair value method.

      The fair value of these options for all periods presented was estimated at the date of grant using the Black-Scholes option pricing model with the following assumptions: expected volatility ranging from 85 to 91 percent; risk-free interest rates ranging from 3.2 to 4.4 percent; no dividend yield; and expected lives of one to seven years.

      The weighted average fair value per share of options granted for 2004, 2003 and 2002 was $1.32, $0.88, and $1.04.