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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 December 31, 2013
   
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 x 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 January 31, 2014, 8,648,120 shares of the Registrant’s Common Stock, par value $.001 per share, were outstanding.

 
 

INDEX

 

‘mktg, inc.’

 

        Page 
PART I - FINANCIAL INFORMATION    
     
Item 1.   Condensed Consolidated Financial Statements (Unaudited)    
         
    Balance Sheets (Unaudited) – December 31, 2013 and March 31, 2013   3
    Statements of Operations (Unaudited) – Three and Nine Months ended December 31, 2013 and 2012   4
    Statements of Comprehensive Income (Unaudited) – Three and Nine Months ended December 31, 2013 and 2012   5
    Statements of Cash Flows (Unaudited) – Nine Months ended December 31, 2013 and 2012   6
         
    Notes to Unaudited Condensed Consolidated Financial Statements   7
         
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations   20
         
Item 4.   Controls and Procedures   26
         
PART II - OTHER INFORMATION    
     
Item 6.   Exhibits   27
         
SIGNATURES   28
2
 


PART I - FINANCIAL INFORMATION

Item 1.Interim Condensed Consolidated Financial Statements.

‘mktg, inc.’

Condensed Consolidated Balance Sheets

December 31, 2013 and March 31, 2013

(Unaudited)

   December 31, 2013   March 31, 2013 
Assets        
Current assets:        
Cash and cash equivalents  $7,195,351   $11,239,835 
Accounts receivable, net of allowance for doubtful accounts of $297,000 at December 31, 2013 and March 31, 2013   15,102,025    10,228,377 
Unbilled contracts in progress   1,279,863    2,397,873 
Deferred contract costs   838,914    1,023,460 
Prepaid expenses and other current assets   451,392    253,999 
Deferred tax asset   531,138    774,138 
Total current assets   25,398,683    25,917,682 
           
Property and equipment, net   1,769,103    1,486,686 
           
Deferred tax asset   2,422,500    2,412,500 
Goodwill   10,052,232    10,052,232 
Intangible assets - net   200,000    280,422 
Long-term investments   184,557     
Other assets   484,209    457,448 
Total assets  $40,511,284   $40,606,970 
           
Liabilities and Stockholders’ Equity          
Current liabilities:          
Accounts payable  $920,616   $1,591,807 
Accrued compensation   594,710    1,676,675 
Accrued job costs   361,937    736,669 
Other accrued liabilities   2,653,829    2,773,637 
Income taxes payable       31,686 
Deferred revenue   12,442,403    11,900,222 
Total current liabilities   16,973,495    18,710,696 
           
Deferred rent   637,872    925,788 
Compound embedded derivative   3,702,128    4,664,894 
Deferred tax liability   3,429,866    2,995,866 
Total liabilities   24,743,361    27,297,244 
           
Commitments and contingencies          
           
Redeemable Series D Convertible Participating Preferred Stock, $4,077,461 redemption and liquidation value, par value $.001, stated value $1.00: 2,500,000 shares designated, issued and outstanding at December 31, 2013 and March 31, 2013   3,627,671    3,132,882 
           
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; 9,104,752 shares issued and 8,654,974 outstanding at December 31, 2013 and 9,066,752 shares issued and 8,641,448 shares outstanding at March 31, 2013   9,105    9,067 
Additional paid-in capital   15,538,423    15,250,715 
Accumulated deficit   (2,896,526)   (4,509,462)
Cumulative translation adjustment   22,488    (71,770)
Treasury stock, at cost, 449,778 shares at December 31, 2013 and 425,304 shares at March 31, 2013   (533,238)   (501,706)
Total stockholders’ equity   12,140,252    10,176,844 
Total liabilities and stockholders’ equity  $40,511,284   $40,606,970 
           

See notes to unaudited condensed consolidated financial statements.

3
 

‘mktg, inc.’

Condensed Consolidated Statements of Operations

Three and Nine Months Ended December 31, 2013 and 2012

(Unaudited)

 

   Three Months Ended
December 31,
   Nine Months Ended
December 31,
 
   2013   2012   2013   2012 
                 
Sales  $40,789,311   $32,453,829   $104,981,644   $100,888,715 
                     
Operating expenses:                    
Reimbursable program costs and expenses   7,145,820    5,920,169    20,634,923    17,945,614 
Outside production and other program expenses   21,759,219    15,900,309    52,103,957    50,656,028 
Compensation expense   9,014,732    7,536,154    24,588,954    22,854,524 
General and administrative expenses   1,960,879    1,811,750    5,751,236    5,470,284 
Total operating expenses   39,880,650    31,168,382    103,079,070    96,926,450 
                     
Operating income   908,661    1,285,447    1,902,574    3,962,265 
                     
Interest income (expense), net   (145)   (188)   385    328 
Fair value adjustments to a compound embedded derivative   (90,426)   755,319    962,766    (53,192)
                     
Income before provision for income taxes   818,090    2,040,578    2,865,725    3,909,401 
                     
Provision for income taxes   362,000    504,000    758,000    1,543,000 
                     
Net income  $456,090   $1,536,578   $2,107,725   $2,366,401 
                     
Basic earnings per share  $.05   $.19   $.25   $.29 
Diluted earnings per share  $.03   $.09   $.12   $.15 
                     
Weighted average number of common shares outstanding:                    
Basic   8,319,929    8,298,871    8,277,407    8,260,056 
Diluted   17,270,952    16,275,351    17,265,845    16,121,665 

 

See notes to unaudited condensed consolidated financial statements.

4
 

‘mktg, inc.’

Condensed Consolidated Statements of Comprehensive Income

Three and Nine Months Ended December 31, 2013 and 2012

(Unaudited)

 

   Three Months Ended
December 31,
   Nine Months Ended
December 31,
 
   2013   2012   2013   2012 
                 
Net income  $456,090   $1,536,578   $2,107,725   $2,366,401 
                     
Other comprehensive gain, net of tax:                    
Foreign currency translation gains   17,769    646    56,555    12,023 
                     
Comprehensive income  $473,859   $1,537,224   $2,164,280   $2,378,424 

 

See notes to unaudited condensed consolidated financial statements.

5
 

‘mktg, inc.’

Condensed Consolidated Statements of Cash Flows

Nine Months Ended December 31, 2013 and 2012

(Unaudited)

 

   2013   2012 
         
Cash flows from operating activities:        
         
Net income  $2,107,725   $2,366,401 
Adjustments to reconcile net income to net cash (used in) provided by operating activities:          
Depreciation and amortization   592,731    730,526 
Deferred rent amortization   (287,916)   (225,990)
Fair value adjustments to compound embedded derivative   (962,766)   53,192 
Share based compensation expense   287,746    336,584 
Deferred income taxes   667,000    1,361,000 
Changes in operating assets and liabilities:          
Accounts receivable   (4,873,648)   2,107,653 
Unbilled contracts in progress   1,118,010    1,101,151 
Deferred contract costs   184,546    125,168 
Prepaid expenses and other current assets   (197,393)   9,050 
Other assets   (26,761)   (17,257)
Accounts payable   (671,191)   (1,025,441)
Accrued compensation   (1,081,965)   (451,298)
Accrued job costs   (374,732)   66,110 
Other accrued liabilities   (119,808)   (331,477)
Income taxes payable   (31,686)   7,359 
Deferred revenue   542,181    (1,747,994)
           
Net cash (used in) provided by operating activities   (3,127,927)   4,464,737 
           
Cash flows from investing activities:          
Release of restricted cash       500,000 
Purchases of property and equipment   (794,726)   (302,382)
Investments   (184,557)    
Net cash (used in) provided by investing activities   (979,283)   197,618 
           
Cash flows from financing activities:          
Purchase of treasury stock   (31,532)   (22,087)
Net cash used in financing activities   (31,532)   (22,087)
           
Effect of exchange rate changes on cash and cash equivalents   94,258    20,038 
           
Net (decrease) increase in cash and cash equivalents   (4,044,484)   4,660,306 
           
Cash and cash equivalents at beginning of period   11,239,835    6,660,695 
Cash and cash equivalents at end of period  $7,195,351   $11,321,001 
         
Supplemental disclosures of cash flow information:        
Interest paid during the period  $778   $444 
Income taxes paid during the period  $220,026   $174,642 

 

See notes to unaudited condensed consolidated financial statements.

6
 

‘mktg, inc.’

Notes to the Unaudited Condensed Consolidated Financial Statements

 

(1)Basis of Presentation

 

The condensed consolidated financial statements of ‘mktg, inc.’ (the “Company”) 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, 2013.

 

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 and nine months ended December 31, 2013 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 Inmark Services LLC, Optimum Group LLC, U.S. Concepts LLC, Digital Intelligence Group LLC, mktg retail LLC and Mktg, inc. UK Ltd. 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. Significant estimates include the allowance for doubtful accounts, valuation of stock options and equity transactions, and revenue recognition. Management bases its estimates on certain assumptions, which it believes are reasonable in the circumstances. Actual results could differ from those estimates.

 

(c)Internal-Use Software Development

 

Included in property and equipment are costs incurred to develop software for internal use that are capitalized and amortized over the estimated useful life of the software. Costs related to training and maintenance of internal-use software development are expensed as incurred. For the three and nine months ended December 31, 2013 the Company capitalized $296,310 and $525,260, respectively, of costs associated with internal-use software development. The Company did not incur any amortization expense related to capitalized software development costs during the three and nine months ended December 31, 2013 and 2012.

 

(d)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 Company to first assess qualitative factors to determine whether it is necessary to perform a two-step quantitative goodwill impairment test. The Company is not required to calculate the fair value of a reporting unit unless it determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. 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 that a two-step quantitative goodwill impairment test was not necessary. There were no events or changes in circumstances during the nine months ended December 31, 2013 that indicated to management that the carrying value of goodwill may not be recoverable.

7
 
(e)Long-term Investments

 

Companies in which the Company has made an investment (referred to as “investee companies”) which are not accounted for under the consolidation or the equity method of accounting are accounted for under the cost method of accounting. Under this method, the Company’s share of the earnings or losses of the investee company is not included in the Consolidated Balance Sheet or Statement of Operations. However, impairment charges, if deemed necessary, are recognized in the Consolidated Statement of Operations. If circumstances suggest that the value of the investee company has subsequently recovered, such recovery is not recorded. See Note 3 for additional information.

 

(f)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 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 Series D Preferred Stock as of December 31, 2013:

 

   Carrying Values          Fair Values 
Series D Preferred Stock (See Notes 4 and 6)  $3,627,671   $7,800,866 

 

The fair value of the Company’s Series D Preferred Stock has 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 6 and 7 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 6 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, and Warrants issued in December 2009 as described in Note 7, and ASC 718 Stock Compensation to the Company’s share based payment arrangements.

8
 

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.

 

(g)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.

The Company follows the guidance on “Reporting Revenue Gross as a Principal versus Net as an Agent” and “Income Statement Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred” issued by the FASB. Indicators identified by the Company for gross revenue reporting include the fact that the Company is the primary obligor in customer arrangements, the Company has discretion in supplier selection, and the Company has credit risk. Accordingly, the Company records its client reimbursements, including out-of-pocket expenses, as revenue on a gross basis.

 

(h)Income Taxes

 

The provision for income taxes includes federal, state and local income taxes that are currently payable. Deferred income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

(i)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 vested options, warrants, preferred stock, and restricted stock. For the three and nine months ended December 31, 2013 and 2012, stock options to purchase 70,000 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 consists of:

 

   Three Months Ended
December 31,
   Nine Months Ended
December 31,
 
   2013   2012   2013   2012 
Basic   8,319,929    8,298,871    8,277,407    8,260,056 
Dilutive effect of:                    
Options   1,131,659    143,730    1,164,079    45,320 
Restricted stock   46,145    59,638    51,039    43,349 
Warrants   2,454,070    2,453,963    2,454,171    2,453,791 
Series D preferred stock   5,319,149    5,319,149    5,319,149    5,319,149 
Diluted   17,270,952    16,275,351    17,265,845    16,121,665 
9
 
(j)Recent Accounting Standards Affecting the Company

 

Testing Indefinite-Lived Intangible Assets for Impairment

In July 2012, the FASB issued ASU 2012-02, “Testing Indefinite-Lived Intangible Assets for Impairment.” Similar to ASU 2011-08, “Intangibles - Goodwill and Other (Topic 250) - Testing Goodwill for Impairment”, ASU 2012-02 addresses the growing cost and complexity of performing an analysis to evaluate indefinite-lived intangible assets (other than goodwill) for impairment. This ASU introduces qualitative factors which would simplify the analysis if facts and circumstances make it more-likely-than-not that impairment would not exist. Rather than requiring a purely quantitative impairment test, the ASU provides entities with the option to first examine qualitative factors to make this determination. Factors to be considered would include, but are not limited to:

Increases in interest rates, salaries, or other operating expenses, which would have a negative impact on future earnings or cash flows;
Recent financial performance and cash flow trends;
Aspects of the legal and regulatory environment which are expected to impact future cash flows, such as the Dodd-Frank Act;
Management turnover;
Economic and industry conditions.

 

Entities are required by the guidance to consider both positive and negative impacts of such factors before determining whether it is more-likely-than-not (i.e. greater than 50% probability) that the indefinite-lived intangible asset is impaired. It should be noted that the qualitative portion of the analysis is optional for all issuers.

This ASU is effective for impairment tests performed during fiscal years beginning after September 15, 2012, and may be early adopted if the entity’s financial statements for the most recent fiscal or interim period have not yet been issued. The adoption of this ASU did not have a material impact on the Company’s operating results, financial position or cash flows.

 

Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities

In January 2013, the FASB has issued ASU No. 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. ASU 2013-01 clarifies that ordinary trade receivables and receivables are not in the scope of ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. Specifically, ASU 2011-11 applies only to derivatives, repurchase agreements and reverse purchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with specific criteria contained in the FASB Accounting Standards Codification™ (Codification) or subject to a master netting arrangement or similar agreement.

The FASB undertook this clarification project in response to concerns expressed by U.S. stakeholders about the standard’s broad definition of financial instruments. After the standard was finalized, companies realized that many contracts have standard commercial provisions that would equate to a master netting arrangement, significantly increasing the cost of compliance at minimal value to financial statement users.

An entity is required to apply the amendments in ASU 2013-01 for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the required disclosures retrospectively for all comparative periods presented. The effective date is the same as the effective date of ASU 2011-11. The adoption of this ASU did not have a material impact on the Company’s operating results, financial position, or cash flows.

10
 

Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income

In February 2013, the FASB has issued Accounting Standards Update (ASU) No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, to improve the transparency of reporting these reclassifications. Other comprehensive income includes gains and losses that are initially excluded from net income for an accounting period. Those gains and losses are later reclassified out of accumulated other comprehensive income into net income. The amendments in this ASU do not change the current requirements for reporting net income or other comprehensive income in financial statements. All of the information that this ASU requires already is required to be disclosed elsewhere in the financial statements under U.S. GAAP. The new amendments will require an organization to:

 

Present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income - but only if the item reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period.
Cross-reference to other disclosures currently required under U.S. GAAP for other reclassification items (that are not required under U.S. GAAP) to be reclassified directly to net income in their entirety in the same reporting period. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is initially transferred to a balance sheet account (e.g., inventory for pension-related amounts) instead of directly to income or expense.

The amendments apply to all public and private companies that report items of other comprehensive income. Public companies are required to comply with these amendments for all reporting periods (interim and annual).

The amendments are effective for reporting periods beginning after December 15, 2012. The adoption of this ASU did not have a material impact on the Company’s operating results, financial position, or cash flows. 

Income Taxes: Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists

In July, 2013, the FASB issued ASU No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force). U.S. GAAP does not include explicit guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The amendments in this ASU state that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets.

This ASU applies to all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2014. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. 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)Long-Term Investment

 

On April 10, 2013, the Company entered into a stock purchase agreement with Moving Off Campus, doing business as Bonfyre (“Bonfyre”) to purchase a 2.0% interest in Bonfyre for $150,000. The investment in Bonfyre is accounted for using the cost method of accounting because the Company does not have the ability to exercise significant influence over Bonfyre. Accordingly, the investment is adjusted only for other-than-temporary declines in fair value, certain distributions and additional investments. Since the date of the initial investment the Company has provided $34,557 worth of services that in accordance with the stock purchase agreement constitutes additional investments. The carrying amount of the investment in Bonfyre at December 31, 2013 was $184,557, representing a 2.4% interest in Bonfyre. Management determined that there was no impairment of value at December 31, 2013.

11
 
(4)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 Senior Secured Notes (the “Secured Notes”) which were repaid in full in November 2011, $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.

 

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 weighted-average anti-dilution provisions. 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 the Company’s 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 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.

12
 

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 currently pays Union Capital a fee of $62,500 per year. 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).

 

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. 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 Secured Notes under the guidance of ASC 815, Derivatives and Hedging. The terms of the Notes that qualified as a derivative instrument were (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 were indexed to events that were 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 were not considered clearly and closely related to the Note, and bifurcation was 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. 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 were the Secured Notes, Series D Preferred Stock, Compound Embedded Derivatives 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 Compound Embedded Derivatives; and the remainder based upon relative fair values.

13
 

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 
Secured Notes  $2,536,015    1,070,519    363,293    1,433,812 
Compound Embedded Derivatives:                    
Series D Preferred Stock  $1,116,595    949,106    167,489    1,116,595 
Secured 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. 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 Secured Notes, Compound Embedded 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. In November, 2011, in conjunction with the Company obtaining a bank credit facility (see Note 5), the Company repaid in full the remaining $2 million of principal then outstanding under the Secured Notes.

 

There were no transfers between Level 1 and Level 2, or transfers in and out of Level 3 during the nine months ended December 31, 2013 and 2012.

The Company’s 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 on 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.

14
 

Significant assumptions embodied in these methods are as follows:

 

      Market or Calculated Inputs
Assumption:  Level  December 31,
2013
  March 31,
2013
Common stock trading market price  1  $1.17  $1.35
Common stock trading volatility:         
Preferred Compound Embedded Derivative  1  36.29%—40.82%  55.98%—88.87%
Preferred Compound Embedded Derivative (effective volatility)  3  37.08%  67.38%
Warrant  1   
Credit-risk adjusted yields:          
Periods ranging from one to three years  2  6.13%—7.31%  6.64%—7.40%
Effective risk-adjusted yield  3  6.34%  6.96%
Terms (years):         
Preferred Compound Embedded Derivative (effective term)  3  .889  1.10

 

Effective assumption amounts represent the effective averages arising from multiple input ranges utilized in the Monte Carlo Simulation Technique. The level designations represent the fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value.

Except for those assets and liabilities which are required by authoritative guidance to be recorded at fair value on the Company’s balance sheet, the Company has elected not to record any other assets and liabilities at fair value.

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, 2013 
   Total   Level 1   Level 2   Level 3 
Instruments:                    
Compound Embedded Derivative  $4,664,894   $   $   $4,664,894 
                     
Total Instruments  $4,664,894   $   $   $4,664,894 

 

   Fair Value Measurements as of December 31, 2013 
   Total   Level 1   Level 2   Level 3 
Instruments:                    
Compound Embedded Derivative  $3,702,128   $   $   $3,702,128 
                     
Total Instruments  $3,702,128   $   $   $3,702,128 

 

The following table presents the changes in Level 3 Instruments measured at fair value on a recurring basis for the three months ended December 31, 2013 and 2012:

 

   Compound
Embedded
Derivative
 
     
Balances at, September 30, 2012  $   3,813,830 
Fair value adjustments   (755,319)
Balances at, December 31, 2012  $3,058,511 
      
Balances at, September 30, 2013  $3,611,702 
Fair value adjustments   90,426 
Balances at, December 31, 2013  $3,702,128 
15
 

The following table presents the changes in Level 3 Instruments measured at fair value on a recurring basis for the nine months ended December 31, 2013 and 2012:

 

   Compound
Embedded
Derivative
 
     
Balances at, March 31, 2012  $   3,005,319 
Fair value adjustments   53,192 
Balances at, December 31, 2012  $3,058,511 
      
Balances at, March 31, 2013  $4,664,894 
Fair value adjustments   (962,766)
Balances at, December 31, 2013  $3,702,128 

 

The fair value adjustments recorded for the Compound Embedded Derivative are reported separately in the Statement of Operations.

 

(5)Bank Credit Facility

 

On November 23, 2011, the Company entered into a Loan and Security Agreement with TD Bank, N.A. (the “Bank”), pursuant to which it was provided with a $4.0 million revolving credit facility (the “Credit Facility”). Borrowings under the Credit Facility are secured by substantially all of Company’s assets and have been guaranteed by the Company’s subsidiaries.

 

Pursuant to the Loan Agreement (as amended), among other things:

 

All outstanding loans will become due on November 23, 2014, provided that following the Company’s request, the Bank may in its sole discretion agree to one year extensions of the maturity date;
   
Interest accrues on outstanding loans at a per annum rate equal to the greater of (i) 4.0%, and (ii) the Bank’s prime rate as from time to time in effect plus one percent;
   
Aggregate loans outstanding at any time are limited to a borrowing base equal to 80% of the Company’s eligible accounts receivable, as determined by the Bank, provided that the advance rate is limited to 50% with respect to accounts receivable from customers of the Company whose receivables constitute more than 50% of the Company’s receivables in the aggregate; and
   
The Company is required to comply with a number of affirmative, negative and financial covenants. Among other things, these covenants restrict the Company’s ability to pay dividends, provide that the Company’s debt service coverage ratio (as determined pursuant to the Loan Agreement) cannot be less than 1.25 to 1.0 as of the end of any fiscal year, and require that the Company have immediately available cash at all times, including borrowings under the Credit Facility, of at least $3 million.

 

If the Company does not comply with the financial and other covenants and requirements of the Loan Agreement, the Bank may, subject to various cure rights, require the immediate payment of all amounts outstanding under the Loan Agreement.

 

Upon the closing of the Credit Facility, the Company paid a $30,000 commitment fee to the Bank plus its legal costs and expenses.

 

On December 11, 2012, the Company entered into an amendment to the Loan Agreement, effective as of November 23, 2012, pursuant to which (i) the maturity date under the Loan Agreement was extended for one year to November 23, 2013, and (ii) the Company’s obligation to maintain $500,000 in a blocked account with the Bank to secure the Company’s obligations under the Loan Agreement was terminated. Accordingly, in connection with the amendment, such blocked account was released to the Company. On November 14, 2013, the Loan Agreement was extended for one year to November 23, 2014.

 

At December 31, 2013, the Company had no borrowings outstanding under the Credit Facility and availability of $4,000,000.

16
 

In connection with the Loan Agreement, the holders of the Company’s Series D Preferred Stock entered into a Standstill Agreement with the Bank under which such stockholders have agreed not to exercise any rights they may have to cause the Company to redeem their shares of Series D Preferred Stock prior to December 15, 2015 (or such earlier date as the Credit Facility is terminated), other than upon a change of control or liquidation event of the Company.

 

(6)Redeemable Preferred Stock

 

Redeemable preferred stock consists of the following as of December 31, 2013 and March 31, 2013:

 

   December 31,
2013
   March 31,
2013
 
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 December 31, 2013 and March 31, 2013; redemption and liquidation value $4,077,461 at December 31, 2013  $3,627,671   $3,132,882 

 

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 and nine months ended December 31, 2013, accretion, which is recorded to the accumulated deficit, amounted to $206,515 and $494,789, respectively, and for the three and nine months ended December 31, 2012, accretion amounted to $145,753 and $422,075, respectively. 

 

(7)Derivative Financial Instruments

 

The Company’s derivative financial instrument consists of a Compound Embedded Derivative that was bifurcated from our Series D Preferred Stock. The Preferred Compound Embedded Derivative 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 following table reflects the changes in fair value of the Preferred Compound Embedded Derivative using the techniques and assumptions described in Note 4:

 

   Compound
Embedded Derivative
   Total 
Balances at April 1, 2012  $3,005,319        $   3,005,319 
Fair value adjustments   53,192    53,192 
Balances at December 31, 2012  $3,058,511   $3,058,511 
           
Balances at April 1, 2013  $4,664,894   $4,664,894 
Fair value adjustments   (962,766)   (962,766)
Balances at December 31, 2013  $3,702,128   $3,702,128 

 

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.

 

(8)Accounting for Stock-Based Compensation

(i) Stock Options

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 December 31, 2013, there were options to purchase 70,000 shares of Common Stock, expiring from April 2015 through September 2017, issued under the 2002 Plan that remained outstanding. The 2002 Plan terminated on September 30, 2012.

17
 

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 December 31, 2013, there were options to purchase 2,455,428 shares of Common Stock, expiring May 2020, 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 December 31, 2013, the Company had options or other awards for 6,135 shares of Common Stock available for grant under the 2010 Plan.

On November 6, 2013, the Company entered into an Amended and Restated Employment Agreement (the “Employment Agreement”) with Charles Horsey, the Company’s Chairman of the Board, President and Chief Executive Officer. Pursuant to the Employment Agreement Mr. Horsey was awarded a stock option to purchase 200,000 shares of the Company’s common stock at an exercise price of $2.00 per share that vests in equal installments over a five-year period. In addition, Mr. Horsey was awarded a stock option to purchase 400,000 shares of common stock at an exercise price of $2.00 per share. This option vests only upon a Liquidity Event (as defined in the Employment Agreement) as follows: as to (i) 100,000 shares of common stock if the Liquidity Event results in consideration paid to the Company’s stockholders of at least $2.50 per share of common stock but less than $2.80 per share of common stock, (ii) 200,000 shares of common stock if such Liquidity Event results in consideration paid to the Company’s stockholders of at least $2.80 per share of common stock but less than $3.10 per share of common stock, (iii) 300,000 shares of common stock if such Liquidity Event results in consideration paid to the Company’s stockholders of at least $3.10 per share of common stock but less than $6.00 per share of common stock, and (iv) all 400,000 shares of common stock if such Liquidity Event results in consideration paid to the Company’s stockholders of $6.00 per share or more. These options had an estimated grant date value of $.65 per share and expire on October 31, 2023.

 

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 December 31, 2013, and changes during the nine 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, 2013  $0.49    2,525,428    7.05   $2,171,868 
Granted  $2.00    600,000           
Exercised                  
Canceled                  
Balance at December 31, 2013 (vested and expected to vest)  $0.78    3,125,428    6.92   $1,218,917 
Exercisable at December 31, 2013  $0.50    1,911,572    6.27   $1,280,753 
18
 

Total unrecognized compensation cost related to vested and expected to vest options at December 31, 2013 amounted to $210,294 and is expected to be recognized over a weighted average period of 3.16 years. Total compensation cost for all outstanding option awards amounted to $44,107 and $123,601 for the three and nine months ended December 31, 2013 and $39,747 and $122,359 for the three and nine months ended December 31, 2012, respectively. The Company did not record any compensation cost related to the Liquidity Event options described above as the condition for vesting was not probable as of December 31, 2013.

 

(ii) Warrants

 

At December 31, 2013 and March 31, 2013 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 December 31, 2013 and March 31, 2013 were $2,871,382 and $3,313,511, respectively.

 

(iii) Restricted Stock

As of December 31, 2013 the Company had awarded 1,184,571 shares (net of forfeited shares) of restricted stock under the Company’s 2002 Plan, 394,000 shares (net of forfeited shares) of restricted stock under the Company’s 2010 Plan, and 189,767 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 $2,669,014 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 December 31, 2013, and changes during the nine 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, 2013  $1.36    485,616    1.70   $655,582 
                     
Awarded  $1.38    45,000           
Vested  $1.81    (193,693)          
Forfeited  $1.02    (7,000)          
                     
Unvested at December 31, 2013  $1.01    329,923    1.86   $386,010 

 

Total unrecognized compensation cost related to unvested stock awards at December 31, 2013 amounted to $195,168 and is expected to be recognized over a weighted average period of 1.86 years. Total compensation cost for the stock awards amounted to $45,637 and $166,145 for the three and nine months ended December 31, 2013, and $71,108 and $214,225 for the three and nine months ended December 31, 2012, respectively.

 

(9)Concentrations

 

The Company had sales to one customer that approximated $27,330,000 or 67% and $70,801,000 or 67% of total sales for the three and nine months ended December 31, 2013, respectively. Accounts receivable due from this customer approximated $11,064,000 at December 31, 2013 and $5,802,000 at March 31, 2013. In addition, the Company had sales to a second customer that approximated $4,787,000 or 12% and $5,741,000 or 5% of total sales for the three and nine months ended December 31, 2013, respectively. Accounts receivable due from this customer approximated $601,000 at December 31, 2013 and $32,000 at March 31, 2013. For the three and nine months ended December 31, 2012 the Company had sales to one customer that approximated $19,401,000 or 60% and $61,243,000 or 61% of total sales, respectively. Accounts receivable due from this customer approximated $9,749,000 and $7,329,000 at December 31, 2012 and March 31, 2012, respectively. In addition, the Company’s second largest customer for the nine months ended December 31, 2012 accounted for approximately $3,650,000 or 11% and $14,830,000 or 15% of total sales for the three and nine months ended December 31, 2012, respectively. Accounts receivable due from this customer approximated $1,994,000 and $1,504,000 at December 31, 2012 and March 31, 2012, respectively.

19
 
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

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, 2013 under “Risk Factors,” including but not limited to “Concentration of Customers,” “Dependence on Key Personnel,” “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,” “Recent Losses,” “Recent Economic Changes,” “Lender’s Security Interest,” 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 (“Inmark”), Optimum Group LLC, U.S. Concepts LLC, Digital Intelligence Group LLC, mktg retail LLC and Mktg, inc. UK Ltd., 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, San Francisco, California and London, England.

 

‘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 December 31, 2013 we generated $909,000 in operating income, a decrease of $377,000 compared to the $1,286,000 earned during the three months ended December 31, 2012. This decline was the result of a $1,478,000 increase in compensation expense and a $149,000 increase in general and administrative expenses, partially offset by a $1,250,000 increase in Operating Revenue. Modified EBITDA fell to $1,166,000 from $1,644,000 for the three months ended December 31, 2012. For the nine months ended December 31, 2013 we generated $1,903,000 in operating income, a $2,059,000 decrease over the $3,962,000 earned during the nine months ended December 31, 2012. This decline was the result of a $1,734,000 increase in compensation expense, a $281,000 increase in general and administrative expenses, and a $44,000 decrease in Operating Revenue. In addition, Modified EBITDA decreased to $2,784,000 from $5,030,000 for the nine months ended December 31, 2012.

20
 

Our net income reflects a non-cash benefit or (charge) for the fair value adjustment to the derivative financial instruments reflected on our balance sheet in connection with our December 2009 financing. These adjustments are primarily attributable to changes in the price of our Common Stock during the period, which under generally accepted accounting principles require us to adjust the carrying values of the compound embedded derivative and other derivative liabilities on our balance sheets and record a benefit or (charge) under “Fair value adjustments to compound embedded derivative” on our statements of operations. In addition, these adjustments are treated as non-deductible or includable permanent difference items for income tax reporting purposes. A more detailed explanation of the accounting treatment for these derivative financial instruments is provided in Note 4 to our Condensed Consolidated Financial Statements in Item 1 of this Report.

The following table presents the reported operating results for the three and nine months ended December 31, 2013 and 2012:

 

   Three Months Ended December 31,   Nine Months Ended December 31, 
   2013   2012   2013   2012 
Operations Data:                    
                     
Sales  $40,789,000   $32,454,000   $104,982,000   $100,889,000 
Reimbursable program costs and expenses   7,146,000    5,920,000    20,635,000    17,946,000 
Outside production and other program expenses   21,759,000    15,900,000    52,104,000    50,656,000 
                     
Operating revenue   11,884,000    10,634,000    32,243,000    32,287,000 
                     
Compensation expense   9,014,000    7,536,000    24,589,000    22,855,000 
General and administrative expenses   1,961,000    1,812,000    5,751,000    5,470,000 
Operating income   909,000    1,286,000    1,903,000    3,962,000 
Interest income (expense), net                
Fair value adjustments to compound embedded derivative   (91,000)   755,000    963,000    (53,000)
Income before provision for income taxes   818,000    2,041,000    2,866,000    3,909,000 
                     
Provision for income taxes   362,000    504,000    758,000    1,543,000 
                     
Net income  $456,000   $1,537,000   $2,108,000   $2,366,000 
                     
Per Share Data:                    
Basic earnings per share  $0.05   $0.19   $0.25   $0.29 
Diluted earnings per share  $0.03   $0.09   $0.12   $0.15 
                     
Weighted Average Shares Outstanding:                    
Basic   8,319,929    8,298,871    8,277,407    8,260,056 
Diluted   17,270,952    16,275,351    17,265,845    16,121,665 
21
 

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.

 

The following table presents operating data expressed as a percentage of Operating Revenue for the three and nine months ended December 31, 2013 and 2012, respectively:

 

   Three Months Ended
December 31,
   Nine Months Ended
December 31,
 
   2013   2012   2013   2012 
                 
Statement of Operations Data:                    
Operating revenue   100.0%   100.0%   100.0%   100.0%
Compensation expense   75.9%   70.9%   76.3%   70.8%
General and administrative expense   16.5%   17.0%   17.8%   16.9%
Operating income   7.6%   12.1%   5.9%   12.3%
Interest income, net   0.0%   0.0%   0.0%   0.0%
Fair value adjustments to compound embedded derivative   (0.8%)   7.1%   3.0%   (0.2%) 
Income before provision for income taxes   6.8%   19.2%   8.9%   12.1%
Provision for income taxes   3.0%   4.7%   2.4%   4.8%
Net income   3.8%   14.5%   6.5%   7.3%

 

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 sales will vary from period to period, based on the type and scope of the service being provided. Sales for the three months ended December 31, 2013 increased $8,335,000 to $40,789,000, compared to $32,454,000 for the three months ended December 31, 2012. This increase in sales is attributable to a $7,929,000 increase in sales from our largest customer, Diageo North America, Inc. (“Diageo”), a $416,000 increase in experiential sales and a $227,000 increase in interactive marketing sales, offset by a $237,000 decrease in trade marketing sales. Sales for the nine months ended December 31, 2013 increased $4,093,000 to $104,982,000, compared to $100,889,000 for the nine months ended December 31, 2012. This increase in sales is attributable to a $9,558,000 increase in sales from Diageo, and a $1,192,000 increase in interactive marketing sales, offset by a $6,057,000 decrease in experiential sales and a $600,000 decrease in trade marketing sales.

 

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 December 31, 2013 increased $1,226,000 to $7,146,000, compared to $5,920,000 for the three months ended December 31, 2012. This increase primarily reflects an increase in the number of events executed during the three months ended December 31, 2013 versus the same period in the prior fiscal year. Reimbursable program costs and expenses for the nine months ended December 31, 2013 increased $2,689,000 to $20,635,000, compared to $17,946,000 for the nine months ended December 31, 2012. This increase primarily reflects an increase in the number of events executed during the nine months ended December 31, 2013 versus the same period in the prior fiscal year.

 

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 December 31, 2013 increased $5,859,000 to $21,759,000, compared to $15,900,000 for the three months ended December 31, 2012. This increase in outside production and other program expenses is primarily due to an increase in the cost of Diageo events executed, and an increase in the cost of experiential marketing programs. Outside production and other program expenses for the nine months ended December 31, 2013 increased $1,448,000 to $52,104,000, compared to $50,656,000 for the nine months ended December 31, 2012. This increase in outside production and other program expenses is primarily due to an increase in the cost of Diageo events executed, partially offset by a decrease in the cost of experiential marketing programs.

22
 

Operating Revenue. For the three months ended December 31, 2013, Operating Revenue increased $1,250,000 or 12% to $11,884,000, compared to $10,634,000 for the three months ended December 31, 2012. For the nine months ended December 31, 2013, Operating Revenue decreased slightly by $44,000 to $32,243,000, compared to $32,287,000 for the nine months ended December 31, 2012. These increases in Operating Revenue for the three and nine month periods are primarily due to an increase in Diageo and interactive marketing revenues, partially offset by a decrease in experiential marketing revenue. Operating Revenue as a percentage of Sales for the three and nine months ended December 31, 2013 was 29% and 31%, compared to 31% and 32% for the three and nine months ended December 31, 2012. These decreases in the Operating Revenue to Sales percentages for three and nine month periods are primarily due to an increase in reimbursable program expenses that are passed through to our clients at cost. A reconciliation of Sales to Operating Revenues for the three and nine months ended December 31, 2013 and 2012 is set forth below.

 

   Three Months Ended
December 31,
   Nine Months Ended
December 31,
 
Sales  2013   %   2012   %   2013   %   2012   % 
Sales – U.S. GAAP   40,789,000    100    32,454,000    100   $  104,982,000    100    100,889,000    100 
Reimbursable program costs and outside production expenses   28,905,000    71    21,820,000    67    72,739,000    69    68,602,000    68 
Operating Revenue – Non-GAAP  $11,884,000    29   $10,634,000    33   $32,243,000    31   $32,287,000    32 

 

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 December 31, 2013, compensation expense increased $1,478,000 to $9,014,000, compared to $7,536,000 for the three months ended December 31, 2012. This 20% increase in compensation expense is primarily the result of a $1,078,000 increase in salary expense and a $189,000 increase in payroll taxes and benefits resulting mainly from staff increases, and a $157,000 increase in bonus expense. For the nine months ended December 31, 2013, compensation expense increased $1,734,000 to $24,589,000, compared to $22,855,000 for the nine months ended December 31, 2012. This 8% increase in compensation expense is the result of a $2,093,000 increase in salary expense and a $356,000 increase in payroll taxes and benefits resulting mainly from staff increases, offset by a $623,000 decrease in bonus expense, a $49,000 decrease in share based compensation expense, and a $43,000 decrease in severance costs.

 

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 December 31, 2013, general and administrative expenses increased $149,000 to $1,961,000, compared to $1,812,000 for the three months ended December 31, 2012. This 8% increase in general and administrative expenses is primarily the result of a $116,000 increase in professional fees, a $114,000 increase in consultancy fees, a $39,000 increase in office expense, and a $28,000 increase in rent and occupancy expense, partially offset by a $80,000 reduction in depreciation and amortization expense, a $38,000 decrease in new business expense, a $22,000 decrease in travel and entertainment expense, and a $19,000 decrease in promotional expense. For the nine months ended December 31, 2013, general and administrative expenses increased $281,000 to $5,751,000, compared to $5,470,000 for the nine months ended December 31, 2012. This 5% increase in general and administrative expenses is primarily the result of a $343,000 increase in consultancy fees, a $116,000 increase in office expense, a $88,000 increase in new business expense, and a $48,000 increase in professional fees, partially offset by a $138,000 reduction in depreciation and amortization expense, a $122,000 decrease in promotional expense, a $42,000 decrease in insurance expenses, and a $32,000 decrease in telecommunication 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. The Company’s Modified EBITDA for the three months ended December 31, 2013 decreased by $478,000 or 29% to $1,166,000 compared to $1,644,000 for the three months ended December 31, 2012. For the nine months ended December 31, 2013 the Company’s modified EBITDA decreased by $2,246,000 or 45% to $2,784,000 compared to $5,030,000 for the nine months ended December 31, 2012. A reconciliation of operating income to Modified EBITDA for the three and nine months ended December 31, 2013 and 2012, is set forth below:

         
   Three Months Ended   Nine Months Ended 
   December 31,   December 31, 
   2013   2012   2013   2012 
                 
Operating income – US GAAP  $909,000   $1,286,000   $1,903,000   $3,962,000 
Depreciation and amortization   167,000    247,000    593,000    731,000 
Share based compensation expense   90,000    111,000    288,000    337,000 
Modified EBITDA – Non-GAAP  $1,166,000   $1,644,000   $2,784,000   $5,030,000 
23
 

Interest income (expense), net. We had nominal net interest income for the three and nine months ended December 31, 2013 and 2012.

 

Fair Value Adjustments to Compound Embedded Derivative. Fair value adjustments to Compound Embedded Derivative for the three and nine months ended December 31, 2013, were ($91,000) and $963,000, respectively. Fair value adjustments to Compound Embedded Derivative for the three and nine months ended December 31, 2012, were $755,000 and ($53,000), respectively. These amounts consist entirely of a non-cash fair value adjustment to the derivative financial instrument 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 compound embedded derivative on our balance sheets and record the amount of such adjustments under “Fair value adjustments to compound embedded derivative” 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 Derivative” 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 4 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 December 31, 2013, was $818,000 compared to $2,041,000 for the three months ended December 31, 2012. For the nine months ended December 31, 2013, the Company’s income before provision for income taxes was $2,866,000 compared to $3,909,000 for the nine months ended December 31, 2012.

 

Provision for Income Taxes. The provision for income taxes for the three months ended December 31, 2013, was $362,000 compared to $504,000 for the three months ended December 31, 2012. For the nine months ended December 31, 2013, the Company’s provision for income taxes was $758,000 compared to $1,543,000 for the nine months ended December 31, 2012.

 

Net Income. As a result of the items discussed above, net income for the three months ended December 31, 2013 was $456,000 compared to $1,537,000 for the three months ended December 31, 2012. For the nine months ended December 31, 2013, the Company’s net income was $2,108,000 compared to $2,366,000 for the nine months ended December 31, 2012. Fully diluted earnings per share amounted to $.03 and $.12 for the three and nine months ended December 31, 2013, compared to $.09 and $.15 for the three and nine months ended December 31, 2012.

 

Liquidity and Capital Resources

For the nine months ended December 31, 2013, working capital increased by $1,218,000 from $7,207,000 to $8,425,000, primarily as a result of the operating income we generated during the period, partially offset by investing activities.

 

At December 31, 2013, we had cash and cash equivalents of $7,195,000, borrowing availability under the Credit Facility of $4,000,000, working capital of $8,425,000, and stockholders’ equity of $12,437,000. In comparison, at March 31, 2013, we had cash and cash equivalents of $11,240,000, borrowing availability under the Credit Facility of $3,198,000, working capital of $7,207,000, and stockholders’ equity of $10,177,000. The $4,045,000 decrease in cash and cash equivalents during the nine months ended December 31, 2013 was primarily due to $3,128,000 of cash used in operating activities, a $184,000 long-term investment, and $795,000 in property and equipment purchases.

 

Operating Activities. Net cash used in operating activities for the nine months ended December 31, 2013 was $3,128,000, primarily attributable to a $4,874,000 increase in accounts receivable, and $657,000 of cash used in the changes in the operating assets and liabilities excluding accounts receivable, and by net income of $2,108,000. The $4,874,000 increase in accounts receivable is primarily attributable to new contractual payment terms and processes with Diageo.

 

Investing Activities. Net cash used in investing activities for the nine months ended December 31, 2013 was $979,000, resulting from a $184,000 long-term investment, along with $795,000 in property and equipment purchases.

24
 

Financing Activities. Net cash used in financing activities for the nine months ended December 31, 2013 consisted of $32,000 in repurchases of our Common Stock from employees to satisfy employee tax withholding obligations in connection with the vesting of restricted stock.

 

On November 23, 2011, we entered into a Loan and Security Agreement with TD Bank, N.A. (the “Bank”), pursuant to which we were provided with a $4.0 million revolving credit facility (the “Credit Facility”). Borrowings under the Credit Facility are secured by substantially all of our assets and have been guaranteed by our subsidiaries.

 

Pursuant to the Loan Agreement (as amended), among other things:

 

All outstanding loans will become due on November 23, 2014, provided that following our request, the Bank may in its sole discretion agree to one year extensions of the maturity date;
   
Interest accrues on outstanding loans at a per annum rate equal to the greater of (i) 4.0%, and (ii) the Bank’s prime rate as from time to time in effect plus one percent;
   
Aggregate loans outstanding at any time are limited to a borrowing base equal to 80% of our eligible accounts receivable, as determined by the Bank, provided that the advance rate is limited to 50% with respect to accounts receivable from our customers whose receivables constitute more than 50% of our receivables in the aggregate; and
   
We are required to comply with a number of affirmative, negative and financial covenants. Among other things, these covenants restrict our ability to pay dividends, provide that our debt service coverage ratio (as determined pursuant to the Loan Agreement) cannot be less than 1.25 to 1.0 as of the end of any fiscal year, and require that we have immediately available cash at all times, including borrowings under the Credit Facility, of at least $3 million. We were in compliance with these covenants at December 31, 2013.

 

If we do not comply with the financial and other covenants and requirements of the Loan Agreement, the Bank may, subject to various cure rights, require the immediate payment of all amounts outstanding under the Loan Agreement.

 

In connection with the Loan Agreement, the holders of our Series D Preferred Stock entered into a Standstill Agreement with the Bank under which such stockholders have agreed not to exercise any rights they may have to cause us to redeem their shares of Series D Preferred Stock prior to December 15, 2015 (or such earlier date as the Credit Facility is terminated), other than upon a change of control or liquidation event of the Company.

 

On December 11, 2012, we entered into an amendment to the Loan Agreement, effective as of November 23, 2012, pursuant to which (i) the maturity date under the Loan Agreement was extended for one year to November 23, 2013, and (ii) our obligation to maintain $500,000 in a blocked account with the Bank to secure our obligations under the Loan Agreement was terminated. Accordingly, in connection with the amendment, such blocked account was released back to us. On November 14, 2013, the Loan Agreement was extended for another year to November 23, 2014.

 

We believe that cash currently on hand together with cash expected to be generated from operations and borrowing availability under the Credit Facility, will be sufficient to fund our cash and near-cash requirements both through December 31, 2014 and on a long-term basis. We had no loans outstanding under the Credit Facility at December 31, 2013.

 

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 2013 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 nine months ended December 31, 2013, there were no material changes to these policies.

 

Internal-Use Software Development

 

Included in property and equipment, net are costs incurred to develop software for internal use that are capitalized and amortized over the estimated useful life of the software. Costs related to training or maintenance of internal-use software development are expensed as incurred. For the three and nine months ended December 31, 2013 we capitalized $296,310 and $525,260, respectively, of costs associated with internal-use software development. We did not incur any amortization expense related to capitalized software development costs during the three and nine months ended December 31, 2013 and 2012.

25
 

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 which has been fully amortized as of December 31, 2013, and an Internet domain name and related intellectual property rights. At December 31, 2013 and March 31, 2013, our balance sheet reflected goodwill and intangible assets as set forth below:

   December 31,
2013
   March 31,
2013
 
Amortizable:          
Customer relationship   $   $80,422 
           
Non-Amortizable:         
Goodwill   $10,052,232   $  10,052,232 
Internet domain name    200,000    200,000 
   $10,252,232   $10,252,232 
Total  $10,252,232   $10,332,654 

Goodwill and the internet domain name are deemed to have indefinite lives and are subject to annual impairment tests. Goodwill impairment tests require that we first assess qualitative factors to determine whether it is necessary to perform a two-step quantitative goodwill impairment test. We are not required to calculate the fair value of a reporting unit unless we determine, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. We assess 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 review, if impairment is found to have occurred, a corresponding charge will be recorded. The value assigned to the customer relationship was amortized over a five year period.

As of March 31, 2013, we assessed qualitative factors which included an analysis of macroeconomic conditions, financial performance, and industry and market considerations, and concluded that it was not necessary to perform a two-step quantitative goodwill impairment test and that the goodwill of the Company was not impaired as of March 31, 2013. 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 nine months ended December 31, 2013 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.

 

Item 4.Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

Our management has evaluated, with the participation of our Chief Executive Officer and Chief 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 December 31, 2013. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of December 31, 2013.

 

Changes in Internal Controls over Financial Reporting

There were no changes in our internal control over financial reporting during the fiscal quarter ended December 31, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II - OTHER INFORMATION

 

Item 6.Exhibits.

 

  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.
     
  101.INS§ XBRL Instance Document
     
  101.SCH§ XBRL Taxonomy Extension Schema Document
     
  101.CAL§ XBRL Taxonomy Extension Calculation Linkbase Document
     
  101.LAB§ XBRL Taxonomy Extension Label Linkbase Document
     
  101.PRE§ XBRL Taxonomy Extension Presentation Linkbase Document
     
  101.DEF§ XBRL Taxonomy Extension Definition Linkbase Document
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SIGNATURES

  

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: February 14, 2014 By:  /s/ Charles W. Horsey  
  Charles W. Horsey, Chairman and Chief Executive Officer
  (Principal Executive Officer)
   
Dated: February 14, 2014 By: /s/ Paul Trager  
  Paul Trager, Chief Financial Officer
  (Principal Financial Officer)
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