UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

 

(Mark One)

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2014

 

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 July 31, 2014, 9,878,681 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) – June 30, 2014 and March 31, 2014	3
		Statements of Operations (Unaudited) – Three Months ended June 30, 2014 and 2013	4
		Statements of Comprehensive Income (Unaudited) – Three Months ended June 30, 2014 and 2013	5
		Statements of Cash Flows (Unaudited) –Three Months ended June 30, 2014 and 2013	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	26
SIGNATURES			27

PART I - FINANCIAL INFORMATION

 

Item 1.

Interim Condensed Consolidated Financial Statements

‘mktg, inc.’

Condensed Consolidated Balance Sheets

June 30, 2014 and March 31, 2014

(Unaudited)

 

		June 30, 2014				March 31, 2014
Assets
Current assets:
Cash and cash equivalents		$	7,080,025			$	9,473,743
Accounts receivable, net of allowance for doubtful accounts of $297,000 at June 30, 2014 and March 31, 2014			18,960,046				16,229,522
Unbilled contracts in progress			222,919				2,231,775
Deferred contract costs			872,955				857,219
Prepaid expenses and other current assets			756,784				333,568
Deferred tax asset			276,293				219,293
Total current assets			28,169,022				29,345,120
Property and equipment, net			2,400,603				2,398,434
Deferred tax asset			1,942,059				1,730,059
Goodwill			10,052,232				10,052,232
Intangible assets - net			200,000				200,000
Long-term investments			187,487				187,487
Other assets			475,624				475,477
Total assets		$	43,427,027			$	44,388,809
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$	2,243,559			$	877,855
Accrued compensation			384,455				295,509
Accrued job costs			557,644				340,131
Other accrued liabilities			2,664,367				2,628,028
Deferred revenue			14,354,995				16,758,435
Total current liabilities			20,205,020				20,899,958
Deferred rent			458,115				552,507
Warrant derivative liability			11,319,149				3,686,170
Deferred tax liability			3,262,580				3,211,580
Total liabilities			35,244,864				28,350,215
Commitments and contingencies
Redeemable Series D Convertible Participating Preferred Stock, $4,420,231 redemption and liquidation value, par value $1.00: 2,500,000 shares designated, issued and outstanding at June 30, 2014 and March 31, 2014			4,076,971				3,848,272
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; 9,075,383 shares issued and 8,625,605 shares outstanding at June 30, 2014 and 9,080,383 shares issued and 8,630,605 shares outstanding at March 31, 2014			9,075				9,080
Additional paid-in capital			15,795,875				15,605,371
Accumulated deficit			(11,227,545	)			(2,931,580	)
Cumulative translation adjustment			61,025				40,689
Treasury stock, at cost, 449,778 shares at June 30, 2014 and March 31, 2014			(533,238	)			(533,238	)
Total stockholders’ equity			4,105,192				12,190,322
Total liabilities and stockholders’ equity		$	43,427,027			$	44,388,809

 

See notes to unaudited condensed consolidated financial statements.

‘mktg, inc.’

Condensed Consolidated Statements of Operations

Three Months Ended June 30, 2014 and 2013

(Unaudited)

 

		Three Months Ended June 30,
		2014				2013
Sales		$	35,841,984			$	30,801,150
Operating expenses:
Reimbursable program costs and expenses			6,970,950				6,325,217
Outside production and other program expenses			18,150,616				14,554,979
Compensation expense			8,665,599				7,727,556
General and administrative expenses			2,777,106				1,875,017
Total operating expenses			36,564,271				30,482,769
Operating (loss) income			(722,287	)			318,381
Fair value adjustments to compound embedded derivative			(7,632,979	)			313,830
(Loss) income before (benefit) provision for income taxes			(8,355,266	)			632,211
(Benefit) provision for income taxes			(288,000	)			126,000
Net (loss) income		$	(8,067,266	)		$	506,211
Basic (loss) earnings per share		$	(.96	)		$	.06
Diluted (loss) earnings per share		$	(.96	)		$	.03
Weighted average number of common shares outstanding:
Basic			8,377,862				8,196,635
Diluted			8,377,862				17,294,985

 

See notes to unaudited condensed consolidated financial statements.

‘mktg, inc.’

Condensed Consolidated Statements of Comprehensive Income

Three Months Ended June 30, 2014 and 2013

(Unaudited)

 

		Three Months Ended June 30,
		2014				2013
Net (loss) income		$	(8,067,266	)		$	506,211
Other comprehensive income, net of tax:
Foreign currency translation gain			12,202				8,728
Comprehensive (loss) income		$	(8,055,064	)		$	514,939

 

See notes to unaudited condensed consolidated financial statements.

‘mktg, inc.’

Condensed Consolidated Statements of Cash Flows

Three Months Ended June 30, 2014 and 2013

(Unaudited)

 

		2014				2013
Cash flows from operating activities:
Net (loss) income		$	(8,067,266	)		$	506,211
Adjustments to reconcile net (loss) income to net cash used in operating activities:
Depreciation and amortization			163,112				256,001
Deferred rent amortization			(94,392	)			(94,297	)
Fair value adjustments to compound embedded derivatives			7,632,979				(313,830	)
Share based compensation expense			190,499				109,080
Deferred income (benefit) taxes			(218,000	)			111,000
Changes in operating assets and liabilities:
Accounts receivable			(2,730,524	)			2,065,815
Unbilled contracts in progress			2,008,856				1,255,036
Deferred contract costs			(15,736	)			140,664
Prepaid expenses and other current assets			(423,216	)			(149,217	)
Other assets			(147	)			1,520
Accounts payable			1,365,704				118,155
Accrued compensation			88,946				(1,345,875	)
Accrued job costs			217,513				59,797
Other accrued liabilities			36,339				(393,212	)
Income taxes payable			—				(31,686	)
Deferred revenue			(2,403,440	)			(5,658,136	)
Net cash used in operating activities			(2,248,773	)			(3,362,974	)
Cash flows from investing activities:
Purchases of property and equipment			(165,281	)			(112,507	)
Investments			—				(150,000	)
Net cash used in investing activities			(165,281	)			(262,507	)
Effect of exchange rate changes on cash and cash equivalents			20,336				14,546
Net decrease in cash and cash equivalents			(2,393,718	)			(3,610,935	)
Cash and cash equivalents at beginning of period			9,473,743				11,239,835
Cash and cash equivalents at end of period		$	7,080,025			$	7,628,900
Supplemental disclosures of cash flow information:
Income taxes paid during the period		$	67,927			$	88,036

 

See notes to unaudited condensed consolidated financial statements.

‘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, 2014.

 

In the opinion of management, such condensed consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, necessary to present fairly the Company’s results for the interim periods presented. The results of operations for the three months ended June 30, 2014 are not necessarily indicative of the results for the full fiscal year or any future periods.

 

(2)

Merger and Voting Agreements

(i) Merger Agreement

On May 27, 2014, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Aegis Lifestyle, Inc. a Delaware corporation (“Aegis”) and Morgan Acquisition, Inc., a Delaware corporation and wholly owned subsidiary of Aegis (“Merger Sub”). The Merger Agreement provides for, subject to the satisfaction or waiver of specified conditions, the acquisition of the Company by Aegis at a price of $2.80 per share in cash (the “Merger Consideration”). Subject to the terms and conditions of the Merger Agreement, Merger Sub will be merged with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly owned subsidiary of Aegis.

At the effective time of the Merger, except as set forth below, each share of the Company’s common stock issued and outstanding immediately prior to the effective time of the Merger will be converted into the right to the Merger Consideration, including all shares of common stock issuable upon conversion of the Company’s Series D Convertible Participating Preferred Stock (“Series D Preferred Stock”) which shall be converted into the Company’s common stock prior to the Merger. Shares held by stockholders who have properly exercised and perfected appraisal rights under Delaware law, shall not be converted into the right to receive the Merger Consideration but shall instead be converted into the right to receive such consideration as provided under Delaware law. Shares owned by the Company, Aegis, Company subsidiaries or Merger Sub shall be canceled without payment.

In addition, each of the Company’s warrants to purchase common stock that is outstanding immediately prior to the effective time of the Merger will be canceled in exchange for the right to receive an amount in cash equal to the excess of the Merger Consideration over the per-share exercise price with respect to such warrant.

As a result of the Merger, each vested and unvested outstanding stock option under the Company’s equity plans or otherwise will be canceled in exchange for the right to receive an amount in cash equal to the excess of the Merger Consideration over the per-share exercise price with respect to such stock option, provided, however, that that certain option to purchase 400,000 shares of common stock at an exercise price of $2.00 per share issued to the Charles Horsey, the Company’s Chief Executive Officer, which vests only upon a “Liquidity Event,” will be exchanged for the right to receive an amount in cash equal to the excess of the Merger Consideration over the per-share exercise price only with respect to 200,000 shares subject to such stock option. The remaining shares subject to such option shall be canceled without payment. Each restricted share of common stock under the Company’s equity plans that is outstanding as of the closing date will vest and be converted into the right to receive the Merger Consideration. The payments pursuant to this paragraph are subject to any applicable withholding taxes.

The Merger Agreement contains customary representations and warranties from both the Company and Aegis, and also contains customary covenants, including covenants providing for each of the parties to use its reasonable best efforts to cause the Merger to be consummated, and covenants requiring the Company to carry on its business in all material respects in the ordinary course of business consistent with past practice during the period between the execution of the Merger Agreement and the closing of the Merger.

The Merger Agreement also contains a “no shop” provision that, in general, restricts the Company’s ability to solicit third-party acquisition proposals, provide information to or engage in discussions or negotiations with third parties that have made or that might make an acquisition proposal, approve any third party acquisition proposal, or enter into any acquisition agreement relating to any third party acquisition proposal. The no shop provision is subject to a “fiduciary out” provision that allows the Company, under certain circumstances and in compliance with certain obligations, to provide information and participate in discussions and negotiations with respect to unsolicited written third-party acquisition proposals that the Company’s Board of Directors reasonably believes is likely to result in a Superior Proposal (as defined in the Merger Agreement) and to terminate the Merger Agreement and accept a Superior Proposal upon payment to Aegis of the termination fee discussed below. The foregoing is subject to Aegis’ rights to offer terms that will cause the Superior Proposal to no longer constitute a Superior Proposal.

The Merger Agreement contains certain termination rights and provides that, upon termination of the Merger Agreement under specified circumstances, including, but not limited to, a change in the recommendation of the board of directors of the Company or a termination of the Merger Agreement by the Company to enter into an agreement for a Superior Proposal, the Company will pay Aegis a cash termination fee of $2.08 million. The Merger Agreement also provides that upon termination of the Merger Agreement as a result of the failure of Company’s stockholders to approve the Merger Agreement at the special meeting where the Company’s stockholders have voted on a proposal to adopt the Merger Agreement, the Company will pay Aegis an amount equal to its reasonably documented transaction related expenses in an amount not to exceed $500,000.

The completion of the Merger is subject to certain customary conditions, including (i) the adoption of the Merger Agreement by holders of a majority of the Company’s common stock and Series D Preferred Stock, voting as separate classes; (ii) the absence of any law or order prohibiting or restraining the Merger, and (iii) exercise of dissenters’ rights by holders of no more than 5% of the Company’s outstanding common stock. In addition, the obligation of Aegis to complete the Merger is subject to the condition that the Company shall have available cash (as provided for in the Merger Agreement) of not less than $8,000,000 at the effective time of the Merger, less up to $2,000,000 in fees and expenses paid or incurred in connection with the Merger. Each of the Company’s and Aegis’s obligation to complete the Merger is also subject to certain additional customary conditions, including (i) subject to specified standards, the accuracy of the representations and warranties of the other party and (ii) performance in all material respects by the other party of its obligations under the Merger Agreement.

Aegis is a newly-formed indirect subsidiary of Aegis Media Americas, Inc., which has guaranteed the obligations of Aegis to pay the merger consideration under the Merger Agreement. The Merger is not conditioned upon receipt of financing by Aegis or Aegis Media Americas.

(ii) Voting Agreement

Concurrently and in connection with the execution of the Merger Agreement, Aegis entered into Voting Agreements with Rutabaga Capital Management LLC, affiliates of Union Capital Corporation, and certain directors and members of management of the Company, including all of the holders of the Company’s Series D Preferred Stock. Pursuant to the Voting Agreements such stockholders agreed to vote their respective shares of common stock and Series D Preferred Stock (i) in favor of the adoption of the Merger Agreement and the Merger and each of the other actions contemplated by the Merger Agreement, (ii) against any proposal or transaction in opposition to the consummation of the Merger or any other transactions contemplated by the Merger Agreement and (iii) against any other action or agreement that could reasonably be expected to interfere with or delay or adversely affect the Merger or any other transactions contemplated by the Merger Agreement.

In addition, pursuant to the Voting Agreement entered into by the holders of the Company’s Series D Preferred Stock, such stockholders agreed to convert (i) approximately 23.5% of their shares of Series D Preferred Stock into shares of the Company’s common stock prior to the record date for the Company’s special meeting of stockholders to consider the Merger, and (ii) their remaining shares of Series D Preferred Stock into shares of the Company’s common stock immediately prior to the effective time of the Merger. The Voting Agreements terminate upon termination of the Merger Agreement and certain other specified events.

Company stockholders party to the Voting Agreements hold an aggregate of approximately 45% of the shares of the Company’s common stock, as well as 100% of the shares of Series D Preferred Stock, that are expected to be outstanding as of the record date for the meeting of stockholders to be called to consider the adoption of the Merger Agreement. The Voting Agreements also restrict the transfer of shares owned by the stockholders parties thereto.

 

(3)

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 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)

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 three months ended June 30, 2014 that indicated to management that the carrying value of goodwill and the intangible asset may not be recoverable.

 

(d)

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 Condensed Consolidated Balance Sheet or Condensed Consolidated Statement of Operations. However, impairment charges, if deemed necessary, are recognized in the Condensed Consolidated Statement of Operations. If circumstances suggest that the value of the investee company has subsequently recovered, such recovery is not recorded. See Note 4 for additional information.

 

(e)

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 June 30, 2014 and March 31, 2014:

 

		June 30, 2014				March 31, 2014
Series D Preferred Stock (See Notes 5 and 7):
Carrying Values		$	4,076,971			$	3,848,272
Fair Values		$	15,909,593			$	8,128,451

 

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 7 and 8 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 7 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 8, and ASC 718 Stock Compensation to the Company’s share based payment arrangements.

 

ASC 815 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Standard applies under other accounting pronouncements that require or permit fair value measurements. ASC 815 further permits entities to choose to measure many financial instruments and certain other items at fair value. At this time, the Company does not intend to reflect any of its current financial instruments at fair value (except that the Company is required to carry derivative financial instruments at fair value). However, the Company will consider the appropriateness of recognizing financial instruments at fair value on a case by case basis as they arise in future periods.

 

(f)

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.

 

(g)

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.

(h)

Net Earnings Per Share

 

Basic earnings per share is based upon the weighted average number of common shares outstanding during the period, excluding restricted shares subject to forfeiture. Diluted earnings per share is computed on the same basis, including, if dilutive, common share equivalents, which include outstanding options, warrants, preferred stock, and restricted stock. For the three months ended June 30, 2014, stock options, restricted stock, warrants and preferred stock to purchase approximately 9,049,265 shares, and for the three months ended June 30, 2013, stock options to purchase approximately 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 June 30,
		2014				2013
Basic			8,377,862				8,196,635
Dilutive effect of:
Options			—				1,219,930
Restricted stock			—				104,927
Warrants			—				2,454,344
Series D preferred stock			—				5,319,149
Diluted			8,377,862				17,294,985

 

(i)

Recent Accounting Standards Affecting the Company

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. The adoption of this ASU did not have a material impact on the Company’s operating results, financial position, or cash flows.

Revenue from Contracts with Customers

In May 2014, the FASB issued FASB ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The core principle of this ASU is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU provides for one of two methods of transition: retrospective application to each prior period presented; or, recognition of the cumulative effect of retrospective application of the new standard in the period of initial application.

This ASU is effective for fiscal years and interim periods beginning after December 15, 2016 and early application is not permitted. Management is currently assessing the impact the adoption this ASU will have on the Company’s operating results, financial position and cash flows.

Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period

In June 2014, the FASB issued ASU No. 2014-12, Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. The issue is the result of a consensus of the FASB Emerging Issues Task Force (EITF). The amendments in this ASU require that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition.

The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015 and can be either applied prospectively or retrospectively. Earlier adoption is permitted. Management currently believes the adoption this ASU will not have a material impact on the Company’s operating results, financial position or cash flows.

 

(4)

Long-Term Investment

On April 10, 2013, the Company entered into a stock purchase agreement with Moving Off Campus, LLC, 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 $37,487 worth of services that in accordance with the stock purchase agreement constitutes additional investments. The carrying amount of the investment in Bonfyre at June 30, 2014 was $187,487. In October 2013, Bonfyre was converted into a corporation, Bonfyre Inc., in which the Company has a 7.3% interest as of June 30, 2014. Management determined that there was no impairment of value at June 30, 2014.

 

(5)

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 2,456,271 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 2,456,271 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.

 

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.

 

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, Warrant derivative liability, Put option derivative and Series D Preferred Stock are classified within Level 3 of the fair value hierarchy as they are valued using unobservable inputs including significant assumptions of the Company and other market participants. In November, 2011, in conjunction with the Company obtaining a bank credit facility (see Note 6), 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 three months ended June 30, 2014 and 2013.

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.

 

Significant assumptions embodied in these methods are as follows:

 

						Market or Calculated Inputs
Assumption:		Level				June 30, 2014				March 31, 2014
Common stock trading market price			1				$2.63				$1.20
Common stock trading volatility:
Preferred Compound Embedded Derivative			1				53.18%—78.64	%			33.25%—33.76%
Preferred Compound Embedded Derivative (effective volatility)			3				67.89%				33.20%
Warrant			1				—				—
Credit-risk adjusted yields:
Periods ranging from one to three years			2				3.46%—4.65%				6.13%—7.43%
Effective risk-adjusted yield			3				3.60%				6.30%
Terms (years):
Preferred Compound Embedded Derivative (effective term)			3				1.038				.665

 

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 in the Company’s balance sheet, the Company has elected not to record any other assets and liabilities at fair value.

Except for those assets and liabilities which are required by authoritative guidance to be recorded at fair value in 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 June 30, 2014
		Total				Level 1				Level 2				Level 3
Instruments:
Compound Embedded Derivative		$	11,319,149			$	—			$	—			$	11,319,149
Total Instruments		$	11,319,149			$	—			$	—			$	11,319,149

 

		Fair Value Measurements as of March 31, 2014
		Total				Level 1				Level 2				Level 3
Instruments:
Compound Embedded Derivative		$	3,686,170			$	—			$	—			$	3,686,170
Total Instruments		$	3,686,170			$	—			$	—			$	3,686,170

The following table presents the changes in Level 3 Instruments measured at fair value on a recurring basis for the three months ended June 30, 2014 and 2013:

 

		Compound Embedded Derivative
Balances at, March 31, 2014		$	3,686,170
Fair value adjustments			7,632,979
Balances at, June 30, 2014		$	11,319,149
Balances at, March 31, 2013		$	4,664,894
Fair value adjustments			(313,830	)
Balances at, June 30, 2013		$	4,351,064

 

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

 

(6)

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 June 30, 2014, the Company had no borrowings outstanding under the Credit Facility and availability of $4,000,000.

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.

 

(7)

Redeemable Preferred Stock

 

Redeemable preferred stock consists of the following as of June 30, 2014 and March 31, 2014:

 

		June 30, 2014				March 31, 2014
Series D Convertible Participating Preferred Stock, par value  $0.001, stated value $1.00, 2,500,000 shares designated,  2,500,000 shares issued and outstanding at June 30, 2014 and March 31, 2014; redemption and liquidation value $4,420,231 at June 30, 2014		$	4,076,971			$	3,848,272

 

The Series D Preferred Stock is subject to accretion to its redemption value, through charges to equity, over the period from issuance to the contractual redemption date, discussed in the Financing Overview, above, using the effective interest method. The redemption value is determined based upon the stated redemption amount of $1.00 per share, plus an accretion amount, more fully discussed above. For the three months ended June 30, 2014 and 2013, accretion, which is recorded to the accumulated deficit, amounted to $228,699 and $142,075, respectively.

 

(8)

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 Compound Embedded Derivative using the techniques and assumptions described in Note 5:

 

		Compound Embedded Derivative
Balances at March 31, 2014		$	3,686,170
Fair value adjustments			7,632,979
Balances at June 30, 2014		$	11,319,149
Balances at March 31, 2013		$	4,664,894
Fair value adjustments			(313,830	)
Balances at June 30, 2013		$	4,351,064

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.

(9)

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 June 30, 2014, there were options to purchase 70,000 shares of Common Stock, expiring from April 2013 through September 2017, issued under the 2002 Plan that remained outstanding. The 2002 Plan terminated on June 30, 2012.

On March 25, 2010, the stockholders of the Company approved the ‘mktg, inc.’ 2010 Equity Incentive Plan (the “2010 Plan”), under which 3,000,000 shares of Common Stock have been set aside and reserved for issuance. The 2010 Plan provides for the granting to our employees, officers, directors, consultants and advisors of stock options (non-statutory and incentive), restricted stock awards, stock appreciation rights, restricted stock units and other performance stock awards. The 2010 Plan is administered by the Compensation Committee of the Board of Directors.  The exercise price per share of a stock option, which is determined by the Compensation Committee, may not be less than 100% of the fair market value of the common stock on the date of grant. For non-qualified options the term of the option is determined by the Compensation Committee. For incentive stock options the term of the option is not more than ten years. However, if the optionee owns more than 10% of the total combined voting power of the Company, the term of the incentive stock option will be no longer than five years. The 2010 Plan automatically terminates on February 22, 2020, unless it is terminated earlier by a vote of the Company’s stockholders or the Board of Directors; provided, however, that any such action does not affect the rights of any participants of the 2010 Plan. In addition, the 2010 Plan may be amended by the stockholders of the Company or the Board of Directors, subject to stockholder approval if required by applicable law or listing requirements. At June 30, 2014, there were options to purchase 2,412,097 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 June 30, 2014, the Company had options or other awards for 66,966 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 30, 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 June 30, 2014, and changes during the three month period then ended is presented below:

 

		Weighted average exercise price				Number of options				Weighted average remaining contractual term (years)				Aggregate intrinsic value
Balance at March 31, 2014		$	0.78				3,082,097				6.68			$	1,294,481
Granted			—				—
Exercised			—				—
Canceled			—				—
Balance at June 30, 2014 (vested and expected to vest)		$	0.78				3,082,097				6.43			$	5,701,879
Exercisable at June 30, 2014		$	0.50				1,911,572				5.78			$	4,071,648

Total unrecognized compensation cost related to vested and expected to vest options at June 30, 2014 amounted to $113,360 and is expected to be recognized over a weighted average period of 4.34 years. Total compensation cost for all outstanding option awards amounted to $161,968 for the three months ended June 30, 2014, which included $130,800 of compensation cost related to the Liquidity Event options described above as the condition for vesting was determined to be probable as of June 30, 2014. For the three months ended June 30, 2013 total compensation cost for all outstanding option awards amounted to $39,747.

 

(ii) Warrants

 

At June 30, 2014 and March 31, 2014 there were warrants outstanding to purchase 2,456,271 shares of common stock at a price of $.001 per share, which were issued in the December 2009 financing and expire December 15, 2015. The aggregate intrinsic value of the warrants outstanding at June 30, 2014 and March 31, 2014 were $6,457,536 and $2,945,069, respectively.

 

(iii) Restricted Stock

As of June 30, 2014 the Company had awarded 1,179,556 shares (net of forfeited shares) of restricted stock under the Company’s 2002 Plan, 376,500 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 $2,651,323 and are recognized ratably as compensation expense over the vesting periods. The shares of restricted stock granted pursuant to such agreements vest in various tranches over one to five years from the date of grant.

 

The shares awarded to employees under the restricted stock agreements vest on the applicable vesting dates only to the extent the recipient of the shares is then an employee of the Company or one of its subsidiaries, and each recipient will forfeit all of the shares that have not vested on the date his or her employment is terminated.

 

A summary of all non-vested stock activity as of June 30, 2014, and changes during the three month period then ended is presented below:

 

		Weighted average grant date fair value				Number of shares				Weighted average remaining contractual term (years)				Aggregate intrinsic value
Unvested at March 31, 2014		$	1.01				296,362				1.76			$	355,634
Awarded			—				—
Vested		$	0.97				(104,750	)
Forfeited		$	0.71				(5,000	)
Unvested at June 30, 2014		$	1.03				186,612				1.58			$	490,790

 

Total unrecognized compensation cost related to unvested stock awards at June 30, 2014 amounted to $137,387 and is expected to be recognized over a weighted average period of 1.58 years. Total compensation cost for the stock awards amounted to $28,531 and $69,333 for the three months ended June 30, 2014 and 2013, respectively.

 

(10)

Concentrations

 

The Company had sales to one customer that approximated $22,728,000 or 63% of total sales for the three months ended June 30, 2014. Accounts receivable due from this customer approximated $10,939,000 at June 30, 2014 and $9,171,000 at March 31, 2014. The Company had sales to one customer that approximated $19,533,000 or 63% of total sales for the three months ended June 30, 2013. Accounts receivable due from this customer approximated $2,690,000 at June 30, 2013 and $5,802,000 at March 31, 2013. In addition, the Company had sales to a second customer that approximated $3,985,000 or 13% of total sales for the three months ended June 30, 2013. Accounts receivable due from this customer approximated $1,655,000 at June 30, 2013 and $1,783,000 at March 31, 2013.

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, 2014 under “Risk Factors,” including but not limited to “The proposed Merger with Aegis may disrupt our business and, if the Merger does not occur, our stock price may decline, we will have incurred significant expenses, and we may need to pay a termination fee to Aegis,” “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.’ 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.

 

On May 27, 2014, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Aegis Lifestyle, Inc. a Delaware corporation (“Aegis”) and Morgan Acquisition, Inc., a Delaware corporation and wholly owned subsidiary of Aegis (“Merger Sub”), pursuant to which Aegis will acquire all of our common stock for $2.80 per share in cash, or approximately $52 million, resulting in our becoming a wholly-owned subsidiary of Aegis (the “Merger”). The Merger is subject to customary closing conditions including receipt of the approval of our stockholders, as well as the condition that we have available cash (as defined in the Merger Agreement) of at least $8,000,000 at the effective time of the Merger, less up to $2,000,000 in fees and expenses paid or incurred in connection with the Merger. Our Board of Directors has voted unanimously in favor of the Merger, which is expected to close in the third calendar quarter of 2014. There are no assurances that the Merger will be consummated.

 

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

We were unprofitable for the three months ended June 30, 2014, primarily as a result of costs associated with our development of word-of-mouth marketing services capabilities (“WOM”) including a proprietary community management platform and advocacy community, and to a lesser degree fees and expenses incurred in connection with the proposed Merger. Our operating loss for the three months ended June 30, 2014 was ($722,000), compared to $318,000 in operating income for the three months ended June 30, 2013. This $1,040,000 reduction in operating income was the result of a $937,000 increase in compensation expense and a $902,000 increase in general and administrative expenses partially offset by a $799,000 increase in Operating Revenue. Modified EBITDA declined to ($369,000) for the three months ended June 30, 2014 from $683,000 for the three months ended June 30, 2013.

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 Warrant derivative liability 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 5 to our Condensed Consolidated Financial Statements in Item 1 of this Report.

The following table presents the reported operating results for the three months ended June 30, 2014 and 2013:

 

		Three Months Ended June 30,
		2014				2013
Operations Data:
Sales		$	35,842,000			$	30,801,000
Reimbursable program costs and expenses			6,971,000				6,325,000
Outside production and other program expenses			18,151,000				14,555,000
Operating revenue			10,720,000				9,921,000
Compensation expense			8,665,000				7,728,000
General and administrative expenses			2,777,000				1,875,000
Operating (loss) income			(722,000	)			318,000
Fair value adjustments to compound embedded derivative			(7,633,000	)			314,000
(Loss) income before (benefit) provision for income taxes			(8,355,000	)			632,000
(Benefit) provision for income taxes			(288,000	)			126,000
Net (loss) income		$	(8,067,000	)		$	506,000
Per Share Data:
Basic (loss) earnings per share		$	(0.96	)		$	0.06
Diluted (loss) earnings per share		$	(0.96	)		$	0.03
Weighted Average Number of Shares Outstanding:
Basic			8,377,862				8,196,635
Diluted			8,377,862				17,294,985

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 months ended June 30, 2014 and 2013, respectively:

 

		Three Months Ended June 30,
		2014				2013
Statement of Operations Data:
Operating revenue			100.0	%			100.0	%
Compensation expense			80.8	%			77.9	%
General and administrative expense			25.9	%			18.9	%
Operating (loss) income			(6.7	%)			3.2	%
Fair value adjustments to compound embedded derivative			(71.2	%)			3.2	%
(Loss) income before (benefit) provision for income taxes			(77.9	%)			6.4	%
(Benefit) provision for income taxes			(2.7	%)			1.3	%
Net (loss) income			(75.2	%)			5.1	%

 

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 June 30, 2014 increased $5,041,000 to $35,842,000, compared to $30,801,000 for the three months ended June 30, 2013. This increase in sales is attributable to a $3,196,000 increase in sales from our largest customer, Diageo North America, Inc. (“Diageo”), and a $2,456,000 increase in experiential marketing sales, partially offset by a $611,000 decrease in interactive 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 June 30, 2014 increased $646,000 to $6,971,000, compared to $6,325,000 for the three months ended June 30, 2013. This increase primarily reflects an increase in the number of events executed during the three months ended June 30, 2014 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, services, certain direct labor charged to programs and other expenditures incurred in connection with and directly related to sales but which are not classified as reimbursable program costs and expenses. Outside production and other program expenses for the three months ended June 30, 2014 increased $3,596,000 to $18,151,000, compared to $14,555,000 for the three months ended June 30, 2013. This increase in outside production and other program expenses is primarily due to an increase in the number of Diageo events we executed, along with an increase in the cost of experiential marketing programs, partially offset by a reduction in the cost of interactive marketing programs.

Operating Revenue. For the three months ended June 30, 2014, Operating Revenue increased $799,000 or 8%, to $10,720,000, compared to $9,921,000 for the three months ended June 30, 2013. This increase in Operating Revenue is primarily due to increases in Diageo and experiential marketing revenue, partially offset by a decrease in interactive marketing revenue. Operating Revenue as a percentage of sales for the three months ended June 30, 2014 decreased 2% to 30%, compared to 32% for the three months ended June 30, 2013. This reduction in the Operating Revenue percentage is a result of lower fee-revenue projects for the three months ended June 30, 2014 versus the same period in fiscal 2014. A reconciliation of Sales to Operating Revenues for the three months ended June 30, 2014 and 2013 is set forth below.

		Three Months Ended
		June 30,
Sales		2014				%				2013				%
Sales – U.S. GAAP		$	35,842,000				100			$	30,801,000				100
Reimbursable program costs and outside production expenses			25,122,000				70				20,880,000				68
Operating Revenue – Non-GAAP		$	10,720,000				30			$	9,921,000				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 June 30, 2014, compensation expense increased $937,000 to $8,665,000, compared to $7,728,000 for the three months ended June 30, 2013. This increase in compensation expense is primarily the result of a $785,000 increase in salary expense, a $81,000 increase in share based compensation expense, and a $74,000 increase in bonus expense.

 

General and Administrative Expenses. General and administrative expenses consist of office and equipment rent, depreciation and amortization, professional fees, and other overhead expenses. For the three months ended June 30, 2014, general and administrative expenses increased $902,000 to $2,777,000, compared to $1,875,000 for the three months ended June 30, 2013. This 48% increase in general and administrative expenses is primarily the result of $548,000 in consulting fees associated with the development of our WOM community platform, $443,000 in fees and expenses incurred in connection with the proposed Merger, and a $63,000 increase in legal fees, partially offset by a $95,000 decrease in other consultancy expense, and a $93,000 decrease in depreciation and amortization 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 June 30, 2014 decreased by $1,052,000 to ($369,000) compared to $683,000 for the three months ended June 30, 2013. A reconciliation of operating income to Modified EBITDA for the three months ended June 30, 2014 and 2013, is set forth below:

 

		Three Months Ended June 30,
		2014				2013
Operating (loss) income – US GAAP		$	(722,000	)		$	318,000
Depreciation and amortization			163,000				256,000
Share based compensation expense			190,000				109,000
Modified EBITDA – Non-GAAP		$	(369,000	)		$	683,000

 

Fair Value Adjustments to Compound Embedded Derivative. Fair value adjustments to compound embedded derivative for the three months ended June 30, 2014 and 2013 were $7,633,000 and ($314,000), respectively. These amounts consist entirely of a non-cash fair value adjustment to the derivative financial instruments generated from the December 2009 financing. This adjustment is primarily attributable to the fluctuation in the price of our Common Stock during the relevant periods, which under generally accepted accounting principles required us to adjust the carrying values of the Warrant derivative liability and other derivative liabilities on our balance sheets and record the amount of such adjustments under “Fair value adjustments to compound embedded derivatives” on our statements of operations. In general, an increase in the price of our Common Stock in a particular period will result in an increase in the carrying values of these derivative liabilities on our balance sheets at the end of such period and require us to record the amount of such increase as a charge under “Fair value adjustments to compound embedded 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. As a result of the proposed Merger the price of our Common Stock increased to $2.63 per share as of June 30, 2014, a $1.43 per share increase over the $1.20 price per share as of March 31, 2014. This 119% increase in the share price is the primary reason for the $7,633,000 non-cash fair value adjustments to compound embedded derivative charge for the three months ended June 30, 2014. A more detailed explanation of the accounting treatment for these derivative financial instruments is provided in Note 5 to our Consolidated Financial Statements in Item 1 of this Report.

(Loss) Income before (Benefit) Provision for Income Taxes. The Company’s loss before benefit for income taxes for the three months ended June 30, 2014, was ($8,355,000) compared to income before provision for income taxes of $632,000 for the three months ended June 30, 2013.

 

(Benefit) Provision for Income Taxes. The benefit for income taxes for the three months ended June 30, 2014 was ($288,000). The provision for income taxes for the three months ended June 30, 2013 was $126,000.

 

Net (Loss) Income. As a result of the items discussed above, we incurred a net loss of ($8,067,000) for the three months ended June 30, 2014, a decrease of $8,573,000 compared to $506,000 of net income for the three months ended June 30, 2013. Diluted loss per share amounted to ($.96) for the three months ended June 30, 2014 versus diluted earnings per share of $.03 for the three months ended June 30, 2013.

 

Liquidity and Capital Resources

For the three months ended June 30, 2014, working capital decreased by $481,000 from $8,445,000 to $7,964,000, primarily as a result of the operating loss we incurred during the period.

 

At June 30, 2014, we had cash and cash equivalents of $7,080,000, borrowing availability under the Credit Facility of $4,000,000, working capital of $7,964,000, and stockholders’ equity of $4,105,000. In comparison, at March 31, 2014, we had cash and cash equivalents of $9,474,000, borrowing availability under the Credit Facility of $4,000,000, working capital of $8,445,000, and stockholders’ equity of $12,190,000. The $2,394,000 decrease in cash and cash equivalents during the three months ended June 30, 2014 was due to $2,249,000 of cash used in operating activities, and $165,000 in property and equipment purchases, partially offset by a $20,000 positive effect on exchange rate changes to cash and cash equivalents.

 

Operating Activities. Net cash used in operating activities for the three months ended June 30, 2014 was $2,249,000, primarily attributable to a net loss of $8,067,000, a $2,731,000 increase in accounts receivable, a $2,403,000 decrease in deferred revenue, and a $423,000 increase in prepaid expenses and other current assets, partially offset by a $7,633,000 non-cash charge resulting from fair value adjustments to compound derivative, a $2,009,000 decrease in unbilled contracts in progress, a $1,366,000 increase in accounts payable, a $218,000 increase in accrued job costs plus $41,000 in other net non-cash charges that consist of depreciation and amortization expense, share based compensation expense, and deferred rent amortization.

 

Investing Activities. Net cash used in investing activities for the three months ended June 30, 2014 was $165,000, resulting from property and equipment purchases.

 

Financing Activities. There were no financing activities for the three months ended June 30, 2014.

 

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, 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 June 30, 2014.

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 June 30, 2015 and on a long-term basis. We had no loans outstanding under the Credit Facility at June 30, 2014.

 

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 2014 Annual Report on Form 10-K for a discussion of the Company’s critical accounting policies relating to revenue recognition, goodwill (expanded below) and other intangible assets and accounting for income taxes. During the three months ended June 30, 2014, there were no material changes to these policies.

 

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 June 30, 2014, and an Internet domain name and related intellectual property rights. At June 30, 2014 and March 31, 2014, our balance sheet reflected goodwill and intangible assets as set forth below:

		June 30, 2014				March 31, 2014
Non-Amortizable:
Goodwill		$	10,052,232			$	10,052,232
Internet domain name			200,000				200,000
Total		$	10,252,232			$	10,252,232

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.

As of March 31, 2014, 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, 2014. Goodwill and the intangible asset will continue to be tested annually at the end of each fiscal year to determine whether they have been impaired. Upon completion of each annual review, there can be no assurance that a material charge will not be recorded. Impairment testing is required more often than annually if an event or circumstance indicates that an impairment or decline in value may have occurred. There were no events or changes in circumstances during the three months ended June 30, 2014 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 June 30, 2014. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of June 30, 2014.

 

Changes in Internal Controls over Financial Reporting

There were no changes in our internal control over financial reporting during the fiscal quarter ended June 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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

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: August 7, 2014		By:	/s/ Charles W. Horsey
		Charles W. Horsey, Chairman and Chief Executive Officer
		(Principal Executive Officer)
Dated: August 7, 2014		By:	/s/ Paul Trager
		Paul Trager, Chief Financial Officer
		(Principal Financial Officer)