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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
For the quarterly period ended June 30, 2011
   
OR
   
o
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 0-20394

  ‘mktg, inc.’
  (Exact name of registrant as specified in its charter)
     
Delaware
 
06-1340408
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification Number)
     
75 Ninth Avenue
   
New York, New York
 
10011
(Address of principal executive offices)
 
(Zip Code)

Registrant’s telephone number, including area code: (212) 366-3400
 
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 x                                                                           No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes o                                                                           No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):
 
Large accelerated filer o
Accelerated filer o
 
Non-accelerated filer o
Smaller reporting company x
(Do not check if a smaller reporting company)
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o                                                                           No x

As of July 25, 2011, 8,800,845 shares of the Registrant’s Common Stock, par value $.001 per share, were outstanding.
 
 
 

 
 
INDEX
‘mktg, inc.’

   
Page
PART I - FINANCIAL INFORMATION    
       
   
       
 
3
 
 
4
 
 
5
 
       
 
6
 
       
18
 
       
24
 
       
PART II - OTHER INFORMATION    
       
24
 
       
24
 
       
SIGNATURES
25
 
 
 
2

 
Item 1.  Interim Condensed Consolidated Financial Statements
 
‘mktg, inc.’
June 30, 2011 (Unaudited) and March 31, 2011

   
June 30, 2011
   
March 31, 2011
 
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 6,689,407     $ 7,977,068  
Accounts receivable, net of allowance for doubtful accounts of $317,000 at June 30, 2011 and March 31, 2011
    9,272,339       7,686,383  
Unbilled contracts in progress
    1,473,946       1,535,767  
Deferred contract costs
    761,038       1,177,484  
Prepaid expenses and other current assets
    235,188       172,970  
Total current assets
    18,431,918       18,549,672  
                 
Property and equipment, net
    1,712,251       1,789,870  
                 
Restricted cash
    500,000       500,000  
Goodwill
    10,052,232       10,052,232  
Intangible assets - net
    843,365       923,786  
Other assets
    443,227       425,193  
Total assets
  $ 31,982,993     $ 32,240,753  
                 
Liabilities and Stockholders’ Equity
               
Current liabilities:
               
Senior secured notes payable
  $ 2,500,000     $ 2,500,000  
Accounts payable
    843,977       944,764  
Accrued compensation
    654,364       1,861,778  
Accrued job costs
    971,540       1,683,477  
Other accrued liabilities
    2,016,009       2,196,839  
Income taxes payable
          174,000  
Deferred revenue
    13,432,039       12,287,624  
Total current liabilities
    20,417,929       21,648,482  
                 
Deferred rent
    1,394,786       1,456,988  
Warrant derivative liability
    2,680,150       2,837,143  
Put option derivative
    4,280       5,272  
Total liabilities
    24,497,145       25,947,885  
                 
Commitments and contingencies
               
                 
Redeemable Series D Convertible Participating Preferred Stock, $3,038,904 redemption and liquidation value, par value $1.00: 2,500,000 designated shares, 2,500,000 issued and outstanding shares at June 30, 2011
    2,130,145       2,003,085  
                 
Stockholders’ equity:
               
Class A convertible preferred stock, par value $.001; authorized 650,000 shares; none issued and outstanding
           
Class B convertible preferred stock, par value $.001; authorized 700,000 shares; none issued and outstanding
           
Preferred stock, undesignated; authorized 3,650,000 shares; none issued and outstanding
           
Common stock, par value $.001; authorized 25,000,000 shares; 8,838,815 shares issued and 8,800,845 outstanding at June 30, 2011 and 8,590,315 shares issued and 8,552,345 outstanding at March 31, 2011
    8,839       8,590  
Additional paid-in capital
    14,404,525       14,302,693  
Accumulated deficit
    (9,030,150 )     (9,993,989 )
Treasury stock at cost, 37,970 shares at June 30, 2011 and March 31, 2011
    (27,511 )     (27,511 )
Total stockholders’ equity
    5,355,703       4,289,783  
Total liabilities and stockholders’ equity
  $ 31,982,993     $ 32,240,753  

See notes to unaudited condensed consolidated financial statements.
 
 
3

 

‘mktg, inc.’
Three Months Ended June 30, 2011 and 2010
(Unaudited)

   
Three Months Ended
June 30,
 
   
2011
   
2010
 
             
Sales
  $ 31,328,685     $ 29,136,788  
                 
Operating expenses:
               
Reimbursable program costs and expenses
    7,147,447       5,480,754  
Outside production and other program expenses
    14,852,836       15,499,353  
Compensation expense
    6,587,887       5,684,731  
General and administrative expenses
    1,666,286       1,782,419  
Total operating expenses
    30,254,456       28,447,257  
                 
Operating income
    1,074,229       689,531  
                 
Interest expense, net
    (96,315 )     (162,368 )
Fair value adjustments to compound embedded derivatives
    157,985       186,230  
                 
Income before provision for income taxes
    1,135,899       713,393  
                 
Provision for income taxes
    45,000        
                 
Net income
  $ 1,090,899     $ 713,393  
                 
Basic earnings per share
  $ .14     $ .09  
Diluted earnings per share
  $ .07     $ .05  
                 
Weighted average number of common shares outstanding:
               
Basic
    8,079,744       7,842,377  
Diluted
    15,852,912       15,611,730  

See notes to unaudited condensed consolidated financial statements.
 
 
4

 

‘mktg, inc.’
Three Months Ended June 30, 2011 and 2010
(Unaudited)
 
   
2011
   
2010
 
             
Cash flows from operating activities:
           
             
Net income
  $ 1,090,899     $ 713,393  
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
               
Depreciation and amortization
    241,412       279,414  
Deferred rent amortization
    (62,202 )     (41,203 )
Provision for bad debt expense
          18,660  
Amortization of original issue discount on senior secured notes payable
          71,701  
Fair value adjustments to compound embedded derivatives
    (157,985 )     (186,230 )
Share based compensation expense
    102,081       86,851  
Changes in operating assets and liabilities:
               
Accounts receivable
    (1,585,956 )     468,027  
Unbilled contracts in progress
    61,821       384,083  
Deferred contract costs
    416,446       260,282  
Prepaid expenses and other assets
    (80,252 )     366,329  
Accounts payable
    (100,787 )     (743,847 )
Accrued compensation
    (1,207,414 )     302,038  
Accrued job costs
    (711,937 )     2,033,672  
Other accrued liabilities
    (180,830 )     (152,202 )
Income taxes payable
    (174,000 )      
Deferred revenue
    1,144,415       429,884  
                 
Net cash (used in) provided by operating activities
    (1,204,289 )     4,290,852  
                 
Cash flows from investing activities:
               
Restricted cash
          (500,000 )
Purchases of property and equipment
    (83,372 )     (29,873 )
Net cash used in investing activities
    (83,372 )     (529,873 )
                 
Cash flows from financing activities:
               
Net cash from financing activities
           
                 
Net (decrease) increase in cash and cash equivalents
    (1,287,661 )     3,760,979  
                 
Cash and cash equivalents at beginning of period
    7,977,068       663,786  
Cash and cash equivalents at end of period
  $ 6,689,407     $ 4,424,765  
                 
Supplemental disclosures of cash flow information:
               
Interest paid during the period
  $ 102,843     $ 164,680  
Income taxes paid during the period
  $ 246,670     $ 43,106  
 
See notes to unaudited condensed consolidated financial statements.
 
 
5

 
 
‘mktg, inc.’

(1)
Basis of Presentation
   
 
The following unaudited interim condensed consolidated financial statements of ‘mktg, inc.’ (the “Company”) for the three months ended June 30, 2011 and 2010 have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to GAAP for interim financial information and SEC rules and regulations, although the Company believes that the disclosures made are adequate to make the information not misleading. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2011.
   
 
In the opinion of management, such condensed consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, necessary to present fairly the Company’s results for the interim periods presented. The results of operations for the three months ended June 30, 2011 are not necessarily indicative of the results for the full fiscal year or any future periods.
 
(2)
Summary of Significant Accounting Policies
     
 
(a)
Principles of Consolidation
     
   
The condensed consolidated financial statements include the financial statements of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
     
 
(b)
Use of Estimates
     
   
The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of the contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management bases its estimates on certain assumptions, which it believes are reasonable in the circumstances. Actual results could differ from those estimates.
     
 
(c)
Goodwill
     
   
Goodwill consists of the cost in excess of the fair value of the acquired net assets of the Company’s subsidiaries. Goodwill is subject to annual impairment tests which require the comparison of the fair value and carrying value of reporting units. The Company assesses the potential impairment of goodwill annually and on an interim basis whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Upon completion of such annual review, if impairment is found to have occurred, a corresponding charge will be recorded. The Company has determined that it has one reporting unit, and uses three generally accepted methods for estimating fair value of the reporting unit; the income approach, market approach and market capitalization to determine the overall fair value. There were no events or changes in circumstances during the three months ended June 30, 2011 that indicated to management that the carrying value of goodwill and the intangible asset may not be recoverable.
     
 
(d)
Fair Value of Financial Instruments
     
   
The Company’s financial instruments consist of cash and cash equivalents, accounts receivables, accounts payable and accrued liabilities, derivative financial instruments, and the Company’s Senior Secured Notes (“Senior Notes”) and Redeemable Series D Convertible Participating Stock (“Series D Preferred Stock”) issued December 15, 2009. The fair values of cash and cash equivalents, accounts receivables, accounts payable and accrued liabilities generally approximate their respective carrying values due to their current nature. Derivative liabilities, as discussed below, are required to be carried at fair value. The following table reflects the comparison of the carrying value and the fair value of the Company’s Senior Notes and Series D Preferred Stock as of June 30, 2011:
 
     
Carrying Values
   
Fair Values
 
 
Senior Notes (See Notes 3 and 4)
  $ 2,500,000     $ 3,080,104  
 
Series D Preferred Stock (See Notes 3 and 5)
  $ 2,130,145     $ 4,794,223  
 
 
6

 

   
The fair values of the Company’s Senior Notes and Series D Preferred Stock have been determined based upon the forward cash flow of the contracts, discounted at credit-risk adjusted market rates.
     
   
Derivative financial instruments – Derivative financial instruments, as defined in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 815 Derivatives and Hedging, consist of financial instruments or other contracts that contain a notional amount and one or more underlying features (e.g. interest rate, security price or other variable), require no initial net investment and permit net settlement. Derivative financial instruments may be free-standing or embedded in other financial instruments. Further, derivative financial instruments are initially, and subsequently, measured at fair value and recorded as liabilities or, in rare instances, assets.
     
   
The Company generally does not use derivative financial instruments to hedge exposures to cash-flow, market or foreign-currency risks. However, the Company issued other financial instruments with features that are either (i) not afforded equity classification, (ii) embody risks not clearly and closely related to host contracts, or (iii) may be net-cash settled by the counterparty. As required by ASC 815, these instruments are required to be carried as derivative liabilities at fair value in the Company’s financial statements. See Notes 4, 5 and 6 for additional information.
     
   
Redeemable preferred stock – Redeemable preferred stock (such as the Series D Preferred Stock, and any other redeemable financial instrument the Company may issue) is initially evaluated for possible classification as a liability under ASC 480 Financial Instruments with Characteristics of Both Liabilities and Equity. Redeemable preferred stock classified as a liability is recorded and carried at fair value. Redeemable preferred stock that does not, in its entirety, require liability classification, is evaluated for embedded features that may require bifurcation and separate classification as derivative liabilities under ASC 815. In all instances, the classification of the redeemable preferred stock host contract that does not require liability classification is evaluated for equity classification or mezzanine classification based upon the nature of the redemption features. Generally, any feature that could require cash redemption for matters not within the Company’s control, irrespective of probability of the event occurring, requires classification outside of stockholders’ equity. See Note 5 for further disclosures about the Company’s Series D Preferred Stock, which constitutes redeemable preferred stock.
     
   
Fair value measurements - Fair value measurement requirements are embodied in certain accounting standards applied in the preparation of the Company’s financial statements. Significant fair value measurements resulted from the application of the fair value measurement guidance included in ASC 815 to the Company’s Series D Preferred Stock, Secured Notes and Warrants issued in December 2009 as described in Note 6, and ASC 718 Stock Compensation to the Company’s share based payment arrangements.
     
   
ASC 815 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Standard applies under other accounting pronouncements that require or permit fair value measurements. ASC 815 further permits entities to choose to measure many financial instruments and certain other items at fair value. At this time, the Company does not intend to reflect any of its current financial instruments at fair value (except that the Company is required to carry derivative financial instruments at fair value). However, the Company will consider the appropriateness of recognizing financial instruments at fair value on a case by case basis as they arise in future periods.

 
(e)
Revenue Recognition
       
    The Company’s revenues are generated from projects subject to contracts requiring the Company to provide its services within specified time periods generally ranging up to twelve months. As a result, on any given date, the Company has projects in process at various stages of completion. Depending on the nature of the contract, revenue is recognized as follows: (i) on time and material service contracts, revenue is recognized as services are rendered; (ii) on fixed price retainer contracts, revenue is recognized on a straight-line basis over the term of the contract; and (iii) on certain fixed price contracts, revenue is recognized as certain key performance criteria are achieved. Incremental direct costs associated with the fulfillment of certain specific contracts are accrued or deferred and recognized proportionately to the related revenue. Provisions for anticipated losses on uncompleted projects are made in the period in which such losses are determined.
 
 
7

 
 
 
(f)
Income Taxes
       
    The Company has provided for a full allowance against its net deferred tax asset, and except for alternative minimum tax, currently does not record an expense or benefit for federal, state and local income taxes, as any such expense or benefit would be fully offset by a change in the valuation allowance against the Company’s net deferred tax asset. In assessing the realizability of deferred tax assets, management considers, in light of available objective evidence, whether it is more likely than not that some or all of such assets will be utilized in future periods. At March 31, 2011, the Company has incurred losses for fiscal years 2004 through 2011 for financial reporting purposes aggregating $13,817,000 and would have been required to generate approximately $8,535,000 of aggregate taxable income, exclusive of any reversals or timing differences, to fully utilize its net deferred tax asset. Accordingly, based upon the available objective evidence, particularly the Company’s history of losses, the Company provided for a full valuation allowance against its net deferred tax asset at June 30, 2011.

 
(g)
Net Income Per Share
       
    Basic earnings per share is based upon the weighted average number of common shares outstanding during the period, excluding restricted shares subject to forfeiture. Diluted earnings per share is computed on the same basis, including if dilutive, common share equivalents, which include outstanding options, warrants, preferred stock, and restricted stock. For the three months ended June 30, 2011 and 2010, stock options and warrants to purchase approximately 299,767 and 352,016 shares of common stock were excluded from the calculation of diluted earnings per share as their inclusion would be anti-dilutive. The weighted average number of shares outstanding consist of:

   
Three Months Ended
June 30,
 
   
2011
   
2010
 
Basic
    8,079,744       7,842,377  
Dilutive effect of:
               
Restricted stock
    931        
Warrants
    2,453,088       2,450,204  
Series D preferred stock
    5,319,149       5,319,149  
Diluted
    15,852,912       15,611,730  

 
(h)
Recent Accounting Standards Affecting the Company
     
   
Revenue Arrangements with Multiple Deliverables
     
   
In October 2009, the FASB issued authoritative guidance that amends existing guidance for identifying separate deliverables in a revenue-generating transaction where multiple deliverables exist, and provides guidance for allocating and recognizing revenue based on those separate deliverables. The guidance is expected to result in more multiple-deliverable arrangements being separable than under current guidance. This guidance was effective for the Company beginning on April 1, 2011 and was required to be applied prospectively to new or significantly modified revenue arrangements. The adoption of this guidance did not have a material impact on the Company’s operating results, financial position or cash flows.
     
   
Intangibles – Goodwill and Other
     
   
In December 2010, the FASB amended the existing guidance to modify Step 1 of the goodwill impairment test for a reporting unit with a zero or negative carrying amount. Upon adoption of the amendment, an entity with a reporting unit that has a carrying amount that is zero or negative is required to assess whether it is more likely than not that the reporting unit’s goodwill is impaired. If the entity determines that it is more likely than not that the goodwill of the reporting unit is impaired, the entity should perform Step 2 of the goodwill impairment test for the reporting unit. Any resulting goodwill impairment should be recorded as a cumulative-effect adjustment to beginning retained earnings in the period of adoption. Any goodwill impairments occurring after the initial adoption of the amendment should be included in earnings. This guidance was effective for the Company beginning April 1, 2011. The adoption of this guidance did not have a material impact on the Company’s operating results, financial position or cash flows.
 
 
8

 
 
   
Broad Transactions – Business Combination
     
   
In December 2010, the FASB amended the existing guidance to require a public entity, which presents comparative financial statements, to disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendment also expanded the required supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination, which are included in the reported pro forma revenue and earnings. The amendments were effective for the Company beginning April 1, 2011. The adoption of this guidance did not have a material impact on the Company’s operating results, financial position or cash flows.
     
   
Fair Value Measurements
 
 
 
   
In January 2010, the FASB issued guidance which requires, in both interim and annual financial statements, for assets and liabilities that are measured at fair value on a recurring basis, disclosures regarding the valuation techniques and inputs used to develop those measurements. It also requires separate disclosures of significant amounts transferred in and out of Level 1 and Level 2 fair value measurements and a description of the reasons for the transfers. This guidance was effective for the Company beginning on April 1, 2011 and is required to be applied prospectively to new or significantly modified revenue arrangements. The adoption of this guidance did not have a material impact on the Company’s operating results, financial position or cash flows.
     
   
In May 2011, the FASB issued FASB Accounting Standards Update (“ASU”) 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The amendments in this ASU generally represent clarifications of Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This ASU results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and IFRS. The amendments in this ASU are to be applied prospectively and are effective during interim and annual periods beginning after December 15, 2011. Management currently believes that the adoption of this ASU will not have a material impact on the Company’s operating results, financial position or cash flows.
     
   
Comprehensive Income
     
   
In June 2011, the FASB issued FASB Accounting Standards Update (“ASU”) 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. Under the amendments to Topic 220, Comprehensive Income, in this ASU, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments in this ASU should be applied retrospectively and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Management currently believes that the adoption of this ASU will not have a material impact on the Company’s operating results, financial position or cash flows.
 
(3)
Union Capital Financing
   
 
Overview:
   
 
On December 15, 2009, the Company consummated a $5.0 million financing led by an investment vehicle organized by Union Capital Corporation (“UCC”). In the financing, the Company issued $2.5 million in aggregate principal amount of the Senior Notes, $2.5 million in aggregate stated value of Series D Preferred Stock initially convertible into 5,319,149 shares of Common Stock, and Warrants to purchase 2,456,272 shares of Common Stock (“Warrants”). As a condition to its participation in the financing, UCC required that certain of our directors, officers and employees (“Management Buyers”) collectively purchase $735,000 of the financial instruments on the same terms and conditions as the lead investor. Aggregate amounts above are inclusive of Management Buyers amounts. See Note 4 for terms of the Senior Notes.
 
 
9

 
 
 
The shares of Series D Preferred Stock issued in the financing have a stated value of $1.00 per share, and are convertible into Common Stock at an initial conversion price of $0.47. The conversion price of the Series D Preferred Stock is subject to full ratchet anti-dilution provisions for 18 months following issuance and weighted-average anti-dilution provisions thereafter. Generally, this means that if the Company sells non-exempt securities below the conversion price, the holders’ conversion price will be adjusted downwards. Holders of the Series D Preferred Stock are not entitled to special dividends but will be entitled to be paid upon a liquidation, redemption or change of control, the stated value of such shares plus the greater of (a) a 14% accreting liquidation preference, compounding annually, and (b) 3% of the volume weighted average price of the Common Stock outstanding on a fully-diluted basis (excluding the shares issued upon conversion of the Series D Preferred Stock) for the 20 days preceding the event. A consolidation or merger, a sale of all or substantially all of the Company’s assets, and a sale of 50% or more of Common Stock would be treated as a change of control for this purpose.
 
 
After December 15, 2015, holders of the Series D Preferred Stock can require the Company to redeem the Series D Preferred Stock for cash at its stated value plus any accretion thereon (“Put Derivative”). In addition, the Company may be required to redeem the Series D Preferred Stock for cash earlier upon the occurrence of a “Triggering Event.” Triggering Events include (i) a failure to timely deliver shares of Common Stock upon conversion of Series D Preferred Stock, (ii) failure to pay amounts due to the holders (after notice and a cure period), (iii) a bankruptcy event with respect to the Company or any of its subsidiaries, (iv) default under other indebtedness in excess of certain amounts, and (v) a breach of representations, warranties or covenants in the documents entered into in connection with the financing. Upon a Triggering Event or failure to redeem the Series D Preferred Stock, the accretion rate on the Series D Preferred Stock will increase to 16.5% per annum. The Company may also be required to pay penalties upon a failure to timely deliver shares of Common Stock upon conversion of Series D Preferred Stock.
   
 
The Series D Preferred Stock votes together with the Common Stock on an as-converted basis, and the vote of a majority of the shares of the Series D Preferred Stock is required to approve, among other things, (i) any issuance of capital stock senior to or pari passu with the Series D Preferred Stock; (ii) any increase in the number of authorized shares of Series D Preferred Stock; (iii) any dividends or payments on equity securities; (iv) any amendment to the Company’s Certificate of Incorporation, By-laws or other governing documents that would result in an adverse change to the rights, preferences, or privileges of the Series D Preferred Stock; (v) any material deviation from the annual budget approved by the Board of Directors; and (vi) entering into any material contract not contemplated by the annual budget approved by the Board of Directors.
   
 
So long as at least 25% of the shares of Series D Preferred Stock issued at closing are outstanding, the holders of the Series D Preferred Stock as a class will have the right to designate two members of the Company’s Board of Directors, and so long as at least 15% but less than 25% of the shares of Series D Preferred Stock issued at the closing are outstanding, the holders of the Series D Preferred Stock will have the right to designate one member of the Board of Directors. Additionally, the holders of Series D Preferred Stock have the right to designate two non-voting observers to our Board of Directors.
   
 
The Warrants to purchase 2,456,272 shares of Common Stock issued in the financing have an exercise price of $0.001 per share, subject to adjustment solely for recapitalizations. The Warrants may also be exercised on a cashless basis under a formula that explicitly limits the number of issuable common shares. The exercise period for the Warrants commences 180 days following December 15, 2009 and ends December 15, 2015.
   
 
At the request of the holders of a majority of the shares of Common Stock issuable upon conversion of the Series D Preferred Stock and exercise of the Warrants, if ever, the Company will be required to file a registration statement with the SEC to register the resale of such shares of Common Stock under the Securities Act of 1933, as amended.
   
 
Upon closing of the financing, UCC became entitled to a closing fee of $325,000, half of which was paid upon the closing and the balance of which was paid in six monthly installments following the closing. The Company also reimbursed UCC for its fees and expenses in the amount of $250,000. Additionally, the Company entered into a management consulting agreement with Union Capital under which Union Capital provides the Company with management advisory services and the Company pays Union Capital a fee of $125,000 per year for such services. Such fee will be reduced to $62,500 per year if the holders of the Series D Preferred Stock no longer have the right to nominate two directors and Union Capital no longer owns at least 40% of the Common Stock purchased by it at closing (assuming conversion of Series D Preferred Stock and exercise of Warrants held by it). The management consulting agreement will terminate when the holders of the Series D Preferred Stock no longer have the right to nominate any directors and Union Capital no longer owns at least 20% of the Common Stock purchased by it at closing (assuming conversion of Series Preferred D Stock and exercise of Warrants held by it).
 
 
10

 
 
 
Accounting for the December 2009 Financing:
   
 
Current accounting standards require analysis of each of the financial instruments issued in the December 2009 financing for purposes of classification and measurement in our financial statements.
   
 
The Series D Preferred Stock is a hybrid financial instrument. Due to the redemption feature and the associated participation feature that behaves similarly to a coupon on indebtedness, the Company determined that the embedded conversion feature and other features that have risks associated with debt require bifurcation and classification in liabilities as a compound embedded derivative financial instrument. The conversion feature, along with certain other features that have risks of equity, required bifurcation and classification in their compound form in liabilities as a derivative financial instrument. Derivative financial instruments are required to be measured at fair value both at inception and an ongoing basis. As more fully discussed below, the Company has used the Monte Carlo simulation technique to value the compound embedded derivative, because that model affords the flexibility to incorporate all of the assumptions that market participants would likely consider in determining the value for purposes of trading the hybrid contract. Further, due to the redemption feature, the Company is required to carry the host Series D Preferred Stock outside of stockholders’ equity and the discount resulting from the initial allocation requires accretion through charges to retained earnings, using the effective method, over the period from issuance to the redemption date.
   
 
The Company evaluated the terms and conditions of the Senior Secured Notes under the guidance of ASC 815, Derivatives and Hedging. The terms of the Notes that qualify as a derivative instrument are (i) a written put option which allows the holders of the Notes to accelerate interest and principal (effectively forcing an early redemption of the Notes) in the event of certain events of default, including a change of control of the Company, and (ii) the holders’ right to increase the interest rate on the Notes by 4% per year in the event of a suspension from trading of the Company’s Common Stock or an event of default. Pursuant to ASC 815-15-25-40, put options that can accelerate repayment of principal meet the requisite criteria of a derivative financial instrument. In addition, as addressed in ASC 815-15-25-41, for a contingently exercisable put to be considered clearly and closely related to the relevant instrument and not constitute a separate derivative financial instrument, it can be indexed only to interest or credit risk. In this instance, the put instruments embedded in the Notes are indexed to events that are not related to interest or credit risk, namely, a change of control of the Company, and suspension of trading of the Company’s Common Stock. Accordingly, these features are not considered clearly and closely related to the Note, and bifurcation is necessary.
   
 
The Company determined that the Warrants should be classified as stockholders’ equity. The principal concepts underlying accounting for warrants provide a series of conditions, related to the potential for net cash settlement, which must be met in order to achieve equity classification. Our conclusion is that the Warrants are indexed to the Company’s common stock and meet all of the conditions for equity classification. The Company measured the fair value of the Warrants on the inception date to provide a basis for allocating the net proceeds to the various financial instruments issued in the December 2009 financing. As more fully discussed below, the Company used the Black-Scholes-Merton valuation technique, because that method embodies, in its view, all of the assumptions that market participants would consider in determining the fair value of the Warrants for purposes of a sale or exchange. The allocated value of the Warrants was recorded to Additional Paid-in Capital.
   
 
The financial instruments sold to the Management Buyers, were recognized as compensation expense in the amount by which the fair value of the share-linked financial instruments (i.e. Series D Preferred Stock and Warrants) exceeded the proceeds that the Company received. The financial instruments subject to allocation are the Secured Notes, Series D Preferred Stock, Compound Embedded Derivatives (“CED”) and the Warrants. Other than the compensatory amounts, current accounting concepts generally provide that the allocation is, first, to those instruments that are required to be recorded at fair value; that is, the CED; and the remainder based upon relative fair values.
 
 
11

 
 
 
The following table provides the components of the allocation and the related fair values of the subject financial instruments:

               
Allocation
       
   
Fair Values
   
UCC
   
Management Buyers
   
Total
 
                         
Proceeds:
                       
Gross proceeds
        $ 4,265,000     $ 735,000     $ 5,000,000  
Closing costs
          (325,000 )           (325,000 )
Reimbursement of investor costs
          (250,000 )             (250,000 )
Net proceeds
        $ 3,690,000     $ 735,000     $ 4,425,000  
                               
Allocation:
                             
Series D Preferred Stock
  $ 2,670,578     $ 1,127,574     $ 233,098     $ 1,360,672  
Senior Notes
  $ 2,536,015       1,070,519       363,293       1,433,812  
Compound Embedded Derivatives (CED):
                               
Series D Preferred Stock
  $ 1,116,595       949,106       167,489       1,116,595  
Senior Notes
  $ 28,049       23,842       4,207       28,049  
Warrants
  $ 1,225,680       518,959       183,852       702,811  
Compensation Expense
                  (216,939 )     (216,939 )
            $ 3,690,000     $ 735,000     $ 4,425,000  

 
Closing costs of $325,000 were paid directly to the lead investor. The Company agreed to reimburse UCC $250,000 for out-of-pocket expenses of which $150,000 was paid upon signing of the purchase agreement in November 2009, and the remainder paid at closing. As required by current accounting standards, financing costs paid directly to an investor or creditor are reflected in the allocation as original issue discount to the financial instruments.
   
 
Fair Value Considerations:
   
 
The Company has adopted the authoritative guidance on “Fair Value Measurements.” The guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, not adjusted for transaction costs. The guidance also establishes a fair value hierarchy that prioritizes the inputs to the valuation techniques used to measure fair value into three broad levels giving the highest priority to quoted prices in active markets for identical asset or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3) as described below:

   
Level 1 Inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that are accessible by the Company.
     
   
Level 2 Inputs – Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly.
     
   
Level 3 Inputs – Unobservable inputs for the asset or liability including significant assumptions of the Company and other market participants.

 
The Company’s Senior Secured Notes, Warrant derivative liability, Put option derivative and Series D Preferred Stock are classified within Level 3 of the fair value hierarchy as they are valued using unobservable inputs including significant assumptions of the Company and other market participants.
   
 
The following tables present the Company’s instruments that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy.
 
    Fair Value Measurements as of March 31, 2011  
   
Total
   
Level 1
   
Level 2
   
Level 3
 
Instruments:
                       
Senior Notes
  $ 2,500,000     $     $     $ 2,500,000  
Warrants
    2,837,143                   2,837,143  
Put Derivative
    5,272                   5,272  
Series D Preferred Stock
    2,003,085                   2,003,085  
Total Instruments
  $ 7,345,500     $     $     $ 7,345,500  
 
    Fair Value Measurements as of June 30, 2011  
   
Total
   
Level 1
   
Level 2
   
Level 3
 
Instruments:
                       
Senior Notes
  $ 2,500,000     $     $     $ 2,500,000  
Warrants
    2,680,150                   2,680,150  
Put Derivative
    4,280                   4,280  
Series D Preferred Stock
    2,130,145                   2,130,145  
Total Instruments
  $ 7,314,575     $     $     $ 7,314,575  
 
 
12

 
 
 
The following table presents the changes in Level 3 Instruments measured at fair value on a recurring basis for the three months ended June 30, 2011 and 2010:

   
Total
   
Senior Notes
   
Warrants
   
Put Derivative
   
Series D Preferred Stock
 
                               
Balances at, March 31, 2010
  $ 3,978,080     $ 1,514,340     $ 849,211     $ 110,940     $ 1,503,589  
Fair value adjustments
    (186,230 )           (87,230 )     (99,000 )      
Discount amortization
    71,701       71,701                    
Accretion
    123,227                         123,227  
Balances at, June 30, 2010
  $ 3,986,778     $ 1,586,041     $ 761,981     $ 11,940     $ 1,626,816  
                                         
Balances at, March 31, 2011
  $ 7,345,500     $ 2,500,000     $ 2,837,143     $ 5,272     $ 2,003,085  
Fair value adjustments
    (157,985 )           (156,993 )     (992 )      
Discount amortization
                             
Accretion
    127,060                         127,060  
Balances at, June 30, 2011
  $ 7,314,575     $ 2,500,000     $ 2,680,150     $ 4,280     $ 2,130,145  

 
The fair value adjustments recorded for Warrants and Put Derivative are reported separately in the Statement of Operations, the discount amortization on Senior Notes is reported in interest expense, and accretion on Series D Preferred Stock is recorded to the accumulated deficit.

(4)
Long-Term Debt
   
 
Long-term debt consists of the following as of June 30, 2011 and March 31, 2011:

   
June 30, 2011
   
March 31, 2011
 
$2,500,000 face value, 12.5% Senior Secured Notes due December 15, 2012
  $ 2,500,000     $ 2,500,000  
      2,500,000       2,500,000  
Less current portion
    (2,500,000 )     (2,500,000 )
Long-term debt
  $     $  

 
The Company issued $2,500,000 face value of Senior Notes on December 15, 2009 in connection with the December 15, 2009 financing described in Note 3. As described in Note 3, the proceeds from the financing were allocated among multiple financial instruments based on fair values. Proceeds allocated to the Senior Notes amounted to $1,433,811. The resulting discount was subject to amortization through charges to interest expense over the term to maturity using the effective interest method. Discount amortization included in interest expense for the three months ended June 30, 2010 amounted to $71,701. The Company did not incur any amortization of the original interest discount on the Secured Notes for the three months end June 30, 2011 as they were fully amortized as of March 31, 2011.
   
 
The Senior Notes are secured by substantially all of the Company’s assets; bear interest at a rate of 12.5% per annum payable quarterly; and mature in one installment on December 15, 2012. The Company has the right to prepay the Secured Notes at any time. While the Secured Notes are outstanding, the Company is subject to customary affirmative, negative and financial covenants. The financial covenants include (i) a fixed charge coverage ratio test requiring the Company to maintain a fixed charge coverage ratio of not less then 1.40 to 1.00 at the close of each fiscal quarter, (ii) a minimum EBITDA test, tested at the end of each fiscal quarter, requiring the Company to generate “EBITDA” of at least $3,000,000 over the preceding four fiscal quarters, (iii) a minimum liquidity test requiring the Company to maintain cash and cash equivalents of $500,000 at all times, and (iv) limitations on capital expenditures. The Company was in compliance with these financial covenants as of June 30, 2011.
   
 
In May 2010, the Company entered into a First Amendment to Senior Secured Notes (the “Note Amendment”), in connection with the Company’s pledge of $500,000 as cash collateral to Sovereign Bank to secure the Company’s reimbursement obligations under a letter of credit issued on behalf of the Company in favor of American Express Related Services Company, Inc. (“Amex”). The letter of credit supports the Company’s credit line with respect to Amex credit cards issued to the Company and its employees. Pursuant to the Note Amendment, among other things, the Senior Notes were amended to (i) permit the Company to pledge the cash collateral to Sovereign Bank, and (ii) increase the interest rate thereunder by four percent to 16.5% during the period that the is cash pledged to Sovereign Bank.
 
 
13

 
 
 
As described in Note 10, the parties to the derivative lawsuit pending against the Company agreed in principle to settle the matter. The terms of the settlement are anticipated to include a commitment by the Company to redeem its Senior Secured Notes. Accordingly the Company has classified the face value of the Senior Notes as a current liability at March 31, 2011 and June 30, 2011.

(5)
Redeemable Preferred Stock
   
 
Redeemable preferred stock consists of the following as of June 30, 2011 and March 31, 2011:

   
June 30,
2011
   
March 31,
2011
 
Series D Convertible Participating Preferred Stock, par value $0.001, stated value $1.00, 2,500,000 shares designated, 2,500,000 shares issued and outstanding at June 30, 2011; redemption and liquidation value $3,038,094 at June 30, 2011
  $ 2,130,145     $ 2,003,085  

 
The Series D Preferred Stock is subject to accretion to its redemption value, through charges to equity, over the period from issuance to the contractual redemption date, discussed in the Financing Overview, above, using the effective interest method. The redemption value is determined based upon the stated redemption amount of $1.00 per share, plus an accretion amount, more fully discussed above. For the three months ended June 30, 2011 and 2010, accretion amounted to $127,060 and $123,227, respectively.

(6)
Derivative Financial Instruments
   
 
The Company’s derivative financial instruments consist of CEDs that were bifurcated from our Series D Preferred Stock and Senior Notes. The Preferred CED comprises the embedded conversion option and certain other equity-indexed features that were not clearly and closely related to the Series D Preferred Stock in terms of risks. The Senior Note CED comprises certain put features that were not clearly and closely related to the Senior Notes in terms of risks. Derivative financial instruments are carried at fair value. The following table reflects the components of the CEDs and changes in fair value, using the techniques and assumptions described in Note 3:

   
Warrant
Derivative
   
Put
Derivative
   
Total
 
Balances at April 1, 2010
  $ 849,211     $ 110,940     $ 960,151  
Fair value adjustments
    (87,230 )     (99,000 )     (186,230 )
Balances at June 30, 2010
  $ 761,981     $ 11,940     $ 773,921  
                         
Balances at April 1, 2011
  $ 2, 837,143     $ 5,272     $ 2,842,415  
Fair value adjustments
    (156,993 )     (992 )     (157,985 )
Balances at June 30, 2011
  $ 2,680,150     $ 4,280     $ 2,684,430  

 
Fair value adjustments are recorded in other income in the accompanying financial statements. As a result, the Company’s earnings are and will be affected by changes in the assumptions underlying the valuation of the derivative financial instruments. The principal assumptions that have, in the Company’s view, the most significant effects are the Company’s trading market prices, volatilities and risk-adjusted market credit rates.

(7)
Accounting for Stock-Based Compensation
   
 
(i) Stock Options
   
 
Under the Company’s 1992 Stock Option Plan (the “1992 Plan”), employees of the Company and its subsidiaries and members of the Board of Directors were granted options to purchase shares of Common Stock of the Company. The 1992 Plan was amended on May 11, 1999 to increase the maximum number of shares of Common Stock for which options may be granted to 1,500,000 shares. The 1992 Plan terminated in 2002, although options issued thereunder remain exercisable until the termination dates provided in such options. Options granted under the 1992 Plan were either intended to qualify as incentive stock options under the Internal Revenue Code of 1986, or non-qualified options. Grants under the 1992 Plan were awarded by a committee of the Board of Directors, and are exercisable over periods not exceeding ten years from date of grant. The option price for incentive stock options granted under the 1992 Plan must be at least 100% of the fair market value of the shares on the date of grant, while the price for non-qualified options granted to employees and employee directors was determined by the committee of the Board of Directors. The remaining options to purchase shares of Common Stock issued under the 1992 Plan expired in April 2011.
 
 
14

 
 
 
On July 1, 2002, the Company established the 2002 Long-Term Incentive Plan (the “2002 Plan”) providing for the grant of options or other awards, including stock grants, to employees, officers or directors of, consultants to, the Company or its subsidiaries to acquire up to an aggregate of 750,000 shares of Common Stock. In September 2005, the 2002 Plan was amended so as to increase the number of shares of Common Stock available under the plan to 1,250,000. In September 2008, the 2002 Plan was amended to increase the number of shares of Common Stock available under the plan to 1,650,000. Options granted under the 2002 Plan may either be intended to qualify as incentive stock options under the Internal Revenue Code of 1986, or may be non-qualified options. Grants under the 2002 Plan are awarded by a committee of the Board of Directors, and are exercisable over periods not exceeding ten years from date of grant. The option price for incentive stock options granted under the 2002 Plan must be at least 100% of the fair market value of the shares on the date of grant, while the price for non-qualified options granted is determined by the Compensation Committee of the Board of Directors. At June 30, 2011, there were options to purchase 297,500 shares of Common Stock, expiring from April 2011 through September 2017, issued under the 2002 Plan that remained outstanding. Any option under the 2002 Plan that is not exercised by an option holder prior to its expiration may be available for re-issuance by the Company. As of June 30, 2011, the Company had options or other awards for 145,929 shares of Common Stock available for grant under the 2002 Plan.
   
 
On March 25, 2010, the stockholders of the Company approved the ‘mktg, inc.’ 2010 Equity Incentive Plan (the “2010 Plan”), under which 3,000,000 shares of Common Stock have been set aside and reserved for issuance. The 2010 Plan provides for the granting to our employees, officers, directors, consultants and advisors of stock options (non-statutory and incentive), restricted stock awards, stock appreciation rights, restricted stock units and other performance stock awards. The 2010 Plan is administered by the Compensation Committee of the Board of Directors. The exercise price per share of a stock option, which is determined by the Compensation Committee, may not be less than 100% of the fair market value of the common stock on the date of grant. For non-qualified options the term of the option is determined by the Compensation Committee. For incentive stock options the term of the option is not more than ten years. However, if the optionee owns more than 10% of the total combined voting power of the Company, the term of the incentive stock option will be no longer than five years. The 2010 Plan automatically terminates on February 22, 2020, unless it is terminated earlier by a vote of the Company’s stockholders or the Board of Directors; provided, however, that any such action does not affect the rights of any participants of the 2010 Plan. In addition, the 2010 Plan may be amended by the stockholders of the Company or the Board of Directors, subject to stockholder approval if required by applicable law or listing requirements. At June 30, 2011, there were options to purchase 2,744,302 shares of Common Stock, expiring May 2012, issued under the 2010 Plan that remained outstanding. Any option under the 2010 Plan that is not exercised by an option holder prior to its expiration may be available for re-issuance by the Company. As of June 30, 2011, the Company had options or other awards for 5,198 shares of Common Stock available for grant under the 2010 Plan.
   
 
The maximum contractual life for any of the options is ten years. The Company uses the Black-Scholes model to estimate the value of stock options granted under FASB guidance. Because option-pricing models require the use of subjective assumptions, changes in these assumptions can materially affect the fair value of options.
   
 
A summary of option activity under all plans as of June 30, 2011, and changes during the three month period then ended is presented below:

   
Weighted average exercise price
   
Number
of
options
   
Weighted average remaining contractual term (years)
   
Aggregate intrinsic value
 
                         
Balance at March 31, 2011
  $ 0.60       3,048,677       8.55     $ 701,196  
Granted
                           
Exercised
                           
Canceled
  $ 1.55       (6,875 )                
Balance at June 30, 2011 (vested and expected to vest)
  $ 0.60       3,041,802       8.32     $ 608,360  
Exercisable at June 30, 2011
  $ 2.18       297,500       2.96     $ 0  
 
 
15

 
 
 
Total unrecognized compensation cost related to vested and expected to vest options at June 30, 2011 amounted to $518,270 and is expected to be recognized over a weighted average period of 2.92 years. Total compensation cost for all outstanding option awards amounted to $44,424 and $14,808 for the three months ended June 30, 2011 and 2010, respectively.
   
 
(ii) Warrants
   
 
At June 30, 2011 and March 31, 2011 there were warrants outstanding to purchase 2,456,272 shares of common stock at a price of $.001 per share, which were issued in the December 2009 financing and expire December 15, 2015. The aggregate intrinsic value of the warrants outstanding at June 30, 2011 and March 31, 2011 were $1,962,561 and $2,036,249, respectively.
   
 
(iii) Restricted Stock
   
 
During the three months ended June 30, 2011, the Company awarded 250,500 shares of Common Stock initially subject to forfeiture (“restricted stock”) pursuant to the authorization of the Company’s Board of Directors and certain Restricted Stock Agreements under the Company’s 2010 Plan.
   
 
As of June 30, 2011 the Company had awarded 1,437,071 shares (net of forfeited shares) of restricted stock under the Company’s 2002 and 2010 Plans, and 209,767 shares (net of forfeited shares) of restricted stock that were issued outside of the Company’s 2002 and 2010 Plans. Grant date fair value is determined by the market price of the Company’s common stock on the date of grant. The aggregate value of these shares at their respective grant dates amount to approximately $2,130,952 and are recognized ratably as compensation expense over the vesting periods. The shares of restricted stock granted pursuant to such agreements vest in various tranches over one to five years from the date of grant.
   
 
The shares awarded to employees under the restricted stock agreements vest on the applicable vesting dates only to the extent the recipient of the shares is then an employee of the Company or one of its subsidiaries, and each recipient will forfeit all of the shares that have not vested on the date his or her employment is terminated.
   
 
A summary of all non-vested stock activity as of June 30, 2011, and changes during the three month period then ended is presented below:

   
Weighted average grant date fair value
   
Number
of
shares
   
Weighted average remaining contractual term (years)
   
Aggregate intrinsic value
 
                         
Unvested at March 31, 2011
  $ 1.96       500,845       2.62     $ 415,701  
                                 
Awarded
  $ 0.71       250,500                  
Vested
  $ 2.49       (63,564 )                
Forfeited
  $ 2.50       (2,000 )                
                                 
Unvested at June 30, 2011
  $ 1.60       685,781       2.79     $ 548,625  

 
Total unrecognized compensation cost related to unvested stock awards at June 30, 2011 amounted to $726,193 and is expected to be recognized over a weighted average period of 2.79 years. Total compensation cost for the stock awards amounted to $57,657 and $72,043 for the three months ended June 30, 2011 and 2010, respectively.

(8)
Concentrations
   
 
The Company had sales to one customer that equaled 63% of total sales for the three months ended June 30, 2011. Sales to this customer approximated $19,781,000 for the period. Accounts receivable due from this customer approximated $6,102,000 at June 30, 2011. In addition, our second largest customer accounted for approximately 10% of total sales for the three months ended June 30, 2011. Sales to this customer approximated $3,159,000 for the period. Accounts receivable due from this customer approximated $1,211,000 at June 30, 2011. The Company had sales to one customer that equaled 74% of total sales for the three months ended June 30, 2010. Sales to this customer approximated $21,663,000 for the period. Accounts receivable due from this customer approximated $3,989,000 at June 30, 2010. In addition, our second largest customer accounted for approximately 16% of total sales for the three months ended June 30, 2010. Sales to this customer approximated $4,677,000 for the period. Accounts receivable due from this customer approximated $3,182,000 at June 30, 2010.
 
 
16

 
 
(9)
Income Taxes
   
 
The Company has provided for a full allowance against its net deferred tax asset, and except for alternative minimum tax, currently does not record an expense or benefit for federal, state and local income taxes, as any such expense or benefit would be fully offset by a change in the valuation allowance against the Company’s net deferred tax asset.

(10)
Derivative Complaint
   
 
On May 7, 2010, Brian Murphy, derivatively on behalf of the Company, commenced a lawsuit in the Supreme Court of the State of New York, County of New York (the “Court”), against the former Chairman of the Company’s Board of Directors, certain former directors and officers of the Company, and the Company as a nominal defendant. The Complaint filed by Mr. Murphy in the action alleges, among other things, that the defendants breached fiduciary duties owed to the Company and its stockholders by failing to ensure that the Company’s financial statements for its fiscal year ended March 31, 2008 and quarter ended June 20, 2008 were prepared correctly, and by causing the Company to enter into the December 2009 financing on terms dilutive to the Company’s stockholders.
   
 
On June 30, 2010 the defendants filed a motion to dismiss the Complaint. Thereafter, on October 27, 2010, Mr. Murphy filed an Amended Complaint with the Court, naming the investors in the Company’s December 2009 financing as additional defendants. In addition to repeating the allegations made in the original Complaint, the Amended Complaint alleges that the investors in the Company’s December 2009 financing were unjustly enriched at the Company’s expense, and seeks the rescission of the financing transaction, or in the alternative, the reformation of the terms of the financing. On December 23, 2010 the defendants filed a motion to dismiss the Amended Complaint. The Court scheduled a hearing on the motion for April 7, 2011.
   
 
Shortly before the hearing was held on the motion to dismiss, the parties (including the Company) agreed in principle to settle the matter. The terms of the settlement are anticipated to include a commitment by the Company to redeem its Senior Secured Notes. The settlement is not expected to have a material adverse impact on the finances of the Company. However, the precise terms of the settlement are under negotiation and subject to final approval by all parties, and approval by the Court. Although the Company believes that a final settlement will be reached during the 2012 fiscal year, it is not certain that the parties will ultimately agree on the specific terms described above, or that the Court (whose approval of any settlement is required) will approve the terms that the parties may agree upon. In the event the parties are unable to conclude a final settlement, for whatever reason, the litigation will resume. The ultimate outcome of any litigation is uncertain and could result in substantial damages.
   
 
The Company has obligations to provide indemnification to its officers and directors (and former officers and directors), as well as to the investors in the December 2009 financing, including for all legal costs incurred by them in defending these claims. As of June 30, 2011, the Company’s legal expenses in connection with its defense of the lawsuit and its indemnification obligations amounted to $957,000, with $126,000 of that amount incurred during the three months end June 30, 2011.
 
 
17

 

 

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that are based on beliefs of the Company’s management as well as assumptions made by and information currently available to the Company’s management. When used in this report, the words “estimate,” “project,” “believe,” “anticipate,” “intend,” “expect,” “plan,” “predict,” “may,” “should,” “will,” the negatives thereof or other variations thereon or comparable terminology are intended to identify forward-looking statements. Such statements reflect the current views of the Company with respect to future events based on currently available information and are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated in those forward-looking statements. Factors that could cause actual results to differ materially from the Company’s expectations are set forth in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2011 under “Risk Factors,” including but not limited to “Recent Losses,” “Concentration of Customers,” “Recent Economic Changes,” “Dependence on Key Personnel,” “Outstanding Indebtedness; Security Interest,”“ Series D Preferred Stock Liquidation Preference; Redemption,”“ Control by Union Capital Corporation and Holders of Series D Preferred Stock,” “Anti-Dilution Provisions of The Series D Preferred Stock Could Result In Dilution of Stockholders,” “Unpredictable Revenue Patterns,” “Competition,” “Derivative Litigation,” and “Risks Associated with Acquisitions,” in addition to other information set forth herein and elsewhere in our other public filings with the Securities and Exchange Commission. The forward-looking statements contained in this report speak only as of the date hereof. The Company does not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
 
Overview
‘mktg, inc.’, through its wholly-owned subsidiaries Inmark Services LLC, Optimum Group LLC, U.S. Concepts LLC and Digital Intelligence Group LLC, is a full-service marketing agency. We develop, manage and execute sales promotion programs at both national and local levels, utilizing both online and offline media channels. Our programs help our clients effectively promote their goods and services directly to retailers and consumers and are intended to assist them in achieving maximum impact and return on their marketing investment. Our activities reinforce brand awareness, provide incentives to retailers to order and display our clients’ products, and motivate consumers to purchase those products, and are designed to meet the needs of our clients by focusing on communities of consumers who want to engage brands as part of their lifestyles.
 
Our services include experiential and face to face marketing, event marketing, interactive marketing, ethnic marketing, and all elements of consumer and trade promotion, and are marketed directly to our clients by our sales force operating out of offices located in New York, New York; Cincinnati, Ohio; Chicago, Illinois; Los Angeles, California and San Francisco, California.
 
‘mktg, inc.’ was formed under the laws of the State of Delaware in March 1992 and is the successor to a sales promotion business originally founded in 1972. ‘mktg, inc.’ began to engage in the promotion business following a merger consummated on September 29, 1995 that resulted in Inmark becoming its wholly-owned subsidiary.
 
Our corporate headquarters are located at 75 Ninth Avenue, New York, New York 10011, and our telephone number is 212-366-3400. Our Web site is www.mktg.com. Copies of all reports we file with the Securities and Exchange Commission are available on our Web site.
 
Results of Operations
 
Overview
 
For the three months ended June 30, 2011 we generated $1,074,000 in operating income, a $384,000 increase over the $690,000 earned during the three months ended June 30, 2010. This improvement was primarily the result of a $1,172,000 increase in Operating Revenue, partially offset by a $903,000 increase in compensation expense.
 
Operating Revenue and Modified EBITDA
 
We believe Operating Revenue and Modified EBITDA are key performance indicators. We define Operating Revenue as our sales less reimbursable program costs and expenses, and outside production and other program expenses. Operating Revenue is the net amount derived from sales to customers that we believe is available to fund our compensation, general and administrative expenses, and capital expenditures. We define Modified EBITDA as income before interest, income taxes, depreciation and amortization plus other non-cash expenses. Modified EBITDA is a supplemental measure to evaluate operational performance. Operating Revenue and Modified EBITDA are Non-GAAP financial measures disclosed by management to provide additional information to investors in order to provide them with an alternative method for assessing our financial condition and operating results. These measures are not in accordance with, or a substitute for, GAAP, and may be different from or inconsistent with Non-GAAP financial measures used by other companies.
 
 
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The following table presents operating data expressed as a percentage of Operating Revenue for the three ended June 30, 2011 and 2010, respectively:

   
Three Months Ended
June 30,
   
2011
 
2010
             
Statement of Operations Data:
           
Operating revenue
  100.0 %   100.0 %
Compensation expense
  70.6 %   69.7 %
General and administrative expense
  17.9 %   21.8 %
Operating income
  11.5 %   8.5 %
Interest (expense), net
  (1.0 %)   (2.0 %)
Fair value adjustments to compound embedded derivatives
  1.7 %   2.3 %
Income before provision for income taxes
  12.2 %   8.8 %
Provision for income taxes
  0.5 %   0.0 %
Net income
  11.7 %   8.8 %

Sales. Sales consist of fees for services, commissions, reimbursable program costs and expenses and other production and program expenses. We purchase a variety of items and services on behalf of our clients for which we are reimbursed pursuant to our client contracts. The amount of reimbursable program costs and expenses, and outside production and other program expenses which are included in revenues will vary from period to period, based on the type and scope of the service being provided. Sales for the three months ended June 30, 2011 increased $2,192,000 to $31,329,000, compared to $29,137,000 for the quarter ended June 30, 2010. This 8% increase in sales is primarily attributable to a $4,202,000 increase in experiential marketing revenues, along with a $1,666,000 increase in reimbursable program cost revenue from our largest customer, Diageo North America, Inc. (“Diageo”), partially offset by a $3,548,000 decrease in other Diageo revenues.
 
Reimbursable Program Costs and Expenses. Reimbursable program costs and expenses are primarily direct labor, travel and product costs generally associated with events we execute for Diageo. Reimbursable program costs and expenses for the three months ended June 30, 2011 and 2010 were $7,147,000 and $5,481,000, respectively. This $1,666,000 increase is primarily due to an increase in the number of events we executed during the three month period ended June 30, 2011 versus the same period in Fiscal 2011.
 
Outside Production and Other Program Expenses. Outside production and other program expenses consist of the costs of purchased materials, media, services, certain direct labor charged to programs and other expenditures incurred in connection with and directly related to sales but which are not classified as reimbursable program costs and expenses. Outside production and other program expenses for the three months ended June 30, 2011 were $14,853,000 compared to $15,499,000 for the three months ended June 30, 2010. This $646,000 decrease in outside production and other program expenses is primarily attributable to a reduction in the amount of cost incurred on Diageo events executed, offset by an increase in experiential marketing programs.
 
Operating Revenue. For the three months ended June 30, 2011, Operating Revenue increased by $1,172,000 to $9,329,000, compared to $8,157,000 for the three months ended June 30, 2010. This 14% increase in Operating Revenue is primarily due to an increase in experiential marketing programs we executed. Operating Revenue as percentage of sales for the three months ended June 30, 2011 was 30%, compared to 28% for the three months ended June 30, 2010. A reconciliation of Sales to Operating Revenues for the three months ended June 30, 2011 and 2010 is set forth below.
 
   
Three Months Ended
June 30,
 
Sales
 
2011
   
%
    2010 %    
Sales – U.S. GAAP
  $ 31,329,000       100     $ 29,137,000       100  
Reimbursable program costs and outside production expenses
    22,000,000       70       20,980,000       72  
Operating Revenue – Non-GAAP
  $ 9,329,000       30     $ 8,157,000       28  
 
 
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Compensation Expense. Compensation expense, exclusive of reimbursable program costs and expenses and other program expenses, consists of the salaries, payroll taxes and benefit costs related to indirect labor, overhead personnel and certain direct labor otherwise not charged to programs. For the three months ended June 30, 2011, compensation expense increased $903,000 to $6,588,000, compared to $5,685,000 for the three months ended June 30, 2010. This 16% increase in compensation expense is primarily the result of a $612,000 increase in salary expense and a $119,000 increase in payroll taxes and benefits due to staff increases, plus a $88,000 increase in bonus expense.
 
General and Administrative Expenses. General and administrative expenses consist of office and equipment rent, depreciation and amortization, professional fees, other overhead expenses and charges for doubtful accounts. For the three months ended June 30, 2011, general and administrative expenses decreased $116,000 to $1,666,000, compared to $1,782,000 for the three months ended June 30, 2010. This 7% decrease in general and administrative expenses is primarily the result of a $55,000 decrease in legal fees, a $43,000 reduction in telecommunication expense, and a $38,000 decrease in depreciation and amortization expense, partially offset by a $31,000 increase in new business expense.
 
Modified EBITDA. As described above, we believe that Modified EBITDA is an additional key performance indicator. We use it to measure and evaluate operational performance and it is one of the metrics against which we are tested under the Secured Notes as described in the Liquidity and Capital Resources section below. The Company’s Modified EBITDA for the three months ended June 30, 2011 was $1,417,000 compared to $1,056,000 for the three months end June 30, 2010. A reconciliation of operating income to Modified EBITDA for the three months ended June 30, 2011 and 2010 is set forth below:

   
Three Months Ended
 
   
June 30,
 
   
2011
   
2010
 
             
Operating income- US GAAP
  $ 1,074,000     $ 690,000  
Depreciation and amortization
    241,000       279,000  
Share based compensation expense
    102,000       87,000  
Modified EBITDA – Non-GAAP
  $ 1,417,000     $ 1,056,000  

Interest (expense), net. Net interest expense for the three months ended June 30, 2011 amounted to ($96,000), compared to ($162,000) for the three months ended June 30, 2010. Interest expense consisted primarily of interest on the Secured Notes. Interest income consists primarily of interest on our money market and CD accounts. Interest expense included amortization of the original interest discount on the Secured Notes of ($72,000) for the three months ended June 30, 2010. We did not incur any amortization of the original interest discount on the Secured Notes for the three months end June 30, 2011 as they were fully amortized as of March 31, 2011.
 
Fair value adjustments to compound embedded derivatives. Fair value adjustments to compound embedded derivatives for the three months ended June 30, 2011 and 2010 were $158,000 and $186,000, respectively. These amounts consist entirely of a non-cash fair value adjustment to the derivative financial instruments generated from the December 2009 financing. This adjustment is primarily attributable to the fluctuation in the price of our Common Stock during the relevant periods, which under generally accepted accounting principles required us to adjust the carrying values of the Warrant derivative liability and other derivative liabilities on our balance sheets and record the amount of such adjustments under “Fair value adjustments to compound embedded derivatives” on our statements of operations. In general, an increase in the price of our Common Stock in a particular period will result in an increase in the carrying values of these derivative liabilities on our balance sheets at the end of such period and require us to record the amount of such increase as a charge under “Fair value adjustments to compound embedded derivatives” on our statements of operations for such period, and a decrease in the price of our Common Stock in a particular period will have the opposite effect. A more detailed explanation of the accounting treatment for these derivative financial instruments is provided in Note 3 to our Consolidated Financial Statements in Item 1 of this Report.
 
Income before Provision for Income Taxes. The Company’s income before provision for income taxes for the three months ended June 30, 2011 was $1,136,000 compared to income before provision for income taxes of $713,000 for the three months ended June 30, 2010.
 
Provision for Income Taxes. Except for $45,000 in alternative minimum tax for the three months ended June 30, 2011, we did not record a provision for federal, state and local income taxes for the three months ended June 30, 2011 and 2010 because any such provision would be fully offset by a change in the valuation allowance against the Company’s net deferred tax asset established as a result of our historical operating losses. We established this allowance because, in light of our losses in prior fiscal years and other factors, there is uncertainty as to whether we will be able to utilize these assets to reduce our tax expense in future periods.
 
 
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Net Income. As a result of the items discussed above, net income for the three months ended June 30, 2011 increased $378,000 to $1,091,000 compared to net income of $713,000 for the three months ended June 30, 2010. Fully diluted earnings per share increased $.02 to $.07 for the three months ended June 30, 2011, compared to $.05 for the three months ended June 30, 2010.
 
Liquidity and Capital Resources
 
We have continuously operated with negative working capital. This deficit has generally resulted from our inability to generate sufficient cash and receivables from our programs to offset our current liabilities, which consist primarily of obligations to vendors and other accounts payable, deferred revenues and bank borrowings required to be paid within 12 months from the date of determination. We are continuing our efforts to increase revenues from our programs and reduce our expenses, but to date these efforts have not been sufficiently successful to eliminate our working capital deficit. We have been able to operate during this extended period with negative working capital due primarily to advance payments made to us on a regular basis by our largest customers, and to a lesser degree, borrowings, equity infusions from private placements of our securities, and stock option and warrant exercises. For the three months ended June 30, 2011, the working capital deficit decreased by $1,113,000 (36%) from $3,099,000 to $1,986,000, primarily as a result of the net income generated during the quarter.
 
In Fiscal 2010, we experienced a reduction in deferred revenues (i.e., advance payments by clients). We were also required to repay approximately $1.6 million in advance billings to Diageo as a result of a reduction in our Diageo business, which payment was made using a portion of the proceeds from the $5 million financing described below. Furthermore, in November 2009 the method by which Diageo prepays expenses we incur in connection with the execution of their programs was changed so that we are now reimbursed on a semi-monthly basis (twice each month) instead of on a monthly basis, thereby reducing the amount of each such prepayment. Specifically, we are now generally reimbursed in advance on the first and 15th day of each month for the reimbursable expenses we expect to incur during the half-month period following the date of reimbursement. Previously, Diageo generally reimbursed us in advance on the first day of each month for the reimbursable expenses we expected to incur during the entire month.
 
In light of our pressing cash needs caused by the events described above, on December 15, 2009, we consummated a $5 million financing led by an investment vehicle organized by Union Capital Corporation (“Union Capital”). In the financing, we issued $2.5 million in aggregate principal amount of Senior Secured Notes, $2.5 million in aggregate stated value of Series D Convertible Participating Preferred Stock initially convertible into 5,319,149 shares of Common Stock, and Warrants to purchase 2,456,272 shares of Common Stock. The Secured Notes are secured by substantially all of our assets; originally bore interest at a rate of 12.5% per annum payable quarterly; and mature in one installment on December 15, 2012. On May 7, 2010, in connection with our pledge of $500,000 as cash collateral to secure our reimbursement obligations under a letter of credit, the Secured Notes were amended to increase the interest rate to 16.5% during the period that the cash so pledged is not subject to the lien of the holders of the Secured Notes.
 
We have the right to prepay the Secured Notes at any time. While the Secured Notes are outstanding, we are subject to customary affirmative, negative and financial covenants. The financial covenants include (i) a fixed charge coverage ratio test requiring us to maintain a fixed charge coverage ratio of not less then 1.40 to 1.00 at the close of each fiscal quarter, (ii) a minimum EBITDA test, tested at the end of each fiscal quarter, requiring us to generate “EBITDA” of at least $3,000,000 over the preceding four quarters, (iii) a minimum liquidity test requiring us to maintain cash and cash equivalents of $500,000 at all times, and (iv) limitations on our capital expenditures. We are in compliance with these financial covenants as of June 30, 2011. The Secured Notes are not convertible into equity.
 
The shares of Series D Preferred Stock issued in the financing have a stated value of $1.00 per share, and are convertible into Common Stock at a conversion price of $0.47. The conversion price of the Preferred Stock is subject to full ratchet anti-dilution provisions for 18 months following issuance, and weighted-average anti-dilution provisions thereafter. Holders of the Series D Preferred Stock are not entitled to special dividends but will be entitled to be paid upon a liquidation, redemption or change of control, the stated value of such shares plus the greater of (a) a 14% accreting liquidation preference, compounding annually, and (b) 3% of the volume weighted average price of our Common Stock outstanding on a fully-diluted basis (excluding the shares issued upon conversion of the Series D Preferred Shares) for the 20 days preceding the event. A consolidation or merger, a sale of all or substantially all of our assets, and a sale of 50% or more of our Common Stock would be treated as a change of control for this purpose.
 
After December 15, 2015, holders of the Series D Preferred Stock can require us to redeem the Series D Preferred Stock at its stated value plus any accretion thereon. In addition, we may be required to redeem the Series D Preferred Stock earlier upon the occurrence of a “Triggering Event.” Triggering Events include (i) failure to timely deliver shares of Common Stock upon conversion of Series D Preferred Stock, (ii) failure to pay amounts due to the holders (after notice and a cure period), (iii) a bankruptcy event with respect to us or any of our subsidiaries; (iv) our default under other indebtedness in excess of certain amounts, and (v) our breach of representations, warranties or covenants in the documents entered into in connection with the Financing. Upon a Triggering Event or our failure to redeem the Series D Preferred Stock, the accretion rate on the Series D Preferred Stock will increase to 16.5% per annum. We may also be required to pay penalties upon our failure to timely deliver shares of Common Stock upon conversion of Series D Preferred Stock.
 
 
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Upon closing of the financing, Union Capital became entitled to a closing fee of $325,000, half of which was paid upon closing and the balance of which was paid in six monthly installments following the closing. We also reimbursed Union Capital for its fees and expenses in the amount of $250,000. Additionally, we entered into a management consulting agreement with Union Capital under which Union Capital provides us with management advisory services and we pay Union Capital a fee of $125,000 per year for such services. Such fee will be reduced to $62,500 per year if the holders of the Series D Preferred Stock no longer have the right to nominate two directors and Union Capital no longer owns at least 40% of the Common Stock purchased by it at closing (assuming conversion of Series D Preferred Stock and exercise of Warrants held by it). The management consulting agreement will terminate when the holders of the Series D Preferred Stock no longer have the right to nominate any directors and Union Capital no longer owns at least 20% of the Common Stock purchased by it at closing (assuming conversion of Series D Preferred Stock and exercise of Warrants held by it)
 
In light of the completion of our December 2009 financing, we believe that cash currently on hand together with cash expected to be generated from operations, will be sufficient to fund our cash and near-cash requirements both through June 30, 2012 and on a long term basis.
 
At June 30, 2011, we had cash and cash equivalents of $6,689,000, a working capital deficit of $1,986,000, and stockholders’ equity of $5,356,000. In comparison, at March 31, 2011, we had cash and cash equivalents of $7,977,000, a working capital deficit of $3,099,000, and stockholders’ equity of $4,290,000. The $1,288,000 decrease in cash and cash equivalents during the three months ended June 30, 2011 was primarily due to $1,204,000 in cash used in operating activities.
 
Operating Activities. Net cash used in operating activities for the three months ended June 30, 2011 was $1,204,000, primarily attributable to $2,418,000 of cash used by the changes in operating assets and liabilities as the result of an increase in accounts receivables, prepaid expenses, and a decrease in accounts payable, accrued compensation, accrued job costs, other accrued liabilities, income taxes payable and deferred revenue account balances, offset by an decrease in unbilled contracts in progress and deferred contract costs, and additionally offset by net income of $1,091,000.
 
Investing Activities. For the three months ended June 30, 2011, net cash used in investing activities was the result of $83,000 in property and equipment purchases.
 
Financing Activities. There were no cash flows from financing activities during the three months ended June 30, 2011.
 
Critical Accounting Policies
 
The preparation of consolidated financial statements in accordance with accounting principles generally accepted in the United States of America requires management to use judgment in making estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Certain of the estimates and assumptions required to be made relate to matters that are inherently uncertain as they pertain to future events. While management believes that the estimates and assumptions used were the most appropriate, actual results may vary from these estimates under different assumptions and conditions.
 
Please refer to our 2011 Annual Report on Form 10-K for a discussion of the Company’s critical accounting policies relating to revenue recognition, goodwill (expanded below) and other intangible assets and accounting for income taxes. During the three months ended June 30, 2011, there were no material changes to these policies.
 
 
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Goodwill and Other Intangible Assets
 
Our goodwill consists of the cost in excess of the fair market value of the acquired net assets of our subsidiary companies, Inmark, Optimum, U.S. Concepts and Digital Intelligence as well as our mktgpartners business. These companies and businesses have been integrated into a structure which does not provide the basis for separate reporting units. Consequently, we are a single reporting unit for goodwill impairment testing purposes. We also have intangible assets consisting of a customer relationship acquired from mktgpartners, and an Internet domain name and related intellectual property rights. At June 30, 2011 and March 31, 2011, our balance sheet reflected goodwill and intangible assets as set forth below:
 
   
June 30,
2011
   
March 31,
2011
 
Amortizable:
           
Customer relationship
  $ 643,365     $ 723,786  
 
               
Non-Amortizable:
               
Goodwill
  $ 10,052,232     $ 10,052,232  
Internet domain name
    200,000       200,000  
    $ 10,252,232     $ 10,252,232  
Total
  $ 10,895,597     $ 10,976,018  
 
Goodwill and the internet domain name are deemed to have indefinite lives and are subject to annual impairment tests. Goodwill impairment tests require the comparison of the fair value and carrying value of the reporting unit. We assess the potential impairment of goodwill and intangible assets annually and on an interim basis whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Upon completion of such review, if impairment is found to have occurred, a corresponding charge will be recorded. The value assigned to the customer relationship is being amortized over a five year period.
 
As of March 31, 2011, we used a combination of three generally accepted methods for estimating fair value of the reporting unit; the income approach, market approach and market capitalization to determine the overall fair value. Based on such analysis, we concluded that our goodwill was not impaired as of March 31, 2011. Goodwill and the intangible asset will continue to be tested annually at the end of each fiscal year to determine whether they have been impaired. Upon completion of each annual review, there can be no assurance that a material charge will not be recorded. Impairment testing is required more often than annually if an event or circumstance indicates that an impairment or decline in value may have occurred. There were no events or changes in circumstances during the three months ended June 30, 2011 that indicated that the carrying value of goodwill and the intangible asset may not be recoverable. Management has also determined that there was no impairment of the amortizable intangible asset.
 
 
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Controls and Procedures

Evaluation of Disclosure Controls and Procedures
 
Our management has evaluated, with the participation of our Chief Executive Officer and Principal Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of June 30, 2011. Based on that evaluation, our Chief Executive Officer and Principal Financial Officer have concluded that our disclosure controls and procedures were effective as of June 30, 2011.
 
Changes in Internal Controls over Financial Reporting
 
There were no changes in our internal control over financial reporting during the fiscal quarter ended June 30, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
.


On May 7, 2010, Brian Murphy, derivatively on behalf of the Company, commenced a lawsuit in the Supreme Court of the State of New York, County of New York (the “Court”), against the former Chairman of the Company’s Board of Directors, certain former directors and officers of the Company, and the Company as a nominal defendant. The Complaint filed by Mr. Murphy in the action alleges, among other things, that the defendants breached fiduciary duties owed to the Company and its stockholders by failing to ensure that the Company’s financial statements for its fiscal year ended March 31, 2008 and quarter ended June 20, 2008 were prepared correctly, and by causing the Company to enter into the December 2009 financing on terms dilutive to the Company’s stockholders.
 
On June 30, 2010 the defendants filed a motion to dismiss the Complaint. Thereafter, on October 27, 2010, Mr. Murphy filed an Amended Complaint with the Court, naming the investors in the Company’s December 2009 financing as additional defendants. In addition to repeating the allegations made in the original Complaint, the Amended Complaint alleges that the investors in the Company’s December 2009 financing were unjustly enriched at the Company’s expense, and seeks the rescission of the financing transaction, or in the alternative, the reformation of the terms of the financing. On December 23, 2010 the defendants filed a motion to dismiss the Complaint. The Court scheduled a hearing on the motion for April 7, 2011.
 
Shortly before the hearing was held on the motion to dismiss, the parties (including the Company) agreed in principle to settle the matter. The terms of the settlement are anticipated to include a commitment by the Company to redeem its Senior Secured Notes and pay plaintiff’s legal fees. The settlement is not expected to have a material adverse impact on our finances. However, the precise terms of the settlement are under negotiation and subject to final approval by all parties, and approval by the Court. Although the Company believes that a final settlement will be reached during the 2012 fiscal year, it is not certain that the parties will ultimately agree on the specific terms described above, or that the Court (whose approval of any settlement is required) will approve the terms that the parties may agree upon. In the event the parties are unable to conclude a final settlement, for whatever reason, the litigation will resume. The ultimate outcome of any litigation is uncertain and could result in substantial damages.
 
The Company has obligations to provide indemnification to its officers and directors (and former officers and directors), as well as to the investors in the December 2009 financing, including for all legal costs incurred by them in defending these claims. As of June 30, 2011, the Company’s legal expenses in connection with its defense of the lawsuit and its indemnification obligations amounted to $957,000, with $126,000 of that amount incurred during the three months end June 30, 2011.

Item 6.

 
31.1
Certification of principal executive officer pursuant to Rule 13a-14(a) of the Exchange Act.
     
 
31.2
Certification of principal financial officer pursuant to Rule 13a-14(a) of the Exchange Act.
     
 
32.1
Certification of principal executive officer pursuant to Rule 13a-14(b) of the Exchange Act.
     
 
32.2
Certification of principal financial officer pursuant to Rule 13a-14(b) of the Exchange Act.
 
 
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

    ‘mktg, inc.’
       
Dated: July 29, 2011
 
By:
/s/ Charles W. Horsey
     
Charles W. Horsey, President and Chief Executive Officer
     
(Principal Executive Officer)
       
Dated: July 29, 2011
 
By:
/s/ Paul Trager
     
Paul Trager, Chief Financial Officer
     
(Principal Financial Officer)
 
 
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