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EX-31.2 - EXHIBIT 31.2 - 'mktg, inc.'ex31_2.htm
EX-31.1 - EXHIBIT 31.1 - 'mktg, inc.'ex31_1.htm
EX-32.1 - EXHIBIT 32.1 - 'mktg, inc.'ex32_1.htm
EX-32.2 - EXHIBIT 32.2 - 'mktg, inc.'ex32_2.htm

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
For the quarterly period ended December 31, 2010
   
OR
   
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ___________ to  ___________
 
Commission file number 0-20394
 
‘mktg, inc.’
(Exact name of registrant as specified in its charter)
     
Delaware
 
06-1340408
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification Number)
     
75 Ninth Avenue
   
New York, New York
 
10011
(Address of principal executive offices)
 
(Zip Code)
 
Registrant’s telephone number, including area code: (212) 366-3400
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x      No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes o      No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):
 
Large accelerated filer o
Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company x
 
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 February 1, 2011, 8,552,974 shares of the Registrant’s Common Stock, par value $.001 per share, were outstanding.
 
 
 

 
 
INDEX
 
‘mktg, inc.’
 

     
Page
     
         
  3  
         
   
3
 
   
4
 
   
5
 
         
   
6
 
         
 
18
 
         
 
25
 
         
     
         
 
25
 
         
 
25
 
         
 
26
 
 
 
2

 

 
 
‘mktg, inc.’
December 31, 2010 (Unaudited) and March 31, 2010
 
   
December 31, 2010
   
March 31, 2010
 
             
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 6,522,300     $ 663,786  
Accounts receivable, net of allowance for doubtful accounts of $306,000 at December 31, 2010 and $288,000 at March 31, 2010
    9,276,751       9,043,506  
Unbilled contracts in progress
    200,165       740,540  
Deferred contract costs
    904,556       1,235,967  
Prepaid expenses and other current assets
    224,818       611,947  
Total current assets
    17,128,590       12,295,746  
                 
Property and equipment, net
    1,832,342       2,115,506  
                 
Restricted cash
    500,000        
Goodwill
    10,052,232       10,052,232  
Intangible assets - net
    1,004,207       1,245,469  
Other assets
    484,985       485,078  
Total assets
  $ 31,002,356     $ 26,194,031  
                 
Liabilities and Stockholders’ Equity
               
Current liabilities:
               
Accounts payable
  $ 1,148,651     $ 2,158,687  
Accrued compensation
    1,718,044       431,614  
Accrued job costs
    3,355,057       3,190,782  
Other accrued liabilities
    1,777,107       2,002,427  
Deferred revenue
    10,389,681       8,365,407  
Total current liabilities
    18,388,540       16,148,917  
                 
Deferred rent
    1,496,542       1,622,953  
Senior secured notes payable
    1,739,789       1,514,340  
Warrant derivative liability
    1,859,205       849,211  
Put option derivative
    6,851       110,940  
Total liabilities
    23,490,927       20,246,361  
                 
Commitments and contingencies
               
                 
Redeemable Series D Convertible Participating Preferred Stock, $2,865,342 redemption and liquidation value, par value $1.00: 2,500,000 designated, 2,500,000 issued and outstanding at December 31, 2010 and March 31, 2010, respectively
    1,877,978       1,503,589  
                 
Stockholders’ equity:
               
Class A convertible preferred stock, par value $.001; authorized 650,000 shares; none issued and outstanding
           
Class B convertible preferred stock, par value $.001; authorized 700,000 shares; none issued and outstanding
           
Preferred stock, undesignated; authorized 3,650,000 shares; none issued and outstanding
           
Common stock, par value $.001; authorized 25,000,000 shares; 8,590,315 shares issued and outstanding at December 31, 2010 and 8,613,288 shares issued and outstanding at and March 31, 2010
    8,590       8,613  
Additional paid-in capital
    14,195,520       13,806,871  
Accumulated deficit
    (8,543,777 )     (9,351,126 )
Treasury stock at cost, 37,341 shares at December 31, 2010 and 19,189 shares at March 31, 2010
    (26,882 )     (20,277 )
Total stockholders’ equity
    5,633,451       4,444,081  
Total liabilities and stockholders’ equity
  $ 31,002,356     $ 26,194,031  
 
See notes to unaudited condensed consolidated financial statements.
 
 
3

 
 
‘mktg, inc.’
Three and Nine Months Ended December 31, 2010 and 2009
(Unaudited)

   
Three Months Ended
December 31,
   
Nine Months Ended
December 31,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Sales
  $ 31,744,668     $ 24,102,293     $ 89,437,543     $ 61,788,780  
                                 
Operating expenses:
                               
Reimbursable program costs and expenses
    5,881,340       4,149,839       17,462,036       11,911,739  
Outside production and other program expenses
    17,289,650       11,822,787       46,078,306       26,087,184  
Compensation expense
    6,156,253       5,967,035       17,989,548       19,293,637  
General and administrative expenses
    1,730,419       1,888,395       5,316,120       5,229,027  
Total operating expenses
    31,057,662       23,828,056       86,846,010       62,521,587  
                                 
Operating income (loss)
    687,006       274,237       2,591,533       (732,807 )
                                 
Interest expense, net
    (176,876 )     (40,505 )     (515,767 )     (63,341 )
Other income
    11,877             11,877        
Fair value adjustments to compound embedded derivatives
    560,269       269,493       (905,905 )     269,493  
                                 
Income (loss) before provision for income taxes
    1,082,276       503,225       1,181,738       (526,655 )
                                 
Provision for income taxes
                       
                                 
Net income (loss)
  $ 1,082,276     $ 503,225     $ 1,181,738     $ (526,655 )
                                 
Basic earnings (loss) per share
  $ .13     $ .07     $ .15     $ (.07 )
Diluted earnings (loss) per share
  $ .07     $ .06     $ .08     $ (.07 )
                                 
Weighted average number of common shares outstanding:
                               
Basic
    8,030,082       7,589,551       7,934,134       7,055,068  
Diluted
    15,804,981       8,951,461       15,706,298       7,055,068  
 
See notes to unaudited condensed consolidated financial statements.
 
 
4

 
 
‘mktg, inc.’
Nine Months Ended December 31, 2010 and 2009
(Unaudited)
 
   
2010
   
2009
 
             
Cash flows from operating activities:
           
                 
Net income (loss)
  $ 1,181,738     $ (526,655 )
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
               
Depreciation and amortization
    828,984       899,655  
Deferred rent amortization
    (126,411 )     (84,002 )
Provision for bad debt expense
    24,045       (36,878 )
Amortization of original issue discount on senior secured notes payable
    225,449       12,069  
Fair value adjustments to compound embedded derivatives
    905,905       (269,493 )
Share based compensation expense
    388,626       642,434  
Gain on sale of property and equipment
    (11,877 )      
Changes in operating assets and liabilities:
               
Accounts receivable
    (257,290 )     1,985,046  
Unbilled contracts in progress
    540,375       711,718  
Deferred contract costs
    331,411       635,706  
Prepaid expenses and other current assets
    387,222       (14,462 )
Other assets
          (3,500 )
Accounts payable
    (1,010,036 )     (1,332,465 )
Accrued compensation
    1,286,430       (130,224 )
Accrued job costs
    164,275       (1,155,170 )
Other accrued liabilities
    (225,320 )     (822,201 )
Deferred revenue
    2,024,274       (4,740,401 )
                 
Net cash provided by (used in) operating activities
    6,657,800       (4,228,823 )
                 
Cash flows from investing activities:
               
Restricted cash
    (500,000 )     1,993,750  
Proceeds from sale of property and equipment
    15,000        
Purchases of property and equipment
    (307,681 )     (110,733 )
Net cash (used in) provided by investing activities
    (792,681 )     1,883,017  
                 
Cash flows from financing activities:
               
Net proceeds from financing transaction
          4,425,000  
Payment of debt
          (1,993,750 )
Purchase of treasury stock
    (6,605 )     (20,277 )
Net cash (used in) provided by financing activities
    (6,605 )     2,410,973  
                 
Net increase in cash and cash equivalents
    5,858,514       65,167  
                 
Cash and cash equivalents at beginning of period
    663,786       1,904,014  
Cash and cash equivalents at end of period
  $ 6,522,300     $ 1,969,181  
                 
Supplemental disclosures of cash flow information:
               
Interest paid during the period
  $ 300,925     $ 55,270  
State income taxes paid during the period
  $ 43,156     $ 61,363  
 
See notes to unaudited condensed consolidated financial statements.
 
 
5

 
 
‘mktg, inc.’
 
(1)
Basis of Presentation
       
 
The following unaudited interim condensed consolidated financial statements of ‘mktg, inc.’ (the “Company”) for the three and nine months ended December 31, 2010 and 2009 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, 2010.
       
 
In the opinion of management, such condensed consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, necessary to present fairly the Company’s results for the interim periods presented. The results of operations for the three and nine months ended December 31, 2010 are not necessarily indicative of the results for the full fiscal year or any future periods.
       
(2)
Summary of Significant Accounting Policies
       
   
(a)
Principles of Consolidation
       
     
The condensed consolidated financial statements include the financial statements of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
       
   
(b)
Use of Estimates
       
     
The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of the contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management bases its estimates on certain assumptions, which it believes are reasonable in the circumstances. Actual results could differ from those estimates.
       
   
(c)
Goodwill
       
     
Goodwill consists of the cost in excess of the fair value of the acquired net assets of the Company’s subsidiaries. Goodwill is subject to annual impairment tests which require the comparison of the fair value and carrying value of reporting units. The Company assesses the potential impairment of goodwill annually and on an interim basis whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Upon completion of such annual review, if impairment is found to have occurred, a corresponding charge will be recorded. The Company has determined that it has one reporting unit, and uses three generally accepted methods for estimating fair value of the reporting unit; the income approach, market approach and market capitalization to determine the overall fair value. There were no events or changes in circumstances during the nine months ended December 31, 2010 that indicated to management that the carrying value of goodwill and the intangible asset may not be recoverable.
 
 
6

 
 
   
(d)
Fair Value of Financial Instruments
       
     
The Company’s financial instruments consist of cash and cash equivalents, accounts receivables, accounts payable and accrued liabilities, derivative financial instruments, and the Company’s Senior Secured Notes (“Senior Notes”) and Redeemable Series D Convertible Participating Preferred Stock (“Series D Preferred Stock”) issued December 15, 2009. The fair values of cash and cash equivalents, accounts receivables, accounts payable and accrued liabilities generally approximate their respective carrying values due to their current nature. Derivative liabilities, as discussed below, are required to be carried at fair value. The following table reflects the comparison of the carrying value and the fair value of the Company’s Senior Notes and Series D Preferred Stock as of December 31, 2010:
 
   
Carrying Values
   
Fair Values
 
Senior Notes (See Notes 3 and 4)
  $ 1,739,789     $ 2,945,179  
Series D Preferred Stock (See Notes 3 and 5)
  $ 1,877,978     $ 3,567,827  
 
   
The fair values of the Company’s Senior Notes and Series D Preferred Stock have been determined based upon the forward cash flow of the contracts, discounted at credit-risk adjusted market rates.
     
   
Derivative financial instruments – Derivative financial instruments, as defined in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 815 Derivatives and Hedging, consist of financial instruments or other contracts that contain a notional amount and one or more underlying features (e.g. interest rate, security price or other variable), require no initial net investment and permit net settlement. Derivative financial instruments may be free-standing or embedded in other financial instruments. Further, derivative financial instruments are initially, and subsequently, measured at fair value and recorded as liabilities or, in rare instances, assets.
     
   
The Company generally does not use derivative financial instruments to hedge exposures to cash-flow, market or foreign-currency risks. However, the Company issued other financial instruments with features that are either (i) not afforded equity classification, (ii) embody risks not clearly and closely related to host contracts, or (iii) may be net-cash settled by the counterparty. As required by ASC 815, these instruments are required to be carried as derivative liabilities at fair value in the Company’s financial statements. See Notes 4, 5 and 6 for additional information.
     
   
Redeemable preferred stock – Redeemable preferred stock (such as the Series D Preferred Stock, and any other redeemable financial instrument the Company may issue) is initially evaluated for possible classification as a liability under ASC 480 Financial Instruments with Characteristics of Both Liabilities and Equity. Redeemable preferred stock classified as a liability is recorded and carried at fair value. Redeemable preferred stock that does not, in its entirety, require liability classification, is evaluated for embedded features that may require bifurcation and separate classification as derivative liabilities under ASC 815. In all instances, the classification of the redeemable preferred stock host contract that does not require liability classification is evaluated for equity classification or mezzanine classification based upon the nature of the redemption features. Generally, any feature that could require cash redemption for matters not within the Company’s control, irrespective of probability of the event occurring, requires classification outside of stockholders’ equity. See Note 5 for further disclosures about the Company’s Series D Preferred Stock, which constitutes redeemable preferred stock.
     
   
Fair value measurements - Fair value measurement requirements are embodied in certain accounting standards applied in the preparation of the Company’s financial statements. Significant fair value measurements resulted from the application of the fair value measurement guidance included in ASC 815 to the Company’s Series D Preferred Stock, Secured Notes and Warrants issued in December 2009 as described in Note 6, and ASC 718 Stock Compensation to the Company’s share based payment arrangements.
     
   
ASC 815 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Standard applies under other accounting pronouncements that require or permit fair value measurements. ASC 815 further permits entities to choose to measure many financial instruments and certain other items at fair value. At this time, the Company does not intend to reflect any of its current financial instruments at fair value (except that the Company is required to carry derivative financial instruments at fair value). However, the Company will consider the appropriateness of recognizing financial instruments at fair value on a case by case basis as they arise in future periods.
     
 
(e)
Revenue Recognition
     
   
The Company’s revenues are generated from projects subject to contracts requiring the Company to provide its services within specified time periods generally ranging up to twelve months. As a result, on any given date, the Company has projects in process at various stages of completion. Depending on the nature of the contract, revenue is recognized as follows: (i) on time and material service contracts, revenue is recognized as services are rendered; (ii) on fixed price retainer contracts, revenue is recognized on a straight-line basis over the term of the contract; and (iii) on certain fixed price contracts, revenue is recognized as certain key performance criteria are achieved. Incremental direct costs associated with the fulfillment of certain specific contracts are accrued or deferred and recognized proportionately to the related revenue. Provisions for anticipated losses on uncompleted projects are made in the period in which such losses are determined.
 
 
7

 
 
 
(f)
Income Taxes
     
 
 
In assessing the realizability of deferred tax assets, management considers, in light of available objective evidence, whether it is more likely than not that some or all of such assets will be utilized in future periods. At March 31, 2010, the Company had incurred losses for fiscal years 2004 through 2010 for financial reporting purposes aggregating $13,674,000 and would have been required to generate approximately $14,626,000 of aggregate taxable income, exclusive of any reversals or timing differences, to fully utilize its net deferred tax asset. Accordingly, based upon the available objective evidence, particularly the Company’s history of losses, the Company provided a full valuation allowance against its net deferred tax asset.
     
 
(g)
Net Income Per Share
     
   
Basic earnings per share is based upon the weighted average number of common shares outstanding during the period, excluding restricted shares subject to forfeiture. Diluted earnings per share is computed on the same basis, including if dilutive, common share equivalents, which include outstanding options, warrants, preferred stock, and restricted stock. For the nine months ended December 31, 2009, stock options and warrants to purchase 352,016 shares of common stock were excluded from the calculation of diluted earnings (loss) per share as their inclusion would be anti-dilutive. On December 15, 2009, the Company entered into a financing agreement which included the issuance of Series D Preferred Stock, convertible into 5,319,149 shares of Common Stock and warrants to purchase 2,456,272 shares of the Company’s Common Stock (see Note 3), the weighted average of these common share equivalents were included in the calculation of diluted earnings (loss) per share for the three and nine months ended December 31, 2010, and for the three months ended December 31, 2009. For the nine months ended December 31, 2009, 452,250 of these common share equivalents were excluded from the calculation as their inclusion would be anti-dilutive. The weighted average number of shares outstanding consist of:
 
   
Three Months Ended
December 31,
   
Nine Months Ended
December 31,
 
   
2010
   
2009
   
2010
   
2009
 
Basic
    8,030,082       7,589,551       7,934,134       7,055,068  
Dilutive effect of:
                               
Restricted stock
    2,993             1,536        
Warrants
    2,452,757       426,675       2,451,479        
Series D preferred stock
    5,319,149       935,235       5,319,149        
Diluted
    15,804,981       8,951,461       15,706,298       7,055,068  
 
 
(h)
Recent Accounting Standards Affecting the Company
     
   
Revenue Arrangements with Multiple Deliverables
     
   
In October 2009, the FASB issued authoritative guidance that amends existing guidance for identifying separate deliverables in a revenue-generating transaction where multiple deliverables exist, and provides guidance for allocating and recognizing revenue based on those separate deliverables. The guidance is expected to result in more multiple-deliverable arrangements being separable than under current guidance. This guidance is effective for the Company beginning on April 1, 2011 and is required to be applied prospectively to new or significantly modified revenue arrangements. Management currently believes that the adoption of this guidance will not have a material impact on the Company’s financial statements.
     
   
Fair Value Measurements
     
   
In January 2010, the FASB issued guidance which requires, in both interim and annual financial statements, for assets and liabilities that are measured at fair value on a recurring basis disclosures regarding the valuation techniques and inputs used to develop those measurements. It also requires separate disclosures of significant amounts transferred in and out of Level 1 and Level 2 fair value measurements and a description of the reasons for the transfers. This guidance is effective for the Company beginning on April 1, 2011 and is required to be applied prospectively to new or significantly modified revenue arrangements. Management currently believes that the adoption of this guidance will not have a material impact on the Company’s financial statements.
 
 
8

 
 
   
Intangibles – Goodwill and Other
     
   
In December 2010, the FASB amended the existing guidance to modify Step 1 of the goodwill impairment test for a reporting unit with a zero or negative carrying amount. Upon adoption of the amendment, an entity with a reporting unit that has a carrying amount that is zero or negative is required to assess whether it is more likely than not that the reporting unit’s goodwill is impaired. If the entity determines that it is more likely than not that the goodwill of the reporting unit is impaired, the entity should perform Step 2 of the goodwill impairment test for the reporting unit. Any resulting goodwill impairment should be recorded as a cumulative-effect adjustment to beginning retained earnings in the period of adoption. Any goodwill impairments occurring after the initial adoption of the amendment should be included in earnings. This guidance is effective for the Company beginning April 1, 2011. The Company is currently assessing the impact, if any, this may have on its consolidated financial statements.
     
   
Broad Transactions – Business Combination
     
   
In December 2010, the FASB amended the existing guidance to require a public entity, which presents comparative financial statements, to disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only.
     
   
The amendment also expanded the required supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination, which are included in the reported pro forma revenue and earnings. The amendments are effective for the Company beginning April 1, 2011. Management currently believes that the adoption of this guidance will not have an impact on the Company’s financial statements
 
(3)
Union Capital Financing
   
 
Overview:
   
 
On December 15, 2009, the Company consummated a $5.0 million financing led by an investment vehicle organized by Union Capital Corporation (“UCC”). In the financing, the Company issued $2.5 million in aggregate principal amount of the Senior Notes, $2.5 million in aggregate stated value of Series D Preferred Stock initially convertible into 5,319,149 shares of Common Stock, and Warrants to purchase 2,456,272 shares of Common Stock (“Warrants”). As a condition to its participation in the financing, UCC required that certain of the Company’s directors, officers and employees (“Management Buyers”) collectively purchase $735,000 of the financial instruments on the same terms and conditions as the lead investor. Aggregate amounts above are inclusive of Management Buyers amounts. See Note 4 for terms of the Senior Notes.
   
 
The shares of Series D Preferred Stock issued in the financing have a stated value of $1.00 per share, and are convertible into Common Stock at an initial conversion price of $0.47. The conversion price of the Series D Preferred Stock is subject to full ratchet anti-dilution provisions for 18 months following issuance and weighted-average anti-dilution provisions thereafter. Generally, this means that if the Company sells non-exempt securities below the conversion price, the holders’ conversion price will be adjusted downwards. Holders of the Series D Preferred Stock are not entitled to special dividends but will be entitled to be paid upon a liquidation, redemption or change of control, the stated value of such shares plus the greater of (a) a 14% accreting liquidation preference, compounding annually, and (b) 3% of the volume weighted average price of the Common Stock outstanding on a fully-diluted basis (excluding the shares issued upon conversion of the Series D Preferred Stock) for the 20 days preceding the event. A consolidation or merger, a sale of all or substantially all of the Company’s assets, and a sale of 50% or more of Common Stock would be treated as a change of control for this purpose.
   
 
After December 15, 2015, holders of the Series D Preferred Stock can require the Company to redeem the Series D Preferred Stock for cash at its stated value plus any accretion thereon (“Put Derivative”). In addition, the Company may be required to redeem the Series D Preferred Stock for cash earlier upon the occurrence of a “Triggering Event.” Triggering Events include (i) a failure to timely deliver shares of Common Stock upon conversion of Series D Preferred Stock, (ii) failure to pay amounts due to the holders (after notice and a cure period), (iii) a bankruptcy event with respect to the Company or any of its subsidiaries, (iv) default under other indebtedness in excess of certain amounts, and (v) a breach of representations, warranties or covenants in the documents entered into in connection with the financing. Upon a Triggering Event or failure to redeem the Series D Preferred Stock, the accretion rate on the Series D Preferred Stock will increase to 16.5% per annum. The Company may also be required to pay penalties upon a failure to timely deliver shares of Common Stock upon conversion of Series D Preferred Stock.
 
 
9

 
 
 
The Series D Preferred Stock votes together with the Common Stock on an as-converted basis, and the vote of a majority of the shares of the Series D Preferred Stock is required to approve, among other things, (i) any issuance of capital stock senior to or pari passu with the Series D Preferred Stock; (ii) any increase in the number of authorized shares of Series D Preferred Stock; (iii) any dividends or payments on equity securities; (iv) any amendment to the Company’s Certificate of Incorporation, By-laws or other governing documents that would result in an adverse change to the rights, preferences, or privileges of the Series D Preferred Stock; (v) any material deviation from the annual budget approved by the Board of Directors; and (vi) entering into any material contract not contemplated by the annual budget approved by the Board of Directors.
   
 
So long as at least 25% of the shares of Series D Preferred Stock issued at closing are outstanding, the holders of the Series D Preferred Stock as a class will have the right to designate two members of the Company’s Board of Directors, and so long as at least 15% but less than 25% of the shares of Series D Preferred Stock issued at the closing are outstanding, the holders of the Series D Preferred Stock will have the right to designate one member of the Board of Directors. Additionally, the holders of Series D Preferred Stock have the right to designate two non-voting observers to the Company’s Board of Directors.
   
 
The Warrants to purchase 2,456,272 shares of Common Stock issued in the financing have an exercise price of $0.001 per share, subject to adjustment solely for recapitalizations. The Warrants may also be exercised on a cashless basis under a formula that explicitly limits the number of issuable common shares. The exercise period for the Warrants commences 180 days following December 15, 2009 and ends December 15, 2015.
   
 
At the request of the holders of a majority of the shares of Common Stock issuable upon conversion of the Series D Preferred Stock and exercise of the Warrants, if ever, the Company will be required to file a registration statement with the SEC to register the resale of such shares of Common Stock under the Securities Act of 1933, as amended.
   
 
Upon closing of the financing, UCC became entitled to a closing fee of $325,000, half of which was paid upon the closing and the balance of which was paid in six monthly installments following the closing. The Company also reimbursed UCC for its fees and expenses in the amount of $250,000. Additionally, the Company entered into a management consulting agreement with Union Capital under which Union Capital provides the Company with management advisory services and the Company pays Union Capital a fee of $125,000 per year for such services. Such fee will be reduced to $62,500 per year if the holders of the Series D Preferred Stock no longer have the right to nominate two directors and Union Capital no longer owns at least 40% of the Common Stock purchased by it at closing (assuming conversion of Series D Preferred Stock and exercise of Warrants held by it). The management consulting agreement will terminate when the holders of the Series D Preferred Stock no longer have the right to nominate any directors and Union Capital no longer owns at least 20% of the Common Stock purchased by it at closing (assuming conversion of Series Preferred D Stock and exercise of Warrants held by it).
   
 
Accounting for the 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 the Company’s financial statements.
   
 
The Series D Preferred Stock is a hybrid financial instrument. Due to the redemption feature and the associated participation feature that behaves similarly to a coupon on indebtedness, the Company determined that the embedded conversion feature and other features that have risks associated with debt require bifurcation and classification in liabilities as a compound embedded derivative financial instrument. The conversion feature, along with certain other features that have risks of equity, required bifurcation and classification in their compound form in liabilities as a derivative financial instrument. Derivative financial instruments are required to be measured at fair value both at inception and an ongoing basis. As more fully discussed below, the Company has used the Monte Carlo simulation technique to value the compound embedded derivative, because that model affords the flexibility to incorporate all of the assumptions that market participants would likely consider in determining the value for purposes of trading the hybrid contract. Further, due to the redemption feature, the Company is required to carry the host Series D Preferred Stock outside of stockholders’ equity and the discount resulting from the initial allocation requires accretion through charges to retained earnings, using the effective method, over the period from issuance to the redemption date.
 
 
10

 
 
 
We evaluated the terms and conditions of the Senior Secured Notes under the guidance of ASC 815, Derivatives and Hedging. The terms of the Notes that qualify as a derivative instrument are (i) a written put option which allows the holders of the Notes to accelerate interest and principal (effectively forcing an early redemption of the Notes) in the event of certain events of default, including a change of control of the Company, and (ii) the holders’ right to increase the interest rate on the Notes by 4% per year in the event of a suspension from trading of the Company’s Common Stock or an event of default. Pursuant to ASC 815-15-25-40, put options that can accelerate repayment of principal meet the requisite criteria of a derivative financial instrument. In addition, as addressed in ASC 815-15-25-41, for a contingently exercisable put to be considered clearly and closely related to the relevant instrument and not constitute a separate derivative financial instrument, it can be indexed only to interest or credit risk. In this instance, the put instruments embedded in the Notes are indexed to events that are not related to interest or credit risk, namely, a change of control of the Company, and suspension of trading of the Company’s Common Stock. Accordingly, these features are not considered clearly and closely related to the Note, and bifurcation is necessary.
   
 
The Company determined that the Warrants should be classified as stockholders’ equity. The principal concepts underlying accounting for warrants provide a series of conditions, related to the potential for net cash settlement, which must be met in order to achieve equity classification. Our conclusion is that the Warrants are indexed to the Company’s common stock and meet all of the conditions for equity classification. The Company measured the fair value of the Warrants on the inception date to provide a basis for allocating the net proceeds to the various financial instruments issued in the December 2009 financing. As more fully discussed below, the Company used the Black-Scholes-Merton valuation technique, because that method embodies, in its view, all of the assumptions that market participants would consider in determining the fair value of the Warrants for purposes of a sale or exchange. The allocated value of the Warrants was recorded to Additional Paid-in Capital.
   
 
The financial instruments sold to the Management Buyers, were recognized as compensation expense in the amount by which the fair value of the share-linked financial instruments (i.e. Series D Preferred Stock and Warrants) exceeded the proceeds that the Company received. The financial instruments subject to allocation are the Secured Notes, Series D Preferred Stock, Compound Embedded Derivatives (“CED”) and the Warrants. Other than the compensatory amounts, current accounting concepts generally provide that the allocation is, first, to those instruments that are required to be recorded at fair value; that is, the CED; and the remainder based upon relative fair values.
   
 
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     $ 1,127,575     $ 233,098     $ 1,360,673  
Senior Notes
  $ 2,536,015       1,070,518       363,293       1,433,811  
Compound Embedded Derivatives (CED):
                               
Series D Preferred Stock
  $ 1,116,595       949,106       167,489       1,116,595  
Senior Notes
  $ 28,049       23,842       4,207       28,049  
Warrants
  $ 1,225,680       518,959       183,852       702,811  
Compensation Expense
                  (216,939 )     (216,939 )
            $ 3,690,000     $ 735,000     $ 4,425,000  
 
 
Closing costs of $325,000 were paid directly to the lead investor. The Company agreed to reimburse UCC $250,000 for out-of-pocket expenses of which $150,000 was paid upon signing of the purchase agreement in November 2009, and the remainder was paid at closing. Financing costs paid directly to an investor or creditor are reflected in the allocation as original issue discount to the financial instruments.
 
 
11

 
 
 
Fair Value Considerations:
   
 
The Company has adopted the authoritative guidance on “Fair Value Measurements.” The guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, not adjusted for transaction costs. The guidance also establishes a fair value hierarchy that prioritizes the inputs to the valuation techniques used to measure fair value into three broad levels giving the highest priority to quoted prices in active markets for identical asset or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3) as described below:
 
 
Level 1 Inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that are accessible by the Company.
   
 
Level 2 Inputs – Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly.
   
 
Level 3 Inputs – Unobservable inputs for the asset or liability including significant assumptions of the Company and other market participants.
 
 
The Company’s Senior Secured Notes, Warrant derivative liability, Put option derivative and Series D Preferred Stock are classified within Level 3 of the fair value hierarchy as they are valued using unobservable inputs including significant assumptions of the Company and other market participants.
   
 
The following tables present the Company’s instruments that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy.
 
   
Unaudited
Fair Value Measurements as of December 31, 2010
 
   
Total
   
Level 1
   
Level 2
   
Level 3
 
Instruments:
                       
Senior Notes
  $ 1,739,789     $     $     $ 1,739,789  
Warrants
    1,859,205                   1,859,205  
Put Derivative
    6,851                   6,851  
Series D Preferred Stock
    1,877,978                   1,877,978  
Total Instruments
  $ 5,483,823     $     $     $ 5,483,823  
 
   
Audited
Fair Value Measurements as of March 31, 2010
 
   
Total
   
Level 1
   
Level 2
   
Level 3
 
Instruments:
                       
Senior Notes
  $ 1,514,340     $     $     $ 1,514,340  
Warrants
    849,211                   849,211  
Put Derivative
    110,940                   110,940  
Series D Preferred Stock
    1,503,589                   1,503,589  
Total Instruments
  $ 3,978,080     $     $     $ 3,978,080  
 
 
The following table presents the changes in Level 3 Instruments measured at fair value on a recurring basis for the nine months ended December 31, 2010 and 2009:
 
   
2010
   
2009
 
   
Instruments
   
Instruments
 
Beginning balance at March 31,
  $  3,978,080     $  —  
Initial allocation of fair values
          3,939,128  
Fair value adjustments – Warrants and Put Derivative
    905,905       (269,493 )
Discount amortization – Senior Notes
    225,449       12,069  
Accretion - Series D Preferred Stock
    374,389       21,548  
Ending balance at December 31,
  $ 5,483,823     $ 3,703,252  
 
 
The fair value adjustments recorded for Warrants and Put Derivative are reported separately in the Statement of Operations, the discount amortization on Senior Notes is reported in interest expense, and accretion on Series D Preferred Stock is recorded to the accumulated deficit.
 
 
12

 
 
(4)
Long-Term Debt
   
 
Long-term debt consists of the following as of December 31, 2010 and March 31, 2010:
 
   
December 31, 2010
   
March 31, 2010
 
$2,500,000 face value, 12.5% Senior Secured Notes due December 15, 2012, net of $760,211 and $985,660 discount as of December 31, 2010 and March 31, 2010, respectively(a)
  $ 1,739,789     $ 1,514,340  
      1,739,789       1,514,340  
Less current maturities
           
Long-term debt
  $ 1,739,789     $ 1,514,340  
                 
                 
Maturities of long-term debt as of December 31, 2010 are as follows:
               
Year ending December 31:
               
2011
  $          
2012
    2,500,000          
    $ 2,500,000          
 
 
(a)
Senior Secured Notes
     
   
The Company issued $2,500,000 face value of Senior Notes on December 15, 2009 in connection with the December 15, 2009 financing described in Note 3. As described in Note 3, the proceeds from the financing were allocated among multiple financial instruments based on fair values. Proceeds allocated to the Senior Notes amounted to $1,433,811. The resulting discount is subject to amortization through charges to interest expense over the term to maturity using the effective interest method. Discount amortization included in interest expense for the three and nine months ended December 31, 2010 amounted to $78,652 and $225,449 respectively, and for the period from December 15, 2009 to March 31, 2010 amounted to $80,529. For the three and nine months ended December 31, 2009, discount amortization amounted to $12,069.
     
   
The Senior Notes are secured by substantially all of the Company’s assets; bear interest at a rate of 12.5% per annum payable quarterly; and mature in one installment on December 15, 2012. The Company has the right to prepay the Secured Notes at any time. While the Secured Notes are outstanding, the Company is subject to customary affirmative, negative and financial covenants. The financial covenants include (i) a fixed charge coverage ratio test requiring the Company to maintain a fixed charge coverage ratio of not less then 1.40 to 1.00 at the close of each fiscal quarter commencing December 31, 2010, (ii) a minimum EBITDA test, to be tested at the end of each fiscal quarter commencing ending December 31, 2010, requiring the Company to generate “EBITDA” of at least $3,000,000 over the preceding four fiscal quarters, (iii) a minimum liquidity test requiring the Company to maintain cash and cash equivalents of $500,000 at all times, and (iv) limitations on capital expenditures. The Company is in compliance with the financial covenants set forth in the Secured Notes for the period ended December 31, 2010.
     
   
In May 2010, the Company entered into a First Amendment to Senior Secured Notes (the “Note Amendment”), in connection with the Company’s pledge of $500,000 as cash collateral to Sovereign Bank to secure the Company’s reimbursement obligations under a letter of credit issued on behalf of the Company in favor of American Express Related Services Company, Inc. (“Amex”). The letter of credit supports the Company’s credit line with respect to Amex credit cards issued to the Company and its employees. Pursuant to the Note Amendment, among other things, the Senior Notes were amended to (i) permit the Company to pledge the cash collateral to Sovereign Bank, and (ii) increase the interest rate thereunder by four percent to 16.5% during the period that the cash is pledged to Sovereign Bank.
 
 
13

 
 
(5)
Redeemable Preferred Stock
   
 
Redeemable preferred stock consists of the following as of December 31, 2010 and March 31, 2010:
 
   
December 31, 2010
   
March 31, 2010
 
Series D Convertible Participating Preferred Stock, par value $0.001, stated value $1.00, 2,500,000 shares designated, 2,500,000 shares issued and outstanding at December 31, 2010; redemption and liquidation value $2,865,342 and $2,601,644 at December 31, 2010 and March 31, 2010, respectively
  $ 1,877,978     $ 1,503,589  
 
 
The Series D Preferred Stock is subject to accretion to its redemption value, through charges to equity, over the period from issuance to the contractual redemption date, discussed in the Financing Overview, above, using the effective interest method. The redemption value is determined based upon the stated redemption amount of $1.00 per share, plus an accretion amount, more fully discussed above. For the three and nine months ended December 31, 2010, accretion amounted to $126,054 and $374,389 respectively, and for the period from December 15, 2009 to March 31, 2010 amounted to $142,916. For the three and nine months ended December 31, 2009, accretion amounted to $21,548.
   
(6)
Derivative Financial Instruments
   
 
The Company’s derivative financial instruments consist of CEDs that were bifurcated from the Company’s Series D Preferred Stock and Senior Notes. The Preferred CED comprises the embedded conversion option and certain other equity-indexed features that were not clearly and closely related to the Series D Preferred Stock in terms of risks. The Senior Note CED comprises certain put features that were not clearly and closely related to the Senior Notes in terms of risks. Derivative financial instruments are carried at fair value. The following table reflects the components of the CEDs and changes in fair value, using the techniques and assumptions described in Note 3:
 
   
Warrant
Derivative
   
Put
Derivative
   
Total
 
Balances at April 1, 2009
  $     $     $  
Issuances
    1,116,595       28,049       1,144,644  
Fair value adjustments
    (267,384 )     82,891       (184,493 )
Balances at March 31, 2010
    849,211       110,940       960,151  
Fair value adjustments
    1,009,994       (104,089 )     905,905  
Balances at December 31, 2010
  $ 1,859,205     $ 6,851     $ 1,866,056  
 
 
Fair value adjustments are recorded separately in the Statement of Operations. As a result, the Company’s earnings are and will be affected by changes in the assumptions underlying the valuation of the derivative financial instruments. The principal assumptions that have, in the Company’s view, the most significant effects are the Company’s trading market prices, volatilities and risk-adjusted market credit rates.
   
(7)
Accounting for Stock-Based Compensation
   
 
(i) Stock Options
   
 
Under the Company’s 1992 Stock Option Plan (the “1992 Plan”), employees of the Company and its subsidiaries and members of the Board of Directors were granted options to purchase shares of Common Stock of the Company. The 1992 Plan was amended on May 11, 1999 to increase the maximum number of shares of Common Stock for which options may be granted to 1,500,000 shares. The 1992 Plan terminated in 2002, although options issued thereunder remain exercisable until the termination dates provided in such options. Options granted under the 1992 Plan were either intended to qualify as incentive stock options under the Internal Revenue Code of 1986, or non-qualified options. Grants under the 1992 Plan were awarded by a committee of the Board of Directors, and are exercisable over periods not exceeding ten years from date of grant. The option price for incentive stock options granted under the 1992 Plan must be at least 100% of the fair market value of the shares on the date of grant, while the price for non-qualified options granted to employees and employee directors was determined by the committee of the Board of Directors. At December 31, 2010, there were options to purchase 6,875 shares of Common Stock, expiring April 2011, issued under the 1992 Plan.
   
 
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 Committee of the Board of Directors. At December 31, 2010, there were options to purchase 297,500 shares of Common Stock, expiring from April 2011 through September 2017, issued under the 2002 Plan that remained outstanding. Any option under the 2002 Plan that is not exercised by an option holder prior to its expiration may be available for re-issuance by the Company. As of December 31, 2010, the Company had options or other awards for 143,929 shares of Common Stock available for grant under the 2002 Plan.
 
 
14

 
 
 
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 employees, officers, directors, consultants and advisors of stock options (non-statutory and incentive), restricted stock awards, stock appreciation rights, restricted stock units and other performance stock awards. The 2010 Plan is administered by the Compensation Committee of the Board of Directors. The exercise price per share of a stock option, which is determined by the Compensation Committee, may not be less than 100% of the fair market value of the common stock on the date of grant. For non-qualified options the term of the option is determined by the Compensation Committee. For incentive stock options the term of the option is not more than ten years. However, if the optionee owns more than 10% of the total combined voting power of the Company, the term of the incentive stock option will be no longer than five years. The 2010 Plan automatically terminates on February 22, 2020, unless it is terminated earlier by a vote of the Company’s stockholders or the Board of Directors; provided, however, that any such action does not affect the rights of any participants of the 2010 Plan. In addition, the 2010 Plan may be amended by the stockholders of the Company or the Board of Directors, subject to stockholder approval if required by applicable law or listing requirements. At December 31, 2010, there were options to purchase 2,744,302 shares of Common Stock, expiring May 2020, issued under the 2010 Plan that remained outstanding. Any option under the 2010 Plan that is not exercised by an option holder prior to its expiration may be available for re-issuance by the Company. As of December 31, 2010, the Company had options or other awards for 255,698 shares of Common Stock available for grant under the 2010 Plan.
   
 
The maximum contractual life for any of the options is ten years. The Company uses the Black-Scholes model to estimate the value of stock options granted under FASB guidance. Because option-pricing models require the use of subjective assumptions, changes in these assumptions can materially affect the fair value of options.
   
 
A summary of option activity under all plans as of December 31, 2010, and changes during the nine month period then ended is presented below:
 
   
Weighted average exercise price
   
Number
of
options
   
Weighted average remaining contractual term (years)
   
Aggregate intrinsic value
 
                         
Balance at March 31, 2010
  $ 2.16       311,250       4.05     $  
Granted
  $ 0.43       2,744,302                  
Exercised
                           
Canceled
  $ 2.00       (6,875 )                
Balance at December 31, 2010 (vested and expected to vest)
  $ 0.60       3,048,677       8.79     $  
Exercisable at December 31, 2010
  $ 2.16       304,375       3.39     $  
 
 
Total unrecognized compensation cost related to vested and expected to vest options at December 31, 2010 amounted to $607,118 and is expected to be recognized over a weighted average period of 3.42 years. Total compensation cost for all outstanding option awards amounted to $44,424 and $103,656 for the three and nine months ended December 31, 2010 and $3,261 for the nine months ended December 31, 2009, respectively.
   
 
(ii) Warrants
   
 
At December 31, 2010 and March 31,2010 there were warrants to purchase 2,456,272 shares of common stock at a price of $.001 per share, which were issued in the December 2009 financing and expire December 15, 2015. At March 31, 2010 there was also an outstanding warrant to purchase 40,766 shares of common stock at an exercise price per share of $3.68 held by one individual, which expired on April 30, 2010. The aggregate intrinsic value of the warrants at December 31, 2010 and March 31, 2010 was $1,471,307 and $906,364, respectively.
 
 
15

 
 
 
(iii) Restricted Stock
   
 
During the nine months ended December 31, 2010, the Company did not award any shares of Common Stock initially subject to forfeiture (“restricted stock”).
   
 
As of December 31, 2010 the Company had outstanding 516,892 shares of unvested restricted stock that had been issued pursuant to the authorization of the Company’s Board of Directors and certain Restricted Stock Agreements, including 81,860 shares of restricted stock that were not issued under any of the Company’s equity 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 December 31, 2010 amounted to approximately $310,135. The shares of restricted stock granted pursuant to such agreements generally vest in various tranches over five years from the date of grant.
   
 
The shares awarded to employees under the restricted stock agreements vest on the applicable vesting dates only to the extent the recipient of the shares is then an employee of the Company or one of its subsidiaries, and each recipient will forfeit all of the shares that have not vested on the date his or her employment is terminated.
   
 
A summary of all non-vested stock activity as of December 31, 2010, and changes during the nine month period then ended is presented below:
 
   
Weighted average grant date fair value
   
Number
of
shares
   
Weighted average remaining contractual term (years)
   
Aggregate intrinsic value
 
                         
Unvested at March 31, 2010
  $ 1.92       786,966       3.57     $ 291,177  
                                 
Awarded
                           
Vested
  $ 1.84       (247,101 )                
Forfeited
  $ 2.37       (22,973 )                
                                 
Unvested at December 31, 2010
  $ 1.94       516,892       2.87     $ 310,135  
 
 
Total unrecognized compensation cost related to unvested stock awards at December 31, 2010 amounted to $673,744 and is expected to be recognized over a weighted average period of 2.87 years. Total compensation cost for the stock awards amounted to $60,217 and $284,970 for the three and nine months ended December 31, 2010 and $205,044 and $422,234 for the three and nine months ended December 31, 2009, respectively.
   
(8)
Concentrations
   
 
The following tables list the sales by dollar amount and as a percentage of total sales for the Company’s three largest customers for the three and nine months ended December 31, 2010 and 2009, and accounts receivable due from those customers as of December 31, 2010 and 2009:
 
   
Sales for the Three and Nine Months Ended December 31, 2010
     
   
Three Months Ended
12/31/10
   
% of Total
 
Nine Months Ended 12/31/10
   
% of Total
 
Accounts Receivable as of 12/31/10
 
                               
Customer A
  $ 23,177,000     69 %   $ 59,738,000     65 %   $ 6,585,000  
Customer B
  $ 3,886,000     12 %   $ 16,656,000     18 %   $ 922,000  
Customer C
  $ 4,143,000     12 %   $ 5,687,000     6 %   $ 196,000  
 
 
16

 
 
   
Sales for the Three and Nine Months Ended December 31, 2009
     
   
Three Months Ended
12/31/09
   
% of Total
 
Nine Months Ended 12/31/09
   
% of Total
 
Accounts Receivable as of 12/31/09
 
                               
Customer A
  $ 13,138,000     62 %   $ 37,003,000     62 %   $ 3,715,000  
Customer B
  $ 4,069,000     12 %   $ 6,939,000     8 %   $ 360,000  
Customer C
  $ 4,406,000     11 %   $ 6,088,000     8 %   $ 138,000  
 
(9)
Income Taxes
   
 
The Company did not record a benefit for federal, state and local income taxes for the three and nine months ended December 31, 2010 and 2009 because any such benefit would be fully offset by an increase in the valuation allowance against the Company’s net deferred tax asset established as a result of the Company’s historical operating losses.
   
(10)
Derivative Complaint
   
 
On May 7, 2010, Brian Murphy, derivatively on behalf of the Company, commenced a lawsuit in the Supreme Court of the State of New York, County of New York (the “Court”), against the former Chairman of the Company’s Board of Directors, certain former directors and officers of the Company, and the Company as a nominal defendant. The Complaint filed by Mr. Murphy in the action alleges, among other things, that the defendants breached fiduciary duties owed to the Company and its stockholders by failing to ensure that the Company’s financial statements for its fiscal year ended March 31, 2008 and quarter ended June 20, 2008 were prepared correctly, and by causing the Company to enter into the December 2009 financing on terms dilutive to the Company’s stockholders.
   
 
On June 30, 2010 the defendants filed a motion to dismiss the Complaint. Thereafter, on October 27, 2010, Mr. Murphy filed an Amended Complaint with the Court, naming the investors in the Company’s December 2009 financing as additional defendants. In addition to repeating the allegations made in the original Complaint, the Amended Complaint alleges that the investors in the Company’s December 2009 financing were unjustly enriched at the Company’s expense, and seeks the rescission of the financing transaction, or in the alternative, the reformation of the terms of the financing. On December 23, 2010 the defendants filed a motion to dismiss the Amended Complaint, which motion is currently pending before the Court.
   
 
The Company is a nominal defendant for purposes of the derivative action claims, and is not aware of any claims for affirmative relief being made against it other than with respect to the rescission or reformation of the December 2009 financing transaction. The Company has obligations to provide indemnification to its officers and directors (and former officers and directors), as well as to the investors in the December 2009 financing, including for all legal costs incurred by them in defending these claims. The Company believes the lawsuit is without merit and intends to defend this action vigorously. However, the ultimate outcome of any litigation is uncertain and could result in substantial damages. Through the quarter ended December 31, 2010, the Company had incurred approximately $410,000 in legal expenses in connection with its defense of the lawsuit and its indemnification obligations.
 
 
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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, 2010 under “Risk Factors,” including but not limited to “Recent Losses,” “Internal Controls,” “Concentration of Customers,” “Recent Economic Changes,” “Dependence on Key Personnel,” “Outstanding Indebtedness; Security Interest,” Series D Preferred Stock Liquidation Preference; Redemption,” Control by Union Capital Corporation and Holders of Series D Preferred Stock,” Anti-Dilution Provisions of The Series D Preferred Stock Could Result In Dilution of Stockholders,” “Unpredictable Revenue Patterns,” “Competition,” “Derivative Litigation,” and “Risks Associated with Acquisitions,” in addition to other information set forth herein and elsewhere in our other public filings with the Securities and Exchange Commission. The forward-looking statements contained in this report speak only as of the date hereof. The Company does not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Overview
 
‘mktg, inc.’, through its wholly-owned subsidiaries Inmark Services LLC, Optimum Group LLC, U.S. Concepts LLC and Digital Intelligence Group LLC, is a full-service marketing agency. We develop, manage and execute sales promotion programs at both national and local levels, utilizing both online and offline media channels. Our programs help our clients effectively promote their goods and services directly to retailers and consumers and are intended to assist them in achieving maximum impact and return on their marketing investment. Our activities reinforce brand awareness, provide incentives to retailers to order and display our clients’ products, and motivate consumers to purchase those products, and are designed to meet the needs of our clients by focusing on communities of consumers who want to engage brands as part of their lifestyles.
 
Our services include experiential and face to face marketing, event marketing, interactive marketing, ethnic marketing, and all elements of consumer and trade promotion, and are marketed directly to our clients by our sales force operating out of offices located in New York, New York; Cincinnati, Ohio; Chicago, Illinois; Los Angeles, California and San Francisco, California.
 
‘mktg, inc.’ was formed under the laws of the State of Delaware in March 1992 and is the successor to a sales promotion business originally founded in 1972. ‘mktg, inc.’ began to engage in the promotion business following a merger consummated on September 29, 1995 that resulted in Inmark becoming its wholly-owned subsidiary.
 
Our corporate headquarters are located at 75 Ninth Avenue, New York, New York 10011, and our telephone number is 212-660-3800. Our Web site is www.mktg.com. Copies of all reports we file with the Securities and Exchange Commission are available on our Web site.
 
Results of Operations
 
Overview
 
For the nine months ended December 31, 2010 we generated $2,592,000 in operating income, a $3,325,000 increase over the ($733,000) operating loss realized in the same period of the prior fiscal year. This improvement was primarily the result of an increase of $2,108,000 in Operating Revenue, as well as the previously reported expense reduction actions taken by management. These efforts included a reduction in our workforce in prior periods, resulting in a $1,304,000 reduction in compensation expense for the nine months ended December 31, 2010, compared to the same period in the prior year. Operating income for the nine months ended December 31, 2010 was negatively impacted by approximately $410,000 of legal costs incurred in connection with the derivative lawsuit commenced by Brian Murphy, which is described in Legal Proceedings below.
 
 
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Our net income for the nine months ended December 31, 2010 was $1,182,000, which reflects a $906,000 non-cash charge for the fair value adjustment to the derivative financial instruments reflected on our balance sheets in connection with our December 2009 financing. This adjustment is primarily attributable to the rise in the price of our Common Stock during the period, which under generally accepted accounting principles required us to increase the carrying values of the Warrant derivative liability and other derivative liabilities on our balance sheets and record the amount of such increases under “Fair value adjustments to compound embedded derivatives” on our statements of operations. A more detailed explanation of the accounting treatment for these derivative financial instruments is provided in Note 3 to our Condensed Consolidated Financial Statements in Item 1 of this Report.
 
Operating Revenue and Modified EBITDA
 
We believe Operating Revenue and Modified EBITDA are key performance indicators. We define Operating Revenue as our sales less reimbursable program costs and expenses, and outside production and other program expenses. Operating Revenue is the net amount derived from sales to customers that we believe is available to fund our compensation, general and administrative expenses, and capital expenditures. We define Modified EBITDA as income before interest, income taxes, depreciation and amortization plus other non-cash expenses. Modified EBITDA is a supplemental measure to evaluate operational performance. Operating Revenue and Modified EBITDA are Non-GAAP financial measures disclosed by management to provide additional information to investors in order to provide them with an alternative method for assessing our financial condition and operating results. These measures are not in accordance with, or a substitute for, GAAP, and may be different from or inconsistent with Non-GAAP financial measures used by other companies.
 
The following table presents operating data expressed as a percentage of Operating Revenue for the three and nine months ended December 31, 2010 and 2009, respectively:

   
Three Months Ended
December 31,
 
Nine Months Ended
December 31,
   
2010
 
2009
 
2010
 
2009
                         
Statement of Operations Data:
                       
Operating revenue
  100.0 %   100.0 %   100.0 %   100.0 %
Compensation expense
  71.8 %   73.4 %   69.5 %   81.1 %
General and administrative expense
  20.2 %   23.2 %   20.5 %   22.0 %
Operating income (loss)
  8.0 %   3.4 %   10.0 %   (3.1 %)
Interest expense, net
  (2.1 %)   (0.5 %)   (2.0 %)   (0.2 %)
Other income
  0.2 %   0.0 %   0.1 %   1.1 %
Fair value adjustments to compound embedded derivatives
  6.5 %   3.3 %   (3.5 %)   0.0 %
Income (loss) before provision for income taxes
  12.6 %   6.2 %   4.6 %   (2.2 %)
Provision for income taxes
  0.0 %   0.0 %   0.0 %   0.0 %
Net income (loss)
  12.6 %   6.2 %   4.6 %   (2.2 %)

Sales. Sales consist of fees for services, commissions, reimbursable program costs and expenses and other production and program expenses. We purchase a variety of items and services on behalf of our clients for which we are reimbursed pursuant to our client contracts. The amount of reimbursable program costs and expenses, and outside production and other program expenses which are included in revenues will vary from period to period, based on the type and scope of the service being provided. Sales for the three months ended December 31, 2010 increased 32% to $31,745,000, compared to $24,102,000 for the quarter ended December 31, 2009. Sales for the nine months ended December 31, 2010 increased 45% to $89,438,000, compared to $61,789,000 for the nine months ended December 31, 2009. These increases in sales are primarily due to an increase in events we executed for our largest customer, Diageo North America, Inc. (“Diageo”), and an increase in experiential marketing revenues, partially offset by a decrease in trade and digital marketing revenues.
 
Reimbursable Program Costs and Expenses. Reimbursable program costs and expenses are primarily direct labor, travel and product costs generally associated with events we execute for Diageo. Reimbursable program costs and expenses for the three months ended December 31, 2010 and 2009 were $5,881,000 and $4,150,000, respectively. Reimbursable program costs and expenses for the nine months ended December 31, 2010 and 2009 were $17,462,000 and $11,912,000, respectively. These increases are primarily due to the increase in the number of events we executed during the three and nine month periods ended December 31, 2010 versus the same periods in Fiscal 2010.
 
 
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Outside Production and other Program Expenses. Outside production and other program expenses consist of the costs of purchased materials, media, services, certain direct labor charged to programs and other expenditures incurred in connection with and directly related to sales but which are not classified as reimbursable program costs and expenses. Outside production and other program expenses for the three months ended December 31, 2010 were $17,290,000 compared to $11,823,000 for the three months ended December 31, 2009. This increase is primarily due to an increase in the Diageo events we executed during the period, partially offset by reductions in our experiential and digital marketing programs. Outside production and other program expenses for the nine months ended December 31, 2010 were $46,078,000 compared to $26,087,000 for the nine months ended December 31, 2009. This increase is primarily due to the increase in the Diageo and experiential events we executed during the period, partially offset by reductions in our trade and digital marketing programs.
 
Operating Revenue. For the three months ended December 31, 2010, Operating Revenue increased by 5% to $8,574,000, compared to $8,129,000 for the three months ended December 31, 2009. For the nine months ended December 31, 2010, Operating Revenue increased by 9% to $25,898,000, compared to $23,790,000 for the nine months ended December 31, 2009. These increases in Operating Revenue are primarily due to an increase in the Diageo and experiential events we executed during the periods, partially offset by a decrease in digital marketing revenues. Operating Revenue as a percentage of Sales for the three and nine months ending December 31, 2010 were 27% and 29%, respectively, compared to 34% and 39% for the three and nine months ending December 31, 2009. These decreases are primarily due to an increase in Diageo events we executed, which typically include a higher percentage of pass-through expense billed at cost. A reconciliation of Sales to Operating Revenues for the three and nine months ended December 31, 2010 and 2009 is set forth below.

      Three Months Ended
December 31,
     Nine Months Ended
December 31,
 
Sales
 
2010
 
%
  2009   %  
2010
 
%
 
2009
 
%
 
 
Sales – U.S. GAAP
  $ 31,745,000   100   $ 24,102,000   100   $ 89,438,000   100   $ 61,789,000   100  
Reimbursable program costs and outside production expenses
    23,171,000   73     15,973,000   66     63,540,000   71     37,999,000   61  
Operating Revenue – Non-GAAP
  $ 8,574,000   27   $ 8,129,000   34   $ 25,898,000   29   $ 23,790,000   39  

Compensation Expense. Compensation expense, exclusive of reimbursable program costs and expenses and other program expenses, consists of the salaries, payroll taxes and benefit costs related to indirect labor, overhead personnel and certain direct labor otherwise not charged to programs. For the three months ended December 31, 2010, compensation expense increased $189,000 to $6,156,000, compared to $5,967,000 for the three months ended December 31, 2009. This increase is primarily the result of an increase in accrued bonuses, partially offset by a decrease in share based compensation expense. For the nine months ended December 31, 2010, compensation expense decreased $1,304,000 to $17,990,000, compared to $19,294,000 for the nine months ended December 31, 2009. This decrease is primarily the result of staff reductions in the trade and digital marketing departments, a reduction in share based compensation expense and a decrease in severance expense, partially offset by an increase in accrued bonuses.
 
General and Administrative Expenses. General and administrative expenses consists of office and equipment rent, depreciation and amortization, professional fees, other overhead expenses and charges for doubtful accounts. For the three months ended December 31, 2010, general and administrative expenses decreased $158,000 to $1,730,000, compared to $1,888,000 for the three months ended December 31, 2009. This decrease is primarily the result of non-recurring broker fee paid in 2009 on the sublease of our principal office space in New York, partially offset by legal fees we incurred in the defense of the derivative lawsuit commenced by Brain Murphy. For the nine months ended December 31, 2010, general and administrative expenses increased $87,000 to $5,316,000, compared to $5,229,000 for the nine months ended December 31, 2009. This increase is primarily the result of legal fees we incurred in the defense of the derivative lawsuit commenced by Brain Murphy, partially offset by reductions in depreciation, communication expenses, and a non-recurring broker fee paid in 2009 on the sublease of our principal office space in New York.
 
 
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Modified EBITDA. As described above, we believe that Modified EBITDA is an additional key performance indicator. We use it to measure and evaluate operational performance and it is one of the metrics against which we are tested under the Secured Notes as described in the Liquidity and Capital Resources section below. The Company’s Modified EBITDA for the three months ended December 31, 2010 was $1,077,000 compared to $989,000 for the three months end December 31, 2009. For the nine months ended December 31, 2010 the Company’s modified EBITDA was $3,855,000 compared to $809,000 for the nine months end December 31, 2009. A reconciliation of operating income (loss) to Modified EBITDA for the three and nine months ended December 31, 2010 and 2009 is set forth below.
 
   
Three Months Ended
   
Nine Months Ended
 
   
December 31,
   
December 31,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Operating income (loss)- US GAAP
  $ 687,000     $ 274,000     $ 2,592,000     $ (733,000 )
Depreciation and amortization
    270,000       293,000       829,000       900,000  
Income tax expense
    15,000             45,000        
Share based compensation expense
    105,000       422,000       389,000       642,000  
Modified EBITDA – Non-GAAP
  $ 1,077,000     $ 989,000     $ 3,855,000     $ 809,000  
 
Interest Expense, Net. Net interest expense for the three months ended December 31, 2010 was $177,000 compared to $41,000 for the three months ended December 31, 2009. Net interest expense for the nine months ended December 31, 2010 was $516,000 compared to $63,000 for the nine months ended December 31, 2009. The increase in interest expense was primarily due to the Secured Notes we issued in the December 2009 financing. Interest expense on the Secured Notes included non-cash charges of $79,000 and $225,000 in discount amortization for the three and nine months ending December 31, 2010, respectively. For the three and nine months ending December 31, 2009 these non-cash charges amounted to $12,000.
 
Fair value adjustments to compound embedded derivatives. Fair value adjustments to compound embedded derivatives for the three and nine months ended December 31, 2010 were $560,000 and ($906,000), respectively. For the three and nine months ended December 31, 2009 these fair value adjustments to compound embedded derivatives amounted to $269,000. 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 in increase in the price of our Common Stock in a particular period will result in an increase in the carrying values of these derivative liabilities on our balance sheets at the end of such period and require us to record the amount of such increase as a charge under “Fair value adjustments to compound embedded derivatives” on our statements of operations for such period, and a decrease in the price of our Common Stock in a particular period will have the opposite effect. A more detailed explanation of the accounting treatment for these derivative financial instruments is provided in Note 3 to our Condensed Consolidated Financial Statements in Item 1 of this Report.
 
Income (Loss) before Provision for Income Taxes. The Company’s income before provision for income taxes for the three months ended December 31, 2010 was $1,082,000 compared to $503,000 for the three months ended December 31, 2009. For the nine months ended December 31, 2010 the Company’s income before provision for income taxes was $1,182,000 compared to a loss before provision for income taxes of ($527,000) for the nine months ended December 31, 2009.
 
Provision for Income Taxes. We did not record a provision or benefit for federal, state and local income taxes for the three and nine months ended December 31, 2010 and 2009 because any such provision or benefit would be fully offset by a change in the valuation allowance against our net deferred tax asset established as a result of our historical operating losses.
 
Net Income (Loss). As a result of the items discussed above, the net income for the three months ended December 31, 2010 was $1,082,000 compared to $503,000 for the three months end December 31, 2009. For the nine months ended December 31, 2010 the Company’s net income was $1,182,000 compared to a net loss of ($527,000) for the nine months ended December 31, 2009. Fully diluted earnings (loss) per share amounted to $.07 and $.08 for the three and nine months ended December 31, 2010, compared to $.06 and ($.07) for the three and nine months ended December 31, 2009.
 
 
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Liquidity and Capital Resources
 
We have continuously operated with negative working capital. This deficit has generally resulted from our inability to generate sufficient cash and receivables from our programs to offset our current liabilities, which consist primarily of obligations to vendors and other accounts payable, deferred revenues and bank borrowings required to be paid within 12 months from the date of determination. We have been able to operate during this extended period with negative working capital due primarily to advance payments made to us on a regular basis by our largest customers, and to a lesser degree, equity infusions from private placements of our securities, and stock option and warrant exercises. For the nine months ended December 31, 2010, the working capital deficit decreased by $2,593,000 (67%) from $3,853,000 to $1,260,000, primarily as a result of the operating income generated during the period.
 
In Fiscal 2010, we experienced a reduction in deferred revenues (i.e., advance payments by clients). We were also required to repay approximately $1.6 million in advance billings to Diageo as a result of a reduction in our Diageo business, which payment was made using a portion of the proceeds from the $5 million financing described below. Furthermore, in November 2009 the method by which Diageo prepays expenses we incur in connection with the execution of their programs was changed so that we are now reimbursed on a semi-monthly basis (twice each month) instead of on a monthly basis, thereby reducing the amount of each such prepayment. Specifically, we are now generally reimbursed in advance on the first and 15th day of each month for the reimbursable expenses we expect to incur during the half-month period following the date of reimbursement. Previously, Diageo generally reimbursed us in advance on the first day of each month for the reimbursable expenses we expected to incur during the entire month.
 
Due to our performance, management took substantial steps at the end of Fiscal 2009 and in Fiscal 2010 to reduce expenses and to reset the direction of the business into areas and markets consistent with our core capabilities. These steps included the reduction of our workforce by approximately 60 full-time persons, in the aggregate, and other cost cutting measures which reduced compensation, and general and administrative expenses by approximately $6.2 million ($5.3 million of compensation and $900,000 of general and administrative expenses) in Fiscal 2010, and which are expected to reduce such costs by an aggregate of approximately $8.6 million (approximately $7.8 million of compensation and approximately $800,000 of general and administrative expenses) in the aggregate in Fiscal 2011.
 
In light of our pressing cash needs caused by the events described above, on December 15, 2009, we consummated a $5 million financing led by an investment vehicle organized by Union Capital Corporation (“Union Capital”). In the financing, we issued $2.5 million in aggregate principal amount of Senior Secured Notes, $2.5 million in aggregate stated value of Series D Convertible Participating Preferred Stock initially convertible into 5,319,149 shares of Common Stock, and Warrants to purchase 2,456,272 shares of Common Stock. The Secured Notes are secured by substantially all of our assets; originally bore interest at a rate of 12.5% per annum payable quarterly; and mature in one installment on December 15, 2012. On May 7, 2010, in connection with our pledge of $500,000 as cash collateral to secure our reimbursement obligations under a letter of credit, the Secured Notes were amended to increase the interest rate to 16.5% during the period that the cash so pledged is not subject to the lien of the holders of the Secured Notes.
 
We have the right to prepay the Secured Notes at any time. While the Secured Notes are outstanding, we are subject to customary affirmative, negative and financial covenants. The financial covenants include (i) a fixed charge coverage ratio test requiring us to maintain a fixed charge coverage ratio of not less then 1.40 to 1.00 at the close of each fiscal quarter commencing December 31, 2010, (ii) a minimum EBITDA test, to be tested at the end of each fiscal quarter commencing December 31, 2010, requiring us to generate “EBITDA” of at least $3,000,000 over the preceding four quarters, (iii) a minimum liquidity test requiring us to maintain cash and cash equivalents of $500,000 at all times, and (iv) limitations on our capital expenditures. We are in compliance with these financial covenants as of December 31, 2010. The Secured Notes are not convertible into equity.
 
The shares of Series D Preferred Stock issued in the financing have a stated value of $1.00 per share, and are convertible into Common Stock at a conversion price of $0.47. The conversion price of the Preferred Stock is subject to full ratchet anti-dilution provisions for 18 months following issuance, and weighted-average anti-dilution provisions thereafter. Holders of the Series D Preferred Stock are not entitled to special dividends but will be entitled to be paid upon a liquidation, redemption or change of control, the stated value of such shares plus the greater of (a) a 14% accreting liquidation preference, compounding annually, and (b) 3% of the volume weighted average price of our Common Stock outstanding on a fully-diluted basis (excluding the shares issued upon conversion of the Series D Preferred Shares) for the 20 days preceding the event. A consolidation or merger, a sale of all or substantially all of our assets, and a sale of 50% or more of our Common Stock would be treated as a change of control for this purpose.
 
After December 15, 2015, holders of the Series D Preferred Stock can require us to redeem the Series D Preferred Stock at its stated value plus any accretion thereon. In addition, we may be required to redeem the Series D Preferred Stock earlier upon the occurrence of a “Triggering Event.” Triggering Events include (i) failure to timely deliver shares of Common Stock upon conversion of Series D Preferred Stock, (ii) failure to pay amounts due to the holders (after notice and a cure period), (iii) a bankruptcy event with respect to us or any of our subsidiaries; (iv) our default under other indebtedness in excess of certain amounts, and (v) our breach of representations, warranties or covenants in the documents entered into in connection with the Financing. Upon a Triggering Event or our failure to redeem the Series D Preferred Stock, the accretion rate on the Series D Preferred Stock will increase to 16.5% per annum. We may also be required to pay penalties upon our failure to timely deliver shares of Common Stock upon conversion of Series D Preferred Stock.
 
 
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Upon closing of the financing, Union Capital became entitled to a closing fee of $325,000, half of which was paid upon closing and the balance of which was paid in six monthly installments following the closing. We also reimbursed Union Capital for its fees and expenses in the amount of $250,000. Additionally, we entered into a management consulting agreement with Union Capital under which Union Capital provides us with management advisory services and we pay Union Capital a fee of $125,000 per year for such services. Such fee will be reduced to $62,500 per year if the holders of the Series D Preferred Stock no longer have the right to nominate two directors and Union Capital no longer owns at least 40% of the Common Stock purchased by it at closing (assuming conversion of Series D Preferred Stock and exercise of Warrants held by it). The management consulting agreement will terminate when the holders of the Series D Preferred Stock no longer have the right to nominate any directors and Union Capital no longer owns at least 20% of the Common Stock purchased by it at closing (assuming conversion of Series D Preferred Stock and exercise of Warrants held by it).
 
In May 2010, we entered into a First Amendment to Senior Secured Notes (the “Note Amendment”), in connection with our pledge of $500,000 as cash collateral to Sovereign Bank to secure our reimbursement obligations under a letter of credit issued on our behalf in favor of American Express Related Services Company, Inc. (“Amex”). The letter of credit supports our credit line with respect to Amex credit cards issued to us and our employees. Pursuant to the Note Amendment, among other things, the Senior Notes were amended to (i) permit us to pledge the cash collateral to Sovereign Bank, and (ii) increase the interest rate thereunder by four percent to 16.5% during the period that the cash pledged to Sovereign Bank is not subject to the lien of the holders of the Senior Notes.
 
In light of the completion of our December 2009 financing and steps taken by management to reduce expenses, we believe that cash currently on hand together with cash expected to be generated from operations, will be sufficient to fund our cash and near-cash requirements both through the end of its fiscal year ending March 31, 2011 and on a long-term basis.
 
At December 31, 2010, we had cash and cash equivalents of $6,522,000, a working capital deficit of $1,260,000, and stockholders’ equity of $5,633,000. In comparison, at March 31, 2010, we had cash and cash equivalents of $664,000, a working capital deficit of $3,853,000, and stockholders’ equity of $4,444,000. The $5,858,000 increase in cash and cash equivalents during the nine months ended December 31, 2010 was primarily due to $6,658,000 in cash provided by operating activities offset by $793,000 of cash used in investing activities.
 
Operating Activities. Net cash provided by operating activities for the nine months ended December 31, 2010 was $6,658,000, attributable to net income of $1,182,000 plus $2,235,000 in non-cash expenses, and $3,241,000 of cash provided by the changes in operating assets and liabilities as the result of a reduction in unbilled contracts in progress, deferred contract costs, prepaid expenses, and an increase in accrued compensation, accrued job costs and deferred revenue account balances, offset by an increase in accounts receivable and a reduction in accounts payable and other accrued liabilities.
 
Investing Activities. For the nine months ended December 31, 2010, net cash used in investing activities was $793,000, the result of $500,000 of restricted cash pledged as collateral to Sovereign Bank to secure our reimbursement obligations under a letter of credit issued on our behalf in favor of Amex, $308,000 in property and equipment purchases, offset by $15,000 in proceeds from the sale of property and equipment.
 
Financing Activities. We did not engage in any financing activities during the nine months ended December 31, 2010 other than minimal repurchases of our Common Stock from employees to satisfy employee tax withholding obligations in connection with the vesting of restricted stock.
 
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 2010 Annual Report on Form 10-K for a discussion of our critical accounting policies relating to revenue recognition, goodwill (expanded below) and other intangible assets and accounting for income taxes. During the nine months ended December 31, 2010, there were no material changes to these policies.
 
 
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Goodwill and Other Intangible Assets
 
Our goodwill consists of the cost in excess of the fair market value of the acquired net assets of our subsidiary companies, Inmark, Optimum, U.S. Concepts and Digital Intelligence as well as our mktgpartners business. These companies and businesses have been integrated into a structure which does not provide the basis for separate reporting units. Consequently, we are a single reporting unit for goodwill impairment testing purposes. We also have intangible assets consisting of a customer relationship acquired from mktgpartners, and an Internet domain name and related intellectual property rights. At December 31, 2010 and March 31, 2010, our balance sheet reflected goodwill and intangible assets as set forth below:
 
   
December 31, 2010
   
March 31, 2010
 
Amortizable:
           
Customer relationship
  $ 804,207     $ 1,045,469  
                 
Non-Amortizable:
               
Goodwill
  $ 10,052,232     $ 10,052,232  
Internet domain name
    200,000       200,000  
    $ 10,252,232     $ 10,252,232  
Total
  $ 11,056,439     $ 11,297,701  
 
Goodwill and the internet domain name are deemed to have indefinite lives and are subject to annual impairment tests. Goodwill impairment tests require the comparison of the fair value and carrying value of the reporting unit. We assess the potential impairment of goodwill and intangible assets annually and on an interim basis whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Upon completion of such review, if impairment is found to have occurred, a corresponding charge will be recorded. The value assigned to the customer relationship is being amortized over a five year period.
 
As of March 31, 2010, we used a combination of three generally accepted methods for estimating fair value of the reporting unit; the income approach, market approach and market capitalization to determine the overall fair value. Based on such analysis, we concluded that our goodwill was not impaired as of March 31, 2010. Goodwill and the intangible asset will continue to be tested annually at the end of each fiscal year to determine whether they have been impaired. Upon completion of each annual review, there can be no assurance that a material charge will not be recorded. Impairment testing is required more often than annually if an event or circumstance indicates that an impairment or decline in value may have occurred. There were no events or changes in circumstances during the nine months ended December 31, 2010 that indicated that the carrying value of goodwill and the intangible asset may not be recoverable. Management has also determined that there was no impairment of the amortizable intangible asset.
 
 
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Evaluation of Disclosure Controls and Procedures
 
Our management has evaluated, with the participation of our Chief Executive Officer and Principal Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of December 31, 2010. Based on that evaluation, our Chief Executive Officer and Principal Financial Officer have concluded that our disclosure controls and procedures were effective as of December 31, 2010.
 
Changes in Internal Controls over Financial Reporting
 
There were no changes in our internal control over financial reporting during the fiscal quarter ended December 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
 
 
On May 7, 2010, Brian Murphy, derivatively on behalf of the Company, commenced a lawsuit in the Supreme Court of the State of New York, County of New York (the “Court”), against the former Chairman of the Company’s Board of Directors, certain former directors and officers of the Company, and the Company as a nominal defendant. The Complaint filed by Mr. Murphy in the action alleges, among other things, that the defendants breached fiduciary duties owed to the Company and its stockholders by failing to ensure that the Company’s financial statements for its fiscal year ended March 31, 2008 and quarter ended June 20, 2008 were prepared correctly, and by causing the Company to enter into the December 2009 financing on terms dilutive to the Company’s stockholders.
 
On June 30, 2010 the defendants filed a motion to dismiss the Complaint. Thereafter, on October 27, 2010, Mr. Murphy filed an Amended Complaint with the Court, naming the investors in the Company’s December 2009 financing as additional defendants. In addition to repeating the allegations made in the original Complaint, the Amended Complaint alleges that the investors in the Company’s December 2009 financing were unjustly enriched at the Company’s expense, and seeks the rescission of the financing transaction, or in the alternative, the reformation of the terms of the financing. On December 23, 2010 the defendants filed a motion to dismiss the Complaint, which motion is currently pending before the Court.
 
The Company is a nominal defendant for purposes of the derivative action claims, and is not aware of any claims for affirmative relief being made against it other than with respect to the rescission or reformation of the December 2009 financing transaction. The Company has obligations to provide indemnification to its officers and directors (and former officers and directors), as well as to the investors in the December 2009 financing, including for all legal costs incurred by them in defending these claims. The Company believes the lawsuit is without merit and intends to defend this action vigorously. However, the ultimate outcome of any litigation is uncertain and could result in substantial damages. Through the nine months ended December 31, 2010, the Company had incurred approximately $410,000 in legal expenses in connection with its defense of the lawsuit and its indemnification obligations.
 
 
 
31.1
Certification of principal executive officer pursuant to Rule 13a-14(a) of the Exchange Act.
     
 
31.2
Certification of principal financial officer pursuant to Rule 13a-14(a) of the Exchange Act.
     
 
32.1
Certification of principal executive officer pursuant to Rule 13a-14(b) of the Exchange Act.
     
 
32.2
Certification of principal financial officer pursuant to Rule 13a-14(b) of the Exchange Act.
 
 
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
‘mktg, inc.’
 
Dated: February 3, 2011
By:
/s/ Charles W. Horsey
   
Charles W. Horsey, President and Chief Executive Officer
(Principal Executive Officer)
     
Dated: February 3, 2011
By:
/s/ James R. Haughton
   
James R. Haughton, Senior Vice President-Controller
(Principal Financial Officer)
 
 
 
 
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