UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934 for the third quarterly period ended September 30,
2004
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 of Incorporation IRS Employer Identification No.
580 White Plains Road, Tarrytown, New York, 10591
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (914) 332-4100
Indicate by check whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days: [ X ] Yes [ ] No
Indicate by check whether the registrant is an accelerated filer (as defined in
Rule 12b-2 of the Exchange Act): [ ] Yes [X] No
On September 30, 2004, there were 18,858,972 shares of Common Stock outstanding.
SPAR Group, Inc.
Index
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements
Consolidated Balance Sheets
as of September 30, 2004, and December 31, 2003................................. 3
Consolidated Statements of Operations for the three months
and nine months ended September 30, 2004, and 2003..............................4
Consolidated Statements of Cash Flows for the
nine months ended September 30, 2004, and 2003.................................. 5
Notes to Consolidated Financial Statements.......................................6
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................................17
Item 3: Quantitative and Qualitative Disclosures About Market Risk......................29
Item 4: Controls and Procedures.........................................................29
PART II: OTHER INFORMATION
Item 1: Legal Proceedings...............................................................30
Item 2: Changes in Securities and Use of Proceeds.......................................30
Item 3: Defaults upon Senior Securities.................................................30
Item 4: Submission of Matters to a Vote of Security Holders.............................30
Item 5: Other Information...............................................................31
Item 6: Exhibits........................................................................31
SIGNATURES............................................................................................33
2
PART I:.FINANCIAL INFORMATION
Item 1: Financial Statements
SPAR Group, Inc.
Consolidated Balance Sheets
(In thousands, except share and per share data)
September 30, December 31,
2004 2003
-------- --------
(Unaudited) (Note)
Assets
Current assets:
Cash and cash equivalents $ 236 $ -
Accounts receivable, net 7,966 13,942
Prepaid expenses and other current assets 1,267 659
Deferred income taxes - 1,305
-------- --------
Total current assets 9,469 15,906
Property and equipment, net 1,686 2,099
Goodwill 798 8,749
Deferred income taxes - 434
Other assets 431 926
-------- --------
Total assets $ 12,384 $ 28,114
======== ========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 1,593 $ 1,350
Accrued expenses and other current liabilities 1,194 4,081
Accrued expenses, due to affiliates 1,889 1,091
Restructuring charges, current 162 685
Customer deposits 915 530
Line of credit, short-term 2,809 4,084
-------- --------
Total current liabilities 8,562 11,821
Other long-term liabilities 476 270
Restructuring charges, long-term 117 -
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 - September 30, 2004
18,858,972 - December 31, 2003 189 189
Treasury stock (176) (384)
Accumulated other comprehensive loss (56) (7)
Additional paid-in capital 11,051 11,249
Accumulated (deficit) retained earnings (7,779) 4,976
-------- --------
Total stockholders' equity 3,229 16,023
-------- --------
Total liabilities and stockholders' equity $ 12,384 $ 28,114
======== ========
Note: The Balance Sheet at December 31, 2003, has been derived from the
audited financial statements at that date but does not include any of
the information and footnotes required by accounting principles
generally accepted in the United States for complete financial
statements.
See accompanying notes.
3
SPAR Group, Inc.
Consolidated Statements of Operations
(unaudited)
(In thousands, except per share data)
Three Months Ended Nine Months Ended
------------------------- -------------------------
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
-------- -------- -------- --------
Net revenues $ 10,683 $ 16,615 $ 35,418 $ 52,704
Cost of revenues 6,963 11,380 24,474 33,777
-------- -------- -------- --------
Gross profit 3,720 5,235 10,944 18,927
Selling, general and administrative expenses 4,028 5,334 14,471 15,044
Impairment charges - - 8,141 -
Depreciation and amortization 275 385 1,005 1,162
-------- -------- -------- --------
Operating (loss) income (583) (484) (12,673) 2,721
Interest expense 29 69 127 209
Other income (expense) 773 - 764 (28)
-------- -------- -------- --------
Income (loss) before provision for income taxes 161 (553) (12,036) 2,484
Provision (benefit) for income taxes 15 (208) 783 943
-------- -------- -------- --------
Net income (loss) before minority interest 146 (345) (12,819) 1,541
Minority interest 64 - 64 -
-------- -------- -------- --------
Net income (loss) $ 210 $ (345) $(12,755) $ 1,541
======== ======== ======== ========
Basic/diluted net income (loss) per common share:
Net income (loss) - basic/diluted $ 0.01 $ (0.02) $ (0.68) $ 0.08
======== ======== ======== ========
Weighted average common shares - basic 18,859 18,859 18,859 18,853
======== ======== ======== ========
Weighted average common shares - diluted 19,206 18,859 18,859 19,508
======== ======== ======== ========
See accompanying notes.
4
SPAR Group, Inc.
Consolidated Statements of Cash Flows
(unaudited) (In thousands)
Nine Months Ended
-------------------------
September 30, September 30,
2004 2003
-------- --------
Operating activities
Net (loss) income before minority interest $(12,819) $ 1,541
Adjustments to reconcile net (loss) income to net cash provided
by (used in) operating activities:
Impairment charges 8,141 -
Minority interest earnings in subsidiaries 64 -
Deferred tax asset adjustments 709 254
Depreciation 1,005 1,162
Changes in operating assets and liabilities:
Accounts receivable 5,976 1,456
Prepaid expenses and other assets (181) (816)
Accounts payable, accrued expenses, other current
liabilities and customer deposits (1,216) (1,642)
Accrued expenses due to affiliates 798 670
Restructuring charges 280 (817)
-------- --------
Net cash provided by operating activities 2,757 1,808
Investing activities
Purchases of property and equipment (1,014) (1,356)
Acquisition of businesses (399) (299)
-------- --------
Net cash used in investing activities (1,413) (1,655)
Financing activities
Net (payments) borrowings on line of credit (1,275) 4,524
Other long-term liabilities 206 -
Proceeds from employee stock purchase plan and exercised options 10 198
Payments to certain stockholders - (3,951)
Purchase of treasury stock - (924)
-------- --------
Net cash used in financing activities (1,059) (153)
Translation loss (49) -
Net change in cash 236 -
Cash at beginning of period - -
-------- --------
Cash at end of period $ 236 $ -
======== ========
Supplemental disclosure of cash flow information
Interest paid $ 124 $ 174
See accompanying notes.
5
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited)
1. Basis of Presentation
The accompanying unaudited, consolidated financial statements of SPAR
Group, Inc., a Delaware corporation ("SGRP"), and its subsidiaries (together
with SGRP, collectively, the "Company" or the "SPAR Group") have been prepared
in accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included in these interim financial
statements. However, these interim financial statements should be read in
conjunction with the annual consolidated financial statements and notes thereto
for the Company as contained in the Company's Annual Report for 2003 on Form
10-K for the year ended December 31, 2003, as filed with the Securities and
Exchange Commission on March 30, 2004 (the "Company's Annual Report for 2003 on
Form 10-K"). The Company's results of operations for the interim periods are not
necessarily indicative of its operating results for the entire year.
2. Impairment Charges
Goodwill:
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 30.2% and 31.1% of
the Company's net revenues for the nine months ended September 30, 2004, and
2003, respectively. This customer was the last remaining profitable business
that resulted from the PIA acquisition on July 9, 1999.
At March 31, 2004, the Company had $7.6 million of goodwill related to the
acquisition of PIA. As a result of the loss of this major client, 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 operations for the nine months ending
September 30, 2004. Also, in connection with the PIA acquisition, certain
deferred tax assets related to PIA net operating loss carry forward benefits
were recognized as an adjustment to goodwill. The Company also recorded as an
impairment charge, a $709,000 valuation allowance on these deferred tax assets.
At March 31, 2004, the Company had approximately $2.1 million accrued for
restructure costs and PIA merger 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
the tax effect) reduction in PIA related acquisition liabilities against the
related goodwill thereby reducing the impairment charges recognized during the
nine months ended September 30, 2004.
6
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
In June 2003, the Company acquired its Canadian operations. In connection
with the acquisition, the Company recorded goodwill of $712,000. At the time of
acquisition, it was expected that the Canadian subsidiary would be profitable.
However, the Canadian subsidiary has operated at a loss since its acquisition.
It is also expected that the Canadian subsidiary will incur a loss for the year
ending December 31, 2004. As a result of the continued losses and the failure to
attract new customers the Company has recorded an impairment of the related
goodwill resulting in a non-cash charge of $712,000 for the nine months ending
September 30, 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 the nine months ended September 30, 2004.
Other Assets:
In addition to the above, the Company has recorded impairment of other
assets totaling $68,000 for the nine months ending September 30, 2004.
3. Management's Plans Concerning Cash Flow
Management believes that based upon the Company's cost saving initiatives
(outlined in Note 4 - Restructuring Charges) and the existing credit facilities,
funding will be sufficient to support ongoing operations over the next twelve
months. The Company is and has been in violation of certain covenants of its
Credit Facility (see Note 6 - Line of Credit) and expects to violate such
covenants in the future. The Company's bank, Webster Business Credit
Corporation, has issued waivers for past covenant violations, however, there can
be no assurances that Webster will continue to issue such waivers in the future.
4. Restructuring Charges
In 1999, in connection with the PIA merger, 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 Companies' and the PIA Companies' field organizations and the consolidation
of administrative functions to achieve beneficial synergies and costs savings.
(For the specific definitions of those terms, see Item 1 - Business - GENERAL -
Continuing Operations - Merchandising Services Division in the Company's Annual
Report for 2003 on Form 10-K.) At June 30, 2004, the Company evaluated its
restructuring reserves and determined that the restructuring reserves were no
longer necessary (See Note 2 - Impairment Charges).
7
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
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 and related expenses and office
closings. In July 2004, the Company implemented several of the savings
initiatives and will continue to implement certain others over the next several
months. 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 September 30, 2004, the Company had
approximately $280,000 reserved for future restructure payments. The Company
will continue to evaluate cost saving opportunities and expects to incur
additional restructuring costs in the future.
5. Earnings Per Share
The following table sets forth the computations of basic and diluted
earnings (loss) per share (in thousands, except per share data):
Three Months Ended Nine Months Ended
------------------------------------- ----------------------------------
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
------------------ ------------------ ---------------- -----------------
Numerator:
Net income (loss) $ 210 $ (345) $ (12,755) $ 1,541
Denominator:
Shares used in basic earnings
(loss) per share calculation 18,859 18,859 18,859 18,853
Effect of diluted securities:
Employee stock options 167 - - 655
------------------ ------------------ ---------------- -----------------
Shares used in diluted earnings
(loss) per share calculation 19,026 18,859 18,859 19,508
================== ================== ================ =================
Basic and diluted earnings (loss) per common share:
Net income (loss) - basic and $ 0.01 $ (0.02) $ (0.68) $ 0.08
diluted
================== ================== ================ =================
The computation of dilutive loss per share excluded anti-dilutive stock
options to purchase approximately 726,000 shares for three months September 30,
2003 and approximately 591,000 shares for the nine months ending September 30,
2004.
8
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
6. Line of Credit
In January 2003, the Company and Webster Business Credit Corporation, then
known as Whitehall Business Credit Corporation ("Webster"), entered into the
Third Amended and Restated Revolving Credit and Security Agreement (as amended,
collectively, the "Credit Facility"). The Credit Facility provided a $15.0
million revolving credit facility that matures on January 23, 2006. The Credit
Facility allowed 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 certain 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. At September 30, 2004, the Credit Facility bears interest at
Webster's "Alternative Base Rate" plus 0.75% (a total of 5.25% per annum), or
LIBOR plus 3.25%. The Credit Facility is secured by all of the assets of the
Company and its subsidiaries. In connection with the May 17, 2004, amendment,
Mr. Robert Brown, a Director, the Chairman, President, 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. The amendment did not change the future covenant levels.
The Credit Facility contains certain financial covenants that must be
met by the Company on a consolidated basis, including, a minimum monthly and
cumulative "EBITDA", minimum "Net Worth", a minimum "Fixed Charge Coverage
Ratio", as such terms are defined in the Credit Facility. The Credit Facility
also limits certain expenditures including but not limited to capital
expenditures and other investments. The Company was in violation of certain
quarterly covenants at September 30, 2004, and expects to be in violation at
future measurement dates. Webster issued a waiver for the September 30, 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
and 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 September 30, 2004, and December
31, 2003, in accordance with EITF 95-22.
The revolving loan balances outstanding under the Credit Facility were
$2.8 million and $4.1 million at September 30, 2004, and December 31, 2003,
respectively. There were letters of credit outstanding under the Credit Facility
of $0.7 million at each of September 30, 2004, and December 31, 2003. As of
September 30, 2004, the SPAR Group had unused availability under the Credit
Facility of $0.2 million out of the remaining maximum $3.5 million unused
revolving line of credit after reducing the borrowing base by outstanding loans
and letters of credit.
9
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
7. Related-Party Transactions
Mr. Robert G. Brown, a Director, the Chairman, President and Chief
Executive Officer and a major stockholder of the Company, and Mr. William H.
Bartels, a Director, the Vice Chairman and a major stockholder of the Company
(collectively, the "SMS Principals"), are executive officers and the sole
stockholders and directors of SPAR Marketing Services, Inc. ("SMS"), SPAR
Management Services, Inc. ("SMSI"), and SPAR Infotech, Inc. ("SIT").
SMS provided approximately 99% of the Company's field representatives in
the United States (through its independent contractor field force), and SMSI
provided approximately 92% of the Company's field management in the United
States at September 30, 2004. Pursuant to the Amended and Restated Field Service
Agreement dated as of January 1, 2004 (the "Field Service Agreement"), SMS
provides the services of approximately 6,300 field representatives to the
Company at its request from time to time, for which the Company has agreed to
reimburse SMS for all of its costs of providing those services and to pay SMS a
premium equal to 4% of such costs. Pursuant to the terms of the Amended and
Restated Field Management Agreement dated as of January 1, 2004 (the "Field
Management Agreement"), SMSI provides approximately 50 full-time national,
regional and district managers to the Company at its request, from time to time,
for which the Company has agreed to reimburse SMSI for all of its costs of
providing those services and to pay SMSI a premium equal to 4% of such costs,
except that for 2004 SMSI agreed to concessions that reduced the Company's costs
by approximately $230,000 and $470,000 for the three and nine month periods
ended September 30, 2004, respectively. The SMS Principals 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, the SMS Principals benefit from any income of such
companies allocated to them.
SIT provided substantially all of the Internet computer programming
services to the Company for the three and nine month periods ended September 30,
2004. Pursuant to the Amended and Restated Programming and Support Agreement
dated as of January 1, 2004 (the "Programming and Support Agreement"), SIT
continues to provide programming services to the Company at its 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 the related
out-of-pocket expenses of SIT and its personnel. No hourly charges or business
expenses for the SMS Principals were charged to the Company for the three and
nine month periods ended September 30, 2004. However, since SIT is a "Subchapter
S" corporation, the SMS Principals benefit from any income of such company
allocated to them.
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.
10
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
The following transactions occurred between the SPAR Companies and the
above affiliates (in thousands):
Three Months Ended Nine Months Ended
---------------------- ----------------------
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
------- ------- ------- -------
Services provided by affiliates:
SMS: Independent contractor
field services $ 4,183 $ 7,970 $15,941 $22,926
======= ======= ======= =======
SMSI: Field management
services $ 946 $ 1,939 $ 3,561 $ 5,701
======= ======= ======= =======
SIT: Internet and computer
programming services $ 218 $ 359 $ 897 $ 1,215
======= ======= ======= =======
Reimbursed costs from affiliates: $ 24 $ 61 $ 87 $ 169
======= ======= ======= =======
Accrued expenses due to affiliates (in thousands): September 30, December 31,
2004 2003
---------------------------------
SMS $ 1,200 $ 397
SMSI 343 517
SIT 346 177
---------------------------------
$ 1,889 $ 1,091
8. Stock Options
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 transactions under Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees.
11
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
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. For disclosure
purposes, the compensation cost for the Company's option grants that were
awarded 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 operations would
have been reduced to the adjusted amounts indicated below (in thousands, except
per share data):
Nine Months Ended
-------------------------
September 30, September 30,
2004 2003
-------- --------
Net (loss) income, as reported $(12,755) $ 1,541
Stock based employee compensation expense
under the fair market value method $ 367 $ 1,188
-------- --------
Adjusted pro forma net (loss) income $(13,122) $ 353
Basic and diluted net (loss) income per share, as reported $ (0.68) $ 0.08
Basic and diluted adjusted pro forma net (loss) income $ (0.70) $ 0.02
per share, after adjustment for stock based
employee compensation expense under the fair market
value method
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.
For the nine months ended September 30, 2004, under the provision of SFAS
No. 123 dealing with non-employee stock option grants awarded to the employees
of the Company's affiliates, there was a recovery of amounts previously expensed
of approximately $114,000 as a result of the declining market price of the
Company's stock from December 31, 2003 to September 30, 2004. The Company
determines the fair value of the options granted to non-employees using the
Black-Scholes valuation model and recovers amounts previously expensed or
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.
12
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
9. Treasury Stock
The Company utilized 40,648 of repurchased shares to issue stock for the
exercise of stock options during the nine months ended September 30, 2004. As of
September 30, 2004, the Company has 35,408 shares of treasury stock, which it
acquired at a cost of approximately $176,000. Currently, the Company has no
stock repurchase program in place.
10. Line of Credit and Advances due from SPAR Performance Group, Inc. (now
called STIMULYS, Inc.); Inability to Consolidate under FIN 46
In connection with the sale of SPAR Performance Group, Inc. ("SPGI"), on
June 30, 2002, the Company sold all of the stock of its subsidiary, SPGI. In
connection with the sale, SPGI entered into a term loan agreement with the
Company under which SPGI borrowed $6.0 million in term loans (the "Term Loans"),
which due to their speculative nature were fully reserved.
Also in connection with the sale, the Company agreed to provide a
discretionary revolving line of credit to SPGI not to exceed $2.0 million (the
"SPGI Revolver") through September 30, 2005. The SPGI Revolver was secured by a
pledge of all the assets of SPGI and was guarantied by SPGI's parent,
Performance Holdings, Inc. The SPGI Revolver provided 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. In December
of 2003, SPGI changed its name to STIMULYS, Inc. On 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 established a reserve for
the remaining amount due, totaling approximately $344,000. The STIMULYS note
receivable is recorded in Other Current Assets.
As a result of the termination of the SPGI Revolver, the reserve for
collection of advances and accrued interest under the SPGI Revolver previously
established by the Company totaling approximately $984,000 is no longer
required. The release of this reserve net of the new reserve required for the
Promissory Note resulted in Other Income totaling approximately $640,000 for the
three months ending September 30, 2004.
13
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
11. Income Taxes
During the three months ended June 30, 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 $709,000. The valuation allowance was reduced by
approximately $75,000 representing income taxes in excess of minimum taxes for
the three months ending September 30, 2004. The income tax provision for the
three months ending September 30, 2004 represents minimum state tax liabilities.
12. Customer Deposits
In June 2004, the Company received a non-refundable deposit of
approximately $900,000 from a customer. The deposit is to be applied to future
invoices for services that will be provided by the Company under a master
service agreement through December 31, 2006. Each invoice will be reduced by 20%
until the deposit is depleted. As of September 30, 2004, there have been no
reductions of the deposit.
13. Contingencies
Joint Venture Guarantee
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 300 million Yen Revolving Credit Agreement with a
Japanese bank. The bank required Paltac to 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
150 million Yen or approximately $1.4 million. As of September 30, 2004, SPAR FM
has borrowed 100 million Yen under its Revolving Credit Agreement. Therefore,
the Company's current exposure to Paltac respecting outstanding loans to SPAR FM
at September 30, 2004, would be 50 million Yen or approximately $0.5 million.
The Company has recorded approximately $0.2 million in long-term
liabilities for its share of the cumulative losses associated with this joint
venture.
Legal Matters
On October 24, 2001, Safeway Inc., a former customer of the PIA
Merchandising Co., Inc. and Pivotal Sales Company, filed a complaint alleging
damages of approximately $3.6 million plus interest and costs and alleged
punitive damages in an unspecified amount against the Company in Alameda County
Superior Court, California, Case No. 2001028498 with respect to (among other
things) alleged breach of contract. In December 2002, the Court approved the
filing of Safeway Inc.'s Second Amended Complaint, which alleges causes of
action for (among other things) breach of contract against the Company, PIA
Merchandising Co., Inc. and Pivotal Sales Company. The Second Amended
14
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
Complaint was filed with the Court on January 13, 2003, 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 currently scheduled for
trial in March 2005 and is being vigorously contested by the Company.
The Company is a party to various legal actions and administrative
proceedings arising in the normal course of business. In the opinion of Company
management, disposition of these matters are not anticipated to have a material
adverse effect on the financial position, results of operations or cash flows of
the Company.
14. Geographic Data
A summary of the Company's net revenue, operating income and long lived
assets by geographic area for the three and nine month periods ending September
30, 2004, is as follows (in thousands):
Three Months Ending Nine Months Ending
-------------------------------------------
September 30, September 30,
2004 2004
-------------------------------------------
Net revenue:
United States $ 9,236 $ 32,467
International $ 1,447 $ 2,951
Operating loss:
United States $ (349) $(10,910)
International $ (234) $ (1,763)
-------------------------------------------------------------------------------------------------
Long lived asset as of September 30, 2004:
United States $ 2,616
International $ 299
With the exception of the joint venture in South Africa, no one
international geographic market is greater than 10% of consolidated net revenue.
South Africa accounted for 11% of total consolidated net revenue for the three
months ended September 30, 2004.
15
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
15. Supplemental Balance Sheet Information
September 30, December 31,
Prepaid expenses and other current assets 2004 2003
------------------------------------------------------
STIMULYS Promissory Note, net of reserve (see
Note 10) $ 422 $ -
Prepaid insurance 344 245
Tax refund due 317 244
Prepaid rents 49 70
Other 135 100
------------------------------------------------------
$ 1,267 $ 659
September 30, December 31,
Other assets, long-term 2004 2003
------------------------------------------------------
Deposit on domestic acquisition $ - $ 350
Prepaid insurance, long-term 189 289
Refundable deposits 118 129
Other 124 158
------------------------------------------------------
$ 431 $ 926
September 30, December 31,
Accrued expenses and other current liabilities 2004 2003
------------------------------------------------------
Merger related payables $ 450 $ 1,495
STIMULYS cash deposits - 794
SPGI Revolver - 740
Accrued medical expenses 294 100
State taxes payable 169 139
Accrued accounting and legal expenses 109 219
Accrued salary payable 78 241
Other 94 353
------------------------------------------------------
$ 1,194 $ 4,081
16. Reclassification
Certain amounts in the 2003 financial statements have been reclassified to
conform to the 2004 presentation.
16
SPAR Group, Inc.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
Statements contained in this Quarterly Report on Form 10-Q for the nine
months ended September 30, 2004 (this "Quarterly Report"), of SPAR Group, Inc.
("SGRP", and together with its subsidiaries, the "SPAR Group" or the "Company"),
include "forward-looking statements" within the meaning of Section 27A of the
Securities Act and Section 21E of the Exchange Act, including, in particular and
without limitation, the statements contained in the discussions under the
heading "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", "will",
"expect", "intend", "believe", "estimate", "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 and any other cautionary statements contained in the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 2003, as filed with
the Securities and Exchange Commission on March 30, 2004 (the "Company's Annual
Report for 2003 on Form 10-K"), and the cautionary statements contained in this
Quarterly Report. All 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 the Company's
Annual Report for 2003 on Form 10-K and in this Quarterly Report. 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.
Overview
The Company's operations are divided into two divisions: the
Merchandising Services Division and the International Division. The
Merchandising Services Division provides merchandising services, product
demonstrations, product sampling, database marketing, teleservices and marketing
research to manufacturers and retailers with product distribution primarily in
mass merchandisers, drug chains, convenience stores and grocery stores in the
United States. The International Division, established in July 2000, currently
provides merchandising services in Japan, Canada, Turkey, South Africa and
India.
17
SPAR Group, Inc.
Merchandising Services Division
The Company provides nationwide merchandising and other marketing
services to general merchandise, health and beauty care, consumer goods, home
entertainment, PC software and food products companies in drug chains, mass
merchandisers, convenience stores 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 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. 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, 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, the Company added in-store
product demonstration and in-store product sampling services to its
merchandising service offerings. Marketing services consist of database
marketing, teleservices and marketing research.
International Division
In July 2000, the Company established its International Division,
through a wholly owned subsidiary, SPAR Group International, Inc. ("SGI"), to
focus on expanding its merchandising services business worldwide. In May 2001,
the Company entered into a 50% owned joint venture with a large Japanese
distributor to provide merchandising services in Japan. In June 2003, the
Company expanded its merchandising services into Canada through a wholly owned
subsidiary. In July 2003, the Company established a 51% owned joint venture
based in Istanbul to provide merchandising services throughout Turkey. In April
2004, the Company established a joint venture in South Africa. The joint venture
is headquartered in Durban and is owned 51% by the Company. Also in April 2004,
the Company announced the establishment of a joint venture in India and started
operations during the third quarter. The joint venture is headquartered in New
Delhi and is owned 51% by the Company.
Critical Accounting Policies
The Company's critical accounting 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
18
SPAR Group, Inc.
appropriate in the circumstances. Three critical accounting policies are revenue
recognition, allowance for doubtful accounts and sales allowance, and
capitalized internal use software development costs:
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. 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.
Allowance for Doubtful Accounts and Sales Allowance
The Company continually monitors the collectability of its accounts
receivable based upon current customer credit information and other information
available. Utilizing this information, the Company has established an allowance
for doubtful accounts of $577,000 and $444,000 at September 30, 2004, and
December 31, 2003, respectively.
Internal Use Software Development Costs
Under the rules of SOP 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use, the Company capitalizes certain
costs incurred in connection with developing or obtaining internal use software.
Capitalized software development costs are amortized over three years.
The Company capitalized $298,000 and $802,000 of costs related to
software developed for internal use in the nine months ended September 30, 2004,
and 2003, respectively.
The Company also recorded a net impairment charge of capitalized
software related to lost clients totaling approximately $442,000 in the
nine-month period ending September 30, 2004.
19
SPAR Group, Inc.
Results of Operations
Three months ended September 30, 2004, compared to three months ended September
30, 2003
The following table sets forth selected financial data and data as a
percentage of net revenues for the periods indicated (in thousands, except
percent data).
Three Months Ended
--------------------------------------------------------
September 30, 2004 September 30, 2003 (Decrease)
Amount % Amount % Increase %
-------- ----- -------- ----- -----
Net revenues $ 10,683 100.0% $ 16,615 100.0% (35.7)%
Cost of revenues 6,963 65.2 11,380 68.5 (38.8)
Selling, general and administrative expense 4,028 37.7 5,334 32.1 (24.5)
Depreciation and amortization 275 2.6 385 2.3 (28.7)
Interest expense 29 0.2 69 0.4 (57.7)
Other income 773 7.2 - - -
-------- ----- -------- -----
Income (loss) before provision for income taxes 161 1.5 (553) (3.3) (129.1)
Provision (benefit) for income tax 15 0.1 (208) (1.3) (107.3)
-------- ----- -------- -----
Net income (loss) before minority interest 146 1.4 (345) (2.0) (142.3)
Minority interest 64 0.6 - - -
-------- ----- -------- -----
Net income (loss) $ 210 2.0% $ (345) (2.0)% (160.8)%
======== ===== ======== =====
Net revenues for the three months ended September 30, 2004, were $10.7
million, compared to $16.6 million for the three months ended September 30,
2003, a decrease of 35.7%. The decrease in net revenues was due to lower
domestic sales as a result of reduced business from the Company's largest
customer, which was sold during the third quarter, as well as, the loss of two
other large clients offset by increases in international sales totaling $1.4
million.
20
SPAR Group, Inc.
One customer, a division of a major retailer, accounted for 16.9% and
27.7% of the Company's net revenues for the three months ended September 30,
2004, and 2003, respectively. This customer also accounted for approximately
14.6% and 32.6% of accounts receivable at September 30, 2004, and 2003,
respectively. This customer was sold by its parent on August 2, 2004. During the
third quarter of 2004, the Company experienced a decline in net revenue from
this retailer, a trend which is expected to continue into 2005. The loss of this
business will have a material adverse effect on the Company's business, results
of operations and financial condition.
A second customer accounted for 13.9% and 9.7% of the Company's net
revenue for the three months ended September 30, 2004, and 2003, respectively.
This customer also accounted for approximately 21.7% and 8.9% of accounts
receivable at September 30, 2004, and 2003, respectively.
In addition, approximately 17.2% and 13.8% of the Company's net
revenues for the three months ended September 30, 2004, and 2003, respectively,
resulted from merchandising services performed for manufacturers and others at
Kmart. Kmart emerged from bankruptcy in May 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 or agreements 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.
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.
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 as a percentage of net revenues was 65.2% for the
three months ended September 30, 2004, compared to 68.5% for the three months
ended September 30, 2003. The decrease is primarily a result of the Company
reducing its domestic field structure to reflect its reduction of business.
Approximately 73.7% and 87.1% of the Company's cost of revenue in the
three months ended September 30, 2004, and 2003, respectively, resulted from
in-store independent contractor and field management services purchased from the
Company's affiliates, SPAR Marketing Services, Inc. ("SMS"), and SPAR Management
Services, Inc. ("SMSI"), respectively (see Note 7 to the Financial Statements in
this Quarterly Report).
Operating expenses include selling, general and administrative
expenses, impairment charges and depreciation and amortization. Selling, general
and administrative expenses include corporate overhead, project management,
information technology, executive compensation, human resource expenses, legal
and accounting expenses.
The decrease in selling, general and administrative expenses of $1.3
million consists of reductions in domestic operations' selling, general and
administrative cost structure to reflect its reduction of business totaling $2.1
million offset by increases in international selling, general and administrative
expense primarily as a result of joint venture startups totaling $0.3 million
and restructure expenses totaling $0.5 million.
21
SPAR Group, Inc.
Other Income
Other income of approximately $0.8 million for the three months ended
September 30, 2004, primarily represents the release of the STIMULYS reserve
(see Note 10 to the Financial Statements in this Quarterly Report).
Income Taxes
The Company recorded an income tax provision of $15,000 for the three
months ended September 30, 2004. The provision was primarily for state taxes.
For the three months ended September 30, 2003, the income tax benefit represents
a combined federal and state income tax rate of 38% (see Note 11 to the
Financial Statements in this Quarterly Report).
Net Income
The Company had a net income of $0.2 million for the three months ended
September 30, 2004, or $0.01 per diluted share, compared to a net loss of $0.3
million, or $0.02 per diluted share, for the corresponding period last year.
22
SPAR Group, Inc.
Results of Operations
Nine months ended September 30, 2004, compared to nine months ended September
30, 2003
The following table sets forth selected financial data and data as a
percentage of net revenues for the periods indicated (in thousands, except
percent data):
Nine Months Ended
---------------------------------------------------------------------------------
September 30, 2004 September 30, 2003
% Incr.
Amount % Amount % (Decr.)
---------------- --------------- ----------------- ----------------- --------
Net revenues $ 35,418 100.0% $ 52,704 100.0% (32.8)%
Cost of revenues 24,474 69.1 33,777 64.1 (27.5)
Selling, general, and administrative expense 14,471 40.9 15,044 28.5 (3.8)
Impairment charges 8,141 23.0 - - -
Depreciation and amortization 1,005 2.8 1,162 2.2 (13.6)
Interest expense 127 0.4 209 0.4 (39.2)
Other income (expense) 764 2.2 (28) (0.1) (2828.6)
---------------- --------------- ----------------- -----------------
(Loss) income before provision for income taxes (12,036) (34.0) 2,484 4.7 (584.4)
Provision for income taxes 783 2.2 943 1.8 (16.9)
---------------- --------------- ----------------- -----------------
Net (loss) income before minority interest (12,819) (36.2) 1,541 2.9 (931.9)
Minority interest 64 0.2 - - -
---------------- --------------- ----------------- -----------------
Net (loss) income $ (12,755) (36.0)% $ 1,541 2.9% (927.8)%
================ =============== ================= =================
Net revenues from operations for the nine months ended September 30,
2004, were $35.4 million, compared to $52.7 million for the nine months ended
September 30, 2003, a decrease of 32.8%. The decrease in net revenues was due to
lower domestic sales resulting primarily from reduced business from the
Company's largest customer, which was sold during the third quarter, decreased
project revenue
23
SPAR Group, Inc.
from another client and the loss of two other large clients offset by increases
in international sales totaling $3.0 million.
One customer, a division of a major retailer, accounted for 30.2% and
31.1% of the Company's net revenues for the nine months ended September 30,
2004, and 2003, respectively. This customer also accounted for approximately
14.6% and 32.6% of accounts receivable at September 30, 2004, and 2003,
respectively. The customer was sold by its parent on August 2, 2004. During the
third quarter of 2004, the Company experienced a decline in net revenue from
this retailer, a trend which is expected to continue into 2005. The loss of this
business will have a material adverse effect on the Company's business, results
of operations and financial condition.
A second customer accounted for 10.1% and 7.5% of the Company's net
revenue for the nine months ended September 30, 2004, and 2003, respectively.
This customer also accounted for approximately 21.7% and 8.9% of accounts
receivable at September 30, 2004, and 2003, respectively.
Approximately 15% of the Company's net revenues for the nine months
ended September 30, 2004, and 2003, resulted from merchandising services
performed at Kmart for various customers. Kmart emerged from bankruptcy in May
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 or agreements are with various manufacturers and not this
retailer, a significant reduction of this retailer's stores or cessation of this
retailer's business would negatively impact the Company.
Cost of revenues consists of field 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 was 69.1% for the nine months ended
September 30, 2004, compared to 64.1% for the nine months ended September 30,
2003. The increase is primarily a result of additional costs associated with its
per unit fee revenue programs and reduced pricing to a large customer that
occurred in the first six months of 2004, offset by the reduction of the
Company's field structure to reflect the reduction in business.
Approximately 79.7% and 84.8% of the Company's costs of revenue in the
nine months ended September 30, 2004, and 2003, respectively, resulted from
field in-store independent contractor and field management services purchased
from the Company's affiliates, SMS, and SMSI, respectively (see Note 7 to the
Financial Statements in this Quarterly Report).
Operating expenses include selling, general and administrative
expenses, impairment charges and depreciation and amortization. Selling, general
and administrative expenses include corporate overhead, project management,
information technology, executive compensation, human resources expenses, legal
and accounting expenses.
The decrease in selling, general and administrative expenses of $0.6
million consists of reductions in domestic operations' selling, general and
administrative cost structure to reflect its reduction of business totaling $1.7
million offset by increases in international selling, general and administrative
expenses primarily as a result of joint venture startups totaling $0.6 million,
and restructuring expenses totaling $0.5 million.
Impairment charges were $8.1 million for the nine months ended
September 30, 2004. Impairment charges consisted of $9.0 million of goodwill
impairment, offset by reductions to the other liabilities for PIA merger related
costs of $1.0 million and PIA restructuring charges of $0.7 million, net
24
SPAR Group, Inc.
of a $0.3 million tax effect, $0.4 million of net impairment of software
development costs previously capitalized and $0.1 million for impairment of
other assets.
Other Income
Other income of approximately $0.8 million for the nine months ended
September 30, 2004, primarily represents the release of the STIMULYS reserve
(see Note 10 to the Financial Statements in this Quarterly Report).
Income Taxes
The Company recorded an income tax provision of $0.8 million for the nine
months ended September 30, 2004. The provision represents estimated minimum
taxes due as well as the establishment of a valuation reserve for net deferred
tax assets previously recorded by the Company (see Note 11 to the Financial
Statements in this Quarterly Report). For the nine months ended September 30,
2003 the income tax provision represents a combined federal and state income tax
rate of 38%.
Net Loss/Income
The Company had a net loss of $12.8 million for the nine months ended
September 30, 2004, or $0.68 per diluted share compared to net income of $1.5
million or $0.08 per diluted share for the corresponding period last year.
Liquidity and Capital Resources
In the nine months ended September 30, 2004, the Company had a net loss
of $12.8 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, $1.0
million for depreciation and $0.1 million for minority interest earnings in
subsidiaries.
Net cash provided by operating activities for the nine months ended
September 30, 2004, was $2.8 million, comparable to net cash provided by
operating activities of $1.8 million for the nine months ended September 30,
2003. The increase of $1.0 million in cash provided by operating activities is
due to lower accounts receivable levels, higher accruals for restructuring
charges and accrued expenses due affiliates, lower reductions in accounts
payable, accrued expenses and other current liabilities, lower increases in
prepaid expenses offset by net operating losses.
Net cash used in investing activities for the nine months ended
September 30, 2004, was $1.4 million comparable to net cash used in investing
activities of $1.7 million for the nine months ended September 30, 2003. The
decrease in net cash used in investing activities resulted from lower purchases
of property and equipment in the current year.
Net cash used in financing activities for the nine months ended
September 30, 2004, was $1.1 million, compared with net cash used in financing
activities of $0.2 million for the nine months ended September 30, 2003. The
increase of net cash used in financing activities was primarily a result of
higher net payments on the line of credit.
25
SPAR Group, Inc.
The above activity resulted in a change in cash and cash equivalents
for the nine months ended September 30, 2004 of $0.2 million.
At September 30, 2004, the Company had positive working capital of $0.9
million, as compared to a positive working capital of $4.1 million on December
31, 2003. The decrease in working capital is due primarily to decreases in sales
levels and the related impact on accounts receivable and deferred income taxes.
The Company's current ratio was 1.11 at September 30, 2004, and 1.35 at December
31, 2003.
In January 2003, the Company and Webster Business Credit Corporation,
then known as Whitehall Business Credit Corporation ("Webster"), entered into
the Third Amended and Restated Revolving Credit and Security Agreement (as
amended, collectively, the "Credit Facility"). The Credit Facility provided a
$15.0 million revolving credit facility that matures on January 23, 2006. The
Credit Facility allowed 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 the 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. At September 30, 2004, the Credit Facility bears interest at
Webster's "Alternative Base Rate" plus 0.75% (a total of 5.25% per annum), or
LIBOR plus 3.25%. The Credit Facility is secured by all of the assets of the
Company and its 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. The amendment does not change the future covenant
levels.
The Credit Facility contains certain financial covenants that must be
met by the Company on a consolidated basis, including, a minimum monthly and
cumulative "EBITDA", minimum "Net Worth", a minimum "Fixed Charge Coverage
Ratio", as such terms are defined in the Credit Facility. The Credit Facility
also limits certain expenditures including, but not limited to, capital
expenditures and other investments. The Company was in violation of certain
quarterly covenants at September 30, 2004, and expects to be in violation at
future measurement dates. Webster issued a waiver for the September 30, 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 and 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 September 30, 2004, and December
31, 2003, in accordance with EITF 95-22.
The revolving loan balances outstanding under the Credit Facility were
$2.8 million and $4.1 million at September 30, 2004, and December 31, 2003,
respectively. There were letters of credit
26
SPAR Group, Inc.
outstanding under the Credit Facility of $0.7 million at September 30, 2004, and
December 31, 2003. As of September 30, 2004, the SPAR Group had unused
availability under the Credit Facility of $0.2 million out of the remaining
maximum $3.5 million unused revolving line of credit after reducing the
borrowing base by outstanding loans and letters of credit.
Management believes that based upon the Company's cost saving
initiatives and the existing credit facilities, sources 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 return to
profitability, 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.
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 established
a reserve for the remaining amount due, totaling approximately $344,000. The
STIMULYS note receivable is recorded in Other Assets.
As a result of the termination of the SPGI Revolver, the reserve for
collection of advances and accrued interest under the SPGI Revolver previously
established by the Company totaling approximately $984,000 is no longer
required. The release of this reserve net of the reserve required for the
Promissory Note resulted in Other Income totaling approximately $640,000 for the
three months ending September 30, 2004.
Certain Contractual Obligations
The following table contains a summary of certain of the Company's
contractual obligations by category as of September 30, 2004 (in thousands).
- --------------------------------------------------------------------------------------------------------------------
Contractual Obligations Payments due by Period
- --------------------------------------------------------------------------------------------------------------------
Total Less than 1 1-3 years 3-5 years More than 5
year years
- --------------------------------------------------------------------------------------------------------------------
Credit Facility $2,809 $2,809 $ - $ - $ -
- --------------------------------------------------------------------------------------------------------------------
Operating Lease Obligations 1,673 816 800 57 -
- --------------------------------------------------------------------------------------------------------------------
Total $4,482 $3,625 $ 800 $ 57 $ -
- --------------------------------------------------------------------------------------------------------------------
The Company also had $0.7 in outstanding Letters of Credit at September
30, 2004.
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 300 million Yen
27
SPAR Group, Inc.
Revolving Credit Agreement with a Japanese bank. The bank required Paltac to
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, the Company has agreed to remit to Paltac 50% of any such
payment up to a maximum of 150 million Yen or approximately $1.4 million. As of
September 30, 2004, SPAR FM has borrowed 100 million Yen under its Revolving
Credit Agreement. Therefore, the Company's current exposure to Paltac respecting
outstanding loans to SPAR FM at September 30, 2004, would be 50 million Yen or
approximately $0.5 million.
The Company has recorded approximately $0.2 million in long-term
liabilities for its share of the cumulative losses associated with this joint
venture.
28
SPAR Group, Inc.
Item 3. 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.
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 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 does not believe the risk related to foreign
currency exchange rates is material.
The Company has no derivative financial instruments or derivative
commodity instruments in its cash and cash equivalents and investments. Excess
cash is normally used to pay down its revolving line of credit.
Item 4. 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. There were no material changes in the Company's internal control over
financial reporting during the third quarter of 2004.
29
SPAR Group, Inc.
PART II: OTHER INFORMATION
Item1. Legal Proceedings
No change.
Item 2: Changes in Securities and Use of Proceeds
Item 2(a): Not applicable
Item 2(b): Not applicable
Item 2(c): Not applicable
Item 3: Defaults upon Senior Securities
Item 3(a): Defaults under Indebtedness: None.
Item 3(b): Defaults under Preferred Stock: Not applicable.
Item 4: Submission of Matters to a Vote of Security Holders
The Company held its Annual Meeting of Stockholders on August 12, 2004.
The meeting was held (1) to elect the Board of Directors and (2) to
ratify the appointment of Ernst & Young LLP as the Company's
independent auditors for the year ending December 31, 2004.
The number of votes cast for each proposal are set both below:
Name: For: Abstention:
----------------------------------- ---------------------------------- ---------------------------------
Robert G. Brown 17,236,722 19,182
----------------------------------- ---------------------------------- ---------------------------------
William H. Bartels 17,228,422 27,482
----------------------------------- ---------------------------------- ---------------------------------
Robert O. Aders 17,235,752 20,152
----------------------------------- ---------------------------------- ---------------------------------
Jerry B. Gilbert 17,237,452 18,452
----------------------------------- ---------------------------------- ---------------------------------
Jack W. Partridge 17,238,422 17,482
----------------------------------- ---------------------------------- ---------------------------------
Lorrence T. Kellar 17,237,452 18,452
----------------------------------- ---------------------------------- ---------------------------------
Each of the nominees was elected to the Board of Directors.
Proposal Number 2 - Ratification of the appointment of Ernst & Young
LLP as the Company's independent auditors for the year ending December
31, 2004:
For: Against: Abstention:
------------------------------------ --------------------------------- ---------------------------------
17,252,770 1,387 1,747
------------------------------------ --------------------------------- ---------------------------------
30
SPAR Group, Inc.
Item 5: Other Information
Not applicable.
Item 6: Exhibits
Exhibits.
10.1 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, as filed herewith.
10.2 Change in Control Severance Agreement between Kori Belzer and
SPAR Group, Inc., dated as of August 12, 2004, as filed
herewith.
10.3 Change in Control Severance Agreement between Patricia Franco
and SPAR Group, Inc., dated as of August 12, 2004, as filed
herewith.
31.1 Certification of the CEO pursuant to 18 U.S.C. Section 1350
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002, as filed herewith.
31.2 Certification of the CFO pursuant to 18 U.S.C. Section 1350
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002, as filed herewith.
32.1 Certification of the CEO pursuant to 18 U.S.C. Section 1350
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, as filed herewith.
32.2 Certification of the CFO pursuant to 18 U.S.C. Section 1350
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, as filed herewith.
31
SPAR Group, Inc.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 15, 2004 SPAR Group, Inc., Registrant
By: /s/ Charles Cimitile
---------------------------------------------
Charles Cimitile
Chief Financial Officer, Treasurer, Secretary
and duly authorized signatory
32