- --------------------------------------------------------------------------------
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 second quarterly period ended JUNE 30, 2005
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, Suite 600, 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 June 30, 2005, there were 18,881,397 shares of Common Stock outstanding.
- --------------------------------------------------------------------------------
SPAR GROUP, INC.
Index
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements
Consolidated Balance Sheets
as of June 30, 2005, and December 31, 2004...................................... 3
Consolidated Statements of Operations for the three
months and six months ended June 30, 2005, and 2004..............................4
Consolidated Statements of Cash Flows for the
six months ended June 30, 2005, and 2004........................................ 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......................30
Item 4: Controls and Procedures.........................................................31
Item 5: Other Information...............................................................31
PART II: OTHER INFORMATION
Item 1: Legal Proceedings...............................................................32
Item 2: Changes in Securities and Use of Proceeds.......................................32
Item 3: Defaults upon Senior Securities.................................................32
Item 4: Submission of Matters to a Vote of Security Holders.............................32
Item 5: Other Information...............................................................32
Item 6: Exhibits ......................................................................32
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)
JUNE 30, DECEMBER 31,
2005 2004
-------- --------
(Unaudited) (Note)
ASSETS
Current assets:
Cash and cash equivalents $ 1,158 $ 887
Accounts receivable, net 10,526 11,307
Prepaid expenses and other current assets 423 657
-------- --------
Total current assets 12,107 12,851
Property and equipment, net 1,242 1,536
Goodwill 798 798
Other assets 198 636
-------- --------
Total assets $ 14,345 $ 15,821
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,533 $ 2,158
Accrued expenses and other current liabilities 3,039 2,391
Accrued expenses due to affiliates 714 987
Restructuring charges 99 250
Customer deposits 1,316 1,147
Lines of credit 2,449 4,956
-------- --------
Total current liabilities 9,150 11,889
Other long-term liabilities 56 12
Minority interest 117 206
-------- --------
Total liabilities 9,323 12,107
Commitments and contingencies (Note - 11)
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 -
18,881,397 - June 30, 2005
18,858,972 - December 31, 2004 189 189
Treasury stock (3) (108)
Accumulated other comprehensive loss (175) (86)
Additional paid-in capital 11,018 11,011
Accumulated deficit (6,007) (7,292)
-------- --------
Total stockholders' equity 5,022 3,714
-------- --------
Total liabilities and stockholders' equity $ 14,345 $ 15,821
======== ========
Note: The Balance Sheet at December 31, 2004, is an excerpt 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 SIX MONTHS ENDED
JUNE 30, JUNE 30 JUNE 30, JUNE 30,
2005 2004 2005 2004
-------- -------- -------- --------
Net revenues $ 12,800 $ 11,933 $ 27,321 $ 24,736
Cost of revenues 8,169 8,816 16,820 17,511
-------- -------- -------- --------
Gross profit 4,631 3,117 10,501 7,225
Selling, general and administrative expenses 4,242 5,477 8,498 10,445
Impairment charges - 8,141 - 8,141
Depreciation and amortization 272 369 551 730
-------- -------- -------- --------
Operating income (loss) 117 (10,870) 1,452 (12,091)
Interest expense 33 64 73 98
Other (income) expense (13) 7 (13) 8
-------- -------- -------- --------
Income (loss) before provision for income
taxes and minority interest 97 (10,941) 1,392 (12,197)
Provision for income taxes 15 1,236 30 771
-------- -------- -------- --------
Income (loss) before minority interest 82 (12,177) 1,362 (12,968)
Minority interest (34) - 77 -
-------- -------- -------- --------
Net income (loss) $ 116 $(12,177) $ 1,285 $(12,968)
======== ======== ======== ========
Basic/diluted net income (loss) per common share:
Net income (loss)- basic/diluted $ 0.01 $ (0.65) $ 0.07 $ (0.69)
======== ======== ======== ========
Weighted average common shares - basic 18,870 18,859 18,865 18,859
======== ======== ======== ========
Weighted average common shares - diluted 19,550 18,859 19,202 18,859
======== ======== ======== ========
See accompanying notes.
4
SPAR GROUP, INC.
Consolidated Statements of Cash Flows
(unaudited) (in thousands)
SIX MONTHS ENDED
JUNE 30, JUNE 30,
2005 2004
------- ------
OPERATING ACTIVITIES
Net cash provided by operating activities 3,045 3,089
INVESTING ACTIVITIES
Purchases of property and equipment (257) (824)
Acquisition of businesses - (399)
------- ------
Net cash used in investing activities (257) (1,223)
FINANCING ACTIVITIES
Net payments on lines of credit (2,507) (2,228)
Other long-term liabilities (122) 243
Proceeds from employee stock purchase plan and exercised
options 112 119
------- ------
Net cash used in financing activities (2,517) (1,866)
Net change in cash and cash equivalents 271 -
Cash and cash equivalents at beginning of period 887 -
------- ------
Cash and cash equivalents at end of period $ 1,158 $ -
======= ======
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION
Interest paid $ 75 $ 103
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 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 2004 on Form 10-K for the year ended December 31,
2004, as filed with the Securities and Exchange Commission on April 12, 2005
(the "Company's Annual Report for 2004 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. BUSINESS AND ORGANIZATION
The Company is a supplier of merchandising and other marketing services
throughout the United States and internationally. The Company also provides
in-store event staffing, product sampling, database marketing, technology
services, teleservices and marketing research.
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, in-store event staffing, product sampling, database marketing,
technology services, teleservices and marketing research to manufacturers and
retailers in the United States. The various services are primarily performed in
mass merchandisers, drug store and electronics chains, convenience and grocery
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, Romania and through a 50% owned joint venture in Japan. In
February 2005, the Company announced the establishment of a 50% owned joint
venture in China. The Company's Chinese joint venture is expected to be
operational before the end of 2005.
3. PRINCIPLES OF CONSOLIDATION
The Company consolidates its 100% owned subsidiaries. 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 venture, and
accordingly, consolidates those entities into the Company's financial
statements. All significant intercompany accounts and transactions have been
eliminated.
6
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
4. RESTRUCTURING 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 consisted 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 ended September 30, 2004, approximately
$230,000 for severance benefits and approximately $250,000 for office leases
that the Company ceased using. At June 30, 2005, the Company had approximately
$99,000 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.
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 SIX MONTHS ENDED
-------- -------- -------- --------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2005 2004 2005 2004
-------- -------- -------- --------
Numerator:
Net income (loss) $ 116 $(12,177) $ 1,285 $(12,968)
Denominator:
Shares used in basic earnings
(loss) per share calculation 18,870 18,859 18,865 18,859
Effect of diluted securities:
Employee stock options 680 - 337 -
-------- -------- -------- --------
Shares used in diluted earnings
(loss) per share calculation 19,550 18,859 19,202 18,859
======== ======== ======== ========
Basic and diluted earnings (loss)
per common share:
Net income (loss) - basic and
diluted $ 0.01 $ (0.65) $ 0.07 $ (0.69)
======== ======== ======== ========
The computation of dilutive loss per share excluded anti-dilutive stock
options to purchase approximately 370,000 and 795,000 shares for the three
months and six months ended June 30, 2004, respectively.
7
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
6. LINES OF CREDIT
In January 2003, the Company and Webster Business Credit Corporation
("Webster"), then known as Whitehall Business Credit Corporation, entered into
the Third Amended and Restated Revolving Credit and Security Agreement (as
amended, collectively, the "Credit Facility"). The Credit Facility provides a
$7.0 million revolving credit facility that matures on January 23, 2006. The
Company may borrow up to $7.0 million based upon a borrowing base formula as
defined in the agreement (principally 85% of "eligible" accounts receivable).
The Credit Facility bears interest at a rate based in part upon the earnings
before interest, taxes, depreciation and amortization and depending upon the
type of borrowing, is calculated based upon Webster's "Alternative Base Rate" or
the London Inter Bank Offering Rate ("LIBOR"). At June 30, 2005, there were no
LIBOR based loans and the interest rate calculated at Webster's Alternative Base
Rate plus 0.75% totaled 6.75% per annum. The average interest rate for the six
months ended June 30, 2005, was 6.4% per annum. The Credit Facility is secured
by all of the assets of the Company and its domestic subsidiaries. In addition,
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, provide
personal guarantees totaling $1.0 million to Webster. The Credit Facility
requires the Company satisfy certain financial covenants, including a minimum
"Net Worth", a minimum "Fixed Charge Coverage Ratio", and a minimum "EBITDA", as
such terms are defined in the Credit Facility. The Credit Facility also limits
certain expenditures by the Company, including capital expenditures and other
investments.
The Company was in violation of certain covenants at June 30, 2005, and
Webster has issued a waiver for those violations. The Company is currently
negotiating with Webster to amend the existing covenants. If amended, the
Company expects that it will comply with the amended covenants in future
periods. However, there can be no assurances that the Company will be able to
comply with the amended covenants and that if the Company violates the amended
covenants, Webster will continue to issue such waivers in the future.
The revolving loan balances outstanding under the Credit Facility were
$1.5 million and $4.1 million at June 30, 2005, and December 31, 2004,
respectively. There were letters of credit outstanding under the Credit Facility
of approximately $700,000 at June 30, 2005, and December 31, 2004. As of June
30, 2005, the SPAR Group had unused availability under the Credit Facility of
$3.5 million out of the remaining maximum $4.8 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 June 30, 2005). At June 30, 2005,
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 guarantied by the
joint venture partner, Paltac Corporation ("Paltac"). The Company has agreed to
reimburse Paltac for 50% of any payment made by Paltac as a result of this
Guaranty. The average interest rate on the borrowings under the Japanese line of
credit for the six months ended June 30, 2005, was 1.375% per annum.
8
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,
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 and SMSI provided approximately 99% of the Company's field
representatives (through its independent contractor field force) and
approximately 89% of the Company's field management at a total cost to the
Company of approximately $11.0 million and $14.4 million for the six months
ended June 30, 2005, and 2004, 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 5,200 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 40 full-time national, regional and district managers to the
Company. For those services, the Company has agreed to reimburse SMS and SMSI
for all of their costs of providing those services and 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 $234,000
for the six months ended June 30, 2004. Total net premiums (4% of SMS and SMSI
costs less 2004 concessions) paid to SMS and SMSI for services rendered were
approximately $420,000 and $550,000 for the six months ended June 30, 2005, and
2004, 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 owned by Messrs. Brown and Bartels,
they benefit from any income of such companies allocated to them.
SIT provided substantially all of the Internet computer programming
services to the Company at a total cost of approximately $424,000 and $715,000
for the six months ended June 30, 2005, and 2004, respectively. SIT provided
approximately 14,000 and 20,000 hours of Internet computer programming services
to the Company for the six months ended June 30, 2005, and 2004, respectively.
Pursuant to the Amended and Restated Programming and Support Agreement dated as
of January 1, 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 the related out-of-pocket
expenses of SIT and its personnel. The average hourly billing rate was $30.62
and $35.39 for the six months ended June 30, 2005, and 2004, 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 the six months ended
June 30, 2005, and 2004, respectively. However, since SIT is a "Subchapter S"
corporation owned by Messrs. Brown and Bartels, they benefit from any income of
such company allocated to them.
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.
9
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
("SMF") and SPAR Canada Company ("SPAR Canada"). Each lease has a 36 month term
and representations, covenants and defaults customary for the leasing industry.
The SMF lease is for handheld computers to be used by field merchandisers in the
performance of various merchandising services in the United States and had a
monthly payment of $20,318. These handheld computers had an original purchase
price of $632,200. The SPAR Canada lease is also for handheld computers to be
used by field merchandisers in the performance of various merchandising services
in Canada and had a monthly payment of $3,326. These handheld computers had an
original purchase price of $105,000. In May 2005, the Company and SMS amended
the lease agreements reducing the total monthly payment from $20,318 to $17,891
for SMF and from $3,326 to $2,972 for SPAR Canada. The amended monthly payments
are based upon a lease factor of 2.83%.
In March 2005, SMF entered into an additional 36 month lease with SMS for
handheld computers. The lease factor is 2.83% and the monthly payment is $2,341.
These handheld computers had an original purchase price of $82,727.
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):
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------- --------------------
2005 2004 2005 2004
------- -------- ------- -------
Services provided by affiliates:
Independent contractor services
(SMS) $ 4,369 $ 5,397 $ 9,154 $11,758
======= ======== ======= =======
Field management services (SMSI) $ 912 $ 1,250 $ 1,879 $ 2,634
======= ======== ======= =======
Handheld computer leases (SMS) $ 70 $ - $ 127 $ -
======= ======== ======= =======
Internet and software program
consulting services (SIT) $ 214 $ 334 $ 424 $ 715
======= ======== ======= =======
Accrued expenses due to affiliates (in thousands): JUNE 30, DECEMBER 31,
2005 2004
---- ----
SPAR Marketing Services, Inc. $714 $987
==== ====
10
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
In addition to the above, through the services of Affinity Insurance,
Ltd. ("Affinity"), the Company purchases insurance coverage for its casualty and
property insurance risk. The Company's CEO and Vice Chairman own, through SMSI,
a minority (less than 5%) equity interest in Affinity.
8. 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 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. If compensation cost had been recognized, the Company's net income (loss)
and pro forma net income (loss) per share from continuing operations would have
been reduced to the adjusted amounts indicated below (in thousands, except per
share data):
SIX MONTHS ENDED JUNE 30,
----------------------
2005 2004
-------- --------
Net income (loss), as reported $ 1,285 $(12,968)
Stock based employee compensation expense
under the fair market value method 211 342
-------- --------
Pro forma net income (loss) $ 1,074 $(13,310)
Basic and diluted net income (loss) per share, as
reported $ 0.07 $ (0.69)
Basic and diluted net income (loss) per share,
pro forma $ 0.06 $ (0.71)
The pro forma effect on net income (loss) is not representative of the
pro forma effect on net income (loss) in future years because the options vest
over several years and additional awards may be made in the future.
Under the provision of SFAS No. 123 dealing with non-employee stock
option grants awarded to the employees of the Company's affiliates, for the six
months ended June 30, 2005, the Company recorded an expense of approximately
$72,000. For the six months ended June 30, 2004, as a result of the decrease in
the market price of the Company's stock from December 31, 2003 to June 30, 2004,
there was a recovery of amounts previously expensed of approximately $60,000
under the provision of SFAS
11
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
No. 123. 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.
9. TREASURY STOCK
The Company initiated a share repurchase program in 2002, which allowed
for the 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 from
January 1, 2005, to June 30, 2005.
Quantity Amount
------- --------
Treasury Stock, January 1, 2005 21,908 $ 108,100
Used to fulfill options exercised (21,654) (104,617)
------- --------
TREASURY STOCK, JUNE 30, 2005 254 $ 3,483
======= =========
10. CUSTOMER DEPOSITS
Customer deposits at June 30, 2005, were $1.3 million. Approximately
$870,000 is associated with a non-refundable deposit received by the Company in
June 2004 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. At June 30, 2005, the outstanding balance for this customer was
approximately $870,000.
11. COMMITMENTS AND CONTINGENCIES
INTERNATIONAL COMMITMENTS
The Company's international model is to partner with local merchandising
companies and combine the Company's proprietary software and expertise in the
merchandising business with their partner's knowledge of the local market. In
2001, the Company established its first joint venture and has continued this
strategy. As of this filing, the Company is currently operating in Japan,
Canada, Turkey, South Africa, India and Romania. The Company also announced the
establishment of a joint venture in China. The Company's Chinese joint venture
is expected to be operational before the end of 2005.
12
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
Certain of these joint ventures and joint venture subsidiaries are
becoming profitable, while others are either marginally profitable or 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.
LEGAL MATTERS
Safeway Inc. ("Safeway"), filed a Complaint against the PIA Merchandising
Co., Inc. ("PIA Co."), a wholly owned subsidiary of SGRP, and Pivotal Sales
Company ("Pivotal"), a wholly owned subsidiary of PIA Co., and SGRP in Alameda
Superior Court, case no. 2001028498 on October 24, 2001, and has subsequently
amended it. Safeway alleges causes of action for breach of contract and breach
of implied contract. Safeway has most recently alleged monetary damages in the
principal sum of $3,000,000 and alleged interest of $1,500,000 and has also
demanded unspecified costs. PIA Co. and Pivotal 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
and SGRP are vigorously defending against Safeway's allegations. It is not
possible at this time to determine the likelihood of the outcome of this
lawsuit. However, if Safeway prevails respecting its allegations, and PIA Co.
and Pivotal lose on their cross-claims and counterclaims, 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 Company'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.
12. GEOGRAPHIC DATA
A summary of the Company's net revenue, operating income (loss) and long
lived assets by geographic area for the three months and six months ended June
30, 2005, and 2004, respectively, and at June 30, 2005, and December 31, 2004,
are as follows (in thousands):
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
----------------------- -----------------------
2005 2004 2005 2004
-------- -------- -------- --------
Net revenue:
United States $ 9,180 $10,568 $19,979 $23,232
International 3,620 1,365 7,342 1,504
-------- -------- -------- --------
Total net revenue $12,800 $11,933 $27,321 $24,736
======== ======== ======== ========
13
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
----------------------- -----------------------
2005 2004 2005 2004
-------- -------- -------- --------
Operating income (loss):
United States $ - $ (9,670) $ 895 $(10,562)
International 117 (1,200) 557 (1,529)
-------- -------- -------- --------
Total operating income (loss) $ 117 $(10,870) $ 1,452 $(12,091)
======== ======== ======== ========
JUNE 30, DECEMBER 31,
------ ------
Long lived assets: 2005 2004
------ ------
United States $1,942 $2,484
International 296 486
------ ------
Total long lived assets $2,238 $2,970
====== ======
International revenues disclosed above are the revenues reported by the
Company's 100% owned foreign subsidiary, its 51% owned foreign joint venture
subsidiaries and its 50% owned foreign joint venture. For the six months ended
June 30, 2005, the wholly owned Canadian subsidiary contributed 8% of the
consolidated net revenue of the Company. The joint venture in Japan and joint
venture subsidiary in South Africa contributed 11% and 8%, respectively to the
consolidated net revenue of the Company. Each of the remaining foreign joint
venture subsidiaries contributed less than 5% to the consolidated net revenue
for the six month period ending June 30, 2005.
13. SUPPLEMENTAL BALANCE SHEET INFORMATION
Accounts receivable, net, consists of the following (in thousands):
JUNE 30, DECEMBER 31,
-------- --------
2005 2004
-------- --------
Trade $ 7,716 $ 8,178
Unbilled 3,259 3,600
Non-trade 227 290
-------- --------
11,202 12,068
Less:
Allowance for doubtful accounts (676) (761)
-------- --------
$ 10,526 $ 11,307
======== ========
14
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
Prepaid expenses and other current assets consist JUNE 30, DECEMBER 31,
of the following (in thousands): ---- ----
2005 2004
---- ----
Prepaid insurance $122 $214
Tax refund due 62 62
Prepaid rents 49 49
Other 190 332
---- ----
$423 $657
==== ====
Property and equipment consists of the following (in thousands):
JUNE 30, DECEMBER 31,
------ ------
2005 2004
------ ------
Equipment $5,469 $5,397
Furniture and fixtures 545 547
Leasehold improvements 138 138
Capitalized software development costs 1,818 1,629
------ ------
7,970 7,711
Less accumulated depreciation and amortization 6,728 6,175
------ ------
$1,242 $1,536
====== ======
Accrued expenses and other current liabilities
consist of the following (in thousands):
JUNE 30, DECEMBER 31,
2005 2004
------ ------
Merger Related Payables $ 450 $ 450
Accrued medical expenses 225 225
Taxes Payable 391 345
Accrued accounting and legal expense 512 192
Accrued salaries payable 462 328
Other 999 851
------ ------
$3,039 $2,391
====== ======
14. ISSUANCE OF OPTIONS
On April 12, 2005 and May 12, 2005, the Company issued non-qualified
stock options to various employees of the Company and its affiliates to acquire
500,030 and 100,750 shares of stock of SGRP at $1.26 and $1.75 per share,
respectively, with the normal four year vesting provisions.
15. FOREIGN CURRENCY RATE FLUCTUATIONS
The Company has foreign currency exposure associated with its
international 100% owned subsidiary, its 51% owned joint venture subsidiaries
and its 50% owned joint venture. In the six months ended June 30, 2005, these
exposures were primarily concentrated in the Canadian dollar, South African
15
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
rand and Japanese yen. At June 30, 2005, international assets totaled
approximately $4.0 million and international liabilities totaled approximately
$6.4 million. For six months ended June 30, 2005, international revenues totaled
$7.3 million and the Company's share of the net income was approximately
$456,000.
16. INTEREST RATE FLUCTUATIONS
The Company is exposed to market risk related to the variable interest
rates on its lines of credit. At June 30, 2005, the Company's outstanding debt
totaled approximately $2.4 million, which consisted of domestic variable-rate
(6.8%) debt of $1.5 million and international variable rate (1.4%) debt of
$900,000. Based on the six months ending June 30, 2005, average outstanding
borrowings under variable-rate debt, a one-percentage point increase in interest
rates would negatively impact pre-tax earnings and cash flows for the six months
ended June 30, 2005, by approximately $30,000.
17. RECLASSIFICATION
Certain amounts in the 2004 financial statements have been reclassified
to conform to the 2005 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 SIX
MONTHS ENDED JUNE 30, 2005 (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, 2004, AS FILED WITH THE SECURITIES
AND EXCHANGE COMMISSION ON APRIL 12, 2005 (THE "COMPANY'S ANNUAL REPORT FOR 2004
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 2004 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
In the United States, the Company provides merchandising services to
manufacturers and retailers principally in mass merchandiser, drug, electronics,
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, India and Romania and a 50% owned joint
venture in Japan. In February 2005, the Company established a 50% owned joint
venture in China. For the six months ended
17
SPAR GROUP, INC.
June 30, 2005, the Company consolidated Canada, Turkey, South Africa, India,
Romania and Japan into the Company's financial statements. China did not have
operations for the six months ended June 30, 2005.
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
and electronics chains and grocery stores. Included in its customers are home
entertainment, general merchandise, electronics, 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. The Company also provides in-store event staffing services,
database marketing, technology services, teleservices and marketing research
services.
INTERNATIONAL MERCHANDISING SERVICES 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. The Company has expanded its international business as
follows:
Percent Ownership in
Subsidiary or Joint
Date Venture Location
- ----------------------- ----------------------- ---------------------------
May 2001 50% Osaka, Japan
June 2003 100% Toronto, Canada
July 2003 51% Istanbul, Turkey
April 2004 51% Durban, South Africa
April 2004 51% New Delhi, India
December 2004 51% Bucharest, Romania
February 2005 50% Hong Kong, China
The China joint venture is expected to be operational before the end of 2005.
18
SPAR GROUP, INC.
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 appropriate in the
circumstances. Four critical accounting policies are consolidation of
subsidiaries, revenue recognition, allowance for doubtful accounts and sales
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. 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 venture, and accordingly consolidates these entities into the
Company's financial statements. In addition, 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.
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 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 ALLOWANCES
The Company continually monitors the validity of its accounts receivable
based upon current customer credit information and 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
19
SPAR GROUP, INC.
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 $676,000 and $761,000
at June 30, 2005, and December 31, 2004, respectively.
INTERNAL USE SOFTWARE DEVELOPMENT COSTS
In 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 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 $188,667 and $362,808 of costs related to
software developed for internal use in the six months ended June 30,
2005, and 2004, respectively and amortized capitalized software of
$277,481 and $365,323 in the six months ended June 30, 2005, and 2004,
respectively.
20
SPAR GROUP, INC.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2005, COMPARED TO THREE MONTHS ENDED JUNE 30, 2004
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
---------------------------------------------------------------------------------
June 30, 2005 June 30, 2004
------------- -------------
Increase
Dollars % Dollars % (decrease) %
------- - ------- - ------------
Net revenues $ 12,800 100.0% $ 11,933 100.0% 7.3%
Cost of revenues 8,169 63.8 8,816 73.9 (7.3)
Selling, general and administrative expense 4,242 33.1 5,477 45.9 (22.6)
Impairment charges - - 8,141 68.2 -
Depreciation and amortization 272 2.1 369 3.1 (26.4)
Interest expense 33 0.3 64 0.5 (48.3)
Other (income) expense (13) (0.1) 7 0.1 (286.7)
---------------- --------------- ----------------- ----------------
Income (loss) before provision for income taxes
and minority interest 97 0.8 (10,941) (91.7) -
Provision for income tax 15 0.1 1,236 10.4 -
---------------- --------------- ----------------- ----------------
Net income (loss) before minority interest 82 0.7 (12,177) (102.1) -
Minority interest (34) (0.3) - - -
---------------- --------------- ----------------- ----------------
Net income (loss) $ 116 1.0% $ (12,177) (102.1)% -
================ =============== ================= ================
NET REVENUES
Net revenues for the three months ended June 30, 2005, were $12.8
million, compared to $11.9 million for the three months ended June 30, 2004, an
increase of 7%. For the second quarter domestic revenue decreased $1.4 million
or 13% to $9.2 million, compared to $10.6 million a year ago. The
21
SPAR GROUP, INC.
decrease in domestic revenue is a result of the loss of several significant
customers partially offset by revenue from new customers. Internationally,
revenue for the second quarter increased to $3.6 million from $1.4 million last
year, primarily as a result of the Japan consolidation and increased revenue
from the Company's Canadian operations.
One customer accounted for 21% and 10% of the Company's net revenue for
the three months ended June 30, 2005, and 2004, respectively. This customer also
accounted for approximately 26% and 8% of accounts receivable at June 30, 2005,
and December 31, 2004, respectively.
Approximately 8% and 12% of the Company's net revenues for the three
months ended June 30, 2005, and 2004, respectively, resulted from merchandising
services performed for customers at Kmart. These customers also accounted for
approximately 5% and 22% of accounts receivable at June 30, 2005, and December
31, 2004, respectively. While the contractual relationships or agreements are
with various customers and not Kmart, a significant reduction of this retailer's
stores or cessation of this retailer's business would negatively impact the
Company.
In addition, approximately 9% of the Company's net revenue for the three
months ended June 30, 2005 resulted from merchandising services performed for
customers at Circuit City. These customers also accounted for approximately 7%
and 16% of accounts receivable at June 30, 2005, and December 31, 2004,
respectively. While the contractual relationships or agreements are with various
customers and not Circuit City, a significant reduction of this retailer's
stores or cessation of this retailer's business would negatively impact the
Company.
A second customer accounted for 4% and 28% of the Company's net revenues
for the three months ended June 30, 2005, and 2004, respectively. This customer
also accounted for approximately 8% and 7% of accounts receivable at June 30,
2005, and December 31, 2004, respectively. In 2004, this customer was a division
of a major retailer and was sold by its parent on August 2, 2004. In 2005, the
Company saw a significant decline in net revenue from this customer and expects
the decline to continue in 2005.
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
Cost of revenues 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 64% for the three months ended June
30, 2005, compared to 74% for the three months ended June 30, 2004. For the
second quarter domestic cost of revenues as a percentage of net revenues was 65%
and 73% for the three months ended June 30, 2005 and 2004 respectively. The
decrease is primarily a result of the Company restructuring its domestic field
force to reflect its reduction of business. Internationally, cost of revenues as
a percentage of net revenues was 60% and 80% for the three months ended June 30,
2005 and 2004 respectively. The international cost of revenue percentage was
favorably impacted by the increase in international revenue which enabled the
Company to leverage its infrastructure.
22
SPAR GROUP, INC.
Approximately 88% and 86% of the Company's domestic cost of revenue in
the three months ended June 30, 2005, and 2004, 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 - Related-Party Transactions).
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses include corporate overhead,
project management, information technology, executive compensation, human
resource, legal and accounting expenses.
Selling, general and administrative expenses decreased by $1.2 million,
or 23%, for the three months ended June 30, 2005, to $4.3 million compared to
$5.5 million for the three months ended June 30, 2004. Domestic selling, general
and administrative expenses decreased by $1.8 million to $3.0 million for 2005
from $4.8 million in 2004. The reduction of 38% was primarily due to cost
reduction programs initiated in 2004 as a result of the loss of certain large
customers. Internationally, selling, general and administrative expenses
increased by approximately $560,000 to $1.3 million for 2005 from approximately
$700,000 in 2004. The increase of 77% was primarily due to the consolidation of
the Japan joint venture.
IMPAIRMENT CHARGES
Impairment charges were $8.1 million for the three months ended June 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 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.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization charges of $0.3 million for the three
months ended June 30, 2005, was consistent with $0.4 million in the same period
for 2004.
INCOME TAXES
The Company recorded an income tax provision of $15,000 for the three
months ended June 30, 2005. The provision was primarily for minimum state taxes.
There was no provision for federal tax for the three months ended June 30, 2005,
since the Company expects to utilize net operating loss carryforwards previously
reserved to offset any federal taxes due.
The Company recorded an income tax provision of $1.2 million for the
three months ended June 30, 2004. The provision was primarily a result of the
establishment of a valuation reserve for the deferred tax assets previously
recorded by the Company totaling $0.7 million, a reversal of the $0.5 million
tax benefit previously recorded in the quarter ending March 31, 2004 and
estimated minimum state taxes due.
23
SPAR GROUP, INC.
MINORITY INTEREST
Minority interest of approximately $34,000 resulted from the operations
of the 51% owned joint venture subsidiaries and the 50% owned Japanese joint
venture for the three months ended June 30, 2005.
NET INCOME
The Company had a net income of $116,000 for the three months ended June
30, 2005, or $0.01 per diluted share, compared to a net loss of $12.2 million,
or $0.65 per diluted share, for the corresponding period last year.
24
SPAR GROUP, INC.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2005, COMPARED TO SIX MONTHS ENDED JUNE 30, 2004
- --------------------------------------------------------------------------
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).
Six Months Ended
---------------------------------------------------------------------------------
June 30, 2005 June 30, 2004
------------- -------------
Increase
Dollars % Dollars % (decrease) %
------- - ------- - ------------
Net revenues $ 27,321 100.0% $ 24,736 100.0% 10.5%
Cost of revenues 16,820 61.6 17,511 70.8 (4.0)
Selling, general and administrative expense 8,498 31.1 10,445 42.2 (18.6)
Impairment charges - - 8,141 32.9 -
Depreciation and amortization 551 2.0 730 3.0 (24.6)
Interest expense 73 0.3 98 0.4 (25.6)
Other (income) expense (13) (0.0) 8 0.0 (260.8)
-------- ------- -------- ------- -------
Income (loss) before provision for income taxes
and minority interest 1,392 5.0 (12,197) (49.3) -
Provision for income tax 30 0.1 771 3.1 -
-------- ------- -------- -------
Net income (loss) before minority interest 1,362 4.9 (12,968) (52.4) -
Minority interest 77 0.3 - - -
-------- ------- -------- -------
Net income (loss) $ 1,285 4.6% $(12,968) (52.4)% -
======== ======= ======== =======
NET REVENUES
Net revenues for the six months ended June 30, 2005, were $27.3 million,
compared to $24.7 million for the six months ended June 30, 2004, an increase of
$2.6 million or 11%. For the six month period, domestic revenue decreased $3.3
million or 14% to $19.9 million, compared to $23.2 million in
25
SPAR GROUP, INC.
the prior year. The decrease in domestic revenue is a result of the loss of
several significant customers partially offset by revenue from new customers.
Internationally, revenue for the six months increased to $7.3 million from $1.5
million last year, primarily as a result of the Japan consolidation, the South
African acquisition and increased revenue from the Company's Canadian
operations.
One customer accounted for 19% and 8% of the Company's net revenue for
the six months ended June 30, 2005, and 2004, respectively. This customer also
accounted for approximately 26% and 8% of accounts receivable at June 30, 2005,
and December 31, 2004, respectively.
A second customer accounted for 10% and 36% of the Company's net revenues
for the six months ended June 30, 2005, and 2004, respectively. This customer
also accounted for approximately 8% and 7% of accounts receivable at June 30,
2005, and December 31, 2004, respectively. In 2004, this customer was a division
of a major retailer and was sold by its parent on August 2, 2004. In 2005, the
Company performed a project that resulted in $2.8 million of revenue for this
customer. Even with this project revenue, the Company saw a significant decline
in net revenue from this customer and expects the decline to continue in 2005.
In addition, approximately 10% of the Company's net revenue for the six
months ended June 30, 2005, resulted from merchandising services performed for
customers at Circuit City. These customers also accounted for approximately 7%
and 16% of accounts receivable at June 30, 2005, and December 31, 2004,
respectively. While the contractual relationships or agreements are with various
customers and not Circuit City, a significant reduction of this retailer's
stores or cessation of this retailer's business would negatively impact the
Company.
Approximately 9% and 13% of the Company's net revenues for the six months
ended June 30, 2005, and 2004, respectively, resulted from merchandising
services performed for customers at Kmart. These customers also accounted for
approximately 5% and 22% of accounts receivable at June 30, 2005, and December
31, 2004, respectively. While the contractual relationships or agreements are
with various customers 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
Cost of revenues 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 62% for the six months ended June
30, 2005, compared to 71% for the six months ended June 30, 2004. For the six
months ended June 30, 2005 and 2004, domestic cost of revenues as a percentage
of net revenues was 62% and 70% respectively. The decrease is primarily a result
of the Company restructuring its domestic field force to reflect its reduction
of business. Internationally, cost of revenues as a percentage of net revenues
was 60% and 79% for the six months ended June 30, 2005 and 2004 respectively.
The
26
SPAR GROUP, INC.
international cost of revenue percentage was favorably impacted by the increase
in international revenue which enabled the Company to leverage its
infrastructure.
Approximately 89% and 88% of the Company's domestic cost of revenue in
the six months ended June 30, 2005, and 2004, 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 - Related-Party Transactions).
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses include corporate overhead,
project management, information technology, executive compensation, human
resource, legal and accounting expenses.
Selling, general and administrative expenses decreased by $1.9 million,
or 19%, for the six months ended June 30, 2005, to $8.5 million compared to
$10.4 million for the six months ended June 30, 2004. Domestic selling, general
and administrative expenses decreased by $3.1 million to $6.2 million for 2005
from $9.3 million in 2004. The reduction of 34% was primarily due to cost
reduction programs initiated in 2004 as a result of the loss of certain large
customers. Internationally, selling, general and administrative expenses
increased by approximately $1.2 million to $2.3 million for 2005 from $1.1
million in 2004. The increase of 112% was primarily due to the consolidation of
Japan and increased operations in South Africa and Canada.
IMPAIRMENT CHARGES
Impairment charges were $8.1 million for the six months ended June 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 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.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization charges of $0.6 million for the six months
ended June 30, 2005, was consistent with $0.7 million in the same period for
2004.
INCOME TAXES
The Company recorded an income tax provision of $30,000 for the six
months ended June 30, 2005. The provision was primarily for minimum state taxes.
There was no provision for federal tax for the six months ended June 30, 2005,
since the Company expects to utilize net operating loss carryforwards previously
reserved to offset any federal taxes due.
The Company recorded an income tax provision of $0.8 million for the six
months ended June 30, 2004. The provision was primarily a result of the
establishment of a valuation reserve for net deferred tax assets previously
recorded by the Company and estimated minimum state taxes due.
27
SPAR GROUP, INC.
MINORITY INTEREST
Minority interest expense of approximately $77,000 resulted from the
operations of the 51% owned joint venture subsidiaries and the 50% owned joint
venture for the six months ended June 30, 2005.
NET INCOME
The Company had a net income of $1.3 million for the six months ended
June 30, 2005, or $0.07 per diluted share, compared to a net loss of $13.0
million, or $0.69 per diluted share, for the corresponding period last year.
LIQUIDITY AND CAPITAL RESOURCES
In the six months ended June 30, 2005, the Company had a net income of
$1.3 million.
Net cash provided by operating activities for the six months ended June
30, 2005, and 2004, was $3.1 million.
Net cash used in investing activities for the six months ended June 30,
2005, was approximately $260,000 compared to net cash used in investing
activities of $1.2 million for the six months ended June 30, 2004. The decrease
in net cash used in investing activities was a result of no acquisitions and
lower purchases of property and equipment in 2005.
Net cash used in financing activities for the six months ended June 30,
2005, was $2.5 million, compared to net cash used in financing activities of
$1.9 million for the six months ended June 30, 2004. The increase of net cash
used in financing activities was primarily a result of higher net payments on
the lines of credit and other long term liabilities.
The above activity resulted in an increase in cash and cash equivalents
for the six months ended June 30, 2005, of approximately $271,000.
At June 30, 2005, the Company had positive working capital of $3.0
million, as compared to a positive working capital of $1.0 million at December
31, 2004. The increase in working capital is due primarily to reductions in
lines of credit, and accounts payable, as well as, an increase in cash,
partially offset by reduced accounts receivable and increases in accrued
expenses and other current liabilities. The Company's current ratio was 1.32 at
June 30, 2005, and 1.08 at December 31, 2004.
In January 2003, the Company and Webster Business Credit Corporation
("Webster"), then known as Whitehall Business Credit Corporation, entered into
the Third Amended and Restated Revolving Credit and Security Agreement (as
amended, collectively, the "Credit Facility"). The Credit Facility provides a
$7.0 million revolving credit facility that matures on January 23, 2006. The
Company may borrow up to $7.0 million based upon a borrowing base formula as
defined in the agreement (principally
28
SPAR GROUP, INC.
85% of "eligible" accounts receivable). The Credit Facility bears interest at a
rate based in part upon the earnings before interest, taxes, depreciation and
amortization and depending upon the type of borrowing, is calculated based upon
Webster's "Alternative Base Rate" or the London Inter Bank Offering Rate
("LIBOR"). At June 30, 2005, there were no LIBOR based loans and the interest
rate calculated at Webster's Alternative Base Rate plus 0.75% totaled 6.75% per
annum. The average interest rate for the six months ended June 30, 2005, was
6.4% per annum. The Credit Facility is secured by all of the assets of the
Company and its domestic subsidiaries. In addition, 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, provide personal guarantees
totaling $1.0 million to Webster. The Credit Facility requires the Company
satisfy certain financial covenants, including a minimum "Net Worth", a minimum
"Fixed Charge Coverage Ratio", and a minimum "EBITDA", as such terms are defined
in the Credit Facility. The Credit Facility also limits certain expenditures by
the Company, including capital expenditures and other investments.
The Company was in violation of certain covenants at June 30, 2005, and
Webster has issued a waiver for the June 30, 2005, covenant violations. The
Company is currently negotiating with Webster to amend the existing covenants.
If amended, the Company expects that it will be able to comply with the amended
covenants in future periods. However, there can be no assurances that the
Company will comply with the amended covenants and that if the Company violates
the amended covenants, Webster will continue to issue such waivers in the
future.
The revolving loan balances outstanding under the Credit Facility were
$1.5 million and $4.1 million at June 30, 2005, and December 31, 2004,
respectively. There were letters of credit outstanding under the Credit Facility
of approximately $700,000 at June 30, 2005, and December 31, 2004. As of June
30, 2005, the SPAR Group had unused availability under the Credit Facility of
$3.5 million out of the remaining maximum $4.8 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 June 30, 2005). At June 30, 2005,
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 guarantied by the
joint venture partner, Paltac Corporation ("Paltac"). The Company has agreed to
reimburse Paltac for 50% of any payment made by Paltac as a result of this
Guaranty. The average interest rate on the borrowings under the Japanese line of
credit for its short-term bank loans at June 30, 2005, was 1.375% per annum.
The Company's international model is to partner with local merchandising
companies and combine the Company's proprietary software and expertise in the
merchandising business with the partner's knowledge of the local market . In
2001, the Company established its first joint venture in Japan and has continued
this strategy. As of this filing, the Company is currently operating in Japan,
Canada, Turkey, South Africa, India and Romania. In February 2005, the Company
announced the establishment of a joint venture in China. The Company's Chinese
joint venture is expected to be operational before the end of 2005.
29
SPAR GROUP, INC.
Certain of these joint ventures and joint venture subsidiaries are or are
becoming profitable, while others are either marginally profitable or 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 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 remain
profitable, or the inability to obtain its lender's waivers for future covenant
violations could have a material adverse effect on the Company's cash resources
and its ongoing ability to fund operations.
CERTAIN CONTRACTUAL OBLIGATIONS
The following table contains a summary of certain of the Company's
contractual obligations by category as of June 30, 2005 (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 $2,449 $2,449 $ - $ - $ -
- ---------------------------------------------------------------------------------------------------------
Operating Lease Obligations 1,010 527 483 - -
- ---------------------------------------------------------------------------------------------------------
Total $3,459 $2,976 $ 483 $ - $ -
- ---------------------------------------------------------------------------------------------------------
The Company also had approximately $700,000 in outstanding Letters of
Credit at June 30, 2005.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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 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 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.
The Company is exposed to market risk related to the variable interest
rates on its lines of credit. At June 30, 2005, the Company's outstanding debt
totaled approximately $2.4 million, which consisted of domestic variable-rate
(6.8%) debt of $1.5 million and international variable rate (1.4%) debt of
$900,000. Based on the six months ending June 30, 2005, average outstanding
borrowings under
30
SPAR GROUP, INC.
variable-rate debt, a one-percentage point increase in interest rates would
negatively impact pre-tax earnings and cash flows for the six months ended June
30, 2005, by approximately $30,000.
The Company has foreign currency exposure associated with its
international 100% owned subsidiary, its 51% owned joint venture subsidiaries
and its 50% owned Japanese joint venture. In the six months ended June 30, 2005,
these exposures were primarily concentrated in the Canadian dollar, South
African rand and Japanese yen. At June 30, 2005, international assets totaled
approximately $4.0 million and international liabilities totaled approximately
$6.4 million. For six months ended June 30, 2005, international revenues totaled
$7.3 million and the Company's share of the net income was approximately
$456,000.
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 significant changes in the Company's internal controls or
in other factors that could significantly affect these controls during the six
months covered by this report or from the end of the reporting period to the
date of this Form 10-Q.
The Company has established a plan and has begun to document and test its
domestic internal controls over financial reporting required by Section 404 of
the Sarbanes-Oxley Act of 2002.
ITEM 5. OTHER INFORMATION.
None
31
SPAR GROUP, INC.
PART II: OTHER INFORMATION
ITEM 1. 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
Not applicable.
ITEM 5: OTHER INFORMATION
Not applicable.
ITEM 6: EXHIBITS
EXHIBITS.
10.1 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
August 10, 2005, with respect to the fiscal quarter ended June
30, 2005, 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.
32
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: August 15, 2005 SPAR Group, Inc., Registrant
By: /s/ Charles Cimitile
---------------------------------
Charles Cimitile
Chief Financial Officer,
Treasurer, Secretary
and duly authorized signatory
33