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

                                    FORM 10-K

                       FOR ANNUAL AND TRANSITIONAL REPORTS
                     PURSUANT TO SECTIONS 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

(Mark One)
X       ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES - ---      EXCHANGE
        ACT OF 1934 for the fiscal year ended December 31, 20032004
                                                               OR

- ---
        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 0-27824

                                SPAR GROUP, INC.
             (Exact name of registrant as specified in its charter)

           Delaware                                             33-0684451
(State or other jurisdiction of                              (I.R.S. Employer
 Identification No.)
incorporation or organization)                             Identification No.)

 580 White Plains Road, Tarrytown, New York                        10591
  (Address of principal executive offices)                       (Zip Code)

       Registrant's telephone number, including area code: (914) 332-4100

        Securities registered pursuant to Section 12(b) of the Act: None

           Securities registered pursuant to section 12(g) of the Act:
                     Common Stock, par value $.01 per share

     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  twelve  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     [ ][_]

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

     Indicate by check mark whether the registrant is an  accelerated  filer (as
defined in Exchange Rule 12b-2 of the Act.)   YES  [ ]      NO     [X]

     The aggregate  market value of the Common Stock of the  Registrant  held by
non-affiliates of the Registrant on June 30, 2003,2004, based on the closing price of
the Common  Stock as reported by the Nasdaq  NationalSmall Cap Market on such date,  was
approximately $20,892,441.$4,799,006.

     The number of shares of the  Registrant's  Common Stock  outstanding  as of
December 31, 2003,2004, was 18,858,972 shares.

                       DOCUMENTS INCORPORATED BY REFERENCE

None.






                                SPAR GROUP, INC.


                           ANNUAL REPORT ON FORM 10-K


                                      
INDEX PART I Page Item 1. Business 2 Item 2. Properties 14 Item 3. Legal Proceedings 15 Item 4. Submission of Matters to a Vote of Security Holders 15 PART II Item 5. Market for Registrant's Common Equity and Related Shareholder Matters 16 Item 6. Selected Financial Data 16 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 19 Item 7A. Quantitative and Qualitative Disclosures about Market Risk 27 Item 8. Financial Statements and Supplementary Data 27 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 27 Item 9A. Controls and Procedures 27 PART III Item 10. Directors and Executive Officers of the Registrant 28 Item 11. Executive Compensation and Other Information of SPAR Group, Inc. 30 Item 12. Security Ownership of Certain Beneficial Owners and Management 34 Item 13. Certain Relationships and Related Transactions 35 Item 14. Principal Accountant Fees and Services 36 Part IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 37 Signatures 39
INDEX PART I Page Item 1. Business 2 Item 2. Properties 14 Item 3. Legal Proceedings 15 Item 4. Submission of Matters to a Vote of Security Holders 15 PART II Item 5. Market for Registrant's Common Equity and Related Shareholder Matters 16 Item 6. Selected Financial Data 16 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 19 Item 7A. Quantitative and Qualitative Disclosures about Market Risk 26 Item 8. Financial Statements and Supplementary Data 26 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 26 Item 9A. Controls and Procedures 26 Item 9B. Other Information 27 PART III Item 10. Directors and Executive Officers of the Registrant 28 Item 11. Executive Compensation and Other Information of SPAR Group, Inc. 31 Item 12. Security Ownership of Certain Beneficial Owners and Management 35 Item 13. Certain Relationships and Related Transactions 36 Item 14. Principal Accountant Fees and Services 37 Part IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 38 Signatures 43 PART I STATEMENTS CONTAINED IN THIS ANNUAL REPORT ON FORMStatements contained in this Annual Report on Form 10-K OFof SPAR GROUP, INC.Group, Inc. ("SGRP", AND TOGETHER WITH ITS SUBSIDIARIES, THEand together with its subsidiaries, the "SPAR GROUP" OR THE "COMPANY"Group" or the "Company"), INCLUDE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTIONinclude "forward-looking statements" within the meaning of Section 27A OF THE SECURITIES ACT AND SECTIONof the Securities Act and Section 21E OF THE EXCHANGE ACT, INCLUDING, IN PARTICULAR AND WITHOUT LIMITATION, THE STATEMENTS CONTAINED IN THE DISCUSSIONS UNDER THE HEADINGS "BUSINESS" AND "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS"of the Exchange Act, including, in particular and without limitation, the statements contained in the discussions under the headings "Business" and "Management's Discussion and Analysis of Financial Condition and Results of Operations". FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND OTHER FACTORS THAT COULD CAUSE THE COMPANY'S ACTUAL RESULTS, PERFORMANCE AND ACHIEVEMENTS, WHETHER EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS, TO NOT OCCUR OR BE REALIZED OR TO BE LESS THAN EXPECTED. SUCH FORWARD-LOOKING STATEMENTS GENERALLY ARE BASED UPON THE COMPANY'S BEST ESTIMATES OF FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENT, CURRENT CONDITIONS AND THE MOST RECENT RESULTS OF OPERATIONS. FORWARD-LOOKING STATEMENTS MAY BE IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS "MAY"Forward-looking statements involve known and unknown risks, uncertainties and other factors that could cause the Company's actual results, performance and achievements, whether expressed or implied by such forward-looking statements, to not occur or be realized or to be less than expected. Such forward-looking statements generally are based upon the Company's best estimates of future results, performance or achievement, current conditions and the most recent results of operations. Forward-looking statements may be identified by the use of forward-looking terminology such as "may", "WILL""will", "EXPECT""expect", "INTEND""intend", "BELIEVE""believe", "ESTIMATE""estimate", "ANTICIPATE""anticipate", "CONTINUE" OR SIMILAR TERMS, VARIATIONS OF THOSE TERMS OR THE NEGATIVE OF THOSE TERMS. YOU SHOULD CAREFULLY CONSIDER SUCH RISKS, UNCERTAINTIES AND OTHER INFORMATION, DISCLOSURES AND DISCUSSIONS WHICH CONTAIN CAUTIONARY STATEMENTS IDENTIFYING IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE PROVIDED IN THE FORWARD-LOOKING STATEMENTS. ALTHOUGH THE COMPANY BELIEVES THAT ITS PLANS, INTENTIONS AND EXPECTATIONS REFLECTED IN OR SUGGESTED BY SUCH FORWARD-LOOKING STATEMENTS ARE REASONABLE, IT CANNOT ASSURE THAT SUCH PLANS, INTENTIONS OR EXPECTATIONS WILL BE ACHIEVED IN WHOLE OR IN PART. YOU SHOULD CAREFULLY REVIEW THE RISK FACTORS DESCRIBED HEREIN AND ANY OTHER CAUTIONARY STATEMENTS CONTAINED IN THIS ANNUAL REPORT ON FORM"continue" or similar terms, variations of those terms or the negative of those terms. You should carefully consider such risks, uncertainties and other information, disclosures and discussions which contain cautionary statements identifying important factors that could cause actual results to differ materially from those provided in the forward-looking statements. Although the Company believes that its plans, intentions and expectations reflected in or suggested by such forward-looking statements are reasonable, it cannot assure that such plans, intentions or expectations will be achieved in whole or in part. You should carefully review the risk factors described herein and any other cautionary statements contained in this Annual Report on Form 10-K. ALL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO THE COMPANY OR PERSONS ACTING ON ITS BEHALF ARE EXPRESSLY QUALIFIED BY THE RISK FACTORS (SEE ITEMAll forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified by the risk factors (see Item 1 - CERTAIN RISK FACTORS) AND OTHER CAUTIONARY STATEMENTS IN THIS ANNUAL REPORT ON FORMCertain Risk Factors) and other cautionary statements in this Annual Report on Form 10-K. THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE.The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Item 1. Business. GENERAL The SPAR Group, Inc., a Delaware corporation ("SGRP"), and togetherits subsidiaries (together with its subsidiaries,SGRP, the "SPAR Group" or the "Company"), is a supplier of merchandising and other marketing services both throughout the United States and internationally. In 2002, the Company sold its Incentive Marketing Division, SPAR Performance Group, Inc. ("SPGI"). The Company's operations are divided into two divisions: the Domestic Merchandising Services Division and the International Merchandising Services Division. The Domestic Merchandising Services Division provides merchandising services, product demonstrations,in-store event staffing, product sampling, database marketing, technology services, teleservices and marketing research to manufacturers and retailers with product distribution primarily in mass merchandisers, drug chains and grocery stores in the United States. The various services are primarily performed in mass merchandisers, drug store chains, convenience and grocery stores. The International Merchandising Services Division established in July 2000, currently provides similar merchandising services through a wholly owned subsidiary in Canada, through 51% owned joint venture subsidiaries in India, South Africa and Turkey, and through a 50% owned joint venture in Japan. The Company recently established a 50% owned joint venture in China and a 51% owned joint venture subsidiary in Romania and expects to offer merchandising services in Japan, Canada and Turkey.these countries in 2005. Continuing Operations Domestic Merchandising Services Division The CompanyCompany's Domestic Merchandising Services Division provides nationwide merchandising and other marketing services toprimarily on behalf of consumer product manufacturers and retailers at mass merchandisers, drug store chains and grocery stores. Included in its customers are home entertainment, PC software, general merchandise, health and beauty care, consumer goods and food products companies in mass merchandisers, drug chains and retail grocery stores in the United States. Merchandising services primarily consist of regularly scheduled dedicated routed services and special projects provided at the store level for a specific retailer or single or multiple manufacturers primarily under single or multi-year contracts or agreements. Services also include stand-alone large-scale implementations such as new store openings, new product launches, special seasonal or promotional merchandising, focused product support and product recalls.implementations. These services may include sales enhancing activities such as ensuring that client products authorized for distribution are in stock -2- and on the shelf, adding new products that are approved for distribution but not presently on the shelf, setting category shelves in accordance with approved store schematics, ensuring that shelf tags are in place, checking for the overall salability of client products and setting new and promotional items and placing and/or removing point of purchase and other related media advertising. Specific in-store services can be initiated by retailers or manufacturers, and include new store openings, new product launches, special seasonal or promotional merchandising, focused product support and product recalls. In 2003, theThe Company addedalso provides in-store product demonstration and in-store product samplingevent staffing services, -2- to its merchandising service offerings. Marketing services consist of database marketing, technology services, teleservices and marketing research. The Company'sresearch services. International Merchandising Services Division consists of the following wholly owned subsidiaries, (1) SPAR Marketing, Inc. ("SMI") (an intermediate holding company), SPAR Marketing Force, Inc. ("SMF"), SPAR Marketing, Inc., ("SMNEV"), SPAR/Burgoyne Retail Services, Inc. ("SBRS"), and SPAR, Inc. ("SINC"") (collectively, the "SPAR Marketing Companies"), and SPAR All Store Marketing Services, Inc. ("SASMS"), SPAR Megaforce, Inc. ("SMEGA") and SPAR Bert Fife, Inc. ("SFIFE"); and (2) PIA Merchandising, Co., Inc., Pacific Indoor Display d/b/a Retail Resources, Pivotal Sales Company and PIA Merchandising Ltd. (collectively, "PIA" or the "PIA Companies"). The SPAR Marketing Companies are the original predecessor of the current Company and were founded in 1967. The PIA Companies, first organized in 1943, are also a predecessor of the Company and a supplier of in-store merchandising services throughout the United States, and were deemed "acquired" by the SPAR Marketing Companies for accounting purposes pursuant to the Merger on July 8, 1999 (see Merger and Restructuring, below). International Division In July 2000, the Company established its International Merchandising Services Division, operating through a wholly owned subsidiary, SPAR Group International, Inc. ("SGI"), to focus on expanding its merchandising services business worldwide. InThe Company has expanded its international business as follows: May 2001, the Company entered intoJapan through a 50% owned joint venture with a large Japanese distributor to provide merchandising servicesheadquartered in Japan. InOsaka. June 2003, the Company expandedentered Canada by acquiring an existing business through its merchandising services into Canada. Inwholly-owned Canadian subsidiary, headquartered in Toronto. July 2003, the Company entered Turkey through a 51% owned joint venture subsidiary headquartered in Istanbul. April 2004, the Company entered South Africa through a 51% owned joint venture subsidiary headquartered in Durban. April 2004, the Company entered India through a 51% owned joint venture subsidiary headquartered in New Delhi. December 2004, the Company established a 51% owned joint venture basedsubsidiary headquartered in Istanbul to provide merchandising services throughout Turkey. The start-upBucharest, Romania. In February 2005, the Company announced the establishment of a 50% owned joint venture is 51% owned by the Company.headquartered in Hong Kong, China. Discontinued Operations Incentive Marketing Division As part of a strategic realignment in the fourth quarter of 2001, the Company made the decision to divest its Incentive Marketing Division, operating through its subsidiary, SPAR Performance Group, Inc. ("SPGI"). The Company explored various alternatives for the sale of SPGI and subsequently sold the business to SPGI's employees through the establishment of an employee stock ownership plan on June 30, 2002. In December of 2003, SPGI changed its name to STIMULYS, Inc. Technology Division In October 2002, the Company dissolved its Technology Division that was established in March 2000 for the purpose of marketing its proprietary Internet-based computer software. INDUSTRY OVERVIEW Domestic Merchandising Services Division According to industry estimates over two billion dollars are spent annually on domestic retail merchandising services. The merchandising services industry includes manufacturers, retailers, food brokers, and professional service merchandising companies. The Company believes there is a continuing trend for major manufacturers to move increasingly toward third parties to handle in-store merchandising. The Company also believes that its merchandising services bring added value to retailers, manufacturers and other businesses. Retail merchandising services enhance sales by making a product more visible and available to consumers. These services primarily include placing orders, shelf maintenance, display placement, reconfiguring products on store shelves, replenishing -3- products and providing in-store demonstrations and product sampling, and also includeevent staffing services. The Company provides other marketing services such as test market research, mystery shopping, teleservices, database marketing and promotion planning and analysis. The Company believes merchandising services previously undertaken by retailers and manufacturers have been increasingly outsourced to third parties. Historically, retailers staffed their stores as needed to ensure inventory levels, the advantageous display of new items on shelves, and the maintenance of shelf schematics. In an effort to improve their margins, retailers decreased their own store personnel and increased their reliance on manufacturers to perform such services. Initially, manufacturers attempted to satisfy the need for merchandising services in retail -3- stores by utilizing their own sales representatives. However, manufacturers discovered that using their own sales representatives for this purpose was expensive and inefficient. Therefore, manufacturers have increasingly outsourced the merchandising services to third parties capable of operating at a lower cost by (among other things) serving multiple manufacturers simultaneously. Another significant trend impacting the merchandising segment is the tendency of consumers to make product purchase decisions once inside the store. Accordingly, merchandising services and in-store product promotions have proliferated and diversified. Retailers are continually remerchandising and remodeling entire stores to respond to new product developments and changes in consumer preferences. The Company estimates that these activities have increased in frequency over the last five years, such that most stores are re-merchandised andor remodeled approximately every twenty-four months. Both retailers and manufacturers are seeking third parties to help them meet the increased demand for these labor-intensive services. International Merchandising Services Division The Company believes another current trend in business is globalization. As companies expand into foreign markets they will need assistance in marketing their products. As evidenced in the United States, retailer and manufacturer sponsored merchandising programs are both expensive and inefficient. The Company also believes that the difficulties encountered by these programs are only exacerbated by the logistics of operating in foreign markets. This environment has created an opportunity for the Company to exploit its Internet-based technology and business model that are successful in the United States. In July 2000, the Company established its International Merchandising Services Division to cultivate foreign markets, modify the necessary systems and implement the Company's business model worldwide by expanding its merchandising services business off shore. The Company formed an International Merchandising Services Division task force consisting of members of the Company's information technology, operations and finance groups to evaluate and develop foreign markets. In 2001, the Company and a leading Japanese based distributor established a joint venture to provide the latest in-store merchandising services to the Japanese market. In 2003, the Company expanded its international presence to Canada and Turkey by acquiring the business of a Canadian merchandising company and entering into a start-up joint venture subsidiary in Turkey. In 2004, the Company established 51% owned joint venture subsidiaries in South Africa, India and Romania and in early 2005 a 50% owned joint venture in China. Key to the Company's international strategy is the translation of several of its proprietary Internet-based logistical, communications and reporting software applications into the native language of any market the Company enters. As a result of this requirement for market penetration, the Company has developed translation software that can quickly convert its proprietary software into various languages. Through its computer facilities in Auburn Hills, Michigan, the Company provides worldwide access to its proprietary logistical, communications and reporting software. In addition, the Company maintains officespersonnel in Greece and Australia to assist in its international efforts. The Company is actively pursuing expansion into various other markets. MERGER AND RESTRUCTURINGPIA ACQUISITION SPAR Acquisition, Inc., and its subsidiaries (the "SPAR Companies") are the original predecessor of the current Company and were founded in 1967. On July 8, 1999, SG Acquisition, Inc.,the Company completed a Nevada corporation ("PIAreverse merger with the SPAR Companies (the "PIA Acquisition"), a wholly owned subsidiary of the Company,and then named PIA Merchandising Services, Inc. ("PIA Delaware"), merged into and with SPAR Acquisition, Inc., a Nevada corporation ("SAI") (the "Merger"), pursuant to the Agreement and Plan of Merger dated as of February 28, 1999, as amended (the "Merger Agreement"), by and among the Company and certain of the PIA Companies and SPAR Marketing Companies (among others). In connection with the Merger, PIA Delaware changed its name to SPAR Group, Inc. (which is referred, from PIA Merchandising Services, Inc. (prior to post-Merger individually as "SGRP"such merger, "PIA"). Pursuant to the PIA Acquisition, the SPAR Companies were deemed to have "acquired" PIA and together with its subsidiaries asprior to the "SPAR Group", or the "Company"). Although the SPAR Marketing Companies and SPGI became subsidiaries of PIA Delaware (now SGRP) as a result of this "reverse" Merger, the transaction has been accounted forAcquisition (the "PIA Companies") which was treated as a purchase by the SPAR Marketing Companies of the PIA Companies for accounting purposes, with the books and records of the Company being adjusted to reflect the historical operating results of the SPAR Marketing Companies (together with certain intermediate holding companies and subsidiaries formed after the merger, the "SPAR Companies").Companies. -4- BUSINESS STRATEGY As the marketing services industry continues to grow, consolidate and expand both in the United States and internationally, large retailers and manufacturers are increasingly outsourcing their marketing needs to third-party providers. The Company believes that offering marketing services on a national and global basis will provide it with a competitive advantage. Moreover, the Company believes that successful use of and continuous improvements to a sophisticated technology infrastructure, including its proprietary Internet-based software, is key to providing clients -4- with a high level of customer service while maintaining efficient, low cost operations. The Company's objective is to become an international retail merchandising and marketing service provider by pursuing its operating and growth strategy, as described below. Increased Sales Efforts: The Company is seeking to increase revenues by increasing sales to its current customers, as well as, establishing long-term relationships with new customers, many of which currently use other merchandising companies for various reasons. The Company believes its technology, field implementation and other competitive advantages will allow it to capture a larger share of this market over time. However, there can be no assurance that any increased sales will be achieved. New Products: The Company is seeking to increase revenues through the internal development and implementation of new products and services that add value to its customers' retail merchandising related activities, some of which have been identified and are currently being tested for feasibility and market acceptance. However, there can be no assurance that any new products of value will be developed or that any such new product can be successfully marketed. Acquisitions: The Company is seeking to acquire businesses or enter into joint ventures or other arrangements with companies that offer similar merchandising services both in the United States and worldwide. The Company believes that increasing its industry expertise, adding product segments, and increasing its geographic breadth will allow it to service its clients more efficiently and cost effectively. As part of its acquisition strategy, the Company is actively exploring a number of potential acquisitions, predominately in its core merchandising service businesses (which includes in-store product demonstration businesses)event staffing services). Through such acquisitions, the Company may realize additional operating and revenue synergies and may leverage existing relationships with manufacturers, retailers and other businesses to create cross-selling opportunities. However, there can be no assurance that any of the acquisitions will occur or whether, if completed, the integration of the acquired businesses will be successful or the anticipated efficiencies and cross-selling opportunities will occur. In February 2003, the Company purchased the business and certain assets of All Store Marketing Services, Inc. ("ASMS"), a Texas corporation that specialized in providing in-store product demonstrations. In connection with the acquisition of ASMS, the Company entered into an employment agreement with the President of ASMS for a period of two years. In June 2003, the Company purchased the business and certain assets of Impulse Marketing Solutions ("IMS"), a Canadian company that specialized in providing merchandising services in Canada. In connection with the purchase of the business and certain assets of IMS, the Company entered into a consulting agreement with a corporation that furnishes the services of the former President and a second senior officer of IMS, which agreement expires on December 31, 2006. In July 2003, the Company entered into a joint venture agreement with a company based in Istanbul to provide retail-merchandising services throughout Turkey. The start-up joint venture limited liability company will operate under the English name of SPAR Turkey Ltd. and is 51% owned by the Company. In December of 2003, the Company acquired the business and certain assets of NMI Acquisition Partners, LLC (also known as Megaforce), a Georgia company that specialized in providing in-store merchandising services throughout the United States, and employs the former President of Megaforce. In December of 2003, the Company entered into an agreement to purchase the business and certain assets of Bert Fife & Associates, Inc., and related Companies ("Fife"), which specialized in providing in-store product demonstrations. As part of the agreement the Company entered into a one year consulting agreement with the President of Fife. The purchase was completed in January 2004. In April 2004, the Company established a joint venture subsidiary in South Africa. The effectjoint venture subsidiary is headquartered in Durban and is owned 51% by the Company. Also in April 2004, the Company announced the establishment of these acquisitionsa joint venture subsidiary in India and started operations during the third quarter. The joint ventures was not considered material toventure subsidiary is headquartered in New Delhi and is 51% owned by the Company's financial statements or resultsCompany. In January 2005, the Company announced the establishment of operations for 2003.a joint venture subsidiary in Romania and is owned 51% by the Company. In February 2005, the Company announced the establishment of a joint venture in China which is 50% owned by the Company. Improve Operating Efficiencies: The Company will continue to seek greater operating efficiencies. The Company believes that its existing field force and technology infrastructure can support additional customers and revenue in the Domestic Merchandising Services Division. At the corporate level, the Company will continue to streamline certain administrative functions, such as accounting and finance, insurance, strategic marketing and legal support. -5- Leverage and Improve Technology: The Company intends to continue to utilize computer (including hand-held computers), Internet, and other technology to enhance its efficiency and ability to provide real-time data to its customers, as well as, maximize the speed of communication, and logistical deployment of its merchandising specialists. Industry sources indicate that customers are increasingly relying on marketing service providers to supply rapid, value-added information regarding the results of marketing expenditures on sales and profits. The Company (together with certain of its affiliates) has developed and owns proprietary Internet-based software technology that allows it to utilize the Internet to communicate with its field management, schedule its store-specific field operations more efficiently, receive information and incorporate the data immediately, quantify the benefits of its services to customers faster, respond to customers' needs quickly and implement programs rapidly. The Company has successfully modified and is currently utilizing certain of its software applications in connection with its international ventures. The Company believes that it can continue to improve, modify and adapt its technology to support merchandising and other marketing services for additional customers and projects in the United States and in other foreign markets. The Company also believes that its proprietary Internet-based software technology gives it a competitive advantage in the marketplace. DESCRIPTION OF SERVICES The Company currently provides a broad array of merchandising and other marketing services on a national, regional and local basis to leading home entertainment, general merchandise, consumer goods, food, and health and beauty care manufacturers and retail companies through its Domestic Merchandising Services Division. The Company currently operates throughout the United Statesinternationally serving some of the nation'sworld's leading companies. The Company believes its full-line capabilities provide fully integrated national solutions that distinguish the Company from its competitors. These capabilities include the ability to develop plans at one centralized division headquarter location, effect chain wide execution, implement rapid, coordinated responses to its clients' needs and report on a real time Internet enhanced basis. The Company also believes its nationalinternational presence, industry-leading technology, centralized decision-making ability, local follow-through, ability to recruit, train and supervise merchandisers, ability to perform large-scale initiatives on short notice, and strong retailer relationships provide the Company with a significant advantage over local, regional or other competitors. Domestic Merchandising Services Division The Company provides a broad array of merchandising services on a national, regional, and local basis to manufacturers and retailers.retailers in the United States. The Company provides its merchandising and other marketing services primarily on behalf of consumer product manufacturers at mass merchandiser, drug and retail grocery chains. The Company currently provides three principal types of merchandising and marketing services: syndicated services, dedicated services and project services. Syndicated Services Syndicated services consist of regularly scheduled, routed merchandising services provided at the retail store level for various manufacturers. These services are performed for multiple manufacturers, including, in some cases, manufacturers whose products are in the same product category. Syndicated services may include activities such as: o Reordering and replenishment of products o Ensuring that the clients' products authorized for distribution are in stock and on the shelf o Adding new products that are approved for distribution but not yet present on the shelf o Designing and implementing store planogram schematics o Setting product category shelves in accordance with approved store schematics o Ensuring that product shelf tags are in place o Checking for overall salability of the clients' products o Placing new product and promotional items in prominent positions -6- Dedicated Services Dedicated services consist of merchandising services, generally as described above, which are performed for a specific retailer or manufacturer by a dedicated organization, including a management team working exclusively -6- for that retailer or manufacturer. These services include many of the above activities detailed in syndicated services, as well as, new store set-ups, store remodels and fixture installations. These services are primarily based on agreed-upon rates and fixed management fees. Project Services Project services consist primarily of specific in-store services initiated by retailers and manufacturers, such as new store openings, new product launches, special seasonal or promotional merchandising, focused product support, product recalls, in-store product demonstrations and in-store product sampling. The Company also performs other project services, such as new store sets and existing store resets, re-merchandising, remodels and category implementations, under annual or stand-alone project contracts or agreements. Other Marketing Services Other marketing services performed by the Company include: Event Staffing Services - Performing in-store product demonstrations or product sampling. Test Market Research - Testing promotion alternatives, new products and advertising campaigns, as well as packaging, pricing, and location changes, at the store level. Mystery Shopping - Calling anonymously on retail outlets (e.g. stores, restaurants, banks) to check on distribution or display of a brand and to evaluate products, service of personnel, conditions of store, etc. Database Marketing - Managing proprietary information to permit easy access, analysis and manipulation for use in direct marketing campaigns. Data Collection - Gathering sales and other information systematically for analysis and interpretation. Teleservices - Maintaining a teleservices center in its Auburn Hills, Michigan, facility that performs inbound and outbound telemarketing services, including those on behalf of certain of the Company's manufacturing clients. The Company believes that providing merchandising and other marketing services timely, accurately and efficiently, as well as, delivering timely and accurate reports to its clients, are two key components ofthat will be critical to its success. The Company has developed Internet-based logistic deployment, communications, and reporting systems that improve the productivity of its merchandising specialists and provide timely data and reports to its customers. The Company's merchandising specialists use hand-held computers, personal computers and laptop computers to report through the Internet and Interactive Voice Response (IVR) to report through its Auburn Hills teleservices center the status of each store they service upon completion.completion either through the Internet or using Interactive Voice Response ("IVR") through its Auburn Hills telecommunication center. Merchandising specialists may report on a variety of issues such as store conditions (e.g. out of stocks, inventory, display placement) or they may scan and process new orders for products. This information is reported, analyzed and displayed on graphical execution maps, whichin a variety of reports that can be accessed by both the Company and its customers via the Internet. These execution maps visuallyreports can depict the status of every merchandising project in real time. Through the Company's automated labor tracking system, its merchandising specialists communicate work assignment completion information via the Internet or telephone, enabling the Company to report hours, mileage, and other completion information for each work assignment on a daily basis and providing the Company with daily, detailed tracking of work completion. This technology allows the Company to schedule its merchandising specialists more efficiently, quickly quantify the benefits of its services to customers, rapidly respond to customers' needs and rapidly implement programs. The Company believes that its technological capabilities provide it with a competitive advantage in the marketplace. -7- International Merchandising Services Division The Company believes another current trend in business is globalization. As companies expand into foreign markets they will need assistance in marketing their products. As evidenced in the United States, retailer and manufacturer sponsored merchandising programs are both expensive and inefficient. The Company also believes that the difficulties encountered by these programs are only exacerbated by the logistics of operating in foreign markets. This environment has created an opportunity for the Company to exploit its Internet-based technology and business model that are successful in the United States. In July 2000, the Company established its International Merchandising Services Division to cultivate foreign markets, modify the necessary systems and implement the Company's business model worldwide by expanding its merchandising services business off shore. The Company formed an International Merchandising Services Division task force consisting of members of the Company's information technology, operations and finance groups to evaluate and develop foreign markets. In 2001, the Company and a leading Japanese based distributor established a joint venture to provide the latest in-store merchandising services to the Japanese market. In 2003, the Company expanded its international presence to Canada and Turkey by acquiring a Canadian merchandising company and Turkey by entering into a start-up joint venture. In 2004, the Company established 51% owned joint venture subsidiaries in South Africa, India and Romania and in early 2005, a 50% owned joint venture in Turkey.China. Key to the Company's international strategy is the translation of several of its proprietary Internet-based logistical, communications and reporting software applications into the native language of any market the Company enters. As a result of this requirement for market penetration, the Company has developed translation software that can quickly convert its proprietary software into various languages. Through its computer facilities in Auburn Hills, Michigan, the Company provides worldwide access to its proprietary logistical, communications and reporting software. In addition, the Company maintains officespersonnel in Greece and Australia to assist in its international efforts. The Company is actively pursuing expansion into various other markets. SALES AND MARKETING Domestic Merchandising Services Division The Company's sales efforts within its Domestic Merchandising Services Division are structured to develop new business in national, regional and local markets. The Company's corporate business development team directs its efforts toward the senior management of prospective clients. Sales strategies developed at the Company's headquarters are communicated to the Company's sales force for execution. The sales force, located nationwide, work from both Company and home offices. In addition, the Company's corporate account executives play an important role in the Company's new business development efforts within its existing manufacturer and retailer client base. As part of the retailer consolidation, retailers are centralizing most administrative functions, including operations, procurement and category management. In response to this centralization and the growing importance of large retailers, many manufacturers have reorganized their selling organizations around a retailer team concept that focuses on a particular retailer. The Company has responded to this emerging trend and currently has retailer teams in place at select discount and drug chains.retailers. The Company's business development process includes a due diligence period to determine the objectives of the prospective client, the work required to be performed to satisfy those objectives and the market value of such work to be performed. The Company employs a formal cost development and proposal process that determines the cost of each element of work required to achieve the prospective client's objectives. These costs, together with an analysis of market rates, are used in the development of a formal quotation that is then reviewed at various levels within the organization. The pricing of this internal proposal must meet the Company's objectives for profitability, which are established as part of the business planning process. After approval of this quotation, a detailed proposal is presented to and approved by the prospective client. -8- International Merchandising Services Division The Company's marketing efforts within its International Merchandising Services Division are designedthree fold. First, the Company endeavors to develop new business internationally.markets through acquisitions. The Company maintains officesCompany's international acquisition team, whose primary focus is to seek out and develop acquisitions throughout the world, consists of personnel located in the United States, Greece and AustraliaAustralia. Personnel from information technology, field operations, client services and finance support the international acquisition team. Second, the Company offers global merchandising solutions to assistcustomers that have worldwide distribution. This effort is spearheaded out of the Company's headquarters in these efforts. The Division's corporate business development team targets specific areas andthe United States. Third the Company develops strategic relationships to cultivate business for worldwide expansion. -8- local markets through various joint ventures or subsidiaries throughout the world. CUSTOMERS Domestic Merchandising Services Division In its Domestic Merchandising Services Division, the Company currently represents numerous manufacturers and /or retail clients in a wide range of retail outlets in the United States including: o Mass Merchandisers o Drug o Grocery o Other retail trade groups (e.g. Discount, Home Centers) The Company also provides database, research and other marketing services to the automotive and consumer packaged goods industries.industry. One customer a division of a major retailer, accounted for 30%14%, 26%8%, and 25%6% of the Company's net revenues for the years ended December 31, 2004, 2003, 2002 and 2001,2002, respectively. This customer also accounted for approximately 30%29%, 43% and 24% of accounts receivable at December 31, 2003, 2002 and 2001, respectively. In late 2003, the customer's parent company announced that it was exploring strategic opportunities, including the sale of this division. In the event of a sale, there can be no assurances that any purchaser will continue to use the services of the Company. The loss of this business could have a material adverse effect on the Company's business, results of operations and financial condition. A second customer accounted for 10%13%, 11% and 9% of the Company's net revenues for the years ended December 31, 2003, 2002 and 2001, respectively. This second customer also accounted for approximately 9%, 5% and 4% of accounts receivable at December 31, 2004, 2003, and 2002, and 2001, respectively. As of March 2004, the Company will no longer be providing services for this customer. Failure to attract new large customers could significantly impede the growth of the Company's revenues, which could have a material adverse effect on the Company's future business, results of operations and financial condition. In addition, approximately 16%, 17%, 24% and 31%24% of net revenues for the years ended December 31, 2004, 2003, 2002 and 2001,2002, respectively, resulted from merchandising services performed for manufacturers and others in stores operated by Kmart. These customers also accounted for approximately 22% of accounts receivable at Kmart. Kmart filed for protection under the U.S. Bankruptcy Code in January of 2002 and emerged from bankruptcy in May of 2003. During its time in bankruptcy, Kmart closed a number of stores in the United States.December 31, 2004. While the Company's customers and the resultant contractual relationships are with various manufacturers and not Kmart, a significant reduction of this retailer's stores or cessation of this retailer's business would negatively impact the Company. AsAnother customer, a division of August 31, 2003, one customer discontinued its merchandising programs with the Company. Some, but not all, of these programs were performed at Kmart stores. This customera major retailer, accounted for 10%26%, 17%30%, and 12%26% of the business generated from KmartCompany's net revenues for the twelve-monthsyears ended December 31, 2004, 2003, and 2002, respectively. This customer also accounted for approximately 4%, 30%, and 2001,43% of accounts receivable at December 31, 2004, 2003, and 2002, respectively. On August 2, 2004, this customer was sold by its parent. International Merchandising Services Division The Company believes that the potential international customers for this division have similar profiles to its Domestic Merchandising Services Division customers. The Company is currently operating in Japan, Canada, Turkey, South Africa and Turkey.India. The Company announced the establishment of a 51% owned joint venture subsidiary in Romania in late 2004 and a 50% owned joint venture in China in early 2005. The Company is actively pursuing expansion tointo Europe and other markets. -9- COMPETITION The marketing services industry is highly competitive. CompetitionThe Company's competition in the Company'sDomestic and International Merchandising Services DivisionDivisions arises from a number of large enterprises, many of which are national or international in scope. The Company also competes with a large number of relatively small enterprises with specific client, channel or geographic coverage, as well as with the internal marketing and merchandising operations of its clients and prospective clients. The Company believes that the principal competitive factors within its industry include development and deployment of technology, breadth and quality of client services, cost, and the ability to execute specific client priorities rapidly and consistently over a wide geographic area. The Company believes that its current structure favorably addresses these factors and establishes it as a leader in the mass merchandiser and chain drug store channels of trade. The Company also believes it has the ability to execute major national and international in-store initiatives and develop and administer national and international retailer programs. Finally, the Company believes -9- that, through the use and continuing improvement of its proprietary Internet software, other technological efficiencies and various cost controls, the Company will remain competitive in its pricing and services. TRADEMARKS The Company has numerous registered trademarks. Although the Company believes its trademarks may have value, the Company believes its services are sold primarily based on breadth and quality of service, cost, and the ability to execute specific client priorities rapidly and consistently over a wide geographic area. See "Industry Overview" and "Competition". EMPLOYEES Worldwide the Company utilizes a labor force of approximately 7,700 people. As of December 31, 2003,2004, the Company's Domestic Merchandising Services Division's labor force consisted of approximately 6,750 people, of which approximately 1706,500 people. Approximately 150 were full-time employees and approximately 50015 were part-time employees are employed byof the Company. Of the 150 full-time Company and approximately 6,000 independent contractors and approximately 80 full-time employees, are furnished principally through related parties, (see Item 13 - Certain Relationships and Related Transactions, below), of which 243 full-time employees143 were engaged in operations and 137 were engaged in sales. The Company considers its relations with its employees to be good. The Company's Domestic Merchandising Services Division also utilizedutilizes the services of its affiliate, SPAR Management Services, Inc. ("SMSI"), to schedule and supervise its field force, including its own part-time employees as well aswhich consists of the independent contractors furnished by another affiliate SPAR Marketing Services, Inc. ("SMS") (see Item 13 - Certain Relationships and Related Transactions, below). as well as the Company's field employees. Approximately 6,300 independent contractors and approximately 50 full-time field managers are furnished principally through SMS and SMSI, respectively. As of December 31, 2004, the Company's International Merchandising Services Division's labor force consisted of approximately 1,200 people. Approximately 50 full-time employees were engaged in operations and 3 were engaged in sales. The International Division's field force consisted of approximately 700 full time employees, 70 part time employees and approximately 380 independent contractors. The Company currently utilizes certain of its existingDomestic Merchandising Services Division's employees, as well as, the services of certain employees of its affiliates, SMSI and SPAR Infotech, Inc. ("SIT"), to staffsupport the International Merchandising Services Division. However, dedicated employees will be added to that division as the need arises. The Company's affiliate, SIT, also provides programming and other assistance to the Company's various divisions (see Item 13 - Certain Relationships and Related Transactions, below). The Company, SMS, SMSI and SIT consider their relations with their respective employees and independent contractors to be good. CERTAIN RISK FACTORS There are various risks associated with the Company's growth and operating strategy. Certain (but not all) of these risks are discussed below. -10- Dependency on Largest Customers OneAs discussed above in Customers, the Company does a significant amount of business with one customer and performs a divisionsignificant amount of a major retailer, accounted for 30%, 26% and 25% of the Company's net revenues for the years ended December 31, 2003, 2002 and 2001, respectively. This customer also accounted for approximately 30%, 43% and 24% of accounts receivable at December 31, 2003, 2002 and 2001, respectively. In late 2003, the customer's parent company announced that it was exploring strategic opportunities including the sale of this division. In the event of a sale, there can be no assurances that any purchaser will continue to use the services of the Company.in Kmart. The loss of this customer or the loss of Kmart related business and the failure to attract new large customers, could significantly decrease the Company's revenues and such decreased revenues could have a material adverse effect on the Company's business, results of operations and financial condition. A second customer accounted for 10%, 11% and 9% of the Company's net revenues for the years ended December 31, 2003, 2002 and 2001, respectively. This second customer also accounted for approximately 9%, 5% and 4% of accounts receivable at December 31, 2003, 2002 and 2001, respectively. As of March 2004, the Company will no longer be providing services for this customer. Failure to attract new large customers could significantly impede the growth of the Company's revenues, which could have a material adverse effect on the Company's future business, results of operations and financial condition. In addition, approximately 17%, 24% and 31% of net revenues for the years ended December 31, 2003, 2002 and 2001, respectively, resulted from merchandising services performed for manufacturers and others at Kmart. Kmart filed for protection under the U.S. Bankruptcy Code in January of 2002 and emerged from bankruptcy in May of 2003. During its time in bankruptcy, Kmart closed a number of stores in the United States. While the Company's customers and the resultant contractual relationships are with various manufacturers and not Kmart, a significant reduction of this retailer's stores or cessation of this retailer's business would negatively impact the Company. As of August 31, 2003, one customer discontinued its merchandising programs with the Company. Some but not all of these programs were performed at Kmart stores. This customer accounted for 10%, 17%, and 12% of the business generated from Kmart for the twelve-months ended December 31, 2003 2002 and 2001, respectively. -10- Dependence on Trend Toward Outsourcing The business and growth of the Company depends in large part on the continued trend toward outsourcing of marketing services, which the Company believes has resulted from the consolidation of retailers and manufacturers, as well as, the desire to seek outsourcing specialists and reduce fixed operation expenses. There can be no assurance that this trend in outsourcing will continue, as companies may elect to perform such services internally. A significant change in the direction of this trend generally, or a trend in the retail, manufacturing or business services industry not to use, or to reduce the use of, outsourced marketing services such as those provided by the Company, could significantly decrease the Company's revenues and such decreased revenues could have a material adverse effect on the Company's business, results of operations and financial condition or the desired increases in the Company's business, revenues and profits. Failure to Successfully Compete The marketing services industry is highly competitive and the Company has competitors that are larger (or part of larger holding companies) and may be better financed. In addition, the Company competes with: (i) a large number of relatively small enterprises with specific customer, channel or geographic coverage; (ii) the internal marketing and merchandising operations of its customers and prospective customers; (iii) independent brokers; and (iv) smaller regional providers. Remaining competitive in the highly competitive marketing services industry requires that the Company monitor and respond to trends in all industry sectors. There can be no assurance that the Company will be able to anticipate and respond successfully to such trends in a timely manner. If the Company is unable to successfully compete, it could have a material adverse effect on the Company's business, results of operations and financial condition or the desired increases in the Company's business, revenues and profits. If certain competitors were to combine into integrated marketing services companies, or additional marketing service companies were to enter into this market, or existing participants in this industry were to become more competitive, it could have a material adverse effect on the Company's business, results of operations and financial condition or the desired increases in the Company's business, revenues and profits. Variability of Operating Results and Uncertainty in Customer Revenue The Company has experienced and, in the future, may experience fluctuations in quarterly operating results. Factors that may cause the Company's quarterly operating results to vary and from time to time and may result in reduced revenue include: (i) the number of active customer projects; (ii) seasonality of customer products; (iii) customer delays, changes and cancellations in projects; (iii)(iv) the timing requirements of customer projects; (iv)(v) the completion of major customer projects; (v)(vi) the timing of new engagements; (vi)(vii) the timing of personnel cost increases; and (vii)(viii) the loss of major customers. In particular, the timing of revenues is difficult to forecast for the home entertainment industry because timing is dependent on the commercial success of particular product releases of customers.releases. In the event that a particular release is not widely accepted by the public, the Company's revenue could be significantly reduced. In addition, the Company is subject to revenue uncertainties resulting from factors such as unprofitable customer work and the failure of customers to pay. The Company attempts to mitigate these risks by dealing primarily with large credit-worthy customers, by entering into written or oral agreements with its customers and by using project budgeting systems. These revenue fluctuations could materially and adversely affect the Company's business, results of operations and financial condition or the desired increases in the Company's business, revenues and profits. Failure to Develop New Products A key element of the Company's growth strategy is the development and sale of new products. While several new products are under current development, there can be no assurance that the Company will be able to successfully develop and market new products. The Company's inability or failure to devise useful merchandising or marketing -11- products or to complete the development or implementation of a particular product for use on a large scale, or the failure of such products to achieve market acceptance, could adversely affect the Company's ability to achieve a significant part of its growth strategy and the absence of such growth could have a material adverse effect on the Company's business, results of operations and financial condition or the desired increases in the Company's business, revenues and profits. -11- Inability to Identify, Acquire and Successfully Integrate Acquisitions Another key component of the Company's growth strategy is the acquisition of businesses across the United States and worldwide that offer similar merchandising or marketing services. The successful implementation of this strategy depends upon the Company's ability to identify suitable acquisition candidates, acquire such businesses on acceptable terms, finance the acquisition and integrate their operations successfully with those of the Company. There can be no assurance that such candidates will be available or, if such candidates are available, that the price will be attractive or that the Company will be able to identify, acquire, finance or integrate such businesses successfully. In addition, in pursuing such acquisition opportunities, the Company may compete with other entities with similar growth strategies, these competitors may be larger and have greater financial and other resources than the Company. Competition for these acquisition targets could also result in increased prices of acquisition targets and/or a diminished pool of companies available for acquisition. The successful integration of these acquisitions also may involve a number of additional risks, including: (i) the inability to retain the customers of the acquired business; (ii) the lingering effects of poor customer relations or service performance by the acquired business, which also may taint the Company's existing businesses; (iii) the inability to retain the desirable management, key personnel and other employees of the acquired business; (iv) the inability to fully realize the desired efficiencies and economies of scale: (v) the inability to establish, implement or police the Company's existing standards, controls, procedures and policies on the acquired business; (vi) diversion of management attention; and (vii) exposure to customer, employee and other legal claims for activities of the acquired business prior to acquisition. And of course,In addition, any acquired business could perform significantly worse than expected. The inability to identify, acquire, finance and successfully integrate such merchandising or marketing services business could have a material adverse effect on the Company's growth strategy and could limit the Company's ability to significantly increase its revenues and profits. Uncertainty of Financing for, and Dilution Resulting from, Future Acquisitions The timing, size and success of acquisition efforts and any associated capital commitments cannot be readily predicted. Future acquisitions may be financed by issuing shares of the Company's Common Stock, cash, or a combination of Common Stock and cash. If the Company's Common Stock does not maintain a sufficient market value, or if potential acquisition candidates are otherwise unwilling to accept the Company's Common Stock as part of the consideration for the sale of their businesses, the Company may be required to obtain additional capital through debt or equity financings. To the extent the Company's Common Stock is used for all or a portion of the consideration to be paid for future acquisitions, dilution may be experienced by existing stockholders. There can be no assurance that the Company will be able to obtain the additional financing it may need for its acquisitions on terms that the Company deems acceptable. Failure to obtain such capital would materially adversely affect the Company's ability to execute its growth strategy. Reliance on the Internet The Company relies on the Internet for the scheduling, coordination and reporting of its merchandising and marketing services. The Internet has experienced, and is expected to continue to experience, significant growth in the numbers of users and amount of traffic as well as increased attacks by hackers and other saboteurs. To the extent that the Internet continues to experience increased numbers of users, frequency of use or increased bandwidth requirements of users, there can be no assurance that the Internet infrastructure will continue to be able to support the demands placed on the Internet by this continued growth or that the performance or reliability of the Internet will not be adversely affected. Furthermore, the Internet has experienced a variety of outages and other delays as a result of accidental and intentional damage to portions of its infrastructure, and could face such outages and delays in the future of similar or greater effect. Any protracted disruption in Internet service would increase the Company's costs of operation and reduce efficiency and performance, which could have a material adverse effect on the Company's business, results of operations and financial condition or the desired increases in the Company's business, revenues and profits. -12- Economic and Retail Uncertainty The markets in which the Company operates are cyclical and subject to the effects of economic downturns. The current political, social and economic conditions, including the impact of terrorism on consumer and business behavior, make it difficult for the Company, its vendors and its customers to accurately forecast and plan future business activities. Substantially all of the Company's key customers are either retailers or those seeking to do product merchandising at retailers. If the retail industry experiences a significant economic downturn, a reduction in product sales could significantly decrease the Company's revenues. The Company also has risks associated with its customers changing their business plans and/or reducing their marketing budgets in response to economic conditions, which could also significantly decrease the Company's revenues. Such revenue decreases could have a material adverse effect on the Company's business, results of operations and financial condition or the desired increases in the Company's business, revenues and profits. Significant Stockholders: Voting Control and Market Illiquidity Mr. Robert G. Brown, founder, director, Chairman, President and Chief Executive Officer of the Company, beneficially owns approximately 45.7%45.5% of the Company's outstanding Common Stock, and Mr. William H. Bartels, founder, director, and Vice Chairman of the Company beneficially owns approximately 29.7%29.4% of the Company's outstanding Common Stock. These stockholders have, should they choose to act together, and under certain circumstances Mr. Brown acting alone has, the ability to control all matters requiring stockholder approval, including the election of directors and the approval of mergers and other business combination transactions. In addition, although the Company Common Stock is quoted on the Nasdaq NationalSmall Cap Market, the trading volume in such stock may be limited and an investment in the Company's securities may be illiquid because the founders own a significant amount of the Company's stock. Dependence Upon and Potential Conflicts in Services Provided by Affiliates The success of the Company's domestic business is dependent upon the successful execution of its field services by SPAR Marketing Services, Inc. ("SMS"), and SPAR Management Services, Inc. ("SMSI"), as well as the programming services provided by SPAR Infotech, Inc. ("SIT"), each of which is an affiliate, but not a subsidiary, of the Company, and none of which is consolidated in the Company's financial statements. SMS provides substantially all of the field representatives used by the Company in conducting its domestic business (85%(87% of field expense in 2003)2004), and SMSI provides substantially all of the field management services used by the Company in conducting its business. These services provided to the Company by SMS and SMSI are on a cost-plus basis pursuant to contracts that are cancelable on 60 days notice prior to December 31 of each year, commencing in 1997, or with 180 days notice at any other time. SIT provides substantially all of the Internet programming services and other computer programming needs used by the Company in conducting its business (see Item 13 - Certain Relationships and Related Transactions, below), which are provided to the Company by SIT on an hourly charge basis pursuant to a contract that is cancelable on 30 days notice. The Company has determined that the services provided by SMS, SMSI and SIT are at rates favorable to the Company. SMS, SMSI SIT and certain other affiliated companiesSIT (collectively, the "SPAR Affiliates") are owned solely by Mr. Robert G. Brown, founder, director, Chairman, President and Chief Executive Officer of the Company, and Mr. William H. Bartels, founder, director, and Vice Chairman of the Company, whoeach of whom are also are each directors and executive officers of each of the SPAR Affiliates (see Item 13 - Certain Relationships and Related Transactions, below). In the event of any dispute in the business relationships between the Company and one or more of the SPAR Affiliates, it is possible that Messrs. Brown and Bartels may have one or more conflicts of interest with respect to those relationships and could cause one or more of the SPAR Affiliates to renegotiate or cancel their contracts with the Company or otherwise act in a way that is not in the Company's best interests. -13- While the Company's relationships with SMS, SMSI SIT and the other SPAR AffiliatesSIT are excellent, there can be no assurance that the Company could (if necessary under the circumstances) replace the field representatives and management currently provided by SMS and SMSI, respectively, or replace the Internet and other computer programming services provided by SIT, in sufficient time to perform its customer obligations or at such favorable rates in the event the SPAR Affiliates no longer performed those services. Any cancellation, other nonperformance or material pricing increase under those affiliate contracts could have a material adverse effect on the Company's business, results of operations and financial condition or the desired increases in the Company's business, revenues and profits. -13- The Company has not paid and does not intend to pay cash Dividends The Company has not paid dividends in the past, intends to retain any earnings or other cash resources to finance the expansion of its business and for general corporate purposes, and does not intend to pay dividends in the future. In addition, the Company's Credit Facility with Webster Business Credit Corporation ("Webster") (see Note 5 to the Financial Statements - Lines of Credit) restricts the payment of dividends without Webster's prior consent. Risks Associated with International Joint Ventures While the Company endeavors to limit its exposure for claims and losses in any international joint ventures through contractual provisions, insurance and use of single purpose entities for such ventures, there can be no assurance that the Company will not be held liable for the claims against and losses of a particular international joint venture under applicable local law or local interpretation of any joint venture or insurance provisions. If any such claims and losses should occur, be material in amount and be successfully asserted against the Company, such claims and losses could have a material adverse effect on the Company's business, results of operations and financial condition or the desired increases in the Company's business, revenues and profits. Risks Associated with Foreign Currency The Company also has foreign currency exposure associated with its international joint venture subsidiaries and joint ventures. In 2004, these exposures are primarily concentrated in the Canadian dollar, Japanese yen and South African rand. Risks Associated with International Business The Company's expansion strategy includes expansion into various countries around the world. While the Company endeavors to limit its exposure by entering only countries where the political, social and economic environments are conducive to doing business in that country there can be no assurances that the respective business environments will remain favorable. Item 2. Properties. The Company maintains its corporate headquarters in approximately 6,000 square feet of leased office space located in Tarrytown, New York, under a lease with a term expiring in May 2004. The Company is exploring various leasing options, including an extension of its existing lease.2006. The Company leases certain office and storage facilities for its corporate headquarters, divisions and subsidiaries under operating leases, which expire at various dates during the next five years. Most of these leases require the Company to pay minimum rents, subject to periodic adjustments, plus other charges, including utilities, real estate taxes and common area maintenance. -14- The following is a list of the locations where the Company maintains leased facilities for its division offices and subsidiaries:
Location Office Use ------------------------------- ----------------------------------------Approximate Square Footage -------------------------- -------------------------------------- --------------------------------- Domestic: Tarrytown, NY Corporate Headquarters 6,000 Auburn Hills, MI Regional Office and Warehouse and Teleservices Center Eden Prairie, MN Regional Office27,000 Cincinnati, OH Regional Office Largo, FL5,300 International: Canada Toronto, Ontario Headquarters 4,000 Japan Osaka Headquarters 1,200 Tokyo Regional Office Toronto, Ontario CAN1,000 Nagoya Regional Office 600 Hukuoka Regional Office 400 Turkey Istanbul Headquarters 4,600 South Africa Durban Headquarters 3,100 Port Elizabeth Regional Office 900 Western Cape Regional Office 2,900 Johannesburg Regional Office 2,000 India New Delhi Headquarters 4,300
Although the Company believes that its existing facilities are adequate for its current business, new facilities may be added should the need arise in the future. -14- Item 3. Legal Proceedings. On October 24, 2001, Safeway Inc. ("Safeway"), filed a former customer ofComplaint against the PIA Merchandising Co., Inc. ("PIA Co."), a wholly owned subsidiary of the Company, and Pivotal Sales Company filed("Pivotal"), a complaint alleging damageswholly owned subsidiary of approximately $3.6 million plus interestPIA Co., and costs and alleged punitive damages in an unspecified amount against the CompanySGRP in Alameda County Superior Court, California, Case No.case no. 2001028498 with respect to (among other things) alleged breach of contract. On or about December 30, 2002, the Court approved the filing ofon October 24, 2001, and has subsequently amended it. Safeway Inc.'s Second Amended Complaint, which alleges causes of action for (among other things) breach of contract, againstbreach of implied contract, breach of fiduciary duty, conversion, constructive fraud, breach of trust, unjust enrichment, and accounting fraud. Safeway has most recently alleged monetary damages in the Company,principal sum of $3,000,000 and probable interest of $1,000,000 and has also demanded unspecified costs. PIA Merchandising Co., Inc.Pivotal and SGRP filed cross-claims against Safeway on or about March 11, 2002, and amended them on or about October 15, 2002, alleging causes of action by them against Safeway for breach of contract, interference with economic relationship, unfair trade practices and unjust enrichment and seeking damages and injunctive relief. Mediation between the parties occurred in 2004, but did not result in a settlement. PIA Co., Pivotal Sales Company. The Second Amended Complaint was filed withand SGRP are vigorously defending Safeway's allegations. It is not possible at this time to determine the Courtlikelihood of the outcome of this lawsuit. However, if Safeway prevails respecting its allegations, and PIA Co., Pivotal and SGRP lose on January 13, 2003,their cross-claims and does not specify the amount of monetary damages sought. No punitive or exemplary damages are sought in Safeway Inc.'s Second Amended Complaint. This case is being vigorously contested bycounterclaims, that result could have a material adverse effect on the Company. The Company anticipates that this matter will be resolved in 2005. In addition to the above, the Company is a party to various other legal actions and administrative proceedings arising in the normal course of business. In the opinion of CompanyCompany's management, disposition of these other matters are not anticipated to have a material adverse effect on the financial position, results of operations or cash flows of the Company. Item 4. Submission of Matters to a Vote of Security Holders. None. -15- PART II Item 5. Market for Registrant's Common Equity and Related Shareholder Matters. Price Range of Common Stock The following table sets forth the reported high and low sales prices of the Common Stock for the quarters indicated as reported on the Nasdaq NationalSmall Cap Market.
2002 2003 ------------------------- --------------------------- High Low High Low First Quarter $ 2.41 $ 1.60 $ 3.60 $ 2.42 Second Quarter 2.50 2.00 5.55 3.05 Third Quarter 2.82 1.96 5.32 3.17 Fourth Quarter 4.92 1.912004 2003 ------------------------ ------------------------- High Low High Low First Quarter $ 3.44 $ 2.30 $ 3.60 $ 2.42 Second Quarter 2.33 0.85 5.55 3.05 Third Quarter 1.50 0.75 5.32 3.17 Fourth Quarter 1.80 0.36 4.57 3.00
As of December 31, 2003,2004, there were approximately 600700 beneficial shareholders of the Company's Common Stock. Dividends The Company has never declared or paid any cash dividends on its capital stock and does not anticipate paying cash dividends on its Common Stock in the foreseeable future. The Company currently intends to retain future earnings to finance its operations and fund the growth of the business. Any payment of future dividends will be at the discretion of the Board of Directors of the Company and will depend upon, among other things, the Company's earnings, financial condition, capital requirements, level of indebtedness, contractual restrictions in respect to the payment of dividends and other factors that the Company's Board of Directors deems relevant. The Company's Credit Facility with Webster Business Credit Corporation (see Note 5 to the Financial Statements - Lines of Credit) restricts the payment of dividends without Webster's prior consent. Item 6. Selected Financial Data. The following selected condensed consolidated financial data sets forth, for the periods and the dates indicated, summary financial data of the Company and its subsidiaries. The selected financial data have been derived from the Company's financial statements, which have been audited by independent public accountants.statements. -16- SPAR Group, Inc. Condensed Consolidated Statements of Operations ----------------------------------------------- (In thousands, except per share data)
Year Ended December 31, --------------------------------------------------------------------------------------------------------------------------------- 2004 2003 2002 2001 2000 1999(2) -------- -------- -------- -------- ----------------------------------------------------------------------------- STATEMENT OF OPERATIONS DATA: STATEMENT OF OPERATIONS DATA: Net revenues $ 51,370 $ 64,859 $ 69,612 $ 70,891 $ 81,459 $ 79,613 Cost of revenues 33,644 42,338 40,331 40,883 50,278 50,499 -------- -------- -------- -------- ----------------------------------------------------------------------------- Gross profit 17,726 22,521 29,281 30,008 31,181 29,114 Selling, general and administrative expenses 20,222 20,967 18,804 19,380 24,761 23,213Impairment charges 8,141 - - - - Depreciation and amortization 1,399 1,529 1,844 2,682 2,383 1,204 -------- -------- -------- -------- ----------------------------------------------------------------------------- Operating (loss) income (12,036) 25 8,633 7,946 4,037 4,697 Other (income) expense (income)(754) 237 (26) 107 (790) (90) Interest expense 220 269 363 561 1,326 976 -------- -------- -------- -------- ----------------------------------------------------------------------------- (Loss) income from continuing operations before provision for income taxes and minority interest (11,502) (481) 8,296 7,278 3,501 3,811 Income tax provision 853 58 2,998 3,123 780 3,743 -------- -------- -------- -------- ----------------------------------------------------------------------------- (Loss) income from continuing operations before minority interest (12,355) (539) 5,298 4,155 2,721 68--------------------------------------------------------------------- Minority interest 87 - - - - Discontinued operations: Loss from discontinued operations net of tax benefits of $935 $858 and $595,$858, respectively - - - (1,597) (1,399) (563) Estimated loss on disposal of discontinued operations, including provision of $1,000 for losses during phase-out period and disposal costs net of tax benefit of $2,618 - - - (4,272) - - -------- -------- -------- -------- ----------------------------------------------------------------------------- Net (loss) income $ (12,268) $ (539) $ 5,298 $ (1,714) $ 1,322 $ (495) ======== ======== ======== ======== ======== Unaudited pro forma data (1) -------- Income from continuing operations before provision for income taxes $ 3,811 Pro forma income tax provision 1,840 -------- Pro forma income from continuing operations 1,971 Pro forma loss from discontinued operations net of pro forma tax benefit of $429 (729) Pro forma net income $ 1,242 ============================================================================= Basic/diluted net (loss) income per common share: Actual/Pro formaNet (loss) income from continuing operations $ (0.03 )(0.65) $ (0.03) $ 0.28 $ 0.23 $ 0.15 $ 0.13 -------- -------- -------- -------- ----------------------------------------------------------------------------- Discontinued operations: Actual/Pro forma lossLoss from discontinued operations - - - (0.09) (0.08) (0.05) Estimated loss on disposal of discontinued operations - - - (0.23) - - -------- -------- -------- -------- -------- Loss--------------------------------------------------------------------- Net loss from discontinued operations - - - (0.32) (0.08) (0.05) -------- -------- -------- -------- -------- Actual/Pro-forma--------------------------------------------------------------------- Basic/diluted net (loss) income $ (0.65) $ (0.03) $ 0.28 $ (0.09) $ 0.07 $ 0.08 ======== ======== ======== ======== ======== Actual/Pro forma weighted===================================================================== Weighted average shares outstanding - basic 18,859 18,855 18,761 18,389 18,185 15,361 Actual/Pro forma weighted average shares outstanding - diluted 18,859 18,855 19,148 18,467 18,303 15,367
-17-
December 31, -------------------------------------------------------------------------------------------------------------------- 2004 2003 2002 2001 2000 1999(2) ------ ------ ------ ------ ----------------- --------- ----------- ----------- ----------- BALANCE SHEET DATA: - ------------------- Working capital (deficiency) $ 962 $ 4,085 $ 6,319 $ 8,476 $ (2,273) $ (639) Total assets 27,870$ 15,821 $ 28,137 $ 28,800 $ 41,155 $ 48,004 54,110 Current portionLines of long-term debtcredit, current $ 4,956 $ 4,084 $ - $ 57 $ 1,143 1,147 LineLines of credit and other long-term debt, netdebt(1) $ 218 $ 270 $ 383 $ 13,287 $ 10,093 16,009 Total stockholders' equity $ 3,714 $ 16,023 $ 16,592 $ 10,934 $ 12,240 10,886 ======== ======== ======== ======== ========
(1) The unaudited pro forma income tax information is presented in accordance with StatementPrior to 2003, the Company's lines of Financial Accounting Standards No. 109, "Accounting for Income Taxes," as if the Company had been subjectcredit were charged to federal and state income taxes for all periods presented. (2) In July 1999, PIA and the Spar Companies merged with the SPAR Companies deemed the accounting acquirer. The resultslong-term liabilities (net of operations include the results of PIA from the acquisition date forward.current portion). -18- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Overview - -------- In the United States, the Company provides merchandising services to manufacturers and retailers principally in mass merchandiser, drug store, grocery, and other retail trade classes through its Domestic Merchandising Services Division. Internationally, the Company provides in-store merchandising services through a wholly owned subsidiary in Canada, 51% owned joint venture subsidiaries in Turkey, South Africa and India and a 50% owned joint venture in Japan. TheIn December 2004, the Company also ownsestablished a 51% interest in aowned joint venture subsidiary in Romania. In February 2005, the Company established to provide merchandising services in Turkey. The Company accounts for its investment in the Japanesea 50% owned joint venture utilizingin China. In 2004, the equity methodCompany consolidated Canada, Turkey, South Africa, India and consolidates both Canada and TurkeyJapan into the Company's financial statements. Romania did not have operations in 2004. In December 2001, the Company decided to divest its Incentive Marketing Division and recorded an estimated loss on disposal of SPAR Performance Group, Inc., now called STIMULYS, Inc. ("SPGI"), of approximately $4.3 million, net of taxes, including a $1.0 million reserve recorded for the anticipated cost to divest SPGI and any anticipated losses through the divestiture date. On June 30, 2002, SPAR Incentive Marketing, Inc. ("SIM"), a wholly owned subsidiary of the Company, entered into a Stock Purchase and Sale Agreement with Performance Holdings, Inc. ("PHI"), a Delaware corporation headquartered in Carrollton, Texas. Pursuant to that agreement, SIM sold all of the stock of SPGI, its subsidiary, to PHI for $6.0 million. As a condition of the sale, PHI issued and contributed 1,000,000 shares of its common stock to Performance Holdings, Inc. Employee Stock Ownership Plan, which became the only shareholder of PHI. SIM's results (including those of SPGI) were reclassified as discontinued operations for all periods presented. The results of operations of the discontinued business segment are shown separately below net income from continuing operations. Accordingly, the 2002 consolidated statements of operations of the Company have been prepared, and its 2001 and 2000 consolidated statement of operations have been restated, to report the results of discontinued operations of SIM (including those of SPGI) separately from the continuing operations of the Company and the following discussions reflect such restatement. In October 2002, the Company dissolved its Technology Division that was established in March 2000 for the purpose of marketing its proprietary Internet-based computer software. The operations of this subsidiary were not material.(see Item 6 - Selected Financial Data, above). Critical Accounting PolicyPolicies & Estimates - ---------------------------------------- The Company's critical accounting policies, including the assumptions and judgments underlying them, are disclosed in the Note 2 to the Financial Statements. These policies have been consistently applied in all material respects and address such matters as revenue recognition, depreciation methods, asset impairment recognition, business combination accounting, and discontinued business accounting. While the estimates and judgments associated with the application of these policies may be affected by different assumptions or conditions, the Company believes the estimates and judgments associated with the reported amounts are appropriate in the circumstances. ThreeFour critical accounting policies are consolidation of subsidiaries, revenue recognition, allowance for doubtful accounts and sales allowance,allowances, and internal use software development costs: Consolidation of subsidiaries The Company consolidates its 100% owned subsidiaries. The Company also consolidates its 51% owned joint venture subsidiaries and its 50% owned joint ventures where the Company is the primary beneficiary because the Company believes this presentation is fairer and more meaningful. Rule 3A-02 of Regulation S-X, Consolidated Financial Statements of the Registrant and its Subsidiaries, states that consolidated statements are presumed to be more meaningful, that majority owned subsidiaries (more than 50%) generally should be consolidated, and that circumstances may require consolidation of other subsidiaries to achieve a fairer presentation of its financial condition and results. In addition, the Company has determined that under Financial Accounting Standards Board Interpretation Number 46, as revised December 2003, Consolidation of Variable Interest Entities ("FIN 46(R)"), the Company is the primary beneficiary of its 51% owned joint venture subsidiaries and its 50% owned joint ventures, which accordingly requires consolidation of those entities into the Company's financial statements. Revenue Recognition The Company's services are provided under contracts or agreements that consist primarily of service fees and per unit fee arrangements. Revenues under service fee arrangements are recognized when the service is performed. -19- The Company's per unit contracts or agreements provide for fees to be earned based on the retail sales of client's products to consumers. The Company recognizes per unit fees in the period such amounts become determinable and are reported to the Company. -19- Allowance for Doubtful Accounts and Sales AllowanceAllowances The Company continually monitors the collectabilityvalidity of its accounts receivable based upon current customer credit information and other information available. Utilizing this information,financial condition. Balances that are deemed to be uncollectible after the Company has attempted reasonable collection efforts are written off through a charge to the bad debt allowance and a credit to accounts receivable. Accounts receivable balances are stated at the amount that management expects to collect from the outstanding balances. The Company provides for probable uncollectible amounts through a charge to earnings and a credit to bad debt allowance based on management's assessment of the current status of individual accounts. Based on management's assessment, the Company established an allowance for doubtful accounts of $515,000$761,000 and $301,000$515,000 at December 31, 20032004 and 2002,2003, respectively. The Company also recorded a reserve for sales allowance of $448,000 to properly reflectallowances for potential customer credits as of $448,000 at December 31, 2003. Bad debt and sales allowance expenses were $366,000, $825,000, and $262,000 in 2004, 2003, and 2002, respectively. Internal Use Software Development Costs The Company under the rules ofIn accordance with SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, the Company capitalizes certain costs associated with its internally developed software. Specifically, the Company capitalizes the costs of materials and services incurred in connection with developing or obtaining internal use software. These costs include but are not limited to the cost to purchase software, write program code and payroll, related benefits and travel expenses for those employees who are directly involved with and who devote time to its software development projects. Capitalized software development costs are amortized over three years. The Company capitalized $559,000, $1,004,000, $772,000 and $430,000$772,000 of costs related to software developed for internal use in 2004, 2003, and 2002, and 2001, respectively. The Company also recorded a net impairment charge of capitalized software related to lost clients totaling approximately $442,000 in 2004. Results of operations The following table sets forth selected financial data and such data as a percentage of net revenues for the periods indicated.
Year Ended Year Ended Year Ended December 31, 2004 December 31, 2003 December 31, 2002 December 31, 2001 --------------------------------------------------------------------------------------------------------------------------------------------------------------- (dollars in millions) Dollars % Dollars % Dollars % -------------- ---------- ----------- ----------- ----------------------- ----------- ----------- Net revenues $ 51.4 100.0% $ 64.9 100.0% $ 69.6 100.0% $ 70.9 100.0% Cost of revenues 33.6 65.5 42.3 65.3 40.3 57.9 40.9 57.7 Selling, general & administrative expenses 20.2 39.4 21.0 32.3 18.8 27.0 19.4 27.4Impairment charges 8.1 15.8 - - - - Depreciation & amortization 1.4 2.7 1.5 2.3 1.8 2.6 2.7 3.8 Other income &(income) expenses, net (0.4) (1.0) 0.5 0.8 0.4 0.6 0.6 0.8 -------------- --------------------- ----------- ----------- ----------- ----------- (Loss) income from continuing operations before income tax provision (11.5) (22.4) (0.4) (0.7) 8.3 11.9 7.3 10.3Provision for income tax provision Income tax provisiontaxes 0.9 1.7 0.1 0.1 3.0 4.3 3.1 4.4 -------------- --------------------- ----------- ----------- ----------- ----------- (Loss) income from continuing operationsbefore minority interest (12.4) (24.1)% (0.5) (0.8)% 5.3 7.6% 4.2 5.9% Discontinued operations: Loss from discontinued operations, net of tax benefitsMinority interest 0.1 0.2 - - (1.6) Estimated loss on disposal of discontinued operations, net of tax benefits - - (4.3) -------------- ----------- ----------------------- Net (loss) income $ (12.3) (23.9)% $ (0.5) (0.8)% $ 5.3 $ (1.7)7.6% ============== =========== =======================
-20- Results from continuing operations for the twelve months ended December 31, - -------------------------------------------------------------------------------- 2004, compared to twelve months ended December 31, 2003 - ------------------------------------------------------- Net Revenues Net revenues from operations for the twelve months ended December 31, 2004, were $51.4 million, compared to $64.9 million for the twelve months ended December 31, 2003, a decrease of $13.5 million or 20.8%. The decrease of $13.5 million in net revenues consists of a decrease in domestic revenue of $21.1 million or 32.9% partially offset by increases in international revenue of $7.7 million. The decrease in domestic revenue is a result of the loss of several significant customers partially offset by revenue from new customers in 2004. The international revenue increase of $7.7 million was primarily a result of the South African acquisition, the Japan consolidation and a full year of Canadian operations. Cost of Revenues Cost of revenues from operations consists of in-store labor and field management wages, related benefits, travel and other direct labor-related expenses. Cost of revenues decreased by $8.7 million in 2004 and as a percentage of net revenues was 65.5% for the twelve months ended December 31, 2004, which was consistent with 65.3% for the twelve months ended December 31, 2003. Approximately 87% and 85% of the field services were purchased from the Company's affiliate, SMS, in 2004 and 2003, respectively (see Item 13 - Certain Relationships and Related Transactions, below). SMS's increased share of field services resulted from its more favorable cost structure Operating Expenses Operating expenses include selling, general and administrative expenses, impairment charges, depreciation and amortization. Selling, general and administrative expenses include corporate overhead, project management, information technology, executive compensation, human resource, legal and accounting expenses. The following table sets forth the operating expenses as a percentage of net revenues for the time periods indicated:
Year Ended Year Ended Increase December 31, 2004 December 31, 2003 (decrease) ---------------------------- ------------------------------ ------------- (dollars in millions) Dollars % Dollars % % -------------- ------------ --------------- ------------- ------------- Selling, general & administrative $ 20.2 39.4% $ 21.0 32.3% (3.6)% Impairment charges 8.1 15.8 - - - Depreciation and amortization 1.4 2.8 1.5 2.3 (8.5)% -------------- ------------ --------------- ------------- Total operating expenses $ 29.7 58.0% $ 22.5 34.6% 32.3% ============== ============ =============== =============
Selling, general and administrative expenses decreased by $0.8 million, or 3.6%, for the twelve months ended December 31, 2004, to $20.2 million compared to $21.0 million for the twelve months ended December 31, 2003. Domestic selling, general and administrative expenses totaled $16.7 million for 2004 and were reduced $3.3 million from $19.9 million in 2003. The reduction of 16.1% was a result of cost reduction programs initiated in 2004 as a result of the loss of certain large customers partially offset by restructure costs of $480,000 expensed in 2004 compared to no expense in 2003. Restructure costs included office lease and employee severance costs. The domestic cost reductions were partially offset by increases of $2.5 million in international selling, general and administrative expenses resulting from the consolidation of Japan, the acquisition of South Africa, and a full year of Canadian operations, as well as, the Turkey and India joint venture startups. Impairment charges were $8.1 million for 2004 (see Note 3 to the Financial Statements -Impairment Charges). Impairment charges resulting from the loss of certain large customers consisted of $7.6 million of goodwill impairment, $1.2 million for the impairment of other assets partially offset by the reduction of $1.4 million (net of taxes) of other liabilities related to the PIA Acquisition. In addition there was approximately $700,000 of goodwill impairment associated with the Canadian subsidiary. Depreciation and amortization charges of $1.4 million in 2004 was consistent with $1.5 million in 2003. -21- Other Income/Other Expense Other income was approximately $754,000 for 2004 versus other expense of $237,000 for 2003. In 2004, other income consisted of approximately $640,000 resulting from the release of specific reserves related to the refinancing of the SPGI notes and approximately $114,000 of foreign currency translation gains. In 2003, other expense consisted primarily of the Company's share of its 50% owned Japan joint venture losses accounted for on the equity method. In 2004, the Japan joint venture was consolidated into the Company's financial statements. Interest Expense Interest expense totaled $220,000 for 2004 and was consistent with interest expense of $269,000 for 2003. Income Taxes The provision for income taxes was $853,000 and $58,000 for 2004 and 2003, respectively. During 2004, as a result of the loss of several significant clients, current year losses and the lack of certainty of a return to profitability in the next twelve months, the Company recorded a full valuation allowance against its net deferred tax assets resulting in a charge totaling approximately $750,000. The 2004 tax provision of $853,000 consists of the valuation allowance and minimum state taxes of approximately $103,000. The tax provision for 2003 reflects minimum tax requirements for state filings. Net (Loss) Income The SPAR Group had a net loss of approximately $12.3 million or $0.65 per basic and diluted share for 2004, compared to a net loss of approximately $539,000 or $0.03 per basic and diluted shares for 2003. Off Balance Sheet Arrangements None. -22- Results from continuing operations for the twelve months ended December 31, - -------------------------------------------------------------------------------- 2003, compared to twelve months ended December 31, 2002 - ------------------------------------------------------- Net Revenues Net Revenuesrevenues from operations for the twelve months ended December 31, 2003, were $64.9 million, compared to $69.6 million for the twelve months ended December 31, 2002, a 6.8% decrease. The decrease of 6.8% in net revenues is primarily attributed to decreased business in mass merchandiser chains. The decrease in net revenues was caused by decreased per unit fee revenue resulting from lower retail sales of customer products and the loss of a particular client, partially offset by increases in service fee revenue. Cost of Revenues Cost of revenues from operations consists of in-store labor and field management wages, related benefits, travel and other direct labor-related expenses. Cost of revenues increased by $2.0 million in 2003 and as a percentage of net revenues was 65.3% for the twelve months ended December 31, 2003, compared to 57.9% for the twelve months ended December 31, 2002, a 5.0% increase. Approximately 85% and 76% of the field services were purchased from the Company's affiliate, SMS, in 2003 and 2002, respectively (see Item 13 - Certain Relationships and Related Transactions, below). SMS's increased share of field services resulted from its more favorable cost structure. The increase in cost as a percentage of net revenues is primarily a result of a decrease in per unit fee revenues that do not have a proportionate decrease in cost. As discussed above under Critical Accounting Policies/Revenue Recognition, the Company's revenue consists of: (1) service fee revenue, which is earned when the merchandising services are performed and, therefore, has proportionate costs in the period the services are performed; and (2) per unit fee revenue, which is earned when the client's product is sold to the consumer at retail, not when the services are performed and, therefore, does not have proportionate costs in the period the revenue is earned. Since the merchandising service and the related costs associated with per unit fee revenue are normally performed prior to the retail sale, and the retail sales of client products are influenced by numerous factors including consumer tastes and preferences, and not solely by the merchandising service performed, in any given period, the cost of per unit fee revenues may not be directly proportionate to the per unit fee revenue. Operating Expenses Operating expenses include selling, general and administrative expenses as well as depreciation and amortization. Selling, general and administrative expenses include corporate overhead, project management, information systems, executive compensation, human resource, expenses, legal and accounting expenses. The following table sets forth the operating expenses as a percentage of net revenues for the time periods indicated:
Year Ended Year Ended Increase December 31, 2003 December 31, 2002 (decrease) ------------------- ------------------- ------------------------------------- ------------------------------ ------------- (dollars in millions) Dollars % Dollars % % ------- ---- ------- ---- ------------------ ------------ --------------- ------------- ------------- Selling, general & administrative $ 21.0 32.3% $ 18.8 27.0% 12.0% Depreciation and amortization 1.5 2.3 1.8 2.6 (17.1)% ------- ---- ------- ---- ------------------ ------------ --------------- ------------- Total operating expenses $ 22.5 34.6% $ 20.6 29.6% 9.4% ======= ==== ======= ==== ================== ============ =============== =============
Selling, general and administrative expenses increased by $2.2 million, or 12.0%, for the twelve months ended December 31, 2003, to $21.0 million compared to $18.8 million for the twelve months ended December 31, 2002. This increase was due primarily to increases in travel related expense of $0.4 million, postage and material expense of $0.6 million, stock option expense for non-employees of $0.4 million and increase in bad debt expense of $0.6 million. Depreciation and amortization decreased by $315,000 for the twelve months ended December 31, 2003, primarily due to older, higher priced assets becoming fully depreciated. -21--23- Interest Expense Interest expense decreased $94,000 to $269,000 for the twelve months ended December 31, 2003, from $363,000 for the twelve months ended December 31, 2002, due to decreased average debt levels as well as decreased interest rates in 2003. Income Taxes The provision for income taxes was $0.1 million$58,000 and $3.0 million for the twelve months ended December 31, 2003 and December 31, 2002, respectively. The tax provision for 2003 reflects minimum tax requirements for state filings. The effective tax rate was 36.1% for 2002. Net (Loss) Income The SPAR Group had a net loss of approximately $539,000 or $0.03 per basic and diluted share for the twelve months ended December 31, 2003, compared to a net income of approximately $5.3 million or $0.28 per basic and diluted shares for the twelve months ended December 31, 2002 because of the factors described above. Off Balance Sheet Arrangements None. -22- Results from continuing operations for the twelve months ended December 31, 2002, compared to twelve months ended December 31, 2001 Net Revenues Net Revenues from continuing operations for the twelve months ended December 31, 2002, were $69.6 million, compared to $70.9 million for the twelve months ended December 31, 2001, a 1.8% decrease. The decrease of 1.8% in net revenues is primarily attributed to decreased business in mass merchandiser and drug store chains. Cost of Revenues Cost of revenues from continuing operations consists of in-store labor and field management wages, related benefits, travel and other direct labor-related expenses. Cost of revenues as a percentage of net revenues of 57.9% for the twelve months ended December 31, 2002, was consistent with the 57.7% for the twelve months ended December 31, 2001. Approximately 76% and 37% of the field services were purchased from the Company's affiliate, SMS, in 2002 and 2001, respectively (see Item 13 - Certain Relationships and Related Transactions, below). SMS's increased share of field services resulted from its more favorable cost structure. Operating Expenses Operating expenses include selling, general and administrative expenses as well as depreciation and amortization. Selling, general and administrative expenses include corporate overhead, project management, information systems, executive compensation, human resource expenses, legal and accounting expenses. The following table sets forth the operating expenses as a percentage of net revenues for the time periods indicated:
Year Ended Year Ended Increase December 31, 2002 December 31, 2001 (decrease) ---------------------------- ------------------------------ ------------- (dollars in millions) Dollars % Dollars % % -------------- ------------ --------------- ------------- ------------- Selling, general & administrative $ 18.8 27.0% $ 19.4 27.4% (3.0) % Depreciation and amortization 1.8 2.6 2.7 3.8 (31.3) -------------- ------------ --------------- ------------- Total operating expenses $ 20.6 29.6% $ 22.1 31.2% (6.4)% ============== ============ =============== =============
Selling, general and administrative expenses decreased by $0.6 million, or 3.0%, for the twelve months ended December 31, 2002, to $18.8 million compared to $19.4 million for the twelve months ended December 31, 2001. This decrease was due primarily to a reduction in the SG&A work force and related expenses, as well as lower information technology costs. Depreciation and amortization decreased by $0.9 million for the twelve months ended December 31, 2002, primarily due to the change in accounting rules for goodwill amortization adopted by the Company effective January 1, 2002. Interest Expense Interest expense decreased $0.2 million to $0.4 million for the twelve months ended December 31, 2002, from $0.6 million for the twelve months ended December 31, 2001, due to decreased debt levels, as well as decreased interest rates in 2002. -23- Income Taxes The provision for income taxes was $3.0 million and $3.1 million for the twelve months ended December 31, 2002 and December 31, 2001, respectively. The effective tax rate was 36.1% and 42.9% for 2002 and 2001, respectively. The decrease in the effective tax rate in 2002 is primarily due to the non-amortization of goodwill (as discussed in Note 2 to the financial statements) that was previously expensed in 2001 and was not deductible for tax purposes. Discontinued Operations
Six Months Ended Year Ended June 30, 2002 December 31, 2001 ---------------------- ----------------------- (dollars in millions) Dollars % Dollars % ----------- --------- ----------- ---------- Net revenues $ 15.7 100.0% $ 31.2 100.0% Cost of revenues 13.1 83.2 26.0 83.4 Selling, general and administrative expenses 2.8 17.9 5.7 18.4 Depreciation and amortization 0.1 0.8 1.2 3.4
The Incentive Marketing Division was divested in June 2002 under a plan adopted in 2001. Net revenues from the Incentive Marketing Division for the six months ended June 30, 2002, were $15.7 million, compared to $31.2 million for the twelve months ended December 31, 2001. Cost of revenues in the Incentive Marketing Division consists of direct labor, independent contractor expenses, food, beverages, entertainment and travel costs. Cost of revenue as a percentage of net revenues of 83.2%, for the six months ended June 30, 2002, was consistent with 83.4% for the twelve months ended December 31, 2001. Operating expenses include selling, general and administrative expenses as well as depreciation and amortization. Selling, general and administrative expenses which include corporate overhead, project management, information systems, executive compensation, human resource expenses, legal and accounting expenses were $2.8 million for the six months ended June 30, 2002, and $5.7 million for the twelve months ended December 31, 2001. Depreciation and amortization was $0.1 million for the six months ended June 30, 2002 compared to $1.2 million for the twelve months ended December 31, 2001, reflecting the change in accounting rules for goodwill adopted by the Company effective January 1, 2002. Net Income/(Loss) The SPAR Group had a net income from continuing operations of approximately $5.3 million or $0.28 per basic and diluted share for the twelve months ended December 31, 2002, compared to a net income from continuing operations of approximately $4.2 million or $0.23 per basic and diluted shares for the twelve months ended December 31, 2001. The increase in net income from continuing operations is primarily the result of substantial reductions in selling, general and administrative expenses and a change in accounting for goodwill amortization. The SPAR Group had a net income of approximately $5.3 million or $0.28 per basic and diluted share for the twelve months ended December 31, 2002, compared to a net loss of $1.7 million or $0.09 per basic and diluted share for the twelve months ended December 31, 2001. The increase in total net income includes the effect of the $4.3 million loss in 2001 on disposal of discontinued operations. Liquidity and Capital Resources In the twelve months ended December 31, 2003,2004, the Company had a net loss of $539,000.$12.3 million. Included in the net loss were non-cash charges of $8.1 million for impairment, $0.7 million for deferred tax asset valuation adjustments, $1.4 million for depreciation and $0.1 million for minority interests in losses of subsidiaries. Net cash provided by operating activities for the twelve months ended December 31, 2003,2004, was $3.4$1.4 million, compared with net cash provided by operations of $12.7$3.4 million for the twelve months ended December 31, 2002. Cash2003. The decrease of $2.0 million in cash provided by operating activities in 2003 wasis primarily a result of decreases in accounts receivable, increases in accounts payable and other current liabilities, partiallydue to net operating losses offset by decreases in deferred taxes and restructuring charges, and by increases in prepaid expenses and deferred tax assets and net operating losses. -24- charges. Net cash used in investing activities for the twelve months ended December 31, 2003,2004, was $2.9$1.3 million, compared with net cash used of $1.2$2.9 million for the twelve months ended December 31, 2002.2003. The decrease in net cash used in investing activities in 2003 resulted primarily from thewas a result of fewer acquisitions of new businesses and lower purchases of property and equipment and acquisition of businesses.in 2004. Net cash used inprovided by financing activities for the twelve months ended December 31, 2003,2004, was $0.5$0.9 million, compared with net cash used in financing activities of $11.5$0.5 million for the twelve months ended December 31, 2002.2003. The increase in net cash used inprovided by financing activities in 20032004 was primarily due to payments to shareholders and purchasesa result of treasury stock, partially offset by borrowings on the lineconsolidation of credit.our Japan joint venture into the Company's financial statements in 2004. The above activity resulted in noa change in cash and cash equivalents for the twelve months ended December 31, 2003 as all excess cash is utilized to pay down the line2004 of credit.$0.9 million. At December 31, 2003,2004, the Company had positive working capital of $4.1$1.0 million as compared to $6.3$4.1 million at December 31, 2002.2003. The decrease in working capital is due to decreases in accounts receivable and deferred taxes, increases in other current liabilities and accounts payable, customer deposits and an increase in the Company's bank linelines of credit, partially offset by increases in prepaid expenses.cash and decreases in accrued expenses and other current liabilities, accrued expenses due to affiliates and restructuring charges. The Company's current ratio was 1.351.08 and 1.531.34 at December 31, 20032004 and 2002,2003, respectively. In January 2003, the Company and Webster Business Credit Corporation, then known as Whitehall Business Credit Corporation ("Whitehall"Webster"), as successor to the business of IBJ Whitehall Business Credit Corporation, entered into the Third Amended and Restated Revolving Credit and Security Agreement and related documents (as amended, collectively, the "New Credit"Credit Facility"). The New Credit Facility provides the Company withprovided a $15.0 million revolving credit facility that matures on January 23, 2006. The New Credit Facility allowsallowed the Company to borrow up to $15.0 million based upon a borrowing base formula as defined in the agreement (principally 85% of "eligible" accounts receivable). On May 17, 2004, the Credit Facility was amended to among other things, reduce the revolving credit facility from $15.0 million to $10.0 million, change the interest rate and increase reserves against collateral. The Newamendment provides for interest to be charged at a rate based in part upon the earnings before interest, taxes, depreciation and amortization. The average interest rate for 2004 was 5.1%. At December 31, 2004, the Credit Facility bears interest at Whitehall'sWebster's "Alternative Base Rate" plus 0.75% (a total of 4.0%6.0% per annum at December 31, 2003)annum), or LIBOR plus two and one-half percent and3.25%. The Credit Facility is secured by all of the assets of the Company and its domestic subsidiaries. The NewIn connection with the May 17, 2004, amendment, Mr. Robert Brown, a -24- Director, the Chairman, President and Chief Executive Officer and a major stockholder of theCompany and Mr. William Bartels, a Director, the Vice Chairman and a major stockholder of the Company, provided personal guarantees totaling $1.0 million to Webster. On August 20, 2004, the Credit Facility replaces a previous 1999 agreement, aswas further amended betweenin connection with the Company and Whitehall (the "Old Credit Facility") that was scheduled to mature on February 28, 2003.waiver of certain covenant violations (see below). The Old Credit Facility provided for a $15.0 millionamendment, among other things, reduced the revolving credit facility as well as, a $2.5from $10.0 million term loan. The old revolving facility allowedto $7.0 million, changed the Companycovenant compliance testing for certain covenants from quarterly to borrow up to $15.0 million based upon a borrowing base formula as defined inmonthly and reduced certain advance rates. On November 15, 2004, the old agreement (principally 85% of "eligible" accounts receivable). The term loan under the Old Credit Facility amortized in equal monthly installments of $83,334was further amended to delete any required minimum Net Worth and was repaid in full as ofminimum Fixed Charge Coverage Ratio covenant levels for the period ending December 31, 2001. Both Credit Facilities contain an option for Whitehall to purchase 16,667 shares of Common Stock of2004. The amendments did not change the Company for $0.01 per share in the event that the Company's average closing share price over a ten consecutive trading day period exceeds $15.00 per share. This option expired on July 31, 2003.future covenant levels. The New Credit Facility containsalso limits certain financial covenants (amending, restating,expenditures including, but not limited to, capital expenditures and replacing those contained in the Old Credit Facility) that must be met by the Borrowers on a consolidated basis, among which are a minimum "Net Worth", a "Fixed Charge Coverage Ratio", a capital expenditure limitation and a minimum EBITDA, as such terms are defined in the respective agreement.other investments. The Company was in compliance with such financialviolation of certain monthly covenants at December 31, 2003, except2004, and expects to be in violation at future measurement dates. Webster issued a waiver for the "Fixed Charge Coverage Ratio"December 31, 2004 covenant violations. However, there can be no assurances that Webster will issue such waivers in the future. Because of the requirement to maintain a lock box arrangement with Webster, Webster's ability to invoke a subjective acceleration clause at its discretion and minimum "EBITDA", for which the Company has securedexpected future covenant violations, borrowings under the Credit Facility are classified as current at December 31, 2004, and December 31, 2003, in accordance with EITF 95-22. Balance Sheet Classification of Borrowings Outstanding Under Revolving Credit Agreements That Include Both a waiver from Whitehall.Subjective Acceleration Clause and a Lock-Box Agreement. The revolving loan balances outstanding onunder the revolving line of creditCredit Facility were $4.1 million under the New Revolving Facility at December 31, 2003,2004, and $148,000December 31, 2003. There were letters of credit outstanding under the Old RevolvingCredit Facility as of December 31, 2002. In addition, the Company had outstanding Letters of Credit of $737,337$0.7 million at December 31, 2003,2004, and $842,418 at December 31, 2002.2003. As of December 31, 2003, based upon the borrowing base formula,2004, the Company had unused availability under the Credit Facility of $4.6$1.4 million out of the $10.9remaining maximum $2.2 million unused revolving line of credit after reducing the borrowing base by outstanding loans and letters of credit. In 2001, the Japanese joint venture SPAR FM Japan, Inc. entered into a revolving line of credit arrangement with Japanese banks for 300 million yen or $2.7 million (based upon the exchange rate at September 30, 2004). At September 30, 2004, SPAR FM Japan, Inc. had 100 million yen or approximately $900,000 loan balance outstanding under the New Revolving Facility.line of credit. The line of credit is effectively guarantied by the Company and the joint venture partner, Paltac Corporation. The average interest rates on the borrowings under the Japanese line of credit for its short-term bank loans at September 30, 2004 and 2003 were 1.375% and 1.375% per annum, respectively. The Company's international model is to partner with local merchandising companies and combine their knowledge of the local market with the Company's proprietary software and expertise in the merchandising business. In April 2003, all previously outstanding amounts due certain stockholders under certain notes were paid2001, the Company established its first joint venture and has continued this strategy. As of this filing, the Company is currently operating in full.Japan, Canada, Turkey, South Africa and India. The Company also announced the establishment of joint ventures in Romania and China. Certain of these joint ventures and joint venture subsidiaries are marginally profitable while others are operating at a loss. None of these entities have excess cash reserves. In the event of continued losses, the Company may be required to provide additional cash infusions into these joint ventures and joint venture subsidiaries. Management believes that based upon the results of Company's current working capital positioncost saving initiatives and the existing credit facilities, fundingsources of cash availability will be sufficient to support ongoing operations over the next twelve months. However, delays in collection of receivables due from any of the Company's major clients, or a significant further reduction in business from such clients, or the inability to acquire new clients, or the Company's inability to remain profitable, or the inability to obtain bank waivers for future covenant violations could have a material adverse effect on the Company's cash resources and its ongoing ability to fund operations. -25- In connection with the sale of SPGI on June 30, 2002, the Company agreed to provide a discretionary revolving line of credit to SPGI not to exceed $2.0 million (the "Revolver") through September 30, 2005. The Revolver is secured by a pledge of all the assets of SPGI and is guaranteed by PHI. The SPGI Revolver provides for advances in excess of the borrowing base through September 30, 2003. As of October 1, 2003, the SPGI Revolver was adjusted, as per the agreement, to include a borrowing base calculation (principally 85% of "eligible" accounts receivable). In September 2003, SPGI requested and the Company agreed to provide advances of up to $1.0 million in excess of the borrowing base through September 30, 2004. Under the Revolver terms, SPGI is required to deposit all of its cash to the Company's lockbox. At December 31, 2003, the Company had cash deposits due SPGI totaling approximately $794,000. Certain Contractual Obligations The following table contains a summary of certain of the Company's contractual obligations by category as of December 31, 20032004 (in thousands).
- -------------------------------------------------------------------------------------------------------------------- Contractual Obligations Payments due by Period - -------------------------------------------------------------------------------------------------------------------- Total Less than 1 1-3 years 3-5 years More than 5 year years - -------------------------------------------------------------------------------------------------------------------- New Credit FacilityFacilities $ 4,0844,956 $ 4,0844,956 $ - $ - $ - - -------------------------------------------------------------------------------------------------------------------- Operating Lease Obligations 2,221 947 1,163 1111,468 776 651 41 - - -------------------------------------------------------------------------------------------------------------------- Total $ 6,3056,424 $ 5,0315,732 $ 1,163651 $ 11141 $ - - --------------------------------------------------------------------------------------------------------------------
In addition to the above table, the Company had agreed to provide a discretionary line of credit to SPGI not to exceed $2.0 million through September 30, 2005. Atat December 31, 2003,2004, the Company had $737,337 in outstanding Letters of Credit. In May 2001, the Company and Paltac, Inc. ("Paltac"), a large Japanese distributor, entered into a joint venture to create a Japanese company, SPAR FM. SPAR FM entered into a Yen 300 million Revolving Credit Agreement with a Japanese bank. The bank required Paltac guarantee the outstanding balance on the revolving credit facility. As part of the joint venture agreement, should Paltac be required to make a payment on its guarantee to the bank, then the Company has agreed to remit to Paltac 50% of any such payment up to a maximum of Yen 150 million or approximately $1.4 million. As of December 31, 2003, SPAR FM has borrowed Yen 100 million under its Revolving Credit Agreement. Therefore, the Company's current exposure to Paltac respecting outstanding loans to SPAR FM at December 31, 2003 would be Yen 50 million or approximately $470,000. -26- Item 7A. Quantitative and Qualitative Disclosures about Market Risk. The Company is exposed to market risk related to the variable interest rate on the line of credit and the variable yield on its cash and cash equivalents. The Company's accounting policies for financial instruments and disclosures relating to financial instruments require that the Company's consolidated balance sheets include the following financial instruments: cash and cash equivalents, accounts receivable, accounts payable and long term debt.lines of credit. The Company considers carrying amounts of current assets and liabilities in the consolidated financial statements to approximate the fair value for these financial instruments because of the relatively short period of time between origination of the instruments and their expected realization. The carrying amount of debt due to certain stockholders approximates fair value because the obligation bears interest at a market rate. The Company monitors the risks associated with interest rates and financial instrument positions. The Company's investment policy objectives require the preservation and safety of the principal, and the maximization of the return on investment based upon the safety and liquidity objectives. Currently, the Company's international operations are not material and, therefore, theThe Company is exposed to market risk related to the variable interest rate on its lines of credit. As of December 31, 2004, the variable interest rate on the Company's lines of credit were 6.0% on its domestic line of credit and 1.4% on its Japanese line of credit. The Company has foreign currency exchange rates is not material.exposure associated with its international 100% owned subsidiary, its 51% owned joint venture subsidiaries and its 50% owned joint ventures. In 2004, these exposures are primarily concentrated in the Canadian dollar, Japanese yen and South African rand. At December 31, 2004, international assets totaled $2.8 million and international liabilities totaled $3.8 million. For 2004, international revenues totaled $8.2 million and the Company's share of the net losses was approximately $500,000. Investment Portfolio The Company has no derivative financial instruments or derivative commodity instruments in its cash and cash equivalents and investments. ExcessDomestically, excess cash is normally used to pay down its revolving line of credit. Internationally, excess cash is used to fund operations. Item 8. Financial Statements and Supplementary Data. See Item 15 of this Annual Report on formForm 10-K. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None. Item 9A. Controls and Procedures. The Company's Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) as of the end of the period covering this report. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission's rules and forms. -26- There were no materialsignificant changes in the Company's internal controlcontrols or in other factors that could significantly affect these controls during the twelve months covered by this report or from the end of the reporting period to the date of this Form 10-K. The Company has established a plan and has begun to document and test its internal controls over financial reporting duringrequired by Section 404 of the fourth quarterSarbanes-Oxley Act of 2003.2002. Item 9B. Other Information. In November 2004 and January 2005, the Company entered into separate operating lease agreements between SMS and the Company's wholly owned subsidiaries, SPAR Marketing Force, Inc. ("SMF") and SPAR Canada Company ("SPAR Canada"). Each lease has a 36 month term and has representations, covenants and defaults customary for the leasing industry. The leases are for handheld computers to be used by field merchandisers in the performance of various merchandising services in the United States and Canada (see Item 13 - Certain Relationships and Related Transactions). -27- PART III Item 10. Directors and Executive Officers of the Registrant. Directors and Executive Officers - -------------------------------- The following table sets forth certain information in connection with each person who is or was at December 31, 2003,2004, an executive officer and/or director for the Company or performing an equivalent function for the Company through an affiliate.
Name Age Position with SPAR Group, Inc. and its affiliates - ---- --- ------------------------------------------------- Robert G. Brown. ................ 61 Chairman, Chief Executive Officer, President and Director William H. Bartels ............. 60 Vice Chairman and Director Robert O. Aders (1) ............ 76 Director, Chairman Governance Committee Jack W. Partridge (1) ........... 58 Director, Chairman Compensation Committee Jerry B. Gilbert (1) ........... 69 Director Lorrence T. Kellar (1) ......... 66 Director, Chairman Audit Committee Charles Cimitile ................. 49 Chief Financial Officer, Treasurer and Secretary Kori G. Belzer ................... 38 Chief Operating Officer, SPAR Management Services, Inc. Patricia Franco .................. 43 Sr.Company. Name Age Position with SPAR Group, Inc. - ---- --- ------------------------------ Robert G. Brown. . . . . . . . 62 Chairman, Chief Executive Officer, President and Director William H. Bartels . . . . . . 61 Vice Chairman and Director .. . Robert O. Aders (1). . . . . . 77 Director, Chairman Governance Committee Jack W. Partridge (1) . . . . . 59 Director, Chairman Compensation Committee Jerry B. Gilbert (1) . . . . . 70 Director Lorrence T. Kellar (1) . . . . 67 Director, Chairman Audit Committee Charles Cimitile. . . . . . . . 50 Chief Financial Officer, Treasurer and Secretary Kori G. Belzer . . . . . . . . . 39 Chief Operating Officer Patricia Franco. . . . . . . . . 44 Chief Information Officer James R. Segreto . . . . . . . . 56 Vice President, SPAR Infotech, Inc. James R. Segreto ................. 55 Controller
- --------------------------__________________________ (1) Member of the Board's Governance, Compensation and Audit Committees Robert G. Brown serves as the Chairman, Chief Executive Officer, President and a Director of the CompanySGRP and has held such positions since July 8, 1999, the effective date of the merger of the SPAR Marketing Companies with PIA Merchandising Services, Inc. (the "Merger"). Mr. Brown served as the Chairman, President and Chief Executive Officer of the SPAR Marketing Companies (SPAR/Burgoyne Retail Services, Inc. ("SBRS") since 1994, SPAR, Inc. ("SINC") since 1979, SPAR Marketing, Inc. ("SMNEV") since November 1993, and SPAR Marketing Force, Inc. ("SMF") since 1996). William H. Bartels serves as the Vice Chairman and a Director of the CompanySGRP and has held such positions since July 8, 1999 (the effective date of the PIA Merger). Mr. Bartels served as the Vice-Chairman,Vice Chairman, Secretary, Treasurer and Senior Vice President of the SPAR Marketing Companies (SBRS since 1994, SINC since 1979, SMNEV since November 1993 and SMF since 1996). Robert O. Aders serves as a Director of the CompanySGRP and has done so since July 8, 1999. He has served as the Chairman of the Governance Committee since May 9, 2003. Mr. Aders has served as Chairman of The Advisory Board, Inc., an international consulting organization since 1993, and also as President Emeritus of the Food Marketing Institute ("FMI") since 1993. Immediately prior to his election to the Presidency of FMI in 1976, Mr. Aders was Acting Secretary of Labor in the Ford Administration. Mr. Aders was the Chief Executive Officer of FMI from 1976 to 1993. He also served in The Kroger Co., in various executive positions from 1957-19741957 to 1974 and was Chairman of the Board from 1970 to 1974. Mr. Aders also serves as a Director of Source-Interlink Co., Checkpoint Systems, Inc., Sure Beam Corporation and Telepanel Systems, Inc. -28- Jack W. Partridge serves as a Director of the CompanySGRP and has done so since January 29, 2001. He has served as the Chairman of the Compensation Committee of SGRP since May 9, 2003. Mr. Partridge is President of Jack W. Partridge & Associates. He previously served as Vice Chairman of the Board of The Grand Union Company from 1998 to 2000. Mr. Partridge's service with Grand Union followed a distinguished 23-year career with The Kroger Company, where he served as Group Vice President, Corporate Affairs, and as a member of the Senior Executive Committee, as well as various other executive positions. Mr. Partridge has been a leader in industry and community affairs for over two decades. He has served as Chairman of the Food Marketing Institute's Government Relations Committee, the Food and Agriculture Policy Task Force, and as Chairman of the Board of The Ohio Retail Association. He has also served as Vice Chairman of the Cincinnati Museum Center and a member of the boards of the United Way of Cincinnati, the Childhood Trust, Second Harvest and the Urban League. Jerry B. Gilbert serves as a Director of the CompanySGRP and has done so since June 4, 2001. Mr. Gilbert served as Vice President of Customer Relations for Johnson & Johnson's Consumer and Personal Care Group of Companies from 1989 to 1997. Mr. Gilbert joined Johnson & Johnson in 1958 and from 1958-19891958 to 1989 held various executive positions. Mr. Gilbert also served on the Advisory Boards of the Food Marketing Institute, the National Association of Chain Drug Stores and the General Merchandise Distributors Council (GMDC) where he was elected the first President of the GMDC Educational Foundation. He was honored with lifetime achievement awards from GMDC, Chain Drug Review, Drug Store News and the Food Marketing Institute. He is the recipient of the prestigious National Association of Chain Drug Stores (NACDS) Begley Award, as well as the National Wholesale Druggists Association (NWDA) Tim Barry Award. In June 1997, Mr. Gilbert received an Honorary Doctor of Letters Degree from Long Island University. Lorrence T. Kellar serves as a Director and the Chairman of the Audit Committee of the CompanySGRP and has done so since April 2, 2003. Mr. Kellar had a 31-year career with The Kroger Co., where he served in various financial capacities, including Group Vice President for real estate and finance, and earlier, as Corporate Treasurer. He was responsible for all of Kroger's real estate activities, as well as facility engineering, which coordinated all store openings and remodels. Mr. Kellar subsequently served as Vice President, real estate, for K-Mart.Kmart. He currently is Vice President of Continental Properties Company, Inc. Mr. Kellar also serves on the boards of Frisch's Restaurants and Multi-Color Corporation and is a trustee of the Acadia Realty Trust. He also is a major patron of the arts and has served as Chairman of the Board of the Cincinnati Ballet. Charles Cimitile serves as the Chief Financial Officer, Secretary and Treasurer and Secretary of the CompanySGRP and has done so since November 24, 1999. Mr. Cimitile served as Chief Financial Officer for GT Bicycles from 1996 to 1999 and Cruise Phone, Inc. from 1995 through 1996. Prior to 1995, he served as the Vice President Finance, TreasurerSecretary and SecretaryTreasurer of American Recreation Company Holdings, Inc. and its predecessor company. Kori G. Belzer serves as the de facto chief operating officerChief Operating Officer of the Company's field force through her positionSGRP and has done so since January 1, 2004. Ms. Belzer also serves as Chief Operating Officer of SPAR Management Services, Inc. ("SMSI"), and of SPAR Marketing Services, Inc. ("SMS"), each an affiliate of the CompanySGRP (see Item 13 - Certain Relationships and Related Transactions)Transactions, below), and has done so since January 1,2000. The Audit Committee determined that Ms. Belzer also served during 2003 as determined by the Company's Audit Committee. Prior to 2003, Ms. Belzer servedde facto chief operating officer of SGRP through her position as Chief Operating Officer of SMSI and SMS fromSMS. Prior to 2000, through 2002,Ms. Belzer served as Vice President Operations of SMS from 1997 throughto 2000, and as Regional Director of SMS from 1995 throughto 1997. Prior to 1995, she served as Client Services Manager for SPAR/Servco, Inc. -29- Patricia Franco serves as the de facto chief information officerChief Information Officer of SGRP and President of the Company through her positionSPAR International Merchandising Services Division and has done so since January 1, 2004. Ms. Franco also serves as Senior Vice President of SPAR Infotech, Inc. ("SIT"), an affiliate of the CompanySGRP (see Item 13 - Certain Relationships and Related Transactions)Transactions, below), and has done so since January 1, 2003. The Audit Committee determined that Ms. Franco also servesserved during 2003 as the de facto chief information officer of SGRP as well as, the de facto President of the SPAR International Merchandising Services Division, and has done so since January 1, 2003,through her position as determined by the Company's Audit Committee.Senior Vice President of SIT. Prior to 2003, Ms. Franco served in various management capacities with SIT, SMS and their affiliates. James R. Segreto serves as Vice President, and Controller of the CompanySGRP and has done so since July 8, 1999, the effective date of the Merger. From 1997 through the Merger, he served in the same capacity for SMS. Mr. Segreto served as Chief Financial Officer for Supermarket Communications Systems, Inc. from 1992 throughto 1997 and LM Capital, LLP from 1990 throughto 1992. Prior to 1992, he served as controllerController of Dorman Roth Foods, Inc. Audit Committee Composition and Financial Expert The Audit Committee currently consists of Messrs. Kellar (its Chairman), Aders, Gilbert and Partridge, each of whom has been determined by the Governance Committee and the Board to meet the independence requirements for audit committee members under Nasdaq Rule 4200(a)(14). In connection with his re-nomination as a Director, the Governance Committee and the Board re-determined that Mr. Kellar was qualified to be the "audit committee financial expert" as required by applicable law and the SEC Rules. Section 16(a) Beneficial Ownership Reporting Compliance. Section 16(a) of the Exchange Act ("Section 16(a)") requires the Company's directors and certain of its officers and persons who own more than 10% of the Company's Common Stock (collectively, "Insiders"), to file reports of ownership and changes in their ownership of the Company's Common Stock with the Commission. Insiders are required by Commission regulations to furnish the Company with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms received by it for the year ended December 31, 2003,2004, or written representations from certain reporting persons for such year, the Company believes that its Insiders complied with all applicable Section 16(a) filing requirements for such year, with the exception that Robert G. Brown, William H. Bartels, Jack W. Partridge and Robert O. Aders and Jerry B. Gilbert untimely filed certain Statements of Changes in Beneficial Ownership on Form 4. Kori Belzer and Patricia Franco became filers in March of 2004. All such Section 16(a) filing requirements have since been completed by each of the aforementioned individuals. -29-Ethics Codes The Company has adopted codes of ethical conduct applicable to all of its directors, officers and employees, as approved and recommended by the Audit Committee and Governance Committee and adopted by the Board on May 3, 2004, in accordance with Nasdaq Rules. These codes of conduct consist of: (1) the SPAR Group Code of Ethical Conduct for its Directors, Senior Executives and Employees Dated (as of) May 1, 2004; and (2) the SPAR Group Statement of Policy Regarding Personal Securities Transaction in SGRP Stock and Non-Public Information Dated, Amended and Restated as of May 1, 2004, which amends, restates and completely replaces its existing similar statement of policy. Both Committees were involved because authority over ethics codes shifted from the Audit Committee to the Governance Committee with the adoption of the committee charters on May 18, 2004. Copies of these codes and policies are posted and available to stockholders and the public on the Company's web site (www.SPARinc.com). -30- Item 11. Executive Compensation and Other Information of SPAR Group, Inc. Executive Compensation - ---------------------- The following table sets forth all compensation received for services rendered to the Company in all capacities for the years ended December 31, 2004, 2003, and 2002 (except for amounts paid to SMS, SMSI and 2001SIT, see Item 13 - Certain Relationships and Related Transactions, below) (i) by the Company's Chief Executive Officer, and (ii) each of the other four most highly compensated executive officers of the Company and its affiliates who were serving as executive officers of the Company or performing equivalent functions for the Company through an affiliate, at December 31, 20032004 (collectively, the "Named Executive Officers"). Summary Compensation Table
Long Term Annual Compensation Compensation Awards ------------------------- ---------------------------------------------- ------------------- Securities Underlying All Other Options Compensation Name and Principal Positions Year Salary ($) Bonus ($) (#)(1) ($)(2) - ---------------------------- ---- ---------- --------- ------ ------ Robert G. Brown 2003 180,0002004 114,000 (3) -- -- 2,2001,800 Chief Executive Officer, Chairman of the 2002 164,3402003 180,000 (3) -- -- 2,0402,200 Board, President, and Director 2001 141,2022002 164,340 (3) -- 765,972 -- 2,040 William H. Bartels 2003 180,0002004 114,000 (3) -- -- 2,0071,620 Vice Chairman and Director 2003 180,000 (3) -- -- 2,007 2002 164,340 (3) -- -- 2,040 2001 139,230Charles Cimitile 2004 220,000 -- 471,992 -- Charles Cimitile25,000 1,800 Chief Financial Officer, Treasurer and 2003 221,700 20,000 20,000 2,200 Chief Financial Officer, Treasurer and Secretary 2002 215,564 15,000 20,000 2,040 2001 188,000 -- 75,000 -- Kori G. Belzer 2004 147,990 -- 25,000 1,495 Chief Operating Officer 2003 147,067 19,000 26,750 1,843 Chief Operating Officer, SPAR Management Services, Inc. Patricia Franco 2004 147,900 10,000 25,000 1,493 Chief Information Officer 2003 145,875 20,000 37,500 1,718 Sr. Vice President, SPAR Infotech, Inc.
------------------------________________________ (1) In January 2001, each of the above officersJune 2004, Mr. Brown and Mr. Bartels voluntarily surrendered for cancellation their options for the purchase of the following numbersshares of common stock under the 2000 Plan: 382,986 and 235,996, respectively. In September 2004, Mr. Cimitile, Ms. Belzer and Ms. Franco voluntarily surrendered for cancellation their options for the purchase of the following shares of common stock under the 2000 Plan: 55,000, 76,140 and 87,500 respectively. Also in September 2004, Ms. Franco voluntarily surrendered for cancellation her options for the purchase 10,000 shares of common stock under the 1995 Plan: Mr. Brown - 765,972; Mr. Bartels - 471,992; Mr. Cimitile - 75,000.Plan. (2) Other compensation represents the Company's 401k contribution. Summary Additional Compensation Table (from affiliated Companies) Robert G. Brown(3) Does not include amounts paid to SMS, SMSI, SIT and William H. Bartels (the "SMS Principals") are the sole owners of SPAR Marketing Services, Inc. ("SMS"), SPAR Management Services, Inc. ("SMSI"), and SPAR Infotech, Inc. ("SIT"), which provide significant services to the Company as more fully described inAffinity Insurance Ltd. (see Item 13 - Certain Relationships and Related Transactions. Although the SMS Principals were not paid any salaries as officers of SMS, SMSI or SIT, each of those companies are "Subchapter S" corporations, and accordingly the SMS Principals benefit from any income of such companies allocated to them, all of which income (or substantially all of which income, but not loss, in the case of SIT) is earned from the performance of services for the Company. The following table sets forth all income allocated to the SMS Principals by SMS, SMSI or SIT for the years ended December 31, 2003, 2002 and 2001. -30-Transactions, below) -31-
SIT Income Name Year SMS Income SMSI Income (Loss) (1) ------------------------ -------- --------------- ----------------- ---------------- Robert G. Brown 2003 $ 667,756 $ 177,214 $ 33,591 2002 494,987 174,092 (85,183) 2001 211,117 16,477 (227,370) William H. Bartels 2003 $ 424,937 $ 112,773 $ 21,376 2002 314,992 110,787 (54,208) 2001 134,348 10,486 (144,690)
(1) The subchapter "S" income/loss allocated to the SMS Principals by SIT includes losses on activities unrelated to the Company's business. Stock Option Grants in Last Fiscal Year The following table sets forth information regarding each grant of stock options made during the year ended December 31, 2003,2004, to each of the Named Executive Officers. No stock appreciation rights ("SAR's") were granted during such period to such person.
Individual Grants ---------------------------------------------------------- Number of Percent of Securities Total Options Underlying Granted to Potential Realizable Value at Securities Total Options Employees in Exercise Expiration Assumed Annual Rates of Stock Underlying Granted to Exercise Expiration Price Appreciation for Option (1) Options Employees inName Granted(2)(#) Period (%) Price ($/Sh) Date ---------------------------------- Name Granted (2)(#) Period (%)Price Appreciation for Option(1) - ---- ------------------------------------------------------------------------------------------ 5% ($) 10% ($) - ---- ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Charles Cimitile 20,000 5.0 2.99 2/13/13 37,608 95,30625,000 16.1 2.39 3/31/14 37,596 95,226 Kori G. Belzer 20,500 5.0 2.99 2/13/13 38,548 97,688 6,000 1.5 3.80 5/9/13 14,339 36,337 250 0.1 4.65 8/7/13 731 1,853 --------------- --------------- ------------- ----------------- 26,750 6.6 53,618 135,87825,000 16.1 2.39 3/31/14 37,596 95,226 Patricia Franco 20,500 5.1 2.99 2/13/13 38,548 97,688 16,000 4.0 3.80 5/9/13 38,237 96,900 750 0.2 4.65 8/7/13 2,193 5,558 250 0.1 3.89 11/5/13 612 1,550 --------------- --------------- ------------- ----------------- 37,500 9.4 79,590 201,69625,000 16.1 2.39 3/31/14 37,596 95,226
- ------------____________ (1) The potential realizable value is calculated based upon the term of the option at its time of grant. It is calculated by assuming that the stock price on the date of grant appreciates at the indicated annual rate, compounded annually for the entire term of the option. (2) These options vest over four-year periods at a rate of 25% per year, beginning on the first anniversary of the date of grant. -31- Aggregated Stock Option Exercises in Last Fiscal Year and Fiscal Year End Option Values The following table sets forth the number of shares of Common Stock of the Company purchased by each of the Named Executive Officers in the exercise of stock options during the year ended December 31, 2003,2004, the value realized in the purchase of such shares (the market value at the time of exercise less the exercise price to purchase such shares), and the number of shares that may be purchased and value of the exercisable and unexercisable options held by each of the Named Executive Officers at December 31, 2003.2004.
Number of Securities Underlying Value of Unexercised Unexercised Options at Fiscal In-the-Money Options at Fiscal Year-End (#) Year-End ($) ---------------------------------- -------------------------------- Shares Acquired Value Name on Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable - ---- ----------------- --------------- ---------------- ---------------- -------------- ---------------- Robert G. Brown -- -- -- 95,746 382,986 $181,917 $702,779-- -- William H. Bartels -- -- -- 58,999 235,996 112,098 437,713-- -- Charles Cimitile -- -- 98,750 41,250 196,206 36,56925,000 85,000 10,625 -- Kori G. Belzer -- -- 81,000 76,140 156,134 86,60311,500 94,500 4,513 88 Patricia Franco -- -- 97,250 66,250 168,122 46,99611,500 79,500 4,513 88
Stock Option and Purchase Plans The Company has four stock option plans: the Amended and Restated 1995 Stock Option Plan (1995 Plan)("1995 Plan"), the 1995 Director's Plan (Director's Plan)("Director's Plan"), the Special Purpose Stock Option Plan (the "Special Purpose Plan"), and the 2000 Stock Option Plan (2000 Plan)("2000 Plan"). The 1995 Plan provided for the granting of either incentive or nonqualified stock options to specific employees, consultants, and directors of the Company for the purchase of up to 3,500,000 shares of the Company's common stock. The options had a term of ten years from the date of issuance, except in the case of incentive stock options granted to greater than 10% stockholders for which the term was five years. The exercise price of nonqualified stock options must have been equal to at least 85% of the fair market value of the Company's common stock at the date of grant. Since 2000, the Company has not granted any new options under this Plan.plan. During 2004, 1,500 options to purchase shares of the Company's common stock were exercised and options to purchase 26,625 shares of the Company's stock were cancelled -32- under this plan. At December 31, 2003,2004, options to purchase 43,25015,125 shares of the Company's common stock remain outstanding under this Plan.plan. The 1995 Plan was superseded by the 2000 Stock Option Plan with respect to all new options issued. The Director's Plan was a stock option plan for non-employee directors and provided for the purchase of up to 120,000 shares of the Company's common stock. Since 2000, the Company has not granted any new options under this Plan.plan. During 2003,2004, no options to purchase shares of the Company's common stock were exercised under this Plan.plan. At December 31, 2003,2004, 20,000 options to purchase shares of the Company's common stock remained outstanding under this Plan.plan. The Director's Plan has been replaced by the 2000 Plan with respect to all new options issued. On July 8, 1999, in connection with the merger, the Company established the Special Purpose Stock Option Plan of PIA Merchandising Services, Inc. to provide for the issuance of substitute options to the holders of outstanding options granted by SPAR Acquisition, Inc. There were 134,114 options granted at $0.01 per share. Since July 8, 1999, the Company has not granted any new options under this plan. During 2003, no2004, 21,000 options to purchase shares of the Company's common stock were exercised under this Plan.plan. At December 31, 2003,2004, options to purchase 25,7504,750 shares of the Company's common stock remain outstanding under this Plan.plan. On December 4, 2000, the Company adopted the 2000 Plan, as the successor to the 1995 Plan and the Director's Plan with respect to all new options issued. The 2000 Plan provides for the granting of either incentive or nonqualified stock options to specified employees, consultants, and directors of the Company for the purchase of up to 3,600,000 (less those options still outstanding under the 1995 Plan or exercised after December 4, 2000 under the 1995 Plan). The options have a term of ten years, except in the case of incentive stock options granted to greater than 10% stockholders for whom the term is five years. The exercise price of nonqualified stock options must be equal to at least 85% of the fair market value of the Company's common stock at the date of grant (although typically the options are issued at 100% of the fair market value), and the exercise price of incentive stock options must be equal to at least the fair market value of the Company's common stock at the date of grant. During 2003,2004, options to purchase 401,020476,417 shares of the Company's common stock were granted, options to purchase 143,64153,302 shares of the Company's common stock were exercised and -32- options to purchase 86,5001,345,542 shares of the Company's stock were voluntarily surrendered and cancelled under this Plan.plan. At December 31, 2003,2004, options to purchase 2,180,0601,251,383 shares of the Company's common stock remain outstanding under this Planplan and options to purchase 743,3441,618,719 shares of the Company's common stock were available for grant under this Plan.plan. In 2001, the CompanySGRP adopted its 2001 Employee Stock Purchase Plan (the "ESP Plan"), which replacesreplaced its earlier existing plan, and its 2001 Consultant Stock Purchase Plan (the "CSP Plan"). These plans were each effective as of June 1, 2001. The ESP Plan allows employees of the Company, and its subsidiaries, and the CSP Plan allows employees of the affiliates of the Company (see Item 13-13 - Certain Relationships and Related Transactions, below), to purchase the Company'sSGRP's Common Stock from the CompanySGRP without having to pay any brokerage commissions. On August 8, 2002, the Company'sSGRP's Board of Directors approved a 15% discount for employee purchases of Common Stock under the ESP Plan and recommended that its affiliates pay a 15% cash bonus for affiliate consultant purchases of Common Stock under the CSP Plan. Compensation of Directors The Company's Compensation Committee administers the compensation plan for its outside Directors as well as the compensation for its executives. Each member of the Company's Board who is not otherwise an employee or officer of the Company or any subsidiary or affiliate of the Company (each, an "Eligible Director") is eligible to receive the compensation contemplated under such plan. In January 2001, the CompanySGRP adopted the Director Compensation Plan which was amendedfor its outside Directors, as approved by the Board, as amended (the "Directors Compensation Plan"). SGRP's Compensation Committee in February of 2003.administers the Directors Compensation Plan as well as the compensation for SGRP's executives. Under the amended plan,Directors Compensation Plan, each non-employee director receives thirty thousand dollars ($30,000)member of SGRP's Board who is not otherwise an employee or officer of SGRP or any subsidiary or affiliate of SGRP (each, a "Non-Employee Director") is eligible to receive director's fees of $30,000 per annum (increased from twenty thousand dollars ($20,000) per annum for 2002 and 2001) and the Chairman of the Audit Committee will receive(plus an additional $5,000 per annum. Payments are madeannum for the Audit Committee Chairman), payable quarterly. Each quarterly in equal installments. Itinstallment of such director's fees ($7,500 plus an additional $1,250 for the Audit Committee Chairman) is intended that each quarterly payment will be 50%paid half in cash ($3,750, up from $2,500 for 2002 and 2001) and 50% ($3,750, up from $2,500 for 2002 and 2001)half in stock options to purchase shares of the Company'sSGRP's common stock. Prior to May 2004, SGRP issued such stock options with an exercise price of $0.01 per share (plus an additional $1,250 per quarter for the Chairman of the Audit Committee, half in cash and half in $.01 stock options).share. The number of option shares issued was calculated by dividing the amount of the Company's commoncompensation to be paid in stock that can be purchased under each $.01 stock option granted will be determined based uponoptions by the closing stock price at the end of each quarter. In May 2004, the Compensation Committee approved and recommended and the Board adopted a change in this policy to instead issue such stock options for the purchase of common stock with an exercise price equal to 100% of the fair -33- market value of SGRP's common stock at the end of each quarter. The number of option shares to be issued will be equal to three times the quotient of the amount of compensation to be paid in stock options divided by the closing stock price at the end of each quarter. The Compensation Committee and the Board determined that this revised policy more fairly compensated the Non-Employee Directors. In addition upon acceptance of the directorship, each non-employee directorNon-Employee Director receives options to purchase 10,000 shares of the Company'sSGRP's common stock with an exercise price equal to 100% of the fair market value of the Company'sSGRP's common stock at the date of grant, 10,000 additional options to purchase 10,000 additional shares of the Company'sSGRP's common stock with an exercise price equal to 100% of the fair market value of the Company'sSGRP's common stock at the date of grant after one year of service and 10,000 additional options to purchase 10,000 additional shares of the Company'sSGRP's common stock with an exercise price equal to 100% of the fair market value of the Company'sSGRP's common stock at the date of grant for each additional year of service thereafter. All of thethose options to Non-Employee Directors have been and will be granted under the 2000 Plan described above, under which each member of the SPAR Board is eligible to participate. Non-employee directorsNon-Employee Directors will be reimbursed for all reasonable expenses incurred during the course of their duties. There is no additional compensation for committee participation, phone meetings, or other Board activities. Severance Agreements The Company has entered into a Change of Control Severance Agreement with each of Patricia Franco, the Company's Chief Information Officer, and Kori G. Belzer, the Company's Chief Operating Officer, each providing for a lump sum severance payment and other accommodations from the Company to the employee under certain circumstances if, pending or following a change in control, the employee leaves for good reason or is terminated other than in a termination for cause. The payment is equal to the sum of the employee's monthly salary times a multiple equal to 24 months less the number of months by which the termination of employment followed the change in control plus the maximum bonus that would have been paid to the employee (not to exceed 25% of the employee's annual salary). Compensation Committee Interlocks and Insider Participation No member of the Board's Compensation Committee was at any time during the year ended December 31, 2003,2004, or at any other time an officer or employee of the Company. No executive officer or board member of the Company serves as a member of the board of directors or compensation committee of any other entity, that has one or more executive officers serving as a member of the Company's Board or Compensation Committee, except for the positions of Messrs. Brown and Bartels as directors and officers of the Company (including each of its subsidiaries) and each of its affiliates, including SMS, SMSI and SIT (see Item 13 - Certain Relationships and Related Transactions, below). -33--34- Item 12. Security Ownership of Certain Beneficial Owners and Management. Security Ownership of Certain Beneficial Owners of the Company The following table sets forth certain information regarding beneficial ownership of the Company's common stock as of March 22, 200415, 2005 by: (i) each person (or group of affiliated persons) who is known by the Company to own beneficially more than 5% of the Company's common stock; (ii) each of the Company's directors; (iii) each of the Named Executive Officers in the Summary Compensation Table; and (iv) the Company's directors and such Named Executive Officers as a group. Except as indicated in the footnotes to this table, the persons named in the table, based on information provided by such persons, have sole voting and sole investment power with respect to all shares of common stock shown as beneficially owned by them, subject to community property laws where applicable.
Number of Shares Beneficially Title of Class Name and Address of Beneficial Owner Beneficially Owned Percentage -------------- ------------------------------------ ---------------- ---------- Common Shares Robert G. Brown (1) 8,727,2668,622,407 (2) 45.7%45.5% Common Shares William H. Bartels (1) 5,638,3795,549,842 (3) 29.7%29.4% Common Shares Robert O. Aders (1) 86,203134,543 (4) * Common Shares Jack W. Partridge (1) 30,66878,633 (5) * Common Shares Jerry B. Gilbert (1) 24,00971,974 (6) * Common Shares Lorrence T. Kellar (1) 14,31068,602 (7) * Common Shares Charles Cimitile (1) 109,647107,500 (8) * Common Shares Kori G. Belzer (1) 116,71897,951 (9) * Common Shares Patricia Franco (1) 162,675141,998 (10) * Common Shares Richard J. Riordan (11) 300 South Grand Avenue, Suite 2900 Los Angeles, California 90071 1,209,922 6.4% Common Shares Heartland Advisors, Inc. (11) 1,300,000 6.9%(12) 790 North Milwaukee Street Milwaukee, Wisconsin 53202 1,300,000 6.9% Common Shares Executive Officers and Directors 14,909,875 79.4%14,873,450 79.0%
* Less than 1% (1) The address of such owners is c/o SPAR Group, Inc. 580 White Plains Road, Tarrytown, New York 10591. (2) Includes 1,800,000 shares held by a grantor trust for the benefit of certain family members of Robert G. Brown over which Robert G. Brown, James R. Brown, Sr. and William H. Bartels are trustees. Includes 325,53995,747 shares issuable upon exercise of options. (3) Excludes 1,800,000 shares held by a grantor trust for the benefit of certain family members of Robert G. Brown over which Robert G. Brown, James R. Brown, Sr. and William H. Bartels are trustees, beneficial ownership of which are disclaimed by Mr. Bartels. Includes 229,27558,999 shares issuable upon exercise of options. (4) Includes 36,20362,889 shares issuable upon exercise of options. (5) Includes 19,70067,665 shares issuable upon exercise of options. (6) Includes 24,00971,974 shares issuable upon exercise of options. (7) Includes 13,31062,454 shares issuable upon exercise of options. (8) Includes 108,750107,500 shares issuable upon exercise of options. (9) Includes 115,51596,000 shares issuable upon exercise of options. (10) Includes 109,87588,500 shares issuable upon exercise of options. (11) Share ownership was confirmed with the Company's stock transfer agent and the principal. (12) All information regarding share ownership is taken from and furnished in reliance upon the Schedule 13G (Amendment No. 9), filed by Heartland Advisors, Inc. with the Securities and Exchange Commission on December 31, 2003. -34-2004. -35- Equity Compensation Plans The following table contains a summary of the number of shares of Common Stock of the Company to be issued upon the exercise of options, warrants and rights outstanding at December 31, 2003,2004, the weighted-average exercise price of those outstanding options, warrants and rights, and the number of additional shares of Common Stock remaining available for future issuance under the plans as at December 31, 2003.2004.
Equity Compensation Plan Information ----------------------------- -------------------------- ------------------------- ------------------------- Plan category Number of securities to Weighted average Number of securities be issued upon exercise exercise price of remaining available for of outstanding options, outstanding options, future issuance of warrants and rights (#) warrants and rights ($) options, warrants and Plan category rights (#) ----------------------------- -------------------------- ------------------------- ------------------------- Equity compensation plans 2,269,060 $1.85 743,3441,291,258 $1.66 1,618,719 approved by security holders ----------------------------- -------------------------- ------------------------- ------------------------- Equity compensation plans not approved by security holders -- -- -- ----------------------------- -------------------------- ------------------------- ------------------------- Total 2,269,060 $1.85 743,3441,291,258 $1.66 1,618,719 ----------------------------- -------------------------- ------------------------- -------------------------
Item 13. Certain Relationships and Related Transactions. Mr. Robert G. Brown, a Director, the Chairman, President and the Chief Executive Officer and a major stockholder of the Company, and Mr. William H. Bartels, a Director, and the Vice Chairman and a major stockholder of the Company, (collectively, the "SMS Principals"), are executive officers and the sole stockholders and executive officers and directors of SPAR Marketing Services, Inc. ("SMS") and, SPAR Management Services, Inc. ("SMSI"), and SPAR Infotech, Inc. ("SIT"). SMS and SMSI (through SMS) provided approximately 92%99% of the Company's field representatives (through its independent contractor field force) and substantially allapproximately 92% of the Company's field management services at a total cost of approximately $24.0 million, $36.0 million, and $30.5 million for the twelve months ended December 31,2004, 2003, and 2002, respectively. UnderPursuant to the terms of the Amended and Restated Field Service Agreement dated as of January 1, 2004, SMS provides the services of SMS's field force of approximately 6,000 field representatives6,300 independent contractors to the Company. Pursuant to the terms of the Amended and Restated Field Management Agreement dated as of January 1, 2004, SMSI provides approximately 8050 full-time national, regional and district managers to the Company as they may request from time to time, for whichCompany. For those services, the Company has agreed to payreimburse SMS and SMSI (through SMS) for all of their costs of providing those services plusand to pay SMS and SMSI each a premium equal to 4%. However, SMS may not charge the Company of their respective costs, except that for any past taxes or associated costs for which the SMS Principals have2004 SMSI agreed to indemnifyconcessions that reduced the Company. Although thepremium paid by approximately $640,000 for 2004. Total net premiums (4% of SMS Principalsand SMSI costs less 2004 concessions) paid to SMS and SMSI for services rendered were approximately $320,000, $1,350,000, and $1,100,000 for 2004, 2003, and 2002, respectively. The Company has been advised that Messrs. Brown and Bartels are not paid any salaries as officers of SMS or SMSI so there were no salary reimbursements for them included in such costs or premium. However, since SMS and SMSI are "Subchapter S" corporations, Messrs. Brown and accordingly, the SMS PrincipalsBartels benefit from any income of such companies allocated to them (see Item 11 - Summary Additional Compensation Table - Affiliated Companies above). Ms. Kori Belzer is the Chief Operating Officer of SMSI and SMS. The Company's Audit Committee has determined that Ms. Belzer functions (and has functioned since January 1, 2003) as the de facto chief operating officerthem. SIT provided substantially all of the Company's field force, which as noted above, is managed by SMSI and largely provided by SMS, and accordingly, Ms. Belzer has been included in the Company's list of Named Executive Officers in Item 10 above. Ms. Belzer's compensation and business expenses are part of the costs covered by the "cost plus" contract described above, and accordingly, are indirectly paid by the Company. Ms. Belzer also participates in the CSP Plan and, from time to time, receives options to purchase the Company's stock pursuant to the 2000 Plan (see Item 10-Stock Option and Purchase Plans). Ms. Belzer's compensation is reviewed annually by the Company's Compensation Committee. SIT provided Internet computer programming services to the Company at a total cost of approximately $1,607,400$1,170,000, $1,610,000, and $1,626,000$1,630,000 for the twelve months ended December 31,2004, 2003, and 2002, respectively. Under the termsSIT provided approximately 34,000, 47,000, and 46,000 hours of theInternet computer programming agreement betweenservices to the Company for 2004, 2003, and SIT effective2002, respectively. Pursuant to the Amended and Restated Programming and Support Agreement dated as of OctoberJanuary 1, 1998, as amended (the "Programming Agreement"),2004, SIT continues to provide programming services to the Company as the Company may request from time to time, for which the Company has agreed to pay SIT competitive hourly wage rates for time spent on Company matters and to reimburse SIT'sthe related out-of-pocket expenses. Althoughexpenses of SIT and its personnel. The average hourly billing rate was $34.71, $34.24, and $35.10 for 2004, 2003, and 2002, respectively. The Company has been advised that no hourly charges or business expenses for Messrs. Brown and Bartels were charged to the SMS Principals were not paid any salaries as officers ofCompany by SIT for 2004. However, since SIT is a "Subchapter S" corporation, Messrs. Brown and accordingly the SMS Principals wouldBartels benefit from any income of such company allocated to them. -35- Ms. Patricia Franco isIn November 2004 and January 2005, the Company entered into separate operating lease agreements between SMS and the Company's wholly owned subsidiaries, SPAR Marketing Force, Inc. ("SMF") and SPAR Canada Company ("SPAR Canada"). Each lease has a Senior Vice President36 month term and has representations, covenants and defaults customary for the leasing industry. The SMF lease has a monthly payment of SIT$20,318 and is in charge of its day-to-day operations. The Company's Audit Committee has determined that Ms. Franco functions (and has functioned since January 1, 2003) as the de facto chief information officer of the Company, as well as the de facto President of the International Division and accordingly, Ms. Franco has been includedfor handheld computers to be used by field merchandisers in the Company's listperformance of Named Executive Officers in Item 10 above. Ms. Franco's compensation is paid by SIT, which charges the Company $80.00 per hour for time spent by Ms. Franco on Company matters. For the year ended December 31, 2003, the Company paid $132,600 to SIT for the use of Ms. Franco's services. Ms. Franco also participatesvarious merchandising services in the CSP PlanUnited States. These handheld computers had an original purchase price of $632,200. The SPAR Canada lease has a monthly payment of $3,326 and from timeis for handheld -36- computers to time, receives options tobe used by field merchandisers in the performance of various merchandising services in Canada. These handheld computers had an original purchase the Company's stock pursuant to the 2000 Plan (see Item 10 - Stock Option and Purchase Plans). Ms. Franco's compensation is reviewed annually by the Company's Compensation Committee.price of $105,000. The Company's agreements with SMS, SMSI and SIT are periodically reviewed by the Company's Audit Committee, which includes an examination of the overall fairness of the arrangements and the resulting income to the SMS Principals.arrangements. In February 2004, the Audit Committee approved separate amended and restated agreements with each of SMS, SMSI and SIT, effective as of January 1, 2004. The restated agreements extend the contract maturities for four years, strengthened various contractual provisions in each agreement and continued the basic economic terms of the existing agreements, except that the restated agreement with SMSI provides for a temporary reduction in SMSI's feesconcessions to the Company by SMSI totalling approximately $640,000 for 2004. In July 1999, SMF, SMS and SIT entered into a Software Ownership Agreement with respect to Internet job scheduling software jointly developed by such parties. In addition, SPAR Trademarks, Inc. ("STM"), SMS and SIT entered into trademark licensing agreements whereby STM has granted non-exclusive royalty-free licenses to SIT, SMS and SMSI for their continued use of the name "SPAR" and certain other trademarks and related rights transferred to STM, a wholly owned subsidiary of the Company. The SMS PrincipalsMessrs. Brown and Bartels also collectively own, through SMSI, a minority (less than 5%) equity interest in Affinity Insurance Ltd., which provides certain insurance to the Company. In April 2003, all previously outstanding amounts due certain stockholders under certain notes were paid in full. In the event of any material dispute in the business relationships between the Company and SMS, SMSI, or SIT, it is possible that Messrs. Brown or Bartels may have one or more conflicts of interest with respect to these relationships and such dispute that could have a material adverse effect on the Company. Item 14. Principal Accountant Fees and Services. On October 4, 2004, Ernst & Young LLP ("E&Y") resigned as the independent registered public accounting firm for the Company and its subsidiaries. The resignation was effective upon completion of E&Y's review of the interim financial information for the Company's third fiscal quarter ended September 30, 2004, and the filing of the Company's quarterly report on Form 10-Q for such period. In January 2005, the Company, with the approval of the Company's Audit Committee, appointed Rehmann Robson ("Rehmann") as its independent registered public accounting firm to audit the financial statements of the Company for its year ending December 31, 2004. The Company and its subsidiaries did not engage Ernst & Young LLP ("Rehmann or E&Y")&Y to provide advice regarding financial information systems design or implementation, but did engage E&Y for tax consulting services related to the PHI/SPGI ESOP in 2003 and 2002 (for which E&Y was paid $3,778 and $13,500 respectively)$3,778), due diligence services for the IMS acquisition during 2003 (for which E&Y was paid $14,334) and for tax services in 2003 and 2002 (for which E&Y was paid $2,295 and $13,500 respectively)$2,295). No other non-audit services were performed by Rehmann or E&Y in 20032004 or 2002.2003. Since 2003, as required by law, each non-audit service performed by the Company's auditor either (i) was approved in advance on a case-by-case basis by the Company's Audit Committee, or (ii) fit within a pre-approved "basket" of non-audit services of limited amount, scope and duration established in advance by the Company's Audit Committee. In connection with the standards for independence of the Company's independent public accountants promulgated by the Securities and Exchange Commission, the Audit Committee considers (among other things) whether the provision of such non-audit services would be compatible with maintaining the independence of Rehmann or E&Y. Audit Fees During the Company's fiscal year ended December 31, 20032004 and 2002,2003, respectively, fees billed by Ernst & Young LLPE&Y for all audit services rendered to the Company and its subsidiaries were $179,362$100,203 and $143,000,$179,362, respectively. Audit services principally include fees for the Company's audits and 10-Q filing reviews. Since 2003, as required by law, the choice of the Company's auditor and the audit services to be performed by it have been approved in advance by the Company's Audit Committee. -36--37- PART IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) 1. Index to Financial Statements filed as part of this report: Independent Auditors' Report. F-1 Consolidated Balance Sheets as of December 31, 2003, and December 31, 2002. F-2 Consolidated Statements of Operations for the years ended December 31, 2003, December 31, 2002, and December 31, 2001. F-3 Consolidated Statements of Stockholders' Equity for the years ended December 31, 2003, December 31, 2002, and December 31, 2001. F-4 Consolidated Statements of Cash Flows for the years ended December 31, 2003, December 31, 2002, and December 31, 2001. F-5 Notes to Financial Statements. F-6 2. Financial Statement Schedules. Schedule II - Valuation and Qualifying Accounts for the three years ended December 31, 2003. F-27
(a) 1. Index to Financial Statements filed as part of this report: Reports of Independent Registered Public Accounting Firms - Rehmann Robson. F-1 - Ernst & Young LLP. F-2 Consolidated Balance Sheets as of December 31, 2004, and December 31, 2003. F-3 Consolidated Statements of Operations for the years ended December 31, 2004, December 31, 2003, and December 31, 2002. F-4 Consolidated Statements of Stockholders' Equity for the years ended December 31, 2004, December 31, 2003, and December 31, 2002. F-5 Consolidated Statements of Cash Flows for the years ended December 31, 2004, December 31, 2003, and December 31, 2002. F-6 Notes to Financial Statements. F-7 2. Financial Statement Schedules. Schedule II - Valuation and Qualifying Accounts for the three years ended December 31, 2004. F-30 3. Exhibits. Exhibit Number Description ------ ----------- 3.1 Certificate of Incorporation of SPAR Group, Inc. (referred to therein under its former name PIA), as amended (incorporated by reference to the Company's Registration Statement on Form S-1 (Registration No. 33-80429), as filed with the Securities and Exchange Commission ("SEC") on December 14, 1995 (the "Form S-1")), and the Certificate of Amendment filed with the Secretary of State of the State of Delaware on July 8, 1999 (which, among other things, changes the Company's name to SPAR Group, Inc.) (incorporated by reference to Exhibit 3.1 to the Company's Form 10-Q for the 3rd Quarter ended September 30, 1999). 3.2 By-lawsAmended and Restated By-Laws of the Company (referred to therein under its former name PIA)SPAR Group, Inc. adopted on May 18, 2004 (incorporated by reference to the above referencedCompany's report on Form S-1)8-K, as filed on May 27, 2004). 3.3 Amended and Restated Charter of the Audit Committee of the Board of Directors of SPAR Group, Inc., adopted May 18, 2004 (incorporated by reference to the Company's report on Form 8-K, as filed on May 27, 2004). 3.4 Charter of the Compensation Committee of the Board of Directors of SPAR Group, Inc. adopted on May 18, 2004 (incorporated by reference to the Company's report on Form 8-K, as filed on May 27, 2004). 3.5 Charter of the Governance Committee of the Board of Directors of SPAR Group, Inc. adopted on May 18, 2004 (incorporated by reference to the Company's report on Form 8-K, as filed on May 27, 2004). 3.6 SPAR Group, Inc. Statement of Policy Respecting Stockholder Communications with Directors, adopted on May 18, 2004 (incorporated by reference to the Company's report on Form 8-K, as filed on May 27, 2004). -38- 3.7 SPAR Group, Inc. Statement of Policy Regarding Director Qualifications and Nominations, adopted on May 18, 2004 (incorporated by reference to the Company's report on Form 8-K, as filed on May 27, 2004). 4.1 Registration Rights Agreement entered into as of January 21, 1992, by and between RVM Holding Corporation.Corporation, RVM/PIA, a California Limited Partnership, The Riordan Foundation and Creditanstalt-Bankverine (incorporated by reference to the Form S-1). 10.1 2000 Stock Option Plan, as amended, (incorporated by reference to the Company's Proxy Statement for the Company's Annual meeting held on August 2, 2001, as filed with the SEC on July 12, 2001). 10.2 2001 Employee Stock Purchase Plan (incorporated by reference to the Company's Proxy Statement for the Company's Annual meeting held on August 2, 2001, as filed with the SEC on July 12, 2001). 10.3 2001 Consultant Stock Purchase Plan (incorporated by reference to the Company's Proxy Statement for the Company's Annual meeting held on August 2, 2001, as filed with the SEC on July 12, 2001). 10.4 Amended and Restated Field Service Agreement dated and effective as of January 4, 1999,1, 2004, by and between SPAR Marketing Force,Services, Inc., and SPAR Marketing Services,Force, Inc. (incorporated by reference to the Company's quarterly report on Form 10-K/A (Amendment No. 1)10-Q for the fiscal yearquarter ended DecemberMarch 31, 1999)2004, as filed on May 21, 2004). 10.5 Business ManagerAmended and Restated Field Management Agreement dated and effective as of July 8, 1999,January 1, 2004, by and between SPAR Marketing Force,Management Services, Inc., and SPAR Marketing Services,Force, Inc. (incorporated by reference to the Company's quarterly report on Form 10-K/A (Amendment No. 1)10-Q for the fiscal yearquarter ended DecemberMarch 31, 1999)2004, as filed on May 21, 2004). -37- 10.6 Amended and Restated Programming and Support Agreement dated and effective as of January 1, 2004, by and between SPAR InfoTech, Inc., and SPAR Marketing Force, Inc. (incorporated by reference to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2004, as filed on May 21, 2004). 10.7 Trademark License Agreement dated as of July 8, 1999, by and between SPAR Marketing Services, Inc., and SPAR Trademarks, Inc. (incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 2002.) 10.72002). 10.8 Trademark License Agreement dated as of July 8, 1999, by and between SPAR Infotech, Inc., and SPAR Trademarks, Inc. (incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 2002.) 10.8 [Reserved.]2002). 10.9 Stock Purchase and Sale Agreement by and among Performance Holdings, Inc. and SPAR Incentive Marketing, Inc., effective as of June 30, 2002 (incorporated by reference to the Company's Form 10-Q for the quarter ended June 30, 2002). 10.10 Revolving Credit, Guaranty and Security Agreement by and among Performance Holdings, Inc. and SPAR Incentive Marketing, Inc., effective as of June 30, 2002 (incorporated by reference to the Company's Form 10-Q for the quarter ended June 30, 2002). 10.11 Term Loan, Guaranty and Security Agreement by and among Performance Holdings, Inc. and SPAR Incentive Marketing, Inc., effective as of June 30, 2002 (incorporated by reference to the Company's Form 10-Q for the quarter ended June 30, 2002). 10.12 Amendment No. 7 to Second AmendedPromissory Note in the principal amount of $764,271.00 by STIMULYS, Inc., in favor of SPAR Incentive Marketing, Inc., dated as of September 10, 2004, as filed herewith. -39- 10.13 Payoff and Restated Revolving Credit, Term LoanRelease Letter by and Securitybetween STIMULYS, Inc., and SPAR Incentive Marketing, Inc., dated as of September 10, 2004, as filed herewith. 10.14 Sales Proceeds Agreement by and among thebetween STIMULYS, Inc. and SPAR Borrowers and the Lender, effectiveIncentive Marketing, Inc., dated as of October 31, 2002 (incorporated by reference to the Company's Form 10-Q for the quarter ended September 30, 2002). 10.1310, 2004, as filed herewith. 10.15 Third Amended and Restated Revolving Credit and Security Agreement by and among Whitehall Business Credit Corporation (the "Lender") with SPAR Marketing Force, Inc., SPAR Group, Inc., SPAR, Inc., SPAR/Burgoyne Retail Services, Inc., SPAR Incentive Marketing, Inc., SPAR Trademarks, Inc., SPAR Marketing, Inc. (DE), SPAR Marketing, Inc. (NV), SPAR Acquisition, Inc., SPAR Group International, Inc., SPAR Technology Group, Inc., SPAR/PIA Retail Services, Inc., Retail Resources, Inc., Pivotal Field Services Inc., PIA Merchandising Co., Inc., Pacific Indoor Display Co. and Pivotal Sales Company (collectively, the "Existing Borrowers"), dated as of January 24, 2003 (incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 2002). 10.1410.16 Waiver And Amendment No. 3 To Third Amended And Restated Revolving Credit And Security Agreement entered into as of March 26, 2004 (incorporated by reference to the Company's report on Form 8-K, as filed on May 26, 2004). 10.17 Joinder, Waiver And Amendment No. 4 To Third Amended And Restated Revolving Credit And Security Agreement entered into as of May 17, 2004 (incorporated by reference to the Company's report on Form 8-K, as filed on May 26, 2004). 10.18 Waiver and Amendment to Third Amended and Restated Revolving Credit and Security Agreement by and among the Lender and the Borrowers dated as of January 2004 (incorporated by reference to the Company's report on Form 10-K/A for the year ended December 31, 2003, as filed on June 28, 2004). 10.19 Waiver and Amendment No. 5 to Third Amended and Restated Revolving Credit and Security Agreement among Webster Business Credit Corporation, SPAR Group, Inc., and certain of its subsidiaries dated as of August 20, 2004 (incorporated by reference to the Company's quarterly report of the quarter ended June 30, 2004, as filed on August 23, 2004). 10.20 Waiver and Amendment No. 6 to Third Amended and Restated Revolving Credit and Security Agreement among Webster Business Credit Corporation, SPAR Group, Inc., and certain of its subsidiaries dated as of November 12, 2004 (incorporated by reference to the Company's quarterly report for the quarter ended September 30, 2004, filed November 17, 2004). 10.21 Waiver to the Third Amended and Restated Revolving Credit and Security Agreement among Webster Business Credit Corporation, SPAR Group, Inc., and certain of its subsidiaries dated as of March 31, 2004, as filed herewith. 10.22 Consent, Joinder, Release and Amendment Agreement dated as of October 31, 2003, by and among the Lender, the Existing Borrowers and SPAR All Store Marketing, Inc., as a Borrower (incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 2003). 10.23 Change in Control Severance Agreement between Kori Belzer and SPAR Group, Inc., dated as of August 12, 2004 (incorporated by reference to the Company's quarterly report of the quarter ended June 30, 2004, as filed on August 23, 2004). 10.24 Change in Control Severance Agreement between Patricia Franco and SPAR Group, Inc., dated as of August 12, 2004 (incorporated by reference to the Company's quarterly report of the quarter ended June 30, 2004, as filed on August 23, 2004). -40- 10.25 Master Lease Agreement by and between SPAR Marketing Services, Inc. and SPAR Marketing Force, Inc. dated as of November 2004 relating to lease of handheld computer equipment, as filed herewith. 10.26 Master Lease Agreement by and between SPAR Marketing Services, Inc. and SPAR Canada Company dated as of January 2005 relating to lease of handheld computer equipment, as filed herewith. 10.27 Joint Venture Agreement dated as of March 26, 2004, by and between Solutions Integrated Marketing Services Ltd. and SPAR Group International, Inc. as filed herewith. 10.28 Joint Venture Shareholders Agreement between Friedshelf 401 (Proprietary) Limited, SPAR Group International, Inc., Derek O'Brien, Brian Mason, SMD Meridian CC, Meridian Sales & Mnrechandisign (Western Cape) CC, Retail Consumer Marketing CC, Merhold Holding Trust in respect of SGRP Meridian (Proprietary) Limited, dated as of June 25, 2004, as filed herewith. 10.29 Joint Venture Agreement dated as of July 21, 2003, by and between CEO Produksiyon Tanitim ve Arastirma Hizmetleri Ltd Sti and SPAR Group International, Inc., as filed herewith. 10.30 Joint Venture Agreement dated as of May 1, 2001, by and between Paltac Corporation and SPAR Group, Inc., as filed herewith. 10.31 Agreement on Amendment dated as of August 1, 2004, by and between SPAR Group, Inc. and SPAR FM Japan, Inc., as filed herewith. 10.32 Joint Venture Agreement dated as of January 26, 2005, by and between Best Mark Investments Holdings Ltd and SPAR International Ltd. as filed herewith. 10.33 Joint Venture Agreement dated as of December 14, 2004, by and between Field Insights S.R.L. and SPAR Group International, Inc., as filed herewith. 14.1 Code of Ethical Conduct for the Directors, Senior Executives and Employees, of SPAR Group, Inc., dated May 1, 2004 (incorporated by reference to the Company's Form 8-K filed on May 5, 2004). 14.2 Statement of Policy Regarding Personal Securities Transaction in Company Stock and Non-Public Information, as amended and restated on May 1, 2004 (incorporated by reference to the Company's Form 8-K filed on May 5, 2004). 21.1 List of Subsidiaries. 23.1 Consent of Rehmann Robson. 23.2 Consent of Ernst & Young LLP. 31.1 Certification of the CEO pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, and filed herewith. 31.2 Certification of the CFO pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, and filed herewith. 32.1 Certification of the CEO pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, and filed herewith. -41- 32.2 Certification of the CFO pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, and filed herewith. (b) Reports on Form 8-K. None. -38-Form 8-K - Changes in Registrant's Certifying Accountant filed on October 8, 2004, respecting the resignation of Ernst & Young LLP as the Company's Independent Auditors. Form 8-K - Results of Operations and Financial Condition filed on November 12, 2004, attaching press release respecting financial results for the third quarter ended September 30, 2004. Form 8-K - Unscheduled Material Events filed on February 4, 2005 respecting, appointment of Rehmann Robson as the Company's Independent Auditors. -42- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this amendment to the report to be signed on its behalf by the undersigned, thereunto duly authorized. SPAR Group, Inc. By: /s/ Robert G. Brown -------------------------------------------------------------------------------------------- Robert G. Brown President, Chief Executive Officer and Chairman of the Board Date: March 30, 2004April 12, 2005 Pursuant to the requirements of the Securities Exchange Act of 1934, this amendment to the report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated. SIGNATURE TITLE /s/ Robert G. Brown President, Chief Executive Officer, Director, - ---------------------------------------------------- and Chairman of the Board Robert G. Brown Date: March 30, 2004April 12, 2005 /s/ William H. Bartels Vice Chairman and Director - ---------------------------------------------------- William H. Bartels Date: March 30, 2004April 12, 2005 /s/ Robert O. Aders Director - ---------------------------------------------------- Robert O. Aders Date: March 30, 2004April 12, 2005 /s/ Jack W. Partridge Director - ---------------------------------------------------- Jack W. Partridge Date: March 30, 2004April 12, 2005 /s/ Jerry B. Gilbert Director - ---------------------------------------------------- Jerry B. Gilbert Date: March 30, 2004April 12, 2005 /s/ Lorrence T. Kellar Director - ---------------------------------------------------- Lorrence T. Kellar Date: March 30, 2004April 12, 2005 /s/ Charles Cimitile Chief Financial Officer, - ----------------------------- Treasurer and - ----------------------- Secretary (Principal Financial and Charles Cimitile and Accounting Officer) Date: March 30, 2004 -39-April 12, 2005 -43- Report of Independent AuditorsRegistered Public Accounting Firm The Board of Directors and Stockholders SPAR Group, Inc. and Subsidiaries Tarrytown, New York We have audited the consolidated balance sheetssheet of SPAR Group, Inc. and Subsidiaries as of December 31, 2004, and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended. Our audit also included the financial statement schedule (2004 information only) listed in the Index at Item 15(a). These consolidated financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule (2004 information only) based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, based on our audit, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of SPAR Group, Inc. and Subsidiaries as of December 31, 2004, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial schedule (2004 information only), when considered in relation to the consolidated financial statements taken as a whole, presents fairly in all material respects, the information set forth therein. /s/ Rehmann Robson Troy, Michigan February 28, 2005 F-1 Report of Registered Public Accounting Firm The Board of Directors and Stockholders SPAR Group, Inc. and Subsidiaries Tarrytown, New York We have audited the consolidated balance sheet of SPAR Group, Inc. and Subsidiaries, as of December 31, 2003 and 2002 and the related consolidated statements of operations, shareholders'stockholders' equity and cash flows for each of the threetwo years in the period ended December 31, 2003. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These consolidated financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits. We conducted our audits in accordance with auditingthe standards generally accepted inof the United States.Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of SPAR Group, Inc. and Subsidiaries at December 31, 2003, and 2002 and the consolidated results of their operations and their cash flows for each of the threetwo years in the period ended December 31, 2003, in conformity with accounting principlesU.S. generally accepted in the United States.accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the consolidated financial statements taken as a whole, present fairly in all materielmaterial respects the information set forth therein. As discussed in Note 2, the Company adopted Statement of Accounting Standards No. 142 effective January 1, 2002. /s/ Ernst & Young LLP Minneapolis, Minnesota February 13, 2004 F-1F-2 SPAR Group, Inc. and Subsidiaries Consolidated Balance Sheets (In thousands, except share and per share data) December 31, --------------------- 2003 2002 -------- -------- Assets Current assets: Cash and cash equivalents $ - $ - Accounts receivable, net 13,942 16,458 Prepaid expenses and other current assets 415 783 Deferred income taxes 1,305 903 -------- -------- Total current assets 15,662 18,144 Property and equipment, net 2,099 1,972 Goodwill 8,749 7,858 Deferred income taxes 434 705 Other assets 926 121 -------- -------- Total assets $ 27,870 $ 28,800 ======== ======== Liabilities and stockholders' equity Current liabilities: Accounts payable $ 1,445 $ 422 Accrued expenses and other current liabilities 4,367 5,140 Accrued expenses, due to affiliates 996 958 Restructuring charges, current 685 1,354 Due to certain stockholders - 3,951 Line of credit, short term 4,084 - -------- -------- Total current liabilities 11,577 11,825 Line of credit - 148 Restructuring charges, long term - 235 Other long term liabilities 270 - Commitments and Contingencies Stockholders' equity: Preferred stock, $.01 par value: Authorized shares - 3,000,000 Issued and outstanding shares - none - - Common stock, $.01 par value: Authorized shares - 47,000,000 Issued and outstanding shares - 18,858,972 - 2003 18,824,527 - 2002 189 188 Additional paid-in capital 11,249 10,919 Accumulated other comprehensive loss (7) - Retained earnings 4,976 5,515 Treasury stock (384) (30) -------- -------- Total stockholders' equity 16,023 16,592 -------- -------- Total liabilities and stockholders' equity $ 27,870 $ 28,800 ======== ========
December 31, -------------------------------------------- 2004 2003 ---------------------- -------------------- Assets Current assets: Cash and cash equivalents $ 887 $ 24 Accounts receivable, net 11,307 13,942 Prepaid expenses and other current assets 657 658 Deferred income taxes - 1,305 ---------------------- -------------------- Total current assets 12,851 15,929 Property and equipment, net 1,536 2,099 Goodwill 798 8,749 Deferred income taxes - 434 Other assets 636 926 ---------------------- -------------------- Total assets $ 15,821 $ 28,137 ====================== ==================== Liabilities and stockholders' equity Current liabilities: Accounts payable $ 2,158 $ 1,373 Accrued expenses and other current liabilities 2,391 4,081 Accrued expenses due to affiliates 987 1,091 Restructuring charges 250 685 Customer deposits 1,147 530 Lines of credit 4,956 4,084 ---------------------- -------------------- Total current liabilities 11,889 11,844 Other long-term liabilities 12 270 Minority interest 206 - ---------------------- -------------------- Total liabilities 12,107 12,114 Commitments and contingencies (Note - 7) Stockholders' equity: Preferred stock, $.01 par value: Authorized shares - 3,000,000 Issued and outstanding shares - none - - Common stock, $.01 par value: Authorized shares - 47,000,000 Issued and outstanding shares - 18,858,972 - 2004 and 2003 189 189 Treasury stock (108) (384) Accumulated other comprehensive loss (86) (7) Additional paid-in capital 11,011 11,249 Accumulated (deficit) retained earnings (7,292) 4,976 ---------------------- -------------------- Total stockholders' equity 3,714 16,023 ---------------------- -------------------- Total liabilities and stockholders' equity $ 15,821 $ 28,137 ====================== ====================
See accompanying notes. F-2F-3 SPAR Group, Inc. and Subsidiaries Consolidated Statements of Operations (In thousands, except per share data)
Year Ended December 31, ---------------------------------------------------------------------------------------- 2004 2003 2002 2001 -------- -------- -------------------------------------------------------------- Net revenues $ 51,370 $ 64,859 $ 69,612 $ 70,891 Cost of revenues 33,644 42,338 40,331 40,883 -------- -------- -------------------------------------------------------------- Gross profit 17,726 22,521 29,281 30,008 Selling, general and administrative expenses 20,222 20,967 18,804 19,380Impairment charges 8,141 - - Depreciation and amortization 1,399 1,529 1,844 2,682 -------- -------- -------------------------------------------------------------- Operating (loss) income (12,036) 25 8,633 7,946Interest expense 220 269 363 Other (income) expense (income)(754) 237 (26) 107 Interest expense 269 363 561 -------- -------- -------------------------------------------------------------- (Loss) income from continuing operations before provision for income taxes and (11,502) (481) 8,296 7,278minority interest Provision for income taxes 853 58 2,998 3,123 -------- -------- -------------------------------------------------------------- Net (loss) income from continuing operationsbefore minority interest (12,355) (539) 5,298 4,155 ======== ======== ======== Discontinued operations: Loss from discontinued operations, net of tax benefit of $938Minority interest 87 - - (1,597) Estimated loss on disposal of discontinued operations, net of tax benefit of $2,618 - - (4,272) -------- -------- -------------------------------------------------------------- Net (loss) income $ (12,268) $ (539) $ 5,298 $ (1,714) ======== ======== ============================================================== Basic/diluted net (loss) income per common share: (Loss)Net (loss) income from continuing operations- basic/diluted $ (0.65) $ (0.03) $ 0.28 $ 0.23 Loss from discontinued operations - - (0.32) -------- -------- -------- Net (loss) income $ (0.03) $ 0.28 $ (0.09) ======== ======== ============================================================== Weighted average common shares outstanding - basic 18,859 18,855 18,761 18,389 ======== ======== ============================================================== Weighted average common shares outstanding - diluted 18,859 18,855 19,148 18,467 ======== ======== ==============================================================
See accompanying notes. F-3F-4 SPAR Group, Inc. and Subsidiaries Consolidated Statement of Stockholders' Equity (In thousands)
Common Stock ----------------------------------- Accumulated Total ------------------------------------ Additional Other Stock-Total Treasury Paid-In RetainedEarnings Comprehensive holders'Stockholders' Shares Amount Stock Capital EarningsRetained (Loss) Equity ------------------------------------------------------------------------------------------ Balance at DecemberJanuary 31, 2000 18,2722002 18,583 $ 182186 $ - $ 10,127 $ 1,93110,531 $ - $ 12,240 Stock options exercised and employee stock purchase plan purchases 311 4 - 404$ 10,934 - 408 Net loss - - - - (1,714) (1,714) ------------------------------------------------------------------------------------------ Balance at December 31, 2001 18,583 186 - 10,531 217 - 10,934 Stock options exercised and employee stock purchase plan purchases 242 2 - 388 - 390 Purchase of treasury stock - - (30) - - (30) Net income - - - - 5,298 5,298 ------------------------------------------------------------------------------------------ Balance at December 31, 2002 18,825 188 (30) 10,919 5,515 - 16,592 Stock options exercised and employee stock purchase plan purchases 34 1 570 (86) - - 485 Issuance of stock options to non- employees for services - - - 416 - - 416 Purchase of treasury stock - - (924) - - - (924) Comprehensive loss: Foreign currency translation loss (7) (7) Net loss (539) (539) -------------- Comprehensive loss (546) ------------------------------------------------------------------------------------------ Balance at December 31, 2003 18,859 189 (384) 11,249 4,976 (7) 16,023 Stock options exercised and employee stock purchase plan purchases - - 276 (316) - - (40) Issuance of stock options to non- employees for services - - - 78 - - 78 Comprehensive loss: Foreign currency translation loss (79) (79) Net loss (12,268) (12,268) -------------- Comprehensive loss (12,347) ------------------------------------------------------------------------------------------ Balance at December 31, 2004 18,859 $ 189 $ (384)(108) $ 11,24911,011 $ 4,976(7,292) $ (7)(86) $ 16,0233,714 ==========================================================================================
See accompanying notes. F-4F-5 SPAR Group, Inc. and Subsidiaries Consolidated Statements of Cash Flows (In thousands)
Year Ended December 31, -------------------------------------------------------------------------------------- 2004 2003 2002 2001 ------ ------ ------------------------------------------------------------ Operating activities Net (loss) income $ (12,268) $ (539) $ 5,298 $ (1,714) Adjustments to reconcile net (loss) income (loss) to net cash provided by (used in) operating activities: Depreciation 1,529 1,844 2,217 AmortizationImpairment charges 8,141 - - 1,630 Estimated loss on disposal of discontinued operations - - 4,272 Issuance of stock options for services 416Minority interest earnings in subsidiaries (87) - - Share of loss in joint venture - 270 - Deferred tax asset adjustments 710 (131) 2,022 Depreciation 1,399 1,529 1,844 Issuance of stock options for service 78 416 - Changes in operating assets and liabilities: Accounts receivable 2,635 2,516 4,686 13 Prepaid expenses and other current assets (87)(126) (330) (354) 318 Deferred income taxes (131) 2,022 1,710 Accounts payable, accrued expenses, and other current liabilities 288 (191) (7,202)and customer deposits 756 422 (538) Accrued expenses due to affiliates (104) 133 347 Restructuring charges 250 (904) (593) (1,487) ------ ------ ------------------------------------------------------------ Net cash provided by (used in) operating activities 3,3581,384 3,382 12,712 (243) Investing activities Purchases of property and equipment (1,260) (1,456) (1,172) (1,744) Deposit related to acquisition 350 (350) - - Acquisition of businesses (399) (1,091) - - ------ ------ ------------------------------------------------------------ Net cash used in investing activities (1,309) (2,897) (1,172) (1,744) Financing activities Net borrowings (payments) on linelines of credit 872 3,936 (11,139) 3,526 Payments onOther long-term debtliabilities 35 - (57) (1,465) Payments to certain stockholders (3,951) (704) (482) Proceeds from employee stock purchase plan and exercised options (40) 485 390 408Payments to certain stockholders - (3,951) (704) Purchase of treasury stock - (924) (30) - ------ ------ ------------------------------------------------------------ Net cash provided by (used in) provided by financing activities 867 (454) (11,540) 1,987 Net effect of exchange rates on cashTranslation loss (79) (7) - - Net decreasechange in cash - -863 24 - Cash at beginning of yearperiod 24 - - - ------ ------ ------------------------------------------------------------ Cash at end of year -period $ 887 $ 24 $ - $ - ====== ====== ============================================================ Supplemental disclosure of cash flowflows information Interest paid $ 180 $ 241 $ 686 $1,892 ====== ====== ============================================================ Income taxes paid $ 86 $ 578 $ 200 $ 68 ====== ====== ============================================================
See accompanying notes F-5notes. F-6 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 20032004 1. Business and Organization The SPAR Group, Inc., a Delaware corporation ("SGRP"), and its subsidiaries (together with SGRP, the "SPAR Group" or the "Company"), is a supplier of merchandising and other marketing services throughout the United States and internationally. The Company also provides database marketing, technology services, teleservices and marketing research. SPAR Acquisition, Inc., and its subsidiaries (the "SPAR Companies") are the original predecessor of the Company and were founded in 1967. On July 8, 1999, SGRP completed a reverse merger with the SPAR Companies (the "PIA Acquisition"), and then changed its name to SPAR Group, Inc., from PIA Merchandising Services, Inc. (prior to such merger, "PIA"). Pursuant to the PIA Acquisition, the SPAR Companies were deemed to have "acquired" PIA and its subsidiaries prior to the PIA Acquisition (the "PIA Companies"), which was treated as a purchase of the PIA Companies for accounting purposes, with the books and records of the Company being adjusted to reflect the historical operating results of the SPAR Companies. In 2002, the Company sold its Incentive Marketing Division, SPAR Performance Group, Inc. ("SPGI"). The Company's continuing operations are now divided into two divisions: the Domestic Merchandising Services Division and the International Merchandising Services Division. The Domestic Merchandising Services Division provides merchandising services, in-store product demonstrations, product sampling, database marketing, technology services, teleservices and marketing research to manufacturers and retailers with product distributionin the United States. The various services are primarily performed in mass merchandisers, drug store chains, convenience and grocery stores in the United States.stores. The International Merchandising Services Division, established in July 2000, currently provides merchandising services through a wholly owned subsidiary in Canada, through 51% owned joint venture subsidiaries in Turkey, South Africa, India and Romania and through 50% owned joint ventures in Japan and the acquisition of a merchandising company in Canada in June 2003. The Company has also established a start-up joint venture in Turkey.China. The Company continues to focus on expanding its merchandising services business throughout the world. Domestic Merchandising Services Division The Company's Domestic Merchandising Services Division provides nationwide merchandising and other marketing services primarily on behalf of consumer product manufacturers and retailers at mass merchandisers, drug store chains and retail grocery stores. Included in its customers are home entertainment, PC software, general merchandise, health and beauty care, consumer goods and food products companies in the United States. Merchandising services primarily consist of regularly scheduled dedicated routed services and special projects provided at the store level for a specific retailer or single or multiple manufacturers primarily under single or multi-year contracts or agreements. Services also include stand-alone large-scale implementations. These services may include sales enhancing activities such as ensuring that client products authorized for distribution are in stock and on the shelf, adding new products that are approved for distribution but not presently on the shelf, setting category shelves in accordance with approved store schematics, ensuring that shelf tags are in place, checking for the overall salability of client products and setting new and promotional items and placing and/or removing point of purchase and other related media advertising. Specific in-store services can be initiated by retailers or manufacturers, and include new store openings, new product launches, special seasonal or promotional merchandising, focused product support and product recalls. In 2003, theThe Company addedalso provides in-store product demonstration and in-store product sampling services, to its merchandising service offerings. The Company also provides database marketing, technology services, teleservices and marketing research services. F-6F-7 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 20032004 1. Business and Organization (continued) International Merchandising Services Division In July 2000, the Company established its International Merchandising Services Division, through a wholly owned subsidiary, SPAR Group International, Inc. ("SGI"), to focus on expanding its merchandising services business worldwide. Inworldwide as follows: May 2001, the Company entered intoJapan through a 50% owned joint venture with a large Japanese distributor to provide merchandising servicesheadquartered in Japan. InOsaka. June 2003, the Company expandedentered Canada by acquiring an existing business through its merchandising services into Canada through the purchase of the business and certain assets of Impulse Marketing Services Inc. Inwholly owned Canadian subsidiary, headquartered in Toronto. July 2003, the Company entered intoTurkey through a joint agreement with a company based in Istanbul to provide retail-merchandising services throughout Turkey. The start-up51% owned joint venture will operate undersubsidiary headquartered in Istanbul. April 2004, the name SPAR Turkey Ltd. and isCompany entered South Africa through a 51% owned byjoint venture subsidiary headquartered in Durban. April 2004, the Company.Company entered India through a 51% owned joint venture subsidiary headquartered in New Delhi. December 2004, the Company established a 51% owned joint venture subsidiary headquartered in Bucharest, Romania. In February 2005, the Company announced the establishment of a 50% owned joint venture headquartered in Hong Kong, China. Discontinued Operations - Incentive Marketing Division In the fourth quarter of 2001, the Company made the decision to divest its interest in SPGI. On June 30, 2002, SPAR Incentive Marketing, Inc. ("SIM"), a wholly-owned subsidiary of the Company, entered into a Stock Purchase and Sale Agreement with Performance Holdings, Inc. ("PHI"), a Delaware corporation headquartered in Carrollton, Texas. SIM sold all of the stock of its subsidiary, SPGI, to PHI for $6.0 million. As a condition of the sale, PHI issued and contributed 1,000,000 shares of its common stock to Performance Holdings, Inc. Employee Stock Ownership Plan, which became the only shareholder of PHI. In December of 2003, SPGI changed its name to STIMULYS, Inc. The $6.0 million sales price was evidenced by two Term Loans, an Initial Term Loan totaling $2.5 million and an Additional Term Loan totaling $3.5 million (collectively the "Term Loans"). The Term Loans arewere guarantied by SPGI and secured by pledges of all the assets of PHI and SPGI. The Term Loans bearhad interest at a raterates of 12% per annum through December 31, 2003. On January 1, 2004 and on January 1 each year thereafter, the interest rate is adjustedchanged to equal8.9% per annum. Because the higher of the median or mean of the High Yield Junk Bond interest rate as reported in the Wall Street Journal (or similar publication or service if the Wall Street Journal no longer reports such rate) on the last business day in the immediately preceding December. The Initial Term Loan is required to be repaid in quarterly installments that increase over the term of the loan, commencing March 31, 2003, with a balloon payment required at maturity on June 30, 2007. In addition to the preceding payments of the Initial Term Loan, PHI is required to make annual mandatory prepayments of the Term Loans on February 15th of each year, commencing on February 15, 2004, equal to: o 40% of the amount of Adjusted Cash Flow (as defined in the Revolver) for the immediately preceding fiscal year ended December 31; and o 35% of the amount of excess targeted Adjusted Cash Flow (as defined in the Revolver) for the immediately preceding fiscal year ended December 31. These payments will be applied first to accrued and unpaid interest on the Term Loans and Revolver, then to the Additional Term Loan until repaid, and then to the Initial Term Loan. Because collection of the notes dependsdepended on the future operations of PHI, the $6.0 million notes were fully reserved pending collection. At December 31, 2003, PHI and SPGI werereserved. Also in default of various covenants underconnection with the agreements. F-7 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2003 1. Business and Organization (continued) In addition tosale, the Term Loans, SIMCompany agreed to provide a discretionary revolving line of credit to SPGI not to exceed $2.0 million (the "Revolver""SPGI Revolver"). through September 30, 2005. The SPGI Revolver iswas secured by a pledge of all the assets of SPGI and iswas guarantied by PHI.SPGI's parent, Performance Holdings, Inc. The SPGI Revolver providesprovided for advances in excess of the borrowing base through September 30, 2005. Through September 30,2003. As of October 1, 2003, the SPGI Revolver calculated interest atwas adjusted, as per the higheragreement, to include a borrowing base calculation (principally 85% of the Term Loans interest rate or the prime commercial lending rate as announced in the Wall Street Journal plus 4.0% per annum."eligible" accounts receivable). In September F-8 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 1. Business and Organization (continued) 2003, SPGI requested and the Company agreed to provide advances of up to $1.0 million in excess of the borrowing base through September 30, 2004. AsIn December of October 1, 2003, the Revolver includes a borrowing base calculation (principally 85% of eligible accounts receivable)SPGI changed its name to STIMULYS, Inc ("STIMULYS"). Due to the speculative nature of the loan, andOn April 30, 2004, as a result of various defaults by STIMULYS, the Company amended the discretionary line of credit by eliminating advances in excess of STIMULYS' borrowing base and reducing the maximum amount of the revolving line to the greater of $1.0 million or the borrowing base. Under the SPGI Revolver terms, STIMULYS was required to deposit all of its cash receipts to the Company's lock box. On September 10, 2004, in consideration for a new Promissory Note totaling $764,271 (which represented the amount outstanding under the SPGI Revolver at that time) and in the event of a change in control of STIMULYS, a share in the net proceeds resulting from such change in control, the Company terminated the SPGI Revolver and the Term Loans. SPAR also released its security interest in any collateral previously pledged by STIMULYS. The first payment due under the Promissory Note was received on October 29, 2004. Due to the collection risk associated with the Promissory Note, the Company has included in other current liabilities an $0.8 millionestablished a reserve againstfor the $2.0 millionremaining amount due, including interest of approximately $355,000 at December 31, 2004. As a result of the termination of the SPGI Revolver, commitment. In December 2001,the reserve for collection of advances and accrued interest under the SPGI Revolver previously established by the Company reviewed the goodwill associated with SPGI and recorded an impairmenttotaling approximately $984,000 was no longer required. The release of goodwill totaling $4.3 million,this reserve, net of taxes, including a $1.0 millionthe new reserve recorded in 2001required for the cost to disposePromissory Note, resulted in Other Income totaling approximately $640,000 for 2004. 2. Summary of SPGI and the anticipated losses through the dateSignificant Accounting Policies Principles of divestiture, June 30, 2002.Consolidation The Company continuesconsolidates its 100% owned subsidiaries. The Company also consolidates its 51% owned joint venture subsidiaries and its 50% owned joint ventures where the Company is the primary beneficiary because the Company believes this presentation is fairer and more meaningful. Rule 3A-02 of Regulation S-X, Consolidated Financial Statements of the Registrant and its Subsidiaries, states that consolidated statements are presumed to assess whether SPGI isbe more meaningful, that majority owned subsidiaries (more than 50%) generally should be consolidated, and that circumstances may require consolidation of other subsidiaries to achieve a variable interest entityfairer presentation of its financial condition and results. In addition, the Company has determined that under FASBFinancial Accounting Standards Board Interpretation No.Number 46, "Consolidationas revised December 2003, Consolidation of Variable Interest Entities"Entities ("FIN 46(R)"), and, if so, whether or not the Company may be requiredis the primary beneficiary of its 51% owned joint venture subsidiaries and its 50% owned joint ventures, which accordingly requires consolidation of those entities into the Company's financial statements. All significant intercompany accounts and transactions have been eliminated. In 2004, due to consolidate SPGIthe amendment of a royalty agreement between the Company and its 50% owned Japanese joint venture, the Company has determined that in accordance with FIN 46(R) it is the primary beneficiary of the Japanese joint venture, and has consolidated the Japanese financial results for 2004 in accordance with the provisions of FIN 46(R). The Japanese joint venture's fiscal year ended on September 30, 2004 and accordingly its financial statements. Operating lossesstatements were audited as of $682,000 incurred from January 1,that date. In connection with the consolidation the Company began reporting the Japanese joint venture's financial results as of and for the period ending September 30, 2004. Therefore, for 2004, the Company's consolidated financial statements only include the Japanese joint venture financial results for nine months ended September 30, 2004. In 2004, the Japanese joint venture recorded revenue of approximately $2.6 million, total assets of approximately $822,000, total liabilities of approximately $1.2 million and a deficit of approximately $445,000. In 2003 and 2002, through June 30, 2002, the date of divestiture, were charged against such $1.0 million reserve. In addition, $318,000 of costs to dispose of SPGI were also charged against such reserve. The 2001 consolidated statements of operations were restated to report the results of discontinued operations separately from continuing operations. Operating results of the discontinued operations are summarized as follows (in thousands):
Six Months Year Ended Ended June 30, December 31, 2002 2001 -------- -------- Net sales $ 15,735 $ 31,202 Less: Cost of sales 13,092 26,032 Selling, general and administrative expenses 2,814 5,736 Interest expense 383 804 Depreciation 128 306 Amortization - 859 -------- -------- Operating loss (682) (2,535) Provision for income tax benefit (259) (938) -------- -------- Net loss $ (423) $ (1,597) ======== ========
F-8prior F-9 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 20032004 2. Summary of Significant Accounting Policies Principles(continued) to the amendment of Consolidation The consolidated financial statements include the accountsroyalty agreement, the investment in the Japanese joint venture was accounted for using the equity method based upon the Company's 50% ownership. At December 31, 2004, international assets totaled $2.8 million and international liabilities totaled $3.8 million. For 2004, international revenues totaled $8.2 million and the Company's share of SPAR Group, Inc. and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.the net losses was approximately $500,000. Cash Equivalents The Company considers all highly liquid short-term investments with maturities of three months or less at the time of acquisition to be cash equivalents. Cash equivalents are stated at a cost, which approximates fair value. Revenue Recognition The Company's services are provided under contracts or agreements, which consist primarily ofagreements. The Company bills its clients based upon service fees and perfee or unit fee arrangements. Revenues under service fee arrangements are recognized when the service is performed. The Company's per unit contracts or agreementsfee arrangements provide for fees to be earned based on the retail sales of a client's products to consumers. The Company recognizes per unit fees in the period such amounts become determinable.determinable and are reported to the Company. Unbilled Accounts Receivable Unbilled accounts receivable represent services performed but not billed. Allowance for Doubtful Accounts, Sales Allowances and Sales AllowanceCredit Risks The Company continually monitors the collectabilityvalidity of its accounts receivable based upon current customer credit information and other information available. Utilizing this information,financial condition. Balances that are deemed to be uncollectible after the Company has attempted reasonable collection efforts are written off through a charge to the bad debt allowance and a credit to accounts receivable. Accounts receivable balances are stated at the amount that management expects to collect from the outstanding balances. The Company provides for probable uncollectible amounts through a charge to earnings and a credit to bad debt allowance based on management's assessment of the current status of individual accounts. Based on management's assessment, the Company established an allowance for doubtful accounts of $515,000$761,000 and $301,000$515,000 at December 31, 20032004 and 2002,2003, respectively. The Company also recorded a reserve for sales allowance of $448,000 to properly reflectallowances for potential customer credits as of $448,000 at December 31, 2003. Bad debt and sales allowance expenses were $366,000, $825,000, and $262,000 in 2004, 2003, and 2002, respectively. Property and Equipment Property and equipment, including leasehold improvements, are stated at cost. Depreciation and amortization areis calculated on a straight-line basis over estimated useful lives of the related assets, which range from three to seven years. Leasehold improvements are amortizeddepreciated over the shorter of their estimated useful lives or lease term, using the straight-line method. F-10 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 2. Summary of Significant Accounting Policies (continued) Internal Use Software Development Costs The Company under the rules ofIn accordance with SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, the Company capitalizes certain costs associated with its internally developed software. Specifically, the Company capitalizes the costs of materials and services incurred in connection with developing or obtaining internal use software. These costs include but are not limited to the cost to purchase software, the cost to write program code, payroll, payroll related benefits and travel expenses for those employees who are directly involved with and who devote time to the Company's software development projects. Capitalized software development costs are amortized over three years. The Company capitalized $559,000, $1,004,000, $772,000 and $430,000$772,000 of costs related to software developed for internal use in 2004, 2003, and 2002, and 2001, respectively. F-9 SPAR Group, Inc. and Subsidiaries NotesIn 2004, the Company recorded an impairment charge against capitalized software costs due to Consolidated Financial Statements (continued) December 31, 2003 2. Summarythe loss of Significant Accounting Policies (continued)certain clients during the year (see Note 3 - Impairment Charges). Impairment of Long-Lived Assets The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that thean assets's carrying amountsamount may not be recoverable and the undiscounted cash flows estimated to be generated by those total assets are lesshigher than the assets' carrying amount.its fair value. If such assets arean asset is considered to be impaired, the impairment to becharge recognized is measured by the amount by which the carrying amountexcess of the assets exceedsasset's carrying value over the asset's fair value of the assets.(see Note 3 - Impairment Charges). Fair Value of Financial Instruments The Company's balance sheets include the following financial instruments: accounts receivable, accounts payable and a linelines of credit. The Company considers the carrying amounts of current assets and liabilities in the financial statements to approximate the fair value for these financial instruments, because of the relatively short period of time between origination of the instruments and their expected realization or payment. The carrying amount of the linelines of credit approximates fair value because the obligation bearsobligations bear interest at a floating rate. The carrying amount of long-term debt to certain stockholders approximatesapproximated fair value because the then current effective interest rates reflectreflected the market rate for unsecured debt with similar terms and remaining maturities. Concentration of Credit Risk and Other Risks Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of accounts receivable.Excess Cash The Company has minimalCompany's domestic cash as excess cash isbalances are generally utilized to pay its bank line of credit. International cash balances are maintained in liquid cash accounts and are utilized to fund daily operations. Major Customers One customer a division of a major retailer, accounted for 30%14%, 26%8%, and 25%6% of the Company's net revenues for the years ended December 31, 2004, 2003, 2002 and 2001,2002, respectively. This customer also accounted for approximately 30%29%, 43%13%, and 24%4% of accounts receivable at December 31, 2004, 2003, 2002 and 2001,2002, respectively. In late 2003, the customer's parent company announced that it was exploring strategic opportunities including the saleaddition, approximately 16%, 17%, and 24% of this division. In the event of a sale, there can be no assurances that any purchaser will continue to use the services of the Company. The loss of this business could have a material adverse effect on the Company's business, results of operations and financial condition. A second customer accounted for 10%, 11% and 9% of the Company's net revenues for the years ended December 31, 2004, 2003, and 2002, respectively, resulted from merchandising services performed for manufacturers and 2001, respectively. This second customerothers in stores operated by Kmart. These customers also accounted for approximately 9%, 5% and 4%22% of accounts receivable at December 31, 2003, 2002 and 2001, respectively. As of March 2004, the Company will no longer be providing services for this customer. Failure to attract new large customers could significantly impede the growth of2004. While the Company's revenues, which could have a material adverse effect oncustomers and the Company's future business, results of operations and financial condition. F-10resultant contractual F-11 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 20032004 2. Summary of Significant Accounting Policies (continued) In addition, approximately 17%, 24% and 31% of net revenues for the years ended December 31, 2003, 2002 and 2001, respectively, resulted from merchandising services performed for manufacturers and others at Kmart. Kmart filed for protection under the U.S. Bankruptcy Code in January of 2002 and emerged from bankruptcy in May of 2003. During its time in bankruptcy, Kmart closed a number of stores in the United States. While the Company's customers and the resultant contractual relationships are with various manufacturers and not Kmart, a significant reduction of this retailer's stores or cessation of this retailer's business would negatively impact the Company. AsAnother customer, a division of August 31, 2003, one customer discontinued its merchandising programs with the Company. Some but not all of these programs were performed at Kmart stores. This customera major retailer, accounted for 10%26%, 17%30%, and 12%26% of the business generated from KmartCompany's net revenues for the twelve-monthsyears ended December 31, 2004, 2003, and 2002, respectively. This customer also accounted for approximately 4%, 30%, and 2001,43% of accounts receivable at December 31, 2004, 2003, and 2002, respectively. On August 2, 2004, this customer was sold by its parent. As discussed above, the Company does a significant amount of business with one customer and performs a significant amount of services in Kmart. The loss of this customer or the loss of Kmart related business and the failure to attract new large customers, could significantly decrease the Company's revenues and such decreased revenues could have a material adverse effect on the Company's business, results of operations and financial condition. Foreign Currency Rate Fluctuations The Company has foreign currency exposure associated with its international wholly owned subsidiaries, 51% owned joint venture subsidiaries and 50% owned joint ventures. In 2004, these exposures are primarily concentrated in the Canadian dollar, South African rand and Japanese yen. At December 31, 2004, international assets totaled $2.8 million and international liabilities totaled $3.8 million. For 2004, international revenues totaled $8.2 million and the Company's share of the net losses was approximately $500,000. Interest Rate Fluctuations At December 31, 2004 the Company's outstanding debt totaled $5.0 million, which consisted of domestic variable-rate (6.0%) debt of $4.1 million and international variable rate (1.4%) debt of $0.9 million. Based on 2004 average outstanding borrowings under variable-rate debt, a one-percentage point increase in interest rates would negatively impact annual pre-tax earnings and cash flows by approximately $50,000. Income Taxes Deferred tax assets and liabilities represent the future tax return consequences of certain timing differences that will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred taxes are also are recognized for operating losses that are available to offset future taxable income and tax credits that are available to offset future income taxes. In the event the future consequences of differences between the financial reporting basis and the tax basis of the Company's assets and liabilities result in a net deferred tax assets,asset, an evaluation is required of the probability of being able to realize the future benefits indicated by such asset. A valuation allowance is provided when it is more likely than not that some portion or the entire deferred tax asset will not be realized. Stock-Based Compensation Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock Based Compensation, requires disclosure of the fair value method of accounting for stock options and other equity instruments. Under the fair value method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period, which is usually the vesting period. The Company has chosen, under the provisions of SFAS No. 123, to continue to account for employee stock-based F-12 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 2. Summary of Significant Accounting Policies (continued) transactions under Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Under the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS 148, no compensation cost has been recognized for the stock option grants to Company employees. Compensation cost for the Company's option grants to Company employees has been determined based on the fair value at the grant date consistent with the provisions of SFAS No. 123, the Company's net (loss) income and pro forma net (loss) income per share from continuing operations would have been reduced to the adjusted amounts indicated below (in thousands, except per share data): F-11 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2003 2. Summary of Significant Accounting Policies (continued)
Twelve Months Ended December 31, -------------------------------------------------------------------------- 2004 2003 2002 2001 ----- ----- ---------------------------------------------------- Net (loss) income, as reported $ (12,268) $ (539) $ 5,298 $(1,714) Stock based employee compensation (benefit) expense Underunder the fair market value method 454 1,005 1,844 (1,129) ----- ----- ---------------------------------------------------- Pro forma net (loss) income $(1,544)$ (12,722) $ (1,544) $ 3,454 $ (585) Basic and diluted net (loss) income per share, as reported $ (0.65) $ (0.03) $ 0.28 $ (0.09) reported Basic and diluted net (loss) income per share, pro forma $ (0.67) $ (0.08) $ 0.18 $ (0.03)
The pro forma effect on net (loss) income is not representative of the pro forma effect on net (loss) income in future years because the options vest over several years and additional awards may be made in the future. The fair value of each option grant is estimated based on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: dividend yield of 0% for all years; volatility factor of expected market price of common stock of 150%, 154%, and 172% for 2004, 2003, and 187% for 2003, 2002, and 2001, respectively; risk-free interest rate of 4.23%, 4.27%, 4.03% and 5.14%4.03%; and expected lives of six years. Net (Loss) Income Per Share Basic net (loss) income per share amounts are based upon the weighted average number of common shares outstanding. Diluted net (loss) income per share amounts are based upon the weighted average number of common and potential common shares outstanding except for periods in which such potential common shares are anti-dilutive. Potential common shares outstanding include stock options and are calculated using the treasury stock method. Use of Estimates The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. F-12F-13 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 20032004 2. Summary of Significant Accounting Policies (continued) Goodwill The Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, in the first quarter of 2002. Under the new rules,Therefore, goodwill willis no longer be amortized but will beis subject to annual impairment tests in accordance with thethat Statement. During 2003,At June 30, 2004, the Company performed the required impairment teststest discussed in FAS 142. The Company calculated the fair value of goodwill.each business unit for which goodwill was recorded to determine if there was an impairment. The fair value of each unit was based upon the estimate of the discounted cash flow generated by the respective business unit. As a result of these tests,calculations, it was determined that there was no effectwere impairments to the goodwill associated with the PIA Acquisition on the earningsJuly 8, 1999 and financial positionacquisition of the Company. The following table presents the results ofCompany's Canadian subsidiary in June 2003. Therefore, the Company for all periods presented on a comparable basis (in thousands except per share information):
2003 2002 2001 ------------------- ------------------- -------------------- Reported net (loss) income $ (539) $ 5,298 $ (1,714) Add: Goodwill amortization - - 771 ------------------- ------------------- -------------------- Adjusted net (loss) income $ (539) $ 5,298 $ (943) =================== =================== ==================== Basic and diluted net (loss) income per share: Reported net (loss) income $ (0.03) $ 0.28 $ (0.09) Add: Goodwill amortization - - 0.04 ------------------- ------------------- -------------------- Adjusted net (loss) income $ (0.03) $ 0.28 $ (0.05) =================== =================== ====================
Prior to 2002, the Company amortized all goodwill over 15 years.recorded an impairment charge of approximately $8.4 million (see Note 3 - Impairment Charges). Changes to goodwill for the years ended December 31, 2004, 2003, and 2002 were as follows:
2004 2003 2002 ----------------- --------------------------------- ---------------- ---------------- Beginning of the year $ 8,749 $ 7,858 $ 8,357 Impairment charges (8,350) - - Changes in deferred tax assets related to use of PIA net operating losses acquired - - (499) Adjustment to merger related and restructure liabilities - (89) - Acquisitions 399 980 - ----------------- --------------------------------- ---------------- ---------------- End of the year $ 798 $ 8,749 $ 7,858 ================= ================================= ================ ================
Translation of Foreign Currencies The financial statements of the foreign entities consolidated into SPAR Group, Inc. consolidated financial statements were translated into United States dollar equivalents at exchange rates as follows: balance sheet accounts for assets and liabilities at year-end rates and equity and the income statement accounts at average exchange rates for the year. The resulting translation gains and losses are reflected in accumulated other comprehensive gain or losses in the statement of stockholders' equity. Foreign currency transaction gains and losses are reflected in net earnings. Recently Issued Accounting Standards In 2003,December 2004, the FASB issued SFAS 123 (revised 2004), Share-Based Payment, (SFAS 123R). SFAS 123R addresses the accounting for share-based payments to employees, including grants of employee stock options. Under the new standard, companies will no longer be able to account for share-based compensation transactions using the intrinsic method in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees. Instead, the Company completed two acquisitions totaling approximately $1.1 million.will be required to account for such transactions using a fair-value method and recognize the expense in the consolidated statement of income. SFAS 123R will be effective for periods beginning after June 15, 2005 and allows, but does not require, the Company to restate the full fiscal year of 2005 to reflect the impact of expensing share-based payments under SFAS 123R. The purchase prices were allocated toCompany has not yet determined which fair-value method and transitional provision it will follow. See Note 2 - Stock-Based Compensation for the pro forma impact on net income and net income per share from calculating stock-based compensation costs under the fair value alternative of the assets acquired with approximately $0.1 million in equipment and the remainder of $1.0 million allocated to tax deductible goodwill. In 2003, the Company also paid approximately $0.4 million as a deposit related to a third acquisition that closed in 2004. The total purchase price will approximate $0.9 million. F-13SFAS F-14 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 20032004 2. Summary of Significant Accounting Policies (continued) 123. However, the calculation of compensation cost for share-based payment transactions after the effective date of SFAS 123R may be different from the calculation of compensation cost under SFAS 123, but such differences have not yet been quantified. Reclassifications Certain reclassifications have been made to the prior years' financial statements to conform to the 20032004 presentation. 3. Impairment Charges Goodwill During 2004, in accordance with the requirements of SFAS 142, the Company determined that there were impairments of the goodwill amounts associated with certain of its reporting entities. In April 2004, the Company's largest customer announced that they signed definitive agreements for the sale of its business to two purchasers. The sale was completed on August 2, 2004. This customer accounted for 26%, 30%, and 26% of the Company's net revenues for the twelve months ended December 31, 2004, 2003, and 2002, respectively and was the last remaining profitable business related to the PIA Acquisition on July 8, 1999. At June 30, 2004, the Company had $7.6 million of goodwill remaining that was related to the PIA Acquisition. As a result of the loss of this major client, the Company does not expect a positive cash flow from this business unit. Therefore, the Company has recorded an impairment of the PIA related goodwill resulting in a non-cash charge of $7.6 million to the results of the operations for 2004. In June 2003, the Company began its Canadian operations through the acquisition of substantially all of the business and assets of Impulse Marketing Services, Inc. In connection with this acquisition, the Company recorded goodwill of $712,000. At the time of the acquisition, it was expected that the Canadian subsidiary would be profitable. However, the Canadian subsidiary has operated at a loss since its acquisition. As a result of the continued losses and the failure to attract new customers the Company does not expect to receive positive cash flow from this unit. Therefore, the Company has recorded an impairment of the related goodwill resulting in a non-cash charge of $712,000 for 2004. Capitalized Internal Use Software Development Costs Historically, the Company has capitalized costs of computer software developed for internal use. Some of the costs capitalized were associated with certain clients to whom the Company no longer provides merchandising services. As a result of the loss of these clients, the Company recorded an impairment charge for the net book value of internally developed software costs of approximately $442,000 for 2004. Other Assets and Liabilities Also, in connection with the PIA Acquisition, certain tax deferred assets related to the PIA net operating loss carry forward benefits were recognized. The Company also recorded as an impairment charge, a $750,000 valuation allowance on these deferred tax assets. F-15 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 3. Impairment Charges (continued) The Company had approximately $2.1 million accrued for restructure costs and PIA Acquisition related costs. As a result of the PIA business impairment, the Company evaluated these accruals and determined that only $0.4 million is required. The Company applied the $1.7 million ($1.4 million net of tax effect) reduction in PIA related acquisition liabilities against the related goodwill thereby reducing the impairment charges recognized for 2004. In addition to the above, the Company has recorded an impairment of other assets totaling $68,000 for 2004. The above net impairment of $8.1 million is shown in the accompanying consolidated statement of operations in 2004 as "Impairment charges". 4. Supplemental Balance Sheet Information Accounts receivable, net, consists of the following (in thousands):
December 31, ------------------------------------ 2004 2003 2002 ------------------------------------ Trade $ 8,178 $ 10,333 $ 11,016 Unbilled 3,600 4,551 5,743 Non-trade 290 21 - ------------------------------------ 12,068 14,905 16,759 Less: - Allowance for doubtful accounts (761) (515) (301)Sales allowances - Sales allowance (448) - ------------------------------------ $ 11,307 $ 13,942 $ 16,458 ====================================
Property and equipment consists of the following (in thousands):
December 31, ------------------------------------ 2004 2003 2002 ------------------------------------ Equipment $ 4,7845,397 $ 4,1754,784 Furniture and fixtures 547 550 509 Leasehold improvements 138 141 138 Capitalized software development costs 1,629 2,128 2,216 ------------------------------------ 7,711 7,603 7,038 Less accumulated depreciation and amortization 6,175 5,504 5,066 ------------------------------------ $ 1,536 $ 2,099 ==================================== December 31, ------------------------------------- Prepaid expenses and other current assets (in thousands): 2004 2003 ------------------------------------- Prepaid insurance $ 1,972 ====================================214 $ 245 Tax refund due 62 244 Prepaid rents 49 70 Other 332 99 ----------------------------------- $ 657 $ 658 =====================================
F-14F-16 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2003 3.2004 4. Supplemental Balance Sheet Information (continued) December 31, ------------------------------------- Accrued expenses and other current liabilities consists of the following (in thousands):
December 31,2004 2003 2002 ------------------------------------------------------------------------- Merger related payables $ 450 $ 1,495 STIMULYS cash deposits - 794 SPGI Revolver - 740 Accrued medical expenses 225 100 Taxes payable 345 139 Accrued accounting and legal expenses 192 219 Accrued salaries and other related costspayable 328 241 Other 851 353 ------------------------------------- $ 3432,391 $ 623 Accrued merger related costs 1,495 1,945 Due to SPGI (STIMULYS) (cash deposits) 794 917 Other 1,735 1,655 ------------------------------------ $ 4,367 $ 5,140 ====================================4,081 =====================================
4. Line5. Lines of Credit and Long-Term Liabilities In January 2003, the Company and Webster Business Credit Corporation, then known as Whitehall Business Credit Corporation ("Whitehall"Webster"), entered into the Third Amended and Restated Revolving Credit and Security Agreement (as amended, collectively, the "Credit Facility") including amendments made by the Consent, Joinder, Release and Amendment Agreement dated as of October 31, 2003.. The Credit Facility providesprovided a $15.0 million revolving credit facility that matures on January 23, 2006. The Credit Facility allowsallowed the Company to borrow up to $15.0 million based upon a borrowing base formula as defined in the agreement (principally 85% of "eligible" accounts receivable). On May 17, 2004, the Credit Facility was amended to among other things, reduce the revolving credit facility from $15.0 million to $10.0 million, change the interest rate and increase reserves against collateral. The amendment provides for interest to be charged at a rate based in part upon the earnings before interest, taxes, depreciation and amortization. The average interest rate for 2004 was 5.1%. At December 31, 2004, the Credit Facility bears interest at Whitehall'sWebster's "Alternative Base Rate" plus 0.75% (a total of 4.0%6.0% per annum at December 31, 2003)annum), or LIBOR plus two and one-half percent and3.25%. The Credit Facility is secured by all of the assets of the Company and its domestic subsidiaries. In connection with the May 17, 2004, amendment, Mr. Robert Brown, a Director, the Chairman, President and Chief Executive Officer and a major stockholder of the Company and Mr. William Bartels, a Director, the Vice Chairman and a major stockholder of the Company, provided personal guarantees totaling $1.0 million to Webster. On August 20, 2004, the Credit Facility was further amended in connection with the waiver of certain covenant violations (see below). The amendment, among other things, reduced the revolving credit facility from $10.0 million to $7.0 million, changed the covenant compliance testing for certain covenants from quarterly to monthly and reduced certain advance rates. On November 15, 2004, the Credit Facility was further amended to delete any required minimum Net Worth and minimum Fixed Charge Coverage Ratio covenant levels for the period ending December 31, 2004. The amendments did not change the future covenant levels. The Credit Facility containsalso limits certain financial covenants which must be met by the Company on a consolidated basis, among which are a minimum "Net Worth", a "Fixed Charge Coverage Ratio", aexpenditures including, but not limited to, capital expenditure limitationexpenditures and a minimum EBITDA, as such terms are defined in the agreement.other investments. The Company was in compliance with such financialviolation of certain monthly covenants at December 31, 2003, except2004, and expects to be in violation at future measurement dates. Webster issued a waiver for the "Fixed Charge Coverage Ratio", and minimum EBITDA, for whichDecember 31, 2004 covenant violations. However, there can be no assurances that Webster will issue such waivers in the Company has secured a waiver from Whitehall.future. Because of the requirement to maintain a lock box arrangement with Whitehall and Whitehall'sWebster, Webster's ability to invoke a subjective acceleration clause at its discretion, and the expected future covenant violations, borrowings under the Credit Facility are classified as current at December 31, 2004 and 2003, in accordance with EITF 95-22. The balances outstanding on the revolving lineBalance Sheet Classification of credit under theBorrowings Outstanding Under Revolving Credit Facility were $4.1 millionAgreements That Include Both a Subjective Acceleration Clause and $148,000 at December 31, 2003 and December 31, 2002, respectively. As of December 31, 2003, based upon the borrowing base formula, the SPAR Group had availability under the Credit Facility of $4.6 million of the $10.9 million unused revolving line of credit. A prior credit facility contained an option for Whitehall to purchase 16,667 shares of Common Stock of the Company for $0.01 per share in the event that the Company's average closing share price over a ten consecutive trading day period exceeds $15.00 per share. This option expired on July 31, 2003. F-15Lock-Box Agreement. F-17 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 5. Lines of Credit (continued) The revolving loan balances outstanding under the Credit Facility were $4.1 million at December 31, 2004, and December 31, 2003. There were letters of credit outstanding under the Credit Facility of $0.7 million at December 31, 2004, and December 31, 2003. As of December 31, 2004, the SPAR Group had unused availability under the Credit Facility of $1.4 million out of the remaining maximum $2.2 million unused revolving line of credit after reducing the borrowing base by outstanding loans and letters of credit. In 2001, the Japanese joint venture SPAR FM Japan, Inc. entered into a revolving line of credit arrangement with Japanese banks for 300 million yen or $2.7 million (based upon the exchange rate at September 30, 2004). At September 30. 2004, SPAR FM Japan, Inc. had 100 million yen or approximately $900,000 loan balance outstanding under the line of credit. The line of credit is effectively guarantied by the Company and the joint venture partner, Paltac Corporation. The average interest rates on the borrowings under the Japanese line of credit for its short-term bank loans at September 30, 2004 and 2003 5.were 1.375% and 1.375% per annum, respectively. 6. Income Taxes The provision for income tax expense from continuing operations is summarized as follows (in thousands):
December 31, ---------------------------------------------------------- 2004 2003 2002 2001 ----------------- ------------------ ------------------- Current $ 103 $ 189 $ 476 $ 109 Deferred 750 (131) 2,522 3,014 ----------------- ------------------ ------------------- $ 853 $ 58 $ 2,998 $ 3,123 ================= ================== ===================
The provision for income taxes from continuing operations is different from that which would be obtained by applying the statutory federal income tax rate to income before income taxes. The items causing this difference are as follows (in thousands):
December 31, -------------------------------------------------------- 2004 2003 2002 2001 --------------- ---------------- ---------------- Provision(Benefit) provision for income taxes at federal statutory rate $ (3,911) $ (77) $ 2,821 $ 2,475 State income taxes, net of federal benefit 117 95 175 317 Permanent differences 1,613 41 (48) 317Change in valuation allowance 3,013 - - Other 21 (1) 50 14 --------------- ---------------- ---------------- Provision for income taxes $ 853 $ 58 $ 2,998 $ 3,123 =============== ================ ================
F-16F-18 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2003 5.2004 6. Income Taxes (continued)(continue) Deferred taxes consist of the following (in thousands):
December 31, ------------------------------------ 2004 2003 2002 ------------------------------------ Deferred tax assets: Deferred tax assets: Net operating loss carryforwards $ 3,8765,230 $ 3,876 Restructuring 266 309 454 Accrued compensation and related benefitsDeferred revenue 384 - 160 SIM reserve against loan commitment 135 304 320 Allowance for doubtful accounts and other receivable 288 323 114 Other 455 559 206 Valuation allowance (3,126)(6,139) (3,126) ------------------------------------ Total deferred tax assets 619 2,245 2,004 Deferred tax liabilities: Capitalized software development costs 619 506 396 ------------------------------------ Total deferred tax liabilities 619 506 396 ------------------------------------ Net deferred tax assets $ 1,739- $ 1,6081,739 ====================================
At December 31, 2003,2004, the Company has net operating loss carryforwards (NOL's)(NOLs) of $10.2 million, primarily related to the PIA reverse merger,Acquisition available to reduce future federal taxable income. The Company's$10.2 million PIA related net operating loss carryforwards begin to expire in the year 2012. Section 382 of the Internal Revenue Code restricts the annual utilization of the NOL'sNOLs incurred prior to a change in ownership. Such a change in ownership had occurred in 1999, thereby restricting the NOL's prior to such date available to the Company to approximately $657,500 per year. In addition, the Company has NOLs related to its current losses totaling $4.1 million. The $4.1 million net operating loss carryfowards begin to expire in the year 2023. As a result of the loss of several significant clients, current year losses and the lack of certainty of a return to profitably in the next twelve months, the Company has established a valuation allowance forequal to the total of its net deferred tax assets relatedof $6.1 million. The Company does not provide for U.S. income taxes on the undistributed earnings of its foreign subsidiaries since, at the present time, management considers them to be permanently invested in the available NOL's that are deductible for years subsequent to 2005 totaling $3,126,000. The $3,126,000 valuation allowance at December 31, 2003, when realized will result in a reduction of goodwill associated with the PIA acquisition. Due to the loss in 2003, the Company did not reduce the valuation allowance or goodwill associated with PIA NOL's. In 2002, the Company reduced the valuation allowance and goodwill by $499,000. F-17subsidiary. F-19 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2003 6.2004 7. Commitments and Contingencies Lease Commitments The Company leases equipment and certain office space in several cities, under non-cancelable operating lease agreements. Certain leases require the Company to pay its share of any increases in operating expenses and real estate taxes. Rent expense was approximately $0.9$1.0 million, $1.0$0.9 million, and $1.0 million for the years ended December 31,2004, 2003, 2002 and 2001,2002, respectively. At December 31, 2003,2004, future minimum commitments under all non-cancelable operating lease arrangements are as follows (in thousands): 20042005 $ 947 2005 651776 2006 512569 2007 9182 2008 20 Joint Venture Guarantee40 2009 1 ------------------ Total $ 1,468 =================== International Commitments The Company's international model is to partner with local merchandising companies and combine their knowledge of the local market with the Company's proprietary software and expertise in the merchandising business. In May 2001, the Company and Paltac, Inc. ("Paltac"), a large Japanese distributor, entered into aestablished its first joint venture to create a Japanese company, SPAR FM. SPAR FM entered into a Yen 300 million Revolving Credit Agreement with a Japanese bank.and has continued this strategy. As of this filing, the Company is currently operating in Japan, Canada, Turkey, South Africa and India. The bank required Paltac guaranteeCompany also announced the outstanding balance on the revolving credit facility. As partestablishment of thejoint ventures in Romania and China. Certain of these joint ventures and joint venture agreement, should Paltacsubsidiaries are marginally profitable while others are operating at a loss. None of these entities have excess cash reserves. In the event of continued losses, the Company may be required to make a payment on its guarantee to the bank, then the Company has agreed to remit to Paltac 50% of any such payment up to a maximum of Yen 150 million or approximately $1.4 million. As of December 31, 2003, SPAR FM has borrowed Yen 100 million under its Revolving Credit Agreement. Therefore, the Company's current exposure to Paltac respecting outstanding loans to SPAR FM at December 31, 2003 would be Yen 50 million or approximately $470,000. The Company has recorded approximately Yen 0.3 million in long-term liabilities for its share of the cumulative losses associated with thisprovide additional cash infusions into these joint venture.ventures and joint venture subsidiaries. Legal Matters On October 24, 2001, Safeway Inc. ("Safeway"), filed a former customer ofComplaint against the PIA Merchandising Co., Inc. ("PIA Co."), a wholly owned subsidiary of the Company, and Pivotal Sales Company filed("Pivotal"), a complaint alleging damageswholly owned subsidiary of approximately $3.6 million plus interestPIA Co., and costs and alleged punitive damages in an unspecified amount against the CompanySGRP in Alameda County Superior Court, California, Case No.case no. 2001028498 with respect to (among other things) alleged breach of contract. On or about December 30, 2002, the Court approved the filing ofon October 24, 2001, and has subsequently amended it. Safeway Inc.'s Second Amended Complaint, which alleges causes of action for (among other things) breach of contract, againstbreach of implied contract, breach of fiduciary duty, conversion, constructive fraud, breach of trust, unjust enrichment, and accounting fraud. Safeway has most recently alleged monetary damages in the Company,principal sum of $3,000,000 and probable interest of $1,000,000 and has also demanded unspecified costs. PIA Merchandising Co., Inc.Pivotal and SGRP filed cross-claims against Safeway on or about March 11, 2002, and amended them on or about October 15, 2002, alleging causes of action by them against Safeway for breach of contract, interference with economic relationship, unfair trade practices and unjust enrichment and seeking damages and injunctive relief. Mediation between the parties occurred in 2004, but did not result in a settlement. PIA Co., Pivotal Sales Company. The Second Amended Complaint was filed withand SGRP are vigorously defending Safeway's allegations. It is not possible at this time to determine the Courtlikelihood of the outcome of this lawsuit. However, if Safeway prevails respecting its allegations, and PIA Co., Pivotal and SGRP lose on January 13, 2003,their cross-claims and does not specify the amount of monetary damages sought. No punitive or exemplary damages are sought in Safeway Inc.'s Second Amended Complaint. This case is being vigorously contested bycounterclaims, that result could have a material adverse effect on the Company. The Company anticipates that this matter will be resolved in 2005. In addition to the above, the Company is a party to various other legal actions and administrative proceedings arising in the normal course of business. In the opinion of CompanyCompany's management, disposition F-20 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 7. Commitments and Contingencies (continued) of these other matters are not anticipated to have a material adverse effect on the financial position, results of operations or cash flows of the Company. F-18 SPAR Group, Inc.8. Treasury Stock The Company initiated a share repurchase program in 2002, which allowed for repurchase of up to 100,000 shares. In 2003, the Board of Directors authorized the repurchase of an additional 122,000 shares increasing the total to 222,000 shares. The following table summarizes the Company's treasury stock activity for the years 2004 and Subsidiaries Notes2003. Quantity Amount ------------------------------------ Treasury Stock, January 1, 2003 9,783 $ 30,073 Purchases 211,315 923,714 Used to Consolidated Financial Statements (continued)fulfill: Employee Stock Purchases (9,848) (30,297) Options Exercised (135,194) (539,383) ------------------------------------ Treasury Stock, December 31, 2003 7.76,056 384,107 Used to fulfill: Options Exercised (54,148) (276,007) ------------------------------------ Treasury Stock, December 31, 2004 21,908 $ 108,100 ==================================== 9. Employee Benefits Retirement/Pension Plans The Company has a 401(k) Profit Sharing Plan covering substantially all eligible employees. Employer contributions were approximately $87,000, $117,000 and $118,000 for the years ended December 31, 2003, 2002 and 2001, respectively. Certain of the Company's employees are covered by union-sponsored, collectively bargained, multi-employer pension plans. Pension expense related to these plans was approximately $32,000, $60,000 and $77,000 for the years ended December 31, 2003, 2002 and 2001, respectively. Stock Purchase Plans The Company has Employee and Consultant Stock Purchase Plans (the "SP Plans"). The SP Plans allow employees and consultants of the Company to purchase common stock without having to pay any commissions on the purchases. On August 8, 2002, the Company's Board of Directors approved a 15% discount for employee purchases and recommended that its affiliates (see Note 10 - Related-Party Transactions) approve a 15% cash bonus for affiliate consultant purchases. The maximum amount that any employee or consultant can contribute to the SP Plans per quarter is $6,250, and the total number of shares reserved by the Company for purchase under the SP Plans is 500,000. DuringShares purchased by employees and consultants under the SP Plans were 43,023, 22,561, and 10,104 for 2004, 2003, and 2002, respectively. The Company's expense as a result of the 15% discount offered to employees and consultants were approximately $10,000, $11,000, and $4,000 for 2004, 2003, and 2002, respectively. Retirement/Pension Plans The Company has a 401(k) Profit Sharing Plan covering substantially all eligible employees. Employer contributions were approximately $97,000, $87,000, and $117,000 for 2004, 2003, and 2002, respectively. F-21 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 9. Employee Benefits (continued) In 2003 and 2002, certain of the Company's employees were covered by union-sponsored, collectively bargained, multi-employer pension plans. Pension expense related to these plans was approximately $32,000 and $60,000 for the years ended December 31, 2003 and 2002, respectively. There were no employees under union contract in 2004. 10. Related-Party Transactions Mr. Robert G. Brown, a Director, the Chairman, President and Chief Executive Officer and a major stockholder of the Company, transferred from Treasury Stock, for purchase underand Mr. William H. Bartels, a Director, the plans, 9,848 shares atVice Chairman and a weighted average pricemajor stockholder of $3.04 and purchased 12,713 shares at a weighted average price of $3.57. During 2002 and 2001, the Company, issued 10,104 shares,are executive officers and 2,638 sharesthe sole stockholders and directors of common stock, at a weighted average price of $2.51 and $1.90 per share, respectively. 8. Related-Party Transactions The Company. is affiliated through common ownership with SPAR Marketing Services, Inc. ("SMS"), SPAR Management Services, Inc. ("SMSI"), and SPAR Infotech, Inc. ("SIT"). The Company's CEO and Vice Chairman are sole owners of these affiliates. SMS and SMSI (through SMS) provided approximately 92%99% of the Company's field representatives (through its independent contractor field force) and substantially allapproximately 92% of the Company's field management services. Underat a total cost of approximately $24.0 million, $36.0 million, and $30.5 million for 2004, 2003, and 2002, respectively. Pursuant to the terms of the Amended and Restated Field Service Agreement dated as of January 1, 2004, SMS provides the services of SMS's field force of approximately 6,000 field representatives6,300 independent contractors to the Company. Pursuant to the terms of the Amended and Restated Field Management Agreement dated as of January 1, 2004, SMSI provides approximately 8050 full-time national, regional and district managers to the Company as they may request from time to time, for whichCompany. For those services, the Company has agreed to payreimburse SMS and SMSI for all of itstheir costs of providing those services plusand to pay SMS and SMSI each a premium equal to 4%. of their respective costs, except that for 2004 SMSI agreed to concessions that reduced the premium paid by approximately $640,000 for 2004. Total net premiums (4% of SMS and SMSI costs less 2004 concessions) paid to SMS and SMSI for services rendered were approximately $320,000, $1,350,000, and $1,100,000 for 2004, 2003, and 2002, respectively. The Company has been advised that Messrs. Brown and Bartels are not paid any salaries as officers of SMS or SMSI so there were no salary reimbursements for them included in such costs or premium. However, since SMS and SMSI are "Subchapter S" corporations, Messrs. Brown and Bartels benefit from any income of such companies allocated to them. SIT provided substantially all of the Internet computer-programmingcomputer programming services to the Company. Under the termsCompany at a total cost of theapproximately $1,170,000, $1,610,000, and $1,630,000 for 2004, 2003, and 2002, respectively. SIT provided approximately 34,000, 47,000, and 46,000 hours of Internet computer programming agreement betweenservices to the Company for 2004, 2003, and SIT effective2002, respectively. Pursuant to the Amended and Restated Programming and Support Agreement dated as of OctoberJanuary 1, 1998,2004, SIT continues to provide programming services to the Company for which the Company has agreed to pay SIT competitive hourly wage rates for time spent on Company matters and to reimburse SIT'sthe related out-of-pocket expenses. F-19expenses of SIT and its personnel. The average hourly billing rate was $34.71, $34.24, and $35.10 for 2004, 2003, and 2002, respectively. The Company has been advised that no hourly charges or business expenses for Messrs. Brown and Bartels were charged to the Company by SIT for 2004. However, since SIT is a "Subchapter S" corporation, Messrs. Brown and Bartels benefit from any income of such company allocated to them. F-22 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2003 8.2004 10. Related-Party Transactions (continued) Through arrangements with the Company, SMS, SMSI and SIT participate in various benefit plans, insurance policies and similar group purchases by the Company, for which the Company charges them their allocable shares of the costs of those group items and the actual costs of all items paid specifically for them. All transactions between the Company and the above affiliates are paid and/or collected by the Company in the normal course of business. The following transactions occurred between the Company and the above affiliates (in thousands):
Twelve Months Ended December 31, ------------------------------------------------- 2004 2003 2002 2001 ------------------------------------------------- Services provided by affiliates: Independent contractor services (SMS) $28,411$ 19,944 $ 28,411 $ 23,262 $ 8,337 ================================================= Field management services (SMSI) $ 4,502 $ 7,600 $ 7,280 $ 6,779 ================================================= Internet and software program consulting services (SIT) $ 1,172 $ 1,607 $ 1,626 $ 1,185 ================================================= Services provided to affiliates: Field management services (SMSI) $ 805 $ 732 $ 390 ================================================= BalanceAccrued expenses due to affiliates included in accrued expenses (in thousands): December 31, 2004 2003 2002 2001 ---------------------------------------------------------------------------------- SPAR Marketing Services, Inc. $ 996987 $ 932 $ 611 SPAR Infotech, Inc. - 26 - ------------------------------------------------- $ 996 $ 958 $ 611 =================================================1,091 =================================
In addition to the above, through the services of Affinity Insurance, Ltd., the Company purchased insurance coverage for its casualty and property insurance risk for approximately $1.1 million for each of the three years ended December 31, 2004, 2003, 2002 and 2001.2002. The Company's CEO and Vice Chairman own, through SMSI, a minority (less than 5%) equity interest in Affinity. 9.11. Stock Options The Company has four stock option plans: the Amended and Restated 1995 Stock Option Plan (1995 Plan)("1995 Plan"), the 1995 Director's Plan (Director's Plan)("Director's Plan"), the Special Purpose Stock Option Plan ("Special Purpose Plan"), and the 2000 Stock Option Plan (2000 Plan)("2000 Plan"). The 1995 Plan provided for the granting of either incentive or nonqualified stock options to specific employees, consultants, and directors of the Company for the purchase of up to 3,500,000 shares of the Company's common stock. The options had a term of ten years from the date of issuance, except in the case of incentive stock options granted to greater than 10% stockholders for which the term was five years. The exercise price of nonqualified stock options must have been equal to at least 85% of the fair market value of the Company's common stock at the date of grant. Since 2000, the Company has not granted any new options under this Plan.plan. During 2004, 1,500 options to purchase shares of the Company's common stock were exercised and options to purchase 26,625 shares of the Company's stock were cancelled under this plan. At December 31, 2003,2004, options to purchase 43,25015,125 shares of the Company's common stock remain outstanding under this Plan.plan. The 1995 Plan was superseded by the 2000 Stock Option Plan with respect to all new options issued. F-20F-23 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2003 9.2004 11. Stock Options (continued) The Director's Plan was a stock option plan for non-employee directors and provided for the purchase of up to 120,000 shares of the Company's common stock. Since 2000, the Company has not granted any new options under this Plan.plan. During 2003,2004, no options to purchase shares of the Company's common stock were exercised under this Plan.plan. At December 31, 2003,2004, 20,000 options to purchase shares of the Company's common stock remained outstanding under this Plan.plan. The Director's Plan has been replaced by the 2000 Plan with respect to all new options issued. On July 8, 1999, in connection with the merger, the Company established the Special Purpose Stock Option Plan of PIA Merchandising Services, Inc. to provide for the issuance of substitute options to the holders of outstanding options granted by SPAR Acquisition, Inc. There were 134,114 options granted at $0.01 per share. Since July 8, 1999, the Company has not granted any new options under this plan. During 2003, no2004, 21,000 options to purchase shares of the Company's common stock were exercised under this Plan.plan. At December 31, 2003,2004, options to purchase 25,7504,750 shares of the Company's common stock remain outstanding under this Plan.plan. On December 4, 2000, the Company adopted the 2000 Plan, as the successor to the 1995 Plan and the Director's Plan with respect to all new options issued. The 2000 Plan provides for the granting of either incentive or nonqualified stock options to specified employees, consultants, and directors of the Company for the purchase of up to 3,600,000 (less those options still outstanding under the 1995 Plan or exercised after December 4, 2000 under the 1995 Plan). The options have a term of ten years, except in the case of incentive stock options granted to greater than 10% stockholders for whom the term is five years. The exercise price of nonqualified stock options must be equal to at least 85% of the fair market value of the Company's common stock at the date of grant (although typically the options are issued at 100% of the fair market value), and the exercise price of incentive stock options must be equal to at least the fair market value of the Company's common stock at the date of grant. During 2003,2004, options to purchase 401,020476,417 shares of the Company's common stock were granted, options to purchase 143,64153,302 shares of the Company's common stock were exercised and options to purchase 86,5001,345,542 shares of the Company's stock were voluntarily surrendered and cancelled under this Plan.plan. At December 31, 2003,2004, options to purchase 2,180,0601,251,383 shares of the Company's common stock remain outstanding under this Planplan and options to purchase 743,3441,618,719 shares of the Company's common stock were available for grant under this Plan. F-21plan. F-24 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2003 9.2004 11. Stock Options (continued) The following table summarizes stock option activity under the Company's plans:
Weighted Average Shares Exercise Price Shares ---------------------------------------- Granted 2,564,844 $ 1.31 Exercised (309,492) 1.30 Canceled or expired (2,761,474) 5.00 --------------------- Options outstanding, December 31, 2001 2,483,727 $ 1.42 Granted 332,792 $ 2.01 Exercised (230,463) 1.23 Canceled or expired (487,875) 5.05 --------------------- Options outstanding, December 31, 2002 2,098,181 $ 1.52 Granted 401,020 $ 3.51 Exercised (143,641) 1.17 Canceled or expired (86,500)(92,750) 2.38 --------------------- Options outstanding, December 31, 2003 2,269,0602,262,810 $ 1.85 Option price range at end of year $0.01 to $14.00
Granted 476,417 $ 1.47 Exercised (75,802) 0.49 Canceled or expired (1,372,167) 6.18 --------------------- Options outstanding, December 31, 2004 1,291,258 $ 1.66 Option price range at end of year $0.01 to $14.00 2004 2003 2002 2001 -------------------------------------------------- Grant Date weighted average fair value of options granted during the year $ 2.331.43 $ 1.602.33 $ 1.281.60
F-22F-25 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2003 9.2004 11. Stock Options (continued) The following table summarizes information about stock options outstanding at December 31, 2003:2004:
Options Outstanding Options Exercisable ------------------------------------------------------------------------------------------------------ -------------------------------- Weighted Number Average Weighted Number Outstanding at Remaining Average Exercisable at Weighted Range of December 31, 2004 Contractual Life Exercise December 31, Average Exercise Prices 2003 Life Price 20032004 Exercise Price -------------------- ------------------------------------------------------------------------------------------------------ -------------------------------- Less than $1.00 184,972 7.2273,536 8.1 years $0.45 147,222 $0.38$ 0.71 230,336 $ 0.70 $1.01 - $2.00 1,513,088 6.5783,347 7.0 years 1.35 1,270,614 1.321.31 697,972 1.30 $2.01 - $4.00 473,750 8.9192,875 8.4 years 3.02 62,194 2.612.75 61,196 2.88 Greater than $4.00 97,250 7.841,500 5.1 years 6.69 27,000 11.679.37 41,126 9.42 ------------------ ----------------- Total 2,269,060 1,507,0301,291,258 1,030,630 ================== =================
Outstanding warrants are summarized below: Shares Subject Exercise Price to Warrants Per Share ------------------------------------ Balance, December 31, 2003 96,395 $2.78 - $8.51
The above warrants expire at various dates during 2004. In 2003,2004, the Company recorded an expense of $415,000approximately $103,000 under the provision of SFAS No. 123 dealing with stock option grants to non-employees for stock option grants that were awarded to the employees of the Company's affiliates. The Company determines the fair value of the options granted to non-employees using the Black-Scholes valuation model and expenses that value over the service period. Until an option is vested, the fair value of the option continues to be updated through the vesting date. The options granted have a ten (10) year life and vest over four-year periods at a rate of 25% per year, beginning on the first anniversary of the date of grant. 10.12. Notes Payable to Certain Stockholders In April 2003, all previously outstanding amounts due certain stockholders under certain notes bearing interest at 8.0% were paid in full. 11. Segments As a result13. Geographic Data A summary of the Company's divestiturenet revenue, operating (loss) income and long lived assets by geographic area as of its Incentive Marketing Division,and for the Company now operates solely in the Merchandising Services Industry Segment both in the domestic and international markets. F-23year ended December 31, is as follows (in thousands): Twelve Months Ended December 31, ---------------------------------------------- 2004 2003 2002 ---------------------------------------------- Net revenue: United States $ 43,163 $ 64,305 $ 69,612 International 8,207 554 - ---------------------------------------------- Total net revenue $ 51,370 $ 64,859 $ 69,612 ============================================== F-26 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2003 12.2004 13. Geographic Data (continued)
Twelve Months Ended December 31, ---------------------------------------------- 2004 2003 2002 ---------------------------------------------- Operating (loss) income: United States $ (10,559) $ 893 $ 9,100 International (1,477) (868) (467) ---------------------------------------------- Total operating (loss) income $ (12,036) $ 25 $ 8,633 ============================================== December 31, ------------------------------------- Long lived assets: 2004 2003 ------------------------------------- United States $ 2,484 $ 11,632 International 486 576 ------------------------------------- Total long lived assets $ 2,970 $ 12,208 =====================================
International revenues disclosed above were based upon revenues reported by the Company's foreign subsidiaries and joint ventures. No one international geographic market is greater than 10% of consolidated net revenue for the twelve months ended December 31, 2004. 14. Restructuring Charges In 1999, in connection with the PIA Acquisition, the Company's Board of Directors approved a plan to restructure the operations of the PIA Companies. Restructuring costs were composed of committed costs required to integrate the SPAR CompaniesCompanies' and the PIA Companies' field organizations and the consolidation of administrative functions to achieve beneficial synergies and costs savings. At June 30, 2004, the Company evaluated its restructuring reserves and determined that certain restructuring reserves were no longer necessary (see Note 3 - Impairment Charges). In July 2004, as a result of the loss of several significant customers and the pending sale of the Company's largest customer, the Company entered into a plan to restructure and reduce its field force, as well as, its selling, general and administrative cost structure to reflect its lower revenue base. These reductions consist of personnel reductions, personnel related expenses and office closings. As a result of the July restructuring, the Company expensed approximately $480,000 in the quarter ending September 30, 2004, approximately $230,000 for severance benefits and approximately $250,000 for office leases that the Company ceased using. At December 31, 2004, the Company had approximately $250,000 reserved for future restructure payments that are expected to be paid in 2005. The Company records restructure expenses in the selling, general and administrative section of its consolidated operating statements. F-27 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 14. Restructuring Charges (continued) The following table displays a roll forward of the liabilities for restructuring charges from December 31, 2000January 1, 2001 to December 31, 20032004 (in thousands):
Equipment Office Employee Lease Lease Separation Settlements Settlements Total --------------- ---------------- ---------------- -------------- December 31, 2000January 1, 2001 balance $ 487 $ 2,770 $ 544 $ 3,801 Adjustments in restructuring charges (132) - - (132) 2001 payments (355) (1,008) (124) (1,487) --------------- ---------------- ---------------- -------------- December 31, 2001 balance $ - $ 1,762 $ 420 $ 2,182 2002 payments - (593) - (593) --------------- ---------------- ---------------- -------------- December 31, 20012002 balance $ - $ 1,7621,169 $ 420 $ 2,182 20021,589 Adjustments in restructuring charges - 98 (185) (87) 2003 payments - (593) - (593)(817) (817) --------------- ---------------- ---------------- -------------- December 31, 20022003, balance $ - $ 1,169450 $ 420235 $ 1,589 Adjustments in restructuring charges685 Impairment charge (see Note 3 - 98 (185) (87) 2003Impairment Charges) - (450) (235) (685) 2004 restructure plan 230 - 250 480 2004 payments (817) (817)(230) - - (230) --------------- ---------------- ---------------- -------------- December 31, 2003,2004, balance $ - $ 450- $ 235250 $ 685250 =============== ================ ================ ==============
All remaining restructuring charges at December 31, 2003 are expected to be utilized in 2004. Management believes that the remaining reserves for restructuring are adequate to complete its plan. F-24 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2003 13.15. Net (Loss) Income Per Share The following table sets forth the computations of basic and diluted net (loss) income per share (in thousands, except per share data):
Twelve Months Ended December 31, -------------------------------------------------- 2004 2003 2002 2001 -------------------------------------------------- Numerators: Net (loss) income from continuing operations $ (539) $ 5,298 $ 4,155 Loss from operations of discontinued division - - (5,869) --------------------------------------------------Numerator: Net (loss) income $ (12,268) $ (539) $ 5,298 $ (1,714) ================================================== Denominator: Shares used in basic net (loss) income per share calculation 18,859 18,855 18,761 18,389 Effect of diluted securities: Employee stock options - - 387 78 -------------------------------------------------- Shares used in diluted net (loss) income per share calculations 18,859 18,855 19,148 18,467 ================================================== Basic and diluted net (loss) income per common share: (Loss) income from continuing operations$ (0.65) $ (0.03) $ 0.28 $ 0.23 Loss from operations of discontinued division - - (0.32) -------------------------------------------------- Net (loss) income $ (0.03) $ 0.28 $ (0.09) ==================================================
The computation of dilutive loss per share excluded anti-dilutive stock options to purchase approximately 430,000 and 657,000 shares as of December 31, 2003. F-252004 and 2003, respectively. F-28 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2003 14.16. Quarterly Financial Data (Unaudited) Quarterly data for 20032004 and 20022003 was as follows (in thousands, except earnings per share data):
Quarter ------------------------------------------------------------- First Second Third Fourth -------- -------- -------- --------------------------------------------------------------------- Year Ended December 31, 2004: Net revenues $ 12,803 $ 11,932 $ 10,683 $ 15,952 Gross profit 4,109 3,115 3,720 6,782 ------------------------------------------------------------- Net (loss) income $ (790) $ (12,177) $ 210 $ 489 ============================================================= Basic/diluted net (loss) income per common share $ (0.04) $ (0.65) $ 0.01 $ 0.03 ============================================================= Year Ended December 31, 2003: Net revenues $ 18,738 $ 17,351$17,351 $ 16,615 $ 12,155 Gross profit 7,487 6,205 5,235 3,594 -------- -------- -------- --------------------------------------------------------------------- Net income (loss) $ 1,278 $ 608 $ (345) $ (2,080) ======== ======== ======== ===================================================================== Basic/diluted net income (loss) per common share $ 0.07 $ 0.03 $ (0.02) $ (0.11) ======== ======== ======== ======== Year Ended December 31, 2002: Net revenues $ 16,046 $ 17,542 $ 17,775 $ 18,249 Gross profit 6,295 6,951 7,015 9,020 -------- -------- -------- -------- Net income $ 482 $ 1,068 $ 1,213 $ 2,535 ======== ======== ======== ======== Basic/diluted net income per common share $ 0.03 $ 0.06 $ 0.06 $ 0.13 ======== ======== ======== =====================================================================
2004 The lost business and subsequent impairment charges were the primary factors for the losses incurred in the first two quarters of 2004. However, primarily as a result of the restructure plan initiated in the third quarter, the Company was profitable in the second half of 2004. 2003 In the fourth quarter 2003, the Company experienced certain charges to revenue and cost of sales that aredid not expected to recuroccur in the future.2004. These charges accounted for approximately 50% of the loss in 2003 fourth quarter. However, theThe Company did experiencealso experienced lower revenues from per unit fee contracts in the fourth quarter caused byresulting from decreased retail sales of some of the Company's larger clientsclients' products, andas well as the loss of a particular client earlier in the year. F-26F-29 SPAR Group, Inc. and Subsidiaries Schedule II - Valuation and Qualifying Accounts (In thousands)
Balance at Charged to Beginning of Charged to Costs and Balance at End Period and Expenses Deductions (1) of Period ----------------------------------------------------------------------------------------------------------------------------------------- Year ended December 31, 2004: Deducted from asset accounts: Allowance for doubtful accounts $ 515 $ 366 $ 120 (1) $ 761 Sales allowances $ 448 $ - $ 448 $ - Year ended December 31, 2003: Deducted from asset accounts: Allowance for doubtful accounts $ 301 $ 377 $ 163 (1) $ 515 Sales allowances $ - $ 448 $ - $ 448 Year ended December 31, 2002: Deducted from asset accounts: Allowance for doubtful accounts $ 325 $ 262 $ 286 (1) $ 301 Year ended December 31, 2001: Deducted from asset accounts: Allowance for doubtful accounts $2,648 $ 472 $2,795 $ 325
(1) Uncollectible accounts written off, net of recoveries. F-27 recoveries F-30